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+Item 7.—Management's Discussion and Analysis of Financial Condition and Results of Operations—SBU Performance Analysis of this Form 10-K for reconciliation and definitions of Adjusted PTC.10 | 2022 Annual ReportFor financial reporting purposes, the Company's corporate activities and certain other investments are reported within "Corporate and Other" because they do not require separate disclosure. See Item 7.—Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 18—Segment and Geographic Information included in
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diff --git a/ALBEMARLE CORP_10-K_2023-02-15_915913-0000915913-23-000039.html b/ALBEMARLE CORP_10-K_2023-02-15_915913-0000915913-23-000039.html
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations for further details.Climate Change and Natural ResourcesThe growing concerns about climate change and the related increasingly stringent regulations may provide us with new or expanded business opportunities. We provide solutions to companies pursuing alternative fuel products and technologies (such as renewable fuels), emission control technologies (including mercury emissions), alternative transportation vehicles and energy storage technologies and other similar solutions. As demand for, and legislation mandating or incentivizing the use of, alternative fuel technologies that limit or eliminate greenhouse gas emissions increase, we continue to monitor the market and offer solutions where we have appropriate technology and believe we are well positioned to take advantage of opportunities that may arise from such demand or legislation.In addition to potential business opportunities, we acknowledge our responsibility to address the impact of our operations on the environment. We are investing in technology and people to reduce energy consumption, greenhouse gas emissions and air emissions of ozone-depleting substances. In 2021, we established greenhouse gas emission targets for each of our businesses, including achieving net zero carbon emissions by 2050, reducing the carbon-intensity of our Bromine and Catalysts businesses by a combined 35% by 2030, and growing our Lithium business in a carbon-intensity neutral manner through 2030.Water is a critical input to Albemarle’s production operations. As water is a scarce resource, we understand the need to responsibly manage our water consumption not only for the preservation of the environment, but for the viability of our local communities. We are investing in new process technologies to reduce our water footprint and expand capacity sustainably in locations with high water risk. Our goal is to reduce our intensity of freshwater usage by 25% by 2030 in areas of high or extremely high-water risk as defined by the World Resources Institute, such as Chile and Jordan.Our businesses are dependent on the availability and responsible management of natural resources. We manage our natural resources to operate efficiently and preserve the environment for our local communities and the world. Our natural resource management includes mineral resource transparency with local communities, governments, regulators and other key stakeholders, as well as partnering with the Initiative for Responsible Mining Assurance for our lithium production for the assurance of responsible mining. We attempt to maximize the recovery of our extracted minerals and recycle or reuse by-products where possible. In addition, we work with local communities, regulatory agencies and wildlife organizations to preserve and restore land and biodiversity before, during and after all operations commence.8Albemarle Corporation and SubsidiariesRecent Acquisitions, Joint Ventures and DivestituresDuring recent years, we have devoted resources to acquisitions and joint ventures, including the subsequent integration of acquired businesses. These acquisitions and joint ventures have expanded our base business, provided our customers with a wider array of products and presented new alternatives for discovery through additional chemistries. In addition, we have pursued opportunities to divest businesses which do not fit our high priority business growth profile. The following is a summary of our significant acquisitions, joint ventures and divestitures over the last three years.On October 25, 2022 the Company completed the acquisition of all of the outstanding equity of Guangxi Tianyuan New Energy Materials Co., Ltd. (“Qinzhou”), for approximately $200 million in cash. Qinzhou's operations include a recently constructed lithium processing plant strategically positioned near the Port of Qinzhou in Guangxi, which began commercial production in the first half of 2022. The plant has designed annual conversion capacity of up to 25,000 metric tons of lithium carbonate equivalent (“LCE”) and produces battery-grade lithium carbonate and lithium hydroxide.On June 1, 2021, we completed the sale of our fine chemistry services (“FCS”) business to W. R. Grace & Co. (“Grace”) for proceeds of approximately $570 million, consisting of $300 million in cash and the issuance to Albemarle of preferred equity of a Grace subsidiary having an aggregate stated value of $270 million. As part of the transaction, Grace acquired our manufacturing facilities located in South Haven, Michigan and Tyrone, Pennsylvania.In the fourth quarter of 2020, we divested our ownership interest in the Saudi Organometallic Chemicals Company LLC (“SOCC”) joint venture for cash proceeds of $11.0 million. As a result of this divestiture, the Company recorded a gain of $7.2 million in Other income (expenses), net during the year ended December 31, 2020.These transactions reflect our commitment to investing in future growth of our high priority businesses, maintaining leverage flexibility and returning capital to our shareholders.Available InformationOur website address is www.albemarle.com. We make available free of charge through our website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), as well as beneficial ownership reports on Forms 3, 4 and 5 filed pursuant to Section 16 of the Exchange Act, as soon as reasonably practicable after such documents are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). The information on our website is not, and shall not be deemed to be, a part of this report or incorporated into any other filings we make with the SEC. The SEC also maintains a website at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including Albemarle.Our Corporate Governance Guidelines, Code of Conduct and the charters of the Audit and Finance, Health, Safety and Environment, Executive Compensation, and Nominating and Governance Committees of our Board of Directors are also available on our website and are available in print to any shareholder upon request by writing to Investor Relations, 4250 Congress Street, Suite 900, Charlotte, North Carolina 28209, or by calling (980) 299-5700.Item 1A.Risk Factors.You should consider carefully the following risks when reading the information, including the financial information, contained in this Annual Report on Form 10-K.Risks Related to Our BusinessOur substantial international operations subject us to risks of doing business in foreign countries, which could adversely affect our business, financial condition and results of operations.We conduct a substantial portion of our business outside the U.S., with approximately 88% of our sales to foreign countries. We operate and/or sell our products to customers in approximately 70 countries. We currently have many production, research and development and administrative facilities as well as sales offices located outside the U.S., as detailed in Item 2. Properties. Accordingly, our business is subject to risks related to the differing legal, political, social and regulatory requirements and economic conditions of many jurisdictions. Risks inherent in international operations include the following:•fluctuations in foreign currency exchange rates may affect product demand and may adversely affect the profitability in U.S. dollars of products and services we provide in international markets where payment for our products and services is made in the local currency;9Albemarle Corporation and Subsidiaries•transportation and other shipping costs may increase, or transportation may be inhibited;•increased cost or decreased availability of raw materials;•increased regulations on, or reduced access to, scarce resources, such as freshwater; •changes in foreign laws and tax rates or U.S. laws and tax rates with respect to foreign income may unexpectedly increase the rate at which our income is taxed, impose new and additional taxes on remittances, repatriation or other payments by subsidiaries, or cause the loss of previously recorded tax benefits;•foreign countries in which we do business may adopt other restrictions on foreign trade or investment, including currency exchange controls;•trade sanctions by or against foreign countries in which we do business could result in our losing access to customers and suppliers in those countries;•unexpected adverse changes in foreign laws or regulatory requirements may occur;•our agreements with counterparties in foreign countries may be difficult for us to enforce and related receivables may be difficult for us to collect;•compliance with the variety of foreign laws and regulations may be unduly burdensome;•compliance with anti-bribery and anti-corruption laws (such as the Foreign Corrupt Practices Act) as well as anti-money-laundering laws may be costly;•unexpected adverse changes in export duties, quotas and tariffs and difficulties in obtaining export licenses may occur;•general economic conditions in the countries in which we operate could have an adverse effect on our earnings from operations in those countries;•our foreign operations may experience staffing difficulties and labor disputes;•termination or substantial modification of international trade agreements may adversely affect our access to raw materials and to markets for our products outside the U.S.;•foreign governments may nationalize or expropriate private enterprises; •increased sovereign risk (such as default by or deterioration in the economies and credit worthiness of local governments) may occur; and•political or economic repercussions from terrorist activities, including the possibility of hyperinflationary conditions and political instability, may occur in certain countries in which we do business.In addition, certain of our operations and ongoing capital projects are in regions of the world such as Asia, the Middle East and South America that are of high risk due to significant civil, political and security instability. Unanticipated events, such as geopolitical changes, could result in a write-down of our investment in the affected joint venture or a delay or cause cancellation of those capital projects, which could negatively impact our future growth and profitability. Our success as a global business will depend, in part, upon our ability to succeed in differing legal, regulatory, economic, social and political conditions by developing, implementing and maintaining policies and strategies that are effective in each location where we and our joint ventures do business.Furthermore, we are subject to rules and regulations related to anti-bribery and antitrust prohibitions of the U.S. and other countries, as well as export controls and economic embargoes, violations of which may carry substantial penalties. For example, export control and economic embargo regulations limit the ability of our subsidiaries to market, sell, distribute or otherwise transfer their products or technology to prohibited countries or persons. Failure to comply with these regulations could subject our subsidiaries to fines, enforcement actions and/or have an adverse effect on our reputation and the value of our common stock.Because we conduct substantial operations in China, risks associated with regulatory activity and political and social events in China could negatively affect our business and operating results.In 2022, net sales shipped to China represented 33% of our total net sales. Additionally, we own three production facilities located in China and are in the process of constructing a lithium conversion plant in Meishan, China. In addition to the risks described above under “Our substantial international operations subject us to risks of doing business in foreign countries, which could adversely affect our business, financial condition and results of operations.”, our operations in China expose us to risks particular to conducting business in that country. For example, over the past several years the U.S. and China have applied tariffs to certain of each other’s exports, which have resulted in shifting trade flows and restrictions on certain sales of goods into China. Additionally, geopolitical disputes (including as a result of China-Taiwan and U.S.-Taiwan relations) between the U.S. and China may lead to further restrictions on trade and/or obstacles to conducting business in China. Recently, Australia 10Albemarle Corporation and Subsidiariesand China have attempted to improve relations and resolve trade disputes. As we ship a significant portion of our lithium from Australia into China for further processing, tensions or a breakdown in relations between the countries could have a material impact on our operations. Furthermore, the Chinese government has, from time to time, curtailed manufacturing operations, with little or no notice, in industrial regions out of growing concern over air quality and in response to COVID-19 outbreaks. The Chinese government has also instituted energy intensity and energy consumption targets in a number of provinces in its efforts to reduce energy consumption, resulting in energy quotas and shortages in energy supply that can be disruptive to construction and manufacturing operations. These and other risks may have an adverse effect on our sales to Chinese customers and/or result in our not realizing a return on, or losing some, or all, of our strategic investments in China.Our inability to secure key raw materials, or to pass through increases in costs and expenses for other raw materials and energy, on a timely basis or at all, including due to climate change, could have an adverse effect on the margins of our products and our results of operations.The long-term profitability of our operations will, in part, depend on our ability to continue to economically obtain resources, including energy and raw materials. For example, our lithium and bromine businesses rely upon our continued ability to produce, or otherwise obtain, lithium and bromine of sufficient quality and in adequate amounts to meet our customers’ demand. If we fail to secure and retain the rights to continue to access these key raw materials, we may have to restrict or suspend our operations that rely upon these key resources, which could harm our business, results of operations and financial condition. In addition, in some cases access to these raw materials by us and our competitors is subject to decisions or actions by governmental authorities, which could adversely impact us. Furthermore, other raw material and energy costs account for a significant percentage of our total costs of products sold, even if they can be obtained on commercially reasonable terms. Our raw material and energy costs can be volatile and may increase significantly. Increases are primarily driven by tightening of market conditions and major increases in the pricing of key constituent materials for our products such as crude oil, chlorine and metals (including molybdenum and rare earths which are used in the refinery catalysts business). We generally attempt to pass through changes in the prices of raw materials and energy to our customers, but we may be unable to do so (or may be delayed in doing so). In addition, raising prices we charge to our customers in order to offset increases in the prices we pay for raw materials could cause us to suffer a loss of sales volumes. Our inability to efficiently and effectively pass through price increases, or inventory impacts resulting from price volatility, could adversely affect our margins.Competition within our industry may place downward pressure on the prices and margins of our products and may adversely affect our businesses and results of operations.We compete against a number of highly competitive global specialty chemical producers. Competition is based on several key criteria, including product performance and quality, product price, product availability and security of supply, and responsiveness of product development in cooperation with customers and customer service. Some of our competitors are larger than we are and may have greater financial resources. These competitors may also be able to maintain significantly greater operating and financial flexibility. As a result, these competitors may be better able to withstand changes in conditions within our industry. Competitors’ pricing decisions could compel us to decrease our prices, which could negatively affect our margins and profitability. Our ability to maintain or increase our profitability is, and will continue to be, dependent upon our ability to offset decreases in the prices and margins of our products by improving production efficiency and volume and other productivity enhancements, shifting to production of higher margin chemical products and improving existing products through innovation and research and development. If we are unable to do so or to otherwise maintain our competitive position, we could lose market share to our competitors.In addition, Albemarle’s brands, product image and trademarks represent the unique product identity of each of our products and are important symbols of the Company’s reputation. Accordingly, the performance of our business could be adversely affected by any marketing and promotional materials used by our competitors that make adverse claims, whether with or without merit, against our Company or its products, imply or assert immoral or improper conduct by us, or are otherwise disparaging of our Company or its products. Further, our own actions could hurt such brands, product image and trademarks if our products underperform or we otherwise draw negative publicity.Our research and development efforts may not succeed in addressing changes in our customers’ needs, and our competitors may develop more effective or successful products.Our industries and the end markets into which we sell our products experience technological change and product improvement. Manufacturers periodically introduce new products or require new technological capacity to develop customized products. Our future growth depends on our ability to gauge the direction of the commercial and technological progress in all key end markets in which we sell our products and upon our ability to fund and successfully develop, manufacture and market products in such changing end markets. As a result, we must commit substantial resources each year to research and 11Albemarle Corporation and Subsidiariesdevelopment. There is no assurance that we will be able to continue to identify, develop, market and, in certain cases, secure regulatory approval for innovative products in a timely manner or at all, as may be required to replace or enhance existing products, and any such inability could have a material adverse effect on our profit margins and our competitive position.In addition, our customers use our specialty chemicals for a broad range of applications. Changes in our customers’ products or processes may enable our customers to reduce consumption of the specialty chemicals that we produce or make our specialty chemicals unnecessary. Customers may also find alternative materials or processes that do not require our products. Should a customer decide to use a different material due to price, performance or other considerations, we may not be able to supply a product that meets the customer’s new requirements. Consequently, it is important that we develop new products to replace the sales of products that mature and decline in use. Our business, results of operations, cash flows and margins could be materially adversely affected if we are unable to manage successfully the maturation of our existing products and the introduction of new products.Despite our efforts, we may not be successful in developing new products and/or technology, either alone or with third parties, or licensing intellectual property rights from third parties on a commercially competitive basis. Our new products may not be accepted by our customers or may fail to receive regulatory approval. Moreover, new products may have lower margins than the products they replace. Furthermore, ongoing investments in research and development for the future do not yield an immediate beneficial impact on our operating results and therefore could result in higher costs without a proportional increase in revenues.The development of non-lithium battery technologies could adversely affect us.The development and adoption of new battery technologies that rely on inputs other than lithium compounds could significantly impact our prospects and future revenues. Current and next generation high energy density batteries for use in electric vehicles rely on lithium compounds as a critical input. Alternative materials and technologies are being researched with the goal of making batteries lighter, more efficient, faster charging and less expensive, and some of these could be less reliant on lithium compounds. We cannot predict which new technologies may ultimately prove to be commercially viable and on what time horizon. Commercialized battery technologies that use no, or significantly less, lithium could materially and adversely impact our prospects and future revenues.Downturns in our customers’ industries, many of which are cyclical, could adversely affect our sales and profitability.Downturns in the businesses that use our specialty chemicals may adversely affect our sales. Many of our customers are in industries, including the electronics, building and construction, oilfield and automotive industries, which are cyclical in nature, or which are subject to secular market downturns. Historically, cyclical or secular industry downturns have resulted in diminished demand for our products, excess manufacturing capacity and lower average selling prices, and we may experience similar problems in the future. A decline in our customers’ industries may have a material adverse effect on our sales and profitability.Our results are subject to fluctuation because of irregularities in the demand for our HPC catalysts and certain of our agrichemicals.Our HPC catalysts are used by petroleum refiners in their processing units to reduce the quantity of sulfur and other impurities in petroleum products. The effectiveness of HPC catalysts diminishes with use, requiring the HPC catalysts to be replaced, on average, once every one to four years. The sales of our HPC catalysts, therefore, are largely dependent on the useful life cycle of the HPC catalysts in the processing units and may vary materially by quarter. In addition, the timing and profitability of HPC catalysts sales can have a significant impact on revenue and profit in any one quarter. Sales of our agrichemicals are also subject to fluctuation as demand varies depending on climate and other environmental conditions, which may prevent or reduce farming for extended periods. In addition, crop pricing and the timing of when farms alternate from one crop to another crop in a particular year can also alter sales of agrichemicals.Regulation, or the threat of regulation, of some of our products could have an adverse effect on our sales and profitability.We manufacture or market a number of products that are or have been the subject of attention by regulatory authorities and environmental interest groups. For example, over the past decade, there has been increasing scrutiny of certain brominated fire safety solutions by regulatory authorities, legislative bodies and environmental interest groups in various countries. We manufacture a broad range of brominated fire safety solution products, which are used in a variety of applications to protect people, property and the environment from injury and damage caused by fire. Concern about the impact of some of our products on human health or the environment may lead to regulation, or reaction in our markets independent of regulation, that could reduce or eliminate markets for such products.12Albemarle Corporation and SubsidiariesAgencies in the European Union (“E.U.”) continue to evaluate the risks to human health and the environment associated with certain brominated fire safety solutions such as tetrabromobisphenol A and decabromodiphenylethane, both of which we manufacture. Additional government regulations, including limitations or bans on the use of brominated flame retardants, could result in a decline in our net sales of brominated fire safety solutions and have an adverse effect on our sales and profitability. In addition, the threat of additional regulation or concern about the impact of brominated fire safety solutions on human health or the environment could lead to a negative reaction in our markets that could reduce or eliminate our markets for these products, which could have an adverse effect on our sales and profitability.Our business and our customers are subject to significant requirements under REACH, which imposes obligations on E.U. manufacturers and importers of chemicals and other products into the E.U. to compile and file comprehensive reports, including testing data, on each chemical substance, and perform chemical safety assessments. Additionally, substances of high concern, as defined under REACH, are subject to an authorization process, which may result in restrictions in the use of products by application or even banning the product. REACH regulations impose significant additional burdens on chemical producers, importers, downstream users of chemical substances and preparations, and the entire supply chain. See “Regulation” in Item 1. Business. Our significant manufacturing presence and sales activities in the E.U. require significant compliance costs and may result in increases in the costs of raw materials we purchase and the products we sell. Increases in the costs of our products could result in a decrease in their overall demand; additionally, customers may seek products with lower regulatory compliance requirements, which could also result in a decrease in the demand of certain products subject to the REACH regulations.The TSCA requires chemicals to be assessed against a risk-based safety standard and calling for the elimination of unreasonable risks identified during risk evaluation. This regulation and other pending initiatives at the U.S. state level, as well as initiatives in Canada, Asia and other regions, could potentially require toxicological testing and risk assessments of a wide variety of chemicals, including chemicals used or produced by us. These assessments may result in heightened concerns about the chemicals involved and additional requirements being placed on the production, handling, labeling or use of the subject chemicals. Such concerns and additional requirements could also increase the cost incurred by our customers to use our chemical products and otherwise limit the use of these products, which could lead to a decrease in demand for these products. Such a decrease in demand could have an adverse impact on our business and results of operations.We could be subject to damages based on claims brought against us by our customers or lose customers as a result of the failure of our products to meet certain quality specifications.Our products enable important performance attributes to our customers’ products. If a product fails to perform in a manner consistent with quality specifications or has a shorter useful life than guaranteed, a customer of ours could seek the replacement of the product or damages for costs incurred as a result of the product failing to perform as guaranteed. These risks apply to our refinery catalysts in particular because, in certain instances, we sell our refinery catalysts under agreements that contain limited performance and life cycle guarantees. Also, because many of our products are integrated into our customers’ products, we may be requested to participate in, or fund in whole or in part the costs of, a product recall conducted by a customer. For example, some of our businesses supply products to customers in the automotive industry. In the event one of these customers conducts a product recall that it believes is related to one of our products, we may be asked to participate in, or fund in whole or in part, such a recall.Our customers often require our subsidiaries to represent that our products conform to certain product specifications provided by our customers. Any failure to comply with such specifications could result in claims or legal action against us. A successful claim or series of claims against us could have a material adverse effect on our financial condition and results of operations and could result in our loss of one or more customers.Our business is subject to hazards common to chemical and natural resource extraction businesses, any of which could injure our employees or other persons, damage our facilities or other properties, interrupt our production and adversely affect our reputation and results of operations.Our business is subject to hazards common to chemical manufacturing, storage, handling and transportation, as well as natural resource extraction, including explosions, fires, severe weather, natural disasters, mechanical failure, unscheduled downtime, transportation interruptions, remediation, chemical spills, discharges or releases of toxic or hazardous substances or gases and other risks. These hazards can cause personal injury and loss of life to our employees and other persons, severe damage to, or destruction of, property and equipment and environmental contamination. In addition, the occurrence of disruptions, shutdowns or other material operating problems at our facilities due to any of these hazards may diminish our ability to meet our output goals. Accordingly, these hazards and their consequences could adversely affect our reputation and 13Albemarle Corporation and Subsidiarieshave a material adverse effect on our operations as a whole, including our results of operations and cash flows, both during and after the period of operational difficulties.Our business could be adversely affected by environmental, health and safety laws and regulations.The nature of our business, including historical operations at our current and former facilities, exposes us to risks of liability under environmental laws and regulations due to the production, storage, use, transportation and sale of materials that can cause contamination or personal injury if released into the environment. In the jurisdictions in which we operate, we are subject to numerous U.S. and non-U.S. national, federal, state and local environmental, health and safety laws and regulations, including those governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes and the cleanup of contaminated properties. We currently use, and in the past have used, hazardous substances at many of our facilities, and we have in the past been, and may in the future be, subject to claims relating to exposure to hazardous materials. We also have generated, and continue to generate, hazardous wastes at a number of our facilities. Some of our facilities also have lengthy histories of manufacturing or other activities that may have resulted in site contamination. Liabilities associated with the investigation and cleanup of hazardous substances, as well as personal injury, property damages or natural resource damages arising from the release of, or exposure to, such hazardous substances, may be imposed in many situations without regard to violations of laws or regulations or other fault, and may also be imposed jointly and severally (so that a responsible party may be held liable for more than its share of the losses involved, or even the entire loss). Such liabilities may also be imposed on many different entities, including, for example, current and prior property owners or operators, as well as entities that arranged for the disposal of the hazardous substances. Such liabilities may be material and can be difficult to identify or quantify.Further, some of the raw materials we handle are subject to government regulation. These regulations affect the manufacturing processes, handling, uses and applications of our products. In addition, our production facilities and a number of our distribution centers require numerous operating permits. Due to the nature of these requirements and changes in our operations, our operations may exceed limits under permits or we may not have the proper permits to conduct our operations. Ongoing compliance with such laws, regulations and permits is an important consideration for us and we incur substantial capital and operating costs in our compliance efforts.Compliance with environmental laws generally increases the costs of manufacturing, registration/approval requirements, transportation and storage of raw materials and finished products, and storage and disposal of wastes, and could have a material adverse effect on our results of operations. We may incur substantial costs, including fines, damages, criminal or civil sanctions and remediation costs, or experience interruptions in our operations, for violations arising under these laws or permit requirements. Additional information may arise in the future concerning the nature or extent of our liability with respect to identified sites, and additional sites may be identified for which we are alleged to be liable, that could cause us to materially increase our environmental accrual or the upper range of the costs we believe we could reasonably incur for such matters. Furthermore, environmental laws are subject to change and have become increasingly stringent in recent years. We expect this trend to continue and to require materially increased capital expenditures and operating and compliance costs.We may be subject to indemnity claims and liable for other payments relating to properties or businesses we have divested. In connection with the sale of certain properties and businesses, we have agreed to indemnify the purchasers of such properties for certain types of matters, such as certain breaches of representations and warranties, taxes and certain environmental matters. With respect to environmental matters, the discovery of contamination arising from properties that we have divested may expose us to indemnity obligations under the sale agreements with the buyers of such properties or cleanup obligations and other damages under applicable environmental laws. We may not have insurance coverage for such indemnity obligations or cash flows to make such indemnity or other payments. Further, we cannot predict the nature of and the amount of any indemnity or other obligations we may have to the applicable purchaser. Such payments may be costly and may adversely affect our financial condition and results of operations. For example, in 2021, we agreed to pay $665 million to settle claims related to a legacy Rockwood Holdings, Inc. (“Rockwood”) business sold to a third party prior to our acquisition of Rockwood in 2015.At several of our properties where hazardous substances are known to exist (including some sites where hazardous substances are being investigated or remediated), we believe we are entitled to contractual indemnification from one or more former owners or operators; however, in the event we make a claim, the indemnifier may disagree with us regarding, or not have the financial capacity to fulfill, its indemnity obligation. If our contractual indemnity is not upheld or effective, our accrual and/or our costs for the investigation and cleanup of hazardous substances could increase materially.14Albemarle Corporation and SubsidiariesWe could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act and similar foreign anti-corruption laws.The U.S. Foreign Corrupt Practices Act (the “FCPA”) and similar foreign anti-corruption laws in other jurisdictions around the world generally prohibit companies and their intermediaries from making improper payments or providing anything of value to non-U.S. government officials for the purpose of obtaining or retaining business or securing an unfair advantage. We operate in some parts of the world that have experienced governmental corruption to some degree, and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices. Although we have established formal policies or procedures for prohibiting or monitoring this conduct, we cannot assure you that our employees or other agents will not engage in such conduct for which we might be held responsible. In the event that we believe or have reason to believe that our employees, agents or distributors have or may have violated applicable anti-corruption laws, including the FCPA, we may be required to investigate or have outside counsel investigate the relevant facts and circumstances, which can be expensive and require significant time and attention from senior management. If we are found to be liable for violations of the FCPA or other applicable anti-corruption laws (either due to our own acts or our inadvertence, or due to the acts or inadvertence of others, including employees of our joint ventures), we could suffer from civil and criminal penalties or other sanctions, which could have a material adverse effect on our business and results of operations.As first reported in 2018, following receipt of information regarding potential improper payments being made by third-party sales representatives of our Refining Solutions business, within our Catalysts segment, we promptly retained outside counsel and forensic accountants to investigate potential violations of the Company’s Code of Conduct, the Foreign Corrupt Practices Act, and other potentially applicable laws. Based on this internal investigation, we have voluntarily self-reported potential issues relating to the use of third-party sales representatives in our Refining Solutions business, within our Catalysts segment, to the U.S. Department of Justice (“DOJ”), the SEC, and the Dutch Public Prosecutor (“DPP”), and are cooperating with the DOJ, the SEC, and the DPP in their review of these matters. In connection with our internal investigation, we have implemented, and are continuing to implement, appropriate remedial measures. We have commenced discussions with the SEC, DOJ and DPP about a potential resolution of these matters.At this time, we are unable to predict the duration, scope, result, or related costs associated with the investigations. We also are unable to predict what action may be taken by the DOJ, the SEC, or the DPP, or what penalties or remedial actions they may ultimately seek. Any determination that our operations or activities are not, or were not, in compliance with existing laws or regulations could result in the imposition of fines, penalties, disgorgement, equitable relief, or other losses. We do not believe, however, that any such fines, penalties, disgorgement, equitable relief, or other losses would have a material adverse effect on our financial condition or liquidity. However, an adverse resolution could have a material adverse effect on our results of operations in a particular period.We are subject to extensive foreign government regulation that can negatively impact our business.We are subject to government regulation in non-U.S. jurisdictions in which we conduct our business. The requirements for compliance with these laws and regulations may be unclear or indeterminate and may involve significant costs, including additional capital expenditures or increased operating expenses, or require changes in business practice, in each case that could result in reduced profitability for our business. Our having to comply with these foreign laws or regulations may provide a competitive advantage to competitors who are not subject to comparable restrictions or prevent us from taking advantage of growth opportunities. Determination of noncompliance can result in penalties or sanctions that could also adversely impact our operating results and financial condition.Our inability to protect our intellectual property rights, or being accused of infringing on intellectual property rights of third parties, could have a material adverse effect on our business, financial condition and results of operations.Protection of our proprietary processes, methods and compounds and other technology is important to our business. We generally rely on patent, trade secret, trademark and copyright laws of the U.S. and certain other countries in which our products are produced or sold, as well as licenses and nondisclosure and confidentiality agreements, to protect our intellectual property rights. The patent, trade secret, trademark and copyright laws of some countries, or their enforcement, may not protect our intellectual property rights to the same extent as the laws of the U.S. Failure to protect our intellectual property rights may result in the loss of valuable proprietary technologies. Additionally, some of our technologies are not covered by any patent or patent application and, even if a patent application has been filed, it may not result in an issued patent. If patents are issued to us, those patents may not provide meaningful protection against competitors or against competitive technologies. We cannot assure you that our intellectual property rights will not be challenged, invalidated, circumvented or rendered unenforceable.We also conduct research and development activities with third parties and license certain intellectual property rights from third parties and we plan to continue to do so in the future. We endeavor to license or otherwise obtain intellectual 15Albemarle Corporation and Subsidiariesproperty rights on terms favorable to us. However, we may not be able to license or otherwise obtain intellectual property rights on such terms or at all. Our inability to license or otherwise obtain such intellectual property rights could have a material adverse effect on our ability to create a competitive advantage and create innovative solutions for our customers, which will adversely affect our net sales and our relationships with our customers.We could face patent infringement claims from our competitors or others alleging that our processes or products infringe on their proprietary technologies. If we are found to be infringing on the proprietary technology of others, we may be liable for damages and we may be required to change our processes, redesign our products partially or completely, pay to use the technology of others, stop using certain technologies or stop producing the infringing product entirely. Even if we ultimately prevail in an infringement suit, the existence of the suit could prompt customers to switch to products that are not the subject of infringement suits. We may not prevail in intellectual property litigation and such litigation may result in significant legal costs or otherwise impede our ability to produce and distribute key products.We also rely upon unpatented proprietary manufacturing expertise, continuing technological innovation and other trade secrets to develop and maintain our competitive position. While we generally enter into confidentiality agreements with our employees and third parties to protect our intellectual property, we cannot assure you that our confidentiality agreements will not be breached, that they will provide meaningful protection for our trade secrets and proprietary manufacturing expertise or that adequate remedies will be available in the event of an unauthorized use or disclosure of our trade secrets or manufacturing expertise. In addition, our trade secrets and know-how may be improperly obtained by other means, such as a breach of our information technologies security systems or direct theft.Our inability to acquire or develop additional reserves that are economically viable could have a material adverse effect on our future profitability.Our lithium reserves will, without more, decline as we continue to extract these raw materials. Accordingly, our future profitability depends upon our ability to acquire additional lithium reserves that are economically viable to replace the reserves we will extract. Exploration and development of lithium resources are highly speculative in nature. Exploration projects involve many risks, require substantial expenditures and may not result in the discovery of sufficient additional resources that can be extracted profitably. Once a site with potential resources is discovered, it may take several years of development until production is possible, during which time the economic viability of production may change. Substantial expenditures are required to establish recoverable proven and probable reserves and to construct extraction and production facilities. As a result, there is no assurance that current or future exploration programs will be successful and there is a risk that depletion of reserves will not be offset by discoveries or acquisitions. We utilize feasibility studies to estimate the anticipated economic returns of an exploration project. The actual project profitability or economic feasibility may differ from such estimates as a result of factors such as, but not limited to, changes in volumes, grades and characteristics of resources to be mined and processed; changes in labor costs or availability of adequate and skilled labor force; the quality of the data on which engineering assumptions were made; adverse geotechnical conditions; availability, supply and cost of water and power; fluctuations in inflation and currency exchange rates; delays in obtaining environmental or other government permits or approvals or changes in the laws and regulations related to our operations or project development; changes in royalty agreements, laws and/or regulations around royalties and other taxes; and weather or severe climate impacts.For our existing operations, we utilize geological and metallurgical assumptions, financial projections and price estimates. These estimates are periodically updated to reflect changes in our operations, including modifications to our proven and probable reserves and mineralized material, revisions to environmental obligations, changes in legislation and/or social, political or economic environment, and other significant events associated with natural resource extraction operations. There are numerous uncertainties inherent in estimating quantities and qualities of lithium and costs to extract recoverable reserves, including many factors beyond our control, that could cause results to differ materially from expected financial and operating results or result in future impairment charges. In addition, it cannot be assumed that any part or all of the inferred mineral resources will ever be converted into mineral reserves, as defined by the SEC. See Item 2. Properties, for a discussion and quantification of our current mineral resources and reserves.There is risk to the growth of lithium markets.Our lithium business is significantly dependent on the development and adoption of new applications for lithium batteries and the growth in demand for plug-in hybrid electric vehicles and battery electric vehicles. To the extent that such development, adoption and growth do not occur in the volume and/or manner that we contemplate, including for reasons described under the heading “The development of non-lithium battery technologies could adversely affect us,” above, the long-term growth in the 16Albemarle Corporation and Subsidiariesmarkets for lithium products may be adversely affected, which would have a material adverse effect on our business, financial condition and operating results.Demand and market prices for lithium will greatly affect the value of our investment in our lithium resources and our revenues and profitability generally.Our ability to successfully develop our lithium resources, including our 60% interest in MARBL’s Wodgina mine, and generate a return on investment will be affected by changes in the demand for and market price of lithium-based end products, such as lithium hydroxide. The market price of these products can fluctuate and is affected by numerous factors beyond our control, primarily world supply and demand. Such external economic factors are influenced by changes in international investment patterns, various political developments and macro-economic circumstances. In addition, the price of lithium products is impacted by their purity and performance. We may not be able to effectively mitigate against such fluctuations. Following the Wodgina acquisition, the Wodgina mine idled production of spodumene until market demand supported bringing the mine back into production. We have resumed spodumene concentrate production at the Wodgina mine, but there are no assurances that we will not idle production at the Wodgina mine or one of our other mines in the future due to lack of market demand or for other reasons.In addition, we have renegotiated certain of our long-term agreements to include higher pricing that is more reflective of current market conditions. In other cases, we have moved from our previous fixed-price, long-term agreements toward index-referenced and variable-priced contracts. As a result, our Lithium business is more aligned with changes in market and index pricing than it has been in the past. While lithium market indices have increased 70% to 200% since the start of 2022, they may decline in the future, and any such decline could have a material and adverse effect on the revenues and profitability of our Lithium business and on our company generally.If we are unable to retain key personnel or attract new skilled personnel, it could have an adverse effect on our business.Our success depends on our ability to attract and retain key personnel including our management team. In light of the specialized and technical nature of our business, our performance is dependent on the continued service of, and on our ability to attract and retain, qualified management, scientific, technical, marketing and support personnel. Competition for such personnel is intense, and we may be unable to continue to attract or retain such personnel. In addition, because of our reliance on our senior management team, the unanticipated departure of any key member of our management team could have an adverse effect on our business. Our future success depends, in part, on our ability to identify and develop or recruit talent to succeed our senior management and other key positions throughout the organization. If we fail to identify and develop or recruit successors, we are at risk of being harmed by the departures of these key employees. Effective succession planning is also important to our long-term success. Failure to ensure effective transfer of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. In addition, the U.S. and other regions in which we operate are experiencing an acute workforce shortage for skilled workers, which in turn has created a hyper-competitive wage environment that may impact our ability to attract and retain employees.Some of our employees are unionized, represented by works councils or are employed subject to local laws that are less favorable to employers than the laws of the U.S.As of December 31, 2022, we had approximately 7,400 employees, including employees of our consolidated joint ventures. Approximately 30% of these employees are represented by unions or works councils. In addition, a large number of our employees are employed in countries in which employment laws provide greater bargaining or other rights to employees than the laws of the U.S. Such employment rights require us to work collaboratively with the legal representatives of those employees to effect any changes to labor arrangements. For example, most of our employees in Europe are represented by works councils that must approve any changes in conditions of employment, including salaries and benefits and staff changes, and may impede efforts to restructure our workforce. Although we believe that we have a good working relationship with our employees, a strike, work stoppage, slowdown or significant dispute with our employees could result in a significant disruption of our operations or higher labor costs.Our joint ventures may not operate according to their business plans if our partners fail to fulfill their obligations, which may adversely affect our results of operations and may force us to dedicate additional resources to these joint ventures.We currently participate in a number of joint ventures and may enter into additional joint ventures in the future. The nature of a joint venture requires us to share control with unaffiliated third parties. If our joint venture partners do not fulfill their obligations, the affected joint venture may not be able to operate according to its business plan. In that case, our results of operations may be adversely affected and we may be required to materially change the level of our commitment to the joint 17Albemarle Corporation and Subsidiariesventure. Also, differences in views among joint venture participants may result in delayed decisions or failures to agree on major issues. If these differences cause the joint ventures to deviate from their business plans, our results of operations could be adversely affected.The realignment of our former Lithium, Bromine and Catalysts segments into our Energy Storage, Specialties and Ketjen (Catalysts) segments may not benefit us as we expect or result in an improvement in our operating results.In August 2022, we announced plans to realign our Lithium and Bromine global business units into a new corporate structure designed to better meet customer needs and foster talent required to deliver in a competitive global environment. In addition, we announced our decision to retain our Catalysts business under a separate, wholly-owned subsidiary. Effective January 1, 2023, we realigned our Lithium and Bromine global business units into new Energy Storage and Specialties segments. Energy Storage focuses on the lithium-ion battery evolution and the transition to clean energy. Specialties combines the former Bromine business with the Lithium specialties business. We also reorganized our former Catalysts business unit into a wholly-owned subsidiary branded as Ketjen. If we do not manage this reorganization and the consequent realignment of responsibilities effectively, or if this new organization does not provide better service and products to our customers, then our overall business could suffer with an adverse impact on our financial condition and results of operations.We will continue to report our segments in the current structure until our Quarterly Report on Form 10-Q for the quarter ended March 31, 2023, the period in which the new organizational structure became effective.Risks Related to Our Financial ConditionOur required capital expenditures can be complex, may experience delays or other difficulties, and the costs may exceed our estimates.Our capital expenditures generally consist of expenditures to maintain and improve existing equipment, facilities and properties, and substantial investments in new or expanded equipment, facilities and properties. Execution of these capital expenditures can be complex, and commencement of production requires start-up, commission and certification of product quality by our customers, which may impact the expected output and timing of sales of product from such facilities. Construction of large chemical operations is subject to numerous risks and uncertainties, including, among others, the ability to complete a project on a timely basis and in accordance with the estimated budget for such projects and our ability to estimate future demand for our products. In addition, our returns on these capital expenditures may not meet our expectations.Future capital expenditures may be significantly higher, depending on the investment requirements of each of our business lines, and may also vary substantially if we are required to undertake actions to compete with new technologies in our industry. We may not have the capital necessary to undertake these capital investments. If we are unable to do so, we may not be able to effectively compete in some of our markets.We will need a significant amount of cash to service our indebtedness and our ability to generate cash depends on many factors beyond our control.Our ability to generate sufficient cash flow from operations or use existing cash balances to make scheduled payments on our debt depends on a range of economic, competitive and business factors, many of which are outside our control. Our business may not generate sufficient cash flow from operations to service our debt obligations. If we are unable to service our debt obligations, we may need to refinance all or a portion of our indebtedness on or before maturity, reduce or delay capital expenditures, sell assets or raise additional equity. We may not be able to refinance any of our indebtedness, sell assets or raise additional equity on commercially reasonable terms or at all, which could cause us to default on our obligations and impair our liquidity. Our inability to generate sufficient cash flow or use existing cash balances to satisfy our debt obligations, or to refinance our obligations on commercially reasonable terms, could have a material adverse effect on our business and financial condition.Restrictive covenants in our debt instruments may adversely affect our business.Our senior credit facilities and the indentures governing our senior notes contain select restrictive covenants. These covenants provide constraints on our financial flexibility. The failure to comply with these or other covenants governing other indebtedness, including indebtedness incurred in the future, could result in an event of default, which, if not cured or waived, could have a material adverse effect on our business, financial condition and results of operations, including cross-defaults to other debt facilities. See “Financial Condition and Liquidity—Long-Term Debt” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.18Albemarle Corporation and Subsidiaries19Albemarle Corporation and SubsidiariesChanges in credit ratings issued by nationally recognized statistical rating organizations could adversely affect our cost of financing, the market price of our securities and our debt service obligations.Credit rating agencies rate our debt securities on factors that include our operating results, actions that we take, their view of the general outlook for our industry and their view of the general outlook for the economy. Actions taken by the rating agencies can include maintaining, upgrading or downgrading the current rating or placing us on a watch list for possible future downgrades. Downgrading the credit rating of our debt securities or placing us on a watch list for possible future downgrades would likely increase our cost of future financing, limit our access to the capital markets and have an adverse effect on the market price of our securities.Borrowings under a portion of our debt facilities bear interest at floating rates, and are subject to adjustment based on the ratings of our senior unsecured long-term debt. The downgrading of any of our ratings or an increase in any of the benchmark interest rates would result in an increase of the interest expense on our variable rate borrowings.We are exposed to fluctuations in currency exchange rates, which may adversely affect our operating results and net income.We conduct our business and incur costs in the local currency of most of the countries in which we operate. Changes in exchange rates between foreign currencies and the U.S. Dollar will affect the recorded levels of our assets, liabilities, net sales, cost of goods sold and operating margins and could result in exchange losses. The primary currencies to which we have exposure are the Chinese Renminbi, Euro, Australian Dollar, Chilean Peso and Japanese Yen. Exchange rates between these currencies and the U.S. Dollar in recent years have fluctuated significantly and may do so in the future. With respect to our potential exposure to foreign currency fluctuations and devaluations, for the year ended December 31, 2022, approximately 29% of our net sales were denominated in currencies other than the U.S. Dollar. Significant changes in these foreign currencies relative to the U.S. Dollar could also have an adverse effect on our ability to meet interest and principal payments on any foreign currency-denominated debt outstanding. In addition to currency translation risks, we incur currency transaction risks whenever one of our operating subsidiaries or joint ventures enters into either a purchase or a sales transaction using a different currency from its functional currency. Our operating results and net income may be affected by any volatility in currency exchange rates and our ability to manage effectively our currency transaction and translation risks.Inflationary trends in the price of our input costs, such as raw materials, transportation and energy, could adversely affect our business and financial results.We have experienced, and may continue to experience, volatility and increases in the price of certain raw materials and in transportation and energy costs as a result of global market and supply chain disruptions and the broader inflationary environment. For example, results for our Catalysts segment have been negatively impacted in 2022 as a result of inflationary pressures in freight and input costs, including as a result of the volatility of natural gas pricing in Europe related to the war in Ukraine.If we are unable to increase the prices to our customers of our products to offset inflationary cost trends, or if we are unable to achieve cost savings to offset such cost increases, we could fail to meet our cost expectations, and our profits and operating results could be adversely affected. Our ability to price our products competitively to timely reflect higher input costs is critical to maintain and grow our sales. Increases in prices of our products to customers or the impact of the broader inflationary environment on our customers and may lead to declines in demand and sales volumes. Further, we may not be able to accurately predict the volume impact of price increases, especially if our competitors are able to more successfully adjust to such input cost volatility. Increasing our prices to our customers could result in long-term sales declines or loss of market share if our customers find alternative suppliers or purchase less of our products, which could have an adverse long-term impact on our results of operations.Changes in, or the interpretation of, tax legislation or rates throughout the world could materially impact our results.Our effective tax rate and related tax balance sheet attributes could be impacted by changes in tax legislation throughout the world. Recent changes in the U.S. include the Inflation Reduction Act of 2022 (the “Inflation Reduction Act”), enacted August 16, 2022, which, among other items, imposes a 15% alternative minimum tax on corporations with three-year average annual adjusted financial statement income exceeding $1 billion and introduces or extends a number of tax credits to promote clean energy development. We continue to monitor the effects of the Inflation Reduction Act and other regulatory developments on our financial condition, operating results, and income tax rate. Currently, the majority of our net sales are generated from customers located outside the U.S., and a substantial portion of our assets and employees are located outside of the U.S.20Albemarle Corporation and SubsidiariesWe have not accrued income taxes or foreign withholding taxes on undistributed earnings for most non-U.S. subsidiaries, because those earnings are intended to be indefinitely reinvested in the operations of those subsidiaries. Certain tax proposals with respect to such earnings could substantially increase our tax expense, which would substantially reduce our income and have a material adverse effect on our results of operations and cash flows from operating activities.Our future effective tax rates could be affected by changes in the mix of earnings in countries with differing statutory tax rates, expirations of tax holidays or rulings, changes in the assessment regarding the realization of the valuation of deferred tax assets, or changes in tax laws and regulations or their interpretation. Recent developments, including the European Commission’s investigations on illegal state aid, as well as the Organisation for Economic Co-operation and Development (“OECD”) project on Base Erosion and Profit Shifting may result in changes to long-standing tax principles, which could adversely affect our effective tax rates or result in higher cash tax liabilities. The OECD has also proposed the introduction of a global minimum tax rate at 15%. Consultations are ongoing and while we expect increased tax compliance requirements, we are unable to predict the ultimate outcome of this proposal.We are subject to the regular examination of our income tax returns by various tax authorities. Examinations in material jurisdictions or changes in laws, rules, regulations or interpretations by local taxing authorities could result in impacts to tax years open under statute or to foreign operating structures currently in place. We regularly assess the likelihood of adverse outcomes resulting from these examinations or changes in laws, rules, regulations or interpretations to determine the adequacy of our provision for taxes. It is possible the outcomes from these examinations will have a material adverse effect on our financial condition and operating results.Future events may impact our deferred tax asset position and U.S. deferred federal income taxes on undistributed earnings of international affiliates that are considered to be indefinitely reinvested.We evaluate our ability to utilize deferred tax assets and our need for valuation allowances based on available evidence. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between future projected operating performance and actual results. We are required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be utilized. In making this determination, we evaluate all positive and negative evidence as of the end of each reporting period. Future adjustments (either increases or decreases) to the deferred tax asset valuation allowance are determined based upon changes in the expected realization of the net deferred tax assets. The utilization of our deferred tax assets ultimately depends on the existence of sufficient taxable income in either the carry-back or carry-forward periods under the applicable tax law. Due to significant estimates used to establish the valuation allowance and the potential for changes in facts and circumstances, it is reasonably possible that we will be required to record adjustments to the valuation allowance in future reporting periods. Changes to the valuation allowance or the amount of deferred tax liabilities could have a materially adverse effect on our business, financial condition and results of operations. Further, should we change our assertion regarding the permanent reinvestment of the undistributed earnings in foreign operations, a deferred tax liability may need to be established.Our business and financial results may be adversely affected by various legal and regulatory proceedings.We are involved from time to time in legal and regulatory proceedings, which may be material in the future. The outcome of proceedings, lawsuits and claims may differ from our expectations, leading us to change estimates of liabilities and related insurance receivables. Legal and regulatory proceedings, whether with or without merit, and associated internal investigations, may be time-consuming and expensive to prosecute, defend or conduct, may divert management’s attention and other resources, inhibit our ability to sell our products, result in adverse judgments for damages, injunctive relief, penalties and fines, and otherwise negatively affect our business.Because a significant portion of our operations is conducted through our subsidiaries and joint ventures, our ability to service our debt may be dependent on our receipt of distributions or other payments from our subsidiaries and joint ventures.A significant portion of our operations is conducted through our subsidiaries and joint ventures. As a result, our ability to service our debt may be partially dependent on the earnings of our subsidiaries and joint ventures and the payment of those earnings to us in the form of dividends, loans or advances and through repayment of loans or advances from us. Payments to us by our subsidiaries and joint ventures are contingent upon our subsidiaries’ or joint ventures’ earnings and other business considerations and may be subject to statutory or contractual restrictions. In addition, there may be significant tax and other legal restrictions on the ability of our non-U.S. subsidiaries or joint ventures to remit money to us.21Albemarle Corporation and SubsidiariesAlthough our pension plans currently meet minimum funding requirements, events could occur that would require us to make significant contributions to the plans and reduce the cash available for our business.We have several defined benefit pension plans around the world, including in the U.S., U.K., Germany, Belgium and Japan. We are required to make cash contributions to our pension plans to the extent necessary to comply with minimum funding requirements imposed by the various countries’ benefit and tax laws. The amount of any such required contributions will be determined annually based on an actuarial valuation of the plans as performed by the plans’ actuaries.In previous years, we have made voluntary contributions to our U.S. qualified defined benefit pension plans. We anticipate approximately $12 million of required cash contributions during 2023 for our defined benefit pension plans. Additional voluntary pension contributions in and after 2023 may vary depending on factors such as asset returns, interest rates, and legislative changes. The amounts we may elect or be required to contribute to our pension plans in the future may increase significantly. These contributions could be substantial and would reduce the cash available for our business.Further, an economic downturn or recession or market disruption in the capital and credit markets may adversely impact the value of our pension plan assets, our results of operations, our statement of changes in stockholders’ equity and our liquidity. Our funding obligations could change significantly based on the investment performance of the pension plan assets and changes in actuarial assumptions for local statutory funding valuations. Any deterioration of the capital markets or returns available in such markets may negatively impact our pension plan assets and increase our funding obligations for one or more of these plans and negatively impact our liquidity. We cannot predict the impact of this or any further market disruption on our pension funding obligations.We may not be able to consummate future acquisitions or integrate acquisitions into our business, which could result in unanticipated expenses and losses.We believe that our customers are increasingly looking for strong, long-term relationships with a few key suppliers that help them improve product performance, reduce costs, and support new product development. To satisfy these growing customer requirements, our competitors have been consolidating within product lines through mergers and acquisitions. As part of our business growth strategy, we have acquired businesses and entered into joint ventures in the past and intend to pursue acquisitions and joint venture opportunities in the future. Our ability to implement this component of our growth strategy will be limited by our ability to identify appropriate acquisition or joint venture candidates and our financial resources, including available cash and borrowing capacity. The expense incurred in consummating acquisitions or entering into joint ventures, the time it takes to integrate an acquisition or our failure to integrate businesses successfully, could result in unanticipated expenses and losses. Furthermore, we may not be able to realize any of the anticipated benefits from acquisitions or joint ventures.The process of integrating acquired operations into our existing operations may result in unforeseen operating difficulties and may require significant financial resources that would otherwise be available for the ongoing development or expansion of existing operations. Some of the risks associated with the integration of acquisitions include:•potential disruption of our ongoing business and distraction of management;•unforeseen claims and liabilities, including unexpected environmental exposures;•unforeseen adjustments, charges and write-offs;•problems enforcing the indemnification obligations of sellers of businesses or joint venture partners for claims and liabilities;•unexpected losses of customers of, or suppliers to, the acquired business;•difficulty in conforming the acquired businesses’ standards, processes, procedures and controls with our operations;•in the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political and regulatory risks associated with specific countries;•variability in financial information arising from the implementation of purchase price accounting;•inability to coordinate new product and process development;•loss of senior managers and other critical personnel and problems with new labor unions and cultural challenges associated with integrating employees from the acquired company into our organization; and•challenges arising from the increased scope, geographic diversity and complexity of our operations.22Albemarle Corporation and SubsidiariesWe may continue to expand our business through acquisitions and we may incur additional indebtedness, including indebtedness related to acquisitions.We have historically expanded our business primarily through acquisitions. A part of our business strategy is to continue to grow through acquisitions that complement our existing technologies and accelerate our growth. Our credit facilities have limited financial maintenance covenants. In addition, the indenture and other agreements governing our senior notes do not limit our ability to incur additional indebtedness in connection with acquisitions or otherwise. As a result, we may incur substantial additional indebtedness in connection with acquisitions.Any such additional indebtedness and the related debt service obligations (whether or not arising from acquisitions) could have important consequences and risks for us, including: •reducing flexibility in planning for, or reacting to, changes in our businesses, the competitive environment and the industries in which we operate, and to technological and other changes; •lowering credit ratings;•reducing access to capital and increasing borrowing costs generally or for any additional indebtedness to finance future operating and capital expenses and for general corporate purposes;•to the extent that our debt is subject to floating interest rates, increasing our vulnerability to fluctuations in market interest rates;•reducing funds available for operations, capital expenditures, share repurchases, dividends and other activities; and•creating competitive disadvantages relative to other companies with lower debt levels.If our goodwill, intangible assets or long-lived assets become impaired, we may be required to record a significant charge to earnings.Under U.S. Generally Accepted Accounting Principles (“GAAP”), we review our intangible assets and long-lived assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is tested for impairment on October 31 of each year, or more frequently if required. Factors that may be considered a change in circumstances, indicating that the carrying value of our goodwill, intangible assets or long-lived assets may not be recoverable, include, but are not limited to, a decline in our stock price and market capitalization, reduced future cash flow estimates, and slower growth rates in our industry. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill, intangible assets or long-lived assets is determined, negatively impacting our results of operations and financial condition.General Risk FactorsAdverse conditions in the economy, and volatility and disruption of financial markets can negatively impact our customers, suppliers and other business partners and therefore have a material adverse effect on our business and results of operations.A global, regional or localized economic downturn may reduce customer demand or inhibit our ability to produce our products, negatively impacting our operating results. Our business and operating results have been and will continue to be sensitive to the many challenges that can affect national, regional and global economies, including economic downturns (including credit market tightness, which can impact our liquidity as well as that of our customers, suppliers and other business partners), declining consumer and business confidence, fluctuating commodity prices and volatile exchange rates. Our customers may experience deterioration of their businesses, cash flow shortages and difficulty obtaining financing, leading them to delay or cancel plans to purchase products, and they may not be able to fulfill their obligations in a timely fashion. Further, suppliers and other business partners may experience similar conditions, which could impact their ability to fulfill their obligations to us. Also, it could be difficult to find replacements for business partners without incurring significant delays or cost increases. Finally, any such adverse conditions in the economy and financial markets could make it difficult for us to raise debt or equity capital on favorable terms.Our business and operations could suffer in the event of cybersecurity breaches, information technology system failures, or network disruptions.Attempts to gain unauthorized access to our information technology systems become more sophisticated over time. These attempts, which might be related to industrial or other espionage, include covertly introducing malware to our computers and networks and impersonating authorized users, among others. We seek to detect and investigate all security incidents and to prevent their recurrence, but in some cases we might be unaware of an incident or its magnitude and effects. The theft, unauthorized use or publication of our intellectual property and/or confidential business information could harm our competitive position, reduce the value of our investment in research and development and other strategic initiatives or otherwise 23Albemarle Corporation and Subsidiariesadversely affect our business. To the extent that any cybersecurity breach results in inappropriate disclosure of our customers’ or licensees’ confidential information, we may incur liability as a result. The devotion of additional resources to the security of our information technology systems in the future could significantly increase the cost of doing business or otherwise adversely impact our financial results.In addition, risks associated with information technology systems failures or network disruptions, including risks associated with upgrading our systems or in successfully integrating information technology and other systems in connection with the integration of businesses we acquire, could disrupt our operations by impeding our processing of transactions, financial reporting and our ability to protect our customer or company information, which could adversely affect our business and results of operations. Finally, we face increased information technology security and fraud risks due to our increased reliance on working remotely during the COVID-19 pandemic and beyond, which may create additional information security vulnerabilities and/or magnify the impact of any disruption in information technology systems.The occurrence or threat of extraordinary events, including domestic and international terrorist attacks, may disrupt our operations and decrease demand for our products.Chemical-related assets may be at greater risk of future terrorist attacks than other possible targets in the U.S. and around the world. As a result, we are subject to existing federal rules and regulations (and may be subject to additional legislation or regulations in the future) that impose site security requirements on chemical manufacturing facilities, which increase our overhead expenses.We are also subject to federal regulations that have heightened security requirements for the transportation of hazardous chemicals in the U.S. We believe we have met these requirements but additional federal and local regulations that limit the distribution of hazardous materials are being considered. We ship and receive materials that are classified as hazardous. Bans on movement of hazardous materials through cities, like Washington, D.C., could affect the efficiency of our logistical operations. Broader restrictions on hazardous material movements could lead to additional investment to produce hazardous raw materials and change where and what products we manufacture.The Chemical Facility Anti-Terrorism Standards program (“CFATS Program”), which is administered by the Department of Homeland Security (“DHS”), identifies and regulates chemical facilities to ensure that they have security measures in place to reduce the risks associated with potential terrorist attacks on chemical plants located in the U.S. In December 2014, the Protecting and Securing Chemical Facilities from Terrorist Attacks Act of 2014 (“CFATS Act”) was enacted. DHS has enacted new rules under the CFATS Program that imposes comprehensive federal security regulations for high-risk chemical facilities in possession of specified quantities of chemicals of interest. This rule establishes risk-based performance standards for the security of the U.S.’s chemical facilities. It requires covered chemical facilities to prepare Security Vulnerability Assessments, which identify facility security vulnerabilities, and to develop and implement Site Security Plans, which include measures that satisfy the identified risk-based performance standards. We have implemented all necessary changes to comply with the rules under the CFATS Program to date, however, we cannot determine with certainty any future costs associated with any additional security measures that DHS may require.The occurrence of extraordinary events, including future terrorist attacks and the outbreak or escalation of hostilities, cannot be predicted, and their occurrence can be expected to continue to negatively affect the economy in general, and the markets for our products in particular. The resulting damage from a direct attack on our assets, or assets used by us, could include loss of life and property damage. In addition, available insurance coverage may not be sufficient to cover all of the damage incurred or, if available, may be prohibitively expensive.The COVID-19 pandemic, and any future pandemic, could have a material adverse effect on our results of operations, financial position, and cash flows.We continue to closely monitor the impact of the COVID-19 pandemic and its impact on our business. The COVID-19 pandemic has created significant uncertainty, volatility and economic disruption and any future pandemics could have a serious adverse impact on the economy and on our business, results of operations and cash flows. While we have not experienced a material impact as a result of the COVID-19 pandemic to date, the ultimate extent to which the COVID-19 pandemic and any future pandemics impact our business, results of operations, financial position, and cash flows is difficult to predict and dependent upon many factors over which we have no control. These factors include, but are not limited to, the duration and severity of the pandemic, including from the discovery of new strain variants; government restrictions on businesses and individuals; the health and safety of our employees and communities in which we do business; the impact of the pandemic on our customers' businesses and the resulting demand for our products; the impact on our suppliers and supply chain network; the impact on U.S. and global economies and the timing and rate of economic recovery; and potential adverse effects on the financial markets.24Albemarle Corporation and SubsidiariesThe military conflict between Russia and Ukraine, and the global response to it, could impact our results of operations.The U.S. government and other nations have imposed significant restrictions on most companies’ ability to do business in Russia as a result of the military conflict between Russia and Ukraine. It is not possible to predict the broader or longer-term consequences of this conflict, which could include further sanctions, embargoes, regional instability, energy shortages, geopolitical shifts and adverse effects on macroeconomic conditions, security conditions, currency exchange rates and financial markets. Such geo-political instability and uncertainty could have a negative impact on our ability to sell to, ship products to, collect payments from, and support customers in certain regions based on trade restrictions, embargoes and export control law restrictions, and logistics restrictions including closures of air space, and could increase the costs, risks and adverse impacts from these new challenges. For example, results for our Catalysts segment were negatively impacted in 2022 as a result of inflationary pressures in freight and input costs, including the volatility of natural gas pricing in Europe related to the war in Ukraine. We may also be the subject of increased cybersecurity breaches. We currently do not sell our products into Russia nor have assets or any operations in the country, however, a significant escalation or expansion of economic disruption or the conflict’s current scope could have a material adverse effect on our results of operations due to its impact in the countries in which we do conduct business.Natural disasters or other unanticipated catastrophes could impact our results of operations.The occurrence of natural disasters, such as hurricanes, floods or earthquakes; pandemics, such as COVID-19; or other unanticipated catastrophes at any of the locations in which we or our key partners, suppliers and customers do business, could cause interruptions in our operations. Historically, major hurricanes have caused significant disruption to the operations on the U.S. Gulf Coast for many of our customers and our suppliers of certain raw materials, which had an adverse impact on volume and cost for some of our products. Our operations in Chile could be subject to significant rain events and earthquakes, and our operations in Asia could be subject to weather events such as typhoons. A global or regional pandemic or similar outbreak in a region of our, our customers, or our suppliers could disrupt business. If similar or other weather events, natural disasters, or other catastrophe events occur in the future, they could negatively affect the results of operations at our sites in the affected regions as well as have adverse impacts on the global economy.Our insurance may not fully cover all potential exposures.We maintain property, business interruption, casualty, and other insurance, but such insurance may not cover all risks associated with the hazards of our business and is subject to limitations, including deductibles and coverage limits. We may incur losses beyond the limits, or outside the coverage, of our insurance policies, including liabilities for environmental remediation. In addition, from time to time, various types of insurance for companies in the specialty chemical industry have not been available on commercially acceptable terms or, in some cases, have not been available at all. We are potentially at additional risk if one or more of our insurance carriers fail. Additionally, severe disruptions in the domestic and global financial markets could adversely impact the ratings and survival of some insurers. Future downgrades in the ratings of enough insurers could adversely impact both the availability of appropriate insurance coverage and its cost. In the future, we may not be able to obtain coverage at current levels, if at all, and our premiums may increase significantly on coverage that we maintain.We may be exposed to certain regulatory and financial risks related to climate change.Growing concerns about climate change may result in the imposition of additional regulations or restrictions to which we may become subject. Climate changes include changes in rainfall and in storm patterns and intensities, water shortages, significantly changing sea levels and increasing atmospheric and water temperatures, among others. For example, there have been concerns regarding the declining water level of the Dead Sea, from which our joint venture, JBC, produces bromine. Climate changes and unprecedented weather events may pose a risk to business operations in vulnerable areas. Storms could cause business interruptions, incur additional restoration costs, and impact product availability and pricing. Disruptions to the global supply chain due to climate related impacts or geopolitical events are possible and exist as external risk factors that we can respond to but not control. These events could limit the supply of key raw materials to us, or could have significant impacts to pricing. We work with numerous independent suppliers to mitigate lack of availability from a single supplier, however in some cases products with limited numbers of suppliers may become difficult to obtain.A number of governments or governmental bodies have introduced or are contemplating regulatory changes in response to climate change, including regulating greenhouse gas emissions. Potentially, additional U.S. federal regulation will be forthcoming with respect to greenhouse gas emissions (including carbon dioxide) and/or “cap and trade” legislation that could impact our operations. In addition, we have operations in the E.U., Brazil, China, Japan, Jordan, Saudi Arabia, Singapore and the United Arab Emirates, which have implemented, or may implement, measures to achieve objectives under the 2015 Paris Climate Agreement, an international agreement linked to the United Nations Framework Convention on Climate Change (“UNFCC”), which set targets for reducing greenhouse gas emissions. Significant regional or national differences in approaches 25Albemarle Corporation and Subsidiariesto environmental laws and regulations could affect us disproportionately compared to our competitors and result in a competitive disadvantage to us.The outcome of new legislation or regulation in the U.S. and other jurisdictions in which we operate may result in new or additional requirements, additional charges to fund energy efficiency activities, and fees or restrictions on certain activities. We may have heightened credit risk due to our exposure to climate risks. While certain climate change initiatives may result in new business opportunities for us in the area of alternative fuel technologies and emissions control, compliance with these initiatives may also result in additional costs to us, including, among other things, increased production costs, additional taxes, reduced emission allowances or additional restrictions on production or operations. Any adopted future climate change regulations could also negatively impact our ability to compete with companies situated in areas not subject to such limitations. Even without such regulation, increased public awareness and adverse publicity about potential impacts on climate change emanating from us or our industry could harm us. We may not be able to recover the cost of compliance with new or more stringent laws and regulations, which could adversely affect our business and negatively impact our growth. Furthermore, the potential impact of climate change and related regulation, market trends or litigation on the Company is highly uncertain and there can be no assurance that it will not have an adverse effect on our financial condition and results of operations.Item 1B.Unresolved Staff Comments.NONEItem 2.Properties.We operate globally, with our principal executive offices located in Charlotte, North Carolina and regional shared services offices located in Budapest, Hungary and Dalian, China. Each of these properties are leased. We and our affiliates also operate regional sales and administrative offices in various locations throughout the world, which are generally leased.We believe that our production facilities, research and development facilities, and sales and administrative offices are generally well maintained, effectively used and are adequate to operate our business. During 2022, the Company’s manufacturing plants operated at approximately 84% capacity, in the aggregate.Set forth below is information regarding our production facilities operated by us and our affiliates. Additional details regarding our significant mineral properties can be found below the table.LocationPrincipal UseOwned/LeasedLithiumChengdu, ChinaProduction of lithium carbonate and technical and battery-grade lithium hydroxideOwnedGreenbushes, Australia(a)Production of lithium spodumene minerals and lithium concentrateOwned(c)Kemerton, AustraliaProduction of lithium carbonate and technical and battery-grade lithium hydroxideOwned(c)Kings Mountain, NCProduction of technical and battery-grade lithium hydroxide, lithium salts and battery-grade lithium metal productsOwnedLa Negra, ChileProduction of technical and battery-grade lithium carbonate and lithium chlorideOwnedLangelsheim, GermanyProduction of butyllithium, lithium chloride, specialty products, lithium hydrides, cesium and special metalsOwnedNew Johnsonville, TNProduction of butyllithium and specialty productsOwnedQinzhou, ChinaProduction of lithium carbonate and technical and battery-grade lithium hydroxideOwnedSalar de Atacama, Chile(a)Production of lithium brine and potashOwned(d)Silver Peak, NV(a)Production of lithium brine, technical-grade lithium carbonate and lithium hydroxideOwnedTaichung, TaiwanProduction of butyllithiumOwnedWodgina, Australia(a)Production of lithium spodumene minerals and lithium concentrateOwned and leased(c)Xinyu, ChinaProduction of lithium carbonate and technical and battery-grade lithium hydroxideOwnedBromineBaton Rouge, LAResearch and product development activities, and production of fire safety solutionsLeasedMagnolia, AR(a)Production of fire safety solutions, bromine, inorganic bromides, agricultural intermediates and tertiary aminesOwned26Albemarle Corporation and SubsidiariesLocationPrincipal UseOwned/LeasedSafi, Jordan(a)Production of bromine and derivatives and fire safety solutionsOwned and leased(c)Twinsburg, OHProduction of bromine-activated carbonLeasedCatalystsAmsterdam, the NetherlandsProduction of refinery catalysts, research and product development activitiesOwnedBitterfeld, GermanyRefinery catalyst regeneration, rejuvenation, and sulfidingOwned(c)La Voulte, FranceRefinery catalysts regeneration and treatment, research and development activitiesOwned(c)McAlester, OKRefinery catalyst regeneration, rejuvenation, pre-reclaim burn off, as well as specialty zeolites and additives marketing activitiesOwned(c)Mobile, ALProduction of tin stabilizersOwned(c)Niihama, JapanProduction of refinery catalystsLeased(c)Pasadena, TX(b)Production of aluminum alkyls, orthoalkylated anilines, refinery catalysts and other specialty chemicals; refinery catalysts regeneration services and research and development activitiesOwnedSanta Cruz, BrazilProduction of catalysts, research and product development activitiesOwned(c)Takaishi City, Osaka, JapanProduction of aluminum alkylsOwned(c)(a) See below for further discussion of these significant mineral extraction facilities.(b) The Pasadena, Texas location includes three separate manufacturing plants which are owned, primarily utilized by Catalysts, including one plant that is owned by an unconsolidated joint venture.(c) Owned or leased by joint venture.(d) Ownership will revert to the Chilean government once we have sold all remaining amounts under our contract with the Chilean government pursuant to which we obtain lithium brine in Chile.Mineral PropertiesSet forth below are details regarding our mineral properties operated by us and our affiliates which have been prepared in accordance with the requirements of subpart 1300 of Regulation S-K, issued by the SEC. As used in this Annual Report on Form 10-K, the terms “mineral resource,” “measured mineral resource,” “indicated mineral resource,” “inferred mineral resource,” “mineral reserve,” “proven mineral reserve” and “probable mineral reserve” are defined and used in accordance with subpart 1300 of Regulation S-K. Under subpart 1300 of Regulation S-K, mineral resources may not be classified as “mineral reserves” unless the determination has been made by a qualified person (“QP”) that the mineral resources can be the basis of an economically viable project. Except for that portion of mineral resources classified as mineral reserves, mineral resources do not have demonstrated economic value. Inferred mineral resources are estimates based on limited geological evidence and sampling and have a too high of a degree of uncertainty as to their existence to apply relevant technical and economic factors likely to influence the prospects of economic extraction in a manner useful for evaluation of economic viability. Estimates of inferred mineral resources may not be converted to a mineral reserve. It cannot be assumed that all or any part of an inferred mineral resource will ever be upgraded to a higher category. A significant amount of exploration must be completed in order to determine whether an inferred mineral resource may be upgraded to a higher category. Therefore, it cannot be assumed that all or any part of an inferred mineral resource exists, that it can be the basis of an economically viable project, that it will ever be upgraded to a higher category, or that all or any part of the mineral resources will ever be converted into mineral reserves. See risk factor - “Our inability to acquire or develop additional reserves that are economically viable could have a material adverse effect on our future profitability,” in Item 1A. Risk Factors.27Albemarle Corporation and SubsidiariesOverviewAt December 31, 2022, we had the following mineral extraction facilities:LocationBusiness SegmentOwnership %Extraction TypeStageAustraliaGreenbushesLithium49%Hard rockProductionWodginaLithium60%Hard rockProduction(a)ChileSalar de AtacamaLithium100%BrineProductionJordanSafi(b)Bromine50%BrineProductionUnited StatesKings Mountain, NCLithium100%Hard rockDevelopmentMagnolia, AR(b)Bromine100%BrineProductionSilver Peak, NV(b)Lithium100%BrineProduction(a) Production of spodumene concentrate at the Wodgina mine resumed in the second quarter of 2022 after it had been idled in 2019, following the acquisition of our the 60% interest in the Wodgina Project.(b) Site includes on-site, or otherwise near-by exclusive, conversion facilities. See individual property disclosure below for further details.Aggregate annual production from our mineral extraction facilities is shown in the below table. Amounts represent Albemarle’s attributable portion based on ownership percentages noted above and are shown in thousands of metric tonnes of lithium metal and bromine production. Lithium and bromine is extracted as brine or hard rock concentrate at the extraction facilities. These are then further converted into various compounds and products at on-site processing facilities or other conversion facilities owned by Albemarle around the world. In addition, the brine or concentrate can be used by tolling entities for further processing. 28Albemarle Corporation and SubsidiariesAggregate Annual Production (metric tonnes in thousands)Year Ended December 31,202220212020Lithium (lithium metal)(a)AustraliaGreenbushes(b)19 13 8 Wodgina(c)3 — — ChileSalar de Atacama(d)10 8 8 United StatesSilver Peak, NV2 2 2 Total lithium metal34 23 18 BromineJordanSafi(e)(f)60 57 56 United StatesMagnolia, AR(g)73 71 74 Total bromine133 128 130 (a) Lithium production amounts shown as lithium metal. Conversion to LCE is 0.1878 metric tonne of lithium metal to 1 metric tonne of LCE.(b) Production from Greenbushes represents 49% of production of the Greenbushes mine which is attributable to the Company’s interest in the Talison joint venture.(c) Production of spodumene concentrate at the Wodgina mine resumed in the second quarter of 2022 after it had been idled in 2019. Production amounts presented from Wodgina represent 60% of production of the Wodgina mine which is attributable to the Company’s interest in the MARBL joint venture.(d) The Salar de Atacama operation also produces potash (potassium chloride), bichofite, halite and sylvinite as byproducts. However, the Company does not consider production of these byproducts as material to the economics of the operation.(e) Production from Safi represents the 50% production by the Jordan Bromine Project which is attributable to the Company’s interest in the JBC joint venture.(f) The Safi operation also produces potassium hydroxide (“KOH”) as a byproduct. However, the Company does not consider production of this byproduct as material to the economics of the operation.(g) In addition, elemental sulfur and sodium hydrosulfide solution (“NaHS”) are manufactured from the sour gas produced by the Magnolia operation. However, the Company does not consider these products as material to the economics of the operation.See individual property disclosure below for further details regarding mineral rights, titles, property size, permits and other information for our significant mineral extraction properties. The extracted brine or hard rock is processed at facilities on location (as described below) or processed, or further processed, at other facilities throughout the world.The following table provides a summary of our mineral resources, exclusive of reserves, at December 31, 2022. The below mineral resource amounts are rounded and shown in thousands of metric tonnes. Where applicable, the amounts represent Albemarle’s attributable portion based on ownership percentages noted. The relevant technical information supporting mineral resources for each material property is included in the “Material Individual Properties” section below, as well as in the technical report summaries filed as Exhibits 96.1 to 96.6 to this report.29Albemarle Corporation and SubsidiariesMeasured Mineral ResourcesIndicated Mineral ResourcesMeasured and Indicated Mineral ResourcesInferred Mineral ResourcesAmount (‘000s metric tonnes)Grade(Li2O%)Amount (‘000s metric tonnes)Grade(Li2O%)Amount (‘000s metric tonnes)Grade(Li2O%)Amount (‘000s metric tonnes)Grade(Li2O%)Lithium - Hard Rock:AustraliaGreenbushes(a)——21,8001.53%21,8001.53%28,3001.15%Wodgina(b)——12,6001.36%12,6001.36%98,3001.12%United StatesKings Mountain, NC——46,8161.37%46,8161.37%42,8691.10%Amount (‘000s metric tonnes)Concentration (mg/L)Amount (‘000s metric tonnes)Concentration (mg/L)Amount (‘000s metric tonnes)Concentration (mg/L)Amount (‘000s metric tonnes)Concentration (mg/L)Lithium - Brine:ChileSalar de Atacama4712,3903631,9438342,1592371,617United StatesSilver Peak, NV14153361445014690121(a) Through our Talison joint venture, we own a 49% interest in the Greenbushes mine. We are therefore reporting 49% of Greenbushes’ mineral resources.(b) Through our MARBL joint venture, we own a 60% interest in the Wodgina project. We are therefore reporting 60% of Wodgina’s mineral resources.The feedstock for the Safi, Jordan site, owned 50% by Albemarle through its JBC joint venture, is drawn from the Dead Sea, a nonconventional reservoir owned by the nations of Israel and Jordan. As such, there are no specific resources owned by JBC, but Albemarle’s joint venture partner, Arab Potash Company (“APC”) has exclusive rights granted by the Hashemite Kingdom of Jordan to withdraw brine from the Dead Sea and process it to extract minerals. The measured resource of bromide ion attributable to Albemarle’s 50% interest in its JBC joint venture is estimated to be approximately 178.3 million metric tonnes. JBC is extracting approximately 1 percent of the bromine available in Jordan’s share of the Dead Sea. Bromide concentration in the Dead Sea is estimated to average approximately 5,000 parts per million (“ppm”).There are no mineral resource estimates at the Magnolia, AR bromine extraction site. All bromine mineral accumulations of economic interest and with reasonable prospects for eventual economic extraction within the Magnolia production lease area are either currently on production or subject to an economically viable future development plan and are classified as mineral reserves.The following table provides a summary of our mineral reserves at December 31, 2022. The below mineral reserve amounts are rounded and shown in thousands of metric tonnes. The amounts represent Albemarle’s attributable portion based on ownership percentages noted above. The relevant technical information supporting mineral reserves for each material property is included in the ”Material Individual Properties” section below, as well as the in the technical report summaries referenced in Exhibits 96.1 to 96.6 to this report.30Albemarle Corporation and SubsidiariesProven Mineral ReservesProbable Mineral ReservesTotal Mineral ReservesAmount (‘000s metric tonnes)Grade(Li2O%)Amount (‘000s metric tonnes)Grade(Li2O%)Amount (‘000s metric tonnes)Grade(Li2O%)Lithium - Hard Rock(a):AustraliaGreenbushes(b)——77,0001.91%77,0001.91%Amount (‘000s metric tonnes)Concentration (mg/L)Amount (‘000s metric tonnes)Concentration (mg/L)Amount (‘000s metric tonnes)Concentration (mg/L)Lithium - Brine:ChileSalar de Atacama3292,4302372,0635662,262United StatesSilver Peak, NV139556956995Bromine:United StatesMagnolia, AR(c)2,4195652,984(a) The Wodgina mine is at an initial assessment level, and as a result, contains no mineral reserves. Mineral reserve estimates are not applicable for the Kings Mountain site.(b) Through our Talison joint venture, we own a 49% interest in the Greenbushes mine. We are therefore reporting 49% of Greenbushes’ mineral reserves.(c) The concentration of bromine at the Magnolia site varies based on the physical location of the field and can range over 6,000 mg/L.All bromine reserves reported by Albemarle for the JBC project are classified as proven mineral reserves. The mineral reserve estimate for the Safi, Jordan bromine site attributable to Albemarle’s 50% interest in its JBC joint venture is approximately 2.38 million metric tonnes of bromine from the Dead Sea. This estimate is based on the time available under the concession agreement with the Hashemite Kingdom of Jordan and the processing capability of the JBC plant. As only approximately one percent of the available resource is consumed from the Dead Sea, as noted above, the reserve estimate is based on the amount the JBC plant can produce over until the end of 2058, when the APC concession agreement ends. Bromine concentration used to calculate the reserve estimate from the Dead Sea was approximately 8,890 ppm based on historical pumping.Mineral resource and reserve estimates were prepared by a QP with an effective date provided in the individual technical report summaries referenced in Exhibits 96.1 to 96.6 to this report. Differences between the amounts in the table above and those amounts in the technical report summaries represent estimated depletion from the effective date of the report until December 31, 2022. Our mineral resource and reserve estimates are based on many factors, including the area and volume covered by our mining rights, assumptions regarding our extraction rates based upon an expectation of operating the mines on a long-term basis and the quality of in-place reserves.Internal ControlsThe modeling and analysis of our mineral resources and reserves was developed by our site personnel and reviewed by several levels of internal management, as well as the QP for each site. The development of such resources and reserves estimates, including related assumptions, were prepared by a QP.When determining resources and reserves, as well as the differences between resources and reserves, management developed specific criteria, each of which must be met to qualify as a resource or reserve, respectively. These criteria, such as demonstration of economic viability, points of reference and grade, are specific and attainable. The QP and management agree on the reasonableness of the criteria for the purposes of estimating resources and reserves. Calculations using these criteria are reviewed and validated by the QP.Estimations and assumptions were developed independently for each significant mineral location. All estimates require a combination of historical data and key assumptions and parameters. When possible, resources and data from public information and generally accepted industry sources, such as governmental resource agencies, were used to develop these estimations.31Albemarle Corporation and SubsidiariesEach site has developed quality control and quality assurance (“QC/QA”) procedures, which were reviewed by the QP, to ensure the process for developing mineral resource and reserve estimates were sufficiently accurate. QC/QA procedures include independent checks (duplicates) on samples by third party laboratories, blind blank/standard insertion into sample streams, duplicate sampling, among others. In addition, the QPs reviewed the consistency of historical production at each site as part of their analysis of the QC/QA procedures. See details of the controls for each site in the technical summary reports filed as Exhibits 96.1 to 96.6 to this report.We recognize the risks inherent in mineral resource and reserve estimates, such as the geological complexity, the interpretation and extrapolation of field and well data, changes in operating approach, macroeconomic conditions and new data, among others. The capital, operating and economic analysis estimates rely on a range of assumptions and forecasts that are subject to change. In addition, certain estimates are based on mineral rights agreements with local and foreign governments. Any changes to these access rights could impact the estimates of mineral resources and reserves calculated in these reports. Overestimated resources and reserves resulting from these risks could have a material effect on future profitability.Material Individual PropertiesGreenbushes, AustraliaThe Greenbushes mine is a hard rock, open pit mine (latitude 33° 52´S, longitude 116° 04´ E) located approximately 250km south of Perth, Western Australia, 90km southeast of the port of Bunbury, a major bulk-handling port in the southwest of Western Australia. The lithium mining operation is near the Greenbushes townsite located in the Shire of Bridgetown-Greenbushes. Access to the Greenbushes Mine is via the paved South Western Highway between Bunbury and Bridgetown to Greenbushes Township and via the paved Maranup Ford Road to the Greenbushes Mine.Lithium production from the Greenbushes Mine has been undertaken continuously for more than 20 years. Modern exploration has been undertaken on the property since the mid-1980s, first by Greenbushes Limited, then by Lithium Australia 32Albemarle Corporation and SubsidiariesLtd and in turn by Sons of Gwalia prior to the acquisition of Greenbushes by Talison in 2007. Initial exploration focused largely on tantalum, with the emphasis changing to lithium from around 2000. In 2014, Rockwood acquired a 49% ownership interest in Windfield, which owns 100% of Talison, from Sichuan Tianqi Lithium Industries Inc. This 49% ownership in Windfield was assumed by Albemarle in 2015 as part of the acquisition of Rockwood. We purchase lithium concentrate from Windfield, and our investment in the joint venture is reported as an unconsolidated equity investment on our balance sheet.About 55% of the tenements held by Talison are covered by Western Australia’s State Forest, which is under the authority of the Western Australia Department of Biodiversity, Conservation and Attractions. The majority of the remaining land is private land that covers about 40% of the surface rights. The remaining ground comprises crown land, road reserves and other miscellaneous reserves. The tenements cover a total area of approximately 10,000 hectares and include the historic Greenbushes tin, tantalum and current lithium mining areas. See section 3 of the Greenbushes technical report summary, filed as Exhibit 96.1 to this report, for a listing of tenements held by the Greenbushes site. Talison holds the mining rights for all lithium minerals on these tenements. The operating open pit lithium mining and processing plant area covers approximately 2,000 hectares comprising three mining leases. All lithium mining activities, including tailings storage, processing plant operations, open pits and waste rock dumps, are currently carried out within the boundaries of the three mining leases plus two general purpose leases. In order to keep the granted tenements in good standing, Talison is required to maintain permits, make an annual contribution to the statutory Mining Rehabilitation Fund and pay a royalty on concentrate sales for lithium mineral production as prescribed under the Mining Act 1978 in Western Australia. There are no private royalties that apply to the Greenbushes property. Talison reviews and renews all tenements on an annual basis.The Greenbushes pegmatite deposit consists of a primary pegmatite intrusion (Central Lode) with a smaller, sub-parallel pegmatite to the east (Kapanga). The primary intrusion and its subsidiary dikes and pods are concentrated within shear zones within a metamorphic belt consisting of granofels, ultramafic schists and amphibolites. The pegmatites are crosscut by mafic dolerite dikes. The Central Lode pegmatite is over 3 kilometers long (north by northwest), up to 300 meters wide (normal to dip), strikes north to north-west and dips moderately to steeply west to south-west. The Kapanga deposit sits approximately 300 m to the east of the Central Lode deposit with strike length of 1.8 km, thickness averaging 150 meters and dips between 40o and 60o toward the west. Current drilling has defined the Kapanga deposit to approximately 450 meters depth below surface. The major minerals from the Greenbushes pegmatite are quartz, spodumene, albite and K-feldspar.The main lithium-bearing minerals are spodumene (containing approximately 8% lithium oxide) and varieties kunzite and hiddenite. Minor to trace lithium minerals include lepidolite mica, amblygonite and lithiophilite. Lithium is readily leached in the weathering environment and thus is virtually non-existent in weathered pegmatite. Exploration drilling at Greenbushes has been ongoing for over 40 years, including drilling in 2020, using reverse circulation and diamond drill holes.Three lithium mineral processing plants are currently operating on the Greenbushes site, two chemical grade plants and a technical grade plant. Tailings are discharged to the tailings storage facility without the need for any neutralization process. Additional infrastructure on site includes power and water supply facilities, a laboratory, administrative offices, occupational health/safety/training offices, dedicated mines rescue area, stores, storage sheds, workshops and engineering offices. The Greenbushes site also leases production drills, excavators, trucks and various support equipment to extract the ore deposit by open pit methods. Talison’s power is delivered by a local distribution system and reticulated and metered within the site. Water is sourced from rainfall and stored in several process dams located on site. We consider the condition of all of our plants, facilities and equipment to be suitable and adequate for the businesses we conduct, and we maintain them regularly. As of December 31, 2022, our 49% ownership interest of the gross asset value of the facilities at the Greenbushes site was approximately $471.7 million. Greenbushes is currently constructing a new chemical grade plant with a target completion in 2025 and is developing plans for a fourth chemical grade plant to be constructed in 2027. Other planned upgrades to the infrastructure include a new mine service area, a new mine access road, expansions of warehouse and laboratories and the expansion of tailings facilities.Talison ships the chemical-grade lithium concentrate in vessels to our facilities in Meishan and Xinyu, China, and by land transport to our recently completed Kemerton, Australia facility, to process into battery-grade lithium hydroxide. In addition, the output from Talison can be used by tolling entities in China to produce both lithium carbonate and lithium hydroxide.A summary of the Greenbushes facility’s lithium mineral resources, exclusive of reserves, and reserves as of December 31, 2022 are shown in the following tables. SRK Consulting (U.S.) Inc. (“SRK”), a third-party firm comprising mining experts in accordance with Item 1302(b)(1) of Regulation S-K, served as the QP and prepared the estimates of lithium mineral resources and reserves at the Greenbushes facility, with an effective date of December 31, 2022. A copy of the QP’s technical report summary with respect to the lithium mineral resource and reserve estimates at the Greenbushes facility, dated February 14, 2023 is filed as Exhibit 96.1 to this report. The amounts represent Albemarle’s attributable portion based on a 49% ownership percentage, and are presented as metric tonnes of lithium ore in thousands.33Albemarle Corporation and SubsidiariesThe Greenbushes mineral resources, exclusive of reserves, estimates with depletion from production from the effective date of the report through December 31, 2022 are summarized in the following table:Amount (‘000s metric tonnes)Grade (Li2O%)Indicated mineral resources21,8001.53%Inferred mineral resources28,3001.15%•Albemarle’s attributable portion of mineral resources is 49%.•Mineral resources are reported exclusive of mineral reserves. Mineral resources are not mineral reserves and do not have demonstrated economic viability. •Resources have been reported as in situ (hard rock within an optimized pit shell).•Resources have been categorized subject to the opinion of a QP based on the quality of informing data for the estimate, consistency of geological/grade distribution, data quality, and have been validated against long term mine reconciliation. •Resources which are contained within the mineral reserve pit design may be excluded from reserves due to an Inferred classification. •All stockpiled resources have been converted to mineral reserves. •Mineral resources are reported considering a nominal set of assumptions for reporting purposes:◦The mass yield for resources processed through the chemical grade plants is estimated based on Greenbushes’ mass yield formula, which is Yield%=9.362*(Li2O %)^1.319, subject to a 97% recovery limitation when the Li2O grade exceeds 5.5%.◦Derivation of economic cutoff grade for resources is based on the mine gate pricing of $1,523/metric tonne of 6% Li2O concentrate. The mine gate price is based on $1,650/metric tonne-conc CIF less $127/metric tonne-conc for government royalty and transportation to China.◦Costs estimated in Australian Dollars were converted to U.S. dollars based on an exchange rate of AU$1.00:$0.72.◦The economic cutoff grade calculation is based on $2.79/metric tonne-ore incremental ore mining cost, $23.35/metric tonne-ore processing cost, $3.57/metric tonne-ore G&A cost, and $1.88/metric tonne-ore sustaining capital cost. Incremental ore mining costs are the costs associated with the run-of-mine loader, stockpile rehandling, grade control assays and rockbreaker. ◦The price, cost and mass yield parameters produce a calculated resource economic cutoff grade of 0.319% Li2O. However, due to the internal constraints of the current operations, an elevated resource cutoff grade of 0.7% Li2O has been applied. SRK notes actual economic cutoff grade is lower, but it is the QP’s opinion to use a 0.7% Li2O cutoff grade to align with current site practices.◦An overall 42° (east side) and 46° (west side) pit slope angle, 0% mining dilution, and 100% mining recovery.◦Resources were reported above the assigned 0.7% Li2O cutoff grade and are constrained by an optimized 0.95 revenue factor pit shell.◦No infrastructure movement capital costs have been added to the optimization.•Mineral resources tonnage and contained metal have been rounded to reflect the accuracy of the estimate, and numbers may not add due to rounding.The Greenbushes indicated mineral resources of 21.8 million metric tonnes at December 31, 2022 increased by 29% from 16.9 million metric tonnes at December 31, 2021. The Greenbushes inferred mineral resources of 28.3 million metric tonnes at December 31, 2022 increased by 42% from 20.0 million metric tonnes at December 31, 2021. The increase in mineral resources was primarily driven by an update of the resource model including the addition of Kapanga, changes in the economic parameters (specifically the increase in lithium pricing) and updating of the economic pit shell, partially offset by mine depletion and an increase to the cutoff grade used in the resource model.The Greenbushes mineral reserve estimates with depletion from production from the effective date of the report through December 31, 2022 are summarized in the following table:Amount (‘000s metric tonnes)Grade (Li2O%)Probable mineral reserves:Reserve Pit75,0001.91%Stockpiles2,0001.99%•Albemarle’s attributable portion of mineral resources and reserves is 49%.•Mineral reserves are reported exclusive of mineral resources.•Indicated in situ resources have been converted to Probable reserves.•Measured and Indicated stockpile resources have been converted to Probable mineral reserves.•Mineral reserves are reported considering a nominal set of assumptions for reporting purposes:◦Mineral reserves are based on a mine gate price of $1,381/metric tonne of chemical grade concentrate (6% Li2O).◦Mineral reserves assume 93% global mining recovery.34Albemarle Corporation and Subsidiaries◦Mineral reserves are diluted at approximately 5% at zero grade for all mineral reserve blocks in addition to internal dilution built into the resource model (2.7% with the assumed selective mining unit of 5 meter x 5 meter x 5 meter).◦The mass yield for reserves processed through the chemical grade plants is estimated based on Greenbushes’ mass yield formula, which is Yield%=9.362*(Li2O %)^1.319, subject to a 97% recovery limitation when the Li2O grade exceeds 5.5%. The average life of mine mass yield for the chemical grade plants is 22.2%.◦The mass yield for reserves processed through the technical grade plant is estimated based on Greenbushes’ mass yield formula, which is Yield%=(31.792* Li2O %)–80.809. There is approximately 3.2 million metric tonnes of technical grade plant feed at 3.7% Li2O. The average life of mine mass yield for the technical grade plant is 37.5%.◦Although Greenbushes produces a technical grade product from the current operation, it is assumed that the reserves reported herein will be sold as a chemical grade product. This assumption is necessary because feed for the technical grade plant is currently only defined at the grade control or blasting level. Therefore, it is conservatively assumed that concentrate produced by the technical grade plant will be sold at the chemical grade product price◦Derivation of economic cutoff grade for reserves is based on mine gate pricing of $1,381/metric tonne of 6% Li2O concentrate. The mine gate price is based on $1,500/metric tonne-conc CIF less $119/metric tonne-conc for government royalty and transportation to China. ◦Costs estimated in Australian Dollars were converted to U.S. dollars based on an exchange rate of AU$1.00:$0.72.◦The economic cutoff grade calculation is based on $2.79/metric tonne-ore incremental ore mining cost, $23.35/metric tonne-ore processing cost, $3.57/metric tonne-ore G&A cost, and $1.88/metric tonne-ore sustaining capital cost. Incremental ore mining costs are the costs associated with the run-of-mine loader, stockpile rehandling, grade control assays and rockbreaker. ◦The price, cost and mass yield parameters produce a calculated economic cutoff grade of 0.344% Li2O. However, due to the internal constraints of the current operations, an elevated mineral reserves cutoff grade of 0.7% Li2O has been applied.◦The cutoff grade of 0.7% Li2O was applied to reserves that are constrained by the ultimate pit design and are detailed in a yearly mine schedule.◦Stockpile reserves have been previously mined and are reported at a 0.7% Li2O cutoff grade.•Waste tonnage within the reserve pit is 701.5 million metric tonnes at a strip ratio of 4.58:1 (waste to ore – not including reserve stockpiles)•Mineral reserve tonnage, grade and mass yield have been rounded to reflect the accuracy of the estimate, and numbers may not add due to rounding.The Greenbushes total mineral reserves of 77.0 million metric tonnes at December 31, 2022 increased by 10% from 69.9 million metric tonnes at December 31, 2021. The increase in total mineral reserves was primarily driven by use of a different resource block model, changes in the economic parameters (specifically the increase in lithium pricing) and updating of the economic pit shell, partially offset by mine depletion differing recovery and dilution methodology and a higher strip ratio. The increases in costs were offset by higher revenue.The LoM sustaining capital cost of $1.88/metric tonne of ore was used only for the purposes of pit optimization and cut-off grade calculation. This sustaining capital cost was based on estimates of LoM annual sustaining capital costs for Greenbushes that were included in the 2023 budget. Subsequent to pit optimization, design and scheduling, a detailed estimate of LoM sustaining capital costs was prepared.Additional information about key assumptions and parameters relating to the lithium mineral resources and reserves at the Greenbushes facility is discussed in sections 11 and 12, respectively, of the Greenbushes technical report summary.35Albemarle Corporation and SubsidiariesWodgina, AustraliaThe Wodgina property, which includes a hard rock, open pit mine (latitude -21° 11' 25"S, longitude 118° 40' 25"E) is located approximately 110 km south-southeast of Port Hedland, Western Australia between the Turner and Yule Rivers. The area includes multiple prominent greenstone ridges up to 180 m above mean sea level surrounded by granitic plains and lowlands. The property is accessible via National Highway 1 to National highway 95 to the Wodgina camp road. All roads to site are paved. The nearest large regional airport is in Port Hedland which also hosts an international deep-water port facility. In addition, a site dedicated all-weather airstrip is located near to site, capable of landing certain aircrafts.The Wodgina pegmatite deposits were discovered in 1902. Since then, the pegmatite-hosted deposits have been mined for tin, tantalum, beryl, and lithium by various companies. Mining occurred sporadically until Goldrim Mining formed a new partnership with Pan West Tantalum Pty Ltd., who opened open pit mining at the site in 1989 and progressively expanded during the 1990s. Active mining at the Mt. Cassiterite pit has been started and stopped regularly between 2008 and the present. The mine was placed on care and maintenance in 2008, 2012, and most recently in 2019. In 2016, MRL acquired the mine and upgraded the processing facilities and site infrastructure to 750ktpa spodumene plant producing 6% spodumene concentrate, completed in 2019. On October 31, 2019, we completed the acquisition of a 60% interest in this hard rock lithium mine project and formed an unincorporated joint venture with MRL, named MARBL. We formed MARBL for the exploration, development, mining, processing and production of lithium and other minerals (other than iron ore and tantalum) from the Wodgina Project. Production of spodumene concentrate from the first and second trains at the Wodgina mine was achieved in May and July of this year, respectively, after it had been idled following its acquisition in 2019.Wodgina holds mining tenements within the Karriyarra native title claim and are subject to the Land Use Agreement dated March 2001 between the Karriyarra People and Gwalia Tantalum Ltd (now Wodgina Lithium, a 100% subsidiary of MRL, our MARBL joint venture partner). See section 3 of the Wodgina technical report summary, filed as Exhibit 96.2 to this report, for a listing of all mining and exploration land tenements, which are in good standing and no known impediments exist. Certain 36Albemarle Corporation and Subsidiariestenements are due for renewal in 2026 and another in 2030. Drilling and exploration activities have been conducted throughout the mining life of the Wodgina property.The Wodgina mine is a pegmatite lithium deposit with spodumene the dominant mineral. The lithium mineralization occurs as 10 - 30 cm long grey-white spodumene crystals within medium grained pegmatites comprising primarily of quartz, feldspar, spodumene, and muscovite. Typically, the spodumene crystals are oriented orthogonal to the pegmatite contacts.The facilities at Wodgina consist of a three stage crushing plant, the spodumene concentration plant, administrative offices, an accommodation camp, a power station, gas pipeline, three mature and reliable water bore fields, extension for future tailing storage and a fleet of owned and leased mine production equipment. The gas pipeline feeds the site power station to provide the power to the facilities. Water is obtained from the dedicated water bore fields. We consider the condition of all of our plants, facilities and equipment to be suitable and adequate for the businesses we conduct, and we maintain them regularly. As of December 31, 2022, our 60% ownership interest of the gross asset value of the facilities at our Wodgina site was approximately $255.4 million.A summary of the Wodgina facility’s lithium mineral resources as of December 31, 2022 is shown in the following table. SRK served as the QP and prepared the estimates of lithium mineral resources at the Wodgina facility, with an effective date of September 30, 2020. No reserves have been declared at Wodgina. A copy of the QP’s amended technical report summary with respect to the lithium mineral resource estimates at the Wodgina facility, dated December 16, 2022, is referenced in Exhibit 96.2 to this report. The mineral resource economic pit and cutoff grade economic assumptions remain unchanged from December 31, 2021. The September 30, 2020 resource has been depleted for 2022 production and is reported as of December 31, 2022 in the below table. Mineral resources for Wodgina represent 60% interest in the Wodgina Project, which is attributable to the Company’s interest in the MARBL joint venture. Amounts are presented as metric tonnes of lithium ore in thousands.The Wodgina mineral resources, exclusive of reserves, estimates with depletion from production from the effective date of the report through December 31, 2022 are summarized in the following table:Amount (‘000s metric tonnes)Grade (Li2O%)Indicated mineral resources12,6001.36%Inferred mineral resources98,3001.12%•The summary mineral resources attributable tonnes reflects Albemarle’s 60% ownership percentage in the Wodgina project.•All significant figures are rounded to reflect the relative accuracy of the estimates. •The mineral resource estimate has been classified in accordance with SEC S-K 1300 guidelines and definitions.•The Cassiterite Deposit comprises the historically mined Mt. Cassiterite pit and undeveloped North Hill areas.•Mineral resources are not mineral reserves and do not have demonstrated economic viability. Inferred mineral resources have a high degree of uncertainty as to their economic and technical feasibility. It cannot be assumed that all or any part of an inferred mineral resources can be upgraded to measured or indicated mineral resources.•Metallurgical recovery of lithium has been estimated on a block basis at a consistent 65% based on documentation from historical plant production.•To demonstrate reasonable prospects for eventual economic extraction of Mineral Resources, a cut-off grade of 0.5% Li2O based on metal recoverability assumptions, long-term price assumptions of $584 per metric tonne, variable mining costs averaging $3.40/metric tonne, processing costs and G&A costs totaling $23/metric tonne.•The mineral resources are constrained by an economic pit shell using an overall 43° pit slope angle, 0% mining dilution, and 100% mining recovery.•There are no known legal, political, environmental, or other risks that could materially affect the potential development of the Mineral Resources based on the level of study completed for this property.The Wodgina indicated mineral resources of 12.6 million metric tonnes at December 31, 2022 decreased by 6% from 13.4 million metric tonnes at December 31, 2021. The Wodgina inferred mineral resources of 98.3 million metric tonnes at December 31, 2022 decreased by less than 1% from 98.5 million metric tonnes at December 31, 2021. The decrease in mineral resources was driven by mine depletion from the restart of mining activities during 2022.The Wodgina mine is at an initial assessment level, and as a result, contains no mineral reserves. Additional information about key assumptions and parameters relating to the lithium mineral resources at the Wodgina facility is discussed in section 11 of the Wodgina technical report summary.37Albemarle Corporation and SubsidiariesSalar de Atacama/La Negra, ChileThe Salar de Atacama is located in the commune of San Pedro de Atacama, with the operations approximately 100 kilometers to the south of this commune, in the extreme east of the Antofagasta Region and close to the border with the republics of Argentina and Bolivia. Access to the property is on the major four-lane paved Panamericana Route 5 north from Antofagasta, Chile approximately 60 km northeast to B-385. On B-385, a two-lane paved highway, the Albemarle Salar de Atacama project (latitude 23°38'31.52"S, longitude 68°19'30.31"W) is approximately 175 km to the east. The site has a small private airport that serves the project. A small paved runway airport is also located near San Pedro de Atacama and a large international airport is located in Antofagasta. The La Negra plant (latitude 23°45'20.31"S, longitude 70°18'36.92"W) has direct access roads and located approximately 20 km by paved four lane highway Route 28 southeast of Antofagasta turning north approximately 3 km on Route 5.In the early 1960s, water with high concentrations of salts was discovered in the Salar de Atacama Basin. In January 1975, one of our predecessors, Foote Mineral Company, signed a long-term contract with the Chilean government for mineral rights with respect to the Salar de Atacama consisting exclusively of the right to access lithium brine, covering an area of approximately 16,700 hectares. See section 3 of the Salar de Atacama technical report summary, filed as Exhibit 96.3 to this report, for a listing of mining concessions at the Salar de Atacama site. The contract originally permitted the production and sale of up to 200,000 metric tons of lithium metal equivalent (“LME”), a calculated percentage of LCE. In 1981, the first construction of evaporation ponds in the Salar de Atacama began. The following year, the construction of the lithium carbonate plant in La Negra began. In 1990, the facilities at the Salar de Atacama were expanded with a new well system and the capacity of the lithium carbonate plant in the La Negra plant was expanded. In 1998, the lithium chloride plant in La Negra began operating, the same year that Chemetall purchased Foote Mineral Company. Subsequently, in 2004, Chemetall was acquired by Rockwood, and in 2015, Rockwood was acquired by Albemarle. Effective January 1, 2017, the Chilean government and Albemarle entered into an annex to the original agreement through which its duration was modified, extending it until the balance of: (a) the original 200,000 metric tons of LME and an additional 262,132 metric tons of LME granted through this 38Albemarle Corporation and Subsidiariesannex have been exploited, processed, and sold, or (b) on January 1, 2044, whichever comes first. In addition, the amended agreement provides for commission payments to the Chilean government based on sales price/metric ton on the amounts sold under the additional quota granted, our support of research and development in Chile of lithium applications and solar energy, and our support of local communities in Northern Chile. Albemarle currently operates its extraction and production facilities in Chile under this mineral rights agreement with the Chilean government.The Salar de Atacama is a salt flat, the largest in Chile, located in the Atacama Desert in northern Chile, which is the driest place on the planet and thus has an extremely high annual rate of evaporation and extremely low annual rainfall. Our extraction through evaporation process works as follows: snow in the Andes Mountains melts and flows into underground pools of water containing brine, which generally have high concentrations of lithium. We then pump the water containing brine above ground through a series of pumps and wells into a network of large evaporation ponds. Over the course of approximately eighteen months, the desert sun evaporates the water causing other salts to precipitate and leaving behind concentrated lithium brine. If weather conditions are not favorable, the evaporation process may be prolonged. After we obtain the lithium brine from the Salar de Atacama, we process it into lithium carbonate and lithium chloride at our manufacturing facilities in nearby La Negra, Chile.The filling materials of the Salar de Atacama Basin are dominated by the Vilama Formation and the more recently, in geologic time, by evaporitic and clastic materials that are currently being deposited in the basin. These units house the basin's aquifer system and are composed of evaporitic chemical sediments that include carbonate, gypsum and halite intervals interrupted by volcanic deposits of large sheets of ignimbrite, volcanic ash and smaller classical deposits. Lithium-rich brines are extracted from the halite aquifer that is located within the nucleus of the salt flat. The Salar de Atacama basin contains a continental system of lithium-rich brine. These types of systems have six common (global) characteristics: arid climate; closed basin that contains a salt flat (salt crust), a salt lake, or both; igneous and/or hydrothermal activity; tectonic subsidence; suitable sources of lithium; and sufficient time to concentrate the lithium in the brine.In the Salar de Atacama basin, lithium-rich brines are found in a halite aquifer. Carbonate and sulfates are found near the edges of the basin. The average, minimum and maximum concentrations of lithium in the Salar de Atacama basin are approximately 1,400, 900 and 7,000 mg/L, respectively. From 2017 through 2019, two drilling campaigns were carried out in order to obtain geological and hydrogeological information at the Albemarle mining concession.The facilities at the Salar de Atacama consist of extraction wells, evaporation and concentration ponds, leaching plants, a potash plant, a drying plant, salar yield improvement plant, services and general areas, including salt stockpiles, as well as a fleet of owned and leased equipment. In addition, the site includes administrative offices, an operations building and a laboratory. The extracted concentrated lithium brine is sent to the La Negra plant by truck for processing. The Salar de Atacama has its own powerhouse that generates the energy necessary for the entire operation of the facilities. We also have permanent and continuous groundwater exploitation rights for two wells that are for industrial use and to supply the Salar de Atacama facilities. The La Negra facilities consist of a boron removal plant, a calcium and magnesium removal plant, two lithium carbonate conversion plants, a lithium chloride plant, evaporation-sedimentation ponds, an offsite area where the raw materials are housed and the inputs that are used in the process are prepared, a dry area where the various products are prepared, as well as a fleet of owned and leased equipment. La Negra is supplied electricity from a local company and has rights to a well in the Peine community for its water supply. We have completed construction of the third lithium carbonate conversion plant in late 2022. The plant has begun a six-month commissioning, qualification process, and ramp up process. We consider the condition of all of our plants, facilities and equipment to be suitable and adequate for the businesses we conduct, and we maintain them regularly. As of December 31, 2022, the combined gross asset value of our facilities at the Salar de Atacama and in La Negra, Chile (not inclusive of construction in process) was approximately $1,673.5 million.A summary of the Salar de Atacama facility’s lithium mineral resources, exclusive of reserves, and reserves as of December 31, 2022 are shown in the following tables. SRK served as the QP and prepared the estimates of lithium mineral resources and reserves at the Salar de Atacama facility, with an effective date of August 31, 2022. A copy of the QP’s technical report summary with respect to the lithium mineral resource and reserve estimates at the Salar de Atacama facility, dated February 14, 2023, is filed as Exhibit 96.3 to this report. The amounts represent Albemarle’s attributable portion based on a 100% ownership percentage, and are presented as metric tonnes of lithium metal in thousands.The Salar de Atacama mineral resource, exclusive of reserves, estimates with depletion from production from the effective date of the report to December 31, 2022 are summarized in the following table:39Albemarle Corporation and SubsidiariesAmount (‘000s metric tonnes)Li Concentration (mg/L)Measured mineral resources4712,390Indicated mineral resources3631,943Measured and Indicated mineral resources8342,159Inferred mineral resources2371,617•Mineral resources are reported exclusive of mineral reserves. Mineral resources are not mineral reserves and do not have demonstrated economic viability.•Given the dynamic reserve versus the static resource, a direct measurement of resources post-reserve extraction is not practical. Therefore, as a simplification, to calculate mineral resources, exclusive of reserves, the quantity of lithium pumped in the life of mine plan was subtracted from the overall resource without modification to lithium concentration. Measured and indicated resource were deducted proportionate to their contribution to the overall mineral resource.•Resources are reported on an in situ basis. •Resources are reported above the elevation of 2,200 meters above sea level. Resources are reported as lithium metal.•Resources have been categorized subject to the opinion of a QP based on the amount/robustness of informing data for the estimate, consistency of geological/grade distribution, survey information.•Resources have been calculated using drainable porosity estimated from measured values in Upper Halite and Volcano-sedimentary units, and bibliographical values based on the lithology and QP’s experience in similar deposits.•The estimated economic cutoff grade utilized for resource reporting purposes is 800 mg/l lithium, based on the following assumptions:◦A technical grade lithium carbonate price of $22,000/metric tonne CIF La Negra. This is a 10% premium to the price utilized for reserve reporting purposes. The 10% premium applied to the resource versus the reserve was selected to generate a resource larger than the reserve, ensuring the resource fully encompassed the reserve while still maintaining reasonable prospect for eventual economic extraction.◦Recovery factors for the salar operation increase gradually over the span of 4 years, from the current 40% to the proposed salar yield improvement program 65% recovery in 2025. After that point, evaporation pond recovery is relatively constant at 65%. An additional recovery factor of 80% lithium recovery is applied to the La Negra lithium carbonate plant.◦An average annual brine pumping rate of 414 L/s is assumed to meet drawdown constraint consistent with Albemarle’s permit conditions.◦Operating cost estimates are based on a combination of fixed brine extraction, G&A and plant costs and variable costs associated with raw brine pumping rate or lithium production rate. Average life of mine operating cost is calculated at approximately $4,155/metric tonne CIF Asia.◦Sustaining capital costs are included in the cut-off grade calculation and post the salar yield improvement program installation, average around $98 million per year.•Mineral Resources tonnage and contained metal have been rounded to reflect the accuracy of the estimate, and numbers may not add due to rounding.The Salar de Atacama measured and indicated mineral resources, exclusive of reserves, of 834,000 metric tonnes at December 31, 2022 decreased by 39% from 1.4 million metric tonnes at December 31, 2021. The Salar de Atacama inferred mineral resources, exclusive of reserves, of 237,000 metric tonnes at December 31, 2022 increased by 81% from 131,000 metric tonnes at December 31, 2021. The geology model reinterpretation coupled with results from the sampling campaign reduced the brine volume and lithium contained. Some specific yield factors in the salar decreased, reducing the resource by approximately 10%. Increases in grade were driven by higher grade in some deeper wells. The re-estimation also resulted in the reclassification of some brine from indicated to the inferred. Increases in revenue were offset by cost increase. The mineral resources were also reduced by depletion during the year.The Salar de Atacama reserve estimates with depletion from production from the effective date of the report through December 31, 2022 are summarized in the following table:40Albemarle Corporation and SubsidiariesAmount (‘000s metric tonnes)Concentration (mg/L)Proven mineral reserves:In Situ3062,407In Process232,741Probable mineral reserves:In Situ2372,063Total mineral reserves:In Situ5422,244In Process232,741•In process reserves quantify the prior 24 months of pumping data and reflect the raw brine, at the time of pumping. These reserves represent the first 24 months of feed to the lithium process plant in the economic model.•Proven reserves have been estimated as the lithium mass pumped during Years 2020 through 2030 of the proposed life of mine plan.•Probable reserves have been estimated as the lithium mass pumped from 2031 until the end of the proposed life of mine plan (2041).•Reserves are reported as lithium metal•This mineral reserve estimate was derived based on a production pumping plan truncated in December 31, 2041 (i.e., approximately 20 years). This plan was truncated to reflect the projected depletion of Albemarle’s authorized lithium production quota. •The estimated economic cut-off grade for the Project is 858 mg/l lithium, based on the assumptions discussed below. The truncated production pumping plan remained well above the economic cut-off grade (i.e., the economic cut-off grade did not result in a limiting factor to the estimation of the reserve).◦A technical grade lithium carbonate price of $20,000/metric tonne CIF Asia.◦Recovery factors for the salar operation increase gradually over the span of 4 years, from the current 40% to the proposed salar yield improvement program 65% recovery in 2025. After that point, evaporation pond recovery remains relatively constant at 65%, An additional recovery factor of 80% lithium recovery is applied to the La Negra lithium carbonate plant.◦A fixed average annual brine pumping rate of 414 L/s is assumed to meet consistent with Albemarle’s permit conditions.◦Operating cost estimates are based on a combination of fixed brine extraction, G&A and plant costs and variable costs associated with raw brine pumping rate or lithium production rate. Average life of mine operating cost is calculated at approximately $4,155/metric tonne CIF Asia.◦Sustaining capital costs are included in the cut-off grade calculation and post the salar yield improvement program installation, average around $98 million per year.•Mineral reserve tonnage, grade and mass yield have been rounded to reflect the accuracy of the estimate and numbers may not add due to rounding. The Salar de Atacama total mineral reserves of 566,000 metric tonnes at December 31, 2022 decreased by 13% from 647,000 metric tonnes at December 31, 2021. The decrease in total mineral reserves was driven by depletion during the year. Increases in model assumptions such as lithium pricing were offset by higher costs. These changes in economics did not have a material impact because mining at the Salar de Atacama is done at an elevated cutoff grade. Changes in the resource had minimal impact on the reserve as the production total is limited by quota.Additional information about key assumptions and parameters relating to the lithium mineral resources and reserves at the Salar de Atacama facility is discussed in sections 11 and 12, respectively, of the Salar de Atacama technical report summary.41Albemarle Corporation and SubsidiariesSilver Peak, NevadaThe Silver Peak site (latitude 37.751773°N, longitude 117.639027°W) is located in a rural area approximately 30 miles southwest of Tonopah, in Esmeralda County, Nevada. It is located in the Clayton Valley, an arid valley historically covered with dry lake beds (playas). The operation borders the small unincorporated town of Silver Peak, Nevada. Albemarle uses the Silver Peak site for the production of lithium brines, which are used to make lithium carbonate and, to a lesser degree, lithium hydroxide. Access to the site is off of the paved highway SR-265 in the town of Silver Peak, Nevada. The administrative offices are located on the south side of the road. The process facility is on the north side of the road and the brine operations are located approximately three miles east of Silver Peak on Silver Peak Road and occupy both the north and south sides of the road. In addition, access to the site is also possible via gravel/dirt roads from Tonopah, Nevada and Goldfield, Nevada.Lithium brine extraction in the Clayton Valley began in the mid-1960’s by one of our predecessors, the Foote Mineral Company. Since that time, lithium brine operations have been operated on a continuous basis. In 1998, Chemetall purchased Foote Mineral Company. Subsequently, in 2004, Chemetall was acquired by Rockwood, and in 2015, Rockwood was acquired by Albemarle. Our mineral rights in Silver Peak consist of our right to access lithium brine pursuant to our permitted and certified senior water rights, a settlement agreement with the U.S. government, originally entered into in June 1991, and our patented and unpatented land claims. Pursuant to the 1991 agreement, our water rights and our land claims, we have rights to all lithium that we can remove economically from the Clayton Valley Basin in Nevada. See section 3 of the Silver Peak technical report summary, filed as Exhibit 96.4 to this report, for a listing of patented and unpatented claims at the Silver Peak site. We have been operating at the Silver Peak site since 1966. Our Silver Peak site covers a surface of over 13,500 acres, more than 10,500 acres of which we own through a subsidiary. The remaining acres are owned by the U.S. government from whom we lease the land pursuant to unpatented land claims that are renewed annually. Actual surface disturbance associated with the operations is 7,390 acres, primarily associated with the evaporation ponds. The manufacturing and administrative activities are confined to an area approximately 20 acres in size. 42Albemarle Corporation and SubsidiariesWe extract lithium brine from our Silver Peak site through substantially the same evaporation process we use at the Salar de Atacama. We process the lithium brine extracted from our Silver Peak site into lithium carbonate at our plant in Silver Peak. It is hypothesized that the current levels of lithium dissolved in brine originate from relatively recent dissolution of halite by meteoric waters that have penetrated the playa in the last 10,000 years. The halite formed in the playa during the aforementioned climatic periods of low precipitation and that the concentrated lithium was incorporated as liquid inclusions into the halite crystals. There are no current exploration activities on the Silver Peak lithium operation. However, in January 2021, we announced that we will expand capacity in Silver Peak and begin a program to evaluate clays and other available Nevada resources for commercial production of lithium. As previously announced, we are investing in our Silver Peak site with the goal of doubling the current production in Silver Peak by 2025 by making full use of the brine water rights.The facilities at Silver Peak consist of extraction wells, evaporation and concentration ponds, a lithium carbonate plant, a lithium anhydrous plant, a lithium hydroxide plant, a new liming plant, wellfield and mill maintenance, a shipping and packaging facility and administrative offices, as well as a fleet of owned and leased equipment. Silver Peak is supplied electricity from a local company and we currently have two operating fresh water wells nearby that supply water to the facilities. We consider the condition of all of our plants, facilities and equipment to be suitable and adequate for the businesses we conduct, and we maintain them regularly. As of December 31, 2022, the gross asset value of our facilities at our Silver Peak site was approximately $77.8 million.A summary of the Silver Peak facility’s lithium mineral resources, exclusive of reserves, and reserves as of December 31, 2022 are shown in the following tables. SRK served as the QP and prepared the estimates of lithium mineral resources (exclusive of reserves) and reserves at the Silver Peak facility, with an effective date of September 30, 2022. A copy of the QP’s technical report summary with respect to the lithium mineral resource and reserve estimates at the Silver Peak facility, dated February 14, 2023, is filed as Exhibit 96.4 to this report. The amounts represent Albemarle’s attributable portion based on a 100% ownership percentage, and are presented as metric tonnes of lithium metal in thousands. The Silver Peak mineral resources, exclusive of reserves, estimates with depletion from production from the effective date of the report through December 31, 2022 are summarized in the following table:Amount (‘000s metric tonnes)Concentration (mg/L) Measured mineral resources14153Indicated mineral resources36144Measured and Indicated mineral resources50146Inferred mineral resources90121•Mineral resources are reported exclusive of mineral reserves. Mineral resources are not mineral reserves and do not have demonstrated economic viability. •Given the dynamic reserve versus the static resource, a direct measurement of resources post-reserve extraction is not practical. Therefore, as a simplification, to calculate mineral resources, exclusive of reserves, the quantity of lithium pumped in the life of mine plan was subtracted from the overall resource without modification to lithium concentration. Measured and indicated resource were deducted proportionate to their contribution to the overall mineral resource.•Resources are reported on an in-situ basis. •Resources are reported as lithium metal.•The resources have been calculated from the block model above 740 meters above sea level.•Resources have been categorized subject to the opinion of a QP based on the amount/robustness of informing data for the estimate, consistency of geological/grade distribution, survey information.•Resources have been calculated using drainable porosity estimated from bibliographical values based on the lithology and QP’s experience in similar deposits.•The estimated economic cutoff grade utilized for resource reporting purposes is 50 mg/l lithium, based on the following assumptions:◦A technical grade lithium carbonate price of $22,000/metric tonne CIF North Carolina. This is a 10% premium to the price utilized for reserve reporting purposes. The 10% premium applied to the resource versus the reserve was selected to generate a resource larger than the reserve, ensuring the resource fully encompassed the reserve while still maintaining reasonable prospect for eventual economic extraction.◦Recovery factors for the wellfield are = -206.23*(Li wellfield feed)2 +7.1903*(wellfield Li feed)+0.4609. An additional recovery factor of 78% lithium recovery is applied to the lithium carbonate plant.◦A fixed brine pumping rate of 20,000 acre feet per year, ramped up from current levels over a period of five years.◦Operating cost estimates are based on a combination of fixed brine extraction, G&A and plant costs and variable costs associated with raw brine pumping rate or lithium production rate. Average life of mine operating costs is calculated at approximately $6,200/metric tonne lithium carbonate CIF North Carolina.43Albemarle Corporation and Subsidiaries◦Sustaining capital costs are included in the cut-off grade calculation and include a fixed component at $7.0 million per year and an additional component tied to the estimated number of wells replaced per year and other planned capital programs.•Mineral Resources tonnage and contained metal have been rounded to reflect the accuracy of the estimate, and numbers may not add due to rounding.The Silver Peak measured and indicated mineral resources of 50,200 metric tonnes at December 31, 2022 increased by 43% from 35,100 metric tonnes at December 31, 2021. The Silver Peak inferred mineral resources of 89,500 metric tonnes at December 31, 2022 increased by 43% from 62,800 metric tonnes at December 31, 2021. The increase in mineral resources was driven by updated geologic modeling and increased brine volume at depth. Cost increases offset revenue increase with minimal impact to the overall resource as the overall grade is unchanged. The increase in resource was partially offset by production depletion during the year.The Silver Peak reserve estimates with depletion from production from the effective date of the report through December 31, 2022 are summarized in the following table:Amount (‘000s metric tonnes)Concentration (mg/L)Proven mineral reserves:In Situ1294In Process1104Probable mineral reserves:In Situ5695Total mineral reserves:In Situ6895In Process1104•In process reserves quantify the prior 24 months of pumping data and reflect the raw brine, at the time of pumping. These reserves represent the first 24 months of feed to the lithium process plant in the economic model.•Proven reserves have been estimated as the lithium mass pumped during the Partial Year 2022 through 2027 of the proposed life of mine plan.•Probable reserves have been estimated as the lithium mass pumped from 2028 until the end of the proposed life of mine plan (2052).•Reserves are reported as lithium metal.•This mineral reserve estimate was derived based on a production pumping plan truncated at the end of year 2052 (i.e., approximately 29.5 years). This plan was truncated to reflect the QP’s opinion on uncertainty associated with the production plan as a direct conversion of measured and indicated resource to proven and probable reserve is not possible in the same way as a typical hard-rock mining project.•The estimated economic cutoff grade for the Silver Peak project is 57 mg/l lithium, based on the assumptions discussed below. The production pumping plan was truncated due to technical uncertainty inherent in long-term production modeling and remained well above the economic cutoff grade (i.e., the economic cutoff grade did not result in a limiting factor to the estimation of the reserve).◦A technical grade lithium carbonate price of US$20,000/metric tonne CIF North Carolina.◦Recovery factors for the wellfield are = -206.23*(Li wellfield feed)2 +7.1903*(wellfield Li feed)+0.4609. An additional recovery factor of 78% lithium recovery is applied to the lithium carbonate plant.◦A fixed brine pumping rate of 20,000 acre feet per year, ramped up from current levels over a period of five years.◦Operating cost estimates are based on a combination of fixed brine extraction, G&A and plant costs and variable costs associated with raw brine pumping rate or lithium production rate. Average life of mine operating costs is calculated at approximately $6,200/metric tonne lithium carbonate CIF North Carolina.◦Sustaining capital costs are included in the cut-off grade calculation and include a fixed component at $7.0 million per year and an additional component tied to the estimated number of wells replaced per year and other planned capital programs.•Mineral reserve tonnage, grade and mass yield have been rounded to reflect the accuracy of the estimate (thousand tonnes), and numbers may not add due to rounding. The Silver Peak total mineral reserves of 69,100 metric tonnes at December 31, 2022 increased by 12% from 61,700 metric tonnes at December 31, 2021. The increase in total mineral reserves was driven by increase brine grades at depth, partially offset by a decrease in the recovery factor at the processing plant to 78% from 85% based on recent operating history. The Silver Peak reserves were also offset by depletion during the year.Additional information about key assumptions and parameters relating to the lithium mineral resources and reserves at the Silver Peak facility is discussed in sections 11 and 12, respectively, of the Silver Peak technical report summary.44Albemarle Corporation and SubsidiariesSafi, JordanOur 50% interest in JBC, a consolidated joint venture established in 1999, with operations in Safi, Jordan, acquires bromine that is originally sourced from the Dead Sea. JBC processes the bromine at its facilities into a variety of end products. The JBC operation (latitude 31°8'34.85"N , longitude 35°31'34.68"E) is located in Safi, Jordan, and is located on a 26-ha area on the southeastern edge of the Dead Sea, about 6 kilometers north of the of the APC plant. JBC also has a 2-hectare storage facility within the free-zone industrial area at the Port of Aqaba. The Jordan Valley Highway/Route 65 is the primary method of access for supplies and personnel to JBC. The Port of Aqaba is the main entry point for supplies and equipment for JBC, where imported shipping containers are offloaded from ships and are transported by truck to JBC via the Jordan Valley Highway. Aqaba is approximately 205 km south of JBC via Highway 65. Major international airports can be readily accessed either at Amman or Aqaba. Jordan’s railway transport runs north-south through Jordan and is not used to transport JBC employees and product.In 1958, the Government of the Hashemite Kingdom of Jordan granted APC a concession for exclusive rights to exploit the minerals and salts from the Dead Sea brine until 2058; at that time, APC factories and installations would become the property of the Government. APC was granted its exclusive mineral rights under the Concession Ratification Law No. 16 of 1958. APC produces potash from the brine extracted from the Dead Sea. A concentrated bromide-enriched brine extracted from APC’s evaporation ponds is the feed material for the JBC plant. Following the formation of the joint venture, the JBC bromine plant began operations in 2002. Expansion of the facilities to double its bromine production capacity went into operation in 2017.The climate, geology and location provide a setting that makes the Dead Sea a valuable large-scale natural resource for potash and bromine. Today, the Dead Sea has a surface area of 583 km2 and a brine volume of 110 km3. The Dead Sea is the world’s saltiest natural lake, containing high concentrations of ions compared to that of regular sea water and an unusually high amount of magnesium and bromine. There is an estimated 900 million tonnes of bromine in the Dead Sea.45Albemarle Corporation and SubsidiariesMining methods consist of all activities necessary to extract brine from the Dead Sea and extract Bromine. The low rainfall, low humidity and high temperatures in the Dead Sea area provide ideal conditions for recovering potash from the brine by solar evaporation. JBC obtains its feedbrine from APC’s evaporation pond and this supply is intimately linked to the APC operation. As evaporation takes place the specific gravity of the brine increases until its constituent salts progressively crystallize and precipitate out of solution, starting with sodium chloride (common salt) precipitating out to the bottom of the ponds (pre-carnallite ponds). Brine is transferred to other pans in succession where its specific gravity increases further, ultimately precipitating out of the sodium chloride. Carnallite precipitation takes place at the evaporation pond where it is harvested from the brine and pumped as slurry to a process plant (where the potassium chloride is separated from the magnesium chloride). JBC extracts the bromide-rich, “carnallite-free” brine through a pumping station. This brine feeds the bromine and magnesium plants. There is no exploration as typically conducted for the characterization of a mineral deposit.Infrastructure and facilities to support the operation of the bromine production plant at the Safi site is compact and contained in an approximately 33 ha area. JBC ships product in bulk through a storage terminal in Aqaba. There are above ground storage tanks as well as pumps and piping for loading these products onto ships. JBC main activities at Aqaba are raw material/product storing, importing, and exporting. An evaporation pond collects the waste streams from pipe flushing, housekeeping, and other activities. Fresh water is sources from the Mujib Reservoir, a man-made reservoir. JBC is supplied electricity from the National Electric Power Company of Jordan. We consider the condition of all of our plants, facilities and equipment to be suitable and adequate for the businesses we conduct, and we maintain them regularly. As of December 31, 2022, our 50% ownership interest of the gross asset value of the facilities at the Safi, Jordan site was approximately $222.3 million.A summary of the Safi facility’s bromine mineral resources and reserves as of December 31, 2022 is provided below. RPS Energy Canada Ltd (“RPS”), a third-party firm comprising mining experts in accordance with Item 1302(b)(1) of Regulation S-K, served as the QP and prepared the estimates of bromine mineral resources and reserves at the Safi facility, with an effective date of December 31, 2022. A copy of the QP’s amended technical report summary with respect to the bromine mineral resource and reserve estimates at the Safi facility, dated February 15, 2023, is filed as Exhibit 96.5 to this report.The feedstock is drawn from the Dead Sea, a nonconventional reservoir owned by the nations of Israel and Jordan. As such, there are no specific resources owned by JBC, but Albemarle’s joint venture partner, APC, has exclusive rights granted by the Hashemite Kingdom of Jordan to withdraw brine from the Dead Sea and process it to extract minerals. Revenues are based on a forecast bromine price ranging from $3,560 to $6,480 per metric tonne and the operating cost ranges between $341 and $529 per metric tonne. The measured resource of bromide ion attributable to Albemarle’s 50% interest in its JBC joint venture is estimated to be approximately 178.3 million metric tonnes. JBC is extracting approximately 1 percent of the bromine available in Jordan’s share of the Dead Sea. Bromide concentration in the Dead Sea is estimated to average approximately 5,000 ppm. The cut-off grade of the Albemarle bromine operations has been estimated to be at 1,000 ppm. The bromide ion concentration in the brine extracted which feeds the bromine plants, significantly exceeds the selected cut-off grade.The Safi measured mineral reserves of 178.3 million metric tonnes at December 31, 2022 increased by 1% from 177.5 million metric tonnes at December 31, 2021. The increase in measured mineral resources was driven by evaporation in the Dead Sea, partially offset by the end date of the forecast remained unchanged due to the concession agreement and depletion during 2022.All bromine reserves reported by Albemarle for the JBC project are classified as proven mineral reserves. The mineral reserve estimate attributable to Albemarle’s 50% interest in its JBC joint venture is approximately 2.38 million metric tonnes of bromine from the Dead Sea. This estimate is based on the time available under the concession agreement with the Hashemite Kingdom of Jordan and the processing capability of the JBC plant. As only approximately one percent of the available resource is consumed from the Dead Sea, as noted above, the reserve estimate is based on the amount the JBC plant can produce over until the end of 2058, when the APC concession agreement ends. Revenues are based on a forecast bromine price ranging from $3,560 to $6,480 per metric tonne and the operating cost ranges between $341 and $529 per metric tonne. At the plant process recovery of 80 to 85 percent (bromine from bromide), product bromine is estimated at approximately 120,000 metric tonnes per year. Bromine concentration used to calculate the reserve estimate from the Dead Sea was approximately 8,890 ppm based on historical pumping. The cut-off grade of the Albemarle bromine operations has been estimated to be at 1,000 ppm. The bromide ion concentration in the brine extracted which feeds the bromine plants, significantly exceeds the selected cut-off grade.The Safi total mineral reserves of 2.38 million metric tonnes at December 31, 2022 decreased by 3% from 2.45 million metric tonnes at December 31, 2021. The decrease in total mineral reserves was driven by depletion during 2022 and the end date of the forecast remained unchanged due to the concession agreement.Additional information about key assumptions and parameters relating to the bromine mineral resources and reserves at the Safi facility is discussed in sections 11 and 12, respectively, of the Safi technical report summary.46Albemarle Corporation and SubsidiariesMagnolia, ArkansasMagnolia is located in the southwest Arkansas, north of the center of Columbia County, approximately 50 miles east of Texarkana and 135 miles south of Little Rock. Our facilities include two separate production plants, the South Plant and the West Plant. The South Plant (latitude 33.1775°N, longitude 93.2161°W) is accessible via U.S. Route 79 and paved local roads. The West Plant (latitude 33.2648°N, longitude 93.3151°W) is accessible by U.S. Route 371 and paved local roads. The decentralized well sites around the brine fields are accessed via paved Arkansas Highway 19, 98, 160 and 344. In Magnolia, bromine is recovered from underground brine wells and then processed into a variety of end products at the plant on location. Albemarle has more than 50 brine production and injection wells that are currently active on the property. Albemarle’s area of bromine operation is comprised of over 9,500 individual leases with local landowners comprising a total area of over 99,500 acres. The leases have been acquired over time as field development extended across the field. Each lease continues for a period of 25 years or longer until after a two year period where brine is not injected or produced from/to a well within two miles of lease land areas, as long as lease rentals are continuing to be paid. See section 3 of the Magnolia technical report summary, filed as Exhibit 96.6 to this report, for a map of leases and burdens on those leases at the Magnolia site.Bromine extraction began in Magnolia in 1965 as the first brine supply well was drilled, and additional wells were put into production over the next few years. In 1987, a predecessor company took over operations of certain brine supply and injection wells, which Albemarle continues to operate to this day. In 2019, Albemarle completed, and put into production, two new brine production supply wells in Magnolia.In Magnolia, bromine exists as sodium bromide in the formation waters or brine of the Jurassic age Smackover Formation, a geological formation in Arkansas, in the subsurface at 7,000 to 8,500 feet below sea level. The mineralization occurs within the highly saline Smackover Formation waters or brine where the bromide has an abnormally rich composition. The bromine concentration is more than twice as high as that found in normal evaporated sea water. The bromine mineralization of the brine is distributed throughout the porous intervals of the upper and middle Smackover on the property. The strong permeability and porosity of the Smackover grainstones provide excellent continuity of the bromine mineralization within the brine.The facilities at Magnolia consist of brine production and injection wells, brine ponds, two bromine processing plants, pipelines between the plants and wells, a laboratory, storage and warehouses, administrative offices, as well as a fleet of owned and leased equipment. Our Magnolia facilities are supplied electricity from a local company and we currently have several operating freshwater wells nearby that supply water to the facilities. In addition, both plants have dedicated rail spurs that provide access to several rail lines to transport product throughout the country. We consider the condition of all of our plants, 47Albemarle Corporation and Subsidiariesfacilities and equipment to be suitable and adequate for the businesses we conduct, and we maintain them regularly. As of December 31, 2022, the gross asset value of our facilities at our Magnolia site was approximately $833.5 million.A summary of the Magnolia facility’s bromine mineral reserves as of December 31, 2022 is shown in the following table. RPS served as the QP and prepared the estimates of bromine mineral reserves at the Magnolia facility, with an effective date of December 31, 2022. A copy of the QP’s technical report summary with respect to the bromine mineral resource and reserve estimates at the Magnolia facility, dated February 15, 2023, is filed as Exhibit 96.6 to this report. The amounts represent Albemarle’s attributable portion based on a 100% ownership percentage, and are presented as metric tonnes in thousands.There are no mineral resource estimates at the Magnolia, AR bromine extraction site. All bromine mineral accumulations of economic interest and with reasonable prospects for eventual economic extraction within the Magnolia production lease area are either currently on production or subject to an economically viable future development plan and are classified as mineral reserves.Amount (‘000s metric tonnes)Proven mineral reserves2,419Probable mineral reserves565Total mineral reserves2,984•Reserves are reported as bromine, on an in situ basis.•The estimated economic cutoff grade utilized for reserve reporting purposes is 1,000 mg/L bromine, with a bromine price ranging from $3,560 to $6,480 per metric tonne and operating costs ranging from $850 to $1,150 per metric tonne.•Recovery factors for the Magnolia are 75% and 82% for the proven mineral reserves and total mineral reserves, respectively.•The concentration of bromine at the Magnolia site varies based on the physical location of the field and can range up to over 6,000 mg/L.The Magnolia total mineral reserves of 3.0 million metric tonnes at December 31, 2022 decreased by 3% from 3.1 million metric tonnes at December 31, 2021. The decrease in total mineral reserves was driven by depletion of the reserve during 2022.Additional information about key assumptions and parameters relating to the bromine mineral reserves at the Magnolia facility is discussed in section 12 of the Magnolia technical report summary.Item 3.Legal Proceedings.We are involved in litigation incidental to our business and are a party to a number of legal actions and claims, various governmental proceedings and private civil lawsuits, including, but not limited to, those related to environmental and hazardous material exposure matters, product liability, and breach of contract. Some of the legal proceedings include claims for compensatory as well as punitive damages. While the final outcome of these matters cannot be predicted with certainty, considering, among other things, the legal defenses available and liabilities that have been recorded along with applicable insurance, it is currently the opinion of management that none of these pending items will have a material adverse effect on our financial condition, results of operations or liquidity.In addition, the information set forth under Note 17, “Commitments and Contingencies – Litigation” to the Consolidated Financial Statements of this Annual Report on Form 10-K is incorporated herein by reference.An unexpected adverse resolution of one or more of these items, however, could have a material adverse effect on our financial condition, results of operations or liquidity in that particular period.Item 4.Mine Safety Disclosures.NONEExecutive Officers of the Registrant.The names, ages and biographies of our executive officers, as of February 15, 2023, are set forth below. The term of office of each officer is until the meeting of the Board of Directors following the next annual shareholders’ meeting in May 2023.48Albemarle Corporation and SubsidiariesNameAgePositionJ. Kent Masters62Chairman, President and Chief Executive OfficerScott A. Tozier57Executive Vice President, Chief Financial OfficerKristin M. Coleman54Executive Vice President, General Counsel and Corporate SecretaryKaren G. Narwold63Executive Vice President, Chief Administrative OfficerMelissa Anderson58Senior Vice President, Chief Human Resources OfficerJohn C. Barichivich III55Vice President, Corporate Controller, Chief Accounting OfficerRaphael Crawford47President, Catalysts Global Business UnitNetha Johnson52President, Bromine Global Business UnitEric Norris56President, Lithium Global Business UnitJ. Kent Masters was elected as Chairman, President and Chief Executive Officer in April 2020. He joined the Albemarle board of directors in 2015 and served as Lead Independent Director from 2018 until April 2020. Prior to joining Albemarle, Mr. Masters served as Operating Partner of Advent International, an international private equity group. Prior to Advent, he served as Chief Executive Officer of Foster Wheeler AG, a global engineering and construction contractor and power equipment supplier, when Foster Wheeler AG was acquired by Amec plc to form Amec Foster Wheeler plc. He is also a former member of the executive board of Linde AG, a global leader in manufacturing and sales of industrial gases, with responsibility for the Americas, Africa, and the South Pacific.Scott A. Tozier was elected as our Executive Vice President and Chief Financial Officer effective January 2011. Mr. Tozier also served as our Chief Accounting Officer from January 2013 until February 2014. Mr. Tozier has over 25 years of diversified international financial management experience. Following four years of assurance services with the international firm Ernst & Young, LLP, Mr. Tozier joined Honeywell International, Inc., where his 16 year career spanned senior financial positions in the U.S., Australia and Europe. His roles of increasing responsibilities included management of financial planning, analysis and reporting, global credit and treasury services and Chief Financial Officer of Honeywell’s Transportation Systems, Turbo Technologies and Building Solutions divisions. Most recently, Mr. Tozier served as Vice President of Finance, Operations and Transformation of Honeywell International, Inc.Kristin M. Coleman joined us in November of 2022 and currently serves as Executive Vice President, General Counsel and Corporate Secretary. Ms. Coleman has nearly 30 years of legal experience, previously serving as Executive Vice President, General Counsel, and Chief Compliance Officer at US Foods. She also served as Senior Vice President, General Counsel, and Corporate Secretary of Sears Holdings Corporation and as Vice President, General Counsel, and Corporate Secretary for Brunswick Corporation. Before moving in-house, she worked in private practice with Sidley Austin LLP. Ms. Coleman founded the Chicago General Counsel Forum and is a member of the Economic Club of Chicago. She serves as a Board Member Emeritus for the Center for Enriched Living.Karen G. Narwold joined us in September of 2010 and currently serves as Executive Vice President and Chief Administrative Officer. Ms. Narwold has over 25 years of legal, management and business experience with global industrial and chemical companies. After five years in private practice, she served as Vice President, General Counsel, Human Resources and Secretary of GrafTech International Ltd., a global graphite and carbon manufacturer and former subsidiary of Union Carbide. She then served as Vice President and Strategic Counsel of Barzel Industries, a North American steel processor and distributor. Prior to joining Albemarle, Ms. Narwold served as Special Counsel with Kelley Drye & Warren LLP and with Symmetry Advisors where she worked in the areas of strategic, financial and capital structure planning and restructuring for public and private companies. Ms. Narwold was appointed as a member of the Board of Directors of Ingevity Corporation on February 20, 2019. On October 31, 2022, Ms. Narwold announced that she will retire from the Company, effective April 4, 2023.Melissa Anderson joined Albemarle as Senior Vice President, Chief Human Resources Officer in January 2021. Prior to joining Albemarle, Ms. Anderson served as Executive Vice President, Administration and Chief Human Resources Officer at Duke Energy, an American electric power holding company based in North Carolina. Previous to that role, she held the role of Senior Vice President, Human Resources, for Domtar Corporation in South Carolina. Her previous experience also includes 17 years with IBM in progressive Human Resources leadership roles. Ms. Anderson serves on the board of Vulcan Materials and as Chair of the Society of Human Resource Management (SHRM), the world's largest HR professional association. She is also a member of the advisory board for the Center for Executive Succession at the University of South Carolina's Darla Moore School of Business.49Albemarle Corporation and SubsidiariesJohn C. Barichivich III was elected Vice President, Corporate Controller and Chief Accounting Officer effective November 2019. Mr. Barichivich has worked for the Company since 2007, holding various staff and leadership positions of increasing responsibility. Most recently, Mr. Barichivich served as Chief Financial Officer Vice President Finance, Purchasing, and S&OP Catalysts GBU since February 2019. Between January 2016 and February 2019, Mr. Barichivich acted as Vice President - Finance, Bromine Specialties global business unit, and he previously served as Vice President of Finance, Catalysts global business unit from September 2012 until December 2015. Mr. Barichivich was also the Director of Finance for the Albemarle shared service centers and he started his career with Albemarle as the Operations Controller for the Polymer Solutions business. Prior to Albemarle, Mr. Barichivich held a number of positions, including Director of Finance at the Home Depot, CFO Sensors SBE at PerkinElmer, and Manager of FP&A at General Electric. Mr. Barichivich began his career at Georgia Pacific, where he worked as an internal auditor and was a financial analyst supporting the restructuring of the Distribution Division.Raphael Crawford was appointed President, Catalysts Global Business Unit in 2018. Mr. Crawford joined Albemarle in 2012 as Vice President of the Performance Catalysts Solutions unit, and the additional responsibility of Managing Director for Rockwood Lithium GmbH after the Rockwood acquisition. In 2015, Mr. Crawford was appointed President of the Bromine Specialties business unit until being named to his current role. Prior to Albemarle, Mr. Crawford served as the Director of Global Marketing and Business Development for Dow Coating Materials, a global business unit of The Dow Chemical Company. He also served as the Global Commercial Director and Global Asset Director for Dow Water and Process Solutions, following the acquisition of Rohm and Haas Company. Previously, Crawford held various strategic marketing and commercial roles at Rohm and Haas. Prior to Rohm and Haas, Mr. Crawford worked at Campbell Soup Company as a Marketing Manager. He began his career at SNET Telecommunications where he served in several capacities including new ventures, finance and marketing. Mr. Crawford is a member of the board of directors of the American Fuel & Petrochemical Manufacturers (AFPM) association, where he had served as chairman of the Petrochemical Members Committee and as a member of the Executive Committee.Netha Johnson joined Albemarle as President, Bromine Global Business Unit in 2018. Mr. Johnson has more than 20 years of diverse leadership experience, both domestically and internationally, including having worked extensively in Singapore, Malaysia, Taiwan, Japan and Germany. Prior to joining Albemarle, Mr. Johnson served in several progressive leadership roles with 3M Company. Most recently, he served as Vice President and General Manager, Electrical Markets Division, where he was directly responsible for 3M’s electrical and renewable energy solutions. Prior to that, he served as 3M’s Vice President, Advanced Materials Division. In this role, he was responsible for three distinct businesses comprising the Advanced Material division, which provided world-leading, innovative solutions in fluoropolymer chemicals, advanced ceramics and light-weighting materials. Preceding his business career, Mr. Johnson served as a U.S. Naval Officer. Mr. Johnson has served as a member of the board of directors of Xcel Energy, Inc. since March 2020.Eric Norris was appointed President, Lithium Global Business Unit in August 2018. Mr. Norris joined Albemarle in January 2018 as Chief Strategy Officer. In this role, he managed the company’s strategic planning, M&A, and corporate business development programs as well as its investor relations efforts. Prior to joining Albemarle, Mr. Norris served as President of Health and Nutrition for FMC Corporation. Following FMC’s announcement to acquire DuPont Agricultural Chemical assets, he led the divestiture of FMC Health and Nutrition to DuPont. Previously, Mr. Norris served as Vice President and Global Business Director for FMC Health and Nutrition, and Vice President and Global Business Director for FMC Lithium. During his 16-year FMC career, he served in additional leadership roles including Investor Relations, Corporate Development and Director of FMC Healthcare Ventures. Prior to FMC, Mr. Norris founded and led an internet-based firm offering formulation and design tools to the chemical industry. Previously, he served in a variety of roles for Rohm and Haas Company including sales, marketing, strategic planning and investor relations. Norris is a member of the board of directors of Communities in Schools of Charlotte-Mecklenburg and is a member of the board of directors of The Zero Emission Transportation Association (ZETA).PART IIItem 5.Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.Our common stock trades on the New York Stock Exchange (“NYSE”) under the symbol “ALB.” There were 117,197,977 shares of common stock held by 2,101 shareholders of record as of February 8, 2023. On each of February 24, 2022, May 3, 2022, July 18, 2022, and October 24, 2022, we declared a dividend of $0.395 per share. In each quarter of 2021, we declared a dividend of $0.39 per share and, in each quarter of 2020, we declared a dividend of $0.385 per share. We expect to continue to declare and pay comparable dividends to our shareholders in the future, however, dividends are declared solely at 50Albemarle Corporation and Subsidiariesthe discretion of our Board of Directors and there is no guarantee that the Board of Directors will continue to declare dividends in the future.Stock Performance GraphThe graph below shows the cumulative total shareholder return assuming the investment of $100 in our common stock on December 31, 2017 and the reinvestment of all dividends thereafter. The information contained in the graph below is furnished and therefore not to be considered “filed” with the SEC, and is not incorporated by reference into any document that incorporates this Annual Report on Form 10-K by reference.Item 6.[Reserved]Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations.Forward-looking StatementsSome of the information presented in this Annual Report on Form 10-K, including the documents incorporated by reference herein, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on our current expectations, which are in turn based on assumptions that we believe are reasonable based on our current knowledge of our business and operations. We have used words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “should,” “would,” “will” and variations of such words and similar expressions to identify such forward-looking statements.These forward-looking statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict and many of which are beyond our control. There can be no assurance that our actual results will not differ materially from the results and expectations expressed or implied in the forward-looking statements. Factors that could cause actual results to differ materially from the outlook expressed or implied in any forward-looking statement include, without limitation, information related to:•changes in economic and business conditions;•product development;•changes in financial and operating performance of our major customers and industries and markets served by us;•the timing of orders received from customers;•the gain or loss of significant customers;51Albemarle Corporation and Subsidiaries•fluctuations in lithium market pricing, which could impact our revenues and profitability particularly due to our increased exposure to index-referenced and variable-priced contracts for battery grade lithium sales;•inflationary trends in our input costs, such as raw materials, transportation and energy, and their effects on our business and financial results;•changes with respect to contract renegotiations;•potential production volume shortfalls;•competition from other manufacturers;•changes in the demand for our products or the end-user markets in which our products are sold;•limitations or prohibitions on the manufacture and sale of our products;•availability of raw materials;•increases in the cost of raw materials and energy, and our ability to pass through such increases to our customers;•technological change and development;•changes in our markets in general;•fluctuations in foreign currencies;•changes in laws and government regulation impacting our operations or our products;•the occurrence of regulatory actions, proceedings, claims or litigation (including with respect to the U.S. Foreign Corrupt Practices Act and foreign anti-corruption laws);•the occurrence of cyber-security breaches, terrorist attacks, industrial accidents or natural disasters;•the effects of climate change, including any regulatory changes to which we might be subject;•hazards associated with chemicals manufacturing;•the inability to maintain current levels of insurance, including product or premises liability insurance, or the denial of such coverage;•political unrest affecting the global economy, including adverse effects from terrorism or hostilities;•political instability affecting our manufacturing operations or joint ventures;•changes in accounting standards;•the inability to achieve results from our global manufacturing cost reduction initiatives as well as our ongoing continuous improvement and rationalization programs;•changes in the jurisdictional mix of our earnings and changes in tax laws and rates or interpretation;•changes in monetary policies, inflation or interest rates that may impact our ability to raise capital or increase our cost of funds, impact the performance of our pension fund investments and increase our pension expense and funding obligations;•volatility and uncertainties in the debt and equity markets;•technology or intellectual property infringement, including cyber-security breaches, and other innovation risks;•decisions we may make in the future;•future acquisition and divestiture transactions, including the ability to successfully execute, operate and integrate acquisitions and divestitures and incurring additional indebtedness;•expected benefits from proposed transactions;•timing of active and proposed projects;•continuing uncertainties as to the duration and impact of the novel coronavirus (“COVID-19”) pandemic and any future pandemic;•impacts of the military conflict between Russia and Ukraine and the global response to it;•performance of our partners in joint ventures and other projects;•changes in credit ratings;•the inability to realize the benefits of our decision to retain our Catalysts business as a wholly-owned subsidiary and to realign our Lithium and Bromine global business units into a new corporate structure, including Energy Storage and Specialties business units; and•the other factors detailed from time to time in the reports we file with the SEC.52Albemarle Corporation and SubsidiariesWe assume no obligation to provide revisions to any forward-looking statements should circumstances change, except as otherwise required by securities and other applicable laws. The following discussion should be read together with our consolidated financial statements and related notes included in this Annual Report on Form 10-K.The following is a discussion and analysis of our results of operations for the years ended December 31, 2022, 2021 and 2020. A discussion of our consolidated financial condition and sources of additional capital is included under a separate heading “Financial Condition and Liquidity.”OverviewWe are a leading global developer, manufacturer and marketer of highly-engineered specialty chemicals that are designed to meet our customers’ needs across a diverse range of end markets. Our corporate purpose is making the world safe and sustainable by powering the potential of people. The end markets we serve include energy storage, petroleum refining, consumer electronics, construction, automotive, lubricants, pharmaceuticals and crop protection. We believe that our commercial and geographic diversity, technical expertise, access to high-quality resources, innovative capability, flexible, low-cost global manufacturing base, experienced management team and strategic focus on our core base technologies will enable us to maintain leading positions in those areas of the specialty chemicals industry in which we operate.Secular trends favorably impacting demand within the end markets that we serve combined with our diverse product portfolio, broad geographic presence and customer-focused solutions will continue to be key drivers of our future earnings growth. We continue to build upon our existing green solutions portfolio and our ongoing mission to provide innovative, yet commercially viable, clean energy products and services to the marketplace to contribute to our sustainable revenue. For example, our Lithium business contributes to the growth of clean miles driven with electric vehicles and more efficient use of renewable energy through grid storage; Bromine enables the prevention of fires starting in electronic equipment, greater fuel efficiency from rubber tires and the reduction of emissions from coal fired power plants; and the Catalysts business creates efficiency of natural resources through more usable products from a single barrel of oil, enables safer, greener production of alkylates used to produce more environmentally-friendly fuels, and reduced emissions through cleaner transportation fuels. We believe our disciplined cost reduction efforts and ongoing productivity improvements, among other factors, position us well to take advantage of strengthening economic conditions as they occur, while softening the negative impact of the current challenging global economic environment.2022 Highlights•In the first quarter of 2022, we increased our quarterly dividend for the 29th consecutive year, to $0.395 per share.•In January 2022, we signed a joint development agreement with 6K to explore the use of 6K’s patented UniMelt® advanced, sustainable materials production platform to develop novel lithium battery materials through potentially disruptive manufacturing processes.•In February 2022, we announced that we signed a non-binding letter agreement with our MARBL joint venture partner, MRL, to explore a potential expansion of the MARBL joint venture, in an effort to expand lithium conversion capacity with increased optionality and reduced risk.•In May 2022, we issued $1.7 billion of senior notes pursuant to an underwritten public offering. The proceeds from this issuance were used to redeem the 4.15% Senior Notes due in 2024 (the “2024 Notes”), repay the balance of commercial paper outstanding and for general corporate purposes.•Production of spodumene concentrate from the first and second trains at the Wodgina mine managed by our 60%-owned MARBL joint venture was achieved in May and July of this year, respectively.•We announced plans to build integrated lithium operations in the United States, including the Kings Mountain, North Carolina spodumene mine and a lithium conversion plant in the Southeast.•We announced the conclusion of our strategic review of the Catalysts business. As a result of the review, we chose to retain the business under a separate, wholly-owned subsidiary of Albemarle that has been renamed Ketjen in 2023. This structure is intended to allow the Catalysts business to respond to unique customer needs and global market dynamics more effectively while also achieving its growth ambitions.•We announced the realignment of our Lithium and Bromine global business units into a new corporate structure designed to better meet customer needs and foster talent required to deliver in a competitive global environment. The realignment was effective January 1, 2023, and resulted in the following three reportable segments: (1) Energy Storage; (2) Specialties; and (3) Ketjen (Catalysts).•In October 2022, we announced that we have been awarded a nearly $150 million grant from the U.S. Department of Energy to expand domestic manufacturing of batteries for EVs and the electric grid and for materials and components 53Albemarle Corporation and Subsidiariescurrently imported from other countries. The grant funding is intended to support a portion of the anticipated cost to construct a new, commercial-scale U.S.-based lithium concentrator facility at our Kings Mountain, North Carolina, location.•In October 2022, we completed the acquisition of all of the outstanding equity of Qinzhou, for approximately $200 million in cash. Qinzhou's operations include a recently constructed lithium processing plant strategically positioned near the Port of Qinzhou in Guangxi, which began commercial production in the first half of 2022. The plant has designed annual conversion capacity of up to 25,000 metric tonnes of LCE and is capable of producing battery-grade lithium carbonate and lithium hydroxide.•In December 2022, we unveiled a groundbreaking product, MercLok™, which captures mercury from soil and mining waste, helping to remove this harmful element from the food chain.•In December 2022, we announced the acquisition of a location in Charlotte, North Carolina, where we intend to invest at least $180 million to establish the Albemarle Technology Park, a world-class facility designed for novel materials research, advanced process development, and acceleration of next-generation lithium products to market. We anticipate that innovations from the new site will enhance lithium recovery, improve production methods, and introduce new forms of lithium to enable breakthrough levels of battery performance. In addition, we anticipate the creation of at least 200 jobs at the site.•We achieved net income of $2.7 billion during 2022 compared to $123.7 million for 2021. The increase in 2022 net income was primarily driven by increased lithium prices reflecting tight market conditions and greater volumes sold under index-referenced and variable-based contracts. •Cash flows from operations in 2022 were $1.9 billion compared to $344.3 million in 2021.OutlookThe current global business environment presents a diverse set of opportunities and challenges in the markets we serve. In particular, the market for lithium battery and energy storage, particularly for electric vehicles (“EVs”), remains strong, providing the opportunity to continue to develop high quality and innovative products while managing the high cost of expanding capacity. The other markets we serve continue to present various opportunities for value and growth as we have positioned ourselves to manage the impact on our business of changing global conditions, such as slow and uneven global growth, currency exchange volatility, crude oil price fluctuation, a dynamic pricing environment, an ever-changing landscape in electronics, the continuous need for cutting edge catalysts and technology by our refinery customers and increasingly stringent environmental standards. Amidst these dynamics, we believe our business fundamentals are sound and that we are strategically well-positioned as we remain focused on increasing sales volumes, optimizing and improving the value of our portfolio primarily through pricing and product development, managing costs and delivering value to our customers and shareholders. We believe that our businesses remain well-positioned to capitalize on new business opportunities and long-term trends driving growth within our end markets and to respond quickly to changes in economic conditions in these markets.Beginning in the first quarter of 2023, the chief operating decision maker began evaluating performance, forecasting and making resource allocation decisions based on our previously announced realignment of the Lithium and Bromine global business units. The new corporate structure was designed to better meet customer needs and foster talent required to deliver in a competitive global environment. The realignment resulted in the following three reportable segments: (1) Energy Storage; (2) Specialties; and (3) Ketjen (Catalysts). The below segment outlook is presented in the new segment structure based on how the chief operating decision maker started reviewing the business starting in 2023.Energy Storage: We expect Energy Storage results to increase year-over-year in 2023, mainly due to increased pricing as well as higher sales volume. The increased market pricing reflects tight market conditions, primarily in battery- and tech-grade carbonate and hydroxide, as well as renegotiations of certain of our long-term agreements. Since the beginning of 2022 market indices have increased 70% to 200%. Some of our renegotiated contracts include higher prices on existing long-term agreements that are more reflective of current market conditions. In other cases, we have moved from previous fixed-price, long-term agreements towards index-referenced and variable-priced contracts. As a result, our Energy Storage business is more aligned with changes in market and index pricing than it has been in the past. While we expect these prices to remain strong throughout the year, a material decline in these market prices would have a negative impact on our outlook. The increased sales volume is primarily expected from new capacity coming on line from La Negra, Chile, Kemerton, Western Australia, and the recently completed acquisition of Qinzhou, which includes a lithium hydroxide conversion plant designed to produce up to 25,000 metric tons of LCE per year. While we ramp up our new capacity, we will continue to utilize tolling arrangements to meet growing customer demand. EV sales are expected to continue to increase over the prior year as the lithium battery market remains strong.54Albemarle Corporation and SubsidiariesWe announced agreements for a strategic investment in China with plans to build a battery grade lithium conversion plant in Meishan initially targeting 50,000 metric tons of LCE per year. Construction of the Meishan facility is currently underway and is expected to be complete by the end of 2024. In addition, production of spodumene concentrate from the first and second trains at the Wodgina mine managed by our 60%-owned MARBL joint venture was achieved in May and July of this year, respectively. In February 2022, we announced that we signed a non-binding letter agreement with our MARBL joint venture partner, MRL, to explore a potential expansion of the MARBL joint venture, in an effort to expand lithium conversion capacity with increased optionality and reduced risk.On a longer-term basis, we believe that demand for lithium will continue to grow as new lithium applications advance and the use of plug-in hybrid electric vehicles and full battery electric vehicles increases. This demand for lithium is supported by a favorable backdrop of steadily declining lithium-ion battery costs, increasing battery performance, continuing significant investments in the battery and EV supply chain by cathode and battery producers and automotive OEMs and favorable global public policy toward e-mobility/renewable energy usage. Our outlook is also bolstered by long-term supply agreements with key strategic customers, reflecting our standing as a preferred global lithium partner, highlighted by our scale, access to geographically diverse, low-cost resources and long-term track record of reliability of supply and operating execution.Specialties: We expect both net sales and profitability to increase in 2023 due to strength in demand across our product portfolio that benefits from diverse end markets. One anticipated contributor to growth is the December 2022 launch of MercLok, a groundbreaking new bromine-based product that sequesters elemental and ionic mercury in the environment. Volumes are expected to increase compared to 2022 due to the continued successful execution of growth projects, assuming continued availability of raw materials like chlorine. In addition, Specialties’ ongoing cost savings initiatives and higher pricing are expected to offset higher freight and raw material costs such as lithium chloride.On a longer-term basis, we continue to believe that improving global standards of living, widespread digitization, increasing demand for data management capacity and the potential for increasingly stringent fire safety regulations in developing markets are likely to drive continued demand for fire safety products. We are focused on profitably growing our globally competitive bromine and derivatives production network to serve all major bromine consuming products and markets. The combination of our solid, long-term business fundamentals, strong cost position, product innovations and effective management of raw material costs should enable us to manage our business through end-market challenges and to capitalize on opportunities that are expected with favorable market trends in select end markets.Ketjen (Catalysts): Total Ketjen results in 2023 are expected to increase year-over-year despite inflationary pressures in freight and input costs, including the volatility of natural gas pricing in Europe related to the war in Ukraine. These higher costs are expected to be offset by higher pricing in refining markets. Volume is expected to grow across each of the Ketjen businesses. The fluidized catalytic cracking (“FCC”) market has recovered from the COVID-19 pandemic as a result of increased travel and depletion of global gasoline inventories. Hydroprocessing catalysts (“HPC”) demand tends to be lumpier than FCC demand, but is expected to see a prolonged recovery due to refineries pushing out turnarounds. In addition, the Ketjen business is seeking contingent business interruption insurance settlements for lost income from 2019 to 2022 due to multiple incidents with one of its customers. If we prevail with these claims, we could receive these settlements in multiple distributions in 2023, totaling up to an additional $47 million. Our decision to retain this business as a separate, wholly-owned subsidiary is intended to better meet customer needs and foster talent required to deliver in a competitive global environment.On a longer-term basis, we believe increased global demand for transportation fuels, new refinery start-ups and ongoing adoption of cleaner fuels will be the primary drivers of growth in our Ketjen business. We believe delivering superior end-use performance continues to be the most effective way to create sustainable value in the refinery catalysts industry. We also believe our technologies continue to provide significant performance and financial benefits to refiners challenged to meet tighter regulations around the world, including those managing new contaminants present in North America tight oil, and those in the Middle East and Asia seeking to use heavier feedstock while pushing for higher propylene yields. Longer-term, we believe that the global crude supply will get heavier and more sour, a trend that bodes well for our catalysts portfolio. With superior technology and production capacities, and expected growth in end market demand, we believe that Ketjen remains well-positioned for the future. In performance catalyst solutions (“PCS”), we expect growth on a longer-term basis in our organometallics business due to growing global demand for plastics driven by rising standards of living and infrastructure spending.Corporate: We continue to focus on cash generation, working capital management and process efficiencies. We expect our global effective tax rate will vary based on the locales in which income is actually earned and remains subject to potential volatility from changing legislation in the United States, such as the Inflation Reduction Act and the CHIPS and Science Act of 2022, and other tax jurisdictions.55Albemarle Corporation and SubsidiariesActuarial gains and losses related to our defined benefit pension and OPEB plan obligations are reflected in Corporate as a component of non-operating pension and OPEB plan costs under mark-to-market accounting. Results for the year ended December 31, 2022 include an actuarial gain of $37.0 million ($26.5 million after income taxes), as compared to a loss of $56.9 million ($43.6 million after income taxes) for the year ended December 31, 2021.We remain committed to evaluating the merits of any opportunities that may arise for acquisitions or other business development activities that will complement our business footprint. Additional information regarding our products, markets and financial performance is provided at our website, www.albemarle.com. Our website is not a part of this document nor is it incorporated herein by reference.Results of OperationsThe following data and discussion provides an analysis of certain significant factors affecting our results of operations during the periods included in the accompanying consolidated statements of income.Discussion of our results of operations for the year ended December 31, 2021 compared to the year ended December 31, 2020 can be found in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021.Comparison of 2022 to 2021Selected Financial DataNet SalesIn thousands20222021$ Change% ChangeNet sales$7,320,104 $3,327,957 $3,992,147 120 %•$3.5 billion of favorable pricing from each of our businesses, primarily in Lithium•$698.6 million of higher sales volume from each of our businesses, primarily in Lithium•$75.1 million decrease in net sales following the sale of the FCS business on June 1, 2021•$177.8 million of unfavorable currency translation resulting from the stronger U.S. Dollar against various currenciesGross ProfitIn thousands20222021$ Change% ChangeGross profit$3,074,587 $997,971 $2,076,616 208 %Gross profit margin42.0 %30.0 %•Favorable pricing impacts and higher sales volume in all businesses, primarily in Lithium•Increased commission expenses in Chile resulting from the higher pricing in Lithium•Increased utility costs, primarily natural gas in Europe, and freight costs in each of our businesses•Unfavorable currency exchange impacts resulting from the stronger U.S. Dollar against various currenciesSelling, General and Administrative (“SG&A”) ExpensesIn thousands20222021$ Change% ChangeSelling, general and administrative expenses$524,145 $441,482 $82,663 19 %Percentage of Net sales7.2 %13.3 %•Higher compensation, including incentive-based, expenses across all businesses and Corporate•Increase in professional fees for various growth and improvement projects•Partially offset by productivity improvements and a reduction in administrative costs•2021 included a $20.0 million charitable contribution, using a portion of the proceeds received from the FCS divestiture, to the Albemarle Foundation, in addition to the normal annual contributions•2021 also included $11.5 million of legal fees related to a legacy Rockwood legal matter and $9.8 million of expenses in 2021 primarily related to non-routine labor and compensation related costs that are outside normal compensation arrangements56Albemarle Corporation and SubsidiariesResearch and Development ExpensesIn thousands20222021$ Change% ChangeResearch and development expenses$71,981 $54,026 $17,955 33 %Percentage of Net sales1.0 %1.6 %•Increased research and development spending in each of our businessesLoss (Gain) on Sale of Business/Interest in Properties, NetIn thousands20222021$ Change% ChangeLoss (gain) on sale of business/interest in properties, net$8,400 $(295,971)$304,371 •2022 expense related to cost overruns for MRL’s 40% interest in lithium hydroxide conversion assets being built in Kemerton, Western Australia•2021 included a gain of $428.4 million resulting from the sale of the FCS business on June 1, 2021•A $132.4 million expense related to cost overruns for MRL’s 40% interest in lithium hydroxide conversion assets being built in Kemerton in 2021Interest and Financing ExpensesIn thousands20222021$ Change% ChangeInterest and financing expenses$(122,973)$(61,476)$(61,497)100 %•2022 included a $19.2 million loss on early extinguishment of debt, representing the tender premiums, fees, unamortized discounts, unamortized deferred financing costs and accelerated amortization of the interest rate swapbalance from the redemption of debt during the second quarter of 2022•2022 also included an expense of $17.5 million related to the correction of out of period errors regarding overstatedcapitalized interest values in prior periods•2021 included a $29.0 million loss on early extinguishment of debt, representing the tender premiums, fees,unamortized discounts and unamortized deferred financing costs from the redemption of debt during the first quarterof 2021•Increased debt balance during 2022 compared to 2021 following the issuance of $1.7 billion in new senior notesOther Income (Expenses), NetIn thousands20222021$ Change% ChangeOther income (expenses), net$86,356 $(603,340)$689,696 (114)%•2021 included $657.4 million of additional expense recorded following the settlement of an arbitration ruling for a prior legal matter. See Note 17, “Commitments and Contingencies,” to our consolidated financial statements included in Part II, Item 8 of this report for further details•$39.4 million of indemnification expenses in 2021 primarily to revise an indemnification estimate for an ongoing tax-related matter of a previously disposed business in Germany•$21.8 million increase in foreign exchange losses•$5.3 million increase in income from accretion of discount in preferred equity of Grace subsidiary acquired as a portion of the proceeds of the FCS sale•$57.0 million of pension and OPEB credits (including mark-to-market actuarial gains of $37.0 million) in 2022 as compared to $78.8 million of pension and OPEB credits (including mark-to-market actuarial gains of $56.9 million) in 2021•The mark-to-market actuarial gain in 2022 is primarily attributable to a significant increase in the weighted-average discount rate to 5.46% from 2.86% for our U.S. pension plans and to 4.04% from 1.44% for our foreign pension plans to reflect market conditions as of the December 31, 2022 measurement date. This was partially offset by a lower return on pension plan assets in 2022 than was expected, as a result of overall market and investment portfolio performance. The weighted-average actual return on our U.S. and foreign pension plan assets was (17.94)% versus an expected return of 6.48%.•The mark-to-market actuarial loss in 2021 is primarily attributable to a higher return on pension plan assets in 2021 than was expected, as a result of overall market and investment portfolio performance. The weighted-average actual return on our U.S. and foreign pension plan assets was 8.42% versus an expected return of 6.50%. In addition, there was an increase in the weighted-average discount rate to 2.86% from 2.50% for our U.S. pension plans and to 1.44% from 0.86% for our foreign pension plans to reflect market conditions as of the December 31, 2021 measurement date.57Albemarle Corporation and SubsidiariesIncome Tax ExpenseIn thousands20222021$ Change% ChangeIncome Tax Expense$390,588 $29,446 $361,142 1,226 %Effective income tax rate16.1 %22.0 %•2022 includes a $91.8 million tax benefit resulting from the release of a valuation allowance in Australia, a $72.6 million benefit resulting from foreign-derived intangible income, partially offset by a $50.6 million current year tax reserve related to an uncertain tax position in Chile•Change in geographic mix in earnings in 2022•2021 included $148.9 million tax benefit resulting from an accrual recorded following an arbitration ruling related to a prior legal matter. See Note 17, “Commitments and Contingencies,” to our consolidated financial statements included in Part II, Item 8 of this report for further details•$97.5 million one-time tax expense recorded for the gain on the sale of the FCS business in 2021•$27.9 million discrete tax benefit recorded in 2021 related to the indemnification estimate of an ongoing tax-related matter in Germany•2021 included a discrete tax expense due to an out-of-period adjustment for an overstated deferred tax liability recorded during the three-month period ended December 31, 2017Equity in Net Income of Unconsolidated InvestmentsIn thousands20222021$ Change% ChangeEquity in net income of unconsolidated investments$772,275 $95,770 $676,505 706 %•Increased earnings due to strong pricing and volume increases from the Talison joint venture•$10.9 million of favorable foreign exchange impacts from the Talison joint ventureNet Income Attributable to Noncontrolling InterestsIn thousands20222021$ Change% ChangeNet income attributable to noncontrolling interests$(125,315)$(76,270)$(49,045)64 %▪Increase in consolidated income related to our JBC joint venture due to favorable pricingNet Income Attributable to Albemarle CorporationIn thousands20222021$ Change% ChangeNet income attributable to Albemarle Corporation$2,689,816 $123,672 $2,566,144 2,075 %Percentage of Net Sales36.7 %3.7 %Basic earnings per share$22.97 $1.07 $21.90 2,047 %Diluted earnings per share$22.84 $1.06 $21.78 2,055 %▪Favorable pricing and increased sales volume in all businesses, particularly in Lithium▪Increased earnings from Talison joint venture▪Productivity improvements and a reduction in administrative costs▪Increased commission expenses in Chile resulting from the higher pricing in Lithium▪$504.5 million, net of income taxes, of additional expense recorded following the settlement of an arbitration ruling for a prior legal matter in 2021▪Gain on sale of FCS business of $330.9 million, net of tax in 2021▪$132.4 million expense related to cost overruns for MRL’s 40% interest in lithium hydroxide conversion assets being built in Kemerton in 2021▪Increased utility, primarily natural gas in Europe, and freight costs in each of our businesses▪Increased SG&A expenses, primarily related to increased compensation expense▪Increased interest and financing expenses due to higher debt balances▪Mark-to-market actuarial gains of $26.5 million, net of income taxes, recorded in 2022 compared to mark-to-market actuarial gains of $43.6 million, net of income taxes, recorded in 202158Albemarle Corporation and SubsidiariesOther Comprehensive (Loss) Income, Net of TaxIn thousands20222021$ Change% ChangeOther comprehensive (loss) income, net of tax$(168,295)$(66,478)$(101,817)153 %•Foreign currency translation$(171,295)$(74,385)$(96,910)130 %▪2022 included unfavorable movements in the Chinese Renminbi of approximately $74 million, the Euro of approximately $64 million, the Japanese Yen of approximately $14 million, the Taiwanese Dollar of approximately $9 million, the South Korean Won of approximately $5 million and the net unfavorable variance in other currencies totaling approximately $6 million▪2022 included a $0.9 million gain compared to a loss of $5.4 million in 2021, representing adjustments to the fair value of our available-for-sale debt securities▪2021 included unfavorable movements in the Euro of approximately $62 million, the Japanese Yen of approximately $8 million, the Brazilian Real of approximately $5 million, the South Korean Won of approximately $4 million and the net unfavorable variance in other currencies totaling approximately $5 million, partially offset by favorable movements in the Chinese Renminbi of approximately $10 million•Net investment hedge$— $5,110 $(5,110)(100)%•Cash flow hedge$(4,399)$174 $(4,573)*•Interest rate swap$7,399 $2,623 $4,776 182 %▪Accelerated the amortization of the remaining interest rate swap balance in 2022 as a result of the repayment of the 4.15% senior notes in 2024•Percentage calculation is not meaningfulSegment Information Overview. We have identified three reportable segments according to the nature and economic characteristics of our products as well as the manner in which the information is used internally by the Company’s chief operating decision maker to evaluate performance and make resource allocation decisions. During 2022, our reportable business segments consisted of: (1) Lithium, (2) Bromine and (3) Catalysts.Summarized financial information concerning our reportable segments is shown in the following tables. The “All Other” category included only the FCS business that did not fit into any of the Company’s core businesses. On June 1, 2021, the Company completed the sale of the FCS business. Amounts in the “All Other” category represent activity in this business until divested on June 1, 2021.The Corporate category is not considered to be a segment and includes corporate-related items not allocated to the operating segments. Pension and OPEB service cost (which represents the benefits earned by active employees during the period) and amortization of prior service cost or benefit are allocated to the reportable segments, All Other, and Corporate, whereas the remaining components of pension and OPEB benefits cost or credit (“Non-operating pension and OPEB items”) are included in Corporate. Segment data includes intersegment transfers of raw materials at cost and allocations for certain corporate costs.Our chief operating decision maker uses adjusted EBITDA (as defined below) to assess the ongoing performance of the Company’s business segments and to allocate resources. We define adjusted EBITDA as earnings before interest and financing expenses, income tax expense, depreciation and amortization, as adjusted on a consistent basis for certain non-operating, non-recurring or unusual items in a balanced manner and on a segment basis. These non-operating, non-recurring or unusual items may include acquisition and integration-related costs, gains or losses on sales of businesses, restructuring charges, facility divestiture charges, certain litigation and arbitration costs and charges, non-operating pension and OPEB items and other significant non-recurring items. In addition, management uses adjusted EBITDA for business planning purposes and as a significant component in the calculation of performance-based compensation for management and other employees. We reported adjusted EBITDA because management believes it provides transparency to investors and enables period-to-period comparability of financial performance. Total adjusted EBITDA is a financial measure that is not required by, or presented in accordance with, the generally accepted accounting principles in the United States (“U.S. GAAP”). Adjusted EBITDA should not be considered as an alternative to Net (loss) income attributable to Albemarle Corporation, the most directly comparable financial measure calculated and reported in accordance with U.S. GAAP, or any other financial measure reported in accordance with U.S. GAAP.59Albemarle Corporation and SubsidiariesYear Ended December 31,Percentage Change2022%2021%2022 vs. 2021(In thousands, except percentages)Net sales:Lithium$5,008,850 68.4 %$1,363,284 41.0 %267 %Bromine1,411,682 19.3 %1,128,343 33.9 %25 %Catalysts899,572 12.3 %761,235 22.9 %18 %All Other— — %75,095 2.2 %(100)%Total net sales$7,320,104 100.0 %$3,327,957 100.0 %120 %Adjusted EBITDA:Lithium$3,102,662 89.3 %$479,538 55.1 %547 %Bromine456,916 13.1 %360,682 41.4 %27 %Catalysts28,732 0.8 %106,941 12.3 %(73)%All Other— — %29,858 3.4 %(100)%Corporate(112,453)(3.2)%(106,045)(12.2)%6 %Total adjusted EBITDA$3,475,857 100.0 %$870,974 100.0 %299 %60Albemarle Corporation and SubsidiariesSee below for a reconciliation of adjusted EBITDA, the non-GAAP financial measure, from Net income attributable to Albemarle Corporation, the most directly comparable financial measure calculated and reported in accordance with U.S. GAAP, (in thousands):LithiumBromineCatalystsAll OtherCorporateConsolidated Total2022Net income (loss) attributable to Albemarle Corporation$2,903,076 $402,820 $(27,104)$— $(588,976)$2,689,816 Depreciation and amortization189,347 54,096 51,417 — 5,981 300,841 Loss on sale of interest in properties(a)8,400 — — — — 8,400 Acquisition and integration related costs(b)— — — — 16,259 16,259 Interest and financing expenses(c)— — — — 122,973 122,973 Income tax expense— — — — 390,588 390,588 Non-operating pension and OPEB items— — — — (57,032)(57,032)Other(d)1,839 — 4,419 — (2,246)4,012 Adjusted EBITDA$3,102,662 $456,916 $28,732 $— $(112,453)$3,475,857 2021Net income (loss) attributable to Albemarle Corporation$192,244 $309,501 $55,353 $27,988 $(461,414)$123,672 Depreciation and amortization138,772 51,181 51,588 1,870 10,589 254,000 Restructuring and other(e)— — — — 3,027 3,027 Loss (gain) on sale of business/interest in properties, net(f)132,400 — — — (428,371)(295,971)Acquisition and integration related costs(b)— — — — 12,670 12,670 Interest and financing expenses(c)— — — — 61,476 61,476 Income tax expense— — — — 29,446 29,446 Non-operating pension and OPEB items— — — — (78,814)(78,814)Legal accrual(g)— — — — 657,412 657,412 Albemarle Foundation contribution(h)— — — — 20,000 20,000 Indemnification adjustments(i)— — — — 39,381 39,381 Other(j)16,122 — — — 28,553 44,675 Adjusted EBITDA$479,538 $360,682 $106,941 $29,858 $(106,045)$870,974 (a)Expense recorded as a result of revised estimates of the obligation to construct certain lithium hydroxide conversion assets in Kemerton, Western Australia, due to cost overruns from supply chain, labor and COVID-19 pandemic related issues. The corresponding obligation was recorded in Accrued liabilities to be transferred to Mineral Resources Limited (“MRL”), which maintains a 40% ownership interest in these Kemerton assets.(b)See Note 2, “Acquisitions,” for additional information.(c)Included in Interest and financing expenses is a loss on early extinguishment of debt of $19.2 million and $29.0 million for the years ended December 31, 2022 and 2021, respectively. See Note 14, “Long-term Debt,” for additional information. In addition, Interest and financing expenses for the year ended December 31, 2022 includes the correction of an out of period error of $17.5 million related to the overstatement of capitalized interest in prior periods.(d)Included amounts for the year ended December 31, 2022 recorded in:•Cost of goods sold - $2.7 million of expense related to one-time retention payments for certain employees during the Catalysts strategic review and business unit realignment, and $0.5 million related to the settlement of a legal matter resulting from a prior acquisition.•SG&A - $4.3 million related to facility closure expenses of offices in Germany, $2.8 million of charges for environmental reserves at sites not part of our operations, $2.8 million of shortfall contributions for our multiemployer plan financial improvement plan, $1.9 million of expense primarily related to one-time retention payments for certain employees during the Catalysts strategic review, partially offset by $4.3 million of gains from the sale of legacy properties not part of our operations.•Other income (expenses), net - $4.3 million net gain related to the fair value adjustment of equity securities in a public company, a $3.0 million gain from the reversal of a liability related to a previous divestiture, a $2.0 million gain relating to the adjustment of an environmental reserve at non-operating businesses we have previously divested and a $0.6 million gain related to a 61Albemarle Corporation and Subsidiariessettlement received from a legal matter in a prior period, partially offset by a $3.2 million loss resulting from the adjustment of indemnification related to previously disposed businesses.(e)In 2021, we recorded facility closure related to offices in Germany, and severance expenses in Germany and Belgium, in SG&A.(f)Includes a $428.4 million gain related to the FCS divestiture recorded during the year ended December 31, 2021. In addition, includes a $132.4 million expense related to anticipated cost overruns for MRL’s 40% interest in lithium hydroxide conversion assets being built in Kemerton.(g)Loss recorded in Other income (expenses), net for the year ended December 31, 2021 related to the settlement of an arbitration ruling for a prior legal matter. See Note 17, “Commitments and Contingencies,” for further details.(h)Included in SG&A is a charitable contribution, using a portion of the proceeds received from the FCS divestiture, to the Albemarle Foundation, a non-profit organization that sponsors grants, health and social projects, educational initiatives, disaster relief, matching gift programs, scholarships and other charitable initiatives in locations where the Company’s employees live and the Company operates. This contribution is in addition to the normal annual contribution made to the Albemarle Foundation by the Company, and is significant in size and nature in that it is intended to provide more long-term benefits in these communities.(i)Included in Other income (expenses), net to revise an indemnification estimate for an ongoing tax-related matter of a previously disposed business in Germany. A corresponding discrete tax benefit of $27.9 million was recorded in Income tax expense during the same period, netting to an expected cash obligation of approximately $11.5 million.(j)Included amounts for the year ended December 31, 2021 recorded in:•Cost of goods sold - $10.5 million of expense related to a legal matter as part of a prior acquisition in our Lithium business.•SG&A - $11.5 million of legal fees related to a legacy Rockwood legal matter noted above, $9.8 million of expenses primarily related to non-routine labor and compensation related costs that are outside normal compensation arrangements, a $4.0 million loss resulting from the sale of property, plant and equipment and $3.8 million of charges for environmental reserves at a sites not part of our operations.•Other income (expenses), net - $4.8 million of net expenses primarily related to asset retirement obligation charges to update of an estimate at a site formerly owned by Albemarle.LithiumIn thousands20222021$ Change% ChangeNet sales$5,008,850 $1,363,284 $3,645,566 267 %▪$3.2 billion of favorable pricing impacts, reflecting tight market conditions, primarily in battery- and tech-grade carbonate and hydroxide, as well as greater volumes sold under index-referenced and variable-priced contracts, and mix▪$549.2 million of higher sales volume, driven by the La Negra III/IV expansion in Chile and increased tolling volume to meet growing customer demand▪$133.1 million of unfavorable currency translation resulting from the stronger U.S. Dollar against various currenciesAdjusted EBITDA$3,102,662 $479,538 $2,623,124 547 %•Favorable pricing impacts and higher sales volume•Higher equity in net income from the Talison joint venture, driven by increased pricing and sales volume•Savings from designed productivity improvements•Increased commission expenses in Chile resulting from the higher pricing in Lithium•Increased SG&A expenses from higher compensation and other administrative costs•Increased utility and freight costs•Increased spending for investments to support business growth•$2.2 million of unfavorable currency translation resulting from a stronger Chilean PesoBromineIn thousands20222021$ Change% ChangeNet sales$1,411,682 $1,128,343 $283,339 25 %•$260.6 million of favorable pricing impacts, primarily in the fire safety solutions division•$49.8 million of higher sales volume related to increased demand across all products•$26.9 million of unfavorable currency translation resulting from the stronger U.S. Dollar against various currenciesAdjusted EBITDA$456,916 $360,682 $96,234 27 %•Favorable pricing impacts and higher sales volume•Increased freight costs, partially due to trucker strikes in Jordan during the fourth quarter of 2022•Increased utility costs and raw material prices, primarily due to the higher costs of bisphenol A (BPA)•Increased SG&A expenses from higher compensation costs•2021 included higher production and utility costs of approximately $6 million resulting from the U.S. Gulf Coast winter storm•$19.9 million of unfavorable currency translation resulting from the stronger U.S. Dollar against various currencies62Albemarle Corporation and SubsidiariesCatalystsIn thousands20222021$ Change% ChangeNet sales$899,572 $761,235 $138,337 18 %•$99.7 million of higher sales volume, primarily from the timing of clean fuel technologies sales, which has lumpier demand; sales volume was negatively affected by the impacts of a winter freeze in the U.S. during the fourth quarter of 2022•$56.5 million of favorable pricing impacts, primarily in clean fuel technologies and PCS•$17.8 million of unfavorable currency translation resulting from the stronger U.S. Dollar against various currenciesAdjusted EBITDA$28,732 $106,941 $(78,209)(73)%•Increased utility costs, primarily natural gas in Europe•Increased raw material and freight costs•Higher sales volume and favorable pricing impacts; adjusted EBITDA was negatively affected by the impacts of a winter freeze in the U.S. during the fourth quarter of 2022•2022 benefited from $7 million of government grants from the Netherlands in response to losses during the COVID-19 pandemic as compared to $19 million of these grants in 2021•Recorded $10 million gain from contingent business interruption insurance settlements resulting from lost income during 2019 to 2022 due to multiple incidents at one of its customers•2021 included higher production and utility costs of approximately $16 million resulting from the U.S. Gulf Coast winter storm•2021 included a $3.1 million out-of-period adjustment expense recorded in Cost of goods sold to correct inventory foreign exchange values relating to prior year periodsAll OtherIn thousands20222021$ Change% ChangeNet sales$— $75,095 $(75,095)(100)%▪Decreased volume resulting from the sale of the FCS business in the second quarter of 2021Adjusted EBITDA$— $29,858 $(29,858)(100)%▪Decreased volume resulting from the sale of the FCS business in the second quarter of 2021CorporateIn thousands20222021$ Change% ChangeAdjusted EBITDA$(112,453)$(106,045)$(6,408)6 %▪Increase in compensation costs, including incentive-based compensation▪$10.9 million of unfavorable currency exchange impacts, including a $10.9 million increase in foreign currency impacts from our Talison joint ventureSummary of Critical Accounting Policies and EstimatesEstimates, Assumptions and ReclassificationsThe preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of revenues, expenses, assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Listed below are the estimates and assumptions that we consider to be critical in the preparation of our financial statements.Property, Plant and Equipment. We assign the useful lives of our property, plant and equipment based upon our internal engineering estimates which are reviewed periodically. The estimated useful lives of our property, plant and equipment range from two to sixty years and depreciation is recorded on the straight-line method, with the exception of our mineral rights and reserves, which are depleted on a units-of-production method. We evaluate the recovery of our property, plant and equipment by comparing the net carrying value of the asset group to the undiscounted net cash flows expected to be generated from the use and eventual disposition of that asset group when events or changes in circumstances indicate that its carrying amount may not be recoverable. If the carrying amount of the asset group is not recoverable, the fair value of the asset group is measured and if the carrying amount exceeds the fair value, an impairment loss is recognized.Acquisition Method of Accounting. We recognize the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their estimated fair values on the date of acquisition for acquired businesses. Determining the fair value of these items requires management’s judgment and the utilization of independent valuation 63Albemarle Corporation and Subsidiariesspecialists and involves the use of significant estimates and assumptions with respect to the timing and amounts of future cash flows and discount rates, among other items. When acquiring mineral reserves, the fair value is estimated using an excess earnings approach, which requires management to estimate future cash flows, net of capital investments in the specific operation. Management’s cash flow projections involved the use of significant estimates and assumptions with respect to the expected production of the mine over the estimated time period, sales prices, shipment volumes, and expected profit margins. The present value of the projected net cash flows represents the preliminary fair value assigned to mineral reserves. The discount rate is a significant assumption used in the valuation model. The judgments made in the determination of the estimated fair value assigned to the assets acquired, the liabilities assumed and any noncontrolling interest in the investee, as well as the estimated useful life of each asset and the duration of each liability, can materially impact the financial statements in periods after acquisition, such as through depreciation and amortization expense. For more information on our acquisitions and application of the acquisition method, see Note 2, “Acquisitions,” to our consolidated financial statements included in Part II, Item 8 of this report.Income Taxes. We assume the deductibility of certain costs in our income tax filings, and we estimate the future recovery of deferred tax assets, uncertain tax positions and indefinite investment assertions.Environmental Remediation Liabilities. We estimate and accrue the costs required to remediate a specific site depending on site-specific facts and circumstances. Cost estimates to remediate each specific site are developed by assessing (i) the scope of our contribution to the environmental matter, (ii) the scope of the anticipated remediation and monitoring plan and (iii) the extent of other parties’ share of responsibility.Actual results could differ materially from the estimates and assumptions that we use in the preparation of our financial statements.Revenue RecognitionRevenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services, and is recognized when performance obligations are satisfied under the terms of contracts with our customers. A performance obligation is deemed to be satisfied when control of the product or service is transferred to our customer. The transaction price of a contract, or the amount we expect to receive upon satisfaction of all performance obligations, is determined by reference to the contract’s terms and includes adjustments, if applicable, for any variable consideration, such as customer rebates, noncash consideration or consideration payable to the customer, although these adjustments are generally not material. Where a contract contains more than one distinct performance obligation, the transaction price is allocated to each performance obligation based on the standalone selling price of each performance obligation, although these situations do not occur frequently and are generally not built into our contracts. Any unsatisfied performance obligations are not material. Standalone selling prices are based on prices we charge to our customers, which in some cases are based on established market prices. Sales and other similar taxes collected from customers on behalf of third parties are excluded from revenue. Our payment terms are generally between 30 to 90 days, however, they vary by market factors, such as customer size, creditworthiness, geography and competitive environment.All of our revenue is derived from contracts with customers, and almost all of our contracts with customers contain one performance obligation for the transfer of goods where such performance obligation is satisfied at a point in time. Control of a product is deemed to be transferred to the customer upon shipment or delivery. Significant portions of our sales are sold free on board shipping point or on an equivalent basis, while delivery terms of other transactions are based upon specific contractual arrangements. Our standard terms of delivery are generally included in our contracts of sale, order confirmation documents and invoices, while the timing between shipment and delivery generally ranges between 1 and 45 days. Costs for shipping and handling activities, whether performed before or after the customer obtains control of the goods, are accounted for as fulfillment costs.The Company currently utilizes the following practical expedients, as permitted by Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers:•All sales and other pass-through taxes are excluded from contract value;•In utilizing the modified retrospective transition method, no adjustment was necessary for contracts that did not cross over the reporting year;•We will not consider the possibility of a contract having a significant financing component (which would effectively attribute a portion of the sales price to interest income) unless, if at contract inception, the expected payment terms (from time of delivery or other relevant criterion) are more than one year;64Albemarle Corporation and Subsidiaries•If our right to customer payment is directly related to the value of our completed performance, we recognize revenue consistent with the invoicing right; and•We expense as incurred all costs of obtaining a contract incremental to any costs/compensation attributable to individual product sales/shipments for contracts where the amortization period for such costs would otherwise be one year or less.Certain products we produce are made to our customer’s specifications where such products have no alternative use or would need significant rework costs in order to be sold to another customer. In management’s judgment, control of these arrangements is transferred to the customer at a point in time (upon shipment or delivery) and not over the time they are produced. Therefore revenue is recognized upon shipment or delivery of these products.Costs incurred to obtain contracts with customers are not significant and are expensed immediately as the amortization period would be one year or less. When the Company incurs pre-production or other fulfillment costs in connection with an existing or specific anticipated contract and such costs are recoverable through margin or explicitly reimbursable, such costs are capitalized and amortized to Cost of goods sold on a systematic basis that is consistent with the pattern of transfer to the customer of the goods or services to which the asset relates, which is less than one year. We record bad debt expense in specific situations when we determine the customer is unable to meet its financial obligation.Goodwill and Other Intangible AssetsWe account for goodwill and other intangibles acquired in a business combination in conformity with current accounting guidance which requires goodwill and indefinite-lived intangible assets to not be amortized.We test goodwill for impairment by comparing the estimated fair value of our reporting units to the related carrying value. Our reporting units are either our operating business segments or one level below our operating business segments for which discrete financial information is available and for which operating results are regularly reviewed by the business management. In applying the goodwill impairment test, we initially perform a qualitative test (“Step 0”), where we first assess qualitative factors to determine whether it is more likely than not that the fair value of the reporting units is less than its carrying value. Qualitative factors may include, but are not limited to, economic conditions, industry and market considerations, cost factors, overall financial performance of the reporting units and other entity and reporting unit specific events. If after assessing these qualitative factors, we determine it is “more-likely-than-not” that the fair value of the reporting unit is less than the carrying value, we perform a quantitative test (“Step 1”). During Step 1, we estimate the fair value based on present value techniques involving future cash flows. Future cash flows for all reporting units include assumptions about revenue growth rates, adjusted EBITDA margins, discount rate as well as other economic or industry-related factors. For the Refining Solutions reporting unit, the revenue growth rates, adjusted EBITDA margins and the discount rate were deemed to be significant assumptions. Significant management judgment is involved in estimating these variables and they include inherent uncertainties since they are forecasting future events. We use a Weighted Average Cost of Capital (“WACC”) approach to determine our discount rate for goodwill recoverability testing. Our WACC calculation incorporates industry-weighted average returns on debt and equity from a market perspective. The factors in this calculation are largely external to Albemarle and, therefore, are beyond our control. We perform a sensitivity analysis by using a range of inputs to confirm the reasonableness of these estimates being used in the goodwill impairment analysis. We test our recorded goodwill for impairment in the fourth quarter of each year or upon the occurrence of events or changes in circumstances that would more likely than not reduce the fair value of our reporting units below their carrying amounts. We performed our annual goodwill impairment test as of October 31, 2022 and no evidence of impairment was noted from the analysis. As a result, we concluded there was no impairment as of that date. However, if the adjusted EBITDA or discount rate estimates for the Refining Solutions reporting unit negatively changed by 10%, the Refining Solutions fair value would be below its carrying value.We assess our indefinite-lived intangible assets, which include trade names and trademarks, for impairment annually and between annual tests if events or changes in circumstances indicate that it is more likely than not that the asset is impaired. The indefinite-lived intangible asset impairment standard allows us to first assess qualitative factors to determine if a quantitative impairment test is necessary. Further testing is only required if we determine, based on the qualitative assessment, that it is more likely than not that the indefinite-lived intangible asset’s fair value is less than its carrying amount. If we determine based on the qualitative assessment that it is more likely than not that the asset is impaired, an impairment test is performed by comparing the fair value of the indefinite-lived intangible asset to its carrying amount. During the year ended December 31, 2022, no evidence of impairment was noted from the analysis for our indefinite-lived intangible assets.Definite-lived intangible assets, such as purchased technology, patents and customer lists, are amortized over their estimated useful lives generally for periods ranging from five to twenty-five years. Except for customer lists and relationships associated with the majority of our Lithium business, which are amortized using the pattern of economic benefit method, 65Albemarle Corporation and Subsidiariesdefinite-lived intangible assets are amortized using the straight-line method. We evaluate the recovery of our definite-lived intangible assets by comparing the net carrying value of the asset group to the undiscounted net cash flows expected to be generated from the use and eventual disposition of that asset group when events or changes in circumstances indicate that its carrying amount may not be recoverable. If the carrying amount of the asset group is not recoverable, the fair value of the asset group is measured and if the carrying amount exceeds the fair value, an impairment loss is recognized. See Note 12, “Goodwill and Other Intangibles,” to our consolidated financial statements included in Part II, Item 8 of this report.Pension Plans and Other Postretirement BenefitsUnder authoritative accounting standards, assumptions are made regarding the valuation of benefit obligations and the performance of plan assets. As required, we recognize a balance sheet asset or liability for each of our pension and OPEB plans equal to the plan’s funded status as of the measurement date. The primary assumptions are as follows:•Discount Rate—The discount rate is used in calculating the present value of benefits, which is based on projections of benefit payments to be made in the future.•Expected Return on Plan Assets—We project the future return on plan assets based on prior performance and future expectations for the types of investments held by the plans as well as the expected long-term allocation of plan assets for these investments. These projected returns reduce the net benefit costs recorded currently.•Rate of Compensation Increase—For salary-related plans, we project employees’ annual pay increases, which are used to project employees’ pension benefits at retirement.•Mortality Assumptions—Assumptions about life expectancy of plan participants are used in the measurement of related plan obligations.Actuarial gains and losses are recognized annually in our consolidated statements of income in the fourth quarter and whenever a plan is determined to qualify for a remeasurement during a fiscal year. The remaining components of pension and OPEB plan expense, primarily service cost, interest cost and expected return on assets, are recorded on a monthly basis. The market-related value of assets equals the actual market value as of the date of measurement.During 2022, we made changes to assumptions related to discount rates and expected rates of return on plan assets. We consider available information that we deem relevant when selecting each of these assumptions.Our U.S. defined benefit plans for non-represented employees are closed to new participants, with no additional benefits accruing under these plans as participants’ accrued benefits have been frozen. In selecting the discount rates for the U.S. plans, we consider expected benefit payments on a plan-by-plan basis. As a result, the Company uses different discount rates for each plan depending on the demographics of participants and the expected timing of benefit payments. For 2022, the discount rates were calculated using the results from a bond matching technique developed by Milliman, which matched the future estimated annual benefit payments of each respective plan against a portfolio of bonds of high quality to determine the discount rate. We believe our selected discount rates are determined using preferred methodology under authoritative accounting guidance and accurately reflect market conditions as of the December 31, 2022 measurement date.In selecting the discount rates for the foreign plans, we look at long-term yields on AA-rated corporate bonds when available. Our actuaries have developed yield curves based on the yields of constituent bonds in the various indices as well as on other market indicators such as swap rates, particularly at the longer durations. For the Eurozone, we apply the Aon Hewitt yield curve to projected cash flows from the relevant plans to derive the discount rate. For the U.K., the discount rate is determined by applying the Aon Hewitt yield curve for typical schemes of similar duration to projected cash flows of Albemarle’s U.K. plan. In other countries where there is not a sufficiently deep market of high-quality corporate bonds, we set the discount rate by referencing the yield on government bonds of an appropriate duration.At December 31, 2022, the weighted-average discount rate for the U.S. and foreign pension plans increased to 5.46% and 4.04%, respectively, from 2.86% and 1.44%, respectively, at December 31, 2021 to reflect market conditions as of the December 31, 2022 measurement date. The discount rate for the OPEB plans at December 31, 2022 and 2021 was 5.45% and 2.85%, respectively.In estimating the expected return on plan assets, we consider past performance and future expectations for the types of investments held by the plan as well as the expected long-term allocations of plan assets to these investments. For the years 2022 and 2021, the weighted-average expected rate of return on U.S. pension plan assets was 6.89%, and the weighted-average expected rate of return on foreign pension plan assets was 3.85% and 3.98%, respectively. Effective January 1, 2023, the weighted-average expected rate of return on U.S. and foreign pension plan assets is 6.88% and 4.86%, respectively.66Albemarle Corporation and SubsidiariesIn projecting the rate of compensation increase, we consider past experience in light of changes in inflation rates. At December 31, 2022 and 2021, the assumed weighted-average rate of compensation increase was 3.67% and 3.20%, respectively, for our foreign pension plans. For the purpose of measuring our U.S. pension and OPEB obligations at December 31, 2022 and 2021, we used the Pri-2012 Mortality Tables along with the MP-2021 Mortality Improvement Scale, respectively, published by the SOA.At December 31, 2022, the assumed rate of increase in the pre-65 and post-65 per capita cost of covered health care benefits for U.S. retirees was zero as the employer-paid premium caps (pre-65 and post-65) were met starting January 1, 2013.A variance in the assumptions discussed above would have an impact on the projected benefit obligations, the accrued OPEB liabilities, and the annual net periodic pension and OPEB cost. The following table reflects the sensitivities associated with a hypothetical change in certain assumptions, primarily in the U.S. (in thousands):(Favorable) Unfavorable1% Increase1% DecreaseIncrease (Decrease)in Benefit ObligationIncrease (Decrease)in Benefit CostIncrease (Decrease)in Benefit ObligationIncrease (Decrease)in Benefit CostActuarial AssumptionsDiscount Rate:Pension$(60,603)$2,670 $71,494 $(3,289)Other postretirement benefits$(2,822)$158 $3,293 $(193)Expected return on plan assets:Pension* $(5,066)* $5,066 Other postretirement benefits* $— * $— * Not applicable.Of the $528.1 million total pension and postretirement assets at December 31, 2022, $68.7 million, or approximately 13%, are measured using the net asset value as a practical expedient. Gains or losses attributable to these assets are recognized in the consolidated balance sheets as either an increase or decrease in plan assets. See Note 15, “Pension Plans and Other Postretirement Benefits,” to our consolidated financial statements included in Part II, Item 8 of this report.Income TaxesWe use the liability method for determining our income taxes, under which current and deferred tax liabilities and assets are recorded in accordance with enacted tax laws and rates. Under this method, the amounts of deferred tax liabilities and assets at the end of each period are determined using the tax rate expected to be in effect when taxes are actually paid or recovered. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not. In order to record deferred tax assets and liabilities, we are following guidance under ASU 2015-17, which requires deferred tax assets and liabilities to be classified as noncurrent on the balance sheet, along with any related valuation allowance. Tax effects are released from Accumulated Other Comprehensive Income using either the specific identification approach or the portfolio approach based on the nature of the underlying item.Deferred income taxes are provided for the estimated income tax effect of temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. Deferred tax assets are also provided for operating losses, capital losses and certain tax credit carryovers. A valuation allowance, reducing deferred tax assets, is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of such deferred tax assets is dependent upon the generation of sufficient future taxable income of the appropriate character. Although realization is not assured, we do not establish a valuation allowance when we believe it is more likely than not that a net deferred tax asset will be realized. We elected to not consider the estimated impact of potential future Corporate Alternative Minimum Tax liabilities for purposes of assessing valuation allowances on its deferred tax balances.We only recognize a tax benefit after concluding that it is more likely than not that the benefit will be sustained upon audit by the respective taxing authority based solely on the technical merits of the associated tax position. Once the recognition threshold is met, we recognize a tax benefit measured as the largest amount of the tax benefit that, in our judgment, is greater than 50% likely to be realized. Interest and penalties related to income tax liabilities are included in Income tax expense on the consolidated statements of income.67Albemarle Corporation and SubsidiariesWe are subject to income taxes in the U.S. and numerous foreign jurisdictions. Due to the statute of limitations, we are no longer subject to U.S. federal income tax audits by the Internal Revenue Service (“IRS”) for years prior to 2019. Due to the statute of limitations, we also are no longer subject to U.S. state income tax audits prior to 2017.With respect to jurisdictions outside the U.S., several audits are in process. We have audits ongoing for the years 2011 through 2022 in Germany, Italy, Belgium, South Africa, China, Canada and Chile, some of which are for entities that have since been divested.While we believe we have adequately provided for all tax positions, amounts asserted by taxing authorities could be greater than our accrued position. Accordingly, additional provisions on federal and foreign tax-related matters could be recorded in the future as revised estimates are made or the underlying matters are settled or otherwise resolved.Since the timing of resolutions and/or closure of tax audits are uncertain, it is difficult to predict with certainty the range of reasonably possible significant increases or decreases in the liability related to uncertain tax positions that may occur within the next twelve months. Our current view is that it is reasonably possible that we could record a decrease in the liability related to uncertain tax positions, relating to a number of issues, up to approximately $0.3 million as a result of closure of tax statutes. As a result of the sale of the Chemetall Surface Treatment business in 2016, we agreed to indemnify certain income and non-income tax liabilities, including uncertain tax positions, associated with the entities sold. The associated liability is recorded in Other noncurrent liabilities. See Note 16, “Other Noncurrent Liabilities,” and Note 21, “Income Taxes,” to our consolidated financial statements included in Part II, Item 8 of this report for further details.We have designated the undistributed earnings of a portion of our foreign operations as indefinitely reinvested and as a result we do not provide for deferred income taxes on the unremitted earnings of these subsidiaries. Our foreign earnings are computed under U.S. federal tax earnings and profits (“E&P”) principles. In general, to the extent our financial reporting book basis over tax basis of a foreign subsidiary exceeds these E&P amounts, deferred taxes have not been provided, as they are essentially permanent in duration. The determination of the amount of such unrecognized deferred tax liability is not practicable. We provide for deferred income taxes on our undistributed earnings of foreign operations that are not deemed to be indefinitely invested. We will continue to evaluate our permanent investment assertion taking into consideration all relevant and current tax laws.Financial Condition and LiquidityOverviewThe principal uses of cash in our business generally have been capital investments and resource development costs, funding working capital, and service of debt. We also make contributions to our defined benefit pension plans, pay dividends to our shareholders and have the ability to repurchase shares of our common stock. Historically, cash to fund the needs of our business has been principally provided by cash from operations, debt financing and equity issuances.We are continually focused on working capital efficiency particularly in the areas of accounts receivable, payables and inventory. We anticipate that cash on hand, cash provided by operating activities, proceeds from divestitures and borrowings will be sufficient to pay our operating expenses, satisfy debt service obligations, fund capital expenditures and other investing activities, fund pension contributions and pay dividends for the foreseeable future.Cash FlowOur cash and cash equivalents were $1.5 billion at December 31, 2022 as compared to $439.3 million at December 31, 2021. Cash provided by operating activities was $1.9 billion, $344.3 million and $798.9 million during the years ended December 31, 2022, 2021 and 2020, respectively.The increase in cash provided by operating activities in 2022 versus 2021 was primarily due to significantly higher earnings from the Lithium and Bromine segments and higher dividends received from unconsolidated investments, primarily from the Talison joint venture. This increase was partially offset by an increase in working capital outflow driven by higher inventory and accounts receivable balances from higher lithium pricing and increased sales. The decrease in cash provided by operating activities in 2021 versus 2020 was primarily due to the $332.5 million payment to settle a prior legal matter, lower earnings from the FCS business sold on June 1, 2021, as well as increased inventory balances and accounts receivable due to the timing of payments. This was partially offset by increased sales in our Lithium and Bromine segments. During 2022, cash on hand, cash provided by operations and the proceeds of $2.0 billion in long-term debt and credit agreements funded $1.3 billion of capital expenditures for plant, machinery and equipment, the repayment of long-term debt 68Albemarle Corporation and Subsidiariesand credit agreements of $705.0 million, the net repayment of $391.7 million of commercial paper, the final payment of $332.5 million of a settlement of an arbitration ruling for a prior legal matter and dividends to shareholders of $184.4 million. During 2021, cash on hand, cash provided by operations, net cash proceeds of $289.8 million from the sale of the FCS business, $388.5 million of commercial paper borrowings and the $1.5 billion net proceeds from our underwritten public offering of common stock funded debt principal payments of approximately $1.5 billion, early extinguishment of debt fees of $24.9 million, $332.5 million of a settlement of an arbitration ruling for a prior legal matter, $953.7 million of capital expenditures for plant, machinery and equipment, dividends to shareholders of $177.9 million, and pension and postretirement contributions of $30.3 million. During 2020, cash on hand, cash provided by operations and proceeds from borrowings of $200 million from one of our credit facilities funded $850.0 million of capital expenditures for plant, machinery and equipment, dividends to shareholders of $161.8 million, and pension and postretirement contributions of $16.4 million. In addition, during 2020 we received $11.0 million in proceeds from the sale of our ownership interest in the SOCC joint venture during and paid $22.6 million of agreed upon purchase price adjustments for the Wodgina Project acquisition. In addition, during the years ended December 31, 2022, 2021 and 2020, our consolidated joint venture, JBC, declared dividends of $274.5 million, $274.6 million and $89.9 million, respectively, which resulted in dividends paid to noncontrolling interests of $44.2 million ($53.1 million declared in 2022 was paid in the first quarter of 2023), $96.1 million and $32.1 million, respectively.On October 25, 2022, the Company completed the acquisition of all of the outstanding equity of Qinzhou, for approximately $200 million in cash, which includes a deferral of approximately $29 million to be paid in installments within a year of the acquisition closing date. Qinzhou's operations include a recently constructed lithium processing plant strategically positioned near the Port of Qinzhou in Guangxi, which began commercial production in the first half of 2022. The plant has designed annual conversion capacity of up to 25,000 metric tonnes of LCE and is capable of producing battery-grade lithium carbonate and lithium hydroxide.On May 13, 2022, the Company issued a series of notes (collectively, the “2022 Notes”) as follows:•$650.0 million aggregate principal amount of senior notes, bearing interest at a rate of 4.65% payable semi-annually on June 1 and December 1 of each year, beginning on December 1, 2022. The effective interest rate on these senior notes is approximately 4.84%. These senior notes mature on June 1, 2027.•$600.0 million aggregate principal amount of senior notes, bearing interest at a rate of 5.05% payable semi-annually on June 1 and December 1 of each year, beginning on December 1, 2022. The effective interest rate on these senior notes is approximately 5.18%. These senior notes mature on June 1, 2032.•$450.0 million aggregate principal amount of senior notes, bearing interest at a rate of 5.65% payable semi-annually on June 1 and December 1 of each year, beginning on December 1, 2022. The effective interest rate on these senior notes is approximately 5.71%. These senior notes mature on June 1, 2052.The net proceeds from the issuance of the 2022 Notes were used to repay the balance of the commercial paper notes, the remaining balance of $425.0 million of the 4.15% Senior Notes due 2024 (the “2024 Notes”) and for general corporate purposes. The 2024 Notes were originally due to mature on December 15, 2024 and bore interest at a rate of 4.15%. During the year ended December 31, 2022, the Company recorded a loss on early extinguishment of debt of $19.2 million in Interest and financing expenses, representing the tender premiums, fees, unamortized discounts and unamortized deferred financing costs from the redemption of the 2024 Notes. In addition, the loss on early extinguishment of debt includes the accelerated amortization of the interest rate swap associated with the 2024 Notes from Accumulated other comprehensive income.On June 1, 2021, we completed the sale of the FCS business to Grace for proceeds of approximately $570 million, consisting of $300 million in cash and the issuance to Albemarle of preferred equity of a Grace subsidiary having an aggregate stated value of $270 million. The preferred equity can be redeemed at Grace’s option under certain conditions and will accrue payment-in-kind dividends at an annual rate of 12% beginning on June 1, 2023, two years after issuance.On February 8, 2021, we completed an underwritten public offering of 8,496,773 shares of our common stock at a price to the public of $153.00 per share. We also granted to the underwriters an option to purchase up to an additional 1,274,509 shares, which was exercised. The total gross proceeds from this offering were approximately $1.5 billion, before deducting expenses, underwriting discounts and commissions. In the first quarter of 2021, we made the following debt principal payments using the net proceeds from this underwritten public offering:•€123.8 million of the 1.125% notes due in November 2025•€393.0 million, the remaining balance, of the 1.875% Senior notes originally due in December 2021•$128.4 million of the 3.45% senior notes due in November 2029•$200.0 million, the remaining balance, of the floating rate notes originally due in November 202269Albemarle Corporation and Subsidiaries•€183.3 million, the outstanding balance, of the unsecured credit facility originally entered into on August 14, 2019, as amended and restated on December 15, 2020 (the “2019 Credit Facility”)•$325.0 million, the outstanding balance, of the commercial paper notesCapital expenditures were $1.3 billion, $953.7 million and $850.5 million for the years ended December 31, 2022, 2021 and 2020, respectively, and were incurred mainly for plant, machinery and equipment. We expect our capital expenditures to be between $1.7 billion and $1.9 billion in 2023 primarily for Energy Storage growth and capacity increases, including in Australia, Chile, China and Silver Peak, Nevada, as well as productivity and continuity of operations projects in all segments. Our La Negra, Chile plant has completed the qualification stage and is running as expected. Train I of our Kemerton, Western Australia plant is complete and ramping through the commissioning stage. Train II has achieved mechanical completion and transitioned to the commissioning stage, with commercial sales volume from Train II expected to begin in 2023. In addition, construction of our announced lithium conversion plant in Meishan, China is progressing on schedule, with estimated completion by the end of 2024.The Company is permitted to repurchase up to a maximum of 15,000,000 shares under a share repurchase program authorized by our Board of Directors. There were no shares of our common stock repurchased during 2022, 2021 or 2020. At December 31, 2022, there were 7,396,263 remaining shares available for repurchase under the Company’s authorized share repurchase program.Net current assets increased to approximately $2.4 billion at December 31, 2022 from $119.3 million at December 31, 2021. The increase is primarily due to increases in cash and cash equivalents from the issuance of the 2022 Notes, as well as increased inventory and accounts receivable balances from higher lithium pricing. Additional changes in the components of net current assets are primarily due to the timing of the sale of goods and other ordinary transactions leading up to the balance sheet dates. The additional changes are not the result of any policy changes by the Company, and do not reflect any change in either the quality of our net current assets or our expectation of success in converting net working capital to cash in the ordinary course of business.At December 31, 2022 and 2021, our cash and cash equivalents included $1.3 billion and $374.0 million, respectively, held by our foreign subsidiaries. The majority of these foreign cash balances are associated with earnings that we have asserted are indefinitely reinvested and which we plan to use to support our continued growth plans outside the U.S. through funding of capital expenditures, acquisitions, research, operating expenses or other similar cash needs of our foreign operations. From time to time, we repatriate cash associated with earnings from our foreign subsidiaries to the U.S. for normal operating needs through intercompany dividends, but only from subsidiaries whose earnings we have not asserted to be indefinitely reinvested or whose earnings qualify as “previously taxed income” as defined by the Internal Revenue Code. For the years ended December 31, 2022, 2021 and 2020, we repatriated approximately $1.7 million, $0.9 million and $1.8 million of cash, respectively, as part of these foreign earnings cash repatriation activities.While we continue to closely monitor our cash generation, working capital management and capital spending in light of continuing uncertainties in the global economy, we believe that we will continue to have the financial flexibility and capability to opportunistically fund future growth initiatives. Additionally, we anticipate that future capital spending, including business acquisitions, share repurchases and other cash outlays, should be financed primarily with cash flow provided by operations and cash on hand, with additional cash needed, if any, provided by borrowings. The amount and timing of any additional borrowings will depend on our specific cash requirements.Long-Term DebtWe currently have the following notes outstanding:Issue Month/YearPrincipal (in millions)Interest RateInterest Payment DatesMaturity DateNovember 2019€371.71.125%November 25November 25, 2025May 2022(a)$650.04.65%June 1 and December 1June 1, 2027November 2019€500.01.625%November 25November 25, 2028November 2019(a)$171.63.45%May 15 and November 15November 15, 2029May 2022(a)$600.05.05%June 1 and December 1June 1, 2032November 2014(a)$350.05.45%June 1 and December 1December 1, 2044May 2022(a)$450.05.65%June 1 and December 1June 1, 205270Albemarle Corporation and Subsidiaries(a) Denotes senior notes.Our senior notes are senior unsecured obligations and rank equally with all our other senior unsecured indebtedness from time to time outstanding. The notes are effectively subordinated to all of our existing or future secured indebtedness and to the existing and future indebtedness of our subsidiaries. As is customary for such long-term debt instruments, each series of notes outstanding has terms that allow us to redeem the notes before maturity, in whole at any time or in part from time to time, at a redemption price equal to the greater of (i) 100% of the principal amount of these notes to be redeemed, or (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon (exclusive of interest accrued to the date of redemption) discounted to the redemption date on a semi-annual basis using the comparable government rate (as defined in the indentures governing these notes) plus between 25 and 40 basis points, depending on the series of notes, plus, in each case, accrued interest thereon to the date of redemption. Holders may require us to purchase such notes at 101% upon a change of control triggering event, as defined in the indentures. These notes are subject to typical events of default, including bankruptcy and insolvency events, nonpayment and the acceleration of certain subsidiary indebtedness of $40 million or more caused by a nonpayment default.Our Euro notes issued in 2019 are unsecured and unsubordinated obligations and rank equally in right of payment to all our other unsecured senior obligations. The Euro notes are effectively subordinated to all of our existing or future secured indebtedness and to the existing and future indebtedness of our subsidiaries. As is customary for such long-term debt instruments, each series of notes outstanding has terms that allow us to redeem the notes before their maturity, in whole at any time or in part from time to time, at a redemption price equal to the greater of (i) 100% of the principal amount of the notes to be redeemed and (ii) the sum of the present values of the remaining scheduled payments of principal thereof and interest thereon (exclusive of interest accrued to, but excluding, the date of redemption) discounted to the redemption date on an annual basis using the bond rate (as defined in the indentures governing these notes) plus between 25 and 35 basis points, depending on the series of notes, plus, in each case, accrued and unpaid interest on the principal amount being redeemed to, but excluding, the date of redemption. Holders may require us to purchase such notes at 101% upon a change of control triggering event, as defined in the indentures. These notes are subject to typical events of default, including bankruptcy and insolvency events, nonpayment and the acceleration of certain subsidiary indebtedness exceeding $100 million caused by a nonpayment default.On October 28, 2022, we amended our revolving, unsecured credit agreement (the “2018 Credit Agreement”), which provides for borrowings of up to $1.5 billion and matures on October 28, 2027. The 2018 Credit Agreement was originally dated as of June 21, 2018, and was previously amended on August 14, 2019, May 11, 2020 and December 10, 2021. Borrowings under the 2018 Credit Agreement bear interest at variable rates based on a benchmark rate depending on the currency in which the loans are denominated, plus an applicable margin which ranges from 0.910% to 1.375%, depending on the Company’s credit rating from Standard & Poor’s Ratings Services LLC (“S&P”), Moody’s Investors Services, Inc. (“Moody’s”) and Fitch Ratings, Inc. (“Fitch”). With respect to loans denominated in U.S. dollars, interest is calculated using the term Secured Overnight Financing Rate (“SOFR”) plus a term SOFR adjustment of 0.10%, plus the applicable margin. The applicable margin on the facility was 1.125% as of December 31, 2022. There were no borrowings outstanding under the 2018 Credit Agreement as of December 31, 2022.On August 14, 2019, the Company entered into a $1.2 billion unsecured credit facility with several banks and other financial institutions, which was amended and restated on December 15, 2020 and again on December 10, 2021 (the “2019 Credit Facility”). On October 24, 2022, the 2019 Credit Facility was terminated, with the outstanding balance of $250 million repaid using cash on hand.Borrowings under the 2018 Credit Agreement are conditioned upon satisfaction of certain conditions precedent, including the absence of defaults. The Company is subject to one financial covenant, as well as customary affirmative and negative covenants. The financial covenant requires that the Company’s consolidated net funded debt to consolidated EBITDA ratio (as such terms are defined in the 2018 Credit Agreement) be less than or equal to 3.50:1 for all fiscal quarters, subject to adjustments in accordance with the terms of the 2018 Credit Agreement relating to a consummation of an acquisition where the consideration includes cash proceeds from issuance of funded debt in excess of $500 million. The 2018 Credit Agreement also contains customary default provisions, including defaults for non-payment, breach of representations and warranties, insolvency, non-performance of covenants and cross-defaults to other material indebtedness. The occurrence of an event of default under the 2018 Credit Agreement could result in all loans and other obligations becoming immediately due and payable and the 2018 Credit Agreement being terminated.On May 29, 2013, we entered into agreements to initiate a commercial paper program on a private placement basis under which we may issue unsecured commercial paper notes (the “Commercial Paper Notes”) from time-to-time up to a maximum aggregate principal amount outstanding at any time of $750.0 million. The proceeds from the issuance of the Commercial Paper Notes are expected to be used for general corporate purposes, including the repayment of other debt of the Company. The 2018 71Albemarle Corporation and SubsidiariesCredit Agreement is available to repay the Commercial Paper Notes, if necessary. Aggregate borrowings outstanding under the 2018 Credit Agreement and the Commercial Paper Notes will not exceed the $1.5 billion current maximum amount available under the 2018 Credit Agreement. The Commercial Paper Notes will be sold at a discount from par, or alternatively, will be sold at par and bear interest at rates that will vary based upon market conditions at the time of issuance. The maturities of the Commercial Paper Notes will vary but may not exceed 397 days from the date of issue. The definitive documents relating to the commercial paper program contain customary representations, warranties, default and indemnification provisions. There were no Commercial Paper Notes outstanding at December 31, 2022.When constructing new facilities or making major enhancements to existing facilities, we may have the opportunity to enter into incentive agreements with local government agencies in order to reduce certain state and local tax expenditures. Under these agreements, we transfer the related assets to various local government entities and receive bonds. We immediately lease the facilities from the local government entities and have an option to repurchase the facilities for a nominal amount upon tendering the bonds to the local government entities at various predetermined dates. The bonds and the associated obligations for the leases of the facilities offset, and the underlying assets are recorded in property, plant and equipment. We currently have the ability to transfer up to $540 million in assets under these arrangements, however, at December 31, 2022, there are no amounts outstanding under these arrangements.The non-current portion of our long-term debt amounted to $3.2 billion at December 31, 2022, compared to $2.0 billion at December 31, 2021. In addition, at December 31, 2022, we had the ability to borrow $1.5 billion under our commercial paper program and the 2018 Credit Agreement, and $179.0 million under other existing lines of credit, subject to various financial covenants under the 2018 Credit Agreement. We have the ability and intent to refinance our borrowings under our other existing credit lines with borrowings under the 2018 Credit Agreement, as applicable. Therefore, the amounts outstanding under those credit lines, if any, are classified as long-term debt. We believe that as of December 31, 2022 we were, and currently are, in compliance with all of our debt covenants. For additional information about our long-term debt obligations, see Note 14, “Long-Term Debt,” to our consolidated financial statements included in Part II, Item 8 of this report.Off-Balance Sheet ArrangementsIn the normal course of business with customers, vendors and others, we have entered into off-balance sheet arrangements, including bank guarantees and letters of credit, which totaled approximately $142.3 million at December 31, 2022. None of these off-balance sheet arrangements has, or is likely to have, a material effect on our current or future financial condition, results of operations, liquidity or capital resources.Liquidity OutlookWe anticipate that cash on hand and cash provided by operating activities, divestitures and borrowings will be sufficient to pay our operating expenses, satisfy debt service obligations, fund any capital expenditures and share repurchases, make acquisitions, make pension contributions and pay dividends for the foreseeable future. Our main focus in the short-term, during the continued uncertainty surrounding the global economy, including caused by the ongoing COVID-19 pandemic and recent inflationary trends, is to continue to maintain financial flexibility by continuing our cost savings initiative, while still protecting our employees and customers, committing to shareholder returns and maintaining an investment grade rating. Over the next three years, in terms of uses of cash, we will continue to invest in growth of the businesses and return value to shareholders. Additionally, we will continue to evaluate the merits of any opportunities that may arise for acquisitions of businesses or assets, which may require additional liquidity.Our growth investments include the recently completed acquisition all of the outstanding equity of Qinzhou for approximately $200 million in cash. Qinzhou's operations include a recently constructed lithium processing plant that has designed annual conversion capacity of up to 25,000 metric tons of LCE and is capable of producing battery-grade lithium carbonate and lithium hydroxide. In addition, we announced agreements for a strategic investment in China with plans to build a battery grade lithium conversion plant in Meishan initially targeting 50,000 metric tons of LCE per year. Construction of the Meishan facility is currently underway and is expected to be complete by the end of 2024.In October 2022, we announced we had been awarded a nearly $150 million grant from the U.S. Department of Energy to expand domestic manufacturing of batteries for EVs and the electrical grid and for materials and components currently imported from other countries. The grant funding is intended to support a portion of the anticipated cost to construct a new, commercial-scale U.S.-based lithium concentrator facility at our Kings Mountain, North Carolina, location. We expect the concentrator facility to create hundreds of construction and full-time jobs, and to supply up to 350,000 metric tons per year of spodumene concentrate to our previously announced mega-flex lithium conversion facility.72Albemarle Corporation and SubsidiariesOverall, with generally strong cash-generative businesses and no significant long-term debt maturities before November 2025, we believe we have, and will be able to maintain a solid liquidity position. Our annual maturities of long-term debt as of December 31, 2022 are as follows (in millions): 2023—$2.1; 2024—$0.0; 2025—$401.3; 2026—$0.0; 2027—$650.0; thereafter—$2,192.4. In addition, we expect to make interest payments on those long-term debt obligations as follows (in millions): 2023—$124.5; 2024—$124.5; 2025—$124.1; 2026—$119.8; 2027—$102.3; thereafter—$1,098.5. For variable-rate debt obligations, projected interest payments are calculated using the December 31, 2022 weighted average interest rate of approximately 0.07%.In addition, we expect our capital expenditures to be between $1.7 billion and $1.9 billion in 2023, primarily for Energy Storage growth and capacity increases, including in Australia, Chile, China and Silver Peak, Nevada, as well as productivity and continuity of operations projects in all segments. As of December 31, 2022, we have also committed to approximately $350.7 million of payments to third-party vendors in the normal course of business to secure raw materials for our production processes, with approximately $161.2 million to be paid in 2023. In order to secure materials, sometimes for long durations, these contracts mandate a minimum amount of product to be purchased at predetermined rates over a set timeframe.See Note 18, “Leases,” to our consolidated financial statements included in Part II, Item 8 of this report for our annual expected payments under our operating lease obligations at December 31, 2022.In 2023, we expect to pay $41.8 million of the $233.5 million balance remaining from the transition tax on foreign earnings as a result of the Tax Cuts and Jobs Act (“TCJA”) signed into law in December 2017. The one-time transition tax imposed by the TCJA is based on our total post-1986 earnings and profits that we previously deferred from U.S. income taxes and is payable over an eight-year period, with the final payment made in 2026.Contributions to our domestic and foreign qualified and nonqualified pension plans, including our supplemental executive retirement plan, are expected to approximate $15 million in 2023. We may choose to make additional pension contributions in excess of this amount. We made contributions of approximately $13.4 million to our domestic and foreign pension plans (both qualified and nonqualified) during the year ended December 31, 2022.The liability related to uncertain tax positions, including interest and penalties, recorded in Other noncurrent liabilities totaled $83.7 million and $27.7 million at December 31, 2022 and 2021, respectively. Related assets for corresponding offsetting benefits recorded in Other assets totaled $32.4 million and $32.9 million at December 31, 2022 and 2021, respectively. We cannot estimate the amounts of any cash payments during the next twelve months associated with these liabilities and are unable to estimate the timing of any such cash payments in the future at this time.Our cash flows from operations may be negatively affected by adverse consequences to our customers and the markets in which we compete as a result of moderating global economic conditions, continuing inflationary trends and reduced capital availability. We have experienced, and may continue to experience, volatility and increases in the price of certain raw materials and in transportation and energy costs as a result of global market and supply chain disruptions and the broader inflationary environment. In addition, the COVID-19 pandemic has not had a material impact on our liquidity to date; however, we cannot predict the overall impact in terms of cash flow generation as that will depend on the length and severity of the outbreak and any future pandemics and its and their impact. As a result, we are planning for various economic scenarios and actively monitoring our balance sheet to maintain the financial flexibility needed.Although we maintain business relationships with a diverse group of financial institutions as sources of financing, an adverse change in their credit standing could lead them to not honor their contractual credit commitments to us, decline funding under our existing but uncommitted lines of credit with them, not renew their extensions of credit or not provide new financing to us. While the global corporate bond and bank loan markets remain strong, periods of elevated uncertainty related to the COVID-19 pandemic or future pandamic or global economic and/or geopolitical concerns may limit efficient access to such markets for extended periods of time. If such concerns heighten, we may incur increased borrowing costs and reduced credit capacity as our various credit facilities mature. If the U.S. Federal Reserve or similar national reserve banks in other countries decide to continue tightening the monetary supply, we may incur increased borrowing costs (as interest rates increase on our variable rate credit facilities, as our various credit facilities mature or as we refinance any maturing fixed rate debt obligations), although these cost increases would be partially offset by increased income rates on portions of our cash deposits.On February 6, 2017, Huntsman International LLC (“Huntsman”), a subsidiary of Huntsman Corporation, filed a lawsuit in New York state court against Rockwood Holdings, Inc. (“Rockwood”), Rockwood Specialties, Inc., certain former executives of Rockwood and its subsidiaries, Seifollah Ghasemi, Thomas Riordan, Andrew Ross, and Michael Valente, and Albemarle. The lawsuit arises out of Huntsman’s acquisition of certain Rockwood subsidiaries in connection with a stock purchase agreement (the “SPA”), dated September 17, 2013. Before that transaction closed on October 1, 2014, Albemarle began discussions with Rockwood to purchase all outstanding equity of Rockwood and did so in a transaction that closed on 73Albemarle Corporation and SubsidiariesJanuary 12, 2015. Huntsman’s complaint asserted that certain technology that Rockwood had developed for a production facility in Augusta, Georgia, and which was among the assets that Huntsman acquired pursuant to the SPA, did not work, and that Rockwood and the defendant executives had intentionally misled Huntsman about that technology in connection with the Huntsman-Rockwood transaction. The complaint asserted claims for, among other things, fraud, negligent misrepresentation, and breach of the SPA, and sought certain costs for completing construction of the production facility.On March 10, 2017, Albemarle moved in New York state court to compel arbitration, which was granted on January 8, 2018 (although Huntsman unsuccessfully appealed that decision). Huntsman’s arbitration demand asserted claims substantially similar to those asserted in its state court complaint, and sought various forms of legal remedies, including cost overruns, compensatory damages, expectation damages, punitive damages, and restitution. After a trial, the arbitration panel issued an award on October 28, 2021, awarding approximately $600 million (including interest) to be paid by Albemarle to Huntsman, in addition to the possibility of attorney’s fees, costs and expenses. Following the arbitration panel decision, Albemarle reached a settlement with Huntsman to pay $665 million in two equal installments, with the first payment made in December 2021. The second and final payment of $332.5 million was made in May 2022. As a result, the consolidated statements of income for the year ended December 31, 2021, includes expense of $657.4 million ($508.5 million net of income tax), inclusive of estimated possible legal fees incurred by Huntsman and other related obligations, to reflect the increase in liabilities for this legal matter.As first reported in 2018, following receipt of information regarding potential improper payments being made by third-party sales representatives of our Refining Solutions business, within our Catalysts segment, we promptly retained outside counsel and forensic accountants to investigate potential violations of the Company’s Code of Conduct, the Foreign Corrupt Practices Act, and other potentially applicable laws. Based on this internal investigation, we have voluntarily self-reported potential issues relating to the use of third-party sales representatives in our Refining Solutions business, within our Catalysts segment, to the U.S. Department of Justice (“DOJ”), the SEC, and the Dutch Public Prosecutor (“DPP”), and are cooperating with the DOJ, the SEC, and the DPP in their review of these matters. In connection with our internal investigation, we have implemented, and are continuing to implement, appropriate remedial measures. We have commenced discussions with the SEC, DOJ and DPP about a potential resolution of these matters.At this time, we are unable to predict the duration, scope, result, or related costs associated with the investigations. We also are unable to predict what action may be taken by the DOJ, the SEC, or the DPP, or what penalties or remedial actions they may ultimately seek. Any determination that our operations or activities are not, or were not, in compliance with existing laws or regulations could result in the imposition of fines, penalties, disgorgement, equitable relief, or other losses. We do not believe, however, that any such fines, penalties, disgorgement, equitable relief, or other losses would have a material adverse effect on our financial condition or liquidity. However, an adverse resolution could have a material adverse effect on our results of operations in a particular period.We had cash and cash equivalents totaling $1.5 billion as of December 31, 2022, of which $1.3 billion is held by our foreign subsidiaries. This cash represents an important source of our liquidity and is invested in bank accounts or money market investments with no limitations on access. The cash held by our foreign subsidiaries is intended for use outside of the U.S. We anticipate that any needs for liquidity within the U.S. in excess of our cash held in the U.S. can be readily satisfied with borrowings under our existing U.S. credit facilities or our commercial paper program.Guarantor Financial InformationAlbemarle Wodgina Pty Ltd Issued NotesAlbemarle Wodgina Pty Ltd (the “Issuer”), a wholly-owned subsidiary of Albemarle Corporation, issued $300.0 million aggregate principal amount of 3.45% Senior Notes due 2029 (the “3.45% Senior Notes”) in November 2019. The 3.45% Senior Notes are fully and unconditionally guaranteed (the “Guarantee”) on a senior unsecured basis by Albemarle Corporation (the “Parent Guarantor”). No direct or indirect subsidiaries of the Parent Guarantor guarantee the 3.45% Senior Notes (such subsidiaries are referred to as the “Non-Guarantors”).In 2019, we completed the acquisition of a 60% interest in MRL’s Wodgina hard rock lithium mine project (“Wodgina Project”) in Western Australia and formed an unincorporated joint venture with MRL, named MARBL Lithium Joint Venture, for the exploration, development, mining, processing and production of lithium and other minerals (other than iron ore and tantalum) from the Wodgina spodumene mine and for the operation of the Kemerton assets in Western Australia. We participate in the Wodgina Project through our ownership interest in the Issuer. The Parent Guarantor conducts its U.S. Bromine and Catalysts operations directly, and conducts its other operations (other than operations conducted through the Issuer) through the Non-Guarantors.74Albemarle Corporation and SubsidiariesThe 3.45% Senior Notes are the Issuer’s senior unsecured obligations and rank equally in right of payment to the senior indebtedness of the Issuer, effectively subordinated to all of the secured indebtedness of the Issuer, to the extent of the value of the assets securing that indebtedness, and structurally subordinated to all indebtedness and other liabilities of its subsidiaries. The Guarantee is the senior unsecured obligation of the Parent Guarantor and ranks equally in right of payment to the senior indebtedness of the Parent Guarantor, effectively subordinated to the secured debt of the Parent Guarantor to the extent of the value of the assets securing the indebtedness and structurally subordinated to all indebtedness and other liabilities of its subsidiaries.For cash management purposes, the Parent Guarantor transfers cash among itself, the Issuer and the Non-Guarantors through intercompany financing arrangements, contributions or declaration of dividends between the respective parent and its subsidiaries. The transfer of cash under these activities facilitates the ability of the recipient to make specified third-party payments for principal and interest on the Issuer and/or the Parent Guarantor’s outstanding debt, common stock dividends and common stock repurchases. There are no significant restrictions on the ability of the Issuer or the Parent Guarantor to obtain funds from subsidiaries by dividend or loan.The following tables present summarized financial information for the Parent Guarantor and the Issuer on a combined basis after elimination of (i) intercompany transactions and balances among the Issuer and the Parent Guarantor and (ii) equity in earnings from and investments in any subsidiary that is a Non-Guarantor. Each entity in the combined financial information follows the same accounting policies as described herein.Summarized Statement of OperationsYear ended December 31,$ in thousands2022Net sales(a)$2,981,170 Gross profit636,894 Loss before income taxes and equity in net income of unconsolidated investments(b)52,048 Net loss attributable to the Guarantor and the Issuer119,551 (a) Includes net sales to Non-Guarantors of $2,155.7 million for the year ended December 31, 2022.(b) Includes intergroup expenses to Non-Guarantors of $134.2 million for the year ended December 31, 2022.Summarized Balance SheetAt December 31,$ in thousands2022Current assets(a)$1,274,018 Net property, plant and equipment3,379,369 Other non-current assets(b)687,603 Current liabilities(c)$2,103,749 Long-term debt2,260,397 Other non-current liabilities(d)7,173,636 (a) Includes receivables from Non-Guarantors of $605.3 million at December 31, 2022.(b) Includes non-curent receivables from Non-Guarantors of $109.3 million at December 31, 2022.(c) Includes current payables to Non-Guarantors of $1.6 billion at December 31, 2022.(d) Includes non-current payables to Non-Guarantors of $6.6 billion at December 31, 2022.The 3.45% Senior Notes are structurally subordinated to the indebtedness and other liabilities of the Non-Guarantors. The Non-Guarantors are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the 3.45% Senior Notes or the Indenture under which the 3.45% Senior Notes were issued, or to make any funds available therefor, whether by dividends, loans, distributions or other payments. Any right that the Parent Guarantor has to receive any assets of any of the Non-Guarantors upon the liquidation or reorganization of any Non-Guarantor, and the consequent rights of holders of the 3.45% Senior Notes to realize proceeds from the sale of any of a Non-Guarantor’s assets, would be effectively subordinated to the claims of such Non-Guarantor’s creditors, including trade creditors and holders of 75Albemarle Corporation and Subsidiariespreferred equity interests, if any, of such Non-Guarantor. Accordingly, in the event of a bankruptcy, liquidation or reorganization of any of the Non-Guarantors, the Non-Guarantors will pay the holders of their debts, holders of preferred equity interests, if any, and their trade creditors before they will be able to distribute any of their assets to the Parent Guarantor. The 3.45% Senior Notes are obligations of the Issuer. The Issuer’s cash flow and ability to make payments on the 3.45% Senior Notes could be dependent upon the earnings it derives from the production from MARBL for the Wodgina Project. Absent income received from sales of its share of production from MARBL, the Issuer’s ability to service the 3.45% Senior Notes could be dependent upon the earnings of the Parent Guarantor’s subsidiaries and other joint ventures and the payment of those earnings to the Issuer in the form of equity, loans or advances and through repayment of loans or advances from the Issuer.The Issuer’s obligations in respect of MARBL are guaranteed by the Parent Guarantor. Further, under MARBL pursuant to a deed of cross security between the Issuer, the joint venture partner and the manager of the project (the “Manager”), each of the Issuer, and the joint venture partner have granted security to each other and the Manager for the obligations each of the Issuer and the joint venture partner have to each other and to the Manager. The claims of the joint venture partner, the Manager and other secured creditors of the Issuer will have priority as to the assets of the Issuer over the claims of holders of the 3.45% Senior Notes.Albemarle Corporation Issued NotesIn March 2021, Albemarle New Holding GmbH (the “Subsidiary Guarantor”), a wholly-owned subsidiary of Albemarle Corporation, added a full and unconditional guarantee (the “Upstream Guarantee”) to all securities of Albemarle Corporation (the “Parent Issuer”) issued and outstanding as of such date and, subject to the terms of the applicable amendment or supplement, securities issuable by the Parent Issuer pursuant to the Indenture, dated as of January 20, 2005, as amended and supplemented from time to time (the “Indenture”). No other direct or indirect subsidiaries of the Parent Issuer guarantee these securities (such subsidiaries are referred to as the “Upstream Non-Guarantors”). See Long-term debt section above for a description of the securities issued by the Parent Issuer.The current securities outstanding under the Indenture are the Parent Issuer’s unsecured and unsubordinated obligations and rank equally in right of payment with all other unsecured and unsubordinated indebtedness of the Parent Issuer. All securities currently outstanding under the Indenture are effectively subordinated to the Parent Issuer’s existing and future secured indebtedness to the extent of the value of the assets securing that indebtedness. With respect to any series of securities issued under the Indenture that is subject to the Upstream Guarantee (which series of securities does not include the 2022 Notes), the Upstream Guarantee is, and will be, an unsecured and unsubordinated obligation of the Subsidiary Guarantor, ranking pari passu with all other existing and future unsubordinated and unsecured indebtedness of the Subsidiary Guarantor. All securities currently outstanding under the Indenture (other than the 2022 Notes) are effectively subordinated to all existing and future indebtedness and other liabilities of the Parent’s Subsidiaries other than the Subsidiary Guarantor. The 2022 Notes are effectively subordinated to all existing and future indebtedness and other liabilities of the Parent’s Subsidiaries, including the Subsidiary Guarantor.For cash management purposes, the Parent Issuer transfers cash among itself, the Subsidiary Guarantor and the Upstream Non-Guarantors through intercompany financing arrangements, contributions or declaration of dividends between the respective parent and its subsidiaries. The transfer of cash under these activities facilitates the ability of the recipient to make specified third-party payments for principal and interest on the Parent Issuer and/or the Subsidiary Guarantor’s outstanding debt, common stock dividends and common stock repurchases. There are no significant restrictions on the ability of the Parent Issuer or the Subsidiary Guarantor to obtain funds from subsidiaries by dividend or loan.The following tables present summarized financial information for the Subsidiary Guarantor and the Parent Issuer on a combined basis after elimination of (i) intercompany transactions and balances among the Parent Issuer and the Subsidiary Guarantor and (ii) equity in earnings from and investments in any subsidiary that is an Upstream Non-Guarantor.76Albemarle Corporation and SubsidiariesSummarized Statement of OperationsYear ended December 31,$ in thousands2022Net sales(a)$2,557,914 Gross profit353,515 Loss before income taxes and equity in net income of unconsolidated investments(b)(121,421)Net loss attributable to the Subsidiary Guarantor and the Parent Issuer(77,487)(a) Includes net sales to Non-Guarantors of $1,752.5 million for the year ended December 31, 2022.(b) Includes intergroup expenses to Non-Guarantors of $25.4 million for the year ended December 31, 2022.Summarized Balance SheetAt December 31,$ in thousands2022Current assets(a)$1,261,682 Net property, plant and equipment893,715 Other non-current assets(b)1,783,357 Current liabilities(c)$1,981,456 Long-term debt2,955,934 Other non-current liabilities(d)6,393,534 (a) Includes current receivables from Non-Guarantors of $644.0 million at December 31, 2022.(b) Includes noncurrent receivables from Non-Guarantors of $1.2 billion at December 31, 2022.(c) Includes current payables to Non-Guarantors of $1.6 billion at December 31, 2022.(d) Includes non-current payables to Non-Guarantors of $5.8 billion at December 31, 2022.These securities are structurally subordinated to the indebtedness and other liabilities of the Upstream Non-Guarantors. The Upstream Non-Guarantors are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to these securities or the Indenture under which these securities were issued, or to make any funds available therefor, whether by dividends, loans, distributions or other payments. Any right that the Subsidiary Guarantor has to receive any assets of any of the Upstream Non-Guarantors upon the liquidation or reorganization of any Upstream Non-Guarantors, and the consequent rights of holders of these securities to realize proceeds from the sale of any of an Upstream Non-Guarantor’s assets, would be effectively subordinated to the claims of such Upstream Non-Guarantor’s creditors, including trade creditors and holders of preferred equity interests, if any, of such Upstream Non-Guarantor. Accordingly, in the event of a bankruptcy, liquidation or reorganization of any of the Upstream Non-Guarantors, the Upstream Non-Guarantors will pay the holders of their debts, holders of preferred equity interests, if any, and their trade creditors before they will be able to distribute any of their assets to the Subsidiary Guarantor.Safety and Environmental MattersWe are subject to federal, state, local and foreign requirements regulating the handling, manufacture and use of materials (some of which may be classified as hazardous or toxic by one or more regulatory agencies), the discharge of materials into the environment and the protection of the environment. To our knowledge, we are currently complying and expect to continue to comply in all material respects with applicable environmental laws, regulations, statutes and ordinances. Compliance with existing federal, state, local and foreign environmental protection laws is not currently expected to have a material effect on capital expenditures, earnings or our competitive position, but the costs associated with increased legal or regulatory requirements could have an adverse effect on our operating results.Among other environmental requirements, we are subject to the federal Superfund law, and similar state laws, under which we may be designated as a PRP, and may be liable for a share of the costs associated with cleaning up various hazardous waste sites. Management believes that in cases in which we may have liability as a PRP, our liability for our share of cleanup is de minimis. Further, almost all such sites represent environmental issues that are quite mature and have been investigated, studied and in many cases settled. In de minimis situations, our policy generally is to negotiate a consent decree and to pay any 77Albemarle Corporation and Subsidiariesapportioned settlement, enabling us to be effectively relieved of any further liability as a PRP, except for remote contingencies. In other than de minimis PRP matters, our records indicate that unresolved PRP exposures should be immaterial. We accrue and expense our proportionate share of PRP costs. Because management has been actively involved in evaluating environmental matters, we are able to conclude that the outstanding environmental liabilities for unresolved PRP sites should not have a material adverse effect upon our results of operations or financial condition.Our environmental and safety operating costs charged to expense were $46.3 million, $43.2 million and $44.9 million in 2022, 2021 and 2020, respectively, excluding depreciation of previous capital expenditures, and are expected to be in the same range in the next few years. Costs for remediation have been accrued and payments related to sites are charged against accrued liabilities, which at December 31, 2022 totaled approximately $38.2 million, a decrease of $8.4 million from $46.6 million at December 31, 2021. See Note 17, “Commitments and Contingencies” to our consolidated financial statements included in Part II, Item 8 of this report for a reconciliation of our environmental liabilities for the years ended December 31, 2022, 2021 and 2020.We believe that any sum we may be required to pay in connection with environmental remediation and asset retirement obligation matters in excess of the amounts recorded should occur over a period of time and should not have a material adverse effect upon our results of operations, financial condition or cash flows on a consolidated annual basis, although any such sum could have a material adverse impact on our results of operations, financial condition or cash flows in a particular quarterly reporting period.Capital expenditures for pollution-abatement and safety projects, including such costs that are included in other projects, were approximately $75.6 million, $55.4 million and $40.4 million in 2022, 2021 and 2020, respectively. In the future, capital expenditures for these types of projects may increase due to more stringent environmental regulatory requirements and our efforts in reaching sustainability goals. Management’s estimates of the effects of compliance with governmental pollution-abatement and safety regulations are subject to (a) the possibility of changes in the applicable statutes and regulations or in judicial or administrative construction of such statutes and regulations and (b) uncertainty as to whether anticipated solutions to pollution problems will be successful, or whether additional expenditures may prove necessary.Recently Issued Accounting PronouncementsSee Note 1, “Summary of Significant Accounting Policies” to our consolidated financial statements included in Part II, Item 8 of this report for a discussion of our Recently Issued Accounting Pronouncements.Item 7A.Quantitative and Qualitative Disclosures About Market Risk.The primary currencies to which we have foreign currency exchange rate exposure are the Chinese Renminbi, Euro, Australian Dollar, Chilean Peso and Japanese Yen. In response to greater fluctuations in foreign currency exchange rates in recent periods, we have increased the degree of exposure risk management activities to minimize the potential impact on earnings.We manage our foreign currency exposures by balancing certain assets and liabilities denominated in foreign currencies and through the use, from time to time, of foreign currency forward contracts. The principal objective of such contracts is to minimize the financial impact of changes in foreign currency exchange rates. The counterparties to these contractual agreements are major financial institutions with which we generally have other financial relationships. We are exposed to credit loss in the event of nonperformance by these counterparties. However, we do not anticipate nonperformance by the counterparties. We do not utilize financial instruments for trading or other speculative purposes.The primary method we use to reduce foreign currency exposure is to identify natural hedges, in which the operating activities denominated in respective currencies across various subsidiaries balance in respect to timing and the underlying exposures. In the event a natural hedge is not available, we may employ a forward contract to reduce exposure, generally expiring within one year. While these contracts are subject to fluctuations in value, such fluctuations are intended to offset the changes in the value of the underlying exposures being hedged. In the fourth quarter of 2019, we entered into a foreign currency forward contract to hedge the cash flow exposure of non-functional currency purchases during the construction of the Kemerton plant in Australia. This contract has been designated as an effective hedging instrument, and beginning the date of designation, gains or losses on the revaluation of this contract to our reporting currency have been and will be recorded in Accumulated other comprehensive loss. All other gains and losses on foreign currency forward contracts not designated as an effective hedging instrument are recognized in Other income (expenses), net, and generally do not have a significant impact on results of operations.78Albemarle Corporation and SubsidiariesAt December 31, 2022, our financial instruments subject to foreign currency exchange risk consisted of foreign currency forward contracts with an aggregate notional value of $2.9 billion and with a fair value representing a net asset position of $2.8 million. The aggregate notional value of foreign currency forward contracts increased in 2022 due to increased balance sheet exposure from higher sales and income in foreign-denominated currencies. Fluctuations in the value of these contracts are intended to offset the changes in the value of the underlying exposures being hedged. We conducted a sensitivity analysis on the fair value of our foreign currency hedge portfolio assuming an instantaneous 10% change in select foreign currency exchange rates from their levels as of December 31, 2022, with all other variables held constant. A 10% appreciation of the U.S. Dollar against foreign currencies that we hedge would result in a decrease of approximately $30.0 million in the fair value of our foreign currency forward contracts. A 10% depreciation of the U.S. Dollar against these foreign currencies would result in an increase of approximately $15.2 million in the fair value of our foreign currency forward contracts. The sensitivity of the fair value of our foreign currency hedge portfolio represents changes in fair values estimated based on market conditions as of December 31, 2022, without reflecting the effects of underlying anticipated transactions. When those anticipated transactions are realized, actual effects of changing foreign currency exchange rates could have a material impact on our earnings and cash flows in future periods.On December 18, 2014, the carrying value of our 1.875% Euro-denominated senior notes was designated as an effective hedge of our net investment in foreign subsidiaries where the Euro serves as the functional currency, and beginning on the date of designation, gains or losses on the revaluation of these senior notes to our reporting currency have been were recorded in Accumulated other comprehensive loss. In the first quarter of 2021, we repaid the outstanding balance of these senior notes, and as a result, this net investment hedge was discontinued. The balance of foreign exchange revaluation gains and losses associated with this discontinued net investment hedge will remain within accumulated other comprehensive loss until the hedged net investment is sold or liquidated. We are exposed to changes in interest rates that could impact our results of operations and financial condition. We manage global interest rate and foreign exchange exposure as part of our regular operational and financing strategies. We had variable interest rate borrowings of $14.4 million and $393.7 million outstanding at December 31, 2022 and 2021, respectively. These borrowings represented less than 1% and 16% of total outstanding debt and bore average interest rates of 0.07% and 0.40% at December 31, 2022 and 2021, respectively. A hypothetical 100 basis point increase in the average interest rate applicable to these borrowings would change our annualized interest expense by approximately $0.1 million as of December 31, 2022. We may enter into interest rate swaps, collars or similar instruments with the objective of reducing interest rate volatility relating to our borrowing costs.Our raw materials are subject to price volatility caused by weather, supply conditions, political and economic variables and other unpredictable factors. Historically, we have not used futures, options or swap contracts to manage the volatility related to the above exposures. However, the refinery catalysts business has used financing arrangements to provide long-term protection against changes in natural gas and metals prices. We seek to limit our exposure by entering into long-term contracts when available, and we seek price increase limitations through contracts. These contracts do not have a significant impact on our results of operations.79Albemarle Corporation and Subsidiaries
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with the “Forward-Looking Statements,” our Consolidated Financial Statements and Notes that follow and the “Risk Factors” included in our Annual Report on Form 10-K. References to “Ameriprise Financial,” “Ameriprise,” the “Company,” “we,” “us,” and “our” refer to Ameriprise Financial, Inc. exclusively, to our entire family of companies, or to one or more of our subsidiaries.OverviewAmeriprise is a diversified financial services company with a more than 125-year history of providing financial solutions. We are a long-standing leader in financial planning and advice with $1.2 trillion in assets under management and administration as of December 31, 2022. We offer a broad range of products and services designed to achieve individual and institutional clients’ financial objectives. For additional discussion of our businesses, see Part I, Item 1 of this Annual Report on Form 10-K.The products and services we provide retail clients and, to a lesser extent, institutional clients, are the primary source of our revenues and net income. Revenues and net income are significantly affected by investment performance and the total value and composition of assets we manage and administer for our retail and institutional clients as well as the distribution fees we receive from other companies. These factors, in turn, are largely determined by overall investment market performance and the depth and breadth of our individual client relationships.We operate our business in the broader context of the macroeconomic forces around us, including the global and U.S. economies, the coronavirus disease 2019 (“COVID-19”) pandemic, changes in interest and inflation rates, financial market volatility, fluctuations in foreign exchange rates, geopolitical strain, the competitive environment, client and customer activities and preferences, and the various regulatory and legislative developments. Financial markets and macroeconomic conditions have had and will continue to have a significant impact on our operating and performance results. In addition, the business, political and regulatory environments in which we operate are subject to elevated uncertainty and substantial, frequent change. Accordingly, we expect to continue focusing on our key strategic objectives and obtaining operational and strategic leverage from our core capabilities. The success of these and other strategies may be affected by the factors discussed in Item 1A of this Annual Report on Form 10-K - “Risk Factors” - and other factors as discussed herein.Equity price, credit market and interest rate fluctuations can have a significant impact on our results of operations, primarily due to the effects they have on the asset management and other asset-based fees we earn, the value of deferred acquisition costs (“DAC”) and deferred sales inducement costs (“DSIC”) assets, the values of liabilities for guaranteed benefits associated with our variable annuities and the values of derivatives held to hedge these benefits and the “spread” income generated on our deposit products, fixed insurance, the fixed portion of variable annuities and variable insurance contracts and fixed deferred annuities. We have been operating in a historically low interest rate environment but have recently experienced a substantial increase in rates with uncertainty about where rates will go in the future. A higher (lower) interest rate environment may result in decreases (increases) to our reserves and changes in various rate assumptions we use to amortize DAC and DSIC, which may impact our adjusted operating earnings after tax. For additional discussion on our interest rate risk, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.”In the third quarter, we updated our market-related assumptions and implemented model changes related to our living benefit valuation. In addition, we conducted our annual review of life insurance and annuity valuation assumptions relative to current experience and management expectations including modeling changes. These aforementioned changes are collectively referred to as unlocking. We also reviewed our future policy benefit reserve adequacy for our long term care (“LTC”) business in the third quarter. See our Consolidated and Segment Results of Operations sections for the pretax impacts on our revenues and expenses attributable to unlocking and LTC loss recognition.The following discussion includes a comparison of our 2022 and 2021 results. For a discussion of our 2020 results and for a comparison of results for 2021 and 2020, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on February 25, 2022.On June 2, 2021, we filed an application to convert Ameriprise Bank, FSB (“Ameriprise Bank”) to a state-chartered industrial bank regulated by the Utah Department of Financial Institutions and the Federal Deposit Insurance Corporation. We also filed an application to transition the Ameriprise Bank’s personal trust services business to a new limited purpose national trust bank regulated by the Office of the Comptroller of the Currency. If the applications are approved, the proposed changes are not expected to impact our long-term strategy for the bank and should enable us to continue our strong lineup of banking solutions, including deposits, credit cards, mortgages and securities-based lending to our wealth management clients without interruption.We consolidate certain variable interest entities for which we provide asset management services. These entities are defined as consolidated investment entities (“CIEs”). While the consolidation of the CIEs impacts our balance sheet and income statement, our exposure to these entities is unchanged and there is no impact to the underlying business results. For further information on CIEs, see Note 5 to our Consolidated Financial Statements. The results of operations of the CIEs are reflected in the Corporate & Other segment. On a consolidated basis, the management fees we earn for the services we provide to the CIEs and the related general and administrative expenses are eliminated and the changes in fair value of assets and liabilities related to the CIEs, primarily syndicated 31loans and debt, are reflected in Net investment income. We include the fees from these entities in the Management and financial advice fees line within our Asset Management segment. While our Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), management believes that adjusted operating measures, which exclude net realized investment gains or losses, net of the related DSIC and DAC amortization, unearned revenue amortization and the reinsurance accrual; the market impact on non-traditional long-duration products (including variable and fixed deferred annuity contracts and universal life (“UL”) insurance contracts), net of hedges and the related DSIC and DAC amortization, unearned revenue amortization and the reinsurance accrual; mean reversion related impacts (the impact on variable annuity and variable universal life (“VUL”) products for the difference between assumed and updated separate account investment performance on DAC, DSIC, unearned revenue amortization, reinsurance accrual and additional insurance benefit reserves); the market impact of hedges to offset interest rate and currency changes on unrealized gains or losses for certain investments; block transfer reinsurance transaction impacts; gain or loss on disposal of a business that is not considered discontinued operations; integration and restructuring charges; income (loss) from discontinued operations; and the impact of consolidating CIEs, best reflect the underlying performance of our core operations and facilitate a more meaningful trend analysis. Management uses these non-GAAP measures to evaluate our financial performance on a basis comparable to that used by some securities analysts and investors. Also, certain of these non-GAAP measures are taken into consideration, to varying degrees, for purposes of business planning and analysis and for certain compensation-related matters. Throughout our Management’s Discussion and Analysis, these non-GAAP measures are referred to as adjusted operating measures. These non-GAAP measures should not be viewed as a substitute for U.S. GAAP measures. It is management’s priority to increase shareholder value over a multi-year horizon by achieving our on-average, over-time financial targets.Our financial targets are:•Adjusted operating earnings per diluted share growth of 12% to 15%, and •Adjusted operating return on equity excluding accumulated other comprehensive income (“AOCI”) of over 30%.The following tables reconcile our GAAP measures to adjusted operating measures:Per Diluted Share Years Ended December 31,Years Ended December 31,2022202120222021(in millions, except per share amounts)Net income$2,559 $2,760 $22.51 $23.00 Less: Net realized investment gains (losses) (1)(97)87 (0.85)0.73 Add: Market impact on non-traditional long-duration products (1)(211)656 (1.86)5.47 Add: Mean reversion related impacts (1)268 (152)2.36 (1.27)Add: Market impact of hedges on investments (1)— 22 — 0.18 Less: Block transfer reinsurance transaction impacts (1)— 521 — 4.34 Add: Integration/restructuring charges (1)50 32 0.44 0.27 Less: Net income (loss) attributable to CIEs(4)(3)(0.04)(0.03)Add: Tax effect of adjustments (2)(43)11 (0.38)0.09 Adjusted operating earnings$2,724 $2,724 $23.96 $22.70 Weighted average common shares outstanding: Basic111.3 117.3 Diluted113.7 120.0 (1) Pretax adjusted operating adjustments.(2) Calculated using the statutory tax rate of 21%.32The following table reconciles net income to adjusted operating earnings and the five-point average of quarter-end equity to adjusted operating equity: Years Ended December 31,20222021(in millions)Net income$2,559 $2,760 Less: Adjustments (1)(165)36 Adjusted operating earnings$2,724 $2,724 Total Ameriprise Financial, Inc. shareholders’ equity (2)$4,453 $5,944 Less: AOCI, net of tax (2)(1,487)556 Total Ameriprise Financial, Inc. shareholders’ equity, excluding AOCI5,940 5,388 Less: Equity impacts attributable to CIEs— 2 Adjusted operating equity$5,940 $5,386 Return on equity, excluding AOCI43.1 %51.2 %Adjusted operating return on equity, excluding AOCI (3)45.9 %50.6 %(1) Adjustments reflect the sum of after-tax net realized investment gains/losses, net of DSIC and DAC amortization, unearned revenue amortization and the reinsurance accrual; the market impact on non-traditional long-duration products (including variable and fixed deferred annuity contracts and UL insurance contracts), net of hedges and related DSIC and DAC amortization, unearned revenue amortization and the reinsurance accrual; mean reversion related impacts; block transfer reinsurance transaction impacts; the market impact of hedges to offset interest rate and currency changes on unrealized gains or losses for certain investments; gain or loss on disposal of a business that is not considered discontinued operations; integration and restructuring charges; income (loss) from discontinued operations; and net income (loss) from consolidated investment entities. After-tax is calculated using the statutory tax rate of 21%.(2) We revised prior period Consolidated Financial Statements to correct shadow unearned revenue liability balances associated with universal life insurance products. See Note 28 to our Consolidated Financial Statements for a summary of the revision.(3) Adjusted operating return on equity, excluding AOCI is calculated using adjusted operating earnings in the numerator and Ameriprise Financial shareholders’ equity, excluding AOCI and the impact of consolidating investment entities using a five-point average of quarter-end equity in the denominator. After-tax is calculated using the statutory rate of 21%.Critical Accounting EstimatesThe accounting and reporting policies that we use affect our Consolidated Financial Statements. Certain of our accounting and reporting policies are critical to an understanding of our consolidated results of operations and financial condition and, in some cases, the application of these policies can be significantly affected by the estimates, judgments and assumptions made by management during the preparation of our Consolidated Financial Statements. The accounting and reporting policies and estimates we have identified as fundamental to a full understanding of our consolidated results of operations and financial condition are described below. See Note 2 to our Consolidated Financial Statements for further information about our accounting policies.Valuation of InvestmentsThe most significant component of our investments is our Available-for-Sale securities, which we carry at fair value within our Consolidated Balance Sheets. See Note 15 to our Consolidated Financial Statements for discussion of the fair value of our Available-for-Sale securities. Financial markets are subject to significant movements in valuation and liquidity, which can impact our ability to liquidate and the selling price that can be realized for our securities and increases the use of judgment in determining the estimated fair value of certain investments. We are unable to predict impacts and determine sensitivities in reported amounts reflecting such market movements on our aggregate Available-for-Sale portfolio. Changes to these assumptions do not occur in isolation and it is impracticable to predict such impacts at the individual security unit of measure which are predominately Level 2 fair value and based on observable inputs.Deferred Acquisition CostsSee Note 2 to our Consolidated Financial Statements for discussion of our DAC accounting policy. Non-Traditional Long-Duration ProductsFor our non-traditional long-duration products (including variable, structured variable and fixed deferred annuity contracts, UL and VUL insurance products), our DAC balance at any reporting date is based on projections that show management expects there to be estimated gross profits (“EGPs”) after that date to amortize the remaining balance. These projections are inherently uncertain because they require management to make assumptions about financial markets, mortality levels and contractholder and policyholder behavior over periods extending well into the future. Projection periods used for our annuity products are typically 30 to 50 years and for our UL insurance products 50 years or longer. 33EGPs vary based on persistency rates (assumptions at which contractholders and policyholders are expected to surrender, make withdrawals from and make deposits to their contracts), mortality levels, client asset value growth rates (based on equity and bond market performance), variable annuity benefit utilization and interest margins (the spread between earned rates on invested assets and rates credited to contractholder and policyholder accounts). Changes in these assumptions can be offsetting and we are unable to predict their movement, sensitivities in reported amounts, offsetting impacts or future impacts to the Consolidated Financial Statements over time or in any given future period. When assumptions are changed, the percentage of EGPs used to amortize DAC might also change. A change in the required amortization percentage is applied retrospectively; an increase in amortization percentage will result in a decrease in the DAC balance and an increase in DAC amortization expense, while a decrease in amortization percentage will result in an increase in the DAC balance and a decrease in DAC amortization expense. The effect on the DAC balance that would result from the realization of unrealized gains (losses) on securities is recognized with an offset to AOCI on the Consolidated Balance Sheets.The client asset value growth rates are the rates at which variable annuity and VUL insurance contract values invested in separate accounts are assumed to appreciate in the future. The rates used vary by equity and fixed income investments. The long-term client asset value growth rates are based on assumed gross annual returns of 9% for equity funds and 5.6% for fixed income funds. We typically use a five-year mean reversion process as a guideline in setting near-term equity fund growth rates based on a long-term view of financial market performance as well as recent actual performance. The suggested near-term equity fund growth rate is reviewed quarterly to ensure consistency with management’s assessment of anticipated equity market performance.A decrease of 100 basis points in separate account fund growth rate assumptions is likely to result in an increase in DAC amortization and an increase in benefits and claims expense for variable annuity and VUL insurance contracts. The following table presents the estimated impact to current period pretax income:Estimated Impact to Pretax Income (1)DAC AmortizationBenefits and Claims ExpenseTotal(in millions)Decrease in future near- and long-term fixed income fund growth returns by 100 basis points$(32)$(83)$(115)Decrease in future near-term equity fund growth returns by 100 basis points$(31)$(61)$(92)Decrease in future long-term equity fund growth returns by 100 basis points(19)(41)(60)Decrease in future near- and long-term equity fund growth returns by 100 basis points$(50)$(102)$(152)(1) An increase in the above assumptions by 100 basis points would result in an increase to pretax income for approximately the same amount.An assessment of sensitivity associated with isolated changes of any single assumption is not an indicator of future results.Traditional Long-Duration ProductsFor our traditional long-duration products (including traditional life and disability income (“DI”) insurance products), our DAC balance at any reporting date is based on projections that show management expects there to be adequate premiums after the reporting date to amortize the remaining balance. These projections are inherently uncertain because they require management to make assumptions over periods extending well into the future. These assumptions include interest rates, persistency rates and mortality and morbidity rates and are not modified (unlocked) unless recoverability testing determines that reserves are inadequate. Changes in these assumptions can be offsetting and we are unable to predict their movement, sensitivities in reported amounts, offsetting impacts, or future impacts to the Consolidated Financial Statements over time or in any given future period. Projection periods used for our traditional life insurance are up to 30 years. Projection periods for our DI products are up to 45 years. We may experience accelerated amortization of DAC if policies terminate earlier than projected or a slower rate of amortization of DAC if policies persist longer than projected.For traditional life and DI insurance products, the assumptions provide for adverse deviations in experience and are revised only if management concludes experience will be so adverse that DAC are not recoverable. If management concludes that DAC are not recoverable, DAC are reduced to the amount that is recoverable based on best estimate assumptions. Future Policy Benefits and ClaimsWe establish reserves to cover the benefits associated with non-traditional and traditional long-duration products. Non-traditional long-duration products include variable and structured variable annuity contracts, fixed annuity contracts and UL and VUL policies. Traditional long-duration products include term life, whole life, DI and LTC insurance products. Guarantees accounted for as insurance liabilities include guaranteed minimum death benefits (“GMDB”), gain gross-up (“GGU”), guaranteed minimum income benefit (“GMIB”) and the life contingent benefits associated with guaranteed minimum withdrawal benefit (“GMWB”). In addition, UL and VUL policies with product features that result in profits followed by losses are accounted for as insurance liabilities.34Guarantees accounted for as embedded derivatives include guaranteed minimum accumulation benefit (“GMAB”) and the non-life contingent benefits associated with GMWB. In addition, the portion of structured variable annuities, indexed annuities and IUL policies allocated to the indexed account is accounted for as an embedded derivative.The establishment of reserves is an estimation process using a variety of methods, assumptions and data elements. If actual experience is better than or equal to the results of the estimation process, then reserves should be adequate to provide for future benefits and expenses. If actual experience is worse than the results of the estimation process, additional reserves may be required.Non-Traditional Long-Duration Products, including Embedded DerivativesUL and VULA portion of our UL and VUL policies have product features that result in profits followed by losses from the insurance component of the contract. These profits followed by losses can be generated by the cost structure of the product or secondary guarantees in the contract. The secondary guarantee ensures that, subject to specified conditions, the policy will not terminate and will continue to provide a death benefit even if there is insufficient policy value to cover the monthly deductions and charges. The liability for these future losses is determined using actuarial models to estimate the death benefits in excess of account value and recognizing the excess over the estimated life based on expected assessments (e.g. cost of insurance charges, contractual administrative charges, similar fees and investment margin). Significant assumptions made in projecting future benefits and assessments relate to client asset value growth rates, mortality, persistency and investment margins and are consistent with those used for DAC valuation for the same contracts. Changes in these assumptions can be offsetting and we are unable to predict their movement, sensitivities in reported amounts, offsetting impacts, or future impacts to the Consolidated Financial Statements over time or in any given future period. See Note 12 to our Consolidated Financial Statements for information regarding the liability for contracts with secondary guarantees.Variable AnnuitiesWe have approximately $74 billion of variable annuity account value that has been issued over a period of more than 50 years. The diversified variable annuity block consists of $32 billion of account value with no living benefit guarantees and $42 billion of account value with living benefit guarantees, primarily GMWB provisions. The business is predominately issued through the Ameriprise Financial® advisor network. The majority of the variable annuity contracts offered by us contain GMDB provisions. We also offer variable annuities with death benefit provisions that gross up the amount payable by a certain percentage of contract earnings which are referred to as GGU benefits. We discontinued most new sales of GMWB and GMAB by the end of 2021 and new sales were completely discontinued as of mid-2022. We also previously offered contracts containing GMIB provisions. See Note 12 to our Consolidated Financial Statements for further discussion of our variable annuity contracts.In determining the liabilities for GMDB, GGU, GMIB and the life contingent benefits associated with GMWB, we project these benefits and contract assessments using actuarial models to simulate various equity market scenarios. Significant assumptions made in projecting future benefits and assessments relate to customer asset value growth rates, mortality, persistency, benefit utilization and investment margins and are consistent with those used for DAC valuation for the same contracts. As with DAC, management reviews, and where appropriate, adjusts its assumptions each quarter. Unless management identifies a material deviation over the course of quarterly monitoring, management reviews and updates these assumptions annually in the third quarter of each year. Regarding the exposure to variable annuity living benefit guarantees, the source of behavioral risk is driven by changes in policyholder surrenders and utilization of guaranteed withdrawal benefits. We have extensive experience studies and analysis to monitor changes and trends in policyholder behavior. A significant volume of company-specific policyholder experience data is available and provides management with the ability to regularly analyze policyholder behavior. On a monthly basis, actual surrender and benefit utilization experience is compared to expectations. Experience data includes detailed policy information providing the opportunity to review impacts of multiple variables. The ability to analyze differences in experience, such as presence of a living benefit rider, existence of surrender charges, and tax qualifications provide us an effective approach in quickly detecting changes in policyholder behavior.At least annually, we perform a thorough policyholder behavior analysis to validate the assumptions included in our benefit reserve, embedded derivative and DAC balances. The variable annuity assumptions and resulting reserve computations reflect multiple policyholder variables. Differentiation in assumptions by policyholder age, existence of surrender charges, guaranteed withdrawal utilization, and tax qualification are examples of factors recognized in establishing management’s assumptions used in reserve calculations. The extensive data derived from our variable annuity block informs management in confirming previous assumptions and revising the variable annuity behavior assumptions. Changes in assumptions are governed by a review and approval process to ensure an appropriate measurement of all impacted financial statement balances. Changes in these assumptions can be offsetting and we are unable to predict their movement, sensitivities in reported amounts, offsetting impacts, or future impacts to the Consolidated Financial Statements over time or in any given future period.See the table in the previous discussion of “Deferred Acquisition Costs” for the estimated impact to benefits and claims expense related to variable annuity and VUL insurance contracts resulting from a decrease of 100 basis points in separate account fund growth rate assumptions.Embedded DerivativesThe fair value of embedded derivatives related to GMAB and the non-life contingent benefits associated with GMWB provisions 35fluctuates based on equity, interest rate and credit markets which can cause these embedded derivatives to be either an asset or a liability. The fair value of embedded derivatives related to structured variable annuities, indexed annuities and IUL fluctuates based on equity markets and interest rates and is a liability. In addition, the valuation of embedded derivatives is impacted by an estimate of our nonperformance risk adjustment. This estimate includes a spread over the U.S. Treasury curve as of the balance sheet date. As our estimate of this spread over the U.S. Treasury curve widens or tightens, the liability will decrease or increase. Additionally, our Corporate Actuarial Department calculates the fair value of the embedded derivatives on a monthly basis. During this process, control checks are performed to validate the completeness of the data. Actuarial management approves various components of the valuation along with the final results. The change in the fair value of the embedded derivatives is reviewed monthly with senior management. See Note 15 to our Consolidated Financial Statements for information regarding the fair value measurement of embedded derivatives. Traditional Long-Duration ProductsLiabilities for unpaid amounts on reported DI and LTC claims include any periodic or other benefit amounts due and accrued, along with estimates of the present value of obligations for continuing benefit payments. These unpaid amounts are calculated using anticipated claim continuance rates based on established industry tables, adjusted as appropriate for our experience. The discount rates used to calculate present values are based on average interest rates earned on assets supporting the liability for unpaid amounts. Liabilities for estimates of benefits that will become payable on future claims on term life, whole life and DI policies are based on the net level premium and LTC policies are based on a gross premium valuation reflecting management’s current best estimate assumptions. Net level premium includes anticipated premium payments, mortality and morbidity rates, policy persistency and interest rates earned on assets supporting the liability. Gross premium valuation includes expected premium rate increases, benefit reductions, morbidity rates, policy persistency and interest rates earned on assets supporting the liability. Anticipated mortality and morbidity rates are based on established industry mortality and morbidity tables, with modifications based on our experience. Anticipated premium payments and persistency rates vary by policy form, issue age, policy duration and certain other pricing factors. Derivative Instruments and Hedging ActivitiesWe use derivative instruments to manage our exposure to various market risks. All derivatives are recorded at fair value. The fair value of our derivative instruments is determined using either market quotes or valuation models that are based upon the net present value of estimated future cash flows and incorporate current market observable inputs to the extent available. We are unable to predict impacts and determine sensitivities in reported amounts reflecting such market movements on our aggregate derivative portfolio. Changes to assumptions do not occur in isolation and it is impracticable to predict such impacts at the individual security unit of measure which are predominately Level 2 fair value and based on observable inputs.For further details on the types of derivatives we use and how we account for them, see Note 2, Note 15 and Note 17 to our Consolidated Financial Statements. For discussion of our market risk exposures and hedging program and related sensitivity testing, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.”Recent Accounting PronouncementsFor information regarding recent accounting pronouncements and their expected impact on our future consolidated results of operations and financial condition, see Note 3 to our Consolidated Financial Statements.Sources of Revenues and ExpensesManagement and Financial Advice FeesManagement and financial advice fees relate primarily to fees earned from managing mutual funds, private funds, separate account and wrap account assets and institutional investments, as well as fees earned from providing financial advice, administrative services (including transfer agent and administration fees earned from providing services to retail mutual funds) and other custodial services. Management and financial advice fees include performance-based incentive management fees, which we may receive on certain management contracts. Management and financial advice fees also include mortality and expense risk fees.Distribution FeesDistribution fees primarily include point-of-sale fees (such as mutual fund front-end sales loads) and asset-based fees (such as 12b-1 distribution and shareholder service fees). Distribution fees also include amounts received under marketing support arrangements for sales of mutual funds and other companies’ products, such as through our wrap accounts, as well as surrender charges on annuities and UL and VUL insurance. Distribution fees also include revenue for placing clients’ deposits in its brokerage sweep program with third-party banks as well as revenue from brokerage clients for the execution of requested trades.Net Investment IncomeNet investment income primarily includes interest income on fixed maturity securities classified as Available-for-Sale, mortgage loans, policy loans, margin loans, pledged asset lines of credit, other investments, cash and cash equivalents and investments of CIEs; the changes in fair value of trading securities, certain derivatives and certain assets and liabilities of CIEs; the pro rata share of net 36income or loss on equity method investments; and realized gains and losses on the sale of investments and changes for the allowance for credit losses. Premiums, Policy and Contract ChargesPremiums include premiums on traditional life, DI and LTC insurance and life contingent immediate annuities and are net of reinsurance premiums. Policy and contract charges include variable annuity rider charges and UL and VUL insurance charges, which consist of cost of insurance charges (net of reinsurance premiums and cost of reinsurance for UL and VUL insurance products) and administrative charges. Other RevenuesOther revenues primarily include the accretion on the fixed annuities reinsurance deposit receivables and other miscellaneous revenues. For discussion of our accounting policies on revenue recognition, see Note 2 to our Consolidated Financial Statements.Banking and Deposit Interest ExpenseBanking and deposit interest expense primarily includes interest expense related to investment certificates and banking deposits. The changes in fair value of stock market certificate embedded derivatives and the derivatives hedging stock market certificates are included within Banking and deposit interest expense. Distribution ExpensesDistribution expenses primarily include compensation paid to our financial advisors, registered representatives, third-party distributors and wholesalers. The portion of these costs which are incremental and direct to the acquisition of a new or renewal insurance policy or annuity contract issued by the RiverSource Life companies are deferred. The amounts capitalized and amortized are based on actual distribution costs. The majority of these costs, such as advisor and wholesaler compensation, vary directly with the level of sales. Distribution expenses also include marketing support and other distribution and administration related payments made to affiliated and unaffiliated distributors of products provided by our affiliates. The majority of these expenses vary with the level of sales, or assets held, by these distributors, and the remainder is fixed. Distribution expenses also include wholesaling costs.Interest Credited to Fixed AccountsInterest credited to fixed accounts represents amounts earned by contractholders and policyholders on fixed account values associated with UL and VUL insurance and annuity contracts. The changes in fair value of fixed deferred indexed annuity and IUL embedded derivatives and the derivatives hedging these products are also included within Interest credited to fixed accounts.Benefits, Claims, Losses and Settlement ExpensesBenefits, claims, losses and settlement expenses consist of amounts paid and changes in liabilities held for anticipated future benefit payments under insurance policies and annuity contracts, along with costs to process and pay such amounts. Amounts are net of benefit payments recovered or expected to be recovered under reinsurance contracts. Benefits under variable annuity guarantees include the changes in fair value of GMWB and GMAB embedded derivatives and the derivatives hedging these benefits, as well as the changes in fair value of derivatives hedging GMDB provisions. The changes in fair value of structured variable annuity embedded derivatives and the derivatives hedging this product, as well as the amortization of DSIC are also included in Benefits, claims, losses and settlement expenses.Amortization of DACDirect sales commissions and other costs capitalized as DAC are amortized over time. For annuity and UL/VUL contracts, DAC are amortized based on projections of EGPs over amortization periods equal to the approximate life of the business. For other insurance products, DAC are generally amortized as a percentage of premiums over amortization periods equal to the premium-paying period.Interest and Debt ExpenseInterest and debt expense primarily includes interest on corporate debt and CIE debt, the impact of interest rate hedging activities and amortization of debt issuance costs.General and Administrative ExpenseGeneral and administrative expense includes compensation, share-based awards and other benefits for employees (other than employees directly related to distribution, such as financial advisors), professional and consultant fees, information technology, facilities and equipment, advertising and promotion, legal and regulatory and corporate related expenses.37Economic EnvironmentGlobal equity market conditions and fluctuations affect our results of operations and financial condition. The following table presents relevant market indices:Years Ended December 31, 20222021ChangeS&P 500Daily average4,1004,270(4)%Period end3,8404,766(19)%Weighted Equity Index (“WEI”) (1)Daily average2,6992,894(7)%Period end2,5493,152(19)%(1) Weighted Equity Index is an Ameriprise calculated proxy for equity market movements calculated using a weighted average of the S&P 500, Russell 2000, Russell Midcap and MSCI EAFE indices based on North America distributed equity assets.See our segment results of operations discussion below for additional information on how changes in the economic environment have and may continue to impact our results. For further information regarding the impact of the economic environment on our results of operations and financial condition, and potentially material effects, see Part 1 - Item 1A “Risk Factors” of this Annual Report on Form 10-K.Assets Under Management and AdministrationAssets under management (“AUM”) include external client assets for which we provide investment management services, such as the assets of the Columbia Threadneedle Investments funds, institutional clients and clients in our advisor platform held in wrap accounts as well as assets managed by sub-advisors selected by us. AUM also include certain assets on our Consolidated Balance Sheets for which we provide investment management services and recognize management fees in our Asset Management segment, such as the assets of the general account and the variable product funds held in the separate accounts of our life insurance subsidiaries and CIEs.Assets under administration (“AUA”) include assets for which we provide administrative services such as client assets invested in other companies’ products that we offer outside of our wrap accounts. These assets include those held in clients’ brokerage accounts. We generally record revenues received from administered assets as distribution fees. We do not exercise management discretion over these assets and do not earn a management fee. These assets are not reported on our Consolidated Balance Sheets. AUA also include certain assets on our Consolidated Balance Sheets for which we do not provide investment management services and do not recognize management fees, such as investments in non-affiliated funds held in the separate accounts of our life insurance subsidiaries. AUM and AUA do not include assets under advisement, for which we provide advisory services such as model portfolios but do not have full discretionary investment authority. The following table presents detail regarding our AUM and AUA: December 31,Change20222021(in billions)Assets Under Management and AdministrationAdvice & Wealth Management AUM$409.0 $460.9 $(51.9)(11)%Asset Management AUM584.0 754.1 (170.1)(23)Corporate AUM0.2 0.1 0.1 NMEliminations(36.9)(44.1)7.2 16 Total Assets Under Management956.3 1,171.0 (214.7)(18)Total Assets Under Administration222.0 246.9 (24.9)(10)Total AUM and AUA$1,178.3 $1,417.9 $(239.6)(17)%NM Not Meaningful.Total AUM decreased $214.7 billion, or 18%, to $956.3 billion as of December 31, 2022 compared to $1.2 trillion as of December 31, 2021 due to a $51.9 billion decrease in Advice & Wealth Management AUM driven by market depreciation, partially offset by wrap account net inflows, and a $170.1 billion decrease in Asset Management AUM primarily driven by equity and bond market depreciation and an unfavorable foreign currency translation impact. See our segment results of operations discussion for additional information on changes in our AUM.38Consolidated Results of OperationsYear Ended December 31, 2022 Compared to Year Ended December 31, 2021 The following table presents our consolidated results of operations: Years Ended December 31,Change20222021(in millions)RevenuesManagement and financial advice fees$9,033 $9,275 $(242)(3)%Distribution fees1,938 1,830 108 6 Net investment income1,474 1,683 (209)(12)Premiums, policy and contract charges1,411 273 1,138 NMOther revenues491 382 109 29 Total revenues14,347 13,443 904 7 Banking and deposit interest expense76 12 64 NMTotal net revenues14,271 13,431 840 6 Expenses Distribution expenses4,923 5,015 (92)(2)Interest credited to fixed accounts665 600 65 11 Benefits, claims, losses and settlement expenses1,372 716 656 92 Amortization of deferred acquisition costs208 124 84 68 Interest and debt expense198 191 7 4 General and administrative expense3,723 3,435 288 8 Total expenses11,089 10,081 1,008 10 Pretax income3,182 3,350 (168)(5)Income tax provision623 590 33 6 Net income$2,559 $2,760 $(201)(7)%NM Not Meaningful.OverallPretax income decreased $168 million, or 5%, for 2022 compared to the prior year. The following impacts were significant drivers of the year-over-year change in pretax income:•The prior year impact of the block transfer reinsurance transaction resulted in $521 million of pretax income for 2021 primarily reflecting the net realized gains on investments sold to the reinsurer.•The mean reversion related impact was an expense of $268 million for 2022 compared to a benefit of $152 million for the prior year.•A negative impact from lower average equity markets compared to the prior year. Our average WEI, which is a proxy for equity movements on AUM, decreased 7% in 2022 compared to the prior year. The average S&P 500 index was 4% lower for 2022 compared to the prior year. •The unfavorable impact of unlocking was $161 million for 2022 compared to a favorable impact of unlocking of $17 million for the prior year.•A favorable impact from the continued increase in short-term interest rates compared to the prior year. •The market impact on non-traditional long-duration products (including variable and fixed deferred annuity contracts and UL insurance contracts), net of hedges and the related DSIC and DAC amortization, unearned revenue amortization and the reinsurance accrual was a benefit of $211 million for 2022 compared to an expense of $656 million for the prior year.39The following table presents the total pretax impacts on our revenues and expenses attributable to unlocking for the years ended December 31:Pretax Increase (Decrease)20222021(in millions)Distribution fees$— $2 Premiums, policy and contract charges1 17 Total revenues1 19 Benefits, claims, losses and settlement expenses:LTC unlocking— 3 Unlocking impact, excluding LTC170 59 Total benefits, claims, losses and settlement expenses170 62 Amortization of DAC(8)(60)Total expenses162 2 Pretax income (1)$(161)$17 (1) Includes an $8 million net benefit and a $25 million net benefit related to the market impact on non-traditional long-duration products for 2022 and 2021, respectively, which is excluded from adjusted operating earnings. Refer to Results of Operations by Segment for the impact to pretax adjusted operating earnings attributable to unlocking and LTC loss recognition.The primary drivers of the year-over-year unlocking impact include the following items:•Mortality assumption on variable annuities with living benefit guarantees resulted in a higher expense in the 2022 compared to the prior year.•Equity market volatility and correlation assumptions on variable annuities resulted in an unfavorable impact in 2022 compared to a favorable impact in the prior year.Net RevenuesManagement and financial advice fees decreased $242 million, or 3%, for 2022 compared to the prior year primarily reflecting market depreciation, an unfavorable foreign exchange impact, and a decrease in performance fees of $39 million, partially offset by revenue associated with the acquisition of the BMO Global Asset Management (EMEA) business and continued wrap account net inflows.Distribution fees increased $108 million, or 6%, for 2022 compared to the prior year due to $264 million of higher fees on off-balance sheet brokerage cash primarily due to an increase in short-term interest rates, partially offset by lower average equity markets and decreased transactional activity.Net investment income decreased $209 million, or 12%, for 2022 compared to the prior year primarily due to the following impacts:•Net realized investment losses of $87 million for 2022 compared to net realized investment gains of $636 million for the prior year period. Net realized losses for 2022 were primarily driven by the fixed maturity investment portfolio repositioning in the fourth quarter of 2022. Net realized gains for 2021 included net realized gains of $561 million on Available-for-Sale securities and a $58 million net gain related to commercial mortgage loans primarily due to the sale of securities and loans to the reinsurer as a result of the fixed deferred and immediate annuity reinsurance transaction that closed in the third quarter 2021, as well as a $15 million gain on a strategic investment. •The favorable impact of the recent trend in rising interest rates on the investment portfolio yield, including the fourth quarter of 2022 impact of portfolio repositioning.•The favorable impact of growth in Ameriprise Bank and certificate businesses as a result of the market environment and our strategic decision to invest in these businesses. •The unfavorable impact of lower average invested assets due to the sale of investments as a result of the fixed deferred and immediate annuity reinsurance transaction in the prior year.•The $22 million unfavorable market impact of hedges to offset interest rate and currency changes on certain investments in the prior year.Premiums, policy and contract charges increased $1.1 billion for 2022 compared to the prior year primarily reflecting ceded premiums of $1.2 billion associated with the reinsurance transaction for life contingent immediate annuity policies in the prior year. Other revenues increased $109 million, or 29%, for 2022 compared to the prior year primarily reflecting the yield on deposit receivables arising from reinsurance transactions.Banking and deposit interest expense increased $64 million for 2022 compared to the prior year primarily due to higher average crediting rates on certificates and bank cash deposits and increased cash deposits at the bank.40ExpensesDistribution expenses decreased $92 million, or 2%, for 2022 compared to the prior year primarily reflecting lower average equity markets and decreased transactional activity. Interest credited to fixed accounts increased $65 million, or 11%, for 2022 compared to the prior year primarily reflecting the following items: •An $23 million decrease in expense from the unhedged nonperformance credit spread risk adjustment on IUL benefits. The favorable impact of the nonperformance credit spread was $13 million for 2022 compared to an unfavorable impact of $10 million for the prior year. •A $105 million increase in expense from other market impacts on IUL benefits, net of hedges, which was an expense of $51 million for 2022 compared to a benefit of $54 million for the prior year. The increase in expense was primarily due to an increase in the IUL embedded derivative in the current year period, which reflected higher option costs due to a higher new money rate, compared to a decrease in the IUL embedded derivative in the prior year period, which reflected lower option costs due to higher discount rates.Benefits, claims, losses and settlement expenses increased $656 million, or 92%, for 2022 compared to the prior year primarily reflecting the following items:•A $1.2 billion decrease in expense associated with the reinsurance transaction for life contingent immediate annuity policies in the prior year.•A $145 million increase in expense primarily reflecting the impact of year-over-year changes in the unhedged nonperformance credit spread risk adjustment on variable annuity guaranteed benefits. •A $1.0 billion decrease in expense from other market impacts on variable annuity guaranteed benefits, net of hedges in place to offset those risks and the related DSIC amortization. This decrease was the result of a favorable $1.2 billion change in the market impact on variable annuity guaranteed living benefits reserves, partially offset by an unfavorable $127 million change in the market impact on derivatives hedging the variable annuity guaranteed benefits. The main market drivers contributing to these changes are summarized below:•Equity market impact on the variable annuity guaranteed living benefits liability net of the impact on the corresponding hedge assets resulted in a benefit for 2022 compared to an expense in the prior year.•Interest rate impact on the variable annuity guaranteed living benefits liability net of the impact on the corresponding hedge assets resulted in a higher expense for 2022 compared to the prior year.•Volatility impact on the variable annuity guaranteed living benefits liability net of the impact on the corresponding hedge assets resulted in a lower expense for 2022 compared to the prior year.•Other unhedged items, including the difference between the assumed and actual underlying separate account investment performance, fixed income credit exposures, transaction costs and various contractholder behavioral items, were a lower net benefit for 2022 compared to the prior year. •The impact of unlocking was an expense of $170 million for 2022 compared to an expense of $59 million for the prior year. •The mean reversion related impact was an expense of $159 million for 2022 compared to a benefit of $91 million for the prior year.Amortization of DAC increased $84 million, or 68%, for 2022 compared to the prior year primarily reflecting the following items:•The mean reversion related impact was an expense of $108 million for 2022 compared to a benefit of $60 million for the prior year.•The impact of unlocking in 2022 was a benefit of $8 million compared to a benefit of $60 million in the prior year period. •The DAC offset to the market impact on non-traditional long-duration products was a benefit of $106 million for 2022 compared to a benefit of $51 million for the prior year.•A decrease in amortization reflecting lower than expected client exit rates. General and administrative expense increased $288 million, or 8%, for 2022 compared to the prior year primarily reflecting the operating expenses of the acquired BMO Global Asset Management (EMEA) business and higher integration related expenses, partially offset by disciplined expense management and reengineering, lower performance fee related compensation and a favorable foreign exchange impact.Income TaxesOur effective tax rate was 19.6% for 2022 compared to 17.6% for the prior year. See Note 23 to our Consolidated Financial Statements for additional discussion on income taxes.41Results of Operations by SegmentYear Ended December 31, 2022 Compared to Year Ended December 31, 2021 Adjusted operating earnings is the measure of segment profit or loss management uses to evaluate segment performance. Adjusted operating earnings should not be viewed as a substitute for GAAP pretax income. We believe the presentation of segment adjusted operating earnings as we measure it for management purposes enhances the understanding of our business by reflecting the underlying performance of our core operations and facilitating a more meaningful trend analysis. See Note 27 to the Consolidated Financial Statements for further information on the presentation of segment results and our definition of adjusted operating earnings.The following table presents summary financial information by segment: Years Ended December 31,20222021(in millions)Advice & Wealth Management Net revenues$8,461 $8,021 Expenses6,269 6,278 Adjusted operating earnings$2,192 $1,743 Asset ManagementNet revenues$3,506 $3,682 Expenses2,662 2,586 Adjusted operating earnings$844 $1,096 Retirement & Protection SolutionsNet revenues$3,134 $3,244 Expenses2,504 2,509 Adjusted operating earnings$630 $735 Corporate & OtherNet revenues$479 $487 Expenses754 757 Adjusted operating loss$(275)$(270)The following table presents the segment pretax adjusted operating impacts on our revenues and expenses attributable to unlocking for the years ended December 31:Segment Pretax Adjusted Operating Increase (Decrease)20222021Retirement & Protection SolutionsCorporateRetirement & Protection SolutionsCorporate(in millions)Distribution fees$— $— $2 $— Premiums, policy and contract charges3 (2)17 — Total revenues3 (2)19 — Benefits, claims, losses and settlement expenses:LTC unlocking— — — 3 Unlocking, excluding LTC180 (1)89 — Total benefits, claims, losses and settlement expenses180 (1)89 3 Amortization of DAC(5)(4)(65)— Total expenses175 (5)24 3 Pretax income (loss)$(172)$3 $(5)$(3)42Advice & Wealth ManagementThe following table presents the changes in wrap account assets and average balances for the years ended December 31:20222021(in billions)Beginning balance$464.7 $380.0 Net flows27.5 40.4 Market appreciation (depreciation) and other(80.1)44.3 Ending balance$412.1 $464.7 Advisory wrap account assets ending balance (1)$407.8 $459.5 Average advisory wrap account assets (2)$419.9 $415.3 (1) Advisory wrap account assets represent those assets for which clients receive advisory services and are the primary driver of revenue earned on wrap accounts. Clients may hold non-advisory investments in their wrap accounts that do not incur an advisory fee. (2) Average ending balances are calculated using an average of the prior period’s ending balance and all months in the current period excluding the most recent month for the twelve months ended December 31, 2022 and 2021.Wrap account assets decreased $52.6 billion, or 11%, during 2022 primarily due to market depreciation of $80.1 billion, partially offset by net inflows of $27.5 billion. Average advisory wrap account assets increased $4.6 billion, or 1%, compared to the prior year primarily reflecting continued net inflows, partially offset by market depreciation. The following table presents the results of operations of our Advice & Wealth Management segment on an adjusted operating basis:Years Ended December 31,Change20222021(in millions)RevenuesManagement and financial advice fees$5,308 $5,297 $11 — %Distribution fees2,249 2,253 (4)— Net investment income748 257 491 NMOther revenues232 226 6 3 Total revenues8,537 8,033 504 6 Banking and deposit interest expense76 12 64 NMTotal net revenues8,461 8,021 440 5 Expenses Distribution expenses4,719 4,842 (123)(3)Interest and debt expense10 10 — — General and administrative expense1,540 1,426 114 8 Total expenses6,269 6,278 (9)— Adjusted operating earnings$2,192 $1,743 $449 26 %NM Not Meaningful.Our Advice & Wealth Management segment pretax adjusted operating earnings, which exclude net realized investment gains or losses, increased $449 million, or 26%, for 2022 compared to the prior year primarily reflecting the benefit from higher interest rates and client net inflows, partially offset by market depreciation and decreased transactional activity. Pretax adjusted operating margin was 25.9% for 2022 compared to 21.7% for the prior year. Adjusted operating net revenue per advisor increased to $827,000 for 2022, up 4%, from $796,000 for the prior year.Ameriprise Bank is continuing its deposit growth trend, with cash sweep balances increasing $6.9 billion from the prior year period to $18.3 billion and brokerage client pledged asset lines of credit increasing $122 million from the prior year to $589 million as of December 31, 2022. Net RevenuesManagement and financial advice fees increased $11 million for 2022 compared to the prior year primarily due to an increase in financial planning fees, partially offset by lower advisory fees. Average advisory wrap account assets increased $4.6 billion, or 1%, compared to the prior year reflecting net inflows, partially offset by market depreciation.43Distribution fees decreased $4 million for 2022 compared to the prior year primarily reflecting lower average equity markets and decreased transactional activity mostly offset by $264 million of higher fees on off-balance sheet brokerage cash due to an increase in short-term interest rates. Net investment income increased $491 million for 2022 compared to the prior year primarily due to higher average invested assets due to increased bank deposits and higher investment yields on the investment portfolio supporting the bank and certificate products.Banking and deposit interest expense increased $64 million for 2022 compared to the prior year primarily due to higher average crediting rates on certificates and bank cash deposits and increased cash deposits at the bank.ExpensesDistribution expenses decreased $123 million, or 3%, for 2022 compared to the prior year reflecting market depreciation and decreased transactional activity.General and administrative expense increased $114 million, or 8%, for 2022 compared to the prior year primarily due to higher volume related expenses and investments for business growth as well as lower staffing levels and limited travel and entertainment expenses in the prior year. Asset ManagementThe following tables present the mutual fund performance of our retail Columbia Threadneedle Investments funds as of December 31, 2022:Retail Fund Rankings in Top 2 Quartiles or Above Index Benchmark - Asset Weighted (1)1 year3 year5 year10 yearEquity56%75%75%90%Fixed Income39%52%56%86%Asset Allocation22%61%70%90%4- or 5-star Morningstar Rated Funds (2)Overall3 year5 year10 yearNumber of rated funds131918699Percent of rated assets55%43%45%57%(1) Retail Fund performance rankings for each fund are measured on a consistent basis against the most appropriate peer group or index. Peer groupings of Columbia funds are defined by Lipper category and are based on the Primary Share Class (i.e., Institutional if available, otherwise Advisor or Instl3 share class) net of fees. Peer groupings of Threadneedle funds are defined by either IA or Morningstar index and based on the Primary Share Class. Comparisons to Index are measured gross of fees.To calculate asset weighted performance, the sum of the total assets of the funds with above median ranking are divided by total assets of all funds. Funds with more assets will receive a greater share of the total percentage above or below median.Aggregated Asset Allocation Funds may include funds that invest in other Columbia or Threadneedle branded mutual funds included in both equity and fixed income.(2) Columbia funds are available for purchase by U.S. customers. Out of 104 Columbia funds rated (based on primary share class), 15 received a 5-star Overall Rating and 35 received a 4-star Overall Rating. Out of 157 Threadneedle funds rated (based on highest-rated share class), 27 received a 5-star Overall Rating and 54 received a 4-star Overall Rating. The Overall Morningstar Rating is derived from a weighted average of the performance figures associated with its 3-, 5- and 10-year (if applicable) Morningstar Rating metrics. The following table presents managed assets by type:December 31,ChangeAverage (1)ChangeDecember 31,2022202120222021(in billions)(in billions)Equity$301.2 $402.9 $(101.7)(25)%$333.1 $338.3 $(5.2)(2)%Fixed income210.0 277.0 (67.0)(24)232.0 211.8 20.2 10 Money market21.9 10.1 11.8 NM17.1 6.5 10.6 NMAlternative33.7 39.9 (6.2)(16)37.3 25.8 11.5 45 Hybrid and other17.2 24.2 (7.0)(29)19.8 22.6 (2.8)(12)Total managed assets (2)$584.0 $754.1 $(170.1)(23)%$639.3 $605.0 $34.3 6 %NM Not Meaningful(1) Average ending balances are calculated using an average of the prior period’s ending balance and all months in the current period. (2) In the fourth quarter of 2021, the definition of Alternative AUM was changed to now include real estate, CLOs, private equity, hedge funds (direct and fund of funds), infrastructure and commodities to better demonstrate our underlying business and the additional assets from the acquisition of the BMO Global Asset Management (EMEA) business. 44The following table presents the changes in global managed assets:Years Ended December 31,20222021(in billions)Global Retail Funds (1) Beginning assets$409.4 $323.5 Inflows60.9 78.5 Outflows(84.7)(68.8)Net VP/VIT fund flows(4.3)(4.2)Net new flows (2)(28.1)5.5 Reinvested dividends11.4 19.0 Net flows(16.7)24.5 Distributions(12.9)(21.5)Acquired assets (3)— 37.0 Market appreciation (depreciation) and other(65.6)47.5 Foreign currency translation (4)(4.9)(1.6)Total ending assets309.3 409.4 Global Institutional (1) Beginning assets344.7 223.1 Inflows (5)59.1 50.9 Outflows (5)(49.0)(32.5)Net flows (2)10.1 18.4 Acquired assets (3)— 99.2 Market appreciation (depreciation) and other (6)(65.0)6.7 Foreign currency translation (4)(15.1)(2.7)Total ending assets274.7 344.7 Total managed assets$584.0 $754.1 Total net flows$(6.6)$42.9 Legacy insurance partners net flows (7)$(4.6)$(4.9)(1) The 2021 rollforwards for Global Retail Funds and Global Institutional were restated for a reclass between retail and institutional. Total AUM as of December 31, 2021 remained unchanged.(2) Included in net flows are the amounts from the U.S. asset transfer from the BMO acquisition of $2.6 billion ($2.5 billion retail and $0.1 billion institutional) in 2022 and $16.9 billion ($2.9 billion retail and $14.0 billion institutional) in 2021.(3) Reflects the acquisition of the BMO Global Asset Management (EMEA) business that closed on November 8, 2021.(4) Amounts represent local currency to U.S. dollar translation for reporting purposes.(5) Global Institutional inflows and outflows include net flows from our structured variable annuity product and Ameriprise Bank. (6) Included in Market appreciation (depreciation) and other for Global Institutional is the change in affiliated general account balance, excluding net flows related to our structured variable annuity product and Ameriprise Bank. (7) Legacy insurance partners assets and net flows are included in the rollforwards above.Total segment AUM decreased $170.1 billion, or 23%, during 2022 primarily driven by equity and bond market depreciation and an unfavorable foreign exchange impact. Net outflows were $6.6 billion for 2022, compared to net inflows of $42.9 billion in the prior year which included the transfer of $16.9 billion of retail and institutional assets from U.S. BMO asset management clients that elected to move their assets to us during the fourth quarter of 2021, resulting from the transition of investment advisory services as part of an arrangement with BMO Financial Group for their U.S. business. 45The following table presents the results of operations of our Asset Management segment on an adjusted operating basis:Years Ended December 31,Change20222021(in millions)Revenues Management and financial advice fees$3,086 $3,202 $(116)(4)%Distribution fees397 471 (74)(16)Net investment income9 6 3 50 Other revenues14 3 11 NMTotal revenues3,506 3,682 (176)(5)Banking and deposit interest expense— — — — Total net revenues3,506 3,682 (176)(5)Expenses Distribution expenses995 1,132 (137)(12)Amortization of deferred acquisition costs9 12 (3)(25)Interest and debt expense5 5 — — General and administrative expense1,653 1,437 216 15 Total expenses2,662 2,586 76 3 Adjusted operating earnings$844 $1,096 $(252)(23)%NM Not Meaningful.Our Asset Management segment pretax adjusted operating earnings, which exclude net realized investment gains or losses, decreased $252 million, or 23%, for 2022 compared to the prior year primarily due to market depreciation, an unfavorable foreign exchange impact and the cumulative impact of net outflows. Net RevenuesManagement and financial advice fees decreased $116 million, or 4%, for 2022 compared to the prior year primarily driven by lower average markets, the cumulative impact of net outflows, the impact of foreign exchange rates and a decrease in performance fees, partially offset by revenue associated with the acquired BMO Global Asset Management (EMEA) business. Distribution fees decreased $74 million, or 16%, for 2022 compared to the prior year primarily due to lower average markets and the cumulative impact from net outflows.Other revenues increased $11 million for 2022 compared to the prior year primarily due to the acquired BMO Global Asset Management (EMEA) business.ExpensesDistribution expenses decreased $137 million, or 12%, for 2022 compared to the prior year primarily due to market depreciation and the cumulative impact of net outflows.General and administrative expense increased $216 million, or 15%, for 2022 compared to the prior year primarily reflecting the operating expenses of the acquired BMO Global Asset Management (EMEA) business, partially offset by the impact of foreign exchange rates and $17 million in lower performance fee related compensation.46Retirement & Protection SolutionsThe following table presents the results of operations of our Retirement & Protection Solutions segment on an adjusted operating basis:Years Ended December 31,Change20222021(in millions)Revenues Management and financial advice fees$788 $932 $(144)(15)%Distribution fees417 487 (70)(14)Net investment income569 480 89 19 Premiums, policy and contract charges1,348 1,338 10 1 Other revenues12 7 5 71 Total revenues3,134 3,244 (110)(3)Banking and deposit interest expense— — — — Total net revenues3,134 3,244 (110)(3)Expenses Distribution expenses436 531 (95)(18)Interest credited to fixed accounts386 389 (3)(1)Benefits, claims, losses and settlement expenses1,130 1,042 88 8 Amortization of deferred acquisition costs204 208 (4)(2)Interest and debt expense39 37 2 5 General and administrative expense309 302 7 2 Total expenses2,504 2,509 (5)— Adjusted operating earnings$630 $735 $(105)(14)%Our Retirement & Protection Solutions segment pretax adjusted operating earnings, which excludes net realized investment gains or losses (net of the related DSIC and DAC amortization, unearned revenue amortization and the reinsurance accrual), the market impact on non-traditional long-duration products (including variable annuity contracts and IUL contracts, net of hedges and the related DSIC and DAC amortization, unearned revenue amortization and the reinsurance accrual), mean reversion related impacts, and block transfer reinsurance transaction impacts decreased $105 million, or 14%, for 2022 compared to the prior year.Variable annuity account balances decreased 19% to $74.4 billion as of December 31, 2022 compared to the prior year due to market depreciation and net outflows of $2.1 billion. Variable annuity sales decreased 33% to $4.0 billion for 2022 compared to the prior year reflecting a decrease in sales of variable annuities with living benefit guarantees. The risk profile of our in force block continues to improve, with account values with living benefit riders down to 57% as of December 31, 2022 compared to 61% a year ago. This trend is expected to continue and meaningfully shift the mix of business away from products with living benefit guarantees over time.We continue to optimize our risk profile and shift our business mix to lower risk offerings. During the fourth quarter of 2021, we made the decision to discontinue new sales of our variable annuities with living benefit guarantees at the end of 2021, and have stopped issuing new contracts as of mid-2022. In addition, we discontinued new sales of our universal life insurance with secondary guarantees and our single-pay fixed universal life with a long term care rider products at the end of 2021.Net RevenuesManagement and financial advice fees decreased $144 million, or 15%, for 2022 compared to the prior year primarily reflecting lower average equity markets and variable annuity net outflows.Distribution fees decreased $70 million, or 14%, for 2022 compared to the prior year reflecting lower average equity markets and lower sales.Net investment income, which excludes net realized investment gains or losses, increased $89 million, or 19%, for 2022 compared to the prior year reflecting higher fixed maturity investment yields and increased volume of invested assets partially driven by our portfolio repositioning in the fourth quarter.ExpensesDistribution expenses decreased $95 million, or 18%, for 2022 compared to the prior year primarily reflecting lower variable annuity and insurance sales and market depreciation.Benefits, claims, losses and settlement expenses, which exclude the market impact on variable annuity contracts (net of hedges and the related DSIC amortization), mean reversion related impacts and the DSIC offset to net realized investment gains or losses, increased 47$88 million, or 8%, for 2022 compared to the prior year primarily due to the impact of unlocking. The unlocking impact for 2022 was an expense of $180 million primarily reflecting continued lower surrender rates and updated mortality assumptions for variable annuities with living benefits compared to an expense of $89 million for the prior year which was also driven by lower surrender rates. Corporate & OtherThe following table presents the results of operations of our Corporate & Other segment on an adjusted operating basis:Years Ended December 31,Change20222021(in millions)Revenues Distribution fees$— $1 $(1)NMNet investment income155 242 (87)(36)%Premiums, policy and contract charges99 100 (1)(1)Other revenues230 146 84 58 Total revenues484 489 (5)(1)Banking and deposit interest expense5 2 3 NMTotal net revenues479 487 (8)(2)Expenses Distribution expenses(10)(9)(1)11 Interest credited to fixed accounts242 250 (8)(3)Benefits, claims, losses and settlement expenses223 179 44 25 Amortization of deferred acquisition costs3 9 (6)(67)Interest and debt expense70 63 7 11 General and administrative expense226 265 (39)(15)Total expenses754 757 (3)— Adjusted operating loss$(275)$(270)$(5)(2)%NM Not Meaningful.Our Corporate & Other segment includes our closed blocks of LTC insurance and fixed annuity and fixed indexed annuity (“FA”) business.Our Corporate & Other segment pretax adjusted operating loss excludes net realized investment gains or losses, the market impact on fixed deferred annuity contracts (net of hedges and the related DAC amortization), the market impact of hedges to offset interest rate and currency changes on unrealized gains or losses for certain investments, block transfer reinsurance transaction impacts, gain or loss on disposal of a business that is not considered discontinued operations, integration and restructuring charges, and the impact of consolidating CIEs. Our Corporate & Other segment pretax adjusted operating loss increased $5 million, or 2%, for 2022 compared to the prior year. LTC insurance had pretax adjusted operating earnings of $15 million for 2022 compared to pretax adjusted operating earnings of $52 million for the prior year period primarily reflecting the favorable impacts in 2021 from COVID-19 effects on policyholder expenses. FA business had a pretax adjusted operating loss of $16 million for 2022 compared to a pretax adjusted operating loss of $24 million for the prior year. Fixed deferred annuity account balances declined 6% to $7.1 billion as of December 31, 2022 compared to the prior year period as surrender trends continue. During the third quarter of 2021, we closed on a transaction to reinsure RiverSource Life’s fixed deferred and immediate annuity policies. Net RevenuesNet investment income, which excludes net realized investment gains or losses, the market impact of hedges to offset interest rate and currency changes on unrealized gains or losses for certain investments, integration and restructuring charges, and the impact of consolidating CIEs, decreased $87 million, or 36%, for 2022 compared to the prior year primarily reflecting lower average invested assets due to the sale of investments to the reinsurer as a result of the fixed deferred and immediate annuity reinsurance transaction and a $15 million gain on a strategic investment in the prior year. Other revenues increased $84 million, or 58%, for 2022 compared to the prior year primarily reflecting the yield on deposit receivables arising from reinsurance transactions.48ExpensesBenefits, claims, losses and settlement expenses, which excludes DSIC offset to net realized investment gains or losses, increased $44 million, or 25%, for 2022 compared to the prior year primarily reflecting more normalized claims on LTC insurance, which benefited from COVID-19 related impacts in the prior year.General and administrative expense, which excludes integration and restructuring charges and expenses attributable to CIEs, decreased $39 million, or 15%, for 2022 compared to the prior year primarily due to a larger unfavorable change in the mark-to-market impact on share-based compensation expense in the prior year due to share price appreciation.Closed Block LTC InsuranceAs of December 31, 2022, our nursing home indemnity LTC block had approximately $71 million in gross in force annual premium and future policyholder benefits and claim reserves of approximately $1.3 billion, net of reinsurance, which was 51% of GAAP reserves. This block has been shrinking over the last few years given the average attained age is 83 and the average attained age of policyholders on claim is 88. Fifty-four percent of daily benefits in force in this block come from policies that have a lifetime benefit period.As of December 31, 2022, our comprehensive reimbursement LTC block had approximately $114 million in gross in force annual premium and future policyholder benefits and claim reserves of approximately $1.3 billion, net of reinsurance. This block has higher premiums per policy than the nursing home indemnity LTC policies. The average attained age is 79 and the average attained age of policyholders on claim is 85. Thirty-five percent of daily benefits in force in this block come from policies that have a lifetime benefit period. We utilize three primary levers to manage our LTC business. First, we have taken an active approach of steadily increasing rates since 2005, with cumulative rate increases of 237% on our nursing home indemnity LTC block and 135% on our comprehensive reimbursement LTC block as of December 31, 2022. Second, we have a reserving process that reflects the policy features and risk characteristics of our blocks. As of December 31, 2022, we had 41,000 policies that were closed with claim activity, as well as 8,000 open claims. We apply this experience to our in force policies, which were 86,000 as of December 31, 2022, at a very granular level by issue year, attained age and benefit features. Our statutory reserves are $374 million higher than our GAAP reserves and include margins on key assumptions for morbidity and mortality, as well as $345 million in asset adequacy reserves as of December 31, 2022. Lastly, we have prudently managed our investment portfolio primarily through a liquid, investment grade portfolio. We undertake an extensive review of active life future policy benefit reserve adequacy annually during the third quarter of each year, or more frequently if appropriate, using current best estimate assumptions as of the date of the review. Our annual review process includes an analysis of our key reserve assumptions, including those for morbidity, terminations (mortality and lapses), premium rate increases and investment yields. Fair Value MeasurementsWe report certain assets and liabilities at fair value; specifically, separate account assets, derivatives, embedded derivatives and most investments and cash equivalents. Fair value assumes the exchange of assets or liabilities occurs in orderly transactions and is not the result of a forced liquidation or distressed sale. We include actual market prices, or observable inputs, in our fair value measurements to the extent available. Broker quotes are obtained when quotes from pricing services are not available. We validate prices obtained from third parties through a variety of means such as: price variance analysis, subsequent sales testing, stale price review, price comparison across pricing vendors and due diligence reviews of vendors. See Note 15 to the Consolidated Financial Statements for additional information on our fair value measurements.Fair Value of Liabilities and Nonperformance RiskCompanies are required to measure the fair value of liabilities at the price that would be received to transfer the liability to a market participant (an exit price). Since there is not a market for our obligations of our variable annuity riders, fixed deferred indexed annuities, structured variable annuities, and IUL insurance, we consider the assumptions participants in a hypothetical market would make to reflect an exit price. As a result, we adjust the valuation of variable annuity riders, fixed deferred indexed annuities, structured variable annuities, and IUL insurance by updating certain contractholder assumptions, adding explicit margins to provide for risk, and adjusting the rates used to discount expected cash flows to reflect a current market estimate of our nonperformance risk. The nonperformance risk adjustment is based on observable market data adjusted to estimate the risk of our life insurance company subsidiaries not fulfilling these liabilities. Consistent with general market conditions, this estimate resulted in a spread over the U.S. Treasury curve as of December 31, 2022. As our estimate of this spread widens or tightens, the liability will decrease or increase. If this nonperformance credit spread moves to a zero spread over the U.S. Treasury curve, the reduction to future net income would be approximately $359 million, net of DAC, DSIC, unearned revenue amortization, the reinsurance accrual and income taxes (calculated at the statutory tax rate of 21%), based on December 31, 2022 credit spreads.49Liquidity and Capital Resources OverviewWe maintained substantial liquidity during the year ended December 31, 2022. At December 31, 2022 and 2021, we had $7.0 billion and $7.1 billion, respectively, in cash and cash equivalents excluding CIEs and other restricted cash on a consolidated basis. At December 31, 2022 and 2021, the parent company had $389 million and $841 million, respectively, in cash, cash equivalents, and unencumbered liquid securities. Liquid securities predominantly include U.S. government agency mortgage back securities. Additional sources of liquidity include a line of credit with an affiliate up to $729 million and an unsecured revolving committed credit facility for up to $1.0 billion that expires in June 2026. Management’s estimate of liquidity available to the parent company as of December 31, 2022 was $1.6 billion which includes cash, cash equivalents, unencumbered liquid securities, the line of credit with an affiliate and a portion of the committed credit facility. Under the terms of the committed credit facility, we can increase the availability to $1.25 billion upon satisfaction of certain approval requirements. Available borrowings under this facility are reduced by any outstanding letters of credit. At December 31, 2022, we had no outstanding borrowings under this credit facility and had $1 million of letters of credit issued against the facility. Our credit facility contains various administrative, reporting, legal and financial covenants. We remain in compliance with all such covenants at December 31, 2022.In addition, we have access to collateralized borrowings, which may include repurchase agreements and Federal Home Loan Bank (“FHLB”) advances. Our subsidiaries, RiverSource Life Insurance Company (“RiverSource Life”), and Ameriprise Bank are members of the FHLB of Des Moines, which provides access to collateralized borrowings. As of December 31, 2022 and 2021, we had an estimated maximum borrowing capacity of $8.0 billion and $8.1 billion, respectively, under the FHLB facilities, of which $201 million and $200 million was outstanding as of December 31, 2022 and 2021, respectively, and is collateralized with commercial mortgage backed securities and residential mortgage backed securities.Short-term contractual obligations for the year 2023 include investment certificate maturities of $8.9 billion and estimated insurance and annuity benefits of $1.8 billion in addition to operating liquidity needs and maturing long-term debt in October 2023 of $750 million. Long-term contractual obligations for years after 2023 include estimated insurance and annuity benefits of $49.3 billion.We repaid $500 million principal amount of our 3.0% senior notes at maturity on March 22, 2022. We issued $500 million of 4.5% unsecured senior notes on May 13, 2022. See Note 14 to our Consolidated Financial Statements for further information about our long-term debt maturities.We believe cash flows from operating activities, available cash balances, our availability of revolver borrowings, access to debt markets, and dividends from our subsidiaries will be sufficient to fund our short-term and long-term operating liquidity needs and stress requirements.On August 16, 2022, federal legislation commonly referred to as the Inflation Reduction Act of 2022 (“IRA”) was enacted. We have evaluated the tax provisions of the IRA, the most significant of which are the corporate alternative minimum tax (“CAMT”) and the share repurchase excise tax. Both the CAMT and share repurchase tax are effective beginning in 2023. We expect to be an applicable corporation required to compute the CAMT; however, we have not determined if we will be liable for the CAMT in 2023. We will be a covered corporation subject to the share repurchase excise tax. As the Internal Revenue Service issues additional guidance related to the IRA, we will continue to evaluate any impact to our consolidated financial statements. Dividends from SubsidiariesAmeriprise Financial is primarily a parent holding company for the operations carried out by our wholly-owned subsidiaries. Because of our holding company structure, our ability to meet our cash requirements, including the payment of dividends on our common stock, substantially depends upon the receipt of dividends or return of capital from our subsidiaries, particularly our life insurance subsidiary, RiverSource Life, our face-amount certificate subsidiary, Ameriprise Certificate Company (“ACC”), AMPF Holding, LLC, which is the parent company of our retail introducing broker-dealer subsidiary, Ameriprise Financial Services, LLC (“AFS”) and our clearing broker-dealer subsidiary, American Enterprise Investment Services, Inc. (“AEIS”), our transfer agent subsidiary, Columbia Management Investment Services Corp., our investment advisory company, Columbia Management Investment Advisers, LLC, TAM UK International Holdings Ltd., which includes Ameriprise International Holdings GmbH within its organizational structure, and Columbia Threadneedle Investments UK International Ltd. The payment of dividends by many of our subsidiaries is restricted and certain of our subsidiaries are subject to regulatory capital requirements.50Actual capital and regulatory capital requirements for our wholly owned subsidiaries subject to regulatory capital requirements were as follows: Actual CapitalRegulatory Capital RequirementsDecember 31,December 31,2022202120222021(in millions)RiverSource Life (1)(2)$3,103 $3,419 $571 $502 RiverSource Life of NY (1)(2)320 310 40 42 ACC (4)(5)534 304 496 283 TAM UK International Holdings Ltd.(6)437 330 214 248 Ameriprise Bank (4)(7)1,542 853999 589AFS (3)(4)90 103 ##Ameriprise Captive Insurance Company (3)38 39 10 10 Ameriprise Trust Company (3)54 47 38 44 AEIS (3)(4)208 155 26 29 RiverSource Distributors, Inc. (3)(4)12 10 ##Columbia Management Investment Distributors, Inc. (3)(4)17 14 ##Columbia Threadneedle Investments UK International Ltd. (6)330 348 152 170 # Amounts are less than $1 million.(1) Actual capital is determined on a statutory basis.(2) Regulatory capital requirement is the company action level and is based on the statutory risk-based capital filing.(3) Regulatory capital requirement is based on the applicable regulatory requirement, calculated as of December 31, 2022 and 2021.(4) Actual capital is determined on an adjusted GAAP basis.(5) ACC is required to hold capital in compliance with the Minnesota Department of Commerce and SEC capital requirements.(6) Actual capital and regulatory capital requirements are determined in accordance with U.K. regulatory legislation.(7) Regulatory capital requirement is based on minimum requirements for well capitalized banks in accordance with the Office of the Comptroller of the Currency (“OCC”).In addition to the particular regulations restricting dividend payments and establishing subsidiary capitalization requirements, we take into account the overall health of the business, capital levels and risk management considerations in determining a strategy for payments to our parent holding company from our subsidiaries, and in deciding to use cash to make capital contributions to our subsidiaries.During the year ended December 31, 2022, the parent holding company received cash dividends or a return of capital from its subsidiaries of $2.7 billion and contributed cash to its subsidiaries of $743 million. During the year ended December 31, 2021, the parent holding company received cash dividends or a return of capital from its subsidiaries of $4.1 billion and contributed cash to its subsidiaries of $1.3 billion, which included a $973 million contribution to Columbia Threadneedle Investments UK International Ltd. and Ameriprise Asset Management Holdings Singapore Ltd. for the acquisition of the BMO Global Asset Management (EMEA) business.51The table below presents the historical subsidiary capacity for dividends and return of capital to the parent holding company in each of the years ended December 31: 202220212020(in millions)RiverSource Life (1)$600 $1,900 $1,505 Ameriprise Bank359 78 74 ACC (2)39 129 97 CMIA (3)613 674 381 CMIS (3)27 20 14 TAM UK International Holdings Ltd.223 355 N/AAmeriprise International Holdings GmbHN/AN/A254 Ameriprise Trust Company15 3 — Ameriprise Captive Insurance Company28 34 48 RiverSource Distributors, Inc. 11 — 12 AMPF Holding, LLC1,606 1,469 1,116 Columbia Threadneedle Investments UK International Ltd. (4)178 178 N/ATotal capacity$3,699 $4,840 $3,501 N/A Not applicable.(1) RiverSource Life payments in excess of statutory unassigned funds require advanced notice to the Minnesota Department of Commerce, RiverSource Life’s primary regulator, and are subject to potential disapproval. In addition, dividends and other distributions whose fair market value, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (1) the previous year’s statutory net gain from operations or (2) 10% of the previous year-end statutory capital and surplus are referred to as “extraordinary dividends.” Extraordinary dividends also require advanced notice to the Minnesota Department of Commerce, and are subject to potential disapproval. For dividends exceeding these thresholds, RiverSource Life provided notice to the Minnesota Department of Commerce and received responses indicating that it did not object to the payment of these dividends. Total dividend capacity for RiverSource Life represents dividends paid during year ended December 31 along with any unpaid ordinary dividend capacity, subject to unassigned funds limitation. (2) The capacity for dividends and return of capital for ACC is based on capital held in excess of regulatory requirements.(3) The dividend capacity for CMIA and CMIS is based on available tangible capital net of regulatory non-allowable assets and internal requirements backing Seed Capital.(4) Dividend capacity is subject to regulatory approval. The following table presents cash dividends paid or return of capital to the parent holding company, net of cash capital contributions made by the parent holding company for the following subsidiaries for the years ended December 31: 202220212020(in millions)RiverSource Life$600 $1,900 $800 Ameriprise Bank(395)(142)(300)ACC(168)109 72 CMIA480 510 324 TAM UK International Holdings Ltd.— 256 N/AAmeriprise Advisor Capital, LLC78 (172)(102)Ameriprise Captive Insurance Company— 5 15 AMPF Holding, LLC1,375 1,284 924 Ameriprise Trust Company— — (4)Ameriprise India6 2 4 RiverSource Distributors, Inc.— (3)— Columbia Threadneedle Investments UK International Ltd.— (966)— Ameriprise Asset Management Holdings Singapore Ltd.— (7)— Total$1,976 $2,776 $1,733 N/A Not applicable.52In 2009, RiverSource Life established an agreement to protect its exposure to Genworth Life Insurance Company (“GLIC”) for its reinsured LTC. In 2016, substantial enhancements to this reinsurance protection agreement were finalized. The terms of these confidential provisions within the agreement have been shared, in the normal course of regular reviews, with our domiciliary regulator and rating agencies. GLIC is domiciled in Delaware, so in the event GLIC were subjected to rehabilitation or insolvency proceedings, such proceedings would be located in (and governed by) Delaware laws. Delaware courts have a long tradition of respecting commercial and reinsurance affairs, as well as contracts among sophisticated parties. Similar credit protections to what we have with GLIC have been tested and respected in Delaware and elsewhere in the United States, and as a result we believe our credit protections would be respected even in the unlikely event that GLIC becomes subject to rehabilitation or insolvency proceedings in Delaware. Accordingly, while no credit protections are perfect, we believe the correct way to think about the risks represented by our counterparty credit exposure to GLIC is not the full amount of the gross liability that GLIC reinsures, but a much smaller net exposure to GLIC (if any that might exist after taking into account our credit protections). Thus, management believes that our agreement and offsetting non-LTC legacy arrangements with Genworth will enable RiverSource Life to recover on all net exposure in all material respects in the event of a rehabilitation or insolvency of GLIC.Dividends Paid to Shareholders and Share RepurchasesWe paid regular quarterly dividends to our shareholders totaling $553 million and $527 million for the years ended December 31, 2022 and 2021, respectively. On January 25, 2023, we announced a quarterly dividend of $1.25 per common share. The dividend will be paid on February 28, 2023 to our shareholders of record at the close of business on February 10, 2023.In January 2022, our Board of Directors authorized us to repurchase up to $3.0 billion for the repurchase of our common stock through March 31, 2024. As of December 31, 2022, we had $1.6 billion remaining under this share repurchase authorization. We intend to fund share repurchases through existing working capital, future earnings and other customary financing methods. The share repurchase program does not require the purchase of any minimum number of shares, and depending on market conditions and other factors, these purchases may be commenced or suspended at any time without prior notice. Acquisitions under the share repurchase program may be made in the open market, through privately negotiated transactions or block trades or other means. During the year ended December 31, 2022, we repurchased a total of 6.6 million shares of our common stock at an average price of $282.33 per share.Cash FlowsCash flows of CIEs and restricted and segregated cash are reflected in our cash flows provided by (used in) operating activities, investing activities and financing activities. Cash held by CIEs is not available for general use by Ameriprise Financial, nor is Ameriprise Financial cash available for general use by its CIEs. Cash segregated under federal and other regulations is held for the exclusive benefit of our brokerage customers and is not available for general use by Ameriprise Financial.Operating ActivitiesNet cash provided by operating activities increased $1.1 billion to $4.4 billion for the year ended December 31, 2022 compared to $3.3 billion for the prior year primarily reflecting a $885 million increase in derivatives, net of collateral, and a $564 million increase in receivables, partially offset by a $653 million decrease in policyholder account balances, future policy benefits and claims, net.Investing ActivitiesOur investing activities primarily relate to our Available-for-Sale investment portfolio. This activity is significantly affected by the net flows of our brokerage cash and certificates businesses, fixed annuity and universal life products reflected in financing activities.Net cash used in investing activities increased $9.2 billion to $13.6 billion for the year ended December 31, 2022 compared to $4.4 billion for the prior year primarily reflecting a $7.3 billion increase in cash used for purchases of Available-for-Sale securities and a $3.9 billion decrease in proceeds from maturities, sinking fund payments and calls of Available-for-Sale securities. Financing ActivitiesNet cash provided by financing activities increased $6.7 billion to $8.4 billion for the year ended December 31, 2022 compared to $1.7 billion for the prior year primarily reflecting a $5.5 billion increase in net cash flows from investment certificates, a $2.9 billion increase in banking deposits, a $491 million increase in issuance of long-term debt and a $1.1 billion increase in repayments of debt by CIEs, partially offset by a $1.4 billion decrease in borrowings by CIEs, a $1.0 billion decrease due to lower deferred premium derivative transactions, and a $501 million increase in repayments of long-term debt.Forward-Looking Statements This report contains forward-looking statements that reflect management’s plans, estimates and beliefs. Actual results could differ materially from those described in these forward-looking statements. Examples of such forward-looking statements include: •statements of the Company’s plans, intentions, positioning, expectations, objectives or goals, including those relating to asset flows, mass affluent and affluent client acquisition strategy, client retention and growth of our client base, financial advisor productivity, retention, recruiting and enrollments, the introduction, cessation, terms or pricing of new or existing products and services, acquisition integration, benefits and claims expenses, general and administrative costs, consolidated tax rate, return of capital to shareholders, debt repayment and excess capital position and financial flexibility to capture additional growth 53opportunities;•statements about the expected trend in the shift to lower-risk products, including the exit from variable annuities with living benefit riders and the discontinuance of new sales of universal life insurance with secondary guarantees;•statements about the outcomes from the application to convert Ameriprise Bank to a state-chartered bank and national trust bank or the anticipated deposit growth or impacts from possible future interest rate increases;•other statements about future economic performance, the performance of equity markets and interest rate variations and the economic performance of the United States and of global markets; and•statements of assumptions underlying such statements.The words “believe,” “expect,” “anticipate,” “optimistic,” “intend,” “plan,” “aim,” “will,” “may,” “should,” “could,” “would,” “likely,” “forecast,” “on track,” “project,” “continue,” “able to remain,” “resume,” “deliver,” “develop,” “evolve,” “drive,” “enable,” “flexibility,” “scenario,” “case”, “appear”, “expand” and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from such statements.Such factors include, but are not limited to:•market fluctuations and general economic and political factors, including volatility in the U.S. and global market conditions, client behavior and volatility in the markets for our products; •changes in interest rates; •adverse capital and credit market conditions or any downgrade in our credit ratings;•effects of competition and our larger competitors’ economies of scale;•declines in our investment management performance;•our ability to compete in attracting and retaining talent, including financial advisors;•impairment, negative performance or default by financial institutions or other counterparties;•the ability to maintain our unaffiliated third-party distribution channels and the impacts of sales of unaffiliated products;•changes in valuation of securities and investments included in our assets;•the determination of the amount of allowances taken on loans and investments;•the illiquidity of our investments;•effects of the elimination of LIBOR on, and value of, securities and other assets and liabilities tied to LIBOR;•failures by other insurers that lead to higher assessments we owe to state insurance guaranty funds;•failures or defaults by counterparties to our reinsurance arrangements;•inadequate reserves for future policy benefits and claims or for future redemptions and maturities;•deviations from our assumptions regarding morbidity, mortality and persistency affecting our insurance profitability;•changes to our reputation arising from employee or advisor misconduct or otherwise;•direct or indirect effects of or responses to climate change;•interruptions or other failures in our operating systems and networks, including errors or failures caused by third-party service providers, interference or third-party attacks;•interruptions or other errors in our telecommunications or data processing systems;• identification and mitigation of risk exposure in market environments, new products, vendors and other types of risk; • ability of our subsidiaries to transfer funds to us to pay dividends;• changes in exchange rates and other risks in connection with our international operations and earnings and income generated overseas;• occurrence of natural or man-made disasters and catastrophes;• risks in acquisition transactions, such as the integration of the BMO Global Asset Management (EMEA) business, or other potential strategic acquisitions or divestitures;• legal and regulatory actions brought against us;• changes to laws and regulations that govern operation of our business;• supervision by bank regulators and related regulatory and prudential standards as a savings and loan holding company that may limit our activities and strategies;• changes in corporate tax laws and regulations and interpretations and determinations of tax laws impacting our products; • protection of our intellectual property and claims we infringe the intellectual property of others; and•changes in and the adoption of new accounting standards.Management cautions the reader that the foregoing list of factors is not exhaustive. There may also be other risks that management is unable to predict at this time that may cause actual results to differ materially from those in forward-looking statements. Readers are 54cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. Management undertakes no obligation to update publicly or revise any forward-looking statements. Ameriprise Financial announces financial and other information to investors through the Company’s investor relations website at ir.ameriprise.com, as well as SEC filings, press releases, public conference calls and webcasts. Investors and others interested in the company are encouraged to visit the investor relations website from time to time, as information is updated and new information is posted. The website also allows users to sign up for automatic notifications in the event new materials are posted. The information found on the website is not incorporated by reference into this report or in any other report or document the Company furnishes or files with the SEC.Item 7A. Quantitative and Qualitative Disclosures About Market Risk Market RiskOur primary market risk exposures are interest rate, equity price, foreign currency exchange rate and credit risk. Equity price and interest rate fluctuations can have a significant impact on our results of operations, primarily due to the effects they have on the asset management and other asset-based fees we earn, the spread income generated on our fixed deferred annuities, fixed insurance, brokerage client cash balances, banking deposits, face-amount certificate products, fixed portion of our variable annuities and variable insurance contracts, the value of deferred acquisition costs (“DAC”) and deferred sales inducement costs (“DSIC”) assets, the value of liabilities for guaranteed benefits associated with our variable annuities and the value of derivatives held to hedge these benefits.RiverSource Life has the following variable annuity guarantee benefits: guaranteed minimum withdrawal benefits (“GMWB”), guaranteed minimum accumulation benefits (“GMAB”), guaranteed minimum death benefits (“GMDB”) and guaranteed minimum income benefits (“GMIB”). Each of these benefits guarantees payouts to the annuity holder under certain specific conditions regardless of the performance of the underlying invested assets.The variable annuity guarantees continue to be managed by utilizing a hedging program which attempts to match the sensitivity of the assets with the sensitivity of the liabilities. This approach works with the premise that matched sensitivities will produce a highly effective hedging result. Our comprehensive hedging program focuses mainly on first order sensitivities of assets and liabilities: Equity Market Level (Delta), Interest Rate Level (Rho) and Volatility (Vega). Additionally, various second order sensitivities are managed. We use various options, swaptions, swaps and futures to manage risk exposures. The exposures are measured and monitored daily, and adjustments to the hedge portfolio are made as necessary.We have a macro hedge program to provide protection against the statutory tail scenario risk arising from variable annuity reserves on our statutory surplus and to cover some of the residual risks not covered by other hedging activities. We assess the residual risk under a range of scenarios in creating and executing the macro hedge program. As a means of economically hedging these risks, we may use a combination of futures, options, swaps and swaptions. Certain of the macro hedge derivatives used contain settlement provisions linked to both equity returns and interest rates; the remaining are interest rate contracts or equity contracts. The macro hedge program could result in additional earnings volatility as changes in the value of the macro hedge derivatives, which are designed to reduce statutory capital volatility, may not be closely aligned to changes in the variable annuity guarantee embedded derivatives.To evaluate interest rate and equity price risk we perform sensitivity testing which measures the impact on pretax income from the sources listed below for a 12-month period following a hypothetical 100 basis point increase in interest rates or a hypothetical 10% decline in equity prices. The interest rate risk test assumes a sudden 100 basis point parallel shift in the yield curve, with rates then staying at those levels for the next 12 months. The equity price risk test assumes a sudden 10% drop in equity prices, with equity prices then staying at those levels for the next 12 months. In estimating the values of variable annuities, indexed annuities, stock market certificates, indexed universal life (“IUL”) insurance and the associated hedge assets, we assume no change in implied market volatility despite the 10% drop in equity prices.55The following tables present our estimate of the impact on pretax income from the above defined hypothetical market movements as of December 31, 2022:Equity Price Decline 10%Equity Price Exposure to Pretax IncomeBefore Hedge ImpactHedge ImpactNet Impact (in millions)Asset-based management and distribution fees (1)$(285)$2 $(283)DAC and DSIC amortization (2)(3)(43)— (43)Variable annuities: GMDB and GMIB (3)(33)— (33)GMWB (3)(534)489 (45)GMAB(31)31 — Structured variable annuities494 (463)31 DAC and DSIC amortization (4)N/AN/A(4)Total variable annuities(104)57 (51)Macro hedge program (5)— 230 230 Certificates1 (1)— IUL insurance15 (30)(15)Total$(416)$258 $(162)(6)N/A Not ApplicableInterest Rate Increase 100 Basis PointsInterest Rate Exposure to Pretax IncomeBefore Hedge ImpactHedge ImpactNet Impact (in millions)Asset-based management and distribution fees (1)$(53)$— $(53)Variable annuities: GMWB702 (766)(64)GMAB1 (1)— Structured variable annuities (29)183 154 DAC and DSIC amortization (4)N/AN/A(18)Total variable annuities674 (584)72 Macro hedge program (5)— (313)(313)Fixed annuities, fixed insurance and fixed portion of variable annuities and variable insurance products57 — 57 Banking deposits28 — 28 Brokerage client cash balances146 — 146 Certificates(9)— (9)IUL insurance18 2 20 Total$861 $(895)$(52)N/A Not Applicable.(1) Excludes incentive income which is impacted by market and fund performance during the period and cannot be readily estimated.(2) Market impact on DAC and DSIC amortization resulting from lower projected profits. (3) In estimating the impact to pretax income on DAC and DSIC amortization and additional insurance benefit reserves, our assumed equity asset growth rates reflect what management would follow in its mean reversion guidelines. (4) Market impact on DAC and DSIC amortization related to variable annuity riders and structured variable annuities is modeled net of hedge impact.(5) The market impact of the macro hedge program is modeled net of any related impact to DAC and DSIC amortization.(6) Represents the net impact to pretax income. The estimated net impact to pretax adjusted operating income is $(283) million.The above results compare to an estimated negative net impact to pretax income of $190 million related to a 10% equity price decline and an estimated positive net impact to pretax income of $80 million related to a 100 basis point increase in interest rates as of December 31, 2021. The change in interest rate exposure as of December 31, 2022 compared to prior year-end was primarily driven by additional downside rate protection added in the macro hedge program.56Net impacts shown in the above table from GMWB riders result largely from differences between the liability valuation basis and the hedging basis. Liabilities are valued using fair value accounting principles, with risk margins incorporated in contractholder behavior assumptions and with discount rates increased to reflect a current market estimate of our risk of nonperformance specific to these liabilities. Our hedging is based on our determination of economic risk, which excludes certain items in the liability valuation including the nonperformance spread risk.Actual results could differ materially from those illustrated above as they are based on a number of estimates and assumptions. These include assuming that implied market volatility does not change when equity prices fall by 10% and that the 100 basis point increase in interest rates is a parallel shift of the yield curve. Furthermore, we have not tried to anticipate changes in client preferences for different types of assets or other changes in client behavior, nor have we tried to anticipate all strategic actions management might take to increase revenues or reduce expenses in these scenarios.The selection of a 100 basis point interest rate increase as well as a 10% equity price decline should not be construed as a prediction of future market events. Impacts of larger or smaller changes in interest rates or equity prices may not be proportional to those shown for a 100 basis point increase in interest rates or a 10% decline in equity prices.Asset-Based Management and Distribution FeesWe earn asset-based management fees and distribution fees on our assets under management. As of December 31, 2022, the value of our assets under management was $1.0 trillion. These sources of revenue are subject to both interest rate and equity price risk since the value of these assets and the fees they earn fluctuate inversely with interest rates and directly with equity prices. We currently only hedge certain equity price risk for this exposure, primarily using futures and swaps. We currently do not hedge any of the interest rate risk for this exposure.DAC and DSIC AmortizationFor annuity and UL/variable universal life (“VUL”) products, DAC and DSIC are amortized on the basis of estimated gross profits (“EGPs”). EGPs are a proxy for pretax income prior to the recognition of DAC and DSIC amortization expense. When events occur that reduce or increase current period EGPs, DAC and DSIC amortization expense is typically reduced or increased as well, somewhat mitigating the impact of the event on pretax income.Variable Annuity RidersThe total contract value of all variable annuities as of December 31, 2022 was $74.4 billion. These contract values include GMWB and GMAB contracts which were $41.1 billion and $1.4 billion, respectively, as of December 31, 2022. As of December 31, 2022, reserves for GMWB were net liabilities of $1.9 billion and reserves for GMAB were net assets of $35 million. The GMWB and GMAB reserves include the fair value of embedded derivatives, which fluctuates based on equity, interest rate and credit markets which can cause these embedded derivatives to be either an asset or a liability. As of December 31, 2022, the reserve for GMDB and GMIB was a net liability of $56 million.Equity Price Risk The variable annuity guaranteed benefits guarantee payouts to the annuity holder under certain specific conditions regardless of the performance of the investment assets. For this reason, when equity prices decline, the returns from the separate account assets coupled with guaranteed benefit fees from annuity holders may not be sufficient to fund expected payouts. In that case, reserves must be increased with a negative impact to earnings.The core derivative instruments with which we hedge the equity price risk of our GMWB and GMAB provisions are longer dated put and call options; these core instruments are supplemented with equity futures and total return swaps. See Note 17 to our Consolidated Financial Statements for further information on our derivative instruments.Interest Rate RiskThe GMAB and the non-life contingent benefits associated with the GMWB provisions create embedded derivatives which are carried at fair value separately from the underlying host variable annuity contract. The changes in fair value of the GMWB and GMAB liabilities are recorded through earnings with fair value calculated based on projected, discounted cash flows over the life of the contract, including projected, discounted benefits and fees. Increases in interest rates reduce the fair value of the GMWB and GMAB liabilities. The GMWB and GMAB interest rate exposure is hedged with a portfolio of longer dated put and call options, futures, interest rate swaps and swaptions. We have entered into interest rate swaps according to risk exposures along maturities, thus creating both fixed rate payor and variable rate payor terms. If interest rates were to increase, we would have to pay more to the swap counterparty, and the fair value of our equity puts would decrease, resulting in a negative impact to our pretax income.Structured Variable AnnuitiesStructured variable annuities offer the contract-holder the ability to allocate premiums to either an account that earns fixed interest (fixed account) or an account that credits interest based on the performance of various equity indices (indexed account) subject to a cap, floor, or buffer. Our earnings are based upon the spread between investment income earned and the credits made to the fixed and indexed accounts of the structured variable annuities. As of December 31, 2022, we had $6.6 billion in liabilities related to structured variable annuities. 57Equity Price RiskThe equity-linked return to investors creates equity price risk as the amount credited depends on changes in equity prices. The equity price risk for structured variable annuities is evaluated together with the variable annuity riders as part of a hedge program using the derivative instruments consistent with our hedging on variable annuity riders. Interest Rate RiskThe fair value of the embedded derivative associated with structured variable annuities is based on a discounted cash flow approach. Changes in interest rates impact the discounting of the embedded derivative liability. The spread between the investment income earned and amounts credited to contract-holders is also affected by changes in interest rates. These interest rate risks associated with structured variable annuities are not currently hedged. Fixed Annuities, Fixed Insurance and Fixed Portion of Variable Annuities and Variable Insurance ContractsOur earnings from fixed deferred annuities, fixed insurance, and the fixed portion of variable annuities and variable insurance contracts are based upon the spread between rates earned on assets held and the rates at which interest is credited to accounts. We primarily invest in fixed rate securities to fund the rate credited to clients. We guarantee an interest rate to the holders of these products. Investment assets and client liabilities generally differ as it relates to basis, repricing or maturity characteristics. Rates credited to clients’ accounts generally reset at shorter intervals than the yield on the underlying investments. Therefore, in an increasing interest rate environment, higher interest rates may be reflected in crediting rates to clients sooner than in rates earned on invested assets, which could result in a reduced spread between the two rates, reduced earned income and a negative impact on pretax income. While interest rates under the current environment have relieved some pressure from the liability guaranteed minimum interest rates (“GMIRs”), there are still some GMIRs above current levels. Hence, liability credited rates will move more slowly under a modest rise in interest rates while projected asset purchases would capture the full increase in interest rates. This dynamic would result in widening spreads under a modestly rising rate scenario given the current relationship between the current level of interest rates and the underlying GMIRs on the business. Of the $36.1 billion in Policyholder account balances, future policy benefits and claims as of December 31, 2022, $24.9 billion is related to liabilities created by these products. We do not hedge this exposure.As a result of the current market environment, reinvestment yields are becoming more aligned with the current portfolio yield. We would expect the recent decline in our portfolio income yields to slow and begin to stabilize in future periods if the current environment continues. The carrying value and weighted average yield of non-structured fixed maturity securities and commercial mortgage loans that may generate proceeds to reinvest through 2024 due to prepayment, maturity or call activity at the option of the issuer, excluding securities with a make-whole provision, were $4.0 billion and 4.1%, respectively, as of December 31, 2022. In addition, residential mortgage backed securities, which can be subject to prepayment risk under a low interest rate environment, totaled $15.7 billion and had a weighted average yield of 3.5% as of December 31, 2022. While these amounts represent investments that could be subject to reinvestment risk, it is also possible that these investments will be used to fund liabilities or may not be prepaid and will remain invested at their current yields. In addition to the interest rate environment, the mix of benefit payments versus product sales as well as the timing and volumes associated with such mix may impact our investment yield. Furthermore, reinvestment activities and the associated investment yield may also be impacted by corporate strategies implemented at management’s discretion. The average yield for investment purchases during the year ended December 31, 2022 was approximately 4.3%.The reinvestment of proceeds from maturities, calls and prepayments at rates near the current portfolio yield will have a limited impact to future operating results. In this volatile rate environment, we assess reinvestment risk in our investment portfolio and monitor this risk in accordance with our asset/liability management framework. In addition, we may update the crediting rates on our fixed products when warranted, subject to guaranteed minimums. 58The following table presents the account values of fixed deferred annuities, fixed insurance, and the fixed portion of variable annuities and variable insurance contracts by range of GMIRs and the range of the difference between rates credited to policyholders and contractholders as of December 31, 2022 and the respective guaranteed minimums, as well as the percentage of account values subject to rate reset in the time period indicated. Rates are reset at our discretion, subject to guaranteed minimums.Account Values with Crediting RatesAt Guaranteed Minimum1-49 bps above Guaranteed Minimum50-99 bps above Guaranteed Minimum100-150 bps above Guaranteed MinimumTotal(in billions, except percentages)Range of Guaranteed Minimum Crediting Rates1% - 1.99%$0.6 $0.5 $0.2 $0.1 $1.4 2% - 2.99%0.5 — — — 0.5 3% - 3.99%7.0 — — — 7.0 4% - 5.00%5.5 — — — 5.5 Total$13.6 $0.5 $0.2 $0.1 $14.4 Percentage of Account Values That Reset In:Next 12 months (1)100 %95 %93 %100 %100 %> 12 months to 24 months (2)— 4 6 — — > 24 months (2)— 1 1 — — Total100 %100 %100 %100 %100 %(1) Includes contracts with annual discretionary crediting rate resets and contracts with 12 or less months until the crediting rate becomes discretionary on an annual basis.(2) Includes contracts with more than 12 months remaining until the crediting rate becomes an annual discretionary rate.Equity Indexed AnnuitiesOur equity indexed annuity (“EIA”) product is a single premium annuity issued with an initial term of seven years. The annuity guarantees the contractholder a minimum return of 3% on 90% of the initial premium or end of prior term accumulation value upon renewal plus a return that is linked to the performance of the S&P 500® Index. The equity-linked return is based on a participation rate initially set at between 50% and 90% of the S&P 500® Index, which is guaranteed for the initial seven-year term when the contract is held to full term. As of December 31, 2022, we had $16 million in liabilities related to EIAs. We discontinued new sales of EIAs in 2007.Equity Price Risk The equity-linked return to investors creates equity price risk as the amount credited depends on changes in equity prices. To hedge this exposure, we purchase futures, which generate returns to replicate what we must credit to client accounts. Interest Rate Risk Most of the proceeds received from EIAs are invested in fixed income securities with the return on those investments intended to fund the 3% guarantee. We earn income from the difference between the return earned on invested assets and the 3% guarantee rate credited to customer accounts. The spread between return earned and amount credited is affected by changes in interest rates. This risk is not currently hedged and was immaterial as of December 31, 2022.Banking Deposits and Brokerage Client Cash BalancesWe pay interest on banking deposits and certain brokerage client cash balances and have the ability to reset these rates from time to time based on prevailing economic and business conditions. We earn revenue to fund the interest paid from interest-earning assets or fees from off-balance sheet deposits at Federal Deposit Insurance Corporation insured institutions, which are indexed to short-term interest rates. In general, the change in interest paid lags the change in revenues earned.Certificate ProductsFixed Rate CertificatesWe have interest rate risk from our investment certificates generally ranging in amounts from $1 thousand to $2 million with interest crediting rate terms ranging from 3 to 36 months. We guarantee an interest rate to the holders of these products. Payments collected from clients are primarily invested in fixed income securities to fund the client credited rate with the spread between the rate earned from investments and the rate credited to clients recorded as earned income. Client liabilities and investment assets generally differ as it relates to basis, repricing or maturity characteristics. Rates credited to clients generally reset at shorter intervals than the yield on underlying investments. This exposure is not currently hedged although we monitor our investment strategy and make modifications based on our changing liabilities and the expected interest rate environment. Of the $30.8 billion in customer deposits as of December 31, 2022, $9.1 billion related to reserves for our fixed rate certificate products.59Stock Market CertificatesStock market certificates are purchased for amounts generally from $1 thousand to $2 million for terms of 52 weeks, 104 weeks or 156 weeks, which can be extended to a maximum of 15 years depending on the term. For each term the certificate holder can choose to participate 100% in any percentage increase in the S&P 500® Index up to a maximum return or choose partial participation in any increase in the S&P 500® Index plus a fixed rate of interest guaranteed in advance. If partial participation is selected, the total of equity-linked return and guaranteed rate of interest cannot exceed the maximum return. Liabilities for our stock market certificates are included in Customer deposits. As of December 31, 2022, we had $221 million in reserves related to stock market certificates. The equity-linked return to investors creates equity price risk exposure. We seek to minimize this exposure with purchased futures and call spreads that replicate what we must credit to client accounts. This risk continues to be fully hedged. Stock market certificates have some interest rate risk as changes in interest rates affect the fair value of the payout to be made to the certificate holder. This risk is not currently hedged and was immaterial as of December 31, 2022.Indexed Universal LifeIUL insurance is similar to UL in many regards, although the rate of credited interest above the minimum guarantee for funds allocated to an indexed account is linked to the performance of the specified index for the indexed account (subject to stated account parameters, which include a cap and floor, or a spread and floor). We offer an S&P 500® Index account option and a blended multi-index account option comprised of the S&P 500® Index, the MSCI® EAFE Index and the MSCI EM Index. Both options offer two crediting durations, one-year and two-year. The policyholder may allocate all or a portion of the policy value to a fixed or any available indexed account. As of December 31, 2022, we had $2.5 billion in liabilities related to the indexed accounts of IUL, with the vast majority in the S&P 500® Index account option.Equity Price Risk The equity-linked return to investors creates equity price risk as the amount credited depends on changes in equity prices. Most of the proceeds received from IUL insurance are invested in fixed income securities. To hedge the equity exposure, a portion of the investment earnings received from the fixed income securities is used to purchase call spreads which generate returns to replicate what we must credit to client accounts.Interest Rate Risk As mentioned above, most of the proceeds received from IUL insurance are invested in fixed income securities with the return on those investments intended to fund the purchase of call spreads and options. There are two risks relating to interest rates. First, we have the risk that investment returns are such that we do not have enough investment income to purchase the needed call spreads. Second, in the event the policy is surrendered we pay out a book value surrender amount and there is a risk that we will incur a loss upon having to sell the fixed income securities backing the liability (if interest rates have risen). This risk is not currently hedged.Foreign Currency RiskWe have foreign currency risk through our net investment in foreign subsidiaries and our operations in foreign countries. We are primarily exposed to changes in British Pounds related to our net investment in Threadneedle and BMO Global Asset Management (EMEA), which was approximately £1.4 billion as of December 31, 2022. We also have exposure related to operations in foreign countries to Euros, Indian Rupees and other currencies. We monitor the foreign exchange rates that we have exposure to and enter into foreign currency forward contracts to mitigate risk when economically prudent. As of December 31, 2022, the notional value of outstanding contracts and our remaining foreign currency risk related to operations in foreign countries were not material.Interest Rate Risk on External DebtThe stated interest rate on the $2.8 billion of our senior unsecured notes is fixed. We did not enter into interest rate swap agreements to effectively convert the fixed interest rate on any of the senior unsecured notes to floating interest rates.Credit RiskWe are exposed to credit risk within our investment portfolio, including our loan portfolio, and through our derivative and reinsurance activities. Credit risk relates to the uncertainty of an obligor’s continued ability to make timely payments in accordance with the contractual terms of the financial instrument or contract. We consider our total potential credit exposure to each counterparty and its affiliates to ensure compliance with pre-established credit guidelines at the time we enter into a transaction which would potentially increase our credit risk. These guidelines and oversight of credit risk are managed through a comprehensive enterprise risk management program that includes members of senior management.We manage the risk of credit-related losses in the event of nonperformance by counterparties by applying disciplined fundamental credit analysis and underwriting standards, prudently limiting exposures to lower-quality, higher-yielding investments, and diversifying exposures by issuer, industry, region and underlying investment type. We remain exposed to occasional adverse cyclical economic downturns during which default rates may be significantly higher than the long-term historical average used in pricing.We manage our credit risk related to over-the-counter derivatives by entering into transactions with creditworthy counterparties, maintaining collateral arrangements and through the use of master netting arrangements that provide for a single net payment to be made by one counterparty to another at each due date and upon termination. Generally, our current credit exposure on over-the-60counter derivative contracts is limited to a derivative counterparty’s net positive fair value of derivative contracts after taking into consideration the existence of netting arrangements and any collateral received. This exposure is monitored and managed to an acceptable threshold level.The counterparty risk for centrally cleared over-the-counter derivatives is transferred to a central clearing party through contract novation. Because the central clearing party monitors open positions and adjusts collateral requirements daily, we have minimal credit exposure from such derivative instruments.Exchange-traded derivatives are effected through regulated exchanges that require contract standardization and initial margin to transact through the exchange. Because exchange-traded futures are marked to market and generally cash settled on a daily basis, we have minimal exposure to credit-related losses in the event of nonperformance by counterparties to such derivative instruments. Other exchange-traded derivatives would be exposed to nonperformance by counterparties for amounts in excess of initial margin requirements only if the exchange is unable to fulfill the contract.We manage our credit risk related to reinsurance treaties by evaluating the financial condition of reinsurance counterparties prior to entering into new reinsurance treaties. In addition, we regularly evaluate their financial strength during the terms of the treaties. As of December 31, 2022, our largest reinsurance credit risks are related to coinsurance treaties with Commonwealth and with life insurance subsidiaries of Genworth Financial, Inc. See Note 7 and Note 8 to our Consolidated Financial Statements for additional information on reinsurance.61Ameriprise Financial, Inc.
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+Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations.”A further discussion of our development, redevelopment, disposition, acquisition, property management and related strategies follows.Development Strategy. We select land for development and follow established procedures that we believe minimize both the cost and the risks of development. As one of the largest developers of multifamily rental apartment communities in our selected markets, we maintain regional offices to identify and support development opportunities through local market presence and access to local market information. In addition to our principal executive office in Arlington, Virginia, we also have regional offices, administrative offices or specialty offices, including offices that are in or near the following cities:•Bellevue, Washington;•Boston, Massachusetts;•Chapel Hill, North Carolina;•Denver, Colorado;•Fort Lauderdale, Florida;•Irvine, California;•Los Angeles, California;•Melville, New York;•New York, New York;•San Francisco, California;•San Jose, California;•Shelton, Connecticut;•Virginia Beach, Virginia; and•Westfield, New Jersey.2 Table of ContentsAfter selecting a site for development, we usually negotiate for the right to acquire the site either through an option or a long-term conditional contract. Options and long-term conditional contracts generally allow us to acquire an interest in the site after the completion of entitlements and shortly before the start of construction, which reduces development-related risks and preserves capital. However, as a result of competitive market conditions for land suitable for development, we have sometimes acquired and held land prior to construction for extended periods while entitlements are obtained. When acquiring improved land with existing commercial uses prior to development, any rent received in excess of expenses from these operations, which we consider to be incidental, is accounted for as a reduction in our investment in the development pursuit and not as net income. Any expenses relating to these operations, in excess of any rents received, are recognized in net income. In addition, we have previously identified, and may again in the future identify, opportunities to increase value by expanding the density of certain existing operating communities. We have also participated, and may in the future participate, in master planned or other large multi-use developments where we commit to build infrastructure (such as roads) to be used by other participants or commit to act as construction manager or general contractor in building structures or spaces for third parties (such as unimproved ground floor commercial space, municipal garages or parks). Costs we incur in connection with these activities may be accounted for as additional invested capital in the community or we may earn fee income for providing these services. Particularly with large scale, urban in-fill developments, we may engage in significant environmental remediation efforts to prepare a site for construction. For further discussion of our Development Rights, refer to Item 2. “Properties” in this report.We generally act as our own development manager, general contractor and construction manager directly (although we may use a wholly-owned subsidiary), and will elect to use a third-party developer or general contractor where we believe it is beneficial to do so, such as in our expansion markets where we have limited experience. We believe direct involvement in construction enables us to achieve higher construction quality, greater control over construction schedules and cost savings. Our development, property management and construction teams monitor construction progress to ensure quality workmanship and a smooth and timely transition into the leasing and operating phase.Throughout this report, the term “development” is used to refer to the entire property development cycle, including pursuit of zoning approvals, procurement of architectural and engineering designs and the construction process. References to “construction” refer to the actual construction of the property, which is only one element of the development cycle.Redevelopment Strategy. When we undertake the redevelopment of a community, our goal is to renovate and/or rebuild an existing community so that our total investment is generally below replacement cost and the community is well positioned in the market to achieve attractive returns on our capital. In addition to large scale redevelopment where a community is classified as a redevelopment, we undertake smaller scale redevelopment activities related to the apartment interiors to enhance the resident experience at our operating communities. We have dedicated redevelopment teams and procedures that are intended to control both the cost and risks of redevelopment. Our redevelopment teams, which include redevelopment, construction and property management personnel, monitor redevelopment progress. Throughout this report, the term “redevelopment” is used to refer to the entire redevelopment cycle, including planning and procurement of architectural and engineering designs, budgeting and actual renovation work. The actual renovation work is referred to as “reconstruction,” which is only one element of the redevelopment cycle.Disposition Strategy. We sell assets that no longer meet our long-term strategy or when real estate market conditions are favorable, and we redeploy the proceeds from those sales to develop, redevelop and acquire communities and to rebalance our portfolio across or within geographic regions. This also allows us to realize a portion of the value created through our investments and provides additional liquidity by redeploying the net proceeds from our dispositions in lieu of raising that amount of capital externally. When we decide to sell a community, we generally solicit competing bids from unrelated parties for these individual assets and consider the sales price and other terms of each proposal.As part of the Archstone Acquisition in 2013 (as defined in Item 1. “Business” in the Company's Form 10-K filed with the Securities and Exchange Commission (the "SEC") on February 22, 2019), we acquired, and still own, 14 assets that had previously been contributed by third parties on a tax-deferred basis to an Archstone partnership in which the third parties received ownership interests. To protect the tax-deferred nature of the contribution, the third parties are entitled to cash payments if we trigger tax obligations to the third parties by selling, or failing to maintain sufficient levels of secured financing on, the contributed assets. Our tax protection payment obligations with respect to these assets expire at different times and in some cases don’t expire until the death of a third party who contributed ownership interests to the Archstone partnership. After review and investigation of Archstone’s tax and accounting records, we estimate that, had we sold or taken other triggering actions in 2022 with respect to all 14 assets, the aggregate amount of the tax protection payments that would have been triggered would have been approximately $44,900,000. At the present time, we do not intend to take actions that would cause us to be required to make tax protection payments with respect to any of these assets.3 Table of ContentsAcquisition Strategy. Our core competencies in development and redevelopment discussed above allow us to be selective in the acquisitions we target. Acquisitions allow us to achieve rapid penetration into markets in which we desire an increased presence. Acquisitions (and dispositions) also help us achieve our desired product mix or rebalance our portfolio. While we are primarily focused on acquisitions in our expansion markets of Raleigh-Durham and Charlotte, North Carolina, Southeast Florida, Dallas and Austin, Texas, and Denver, Colorado, we may pursue additional investments in our established regions based on market conditions.Property Management Strategy. We seek to increase operating income through innovative, proactive property management that will result in higher revenue from communities while constraining operating expenses. Our principal strategies to maximize operating income include:•focusing on associate engagement and resident satisfaction;•staggering lease terms such that lease expirations are matched with seasonal demand;•delivering high occupancy with premium pricing for various customer segments; and•making innovations in our operating model through (i) leveraging technology, including digital smart access and various automation technologies and (ii) data science to optimize revenue from the portfolio, while reducing customer acquisition, transaction and retention costs.Constraining growth in operating expenses is another way in which we seek to increase earnings growth. Growth in our portfolio and the resulting increase in revenue allows for fixed operating costs to be spread over a larger volume of revenue, thereby increasing operating margins. We constrain growth in operating expenses in a variety of ways, which include, but are not limited to, the following:•purchase order controls, including acquiring goods and services from pre-approved vendors;•national negotiated contracts and bulk purchases where possible;•bidding third-party contracts on a volume basis;•retaining residents through high levels of service, which reduces apartment turnover costs, marketing and vacant apartment utility costs;•performing turnover work in-house or hiring third parties, generally considering the most cost effective approach as well as expertise needed to perform the work;•regular preventive maintenance to maximize resident safety and satisfaction and property and equipment life; •centralization of many community administration and support tasks at our shared service center;•pursuing real estate tax appeals; •installing high efficiency lighting and water fixtures, cogeneration systems and solar panels; and•implementing technology for resident and prospect services such as package lockers and self guided or virtual tours.On-site property management teams receive bonuses based largely upon the revenue, expense, Net Operating Income (“NOI”), prospect conversion, resident retention and customer service metrics produced at their respective communities. We use and continuously seek ways to improve technology applications to help manage our communities, believing that technology applications can improve the delivery and efficiency of our services and aid in the accurate collection of financial and resident data, which will enable us to maximize revenue and control costs through careful leasing decisions, maintenance decisions and financial management.We generally manage the operation and leasing activity of our communities directly (although we may use a wholly-owned subsidiary) both for ourselves and the joint ventures and partnerships of which we are a member or a partner. From time to time we may engage a third party to manage leasing and/or maintenance activity at one or more of our communities where we have limited historical experience such as our expansion markets or for other reasons.From time to time we also pursue or arrange ancillary services for our residents to provide additional revenue sources or increase resident satisfaction. We provide such non-customary services to residents or share in the revenue or income from such services through a taxable REIT subsidiary ("TRS"), which is a subsidiary that is treated as a “C corporation” subject to federal income taxes. See “Tax Matters” below.Financing Strategy. Our financing strategy is to maintain a capital structure that provides financial flexibility to help ensure we can select cost effective capital market options that are well matched to our business risks. We estimate that our short-term liquidity needs will be met from cash on hand, borrowings under our $2,250,000,000 revolving variable rate unsecured credit facility (the “Credit Facility”) and our $500,000,000 unsecured commercial paper note program (the "Commercial Paper Program"), sales of current operating communities and/or issuance of additional debt or equity securities, including amounts through the planned settlement of the outstanding forward contracts to sell 2,000,000 shares of common stock by no later than 4 Table of ContentsDecember 31, 2023. A determination to engage in an equity or debt offering depends on a variety of factors such as general market and economic conditions, our short and long-term liquidity needs, the relative costs of debt and equity capital and growth opportunities. A summary of debt and equity activity for the last three years is reflected on our Consolidated Statement of Cash Flows of the Consolidated Financial Statements set forth in Item 8 of this report.We have entered into, and may continue in the future to enter into, joint ventures (including limited liability companies or partnerships) through which we would develop and/or own an indirect economic interest of less than 100% of the community or communities owned directly by such joint ventures. Our decision to either hold an apartment community in fee simple or to have an indirect interest in the community through a joint venture is based on a variety of factors and considerations, including: (i) the economic and tax terms required by a seller of land or of a community; (ii) our desire to diversify our portfolio of communities by market, submarket and product type; (iii) our desire at times to preserve our capital resources to maintain liquidity or balance sheet strength; and (iv) our projection, in some circumstances, that we will achieve higher returns on our invested capital or reduce our risk if a joint venture vehicle is used. Investments in joint ventures are not limited to a specified percentage of our assets. Each joint venture agreement is individually negotiated, and our ability to operate and/or dispose of a community in our sole discretion may be limited to varying degrees depending on the terms of the joint venture agreement.In addition, from time to time, we may offer shares of our equity securities, debt securities or options to purchase stock in exchange for property. We may also acquire properties in exchange for properties we currently own.Other Strategies and Activities. While we emphasize equity real estate investments in rental apartment communities, we have the ability to invest in other activities and to make non-equity investments, including the following:•Commercial space: we develop, own and lease commercial space at our communities when either (i) the highest and best use of the space is for commercial (e.g., street level in an urban area); (ii) we believe the commercial space will enhance the attractiveness of the community to residents; or (iii) some component of commercial space is required to obtain entitlements to build apartment homes. As of December 31, 2022, we had a total of approximately 926,000 square feet of rentable commercial space, excluding commercial space within communities currently under development. Gross rental revenue provided by leased commercial space in 2022 was $42,971,000 (1.7% of total revenue).•For-sale real estate development: we may also develop a property in conjunction with another real estate company that will own and operate the commercial or for-sale residential components of a mixed-use building or project that we help develop. We may from time to time, through a TRS, develop real estate and hold it for sale upon completion if we believe that this will be the best use or disposition opportunity for the property, as is the case with our sale of apartment condominium units at The Park Loggia condominium development in New York, NY.•Structured Investment Program: while we generally invest in multifamily real estate through fee simple ownership or an equity investment in a joint venture, we established a new investment platform through which we provide mezzanine loans or preferred equity to third-party multifamily developers. At December 31, 2022, we had commitments for three mezzanine loans of up to $92,375,000 in the aggregate. The mezzanine loans have a weighted average rate of return of 9.8% and mature at various dates on or before June 2026. At December 31, 2022, we have funded $29,352,000 of these commitments.•Property technology and environmentally focused companies and investment management funds: we have also invested, either through a wholly-owned TRS, or in an investment vehicle that has elected to be treated as a TRS, in companies (and in venture funds that invest in companies) that provide technology services to the real estate industry, and we have invested, through a TRS, in environmentally focused companies and investment management funds to further our sustainability efforts and learning. As of December 31, 2022, we had invested $36,178,000 in various property technology and environmentally focused companies directly and indirectly through investment management funds. As of December 31, 2022, we have $34,299,000 of outstanding equity commitments to these investment management funds, with the timing and amount for these commitments to be fulfilled dependent on if, and when, investment opportunities are identified by their respective funds.We have not engaged in trading, underwriting or agency distribution or sale of securities of other issuers and do not intend to do so. At all times we intend to make investments in a manner so as to qualify as a REIT unless, because of circumstances or changes to the Internal Revenue Code of 1986, as amended (the “Code”) (or the Treasury Regulations thereunder), our Board of Directors determines that it is no longer in our best interest to qualify as a REIT.5 Table of ContentsWe conduct many of the administrative functions associated with our property operations (including billing, collections, and response to resident inquiries) through an internally operated shared services center, rather than having on-site associates conduct such activities. We believe this centralized platform allows our on-site associates to focus more on current and prospective resident services, while at the same time enabling us to reduce costs, mitigate risk and increase our availability and responsiveness to our residents. We are exploring the possibility of performing these shared service center administrative functions for a third party as a means of creating an additional revenue stream and economies of scale at our center. We cannot assure that we will provide such services to a third party or that it will be successful if we do so. Tax MattersWe filed an election with our 1994 federal income tax return to be taxed as a REIT under the Code and intend to maintain our qualification as a REIT in the future. As a REIT, with limited exceptions, such as those described under “Property Management Strategy” above, we will not be taxed under federal and certain state income tax laws at the corporate level on our taxable net income to the extent such taxable net income is distributed to our stockholders. We expect to make sufficient distributions to avoid income tax at the corporate level. While we believe that we are organized and qualified as a REIT and we intend to operate in a manner that will allow us to continue to qualify as a REIT, there can be no assurance that we will be successful in this regard. Qualification as a REIT involves the application of highly technical and complex provisions of the Code for which there are limited judicial and administrative interpretations and involves the determination of a variety of factual matters and circumstances not entirely within our control.CompetitionWe face competition from other real estate investors, including insurance companies, pension and investment funds, REITs both in the multifamily as well as other sectors, and other well capitalized investors, to acquire and develop apartment communities and acquire land for future development. As an owner and operator of apartment communities, we also face competition for prospective residents from other operators whose communities may be perceived to offer a better location or better amenities or whose pricing may be perceived as a better value given the quality, location, terms and amenities that the prospective resident seeks. We also compete against condominiums and single-family homes that are for sale or rent, including those offered through online platforms. Although we often compete against large, sophisticated developers and operators for development opportunities and for prospective residents, real estate developers and operators of any size can provide effective competition for both real estate assets and potential residents.Regulatory MattersCompliance with various governmental regulations has an impact on our business, including our capital expenditures, earnings and competitive position, which can be material. We incur costs to monitor and take actions to comply with governmental regulations that are applicable to our business, which include, among others, federal securities laws and regulations, applicable stock exchange requirements, REIT and other tax laws and regulations, environmental and health and safety laws and regulations, local zoning, usage and other regulations relating to real property, the Americans with Disabilities Act of 1990 and related laws and regulations.Environmental Regulations. As a current or prior owner, operator and developer of real estate, we are subject to various federal, state and local environmental laws, regulations and ordinances and also could be liable to third parties resulting from environmental contamination or noncompliance at our communities. For some Development Communities, we undertake extensive environmental remediation to prepare the site for construction, which could be a significant portion of our total construction cost. Environmental remediation efforts could expose us to possible liabilities for accidents or improper handling of contaminated materials during construction.Regulations Relating to the Construction, Operation and Leasing of Our Communities. The construction, operation and leasing of our communities is subject to federal, state and local laws and regulations, include zoning laws, building codes, requirements that our communities be accessible to persons with disabilities, fair housing laws, and, depending on the jurisdiction, regulations regarding the charging of rents and fees and increases in such amounts upon renewal of leases. Some laws relating to the setting of rents apply broadly, such as in California, where residential rent increases at renewal in communities older than fifteen years are limited to the lesser of 10% or 5% plus local consumer price index (CPI), and in New York, where laws regulate increases on those units that are subject to rent-control or rent-stabilization. In California, the Governor and local governments have the ability to enact (and have in recent years exercised such right, for example, in connection with wildfires) local or statewide states of emergency which limit our ability to increase new and renewal rents to no more than 10% over the rent in place on the date such state of emergency was declared, which has impacted some of our California communities. In addition, various temporary federal, state and local laws enacted during the COVID-19 pandemic have imposed additional 6 Table of Contentsregulations of or limitations on our ability to evict tenants who are delinquent in payment of their rent, charge late fees, or raise rents more than a regulated amount upon renewal. We have seen an increase in state and local governments in our markets implementing, considering or being urged by various constituencies to consider new or modified rent control regulations, rent stabilization, or other laws that may limit or delay our ability to charge market rents, increase rents, charge ancillary fees or evict tenants.See Part I, Item 1A. “Risk Factors” for a discussion of material risks to us, including, to the extent material, to our competitive position, relating to governmental regulations, and see Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” together with the Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included elsewhere in this report, for a discussion of material information relevant to an assessment of our financial condition and results of operations.Human Capital Attracting, motivating, developing, and retaining talented associates is important to our long-term success. We engage with our associates to understand our purpose, "Creating a Better Way to Live," our core values (a commitment to integrity, a spirit of caring and a focus on continuous improvement) and our cultural norms (we collaborate, excel, innovate, act like owners, are thoughtful and thorough, and show appreciation).At January 31, 2023, we had 2,947 employees, of which approximately 97% were employed on a full-time basis. Approximately 66% of our associates work on-site at our operating communities and the balance work on other matters. None of our associates are represented by a union except for approximately 13 maintenance associates at communities in Westchester County, New York, where we are in the process of negotiating a collective bargaining agreement.We consider the following aspects of human capital management to be important:Diversity and Inclusion. We value workforce diversity and an inclusive culture. We believe that a diverse workplace will produce a variety of perspectives, motivate associates and help us understand and better serve our customers and the communities in which we do business. At January 31, 2023, 37% of our associates self-identified as White, 30% as Hispanic, 15% as Black, 7% as Asian, and 11% as other ethnicities, two or more ethnicities or did not respond. At January 31, 2023, 60% of our associates self-identified as male and 40% as female. We are committed to promoting and achieving greater workplace diversity and have undertaken active steps to further this goal, including by supporting associate resource groups.Associate Engagement. We monitor the engagement of our associates, receive feedback from our associates, and benchmark our performance by having a third party firm conduct anonymous associate perspective surveys each year. The results are discussed and presented both on a company-wide basis and within each functional group.Safety. We take workplace safety seriously at our construction sites, our operating communities and our offices. Through our Construction Site Safety Observation program and our dedicated safety team, we monitor project-level safety performance metrics at our construction sites, and elements of compensation for our construction group and our CEO are based on safety compliance performance. Our maintenance associates are required to take monthly safety training on a variety of subjects, and our risk management group monitors incident reports from our offices and communities.Training. To help our associates develop the skills they need to advance in their careers and succeed at AvalonBay, we train them in a variety of ways, including online, instructor-led and on-the-job learning. Our learning management system, AvalonBay University, offers approximately 600 courses providing functional, technical, management, ethics, compliance and cyber-awareness training.7 Table of ContentsOther InformationWe file annual, quarterly and current reports, proxy statements and other information with the SEC. You may obtain copies of our SEC filings, free of charge, from the SEC's website at www.sec.gov.We maintain a website at www.avalonbay.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, including exhibits and amendments to those reports, filed or furnished pursuant to the Securities Exchange Act of 1934 are available free of charge in the “Investor Relations” section of our website as soon as reasonably practicable after the reports are filed with or furnished to the SEC. In addition, the charters of our Board's Nominating, Governance and Corporate Responsibility Committee, Audit Committee and Compensation Committee, as well as our Director Independence Standards, Corporate Governance Guidelines, Code of Business Conduct and Ethics, Policy Regarding Shareholder Rights Agreements, Policy Regarding Shareholder Approval of Future Severance Agreements, Senior Officer Stock Ownership Guidelines, Policy on Political Contributions and Government Relations, Policy on Recoupment, AvalonBay Sanctions Compliance and Anti-Corruption Policy and Environmental, Social, and Governance Reports, are available free of charge in that section of our website or by writing to AvalonBay Communities, Inc., 4040 Wilson Blvd., Suite 1000, Arlington, Virginia 22203, Attention: Chief Financial Officer. To the extent required by the rules of the SEC and the NYSE, we will disclose amendments and waivers relating to these documents in the same place on our website. The information posted on our website is not incorporated into this Annual Report on Form 10-K.Supplemental U.S. Federal Income Tax ConsiderationsThe following discussion supplements and updates the disclosures under “Certain U.S. Federal Income Tax Considerations and Consequences of Your Investment” in the prospectus dated February 25, 2021, contained in our Registration Statement on Form S-3 filed with the SEC on February 25, 2021, as supplemented by the discussion under the heading “Supplemental U.S. Federal Income Tax Considerations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on February 25, 2022. Capitalized terms herein that are not otherwise defined shall have the same meaning as when used in such disclosures (as supplemented).On December 29, 2022, the Internal Revenue Service promulgated final Treasury Regulations under Sections 897, 1441, 1445, and 1446 of the Code that were, in part, intended to coordinate various withholding regimes for non-U.S. stockholders. The new Treasury Regulations provide that: i.The withholding rules applicable to ordinary REIT dividends paid to a non-U.S. stockholder (generally, a 30% rate of withholding on gross amounts unless otherwise reduced by treaty or effectively connected with such non-U.S. stockholder’s trade or business within the U.S. and proper certifications are provided) apply to (a) that portion of any distribution paid by us that is not designated as a capital gain dividend, a return of basis or a distribution in excess of the non-U.S. stockholder’s adjusted basis in its stock that is treated as gain from the disposition of such stock and (b) any portion of a capital gain dividend paid by us that is not treated as gain attributable to the sale or exchange of a U.S. real property interest by reason of the recipient not owning more than 10% of a class of our stock that is regularly traded on an established securities market during the one-year period ending on the date of the capital gain dividend.ii.The withholding rules under FIRPTA apply to a distribution paid by us in excess of a non-U.S. stockholder’s adjusted basis in our stock, unless the interest in our stock is not a U.S. real property interest (for example, because we are a domestically controlled qualified investment entity) or the distribution is paid to a “withholding qualified holder.” A “withholding qualified holder” means a qualified holder (as defined below) and a foreign partnership all of the interests of which are held by qualified holders, including through one or more partnerships.iii.The withholding rules under FIRPTA apply to any portion of a capital gain dividend paid by us to a non-U.S. stockholder that is attributable to the sale or exchange of a U.S. real property interest, unless it is paid to a withholding qualified holder.In the case of FIRPTA withholding under clause (ii) above, the applicable withholding rate is currently 15%, and in the case of FIRPTA withholding under clause (iii) above the withholding rate is currently 21%. For purposes of FIRPTA withholding under clause (iii), whether a capital gain dividend is attributable to the sale or exchange of a U.S. real property interest is determined taking into account the general exception from FIRPTA distribution treatment for distributions paid to certain non-U.S. stockholders under which any distribution by us to a non-U.S. stockholder with respect to any class of stock which is regularly traded on an established securities market located in the United States is not treated as gain recognized from the sale or exchange of a U.S. real property interest if such non-U.S. stockholder did not own more than 10% of such class of stock at any time during the 1-year period ending on the date of such distribution. To the extent inconsistent, these Treasury Regulations supersede the discussion on withholding contained in the above-referenced disclosures (as supplemented) under the heading “-U.S. Taxation of Non-U.S. Stockholders.” However, if, notwithstanding these Treasury Regulations, we encounter difficulties 8 Table of Contentsin properly characterizing a distribution for purposes of the withholding rules, we may decide to withhold on such distribution at the highest possible U.S. federal withholding rate that we determine could apply.Additionally, the second paragraph under the heading “-U.S. Taxation of Non-U.S. Stockholders-Distributions by Avalon Bay” is hereby deleted and replaced with the following:Distributions in excess of our current and accumulated earnings and profits (not attributable to gains from disposition of U.S. real property interests) that exceed the non-U.S. stockholder’s basis in its common stock will be taxable to a non-U.S. stockholder as gain from the sale of its common stock, which is discussed below. Distributions in excess of our current or accumulated earnings and profits and not attributable to gains from our sales or exchanges of U.S. real property interests will not be taxable to a non-U.S. stockholder to the extent they do not exceed the adjusted basis of the non-U.S. stockholder’s shares (determined separately for each share). Instead, they will reduce adjusted basis of such shares. To the extent that such distributions exceed the adjusted basis of a non-U.S. stockholder’s shares, they will be treated as gain from the sale or disposition of the non-U.S. stockholder’s shares and may be subject to tax as described in the “- Sale of Common Stock” portion of this section below. The new Treasury Regulations also provide new guidance regarding qualified foreign pension funds. Accordingly, the first paragraph under the heading “-U.S. Taxation of Non-U.S. Stockholders-Qualified Foreign Pension Funds” is hereby deleted and replaced with the following:In general, for FIRPTA purposes, and subject to the discussion below regarding “qualified holders,” neither a “qualified foreign pension fund” (as defined below) nor any entity all of the interests of which are held by a qualified foreign pension fund is treated as a foreign person, thereby exempting such entities from tax under FIRPTA. A “qualified foreign pension fund” is an organization or arrangement (i) created or organized in a foreign country, (ii) established by a foreign country (or one or more political subdivisions thereof) or one or more employers to provide retirement or pension benefits to current or former employees (including self-employed individuals) or their designees or, in consideration for, services rendered, (iii) which does not have a single participant or beneficiary that has a right to more than 5% of its assets or income, (iv) which is subject to government regulation and with respect to which annual information about its beneficiaries is provided, or is otherwise available, to relevant local tax authorities, and (v) with respect to which, under its local laws, (A) contributions that would otherwise be subject to tax are deductible or excluded from its gross income or taxed at a reduced rate, or (B) taxation of its investment income is deferred, or such income is excluded from its gross income or taxed at a reduced rate. Under Treasury Regulations, subject to the discussion below regarding “qualified holders,” a “qualified controlled entity” also is not generally treated as a foreign person for purposes of FIRPTA. A qualified controlled entity generally includes a trust or corporation organized under the laws of a foreign country all of the interests of which are held by one or more qualified foreign pension funds either directly or indirectly through one or more qualified controlled entities. Treasury Regulations further require that a qualified foreign pension fund or qualified controlled entity will not be exempt from FIRPTA with respect to dispositions of U.S. real property interests or REIT distributions attributable to the same unless the qualified foreign pension fund or qualified controlled entity is a “qualified holder.” To be a qualified holder, a qualified foreign pension fund or qualified controlled entity must satisfy one of two alternative tests at the time of the disposition of the U.S. real property interest or the REIT distribution. Under the first test, a qualified foreign pension fund or qualified controlled entity is a qualified holder if it owned no U.S. real property interests as of the earliest date during an uninterrupted period ending on the date of the disposition or distribution during which it qualified as a qualified foreign pension fund or qualified controlled entity. Alternatively, if a qualified foreign pension fund or qualified controlled entity held U.S. real property interests as of the earliest date during the period described in the preceding sentence, it can be a qualified holder only if it satisfies certain testing period requirements.Treasury Regulations also provide that a foreign partnership all of the interests of which are held by qualified holders, including through one or more partnerships, may certify its status as such and will not be treated as a foreign person for purposes of withholding under Code Section 1445 (and Code Section 1446, as applicable).9 Table of ContentsITEM 1A. RISK FACTORSOur operations involve various risks that could have adverse consequences, including those described below. This Item 1A. includes forward-looking statements. You should refer to our discussion of the qualifications and limitations on forward-looking statements in this Form 10-K.Risks related to investments through acquisitions, construction, development, and joint venturesDevelopment, redevelopment and construction risks could affect our profitability. We intend to continue to develop and redevelop apartment home communities. These activities can include long planning and entitlement timelines and can involve complex and costly activities, including significant environmental remediation or construction work in high-density urban areas. These activities may expose us to the following risks, among others:•we may abandon opportunities that we have already begun to explore for a number of reasons, including changes in local market conditions or increases in construction or financing costs, and, as a result, we may fail to recover expenses already incurred in exploring those opportunities;•occupancy rates and rents at a community may fail to meet our original expectations for a number of reasons, including changes in market and economic conditions beyond our control and the development by competitors of competing communities;•we may be unable to obtain, or experience delays in obtaining, necessary zoning, occupancy or other required governmental or third party permits and authorizations, which could result in increased costs, or the delay or abandonment of opportunities;•we may incur costs that exceed our original estimates due to increased material, labor or other costs or supply chain disruptions which could impact our overall return from our development, redevelopment or construction activity;•we may be unable to complete construction of a community on schedule or for the originally projected cost resulting in increased construction and financing costs;•we may incur liabilities to third parties during the development process, for example, in connection with managing existing improvements on the site prior to tenant terminations and demolition (such as commercial space) or in connection with providing services to third parties (such as the construction of shared infrastructure or other improvements); and •we may incur liability if our communities are not constructed in compliance with the accessibility provisions of the Americans with Disabilities Acts, the Fair Housing Act or other federal, state or local requirements. Noncompliance could result in imposition of fines, an award of damages to private litigants and a requirement that we undertake structural modifications to remedy the noncompliance.Refer to our “Risks related to liquidity and financing” section below for additional construction and development risks related to financing. Attractive investment opportunities may not be available, which could adversely affect our profitability. We expect that other real estate investors, including insurance companies, pension and investment funds, other REITs and other well-capitalized investors, will compete with us to acquire existing properties and to develop new properties. This competition could increase prices for properties of the type we would likely pursue and adversely affect our profitability for new investments.Acquisitions may not yield anticipated results. Our business strategy of acquiring communities may have the following risks: (i) acquisitions may not perform as we expected; (ii) our estimate of the costs of operating, repositioning or redeveloping an acquisition may be inaccurate; and (iii) acquisitions may subject us to unknown liabilities.Failure to succeed in new markets, or with new brands and community formats, or in activities other than the development, ownership and operation of residential rental communities may have adverse consequences. We have in recent years engaged, and may continue from time to time to engage in development, acquisition and operating activity outside of our pre-existing market areas. Our historical experience in our existing markets in developing, owning and operating rental communities does not ensure that we will be able to operate successfully in new markets. We may be exposed to a variety of risks when we enter a new market, including an inability to accurately evaluate local apartment market conditions and an inability to obtain land for development or to identify appropriate acquisition opportunities. In order to more rapidly expand in our new markets, we have relied on third party developers to source and manage developments and on third party general contractors to manage construction more than we have in our existing markets. Relying on third parties to assist with and/or oversee development and construction creates additional and different risks than when we manage these activities directly, including that the third party may not perform to our standards, may breach contractual arrangements, or may incur liquidity constraints.We also may engage or have an interest in for-sale activity, such as the sale of the residential condominiums at The Park Loggia, a mixed-use development located in New York, New York. We may be unsuccessful at developing real estate with the 10 Table of Contentsintent to sell or in selling condominiums at originally underwritten values, or at all, as a disposition strategy for an asset, which could have an adverse effect on our results of operations.We are exposed to risks associated with investment in technology and environmentally focused venture funds and companies. In recent years we have invested in, and may in the future invest in, venture funds that invest in companies seeking innovation through new processes and the application of technology to property operations, development, construction and energy management. We have also invested directly in, and may in the future invest directly in, companies that engage in these activities. While such investments give us a greater understanding of new and emerging technologies, such investments involve risks, including the possibility that our investments will decline substantially in value.Our investments in technology companies, or in funds that invest in technology companies, are generally held through taxable REIT subsidiaries pursuant to which we will incur taxable gains upon the disposition of our interests. In addition, the value of these investments may be volatile and declines in value may impact our reported income even if we do not sell the investment.We are exposed to risks associated with investment in, and management of, discretionary real estate investment funds and joint ventures. At times we invest directly and indirectly in real estate as a partner or a co-venturer with other investors. Joint venture investments (including investments through partnerships or limited liability companies) involve risks, including the possibility that our partner might become insolvent or otherwise refuse to make capital contributions when due; that we may be responsible to our partner for indemnifiable losses or the debt and obligations of an investment; that our investments may lose all or some of their value; that our partner might have business goals that are inconsistent with ours which may result in the venture or investment being unable to implement certain decisions that we consider beneficial; that our partner may be in a position to take action or withhold consent contrary to our instructions or requests; that, in cases where we are the general partner or managing member, our partners holding a majority of the equity interests may remove us from such role in certain cases involving cause; and that we may be liable and/or our status as a REIT may be jeopardized if either the investments, or the REIT entities associated with the investments, fail to comply with various tax or other regulatory matters. Frequently, we and our partner may each have the right to trigger a buy-sell or similar arrangement that could cause us to sell our interest, acquire our partner's interest or force a sale of the asset, which could occur at a time when we otherwise would not have initiated such a transaction or on terms that are not most advantageous to us.Mezzanine debt and preferred equity investments could cause us to incur expenses, which could adversely affect our results of operations. We hold mezzanine loans and plan to hold preferred equity interests as part of our SIP through which we make these kinds of investments in projects owned by third parties. Some of these instruments may have some recourse to their sponsors, while others are limited to the collateral securing the loan. In the event of a default under these obligations, we may have to take possession of the collateral securing these interests. Borrowers may contest enforcement of foreclosure or other remedies, seek bankruptcy protection against such enforcement and/or bring claims for lender liability in response to actions to enforce their obligations to us. Declines in the value of the property may prevent us from realizing an amount equal to our investment upon foreclosure even if we make substantial improvements or repairs to the underlying real estate in order to maximize such property's investment potential. We cannot be certain that reserves carried to protect against future credit losses will be adequate over time to protect against future credit losses because of unanticipated adverse changes in the economy or events adversely affecting specific properties, assets, tenants, borrowers, industries in which our tenants and borrowers operate or markets in which our tenants and borrowers or their properties are located. The ultimate resolutions may differ from our expectation, and we could suffer losses that would have a material adverse effect on our financial performance, the trading price of our securities and our ability to pay dividends and distributions.We are exposed to risks associated with real estate assets that are subject to ground leases that may restrict our ability to finance, sell or otherwise transfer our interests in those assets, limit our use and expose us to loss if such agreements are breached by us or terminated. We own assets that are subject to long-term ground leases. These ground leases may impose limitations on our use of the properties, restrict our ability to finance, sell or otherwise transfer our interests or restrict the leasing of the properties. These restrictions may limit our ability to timely sell or exchange the properties, impair the properties’ value or negatively impact our ability to operate the properties. In addition, we could lose our interests in the properties if the ground leases are breached by us, terminated or lapse. As we get closer to the lease termination dates, the values of the properties could decrease if we are unable to agree upon an extension of the lease with the lessor. Certain of these ground leases have payments subject to annual escalations and/or periodic fair market value adjustments which could adversely affect our financial condition or results of operations.11 Table of ContentsLand we hold with no current intent to develop may be subject to future impairment charges. We own land parcels that we do not currently intend to develop. As discussed in Item 2. “Properties—Other Land and Real Estate Assets,” in the event that the fair market value, less the cost to dispose of a parcel, changes such that it is less than the carrying basis of the parcel, we would be subject to an impairment charge, which would reduce our net income.Our various technology-related initiatives to improve our operating margins and customer experience may fail to perform as expected. We have developed and may continue to develop initiatives that are intended to serve our customers better and operate more efficiently, including “smart home” technology and self-service options that are accessible to residents through smart devices or otherwise. Such initiatives have involved and may involve our employees having new or different responsibilities and processes. We may incur significant costs and divert resources in connection with such initiatives, and these initiatives may not perform as expected, which could adversely affect our business, results of operations, cash flows and financial condition.Risks related to liquidity and financingCapital and credit market conditions may adversely affect our access to various sources of capital and/or the cost of capital, which could impact our business activities, dividends, earnings and common stock price, among other things. In periods when the capital and credit markets experience significant volatility, the amounts, sources and cost of capital available to us may be adversely affected. We use external financing as one source of capital to fund construction and to refinance indebtedness as it matures. If sufficient sources of external financing are not available to us on cost effective terms, we could be forced to limit our development and redevelopment activity and/or take other actions to fund our business activities and repayment of debt, such as selling assets, reducing our cash dividend or issuing equity or debt securities. If we are able and/or choose to access capital at a higher cost than we have experienced in recent years, our earnings per share and cash flows could be adversely affected. In addition, the price of our common stock may fluctuate significantly and/or decline in a high interest rate environment or a volatile economic environment, or if we dilute the interest of stockholders by issuing additional equity. We believe that the lenders under our Credit Facility and the dealers under our Commercial Paper Program will fulfill their lending obligations thereunder, but if economic conditions deteriorate, the ability of those lenders and/or dealers to fulfill their obligations may be adversely impacted.Insufficient cash flow could affect our debt financing and create refinancing risk. We are subject to the risks associated with debt financing, including the risk that our available cash will be insufficient to meet required payments of principal and interest on our debt. For us to continue to qualify as a REIT, we are required to annually distribute dividends generally equal to at least 90% of our REIT taxable income, which limits the amount of our cash flow available to meet required principal and interest payments. The principal outstanding balance on a portion of our debt will not be fully amortized prior to its maturity. We cannot assure you that we will have sufficient cash flows available to make all required principal payments. Therefore, we expect that we will generally need to refinance at least a portion of our outstanding debt as it matures. There is a risk that we may not be able to refinance existing debt or that a refinancing will not be done on as favorable terms; either of these outcomes could have a material adverse effect on our financial condition and results of operations.Rising interest rates could increase interest costs and could affect the market price of our common stock, and efforts to hedge such risk could be ineffective and cause us to incur additional costs. If interest rates increase, our interest costs on variable rate debt will rise unless we have hedged the risk of rising interest rates. In addition, an increase in market interest rates may lead purchasers of our common stock to demand a greater annual dividend yield, which could adversely affect the market price of our common stock.We may use interest rate derivatives to manage our exposure to fluctuations in interest rates, such as by entering into interest rate contracts. For example, when we anticipate issuing debt securities, we may seek to limit our exposure to fluctuations in interest rates prior to debt issuance by entering into interest rate hedging contracts. Although these agreements may partially protect against rising interest rates, they also may reduce the benefits to us if interest rates decline. The interest rate derivatives we use, primarily to manage interest rate risk for our anticipated debt issuance activity, could result in a material charge to earnings if we do not issue the anticipated debt, or are otherwise unsuccessful in our hedging activities. In addition, our use of hedging arrangements may expose us to additional risks, including a risk that a counterparty to a hedging arrangement may default on the contract. There can be no assurance that our hedging activities will be effective reducing the risks associated with interest rate fluctuations. Bond financing and zoning and other compliance requirements could limit our income, restrict the use of communities and cause favorable financing to become unavailable. We have financed some of our apartment communities with obligations issued by local government agencies because the interest paid to the holders of this debt is generally exempt from federal income taxes, which typically provides a more favorable interest rate for us. These obligations are commonly referred to as “tax-exempt bonds” and generally must be secured by mortgages on our communities. As a condition to obtaining (i) tax-exempt financing, (ii) favorable zoning or (iii) an agreement relating to property taxes in some jurisdictions, we will commit to 12 Table of Contentsmake some of the apartments in a community available to households whose income does not exceed certain thresholds (e.g., 50% or 80% of area median income), or who meet other qualifying tests. As of December 31, 2022, 4.9% of our apartment homes at current operating communities were under income limitations such as these. These commitments, which may or may not expire, may limit our ability to raise rents, adversely affecting the value of communities subject to these restrictions. If we fail to observe these commitments, we could lose benefits (such as reduced property taxes) or face liabilities including liability for the benefits we received under tax exempt bonds, tax credits or agreements related to property taxes.Our tax-exempt bonds may require us to obtain a guarantee from a financial institution of payment of the principal and interest on the bonds, such as a letter of credit, surety bond, guarantee agreement or other additional collateral. If the financial institution defaults in its guarantee obligations, or if we are unable to renew the applicable guarantee or otherwise post satisfactory collateral, a default will occur and the community could be foreclosed upon if we do not redeem the tax exempt bonds.Risks related to indebtedness. We have a Credit Facility and Commercial Paper Program with a syndicate of commercial banks as well as secured and unsecured notes. Our organizational documents do not limit the amount or percentage of indebtedness that may be incurred. Accordingly, subject to compliance with outstanding debt covenants, we could incur more debt, resulting in an increased risk of default on our obligations and an increase in debt service requirements that could adversely affect our financial condition and results of operations.The mortgages on properties that are subject to secured debt, our Credit Facility, Commercial Paper Program and the indentures under which a substantial portion of our debt was issued contain customary restrictions, requirements and other limitations, as well as certain financial and operating covenants including maintenance of certain financial ratios. Maintaining compliance with these restrictions could limit our flexibility. A default in these requirements, if uncured, could result in a requirement that we repay indebtedness, which could materially adversely affect our liquidity and increase our financing costs. Refer to Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations” for further discussion.A substantial portion of our debt is subject to prepayment penalties or premiums that we will be obligated to pay in the event that we elect to prepay the debt prior to the earlier of (i) its stated maturity or (ii) another stated date. If we elect to prepay a significant amount of outstanding debt, our prepayment penalties or payments under these provisions could materially adversely affect our results of operations.Failure to maintain our current credit ratings could adversely affect our cost of funds, related margins, liquidity and access to capital markets. There are two major debt rating agencies that routinely evaluate and rate our debt. Their ratings are based on a number of factors, which include their assessment of our financial strength, liquidity, capital structure, asset quality, amount of real estate under development, and sustainability of cash flow and earnings, among other factors. If market conditions change, we may not be able to maintain our current credit ratings, which could adversely affect our cost of funds and related margins, liquidity and access to capital markets.The form, timing and/or amount of dividend distributions in future periods may vary and be impacted by our revenue generation, other liquidity needs and economic and other considerations. The form, timing and/or amount of dividend distributions will be declared at the discretion of the Board of Directors and will depend on our rental revenue, actual cash from operations, our financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Code and other factors as the Board of Directors may consider relevant. The Board of Directors may modify our dividend policy from time to time.We may experience barriers to selling apartment communities that could limit financial flexibility. Difficulties in selling real estate at prices we find acceptable in a timely manner may limit our ability to quickly change or reduce the apartment communities in our portfolio in response to changes in economic, regulatory, or other conditions. Federal tax laws may also limit our ability to sell properties when desired. See “Risks related to our REIT or tax status” section for more information on federal tax law risks. In addition, the capitalization rates/disposition yields at which apartment communities may be sold could also be higher than historic rates, thereby reducing our potential proceeds from sale.Increased scrutiny and changing expectations from investors, tenants and others regarding our environmental, social and governance ("ESG") practices and reporting could impact the price of our securities and business practices, and could cause us to incur additional costs. ESG evaluations, including ESG scores and ratings, are important to some investors and other stakeholders and may impact the price of our securities and business practices. Investors may focus on, and consider a company's ESG-related business practices, scores and reporting when choosing to allocate their capital in making investment decisions, including if they invest in our securities. In addition, the adoption of increased government regulations and changes in investor preference related to ESG and similar matters may result in changes to our business practices, including increasing expenses or capital expenditures.13 Table of ContentsRisks related to ongoing operations of our communitiesLaws, regulations and orders imposing rent control or rent stabilization, or limiting our rights as a landlord, could adversely affect our operations and revenue. A number of states and municipalities have implemented or are seeking to implement rent control or rent stabilization laws and regulations or take other actions that could limit or delay our ability to raise rents, charge non-rent fees and evict tenants for non-payment of rent or other lease violations. For example, the State of California has statewide rent control for communities older than fifteen years, limiting rent increases to the lesser of 10% or 5% plus local CPI, and the State of New York has rules for rent-controlled and rent-stabilized units that limit the way rent increases are calculated for renewal leases, basing increases solely on rent actually paid and eliminating the ability to increase the renewal rent to a higher “registered rent.” Furthermore, in California the Governor has the ability to enact local or statewide states of emergency which limit our ability to increase new and renewal rents more than 10% over the rent in place on the date such state of emergency was declared, which has impacted some of our California communities. We have seen an increase in state and local governments in our markets implementing, considering or being urged by various constituencies to consider regulations of the types described above. Additionally, in January 2023, the White House published a white paper entitled the Blueprint for a Renters Bill of Rights and announced accompanying efforts aimed at increasing fairness in the rental market. Current and future enactments of rent control or rent stabilization laws or other laws regulating rental housing may limit our ability to charge market rents, increase rents, evict tenants or recover increases in our operating expenses and could make it more difficult for us to dispose of properties in certain circumstances. Expenses associated with our investment in these communities, such as debt service, real estate taxes, insurance and maintenance costs, are generally not reduced when circumstances cause a reduction in rental income from the community. Noncompliance with applicable laws in the building and operation of our communities could adversely affect our operations or expose us to liability. We must develop, construct and operate our communities in compliance with federal, state and local laws and regulations, some of which may conflict with one another or be subject to limited judicial or regulatory interpretations. These laws and regulations may include zoning laws, building codes, landlord/tenant laws and other laws generally applicable to business operations. Noncompliance with laws could expose us to liability. Lower revenue growth or significant unanticipated expenditures may result from our need to comply with changes in (i) laws imposing remediation requirements or other conditions, or (ii) other governmental rules and regulations or enforcement policies affecting the development, use and operation of our communities, including changes to building codes and fire and life-safety codes.Short-term leases expose us to the effects of declining market rents. Substantially all of our apartment leases are for a term of one year or less. Because these leases generally permit the residents to leave at the end of the lease term without penalty, our rental revenues are impacted by declines in market rents more quickly than if our leases were for longer terms.Competition could limit our ability to lease apartment homes or increase or maintain rents. Our apartment communities compete with other apartment operators as well as rental housing alternatives, such as single-family homes for rent and short term furnished offerings such as those available from extended stay hotels or through online listing services. In addition, our residents and prospective residents also consider, as an alternative to renting, the purchase of a new or existing condominium or single-family home. Competitive residential housing could adversely affect our ability to lease apartment homes and to increase or maintain rental rates.Unfavorable changes in market and economic conditions could adversely affect occupancy, rental rates, operating expenses, and the overall market value of our real estate assets. Local conditions in our markets significantly affect occupancy, rental rates and the operating performance of our communities, and may be adversely affected by the following risks:•corporate restructurings and/or layoffs, and industry slowdowns;•an oversupply of, or a reduced demand for, apartment homes;•a decline in household formation or employment or lack of employment growth;•the inability or unwillingness of residents to pay rent increases; and•economic conditions that could cause an increase in our operating expenses, such as increases in property taxes, utilities, compensation of on-site associates and routine maintenance.Risks related to a pandemic’s impact on multifamily rental housing. The national and global impacts of a pandemic, such as the COVID-19 pandemic, may present material uncertainty and risk with respect to our financial condition, results of operations and cash flows. Moreover, many of the risk factors set forth in this Form 10-K could be interpreted as heightened risks as a result of the impact of a pandemic. Impacts from a pandemic may include the following:•State, local, and federal entities may impose restrictions, for varying times and to varying degrees, on our ability to enforce residents’ contractual lease obligations, and this may affect our ability to enforce all our remedies (such as pursuing collections and seeking evictions) for the failure to pay rent.14 Table of Contents•Consumers whose income has declined, who are working remotely or who cannot freely access neighborhood amenities like restaurants, may decide to live in a location other than our markets. Demand from students and demand for corporate apartment homes may be negatively impacted by trends in remote learning and work, and the adoption of new online technologies.•Various state, local and federal rules may require us, in some jurisdictions or for some properties, to waive late fees and certain other customary fees associated with our apartment rental business. These requirements or practices may result in foregone revenue.•Our properties may incur significant costs or losses related to shelter-in-place or stay-at-home orders, quarantines, infection, clean-up costs or other related factors.•There may be concerns related to the general economy about (i) supply chain constraints and (ii) inflation caused by both supply chain constraints and governmental fiscal and monetary policies. Supply chain constraints could cause delays in our construction and redevelopment activity, and inflation could cause our construction and operating costs to increase without a commensurate increase in our rental revenue.Emergency orders shutting down non-essential businesses, limiting congregations of people, and requiring social distancing may at times disrupt our development and construction activity. To the extent we experience delays in construction, our construction costs may increase and we may not achieve, on the schedule we originally planned, the cash flows that we expect when we begin leasing a completed property. We may also delay the start of construction of additional development communities which, if constructed and leased as originally planned, would have been a source of future additional cash flow.The same factors as described immediately above may also impact our workforce. A disruption in the normal operations of our workforce, as well as the possibility of illness among our associates or a substantial portion of our workforce, could also adversely affect our operations.Risks related to commercial leasing operations. Although we are primarily in the multifamily rental business, we also own and lease ancillary commercial space. Gross rental revenue provided by leased commercial space in our portfolio represented 1.7% of our total revenue in 2022. The long term nature of our commercial leases and characteristics of many of our tenants (small, local businesses) may subject us to certain risks. We may not be able to lease new space for rents that are consistent with our projections or at market rates. Also, when leases for our existing commercial space expire, the space may not be relet or the terms of reletting, including the cost of allowances and concessions to tenants, may be less favorable than the current lease terms. Our properties compete with other properties with commercial space. If our commercial tenants experience financial distress or bankruptcy, they may fail to comply with their contractual obligations, seek concessions in order to continue operations or cease their operations, which could adversely impact our results of operations and financial condition.Inflation and related volatility in the economy could negatively impact our residents and our results of operations. Inflation accelerated rapidly in 2022 and may continue at an elevated level. Inflation and its related impacts, including increased prices for services and goods and higher interest rates and wages, and any policy interventions by the U.S. government, could negatively impact our residents’ ability to pay rents or our results of operations. Substantially all of our apartment leases are for a term of one year or less, which we believe mitigates our exposure to inflation, by permitting us to set rents commensurate with inflation (subject to rent regulations to the extent they apply and assuming our current or prospective residents will accept and can pay commensurate increased rents, of which there can be no assurance). Inflation could outpace any increases in rent and adversely affect us. We may not be able to mitigate the effects of inflation and related impacts, and the duration and extent of any prolonged periods of inflation, and any related adverse effects on our results of operations and financial condition, are unknown at this time. Inflation may also cause increased volatility in financial markets, which could affect our ability to access the capital markets or impact the cost or timing at which we are able to do so.Inflation may also increase the costs to complete our development projects, including costs of materials, labor and services from third-party contractors and suppliers. Higher construction costs could adversely impact our investments in real estate assets and our expected yields on development projects. Risks related to our REIT or tax status or reliance on various tax regulationsFailure to qualify as a REIT would cause us to be taxed as a corporation, which would significantly reduce funds available for distribution to stockholders. If we fail to qualify as a REIT for federal income tax purposes, we will be subject to regular federal corporate income tax on our taxable income. In addition, unless we are entitled to relief under applicable statutory provisions, we would be ineligible to make an election for treatment as a REIT for the four taxable years following the year we lose our qualification. The additional tax liability resulting from the failure to qualify as a REIT would significantly reduce or eliminate the amount of funds available for distribution to our stockholders. Furthermore, we would no longer be required to 15 Table of Contentsmake distributions to our stockholders. Thus, our failure to qualify as a REIT could also impair our ability to expand our business and raise capital and would adversely affect the value of our common stock.We believe that we are organized and qualified as a REIT, and we intend to operate in a manner that will allow us to continue to qualify as a REIT. However, we cannot assure you that we are qualified as a REIT, or that we will remain qualified in the future. This is because qualification as a REIT involves the application of highly technical and complex provisions of the Code for which there are only limited judicial and administrative interpretations and involves the determination of a variety of factual matters and circumstances not entirely within our control. Our qualification as a REIT depends on our satisfaction of certain asset, income, organizational, distribution, shareholder ownership and other requirements on a continuing basis. In addition, future legislation, new regulations, administrative interpretations or court decisions may significantly change the tax laws or the application of the tax laws with respect to qualification as a REIT for federal income tax purposes or the federal income tax consequences of this qualification. Additionally, our expanding range of investments (such as investments in mezzanine loans, preferred equity, and technology and environmentally focused venture funds and companies) may add additional REIT compliance challenges, some of which may involve determinations or circumstances that may be beyond our control.Even if we qualify as a REIT, we will be subject to certain federal, state and local taxes on our income and property and on taxable income that we do not distribute to our stockholders. In addition, we hold certain assets and engage in certain activities through our taxable REIT subsidiaries that a REIT could not engage in directly. We also use taxable REIT subsidiaries to hold certain assets that we believe would be subject to the 100% prohibited transaction tax if sold at a gain outside of a taxable REIT subsidiary or to engage in activities that generate non-qualifying REIT income. Our taxable REIT subsidiaries are subject to federal income tax as regular corporations. Legislative or other actions affecting REITs could have a negative effect on us or our stockholders. The rules dealing with federal income taxation are constantly under review by persons involved in the legislative process and by the Internal Revenue Service and the U.S. Department of the Treasury. Changes to the tax laws, with or without retroactive legislation, could adversely affect us or our stockholders. New legislation, Treasury Regulations, administrative interpretations or court decisions could significantly and negatively affect our ability to qualify as a REIT, the federal income tax consequences of such qualification, or the federal income tax consequences of an investment in our Company. Also, the law relating to the tax treatment of other entities, or an investment in other entities, could change, making an investment in such other entities more attractive relative to an investment in a REIT.Our ownership of taxable REIT subsidiaries is subject to certain restrictions, and it will be required to pay a 100% penalty tax on certain income or deductions if transactions with our TRSs are not conducted on arm’s length terms. We have established several TRSs. The TRSs must pay U.S. federal income tax on their taxable income as a regular C corporation. While we will attempt to ensure that our dealings with our TRSs do not adversely affect our REIT qualification, we cannot provide assurances that it will successfully achieve that result. Furthermore, we may be subject to a 100% penalty tax, to the extent dealings between us and our TRSs are not deemed to be arm’s length in nature. We intend that our dealings with our TRSs will be on an arm’s length basis. No assurances can be given, however, that the Internal Revenue Service will not assert a contrary position.Failure of one or more of our subsidiaries to qualify as a REIT could adversely affect our ability to qualify as a REIT. We own interests in subsidiaries that have elected to be taxed as REITs under the Code. These subsidiary REITs are subject to the REIT qualification requirements and other limitations that are applicable to us. If any of our subsidiary REITs were to fail to qualify as a REIT, then (i) the subsidiary REIT would become subject to federal income tax, (ii) our ownership of shares in such subsidiary REIT would cease to be a qualifying asset for purposes of the asset tests applicable to REITs, and (iii) it is possible that we could also fail to qualify as a REIT.The tax imposed on REITs engaging in "prohibited transactions" may limit our ability to engage in transactions which would be treated as sales for federal income tax purposes. We may transfer or otherwise dispose of some of our properties. Under the Code, unless certain exceptions apply, any gain resulting from transfers of properties that we hold as inventory or primarily for sale to customers in the ordinary course of business could be treated as income from a prohibited transaction subject to a 100% penalty tax from the gain on the sale of the community, which could potentially adversely impact our status as a REIT unless we own the community through a TRS. Since we acquire properties for investment purposes, we do not believe that our occasional transfers or disposals of property should be treated as prohibited transactions. However, whether property is held for investment purposes depends on the facts and circumstances surrounding the particular transaction. The IRS may contend that certain of our transfers or disposals of properties are prohibited transactions. If the IRS were to argue successfully that a transfer or disposition of property was a prohibited transaction, then we would be required to pay a 100% penalty tax on any gain allocable to it from the prohibited transaction, and our ability to retain proceeds from real property sales may be jeopardized.16 Table of ContentsWe may face risks in connection with Section 1031 exchanges. We may dispose of real properties in transactions intended to qualify as "like-kind exchanges" under Section 1031 of the Code. If a transaction intended to qualify as a Section 1031 exchange is later determined to be taxable, we may face adverse consequences, and if the laws applicable to such transactions are amended or repealed, we may not be able to dispose of real properties on a tax deferred basis.We may choose to pay dividends in our own stock, in which case stockholders may be required to pay tax in excess of the cash they receive. We may distribute taxable dividends that are payable in part in our stock. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as income to the extent of our current and accumulated earnings and profits for federal income tax purposes. As a result, a U.S. stockholder may be required to pay tax with respect to such dividends in excess of the cash dividend received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, the trading price of our stock would experience downward pressure if a significant number of our stockholders sell shares of our stock in order to pay taxes owed on dividends.Risks that may not be insured in full or in partWe are exposed to risks that are either uninsurable, not economically insurable or in excess of our insurance coverage, including risks discussed below. Insurance coverage for various risks can be costly and in limited supply. As a result, we may experience shortages in desired coverage levels if market conditions are such that insurance is not available or the cost of insurance makes it, in our view, economically impractical. Incidents that directly or indirectly damage our communities, both physically and financially, or cause losses that exceed our insurance coverage could have a material adverse effect on our business, financial condition and results of operations including increased maintenance, repair, and delays in construction. In addition, we would also continue to be obligated to repay any mortgage indebtedness or other obligations related to the community which could have a material adverse effect on our business and our financial condition and results of operations. The following risks are uninsurable or insurance coverage is limited due to premium rates (See Item 2. “Properties—Insurance and Risk of Uninsured Losses”): •Earthquake risk. As further described in Item 2. “Properties—Insurance and Risk of Uninsured Losses,” many of our West Coast communities are located in the general vicinity of active earthquake faults. Insurance coverage for earthquakes can be costly and in limited supply. •Climate and severe or inclement weather risk. Many of our markets, particularly those located in coastal cities, are exposed to risks associated with inclement or severe weather including those arising from climate change such as hurricanes, severe winter storms and coastal flooding. •Terrorism and other risk. We have significant investments in metropolitan markets such as Metro New York/New Jersey and Washington, D.C., which have in the past been or may in the future be the target of actual or threatened terrorist attacks. We carry commercial general liability insurance, property insurance and terrorism insurance with respect to our communities on terms and in amounts we consider commercially reasonable. There are, however, certain types of losses (such as from acts of war) we do not insure, in full or in part, because they are either uninsurable or we believe the cost of insurance is economically impractical.We may incur costs related to climate change. We may experience climate change impacts including extreme weather and changes in precipitation, temperature and wildfire exposure, all of which may result in physical damage to or a decrease in demand for properties located in these areas or affected by these conditions. Should the impact of these conditions be material in nature or occur for lengthy periods of time, our financial condition or results of operations may be adversely affected, and may negatively impact the types and pricing of insurance we are able to procure. In addition, implementation of new or changes in existing federal, state and local regulations based on concerns about climate change could result in increased capital expenditures or operating expenses on our existing properties (for example, requiring retrofitting of existing systems) and our new development properties (for example, to improve energy efficiency, reduce greenhouse gas emissions and/or improve resistance to inclement weather) without a corresponding increase in revenue, resulting in adverse impacts to our results of operations.We may incur costs due to environmental contamination or non-compliance. Under various public health laws and regulations, we may be required, regardless of knowledge or responsibility, to investigate and remediate the presence or effects of hazardous or toxic substances such as asbestos, lead paint, chemical vapors from soils or groundwater, petroleum product releases, and natural substances such as methane and radon gas. We may be held liable under these laws or common law to a governmental entity or to third parties for property, personal injury or natural resources damages and for investigation and remediation costs incurred as a result of the contamination. These damages and costs may be substantial and may exceed any 17 Table of Contentsinsurance coverage we have for such events. The presence of these substances, or the failure to properly remediate or contain the contamination, may adversely affect our ability to borrow against, develop, sell or rent the affected property. In addition, some environmental laws create or allow a government agency to impose a lien on the contaminated site in favor of the government for damages and costs it incurs as a result of the contamination.The development, construction and operation of our communities are subject to regulations and permitting under various federal, state and local laws, regulations and ordinances, which regulate matters including wetlands protection, storm water runoff and wastewater discharge. These laws and regulations may impose restrictions on the manner in which our communities may be developed, and noncompliance with these laws and regulations may subject us to fines and penalties and may subject us to liability in connection with personal injury.Certain laws and regulations govern the removal, encapsulation or disturbance of asbestos containing materials (“ACMs”) when such materials are in poor condition or in the event of renovation or demolition of a building. These laws and the common law may impose liability for release of ACMs and may allow third parties to seek recovery from owners or operators of real properties for personal injury associated with exposure to ACMs. We are not aware that any ACMs were used in the construction of the communities we developed. ACMs were, however, used in the construction of a number of the communities that we have acquired. Although we implement an operations and maintenance program at each of the communities at which ACMs are detected, we may fail to adequately observe such program or a disturbance of ACMs may occur nevertheless, exposing us to liability. We are aware that some of our communities have lead paint and have implemented an operations and maintenance program at each of those communities.All of our stabilized operating communities, and all of the communities that we are currently developing, have been subjected to at least a Phase I or similar environmental assessment, which generally does not involve invasive techniques such as soil or groundwater sampling. These assessments, together with subsurface assessments conducted on some properties, have not revealed, and we are not otherwise aware of, any environmental conditions that we believe would have a material adverse effect on our business, assets, financial condition or results of operations. In connection with our ownership, operation and development of communities, we may undertake substantial remedial action in response to the presence of subsurface or other contaminants, including contaminants in soil, groundwater and soil vapor beneath or affecting our buildings. In some cases, an indemnity exists upon which we may be able to rely if environmental liability arises from the contamination or remediation costs exceed estimates. There can be no assurance, however, that all necessary remediation actions have been or will be undertaken at our properties or that we will be indemnified, in full or at all, in the event that environmental liability arises.Mold growth may occur when excessive moisture accumulates in buildings or on building materials, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Certain molds may lead to adverse health effects, including allergic or other reactions. We cannot provide assurance that mold or excessive moisture will be detected and remediated in a timely manner. If a significant mold problem arises at one of our communities, we could be required to undertake a costly remediation program to contain or remove the mold from the affected community and could be exposed to other liabilities that may exceed any applicable insurance coverage.Additionally, we have occasionally been involved in developing, managing, leasing and operating various properties for third parties. Consequently, we may be considered to have been an operator of such properties and, therefore, potentially liable for removal or remediation costs or other potential costs which relate to the release or presence of hazardous or toxic substances or petroleum products at such properties. We cannot assure you that:•the environmental assessments described above have identified all potential environmental liabilities;•no prior owner created any material environmental condition not known to us or the consultants who prepared the assessments;•no environmental liabilities have developed since the environmental assessments were prepared;•the condition of land or operations in the vicinity of our communities, such as the presence of underground storage tanks, will not affect the environmental condition of our communities;•future uses or conditions, including, without limitation, changes in applicable environmental laws and regulations, will not result in the imposition of environmental liability; and•no environmental liabilities will arise at communities that we have sold for which we may have liability.General Risk FactorsThe ability of our stockholders to control our policies and effect a change of control of our company is limited by certain provisions of our charter and bylaws and by Maryland law. There are provisions in our charter and bylaws that may discourage a third party from making a proposal to acquire us. These provisions include the following:18 Table of ContentsOur charter authorizes our Board of Directors to issue up to 50,000,000 shares of preferred stock without stockholder approval and to establish the preferences and rights, including voting rights, of any series of preferred stock issued. This could allow the Board to issue one or more classes or series of preferred stock that could discourage or delay a tender offer or a change in control.To maintain our qualification as a REIT for federal income tax purposes, not more than 50% in value of our outstanding stock may be owned, directly or indirectly, by or for five or fewer individuals at any time during the last half of any taxable year. To maintain this qualification, and/or to address other concerns about concentrations of ownership of our stock, our charter generally prohibits ownership (directly, indirectly by virtue of the attribution provisions of the Code, or beneficially as defined in Section 13 of the Securities Exchange Act of 1934) by any single stockholder of more than 9.8% of the issued and outstanding shares of any class or series of our stock. In general, under our charter, pension plans and mutual funds may directly and beneficially own up to 15% of the outstanding shares of any class or series of stock. Under our charter, our Board of Directors may in its sole discretion waive or modify the ownership limit for one or more persons, but it is not required to do so even if such waiver would not affect our qualification as a REIT. These ownership limits may prevent or delay a change in control and, as a result, could adversely affect our stockholders' ability to realize a premium for their shares of common stock.As a Maryland corporation, we are subject to the provisions of the Maryland General Corporation Law which restricts some business combinations and requires compliance with statutory procedures before some mergers and acquisitions may occur, which may delay or prevent offers to acquire us even if they are in our stockholders' best interests. In addition, other provisions of the Maryland General Corporation Law permit the Board of Directors to make elections and to take actions without stockholder approval (such as classifying our Board such that the entire Board is not up for re-election annually) that, if made or taken, could have the effect of discouraging or delaying a change in control.Litigation could adversely affect our business. We are and may in the future become involved in legal proceedings, claims, actions, inquiries and/or investigations in connection with our operations, which may result in defense costs, settlements, fines and/or judgments against us, some of which are not, or cannot be, covered by insurance. For example, in late 2022 and early 2023, 14 purported class actions were filed against the Company, RealPage, Inc., (“RealPage”) and other defendants (the “RealPage Litigation”) alleging that RealPage and lessors of multifamily residential real estate conspired, principally in connection with the alleged use of RealPage revenue management systems, to artificially inflate the rental rates for multifamily residential real estate above competitive levels. The plaintiffs are seeking monetary damages and attorneys’ fees and costs and injunctive relief. We believe that the RealPage Litigation is without merit as it pertains to our Company, and plan to vigorously defend the lawsuits. While we do not currently believe the RealPage litigation will have a material impact on our financial condition or results of operations, we cannot predict the outcome of the lawsuits given the early stage. Legal proceedings and other claims, if decided adversely to or settled by us, and not covered by insurance, could result in liability material to our financial condition, results of operations or cash flows. Likewise, regardless of outcome, legal proceedings and other claims may result in substantial costs and expenses, affect the availability or cost of some of our insurance coverage and significantly divert the attention of our management. With respect to any legal proceeding or other claim, there can be no assurance that we will be able to prevail, or achieve a favorable settlement or outcome, or that our insurance and/or any contractual indemnities will be enough to cover all of our defense costs or any resulting liabilities.Changes in U.S. accounting standards may materially and adversely affect the reporting of our operations. We follow accounting principles generally accepted in the United States (“GAAP”). GAAP is established by the Financial Accounting Standards Board (“FASB”), an independent body whose standards are recognized by the SEC as authoritative for publicly held companies. The FASB and the SEC create and interpret accounting standards and may change the interpretation and application of these standards that govern the preparation of our financial statements. These changes could have a material impact on our reported consolidated results of operations and financial position.We rely on information technology in our operations, and any breach, interruption or security failure of that technology, or any non-compliance with applicable laws with respect to the use of that technology, could have a negative impact on our business, results of operations, financial condition and/or reputation. We rely on information technology, including the internet, to process, transmit and store electronic information, and to manage or support a variety of business processes, including financial transactions, personally identifiable information ("PII"), and tenant and lease data. Our business requires us and some of our vendors, to use and store PII and other sensitive information of our residents and employees. Privacy and information security laws and regulations for PII continue to evolve and may be inconsistent from one jurisdiction to another. Compliance with all such laws and regulations may increase our operating costs and adversely impact our ability to market our properties and services.Information security risks have generally increased in recent years due to the rise in new technologies and the increased sophistication and activities of perpetrators of cyber attacks. Although our information technology is essential to the operation of our business and our ability to perform day-to-day operations, even the most well-protected information, networks, systems 19 Table of Contentsand facilities remain potentially vulnerable because the techniques used in such attempted security breaches evolve and generally are not recognized until launched against a target, and in some cases are designed not to be detected and, in fact, may not be detected. Accordingly, we may be unable to implement adequate security barriers or other preventative measures, and thus it is impossible for us to entirely mitigate this risk.There can be no assurance that we will be able to prevent unauthorized access to this PII or to our network or business systems in general. Any failure in or breach of our operational or information security systems, or those of our third party service providers, as a result of cyber attacks or information security breaches, could result in a wide range of potentially serious harm to our business operations and financial prospects, including (among others) disruption of our business and operations caused by an inability to access network systems or otherwise, disclosure or misuse of confidential or proprietary information (including PII of our residents and/or associates), damage to our reputation, and/or potentially significant legal and/or financial liabilities and penalties.Various laws and regulations and interpretations thereof, as well as agreements with payment processors, require, or may require, us to comply with rules related to our websites for use by residents and prospective residents, including requirements related to accessibility of our websites to persons with disabilities and our handling and use of data we collect. We could face liabilities for failure to comply with these requirements. New statutes, such as the California Consumer Privacy Act (“CCPA”), and related regulations are evolving and may be subject to differing interpretations. We could incur costs to comply with stricter and more complex data privacy, data collection and information security laws and standards.Any material weaknesses identified in our internal control over financial reporting could have an impact on our Company. Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal control over financial reporting. One or more material weaknesses in our internal control over financial reporting could result in misstatements of our results of operations and related restatements, a decline in the price/value of our securities, or otherwise materially adversely affect our business, reputation, results of operations, financial condition or liquidity.Our success depends on key personnel whose continued service is not guaranteed. Our success depends in part on our ability to attract and retain the services of executive officers and other personnel. There is substantial competition for qualified personnel in the real estate industry, and the loss of our key personnel could adversely affect us.ITEM 1B. UNRESOLVED STAFF COMMENTSNone.20 Table of ContentsITEM 2. PROPERTIESOur real estate investments consist primarily of current operating apartment communities ("Current Communities"), consolidated and unconsolidated communities in various stages of development ("Development" communities and "Unconsolidated Development" communities) and Development Rights (as defined below). Our Current Communities are further classified as Same Store communities, Other Stabilized communities, Redevelopment communities and Unconsolidated communities. While we generally establish the classification of communities on an annual basis, we update the classification of communities during the calendar year to the extent that our plans with regard to the disposition or redevelopment of a community change. The following is a description of each category:Current Communities are categorized as Same Store, Other Stabilized, Redevelopment or Unconsolidated according to the following attributes:•Same Store for the year ended December 31, 2022 is composed of consolidated communities where a comparison of operating results from the prior year to the current year is meaningful as these communities were owned and had stabilized occupancy as of the beginning of the respective prior year period. For the year ended December 31, 2022, Same Store communities are consolidated for financial reporting purposes, had stabilized occupancy as of January 1, 2021, are not conducting or are not probable to conduct substantial redevelopment activities and are not held for sale or probable for disposition to unrelated third parties within the current year. A community is considered to have stabilized occupancy at the earlier of (i) attainment of 90% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment.•Other Stabilized is composed of completed consolidated communities that we own and that are not Same Store but which have stabilized occupancy, as defined above, as of January 1, 2022, or which were acquired subsequent to January 1, 2021. Other Stabilized includes stabilized wholly-owned communities in Charlotte, North Carolina and Dallas, Texas, the two new expansion markets we entered in 2021, but excludes communities that are conducting or are probable to conduct substantial redevelopment activities within the current year, as defined below.•Redevelopment is composed of consolidated communities where substantial redevelopment is in progress or is probable to begin during the current year. Redevelopment is considered substantial when (i) capital invested is expected to exceed the lesser of $5,000,000 or 10% of the community's pre-redevelopment basis and (ii) physical occupancy is below or is expected to be below 90% during, or as a result of, the redevelopment activity. •Unconsolidated is composed of communities that we have an indirect ownership interest in through our investment interest in an unconsolidated joint venture.Development is composed of consolidated communities that are either currently under construction, were under construction and were completed during the current year or where construction has been complete for less than one year and that do not have stabilized occupancy. These communities may be partially or fully complete and operating.Unconsolidated Development is composed of communities that are either currently under construction, or were under construction and were completed during the current year, in which we have an indirect ownership interest through our investment interest in an unconsolidated joint venture. These communities may be partially or fully complete and operating.Development Rights are development opportunities in the early phase of the development process where we either have an option to acquire land or enter into a leasehold interest, where we are the buyer under a long-term conditional contract to purchase land, where we control the land through a ground lease or own land to develop a new community, or where we are the designated developer in a public-private partnership. We capitalize related pre-development costs incurred in pursuit of new developments for which we currently believe future development is probable.We currently lease our corporate headquarters located in Arlington, Virginia, as well as our other regional and administrative offices, under operating leases.21 Table of ContentsAs of December 31, 2022, communities that we owned or held a direct or indirect interest in were classified as follows: Number ofcommunitiesNumber ofapartment homesCurrent Communities Same Store: New England37 9,618 Metro NY/NJ 39 11,641 Mid-Atlantic37 12,577 Southeast Florida4 1,214 Denver, CO4 1,086 Pacific Northwest18 4,807 Northern California40 12,128 Southern California56 16,422 Total Same Store235 69,493 Other Stabilized: New England3 253 Metro NY/NJ3 1,354 Mid-Atlantic4 1,337 North Carolina4 760 Southeast Florida4 1,623 Texas2 621 Denver, CO1 207 Pacific Northwest2 667 Northern California1 200 Southern California2 849 Total Other Stabilized26 7,871 Redevelopment1 714 Unconsolidated8 2,247 Total Current270 80,325 Development 23 7,675 Unconsolidated Development1 475 Total Communities294 88,475 Development Rights39 13,312 Our holdings under each of the above categories are discussed on the following pages.22 Table of ContentsWe generally establish the composition of our Same Store communities portfolio annually. Changes in the Same Store communities portfolios for the years ended December 31, 2022, 2021 and 2020 were as follows:Number ofcommunitiesSame Store communities as of December 31, 2019210 Communities added32 Communities removed (1) Redevelopment communities(1) Disposed communities(9)Same Store communities as of December 31, 2020232 Communities added15 Communities removed (1) Redevelopment communities— Disposed communities(9) Other Stabilized(1)Same Store communities as of December 31, 2021237 Communities added8 Communities removed (1) Redevelopment communities(1) Disposed communities(9)Same Store communities as of December 31, 2022235 _________________________________(1) We remove a community from our Same Store portfolio if we believe that planned activity for the upcoming year will result in that community's expected operations not being comparable to the prior year, including (i) when we intend to undertake a significant capital renovation, such that the community will be classified as a Redevelopment community; (ii) when we intend to dispose of a community; or (iii) when a significant casualty loss occurs.Current CommunitiesOur Current Communities include garden-style apartment communities consisting of multi-story buildings of stacked flats and/or townhome apartments in landscaped settings, as well as mid and high rise apartment communities consisting of larger elevator-served buildings of four or more stories, frequently with structured parking. As of January 31, 2023, our Current Communities consisted of the following: Number ofcommunitiesNumber ofapartment homes Garden-style128 39,909 Mid-rise119 34,060 High-rise28 8,442 Total Current Communities275 82,411 As discussed in Item 1. “Business,” we operate under four core brands: Avalon, AVA, eaves by Avalon and Kanso . We believe that this branding differentiation allows us to target our product offerings to multiple customer groups and submarkets within our existing geographic footprint.We also have an extensive and ongoing maintenance program to continually maintain and enhance our communities and apartment homes. The aesthetic appeal of our communities, and a service-oriented property management team that is focused on the specific needs of residents, enhances market appeal. We believe our mission of "Creating a Better Way to Live" helps us achieve higher rental rates and occupancy levels while minimizing resident turnover and operating expenses.Our Current Communities are located in the following geographic markets:23 Table of Contents Number ofcommunities atNumber ofapartment homes atPercentage of totalapartment homes at 1/31/20221/31/20231/31/20221/31/20231/31/20221/31/2023New England43 41 10,552 10,221 12.9 %12.4 %Metro NY/NJ52 47 15,261 14,296 18.6 %17.4 %New York City, NY14 14 5,089 5,089 6.2 %6.2 %New York Suburban16 12 4,577 3,792 5.6 %4.6 %New Jersey 22 21 5,595 5,415 6.8 %6.6 %Mid-Atlantic46 45 15,924 15,770 19.5 %19.2 %Washington Metro40 39 13,962 13,808 17.1 %16.8 %Baltimore, MD6 6 1,962 1,962 2.4 %2.4 %North Carolina3 4 500 760 0.6 %0.9 %Southeast Florida7 8 2,187 2,837 2.7 %3.4 %Texas1 2 425 621 0.5 %0.8 %Denver, Colorado4 6 1,086 1,539 1.3 %1.9 %Pacific Northwest20 21 5,474 5,802 6.7 %7.0 %Northern California42 42 12,633 12,641 15.5 %15.3 %San Jose, CA12 12 4,717 4,723 5.8 %5.7 %Oakland-East Bay, CA15 15 4,336 4,338 5.3 %5.3 %San Francisco, CA15 15 3,580 3,580 4.4 %4.3 %Southern California60 59 17,761 17,924 21.7 %21.7 %Los Angeles, CA41 39 12,624 12,133 15.4 %14.7 %Orange County, CA12 13 3,370 4,024 4.1 %4.9 %San Diego, CA7 7 1,767 1,767 2.2 %2.1 %278 275 81,803 82,411 100.0 %100.0 %We manage and operate substantially all of our Current Communities. During the year ended December 31, 2022, we completed construction of five communities containing 1,858 apartment homes and sold 12 operating communities containing 2,733 apartment homes.Of the Current Communities, as of January 31, 2023, we owned (directly or through wholly-owned subsidiaries):•265 operating communities, including 258 with a full fee simple, or absolute, ownership interest and seven that are on land subject to a land lease. The land leases have various expiration dates from July 2046 to April 2106, and three of the land leases are used to support tax advantaged structures that ultimately allow us to purchase the land upon lease expiration.24 Table of Contents•A membership interest in five limited liability companies. One of the ventures, the NYTA MF Investors LLC, through subsidiaries owns a fee simple interest in three operating communities and a leasehold interest in two additional operating communities. The other four ventures that each hold a fee simple interest in an operating community, one of which is consolidated for financial reporting purposes.•A general partnership interest in one partnership structured as a “DownREIT,” which is consolidated and owns one community. At January 31, 2023, there were 7,500 DownREIT partnership units outstanding. The limited partnership interests have the right to present all or some of their units for redemption for a cash amount based on the fair value of our common stock or we may elect to acquire any unit presented for redemption for one share of our common stock. In addition to our Current Communities, we also hold, directly or through wholly-owned subsidiaries, a full fee simple ownership interest in our wholly-owned Development Communities and a membership interest in one limited liability company that holds a fee simple interest in an Unconsolidated Development Community.Development CommunitiesAs of December 31, 2022, we owned or held a direct interest in 17 Development Communities under construction. We expect these Development Communities, when completed, to add a total of 5,417 apartment homes and 56,000 square feet of commercial space to our portfolio for a total capitalized cost, including land acquisition costs, of approximately $2,259,000,000. We cannot assure you that we will meet our schedule for construction completion or that we will meet our budgeted costs, either individually, or in the aggregate. You should carefully review Item 1A. “Risk Factors” for a discussion of the risks associated with development activity and our discussion under Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations” (including the factors identified under “Forward-Looking Statements”) for further discussion of development activity.The following table presents a summary of the Development Communities.25 Table of ContentsNumber ofapartmenthomesProjected totalcapitalized cost (1)($ millions)ConstructionstartInitial projected or actual occupancyEstimatedcompletionEstimatedstabilized operations (2)1.Avalon Harrison (3)Harrison, NY143 $94 Q4 2018Q3 2021Q2 2023Q3 20232.Avalon Somerville StationSomerville, NJ374 122 Q4 2020Q2 2022Q3 2023Q1 20243.Avalon North Andover (4)North Andover, MA221 78 Q2 2021Q4 2022Q3 2023Q4 20234.Avalon BrightonBoston, MA180 89 Q2 2021Q1 2023Q2 2023Q4 20235.Avalon Merrick ParkMiami, FL254 101 Q2 2021Q1 2023Q2 2023Q1 20246.Avalon Amityville IAmityville, NY338 135 Q2 2021Q4 2023Q2 2024Q4 20247.Avalon Bothell Commons IBothell, WA467 236 Q2 2021Q3 2023Q3 2024Q2 20258.Avalon Westminster PromenadeWestminster, CO312 110 Q3 2021Q1 2024Q2 2024Q1 20259.Avalon West DublinDublin, CA499 270 Q3 2021Q4 2023Q1 2025Q2 202510.Avalon Princeton CirclePrinceton, NJ221 88 Q4 2021Q2 2023Q1 2024Q3 202411.Avalon MontvilleMontville, NJ349 127 Q4 2021Q4 2023Q3 2024Q4 202412.Avalon Redmond Campus (5)Redmond, WA214 80 Q4 2021Q3 2023Q1 2024Q3 202413.Avalon Governor's ParkDenver, CO304 135 Q1 2022Q2 2024Q3 2024Q2 202514.Avalon West Windsor (3)West Windsor, NJ535 201 Q2 2022Q3 2024Q4 2025Q2 202615.Avalon DurhamDurham, NC336 125 Q2 2022Q2 2024Q3 2024Q2 202516.Avalon AnnapolisAnnapolis, MD508 202 Q3 2022Q3 2024Q3 2025Q2 202617.Kanso MilfordMilford, MA162 66 Q4 2022Q1 2024Q3 2024Q1 2025 Total5,417 $2,259 _________________________________(1)Projected total capitalized cost includes all capitalized costs projected to be or actually incurred to develop the respective Development Community, determined in accordance with GAAP, including land acquisition costs, construction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees, allocated development overhead and other regulatory fees, as well as costs incurred for first generation commercial tenants such as tenant improvements and leasing commissions. (2)Stabilized operations is defined as the earlier of (i) attainment of 90% or greater physical occupancy or (ii) the one-year anniversary of completion of development.(3)Development Communities containing at least 10,000 square feet of commercial space include Avalon Harrison (27,000 square feet) and Avalon West Windsor (19,000 square feet).(4)During the year ended December 31, 2022, we expanded our existing Development Community, Avalon North Andover, adding 51 apartment homes at an incremental projected total capitalized cost of $22,000.(5)Avalon Redmond Campus is a densification of the existing eaves Redmond Campus wholly-owned community, replacing 48 existing older apartment homes that were demolished. 26 Table of ContentsDuring the year ended December 31, 2022, we completed the development of the following wholly-owned communities:Number ofapartmenthomesTotal capitalized cost (1)($ millions)Approximate rentable area (sq. ft.)Total capitalized cost per sq. ft.Quarter of completion1.Avalon Foundry RowOwings Mills, MD437 $98 364,310 $269 Q1 20222.Avalon WoburnWoburn, MA 350 120 329,792 $364 Q1 20223.Avalon Brea PlaceBrea, CA653 293 557,454 $526 Q2 20224.AVA RiNoDenver, CO246 87 187,733 $463 Q2 20225.Avalon Harbor IsleIsland Park, NY172 94 227,070 $414 Q4 2022Total1,858 $692 ____________________________________(1)Total capitalized cost is as of December 31, 2022. We generally anticipate incurring additional costs associated with these communities that are customary for new developments.Unconsolidated Development CommunitiesAs of December 31, 2022, we had an indirect interest in the following Unconsolidated Development Communities.Unconsolidated Development CommunityCompany ownership percentage# of apartment homesProjected totalcapitalized cost (1)($ millions)ConstructionstartInitial projected or actual occupancyEstimatedcompletion1.AVA Arts District (2)(3)Los Angeles, CA25.0 %475$276 Q3 2020Q3 2023Q4 2023_____________________________(1)Projected total capitalized cost includes all capitalized costs projected to be incurred to develop the respective Unconsolidated Development Community, determined in accordance with GAAP, including land acquisition costs, construction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees and other regulatory fees, as well as costs incurred for first generation commercial tenants such as tenant improvements and leasing commissions. Projected total capitalized cost is the total projected joint venture amount.(2)AVA Arts District is expected to contain 56,000 square feet of commercial space.(3)As of December 31, 2022, we have contributed our equity investment in AVA Arts District of $28,660. The remaining development costs, representing 60% of the total project cost, are expected to be funded by the venture's variable rate construction loan. The venture has drawn $86,664 of the $167,147 maximum borrowing capacity of the construction loan as of December 31, 2022. While we guarantee the construction loan on behalf of the venture, any amounts under the guarantee are obligations of the venture partners in proportion to ownership interest.Unconsolidated Operating CommunitiesAs of December 31, 2022, we had investments in the following unconsolidated real estate entities accounted for under the equity method of accounting, excluding development joint ventures. See Note 5, “Investments,” of the Consolidated Financial Statements included elsewhere in this report, which includes information on the aggregate assets, liabilities and equity, as well as operating results, and our proportionate share of their operating results. For joint ventures holding operating apartment communities as of December 31, 2022, detail of the real estate and associated indebtedness underlying our unconsolidated investments is presented in the following table (dollars in thousands).27 Table of Contents Debt (1)Unconsolidated Real Estate InvestmentsCompanyOwnershipPercentage# ofApartmentHomesTotalCapitalizedCostPrincipal AmountTypeInterestRateMaturityDateNYTA MF Investors LLC1. Avalon Bowery Place I—New York, NY206$214,411 $93,800 Fixed4.01 %Jan 20292. Avalon Bowery Place II—New York, NY9091,236 39,639 Fixed4.01 %Jan 20293. Avalon Morningside—New York, NY (2)295211,471 111,750 Fixed3.55 %Jan 2029/May 20464. Avalon West Chelsea—New York, NY (3)305128,851 66,000 Fixed4.01 %Jan 20295. AVA High Line—New York, NY (3)405122,181 84,000 Fixed4.01 %Jan 2029Total NYTA MF Investors LLC20.0 %1,301 768,150 395,189 3.88 %Other Operating Joint Ventures 1. MVP I, LLC - Avalon at Mission Bay II - San Francisco, CA25.0 %313 129,305 103,000 Fixed3.24 %Jul 20252. Brandywine Apartments of Maryland, LLC - Brandywine - Washington, D.C.28.7 %305 19,383 19,731 Fixed3.40 %Jun 20283. Avalon Alderwood MF Member, LLC - Avalon Alderwood Place - Lynnwood, WA (4)50.0 %328 108,682 — N/AN/AN/ATotal Other Joint Ventures 946 257,370 122,731 3.27 % Total Unconsolidated Investments (5) 2,247 $1,025,520 $517,920 3.73 % _________________________________(1)We have not guaranteed the debt of these unconsolidated investees and bear no responsibility for the repayment unless otherwise disclosed.(2)Borrowing on this community is comprised of two mortgage loans. The interest rate is the weighted average interest rate as of December 31, 2022.(3)Borrowing on this dual-branded community is comprised of a single mortgage loan. This dual-branded community is subject to a leasehold interest which is not included in the total capitalized cost.(4)Development of this community, which contains 284,000 square feet of rentable space, was completed during the year ended December 31, 2022.(5)In addition to leasehold assets, there are net other assets of $49,848 as of December 31, 2022 associated with these unconsolidated real estate investments which are primarily cash and cash equivalents.During 2022, the Archstone Multifamily Partners AC LP (the "U.S. Fund") sold its final three communities containing 671 apartment homes for a sales price of $313,500,000. Our share of the gain in accordance with GAAP was $38,144,000. The U.S. Fund repaid the $115,213,000 of outstanding secured indebtedness at par in advance of the scheduled maturity dates. We have an equity interest of 28.6% in the U.S. Fund and during the year ended December 31, 2022 in conjunction with the final dispositions, achieved a threshold return, resulting in an incentive distribution for our promoted interest based on the returns earned by the U.S. Fund. During the year ended December 31, 2022, we recognized income of $4,690,000 for our promoted interest included in income from investments in unconsolidated entities on the accompanying Consolidated Statements of Comprehensive Income. 28 Table of ContentsDevelopment RightsAt December 31, 2022, we had $179,204,000 in acquisition and related capitalized costs for direct interests in eight land parcels we own. In addition, we had $58,489,000 in capitalized costs (including legal fees, design fees and related overhead costs) related to (i) 27 Development Rights for which we control the land parcel, typically through a conditional agreement or option to purchase or lease the land, as well as (ii) costs incurred for four Development Rights that we expect to construct as additional phases of our existing stabilized operating communities on land we own. Collectively, the land held for development and associated costs for deferred development rights relate to 39 Development Rights for which we expect to develop new apartment communities in the future. The Development Rights range from those beginning design and architectural planning to those that have completed site plans and drawings and can begin construction almost immediately. We estimate that the successful completion of all of these communities would ultimately add approximately 13,312 apartment homes to our portfolio. Substantially all of these apartment homes will offer features like those offered by the communities we currently own.The Development Rights are in different stages of the due diligence and regulatory approval process. The decisions as to which of the Development Rights to invest in, if any, or to continue to pursue once an investment in a Development Right is made, are business judgments that we make after we perform financial, demographic and other analyses. In the event that we do not proceed with a Development Right, we generally would not recover any of the capitalized costs incurred in the pursuit of those communities, unless we were to recover amounts in connection with the sale of land; however, we cannot guarantee a recovery. Pre-development costs incurred in the pursuit of Development Rights, for which future development is not yet considered probable, are expensed as incurred. In addition, if the status of a Development Right changes, making future development no longer probable, any unrecoverable capitalized pre-development costs are charged to expense. During 2022, we incurred a charge of $16,565,000 for expensed transaction, development and other pursuit costs, net of recoveries, which include development pursuits that were not yet probable of future development at the time incurred, or for pursuits that we determined were no longer probable of being developed. This amount includes charges of $10,073,000 primarily related to development opportunities in the Pacific Northwest and Southern California that we determined are no longer probable. You should carefully review Item 1A. “Risk Factors,” for a discussion of the risks associated with Development Rights.Land AcquisitionsWe select land for development and follow established procedures that we believe minimize both the cost and the risks of development. During 2022, we acquired the following land parcels for an aggregate investment of $137,885,000. Estimatednumber ofapartmenthomesProjected totalcapitalizedcost (1)($ millions)Dateacquired1.Avalon Northtown (2)Austin, TX1,427 $429 March 20222.Avalon Durham (3)Durham, NC336 125 March 20223.Avalon PleasantonPleasanton, CA305 191 June 20224.Avalon Annapolis (3)(4)Annapolis, MD508 202 September 20225.Avalon Lake NormanMooresville, NC345 104 October 20226.Kanso Milford (3)Milford, MA162 66 November 2022 Total 3,083 $1,117 ____________________________________(1)Projected total capitalized cost includes all capitalized costs incurred to date (if any) and projected to be incurred to develop the respective community, determined in accordance with GAAP, including land and related acquisition costs, construction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees, allocated development overhead and other regulatory fees, as well as costs incurred for first generation commercial tenants such as tenant improvements and leasing commissions, net of projected proceeds for any planned sales of associated outparcels and other real estate.(2)Land purchased for the expected development of three adjacent operating communities.(3)Construction on this land parcel commenced during 2022.29 Table of Contents(4)Additional parcel of land acquired in 2022 for a current Development Community. The estimated number of apartment homes and projected total capitalized cost represent the amounts for the full Development Community.Disposition ActivityWe sell assets when they do not meet our long-term investment strategy or when real estate markets allow us to realize a portion of the value created over our periods of ownership, and we generally redeploy the proceeds from those sales to develop, redevelop and acquire communities. Pending such redeployment, we will generally use the proceeds from the sale of these communities to reduce amounts outstanding under our Credit Facility or Commercial Paper Program or retain the cash proceeds on our balance sheet until it is redeployed into acquisition, development or redevelopment activity. On occasion, we will set aside the proceeds from the sale of communities into a cash escrow account to facilitate a tax-deferred, like-kind exchange transaction. From January 1, 2022 to January 31, 2023, we sold our interest in nine wholly-owned communities, containing 2,062 apartment homes, with an aggregate gross sales price of $924,450,000.Insurance and Risk of Uninsured LossesWe maintain commercial general liability insurance and property insurance with respect to all of our communities, with insurance policies issued by a combination of third party insurers as well as a wholly-owned captive insurance company. These policies, along with other insurance policies we maintain, have policy specifications, insured and self-insured limits, exclusions and deductibles that we consider commercially reasonable. We utilize a wholly-owned captive insurance company to insure certain types and amounts of risks, which include property damage and resulting business interruption losses, general liability insurance and other construction related liability risks. The captive is utilized to insure other limited levels of risk, which may be in part reinsured by third party insurance. There are, however, certain types of losses (including, but not limited to, losses arising from nuclear liability, pandemic or acts of war) that are not insured, in full or in part, because they are either uninsurable or the cost of insurance makes it, in management’s view, economically impractical. You should carefully review the discussion under Part I, Item 1A. “Risk Factors” of this Form 10-K for a discussion of risks associated with an uninsured property or casualty loss.Our communities are insured for certain property damage and business interruption losses through a combination of community specific insurance policies and/or a master property insurance program which covers the majority of our communities. This master property program provides a $400,000,000 limit for any single occurrence and annually in the aggregate, subject to certain sub-limits and exclusions. Under the master property program, we are subject to various deductibles per occurrence, as well as additional self-insured retentions. In addition to our potential liability for the various policy self-insured retentions and deductibles, our captive insurance company is directly responsible for 100% of the first $25,000,000 of losses (per occurrence) and 10% of the second $25,000,000 of losses (per occurrence) incurred by the master property insurance policy. Our master property insurance program includes coverage for losses resulting from customary perils, including but not limited to wildfires and windstorms. Limits, deductibles, self-insured retentions and coverages may increase or decrease annually during the insurance renewal process, which occurs on different dates throughout the calendar year.Many of our West Coast communities are located within the general vicinity of active earthquake faults. Many of our communities are near, and thus susceptible to, the major fault lines in California, including the San Andreas Fault, the Hayward Fault or other geological faults that are known or unknown. We cannot assure you that an earthquake would not cause damage or losses greater than our current insured levels. We procure property damage and resulting business interruption insurance coverage with a loss limit of $175,000,000 for any single occurrence and in the annual aggregate for losses resulting from earthquakes, subject to deductibles and self-insured retentions. However, for any losses resulting from earthquakes at communities located in California or Washington, the loss limit is $200,000,000 for any single occurrence and in the annual aggregate, subject to deductibles and self-insured retentions. Our Southeast Florida communities could be impacted by significant storm events like hurricanes. We include coverage for losses arising from these types of weather events within our master property insurance program. We cannot assure you that a significant storm event would not cause damage or losses greater than our current insured levels.Our communities and construction sites are insured for third-party liability losses through a combination of community specific insurance policies and/or coverage provided under a master commercial general liability and umbrella/excess insurance program. The master commercial general liability and umbrella/excess insurance policies cover the majority of our communities and construction sites and are subject to certain coverage limitations and exclusions, which we believe are commercially reasonable. After applicable self-insured retentions borne by us, our captive insurance company is directly responsible for the first $2,000,000 of losses (per occurrence) covered by the master general liability insurance policy.30 Table of ContentsJust as with office buildings, transportation systems and government buildings, apartment communities could become targets of terrorism. Our communities are insured for terrorism related losses through the Terrorism Risk Insurance Program Reauthorization Act (“TRIPRA”) program. This coverage extends to most of our casualty exposures (subject to deductibles and insured limits) and certain property insurance policies. We have also purchased private-market insurance for property damage due to terrorism with limits of $600,000,000 per occurrence and in the annual aggregate that includes certain coverages (not covered under TRIPRA) such as domestic-based terrorism. This insurance, often referred to as “non-certified” terrorism insurance, is subject to deductibles, limits and exclusions.An additional consideration for insurance coverage and potential uninsured losses is mold growth or other environmental contamination. Mold growth may occur when excessive moisture accumulates in buildings or on building materials, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. If a significant mold problem arises at one of our communities, we could be required to undertake a costly remediation program to contain or remove the mold from the affected community and could be exposed to other liabilities. For further discussion of the risks and our related prevention and remediation activities, please refer to the discussion under Part I, Item 1A. “Risk Factors - We may incur costs due to environmental contamination or non-compliance” elsewhere in this report. We cannot provide assurance that we will have coverage under our existing policies for property damage or liability to third parties arising as a result of exposure to mold or a claim of exposure to mold at one of our communities.We also maintain other insurance programs that provide coverage for events including but not limited to employee dishonesty, loss of data, and liability associated with management of certain employee benefit plans. These policies are subject to maximum loss limits and include coverage limitations or exclusion that may preclude us from fully recovering. The amount or types of insurance we maintain may not be sufficient to cover all losses and we may change our policy limits, coverages, and self-insured retentions or deductibles at any time.31 Table of ContentsITEM 3. LEGAL PROCEEDINGSThe Company is involved in various legal proceedings that arise in the ordinary course of its business. While the resolutions of these matters cannot be predicted with certainty, the Company does not currently believe that any of these outstanding litigation matters, either individually or in the aggregate, will have a material adverse effect on its financial condition or results of operations.ITEM 4. MINE SAFETY DISCLOSURESNot Applicable.32 Table of ContentsPART IIITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESOur common stock is traded on the NYSE under the ticker symbol AVB. On January 31, 2023 there were 687 holders of record of an aggregate of 139,920,107 shares of our outstanding common stock. The number of holders does not include individuals or entities who beneficially own shares but whose shares are held of record by a broker or clearing agency, but does include each such broker or clearing agency as one record holder.At present, we expect to continue our policy of paying regular quarterly cash dividends. However, the form, timing and/or amount of dividend distributions will be declared at the discretion of the Board of Directors and will depend on actual cash from operations, our financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Code and other factors as the Board of Directors may consider relevant. The Board of Directors may modify our dividend policy from time to time.In February 2023, we announced that our Board of Directors declared a dividend on our common stock for the first quarter of 2023 of $1.65 per share, a 3.8% increase over the Company's prior quarterly dividend of $1.59 per share. The dividend will be payable on April 17, 2023 to all common stockholders of record as of March 31, 2023.Issuer Purchases of Equity SecuritiesPeriod(a)Total Numberof SharesPurchased (1)(b)AveragePrice PaidPer Share(c)Total Number ofShares Purchased asPart of PubliclyAnnounced Plans orPrograms(d)Maximum Number (or Approximate Dollar Value) of Shares that May Yetbe Purchased Underthe Plans or Programs(in thousands) (2)October 1 - October 31, 2022428 $184.19 — $316,148 November 1 - November 30, 2022— $— — $316,148 December 1 - December 31, 2022223 $173.92 — $316,148 Total651 $180.67 — _________________________________(1)Consists of shares surrendered to the Company in connection with exercise of stock options as payment of exercise price, as well as for taxes associated with the vesting of restricted share grants.(2)In July 2020, the Board of Directors approved the 2020 Stock Repurchase Program, under which the Company may acquire shares of its common stock in open market or negotiated transactions up to an aggregate purchase price of $500,000,000. Purchases of common stock under the 2020 Stock Repurchase Program may be exercised from time to time in the Company’s discretion and in such amounts as market conditions warrant. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, market conditions and other corporate liquidity requirements and priorities. The 2020 Stock Repurchase Program does not have an expiration date and may be suspended or terminated at any time without prior notice.Information regarding securities authorized for issuance under equity compensation plans is included in the section entitled Item 12. “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” in this Form 10-K. ITEM 6. [RESERVED]33 Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSManagement's Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help provide an understanding of our business, financial condition and results of operations. This MD&A should be read in conjunction with our Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included elsewhere in this report. This report, including the following MD&A, contains forward-looking statements regarding future events or trends that should be read in conjunction with the factors described under “Forward-Looking Statements” included in this report. Actual results or developments could differ materially from those projected in such statements as a result of the factors described under “Forward-Looking Statements” as well as the risk factors described in Part I, Item 1A. “Risk Factors” of this report.Capitalized terms used without definition have the meanings provided elsewhere in this Form 10-K.Executive Overview2022 Financial HighlightsNet income attributable to common stockholders for the year ended December 31, 2022 was $1,136,775,000, an increase of $132,476,000, or 13.2%, over the prior year. The increase is primarily attributable to an increase in NOI from communities, over the prior year. These amounts were partially offset by an increase in depreciation expense and decrease in gains related to real estate sales in the current year.Same Store NOI attributable to our apartment rental operations, including parking and other ancillary residential revenue ("Residential"), for the year ended December 31, 2022 was $1,540,390,000, an increase of $179,941,000, or 13.2%, over the prior year. The increase was due to an increase in Residential rental revenue of $218,692,000, or 10.9%, partially offset by an increase in Residential property operating expenses of $39,015,000, or 6.0%, over 2021.During 2022, we raised approximately $1,445,710,000 of gross capital through the sale of nine consolidated operating communities, the sale of condominiums at The Park Loggia and other real estate, the issuance of unsecured notes and the settlement of outstanding forward contracts entered into under our current continuous equity program. This amount does not include our share of proceeds from joint venture dispositions. We believe that our current capital structure will continue to provide financial flexibility to access capital on attractive terms.We believe our portfolio management activity through dispositions, development and acquisitions will continue to create long-term value. During 2022, we:•sold nine consolidated apartment communities containing an aggregate of 2,062 apartment homes for $924,450,000;•completed the construction of five consolidated apartment communities containing an aggregate of 1,858 apartment homes for an aggregate total capitalized cost of $692,000,000;•completed the construction of one unconsolidated apartment community containing 328 apartment homes for a total capitalized cost of $110,000,000, or $55,000,000 when including only our 50.0% interest;•started the construction of five consolidated apartment communities containing an aggregate of 1,845 apartment homes, which are expected to be completed for an estimated total capitalized cost of $729,000,000; and•acquired four consolidated apartment communities containing an aggregate of 1,313 apartment homes and 16,000 square feet of commercial space for an aggregate purchase price of $536,200,000.34 Table of ContentsWe believe that our balance sheet strength, as measured by our current level of indebtedness, our current ability to service interest and other fixed charges, and our current moderate use of financial encumbrances (such as secured financing), provide us with adequate access to liquidity from the capital markets. We expect to be able to meet our reasonably foreseeable liquidity needs, as they arise, through a combination of one or more of the following sources: existing cash on hand; operating cash flows; borrowings under our Credit Facility and Commercial Paper Program; secured debt; the issuance of corporate securities (which could include unsecured debt, preferred equity, including amounts through the planned settlement of the outstanding forward contracts to sell 2,000,000 shares of common stock by no later than December 31, 2023 and/or common equity); the sale of apartment communities; or through the formation of joint ventures. See the discussion under "Liquidity and Capital Resources."Communities OverviewAs of December 31, 2022 we owned or held a direct or indirect ownership interest in 294 apartment communities containing 88,475 apartment homes in 12 states and the District of Columbia, of which 18 communities were under development and one community was under redevelopment. We have an indirect interest in nine of the 294 apartment communities which were owned by entities that were not consolidated for financial reporting purposes, including one that is being developed within a joint venture. In addition, we held a direct or indirect ownership interest in Development Rights to develop an additional 39 communities that, if developed as expected, will contain an estimated 13,312 apartment homes.Our real estate investments consist primarily of Current Communities, Development communities, Unconsolidated Development communities and Development Rights. Our Current Communities are further classified as Same Store communities, Other Stabilized communities, Redevelopment communities and Unconsolidated communities.Same Store communities are consolidated communities that were owned and had stabilized occupancy as of the beginning of the prior year, allowing for a meaningful comparison of operating results between years. Other Stabilized communities are generally all other completed consolidated communities that have stabilized occupancy at the beginning of the current year or were acquired during the year. Redevelopment communities are consolidated communities where substantial redevelopment is in progress or is probable to begin during the fiscal year. Unconsolidated communities are communities in which we have an indirect ownership interest through our investment interest in an unconsolidated entity. A more detailed description of our reportable segments and other related operating information can be found in Note 8, “Segment Reporting,” of our Consolidated Financial Statements.Although each of these categories is important to our business, we generally evaluate overall operating, industry and market trends based on the operating results of Same Store communities, for which a detailed discussion can be found in “Results of Operations” as part of our discussion of overall operating results. We evaluate our current and future cash needs and future operating potential based on acquisition, disposition, development, redevelopment and financing activities within Other Stabilized, Redevelopment and Development communities. Discussions related to current and future cash needs and financing activities can be found under "Liquidity and Capital Resources."NOI of our current operating communities is one of the financial measures that we use to evaluate the performance of our communities. NOI is affected by the demand and supply dynamics within our markets, our rental rates and occupancy levels and our ability to control operating costs. Our overall financial performance is also impacted by the general availability and cost of capital and the performance of newly developed, redeveloped and acquired apartment communities.Results of OperationsOur year-over-year operating performance is primarily affected by both overall and individual geographic market conditions and apartment fundamentals and is reflected in changes in Same Store NOI; NOI derived from acquisitions, development completions and development under construction and in lease-up; loss of NOI related to disposed communities; and capital market and financing activity. See also Part I, Item 1A, “Risk Factors.” Discussion of our operating results for 2021 and comparison to 2020 can be found in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Form 10-K filed with the SEC on February 25, 2022. A comparison of our operating results for 2022 and 2021 follows (dollars in thousands).35 Table of ContentsFor the year ended December 31,2022 vs. 2021 20222021$ Change% ChangeRevenue: Rental and other income$2,587,113 $2,291,766 $295,347 12.9 %Management, development and other fees6,333 3,084 3,249 105.4 %Total revenue2,593,446 2,294,850 298,596 13.0 %Expenses: Direct property operating expenses, excluding property taxes509,529 469,123 40,406 8.6 %Property taxes288,960 283,089 5,871 2.1 %Total community operating expenses798,489 752,212 46,277 6.2 %Corporate-level property management and other indirect operating expenses(120,625)(101,730)(18,895)18.6 %Expensed transaction, development and other pursuit costs, net of recoveries(16,565)(3,231)(13,334)412.7 %Interest expense, net(230,074)(220,415)(9,659)4.4 %Loss on extinguishment of debt, net(1,646)(17,787)16,141 (90.7)%Depreciation expense(814,978)(758,596)(56,382)7.4 %General and administrative expense(74,064)(69,611)(4,453)6.4 %Casualty loss— (3,119)3,119 100.0 %Income from investments in unconsolidated entities53,394 38,585 14,809 38.4 %Gain on sale of communities555,558 602,235 (46,677)(7.8)%Gain on other real estate transactions, net5,039 2,097 2,942 140.3 %Net for-sale condominium activity88 (977)1,065 N/A (1)Income before income taxes1,151,084 1,010,089 140,995 14.0 %Income tax expense(14,646)(5,733)(8,913)155.5 %Net income1,136,438 1,004,356 132,082 13.2 %Net loss (income) attributable to noncontrolling interests337 (57)394 N/A (1)Net income attributable to common stockholders$1,136,775 $1,004,299 $132,476 13.2 %_________________________________(1) Percent change is not meaningful.Net income attributable to common stockholders increased $132,476,000, or 13.2%, to $1,136,775,000 in 2022 over 2021, primarily due to increases in NOI from communities in the current year.NOI is considered by management to be an important and appropriate supplemental performance measure to net income because it helps both investors and management to understand the core operations of a community or communities prior to the allocation of any corporate-level or financing-related costs. NOI reflects the operating performance of a community and allows for an easier comparison of the operating performance of individual assets or groups of assets. In addition, because prospective buyers of real estate have different financing and overhead structures, with varying marginal impact to overhead as a result of acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure for determining the value of a real estate asset or group of assets. We define NOI as total property revenue less direct property operating expenses (including property taxes), and excluding corporate-level income (including management, development and other fees), corporate-level property management and other indirect operating expenses, expensed transaction, development and other pursuit costs, net of recoveries, interest expense, net, loss on extinguishment of debt, net, general and administrative expense, income from investments in unconsolidated entities, depreciation expense, income tax expense, casualty loss, gain on sale of communities, gain on other real estate transactions, net, net for-sale condominium activity and net operating income from real estate assets sold or held for sale.NOI does not represent cash generated from operating activities in accordance with GAAP, and NOI should not be considered an alternative to net income as an indication of our performance. NOI should also not be considered an alternative to net cash flow from operating activities, as determined by GAAP, as a measure of liquidity, nor is NOI indicative of cash available to fund cash needs. Residential NOI represents results attributable to our apartment rental operations, including parking and other 36 Table of Contentsancillary residential revenue. Reconciliations of NOI and Residential NOI for the years ended December 31, 2022 and 2021 to net income for each year are as follows (dollars in thousands): For the year ended December 31, 20222021Net income$1,136,438 $1,004,356 Property management and other indirect operating expenses, net of corporate income114,200 98,665 Expensed transaction, development and other pursuit costs, net of recoveries16,565 3,231 Interest expense, net230,074 220,415 Loss on extinguishment of debt, net1,646 17,787 General and administrative expense74,064 69,611 Income from investments in unconsolidated entities(53,394)(38,585)Depreciation expense814,978 758,596 Income tax expense14,646 5,733 Casualty loss— 3,119 Gain on sale of communities(555,558)(602,235)Gain on other real estate transactions, net(5,039)(2,097)Net for-sale condominium activity(88)977 Net operating income from real estate assets sold or held for sale(22,746)(61,105) NOI1,765,786 1,478,468 Commercial NOI (1)(36,144)(25,326)Residential NOI$1,729,642 $1,453,142 _________________________(1)Represents results attributable to the commercial and other non-residential operations at our communities ("Commercial"). The Residential NOI changes for 2022 as compared to 2021 consists of changes in the following categories (dollars in thousands):Full Year 2022Same Store$179,941 Other Stabilized59,954 Development / Redevelopment36,605 Total$276,500 The increase in our Same Store Residential NOI in 2022 is due to an increase in Residential rental revenue of $218,692,000, or 10.9%, partially offset by an increase in property operating expenses of $39,015,000, or 6.0%, over 2021.37 Table of ContentsOur results of operations in future periods may be impacted directly or indirectly by uncertainties such as the lingering effects of the COVID-19 pandemic (the "Pandemic") and the recent increases in inflation. If the financial condition of our residents and commercial tenants deteriorates, and/or regulations that limit our ability to evict residents and tenants continue or are adopted in response to future developments related to the Pandemic, that may result in higher than normal uncollectible lease revenue. The Pandemic may also depress consumer demand for our apartments for a variety of reasons, including (i) if consumers decide to live in markets that are less costly than ours for one or more reasons, such as a decline in their income or remote working arrangements; (ii) consumers who would otherwise rent may seek home ownership; and (iii) ongoing downward pressures on demand for certain types of housing (e.g., corporate apartment homes) or by certain consumers (e.g., students or consumers who require seasonal job-related demand such as in the entertainment industry). Increases in inflation can result in an increase in our operating costs, including utilities and payroll, both at our communities and at the corporate level. Substantially all of our apartment leases are for a term of one year or less. In an inflationary environment, this may allow us to realize increased rents upon renewal of existing leases or the beginning of new leases. Short-term leases generally reduce our risk from the adverse effect of inflation, although these leases also permit residents to leave at the end of their lease term. In addition, inflation could cause our construction costs and cost of other capitalized expenditures to increase, impacting the expected economic return of, and expected operating results for, current and planned development activity.Rental and other income increased $295,347,000, or 12.9%, in 2022 compared to the prior year primarily due to the increased rental revenue from our stabilized wholly-owned communities, discussed below.Consolidated Communities—The weighted average number of occupied apartment homes for consolidated communities increased to 77,319 apartment homes for 2022, as compared to 75,744 homes for 2021. The weighted average monthly rental revenue per occupied apartment home increased to $2,784 for 2022 as compared to $2,518 in 2021.The increase in Same Store rental revenue is due to (i) an increase in Same Store Residential rental revenue of $218,692,000, or 10.9%, for the year ended December 31, 2022, compared to the prior year, and (ii) an increase in Same Store Commercial rental revenue of $3,873,000, or 18.8%, for the year ended December 31, 2022, compared to the prior year.The following table presents the change in Same Store Residential rental revenue, including the attribution of the change between average rental revenue per occupied home and Economic Occupancy for the year ended December 31, 2022 (dollars in thousands).For the year ended December 31,Residential rental revenueAverage monthly rental revenue per occupied homeEconomic Occupancy (1)$ Change% Change% Change% Change202220212022 to 20212022 to 2021202220212022 to 2021202220212022 to 2021New England$343,179 $305,040 $38,139 12.5 %$3,064 $2,744 11.7 %97.0 %96.2 %0.8 %Metro NY/NJ460,774 410,726 50,048 12.2 %3,423 3,048 12.3 %96.4 %96.5 %(0.1)%Mid-Atlantic330,272 307,529 22,743 7.4 %2,297 2,140 7.3 %95.3 %95.2 %0.1 %Southeast Florida38,206 31,644 6,562 20.7 %2,734 2,253 21.3 %95.9 %96.5 %(0.6)%Denver, CO26,845 23,739 3,106 13.1 %2,151 1,896 13.4 %95.8 %96.1 %(0.3)%Pacific Northwest140,384 121,791 18,593 15.3 %2,555 2,218 15.2 %95.2 %95.1 %0.1 %Northern California399,152 368,419 30,733 8.3 %2,860 2,640 8.3 %95.9 %95.9 %— %Southern California485,313 436,545 48,768 11.2 %2,555 2,296 11.3 %96.4 %96.5 %(0.1)% Total Same Store$2,224,125 $2,005,433 $218,692 10.9 %$2,774 $2,504 10.8 %96.1 %96.0 %0.1 %_________________________________(1) Economic Occupancy considers that apartment homes of different sizes and locations within a community have different economic impacts on a community's gross revenue. Economic Occupancy is defined as gross potential revenue less vacancy loss, as a percentage of gross potential revenue. Gross potential revenue is determined by valuing occupied homes at leased rates and vacant homes at market rents. Vacancy loss is determined by valuing vacant units at current market rents.38 Table of ContentsThe following table details the increase in Same Store Residential rental revenue by component for the year ended December 31, 2022, compared to the prior year:For the year endedDecember 31, 2022Residential rental revenueLease rates7.8 %Concessions and other discounts1.9 %Economic Occupancy0.1 %Other rental revenue1.0 %Uncollectible lease revenue (excluding rent relief)(0.1)%Rent relief0.2 %Total Residential rental revenue10.9 %The increase for Same Store Residential rental revenue for the year ended December 31, 2022, compared to the prior year, was impacted by (i) uncollectible lease revenue, net of amounts received from government rent relief programs and (ii) concessions.Same Store uncollectible lease revenue decreased for the year ended December 31, 2022 by $3,556,000. The change in uncollectible lease revenue for the year ended December 31, 2022 was impacted by amounts received from government rent relief programs. Adjusting to remove the impact of rent relief, uncollectible lease revenue as a percentage of Same Store Residential rental revenue decreased to 3.4% in the year ended December 31, 2022 from 3.7% in the year ended December 31, 2021. We recognized $36,778,000 and $31,823,000 from government rent relief programs during the years ended December 31, 2022 and 2021, respectively.During the Pandemic, we increased our use of residential concessions relative to concessions granted prior to 2020. While concessions granted remained slightly elevated relative to periods prior to 2020, concessions for our Same Store communities granted in the year ended December 31, 2022 decreased from the prior year by $31,618,000 to $10,514,000. We amortize concessions on a straight-line basis over the life of the respective leases (generally one year), reducing the income recognized over the lease term. For the year ended December 31, 2022, amortized concessions decreased by $39,932,000 contributing to the increase in revenue as compared to the prior year. The remaining net unamortized balance of Same Store residential concessions as of December 31, 2022 and 2021 was $5,671,000 and $14,081,000, respectively.Management, development and other fees increased $3,249,000, or 105.4%, in 2022 as compared to the prior year, primarily due to the net construction and development fee income for work performed at joint ventures.Direct property operating expenses, excluding property taxes, increased $40,406,000, or 8.6%, in 2022 as compared to the prior year, primarily due to the addition of newly developed and acquired apartment communities, as well as increased operating expenses at our Same Store communities as discussed below.Same Store Residential direct property operating expenses, excluding property taxes, represents substantially all of total Same Store operating expenses for the year ended December 31, 2022. Residential direct property operating expenses, excluding property taxes, increased $33,171,000, or 8.1%, in 2022 as compared to the prior year, primarily due to increased utilities and maintenance costs as well as bad debt associated with resident expense reimbursements.Property taxes increased $5,871,000, or 2.1%, in 2022 as compared to the prior year, primarily due to the addition of newly developed and acquired apartment communities and increased assessments for our stabilized portfolio, partially offset by decreased property taxes from dispositions.Same Store Residential property taxes represents substantially all of total Same Store property taxes for the year ended December 31, 2022. Same Store Residential property taxes increased $5,844,000, or 2.5%, in 2022 as compared to the prior year, primarily due to increased assessments across the portfolio and the expiration of property tax incentive programs at certain of our properties in New York City, partially offset by successful appeals in the current year in excess of the prior year.39 Table of ContentsCorporate-level property management and other indirect operating expenses increased $18,895,000, or 18.6%, for the year ended December 31, 2022 compared to the prior year, primarily due to increased compensation related costs as well as costs related to increased investment in technology and other initiatives in the current year to improve future efficiency in services for residents and prospects.Expensed transaction, development and other pursuit costs, net of recoveries primarily reflect costs incurred for development pursuits not yet considered probable for development, as well as write downs and abandonment of Development Rights and costs related to abandoned acquisition and disposition pursuits and any recoveries of costs incurred. These costs can be volatile, particularly in periods of increased acquisition pursuit activity, periods of economic downturn or when there is limited access to capital, and therefore may vary significantly from year to year. In addition, the timing for potential recoveries will not always align with the timing for expensing an abandoned pursuit. Expensed transaction, development and other pursuit costs, net of recoveries, increased $13,334,000 in 2022 as compared to the prior year. The amount for 2022 includes charges of $10,073,000 primarily related to development opportunities in the Pacific Northwest and Southern California that we determined are no longer probable. Interest expense, net increased $9,659,000, or 4.4%, in 2022 as compared to the prior year. This category includes interest costs offset by capitalized interest pertaining to development and redevelopment activity, amortization of premium/discount on debt, interest income, any mark to market impact from derivatives not in qualifying hedge relationships and the recognition of the GAAP required estimate of future credit losses for the SIP. The increase in 2022 is primarily due to an increase in variable rates on unsecured and secured indebtedness, partially offset by an increase in capitalized interest.Loss on extinguishment of debt, net reflects prepayment penalties, the write-off of unamortized deferred financing costs and premiums/discounts from our debt repurchase and retirement activity, or payments to acquire our outstanding debt at amounts above or below the carrying basis of the debt acquired. The loss of $1,646,000 in 2022 was primarily due to the repayment of secured debt. The loss of $17,787,000 in 2021 was due to the repayments of unsecured debt.Depreciation expense increased $56,382,000, or 7.4%, in 2022 as compared to the prior year, primarily due to the addition of newly developed and acquired apartment communities, partially offset by dispositions.General and administrative expense (“G&A”) increased $4,453,000, or 6.4%, in 2022 as compared to the prior year, primarily due to an increase in compensation related expenses in the current year, partially offset by legal settlement recoveries recognized in the current year.Casualty loss for the year ended December 31, 2021 of $3,119,000 related to damage across several communities in our East Coast markets from severe storms and a fire at an operating community.Income from investments in unconsolidated entities increased $14,809,000 in 2022 as compared to the prior year, primarily due to the gain from the sale of the final three communities in the U.S. Fund and includes the recognition of $4,690,000 for the promoted interest associated with the final U.S. Fund dispositions. The increase for the year ended December 31, 2022 was partially offset by the gain from the sale of the final two communities in the Archstone Multifamily Partners AC JV LP in the prior year.Gain on sale of communities decreased in 2022 as compared to the prior year. The amount of gain realized in a given period depends on many factors, including the number of communities sold, the size and carrying value of the communities sold and the market conditions in the local area. The gains of $555,558,000 and $602,235,000 in 2022 and 2021, respectively, were primarily due to the sale of nine wholly-owned communities in both 2022 and 2021.Gain on other real estate transactions, net represents the impact from the sale of land parcels and other tangible and intangible real estate assets, and increased $2,942,000, or 140.3%, in 2022 over the prior year.Net for-sale condominium activity is a net gain of $88,000 for the year ended December 31, 2022 and a net expense of $977,000 for the year ended December 31, 2021, and is comprised of the net gain before taxes on the sale of condominiums at The Park Loggia and associated marketing, operating and administrative costs. During the year ended December 31, 2022, we sold 40 residential condominiums at The Park Loggia, for gross proceeds of $126,848,000, resulting in a gain in accordance with GAAP of $2,217,000. During the year ended December 31, 2021, we sold 53 residential condominiums at The Park Loggia for gross proceeds of $135,458,000, resulting in a gain in accordance with GAAP of $3,110,000. In addition, we incurred $2,129,000 and $4,087,000 for the years ended December 31, 2022 and 2021, respectively, in marketing, operating and administrative costs.40 Table of ContentsIncome tax expense of $14,646,000 and $5,733,000 for the years ended December 31, 2022 and 2021, respectively, is primarily related to the activity at The Park Loggia and other taxable REIT subsidiary (“TRS”) activity.Non-GAAP Financial Measures — Reconciliation of FFO and Core FFOFFO and FFO adjusted for non-core items, or “Core FFO,” as defined below, are generally considered by management to be appropriate supplemental measures of our operating and financial performance. Consistent with the definition adopted by the Board of Governors of the National Association of Real Estate Investment Trusts® (“Nareit”), we calculate Funds from Operations Attributable to Common Stockholders ("FFO") as net income or loss attributable to common stockholders computed in accordance with GAAP, adjusted for:•gains or losses on sales of previously depreciated operating communities;•cumulative effect of change in accounting principle;•impairment write-downs of depreciable real estate assets;•write-downs of investments in affiliates due to a decrease in the value of depreciable real estate assets held by those affiliates;•depreciation of real estate assets; and•similar adjustments for unconsolidated partnerships and joint ventures, including those from a change in control.FFO can help with the comparison of the operating and financial performance of a real estate company between periods or as compared to different companies because the adjustments such as (i) excluding gains or losses on sales of previously depreciated property or (ii) real estate depreciation may impact comparability between companies as the amount and timing of these or similar items can vary among owners of identical assets in similar condition based on historical cost accounting and useful like estimates. By further adjusting for items that we do not consider part of our core business operations, Core FFO can help with the comparison of our core operating performance year over year. We believe that, in order to understand our operating results, FFO and Core FFO should be considered in conjunction with net income as presented in the Consolidated Statements of Comprehensive Income included elsewhere in this report.We calculate Core FFO as FFO, adjusted for:•joint venture gains (if not adjusted through FFO), non-core costs and promoted interests from partnerships;•casualty and impairment losses or gains, net on non-depreciable real estate;•gains or losses from early extinguishment of consolidated borrowings;•expensed transaction, development and other pursuit costs, net of recoveries;•third-party business interruption insurance proceeds and the related lost NOI that is covered by the expected third party business interruption insurance proceeds;•property and casualty insurance proceeds and legal settlement activity;•gains or losses on sales of assets not subject to depreciation and other investment gains or losses;•advocacy contributions, representing payments to promote our business interests;•hedge ineffectiveness or gains or losses from derivatives not designated as hedges for accounting purposes;•expected credit losses associated with the lending commitments under the SIP;•severance related costs; •executive transition compensation costs;•net for-sale condominium activity, including gains, marketing, operating and administrative costs and imputed carry cost; and•income taxes.FFO and Core FFO do not represent net income in accordance with GAAP, and therefore should not be considered an alternative to net income, which remains the primary measure, as an indication of our performance. In addition, FFO and Core FFO as calculated by other REITs may not be comparable to our calculations of FFO and Core FFO.FFO and Core FFO also do not represent cash generated from operating activities in accordance with GAAP, and therefore should not be considered an alternative to net cash flows from operating activities, as determined by GAAP, as a measure of liquidity. Additionally, it is not necessarily indicative of cash available to fund cash needs. A presentation of GAAP-based cash flow metrics is included in our Consolidated Financial Statements included elsewhere in this report.41 Table of ContentsThe following is a reconciliation of net income attributable to common stockholders to FFO attributable to common stockholders and to Core FFO attributable to common stockholders for the years ended December 31, 2022 and 2021 (dollars in thousands, except per share amounts). For the year ended December 31, 20222021Net income attributable to common stockholders$1,136,775 $1,004,299 Depreciation - real estate assets, including joint venture adjustments810,611 753,755 Distributions to noncontrolling interests48 48 Gain on sale of unconsolidated entities holding previously depreciated real estate(38,144)(23,305)Gain on sale of previously depreciated real estate(555,558)(602,235)Casualty loss on real estate— 3,119 FFO attributable to common stockholders$1,353,732 $1,135,681 Adjusting items:Unconsolidated entity gains, net (1)(8,355)(14,870)Joint venture promote (2)(4,690)— Structured Investment Program loan reserve (3)1,632 — Loss on extinguishment of consolidated debt1,646 17,787 Gain on interest rate contract(229)(2,654)Advocacy contributions 634 59 Executive transition compensation costs1,631 3,010 Severance related costs1,097 313 Expensed transaction, development and other pursuit costs, net of recoveries (4)13,288 1,363 Gain on for-sale condominiums (5)(2,217)(3,110)For-sale condominium marketing, operating and administrative costs (5)2,129 4,087 For-sale condominium imputed carry cost (6)2,306 7,031 Gain on other real estate transactions, net(5,039)(2,097)Legal settlements(2,212)1,139 Income tax expense (7)14,646 5,733 Core FFO attributable to common stockholders$1,369,999 $1,153,472 Weighted average common shares outstanding - diluted139,975,087139,717,399EPS per common share - diluted $8.12 $7.19 FFO per common share - diluted$9.67 $8.13 Core FFO per common share - diluted$9.79 $8.26 _________________________________(1) Amounts consist primarily of net unrealized gains on technology investments.(2) Amount for 2022 is for our recognition of our promoted interest in the U.S. Fund.(3) Amount for 2022 is the expected credit losses associated with the lending commitments under our SIP. The timing and amount of actual losses that will be incurred, if any, is to be determined.(4) Amount for 2022 includes charges of $10,073 primarily related to development opportunities in the Pacific Northwest and Southern California that we determined are no longer probable.(5) The aggregate impact of (i) gain on for-sale condominiums and (ii) for-sale condominium marketing, operating and administrative costs is a net gain of $88 for 2022, and a net expense of $977 for 2021.(6) Represents the imputed carry cost of for-sale residential condominiums at The Park Loggia. We computed this adjustment by multiplying the total capitalized cost of completed and unsold for-sale residential condominiums by our weighted average unsecured debt rate.(7) Amounts are primarily for the recognition of taxes associated with The Park Loggia and other TRS activity.42 Table of ContentsLiquidity and Capital ResourcesWe employ a disciplined approach to our liquidity and capital management. When we source capital, we take into account both our view of the most cost effective alternative available and our desire to maintain a balance sheet that provides us with flexibility. Our principal focus on near-term and intermediate-term liquidity is to ensure we have adequate capital to fund:•development and redevelopment activity in which we are currently engaged or in which we plan to engage;•the minimum dividend payments on our common stock required to maintain our REIT qualification under the Code;•debt service and principal payments either at maturity or opportunistically before maturity;•lending commitments under our SIP;•normal recurring operating and corporate overhead expenses; and•investment in our operating platform, including strategic investments.Factors affecting our liquidity and capital resources are our cash flows from operations, financing activities and investing activities (including dispositions) as well as general economic and market conditions. Cash flows from operations are determined by: operating activities and factors including but not limited to (i) the number of apartment homes currently owned, (ii) rental rates, (iii) occupancy levels, (iv) uncollectible lease revenue levels or interruptions in collections caused by market conditions and (v) operating expenses with respect to apartment homes. The timing and type of capital markets activity in which we engage is affected by changes in the capital markets environment, such as changes in interest rates or the availability of cost-effective capital. Our plans for development, redevelopment, non-routine capital expenditure, acquisition and disposition activity are affected by market conditions and capital availability. We frequently review our liquidity needs, especially in periods with volatile market conditions, as well as the adequacy of cash flows from operations and other expected liquidity sources to meet these needs.We had cash, cash equivalents and cash in escrow of $734,245,000 at December 31, 2022, an increase of $190,457,000 from $543,788,000 at December 31, 2021. The following discussion relates to changes in cash, cash equivalents and cash in escrow due to operating, investing and financing activities, which are presented in our Consolidated Statements of Cash Flows included elsewhere in this report.Operating Activities—Net cash provided by operating activities increased to $1,421,932,000 in 2022 from $1,203,170,000 in 2021, primarily due to increases in rental income.Investing Activities—Net cash used in investing activities totaled $560,419,000 in 2022. The net cash used was primarily due to:•investment of $921,203,000 in the development and redevelopment of communities; •acquisition of four wholly-owned communities for $536,838,000; and•capital expenditures of $174,705,000 for our wholly-owned communities and non-real estate assets.These amounts were partially offset by:•net proceeds from the disposition of nine wholly-owned communities and ancillary real estate of $934,117,000; and•net proceeds from the sale of for-sale residential condominiums of $117,266,000.Financing Activities—Net cash used in financing activities totaled $671,056,000 in 2022. The net cash used was primarily due to:•payment of cash dividends in the amount of $889,607,000; •the repayment of the $100,000,000 variable rate unsecured term loan; and•the mortgage note repayment and principal amortization payments in the amount of $43,332,000.These amounts were partially offset by proceeds from the issuance of unsecured notes in the amount of $348,565,000.43 Table of ContentsCommercial Paper ProgramIn March 2022, we established the Commercial Paper Program. Under the terms of the Commercial Paper Program, we may issue, from time to time, unsecured commercial paper notes with varying maturities of less than one year. Amounts available under the Commercial Paper Program may be issued, repaid and re-issued from time to time, with the maximum aggregate face or principal amount outstanding at any one time not to exceed $500,000,000. The Commercial Paper Program is backstopped by our commitment to maintain available borrowing capacity under the Credit Facility in an amount equal to actual borrowings under the Commercial Paper Program. As of January 31, 2023, we did not have any amounts outstanding under the Commercial Paper Program.Variable Rate Unsecured Credit FacilityIn September 2022, we entered into the Sixth Amended and Restated Revolving Loan Agreement (the “Credit Facility”) with a syndicate of banks, which replaces our prior credit facility dated as of February 28, 2019. The amended and restated Credit Facility (i) increased the borrowing capacity from $1,750,000,000 to $2,250,000,000, (ii) extended the term of the Credit Facility from February 28, 2024 to September 27, 2026, with two six-month extension options available to us, provided we are not in default and upon payment of a $1,406,000 extension fee, (iii) amended certain provisions, notably to reduce the capitalization rate used to derive certain financial covenants from 6.0% to 5.75% and (iv) transitioned the benchmark rate from the London Interbank Offered Rate ("LIBOR") to the Secured Overnight Financing Rate ("SOFR"). We may elect to expand the Credit Facility to $3,000,000,000, provided that one or more banks (from the syndicate or otherwise) voluntarily agree to provide the additional commitment. No member of the syndicate of banks can prohibit the increase, which will only be effective to the extent banks (from the syndicate or otherwise) choose to commit to lend additional funds.The interest rate applicable to borrowings under the Credit Facility is 5.14% at January 31, 2023 and is composed of (i) SOFR, applicable to the period of borrowing for a particular draw of funds from the facility (e.g., one month to maturity, three months to maturity, etc.), plus (ii) the current borrowing spread to SOFR of 0.825% per annum, which consists of a 0.10% SOFR adjustment plus 0.725% per annum, assuming a one month term SOFR borrowing rate. The borrowing spread to SOFR can vary from SOFR plus 0.65% to SOFR plus 1.40% based upon the rating of our unsecured and unsubordinated long-term indebtedness. There is also an annual facility commitment fee of 0.125% of the borrowing capacity under the facility, which can vary from 0.10% to 0.30% based upon the rating of our unsecured and unsubordinated long-term indebtedness. The Credit Facility contains a sustainability-linked pricing component which provides for interest rate margin and commitment fee reductions or increases by meeting or missing targets related to environmental sustainability, specifically greenhouse gas emission reductions, with the adjustment determined annually beginning in July 2023. The Credit Facility also contains a competitive bid option that is available for borrowings of up to 65% of the Credit Facility amount. This option allows banks that are part of the lender consortium to bid to provide us loans at a rate that is lower than the stated pricing provided by the Credit Facility. The competitive bid option may result in lower pricing than the stated rate if market conditions allow.Prior to the amended and restated Credit Facility, our cost of borrowing was comprised of LIBOR plus 0.775% and an annual facility fee at 0.125%, both as determined by our credit ratings.We did not have any borrowings outstanding under the Credit Facility and after taking into account the Commercial Paper Program and $1,914,000 outstanding in letters of credit, we had $2,248,086,000 available under the Credit Facility as of January 31, 2023. We had $48,297,000 outstanding in additional letters of credit unrelated to the Credit Facility as of January 31, 2023.Financial CovenantsWe are subject to financial covenants contained in the Credit Facility and the Commercial Paper Program, Term Loan and the indentures under which our unsecured notes were issued. The principal financial covenants include the following:•limitations on the amount of total and secured debt in relation to our overall capital structure;•limitations on the amount of our unsecured debt relative to the undepreciated basis of real estate assets that are not encumbered by property-specific financing; and•minimum levels of debt service coverage.We were in compliance with these covenants at December 31, 2022.In addition, some of our secured borrowings include yield maintenance, defeasance, or prepayment penalty provisions, which would result in us incurring an additional charge in the event of a full or partial prepayment of outstanding principal before the 44 Table of Contentsscheduled maturity. These provisions in our secured borrowings are generally consistent with other similar types of debt instruments issued during the same time period in which our borrowings were secured.Continuous Equity Offering Program In May 2019, we commenced CEP V under which we may sell (and/or enter into forward sale agreements for the sale of) up to $1,000,000,000 of our common stock from time to time. Actual sales will depend on a variety of factors to be determined, including market conditions, the trading price of our common stock and our determinations of the appropriate funding sources. We engaged sales agents for CEP V who receive compensation of up to 1.5% of the gross sales price for shares sold. We expect that, if entered into, we will physically settle each forward sale agreement on one or more dates prior to the maturity date of that particular forward sale agreement, and to receive aggregate net cash proceeds at settlement equal to the number of shares underlying the particular forward agreement multiplied by the forward sale price. However, we may also elect to cash settle or net share settle a forward sale agreement. In connection with each forward sale agreement, we will pay the forward seller, in the form of a reduced initial forward sale price, a commission of up to 1.5% of the sales prices of all borrowed shares of common stock sold. During 2022 and through January 31, 2023, we had no sales under this program. In October 2022, we settled the outstanding forward contracts entered into in December 2021 under CEP V, selling 68,577 shares of common stock for $229.34 per share and net proceeds of $15,727,000. As of January 31, 2023, we had $705,961,000 remaining authorized for issuance under this program.Forward Equity OfferingIn addition to CEP V, during the year ended December 31, 2022, we completed an underwritten public offering of 2,000,000 shares of common stock for an initial net forward sales price of $247.30 per share, after offering fees and discounts, offered in connection with forward contracts entered into with certain financial institutions acting as forward purchasers. Assuming full physical settlement of the forward contracts, which we expect to occur no later than December 31, 2023, we will receive approximate proceeds of $494,200,000 net of offering fees and discounts and based on the initial forward price. The final proceeds will be determined on the date(s) of settlement and are subject to certain customary adjustments for our dividends and a daily interest factor during the term of the forward contracts.Interest Rate Swap AgreementsDuring the year ended December 31, 2022, related to the issuance of our $350,000,000 unsecured notes due 2033 in November 2022, we terminated $150,000,000 of forward interest swap agreements designated as cash flow hedges of the interest rate variability on the issuance of unsecured notes, receiving a net payment of $26,869,000. We have deferred these amounts in accumulated other comprehensive income (loss) on the accompanying Consolidated Balance Sheets, and are recognizing the impact as a component of interest expense, net, over the term of the respective hedged debt.Stock Repurchase ProgramIn July 2020, our Board of Directors approved the 2020 Stock Repurchase Program. Purchases of common stock under the 2020 Stock Repurchase Program may be exercised at our discretion with the timing and number of shares repurchased depending on a variety of factors including price, corporate and regulatory requirements and other corporate liquidity requirements and priorities. The 2020 Stock Repurchase Program does not have an expiration date and may be suspended or terminated at any time without prior notice. During 2022 and through January 31, 2023, we had no repurchases of shares under this program. As of January 31, 2023, we had $316,148,000 remaining authorized for purchase under this program.Future Financing and Capital Needs—Debt Maturities and Material ObligationsOne of our principal long-term liquidity needs is the repayment of long-term debt at maturity. For both our unsecured and secured notes, a portion of the principal of these notes may be repaid prior to maturity. Early retirement of our unsecured or secured notes could result in gains or losses on extinguishment. If we do not have funds on hand sufficient to repay our indebtedness as it becomes due, it will be necessary for us to refinance or otherwise provide liquidity to satisfy the debt at maturity. This refinancing may be accomplished by uncollateralized private or public debt offerings, equity issuances, additional debt financing that is secured by mortgages on individual communities or groups of communities or borrowings under our Credit Facility or Commercial Paper Program. In addition, to the extent we have amounts outstanding under the Commercial Paper Program, we are obligated to repay the short-term indebtedness at maturity through either current cash on hand or by incurring other indebtedness, including by way of borrowing under our Credit Facility. Although we believe we will have the capacity to meet our currently anticipated liquidity needs, we cannot assure you that capital from additional debt financing or debt or equity offerings will be available or, if available, that they will be on terms we consider satisfactory.45 Table of ContentsThe following debt activity occurred during 2022:•In February 2022, we repaid our $100,000,000 variable rate unsecured term loan at par upon maturity.•In September 2022, we repaid $35,276,000 principal amount of secured fixed rate debt with an effective rate of 6.16% in advance of the October 2047 scheduled maturity, recognizing a loss on debt extinguishment of $1,399,000, composed of prepayment penalties and the non-cash write off of unamortized deferred financing costs.•In December 2022, we issued $350,000,000 principal amount of unsecured notes in a public offering under our existing shelf registration statement for proceeds net of underwriting fees of approximately $346,290,000, before considering the impact of other offering costs. The notes mature in February 2033 and were issued at a 5.00% interest rate, resulting in a 4.37% effective rate including the impact of issuance costs and hedging activity.The following table details our consolidated debt obligations, including the effective interest rate and contractual maturity dates, and principal payments for periodic amortization and maturities for the next five years, excluding our Credit Facility and Commercial Paper Program and amounts outstanding related to communities classified as held for sale, for debt outstanding at December 31, 2022 and 2021 (dollars in thousands). We are not directly or indirectly (as borrower or guarantor) obligated in any material respect to pay principal or interest on the indebtedness of any unconsolidated entities in which we have an equity or other interest, other than as disclosed related to the AVA Arts District construction loan (see "Investments" for further discussion of the construction loan). All-Ininterestrate (1)PrincipalmaturitydateBalance Outstanding (2)Scheduled MaturitiesCommunity12/31/202112/31/202220232024202520262027ThereafterTax-exempt bondsFixed rateAvalon at Chestnut Hill— %Oct-2047(3)$35,770 $— $— $— $— $— $— $— 35,770 — — — — — — — Variable rate Avalon Acton4.70 %Jul-2040(4)45,000 45,000 — — — — — 45,000 Avalon Clinton North5.35 %Nov-2038(4)147,000 147,000 — — — — 700 146,300 Avalon Clinton South5.35 %Nov-2038(4)121,500 121,500 — — — — 600 120,900 Avalon Midtown West5.29 %May-2029(4)88,300 82,700 6,100 6,800 7,300 8,100 8,800 45,600 Avalon San Bruno I5.24 %Dec-2037(4)62,350 60,950 2,200 2,300 2,400 2,500 2,800 48,750 464,150 457,150 8,300 9,100 9,700 10,600 12,900 406,550 Conventional loans Fixed rate $250 million unsecured notes3.00 %Mar-2023250,000 250,000 250,000 — — — — — $350 million unsecured notes4.30 %Dec-2023350,000 350,000 350,000 — — — — — $300 million unsecured notes3.66 %Nov-2024300,000 300,000 — 300,000 — — — — $525 million unsecured notes3.55 %Jun-2025525,000 525,000 — — 525,000 — — — $300 million unsecured notes3.62 %Nov-2025300,000 300,000 — — 300,000 — — — $475 million unsecured notes3.35 %May-2026475,000 475,000 — — — 475,000 — — $300 million unsecured notes3.01 %Oct-2026300,000 300,000 — — — 300,000 — — $350 million unsecured notes3.95 %Oct-2046350,000 350,000 — — — — — 350,000 $400 million unsecured notes3.50 %May-2027400,000 400,000 — — — — 400,000 — $300 million unsecured notes4.09 %Jul-2047300,000 300,000 — — — — — 300,000 $450 million unsecured notes3.32 %Jan-2028450,000 450,000 — — — — — 450,000 $300 million unsecured notes3.97 %Apr-2048300,000 300,000 — — — — — 300,000 $450 million unsecured notes3.66 %Jun-2029450,000 450,000 — — — — — 450,000 $700 million unsecured notes2.69 %Mar-2030700,000 700,000 — — — — — 700,000 $600 million unsecured notes2.65 %Jan-2031600,000 600,000 — — — — — 600,000 $700 million unsecured notes2.16 %Jan-2032700,000 700,000 — — — — — 700,000 $400 million unsecured notes2.03 %Dec-2028400,000 400,000 — — — — — 400,000 $350 million unsecured notes4.37 %Feb-2033— 350,000 — — — — — 350,000 Avalon Walnut Creek4.00 %Jul-20664,161 4,327 — — — — — 4,327 eaves Los Feliz3.68 %Jun-202741,400 41,400 — — — — 41,400 — 46 Table of Contents All-Ininterestrate (1)PrincipalmaturitydateBalance Outstanding (2)Scheduled MaturitiesCommunity12/31/202112/31/202220232024202520262027Thereaftereaves Woodland Hills3.67 %Jun-2027111,500 111,500 — — — — 111,500 — Avalon Russett3.77 %Jun-202732,200 32,200 — — — — 32,200 — Avalon San Bruno III2.38 %Mar-202751,000 51,000 — — — — 51,000 — Avalon Cerritos3.35 %Aug-202930,250 30,250 — — — — — 30,250 7,420,511 7,770,677 600,000 300,000 825,000 775,000 636,100 4,634,577 Variable rate Term Loan - $100 million— %Feb-2022(5)100,000 — — — — — — — Term Loan - $150 million5.42 %Feb-2024150,000 150,000 — 150,000 — — — — 250,000 150,000 — 150,000 — — — — Total indebtedness - excluding Credit Facility and Commercial Paper$8,170,431 $8,377,827 $608,300 $459,100 $834,700 $785,600 $649,000 $5,041,127 _________________________________(1)Rates are as of December 31, 2022 and include credit enhancement fees, facility fees, trustees’ fees, the impact of interest rate hedges, offering costs, mark to market amortization and other fees.(2)Balances outstanding represent total amounts due at maturity, and exclude deferred financing costs and debt discount for the unsecured notes of $47,695 and $50,606 as of December 31, 2022 and 2021, respectively, deferred financing costs and debt discount associated with secured notes of $14,087 and $16,278 as of December 31, 2022 and 2021, respectively, as reflected on our Consolidated Balance Sheets included elsewhere in this report.(3)During 2022, we repaid this borrowing in advance of its scheduled maturity date.(4)Financed by variable rate debt, but interest rate is capped through an interest rate protection agreement.(5)During 2022, we repaid this borrowing at its scheduled maturity date.In addition to consolidated debt, we have scheduled contractual obligations associated with (i) ground leases for land underlying current operating or development communities and commercial and parking facilities and (ii) office leases for our corporate headquarters and regional offices of $15,905,000 for 2023, $15,631,000 for 2024 and $361,248,000 thereafter. Future Financing and Capital Needs—Portfolio and Capital Markets ActivityWe invest in various real estate and real estate related investments, which include (i) the acquisition, development and redevelopment of communities both wholly-owned and through the formation of joint ventures, (ii) other indirect investments in real estate through the SIP, all as further discussed below and (iii) investments in other real estate-related ventures through direct and indirect investments in property technology and environmentally focused companies and investment management funds.In 2023, we expect to meet our liquidity needs from one or more of a variety of internal and external sources, which may include (i) the settlement of the outstanding forward equity contracts to sell 2,000,000 shares of our common stock, (ii) real estate dispositions, (iii) cash balances on hand as well as cash generated from our operating activities, (iv) borrowing capacity under the Credit Facility, (v) borrowings under the Commercial Paper Program and (vi) secured and unsecured debt financings. Additional sources of liquidity in 2023 may include the issuance of common and preferred equity, including the issuance of shares of our common stock under CEP V. Our ability to obtain additional financing will depend on a variety of factors, such as market conditions, the general availability of credit, the overall availability of credit to the real estate industry, our credit ratings and credit capacity, as well as the perception of lenders regarding our long or short-term financial prospects.Before beginning new construction or reconstruction activity in 2023, including activity related to communities owned by unconsolidated joint ventures, we plan to source sufficient capital to complete these undertakings, although we cannot assure you that we will be able to obtain such financing. In the event that financing cannot be obtained, we may abandon Development Rights, write off associated pre-development costs that were capitalized and/or forego reconstruction activity. In such instances, we will not realize the increased revenues and earnings that we expected from such Development Rights or reconstruction activity and significant losses could be incurred.47 Table of ContentsFrom time to time we use joint ventures to hold or develop individual real estate assets. We generally employ joint ventures to mitigate asset concentration or market risk and secondarily as a source of liquidity. We may also use joint ventures related to mixed-use land development opportunities and new markets where our partners bring development and operational expertise and/or experience to the venture. Each joint venture or partnership agreement has been individually negotiated, and our ability to operate and/or dispose of a community in our sole discretion may be limited to varying degrees depending on the terms of the joint venture or partnership agreement. We cannot assure you that we will achieve our objectives through joint ventures.In addition, we may invest, through mezzanine loans or other preferred equity investments, in multifamily development projects being undertaken by third parties. In these cases, we do not expect to acquire the underlying real estate but rather to earn a return on our investment (through interest or fixed rate preferred equity returns) and a return of the invested capital generally following completion of construction either on or before a set due date.In evaluating our allocation of capital within our markets, we sell assets that do not meet our long-term investment criteria or when capital and real estate markets allow us to realize a portion of the value created over our ownership periods and redeploy the proceeds from those sales to develop and redevelop communities. Because the proceeds from the sale of communities may not be immediately redeployed into revenue-generating assets that we develop, redevelop or acquire, the immediate effect of a sale of a community for a gain is to increase net income, but reduce future total revenues, total expenses and NOI until such time as the proceeds have been redeployed into revenue generating assets. We believe that the temporary absence of future cash flows from communities sold will not have a material impact on our ability to fund future liquidity and capital resource needs.InvestmentsWe invest in consolidated real estate entities, unconsolidated investments in real estate ventures and direct and indirect investments in property technology and environmentally focused companies through investment management funds. Consolidated InvestmentsDuring the year ended December 31, 2022, we acquired the following communities containing 16,000 square feet of commercial space (dollars in thousands). See Note 5, "Investments," of the Consolidated Financial Statements included elsewhere in this report for further discussion. Community NameLocationApartmenthomesPurchase priceAvalon FlatironsLafayette, CO207 $95,000 Waterford CourtAddison, TX196 69,500 Avalon Miramar Park PlaceMiramar, FL650 295,000 Avalon Highland CreekCharlotte, NC260 76,700 Total acquisitions1,313 $536,200 During the year ended December 31, 2022, we sold nine wholly-owned communities containing 2,062 apartment homes (dollars in thousands). See Note 6, "Real Estate Disposition Activities," of the Consolidated Financial Statements included elsewhere in this report for further discussion.Community NameLocationPeriodof saleApartmenthomesGrosssales priceGain on dispositionAvalon West Long BranchWest Long Branch, NJQ122180 $75,000 $56,434 Avalon OssiningOssining, NYQ122168 70,000 40,512 Avalon East NorwalkNorwalk, CTQ122240 90,000 51,762 Avalon Green I/Avalon Green II/Avalon Green IIIElmsford, NYQ322617 306,000 196,466 Avalon Del Mar StationPasadena, CAQ322347 172,300 77,141 Avalon SharonSharon, MAQ322156 65,650 44,355 Avalon Park CrestTysons Corner, VAQ422354 145,500 88,156 Total asset sales2,062 $924,450 $554,826 48 Table of ContentsUnconsolidated InvestmentsDuring the year ended December 31, 2022, we had the following investment activity related to our unconsolidated real estate and property technology and environmentally focused investments. See Note 5, "Investments," of the Consolidated Financial Statements included elsewhere in this report for further discussion. •The U.S. Fund sold its final three communities for $313,500,000. Our proportionate share of the gain in accordance with GAAP was $38,144,000. The U.S. Fund repaid the $115,213,000 of outstanding secured indebtedness at par in advance of the scheduled maturity dates. In conjunction with the final dispositions, we achieved a threshold return resulting in an incentive distribution for the promoted interest based on the returns earned by the U.S. Fund. During the year ended December 31, 2022, we recognized income of $4,690,000 for the promoted interest, which is reported as a component of income from investments in unconsolidated entities on the accompanying Consolidated Statements of Comprehensive Income.•Arts District Joint Venture was formed to develop, own, and operate AVA Arts District, an apartment community located in Los Angeles, CA, which is currently under construction and expected to contain 475 apartment homes and 56,000 square feet of commercial space when completed. We have a 25% ownership interest in the venture. As of December 31, 2022, excluding costs incurred in excess of equity in the underlying net assets of the venture, we have an equity investment of $28,660,000 in the venture. The remaining development costs, representing 60.0% of the total project cost, are expected to be funded by the venture's variable rate construction loan. The venture has drawn $86,664,000 of $167,147,000 maximum borrowing capacity of the construction loan as of December 31, 2022. While we guarantee the construction loan on behalf of the venture, any amounts due under the guarantee are obligations of the venture partners in proportion to ownership interest.•Avalon Alderwood MF Member, LLC (“Avalon Alderwood Place”) was formed to develop, own, and operate Avalon Alderwood Place, an apartment community located in Lynnwood, WA, which completed development in 2022 and contains 328 apartment homes. We have a 50% ownership interest in the venture. As of December 31, 2022, we have an equity investment of $54,938,000 in the venture.•We invested $18,714,000 in various property technology and environmentally focused companies directly and indirectly through investment management funds during the year ended December 31, 2022. As of December 31, 2022, we have $34,299,000 of remaining equity commitments to contribute to these investment management funds, with the timing and amount for these commitments to be fulfilled dependent on if, and when, investment opportunities are identified by the respective funds. During the year ended December 31, 2022, we recognized income and unrealized gains of $8,315,000 related to these investments, included as a component of income from investments in unconsolidated entities on the Consolidated Statements of Comprehensive Income. Structured Investment ProgramDuring the year ended December 31, 2022, we entered into commitments under the SIP in our existing markets for three mezzanine loans of up to $92,375,000 in the aggregate. The mezzanine loans have a weighted average rate of return of 9.8%, and mature at various dates on or before June 2026. As of January 31, 2023, we have funded $34,046,000 of these commitments. See Note 5, "Investments," of the Consolidated Financial Statements included elsewhere in this report.You should carefully review Part I, Item 1A. "Risk Factors" of this Form 10-K for a discussion of the risks associated with our investment activity.Forward-Looking StatementsThis Form 10-K contains “forward-looking statements” as that term is defined under the Private Securities Litigation Reform Act of 1995. You can identify forward-looking statements by our use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” “project,” “plan,” “may,” “shall,” “will,” "pursue" and other similar expressions in this Form 10-K, that predict or indicate future events and trends and that do not report historical matters. These statements include, among other things, statements regarding our intent, belief or expectations with respect to:•the impact of the Pandemic on our business, results of operations and financial condition;•our potential development, redevelopment, acquisition or disposition of communities;•the timing and cost of completion of apartment communities under construction, reconstruction, development or redevelopment;49 Table of Contents•the timing of lease-up, occupancy and stabilization of apartment communities;•the timing and net sales proceeds of condominium sales;•the pursuit of land on which we are considering future development;•the anticipated operating performance of our communities;•cost, yield, revenue, NOI and earnings estimates;•the impact of landlord-tenant laws and rent regulations;•our expansion into new markets;•our declaration or payment of dividends;•our joint venture and discretionary fund activities;•our policies regarding investments, indebtedness, acquisitions, dispositions, financings and other matters;•our qualification as a REIT under the Code;•the real estate markets in Metro New York/New Jersey, Northern and Southern California, Denver, Colorado, Southeast Florida, Dallas and Austin, Texas and Charlotte and Raleigh-Durham, North Carolina, and markets in selected states in the Mid-Atlantic, New England and Pacific Northwest regions of the United States and in general;•the availability of debt and equity financing;•interest rates;•general economic conditions, including the potential impacts from current economic conditions, including rising interest rates and general price inflation, and the Pandemic; •trends affecting our financial condition or results of operations;•adverse regulatory developments that may affect us; and•the impact of legal proceedings.We cannot assure the future results or outcome of the matters described in these statements; rather, these statements merely reflect our current expectations of the approximate outcomes of the matters discussed. We do not undertake a duty to update these forward-looking statements, and therefore they may not represent our estimates and assumptions after the date of this report. You should not rely on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, some of which are beyond our control. These risks, uncertainties and other factors may cause our actual results, performance or achievements to differ materially from the anticipated future results, performance or achievements expressed or implied by these forward-looking statements. You should carefully review the discussion under Item 1A. “Risk Factors” in this report for further discussion of risks associated with forward-looking statements.Risks and uncertainties that might cause such differences include those related to the Pandemic, including, among other factors, (i) the Pandemic's effect on the multifamily industry and the general economy, including from measures taken by businesses and the government, such as governmental limitations on the ability of multifamily owners to evict residents who are delinquent in the payment of their rent and (ii) the preferences of consumers and businesses for living and working arrangements both during and after the Pandemic. In addition, the effects of the Pandemic are likely to heighten the following risks, which we routinely face in our business.Some of the factors that could cause our actual results, performance or achievements to differ materially from those expressed or implied by these forward-looking statements include, but are not limited to, the following:•we may fail to secure development opportunities due to an inability to reach agreements with third parties to obtain land at attractive prices or to obtain desired zoning and other local approvals;•we may abandon or defer development opportunities for a number of reasons, including changes in local market conditions which make development less desirable, increases in costs of development, increases in the cost of capital or lack of capital availability, resulting in losses;•construction costs of a community may exceed our original estimates;•we may not complete construction and lease-up of communities under development or redevelopment on schedule, resulting in increased interest costs and construction costs and a decrease in our expected rental revenues;•the timing and net proceeds of condominium sales at The Park Loggia may not equal our current expectations;•occupancy rates and market rents may be adversely affected by competition and local economic and market conditions which are beyond our control;•financing may not be available on favorable terms or at all, and our cash flows from operations and access to cost effective capital may be insufficient for the development of our pipeline, which could limit our pursuit of opportunities;•the impact of new landlord-tenant laws and rent regulations may be greater than we expect;•our cash flows may be insufficient to meet required payments of principal and interest, and we may be unable to refinance existing indebtedness or the terms of such refinancing may not be as favorable as the terms of existing indebtedness;50 Table of Contents•we may be unsuccessful in our management of joint ventures and the REIT vehicles that are used with certain joint ventures; •laws and regulations implementing rent control or rent stabilization, or otherwise limiting our ability to increase rents, charge fees or evict tenants, may impact our revenue or increase our costs;•our expectations, estimates and assumptions as of the date of this filing regarding legal proceedings are subject to change; •the possibility that we may choose to pay dividends in our stock instead of cash, which may result in stockholders having to pay taxes with respect to such dividends in excess of the cash received, if any; and•investments made under the SIP in either mezzanine debt or preferred equity of third-party multifamily development may not be repaid as expected or the development may not be completed on schedule, which could require us to engage in litigation, foreclosure actions, and/or first party project completion to recover our investment, which may not be recovered in full or at all in such event.Critical Accounting Policies and EstimatesThe preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, or different assumptions were made, it is possible that different accounting policies would have been applied, resulting in different financial results or a different presentation of our financial statements. Below is a discussion of the accounting policies that we consider critical to an understanding of our financial condition and operating results that may require complex or significant judgment in their application or require estimates about matters which are inherently uncertain. A discussion of our significant accounting policies, including further discussion of the accounting policies described below, can be found in Note 1, “Organization, Basis of Presentation and Significant Accounting Policies,” of our Consolidated Financial Statements.Cost CapitalizationWe capitalize costs during the development of assets. Capitalization begins when we determine that development of a future asset is probable and continues until the asset, or a portion of the asset, is delivered and is ready for its intended use. For redevelopment efforts, we capitalize costs either (i) in advance of taking apartment homes out of service when significant renovation of the common area has begun and continue until the redevelopment is completed, or (ii) when an apartment home is taken out of service for redevelopment and continue until the redevelopment is completed and the apartment home is available for a new resident. Rental income and operating expenses incurred during the initial lease-up or post-redevelopment lease-up period are fully recognized in earnings as they accrue. During the development and redevelopment efforts we capitalize all direct costs and indirect costs which have been incurred as a result of the development and redevelopment activities. These costs include interest and related loan fees, property taxes as well as other direct and indirect costs. Interest is capitalized for any project-specific financing, as well as for general corporate financing to the extent of our aggregate investment in the projects. Indirect project costs, which include personnel and office and administrative costs that are clearly associated with our development and redevelopment efforts, are also capitalized. Capitalized indirect costs associated with our development and redevelopment activities are comprised primarily of compensation related costs for associates dedicated to our development and redevelopment efforts and total $50,039,000 and $46,263,000 for 2022 and 2021, respectively. The estimation of the direct and indirect costs to capitalize as part of our development and redevelopment activities requires judgment and, as such, we believe cost capitalization to be a critical accounting estimate.There may be a change in our operating expenses in the event that there are changes in accounting guidance governing capitalization or changes to our levels of development or redevelopment activity. If changes in the accounting guidance limit our ability to capitalize costs or if we reduce our development and redevelopment activities without a corresponding decrease in indirect project costs, there may be an increase in our operating expenses. 51 Table of ContentsWe capitalize pre-development costs incurred in pursuit of Development Rights. These costs include legal fees, design fees and related overhead costs. Future development of these pursuits is dependent upon various factors, including zoning and regulatory approval, rental market conditions, construction costs and availability of capital. Pre-development costs incurred for pursuits for which future development is not yet considered probable are expensed as incurred. In addition, if the status of a Development Right changes, making future development no longer probable, any capitalized pre-development costs are written off with a charge to expense.Due to the subjectivity in determining whether a pursuit will result in the development of an apartment community, and therefore should be capitalized, the accounting for pursuit costs is a critical accounting estimate. As of December 31, 2022, capitalized pursuit costs associated with Development Rights totaled $58,489,000.Abandoned Pursuit Costs & Asset ImpairmentWe evaluate our direct and indirect investments in real estate and other long-lived assets for impairment when potential indicators of impairment exist. If events or circumstances indicate that the carrying amount of a property may not be recoverable, we assess its recoverability by comparing the carrying amount of the property to its estimated undiscounted future cash flows. If the carrying amount exceeds the aggregate undiscounted future cash flows, we recognize an impairment loss to the extent the carrying amount exceeds the estimated fair value of the property. We assess land held for development for impairment if our intent changes with respect to the development of the land. We evaluate our unconsolidated investments for impairment, considering both the carrying value of the investment, estimated expected proceeds that it would receive if the entity were dissolved and the net assets were liquidated, as well as our proportionate share of any impairment of assets held by unconsolidated investments.The assessment of impairment can involve subjectivity in determining if indicators are present and in estimating the future undiscounted cash flows or the fair value of an asset. Estimates of the undiscounted cash flows are sensitive to significant assumptions including future rental revenues, operating expenses, and our intent and ability to hold the related asset, which could be impacted by our expectations about the future.We expense costs related to abandoned pursuits, which include the abandonment of Development Rights and disposition pursuits. These costs can vary greatly, and the costs incurred in any given period may be significantly different in future years. Our focus on value creation through real estate development presents an impairment risk in the event of a future deterioration of the real estate and/or capital markets or a decision by us to reduce or cease development. We cannot predict the occurrence of future events that may cause an impairment assessment to be performed, or the likelihood of any future impairment charges, if any. You should also review Item 1A. “Risk Factors” in this Form 10-K.52 Table of ContentsITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are exposed to market risks from our financial instruments primarily from changes in market interest rates. Our financial instruments do not expose us to significant risk from foreign currency exchange rates or commodity or equity prices. We monitor interest rate risk as an integral part of our overall risk management, which recognizes the unpredictability of financial markets and seeks to reduce the potentially adverse effect on our results of operations. Our operating results are affected by changes in interest rates, primarily in short-term SOFR and the SIFMA index as a result of borrowings under our Credit Facility and Commercial Paper Program, outstanding bonds and unsecured notes with variable interest rates. In addition, the fair value of our fixed rate unsecured and secured notes are impacted by changes in market interest rates.We currently use interest rate protection agreements in the form of interest rate cap agreements for our risk management objectives, as well as for compliance with the requirements of certain lenders, and not for trading or speculative purposes. In addition, we may use interest rate swap agreements for our risk management objectives. During the year ended December 31, 2022, in connection with the issuance of our $350,000,000 unsecured notes due 2033 in November 2022, we terminated $150,000,000 of forward interest swap agreements designated as cash flow hedges of the interest rate variability on the issuance of unsecured notes, receiving a net payment of $26,869,000. In addition, we have interest rate caps that serve to effectively limit the amount of interest rate expense we would incur on a floating rate borrowing. Further discussion of the financial instruments impacted and our exposure is presented below.As of December 31, 2022 and 2021, we had $607,150,000 and $714,150,000, respectively, in variable rate debt outstanding, with no amounts outstanding under our Credit Facility or Commercial Paper Program. If interest rates on the variable rate debt had been 100 basis points higher throughout 2022 and 2021, our annual interest incurred would have increased by approximately $6,850,000 and $7,716,000, respectively, based on balances outstanding during the applicable years.Because the counterparties providing the interest rate cap and swap agreements are major financial institutions which have an A or better credit rating by the Standard & Poor's Ratings Group, we do not believe there is exposure at this time to a default by a counterparty provider.In addition, changes in interest rates affect the fair value of our fixed rate debt, computed using quoted market prices for our unsecured notes or a discounted cash flow model for our secured notes, considering our current market yields, which impacts the fair value of our aggregate indebtedness. Debt securities and notes payable (including amounts outstanding under our Credit Facility and Commercial Paper Program) with an aggregate principal amount outstanding of $8,377,827,000 at December 31, 2022 had an estimated aggregate fair value of $7,207,272,000 at December 31, 2022. Contractual fixed rate debt represented $6,887,811,000 of the fair value at December 31, 2022. If interest rates had been 100 basis points higher as of December 31, 2022, the fair value of this fixed rate debt would have decreased by approximately $463,553,000.
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+ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following is a discussion and analysis of the financial condition of AbbVie Inc. (AbbVie or the company). This commentary should be read in conjunction with the Consolidated Financial Statements and accompanying notes appearing in Item 8, "Financial Statements and Supplementary Data." This section of Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in “Management's Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021.EXECUTIVE OVERVIEWCompany OverviewAbbVie is a global, diversified research-based biopharmaceutical company positioned for success with a comprehensive product portfolio that has leadership positions across immunology, oncology, aesthetics, neuroscience and eye care. AbbVie uses its expertise, dedicated people and unique approach to innovation to develop and market advanced therapies that address some of the world’s most complex and serious diseases.AbbVie's products are generally sold worldwide directly to wholesalers, distributors, government agencies, health care facilities, specialty pharmacies and independent retailers from AbbVie-owned distribution centers and public warehouses. Certain products (including aesthetic products and devices) are also sold directly to physicians and other licensed healthcare providers. In the United States, AbbVie distributes pharmaceutical products principally through independent wholesale distributors, with some sales directly to retailers, pharmacies, patients or other customers. Outside the United States, AbbVie sells products primarily to wholesalers or through distributors, and depending on the market works through largely centralized national payers system to agree on reimbursement terms. Certain products are co-marketed or co-promoted with other companies. AbbVie operates as a single global business segment and has approximately 50,000 employees. 2022 Financial ResultsAbbVie's strategy has focused on delivering strong financial results, maximizing the benefits of the Allergan acquisition, advancing and investing in its pipeline and returning value to shareholders while ensuring a strong, sustainable growth business over the long term. The company's financial performance in 2022 included delivering worldwide net revenues of $58.1 billion, operating earnings of $18.1 billion, diluted earnings per share of $6.63 and cash flows from operations of $24.9 billion. Worldwide net revenues increased by 3% on a reported basis and 5% on a constant currency basis, reflecting growth across its immunology, neuroscience and aesthetics portfolios.Diluted earnings per share in 2022 was $6.63 and included the following after-tax costs: (i) $6.4 billion related to the amortization of intangible assets; (ii) $2.8 billion for the change in fair value of contingent consideration liabilities; (iii) $2.0 billion for charges related to litigation matters; (iv) $766 million of acquisition and integration expenses; and (v) $604 million related to intangible asset impairment. These costs were partially offset by an after-tax gain of $126 million related to the divestiture of Pylera and a benefit of $26 million related to certain tax items. Additionally, financial results reflected continued funding to support all stages of AbbVie’s pipeline assets and continued investment in AbbVie’s on-market brands.Following the closing of the Allergan acquisition in 2020, AbbVie implemented an integration plan designed to reduce costs, integrate and optimize the combined organization. As a result of the successful execution of the integration plan, AbbVie realized $2.5 billion of annual cost synergies in 2022.To achieve these integration objectives, AbbVie incurred total cumulative charges of $2.3 billion through 2022. These costs consisted of severance and employee benefit costs (cash severance, non-cash severance, including accelerated equity award compensation expense, retention and other termination benefits) and other integration expenses.2022 Form 10-K | 32 Recent Global EventsRussia/UkraineIn response to the military conflict between Russia and Ukraine, the United States and other North Atlantic Treaty Organization member states, as well as certain non-member states, announced targeted economic sanctions and export controls on Russia and Belarus. These include restrictions on the export and transfer of products containing certain toxins, including Botox, to Russia and Belarus. However, AbbVie is not prohibited to continue the sale of essential pharmaceutical products to help ensure patients receive an uninterrupted supply of their medicines. In March 2022, AbbVie announced the suspension of operations for all aesthetics products in Russia. In April 2022, AbbVie also announced that all profits from the sales of essential medicines in Russia will be donated to support direct humanitarian relief efforts in Ukraine. While the company’s operations in Russia, Belarus and Ukraine are not significant, if the conflict escalates and results in broader economic and political concerns, AbbVie’s business could be adversely impacted.Impact of the Coronavirus Disease 2019 (COVID-19)In response to COVID-19, AbbVie continues to closely manage manufacturing and supply chain resources around the world to help ensure that patients continue to receive an uninterrupted supply of their medicines. Clinical trial sites are being monitored locally to protect the safety of study participants, staff and employees. While the impact of COVID-19 on AbbVie's operations to date has not been material, AbbVie continues to experience lower new patient starts in certain products and markets. AbbVie expects this matter could continue to negatively impact its results of operations throughout the duration of the pandemic. The extent to which COVID-19 may impact AbbVie's financial condition and results of operations remains uncertain and is dependent on numerous evolving factors, including the measures being taken by authorities to mitigate against the spread of COVID-19, the emergence of new variants and the effectiveness of vaccines and therapeutics.2023 Strategic ObjectivesAbbVie's mission is to discover and develop innovative medicines and products that solve serious health issues today and address the medical challenges of tomorrow while achieving top-tier financial performance through outstanding execution. AbbVie intends to execute its strategy and advance its mission in a number of ways, including: (i) maximizing the benefits of a diversified revenue base with multiple long-term growth drivers; (ii) leveraging AbbVie's commercial strength and international infrastructure across therapeutic areas and ensuring strong commercial execution of new product launches; (iii) continuing to invest in and expand its pipeline in support of opportunities in immunology, oncology, aesthetics, neuroscience and eye care as well as continued investment in key on-market products; (iv) generating substantial operating cash flows to support investment in innovative research and development, and return cash to shareholders via a strong and growing dividend while also reducing debt. In addition, AbbVie anticipates several regulatory submissions and data readouts from key clinical trials in the next 12 months.AbbVie expects to achieve its strategic objectives through:•Skyrizi and Rinvoq revenue growth driven by increasing market share and indication expansion.•Advancing our hematologic oncology portfolio by increasing Venclexta market share and new indications, strong commercial execution of new product launches and effectively managing market and competitive challenges impacting Imbruvica. •Continuing investment in the global expansion of aesthetics and increasing market penetration of Botox and Juvederm Collection.•Neuroscience revenue growth driven by Vraylar, Botox Therapeutic, Ubrelvy and Qulipta.•Maximizing AbbVie's existing eye care portfolio. •Effectively managing the impact of Humira biosimilar erosion. •The favorable impact of pipeline products and indications recently approved or currently under regulatory review where approval is expected in 2023. These products are described in greater detail in the section labeled "Research and Development" included as part of this Item 7.33 | 2022 Form 10-K Research and DevelopmentResearch and innovation are the cornerstones of AbbVie's business as a global biopharmaceutical company. AbbVie's long-term success depends to a great extent on its ability to continue to discover and develop innovative products and acquire or collaborate on compounds currently in development by other biotechnology or pharmaceutical companies.AbbVie's pipeline currently includes over 80 compounds, devices or indications in development individually or under collaboration or license agreements and is focused on such important specialties as immunology, oncology, aesthetics, neuroscience and eye care. Of these programs, approximately 50 are in mid- and late-stage development.The following sections summarize transitions of significant programs from mid-stage development to late-stage development as well as developments in significant late-stage and registration programs. AbbVie expects multiple mid-stage programs to transition into late-stage programs in the next 12 months.Significant Programs and DevelopmentsImmunologySkyrizi•In January 2022, AbbVie announced that the U.S. Food and Drug Administration (FDA) approved Skyrizi for the treatment of adults with active psoriatic arthritis. •In June 2022, AbbVie announced that the FDA approved Skyrizi for the treatment of adults with moderately to severely active Crohn’s disease.•In November 2022, AbbVie announced that the European Commission (EC) approved Skyrizi for the treatment of adults with moderately to severely active Crohn's disease who have had inadequate response, lost response or were intolerant to conventional or biologic therapy.Rinvoq•In January 2022, AbbVie announced that the FDA approved Rinvoq for the treatment of moderate to severe atopic dermatitis in adults and children 12 years of age and older whose disease did not respond to previous treatment and is not well controlled with other pills or injections, including biologic medicines, or when use of other pills or injections is not recommended. •In February 2022, AbbVie announced top-line results from its second Phase 3 induction study, U-Excel, for Rinvoq in patients with moderate to severe Crohn’s disease who had an inadequate response or were intolerant to conventional or biologic therapy met the primary and most key secondary endpoints.•In March 2022, AbbVie announced that the FDA approved Rinvoq for the treatment of adults with moderately to severely active ulcerative colitis (UC) who have had an inadequate response or intolerance to one or more tumor necrosis factor (TNF) blockers. •In April 2022, AbbVie announced that the FDA approved Rinvoq for the treatment of adults with active ankylosing spondylitis who have had an inadequate response or intolerance to one or more TNF blockers.•In May 2022, AbbVie announced positive top-line results from U-ENDURE, a Phase 3 maintenance study for Rinvoq in adult patients with moderate to severe Crohn's disease who had an inadequate response or were intolerant to a conventional or biologic therapy. The results showed that more patients treated with Rinvoq achieved the co-primary and secondary endpoints at one year compared to placebo.•In July 2022, AbbVie announced that the EC approved Rinvoq for the treatment of adults with moderately to severely active UC who have had an inadequate response, lost response or were intolerant to either conventional therapy or a biologic agent.•In July 2022, AbbVie announced its submission of a supplemental New Drug Application (sNDA) to the FDA and a marketing authorization application (MAA) to the EMA for Rinvoq for the treatment of adult patients with moderately to severely active Crohn’s disease. •In July 2022, AbbVie announced that the EC approved Rinvoq for the treatment of adult patients with active non-radiographic axial spondyloarthritis (nr-axSpA).2022 Form 10-K | 34 •In October 2022, AbbVie announced that the FDA approved Rinvoq for the treatment of adults with active nr-axSpA with objective signs of inflammation who have had an inadequate response or intolerance to TNF blocker therapy.•In November 2022, AbbVie announced that the EMA's Committee for Medical Products for Human Use (CHMP) adopted an opinion following a review of the benefit-risk of medicines within the JAK inhibitor class for the treatment of inflammatory diseases, including Rinvoq. Confirming the recommendation from the Pharmacovigilance Risk Assessment Committee (PRAC), the CHMP did not recommend changes to the current Rinvoq indication statements and recommended updates to dosage and special warnings for all JAK inhibitor products indicated for the treatment of inflammatory diseases. These recommendations will be forwarded to the EC, which is expected to issue a final decision. OncologyTeliso-V•In January 2022, AbbVie announced that the FDA granted Breakthrough Therapy Designation to investigational telisotuzumab vedotin (Teliso-V) for the treatment of patients with advanced/metastatic epidermal growth factor receptor wild type, nonsquamous non-small cell lung cancer with high levels of c-Met overexpression whose disease has progressed on or after platinum-based therapy.•In May 2022, AbbVie initiated a Phase 3 clinical trial to evaluate Teliso-V versus docetaxel for the treatment of patients with previously treated c-Met overexpressing, epidermal growth factor receptor wild type, advanced/metastatic non-squamous non-small cell lung cancer.Epcoritamab•In March 2022, Genmab A/S (Genmab) announced that the FDA granted orphan-drug designation to the investigational medicine, epcoritamab (DuoBody-CD3xCD20), for the treatment of follicular lymphoma. Genmab and AbbVie are co-developing epcoritamab and will share commercial responsibilities in the U.S. and Japan, with AbbVie responsible for further global commercialization.•In June 2022, AbbVie and Genmab announced primary results from the large B-cell lymphoma expansion cohort in the EPCORE NHL-1 phase 2 clinical trial evaluating epcoritamab, an investigational subcutaneous bispecific antibody. In this study, epcoritamab demonstrated efficacy with durable responses in patients who had previously received at least two prior lines of anti-lymphoma therapy including chimeric antigen receptor T-cell therapy. •In September 2022, AbbVie and Genmab submitted a biological license application (BLA) to the FDA for epcoritamab for the treatment of patients with relapsed/refractory large B-cell lymphoma.•In October 2022, AbbVie and Genmab submitted an MAA to the EMA for epcoritamab for the treatment of patients with relapsed/refractory diffuse large B-cell lymphoma.•In October 2022, AbbVie initiated a Phase 3 clinical trial to evaluate epcoritamab in combination with rituximab and lenalidomide compared to rituximab and lenalidomide in patients with relapsed or refractory follicular lymphoma.•In November 2022, AbbVie announced that the FDA has accepted for priority review the BLA for epcoritamab for the treatment of relapsed/refractory large B-cell lymphoma.Imbruvica•In August 2022, AbbVie announced that the FDA approved the use of Imbruvica for the treatment of pediatric patients one year and older with chronic graft versus host disease after failure of one or more lines of systemic therapy.•In August 2022, the National Comprehensive Cancer Network (NCCN) in the United States issued updated guidelines for the management of chronic lymphocytic leukemia (CLL) re-categorizing Imbruvica from “Preferred Regimen” to “Other Recommended Regimen”.35 | 2022 Form 10-K AestheticsJuvederm Collection•In February 2022, AbbVie announced that the FDA approved Juvederm Volbella XC for improvement of infraorbital hollows in adults over the age of 21.•In August 2022, AbbVie announced that the FDA approved Juvederm Volux XC for the improvement of jawline definition in adults over the age of 21 with moderate to severe loss of jawline definition.BoNTE•In March 2022, AbbVie initiated three Phase 3 clinical trials to evaluate the efficacy and safety of BoNTE (AGN-151586) for the treatment of glabellar lines.NeuroscienceVraylar•In December 2022, AbbVie announced that the FDA approved Vraylar as an adjunctive therapy to antidepressants for the treatment of major depressive disorder in adults.Qulipta•In March 2022, AbbVie announced results from the Phase 3 PROGRESS trial for Qulipta in the preventive treatment of chronic migraine in adults met the primary endpoint and resulted in significant improvements in all secondary endpoints after adjustment for multiple comparisons.•In June 2022, AbbVie submitted an sNDA to the FDA for Qulipta for the preventative treatment of chronic migraine in adults.•In July 2022, AbbVie submitted an MAA to the EMA for Qulipta for the prophylactic treatment of migraine in adult patients who have at least four migraine days per month.ABBV-951•In May 2022, AbbVie submitted a New Drug Application to the FDA for ABBV-951 (foscarbidopa/foslevodopa) for the treatment of motor fluctuations in patients with advanced Parkinson's disease.2022 Form 10-K | 36 RESULTS OF OPERATIONSNet RevenuesThe comparisons presented at constant currency rates reflect comparative local currency net revenues at the prior year's foreign exchange rates. This measure provides information on the change in net revenues assuming that foreign currency exchange rates had not changed between the prior and current periods. AbbVie believes that the non-GAAP measure of change in net revenues at constant currency rates, when used in conjunction with the GAAP measure of change in net revenues at actual currency rates, may provide a more complete understanding of the company's operations and can facilitate analysis of the company's results of operations, particularly in evaluating performance from one period to another.Percent changeAt actual currency ratesAt constant currency ratesyears ended (dollars in millions)2022202120202022202120222021United States$45,713 $43,510 $34,879 5.1 %24.7 %5.1 %24.7 %International12,341 12,687 10,925 (2.7)%16.1 %5.5 %12.6 %Net revenues$58,054 $56,197 $45,804 3.3 %22.7 %5.1 %21.9 %37 | 2022 Form 10-K The following table details AbbVie's worldwide net revenues:Percent changeAt actual currency ratesAt constant currency ratesyears ended December 31 (dollars in millions)2022202120202022202120222021ImmunologyHumiraUnited States$18,619 $17,330 $16,112 7.4 %7.6 %7.4 %7.6 %International2,618 3,364 3,720 (22.2)%(9.6)%(14.9)%(12.8)%Total$21,237 $20,694 $19,832 2.6 %4.3 %3.8 %3.7 %SkyriziUnited States$4,484 $2,486 $1,385 80.4 %79.6 %80.4 %79.6 %International681 453 205 50.4 %>100.0 %67.1 %>100.0 %Total$5,165 $2,939 $1,590 75.7 %84.9 %78.3 %84.0 %RinvoqUnited States$1,794 $1,271 $653 41.2 %94.8 %41.2 %94.8 %International728 380 78 91.4 %>100.0 %>100.0 %>100.0 %Total$2,522 $1,651 $731 52.8 %>100.0 %58.1 %>100.0 %Hematologic OncologyImbruvicaUnited States$3,426 $4,321 $4,305 (20.7)%0.4 %(20.7)%0.4 %Collaboration revenues1,142 1,087 1,009 5.1 %7.7 %5.1 %7.7 %Total$4,568 $5,408 $5,314 (15.5)%1.8 %(15.5)%1.8 %VenclextaUnited States$1,009 $934 $804 8.0 %16.1 %8.0 %16.1 %International1,000 886 533 12.9 %66.2 %24.6 %60.9 %Total$2,009 $1,820 $1,337 10.4 %36.1 %16.1 %34.0 %AestheticsBotox Cosmetic (a)United States$1,654 $1,424 $687 16.2 %>100.0 %16.2 %>100.0 %International961 808 425 18.9 %90.0 %28.8 %83.9 %Total$2,615 $2,232 $1,112 17.2 %>100.0 %20.8 %98.4 %Juvederm Collection (a)United States$548 $658 $318 (16.7)%>100.0 %(16.7)%>100.0 %International880 877 400 0.3 %>100.0 %8.9 %>100.0 %Total$1,428 $1,535 $718 (7.0)%>100.0 %(2.1)%>100.0 %Other Aesthetics (a)United States$1,122 $1,268 $666 (11.5)%90.2 %(11.5)%90.2 %International168 198 94 (14.9)%>100.0 %(8.3)%>100.0 %Total$1,290 $1,466 $760 (12.0)%93.0 %(11.1)%91.9 %NeuroscienceBotox Therapeutic (a)United States$2,255 $2,012 $1,155 12.1 %74.3 %12.1 %74.3 %International464 439 232 5.6 %89.0 %15.3 %78.8 %Total$2,719 $2,451 $1,387 10.9 %76.7 %12.6 %75.0 %Vraylar (a)United States$2,037 $1,728 $951 17.9 %81.7 %17.9 %81.7 %International1 — — n/mn/mn/mn/mTotal$2,038 $1,728 $951 17.9 %81.7 %17.9 %81.7 %DuodopaUnited States$95 $102 $103 (6.7)%(1.0)%(6.7)%(1.0)%International363 409 391 (11.3)%4.6 %(0.8)%(0.1)%Total$458 $511 $494 (10.4)%3.4 %(2.0)%(0.3)%Ubrelvy (a)United States$680 $552 $125 23.2 %>100.0 %23.2 %>100.0 %QuliptaUnited States$158 $— $— >100.0 %n/m>100.0 %n/mOther Neuroscience (a)United States$456 $667 $528 (30.5)%26.3 %(30.5)%26.3 %International19 18 11 4.8 %77.4 %9.0 %64.7 %Total$475 $685 $539 (29.6)%27.2 %(29.5)%27.0 %2022 Form 10-K | 38 Percent changeAt actual currency ratesAt constant currency ratesyears ended December 31 (dollars in millions)2022202120202022202120222021Eye CareLumigan/Ganfort (a)United States$242 $273 $165 (11.0)%64.7 %(11.0)%64.7 %International272 306 213 (11.3)%44.1 %(3.0)%38.1 %Total$514 $579 $378 (11.2)%53.1 %(6.8)%49.7 %Alphagan/Combigan (a)United States$202 $373 $223 (45.8)%66.5 %(45.8)%66.5 %International144 156 103 (7.9)%52.5 %2.5 %50.6 %Total$346 $529 $326 (34.6)%62.1 %(31.5)%61.5 %Restasis (a)United States$621 $1,234 $755 (49.6)%63.3 %(49.6)%63.3 %International45 56 32 (20.2)%75.3 %(13.8)%80.1 %Total$666 $1,290 $787 (48.3)%63.8 %(48.0)%64.0 %Other Eye Care (a)United States$538 $523 $305 2.3 %72.7 %2.3 %72.7 %International637 646 388 (1.2)%66.1 %8.7 %61.0 %Total$1,175 $1,169 $693 0.4 %69.0 %5.9 %66.1 %Other Key ProductsMavyretUnited States$755 $754 $785 0.2 %(4.0)%0.2 %(4.0)%International786 956 1,045 (17.8)%(8.5)%(8.5)%(10.8)%Total$1,541 $1,710 $1,830 (9.9)%(6.5)%(4.7)%(7.8)%CreonUnited States$1,278 $1,191 $1,114 7.3 %6.9 %7.3 %6.9 %Linzess/Constella (a)United States$1,003 $1,006 $649 (0.4)%55.1 %(0.4)%55.1 %International32 32 18 0.3 %77.3 %7.6 %66.4 %Total$1,035 $1,038 $667 (0.3)%55.7 %(0.1)%55.4 %All other$4,137 $5,019 $5,119 (17.6)%(2.0)%(16.3)%(2.8)%Total net revenues$58,054 $56,197 $45,804 3.3 %22.7 %5.1 %21.9 %n/m – Not meaningful(a)Net revenues include Allergan product revenues after the acquisition closing date of May 8, 2020.The following discussion and analysis of AbbVie's net revenues by product is presented on a constant currency basis.Global Humira sales increased 4% in 2022 primarily driven by market growth across therapeutic categories, partially offset by direct biosimilar competition in international markets. In the United States, Humira sales increased 7% in 2022 primarily driven by market growth across all indications and favorable pricing. This increase was partially offset by a lower market share following the corresponding market share gains of Skyrizi and Rinvoq. Internationally, Humira revenues decreased 15% in 2022 primarily driven by direct biosimilar competition. On January 31, 2023, Humira lost exclusivity in the United States. Following this loss of exclusivity, AbbVie expects direct biosimilar competition and Humira net revenues to decline in the United States. AbbVie continues to pursue strategies to maintain broad formulary access of Humira and manage the impact of biosimilar erosion. Net revenues for Skyrizi increased 78% in 2022 primarily driven by continued strong volume and market share uptake since launch as a treatment for plaque psoriasis as well as market growth. Net revenues were also favorably impacted by recent regulatory approvals and expansion of Skyrizi for the treatment of psoriatic arthritis and Crohn’s disease.Net revenues for Rinvoq increased 58% in 2022 primarily driven by continued strong volume and market share uptake since launch for the treatment of moderate to severe rheumatoid arthritis as well as market growth. Net revenues were also favorably impacted by recent regulatory approvals and expansion of Rinvoq for the treatment of psoriatic arthritis, atopic dermatitis, ankylosing spondylitis, ulcerative colitis and non-radiographic axial spondyloarthritis.Net revenues for Imbruvica represent product revenues in the United States and collaboration revenues outside of the United States related to AbbVie's 50% share of Imbruvica profit. AbbVie's global Imbruvica revenues decreased 16% in 2022 as a result of decreased market demand and lower market share in the United States. The decrease in net revenues was also partially offset by increased collaboration revenues.Net revenues for Venclexta increased 16% in 2022 primarily due to continued expansion of Venclexta for the treatment of patients with CLL and acute myeloid leukemia.39 | 2022 Form 10-K Net revenues for Botox Cosmetic increased 21% in 2022 due to sustained consumer demand in the United States, which was moderated in the second half of the year by economic pressures impacting consumer discretionary spending, and increased investment in key international markets.Net revenues for Juvederm Collection decreased 2% in 2022 due to economic pressures impacting consumer discretionary spending and increased pricing promotions to support the market. International net revenues increased by 9% due to increased investment in key markets, partially offset by the suspension of aesthetic operations in Russia and the impact of COVID-19 in China.Net revenues for Botox Therapeutic increased 13% in 2022 due to market growth.Net revenues for Vraylar increased 18% in 2022 due to higher market share and market growth.Net revenues for Ubrelvy increased 23% in 2022 primarily due to increased market share uptake since launch, partially offset by unfavorable pricing.Net revenues for Qulipta increased greater than 100% in 2022 due to strong volume and market share uptake since launch for the preventative treatment of episodic migraine in adults. Net revenues for Mavyret decreased 5% in 2022 due to the continued disruption of global hepatitis C virus markets due to the COVID-19 pandemic.Gross MarginPercent changeyears ended December 31 (dollars in millions)20222021202020222021Gross margin$40,640 $38,751 $30,417 5 %27 %as a percent of net revenues70 %69 %66 %Gross margin as a percentage of net revenues in 2022 increased compared to 2021. Gross margin percentage for 2022 was favorably impacted by changes in product mix, partially offset by an intangible asset impairment charge of $770 million. Selling, General and AdministrativePercent changeyears ended December 31 (dollars in millions)20222021202020222021Selling, general and administrative$15,260 $12,349 $11,299 24 %9 %as a percent of net revenues26 %22 %25 %Selling, general and administrative (SG&A) expenses as a percentage of net revenues increased in 2022 compared to the prior year primarily due to the unfavorable impact of litigation reserve charges of $2.5 billion, partially offset by leverage from revenue growth and increased synergies realized.Research and Development and Acquired IPR&D and MilestonesPercent changeyears ended December 31 (dollars in millions)20222021202020222021Research and development$6,510 $6,922 $6,379 (6)%9 %as a percent of net revenues11 %12 %14 %Acquired IPR&D and milestones$697 $1,124 $1,376 (38)%(18)%R&D expenses as a percentage of net revenues decreased in 2022 compared to 2021. R&D expense percentage for 2022 was favorably impacted by increased scale of the combined company and synergies realized, the purchase of priority review vouchers from third parties in the prior year as well as lower integration costs related to the acquisition of Allergan. Acquired IPR&D and milestones expense represents upfront and subsequent development milestone payments incurred prior to regulatory approval to acquire rights to in-process R&D projects through R&D collaborations, licensing arrangements or other asset acquisitions. Acquired IPR&D and milestones expense in 2022 included a charge of $130 million related to acquiring Syndesi Therapeutics SA, charges related to other upfront payments totaling $315 million and development milestones of $252 million. Acquired IPR&D and milestones expense in 2021 included a charge of $400 million related to exercising the company's exclusive right to acquire TeneoOne, a charge of $370 million related to a collaboration 2022 Form 10-K | 40 agreement with REGENXBIO Inc, charges related to other upfront payments totaling $192 million and development milestones of $162 million. See Note 5 to the Consolidated Financial Statements for additional information.Other Operating Expense, NetOther operating expense, net in 2022 included a one-time charge of $229 million related to an asset divested as part of the Allergan acquisition, partially offset by $172 million of income related to the sale of worldwide commercial rights of a mature brand Pylera. Other operating expense, net in 2021 included a $500 million charge related to the extension of the Calico Life Sciences LLC collaboration. See Note 5 to the Consolidated Financial Statements for additional information.Other Non-Operating Expensesyears ended December 31 (in millions)202220212020Interest expense$2,230 $2,423 $2,454 Interest income(186)(39)(174)Interest expense, net$2,044 $2,384 $2,280 Net foreign exchange loss$148 $51 $71 Other expense, net2,448 2,500 5,614 Interest expense in 2022 decreased compared to 2021 primarily due to a lower average debt balance as a result of deleveraging, partially offset by the impact of higher interest rates.Interest income in 2022 increased compared to 2021 primarily due to the impact of higher interest rates.Other expense, net included charges related to changes in fair value of contingent consideration liabilities of $2.8 billion in 2022 and $2.7 billion in 2021. The fair value of contingent consideration liabilities is impacted by the passage of time and multiple other inputs, including the probability of success of achieving regulatory/commercial milestones, discount rates, the estimated amount of future sales of the acquired products and other market-based factors. In 2022, the change in fair value reflected higher estimated Skyrizi sales driven by stronger market share uptake and the passage of time, partially offset by higher discount rates. In 2021, the change in fair value reflected higher estimated Skyrizi sales driven by stronger market share uptake, favorable clinical trial results and the passage of time, partially offset by higher discount rates.Income Tax ExpenseThe effective income tax rate was 12% in 2022, 11% in 2021 and negative 36% in 2020. The effective income tax rates differed from the U.S. statutory tax rate of 21% principally due to the impact of foreign operations which reflects the impact of lower income tax rates in locations outside the United States, tax incentives in Puerto Rico and other foreign tax jurisdictions, business development activities and changes in fair value of contingent consideration. The effective tax rates for these periods also reflected the benefit from U.S. tax credits principally related to research and development credits, the orphan drug tax credit and Puerto Rico excise tax credits. The Puerto Rico tax credits relate to excise tax on certain products manufactured in Puerto Rico. The tax is levied on gross inventory purchases from entities in Puerto Rico and is included in cost of products sold in the consolidated statements of earnings. The majority of the tax is creditable for U.S. income tax purposes. In 2022, Puerto Rico enacted Act 52-2002 (the “Puerto Rico Act”) allowing for a transition from a Puerto Rico excise tax levied on gross inventory purchases to an income-based tax beginning in 2023. The company completed the transition requirements of the Puerto Rico Act in 2022, resulting in the remeasurement of certain deferred tax assets and liabilities based on income tax rates at which they are expected to reverse in the future. The net tax benefit from the remeasurement of deferred taxes related to the Puerto Rico Act was $323 million.FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES years ended December 31 (in millions)202220212020Cash flows provided by (used in)Operating activities$24,943 $22,777 $17,588 Investing activities(623)(2,344)(37,557)Financing activities(24,803)(19,039)(11,501)Operating cash flows in 2022 increased from 2021 primarily due to improved results of operations resulting from revenue growth and lower income tax payments, partially offset by the timing of working capital. Operating cash flows also reflected AbbVie’s contributions to its defined benefit plans of $357 million in 2022 and $376 million in 2021.41 | 2022 Form 10-K Investing cash flows in 2022 included payments made for capital expenditures of $695 million, other acquisitions and investments of $539 million, $255 million cash consideration paid to acquire DJS Antibodies Ltd offset by cash acquired and net sales and maturities of investments securities totaling $92 million. Investment cash flows in 2021 included $535 million cash consideration paid to acquire Soliton, Inc. offset by cash acquired, payments made for other acquisitions and investments of $1.4 billion, capital expenditures of $787 million and net purchases of investment securities totaling $21 million. Financing cash flows in 2022 included repayment of $3.1 billion aggregate principal amount of the company's 2.9% senior notes, $3.0 billion aggregate principal amount of the company's 2.3% senior notes, $2.9 billion aggregate principal amount of the company's 3.45% senior notes, $1.7 billion aggregate principal amount of the company's 3.25% senior notes, $1.0 billion aggregate principal amount of the company’s 3.2% senior notes and $750 million aggregate principal amount of the company's floating rate senior notes. Additionally financing cash flows included repayment of a $2.0 billion floating term loan due May 2025 and issuance of a new $2.0 billion floating rate term loan as part of the term loan refinancing in February 2022. Subsequent to December 31, 2022, the company repaid a $1.0 billion floating rate three-year term loan that was scheduled to mature in May 2023.Financing cash flows in 2021 included early repayments of $1.8 billion aggregate principal amount of the company's 2.3% principal notes, $1.2 billion aggregate principal amount of the company's 5.0% senior notes and €750 million aggregate principal amount of the company's 0.5% senior Euro notes. Financing cash flows also included repayment of $750 million aggregate principal amount of floating rate senior notes, $1.3 billion aggregate principal amount of 3.375% senior notes, $1.8 billion aggregate principal amount of 2.15% senior notes and $750 million aggregate principal amount of floating rate senior notes at maturity. Additionally, financing cash flows included repayment of a $1.0 billion floating rate term loan due May 2023 and issuance of a new $1.0 billion floating rate term loan as part of the term loan refinancing in September 2021.Financing cash flows also included cash dividend payments of $10.0 billion in 2022 and $9.3 billion in 2021. The increase in cash dividend payments was primarily driven by an increase of the dividend rate.The company's stock repurchase authorization permits purchases of AbbVie shares from time to time in open-market or private transactions at management’s discretion. The program has no time limit and can be discontinued at any time. AbbVie repurchased 8 million shares for $1.1 billion in 2022 and 6 million shares for $670 million in 2021. AbbVie's remaining stock repurchase authorization was $1.4 billion as of December 31, 2022. On February 16, 2023, AbbVie's board of directors authorized a $5.0 billion increase to the existing stock repurchase authorization.No commercial paper borrowings were issued during 2022 or 2021 and there were no commercial paper borrowings outstanding as of December 31, 2022 or December 31, 2021. AbbVie may issue additional commercial paper or retire commercial paper to meet liquidity requirements as needed.Credit RiskAbbVie monitors economic conditions, the creditworthiness of customers and government regulations and funding, both domestically and abroad. AbbVie regularly communicates with its customers regarding the status of receivable balances, including their payment plans and obtains positive confirmation of the validity of the receivables. AbbVie establishes an allowance for credit losses equal to the estimate of future losses over the contractual life of outstanding accounts receivable. AbbVie may also utilize factoring arrangements to mitigate credit risk, although the receivables included in such arrangements have historically not been a significant amount of total outstanding receivables.Credit Facility, Access to Capital and Credit RatingsCredit FacilityAbbVie currently has a $4.0 billion five-year revolving credit facility that matures in August 2024. This credit facility enables the company to borrow funds on an unsecured basis at variable interest rates and contains various covenants. At December 31, 2022, the company was in compliance with all covenants, and commitment fees under the credit facility were insignificant. No amounts were outstanding under the company's credit facility as of December 31, 2022 and December 31, 2021.2022 Form 10-K | 42 Access to CapitalThe company intends to fund short-term and long-term financial obligations as they mature through cash on hand, future cash flows from operations or has the ability to issue additional debt. The company's ability to generate cash flows from operations, issue debt or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for the company's products or in the solvency of its customers or suppliers, deterioration in the company's key financial ratios or credit ratings, or other material unfavorable changes in business conditions. At the current time, the company believes it has sufficient financial flexibility to issue debt, enter into other financing arrangements and attract long-term capital on acceptable terms to support the company's growth objectives.Credit RatingsIn 2022, Moody’s Investors Service upgraded AbbVie's senior unsecured long-term credit rating to Baa1 from Baa2, affirmed its Prime-2 short-term credit rating and revised its outlook to positive from stable. In addition, Standard and Poor's Global Ratings revised its outlook to positive from stable and affirmed its long-term issuer credit rating of BBB+.Unfavorable changes to the ratings may have an adverse impact on future financing arrangements; however, they would not affect the company’s ability to draw on its credit facility and would not result in an acceleration of scheduled maturities of any of the company’s outstanding debt.Future Cash RequirementsContractual ObligationsThe following table summarizes AbbVie's estimated material contractual obligations as of December 31, 2022:(in millions)TotalCurrentLong-termLong-term debt, including current portion$63,128 $4,132 $58,996 Interest on long-term debt(a)28,445 2,363 26,082 Contingent consideration liabilities(b)16,384 1,469 14,915 (a)Includes estimated future interest payments on long-term debt. Interest payments on debt are calculated for future periods using forecasted interest rates in effect at the end of 2022. Projected interest payments include the related effects of interest rate swap agreements. Certain of these projected interest payments may differ in the future based on changes in floating interest rates or other factors or events. The projected interest payments only pertain to obligations and agreements outstanding at December 31, 2022. See Note 10 to the Consolidated Financial Statements for additional information regarding the company's debt instruments and Note 11 for additional information on the interest rate swap agreements outstanding at December 31, 2022.(b)Includes contingent consideration liabilities which are recorded at fair value on the consolidated balance sheet. Potential contingent consideration payments that exceed the fair value recorded on the consolidated balance sheet are not included in the table of contractual obligations. See Note 11 to the Consolidated Financial Statements for additional information regarding these liabilities. AbbVie enters into certain unconditional purchase obligations and other commitments in the normal course of business. There have been no changes to these commitments that would have a material impact on the company’s ability to meet either short-term or long-term future cash requirements.Income TaxesFuture income tax cash requirements include a one-time transition tax liability on a mandatory deemed repatriation of previously untaxed earnings of foreign subsidiaries resulting from U.S. tax reform enacted in 2017. The one-time transition tax liability was $3.4 billion as of December 31, 2022 and is payable in four future annual installments. Liabilities for unrecognized tax benefits totaled $6.5 billion as of December 31, 2022. It is not possible to reliably estimate the timing of the future cash outflows related to these liabilities. See Note 14 to the Consolidated Financial Statements for additional information on these unrecognized tax benefits.Quarterly Cash DividendOn October 28, 2022, AbbVie announced that its board of directors declared an increase in the quarterly cash dividend from $1.41 per share to $1.48 per share beginning with the dividend payable on February 15, 2023, to stockholders of record as of January 13, 2023. This reflects an increase of approximately 5.0% over the previous quarterly rate. The timing, 43 | 2022 Form 10-K declaration, amount of and payment of any dividends by AbbVie in the future is within the discretion of its board of directors and will depend upon many factors, including AbbVie's financial condition, earnings, capital requirements of its operating subsidiaries, covenants associated with certain of AbbVie's debt service obligations, legal requirements, regulatory constraints, industry practice, ability to access capital markets and other factors deemed relevant by its board of directors.Collaborations, Licensing and Other ArrangementsAbbVie enters into collaborative, licensing and other arrangements with third parties that may require future milestone payments to third parties contingent upon the achievement of certain development, regulatory, or commercial milestones. Individually, these arrangements are insignificant in any one annual reporting period. However, if milestones for multiple products covered by these arrangements happen to be reached in the same reporting period, the aggregate charge to expense could be material to the results of operations in that period. From a business perspective, the payments are viewed as positive because they signify that the product is successfully moving through development and is now generating or is more likely to generate future cash flows from product sales. It is not possible to predict with reasonable certainty whether these milestones will be achieved or the timing for achievement. See Note 5 to the Consolidated Financial Statements for additional information on these collaboration arrangements.CRITICAL ACCOUNTING POLICIES AND ESTIMATESThe preparation of financial statements in accordance with generally accepted accounting principles in the United States requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenue and expenses. A summary of the company's significant accounting policies is included in Note 2 to the Consolidated Financial Statements. Certain of these policies are considered critical as these most significantly impact the company's financial condition and results of operations and require the most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Actual results may vary from these estimates.Revenue RecognitionAbbVie recognizes revenue when control of promised goods or services is transferred to the company’s customers, in an amount that reflects the consideration AbbVie expects to be entitled to in exchange for those goods or services. Sales, value add and other taxes collected concurrent with revenue-producing activities are excluded from revenue. AbbVie generates revenue primarily from product sales. For the majority of sales, the company transfers control, invoices the customer and recognizes revenue upon shipment to the customer. Rebates AbbVie provides rebates to pharmacy benefit managers, state government Medicaid programs, insurance companies that administer Medicare drug plans, wholesalers, group purchasing organizations and other government agencies and private entities.Rebate and chargeback accruals are accounted for as variable consideration and are recorded as a reduction to revenue in the period the related product is sold. Provisions for rebates and chargebacks totaled $41.4 billion in 2022, $33.9 billion in 2021 and $27.0 billion in 2020. Rebate amounts are typically based upon the volume of purchases using contractual or statutory prices, which may vary by product and by payer. For each type of rebate, the factors used in the calculations of the accrual for that rebate include the identification of the products subject to the rebate, the applicable price terms and the estimated lag time between sale and payment of the rebate, which can be significant.In order to establish its rebate and chargeback accruals, the company uses both internal and external data to estimate the level of inventory in the distribution channel and the rebate claims processing lag time for each type of rebate. To estimate the rebate percentage or net price, the company tracks sales by product and by customer or payer. The company evaluates inventory data reported by wholesalers, available prescription volume information, product pricing, historical experience and other factors in order to determine the adequacy of its reserves. AbbVie regularly monitors its reserves and records adjustments when rebate trends, rebate programs and contract terms, legislative changes, or other significant events indicate that a change in the reserve is appropriate. Historically, adjustments to rebate accruals have not been material to net earnings.2022 Form 10-K | 44 The following table is an analysis of the three largest accruals for rebates and chargebacks, which comprise approximately 94% of the total consolidated rebate and chargebacks recorded as reductions to revenues in 2022. Remaining rebate provisions charged against gross revenues are not significant in the determination of operating earnings.(in millions)Medicaid and Medicare RebatesManaged Care RebatesWholesalerChargebacksBalance at December 31, 2019$1,765 $1,936 $686 Additions(a)1,266 649 71 Provisions6,715 8,656 8,677 Payments(6,801)(8,334)(8,693)Balance at December 31, 20202,945 2,907 741 Provisions9,622 11,306 11,286 Payments(8,751)(11,116)(11,125)Balance at December 31, 20213,816 3,097 902 Provisions11,713 14,119 13,070 Payments(10,331)(12,974)(12,829)Balance at December 31, 2022$5,198 $4,242 $1,143 (a)Represents rebate accruals and chargeback allowances assumed in the Allergan acquisition.Other AllowancesOther allowances include cash discounts, product returns, sales incentives, and other adjustments, which are accounted for as variable consideration and are recorded as a reduction to revenue in the same period the related product is sold. Reserves for cash discounts and sales incentives are readily determinable because the company's experience of payment history is fairly consistent. Product returns can be reliably estimated based on the company's historical return experience. Cash discounts totaled $1.8 billion in 2022, $1.6 billion in 2021 and $1.2 billion in 2020. Allowances other than cash discounts are not significant.Pension and Other Post-Employment BenefitsAbbVie engages outside actuaries to assist in the determination of the obligations and costs under the pension and other post-employment benefit plans that are direct obligations of AbbVie. The valuation of the funded status and the net periodic benefit cost for these plans are calculated using actuarial assumptions. The significant assumptions, which are reviewed annually, include the discount rate, the expected long-term rate of return on plan assets and the health care cost trend rates and are disclosed in Note 12 to the Consolidated Financial Statements.The discount rate is selected based on current market rates on high-quality, fixed-income investments at December 31 each year. AbbVie employs a yield-curve approach for countries where a robust bond market exists. The yield curve is developed using high-quality bonds. The yield-curve approach reflects the plans' specific cash flows (i.e. duration) in calculating the benefit obligations by applying the corresponding individual spot rates along the yield curve. AbbVie reflects the plans' specific cash flows and applies them to the corresponding individual spot rates along the yield curve in calculating the service cost and interest cost portions of expense. For other countries, AbbVie reviews various indices such as corporate bond and government bond benchmarks to estimate the discount rate. 45 | 2022 Form 10-K AbbVie's assumed discount rates have a significant effect on the amounts reported for defined benefit pension and other post-employment plans as of December 31, 2022. A 50 basis point change in the assumed discount rate would have had the following effects on AbbVie's calculation of net periodic benefit costs in 2023 and projected benefit obligations as of December 31, 2022:50 basis point(in millions) (brackets denote a reduction)IncreaseDecreaseDefined benefit plansNet periodic benefit cost$(34)$57 Projected benefit obligation(612)687 Other post-employment plansNet periodic benefit cost$(5)$6 Projected benefit obligation(44)49 The expected long-term rate of return is based on the asset allocation, historical performance and the current view of expected future returns. AbbVie considers these inputs with a long-term focus to avoid short-term market influences. The current long-term rate of return on plan assets for each plan is supported by the historical performance of the trust's actual and target asset allocation. AbbVie's assumed expected long-term rate of return has a significant effect on the amounts reported for defined benefit pension plans as of December 31, 2022 and will be used in the calculation of net periodic benefit cost in 2023. A one percentage point change in assumed expected long-term rate of return on plan assets would increase or decrease the net period benefit cost of these plans in 2023 by $98 million.The health care cost trend rate is selected by reviewing historical trends and current views on projected future health care cost increases. The current health care cost trend rate is supported by the historical trend experience of each plan. Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans as of December 31, 2022 and will be used in the calculation of net periodic benefit cost in 2023. Income TaxesAbbVie accounts for income taxes under the asset and liability method. Provisions for federal, state and foreign income taxes are calculated on reported pre-tax earnings based on current tax laws. Deferred taxes are provided using enacted tax rates on the future tax consequences of temporary differences, which are the differences between the financial statement carrying amount of assets and liabilities and their respective tax bases and the tax benefits of carryforwards. A valuation allowance is established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized.LitigationThe company is subject to contingencies, such as various claims, legal proceedings and investigations regarding product liability, intellectual property, commercial, securities and other matters that arise in the normal course of business. See Note 15 to the Consolidated Financial Statements for additional information. Loss contingency provisions are recorded for probable losses at management's best estimate of a loss, or when a best estimate cannot be made, a minimum loss contingency amount within a probable range is recorded. Accordingly, AbbVie is often initially unable to develop a best estimate of loss and therefore, the minimum amount, which could be zero, is recorded. As information becomes known, either the minimum loss amount is increased, resulting in additional loss provisions, or a best estimate can be made, also resulting in additional loss provisions. Occasionally, a best estimate amount is changed to a lower amount when events result in an expectation of a more favorable outcome than previously expected.Valuation of Goodwill and Intangible AssetsAbbVie has acquired and may continue to acquire significant intangible assets in connection with business combinations that AbbVie records at fair value. Transactions involving the purchase or sale of intangible assets occur between companies in the pharmaceuticals industry and valuations are usually based on a discounted cash flow analysis incorporating the stage of completion. The discounted cash flow model requires assumptions about the timing and amount of future net cash flows, risk, cost of capital, terminal values and market participants. Each of these factors can significantly affect the value of the intangible asset. In-process research and development (IPR&D) acquired in a business combination is capitalized as an indefinite-lived intangible asset until regulatory approval is obtained, at which time it is accounted for as a definite-lived asset and amortized over its estimated useful life, or discontinuation, at which point the intangible asset will be written off. IPR&D acquired in transactions that are not business combinations is expensed immediately, unless deemed to have an alternative 2022 Form 10-K | 46 future use. Payments made to third parties subsequent to regulatory approval are capitalized and amortized over the remaining useful life.AbbVie reviews the recoverability of definite-lived intangible assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Goodwill and indefinite-lived intangible assets are reviewed for impairment annually or when an event occurs that could result in an impairment. See Note 2 to the Consolidated Financial Statements for additional information.Annually, the company tests its goodwill for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. Some of the factors considered in the assessment include general macro-economic conditions, conditions specific to the industry and market, cost factors, the overall financial performance and whether there have been sustained declines in the company's share price. If the company concludes it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed. AbbVie tests indefinite-lived intangible assets for impairment by first assessing qualitative factors to determine whether it is more likely than not that the fair value is less than its carrying amount. If the company concludes it is more likely than not that the fair value is less than its carrying amount, a quantitative impairment test is performed. For its quantitative impairment tests, the company uses an estimated future cash flow approach that requires significant judgment with respect to future volume, revenue and expense growth rates, changes in working capital use, the selection of an appropriate discount rate, asset groupings and other assumptions and estimates. The estimates and assumptions used are consistent with the company's business plans and a market participant's views. The use of alternative estimates and assumptions could increase or decrease projected cash flows and the estimated fair value of the related intangible assets. Future changes to these estimates and assumptions could have a material impact on the company's results of operations. Actual results may differ from the company's estimates.Contingent ConsiderationThe fair value measurements of contingent consideration liabilities are determined as of the acquisition date based on significant unobservable inputs, including the discount rate, estimated probabilities and timing of achieving specified development, regulatory and commercial milestones and the estimated amount of future sales of the acquired products. Contingent consideration liabilities are revalued to fair value at each subsequent reporting date until the related contingency is resolved. The potential contingent consideration payments are estimated by applying a probability-weighted expected payment model for contingent milestone payments and a Monte Carlo simulation model for contingent royalty payments, which are then discounted to present value. Changes to the fair value of the contingent consideration liabilities can result from changes to one or a number of inputs, including discount rates, the probabilities of achieving the milestones, the time required to achieve the milestones and estimated future sales. Significant judgment is employed in determining the appropriateness of certain of these inputs, which are disclosed in Note 11 to the Consolidated Financial Statements. Changes to the inputs described above could have a material impact on the company's financial position and results of operations in any given period.47 | 2022 Form 10-K ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKThe company is exposed to risk that its earnings, cash flows and equity could be adversely impacted by changes in foreign exchange rates and interest rates. Certain derivative instruments are used when available on a cost-effective basis to hedge the company's underlying economic exposures. See Note 11 to the Consolidated Financial Statements for additional information regarding the company's financial instruments and hedging strategies.Foreign Currency RiskAbbVie's primary net foreign currency exposures are the Euro, Japanese yen, Canadian dollar, Chinese yuan and British pound. The following table reflects the total foreign currency forward exchange contracts outstanding at December 31, 2022 and 2021:20222021as of December 31 (in millions)Contract amountWeighted average exchange rateFair and carrying value receivable/(payable)Contract amountWeighted average exchange rateFair and carrying value receivable/(payable)Receive primarily U.S. dollars in exchange for the following currencies:Euro$8,507 1.071 $9 $10,253 1.155 $195 Canadian dollar1,302 1.312 40 571 1.258 9 British pound772 1.234 (8)605 1.331 9 Chinese yuan596 7.024 (5)673 6.400 (1)Japanese yen567 133.3 (3)602 113.3 9 All other currencies1,954 n/a(2)1,549 n/a5 Total$13,698 $31 $14,253 $226 The company estimates that a 10% appreciation in the underlying currencies being hedged from their levels against the U.S. dollar, with all other variables held constant, would decrease the fair value of foreign exchange forward contracts by $1.4 billion at December 31, 2022. If realized, this appreciation would negatively affect earnings over the remaining life of the contracts. However, gains and losses on the hedging instruments offset losses and gains on the hedged transactions and reduce the earnings and stockholders' equity volatility relating to foreign exchange. A 10% appreciation is believed to be a reasonably possible near-term change in foreign currencies.As of December 31, 2022, the company has €5.9 billion aggregate principal amount of unsecured senior Euro notes outstanding, which are exposed to foreign currency risk. The company designated these foreign currency denominated notes as hedges of its net investments in certain foreign subsidiaries and affiliates. As a result, any foreign currency translation gains or losses related to the Euro notes will be included in accumulated other comprehensive loss. See Note 10 to the Consolidated Financial Statements for additional information regarding the senior Euro notes and Note 11 to the Consolidated Financial Statements for additional information regarding the net investment hedging program. Interest Rate RiskThe company estimates that an increase in interest rates of 100 basis points would adversely impact the fair value of AbbVie's interest rate swap contracts by approximately $155 million at December 31, 2022. If realized, the fair value reduction would affect earnings over the remaining life of the contracts. The company estimates that an increase of 100 basis points in long-term interest rates would decrease the fair value of long-term debt by $4.2 billion at December 31, 2022. A 100 basis point change is believed to be a reasonably possible near-term change in interest rates. 2022 Form 10-K | 48
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsYou should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the section titled “Risk Factors” or in other parts of this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results that may be expected for any period in the future. Except as otherwise noted, all references to 2022 refer to the year ended December 31, 2022, references to 2021 refer to the year ended December 31, 2021, and references to 2020 refer to the year ended December 31, 2020.The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in Part II, Item 8 of this Annual Report on Form 10-K. This section of this Annual Report on Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 are not included in this Form 10-K, and can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021, filed on February 25, 2022.Revision of Previously Issued Financial StatementsAs described in Note 2, Summary of Significant Accounting Policies, to our consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K, we have revised previously issued financial statements to correct immaterial misstatements. This had no impact on our consolidated financial statements outside of the presentation in the consolidated statements of cash flow and did not affect the consolidated statements of operations. Overview We are a community based on connection and belonging—a community that was born in 2007 when two Hosts welcomed three guests to their San Francisco home, and has since grown to over 4 million Hosts who have welcomed over 1.4 billion guest arrivals to over 100,000 cities and towns in almost every country and region across the globe. Hosts on Airbnb are everyday people who share their worlds to provide guests with the feeling of connection and being at home. We have five stakeholders and we have designed our company with all of them in mind. Along with employees and shareholders, we serve Hosts, guests, and the communities in which they live. We intend to make long-term decisions considering all of our stakeholders because their collective success is key for our business to thrive. 51Table of ContentsWe operate a global marketplace, where Hosts offer guests stays and experiences on our platform. Our business model relies on the success of Hosts and guests (collectively referred to as “customers”) who join our community and generate consistent bookings over time. As Hosts become more successful on our platform and as guests return over time, we benefit from the recurring activity of our community.Initial Public Offering Our initial public offering (“IPO”) was completed on December 14, 2020. Our consolidated financial statements as of December 31, 2020 and for the year then-ended reflect the sale by us of an aggregate of 55,000,000 shares in our IPO, including the exercise of the underwriters’ option to purchase additional shares, at the public offering price of $68.00 per share, for net proceeds to us of approximately $3.7 billion, after underwriting discounts and commissions and offering expenses, and the conversion of all outstanding shares of our redeemable convertible preferred stock into an aggregate of 240,910,588 shares of Class B common stock, including 1,286,694 shares of Class B common stock issuable pursuant to the anti-dilution adjustment provisions relating to our Series C redeemable convertible preferred stock.Our consolidated financial statements as of December 31, 2020 and for the year then-ended include stock-based compensation expense of $2.8 billion associated with the vesting of RSUs in connection with our IPO for which the requisite service-based vesting condition was met as of December 31, 2020. The liquidity-based vesting condition for RSUs was satisfied upon the effectiveness of our Registration Statement on Form S-1 on December 9, 2020.2022 Financial HighlightsIn 2022, revenue grew by 40% to $8.4 billion compared to 2021, primarily due to a 31% increase in Nights and Experiences Booked of 93.0 million combined with higher average daily rates driving a 35% increase in Gross Booking Value of $16.3 billion. The growth in revenue demonstrated the continued strong travel demand. On a constant-currency basis, revenue increased 46% in 2022 compared to 2021.We ended 2022 with net income of $1.9 billion, an improvement from a net loss of $352.0 million in 2021, and our first profitable year to date. Our net profit margin increased to 23% from a negative 6% in 2021, primarily due to our revenue growth outpacing the growth in our operating expenses and cost management.Adjusted EBITDA1 increased 82% to $2.9 billion in 2022 demonstrating the continued strength of our business and disciplined management of our cost structure. Our net cash provided by operating activities was $3.4 billion in 2022, up from $2.3 billion in 2021, and we generated Free Cash Flow1 of $3.4 billion. The increase was driven by our revenue growth, net margin expansion, and significant growth in unearned fees. In August 2022, our board of directors approved a share repurchase program with authorization to purchase up to $2.0 billion of our Class A common stock at management’s discretion. During 2022, we repurchased and retired 13.8 million shares of common stock for $1.5 billion. Macroeconomic Conditions on our BusinessAs we look forward, we recognize the potential impact of challenging macroeconomic conditions on our business, including inflation and rising interest rates, foreign currency fluctuations, and potential decreased consumer spending. To date, these conditions have had a modest impact on our business, results of operations, cash flows, and financial condition; however, the impact in the future of these macroeconomic events on our business, results of operations, cash flows, and financial condition is uncertain and will depend on future developments that we may not be able to accurately predict.Impact of COVID-19In response to the outbreak of the novel strain of the coronavirus disease (“COVID-19”) in the first half of 2020, as well as subsequent outbreaks driven by new variants of COVID-19, governments around the world have implemented, and continue to implement, a variety of measures to reduce the spread of COVID-19, including travel restrictions, social distancing, shelter-in-place orders, vaccination mandates, or requirements for businesses to confirm employees’ vaccination status, and other restrictions. While COVID-19 still plagues the world, for the year ended December 31, 2022, Gross Booking Value (“GBV”) and revenue were $63.2 billion and $8.4 billion, respectively, which were both higher compared to the same periods in 2021, 2020, and pre-COVID-19. In 2020 and 2021, we faced lower demand for long distance travel and overall depressed Nights and Experiences Booked compared to pre-COVID-19. However, in 2022, we saw significant growth with Nights and Experiences Booked exceeding pre-COVID-19 levels for the same period. The trends in our recovery continue to vary by region due to a variety of factors, including the emergence of COVID-19 variants, vaccination rates, COVID-19 caseloads, and associated travel restrictions, as well as historical cross-border compared to domestic travel dependence. During 2022, we saw strength in all regions relative to 2021 as well as sequential growth in nights booked in Latin America and Asia Pacific.The extent and duration of the impact of the COVID-19 pandemic over the longer term remain uncertain and dependent on future developments that cannot be accurately predicted at this time, such as the severity and transmission rate of COVID-19, the introduction and spread of new variants of the virus that may be resistant to currently approved vaccines, and the continuation of existing or implementation of new government travel restrictions, the extent and effectiveness of containment actions taken, including mobility restrictions, the timing, availability, and effectiveness of vaccines, and the impact of these and other factors on travel behavior in general, and on our business in particular, which may result in a reduction in bookings and an increase in booking cancellations.1 A reconciliation of non-generally accepted accounting principal financial measures to the most comparable generally accepted accounting principal financial measures is provided under the subsection titled “Key Business Metrics and Non-GAAP Financial Measures— Adjusted EBITDA” and “— Free Cash Flow” below.52Table of ContentsInflation Reduction Act of 2022On August 16, 2022, the Inflation Reduction Act (the “IRA”) was signed into law in the United States. Among other changes, the IRA introduced a corporate minimum tax on certain corporations with average adjusted financial statement income over a three-tax year period in excess of $1 billion and an excise tax on certain stock repurchases by certain covered corporations for taxable years beginning after December 31, 2022. While the corporate minimum tax law change has no immediate effect and is not expected to have a material adverse effect on our results of operations going forward, we will continue to evaluate its impact as further information becomes available.Key Business Metrics and Non-GAAP Financial Measures We track the following key business metrics and financial measures that are not calculated and presented in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) (“non-GAAP financial measures”) to evaluate our operating performance, identify trends, formulate financial projections, and make strategic decisions. Accordingly, we believe that these key business metrics and non-GAAP financial measures provide useful information to investors and others in understanding and evaluating our results of operations in the same manner as our management team. We believe that non-GAAP financial information, when taken collectively, may be helpful to investors because it provides consistency and comparability with past financial performance, and assists in comparisons with other companies, some of which use similar non-GAAP financial information to supplement their U.S. GAAP results. These key business metrics and non-GAAP financial measures are presented for supplemental informational purposes only, should not be considered a substitute for financial information presented in accordance with U.S. GAAP, and may be different from similarly titled metrics or measures presented by other companies. A reconciliation of each non-GAAP financial measure to the most directly comparable financial measure stated in accordance with U.S. GAAP is provided under the subsection titled “— Adjusted EBITDA” and “— Free Cash Flow” below. Investors are encouraged to review the related U.S. GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable U.S. GAAP financial measures. Key Business MetricsWe review the following key business metrics to measure our performance, identify trends, formulate financial projections, and make strategic decisions. We are not aware of any uniform standards for calculating these key metrics, which may hinder comparability with other companies that may calculate similarly titled metrics in a different way.20212022(in millions)Nights and Experiences Booked301 394 Gross Booking Value$46,877 $63,212 Nights and Experiences Booked Nights and Experiences Booked is a key measure of the scale of our platform, which in turn drives our financial performance. Nights and Experiences Booked on our platform in a period represents the sum of the total number of nights booked for stays and the total number of seats booked for experiences, net of cancellations and alterations that occurred in that period. For example, a booking made on February 15 would be reflected in Nights and Experiences Booked for our quarter ended March 31. If, in the example, the booking were canceled on May 15, Nights and Experiences Booked would be reduced by the cancellation for our quarter ended June 30. A night can include one or more guests and can be for a listing with one or more bedrooms. A seat is booked for each participant in an experience. Substantially all of the bookings on our platform to date have come from nights. We believe Nights and Experiences Booked is a key business metric to help investors and others understand and evaluate our results of operations in the same manner as our management team, as it represents a single unit of transaction on our platform. In 2022, we had 393.7 million Nights and Experiences Booked, a 31% increase from 300.6 million in 2021. Nights and Experiences Booked grows as we attract new customers to our platform and as repeat customers increase their activity on our platform. Our Nights and Experiences Booked increased from prior year levels driven by strong growth across all regions, in particular in Europe, Latin America, and Asia. Gross Booking Value GBV represents the dollar value of bookings on our platform in a period and is inclusive of Host earnings, service fees, cleaning fees, and taxes, net of cancellations and alterations that occurred during that period. The timing of recording GBV and any related cancellations is similar to that described in the subsection titled “— Key Business Metrics and Non-GAAP Financial Measures — Nights and Experiences Booked” above. Revenue from the booking is recognized upon check-in; accordingly, GBV is a leading indicator of revenue. The entire amount of a booking is reflected in GBV during the quarter in which booking occurs, whether the guest pays the entire amount of the booking upfront or elects to use our Pay Less Upfront program. Growth in GBV reflects our ability to attract and retain customers and reflects growth in Nights and Experiences Booked.In 2022, our GBV was $63.2 billion, a 35% increase from $46.9 billion in 2021. The increase in our GBV was primarily due to an increase in Nights and Experiences Booked. The travel recovery we are experiencing has been dominated by our higher average daily rate (“ADR”) regions—North America and Europe, in particular. Similar to Nights and Experiences Booked, our GBV improvement was driven by stronger bookings in all regions. 53Table of ContentsNon-GAAP Financial MeasuresOur non-GAAP financial measures include Adjusted EBITDA, Free Cash Flow, and revenue growth rates in constant currency, which are described below. A reconciliation of each non-GAAP financial measure to the most directly comparable financial measure stated in accordance with U.S. GAAP is provided below. Investors are encouraged to review the related U.S. GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable U.S. GAAP financial measures. The following table summarizes our non-GAAP financial measures, along with the most directly comparable GAAP measure:20212022(in millions)Net income (loss)$(352)$1,893 Adjusted EBITDA$1,593 $2,903 Net cash provided by operating activities$2,313 $3,430 Free Cash Flow$2,288 $3,405 Adjusted EBITDA We define Adjusted EBITDA as net income or loss adjusted for (i) provision for (benefit from) income taxes; (ii) other income (expense), net, interest expense, and interest income; (iii) depreciation and amortization; (iv) stock-based compensation expense; (v) acquisition-related impacts consisting of gains (losses) recognized on changes in the fair value of contingent consideration arrangements; (vi) net changes to the reserves for lodging taxes for which management believes it is probable that we may be held jointly liable with Hosts for collecting and remitting such taxes; and (vii) restructuring charges. The above items are excluded from our Adjusted EBITDA measure because these items are non-cash in nature, or because the amount and timing of these items is unpredictable, not driven by core results of operations, and renders comparisons with prior periods and competitors less meaningful. We believe Adjusted EBITDA provides useful information to investors and others in understanding and evaluating our results of operations, as well as provides a useful measure for period-to-period comparisons of our business performance. Moreover, we have included Adjusted EBITDA in this Annual Report on Form 10-K because it is a key measurement used by our management internally to make operating decisions, including those related to operating expenses, evaluating performance, and performing strategic planning and annual budgeting. Adjusted EBITDA also excludes certain items related to transactional tax matters, for which management believes it is probable that we may be held jointly liable with Hosts in certain jurisdictions, and we urge investors to review the detailed disclosure regarding these matters included in the subsection titled “—Critical Accounting Policies and Estimates—Lodging Tax Obligations,” as well as the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.Adjusted EBITDA has limitations as a financial measure, should be considered as supplemental in nature, and is not meant as a substitute for the related financial information prepared in accordance with GAAP. These limitations include the following: •Adjusted EBITDA does not reflect interest income (expense) and other income (expense), net, which include loss on extinguishment of debt and unrealized and realized gains and losses on foreign currency exchange, investments, and financial instruments, including the warrants issued in connection with a term loan agreement entered into in April 2020. We amended the anti-dilution feature in the warrant agreements in March 2021. The balance of the warrants of $1.3 billion was reclassified from liability to equity as the amended warrants met the requirements for equity classification and are no longer remeasured at each reporting period; •Adjusted EBITDA excludes certain recurring, non-cash charges, such as depreciation of property and equipment and amortization of intangible assets, and although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect all cash requirements for such replacements or for new capital expenditure requirements; •Adjusted EBITDA excludes stock-based compensation expense, which has been, and will continue to be for the foreseeable future, a significant recurring expense in our business and an important part of our compensation strategy; •Adjusted EBITDA excludes acquisition-related impacts consisting of gains (losses) recognized on changes in the fair value of contingent consideration arrangements. The contingent consideration, which was in the form of equity, was valued as of the acquisition date and is marked-to-market at each reporting period based on factors including our stock price;•Adjusted EBITDA does not reflect net changes to reserves for lodging taxes for which management believes it is probable that we may be held jointly liable with Hosts for collecting and remitting such taxes; and •Adjusted EBITDA does not reflect restructuring charges, which include severance and other employee costs, lease impairments, and contract amendments and terminations. Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including net loss and our other GAAP results.54Table of ContentsIn 2022, Adjusted EBITDA was $2.9 billion, compared to $1.6 billion in 2021. This favorable change was due to our revenue growth combined with continued cost management.Adjusted EBITDA ReconciliationThe following is a reconciliation of Adjusted EBITDA to the most comparable GAAP measure, net income (loss): 20212022(in millions, except percentages)Revenue$5,992 $8,399 Net income (loss)$(352)$1,893 Adjusted to exclude the following:Provision for (benefit from) income taxes52 96 Other income (expense), net304 (25)Interest expense438 24 Interest income(13)(186)Depreciation and amortization138 81 Stock-based compensation expense(1)899 930 Acquisition-related impacts11 (12)Net changes in lodging tax reserves3 13 Restructuring charges113 89 Adjusted EBITDA$1,593 $2,903 Adjusted EBITDA as a percentage of Revenue27 %35 %(1)Excludes stock-based compensation related to restructuring, which is included in restructuring charges in the table above. Free Cash Flow We define Free Cash Flow as net cash provided by (used in) operating activities less purchases of property and equipment. We believe that Free Cash Flow is a meaningful indicator of liquidity that provides information to our management, investors and others about the amount of cash generated from operations, after purchases of property and equipment, that can be used for strategic initiatives, including continuous investment in our business, growth through acquisitions, and strengthening our balance sheet. Our Free Cash Flow is impacted by the timing of GBV because we collect our service fees at the time of booking, which is generally before a stay or experience occurs. Funds held on behalf of our customers and amounts payable to our customers do not impact Free Cash Flow, except interest earned on these funds. Free Cash Flow has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of other GAAP financial measures, such as net cash provided by (used in) operating activities. Free Cash Flow does not reflect our ability to meet future contractual commitments and may be calculated differently by other companies in our industry, limiting its usefulness as a comparative measure.In 2022, Free Cash Flow was $3.4 billion compared to $2.3 billion in 2021, representing 41% of revenue. The increase was primarily driven by revenue growth, margin expansion, and significant growth in unearned fees.55Table of ContentsFree Cash Flow Reconciliation The following is a reconciliation of Free Cash Flow to the most comparable GAAP cash flow measure, net cash provided by operating activities: 20212022 (in millions, except percentages)Revenue$5,992 $8,399 Net cash provided by operating activities$2,313 $3,430 Purchases of property and equipment(25)(25)Free Cash Flow$2,288 $3,405 Free Cash Flow as a percentage of Revenue38 %41 %Other cash flow components:Net cash used in investing activities$(1,352)$(28)Net cash provided by (used in) financing activities$1,308 $(689)Constant CurrencyIn addition to revenue growth rates derived from revenue presented in accordance with U.S. GAAP, we disclose below the percentage change in our current period revenue from the corresponding prior period by comparing results using constant currencies. We present constant currency revenue growth rate information to provide a framework for assessing how our underlying revenue performed excluding the effect of changes in exchange rates. We use the percentage change in constant currency revenues for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe the presentation of revenue on a constant currency basis in addition to the U.S. GAAP presentation helps improve the ability to understand our performance because it excludes the effects of foreign currency volatility that are not indicative of our core operating results. We calculate the percentage change in constant currency by determining the change in the current period revenue over the prior comparable period where current period foreign currency revenue is translated using the exchange rates of the comparative period. Geographic Mix Our operations are global, and certain trends in our business, such as Nights and Experiences Booked, GBV, revenue, GBV per Night and Experience Booked, and Nights per Booking vary by geography. We measure Nights and Experiences Booked by region based on the location of the listing. 2021% of Total2022% of Total(in millions, except percentages)Nights and Experiences BookedNorth America114 38 %133 34 %EMEA118 39 %168 43 %Latin America39 13 %53 13 %Asia Pacific30 10 %40 10 %Total301 100 %394 100 %Gross Booking ValueNorth America$25,305 54 %$32,246 51 %EMEA14,607 31 %21,486 34 %Latin America3,706 8 %4,838 8 %Asia Pacific3,259 7 %4,642 7 %Total$46,877 100 %$63,212 100 %RevenueNorth America$3,201 54 %$4,210 50 %EMEA1,931 32 %2,924 35 %Latin America431 7 %643 8 %Asia Pacific429 7 %622 7 %Total$5,992 100 %$8,399 100 %We saw an increase in GBV per Night and Experience Booked in 2022 compared to 2021, in part because our geographic mix shifted to these higher GBV per Night and Experience Booked regions. Specifically, GBV per Night and Experience Booked in 2022 was $240.29 for North America compared to $127.99 for EMEA, $117.41 for Asia Pacific, and $92.89 for Latin America, with a total global GBV per Night and Experience Booked of $160.56. Our total company average nights per booking, excluding experiences for 2022 were 4.2 nights for each of North America, EMEA, and Latin 56Table of ContentsAmerica, and 3.2 nights for Asia Pacific, with a total average of 4.1 nights. We expect that our blended global average nights per booking will continue to fluctuate based on our geographic mix and changes in traveler behaviors.Components of Results of Operations RevenueOur revenue consists of service fees, net of incentives and refunds, charged to our customers. For stays, service fees, which are charged to customers as a percentage of the value of the booking, excluding taxes, vary based on factors specific to the booking, such as booking value, the duration of the booking, geography, and Host type. For experiences, we only earn a Host fee. Substantially all of our revenue comes from stays booked on our platform. Incentives include our referral programs and marketing promotions to encourage the use of our platform and attract new customers, while our refunds to customers are part of our customer support activities. We experience a difference in timing between when a booking is made and when we recognize revenue, which occurs upon check-in. We record the service fees that we collect from customers prior to check-in on our balance sheet as unearned fees. Revenue is net of incentives and refunds provided to customers. Cost of Revenue Cost of revenue includes payment processing costs, including merchant fees and chargebacks, costs associated with third-party data centers used to host our platform, and amortization of internally developed software and acquired technology. Because we act as the merchant of record, we incur all payment processing costs associated with our bookings, and we have chargebacks, which arise from account takeovers and other fraudulent activities. Cost of revenue may vary as a percentage of revenue from year to year based on activity on our platform and may also vary from quarter to quarter as a percentage of revenue based on the seasonality of our business and the difference in the timing of when bookings are made and when we recognize revenue. Operations and Support Operations and support expense primarily consists of personnel-related expenses and third-party service provider fees associated with community support provided via phone, email, and chat to customers; customer relations costs, which include refunds and credits related to customer satisfaction and expenses associated with our Host protection programs; and allocated costs for facilities and information technology.Product Development Product development expense primarily consists of personnel-related expenses and third-party service provider fees incurred in connection with the development of our platform, and allocated costs for facilities and information technology. Sales and Marketing Sales and marketing expense primarily consists of brand and performance marketing, personnel-related expenses, including those related to our field operations, policy and communications, portions of referral incentives and coupons, and allocated costs for facilities and information technology. General and Administrative General and administrative expense primarily consists of personnel-related expenses for management and administrative functions, including finance and accounting, legal, and human resources. General and administrative expense also includes certain professional services fees, general corporate and director and officer insurance, allocated costs for facilities and information technology, indirect taxes, including lodging tax reserves for which we may be held jointly liable with Hosts for collecting and remitting such taxes, and bad debt expense. Restructuring Charges Restructuring charges primarily consist of costs associated with a global workforce reduction in May 2020, lease impairments, and costs associated with amendments and terminations of contracts, including commercial agreements with service providers. Stock-Based CompensationWe grant stock-based awards consisting primarily of stock options, restricted stock awards (“RSAs”), and restricted stock units (“RSUs”) to employees, members of our board of directors, and non-employees. In addition, we have an Employee Stock Purchase Plan (“ESPP”), which was adopted by our board of directors in December 2020. Interest Income Interest income consists primarily of interest earned on our cash, cash equivalents, marketable securities, and amounts held on behalf of customers. 57Table of ContentsInterest Expense Interest expense consists primarily of interest associated with various indirect tax reserves, amortization of debt issuance and debt discount costs, and the loss on extinguishment of debt related to the repayment of the first and second lien loans in March 2021. Other Income (Expense), Net Other income (expense), net consists primarily of realized and unrealized gains and losses on foreign currency transactions and balances, the change in fair value of investments and financial instruments, including the warrants issued in connection with a term loan agreement entered into in April 2020, and our share of income or loss from our equity method investments. Our platform generally enables guests to make payments in the currency of their choice to the extent that the currency is supported by Airbnb, which may not match the currency in which the Host elects to be paid. As a result, in those cases, we bear the currency risk of both the guest payment as well as the Host payment due to timing differences in such payments. We enter into derivative contracts to offset a portion of our exposure to the impact of movements in currency exchange rates on our transactional balances denominated in currencies other than the U.S. dollar. The effects of these derivative contracts are reflected in other income (expense), net. Provision for (Benefit from) Income Taxes We are subject to income taxes in the United States and foreign jurisdictions in which we do business. Foreign jurisdictions have different statutory tax rates than those in the United States. Additionally, certain of our foreign earnings may also be taxable in the United States. Accordingly, our effective tax rate is subject to significant variation due to several factors, including variability in our pre-tax and taxable income and loss and the mix of jurisdictions to which they relate, intercompany transactions, changes in how we do business, acquisitions, investments, tax audit developments, changes in our deferred tax assets and liabilities and their valuation, foreign currency gains and losses, changes in statutes, regulations, case law, and administrative practices, principles, and interpretations related to tax, including changes to the global tax framework, competition, and other laws and accounting rules in various jurisdictions, and relative changes of expenses or losses for which tax benefits are not recognized. Additionally, our effective tax rate can vary based on the amount of pre-tax income or loss. For example, the impact of discrete items and non-deductible expenses on our effective tax rate is greater when our pre-tax income is lower. We have a valuation allowance for our net U.S. deferred tax assets, including federal and state net operating loss carryforwards, tax credits, and intangible assets. We expect to maintain these valuation allowances until it becomes more likely than not that the benefit of our deferred tax assets will be realized by way of expected future taxable income in the United States. We regularly assess all available evidence, including cumulative historic losses and forecasted earnings. Given our current earnings and anticipated future earnings, we believe that there is a reasonable possibility that sufficient positive evidence may become available in a future period to reach a conclusion that the U.S. valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of material U.S. federal and state deferred tax assets and a corresponding decrease to income tax expense in the period the release is recorded. The exact timing and amount of the valuation allowance release are subject to change on the basis of the level of sustained U.S. profitability that we are able to actually achieve, as well as the amount of tax deductible stock compensation dependent upon our publicly traded share price, foreign currency movements, and macroeconomic conditions, among other factors.We recognize accrued interest and penalties related to unrecognized tax benefits in the provision for (benefit from) income taxes. 58Table of ContentsResults of Operations The following table sets forth our results of operations for the periods presented (in millions, except percentages): 20212022Amount% of RevenueAmount% of RevenueRevenue$5,992 100 %$8,399 100 %Costs and expenses:Cost of revenue1,156 19 1,499 18 Operations and support(1)847 14 1,041 12 Product development(1)1,425 24 1,502 18 Sales and marketing(1)1,186 20 1,516 18 General and administrative(1)836 14 950 11 Restructuring charges(1)113 2 89 1 Total costs and expenses5,563 93 6,597 78 Income from operations429 7 1,802 22 Interest income13 — 186 2 Interest expense(438)(7)(24)— Other income (expense), net(304)(5)25 — Income (loss) before income taxes(300)(5)1,989 24 Provision for income taxes52 1 96 1 Net income (loss)$(352)(6)%$1,893 23 %(1)Includes stock-based compensation expense as follows (in millions): 20212022Operations and support$49 $63 Product development545 548 Sales and marketing100 114 General and administrative205 205 Stock-based compensation expense$899 $930 Comparison of the Years Ended December 31, 2021 and 2022 Revenue 20212022% Change(in millions, except percentages)Revenue$5,992 $8,399 40 %Revenue increased $2.4 billion, or 40%, in 2022 compared to 2021, primarily due to a 31% increase in Nights and Experiences Booked combined with higher ADRs. On a constant-currency basis, revenue increased 46% compared to 2021, due to the strengthening of the U.S. dollar against the Euro and British Pounds.Cost of Revenue 20212022% Change(in millions, except percentages)Cost of revenue$1,156 $1,499 30 %Percentage of revenue19 %18 %Cost of revenue increased $343.2 million, or 30%, in 2022 compared to 2021, primarily due to an increase in merchant fees of $313.9 million and an increase of $35.8 million in chargebacks, both related to an increase in pay-in volumes, an increase in cloud computing costs of $24.9 million due to increased server and data storage usage, and an increase of $10.0 million related to SMS notification costs, partially offset by a decrease of $44.3 million in amortization expense for internally developed software and acquired technology.59Table of ContentsOperations and Support 20212022% Change(in millions, except percentages)Operations and support$847 $1,041 23 %Percentage of revenue14 %12 %Operations and support expense increased $193.8 million, or 23%, in 2022 compared to 2021, primarily due to $130.7 million increase in third-party community support personnel and customer relations costs, a $29.8 million increase in insurance costs due to a higher Host Liability Insurance premium resulting from higher overall nights and a higher premium rate, and a $29.2 million increase in payroll-related expenses due to growth in headcount and increased compensation costs. Product Development 20212022% Change(in millions, except percentages)Product development$1,425 $1,502 5 %Percentage of revenue24 %18 %Product development expense increased $77.4 million, or 5%, in 2022 compared to 2021, primarily due to a $51.9 million increase in payroll-related expenses due to growth in headcount and increased compensation costs, and a $14.9 million increase in third-party service providers for contingent workers and consultant support for infrastructure projects, quality assurance services, and support of new product rollouts, including AirCover. Product development expense as a percent of revenue decreased to 18% in 2022, from 24% in the prior year, primarily due to growth in revenue outpacing growth in product development expense as a result of the significant increase in Nights and Experiences Booked combined with higher ADRs and cost saving initiatives.Sales and Marketing 20212022% Change(in millions, except percentages)Brand and performance marketing$723 $1,030 42 %Field operations and policy463 486 5 %Total sales and marketing$1,186 $1,516 28 %Percentage of revenue20 %18 %Sales and marketing expense increased $329.9 million, or 28%, in 2022 compared to 2021, primarily due to a $197.8 million increase in marketing activities associated with our Made Possible by Hosts, Strangers, AirCover, Categories, and OMG marketing campaigns and launches, a $67.9 million increase in our search engine marketing and advertising spend, a $25.1 million increase in payroll-related expenses due to growth in headcount and increase in compensation costs, a $22.0 million increase in third-party service provider expenses, and a $11.1 million increase in coupon expense in line with increase in revenue and launch of AirCover for guests, partially offset by a decrease of $22.9 million related to the changes in the fair value of contingent consideration related to a 2019 acquisition.General and Administrative 20212022% Change(in millions, except percentages)General and administrative$836 $950 14 %Percentage of revenue14 %11 %General and administrative expense increased $114.0 million, or 14%, in 2022 compared to 2021, primarily due to an increase in other business and operational taxes of $41.3 million, a $25.5 million increase in professional services expenses, primarily due to third-party service provider expenses, a $21.7 million increase in bad debt expenses, a $6.2 million increase in travel and entertainment expenses, and a $6.0 million increase in charitable contributions to Airbnb.org, primarily to support Ukrainian refugees.Restructuring Charges 20212022% Change(in millions, except percentages)Restructuring charges$113 $89 (21)%Percentage of revenue2 %1 %Restructuring charges decreased $23.7 million, or 21%, in 2022 compared to 2021. The shift to a remote work model was in direct response to the change in how our employees work due to the impact of COVID-19. As a result, in 2022 we recorded restructuring charges of $89.1 million, which include $80.5 million relating to an impairment of both domestic and international operating lease right-of-use (“ROU”) assets, 60Table of Contentsand $8.4 million of related leasehold improvements. Refer to Note 17, Restructuring, to our consolidated financial statements included in Item 8 of Part 2 of this Annual Report on Form 10-K for additional information.Interest Income and Expense 20212022% Change(in millions, except percentages)Interest income$13 $186 1,361 %Percentage of revenue— %2 %Interest expense$(438)$(24)(95)%Percentage of revenue(7)%— %Interest income increased $173.2 million, or 1,361%, in 2022 compared to 2021, primarily due to higher interest rates. Our investment portfolio was largely invested in money market funds and short-term, high-quality bonds. Interest expense decreased $413.9 million in 2022, primarily due to the $377.2 million loss on extinguishment of debt resulting from retirement of two term loans in March 2021. Refer to Note 9, Debt, to our consolidated financial statements included in Item 8 of Part II of this Annual Report on Form 10-K, for additional information. Other Income (Expense), Net 20212022% Change(in millions, except percentages)Other income (expense), net$(304)$25 (108)%Percentage of revenue(5)%— %Other income (expense), net increased $328.3 million in 2022 compared to 2021, primarily driven by $292.0 million of fair value remeasurement on our warrants issued in connection with our second lien loan in the prior year, which were reclassified to equity in March 2021 and no longer require fair value remeasurement. Provision for Income Taxes 20212022% Change(in millions, except percentages)Provision for income taxes$52 $96 85 %Effective tax rate(17)%5 %The provision for income taxes for the year ended December 31, 2022 increased $44.0 million, compared to 2021, primarily due to increased profitability. See Note 13, Income Taxes, to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further details.Liquidity and Capital Resources Sources and Conditions of LiquidityAs of December 31, 2022, our principal sources of liquidity were cash and cash equivalents and marketable securities totaling $9.6 billion. As of December 31, 2022, cash and cash equivalents totaled $7.4 billion, which included $2.1 billion held by our foreign subsidiaries. Cash and cash equivalents consist of checking and interest-bearing accounts and highly-liquid securities with an original maturity of 90 days or less. As of December 31, 2022, marketable securities totaled $2.2 billion. Marketable securities primarily consist of highly-liquid investment grade corporate debt securities, commercial paper, certificates of deposit, and U.S. government and agency bonds. These amounts do not include funds of $4.8 billion as of December 31, 2022 that we held for bookings in advance of guests completing check-ins that we record separately on our balance sheet in funds receivable and amounts held on behalf of customers with a corresponding liability in funds payable and amounts payable to customers. Cash, cash equivalents, and marketable securities held outside the United States may be repatriated, subject to certain limitations, and would be available to be used to fund our domestic operations. However, repatriation of such funds may result in additional tax liabilities. We believe that our existing cash, cash equivalents, and marketable securities balances in the United States are sufficient to fund our working capital needs in the United States. We have access to $1.0 billion of commitments under the 2022 Credit Facility. As of December 31, 2022, no amounts were drawn under the 2022 Credit Facility. See Note 9, Debt, to our consolidated financial statements included in Item 8 of Part 2 of this Annual Report on Form 10-K for a description of the 2022 Credit Facility entered into on October 31, 2022.Material Cash RequirementsAs of December 31, 2022, we had outstanding $2.0 billion in aggregate principal amount of indebtedness of our convertible senior notes due 2026. On March 3, 2021, in connection with the pricing of the 2026 Notes, we entered into privately negotiated capped call transactions (the “Capped Calls”) with certain of the initial purchasers and other financial institutions (the "option counterparties") at a cost of approximately 61Table of Contents$100.2 million. The cap price of the Capped Calls was $360.80 per share of Class A common stock, which represented a premium of 100% over the last reported sale price of the Class A common stock of $180.40 per share on March 3, 2021, subject to certain customary adjustments under the terms of the Capped Call Transactions. See Note 9, Debt, to our consolidated financial statements included in Item 8 of Part 2 of this Annual Report on Form 10-K for additional information. As of December 31, 2022, our total minimum lease payments were $354.0 million, of which $80.7 million is due in the succeeding 12 months. We have a commercial agreement with a data hosting services provider to spend or incur an aggregate of at least $941.7 million for vendor services through 2027. See Note 8. Leases, Note 9, Debt, and Note 12, Commitments and Contingencies to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for further information regarding these commitments.On August 2, 2022, we announced that our board of directors approved a share repurchase program with authorization to purchase up to $2.0 billion of our Class A common stock at management’s discretion (the “Share Repurchase Program”). Share repurchases under the Share Repurchase Program may be made through a variety of methods, which may include open market purchases, privately negotiated transactions, block trades, or accelerated share repurchase transactions, or by any combination of such methods. Any such repurchases will be made from time to time subject to market and economic conditions, applicable legal requirements, and other relevant factors. The Share Repurchase Program does not have an expiration date, does not obligate us to repurchase any specific number of shares, and may be modified, suspended, or terminated at any time at our discretion. During 2022, we repurchased and subsequently retired 13.8 million shares of our common stock for $1.5 billion under the Share Repurchase Program. As of December 31, 2022, we had $500.0 million available to repurchase shares pursuant to the Share Repurchase Program.Cash Flows The following table summarizes our cash flows for the periods indicated (in millions): 20212022Net cash provided by operating activities$2,313 $3,430 Net cash used in investing activities(1,352)(28)Net cash provided by (used in) financing activities1,308 (689)Effect of exchange rate changes on cash, cash equivalents, and restricted cash(210)(337)Net increase in cash, cash equivalents, and restricted cash$2,059 $2,376 Cash Provided by Operating Activities Net cash provided by operating activities in 2022 was $3.4 billion, which is due to net income in 2022 of $1.9 billion, adjusted for non-cash charges, primarily consisting of $929.6 million of stock-based compensation expense, impairment of long-lived assets of $91.4 million, and $62.5 million of foreign exchange losses due to the strengthening of the U.S. dollar against the Euro and British Pound. Additional cash was provided by changes in working capital, including a $279.9 million increase in unearned fees resulting from significantly higher bookings and accrued expenses and other liabilities of $272.7 million.Net cash provided by operating activities in 2021 was $2.3 billion. Our net loss for 2021 was $352.0 million, adjusted for non-cash charges, primarily consisting of $898.8 million of stock-based compensation expense, $377.2 million of loss on extinguishment of debt, $292.0 million of fair value remeasurement on warrants issued in connection with a term loan agreement entered into in April 2020, $138.3 million of depreciation and amortization, $112.5 million of impairment of long-lived assets, and $27.3 million of bad debt expense. Additional inflow of cash resulted from changes in working capital, including a $495.8 million increase in unearned fees resulting from significantly higher bookings.Cash Used in Investing Activities Net cash used in investing activities in 2022 was $28.0 million, which was primarily from the proceeds from maturities and sales of marketable securities of $3.2 billion and $909.5 million, respectively, partially offset by purchases of marketable securities of $4.1 billion.Net cash used in investing activities in 2021 was $1.4 billion, which was primarily due to purchases of marketable securities of $4.9 billion, partially offset by proceeds resulting from sales and maturities of marketable securities of $1.6 billion and $2.0 billion, respectively. Cash Provided by (Used in) Financing Activities Net cash used in financing activities in 2022 was $689.2 million, primarily reflecting the increase in funds payable and amounts payable to customers of $1.3 billion resulting from significantly higher bookings, offset by our share repurchase of $1.5 billion under the Share Repurchase Program, and an increase in the taxes paid related to net share settlement of equity awards of $607.4 million. Net cash provided by financing activities in 2021 was $1.3 billion, primarily reflecting the proceeds from the issuance of convertible senior notes, net of issuance costs, of $2.0 billion and an increase in funds payable and amounts payable to customers of $1.6 billion, partially offset by the repayment of long-term debt and a related prepayment penalty of $2.0 billion and $212.9 million, respectively.Effect of Exchange Rates 62Table of ContentsThe effect of exchange rate changes on cash, cash equivalents, and restricted cash on our consolidated statements of cash flows relates to certain of our assets, principally cash balances held on behalf of customers, that are denominated in currencies other than the functional currency of certain of our subsidiaries. During 2021 and 2022, we recorded reductions of $209.9 million and $337.4 million, respectively, in cash, cash equivalents, and restricted cash, primarily due to the strengthening of the U.S. dollar against certain currencies. The impact of exchange rate changes on cash balances can serve as a natural hedge for the effect of exchange rates on our liabilities to our customers. We assess our liquidity in terms of our ability to generate cash to fund our short- and long-term cash requirements. As such, we believe that the cash flows generated from operating activities will meet our anticipated cash requirements in the short-term. In addition to normal working capital requirements, we anticipate that our short- and long-term cash requirements will include funding capital expenditures, debt repayments, share repurchases, introduction of new products and offerings, timing and extent of spending to support our efforts to develop our platform, and expansion of sales and marketing activities. Our future capital requirements, however, will depend on many factors, including, but not limited to our growth, headcount, and ability to attract and retain customers on our platform. Additionally, we may in the future raise additional capital or incur additional indebtedness to continue to fund our strategic initiatives. On a long-term basis, we would rely on either our access to the capital markets or our credit facility for any long-term funding not provided by operating cash flows and cash on hand. In the event that additional financing is required from outside sources, we may seek to raise additional funds at any time through equity, equity-linked arrangements, and/or debt, which may not be available on favorable terms, or at all. If we are unable to raise additional capital when desired and at reasonable rates, our business, results of operations, and financial condition could be materially adversely affected. Our liquidity is subject to various risks including the risks identified in the section titled "Risk Factors" in Item 1A and market risks identified in the section entitled "Quantitative and Qualitative Disclosures about Market Risk" in Item 7A.Indemnification Agreements In the ordinary course of business, we include limited indemnification provisions under certain agreements with parties with whom we have commercial relations of varying scope and terms. Under these contracts, we may indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with breach of the agreements, or intellectual property infringement claims made by a third party, including claims by a third party with respect to our domain names, trademarks, logos, and other branding elements to the extent that such marks are applicable to its performance under the subject agreement. It is not possible to determine the maximum potential loss under these indemnification provisions due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular provision. To date, no significant costs have been incurred, either individually or collectively, in connection with our indemnification provisions. In addition, we have entered into indemnification agreements with our directors, executive officers, and certain other employees that require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, executive officers, or employees. Critical Accounting Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs, and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions. We believe that of our significant accounting policies, which are described in Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition, results of operations, and cash flows.Lodging Tax Obligations In jurisdictions where we do not collect and remit lodging taxes, the responsibility for collecting and remitting these taxes, if applicable, generally rests with Hosts. We estimate liabilities for a certain number of jurisdictions with respect to state, city, and local taxes related to lodging where we believe it is probable that Airbnb could be held jointly liable with Hosts for collecting and remitting such taxes and the related amounts can be reasonably estimated. Changes to these liabilities are recorded in general and administrative expense in our consolidated statements of operations.Evaluating potential outcomes for lodging taxes is inherently uncertain and requires us to utilize various judgments, assumptions, and estimates in determining our reserves. A variety of factors could affect our potential obligation for collecting and remitting such taxes which include, but are not limited to, whether we determine, or any tax authority asserts, that we have a responsibility to collect lodging and related taxes on either historic or future transactions; the introduction of new ordinances and taxes which subject our operations to such taxes; or the ultimate resolution of any historic claims that may be settled through negotiation. Accordingly, the ultimate resolution of lodging taxes may be greater or less than reserve amounts we have established. See Note 12, Commitments and Contingencies, to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for additional information. Income Taxes We are subject to income taxes in the United States and foreign jurisdictions. We account for income taxes using the asset and liability method. We account for uncertainty in tax positions by recognizing a tax benefit from uncertain tax positions when it is more likely than not that the position will be sustained upon examination. Evaluating our uncertain tax positions, determining our provision for (benefit from) 63Table of Contentsincome taxes, and evaluating the impact of tax law changes, are inherently uncertain and require making judgments, assumptions, and estimates. In determining the need for a valuation allowance, we weigh both positive and negative evidence in the various jurisdictions in which we operate to determine whether it is more likely than not that our deferred tax assets are recoverable. We regularly assess all available evidence, including cumulative historic losses and forecasted earnings. Due to cumulative losses in the U.S. during the prior three years, including tax deductible stock compensation, and based on all available positive and negative evidence, we do not believe it is more likely than not that our U.S. deferred tax assets will be realized as of December 31, 2022. Accordingly, a full valuation allowance has been established in the United States, and no deferred tax assets and related tax benefit have been recognized in the financial statements. However, given our current earnings and anticipated future earnings, we believe that there is a reasonable possibility that sufficient positive evidence may become available in a future period to allow us to reach a conclusion that the U.S. valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of material U.S. federal and state deferred tax assets and a corresponding decrease to income tax expense in the period the release is recorded. The exact timing and amount of the valuation allowance release are subject to change on the basis of the level of sustained U.S. profitability that we are able to actually achieve, as well as the amount of tax deductible stock compensation dependent upon our publicly traded share price, foreign currency movements, and macroeconomic conditions, among other factors.While we believe that we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for (benefit from) income taxes and the effective tax rate in the period in which such determination is made. Recent Accounting Pronouncements See Note 2, Summary of Significant Accounting Policies, to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. Item 7A. Quantitative and Qualitative Disclosures About Market RiskOur substantial operations around the world expose us to various market risks. These risks primarily include foreign currency risk and investment risk. Foreign Currency Exchange Risk We offer the ability to transact on our platform in over 40 currencies, of which the most significant foreign currencies to our operations in 2022 were the Euro, British Pound, Canadian Dollar, Australian Dollar, Brazilian Real, and Mexican Peso. Our international revenue, as well as costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. Accordingly, we are subject to foreign currency risk, which may adversely impact our financial results. We have foreign currency exchange risks related primarily to: •revenue and cost of revenue associated with bookings on our platform denominated in currencies other than the U.S. dollar; •balances held as funds receivable and amounts held on behalf of customers and funds payable and amounts payable to customers; •unbilled amounts for confirmed bookings under the terms of our Pay Less Upfront program; and •intercompany balances primarily related to our payment entities that process customer payments. For revenue and cost of revenue associated with bookings on our platform outside of the United States, we generally receive net foreign currency amounts and therefore benefit from a weakening of the U.S. dollar and are adversely affected by a strengthening of the U.S. dollar. Movements in foreign exchange rates are recorded in other income (expense), net in our consolidated statements of operations. Furthermore, our platform generally enables guests to make payments in the currency of their choice to the extent that the currency is supported by Airbnb, which may not match the currency in which the Host elects to be paid. As a result, in those cases, we bear the currency risk of both the guest payment as well as the Host payment due to timing differences in such payments.We use foreign currency derivative contracts to protect against foreign exchange risks. These hedges are primarily designed to manage foreign exchange risk associated with balances held as funds payable and amounts payable to customers. These contracts reduce, but do not entirely eliminate, the impact of currency exchange rate movements on our assets and liabilities. In the first quarter of 2023, we initiated a foreign exchange cash flow hedging program to minimize the effects of currency fluctuations on revenue in the future.We have experienced and will continue to experience fluctuations in foreign exchange gains and losses related to changes in exchange rates. If our foreign-currency denominated assets, liabilities, revenues, or expenses increase, our results of operations may be more significantly impacted by fluctuations in the exchange rates of the currencies in which we do business. During 2022, we experienced negative foreign currency impacts to revenue due to the strengthening of the U.S. dollar relative to certain foreign currenciesIf an adverse 10% foreign currency exchange rate change was applied to total net monetary assets and liabilities denominated in currencies other than the local currencies as of December 31, 2022, it would not have had a material impact on our consolidated financial statements. Investment and Interest Rate Risk 64Table of ContentsWe are exposed to interest rate risk related primarily to our investment portfolio. Changes in interest rates affect the interest earned on our total cash, cash equivalents, and marketable securities and the fair value of those securities. We had cash and cash equivalents of $7.4 billion and marketable securities of $2.2 billion as of December 31, 2022, which consisted of highly-liquid investment grade corporate debt securities, commercial paper, certificates of deposit, and U.S. government and agency bonds. As of December 31, 2022, we had an additional $4.8 billion that we held for bookings in advance of guests completing check-ins, which we record separately on our consolidated balance sheets as funds receivable and amounts held on behalf of customers. The primary objective of our investment activities is to preserve capital and meet liquidity requirements without significantly increasing risk. We invest primarily in highly-liquid, investment grade debt securities, and we limit the amount of credit exposure to any one issuer. We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. Because our cash equivalents and marketable securities generally have short maturities, the fair value of our portfolio is relatively insensitive to interest rate fluctuations. Due to the short-term nature of our investments, we have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in interest rates. A hypothetical 100 basis points increase in interest rates would have resulted in a decrease of $13.1 million to our investment portfolio as of December 31, 2022. 65Table of Contents
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+Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report. We do not undertake to update any forward-looking statements.3Table of ContentsPART IItem 1. BUSINESSOverviewAllegion plc ("Allegion," "we," "us" or "the Company") is a leading global provider of security products and solutions that keep people and assets safe and secure in the places they live, learn, work and visit. We create peace of mind by pioneering safety and security with a vision of seamless access and a safer world. Seamless access allows authorized, automated and safe passage and movement through spaces and places in the most efficient and frictionless manner possible. Central to our vision is partnering and developing ecosystems to create a flawless experience and enable an uninterrupted and secure flow of people and assets. We offer an extensive and versatile portfolio of security and access control products and solutions across a range of market-leading brands. Our experts across the globe deliver high-quality security products, services and systems, and we use our deep expertise to serve as trusted partners to end-users who seek customized solutions to their security needs.Allegion Principal Products and ServicesDoor controls and systemsLocks, locksets, portable locks and key systemsExit devicesElectronic security productsSoftware-enabled access control systemsTime, attendance and workforce productivity systemsDoors, accessories and otherServices and softwareAccess control security products and solutions are critical elements in every building and home. Many door openings are configured to maximize a room’s particular form and function while also meeting local and national building and safety code requirements and end-user security needs. Most buildings have multiple door openings, each serving its own purpose and requiring different specific access control solutions. Each door must fit exactly within its frame, be prepared precisely for its hinges, synchronize with its specific lockset and corresponding latch and align with a specific key to secure the door. Moreover, with the increasing adoption of the Internet of Things ("IoT"), security products – including credentials – are increasingly linked electronically, integrated into software and popular consumer technology platforms and controlled with mobile applications, creating additional functionality and complexity. Seamless access capitalizes on the ability for multiple products and brands to work in tandem, allowing people and assets to move efficiently and safely by adapting access rights for various settings or use cases. These solutions can also provide insights on usage and traffic patterns to boost efficiency, improve hygiene of high-traffic areas and improve visitor, staff and tenant experiences.We believe our ability to deliver a wide range of solutions that can be custom configured to meet end-users’ security needs is a key driver of our success. We accomplish this with: •Our extensive and versatile product and service portfolio, combined with our deep expertise, which enables us to deliver the right products and solutions to meet diverse security and functional specifications and to successfully and securely integrate into leading technologies and systems; •Our consultative approach and expertise, which enables us to develop the most efficient and appropriate building security and access control specifications to fulfill the unique needs of our end-users and their partners, including architects, contractors, homebuilders and engineers;•Our access to and management of key channels in the market, which is critical to delivering our products in an efficient and consistent manner; and •Our enterprise excellence capabilities, including our global manufacturing operations and agile supply chain, which facilitate our ability to deliver specific product and system configurations to end-users and consumers worldwide, quickly and efficiently. We believe the security products industry will continue to benefit from several global macroeconomic trends, including:•Expected growth in global electronic products and solutions as end-users adopt newer technologies in their facilities and homes;•Heightened awareness of security and privacy requirements;•Increased focus on touchless solutions that help promote a healthy environment; and•The shift to a digital, interconnected environment.We operate in and report financial results for two segments: Allegion Americas and Allegion International, the latter of which provides security products, services and solutions primarily throughout Europe, Asia and Oceania. We sell our products and solutions under the following brands:4Table of Contents5Table of Contents6Table of ContentsWe sell a wide range of security and access control solutions for end-users in commercial, institutional and residential facilities worldwide, including the education, healthcare, government, hospitality, retail, commercial office and single and multi-family residential markets. Our leading brands include CISA®, Interflex®, LCN®, Schlage®, SimonsVoss® and Von Duprin®. We believe LCN, Schlage and Von Duprin hold the No. 1 or No. 2 position in their primary product categories in North America while CISA, Interflex and SimonsVoss hold the No. 1 or No. 2 position in their primary product categories in certain European markets.During the year ended December 31, 2022, we generated Net revenues of $3,271.9 million and Operating income of $586.4 million. History and DevelopmentsWe were incorporated in Ireland on May 9, 2013, to hold the commercial and residential security businesses of what was then Ingersoll Rand plc ("Ingersoll Rand"). On December 1, 2013, we became a stand-alone public company after Ingersoll Rand completed the separation of these businesses from the rest of Ingersoll Rand via the transfer of these businesses from Ingersoll Rand to us and the issuance by us of ordinary shares directly to Ingersoll Rand’s shareholders (the "Spin-off"). Our security businesses have long and distinguished operating histories. Several of our brands were established more than 100 years ago, and many originally created their categories: •Von Duprin, established in 1908, was awarded the first exit device patent;•Schlage, established in 1920, was awarded the first patents granted for the cylindrical lock and the push button lock; •LCN, established in 1926, created the first door closer; •CISA, established in 1926, devised the first electronically controlled lock; and•SimonsVoss, established in 1995, created the first keyless digital transponder.We have built upon these founding legacies since our entry into the security products market through the acquisition of Schlage, Von Duprin and LCN in 1974. Today, we continue to develop, acquire and introduce innovative and market-leading products. For example, in 2022, we acquired Stanley Access Technologies LLC and assets related to the automatic entrance solutions business from Stanley Black & Decker, Inc. (the "Access Technologies business"), which patented the world's first hands-free door operator in 1931. Through this acquisition, we have added another innovative market leader to our portfolio of businesses and broadened our product and service offerings throughout the U.S. and Canada. 7Table of ContentsIn 2018, we announced the formation of Allegion Ventures to invest in and help accelerate the growth of companies that have innovative, digital-first technologies and products such as touchless access and workspace monitoring solutions that complement our core business solutions. Building on this success, in December 2021, Allegion Ventures announced a second fund with an additional allocation of $100 million to focus on investing in technologies like artificial intelligence, video monitoring, machine learning and cybersecurity.Recent examples of successful product launches by Allegion are illustrated in the table below:ProductBrandsYearInnovationElectronic Locks, Locksets and Portable LocksSchlage, Gainsborough, CISA2020/ 2021/2022Schlage Encode Plus Smart WiFi Deadbolt, one of the first in the market to work with Apple home keys, allows lock or unlock access using an iPhone or Apple Watch. NDEBSi and LEBSi (Schlage) wireless electronic locks expand access control. Introduction of MIFARE® DESFire® EV3 family (Schlage) provides increased levels of security, flexibility and freedom of choice for customers when it comes to providing access using credential technology. In Australia, a next generation smart lock, Freestyle Trilock (Gainsborough), features passage, privacy or dead lock modes and can be operated using the built-in keypad, a key override or through the mobile app. In conjunction with the optional WiFi bridge, the Trilock can be programmed and operated from anywhere in the world. In Europe, new high security connected solutions (CISA Domo Connexa) and integration of Smart Access functionalities include CISA ACS platform solutions for hospitality, with both cloud-based (Aero) and on-premise hardware (eServer), as well as wall mount energy saver with card intelligent detection. Electronic Key Systems and Access Control, Mobile and Web ApplicationsSchlage, ISONAS, SimonsVoss2020/ 2021/2022Mobile Student ID (Schlage) allows university students, faculty and staff to add student ID cards to their virtual wallets for door access, payments, attendance tracking and ticketing. Pure Access (ISONAS) enhanced support for mobile-ready MTB readers (Schlage) connected to an ISONAS IP-Bridge allows seamless integration with mobile credentials and enhanced functionality for the NDE/LE (Schlage) wireless locks.FSS1 High Security Door Position Sensors (Schlage) provide a high-security solution with adjustable anti-tamper features to help prevent against attacks through magnetic, electronic or physical means. AX Manager Classic (SimonsVoss) for management of digital locking systems based on a new Microsoft SQL-based backend system with new user interface.Mechanical Locks, Locksets, Portable Locks and Key SystemsCISA, Bricard, AXA2020/ 2021/2022New flat key European cylinders for multiple entrance buildings (CISA Asix P8). Evidence (Bricard) handle ranges for commercial and residential markets, with an exclusive rose fixation and adjustment design, functionality and finishes.Innovation in bike safety including Fold Lite (AXA) folding bike lock with a bracket that can be mounted on the frame.Electronic and Electrified Door Controls and Systems and Exit DevicesVon Duprin, LCN2020/ 2021/2022Security indicator (Von Duprin) for visual verification and lockdown. The 2SI security indicator provides at-a-glance verification of door status from inside the room. Also available as a retrofit conversion kit for existing 98/99 Series (Von Duprin) exit devices.New 6400 Compact Series (LCN) low-energy automatic operator retrofit solution with actuators reduces the cost and complexity of touchless access and adds ADA accessibility. Enhancements to the already durable 4040XP (LCN) door closer, making it even easier to install and maintain. Follows the introduction of a range of touchless solutions, including automatic operators, actuators and wireless transmitters.Doors, Accessories and OtherTGP2021North America's first fire-rated Full-Lite Door System (TGP), certified to meet forced entry standards.8Table of ContentsIndustry and Competition We serve customers within institutional, commercial and residential construction and remodeling markets throughout North America, Europe, Asia and Oceania. We expect the security products industry will continue to benefit from favorable trends such as increased concerns about safety and security, new attention on touchless solutions that help promote a healthy environment and technology-driven innovation that enables seamless access and a better user experience as people and assets traverse multiple locations and facilities. Further, we expect continued growth in connected security products and solutions as end-users continue to adopt newer technologies, including IoT, in their facilities and single and multi-family homes.The security products markets are highly competitive and fragmented throughout the world, with a number of large multi-national companies and thousands of smaller regional and local companies. This high degree of fragmentation primarily reflects local regulatory requirements and highly variable end-user needs. We believe our principal global competitors are Assa Abloy AB and dormakaba Group. We also face competition in various markets and product categories throughout the world, including from Spectrum Brands Holdings, Inc. in the North American residential market. As we move into more technologically advanced product categories, we may also compete against new, more specialized competitors and technology companies.Our success depends on a variety of factors, including brand and reputation, product breadth, innovation, integration with popular technology platforms, quality and delivery capabilities, price and service capabilities. As many of our businesses sell through wholesale distribution, our success also depends on building and partnering with a strong channel network. Although price often serves as an important customer decision point, we also compete based on the breadth, innovation and quality of our products and solutions, our ability to custom-configure solutions to meet individual end-user requirements and our global supply chain.Products and ServicesWe offer the following extensive and versatile portfolio of security and access control products and solutions across a range of market-leading brands:•Locks, locksets, portable locks and key systems: A broad array of cylindrical, tubular and mortise door locksets, security levers and master key systems that are used to protect and control access and a range of portable security products, including bicycle, small vehicle and travel locks;•Electronic security products and access control systems: A broad range of electrified locks, electrified door closers and exit devices, access control products and systems, credentials and credential readers and accessories, including IoT, Bluetooth Low Energy, Power over Ethernet and cloud-based solutions;•Time, attendance and workforce productivity systems: These products are designed to help business customers manage and monitor workforce access, attendance and employee scheduling;•Door controls and systems and exit devices: An extensive portfolio of life-safety products and solutions generally installed on fire doors and facility entrances and exits. Exit devices, also known as panic hardware, provide rapid egress to allow building occupants to exit safely in an emergency. Door controls and systems include mechanical door closers, automatic door operators, as well as high-performance interior and storefront door systems. In addition, with our recently acquired Access Technologies business, we now offer a full range of automatic entrance solutions, including sliding, swing, folding and ICU doors, as well as an array of sensors, controls and security options for commercial and institutional buildings;•Doors, accessories and other: A portfolio of hollow metal, glass and specialty doors, as well as a variety of additional security products and components, including hinges, door pulls, door stops, bike lights, louvers, weather stripping, thresholds and other accessories, as well as certain bathroom fittings and accessibility aids; and•Services and software: Our Access Technologies business offers extensive planned inspection, maintenance and repair services for its automatic entrance solutions throughout the U.S. and Canada. Additionally, we offer software as a service ("SaaS") offerings throughout the U.S. and internationally, including access control, IoT integration and workforce management solutions. We also offer ongoing aftermarket services, design and installation offerings and locksmith services in select locations.CustomersWe sell most of our products and solutions through distribution and retail channels, including specialty distribution, e-commerce and wholesalers. We have built a network of channel partners that help our customers choose the right solution to meet their security needs and help commercial and institutional end-users fulfill and install orders. We also sell through a variety of retail channels, including large do-it-yourself home improvement centers, multiple online and e-commerce platforms, as well as small, specialty showroom outlets. We work with our retail partners on developing marketing and merchandising strategies to maximize their sales per square foot of shelf space. Through a few of our businesses, most notably our Access Technologies business, Interflex and our Global Portable Security brands, we also provide products and services directly to end-users.Our 10 largest customers represented approximately 26% of our total Net revenues in 2022. No single customer represented 10% or more of our total Net revenues in 2022.9Table of ContentsSales and MarketingIn markets where we sell through commercial and institutional distribution channels, we employ sales professionals around the world who work with a combination of end-users, security professionals, architects, contractors, engineers and distribution partners to develop specific, custom-configured solutions for our end-users’ needs. Our field sales professionals are assisted by specification writers who work with architects, engineers and consultants to help design door openings and security systems to meet end-users’ functional, aesthetic and regulatory requirements. Both groups are supported by dedicated customer care and technical sales-support specialists worldwide. We also support our sales efforts with a variety of marketing efforts, including trade-specific advertising, cooperative distributor merchandising, digital marketing and marketing at a variety of industry trade shows.In markets in which we sell through retail and home-builder distribution channels, we have teams of sales, merchandising and marketing professionals who help drive brand and product awareness through our channel partners and to consumers. We utilize a variety of advertising and marketing strategies, including traditional consumer media, retail merchandising, digital marketing, retail promotions and builder and consumer trade shows, to support these teams. We also work actively with several industry bodies around the world to help promote effective and consistent safety and security standards. For example, we are members of the American Association of Automatic Door Manufacturers (AAADM), Builders Hardware Manufacturers Association (BHMA), Connectivity Standards Alliance, Construction Specification Institute, Door and Hardware Institute (DHI), FiRa Consortium, National Association of State Fire Marshals (NASFM), Partner Alliance for Safer Schools (PASS), Physical Security Interoperability Alliance (PSIA), Security Industry Association, Security Technology Alliance, Z-Wave Alliance, The European Federation of Associations of Locks and Builders Hardware Manufacturers (ARGE), ASSOFERMA (Italy), BHE (Germany) and UNIQ (France).Production and DistributionWe manufacture products in several geographic markets around the world. We operate 29 principal production and assembly facilities – 16 in our Allegion Americas segment and 13 in our Allegion International segment. We own 16 of these facilities and lease the others. Our strategy is to produce in the region of use, wherever appropriate, to allow us to be closer to the end-user and increase efficiency and timely product delivery. Much of our U.S. based residential portfolio is manufactured in the Baja region of Mexico under the Maquiladora, Manufacturing and Export Services Industry ("IMMEX") program. In managing our network of production and assembly facilities, we focus on continuous improvement in customer experience, employee health and safety, productivity, resource utilization and operational excellence.We distribute our products through a broad network of channel partners. In addition, third-party manufacturing and logistics providers perform certain manufacturing, storage and distribution services for us to support certain parts of our manufacturing and distribution network.Raw MaterialsWe support our region-of-use production strategy with corresponding region-of-use supplier partners for much of our supply base. Our global and regional commodity teams work with production leadership, product management and materials management teams to procure materials for production. Where appropriate, we may enter into fixed-cost contracts to lower overall costs.We purchase a wide range of raw materials, including steel, zinc, brass and other non-ferrous metals, as well as other parts and components, such as electronic components, to support our production facilities. Through much of 2022, we continued to experience supply chain disruptions and delays, including logistical challenges; shortages in parts and materials (particularly shortages of electronic components); and increased material and other inflation. While these trends have negatively impacted our results of operations, we have taken multiple actions to address these challenges, including product redesigns, carrying increased levels of safety stock and working with our supplier base, including establishing new and diverse supplier relationships, to increase part and component availability and our overall supply chain agility. As a result of these actions, we have seen many of these supply chain related challenges improve over the second half of 2022, although shortages of electronic parts and components persist. See "Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" for a more detailed discussion of these trends and challenges.Intellectual PropertyIntellectual property, inclusive of certain patents, trademarks, copyrights, know-how, trade secrets and other proprietary rights, is important to our business. We create, protect and enforce our intellectual property investments in a variety of ways. We work actively in the U.S. and internationally to try to ensure the protection and enforcement of our intellectual property rights. We use trademarks on nearly all of our products and believe such distinctive marks are an important factor in creating a market for our goods, in identifying us and in distinguishing our products from others. We consider our CISA, Interflex, LCN, Schlage, SimonsVoss, Von Duprin and other associated trademarks to be among our most valuable assets, and we have registered these trademarks in a number of countries. Although certain proprietary intellectual property rights are important to our success, we do not believe we are materially dependent on any particular patent or license, or any particular group of patents or licenses. 10Table of ContentsFacilitiesWe operate through a broad network of sales offices, engineering centers, 29 principal production and assembly facilities and several distribution centers throughout the world. Our active properties represent approximately 6.7 million square feet, of which approximately 41% is leased. The following table shows the location of our principal worldwide production and assembly facilities:Production and Assembly FacilitiesAllegion AmericasAllegion InternationalBlue Ash, OhioAuckland, New ZealandChino, CaliforniaBlackburn, AustraliaEnsenada, MexicoBrooklyn, AustraliaEverett, WashingtonClamecy, FranceFarmington, ConnecticutDurchhausen, GermanyGreenfield, IndianaFaenza, ItalyIndianapolis, IndianaFeuquieres, FranceIrving, TexasJinshan, ChinaMcKenzie, TennesseeMonsampolo, ItalyMississauga, OntarioOsterfeld, GermanyPerrysburg, OhioRenchen, GermanyPrinceton, IllinoisVeenendaal, NetherlandsSecurity, ColoradoZawiercie, PolandSnoqualmie, WashingtonTecate, MexicoTijuana, MexicoResearch and DevelopmentWe are committed to investing in our research and development capabilities with a focus on innovations that will deliver growth through the introduction of new products and solutions. In addition, we invest in initiatives that continuously drive improvements in product cost, quality, safety and sustainability.Our research and development team is managed as a global, collaborative group to identify and develop new technologies and worldwide product platforms. Our regionally located resources leverage expertise in local standards and configurations and apply those to adapt products for the benefit of our customers. Further, we operate a global technology center in Bengaluru, India, which augments and supports our regional engineering and technology teams.SeasonalityOur business experiences seasonality that varies by product and service line. For instance, as more construction and do-it-yourself projects occur during the second and third calendar quarters in the Northern Hemisphere, our security product sales related to those projects are typically higher in those quarters than in the first and fourth quarters. However, certain other businesses typically experience higher sales in the fourth quarter due to demand for services and project timing. Human CapitalOur human capital strategy is based on our values and is foundational to achieving our business strategy. To ensure we attract and retain top talent, we strive for a diverse and inclusive culture that rewards performance, provides growth and development opportunities and supports employees through competitive compensation, benefits and numerous volunteer and charitable giving opportunities.As of December 31, 2022, we had approximately 12,300 employees worldwide, with approximately 46% employed within the U.S. and approximately 54% based outside the U.S. Among our U.S. based employees, approximately 15% were subject to collective bargaining agreements with various labor unions. Outside the U.S., we have employees in certain countries, particularly in Europe, that are represented by an employee representative organization, such as a works council. The vast majority of our employees work on a full-time basis. Our employee base is supplemented by contingent labor where business demand fluctuates or we experience short-term needs for specialized skills. We believe our relations with our workforce in both unionized and non-unionized settings are generally positive.Compensation and BenefitsCompensation and benefit programs are tailored to be competitive in the geographies where we work, including a total rewards package (which varies by country/region) that includes hourly and salaried compensation, performance-based incentive and long-term equity incentive plans, retirement, insurance and government social welfare programs, disability and family leave, 11Table of Contentshealth and wellness programs, education benefits to pursue degrees and certifications and additional offerings to support financial stability and personal planning. The Allegion Leadership Behaviors – break boundaries, innovate, be courageous, engage and develop, champion change and be inclusive – work in concert with our performance management system to reinforce our values and code of conduct in assessing how people lead and deliver top performance.Talent Attraction Our employer brand strength creates a differentiated employee experience that attracts and retains the right talent for Allegion. Our talent attraction efforts are focused on and highlight a culture that reflects our core values, Allegion Leadership Behaviors and business objectives. These efforts begin well before people work for us. Around the world, our sites partner with schools and support teachers, providing mentoring, grants, scholarships, internships, co-op programs, classroom technology and on-site activities and full-time rotational programs after graduation. Our sites sponsor science, technology, engineering and math ("STEM") programs and competitions to spur interest in fields like robotics, IT and engineering. In the U.S., we also host annual Manufacturing Day events virtually and at several of our production and assembly facilities. These programs expose students to careers in manufacturing and technology and provide educators with programming to encourage academic excellence and social development while building a pipeline of talent for us. We want to attract talent with core capabilities relevant to our long-term corporate business strategy: customer focus, innovation, partnering, pace and agility and collaboration. We use a variety of recruitment tactics to ensure a strong base of labor for manufacturing operations and to build the base of talent with these capabilities. Throughout the recruitment cycle, we provide a technology-enabled seamless experience for internal and external candidates and hiring managers.Talent Development and Succession PlanningTalent development and succession planning are key components of the Allegion Operating System, our system of annual operation that supports governance, reporting processes and management of the business. Our performance management system includes annual performance reviews for all permanent salaried employees, where, in alignment with our values, an open feedback culture is encouraged, regardless of level or hierarchy. Inclusive talent development and succession planning takes place at all levels of the organization and is supported through the Allegion Leadership Behaviors, individual career mapping, assessment of performance and talent pipeline planning up to and including the executive leadership team ("ELT"). As part of their quarterly business review, the ELT reviews talent development, focusing on developing a diverse succession pipeline. These cross-functional reviews highlight individuals who are ready for new opportunities, individuals who are on a special assignment or project and individuals early in their career that demonstrate emerging leadership skills.Learning and Development Opportunities for on-going learning and development are delivered to employees through structured coursework, on-site and expert-led training and experiential, applied development. The Allegion Academy is offered globally, supporting multiple languages and providing more than 20,000 self-guided online courses, as well as learning community channels on targeted skills and topics like inclusion and diversity. We offer programs to provide successive levels of development, including reskilling and upskilling existing employees, as well as strengths-based leadership curriculum and global programs for employee mentoring and coaching. Enterprise excellence initiatives and sprint teams expand skills in lean manufacturing and quality principles and lead to redesigning workflow to boost productivity and reduce waste.Engagement and Diversity, Equity and Inclusion ("DEI") Engagement and DEI are also parts of the Allegion Operating System. Engagement surveys provide a mechanism to gather direct employee feedback, give team leaders insights on potential areas of focus and allow leaders to prioritize and take action on their teams’ foundational, inclusion, growth and development needs. Strengths-based leadership is an element of our commitment to inclusion: the more employees understand their own strengths, the better equipped they are to add value and appreciate the contributions of diverse members of their teams.Engagement and DEI are topics for learning communities, employee roundtables and ongoing, regular analysis and dialogue among people leaders, executive leadership and Board of Directors. We believe in fundamental standards that support our employees, including a commitment to building and maintaining diverse and inclusive workplaces, safe and healthy practices and competitive wages and benefits. We embrace all differences and similarities among colleagues and within the relationships we foster with customers, suppliers and the communities where we live and work. Employee led resource and affinity groups provide enrichment opportunities for women's leadership, early career professionals, allies and members of the LBGTQIA+, veteran and Hispanic communities, working parents, innovation, health and fitness, site-specific engagement and community volunteering and philanthropy. Whatever background, experience, race, color, national origin, religion, age, gender, gender identity, disability status, sexual orientation, protected veteran status or any other characteristic protected by law, we make sure that potential and current employees have every opportunity for application and the opportunity to give their best at work.The efforts of Allegion’s DEI Steering Committee, our ELT and the employee-led Inclusion Council, are driving expectations and accountability while creating role models and change champions. Our DEI strategy has three core pillars:12Table of Contents•Learn & listen deeply: Learn to recognize biases and mitigate them. Seek to first understand an individual's perspective rather than respond or act;•Unite widely: Create a workplace where all employees feel welcomed, respected and valued, enabling customers to more easily connect with our brands through our people; and •Take action: Identify the unique things that impact our organization, our communities and our industry. During 2022, we updated our strategic action priorities, which center on: 1) Building and sustaining equitable policies and practices; 2) Creating an inclusive culture; and 3) Elevating the approach to DEI in our industry and having a positive impact on our communities. We are dedicated to fulfilling equal opportunity commitments in all decisions regarding all employment actions and at all levels of employment. In partnership with our Human Resources organization, our Equal Employment Opportunity Officer ensures that the applicable policy and procedures are appropriately established, implemented and disseminated, including those prohibiting discrimination, harassment, bullying and/or retaliation.Civic Involvement Civic involvement is part of the value proposition we offer employees and supports DEI, growth and development. We provide multi-faceted support for our communities, guided by three philanthropic pillars: safety and security; wellness; and addressing the unique needs of the communities where we live, learn, work and visit. Corporate sponsorships and voluntary employee payroll deductions support a wide range of non-profits, including those that address housing and school security and safety; children and youth programs; education and scholarships for people of color and those who are economically disadvantaged and support for Historically Black Colleges and Universities; community safety nets for basic needs (e.g., food, shelter, transportation) for underserved people and to break the cycle of poverty; wellness, mental health, health research, emergency relief and blood supply initiatives; and programs to advance equality, justice and address systemic bias. In addition to corporate sponsorships, site leaders and employees are encouraged to organize local volunteer and fundraising activities, provide grants to local organizations and serve on boards and committees. Respect for Human RightsOur respect for human rights is expressed in standards for our employees, our business partners, our customers and our communities. We uphold our Global Human Rights Policy, with standards that align with basic working conditions and human rights concepts advanced by international organizations such as the International Labor Organization and the United Nations. This policy also represents our own minimum standards for working conditions and human rights in our business and supply chains. In addition, we conduct risk assessments and continue to have conversations with the suppliers and companies we work with about the importance of human rights.Employee Health and Safety Employee health and safety are top priorities, and we consistently rank as the safest among leading competitors on core measures such as the total recordable incident rate. ‘Be safe, be healthy’ is a core organizational value in our proactive safety culture and has guided our response throughout the COVID-19 pandemic. We continue to adapt to changing health conditions at a local level and support a wide range of health and safety measures, including encouraging preventative measures such as COVID-19 and influenza vaccines and booster shots.The ELT, with oversight from our Board of Directors, is responsible for risk management, employee accountability, safety hazard recognition and executing safety initiatives. We monitor leading and lagging indicators related to health and safety as part of our ongoing management of the Allegion Operating System and regularly update the Corporate Governance and Nominating Committee of the Board of Directors on key developments and employee health and safety topics. In recognition of our efforts to integrate sound environmental, health and safety ("EHS") management with our business operations, in 2021, we received the renowned Robert W. Campbell Award from the National Safety Council.Regulatory MattersWe are subject to a variety of federal, state and local laws and regulations, both within and outside the U.S., relating to EHS matters. We are committed to conducting our business in a safe, environmentally responsible and sustainable manner, in compliance with all applicable EHS laws and regulations, and in a manner that helps promote and protect the health and safety of our environment, associates, customers, contractors and members of our local communities worldwide. We operate with principles that support our proactive commitments, including:•Integrating sound EHS and sustainability strategies in all elements of our business functions, including objectives and measurements;•Conducting periodic, formal evaluation of our compliance status and annual review of objectives and targets;•Creating a workplace culture where all employees are responsible for safety;•Making continuous improvements in EHS and sustainability management systems and performance, including the reduction in the usage of natural resources, waste minimization, prevention of pollution and prevention of workplace accidents, injuries and risks;13Table of Contents•Designing, operating and maintaining our facilities in a manner that minimizes negative EHS and sustainability impacts;•Using materials responsibly, including the recycling and reuse of materials, where feasible; and•Acting in a way that shows sensitivity to community concerns about EHS and sustainability issues.We recognize that these principles are critical to our future success. We have a dedicated environmental program designed to reduce the utilization and generation of hazardous materials during the manufacturing process and to remediate any identified environmental concerns. As to the latter, we are currently engaged in site investigations and remediation activities to address environmental cleanup from past operations at current and former production facilities. We also regularly evaluate our remediation methods that are in addition to, or in replacement of, those we currently utilize based upon enhanced technology and regulatory changes. We are sometimes a party to environmental lawsuits and claims and have, from time to time, received notices of potential violations of environmental laws and regulations from the U.S. Environmental Protection Agency ("EPA") and similar state authorities. We have also been identified as a potentially responsible party ("PRP") for cleanup costs associated with off-site waste disposal at federal Superfund and state remediation sites. For all such sites, there are other PRPs and, in most instances, our involvement is minimal.In estimating our liability, we have assumed that we will not bear the entire cost of remediation of any site to the exclusion of other PRPs who may be jointly and severally liable. The ability of other PRPs to participate has been taken into account, based on our understanding of the parties’ financial condition and probable contributions on a per site basis. Additional lawsuits and claims involving environmental matters are likely to arise from time to time in the future. For a further discussion of our potential environmental liabilities, see Notes 2 and 21 to the Consolidated Financial Statements. Environmental, social and governance ("ESG") factors important to our business are embedded into our values and our leadership's commitment to create a workplace culture committed to doing the right thing in the right way. Our Board of Directors oversees the Company's ESG strategies, goals and performance, and both our leadership and employees all have a responsibility to uphold excellence, as we believe our commitment to ESG matters helps advance engagement and business vitality. In 2022, Allegion was among the notable companies honored with a SEAL Business Sustainability Award, in recognition of our proactive water reduction project implemented across two of our production facilities in the Baja region of Mexico. Additional information about our ESG priorities and progress may be found in the ESG section of our website (found under the ESG tab at www.allegion.com). The website highlights our ongoing progress and advancements in ESG matters, and includes our materiality matrix of ESG priorities.Available InformationWe are required to file annual, quarterly and current reports, proxy statements and other documents with the SEC under the Exchange Act. The SEC maintains an Internet website that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The public can obtain any documents that are filed by us at www.sec.gov.In addition, the Company's Annual Report on Form 10-K, as well as future quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to all of the foregoing reports, are made available free of charge on our Internet website (www.allegion.com) as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC. Throughout this Form 10-K, we refer to additional information that may be found or is available on our websites. The information contained on, or that may be accessed through, our websites is not incorporated by reference into, and is not part of, this Form 10-K.14Table of ContentsItem 1A. RISK FACTORS We are subject to future events, risks and uncertainties – many of which are beyond our control – that could materially and adversely affect our business, financial condition, results of operations and cash flows. You should carefully consider the risk factors discussed below, together with all the other information included in this Form 10-K, in evaluating us, our ordinary shares and our senior notes. If any of the events, risks or uncertainties below actually occurs, our business, financial condition, results of operations and cash flows could be materially and adversely affected. Any such adverse effect may cause the trading price of our ordinary shares to decline, and as a result, you could lose all or part of your investment in us. Our business, financial condition, results of operations and cash flows may also be materially and adversely affected by events, risks and uncertainties not known to us or events, risks and uncertainties that we currently believe to be immaterial.Economic, Market and Financial RisksOur business operations and performance have been, and are expected to continue to be, impacted by global macroeconomic factors. Ongoing macroeconomic challenges could adversely impact our business, results of operations, financial conditions and cash flows.Macroeconomic challenges, including ongoing supply chain disruptions and delays, material, electronic component and labor shortages, cost inflation, rising interest rates and volatility in the capital markets, have impacted, and may continue to impact, our business, our customers and our suppliers. These challenges may also make it more challenging for us to manufacture and deliver products to our customers, could cause periodic production interruptions and supply constraints, impact our ability to forecast and plan for future business activities and, if not adequately managed, could have a material adverse impact on our business, results of operations, financial condition and cash flows.Further, demand for our products and solutions is impacted by the strength of institutional, commercial and residential construction and remodeling markets, which are sensitive to national, regional and local economic conditions. As a result, deterioration of these macroeconomic conditions (or weakness in these conditions existing for an extended period of time), a decline in general economic activity or recession in the U.S. or global economy could slow demand for new construction or remodeling projects and result in our customers cancelling or delaying orders, which in turn could erode average selling prices and result in declines in our revenues, profitability and cash flows.Increased prices and inflation could negatively impact our margin performance and our financial results.Elevated levels of inflation, including rising prices for raw materials, parts and components, freight, packaging, labor and energy, increases our costs to manufacture and distribute our products and services, and we may be unable to pass these increased costs on to our customers. We do not currently use financial derivatives to hedge against volatility in commodity prices; however, we utilize firm purchase commitments, where possible, to help mitigate risk. The pricing of some materials, parts and components we use is based on market prices. To mitigate this exposure, we may use annual price contracts to minimize the impact of inflation and to benefit from deflation. Additionally, we are exposed to fluctuations in other costs such as packaging, freight, labor and energy prices. If inflation in these costs increases beyond our ability to control for them through measures such as implementing operating efficiencies, or we are not able to increase prices to sufficiently offset the effect of various cost increases without negatively impacting customer demand, our margin performance and results of operations would be negatively impacted.Our global operations subject us to economic risks.Our businesses operate around the world in various geographic regions and product markets. Additionally, we procure various products, parts, components and services from supplier partners located throughout the world. Our global operations depend on products manufactured, purchased and sold in the U.S. and internationally, including in Australia, Canada, China, Europe, Mexico, New Zealand and the Middle East. The political, economic and regulatory environments in which we operate are becoming increasingly volatile and uncertain. Accordingly, we are subject to multiple risks that are inherent in operating and sourcing globally, including:•Changes to trade agreements, sanctions, import and export regulations, including imposition of burdensome tariffs and quotas, and customs duties;•Changes in applicable tax regulations and interpretations;•Economic downturns;•Social and political unrest, instability, national and international conflict, including war, border closures, civil disturbances, terrorist acts and other geographical disputes and uncertainties;•Government measures to restrict business activity, for example, to prevent the spread of a communicable disease;•Changes in laws and regulations or imposition of currency restrictions and other restraints in various jurisdictions;•Limitation of ownership rights, including expropriation of assets by a local government, and limitation on the ability to repatriate earnings;15Table of Contents•Sovereign debt crises and currency instability in developed and developing countries;•Difficulty in staffing and managing global operations;•Difficulty in enforcing agreements, collecting receivables and protecting assets through non-U.S. legal systems; and•Difficulty in transporting materials, components and products.These risks have increased our cost of doing business in the U.S. and internationally. These risks may also increase our counterparty risk, disrupt our operations, disrupt the ability of suppliers and customers to fulfill their obligations, increase our effective tax rate, increase the cost of our products, limit our ability to sell products and services in certain markets, reduce our operating margin and cash flows and/or negatively impact our ability to compete.Our business relies on the institutional, commercial and residential construction and remodeling markets.Demand for our security products and solutions relies on the institutional, commercial and residential construction and remodeling markets, which are marked by cyclicality based on overall economic conditions, including consumer confidence and disposable income, corporate and government spending, work-from-home trends, availability of credit and demand for new housing and infrastructure. Weakness or instability in one or more of these markets may cause current and potential customers to delay or cancel major capital projects or otherwise choose not to make purchases, which could negatively impact the demand for our products and solutions and erode average selling prices.Currency exchange rate fluctuations have had, and may continue to have, an adverse effect on our business, financial condition, results of operations and cash flows.We are exposed to a variety of market risks, including the effects of changes in currency exchange rates. See "Part II, Item 7A. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Quantitative and Qualitative Disclosures About Market Risk."Approximately 25% of our 2022 Net revenues were derived outside the U.S., and we expect sales to non-U.S. customers to continue to represent a significant portion of our consolidated Net revenues. Although we may enter into currency exchange contracts to reduce our risk related to currency exchange fluctuations, changes in the relative fair values of currencies occur from time to time and in some instances, as was the case in 2022, have had a significant impact on our Net revenues. We do not hedge against all our currency exposure, and therefore, our results of operations will continue to be susceptible to impacts from currency fluctuations.We also translate assets, liabilities, revenues and expenses denominated in non-U.S. dollar currencies into U.S. dollars for our Consolidated Financial Statements based on applicable exchange rates. Consequently, fluctuations in the value of the U.S. dollar compared to other currencies may have a material impact on the value of these items in our Consolidated Financial Statements, even if their value has not changed in their original currency. Further, certain of our businesses may invoice customers in a currency other than its functional currency, or may be invoiced by suppliers in a currency other than its functional currency, which could result in unfavorable translation effects on these businesses and our results of operations.We may be required to recognize impairment charges for our goodwill, indefinite-lived intangible assets and other long-lived assets.At December 31, 2022, the net carrying value of our goodwill and other indefinite-lived intangible assets totaled approximately $1.4 billion and $110 million, respectively. Pursuant to U.S. generally accepted accounting principles ("GAAP"), we are required to annually assess our goodwill and indefinite-lived intangible assets for impairment. In addition, interim assessments must be performed for these and other long-lived assets whenever events or changes in circumstances indicate that an impairment may have occurred. Significant disruptions to our business or end market conditions, protracted economic weakness (including a potential economic downturn or recession), unexpected significant declines in operating results of reporting units, divestitures or market capitalization declines may result in recognition of impairment charges to our goodwill, indefinite-lived intangible or other long-lived assets. Any charges relating to such impairments could have a material adverse impact on our results of operations in the periods when recognized.The capital and credit markets are important to our business.Continued instability in U.S. and global capital and credit markets, including market disruptions, limited liquidity and interest rate volatility or reductions in the credit ratings assigned to us by independent ratings agencies, could reduce our access to capital markets, increase our costs of borrowing or adversely impact our ability to obtain favorable financing terms in the future. In particular, if we are unable to access capital and credit markets on terms that are acceptable to us, we may not be able to execute potential merger and acquisition plans, make other investments or fully execute our business plans and strategy.Our suppliers and customers are also dependent upon the capital and credit markets. Limitations on the ability of customers, suppliers or financial counterparties to access credit could lead to insolvencies of key suppliers and customers, limit or prevent customers from obtaining credit to finance purchases of our products and services, delay institutional, commercial and/or residential construction and remodeling projects and cause delays in the delivery of key products from suppliers. 16Table of ContentsThere are risks associated with our outstanding and future indebtedness.We had approximately $2.1 billion of outstanding indebtedness at December 31, 2022. Included in this total was $69 million outstanding under our senior unsecured revolving credit facility (the "2021 Revolving Facility") that permits borrowings of up to $500 million. A portion of our cash flows from operations is dedicated to servicing our indebtedness and will not be available for other purposes, including our operations, capital expenditures, payment of dividends, share repurchases or future business opportunities or other strategic investments.Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control, such as the credit ratings assigned to us by independent ratings agencies or our ability to access capital markets on acceptable terms. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, reduce or eliminate the payment of dividends, sell assets, seek additional capital or seek to restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In such event, we could face substantial liquidity problems and might be required to sell material assets or operations to attempt to meet our debt service and other obligations. Additionally, at December 31, 2022, our borrowings included a variable rate term loan facility (the "2021 Term Facility", and together with the 2021 Revolving Facility, the "2021 Credit Facilities"). The 2021 Credit Facilities had a combined outstanding variable rate balance of $306.5 million at December 31, 2022, which exposes us to variable interest rate risk. Applicable variable interest rates have increased throughout 2022, resulting in increased Interest expense. We are also exposed to the risk of continued rising interest rates to the extent we fund our short or long-term financing needs with variable-rate borrowings under the 2021 Revolving Facility. If variable base rates under the 2021 Credit Facilities continue to increase in the future, our Interest expense could increase as well. For more details about our interest rate exposure under the 2021 Credit Facilities, please see Part II. Item 7A.Strategic and Operational RisksIncreased competition, including from technological developments, could adversely affect our business. The markets in which we operate include a large number of participants, including multi-national, regional and small, local companies. We primarily compete on the basis of quality, innovation, expertise, effective channels to market, breadth of product offering and price. We may be unable to effectively compete on all these bases. Further, in a number of our product offerings, we compete with our retail customers and technology partners who use their own private labels. If we are unable to anticipate evolving trends in the market or the timing and scale of our competitors’ activities and initiatives, including increased competition from private label brands, the demand for our products and services could be negatively impacted. In addition, we compete in an industry that is experiencing the convergence of mechanical, electronic and digital products. Technology and innovation play significant roles in the competitive landscape. Our success depends, in part, upon the research, development and implementation of new technologies and products including obtaining, maintaining and enforcing necessary intellectual property protections. Securing and maintaining key partnerships and alliances, recruiting and retaining highly skilled and qualified employee talent and having access to technologies, services, intellectual property and solutions developed by others will play a significant role in our ability to effectively compete. The continual development of new technologies by existing and new competitors, including non-traditional competitors with significant resources, could adversely affect our ability to sustain operating margins and desirable levels of sales volumes. To remain competitive, we must develop new products and service offerings and respond to new technologies in a timely manner.Our growth is dependent, in part, on the development, commercialization and acceptance of new products and services.We must develop and commercialize new products and services that meet the varied and evolving needs of our customers and end-users in order to remain competitive in our current and future markets and in order to continue to grow our business. End users are continually adopting more advanced technologies in their facilities and homes, accelerated by the increasing adoption of IoT technologies and connected devices, which will require us to devote significant effort and resources to the development, maintenance and enhancement of the IT systems and other infrastructure required to support and/or enhance the functionality of our electronic products and solutions. The speed of development by our competitors and new market entrants is increasing. We cannot provide any assurance that any new product or service will be successfully commercialized in a timely manner, if ever, or, if commercialized, will result in returns greater than our investment. Investment in a product or service could divert our attention and resources from other projects that become more commercially viable in the market. We also cannot provide any assurance that any new product or service will be accepted by the market.Changes in customer and consumer preferences and the inability to maintain beneficial relationships with large customers could adversely affect our business. We have significant customers, particularly major retailers, although no one customer represented 10% or more of our total Net revenues in any of the past three fiscal years. The loss or material reduction of business, either due to a reduction in demand 17Table of Contentsfrom one or more of our significant customers, or our inability to timely meet any elevated level of customer demand for various reasons, the lack of success of sales initiatives or changes in customer preferences or loyalties for our products related to any such significant customer could have a material adverse impact on our business. In addition, major customers who are volume purchasers are much larger than us and have strong bargaining power with their suppliers. This limits our ability to recover cost increases through higher selling prices. Furthermore, unanticipated inventory adjustments by these customers can have a negative impact on sales. We also sell our products through various trade channels, including traditional retail and e-commerce channels. If we or our major customers are not successful in navigating the shifting consumer preferences to distribution channels such as e-commerce, our expected future revenues may be negatively impacted.If our products or solutions fail to meet certification and specification requirements, are defective, cause, or are alleged to have caused, bodily harm or injury, or otherwise fall short of end-users' needs and expectations, our business may be negatively impacted.The security and access control product markets we serve often have unique certification and specification requirements, reflecting local regulatory requirements and highly variable end-user needs. While we strive to meet all certification and specification requirements, if any of our products or solutions do not meet such requirements, or contain, or are perceived to contain, defects or otherwise fall short of end-users' needs and expectations, fail to perform as intended, or are otherwise alleged to result in property damage, bodily injury and/or death we may become subject to personal injury lawsuits and/or product liability claims, and if found liable, may incur significant costs, which could negatively impact our business, results of operations or financial condition. Additionally, electronic security products and solutions are increasingly more sophisticated and technologically complex than the mechanical security products we sell and have an increased risk of design, cybersecurity or manufacturing defects, which could lead to recalls, product replacements or modifications, write-offs of inventory or other assets and significant warranty and other expenses. Product quality issues could also adversely affect the end-user experience, resulting in reputational harm, loss of competitive advantage, poor market acceptance, reduced demand for products and solutions, delay in new product and service introductions and lost sales. Further, adverse publicity, whether or not justified, or allegations of product or service quality issues, even if false or unfounded, could damage our reputation and negatively affect our sales.Our business and innovation strategies include making acquisitions of, and investments in, external companies. These acquisitions and investments could be unsuccessful, consume significant resources or increase our exposure to cybersecurity, data privacy or other regulatory risks, which could adversely affect our business, financial condition, results of operations and cash flows.Our long-term growth strategies include the acquisition of businesses or product lines to strengthen our industry position, enhance our existing set of products and services offerings or expand into adjacent markets. For example, in July 2022, we completed the acquisition of the Access Technologies business. However, we cannot provide assurance that we will identify or successfully complete acquisitions with suitable candidates in the future, nor can we provide assurance that completed or future acquisitions will be successful or otherwise achieve the anticipated strategic and financial benefits, including cost and revenue synergies. Acquisitions often place significant demands on management, operational and financial resources, which could decrease management’s capacity to focus on other important business strategies or divert resources from other parts of our business. Further, the success of future or completed acquisitions will depend, in large part, on the successful integration of operations, sales and marketing, information technology, finance and administrative operations. We cannot provide assurance that we will be able to successfully integrate these new businesses. Additionally, the financing of future business acquisitions may increase our leverage, impact our credit rating and/or diminish our financial position and ability to re-invest in our existing businesses. Future acquisitions may also be dependent on our ability to access the capital and credit markets to obtain new debt or equity financing to fund the purchase price on terms that are acceptable to us.Some of the businesses we may seek to acquire may be marginally profitable or unprofitable. For these businesses to achieve acceptable levels of profitability, we may need to improve their management, operations, products and market penetration or incur significant capital expenditures. We may not be successful in this regard, the costs of doing so may exceed our original estimates or we may encounter other potential difficulties.Acquisitions also involve numerous other risks, including: •Difficulties in obtaining and verifying the financial statements and other business information of acquired businesses;•Inability to obtain regulatory approvals and/or required financing on favorable terms;•Potential loss of key employees, key contractual relationships or key customers of acquired companies or of us;•Difficulties competing in any new markets we may enter;•Assumption of the liabilities and exposure to unforeseen liabilities (including, but not limited to, regulatory, legal and product or personal liability claims) of acquired companies;18Table of Contents•Cybersecurity related vulnerabilities or data security incidents that may be present in the IT Systems of acquired companies, or emerge when integrating the acquired company into our IT Systems; •Dilution of interests of holders of our ordinary shares through the issuance of equity securities or equity-linked securities; •Labor disruptions, work stoppages or other employee-related issues, particularly if employees of the acquired companies are represented by labor unions or trade councils; and•Difficulty in integrating financial reporting systems and implementing controls, procedures and policies, including disclosure controls and procedures and internal control over financial reporting appropriate for public companies of our size at companies that, prior to the acquisition, had lacked such controls, procedures and policies. Further, as part of our innovation strategy, from time to time we invest in start-up companies and/or development stage technology or other companies. In evaluating these opportunities, we follow a structured evaluation process that considers factors such as potential financial returns, new expertise in emerging technology and business benefits. Despite our best efforts to calculate potential return and risk, some or all of the companies we invest in may be unprofitable at the time of, and subsequent to, our investment. We may lose money in these investments, including the potential for future impairment charges on the investments, and the anticipated benefits of the technology and business relationships may be less than expected.We may pursue business opportunities that diverge from our core business.We may pursue business opportunities that diverge from our core business, including expanding our products or service offerings, seeking to expand our products and services into new international markets, investing in new and unproven technologies and forming new alliances with companies to develop and distribute our products and services. We can offer no assurance that any such business opportunities will prove successful. Certain international markets may be slower than our established markets in adopting our services and products, and our operations in such markets may not develop at a rate that supports our level of investment. Among other negative effects, our investment in new business opportunities may exceed the returns we realize. New investments could have higher cost structures than our current business, which could reduce operating margins and require more working capital. In the event that working capital requirements exceed operating cash flow, we may be required to draw on the 2021 Revolving Facility or pursue other external financing, which may not be readily available. Additionally, our pursuit of new business opportunities that diverge from our core business may expose us to different risks and uncertainties other than those described in this “Risk Factors” section or elsewhere in this Annual Report on Form 10-K. In addition to the risks outlined above, expansion into certain new markets may require us to compete with local businesses with greater knowledge of the market, including the tastes and preferences of end-users, and higher market shares. Our strategic initiatives, including enterprise excellence efforts among other significant capital expenditure projects, may not achieve the improvements or financial returns we expect.We utilize a number of tools to improve efficiency and productivity. Implementation of new processes to our operations could cause disruptions and may prove to be more difficult, costly or time consuming than expected. Additionally, from time to time we undertake substantial capital projects for varying reasons, such as to increase production capacity or to insource certain products, parts or components. We invest in areas we believe best align with our business strategies and that will optimize future returns. However, there can be no assurance that all our planned enterprise excellence projects or other capital expenditures will be fully implemented, or if implemented, will realize the expected improvements or financial returns.We may not be able to effectively manage and implement restructuring initiatives or other organizational changes. We have, from time to time, restructured or made other adjustments to our workforce and manufacturing footprint, and may need to do so in the future, in response to market or product changes, performance issues, changes in strategy, acquisitions and/or other internal or external considerations. These restructuring activities and other organizational changes often result in increased restructuring costs, diversion of management’s time and attention from daily operations, cybersecurity and other operational risks and temporarily reduced productivity. If we are unable to successfully manage and implement restructuring and other organizational changes, we may not achieve or sustain the expected growth or cost savings benefits of these activities or do so within the expected timeframe. These effects could recur in connection with future acquisitions and other organizational changes and our results of operations could be negatively affected.The effects of global climate change or other unexpected events, including global health crises, may disrupt our operations and have a negative impact on our business.The effects of global climate change, such as extreme weather conditions and natural disasters occurring more frequently or with more intense effects, or the occurrence of unexpected events including wildfires, tornadoes, hurricanes, earthquakes, floods, tsunamis and other severe hazards in the countries where we operate or sell products and services, could adversely affect our business, financial condition, results of operations and cash flows. These events could disrupt our operations by impacting the availability and cost of materials needed for manufacturing, cause physical damage or closure of our manufacturing sites or distribution centers, lead to loss of human capital and/or cause temporary or long-term disruption in the manufacturing or delivery of products and services to customers. These events and disruptions could also adversely affect our customers’ and 19Table of Contentssuppliers’ financial condition or ability to operate, resulting in reduced customer demand, delays in payments received or supply chain disruptions. Further, these events and disruptions could increase insurance and other operating costs, including impacting our decisions regarding construction of new facilities to select areas less prone to climate change risks and natural disasters, which could result in indirect financial risks passed through the supply chain or other price modifications to our products and services. Additionally, as we have experienced in recent years, the COVID-19 pandemic created significant volatility, uncertainty and economic disruption, both for our business (and many of our customers and suppliers) and the U.S. and global economy more generally. It also led, both directly and indirectly, to significant operating challenges, including disruptions to our and our suppliers’ operations, shortages of electronic and other parts and components, freight delays, increased labor shortages and logistical challenges. Although most governments have eased or eliminated their restrictions on travel and social interactions, and lifted non-essential business closures, several jurisdictions in which we have operations, such as China, have public health and government mandates that restrict business activities. These mandates and restrictions have, and could continue to have, an impact on our business and operations, and on the operations of some of our suppliers. Global health crises, such as the COVID-19 pandemic or any other actual or threatened epidemic, pandemic, or outbreak and spread of a communicable disease or virus in the countries where we operate or sell products and provide services could adversely affect our operations and financial performance. Further, any national, state or local government mandates or other orders taken to minimize the spread of a global health crisis could restrict our ability to conduct business as usual, as well as the business activities of our key customers and suppliers, including the potential for labor shortages. In particular, the ultimate extent of the impact of any epidemic, pandemic or other global health crisis on our business, financial condition and results of operations will depend on future developments which are highly uncertain and cannot be predicted.We may be subject to risks relating to our information technology and operational technology systems.We rely extensively on information technology and operational technology systems, networks and services including hardware, software, firmware and technological applications and platforms (collectively, "IT Systems") to manage and operate our business from end-to-end, including ordering and managing materials from suppliers, design and development, manufacturing, marketing, selling and shipping to customers, invoicing and billing, managing our banking and cash liquidity systems, managing our enterprise resource planning and other accounting and financial systems and complying with regulatory, legal and tax requirements. There can be no assurance that our current IT Systems will function properly. We have invested and will continue to invest in improving our IT Systems. Some of these investments are significant and impact many important operational processes and procedures. There is no assurance that newly implemented IT Systems will improve our current systems, improve our operations or yield the expected returns on the investments. In addition, the implementation of new IT Systems may be more difficult, costly or time consuming than expected and cause disruptions in our operations and, if not properly implemented and maintained, negatively impact our business. If our IT Systems cease to function properly or if these systems do not provide the anticipated benefits, our ability to manage our operations could be impaired. We currently rely on third-party service providers for many of the critical elements of our global information and operational technology infrastructure, and their failure to provide effective support for such infrastructure could increase our cybersecurity risk or otherwise negatively impact our business and financial results.We have outsourced many of the critical elements of our global information and operational technology infrastructure to third-party service providers in order to achieve efficiencies. If such service providers experience a disruption due to a cyberattack or other internal or external factors, or they do not perform or perform effectively, we may not be able to achieve the expected efficiencies and may have to incur additional costs to address failures in providing service by the service providers. Depending on the function involved, such non-performance, ineffective performance or failures of service may lead to business disruptions, processing inefficiencies or security breaches. Disruptions or breaches of our information systems could adversely affect us.Despite our implementation of cybersecurity measures, which have focused on prevention, mitigation, resilience and recovery, our network and products, including access solutions, may be vulnerable to cybersecurity attacks, computer viruses, malicious codes, malware, ransomware, phishing, social engineering, denial of service, hacking, break-ins and similar disruptions. Cybersecurity attacks and intrusion efforts are continuous and evolving, and in certain cases they have been successful at the most robust institutions. The scope and severity of risks that cyber threats present have increased dramatically and include, but are not limited to, malicious software, ransomware attacks, attempts to gain unauthorized access to data or premises, exploiting weaknesses related to vendors or other third parties that could be exploited to attack our systems, denials of service and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and corruption of data. Any such event could have a material adverse effect on our business, financial condition, results of operations and cash flows as we face regulatory, reputational and litigation risks resulting from potential cyber incidents, as well as the potential of incurring significant remediation costs. Further, while we maintain insurance coverage that may, subject to policy terms and exclusions, cover certain aspects of our cyber risks, such insurance coverage may be insufficient to cover our losses or all types of claims that may arise in the continually evolving area of cyber risk.20Table of ContentsOur daily business operations also require us to collect and/or retain sensitive data such as intellectual property, proprietary business information and data related to customers, employees, suppliers and business partners within our networking infrastructure including data from individuals subject to the European Union's General Data Protection Regulation, that is subject to privacy and security laws, regulations and/or customer-imposed controls. Despite our efforts to protect such data, the loss or breach of such data due to various causes including material security breaches, catastrophic events, extreme weather, natural disasters, power outages, system failures, computer viruses, improper data handling, programming errors, unauthorized access and employee error or malfeasance could result in wide reaching negative impacts to our business. As such, the ongoing maintenance and security of this information is pertinent to the success of our business operations and our strategic goals.In addition, we operate in an environment where there are different and potentially conflicting data privacy laws and regulations in effect or expected to go into effect in the future, including regulations related to devices connected through IoT, in the various jurisdictions in which we operate, and we must understand and comply with such laws and regulations while ensuring our data is secure.Our networking infrastructure and related assets may be subject to unauthorized access by hackers, employee error or malfeasance or other unforeseen activities. Such issues could result in the disruption of business processes, network degradation and system downtime, along with the potential that a third party will exploit our critical assets such as intellectual property, proprietary business information and data related to our customers, suppliers and business partners. To the extent that such disruptions occur, and our business continuity plans do not effectively address these disruptions in a timely manner, they may cause delays in the manufacture or shipment of our products and the cancellation of customer orders and, as a result, our business operating results and financial condition could be materially and adversely affected, resulting in a possible loss of business or brand reputation.Our ability to successfully grow and expand our business depends on our ability to recruit and retain a highly qualified and diverse workforce. Our ability to successfully grow and expand our business is dependent upon our ability to recruit and retain a workforce with the skills necessary to develop, manufacture and deliver the products and services desired by our customers. We need highly skilled and qualified personnel in multiple areas, including engineering, sales, manufacturing, information technology, cybersecurity, business development, strategy and management. We must therefore continue to effectively recruit, retain and motivate highly qualified, skilled and diverse personnel to maintain our current business and support our projected growth. A shortage of these employees for various reasons, including intense competition for skilled employees, labor shortages, increased labor costs, candidates’ preference to work remotely, changes in laws and policies regarding immigration and work authorizations or any government or public health mandates in jurisdictions where we have operations that may result in workforce attrition and difficulty with recruiting, may jeopardize our ability to grow and expand our business.We continue to experience increased labor shortages at some of our production and distribution facilities. While we have historically experienced some level of ordinary course turnover of employees, the COVID-19 pandemic increased turnover and the ensuing negative macroeconomic environment exacerbated labor shortages and contributed to further increases in employee turnover. Labor shortages and increased turnover rates have led to, and could in the future lead to, increased costs, such as increased overtime to meet customer demand and increased wage rates to attract and retain employees and could negatively affect our ability to efficiently operate our production facilities or otherwise operate at full capacity. An overall or prolonged labor shortage, lack of skilled labor, increased turnover or sustained level of wage inflation could have a material adverse impact on our business, financial position, results of operations and cash flows.Disruptions in our global supply chain, including product manufacturing and logistical services provided by our supplier partners, may negatively impact our business.We procure certain products, including raw materials and other commodities, including steel, zinc, brass and other non-ferrous metals, as well as parts, components (including electronic components) and logistical services from supplier partners located throughout the world. Our ability to meet our customers' needs and achieve cost targets depends on our ability to maintain key manufacturing and supply arrangements, including supplier execution and certain sole supplier or sole manufacturing arrangements. Our reliance on these third parties reduces our control over the manufacturing and delivery process, exposing us to risks including reduced control over product costs and delivery. Additionally, because not all of our supply arrangements provide for guaranteed supply and some key parts and components may be available only from a single supplier or a limited group of suppliers, we are also subject to supply and pricing risks, which could negatively impact our margin performance, results of operations, inventory levels and cash flows. If we are unable to effectively manage these relationships, or if these third parties experience delays, disruptions, shortages of materials, labor, electronic and other components, capacity constraints, regulatory issues or quality control problems in their operations, freight delays and other supply chain constraints and disruptions, or otherwise fail to meet our future requirements for timely delivery, our ability to ship and deliver certain of our products to our customers could be impaired and our business could be harmed.21Table of ContentsLegal and Compliance RisksWe are subject to risks related to corporate social responsibility and reputational matters.Our reputation and the reputation of our brands, including the perception held by our customers, end-users, business partners, investors, other key stakeholders and the communities in which we do business are influenced by various factors. There is an increased focus from our stakeholders, as well as regulatory authorities both within the U.S. and internationally, on ESG practices and disclosure. If we fail, or are perceived to have failed, in any number of ESG matters, such as environmental stewardship, DEI, good corporate governance, workplace conduct and support for local communities, or to effectively respond to changes in, or new, legal, regulatory or reporting requirements concerning climate change or other sustainability concerns, we may be subject to regulatory fines and penalties, and our reputation or the reputation of our brands may suffer. Further, we have made several public commitments regarding our intended reduction of carbon emissions, including a commitment to achieve carbon neutral emissions by 2050. Although we intend to meet these commitments, we may be required to expend significant resources to do so, which could increase our operational costs. Further, there can be no assurance of the extent to which any of our commitments will be achieved, or that any future investments we make to achieve such commitments will meet investor, legal and/or any other regulatory expectations and requirements. If we are unable to meet our commitments, we could incur adverse publicity and reaction from investors, advocacy groups or other stakeholders, which could adversely impact our reputation and brand perception. Such damage to our reputation and the reputation of our brands may negatively impact our business, demand for our products and services, our financial condition and results of operations.In addition, negative or inaccurate postings or comments on social media or networking websites about our company or our brands could generate adverse publicity that could damage our reputation or the reputation of our brands. If we are unable to effectively manage real or perceived issues, including concerns about product quality, safety, corporate social responsibility or other matters, sentiments toward the Company or our products could be negatively impacted, and our financial results could suffer.Our brands are important assets of our businesses, and violation of our trademark rights by imitators could negatively impact revenues and brand reputation. Our brands and trademarks enjoy a reputation for quality and value and are important to our success and competitive position. Unauthorized use of our trademarks may not only erode sales of our products but may also cause significant damage to our brand name and reputation, interfere with relationships with our customers and increase litigation costs. There can be no assurance that our on-going effort to protect our brand and trademark rights will prevent all violations. Material legal judgments, fines, penalties or settlements imposed against us or our assets could adversely affect our business, financial condition, results of operations and cash flows.We are currently, and may in the future become, involved in legal proceedings, claims and disputes incidental to the operation of our business in the ordinary course. Our business may be adversely affected by the outcome of these proceedings and other contingencies (including, without limitation, environmental, product and warranty liability, claims for property damage, physical harm or bodily injury, antitrust, intellectual property, data protection, privacy and labor and employment matters) that cannot be predicted with certainty. As required by GAAP, we establish reserves based on our assessment of the probability of contingencies and whether we are able to reasonably estimate the expected range of loss. Subsequent developments in legal proceedings and other contingencies may affect our assessment and estimates of the loss contingency recorded as a reserve, and we may incur additional costs or be required to make material payments beyond our previously recorded reserves.Allegations that we have infringed the intellectual property rights of third parties could negatively affect us. We may be subject to claims of infringement of intellectual property rights by third parties. In particular, we often compete in areas having extensive intellectual property rights owned by others, and we have become subject to claims alleging infringement of intellectual property rights of others. In general, if it is determined that one or more of our technologies, products or services infringes the intellectual property rights owned by others, we may be required to cease marketing those products or services, to obtain licenses from the holders of the intellectual property at a material cost or to take other actions to avoid infringing such intellectual property rights. The litigation process is costly and subject to inherent uncertainties, and we may not prevail in litigation matters regardless of the merits of our position. Adverse intellectual property litigation or claims of infringement against us may become extremely disruptive if the plaintiffs succeed in blocking the trade of our products and services and may have a material adverse effect on our business.Our reputation, ability to do business and results of operations could be impaired by improper conduct by any of our employees, agents or business partners.We are subject to regulation under a variety of U.S. federal and state and non-U.S. laws, regulations and policies including laws related to anti-bribery and anti-corruption, export and import compliance, competition and anti-money laundering due to our global operations. We provide compliance training for our employees and have other controls and procedures in these areas. We cannot provide assurance that our internal controls will always protect us from the improper conduct of our employees, agents and business partners. Any improper conduct could damage our reputation and subject us to, among other things, civil and 22Table of Contentscriminal penalties, material fines, equitable remedies (including profit disgorgement and injunctions on future conduct), securities litigation, adverse publicity and a general loss of investor or public confidence.Our operations are subject to regulatory risks.Our U.S. and non-U.S. operations are subject to a number of laws and regulations, including fire and building codes and EHS standards. We have incurred, and will be required to continue to incur, significant expenditures to comply with these laws and regulations. Changes to, or changes in interpretations of, current laws and regulations, including climate change legislation or other environmental mandates, could require us to increase our compliance expenditures, cause us to significantly alter or discontinue offering existing products and services or cause us to develop new products and services. Altering current products and services or developing new products and services to comply with changes in the applicable laws and regulations could require significant research and development investments, increase the cost of providing the products and services and adversely affect the demand for our products and services. In the event a regulatory authority concludes that we are not or have not at all times been in full compliance with these laws or regulations, we could be fined, criminally charged or otherwise sanctioned. Certain environmental laws assess liability on current or previous owners of real property or operators of manufacturing facilities for the costs of investigation, removal or remediation of hazardous substances or materials at such properties or at properties at which parties have disposed of hazardous substances. Liability for investigative, removal and remedial costs under certain U.S. federal and state laws and certain non-U.S. laws are retroactive, strict and joint and several. In addition to cleanup actions brought by governmental authorities, private parties could bring personal injury or other claims due to the presence of, or exposure to, hazardous substances. We have received notifications from U.S. and non-U.S. governmental agencies, including the EPA and similar state environmental agencies, that conditions at a number of current and formerly owned sites where we and others have disposed of hazardous substances require investigation, cleanup and other possible remedial action. These agencies may require that we reimburse the government for its costs incurred at these sites or otherwise pay for the costs of investigation and cleanup of these sites, including by providing compensation for natural resource damage claims from such sites. For more information, see "Item 1. Business – Regulatory Matters." While we have planned for future capital and operating expenditures to maintain compliance with environmental laws and have accrued for costs related to current remedial efforts, our costs of compliance, or our liabilities arising from past or future releases of, or exposures to, hazardous substances, may exceed our estimates. We may also be subject to additional environmental claims for personal injury or cost recovery actions for remediation of facilities in the future based on our past, present or future business activities. As a global business, we have a relatively complex tax structure, and there is a risk that tax authorities will disagree with our tax positions.Since we conduct operations worldwide through our subsidiaries, we are subject to complex transfer pricing regulations in the countries in which we operate. Transfer pricing regulations generally require that, for tax purposes, transactions between us and our affiliates be priced on a basis that would be comparable to an arm's length transaction and that contemporaneous documentation be maintained to support the tax allocation. Although uniform transfer pricing standards are emerging in many of the countries in which we operate, there is still a relatively high degree of uncertainty and inherent subjectivity in complying with these rules. To the extent that any tax authority disagrees with our transfer pricing policies, we could become subject to significant tax liabilities and penalties. Our tax returns are subject to review by taxing authorities in the jurisdictions in which we operate. Although we believe we have provided for all tax exposures, the ultimate outcome of a tax review could differ materially from our provisions.We could be subject to changes in tax rates, the adoption of new tax legislation or exposure to additional tax liabilities.Our future effective tax rate and cash tax obligations could be adversely affected by shifts in our mix of earnings in countries with varying statutory tax rates, changes in the valuation of our deferred tax assets or liabilities or changes in tax laws, regulations, interpretations or accounting principles, as well as certain discrete items. In addition, we are subject to regular review and audit by tax authorities. As a result, we have received, and may in the future receive, assessments in multiple jurisdictions on various tax-related assertions. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition. In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment, and there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our Consolidated Financial Statements and may materially affect our financial results in the period or periods for which such determination is made. Furthermore, due to shifting economic and political conditions, tax policies, laws, interpretations and rates in various jurisdictions may be subject to significant change, which could materially affect our financial position and results of operations. For example, many countries in Europe, as well as a number of other countries and organizations, have recently proposed, recommended or implemented changes to existing tax laws or have enacted new laws that could significantly increase our effective tax rate or cash tax obligations in countries where we do business or require us to change the manner in which we operate our business.23Table of ContentsThe Organization for Economic Cooperation and Development (“OECD”) has led international efforts in recent years to devise a permanent two-pillar solution to address the tax challenges arising from the digitization of the economy. Pillar One focuses on nexus and profit allocation. Pillar Two provides for a global minimum effective corporate tax rate of 15%, applied on a jurisdiction-by-jurisdiction basis. We currently expect to be outside the scope of the Pillar One proposals. In December 2021, the OECD published detailed rules that define the scope of the Pillar Two proposal and, based on our current understanding of the minimum revenue thresholds contained in these rules, we expect to be within their scope and implementation. A number of countries are currently proposing to implement core elements of the Pillar Two proposal by the start of 2024, and on December 15, 2022, the European Union adopted a Council Directive which requires certain Pillar Two rules to be transposed into member states’ national laws starting in 2024. As a consequence, our global effective tax rate could be materially impacted by such legislation, or any resulting local country legislation enacted in response to any potential global minimum tax rates. Additionally, the European Commission has been investigating whether various tax regimes or private tax rulings provided by a country to particular taxpayers may constitute State Aid. We cannot currently predict the outcome of any of these potential changes or investigations in any jurisdiction, but if any of the above occurs and impacts us, this could increase our tax burden and/or effective tax rate. We continue to examine the impact the above items may have on our business, including their impact on the amount of tax we must pay.Risks Related to Our Incorporation in IrelandIrish law differs from the laws in effect in the United States and may afford less protection to holders of our securities.The U.S. currently does not have a treaty with Ireland providing for the reciprocal recognition and enforcement of judgments in civil and commercial matters. As such, there is some uncertainty as to whether the courts of Ireland would recognize or enforce judgments of U.S. courts obtained against us or our directors or officers based on U.S. federal or state civil liability laws, including the civil liability provisions of the U.S. federal or state securities laws, or hear actions against us or those persons based on those laws.As an Irish company, we are governed by the Companies Act 2014 of Ireland, as amended, which differs in some material respects from laws generally applicable to U.S. corporations and shareholders, including, among others, differences relating to interested director and officer transactions and shareholder lawsuits. Likewise, the duties of directors and officers of an Irish company generally are owed to the company only. Shareholders of Irish companies generally do not have a personal right of action against directors or officers of the company and may exercise such rights of action on behalf of the company only in limited circumstances. Accordingly, holders of our securities may have more difficulty protecting their interests than would holders of securities of a corporation incorporated in a jurisdiction of the U.S.In addition, Irish law allows shareholders to authorize share capital which then can be issued by a board of directors without shareholder approval. Also, subject to specified exceptions, Irish law grants statutory preemptive rights to existing shareholders to subscribe for new issuances of shares for cash. At our annual general meeting of shareholders, our shareholders authorized our Board of Directors to issue up to 33% of our issued ordinary shares and further authorized our Board of Directors to issue up to 5% of such shares for cash without first offering them to our existing shareholders. Both of these authorizations will expire after a certain period unless renewed by our shareholders, and we cannot guarantee that the renewal of these authorizations will always be approved. If the Directors' authority to issue ordinary shares is not renewed, then we may be limited in our ability to use our shares, for example, as consideration for acquisitions.Changes in tax laws, regulations or treaties, changes in our status under the tax laws of many jurisdictions or adverse determinations by taxing authorities could increase our tax burden or otherwise affect our financial condition or operating results, as well as subject our shareholders to additional taxes. The realization of any tax benefit related to our incorporation and tax residence in Ireland could be impacted by changes in tax laws, tax treaties or tax regulations or the interpretation or enforcement thereof by the tax authorities of many jurisdictions. From time to time, proposals have been made and/or legislation introduced to change the tax laws of various jurisdictions or limit tax treaty benefits that if enacted could materially increase our tax burden and/or our effective tax rate. Moreover, other legislative proposals could have a material adverse impact on us by overriding certain tax treaties and limiting the treaty benefits on certain payments, which could increase our tax liability. We cannot predict the outcome of any specific legislation in any jurisdiction.While we monitor proposals that would materially impact our tax burden and/or our effective tax rate and investigate our options, we could still be subject to increased taxation on a going forward basis no matter what action we undertake if certain proposals are enacted, certain tax treaties are amended and/or our interpretation of applicable tax law is challenged and determined to be incorrect. In particular, any changes and/or differing interpretations of applicable tax law that have the effect of disregarding our incorporation in Ireland, limiting our ability to take advantage of tax treaties between jurisdictions, modifying or eliminating the deductibility of various currently deductible payments or increasing the tax burden of operating or being resident in a particular country, could subject us to increased taxation.24Table of ContentsDividends received by our shareholders may be subject to Irish dividend withholding tax.In certain circumstances, we are required to deduct Irish dividend withholding tax of 25% from dividends paid to our shareholders. In the majority of cases, shareholders residing in the U.S. will not be subject to Irish withholding tax, and shareholders resident in a number of other countries will not be subject to Irish withholding tax provided that they complete certain Irish dividend withholding tax forms. However, some shareholders may be subject to withholding tax, which could discourage the investment in our stock and adversely impact the price of our shares. Dividends received by our shareholders may be subject to Irish income tax.Dividends paid in respect of our shares generally are not subject to Irish income tax where the beneficial owner of these dividends is exempt from Irish dividend withholding tax, unless the beneficial owner of the dividend has some connection with Ireland other than his or her shareholding in Allegion.Our shareholders who receive their dividends subject to Irish dividend withholding tax will generally have no further liability to Irish income tax on the dividends unless the beneficial owner of the dividend has some connection with Ireland other than his or her shareholding in Allegion. Certain provisions in our Memorandum and Articles of Association, among other things, could prevent or delay an acquisition of us, which could decrease the trading price of our ordinary shares.Our Memorandum and Articles of Association contains provisions to deter takeover practices, inadequate takeover bids and unsolicited offers. These provisions include, amongst others:•A provision of our Articles of Association which generally prohibits us from engaging in a business combination with an interested shareholder (being (i) the beneficial owner, directly or indirectly, of 10% or more of our voting shares or (ii) an affiliate or associate of us that has at any time within the last five years been the beneficial owner, directly or indirectly, of 10% or more of our voting shares), subject to certain exceptions;•Rules regarding how shareholders may present proposals or nominate directors for election at shareholder meetings; •The right of our Board of Directors to issue preferred shares without shareholder approval in certain circumstances, subject to applicable law; and•The ability of our Board of Directors to set the number of directors and to fill vacancies on our Board of Directors.We believe these provisions will provide some protection to our shareholders from coercive or otherwise unfair takeover tactics. These provisions are not intended to make us immune from takeovers. However, these provisions will apply even if the offer may be considered beneficial by some shareholders and could delay or prevent an acquisition that our Board of Directors determines is in our best interests and our shareholders' best interests. These provisions may also prevent or discourage attempts to remove and replace incumbent directors.In addition, several mandatory provisions of Irish law could prevent or delay an acquisition of us. For example, Irish law does not permit shareholders of an Irish public limited company to take action by written consent with less than unanimous consent. We also will be subject to various provisions of Irish law relating to mandatory bids, voluntary bids, requirements to make a cash offer and minimum price requirements, as well as substantial acquisition rules and rules requiring the disclosure of interests in our shares in certain circumstances. Also, Irish companies, including us, may alter their Memorandum of Association and Articles of Association only with the approval of at least 75% of the votes of the company’s shareholders cast in person or by proxy at a general meeting of the company.Item 1B. UNRESOLVED STAFF COMMENTSNone.Item 2. PROPERTIESWe operate through a broad network of sales offices, engineering centers, 29 principal production and assembly facilities and several distribution centers throughout the world. Our active properties represent about 6.7 million square feet, of which approximately 41% is leased.We own 16 of our production and assembly facilities, with the remainder under long-term lease arrangements. We believe that our plants have been well maintained, are generally in good condition and are suitable for the conduct of our business.Item 3. LEGAL PROCEEDINGSIn the normal course of business, we are involved in a variety of lawsuits, claims and legal proceedings, including commercial and contract disputes, employment matters, product liability claims, environmental liabilities, intellectual property disputes and tax-related matters. In our opinion, pending legal matters are not expected to have a material adverse impact on our results of operations, financial condition, liquidity or cash flows.This item should be read in conjunction with the Risk Factors set forth in Part I. Item 1A of this Form 10-K.25Table of ContentsItem 4. MINE SAFETY DISCLOSURESNot applicable.INFORMATION ABOUT OUR EXECUTIVE OFFICERSThe following is a list of executive officers of the Company as of February 22, 2023. John H. Stone, age 52, has served as our President and Chief Executive Officer since July 2022. Prior to joining Allegion, Mr. Stone served as President, Worldwide Construction, Forestry and Power Systems at Deere & Company, an agricultural machinery and heavy equipment company ("Deere"), from 2020 to 2022, and prior to that, served as Senior Vice President, Intelligent Solutions Group at Deere from 2016 to 2020.Michael J. Wagnes, age 49, has served as our Senior Vice President and Chief Financial Officer since March 2022. Mr. Wagnes served as our Vice President and General Manager, Commercial Americas from 2020 to 2022 and as our Vice President – Investor Relations and Treasury from 2016 to 2020. Jeffrey N. Braun, age 63, has served as our Senior Vice President and General Counsel since 2014. Mr. Braun also served as Secretary from July 2022 to February 2023 and from 2018 to 2020. Timothy P. Eckersley, age 61, has served as our Senior Vice President – Allegion International since 2021. Mr. Eckersley served as our Senior Vice President – Americas from 2013 to 2020.Cynthia D. Farrer, age 60, has served as our Senior Vice President – Global Operations and Integrated Supply Chain since June 2021. Ms. Farrer served as our Vice President – Global Operations and Integrated Supply Chain from 2020 to 2021 and as Vice President, Global Supply Management from 2017 to 2020.David S. Ilardi, age 44, has served as our Senior Vice President – Allegion Americas since March 2022. Mr. Ilardi served as our General Manager, Allegion Home from 2019 to 2022 and Regional Vice President Sales, Central Region from 2017 to 2019.Tracy L. Kemp, age 54, has served as our Senior Vice President – Chief Information and Digital Officer since December 2020. Ms. Kemp served as our Senior Vice President – Chief Customer and Digital Officer from 2019 to 2020 and Senior Vice President and Chief Information Officer from 2015 to 2019. Robert C. Martens, age 52, has served as our Senior Vice President – Chief Innovation and Design Officer since December 2019 and Futurist and President of Allegion Ventures since 2017. Nickolas A. Musial, age 42, has served as our Vice President, Controller and Chief Accounting Officer since March 2022. Mr. Musial served as our Vice President of Finance, Allegion Americas from 2017 to 2022.Jennifer L. Preczewski, age 41, has served as our Senior Vice President – Chief Human Resources Officer since February 2023. Ms. Preczewski served as our Vice President – Chief Human Resources Officer from July 2022 to February 2023, as our Vice President, HR – Total Rewards and Global Talent from 2020 to 2022, Vice President, Global Talent from 2018 to 2020, and Vice President, Human Resources – Americas from 2016 to 2018.Vincent M. Wenos, age 56, has served as our Senior Vice President – Chief Technology Officer since June 2019. Mr. Wenos served as our Vice President – Global Technology and Engineering from 2018 to 2019 and as both Vice President – Americas Engineering and Vice President – Global Mechanical Products from 2016 to 2018. All above-listed executive officers except for Mr. Stone have been employed by the Company for more than the past five years. No family relationship exists between any of the above-listed executive officers or directors of the Company. All executive officers are elected to hold office for one year or until their successors are elected and qualified or their earlier death, resignation or removal from office by our Board of Directors.26Table of ContentsPART II Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESOur ordinary shares are traded on the New York Stock Exchange under the symbol ALLE. As of February 16, 2023, the number of record holders of ordinary shares was 2,054. Dividend PolicyOur Board of Directors declared dividends of $0.41 per ordinary share on February 4, 2022, April 7, 2022, September 1, 2022 and December 1, 2022. On February 9, 2023, our Board of Directors declared a dividend of $0.45 per ordinary share payable on March 31, 2023, to shareholders of record on March 15, 2023. We paid a total of $143.9 million in cash for dividends to ordinary shareholders during the year ended December 31, 2022. Future dividends on our ordinary shares, if any, will be at the discretion of our Board of Directors and will depend on, among other things, our results of operations, cash requirements and surplus, financial condition, contractual restrictions (including under the agreements governing our indebtedness) and other factors that the Board of Directors may deem relevant, as well as our ability to pay dividends in compliance with the Irish Companies Act. Under the Irish Companies Act, dividends and distributions may only be made from distributable reserves. Distributable reserves, broadly, means the accumulated realized profits of Allegion plc ("ALLE-Ireland") which are unrelated to any GAAP reported amounts (e.g., retained earnings). As of December 31, 2022, we had distributable reserves of $3.8 billion. In addition, no distribution or dividend may be made unless the net assets of ALLE-Ireland are equal to, or in excess of, the aggregate of ALLE-Ireland’s called up share capital plus undistributable reserves, and the distribution or dividend does not reduce ALLE-Ireland’s net assets below such aggregate.Issuer Purchases of Equity SecuritiesPeriodTotal number of shares purchased (000s)Average price paid per shareTotal number of shares purchased as part of the 2020 Share Repurchase Authorization (000s)Approximate dollar value of shares still available to be purchased under the 2020 Share Repurchase Authorization (000s)October 1 - October 31— $— — $140,454 November 1 - November 30— — — 140,454 December 1 - December 31— — — 140,454 Total— $— — $140,454 In February 2020, our Board of Directors approved a share repurchase authorization of up to, and including, $800 million of the Company’s ordinary shares (the "2020 Share Repurchase Authorization"). The 2020 Share Repurchase Authorization does not have a prescribed expiration date. Based on market conditions, share repurchases may be made from time to time in the open market at the discretion of management. 27Table of ContentsPerformance GraphThe annual changes for the five-year period shown below are based on the assumption that $100 had been invested in Allegion plc ordinary shares, the Standard & Poor’s 500 Stock Index ("S&P 500") and the Standard & Poor's 400 Capital Goods Index ("S&P 400 Capital Goods") on December 31, 2017, and that all quarterly dividends were reinvested. The total cumulative dollar returns shown on the graph represent the value that such investments would have had on December 31, 2022.December 31, 2017December 31, 2018December 31, 2019December 31, 2020December 31, 2021December 31, 2022Allegion plc100.00101.18159.74151.14173.89140.42S&P 500100.0095.62125.72148.85191.58156.88S&P 400 Capital Goods100.0085.99114.15136.80174.64157.15Item 6. [RESERVED]28Table of ContentsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed under Part I, Item 1A. Risk Factors in this Annual Report on Form 10-K. The following section is qualified in its entirety by the more detailed information, including our consolidated financial statements and the notes thereto, which appears elsewhere in this Annual Report on Form 10-K.OverviewOrganizationWe are a leading global provider of security products and solutions operating in two segments: Allegion Americas and Allegion International. We sell a wide range of security products and solutions for end-users in commercial, institutional and residential facilities worldwide, including the education, healthcare, government, hospitality, retail, commercial office and single and multi-family residential markets. Our leading brands include CISA, Interflex, LCN, Schlage, SimonsVoss and Von Duprin. Recent DevelopmentsIndustry Trends and OutlookThroughout 2022 we experienced strong demand for our non-residential products and services in our Allegion Americas segment. Our ability to meet this elevated level of customer demand improved substantially as the year progressed, due in part to our actions taken to address industry-wide supply-chain challenges (particularly shortages of electronic components), as well as improving availability of non-electronic parts and materials. Further, in response to the persistent, elevated levels of inflation seen throughout the year, we implemented a series of pricing initiatives across our global businesses. Not only did these pricing initiatives significantly contribute to revenue growth in 2022, they also helped mitigate the inflationary pressures on our cost base. We expect this pricing momentum to continue to drive revenue growth and help offset the impact of inflation into 2023. While 2022 began with similar strong demand for our residential products in our Allegion Americas segment, macroeconomic conditions had a more challenging impact on demand as the year progressed. A combination of elevated inflation and lower consumer sentiment impacted sales volumes of residential products within our Allegion Americas segment. We also experienced a softening of demand throughout many of the Eurozone economies during the second half of 2022, reflecting increased economic and geopolitical concerns in this region, which impacted several of our businesses in our Allegion International segment.While supply chain challenges around the availability of electronic parts and components persist, and will likely continue to impact our ability to meet the elevated levels of demand for our electronic security products into 2023, we remain focused on providing exceptional service and innovation to our customers. Over the course of 2022, we began to realize the benefits from our measures taken to mitigate operational and logistical inefficiencies caused by the supply chain challenges, such as re-engineering product designs and configurations to accept alternate electronic components and developing alternate sources of supply. We continue to invest in business initiatives to drive future growth and add value through seamless access and explore various options to enhance financial performance while minimizing disruption to customers and our overall business.The macroeconomic and geopolitical trends and uncertainties noted above will likely continue to affect us in numerous and evolving ways, the full impact of which on our business, financial condition and results of operations will continue to depend on future developments that are beyond our control and we may not be able to accurately predict. These trends and uncertainties and their potential impact on our business, results of operations, financial condition and cash flows, as well as other risks, trends and uncertainties that could affect our business, financial condition and results of operations are described further under "Part I, Item 1A. Risk Factors". 2022 and 2021 Significant Events Acquisition of the Access Technologies businessOn July 5, 2022, we completed the acquisition of the Access Technologies business for a closing purchase price of $923.1 million. This acquisition was financed by the net proceeds from the issuance of our 5.411% Senior Notes, together with borrowings under the 2021 Revolving Facility. The Access Technologies business has been integrated into our Allegion Americas segment The Access Technologies business is a leading manufacturer, installer and service provider of automatic entrance solutions in North America, primarily in the U.S. and Canada. Its diversified customer base centers on non-residential settings, including retail, healthcare, education, commercial offices, hospitality and government. This acquisition helps us create a more comprehensive portfolio of access solutions, with the addition of automated entrance solutions. Additionally, the Access 29Table of ContentsTechnologies business adds an expansive service and support network throughout the U.S. and Canada, broadening our solutions to national, regional and local customers, and complementing our existing strengths in these non-residential markets. Since the acquisition date and through December 31, 2022, the Access Technologies business generated $185.9 million in Net revenues.Divestiture of Milre In September 2022, we sold Milre Systek Co. Ltd. ("Milre") in South Korea for an immaterial amount. As a result of the sale, we recorded a net loss on divestiture of $7.6 million.Financing activitiesOn June 22, 2022, Allegion US Holding Company Inc., a wholly-owned subsidiary of the Company ("Allegion US Hold Co"), issued $600.0 million aggregate principal amount of its 5.411% Senior Notes due 2032 (the “5.411% Senior Notes”). The 5.411% Senior Notes require semi-annual interest payments on January 1 and July 1, beginning January 1, 2023, and will mature on July 1, 2032. We incurred and deferred $5.9 million of discounts and financing costs associated with the 5.411% Senior Notes, which will be amortized to Interest expense over their 10-year term, as well as $4.3 million of third party financing costs that were recorded within Interest expense on the Consolidated Statement of Comprehensive Income for the year ended December 31, 2022.On November 18, 2021, we entered into a new $750.0 million unsecured credit agreement, consisting of the $250.0 million 2021 Term Facility and the $500.0 million 2021 Revolving Facility. The proceeds of $250.0 million from the 2021 Term Facility were primarily used to repay in full our previously outstanding unsecured Term Facility. 2022 Dividends and Share RepurchasesWe paid quarterly dividends of $0.41 per ordinary share to shareholders on record as of March 16, 2022, June 16, 2022, September 16, 2022, and December 16, 2022, for a total of $143.9 million and repurchased approximately 0.5 million ordinary shares for approximately $61.0 million during the year ended December 31, 2022.30Table of ContentsResults of Operations - For the years ended December 31Dollar amounts in millions, except per share amounts2022% of Netrevenues2021% of NetrevenuesNet revenues$3,271.9 $2,867.4 Cost of goods sold1,949.5 59.6 %1,662.5 58.0 %Selling and administrative expenses736.0 22.5 %674.7 23.5 %Operating income586.4 17.9 %530.2 18.5 %Interest expense75.9 50.2 Loss on divestitures7.6 — Other income, net(11.6) (44.0) Earnings before income taxes514.5 524.0 Provision for income taxes56.2 40.7 Net earnings458.3 483.3 Less: Net earnings attributable to noncontrolling interests0.3 0.3 Net earnings attributable to Allegion plc$458.0 $483.0 Diluted net earnings per ordinary share attributable to Allegion plc ordinary shareholders:$5.19 $5.34 The discussions that follow describe the significant factors contributing to the changes in our results of operations for the years presented and form the basis used by management to evaluate the financial performance of the business. For a discussion of our results of operations for the year ended December 31, 2021, compared to the year ended December 31, 2020, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2021 Annual Report on Form 10-K filed with the SEC on February 15, 2022.Net RevenuesNet revenues for the year ended December 31, 2022, increased by 14.1%, or $404.5 million, as compared to the year ended December 31, 2021, due to the following:Pricing9.8 %Volume0.9 %Acquisitions / divestitures6.4 %Currency exchange rates(3.0)%Total14.1 %The increase in Net revenues was driven by improved pricing across our major businesses, our acquisition of the Access Technologies business and higher volumes in our Allegion Americas segment. These increases were partially offset by unfavorable foreign currency exchange rate movements, lower volumes in our Allegion International segment and a divestiture in each of the prior and current year. Increased pricing was the result of multiple pricing initiatives implemented to help mitigate the impact of the persistent, elevated levels of inflation. We will continue to monitor the inflationary pressures to our businesses and address them through pricing initiatives where appropriate.Pricing includes increases or decreases of price, including discounts, surcharges and/or other sales deductions, on our existing products and services. Volume includes increases or decreases of revenue due to changes in unit volume of existing products and services, as well as new products and services.Cost of Goods SoldFor the year ended December 31, 2022, Cost of goods sold as a percentage of Net revenues increased to 59.6% from 58.0%, as compared to the year ended December 31, 2021, due to the following: Inflation in excess of pricing and productivity0.7 %Volume / product mix(0.9)%Acquisitions / divestitures0.7 %Investment spending0.2 %Currency exchange rates0.3 %Restructuring / acquisition expenses0.6 %Total1.6 %31Table of ContentsCost of goods sold as a percentage of Net revenues increased primarily due to the impact inflation had on Cost of goods sold, which exceeded the beneficial impacts from pricing and productivity, lower gross margins associated with our acquired Access Technologies business, increased investment spending, higher restructuring and acquisition and integration costs year-over-year and unfavorable foreign currency exchange rate movements. These increases to Cost of goods sold as a percentage of Net revenues were partially offset by favorable product mix, due to increased volumes in the Allegion Americas segment. Inflation in excess of pricing and productivity includes the impact to Costs of goods sold from pricing, as defined above, in addition to productivity and inflation. Productivity represents improvements in unit costs of materials and cost reductions related to improvements to our manufacturing design and processes. Inflation includes unit costs for the current period compared to the average actual cost for the prior period, multiplied by current year volumes. Volume/product mix represents the impact due to increases or decreases of revenue due to changes in unit volume, including new products and services, including the effect of changes in the mix of products and services sold on Cost of goods sold.Selling and Administrative ExpensesFor the year ended December 31, 2022, Selling and administrative expenses as a percentage of Net revenues decreased to 22.5% from 23.5%, as compared to the year ended December 31, 2021, due to the following:Productivity in excess of inflation(1.5)%Volume leverage(0.2)%Acquisitions / divestitures(0.3)%Investment spending0.3 %Restructuring / acquisition expenses0.7 %Total(1.0)%Selling and administrative expenses as a percentage of Net revenues decreased primarily due to productivity improvements exceeding the impact of inflation, as well as favorable volume leverage and the beneficial impact from current and prior year acquisition and divestiture activity. These decreases were partially offset by a year-over-year increase in acquisition and integration expenses, which were primarily related to our acquisition of the Access Technologies business, and increased investment spending.Productivity in excess of inflation includes the impact from reductions in selling and administrative expenses due to productivity projects and current period costs of ongoing selling and administrative functions compared to the same ongoing expenses in the prior period. Volume leverage represents the contribution margin related to changes in sales volume, excluding the impact of price, productivity, mix and inflation. Expenses related to increased head count for strategic initiatives, new facilities or significant spending for strategic initiatives or new product and channel development, are captured in Investment spending in the table above.Operating Income/MarginOperating income for the year ended December 31, 2022, increased $56.2 million as compared to the year ended December 31, 2021, and Operating margin decreased to 17.9% from 18.5%, due to the following: In millionsOperating IncomeOperating MarginDecember 31, 2021$530.2 18.5 %Pricing and productivity in excess of inflation79.7 0.9 %Volume / product mix36.5 1.1 %Currency exchange rates(21.9)(0.2)%Investment spending(16.0)(0.6)%Acquisitions/ divestitures18.6 (0.4)%Restructuring / acquisition expenses(40.7)(1.4)%December 31, 2022$586.4 17.9 %The increase in Operating income was driven by pricing improvements in excess of inflation and productivity, favorable volume/product mix and the contribution to Operating income from our acquired Access Technologies business. These increases were partially offset by unfavorable foreign currency exchange rate movements, increased investment spending and a year-over-year increase in restructuring and acquisition and integration expenses, which were primarily related to our acquisition of the Access Technologies business. The decrease in Operating margin was primarily due to the year-over-year increase in restructuring and acquisition expenses, unfavorable foreign currency exchange rate movements, increased investment spending and the dilutive impact to Operating 32Table of Contentsmargin from our Access Technologies business. These decreases were partially offset by pricing improvements in excess of inflation and productivity, favorable volume/product mix and the positive impact to operating margin from recent divestitures.Interest ExpenseInterest expense for the year ended December 31, 2022, increased $25.7 million as compared to the year ended December 31, 2021, primarily due to interest on our 5.411% Senior Notes and the 2021 Revolving Facility, as well as $4.3 million of third-party costs related to the financing of the Access Technologies business acquisition. The rise in interest rates over the course of 2022 also contributed to a higher weighted-average interest rate on our variable rate outstanding indebtedness.Loss on DivestitureAs discussed above, in September 2022 we sold Milre for an immaterial amount, resulting in a net loss of $7.6 million.Other Income, netThe components of Other income, net, for the years ended December 31 were as follows:In millions20222021Interest income$(1.3)$(0.4)Foreign currency exchange loss2.4 2.7 Earnings and gains from the sale of equity method investments, net(0.8)(6.4)Net periodic pension and postretirement benefit income, less service cost(9.4)(7.1)Other(2.5)(32.8)Other income, net$(11.6)$(44.0)For the year ended December 31, 2022, Other income, net decreased $32.4 million compared to 2021, primarily due to a non-operating investment gain of $20.7 in 2021 that did not recur in 2022. This gain is included within Other in the table above. Also contributing to the decrease in Other income, net, are a prior year gain of $6.4 million from the sale of an equity method investment that did not recur in 2022 and a decrease in other realized and unrealized investment gains year-over-year. Provision for Income TaxesFor the year ended December 31, 2022, our effective tax rate was 10.9%, compared to 7.8% for the year ended December 31, 2021. The increase in the effective tax rate was primarily due to the favorable resolutions of uncertain tax positions, changes in jurisdictional tax rates and other discrete tax benefits in 2021 that have not recurred in 2022 and the mix of income earned in higher tax rate jurisdictions. Review of Business SegmentsWe operate in and report financial results for two segments: Allegion Americas and Allegion International. These segments represent the level at which our chief operating decision maker reviews our financial performance and makes operating decisions. Segment operating income is the measure of profit and loss that our chief operating decision maker uses to evaluate the financial performance of the business and as the basis for resource allocation, performance reviews and compensation. For these reasons, we believe Segment operating income represents the most relevant measure of Segment profit and loss. Our chief operating decision maker may exclude certain charges or gains, such as corporate charges and other special charges, to arrive at a Segment operating income that is a more meaningful measure of profit and loss upon which to base our operating decisions. We define Segment operating margin as Segment operating income as a percentage of the segment's Net revenues.33Table of ContentsSegment Results of Operations - For the years ended December 31In millions20222021% ChangeNet revenuesAllegion Americas$2,551.6 $2,072.2 23.1 %Allegion International720.3 795.2 (9.4)%Total$3,271.9 $2,867.4 Segment operating incomeAllegion Americas$613.3 $525.0 16.8 %Allegion International68.3 82.4 (17.1)%Total$681.6 $607.4 Segment operating marginAllegion Americas24.0 %25.3 %Allegion International9.5 %10.4 %Allegion AmericasOur Allegion Americas segment is a leading provider of security products, services and solutions throughout North America. The segment sells a broad range of products and solutions including, locks, locksets, portable locks, key systems, door controls and systems, exit devices, doors, accessories, electronic security products, access control systems and software and service solutions to customers in commercial, institutional and residential facilities, including the education, healthcare, government, hospitality, retail, commercial office and single and multi-family residential markets. This segment’s primary brands are LCN, Schlage, Von Duprin and Stanley Access Technologies, which we utilize with permission in accordance with the terms of the Access Technologies acquisition agreement ("Stanley" is the property of Stanley Logistics L.L.C).Net revenuesNet revenues for the year ended December 31, 2022, increased by 23.1%, or $479.4 million, as compared to the year ended December 31, 2021, due to the following: Pricing11.4 %Volume3.0 %Acquisitions9.0 %Currency exchange rates(0.3)%Total23.1 %The increase in Net revenues was driven by significantly improved pricing, higher volumes for our non-residential products and our Access Technologies business acquisition. These increases were partially offset by unfavorable foreign currency exchange rate movements and lower volumes for our residential products. Increased pricing was the result of multiple pricing initiatives implemented to help mitigate the impact of persistent, elevated levels of inflation. We will continue to monitor the inflationary pressures to our businesses and address them through pricing initiatives where appropriate.Net revenues from non-residential products (excluding Net revenues from our acquired Access Technologies business), increased by a low twenties percent compared to the prior year, driven by improved pricing and higher volumes. Strong demand throughout 2022 and improvements around the availability of materials and components, driven in part by our actions to mitigate these supply-chain challenges, helped drive the increase in volumes compared to 2021. Net revenues from residential products decreased by a low single digits percent compared to the prior year. Increased pricing was offset by lower volumes during the year. During the second half of 2022, we experienced a softening in market demand for our residential products, due in part to elevated inflation and lower consumer sentiment, which resulted in reduced sales volumes. Further, market conditions for new residential construction deteriorated over the latter half of 2022, due in part to a rapid and substantial increase in mortgage rates. Given these factors, we anticipate softness in demand for our residential products to continue into 2023. Growth in electronic security products and solutions is a metric monitored by management and a focus of our investors. Electronic products encompass both residential and non-residential products, and include all electrified product categories including, but not limited to, electronic and electrified locks, access control systems and electronic and electrified door controls and systems and exit devices. Net revenues from the sale of electronic products increased by a high teens percent compared to 2021, driven by improved pricing and higher volumes. While we continue to experience delays and shortages of electronic components from key suppliers, we expect continued growth from the sale of electronic products in 2023 given the combination of our pricing initiatives and our actions taken to mitigate these delays and shortages. 34Table of ContentsOperating income/marginSegment operating income for the year ended December 31, 2022, increased $88.3 million, and Segment operating margin decreased to 24.0% from 25.3% as compared to the year ended December 31, 2021, due to the following: In millionsOperating IncomeOperating MarginDecember 31, 2021$525.0 25.3 %Pricing and productivity in excess of inflation57.1 — %Volume / product mix52.2 1.7 %Currency exchange rates(4.4)(0.1)%Investment spending(10.4)(0.5)%Acquisitions16.4 (1.3)%Acquisition expenses(22.6)(1.1)%December 31, 2022$613.3 24.0 %The increase in Segment operating income was primarily driven by pricing improvements in excess of inflation and productivity, favorable volume/product mix and the contribution to Segment operating income from our acquired Access Technologies business. These increases were partially offset by unfavorable foreign currency exchange rate movements, increased investment spending and a year-over-year increase in acquisition and integration expenses, which were primarily related to our acquisition of the Access Technologies business.The decrease in Segment operating margin was primarily due to the year-over-year increase in acquisition and integration expenses, the impact to Segment operating margin from our Access Technologies business, increased investment spending and unfavorable foreign currency exchange rate movements. These decreases were partially offset by favorable volume/product mix.Allegion InternationalOur Allegion International segment provides security products, services and solutions primarily throughout Europe, Asia and Oceania. The segment offers end-users a broad range of products, services and solutions including locks, locksets, portable locks, key systems, door controls and systems, exit devices, doors, electronic security products, access control systems, time and attendance and workforce productivity solutions, among other software and service solutions. This segment’s primary brands are AXA, Bricard, Briton, CISA, Gainsborough, Interflex and SimonsVoss.Net revenuesNet revenues for the year ended December 31, 2022, decreased by 9.4%, or $74.9 million, as compared to the year ended December 31, 2021, due to the following:Pricing5.6 %Volume(4.6)%Acquisitions / divestitures(0.3)%Currency exchange rates(10.1)%Total(9.4)%The decrease in Net revenues was driven by lower volumes and unfavorable foreign currency exchange rate movements, due to the strengthening of the U.S. dollar relative to most of the currencies in which we do business throughout our Allegion International segment. Both a prior year and current year divestiture also contributed slightly to the decrease in Net revenues. These decreases were partially offset by improved pricing.As discussed above, softening demand throughout much of the Eurozone in 2022 has impacted several of our businesses in our Allegion International segment. Additionally, COVID-19 related lockdowns in China throughout the year also contributed to lower volumes. While we anticipate pricing initiatives to continue to positively contribute to revenue growth in 2023, volume growth will likely continue to be tempered until prevailing macroeconomic and geopolitical conditions improve. Operating income marginSegment operating income for the year ended December 31, 2022, decreased $14.1 million, and Segment operating margin decreased to 9.5% from 10.4% as compared to the year ended December 31, 2021, due to the following:35Table of ContentsIn millionsOperating IncomeOperating MarginDecember 31, 2021$82.4 10.4 %Pricing and productivity in excess of inflation23.7 2.4 %Volume / product mix(15.6)(1.5)%Currency exchange rates(17.6)(1.3)%Investment spending(5.5)(0.7)%Acquisitions / divestitures2.1 0.3 %Restructuring / acquisition expenses(1.2)(0.1)%December 31, 2022$68.3 9.5 %The decreases in Segment operating income and Segment operating margin were primarily driven by unfavorable volume/product mix, unfavorable foreign currency exchange rate movements, increased investment spending and a year-over-year increase in restructuring and acquisition expenses. These decreases were partially offset by pricing and productivity improvements in excess of inflation and both prior year and current year acquisition and divestiture activity.Liquidity and Capital ResourcesLiquidity Outlook, Sources and UsesOur primary source of liquidity is cash provided by operating activities. Cash provided by operating activities is used to invest in new product development and fund capital expenditures and working capital requirements. Our ability to generate cash from our operating activities, our unused availability under the 2021 Revolving Facility and our access to the capital and credit markets enable us to fund these capital needs, execute our long-term growth strategies and return value to our shareholders. Further, our business operates with strong operating cash flows, low leverage and low capital intensity, providing financial flexibility, including sufficient access to credit markets. Our short-term financing needs primarily consist of working capital requirements, restructuring initiatives, capital spending, dividend payments and principal and interest payments on our long-term debt. Long-term financing needs depend largely on potential growth opportunities, including potential acquisitions, repayment or refinancing of our long-term obligations and repurchases of our ordinary shares. Of our total outstanding indebtedness as of December 31, 2022, approximately 85% incurs fixed-rate interest and is therefore not exposed to the risk of rising variable interest rates. Based upon our operations, existing cash balances and unused availability under the 2021 Revolving Facility, as of December 31, 2022, we expect cash flows from operations to be sufficient to maintain a sound financial position and liquidity and to meet our financing needs for at least the next 12 months. Further, we do not anticipate any covenant compliance challenges with any of our outstanding indebtedness for at least the next 12 months. We also believe existing availability under the 2021 Credit Facilities and access to credit and capital markets are sufficient to achieve our longer-term strategic plans.The following table reflects the major categories of cash flows for the years ended December 31. For additional details, see the Consolidated Statements of Cash Flows in the Consolidated Financial Statements.In millions20222021Net cash provided by operating activities$459.5 $488.6 Net cash used in investing activities(994.1)(31.6)Net cash provided by (used in) financing activities$437.0 $(529.3)Operating activities: Net cash provided by operating activities for the year ended December 31, 2022, decreased by $29.1 million compared to 2021, driven primarily by changes in working capital. Investing activities: Net cash used in investing activities for the year ended December 31, 2022, increased by $962.5 million compared to 2021, primarily due to $923.1 million of cash paid for our acquisition of the Access Technologies business, as well as an increase of $18.6 million in capital expenditures compared to 2021.Financing activities: Net cash provided by (used in) financing activities for the year ended December 31, 2022, changed by $966.3 million compared to 2021, primarily due to the $600.0 million issuance of our 5.411% Senior Notes to help finance the acquisition of the Access Technologies business. Additionally, cash used to repurchase shares was $351.8 million lower in 2022 compared to 2021.36Table of ContentsCapitalizationAt December 31, long-term debt and other borrowings consisted of the following:In millions202220212021 Term Facility$237.5 $250.0 2021 Revolving Facility69.0 — 3.200% Senior Notes due 2024400.0 400.0 3.550% Senior Notes due 2027400.0 400.0 3.500% Senior Notes due 2029400.0 400.0 5.411% Senior Notes due 2032600.0 — Other debt0.2 0.3 Total borrowings outstanding2,106.7 1,450.3 Discounts and debt issuance costs, net(12.2)(8.2)Total debt2,094.5 1,442.1 Less current portion of long-term debt12.6 12.6 Total long-term debt$2,081.9 $1,429.5 As of December 31, 2022, we have an unsecured Credit Agreement in place, consisting of the $250.0 million 2021 Term Facility, of which $237.5 million was outstanding at December 31, 2022, and the 2021 Revolving Facility (together with the 2021 Term Facility, the “2021 Credit Facilities”). The 2021 Credit Facilities mature on November 18, 2026. The 2021 Term Facility will amortize in quarterly installments at the following rates: 1.25% per quarter starting March 31, 2022 through March 31, 2025, 2.5% per quarter starting June 30, 2025 through September 30, 2026, with the balance due on November 18, 2026. Principal amounts repaid on the Term Facility may not be reborrowed. The 2021 Revolving Facility provides aggregate commitments of up to $500.0 million, which includes up to $100.0 million for the issuance of letters of credit. On July 1, 2022, we borrowed $340.0 million under the 2021 Revolving Facility to partially fund our acquisition of the Access Technologies business. We subsequently repaid $271.0 million, resulting in $69.0 million of borrowings outstanding on the 2021 Revolving Facility as of December 31, 2022. We also had $13.2 million of letters of credit outstanding as of December 31, 2022. Outstanding borrowings under the 2021 Revolving Facility may be repaid at any time without premium or penalty, and amounts repaid may be reborrowed.Outstanding borrowings under the 2021 Credit Facilities accrue interest at our option of (i) a Bloomberg Short-Term Bank Yield Index (“BSBY”) rate plus an applicable margin, or (ii) a base rate (as defined in the Credit Agreement) plus an applicable margin. The applicable margin ranges from 0.875% to 1.375% depending on our credit ratings. At December 31, 2022, outstanding borrowings under the 2021 Credit Facilities accrued interest at BSBY plus a margin of 1.125%, resulting in an interest rate of 5.498%. The Credit Agreement also contains negative and affirmative covenants and events of default that, among other things, limit or restrict our ability to enter into certain transactions. In addition, the Credit Agreement requires us to comply with a maximum leverage ratio as defined within the agreement. As of December 31, 2022, our leverage ratio of approximately 2.5 was significantly below the covenant requirement, and we do not anticipate any potential concerns for at least the next 12 months.On June 22, 2022, we issued $600.0 million aggregate principal amount of 5.411% Senior Notes due 2032 (the “5.411% Senior Notes”). The 5.411% Senior Notes require semi-annual interest payments on January 1 and July 1, beginning January 1, 2023, and will mature on July 1, 2032. We incurred and deferred $5.9 million of discounts and financing costs associated with the 5.411% Senior Notes, which will be amortized to Interest expense over their 10-year term, as well as $4.3 million of third party financing costs that were recorded within Interest expense.As of December 31, 2022, we also have $400.0 million outstanding of 3.200% Senior Notes due 2024 (the “3.200% Senior Notes”), $400.0 million outstanding of 3.550% Senior Notes due 2027 (the “3.550% Senior Notes”) and $400.0 million outstanding of 3.500% Senior Notes due 2029 (the “3.500% Senior Notes”, and all four senior notes collectively, the "Senior Notes"). The 3.200% Senior Notes, 3.550% Senior Notes and 3.500% Senior Notes all require semi-annual interest payments on April 1 and October 1 of each year, and will mature on October 1, 2024, October 1, 2027, and October 1, 2029, respectively.Historically, the majority of our earnings were considered to be permanently reinvested in jurisdictions where we have made, and intend to continue to make, substantial investments to support the ongoing development and growth of our global operations. At December 31, 2022, we analyzed our working capital requirements and the potential tax liabilities that would be incurred if certain subsidiaries made distributions and concluded that no material changes to our historic permanent reinvestment assertions were required.Scheduled future principal repayments on our outstanding indebtedness can be found in Note 9 to the Consolidated Financial Statements. Expected principal and interest payments related to our long-term indebtedness in 2023 amount to $12.6 million and $90.9 million, respectively, given our current level of indebtedness and effective interest rates as of December 31, 2022. 37Table of ContentsContractual Obligations and Other CommitmentsIn addition to the scheduled principal and interest payments discussed above, our material cash requirements include the following contractual and other obligations:Purchase Commitments – We occasionally enter into short-term, firm purchase commitments to mitigate pricing risk related to certain of our commodity, parts and component purchases, which represent commitments under enforceable and legally binding agreements. Such purchase commitments are made in the normal course of business and are not anticipated to materially impact our liquidity or financial position over the next 12 months.Leases – We have numerous real estate and equipment leasing arrangements for which we are a lessee. See Note 11 to the Consolidated Financial Statements for further information as to the short and long-term lease liabilities included within the Consolidated Balance Sheets, as well as future minimum lease payments for 2023 and future years.Defined Benefit Plans – Our investment objective in managing defined benefit plan assets is to ensure that all present and future benefit obligations are met as they come due. We seek to achieve this goal while trying to mitigate volatility in plan funded status, contributions and expense by better matching the characteristics of the plan assets to that of the plan liabilities. Global asset allocation decisions are based on a dynamic approach whereby a plan's allocation to fixed income assets increases as the funded status increases. We monitor plan funded status, asset allocation and the impact of market conditions on our defined benefit plans regularly in addition to investment manager performance. None of our defined benefit plans have experienced a significant impact on their liquidity due to volatility in the markets.At December 31, 2022, we had net pension liabilities of $12.1 million, which consist of plan assets of $490.7 million and benefit obligations of $502.8 million. It is our objective to contribute to our pension plans in order to ensure adequate funds are available to make benefit payments to plan participants and beneficiaries when required. At December 31, 2022, the funded status of our U.S. pension plans increased to 97.8% from 97.2% at December 31, 2021. The funded status for our non-U.S. pension plans decreased to 97.4% at December 31, 2022 from 107.7% at December 31, 2021. The funded status for all of our pension plans at December 31, 2022 decreased to 97.6% from 103.0% at December 31, 2021. We currently expect to contribute approximately $12 million to our plans worldwide in 2023. Determining the costs and obligations associated with our defined benefit plans is dependent on various actuarial assumptions including discount rates, expected returns on plan assets, employee mortality and turnover rates. Changes in any of the assumptions can have an impact on the net periodic pension benefit cost. An estimated 0.5% rate decline in the discount rate would have increased net periodic pension benefit cost by approximately $0.6 million in 2022, while a 0.5% rate decline in the estimated return on assets would have increased net periodic pension benefit cost by approximately $2.4 million. For further details on defined benefit plan activity, see Note 12 to the Consolidated Financial Statements. Income Taxes – At December 31, 2022, we have total unrecognized tax benefits for uncertain tax positions of $45.2 million and $11.0 million of related accrued interest and penalties, net of tax, although we are unable to reasonably estimate the timing over which these liabilities might be paid. See Note 18 to the Consolidated Financial Statements for additional information regarding matters relating to income taxes, including unrecognized tax benefits and tax authority disputes.Contingent Liabilities – We are involved in various litigation, claims and administrative proceedings, including those related to environmental, asbestos-related and product liability matters. We believe that these liabilities are subject to the uncertainties inherent in estimating future costs for contingent liabilities and will likely be resolved over an extended period of time. See Note 21 to the Consolidated Financial Statements for additional information.Guarantor Financial InformationAllegion US Hold Co is the issuer of the 3.200% Senior Notes, 3.550% Senior Notes and 5.411% Senior Notes and is the guarantor of the 3.500% Senior Notes. Allegion plc (the “Parent”) is the issuer of the 3.500% Senior Notes and is the guarantor of the 3.200% Senior Notes, 3.550% Senior Notes and 5.411% Senior Notes. Allegion US Hold Co is directly or indirectly 100% owned by the Parent and each of the guarantees of Allegion US Hold Co and the Parent is full and unconditional and joint and several.The 3.200% Senior Notes, 3.550% Senior Notes and 5.411% Senior Notes are senior unsecured obligations of Allegion US Hold Co and rank equally with all of Allegion US Hold Co’s existing and future senior unsecured and unsubordinated indebtedness. The guarantee of the 3.200% Senior Notes, 3.550% Senior Notes and 5.411% Senior Notes is the senior unsecured obligation of the Parent and ranks equally with all of the Parent’s existing and future senior unsecured and unsubordinated indebtedness. The 3.500% Senior Notes are senior unsecured obligations of the Parent and rank equally with all of the Parent’s existing and future senior unsecured and unsubordinated indebtedness. The guarantee of the 3.500% Senior Notes is the senior unsecured obligation of Allegion US Hold Co and ranks equally with all of Allegion US Hold Co's existing and future senior unsecured and unsubordinated indebtedness.Each guarantee is effectively subordinated to any secured indebtedness of the Guarantor to the extent of the value of the assets securing such indebtedness. The Senior Notes are structurally subordinated to indebtedness and other liabilities of the 38Table of Contentssubsidiaries of the Guarantor, none of which guarantee the notes. The obligations of the Guarantor under its Guarantee are limited as necessary to prevent such Guarantee from constituting a fraudulent conveyance under applicable law and, therefore, are limited to the amount that the Guarantor could guarantee without such Guarantee constituting a fraudulent conveyance; this limitation, however, may not be effective to prevent such Guarantee from constituting a fraudulent conveyance. If the Guarantee was rendered voidable, it could be subordinated by a court to all other indebtedness (including guarantees and other contingent liabilities) of the Guarantor, and, depending on the amount of such indebtedness, the Guarantor’s liability on its Guarantee could be reduced to zero. In such an event, the notes would be structurally subordinated to the indebtedness and other liabilities of the Guarantor. For further details, terms and conditions of the Senior Notes refer to the Company’s Forms 8-K filed October 2, 2017, September 27, 2019, and June 22, 2022.The following tables present the summarized financial information specified in Rule 1-02(bb)(1) of Regulation S-X for each issuer and guarantor. The summarized financial information has been prepared in accordance with Rule 13-01 of Regulation S-X.Selected Condensed Statement of Comprehensive Income InformationYear ended December 31, 2022In millionsAllegion plcAllegion US Hold CoNet revenues$— $— Gross profit— — Operating loss(6.7)(14.4)Equity earnings in affiliates, net of tax505.9 195.5 Transactions with related parties and subsidiaries(a)(21.1)(79.6)Net earnings458.0 85.0 Net earnings attributable to the entity458.0 85.0 (a) Transactions with related parties and subsidiaries include intercompany interest and fees.Selected Condensed Balance Sheet InformationDecember 31, 2022In millionsAllegion plcAllegion US Hold CoCurrent assets:Amounts due from related parties and subsidiaries$— $380.2 Total current assets3.3 417.4 Noncurrent assets:Amounts due from related parties and subsidiaries— 1,523.9 Total noncurrent assets1,792.6 1,596.6 Current liabilities:Amounts due to related parties and subsidiaries$45.9 $278.8 Total current liabilities65.3 303.5 Noncurrent liabilities:Amounts due to related parties and subsidiaries659.5 2,694.5 Total noncurrent liabilities1,282.0 4,166.1 Critical Accounting EstimatesManagement’s Discussion and Analysis of Financial Condition and Results of Operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with GAAP. The preparation of financial statements in accordance with GAAP requires management to use judgment in making estimates and assumptions based on the relevant information available at the end of each period. These estimates and assumptions have a significant effect on reported amounts of assets and liabilities, revenues and expenses as well as the disclosure of contingent assets and liabilities because they result primarily from the need to make estimates and assumptions on matters that are inherently uncertain. Actual results may differ from estimates. If updated information or actual amounts are different from previous estimates, the revisions are included in our results for the period in which they become known.The following is a summary of certain accounting estimates and assumptions made by management that we consider critical:•Goodwill – Goodwill is tested annually during the fourth quarter for impairment or when there is a significant change in events or circumstances that indicate the fair value of a reporting unit is, more likely than not, less than its carrying 39Table of Contentsamount. Recoverability of goodwill is measured at the reporting unit level and starts with a comparison of the carrying amount of a reporting unit to its estimated fair value. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. To the extent that the carrying value of a reporting unit exceeds its estimated fair value, a goodwill impairment charge will be recognized for the amount by which the carrying value of the reporting unit exceeds its fair value, not to exceed the carrying amount of the reporting unit's goodwill. As quoted market prices are not available for our reporting units, the calculation of their estimated fair values is based on two valuation techniques, a discounted cash flow model (income approach) and a market multiple of earnings (market approach), with each method being weighted in the calculation. The income approach relies on our estimates of revenue growth rates, margin assumptions and discount rates to estimate future cash flows and explicitly addresses factors such as timing, with due consideration given to forecasting risk. These assumptions are subject to varying degrees of judgment and complexity. Estimates of future revenue growth rates and margin assumptions represent our best estimates of future cash flows given our expectations of market growth for the security products industry in the specific markets in which we operate, as well as factors such as our market positioning, brand strength, pricing and marketing efforts and other growth and productivity opportunities and initiatives. Discount rate assumptions represent our best estimates of market participant adjusted weighted-average costs of capital. Although these assumptions represent our best estimates as of the assessment date, certain factors could potentially create variances in these estimates, including, but not limited to:•Decreases in estimated market sizes or market growth rates due to greater than expected declines in volumes, pricing pressures or disruptive technology;•Declines in our market share and penetration assumptions due to increased competition or an inability to develop or launch new products;•The impacts of market volatility, including but not limited to, impacts of global pandemics, greater than expected inflation, supply chain disruption and delays, declines in pricing, reductions in volumes or fluctuations in foreign currency exchange rates; •The level of success of on-going and future research and development efforts, including those related to acquisitions, and increases in the research and development costs necessary to obtain regulatory approvals and launch new products; and•Volatility in market interest rates that could impact the selection of an appropriate discount rate.The market approach requires determining an appropriate peer group, which is utilized to derive estimated fair values of our reporting units based on selected market multiples. The market approach reflects the market’s expectations for future growth and risk, with adjustments to account for differences between the selected peer group companies and the subject reporting units. While market multiples are based on observable, arm’s-length evidence of value, these assumptions are still subject to inherent uncertainty, as the peer-group companies may differ in significant ways from one or more of our reporting units in terms of size, growth or business characteristics.The critical accounting estimates and assumptions discussed above, include our estimates of revenue growth rates and margin assumptions, discount rates, our selection of an appropriate peer group and selected market multiples. These estimates and assumptions are considered critical, as they are subject to a high degree of judgment and complexity. The selection of an applicable peer group has not significantly changed in recent years. Forecasted revenue growth rates and margin assumptions are updated annually and often fluctuate from year to year due to a myriad of factors, such as our assessment of the macroeconomic conditions throughout the major markets in which we do business, navigating the COVID-19 pandemic, supply chain challenges, elevated levels of inflation in recent years and pricing initiatives to offset inflation, market acceptance of new product innovation, investments in productivity projects, restructuring efforts, among other economic, strategic and operational factors impacting our businesses. Discount rate and market multiple assumptions are similarly updated annually, based on our best estimates of market participants, which typically include observable, arm's length-evidence of value, where possible. While we make every effort to estimate fair value as accurately as possible with the information available at the assessment date, changes in assumptions and estimates may affect the estimated fair value of the reporting unit and could result in impairment charges in future periods. During our most recent annual impairment analysis, none of our reporting units were determined to be at risk of impairment.•Indefinite-lived intangible assets – Similar to goodwill, indefinite-lived intangible assets are tested annually during the fourth quarter for impairment or when there is a significant change in events or circumstances that indicate the fair value of the asset is, more likely than not, less than its carrying amount. Recoverability of indefinite-lived intangible assets is determined on a relief from royalty methodology, which is based on the implied royalty paid, at an appropriate discount rate, to license the use of an asset rather than owning the asset. The present value of the after-tax cost savings (i.e. royalty relief) indicates the estimated fair value of the asset. Any excess of the carrying value over the estimated fair value is recognized as an impairment loss equal to that excess. The critical assumptions utilized in our annual impairment analysis for indefinite-lived intangible assets are the royalty rates and discount rates, which often differ amongst our various indefinite-lived assets. We assess the appropriateness of each royalty rate assumption annually, based on our assessment of observable market royalty rates and an analysis of the profitability of the primary business that owns or otherwise uses the indefinite-lived asset. Discount rate assumptions typically consider the discount rate conclusions for 40Table of Contentsthe reporting unit in which an underlying business operates, plus an incremental spread, where appropriate, to consider size, country or other company-specific risk. A significant change in any or a combination of the assumptions used to estimate fair value of our indefinite-lived intangible assets could have a negative impact on the estimated fair values. •Income taxes – We account for income taxes in accordance with ASC Topic 740. Deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax bases of assets and liabilities, applying enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. We recognize future tax benefits, such as net operating losses and non-U.S. tax credits, to the extent that realizing these benefits is considered in our judgment to be more likely than not. The recoverability of our deferred tax assets, which we consider to be a critical estimate, is reviewed regularly by considering our historic profitability, projected future taxable income, timing of the reversals of existing temporary differences and the feasibility of our tax planning strategies. Where appropriate, we record a valuation allowance with respect to future tax benefits. We establish valuation allowances against the realizability of any deferred tax assets based on our consideration of all available evidence, both positive and negative, using a “more likely than not” standard. This assessment considers the nature, frequency and amount of recent losses, the duration of statutory carryforward periods and tax planning strategies. Although our assessments of the valuation and recoverability of our deferred tax assets can change given a change in facts and circumstances (such as a change in a statutory tax rate), in making such judgments and estimates, significant weight is given to evidence that can be objectively verified. The provision for income taxes also involves a significant amount of management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which we operate. Future changes in applicable laws, projected levels of taxable income and tax planning could change the effective tax rate and tax balances recorded by us. In addition, tax authorities periodically review income tax returns filed by us and can raise issues regarding our filing positions, timing and amount of income or deductions and the allocation of income among the jurisdictions in which we operate. A significant period of time may elapse between the filing of an income tax return and the ultimate resolution of an issue raised by a tax authority with respect to that return. We believe we have adequately provided for any reasonably foreseeable resolution of these matters and will adjust our estimates if significant events so dictate. To the extent that the ultimate results differ from our original or adjusted estimates, the effect will be recorded in the Provision for income taxes in the period the matter is finally resolved.•Business combinations – The accounting for business combinations involves a considerable amount of judgment and estimation, including the identification of and fair values determined for acquired intangible assets, which typically include trade names, customer relationships and completed technologies. The determination of fair values of acquired intangible assets involves projections of future revenues and cash flows that are either discounted at an estimated discount rate or measured at an estimated royalty rate; fair values of other acquired assets and assumed liabilities, including potential contingencies; and the useful lives of the acquired assets. Due to the level of judgment and estimation required, in the case of significant acquisitions, we normally obtain the assistance of a third-party valuation specialist in estimating fair values of acquired tangible and intangible assets and assumed liabilities. An income approach or market approach (or both) is utilized in accordance with accepted valuation models to determine fair value. The determination of fair value of acquired assets typically requires the use of assumptions that include projections developed using historical information, internal forecasts, available industry and market data, estimates of revenue growth rates, profitability, customer attrition and discount and royalty rates, which are estimated at the time of acquisition, considering the perspective of marketplace participants. While we believe expectations and assumptions utilized for historical business combinations have been reasonable, they are inherently uncertain, and unanticipated market or macroeconomic events and circumstances occasionally do occur, and may occur in the future, which could affect the accuracy and validity of such assumptions. For our acquisition of the Access Technologies business in 2022, we believe the critical assumptions that significantly impacted recorded amounts for identifiable intangible assets include the financial projections of future performance of the business, the royalty rate assumption utilized in determining the fair value of the finite-lived trade name asset and the allocation of revenues by customer type and attrition rate assumptions utilized in determining the fair value of the customer relationship asset. The royalty rate assumption utilized in the valuation of the trade name asset was determined based on a review of market royalty rates and an analysis of the Access Technologies business’ profitability. An increase or decrease of 1% in the royalty rate assumption would have resulted in an approximate $15 million change in the value ascribed to the trade name asset. The attrition rate assumption utilized in the valuation of the customer relationship asset was determined based on a detailed review of customer specific data for the Access Technologies business spanning multiple years, combined with our estimation of the likelihood of these trends continuing for the foreseeable future. An increase or decrease of 1% in the attrition rate assumption would have resulted in an approximate $15-20 million change in the value ascribed to the customer relationship asset.The impact of future business combinations on our financial condition or results of operations may also be materially impacted by the change in or initial selection of assumptions and estimates, in addition to events and circumstances 41Table of Contentssubsequent to the acquisition that are not reasonably anticipated when finalizing our purchase accounting estimates and assumptions.Recent Accounting PronouncementsSee Note 2 to our Consolidated Financial Statements included in Item 8 herein for a discussion of recently issued and adopted accounting pronouncements.Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are exposed to fluctuations in currency exchange rates, commodity prices and interest rates which could impact our results of operations and financial condition.Foreign Currency ExposuresWe have operations throughout the world that manufacture and sell products in various international markets. As a result, we are exposed to movements in exchange rates of various currencies against the U.S. dollar as well as against other currencies throughout the world. We actively manage material currency exposures that are associated with purchases and sales and other assets and liabilities at the legal entity level; however, we do not hedge currency translation risk. We attempt to hedge exposures that cannot be naturally offset to an insignificant amount with foreign currency derivatives. Derivative instruments utilized in our hedging activities are viewed as risk management tools, involve little complexity and are not used for trading or speculative purposes. To minimize the risk of counter party non-performance, derivative instrument agreements are made only through major financial institutions with significant experience in such derivative instruments.We evaluate our exposure to changes in currency exchange rates on our foreign currency derivatives using a sensitivity analysis. The sensitivity analysis is a measurement of the potential loss in fair value based on a percentage change in exchange rates. Based on the firmly committed currency derivative instruments in place at December 31, 2022, a hypothetical change in fair value of those derivative instruments assuming a 10% adverse change in exchange rates would result in an additional unrealized loss of approximately $1.5 million. This amount, when realized, would be partially offset by changes in the fair value of the underlying transactions.Commodity Price ExposuresWe purchase a wide range of raw material, including steel, zinc, brass and other non-ferrous metals, and are exposed to volatility in the prices of these and other commodities used in our products. We use fixed price contracts to manage this exposure where appropriate. We do not have committed commodity derivative instruments in place at December 31, 2022.Interest Rate ExposureOf our total outstanding indebtedness of $2.1 billion as of December 31, 2022, approximately 85% incurs fixed-rate interest and is therefore not exposed to the risk of rising variable interest rates. However, outstanding borrowings under the 2021 Credit Facilities do accrue variable rate interest at our option of (i) a BSBY rate plus the applicable margin or (ii) a base rate plus the applicable margin. The applicable margin ranges from 0.875% to 1.375% depending on our credit ratings. At December 31, 2022, the outstanding borrowings of $306.5 million under the 2021 Credit Facilities accrue interest at BSBY plus a margin of 1.125%, resulting in an interest rate of 5.498%. Applicable variable interest rates increased throughout 2022, resulting in increased Interest expense. We are also exposed to the risk of rising interest rates to the extent that we fund our operations with short-term or variable-rate borrowings, as we currently have unused availability of $417.8 million under the 2021 Revolving Facility as of December 31, 2022. If the BSBY or other applicable base rates of the 2021 Credit Facilities increase in the future, our Interest expense could increase.42Table of Contents
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion should be read together with the Consolidated Financial Statements and the Notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about the Company’s business, operations and financial performance. The cautionary statements made in this Form 10-K should be read as applying to all related forward-looking statements whenever they appear in this Form 10-K. The Company’s actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those that are discussed under “Forward-Looking Statements,” Item 1A—Risk Factors and elsewhere in this Form 10-K. The Company has a disclosure committee consisting of members of senior management and other key employees involved in the preparation of the Company’s SEC reports. The disclosure committee is actively involved in the review and discussion of the Company’s SEC filings. For a discussion and analysis of the Company’s financial statements for fiscal 2021 compared to fiscal 2020, please refer to Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 16, 2022.OverviewAmerican Water is the largest and most geographically diverse, publicly-traded water and wastewater utility company in the United States, as measured by both operating revenues and population served. The Company employs approximately 6,500 professionals who provide drinking water, wastewater and other related services to over 14 million people in 24 states. The Company’s primary business involves the ownership of utilities that provide water and wastewater services to residential, commercial, industrial, public authority, fire service and sale for resale customers, collectively presented as the “Regulated Businesses.” The Company’s utilities operate in approximately 1,600 communities in 14 states in the United States, with 3.4 million active customers with services provided by its water and wastewater networks. Services provided by the Company’s utilities are subject to regulation by PUCs. The Company also operates other businesses not subject to economic regulation by state PUCs that provide water and wastewater services to the U.S. government on military installations, as well as municipalities, collectively presented throughout this Form 10-K within “Other.” See Item 1—Business for additional information.Selected Financial DataThis selected financial data below should be read in conjunction with the Company’s Consolidated Financial Statements and related Notes in this Annual Report on Form 10-K as well as the remainder of this Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations. For the Years Ended December 31,(In millions, except per share data)20222021202020192018Statement of Operations data: Operating revenues$3,792 $3,930 $3,777 $3,610 $3,440 Net income attributable to common shareholders820 1,263 709 621 567 Net income attributable to common shareholders per basic common share4.51 6.96 3.91 3.44 3.16 Net income attributable to common shareholders per diluted common share4.51 6.95 3.91 3.43 3.15 Balance Sheet data: Total assets$27,787 $26,075 $24,766 $22,682 $21,223 Long-term debt and redeemable preferred stock at redemption value10,929 10,344 9,333 8,644 7,576 Other data: Cash dividends declared per common share$2.62 $2.41 $2.20 $2.00 $1.82 Net cash provided by operating activities1,108 1,441 1,426 1,383 1,386 Net cash used in investing activities(2,127)(1,536)(2,061)(1,945)(2,036)Net cash provided by (used in) financing activities1,000 (345)1,120 494 726 Capital expenditures included in net cash used in investing activities(2,297)(1,764)(1,822)(1,654)(1,586)48Table of ContentsFinancial ResultsFor the years ended December 31, 2022, 2021 and 2020, diluted earnings per share (GAAP) were $4.51, $6.95 and $3.91, respectively. The 2021 financial results included a pre-tax gain of $748 million relating to the sale of HOS and a $45 million pre-tax contribution to the American Water Charitable Foundation, a consolidated net impact of $2.70 diluted earnings per share. After excluding the gain related to the sale of HOS and charitable contribution in 2021, diluted earnings per share increased $0.26 in 2022 as compared to 2021. This increase was primarily driven by continued growth in the Regulated Businesses from infrastructure investment and acquisitions, as well as organic growth, offset somewhat by impacts from inflationary pressures on production costs and higher interest costs along with higher depreciation expenses from the growth of the business. Results for 2022 also reflect the favorable impact of weather, estimated at $0.06 per share, primarily due to hot and dry weather in the third quarter of 2022 as compared to a $0.02 per share favorable impact in 2021. Also, included in the results for 2022 are $0.24 per share from interest income earned on the seller note and income earned on revenue share agreements, which compares to HOS operating results for 2021 of $0.31 per share. Lastly, the operating results for the Company’s New York subsidiary, which was sold on January 1, 2022, were $0.12 per share in 2021. See Note 5—Acquisitions and Divestitures in the Notes to Consolidated Financial Statements for additional information.Growth Through Capital Investment in Infrastructure and Regulated AcquisitionsThe Company continues to grow its businesses, with the majority of its growth to be achieved in the Regulated Businesses through (i) continued capital investment in the Company’s infrastructure to provide safe, reliable and affordable water and wastewater services to its customers, and (ii) regulated acquisitions to expand the Company’s services to new customers. In 2022, the Company invested $2.6 billion, primarily in the Regulated Businesses, as discussed below:Regulated Businesses Growth and Optimization•$2.3 billion capital investment in the Regulated Businesses, the substantial majority for infrastructure improvements and replacements; and•$315 million to fund acquisitions in the Regulated Businesses, which added approximately 70,000 customers during 2022, in addition to approximately 18,500 customers added through organic growth during 2022. This includes the Company’s Pennsylvania subsidiary’s acquisition of the wastewater system assets from the York City Sewer Authority and the City of York on May 27, 2022, for a cash purchase price of $235 million, $20 million of which was funded as a deposit to the seller in April 2021 in connection with the execution of the acquisition agreement. On October 11, 2022, the Company’s Pennsylvania subsidiary entered into an agreement to acquire the wastewater assets of the Butler Area Sewer Authority for a total purchase price of $232 million in cash, subject to adjustment as provided for in the Asset Purchase Agreement. This system provides wastewater service for approximately 14,700 customer connections. The Company expects to close this acquisition by the end of 2023, pending regulatory approval.On March 29, 2021, the Company’s New Jersey subsidiary entered into an agreement to acquire the water and wastewater assets of Egg Harbor City for $22 million. The water and wastewater systems currently serve approximately 1,500 customers each, or 3,000 combined, and are being sold through the New Jersey Water Infrastructure Protection Act process. The Company expects to close this acquisition in early 2023.As of December 31, 2022, the Company has entered into agreements for 21 pending acquisitions in the Regulated Businesses, including the two agreements discussed above, to add approximately 32,400 additional customers.Sale of Homeowner Services GroupOn December 9, 2021, the Company sold all of the equity interests in subsidiaries that comprised the Company’s HOS to a wholly owned subsidiary of funds advised by Apax Partners LLP, a global private equity advisory firm (the “Buyer”), for total consideration of approximately $1.275 billion, resulting in pre-tax gain of $748 million during the fourth quarter of 2021. The consideration was comprised of $480 million in cash, a seller promissory note issued by the Buyer in the principal amount of $720 million, and a contingent cash payment of $75 million payable upon satisfaction of certain conditions on or before December 31, 2023. See Note 18—Fair Value of Financial Information for additional information relating to the seller promissory note and contingent cash payment. For the year ended December 31, 2022, the Company recorded post-close adjustments, primarily related to working capital, of pre-tax income of $20 million, which is included in Gain on sale of businesses on the Consolidated Statements of Operations.The seller note has a five-year term, is payable in cash, and bears interest at a rate of 7.00% per year during the term. The Company recognized $50 million of interest income during the year ended December 31, 2022, from the seller note.49Table of ContentsThe Company and the Buyer also entered into revenue share agreements, pursuant to which the Company is to receive 10% of the revenue generated from customers who are billed for home warranty services through an applicable Company subsidiary (an “on-bill” arrangement), and 15% of the revenue generated from any future on-bill arrangements entered into after the closing. Unless earlier terminated, this agreement has a term of up to 15 years, which may be renewed for up to two five-year periods. The Company recognized $9 million of income during the year ended December 31, 2022, from the revenue share agreements, which is included in Other, net on the Consolidated Statements of Operations. See Note 5—Acquisitions and Divestitures in the Notes to Consolidated Financial Statements for additional information.Sale of New York American Water Company, Inc.On January 1, 2022, the Company completed the previously disclosed sale of its regulated utility operations in New York to Liberty Utilities (Eastern Water Holdings) Corp. (“Liberty”), an indirect, wholly owned subsidiary of Algonquin Power & Utilities Corp. Liberty purchased from the Company all of the capital stock of the Company’s New York subsidiary for a purchase price of $608 million in cash. See Note 5—Acquisitions and Divestitures in the Notes to Consolidated Financial Statements for additional information.Sale of Michigan American Water CompanyOn February 4, 2022, the Company completed the sale of its operations in Michigan for $6 million in cash.Future GrowthThe Company expects to invest between $14 billion to $15 billion over the next five years, and between $30 billion to $34 billion over the next 10 years, including $2.9 billion in 2023. The Company’s expected future investments include:•capital investment for infrastructure improvements in the Regulated Businesses between $12.5 billion to $13 billion over the next five years, and between $27 billion to $30 billion over the next 10 years, including $2.5 billion expected in 2023; and•growth from acquisitions in the Regulated Businesses to expand the Company’s water and wastewater customer base of between $1.5 billion to $2 billion over the next five years, and between $3 billion to $4 billion over the next 10 years, including $400 million expected in 2023.Presented in the following chart is the estimated allocation of the Company’s expected capital investment for infrastructure improvements in its Regulated Businesses over the next five years, by purpose:50Table of ContentsOther MattersMilitary Services GroupOn June 30, 2022, MSG was awarded a contract for the ownership, operation, maintenance and replacement of the wastewater utility system assets at Naval Station Mayport in Jacksonville, Florida. The contract was effective July 1, 2022, and its total revenue is approximately $341 million over a 50-year period, subject to an annual economic price adjustment. The performance start date for operation is scheduled for March 1, 2023. MSG operates and maintains water and/or wastewater systems and related capital programs as part of the U.S. government’s Utilities Privatization Program. This contract represents the 18th installation in MSG’s footprint and the first contract with respect to a U.S. Navy installation.Permanganate Supply Disruption In January 2023, a fire occurred at a plant owned by the sole supplier of permanganate in the Western Hemisphere, which has severely limited the U.S. supply of potassium and sodium permanganate, two chemicals used by water utilities to treat water. The Company is seeking to utilize alternative methods of treatment and to manage its existing supplies of permanganate, but any inability to source sufficient quantities of these chemicals or utilize alternative chemicals may have a material adverse effect on the Company’s ability to comply with applicable environmental and regulatory requirements.Operational ExcellenceThe Company’s adjusted regulated O&M efficiency ratio was 33.7% for the year ended December 31, 2022, compared to 34.1% for the year ended December 31, 2021. The ratio reflects an increase in operating revenues for the Regulated Businesses, after considering the adjustment for the amortization of the excess accumulated deferred income taxes (“EADIT”) shown in the table below, as well as the continued focus on operating costs.The Company’s adjusted regulated O&M efficiency ratio is a non-GAAP measure and is defined by the Company as its operation and maintenance expenses from the Regulated Businesses, divided by the operating revenues from the Regulated Businesses, where both operation and maintenance expenses and operating revenues were adjusted to eliminate purchased water expense. Operating revenues were further adjusted to exclude reductions for the amortization of the EADIT. Also excluded from operation and maintenance expenses is the allocable portion of non-O&M support services costs, mainly depreciation and general taxes, which is reflected in the Regulated Businesses segment as operation and maintenance expenses, but for consolidated financial reporting purposes, is categorized within other line items in the accompanying Consolidated Statements of Operations. The items discussed above were excluded from the O&M efficiency ratio calculation as they are not reflective of management’s ability to increase the efficiency of the Regulated Businesses.The Company evaluates its operating performance using this ratio, and believes it is useful to investors because it directly measures improvement in the operating performance and efficiency of the Regulated Businesses. This information is derived from the Company’s consolidated financial information but is not presented in its financial statements prepared in accordance with GAAP. This information supplements and should be read in conjunction with the Company’s GAAP disclosures, and should be considered as an addition to, and not a substitute for, any GAAP measure. The Company’s adjusted regulated O&M efficiency ratio (i) is not an accounting measure that is based on GAAP; (ii) is not based on a standard, objective industry definition or method of calculation; (iii) may not be comparable to other companies’ operating measures; and (iv) should not be used in place of the GAAP information provided elsewhere in this Annual Report on Form 10-K.51Table of ContentsPresented in the table below is the calculation of the Company’s adjusted regulated O&M efficiency ratio and a reconciliation that compares operation and maintenance expenses and operating revenues, each as determined in accordance with GAAP, to those amounts utilized in the calculation of its adjusted O&M efficiency ratio:For the Years Ended December 31,(Dollars in millions)202220212020Total operation and maintenance expenses$1,589 $1,777 $1,622 Less: Operation and maintenance expenses—Other244 452 364 Total operation and maintenance expenses—Regulated Businesses1,345 1,325 1,258 Less: Regulated purchased water expenses154 153 149 Allocation of non-operation and maintenance expenses31 34 41 Adjusted operation and maintenance expenses—Regulated Businesses (i)$1,160 $1,138 $1,068 Total operating revenues$3,792 $3,930 $3,777 Less: Operating revenues—Other287 546 522 Total operating revenues—Regulated Businesses3,505 3,384 3,255 Less: Regulated purchased water revenues (a)154 153 149 Revenue reductions from the amortization of EADIT(89)(104)(7)Adjusted operating revenues—Regulated Businesses (ii)$3,440 $3,335 $3,113 Adjusted O&M efficiency ratio—Regulated Businesses (i) / (ii)33.7 %34.1 %34.3 %(a) The calculation assumes regulated purchased water revenues approximate regulated purchased water expenses.52Table of ContentsRegulatory MattersGeneral Rate CasesPresented in the table below are annualized incremental revenues, including reductions for the amortization of EADIT that are generally offset in income tax expense, assuming a constant water sales volume and customer count, resulting from general rate case authorizations that became effective during 2022:(In millions)Effective DateAmountGeneral rate cases by state:New JerseySeptember 1, 2022$46 HawaiiJuly 1, 20222 West VirginiaFebruary 25, 202213 California, Step IncreaseJanuary 1, 20229 Pennsylvania, Step IncreaseJanuary 1, 202220 Total general rate case authorizations$90 Presented in the table below are annualized incremental revenues, including reductions for the amortization of EADIT that are generally offset in income tax expense, assuming a constant water sales volume and customer count, resulting from general rate case authorizations that became effective on or after January 1, 2023:(In millions)Effective DateAmountGeneral rate cases by state:PennsylvaniaJanuary 28, 2023$138 IllinoisJanuary 1, 202367 California, Step IncreaseJanuary 1, 202313 Total general rate case authorizations$218 On December 15, 2022, the Illinois Commerce Commission issued an order approving the adjustment of base rates requested in a rate case filed on February 10, 2022, by the Company’s Illinois subsidiary. As updated in the Illinois subsidiary’s June 29, 2022 rebuttal filing, the request sought $83 million in additional annualized revenues excluding previously recovered infrastructure surcharges. The general rate case order approved a $67 million annualized increase in water and wastewater system revenues excluding previously recovered infrastructure surcharges, effective January 1, 2023, based on an authorized return on equity of 9.8%, authorized rate base of $1.64 billion, a common equity ratio of 49.0% and a debt ratio of 51.0%. The annualized revenue increase is being driven primarily by significant water and wastewater system capital investments since the Illinois subsidiary’s 2017 rate case order that have been completed or are planned through December 31, 2023, expected higher pension and other postretirement benefit costs, and increases in production costs, including chemicals, fuel and power costs.On December 8, 2022, the Pennsylvania Public Utility Commission issued an order approving the joint settlement of the rate case filed on April 29, 2022, by the Company’s Pennsylvania subsidiary. The general rate case order approved a $138 million annualized increase in water and wastewater revenues and authorizes implementation of the new water and wastewater rates effective January 28, 2023. The rate case proceeding was resolved through a “black box” settlement agreement and did not specify an approved return on equity (“ROE”). The annualized revenue increase is driven primarily by significant incremental capital investments since the Pennsylvania subsidiary’s 2021 rate case order that will be completed through December 31, 2023, increases in pension and other postretirement benefits expense and increases in production costs, including chemicals, fuel and power costs. The general rate case order also includes recovery of the Company’s Pennsylvania subsidiary’s COVID-19 deferral balance.On August 17, 2022, the Company’s New Jersey subsidiary was authorized additional annual revenues of $46 million in its general rate case, effective September 1, 2022, based on an authorized return on equity of 9.6%, authorized rate base of $4.15 billion, a common equity ratio of 54.6% and a long-term debt ratio of 45.4%. The request incorporated updated estimates of production costs, including chemicals, fuel and power costs. Beginning January 1, 2023, the Company’s New Jersey subsidiary will defer as a regulatory asset or liability, as appropriate, the difference between its pension expense and other postretirement benefits expense and those amounts included in base rates. The deferral period for this regulatory asset or liability will be two years or, if earlier, will end at the conclusion of the Company’s New Jersey subsidiary’s next general rate case. The Company’s New Jersey subsidiary also withdrew its request, without prejudice, to recover its existing authorized COVID-19-related regulatory asset in the general rate case and will seek recovery in a separate proceeding within the process established in the New Jersey Board of Public Utilities’ (the “NJBPU”) generic COVID-19-related proceeding.53Table of ContentsOn February 24, 2022, WVAWC was authorized additional annual revenues of $13 million in its general rate case, effective February 25, 2022, based on an authorized return on equity of 9.8%, authorized rate base of $734 million and a common equity ratio of 47.9%. Staff of the Public Service Commission of West Virginia moved for reconsideration of the final order on several grounds. WVAWC filed its response to the Staff's Petition for Reconsideration on March 28, 2022, in support of the authorized revenue requirement. On October 21, 2022, the Public Service Commission of West Virginia denied the motion for reconsideration.Pending General Rate Case FilingsOn July 1, 2022, the Company’s California subsidiary filed a general rate case requesting an increase in 2024 revenue of $56 million and a total increase in revenue over the 2024 to 2026 period of $95 million, with all increases compared against 2022 revenues. The Company updated its filing in January 2023 to capture the authorized step increase effective January 1, 2023. The filing was also updated to incorporate a decoupling proposal and a revision to the Company’s sales and associated variable expense forecast. The revised requested additional annualized revenues for the test year 2024 is now $37 million, compared against 2023 revenues. This excludes the proposed step rate and attrition rate increase for 2025 and 2026 of $20 million and $19 million, respectively. The total revenue requirement request for the three-year rate case cycle, incorporating updates to present rate revenues and forecasted demand, is $76 million.On July 1, 2022, the Company’s Missouri subsidiary filed a general rate case requesting $105 million in additional annualized revenues.On November 15, 2021, the Company’s Virginia subsidiary filed a general rate case requesting $14 million in additional annualized revenues. Interim rates were effective on May 1, 2022, and the difference between interim and final approved rates is subject to refund. On September 26, 2022, a settlement agreement, supported by all parties except one, was filed with the Virginia State Corporation Commission for a $11 million annual revenue increase. Public hearings were held on September 27 and 28, 2022. A final decision on this matter is expected in the first quarter of 2023.The Company’s California subsidiary submitted its application on May 3, 2021, to set its cost of capital for 2022 through 2024. According to the CPUC’s procedural schedule, a decision setting the authorized cost of capital is expected to be issued in the first quarter of 2023.Infrastructure SurchargesA number of states have authorized the use of regulatory mechanisms that permit rates to be adjusted outside of a general rate case for certain costs and investments, such as infrastructure surcharge mechanisms that permit recovery of capital investments to replace aging infrastructure. Presented in the table below are annualized incremental revenues, assuming a constant water sales volume and customer count, resulting from infrastructure surcharge authorizations that became effective during 2022:(In millions)Effective DateAmountInfrastructure surcharges by state:New Jersey(a)$11 Pennsylvania(b)19 Missouri(c)30 TennesseeAugust 8, 20223 KentuckyJuly 1, 20223 IndianaMarch 21, 20228 West VirginiaMarch 1, 20223 IllinoisJanuary 1, 20226 Total infrastructure surcharge authorizations$83 (a)In 2022, $1 million was effective December 30 and $10 million was effective June 27.(b)In 2022, $8 million was effective on October 1, $9 million was effective July 1 and $2 million was effective April 1.(c)In 2022, $18 million was effective August 11 and $12 million was effective February 1.54Table of ContentsPresented in the table below are annualized incremental revenues, assuming a constant water sales volume and customer count, resulting from infrastructure surcharge authorizations that became effective on or after January 1, 2023:(In millions)Effective DateAmountInfrastructure surcharge filings by state:MissouriJanuary 16, 2023$15 West VirginiaJanuary 1, 20237 PennsylvaniaJanuary 1, 20233 Total infrastructure surcharge filings$25 Pending Infrastructure Surcharge Filings On January 20, 2023, the Company’s Indiana subsidiary filed an infrastructure surcharge proceeding requesting $21 million in additional annualized revenueOn November 18, 2022, the Company’s Indiana subsidiary filed an infrastructure surcharge proceeding requesting $7 million in additional annualized revenues.Other Regulatory MattersIn September 2020, the CPUC released a decision under its Low-Income Rate Payer Assistance program rulemaking that required the Company’s California subsidiary to file a proposal to alter its water revenue adjustment mechanism in its next general rate case filing in 2022, which would become effective in January 2024. On October 5, 2020, the Company’s California subsidiary filed an application for rehearing of the decision and following the CPUC’s denial of its rehearing application in September 2021, the Company’s California subsidiary filed a petition for writ of review with the California Supreme Court on October 27, 2021. On May 18, 2022, the California Supreme Court issued a writ of review for the Company’s California subsidiary’s petition and the petitions filed by other entities challenging the decision. Independent of the judicial challenge, California passed Senate Bill 1469, which allows the CPUC to consider and authorize the implementation of a mechanism that separates the water corporation’s revenue and its water sales. Legislation was signed by the Governor on September 30, 2022, and became effective on January 1, 2023. In response to the legislation, on January 27, 2023, the Company’s California subsidiary filed an updated application requesting the CPUC to consider a Water Resources Sustainability Plan decoupling mechanism in its pending 2022 general rate case, which would be effective 2024 through 2026.On March 2, 2021, an administrative law judge (“ALJ”) in the Office of Administrative Law of New Jersey filed an initial decision with the NJBPU that recommended denial of a petition filed by the Company’s New Jersey subsidiary, which sought approval of acquisition adjustments in rate base of $29 million associated with the acquisitions of Shorelands Water Company, Inc. in 2017 and the Borough of Haddonfield’s water and wastewater systems in 2015. On July 29, 2021, the NJBPU issued an order adopting the ALJ’s initial decision without modification. The Company’s New Jersey subsidiary filed a Notice of Appeal with the New Jersey Appellate Division on September 10, 2021. The Company’s New Jersey subsidiary filed its brief in support of the appeal on March 4, 2022. Response and Reply briefs were filed on June 22, 2022, and August 4, 2022, respectively. There is no financial impact to the Company as a result of the NJBPU’s order, since the acquisition adjustments are currently recorded as goodwill on the Consolidated Balance Sheets.55Table of ContentsConsolidated Results of OperationsPresented in the table below are the Company’s consolidated results of operations: For the Years Ended December 31,202220212020(In millions) Operating revenues$3,792 $3,930 $3,777 Operating expenses: Operation and maintenance1,589 1,777 1,622 Depreciation and amortization649 636 604 General taxes281 321 303 Total operating expenses, net2,519 2,734 2,529 Operating income1,273 1,196 1,248 Other income (expense): Interest expense(433)(403)(397)Interest income52 4 2 Non-operating benefit costs, net77 78 49 Gain on sale of businesses19 747 — Other, net20 18 22 Total other income (expense)(265)444 (324)Income before income taxes1,008 1,640 924 Provision for income taxes188 377 215 Net income attributable to common shareholders$820 $1,263 $709 Segment Results of OperationsThe Company’s operating segments are comprised of its businesses which generate revenue, incur expense and have separate financial information which is regularly used by management to make operating decisions, assess performance and allocate resources. The Company operates its business primarily through one reportable segment, the Regulated Businesses segment. Other primarily includes MSG, which does not meet the criteria of a reportable segment in accordance with GAAP. Other also includes corporate costs that are not allocated to the Regulated Businesses segment, interest income related to the seller promissory note and income from the revenue share agreement from the sale of HOS, eliminations of inter-segment transactions and fair value adjustments related to acquisitions that have not been allocated to the Regulated Businesses segment. This presentation is consistent with how management assesses the results of these businesses. For a discussion and analysis of the Company’s financial statements for fiscal 2021 compared to fiscal 2020, please refer to Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 16, 2022.As a result of the sale of HOS, the categories which were previously shown as “Market-Based Businesses” and “Other” have been combined and shown as Other. Segment results for the year ended December 31, 2021, have been adjusted retrospectively to reflect this change.56Table of ContentsRegulated Businesses SegmentPresented in the table below is financial information for the Regulated Businesses: For the Years Ended December 31,202220212020(In millions) Operating revenues$3,505 $3,384 $3,255 Operation and maintenance1,345 1,325 1,258 Depreciation and amortization633 601 562 General taxes264 301 285 Other operating expenses— 1 (3)Other income (expense)(220)(195)(221)Income before income taxes1,042 962 932 Provision for income taxes188 172 217 Net income attributable to common shareholders$854 $789 $715 Operating RevenuesPresented in the tables below is information regarding the main components of the Regulated Businesses’ operating revenues:For the Years Ended December 31, 202220212020(In millions)Water services: Residential$1,941 $1,935 $1,895 Commercial710 676 627 Fire service147 151 147 Industrial153 141 133 Public and other267 239 226 Total water services3,218 3,142 3,028 Wastewater services:Residential174 151 134 Commercial45 37 34 Industrial4 4 3 Public and other19 16 14 Total wastewater services242 208 185 Other (a)45 34 42 Total operating revenues$3,505 $3,384 $3,255 (a)Includes other operating revenues consisting primarily of miscellaneous utility charges, fees and rents.57Table of Contents For the Years Ended December 31, 202220212020(Gallons in millions)Billed water services volumes: Residential162,105 173,644 178,753 Commercial77,627 77,476 75,875 Industrial37,265 35,738 34,875 Fire service, public and other51,966 51,957 49,031 Total billed water services volumes328,963 338,815 338,534 Included in operating revenues for 2021, was $127 million related to the Company’s New York operations. Excluding the Company’s New York operations, for 2022, operating revenues increased $248 million, primarily due to: (i) a $180 million increase from authorized rate increases, including infrastructure surcharges, principally to fund infrastructure investment in various states; (ii) a $36 million increase from water and wastewater acquisitions, as well as organic growth in existing systems; (iii) a $17 million net increase as a result of reduced amortization of EADIT, primarily in the Company’s New Jersey subsidiary; and (iv) a $13 million estimated net increase primarily due to warmer and drier than normal weather in the third quarter of 2022 in the Company’s New Jersey and Missouri service territories, which was partially offset by warmer and drier than normal weather in the second quarter of 2021 in the Northeast.Operation and MaintenancePresented in the table below is information regarding the main components of the Regulated Businesses’ operating and maintenance expense: For the Years Ended December 31, 202220212020(In millions) Employee-related costs$505 $522 $495 Production costs387 353 335 Operating supplies and services242 245 242 Maintenance materials and supplies96 93 84 Customer billing and accounting59 66 58 Other56 46 44 Total$1,345 $1,325 $1,258 Employee-Related Costs For the Years Ended December 31, 202220212020(In millions) Salaries and wages$395 $402 $382 Group insurance59 66 65 Pensions21 25 20 Other benefits30 29 28 Total$505 $522 $495 Included in employee-related costs for 2021, was $16 million related to the Company’s New York operations. After excluding the Company’s New York operations, for 2022, employee-related costs remained consistent compared to 2021. In 2022, the Regulated Businesses experienced an increase in salaries and wages due to merit increases and higher headcount to support growth, which was offset by higher capitalized labor and overhead rates, as well as lower pension service costs.58Table of ContentsProduction Costs For the Years Ended December 31, 202220212020(In millions) Purchased water$154 $153 $149 Fuel and power104 97 88 Chemicals78 59 57 Waste disposal51 44 41 Total$387 $353 $335 Included in production costs for 2021, was $8 million related to the Company’s New York operations. Excluding the Company’s New York operations, for 2022, production costs increased $42 million, primarily due to inflationary pressures which resulted in increased fuel, power and chemical costs.Customer Billing and AccountingIn 2022, as compared to 2021, customer billing and accounting decreased $7 million primarily due to the sale of the Company’s New York operations and lower uncollectible customer accounts expense.OtherIn 2022, as compared to 2021, other increased $10 million primarily due to increase to the insurance other than group reserve which had an unfavorable claims experience compared to prior year.Depreciation and AmortizationIn 2022, as compared to 2021, depreciation and amortization increased $32 million primarily due to additional utility plant placed in service from capital infrastructure investments and acquisitions.General TaxesIn 2022, as compared to 2021, general taxes decreased $37 million, primarily related to the sale of the Company’s New York operations.Other Income (Expense)In 2022, as compared to 2021, other expenses increased $25 million primarily due to higher interest expense as a result of an $800 million long-term debt issuance in May 2022 and higher interest rates on short-term debt due to macroeconomic market conditions.Provision for Income TaxesIn 2022, as compared to 2021, the Regulated Businesses’ provision for income taxes increased $16 million. The Regulated Businesses’ effective income tax rate was 18.0% and 17.9% for the years ended December 31, 2022 and 2021, respectively. The increase was primarily due to the decrease in the amortization of EADIT due to the completion of stub period amortization, pursuant to regulatory orders. The amortization of EADIT is generally offset with reductions in revenue. 59Table of ContentsOther Presented in the table below is information for Other: For the Years Ended December 31,202220212020(In millions) Operating revenues$287 $546 $522 Operation and maintenance244 452 364 Depreciation and amortization16 35 42 Gain on sale of businesses19 748 3 Income before income taxes(34)678 (8)Provision for income taxes— 205 (2)Net (loss) income attributable to common shareholders$(34)$474 $(6)Operating RevenuesIn 2022, operating revenues decreased $259 million primarily due to the sale of HOS, which had operating revenues of $293 million in 2021. Excluding the Company’s HOS operations, for 2022, operating revenues increased $34 million, largely driven by an increase in capital and O&M projects in MSG, primarily at Joint Base Lewis-McChord and the United States Military Academy at West Point, New York.Operation and MaintenancePresented in the table below is information regarding the main components of Other’s operating and maintenance expense: For the Years Ended December 31, 202220212020(In millions) Operating supplies and services$120 $191 $118 Maintenance materials and supplies35 123 114 Employee-related costs73 109 111 Production costs10 7 6 Other6 22 15 Total$244 $452 $364 Operating Supplies and ServicesIncluded in operating supplies and services for 2021, was $39 million related to the Company’s HOS operations and a $45 million pre-tax contribution to the AWCF. Excluding the Company’s HOS operations and AWCF contribution, for 2022, operating supplies and services increased $13 million, primarily driven by costs associated with increased capital and O&M projects in MSG, as discussed above.Maintenance Materials and SuppliesIncluded in maintenance materials and supplies for 2021, was $96 million related to the Company’s HOS operations. Excluding the Company’s HOS operations, for 2022, operating supplies and services increased $8 million, primarily due to an increase in CSG costs related to contract with the City of Camden, New Jersey.Employee-Related CostsIn 2022, as compared to 2021, employee-related costs decreased $36 million primarily due to the sale of HOS. Depreciation and AmortizationIn 2022, as compared to 2021, depreciation and amortization decreased $19 million primarily due to the sale of HOS.60Table of ContentsGain on Sale of BusinessesDuring the fourth quarter of 2021, the Company recognized a pre-tax gain of $748 million relating to the sale of HOS. In 2022, the Company recorded post-closing adjustments, primarily related to working capital, of pre-tax income of $20 million, which increased the total gain related to the sale of HOS. See Note 5—Acquisitions and Divestitures in the Notes to Consolidated Financial Statements for additional information.Provision for Income TaxesIn 2022, as compared to 2021, provision for income taxes decreased $205 million primarily due to the sale of HOS. See Note 5—Acquisitions and Divestitures in the Notes to Consolidated Financial Statements for additional information.Tax MattersOn August 16, 2022, President Biden signed into law the Inflation Reduction Act of 2022 (the “IRA”). The IRA contains a Corporate Alternative Minimum Tax (“CAMT”) provision, effective January 1, 2023. To determine if a company is considered an applicable corporation subject to CAMT, the company’s average adjusted financial statement income (“AFSI”) for the three consecutive years preceding the tax year must exceed $1 billion. An applicable corporation must make several adjustments to AFSI when determining CAMT under the new law. Initial guidance regarding the application of the CAMT was issued on December 27, 2022, and additional guidance is forthcoming. The Company is continuing to assess the impact of the initial guidance and will continue to monitor as additional guidance is released.On July 8, 2022, Pennsylvania Governor Tom Wolf signed into law Act 53 of 2022, which reduces the Pennsylvania State Income Tax Rate in yearly increments starting January 1, 2023, with an initial rate of 8.99% and ending effective January 1, 2031, with a rate of 4.99%. Under Accounting Standards Codification Topic 740, Income Taxes (“ASC 740”), the tax effects of changes in tax laws must be recognized in the period in which the law is enacted. ASC 740 also requires deferred tax assets and liabilities to be measured at the enacted tax rate expected to apply when temporary differences are to be realized or settled. As such, the Company’s accumulated deferred income tax (“ADIT”) balances for its Pennsylvania subsidiary were remeasured during the quarter ended September 30, 2022, to estimate the impacts of the recently enacted tax rate. The remeasurement reduced the ADIT liability by $159 million as of December 31, 2022 and created a corresponding regulatory liability since the EADIT is expected to be returned to customers in a future rate case. However, since the rate is declining in yearly increments, the total EADIT will be subject to change.On September 27, 2022, Iowa’s Department of Revenue announced a reduction in the state’s top corporate rate from 9.8% to 8.4% effective January 1, 2023. As such, the Company’s ADIT balances for its Iowa subsidiary were remeasured during the quarter ended September 30, 2022, to estimate the impacts of the recently enacted tax rate. The remeasurement reduced the ADIT liability by $2 million as of December 31, 2022 and created a corresponding regulatory liability since the EADIT is expected to be returned to customers in a future rate case.Federal Net Operating LossThe Company had no federal NOL carryover balance as of December 31, 2021.Legislative UpdatesDuring 2022, the Company’s regulatory jurisdictions enacted the following legislation that has been approved and is effective as of February 15, 2023:•Indiana passed Senate Enrolled Act 272, which requires public reporting of a non-jurisdictional utility’s asset management programs. Non-jurisdictional utilities are exempt from the jurisdiction of the Indiana Utility Regulatory Commission (the “IURC”). The legislation also creates a water and wastewater research and extension program at a state university to serve as a repository for data collected from utilities. Additionally, the legislation establishes oversight and a receivership program in the IURC for non-jurisdictional utilities with violations that create environmental or human health and safety issues. Legislation was signed by the Governor on March 7, 2022, and became effective on July 1, 2022.•Indiana passed water and wastewater utility asset financing legislation, Senate Enrolled Act 273, which authorizes the recovery of property tax in Distribution System Improvement Charge filings. The legislation also permits the IURC to allow recovery through tracking mechanisms for changes in property tax and for costs attributable to referenda or action by elected or appointed individuals. Legislation was signed by the Governor on March 10, 2022, and became effective on July 1, 2022.61Table of Contents•Virginia passed Senate Bill 500 and House Bill 182, which requires the Virginia State Corporation Commission, in any future ratemaking proceeding for an investor-owned water/wastewater utility, to evaluate the utility on a stand-alone basis and utilize the utility’s actual end-of-test period capital structure and cost of capital without regard to the cost of capital, capital structure, or investments of any other entities with which the utility may be affiliated. Legislation was signed by the Governor on April 11, 2022, and became effective on July 1, 2022.•Illinois passed House Bill 900/Public Act 102-0698, which contains appropriations to the Department of Commerce and Economic Opportunity of $3 million for the purposes of the Water and Sewer Finance Assistance Act (H.B. 414/Public Act 102-0262) and $55 million for the purposes of the federal Low-Income Household Water Assistance Program (LIHWAP). Legislation was signed by the Governor on April 19, 2022, with these provisions of the bill taking effect on July 1, 2022.•Tennessee passed Senate Bill 2282 and House Bill 2346, which requires all utilities to implement a cyber security plan and update it every two years to provide for the protection of the utility’s facilities from unauthorized use, alteration, ransom, or destruction of electronic data. The relevant regulatory body will verify if a utility has complied or impose reasonable sanctions if out of compliance. Utility compliance will be required by July 1, 2023. Legislation was signed by the Governor on June 1, 2022, and became effective immediately. •The Missouri General Assembly passed state and local property tax tracker legislation, Senate Bill 745, which requires a utility to defer to a regulatory asset or liability account any difference in what was actually paid in state or local property taxes and what was used to set the revenue requirement in the utility’s most recently completed general rate case. Legislation was signed by the Governor on June 29, 2022, and became effective on August 28, 2022.•California passed Senate Bill 1469, which allows the CPUC to consider and authorize the implementation of a mechanism that separates the water corporation’s revenue and its water sales. Legislation was signed by the Governor on September 30, 2022 and became effective on January 1, 2023.Liquidity and Capital ResourcesThe Company uses its capital resources, including cash, primarily to (i) fund operating and capital requirements, (ii) pay interest and meet debt maturities, (iii) pay dividends, (iv) fund acquisitions, (v) fund pension and postretirement benefit obligations, and (vi) to pay federal income taxes. The Company invests a significant amount of cash on regulated capital projects where it expects to earn a long-term return on investment. Additionally, the Company operates in rate regulated environments in which the amount of new investment recovery may be limited, and where such recovery generally takes place over an extended period of time, and certain capital recovery is also subject to regulatory lag. See Item 1—Business—Regulated Businesses—Regulation and Rate Making for additional information. The Company expects to fund future maturities of long-term debt through a combination of external debt and, to the extent available, cash flows from operations. Since the Company expects its capital investments over the next few years to be greater than its cash flows from operating activities, the Company currently plans to fund the excess of its capital investments over its cash flows from operating activities for the next five years through a combination of long-term debt and equity in addition to the remaining proceeds from the sale of HOS. The remaining proceeds from the sale of HOS include receipt of a seller promissory note, plus interest, and a contingent cash payment payable upon satisfaction of certain conditions on or before December 31, 2023. If necessary, the Company may delay certain capital investments or other funding requirements or pursue financing from other sources to preserve liquidity. In this event, the Company believes it can rely upon cash flows from operations to meet its obligations and fund its minimum required capital investments for an extended period of time.The Company regularly evaluates and monitors its cash requirements for capital investments, acquisitions, operations, commitments, debt maturities, interest and dividends. The Company’s business is capital intensive, with a majority of this capital funded by cash flows from operations. The Company also obtains funds from external sources, primarily in the debt markets and through short-term commercial paper borrowings, and may also access the equity capital markets as needed or desired to support capital funding requirements. In order to meet short-term liquidity needs, American Water Capital Corp. (“AWCC”), the wholly owned finance subsidiary of parent company, issues commercial paper that is supported by its revolving credit facility. The Company’s access to external financing on reasonable terms may depend on, as appropriate, any or all of the following: current business conditions, including that of the utility and water utility industry in general; conditions in the debt or equity capital markets; the Company’s credit ratings; and conditions in the national and international economic and geopolitical arenas. Disruptions in the credit markets may discourage lenders from extending the terms of such commitments or agreeing to new commitments. Market disruptions may also limit the Company’s ability to issue debt and equity securities in the capital markets. 62Table of ContentsIf these unfavorable business, market, financial and other conditions deteriorate to the extent that the Company is no longer able to access the commercial paper and/or capital markets on reasonable terms, AWCC has access to an unsecured revolving credit facility. AWCC’s revolving credit facility is used principally to support its commercial paper program, to provide additional liquidity support, and to provide a sublimit for the issuance of up to $150 million in letters of credit. On October 26, 2022, AWCC and certain lenders amended and restated the credit agreement with respect to the revolving credit facility to, among other things, increase the maximum commitments under the facility from $2.25 billion to $2.75 billion and to extend the expiration date of the facility from March 2025 to October 2027. Subject to satisfying certain conditions, the credit agreement also permits AWCC to increase the maximum commitment under the facility by up to an aggregate of $500 million and to request extensions of its expiration date for up to two one-year periods. Also, effective October 26, 2022, the maximum aggregate principal amount of short-term borrowings authorized under AWCC’s commercial paper program was increased from $2.10 billion to $2.60 billion. As of December 31, 2022, AWCC had no outstanding borrowings and $78 million of outstanding letters of credit under its revolving credit facility, with $1.50 billion available to fulfill its short-term liquidity needs and to issue letters of credit. The Company believes that its ability to access the debt and equity capital markets, the revolving credit facility and cash flows from operations will generate sufficient cash to fund the Company’s short-term requirements. The Company believes it has sufficient liquidity and the ability to manage its expenditures, should there be a disruption of the capital and credit markets. However, there can be no assurance that the lenders will be able to meet existing commitments to AWCC under the revolving credit facility, or that AWCC will be able to access the commercial paper or loan markets in the future on acceptable terms or at all.Cash Flows from Operating ActivitiesCash flows from operating activities primarily result from the sale of water and wastewater services and, due to the seasonality of demand, are generally greater during the warmer months. The Company’s future cash flows from operating activities will be affected by, among other things: customers’ ability to pay for service in a timely manner, economic utility regulation, inflation, compliance with environmental, health and safety standards, production costs, maintenance costs, customer growth, declining customer usage of water, employee-related costs, including pension funding, weather and seasonality, taxes, and overall economic conditions.Operating cash flows can be negatively affected by changes in the Company’s rate regulated environments, changes in the economy, interest rates, the timing of tax payments, and the Company’s customers’ ability to pay for service in a timely manner, among other items. The Company can provide no assurance that its customers’ historical payment pattern will continue in the future. The Company’s current liabilities may exceed current assets mainly from debt maturities due within one year and the use of short-term debt as a funding source, primarily to meet scheduled maturities of long-term debt, fund acquisitions and construction projects, as well as cash needs, which can fluctuate significantly due to the seasonality of the business and other factors. The Company addresses cash timing differences primarily through its short-term liquidity funding mechanisms.Presented in the table below is a summary of the major items affecting the Company’s cash flows from operating activities: For the Years Ended December 31,(In millions)202220212020Net income$820 $1,263 $709 Add (less): Depreciation and amortization649 636 604 Deferred income taxes and amortization of investment tax credits (c)80 230 207 Other non-cash activities (a)(16)(27)— Changes in working capital (b)(355)126 (55)Pension and non-pension postretirement benefit contributions(51)(40)(39)(Gain) or loss on sale of businesses(19)(747)— Net cash provided by operating activities$1,108 $1,441 $1,426 (a)Includes provision for losses on accounts receivable, pension and non-pension postretirement benefits and other non-cash, net. Details of each component can be found on the Consolidated Statements of Cash Flows.(b)Changes in working capital include changes to receivables and unbilled revenues, income tax receivable, accounts payable and accrued liabilities, accrued taxes and other current assets and liabilities, net.(c)The decrease in the 2022 deferred tax activity is primarily due to the settlement of the deferred tax liability related to New York American Water, sold in January 2022.63Table of ContentsIn 2022, cash flows provided by operating activities decreased $333 million. The changes were driven by $338 million of estimated tax payments primarily for taxable gains on the sales of the Company’s HOS business and its New York regulated operations, as well as the contribution of $45 million to the American Water Charitable Foundation. Partially offsetting these changes was a decrease due to the gain recognized from the sale of HOS in 2021.The Company expects to make pension contributions to the plan trusts of $39 million in 2023. Actual amounts contributed could change materially from this estimate as a result of changes in assumptions and actual investment returns, among other factors.Cash Flows from Investing ActivitiesPresented in the table below is a summary of the major items affecting the Company’s cash flows from investing activities: For the Years Ended December 31,(In millions)202220212020Capital expenditures$(2,297)$(1,764)$(1,822)Acquisitions, net of cash acquired(315)(135)(135)Proceeds from sale of assets, net of cash on hand608 472 2 Removal costs from property, plant and equipment retirements, net(123)(109)(106)Net cash used in investing activities$(2,127)$(1,536)$(2,061)In 2022, cash flows used in investing activities increased $591 million primarily due to increased payments for capital expenditures and acquisitions partially offset by proceeds of $608 million received from the sale of the Company’s New York operations. The Company continues to invest across all infrastructure categories, mainly replacement and renewal of transmission and distribution and services, meter and fire hydrants infrastructure in the Company’s Regulated Businesses, as discussed below. The Company’s infrastructure investment plan consists of both infrastructure renewal programs, where the Company replaces mains, services, meters, hydrants and valves, as needed, and major capital investment projects, where the Company constructs new water and wastewater treatment and delivery facilities to meet new customer growth and water quality regulations. The Company’s projected capital expenditures and other investments are subject to periodic review and revision to reflect changes in economic conditions and other factors.Presented in the table below is a summary of the Company’s capital expenditures by category: For the Years Ended December 31,(In millions)202220212020Transmission and distribution$901 $749 $704 Treatment and pumping190 197 306 Services, meter and fire hydrants546 366 333 General structure and equipment380 251 299 Sources of supply95 64 54 Wastewater185 137 126 Total capital expenditures$2,297 $1,764 $1,822 In 2022, the Company’s capital expenditures increased $533 million due to an increase across most infrastructure categories.The Company also grows its business primarily through acquisitions of water and wastewater systems. These acquisitions are generally located in geographic proximity to the Company’s existing Regulated Businesses and support continued geographical diversification and growth of its operations. Generally, acquisitions are funded initially with short-term debt, and later refinanced with long-term financing. During 2022, the Company paid $315 million for the acquisition of 26 water and wastewater systems, representing in the aggregate approximately 70,000 customers.As previously noted, over the next five years the Company expects to invest between $14 billion to $15 billion, with $12.5 billion to $13 billion for infrastructure improvements in the Regulated Businesses, and the Company expects to invest between $30 billion to $34 billion over the next 10 years. In 2023, the Company expects to invest $2.9 billion, consisting of $2.5 billion for infrastructure improvements and $400 million for acquisitions in the Regulated Businesses.64Table of ContentsCash Flows from Financing ActivitiesPresented in the table below is a summary of the major items affecting the Company’s cash flows from financing activities:For the Years Ended December 31,202220212020(In millions)Proceeds from long-term debt$822 $1,118 $1,334 Repayments of long-term debt(15)(372)(342)(Repayments of) proceeds from term loan— (500)500 Net short-term borrowings (repayments) with maturities less than three months591 (198)(5)Dividends paid(467)(428)(389)Other financing activities, net (a)69 35 22 Net cash provided by (used in) financing activities$1,000 $(345)$1,120 (a)Includes proceeds from issuances of common stock under various employee stock plans and the Company’s dividend reinvestment plan, net of taxes paid, advances and contributions in aid of construction, net of refunds, and debt issuance costs and make-whole premiums on early debt redemption.In 2022, cash flows provided by financing activities increased $1,345 million, primarily due to an increase in commercial paper borrowings, the repayment in full at maturity of the $500 million term loan in 2021 and repayments of long-term debt due to the prepayment of $327 million in aggregate principal amount of AWCC’s outstanding senior notes in 2021, with no comparable repayments in 2022. These changes were partially offset by lower proceeds from long-term debt.The Company’s financing activities are primarily focused on funding regulated infrastructure expenditures, regulated acquisitions and payment of dividends. These activities included the issuance of long-term and short-term debt, primarily through AWCC. Based on the needs of the Regulated Businesses and the Company, AWCC may borrow funds or issue its debt in the capital markets and then, through intercompany loans, provide those borrowings to the Regulated Businesses and parent company. The Regulated Businesses and parent company are obligated to pay their portion of the respective principal and interest to AWCC, in the amount necessary to enable AWCC to meet its debt service obligations. Parent company’s borrowings are not a source of capital for the Regulated Businesses, therefore, parent company is not able to recover the interest charges on its debt through regulated water and wastewater rates. As of December 31, 2022, AWCC has made long-term fixed rate loans and commercial paper loans to the Regulated Businesses amounting to $7.6 billion. Additionally, as of December 31, 2022, AWCC has made long-term fixed rate loans and commercial paper loans to parent company amounting to $3.6 billion.On May 5, 2022, AWCC issued $800 million aggregate principal amount of its 4.45% senior notes due 2032. At closing, AWCC received, after deduction of underwriting discounts and before deduction of offering expenses, net proceeds of approximately $792 million. AWCC used the net proceeds of the offering: (i) to lend funds to parent company and its regulated subsidiaries; (ii) to repay AWCC’s commercial paper obligations; and (iii) for general corporate purposes.One of the principal market risks to which the Company is exposed is changes in interest rates. In order to manage the exposure, the Company follows risk management policies and procedures, including the use of derivative contracts such as treasury lock agreements. The Company also reduces exposure to interest rates by managing commercial paper and debt maturities. The Company does not enter into derivative contracts (through AWCC) for speculative purposes and does not use leveraged instruments. The derivative contracts entered into are for periods consistent with the related underlying exposures. The Company is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. The Company minimizes the counterparty credit risk on these transactions by dealing only with leading, creditworthy financial institutions, having long-term credit ratings of “A” or better.In April 2022, the Company entered into several 10-year treasury lock agreements, with notional amounts totaling $400 million, and an average fixed interest rate of 2.89%. The Company designated these treasury lock agreements as cash flow hedges, with their fair value recorded in accumulated other comprehensive gain or loss. In May 2022, the Company terminated the treasury lock agreements, realizing a net gain of approximately $4 million, to be amortized through interest, net over a 10-year period, in accordance with the tenor of the debt issuance on May 5, 2022. 65Table of ContentsIn November and December 2022, the Company entered into four 10-year treasury lock agreements, with notional amounts totaling $100 million, to reduce interest rate exposure on debt expected to be issued in 2023. These treasury lock agreements terminate in January 2024, and have an average fixed rate of 3.56%. In January 2023, the Company entered into three additional 10-year treasury lock agreements, with notional amounts totaling $100 million, to reduce interest rate exposure on debt expected to be issued in 2023. These treasury lock agreements terminate in January 2024, and have an average fixed rate of 3.35%. The Company designated these treasury lock agreements as cash flow hedges, with their fair value recorded in accumulated other comprehensive gain or loss. Upon termination, the cumulative gain or loss recorded in accumulated other comprehensive gain or loss will be amortized through interest, net over the term of the new debt. No ineffectiveness was recognized on hedging instruments for the years ended December 31, 2022, 2021 or 2020.In February 2021, parent company and AWCC filed with the SEC a universal shelf registration statement that enables the Company to meet its capital needs through the offer and sale to the public from time to time of an unlimited amount of various types of securities, including American Water common stock, preferred stock, and other equity and hybrid securities, and AWCC debt securities, all subject to market conditions and demand, general economic conditions, and as applicable, rating status. The shelf registration statement will expire in February 2024. During 2022, 2021 and 2020, $800 million, $1.10 billion, and $1.00 billion, respectively, of debt securities were issued under this and predecessor registration statements.Presented in the table below are the issuances of long-term debt in 2022:CompanyTypeRateWeighted Average RateMaturityAmount (in millions)AWCC (a)Senior notes—fixed rate4.45%4.45%2032$800 Other American Water subsidiariesPrivate activity bonds and government funded debt—fixed rate0.00%-1.75%1.03%2027-204222 Total issuances $822 (a)This indebtedness is considered “debt” for purposes of a support agreement between parent company and AWCC, which serves as a functional equivalent of a full and unconditional guarantee by parent company of AWCC’s payment obligations under such indebtedness. See “—Issuer and Guarantor of Senior Notes” below.Presented in the table below are the retirements and redemptions of long-term debt in 2022 through sinking fund provisions, optional redemption or payment at maturity:CompanyTypeRateWeighted Average RateMaturityAmount (in millions)AWCCPrivate activity bonds and government funded debt—fixed rate1.79%-2.31%2.24%2024-2031$1 Other American Water subsidiariesPrivate activity bonds and government funded debt—fixed rate0.00%-5.50%1.50%2022-205113 Other American Water subsidiariesMandatorily redeemable preferred stock8.49%8.49%20221 Total retirements and redemptions $15 From time to time and as market conditions warrant, the Company may engage in long-term debt retirements through make-whole redemptions, tender offers, open market repurchases or other viable alternatives.66Table of ContentsIssuer and Guarantor of Senior NotesThe outstanding senior notes issued by AWCC have been issued under two indentures, each by and between AWCC and Computershare Trust Company, N.A., as successor to Wells Fargo Bank, National Association, as trustee, providing for the rights and obligations of the parties thereto and the holders of the notes issued thereunder. The senior notes also have been issued with the benefit of a support agreement, as amended, between parent company and AWCC, which serves as the functional equivalent of a full and unconditional guarantee by parent company of AWCC’s payment obligations under the senior notes. No other subsidiary of parent company provides guarantees for any of the outstanding senior notes. If AWCC is unable to make timely payment of any interest, principal or premium, if any, on such senior notes, parent company will provide to AWCC, at its request or the request of any holder of such senior notes, funds to make such payment in full. If AWCC fails or refuses to take timely action to enforce certain rights under the support agreement or if AWCC defaults in the timely payment of any amounts owed to any holder of such senior notes, when due, the support agreement provides that the holder may proceed directly against parent company to enforce such rights or to obtain payment of the defaulted amounts owed to that holder. As a wholly owned finance subsidiary of parent company, AWCC has no significant assets other than obligations of parent company and certain of its subsidiaries in its Regulated Businesses segment to repay certain intercompany loans made to them by AWCC. AWCC’s ability to make payments of amounts owed to holders of the senior notes will be dependent upon AWCC’s receipt of sufficient payments of amounts owed pursuant to the terms of such intercompany loans and from its ability to issue indebtedness or otherwise obtain loans in the future, the proceeds of which would be used to fund the repayment of the senior notes.Because parent company is a holding company and substantially all of its operations are conducted through its subsidiaries other than AWCC, parent company’s ability to fulfill its obligations under the support agreement will be dependent upon its receipt of sufficient cash dividends or distributions from its operating subsidiaries. See Note 9—Shareholders’ Equity—Dividends and Distributions, in the Notes to the Consolidated Financial Statements for a summary of the limitations on parent company and its subsidiaries to pay dividends or make distributions. Furthermore, parent company’s operating subsidiaries are separate and distinct legal entities and, other than AWCC, have no obligation to make any payments on the senior notes or to make available or provide any funds for such payment, other than through their repayment obligations under intercompany loans, if any, with AWCC. Based on the foregoing, parent company’s obligations under the support agreement will be effectively subordinated to all indebtedness and other liabilities, including trade payables, lease commitments and moneys borrowed or other indebtedness incurred or issued by parent company’s subsidiaries other than AWCC.Credit Facilities and Short-Term DebtInterest rates on advances under the Company’s revolving credit facility are based on a credit spread to the Secured Overnight Financing Rate (“SOFR”) rate (or applicable market replacement rate) or base rate, each determined in accordance with Moody Investors Service’s and S&P Global Ratings’ then applicable credit rating on AWCC’s senior unsecured, non-credit enhanced debt. The facility is used principally to support AWCC’s commercial paper program and to provide up to $150 million in letters of credit. Indebtedness under the facility and AWCC’s commercial paper are considered “debt” for purposes of a support agreement between parent company and AWCC, which serves as a functional equivalent of a full and unconditional guarantee by parent company of AWCC’s payment obligations thereunder.Presented in the tables below are the aggregate credit facility commitments, commercial paper limit and letter of credit availability under the revolving credit facility, as well as the available capacity for each, as of December 31:2022Commercial Paper LimitLetters of CreditTotal (a)(In millions)Total availability$2,600 $150 $2,750 Outstanding debt(1,177)(78)(1,255)Remaining availability as of December 31, 2022$1,423 $72 $1,495 (a)Total remaining availability of $1.50 billion as of December 31, 2022, may be accessed through revolver draws.67Table of Contents2021Commercial Paper LimitLetters of CreditTotal (a)(In millions)Total availability$2,100 $150 $2,250 Outstanding debt(584)(76)(660)Remaining availability as of December 31, 2021$1,516 $74 $1,590 (a)Total remaining availability of $1.59 billion as of December 31, 2021, may be accessed through revolver draws.Presented in the table below is the Company’s total available liquidity as of December 31, 2022 and 2021:Cash and Cash EquivalentsAvailability on Revolving Credit FacilityTotal Available Liquidity(In millions)Available liquidity as of December 31, 2022$85 $1,495 $1,580 Available liquidity as of December 31, 2021116 1,590 1,706 The weighted average interest rate on AWCC’s outstanding short-term borrowings was approximately 4.41% and 0.20%, for the years ended December 31, 2022 and 2021, respectively.Capital StructurePresented in the table below is the percentage of the Company’s capitalization represented by the components of its capital structure as of December 31: 202220212020Total common shareholders’ equity38.3 %39.9 %37.1 %Long-term debt and redeemable preferred stock at redemption value54.4 %56.6 %53.6 %Short-term debt and current portion of long-term debt7.3 %3.5 %9.3 %Total100 %100 %100 %The changes in the capital structure mix between periods were mainly attributable to the impacts of the HOS sale on December 9, 2021, and the repayment of short-term borrowings with proceeds from the sale, and the Company’s long-term debt offering that was completed on May 5, 2022.Debt CovenantsThe Company’s debt agreements contain financial and non-financial covenants. To the extent that the Company is not in compliance with these covenants, an event of default may occur under one or more debt agreements and the Company, or its subsidiaries, may be restricted in its ability to pay dividends, issue new debt or access the revolving credit facility. The long-term debt indentures contain a number of covenants that, among other things, prohibit or restrict the Company from issuing debt secured by the Company’s assets, subject to certain exceptions. Failure to comply with any of these covenants could accelerate repayment obligations.Covenants in certain long-term notes and the revolving credit facility require the Company to maintain a ratio of consolidated debt to consolidated capitalization (as defined in the relevant documents) of not more than 0.70 to 1.00. On December 31, 2022, the Company’s ratio was 0.62 to 1.00 and therefore the Company was in compliance with the covenants.68Table of ContentsSecurity RatingsPresented in the table below are long-term and short-term credit ratings and rating outlooks as of February 15, 2023, as issued by Moody’s Investors Service on December 19, 2022, and S&P Global Ratings on February 6, 2023:SecuritiesMoody’s Investors ServiceS&P Global RatingsRating outlookStableStableSenior unsecured debtBaa1ACommercial paperP-2A-1A security rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agency, and each rating should be evaluated independently of any other rating. Security ratings are highly dependent upon the ability to generate cash flows in an amount sufficient to service debt and meet investment plans. The Company can provide no assurances that its ability to generate cash flows is sufficient to maintain its existing ratings. None of the Company’s borrowings are subject to default or prepayment as a result of the downgrading of these security ratings, although such a downgrading could increase fees and interest charges under its credit facility.As part of its normal course of business, the Company routinely enters into contracts for the purchase and sale of water, power and other fuel, chemicals and other services. These contracts either contain express provisions or otherwise permit the Company and its counterparties to demand adequate assurance of future performance when there are reasonable grounds for doing so. In accordance with the contracts and applicable contract law, if the Company is downgraded by a credit rating agency, especially if such downgrade is to a level below investment grade, it is possible that a counterparty would attempt to rely on such a downgrade as a basis for making a demand for adequate assurance of future performance, which could include a demand that the Company must provide collateral to secure its obligations. The Company does not expect to post any collateral which will have a material adverse impact on the Company’s results of operations, financial position or cash flows.Access to the capital markets, including the commercial paper market, and respective financing costs in those markets, may be directly affected by the Company’s securities ratings. The Company primarily accesses the debt capital markets, including the commercial paper market, through AWCC. However, the Company has also issued debt through its regulated subsidiaries, primarily in the form of mortgage bonds and tax exempt securities or borrowings under state revolving funds, to lower the overall cost of debt.Dividends and Regulatory RestrictionsFor discussion of the Company’s dividends, dividend restrictions and dividend policy, see Note 9—Shareholders’ Equity in the Notes to Consolidated Financial Statements for additional information.Insurance CoverageThe Company carries various property, casualty, cyber and financial insurance policies with limits, deductibles and exclusions that it believes are consistent with industry standards. However, insurance coverage may not be adequate or available to cover unanticipated losses or claims. Additionally, annual policy renewals can be impacted by claims experience which in turn can impact coverage terms and conditions on a going-forward basis. The Company is self-insured to the extent that losses are within the policy deductible or exceed the amount of insurance maintained. Such losses could have a material adverse effect on the Company’s short-term and long-term financial condition and its results of operations and cash flows.Critical Accounting Policies and EstimatesThe preparation of financial statements in conformity with GAAP requires that management apply accounting policies and make estimates, assumptions and judgments that could affect the Company’s financial condition, results of operations and cash flows. Actual results could differ from these estimates, assumptions and judgments. Management believes that the areas described below require significant judgment in the application of accounting policy or in making estimates and assumptions in matters that are inherently uncertain and that may change in subsequent periods. Accordingly, changes in the estimates, assumptions and judgments applied to these accounting policies could have a significant impact on the Company’s financial condition, results of operations and cash flows, as reflected in the Company’s Consolidated Financial Statements. Management has reviewed the critical accounting polices described below with the Company’s Audit, Finance and Risk Committee, including the estimates, assumptions and judgments used in their application. Additional discussion regarding these critical accounting policies and their application can be found in Note 2—Significant Accounting Policies in the Notes to Consolidated Financial Statements.69Table of ContentsRegulation and Regulatory AccountingThe Company’s regulated utilities are subject to regulation by PUCs and, as such, the Company follows the authoritative accounting principles required for rate regulated utilities, which requires the Company to reflect the effects of rate regulation in its Consolidated Financial Statements. Use of this authoritative guidance is applicable to utility operations that meet the following criteria: (i) third-party regulation of rates; (ii) cost-based rates; and (iii) a reasonable assumption that rates will be set to recover the estimated costs of providing service, plus a return on net investment, or rate base. As of December 31, 2022, the Company concluded that the operations of its utilities met the criteria.Application of this authoritative guidance has a further effect on the Company’s financial statements as it pertains to allowable costs used in the ratemaking process. The Company makes significant assumptions and estimates to quantify amounts recorded as regulatory assets and liabilities. Such judgments include, but are not limited to, assets and liabilities related to regulated acquisitions, pension and postretirement benefits, depreciation rates and taxes. Due to timing and other differences in the collection of revenues, these authoritative accounting principles allow a cost that would otherwise be charged as an expense by a non-regulated entity, to be deferred as a regulatory asset if it is probable that such cost is recoverable through future rates. Conversely, the principles require the creation of a regulatory liability for amounts collected in rates to recover costs expected to be incurred in the future, or amounts collected in excess of costs incurred and are refundable to customers.For each regulatory jurisdiction where the Company conducts business, the Company assesses, at the end of each reporting period, whether the regulatory assets continue to meet the criteria for probable future recovery and regulatory liabilities continue to meet the criteria for probable future settlement. This assessment includes consideration of factors such as changes in regulatory environments, recent rate orders (including recent rate orders on recovery of a specific or similar incurred cost to other regulated entities in the same jurisdiction) and the status of any pending or potential legislation. If subsequent events indicate that the regulatory assets or liabilities no longer meet the criteria for probable future recovery or probable future settlement, the Company’s Consolidated Statements of Operations and financial position could be materially affected. In addition, if the Company concludes in a future period that a separable portion of the business no longer meets the criteria, the Company is required to eliminate the financial statement effects of regulation for that part of the business, which would include the elimination of any or all regulatory assets and liabilities that had been recorded in the Consolidated Financial Statements. Failure to meet the criteria of this authoritative guidance could materially impact the Company’s Consolidated Financial Statements.As of December 31, 2022 and 2021, the Company’s regulatory asset balance was $1.0 billion and $1.1 billion, respectively, and its regulatory liability balance was $1.6 billion and $1.6 billion, respectively. See Note 3—Regulatory Matters in the Notes to Consolidated Financial Statements for further information regarding the Company’s significant regulatory assets and liabilities.Accounting for Income TaxesSignificant management judgment is required in determining the provision for income taxes, primarily due to the uncertainty related to tax positions taken, as well as deferred tax assets and liabilities, valuation allowances and the utilization of NOL carryforwards.In accordance with applicable authoritative guidance, the Company accounts for uncertain income tax positions using a benefit recognition model with a two-step approach, including a more-likely-than-not recognition threshold and a measurement approach based on the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement. If it is not more-likely-than-not that the benefit of the tax position will be sustained on its technical merits, no benefit is recorded. Uncertain tax positions that relate only to timing of when an item is included on a tax return are considered to have met the recognition threshold. Management evaluates each position based solely on the technical merits and facts and circumstances of the position, assuming the position will be examined by a taxing authority having full knowledge of all relevant information. Significant judgment is required to determine whether the recognition threshold has been met and, if so, the appropriate amount of unrecognized tax benefit to be recorded in the Consolidated Financial Statements.The Company evaluates the probability of realizing deferred tax assets quarterly by reviewing a forecast of future taxable income and its intent and ability to implement tax planning strategies, if necessary, to realize deferred tax assets. The Company also assesses its ability to utilize tax attributes, including those in the form of carryforwards, for which the benefits have already been reflected in the financial statements. The Company records valuation allowances for deferred tax assets when it concludes that it is more-likely-than-not such benefit will not be realized in future periods.Under GAAP, specifically ASC 740, Income Taxes, the tax effects of changes in tax laws must be recognized in the period in which the law is enacted. ASC 740 also requires deferred tax assets and liabilities to be measured at the enacted tax rate expected to apply when temporary differences are to be realized or settled. For the Company’s regulated entities, the change in deferred taxes are recorded as either an offset to a regulatory asset or a regulatory liability and may be subject to refund to customers. For the Company’s unregulated operations, the change in deferred taxes are recorded as a non-cash re-measurement adjustment to earnings.70Table of ContentsActual income taxes could vary from estimated amounts due to the future impacts of various items, including changes in income tax laws, the Company’s forecasted financial condition and results of operations, failure to successfully implement tax planning strategies and recovery of taxes through the regulatory process for the Regulated Businesses, as well as results of audits and examinations of filed tax returns by taxing authorities. The resulting tax balances as of December 31, 2022 and 2021 are appropriately accounted for in accordance with the applicable authoritative guidance; however, the ultimate outcome of tax matters could result in favorable or unfavorable adjustments to the Consolidated Financial Statements and such adjustments could be material. See Note 14—Income Taxes in the Notes to Consolidated Financial Statements for additional information regarding income taxes.Accounting for Pension and Postretirement BenefitsThe Company maintains noncontributory defined benefit pension plans covering eligible employees of its regulated utility and shared service operations. The Company also maintains other postretirement benefit plans providing medical and life insurance to eligible retirees. See Note 2—Significant Accounting Policies and Note 15—Employee Benefits in the Notes to Consolidated Financial Statements for additional information regarding the description of and accounting for the defined benefit pension plans and postretirement benefit plans.The Company’s pension and postretirement benefit costs are developed from actuarial valuations. Inherent in these valuations are key assumptions provided by the Company to its actuaries, including the discount rate and expected long-term rate of return on plan assets. Material changes in the Company’s pension and postretirement benefit costs may occur in the future due to changes in these assumptions as well as fluctuations in plan assets. The assumptions are selected to represent the average expected experience over time and may differ in any one year from actual experience due to changes in capital markets and the overall economy. These differences will impact the amount of pension and other postretirement benefit expense that the Company recognizes. The primary assumptions are:•Discount Rate—The discount rate is used in calculating the present value of benefits, which are based on projections of benefit payments to be made in the future. The objective in selecting the discount rate is to measure the single amount that, if invested at the measurement date in a portfolio of high-quality debt instruments, would provide the necessary future cash flows to pay the accumulated benefits when due.•Expected Return on Plan Assets (“EROA”)—Management projects the future return on plan assets considering prior performance, but primarily based upon the plans’ mix of assets and expectations for the long-term returns on those asset classes. These projected returns reduce the net benefit costs the Company records currently.•Rate of Compensation Increase—Management projects employees’ pay increases, which are used to project employees’ pension benefits at retirement.•Health Care Cost Trend Rate—Management projects the expected increases in the cost of health care.•Mortality— Management adopted the Society of Actuaries Pri-2012 mortality base table, the most recent table developed from private pension plan experience, which provides rates of mortality in 2012 and adopted the new MP-2021 mortality improvement scale to gradually adjust future mortality rates downward due to increased longevity in each year after 2012.The discount rate assumption, which is determined for the pension and postretirement benefit plans independently, is subject to change each year, consistent with changes in applicable high-quality, long-term corporate bond indices. The Company uses an approach that approximates the process of settlement of obligations tailored to the plans’ expected cash flows by matching the plans’ cash flows to the coupons and expected maturity values of individually selected bonds. For each plan, the discount rate was developed as the level equivalent rate that would yield the same present value as using spot rates aligned with the projected benefit payments. The weighted-average discount rate assumption for determining pension benefit obligations was 5.58%, 2.94% and 2.74% at December 31, 2022, 2021 and 2020, respectively. The weighted-average discount rate assumption for determining other postretirement benefit obligations was 5.60%, 2.90% and 2.56% at December 31, 2022, 2021 and 2020, respectively.In selecting an EROA, the Company considered tax implications, past performance and economic forecasts for the types of investments held by the plans. The weighted-average EROA assumption used in calculating pension cost was 6.50% for 2022, 6.50% for 2021, and 6.50% for 2020. The weighted-average EROA assumption used in calculating other postretirement benefit costs was 3.60% for 2022, 3.67% for 2021 and 3.68% for 2020.71Table of ContentsPresented in the table below are the allocations of the pension plan assets by asset category: 2023 Target AllocationPercentage of Plan Assets as of December 31,Asset Category20222021Equity securities37 %57 %53 %Fixed income63 %43 %47 %Total100 %100 %100 %Presented in the table below are the allocations of the other postretirement benefit plan assets by asset category: 2023 Target Allocation (a)Percentage of Plan Assets as of December 31,Asset Category20222021Equity securities27 %30 %22 %Fixed income73 %70 %78 %Total100 %100 %100 %(a)Refer to Note 15—Employee Benefits in the Notes to Consolidated Financial Statements for additional details on the allocations of assets and the trusts which fund the other postretirement benefit plansThe investments of the pension and postretirement welfare plan trusts include debt and equity securities held either directly or through mutual funds, commingled funds and limited partnerships. The trustee for the Company’s defined benefit pension and postretirement welfare plans uses an independent valuation firm to calculate the fair value of plan assets.In selecting a rate of compensation increase, the Company considers past experience in light of movements in inflation rates. The Company’s rate of compensation increase was 3.51% for 2022, 3.51% for 2021 and 3.51% for 2020.In selecting health care cost trend rates, the Company considers past performance and forecasts of increases in health care costs. As of January 1, 2022, the Company’s health care cost trend rate assumption used to calculate the periodic benefit cost was 6.00% in 2022 gradually declining to 5.00% in 2026 and thereafter. As of December 31, 2022, the Company projects that medical inflation will be 7.00% in 2023 gradually declining to 5.00% in 2031 and thereafter.The Company will use a weighted-average discount rate and EROA of 5.58% and 6.75%, respectively, for estimating its 2023 pension costs. Additionally, the Company will use a weighted-average discount rate and EROA of 5.60% and 5.00%, respectively, for estimating its 2023 other postretirement benefit costs. A decrease in the discount rate or the EROA would increase the Company’s pension expense. The Company’s 2022 pension and postretirement total net benefit credit was $47 million and the 2021 pension and postretirement total net benefit credit was $41 million. The Company expects to make pension contributions to the plan trusts of $39 million in 2023; however, the actual amounts contributed could change materially from this estimate. The assumptions are reviewed annually and at any interim re-measurement of the plan obligations. The impact of assumption changes is reflected in the recorded pension and postretirement benefit amounts as they occur, or over a period of time if allowed under applicable accounting standards.Benefit Plan Amendments In December 2022, the Company amended the American Water Pension Plan (“AWPP”), a tax-qualified defined benefit pension plan, to restructure it as of December 31, 2022. The restructuring involved the spin-off of certain inactive participants from the existing AWPP into a separate tax-qualified defined benefit pension plan, the American Water Pension Plan for Certain Inactive Participants (“AWPP Inactive”). Benefits offered to the plan participants remain unchanged. Actuarial gains and losses associated with AWPP Inactive will be amortized over the average remaining life expectancy of the inactive participants, which increases the amortization period from approximately 7 years to 18 years. The longer amortization period is expected to lower the Company’s pre-tax pension expense by approximately $5 million in 2023. The actuarial gains and losses associated with the AWPP will continue to be amortized over the average remaining service period for active participants. The Company remeasured the pension plan obligation and assets for each plan as of December 31, 2022. 72Table of ContentsUpon evaluating prior plan changes, Company funding and market performance, in December 2022, the Company completed plan amendments to spin-off and merge a portion of the American Water Retiree Welfare Plan, with and into the Company’s medical plan for active employees (“Active Medical Plan”), in order to repurpose the over-funded portion of the Bargained Retiree Voluntary Employees’ Beneficiary Association (“Bargained VEBA”) trust. Benefits offered to the plan participants remain unchanged. As a result of these changes, effective December 31, 2022, the Company transferred investment assets from the Bargained VEBA into the existing trust maintained for the benefit of Active Medical Plan participants (“Active VEBA”). The transfer of these Bargained VEBA investment assets into the Active VEBA permits access to approximately $194 million of assets for purposes of paying active union employee medical benefits. The Company recorded the transfer of assets as a negative contribution and therefore did not record a gain or loss, as permitted by accounting guidance. See Note 18—Fair Value of Financial Information in the Notes to Consolidated Financial Statements, for additional information on accounting for the assets as investments in debt and equity securities as of December 31, 2022. Revenue RecognitionRevenue from the Company’s Regulated Businesses is generated primarily from water and wastewater services delivered to customers. These contracts contain a single performance obligation, the delivery of water or wastewater services, as the promise to transfer the individual good or service is not separately identifiable from other promises within the contracts and, therefore, is not distinct. Revenues are recognized over time, as services are provided. There are generally no significant financing components or variable consideration. Revenues include amounts billed to customers on a cycle basis, and unbilled amounts calculated based on estimated usage from the date of the meter reading associated with the latest customer bill, to the end of the accounting period. The amounts that the Company has a right to invoice are determined by each customer’s actual usage, an indicator that the invoice amount corresponds directly to the value transferred to the customer.Increases or decreases in the volumes delivered to customers and rate mix due to changes in usage patterns in customer classes in the period could be significant to the calculation of unbilled revenue. In addition, changes in the timing of meter reading schedules and the number and type of customers scheduled for each meter reading date would also have an effect on the unbilled revenue calculation. Unbilled revenue for the Company’s regulated utilities as of December 31, 2022 and 2021 was $178 million and $162 million, respectively.The Company also recognizes revenue when it is probable that future recovery of previously incurred costs or future refunds that are to be credited to customers will occur through the ratemaking process.Revenue from the Company’s former HOS business, which was sold in December 2021, was generated through various protection programs in which the Company provided fixed fee services to domestic homeowners and smaller commercial customers for interior and exterior water and sewer lines, interior electric and gas lines, heating and cooling systems, water heaters, power surge protection and other related services. Most of the contracts had a one-year term and each service was a separate performance obligation, satisfied over time, as the customers simultaneously received and consumed the benefits provided from the service. Customers were obligated to pay for the protection programs ratably over 12 months or via a one-time, annual fee, with revenues recognized ratably over time for those services. Advances from customers were deferred until the performance obligation was satisfied.The Company also has long-term, fixed fee contracts to operate and maintain water and wastewater systems for the U.S. government on various military installations and facilities owned by municipal customers. Billing and revenue recognition for the fixed fee revenues occurs ratably over the term of the contract, as customers simultaneously receive and consume the benefits provided by the Company. Additionally, these contracts allow the Company to make capital improvements to underlying infrastructure, which are initiated through separate modifications or amendments to the original contract, whereby stand-alone, fixed pricing is separately stated for each improvement. The Company has determined that these capital improvements are separate performance obligations, with revenue recognized over time based on performance completed at the end of each reporting period. Losses on contracts are recognized during the period in which the losses first become probable and estimable. Revenues recognized during the period in excess of billings on construction contracts are recorded as unbilled revenues, with billings in excess of revenues recorded as other current liabilities until the recognition criteria are met. Changes in contract performance and related estimated contract profitability may result in revisions to costs and revenues and are recognized in the period in which revisions are determined. Unbilled revenue within Other as of December 31, 2022 and 2021 was $97 million and $86 million, respectively.73Table of ContentsAccounting for ContingenciesThe Company records loss contingencies when management determines that the outcome of future events is probable of occurring and when the amount of the loss or a range of losses can be reasonably estimated. The determination of a loss contingency is based on management’s judgment and estimates about the likely outcome of the matter, which may include an analysis of different scenarios. Liabilities are recorded or adjusted when events or circumstances cause these judgments or estimates to change. In assessing whether a loss is reasonably possible, management considers many factors, which include, but are not limited to: the nature of the litigation, claim or assessment, review of applicable law, opinions or views of legal counsel and other advisors, and the experience gained from similar cases or situations. The Company provides disclosures for material contingencies when management deems there is a reasonable possibility that a loss or an additional loss may be incurred. The Company provides estimates of reasonably possible losses when such estimates may be reasonably determined, either as a single amount or within a reasonable range.Actual amounts realized upon settlement or other resolution of loss contingencies may be different than amounts recorded and disclosed and could have a significant impact on the liabilities, revenue and expenses recorded on the Consolidated Financial Statements. See Note 16—Commitments and Contingencies in the Notes to Consolidated Financial Statements for additional information regarding contingencies.Recent Accounting StandardsSee Note 2—Significant Accounting Policies in the Notes to Consolidated Financial Statements for a description of recent accounting standards.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKThe Company is exposed to market risk associated with changes in commodity prices, equity prices and interest rates. The Company is exposed to risks from changes in interest rates as a result of its issuance of variable and fixed rate debt and commercial paper. The Company manages its interest rate exposure by limiting its variable rate exposure and by monitoring the effects of market changes in interest rates. The Company also has the ability to enter into financial derivative instruments, which could include instruments such as, but not limited to, interest rate swaps, forward starting swaps and U.S. Treasury lock agreements to manage and mitigate interest rate risk exposure. As of December 31, 2022, a hypothetical increase of interest rates by 1% associated with the Company’s short-term borrowings would result in a $6 million increase in short-term interest expense.The Company’s risks associated with price increases for chemicals, electricity and other commodities are reduced through contractual arrangements and the expected ability to recover price increases through rates, in the next general rate case proceeding or other regulatory mechanism, as authorized by each regulatory jurisdiction. Non-performance by these commodity suppliers could have a material adverse impact on the Company’s results of operations, financial position and cash flows.The market price of the Company’s common stock may experience fluctuations, which may be unrelated to its operating performance. In particular, the Company’s stock price may be affected by general market movements as well as developments specifically related to the water and wastewater industry. These could include, among other things, interest rate movements, quarterly variations or changes in financial estimates by securities analysts and governmental or regulatory actions. This volatility may make it difficult for the Company to access the capital markets in the future through additional offerings of its common stock or other equity securities, regardless of its financial performance, and such difficulty may preclude the Company from being able to take advantage of certain business opportunities or meet business obligations.The Company is exposed to credit risk through its water, wastewater and related services. The Company’s Regulated Businesses serve residential, commercial, industrial and other customers, while the businesses within Other engage in business activities with government entities and other customers. The Company’s primary credit risk is exposure to customer default on contractual obligations and the associated loss that may be incurred due to the non-payment of customer accounts receivable balances. The Company’s credit risk is managed through established credit and collection policies which are in compliance with applicable regulatory requirements and involve monitoring of customer exposure and the use of credit risk mitigation measures such as letters of credit or prepayment arrangements. The Company’s credit portfolio is diversified with no significant customer or industry concentrations. In addition, the Regulated Businesses are generally able to recover all prudently incurred costs including uncollectible customer accounts receivable expenses and collection costs through rates.74Table of ContentsThe Company’s retirement trust assets are exposed to the market prices of debt and equity securities. Changes to the retirement trust asset values can impact the Company’s pension and other benefits expense, funded status and future minimum funding requirements. Changes in interest rates can impact retirement liabilities. The Company aims to reduce risk through asset diversification and by investing in long duration fixed-income securities that have a duration similar to that of its pension liabilities, seeking to hedge some of the interest rate sensitivity of its liabilities. That way, if interest rates fall and liabilities increase, the Company expects that the fixed-income assets in its retirement trust will also increase in value. The Company also expects its risk to be reduced through its ability to recover pension and other benefit costs through rates.The Company is also exposed to a potential national economic recession or deterioration in local economic conditions in the markets in which it operates. The credit quality of the Company’s customer accounts receivable is dependent on the economy and the ability of its customers to manage through unfavorable economic cycles and other market changes. In addition, there can be no assurances that regulators will grant sufficient rate authorizations. Therefore, the Company’s ability to fully recover operating expense, recover its investment and provide an appropriate return on invested capital made in the Regulated Businesses may be adversely impacted.75Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 22. Segment Reporting to the audited consolidated financial statements for financial information about our business segments.Our business is diversified across end-markets, regions, customers, vehicle platforms and products. Our customer base includes the 25 largest automotive OEMs in the world, and in 2022, 30% of our net sales came from the Asia Pacific region, 5Table of Contentswhich we have identified as a key market likely to experience substantial long-term growth. Our ten largest platforms in 2022 were with seven different OEMs. In addition, in 2022 our products were found in 18 of the 20 top-selling vehicle models in the United States (“U.S.”), in 18 of the 20 top-selling vehicle models in Europe and in 12 of the 20 top-selling vehicle models in China.We have established a worldwide design and manufacturing footprint with a regional service model that enables us to efficiently and effectively serve our global customers from best cost countries. This regional model is structured primarily to service the North American market from Mexico, the South American market from Brazil, the European market from Eastern Europe and North Africa, and the Asia Pacific market from China. Our global scale and regional service model enables us to engineer globally and execute regionally to serve the largest OEMs, which are seeking suppliers that can serve them on a worldwide basis. Our footprint also enables us to adapt to the regional design variations the global OEMs require while also serving key growth market OEMs.Our IndustryThe automotive technology and components industry provides critical technologies, components, systems, subsystems and modules to OEMs for the manufacture of new vehicles, as well as to the aftermarket for use as replacement parts for current production and older vehicles. In addition, the industry is increasingly progressing towards software-defined vehicles becoming critical elements of the overall automotive ecosystem. Overall, we expect long-term growth of global vehicle sales and production in the OEM market. In 2022, the industry experienced increased global customer sales and production schedules, despite the ongoing adverse impacts of global supply chain disruptions and increased global inflationary pressures. Global automotive vehicle production increased 5% (5% on an Aptiv weighted market basis, which represents global vehicle production weighted to the geographic regions in which the Company generates its revenue) from 2021 to 2022, reflecting increased vehicle production of 10% in North America, 3% in China and 8% in South America, our smallest region, and a decrease of 1% in Europe. Demand for automotive components in the OEM market is generally a function of the number of new vehicles produced in response to consumer demand, which is primarily driven by macro-economic factors such as credit availability, interest rates, fuel prices, consumer confidence, employment and other trends. Although OEM demand is tied to actual vehicle production, participants in the automotive technology and components industry also have the opportunity to grow through increasing product content per vehicle by further penetrating business with existing customers and in existing markets, gaining new customers and increasing their presence in global markets. We believe that evolving entrants into the global transportation industry such as mobility providers, electric vehicle developers and smart cities will provide additional markets for our advanced technologies. We believe that as a company with a global presence and advanced technology, engineering, manufacturing and customer support capabilities, we are well-positioned to benefit from these opportunities.We believe that continuously increasing societal demands have created the three “mega-trends” that serve as the basis for the next wave of market-driven automotive technology advancement. We aim to continue developing leading edge technology focused on addressing these mega-trends, and apply that technology toward products with sustainable margins that enable our customers, both OEMs and others, to produce distinctive market-leading products. We have identified a core portfolio of products that draw on our technical strengths and align with these mega-trends where we believe we can provide differentiation to our customers.Safe. The first mega-trend, “Safe,” represents technologies aimed not just at protecting vehicle occupants when a crash occurs, but those that actually proactively reduce the risk of a crash occurring. OEMs continue to focus on improving occupant and pedestrian safety in order to meet increasingly stringent regulatory requirements in various markets. As a result, suppliers are focused on developing technologies aimed at protecting vehicle occupants when a crash occurs, as well as advanced driver assistance systems that reduce driver distractions and automated safety features that proactively mitigate the risk of a crash occurring. Examples of new and alternative technologies that incorporate sophisticated detection and advanced software for collision avoidance include lane departure warning and centering systems, adaptive cruise control and traffic jam assist, and driver and cabin monitoring systems.Green. The second mega-trend, “Green,” represents technologies designed to help reduce emissions, increase fuel economy and minimize the environmental impact of vehicles. Green is a key mega-trend today because of the convergence of several issues: climate change, volatility in oil prices, an increasing number of vehicles in use worldwide and recent and pending regulation in every region regarding fuel economy and greenhouse gas (“GHG”) emissions. OEMs continue to focus on improving fuel efficiency and reducing emissions in order to meet increasingly stringent regulatory requirements in various markets. On a worldwide basis, the relevant authorities in the largest markets in which we operate have already instituted regulations requiring reductions in emissions and/or increased fuel economy. In many cases, other authorities have initiated legislation or regulation that would further tighten the standards through 2023 and beyond. Based on the current regulatory environment, we believe that OEMs, including those in the U.S. and China, will be subject to requirements for even greater reductions in carbon dioxide (“CO2”) emissions over the next ten years. For example, in the U.S., the California Air Resources Board 6Table of Contentsapproved new rules, which require that all new passenger cars and light trucks sold in California be electric vehicles or other emissions-free models by 2035. Furthermore, the Environmental Protection Agency in December 2021 finalized more stringent GHG emissions standards for passenger car and light trucks for model years 2023-2026. These and other standards will require meaningful innovation as OEMs and suppliers are challenged to find ways to improve engine management, electrical power consumption, vehicle weight and integration of electric vehicles and alternative technologies. As a result, suppliers are developing innovations that result in significant improvements in fuel economy, emissions and performance from internal combustion engines and electric vehicles. At the same time, suppliers are also developing and marketing new and alternative technologies that support electric vehicles, hybrid vehicles and fuel cell products to improve fuel economy and emissions. We are developing key enabling technologies in the areas of vehicle charging and vehicle power distribution and control that are essential to the introduction of our customers’ electrified vehicle platforms. We are also enabling the trend towards vehicle electrification with high voltage electrification solutions that reduce CO2 emissions and increase fuel economy, helping to make the world greener.Connected. The third mega-trend, “Connected,” represents technologies designed to seamlessly integrate today’s highly complex vehicles into the electronic operating environment, and provide drivers with connectivity to the global information network. The technology content of vehicles continues to increase as consumers demand greater safety, personalization, infotainment, productivity and convenience while driving, which in turn leads to increasing demand for electrical architecture as a foundation for this content. Also with increased smart device usage in vehicles, driver distractions can be dramatically increased, which in turn results in greater risk of accidents. We are pioneering vehicle-to-vehicle (V2V) and vehicle-to-infrastructure (V2I) communication technologies which enable vehicles to detect and signal danger, reducing vehicle collisions and improving driver safety, while also maintaining connectivity to an increasing number of devices inside and outside of vehicles. We also utilize advanced connectivity solutions such as over-the-air (OTA) technology that enable vehicles to receive software updates remotely and collect market-relevant data from connected vehicles.We expect these mega-trends to continue to create growth and opportunity for us. We believe we are well-positioned to provide solutions and products to OEMs to expand the electronic and technological content of their vehicles. We also believe electronics integration, which generally refers to products and systems that combine integrated circuits, software algorithms, sensor technologies and mechanical components within the vehicle will allow OEMs to achieve substantial reductions in weight and mechanical complexity, resulting in easier assembly, enhanced fuel economy, improved emissions control and better vehicle performance.Convergence of Safe, Green and Connected Solutions in New Mobility and Autonomous DrivingThe combination of advanced technologies being developed within these mega-trends is also contributing to increasing industry development of autonomous driving technologies, leading to a fully automated driving experience. We expect automated driving technologies will provide strong societal benefit as well as the opportunity for long-term growth for our product offerings in this space, including new potential customers such as mobility providers and smart cities that require solutions to increasing urban mobility challenges. Societal benefits of increased vehicle automation include enhanced safety (resulting from collision avoidance and improved vehicle control), environmental improvements (a reduction in CO2 emissions resulting from optimized driving behavior), labor cost savings and improved productivity (as a result of alternate uses for drive time). Growth opportunities in this space result from increased content, additional computing power and software requirements, enhanced connectivity systems and increased electrification and interconnects. We believe the complexity of these systems will also require ongoing software support services, as these vehicle systems will be continuously upgraded with new features and performance enhancements.As part of our strategy to harness the full potential of connected intelligent systems across industries, strengthen our capabilities in software-defined mobility and to enable advanced smart vehicle architecture changes, we acquired Wind River Systems, Inc. (“Wind River”) in December 2022. Wind River is a global leader in delivering software for the intelligent edge. Previously, in 2021, we executed a strategic collaboration agreement with Wind River to develop a software toolchain for various automotive applications.We are also continuing to invest in the automated driving space, and have continued to develop market-leading automated driving platform solutions such as automated driving software, key active safety sensing technologies and our multi-domain controller, which fuses information from sensing systems as well as mapping and navigation data to make driving decisions. We believe we are well-aligned with industry technology trends that will result in sustainable future growth in this space, and have partnered with leaders in their respective fields to advance the pace of development and commercialization of these emerging technologies.In March 2020, to further our leadership position in the automated driving space, we completed a transaction with Hyundai Motor Group (“Hyundai”) to form Motional AD LLC (“Motional”), a joint venture focused on the design, 7Table of Contentsdevelopment and commercialization of autonomous driving technologies. Motional brings together one of the industry’s most innovative vehicle technology providers with one of the world’s largest OEMs. We expect this partnership to accelerate the path towards the development of production-ready autonomous driving systems for commercialization in the new mobility space.We believe that substantial strategic value will be created from our partnership with Hyundai through our commitment to a shared mission of making driverless vehicles a safe, reliable and accessible reality. Furthermore, we anticipate Motional’s presence in both North America and Asia, along with the global presence of both Aptiv and Hyundai, to generate economies of scale to support the development of a complete autonomous driving platform, as well as to facilitate mobility infrastructure advancements.Motional began testing fully driverless systems in 2020 and began testing a production-ready autonomous driving platform available for robotaxi providers, meal delivery providers, fleet operators and automotive manufacturers at prototype scale in 2022, with higher volume production deployments anticipated in late 2023. In addition, Motional is involved in collaborative arrangements with mobility providers and with smart cities such as Boston, Las Vegas, Los Angeles and Singapore as solutions are developed for the evolving nature of the mobility industry. To guide our product strategies and investments in technology with a focus on developing advanced technologies to drive growth within the Safe, Green and Connected mega-trends, we utilize and benefit from our Technology Advisory Council, a panel of prominent global technology thought leaders.Standardization of Sourcing by OEMsMany OEMs have adopted global vehicle platforms to increase standardization, reduce per unit cost and increase capital efficiency and profitability. As a result, OEMs select suppliers that have the capability to manufacture products on a worldwide basis as well as the flexibility to adapt to regional variations. Suppliers with global scale and strong design, engineering and manufacturing capabilities, are best positioned to benefit from this trend. OEMs are also increasingly looking to their suppliers to simplify vehicle design and assembly processes to reduce costs. As a result, suppliers that sell vehicle components directly to manufacturers (Tier I suppliers) have assumed many of the design, engineering, research and development and assembly functions traditionally performed by vehicle manufacturers. Suppliers that can provide fully-engineered solutions, systems and pre-assembled combinations of component parts are positioned to leverage the trend toward system sourcing.Shorter Product Development CyclesAs a result of government regulations and customer preferences, OEMs are requiring suppliers to respond faster with new designs and product innovations. While these trends are more prevalent in mature markets, certain key growth markets are advancing rapidly towards the regulatory standards and consumer preferences of the more mature markets. Suppliers with strong technologies, robust global engineering and development capabilities will be best positioned to meet OEM demands for rapid innovation.ProductsOur organizational structure and management reporting support the management of these core product lines:Signal and Power Solutions. This segment provides complete design, manufacture and assembly of the vehicle’s electrical architecture, including connectors, wiring assemblies and harnesses, cable management, electrical centers and hybrid high voltage and safety distribution systems. Our products provide the critical signal distribution and computing power backbone that supports increased vehicle content and electrification, reduced emissions and higher fuel economy.•High quality connectors are engineered primarily for use in the automotive and related markets, but also have applications in the industrial, telematics, aerospace, defense and medical sectors.•Electrical centers provide centralized electrical power and signal distribution and all of the associated circuit protection and switching devices, thereby optimizing the overall vehicle electrical system.•Distribution systems, including hybrid high voltage systems, are integrated into one optimized vehicle electrical system that can utilize smaller cable and gauge sizes and ultra-thin wall insulation (which product line makes up approximately 44% of our total revenue for the year ended December 31, 2022 and 42% for each of the years ended December 31, 2021 and 2020).Advanced Safety and User Experience. This segment provides critical technologies and services to enhance vehicle safety, security, comfort and convenience, including sensing and perception systems, electronic control units, multi-domain controllers, vehicle connectivity systems, cloud-native software platforms, application software, autonomous driving technologies and end-to-end DevOps tools.•Advanced safety primarily consists of solutions that enable active and passive safety features and vehicle automation, as well as vision, radar and other sensing technologies.8Table of Contents•The user experience portfolio primarily enables in-cabin solutions around infotainment, driver interface and interior sensing solutions.•Connectivity and security products primarily consists of solutions that provide body control, security and unlock vehicle data.CompetitionAlthough the overall number of our top competitors has decreased due to ongoing industry consolidation, the automotive technology and components industry remains extremely competitive. Furthermore, the rapidly evolving nature of the markets in which we compete has attracted, and may continue to attract, new entrants, particularly in best cost countries such as China and in areas of evolving vehicle technologies such as intelligent systems software, automated driving and mobility solutions, which has attracted competitors from outside the traditional automotive industry. OEMs rigorously evaluate suppliers on the basis of product quality, price, reliability and timeliness of delivery, product design capability, technical expertise and development capability, new product innovation, financial viability, application of lean principles, operational flexibility, customer service and overall management. In addition, our customers generally require that we demonstrate improved efficiencies, through cost reductions and/or price improvement, on a year-over-year basis.Our competitors in each of our operating segments are as follows:SegmentCompetitorsSignal and Power Solutions• Amphenol Corporation• Draexlmaier Automotive• Lear Corporation• Leoni AG• Molex Inc. (a subsidiary of Koch Industries, Inc.)• Sumitomo Corporation• TE Connectivity, Ltd.• Yazaki CorporationAdvanced Safety and User Experience• Bosch Group• Continental AG• Denso Corporation• Harman International (a subsidiary of Samsung Electronics)• Hyundai Mobis• Magna International• Panasonic Corporation• Valeo• Veoneer, Inc.• Visteon Corporation• ZF Friedrichshafen AG9Table of ContentsCustomersWe sell our products and services to the major global OEMs in every region of the world. The following table provides the percentage of net sales to our largest customers for the year ended December 31, 2022:CustomerPercentage of Net SalesGeneral Motors Company9%Stellantis N.V.9%Ford Motor Company8%Volkswagen Group8%Tesla, Inc.5%Geely Automobile Holdings Limited5%Mercedes-Benz Group AG4%SAIC General Motors Corporation Limited3%Bayerische Motoren Werke AG2%Toyota Motor Corporation2%Tata Motors Limited2%Supply Relationships with Our CustomersWe typically supply products to our OEM customers through purchase orders, which are generally governed by general terms and conditions established by each OEM. Although the terms and conditions vary from customer to customer, they typically contemplate a relationship under which our customers place orders for their requirements of specific components supplied for particular vehicles but are not required to purchase any minimum amount of products from us. These relationships typically extend over the life of the related vehicle. Prices are negotiated with respect to each business award, which may be subject to adjustments under certain circumstances, such as commodity or foreign exchange escalation/de-escalation clauses or for cost reductions achieved by us. The terms and conditions typically provide that we are subject to a warranty on the products supplied; in most cases, the duration of such warranty is coterminous with the warranty offered by the OEM to the end-user of the vehicle. We may also be obligated to share in all or a part of recall costs if the OEM recalls its vehicles for defects attributable to our products.Individual purchase orders are terminable for cause or non-performance and, in most cases, upon our insolvency and certain change of control events. In addition, many of our OEM customers have the option to terminate for convenience on certain programs, which permits our customers to impose pressure on pricing during the life of the vehicle program, and issue purchase contracts for less than the duration of the vehicle program, which potentially reduces our profit margins and increases the risk of our losing future sales under those purchase contracts. We manufacture and ship based on customer release schedules, normally provided on a weekly basis, which can vary due to cyclical automobile production or dealer inventory levels.Although customer programs typically extend to future periods, and although there is an expectation that we will supply certain levels of OEM production during such future periods, customer agreements including applicable terms and conditions do not necessarily constitute firm orders. Firm orders are generally limited to specific and authorized customer purchase order releases placed with our manufacturing and distribution centers for actual production and order fulfillment. Firm orders are typically fulfilled as promptly as possible from the conversion of available raw materials, sub-components and work-in-process inventory for OEM orders and from current on-hand finished goods inventory for aftermarket orders. The dollar amount of such purchase order releases on hand and not processed at any point in time is not believed to be significant based upon the time frame involved.MaterialsWe procure our raw materials from a variety of suppliers around the world. Generally, we seek to obtain materials in the region in which our products are manufactured in order to minimize transportation and other costs. The most significant raw materials we use to manufacture our products include copper and resins. As of December 31, 2022, we have not experienced any significant shortages of raw materials, however, as a result of our customers’ recent production volatility and cancellations, our balance of productive, raw and component material inventories has increased substantially from customary levels. These changes to the production environment have been primarily driven by the worldwide semiconductor shortage. We continue to actively monitor and manage inventory levels across all inventory types in order to maximize both supply continuity and the 10Table of Contentsefficient use of working capital. Normally we do not carry inventories of such raw materials in excess of those reasonably required to meet our production and shipping schedules. Commodity cost volatility, most notably related to copper, petroleum-based resin products and fuel, is a challenge for us and our industry. Recently, the industry has been subjected to increased pricing pressures, specifically in relation to these commodities, which have experienced significant volatility in price. We have also been impacted globally by increased overall inflation as a result of a variety of global trends. We are continually seeking to manage these and other material-related cost pressures using a combination of strategies, including working with our suppliers to mitigate costs, seeking alternative product designs and material specifications, combining our purchase requirements with our customers and/or suppliers, changing suppliers, hedging of certain commodities and other means. In the case of copper, which primarily affects our Signal and Power Solutions segment, contract clauses have enabled us to pass on some of the price increases to our customers and thereby partially offset the impact of increased commodity costs on operating income for the related products. Other than in the case of copper, our overall success in passing commodity cost increases on to our customers has been limited. However, in 2022, we have negotiated, and will continue to negotiate, price increases with our customers in response to the global supply chain disruptions impacting the automotive industry. We will continue our efforts to pass market-driven commodity cost increases to our customers in an effort to mitigate all or some of the adverse earnings impacts, including by seeking to renegotiate terms as contracts with our customers expire.SeasonalityIn general, our business is moderately seasonal, as our primary North American customers historically reduce production during the month of July and halt operations for approximately one week in December. Our European customers generally reduce production during the months of July and August and for one week in December. Our Chinese customers generally halt operations for one week during the months of February and October. Shut-down periods in the rest of the world generally vary by country. In addition, automotive production is traditionally reduced in the months of July, August and September due to the launch of component production for new vehicle models.Human Capital ResourcesAs of December 31, 2022, we employed approximately 160,000 people; 32,000 salaried employees and 128,000 hourly employees. In addition, we maintain a contingent workforce of approximately 42,000 to accommodate fluctuations in customer demand. We are a global company serving every major worldwide market. As of December 31, 2022 our workforce is distributed as follows:•53% in North America, with our largest presence in Mexico;•31% in the Europe, Middle East and Africa region, with our largest presence in Morocco and Serbia;•12% in the Asia Pacific region, with our largest presence in China and India; and•4% in South America, with our largest presence in Brazil.Certain of our employees are represented worldwide by numerous unions and works councils, including the International Union of Electronic, Electrical, Salaried, Machine and Furniture Workers - Communications Workers of America, IG Metall and the Confederacion De Trabajadores Mexicanos. We maintain collaborative and constructive labor relationships with our employee representatives in order to foster positive employee relations.Talent DevelopmentOur people are central to our mission of developing safer, greener and more connected solutions. We continually strive to create and maintain an environment where innovation thrives and our employees are empowered to think and act like owners. To this end, we continually provide coaching and mentoring to our employees at all levels, as well as internal job opportunities including global rotations and stretch assignments to help our employees develop and grow their careers. This dedication to employee growth and development was demonstrated by more than half of our management role openings being filled through internal promotions in 2022. We manage succession planning as part of our operating cadence and top leadership succession plans are reviewed with the Board of Directors annually. Aptiv is committed to talent development and growing the next generation of leaders. Our established leadership programs provide our leaders with the tools to be effective today while preparing them for future challenges. In 2022, our people completed over 43,000 hours of leadership and management training. Our Global Leadership Development Program develops business acumen and personal competencies, as well as the opportunity to learn and interact with peers from around the world. We also leverage Aptiv Academy, our online learning management system, across the business, using in-person, online and virtual reality learning opportunities. During 2022, our employees used this system to complete approximately 421,000 individual training hours. We continue to focus on developing great people in order to maximize organizational effectiveness.11Table of ContentsCultureAptiv’s culture is a key advantage to how we do business. Our culture is based on a set of distinct values and behaviors that guide what we do and how we do it. Culture is a central pillar in our business and helps to drive consistent leadership behavior across our businesses. In 2022, we hosted 16 culture training workshops with 620 participants to help newly appointed managers understand Aptiv’s values and behaviors to become better leaders. Our management team actively receives feedback at all levels in our organization and utilizes this feedback to continually improve how we engage our people and improve our operations. We recognize that sustaining a leadership culture requires continual focus and attention. Accordingly, senior executives and leaders throughout the Company commit time, resources and attention to ensure our culture continues to differentiate Aptiv as a great place to work.Diversity and InclusionAt Aptiv, we value each individual’s perspective and foster an environment of respect and inclusion. Leveraging our employees’ diverse backgrounds and experiences allows us to make better decisions and supports stronger performance. Our Board of Directors reviews Aptiv’s talent evolution, inclusion and diversity efforts annually, and our Compensation & Human Resources Committee reviews employee retention, attrition and pay equity on a continual basis.Aptiv participates in, and sponsors, numerous outreach programs around the world, which seek to promote and recruit women and diverse candidates into science, technology, engineering and mathematical (STEM) fields. As of December 31, 2022, the percentage of our global workforce represented by women was approximately 50% and the percentage of management represented by women was 24%. As of December 31, 2022, the percentage of our U.S. based workforce represented by minorities was approximately 43% and the percentage of U.S. based management represented by minorities was approximately 34%. Aptiv is committed to continuing to increase its level of diversity, specifically in middle management, senior leadership and technology roles, over the coming years.Health and SafetyWe prioritize the health and safety of all our employees by focusing on prevention, training, auditing and risk mitigation in our manufacturing plants, technical centers and offices. We routinely assess occupational health and safety risks, define controls and perform internal audits for all manufacturing sites, assessing, among other things, legal compliance, controls and key workplace safety metrics. We are a leader in workplace safety as reflected in our lost time injury frequency rate of 0.143 cases per million hours worked and our lost workday case rate per 100 employees of 0.029 for the year ended December 31, 2022. Our standard safety management system is aligned with ISO 45001 and we are committed to ensuring all of our manufacturing sites are ISO 45001 certified by 2025.Commitment to Environmental SustainabilitySustainability has always been core to Aptiv’s business, values and culture. We believe this strong, foundational focus on sustainability makes Aptiv a partner of choice for our customers, a desirable place to work for our employees and a valued contributor to the communities in which we operate. While a key part of our business is to design solutions that help transition the world’s vehicles to cleaner sources of power, we are also committed to reducing our environmental footprint throughout our operations around the globe. We aim to reduce our environmental impact by decreasing our carbon footprint, reducing waste generated and consuming less water in our operations. Expenditures required to meet our environmental sustainability goals, which are described below, are included in our normal budgeting process.Decreasing our Carbon FootprintWe have committed to becoming carbon-neutral in our global operations by 2030 and to achieve net carbon neutrality by 2040 as we transition away from carbon-intensive energy and processes in our global operations. To achieve these commitments, we are targeting:•Reducing Scope 1 and 2 absolute CO2e emissions by 25% between the baseline year (2019) and 2025;•Maintaining annual certification of all major manufacturing sites to the ISO 14001 standard;•Certifying ten of the most energy-intensive sites to the ISO 50001 certification by 2025;•Sourcing 100% of electricity for operations from renewable sources by 2030; and•Delivering only carbon-neutral products by 2039, from sourcing to disposal.Key to achieving these goals is our global Environmental, Health and Safety and Sustainability management system, which helps to keep us aligned with stringent environmental, health and safety regulations and provides a structure for continuous improvement. This system applies to all Aptiv sites, which means that in some countries our procedures go beyond local regulations and requirements. This system is continuously updated to ensure that our procedures remain up to date.12Table of ContentsReducing our Water Usage and Waste GeneratedWhile our operations are not water intensive, we include water in our environmental risk management approach. We identify locations where we operate that are water-scarce and take action to reduce our water consumption accordingly, while also striving to comply with best practices in lower-risk locations. Our goal is to reduce water consumption in high-risk (water-scarce) locations by 2% per year.We are also committed to reducing waste, with a waste recycled target (volume of recycled waste divided by total waste volume) of 80%. We continue to strive to actively reduce and manage waste across our manufacturing operations, as well as in our offices. We are creating packaging that uses less material and we continue to strive to increase the share of waste and excess materials we divert to recycling.Additional Sustainability InformationAdditional information regarding our environmental sustainability and human capital initiatives, as well as information on our progress towards our commitments, is available in our annual Sustainability Report located on our website at www.aptiv.com/about/sustainability. Nothing on our website, including the aforementioned Sustainability Report, shall be deemed incorporated by reference into this Annual Report.13Table of ContentsSUPPLEMENTARY ITEM. EXECUTIVE OFFICERS OF THE REGISTRANTThe name, age (as of February 1, 2023), current positions and description of business experience of each of our executive officers are listed below. Our executive officers are elected annually by the Board of Directors and hold office until their successors are elected and qualified or until the officer’s resignation or removal. Positions noted below reflect current service to Aptiv PLC and prior service to Delphi Automotive PLC and Delphi Automotive LLP.Kevin P. Clark, 60, is chairman of Aptiv’s board of directors and chief executive officer (CEO) of the company. Mr. Clark was named president and CEO and became a member of the board in March 2015. Previously, Mr. Clark was chief operating officer (COO) from October 2014 to March 2015. Prior to the COO position, Mr. Clark was chief financial officer and executive vice president from February 2013. He was appointed vice president and chief financial officer in July 2010. Previously, Mr. Clark was a founding partner of Liberty Lane Partners, LLC, a private-equity investment firm focused on building and improving middle-market companies. Prior to Liberty Lane Partners, Mr. Clark served as the chief financial officer of Fisher-Scientific International Inc., a manufacturer, distributor and service provider to the global healthcare market. Mr. Clark served as Fisher-Scientific’s chief financial officer from the company’s initial public offering in 2001 through the completion of its merger with Thermo Electron Corporation in 2006. Prior to becoming chief financial officer, Mr. Clark served as Fisher-Scientific’s corporate controller and treasurer.Joseph R. Massaro, 53, is Aptiv’s chief financial officer and senior vice president, business operations. Mr. Massaro joined the Company in October 2013 as vice president, Internal Audit, and in September 2014 was appointed to the position of vice president, corporate controller. In March 2016, he was named senior vice president and chief financial officer and in September 2020, also assumed the role of senior vice president, business operations. Previously, Mr. Massaro was a managing director at Liberty Lane Partners from 2008 to 2010. He also served as chief financial officer of inVentiv Health Inc. from 2010 to 2013, a Liberty Lane portfolio company. Prior to Liberty Lane, he served in a variety of finance and operational roles at Thermo Fisher Scientific from 2002 to 2007, including senior vice president of Global Business Services where his responsibilities included the global sourcing and information technology functions. Prior to the merger with Thermo Electron, he also served as vice president and corporate controller of Fisher Scientific and held several other senior finance positions.Allan J. Brazier, 56, is vice president and chief accounting officer of Aptiv, a position he has held since February 2011. Mr. Brazier joined the Company in June 2005 as senior manager of technical accounting and reporting, and prior to his current role served as assistant controller of technical accounting and reporting. Prior to joining Aptiv, Mr. Brazier was employed for seventeen years in financial roles of increasing responsibility at various companies. Mr. Brazier is a Certified Public Accountant and began his career with the international public accounting firm of KPMG.Matthew M. Cole, 53, is senior vice president of Aptiv and president of Advanced Safety and User Experience, effective January 2023. He joined Aptiv from Tech Transformations, where he was president and business leader from September 2021 until January 2023. He previously served as senior vice president, Global Product Development at Visteon Corporation from 2014 to July 2021. Prior to Visteon, Mr. Cole served as vice president, Product Development, Global Electronics at Johnson Controls from 2010 to 2014. Prior to joining Johnson Controls, Mr. Cole served in a variety of positions of increasing responsibility at Visteon from 1999 to 2010. He began his career at Ford Motor Company in 1992. Glen W. De Vos, 62, is senior vice president, transformation and special programs of Aptiv, a position he has held since December 2022. Previously, he was senior vice president and chief technology officer of Aptiv, effective March 2017, and president, Advanced Safety and User Experience, effective April 2021. From November 2017 to October 2019, he was also president of Aptiv’s Mobility and Services Group. Mr. De Vos was previously vice president of Software and Services for Aptiv’s Advanced Safety and User Experience segment, located at the Company’s Silicon Valley Lab in Mountain View, California from 2016 to 2017. He began his Aptiv career with Advanced Safety and User Experience in 1992, and following several progressive engineering and managerial roles in infotainment and user experience, was named vice president, Global Engineering for Advanced Safety and User Experience in 2012.Obed D. Louissaint, 43, is senior vice president and chief people officer of Aptiv, effective January 2023. He joined Aptiv from IBM, where he was most recently senior vice president, Transformation and Culture from August 2020 through December 2022. He previously served as vice president, Talent, Watson Health & Employee Experience from 2019 to 2020 and vice president, Human Resources, IBM Watson, Watson Health, Research, Technical Talent & Corporate from 2015 to 2020. He began his IBM career in 2001 and held several human resources positions of increasing responsibility. Before joining IBM, Mr. Louissaint was president at Student Agencies, Inc.Benjamin Lyon, 43, is senior vice president and chief technology officer of Aptiv, effective December 2022. He joined Aptiv from Astra Space, Inc., a provider of space products and launch services to the global space industry, where he was chief engineer and executive vice president, Operations and Engineering from February 2021 through December 2022. Prior to joining Astra, Mr. Lyon served as senior director – Special Projects Group at Apple Inc. from April 2014 to February 2021. Mr. Lyon joined Apple in 1999, and while there, held several positions of increasing responsibility.14Table of ContentsWilliam T. Presley, 53, is senior vice president and chief operating officer of Aptiv, a position he has held since December 2022, and president, Signal and Power Solutions, a position he has held since September 2020. Mr. Presley joined Aptiv in January 2019 as president of the Electrical Distribution Systems business unit. Prior to joining Aptiv, he was at Lear Corporation. Mr. Presley most recently served as Lear’s vice president of the Wire Harness and Component business unit from 2018 to 2019, vice president of the Component business unit in 2017 and vice president, Global Electrical Engineering from 2013 to 2017. He began his Lear career in 2008 and held several leadership positions of increasing responsibility. Before joining Lear, Mr. Presley held several positions at Chrysler Corporation. Mr. Presley also served in both the U.S. Army and the Michigan Army National Guard for a combined total of 13 years as a Field Artillery Officer.Katherine H. Ramundo, 55, is senior vice president, chief legal officer, chief compliance officer and secretary of Aptiv, effective March 2021. Prior to joining Aptiv, Ms. Ramundo was executive vice president, chief legal officer and secretary of Howmet Aerospace Inc. (formerly Arconic Inc.), a leading global provider of advanced engineered solutions for the aerospace and transportation industries, a role she held from November 2016 to February 2021. Prior to joining Howmet Aerospace, Ms. Ramundo was executive vice president, general counsel and secretary of ANN, Inc., the owner of the Ann Taylor and LOFT brands. Previously, Ms. Ramundo served as vice president, deputy general counsel and assistant secretary of Colgate-Palmolive. Among her other positions during her 15-year tenure at Colgate, she served as general counsel of the Europe/South Pacific division, and later managed global specialty legal activities. She began her career as a litigator, practicing at major New York-based law firms, including Cravath, Swaine & Moore, and Sidley Austin.Sophia M. Velastegui, 47, is senior vice president and chief product officer of Aptiv, effective February 2022. She joined Aptiv from Microsoft Corporation, where she served as the chief technology officer of Artificial Intelligence and product head of Power Apps Edge within their Business Application Group from February 2020 to January 2022, and previously served as general manager in the AI and Research group since December 2017. Prior to joining Microsoft, Ms. Velastegui served as chief product officer at Doppler Labs, an audio technology company, from April 2017 to September 2017. Prior to joining Doppler Labs, Ms. Velastegui worked at Nest Labs, Inc., a home automation specialist company that is part of Alphabet, Inc., from July 2014 to April 2017, initially as lead for Silicon/Architecture Roadmap, then as head of Silicon/Architecture Roadmap. She has also held a variety of technology and product development roles at Apple, ETM and Applied Materials.15Table of ContentsITEM 1A. RISK FACTORSSet forth below are certain risks and uncertainties that could adversely affect our results of operations or financial condition and cause our actual results to differ materially from those expressed in forward-looking statements made by the Company. Also refer to the Cautionary Statement Regarding Forward-Looking Information in this Annual Report.Risks Related to Business Environment and Economic ConditionsDisruptions in the supply of raw materials and other supplies that we and our customers use in our products may adversely affect our profitability.We and our customers use a broad range of materials and supplies, including copper and other metals, petroleum-based resins, chemicals, electronic components and semiconductors. A significant disruption in the supply of these materials for any reason could decrease our production and shipping levels, which could materially increase our operating costs and materially decrease our profit margins.We, as with other component manufacturers in the automotive industry, ship products to our customers’ vehicle assembly plants throughout the world so they are delivered on a “just-in-time” basis in order to maintain low inventory levels. Our suppliers also use a similar method. However, this “just-in-time” method makes the logistics supply chain in our industry very complex and very vulnerable to disruptions.Such disruptions could be caused by any one of a myriad of potential problems, such as closures of one of our or our suppliers’ plants or critical manufacturing lines due to strikes, mechanical breakdowns or failures, electrical outages, fires, explosions or political upheaval, as well as logistical complications due to weather, global climate change, volcanic eruptions, or other natural or nuclear disasters, delayed customs processing, the spread of an infectious disease, virus or other widespread illness and more. Additionally, as we focus operations in best cost countries, the risk for such disruptions is heightened. The lack of any single subcomponent necessary to manufacture one of our products could force us to cease production, potentially for a prolonged period. Similarly, a potential quality issue could force us to halt deliveries while we validate the products. Even where products are ready to be shipped, or have been shipped, delays may arise before they reach our customer. Our customers may halt or delay their production for the same reason if one of their other suppliers fails to deliver necessary components. This may cause our customers, in turn to suspend their orders, or instruct us to suspend delivery, of our products, which may adversely affect our financial performance.When we fail to make timely deliveries in accordance with our contractual obligations, we generally have to absorb our own costs for identifying and solving the “root cause” problem as well as expeditiously producing replacement components or products. Generally, we must also carry the costs associated with “catching up,” such as overtime and premium freight.Additionally, if we are the cause for a customer being forced to halt production, the customer may seek to recoup all of its losses and expenses from us. These losses and expenses could be significant, and may include consequential losses such as lost profits. Any supply-chain disruption, however small, could potentially cause the complete shutdown of an assembly line of one of our customers, and any such shutdown that is due to causes that are within our control could expose us to material claims of compensation. Where a customer halts production because of another supplier failing to deliver on time, there can be no assurance we will be fully compensated, if at all.Due to various factors that are beyond our control, there are currently global supply chain disruptions, including a worldwide semiconductor supply shortage. The semiconductor supply shortage, due in part to increased demand across multiple industries, is impacting production in automotive and other industries. We anticipate these supply chain disruptions will persist in 2023. We, along with most automotive component manufacturers that use semiconductors, have been unable to fully meet the vehicle production demands of OEMs because of events which are outside our control, including but not limited to, the COVID-19 pandemic, the global semiconductor shortage, fires in our suppliers’ facilities, unprecedented weather events in the southwestern United States, and other extraordinary events. Although we are working closely with suppliers and customers to minimize any potential adverse impacts of these events, some of our customers have indicated that they expect us to bear at least some responsibility for their lost production and other costs. While no assurances can be made as to the ultimate outcome of these customer expectations or any other future claims, we do not currently believe a loss is probable. We will continue to actively monitor all direct and indirect potential impacts of these supply chain disruptions, and will seek to aggressively mitigate and minimize their impact on our business.In addition, we are carrying critical inventory items and key components, and we continue to procure productive, raw material and non-critical inventory components in order to satisfy our customers’ vehicle production schedules. However, as a result of our customers’ recent production volatility and cancellations, our balance of productive, raw and component material inventories has increased substantially from customary levels as of December 31, 2022 and 2021. We will continue to actively monitor and manage inventory levels across all inventory types in order to maximize both supply continuity and the efficient use of working capital.16Table of ContentsThe extent to which the COVID-19 pandemic, including its variants, and measures taken in response thereto impact our business, financial condition, results of operations and cash flows will depend on future developments, which are highly uncertain and difficult to predict.The global spread of COVID-19, which originated in late 2019 and was later declared a pandemic by the World Health Organization in March 2020, negatively impacted the global economy, disrupted supply chains and created significant volatility in global financial markets in 2020 with various adverse impacts continuing to date.The direct adverse impacts of the COVID-19 pandemic on Aptiv, which primarily affected us in the first half of 2020, included extended work stoppages and travel restrictions at our facilities and those of our customers and suppliers, decreases in consumer demand and vehicle production schedules, disruptions to our supply chain and other adverse global economic impacts, particularly those resulting from temporary governmental “lockdown” orders for all non-essential activities, initially in the first quarter of 2020 in China and subsequently in Europe, North America and South America. During the second half of 2020, many of these impacts abated, resulting in increased sales and profitability from the levels observed earlier in 2020. In 2021, our manufacturing facilities were not impacted by prolonged shutdowns directly resulting from the COVID-19 pandemic.Beginning late in the first quarter of 2022 and continuing into the second quarter, various regions in China, including regions where Aptiv has operations, were subjected to lockdowns imposed by governmental authorities to mitigate the spread of COVID-19. In response, our manufacturing facilities located in these areas implemented measures designed to minimize the impacts of any shutdowns. Despite these measures, industry-wide production interruptions adversely impacted our sales and profitability beginning at the end of the first quarter and continuing throughout much of the second quarter. Most of the lockdowns were eased in China late in the second quarter, however many lockdowns were re-imposed and production was once again adversely impacted for portions of the fourth quarter of 2022. Estimated total indirect and direct adverse impacts to revenue as a result of these lockdowns during 2022 was approximately $270 million. The overall duration and impact, as well as possible reoccurrence, of these lockdowns in China or other regions, or other measures aimed at containing and mitigating the effects of the pandemic, including renewed travel bans and restrictions, quarantines, social distancing orders, “lockdown” orders and shutdowns of non-essential activities, remain uncertain and may adversely impact our results of operations and cash flows in future periods. Other than these production interruptions in China, our manufacturing facilities were not impacted by prolonged shutdowns directly resulting from the COVID-19 pandemic in 2022.Due to the continuing uncertainties of the COVID-19 pandemic, including potential future governmental actions and economic impacts, it is possible that these adverse impacts could reoccur, resulting in further adverse impacts on our future operating earnings and cash flows. In addition, to the extent the factors indicated above adversely affect our business, financial condition, results of operations and cash flows, they may also have the effect of heightening many of the other risk factors in this section.The cyclical nature of automotive sales and production can adversely affect our business.Our business is directly related to automotive sales and automotive vehicle production by our customers. Automotive sales and production are highly cyclical and, in addition to general economic conditions, also depend on other factors, such as consumer confidence and consumer preferences. Lower global automotive sales would be expected to result in substantially all of our automotive OEM customers lowering vehicle production schedules, which has a direct impact on our earnings and cash flows. In addition, automotive sales and production can be affected by labor relations issues, regulatory requirements, trade agreements, the availability of consumer financing, inflationary pressures, interest rate volatility, supply chain disruptions and other factors, including global health crises, such as the COVID-19 pandemic. Economic declines that result in a significant reduction in automotive sales and production by our customers have in the past had, and may in the future have, an adverse effect on our business, results of operations and financial condition.Our sales are also affected by inventory levels and OEMs’ production levels. We cannot predict when OEMs will decide to increase or decrease inventory levels or whether new inventory levels will approximate historical inventory levels. Uncertainty and other unexpected fluctuations could have a material adverse effect on our business and financial condition.A prolonged economic downturn or economic uncertainty could adversely affect our business and cause us to require additional sources of financing, which may not be available.Our sensitivity to economic cycles and any related fluctuation in the businesses of our customers or potential customers may have a material adverse effect on our financial condition, results of operations or cash flows. Global automotive vehicle production increased 5% (5% on an Aptiv weighted market basis, which represents global vehicle production weighted to the geographic regions in which the Company generates its revenue) from 2021 to 2022, reflecting increased vehicle production of 10% in North America, 3% in China and 8% in South America, our smallest region, and a decrease of 1% in Europe. Uncertainty relating to global or regional economic conditions may have an adverse impact on our business. A prolonged downturn in the global or regional automotive industry, or a significant change in product mix due to consumer demand, could require us to shut down plants or result in impairment charges, restructuring actions or changes in our valuation allowances 17Table of Contentsagainst deferred tax assets, which could be material to our financial condition and results of operations. If global economic conditions deteriorate or economic uncertainty increases, our customers and potential customers may experience deterioration of their businesses, which may result in the delay or cancellation of plans to purchase our products. If vehicle production were to remain at low levels for an extended period of time or if cash losses for customer defaults rise, our cash flow could be adversely impacted, which could result in our needing to seek additional financing to continue our operations. There can be no assurance that we would be able to secure such financing on terms acceptable to us, or at all.A drop in the market share and changes in product mix offered by our customers can impact our revenues.We are dependent on the continued growth, viability and financial stability of our customers. Our customers generally are OEMs in the automotive industry. This industry is subject to rapid technological change, vigorous competition, cyclical and short product life cycles, reduced consumer demand patterns and industry consolidation. When our customers are adversely affected by these factors, we may be similarly affected to the extent that our customers reduce the volume of orders for our products. As a result of changes impacting our customers, sales mix can shift which may have either favorable or unfavorable impacts on our revenues and would include shifts in regional growth, shifts in OEM sales demand, as well as shifts in consumer demand related to vehicle segment purchases and content penetration. For instance, a shift in sales demand favoring a particular OEMs’ vehicle model for which we do not have a supply contract may negatively impact our revenue. A shift in regional sales demand toward certain markets could favorably impact the sales of those of our customers that have a large market share in those regions, which in turn would be expected to have a favorable impact on our revenue.The mix of vehicle offerings by our OEM customers also impacts our sales. A decrease in consumer demand for specific types of vehicles where we have traditionally provided significant content could have a significant effect on our business and financial condition. Our sales of products in the regions in which our customers operate also depend on the success of these customers in those regions.We operate in the highly competitive automotive technology and component supply industry, and are dependent on the acceptance of new product introductions for continued growth.The global automotive technology and component supply industry is highly competitive. Competition is based primarily on price, technology, quality, delivery and overall customer service. There can be no assurance that our products will be able to compete successfully with the products of our competitors. Furthermore, the rapidly evolving nature of the markets in which we compete has attracted, and may continue to attract, new and disruptive entrants from outside the traditional automotive supply industry, particularly in countries such as China or in areas of evolving vehicle technologies such as automated driving technologies and advanced software. These entrants may seek to gain access to certain vehicle technology and component markets. Any of these new competitors may develop and introduce technologies that gain greater customer or consumer acceptance, which could adversely affect the future growth of the Company. Additionally, consolidation in the automotive industry may lead to decreased product purchases from us. As a result, our sales levels and margins could be adversely affected by pricing pressures from OEMs and pricing actions of competitors. These factors led to selective resourcing of business to competitors in the past and may also do so in the future.In addition, any of our competitors may foresee the course of market development more accurately than us, develop products that are superior to our products, have the ability to produce similar products at a lower cost than us, adapt more quickly than us to new technologies or evolving customer requirements or develop or introduce new products or solutions before we do, particularly related to potential transformative technologies such as autonomous driving solutions. As a result, our products may not be able to compete successfully with their products. These trends may adversely affect our sales as well as the profit margins on our products. If we do not continue to innovate to develop or acquire new and compelling products that capitalize upon new technologies, this could have a material adverse impact on our results of operations.If we do not respond appropriately, the evolution of the automotive industry towards autonomous vehicles and mobility on demand services could adversely affect our business.The automotive industry is increasingly focused on the development of advanced driver assistance technologies, with the goal of developing and introducing a commercially-viable, fully automated driving experience. The high development cost of active safety and autonomous driving technologies may result in a higher risk of exposure to the success of new or disruptive technologies different than those being developed by us. There has also been an increase in consumer preferences for mobility on demand services, such as car- and ride-sharing, as opposed to automobile ownership, which may result in a long-term reduction in the number of vehicles per capita. These evolving areas have also attracted increased competition from entrants outside the traditional automotive industry. If we do not continue to respond quickly and effectively to this evolutionary process our results of operations could be adversely impacted. 18Table of ContentsWe have invested substantial resources in markets and technologies where we expect growth and we may be unable to timely alter our strategies should such expectations not be realized.Our future growth is dependent on our making the right investments at the right time to support product development and manufacturing capacity in geographic areas where we can support our customer base and in product areas of evolving vehicle technologies. We have identified the Asia Pacific region, and more specifically China, as a key geographic market, and have identified intelligent systems software, advanced driver assistance systems, autonomous driving technologies, mobility solutions and high voltage electrification systems as key product markets. We believe these markets are likely to experience substantial long-term growth, and accordingly have made and expect to continue to make substantial investments, both directly and through participation in various partnerships and joint ventures, in numerous manufacturing operations, technical centers, research and development activities and other infrastructure to support anticipated growth in these areas. If we are unable to deepen existing and develop additional customer relationships in the Asia Pacific region, or if we are unable to develop and introduce market-relevant advanced driver assistance or autonomous driving technologies, we may not only fail to realize expected rates of return on our existing investments, but we may incur losses on such investments and be unable to timely redeploy the invested capital to take advantage of other markets or product categories, potentially resulting in lost market share to our competitors. Our results will also suffer if these areas do not grow as quickly as we anticipate.We may not be able to respond quickly enough to changes in regulations, technology and technological risks, and to develop our intellectual property into commercially viable products.Changes in legislative, regulatory or industry requirements or in competitive technologies may render certain of our products obsolete or less attractive. Our ability to anticipate changes in technology and regulatory standards and to successfully develop and introduce new and enhanced products on a timely basis are significant factors in our ability to remain competitive and to maintain or increase our revenues. For example, the evolving sector of automated driver assistance and autonomous driving technologies has led to guidance issued by the U.S. Department of Transportation (“DOT”) regarding best practices for the testing and deployment of automated driving systems, and outlining federal and state roles in the regulation of these systems, including providing state legislatures with best practices on how to safely foster the development and introduction of automated driving technologies onto public roads. There remains potential for the continued introduction of new and expanded regulations in this space, including potential requirements for autonomous vehicle systems to receive approval from the DOT or other regulatory agencies prior to commercial introduction. It is also possible that regulations in this space may diverge among jurisdictions, leading to increased compliance costs.We cannot provide assurance that certain of our products will not become obsolete or that we will be able to achieve the technological advances that may be necessary for us to remain competitive and maintain or increase our revenues in the future. We are also subject to the risks generally associated with new product introductions and applications, including lack of market acceptance, delays in product development or production and failure of products to operate properly. The pace of our development and introduction of new and improved products depends on our ability to implement improved technological innovations in design, engineering and manufacturing, which requires extensive capital investment. Any capital expenditure cuts in these areas that we may determine to implement in the future to reduce costs and conserve cash could reduce our ability to develop and implement improved technological innovations, which may materially reduce demand for our products.To compete effectively in the automotive technology and components industry, we must be able to launch new products to meet changing consumer preferences and our customers’ demand in a timely and cost-effective manner. Our ability to respond to competitive pressures and react quickly to other major changes in the marketplace, including the potential introduction of disruptive technologies such as autonomous driving solutions or consumer desire for and availability of vehicles with advanced driver assistance technologies or which use alternative fuels is also a risk to our future financial performance.We cannot provide assurance that we will be able to install and certify the equipment needed to produce products for new product programs in time for the start of production, or that the transitioning of our manufacturing facilities and resources to full production under new product programs will not impact production rates or other operational efficiency measures at our facilities. Development and manufacturing schedules are difficult to predict, and we cannot provide assurance that our customers will execute on schedule the launch of their new product programs, for which we might supply products. Our failure to successfully launch new products, or a failure by our customers to successfully launch new programs, could adversely affect our results.Certain of our businesses rely on relationships with collaborative partners and other third-parties for development of certain products and potential products, and such collaborative partners or other third-parties could fail to perform sufficiently.We believe that for certain of our businesses, success in developing market-relevant products depends in part on our ability to develop and maintain collaborative relationships with other companies. In particular, Motional is dependent on the success of our relationship with Hyundai, our joint venture partner. There are certain risks involved in such relationships, as our collaborative partners may not devote sufficient resources to the success of our collaborations; may be acquired by other 19Table of Contentscompanies and subsequently terminate our collaborative arrangement; may compete with us; may not agree with us on key details of the collaborative relationship; or may not agree to renew existing collaborations on acceptable terms. Because these and other factors may be beyond our control, the development or commercialization of our products involved in collaborative partnerships may be delayed or otherwise adversely affected. If we or any of our collaborative partners terminate a collaborative arrangement, we may be required to devote additional resources to product development and commercialization or may need to cancel certain development programs, which could adversely affect our business and operational results.Declines in the market share or business of our five largest customers may adversely impact our revenues and profitability.Our five largest customers accounted for approximately 39% of our total net sales for the year ended December 31, 2022. Accordingly, our revenues may be adversely affected by decreases in any of their businesses or market share. For instance, the COVID-19 pandemic and the worldwide semiconductor shortage have adversely impacted the automotive industry in recent years resulting in reduced vehicle production schedules and sales from historical levels, which adversely impacted our financial condition, operating results and cash flows for portions of the years ended December 31, 2022, 2021 and 2020. Furthermore, because our customers typically have no obligation to purchase a specific quantity of parts, a decline in the production levels of any of our major customers, particularly with respect to models for which we are a significant supplier, could reduce our sales and thereby adversely affect our financial condition, operating results and cash flows.Our business in China is subject to aggressive competition and is sensitive to economic and market conditions.Maintaining a strong position in the Chinese market is a key component of our global growth strategy. The automotive technology and components market in China is highly competitive, with competition from many of the largest global manufacturers and numerous smaller domestic manufacturers. As the size of the Chinese market continues to increase over the long-term, we anticipate that additional competitors, both international and domestic, will seek to enter the Chinese market and that existing market participants will act aggressively to increase their market share. Increased competition may result in price reductions, reduced margins and our inability to gain or hold market share. Additionally, there have been periods of increased market volatility and moderations in the level of economic growth in China, which resulted in periods of lower automotive production growth rates in China than those previously experienced. Our business in China is sensitive to economic and market conditions that drive automotive sales volumes in China and may be impacted if there are reductions in vehicle demand in China. For example, in 2022, various regions in China, including regions where Aptiv has operations, were subjected to lockdowns imposed by governmental authorities to mitigate the spread of COVID-19, which resulted in industry-wide production interruptions during portions of the year. Estimated total indirect and direct adverse impacts to revenue as a result of these lockdowns during 2022 was approximately $270 million. If we are unable to maintain our position in the Chinese market or if vehicle sales in China continue to experience minimal growth or decrease, our business and financial results could be materially adversely affected.We may not realize sales represented by awarded business.We estimate awarded business using certain assumptions, including projected future sales volumes. Our customers generally do not guarantee volumes. In addition, awarded business may include business under arrangements that our customers have the right to terminate without penalty. Therefore, our actual sales volumes, and thus the ultimate amount of revenue that we derive from such sales, are not committed. If actual production orders from our customers are not consistent with the projections we use in calculating the amount of our awarded business, we could realize substantially less revenue over the life of these projects than the currently projected estimate.Continued pricing pressures, OEM cost reduction initiatives and the ability of OEMs to re-source or cancel vehicle programs may result in lower than anticipated margins, or losses, which may have a significant negative impact on our business.Cost-cutting initiatives adopted by our customers result in increased downward pressure on pricing. Our customer supply agreements generally require step-downs in component pricing over the period of production, typically one to three percent per year. In addition, our customers often reserve the right to terminate their supply contracts for convenience, which enhances their ability to obtain price reductions. OEMs have also possessed significant leverage over their suppliers, including us, because the automotive technology and component supply industry is highly competitive, serves a limited number of customers, has a high fixed cost base and historically has had excess capacity. Based on these factors, and the fact that our customers’ product programs typically last a number of years and are anticipated to encompass large volumes, our customers are able to negotiate favorable pricing. Accordingly, as a Tier I supplier, we are subject to substantial continuing pressure from OEMs to reduce the price of our products. For example, our customer supply agreements generally provide for annual reductions in pricing of our products over the period of production. It is possible that pricing pressures beyond our expectations could intensify as OEMs pursue restructuring and cost-cutting initiatives. If we are unable to generate sufficient production cost savings in the future to offset price reductions, our gross margin and profitability would be adversely affected. See Item 1. Supply Relationships with Our Customers for a detailed discussion of our supply agreements with our customers.20Table of ContentsOur supply agreements with our OEM customers are generally requirements contracts, and a decline in the production requirements of any of our customers, and in particular our largest customers, could adversely impact our revenues and profitability.We receive OEM purchase orders for specific components supplied for particular vehicles. In most instances our OEM customers agree to purchase their requirements for specific products but are not required to purchase any minimum amount of products from us. The contracts we have entered into with most of our customers have terms ranging from one year to the life of the model (usually three to seven years, although customers often reserve the right to terminate for convenience). Therefore, a significant decrease in demand for certain key models or group of related models sold by any of our major customers or the ability of a manufacturer to re-source and discontinue purchasing from us, for a particular model or group of models, could have a material adverse effect on us. To the extent that we do not maintain our existing level of business with our largest customers because of a decline in their production requirements or because the contracts expire or are terminated for convenience, we will need to attract new customers or win new business with existing customers, or our results of operations and financial condition will be adversely affected. See Item 1. Supply Relationships with Our Customers for a detailed discussion of our supply agreements with our customers.Adverse developments affecting one or more of our suppliers could harm our profitability.Any significant disruption in our supplier relationships, particularly relationships with sole-source suppliers, could harm our profitability. Furthermore, some of our suppliers may not be able to handle commodity cost volatility and/or sharply changing volumes while still performing as we expect. To the extent our suppliers experience supply disruptions, there is a risk for delivery delays, production delays, production issues or delivery of non-conforming products by our suppliers. Even where these risks do not materialize, we may incur costs as we try to make contingency plans for such risks.The loss of business with respect to, or the lack of commercial success of, a vehicle model for which we are a significant supplier could adversely affect our financial performance.Although we receive purchase orders from our customers, these purchase orders generally provide for the supply of a customer’s requirements for a particular vehicle model and assembly plant, rather than for the purchase of a specific quantity of products. The loss of business with respect to, or the lack of commercial success of, a vehicle model for which we are a significant supplier could reduce our sales and thereby adversely affect our financial condition, operating results and cash flows.Increases in costs of the materials and other supplies that we use in our products may have a negative impact on our business.Significant changes in the markets where we purchase materials, components and supplies for the production of our products may adversely affect our profitability, particularly in the event of significant increases in demand where there is not a corresponding increase in supply, inflation or other pricing increases. In recent periods there have been significant fluctuations in the global prices of copper, petroleum-based resin products, semiconductors and fuel charges, which have had and may continue to have an unfavorable impact on our business, results of operations or financial condition. We will continue efforts to pass some supply and material cost increases onto our customers, although competitive and market pressures have limited our ability to do that, particularly with U.S. OEMs, and may prevent us from doing so in the future, because our customers are generally not obligated to accept price increases that we may desire to pass along to them. Even where we are able to pass price increases through to the customer, in some cases there is a lapse of time before we are able to do so. The inability to pass on price increases to our customers when raw material prices increase rapidly or to significantly higher than historic levels could adversely affect our operating margins and cash flow, possibly resulting in lower operating income and profitability. We expect to be continually challenged as demand for our principal raw materials and other supplies, including electronic components, is significantly impacted by demand in key growth markets, particularly in China. We cannot provide assurance that fluctuations in commodity prices will not otherwise have a material adverse effect on our financial condition or results of operations, or cause significant fluctuations in quarterly and annual results of operations.Our hedging activities to address commodity price fluctuations may not be successful in offsetting future increases in those costs or may reduce or eliminate the benefits of any decreases in those costs.In order to mitigate short-term volatility in operating results due to the aforementioned commodity price fluctuations, we hedge a portion of near-term exposure to certain raw materials used in production. The results of our hedging practice could be positive, neutral or negative in any period depending on price changes in the hedged exposures. Our hedging activities are not designed to mitigate long-term commodity price fluctuations and, therefore, will not protect from long-term commodity price increases. Our future hedging positions may not correlate to actual raw material costs, which could cause acceleration in the recognition of unrealized gains and losses on hedging positions in operating results.21Table of ContentsWe may encounter manufacturing challenges.The volume and timing of sales to our customers may vary due to: variation in demand for our customers’ products; our customers’ attempts to manage their inventory; design changes; changes in our customers’ manufacturing strategy; our customers’ production schedules; acquisitions of or consolidations among customers; and disruptions in the supply of raw materials or other supplies used in our customers’ products. Due in part to these factors, many of our customers do not commit to long-term production schedules. Our inability to forecast the level of customer orders with certainty makes it difficult to schedule production and maximize utilization of manufacturing capacity.We rely on third-party suppliers for components used in our products, and we rely on third-party manufacturers to manufacture certain of our assemblies and finished products. Our results of operations, financial condition and cash flows could be adversely affected if our third-party suppliers lack sufficient quality control or if there are significant changes in their financial or business condition. If our third-party manufacturers fail to deliver products, parts and components of sufficient quality on time and at reasonable prices, we could have difficulties fulfilling our orders, sales and profits could decline, and our commercial reputation could be damaged.From time to time, we have underutilized our manufacturing lines. This excess capacity means we incur increased fixed costs in our products relative to the net revenue we generate, which could have an adverse effect on our results of operations, particularly during economic downturns. If we are unable to improve utilization levels for these manufacturing lines and correctly manage capacity, the increased expense levels will have an adverse effect on our business, financial condition and results of operations. In addition, some of our manufacturing lines are located in China or other countries that are subject to a number of additional risks and uncertainties, including increasing labor costs, which may result from market demand or other factors, and political, social and economic instability.Changes in factors that impact the determination of our non-U.S. pension liabilities may adversely affect us.Certain of our non-U.S. subsidiaries sponsor defined benefit pension plans, which generally provide benefits based on negotiated amounts for each year of service. Our primary funded non-U.S. plans are located in Mexico and the United Kingdom and were underfunded by $73 million as of December 31, 2022. The funding requirements of these benefit plans, and the related expense reflected in our financial statements, are affected by several factors that are subject to an inherent degree of uncertainty and volatility, including governmental regulation. In addition to the defined benefit pension plans, we have retirement obligations driven by requirements in many of the countries in which we operate. These legally required plans require payments at the time benefits are due. Obligations, net of plan assets, related to these non-U.S. defined benefit pension plans and statutorily required retirement obligations totaled $344 million at December 31, 2022, of which $18 million is included in accrued liabilities, $351 million is included in long-term liabilities and $25 million is included in long-term assets in our consolidated balance sheets. Key assumptions used to value these benefit obligations and the cost of providing such benefits, funding requirements and expense recognition include the discount rate and the expected long-term rate of return on pension assets. If the actual trends in these factors are less favorable than our assumptions, this could have an adverse effect on our results of operations and financial condition.We may suffer future asset impairment and other restructuring charges, including write downs of long-lived assets, goodwill, or intangible assets.We have taken, are taking, and may take future restructuring actions to realign and resize our production capacity and cost structure to meet current and projected operational and market requirements. Charges related to these actions or any further restructuring actions may have a material adverse effect on our results of operations and financial condition. We cannot ensure that any current or future restructuring actions will be completed as planned or achieve the desired results.Additionally, from time to time, we have recorded asset impairment losses relating to specific plants and operations. Generally, we record asset impairment losses when we determine that our estimates of the future undiscounted cash flows from an operation will not be sufficient to recover the carrying value of that facility’s building, fixed assets and production tooling. For goodwill, we perform a qualitative assessment of whether it is more likely than not that a reporting unit’s value is less than its carrying amount. If the qualitative assessment is not met, the Company then performs a quantitative assessment by comparing the estimated fair value of each reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit is less than its carrying amount, the Company recognizes an impairment loss in an amount equal to the excess, not to exceed the amount of goodwill allocated to the reporting unit. It is possible that we could incur such charges in the future as changes in economic or operating conditions impacting the estimates and assumptions could result in additional impairment.Employee strikes and labor-related disruptions involving us or one or more of our customers or suppliers may adversely affect our operations.Our business is labor-intensive and we have a number of unions, works councils and other represented employees. A strike or other form of significant work disruption by our employees would likely have an adverse effect on our ability to operate our business. A labor dispute involving us or one or more of our customers or suppliers or that could otherwise affect 22Table of Contentsour operations could reduce our sales and harm our profitability. A labor dispute involving another supplier to our customers that results in a slowdown or a closure of our customers’ assembly plants where our products are included in the assembled parts or vehicles could also adversely affect our business and harm our profitability. In addition, our inability or the inability of any of our customers, our suppliers or our customers’ suppliers to negotiate an extension of a collective bargaining agreement upon its expiration could reduce our sales and harm our profitability. Significant increases in labor costs as a result of the renegotiation of collective bargaining agreements could also adversely affect our business and harm our profitability.We are exposed to foreign currency fluctuations as a result of our substantial global operations, which may affect our financial results.We have currency exposures related to buying, selling and financing in currencies other than the local currencies of the countries in which we operate. Approximately 64% of our net revenue for the year ended December 31, 2022 came from sales outside the U.S., which were primarily invoiced in currencies other than the U.S. dollar, and we expect net revenue from non-U.S. markets to continue to represent a significant portion of our net revenue. Accordingly, significant changes in currency exchange rates, particularly the Euro and Chinese Yuan (Renminbi), could cause fluctuations in the reported results of our businesses’ operations that could negatively affect our results of operations. Price increases caused by currency exchange rate fluctuations may make our products less competitive or have an adverse effect on our margins. Currency exchange rate fluctuations may also disrupt the business of our suppliers by making their purchases of raw materials more expensive and more difficult to finance.Historically, we have reduced our currency exposure by aligning our costs in the same currency as our revenues or, if that is impracticable, through financial instruments that provide offsets or limits to our exposures, which are opposite to the underlying transactions. However, any measures that we may implement to reduce the effect of volatile currencies and other risks of our global operations may not be effective.We face risks associated with doing business in various national and local jurisdictions.The majority of our manufacturing and distribution facilities are in Mexico, China and other countries in Asia Pacific, Eastern and Western Europe, South America and Northern Africa. We also purchase raw materials and other supplies from many different countries around the world. For the year ended December 31, 2022, approximately 64% of our net revenue came from sales outside the U.S. International operations are subject to certain risks inherent in doing business globally, including:•exposure to local economic, political and labor conditions;•unexpected changes in laws, regulations, economic and trade sanctions, trade or monetary or fiscal policy, including interest rates, foreign currency exchange rates and changes in the rate of inflation in the U.S. and other countries;•tariffs, quotas, customs and other import or export restrictions and other trade barriers;•expropriation and nationalization;•difficulty of enforcing agreements, collecting receivables and protecting assets through certain non-U.S. legal systems;•reduced technology, data or intellectual property protections;•limitations on repatriation of earnings;•withholding and other taxes on remittances and other payments by subsidiaries;•investment restrictions or requirements;•violence and civil unrest in local countries, including the conflict between Ukraine and Russia; and•compliance with the requirements of an increasing body of applicable anti-bribery laws, including the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act and similar laws of various other countries.Additionally, our global operations may also be adversely affected by political events, terrorist events and hostilities, complications due to natural, nuclear or other disasters or the spread of an infectious disease, virus or other widespread illness. For instance, the conflict between Ukraine and Russia caused the U.S., European Union and other nations to implement broad economic sanctions against Russia. These countries may impose further sanctions and take other actions as the situation continues. While the sanctions announced to date have not had a material adverse impact on us, any further sanctions imposed or actions taken by these countries, and any retaliatory measures by Russia in response, including restrictions on energy supplies from Russia to countries in the region and asset expropriations, could increase our costs, reduce our sales and earnings or otherwise have an adverse effect on our operations.Ukraine and Russia are significant global producers of raw materials used in our supply chain, including copper, aluminum, palladium and neon gases. Disruptions in the supply and volatility in the price of these materials and other inputs produced by Ukraine or Russia, including increased logistics costs and longer transit times, could adversely impact our business and results of operations. In addition, in July 2022, the E.U. introduced an emergency natural gas rationing plan to reduce the 23Table of Contentsuse of natural gas by businesses and in public buildings in E.U. member states from August 2022 through March 2023 in order to replenish gas reserves. Among other impacts, this may cause widespread economic disruptions during this time period, including potential shutdowns at our suppliers’ or customers’ facilities in the region. The conflict has also increased the possibility of cyberattacks occurring, which could either directly or indirectly impact our operations.We do not have a material physical presence in either Ukraine or Russia, with less than 1% of our workforce located in the countries as of December 31, 2022 and less than 1% of our net sales for the year ended December 31, 2022 generated from manufacturing facilities in those countries. However, the impacts of the conflict have adversely impacted, and may continue to adversely impact, global economies, and in particular, the European economy, a region which accounted for approximately 31% of our net sales for the year ended December 31, 2022.We continue to monitor the situation and will seek to minimize its impact to our business, while prioritizing the safety and well-being of our employees located in both countries and our compliance with applicable laws and regulations in the locations where we operate. Any of the impacts mentioned above, among others, could adversely affect our business, business opportunities, results of operations, financial condition and cash flows.In addition, the global spread of COVID-19, which originated in late 2019 and was later declared a pandemic by the World Health Organization in March 2020, caused certain governmental authorities worldwide to initiate “lockdown” orders for all non-essential activities, which at times, included extended shutdowns of businesses in the impacted regions. This includes the lockdowns in China that occurred in 2022, as discussed further above. This or any further political or governmental developments or health concerns in China or Mexico and other countries in which we operate could result in social, economic and labor instability. These uncertainties could have a material adverse effect on the continuity of our business and our results of operations and financial condition.Existing free trade laws and regulations, such as the United States-Mexico-Canada Agreement, provide certain beneficial duties and tariffs for qualifying imports and exports, subject to compliance with the applicable classification and other requirements. Changes in laws or policies governing the terms of trade, and in particular increased trade restrictions, tariffs or taxes on imports from countries where we manufacture products, such as China and Mexico, could have a material adverse effect on our business and financial results. For example, in October 2022, the U.S. government imposed additional export control restrictions targeting the export, re-export or transfer of, among other products, certain advanced computing semiconductors, semiconductor manufacturing items and related technology to China, which could further disrupt supply chains and adversely impact our business. Furthermore, management continues to monitor the volatile geopolitical environment to identify, quantify and assess threatened duties, taxes or other business restrictions which could adversely affect our business and financial results.Increasing our manufacturing footprint in Asian markets, including China, and our business relationships with Asian automotive manufacturers are important elements of our long-term strategy. In addition, our strategy includes increasing revenue and expanding our manufacturing footprint in lower-cost regions. As a result, our exposure to the risks described above may be greater in the future. The likelihood of such occurrences and their potential impact on us vary from country to country and are unpredictable.If we fail to manage our growth effectively or to integrate successfully any new or future business ventures, acquisitions or strategic alliance into our business, our business could be materially adversely harmed. In addition, the failure to realize the expected benefits of any past or future acquisition could adversely affect our business.We have completed a number of acquisitions in recent years, including the acquisitions of Wind River and Intercable Automotive Solutions S.r.l. in 2022. We expect to continue to pursue business ventures, acquisitions, and strategic alliances that leverage our technology capabilities and enhance our customer base, geographic penetration and scale to complement our current businesses and we regularly evaluate potential opportunities, some of which could be material. While we believe that such transactions are an integral part of our long-term strategy, there are risks and uncertainties related to these activities. Assessing a potential growth opportunity involves extensive due diligence. However, the amount of information we can obtain about a potential growth opportunity may be limited, and we can give no assurance that new business ventures, acquisitions, and strategic alliances will positively affect our financial performance or will perform as planned. For instance, our acquisition of Wind River, is subject to numerous risks and uncertainties, which may result in the failure to realize the expected benefits of the transaction. We expect Wind River to become a foundational element of executing our business strategy as Wind River’s industry-leading software services are complementary to our existing portfolio of software solutions, advanced compute and smart architectures and we intend to establish Wind River as the cornerstone of our software strategy. If we are not successful in establishing Wind River in this regard, the anticipated benefits of the acquisition may not be realized fully or at all or may take longer to realize than expected.Furthermore, we may not be successful in fully or partially integrating companies that we acquire, including their personnel, financial systems, distribution, operations and general operating procedures. We may also encounter challenges in achieving appropriate internal control over financial reporting in connection with the integration of an acquired company. If we 24Table of Contentsfail to assimilate or integrate acquired companies successfully, our business, reputation and operating results could be materially impacted. Likewise, our failure to integrate and manage acquired companies profitably may lead to future impairment of any associated goodwill and intangible asset balances. Furthermore, if the benefits of an acquisition do not meet the expectations of investors or securities analysts, the market price of our ordinary shares prior to the closing of the acquisition may decline.Digital technologies are increasingly crucial to our products and our business. Any significant disruptions such as disruptions caused by cyber-attacks to our information technology capabilities, or those of third parties with which we do business, could adversely impact our business. Similarly, as mobility becomes increasingly connected, electric and autonomous, vehicles increasingly depend on the proper functioning of their software and micro-electronics.Our ability to keep our business operating effectively depends on the functional and efficient operation of information technology capabilities, both internally and externally. Our capabilities, as well as those of our customers, suppliers, partners and service providers, are crucial to operations and contain confidential personal information, business-related information or intellectual property. These capabilities are also susceptible to interruptions (including those caused by systems failures, cyber-attacks and other natural or man-made incidents or disasters), which may be prolonged or go undetected. Cyber-attacks are continually increasing in their frequency, sophistication and intensity. Although we have and continue to employ capabilities, processes and other security and privacy measures designed to prevent, detect and mitigate the risk of such events, including but not limited to geographically diverse and resilient infrastructure, third-party risk management and the implementation of proactive security and privacy measures, a significant or large-scale interruption of our information technology capabilities could result in a confidentiality, integrity or availability data breach, and adversely affect our ability to manage and keep operations running efficiently and effectively, and could result in significant costs, regulatory investigations, fines or litigation. Incidents that result in a wider or sustained disruption to our business or products, or result in a personal data breach, could have a material adverse effect on our business, reputation, financial condition and results of operations. In addition, some of our employees work from home on a full-time or part-time basis, which may increase our vulnerability to cyber and other information technology risks.Some of our products, including but not limited to safety-critical products, contain complex digital technologies designed to support today’s increasingly connected vehicles. Although we continue to employ capabilities, processes and other security and privacy measures designed to reduce risks of cyber-attacks against our products, such measures may not provide absolute security (and, in turn, privacy) and may not sufficiently mitigate all potential risks under all scenarios. Failure of such products to effectively protect against attacks targeted at our products can negatively affect our brand and harm our business, prospects, customers, financial condition and operating results.Further, engineering and maintaining security for our systems and products may require significant costs. However, failing to properly respond to and invest in information technology and cybersecurity advancements may limit our ability to attract and retain customers, prevent us from offering similar products and services as those offered by our competitors or inhibit our ability to meet regulatory, industry or other compliance requirements.To date, we have not experienced a system failure, cyber-attack or security breach that has resulted in a material interruption in our operations or material adverse effect on our financial condition. Our Board of Directors regularly reviews relevant information technology and cybersecurity matters and receives periodic updates from information technology and cybersecurity subject matter experts as part of its risk assessment procedures, including analysis of existing and emerging risks, as well as plans and strategies to address those risks. While we continuously seek to expand and improve our information technology systems and maintain adequate disclosure controls and procedures, there can be no assurance that we can adequately anticipate all trends of the market, technology landscapes, and threat landscapes, and there can be no assurance that such measures will prevent interruptions or security breaches that could adversely affect our business.Risks Related to Legal, Regulatory, Tax and Accounting MattersWe may incur material losses and costs as a result of warranty claims, product recalls, product liability and intellectual property infringement actions that may be brought against us.We face an inherent business risk of exposure to warranty claims and product liability in the event that our products fail to perform as expected and, in the case of product liability, such failure of our products results in bodily injury and/or property damage. The fabrication of the products we manufacture is a complex and precise process. Our customers specify quality, performance and reliability standards. If flaws in either the design or manufacture of our products were to occur, we could experience a rate of failure in our products that could result in significant delays in shipment and product re-work or replacement costs. Although we engage in extensive product quality programs and processes, these may not be sufficient to avoid product failures, which could cause us to:25Table of Contents•lose net revenue;•incur increased costs such as warranty expense and costs associated with customer support;•experience delays, cancellations or rescheduling of orders for our products;•experience increased product returns or discounts; or•damage our reputation,all of which could negatively affect our financial condition and results of operations.If any of our products are or are alleged to be defective, we may be required to participate in a recall involving such products. Each vehicle manufacturer has its own practices regarding product recalls and other product liability actions relating to its suppliers. However, as suppliers become more integrally involved in the vehicle design process and assume more of the vehicle assembly functions, OEMs continue to look to their suppliers for contribution when faced with recalls and product liability claims. A recall claim brought against us, or a product liability claim brought against us in excess of our available insurance, may have a material adverse effect on our business. OEMs also require their suppliers to guarantee or warrant their products and bear the costs of repair and replacement of such products under new vehicle warranties. Depending on the terms under which we supply products to a vehicle manufacturer, a vehicle manufacturer may attempt to hold us responsible for some or all of the repair or replacement costs of products under new vehicle warranties when the OEM asserts that the product supplied did not perform as warranted. Although we cannot ensure that the future costs of warranty claims by our customers will not be material, we believe our established reserves are adequate to cover potential warranty settlements. Our warranty reserves are based on our best estimates of amounts necessary to settle future and existing claims. We regularly evaluate the level of these reserves and adjust them when appropriate. However, the final amounts determined to be due related to these matters could differ materially from our recorded estimates.In addition, as we adopt new technology, we face an inherent risk of exposure to the claims of others that we have allegedly violated their intellectual property rights. We cannot ensure that we will not experience any material warranty, product liability or intellectual property claim losses in the future or that we will not incur significant costs to defend such claims.We may be adversely affected by laws or regulations, including environmental, health and safety and climate change, regulation, litigation or other liabilities.We are subject to various U.S. federal, state and local, and non-U.S., laws and regulations, including those related to environmental, health and safety, financial and other matters.We cannot predict the substance or impact of pending or future legislation or regulations, or the application thereof. The introduction of new laws or regulations or changes in existing laws or regulations, or the interpretations thereof, could increase the costs of doing business for us or our customers or suppliers or restrict our actions and adversely affect our financial condition, operating results and cash flows.We are subject to laws and regulations governing, among other things:•the generation, storage, handling, use, transportation, presence of, or exposure to hazardous materials;•the emission and discharge of hazardous materials into the ground, air or water;•climate change;•the incorporation of certain chemical substances into our products, including electronic equipment; and•the health and safety of our employees.We are also required to obtain permits from governmental authorities for certain operations. We cannot assure you that we have been or will be at all times in complete compliance with such laws, regulations and permits. If we violate or fail to comply with these laws, regulations or permits, we could be fined or otherwise sanctioned by regulators. We could also be held liable for any and all consequences arising out of human exposure to hazardous substances or other environmental damage.Certain environmental laws impose liability, sometimes regardless of fault, for investigating or cleaning up contamination on or emanating from our currently or formerly owned, leased or operated property, as well as for damages to property or natural resources and for personal injury arising out of such contamination. Some of these environmental laws may also assess liability on persons who arrange for hazardous substances to be sent to third-party disposal or treatment facilities when such facilities are found to be contaminated. At this time, we are involved in various stages of investigation and cleanup related to environmental remediation matters at a number of present and former facilities. The ultimate cost to us of site cleanups is difficult to predict given the uncertainties regarding the extent of the required cleanup, the potential for ongoing environmental monitoring and maintenance that could be required for many years, the interpretation of applicable laws and regulations, alternative cleanup methods, and potential agreements that could be reached with governmental and third parties. While we have environmental reserves of approximately $2 million at December 31, 2022 for the cleanup of presently-known 26Table of Contentsenvironmental contamination conditions, it cannot be guaranteed that actual costs will not significantly exceed these reserves. We also could be named as a potentially responsible party at additional sites in the future and the costs associated with such future sites may be material.Environmental laws and regulations are complex, change frequently and have tended to become more stringent over time. Specifically, increased public awareness and concern regarding global climate change may continue to result in more international, regional, federal, state and local requirements, or pressure from key stakeholders, to reduce or mitigate climate change, which could impose significant operational restrictions, costs and compliance burdens upon our business or our products. While we have budgeted for future capital and operating expenditures to maintain compliance with environmental laws and regulations, we cannot ensure that environmental laws and regulations will not change or become more stringent in the future. Therefore, we cannot ensure that our costs of complying with current and future environmental, health and safety laws and regulations, and our liabilities arising from past or future releases of, or exposure to, hazardous substances will not adversely affect our business, results of operations or financial condition. For example, adoption of GHG or climate change rules in jurisdictions in which we operate facilities could require installation of emission controls, acquisition of emission credits, emission reductions, or other measures that could be costly, and could also impact utility rates and increase the amount we spend annually for energy. Furthermore, if we fail to achieve our sustainability goals and reduce our impact on the environment, or if there becomes a public perception that we have failed to act responsibly regarding climate change and sustainability, we could be exposed to negative publicity, which could adversely affect our business and reputation.We may identify the need for additional environmental remediation or demolition obligations relating to facility divestiture, closure and decommissioning activities.As we sell, close and/or demolish facilities around the world, environmental investigations and assessments will need to be performed. We may identify previously unknown environmental conditions or further delineate known conditions that may require remediation or incur additional costs related to demolition or decommissioning activities, such as abatement of asbestos containing materials or removal of storage tanks. Such costs could exceed our reserves.We are involved from time to time in legal proceedings and commercial or contractual disputes, which could have an adverse impact on our profitability and consolidated financial position.We are involved in legal proceedings and commercial or contractual disputes that, from time to time, are significant. These are typically claims that arise in the normal course of business including, without limitation, commercial or contractual disputes, including warranty claims and other disputes with customers and suppliers; intellectual property matters; personal injury claims; environmental, health and safety issues; tax matters; and employment matters.While we believe our reserves are adequate, the final amounts required to resolve these matters could differ materially from our recorded estimates and our results of operations could be materially affected.For further information regarding our legal matters, see Item 3. Legal Proceedings. No assurance can be given that such proceedings and claims will not have a material adverse effect on our profitability and consolidated financial position.Developments or assertions by us or against us relating to intellectual property rights could materially impact our business.We own significant intellectual property, including a large number of patents and trade names, and are involved in numerous licensing arrangements. Our intellectual property plays an important role in maintaining our competitive position in a number of the markets we serve. Developments or assertions by or against us relating to intellectual property rights could negatively impact our business. Significant technological developments by others also could materially and adversely affect our business and results of operations and financial condition.Taxing authorities could challenge our historical and future tax positions.Our future effective tax rates could be affected by changes in the mix of earnings in countries with differing statutory rates and changes in tax laws or their interpretation including changes related to tax holidays or tax incentives. Our taxes could increase if certain tax holidays or incentives are not renewed upon expiration, or if tax rates or regimes applicable to us in such jurisdictions are otherwise increased. Existing income tax laws, regulations and related international agreements provide guidance and direction on the allocations of income and applicable taxing rights among the countries in which we operate. Changes in these guidelines are being contemplated at the local, national, regional (particularly in the European Union), and global levels (through organizations like the G20 and the Organisation for Economic Co-operation and Development). Any changes, especially if made inconsistently, could have a materially adverse impact on our financial results.The amount of tax we pay is subject to our interpretation of applicable tax laws in the jurisdictions in which we file. We have taken and will continue to take tax positions based on our interpretation of such tax laws. Additionally, in determining the adequacy of our provision for income taxes, we regularly assess the likelihood of adverse outcomes resulting from tax examinations. While it is often difficult to predict the final outcome or the timing of the resolution of a tax examination, our 27Table of Contentsreserves for uncertain tax benefits reflect the outcome of tax positions that are more likely than not to occur. While we believe that we have complied with all applicable tax laws, there can be no assurance that a taxing authority will not have a different interpretation of the law and assess us with additional taxes. Should additional taxes be assessed, this may result in a material adverse effect on our results of operations and financial condition.General Risk FactorsAny changes in consumer credit availability or cost of borrowing could adversely affect our business.Declines in the availability of consumer credit and increases in consumer borrowing costs have negatively impacted global automotive sales and resulted in lower production volumes in the past. Substantial declines in automotive sales and production by our customers could have a material adverse effect on our business, results of operations and financial condition.We may lose or fail to attract and retain key salaried employees and management personnel.An important aspect of our competitiveness is our ability to attract and retain key salaried employees and management personnel. Our ability to do so is influenced by a variety of factors, including the compensation we award and the competitive market position of our overall compensation package. We may not be as successful as competitors at recruiting, assimilating and retaining highly skilled personnel. The loss of the services of any member of senior management or a key salaried employee could have an adverse effect on our business.ITEM 1B. UNRESOLVED STAFF COMMENTSWe have no unresolved SEC staff comments to report.ITEM 2. PROPERTIESAs of December 31, 2022, we owned or leased 131 major manufacturing sites and 11 major technical centers. A manufacturing site may include multiple plants and may be wholly or partially owned or leased. We also have many smaller manufacturing sites, sales offices, warehouses, engineering centers, joint ventures and other investments strategically located throughout the world. We have a presence in 48 countries. The following table shows the regional distribution of our major manufacturing sites by the operating segment that uses such facilities:North AmericaEurope,Middle East& AfricaAsia PacificSouth AmericaTotalSignal and Power Solutions45 37 33 5 120 Advanced Safety and User Experience2 5 4 — 11 Total47 42 37 5 131 In addition to these manufacturing sites, we had 11 major technical centers: four in North America; two in Europe, Middle East and Africa; and five in Asia Pacific.Of our 131 major manufacturing sites and 11 major technical centers, which include facilities owned or leased by our consolidated subsidiaries, 65 are primarily owned and 77 are primarily leased.We frequently review our real estate portfolio and develop footprint strategies to support our customers’ global plans, while at the same time supporting our technical needs and controlling operating expenses. We believe our evolving portfolio will meet current and anticipated future needs.ITEM 3. LEGAL PROCEEDINGSWe are from time to time subject to various actions, claims, suits, government investigations, and other proceedings incidental to our business, including those arising out of alleged defects, breach of contracts, competition and antitrust matters, product warranties, intellectual property matters, personal injury claims and employment-related matters. It is our opinion that the outcome of such matters will not have a material adverse impact on our consolidated financial position, results of operations, or cash flows. With respect to warranty matters, although we cannot ensure that the future costs of warranty claims by customers will not be material, we believe our established reserves are adequate to cover potential warranty settlements. However, the final amounts required to resolve these matters could differ materially from our recorded estimates.28Table of ContentsBrazil MattersAptiv conducts business operations in Brazil that are subject to the Brazilian federal labor, social security, environmental, health and safety, tax and customs laws, as well as a variety of state and local laws. While Aptiv believes it complies with such laws, they are complex, subject to varying interpretations, and the Company is often engaged in litigation with government agencies regarding the application of these laws to particular circumstances. As of December 31, 2022, the majority of claims asserted against Aptiv in Brazil relate to such litigation. The remaining claims in Brazil relate to commercial and labor litigation with private parties. As of December 31, 2022, claims totaling approximately $105 million (using December 31, 2022 foreign currency rates) have been asserted against Aptiv in Brazil. As of December 31, 2022, the Company maintains accruals for these asserted claims of $5 million (using December 31, 2022 foreign currency rates). The amounts accrued represent claims that are deemed probable of loss and are reasonably estimable based on the Company’s analyses and assessment of the asserted claims and prior experience with similar matters. While the Company believes its accruals are adequate, the final amounts required to resolve these matters could differ materially from the Company’s recorded estimates and Aptiv’s results of operations could be materially affected. The Company estimates the reasonably possible loss in excess of the amounts accrued related to these claims to be zero to $40 million.ITEM 4. MINE SAFETY DISCLOSURESNot applicable.29Table of ContentsPART IIITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESThe Company’s ordinary shares are publicly traded on the New York Stock Exchange under the symbol “APTV.”As of February 3, 2023, there were 2 shareholders of record of our ordinary shares.The following graph reflects the comparative changes in the value from December 31, 2017 through December 31, 2022, assuming an initial investment of $100 and the reinvestment of dividends, if any in (1) our ordinary shares, (2) the S&P 500 index and (3) the Automotive Peer Group. Historical performance may not be indicative of future shareholder returns.Stock Performance Graph* $100 invested on December 31, 2017 in our stock or in the relevant index, including reinvestment of dividends. Fiscal year ended December 31, 2022.(1)Aptiv PLC(2)S&P 500 – Standard & Poor’s 500 Total Return Index(3)Automotive Peer Group – Adient Plc, American Axle & Manufacturing Holdings Inc, Aptiv PLC, Borgwarner Inc, Cooper-Standard Holdings Inc, Dana Inc, Dorman Products Inc, Ford Motor Co, General Motors Co, Gentex Corp, Gentherm Inc, Genuine Parts Co, Goodyear Tire & Rubber Co, Lear Corp, Lkq Corp, Motorcar Parts Of America Inc, Standard Motor Products Inc, Stoneridge Inc, Tesla Inc, Visteon CorpCompany IndexDecember 31, 2017December 31, 2018December 31, 2019December 31, 2020December 31, 2021December 31, 2022Aptiv PLC (1)$100.00 $73.29 $114.25 $157.12 $198.92 $112.31 S&P 500 (2)100.00 95.62 125.72 148.85 191.58 156.89 Automotive Peer Group (3)100.00 76.47 94.74 188.76 284.00 141.98 30Table of ContentsEquity Compensation Plan InformationThe table below contains information about securities authorized for issuance under equity compensation plans. The features of these plans are discussed further in Note 21. Share-Based Compensation to our audited consolidated financial statements.Plan CategoryNumber of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights (a)Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights (b)Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (excluding securities reflected in column (a)) (c)Equity compensation plans approved by security holders1,566,458 (1)$— (2)12,742,596 (3)Equity compensation plans not approved by security holders— — — Total1,566,458 $— 12,742,596 (1)Includes (a) 23,387 outstanding restricted stock units granted to our Board of Directors and (b) 1,543,071 outstanding time- and performance-based restricted stock units granted to our employees. All grants were made under the Aptiv PLC Long Term Incentive Plan, as amended and restated effective April 23, 2015 (the “PLC LTIP”). Includes accrued dividend equivalents.(2)The restricted stock units have no exercise price.(3)Remaining shares available under the PLC LTIP.Repurchase of Equity SecuritiesThere were no repurchases of equity securities during the quarter ended December 31, 2022. In January 2019, the Board of Directors authorized a share repurchase program of up to $2.0 billion. This program will commence following the completion of the previously announced share repurchase program of $1.5 billion, which was approved by the Board of Directors in April 2016. As of December 31, 2022, approximately $2,013 million remained available for repurchases pursuant to these programs.ITEM 6. [RESERVED]Not applicable.ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following management’s discussion and analysis of financial condition and results of operations (“MD&A”) is intended to help you understand the business operations and financial condition of the Company for the year ended December 31, 2022. This discussion should be read in conjunction with
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsYou should read the following discussion and analysis of our financial condition and results of operations together with the consolidated financial statements and related notes that are included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based upon current plans, expectations and beliefs that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this Annual Report on Form 10-K.Overview Arista Networks is an industry leader in data-driven, cognitive cloud networking for next-generation data center and campus workspace environments. At the core of Arista's platform is our EOS, combined with a set of network applications and our Ethernet switching and routing products using merchant silicon, delivering a cloud networking solution with high performance scale and availability, and enabling network automation, visibility, and security. EOS, combined with a set of network applications and ethernet switching and routing platforms using merchant silicon, provides improved price/performance and time to market, delivering a cloud networking solution with high performance scale and availability, and enabling network automation, visibility, and security. We generate revenue primarily from sales of our switching and routing platforms, which incorporate our EOS software, and related network applications. We also generate revenue from post-contract support ("PCS"), which end customers typically purchase in conjunction with our products, and renewals of PCS. We sell our products through both our direct sales force and our channel partners. As of December 31, 2022, we had delivered our cloud networking solutions to over 9,000 end customers worldwide. Our end customers span a range of industries and include large internet companies, service providers, financial services organizations, government agencies, media and entertainment companies, telecommunication service providers and other cloud service providers. Historically, large purchases by a relatively limited number of end customers have accounted for a significant portion of our revenue. We have experienced unpredictability in the timing of orders from these large end customers primarily due to changes in demand patterns specific to these customers, the time it takes these end customers to evaluate, test, qualify and accept our newer products, and the overall complexity of these large orders. For example, sales to our end customers Microsoft and Meta Platforms in fiscal 2022 represented 16% and 26% of our total revenue, respectively, whereas sales to our end customer Microsoft in fiscal 2020 and 2021 amounted to 22% and 15% of our total revenue, respectively, with our end customer Meta Platforms representing less than 10% of our total revenue in both fiscal 2020 and 2021. This variability in customer concentration has been linked to the timing of new product deployments and spending cycles with these customers, and we expect continued variability in our customer concentration and timing of sales on a quarterly and annual basis. Furthermore, we typically provide pricing discounts to large end customers, which may result in lower margins for the period in which such sales occur. We believe that cloud computing represents a fundamental shift from traditional legacy network architectures. As organizations of all sizes have moved workloads to the cloud, spending on cloud and next-generation data centers has increased rapidly, while traditional legacy IT spending has grown more slowly. Our cloud networking platforms are well positioned to address the growing cloud networking market, and to address increasing performance requirements driven by the growing number of connected devices, as well as the need for constant connectivity and access to data and applications. The markets for cloud networking solutions are highly competitive and characterized by rapidly changing technology, changing end-customer needs, evolving industry standards, frequent introductions of new products and services, and industry consolidation. We expect competition to intensify in the future as the market for cloud networking expands and existing competitors and new market entrants introduce new products or enhance existing products. Our future success is dependent upon our ability to continue to evolve and adapt to our rapidly changing environment. We must also continue to develop market-leading products and features that address the needs of our existing and new customers, and increase sales in the enterprise data center switching, and campus workspace markets. We intend to continue expanding our sales force and marketing activities in key geographies, as well as our relationships with channel, technology and system-level partners in order to reach new end customers more effectively, increase sales to existing customers, and provide services and support. In addition, we intend to continue to invest in our research and development organization to enhance the functionality of our existing cloud networking platform, introduce new products and features, and build upon our technology leadership. We believe one of our greatest strengths lies in our ability to rapidly develop new features and applications.50Table of Contents Our development model is focused on the development of new products based on our EOS software and enhancements to EOS. We engineer our products to be agnostic with respect to the underlying merchant silicon architecture. The programmability of EOS has allowed us to expand our software applications to address the ever-increasing demands of cloud networking, including workflow automation, network visibility, analytics and network detection and response, and has further allowed us to integrate rapidly with a wide range of third-party applications for virtualization, management, automation, orchestration and network services. This enables us to focus our research and development resources on our software core competencies and to leverage the investments made by merchant silicon vendors to achieve cost-effective solutions. We work closely with third-party contract manufacturers to manufacture our products. Our contract manufacturers deliver our products to our third-party direct fulfillment facilities. We and our fulfillment partners then perform labeling, final configuration, quality assurance testing and shipment to our customers.Macroeconomic Update Global economic and business activities continue to face widespread macroeconomic uncertainties, including supply chain constraints, inflation and monetary policy shifts, recession risks, the COVID-19 pandemic, and potential disruptions from the Russia-Ukraine conflict and U.S. trade war with China. Although we saw some improvement in our manufacturing and supply chain operations in the latter part of 2022, we continue to experience constraints, with some lingering component shortages, extended lead times, and elevated component and supply chain costs. We continue to work closely with our contract manufacturers and supply chain partners to ramp production following a period of delayed component sourcing and workforce disruptions. Although we have worked diligently to drive improvements in these areas, including funding additional working capital and incremental purchase commitments, these delays have negatively impacted our ability to supply products to our customers on a timely basis. Our demand planning horizon remains extended with high levels of purchase commitments and increased investments in working capital to address delays in component sourcing and the risk of future supply chain disruptions, but we cannot be certain that such delays or disruptions will not occur, or that our extended demand planning horizon will adequately address these disruptions should they occur. In addition, inflation pressure in our supply chain, scarcity of some materials needed to build our products and disruptions to our manufacturing process have increased our cost of revenue and have impacted, and may continue to negatively impact our gross margin. Our operating cash-flows have also been and may continue to be negatively impacted by increased component inventories on hand or at our contract manufacturers, awaiting supply of a limited number of scarce components necessary to build and ship the completed product. While overall demand remains stable, supply chain and manufacturing related constraints could impact our ability to fulfill this demand and as a result could negatively impact our business in future periods. In addition, although our business has experienced limited disruption as a result of the Russia-Ukraine conflict, continued escalation of the conflict may negatively impact the global economy and our future operating results and financial condition. Management continues to actively monitor the impact of these macroeconomic factors on the Company's financial condition, liquidity, operations, suppliers, industry, and workforce. The extent of the impact of these factors on our operational and financial performance, including our ability to execute our business strategies and initiatives in the expected time frame, will depend on future developments, the impact on our customers, partners, employees, contract manufacturers and supply chain, all of which continue to evolve and are unpredictable; however, any continued or renewed disruption in manufacturing and supply resulting from these factors could negatively impact our business. We also believe that any extended or renewed economic disruptions or deterioration in the global economy could have a negative impact on demand from our customers in future periods. Accordingly, current results and financial condition discussed herein may not be indicative of future operating results and trends.Results of OperationsYear Ended December 31, 2022 Compared to Year Ended December 31, 2021 Revenue, Cost of Revenue and Gross Margin (in thousands, except percentages) 51Table of ContentsYear Ended December 31,20222021Change in$% ofRevenue$% ofRevenue$%RevenueProduct$3,716,079 84.8 %$2,377,727 80.7 %$1,338,352 56.3 %Service 665,231 15.2 570,310 19.3 94,921 16.6 Total revenue4,381,310 100.0 2,948,037 100.0 1,433,273 48.6 Cost of revenueProduct1,573,629 35.9 958,363 32.5 615,266 64.2 Service 131,985 3.0 108,895 3.7 23,090 21.2 Total cost of revenue1,705,614 38.9 1,067,258 36.2 638,356 59.8 Gross profit$2,675,696 61.1 %$1,880,779 63.8 %$794,917 42.3 %Gross margin61.1 %63.8 %Revenue by Geography (in thousands, except percentages)Year Ended December 31,2022% of Total2021% of TotalAmericas$3,462,621 79.0 %$2,156,183 73.2 %Europe, Middle East and Africa 529,800 12.1 486,836 16.5 Asia-Pacific 388,889 8.9 305,018 10.3 Total revenue $4,381,310 100.0 %$2,948,037 100.0 %Revenue Product revenue primarily consists of sales of our switching and routing products, and related network applications. Service revenue is primarily derived from sales of PCS contracts, which is typically purchased in conjunction with our products, and subsequent renewals of those contracts. We expect our revenue may vary from period to period based on, among other things, the timing, size, and complexity of orders, especially with respect to our large end customers. Product revenue increased by $1.3 billion, or 56.3%, in the year ended December 31, 2022 compared to 2021. The increase reflects strong demand for our switching and routing platforms from across our customer base, including healthy contributions from our large cloud customers. Although we saw some improvement in component supply in the latter part of fiscal 2022, supply chain and manufacturing constraints limited our revenue performance throughout the year, and while changes in product deferred revenue impacted the timing of revenue recognition on a quarterly basis, the net change in product deferred revenue for the full year was an immaterial contributor to revenue for the year ended December 31, 2022. In addition, service revenue increased by $94.9 million, or 16.6%, in the year ended December 31, 2022 compared to 2021, as a result of continued growth in initial and renewal PCS contracts as our customer installed base continued to expand. International revenues as a percentage of our total revenues decreased from 26.8% in 2021 to 21.0% in 2022, which was primarily driven by increased purchases from large cloud customers in our Americas region. As a result of cost inflation in our supply chain, we implemented targeted price increases during the year, which began to benefit our revenue in late 2022. As supply chain costs improve, we expect to return to a more competitive pricing environment for our products and services. Cost of Revenue and Gross Margin Cost of product revenue primarily consists of amounts paid for inventory to our third-party contract manufacturers and merchant silicon vendors, overhead costs of our manufacturing operations, including freight, and other costs associated with manufacturing our products and managing our inventory and supply chain. Cost of service revenue primarily consists of personnel and other costs associated with our global customer support and services organizations.Cost of revenue increased by $638.4 million, or 59.8% for the year ended December 31, 2022 compared to 2021. These increases were primarily driven by a corresponding increase in product and service revenues, combined with an increase 52Table of Contentsin material and logistics costs to mitigate supply chain constraints and to meet customer demand, as well as an increase in provisions for excess/obsolete finished goods and component inventory.Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including pricing pressure on our products and services due to competition, the mix of sales to large end customers who generally receive lower pricing, the mix of products sold, manufacturing-related costs, including costs associated with supply chain sourcing activities, merchant silicon costs, and excess/obsolete inventory charges, including charges for excess/obsolete component inventory with our contract manufacturers and suppliers. We expect our gross margin to fluctuate over time, depending on the factors described above. Gross margin decreased from 63.8% for the year ended December 31, 2021 to 61.1% for the year ended December 31, 2022. The decrease was primarily driven by an increased proportion of our sales to larger end customers who generally receive larger discounts, increased material and logistics costs, and increased excess/obsolete finished goods and component inventory charges, partly offset by the leverage of fixed overhead costs on a higher revenue base.Operating Expenses (in thousands, except percentages) Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The largest component of our operating expenses is personnel costs. Personnel costs consist of wages, benefits, bonuses and, with respect to sales and marketing expenses, sales commissions. Personnel costs also include stock-based compensation and travel expenses. Year Ended December 31, 20222021Change in $% ofRevenue$% ofRevenue$%Operating expenses:Research and development$728,394 16.6 %$586,752 19.9 %$141,642 24.1 %Sales and marketing326,955 7.5 286,171 9.7 40,784 14.3 General and administrative93,241 2.1 83,117 2.8 10,124 12.2 Total operating expenses$1,148,590 26.2 %$956,040 32.4 %$192,550 20.1 %Research and development. Research and development expenses consist primarily of personnel costs, prototype expenses, third-party engineering costs, and an allocated portion of facility and IT costs. Our research and development efforts are focused on new product development and maintaining and developing additional functionality for our existing products, including new releases and upgrades to our EOS software and applications. We expect our research and development expenses to increase in absolute dollars as we continue to invest in software development in order to expand the capabilities of our cloud networking platform, introduce new products and features, and continue to invest in our technology.Research and development expenses increased by $141.6 million, or 24.1%, for the year ended December 31, 2022 compared to 2021. The increase was primarily due to a $68.6 million increase in personnel costs driven by an increase in headcount, and a $57.5 million increase in new product introduction costs, including third-party engineering and other product development costs.Sales and marketing. Sales and marketing expenses consist primarily of personnel costs, marketing, trade shows, and other promotional activities, and an allocated portion of facility and IT costs. We expect our sales and marketing expenses to increase in absolute dollars as we continue to expand our sales and marketing efforts worldwide.Sales and marketing expenses increased by $40.8 million, or 14.3%, for the year ended December 31, 2022 compared to 2021. The increase was primarily caused by increased personnel costs driven by headcount growth.53Table of ContentsGeneral and administrative. General and administrative expenses consist primarily of personnel costs and professional services costs. General and administrative personnel costs include those for our executive, finance, human resources and legal functions. Our professional services costs are primarily related to external legal, accounting, and tax services. General and administrative expenses increased by $10.1 million, or 12.2%, for the year ended December 31, 2022 compared to 2021. The increase was driven by an increase in personnel costs driven by increased headcount, and increased legal and professional fees primarily driven by acquisitions during the first half of 2022.Other Income, Net (in thousands, except percentages)Other income (expense), net consists primarily of interest income from our cash, cash equivalents and marketable securities, gains and losses on our equity investments in privately-held companies and marketable securities, and foreign currency transaction gains and losses. We expect other income (expense), net may fluctuate in the future as a result of the re-measurement of our equity investments upon the occurrence of either observable price changes or impairments, changes in interest rates or returns on our cash and cash equivalents and marketable securities, and foreign currency exchange rate fluctuations. Year Ended December 31, 20222021Change in $% ofRevenue$% ofRevenue$%Other income (expense), net:Interest income$27,556 0.6 %$7,215 0.2 %$20,341 281.9 %Unrealized gain (loss) on equity investments27,4790.6 — — 27,479 100.0 Other income (expense), net(345)— (1,075)— 730 (67.9)Total other income, net$54,690 1.2 %$6,140 0.2 %$48,550 790.7 %The movement in other income (expense), net, during the year ended December 31, 2022 as compared to 2021 was driven by an increase in interest income due to higher interest rates. In addition, we had unrealized gains of $27.5 million in the year ended December 31, 2022 related to our equity investments.Provision for Income Taxes (in thousands, except percentages) We operate in a number of tax jurisdictions and are subject to taxes in each country or jurisdiction in which we conduct business. Earnings from our non-U.S. activities are subject to local country income tax and may also be subject to U.S. income tax. Generally, our U.S. tax obligations are reduced by a credit for foreign income taxes paid on these foreign earnings, which avoids double taxation. Our tax expense to date consists of federal, state and foreign current and deferred income taxes. Year Ended December 31, 20222021Change in $% ofRevenue$% ofRevenue$%Provision for income taxes$229,350 5.2 %$90,025 3.1 %$139,325 154.8 %Effective tax rate14.5 %9.7 %Our provision for income taxes and effective tax rate increased in 2022 as compared to 2021. The increase in our income taxes was due to an increase in pre-tax income. The increase in our effective tax rate was largely attributable to a decrease in the proportion of tax benefits attributable to stock-based compensation versus total pre-tax income. For further information regarding income taxes and the impact on our results of operations and financial position, refer to Note 8. Income Taxes of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K. Year Ended December 31, 2021 Compared to Year Ended December 31, 2020 Revenue, Cost of Revenue and Gross Margin (in thousands, except percentages) 54Table of Contents Year Ended December 31, 20212020Change in $% ofRevenue$% ofRevenue$%RevenueProduct$2,377,727 80.7 %$1,830,842 79.0 %$546,885 29.9 %Service 570,310 19.3 486,670 21.0 83,640 17.2 Total revenue2,948,037 100.0 2,317,512 100.0 630,525 27.2 Cost of revenueProduct958,363 32.5 749,962 32.4 208,401 27.8 Service 108,895 3.7 85,664 3.7 23,231 27.1 Total cost of revenue1,067,258 36.2 835,626 36.1 231,632 27.7 Gross profit$1,880,779 63.8 %$1,481,886 63.9 %$398,893 26.9 %Gross margin63.8 %63.9 %Revenue by Geography (in thousands, except percentages)Year Ended December 31,2021% of Total2020% of TotalAmericas$2,156,183 73.2 %$1,771,992 76.5 %Europe, Middle East and Africa 486,836 16.5 326,729 14.1 Asia-Pacific 305,018 10.3 218,791 9.4 Total revenue $2,948,037 100.0 %$2,317,512 100.0 %Revenue Product revenue increased by $546.9 million, or 29.9%, in the year ended December 31, 2021 compared to 2020, which reflected stronger demand for our products from new and existing customers, and broader market acceptance of our enterprise and campus products. Service revenue increased by $83.6 million, or 17.2%, in the year ended December 31, 2021 compared to 2020, as a result of continued growth in initial and renewal PCS contracts as our customer installed base continued to expand. International revenues increased from 23.5% in 2020 to 26.8% in 2021, which was mostly driven by increased shipments to our large end customers in the EMEA region. Cost of Revenue and Gross Margin Cost of revenue increased by $231.6 million or 27.7% for the year ended December 31, 2021 compared to 2020. These increases were primarily driven by a corresponding increase in product and service revenues, coupled with an increase in supply chain costs due to increased production capacity and higher volumes.Gross margin slightly decreased from 63.9% for the year ended December 31, 2020 to 63.8% for the year ended December 31, 2021. The change in gross margin was unfavorably impacted by higher supply chain costs, as well as increased service costs to support our growing installed base. These unfavorable impacts were mostly offset by improved product margins due to a reduced proportion of our sales to larger end customers who generally receive larger discounts.55Table of ContentsOperating Expenses (in thousands, except percentages) Year Ended December 31, 20212020Change in $% ofRevenue$% ofRevenue$%Operating expenses:Research and development $586,752 19.9 %$486,594 20.9 %$100,158 20.6 %Sales and marketing 286,171 9.7 229,366 9.9 56,805 24.8 General and administrative83,117 2.8 66,242 2.9 16,875 25.5 Total operating expenses$956,040 32.4 %$782,202 33.7 %$173,838 22.2 %Research and development Research and development expenses increased by $100.2 million, or 20.6%, for the year ended December 31, 2021 compared to 2020. The increase was primarily due to a $67.0 million increase in personnel costs driven by an increase in headcount, and a $32.3 million increase in new product introduction costs, including third-party engineering and other product development costs.Sales and marketing Sales and marketing expenses increased by $56.8 million, or 24.8%, for the year ended December 31, 2021 compared to 2020. The increase was primarily driven by increased headcount and higher sales volume resulting in increased personnel costs.General and administrativeGeneral and administrative expenses increased by $16.9 million, or 25.5%, for the year ended December 31, 2021 compared to 2020. The increase was driven by a $17.7 million increase in personnel costs, primarily stock-based compensation, which was partially offset by a decrease in non-recurring acquisition-related expenses of $4.2 million resulting from the acquisitions of Big Switch and Awake Security in 2020. Other Income, Net (in thousands, except percentages) Year Ended December 31, 20212020Change in $% ofRevenue$% ofRevenue$%Other income, net:Interest income$7,215 0.2 %$27,139 1.2 %$(19,924)(73.4)% Gain on sale of marketable securities— — 9,432 0.4 (9,432)(100.0)Gain on investments in privately-held companies— — 4,164 0.2 (4,164)(100.0)Other income (expense), net(1,075)— (1,556)(0.1)481 (30.9)Total other income, net$6,140 0.2 %$39,179 1.7 %$(33,039)(84.3)%The unfavorable change in other income, net, during the year ended December 31, 2021 as compared to 2020 was driven by a $19.9 million decrease in interest income, which was primarily caused by significant declines in the yields of government and corporate bonds in our investment portfolio. In addition, we recorded a gain on sale of marketable securities and a gain on investments in privately-held companies in 2020, which did not recur in 2021.56Table of ContentsProvision for Income Taxes (in thousands, except percentages) Year Ended December 31, 20212020Change in $% ofRevenue$% ofRevenue$%Provision for income taxes$90,025 3.1 %$104,306 4.5 %$(14,281)(13.7)%Effective tax rate9.7 %14.1 %Despite an increase in pre-tax income in 2021 as compared to 2020, our provision for income taxes and effective tax rate decreased in 2021 as compared to 2020. The decrease in our income taxes and effective tax rate was largely attributable to increased tax benefits from stock-based compensation, combined with a favorable change in jurisdictional mix of earnings. These two factors are variable in nature and past results may not be indicative of future results. For further information regarding income taxes and the impact on our results of operations and financial position, refer to Note 8. Income Taxes of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K. Liquidity and Capital Resources Our principal sources of liquidity are cash, cash equivalents, marketable securities, and cash generated from operations. As of December 31, 2022, our total balance of cash, cash equivalents and marketable securities was $3.0 billion, of which approximately $446.9 million was held outside the U.S. in our foreign subsidiaries. Our cash, cash equivalents and marketable securities are held for general business purposes, including the funding of working capital. Our marketable securities investment portfolio is primarily invested in highly-rated securities, with the primary objective of minimizing the potential risk of principal loss. We plan to continue to invest for long-term growth. We believe that our existing balances of cash, cash equivalents and marketable securities, together with cash generated from operations, will be sufficient to meet our working capital requirements and our growth strategies for at least the next 12 months. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of our spending to support research and development activities, the timing and cost of establishing additional sales and marketing capabilities, the introduction of new and enhanced product and service offerings, our costs associated with supply chain activities, including access to outsourced manufacturing, our costs related to investing in or acquiring complementary or strategic businesses and technologies, the continued market acceptance of our products, and stock repurchases. If we require or elect to seek additional capital through debt or equity financing in the future, we may not be able to raise capital on terms acceptable to us or at all. If we are required and unable to raise additional capital when desired, our business, operating results and financial condition may be adversely affected.Cash FlowsYear Ended December 31,202220212020(in thousands)Cash provided by operating activities$492,813 $1,015,856 $735,114 Cash provided by (used in) investing activities 216,327 (925,562)(608,802)Cash (used in) financing activities(654,601)(360,882)(346,339)Effect of exchange rate changes(3,611)(1,816)1,966 Net increase (decrease) in cash, cash equivalents and restricted cash$50,928 $(272,404)$(218,061)Cash Flows from Operating ActivitiesOur operating activities consist of net income, adjusted for certain non-cash items, and changes in assets and liabilities.During the year ended December 31, 2022, cash provided by operating activities was $492.8 million, primarily from net income of $1.4 billion and net non-cash adjustments to net income of $53.2 million, partially offset by a net increase of $912.8 million in working capital requirements. Net non-cash adjustments primarily consisted of $230.9 million of stock-based compensation expenses and $62.7 million of depreciation, amortization and other expenses, which were largely offset by an increase in deferred income taxes of $244.4 million primarily resulting from increased deferred tax assets associated with the 57Table of Contentscapitalization of research and development costs under IRC Section 174. The increase in working capital requirements primarily consisted of a $638.9 million increase in inventory in response to a significant increase in business volume, increased lead times and supply chain disruptions, and a $401.5 million increase in accounts receivable due to the larger business volume and timing of shipments in the fourth quarter of 2022, as well as an $85.2 million increase in prepaid and other current assets primarily driven by increased inventory deposits to our contract manufacturers. These cash outflows were largely offset by a $99.0 million increase in deferred revenue driven by a growth in PCS contracts, a $98.0 million increase in accounts payable and accrued liabilities related to significant business volume, timing of payments, and increased supplier and contract manufacturer liability reserves and a $44 million increase in income taxes, net, due to an increase in our income tax provision and timing of payments. During the year ended December 31, 2021, cash provided by operating activities was $1.0 billion, primarily from net income of $840.9 million and net non-cash adjustments to net income of $181.9 million, partially offset by a net increase of $6.9 million in working capital requirements. The net non-cash adjustments primarily consist of $186.9 million of stock-based compensation expenses, $50.3 million of depreciation and amortization expenses and $26.8 million of amortization of investment premiums (discounts), all of which were offset by the deferred income tax adjustment of $99.3 million. The increase in working capital primarily consisted of a $170.5 million increase in inventory to help mitigate the impact of COVID-19 related supply chain disruptions, a $134.8 million increase in prepaid and other current assets primarily driven by an increase in deferred cost of sales associated with higher product revenue deferrals, increased inventory deposits to our contract manufacturers, and higher prepaid taxes and other assets. In addition, we had an increase of $127.0 million in accounts receivables due to increased product and service billings. These cash outflows were largely offset by a $278.5 million increase in deferred revenue reflecting ongoing growth in PCS contracts and increased product deferred revenue related to contracts with acceptance terms. In addition, we had a $66.7 million increase in accounts payable related to the volume and timing of production receipts, and an $83.5 million increase in accrued expenses primarily driven by increased supply chain and development costs, as well as accrued compensation-related costs. Cash Flows from Investing ActivitiesOur investing activities consist of our marketable securities investments, business combinations, investments in privately-held companies, and capital expenditures. During the year ended December 31, 2022, cash provided by investing activities was $216.3 million, consisting of proceeds of $1.6 billion from maturities of marketable securities, proceeds from the sale of marketable securities of $193.8 million, partially offset by purchases of available-for-sale securities of $1.4 billion, $145.1 million for business acquisitions, purchases of property, equipment and intangible assets of $44.6 million, and investments and notes receivable in private companies of $12.7 million.During the year ended December 31, 2021, cash used in investing activities was $925.6 million, primarily consisting of purchases of available-for-sale securities of $2.3 billion, investments and notes receivable in private companies of $19.9 million, and purchases of property, equipment and intangible assets of $64.7 million, partially offset by proceeds of $1.5 billion from maturities of marketable securities, proceeds from the sale of marketable securities of $19.6 million, and the receipt of escrow payments of $1.3 million. Cash Flows from Financing ActivitiesOur financing activities consist of proceeds from the issuance of our common stock under employee equity incentive plans, offset by repurchases of our common stock.During the year ended December 31, 2022, cash used in financing activities was $654.6 million, consisting primarily of common stock repurchases of $670.3 million and taxes paid of $32.7 million upon vesting of restricted stock units, offset partially by proceeds from the issuance of common stock under employee equity incentive plans of $48.4 million.During the year ended December 31, 2021, cash used in financing activities was $360.9 million, consisting primarily of payments for repurchases of our common stock of $411.6 million and taxes paid of $16.5 million upon vesting of restricted stock units, offset partially by proceeds from the issuance of common stock under employee equity incentive plans of $67.2 million.Stock Repurchase Programs58Table of ContentsIn April 2019, our board of directors authorized a $1.0 billion stock repurchase program (the “Repurchase Program”). This authorization allowed us to repurchase shares of our common stock over three years and we completed our repurchases under the Repurchase Program during the fourth quarter of 2021. In the fourth quarter of 2021, our board of directors authorized an additional $1.0 billion stock repurchase program (the "New Repurchase Program"). This authorization allows us to repurchase shares of our common stock and will be funded from working capital. The New Repurchase Program commenced in the fourth quarter of 2021, and expires on the three-year anniversary thereof. The New Repurchase Program does not obligate us to acquire any of our common stock and may be suspended or discontinued by the company at any time without prior notice. As of December 31, 2022, the remaining authorized amount for repurchases under the New Repurchase Program was $256.8 million. Refer to Note 6. Stockholders' Equity and Stock-Based Compensation of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K for further discussion. Material cash requirements Our material cash requirements will have an impact on our future liquidity. Our material cash requirements represent material expected or contractually committed future payment obligations. We believe that we will be able to fund these obligations through cash generated from operations and from our existing balances of cash, cash equivalents and marketable securities. Our material cash requirements include the following contractual and other obligations:LeasesWe have operating lease arrangements for office space, data center, equipment and other corporate assets. As of December 31, 2022, we had lease payment obligations, net of immaterial sublease income, of $71.4 million, with $22.5 million payable within 12 months.Purchase ObligationsPurchase obligations represent an estimate of all non-cancellable open purchase orders and contractual obligations, made either directly by Arista or by our contract manufacturers on our behalf, in the ordinary course of business for which we have not received the goods or services. As of December 31, 2022, we had $3.7 billion of such purchase obligations, of which $2.9 billion are expected to be received within 12 months, and $0.8 billion are expected to be received after one year. These open purchase orders are considered enforceable and legally binding, and while we may have some limited ability to reschedule and adjust our requirements based on our business needs prior to the delivery of goods or performance of services, this can only occur with the agreement of the related supplier. Accrued Income TaxesAs of December 31, 2022, we have recorded long-term tax liabilities of $83.5 million related to uncertain tax positions; however, we are unable to make a reasonably reliable estimate of the timing of settlement, if any, of these future payments.In connection with the Tax Cuts and Jobs Act of 2017 ("TCJA"), effective from January 1st, 2022, the TCJA eliminates the option to deduct research and development expenditures currently and requires taxpayers to capitalize and amortize them over five or fifteen years pursuant to IRC Section 174. As of December 31, 2022, the incremental cash tax impact resulting from the new regulations was approximately $195.0 million for the year, of which substantially all of the liability for the full year has been paid. In addition, we may incur incremental cash taxes of up to $180.0 million in fiscal 2023. No material change to our effective tax rate resulted from this new regulation. Off-balance sheet arrangementsAs of December 31, 2022, we did not have any relationships with any unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.Critical Accounting Estimates We have prepared our consolidated financial statements in accordance with accounting principles generally accepted in the United States ("GAAP" or "U.S. GAAP") and include our accounts and the accounts of our wholly owned subsidiaries. 59Table of ContentsThe preparation of these consolidated financial statements requires our management to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the applicable periods. Note 1, “Organization and Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K describes the significant accounting policies and methods used in the preparation of the Company’s consolidated financial statements. We base our estimates, assumptions and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our consolidated financial statements, which, in turn, could change the results from those reported. We evaluate our estimates, assumptions and judgments on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected. Revenue RecognitionWe generate revenue from sales of our products, which incorporate our EOS software and accessories such as cables and optics, to direct customers and channel partners together with PCS. We typically sell products and PCS in a single contract. We recognize revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to be entitled to receive in exchange for those products or services. Most of our contracts with customers, other than renewals of PCS, contain multiple performance obligations with a combination of products and PCS. Products and PCS generally qualify as distinct performance obligations. Our hardware includes EOS software, which together deliver the essential functionality of our products. For contracts which contain multiple performance obligations, we allocate revenue to each distinct performance obligation based on the standalone selling price (“SSP”). Judgment is required to determine the SSP for each distinct performance obligation. We use a range of amounts to estimate SSP for products and PCS sold together in a contract to determine whether there is a discount to be allocated based on the relative SSP of the various products and PCS.If we do not have an observable SSP, such as when we do not sell a product or service separately, then SSP is estimated using judgment and considering all reasonably available information, such as market conditions and information about the size and/or purchase volume of the customer. We generally use a range of amounts to estimate SSP for individual products and services based on multiple factors including, but not limited to, the sales channel (reseller, distributor or end customer), the geographies in which our products and services are sold, and the size of the end customer.We limit the amount of revenue recognition for contracts containing forms of variable consideration, such as future performance obligations, customer-specific returns, and acceptance or refund obligations. We include some or all of an estimate of the related at-risk consideration in the transaction price only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recorded under each contract will not occur when the uncertainties surrounding the variable consideration are resolved. We may occasionally accept returns to address customer satisfaction issues even though there is generally no contractual provision for such returns. We estimate returns for sales to customers based on historical return rates applied against current-period shipments. Specific customer returns and allowances are considered when determining our sales return reserve estimate.We have elected a practical expedient to apply the guidance to a portfolio of contracts or performance obligations with similar characteristics so long as such application would not differ materially from applying the guidance to the individual contracts (or performance obligations) within that portfolio. Consequently, we have chosen to apply the portfolio approach when possible, which we do not believe will happen frequently. Additionally, we will evaluate a portfolio of data, when possible, in various situations, including accounting for commissions, rights of return and transactions with variable consideration.Inventory Valuation and Contract Manufacturer/Supplier LiabilitiesInventories primarily consist of finished goods and strategic components, primarily integrated circuits. Inventories are stated at the lower of cost (computed using the first-in, first-out method) and net realizable value. Manufacturing overhead costs and inbound shipping costs are included in the cost of inventory. We record a provision when inventory is determined to be in excess of anticipated demand, or obsolete, to adjust inventory to its estimated realizable value.60Table of ContentsOur contract manufacturers procure components and assemble products on our behalf based on our forecasts. We record a liability and a corresponding charge for non-cancellable, non-returnable purchase commitments with our contract manufacturers or suppliers for quantities in excess of our demand forecasts or that are considered obsolete due to manufacturing and engineering change orders resulting from design changes. We use significant judgment in establishing our forecasts of future demand and obsolete material exposures. These estimates depend on our assessment of current and expected orders from our customers, product development plans and current sales levels. In addition, industry-wide supply chain shortages have resulted in extended lead times for components and have required us to extend the time horizon of our demand forecasts. There is however no guarantee that all suppliers will meet their commitments in the time frame committed or that actual customer demand will directly match our demand forecasts. If actual market demand conditions or supplier execution on commitments are less favorable than those projected by management, which may be caused by factors within and/or outside of our control, we may be required to increase our inventory write-downs and liabilities to our contract manufacturers and suppliers, which could have an adverse impact on our gross margins and profitability. We regularly evaluate our exposure for inventory write-downs and adequacy of our contract manufacturer and supplier liabilities.Income Taxes Significant management judgment is required in developing our provision for or benefit from income taxes, including the determination of deferred tax assets and liabilities and any valuation allowances that might be required against the deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results and estimates of our ability to generate sufficient future taxable income in certain foreign and state tax jurisdictions, future reversals of taxable temporary differences, and potential tax planning strategies. An adjustment to the valuation allowance will either increase or decrease our provision for or benefit from income taxes in the period such determination is made. We are subject to income taxes in the U.S. and numerous foreign jurisdictions, which involves significant judgment in the interpretation of complex domestic and international tax laws and may give rise to uncertain tax positions. We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether it is more likely than not that additional taxes, interest, and penalties will be due. Although management believes our unrecognized tax benefits are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our unrecognized tax benefits. Our unrecognized tax benefits are adjusted considering changing facts and circumstances, such as the closing of a tax examination or the refinement of an estimate. Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on our financial condition and operating results.Recent Accounting PronouncementsRefer to the subheading titled “Recently Adopted Accounting Pronouncements” in Note 1. Organization and Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K.61Table of ContentsItem 7A. Quantitative and Qualitative Disclosures About Market RiskWe are exposed to market risk in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in foreign currency exchange rates, interest rates, investments in privately-held companies, and marketable equity investments. Macroeconomic uncertainties, including supply chain and labor shortages, inflation and monetary policy shifts, recession risks, the COVID-19 pandemic, and potential disruptions from the Russia-Ukraine conflict and U.S. trade war with China have increased the volatility of global financial markets, which may increase our foreign currency exchange risk and interest rate risk. For further discussion of the potential impacts on our business, operating results, and financial condition, see Risk Factors included in Part I, Item 1A of this Form 10-K. Foreign Currency Exchange Risk Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. Substantially all of our revenue is denominated in U.S. dollars, and therefore, our revenue is not directly subject to foreign currency risk. However, we are indirectly exposed to foreign currency risk. A stronger U.S. dollar could make our products and services more expensive in foreign countries and therefore reduce demand. A weaker U.S. dollar could have the opposite effect. Such economic exposure to currency fluctuations is difficult to measure or predict because our sales are also influenced by many other factors.Our expenses are generally denominated in the currencies in which our operations are located, which is primarily in the U.S. and to a lesser extent in Europe and Asia. Our results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign exchange rates. A hypothetical 10% change in foreign currency exchange rates on our monetary assets and liabilities would not be material to our financial condition or results of operations. To date, foreign currency transaction gains and losses and exchange rate fluctuations have not been material to our financial statements. While we have not engaged in the hedging of our foreign currency transactions to date and do not enter into any hedging contracts for trading or speculative purposes, we may in the future hedge selected significant transactions denominated in currencies other than the U.S. dollar.Interest Rate SensitivityAs of December 31, 2022, and 2021, we had cash, cash equivalents and available-for-sale marketable securities totaling $3.0 billion and $3.4 billion, respectively. Cash equivalents and marketable securities were invested primarily in money market funds, corporate bonds, U.S. agency mortgage-backed securities, U.S. treasury securities and commercial paper. Our primary investment objectives are to preserve capital and maintain liquidity requirements. In addition, our policy limits the amount of credit exposure to any single issuer. We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of the interest rates in the U.S. A decline in interest rates would reduce our interest income on our cash, cash equivalents and marketable securities. For the years ended December 31, 2022, 2021 and 2020, the effect of an immediate 10% change in interest rates would not have been material to our operating results and the total value of the portfolio assuming consistent investment levels. On the other hand, the fair market value of our investments in fixed income securities may be adversely impacted. We would incur unrealized losses on fixed income securities if there is an increase in interest rates compared to interest rates at the time of purchase. In the unlikely event we are forced to sell our marketable securities prior to maturity, we may incur realized losses in such investments. However, because of the conservative and short-term nature of the investments in our portfolio, a change in interest rates is not expected to have a material impact on our consolidated financial statements.Investments in Privately-Held Companies and Marketable Equity InvestmentOur non-marketable equity investments in privately-held companies are recorded in “Investments” in our consolidated balance sheets. As of December 31, 2022 and 2021, the total carrying amount of our investments in privately-held companies was $39.5 million and $20.2 million, respectively. For the years ended December 31, 2022, 2021 and 2020, we recorded a net gain of $15.8 million, $0, and $4.1 million, respectively, on certain investments. See Note 2. Fair Value Measurements of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K for details. The privately-held companies in which we invested are in the startup or development stages. These investments are inherently risky because the markets for the technologies or products these companies are developing are typically in the early 62Table of Contentsstages and may never materialize. We could lose our entire investment in these companies. Our evaluation of investments in privately-held companies is based on the fundamentals of the businesses invested in, including among other factors, the nature of their technologies and potential for financial return.One of our equity investments in a privately-held company completed an initial public offering at the beginning of 2022 and subsequently our investment converted to a marketable equity security and is subject to price risk. This investment generated an unrealized gain of $10.7 million during 2022 and the fair value of the investment was $19.1 million as of December 31, 2022.63Table of Contents
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+Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSORGANIZATION OF INFORMATION Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, provides management’s views on our financial condition and results of operations and should be read in conjunction with the Consolidated Financial Statements and related notes thereto, and includes the sections identified below. Non-GAAP Financial Measures21Overview and Outlook22Analysis of Results of Operations24Results of Operations by Reportable Segment26Financial Condition28Critical Accounting Estimates33Recent Accounting Requirements36NON-GAAP FINANCIAL MEASURES We report our financial results in conformity with accounting principles generally accepted in the United States of America, or GAAP, and also communicate with investors using certain non-GAAP financial measures. These non-GAAP financial measures are not in accordance with, nor are they a substitute for or superior to, the comparable GAAP financial measures. These non-GAAP financial measures are intended to supplement the presentation of our financial results prepared in accordance with GAAP. Based on feedback from investors and financial analysts, we believe that the supplemental non-GAAP financial measures we provide are useful to their assessments of our performance and operating trends, as well as liquidity. Our non-GAAP financial measures exclude the impact of certain events, activities or strategic decisions. The accounting effects of these events, activities or decisions, which are included in the GAAP financial measures, may make it more difficult to assess our underlying performance in a single period. By excluding the accounting effects, positive or negative, of certain items (e.g., restructuring charges, outcomes of certain legal proceedings, certain effects of strategic transactions and related costs, losses from debt extinguishments, gains or losses from curtailment or settlement of pension obligations, gains or losses on sales of certain assets, gains or losses on venture investments and other items), we believe that we are providing meaningful supplemental information that facilitates an understanding of our core operating results and liquidity measures. While some of the items we exclude from GAAP financial measures recur, they tend to be disparate in amount, frequency or timing. We use these non-GAAP financial measures internally to evaluate trends in our underlying performance, as well as to facilitate comparison to the results of competitors for quarters and year-to-date periods, as applicable. We use the non-GAAP financial measures defined below in this MD&A. •Sales change ex. currency refers to the increase or decrease in net sales, excluding the estimated impact of foreign currency translation and the reclassification of sales between segments and, where applicable, an extra week in our fiscal year, the calendar shift resulting from the extra week in the prior fiscal year and currency adjustment for transitional reporting of highly inflationary economies. The estimated impact of foreign currency translation is calculated on a constant currency basis, with prior period results translated at current period average exchange rates to exclude the effect of currency fluctuations. •Organic sales change refers to sales change ex. currency, excluding the estimated impact of acquisitions and product line divestitures. We believe that sales change ex. currency and organic sales change assist investors in evaluating the sales change from the ongoing activities of our businesses and enhance their ability to evaluate our results from period to period. •Free cash flow refers to cash flow provided by operating activities, less payments for property, plant and equipment, software and other deferred charges, plus proceeds from sales of property, plant and equipment, plus (minus) net proceeds from insurance and sales (purchases) of investments. Free cash flow is also adjusted for, where applicable, certain acquisition-related transaction costs. We believe that free cash flow assists investors by showing the amount of cash we have available for debt reductions, dividends, share repurchases, and acquisitions. •Operational working capital as a percentage of annualized current quarter net sales refers to trade accounts receivable and inventories, net of accounts payable, and excludes cash and cash equivalents, short-term borrowings, deferred taxes, other current assets and other current liabilities, as well as net current assets or liabilities held-for-sale divided by annualized current quarter net sales. We believe that operational working capital as a percentage of annualized current quarter net sales assists investors in assessing our working capital 21requirements because it excludes the impact of fluctuations attributable to our financing and other activities (which affect cash and cash equivalents, deferred taxes, other current assets and other current liabilities) that tend to be disparate in amount, frequency or timing, and may increase the volatility of working capital as a percentage of sales from period to period. The items excluded from this measure are not significantly influenced by our day-to-day activities managed at the operating level and do not necessarily reflect the underlying trends in our operations. OVERVIEW AND OUTLOOK Fiscal Year Our fiscal years generally consist of 52 weeks, but every fifth or sixth fiscal year consists of 53 weeks; our 2022 and 2021 fiscal years consisted of 52-week periods ending December 31, 2022 and January 1, 2022, respectively. Our 2020 fiscal year consisted of a 53-week period ending January 2, 2021. Segment InformationIn the fourth quarter of 2022, we changed our operating structure to align with our overall business strategy, and our Chief Executive Officer, who is also our chief operating decision maker, requested changes in the information that he regularly reviews to allocate resources and assess performance. As a result, our fiscal year 2022 results are reported based on our new reportable segments as described in Note 15, "Segment Information." We have recast prior periods to reflect our new operating structure. Net Sales The factors impacting reported net sales change, as compared to the prior-year period, are shown in the table below. 20222021Reported net sales change8 %21 %Foreign currency translation6 (3)Extra week impact— 1 Sales change ex. currency(1)13 %19 %Acquisitions and product line divestitures(4)(3)Organic sales change(1)10 %16 %(1) Totals may not sum due to rounding. In 2022, net sales increased on an organic basis primarily due to pricing actions, partially offset by lower volume/mix. In 2021, net sales increased on an organic basis primarily due to higher volume/mix and recovery from the prior-year impact of COVID-19. Net Income Net income increased from approximately $740 million in 2021 to approximately $757 million in 2022. The major factors affecting this increase were: •The net benefit of pricing, freight, energy and raw material costs, including material re-engineering•Higher income from acquisitions, net of associated amortization of other intangibles•Lower transaction and related costs Offsetting factors: •Lower volume due to inventory destocking •Unfavorable foreign currency translation •Growth investments •Higher employee-related costs Acquisitions Subsequent to our fiscal year-end 2022, in January 2023, we entered into an agreement to acquire Thermopatch, Inc., a New York-based manufacturer specializing in labeling, embellishments, and transfers for the sports, industrial laundry, workwear and hospitality industries. We believe this acquisition will expand the product portfolio in our Solutions Group reportable segment. We expect to complete this acquisition in the first quarter of 2023.2022 AcquisitionsIn January 2022, we completed our acquisitions of TexTrace AG ("TexTrace"), a Switzerland-based technology developer specializing in custom-made woven and knitted RFID products that can be sewn onto or inserted into garments, and Rietveld Serigrafie B.V. and Rietveld Screenprinting Serigrafi Baski Matbaa Tekstil Ithalat Ihracat Sanayi ve Ticaret Limited Sirketi (collectively, "Rietveld"), a Netherlands-based provider of external embellishment solutions and application 22Table of Contentsand printing methods for performance brands and team sports in Europe. These acquisitions expanded the product portfolio in our Solutions Group reportable segment. The acquisitions of TexTrace and Rietveld are referred to collectively as the "2022 Acquisitions."The aggregate purchase consideration for the 2022 Acquisitions was approximately $35 million. We funded the 2022 Acquisitions using cash and commercial paper borrowings. In addition to the cash paid at closing, the sellers in one of these acquisitions are eligible for earn-out payments of up to $30 million, subject to the acquired company achieving certain post-acquisition performance targets. As of the acquisition date, we included an estimate of the fair value of these earn-out payments in the aggregate purchase consideration. The 2022 Acquisitions were not material, individually or in the aggregate, to the Consolidated Financial Statements.Vestcom AcquisitionOn August 31, 2021, we completed our acquisition of CB Velocity Holdings, LLC (“Vestcom”), an Arkansas-based provider of shelf-edge pricing, productivity and consumer engagement solutions for retailers and consumer packaged goods companies, for purchase consideration of $1.47 billion. We funded this acquisition using cash and proceeds from both commercial paper borrowings and issuances of senior notes. Refer to Note 4, “Debt,” to the Consolidated Financial Statements for more information.Vestcom’s solutions expanded our position in high value categories and added channel access and data management capabilities to our Solutions Group reportable segment.Other 2021 Acquisitions On March 18, 2021, we completed our acquisition of the net assets of ZippyYum, LLC (“ZippyYum”), a California-based developer of software products used in the food service and food preparation industries. This acquisition enhanced the product portfolio in our Solutions Group reportable segment. On March 1, 2021, we completed our acquisition of the issued and outstanding stock of JDC Solutions, Inc. (“JDC”), a Tennessee-based manufacturer of pressure-sensitive specialty tapes. This acquisition expanded the product portfolio in our Materials Group reportable segment. The acquisitions of ZippyYum and JDC are referred to collectively as the “Other 2021 Acquisitions.”The aggregate purchase consideration for the Other 2021 Acquisitions was approximately $43 million. We funded the Other 2021 Acquisitions using cash and commercial paper borrowings. In addition to the cash paid at closing, the sellers in one of these acquisitions are eligible for earn-out payments of up to approximately $13 million subject to the acquired company’s achievement of certain post-acquisition performance targets. As of the acquisition date, we estimated the fair value of these earn-out payments to be approximately $12 million, which was included in the $43 million of aggregate purchase consideration. The Other 2021 Acquisitions were not material, individually or in the aggregate, to the Consolidated Financial Statements. Refer to Note 2, “Acquisitions,” to the Consolidated Financial Statements for more information. Cost Reduction Actions 2019/2020 Actions During 2022, we recorded $7.3 million in restructuring charges, net of reversals, related to our 2019/2020 actions. These charges consisted of severance and related costs for the reduction of approximately 830 positions and asset impairment charges at numerous locations across our company, reflecting actions in both our reportable segments. The actions in our Materials Group reportable segment were primarily associated with consolidations of its operations in North America and its graphics business in Europe, in part in response to COVID-19. The actions in our Solutions Group reportable segment were primarily related to global headcount and footprint reduction, with some actions accelerated and expanded in response to COVID-19. During 2021, we recorded $13.3 million in restructuring charges, net of reversals, related to our 2019/2020 actions. These charges consisted of severance and related costs for the reduction of approximately 360 positions, as well as asset impairment charges. Our activities related to our 2019/2020 actions began in the fourth quarter of fiscal year 2019 and continued through fiscal year 2022. Impact of Cost Reduction Actions In 2022 and 2021, we realized approximately $26 million and $65 million, respectively, in savings from restructuring, net of transition costs, primarily related to our 2019/2020 actions. Restructuring charges were included in “Other expense (income), net” in the Consolidated Statements of Income. Refer to Note 13, “Cost Reduction Actions,” to the Consolidated Financial Statements for more information. 23Table of ContentsAccounting Guidance Updates Refer to Note 1, “Summary of Significant Accounting Policies,” to the Consolidated Financial Statements for this information. Cash Flow (In millions)202220212020Net cash provided by operating activities$961.0 $1,046.8 $751.3 Purchases of property, plant and equipment(278.1)(255.0)(201.4)Purchases of software and other deferred charges(20.4)(17.1)(17.2)Proceeds from sales of property, plant and equipment2.3 1.1 9.2 Proceeds from insurance and sales (purchases) of investments, net1.9 3.1 5.6 Payments for certain acquisition-related transaction costs.6 18.8 — Free cash flow$667.3 $797.7 $547.5 In 2022, cash flow provided by operating activities decreased compared to 2021 primarily due to changes in operational working capital, higher incentive compensation payments and the timing of payroll payments, partially offset by higher net income and lower income tax payments, net of refunds. In 2022, free cash flow decreased compared to 2021 primarily due to lower cash provided by operating activities adjusted for payments for certain acquisition-related transaction costs and higher purchases of property, plant and equipment. Outlook Certain factors that we believe will contribute to our 2023 results are described below. •We expect net sales to increase by approximately 0% to 4%, in part reflecting a decrease of approximately 1% from the impact of foreign currency translation.•We anticipate incremental savings from restructuring actions, net of transition costs, of approximately $45 million.•We expect our full-year effective tax rate to be in the mid-twenty percent range.•We expect fixed and IT capital expenditures to be approximately $350 million. ANALYSIS OF RESULTS OF OPERATIONS Income before Taxes (In millions, except percentages)202220212020Net sales$9,039.3 $8,408.3 $6,971.5 Cost of products sold6,635.1 6,095.5 5,048.2 Gross profit2,404.2 2,312.8 1,923.3 Marketing, general and administrative expense1,330.8 1,248.5 1,060.5 Other expense (income), net(.6)5.6 53.6 Interest expense84.1 70.2 70.0 Other non-operating expense (income), net(9.4)(4.1)1.9 Income before taxes$999.3 $992.6 $737.3 Gross profit margin26.6 %27.5 %27.6 %Gross Profit Margin Gross profit margin in 2022 decreased compared to 2021 primarily due the net impact of higher selling prices, higher raw material costs and higher freight costs, as well as higher employee-related costs, partially offset by higher volume/mix primarily related to the impact of acquisitions.Gross profit margin in 2021 decreased slightly compared to 2020 primarily reflecting the net impact of higher selling prices, higher raw material costs and higher freight costs, the impact of prior-year temporary cost reduction actions and higher employee-related costs, partially offset by favorable volume/mix and the benefits from productivity initiatives, including temporary cost reduction actions, material re-engineering and savings from restructuring actions, net of transition costs. 24Table of ContentsMarketing, General and Administrative Expense Marketing, general and administrative expense increased in 2022 compared to 2021 primarily due the impact of acquisitions and growth investments, partially offset by the impact of favorable foreign currency translation.Marketing, general and administrative expense increased in 2021 compared to 2020 primarily due to higher employee-related costs including the impact of acquisitions, growth investments, the impact of prior-year temporary cost reduction actions and unfavorable currency translation, partially offset by lower allowance for credit losses. Other Expense (Income), Net (In millions)202220212020Other expense (income), net by typeRestructuring charges:Severance and related costs$7.6 $10.5 $49.1 Asset impairment charges and lease cancellation costs.1 3.1 6.2 Other items:Transaction and related costs.3 20.9 4.2 Outcomes of legal proceedings, net6.3 (.4)— Gain on venture investments, net(13.5)(23.0)(5.4)(Gain) loss on sales of assets, net(1.4).2 (.5)Gain on sale of product line— (5.7)— Other expense (income), net$(.6)$5.6 $53.6 Refer to Note 13, “Cost Reduction Actions,” to the Consolidated Financial Statements for more information regarding restructuring charges. Refer to Note 9, “Fair Value Measurements,” to the Consolidated Financial Statements for more information regarding gains on venture investments. Refer to Note 15, “Segment and Disaggregated Revenue Information,” to the Consolidated Financial Statements for more information regarding outcomes of legal proceedings. Interest ExpenseInterest expense increased by approximately $13.9 million in 2022 compared to 2021, primarily as a result of additional interest from the $800 million of senior notes we issued in August 2021 and higher interest rates on short-term borrowings. Interest expense in 2021 was comparable to 2020.Net Income and Earnings per Share (In millions, except percentages and per share amounts)202220212020Income before taxes$999.3 $992.6 $737.3 Provision for income taxes242.2 248.6 177.7 Equity method investment (losses) gains— (3.9)(3.7)Net income$757.1 $740.1 $555.9 Net income per common share$9.28 $8.93 $6.67 Net income per common share, assuming dilution9.21 8.83 6.61 Effective tax rate24.2 %25.0 %24.1 %Provision for Income Taxes Our effective tax rate in 2022 decreased compared to 2021 primarily due to higher benefits related to the settlement of certain foreign tax audits and the benefit from the interest portion of the Brazil indirect tax credit being adjudicated as non-taxable, partially offset by U.S. federal return-to-provision benefits that were lower than in 2021. Our effective tax rate in 2021 increased compared to 2020 primarily due to lower benefits from decreases in certain tax reserves, including interest and penalties, as a result of closing tax years, and the tax charge related to certain legal proceeding, partially offset by higher benefits from return-to-provision adjustments related to our global intangible low-taxed income ("GILTI") exclusion elections in 2021.On August 16, 2022, the U.S. government enacted the Inflation Reduction Act ("IRA"), which, among other things, implemented a 15% corporate alternative minimum tax based on the adjusted financial statement income for certain large 25Table of Contentscorporations and a 1% excise tax on net share repurchases. The minimum tax and the excise tax, if applicable, are effective for fiscal years beginning after December 31, 2022. We do not expect the IRA to have a material impact on our financial position, results of operations or cash flows. We will continue to monitor additional guidance from the Internal Revenue Service ("IRS").Our effective tax rate can vary from period to period due to the recognition of discrete events, such as changes in tax reserves, settlements of income tax audits, changes in tax laws and regulations, return-to-provision adjustments, and tax impacts related to stock-based payments, as well as recurring factors, such as changes in our mix of earnings in countries with differing statutory tax rates and our execution of tax planning strategies. Refer to Note 14, “Taxes Based on Income,” to the Consolidated Financial Statements for more information. RESULTS OF OPERATIONS BY REPORTABLE SEGMENT Operating income refers to income before taxes, interest and other non-operating expense (income), net. Materials Group(In millions)202220212020Net sales including intersegment sales$6,632.2 $6,312.3 $5,422.5 Less intersegment sales(137.1)(105.8)(81.9)Net sales$6,495.1 $6,206.5 $5,340.6 Operating income(1)859.3 883.3 747.0 (1) Included charges associated with restructuring actions and related costs in all years, gain on venture investment in 2022 and 2020, outcomes of legal proceedings and gain on sale of product line in 2021, transaction and related costs and gain on sale of assets in 2021 and 2020$(13.4)$(25.7)$30.6 Net Sales The factors impacting reported net sales change are shown in the table below. 20222021Reported net sales change5 %16 %Foreign currency translation6 (4)Extra week impact— 1 Sales change ex. currency(1)11 13 Acquisitions and product line divestitures— (1)Organic sales change(1)11 %13 %(1) Totals may not sum due to rounding. In 2022, net sales increased on an organic basis compared to the same period in the prior year due to pricing actions, partially offset by lower volume/mix. On an organic basis, net sales increased by a mid-to-high single digit rate in emerging markets, a low double-digit rate in North America and a high-teens rate in Western Europe. In 2021, net sales increased on an organic basis compared to the same period in the prior year due to favorable volume/mix and pricing actions. On an organic basis, net sales increased by a mid-teens rate in emerging markets, a low double-digit rate in North America and a mid-teens rate in Western Europe. Operating Income Operating income decreased in 2022 compared to the same period in 2021 primarily due to unfavorable volume/mix, the impact of unfavorable foreign currency translation, higher employee-related costs and the impact of a Brazil indirect tax credit in the prior year, partially offset by the net impact of higher selling prices, higher raw material costs and higher freight costs.Operating income increased in 2021 compared to 2020 compared to the same period last year primarily due to favorable volume/mix, lower restructuring charges, the Brazil indirect tax credit, favorable foreign currency translation and lower allowance for credit losses. These benefits were partially offset by the net impact of higher sales prices, higher raw material costs, and higher freight costs, as well as higher employee-related costs.26Table of ContentsSolutions Group (In millions)202220212020Net sales including intersegment sales$2,581.6 $2,239.1 $1,658.4 Less intersegment sales(37.4)(37.3)(27.5)Net sales$2,544.2 $2,201.8 $1,630.9 Operating income(1)302.3 257.2 144.7 (1) Included charges associated with restructuring actions and transaction and related costs in all years, outcomes of legal proceedings in 2022 and 2021, net gains on sales of assets in 2022 and 2020, loss on sale of asset and gain on venture investments in 2021 and loss on venture investments in 2020.$7.8 $36.6 $22.7 Net Sales The factors impacting reported net sales change are shown in the table below. 20222021Reported net sales change16 %35 %Reclassification of sales between segments(1)— Foreign currency translation4 (2)Extra week impact— 2 Sales change ex. currency(1)19 35 Acquisitions(14)(10)Organic sales change(1)5 %25 %(1) Totals may not sum due to rounding. In 2022, on an organic basis, net sales increased by a mid-teens rate in high value categories and decreased by a low-single digit rate in the base business. Company-wide, on an organic basis, sales of Intelligent Label solutions increased by a mid-teens rate.In 2021, on an organic basis, net sales in the segment related to Intelligent Labels increased over 20%. Net sales in the base business increased by a low double-digit rate, partially due to the recovery from the prior-period impact of COVID-19. Operating Income Operating income increased in 2022 compared to 2021 primarily due to the combined benefit of higher organic volume and acquisitions, the impact of legal proceedings in the prior year, and lower transaction and related costs, partially offset by higher amortization of other intangibles resulting from business acquisitions, growth investments and higher employee-related costs.Operating income increased in 2021 compared to 2020 primarily due to higher volume, including the impact of acquisitions, benefits from productivity initiatives, including savings from restructuring actions, net of transition costs, and lower restructuring charges, partially offset by higher employee-related costs, the impact of prior-year temporary cost reduction actions, growth investments, outcomes of legal proceedings and higher transaction and related costs. 27Table of ContentsFINANCIAL CONDITION Liquidity Operating Activities (In millions)202220212020Net income$757.1 $740.1 $555.9 Depreciation177.4 167.3 154.2 Amortization113.3 76.8 51.1 Provision for credit losses and sales returns50.1 35.7 64.0 Stock-based compensation47.4 37.2 24.0 Pension plan settlements and related charges— 1.6 .5 Deferred taxes and other non-cash taxes18.4 2.6 9.3 Other non-cash expense and loss (income and gain), net23.5 10.1 44.9 Trade accounts receivable(22.1)(113.2)14.7 Inventories(140.7)(182.7)(6.0)Accounts payable68.2 255.2 (68.2)Taxes on income18.9 (7.3)(35.2)Other assets15.3 4.1 18.2 Other liabilities(165.8)19.3 (76.1)Net cash provided by operating activities$961.0 $1,046.8 $751.3 In 2022, cash flow provided by operating activities decreased compared to 2021 primarily due to changes in operational working capital, higher incentive compensation payments and the timing of payroll payments, partially offset by higher net income and lower income tax payments, net of refunds. In 2021, cash flow provided by operating activities increased compared to 2020 primarily due to higher net income, changes in operational working capital and lower severance payments related to restructuring actions, partially offset by higher income tax payments, net of refunds.Investing Activities (In millions)202220212020Purchases of property, plant and equipment$(278.1)$(255.0)$(201.4)Purchases of software and other deferred charges(20.4)(17.1)(17.2)Proceeds from sales of property, plant and equipment2.3 1.1 9.2 Proceeds from insurance and sales (purchases) of investments, net1.9 3.1 5.6 Proceeds from sale of product line and venture investment1.1 7.6 — Payments for acquisitions, net of cash acquired, and venture investments(39.5)(1,477.6)(350.4)Net cash used in investing activities$(332.7)$(1,737.9)$(554.2)Purchases of Property, Plant and Equipment In 2022, we invested in buildings and equipment to support growth in certain countries in Asia, including Malaysia, China and Vietnam, and the U.S. for our Solutions Group reportable segment and in the U.S. and certain countries in Europe, primarily in France, and Latin America, primarily in Brazil, for our Materials Group reportable segment. In 2021, we invested in equipment to support growth in the U.S. and certain countries in Asia Pacific, including India and China, and Europe, including France and Luxembourg for our Materials Group reportable segment and in certain countries in Asia Pacific, including China, Malaysia, and Bangladesh, and the U.S. for our Solutions Group reportable segment. In 2020, we invested in equipment and expanded manufacturing facilities to support growth in certain countries in Asia Pacific, including Malaysia, China, Hong Kong, Bangladesh and Vietnam, and the U.S. for our Solutions Group reportable segment and in the U.S. and certain countries in Asia Pacific, including India and China, for our Materials Group reportable segment.Purchases of Software and Other Deferred Charges In 2022, 2021 and 2020, we invested in information technology upgrades worldwide.28Table of ContentsProceeds from Sales of Property, Plant and Equipment In 2022, the majority of the proceeds from sales of property, plant and equipment was related to the sale of a building in the U.S. and a building and equipment in Europe. In 2021, the majority of the proceeds from sales of property, plant and equipment was related to the sale of equipment in Asia Pacific. In 2020, the majority of the proceeds from sales of property, plant and equipment was related to the sale of a property in Europe. Proceeds from Insurance and Sales (Purchases) of Investments, Net In 2022 and 2021, we had lower proceeds from insurance associated with our company-owned life insurance policies. Proceeds from Sale of Product Line and Venture InvestmentIn 2022, we received proceeds of $1.1 million from the sale of a venture investment. In 2021, proceeds from the sale of a product line were in our Materials Group reportable segment. Payments for Acquisitions, Net of Cash Acquired, and Venture Investments In 2022, we paid purchase consideration, net of cash acquired, of approximately $30 million for the 2022 Acquisitions. We funded the 2022 Acquisitions with cash and commercial paper borrowings. In 2021, we paid purchase consideration, net of cash acquired, of approximately $1.44 billion and $32 million for the Vestcom acquisition and the Other 2021 Acquisitions, respectively. We funded the Vestcom acquisition using the net proceeds from the senior notes we issued in August 2021, commercial paper borrowings and cash. We funded the Other 2021 Acquisitions using cash and commercial paper borrowings. In 2020, we paid consideration, net of cash acquired, of approximately $255 million to acquire Smartrac’s Transponder (RFID Inlay) division (“Smartrac”), which we initially funded through commercial paper borrowings, and approximately $88 million to acquire ACPO, Ltd. We also made certain venture investments in 2022, 2021 and 2020. Refer to Note 2, “Acquisitions,” to the Consolidated Financial Statements for more information. Financing Activities (In millions)202220212020Net increase (decrease) in borrowings with maturities of three months or less$34.6 $259.2 $(110.4)Additional borrowings under revolving credit facility— — 500.0 Repayments of borrowings under revolving credit facility— — (500.0)Additional long-term borrowings— 791.7 493.7 Repayments of long-term debt and finance leases(6.3)(13.4)(270.2)Dividends paid(238.9)(220.6)(196.8)Share repurchases(379.5)(180.9)(104.3)Net (tax withholding) proceeds related to stock-based compensation(25.1)(25.4)(19.7)Other— (6.3)— Net cash (used in) provided by financing activities$(615.2)$604.3 $(207.7)Borrowings and Repayment of Debt During 2022, 2021 and 2020, our commercial paper borrowings were used to fund acquisitions, dividend payments, share repurchases, capital expenditures and other general corporate purposes. In August 2021, we issued $500 million of senior notes, due February 15, 2032, which bear an interest rate of 2.250%, payable semiannually in arrears. Our net proceeds from this issuance, after deducting underwriting discounts and offering expenses, were $493.7 million. Additionally, in August 2021, we issued $300 million of senior notes, due August 15, 2024, which we can repay without penalty on or after August 15, 2022 and bear an interest rate of 0.850%, payable semiannually in arrears. Our net proceeds from this issuance, after deducting underwriting discounts and offering expenses, were $298 million. We used the net proceeds from these two debt issuances to finance a portion of the Vestcom acquisition. During 2020, commercial paper borrowings were also used for the Smartrac acquisition, with those borrowings subsequently repaid using a portion of the net proceeds, after deducting underwriting discounts and offering expenses, of $493.7 million from the $500 million of senior notes we issued in March 2020. We used the remaining proceeds from these notes to repay the $250 million aggregate principal amount of senior notes that matured in April 2020. We also repaid $15 million of medium-term notes that matured in June 2020. In the first quarter of 2020, in light of uncertainty as a result of COVID-19 regarding the availability of commercial paper, which we typically rely upon to fund our day-to-day operational needs, and the relatively favorable terms under our 29Table of Contents$800 million revolving credit facility (the “Revolver”), we borrowed $500 million from the Revolver with a six-month duration. We repaid this amount in June 2020. Refer to Note 2, “Acquisitions,” and Note 4, “Debt,” to the Consolidated Financial Statements for more information. Dividends Paid We paid dividends per share of $2.93, $2.66 and $2.36 in 2022, 2021 and 2020, respectively. In April 2022, we increased our quarterly dividend rate to $.75 per share, representing an increase of approximately 10% from our previous quarterly dividend rate of $.68 per share. In April 2021, we increased our quarterly dividend to $.68 per share, representing an increase of approximately 10% from our previous dividend rate of $.62 per share. Share Repurchases From time to time, our Board authorizes the repurchase of shares of our outstanding common stock. Repurchased shares may be reissued under our long-term incentive plan or used for other corporate purposes. In 2022, 2021 and 2020, we repurchased approximately 2.2 million, .9 million and .8 million shares of our common stock, respectively. We temporarily paused share repurchase activity in March 2020 as a result of COVID-19 and resumed repurchases late in the third quarter of 2020. In April 2022 our Board authorized the repurchase of shares of our common stock with a fair market value of up to $750 million, excluding any fees, commissions or other expenses related to such purchases and in addition to the amount outstanding under our previous Board authorization. Board authorizations remain in effect until shares in the amount authorized thereunder have been repurchased. Shares of our common stock in the aggregate amount of $730.0 million as of December 31, 2022 remained authorized for repurchase under this Board authorization.Net (Tax Withholding) Proceeds Related to Stock-Based Compensation In 2022, tax withholding for stock-based compensation was comparable to 2021. In 2021, tax withholding for stock-based compensation increased compared to 2020 primarily as a result of equity awards vesting at higher share prices. Approximately .02 million and .05 million stock options were exercised in 2021 and 2020, respectively. Refer to Note 12, “Long-Term Incentive Compensation,” to the Consolidated Financial Statements for more information. Analysis of Selected Balance Sheet Accounts Long-lived Assets Property, plant and equipment, net, increased by approximately $63 million to $1.54 billion at year-end 2022, which primarily reflected purchases of property, plant and equipment, partially offset by depreciation expense and the impact of foreign currency translation. Goodwill decreased by approximately $19 million to $1.86 billion at year-end 2022, which reflected the impact of foreign currency translation, partially offset by the acquired goodwill associated with the 2022 Acquisitions. Other intangibles resulting from business acquisitions, net, decreased by approximately $71 million to $840 million at year-end 2022, reflecting current year amortization expense and the impact of foreign currency translation, partially offset by the valuation of intangible assets associated with the 2022 Acquisitions. Refer to Note 3, “Goodwill and Other Intangibles Resulting from Business Acquisitions,” to the Consolidated Financial Statements for more information. Shareholders’ Equity Accounts The balance of our shareholders’ equity increased by approximately $108 million to $2.03 billion at year-end 2022. Refer to Note 11, “Supplemental Equity and Comprehensive Income Information,” to the Consolidated Financial Statements for more information. Impact of Foreign Currency Translation (In millions)20222021Change in net sales$(417)$201 In 2022, international operations generated approximately 72% of our net sales. Our future results are subject to changes in political and economic conditions in the regions in which we operate and the impact of fluctuations in foreign currency exchange and interest rates. The unfavorable impact of foreign currency translation on net sales in 2022 compared to 2021 was primarily related to euro-denominated sales and sales in China. 30Table of ContentsEffect of Foreign Currency Transactions The impact on net income from transactions denominated in foreign currencies is largely mitigated because the costs of our products are generally denominated in the same currencies in which they are sold. In addition, to reduce our income and cash flow exposure to transactions in foreign currencies, we enter into foreign exchange forward, option and swap contracts where available and appropriate. Refer to Note 5, “Financial Instruments,” to the Consolidated Financial Statements for more information. Analysis of Selected Financial Ratios We utilize the financial ratios discussed below to assess our financial condition and operating performance. We believe this information assists our investors in understanding the factors impacting our cash flow other than net income and capital expenditures. Operational Working Capital Ratio Operational working capital, as a percentage of annualized current-quarter net sales, is reconciled to working capital (deficit) below. Working capital (deficit) (current assets minus current liabilities) as of the fourth quarter 2022 decreased approximately $205 million compared to the fourth quarter of 2021 primarily due to the reclassification of the $250 million of senior notes due in the second quarter of 2023, partially offset by a decrease in accrued payroll and employee benefits. Our objective is to minimize our investment in operational working capital, as a percentage of annualized current-quarter net sales, to maximize our cash flow and return on investment. Operational working capital, as a percentage of annualized current-quarter net sales, in 2022 was higher compared to 2021. Further information regarding the components of operational working capital is provided below. (In millions, except percentages)20222021(A)Working capital (deficit)$(17.8)$186.7 Reconciling items:Cash and cash equivalents(167.2)(162.7)Other current assets(230.5)(240.2)Short-term borrowings and current portion of long-term debt and finance leases598.6 318.8 Current income taxes payable and other current accrued liabilities861.9 930.3 (B)Operational working capital$1,045.0 $1,032.9 (C)Fourth-quarter net sales, annualized$8,103.6 $8,732.8 Operational working capital, as a percentage of annualized current-quarter net sales (B) ÷ (C)12.9 %11.8 %Accounts Receivable Ratio The average number of days sales outstanding was 62 days in 2022 compared to 59 days in 2021, calculated using the accounts receivable balance at year-end divided by the average daily sales in the fourth quarter of 2022 and 2021, respectively. The increase in average number of days sales outstanding was primarily due to the impact of foreign currency translation, lower volumes due to customer inventory destocking and the timing of collections. Inventory Ratio Average inventory turnover was 6.0 in 2022 compared to 7.0 in 2021, calculated using the annualized fourth-quarter cost of products sold in 2022 and 2021, respectively, and divided by the inventory balance at the respective year-end. The decrease in average inventory turnover primarily reflected increased inventory due to lower volumes from customer inventory destocking.Accounts Payable Ratio The average number of days payable outstanding was 80 days in 2022 compared to 74 days in 2021, calculated using the accounts payable balance at year-end divided by the annualized fourth-quarter cost of products sold in 2022 and 2021, respectively. The increase in the average number of days payable outstanding from the prior year primarily reflected the impact of higher accounts payable balances due to the timing of payments and the impact of foreign currency translation. Capital Resources Capital resources include cash flows from operations, cash and cash equivalents and debt financing, including access to commercial paper borrowings supported by the Revolver. We use these resources to fund our operational needs. 31Table of ContentsAt year-end 2022, we had cash and cash equivalents of $167.2 million held in accounts at third-party financial institutions. Our cash balances are held in numerous locations throughout the world. At year-end 2022, the majority of our cash and cash equivalents was held by our foreign subsidiaries, primarily in the Asia Pacific region. To meet our U.S. cash requirements, we have several cost-effective liquidity options available. These options include borrowing funds at reasonable rates, including borrowings from our foreign subsidiaries, and repatriating foreign earnings and profits. However, if we were to repatriate foreign earnings and profits, a portion would be subject to cash payments of withholding taxes imposed by foreign tax authorities. Additional U.S. taxes may also result from the impact of foreign currency fluctuations related to these earnings and profits. Subsequent to fiscal year 2022, in January 2023, we extended the maturity date of the Revolver by one year to February 13, 2026, and increased the commitments by $400 million, from $800 million to $1.2 billion. Additionally, we amended the Revolver to replace the LIBOR benchmark interest rate with Term SOFR, Euribor and SONIA benchmark interest rates. We use the Revolver as a back-up facility for our commercial paper program and for other corporate purposes. The Revolver contains a financial covenant that requires us to maintain a maximum leverage ratio (calculated as a ratio of consolidated debt to consolidated EBITDA as defined in the agreement) of not more than 3.50 to 1.00; provided that, in the event of an acquisition by us that exceeds $250 million, which occurred when we acquired Vestcom, the maximum leverage ratio increases to 4.00 to 1.00 for the fiscal quarter in which the acquisition occurs and the three fiscal quarters immediately following that fiscal quarter. As of December 31, 2022 and January 1, 2022, our ratio was substantially below the maximum ratio allowed by the Revolver.In addition to the Revolver, we have short-term lines of credit available in various countries of approximately $341 million in the aggregate at December 31, 2022. These lines may be cancelled at any time by us or the issuing banks. Short-term borrowings outstanding under these lines of credit were $2.4 million and $11.2 million at December 31, 2022 and January 1, 2022, respectively, with weighted average interest rates of 0.64% and 4.97%, respectively. Refer to Note 4, “Debt,” to the Consolidated Financial Statements for more information. We are exposed to financial market risk resulting from changes in interest and foreign currency rates, and to possible liquidity and credit risks of our counterparties. We currently anticipate using cash flows from operations, commercial paper borrowings or other potential debt financing to repay approximately $250 million of senior notes maturing in the second quarter of 2023.Capital from Debt The carrying value of our total debt decreased by approximately $3 million to $3.10 billion at year-end 2022 from 2021, primarily reflecting the revaluation of our euro-denominated senior notes, due in March 2025, partially offset by a net increase in commercial paper borrowings. Credit ratings are a significant factor in our ability to raise short- and long-term financing. The credit ratings assigned to us also impact the interest rates we pay and our access to commercial paper, credit facilities, and other borrowings. A downgrade of our short-term credit ratings could impact our ability to access commercial paper markets. If our access to commercial paper markets were to become limited, as it did in the first quarter of 2020 as a result of COVID-19 when we drew down on the Revolver, the Revolver and our other credit facilities would be available to meet our short-term funding requirements. When determining our credit rating, we believe that rating agencies primarily consider our competitive position, business outlook, consistency of cash flows, debt level and liquidity, geographic footprint and management team. We remain committed to maintaining an investment grade rating. Fair Value of Debt The estimated fair value of our long-term debt is primarily based on the credit spread above U.S. Treasury securities or euro government bond securities, as applicable, on notes with similar rates, credit ratings and remaining maturities. The fair value of short-term borrowings, which includes commercial paper issuances and short-term lines of credit, approximates their carrying value given their short duration. The fair value of our total debt was $2.85 billion at December 31, 2022 and $3.25 billion at January 1, 2022. Fair value amounts were determined based primarily on Level 2 inputs, which are inputs other than quoted prices in active markets that are either directly or indirectly observable. Refer to Note 1, “Summary of Significant Accounting Policies,” for more information. Contractual Obligations, Commitments and Off-Balance Sheet Arrangements Material Cash Requirements at End of Year 2022 We have short- and long-term material cash requirements related to our contractual obligations that arise in the normal course of business. In addition to principal and interest payments on our outstanding debt obligations, our contractual obligations primarily consist of lease payments and purchase commitments.Refer to Note 4, "Debt," to the Consolidated Financial Statements for a summary of our principal payments for short-term borrowings and long-term debt obligations as of December 31, 2022. Interest payments for long-term debt as of 32Table of ContentsDecember 31, 2022 were approximately $70 million in 2023; $66 million in 2024; $63 million in 2025; $55 million in 2026; $55 million in 2027; and $150 million from 2028 through maturity. As of December 31, 2022, we have two commitments to purchase approximately $290 million of raw materials in fiscal year 2023. Refer to Note 7, "Commitments and Leases," to the Consolidated Financial Statements for a summary of our lease obligations as of December 31, 2022.Refer to Note 6, “Pension and Other Postretirement Benefits,” to the Consolidated Financial Statements for information regarding our defined benefit pension plan contributions and future benefit payments, deferred compensation plan benefit payments and unfunded termination indemnity benefits.Refer to Note 12, “Long-term Incentive Compensation,” to the Consolidated Financial Statements for information regarding cash-based awards to employees under our long-term incentive compensation plan.Refer to Note 14, “Taxes Based on Income,” to the Consolidated Financial Statements for more information regarding our unrecognized tax benefits of approximately $70 million.CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions for the reporting period and as of the financial statement date. These estimates and assumptions affect our reported amounts of assets and liabilities, disclosure of contingent liabilities and reported amounts of revenue and expense. Actual results could differ from these estimates. Critical accounting estimates are those that are important to our financial condition and results, and which require us to make difficult, subjective and/or complex judgments. Critical accounting estimates cover accounting matters that are inherently uncertain because their future resolution is unknown. We believe our critical accounting estimates include accounting for goodwill, business combinations, pension and postretirement benefits, taxes based on income and long-term incentive compensation. Goodwill Business combinations are accounted for using the acquisition method, with the excess of the acquisition cost over the fair value of net tangible assets and identified intangible assets acquired considered goodwill. As a result, we disclose goodwill separately from other intangible assets. Our reporting units are composed of either a discrete business or an aggregation of businesses with similar economic characteristics. We perform an annual impairment test of goodwill during the fourth quarter. Certain factors may cause us to perform an impairment test prior to the fourth quarter, including significant underperformance of a business relative to expected operating results, significant adverse economic and industry trends, significant decline in our market capitalization for an extended period of time relative to net book value, or a decision to divest a portion of a reporting unit. In performing impairment tests, we have the option to first assess qualitative factors to determine whether it is necessary to perform a quantitative assessment for goodwill impairment. If the qualitative assessment indicates that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying value, we perform a quantitative assessment. A quantitative assessment primarily consists of using the present value (discounted cash flow) method to determine the fair value of reporting units with goodwill. We compare the fair value of each reporting unit to its carrying amount, and, to the extent the carrying amount exceeds the unit’s fair value, we recognize an impairment of goodwill for the excess up to the amount of goodwill of that reporting unit. In consultation with outside specialists, we estimate the fair value of our reporting units using various valuation techniques, with the primary technique being a discounted cash flow analysis. A discounted cash flow analysis requires us to make various assumptions about our reporting units, including their respective forecasted sales, operating margins and growth rates, as well as discount rates. Our assumptions about discount rates are based on the weighted average cost of capital for comparable companies. Our assumptions about sales, operating margins and growth rates are based on our forecasts, business plans, economic projections, anticipated future cash flows, and marketplace data. We also make assumptions for varying perpetual growth rates for periods beyond the long-term business plan period. We base our fair value estimates on projected financial information and assumptions that we believe are reasonable. However, actual future results may differ materially from these estimates and projections. The valuation methodology we use to estimate the fair value of reporting units requires inputs and assumptions that reflect current market conditions, as well as the impact of planned business and operational strategies that require management judgment. The estimated fair value could increase or decrease depending on changes in the inputs and assumptions. In our annual impairment analysis in the fourth quarter of 2022, the goodwill of all reporting units in our Materials Group and Solutions Group reportable segments were tested utilizing a qualitative assessment. Based on this assessment, we determined that the fair values of these reporting units were more-likely-than-not greater than their respective carrying values. Therefore, the goodwill of our reporting units was not impaired. 33Table of ContentsBusiness CombinationsThe results of acquired businesses are included in our Consolidated Financial Statements from their acquisition date. Assets and liabilities of an acquired business are recorded at their estimated fair values on the acquisition date. We engage third-party valuation specialists to assist us in determining these fair values where necessary. Any excess consideration over the fair value of assets acquired and liabilities assumed is recognized as goodwill. The allocation of purchase price requires management to make significant estimates and assumptions. While we believe our assumptions and estimates are reasonable, they are inherently uncertain and based in part on our experience, market conditions, our projections of future performance and information obtained from management of the acquired companies. Critical estimates include, but are not limited to, the following: •Future revenue and profit margins; •Royalty rates; •Discount rates; •Customer retention rates; •Technology migration curves; and •Useful lives assigned to acquired intangible assets. Acquired identifiable finite-lived intangible assets are amortized on a straight-line basis over their respective estimated useful lives to marketing, general and administrative expense. Pension and Postretirement Benefits The assumptions we use in determining projected benefit obligations and the fair value of plan assets for our defined benefit pension plans and other postretirement benefit plans are evaluated by management in consultation with outside actuaries. In the event that we determine that changes are warranted in the assumptions we use, such as the discount rate, expected long-term rate of return or health care costs, future pension and postretirement benefit expenses could increase or decrease. Due to changes in market conditions or participant population, the actuarial assumptions we use may differ from actual results, which could have a significant impact on our pension and postretirement liability and related costs. Discount Rate In consultation with our actuaries, we annually review and determine the discount rates we use in valuing our postretirement obligations. The assumed discount rates for our international pension plans reflect market rates for high quality corporate bonds currently available. Our discount rates are determined by evaluating yield curves consisting of large populations of high quality corporate bonds. The projected pension benefit payment streams are then matched with the bond portfolios to determine a rate that reflects the liability duration unique to our pension and postretirement benefit plans. As of December 31, 2022, a .25% increase in the discount rates associated with our international plans would have decreased our year-end projected benefit obligation by $24 million and decreased expected periodic benefit cost for the coming year by approximately $1 million. Conversely, a .25% decrease in the discount rates associated with our international plans would have increased our year-end projected benefit obligation by approximately $24 million and increased expected periodic benefit cost for the coming year by approximately $1 million. We use the full yield curve approach to estimate the service and interest cost components of net periodic benefit cost for our pension and other postretirement benefit plans. Using this approach, we apply multiple discount rates from a yield curve composed of the rates of return on several hundred high-quality, fixed income corporate bonds available at the measurement date. We believe this approach provides a more precise measurement of service and interest cost by aligning the timing of these plans’ liability cash flows to the corresponding rates on the yield curve. Long-term Return on Plan Assets We determine the long-term rate of return assumption for plan assets by reviewing the historical and expected returns of both the equity and fixed income markets, taking into account our asset allocation, the correlation between returns in our asset classes, and our mix of active and passive investments. Additionally, current market conditions, including interest rates, are evaluated and market data is reviewed for reasonableness and appropriateness. An increase or decrease of .25% on the long-term return on assets associated with our international plans would have decreased or increased our periodic benefit cost for the coming year by approximately $2 million. Taxes Based on Income Because we are subject to income tax in the U.S. and multiple foreign jurisdictions, judgment is required in evaluating and estimating our worldwide provision, accruals for taxes, deferred taxes and tax positions. Our provision for income taxes is determined using the asset and liability approach in accordance with GAAP. Deferred tax assets represent amounts available to reduce income taxes payable in future years. These assets arise because of temporary differences between the 34Table of Contentsfinancial reporting and tax bases of assets and liabilities, as well as from net operating losses and tax credit carryforwards. These amounts are adjusted, as appropriate, to reflect changes in tax rates expected to be in effect when the temporary differences reverse. We evaluate the realizability of these future tax deductions and credits by assessing the period over which recoverability is allowed by law and the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. Our assessment of these sources of income relies heavily on estimates. Our forecasted earnings by jurisdiction are determined by how we operate our business and any changes to our operations may affect our effective tax rate. For example, our future income tax rate could be adversely affected by earnings being lower than anticipated in jurisdictions in which we have significant deferred tax assets that are dependent on such earnings to be realized. We use our historical experience and operating forecasts to evaluate expected future taxable income. To the extent we do not consider it more-likely-than-not that a deferred tax asset will be recovered, a valuation allowance is established in the period we make that determination. We calculate our current and deferred tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed in subsequent years. Adjustments based on filed returns are recorded when identified. Tax laws and regulations are complex and subject to different interpretations by taxpayers and governmental taxing authorities. We review our tax positions quarterly and adjust the balances if and as new information becomes available. Significant judgment is required in determining our tax expense and evaluating our tax positions, including evaluating uncertainties. Our estimate of the potential outcome of any uncertain tax issue is subject to our assessment of relevant facts and circumstances existing at the balance sheet date, taking into consideration existing laws, regulations and practices of the governmental authorities exercising jurisdiction over our operations. We recognize and measure our uncertain tax positions following the more-likely-than-not threshold for recognition and measurement for tax positions we take or expect to take on a tax return.Refer to Note 14, “Taxes Based on Income,” to the Consolidated Financial Statements for more information. Long-Term Incentive Compensation Valuation of Stock-Based Awards We base our stock-based compensation expense on the fair value of awards, adjusted for estimated forfeitures, amortized on a straight-line basis over the requisite service period for stock options and restricted stock units (“RSUs”). We base compensation expense for performance units (“PUs”) on the fair value of awards, adjusted for estimated forfeitures, and amortized on a straight-line basis as these awards cliff-vest at the end of the requisite service period. We base compensation expense related to market-leveraged stock units (“MSUs”) on the fair value of awards, adjusted for estimated forfeitures, and amortized on a graded-vesting basis over their respective performance periods. Compensation expense for awards with a market condition as a performance objective, which includes PUs and MSUs, is not adjusted if the condition is not met, as long as the requisite service period is met. We determine the fair value of RSUs and the component of PUs that is subject to the achievement of a performance objective based on a financial performance condition based on the fair market value of our common stock as of the date of the grant, adjusted for foregone dividends. Over the performance period of the PUs, the estimated number of shares of our common stock issuable upon vesting is adjusted upward or downward based on the probability of achieving the performance objectives established for the award. We determine the fair value of stock-based awards that are subject to achievement of performance objectives based on a market condition, which includes MSUs and the other component of PUs, using the Monte-Carlo simulation model, which utilizes multiple input variables, including expected stock price volatility and other assumptions appropriate for determining fair value, to estimate the probability of satisfying the respective target performance objectives established for the award. Forfeiture Rate Changes in estimated forfeiture rates are recorded as cumulative adjustments in the period estimates are revised. Certain of our assumptions are based on management’s estimates, in consultation with outside specialists. Significant changes in assumptions for future awards and actual forfeiture rates could materially impact our stock-based compensation expense and results of operations. Valuation of Cash-Based Awards Cash-based awards consist of long-term incentive units (“LTI Units”) granted to eligible employees. LTI Units are classified as liability awards and remeasured at each quarter-end over the applicable vesting or performance period. In addition to LTI Units with terms and conditions that mirror those of RSUs, we also grant certain employees LTI Units with terms and conditions that mirror those of PUs and MSUs. 35Table of ContentsRECENT ACCOUNTING REQUIREMENTS Refer to Note 1, “Summary of Significant Accounting Policies,” to the Consolidated Financial Statements for this information. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Risk Management We are exposed to the impact of changes in foreign currency exchange rates and interest rates. We generally do not purchase or hold foreign currency or interest rate or commodity contracts for trading purposes. Our objective in managing our exposure to foreign currency changes is to reduce the risk to our earnings and cash flow associated with foreign exchange rate changes. As a result, we enter into foreign exchange forward, option and swap contracts to reduce risks associated with the value of our existing foreign currency assets, liabilities, firm commitments and anticipated foreign revenues and costs, when available and appropriate. The gains and losses on these contracts are intended to offset changes in the related exposures. We do not hedge our foreign currency translation exposure in a manner that would entirely eliminate the effects of changes in foreign exchange rates on our net income. Our objective in managing our exposure to interest rate changes is to reduce the impact of interest rate changes on earnings and cash flows. To achieve this objective, we may periodically use interest rate contracts to manage our exposure to interest rate changes. Additionally, we enter into certain natural gas futures contracts to reduce the risks associated with natural gas we anticipate using in our manufacturing operations. These amounts are not material to our financial statements. In the normal course of operations, we also face other risks that are either non-financial or non-quantifiable. These risks principally include changes in economic or political conditions, other risks associated with foreign operations, commodity price risk, and litigation and compliance risk, which are not reflected in the analyses described below. Foreign Exchange Value-At-RiskWe use a Value-At-Risk (“VAR”) model to determine the estimated maximum potential one-day loss in earnings associated with our foreign exchange positions and contracts. This approach assumes that market rates or prices for foreign exchange positions and contracts are normally distributed. VAR model estimates are made assuming normal market conditions. The model includes foreign exchange derivative contracts. Forecasted transactions, firm commitments, accounts receivable and accounts payable denominated in foreign currencies, which certain of these instruments are intended to hedge, are excluded from the model. The VAR model is a risk analysis tool and does not represent actual losses in fair value that we could incur, nor does it consider the potential effect of favorable changes in market factors. In both 2022 and 2021, the VAR was estimated using a variance-covariance methodology. The currency correlation was based on one-year historical data obtained from one of our domestic banks. A 95% confidence level was used for a one-day time horizon. The estimated maximum potential one-day loss in earnings for our foreign exchange positions and contracts was not significant at year-end 2022 or 2021. Interest Rate Sensitivity In 2022 and 2021, an assumed 12 and 9 basis point, respectively, increase in interest rates affecting our variable-rate borrowings (10% of our weighted average interest rate on floating rate debt) would not have had a significant impact on interest expense. 36Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and in Note 3 to the consolidated financial statements within Item 8 of this Annual Report on Form 10-K (annual report).​Beverage Packaging, North and Central America, Segment ​Beverage packaging, North and Central America, is Ball’s largest segment, accounting for 44 percent of consolidated net sales in 2022. Aluminum beverage containers are primarily sold under multi-year supply contracts to fillers of carbonated soft drinks, beer, energy drinks and other beverages.​Aluminum beverage containers and ends are produced at 18 manufacturing facilities in the U.S., one in Canada and two in Mexico. The beverage packaging, North and Central America, segment also includes interests in three investments that are accounted for using the equity method. In the third quarter of 2022, Ball announced the permanent closure of its aluminum beverage can manufacturing facilities in Phoenix, Arizona, and St. Paul, Minnesota. The Phoenix facility ceased production in the fourth quarter of 2022, and the St. Paul facility ceased production in the first quarter of 2023. ​8 Table of ContentsAccording to publicly available information and company estimates, the North American beverage container industry represents approximately 140 billion units. Five companies manufacture substantially all of the aluminum beverage containers in the U.S., Canada and Mexico. Ball shipped approximately 52 billion aluminum beverage containers in North and Central America in 2022, which represented approximately 37 percent of the aggregate shipments in these countries. Historically, sales volumes of metal beverage containers in North America tend to be highest during the period from April through September. All of the beverage containers produced by Ball in the U.S., Canada and Mexico are made of aluminum. In North and Central America, a diverse base of no fewer than ten global suppliers provide almost all of our aluminum can and end sheet requirements.​Beverage containers are sold based on price, quality, service, innovation and sustainability in a highly competitive market, which is relatively capital intensive and characterized by facilities that run more or less continuously in order to operate profitably. In addition, the aluminum beverage container competes aggressively with other packaging materials which include meaningful industry positions by the glass bottle in the packaged beer industry and the polyethylene terephthalate (PET) bottle in the carbonated soft drink and water industries.​We limit our exposure to changes in the cost of aluminum as a result of the inclusion of provisions in most of our aluminum beverage container sales contracts to pass through aluminum price changes, as well as through the use of derivative instruments.​Beverage Packaging, EMEA, Segment​The beverage packaging, EMEA, segment accounted for 25 percent of Ball’s consolidated net sales in 2022. Our EMEA region operations include 17 facilities throughout Europe and one facility each in Cairo, Egypt, and Manisa, Turkey. In the third quarter of 2022, Ball completed the sale of its aluminum beverage packaging business located in Russia, which included three aluminum beverage can manufacturing facilities. For the countries in which we currently operate, not including Russia, the beverage container market is approximately 90 billion containers, and we are the largest producer with an estimated 39 percent of shipments in this region. The regions served by our beverage packaging, EMEA, segment, including Egypt and Turkey, are highly regional in terms of sales growth rates and packaging mix. Four companies manufacture substantially all of the metal beverage containers in EMEA. Our EMEA beverage facilities, not including Russia, shipped 35 billion beverage containers in 2022, all of which were made from aluminum. The company has announced plans to construct additional plants in Pilsen, Czech Republic, and Northamptonshire, U.K. Both facilities are expected to begin production in the first half of 2023. ​Historically, sales volumes of metal beverage containers in EMEA tend to be highest during the period from May through August, with a smaller increase in demand leading up to the winter holiday season in the U.K. Much like in other parts of the world, the aluminum beverage container competes aggressively with other packaging materials used by the beer and carbonated soft drink industries. The glass bottle is heavily utilized in the packaged beer industry, while the PET container is utilized in the carbonated soft drink, beer, juice and water industries. These trends are evolving, however, as customers, regulators and non-governmental organizations continue to press for more sustainable packaging in the wake of the global pollution crisis. More and more brands are choosing aluminum beverage packaging because of its infinite recyclability and other sustainability credentials. Using a new calculation implemented by the European Union (EU) in 2022, the overall recycling rate for aluminum beverage cans in the EU, Switzerland, Norway and Iceland was approximately 73 percent in 2020. ​Raw material supply contracts in this region generally have longer term agreements. Six aluminum suppliers provide almost all of our aluminum can and end sheet requirements. The company minimizes its exchange rate risk using derivative and supply contracts in local currencies. We limit our exposure to changes in the cost of aluminum as a result of the inclusion of provisions in our aluminum beverage container sales contracts to pass through aluminum price changes, as well as through the use of derivative instruments.​9 Table of ContentsBeverage Packaging, South America, Segment​The beverage packaging, South America, segment accounted for 14 percent of Ball’s consolidated net sales in 2022. Our operations consist of 12 facilities—9 in Brazil and one each in Argentina, Chile and Paraguay. In the third quarter, Ball permanently ceased operations at its aluminum beverage can manufacturing facility in Santa Cruz, Brazil, and temporarily reduced production across its remaining Brazilian beverage can manufacturing footprint. For the countries where we operate, the South American beverage container market is approximately 40 billion containers, and we are the largest producer in this region with an estimated 46 percent of South American shipments in 2022. Four companies currently manufacture substantially all of the aluminum beverage containers in Brazil. ​The company’s South American beverage facilities shipped approximately 19 billion aluminum beverage containers in 2022. Historically, sales volumes of beverage containers in South America tend to be highest during the period from September through December. In South America, two suppliers provide virtually all our aluminum can and end sheet requirements with certain requirements also being imported from Asia.​We limit our exposure to changes in the cost of aluminum as a result of the inclusion of provisions in our aluminum beverage container sales contracts to pass through aluminum price changes, as well as through the use of derivative instruments.​Aerospace Segment ​Ball’s aerospace segment, which accounted for 13 percent of consolidated net sales in 2022, includes national defense hardware, antenna and video tactical solutions, civil and operational space hardware and systems engineering services. The segment develops spacecraft, sensors and instruments, radio frequency systems and other advanced technologies for the civil, commercial and national security aerospace markets. The majority of the aerospace business involves work under contracts, generally from one to five years in duration, as a prime contractor or subcontractor for the U.S. Department of Defense (DoD), the National Aeronautics and Space Administration (NASA) and other U.S. government agencies. The company competes against both large and small prime contractors and subcontractors for these contracts. Contracts funded by the various agencies of the federal government represented 98 percent of segment sales in 2022.​Intense competition and long operating cycles are key characteristics of both the company’s business and the aerospace and defense industry. It is common in the aerospace and defense industry for work on major programs to be shared among a number of companies. A company competing to be a prime contractor may, upon ultimate award of the contract to a competitor, become a subcontractor for the ultimate prime contracting company. It is not unusual to compete for a contract award with a peer company and, simultaneously, perform as a supplier to or a customer of that same competitor on other contracts, or vice versa.​Geopolitical events and shifting executive and legislative branch priorities have resulted in an increase in opportunities over the past decade in areas matching our aerospace segment’s core capabilities in space hardware. The businesses include hardware and services sold primarily to U.S. customers, with emphasis on space science and exploration, climate monitoring, weather prediction, environmental and earth sciences, and defense and intelligence applications. Major activities frequently involve the design, manufacture and testing of satellites, remote sensors and ground station control hardware and software, as well as related services such as launch vehicle integration and satellite operations. ​Other hardware activities include target identification, warning and attitude control systems and components; cryogenic systems for reactant storage, and associated sensor cooling devices; star trackers, which are general-purpose stellar attitude sensors; and fast-steering mirrors. ​10 Table of ContentsBacklog represents the estimated transaction prices on performance obligations to our customers for which work remains to be performed. Backlog in the aerospace segment was $2.97 billion and $2.47 billion at December 31, 2022 and 2021, respectively, and consisted of the aggregate contract value of firm orders, excluding amounts previously recognized as revenue. The 2022 backlog includes $1.52 billion expected to be recognized in revenues during 2023, with the remainder expected to be recognized in revenues in the years thereafter. Amounts included in backlog for certain firm government orders, which are subject to annual funding, were $1.61 billion and $1.05 billion at December 31, 2022 and 2021, respectively. Year-over-year comparisons of backlog are not necessarily indicative of the trend of future operations, revenues and earnings due to the nature of varying delivery and milestone schedules on contracts, funding of programs and the uncertainty of timing of future contract awards. Uncertainties in the federal government budgeting process could delay the funding, or even result in cancellation of certain programs currently in our reported backlog.​Other​Other consists of a non-reportable operating segment (beverage packaging, other) that manufactures and sells aluminum beverage containers in India, Saudi Arabia and Myanmar; a non-reportable operating segment that manufactures and sells extruded aluminum aerosol containers, recloseable aluminum bottles across multiple consumer categories and slugs (aerosol packaging); a non-reportable operating segment that manufactures and sells aluminum cups (aluminum cups); undistributed corporate expenses; intercompany eliminations and other business activities.​Beverage Packaging, Other​Our aluminum beverage packaging operations in the beverage packaging, other, segment consist of four facilities – two in India and one each in Saudi Arabia and Myanmar. Our aluminum can and end sheet requirements are provided by several suppliers. Our manufacturing facility in Saudi Arabia, Ball United Arab Can Manufacturing Company, is an investment 51 percent owned by Ball and consolidated in our results. Additionally, Ball has ownership interests in an equity method investment in Vietnam. During 2021, Ball sold its minority-owned investment in South Korea. For additional details, refer to Note 4 to the consolidated financial statements within Item 8 of this annual report​Aerosol Packaging​Our aluminum aerosol packaging operations manufacture and sell extruded aluminum aerosol containers, recloseable aluminum bottles across multiple consumer categories and aluminum slugs, which represented less than 5 percent of Ball’s consolidated net sales in 2022. There are 9 manufacturing facilities that manufacture these products – four in Europe and one each in the U.S., Canada, Brazil, Mexico and India. The aerosol packaging market in these countries shipped approximately 6.6 billion aluminum aerosol units in 2022 and we are one of the major producers in this combined area with shipments of 1.4 billion aluminum aerosol packaging containers, representing approximately 21 percent of total shipments in these markets. Our aluminum aerosol requirements are provided by several suppliers. In 2021, our aerosol business operations launched a new extruded, recloseable aluminum bottle line to provide a circular solution to plastic bottle pollution in personal care and other product categories.​Aluminum Cups​The Ball aluminum cups business serves the growing demand for innovative, sustainable beverage packaging among customers and consumers. Aligned with our Drive for 10 vision, the aluminum cups business leverages our years of experience and specialized expertise to provide another environmentally friendly offering to our industry-leading portfolio of aluminum packages. Sturdy, durable and cool to the touch, the infinitely recyclable Ball aluminum cup is produced at a dedicated manufacturing facility in Rome, Georgia. Ball plans to introduce additional offerings to round out its cups portfolio and intends to expand adoption of the cups to drinking establishments, parks and recreation, colleges and universities, hospitality, restaurants, retail, business and industry. ​Patents​In the opinion of the company’s management, none of our active patents or groups of patents is material to the successful operation of our business as a whole. We manage our intellectual property portfolio to obtain the durations necessary to achieve our business objectives.​11 Table of ContentsResearch and Development​Research and development (R&D) efforts in our packaging segments are primarily directed toward packaging innovation, specifically the development of new features, sizes, shapes and types of containers, as well as new uses for existing containers. Other R&D efforts in these segments seek to improve manufacturing efficiencies and the overall sustainability of our products. Our packaging R&D activities are primarily conducted in a technical center located in Westminster, Colorado.​In our aerospace business, we continue to focus our R&D activities on the design, development and manufacture of innovative aerospace products and systems. This includes the production of spacecraft, instruments and sensors, radio frequency and system components, data exploitation solutions and a variety of advanced aerospace technologies and products that enable deep space missions. Our aerospace R&D activities are conducted at various locations in the U.S.​Additional information regarding company R&D activity is contained in Note 1 to the consolidated financial statements within Item 8 of this annual report, as well as in Item 2, Properties.​Where to Find More Information​Ball Corporation is subject to the reporting and other information requirements of the Securities Exchange Act of 1934, as amended (Exchange Act). Reports and other information filed with the Securities and Exchange Commission (SEC) pursuant to the Exchange Act may be inspected and copied at the public reference facility maintained by the SEC in Washington, D.C. The SEC maintains a website at www.sec.gov containing our reports, proxy materials and other items. The company also maintains a website at www.ball.com/investors on which it provides a link to access Ball’s SEC reports free of charge, under the link “Financials.”​The company has established written Ball Corporation Corporate Governance Guidelines; a Ball Corporation Executive Officers and Board of Directors Business Ethics Statement; a Business Ethics Code of Conduct; and charters for its Audit Committee, Nominating/Corporate Governance Committee, Human Resources Committee and Finance Committee. These documents are available on the company’s website at www.ball.com/investors, under the link “Corporate Governance.” A copy may also be obtained upon request from the company’s corporate secretary. The company’s combined report and updates on Ball’s sustainability progress are available at www.ball.com/sustainability.​The company intends to post on its website the nature of any amendments to the company’s codes of ethics that apply to executive officers and directors, including the chief executive officer, chief financial officer and controller, and the nature of any waiver or implied waiver from any code of ethics granted by the company to any executive officer or director. These postings will appear on the company’s website at www.ball.com/investors, under the link “Corporate Governance.”​Nothing on our website, including postings to the “Corporate Governance” and “Financials” pages, or the Ball Corporation Sustainability Report, or sections thereof, shall be deemed incorporated by reference into this annual report. ​Item 1A. Risk Factors ​Any of the following risks could materially and adversely affect our business, results of operations, cash flows and financial condition.​12 Table of ContentsGeneral Risks​If we do not effectively manage change and growth, our business could be adversely affected.​Our future revenue and operating results will depend on our ability to effectively manage the anticipated growth of our business. We have experienced fluctuations in the growth in demand for our products and services in recent years and are rebalancing our operations, managing our headcount and developing new and innovative product offerings to balance our supply positions with our customers’ requirements in each region. These circumstances have placed significant demands on our management as well as our financial and operational resources, and present several challenges, including:​●rebalancing manufacturing capacity, maintaining quality and optimizing production;●identifying, attracting and retaining qualified personnel;●developing and retaining our global sales, marketing and administrative infrastructure and capabilities;●increasing our regulatory compliance capabilities, particularly in new lines of business;●optimizing our expertise in a number of disciplines, including marketing, licensing, and merchandising; and●implementing appropriate operational, financial and IT systems and internal controls.​Our business, operating results and financial condition are subject to particular risks in certain regions of the world.​We may experience an operating loss in one or more regions of the world for one or more periods, which could have a material adverse effect on our business, operating results or financial condition. Moreover, overcapacity, which often leads to lower prices, may develop over time in certain regions in which we operate even if demand continues to grow. More generally, supply and demand fluctuations could make it difficult for us to forecast and meet certain customers’ needs. Our ability to manage such operational fluctuations and to maintain adequate long-term strategies in the face of such developments will be critical to our continued growth and profitability. ​The loss of a key customer, or a reduction in its requirements, could have a significant negative impact on our sales.​We sell a majority of our packaging products to a relatively limited number of major beverage, personal care and household product companies, some of which operate in multiple geographical markets we serve.​Although the majority of our customer contracts are long-term, these contracts, unless they are renewed, expire in accordance with their respective terms and are terminable under certain circumstances, such as our failure to meet quality, volume or market pricing requirements. Because we depend on a relatively limited number of major customers, our business, financial condition or results of operations could be adversely affected by the loss of any of these customers, a reduction in the purchasing levels of these customers, a strike or work stoppage by a significant number of these customers’ employees or an adverse change in the terms of the supply agreements with these customers.​The primary customers for our aerospace segment are U.S. government agencies or their prime contractors. Our contracts with these customers are subject to several risks, including funding cuts and delays, technical uncertainties, budget changes, government shutdowns, competitive activity and changes in scope.13 Table of Contents​We have a significant level of debt that could have important consequences for our business and any investment in our securities.​The company had $9.00 billion of interest-bearing debt at December 31, 2022. Such indebtedness could have significant consequences for our business and any investment in our securities, including:​●increasing our vulnerability to adverse economic, industry or competitive developments;●requiring more of our cash flows from operations to be dedicated to the payment of principal and interest on our indebtedness, thus limiting our cash flow available to fund our operations, capital expenditures and future business opportunities or the return of cash to our shareholders;●restricting us from making additional acquisitions;●limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes; and●limiting our flexibility in planning for, or reacting to, changes in our business or market conditions and placing us at a competitive disadvantage compared to our competitors who may be less leveraged and who, therefore, may be able to take advantage of opportunities that our leverage prevents us from exploiting.​We face competitive risks from many sources that may negatively impact our profitability.​Competition within the packaging and aerospace industries is intense. Increases in productivity, combined with potential surplus capacity in the industry, have maintained competitive pricing pressures. The principal methods of competition in the general packaging industry are price, innovation, sustainability, service and quality. In the aerospace industry, they are technical capability, cost and schedule. Some of our competitors may have greater financial, technical and marketing resources, and some may currently have excess capacity. Our current or potential competitors may offer products at a lower price or products that are deemed superior to ours. The global economic environment has resulted in reductions in demand for our products in some instances, which, in turn, could increase these competitive pressures.​We are subject to competition from alternative products, which could result in lower profits and reduced cash flows.​Our aluminum packaging products are subject to significant competition from substitute products, particularly plastic carbonated soft drink bottles made from PET, single serve and returnable beer bottles and other beverage containers made of glass, cardboard or other materials. Competition from plastic carbonated soft drink bottles is particularly intense in the U.S. and Europe, and competition from glass beer bottles has recently increased in Brazil. Certain of our aerospace products are also subject to competition from alternative products and solutions. There can be no assurance that our products will successfully compete against alternative products, which could result in a reduction in our profits or cash flows.​Our packaging businesses have a narrow product range, and our business would suffer if usage of our products decreased or if decreases occur in the demand for the beverages and other goods filled in our products.​The majority of our consolidated net sales were from the sale of beverage containers, and we expect to derive a significant portion of our future revenues and cash flows from the sale of beverage containers. Our business would suffer if the use of beverage containers decreased. Accordingly, broad acceptance by consumers of aluminum containers for a wide variety of beverages is critical to our future success. If demand for glass and PET bottles increases relative to aluminum containers, or the demand for aluminum containers does not develop as expected, our business, results of operations, cash flows and financial condition could be materially adversely affected.​14 Table of ContentsOur business, financial condition, cash flows and results of operations are subject to risks resulting from broader geographic operations.​We derived approximately 45 percent of our consolidated net sales from outside of the U.S. for the year ended December 31, 2022. The sizeable scope of operations inside and outside of the U.S. may lead to more volatile financial results and make it more difficult for us to manage our business. Reasons for this include, but are not limited to, the following:​●political and economic instability;●governments’ restrictive trade policies;●the imposition or rescission of duties, taxes or government royalties;●exchange rate risks;●inflation of direct input costs;●virus and disease outbreaks and responses thereto;●difficulties in enforcement of contractual obligations and intellectual property rights; and●the geographic, language and cultural differences between personnel in different areas of the world.​We are exposed to exchange rate fluctuations.​The company’s financial results are exposed to currency exchange rate fluctuations and a significant proportion of assets, liabilities and earnings denominated in non-U.S. dollar currencies. The company presents its financial statements in U.S. dollars and has a significant proportion of its net assets, debt and income in non-U.S. dollar currencies, primarily the euro, as well as the currencies of Argentina, Egypt, Turkey and other emerging markets. The company’s financial results and capital ratios are therefore sensitive to movements in currency exchange rates. ​We manage our exposure to currency fluctuations, particularly our exposure to fluctuations in the euro to U.S. dollar exchange rate to attempt to mitigate the effect of cash flow and earnings volatility associated with exchange rate changes. We primarily use derivative instruments to manage our currency exposures and, as a result, we experience gains and losses on these derivative positions which are offset, in part, by the impact of currency fluctuations on existing assets and liabilities. ​We are vulnerable to fluctuations and disruptions in the supply and price of raw materials.​We purchase aluminum and other raw materials and packaging supplies, including dunnage, from several sources. While all such materials and supplies are available from independent suppliers, they are subject to fluctuations in price and availability attributable to a number of factors, including general economic conditions, commodity price fluctuations (particularly aluminum on the London Metal Exchange), the demand by other industries for the same raw materials and the availability of complementary and substitute materials. Although we enter into commodities purchase agreements from time to time and sometimes use derivative instruments to seek to manage our risk, we cannot ensure that our current suppliers of raw materials will be able to supply us with sufficient quantities at reasonable prices. Economic, financial, and operational factors, including strikes or labor shortages, as well as governmental action, could impact our suppliers, thereby causing supply shortages. Increases in raw material costs, including potential increases due to tariffs, sanctions, or other trade actions, could have a material adverse effect on our business, financial condition or results of operations. Global supply chain disruptions can negatively impact our results. In the Americas, Europe and Asia, some contracts do not allow us to pass along increased raw material costs and we generally use derivative agreements to seek to manage this risk. Our hedging procedures may be insufficient and our results could be materially impacted if costs of materials increase. Due to the fixed-price contracts, increased prices could decrease our sales volume over time. The delayed timing in recovering the pass-through of increasing raw material costs may also impact our short-term profitability and certain costs due to price increases or supply chain inefficiencies may be unrecoverable, which would also impact our profitability. In addition, in view of recent increases in our raw material and other production costs, we initiated a comprehensive cost pass-through program across all our businesses beginning in the second half of 2021, which is ongoing, to seek to recover from our customers the full amount of those cost increases over time.15 Table of ContentsWe use estimates in accounting for many of our programs in our aerospace business, and changes in our estimates could adversely affect our future financial results.​We account for sales and profits on a portion of long-term contracts in our aerospace business in accordance with the percentage-of-completion method of accounting, using the cost-to-cost method to account for updates in estimates. The percentage-of-completion method of accounting involves the use of various estimating techniques to project revenues and costs at completion and various assumptions and projections related to the outcome of future events, including the quantity and timing of product deliveries, future labor performance and rates, and material and overhead costs. These assumptions involve various levels of expected performance improvements. Under the cost-to-cost method, the impact of updates in our estimates related to units shipped to date or progress made to date is recognized immediately. Given the significance of the judgments and estimates described above, it is likely that we could record materially different amounts if we used different assumptions or if the underlying circumstances or estimates were to change. ​Our backlog includes both cost-type and fixed-price contracts. Cost-type contracts generally have lower profit margins than fixed-price contracts. Our earnings and margins may vary depending on the types of government contracts undertaken, the nature of the work performed under those contracts, the costs incurred in performing the work, the achievement of other performance objectives and their impact on our ability to receive fees. The fixed-price contracts could subject us to losses if we have cost overruns or if increases in our costs exceed the applicable escalation rate.​Net earnings and net assets could be materially affected by an impairment of goodwill.​We have a significant amount of goodwill recorded on our consolidated balance sheet as of December 31, 2022. We are required at least annually to test the recoverability of goodwill. The recoverability test of goodwill is based on the current fair value of our identified reporting units. Fair value measurement requires assumptions and estimates of many critical factors, including revenue and market growth, operating cash flows and discount rates. If general market conditions deteriorate in portions of our business, we could experience a significant decline in the fair value of our reporting units. This decline could lead to an impairment of all or a significant portion of the goodwill balance, which could materially affect our U.S. GAAP net earnings and net assets. ​If the investments in Ball’s pension plans, or in the multi-employer pension plans in which Ball participates, do not perform as expected, we may have to contribute additional amounts to the plans, which would otherwise be available for other general corporate purposes.​Ball maintains defined benefit pension plans covering substantially all of its employees in the United States and a significant number of United Kingdom deferred and retired participants, which are funded based on certain actuarial assumptions. The plans’ assets consist primarily of common stocks, fixed-income securities and, in the U.S., alternative investments. Market declines, longevity increases or legislative changes, such as the Pension Protection Act in the U.S., could result in a prospective decrease in our available cash flow and net earnings over time, and the recognition of an increase in our pension obligations could result in a reduction to our shareholders’ equity. Additional risks exist related to the company’s participation in multi-employer pension plans. Assets contributed to a multi-employer pension plan by one employer may be used to provide benefits to employees of other participating employers. If a participating employer in a multi-employer pension plan stops contributing to the plan, the unfunded obligations of the plan may be borne by the remaining participants. This could result in increases to our contributions to the plans as well as pension expense.​16 Table of ContentsRestricted access to capital markets could adversely affect our short-term liquidity and prevent us from fulfilling our obligations under the notes issued pursuant to our bond indentures.​A reduction in global market liquidity could:​●restrict our ability to fund working capital, capital expenditures, research and development expenditures and other business activities;●increase our vulnerability to general adverse economic and industry conditions, including the credit risks stemming from the economic environment;●limit our flexibility in planning for, or reacting to, changes in our businesses and the industries in which we operate;●restrict us from making strategic acquisitions or exploiting business opportunities; and●limit, along with the financial and other restrictive covenants in our debt, among other things, our ability to borrow additional funds, dispose of assets, pay cash dividends or refinance debt maturities. ​If market interest rates increase, our variable-rate debt will create higher debt service requirements, which adversely affects our cash flows. While we sometimes enter into agreements limiting our exposure, any such agreements may not offer complete protection from this risk.​The global credit, financial and economic environment could have a negative impact on our results of operations, financial position or cash flows.​The overall credit, financial and economic environment could have significant negative effects on our operations, including:​●the creditworthiness of customers, suppliers and counterparties could deteriorate resulting in a financial loss or a disruption in our supply of raw materials;●volatile market performance could affect the fair value of our pension assets, potentially requiring us to make significant additional contributions to our defined benefit pension plans to maintain prescribed funding levels;●a significant weakening of our financial position or operating results could result in noncompliance with our debt covenants; and●reduced cash flows from our operations could adversely affect our ability to execute our long-term strategy to increase liquidity, reduce debt, repurchase our stock and invest in our businesses.​Changes in U.S. generally accepted accounting principles (U.S. GAAP) and SEC rules and regulations could materially impact our reported results.​U.S. GAAP and SEC accounting and reporting changes are common. These changes could have significant effects on our reported results when compared to prior periods and other companies and may even require us to retrospectively adjust prior periods. Additionally, material changes to the presentation of transactions in the consolidated financial statements could impact key ratios that investors, analysts and credit rating agencies use to assess or rate Ball’s performance and could ultimately impact our ability to access the credit markets in an efficient manner.​A material weakness in our internal control over financial reporting could, if not remediated, result in material misstatements in our financial statements.​Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act. A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of annual or interim financial statements will not be prevented or detected on a timely basis. If a material weakness is identified, management could conclude that internal control over financial reporting is not effective based on criteria set forth by the Committee of Sponsoring Organization of the Treadway Commission in “Internal Control—An Integrated Framework (2013).” If a material weakness is identified, a remediation plan would be designed to address the material weakness. If remedial measures are insufficient to address the material weakness, or if additional material weaknesses in internal control are discovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results. As of December 31, 2022, the company had no material weaknesses.17 Table of ContentsWe face risks related to health epidemics, pandemics and other outbreaks, including the ongoing COVID-19 pandemic, which could adversely affect our business.​The circumstances of the ongoing COVID-19 pandemic and responses thereto continue to evolve. The products produced and services provided by Ball have been deemed essential and, as a result, relevant governments around the world have allowed our operations to continue through the pandemic. COVID-19 and its related variants, or another different future pandemic, could give rise to circumstances that cause one or more of the following risk factors to occur:​●We could lose key customers, customers could become insolvent or have a reduction in demand for our products and services;●We could be subject to changes in laws and governmental regulations that adversely affect our business and operations;●We could be subject to adverse fluctuations in currency exchange rates;●We might lose key management and operating personnel;●We may be subject to disruptions in the supply or price of our raw materials;●We may face prolonged work stoppages at our facilities;●We may be impacted by government budget constraints or government shutdowns;●Our pension plan investments may not perform as expected, and we may be required to make additional contributions to our pension plans which would otherwise be available for other general corporate purposes;●Our access to capital markets may be restricted, which could adversely affect our short-term liquidity and prevent us from fulfilling our obligations under the notes issued pursuant to our bond indentures;●We may be subject to increased information technology (IT) security threats and reduced network access availability;●Our operations and those of our principal customers and suppliers could be designated as non-essential in key markets; and●A material weakness in our internal control over financial reporting or a material misstatement in our financial statements could occur.​Because the COVID-19 pandemic is far-reaching and its impacts cannot be completely anticipated, additional risks may arise that could materially impact the company’s financial results and liquidity. ​The company has or may implement actions to minimize the risks and associated negative effects from COVID-19, which do not guarantee the prevention or mitigation of material impacts on our business. Some of these actions may include, and are not limited to:​●Implementing alternative work arrangements including work from home;●Limiting or eliminating work-related travel;●Effecting a full or partial shut-down of operations;●Enhancing the cleaning and disinfecting of our physical locations;●Implementing health screening for employees and third parties who enter our facilities;●Adjusting inventory levels to mitigate potential supply disruptions;●Modifying payment terms with customers;●Providing additional health-related services to our employees;●Reducing compensation for our employees;●Reducing our workforce levels;●Modifying our debt arrangements; and●Adjusting contributions to defined benefit pension plans or income tax payments.​18 Table of ContentsGovernmental and regulatory risks​Changes in laws and governmental regulations may adversely affect our business and operations.​We and our customers and suppliers are subject to various federal, state, provincial and local laws and regulations, which have been increasing in number and complexity. Each of our, and their, facilities is subject to federal, state, provincial and local licensing and regulation by health, environmental, workplace safety and other agencies in multiple jurisdictions. Requirements of worldwide governmental authorities with respect to manufacturing, manufacturing facility locations within the jurisdiction, product content and safety, climate change, workplace safety and health, environmental, expropriation of assets and other standards could adversely affect our ability to manufacture or sell our products, and the ability of our customers and suppliers to manufacture and sell their products. In addition, we face risks arising from compliance with and enforcement of numerous and complex federal, state, provincial and local laws and regulations.​Enacted regulatory developments regarding the reporting and use of “conflict minerals” mined from the Democratic Republic of the Congo and adjoining countries could affect the sourcing, availability and price of minerals used in the manufacture of certain of our products. As a result, there may only be a limited pool of suppliers who provide conflict-free materials, and we cannot give assurance that we will be able to obtain such products in sufficient quantities or at competitive prices. Also, because our supply chains are complex, we may face reputational challenges with our customers and other stakeholders if we are unable to sufficiently verify the origins of all materials used in the products that we sell. The compliance and reporting aspects of these regulations may result in incremental costs to the company. While deposit systems and other container-related legislation have been adopted in some jurisdictions, similar legislation has been defeated in public referenda and legislative bodies in many others. We anticipate that continuing efforts will be made to consider and adopt such legislation in the future. The packages we produce are widely used and perform well in U.S. states, Canadian provinces and European countries that have deposit systems, as well as in other countries worldwide.​While deposit systems and other container-related legislation have been adopted in some jurisdictions, similar legislation has been defeated in public referenda and legislative bodies in many others. We anticipate that continuing efforts will be made to consider and adopt such legislation in the future. The packages we produce are widely used and perform well in U.S. states, Canadian provinces and European countries that have deposit systems, as well as in other countries worldwide.​Significant environmental, employment-related and other legislation and regulatory requirements exist and are also evolving. The compliance costs associated with current and proposed laws and potential regulations could be substantial, and any failure or alleged failure to comply with these laws or regulations could lead to litigation or governmental action, all of which could adversely affect our financial condition or results of operations.​Our aerospace segment is subject to certain risks specific to that business.​In our aerospace business, U.S. government contracts are subject to reduction or modification in the event of changes in requirements, and the government may also terminate contracts at its convenience pursuant to standard termination provisions. In such instances, Ball may be entitled to reimbursement for allowable costs and profits on authorized work that has been performed through the date of termination.​In addition, budgetary constraints and government shutdowns may result in further reductions to projected spending levels by the U.S. government. In particular, government expenditures are subject to the potential for automatic reductions, generally referred to as “sequestration.” Sequestration may occur in any given year, resulting in significant additional reductions to spending by various U.S. government defense and aerospace agencies on both existing and new contracts, as well as the disruption of ongoing programs. Even if sequestration does not occur, we expect that budgetary constraints and ongoing concerns regarding the U.S. national debt will continue to place downward pressure on agency spending levels. Due to these and other factors, overall spending on various programs could decline, which could result in significant reductions to revenue, cash flows, net earnings and backlog primarily in our aerospace segment.​19 Table of ContentsAs a U.S. government contractor, we could be adversely affected by changes in regulations or any negative findings from a U.S. government audit or investigation.​Our aerospace business operates in a highly regulated environment and is routinely audited and reviewed by the U.S. government and its agencies, such as the Defense Contract Audit Agency (DCAA) and Defense Contract Management Agency (DCMA). These agencies review performance under our contracts, our cost structure and our compliance with applicable laws, regulations and standards, as well as the adequacy of, and our compliance with, our internal control systems and policies. Business systems that are subject to review under the DoD Federal Acquisition Regulation Supplement (DFARS) are purchasing, estimating, material management and accounting, as well as property and earned value management. Any costs ultimately found to be unallowable or improperly allocated to a specific contract will not be reimbursed or must be refunded if already reimbursed. If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties, sanctions or suspension or debarment from doing business with the U.S. government. Whether or not illegal activities are alleged, the U.S. government also has the ability to decrease or withhold certain payments when it deems systems subject to its review to be inadequate. If such actions were to result in suspension or debarment, this could have a material adverse effect on our business. ​Our business faces the potential of increased regulation on some of the raw materials utilized in our packaging operations.​Our operations are subject to federal, state, provincial and local laws and regulations in multiple jurisdictions relating to some of the raw materials, including epoxy-based coatings utilized in our container making process. Epoxy-based coatings may contain Bisphenol-A (BPA). Scientific evidence evaluated by regulatory agencies in the U.S., Canada, Europe, Japan, Australia and New Zealand has consistently shown these coatings to be safe for food contact at current levels, and these regulatory agencies have stated that human exposure to BPA from epoxy-based container coatings is well below safe exposure limits set by government bodies worldwide. A significant change in these regulatory agency statements, adverse information concerning BPA or other chemicals present in our coatings, or rulings made within certain federal, state, provincial and local jurisdictions could have a material adverse effect on our business, financial condition or results of operations. Ball recognizes that significant interest exists in non-epoxy based coatings, and we have been proactively working with coatings suppliers and our customers to transition to alternative coatings. In addition, various U.S. states have passed or are contemplating legislation restricting, and the EU is reviewing a proposal to restrict, the use of materials that contain intentionally added per- and polyfluoroalkyl substances (PFAS), which may require the company to continue to incur costs to convert existing coatings to accommodate PFAS-free coatings. To mitigate these risks, the Company is working with its suppliers to require them to remove PFAS-containing coatings from our products. ​Earnings and cash flows can be impacted by changes in tax laws. ​As a U.S.-based multinational business, the company is subject to income tax in the U.S. and numerous jurisdictions outside the U.S., including recent OECD, European Commission and other trans-national initiatives that seek to impose minimum tax thresholds on most multi-national companies. The relevant tax rules and regulations are complex, often changing and, in some cases, are interdependent. If these or other tax rules and regulations should change, the company’s earnings and cash flows could be impacted.​The company’s worldwide provision for income taxes is determined, in part, through the use of significant estimates and judgments. Numerous transactions arise in the ordinary course of business where the ultimate tax determination is uncertain. The company undergoes tax examinations by various worldwide tax authorities on a regular basis. While the company believes its estimates of its tax obligations are reasonable, the final outcome after the conclusion of any tax examinations and any litigation could be materially different from what has been reflected in the company’s historical financial statements.​20 Table of ContentsTechnological risks​Decreases in our ability to develop or apply new technology and know-how may affect our competitiveness.​Our success depends partially on our ability to improve production processes and services. We must also introduce new products and services to meet changing customer needs. If we are unable to implement better production processes or to develop new products through research and development or licensing of new technology, we may not be able to remain competitive with other manufacturers. As a result, our business, financial condition, cash flows or results of operations could be adversely affected.​Increased information technology (IT) security threats and more sophisticated and targeted computer crime could pose a risk to our systems, networks, products, solutions and services, as well as those of our suppliers and customers.​The company’s IT systems, or any third party’s system on which the company relies, as well as those of our suppliers and customers, could fail on their own accord or may be vulnerable to a variety of interruptions or shutdowns, including interruptions or shutdowns due to natural disasters, power outages or telecommunications failures, terrorist attacks or failures during the process of upgrading or replacing software or hardware. Increased global IT security threats and more sophisticated and targeted computer crime also pose a risk to the security of our systems and networks and the confidentiality, availability and integrity of our data, as well as to the security and data of our suppliers and customers. As a provider of products and services to government and commercial customers, our aerospace business in particular may be the target of cyber-attacks, including attempts to gain unauthorized access to classified or sensitive information and networks. The company has a number of shared service centers where many of the company’s IT systems are concentrated and any disruption at such a location could impact the company’s business within the operating zones served by the impacted service center. Certain IT-related risks may be heightened due to the transitional support we are providing to the Russian beverage packaging business since its sale to Russian owners in September 2022.​While we attempt to mitigate all of these risks to our networks, systems and data by employing a number of measures, including employee training, comprehensive monitoring of our networks and systems, and maintenance of backup and protective systems, our systems, networks, products, solutions and services remain potentially vulnerable to advanced persistent threats or other IT disruptions. Depending on their nature and scope, such threats could potentially lead to the compromise of confidential information, improper use of our systems and networks, manipulation and destruction of data, defective products, harm to individuals or property, contractual or regulatory actions and fines, penalties and potential liabilities, production downtimes and operational disruptions, which in turn could adversely affect our reputation, competitiveness and results of operations. Data privacy and protection laws are evolving and present increasing compliance challenges, which may increase our costs, affect our competitiveness and could expose us to substantial fines or other penalties. In addition, a security breach that involves classified or other sensitive government information could subject us to civil or criminal penalties and could result in the loss of our secure facility clearance and other accreditation, loss of our government contracts, loss of access to classified information or debarment as a government contractor.​Human capital risks​If we fail to retain key management and personnel, we may be unable to implement our key objectives.​We believe our future success depends, in part, on our experienced management team. Unforeseen losses of key members of our management team without appropriate succession and/or compensation planning could make it difficult for us to manage our business and meet our objectives. ​Prolonged work stoppages at facilities with union employees could jeopardize our financial position.​As of December 31, 2022, 9 percent of our North American employees and 38 percent of our European employees were covered by collective bargaining agreements. These collective bargaining agreements have staggered expirations during the next several years. Although we consider our employee relations to be generally good, a prolonged work stoppage or strike at any facility with union employees could have a material adverse effect on our business, financial condition, cash flows or results of operations. In addition, we cannot ensure that upon the expiration of existing collective bargaining agreements, new agreements will be reached without union action or that any such new agreements will be on terms satisfactory to us.​21 Table of ContentsEnvironmental risks​Adverse weather and climate changes may result in lower sales.​We manufacture packaging products primarily for beverages. Unseasonable weather can reduce demand for certain beverages packaged in our containers. Climate change and the increasing frequency of severe weather events could have various effects on the demand for our products, our supply chain and the costs of inputs to our production and delivery of products in different regions around the world. Our plants’ production may be prevented or curtailed due to severe or unanticipated weather and climate events.​Our business is subject to substantial environmental remediation and compliance costs.​Our operations are subject to federal, state, provincial and local laws and regulations in multiple jurisdictions relating to environmental hazards, such as emissions to air, discharges to water, the handling and disposal of hazardous and solid wastes and the clean-up of hazardous substances. We have been designated, along with numerous other companies, as a potentially responsible party for the clean-up of several hazardous waste sites. Additionally, there is increased focus on the regulation of greenhouse gas emissions and other environmental issues worldwide. We strive to mitigate such risks related to environmental issues, including through the purchase of renewable energy, the adoption of sustainable practices, and by positioning ourselves as a sustainability leader in our industry.​Item 1B. Unresolved Staff Comments​There were no matters required to be reported under this item.​Item 2. Properties ​The company’s properties described below are well maintained, and management considers them to be adequate and utilized for their intended purposes.​Ball’s corporate headquarters are located in Westminster, Colorado, U.S. and our aerospace segment management offices are located in Broomfield, Colorado, U.S. The operations of the aerospace segment occupy a variety of company-owned and leased facilities in Colorado, U.S., which comprise office, laboratory, research and development, engineering and test and manufacturing space. Other aerospace operations carry on business in smaller company owned and leased facilities in other U.S. locations outside of Colorado.​Ball’s manufacturing locations for significant packaging operations, which are owned or leased by the company, are set forth below. Facilities in the process of being constructed, or that have permanently ceased production, have been excluded from the list. In addition to the facilities listed, the company leases other warehousing space.​Beverage packaging, North and Central America, locations:●Bowling Green, Kentucky●Conroe, Texas●Fairfield, California●Findlay, Ohio●Fort Atkinson, Wisconsin●Fort Worth, Texas●Glendale, Arizona●Golden, Colorado●Goodyear, Arizona●Kapolei, Hawaii●Kent, Washington●Monterrey, Mexico●Monticello, Indiana●Pittston, Pennsylvania●Queretaro, Mexico●Rome, Georgia●Saint Paul, Minnesota (closed in the first quarter of 2023)●Saratoga Springs, New York●Tampa, Florida22 Table of Contents●Wallkill, New York●Whitby, Ontario, Canada●Williamsburg, VirginiaBeverage packaging, EMEA, locations:●Belgrade, Serbia●Bierne, France ●Cabanillas del Campo, Spain●Cairo, Egypt●Ejpovice, Czech Republic●Fosie, Sweden●Fredericia, Denmark●Gelsenkirchen, Germany●La Selva, Spain●Lublin, Poland●Ludesch, Austria●Manisa, Turkey●Mantsala, Finland●Milton Keynes, United Kingdom●Mont, France●Nogara, Italy●Wakefield, United Kingdom●Waterford, Ireland●Widnau, SwitzerlandBeverage packaging, South America, locations:●Aguas Claras, Brazil●Asuncion, Paraguay●Brasilia, Brazil●Buenos Aires, Argentina●Extrema, Brazil●Frutal, Brazil ●Jacarei, Sao Paulo, Brazil●Manaus, Brazil●Pouso Alegre, Brazil ●Recife, Brazil●Santiago, Chile●Tres Rios, Rio de Janeiro, BrazilBeverage packaging, Other, locations:●Dammam, Saudi Arabia●Mumbai, India●Sri City, India●Yangon, MyanmarAerosol packaging locations:●Ahmedabad, India●Beaurepaire, France●Bellegarde, France●Devizes, United Kingdom●Itupeva, Brazil●San Luis Potosí, Mexico●Sherbrooke, Quebec, Canada●Velim, Czech Republic●Verona, VirginiaAluminum cups location:●Rome, Georgia​23 Table of ContentsItem 3. Legal Proceedings​Details of the company’s legal proceedings are included in Note 22 to the consolidated financial statements within Item 8 of this annual report.​Item 4. Mine Safety Disclosures​Not applicable.​Part II.​Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.​Ball Corporation common stock is listed for trading on the New York Stock Exchange under the ticker symbol BALL. There were 6,739 common shareholders of record on February 16, 2023.​Common Stock Repurchases​The following table summarizes the company’s repurchases of its common stock during the quarter ended December 31, 2022.​​​​​​​​​​​Purchases of Securities($ in millions) TotalNumber ofSharesPurchased (a) AveragePricePaid perShare Total Number ofShares Purchased asPart of PubliclyAnnounced Plans orPrograms (a) Maximum Number ofShares that May YetBe Purchased Underthe Plans or Programs(b)​​​​​​​​​​October 1 to October 31, 2022​ —​$ —​ —​ 19,657,010November 1 to November 30, 2022​ —​​ —​ —​ 19,657,010December 1 to December 31, 2022​ —​​ —​ —​ 19,657,010Total​ —​​ —​ —​​(a)Includes any open market purchases (on a trade-date basis), share repurchase agreements and/or shares retained by the company to settle employee withholding tax liabilities.(b)The company has an ongoing repurchase program for which 50 million shares were authorized for repurchase by Ball’s Board of Directors.​Shareholder Return Performance​The line graph below compares the annual percentage change in Ball Corporation’s cumulative total shareholder return on its common stock with the cumulative total return of the Dow Jones Containers & Packaging Index and the S&P Composite 500 Stock Index for the five-year period ended December 31, 2022. The graph assumes $100 was invested on December 31, 2017, and that all dividends were reinvested. The Dow Jones Containers & Packaging Index total return has been weighted by market capitalization.​24 Table of Contents​ ​Total Return Analysis​​​​​​​​​​​​​​​​​​​​​12/31/2017​12/31/2018​12/31/2019​12/31/2020​12/31/2021​12/31/2022BALL​$100.00​$ 122.65​$ 173.97​$ 252.58​$ 263.00​$ 141.42S&P 500​​100.00​​ 95.62​​ 125.72​​ 148.85​​ 191.58​​ 156.88DJ US Containers & Packaging​​100.00​​ 79.85​​ 100.28​​ 118.67​​ 129.17​​ 103.73​Source: Bloomberg L.P.® Charts​Item 6. [Reserved]​Removing and reserving Item 6 of Part II.​25 Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations​Management’s discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes included in Item 8 of this Annual Report on Form 10-K (annual report), which include additional information about our accounting policies, practices and the transactions underlying our financial results. The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) requires us to make estimates and assumptions that affect the reported amounts in our consolidated financial statements and the accompanying notes, including various claims and contingencies related to lawsuits, taxes, environmental and other matters arising during the normal course of business. We apply our best judgment, our knowledge of existing facts and circumstances and actions that we may undertake in the future in determining the estimates that affect our consolidated financial statements. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. As future events and their effects cannot be determined with precision, actual results may differ from these estimates. Ball Corporation and its subsidiaries are referred to collectively as “Ball Corporation,” “Ball,” “the company,” “we” or “our” in the following discussion and analysis.​OVERVIEW​Business Overview and Industry Trends​Ball Corporation is one of the world’s leading aluminum packaging suppliers. Our packaging products are produced for a variety of end uses, are manufactured in facilities around the world and are competitive with other substrates, such as plastics and glass. In the aluminum packaging industry, sales and earnings can be increased by reducing costs, increasing prices, developing new products, expanding volumes and making strategic acquisitions. We also provide aerospace and other technologies and services to governmental and commercial customers, including national defense hardware, antenna and video tactical solutions, civil and operational space hardware and system engineering services.​We sell our aluminum packaging products mainly to large, multinational beverage, personal care and household products companies with which we have developed long-term relationships. This is evidenced by our high customer retention and our large number of long-term supply contracts. While we have a diversified customer base, we sell a significant portion of our packaging products to major companies and brands, as well as to numerous regional customers. The overall global aluminum beverage and aerosol container industries are growing and are expected to continue to grow in the medium to long term. The primary customers for the products and services provided by our aerospace segment are U.S. government agencies or their prime contractors.​We purchase our raw materials from relatively few suppliers. We also have exposure to inflation, in particular the rising costs of raw materials, as well as other direct cost inputs. We mitigate our exposure to the changes in the costs of aluminum through the inclusion of provisions in contracts covering the majority of our volumes to pass through aluminum price changes, as well as through the use of derivative instruments. The pass-through provisions generally result in proportional increases or decreases in sales and costs with a greatly reduced impact, if any, on net earnings; however, there may be timing differences of when the costs are passed through. Because of our customer and supplier concentration, our business, financial condition and results of operations could be adversely affected by the loss, insolvency or bankruptcy of a major customer or supplier or a change in a supply agreement with a major customer or supplier, although our contract provisions generally mitigate the risk of customer loss, and our long-term relationships represent a known, stable customer base.​The majority of our aerospace business involves work under contracts, generally from one to five years in duration, as a prime contractor or subcontractor for various U.S. government agencies. Intense competition and long operating cycles are key characteristics of the company’s aerospace and defense industry where it is common for work on major programs to be shared among a number of companies. A company competing to be a prime contractor may, upon ultimate award of the contract to a competitor, become a subcontractor for the ultimate prime contracting company.​26 Table of ContentsCorporate Strategy​Our Drive for 10 vision encompasses five strategic levers that are key to growing our business and achieving long-term success. Since launching Drive for 10 in 2011, we have made progress on each of the levers as follows:​●Maximizing value in our existing businesses by leveraging our aluminum container production capabilities across our global plant network to meet global demand, improving efficiencies and amplifying our sustainability credentials through Aluminum Stewardship Initiative certification across our global aluminum container and end facilities in North America, South America and Europe; leveraging plant floor and integrated planning systems to reduce costs and manage contractual provisions across our diverse customer base; successfully acquiring and integrating a large global aluminum beverage business and regional aluminum aerosol facility while also divesting underperforming assets; and in the aluminum aerosol business, installing new extruded aluminum aerosol lines in our European, Mexican and Indian facilities while also implementing cost-out and value-in initiatives across all of our businesses;​●Expanding further into new products and capabilities through delivering the broadest aluminum beverage and bottle portfolio, commercializing our lightweight, infinitely recyclable aluminum cup and providing next-generation extruded aluminum aerosol packaging that utilizes proprietary technology to significantly lightweight our products; and successfully introducing new specialty beverage cans and aluminum bottle-shaping technology; ​●Aligning ourselves with the right customers and markets by prudently investing capital to meet continued growth for specialty beverage containers throughout our global network, which represent approximately 50 percent of our global beverage packaging mix; aligning with growing beverage customers and brand categories and other new beverage producers who continue to use aluminum beverage containers to grow their business; and in our aluminum cup business, establishing partnerships with food service providers, fast casual restaurants and event venues and utilizing online platforms and North American retailers to provide infinitely recyclable aluminum cups directly to consumers.​●Broadening our geographic reach with our acquisition of Rexam in June 2016 and our new investments in beverage manufacturing facilities in the United States, Brazil, Paraguay, Spain, Czech Republic, United Kingdom, Mexico, Myanmar and Panama, as well as extruded aluminum aerosol manufacturing facilities in North America, Europe, India and Brazil, and the start-up of our aluminum cups business in the U.S.; and​●Leveraging our technological expertise in packaging innovation, including the introduction of our new proprietary, brandable lightweight aluminum cup and providing next-generation aluminum bottle-shaping technologies for new categories, occasions and refillable offerings through the increased production of lightweight ReAl® containers and which utilize technology that increases the strength of aluminum used in the manufacturing process while lightweighting the can by up to 30 percent over a standard aluminum aerosol can, as well as leveraging our aerospace technologies and competencies to deliver exquisite space-based environmental, weather and defense monitoring solutions such as methane monitoring, weather prediction, LIDAR capabilities and hypersonics to preserve and protect our planet through enabling our aerospace customers with actionable ecosystem-related and intelligence data and resilient national security architectures. ​These ongoing business developments help us stay close to our customers while expanding and/or sustaining our industry positions and global reach with major beverage, personal care, household products and aerospace customers. In order to successfully execute our strategy and reach our goals, we realize the importance of excelling in the following areas: customer focus, operational excellence, innovation and business development, people and culture focus and sustainability.​27 Table of ContentsRESULTS OF OPERATIONS ​Management’s discussion and analysis for our results of operations on a consolidated and segment basis include a quantification of factors that had a material impact. Other factors that did not have a material impact, but that are significant to understand the results, are qualitatively described.​Refer to Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of the company’s Annual Report on Form 10-K for the year ended December 31, 2021, as filed on February 16, 2021, for a comparison of our 2021 results of operations to the 2020 results. ​Global Economic Environment​In 2022 data indicated a sharp rise in inflation in the regions where we operate. Current and future inflationary effects may continue to be impacted by, among other things, supply chain disruptions, governmental stimulus or fiscal policies, changes in interest rates, and changing demand for certain goods and services as recovery from the COVID-19 pandemic continues. We cannot predict with any certainty the impact that rising interest rates, a global or any regional recession, or higher inflation may have on our customers or suppliers. Additionally, we are unable to predict the potential effects that any resurgence of COVID-19, its variants or any future pandemic, or the continuation or escalation of the military conflict between Russia and Ukraine, and related sanctions or market disruptions, may have on our business. It remains uncertain how long any of these conditions may last or how severe any of them may become.​Consolidated Sales and Earnings​​​​​​​​​​​​​​Years Ended December 31,​($ in millions) 2022 2021 2020 ​​​​​​​​​​​Net sales​$ 15,349​$ 13,811​$ 11,781​Net earnings attributable to Ball Corporation​​ 719​​ 878​​ 585​Net earnings attributable to Ball Corporation as a % of net sales​​ 5% ​ 6% ​ 5%​Sales in 2022 were $1,538 million higher compared to 2021 primarily due to the pass through of higher aluminum prices and the delayed recoverability of inflationary costs, partially offset by currency translation.​Net earnings attributable to Ball Corporation in 2022 were $159 million lower than 2021 primarily due to increased manufacturing and inflationary costs and net charges from the impairment of Russian long-lived assets and the gain from the sale of Ball’s Russian aluminum beverage packaging business, partially offset by the gain on sale of our remaining equity investment in Ball Metalpack, lower pension settlement charges in 2022 than in 2021 and lower depreciation expense. In 2023 we expect to improve year-over-year results through fixed cost savings from rightsizing production and the contractual recovery of 2022 inflationary costs. ​Cost of Sales (Excluding Depreciation and Amortization)​Cost of sales, excluding depreciation and amortization, was $12,766 million in 2022 compared to $11,085 million in 2021. These amounts represented 83 percent and 80 percent of consolidated net sales for the years ended 2022 and 2021, respectively. The increase year-over-year is primarily due to higher manufacturing costs, general inflationary cost pressures and global supply chain transportation disruptions. To mitigate these recent cost trends, we have established a commercial cost recovery program that is designed to help us recover a significant portion of those cost increases that fall outside our normal customer contracts. Additionally, we took actions to normalize inventory levels and reduce fixed and variable costs heading into 2023 that we expect will improve financial results.​Depreciation and Amortization ​Depreciation and amortization expense was $672 million in 2022 compared to $700 million in 2021. These amounts represented 4 percent and 5 percent of consolidated net sales for the years ended 2022 and 2021, respectively. Amortization expense in 2022 and 2021 included $135 million and $152 million, respectively, for the amortization of acquired Rexam intangibles.The decrease compared to the same period in 2021 is primarily due to revised estimated useful lives of the company’s manufacturing equipment, buildings and certain assembly and test equipment, as well as 28 Table of Contentsthe impairment and ultimate sale of the Russia aluminum beverage packaging business. See Note 4 for details regarding the sale of the Russian operations. ​Effective July 1, 2022, Ball revised the estimated useful lives of all of its equipment and buildings included in the analysis, which resulted in a net reduction in depreciation expense of approximately $49 million ($37 million after tax, or $0.12 per diluted share) for the year ended December 31, 2022, as compared to the amount of depreciation expense that would have been recognized by utilizing the prior depreciable lives. This change in useful lives is expected to reduce depreciation expense by approximately $49 million for the six months ended June 30, 2023, for those assets included in the revision analysis. ​Selling, General and Administrative​Selling, general and administrative (SG&A) expenses were $626 million in 2022 compared to $593 million in 2021. These amounts represented 4 percent of consolidated net sales for 2022 and 2021. The increase in SG&A expenses was primarily due to higher accounts receivable factoring costs, partially offset by lower personnel costs during the fourth quarter. ​Business Consolidation Costs and Other Activities​Business consolidation costs and other activities were $71 million in 2022 compared to $142 million in 2021. These amounts represented less than 1 percent and 1 percent of consolidated net sales for 2022 and 2021, respectively. The amounts in 2022 included impairment losses on Russia’s long-lived asset group, the gain on sale of Ball’s Russian aluminum beverage packaging business, the gain on sale of Ball’s remaining equity method investment in Ball Metalpack, charges related to a Brazilian customer’s contract breach, facility shutdown costs, charges for employee severance and benefits related to cost-out activities and a charge related to a donation to the Ball Foundation. The amounts in 2021 included a non-cash pension settlement charge of $135 million and gains resulting from Brazilian indirect tax rulings of $22 million. Further details regarding business consolidation costs and other activities, including the Russian impairment and gain on sale, are provided in Note 10 and Note 4, respectively.​Interest Expense​Total interest expense was $330 million in 2022 compared to $283 million in 2021. Interest expense, excluding the effect of debt refinancing and other costs, as a percentage of average borrowings increased by approximately 10 basis points from 3.4 percent in 2021 to 3.5 percent in 2022 due to an increase in global interest rates. Increased debt levels in 2022 compared to 2021 further contributed to higher interest expense for the year.​Tax Provision​The company’s effective tax rate is affected by recurring items such as income earned in non-U.S. jurisdictions with tax rates that differ from the U.S. tax rate and by discrete items that may occur in any given year but are not consistent from year to year. ​The 2022 effective income tax rate was 18.0 percent compared to 15.5 percent for 2021. As compared with the statutory U.S. federal income tax rate of 21 percent, the 2022 effective income tax rate was reduced by 3.2 percent for the impact of the U.S. research and development credit and by 2.8 percent for the impact of non-U.S. rate differences including tax holidays. These reductions were partially offset by an increase of 2.3 percent for U.S. state and local taxes and by 1.6 percent for equity compensation related impacts. While these items are expected to recur, the potential magnitude of each item is uncertain.​Further details of taxes on income, including impacts of the U.S. tax reform, are provided in Note 16 to the consolidated financial statements within Item 8 of this annual report.​29 Table of ContentsRESULTS OF BUSINESS SEGMENTS​Segment Results​Ball’s operations are organized and reviewed by management along its product lines and geographical areas, and its operating results are presented in the four reportable segments discussed below.​Beverage Packaging, North and Central America​​​​​​​​​​​​​​Years Ended December 31,​($ in millions)​2022 2021 2020 ​​​​​​​​​​​Net sales​$ 6,696​$ 5,856​$ 5,076​Comparable operating earnings​​ 642​​ 681​​ 683​Comparable operating earnings as a % of segment net sales​​ 10% ​ 12% ​ 13%​In the third quarter of 2022, Ball announced the permanent closure of its aluminum beverage can manufacturing facilities in Phoenix, Arizona, and St. Paul, Minnesota. The Phoenix facility ceased production in the fourth quarter of 2022, and the St. Paul facility ceased production in the first quarter of 2023.​Segment sales in 2022 were $840 million higher compared to 2021 primarily due to the pass through of higher aluminum prices, partially offset by unfavorable price/mix.​Comparable operating earnings in 2022 were $39 million lower compared to 2021 primarily due to unfavorable fixed cost absorption, higher inflationary costs and unfavorable customer mix, partially offset by favorable contractual terms, cost pass throughs and lower depreciation expense associated with the third quarter 2022 revision of estimated useful lives. In 2023 we expect to improve year-over-year results through fixed cost savings from rightsizing production and the contractual recovery of 2022 inflationary costs.​Beverage Packaging, EMEA​​​​​​​​​​​​​​Years Ended December 31,​($ in millions)​2022 2021 2020 ​​​​​​​​​​​Net sales​$ 3,854​$ 3,509​$ 2,945​Comparable operating earnings​​ 358​​ 452​​ 354​Comparable operating earnings as a % of segment net sales​​ 9% ​ 13% ​ 12%​Segment sales in 2022 were $345 million higher compared to 2021 primarily due to the pass through of higher aluminum prices, favorable price/mix and 4 percent volume growth, partially offset by approximately $400 million from unfavorable currency translation and the sale of the Russian aluminum beverage packaging business.​Comparable operating earnings in 2022 were $94 million lower compared to 2021 primarily due to approximately $40 million from unfavorable currency translation, the impact of higher inflation, energy costs, supply disruptions across the region and the sale of the Russian aluminum beverage packaging business, partially offset by the pass through of higher aluminum prices, volume growth and lower depreciation expense associated with the third quarter 2022 revision of estimated useful lives.​During the third quarter of 2022, and further to the Russian invasion of Ukraine, the company sold its Russian business, composed of three manufacturing facilities, for total cash consideration of $530 million. The historical operations and results of the Russian aluminum packaging business, including the gain on sale, are included in the beverage packaging, EMEA segment. See Note 4 to the consolidated financial statements within Item 8 of this annual report for additional discussion regarding the sale and its impact to Ball’s financial results.​A summary of the results of the Russian aluminum packaging business and the non-Russian components of the beverage packaging, EMEA, segment, for the years ended December 31, 2022 and 2021, are shown below:​30 Table of Contents​​​​​​​​​Year Ended December 31,($ in millions) 2022 2021​​​​​​​Net sales​​​​​​Russia​$ 554​$ 594Non-Russia​​ 3,300​​ 2,915Beverage packaging, EMEA, segment​$ 3,854​$ 3,509​​​​​​​Comparable operating earnings​​​​​​Russia​$ 86​$ 129Non-Russia​​ 272​​ 323Beverage packaging, EMEA, segment​$ 358​$ 452​The Russian sales and comparable operating earnings figures in the above table include historical support by Russia for non-Russian regions. See Note 4 to the consolidated financial statements within Item 8 of this annual report for additional discussion regarding the sale.​Beverage Packaging, South America​​​​​​​​​​​​​​Years Ended December 31,​($ in millions)​2022 2021 2020 ​​​​​​​​​​​Net sales​$ 2,108​$ 2,016​$ 1,695​Comparable operating earnings​​ 275​​ 348​​ 280​Comparable operating earnings as a % of segment net sales​​ 13% ​ 17% ​ 17%​To ensure supply/demand balance and optimize low-cost production, the company ceased operations at its Santa Cruz, Brazil, beverage can manufacturing facility during the third quarter of 2022, and temporarily reduced production across its remaining Brazilian beverage can manufacturing footprint. ​Segment sales in 2022 were $92 million higher compared to 2021 primarily due to the contractual pass through of higher aluminum prices and price/mix, partially offset by 6 percent lower volumes.​Comparable operating earnings in 2022 were $73 million lower compared to 2021 primarily due to lower volumes, unfavorable regional customer/product mix and fixed cost absorption in Brazil, partially offset by the contractual pass through of costs and lower depreciation expense associated with the third quarter 2022 revision of estimated useful lives. In 2023 we expect to improve year-over-year financial results through fixed cost savings from rightsizing production.​Aerospace ​​​​​​​​​​​​​​Years Ended December 31,​($ in millions)​2022 2021 2020 ​​​​​​​​​​​Net sales​$ 1,977​$ 1,911​$ 1,741​Comparable operating earnings​​ 170​​ 169​​ 153​Comparable operating earnings as a % of segment net sales​​ 9% ​ 9% ​ 9%​Segment sales in 2022 were $66 million higher compared to 2021, and comparable operating earnings were $1 million higher, primarily due to the company’s new program wins, backlog growth and related backlog liquidation through contract performance, offset by supply chain inefficiencies and cost increases/inflationary pressures during 2022.​Sales to the U.S. government, either directly as a prime contractor or indirectly as a subcontractor, represented 98 percent of segment sales in 2022 and 97 percent in 2021. The aerospace contract mix in 2022 consisted of 40 percent cost-type contracts, which are billed at our costs plus an agreed-upon and/or earned profit component, and 57 percent fixed-price contracts. The remaining sales were for time and materials contracts.​31 Table of ContentsBacklog for the aerospace segment at December 31, 2022 and 2021, was $2.97 billion and $2.47 billion, respectively. The actual amount of funding received in the future may be higher or lower than our estimate of potential contract value. The segment has numerous outstanding bids for future contract awards. The backlog at December 31, 2022, consisted of 35 percent cost-type contracts. Comparisons of backlog are not necessarily indicative of the trend of future operations due to the nature of varying delivery and milestone schedules on contracts, funding of programs and the uncertainty of timing of future contract awards. ​Management Performance Measures​Management internally uses various measures to evaluate company performance such as comparable operating earnings (earnings before interest, taxes and business consolidation and other non-comparable costs); comparable net earnings (earnings before business consolidation costs and other non-comparable costs after tax); comparable diluted earnings per share (comparable net earnings divided by diluted weighted average shares outstanding); return on average invested capital (net operating earnings after tax over the relevant performance period divided by average invested capital over the same period); economic value added (EVA®) dollars (net operating earnings after tax less a capital charge on average invested capital employed); earnings before interest and taxes (EBIT); earnings before interest, taxes, depreciation and amortization (EBITDA); and diluted earnings per share. In addition, management uses operating cash flows as a measure to evaluate the company’s liquidity. We believe this information is also useful to investors as it provides insight into the earnings and cash flow criteria that management uses to make strategic decisions. These financial measures may be adjusted at times for items that affect comparability between periods, including business consolidation costs and other non-comparable items.​Nonfinancial measures used in the packaging businesses include production efficiency and spoilage rates; quality control figures; environmental, health and safety statistics; production and sales volume data; asset utilization rates and measures of sustainability. Additional measures used to evaluate financial performance in the aerospace segment include contract revenue realization, award and incentive fees realized, proposal win rates and backlog. References to sales volume data represent units shipped.​Many of the above noted financial measurements are presented on a non-U.S. GAAP basis and should be considered in connection with the consolidated financial statements within Item 8 of this annual report. Non-U.S. GAAP measures should not be considered in isolation and should not be considered superior to, or a substitute for, financial measures calculated in accordance with U.S. GAAP. A presentation of earnings in accordance with U.S. GAAP is available in Item 8 of this annual report.​CRITICAL ACCOUNTING POLICIES AND ESTIMATES​For information regarding the company’s critical and significant accounting policies, as well as recent accounting pronouncements, see Note 1 and Note 2 to the consolidated financial statements within Item 8 of this annual report.​The company considers certain accounting estimates to be critical, as their application is made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had, or are reasonably likely to have, a material impact on the financial condition or results of operations. Detailed below is a discussion of why, to the extent the estimate is material, these estimates are subject to uncertainty and the sensitivity of the reported amounts to the methods, assumptions, and estimates underlying the estimate’s calculation. ​32 Table of ContentsRevenue Recognition in the Aerospace Segment​Sales under fixed-price long-term contracts in the aerospace segment are primarily recognized using percentage-of-completion accounting under the cost-to-cost method. The company believes the accounting estimates related to revenue recognition in its aerospace segment are critical accounting estimates because they are highly reliant upon estimation throughout the segment’s contracts with its customers. The recognition of revenue requires significant estimation on the part of management, including estimating techniques to project revenues and costs at completion and various assumptions and projections related to the outcome of future events, and evaluation of estimates of total contract revenue, total contract cost, and extent of progress toward completion. Aside from estimation of total contract cost and progress towards completion, total revenues in our aerospace segment are subject to uncertainty due to the total amount that will be paid by the customer giving rise to variable consideration. The primary types of variable consideration present in the company’s contracts are cost reimbursements, performance award fees, incremental funding and finalization of government rates. The company’s accounting policy around revenue recognition in its aerospace segment and further details of estimates used in revenue recognition in its aerospace segment can be found in Note 1 and Note 5, respectively, to the consolidated financial statements within Item 8 of this annual report.​Defined Benefit Pension Plans​The company has defined benefit plans which require management to make assumptions relating to the long-term rate of return on plan assets, discount rates used to determine the present value of future obligations and expenses, salary inflation rates, mortality rates and other assumptions. The company believes the accounting estimates related to its pension plans are critical accounting estimates because several of the company’s defined benefit plans have significant asset and liability balances, and because the assumptions used are highly susceptible to change from period to period based on the performance of plan assets, actuarial valuations, market conditions and contracted benefit changes. These assumptions do not change during the company’s fiscal year unless a remeasurement event occurs in one of the plans, such as a significant settlement. The assumptions used in accounting for the company’s defined benefit plans and how they have changed over time, as well as the sensitivity of the plans to changes in their related assumptions, can be found in Note 17 to the consolidated financial statements within Item 8 of this annual report. ​FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES​Cash Flows and Capital Expenditures​Our primary sources of liquidity are cash provided by operating activities and external borrowings. We believe that cash flows from operating activities and cash provided by short-term, long-term and committed revolver borrowings, when necessary, will be sufficient to meet our ongoing operating requirements, scheduled principal and interest payments on debt, dividend payments, anticipated share repurchases and anticipated capital expenditures. The following table summarizes our cash flows:​​​​​​​​​​​​​Years Ended December 31,($ in millions) 2022 2021 2020​​​​​​​​​​Cash flows provided by (used in) operating activities​$ 301​$ 1,760​$ 1,432Cash flows provided by (used in) investing activities​​ (786)​​ (1,639)​​ (1,181)Cash flows provided by (used in) financing activities​​ 485​​ (894)​​ (602)​Cash flows provided by operating activities were $301 million in 2022, primarily driven by net earnings of $732 million, depreciation and amortization of $672 million and business consolidation and other costs of $71 million, partially offset by working capital outflows of $924 million and pension contributions of $124 million. In comparison to the same period in 2021, and after adjusting for the impact of capital expenditures, our working capital movements reflect an increase in days sales outstanding of 7 days in 2022, an increase in inventory days on hand of 14 days in 2022 and a decrease in days payable outstanding of 6 days in 2022.​Cash outflows from investing activities were $786 million in 2022 predominantly driven by $1.65 billion in capital expenditures, partially offset by $455 million net cash received for the sale of our Russian aluminum beverage packaging business, net of the cash on the disposed business, and $298 million received for the for the sale of our remaining 49 percent owned equity investment in Ball Metalpack.33 Table of ContentsCash inflows from financing activities were $485 million in 2022, primarily driven by the issuance of $750 million of 6.875% senior notes due 2028, $394 million of borrowings under short-term uncommitted credit facilities and $200 million of borrowings under the company’s long-term revolving facility, partially offset by the repayment of $738 million of 4.375% senior notes, net share repurchases of $582 million and common stock dividends of $254 million. ​We have entered into several regional committed and uncommitted accounts receivable factoring programs with various financial institutions for certain of our accounts receivable. Programs accounted for as true sales of the receivables, without recourse to Ball, had combined limits of approximately $2.04 billion and $1.74 billion at December 31, 2022, and December 31, 2021, respectively. A total of $488 million and $308 million were available for sale under these programs at December 31, 2022 and 2021, respectively. ​As of December 31, 2022, approximately $546 million of our cash was held outside of the U.S. In the event we need to utilize any of the cash held outside of the U.S. for purposes within the U.S., there are no material legal or other economic restrictions regarding the repatriation of cash from any of the countries outside the U.S. where we have cash. The company believes its U.S. operating cash flows and cash on hand, as well as availability under its long-term, revolving credit facilities, uncommitted short-term credit facilities and committed and uncommitted accounts receivable factoring programs, will be sufficient to meet the cash requirements of the U.S. portion of our ongoing operations, scheduled principal and interest payments on U.S. debt, dividend payments, capital expenditures and other U.S. cash requirements. If non-U.S. funds are needed for our U.S. cash requirements and we are unable to provide the funds through intercompany financing arrangements, we may be required to repatriate funds from non-U.S. locations where the company has previously asserted indefinite reinvestment of funds outside the U.S. ​Based on its indefinite reinvestment assertion, the company has not provided deferred taxes on earnings in certain non-U.S. subsidiaries because such earnings are intended to be indefinitely reinvested in its international operations. It is not practical to estimate the additional taxes that might become payable if these earnings were remitted to the U.S.​Share Repurchases​The company’s share repurchases totaled $618 million in 2022 and $766 million in 2021. The repurchases were completed using cash on hand, cash provided by operating activities, proceeds from the sale of businesses and available borrowings. ​In the second quarter of 2022, in a privately negotiated transaction, Ball entered into an accelerated share repurchase agreement to buy $300 million of its common shares using cash on hand and available borrowings. In the third quarter of 2022, Ball settled the agreement and received a total of 4.34 million shares with the average price paid per share of $69.06.​Debt Facilities and Refinancing ​Given our cash flow projections and unused credit facilities that are available until June 2027, our liquidity is strong and is expected to meet our ongoing cash and debt service requirements. Total interest-bearing debt of $9.00 billion and $7.78 billion was outstanding at December 31, 2022 and 2021, respectively.​During 2022, Ball issued $750 million of 6.875% senior notes due in 2028, redeemed $738 million of outstanding euro denominated 4.375% debt and completed the closing of its new revolving and term loan senior secured credit facilities that refinanced its existing senior secured credit facilities entered into in 2019. The company’s senior credit facilities include a $1.35 billion term loan and long-term, multi-currency revolving facilities that mature in June 2027, which provide the company with up to the U.S. dollar equivalent of $1.75 billion. During 2021, Ball issued $850 million of 3.125% senior notes due in 2031 and redeemed the outstanding 5% senior notes due in March 2022 in the amount of $748 million.​At December 31, 2022, approximately $1.49 billion was available under the company’s long-term, multi-currency committed revolving credit facilities, which are available until June 2027. In addition to these facilities, the company had approximately $990 million of short-term uncommitted credit facilities available at December 31, 2022, of which $112 million was outstanding and due on demand. ​34 Table of ContentsWhile ongoing financial and economic conditions in certain areas may raise concerns about credit risk with counterparties to derivative transactions, the company mitigates its exposure by allocating the risk among various counterparties and limiting exposure to any one party. We also monitor the credit ratings of our suppliers, customers, lenders and counterparties on a regular basis.​Some of Ball’s loan agreements use the London Inter-Bank Offered Rate (LIBOR) in determining interest rates. The company is continually evaluating the impact that the transition from its LIBOR-based interest rate loan agreements to Secured Overnight Financing Rate (SOFR) based interest rate agreements will have on its consolidated financial statements. Based on our most current understanding, the LIBOR to SOFR transition is not expected to have a material impact on our financial condition, results of operations or cash flows.​We were in compliance with all loan agreements at December 31, 2022, and for all prior years presented, and we have met all debt payment obligations. The U.S. note agreements and bank credit agreement contain certain restrictions relating to dividends, investments, financial ratios, guarantees and the incurrence of additional indebtedness. The most restrictive of our debt covenants requires us to maintain a leverage ratio (as defined) of no greater than 5.0 times, which will change to 4.5 times as of September 30, 2025. As of December 31, 2022, the company could borrow an additional $2.32 billion under its long-term multi-currency committed revolving facilities and short-term uncommitted credit facilities without violating our existing debt covenants. Additional details about our debt are available in Note 15 to the consolidated financial statements within Item 8 of this annual report.​Defined Benefit Pension Plans​The company closed its pension plans to all non-unionized new entrants in the United States effective for anyone hired after December 31, 2021. New employees instead receive a non-elective 401(k) company contribution that is expected to approximate the legacy pension benefit. Anyone employed by Ball prior to that date is unaffected by this change. ​Other Liquidity Measures​Given the on-going growth projects in our businesses being undertaken to support EVA-enchancing contacted volumes, in 2023, we expect capital expenditures to be in the range of $1.2 billion and we intend to return approximately $250 million to shareholders in the form of dividends. We further intend to utilize our operating cash flows to pay down debt and, to the extent available, repurchase Ball common stock or fund acquisitions that meet our rate of return criteria.​We have committed contracts to purchase raw materials and we align these purchase commitments with long-term sales contracts with our customers such that any commitment to purchase aluminum and other direct materials corresponds to a contractual sale. These aluminum purchase commitments include pass-through provisions which generally result in proportional changes in both sales and costs of sales; however, there may be timing differences of when the costs are passed through.​The company’s growth and asset maintenance plans require capital expenditures over the next years, which will be funded by operating cash flows and external borrowings. Approximately $810 million of capital expenditures were contractually committed as of December 31, 2022. Maturities for Ball’s long-term debt are disclosed in Note 15 to the consolidated financial statements within Item 8 of this annual report. Repayments of debt and other operational cash requirements will also be funded by operating cash flows and external borrowings. The company has no material off-balance sheet arrangements.​CONTINGENCIES, INDEMNIFICATIONS AND GUARANTEES​Details of the company’s contingencies, legal proceedings, indemnifications and guarantees are available in Note 22 and Note 23 to the consolidated financial statements within Item 8 of this annual report. The company is routinely subject to litigation incidental to operating its businesses and has been designated by various federal and state environmental agencies as a potentially responsible party, along with numerous other companies, for the clean-up of several hazardous waste sites, including in respect of sites related to alleged activities of certain former Rexam subsidiaries. The company believes the matters identified will not have a material adverse effect upon its liquidity, results of operations or financial condition. ​35 Table of ContentsGuaranteed Securities​The company’s senior notes are guaranteed on a full and unconditional, joint and several basis by the issuer of the company’s senior notes and the subsidiaries that guarantee the notes (the obligor group). The entities that comprise the obligor group are 100 percent owned by the company. As described in the supplemental indentures governing the company’s existing senior notes, the senior notes are guaranteed by any of the company’s domestic subsidiaries that guarantee any other indebtedness of the company.​The following summarized financial information relates to the obligor group as of and for the years ended December 31, 2022 and 2021. Intercompany transactions, equity investments and other intercompany activity between obligor group subsidiaries have been eliminated from the summarized financial information. Investments in subsidiaries not forming part of the obligor group have also been eliminated.​​​​​​​​​​Year Ended​Year Ended($ in millions)​December 31, 2022 December 31, 2021​​​​​​​Net sales​$ 9,975​$ 8,083Gross profit (a)​​ 996​​ 910Net earnings​​ 635​​ 432Net earnings attributable to Ball Corporation​​ 635​​ 432(a)Gross profit is shown after depreciation and amortization related to cost of sales of $261 million and $210 million for the years ended December 31, 2022 and 2021, respectively.​​​​​​​​​​December 31,​December 31,($ in millions) 2022 2021​​​​​​​Current assets​$ 2,478​$ 2,575Noncurrent assets​​ 15,764​​ 14,818Current liabilities​​ 6,032​​ 5,067Noncurrent liabilities​​ 10,790​​ 10,989​Included in the amounts disclosed in the tables above, at December 31, 2022 and 2021, the obligor group held receivables due from other subsidiary companies of $477 million and $436 million, respectively, long-term notes receivable due from other subsidiary companies of $9.89 billion and $9.22 billion, respectively, payables due to other subsidiary companies of $2.22 billion and $2.03 billion, respectively, and long-term notes payable due to other subsidiary companies of $2.21 billion and $1.99 billion, respectively. ​For the years ended December 31, 2022 and 2021, the obligor group recorded the following transactions with other subsidiary companies: sales to them of $1.50 Billion and $803 million, respectively, net credits from them of $19 million and $18 million, respectively, and net interest income from them of $329 million and $337 million, respectively. During the years ended December 31, 2022 and 2021, the obligor group received dividends from other subsidiary companies of $18 million and $269 million, respectively.​A description of the terms and conditions of the company’s debt guarantees is located in Note 23 to the consolidated financial statements within Item 8 of this annual report.​36 Table of ContentsFORWARD-LOOKING STATEMENTS​This report contains “forward-looking” statements concerning future events and financial performance. Words such as “expects,” “anticipates,” “estimates,” “believes,” and similar expressions typically identify forward-looking statements, which are generally any statements other than statements of historical fact. Such statements are based on current expectations or views of the future and are subject to risks and uncertainties, which could cause actual results or events to differ materially from those expressed or implied. You should therefore not place undue reliance upon any forward-looking statements and they should be read in conjunction with, and qualified in their entirety by, the cautionary statements referenced below. Ball undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Key factors, risks and uncertainties that could cause actual outcomes and results to be different are summarized in filings with the Securities and Exchange Commission, including Exhibit 99 in Ball’s Form 10-K, which are available on Ball’s website and at www.sec.gov. Additional factors that might affect: a) Ball’s packaging segments include product capacity, supply, and demand constraints and fluctuations and changes in consumption patterns; availability/cost of raw materials, equipment, and logistics; competitive packaging, pricing and substitution; changes in climate and weather and related events such as drought, wildfires, storms, hurricanes, tornadoes and floods; footprint adjustments and other manufacturing changes, including the startup of new facilities and lines; failure to achieve synergies, productivity improvements or cost reductions; unfavorable mandatory deposit or packaging laws; customer and supplier consolidation; power and supply chain interruptions; changes in major customer or supplier contracts or loss of a major customer or supplier; inability to pass through increased costs; war, political instability and sanctions, including relating to the situation in Russia and Ukraine and its impact on Ball’s supply chain and its ability to operate in Europe, the Middle East and Africa regions generally; changes in foreign exchange or tax rates; and tariffs, trade actions, or other governmental actions, including business restrictions and orders affecting goods produced by Ball or in its supply chain, including imported raw materials; b) Ball’s aerospace segment include funding, authorization, availability and returns of government and commercial contracts; and delays, extensions and technical uncertainties affecting segment contracts; c) Ball as a whole include those listed above plus: the extent to which sustainability-related opportunities arise and can be capitalized upon; changes in senior management, succession, and the ability to attract and retain skilled labor; regulatory actions or issues including those related to tax, environmental, social and governance reporting, competition, environmental, health and workplace safety, including U.S. Federal Drug Administration and other actions or public concerns affecting products filled in Ball’s containers, or chemicals or substances used in raw materials or in the manufacturing process; technological developments and innovations; the ability to manage cyber threats; litigation; strikes; disease; pandemic; labor cost changes; inflation; rates of return on assets of Ball’s defined benefit retirement plans; pension changes; uncertainties surrounding geopolitical events and governmental policies, including policies, orders, and actions related to COVID-19; reduced cash flow; interest rates affecting Ball’s debt; and successful or unsuccessful joint ventures, acquisitions and divestitures, and their effects on Ball’s operating results and business generally.​Item 7A. Quantitative and Qualitative Disclosures About Market Risk​Financial Instruments and Risk Management​The company employs established risk management policies and procedures which seek to reduce the company’s commercial risk exposure to fluctuations in commodity prices, interest rates, currency exchange rates and prices of the company’s common stock with regard to common share repurchases and the company’s deferred compensation stock plan. However, there can be no assurance that these policies and procedures will be successful. Although the instruments utilized involve varying degrees of credit, market and interest risk, the counterparties to the agreements are expected to perform fully under the terms of the agreements. The company monitors counterparty credit risk, including lenders, on a regular basis, but Ball cannot be certain that all risks will be discerned or that its risk management policies and procedures will always be effective. Additionally, in the event of default under the company’s master derivative agreements, the non-defaulting party has the option to set off any amounts owed with regard to open derivative positions. ​We have estimated our market risk exposure using sensitivity analysis. Market risk exposure has been defined as the changes in fair value of derivative instruments, financial instruments and commodity positions. To test the sensitivity of our market risk exposure, we have estimated the changes in fair value of market risk sensitive instruments assuming a hypothetical 10 percent adverse change in market prices or rates. The results of the sensitivity analyses are summarized below.​37 Table of ContentsCommodity Price Risk​Aluminum​We manage commodity price risk in connection with market price fluctuations of aluminum through two different methods. First, we enter into container sales contracts that include aluminum-based pricing terms that generally reflect the same price fluctuations included in commercial purchase contracts for aluminum sheet. The terms include fixed, floating or pass-through aluminum component pricing. Second, we use derivative instruments as economic and cash flow hedges of commodity price risk where there are material differences between sales and purchase contracted pricing and volume.​Considering the effects of derivative instruments, the company’s ability to pass through certain raw material costs through contractual provisions, the market’s ability to accept price increases and the company’s commodity price exposures under its contract terms, a hypothetical 10 percent adverse change in the company’s aluminum prices would result in an estimated $3 million after-tax reduction in net earnings over a one-year period. Additionally, the company has currency exposures on raw materials and the effect of a 10 percent adverse change is included in the total currency exposure discussed below. Actual results may vary based on actual changes in market prices and rates.​Interest Rate Risk​Our objective in managing exposure to interest rate changes is to minimize the impact of interest rate changes on earnings and cash flows and to minimize our overall borrowing and receivables factoring costs. To achieve these objectives, we may use a variety of derivative instruments to manage our mix of floating and fixed-rate debt. Interest rate instruments held by the company at December 31, 2022, included pay-fixed interest rate swaps and options which effectively convert variable rate obligations to fixed-rate instruments.​Based on our interest rate exposure at December 31, 2022, assumed floating rate debt levels throughout the next 12 months and the effects of our existing derivative instruments, a 100-basis point increase in interest rates would result in an estimated $10 million after-tax reduction in net earnings over a one-year period. Actual results may vary based on actual changes in market prices and rates and the timing of these changes.​Currency Exchange Rate Risk​Our objective in managing exposure to currency fluctuations is to limit the exposure of cash flows and earnings from changes associated with currency exchange rate changes through the use of various derivative contracts. In addition, at times Ball manages earnings translation volatility through the use of currency derivative strategies, and the change in the fair value of those derivatives is recorded in the company’s net earnings. Our currency translation risk results from the currencies in which we transact business. The company faces currency exposures in our global operations as a result of various factors including intercompany currency denominated loans, selling our products in various currencies, purchasing raw materials and equipment in various currencies and tax exposures not denominated in the functional currency. Sales contracts are negotiated with customers to reflect cost changes and, where there is not an exchange pass-through arrangement, the company may use derivative instruments to manage significant currency exposures.​Considering the company’s derivative financial instruments outstanding at December 31, 2022, and the various currency exposures, a hypothetical 10 percent reduction (U.S. dollar strengthening) in currency exchange rates compared to the U.S. dollar would result in an estimated $15 million after-tax reduction in net earnings over a one-year period. A hypothetical 10 percent adverse change in the U.S. dollar’s currency exchange rates would increase our forecasted average debt balance by approximately $170 million. Actual changes in market prices or rates may differ from hypothetical changes.​​38 Table of Contents
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+ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSOverviewW. R. Berkley Corporation is an insurance holding company that is among the largest commercial lines writers in the United States and operates worldwide in two segments of the property and casualty business: Insurance and Reinsurance & Monoline Excess. Our decentralized structure provides us with the flexibility to respond quickly and efficiently to local or specific market conditions and to pursue specialty business niches. It also allows us to be closer to our customers in order to better understand their individual needs and risk characteristics. While providing our business units with certain operating autonomy, our structure allows us to capitalize on the benefits of economies of scale through centralized capital, investment, reinsurance, enterprise risk management, and actuarial, financial and corporate legal staff support. The Company’s primary sources of revenues and earnings are its insurance operations and its investments.An important part of our strategy is to form new businesses to capitalize on various opportunities. Over the years, the Company has formed numerous businesses that are focused on important parts of the economy in the U.S., including healthcare, cyber security, energy and agriculture, and on growing international markets, including the Asia-Pacific region, South America and Mexico.The profitability of the Company’s insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known with certainty at the time an insurance policy is issued because premiums are determined before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and change the extent of coverage and the effects of economic or social inflation on the amount of compensation for injuries or losses. General insurance prices are also influenced by available insurance capacity, i.e., the level of capital employed in the industry, and the industry’s willingness to deploy that capital.The Company’s profitability is also affected by its investment income and investment gains. The Company’s invested assets are invested principally in fixed maturity securities. The return on fixed maturity securities is affected primarily by general interest rates, as well as the credit quality and duration of the securities.The Company also invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income. The Company's share of the earnings or losses from investment funds is generally reported on a one-quarter lag in order to facilitate the timely completion of the Company's consolidated financial statements.On February 25, 2022, the Company announced that its Board of Directors approved a 3-for-2 common stock split which was paid in the form of a stock dividend to holders of record as of March 9, 2022. The additional shares were issued on March 23, 2022. Shares outstanding and per share amounts in this Form 10-K reflect such 3-for-2 common stock split.On March 7, 2022, the Company sold a real estate investment consisting of an office building located in London for £718 million. The Company realized a pretax gain of $317 million in the first quarter of 2022, before transaction expenses and the impact of foreign currency, including the reversal of the currency translation adjustment. The gain was $251 million after such adjustments.The COVID-19 pandemic, including the related impact on the U.S. and global economies, continued to adversely affect our results of operations. At the same time, COVID-19 has led to reduced loss frequency in certain lines of business (which partially returned to pre-pandemic levels as many economies and legal systems have reopened). The ultimate impact of COVID-19 on the economy and the Company’s results of operations, financial position and liquidity is not within the Company’s control and remains unclear due to, among other factors, its ongoing impact and uncertainty in connection with its claims, reserves and reinsurance recoverables.39Critical Accounting EstimatesThe following presents a discussion of accounting policies and estimates relating to reserves for losses and loss expenses, assumed reinsurance premiums and other-than-temporary impairments of investments. Management believes these policies and estimates are the most critical to its operations and require the most difficult, subjective and complex judgments. Reserves for Losses and Loss Expenses. To recognize liabilities for unpaid losses, either known or unknown, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. Estimates and assumptions relating to reserves for losses and loss expenses are based on complex and subjective judgments, often including the interplay of specific uncertainties with related accounting and actuarial measurements. Such estimates are also susceptible to change as significant periods of time may elapse between the occurrence of an insured loss, the report of the loss to the insurer, the ultimate determination of the cost of the loss and the insurer’s payment of that loss. In general, when a claim is reported, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment based upon known information about the claim at that time. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis to provide for losses incurred but not reported (“IBNR”) to the insurer, potential inadequacy of case reserves and the estimated expenses of settling claims, including legal and other fees and general expenses of administrating the claims adjustment process. Reserves are established based upon the then current legal interpretation of coverage provided. In examining reserve adequacy, several factors are considered in estimating the ultimate economic value of losses. These factors include, among other things, historical data, legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, adjusted judgmentally for the effects of current developments and anticipated trends, is an appropriate basis for predicting future outcomes. Reserve amounts are based on management’s informed estimates and judgments using currently available data. As additional experience and other data become available and are reviewed, these estimates and judgments may be revised. This may result in reserve increases or decreases that would be reflected in our results in periods in which such estimates and assumptions are changed. Reserves do not represent a certain calculation of liability. Rather, reserves represent an estimate of what management expects the ultimate settlement and claim administration will cost. While the methods for establishing reserves are well tested over time, the major assumptions about anticipated loss emergence patterns are subject to uncertainty. These estimates, which generally involve actuarial projections, are based on management’s assessment of facts and circumstances then known, as well as estimates of trends in claims severity and frequency, judicial theories of liability and other factors, including the actions of third parties which are beyond the Company’s control. These variables are affected by external and internal events, such as inflation and economic volatility, judicial and litigation trends, reinsurance coverage, legislative changes and claim handling and reserving practices, which make it more difficult to accurately predict claim costs. The inherent uncertainties of estimating reserves are greater for certain types of liabilities where long periods of time elapse before a definitive determination of liability is made. Because setting reserves is inherently uncertain, the Company cannot provide assurance that its current reserves will prove adequate in light of subsequent events. Loss reserves included in the Company’s financial statements represent management’s best estimates based upon an actuarially derived point estimate and other considerations. The Company uses a variety of actuarial techniques and methods to derive an actuarial point estimate for each business. These methods include paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency and severity methods. In circumstances where one actuarial method is considered more credible than the others, that method is used to set the point estimate. For example, the paid loss and incurred loss development methods rely on historical paid and incurred loss data. For new lines of business, where there is insufficient history of paid and incurred claims data, or in circumstances where there have been significant changes in claim practices, the paid and incurred loss development methods would be less credible than other actuarial methods. The actuarial point estimate may also be based on a judgmental weighting of estimates produced from each of the methods considered. Industry loss experience is used to supplement the Company’s own data in selecting “tail factors” and in areas where the Company’s own data is limited. The actuarial data is analyzed by line of business, coverage and accident or policy year, as appropriate, for each business. The establishment of the actuarially derived loss reserve point estimate also includes consideration of qualitative factors that may affect the ultimate losses. These qualitative considerations include, among others, the impact of re-underwriting initiatives, changes in the mix of business, changes in distribution sources and changes in policy terms and conditions. Examples of changes in terms and conditions that can have a significant impact on reserve levels are the use of aggregate policy limits, the expansion of coverage exclusions, whether or not defense costs are within policy limits, and changes in deductibles and attachment points. 40The key assumptions used to arrive at the best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, and reported and paid loss emergence patterns. Expected loss ratios represent management’s expectation of losses at the time the business is priced and written, before any actual claims experience has emerged. This expectation is a significant determinant of the estimate of loss reserves for recently written business where there is little paid or incurred loss data to consider. Expected loss ratios are generally derived from historical loss ratios adjusted for the impact of rate changes, loss cost trends and known changes in the type of risks underwritten. Expected loss ratios are estimated for each key line of business within each business. Expected loss cost inflation is particularly important for the long-tail lines, such as excess casualty, and claims with a high medical component, such as workers’ compensation. Reported and paid loss emergence patterns are used to project current reported or paid loss amounts to their ultimate settlement value. Loss development factors are based on the historical emergence patterns of paid and incurred losses, and are derived from the Company’s own experience and industry data. The paid loss emergence pattern is also significant to excess and assumed workers’ compensation reserves because those reserves are discounted to their estimated present value based upon such estimated payout patterns. Management believes the estimates and assumptions it makes in the reserving process provide the best estimate of the ultimate cost of settling claims and related expenses with respect to insured events which have occurred; however, different assumptions and variables could lead to significantly different reserve estimates. Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described in our discussion of loss and loss expense reserves, including expected loss ratios, rate of loss cost inflation and reported and paid loss emergence patterns. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations. Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to the Company. The length of the loss reporting lag affects our ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags) as well as the amount of reserves needed for incurred but not reported losses (less IBNR is required for lines with short reporting lags). As a result, loss reserves for lines with short reporting lags are likely to have less variation from initial loss estimates. For lines with short reporting lags, which include commercial automobile, primary workers’ compensation, other liability (claims-made) and property business, the key assumption is the loss emergence pattern used to project ultimate loss estimates from known losses paid or reported to date. For lines of business with long reporting lags, which include other liability (occurrence), products liability, excess workers’ compensation and liability reinsurance, the key assumption is the expected loss ratio since there is often little paid or incurred loss data to consider. Historically, the Company has experienced less variation from its initial loss estimates for lines of businesses with short reporting lags than for lines of business with long reporting lags. The key assumptions used in calculating the most recent estimate of the loss reserves are reviewed each quarter and adjusted, to the extent necessary, to reflect the latest reported loss data, current trends and other factors observed. If the actual level of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s estimate. The following table reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity, relative to our assumptions, on our loss estimate for claims occurring in 2022: (In thousands)Frequency (+/-)Severity (+/-)1%5%10%1%$116,072 $349,370 $640,993 5%349,370 591,908 895,081 10%640,993 895,081 1,212,690 Our net reserves for losses and loss expenses of approximately $14.2 billion as of December 31, 2022 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above. The impact of such changes would likely be manifested gradually over the course of many years, as the magnitude of the changes became evident.Approximately $3.0 billion, or 21%, of the Company’s net loss reserves as of December 31, 2022 relate to the Reinsurance & Monoline Excess segment. There is a higher degree of uncertainty and greater variability regarding estimates of excess workers' compensation and assumed reinsurance loss reserves. In the case of excess workers’ compensation, our policies generally attach at $1 million or higher. The claims which reach our layer therefore tend to involve the most serious injuries and many remain open for the lifetime of the claimant, which extends the claim settlement tail. These claims also occur less frequently but tend to be larger than primary claims, which increases claim variability. In the case of assumed reinsurance our loss reserve estimates are based, in part, upon information received from ceding companies. If information received from ceding companies is not timely or correct, the Company’s estimate of ultimate losses may not be accurate. Furthermore, due to 41delayed reporting of claim information by ceding companies, the claim settlement tail for assumed reinsurance is also extended. Management considers the impact of delayed reporting and the extended tail in its selection of loss development factors for these lines of business.Information received from ceding companies is used to set initial expected loss ratios, to establish case reserves and to estimate reserves for incurred but not reported losses on assumed reinsurance business. This information, which is generally provided through reinsurance intermediaries, is gathered through the underwriting process and from periodic claim reports and other correspondence with ceding companies. The Company performs underwriting and claim audits of selected ceding companies to determine the accuracy and completeness of information provided to the Company. The information received from the ceding companies is supplemented by the Company’s own loss development experience with similar lines of business as well as industry loss trends and loss development benchmarks.Following is a summary of the Company’s reserves for losses and loss expenses by business segment as of December 31, 2022 and 2021: (In thousands)20222021Insurance$11,233,924 $10,060,420 Reinsurance & Monoline Excess3,014,955 2,787,942 Net reserves for losses and loss expenses14,248,879 12,848,362 Ceded reserves for losses and loss expenses2,762,344 2,542,526 Gross reserves for losses and loss expenses$17,011,223 $15,390,888 Following is a summary of the Company’s net reserves for losses and loss expenses by major line of business as of December 31, 2022 and 2021: (In thousands)Reported CaseReservesIncurred ButNot ReportedTotalDecember 31, 2022Other liability$1,808,700 $3,826,444 $5,635,144 Workers’ compensation (1)1,023,961 899,215 1,923,176 Professional liability501,572 1,243,604 1,745,176 Commercial automobile629,149 528,398 1,157,547 Short-tail lines (2)403,974 368,907 772,881 Total Insurance4,367,356 6,866,568 11,233,924 Reinsurance & Monoline Excess (1) (3)1,551,687 1,463,268 3,014,955 Total$5,919,043 $8,329,836 $14,248,879 December 31, 2021Other liability$1,724,907 $3,319,665 $5,044,572 Workers’ compensation (1)1,016,014 903,448 1,919,462 Professional liability468,680 1,019,344 1,488,024 Commercial automobile504,821 424,382 929,203 Short-tail lines (2)322,917 356,242 679,159 Total Insurance4,037,339 6,023,081 10,060,420 Reinsurance & Monoline Excess (1) (3)1,475,623 1,312,319 2,787,942 Total$5,512,962 $7,335,400 $12,848,362 ____________________(1)Reserves for excess and assumed workers’ compensation business are net of an aggregate net discount of $416 million and $452 million as of December 31, 2022 and 2021, respectively.(2)Short-tail lines include commercial multi-peril (non-liability), inland marine, accident and health, fidelity and surety, boiler and machinery and other lines.(3)Reinsurance & Monoline Excess includes property and casualty reinsurance as well as operations that solely retain risk on an excess basis.42The Company evaluates reserves for losses and loss expenses on a quarterly basis. Changes in estimates of prior year losses are reported when such changes are made. The changes in prior year loss reserve estimates are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims and aggregate claim trends. Certain of the Company's insurance and reinsurance contracts are retrospectively rated, whereby the Company collects more or less premiums based on the level of loss activity. For those contracts, changes in loss and loss expenses for prior years may be fully or partially offset by additional or return premiums. Net prior year development (i.e, the sum of prior year reserve changes and prior year earned premiums changes) for each of the last three years ended December 31, are as follows:(In thousands)202220212020Increase in prior year loss reserves$(54,511)$(863)$(627)Increase in prior year earned premiums18,106 7,510 16,807 Net (unfavorable) favorable prior year development$(36,405)$6,647 $16,180 The COVID-19 global pandemic has impacted, and may further impact, the Company’s results through its effect on claim frequency and severity. Loss cost trends have been impacted and may be further impacted by COVID-19-related claims in certain lines of business. Losses incurred from COVID-19-related claims have been offset, to a certain extent, by lower claim frequency in certain lines of our businesses; however, as the economy and legal systems have reopened, the benefit of lower claim frequency has partially abated. The ultimate net impact of COVID-19 on the Company remains uncertain. New variants of the COVID-19 virus continue to create risks with respect to loss costs and the potential for renewed impact of the other effects of COVID-19 associated with economic conditions, inflation, and social distancing and work from home rules.Most of the COVID-19-related claims reported to the Company to date involve certain short-tailed lines of business, including contingency and event cancellation, business interruption, and film production delay. The Company has also received COVID-19-related claims for longer-tailed casualty lines of business such as workers’ compensation and other liability; however, the estimated incurred loss impact for these reported claims are not material at this time. Given the continuing uncertainty regarding the pandemic's pervasiveness, the future impact that the pandemic may have on claim frequency and severity remains uncertain at this time.The Company has estimated the potential COVID-19 impact to its contingency and event cancellation, workers’ compensation, and other lines of business under a number of possible scenarios; however, due to COVID-19’s continued evolving impact, there remains uncertainty around the Company’s COVID-19 reserves. In addition, should the pandemic continue or worsen as a result of new COVID-19 variants or otherwise, governments in the jurisdictions where we operate may impose restrictions, including lockdowns, as well as renew their efforts to expand policy coverage terms beyond the policy’s intended coverage. Accordingly, losses arising from these actions, and the other factors described above, could exceed the Company’s reserves established for those related policies.As of December 31, 2022, the Company had recognized losses for COVID-19-related claims activity, net of reinsurance, of approximately $341 million, of which $290 million relates to the Insurance segment and $51 million relates to the Reinsurance & Monoline Excess segment. Such $341 million of COVID-19-related losses included $337 million of reported losses and $4 million of IBNR. For the year ended December 31, 2022, the Company recognized current accident year losses for COVID-19-related claims activity, net of reinsurance, of approximately $5 million, of which $3 million relates to the Insurance segment and $2 million relates to the Reinsurance & Monoline Excess segment.Unfavorable prior year development (net of additional and return premiums) was $36 million in 2022.Insurance – Reserves for the Insurance segment developed unfavorably by $40 million in 2022 (net of additional and return premiums). The unfavorable development in the segment primarily related to COVID-19 losses at two businesses. These businesses wrote policies providing coverage for event cancellation and film production delay which were heavily impacted by losses directly caused by the COVID-19 pandemic. Most of this COVID-19 related unfavorable development emerged during the third quarter as a result of settlements of claims at values higher than our expectations. However, the Company believes that as a result of these settlements the remaining level of uncertainty around the ultimate value of its known COVID-19 claims has been significantly reduced.The unfavorable development mentioned above also includes favorable prior year development for the Insurance segment primarily attributable to the 2020 and 2021 accident years and unfavorable development on the 2015 through 2019 accident years. The favorable development on the 2020 and 2021 accident years was concentrated in certain casualty lines of business including general liability, professional liability, and workers’ compensation. The Company experienced lower 43reported claim frequency in these lines of business during 2020 and 2021 relative to historical averages, and continued to experience lower reported incurred losses relative to its expectations for these accident years as they developed during 2022. These trends began in 2020 and we believe were caused by the impacts of the COVID-19 pandemic, including for example, lockdowns, reduced driving/traffic and increased work from home. Due to the ongoing uncertainty regarding the ultimate impacts of the pandemic on accident years 2020 and 2021 incurred losses, the Company has been cautious in reacting to these lower trends in setting and updating its loss ratio estimates for these years. As these accident years have continued to mature, the Company has continued to recognize some of the favorable reported experience in its ultimate loss estimates made during 2022. The unfavorable development on the 2015 through 2019 accident years was concentrated in the general liability and professional liability, including medical professional, lines of business, as well as commercial auto liability. The development was driven by a larger than expected number of large losses reported. The Company believes social inflation is contributing to an increase in the frequency of large losses for these accident years. Social inflation can include higher settlement demands from plaintiffs, use of tactics such as litigation funding by the plaintiffs’ bar, negative public sentiment towards large businesses and corporations, and erosion of tort reforms, among others.Reinsurance & Monoline Excess – Reserves for the Reinsurance & Monoline Excess segment developed favorably by $4 million in 2022 (net of additional and return premiums). The overall favorable development for the segment was driven mainly by favorable development in excess workers compensation, substantially offset by unfavorable development in the professional liability and non-proportional reinsurance assumed liability lines of business. The favorable excess workers’ compensation development was spread across most prior accident years, including 2012 and prior years, and was driven by a review of the Company’s claim reporting patterns as well as a number of favorable claim settlements relative to expectations. The unfavorable professional liability and non-proportional reinsurance assumed liability development was concentrated mainly in accident years 2016 through 2018 and was associated primarily with our U.S. assumed reinsurance business and related to accounts insuring construction projects and professional liability exposures.Favorable prior year development (net of additional and return premiums) was $7 million in 2021.Insurance – Reserves for the Insurance segment developed favorably by $20 million in 2021 (net of additional and return premiums). The overall favorable development in 2021 was attributable to favorable development on the 2020 accident year, partially offset by adverse development on the 2016 through 2019 accident years.The favorable development on the 2020 accident year was largely concentrated in the commercial auto liability and other liability lines of business, including commercial multi-peril liability. During 2020 the Company achieved larger rate increases in these lines of business than were contemplated in its budget and in its initial loss ratio selections. The Company also experienced significantly lower reported claim frequency in these lines in 2020 relative to historical averages, and lower reported incurred losses relative to its expectations. We believe that the lower claim frequency and lower reported incurred losses were caused by the impacts of the COVID-19 pandemic, for example, lockdowns, reduced driving and traffic, work from home, and court closures. However, due to the uncertainty regarding the ultimate impacts of the pandemic on accident year 2020 incurred losses, the Company elected not to react to these lower reported trends during 2020. As more information became available and the 2020 accident year continued to mature, during 2021 the Company started to recognize favorable accident year 2020 development in response to the continuing favorable reported loss experience relative to its expectations. The adverse development on the 2016 through 2019 accident years is concentrated largely in the other liability line of business, including commercial multi-peril liability, but is also seen to a lesser extent in commercial auto liability. The adverse development for these accident years is driven by a higher than expected number of large losses reported, and particularly impacted the directors and officers liability, lawyers professional liability, and excess and surplus lines casualty classes of business. We also believe that increased social inflation is contributing to the increased number of large losses, for example, higher jury awards on cases which go to trial, and the corresponding higher demands from plaintiffs and higher values required to reach settlement on cases which do not go to trial.Reinsurance & Monoline Excess – Reserves for the Reinsurance & Monoline Excess segment developed unfavorably by $13 million in 2021. The unfavorable development in the segment was driven by the non-proportional reinsurance assumed liability and other liability lines of business, related primarily to accident years 2017 through 2019, and was partially offset by favorable development in excess workers’ compensation business which was spread across many prior accident years. The unfavorable non-proportional reinsurance assumed liability and other liability development was associated with our U.S. and U.K. assumed reinsurance business, and related primarily to accounts insuring construction projects and professional liability exposures.44Favorable prior year development (net of additional and return premiums) was $16 million in 2020. Insurance - Reserves for the Insurance segment developed favorably by $24 million in 2020 (net of additional and return premiums). Continuing the pattern seen in recent years, the overall favorable development in 2020 resulted from more significant favorable development on workers’ compensation business, which was partially offset by unfavorable development on professional liability, including excess professional liabilityFor workers’ compensation, the favorable development was spread across almost all prior accident years, including prior to 2011, but was most significant in accident years 2016 through 2019. The favorable workers’ compensation development reflects a continuation of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The long term trend of declining workers’ compensation frequency can be attributable to improved workplace safety. Loss severity trends were also aided by our continued investment in claims handling initiatives such as medical case management services and vendor savings through usage of preferred provider networks and pharmacy benefit managers. Reported workers’ compensation losses in 2020 continued to be below our expectations at most of our businesses, and were below the assumptions underlying our initial loss ratio picks and our previous reserve estimates for most prior accident years. For professional liability business, unfavorable development was driven mainly by large losses reported in the directors and officers (“D&O”), lawyers professional and excess hospital professional liability lines of business. For these lines of business, we continue to see an increase in the number of large losses reported and a lengthening of the reporting “tail” beyond historical levels. We believe a contributing cause is rising social inflation in the form of, for example, higher jury awards on cases that go to trial, and the corresponding higher demands from plaintiffs and higher values required to reach settlement on cases that do not go to trial. The unfavorable development for professional liability affected mainly accident years 2016 through 2018.Reinsurance & Monoline Excess – Reserves for the Reinsurance & Monoline Excess segment developed unfavorably by $8 million in 2020. The unfavorable development in the segment was driven by non-proportional assumed liability business written in both the U.S. and U.K., and was partially offset by favorable development on excess workers’ compensation business. The unfavorable non-proportional assumed liability development was concentrated in accident years 2014 through 2018, and related primarily to accounts insuring construction projects and professional liability exposures.Reserve Discount. The Company discounts its liabilities for certain workers’ compensation reserves. The amount of workers’ compensation reserves that were discounted was $1,267 million and $1,387 million at December 31, 2022 and 2021, respectively. The aggregate net discount for those reserves, after reflecting the effects of ceded reinsurance, was $416 million and $452 million at December 31, 2022 and 2021, respectively. At December 31, 2022, discount rates by year ranged from 0.7% to 6.5%, with a weighted average discount rate of 3.4%.Substantially all discounted workers’ compensation reserves (97% of total discounted reserves at December 31, 2022) are excess workers’ compensation reserves. In order to properly match loss expenses with income earned on investment securities supporting the liabilities, reserves for excess workers’ compensation business are discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve. These rates are determined annually based on the weighted average rate for the period. Once established, no adjustments are made to the discount rate for that period, and any increases or decreases in loss reserves in subsequent years are discounted at the same rate, without regard to when any such adjustments are recognized. The expected loss and loss expense payout patterns subject to discounting are derived from the Company’s loss payout experience.The Company also discounts reserves for certain other long-duration workers’ compensation reserves (representing approximately 3% of total discounted reserves at December 31, 2022), including reserves for quota share reinsurance and reserves related to losses regarding occupational lung disease. These reserves are discounted at statutory rates prescribed or permitted by the Department of Insurance of the State of Delaware.Assumed Reinsurance Premiums. The Company estimates the amount of assumed reinsurance premiums that it will receive under treaty reinsurance agreements at the inception of the contracts. These premium estimates are revised as the actual amount of assumed premiums is reported to the Company by the ceding companies. As estimates of assumed premiums are made or revised, the related amount of earned premiums, commissions and incurred losses associated with those premiums are recorded. Estimated assumed premiums receivable were approximately $60 million at both December 31, 2022 and 2021. The assumed premium estimates are based upon terms set forth in reinsurance agreements, information received from ceding companies during the underwriting and negotiation of agreements, reports received from ceding companies and discussions and correspondence with reinsurance intermediaries. The Company also considers its own view of market conditions, economic trends and experience with similar lines of business. These premium estimates represent management’s best estimate of the ultimate amount of premiums to be received under its assumed reinsurance agreements.45Allowance for Expected Credit Losses on Investments.Fixed Maturity Securities – For fixed maturity securities in an unrealized loss position where the Company intends to sell, or it is more likely than not that it will be required to sell the security before recovery in value, the amortized cost basis is written down to fair value through net investment gains (losses). For fixed maturity securities in an unrealized loss position where the Company does not intend to sell, or it is more likely than not that it will not be required to sell the security before recovery in value, the Company evaluates whether the decline in fair value has resulted from credit losses or all other factors (non-credit factors). In making this assessment, the Company considers the extent to which fair value is less than amortized cost, changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, an allowance for expected credit losses is recorded for the credit loss through net investment gains (losses), limited by the amount that the fair value is less than the amortized cost basis. Effective January 1, 2020, the allowance is adjusted for any change in expected credit losses and subsequent recoveries through net investment gains (losses). The impairment related to non-credit factors is recognized in other comprehensive income (loss). The Company’s credit assessment of allowance for expected credit losses uses a third party model for available for sale and held to maturity securities, as well as loans receivable. The allowance for expected credit losses is generally based on the performance of the underlying collateral under various economic and default scenarios that involve subjective judgments and estimates by management. Modeling these securities involves various factors, such as projected default rates, the nature and realizable value of the collateral, if any, the ability of the issuer to make scheduled payments, historical performance and other relevant economic and performance factors. A discounted cash flow analysis is used to ascertain the amount of the allowance for expected credit losses, if any. In general, the model reverts to the rating-level long-term average marginal default rates based on 10 years of historical data, beyond the forecast period. For other inputs, the model in most cases reverts to the baseline long-term assumptions linearly over 5 years beyond the forecast period. The long-term assumptions are based on the historical averages. The Company classifies its fixed maturity securities by credit rating, primarily based on ratings assigned by credit rating agencies. For purposes of classifying securities with different ratings, the Company uses the average of the credit ratings assigned, unless in limited situations the Company’s own analysis indicates an internal rating is more appropriate. Securities that are not rated by a rating agency are evaluated and classified by the Company on a case-by-case basis.A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at December 31, 2022 is presented in the table below. ($ in thousands)Number ofSecuritiesAggregateFair ValueUnrealizedLossForeign government36 $119,332 $73,900 Corporate10 39,347 4,649 State and municipal1 12,247 2,756 Mortgage-backed securities14 4,464 269 Asset-backed securities1 16 10 Total62 $175,406 $81,584 As of December 31, 2022, the Company has recorded an allowance for expected credit losses on fixed maturity securities of $37 million. The Company has evaluated the remaining fixed maturity securities in an unrealized loss position and believes the unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors. None of these securities are delinquent or in default under financial covenants. Based on its assessment of these issuers, the Company expects them to continue to meet their contractual payment obligations as they become due.Loans Receivable – For loans receivable, the Company estimates an allowance for expected credit losses based on relevant information about past events, including historical loss experience, current conditions and forecasts that affect the expected collectability of the amortized cost of the financial asset. The allowance for expected credit losses is presented as a reduction to amortized cost of the financial asset in the consolidated balance sheet and changes to the estimate for expected credit losses are recognized through net investment gains (losses). Loans receivable are reported net of an allowance for expected credit losses of $2 million as of both December 31, 2022 and 2021.Fair Value Measurements. The Company’s fixed maturity available for sale securities, equity securities, and its trading account securities are carried at fair value. Fair value is defined as "the price that would be received to sell an asset or 46paid to transfer a liability in an orderly transaction between market participants at the measurement date". The Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for similar assets in active markets. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs may only be used to measure fair value to the extent that observable inputs are not available. The fair value of the vast majority of the Company’s portfolio is based on observable data (other than quoted prices) and, accordingly, is classified as Level 2.In classifying particular financial securities in the fair value hierarchy, the Company uses its judgment to determine whether the market for a security is active and whether significant pricing inputs are observable. The Company determines the existence of an active market by assessing whether transactions occur with sufficient frequency and volume to provide reliable pricing information. The Company determines whether inputs are observable based on the use of such information by pricing services and external investment managers, the uninterrupted availability of such inputs, the need to make significant adjustments to such inputs and the volatility of such inputs over time. If the market for a security is determined to be inactive or if significant inputs used to price a security are determined to be unobservable, the security is categorized in Level 3 of the fair value hierarchy.Because many fixed maturity securities do not trade on a daily basis, the Company utilizes pricing models and processes which may include benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Market inputs used to evaluate securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Quoted prices are often unavailable for recently issued securities that are infrequently traded or securities that are only traded in private transactions. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial data, projections and business developments of the issuer and other relevant information.The following is a summary of pricing sources for the Company's fixed maturity securities available for sale as of December 31, 2022:(In thousands)CarryingValuePercentof TotalPricing source:Independent pricing services$17,025,723 97.1 %Syndicate manager62,966 0.4 Directly by the Company based on:Observable data447,364 2.5 Total$17,536,053 100.0 %Independent pricing services - Substantially all of the Company’s fixed maturity securities available for sale were priced by independent pricing services (generally one U.S. pricing service plus additional pricing services with respect to a limited number of foreign securities held by the Company). The prices provided by the independent pricing services are generally based on observable market data in active markets (e.g., broker quotes and prices observed for comparable securities). The determination of whether markets are active or inactive is based upon the volume and level of activity for a particular asset class. The Company reviews the prices provided by pricing services for reasonableness based upon current trading levels for similar securities. If the prices appear unusual to the Company, they are re-examined and the value is either confirmed or revised. In addition, the Company periodically performs independent price tests of a sample of securities to ensure proper valuation and to verify our understanding of how securities are priced. As of December 31, 2022, the Company did not make any adjustments to the prices provided by the pricing services. Based upon the Company’s review of the methodologies used by the independent pricing services, these securities were classified as Level 2.Syndicate manager – The Company has a 15% participation in a Lloyd’s syndicate, and the Company’s share of the securities owned by the syndicate is priced by the syndicate’s manager. The majority of the securities are liquid, short duration fixed maturity securities. The Company reviews the syndicate manager’s pricing methodology and audited financial statements and holds discussions with the syndicate manager as necessary to confirm its understanding and agreement with security prices. Based upon the Company’s review of the methodologies used by the syndicate manager, these securities were classified as Level 2.47Observable data – If independent pricing is not available, the Company prices the securities directly. Prices are based on observable market data where available, including current trading levels for similar securities and non-binding quotations from brokers. The Company generally requests two or more quotes. If more than one quote is received, the Company sets a price within the range of quotes received based on its assessment of the credibility of the quote and its own evaluation of the security. The Company generally does not adjust quotes obtained from brokers. Since these securities were priced based on observable data, they were classified as Level 2.Cash flow model – If the above methodologies are not available, the Company prices securities using a discounted cash flow model based upon assumptions as to prevailing credit spreads, interest rates and interest rate volatility, time to maturity and subordination levels. Discount rates are adjusted to reflect illiquidity where appropriate. These securities were classified as Level 3.48Results of Operations for the Years Ended December 31, 2022 and 2021 Business Segment ResultsFollowing is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of net premiums earned), expense ratios (underwriting expenses expressed as a percentage of net premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the years ended December 31, 2022 and 2021. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit. (In thousands)20222021InsuranceGross premiums written$10,583,785 $9,471,667 Net premiums written8,784,146 7,743,814 Net premiums earned8,369,062 7,077,708 Loss ratio61.3 %61.1 %Expense ratio27.9 28.3 GAAP combined ratio89.2 89.4 Reinsurance & Monoline ExcessGross premiums written$1,325,267 $1,228,467 Net premiums written1,219,924 1,119,053 Net premiums earned1,192,367 1,028,323 Loss ratio61.3 %61.0 %Expense ratio28.4 29.7 GAAP combined ratio89.7 90.7 ConsolidatedGross premiums written$11,909,052 $10,700,134 Net premiums written10,004,070 8,862,867 Net premiums earned9,561,429 8,106,031 Loss ratio61.3 %61.1 %Expense ratio28.0 28.5 GAAP combined ratio89.3 89.6 Net Income to Common Stockholders. The following table presents the Company’s net income to common stockholders and net income per diluted share for the years ended December 31, 2022 and 2021. (In thousands, except per share data)20222021Net income to common stockholders$1,381,062 $1,022,490 Weighted average diluted shares279,461 279,749 Net income per diluted share$4.94 $3.66 The Company reported net income of $1,381 million in 2022 compared to $1,022 million in 2021. The $359 million increase in net income was primarily due to an after-tax increase in underwriting income of $145 million mainly due to the growth in premium rates and exposure as well as reductions in expense ratio driven by net earned premium growth outpacing expense growth, an after-tax increase in net investment gains of $90 million primarily due to the sale of a real estate investment in London as well as change in market value of equity securities, an after-tax increase in net investment income of $87 million primarily due to rising interest rates and a larger investment portfolio related to fixed maturity securities, an after-tax increase in foreign currency gains of $20 million, an after-tax reduction in interest expenses of $14 million due to debt repayment and refinancings, an after-tax reduction on debt extinguishment expense of $9 million for debt redeemed in 2021, an after-tax increase in profit from insurance service businesses of $5 million, an after-tax increase of $5 million in minority interest and a reduction of $2 million in tax expense due to a change in the effective tax rate, partially offset by an after-tax increase in corporate expenses of $17 million mainly due to performance-based compensation costs and an after-tax decrease in profits from non-insurance businesses of $1 million. The number of weighted average diluted shares decreased by 0.3 million for 2022 compared to 2021 mainly reflecting shares repurchased in 2021 and 2022.Premiums. Gross premiums written were $11,909 million in 2022, an increase of 11% from $10,700 million in 2021. The increase was due to the growth in the Insurance segment of $1,112 million and $97 million in the Reinsurance & Monoline 49Excess segment. Approximately 82% of premiums expiring were renewed in both 2022 and 2021. Average renewal premium rates for insurance and facultative reinsurance increased 6.4% in 2022 and 9.1% in 2021, when adjusted for changes in exposures. Average renewal premium rates for insurance and facultative reinsurance excluding workers' compensation increased 7.5% in 2022 and 10.4% in 2021, when adjusted for changes in exposures. A summary of gross premiums written in 2022 compared with 2021 by line of business within each business segment follows:•Insurance gross premiums increased 12% to $10,584 million in 2022 from $9,472 million in 2021. Gross premiums increased $539 million (16%) for other liability, $354 million (17%) for short-tail lines, $143 million (12%) for commercial auto, $70 million (6%) for workers' compensation and $6 million (0.4%) for professional liability.•Reinsurance & Monoline Excess gross premiums increased 8% to $1,325 million in 2022 from $1,228 million in 2021. Gross premiums written increased $58 million (8%) for casualty lines, $28 million (12%) for property lines and $11 million (5%) for monoline excess. Net premiums written were $10,004 million in 2022, an increase of 13% from $8,863 million in 2021. Ceded reinsurance premiums as a percentage of gross written premiums were 16% in 2022 and 17% in 2021. Premiums earned increased 18% to $9,561 million in 2022 from $8,106 million in 2021. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term, and accordingly recent rate increases will be earned over the upcoming quarters. Premiums earned in 2022 are related to business written during both 2022 and 2021. Audit premiums were $312 million in 2022 compared with $195 million in 2021.Net Investment Income. Following is a summary of net investment income for the years ended December 31, 2022 and 2021:AmountAverage AnnualizedYield(In thousands)2022202120222021Fixed maturity securities, including cash and cash equivalents and loans receivable$549,281 $382,001 2.9 %2.2 %Investment funds145,099 220,014 8.9 15.8 Equity securities52,600 32,020 4.9 5.0 Arbitrage trading account45,213 37,676 4.0 5.3 Real estate(3,087)7,703 (0.2)0.4 Gross investment income789,106 679,414 3.2 3.1 Investment expenses(9,921)(7,796)— — Total$779,185 $671,618 3.2 %3.0 %Net investment income increased 16% to $779 million in 2022 from $672 million in 2021 due primarily to an $167 million increase in income from fixed maturity securities mainly driven by rising interest rates and a larger investment portfolio, a $21 million increase from equity securities and a $7 million increase from the arbitrage trading account, partially offset by a $75 million decrease in income from investment funds primarily due to financial service funds, an $11 million decrease in real estate and a $2 million increase in investment expenses. Investment funds are reported on a one quarter lag. The average annualized yield for fixed maturity securities was 2.9% in 2022 and 2.2% in 2021. The effective duration of the fixed maturity portfolio was 2.4 years at both December 31, 2022 and 2021. The Company maintained the shortened duration of its fixed maturity security portfolio, thereby reducing the potential impact of mark-to-market on the portfolio and positioning the Company to react quickly to changes in the current interest rate environment. Average invested assets, at cost (including cash and cash equivalents), were $24.4 billion in 2022 and $22.2 billion in 2021.Insurance Service Fees. The Company earns fees from an insurance distribution business, a third-party administrator, and as a servicing carrier of workers' compensation assigned risk plans for certain states. Insurance service fees increased to $111 million in 2022 from $94 million in 2021 due to organic growth within the business. Net Realized and Unrealized Gains on Investments. The Company buys and sells securities and other investment assets on a regular basis in order to maximize its total return on investments. Decisions to sell securities and other investment assets are based on management’s view of the underlying fundamentals of specific investments as well as management’s expectations regarding interest rates, credit spreads, currency values and general economic conditions. Net realized and unrealized gains on investments were $217 million in 2022 compared with $107 million in 2021. In 2022, the gains reflected net realized gains on investments of $218 million (primarily due to a $251 million net gain from sale of a real estate investment in London after 50transaction expenses and the foreign currency impact including reversal of the currency translation adjustment), partially offset by a change in unrealized losses on equity securities of $1 million. In 2021, the gains reflected net realized gains on investments of $145 million (primarily due to the sale of certain real estate assets and the disposition of an investment fund), partially offset by an increase in unrealized losses on equity securities of $38 million.Change in Allowance for Expected Credit Losses on Investments. Based on credit factors, the allowance for expected credit losses is increased or decreased depending on the percentage of unrealized loss relative to amortized cost by security, changes in rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. For the year ended December 31, 2022, the pre-tax change in allowance for expected credit losses on investments increased by $15 million ($12 million after-tax), which is reflected in net investment gains, primarily due to change in estimate. For the year ended December 31, 2021, the pre-tax change in allowance for expected credit losses on investments increased by $16 million ($13 million after-tax), which is reflected in net investment gains, primarily related to foreign government securities which did not previously have an allowance.Revenues from Non-Insurance Businesses. Revenues from non-insurance businesses were derived from businesses engaged in the distribution of promotional merchandise, world-wide textile solutions, and aviation-related businesses that provide services to aviation markets, including (i) the distribution, manufacturing, repair and overhaul of aircraft parts and components, (ii) the sale of new and used aircraft, and (iii) avionics, fuel, maintenance, storage and charter services. Revenues from non-insurance businesses were $510 million in 2022 and $489 million in 2021. The increase mainly relates to the business recovery from COVID-19 on promotional merchandise and textile business as well as a newly acquired commercial and residential textile business in 2022, partially offset by a decrease for the aviation-related business.Losses and Loss Expenses. Losses and loss expenses increased to $5,862 million in 2022 from $4,954 million in 2021. The consolidated loss ratio was 61.3% in 2022 and 61.1% in 2021. Catastrophe losses, net of reinsurance recoveries, were $212 million (including current accident year losses of approximately $5 million related to COVID-19) in 2022 compared with $202 million in 2021 (including losses of approximately $58 million related to COVID-19). Adverse prior year reserve development (net of premium offsets) was $36 million in 2022 and favorable prior year reserve development was $7 million in 2021 (refer to Note 14 of our consolidated financial statements for more detail). The loss ratio excluding catastrophe losses and prior year reserve development was 58.7% in both 2022 and 2021.A summary of loss ratios in 2022 compared with 2021 by business segment follows:•Insurance - The loss ratio of 61.3% in 2022 was 0.2 points higher than the loss ratio of 61.1% in 2021. Catastrophe losses were $127 million in 2022 compared with $150 million in 2021. The Company reflected a best estimate (net of reinsurance) based upon available information for current accident year COVID-19-related losses of approximately $3 million. Adverse prior year reserve development was $40 million in 2022, driven by two businesses that wrote policies providing coverage for event cancellation, and film production delay which were heavily impacted by losses directly caused by the COVID-19 pandemic and favorable prior year reserve development was $20 million in 2021. The loss ratio excluding catastrophe losses and prior year reserve development was 59.3% in both 2022 and 2021. •Reinsurance & Monoline Excess - The loss ratio of 61.3% in 2022 was 0.3 points higher than the loss ratio of 61.0% in 2021. Catastrophe losses were $85 million in 2022 compared with $52 million in 2021.The Company reflected a best estimate (net of reinsurance) based upon available information for current accident year COVID-19-related losses of approximately $2 million. Favorable prior year reserve development was $4 million in 2022, and adverse prior year reserve development was $13 million in 2021. The loss ratio excluding catastrophe losses and prior year reserve development decreased 0.2 points to 54.5% in 2022 from 54.7% in 2021. Other Operating Costs and Expenses. Following is a summary of other operating costs and expenses: (In thousands)20222021Policy acquisition and insurance operating expenses$2,673,903 $2,306,727 Insurance service expenses96,419 86,003 Net foreign currency gains(50,930)(25,725)Debt extinguishment costs— 11,521 Other costs and expenses242,113 220,744 Total$2,961,505 $2,599,270 51Policy acquisition and insurance operating expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Policy acquisition and insurance operating expenses increased 16% from 2021, while net premiums earned increased 18% over that period. The expense ratio (underwriting expenses expressed as a percentage of net premiums earned) was 28.0% in 2022, down from 28.5% in 2021. The improvement is primarily attributable to higher net premiums earned outpacing compensation expense growth. However, to the extent our net premiums earned decrease or travel and entertainment expenses increase, our expense ratio would be expected to increase.Service expenses, which represent the costs associated with the fee-based businesses, was $96 million in 2022 and $86 million in 2021 due to the organic growth within the business. Net foreign currency gains result from transactions denominated in a currency other than a businesses’ functional currency. Net foreign currency gains was $51 million in 2022 and $26 million in 2021, mainly related to the strengthening of the U.S. dollar compared to the majority of other currencies.Debt extinguishment costs of $12 million in 2021 related to the redemption of $400 million of subordinated debentures in March and June 2021 that were due in 2056.Other costs and expenses represent general and administrative expenses of the parent company and other expenses not allocated to business segments, including the cost of certain long-term incentive plans and new business ventures. Other costs and expenses increased to $242 million in 2022 from $221 million in 2021, primarily due to the increase in performance-based compensation costs in 2022. Expenses from Non-Insurance Businesses. Expenses from non-insurance businesses represent costs associated with businesses engaged in the distribution of promotional merchandise, world-wide textile solutions, and aviation-related businesses that include (i) cost of goods sold related to aircraft and products sold and services provided and (ii) general and administrative expenses. Expenses from non-insurance businesses were $493 million in 2022 compared to $472 million in 2021. The increase mainly relates to the business recovery from COVID-19 on promotional merchandise and textile business as well as a newly acquired residential and commercial textile business in 2022, partially offset by a decrease for the aviation-related business.Interest Expense. Interest expense was $130 million in 2022 and $147 million in 2021. In March 2021, the Company issued $400 million aggregate principal amount of 3.55% senior notes due 2052 and redeemed its $110 million aggregate principal amount of 5.90% subordinated debentures due 2056. In June 2021, the Company redeemed the $290 million aggregate principal amount of its 5.75% subordinated debentures due 2056. In September 2021, the Company issued $350 million aggregate principal amount of 3.15% senior notes due 2061.In the first quarter of 2022, the Company repaid at maturity its $77 million aggregate principal amount of 8.7% senior notes in January and its $350 million aggregate principal amount of 4.625% senior notes in March. The above redemptions during the year ended December 31, 2021 resulted in debt extinguishment costs of $12 million. Additionally, in the second quarter of 2021, the Company sold a real estate asset, which resulted in a $102 million reduction of the Company's non-recourse debt that was supporting the property.The repayment at maturity and redemption of senior notes and debentures and issuance of additional senior notes and debentures in 2022 and 2021 decreased interest expense in 2022.Income Taxes. The effective income tax rate was 19.5% in 2022 and 19.6% in 2021. The lower effective income tax rate for 2022 was primarily due to a net reduction in the Company’s valuation allowance against foreign tax credits and foreign net operating losses. The effective income tax rate reflects tax benefits attributable to tax-exempt investment income and equity-based compensation in both periods. See Note 17 of the Consolidated Financial Statements for a reconciliation of the income tax expense and the amounts computed by applying the Federal income tax rate of 21%.The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $169 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. In the future, if such earnings were distributed the Company projects that the incremental tax, if any, will be immaterial.On August 16, 2022, the Inflation Reduction Act of 2022 was enacted. Among other things, the legislation introduced a corporate alternative minimum tax on certain corporations. The tax is applicable for taxable years beginning after December 31, 2022 and imposes a 15% minimum tax on a corporation’s applicable financial statement income. We are continuing to evaluate the overall impact of this tax legislation on our operations and U.S. federal income tax position at this time.52Results of Operations for the Years Ended December 31, 2021 and 2020For a comparison of the Company’s results of operations for the year ended December 31, 2021 to the year ended December 31, 2020, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the Securities and Exchange Commission on February 24, 2022.53InvestmentsAs part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, it believes is adequate to meet its payment obligations. In addition to fixed-maturity securities, the Company invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income. The Company also attempts to maintain an appropriate relationship between the effective duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The effective duration of the investment portfolio was 2.4 years at both December 31, 2022 and 2021, respectively. The Company’s investment portfolio and investment-related assets as of December 31, 2022 were as follows:($ in thousands)CarryingValuePercentof TotalFixed maturity securities:U.S. government and government agencies$892,258 3.7 %State and municipal:Special revenue1,721,497 7.1 Local general obligation441,097 1.8 State general obligation416,713 1.7 Corporate backed199,639 0.8 Pre-refunded (1)158,840 0.6 Total state and municipal2,937,786 12.0 Mortgage-backed securities:Agency901,332 3.7 Commercial528,609 2.2 Residential-Prime235,315 1.0 Residential-Alt A3,762 — Total mortgage-backed securities1,669,018 6.9 Asset-backed securities3,982,773 16.4 Corporate:Industrial3,252,999 13.4 Financial2,470,372 10.2 Utilities551,048 2.3 Other429,573 1.7 Total corporate6,703,992 27.6 Foreign government1,401,522 5.8 Total fixed maturity securities17,587,349 72.4 Equity securities available for sale:Common stocks982,751 4.0 Preferred stocks203,143 0.8 Total equity securities available for sale1,185,894 4.8 Investment funds1,608,548 6.6 Cash and cash equivalents1,449,346 6.0 Real estate1,340,622 5.5 Arbitrage trading account944,230 3.9 Loans receivable193,002 0.8 Total investments$24,308,991 100.0 %______________(1)Pre-refunded securities are securities for which an escrow account has been established to fund the remaining payments of principal and interest through maturity. Such escrow accounts are funded almost exclusively with U.S. Treasury and U.S. government agency securities.Fixed Maturity Securities. The Company’s investment policy with respect to fixed maturity securities is generally to purchase instruments with the expectation of holding them to their maturity. However, management of the available for sale 54portfolio is considered necessary to maintain an approximate matching of assets and liabilities as well as to adjust the portfolio as a result of changes in financial market conditions and tax considerations.The Company’s philosophy related to holding or selling fixed maturity securities is based on its objective of maximizing total return. The key factors that management considers in its investment decisions as to whether to hold or sell fixed maturity securities are its view of the underlying fundamentals of specific securities as well as its expectations regarding interest rates, credit spreads and currency values. In a period in which management expects interest rates to rise, the Company may sell longer duration securities in order to mitigate the impact of an interest rate rise on the fair value of the portfolio. Similarly, in a period in which management expects credit spreads to widen, the Company may sell lower quality securities, and in a period in which management expects certain foreign currencies to decline in value, the Company may sell securities denominated in those foreign currencies. The sale of fixed maturity securities in order to achieve the objective of maximizing total return may result in realized gains; however, there is no reason to expect these gains to continue in future periods.Equity Securities. Equity securities primarily represent investments in common and preferred stocks in companies with potential growth opportunities in different sectors, mainly in the financial institutions and energy sectors.Investment Funds. At December 31, 2022, the carrying value of investment funds was $1,609 million, including investments in financial services funds of $466 million, other funds of $370 million (which includes a deferred compensation trust asset of $30 million), transportation funds of $337 million, real estate funds of $205 million, energy funds of $116 million, and infrastructure funds of $115 million. Investment funds are primarily reported on a one-quarter lag.Real Estate. Real estate is directly owned property held for investment. At December 31, 2022, real estate properties in operation included a long-term ground lease in Washington D.C., an office complex in New York City and the completed portion of a mixed-use project in Washington D.C. In addition, part of the previously mentioned mixed-use project in Washington D.C. is under development. The Company expects to fund further development costs for the project with a combination of its own funds and external financing. During the first quarter of 2022, the Company sold an office building in London.Arbitrage Trading Account. The arbitrage trading account is comprised of direct investments in arbitrage securities. Merger arbitrage is the business of investing in the securities of publicly held companies that are the targets in announced tender offers and mergers.Loans Receivable. Loans receivable, net of allowance for expected credit losses, had an amortized cost of $193 million and an aggregate fair value of $188 million at December 31, 2022. The amortized cost of loans receivable is net of an allowance for expected credit losses of $2 million as of December 31, 2022. Loans receivable include real estate loans of $174 million that are secured by commercial and residential real estate located primarily in London and New York. Real estate loans generally earn interest at fixed or stepped interest rates and have maturities through 2026. Loans receivable include commercial loans of $19 million that are secured by business assets and have fixed interest rates with varying maturities not exceeding 10 years.55Liquidity and Capital ResourcesCash Flow. Cash flow provided from operating activities increased to $2,569 million in 2022 from $2,184 million in 2021, primarily due to an increase in premium receipts partially offset by increased loss and loss expense payments.The Company's insurance subsidiaries' principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company generally targets an average duration for its investment portfolio that is within 1.5 years of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed maturity securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company's cash and investments is available to pay claims and other obligations as they become due. The Company's investment portfolio is highly liquid, with approximately 76% invested in cash, cash equivalents and marketable fixed maturity securities as of December 31, 2022. If the sale of fixed maturity securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized. Debt. At December 31, 2022, the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of $2,837 million and a face amount of $2,862 million. In the first quarter of 2022, the Company repaid at maturity its $77 million aggregate principal amount of 8.7% senior notes in January and its $350 million aggregate principal amount of 4.625% senior notes in March. The maturities of the outstanding debt are $5 million in 2024, $2 million in 2025, $250 million in 2037, $350 million in 2044, $470 million in 2050, $400 million in 2052, $185 million in 2058, $300 million in 2059, $250 million in 2060, and $650 million in 2061.On April 1, 2022, the Company entered into a senior unsecured revolving credit facility that provides for revolving, unsecured borrowings up to an aggregate of $300 million with a $50 million sublimit for letters of credit. The Company may increase the amount available under the facility to a maximum of $500 million subject to obtaining lender commitments for the increase and other customary conditions. Borrowings under the facility may be used for working capital and other general corporate purposes. All borrowings under the facility must be repaid by April 1, 2027, except that letters of credit outstanding on that date may remain outstanding until April 1, 2028 (or such later date approved by all lenders). Our ability to utilize the facility is conditioned on the satisfaction of representations, warranties and covenants that are customary for facilities of this type. As of December 31, 2022, there were no borrowings outstanding under the facility.Equity. At December 31, 2022, total common stockholders’ equity was $6.7 billion, common shares outstanding were 264,546,100 and stockholders’ equity per outstanding share was $25.51. The Company repurchased 1,370,394 and 1,752,619 shares of its common stock in 2022 and 2021, respectively. The aggregate cost of the repurchases was $94 million in 2022 and $122 million in 2021. In 2022, the Board declared regular quarterly cash dividends of $0.09 per share in the first quarter, and $0.10 per share in each of the remaining three quarters, as well as special dividends of $0.50 per share in the second quarter, for a total of $235 million in aggregate dividends in 2022. Total Capital. Total capitalization (equity, debt and subordinated debentures) was $9.6 billion at December 31, 2022. The percentage of the Company’s capital attributable to senior notes, subordinated debentures and other debt was 30% and 33% at December 31, 2022 and 2021, respectively.Federal and Foreign Income TaxesThe Company files a consolidated income tax return in the U.S. and foreign tax returns in each of the countries in which it has overseas operations. At December 31, 2022, the Company had a gross deferred tax asset of $801 million (which primarily relates to unrealized losses on investments, loss and loss expense reserves and unearned premium reserves). The Company also has a $47 million valuation allowance against the gross deferred tax asset and a gross deferred tax liability of $425 million (which primarily relates to deferred policy acquisition costs, and various investment funds) resulting in a net deferred tax asset of $329 million. The realization of this asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for future operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset.56Reinsurance The Company follows customary industry practice of reinsuring a portion of its exposures in exchange for paying reinsurers a part of the premiums received on the policies it writes. Reinsurance is purchased by the Company principally to reduce its net liability on individual risks and to protect against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance coverage. The Company monitors the financial condition of its reinsurers and attempts to place its coverages only with financially sound carriers. Reinsurance coverage and retentions vary depending on the line of business, location of the risk and nature of loss. The Company’s reinsurance purchases include the following:•Property reinsurance treaties - The Company purchases property reinsurance to reduce its exposure to large individual property losses and catastrophe events. Following is a summary of significant property reinsurance treaties in effect as of January 1, 2023: The Company’s property per risk reinsurance generally covers losses between $2.5 million and $80 million. The Company’s catastrophe excess of loss reinsurance program provides protection for net losses in excess of between $65 million and $80 million up to $500 million for the majority of U.S. business written by its Insurance segment businesses and U.S. and non-U.S. business written by Lloyd's Syndicate, excluding offshore energy; this includes some co-participation in lower layers. For terrorism, we currently retain the first $95 million and then fully insure above this to our desired limit of $400 million. For 2023, some of our property cat reinsurance is placed via an industry loss warranty (ILW) cover and the equivalent W. R. Berkley limit and retention (and resulting net position) are estimated based on our market share and modeled outcome when applying the ILW layering. The Company’s catastrophe reinsurance agreements are subject to certain limits, exclusions and reinstatement premiums. •Casualty reinsurance treaties - The Company purchases casualty reinsurance to reduce its exposure to large individual casualty losses, workers’ compensation catastrophe losses and casualty losses involving multiple claimants or insureds for the majority of business written by its U.S. companies. A significant casualty treaty (casualty catastrophe) in effect as of January 1, 2023 provides significant protection for losses between $10 million and $60 million from single events with claims involving two or more insurable interests or for systemic events involving multiple insureds and/or policy years. The treaty also covers casualty contingency losses in excess of $5 million and up to $100 million. For losses involving two or more claimants for primary workers’ compensation business, coverage is generally in place for losses between $10 million and $500 million. For excess workers’ compensation business, such coverage is generally in place for losses between $25 million and $500 million. Our workers’ compensation catastrophe reinsurance program is a shared cover for both excess and primary workers’ compensation business.•Facultative reinsurance - The Company also purchases facultative reinsurance on certain individual policies or risks that are in excess of treaty reinsurance capacity. •Other reinsurance - Depending on the business, the Company purchases specific additional reinsurance to supplement the above programs.•Effective January 1, 2023, Lifson Re will continue to be a participant on the majority of the Company’s reinsurance placements for a 30.0% share of the placed amounts. This pertains to all traditional treaty reinsurance/retrocessional placements for both property and casualty business where there is more than one open market reinsurer participating. Lifson Re has been capitalized with $380 million of equity from a small group of sophisticated global investors with long-term investment horizons, including a minority participation by the Company. Lifson Re will participate on a fully collateralized basis.The Company places a number of its casualty treaties on a “risk attaching” basis. Under risk attaching treaties, all claims from policies incepting during the period of the reinsurance contract are covered even if they occur after the expiration date of the reinsurance contract. If the Company is unable to renew or replace its existing reinsurance coverage, protection for unexpired policies would remain in place until their expiration. In such case, the Company could revise its underwriting strategy for new business to reflect the absence of reinsurance protection. The casualty catastrophe treaty highlighted above was purchased on a losses discovered basis. Property catastrophe and workers’ compensation catastrophe reinsurance is generally placed on a “losses occurring basis,” whereby only claims occurring during the period are covered. If the Company is unable to renew or replace these reinsurance coverages, unexpired policies would not be protected, though we frequently have the option to purchase run-off coverage in our treaties. Following is a summary of earned premiums and loss and loss expenses ceded to reinsurers for each of the three years ended December 31, 2022: Year Ended December 31,(In thousands)202220212020Earned premiums$1,883,263 $1,805,341 $1,499,948 Losses and loss expenses1,269,338 1,236,960 955,630 Ceded earned premiums increased 4.3% in 2022 to $1,883 million. The ceded losses and loss expenses ratio decreased 2 points to 67% in 2022 from 69% in 2021. 57The following table presents the credit quality of amounts due from reinsurers as of December 31, 2022. (In thousands)ReinsurerRating(1)AmountAmounts due in excess of $20 million:Lloyd’s of LondonA+$347,927 Berkshire HathawayAA+332,034 Munich ReAA-306,530 Partner ReA+275,410 Hannover Re GroupAA-191,264 Swiss ReAA-189,591 Renaissance ReA+163,973 Everest ReA+155,847 Liberty MutualA96,402 Axis CapitalA+81,538 Korean ReA59,884 Fairfax FinancialA-55,228 Axa InsuranceAA-46,058 Arch Capital GroupA+45,663 Sompo Holdings GroupA+36,157 Helvetia Holdings GroupA+30,823 Markel Corp GroupA30,216 Validus Holdings GroupA24,548 TOA ReA+22,945 Other reinsurers: Rated A- or better163,198 Secured (2)332,502 All Others27,299 Subtotal $3,015,037 Residual market pools (3)180,757 Allowance for expected credit losses(8,064)Total $3,187,730 _________________(1)S&P rating, or if not rated by S&P, A.M. Best rating.(2)Secured by letters of credit or other forms of collateral.(3)Many states require licensed insurers that provide workers' compensation insurance to participate in programs that provide workers' compensation to employers that cannot procure coverage from an insurer on a voluntary basis. Insurers can fulfill this residual market obligation by participating in pools where results are shared by the participating companies. The Company acts as a servicing carrier for workers' compensation pools in certain states. As a servicing carrier, the Company writes residual market business directly and then cedes 100% of this business to the respective pool. As a servicing carrier, the Company receives fee income for its services. The Company does not retain underwriting risk, and credit risk is limited as ceded balances are jointly shared by all the pool members. 58Contractual ObligationsFollowing is a summary of the Company's contractual obligations as of December 31, 2022:(In thousands)Estimated Payments By Periods20232024202520262027 ThereafterGross reserves for losses$4,586,303 $3,268,257 $2,461,737 $1,788,739 $1,439,989 $3,895,626 Operating lease obligations47,024 41,788 32,928 25,973 16,472 68,912 Purchase obligations148,593 51,602 51,456 53,819 52,821 55,395 Subordinated debentures— — — — — 1,035,000 Senior notes and other debt— 5,300 1,954 — — 1,820,000 Interest payments125,580 125,580 125,580 125,580 125,580 3,154,164 Other long-term liabilities2,489 2,228 2,035 1,859 1,698 20,232 Total$4,909,989 $3,494,755 $2,675,690 $1,995,970 $1,636,560 $10,049,329 The estimated payments for reserves for losses and loss expenses in the above table represent the projected (undiscounted) payments for gross loss and loss expense reserves related to losses incurred as of December 31, 2022. The estimated payments in the above table do not consider payments for losses to be incurred in future periods. These amounts include reserves for reported losses and reserves for incurred but not reported losses. Estimated amounts recoverable from reinsurers are not reflected. The estimated payments by year are based on historical loss payment patterns.The actual payments may differ from the estimated amounts due to changes in ultimate loss reserves and in the timing of the settlement of those reserves. In addition, at December 31, 2022, the Company had commitments to invest up to $402 million and $146 million in certain investment funds and real estate construction projects, respectively. These amounts are not included in the above table.The Company utilizes letters of credit to back certain reinsurance payments and obligations. Outstanding letters of credit were $5 million as of December 31, 2022. The Company has made certain guarantees to state regulators that the statutory capital of certain subsidiaries will be maintained above certain minimum levels. Off-Balance Sheet Arrangements An off-balance sheet arrangement is any transaction, agreement or other contractual arrangement involving an unconsolidated entity under which a company has (1) made guarantees, (2) a retained or contingent interest in transferred assets, (3) an obligation under derivative instruments classified as equity or (4) any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company, or that engages in leasing, hedging or research and development arrangements with the Company. The Company has no arrangements of these types that management believes may have a material current or future effect on our financial condition, liquidity or results of operations.59ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKMarket Risk. The fair value of the Company’s investments is subject to risks of fluctuations in credit quality and interest rates. The Company uses various models and stress test scenarios to monitor and manage interest rate risk. The Company attempts to manage its interest rate risk by maintaining an appropriate relationship between the effective duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The effective duration for the fixed maturity portfolio (including cash and cash equivalents) was 2.4 years at both December 31, 2022 and 2021. In addition, the fair value of the Company’s international investments is subject to currency risk. The Company attempts to manage its currency risk by matching its foreign currency assets and liabilities where considered appropriate.The following table outlines the groups of fixed maturity securities and their effective duration at December 31, 2022:EffectiveDuration($ in thousands)(Years)Fair ValueMortgage-backed securities4.5$1,669,056 State and municipal3.32,942,025 U.S. government and government agencies3.1892,258 Corporate2.76,703,992 Foreign government2.21,401,522 Loans receivable1.3187,981 Asset-backed securities0.93,982,773 Cash and cash equivalents0.01,449,346 Total2.4$19,228,953 Duration is a common measure of the price sensitivity of fixed maturity securities to changes in interest rates. The Company determines the estimated change in fair value of the fixed maturity securities, assuming parallel shifts in the yield curve for treasury securities while keeping spreads between individual securities and treasury securities static. The estimated fair value at specified levels at December 31, 2022 would be as follows:(In thousands)Estimated Fair ValueChange in Fair ValueChange in interest rates:300 basis point rise$17,931,180 $(1,297,772)200 basis point rise18,344,941 (884,011)100 basis point rise18,778,053 (450,899)Base scenario19,228,952 — 100 basis point decline19,692,291 463,339 200 basis point decline20,161,330 932,378 300 basis point decline20,632,243 1,403,291 Arbitrage investing differs from other types of investments in that its focus is on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes arbitrage investments less vulnerable to changes in general stock market conditions. Potential changes in market conditions are also mitigated by the implementation of hedging strategies, including short sales.Additionally, the arbitrage positions are generally hedged against market declines by purchasing put options, selling call options or entering into swap contracts. The Company's merger arbitrage securities are primarily exposed to the risk of completion of announced deals, which are subject to regulatory as well as transactional and other risks.60
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations included in this report. A discussion of the risks attendant to our operations is set forth in Item 1A. Risk Factors included in this report. 7Table of ContentsMultiple SclerosisWe develop, manufacture and market a number of products designed to treat patients with MS. MS is a progressive disease in which the body loses the ability to transmit messages along nerve cells, leading to a loss of muscle control, paralysis and, in some cases, death. Patients with active RMS experience an uneven pattern of disease progression characterized by periods of stability that are interrupted by flare-ups of the disease after which the patient may return to a lower baseline of functioning.The MS products we market and our major markets are as follows:ProductIndicationCollaboratorMajor MarketsRMS in the U.S.Relapsing-remitting MS (RRMS) in the E.U.NoneU.S.FranceGermanyItalyJapanSpainU.K.RMS in the U.S.RRMS in the E.U.Alkermes Pharma Ireland Limited, a subsidiary of Alkermes plc (Alkermes)U.S.GermanyIsraelSwitzerlandU.K.RMSNoneU.S.FranceGermanyItalyJapanSpainRMS in the U.S.RRMS in the E.U.NoneU.S.FranceGermanyItalySpainU.K.RMSRRMS in the E.U.Crohn's disease in the U.S.NoneU.S.FranceGermanyItalySpainU.K.Walking ability for patients with MSAcorda Therapeutics, Inc. (Acorda)FranceGermanyFor additional information on our collaboration arrangements with Alkermes and Acorda, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Neuromuscular DisordersSMA is characterized by loss of motor neurons in the spinal cord and lower brain stem, resulting in severe and progressive muscular atrophy and weakness. Ultimately, individuals with the most severe type of SMA can become paralyzed and have difficulty performing the basic functions of life, like breathing and swallowing. Due to a deletion or mutations in the SMN1 gene, people with SMA do not produce enough survival motor neuron (SMN) protein, which is critical to the survival of the neurons that control muscles. The severity of SMA correlates with the amount of SMN protein. People with Type 1 SMA, the most severe life-threatening form, produce very little SMN protein and do not 8Table of Contentsachieve the ability to sit without support, and typically do not live beyond two years of age without respiratory support and nutritional interventions. People with Type 2 and Type 3 SMA produce greater amounts of SMN protein and have less severe, but still life-altering, forms of SMA. Our SMA product and major markets are as follows: ProductIndicationCollaboratorMajor MarketsSMAIonisU.S.BrazilCanadaChinaFranceGermanyItalyJapanSpainTurkeyFor additional information on our collaboration arrangements with Ionis, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Alzheimer's DiseaseAlzheimer's disease is characterized by two abnormalities in the brain: amyloid plaques and neurofibrillary tangles. Amyloid plaques, which are found in the tissue between the nerve cells, are unusual clumps of a protein called beta amyloid along with degenerating bits of neurons and other cells.Our Alzheimer's disease products and major markets are as follows:ProductIndicationCollaboratorMajor MarketAlzheimer's diseaseEisaiU.S.Alzheimer's diseaseEisaiU.S.For additional information on our collaboration arrangements with Eisai, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.BiosimilarsBiosimilars are a group of biologic medicines that are highly similar to currently available biologic therapies developed by companies known as "originators". Under our agreements with Samsung Bioepis, we commercialize three anti-tumor necrosis factor (TNF) biosimilars in certain countries in Europe: BENEPALI, an etanercept biosimilar referencing ENBREL, IMRALDI, an adalimumab biosimilar referencing HUMIRA, and FLIXABI, an infliximab biosimilar referencing REMICADE. We have also secured the exclusive rights to commercialize BYOOVIZ, a ranibizumab biosimilar referencing LUCENTIS, which was approved in the U.S., the E.U. and the United Kingdom (U.K.) during the third quarter of 2021. BYOOVIZ launched in the U.S. in June 2022 and became commercially available during the third quarter of 2022.9Table of ContentsOur current biosimilar products and major markets are as follows: ProductIndicationMajor MarketsRheumatoid arthritisJuvenile idiopathic arthritisPsoriatic arthritisAxial spondyloarthritisPlaque psoriasisPaediatric plaque psoriasisFranceGermanyItalySpainU.K.Rheumatoid arthritisJuvenile idiopathic arthritisAxial spondyloarthritisPsoriatic arthritisPsoriasisPaediatric plaque psoriasisHidradenitis suppurativa Adolescent hidradenitis suppurativaCrohn’s diseasePaediatric Crohn's diseaseUlcerative colitisUveitisPaediatric UveitisFranceGermanySwedenU.K.Rheumatoid arthritisCrohn’s diseasePaediatric Crohn’s diseaseUlcerative colitisPaediatric ulcerative colitisAnkylosing spondylitisPsoriatic arthritisPsoriasisFranceGermanyItalyNeovascular (wet) age-related macular degenerationMacular edema following retinal vein occlusionMyopic choroidal neovascularizationU.S.For additional information on our collaboration arrangements with Samsung Bioepis, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.10Table of ContentsGenentech RelationshipsWe have agreements with Genentech that entitle us to certain business and financial rights with respect to RITUXAN, RITUXAN HYCELA, GAZYVA, OCREVUS, LUNSUMIO, which was granted accelerated approval in the U.S. during the fourth quarter of 2022, glofitamab and options to add other potential anti-CD20 therapies.Our current anti-CD20 therapeutic programs and major markets are as follows:ProductIndicationMajor MarketsNon-Hodgkin's lymphomaCLLRheumatoid arthritisTwo forms of ANCA-associated vasculitisPemphigus vulgarisU.S.CanadaNon-Hodgkin's lymphomaCLLU.S.In combination with chlorambucil for previously untreated CLLFollicular lymphomaIn combination with chemotherapy followed by GAZYVA alone for previously untreated follicular lymphomaU.S.RMSPPMSU.S.Relapsed or refractory follicular lymphomaU.S.For additional information on our collaboration arrangements with Genentech, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.OtherProductIndicationCollaboratorMajor MarketsModerate to severe plaque psoriasisNoneGermanyPatient Support and Access We interact with patients, advocacy organizations and healthcare societies in order to gain insights into unmet needs. The insights gained from these engagements help us support patients with services, programs and applications that are designed to help patients lead better lives. Among other things, we provide customer service and other related programs for our products, such as disease and product specific websites, insurance research services, financial assistance programs and the facilitation of the procurement of our marketed products. We are dedicated to helping patients obtain access to our therapies. Our patient representatives have access to a suite of financial assistance tools. With those tools, we help patients understand their insurance coverage and, if needed, help patients compare insurance options and programs. In the U.S., we have established programs that provide co-pay assistance or free product for qualified uninsured or underinsured patients, based on specific eligibility criteria. We also provide charitable contributions to 11Table of Contentsindependent charitable organizations that assist patients with out-of-pocket expenses associated with their therapy.We believe all healthcare stakeholders have a shared responsibility to ensure patients have equitable access to new, innovative medicines. We regularly review our pricing strategy and prioritize patient access to our therapies. We have a value-based contracting program designed to align the price of our therapies to the value our therapies deliver to patients. We also work with regulators, clinical researchers, ethicists, physicians and patient advocacy organizations and communities, among others, to determine how best to address requests for access to our investigational therapies in a manner that is consistent with our patient-focused values and compliant with regulatory standards and protocols. In appropriate situations, patients may have access to investigational therapies through Early Access Programs, single patient access or emergency use based on humanitarian or compassionate grounds.Marketing and DistributionSales Force and MarketingWe promote our marketed products worldwide, including in the U.S., Europe and Japan, primarily through our own sales forces and marketing groups. In some countries, particularly in areas where we continue to expand into new geographic areas, we partner with third parties. RITUXAN, RITUXAN HYCELA, GAZYVA, OCREVUS and LUNSUMIO are marketed by the Roche Group and its sublicensees.We commercialize BENEPALI, IMRALDI and FLIXABI pursuant to our agreement with Samsung Bioepis in certain countries in Europe, as well as BYOOVIZ in the U.S.We focus our sales and marketing efforts on specialist physicians in private practice or at major medical centers. We use customary industry practices to market our products and to educate physicians. This includes our sales representatives calling on individual health care providers (in-person and virtually), advertisements, professional symposia, direct mail, digital marketing, point of care marketing, public relations and other methods. We focus on health care provider sales and marketing efforts on specialty providers in both private practice and at major medical centers.Distribution ArrangementsWe distribute our products in the U.S. principally through wholesale and specialty distributors of pharmaceutical products and specialty pharmacies, mail order specialty distributors or shipping service providers. In other countries, the distribution of our products varies from country to country, including through wholesale distributors of pharmaceutical products and third-party distribution partners who are responsible for most marketing and distribution activities.Eisai distributes AVONEX, TYSABRI, TECFIDERA and PLEGRIDY in India and other Asia-Pacific markets, excluding China.RITUXAN, RITUXAN HYCELA, GAZYVA, OCREVUS and LUNSUMIO are distributed by the Roche Group and its sublicensees.We distribute BENEPALI, IMRALDI and FLIXABI in certain countries in Europe and have an option to acquire exclusive rights to distribute these products in China, as well as BYOOVIZ in the U.S.Our product sales to two wholesale distributors each accounted for more than 10.0% of our total revenue for the years ended December 31, 2022, 2021 and 2020, and on a combined basis, accounted for approximately 37.9%, 38.9% and 45.8%, respectively, of our gross product revenue. For additional information, please read Note 5, Revenue, to our consolidated financial statements included in this report.Patents and Other Proprietary RightsPatents are important for obtaining and protecting exclusive rights in our products and product candidates. We regularly seek patent protection in the U.S. and in selected countries outside the U.S. for inventions originating from our research and development efforts and those we license or acquire. In addition, we license rights to various patents and patent applications. U.S. patents, as well as most foreign patents, are generally effective for 20 years from the date the earliest application was filed; however, U.S. patents on applications filed before June 8, 1995, may be effective until 17 years from the issue date, if that is later than the 20-year date. In some cases, the patent term may be extended to recapture a portion of the term lost during regulatory review of the claimed therapeutic or, in the case of the U.S., because of U.S. Patent and Trademark Office (USPTO) delays in prosecuting the application. Specifically, in the U.S., under the Drug Price Competition and Patent Term Restoration Act of 1984, commonly known as the Hatch-Waxman Act, a patent that covers a drug approved by the FDA may be eligible for patent term extension (for up to 5 years, but not beyond a total of 14 years from the date of product approval) as compensation for patent term lost during the FDA regulatory review process. The duration and extension of the term of foreign patents varies, in accordance with local law. For example, supplementary protection certificates (SPCs) on some of our products have 12Table of Contentsbeen granted in a number of European countries, compensating in part for delays in obtaining marketing approval.Regulatory exclusivity, which may consist of regulatory data protection and market protection, also can provide meaningful protection for our products. Regulatory data protection provides to the holder of a drug or biologic marketing authorization, for a set period of time, the exclusive use of the proprietary pre-clinical and clinical data that it created at significant cost and submitted to the applicable regulatory authority to obtain approval of its product. After the period of exclusive use, third parties are permitted to reference such data in abbreviated applications for approval and to market (subject to any applicable market protection) their generic drugs and biosimilars. Market protection provides the holder of a drug or biologic marketing authorization the exclusive right to commercialize its product for a period of time, thereby preventing the commercialization of another product containing the same active ingredient(s) during that period. Although the World Trade Organization's agreement on trade-related aspects of intellectual property rights (TRIPS) requires signatory countries to provide regulatory exclusivity to innovative pharmaceutical products, implementation and enforcement varies widely from country to country.We also rely upon other forms of unpatented confidential information to remain competitive. We protect such information principally through refraining from public disclosure and confidentiality agreements with our employees, consultants, outside scientific collaborators, scientists whose research we sponsor and other advisers. In the case of our employees, these agreements also provide, in compliance with relevant law, that inventions and other intellectual property conceived by such employees during their employment are our exclusive property.Our trademarks are important to us and are generally covered by trademark applications or registrations in the USPTO and the patent or trademark offices of other countries. We also use trademarks licensed from third parties, such as the trademark FAMPYRA, which we license from Acorda. Trademark protection varies in accordance with local law, and continues in some countries as long as the trademark is used and in other countries as long as the trademark is registered. Trademark registrations generally are for fixed but renewable terms.Our Patent Portfolio The following table describes certain patents in the U.S. and Europe that we currently consider of primary importance to our marketed products, including the territory, patent number, general subject matter and expected expiration dates. Except as otherwise noted, the expected expiration dates include any granted patent term extensions and issued SPCs. In some instances, there are additional later-expiring patents relating to our products directed to, among other things, particular forms or compositions, methods of manufacturing or use of the drug in the treatment of particular diseases or conditions. We also continue to pursue additional patents and patent term extensions in the U.S. and other territories covering various aspects of our products that may, if issued, extend exclusivity beyond the expiration of the patents listed in the table.2Table of ContentsProductTerritoryPatent No.General Subject MatterPatent Expiration(1)TECFIDERAEurope1,131,065Formulations of dialkyl fumarates and their use for treating autoimmune diseases2024(3)Europe2,653,873Methods of use2028PLEGRIDYU.S.8,524,660Methods of treatment2023U.S.8,017,733Polymer conjugates of interferon beta-1a2027Europe1,656,952Polymer conjugates of interferon-beta-1a and uses thereof2024(4)Europe1,476,181Polymer conjugates of interferon-beta-1a and uses thereof2023(5)TYSABRIU.S.8,124,350Methods of treatment2027U.S.8,349,321Formulation2024U.S.8,815,236Formulation2024U.S.8,871,449Methods of treatment2026U.S.8,900,577Formulation2024U.S.9,316,641Safety-related assay2032U.S.9,493,567Methods of treatment2027U.S.9,709,575Methods of treatment2026U.S.10,119,976Methods of evaluating patient risk2034U.S.10,233,245Methods of treatment2027U.S.10,444,234Safety-related assay2031U.S.10,677,803Methods of treatment2034U.S.10,705,095Methods of treatment2026U.S.11,280,794Methods of treatment2034U.S.11,287,423Safety-related assay2031U.S.11,292,845Methods of treatment2027Europe1,485,127Methods of use 2023(2)Europe2,170,390Formulation2028Europe2,236,154Formulation2024Europe2,676,967Methods of use2027Europe3,339,865Safety-related assay2031Europe3,417,875Formulation2024Europe3,575,792Safety-related assay2032FAMPYRAEurope1,732,548Sustained-release aminopyridine compositions for increasing walking speed in patients with MS2025(6)Europe2,377,536Sustained-release aminopyridine compositions for treating MS2025(7)VUMERITYU.S.8,669,281Compounds and pharmaceutical compositions2033U.S.9,090,558Methods of treatment2033U.S.10,080,733Crystalline forms, pharmaceutical compositions and methods of treatment2033Europe2,970,101Crystalline forms, pharmaceutical compositions and methods of treatmentProdrugs of fumarates and their use in treating various diseases2034SPINRAZAU.S.7,101,993Oligonucleotides containing 2’-O-modified purines2023U.S.7,838,657SMA treatment via targeting of SMN2 splice site inhibitory sequences2027U.S.8,110,560SMA treatment via targeting of SMN2 splice site inhibitory sequences2025U.S.8,361,977Compositions and methods for modulation of SMN2 splicing2030U.S.8,980,853Compositions and methods for modulation of SMN2 splicing2030U.S.9,717,750Compositions and methods for modulation of SMN2 splicing2030U.S.9,926,559Compositions and methods for modulation of SMN2 splicing20343Table of ContentsU.S.10,266,822SMA treatment via targeting of SMN2 splice site inhibitory sequences2025U.S.10,436,802Methods for Treating Spinal Muscular Atrophy2035Europe1,910,395Compositions and methods for modulation of SMN2 splicing2026(8)Europe2,548,560Compositions and methods for modulation of SMN2 splicing2026(9)Europe3,305,302Compositions and methods for modulation of SMN2 splicing2030Europe3,308,788Compositions and methods for modulation of SMN2 splicing2026Europe3,449,926Compositions and methods for modulation of SMN2 splicing2030ADUHELMU.S.8,906,367Method of providing disease-specific binding molecules and targets2032(10)U.S.10,131,708Methods of treating Alzheimer's disease2028LEQEMBIU.S.8,025,878Protofibril selective antibodies and the use thereof2027(1)(10)Footnotes follow on next page.4Table of Contents(1)In addition to patent protection, certain of our products are entitled to regulatory exclusivity in the U.S. and the E.U. expected until the dates set forth below:ProductTerritoryExpected ExpirationTECFIDERAE.U.Subject to appealPLEGRIDYU.S.2026E.U.2024SPINRAZAU.S.2023E.U.2029ADUHELMU.S.2033LEQEMBIU.S.2035(2)For additional information as to the validity of this patent, please read Note 21, Litigation, to our consolidated financial statements included in this report.(3)This patent is subject to granted SPCs in certain European countries, which extended the patent term in those countries to 2024.(4)This patent is subject to granted SPCs in certain European countries, which extended the patent term in those countries to 2024.(5)This patent is subject to granted SPCs in certain European countries, which extended the patent term in those countries to 2028.(6)This patent is subject to granted SPCs in certain European countries, which extended the patent term in those countries to 2026.(7)This patent is subject to granted SPCs in certain European countries, which extended the patent term in those countries to 2026.(8)This patent is subject to granted SPCs in certain European countries, which extended the patent term in those countries to 2031.(9)This patent is subject to granted SPCs in certain European countries, which extended the patent term in those countries to 2031.(10)A patent with this subject matter may be entitled to patent term extension in the U.S.The existence of patents does not guarantee our right to practice the patented technology or commercialize the patented product. Patents relating to pharmaceutical, biopharmaceutical and biotechnology products, compounds and processes, such as those that cover our existing products, compounds and processes and those that we will likely file in the future, do not always provide complete or adequate protection. Litigation, interferences, oppositions, inter partes reviews, administrative challenges or other similar types of proceedings are, have been and may in the future be necessary in some instances to determine the validity and scope of certain of our patents, regulatory exclusivities or other proprietary rights, and in other instances to determine the validity, scope or non-infringement of certain patent rights claimed by third parties to be pertinent to the manufacture, use or sale of our products. We also face challenges to our patents, regulatory exclusivities or other proprietary rights covering our products by third-parties, such as manufacturers of generics, biosimilars, prodrugs and products approved under abbreviated regulatory pathways. A discussion of certain risks and uncertainties that may affect our patent position, regulatory exclusivities or other proprietary rights is set forth in Item 1A. Risk Factors included in this report, and the discussion of legal proceedings related to certain patents described above is set forth in Note 21, Litigation, to our consolidated financial statements included in this report.5Table of ContentsCompetitionCompetition in the biopharmaceutical industry and the markets in which we operate is intense. There are many companies, including biotechnology and pharmaceutical companies, engaged in developing products for the indications our approved products are approved to treat and the therapeutic areas we are targeting with our research and development activities. Some of our competitors may have substantially greater financial, marketing, research and development and other resources than we do.We believe that competition and leadership in the industry is based on managerial and technological excellence and innovation as well as establishing patent and other proprietary positions through research and development. The achievement of a leadership position also depends largely upon our ability to maximize the approval, acceptance and use of our product candidates and the availability of adequate financial resources to fund facilities, equipment, personnel, clinical testing, manufacturing and marketing. Another key aspect of remaining competitive in the industry is recruiting and retaining leading scientists and technicians to conduct our research activities and advance our development programs, including with the commercial expertise to effectively market our products.Competition among products approved for sale may be based, among other things, on patent position, product efficacy, safety, patient convenience, delivery devices, reliability, availability, reimbursement and price. In addition, early entry of a new pharmaceutical product into the market may have important advantages in gaining product acceptance and market share. Accordingly, the relative speed with which we can develop products, complete the testing and approval process and supply commercial quantities of products will have a significant impact on our competitive position.The introduction of new products or technologies, including the development of new processes or technologies by competitors or new information about existing products or technologies, results in increased competition for our marketed products and pricing pressure on our marketed products. The development of new or improved treatment options or standards of care or cures for the diseases our products treat reduces and could eliminate the use of our products or may limit the utility and application of ongoing clinical trials for our product candidates.In addition, the commercialization of certain of our own approved products, products of our collaborators and pipeline product candidates may negatively impact future sales of our existing products.Our products and revenue streams continue to face increasing competition in many markets from the introduction of generic versions, prodrugs and biosimilars of existing products and products approved under abbreviated regulatory pathways. Such products are likely to be sold at substantially lower prices than branded products. Accordingly, the introduction of such products as well as other lower-priced competing products may significantly reduce both the price that we are able to charge for our products and the volume of products we sell, which will negatively impact our revenue. In addition, in some markets, when a generic or biosimilar version of one of our products is commercialized, it may be automatically substituted for our product and significantly reduce our revenue in a short period of time. We believe our long-term competitive position depends upon our success in discovering and developing innovative, cost-effective products that serve unmet medical needs, along with our ability to manufacture products efficiently and to launch and market them effectively in a highly competitive environment.Additional information about the competition that our marketed products face is set forth below and in Item 1A. Risk Factors included in this report.Multiple SclerosisTECFIDERA, AVONEX, PLEGRIDY, TYSABRI and VUMERITY each compete with one or more of the following branded products as well as generic and biosimilar versions of these products: Competing ProductCompetitorAUBAGIO (teriflunomide)Sanofi GenzymeBETASERON/BETAFERON (interferon-beta-1b)Bayer GroupBRIUMVI (ublituximab-xiiy)TG Therapeutics, Inc.COPAXONE (glatiramer acetate)Teva Pharmaceuticals Industries Ltd.EXTAVIA (interferon-beta-1b)Novartis AGGILENYA (fingolimod)Novartis AGGLATOPA (glatiramer acetate)Sandoz, a division of Novartis AGLEMTRADA (alemtuzumab)Sanofi GenzymeMAVENCLAD (cladribine)EMD SeronoMAYZENT (siponimod)Novartis AGOCREVUS (ocrelizumab)GenentechPONVORY (ponesimod)Janssen Pharmaceutical Companies of Johnson & JohnsonREBIF (interferon-beta-1)EMD SeronoZEPOSIA (ozanimod)BMSBAFIERTAM (monomethyl fumarate)Banner Life SciencesKESIMPTA (ofatumumab)Novartis AGMultiple TECFIDERA generic entrants are now in North America, Brazil and certain E.U. countries and have deeply discounted prices compared to 6Table of ContentsTECFIDERA. The generic competition for TECFIDERA has significantly reduced our TECFIDERA revenue and we expect that TECFIDERA revenue will continue to decline in the future.In the E.U., we are seeking to enforce a patent granted in June 2022 that relates to TECFIDERA and expires in 2028. In addition, we are litigating to affirm that TECFIDERA is entitled to regulatory data and market protection until at least February 2024. Our Company, the EMA and the EC have each appealed the May 2021 decision of the European General Court, which annulled the EMA's decision not to validate an application for approval of a TECFIDERA generic on the basis that the EMA and EC conducted the wrong assessment when determining TECFIDERA's entitlement to regulatory data and marketing protection. Our Company, the EMA and the EC have each appealed the General Court’s decision as wrongly decided and the appeal is pending. On October 6, 2022, the Advocate General of the CJEU issued a nonbinding advisory opinion in Biogen's favor. This opinion recommends that the CJEU set aside the judgment of the European General Court. We are awaiting the decision of the CJEU.FAMPYRA is indicated as a treatment to improve walking in adult patients with MS who have a walking disability and is the first treatment that addresses this unmet medical need with demonstrated efficacy in people with all types of MS. FAMPYRA is currently the only therapy approved to improve walking in patients with MS. Competition in the MS market is intense. Along with us, a number of companies are working to develop additional treatments for MS that may in the future compete with our MS products. One such product that was approved in the U.S. in 2017 and in the E.U. in 2018 is OCREVUS, a treatment for RMS and PPMS that was developed by Genentech. While we have a financial interest in OCREVUS, future sales of our MS products may be adversely affected if OCREVUS continues to gain market share, or if other MS products that we or our competitors are developing are commercialized.Spinal Muscular AtrophyWe face competition from a gene therapy product and an oral product. We expect that we will experience competition from both products in additional jurisdictions in the future, which may adversely affect our sales of SPINRAZA.Additionally, we are aware of other products now in development that, if launched, may also compete with SPINRAZA. Future sales of SPINRAZA may be adversely affected by the commercialization of competing products.PsoriasisFUMADERM competes with several different types of therapies in the psoriasis market within Germany, including oral systemics such as methotrexate and cyclosporine.BiosimilarsBENEPALI, IMRALDI and FLIXABI, the three biosimilar products we currently commercialize in certain countries in Europe pursuant to an agreement with Samsung Bioepis, compete with their reference products, ENBREL, HUMIRA and REMICADE, respectively, as well as other biosimilars of those reference products. In addition, BYOOVIZ, a biosimilar product we currently commercialize in the U.S. pursuant to an agreement with Samsung Bioepis, competes with its reference product LUCENTIS, as well as other biosimilars of this reference product.Genentech Relationships in Other IndicationsRITUXAN, RITUXAN HYCELA and GAZYVA in OncologyRITUXAN, RITUXAN HYCELA and GAZYVA compete with a number of therapies in the oncology market, including TREANDA (bendamustine HCL), ARZERRA (ofatumumab), IMBRUVICA (ibrutinib) and ZYDELIG (idelalisib). We also expect that over time RITUXAN HYCELA and GAZYVA will increasingly compete with RITUXAN in the oncology market. In addition, we are aware of several other anti-CD20 molecules, including biosimilar products, that have been approved and are competing with RITUXAN, RITUXAN HYCELA and GAZYVA in the oncology and other markets. Biosimilar products referencing RITUXAN have launched in the U.S and are being offered at lower prices. This competition has had a significant adverse impact on the pre-tax profits of our collaboration arrangements with Genentech, as the sales of RITUXAN have decreased substantially compared to prior periods. We expect that biosimilar competition will continue to increase as these products capture additional market share and that this will have a significant adverse impact on our co-promotion profits in the U.S. in future years.RITUXAN in Rheumatoid ArthritisRITUXAN competes with several different types of therapies in the rheumatoid arthritis market, including, among others, traditional disease-modifying anti-rheumatic drugs such as steroids, methotrexate and cyclosporine, TNF inhibitors, ORENCIA (abatacept), ACTEMRA (tocilizumab) and XELJANZ (tofacitinib).We are also aware of other products, including biosimilars, in development that, if approved, may 7Table of Contentscompete with RITUXAN in the rheumatoid arthritis market. Research and Development ProgramsA commitment to research is fundamental to our mission. Our research efforts are focused on better understanding the underlying biology of diseases so we can discover and deliver treatments that have the potential to make a real difference in the lives of patients with high unmet medical needs. By applying our expertise in biologics and our growing capabilities in small molecule, antisense, gene therapy, gene editing and other technologies, we target specific medical needs where we believe new or better treatments are needed.We intend to continue committing significant resources to targeted research and development opportunities where there is a significant unmet need and where a drug candidate has the potential to be highly differentiated. As part of our ongoing research and development efforts, we have devoted significant resources to conducting clinical studies to advance the development of new pharmaceutical products and technologies and to explore the utility of our existing products in treating disorders beyond those currently approved in their labels.For additional information on our research and development expense included in our consolidated statements of income, please read Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations included in this report.8Table of ContentsThe table below highlights our current research and development programs that are in clinical trials and the current phase of such programs. Drug development involves a high degree of risk and investment, and the status, timing and scope of our development programs are subject to change. Important factors that could adversely affect our drug development efforts are discussed in Item 1A. Risk Factors included in this report.Alzheimer's Disease andDementiaLecanemab (Aβ mAb)*** - Alzheimer'sFiled in the U.S., E.U. and JapanLecanemab (Aβ mAb)* - Preclinical Alzheimer'sPhase 3Aducanumab (Aβ mAb)** - Alzheimer'sFiled in Japan and Other MarketsBIIB080 (tau ASO)* - Alzheimer'sPhase 2BIIB113 (OGA inhibitor) - Alzheimer'sPhase 1NeuropsychiatryZuranolone (GABAA PAM)* - MDDFiled in the U.S.Zuranolone (GABAA PAM)* - PPDFiled in the U.S.Specialized ImmunologyDapirolizumab pegol (anti-CD40L)* - SLEPhase 3Litifilimab (anti-BDCA2) - SLEPhase 3Litifilimab (anti-BDCA2) - CLEPhase 2/3Neuromuscular DisordersTofersen (SOD1 ASO)* - SOD1 ALSFiled in the U.S. and E.U.BIIB105 (ataxin-2 ASO)# - ALSPhase 1/2BIIB115 (SMN ASO)* - SMAPhase 1Parkinson's Disease and Movement DisordersBIIB122 (DNL151)* - LRRK2 Parkinson'sPhase 3BIIB122 (DNL151)* - Parkinson'sPhase 2BIIB124 (SAGE-324)* - Essential TremorPhase 2BIIB094 (ION859)# - Parkinson'sPhase 1BIIB101 (ION464)# - Multiple System AtrophyPhase 1BIIB132 (ATXN-3 ASO)# - SCA3Phase 1Multiple SclerosisBIIB091 (peripheral BTK inhibitor) - MSPhase 1BIIB107 (anti-VLA4) - MSPhase 1NeurovascularGlibenclamide IV (SUR1-TRPM4 Inhibitor) - LHI^ StrokePhase 3Glibenclamide IV (SUR1-TRPM4 Inhibitor) - Brain ContusionPhase 2BIIB131 (TMS-007) - Acute Ischemic StrokePhase 2Genetic Neurodevelopmental DisordersBIIB121 (UBE3A ASO)# - Angelman SyndromePhase 1* Collaboration program** Granted accelerated approval in the U.S. in June 2021 under the brand name ADUHELM.*** Granted accelerated approval in the U.S. in January 2023 under the brand name LEQEMBI and filed for traditional approval in the U.S., E.U. and Japan.# Option agreement^ Large Hemispheric Infarction (LHI)For information about certain of our agreements with collaborators and other third parties, please read the subsection entitled Business Relationships below and Note 2, Acquisitions, Note 19, Collaborative and Other Relationships, and Note 20, Investments in Variable Interest Entities, to our consolidated financial statements included in this report.9Table of ContentsBusiness RelationshipsAs part of our business strategy, we establish business relationships, including entering into licenses, joint ventures and collaborative arrangements with other companies, universities and medical research institutions, to assist in the clinical development and/or commercialization of certain of our products and product candidates and to provide support for our research programs. We also evaluate opportunities for acquiring products or rights to products and technologies that are complementary to our business from other companies, universities and medical research institutions.Below is a brief description of certain business relationships and collaborations that expand our pipeline and provide us with certain rights to existing and potential new products and technologies. For additional information on certain of these relationships, including their ongoing financial and accounting impact on our business, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Eisai Co., Ltd.We have a collaboration agreement with Eisai to jointly develop and commercialize LEQEMBI (lecanemab), an anti-amyloid antibody for the treatment of Alzheimer's disease. Eisai serves as the lead of LEQEMBI development and regulatory submissions globally with both companies co-commercializing and co-promoting the product, and Eisai having final decision-making authority. All costs, including research, development, sales and marketing expense, are shared equally between us and Eisai. Upon LEQEMBI marketing approval, we and Eisai will co-promote LEQEMBI and share profits and losses equally. We currently manufacture LEQEMBI drug substance and drug product and in March 2022 we extended our supply agreement with Eisai related to LEQEMBI from five years to ten years for the manufacture of LEQEMBI drug substance.We also have a collaboration agreement with Eisai for ADUHELM. Under our initial ADUHELM Collaboration Agreement, we would lead the ongoing development of ADUHELM, and we and Eisai would co-promote ADUHELM with a region-based profit split. On March 14, 2022, we amended our ADUHELM Collaboration Agreement with Eisai. As of the amendment date, we have sole decision making and commercialization rights worldwide on ADUHELM, and beginning January 1, 2023, Eisai receives only a tiered royalty based on net sales of ADUHELM, and no longer participates in sharing ADUHELM's global profits and losses. Eisai's share of development, commercialization and manufacturing expense was limited to $335.0 million for the period from January 1, 2022 to December 31, 2022, which was achieved as of December 31, 2022. Once this limit was achieved, we became responsible for all ADUHELM related costs.In addition, we and Eisai co-promote AVONEX, TYSABRI and TECFIDERA in Japan in certain settings and Eisai distributes AVONEX, TYSABRI, TECFIDERA and PLEGRIDY in India and other Asia-Pacific markets, excluding China.Sage Therapeutics, Inc.We have a global collaboration and license agreement with Sage to jointly develop and commercialize zuranolone for the potential treatment of MDD and PPD and BIIB124 (SAGE-324) for the potential treatment of essential tremor with potential in other neurological conditions such as epilepsy. Under this collaboration, both companies will share equal responsibility and costs for development as well as profits and losses for commercialization in the U.S. Outside the U.S., we are responsible for development and commercialization, excluding Japan, Taiwan and South Korea, with respect to zuranolone and may pay Sage potential tiered royalties in the high teens to low twenties.Ionis Pharmaceuticals, Inc.We have an exclusive, worldwide option and collaboration agreement with Ionis relating to the development and commercialization of antisense therapeutics for up to three gene targets. Under a separate collaboration and license agreement with Ionis, we have an exclusive, worldwide license to develop and commercialize SPINRAZA for the treatment of SMA. We also have a 10-year exclusive collaboration agreement with Ionis to develop novel ASO drug candidates for a broad range of neurological diseases.In addition, we have research collaboration agreements with Ionis under which both companies perform discovery level research and will develop and commercialize new ASO drug candidates for the potential treatment of SMA and additional antisense or other therapeutics for the potential treatment of neurological diseases.Genentech, Inc. (Roche Group)We have agreements with Genentech that entitle us to certain business and financial rights with respect to RITUXAN, RITUXAN HYCELA, GAZYVA, OCREVUS, LUNSUMIO, which was granted accelerated approval in the U.S. during the fourth quarter of 2022, glofitamab and options to add other potential anti-CD20 therapies.10Table of ContentsDenali Therapeutics Inc.We have a collaboration and license agreement with Denali to co-develop and co-commercialize Denali’s small molecule inhibitors of LRRK2 for Parkinson’s disease. Under this collaboration, both companies share responsibility and costs for global development based on specified percentages as well as profits and losses for commercialization in the U.S. and China. Outside the U.S. and China, we are responsible for commercialization and may pay Denali potential tiered royalties.In addition to the LRRK2 program, we also have an exclusive option to license two preclinical programs from Denali’s Transport Vehicle platform, including its Antibody Transport Vehicle (ATV): ATV enabled anti-amyloid beta program and a second program utilizing its Transport Vehicle technology. Further, we have the right of first negotiation on two additional ATV-enabled therapeutics for indications within specific neurodegenerative diseases, should Denali decide to seek a collaboration for such programs.Samsung Bioepis Co., Ltd.In February 2012 we entered into a joint venture agreement with Samsung BioLogics establishing an entity, Samsung Bioepis, to develop, manufacture and market biosimilar products. We also have an agreement with Samsung Bioepis to commercialize, over a 10-year term, three anti-TNF biosimilar product candidates in certain countries in Europe and, in the case of BENEPALI, Japan. Under this agreement, we are commercializing BENEPALI, an etanercept biosimilar referencing ENBREL, IMRALDI, an adalimumab biosimilar referencing HUMIRA, and FLIXABI, an infliximab biosimilar referencing REMICADE, in certain countries in Europe.In December 2019 we completed a transaction with Samsung Bioepis and acquired an option to extend our existing commercial agreement with Samsung Bioepis for BENEPALI, IMRALDI and FLIXABI in certain countries in Europe. We have also secured the exclusive rights to commercialize BYOOVIZ, a ranibizumab biosimilar referencing LUCENTIS, which was approved in the U.S., the E.U. and the U.K. during the third quarter of 2021. BYOOVIZ launched in the U.S. in June 2022 and became commercially available during the third quarter of 2022. In addition to our commercialization agreements with Samsung Bioepis, we license certain of our proprietary technology to Samsung Bioepis in connection with Samsung Bioepis' development, manufacture and commercialization of its biosimilar products.In April 2022 we completed the sale of our 49.9% equity interest in Samsung Bioepis to Samsung BioLogics. Under the terms of this transaction, we received approximately $1.0 billion in cash at closing and expect to receive approximately $1.3 billion in cash to be deferred over two payments of approximately $812.5 million due at the first anniversary and approximately $437.5 million due at the second anniversary of the closing of this transaction.As part of this transaction, we are also eligible to receive up to an additional $50.0 million upon the achievement of certain commercial milestones. Our policy for contingent payments of this nature is to recognize the payments in the period that they become realizable, which is generally the same period in which the payments are earned.For additional information on the sale of our equity interest in Samsung Bioepis, please read Note 3, Dispositions, to our consolidated financial statements included in this report.UCBWe have a collaboration agreement with UCB to jointly develop and commercialize dapirolizumab pegol, an anti-CD40L pegylated Fab, for the potential treatment of SLE and other future agreed indications. Both companies will share equally costs incurred for agreed indications, including research, development, sales and marketing expense. If marketing approval is obtained, both companies will co-promote dapirolizumab pegol and share profits and losses equally.Sangamo Therapeutics, Inc.We have a collaboration and license agreement with Sangamo Therapeutics, Inc. (Sangamo) to develop and commercialize ST-501 for tauopathies, including Alzheimer’s disease; ST-502 for synucleinopathies, including Parkinson’s disease; a third neuromuscular disease target; and up to nine additional neurological disease targets to be identified and selected within a five-year period. The companies are leveraging Sangamo's proprietary zinc finger protein technology delivered via adeno-associated virus to modulate the expression of key genes involved in neurological diseases. Under this collaboration, we may pay Sangamo tiered royalties on potential net sales of any products developed under this collaboration in the high single digit to sub-teen percentages.11Table of ContentsRegulatoryOur current and contemplated activities and the products, technologies and processes that result from such activities are subject to substantial government regulation.Regulation of PharmaceuticalsProduct Approval and Post-Approval Regulation in the U.S.APPROVAL PROCESSBefore new pharmaceutical products may be sold in the U.S., preclinical studies and clinical trials of the products must be conducted and the results submitted to the FDA for approval. With limited exceptions, the FDA requires companies to register both pre-approval and post-approval clinical trials and disclose clinical trial results in public databases. Failure to register a trial or disclose study results within the required time periods could result in penalties, including civil monetary penalties. Clinical trial programs must establish efficacy, determine an appropriate dose and dosing regimen and define the conditions for safe use. This is a high-risk process that requires stepwise clinical studies in which the candidate product must successfully meet predetermined endpoints. The results of the preclinical and clinical testing of a product are then submitted to the FDA in the form of a BLA or a NDA. In response to a BLA or NDA, the FDA may grant marketing approval, request additional information or deny the application if it determines the application does not provide an adequate basis for approval.Product development and receipt of regulatory approval takes a number of years, involves the expenditure of substantial resources and depends on a number of factors, including the severity of the disease in question, the availability of suitable alternative treatments, potential safety signals observed in preclinical or clinical tests and the risks and benefits of the product as demonstrated in clinical trials. The FDA has substantial discretion in the product approval process, and it is impossible to predict with any certainty whether and when the FDA will grant marketing approval. The agency may require the sponsor of a BLA or NDA to conduct additional clinical studies or to provide other scientific or technical information about the product, and these additional requirements may lead to unanticipated delays or expenses. Furthermore, even if a product is approved, the approval may be subject to limitations based on the FDA's interpretation of the existing pre-clinical and/or clinical data. The FDA has developed four distinct approaches intended to facilitate the development and expedite the regulatory review of therapeutically important drugs, especially when the drugs are the first available treatment or have advantages over existing treatments: accelerated approval, fast track, breakthrough therapy and priority review.•Accelerated Approval: The FDA may grant “accelerated approval” to products that treat serious or life-threatening illnesses and that provide meaningful therapeutic benefits to patients over existing treatments. Under this pathway, the FDA may approve a product based on surrogate endpoints or clinical endpoints other than survival or irreversible morbidity. When approval is based on surrogate endpoints or clinical endpoints other than survival or morbidity, the sponsor will be required to provide the FDA with confirmatory data post-approval to verify and describe clinical benefit. Under the FDA's accelerated approval regulations, if the FDA concludes that a drug that has been shown to be effective can be safely used only if distribution or use is restricted, it may require certain post-marketing restrictions to assure safe use. In addition, for products approved under accelerated approval, sponsors may be required to submit all copies of their promotional materials, including advertisements, to the FDA at least 30 days prior to initial dissemination. The FDA may withdraw approval if, for instance, post-marketing studies fail to verify clinical benefit, it becomes clear that restrictions on the distribution of the product are inadequate to ensure its safe use or if a sponsor fails to comply with the conditions of the accelerated approval.•Fast Track: The FDA may grant "fast track" status to products that treat a serious condition and have data demonstrating the potential to address an unmet medical need or a drug that has been designated as a qualified infectious disease product.•Breakthrough Therapy: The FDA may grant “breakthrough therapy” status to drugs designed to treat, alone or in combination with another drug or drugs, a serious or life-threatening disease or condition and for which preliminary clinical evidence suggests a substantial improvement over existing therapies based on a clinically significant endpoint. Breakthrough therapy status entitles the sponsor to earlier and more frequent meetings with the FDA regarding the development of nonclinical and clinical data and permits the FDA to offer product development or regulatory advice for the purpose of shortening the time to product approval. Breakthrough therapy status does not guarantee that a product will be eligible for priority review and does not ensure FDA approval.12Table of Contents•Priority Review: “Priority review” only applies to applications (original or efficacy supplement) for a drug that treats a serious condition and, if approved, would provide a significant improvement in safety or effectiveness of the treatment, diagnosis or prevention of a serious condition. Priority review may also be granted for any supplement that proposes a labeling change due to studies completed in response to a written request from the FDA for pediatric studies, for an application for a drug that has been designated as a qualified infectious disease product or for any application or supplement for a drug submitted with a priority review voucher.In December 2016 the FDA issued a rare pediatric disease priority review voucher to us in connection with the approval of SPINRAZA. POST-MARKETING STUDIESRegardless of the approval pathway employed, the FDA may require a sponsor to conduct additional post-marketing studies as a condition of approval to provide data on safety and effectiveness. If a sponsor fails to conduct the required studies, the FDA may withdraw its approval. In addition, if the FDA concludes that a drug that has been shown to be effective can be safely used only if distribution or use is restricted, it can mandate post-marketing restrictions to assure safe use. In such a case, the sponsor may be required to establish rigorous systems to assure use of the product under safe conditions. These systems are usually referred to as Risk Evaluation and Mitigation Strategies (REMS). The FDA can impose financial penalties for failing to comply with certain post-marketing commitments, including REMS. In addition, any changes to an approved REMS must be reviewed and approved by the FDA prior to implementation.ADVERSE EVENT REPORTINGWe monitor information on side effects and adverse events reported during clinical studies and after marketing approval and report such information and events to regulatory agencies. Non-compliance with the FDA's safety reporting requirements may result in civil or criminal penalties. Side effects or adverse events that are reported during clinical trials can delay, impede or prevent marketing approval. Based on new safety information that emerges after approval, the FDA can mandate product labeling changes, impose a new REMS or the addition of elements to an existing REMS, require new post-marketing studies (including additional clinical trials) or suspend or withdraw approval of the product. These requirements may affect our ability to maintain marketing approval of our products or require us to make significant expenditures to obtain or maintain such approvals.APPROVAL OF CHANGES TO AN APPROVED PRODUCTIf we seek to make certain types of changes to an approved product, such as adding a new indication, making certain manufacturing changes or changing manufacturers or suppliers of certain ingredients or components, the FDA will need to review and approve such changes in advance. In the case of a new indication, we are required to demonstrate with additional clinical data that the product is safe and effective for a use other than what was initially approved. FDA regulatory review may result in denial or modification of the planned changes, or requirements to conduct additional tests or evaluations that can substantially delay or increase the cost of the planned changes.REGULATION OF PRODUCT ADVERTISING AND PROMOTIONThe FDA regulates all advertising and promotion activities and communications for products under its jurisdiction both before and after approval. Pursuant to FDA guidance, a company can make safety and efficacy claims either in or consistent with the product label. However, physicians may prescribe legally available drugs for uses that are not described in the drug's labeling. Such off-label prescribing is common across medical specialties, and often reflects a physician's belief that the off-label use is the best treatment for patients. The FDA does not regulate the behavior of physicians in their choice of treatments, but FDA regulations do impose stringent restrictions on manufacturers' communications regarding off-label uses. Failure to comply with applicable FDA requirements may subject a company to adverse publicity, enforcement action by the FDA, corrective advertising and the full range of civil and criminal penalties available to the government. Regulation of Combination ProductsCombination products are defined by the FDA to include products comprising two or more regulated components (e.g., a biologic and a device). Biologics and devices each have their own regulatory requirements, and combination products may have additional requirements. Some of our marketed products meet this definition and are regulated under this framework and similar regulations outside the U.S., and we expect that some of our pipeline product candidates may be evaluated for regulatory approval under this framework as well. In May 2017 new regulations governing medical devices (MDR) and in-vitro diagnostic medical devices (IVDR) entered into force in the E.U. The MDR regulations became applicable in May 2021 and the 13Table of ContentsIVDR regulations became applicable in May 2022. All products covered by these regulations will be required to comply with them at the end of the transitional periods. These regulations introduce new requirements, including for clinical investigation of certain classifications of medical devices, require increased regulatory scrutiny, enhance the requirements for post market surveillance and vigilance and provide for greater transparency. These regulations also change the requirements for assessment of the medical device components of integral drug-device combination products, necessitating assessment of the device components under both the medical device and medicinal product regulatory regimes.Product Approval and Post-Approval Regulation Outside the U.S.We market our products in numerous jurisdictions outside the U.S. Most of these jurisdictions have product approval and post-approval regulatory processes that are similar in principle to those in the U.S. In Europe, for example, where a substantial part of our ex-U.S. efforts are focused, there are several routes for marketing approval, depending on the type of product for which approval is sought. Under the centralized procedure, a company submits a single application to the EMA. The marketing authorization application is similar to the NDA or BLA in the U.S. and is evaluated by the CHMP, the expert scientific committee of the EMA responsible for human medicines. If the CHMP determines that the MAA fulfills the requirements for quality, safety and efficacy and that the medicine has a positive benefit risk balance, it will adopt a positive opinion recommending the granting of the marketing authorization by the EC. The CHMP opinion is not binding, but is typically adopted by the EC. A MAA approved by the EC is valid in all member states of the E.U. The centralized procedure is required for all biological products, orphan medicinal products and new treatments for neurodegenerative disorders, and it is available for certain other products, including those which constitute a significant therapeutic, scientific or technical innovation.In addition to the centralized procedure, the European regulatory framework includes the following options for regulatory review and approval in the E.U. member states: •a national procedure, where the first application is made to the competent authority in one E.U. member state only; •a decentralized procedure, where applicants submit identical applications to several E.U. member states and receive simultaneous approval, if the medicine has not yet been authorized in any E.U. member state; and •a mutual recognition procedure, where applicants that have a medicine authorized in one E.U. member state can apply for mutual recognition of this authorization in other E.U. member states As in the U.S., the E.U. also has distinct approaches intended to optimize the regulatory pathways for therapeutically important drugs, including the Priority Medicines Evaluation Scheme (PRIME), accelerated assessment and conditional marketing authorization. PRIME is intended to provide additional support to medicine developers throughout the development process. Regulatory review timelines in the E.U. may be truncated under accelerated assessment for products that address an unmet medical need. In addition, conditional marketing authorizations may be granted for products in the interest of public health, where the benefit of immediate availability outweighs the risk of having less comprehensive data than normally required. Conditional marketing authorizations are valid for one year and can be renewed annually. The marketing authorization holder is required to complete specific obligations (ongoing or new studies and, in some cases, additional activities) with a view to providing comprehensive data confirming that the benefit risk balance is positive. Once comprehensive data on the product have been obtained, the marketing authorization may be converted into a standard marketing authorization.Aside from the U.S. and the E.U., there are countries in other regions where it is possible to receive an "accelerated" review whereby the national regulatory authority will commit to truncated review timelines for products that meet specific medical needs.In the E.U. there is detailed legislation on pharmacovigilance and extensive guidance on good pharmacovigilance practices. A failure to comply with the E.U. pharmacovigilance obligations may result in significant financial penalties for the marketing authorization holder.Regardless of the approval process employed, various parties share responsibilities for the monitoring, detection and evaluation of adverse events post-approval, including national competent authorities, the EMA, the EC and the marketing authorization holder. The EMA’s Pharmacovigilance Risk Assessment Committee is responsible for assessing and monitoring the safety of human medicines and makes recommendations on product safety issues. Marketing authorization holders have an obligation to inform regulatory agencies of any new information which may influence the evaluation of benefits and risks of the medicinal product concerned. 14Table of ContentsIn the U.S., the E.U. and other jurisdictions, regulatory agencies, including the FDA, conduct periodic inspections of NDA, BLA and marketing authorization holders to assess their compliance with pharmacovigilance obligations.Good Manufacturing PracticesRegulatory agencies regulate and inspect equipment, facilities and processes used in the manufacturing and testing of pharmaceutical and biologic products prior to approving a product. If, after receiving approval from regulatory agencies, a company makes a material change in manufacturing equipment, location or process, additional regulatory review and approval may be required. We also must adhere to current Good Manufacturing Practices (cGMP) and product-specific regulations enforced by regulatory agencies following product approval. The FDA, the EMA and other regulatory agencies also conduct periodic visits to re-inspect equipment, facilities and processes following the initial approval of a product. If, as a result of these inspections, it is determined that our equipment, facilities or processes do not comply with applicable regulations and conditions of product approval, regulatory agencies may seek civil, criminal or administrative sanctions or remedies against us, including significant financial penalties and the suspension of our manufacturing operations.Good Clinical PracticesThe FDA, the EMA and other regulatory agencies promulgate regulations and standards for designing, conducting, monitoring, auditing and reporting the results of clinical trials to ensure that the data and results are accurate and that the rights and welfare of trial participants are adequately protected (commonly referred to as current Good Clinical Practices (cGCP)). Regulatory agencies enforce cGCP through periodic inspections of trial sponsors, principal investigators and trial sites, contract research organizations (CROs) and institutional review boards. If our studies fail to comply with applicable cGCP guidelines, the clinical data generated in our clinical trials may be deemed unreliable and relevant regulatory agencies may require us to perform additional clinical trials before approving our marketing applications. Noncompliance can also result in civil or criminal sanctions. We rely on third-parties, including CROs, to carry out many of our clinical trial-related activities. Failure of such third-parties to comply with cGCP can likewise result in rejection of our clinical trial data or other sanctions.In April 2014 the EC adopted a new Clinical Trial Regulation, which was entered into force in June 2014 but did not apply until January 2022. There are transitional provisions for clinical trials which are ongoing at the date of application. Clinical trial applications may also continue to be made under the Clinical Trial Directive (the existing regulatory framework) until January 2023. All clinical trials must fully comply with the Clinical Trial Regulation by January 2025. The regulation harmonizes the procedures for assessment and governance of clinical trials throughout the E.U. and will require that information on the authorization, conduct and results of each clinical trial conducted in the E.U. be publicly available.Approval of Biosimilars In the U.S. the Patient Protection and Affordable Care Act (PPACA) amended the Public Health Service Act (PHSA) to authorize the FDA to approve biological products, referred to as biosimilars or follow-on biologics, that are shown to be "highly similar" to previously approved biological products based upon potentially abbreviated data packages. The biosimilar must show it has no clinically meaningful differences in terms of safety and effectiveness from the reference product, and only minor differences in clinically inactive components are allowable in biosimilar products. The approval pathway for biosimilars does, however, grant a biologics manufacturer a 12-year period of exclusivity from the date of approval of its biological product before biosimilar competition can be introduced. There is uncertainty, however, as the approval framework for biosimilars originally was enacted as part of the PPACA. There have been, and there are likely to continue to be, federal legislative and administrative efforts to repeal, substantially modify or invalidate some or all of the provisions of the PPACA. If the PPACA is repealed, substantially modified or invalidated, it is unclear what, if any, impact such action would have on biosimilar regulation.A biosimilars approval pathway has been in place in the E.U. since 2003. The EMA has issued a number of scientific and product specific biosimilar guidelines, including requirements for approving biosimilars containing monoclonal antibodies. In the E.U., biosimilars are generally approved under the centralized procedure. The approval pathway allows sponsors of a biosimilar to seek and obtain regulatory approval based in part on reliance on the clinical trial data of an innovator product to which the biosimilar has been demonstrated, through comprehensive comparability studies, to be “similar.” In many cases, this allows biosimilars to be brought to market without conducting the full complement of clinical trials typically required for novel biologic drugs.Orphan Drug ActUnder the U.S. Orphan Drug Act, the FDA may grant orphan drug designation to drugs or biologics intended to treat a “rare disease or condition,” which generally is a disease or condition that affects fewer than 200,000 individuals in the U.S. If a product 15Table of Contentswhich has an orphan drug designation subsequently receives an initial FDA approval for the indication for which it has such designation, the product is entitled to orphan exclusivity, i.e., the FDA may not approve any other applications to market the same drug for the same indication for a period of seven years following marketing approval, except in certain very limited circumstances, such as if the later product is shown to be clinically superior to the orphan product. Legislation similar to the U.S. Orphan Drug Act has been enacted in other countries to encourage the research, development and marketing of medicines to treat, prevent or diagnose rare diseases. In the E.U., medicinal products that receive and maintain an orphan designation are entitled to 10 years of market exclusivity following approval, protocol assistance and access to the centralized procedure for marketing authorization. SPINRAZA has been granted orphan drug designation in the U.S., the E.U. and Japan.Regulation Pertaining to Pricing and ReimbursementIn both domestic and foreign markets, sales of our products depend, to a significant extent, on the availability and amount of reimbursement by third-party payors, including governments, private health plans and other organizations. Substantial uncertainty exists regarding the pricing and reimbursement of our products, and drug prices continue to receive significant scrutiny. Governments may regulate coverage, reimbursement and pricing of our products to control cost or affect utilization of our products. Challenges to our pricing strategies, by either government or private stakeholders, could harm our business. The U.S. and foreign governments have enacted and regularly consider additional reform measures that affect health care coverage and costs. Private health plans may also seek to manage cost and utilization by implementing coverage and reimbursement limitations. Other payors, including managed care organizations, health insurers, pharmacy benefit managers, government health administration authorities and private health insurers, seek price discounts or rebates in connection with the placement of our products on their formularies and, in some cases, may impose restrictions on access, coverage or pricing of particular drugs based on perceived value.Within the U.S.•Medicaid: Medicaid is a joint federal and state program that is administered by the states for low income and disabled beneficiaries. Under the Medicaid Drug Rebate Program, we are required to pay a rebate for each unit of product reimbursed by the state Medicaid programs. The amount of the rebate is established by law and is adjusted upward if the average manufacturer price (AMP) increases more than inflation (measured by the Consumer Price Index - Urban). The rebate amount is calculated each quarter based on our report of current AMP and best price for each of our products to the CMS. The requirements for calculating AMP and best price are complex. We are required to report any revisions to AMP or best price previously reported within a certain period, which revisions could affect our rebate liability for prior quarters. In addition, if we fail to provide information timely or we are found to have knowingly submitted false information to the government, the statute governing the Medicaid Drug Rebate Program provides for civil monetary penalties.•Medicare: Medicare is a federal program that is administered by the federal government. The program covers individuals age 65 and over as well as those with certain disabilities. Medicare Part B generally covers drugs that must be administered by physicians or other health care practitioners, are provided in connection with certain durable medical equipment or are certain oral anti-cancer drugs and certain oral immunosuppressive drugs. Medicare Part B pays for such drugs under a payment methodology based on the average sales price (ASP) of the drugs. Manufacturers, including us, are required to provide ASP information to the CMS on a quarterly basis. The manufacturer-submitted information is used to calculate Medicare payment rates. If a manufacturer is found to have made a misrepresentation in the reporting of ASP, the governing statute provides for civil monetary penalties.Medicare Part D provides coverage to enrolled Medicare patients for self-administered drugs (i.e., drugs that are not administered by a physician). Medicare Part D is administered by private prescription drug plans approved by the U.S. government. Each drug plan establishes its own Medicare Part D formulary for prescription drug coverage and pricing, which the drug plan may modify from time-to-time. The prescription drug plans negotiate pricing with manufacturers and pharmacies, and may condition formulary placement on the availability of manufacturer discounts. In addition, manufacturers, including us, are required to provide to the CMS a discount of up to 70.0% on brand name prescription drugs utilized by Medicare Part D beneficiaries when those beneficiaries reach the coverage gap in their drug benefits.On August 16, 2022, President Biden signed into law the IRA, which provides for (i) the government to negotiate prices for select high-cost Medicare Part D drugs (beginning in 2026) and Part B drugs (beginning in 2028), (ii) manufacturers to pay a rebate for Medicare Part B and Part D drugs when prices increase faster than inflation 16Table of Contentsbeginning in 2022 for Part D and 2023 for Part B, and (iii) Medicare Part D redesign which replaces the current coverage gap provisions and establishes a $2,000 cap for out-of-pocket costs for Medicare beneficiaries beginning in 2025, with manufacturers being responsible for 10.0% of costs up to the $2,000 cap and 20.0% after that cap is reached. The result of these forthcoming changes for manufacturers, including us, may include: i) a material adverse effect on our revenue on drugs subject to “negotiation”; ii) new rebate liability for drugs subject to the inflation provisions, and iii) potential significant additional costs related to the Part D re-design. However, as the degree of impact from this legislation on our business depends on a number of forthcoming implementation actions by regulatory authorities, the full extent of the IRA’s impact on our sales and, in turn, our business, remains unclear.•Federal Agency Discounted Pricing: Our products are subject to discounted pricing when purchased by federal agencies via the Federal Supply Schedule (FSS). FSS participation is required for our products to be covered and reimbursed by the Veterans Administration (VA), Department of Defense, Coast Guard and Public Health Service (PHS). Coverage under Medicaid, Medicare and the PHS pharmaceutical pricing program is also conditioned upon FSS participation. FSS pricing is intended not to exceed the price that we charge our most-favored non-federal customer for a product. In addition, prices for drugs purchased by the VA, Department of Defense (including drugs purchased by military personnel and dependents through the TriCare retail pharmacy program), Coast Guard and PHS are subject to a cap on pricing equal to 76.0% of the non-federal average manufacturer price (non-FAMP). An additional discount applies if non-FAMP increases more than inflation (measured by the Consumer Price Index - Urban). In addition, if we fail to provide information timely or we are found to have knowingly submitted false information to the government, the governing statute provides for civil monetary penalties.•340B Discounted Pricing: To maintain coverage of our products under the Medicaid Drug Rebate Program and Medicare Part B, we are required to extend significant discounts to certain covered entities that purchase products under Section 340B of the PHS pharmaceutical pricing program. Purchasers eligible for discounts include hospitals that serve a disproportionate share of financially needy patients, community health clinics and other entities that receive certain types of grants under the PHSA. For all of our products, we must agree to charge a price that will not exceed the amount determined under statute (the “ceiling price”) when we sell outpatient drugs to these covered entities. In addition, we may, but are not required to, offer these covered entities a price lower than the 340B ceiling price. The 340B discount formula is based on AMP and is generally similar to the level of rebates calculated under the Medicaid Drug Rebate Program. Outside the U.S.Outside the U.S., our products are paid for by a variety of payors, with governments being the primary source of payment. Governments may determine or influence reimbursement of products and may also set prices or otherwise regulate pricing. Negotiating prices with governmental authorities can delay commercialization of our products. Governments may use a variety of cost-containment measures to control the cost of products, including price cuts, mandatory rebates, value-based pricing and reference pricing (i.e., referencing prices in other countries and using those reference prices to set a price). Budgetary pressures in many countries are continuing to cause governments to consider or implement various cost-containment measures, such as price freezes, increased price cuts and rebates and expanded generic substitution and patient cost-sharing. Regulation Pertaining to Sales and MarketingWe are subject to various federal and state laws pertaining to health care “fraud and abuse,” including anti-kickback laws and false claims laws. Anti-kickback laws generally prohibit a prescription drug manufacturer from soliciting, offering, receiving or paying any remuneration to generate business, including the purchase or prescription of a particular drug. Although the specific provisions of these laws vary, their scope is generally broad and there may be no regulations, guidance or court decisions that clarify how the laws apply to particular industry practices. There is therefore a possibility that our practices might be challenged under anti-kickback or similar laws. False claims laws prohibit anyone from knowingly and willingly presenting, or causing to be presented, for payment to third-party payors (including Medicare and Medicaid), claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed or claims for medically unnecessary items or services. Our activities relating to the sale and marketing of our products may be subject to scrutiny under these laws. Violations of fraud and abuse laws may be punishable by criminal or civil sanctions, including fines and civil monetary penalties, and exclusion from federal health care programs (including Medicare and Medicaid). In the U.S., federal and state authorities are paying increased attention to enforcement of these laws 17Table of Contentswithin the pharmaceutical industry and private individuals have been active in alleging violations of the laws and bringing suits on behalf of the government under the federal civil False Claims Act. If we were subject to allegations concerning, or were convicted of violating, these laws, our business could be harmed.Laws and regulations have been enacted by the federal government and various states to regulate the sales and marketing practices of pharmaceutical manufacturers. The laws and regulations generally limit financial interactions between manufacturers and health care providers or require disclosure to the government and public of such interactions. The laws include federal “sunshine” provisions. The sunshine provisions apply to pharmaceutical manufacturers with products reimbursed under certain government programs and require those manufacturers to disclose annually to the federal government (for re-disclosure to the public) certain payments made to physicians and certain other healthcare practitioners or to teaching hospitals. State laws may also require disclosure of pharmaceutical pricing information and marketing expenditures. Many of these laws and regulations contain ambiguous requirements. Given the lack of clarity in laws and their implementation, our reporting actions could be subject to the penalty provisions of the pertinent federal and state laws and regulations. Outside the U.S., other countries have implemented requirements for disclosure of financial interactions with healthcare providers and additional countries may consider or implement such laws.Other RegulationsForeign Anti-CorruptionWe are subject to various federal and foreign laws that govern our international business practices with respect to payments to government officials. Those laws include the U.S. Foreign Corrupt Practices Act (FCPA), which prohibits U.S. companies and their representatives from paying, offering to pay, promising to pay or authorizing the payment of anything of value to any foreign government official, government staff member, political party or political candidate for the purpose of obtaining or retaining business or to otherwise obtain favorable treatment or influence a person working in an official capacity. In many countries, the health care professionals we regularly interact with may meet the FCPA's definition of a foreign government official. The FCPA also requires public companies to make and keep books and records that accurately and fairly reflect their transactions and to devise and maintain an adequate system of internal accounting controls.The laws to which we are subject also include the U.K. Bribery Act 2010 (Bribery Act), which proscribes giving and receiving bribes in the public and private sectors, bribing a foreign public official and failing to have adequate procedures to prevent employees and other agents from giving bribes. U.S. companies that conduct business in the U.K. generally will be subject to the Bribery Act. Penalties under the Bribery Act include significant fines for companies and criminal sanctions for corporate officers under certain circumstances.NIH GuidelinesWe seek to conduct research at our U.S. facilities in compliance with the current U.S. National Institutes of Health Guidelines for Research Involving Recombinant DNA Molecules (NIH Guidelines). By local ordinance, we are required to, among other things, comply with the NIH Guidelines in relation to our facilities in RTP, NC and are required to operate pursuant to certain permits.Other LawsOur present and future business has been and will continue to be subject to various other laws and regulations. Various laws, regulations and recommendations relating to data privacy and protection, safe working conditions, laboratory practices, the experimental use of animals and the purchase, storage, movement, import, export and use and disposal of hazardous or potentially hazardous substances, including radioactive compounds and infectious disease agents, used in connection with our research work are or may be applicable to our activities. Certain agreements entered into by us involving exclusive license rights may be subject to national or international antitrust regulatory control, the effect of which cannot be predicted. The extent of government regulation, which might result from future legislation or administrative action, cannot accurately be predicted.The European Parliament and the Council of the E.U. adopted a comprehensive general data privacy regulation (GDPR) in 2016 to replace the current E.U. Data Protection Directive and related country-specific legislation. The GDPR took effect in May 2018 and governs the collection and use of personal data in the E.U. The GDPR, which is wide-ranging in scope, imposes several requirements relating to the consent of the individuals to whom the personal data relates, the information provided to the individuals, the security and confidentiality of the personal data, data breach notification and the use of third-party processors in connection with the processing of the personal data. The GDPR also imposes strict rules on the transfer of personal data out of the E.U. to the U.S., provides an enforcement authority and imposes large penalties for noncompliance, including the potential for fines of up to €20.0 million or 4.0% of the annual global revenue of the infringer, whichever is greater.18Table of ContentsManufacturingWe seek to ensure an uninterrupted supply of medicines to patients around the world. To that end, we continually review our manufacturing capacity, capabilities, processes and facilities. We believe that our manufacturing facilities, together with the third-party contract manufacturing organizations we outsource to, currently provide sufficient capacity for our products and to Samsung Bioepis, our collaboration partner that develops, manufactures and markets biosimilar products, and other strategic contract manufacturing partners.In March 2021 we announced our plans to build a new gene therapy manufacturing facility in RTP, NC to support our gene therapy pipeline across multiple therapeutic areas. The new manufacturing facility will be approximately 197,000 square feet and is expected to be operational by the end of 2023, with an estimated total investment of approximately $195.0 million. Construction for this new facility began during the fourth quarter of 2021.Manufacturing FacilitiesOur drug substance manufacturing facilities include:FacilityDrug Substance ManufacturedRTP, North CarolinaAVONEXPLEGRIDYTYSABRIOther*Solothurn, SwitzerlandADUHELMLEQEMBI* Other includes products manufactured for contract manufacturing partners.In addition to our drug substance manufacturing facilities, we have a drug product manufacturing facility and supporting infrastructure in RTP, NC, including a parenteral facility and an oral solid dose products manufacturing facility. The parenteral facility adds capabilities and capacity for filling biologics into vials and is used for filling product candidates. The oral solid dose products facility can supplement our outsourced small molecule manufacturing capabilities.We also have an oligonucleotide synthesis manufacturing facility in RTP, NC. This facility gives us the capability to manufacture ASO candidates currently in our clinical pipeline.In order to support our future growth and drug development pipeline, we are building a large-scale biologics manufacturing facility in Solothurn, Switzerland. In the second quarter of 2021 a portion of the facility received a Good Manufacturing Practice (GMP) multi-product license from the Swiss Agency for Therapeutic Products (SWISSMEDIC). Solothurn has been approved for the manufacture of ADUHELM and LEQEMBI by the FDA. We estimate the second manufacturing suite at the Solothurn facility will be operational by the end of 2023.Genentech is responsible for all worldwide manufacturing activities for bulk RITUXAN, RITUXAN HYCELA and GAZYVA and has sourced the manufacture of certain bulk RITUXAN, RITUXAN HYCELA and GAZYVA requirements to a third party. Ionis supplies the active pharmaceutical ingredient (API) for SPINRAZA. Alkermes currently supplies both VUMERITY and FAMPYRA to us pursuant to separate supply agreements. In October 2019 we entered into a new supply agreement and amended our license and collaboration agreement with Alkermes for VUMERITY. We have elected to initiate a technology transfer and, following a transition period, to manufacture VUMERITY or have VUMERITY manufactured by a third party we have engaged in exchange for paying an increased royalty rate to Alkermes on any portion of future worldwide net commercial sales of VUMERITY that is manufactured by us or our designee. In October 2022 we entered into a new supply agreement with Alkermes for FAMPYRA. Acorda previously supplied FAMPYRA to us pursuant to a sublicensing arrangement with Alkermes, which was terminated in October 2022 as a result of an arbitration outcome between Acorda and Alkermes.Third-Party Suppliers and ManufacturersWe principally use third parties to manufacture the API and the final product for our small molecule products and product candidates, including TECFIDERA and FUMADERM, and the final drug product for our large molecule products and, to a lesser extent, product candidates. We source the majority of our fill-finish and all of our final product assembly and storage operations for our products, along with a substantial part of our label and packaging operations, to a concentrated group of third-party contract manufacturing organizations. Raw materials, delivery devices, such as syringes and auto-injectors, and other supplies required for the production of our products and product candidates are procured from various third-party suppliers and manufacturers in quantities adequate to meet our needs. Continuity of supply of such raw materials, devices and supplies is assured through inventory management and dual sourcing as appropriate. Our third-party service providers, suppliers and manufacturers may be subject to routine cGMP inspections by the FDA or comparable agencies in other jurisdictions and undergo assessment and certification by our quality management group.19Table of ContentsESG and Climate-Related MattersIntroductionOur environmental, social and governance (ESG) efforts prioritize climate, health and equity, with a focus on vulnerable populations, as well as ongoing leadership in sustainability, governance, transparency and disclosure.We remain committed to reducing our environmental footprint by eliminating harmful emissions and by minimizing resources used to manufacture our products. Since 2014 we have taken responsibility for our impact on climate change by matching 100% of our electricity usage with renewable energy, credits and offsets, driving efficiency initiatives internally and working with our suppliers. Green chemistry is embraced throughout our company, continually exploring new ways to make our drug development processes safer, more efficient and more sustainable while also saving resources.GovernanceESG oversight is formally embedded into our Board of Director's governance principles and includes an annual review of our ESG strategy and short-and long-term goals. We regularly review our environmental commitments within the landscape of our business performance, rising costs and supply chain challenges. We remain committed to engaging employees and suppliers and collaborating with renowned institutions to advance the science and action to improve health outcomes.As part of our broader commitment to these priorities, we continue to tie a portion of our employees' and executive officers' compensation to advancing our ESG efforts.We strive to comply in all material respects with applicable laws and regulations concerning the environment. While it is impossible to predict accurately the future costs associated with environmental compliance and potential remediation activities, compliance with environmental laws is not expected to require significant capital expenditures and has not had, and is not expected to have, a material adverse effect on our operations or competitive position. Our Executive Committee has responsibility for evaluating the impact of climate change on the business and overseeing actions taken by the company to limit its adverse impact on the environment.Our Enterprise Risk Management (ERM) framework is designed to ensure climate-related risks and opportunities are integrated into our overall business strategy. Our ERM team monitors strategic climate-related risks across all aspects of our business and utilizes climate scenarios as part of its assessments. On an annual basis, the ERM team evaluates identified risks, including any climate-related physical and transitional risks, by engaging leaders across the company. The ERM team provides annual updates on their findings and activities to our Executive Committee and Board of Directors.Risk ManagementAddressing ESG matters is part of our long-term global strategy and investment in our future and we have seen increased interest from stakeholders and investors on our ESG practices. While we continue to to advance our ESG efforts, there is no certainty that we will manage ESG matters in ways that successfully meet rapidly changing expectations from investors, regulators, third party rankings firms, customers and society as a whole. Our inability to manage ESG matters in accordance with expectations can negatively impact our reputation and business.Climate Risk ManagementWe identify climate risk as the risk of loss arising from climate change and is comprised of both physical risk and transition risk. Physical risk considers how the physical impacts of climate change (e.g., increased storms, drought, fires, floods) can directly damage physical assets or otherwise impact their value or productivity. Transition risk considers how changes in policy. regulations, culture, technology, business practices and market preferences to address climate change (e.g., carbon pricing policies, power generation shifts from fossil fuels to renewable energy) can lead to changes in the value of assets and businesses. Disruption in supply chains, changing customer expectations in the biosimilar market and potential shifts in the regulatory environment that disadvantage the use of fossil fuels, may make it difficult for us to fulfill business obligations or cause us to incur substantial expense.Identified material risks and opportunities are reported to our ERM team, which reports to our Executive Committee and Board of Directors. We consider and address those risks and opportunities that are financially material and may impact our business model, as well as mitigation measures that are in place or need to be adopted.For additional information on our environment-related risks, please read Item 1A. Risk Factors included in this report. Human CapitalAs of December 31, 2022, we had approximately 8,725 employees worldwide. Approximately 4,970 employees were employed in the U.S. and approximately 3,755 employees were employed in foreign countries. 20Table of ContentsDiversity, Equity and InclusionAt Biogen, prejudice, racism and intolerance are unacceptable. We are committed to Diversity, Equity and Inclusion (DE&I) across all aspects of our organization, including recruitment, hiring, promotion, retention and development practices. As of December 31, 2022, 30.4% of Biogen’s manager-level and above positions were held by ethnic or racial minorities in the U.S. Our policies and practices are global, but the laws in many countries outside the U.S. do not permit us to collect ethnic or racial data on our employees. Globally, 47.4% of Biogen’s positions at director-level and above were held by women as of December 31, 2022. Our DE&I strategy outlines actionable steps to deepen our commitment across the business, building upon a strong foundation. This plan includes the strategy to build our talent and strengthen our leadership, improve health outcomes for underserved communities in the disease areas we treat and contribute to the communities impacting our employees and patients. We plan to create greater awareness and capability in our organization through leadership accountability and transparency. To establish and progress this strategy, we rely on a cross-company governing body of employees known as the Diversity, Equity & Inclusion Strategic Council.We are honored to be recognized as an employer of choice. For the fifth consecutive year, we scored 100% on the Disability:IN's Disability Equality Index, which measures our policies and practices related to disability inclusion. Additionally, for the third consecutive year, we were awarded the DI-NC Employer Award by Disability:IN North Carolina for our commitment to champion and invest in disability inclusion at the affiliate and national levels. For the ninth consecutive year, we were recognized as a Best Place to Work for LGBTQ+ Equality by the Human Rights Campaign, scoring 100% on their Corporate Equality Index.Strengthening our Global CompetencyWe are committed to strengthening the DE&I awareness and capability of our employees. We have focused on ensuring that our employees have the resources and learning they need to contribute to our strategy. Our people managers are trained on inclusive recruiting and hiring and our global employees are trained on DE&I curriculum.In 2022 we introduced GlobeSmart®, a tool to enhance cross-cultural collaboration, increase cultural agility and further connect our global teams. Our people leaders have used GlobeSmart®, allowing them to explore different working styles, perspectives and approaches that exist around the globe, getting actionable, personalized advice for better collaboration and teamwork across cultures, and exploring new ways for teams to build trust, strengthen collaboration and leverage diversity.Philosophy on Pay EquityWe are committed to ensuring our employees receive equal pay for equal work. We establish components and ranges of compensation based on market and benchmark data. Within this context, we strive to pay all employees equitably within a reasonable range, taking into consideration factors such as role; market data; internal equity; job location; relevant experience; and individual, business unit and company performance. In addition, we are committed to providing flexible benefits designed to allow our diverse global workforce to have reward opportunities that meet their varied needs so that they are inspired to perform their best on behalf of patients and stockholders each day.We regularly review our compensation practices and analyze the equity of compensation decisions, for individual employees and our workforce as a whole. In 2022 we shared the results of a global gender pay assessment, analyzing pay at the executive, management and other professional levels.We institute measures, such as communications and trainings, to recognize, interrupt and prevent bias in hiring, performance management and compensation decisions and we provide resources to further develop managers and leaders to help them make equitable decisions about pay.Talent and DevelopmentMany factors influence employee success and well-being. We foster a workplace to allow employees to deliver on our shared mission while helping to mitigate their challenges. From career development to wellness to workplace environment, there are many opportunities to meet employee needs, and to build a workplace where people are empowered to learn, grow and build rewarding careers. Our employees are encouraged to take advantage of an array of professional development resources. Managers coach employees for performance, and also engage in employee development discussions to support growth and learning.Opportunities for ongoing learning can contribute to employee related engagement and success. At Biogen, development occurs through on-the-job learning, challenging new assignments, formal training, online learning, mentoring and more. With many employees continuing to work from home, virtual learning plays a key role. Virtual learnings are available through Biogen University as well as LinkedIn Learning. Through Biogen University we offer more than 1,200 instructor-based courses, of which approximately 300 are available virtually. Through LinkedIn Learning we provided employees with access 21Table of Contentsto more than 20,000 on-demand learning modules in 11 languages: English, German, French, Spanish, Japanese, Portuguese, Italian, Dutch, Polish, Turkish and Mandarin. To create and sustain a workplace as diverse and inclusive as the patients we serve, we offer programs that invest in our talent pipeline and in our current leaders, including:•Activate, Reflect and Co-Create: Preparing top talent for the rigors of executive roles.•Women’s Leadership Program: Addressing the unique challenges faced by female leaders to increase influence and impact.•Executive Leadership Retreat: Immersing leaders in topics designed to help them shape culture and build resilience.•The Partnership, Inc's BioDiversity Fellows Program: To continue to bolster our talent pipeline with a diverse mix of leaders, high potential, mid-career, underrepresented minorities participate in this program, which we helped create.•Women on the Rise: Addressing the unique challenges faced by mid-level female leaders to increase influence and impact.•Emerging Leaders: Preparing high-potential individual contributors for first-level leadership roles.•BetterUp: Coaching program available to support individuals as they work toward enhancing their impact in the organization.Our Employee Resource Networks (ERNs) provide invaluable opportunities for employees to share knowledge and build connections. Our current ERNs include:•Parenting Network Group: Biogen's newest ERN provides support, networking and development opportunities to working parents and caregivers, as well as helping employees navigate the challenges of work-life balance.•IGNITE: Brings together early-career professionals and their advocates.•AccessAbility: Supports employees with disabilities and employees who are caretakers of individuals with disabilities.•Biogen Veterans Network: Encourages veterans and allies of veterans to connect and support one another.•Mosaic: Fosters awareness and appreciation of different cultural backgrounds, in addition to promoting networking and development opportunities for members.•ReachOUT: Supports a best-in-class working environment for LGBTQ+ employees and embraces all LGBTQ+ employees and their allies.•Women’s Innovation Network: Creates networking, mentoring and learning opportunities for women and allies worldwide.•ourIMPACT: Advances climate, health and equity at work, in employees' personal lives and in the communities where we live and work.We continue to evolve our programs to meet our employees’ health and wellness needs, which we believe is essential to attract and retain employees of the highest caliber. We have refreshed our flexible working arrangement policies to allow for more flexibility around work hours to help employees balance the demands of their work and home lives, shifted many of our on-site wellness services to virtual, including virtual behavior health, nutrition, fitness and overall well-being classes and counseling, rolled out the Headspace meditation app globally at no cost, provided workshops and programming to help employees cope with stress, isolation and building resilience, along with financial planning workshops and counseling sessions, expanded our caregiver services to meet the growing needs of our employees and provided additional holidays and time off for recharging, voting and volunteering.Employee SurveysWe utilize an employee survey program to pulse employees through email and mobile apps as well as provide an opportunity for commentary and facilitate feedback to questions. The survey is designed to empower managers and leaders with anonymous information on their practices related to building culture, performance and an engaged workforce, allowing them to create plans and measure efficacy for continuous improvement. We care deeply about employee feedback and are building an analytics community across Human Resources to bring more rigor and sophistication to the collection and analysis of employee opinions. We use their perspectives to guide us to take actions that improve engagement and support and help maintain our reputation as a great place to work for all our employees. An example of such an action was our 2022 Wellness Week, a weeklong mid-year shutdown. Succession Planning Each year we conduct a talent review across our global enterprise that includes, among other important topics, a review of succession plans for many of our roles. To help ensure the long-term continuity of our business, we actively manage the development of talent to fill the roles that are most critical to the 22Table of Contentsongoing success of our company. In addition, each year our Board of Directors reviews the succession plan for our executives.Workplace Health and SafetyThe well-being of our employees is the priority, and we believe every employee plays a role in creating a safe and healthy workplace. Our employees have varied roles and functions, which is why we empower them to promote a safe working environment, regardless of whether work happens in the lab, in an office or in a manufacturing plant. Our policies and practices are intended to protect not only our employees, but also the surrounding communities where we operate.In 2022 we continued to make significant progress integrating Human Performance into our Environment, Health and Safety programs. We believe that, when it comes to safety, workers are part of the solution. We encourage employees to collaboratively engage in proactive problem solving through practices such as Open Reporting and Work Observation and Risk Conversations. Additionally, our physical safety program focused on detailed evaluations of critical tasks that could expose employees to serious injury or fatality if controls are absent or not used. The actions we implement as a result of these evaluations reduce the risks associated with these essential activities and ensure our operational systems are safer and more resilient for employees. We also use “After Action Reviews” following the completion of a project. These reviews enable us to not only focus on areas for improvement, but also to learn and apply good practices from what goes well. By engaging and empowering our employees through such programs, we believe that we can help change how the entire industry approaches safety performance and risk management.23Table of ContentsInformation about our Executive Officers (as of February 15, 2023)OfficerCurrent PositionAgeYear Joined BiogenChristopher A. ViehbacherPresident, Chief Executive Officer622022Susan H. AlexanderExecutive Vice President, Chief Legal Officer and Secretary662006Michael R. McDonnellExecutive Vice President and Chief Financial Officer592020Nicole MurphyExecutive Vice President, Pharmaceutical Operations and Technology502015Ginger Gregory, Ph.D.Executive Vice President and Chief Human Resources Officer552017Rachid IzzarExecutive Vice President, Global Product Strategy and Commercialization482019Priya Singhal, M.D., M.P.H.Executive Vice President, Head of Development552020Robin C. KramerSenior Vice President, Chief Accounting Officer572018Christopher A. ViehbacherExperienceMr. Viehbacher has served as our President and Chief Executive Officer and member of our Board of Directors since November 2022. Prior to joining Biogen, Mr. Viehbacher served as Managing Partner of Gurnet Point Capital, a Boston based investment fund from 2015 to 2022. Prior to that, Mr. Viehbacher served as Global CEO of Sanofi, from 2008 to 2014. Prior to joining Sanofi, Mr. Viehbacher spent over 20 years with GlaxoSmithKline in Germany, Canada, France and, latterly, the U.S. as president of its North American pharmaceutical division. Mr. Viehbacher began his career with PricewaterhouseCoopers LLP and qualified as a chartered accountant. Mr. Viehbacher previously served on the board of directors of Vedanta Biosciences, Inc. as chair, BEFORE Brands, Inc., and Crossover Health. He is also a trustee of Northeastern University and a member of the board of fellows at Stanford Medical School.Public Company BoardslPureTech Health Plc.EducationlQueen's University in Kingston, Ontario, Canada, B.A.Susan H. AlexanderExperienceMs. Alexander has served as our Executive Vice President, Chief Legal Officer and Secretary since April 2018. Prior to that, Ms. Alexander served as our Executive Vice President, Chief Legal, Corporate Services and Secretary from March 2017 to March 2018, as our Executive Vice President, Chief Legal Officer and Secretary from December 2011 to March 2017 and as our Executive Vice President, General Counsel and Corporate Secretary from 2006 to December 2011. Prior to joining Biogen, Ms. Alexander served as the Senior Vice President, General Counsel and Corporate Secretary of PAREXEL International Corporation, a biopharmaceutical services company, from 2003 to January 2006. From 2001 to 2003 Ms. Alexander served as General Counsel of IONA Technologies, a software company. From 1995 to 2001 Ms. Alexander served as Counsel at Cabot Corporation, a specialty chemicals and performance materials company. Prior to that, Ms. Alexander was a partner at the law firms of Hinckley, Allen & Snyder and Fine & Ambrogne. EducationlWellesley College, B.A.lBoston University School of Law, J.D.24Table of ContentsMichael R. McDonnellExperienceMr. McDonnell has served as our Executive Vice President and Chief Financial Officer since August 2020. Prior to joining Biogen, Mr. McDonnell served as Executive Vice President and Chief Financial Officer of IQVIA Holdings Inc., a leading global provider of advanced analytics, technology solutions and contract research services to the life sciences industry, from December 2015 until July 2020. Prior to that, Mr. McDonnell served as the Executive Vice President and Chief Financial Officer of Intelsat, a leading global provider of satellite services, from November 2008 to December 2015, as Executive Vice President and Chief Financial Officer of MCG Capital Corporation, a publicly-held commercial finance company, from September 2004 until October 2008 and as MCG Capital Corporation’s Chief Operating Officer from August 2006 until October 2008. Before joining MCG Capital Corporation, Mr. McDonnell served as Executive Vice President and Chief Financial Officer for EchoStar Communications Corporation (f/k/a DISH Network Corporation), a direct-to-home satellite television operator, from July 2004 until August 2004 and as its Senior Vice President and Chief Financial Officer from August 2000 to July 2004. Mr. McDonnell spent 14 years at PricewaterhouseCoopers LLP, including 4 years as a partner. Mr. McDonnell is a licensed certified public accountant (CPA).Public Company BoardslMerit Medical Systems, Inc.EducationlGeorgetown University, B.S. AccountingNicole MurphyExperienceMs. Murphy has served as our Executive Vice President, Pharmaceutical Operations and Technology since February 2022. Prior to that, Ms. Murphy has held senior executive positions at Biogen, including most recently as our Senior Vice President, Head of Global Manufacturing & Technical Operations, from June 2019 to January 2022. In 2017, Ms. Murphy played a critical role during the successful spin-off of Biogen's hemophilia franchise, as the Vice President and Head of Technical Operations of Bioverativ responsible for clinical and commercial development, quality, regulatory, manufacturing and procurement. Prior to the spin-off Ms. Murphy was the General Manager and Head of Cambridge Site Operations at Biogen from May 2015 to December 2016. Prior to joining Biogen, Ms. Murphy was Executive Director, Head of Supply Chain at Amgen, a biopharmaceutical company, where her responsibilities included leadership of commercial manufacturing and technical operations. Ms. Murphy also held numerous technical and operational roles during her time at Amgen from 2001 to 2015 where she contributed significantly to various facility start-ups, business development integrations, strategic transformations and new product introductions. Prior to Amgen, Ms. Murphy held a variety of process development and engineering positions at Immunex Pharmaceuticals and the Monsanto Company.EducationlUniversity of Massachusetts Amherst, B.S. EngineeringlRensselaer Polytechnic Institute, M.S. Engineering and a Masters of Business AdministrationGinger Gregory, Ph.D.ExperienceDr. Gregory has served as our Executive Vice President and Chief Human Resources Officer since July 2017. Prior to joining Biogen, Dr. Gregory served as Executive Vice President and Chief Human Resources Officer at Shire PLC, a global specialty biopharmaceutical company, from February 2014 to April 2017. Prior to that, Dr. Gregory held executive-level human resources positions for several multinational companies across a variety of industries, including Dunkin’ Brands Group Inc., a restaurant holding company, where she served as Chief Human Resource Officer, Novartis AG, a pharmaceutical company, where she was the division head of Human Resources for Novartis Vaccines and Diagnostics, Novartis Consumer Health and Novartis Institutes of BioMedical Research and Novo Nordisk A/S, a pharmaceutical company, where she served as Senior Vice President, Corporate People & Organization at the company’s headquarters in Copenhagen, Denmark. Earlier in her career, Dr. Gregory held a variety of human resources generalist and specialist positions at BMS, a pharmaceutical company, and served as a consultant with Booz Allen & Hamilton, an information technology consulting company, in the area of organization change and effectiveness.EducationlUniversity of Massachusetts, B.A. PsychologylThe George Washington University, Ph.D. Psychology25Table of ContentsRachid IzzarExperienceMr. Izzar has served as our Executive Vice President, Head of Global Product Strategy and Commercialization since July 2021. Prior to that Mr. Izzar served as our President for the Intercontinental Region, which includes Latin America, Australia, Asia, Japan, the Middle East and Africa, Turkey and Russia, and the Global Biogen Biosimilars Unit. Prior to joining Biogen, Mr. Izzar was a Country President for AstraZeneca in France, where his responsibilities included leadership for commercial and manufacturing operations. He held numerous roles at his time with AstraZeneca, including the position of Global Vice President of the Cardiovascular Franchise where he contributed significantly to the development of the franchise within the North American subsidiary, as well as in Europe and China. Prior to that, Mr. Izzar was Vice President Strategic Transformation, also, China Portfolio for CEO based in Shanghai and Vice President Commercial International covering China, Australia, Brazil, Russia, America Latin, Asia, Turkey, the Middle East and Africa. EducationlUniversity of Sherbrooke, Masters of Business AdministrationlHarvard Business School, Enterprise Executive Transformation ProgramPriya Singhal, M.D., M.P.H.ExperienceDr. Singhal has served as our Executive Vice President and Head of Development since January 2023. Prior to that Dr. Singhal served as our Interim Head of Research and Development since 2021 in addition to serving as Head of Global Safety and Regulatory Sciences, including China and Japan Research and Development, since rejoining Biogen in 2020. Dr. Singhal was initially at Biogen from 2012 to 2018 and served in positions of increasing seniority as Vice President Clinical Trials Benefit-Risk Management, Global Head of Safety and Benefit Risk Management and as the Interim Co-lead and Senior Vice President of Global Development. Prior to her 2020 return to Biogen, Dr. Singhal served as Head of Research and Development and Manufacturing at Zafgen Inc. from 2019 to 2020. From 2008 to 2012 Dr. Singhal held roles at Vertex Pharmaceuticals, including Vice President, Medical Affairs. Dr. Singhal began her drug-development career at Millennium Pharmaceuticals, Inc. in 2005 and led benefit-risk management for Velcade and other compounds.EducationlHarvard School of Public Health, M.P.H. in International HealthlUniversity of Mumbai, Doctor of Medicine (M.D.)Robin C. KramerExperienceMs. Kramer has served as our Senior Vice President, Chief Accounting Officer since December 2020. Prior to that, Ms. Kramer served as our Vice President, Chief Accounting Officer from November 2018 to December 2020. Prior to joining Biogen, Ms. Kramer served as the Senior Vice President and Chief Accounting Officer of Hertz Global Holdings, Inc., a car rental company, from May 2014 to November 2018. Prior to that, Ms. Kramer was an audit partner at Deloitte & Touche LLP (Deloitte), a professional services firm, from 2007 to 2014, including serving in Deloitte's National Office Accounting Standards and Communications Group from 2007 to 2010. From 2005 to 2007 Ms. Kramer served as Chief Accounting Officer of Fisher Scientific International, Inc., a laboratory supply and biotechnology company, and from 2004 to 2005 Ms. Kramer served as Director, External Reporting, Accounting and Control for the Gillette Company, a personal care company. Ms. Kramer also held partner positions in the public accounting firms of Ernst & Young LLP and Arthur Andersen LLP. Ms. Kramer is a licensed CPA in Massachusetts. She is a member of the Massachusetts Society of CPAs and the American Institute of CPAs. Ms. Kramer currently serves on the board of directors of the Center for Women and Enterprise. Ms. Kramer previously served as a Board Member for the Massachusetts State Board of Accountancy from September 2011 to December 2015 and Probus Insurance Company Europe DAC from 2016 to 2018.Public Company BoardslArmata Pharmaceuticals, Inc., a biotechnology companyEducationlSalem State University, B.B.A. Accounting26Table of ContentsAvailable InformationOur principal executive offices are located at 225 Binney Street, Cambridge, MA 02142 and our telephone number is (617) 679-2000. Our website address is www.biogen.com. We make available free of charge through the Investors section of our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the U.S. Securities and Exchange Commission. We include our website address in this report only as an inactive textual reference and do not intend it to be an active link to our website. The contents of our website are not incorporated into this report.27Table of ContentsITEM 1A. RISK FACTORSRisks Related to Our BusinessWe are substantially dependent on revenue from our products. Our revenue depends upon continued sales of our products as well as the financial rights we have in our anti-CD20 therapeutic programs. A significant portion of our revenue is concentrated on sales of our products in increasingly competitive markets. Any of the following negative developments relating to any of our products or any of our anti-CD20 therapeutic programs may adversely affect our revenue and results of operations or could cause a decline in our stock price: •the introduction, greater acceptance or more favorable reimbursement of competing products, including new originator therapies, generics, prodrugs and biosimilars of existing products and products approved under abbreviated regulatory pathways;•safety or efficacy issues;•limitations and additional pressures on product pricing or price increases, including those resulting from governmental or regulatory requirements; increased competition, including from generic or biosimilar versions of our products; or changes in, or implementation of, reimbursement policies and practices of payors and other third-parties;•adverse legal, administrative, regulatory or legislative developments;•our ability to maintain a positive reputation among patients, healthcare providers and others, which may be impacted by our pricing and reimbursement decisions; or•the inability or reluctance of patients to receive a diagnosis, prescription or administration of our products or a decision to prescribe and administer competitive therapies as a direct or indirect result of the COVID-19 pandemic.LEQEMBI is in the early stages of commercial launch in the U.S. In addition to risks associated with new product launches and the other factors described in these Risk Factors, Biogen’s and Eisai’s ability to successfully commercialize LEQEMBI may be adversely affected due to:•Eisai’s ability to obtain and maintain adequate reimbursement for LEQEMBI;•the effectiveness of Eisai's and Biogen’s commercial strategy for marketing LEQEMBI; and•Eisai’s and Biogen’s ability to maintain a positive reputation among patients, healthcare providers and others in the Alzheimer’s disease community, which may be impacted by pricing and reimbursement decisions relating to LEQEMBI, which are made by Eisai.The FDA may withdraw approval if Eisai and Biogen fail to comply with the conditions of the accelerated approval.Our long-term success depends upon the successful development of new products and additional indications for our existing products.Our long-term success will depend upon the successful development of new products from our research and development activities or our licenses or acquisitions from third-parties, as well as additional indications for our existing products.Product development is very expensive and involves a high degree of uncertainty and risk and may not be successful. Only a small number of research and development programs result in the commercialization of a product. It is difficult to predict the success and the time and cost of product development of novel approaches for the treatment of diseases. The development of novel approaches for the treatment of diseases, including development efforts in new modalities such as those based on the antisense oligonucleotide platform and gene therapy, may present additional challenges and risks, including obtaining approval from regulatory authorities that have limited experience with the development of such therapies. Clinical trial data are subject to differing interpretations and even if we view data as sufficient to support the safety, effectiveness and/or approval of an investigational therapy, regulatory authorities may disagree and may require additional data, limit the scope of the approval or deny approval altogether. Furthermore, the approval of a product candidate by one regulatory agency does not mean that other regulatory agencies will also approve such product candidate.28Table of ContentsSuccess in preclinical work or early-stage clinical trials does not ensure that later stage or larger scale clinical trials will be successful. Clinical trials may indicate that our product candidates lack efficacy, have harmful side effects, result in unexpected adverse events or raise other concerns that may significantly reduce the likelihood of regulatory approval. This may result in terminated programs, significant restrictions on use and safety warnings in an approved label, adverse placement within the treatment paradigm or significant reduction in the commercial potential of the product candidate.Even if we could successfully develop new products or indications, we may make a strategic decision to discontinue development of a product candidate or indication if, for example, we believe commercialization will be difficult relative to the standard of care or we prefer to pursue other opportunities in our pipeline. Sales of new products or products with additional indications may not meet investor expectations.If we fail to compete effectively, our business and market position would suffer.The biopharmaceutical industry and the markets in which we operate are intensely competitive. We compete in the marketing and sale of our products, the development of new products and processes, the acquisition of rights to new products with commercial potential and the hiring and retention of personnel. We compete with biotechnology and pharmaceutical companies that have a greater number of products on the market and in the product pipeline, substantially greater financial, marketing, research and development and other resources and other technological or competitive advantages. Our products continue to face increasing competition from the introduction of new originator therapies, generics, prodrugs and biosimilars of existing products and products approved under abbreviated regulatory pathways. Some of these products are likely to be sold at substantially lower prices than our branded products. The introduction of such products as well as other lower-priced competing products has reduced, and may in the future, significantly reduce both the price that we are able to charge for our products and the volume of products we sell, which will negatively impact our revenue. For instance, demand and price for TECFIDERA declined significantly as a result of multiple TECFIDERA generic entrants entering the U.S. market in 2020. In addition, in some markets, when a generic or biosimilar version of one of our products is commercialized, it may be automatically substituted for our product and significantly reduce our revenue in a short period of time.Our ability to compete, maintain and grow our business may also be adversely affected due to a number of factors, including:•the introduction of other products, including products that may be more efficacious, safer, less expensive or more convenient alternatives to our products, including our own products and products of our collaborators;•the off-label use by physicians of therapies indicated for other conditions to treat patients; •patient dynamics, including the size of the patient population and our ability to identify, attract and maintain new and current patients to our therapies;•the reluctance of physicians to prescribe, and patients to use, our products without additional data on the efficacy and safety of such products;•damage to physician and patient confidence in any of our products, generic or biosimilars of our products or any other product from the same class as one of our products, or to our sales and reputation as a result of label changes, pricing and reimbursement decisions or adverse experiences or events that may occur with patients treated with our products or generic or biosimilars of our products;•inability to obtain appropriate pricing and adequate reimbursement for our products compared to our competitors in key international markets; or•our ability to obtain and maintain patent, data or market exclusivity for our products.Our business may be adversely affected if we do not successfully execute or realize the anticipated benefits of our strategic and growth initiatives.The successful execution of our strategic and growth initiatives may depend upon internal development projects, commercial initiatives and external opportunities, which may include the acquisition and in-licensing of products, technologies and companies or the entry into strategic alliances and collaborations. While we believe we have a number of promising programs in our pipeline, failure or delay of internal development projects to advance or difficulties in executing on our commercial initiatives could impact our current and future growth, resulting in additional reliance on external development opportunities for growth. 29Table of ContentsSupporting the further development of our existing products and potential new products in our pipeline will require significant capital expenditures and management resources, including investments in research and development, sales and marketing, manufacturing capabilities and other areas of our business. We have made, and may continue to make, significant operating and capital expenditures for potential new products prior to regulatory approval with no assurance that such investment will be recouped, which may adversely affect our financial condition, business and operations.The availability of high quality, fairly valued external product development is limited and the opportunity for their acquisition is highly competitive. As such, we are not certain that we will be able to identify suitable candidates for acquisition or if we will be able to reach agreement.We may fail to initiate or complete transactions for many reasons, including failure to obtain regulatory or other approvals as well as disputes or litigation. Furthermore, we may not be able to achieve the full strategic and financial benefits expected to result from transactions, or the benefits may be delayed or not occur at all. We may also face additional costs or liabilities in completed transactions that were not contemplated prior to completion.Any failure in the execution of a transaction, in the integration of an acquired asset or business or in achieving expected synergies could result in slower growth, higher than expected costs, the recording of asset impairment charges and other actions which could adversely affect our business, financial condition and results of operations.Sales of our products depend, to a significant extent, on adequate coverage, pricing and reimbursement from third-party payors, which are subject to increasing and intense pressure from political, social, competitive and other sources. Our inability to obtain and maintain adequate coverage, or a reduction in pricing or reimbursement, could have an adverse effect on our business, reputation, revenue and results of operations.Sales of our products depend, to a significant extent, on adequate coverage, pricing and reimbursement from third-party payors. When a new pharmaceutical product is approved, the availability of government and private reimbursement for that product may be uncertain, as is the pricing and amount for which that product will be reimbursed. Pricing and reimbursement for our products may be adversely affected by a number of factors, including:•changes in, and implementation of, federal, state or foreign government regulations or private third-party payors’ reimbursement policies; •pressure by employers on private health insurance plans to reduce costs;•consolidation and increasing assertiveness of payors seeking price discounts or rebates in connection with the placement of our products on their formularies and, in some cases, the imposition of restrictions on access or coverage of particular drugs or pricing determined based on perceived value;•our ability to receive reimbursement for our products or our ability to receive comparable reimbursement to that of competing products; and•our value-based contracting program pursuant to which we aim to tie the pricing of our products to their clinical values by either aligning price to patient outcomes or adjusting price for patients who discontinue therapy for any reason, including efficacy or tolerability concerns.Our ability to set the price for our products varies significantly from country to country and, as a result, so can the price of our products. Governments may use a variety of cost-containment measures to control the cost of products, including price cuts, mandatory rebates, value-based pricing and reference pricing (i.e., referencing prices in other countries and using those reference prices to set a price). Drug prices are under significant scrutiny in the markets in which our products are prescribed; for example the IRA has certain provisions related to drug pricing. We expect drug pricing and other health care costs to continue to be subject to intense political and societal pressures on a global basis. Certain countries set prices by reference to the prices in other countries where our products are marketed. Our inability to obtain and maintain adequate prices in a particular country may not only limit the revenue from our products within that country but may also adversely affect our ability to secure acceptable prices in existing and potential new markets, which may limit market growth. This may create the opportunity for third-party cross-border trade or influence our decision to sell or not to sell a product, thus adversely affecting our geographic expansion plans and revenue. Additionally and in part due to the impact of the COVID-19 pandemic, in certain jurisdictions governmental health agencies may adjust, retroactively and/or prospectively, reimbursement rates for our products.Competition from current and future competitors may negatively impact our ability to maintain pricing and our market share. New products marketed by our competitors could cause our revenue to decrease due to potential price 30Table of Contentsreductions and lower sales volumes. Additionally, the introduction of generic or biosimilar versions of our products, follow-on products, prodrugs or products approved under abbreviated regulatory pathways may significantly reduce the price that we are able to charge for our products and the volume of products we sell.Many payors continue to adopt benefit plan changes that shift a greater portion of prescription costs to patients, including more limited benefit plan designs, higher patient co-pay or co-insurance obligations and limitations on patients' use of commercial manufacturer co-pay payment assistance programs (including through co-pay accumulator adjustment or maximization programs). Significant consolidation in the health insurance industry has resulted in a few large insurers and pharmacy benefit managers exerting greater pressure in pricing and usage negotiations with drug manufacturers, significantly increasing discounts and rebates required of manufacturers and limiting patient access and usage. Further consolidation among insurers, pharmacy benefit managers and other payors would increase the negotiating leverage such entities have over us and other drug manufacturers. Additional discounts, rebates, coverage or plan changes, restrictions or exclusions as described above could have a material adverse effect on sales of our affected products.Our failure to obtain or maintain adequate coverage, pricing or reimbursement for our products could have an adverse effect on our business, reputation, revenue and results of operations.We depend on relationships with collaborators and other third-parties for revenue, and for the development, regulatory approval, commercialization and marketing of certain of our products and product candidates, which are outside of our full control.We rely on a number of collaborative and other third-party relationships for revenue and the development, regulatory approval, commercialization and marketing of certain of our products and product candidates. We also outsource certain aspects of our regulatory affairs and clinical development relating to our products and product candidates to third-parties. Reliance on third-parties subjects us to a number of risks, including:•we may be unable to control the resources our collaborators or third-parties devote to our programs, products or product candidates;•disputes may arise under an agreement, including with respect to the achievement and payment of milestones, payment of development or commercial costs, ownership of rights to technology developed, and the underlying agreement may fail to provide us with significant protection or may fail to be effectively enforced if the collaborators or third-parties fail to perform; •the interests of our collaborators or third-parties may not always be aligned with our interests, and such parties may not pursue regulatory approvals or market a product in the same manner or to the same extent that we would, which could adversely affect our revenue, or may adopt tax strategies that could have an adverse effect on our business, results of operations or financial condition; •third-party relationships require the parties to cooperate, and failure to do so effectively could adversely affect product sales or the clinical development or regulatory approvals of product candidates under joint control, could result in termination of the research, development or commercialization of product candidates or could result in litigation or arbitration;•any failure on the part of our collaborators or third-parties to comply with applicable laws, including tax laws, regulatory requirements and/or applicable contractual obligations or to fulfill any responsibilities they may have to protect and enforce any intellectual property rights underlying our products could have an adverse effect on our revenue as well as involve us in possible legal proceedings; and•any improper conduct or actions on the part of our collaborators or third-parties could subject us to civil or criminal investigations and monetary and injunctive penalties, impact the accuracy and timing of our financial reporting and/or adversely impact our ability to conduct business, our operating results and our reputation.Given these risks, there is considerable uncertainty regarding the success of our current and future collaborative efforts. If these efforts fail, our product development or commercialization of new products could be delayed, revenue from products could decline and/or we may not realize the anticipated benefits of these arrangements.Our results of operations may be adversely affected by current and potential future healthcare reforms.In the U.S., federal and state legislatures, health agencies and third-party payors continue to focus on containing the cost of health care. Legislative and regulatory proposals, enactments to reform health care insurance programs (including those contained in the IRA) and increasing pressure from social sources could significantly 31Table of Contentsinfluence the manner in which our products are prescribed, purchased and reimbursed. For example, provisions of the Patient Protection and Affordable Care Act (PPACA) have resulted in changes in the way health care is paid for by both governmental and private insurers, including increased rebates owed by manufacturers under the Medicaid Drug Rebate Program, annual fees and taxes on manufacturers of certain branded prescription drugs, the requirement that manufacturers participate in a discount program for certain outpatient drugs under Medicare Part D and the expansion of the number of hospitals eligible for discounts under Section 340B of the Public Health Service Act. These changes have had and are expected to continue to have a significant impact on our business. We may face uncertainties as a result of efforts to repeal, substantially modify or invalidate some or all of the provisions of the PPACA. There is no assurance that the PPACA, as currently enacted or as amended in the future, will not adversely affect our business and financial results, and we cannot predict how future federal or state legislative or administrative changes relating to healthcare reform will affect our business.There is increasing public attention on the costs of prescription drugs and we expect drug pricing and other health care costs to continue to be subject to intense political and societal pressures on a global basis. For example, two committees of the U.S. House of Representatives previously investigated the approval and price of ADUHELM. In addition, there have been (including elements of the IRA), and are expected to continue to be, legislative proposals to address prescription drug pricing. Some of these proposals could have significant effects on our business, including an executive order issued in September 2020 to test a “most favored nation” model for Part B and Part D drugs that tie reimbursement rates to international drug pricing metrics. These actions and the uncertainty about the future of the PPACA and healthcare laws may put downward pressure on pharmaceutical pricing and increase our regulatory burdens and operating costs. There is also significant economic pressure on state budgets, including as a result of the COVID-19 pandemic, that may result in states increasingly seeking to achieve budget savings through mechanisms that limit coverage or payment for our drugs. In recent years, some states have considered legislation and ballot initiatives that would control the prices of drugs, including laws to allow importation of pharmaceutical products from lower cost jurisdictions outside the U.S. and laws intended to impose price controls on state drug purchases. State Medicaid programs are increasingly requesting manufacturers to pay supplemental rebates and requiring prior authorization by the state program for use of any drug for which supplemental rebates are not being paid. Government efforts to reduce Medicaid expense may lead to increased use of managed care organizations by Medicaid programs. This may result in managed care organizations influencing prescription decisions for a larger segment of the population and a corresponding limitation on prices and reimbursement for our products. In the E.U. and some other international markets, the government provides health care at low cost to consumers and regulates pharmaceutical prices, patient eligibility or reimbursement levels to control costs for the government-sponsored health care system. Many countries have announced or implemented measures, and may in the future implement new or additional measures, to reduce health care costs to limit the overall level of government expenditures. These measures vary by country and may include, among other things, patient access restrictions, suspensions on price increases, prospective and possible retroactive price reductions and other recoupments and increased mandatory discounts or rebates, recoveries of past price increases and greater importation of drugs from lower-cost countries. These measures have negatively impacted our revenue and may continue to adversely affect our revenue and results of operations in the future.Our success in commercializing biosimilars is subject to risks and uncertainties inherent in the development, manufacture and commercialization of biosimilars. If we are unsuccessful in such activities, our business may be adversely affected.The development, manufacture and commercialization of biosimilar products require specialized expertise and are very costly and subject to complex regulation. Our success in commercializing biosimilars is subject to a number of risks, including:•Reliance on Third-Parties. We are dependent, in part, on the efforts of collaboration partners and other third-parties over whom we have limited or no control in the development and manufacturing of biosimilars products. If these third-parties fail to perform successfully, our biosimilar product development or commercialization of biosimilar products could be delayed, revenue from biosimilar products could decline and/or we may not realize the anticipated benefits of these arrangements;•Regulatory Compliance. Biosimilar products may face regulatory hurdles or delays due to the evolving and uncertain regulatory and commercial pathway of biosimilars products in certain jurisdictions;•Ability to Provide Adequate Supply. Manufacturing biosimilars is complex. If we encounter any manufacturing or supply chain difficulties we may be unable to meet demand. We are dependent on a third-party for the manufacture of our biosimilar products and such third-party may not perform its obligations in a timely and 32Table of Contentscost-effective manner or in compliance with applicable regulations and may be unable or unwilling to increase production capacity commensurate with demand for our existing or future biosimilar products;•Intellectual Property and Regulatory Challenges. Biosimilar products may face extensive patent clearances, patent infringement litigation, injunctions or regulatory challenges, which could prevent the commercial launch of a product or delay it for many years or result in imposition of monetary damages, penalties or other civil sanctions and damage our reputation; •Failure to Gain Market and Patient Acceptance. Market success of biosimilar products will be adversely affected if patients, physicians and/or payors do not accept biosimilar products as safe and efficacious products offering a more competitive price or other benefit over existing therapies; and•Competitive Challenges. Biosimilar products face significant competition, including from innovator products and biosimilar products offered by other companies that may receive greater acceptance or more favorable reimbursement. Local tendering processes may restrict biosimilar products from being marketed and sold in some jurisdictions. The number of competitors in a jurisdiction, the timing of approval and the ability to market biosimilar products successfully in a timely and cost-effective manner are additional factors that may impact our success in this business area.Risks Related to Intellectual PropertyIf we are unable to obtain and maintain adequate protection for our data, intellectual property and other proprietary rights, our business may be harmed. Our success, including our long-term viability and growth, depends, in part, on our ability to obtain and defend patent and other intellectual property rights, including certain regulatory forms of exclusivity, that are important to the commercialization of our products and product candidates. Patent protection and/or regulatory exclusivity in the U.S. and other important markets remains uncertain and depends, in part, upon decisions of the patent offices, courts, administrative bodies and lawmakers in these countries. We may fail to obtain or preserve patent and other intellectual property rights, including certain regulatory forms of exclusivity, or the protection we obtain may not be of sufficient breadth and degree to protect our commercial interests in all countries where we conduct business, which could result in financial, business or reputational harm to us or could cause a decline or volatility in our stock price. In addition, settlements of such proceedings often result in reducing the period of exclusivity and other protections, resulting in a reduction in revenue from affected products.In many markets, including the U.S., manufacturers may be allowed to rely on the safety and efficacy data of the innovator's product and do not need to conduct clinical trials before marketing a competing version of a product after there is no longer patent or regulatory exclusivity. In such cases, manufacturers often charge significantly lower prices and a major portion of the company's revenue may be reduced in a short period of time. In addition, manufacturers of generics and biosimilars may choose to launch or attempt to launch their products before the expiration of our patent or other intellectual property protections.Furthermore, our products may be determined to infringe patents or other intellectual property rights held by third-parties. Legal proceedings, administrative challenges or other types of proceedings are and may in the future be necessary to determine the validity, scope or non-infringement of certain patent rights claimed by third-parties to be pertinent to the manufacture, use or sale of our products. Legal proceedings may also be necessary to determine the rights, obligations and payments claimed during and after the expiration of intellectual property license agreements we have entered with third parties. Such proceedings are unpredictable and are often protracted and expensive. Negative outcomes of such proceedings could hinder or prevent us from manufacturing and marketing our products, require us to seek a license for the infringed product or technology or result in the assessment of significant monetary damages against us that may exceed amounts, if any, accrued in our financial statements. A failure to obtain necessary licenses for an infringed product or technology could prevent us from manufacturing or selling our products. Furthermore, payments under any licenses that we are able to obtain could reduce our profits from the covered products and services. Any of these circumstances could result in financial, business or reputational harm to us or could cause a decline or volatility in our stock price.Risks Related to Development, Clinical Testing and Regulation of Our Products and Product CandidatesSuccessful preclinical work or early stage clinical trials does not ensure success in later stage trials, regulatory approval or commercial viability of a product.Positive results in a clinical trial may not be replicated in subsequent or confirmatory trials. Additionally, success in preclinical work or early stage clinical trials does not ensure that later stage or larger scale clinical trials will be successful or that regulatory approval will be obtained. Even if later stage clinical trials are successful, 33Table of Contentsregulatory authorities may delay or decline approval of our product candidates. Regulatory authorities may disagree with our view of the data, require additional studies, disagree with our trial design or endpoints or not approve adequate reimbursement. Regulatory authorities may also fail to approve the facilities or processes used to manufacture a product candidate, our dosing or delivery methods or companion devices. Regulatory authorities may grant marketing approval that is more restricted than anticipated, including limiting indications to narrow patient populations and the imposition of safety monitoring, educational requirements, requiring confirmatory trials and risk evaluation and mitigation strategies. The occurrence of any of these events could result in significant costs and expense, have an adverse effect on our business, financial condition and results of operations and/or cause our stock price to decline or experience periods of volatility.Clinical trials and the development of biopharmaceutical products is a lengthy and complex process. If we fail to adequately manage our clinical activities, our clinical trials or potential regulatory approvals may be delayed or denied.Conducting clinical trials is a complex, time-consuming and expensive process. Our ability to complete clinical trials in a timely fashion depends on a number of key factors, including protocol design, regulatory and institutional review board approval, patient enrollment rates and compliance with current Good Clinical Practices. If we or our third-party clinical trial providers or third-party CROs do not successfully carry out these clinical activities, our clinical trials or the potential regulatory approval of a product candidate may be delayed or denied.We have opened clinical trial sites and are enrolling patients in a number of countries where our experience is limited. In most cases, we use the services of third-parties to carry out our clinical trial related activities and rely on such parties to accurately report their results. Our reliance on third-parties for these activities may impact our ability to control the timing, conduct, expense and quality of our clinical trials. One CRO has responsibility for a substantial portion of our activities and reporting related to our clinical trials, adversely affect our expense associated with such trials and if such CRO does not adequately perform, many of our trials may be affected. We may need to replace our CROs, which may result in the delay of the affected trials or otherwise adversely affect our efforts to obtain regulatory approvals and commercialize our product candidates.Adverse safety events or restrictions on use and safety warnings for our products can negatively affect our business, product sales and stock price.Adverse safety events involving our marketed products, generic or biosimilar versions of our marketed products or products from the same class as one of our products may have a negative impact on our business. Discovery of safety issues with our products could create product liability and could cause additional regulatory scrutiny and requirements for additional labeling or safety monitoring, withdrawal of products from the market and/or the imposition of fines or criminal penalties. Adverse safety events may also damage physician, patient and/or investor confidence in our products and our reputation. Any of these could result in adverse impacts on our results of operations. Regulatory authorities are making greater amounts of stand-alone safety information directly available to the public through periodic safety update reports, patient registries and other reporting requirements. The reporting of adverse safety events involving our products or products similar to ours and public rumors about such events may increase claims against us and may also cause our product sales to decline or our stock price to experience periods of volatility.Restrictions on use or safety warnings that may be required to be included in the label of our products may significantly reduce expected revenue for those products and require significant expense and management time.Risks Related to Our OperationsA breakdown or breach of our technology systems could subject us to liability or interrupt the operation of our business.We are increasingly dependent upon technology systems and data to operate our business. The COVID-19 pandemic has caused us to modify our business practices in ways that heighten this dependence, including changing the requirement that most of our office-based employees in the U.S. and our other key markets work from the office, with a number of our employees now working in hybrid or full-remote positions. As a result, we are increasingly dependent upon our technology systems to operate our business and our ability to effectively manage our business depends on the security, reliability and adequacy of our technology systems and data, which includes use of cloud technologies, including Software as a Service (SaaS), Platform as a Service (PaaS) and Infrastructure as a Service (IaaS). Breakdowns, invasions, corruptions, destructions and/or breaches of our technology systems or those of our business partners, including our cloud technologies, and/or unauthorized access to our data and information could subject us to liability, negatively impact our business operations, and/or require replacement of technology and/or ransom payments. Our technology systems, including our cloud technologies, continue to increase in multitude and complexity, increasing our vulnerability when breakdowns, malicious intrusions and random attacks occur. Data 34Table of Contentsprivacy or security breaches also pose a risk that sensitive data, including intellectual property, trade secrets or personal information belonging to us, patients, customers or other business partners, may be exposed to unauthorized persons or to the public.Cyber-attacks are increasing in their frequency, sophistication and intensity, and are becoming increasingly difficult to detect, when they impact vendors, customers or companies, including vendors, suppliers and other companies in our supply chain. They are often carried out by motivated, well-resourced, skilled and persistent actors, including nation states, organized crime groups, “hacktivists” and employees or contractors acting with careless or malicious intent. Geopolitical instability, including that related to Russia's invasion of Ukraine may increase cyber-attacks. Cyber-attacks include deployment of harmful malware and key loggers, ransomware, a denial-of-service attack, a malicious website, the use of social engineering and other means to affect the confidentiality, integrity and availability of our technology systems and data. Cyber-attacks also include manufacturing, hardware or software supply chain attacks, which could cause a delay in the manufacturing of products or products produced for contract manufacturing or lead to a data privacy or security breach. Our key business partners face similar risks and any security breach of their systems could adversely affect our security posture. In addition, our increased use of cloud technologies heightens these and other operational risks, and any failure by cloud or other technology service providers to adequately safeguard their systems and prevent cyber-attacks could disrupt our operations and result in misappropriation, corruption or loss of confidential or propriety information.While we continue to build and improve our systems and infrastructure, including our business continuity plans, there can be no assurance that our efforts will prevent breakdowns or breaches in our systems that could adversely affect our business and operations and/or result in the loss of critical or sensitive information, which could result in financial, legal, operational or reputational harm to us, loss of competitive advantage or loss of consumer confidence. Our liability insurance may not be sufficient in type or amount to cover us against claims related to security breaches, cyber-attacks and other related breaches.Regulators are considering new cyber security regulations. For example, the SEC has proposed amendments to its disclosure rules regarding cyber security risk management, strategy, governance and incident reporting by public companies. These proposed regulations may impact the manner in which we operate.Regulators are imposing new data privacy and security requirements, including new and greater monetary fines for privacy violations. For example, the E.U.’s General Data Protection Regulation established regulations regarding the handling of personal data, and provides an enforcement authority and imposes large penalties for noncompliance. New U.S. data privacy and security laws, such as the California Consumer Privacy Act (CCPA), and others that may be passed, similarly introduce requirements with respect to personal information, and non-compliance with the CCPA may result in liability through private actions (subject to statutorily defined damages in the event of certain data breaches) and enforcement. Failure to comply with these current and future laws, policies, industry standards or legal obligations or any security incident resulting in the unauthorized access to, or acquisition, release or transfer of personal information may result in governmental enforcement actions, litigation, fines and penalties or adverse publicity and could cause our customers to lose trust in us, which could have a material adverse effect on our business and results of operations.Manufacturing issues could substantially increase our costs, limit supply of our products and/or reduce our revenue.The process of manufacturing our products is complex, highly regulated and subject to numerous risks, including:•Risks of Reliance on Third-Parties and Single Source Providers. We rely on third-party suppliers and manufacturers for many aspects of our manufacturing process for our products and product candidates including VUMERITY. In some cases, due to the unique manner in which our products are manufactured, we rely on single source providers of raw materials and manufacturing supplies. These third-parties are independent entities subject to their own unique operational and financial risks that are outside of our control. These third-parties may not perform their obligations in a timely and cost-effective manner or in compliance with applicable regulations, and they may be unable or unwilling to increase production capacity commensurate with demand for our existing or future products. Finding alternative providers could take a significant amount of time and involve significant expense due to the specialized nature of the services and the need to obtain regulatory approval of any significant changes to our suppliers or manufacturing methods. We cannot be certain that we could reach agreement with alternative providers or that the FDA or other regulatory authorities would approve our use of such alternatives. Furthermore, factors such as the COVID-19 pandemic, weather events, labor or raw material shortages and other supply chain disruptions could result in difficulties and delays in manufacturing our products, which could have an adverse impact on our results in operations or result in product shortages.35Table of Contents•Global Bulk Supply Risks. We rely on our manufacturing facilities for the production of drug substance for our large molecule products and product candidates. Our global bulk supply of these products and product candidates depends on the uninterrupted and efficient operation of these facilities, which could be adversely affected by equipment failures, labor or raw material shortages, public health epidemics, natural disasters, power failures, cyber-attacks and many other factors.•Risks Relating to Compliance with current GMP (cGMP). We and our third-party providers are generally required to maintain compliance with cGMP and other stringent requirements and are subject to inspections by the FDA and other regulatory authorities to confirm compliance. Any delay, interruption or other issues that arise in the manufacture, fill-finish, packaging or storage of our products as a result of a failure of our facilities or operations or those of third-parties to receive regulatory approval or pass any regulatory agency inspection could significantly impair our ability to develop and commercialize our products. Significant noncompliance could also result in the imposition of monetary penalties or other civil or criminal sanctions and damage our reputation.•Risk of Product Loss. The manufacturing process for our products is extremely susceptible to product loss due to contamination, oxidation, equipment failure or improper installation or operation of equipment or vendor or operator error. Even minor deviations from normal manufacturing processes could result in reduced production yields, product defects and other supply disruptions. If microbial, viral or other contaminations are discovered in our products or manufacturing facilities, we may need to close our manufacturing facilities for an extended period of time to investigate and remediate the contaminant.Any adverse developments affecting our manufacturing operations or the operations of our third-party suppliers and manufacturers may result in shipment delays, inventory shortages, lot failures, product withdrawals or recalls or other interruptions in the commercial supply of our products. We may also have to take inventory write-offs and incur other charges and expense for products that fail to meet specifications, undertake costly remediation efforts or seek more costly manufacturing alternatives. Such developments could increase our manufacturing costs, cause us to lose revenue or market share as patients and physicians turn to competing therapeutics, diminish our profitability or damage our reputation. In addition, although we have business continuity plans to reduce the potential for manufacturing disruptions or delays and reduce the severity of a disruptive event, there is no guarantee that these plans will be adequate, which could adversely affect our business and operations.Management and other personnel changes may disrupt our operations, and we may have difficulty retaining personnel or attracting and retaining qualified replacements on a timely basis for the management and other personnel who may leave the Company.Changes in management, other personnel and our overall retention rate may disrupt our business, and any such disruption could adversely affect our operations, programs, growth, financial condition or results of operations. New members of management may have different perspectives on programs and opportunities for our business, which may cause us to focus on new opportunities or reduce or change emphasis on our existing programs.Our success is dependent upon our ability to attract and retain qualified management and other personnel in a highly competitive environment. Qualified individuals are in high demand, and we may incur significant costs to attract or retain them. We may face difficulty in attracting and retaining talent for a number of reasons, including management changes, the underperformance or discontinuation of one or more marketed or late stage programs, recruitment by competitors or changes in the overall labor market. In addition, changes in our organizational structure or in our flexible working arrangements could impact employees' productivity and morale as well as our ability to attract, retain and motivate employees. We cannot ensure that we will be able to hire or retain the personnel necessary for our operations or that the loss of any personnel will not have a material impact on our financial condition and results of operations.If we fail to comply with the extensive legal and regulatory requirements affecting the health care industry, we could face increased costs, penalties and a loss of business.Our activities, and the activities of our collaborators, distributors and other third-party providers, are subject to extensive government regulation and oversight in the U.S. and in foreign jurisdictions, and are subject to change and evolving interpretations, which could require us to incur substantial costs associated with compliance or to alter one or more of our business practices. The FDA and comparable foreign agencies directly regulate many of our most critical business activities, including the conduct of preclinical and clinical studies, product manufacturing, advertising and promotion, product distribution, adverse event reporting, product risk management and our compliance with good practice quality guidelines and regulations. Our interactions with physicians and other health 36Table of Contentscare providers that prescribe or purchase our products are also subject to government regulation designed to prevent fraud and abuse in the sale and use of products and place significant restrictions on the marketing practices of health care companies. Health care companies are facing heightened scrutiny of their relationships with health care providers and have been the target of lawsuits and investigations alleging violations of government regulation, including claims asserting submission of incorrect pricing information, impermissible off-label promotion of pharmaceutical products, payments intended to influence the referral of health care business, submission of false claims for government reimbursement, antitrust violations or violations related to environmental matters. There is also enhanced scrutiny of company-sponsored patient assistance programs, including insurance premium and co-pay assistance programs and donations to third-party charities that provide such assistance. The U.S. government has challenged some of our donations to third-party charities that provide patient assistance. If we, or our vendors or donation recipients, are found to fail to comply with relevant laws, regulations or government guidance in the operation of these programs, we could be subject to significant fines or penalties. Risks relating to compliance with laws and regulations may be heightened as we continue to expand our global operations and enter new therapeutic areas with different patient populations, which may have different product distribution methods, marketing programs or patient assistance programs from those we currently utilize or support. Conditions and regulations governing the health care industry are subject to change, with possible retroactive effect, including:•new laws, regulations or judicial decisions, or new interpretations of existing laws, regulations or judicial decisions, related to health care availability, pricing or marketing practices, compliance with employment practices, method of delivery, payment for health care products and services, compliance with health information and data privacy and security laws and regulations, tracking and reporting payments and other transfers of value made to physicians and teaching hospitals, extensive anti-bribery and anti-corruption prohibitions, product serialization and labeling requirements and used product take-back requirements; •changes in the FDA and foreign regulatory approval processes or perspectives that may delay or prevent the approval of new products and result in lost market opportunity; •government shutdowns or relocations may result in delays to the review and approval process, slowing the time necessary for new drug candidates to be reviewed and/or approved, which may adversely affect our business;•requirements that provide for increased transparency of clinical trial results and quality data, such as the EMA's clinical transparency policy, which could impact our ability to protect trade secrets and competitively-sensitive information contained in approval applications or could be misinterpreted leading to reputational damage, misperception or legal action, which could harm our business; and•changes in FDA and foreign regulations that may require additional safety monitoring, labeling changes, restrictions on product distribution or use or other measures after the introduction of our products to market, which could increase our costs of doing business, adversely affect the future permitted uses of approved products or otherwise adversely affect the market for our products.Violations of governmental regulation may be punishable by criminal and civil sanctions, including fines and civil monetary penalties and exclusion from participation in government programs, including Medicare and Medicaid, as well as against executives overseeing our business. We could also be required to repay amounts we received from government payors or pay additional rebates and interest if we are found to have miscalculated the pricing information we submitted to the government. In addition, legal proceedings and investigations are inherently unpredictable, and large judgments or settlements sometimes occur. While we believe that we have appropriate compliance controls, policies and procedures in place to comply with the laws or regulations of the jurisdictions in which we operate, there is a risk that acts committed by our employees, agents, distributors, collaborators or third-party providers might violate such laws or regulations. Whether or not we have complied with the law, an investigation or litigation related to alleged unlawful conduct could increase our expense, damage our reputation, divert management time and attention and adversely affect our business.Our sales and operations are subject to the risks of doing business internationally.We are increasing our presence in international markets, subjecting us to many risks that could adversely affect our business and revenue. There is no guarantee that our efforts and strategies to expand sales in international markets will succeed. Emerging market countries may be especially vulnerable to periods of global and local political, legal, regulatory and financial instability and may have a higher incidence of corruption and fraudulent business practices. Certain countries may require local clinical trial data as part of the drug registration process in addition to global clinical trials, which can add to overall drug development and registration timelines. We may also be required 37Table of Contentsto increase our reliance on third-party agents or distributors and unfamiliar operations and arrangements previously utilized by companies we collaborate with or acquire in emerging markets.Our sales and operations are subject to the risks of doing business internationally, including:•the impact of public health epidemics, such as the COVID-19 pandemic, on the global economy and the delivery of healthcare treatments;•less favorable intellectual property or other applicable laws; •the inability to obtain necessary foreign regulatory approvals of products in a timely manner; •limitations and additional pressures on our ability to obtain and maintain product pricing, reimbursement or receive price increases, including those resulting from governmental or regulatory requirements;•increased cost of goods due to factors such as inflation and supply chain disruptions;•additional complexity in manufacturing internationally;•delays in clinical trials relating to geopolitical instability related to Russia's invasion of Ukraine;•the inability to successfully complete subsequent or confirmatory clinical trials in countries where our experience is limited;•longer payment and reimbursement cycles and uncertainties regarding the collectability of accounts receivable; •fluctuations in foreign currency exchange rates that may adversely impact our revenue, net income and value of certain of our investments; •the imposition of governmental controls; •diverse data privacy and protection requirements;•increasingly complex standards for complying with foreign laws and regulations that may differ substantially from country to country and may conflict with corresponding U.S. laws and regulations; •the far-reaching anti-bribery and anti-corruption legislation in the U.K., including the U.K. Bribery Act 2010, and elsewhere and escalation of investigations and prosecutions pursuant to such laws;•compliance with complex import and export control laws;•changes in tax laws; and•the imposition of tariffs or embargoes and other trade restrictions.In addition, our international operations are subject to regulation under U.S. law. For example, the U.S. Foreign Corrupt Practices Act (FCPA) prohibits U.S. companies and their representatives from paying, offering to pay, promising to pay or authorizing the payment of anything of value to any foreign government official, government staff member, political party or political candidate for the purpose of obtaining or retaining business or to otherwise obtain favorable treatment or influence a person working in an official capacity. In many countries, the health care professionals we regularly interact with may meet the FCPA's definition of a foreign government official. Failure to comply with domestic or foreign laws could result in various adverse consequences, including possible delay in approval or refusal to approve a product, recalls, seizures or withdrawal of an approved product from the market, disruption in the supply or availability of our products or suspension of export or import privileges, the imposition of civil or criminal sanctions, the prosecution of executives overseeing our international operations and damage to our reputation. Any significant impairment of our ability to sell products outside of the U.S. could adversely impact our business and financial results. In addition, while we believe that we have appropriate compliance controls, policies and procedures in place to comply with the FCPA, there is a risk that acts committed by our employees, agents, distributors, collaborators or third-party providers might violate the FCPA and we might be held responsible. If our employees, agents, distributors, collaborators or third-party providers are found to have engaged in such practices, we could suffer severe penalties and may be subject to other liabilities, which could negatively affect our business, operating results and financial condition.We are building a large-scale biologics manufacturing facility, which will result in the incurrence of significant investment with no assurance that such investment will be recouped.In order to support our future growth and drug development pipeline, we are expanding our large molecule production capacity by building a large-scale biologics manufacturing facility in Solothurn, Switzerland with no assurance that the additional capacity will be required or this investment will be recouped.38Table of ContentsIf we are unable to fully utilize our manufacturing facilities, our business may be harmed. Charges resulting from excess capacity may continue to occur and would have a negative effect on our financial condition and results of operations.Although the Solothurn facility was approved by the FDA for ADUHELM and LEQEMBI, there can be no assurance that the regulatory authorities will approve the Solothurn facility for the manufacturing of other products.The ongoing COVID-19 pandemic and other global health outbreaks may, directly or indirectly, adversely affect our business, results of operations and financial condition.Our business has and could continue to be adversely affected, directly or indirectly, by the ongoing COVID-19 pandemic and other global health outbreaks.We continue to monitor our operations and applicable government recommendations, and we have made modifications to our normal operations because of the COVID-19 pandemic and other global health outbreaks, including limiting travel and adopting flexible working arrangements. Customer-facing professionals interactions in healthcare settings have changed as a result of the COVID-19 pandemic and other global health outbreaks. This limits our ability to market our products and educate physicians, which, in turn, could have an adverse effect on our ability to compete in the marketing and sales of our products.Changes in flexible working arrangements could impact employee retention, employees' productivity and morale, strain our technology resources and introduce operational risks. Additionally, the risk of cyber-attacks or other privacy or data security incidents may be heightened as a result of our moving increasingly towards a remote working environment, which may be less secure and more susceptible to hacking attacks.The COVID-19 pandemic and other global health outbreaks could affect the health and availability of our workforce as well as those of the third-parties we rely on. Furthermore, delays and disruptions experienced by our collaborators or other third-parties due to the COVID-19 pandemic and other global health outbreaks could adversely impact the ability of such parties to fulfill their obligations, which could affect product sales or the clinical development or regulatory approvals of product candidates under joint control.Our ability to continue our existing clinical trials or to initiate new clinical trials has been and may continue to be adversely affected, directly or indirectly, by the COVID-19 pandemic and other global health outbreaks. Restrictions on travel and/or transport of clinical materials as well as diversion of hospital staff and resources to COVID-19 infected patients could disrupt trial operations and recruitment, possibly resulting in a slowdown in enrollment and/or deviations from or disruptions in key clinical trial activities, such as clinical trial site monitoring. These challenges may lead to difficulties in meeting protocol-specified procedures. We may need to make certain adjustments to the operation of clinical trials in an effort to minimize risks to trial data integrity during the COVID-19 pandemic and other global health outbreaks. In addition, the impact of the COVID-19 pandemic and other global health outbreaks on the operations of the FDA and other health authorities may delay potential approvals of our product candidates.State and federal healthcare reform measures have been adopted in the past, and may be adopted in the future, any of which could limit the amounts that federal and state governments will pay for healthcare products and services, which could result in reduced demand for our products or additional pricing pressures and have a financial impact on our business that we cannot predict.While it is not possible at this time to estimate the entirety of the impact that the COVID-19 pandemic and other global health outbreaks will continue to have on our business, the broad impact of the pandemic on all business activities may materially and adversely affect our business, supply chain and distribution systems, results of operations and financial condition.The illegal distribution and sale by third-parties of counterfeit or unfit versions of our products or stolen products could have a negative impact on our reputation and business.Third-parties might illegally distribute and sell counterfeit or unfit versions of our products, which do not meet our rigorous manufacturing, distribution and testing standards. A patient who receives a counterfeit or unfit drug may be at risk for a number of dangerous health consequences. Our reputation and business could suffer harm as a result of counterfeit or unfit drugs sold under our brand name. Inventory that is stolen from warehouses, plants or while in-transit, and that is subsequently improperly stored and sold through unauthorized channels, could adversely impact patient safety, our reputation and our business.The increasing use of social media platforms presents new risks and challenges.Social media is increasingly being used to communicate about our products and the diseases our therapies are designed to treat. Social media practices in the biopharmaceutical industry continue to evolve and regulations relating to such use are not always clear and create uncertainty and risk of noncompliance with regulations 39Table of Contentsapplicable to our business. For example, patients may use social media channels to comment on the effectiveness of a product or to report an alleged adverse event. When such disclosures occur, there is a risk that we fail to monitor and comply with applicable adverse event reporting obligations or we may not be able to defend the company or the public's legitimate interests in the face of the political and market pressures generated by social media due to restrictions on what we may say about our products. There is also a risk of inappropriate disclosure of sensitive information or negative or inaccurate posts or comments about us on social media. We may also encounter criticism on social media regarding our company, management, product candidates or products. The immediacy of social media precludes us from having real-time control over postings made regarding us via social media, whether matters of fact or opinion. Our reputation could be damaged by negative publicity or if adverse information concerning us is posted on social media platforms or similar mediums, which we may not be able to reverse. If any of these events were to occur or we otherwise fail to comply with applicable regulations, we could incur liability, face restrictive regulatory actions or incur other harm to our business.Risks Related to Holding Our Common StockOur operating results are subject to significant fluctuations.Our quarterly revenue, expense and net income (loss) have fluctuated in the past and are likely to fluctuate significantly in the future due to the risks described in these Risk Factors as well as the timing of charges and expense that we may take. We have recorded, or may be required to record, charges that include:•the cost of restructurings or other initiatives to streamline our operations and reallocate resources; •impairments with respect to investments, fixed assets and long-lived assets, including in-process research and development (IPR&D) and other intangible assets; •inventory write-downs for failed quality specifications, recurring charges for excess or obsolete inventory and charges for inventory write-downs relating to product suspensions, expirations or recalls; •changes in the fair value of contingent consideration or our equity investments;•bad debt expense and increased bad debt reserves;•outcomes of litigation and other legal or administrative proceedings, regulatory matters and tax matters;•payments in connection with acquisitions, divestitures and other business development activities and under license and collaboration agreements;•failure to meet certain contractual commitments; and•the impact of public health epidemics, such as the COVID-19 pandemic, on employees, the global economy and the delivery of healthcare treatments.Our revenue and certain assets and liabilities are also subject to foreign currency exchange rate fluctuations due to the global nature of our operations. Our efforts to mitigate the impact of fluctuating currency exchange rates may not be successful. As a result, currency fluctuations among our reporting currency, the U.S. dollar, and other currencies in which we do business will affect our operating results, often in unpredictable ways. Our net income may also fluctuate due to the impact of charges we may be required to take with respect to foreign currency hedge transactions. In particular, we may incur higher than expected charges from early termination of a hedge relationship.Our operating results during any one period do not necessarily suggest the anticipated results of future periods.Our investments in properties may not be fully realized.We own or lease real estate primarily consisting of buildings that contain research laboratories, office space and manufacturing operations. We may decide to consolidate or co-locate certain aspects of our business operations or dispose of one or more of our properties, some of which may be located in markets that are experiencing high vacancy rates and decreasing property values. If we determine that the fair value of any of our owned properties is lower than their book value, we may not realize the full investment in these properties and incur significant impairment charges or additional depreciation when the expected useful lives of certain assets have been shortened due to the anticipated closing of facilities. If we decide to fully or partially vacate a property, we may incur significant cost, including facility closing costs, employee separation and retention expense, lease termination fees, rent expense in excess of sublease income and impairment of leasehold improvements and accelerated depreciation of assets. Any of these events may have an adverse impact on our results of operations.Our investment portfolio is subject to market, interest and credit risk that may reduce its value.We maintain a portfolio of marketable securities for investment of our cash as well as investments in equity securities of certain biotechnology companies. Changes in the value of our investment portfolio could adversely 40Table of Contentsaffect our earnings. The value of our investments may decline due to, among other things, increases in interest rates, downgrades of the bonds and other securities in our portfolio, negative company-specific news, biotechnology market sentiment, instability in the global financial markets that reduces the liquidity of securities in our portfolio, declines in the value of collateral underlying the securities in our portfolio and other factors. Each of these events may cause us to record charges to reduce the carrying value of our investment portfolio or sell investments for less than our acquisition cost. Although we attempt to mitigate these risks through diversification of our investments and continuous monitoring of our portfolio's overall risk profile, the value of our investments may nevertheless decline.There can be no assurance that we will continue to repurchase shares or that we will repurchase shares at favorable prices.From time to time our Board of Directors authorizes share repurchase programs. The amount and timing of share repurchases are subject to capital availability and our determination that share repurchases are in the best interest of our shareholders and are in compliance with all respective laws and our applicable agreements. Our ability to repurchase shares will depend upon, among other factors, our cash balances and potential future capital requirements for strategic transactions, our results of operations, our financial condition and other factors beyond our control that we may deem relevant. Additionally, the recently enacted IRA includes an excise tax on share repurchases, which will increase the cost of share repurchases. A reduction in repurchases under, or the completion of, our share repurchase programs could have a negative effect on our stock price. We can provide no assurance that we will repurchase shares at favorable prices, if at all.We may not be able to access the capital and credit markets on terms that are favorable to us.We may seek access to the capital and credit markets to supplement our existing funds and cash generated from operations for working capital, capital expenditure and debt service requirements and other business initiatives. The capital and credit markets are experiencing, and have in the past experienced, extreme volatility and disruption, which leads to uncertainty and liquidity issues for both borrowers and investors. In the event of adverse market conditions, we may be unable to obtain capital or credit market financing on favorable terms. Changes in credit ratings issued by nationally recognized credit rating agencies could also adversely affect our cost of financing and the market price of our securities.Our indebtedness could adversely affect our business and limit our ability to plan for or respond to changes in our business. Our indebtedness, together with our significant contingent liabilities, including milestone and royalty payment obligations, could have important consequences to our business; for example, such obligations could: •increase our vulnerability to general adverse economic and industry conditions;•limit our ability to access capital markets and incur additional debt in the future;•require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow for other purposes, including business development, research and development and mergers and acquisitions; and•limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, thereby placing us at a disadvantage compared to our competitors that have less debt.Some of our collaboration agreements contain change in control provisions that may discourage a third-party from attempting to acquire us.Some of our collaboration agreements include change in control provisions that could reduce the potential acquisition price an acquirer is willing to pay or discourage a takeover attempt that could be viewed as beneficial to shareholders. Upon a change in control, some of these provisions could trigger reduced milestone, profit or royalty payments to us or give our collaboration partner rights to terminate our collaboration agreement, acquire operational control or force the purchase or sale of the programs that are the subject of the collaboration.General Risk FactorsOur effective tax rate fluctuates, and we may incur obligations in tax jurisdictions in excess of accrued amounts.As a global biopharmaceutical company, we are subject to taxation in numerous countries, states and other jurisdictions. As a result, our effective tax rate is derived from a combination of applicable tax rates, including withholding taxes, in the various places that we operate. In preparing our financial statements, we estimate the amount of tax that will become payable in each of such places. Our effective tax rate may be different than experienced in the past or our current expectations due to many factors, including changes in the mix of our 41Table of Contentsprofitability from country to country, the results of examinations and audits of our tax filings (including those related to the impact of the Tax Cuts and Jobs Act of 2017), adjustments to the value of our uncertain tax positions, interpretations by tax authorities or other bodies with jurisdiction, the result of tax cases, changes in accounting for income taxes and changes in tax laws and regulations either prospectively or retrospectively (including those related to the IRA). Our inability to secure or sustain acceptable arrangements with tax authorities and future changes in the tax laws, among other things, may result in tax obligations in excess of amounts accrued in our financial statements.The enactment of some or all of the recommendations set forth or that may be forthcoming in the Organization for Economic Cooperation and Development’s project on “Base Erosion and Profit Shifting” (BEPS) by tax authorities and economic blocs in the countries in which we operate, could unfavorably impact our effective tax rate. These initiatives focus on common international principles for the entitlement to taxation of global corporate profits and minimum global tax rates.Our business involves environmental risks, which include the cost of compliance and the risk of contamination or injury.Our business and the business of several of our strategic partners involve the controlled use of hazardous materials, chemicals, biologics and radioactive compounds. Although we believe that our safety procedures for handling and disposing of such materials comply with state, federal and foreign standards, there will always be the risk of accidental contamination or injury. If we were to become liable for an accident, or if we were to suffer an extended facility shutdown, we could incur significant costs, damages and penalties that could harm our business. Manufacturing of our products and product candidates also requires permits from government agencies for water supply and wastewater discharge. If we do not obtain appropriate permits, including permits for sufficient quantities of water and wastewater, we could incur significant costs and limits on our manufacturing volumes that could harm our business. Additionally, regulators are considering new environmental disclosure rules. For example, the SEC has proposed amendments to its disclosure rules regarding climate-related disclosure requirements. These proposed regulations may impact the manner in which we operate.ITEM 1B. UNRESOLVED STAFF COMMENTSNone.ITEM 2. PROPERTIESBelow is a summary of our owned and leased properties as of December 31, 2022.U.S.MassachusettsIn Cambridge, MA we own approximately 263,000 square feet of real estate space, consisting of a building that houses a research laboratory and a cogeneration plant.In addition, we lease a total of approximately 1,429,000 square feet in Massachusetts, which is summarized as follows:•1,072,000 square feet in Cambridge, MA, which is comprised of offices for our corporate headquarters and other administrative and development functions and laboratories, of which 289,000 square feet is subleased by multiple companies for general office space, laboratories and manufacturing facilities; and•357,000 square feet of office space in Weston, MA, of which 174,000 square feet is subleased through the remaining term of our lease agreement.Our Massachusetts lease agreements expire at various dates through the year 2028.125 Broadway Building Sale and LeasebackIn September 2022 we completed the sale of our building and land parcel located at 125 Broadway. In connection with this sale, we simultaneously leased back the building for a term of approximately 5.5 years, which resulted in the recognition of approximately $168.2 million in new lease liabilities and right-of-use assets recorded within our consolidated balance sheets as of December 31, 2022. The sale and immediate leaseback of this building qualified for sale and leaseback treatment and is classified as an operating lease. For additional information 42Table of Contentson our 125 Broadway sale and leaseback transaction, please read Note 11, Property, Plant and Equipment and Note 12, Leases, to our consolidated financial statements included in this report.300 Binney Street Lease ModificationIn September 2022 we entered into an agreement to partially terminate a portion of our lease located at 300 Binney Street, Cambridge, MA (300 Binney Street), as well as to reduce the lease term for the majority of the remaining space. The agreement was driven by our 2022 efforts to reduce costs by consolidating real estate locations. For additional information on our 300 Binney Street lease modification, please read Note 12, Leases, to our consolidated financial statements included in this report.North CarolinaIn RTP, NC we own approximately 1,040,000 square feet of real estate space, which is summarized as follows:•357,000 square feet of laboratory and office space;•206,000 square foot multi-purpose facility, including an ASO manufacturing suite and administrative space;•175,000 square feet related to a large-scale biologics manufacturing facility;•105,000 square feet related to a small-scale biologics manufacturing facility;•84,000 square feet of warehouse space and utilities; •70,000 square feet related to a parenteral fill-finish facility; and•43,000 square feet related to a large-scale purification facility.In addition, we lease approximately 65,000 square feet of warehouse space in Durham, NC. Our North Carolina lease agreements expire at various dates through the year 2025.In March 2021 we announced our plans to build a new gene therapy manufacturing facility in RTP, NC to support our gene therapy pipeline across multiple therapeutic areas. The new manufacturing facility will be approximately 197,000 square feet and is expected to be operational by the end of 2023, with an estimated total investment of approximately $195.0 million. Construction for this new facility began during the fourth quarter of 2021.InternationalSwitzerlandIn order to support our future growth and drug development pipeline, we are building a large-scale biologics manufacturing facility in Solothurn, Switzerland. Upon completion, this facility will include 393,000 square feet related to a large-scale biologics manufacturing facility, 290,000 square feet of warehouse, utilities and support space and 51,000 square feet of administrative space. In the second quarter of 2021 a portion of the facility received a GMP multi-product license from SWISSMEDIC. Solothurn has been approved for the manufacture of ADUHELM and LEQEMBI by the FDA. We estimate the second manufacturing suite at the Solothurn facility will be operational by the end of 2023.Other InternationalWe lease office space in Baar, Switzerland, our international headquarters; the U.K.; Germany; France; Japan; Canada and numerous other countries. Our international lease agreements expire at various dates through the year 2031.ITEM 3. LEGAL PROCEEDINGSFor a discussion of legal matters as of December 31, 2022, please read Note 21, Litigation, to our consolidated financial statements included in this report, which is incorporated into this item by reference.ITEM 4. MINE SAFETY DISCLOSURESNot applicable.43Table of ContentsPART IIITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESMarket and Stockholder InformationOur common stock trades on The Nasdaq Global Select Market under the symbol “BIIB.” As of February 14, 2023, there were approximately 448 shareholders of record of our common stock.DividendsWe have not paid cash dividends since our inception. While we historically have not paid cash dividends and do not have a current intention to pay cash dividends, we continually review our capital allocation strategies, including, among other things, payment of cash dividends, share repurchases and acquisitions.Issuer Purchases of Equity SecuritiesThe following table summarizes our common stock repurchase activity during the fourth quarter of 2022:PeriodTotal Number ofShares Purchased(#)Average PricePaid per Share($)Total Number ofShares Purchasedas Part of PubliclyAnnounced Programs(#)Approximate Dollar Valueof Shares That May Yet BePurchased UnderOur Programs ($ in millions)October 2022— $— — $2,050.0 November 2022— $— — $2,050.0 December 2022— $— — $2,050.0 Total(1)— $— (1) There were no share repurchases during the fourth quarter of 2022.In October 2020 our Board of Directors authorized a program to repurchase up to $5.0 billion of our common stock (2020 Share Repurchase Program). Our 2020 Share Repurchase Program does not have an expiration date. All share repurchases under our 2020 Share Repurchase Program will be retired. Under our 2020 Share Repurchase Program, we repurchased and retired approximately 3.6 million, 6.0 million and 1.6 million shares of our common stock at a cost of approximately $750.0 million, $1.8 billion and $400.0 million during the years ended December 31, 2022, 2021 and 2020, respectively. Approximately $2.1 billion remained available under our 2020 Share Repurchase Program as of December 31, 2022.In December 2019 our Board of Directors authorized a program to repurchase up to $5.0 billion of our common stock (December 2019 Share Repurchase Program), which was completed as of September 30, 2020. All shares repurchased under our December 2019 Share Repurchase Program were retired. Under our December 2019 Share Repurchase Program, we repurchased and retired approximately 16.7 million shares of our common stock at a cost of approximately $5.0 billion during the year ended December 31, 2020.In March 2019 our Board of Directors authorized a program to repurchase up to $5.0 billion of our common stock (March 2019 Share Repurchase Program), which was completed as of March 31, 2020. All shares repurchased under our March 2019 Share Repurchase Program were retired. Under our March 2019 Share Repurchase Program, we repurchased and retired approximately 4.1 million shares of our common stock at a cost of approximately $1.3 billion during the year ended December 31, 2020.In August 2022 the IRA was signed into law. Among other things, the IRA levies a 1.0% excise tax on net stock repurchases after December 31, 2022. Historically, we have made discretionary share repurchases.44Table of ContentsPerformance GraphThe performance graph below compares the five-year cumulative total stockholder return on our common stock, the Nasdaq Pharmaceutical Index, the S&P 500 Index and the Nasdaq Biotechnology Index. The performance graph below assumes the investment of $100.00 on December 31, 2017, in our common stock and each of the three indexes, with dividends being reinvested.The stock price performance in the graph below is not necessarily indicative of future price performance.201720182019202020212022Biogen Inc.$100.00$94.46$93.14$76.86$75.31$86.92Nasdaq Pharmaceutical Index$100.00$107.95$123.62$136.62$169.94$189.23S&P 500 Index$100.00$95.62$125.72$148.85$191.58$156.88Nasdaq Biotechnology Index$100.00$91.14$114.02$144.15$144.18$129.59The information included under the heading Performance Graph is “furnished” and not “filed” for purposes of Section 18 of the Securities Exchange Act, or otherwise subject to the liabilities of that section, nor shall it be deemed to be “soliciting material” subject to Regulation 14A or incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.ITEM 6. RESERVED45Table of ContentsITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes beginning on page F-1 of this report. For our discussion of the year ended December 31, 2021, compared to the year ended December 31, 2020, please read Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations located in our Annual Report on Form 10-K for the year ended December 31, 2021.Executive SummaryIntroductionBiogen is a global biopharmaceutical company focused on discovering, developing and delivering innovative therapies for people living with serious and complex diseases worldwide. We have a broad portfolio of medicines to treat MS, have introduced the first approved treatment for SMA and co-developed two treatments to address a defining pathology of Alzheimer’s disease. We are focused on advancing our pipeline in neurology, neuropsychiatry, specialized immunology and rare diseases. We support our drug discovery and development efforts through internal research and development programs and external collaborations.Our marketed products include TECFIDERA, VUMERITY, AVONEX, PLEGRIDY, TYSABRI and FAMPYRA for the treatment of MS; SPINRAZA for the treatment of SMA; ADUHELM for the treatment of Alzheimer's disease; and FUMADERM for the treatment of severe plaque psoriasis. We also collaborate with Eisai on the commercialization of LEQEMBI for the treatment of Alzheimer's disease, which was granted accelerated approval by the FDA in January 2023. We have certain business and financial rights with respect to RITUXAN for the treatment of non-Hodgkin's lymphoma, CLL and other conditions; RITUXAN HYCELA for the treatment of non-Hodgkin's lymphoma and CLL; GAZYVA for the treatment of CLL and follicular lymphoma; OCREVUS for the treatment of PPMS and RMS; LUNSUMIO (mosunetuzumab), which was granted accelerated approval in the U.S. during the fourth quarter of 2022 for the treatment of relapsed or refractory follicular lymphoma; glofitamab, an investigational bispecific antibody for the potential treatment of non-Hodgkin's lymphoma; and have the option to add other potential anti-CD20 therapies, pursuant to our collaboration arrangements with Genentech, a wholly-owned member of the Roche Group.In addition to continuing to invest in new potential innovation in MS and SMA we are advancing our mid-to-late stage programs including zuranolone for MDD and PPD, BIIB080 for Alzheimer's disease, tofersen for ALS and both litifilimab and dapirolizumab pegol for certain forms of lupus.We also commercialize biosimilars of advanced biologics including BENEPALI, an etanercept biosimilar referencing ENBREL, IMRALDI, an adalimumab biosimilar referencing HUMIRA, and FLIXABI, an infliximab biosimilar referencing REMICADE, in certain countries in Europe, as well as BYOOVIZ, a ranibizumab biosimilar referencing LUCENTIS, in the U.S. We continue to develop potential biosimilar products including BIIB800, a proposed tocilizumab biosimilar referencing ACTEMRA, and SB15, a proposed aflibercept biosimilar referencing EYLEA. In February 2023 we announced that we are exploring strategic options for our biosimilars business.For additional information on our collaboration arrangements, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.We seek to ensure an uninterrupted supply of medicines to patients around the world. To that end, we continually review our manufacturing capacity, capabilities, processes and facilities. In order to support our future growth and drug development pipeline, we are expanding our large molecule production capacity by building a large-scale biologics manufacturing facility in Solothurn, Switzerland. In the second quarter of 2021 a portion of the facility received a GMP multi-product license from SWISSMEDIC. Solothurn has been approved for the manufacture of ADUHELM and LEQEMBI by the FDA. We estimate the second manufacturing suite at the Solothurn facility will be operational by the end of 2023. We believe that the Solothurn facility will support our anticipated near-term needs for the manufacturing of biologic assets. If we are unable to fully utilize our manufacturing facilities, due to lower than forecasted demand for our products, we will incur excess capacity charges which will have a negative effect on our financial condition and results of operations.Our revenue depends upon continued sales of our products as well as the financial rights we have in our anti-CD20 therapeutic programs, and, unless we develop, acquire rights to and/or commercialize new products and technologies, we will be substantially dependent on sales from our products and our financial rights in our anti-CD20 therapeutic programs for many years.In the longer term, our revenue growth will depend upon the successful clinical development, regulatory approval and launch of new commercial 46Table of Contentsproducts as well as additional indications for our existing products, our ability to obtain and maintain patents and other rights related to our marketed products, assets originating from our research and development efforts and/or successful execution of external business development opportunities.Business EnvironmentFor a detailed discussion on our business environment, please read Item 1. Business, included in this report. For additional information on our competition and pricing risks that could negatively impact our product sales, please read Item 1A. Risk Factors, included in this report.ADUHELM (aducanumab)U.S.In June 2021 the FDA granted accelerated approval of ADUHELM, which, until March of 2022, we had been collaborating on with Eisai, based on reduction in amyloid beta plaques observed in patients treated with ADUHELM. As part of the accelerated approval, we are required to conduct a confirmatory trial to verify the clinical benefit of ADUHELM in patients with Alzheimer’s disease. The FDA may withdraw approval if, among other things, the confirmatory trial fails to verify clinical benefit of ADUHELM, ADUHELM's benefit-risk is no longer positive or we fail to comply with the conditions of the accelerated approval.In April 2022 the CMS released a final NCD for the class of anti-amyloid treatments in Alzheimer's disease, including ADUHELM. The final NCD confirmed coverage with evidence development, in which patients with Medicare can only access treatment if they are part of an approved clinical trial. This decision effectively resulted in denying all Medicare beneficiaries access to ADUHELM. We expect that this decision will reduce future demand for ADUHELM to a minimal level.During the first quarter of 2022, as a result of the final NCD, we recorded approximately $275.0 million of charges associated with the write-off of inventory and purchase commitments in excess of forecasted demand related to ADUHELM. Additionally, for the year ended December 31, 2022, we recorded approximately $111.0 million of aggregate gross idle capacity charges related to ADUHELM. These charges were recorded in cost of sales within our consolidated statements of income for the year ended December 31, 2022.We have recognized approximately $197.0 million related to Eisai's 45.0% share of inventory, idle capacity charges and contractual commitments in collaboration profit (loss) sharing within our consolidated statements of income for the year ended December 31, 2022.Additionally, as a result of the final NCD we have substantially eliminated our commercial infrastructure supporting ADUHELM, retaining minimal resources to manage patient access programs, including a continued free drug program for patients currently on treatment in the U.S.We expect to continue funding certain regulatory and research and development activities for ADUHELM, including the continuation of the EMBARK re-dosing study and the Phase 4 post-marketing requirement study, ENVISION. Additional actions regarding ADUHELM may be informed by upcoming data readouts expected for this class of antibodies, as well as further engagement with the FDA and CMS.On March 14, 2022, we amended our ADUHELM Collaboration Agreement with Eisai. As of the amendment date, we have sole decision making and commercialization rights worldwide on ADUHELM, and beginning January 1, 2023, Eisai receives only a tiered royalty based on net sales of ADUHELM, and no longer participates in sharing ADUHELM's global profits and losses. Eisai's share of development, commercialization and manufacturing expense was limited to $335.0 million for the period from January 1, 2022 to December 31, 2022, which was achieved as of December 31, 2022. Once this limit was achieved, we became responsible for all ADUHELM related costs.Rest of WorldIn October 2020 the EMA accepted for review the MAA for aducanumab and in December 2020 the Ministry of Health, Labor and Welfare (MHLW) accepted for review the Japanese NDA for aducanumab.In December 2021 the CHMP of the EMA adopted a negative opinion on the MAA for aducanumab in Europe. We sought re-examination of the opinion by the CHMP. In April 2022 we announced our decision to withdraw our MAA for aducanumab in Europe.TECFIDERAMultiple TECFIDERA generic entrants are now in North America, Brazil and certain E.U. countries and have deeply discounted prices compared to TECFIDERA. The generic competition for TECFIDERA has significantly reduced our TECFIDERA revenue and we expect that TECFIDERA revenue will continue to decline in the future.In the E.U., we are seeking to enforce a patent granted in June 2022 that relates to TECFIDERA and expires in 2028. In addition, we are litigating to affirm that TECFIDERA is entitled to regulatory data and 47Table of Contentsmarket protection until at least February 2024. Our Company, the EMA and the EC have each appealed the May 2021 decision of the European General Court, which annulled the EMA's decision not to validate an application for approval of a TECFIDERA generic on the basis that the EMA and EC conducted the wrong assessment when determining TECFIDERA's entitlement to regulatory data and marketing protection. Our Company, the EMA and the EC have each appealed the General Court’s decision as wrongly decided and the appeal is pending. On October 6, 2022, the Advocate General of the CJEU issued a nonbinding advisory opinion in Biogen's favor. This opinion recommends that the CJEU set aside the judgment of the European General Court. We are awaiting the decision of the CJEU.For additional information, please read Note 21, Litigation, to our consolidated financial statements included in this report and the discussion under Results of Operations - Product Revenue - Multiple Sclerosis (MS) - Fumarate below.Business Update Regarding COVID-19 and Other DisruptionsCOVID-19The COVID-19 pandemic continues to present a substantial public health and economic challenge around the world. The length of time and full extent to which the COVID-19 pandemic directly or indirectly impacts our business, results of operations and financial condition, including sales, expense, reserves and allowances, the supply chain, manufacturing, clinical trials, research and development costs and employee-related costs, depends on future developments that are highly uncertain, subject to change and are difficult to predict, including as a result of new information that may emerge concerning COVID-19 and the actions taken to contain or treat COVID-19 as well as the economic impact on local, regional, national and international customers and markets.We are monitoring the demand for our products, including the duration and degree to which we may see delays in starting new patients on a product due to hospitals diverting the resources that are necessary to administer certain of our products to care for COVID-19 patients, including products, such as TYSABRI and SPINRAZA, that are administered in a physician's office or hospital setting. We may also see reduced demand for immunosuppressant therapies during the COVID-19 pandemic.While we are currently continuing the clinical trials we have underway in sites across the globe, COVID-19 precautions have impacted the timeline for some of our clinical trials and these precautions may, directly or indirectly, have a further impact on timing in the future.Geopolitical TensionsThe ongoing geopolitical tensions related to Russia's invasion of Ukraine have resulted in global business disruptions and economic volatility, including sanctions and other restrictions levied on the government and businesses in Russia. Although we do not have affiliates or employees, in either Russia or Ukraine, we do provide various therapies to patients in Russia through a distributor and are currently involved in clinical trials with sites in Ukraine and Russia. The timing and costs of these trials may be impacted as a result of the conflict. In addition, new government sanctions on the export of certain manufacturing materials to Russia may delay or limit our ability to get new products approved.The impact of the conflict on our operations and financial performance remains uncertain and will depend on future developments, including the severity and duration of the conflict, its impact on regional and global economic conditions and whether the conflict spreads or has effects on countries outside Ukraine and Russia. Revenue generated from sales in these regions represented less than 2.0% of total product revenue for the years ended December 31, 2022 and 2021.We will continue to monitor the ongoing conflict between Russia and Ukraine and assess any potential impacts on our business, supply chain, partners or customers, as well as any factors that could have an adverse effect on our results of operations.Factors such as the COVID-19 pandemic and other global health outbreaks, adverse weather events, geopolitical events, labor or raw material shortages and other supply chain disruptions could result in product shortages or other difficulties and delays or increased costs in manufacturing our products.For additional information on the various risks posed by the COVID-19 pandemic and the conflict in Ukraine, please read Item 1A. Risk Factors, included in this report.48Table of ContentsInflation Reduction Act of 2022In August 2022 the IRA was signed into law in the U.S. The IRA introduced new tax provisions, including a 15.0% corporate alternative minimum tax and a 1.0% excise tax on stock repurchases. The provisions of the IRA will be effective for periods after December 31, 2022. The enactment of the IRA did not result in any material adjustments to our income tax provision or net deferred tax assets as of December 31, 2022. We expect additional guidance and regulations to be issued in future periods and will continue to assess its potential impact on our business and results of operations as further information becomes available.The IRA also contains substantial drug pricing reforms that may have a significant impact on the pharmaceutical industry in the U.S. This includes allowing CMS to negotiate a maximum fair price for certain high-priced single source Medicare drugs, as well as redesigning Medicare Part D to reduce out-of-pocket prescription drug costs for beneficiaries, potentially resulting in higher contributions from plans and manufacturers. The IRA also establishes drug inflationary rebate requirements to penalize manufacturers from raising the prices of Medicare covered single-source drugs and biologics beyond the inflation-adjusted rate. Further, to incentivize biosimilar development, the IRA provides an 8.0% Medicare Part B add-on payment for qualifying biosimilar products for a five-year period.The overall impact that the IRA will have on our business, results of operations and financial condition, and the impact on the pharmaceutical industry as a whole is not yet known. We will continue to assess as further information becomes available.Financial HighlightsDiluted earnings per share attributable to Biogen Inc. were $20.87 for 2022, representing an increase of 100.7% as compared to $10.40 in the same period in 2021.As described below under Results of Operations, our net income and diluted earnings per share attributable to Biogen Inc. for the year ended December 31, 2022, compared to the year ended December 31, 2021, reflects the following:Revenue•Total revenue was $10,173.4 million for 2022, representing an $808.3 million, or 7.4%, decrease compared to $10,981.7 million in 2021.•Product revenue, net totaled $7,987.8 million for 2022, representing an $859.1 million, or 9.7%, decrease compared to $8,846.9 million in 2021. This decrease was primarily due to a $666.5 million, or 10.9%, decrease in MS product revenue, a $111.6 million, or 5.9%, decrease in SPINRAZA product revenue and an $80.0 million, or 9.6%, decrease in revenue from our biosimilar business.◦The decrease in MS product revenue of $666.5 million, or 10.9%, from $6,096.7 million in 2021 to $5,430.2 million in 2022, was primarily due to a decrease in TECFIDERA demand as a result of multiple TECFIDERA generic entrants in North America, Brazil and certain E.U. countries, and a decrease in Interferon demand due to competition as patients transition to higher efficacy and oral MS therapies.◦The decrease in SPINRAZA revenue of $111.6 million, or 5.9%, from $1,905.1 million in 2021 to $1,793.5 million in 2022, was primarily due to country mix, the unfavorable impact of foreign currency exchange and the timing of shipments, partially offset by an increase in sales volumes. The increase in sales volumes reflects growth in certain Asian markets, partially offset by a decrease in sales volumes from increased competition in certain established markets, particularly Germany and Japan.◦The decrease in revenue from our biosimilar business of $80.0 million, or 9.6%, from $831.1 million in 2021 to $751.1 million in 2022, was primarily due to unfavorable pricing and the unfavorable impact of foreign currency exchange, partially offset by an increase in sales volumes.•Revenue from anti-CD20 therapeutic programs totaled $1,700.5 million for 2022, representing a $42.0 million, or 2.5%, increase compared to $1,658.5 million in 2021. This increase was primarily due to a $144.6 million, or 14.6%, increase in royalty revenue on sales of OCREVUS, partially offset by a $103.4 million, or 18.0%, decrease in RITUXAN revenue. Sales of RITUXAN have been adversely affected by biosimilar competition.•Other revenue totaled $485.1 million for 2022, representing a $8.8 million, or 1.8%, increase from $476.3 million in 2021.Expense•Total cost and expense was $6,581.6 million for 2022, representing a $2,654.9 million, or 28.7%, decrease compared to $9,236.5 million in 2021.49Table of Contents◦Research and development expense decreased $270.1 million, or 10.8%, from $2,501.2 million in 2021 to $2,231.1 million in 2022, primarily due to higher upfront payments in 2021. In 2021 we recorded approximately $285.0 million of upfront payments related to our collaborations with InnoCare, Ionis, Bio-Thera, Genentech, Capsigen Inc., and Ginkgo Bioworks, as compared to $28.5 million in 2022. In addition, $39.1 million of estimated clinical trial closeout costs and manufacturing commitments associated with BIIB111 (timrepigene emparvovec) and BIIB112 (cotoretigene toliparvovec) were recorded in 2021.◦Amortization and impairment of acquired intangible assets decreased $515.4 million, or 58.5%, from $881.3 million in 2021 to $365.9 million in 2022, primarily due to higher impairment charges recorded in 2021. In 2021 we recorded $629.3 million of impairment charges, as compared to $119.6 million in 2022.◦The decrease in cost and expense was also due to a pre-tax gain of $503.7 million recognized in 2022 related to the sale of one of our buildings.◦Other (income) expense, net for 2022 reflected a pre-tax gain of $1.5 billion related to the sale of our 49.9% equity interest in Samsung Bioepis, partially offset by a pre-tax charge of $900.0 million, plus settlement fees and expenses, related to a litigation settlement agreement to resolve a qui tam litigation relating to conduct prior to 2015. As described below under Financial Condition, Liquidity and Capital Resources:•We generated $1,384.3 million of net cash flow from operations for 2022.•Cash, cash equivalents and marketable securities totaled approximately $5,598.5 million as of December 31, 2022.•We repurchased and retired approximately 3.6 million shares of our common stock at a cost of approximately $750.0 million during 2022 under our 2020 Share Repurchase Program. Approximately $2.1 billion remained available under our 2020 Share Repurchase Program as of December 31, 2022.Developments in Key Collaborative RelationshipsFor additional information on our collaborative and other relationships discussed below, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Eisai Collaboration AgreementsLEQEMBI (lecanemab) Collaboration AgreementIn January 2023 we and Eisai announced that the FDA granted accelerated approval of LEQEMBI, an anti-amyloid antibody for the treatment of Alzheimer's disease. Additionally, in January 2023 we and Eisai announced the completed submission of a supplemental BLA to the FDA for traditional approval of LEQEMBI.In January 2023 the EMA accepted for review the MAA for lecanemab.In January 2023 Eisai completed the submission of a MAA to the PMDA in Japan for lecanemab, and was granted Priority Review by the Japanese Ministry of Health, Labor and Welfare.In December 2022 Eisai initiated a rolling submission of a BLA to the NMPA of China for the approval of lecanemab.In March 2022 we extended our supply agreement with Eisai related to LEQEMBI from five years to ten years for the manufacture of LEQEMBI drug substance.ADUHELM Collaboration AgreementOn March 14, 2022, we amended our ADUHELM Collaboration Agreement with Eisai. As of the amendment date, we have sole decision making and commercialization rights worldwide on ADUHELM, and beginning January 1, 2023, Eisai receives only a tiered royalty based on net sales of ADUHELM, and no longer participates in sharing ADUHELM's global profits and losses. Eisai's share of development, commercialization and manufacturing expense was limited to $335.0 million for the period from January 1, 2022 to December 31, 2022, which was achieved as of December 31, 2022. Once this limit was achieved, we became responsible for all ADUHELM related costs.For additional information on our collaboration arrangements with Eisai, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.50Table of ContentsZuranolone (BIIB125)In June 2022 we and our collaboration partner Sage announced that the Phase 3 SKYLARK study of zuranolone, for the potential treatment of MDD and PPD, met its primary and all key secondary endpoints.In December 2022 we and Sage completed the rolling submission of a NDA to the FDA for the approval of zuranolone for the potential treatment of MDD and PPD. This submission completes the NDA filing initiated earlier in 2022.In February 2023 the FDA accepted the NDA and granted Priority Review for zuranolone, with a PDUFA action date of August 5, 2023.For additional information on our collaboration arrangement with Sage, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.GenentechLUNSUMIO (mosunetuzumab)In January 2022 we exercised our option with Genentech to participate in the joint development and commercialization of LUNSUMIO (mosunetuzumab), a bispecific antibody for the treatment of relapsed or refractory follicular lymphoma. In connection with this exercise, we recorded a $30.0 million option exercise fee payable to Genentech in December 2021.In December 2022 Genentech announced that the FDA granted accelerated approval of LUNSUMIO, which was also approved by the EC in June 2022.GlofitamabIn December 2022 we reached an agreement with Genentech related to the commercialization and sharing of economics for glofitamab, an investigational T-cell engaging bispecific antibody targeting CD20 and CD3 for the potential treatment of B-cell non-Hodgkin's lymphoma.For additional information on our collaboration arrangements with Genentech, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Other Collaborative RelationshipsAlcyone TherapeuticsIn December 2022 we entered into a license and collaboration agreement with Alcyone to jointly develop the ThecaFlex DRx™ System, an implantable medical device intended for subcutaneous delivery of ASO therapies with a goal of improving the patient treatment experience and accessibility for people suffering from neurological disorders, such as SMA and ALS. Under the terms of this collaboration, we and Alcyone will jointly develop the ThecaFlex DRx™ System and Alcyone will be solely responsible for its manufacture and commercialization. In connection with this transaction, we made an upfront payment of $10.0 million to Alcyone.Other Key DevelopmentsTofersen (BIIB067)In July 2022 we announced that the FDA accepted the NDA and granted Priority Review for tofersen, an investigational antisense drug being evaluated for people with SOD1 ALS, which currently has a PDUFA action date of April 25, 2023. In December 2022 the EMA accepted for review the MAA for tofersen.BIIB800 (referencing ACTEMRA)In September 2022 we and our collaboration partner Bio-Thera announced that the EMA accepted for review the MAA for BIIB800, a proposed tocilizumab biosimilar referencing ACTEMRA, an anti-interleukin-6 receptor monoclonal antibody, for the treatment of severe, active and progressive rheumatoid arthritis. In December 2022 the FDA accepted for review the abbreviated BLA for BIIB800.BIIB122 (DNL151)In October 2022 we and our collaboration partner Denali announced the initiation of the Phase 3 LIGHTHOUSE study of BIIB122 for the potential treatment of Parkinson's disease.For additional information on our collaboration arrangement with Denali, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Corporate MattersSamsung Bioepis - Biogen's Joint Venture with Samsung BioLogicsIn April 2022 we completed the sale of our 49.9% equity interest in Samsung Bioepis to Samsung BioLogics. Under the terms of this transaction, we received approximately $1.0 billion in cash at closing and expect to receive approximately $1.3 billion in cash to be deferred over two payments of approximately $812.5 million due at the first anniversary and approximately $437.5 million due at the second anniversary of the closing of this transaction.As part of this transaction, we are also eligible to receive up to an additional $50.0 million upon the achievement of certain commercial milestones. Our policy for contingent payments of this nature is to recognize the payments in the period that they become realizable, which is generally the same period in which the payments are earned.51Table of ContentsFor additional information on the sale of our equity interest in Samsung Bioepis, please read Note 3, Dispositions, to our consolidated financial statements included in this report.2022 Cost Saving InitiativesIn December 2021 and May 2022 we announced our plans to implement a series of cost-reduction measures that when completed we expect may yield approximately $1.0 billion in expense savings. These savings are being achieved through a number of initiatives, including reductions to our workforce, the substantial elimination of our commercial ADUHELM infrastructure, the consolidation of certain real estate locations and operating efficiency gains across our selling, general and administrative and research and development functions.Under these initiatives, we estimate we will incur total restructuring charges of approximately $131.0 million, primarily related to severance. These amounts were substantially incurred during 2022. As of December 31, 2022, approximately $35.9 million remained in our restructuring reserve and payments are expected to be made through 2026.For additional information on our 2022 cost saving initiatives, please read Note 4, Restructuring, to our consolidated financial statements included in this report.Senior Note RedemptionIn July 2022 we redeemed our 3.625% Senior Notes totaling $1.0 billion in aggregate principal amount prior to their maturity on September 15, 2022.For additional information on the redemption of our Senior Notes, please read Note 13, Indebtedness, to our consolidated financial statements included in this report.125 Broadway Sale and Leaseback TransactionIn September 2022 we completed the sale of our building and land parcel located at 125 Broadway for an aggregate sales price of approximately $603.0 million, which is inclusive of a $10.8 million tenant allowance. Simultaneously, with the close of this transaction we leased back the building for a term of approximately 5.5 years.For additional information on our 125 Broadway sale and leaseback transaction, please read Note 11, Property, Plant and Equipment and Note 12, Leases, to our consolidated financial statements included in this report.RESULTS OF OPERATIONSRevenueRevenue is summarized as follows: For the Years Ended December 31,% Change$ Change 2022 vs.20212021vs.20202022 vs.20212021vs.2020(In millions, except percentages)202220212020Product revenue, net:United States$3,469.3 $3,805.7 $5,900.1 (8.8)%(35.5)%$(336.4)$(2,094.4)Rest of world4,518.5 5,041.2 4,792.1 (10.4)5.2 (522.7)249.1 Total product revenue, net7,987.8 8,846.9 10,692.2 (9.7)(17.3)(859.1)(1,845.3)Revenue from anti-CD20 therapeutic programs1,700.5 1,658.5 1,977.8 2.5 (16.1)42.0 (319.3)Other revenue485.1 476.3 774.6 1.8 (38.5)8.8 (298.3)Total revenue$10,173.4 $10,981.7 $13,444.6 (7.4)%(18.3)%$(808.3)$(2,462.9)52Table of ContentsProduct RevenueProduct revenue is summarized as follows: For the Years Ended December 31,% Change$ Change 2022 vs.20212021vs.20202022 vs.20212021vs.2020(In millions, except percentages)202220212020Multiple Sclerosis (MS):TECFIDERA$1,443.9 $1,951.9 $3,841.1 (26.0)%(49.2)%$(508.0)$(1,889.2)VUMERITY(1)553.4 410.4 64.3 34.8 538.3 143.0 346.1 Total Fumarate1,997.3 2,362.3 3,905.4 (15.5)(39.5)(365.0)(1,543.1)AVONEX973.5 1,208.7 1,491.9 (19.5)(19.0)(235.2)(283.2)PLEGRIDY331.9 357.4 385.6 (7.1)(7.3)(25.5)(28.2)Total Interferon1,305.4 1,566.1 1,877.5 (16.6)(16.6)(260.7)(311.4)TYSABRI2,030.9 2,063.1 1,946.1 (1.6)6.0 (32.2)117.0 FAMPYRA96.6 105.2 103.1 (8.2)2.0 (8.6)2.1 Subtotal: MS5,430.2 6,096.7 7,832.1 (10.9)(22.2)(666.5)(1,735.4)Spinal Muscular Atrophy:SPINRAZA1,793.5 1,905.1 2,052.1 (5.9)(7.2)(111.6)(147.0)Biosimilars:BENEPALI441.0 498.3 481.6 (11.5)3.5 (57.3)16.7 IMRALDI224.5 233.4 216.3 (3.8)7.9 (8.9)17.1 FLIXABI81.3 99.4 97.9 (18.2)1.5 (18.1)1.5 BYOOVIZ(2)4.3 — — nm— 4.3 — Subtotal: Biosimilars751.1 831.1 795.8 (9.6)4.4 (80.0)35.3 Other:FUMADERM8.2 11.0 12.2 (25.5)(9.8)(2.8)(1.2)ADUHELM4.8 3.0 — 60.0 nm1.8 3.0 Total product revenue, net$7,987.8 $8,846.9 $10,692.2 (9.7)%(17.3)%$(859.1)$(1,845.3)(1) VUMERITY became commercially available in the E.U. during the fourth quarter of 2021.(2) BYOOVIZ launched in the U.S. in June 2022 and became commercially available during the third quarter of 2022.nm Not meaningful53Table of ContentsMultiple Sclerosis (MS)FumarateFumarate revenue includes sales from TECFIDERA and VUMERITY. During the fourth quarter of 2021 VUMERITY was approved for the treatment of RRMS in the E.U., Switzerland and the U.K.For 2022 compared to 2021, the 13.8% decrease in U.S. Fumarate revenue was primarily due to a decrease in TECFIDERA demand as a result of multiple TECFIDERA generic entrants in the U.S. market, partially offset by net price increases in TECFIDERA driven by lower pharmacy rebates, managed care rebates and co-pay assistance as well as an increase in VUMERITY sales volumes.For 2022 compared to 2021, the 16.9% decrease in rest of world Fumarate revenue was primarily due to TECFIDERA pricing reductions and a decrease in TECFIDERA demand as multiple TECFIDERA generic entrants entered into markets such as Germany and Canada. The decrease was also driven by the unfavorable impact of foreign currency exchange, partially offset by an increase in VUMERITY sales volumes.In the E.U., we are seeking to enforce a patent granted in June 2022 that relates to TECFIDERA and expires in 2028. In addition, we are litigating to affirm that TECFIDERA is entitled to regulatory data and market protection until at least February 2024. Our Company, the EMA and the EC have each appealed the May 2021 decision of the European General Court, which annulled the EMA's decision not to validate an application for approval of a TECFIDERA generic on the basis that the EMA and EC conducted the wrong assessment when determining TECFIDERA's entitlement to regulatory data and marketing protection. Our Company, the EMA and the EC have each appealed the General Court’s decision as wrongly decided and the appeal is pending. On October 6, 2022, the Advocate General of the CJEU issued a nonbinding advisory opinion in Biogen's favor. This opinion recommends that the CJEU set aside the judgment of the European General Court. We are awaiting the decision of the CJEU.For additional information, please read Note 21, Litigation, to our consolidated financial statements included in this report.We expect that TECFIDERA revenue will continue to decline in 2023, compared to 2022, as a result of generic competition in the North America, Latin America and certain E.U. countries.We expect an increase in VUMERITY sales volumes in 2023, compared to 2022, mostly due to demand growth in the U.S. and select European markets. We believe that we have resolved previously reported manufacturing issues at our contract manufacturer. In addition, we are in the process of securing regulatory approval for a secondary source of supply. We do not anticipate a supply shortage in 2023 and are currently focused on rebuilding adequate inventory.54Table of ContentsInterferonFor 2022 compared to 2021, the 18.9% decrease in U.S. Interferon revenue was primarily due to a decrease in Interferon sales volumes of 15.5%. The net decline in sales volumes reflects the continued decline of the Interferon market as patients transition to higher efficacy and oral MS therapies.For 2022 compared to 2021, the 12.9% decrease in rest of world Interferon revenue was primarily due to a decrease in Interferon sales volumes of 6.0% resulting from the continued decline of the Interferon market as patients transition to higher efficacy and oral MS therapies, as well as the unfavorable impact of foreign currency exchange.We expect that Interferon revenue will continue to decline in both the U.S. and rest of world markets in 2023, compared to 2022, as a result of increasing competition from other MS products.TYSABRIFor 2022 compared to 2021, U.S. TYSABRI revenue was relatively flat, with a modest decrease in sales volumes, partially offset by an increase in pricing, net of higher discounts and allowances.For 2022 compared to 2021, rest of world TYSABRI revenue was relatively flat, with a modest decrease in pricing and the unfavorable impact of foreign currency exchange, partially offset by an increase in sales volumes.We anticipate TYSABRI revenue to be relatively flat on a global basis in 2023, compared to 2022, despite increasing competition from additional treatments for MS. We expect to continue to face price reductions in certain European markets. We are also aware of a potential biosimilar entrant of TYSABRI that may enter the U.S. and European markets as early as 2023.55Table of ContentsSpinal Muscular AtrophySPINRAZAFor 2022 compared to 2021, U.S. SPINRAZA revenue was relatively flat, with a modest increase in sales volumes of 3.7%, resulting from the timing of shipments, partially offset by higher discounts and allowances.For 2022 compared to 2021, the 9.4% decrease in rest of world SPINRAZA revenue was primarily due to country mix, the unfavorable impact of foreign currency exchange and the timing of shipments, partially offset by an increase in sales volumes. The increase in sales volumes reflects growth in certain Asian markets, partially offset by a decrease in sales volumes from increased competition in certain established markets, particularly Germany and Japan.Despite competition from a gene therapy product and an oral product, we anticipate SPINRAZA revenue to be relatively flat in 2023, compared to 2022. Moderate growth in the U.S. as well as continued access expansion in emerging markets is expected to offset increased competition and the impact of loading dose dynamics.For additional information on our collaboration arrangements with Ionis, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.BiosimilarsBENEPALI, IMRALDI, FLIXABI and BYOOVIZDuring the third quarter of 2021 BYOOVIZ, a ranibizumab biosimilar referencing LUCENTIS, was approved in the U.S., the E.U and the U.K. BYOOVIZ launched in the U.S. in June 2022 and became commercially available in July 2022 through major distributors in the U.S.For 2022 compared to 2021, the 9.6% decrease in biosimilar revenue was primarily due to unfavorable pricing and the unfavorable impact of foreign currency exchange, partially offset by an increase in sales volumes.We anticipate modest growth in revenue from our biosimilars business in 2023, compared to 2022, driven by the continued launch of BYOOVIZ in the U.S. and rest of world, offset in part by continued price reductions in certain markets.We are currently working with our contract manufacturer for IMRALDI to address facility regulatory inspection deficiencies at two filling locations, which could impact supply and have an adverse impact on 2023 IMRALDI sales, if not resolved. Manufacturing of BENEPALI also utilizes one of these facilities and therefore could have an adverse impact on 2023 BENEPALI sales. We are working with our existing secondary supplier for BENEPALI with the aim to secure additional capacity.56Table of ContentsFor additional information on our collaboration arrangements with Samsung Bioepis, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Revenue from Anti-CD20 Therapeutic ProgramsGenentech (Roche Group)Our share of RITUXAN, including RITUXAN HYCELA, and GAZYVA collaboration operating profits in the U.S., royalty revenue on sales of OCREVUS and other revenue from anti-CD20 therapeutic programs are summarized in the table below. For purposes of this discussion, we refer to RITUXAN and RITUXAN HYCELA collectively as RITUXAN.Biogen’s Share of Pre-tax Profits in the U.S. for RITUXAN and GAZYVAThe following table provides a summary of amounts comprising our share of pre-tax profits in the U.S. for RITUXAN and GAZYVA: For the Years Ended December 31,(In millions)202220212020Product revenue, net$1,729.2 $2,032.0 $3,334.1 Cost and expense253.6 291.8 433.0 Pre-tax profits in the U.S.$1,475.6 $1,740.2 $2,901.1 Biogen's share of pre-tax profits$547.0 $647.7 $1,080.2 For 2022 compared to 2021, the decrease in U.S. product revenue, net was primarily due to a decrease in sales volumes of RITUXAN in the U.S. of 28.4%, primarily due to the onset of competition from multiple biosimilar products.For 2022 compared to 2021, the decrease in collaboration costs and expense was primarily due to lower cost of sales, selling and marketing expense, distribution costs and other costs and expense related to RITUXAN.We are aware of several other anti-CD20 molecules, including biosimilar products, that have been approved and are competing with RITUXAN and GAZYVA in the oncology and other markets. Biosimilar products referencing RITUXAN have launched in the U.S and are being offered at lower prices. This competition has had a significant adverse impact on the pre-tax profits of our collaboration arrangements with Genentech, as the sales of RITUXAN have decreased substantially compared to prior periods. We expect that biosimilar competition will continue to increase as these products capture additional market share and that this will have a significant adverse impact on our co-promotion profits in the U.S. in future years.Royalty Revenue on Sales of OCREVUSFor 2022 compared to 2021, the increase in royalty revenue on sales of OCREVUS was primarily due to sales growth of OCREVUS in the U.S.OCREVUS royalty revenue is based on our estimates from third party and market research data of OCREVUS sales occurring during the corresponding period. Differences between actual and estimated royalty revenue will be adjusted for in the period in which they become known, which is generally expected to be the following quarter.Other Revenue from Anti-CD20 Therapeutic ProgramsOther revenue from anti-CD20 therapeutic programs consists of our share of pre-tax co-promotion profits from RITUXAN in Canada.In December 2022 the FDA approved LUNSUMIO, a bispecific antibody for the treatment of relapsed or refractory follicular lymphoma. Our share of pre-tax profits and losses on LUNSUMIO will be included as a component of revenue from anti-CD20 therapeutic programs in our consolidated statements of income. For the year ended December 31, 2022, LUNSUMIO revenue was immaterial.For additional information on our collaboration arrangements with Genentech, including information regarding the pre-tax profit-sharing formula and its impact on future revenue from anti-CD20 therapeutic programs, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.57Table of ContentsOther RevenueOther revenue consists of royalty revenue and contract manufacturing and other revenue and is summarized as follows:Royalty Revenue and Contract Manufacturing and Other RevenueContract Manufacturing and Other RevenueWe record contract manufacturing and other revenue primarily from amounts earned under contract manufacturing agreements.For 2022 compared to 2021, the decrease in contract manufacturing and other revenue was primarily due to lower contract manufacturing revenue related to the timing of batch releases.Royalty RevenueWe receive royalties from net sales on products related to patents that we have out-licensed, as well as royalty revenue on biosimilar products from our collaboration arrangements with Samsung Bioepis.For additional information on our collaborative arrangements with Samsung Bioepis, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Reserves for Discounts and AllowancesRevenue from product sales is recorded net of reserves established for applicable discounts and allowances, including those associated with the implementation of pricing actions in certain international markets where we operate.These reserves are based on estimates of the amounts earned or to be claimed on the related sales and are classified as reductions of accounts receivable (if the amount is payable to our customer) or a liability (if the amount is payable to a party other than our customer). These estimates reflect our historical experience, current contractual and statutory requirements, specific known market events and trends, industry data and forecasted customer buying and payment patterns. Actual amounts may ultimately differ from our estimates. If actual results vary, we adjust these estimates, which could have an effect on earnings in the period of adjustment. Reserves for discounts, contractual adjustments and returns that reduced gross product revenue are summarized as follows:58Table of ContentsFor the years ended December 31, 2022, 2021 and 2020, reserves for discounts and allowances as a percentage of gross product revenue were 30.1%, 28.6% and 27.1%, respectively.DiscountsDiscounts include trade term discounts and wholesaler incentives. For 2022 compared to 2021, the decrease in discounts was primarily due to a decrease in gross sales, driven by lower TECFIDERA sales, offset by higher purchase discounts for TYSABRI.Contractual AdjustmentsContractual adjustments primarily relate to Medicaid and managed care rebates in the U.S., pharmacy rebates, co-payment (copay) assistance, Veterans Administration, 340B discounts, specialty pharmacy program fees and other government rebates or applicable allowances. For 2022 compared to 2021, the decrease in contractual adjustments was primarily driven by lower TECFIDERA sales in the U.S., resulting in lower pharmacy rebates, Medicaid rebates and managed care rebates, as well as lower Medicaid rebates in the U.S. driven by a favorable change in estimates for VUMERITY.ReturnsProduct return reserves are established for returns made by wholesalers. In accordance with contractual terms, wholesalers are permitted to return product for reasons such as damaged or expired product. The majority of wholesaler returns are due to product expiration. Provisions for product returns are recognized in the period the related revenue is recognized, resulting in a reduction to product sales. For 2022 compared to 2021, return reserves were relatively consistent. For additional information on our revenue reserves, please read Note 5, Revenue, to our consolidated financial statements included in this report.Cost and ExpenseA summary of total cost and expense is as follows: For the Years Ended December 31,% Change$ Change 2022 vs.20212021vs.20202022 vs.20212021vs.2020(In millions, except percentages)202220212020Cost of sales, excluding amortization and impairment of acquired intangible assets$2,278.3 $2,109.7 $1,805.2 8.0 %16.9 %$168.6 $304.5 Research and development2,231.1 2,501.2 3,990.9 (10.8)(37.3)(270.1)(1,489.7)Selling, general and administrative2,403.6 2,674.3 2,504.5 (10.1)6.8 (270.7)169.8 Amortization and impairment of acquired intangible assets365.9 881.3 464.8 (58.5)89.6 (515.4)416.5 Collaboration profit (loss) sharing(7.4)7.2 232.9 (202.8)(96.9)(14.6)(225.7)(Gain) loss on divestiture of Hillerød, Denmark manufacturing operations— — (92.5)— nm— 92.5 (Gain) loss on fair value remeasurement of contingent consideration(209.1)(50.7)(86.3)312.4 (41.3)(158.4)35.6 Acquired in-process research and development— 18.0 75.0 (100.0)(76.0)(18.0)(57.0)Restructuring charges131.1 — — nm— 131.1 — Gain on sale of building(503.7)— — nm— (503.7)— Other (income) expense, net(108.2)1,095.5 (497.4)(109.9)(320.2)(1,203.7)1,592.9 Total cost and expense$6,581.6 $9,236.5 $8,397.1 (28.7)%10.0 %$(2,654.9)$839.4 nm Not meaningful59Table of ContentsCost of Sales, Excluding Amortization and Impairment of Acquired Intangible AssetsCost of sales, as a percentage of total revenue, were 22.4%, 19.2% and 13.4% for the years ended December 31, 2022, 2021 and 2020, respectively.Product Cost of SalesFor 2022 compared to 2021, the increase in product cost of sales was primarily due to higher charges in 2022 associated with the write-off of excess ADUHELM inventory and purchase commitments, higher gross idle capacity charges associated with our manufacturing facilities and increased product cost of sales driven by product mix.Inventory amounts written down as a result of excess, obsolescence or unmarketability totaled $336.2 million, $167.6 million and $26.6 million for the years ended December 31, 2022, 2021 and 2020, respectively.For the years ended December 31, 2022 and 2021, we recorded approximately $286.0 million and $170.0 million, respectively, of charges associated with the write-off of ADUHELM inventory and purchase commitments in excess of forecasted demand.For the years ended December 31, 2022 and 2021, we recorded approximately $119.0 million and $48.0 million, respectively, of aggregate gross idle capacity charges.We have also recognized approximately $197.0 million and $99.0 million related to Eisai's 45.0% share of inventory, idle capacity charges and contractual commitments, which was recorded in collaboration profit (loss) sharing within our consolidated statements of income for the years ended December 31, 2022 and 2021, respectively.For additional information on our collaboration arrangements with Eisai, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Royalty Cost of SalesFor 2022 compared to 2021, the decrease in royalty cost of sales was primarily due to lower royalties payable on lower sales of SPINRAZA, TYSABRI and AVONEX, partially offset by higher royalties payable on higher sales of VUMERITY.Research and Development60Table of ContentsWe support our drug discovery and development efforts through the commitment of significant resources to discovery, research and development programs and business development opportunities.A significant amount of our research and development costs consist of indirect costs incurred in support of overall research and development activities and non-specific programs, including activities that benefit multiple programs, such as management costs, as well as depreciation, information technology and facility-based expenses. These costs are considered other research and development costs in the table above and are not allocated to a specific program or stage.Research and development expense incurred in support of our marketed products includes costs associated with product lifecycle management activities including, if applicable, costs associated with the development of new indications for existing products. Late stage programs are programs in Phase 3 development or in registration stage. Early stage programs are programs in Phase 1 or Phase 2 development. Research and discovery represents costs incurred to support our discovery research and translational science efforts. Costs are reflected in the development stage based upon the program status when incurred. Therefore, the same program could be reflected in different development stages in the same year. For several of our programs, the research and development activities are part of our collaborative and other relationships. Our costs reflect our share of the total costs incurred.For 2022 compared to 2021, the decrease in research and development expense was primarily due to higher milestone payments in 2021, partially offset by the advancement of BIIB059 (anti-BDCA2) for the potential treatment of SLE and CLE, the development of LUNSUMIO, a a bispecific antibody for the treatment of relapsed or refractory follicular lymphoma, the development of BIIB124 (SAGE-324) for the potential treatment of essential tremor, which we are developing in collaboration with Sage, the development of BIIB122 (DNL151) for the potential treatment of Parkinson's disease, which we are developing in collaboration with Denali, and the development of BIIB800, a proposed tocilizumab biosimilar referencing ACTEMRA.Excluding upfront payments, we expect our core research and development expense to modestly increase in 2023, as we continue to invest in our pipeline. We intend to continue committing significant resources to targeted research and development opportunities where there is a significant unmet need and where a drug candidate has the potential to be highly differentiated.Milestone and Upfront ExpenseResearch and development expense for 2022 includes:•$37.0 million in charges to research and development expense in connection with milestone payments to Ionis;•$15.0 million charge to research and development expense in connection with the upfront payment associated with entering into our collaboration with Alectos in the second quarter of 2022; and•$10.0 million charge to research and development expense in connection with the upfront payment associated with entering into 61Table of Contentsour collaboration with Alcyone in the fourth quarter of 2022.Research and development expense for 2021 includes:•$125.0 million charge to research and development expense in connection with the upfront payment associated with entering into our collaboration with InnoCare in the third quarter of 2021;•$60.0 million charge to research and development expense upon the exercise of our option under our collaboration agreement with Ionis to develop and commercialize BIIB115, an investigational ASO in development for SMA;•$30.0 million charge to research and development expense related to the option exercise fee payable to Genentech to jointly develop and commercialize LUNSUMIO; and•$30.0 million charge to research and development expense in connection with the upfront payment associated with entering into a commercialization and license agreement with Bio-Thera to develop, manufacture and commercialize BIIB800.The upfront payments associated with these collaborations are classified as research and development expense as the programs they relate to had not achieved regulatory approval as of the payment date.For additional information about these collaboration arrangements, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Early Stage ProgramsFor 2022 compared to 2021, the decrease in spending related to our early stage programs was primarily due to a decrease in costs associated with:•the discontinuation of cinpanemab (BIIB054) in Parkinson's disease;•the discontinuation of gosuranemab (BIIB092) in Alzheimer's disease;•the discontinuation of cotoretigene toliparvovec (BIIB112) in X-linked retinitis pigmentosa;•the advancement of litifilimab (BIIB059) for the potential treatment of SLE into late stage;•the advancement of BIIB122 for the potential treatment of Parkinson's disease into late stage;•the discontinuation of vixotrigine (BIIB074) in TGN and DPN; and•the discontinuation of BIIB078 for the potential treatment of Alzheimer's disease.The decrease was partially offset by an increase in costs associated with:•an increase in spending in the development of BIIB124 for the potential treatment of essential tremor;•an increase in spending in the development of litifilimab (BIIB059) for the potential treatment of CLE;•an increase in spending in the development of BIIB113 for the potential treatment of Alzheimer's disease;•an increase in spending in the development of BIIB131 for the potential treatment of acute ischemic stroke; and•an increase in spending in the development of BIIB121 for the potential treatment of Angelman syndrome.Late Stage ProgramsFor 2022 compared to 2021, the decrease in spending associated with our late stage programs was primarily due to a decrease in costs associated with:•the advancement of ADUHELM from late stage to marketed upon the accelerated approval of ADUHELM in the U.S.; and•the discontinuation of BIIB111 in choroideremia.The decrease was partially offset by an increase in costs associated with:•the advancement of litifilimab (BIIB059) for the potential treatment of SLE into late stage;•the advancement of BIIB122 for the potential treatment of Parkinson's disease into late stage; and•the advancement of BIIB800, a proposed tocilizumab biosimilar referencing ACTEMRA, into late stage.Marketed ProgramsFor 2022 compared to 2021, the increase in spending associated with our marketed programs was primarily due to an increase in costs associated with:•the advancement of ADUHELM from late stage to marketed upon the accelerated approval of ADUHELM in the U.S.; and•the advancement of LUNSUMIO from late stage to marketed upon the accelerated approval of LUNSUMIO in the U.S.62Table of ContentsOther Research and DevelopmentIn March 2019 Eisai initiated a global Phase 3 trial for the development of LEQEMBI in early Alzheimer's disease. Under our collaboration arrangement, Eisai serves as the lead of LEQEMBI development and regulatory submissions globally with both companies co-commercializing and co-promoting the product, and Eisai having final decision-making authority. All costs, including research, development, sales and marketing expense, are shared equally between us and Eisai. In January 2023 the FDA granted accelerated approval of LEQEMBI. Additionally, in January 2023 Eisai completed the submission of a supplemental BLA to the FDA for approval under the traditional pathway for LEQEMBI.As of December 31, 2022, we had approximately $89.8 million of work-in-process inventory related to LEQEMBI.For additional information on our collaboration arrangements with Eisai, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Selling, General and AdministrativeFor 2022 compared to 2021, the decrease in selling, general and administrative expense was primarily due to cost-reduction measures realized during 2022.As a result of the final NCD we have substantially eliminated our commercial infrastructure supporting ADUHELM, retaining minimal resources to manage patient access programs, including a continued free drug program for patients currently on treatment in the U.S.Beginning in the second quarter of 2021 reimbursement from Eisai for its share of U.S. ADUHELM selling, general and administrative expense is recognized in collaboration profit (loss) sharing in our consolidated statements of income.We expect selling, general and administrative costs to continue to decline in 2023 due to the implementation of our cost saving initiatives during 2022, which include the substantial elimination of our commercial infrastructure supporting ADUHELM as well as other cost-reduction measures.Amortization and Impairment of Acquired Intangible AssetsOur amortization expense is based on the economic consumption and impairment of intangible assets. Our most significant amortizable intangible assets are related to our TYSABRI, AVONEX, SPINRAZA, VUMERITY and TECFIDERA (rest of world) products and other programs acquired through business combinations.For 2022 compared to 2021, the decrease in amortization and impairment of acquired intangible assets was primarily due to higher impairment charges in 2021 of approximately $629.3 million, compared to impairment charges of approximately $119.6 million in 2022.For the year ended December 31, 2022, amortization and impairment of acquired intangible assets reflects the impact of a $119.6 million impairment charge related to vixotrigine for the potential treatment of DPN.For the year ended December 31, 2021, amortization and impairment of acquired intangible assets reflects the impact of a $365.0 million impairment charge related to BIIB111, a $220.0 million impairment charge related to BIIB112 and a $44.3 million impairment charge related to vixotrigine for the potential treatment of TGN.63Table of ContentsAmortization of acquired intangible assets, excluding impairment charges, totaled $246.3 million, $252.0 million and $255.1 million for the years ended December 31, 2022, 2021 and 2020, respectively.We monitor events and expectations regarding product performance. If new information indicates that the assumptions underlying our most recent analysis are substantially different than those utilized in our current estimates, our analysis would be updated and may result in a significant change in the anticipated lifetime revenue of the relevant products. The occurrence of an adverse event could substantially increase the amount of amortization expense related to our acquired intangible assets as compared to previous periods or our current expectations, which may result in a significant negative impact on our future results of operations.IPR&D Related to Business CombinationsIPR&D represents the fair value assigned to research and development assets that we acquired as part of a business combination and had not yet reached technological feasibility at the date of acquisition. We review amounts capitalized as acquired IPR&D for impairment annually, as of October 31, and whenever events or changes in circumstances indicate to us that the carrying value of the assets might not be recoverable.Overall, the value of our acquired IPR&D assets is dependent upon several variables, including estimates of future revenue and the effects of competition, our ability to secure sufficient pricing in a competitive market, our ability to confirm safety and efficacy based on data from clinical trials and regulatory feedback, the level of anticipated development costs and the probability and timing of successfully advancing a particular research program from one clinical trial phase to the next. We are continually reevaluating our estimates concerning these and other variables, including our life cycle management strategies, research and development priorities and development risk, changes in program and portfolio economics and related impact of foreign currency exchange rates and economic trends and evaluating industry and company data regarding the productivity of clinical research and the development process. Changes in our estimates may result in a significant change to our valuation of our IPR&D assets.VixotrigineIn the periods following our acquisition of vixotrigine, there were numerous delays in the initiation of Phase 3 studies for the potential treatment of TGN and for the potential treatment of DPN, another form of neuropathic pain. We engaged with the FDA regarding the design of the potential Phase 3 studies of vixotrigine for the potential treatment of TGN and DPN and performed an additional clinical trial of vixotrigine, which was completed during 2022.The performance of this additional clinical trial delayed the initiation of the Phase 3 studies of vixotrigine for the potential treatment of TGN, and, as a result, we recognized an impairment charge of $44.3 million related to vixotrigine for the potential treatment of TGN during the first quarter of 2021.During the fourth quarter of 2022 we discontinued further development of vixotrigine based on regulatory, development and commercialization challenges. For the year ended December 31, 2022, we recognized an impairment charge of approximately $119.6 million related to vixotrigine for the potential treatment of DPN, reducing the remaining book value of this IPR&D intangible asset to zero. We also adjusted the value of our contingent consideration obligations related to this asset resulting in a pre-tax gain of approximately $209.1 million, which was recognized in (gain) loss on fair value remeasurement of contingent consideration within our consolidated statements of income.BIIB111 and BIIB112During the second quarter of 2021 we announced that our Phase 3 STAR study of BIIB111 and our Phase 2/3 XIRIUS study of BIIB112 did not meet their primary endpoints. In the third quarter of 2021 we suspended further development on these programs based on the decision by management as part of its strategic review process. For the year ended December 31, 2021, we recognized an impairment charge of $365.0 million related to BIIB111 and an impairment charge of $220.0 million related to BIIB112, reducing the remaining book values of these IPR&D intangible assets to zero.In addition, as a result of our decision to suspend further development of BIIB111 and BIIB112, we recorded charges of approximately $39.1 million during the third quarter of 2021 related to our manufacturing arrangements and other costs that we expect to incur as a result of suspending these programs. These charges were recognized in research and development expense in our consolidated statements of income for the year ended December 31, 2021.64Table of ContentsFor additional information on the amortization and impairment of our acquired intangible assets, please read Note 7, Intangible Assets and Goodwill, to our consolidated financial statements included in this report.Collaboration Profit (Loss) SharingCollaboration profit (loss) sharing primarily includes Samsung Bioepis' 50.0% share of the profit or loss related to our biosimilars 2013 commercial agreement with Samsung Bioepis and, beginning in the second quarter of 2021, Eisai's 45.0% share of income and expense in the U.S. related to the ADUHELM Collaboration Agreement. Beginning January 1, 2023, Eisai receives only a tiered royalty based on net sales of ADUHELM, and will no longer share global profits and losses.For the years ended December 31, 2022 and 2021, we recognized net profit-sharing expense of $217.4 million and $285.4 million, respectively, to reflect Samsung Bioepis’ 50.0% sharing of the net collaboration profits.For the years ended December 31, 2022 and 2021 we recognized net reductions to our operating expense of approximately $224.7 million and $233.2 million, respectively, to reflect Eisai's 45.0% share of net collaboration losses in the U.S.For the year ended December 31, 2021, we also recognized net reductions to our operating expense of $45.0 million to reflect Eisai's 45.0% share of the $100.0 million milestone payment made to Neurimmune related to the launch of ADUHELM in the U.S. during the second quarter of 2021.For additional information on our collaboration arrangements with Samsung Bioepis and Eisai, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.(Gain) Loss on Fair Value Remeasurement of Contingent ConsiderationFor the year ended December 31, 2022, the changes in fair value of our contingent consideration obligations were primarily due to the discontinuation of further development efforts related to vixotrigine for the potential treatment of TGN and DPN, resulting in a reduction of our contingent consideration obligations of approximately $195.4 million, and changes in the interest rates used to revalue our contingent consideration liabilities.For the year ended December 31, 2021, the changes in fair value of our contingent consideration obligations were primarily due to reductions in the probability of technical and regulatory success and delays in the expected timing of the achievement of certain remaining developmental milestones related to our vixotrigine programs.For additional information on our IPR&D intangible assets, please read Note 7, Intangible Assets and Goodwill, to our consolidated financial statements included in this report.65Table of ContentsRestructuring Charges2022 Cost Saving InitiativesIn December 2021 and May 2022 we announced our plans to implement a series of cost-reduction measures that when completed we expect may yield approximately $1.0 billion in expense savings. These savings are being achieved through a number of initiatives, including reductions to our workforce, the substantial elimination of our commercial ADUHELM infrastructure, the consolidation of certain real estate locations and operating efficiency gains across our selling, general and administrative and research and development functions.Under these initiatives, we estimate we will incur total restructuring charges of approximately $131.0 million, primarily related to severance. These amounts were substantially incurred during 2022. As of December 31, 2022, approximately $35.9 million remained in our restructuring reserve and payments are expected to be made through 2026.For the year ended December 31, 2022, we recognized approximately $131.1 million of net pre-tax restructuring charges related to our 2022 cost saving initiatives, of which approximately $112.6 million consisted of employee severance costs. Our restructuring reserve is included in accrued expense and other in our consolidated balance sheets.In September 2022 we entered into an agreement to partially terminate a portion of our lease located at 300 Binney Street, as well as to reduce the lease term for the majority of the remaining space. This resulted in a gain of approximately $5.3 million, which was recorded within restructuring charges in our consolidated statements of income for the year ended December 31, 2022. For additional information on our 300 Binney Street lease modification, please read Note 12, Leases, to these consolidated financial statements included in this report.Following an evaluation of our current capacity needs, in March 2022 we ceased using a patient services office space in Durham, NC. Our decision to cease use of the facility resulted in the immediate expense of certain leasehold improvements and other assets at this facility. As a result, we recognized approximately $10.4 million of accelerated depreciation expense, which was recorded in restructuring charges in our consolidated statements of income for the year ended December 31, 2022. In May 2022 we entered into a lease assignment agreement whereby we assigned our remaining lease obligations to an external third party. As a result of the lease assignment, we derecognized the related operating lease obligation and right-of-use asset during the second quarter of 2022.For the year ended December 31, 2022, we recognized other restructuring costs of approximately $13.2 million, which were recorded in restructuring charges in our consolidated statements of income. Other restructuring costs include items such as facility closure costs, employee non-severance expense, asset write-offs and other costs.The following table summarizes the charges and spending related to our 2022 workforce reductions for the year ended December 31, 2022:(In millions)TotalRestructuring reserve, December 31, 2021$— Expense112.6 Payment(78.0)Foreign currency and other adjustments1.3 Restructuring reserve, December 31, 2022$35.9 66Table of ContentsGain on Sale of BuildingIn September 2022 we completed the sale of our building and land parcel located at 125 Broadway for an aggregate sales price of approximately $603.0 million, which is inclusive of a $10.8 million tenant allowance. This sale resulted in a pre-tax gain on sale of approximately $503.7 million, net of transaction costs, for the year ended December 31, 2022.Simultaneously, with the close of this transaction we leased back the building for a term of approximately 5.5 years, which resulted in the recognition of approximately $168.2 million in new lease liabilities and right-of-use assets recorded within our consolidated balance sheets as of December 31, 2022. The sale and immediate leaseback of this building qualified for sale and leaseback treatment and is classified as an operating lease.For additional information on our 125 Broadway sale and leaseback transaction, please read Note 11, Property, Plant and Equipment and Note 12, Leases, to our consolidated financial statements included in this report.Other (Income) Expense, NetFor 2022 compared to 2021, the change in other (income) expense, net primarily reflects a pre-tax gain during 2022 of approximately $1.5 billion related to the sale of our 49.9% equity interest in Samsung Bioepis, partially offset by a pre-tax charge of $900.0 million, plus settlement fees and expenses, related to a litigation settlement agreement to resolve a qui tam litigation relating to conduct prior to 2015.For the year ended December 31, 2022, net unrealized losses and realized (gains) losses on our holdings in equity securities were approximately $264.7 million and zero, respectively, compared to net unrealized losses and realized gains of $831.4 million and $10.3 million, respectively, in 2021.The net unrealized losses recognized during the year ended December 31, 2022, primarily reflect a decrease in the aggregate fair value of our investments in Denali and Sangamo common stock of approximately $278.0 million.The net unrealized losses recognized during the year ended December 31, 2021, primarily reflect decreases in the aggregate fair value of our investments in Denali, Sage, Sangamo and Ionis common stock of approximately $819.6 million.For the year ended December 31, 2022, net interest expense was $157.3 million, compared to $242.6 million in 2021. This decrease was primarily due to higher interest income earned on our investments in 2022, compared to 2021, and lower interest expense in 2022 due to the redemption of our 3.625% Senior Notes due September 15, 2022, with an aggregate principal amount of $1.0 billion.For 2023 compared to 2022, we anticipate a decrease in net interest expense as a result of lower average debt balances in 2023 and an increase in 67Table of Contentsinterest income driven by higher interest rates on our cash and marketable securities.For additional information on the sale of our equity interest in Samsung Bioepis, please read Note 3, Dispositions, to our consolidated financial statements included in this report.For additional information on the redemption of our Senior Notes, please read Note 13, Indebtedness, to our consolidated financial statements included in this report.For additional information on the litigation settlement agreement, please read Note 18, Other Consolidated Financial Statement Detail, to our consolidated financial statements included in this report.Income Tax ProvisionOur effective tax rate fluctuates from year to year due to the global nature of our operations. The factors that most significantly impact our effective tax rate include changes in tax laws, variability in the allocation of our taxable earnings among multiple jurisdictions, the amount and characterization of our research and development expense, the levels of certain deductions and credits, acquisitions and licensing transactions.For the year ended December 31, 2022, compared to 2021, the increase in our effective tax rate, excluding the impact of the net Neurimmune deferred tax asset, as discussed below, includes the tax impacts of the litigation settlement agreement and the sale of our building at 125 Broadway. These increases were partially offset by the impact of the current year tax benefits related to an international reorganization to align with global tax developments, the impacts of the sale of our equity interest in Samsung Bioepis and the tax impacts of the decision to discontinue development of vixotrigine. Further in 2021, our effective tax rate benefited from the tax effects of the BIIB111 and BIIB112 impairment charges and the non-cash tax effects of changes in the value of our equity instruments.For additional information on the litigation settlement agreement, please read Note 18, Other Consolidated Financial Statement Detail, to our consolidated financial statements included in this report.Neurimmune Deferred Tax AssetDuring 2021 we recorded a net deferred tax asset in Switzerland of approximately $100.0 million on Neurimmune's tax basis in ADUHELM, the realization of which was dependent on future sales of ADUHELM. During the first quarter of 2022, upon issuance of the final NCD related to ADUHELM, we recorded an increase in a valuation allowance of approximately $85.0 million to reduce the net value of this deferred tax asset to zero.These adjustments to our net deferred tax asset are each recorded with an equal and offsetting amount assigned to net income (loss) attributable to noncontrolling interests, net of tax in our consolidated statements of income, resulting in a zero net impact to net income attributable to Biogen Inc.For additional information on our collaboration arrangement with Neurimmune, please read Note 20, Investments in Variable Interest Entities, to our consolidated financial statements included in this report.Inflation Reduction ActIn August 2022 the IRA was signed into law in the U.S. The IRA introduced new tax provisions, including a 15.0% corporate alternative minimum tax and a 1.0% excise tax on stock repurchases. The provisions of the IRA will be effective for periods after December 31, 2022. The enactment of the IRA did not result in any material adjustments to our income 68Table of Contentstax provision or net deferred tax assets as of December 31, 2022.For additional information on our income taxes, uncertain tax positions and income tax rate reconciliation, please read Note 17, Income Taxes, to our consolidated financial statements included in this report.Equity in (Income) Loss of Investee, Net of TaxIn February 2012 we entered into a joint venture agreement with Samsung BioLogics establishing an entity, Samsung Bioepis, to develop, manufacture and market biosimilar products.In April 2022 we completed the sale of our 49.9% equity interest in Samsung Bioepis to Samsung BioLogics. Following the sale of Samsung Bioepis we no longer recognize gains or losses associated with Samsung Bioepis' results of operations and amortization related to basis differences.Prior to this sale, we recognized our share of the results of operations related to our investment in Samsung Bioepis under the equity method of accounting one quarter in arrears when the results of the entity became available, which was reflected as equity in (income) loss of investee, net of tax in our consolidated statements of income. We also recognized amortization on certain basis differences resulting from our November 2018 investment. For the year ended December 31, 2022, we recognized net income on our investment of $2.6 million, reflecting our share of Samsung Bioepis' operating profits, net of tax, totaling $17.0 million offset by amortization of basis differences totaling $14.4 million. This amount reflects our share of results prior to the sale of Samsung Bioepis as the results are recognized one quarter in arrears.For the year ended December 31, 2021, we recognized net income on our investment of $34.9 million, reflecting our share of Samsung Bioepis' operating profits, net of tax, totaling $64.6 million offset by amortization of basis differences totaling $29.7 million.Net income on our investment for the year ended December 31, 2021, reflects a $31.2 million benefit related to the release of a valuation allowance on deferred tax assets associated with Samsung Bioepis. The valuation allowance was released in the second quarter of 2021 based on a consideration of the positive and negative evidence, including the historic earnings of Samsung Bioepis.For additional information on the sale of our equity interest in Samsung Bioepis, please read Note 3, Dispositions, to our consolidated financial statements included in this report.For additional information on our collaboration arrangements with Samsung Bioepis, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Noncontrolling Interests, Net of TaxOur consolidated financial statements include the financial results of our variable interest entity, Neurimmune, as we determined that we are the primary beneficiary.For 2022 compared to 2021, the change in net income (loss) attributable to noncontrolling interests, net of tax, was primarily due to a deferred tax benefit and milestone payment recorded in 2021, as discussed below.69Table of ContentsDuring 2021 we recorded a net deferred tax asset in Switzerland of approximately $100.0 million on Neurimmune's tax basis in ADUHELM, the realization of which was dependent on future sales of ADUHELM.During the first quarter of 2022, upon issuance of the final NCD related to ADUHELM, we recorded an increase in a valuation allowance of approximately $85.0 million to reduce the net value of this deferred tax asset to zero. These adjustments to our net deferred tax asset are each recorded with an equal and offsetting amount assigned to net income (loss) attributable to noncontrolling interests, net of tax in our consolidated statements of income, resulting in a zero net impact to net income attributable to Biogen Inc.For 2021 the change in net income (loss) attributable to noncontrolling interests, net of tax, was also due to the $100.0 million milestone payment to Neurimmune related to the launch of ADUHELM in the U.S. during 2021.For additional information on our collaboration agreement with Neurimmune, please read Note 20, Investments in Variable Interest Entities, to our consolidated financial statements included in this report.For additional information on our income taxes please read Note 17, Income Taxes, to our consolidated financial statements included in this report.70Table of ContentsFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCESOur financial condition is summarized as follows: As of December 31, (In millions, except percentages)20222021% Change$ ChangeFinancial assets:Cash and cash equivalents$3,419.3 $2,261.4 51.2 %$1,157.9 Marketable securities — current1,473.5 1,541.1 (4.4)(67.6)Marketable securities — non-current705.7 892.0 (20.9)(186.3)Total cash, cash equivalents and marketable securities$5,598.5 $4,694.5 19.3 %$904.0 Borrowings:Current portion of notes payable$— $999.1 nm$(999.1)Notes payable6,281.0 6,274.0 0.1 7.0 Total borrowings$6,281.0 $7,273.1 (13.6)%$(992.1)Working Capital:Current assets$9,791.2 $7,856.5 24.6 %$1,934.7 Current liabilities(3,272.8)(4,298.2)(23.9)1,025.4 Total working capital$6,518.4 $3,558.3 83.2 %$2,960.1 nm Not meaningfulOverviewWe have historically financed and expect to continue to fund our operating and capital expenditures primarily through cash flow earned through our operations as well as our existing cash resources. We believe generic competition for TECFIDERA in the U.S. and other key markets and the impact of biosimilar competition on RITUXAN sales volumes will continue to reduce our cash flow from operations in 2023 and will have a significant adverse impact on our future cash flow from operations.For the year ended December 31, 2022, certain significant cash flows were as follows:•$1,384.3 million in net cash flow provided by operating activities;•$990.3 million in net proceeds received from the sale of our equity interest in Samsung Bioepis;•$582.6 million in net proceeds received from the sale of one of our buildings;•$1.0 billion payment made for the redemption of our 3.625% Senior Notes due September 15, 2022;•$917.0 million in total net payments for a litigation settlement agreement and settlement fees and expenses;•$932.9 million in total net payments for income taxes; •$750.0 million used for share repurchases; and•$240.3 million used for purchases of property, plant and equipment.For the year ended December 31, 2021, certain significant cash flows were as follows:•$3,639.9 million in net cash flow provided by operating activities;•$1.8 billion used for share repurchases;•$170.0 million used in connection with our private offer to exchange (Exchange Offer) our tendered 5.200% Senior Notes due September 15, 2045 (2045 Senior Notes) for a new series of 3.250% Senior Notes due February 15, 2051 (2051 Senior Notes) and cash, and an offer to purchase our tendered 2045 Senior Notes for cash;•$258.1 million used for purchases of property, plant and equipment;•$247.9 million in total net payments for income taxes; and•$100.0 million milestone payment to Neurimmune.We believe that our existing funds, when combined with cash generated from operations and our access to additional financing resources, if needed, are sufficient to satisfy our operating, working capital, strategic alliance, milestone payment, capital expenditure and debt service requirements for the foreseeable future. In addition, we may choose to opportunistically return cash to shareholders and pursue other business initiatives, including acquisition and licensing activities. We may, from time to time, also seek additional funding through a combination of new collaborative agreements, strategic alliances and additional equity and debt financings or from other 71Table of Contentssources should we identify a significant new opportunity.For additional information on the litigation settlement agreement, please read Note 18, Other Consolidated Financial Statement Detail, to our consolidated financial statements included in this report.For additional information on certain risks that could negatively impact our financial position or future results of operations, please read Item 1A. Risk Factors and Item 7A. Quantitative and Qualitative Disclosures About Market Risk included in this report.Cash, Cash Equivalents and Marketable SecuritiesUntil required for another use in our business, we typically invest our cash reserves in bank deposits, certificates of deposit, commercial paper, corporate notes, U.S. and foreign government instruments, overnight reverse repurchase agreements and other interest-bearing marketable debt instruments in accordance with our investment policy. It is our policy to mitigate credit risk in our cash reserves and marketable securities by maintaining a well-diversified portfolio that limits the amount of exposure as to institution, maturity and investment type. As of December 31, 2022, we had cash, cash equivalents and marketable securities totaling approximately $5.6 billion compared to approximately $4.7 billion as of December 31, 2021. The change in cash, cash equivalents and marketable securities at December 31, 2022, from December 31, 2021, was primarily due to net cash flow provided by operating activities, which includes $917.0 million in total net payments for a litigation settlement agreement and settlement fees and expenses, and $990.3 million in net proceeds received from the sale of our equity interest in Samsung Bioepis and $582.6 million in net proceeds received from the sale of one of our buildings, partially offset by $1.0 billion of cash used for the redemption of our 3.625% Senior Notes due September 15, 2022 and $750.0 million used for share repurchases.The following table summarizes the fair value of our significant common stock investments:As of December 31, (In millions)20222021Denali$370.2 $550.7 Sage238.0 231.9 Sangamo74.3 173.7 Ionis108.6 87.5 $791.1 $1,043.8 Although the contractual holding period restrictions on our investments in Denali, Sage, Sangamo and Ionis have expired, our ability to liquidate these investments may be limited by the size of our interest, the volume of market related activity, our concentrated level of ownership and potential restrictions resulting from our status as a collaborator. Therefore, we may realize significantly less than the current value of such investments. For additional information on our collaboration arrangements, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Investments and Other AssetsInvestments and other assets in our consolidated balance sheet as of December 31, 2021, includes the carrying value of our investment in Samsung Bioepis of $599.9 million. In April 2022 we completed the sale of our 49.9% equity interest in Samsung Bioepis to Samsung BioLogics. Under the terms of this transaction, we received approximately $1.0 billion in cash at closing and expect to receive approximately $1.3 billion in cash to be deferred over two payments of approximately $812.5 million due at the first anniversary and approximately $437.5 million due at the second anniversary of the closing of this transaction.As part of this transaction, we are also eligible to receive up to an additional $50.0 million upon the achievement of certain commercial milestones. If any payments due to us remain outstanding after the second anniversary of the closing of this transaction, we may elect to receive shares of Samsung BioLogics common stock at a 5.0% discount in lieu of a cash payment for the remaining amount due. Currently, we believe that the likelihood of Samsung BioLogics failing to make timely payments to us for the amounts due is remote.For additional information on the sale of our equity interest in Samsung Bioepis, please read Note 3, Dispositions, to our consolidated financial statements included in this report.Capital ExpendituresIn March 2021 we announced our plans to build a new gene therapy manufacturing facility in RTP, NC to support our gene therapy pipeline across multiple therapeutic areas. The new manufacturing facility will be approximately 197,000 square feet and is expected to be operational by the end of 2023, with an estimated total investment of approximately $195.0 million. Construction for this new facility began during the fourth quarter of 2021.72Table of ContentsBorrowingsIn February 2021 we completed our Exchange Offer, consisting of the following:•$624.6 million aggregate principal amount of our 2045 Senior Notes was exchanged for $700.7 million aggregate principal amount of our 2051 Senior Notes and approximately $151.8 million of aggregate cash payments; and•$8.9 million aggregate principal amount of our 2045 Senior Notes was redeemed for approximately $12.1 million of aggregate cash payments, excluding accrued and unpaid interest.The following is a summary of our currently outstanding senior unsecured notes issued in 2020 (2020 Senior Notes):•$1.5 billion aggregate principal amount of 2.25% Senior Notes due May 1, 2030; and•$1.5 billion aggregate principal amount of 3.15% Senior Notes due May 1, 2050.The following is a summary of our currently outstanding senior unsecured notes issued in 2015 (2015 Senior Notes):•$1.75 billion aggregate principal amount of 4.05% Senior Notes due September 15, 2025; and•$1.12 billion aggregate principal amount of 5.20% Senior Notes due September 15, 2045.Our 2020 Senior Notes and our 2015 Senior Notes were issued at a discount, which are amortized as additional interest expense over the period from issuance through maturity. In July 2022 we redeemed our 3.625% Senior Notes due September 15, 2022, with an aggregate principal amount of $1.0 billion.For additional information on our Senior Notes, please read Note 13, Indebtedness, to our consolidated financial statements included in this report.For a summary of the fair values of our outstanding borrowings as of December 31, 2022 and 2021, please read Note 8, Fair Value Measurements, to our consolidated financial statements included in this report.Credit FacilityIn January 2020 we entered into a $1.0 billion, five-year senior unsecured revolving credit facility under which we are permitted to draw funds for working capital and general corporate purposes. The terms of the revolving credit facility include a financial covenant that requires us not to exceed a maximum consolidated leverage ratio.As of December 31, 2022 and 2021, we had no outstanding borrowings and were in compliance with all covenants under this facility.Working CapitalWorking capital is defined as current assets less current liabilities. Working capital was $6.5 billion and $3.6 billion as of December 31, 2022 and 2021, respectively. The change in working capital reflects an increase in total current assets of approximately $1.9 billion and a decrease in total current liabilities of approximately $1.0 billion. Current AssetsThe increase in total current assets was primarily driven by the following:•net increase in cash, cash equivalents and marketable securities due to net cash flow provided by operating activities of approximately $1,384.3 million;•receipt of approximately $990.3 million in cash, net of expenses, from the sale of our equity interest in Samsung Bioepis;•recording of a receivable from Samsung BioLogics for approximately $798.8 million as part of the sale of our equity interest in Samsung Bioepis; and•cash receipt of approximately $582.6 million related to the sale of one of our buildings.The increase was partially offset by cash used for the redemption of our 3.625% Senior Notes due September 15, 2022, of approximately $1.0 billion and share repurchases of $750.0 million and $917.0 million in total net payments for a litigation settlement agreement and settlement fees and expenses.Current LiabilitiesThe decrease in total current liabilities was primarily due to the following:•redemption of our 3.625% Senior Notes due September 15, 2022, of approximately $1.0 billion, which were classified within current liabilities in 2021; and•a reduction in our accounts payable.Share Repurchase ProgramsIn October 2020 our Board of Directors authorized our 2020 Share Repurchase Program, which is a program to repurchase up to $5.0 billion of our common stock. Our 2020 Share Repurchase Program does not have an expiration date. All share repurchases under our 2020 Share Repurchase 73Table of ContentsProgram will be retired. Under our 2020 Share Repurchase Program, we repurchased and retired approximately 3.6 million, 6.0 million and 1.6 million shares of our common stock at a cost of approximately $750.0 million, $1.8 billion and $400.0 million during the years ended December 31, 2022, 2021 and 2020, respectively. Approximately $2.1 billion remained available under our 2020 Share Repurchase Program as of December 31, 2022.In December 2019 our Board of Directors authorized our December 2019 Share Repurchase Program, which was a program to repurchase up to $5.0 billion of our common stock, which was completed as of September 30, 2020. All shares repurchased under our December 2019 Share Repurchase Program were retired. Under our December 2019 Share Repurchase Program, we repurchased and retired approximately 16.7 million shares of our common stock at a cost of approximately $5.0 billion during the year ended December 31, 2020.In March 2019 our Board of Directors authorized our March 2019 Share Repurchase Program, which was a program to repurchase up to $5.0 billion of our common stock, which was completed as of March 31, 2020. All shares repurchased under our March 2019 Share Repurchase Program were retired. Under our March 2019 Share Repurchase Program, we repurchased and retired approximately 4.1 million shares of our common stock at a cost of approximately $1.3 billion during the year ended December 31, 2020.In August 2022 the IRA was signed into law. Among other things, the IRA levies a 1.0% excise tax on net stock repurchases after December 31, 2022. Historically, we have made discretionary share repurchases.Cash FlowThe following table summarizes our cash flow activity: For the Years Ended December 31,% Change 2022 vs.20212021vs.2020(In millions, except percentages)202220212020Net cash flow provided by (used in) operating activities$1,384.3 $3,639.9 $4,229.8 (62.0)%(13.9)%Net cash flow provided by (used in) investing activities1,576.6 (563.7)(608.6)379.7 (7.4)Net cash flow provided by (used in) financing activities(1,747.3)(2,086.2)(5,272.7)(16.2)(60.4)Operating ActivitiesCash flow from operating activities represents the cash receipts and disbursements related to all of our activities other than investing and financing activities. We expect cash provided from operating activities will continue to be our primary source of funds to finance operating needs and capital expenditures for the foreseeable future.Operating cash flow is derived by adjusting our net income for:•non-cash operating items such as depreciation and amortization, impairment charges, unrealized gain (loss) on strategic investments, acquired IPR&D and share-based compensation;•changes in operating assets and liabilities, which reflect timing differences between the receipt and payment of cash associated with transactions and when they are recognized in results of operations; and•changes in the fair value of contingent payments associated with our acquisitions of businesses and payments related to collaborations.For 2022 compared to 2021, the decrease in net cash flow provided by operating activities was primarily due to lower revenue in 2022, net payments of $917.0 million for a litigation settlement agreement and settlement fees and expenses, timing of payments and higher net income tax payments in 2022. The higher tax payments are, in part, due to a change in the tax deductibility of payments made for research and development.Investing ActivitiesFor 2022 compared to 2021, the increase in net cash flow provided by investing activities was primarily due to proceeds received from the sale of our 49.9% equity interest in Samsung Bioepis of $990.3 million, net of expenses, during the second quarter of 2022 as well as $582.6 million in net proceeds received from the sale of one of our buildings during the third quarter of 2022.Financing ActivitiesFor 2022 compared to 2021, the decrease in net cash flow used in financing activities was primarily due to $1.1 billion in lower share repurchases in 2022, partially offset by $832.2 million in higher debt repayments in 2022.74Table of ContentsContractual Obligations and Off-Balance Sheet ArrangementsContractual ObligationsThe following table summarizes our contractual obligations as of December 31, 2022, excluding amounts related to uncertain tax positions, funding commitments, contingent development, regulatory and commercial milestone payments, contingent payments and contingent consideration related to our business combinations, as described below. Payments Due by Period(In millions)TotalLess than1 Year1 to 3Years3 to 5YearsAfter5 YearsNon-cancellable operating leases (1)(2)(3)$364.2 $82.7 $140.8 $110.3 $30.4 Long-term debt obligations (4)10,262.4 232.7 2,197.7 323.7 7,508.3 Purchase and other obligations (5)917.2 306.7 600.6 1.7 8.2 Defined benefit obligation90.8 — — — 90.8 Total contractual obligations$11,634.6 $622.1 $2,939.1 $435.7 $7,637.7 (1) We lease properties and equipment for use in our operations. Amounts reflected within the table above detail future minimum rental commitments under non-cancelable operating leases as of December 31 for each of the periods presented. In addition to the minimum rental commitments, these leases may require us to pay additional amounts for taxes, insurance, maintenance and other operating expenses. (2) Obligations are presented net of sublease income expected to be received for our vacated portion of our Weston, MA facility and other facilities throughout the world.(3) In September 2022 we completed the sale of our building and land parcel located at 125 Broadway. Simultaneously, with the close of this transaction we leased back the building for a term of approximately 5.5 years. For additional information on our 125 Broadway sale and leaseback transaction, please read Note 11, Property, Plant and Equipment and Note 12, Leases, to our consolidated financial statements included in this report.(4) Long-term debt obligations are related to our 2015 Senior Notes, our 2020 Senior Notes and our 2021 Exchange Offer Senior Notes, including principal and interest payments.(5) Purchase and other obligations include $558.0 million related to the remaining payments on a one-time mandatory deemed repatriation tax on accumulated foreign subsidiaries' previously untaxed foreign earnings (the Transition Toll Tax) and $26.0 million related to the fair value of net liabilities on derivative contracts.Royalty PaymentsTYSABRIWe are obligated to make contingent payments of 18.0% on annual worldwide net sales of TYSABRI up to $2.0 billion and 25.0% on annual worldwide net sales of TYSABRI that exceed $2.0 billion. Royalty payments are recognized as cost of sales in our consolidated statements of income.SPINRAZAWe make royalty payments on annual worldwide net sales of SPINRAZA using a tiered royalty rate between 11.0% and 15.0%, which are recognized as cost of sales in our consolidated statements of income.VUMERITYWe make royalty payments to Alkermes Pharma Ireland Limited, a subsidiary of Alkermes plc (Alkermes) on worldwide net sales of VUMERITY using a royalty rate of 15.0%, which are recognized as cost of sales in our consolidated statements of income.In October 2019 we entered into a new supply agreement and amended our license and collaboration agreement with Alkermes for VUMERITY. We have elected to initiate a technology transfer and, following a transition period, to manufacture VUMERITY or have VUMERITY manufactured by a third party we have engaged in exchange for paying an increased royalty rate to Alkermes on any portion of future worldwide net commercial sales of VUMERITY that is manufactured by us or our designee.For additional information on our collaboration arrangement with Alkermes, please read Note 19, Collaborative and Other Relationships, to our consolidated financial statements included in this report.Contingent Development, Regulatory and Commercial Milestone PaymentsBased on our development plans as of December 31, 2022, we could trigger potential future milestone payments to third parties of up to approximately $9.3 billion, including approximately $2.0 billion in development milestones, approximately $0.5 billion in regulatory milestones and approximately $6.8 billion in commercial milestones, as part of our various collaborations, including licensing and development programs. Payments under these agreements generally become due and payable upon achievement of certain development, regulatory or commercial milestones. Because the achievement of these milestones was not considered probable as 75Table of Contentsof December 31, 2022, such contingencies have not been recorded in our financial statements. Amounts related to contingent milestone payments are not considered contractual obligations as they are contingent on the successful achievement of certain development, regulatory or commercial milestones. If certain clinical and commercial milestones are met, we may pay up to $356.2 million in milestones in 2023 under our current agreements. This includes milestones totaling $225.0 million due to Sage upon the first commercial sale of zuranolone, for the potential treatment of MDD and PPD, in the U.S.Other Funding CommitmentsAs of December 31, 2022, we have several ongoing clinical studies in various clinical trial stages. Our most significant clinical trial expenditures are to CROs. The contracts with CROs are generally cancellable, with notice, at our option. We recorded accrued expense of approximately $20.4 million in our consolidated balance sheets for expenditures incurred by CROs as of December 31, 2022. We have approximately $929.0 million in cancellable future commitments based on existing CRO contracts as of December 31, 2022.Tax Related ObligationsWe exclude liabilities pertaining to uncertain tax positions from our summary of contractual obligations as we cannot make a reliable estimate of the period of cash settlement with the respective taxing authorities. As of December 31, 2022, we have approximately $154.6 million of liabilities associated with uncertain tax positions.As of December 31, 2022 and 2021, we have accrued income tax liabilities of approximately $558.0 million and $633.0 million, respectively, under the Transition Toll Tax. Of the amounts accrued as of December 31, 2022, approximately $137.8 million is expected to be paid within one year. The Transition Toll Tax will be paid in installments over an eight--year period, which started in 2018, and will not accrue interest.Other Off-Balance Sheet ArrangementsWe do not have any relationships with entities often referred to as structured finance or special purpose entities that were established for the purpose of facilitating off-balance sheet arrangements. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. We consolidate variable interest entities if we are the primary beneficiary.New Accounting StandardsFor a discussion of new accounting standards please read Note 1, Summary of Significant Accounting Policies, to our consolidated financial statements included in this report.Legal MattersFor a discussion of legal matters as of December 31, 2022, please read Note 21, Litigation, to our consolidated financial statements included in this report.Critical Accounting Policies and EstimatesThe preparation of our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. (U.S. GAAP), requires us to make estimates, judgments and assumptions that may affect the reported amounts of assets, liabilities, equity, revenue and expense and related disclosure of contingent assets and liabilities. On an ongoing basis we evaluate our estimates, judgments and assumptions. We base our estimates on historical experience and on various other assumptions that we believe are reasonable, the results of which form the basis for making judgments about the carrying values of assets, liabilities and equity and the amount of revenue and expense. Actual results may differ from these estimates. Other significant accounting policies are outlined in Note 1, Summary of Significant Accounting Policies, to our consolidated financial statements included in this report. Revenue RecognitionWe recognize revenue when our customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services. We recognize revenue following the five-step model prescribed under Financial Accounting Standards Board (FASB) Accounting Standards Codification 606, Revenue from Contracts with Customers: (i) identify contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) we satisfy the performance obligations.Product RevenueIn the U.S., we sell our products primarily to wholesale and specialty distributors and specialty pharmacies. In other countries, we sell our products primarily to wholesale distributors, hospitals, pharmacies and other third-party distribution partners. These customers subsequently resell our products to 76Table of Contentshealth care providers and patients. In addition, we enter into arrangements with health care providers and payors that provide for government-mandated or privately-negotiated discounts and allowances related to our products.Product revenue is recognized when the customer obtains control of our product, which occurs at a point in time, typically upon delivery to the customer. We expense incremental costs of obtaining a contract as and when incurred if the expected amortization period of the asset that we would have recognized is one year or less or the amount is immaterial.Reserves for Discounts and AllowancesProduct revenue is recorded net of reserves established for applicable discounts and allowances that are offered within contracts with our customers, health care providers or payors, including those associated with the implementation of pricing actions in certain of the international markets in which we operate. Our process for estimating reserves established for these variable consideration components do not differ materially from our historical practices.Product revenue reserves, which are classified as a reduction in product revenue, are generally characterized in the following categories: discounts, contractual adjustments and returns.These reserves are based on estimates of the amounts earned or to be claimed on the related sales and are classified as reductions of accounts receivable (if the amount is payable to our customer) or a liability (if the amount is payable to a party other than our customer). Our estimates of reserves established for variable consideration are calculated based upon a consistent application of our methodology utilizing the expected value method. These estimates reflect our historical experience, current contractual and statutory requirements, specific known market events and trends, industry data and forecasted customer buying and payment patterns. The transaction price, which includes variable consideration reflecting the impact of discounts and allowances, may be subject to constraint and is included in the net sales price only to the extent that it is probable that a significant reversal of the amount of the cumulative revenue recognized will not occur in a future period. Actual amounts may ultimately differ from our estimates. If actual results vary, we adjust these estimates, which could have an effect on earnings in the period of adjustment.As of December 31, 2022, a 10.0% change in our discounts, contractual adjustments and reserves would have resulted in a decrease of our pre-tax earnings by approximately $338.6 million.In addition to discounts, rebates and product returns, we also maintain certain customer service contracts with distributors and other customers in the distribution channel that provide us with inventory management, data and distribution services, which are generally reflected as a reduction of revenue. To the extent we can demonstrate a separable benefit and fair value for these services we classify these payments in selling, general and administrative expense in our consolidated statements of income.For additional information on our revenue, please read Note 5, Revenue, to our consolidated financial statements included in this report.InventoryAt each reporting period we review our inventories for excess or obsolescence and write-down obsolete or otherwise unmarketable inventory to its estimated net realizable value. The determination of obsolete or excess inventory requires management to make estimates based on assumptions about the future demand of our products, product expiration dates, estimated future sales and our general future plans. If customer demand subsequently differs from our forecasts, we may be required to record additional charges for excess inventory.Although we believe that the assumptions we use in estimating inventory write-downs are reasonable, no assurance can be given that significant future changes in these assumptions or changes in future events and market conditions could result in different estimates.During 2021 we wrote-off approximately $120.0 million of inventory in excess of forecasted demand related to ADUHELM. During the first quarter of 2022 we wrote-off approximately $275.0 million, as a result of the final CMS decision.As of December 31, 2022, the carrying value of our ADUHELM inventory was immaterial. As of December 31, 2021, we had approximately $223.0 million of ADUHELM inventory.Acquired Intangible Assets, including IPR&DWhen we purchase a business, the acquired IPR&D is measured at fair value, capitalized as an intangible asset and tested for impairment at least annually, as of October 31, until commercialization, after which time the IPR&D is amortized over its estimated useful life. If we acquire an asset or group of assets that do not meet the definition of a business under applicable accounting standards, the acquired IPR&D is expensed on its acquisition date. Future costs to develop these assets are recorded to 77Table of Contentsresearch and development expense as they are incurred.We have acquired, and expect to continue to acquire, intangible assets through the acquisition of biotechnology companies or through the consolidation of variable interest entities. These intangible assets primarily consist of technology associated with human therapeutic products and IPR&D product candidates. When significant identifiable intangible assets are acquired, we generally engage an independent third-party valuation firm to assist in determining the fair values of these assets as of the acquisition date. Management will determine the fair value of less significant identifiable intangible assets acquired. Discounted cash flow models are typically used in these valuations, and these models require the use of significant estimates and assumptions including but not limited to:•estimating the timing of and expected costs to complete the in-process projects;•projecting regulatory approvals;•estimating future cash flow from product sales resulting from completed products and in process projects; and•developing appropriate discount rates and probability rates by project.We believe the fair values assigned to the intangible assets acquired are based upon reasonable estimates and assumptions given available facts and circumstances as of the acquisition dates.If these projects are not successfully developed, the sales and profitability of the company may be adversely affected in future periods. Additionally, the value of the acquired intangible assets may become impaired. No assurance can be given that the underlying assumptions used to estimate expected project sales, development costs or profitability, or the events associated with such projects, will transpire as estimated.Impairment and Amortization of Long-lived AssetsLong-lived assets to be held and used include property, plant and equipment as well as intangible assets, including IPR&D and trademarks. Property, plant and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. We review our intangible assets with indefinite lives for impairment annually, as of October 31, and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.When performing our impairment assessment, we calculate the fair value using the same methodology as described above under Acquired Intangible Assets, including IPR&D. If the carrying value of our acquired IPR&D exceeds its fair value, then the intangible asset is written down to its fair value. Changes in estimates and assumptions used in determining the fair value of our acquired IPR&D could result in an impairment. Impairments are recorded within amortization and impairment of acquired intangible assets in our consolidated statements of income.Based on our most recent impairment assessment we incurred impairment charges of approximately $119.6 million and $629.3 million for the years ended December 31, 2022 and 2021, respectively, mainly related to the discontinuation of IPR&D programs. For additional information on our impairments, Note 7, Intangible Assets and Goodwill, to our consolidated financial statements included in this report.Our most significant intangible assets are our acquired and in-licensed rights and patents. Acquired and in-licensed rights and patents primarily relate to our acquisition of all remaining rights to TYSABRI. We amortize the intangible assets related to our marketed products using the economic consumption method based on revenue generated from the products underlying the related intangible assets. An analysis of the anticipated lifetime revenue of our marketed products is performed annually during our long-range planning cycle and whenever events or changes in circumstances would significantly affect anticipated lifetime revenue of the relevant products.For additional information on the impairment charges related to our long-lived assets during 2022, 2021 and 2020, please read Note 7, Intangible Assets and Goodwill, to our consolidated financial statements included in this report.Contingent ConsiderationWe record contingent consideration resulting from a business combination at its fair value on the acquisition date. Each reporting period thereafter, we revalue the remaining obligations and record increases or decreases in their fair value as an adjustment to contingent consideration expense in our consolidated statements of income. Changes in the fair value of our contingent consideration obligations can result from changes to one or multiple inputs, including adjustments to the discount rates and achievement and timing of any cumulative sales-based and development milestones or changes in the probability of certain clinical events and changes in the assumed probability associated with regulatory approval. These fair value measurements represent Level 3 measurements as they are based on significant inputs not observable in the market.78Table of ContentsSignificant judgment is employed in determining the appropriateness of these assumptions as of the acquisition date and for each subsequent period. Accordingly, changes in assumptions described above, could have a material impact on the amount of contingent consideration expense we record in any given period.Income TaxesWe prepare and file income tax returns based on our interpretation of each jurisdiction’s tax laws and regulations. In preparing our consolidated financial statements, we estimate our income tax liability in each of the jurisdictions in which we operate by estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and financial reporting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. Upon our election in the fourth quarter of 2018 to record deferred taxes for global intangible low-taxed income (GILTI), we have included amounts related to GILTI taxes within temporary difference.Significant management judgment is required in assessing the realizability of our deferred tax assets. In performing this assessment, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In making this determination, under the applicable financial accounting standards, we are allowed to consider the scheduled reversal of deferred tax liabilities, projected future taxable income and the effects of tax planning strategies. In the event that actual results differ from our estimates, we adjust our estimates in future periods and we may need to establish a valuation allowance, which could materially impact our consolidated financial position and results of operations.We account for uncertain tax positions using a “more likely than not” threshold for recognizing and resolving uncertain tax positions. We evaluate uncertain tax positions on a quarterly basis and consider various factors including, but not limited to, changes in tax law, the measurement of tax positions taken or expected to be taken in tax returns, the effective settlement of matters subject to audit, information obtained during in process audit activities and changes in facts or circumstances related to a tax position. We adjust the level of the liability to reflect any subsequent changes in the relevant facts surrounding the uncertain positions. Our liabilities for uncertain tax positions can be relieved only if the contingency becomes legally extinguished, through either payment to the taxing authority or the expiration of the statute of limitations, the recognition of the benefits associated with the position meet the “more likely than not” threshold or the liability becomes effectively settled through the examination process. We consider matters to be effectively settled once the taxing authority has completed all of its required or expected examination procedures, including all appeals and administrative reviews, we have no plans to appeal or litigate any aspect of the tax position and we believe that it is highly unlikely that the taxing authority would examine or re-examine the related tax position. We also accrue for potential interest and penalties related to unrecognized tax benefits in income tax expense.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are subject to certain risks that may affect our results of operations, cash flow and fair values of assets and liabilities, including volatility in foreign currency exchange rates, interest rate movements and equity price exposure as well as changes in economic conditions in the markets in which we operate as a result of the COVID-19 pandemic and the conflict in Ukraine. We manage the impact of foreign currency exchange rates and interest rates through various financial instruments, including derivative instruments such as foreign currency forward contracts, interest rate lock contracts and interest rate swap contracts. We do not enter into financial instruments for trading or speculative purposes. The counterparties to these contracts are major financial institutions, and there is no significant concentration of exposure with any one counterparty.Foreign Currency Exchange RiskOur results of operations are subject to foreign currency exchange rate fluctuations due to the global nature of our operations. As a result, our consolidated financial position, results of operations and cash flow can be affected by market fluctuations in foreign currency exchange rates, primarily with respect to the Euro, British pound sterling, Canadian dollar, Swiss franc and Japanese yen.While the financial results of our global activities are reported in U.S. dollars, the functional currency for most of our foreign subsidiaries is their respective local currency. Fluctuations in the foreign currency exchange rates of the countries in which we do business will affect our operating results, often in ways that are difficult to predict. In particular, as the U.S. dollar strengthens versus other currencies, the value of the non-U.S. revenue will decline when reported in U.S. dollars. The impact to net income as a result of a strengthening U.S. dollar will be partially 79Table of Contentsmitigated by the value of non-U.S. expense, which will also decline when reported in U.S. dollars. As the U.S. dollar weakens versus other currencies, the value of the non-U.S. revenue and expense will increase when reported in U.S. dollars.We have established revenue and operating expense hedging and balance sheet risk management programs to protect against volatility of future foreign currency cash flow and changes in fair value caused by volatility in foreign currency exchange rates.During the second quarter of 2018 the International Practices Task Force of the Center for Audit Quality categorized Argentina as a country with a projected three-year cumulative inflation rate greater than 100.0%, which indicated that Argentina’s economy is highly inflationary. This categorization did not have a material impact on our results of operations or financial position as of December 31, 2022, and is not expected to have a material impact on our results of operations or financial position in the future.Revenue and Operating Expense Hedging ProgramOur foreign currency hedging program is designed to mitigate, over time, a portion of the impact resulting from volatility in exchange rate changes on revenue and operating expense. We use foreign currency forward contracts and foreign currency options to manage foreign currency risk, with the majority of our forward contracts used to hedge certain forecasted revenue and operating expense transactions denominated in foreign currencies in the next 12 months. We do not engage in currency speculation. For a more detailed disclosure of our revenue and operating expense hedging program, please read Note 10, Derivative Instruments, to our consolidated financial statements included in this report. Our ability to mitigate the impact of foreign currency exchange rate changes on revenue and net income diminishes as significant foreign currency exchange rate fluctuations are sustained over extended periods of time. In particular, devaluation or significant deterioration of foreign currency exchange rates are difficult to mitigate and likely to negatively impact earnings. The cash flow from these contracts are reported as operating activities in our consolidated statements of cash flow.Balance Sheet Risk Management Hedging ProgramWe also use forward contracts to mitigate the foreign currency exposure related to certain balance sheet items. The primary objective of our balance sheet risk management program is to mitigate the exposure of foreign currency denominated net monetary assets and liabilities of foreign affiliates. In these instances, we principally utilize currency forward contracts. We have not elected hedge accounting for the balance sheet related items. The cash flow from these contracts are reported as operating activities in our consolidated statements of cash flow.The following quantitative information includes the impact of currency movements on forward contracts used in our revenue, operating expense and balance sheet hedging programs. As of December 31, 2022 and 2021, a hypothetical adverse 10.0% movement in foreign currency exchange rates compared to the U.S. dollar across all maturities would result in a hypothetical decrease in the fair value of forward contracts of approximately $293.7 million and $333.1 million, respectively. The estimated fair value change was determined by measuring the impact of the hypothetical exchange rate movement on outstanding forward contracts. Our use of this methodology to quantify the market risk of such instruments is subject to assumptions and actual impact could be significantly different. The quantitative information about market risk is limited because it does not take into account all foreign currency operating transactions.Interest Rate RiskOur investment portfolio includes cash equivalents and short-term investments. The fair value of our marketable securities is subject to change as a result of potential changes in market interest rates. The potential change in fair value for interest rate sensitive instruments has been assessed on a hypothetical 100 basis point adverse movement across all maturities. As of December 31, 2022 and 2021, we estimate that such hypothetical 100 basis point adverse movement would result in a hypothetical loss in fair value of approximately $11.7 million and $14.3 million, respectively, to our interest rate sensitive instruments. The fair values of our investments were determined using third-party pricing services or other market observable data.Credit RiskFinancial instruments that potentially subject us to concentrations of credit risk include cash and cash equivalents, investments, derivatives and accounts receivable. We attempt to minimize the risks related to cash and cash equivalents and investments by investing in a broad and diverse range of financial instruments. We have established guidelines related to credit ratings and maturities intended to safeguard principal balances and maintain liquidity. Our investment portfolio is maintained in accordance with our investment policy, which defines allowable investments, specifies credit quality standards and limits the credit exposure of any single issuer. We minimize credit risk resulting from derivative instruments by choosing only highly rated financial institutions as counterparties.80Table of ContentsWe operate in certain countries where weakness in economic conditions, including the effects of the COVID-19 pandemic and the conflict in Ukraine, can result in extended collection periods. We continue to monitor these conditions, including the volatility associated with international economies and the relevant financial markets, and assess their possible impact on our business. To date, we have not experienced any significant losses with respect to the collection of our accounts receivable.We believe that our allowance for doubtful accounts was adequate as of December 31, 2022 and 2021.Equity Price RiskOur strategic investment portfolio includes investments in equity securities of certain biotechnology companies. While we are holding such securities, we are subject to equity price risk, and this may increase the volatility of our income in future periods due to changes in the fair value of equity investments. We may sell such equity securities based on our business considerations, which may include limiting our price risk.Changes in the fair value of these equity securities are impacted by the volatility of the stock market and changes in general economic conditions, among other factors. The potential change in fair value for equity price sensitive instruments has been assessed on a hypothetical 10.0% adverse movement. As of December 31, 2022 and 2021, a hypothetical adverse 10.0% movement would result in a hypothetical decrease in fair value of approximately $79.1 million and $104.8 million, respectively.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsConsolidated Results of Operations and Financial ConditionOverviewWe are a global market leader in the design, development, manufacture, sale, service and support of commercial jetliners, military aircraft, satellites, missile defense, human space flight and launch systems and services. We are one of the two major manufacturers of 100+ seat airplanes for the worldwide commercial airline industry and one of the largest defense contractors in the U.S. While our principal operations are in the U.S., we conduct operations in an expanding number of countries and rely on an extensive network of non-U.S. partners, key suppliers and subcontractors.Our strategy is centered on successful execution in healthy core businesses – Commercial Airplanes (BCA), Defense, Space & Security (BDS) and Global Services (BGS) – supplemented and supported by Boeing Capital (BCC). Taken together, these core businesses have historically generated substantial earnings and cash flow that enable our investments in new products and services. We focus on producing the products and providing the services that the market demands, and continue to find new ways to improve efficiency and quality to provide a fair return for our shareholders. BCA is committed to being the leader in commercial aviation by offering airplanes and services that deliver superior design, safety, efficiency and value to customers around the world. BDS integrates its resources in defense, intelligence, communications, security, space and services to deliver capability-driven solutions to customers at reduced costs. Our BDS strategy is to leverage our core businesses to capture key next-generation programs while expanding our presence in adjacent and international markets, underscored by an intense focus on growth and productivity. BGS provides support for commercial and defense through innovative, comprehensive and cost-competitive product and service solutions. BCC facilitates, arranges, structures and provides selective financing solutions for our Boeing customers.Business Environment and TrendsDomestic travel continues to recover from the lingering effects of the COVID-19 pandemic before international travel and the narrow-body market continues to follow domestic travel recovery, while the wide-body market continues to be paced by international travel recovery. The pace of the commercial market recovery remains impacted by government restrictions related to COVID-19, especially China. We are seeing a strong recovery in travel demand for our airline customers in North and South America, the Middle East, and Europe, and demand for dedicated freighters continues to be underpinned by a strong recovery in global trade.We and our suppliers are experiencing supply chain disruptions as a result of the lingering impacts of COVID-19, global supply chain constraints, and labor instability. We and our suppliers are also experiencing inflationary pressures. We continue to monitor the health and stability of the supply chain as we ramp up production. These factors have reduced overall productivity and adversely impacted our financial position, results of operations and cash flows.Airline financial performance, which influences demand for new capacity, has been adversely impacted by the COVID-19 pandemic. According to the International Air Transport Association (IATA), net losses for the airline industry were $138 billion in 2020 and $42 billion in 2021. IATA also forecasts $6.9 billion of losses for the industry globally in 2022, with approximately $9.9 billion of profits in North America driven by the robust domestic market being more than offset by losses in other regions. For 2023, IATA is forecasting $4.6 billion in profits for the industry globally. While the outlook continues to improve, we continue to face a challenging environment in the near- to medium-term as airlines are facing increased fuel and other costs, and the global economy is experiencing high inflation. The current environment is also affecting the financial viability of some airlines.20Table of ContentsThe long-term outlook for the industry remains positive due to the fundamental drivers of air travel demand: economic growth, increasing propensity to travel due to increased trade, globalization and improved airline services driven by liberalization of air traffic rights between countries. Our Commercial Market Outlook forecast projects a 3.8% growth rate for passenger and cargo traffic over a 20-year period. Based on long-term global economic growth projections of 2.6% in average annual gross domestic product, we project demand for approximately 41,170 new airplanes over the next 20 years. The industry remains vulnerable to exogenous developments including fuel price spikes, credit market shocks, acts of terrorism, natural disasters, conflicts, epidemics, pandemics and increased global environmental regulations.During 2022, commercial services volume at BGS recovered to pre-pandemic levels. We expect BGS commercial revenues to remain strong in future quarters as the commercial airline industry continues to recover. The demand outlook for our government services business remains stable.At BDS, we continue to see stable demand reflecting the important role our products and services have in ensuring our national security. Outside of the U.S., we are seeing similar solid demand as governments prioritize security, defense technology and global cooperation given evolving threats. We continue to experience near-term production disruptions and inefficiencies due to supplier disruption, labor instability and factory performance. These factors have contributed to significant earnings charges on a number of fixed-price development programs which are expected to adversely affect cash flows in future periods.As a result of the war in Ukraine, we recorded earnings charges totaling $212 million during the first quarter of 2022, primarily related to asset impairments. We have closed our facilities in Russia. We are focused on the safety of our employees and retaining the strength of our engineering talent through voluntary transfers to other countries. We have also suspended our business in Russia, including parts, maintenance and technical support for Russian airlines, and purchases from Russian suppliers. We are complying with U.S. and international sanctions and export control restrictions. We have sufficient material and parts to avoid production disruptions in the near-term, but future impacts to our production from disruptions in our supply chain are possible. The war in Ukraine continues to impact our airline and lessor customers. We continue to monitor developments and potential Boeing impacts, and take mitigating actions as appropriate.21Table of ContentsConsolidated Results of Operations The following table summarizes key indicators of consolidated results of operations:(Dollars in millions, except per share data)Years ended December 31,202220212020Revenues$66,608 $62,286 $58,158 GAAPLoss from operations($3,547)($2,902)($12,767)Operating margins(5.3)%(4.7)%(22.0)%Effective income tax rate(0.6)%14.8 %17.5 %Net loss attributable to Boeing Shareholders($4,935)($4,202)($11,873)Diluted loss per share($8.30)($7.15)($20.88)Non-GAAP (1)Core operating loss($4,690)($4,075)($14,150)Core operating margins(7.0 %)(6.5 %)(24.3 %)Core loss per share($11.06)($9.44)($23.25)(1)These measures exclude certain components of pension and other postretirement benefit expense. See pages 45 - 47 for important information about these non-GAAP measures and reconciliations to the most directly comparable GAAP measures.Revenues The following table summarizes Revenues:(Dollars in millions)Years ended December 31,202220212020Commercial Airplanes$25,867 $19,493 $16,162 Defense, Space & Security23,162 26,540 26,257 Global Services17,611 16,328 15,543 Boeing Capital199 272 261 Unallocated items, eliminations and other(231)(347)(65)Total$66,608 $62,286 $58,158 Revenues increased by $4,322 million in 2022 compared with 2021 driven by higher revenues at BCA and BGS, partially offset by lower revenues at BDS. BCA revenues increased by $6,374 million primarily driven by higher 737 and 787 deliveries. BGS revenues increased by $1,283 million primarily due to higher commercial services volume, partially offset by lower government services volume and performance. BDS revenues decreased by $3,378 million primarily due to charges on development programs, unfavorable performance across other defense programs, and lower P-8 and weapons volume. Revenues increased by $4,128 million in 2021 compared with 2020 driven by higher revenues at BCA, BDS and BGS. BCA revenues increased by $3,331 million primarily driven by higher 737 MAX deliveries due to recertification and return to service in most jurisdictions and the absence of $498 million of 737 MAX customer considerations which reduced revenues in 2020, partially offset by lower 787 deliveries in 2021. BDS revenues increased by $283 million primarily from higher revenue on the 22Table of ContentsKC-46A Tanker program and lower charges in 2021. BGS revenues increased by $785 million primarily due to higher commercial and government services volume.Revenues will continue to be significantly impacted until the global supply chain stabilizes, labor instability diminishes, and deliveries ramp up.Loss From Operations The following table summarizes Loss from operations:(Dollars in millions)Years ended December 31,202220212020Commercial Airplanes($2,370)($6,475)($13,847)Defense, Space & Security(3,544)1,544 1,539 Global Services2,727 2,017 450 Boeing Capital29 106 63 Segment operating loss(3,158)(2,808)(11,795)Pension FAS/CAS service cost adjustment849 882 1,024 Postretirement FAS/CAS service cost adjustment294 291 359 Unallocated items, eliminations and other(1,532)(1,267)(2,355)Loss from operations (GAAP)($3,547)($2,902)($12,767)FAS/CAS service cost adjustment * (1,143)(1,173)(1,383)Core operating loss (Non-GAAP) **($4,690)($4,075)($14,150)* The FAS/CAS service cost adjustment represents the difference between the FAS pension and postretirement service costs calculated under GAAP and costs allocated to the business segments.** Core operating loss is a non-GAAP measure that excludes the FAS/CAS service cost adjustment. See pages 45 - 47.Loss from operations increased by $645 million in 2022 compared with 2021. BDS had a loss from operations of $3,544 million compared with earnings of $1,544 million during 2021, primarily due to charges on development programs. BCA loss from operations decreased by $4,105 million primarily due to the absence in 2022 of the $3,460 million reach-forward loss taken on the 787 program in 2021, higher 737 deliveries and lower abnormal production costs, partially offset by higher research and development spending, charges related to the war in Ukraine and other period expenses. BGS earnings from operations increased by $710 million in 2022 compared with 2021 primarily due to higher commercial services volume and favorable mix, partially offset by lower government services performance. Loss from operations decreased by $9,865 million in 2021 compared with 2020 primarily due to lower losses at BCA and higher earnings at BGS. BCA loss from operations decreased by $7,372 million primarily due to the absence of a $6,493 million reach-forward loss on the 777X program recorded in 2020, lower period expenses, lower 737 MAX customer considerations and higher 737 MAX deliveries, partially offset by a $3,460 million reach-forward loss on the 787 program in 2021. BGS earnings from operations increased by $1,567 million in 2021 compared with 2020 primarily due to charges incurred in 2020 as a result of the COVID-19 pandemic, as well as higher commercial services volume.Core operating loss increased by $615 million in 2022 compared with 2021 and decreased by $10,075 million in 2021 compared with 2020 primarily due to changes in Segment operating loss as described above.23Table of ContentsUnallocated Items, Eliminations and Other The most significant items included in Unallocated items, eliminations and other are shown in the following table:(Dollars in millions)Years ended December 31,202220212020Share-based plans($114)($174)($120)Deferred compensation117 (126)(93)Amortization of previously capitalized interest(95)(107)(95)Research and development expense, net(278)(184)(240)Eliminations and other unallocated items(1,162)(676)(1,807)Unallocated items, eliminations and other($1,532)($1,267)($2,355)Share-based plans expense decreased by $60 million in 2022 and increased by $54 million in 2021. The lower expense in 2022 compared to 2021 was due to decreased grants of restricted stock units (RSUs) and other share-based compensation. The higher expense in 2021 compared to 2020 was primarily related to a one-time grant of RSUs to most employees in December 2020. Deferred compensation expense decreased by $243 million in 2022, primarily driven by changes in broad stock market conditions, and increased by $33 million in 2021, primarily driven by changes in broad stock market conditions and our stock price.Research and development expense increased by $94 million in 2022 and decreased by $56 million in 2021 primarily due to enterprise investments in product development.Eliminations and other unallocated expense increased by $486 million in 2022 primarily due to a $200 million settlement with the Securities and Exchange Commission related to the 737 MAX accidents, lower income from operating investments, and an increase in environmental remediation expense. Eliminations and other unallocated expense decreased by $1,131 million in 2021 primarily due to earnings charges of $744 million in the fourth quarter of 2020 in anticipation of the agreement between Boeing and the U.S. Department of Justice that was finalized in January 2021 and higher income from operating investments in 2021.Net periodic pension benefit costs included in Loss from operations were as follows:(Dollars in millions)PensionYears ended December 31,202220212020Allocated to business segments($852)($885)($1,027)Pension FAS/CAS service cost adjustment849 882 1,024 Net periodic pension benefit cost included in Loss from operations($3)($3)($3)The pension FAS/CAS service cost adjustment recognized in Loss from operations in 2022 decreased by $33 million compared with 2021 and decreased by $142 million in 2021 compared with 2020 due to reductions in allocated pension cost year over year. Net periodic benefit cost included in Loss from operations in 2022 was largely consistent with 2021 and 2020. For additional discussion related to Postretirement Plans, see Note 16 to our Consolidated Financial Statements.24Table of ContentsOther Earnings Items(Dollars in millions)Years ended December 31,202220212020Loss from operations($3,547)($2,902)($12,767)Other income, net1,058 551 447 Interest and debt expense(2,533)(2,682)(2,156)Loss before income taxes(5,022)(5,033)(14,476)Income tax (expense)/benefit(31)743 2,535 Net loss from continuing operations(5,053)(4,290)(11,941)Less: net loss attributable to noncontrolling interest(118)(88)($68)Net loss attributable to Boeing Shareholders($4,935)($4,202)($11,873)Non-operating pension income included in Other income, net was $881 million in 2022, $528 million in 2021, and $340 million in 2020. The increased income in 2022 compared to 2021 was primarily due to lower amortization of net actuarial losses in 2022 and a settlement loss recorded in 2021. The increased income in 2021 compared to 2020 was primarily due to lower interest cost and higher expected return on plan assets, partially offset by higher amortization of net actuarial losses and higher settlement charges.Non-operating postretirement income included in Other income, net was $58 million in 2022, compared with income of $1 million in 2021 and expense of $16 million in 2020. The increased income in 2022 and 2021 was due to lower amortization of net actuarial losses. Interest and debt expense decreased by $149 million in 2022 primarily due to lower average debt balances and increased by $526 million in 2021 as a result of higher average debt balances.In August 2022, the President signed into law the Inflation Reduction Act of 2022, which contained provisions effective January 1, 2023, including a 15% corporate minimum tax and a 1% excise tax on stock buybacks, both of which we do not expect to have a material impact on our results of operations, financial condition or cash flows. For additional discussion related to Income Taxes, see Note 4 to our Consolidated Financial Statements.Total Costs and Expenses (“Cost of Sales”)Cost of sales, for both products and services, consists primarily of raw materials, parts, sub-assemblies, labor, overhead and subcontracting costs. Our BCA segment predominantly uses program accounting to account for cost of sales. Under program accounting, cost of sales for each commercial aircraft program equals the product of (i) revenue recognized in connection with customer deliveries and (ii) the estimated cost of sales percentage applicable to the total remaining program. For long-term contracts, the amount reported as cost of sales is recognized as incurred. Substantially all contracts at our BDS segment and certain contracts at our BGS segment are long-term contracts with the U.S. government and other customers that generally extend over several years. Cost of sales for commercial spare parts is recorded at average cost.25Table of ContentsThe following table summarizes cost of sales:(Dollars in millions)Years ended December 3120222021Change20212020ChangeCost of sales$63,106 $59,269 $3,837 $59,269 $63,843 ($4,574)Cost of sales as a % of Revenues94.7 %95.2 %(0.5)%95.2 %109.8 %(14.6)%Cost of sales increased by $3,837 million in 2022 compared with 2021, primarily due to charges recorded at BDS and higher revenues at BCA. Cost of sales as a percentage of Revenues remained largely consistent in 2022 compared to 2021.Cost of sales decreased by $4,574 million in 2021 compared with 2020, primarily due to higher earnings charges at BCA, BDS and BGS in 2020, partially offset by higher costs as a result of higher revenues in 2021 and the reach-forward loss on the 787 program. Cost of sales as a percentage of Revenues decreased in 2021 compared to 2020 primarily due to higher earnings charges at BCA and BGS in 2020 and higher revenues in 2021.Research and Development The following table summarizes our Research and development expense:(Dollars in millions)Years ended December 31,202220212020Commercial Airplanes$1,510 $1,140 $1,385 Defense, Space & Security945 818 713 Global Services119 107 138 Other278 184 240 Total$2,852 $2,249 $2,476 Research and development expense increased by $603 million in 2022 compared with 2021 primarily due to higher research and development expenditures on 777X, 737 MAX, as well as BCA and enterprise investments in product development.Research and development expense decreased by $227 million in 2021 compared with 2020 primarily due to lower BCA and enterprise investments in product development and lower spending on the 777X program.26Table of ContentsBacklogOur backlog at December 31 was as follows:(Dollars in millions)Years ended December 31,20222021Commercial Airplanes$329,824 $296,882 Defense, Space & Security54,373 59,828 Global Services19,338 20,496 Unallocated items, eliminations and other846 293 Total Backlog$404,381 $377,499 Contractual backlog$381,977 $356,362 Unobligated backlog22,404 21,137 Total Backlog$404,381 $377,499 Contractual backlog of unfilled orders excludes purchase options, announced orders for which definitive contracts have not been executed, orders where customers have the unilateral right to terminate, and unobligated U.S. and non-U.S. government contract funding. The increase in contractual backlog during 2022 was primarily due to an increase in BCA backlog that was partially offset by a decrease in BDS backlog. If we remain unable to deliver 737 MAX aircraft in China for an extended period of time, and/or entry into service of the 777X, 737-7 and/or 737-10 is further delayed, we may experience reductions to backlog and/or significant order cancellations. Unobligated backlog includes U.S. and non-U.S. government definitive contracts for which funding has not been authorized. The increase in unobligated backlog in 2022 was primarily due to contract awards, partially offset by reclassifications to contractual backlog related to BDS and BGS contracts.Additional ConsiderationsGlobal Trade We continually monitor the global trade environment in response to geopolitical economic developments, as well as changes in tariffs, trade agreements or sanctions that may impact the Company.The current state of U.S.-China relations remains an ongoing watch item. Since 2018, the U.S. and China have imposed tariffs on each other’s imports. Certain aircraft parts and components that Boeing procures are subject to these tariffs. We are mitigating import costs through Duty Drawback Customs procedures. China is a significant market for commercial aircraft. Boeing has long-standing relationships with our Chinese customers, who represent a key component of our commercial aircraft backlog. Overall, the U.S.-China trade relationship remains stalled as economic and national security concerns continue to be a challenge.Beginning in June 2018, the U.S. Government imposed tariffs on steel and aluminum imports. In response to these tariffs, several major U.S. trading partners have imposed, or announced their intention to impose, tariffs on U.S. goods. The U.S. has subsequently reached agreements with Mexico, Canada, the United Kingdom, the European Union, and Japan to ease or remove tariffs on steel and/or aluminum. We continue to monitor the potential for any extra costs that may result from the remaining global tariffs.We are complying with all U.S. and other government export control restrictions and sanctions imposed on certain businesses and individuals in Russia. We continue to monitor and evaluate additional sanctions and export restrictions that may be imposed by the U.S. Government or other governments, 27Table of Contentsas well as any responses from Russia that could affect our supply chain, business partners or customers, for any additional impacts to our business.Segment Results of Operations and Financial ConditionCommercial AirplanesBusiness Environment and TrendsAirline Industry Environment See Overview to Management’s Discussion and Analysis of Financial Condition and Results of Operations for a discussion of the airline industry environment.Industry Competitiveness The industry continues to recover from the lingering effects of the COVID-19 pandemic. The commercial aircraft market and the airline industry both remain extremely competitive. While the impacts and responses have varied globally, the reduction of demand and disruption in production has adversely impacted most manufacturers in the commercial aircraft industry.Continued access to global markets remains vital to our ability to fully realize our sales potential and long-term investment returns. Approximately 70% of Commercial Airplanes’ total backlog, in dollar terms, is with non-U.S. airlines. We face aggressive international competitors who are intent on increasing their market share. They offer competitive products and have access to most of the same customers and suppliers. The grounding of the 737 MAX in 2019 and the associated suspension of 737 MAX deliveries in multiple jurisdictions significantly reduced our market share with respect to deliveries of single aisle aircraft and may provide competitors with an opportunity to obtain more orders and increase market share. With government support, Airbus has historically invested heavily to create a family of products to compete with ours. After the acquisition of a majority share of Bombardier’s C Series (now A220) in 2018, Airbus continues to expand in the 100-150 seat transcontinental market. Other competitors are also in different phases of developing commercial jet aircraft, including Commercial Aircraft Corporation of China, Ltd. (COMAC), which delivered its first C919 aircraft in 2022. Some of these competitors have historically enjoyed access to government-provided financial support, including “launch aid,” which greatly reduces the cost and commercial risks associated with airplane development activities. This has enabled the development of airplanes without broad commercial viability; others to be brought to market more quickly than otherwise possible; and many offered for sale below market-based prices. Competitors continue to make improvements in efficiency, which may result in funding product development, gaining market share and improving earnings. This market environment has resulted in intense pressures on pricing and other competitive factors, and we expect these pressures to continue or intensify in the coming years.We are focused on improving our products and services and continuing our business transformation efforts, which enhances our ability to compete and positions us for market recovery. We are also focused on taking actions to ensure that Boeing is not harmed by unfair subsidization of competitors.28Table of ContentsResults of Operations (Dollars in millions)Years ended December 31,202220212020Revenues$25,867 $19,493 $16,162 % of total company revenues39 %31 %28 %Loss from operations($2,370)($6,475)($13,847)Operating margins(9.2)%(33.2)%(85.7)%Research and development$1,510 $1,140 $1,385 Revenues BCA revenues increased by $6,374 million in 2022 compared with 2021 primarily due to higher 737 and 787 deliveries in 2022.BCA revenues increased by $3,331 million in 2021 compared with 2020 primarily due to higher 737 MAX deliveries driven by recertification and return to service in most jurisdictions and the absence of charges for 737 MAX customer considerations which reduced revenues in 2020, partially offset by lower 787 deliveries in 2021.BCA deliveries, including intercompany deliveries, as of December 31 were as follows:737 *747 767 *777 787 Total2022Cumulative deliveries8,1321,5721,2711,7011,037Deliveries387(13)533(15)24314802021Cumulative deliveries7,7451,5671,2381,6771,006Deliveries263(16)732(13)24143402020Cumulative deliveries7,4821,5601,2061,653992Deliveries43(14)530(11)2653157* Intercompany deliveries identified by parenthesesLoss From Operations BCA loss from operations was $2,370 million in 2022 compared with $6,475 million in 2021 reflecting higher 737 deliveries and lower abnormal production costs, partially offset by higher research and development spending, charges related to the war in Ukraine and other period expenses. The 2021 loss also reflects a reach-forward loss on the 787 program of $3,460 million. Abnormal production costs in 2022 were $1,753 million, including $1,240 million related to the 787 program, $325 million related to the 777X program, and $188 million related to the 737 program. BCA loss from operations was $6,475 million in 2021 compared with $13,847 million in 2020. The 2021 loss reflects the reach-forward loss on the 787 program of $3,460 million, abnormal production costs related to the 737 program of $1,887 million, and abnormal production costs related to the 787 program of $468 million resulting from continued production issues, inspections and rework, partially offset by higher 737 MAX deliveries. The 2020 loss reflects the reach-forward loss on the 777X program of $6,493 million, lower deliveries and lower program margins resulting from the COVID-19 pandemic, 29Table of Contents$2,567 million of abnormal production costs related to the 737 program, $623 million of severance cost, $498 million of 737 MAX customer considerations, $336 million related to 737NG frame fitting component repair costs and $270 million of abnormal production costs in the first half of 2020 from the temporary suspension of operations in response to COVID-19, partially offset by lower research and development spending. Lower 787 margins reflecting a reduction in the accounting quantity in the first quarter of 2020 also contributed to lower earnings.BacklogOur total backlog represents the estimated transaction prices on unsatisfied and partially satisfied performance obligations to our customers where we believe it is probable that we will collect the consideration due and where no contingencies remain before we and the customer are required to perform. Backlog does not include prospective orders where customer-controlled contingencies remain, such as the customer receiving approval from its board of directors, shareholders or government or completing financing arrangements. All such contingencies must be satisfied or have expired prior to recording a new firm order even if satisfying such conditions is highly probable. Backlog excludes options and BCC orders as well as orders where customers have the unilateral right to terminate. A number of our customers may have contractual remedies, including rights to reject individual airplane deliveries if the actual delivery date is significantly later than the contractual delivery date. We address customer claims and requests for other contractual relief as they arise. The value of orders in backlog is adjusted as changes to price and schedule are agreed to with customers and is reported in accordance with the requirements of ASC 606.BCA total backlog of $329,824 million at December 31, 2022 increased from $296,882 million at December 31, 2021, reflecting new orders in excess of deliveries and price escalation, offset by order cancellations and by an increase in the value of existing orders that in our assessment do not meet the accounting requirements of ASC 606 for inclusion in backlog. Aircraft order cancellations during the year ended December 31, 2022 totaled $11,251 million and relate to 737 and 787 aircraft. The net ASC 606 adjustments for the year ended December 31, 2022 resulted in a decrease to backlog of $4,675 million primarily due to a net increase of 777X aircraft in the ASC 606 reserve, partially offset by net decreases in 737 and 787 aircraft in the ASC 606 reserve. ASC 606 adjustments include consideration of aircraft orders where a customer-controlled contingency may exist, as well as an assessment of whether the customer is committed to perform, impacts of geopolitical events or related sanctions, or whether it is probable that the customer will pay the full amount of consideration when it is due. If we remain unable to deliver 737 MAX aircraft in China for an extended period of time, and/or entry into service of the 777X, 737-7 and/or 737-10 is further delayed, we may experience reductions to backlog and/or significant order cancellations.Accounting Quantity The accounting quantity is our estimate of the quantity of airplanes that will be produced for delivery under existing and anticipated contracts. The determination of the accounting quantity is limited by the ability to make reasonably dependable estimates of the revenue and cost of existing and anticipated contracts. It is a key determinant of the gross margins we recognize on sales of individual airplanes throughout a program’s life. Estimation of each program’s accounting quantity takes into account several factors that are indicative of the demand for that program, including firm orders, letters of intent from prospective customers and market studies. We review our program accounting quantities quarterly.The accounting quantity for each program may include units that have been delivered, undelivered units under contract and units anticipated to be under contract in the reasonable future (anticipated orders). In developing total program estimates, all of these items within the accounting quantity must be considered.30Table of ContentsThe following table provides details of the accounting quantities and firm orders by program as of December 31. Cumulative firm orders represent the cumulative number of commercial jet aircraft deliveries plus undelivered firm orders. Firm orders include military derivative aircraft that are not included in program accounting quantities. All revenues and costs associated with military derivative aircraft production are reported in the BDS segment.Program737 747 767 777 777X787 †2022Program accounting quantities10,8001,5741,2671,790400 1,600Undelivered units under firm orders3,653110669244505(8)Cumulative firm orders11,7851,5731,3771,7702441,5422021Program accounting quantities10,4001,5741,2431,7503501,500Undelivered units under firm orders3,414610858253411(14)Cumulative firm orders11,1591,5731,3461,7352531,4172020Program accounting quantities10,0001,5741,2071,7003501,500Undelivered units under firm orders3,28287541191458(22)Cumulative firm orders10,7641,5681,2811,6941911,450† Aircraft ordered by BCC are identified in parentheses.Program Highlights737 Program The accounting quantity for the 737 program increased by 400 units during 2022 due to the program's normal progress of obtaining additional orders and delivering airplanes. We increased the production rate to 31 per month in 2022, and expect to implement further gradual production rate increases based on market demand and supply chain capacity. We expensed abnormal production costs of $188 million and $1,887 million during the years ended December 31, 2022 and 2021. Over 190 countries have approved the resumption of 737 MAX operations. The first 737 MAX passenger flight in China since 2019 occurred on January 13, 2023. There is uncertainty regarding timing of resumption of deliveries in China, which are still subject to final regulatory approvals. We continue to work with a small number of customers who have requested to defer deliveries or to cancel orders for 737 MAX aircraft, and we are remarketing and/or delaying deliveries of certain aircraft included within inventory.We have approximately 250 aircraft in inventory as of December 31, 2022, including approximately 140 aircraft in inventory that are designated for customers in China. We are remarketing some of these aircraft to other customers. We anticipate delivering most of the aircraft in inventory by the end of 2024. In the event that we are unable to resume aircraft deliveries in China or remarket those aircraft and/or ramp up deliveries consistent with our assumptions, our expectation of delivery timing could be impacted.31Table of ContentsThe 737-7 and 737-10 models are currently going through FAA certification. The Consolidated Appropriations Act, 2023 amended Section 116 of the ACSAA, such that applications for original or amended type certifications that were submitted to the FAA prior to December 27, 2020, including those of the 737-7 and 737-10, are no longer subject to the crew alerting specifications of Section 116. Additionally, beginning one year after the FAA issues the type certificate for the 737-10, any new 737 MAX aircraft must include certain safety enhancements to be issued an original airworthiness certification by the FAA. These enhancements are included in Boeing’s application for the certification for the 737-10, and the sufficiency of these enhancements will be determined by the FAA. Beginning three years after the issuance of a type certificate for the 737-10, all previously delivered 737 MAX aircraft must be retrofitted with these safety enhancements. As the holder of the type certificate, Boeing is required to bear any costs of these safety enhancement retrofits. We have provisioned for the estimated costs associated with the safety enhancements and do not expect those costs to be material.We are following the lead of the FAA as we work through the certification process, and currently expect the 737-7 to be certified and delivered in 2023, and the 737-10 to begin FAA certification flight testing in 2023 with first delivery in in 2024. At December 31, 2022, we had 27 737-7 and 3 737-10 aircraft in inventory and 236 737-7 and 720 737-10 aircraft in backlog and have delivered a total of 1,033 737 MAX aircraft. If we experience delays in achieving certification and/or incorporating safety enhancements, future revenues, cash flows and results of operations could be adversely impacted. See further discussion of the 737 MAX in Note 7 and Note 13 to our Consolidated Financial Statements.747 Program We completed production of the 747 in the fourth quarter of 2022 and delivery of the last aircraft is expected to occur in early 2023. Ending production of the 747 did not have a material impact on our financial position, results of operations or cash flows.767 Program The accounting quantity for the 767 program increased by 24 units during 2022 due to the program's normal progress of obtaining additional orders and delivering airplanes. The 767 assembly line includes the commercial program and a derivative to support the KC-46A Tanker program. The commercial program has near break-even gross margins. We are currently producing at a combined rate of 3 aircraft per month.777 and 777X Programs The accounting quantity for the 777 program increased by 40 units during 2022 due to the program's normal progress of obtaining additional orders and delivering airplanes. We are currently producing at a combined production rate of 3 per month for the 777/777X programs. The accounting quantity for the 777X program increased by 50 units during 2022 reflecting the launch of the 777X-8 freighter during the first quarter of 2022. First delivery of the 777X-8 freighter is expected in 2027. During the first quarter of 2022, we revised the estimated first delivery date of the 777X-9, previously expected in late 2023, and now expect it will occur in 2025, based on an updated assessment of the time required to meet certification requirements. We are working towards Type Inspection Authorization (TIA) which will enable us to begin FAA certification flight testing. The timing of TIA and certification will ultimately be determined by the regulators, and further determinations with respect to anticipated certification requirements could result in additional delays in entry into service and/or additional cost increases.In April 2022, we decided to pause production of the 777X-9 during 2022 and 2023. We implemented the production pause during the second quarter of 2022, and it is expected to result in abnormal production costs of approximately $1.5 billion that are being expensed as incurred until 777X-9 production resumes. During the year ended December 31, 2022, $0.3 billion of abnormal costs were period expensed.32Table of ContentsThe 777X program had near break-even gross margins at December 31, 2022. The level of profitability on the 777X program will be subject to a number of factors. These factors include continued production disruption due to labor instability and supply chain disruption, customer negotiations, further production rate adjustments for the 777X or other commercial aircraft programs, contraction of the accounting quantity and potential risks associated with the testing program and the timing of aircraft certification. One or more of these factors could result in additional reach-forward losses on the 777X program in future periods.787 Program During the fourth quarter of 2022, we increased the accounting quantity for the 787 program by 100 units due to the program’s normal progress of obtaining additional orders and delivering aircraft. The increase in the accounting quantity improved the program’s profit margin.We received FAA authorization to resume delivery on July 28, 2022 and deliveries resumed in August. During 2022, we delivered 31 aircraft to customers. We continue to conduct inspections and rework on undelivered aircraft. During 2021, we delivered 14 aircraft between March and May 2021 prior to deliveries being paused in May 2021 due to production quality issues including in our supply chain. We have implemented changes in the production process designed to ensure that newly-built airplanes meet our specifications and do not require further inspections and rework. At December 31, 2022, and 2021, we had approximately 100 and 110 aircraft in inventory. Most of the aircraft in inventory at December 31, 2022 are expected to deliver by the end of 2024. We are currently producing at low rates and expect to gradually return to 5 per month in 2023. In the third quarter of 2021, we determined that production rates below 5 per month represented abnormally low production rates and result in abnormal production costs. We also determined that the inspections and rework costs on inventoried aircraft are excessive and should also be accounted for as abnormal production costs that are required to be expensed as incurred. Cumulative abnormal costs recorded through December 31, 2022 totaled $1.7 billion. During the fourth quarter of 2022 we adjusted the total estimate of abnormal production costs up to $2.8 billion with most being incurred by the end of 2023. At December 31, 2021, we were expecting to incur approximately $2 billion of abnormal production costs on a cumulative basis. The increase was primarily driven by a decision in the fourth quarter of 2022 to slow down near-term production due to supply chain constraints and increased inspection and rework costs. We continue to work with customers and suppliers regarding timing of future deliveries and production rate changes. During the fourth quarter of 2021, we recorded a loss of $3.5 billion on the program primarily due to the additional rework, as well as other actions required to resume 787 deliveries, taking longer than expected. These impacts have resulted in longer than expected delivery delays and associated customer considerations. Fleet Support We provide the operators of our commercial aircraft with assistance and services to facilitate efficient and safe airplane operation. Collectively known as fleet support services, these activities and services begin prior to airplane delivery and continue throughout the operational life of the airplane. They include flight and maintenance training, field service support, engineering services, information services and systems and technical data and documents. The costs for fleet support are expensed as incurred and have historically been approximately 1% of total consolidated costs of products and services.33Table of ContentsProgram Development The following chart summarizes the time horizon between go-ahead and planned initial delivery for major Commercial Airplanes derivatives and programs.Go-ahead and Initial Delivery737-720112023737-1020172024777X-920132025777X-8F20222027Reflects models in development during 2022The development schedules shown above are subject to a number of uncertainties, including changes in certification requirements. The timing of certifications will ultimately be determined by the regulators.Additional ConsiderationsThe development and ongoing production of commercial aircraft is extremely complex, involving extensive coordination and integration with suppliers and highly-skilled labor from employees and other partners. Meeting or exceeding our performance and reliability standards, as well as those of customers and regulators, can be costly and technologically challenging, such as the 787 production issues and associated rework. In addition, the introduction of new aircraft and derivatives, such as the 777X, 737-7 and 737-10, involves increased risks associated with meeting development, production and certification schedules. These challenges include increased global regulatory scrutiny of all development aircraft in the wake of the 737 MAX accidents. As a result, our ability to deliver aircraft on time, satisfy performance and reliability standards and achieve or maintain, as applicable, program profitability is subject to significant risks. Factors that could result in lower margins (or a material charge if an airplane program has or is determined to have reach-forward losses) include the following: changes to the program accounting quantity, customer and model mix, production costs and rates, changes to price escalation factors due to changes in the inflation rate or other economic indicators, performance or reliability issues involving completed aircraft, capital expenditures and other costs associated with increasing or adding new production capacity, learning curve, additional change incorporation, achieving anticipated cost reductions, the addition of regulatory requirements in connection with certification in one or more jurisdictions, flight test and certification schedules, costs, schedule and demand for new airplanes and derivatives and status of customer claims, supplier claims or assertions and other contractual negotiations. While we believe the cost and revenue estimates incorporated in the consolidated financial statements are appropriate, the technical complexity of our airplane programs creates financial risk as additional completion costs may become necessary or scheduled delivery dates could be extended, which could trigger termination provisions, order cancellations or other financially significant exposure.34Table of ContentsDefense, Space & SecurityBusiness Environment and TrendsUnited States Government Defense Environment OverviewThe Consolidated Appropriations Act, 2023, enacted in December 2022, provided fiscal year 2023 (FY23) appropriations for government departments and agencies, including $817 billion for the U.S. DoD and $25.4 billion for NASA. The enacted FY23 appropriations included funding for Boeing’s major programs, including the F/A-18 Super Hornet, F-15EX, CH-47 Chinook, AH-64 Apache, V-22 Osprey, KC-46A Tanker, MQ-25, and the Space Launch System. The FY23 appropriations support F/A-18 production further into calendar year 2025. The FY23 appropriations did not include funding for additional P-8 aircraft. The P-8 program continues to pursue additional sales opportunities to extend production beyond 2024.There is ongoing uncertainty with respect to program-level appropriations for the U.S. DoD, NASA and other government agencies for fiscal year 2024 and beyond. U.S. government discretionary spending, including defense spending, is likely to continue to be subject to pressure. Future budget cuts or investment priority changes, including changes associated with the authorizations and appropriations process, could result in reductions, cancellations and/or delays of existing contracts or programs. Any of these impacts could have a material effect on our results of operations, financial position and/or cash flows.Non-U.S. Defense Environment Overview The non-U.S. market continues to be driven by complex and evolving security challenges and the need to modernize aging equipment and inventories. BDS expects that it will continue to have a wide range of opportunities across Asia, Europe and the Middle East given the diverse regional threats. At the end of 2022, 28% of BDS backlog was attributable to non-U.S. customers.Results of Operations (Dollars in millions)Years ended December 31,202220212020Revenues$23,162 $26,540 $26,257 % of total company revenues35 %43 %45 %(Loss)/earnings from operations($3,544)$1,544 $1,539 Operating margins(15.3)%5.8 %5.9 %Since our operating cycle is long-term and involves many different types of development and production contracts with varying delivery and milestone schedules, the operating results of a particular period may not be indicative of future operating results. In addition, depending on the customer and their funding sources, our orders might be structured as annual follow-on contracts, or as one large multi-year order or long-term award. As a result, period-to-period comparisons of backlog are not necessarily indicative of future workloads. The following discussions of comparative results among periods should be viewed in this context.35Table of ContentsDeliveries of new-build production units, including remanufactures and modifications, were as follows:Years ended December 31,202220212020F/A-18 Models14 21 20 F-15 Models12 16 4 CH-47 Chinook (New)19 15 27 CH-47 Chinook (Renewed)9 5 3 AH-64 Apache (New)25 27 19 AH-64 Apache (Remanufactured)50 56 52 MH-139 Grey Wolf4 KC-46 Tanker15 13 14 P-8 Models12 16 15 Commercial Satellites4 Military Satellites1 Total165 169 154 Revenues BDS revenues in 2022 decreased by $3,378 million compared with 2021 primarily due to charges on development programs. Unfavorable performance across other defense programs and lower P-8 and weapons volume also contributed to the decrease in revenue. Cumulative contract catch-up adjustments in 2022 were $1,858 million more unfavorable than the prior year largely due to charges on development programs.BDS revenues in 2021 increased by $283 million compared with 2020 primarily due to higher revenue on the KC-46A Tanker program due to new orders for 27 aircraft received during the first quarter of 2021 and lower charges in 2021. This was partially offset by lower revenues on rotorcraft programs, Commercial Crew and VC-25B. Cumulative contract catch-up adjustments in 2021 were $56 million less unfavorable than the prior year, largely due to the lower charges described below.(Loss)/earnings From Operations BDS loss from operations in 2022 of $3,544 million decreased by $5,088 million compared with earnings from operations of $1,544 million in 2021 primarily due to unfavorable impacts of cumulative contract catch-up adjustments ($4,284 million more unfavorable in 2022 than 2021). Volume and mix and higher research and development also contributed to the year over year earnings decline. Charges of fixed price development programs in 2022 included VC-25B ($1,452 million), KC-46A Tanker ($1,374 million), MQ-25 ($579 million), T-7A Red Hawk Production Options ($552 million), T-7A Red Hawk Engineering, Manufacturing and Development (EMD) ($203 million), and Commercial Crew ($288 million). These were partially offset by charges on the KC-46A Tanker ($402 million), VC-25B ($318 million), and Commercial Crew ($214 million) recognized in 2021. The net unfavorable cumulative contract catch-up adjustments represent losses incurred on these development and other programs. See further discussion of fixed-price contracts in Note 13 to our Consolidated Financial Statements. BDS earnings from operations in 2021 of $1,544 million increased by $5 million compared with earnings from operations of $1,539 million in 2020 primarily due to less unfavorable impacts from cumulative contract catch-up adjustments, which improved $219 million from the prior year, largely due to lower KC-46A Tanker charges in 2021 compared to 2020 and other charges on development programs. The $219 million change in cumulative contract catch-up adjustments was offset primarily by lower volume and mix on rotorcraft programs and lower equity earnings for United Launch Alliance (ULA). During 2020, BDS recorded charges on KC-46A Tanker ($1,320 million) and VC-25B ($168 million).36Table of ContentsBDS (loss)/earnings from operations includes our share of income from equity method investments of $13 million, $53 million and $141 million primarily from our ULA and non-U.S. joint ventures in 2022, 2021 and 2020, respectively. Earnings from our ULA joint venture increased in 2022, partially offset by losses on other operating investments.BacklogTotal backlog of $54,373 million at December 31, 2022 was $5,455 million lower than December 31, 2021 due to the timing of awards and revenue recognized on contracts awarded in prior years.Additional ConsiderationsOur BDS business includes a variety of development programs which have complex design and technical challenges. Some of these programs have cost-type contracting arrangements. In these cases, the associated financial risks are primarily in reduced fees, lower profit rates or program cancellation if cost, schedule or technical performance issues arise. Examples of these programs include Ground-based Midcourse Defense, Proprietary and Space Launch System programs.Some of our development programs are contracted on a fixed-price basis. Examples of significant fixed-price development programs include Commercial Crew, KC-46A Tanker, MQ-25, T-7A Red Hawk, VC-25B, and commercial and military satellites. A number of our ongoing fixed-price development programs have reach-forward losses. New programs could also have risk for reach-forward loss upon contract award and during the period of contract performance. Many development programs have highly complex designs. As technical or quality issues arise during development, we may experience schedule delays and cost impacts, which could increase our estimated cost to perform the work or reduce our estimated price, either of which could result in a material charge or otherwise adversely affect our financial condition. These programs are ongoing, and while we believe the cost and fee estimates incorporated in the financial statements are appropriate, the technical complexity of these programs creates financial risk as additional completion costs may become necessary or scheduled delivery dates could be extended, which could trigger termination provisions or other financially significant exposure. Risk remains that we may be required to record additional reach-forward losses in future periods.Global ServicesBusiness Environment and TrendsThe aerospace markets we serve include parts distribution, logistics and other inventory services; maintenance, engineering and upgrades; training and professional services; and data analytics and digital services. During 2022, commercial services volume at BGS recovered to pre-pandemic levels. We expect BGS commercial revenues to remain strong in future quarters as the commercial airline industry continues to recover.Over the long-term, as the size of the worldwide commercial airline fleet continues to grow, so does demand for aftermarket services designed to increase efficiency and extend the economic lives of aircraft. Airlines are using data analytics to plan flight operations and predictive maintenance to improve their productivity and efficiency. Airlines continue to look for opportunities to reduce the size and cost of their spare parts inventory, frequently outsourcing spares management to third parties.The demand outlook for our government services business has remained stable in 2022. Government services market segments are growing on pace with related fleets, but vary based on the utilization and age of the aircraft. The U.S. government services market is the single largest individual market, comprising over 50 percent of the government services markets served. Over the next decade, we 37Table of Contentsexpect U.S. growth to remain flat and non-U.S. fleets, led by Middle East and Asia Pacific customers, to add rotorcraft and commercial derivative aircraft at faster rates. We expect less than 20 percent of the worldwide fleet of military aircraft to be retired and replaced over the next ten years, driving increased demand for services to maintain aging aircraft and enhance aircraft capability.BGS’ major customer, the U.S. government, remains subject to the spending limits and uncertainty described on page 35, which could restrict the execution of certain program activities and delay new programs or competitions.Industry Competitiveness Aviation services is a competitive market with many domestic and international competitors. This market environment has resulted in intense pressures on pricing, and we expect these pressures to continue or intensify in the coming years. Continued access to global markets remains vital to our ability to fully realize our sales growth potential and long-term investment returns.Results of Operations (Dollars in millions)Years ended December 31,202220212020Revenues$17,611 $16,328 $15,543 % of total company revenues26 %26 %27 %Earnings from operations$2,727 $2,017 $450 Operating margins15.5 %12.4 %2.9 %Revenues BGS revenues in 2022 increased by $1,283 million compared with 2021 primarily due to higher commercial services volume, partially offset by lower government services volume and performance. The decrease in government services volume is partly driven by the discontinuation of an engine distribution agreement in the second quarter of 2022. The net favorable impact of cumulative contract catch-up adjustments in 2022 was $137 million lower than the prior year.BGS revenues in 2021 increased by $785 million compared with 2020 due to higher commercial and government services volume. The net favorable impact of cumulative contract catch-up adjustments in 2021 was $37 million lower than the prior year. Earnings From Operations BGS earnings from operations in 2022 increased by $710 million compared with 2021, primarily due to higher commercial services volume and favorable mix, partially offset by lower government services performance. The net unfavorable impact of cumulative contract catch-up adjustments in 2022 was $148 million worse than the net favorable impact in the prior year.BGS earnings from operations in 2021 increased by $1,567 million compared with 2020, primarily due to charges incurred in 2020 driven by impacts of the COVID-19 pandemic as well as higher commercial services volume in 2021, partially offset by an inventory write-down of $220 million recognized in the fourth quarter of 2021 driven by revised cost estimates on certain customer contracts. Charges in 2020 included $531 million of inventory write-downs, $178 million of related impairments of distribution rights primarily driven by airlines’ decisions to retire certain aircraft, $398 million for higher expected credit losses primarily driven by customer liquidity issues, $115 million of contract termination and facility impairment charges, and $72 million of severance costs. The net favorable impact of cumulative contract catch-up adjustments in 2021 was $98 million lower than the prior year.38Table of ContentsBacklogBGS total backlog of $19,338 million at December 31, 2022 decreased by 6% from $20,496 million at December 31, 2021, primarily due to revenue recognized on contracts awarded in prior years.Boeing CapitalBusiness Environment and TrendsBCC’s gross customer financing and investment portfolio at December 31, 2022 totaled $1,549 million. A substantial portion of BCC’s portfolio is composed of customers that have less than investment-grade credit. BCC’s portfolio is also concentrated by varying degrees across Boeing aircraft product types, most notably 717 and 747-8 aircraft.BCC provided customer financing of $96 million during 2022 and none during 2021. While we may be required to fund a number of new aircraft deliveries in 2023 and/or provide refinancing for existing bridge debt, we expect alternative financing will be available at reasonable prices from broad and globally diverse sources.Aircraft values and lease rates are impacted by the number and type of aircraft that are currently out of service. Approximately 4,950 western-built commercial jet aircraft (18.3% of current world fleet) were parked at the end of 2022, including both in-production and out-of-production aircraft types. Of these parked aircraft, a larger portion are expected to be retired compared to the pre-COVID-19 period, which directly impacts the Company in terms of number of new aircraft deliveries and financing opportunities, the ability of existing customers to meet current payment obligations and the value of aircraft in its portfolio. We continue to work closely with our customers to mitigate the risk. At the end of 2021 and 2020, 20.5% and 29.4% of the western-built commercial jet aircraft were parked. Aircraft valuations could decline if significant numbers of additional aircraft, particularly types with relatively few operators, are placed out of service. See Overview to Management’s Discussion and Analysis of Financial Condition and Results of Operations for a discussion of the airline industry environment.Results of Operations(Dollars in millions)Years ended December 31,202220212020Revenues$199 $272 $261 Earnings from operations$29 $106 $63 Operating margins15 %39 %24 %Revenues BCC segment revenues consist principally of lease income from equipment under operating lease, interest income from financing receivables and notes, and other income. BCC’s revenues in 2022 decreased by $73 million compared with 2021 primarily due to lower gains on re-lease of assets.Earnings From Operations BCC’s earnings from operations is presented net of interest expense, provision for (recovery of) losses, asset impairment expense, depreciation on leased equipment and other operating expenses. In 2022, earnings from operations decreased by $77 million compared with 2021, primarily due to an increase in the allowance for losses on receivables as a result of the war in Ukraine and lower revenues. Earnings from operations in 2021 increased by $43 million compared with 2020 primarily due to higher revenues, lower provision for losses, and lower interest and asset impairment expenses. 39Table of ContentsFinancial PositionThe following table presents selected financial data for BCC as of December 31:(Dollars in millions)20222021Customer financing and investment portfolio, net$1,494 $1,720 Other assets, primarily cash and short-term investments460 462 Total assets$1,954 $2,182 Other liabilities, primarily income taxes$239 $347 Debt, including intercompany loans1,425 1,525 Equity290 310 Total liabilities and equity$1,954 $2,182 Debt-to-equity ratio4.9-to-14.9-to-1BCC’s customer financing and investment portfolio at December 31, 2022 decreased $226 million from December 31, 2021, primarily due to portfolio run-off, partially offset by new volume.BCC enters into certain intercompany transactions, reflected in Unallocated items, eliminations and other, in the form of intercompany guarantees and other subsidies that mitigate the effects of certain credit quality or asset impairment issues on the BCC segment.Liquidity and Capital ResourcesCash Flow Summary(Dollars in millions)Years ended December 31,202220212020Net loss($5,053)($4,290)($11,941)Non-cash items4,426 7,851 10,866 Changes in assets and liabilities4,139 (6,977)(17,335)Net cash provided/(used) by operating activities3,512 (3,416)(18,410)Net cash provided/(used) by investing activities4,370 9,324 (18,366)Net cash (used)/provided by financing activities(1,266)(5,600)34,955 Effect of exchange rate changes on cash and cash equivalents(73)(39)85 Net increase/(decrease) in cash & cash equivalents, including restricted6,543 269 (1,736)Cash & cash equivalents, including restricted, at beginning of year8,104 7,835 9,571 Cash & cash equivalents, including restricted, at end of year$14,647 $8,104 $7,835 Operating Activities Net cash provided by operating activities was $3.5 billion during 2022, compared with net cash used by operating activities of $3.4 billion during 2021. The $6.9 billion improvement in cash provided by operating activities in 2022 is primarily driven by improved changes in assets and liabilities of $11.1 billion, partially offset by lower non-cash items of $3.4 billion and higher net loss of $0.8 billion. Changes in assets and liabilities for 2022 improved by $11.1 billion compared with 2021 primarily driven by favorable changes in Accrued liabilities ($6.6 billion), Accounts payable ($4.6 billion) and Inventories ($1.5 billion), partially offset by a decrease in Advances and progress billings ($2.4 billion) in 2022. The increase in Accrued liabilities is primarily driven by the accrued losses on BDS fixed-price development programs, lower payments to 737 MAX customers in 2022, and a $0.7 billion 40Table of Contentspayment in 2021 consistent with the terms of the Deferred Prosecution Agreement between Boeing and the U.S. Department of Justice. Concessions paid to 737 MAX customers totaled $1.0 billion and $2.5 billion during 2022 and 2021. Growth in Accounts Payable in 2022 is a source of cash while reductions in Accounts Payable in 2021 were a use of cash generally reflecting increases in production rates. Inventory improvements were driven by higher 737 MAX deliveries and resumption of 787 deliveries in 2022. Additionally, in 2022 and 2021 we received income tax refunds of $1.5 billion and $1.7 billion. Cash provided by Advances and progress billings was $0.1 billion in 2022, as compared with $2.5 billion of cash provided in 2021. The $3.4 billion reduction in non-cash items in 2022 is primarily driven by the $3.5 billion reach-forward loss on the 787 program that was recorded in 2021. Net loss for 2022 was $5.1 billion compared with net loss of $4.3 billion in 2021. The $0.8 billion year-over-year increase in the net loss is primarily driven by the absence of an income tax benefit in 2022. The reduction in cash used by operating activities in 2021 compared with 2020 is primarily driven by lower net loss and improved changes in assets and liabilities. Non-cash items in 2021 include the $3.5 billion reach-forward loss on the 787 program which was recorded as a reduction to inventory, as well as $1.2 billion of treasury shares issued to fund Company contributions to the 401(k) plan and $0.8 billion of share-based plans expense reflecting a one-time stock grant to most employees in lieu of 2021 salary increases. The changes in assets and liabilities reflect the significant increase in commercial aircraft inventory in 2020 driven by lower deliveries due to the COVID-19 pandemic and the 737 MAX grounding. In 2021, inventory growth slowed as the continued buildup of 787 aircraft caused by production issues and 777X inventory growth was partially offset by a decrease in 737 MAX inventory following the resumption of deliveries. Compensation payments to 737 MAX customers totaled $2.5 billion in 2021 and $2.2 billion in 2020. In the first quarter of 2021, we paid $0.7 billion consistent with the terms of the Deferred Prosecution Agreement between Boeing and the U.S. Department of Justice. Additionally, in 2021, we received income tax refunds of $1.7 billion. Cash provided by Advances and progress billings was $2.5 billion in 2021, as compared with Cash used by Advances and progress billings of $1.1 billion in 2020. At December 31, 2022 and 2021, Accounts payable included $2.5 billion and $2.3 billion payable to suppliers who have elected to participate in supply chain financing programs. Payables to suppliers who elected to participate in supply chain financing programs increased by $0.2 billion in 2022 and declined by $1.5 billion and $1.9 billion in 2021 and 2020. Supply chain financing is not material to our overall liquidity. The declines in 2021 and 2020 were primarily due to reductions in commercial purchases from suppliers. Investing Activities Cash provided by investing activities during 2022 was $4.4 billion, compared with cash provided by investing activities of $9.3 billion during 2021 and cash used by investing activities of $18.4 billion during 2020. The decrease in cash inflows in 2022 compared to 2021 is primarily due to $5.6 billion of net proceeds from investments compared to $9.8 billion in 2021. The increase in cash inflows in 2021 compared to 2020 is primarily due to $27.1 billion of higher net proceeds from investments. Capital expenditures totaled $1.2 billion in 2022, compared with $1.0 billion in 2021 and $1.3 billion in 2020. We expect capital expenditures in 2023 to be higher than in 2022.Financing Activities Cash used by financing activities was $1.3 billion during 2022, compared with $5.6 billion during 2021 and cash provided of $35.0 billion in 2020. The decrease of $4.3 billion compared with 2021 primarily reflects higher net debt repayments in 2021. During 2021, debt repayments net of new borrowings were $5.6 billion, primarily due to $13.8 billion of repayments of our two-year delayed draw term loan credit agreement, partially offset by $9.8 billion of fixed rate senior notes issued in the first quarter of 2021. During the year ended December 31, 2020, new borrowings net of repayments were $36.3 billion, primarily due to $29.9 billion of fixed rate senior notes issued in 2020 and $13.8 billion of new borrowings under a two-year delayed draw term loan agreement entered into in the first quarter of 2020. 41Table of ContentsAt December 31, 2022 and 2021 debt balances totaled $57.0 billion and $58.1 billion, of which $5.2 billion and $1.3 billion were classified as short-term. This included $1.4 billion and $1.5 billion of debt attributable to BCC at December 31, 2022 and 2021, of which $0.2 billion and $0.3 billion were classified as short-term.During the years ended December 31, 2022, 2021 and 2020, we did not repurchase any shares through our open market share repurchase program. Share repurchases under this program have been suspended since April 2019. In March 2020, the Board of Directors terminated its prior authorization to repurchase shares of the Company's outstanding common stock in the open market. We had 0.2 million, 0.3 million and 0.6 million shares transferred to us from employee tax withholdings in 2022, 2021 and 2020, respectively. In March 2020, we announced the suspension of our dividend until further notice. As a result, we did not pay any dividends in 2022 and 2021 compared with $1.2 billion paid in 2020. 42Table of ContentsCapital ResourcesThe following table summarizes certain cash requirements for known contractual and other obligations as of December 31, 2022, and the estimated timing thereof. See Note 12 for future operating lease payments.(Dollars in millions)CurrentLong-termTotalLong-term debt (including current portion)$5,197 $52,338 $57,535 Interest on debt2,266 31,397 33,663 Pension and other postretirement519 8,133 8,652 Purchase obligations62,025 59,515 121,540 737 MAX customer concessions and consideration(1)100 600 700 (1) For further discussion, see Note 13 to our Consolidated Financial Statements.We expect to be able to fund our cash requirements through cash and short-term investments and cash provided by operations, as well as continued access to capital markets. At December 31, 2022, we had $14.6 billion of cash, $2.6 billion of short-term investments, and $12.0 billion of unused borrowing capacity on revolving credit line agreements. In the third quarter of 2022, we entered into a $5.8 billion 364-day revolving credit agreement expiring in August 2023, a $3 billion three-year revolving credit agreement expiring in August 2025, and amended our $3.2 billion five-year revolving credit agreement, which expires in October 2024, primarily to incorporate a LIBOR successor rate. The 364-day credit facility has a one-year term out option which allows us to extend the maturity of any borrowings one year beyond the aforementioned expiration date. We anticipate that these credit lines will remain undrawn and primarily serve as back-up liquidity to support our general corporate borrowing needs. Our increased debt balance resulted in downgrades to our credit ratings in 2020, and our ratings remained unchanged in 2022 and 2021. We expect to be able to access capital markets when we require additional funding in order to pay off existing debt, address further impacts to our business related to market developments, fund outstanding financing commitments or meet other business requirements. A number of factors could cause us to incur increased borrowing costs and to have greater difficulty accessing public and private markets for debt. These factors include disruptions or declines in the global capital markets and/or a decline in our financial performance, outlook or credit ratings, and/or associated changes in demand for our products and services. These risks will be particularly acute if we are subject to further credit rating downgrades. The occurrence of any or all of these events may adversely affect our ability to fund our operations and financing or contractual commitments.Any future borrowings may affect our credit ratings and are subject to various debt covenants. At December 31, 2022, we were in compliance with the covenants for our debt and credit facilities. The most restrictive covenants include a limitation on mortgage debt and sale and leaseback transactions as a percentage of consolidated net tangible assets (as defined in the credit agreements) and a limitation on consolidated debt as a percentage of total capital (as defined in the credit agreements). When considering debt covenants, we continue to have substantial borrowing capacity.43Table of ContentsPension and Other Postretirement Benefits Pension cash requirements are based on an estimate of our minimum funding requirements, pursuant to Employee Retirement Income Security Act (ERISA) regulations, although we may make additional discretionary contributions. Estimates of other postretirement benefits are based on both our estimated future benefit payments and the estimated contributions to plans that are funded through trusts.At December 31, 2022 and 2021, our pension plans were $5.3 billion and $7.8 billion underfunded as measured under Generally Accepted Accounting Principles in the United States of America (GAAP). On an ERISA basis our plans are more than 100% funded at December 31, 2022. We do not expect to make significant contributions to our pension plans in 2023. We may be required to make higher contributions to our pension plans in future years.In the fourth quarter of 2020, we contributed $3 billion of our common stock to our pension fund. In the fourth quarter of 2020, we also began using our common stock in lieu of cash to fund Company contributions to our 401(k) plans for the foreseeable future. Under this approach, common stock is contributed to our 401(k) plans following each pay period. This further enables the Company to conserve cash. We have retained an independent fiduciary to manage and liquidate stock contributed to these plans at its discretion.Purchase Obligations Purchase obligations represent contractual agreements to purchase goods or services that are legally binding; specify a fixed, minimum or range of quantities; specify a fixed, minimum, variable or indexed price provision; and specify approximate timing of the transaction. Purchase obligations include amounts recorded as well as amounts that are not recorded on the Consolidated Statements of Financial Position.Purchase obligations not recorded on the Consolidated Statements of Financial Position include agreements for inventory procurement, tooling costs, electricity and natural gas contracts, property, plant and equipment, customer financing equipment and other miscellaneous production related obligations. The most significant obligation relates to inventory procurement contracts. We have entered into certain significant inventory procurement contracts that specify determinable prices and quantities, and long-term delivery timeframes. In addition, we purchase raw materials on behalf of our suppliers. These agreements require suppliers and vendors to be prepared to build and deliver items in sufficient time to meet our production schedules. The need for such arrangements with suppliers and vendors arises from the extended production planning horizon for many of our products. A significant portion of these inventory commitments is supported by firm contracts with customers and/or has historically resulted in settlement through reimbursement from customers for penalty payments to the supplier should the customer not take delivery. These amounts are also included in our forecasts of costs for program and contract accounting. Some inventory procurement contracts may include escalation adjustments. In these limited cases, we have included our best estimate of the effect of the escalation adjustment in the amounts disclosed in the table above.Purchase obligations recorded on the Consolidated Statements of Financial Position primarily include accounts payable and certain other current and long-term liabilities including accrued compensation.We have entered into various industrial participation agreements with certain customers outside of the U.S. to facilitate economic flow back and/or technology or skills transfer to their businesses or government agencies as the result of their procurement of goods and/or services from us. These commitments may be satisfied by our local operations there, placement of direct work or vendor orders for supplies, opportunities to bid on supply contracts, transfer of technology or other forms of assistance. However, in certain cases, our commitments may be satisfied through other parties (such as our vendors) who purchase supplies from our non-U.S. customers. In certain cases, penalties could be imposed if we do not meet our industrial participation commitments. During 2022, we incurred no such penalties. As of December 31, 2022, we had outstanding industrial participation agreements 44Table of Contentstotaling $24.8 billion that extend through 2034. Purchase order commitments associated with industrial participation agreements are included in purchase obligations. To be eligible for such a purchase order commitment from us, a non-U.S. supplier must have sufficient capability to meet our requirements and must be competitive in cost, quality and schedule.Off-Balance Sheet Arrangements We are a party to certain off-balance sheet arrangements including certain guarantees. For discussion of these arrangements, see Note 14 to our Consolidated Financial Statements.Commercial CommitmentsThe following table summarizes our commercial commitments outstanding as of December 31, 2022.(Dollars in millions)Total AmountsCommitted/MaximumAmount of LossLess than1 year1-3years4-5yearsAfter 5yearsStandby letters of credit and surety bonds$5,070 $3,859 $1,036 $10 $165 Commercial aircraft financing commitments16,105 3,084 5,989 4,075 2,957 Total commercial commitments$21,175 $6,943 $7,025 $4,085 $3,122 Commercial aircraft financing commitments include commitments to provide financing related to aircraft on order, under option for deliveries or proposed as part of sales campaigns or refinancing with respect to delivered aircraft, based on estimated earliest potential funding dates. Customer financing commitments totaled $16.1 billion and $12.9 billion at December 31, 2022 and 2021. The increase relates to new financing commitments. We anticipate that we will not be required to fund a significant portion of our financing commitments as we continue to work with third party financiers to provide alternative financing to customers. Historically, we have not been required to fund significant amounts of outstanding commitments. However, there can be no assurances that we will not be required to fund greater amounts than historically required. See Note 13 to our Consolidated Financial Statements.Contingent ObligationsWe have significant contingent obligations that arise in the ordinary course of business, which include the following:Legal Various legal proceedings, claims and investigations are pending against us. Legal contingencies are discussed in Note 21 to our Consolidated Financial Statements.Environmental Remediation We are involved with various environmental remediation activities and have recorded a liability of $752 million at December 31, 2022. For additional information, see Note 13 to our Consolidated Financial Statements.Non-GAAP MeasuresCore Operating Loss, Core Operating Margin and Core Loss Per ShareOur Consolidated Financial Statements are prepared in accordance with GAAP which we supplement with certain non-GAAP financial information. These non-GAAP measures should not be considered in isolation or as a substitute for the related GAAP measures, and other companies may define such measures differently. We encourage investors to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure. Core operating earnings, core operating margin and core earnings per share exclude the FAS/CAS service cost adjustment. The FAS/45Table of ContentsCAS service cost adjustment represents the difference between the Financial Accounting Standards (FAS) pension and postretirement service costs calculated under GAAP and costs allocated to the business segments. Core earnings per share excludes both the FAS/CAS service cost adjustment and non-operating pension and postretirement expenses. Non-operating pension and postretirement expenses represent the components of net periodic benefit costs other than service cost. Pension costs, comprising service and prior service costs computed in accordance with GAAP are allocated to BCA and certain BGS businesses supporting commercial customers. Pension costs allocated to BDS and BGS businesses supporting government customers are computed in accordance with U.S. Government Cost Accounting Standards (CAS), which employ different actuarial assumptions and accounting conventions than GAAP. CAS costs are allocable to government contracts. Other postretirement benefit costs are allocated to all business segments based on CAS, which is generally based on benefits paid.The Pension FAS/CAS service cost adjustments recognized in Loss from operations were benefits of $849 million in 2022, $882 million in 2021 and $1,024 million in 2020. The lower benefits in 2022 and 2021 were primarily due to reductions in allocated pension cost year over year. The non-operating pension expense included in Other income, net was a benefit of $881 million in 2022, $528 million in 2021 and $340 million in 2020. The higher benefits in 2022 were primarily due to lower amortization of net actuarial losses and a settlement loss that was recorded in 2021. For further discussion of pension and other postretirement costs, see the Management’s Discussion and Analysis on page 24 of this Form 10-K and see Note 22 to our Consolidated Financial Statements. Management uses core operating earnings, core operating margin and core earnings per share for purposes of evaluating and forecasting underlying business performance. Management believes these core earnings measures provide investors additional insights into operational performance as unallocated pension and other postretirement benefit cost primarily represent costs driven by market factors and costs not allocable to U.S. government contracts.46Table of ContentsReconciliation of Non-GAAP Measures to GAAP MeasuresThe table below reconciles the non-GAAP financial measures of core operating loss, core operating margins and core loss per share with the most directly comparable GAAP financial measures of loss from operations, operating margins and diluted loss per share.(Dollars in millions, except per share data)Years ended December 31, 202220212020Revenues$66,608 $62,286 $58,158 Loss from operations, as reported($3,547)($2,902)($12,767)Operating margins(5.3)%(4.7)%(22.0)%Pension FAS/CAS service cost adjustment(1)($849)($882)($1,024)Postretirement FAS/CAS service cost adjustment(1)(294)(291)(359)FAS/CAS service cost adjustment(1)($1,143)($1,173)($1,383)Core operating loss (non-GAAP)($4,690)($4,075)($14,150)Core operating margins (non-GAAP)(7.0)%(6.5)%(24.3)%Diluted loss per share, as reported($8.30)($7.15)($20.88)Pension FAS/CAS service cost adjustment(1)(1.43)(1.50)(1.80)Postretirement FAS/CAS service cost adjustment(1)(0.49)(0.49)(0.63)Non-operating pension expense(2)(1.47)(0.91)(0.60)Non-operating postretirement expense(2)(0.10) 0.03 Provision for deferred income taxes on adjustments (3)0.73 0.61 0.63 Core loss per share (non-GAAP)($11.06)($9.44)($23.25)Weighted average diluted shares (in millions)595.2 588.0 569.0 (1)FAS/CAS service cost adjustment represents the difference between the FAS pension and postretirement service costs calculated under GAAP and costs allocated to the business segments. This adjustment is excluded from Core operating loss (non-GAAP).(2)Non-operating pension and postretirement expenses represent the components of net periodic benefit costs other than service cost. These expenses are included in Other income, net and are excluded from Core loss per share (non-GAAP).(3)The income tax impact is calculated using the U.S. corporate statutory tax rate.47Table of ContentsCritical Accounting Policies & Estimates Accounting for Long-term ContractsSubstantially all contracts at BDS and certain contracts at BGS are long-term contracts. Our long-term contracts typically represent a single distinct performance obligation due to the highly interdependent and interrelated nature of the underlying goods and/or services and the significant service of integration that we provide.Accounting for long-term contracts involves a judgmental process of estimating the total sales, costs, and profit for each performance obligation. Cost of sales is recognized as incurred, and revenue is determined by adding a proportionate amount of the estimated profit to the amount reported as cost of sales.Due to the size, duration and nature of many of our long-term contracts, the estimation of total sales and costs through completion is complicated and subject to many variables. Total sales estimates are based on negotiated contract prices and quantities, modified by our assumptions regarding contract options, change orders, incentive and award provisions associated with technical performance, and price adjustment clauses (such as inflation or index-based clauses). The majority of these long-term contracts are with the U.S. government where the price is generally based on estimated cost to produce the product or service plus profit. Federal Acquisition Regulations provide guidance on the types of cost that will be reimbursed in establishing contract price. Total cost estimates are largely based on negotiated or estimated purchase contract terms, historical performance trends, business base and other economic projections. Factors that influence these estimates include inflationary trends, technical and schedule risk, internal and subcontractor performance trends, business volume assumptions, asset utilization, anticipated labor agreements, and lingering impacts of COVID-19.Revenue and cost estimates for all significant long-term contract performance obligations are reviewed and reassessed quarterly. Changes in these estimates could result in recognition of cumulative catch-up adjustments to the performance obligation’s inception to date revenues, cost of sales and profit in the period in which such changes are made. Changes in revenue and cost estimates could also result in a reach-forward loss or an adjustment to a reach-forward loss which would be recorded immediately in earnings. Net cumulative catch-up adjustments for changes in estimated revenues and costs at completion across all long-term contracts, including the impact of increases in estimated losses on unexercised options, increased Loss from operations by $5,253 million, $880 million and $942 million in 2022, 2021 and 2020, respectively. The cumulative catch-up adjustments in 2022 were primarily due to losses recognized on the VC-25B, KC-46A Tanker, MQ-25, Commercial Crew and T-7A Red Hawk programs. These are all fixed-price development programs, and there is ongoing risk that similar losses may have to be recognized in future periods on these and/or other programs.Due to the significance of judgment in the estimation process described above, it is likely that materially different earnings could be recorded if we used different assumptions or if the underlying circumstances were to change. Changes in underlying assumptions/estimates, internal and supplier performance, inflationary trends, or other circumstances may adversely or positively affect financial performance in future periods. If the combined gross margins for our profitable long-term contracts had been estimated to be higher or lower by 1% during 2022, it would have increased or decreased pre-tax income for the year by approximately $300 million.Program AccountingProgram accounting requires the demonstrated ability to reliably estimate revenues, costs and gross profit margin for the defined program accounting quantity. A program consists of the estimated number of units (accounting quantity) of a product to be produced in a continuing, long-term production effort for 48Table of Contentsdelivery under existing and anticipated contracts. The determination of the accounting quantity is limited by the ability to make reasonably dependable estimates.Factors that must be estimated include program accounting quantity, sales price, labor and employee benefit costs, material costs, procured part costs, major component costs, overhead costs, program tooling and other non-recurring costs, and warranty costs. Estimation of the accounting quantity for each program takes into account several factors that are indicative of the demand for the particular program, such as firm orders, letters of intent from prospective customers and market studies. Total estimated program sales are determined by estimating the model mix and sales price for all unsold units within the accounting quantity, added together with the sales prices for all undelivered units under contract. The sales prices for all undelivered units within the accounting quantity include an escalation adjustment for inflation that is updated quarterly. Cost estimates are based largely on negotiated and anticipated contracts with suppliers, historical performance trends, and business base and other economic projections. Factors that influence these estimates include production rates, internal and subcontractor performance trends, learning curve, change incorporation, regulatory requirements in connection with certification, flight test and certification schedules, performance or reliability issues involving completed aircraft, customer and/or supplier claims or assertions, asset utilization, anticipated labor agreements, inflationary or deflationary trends, and lingering impacts of COVID-19.To ensure reliability in our estimates, we employ a rigorous estimating process that is reviewed and updated on a quarterly basis. This includes reassessing the accounting quantity. Changes in estimates of program gross profit margins are normally recognized on a prospective basis; however, when estimated costs to complete a program plus costs already included in inventory exceed estimated revenues from the program, a loss is recorded in the current period. Reductions to the estimated loss are included in the gross profit margin for undelivered units in the accounting quantity whereas increases to the estimated loss are recorded as an earnings charge in the period in which the loss is determined.The 767, 777X, and 787 programs had near break-even or single digit margins at December 31, 2022. Adverse changes to the revenue and/or cost estimates for these programs could result in earnings charges in future periods.777X Program The 777X program had near break-even gross margins at December 31, 2022. The level of profitability on the 777X program will be subject to a number of factors. These factors include continued production disruption due to labor instability and supply chain disruption, customer negotiations, further production rate adjustments for the 777X or other commercial aircraft programs, contraction of the accounting quantity and potential risks associated with the testing program and the timing of aircraft certification. One or more of these factors could result in additional reach-forward losses on the 777X program in future periods, which may be material.787 Program During the fourth quarter of 2021, we recorded a loss of $3.5 billion on the 787 program primarily due to rework driving longer delivery delays than were previously expected and associated customer considerations. During the fourth quarter of 2022, we increased the 787 program accounting quantity by 100 units due to the program’s normal progress of obtaining additional orders and delivering aircraft. The increase in the accounting quantity improved the program’s profit margin.Our program revenue and cost assumptions reflect our current best estimate. However, if we are required to reduce the accounting quantity and/or production rates, experience further delivery delays, incur additional customer considerations, or experience other factors that result in lower margins, the 787 program could record additional losses in future periods, which may be material.49Table of ContentsPension PlansMany of our employees have earned benefits under defined benefit pension plans. The majority of employees that had participated in defined benefit pension plans have transitioned to a company-funded defined contribution retirement savings plan. Accounting rules require an annual measurement of our projected obligation and plan assets. These measurements are based upon several assumptions, including the discount rate and the expected long-term rate of asset return. Future changes in assumptions or differences between actual and expected outcomes can significantly affect our future annual expense, projected benefit obligation and Shareholders’ equity.The projected benefit obligation is sensitive to discount rates. The projected benefit obligation would decrease by $1,270 million or increase by $1,415 million if the discount rate increased or decreased by 25 basis points. A 25 basis point change in the discount rate would not have a significant impact on pension cost. However, net periodic pension cost is sensitive to changes in the expected long-term rate of asset return. A decrease or increase of 25 basis points in the expected long-term rate of asset return would have increased or decreased 2022 net periodic pension cost by $158 million. See Note 16 of the Notes to our Consolidated Financial Statements, which includes the discount rate and expected long-term rate of asset return assumptions for the last three years.Deferred Income Taxes – Valuation AllowanceThe Company had deferred income tax assets of $12,301 million at December 31, 2022 that can be used in future years to offset taxable income and reduce income taxes payable. The Company had deferred income tax liabilities of $9,306 million at December 31, 2022 that will partially offset deferred income tax assets and result in higher taxable income in future years and increase income taxes payable. Tax law determines whether future reversals of temporary differences will result in taxable and deductible amounts that offset each other in future years. The particular years in which temporary differences result in taxable or deductible amounts generally are determined by the timing of the recovery of the related asset or settlement of the related liability.On a quarterly basis, we assess the likelihood that we will be able to recover our deferred tax assets against future sources of taxable income and reduce the carrying amounts of deferred tax assets by recording a valuation allowance if, based on the available evidence, it is more likely than not (defined as a likelihood of more than 50%) that all or a portion of such assets will not be realized.This assessment takes into account both positive and negative evidence. A recent history of financial reporting losses is heavily weighted as a source of objectively verifiable negative evidence. Due to our recent history of losses, we determined we could not include future projected earnings in our analysis. Rather, we use systematic and logical methods to estimate when deferred tax liabilities will reverse and generate taxable income and when deferred tax assets will reverse and generate tax deductions. The selection of methodologies and assessment of when temporary differences will result in taxable or deductible amounts involves significant management judgment and is inherently complex and subjective. We believe that the methodologies we use are reasonable and can be replicated on a consistent basis in future periods.Deferred tax liabilities represent the assumed source of future taxable income and the majority are assumed to generate taxable amounts during the next five years. Deferred tax assets include amounts related to pension and other postretirement benefits that are assumed to generate significant deductible amounts beyond five years. The Company’s valuation allowance of $3,162 million at December 31, 2022 primarily relates to pension and other postretirement benefit obligation deferred tax assets, tax credits and other carryforwards that are assumed to reverse beyond the period in which reversals of deferred tax liabilities are assumed to occur. During 2022, the Company increased the valuation allowance by $739 million primarily due to tax credits and other carryforwards generated in 2022 that 50Table of Contentscannot be realized in 2022, partially offset by favorable pension remeasurement. Until the Company generates sustained levels of profitability, additional valuation allowances may have to be recorded with corresponding adverse impacts on earnings and/or other comprehensive income.For additional information regarding income taxes, see Note 4 of the Notes to the Consolidated Financial Statements.Item 7A. Quantitative and Qualitative Disclosures About Market RiskInterest Rate RiskWe have financial instruments that are subject to interest rate risk, principally fixed- and floating-rate debt obligations, and customer financing assets and liabilities. The investors in our fixed-rate debt obligations do not generally have the right to demand we pay off these obligations prior to maturity. Therefore, exposure to interest rate risk is not believed to be material for our fixed-rate debt. As of December 31, 2022, we do not have any significant floating-rate debt obligations. Historically, we have not experienced material gains or losses on our customer financing assets and liabilities due to interest rate changes.Foreign Currency Exchange Rate RiskWe are subject to foreign currency exchange rate risk relating to receipts from customers and payments to suppliers in foreign currencies. We use foreign currency forward contracts to hedge the price risk associated with firmly committed and forecasted foreign denominated payments and receipts related to our ongoing business. Foreign currency forward contracts are sensitive to changes in foreign currency exchange rates. At December 31, 2022, a 10% increase or decrease in the exchange rate in our portfolio of foreign currency contracts would have increased or decreased our unrealized losses by $232 million. Consistent with the use of these contracts to neutralize the effect of exchange rate fluctuations, such unrealized losses or gains would be offset by corresponding gains or losses, respectively, in the remeasurement of the underlying transactions being hedged. When taken together, these forward currency contracts and the offsetting underlying commitments do not create material market risk.Commodity Price RiskWe are subject to commodity price risk relating to commodity purchase contracts for items used in production that are subject to changes in the market price. We use commodity swaps and commodity purchase contracts to hedge against these potentially unfavorable price changes. Our commodity purchase contracts and derivatives are both sensitive to changes in the market price. At December 31, 2022, a 10% increase or decrease in the market price in our commodity derivatives would have increased or decreased our unrealized losses by $70 million. Consistent with the use of these contracts to neutralize the effect of market price fluctuations, such unrealized losses or gains would be offset by corresponding gains or losses, respectively, in the remeasurement of the underlying transactions being hedged. When taken together, these commodity purchase contracts and the offsetting swaps do not create material market risk.51Table of Contents
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K for additional information regarding measures we are undertaking.Product OfferingsOur core businesses are organized into two reportable segments: MedSurg and Cardiovascular. The following describes our key product offerings and new product innovations by reportable segment.MedSurgEndoscopyOur Endoscopy business develops and manufactures devices to diagnose and treat a broad range of gastrointestinal and pulmonary conditions with innovative, less invasive technologies. Our product offerings include the following:•Resolution 360™ Clips and Resolution 360™ ULTRA Clips, hemostatic clipping technology designed to stop and help prevent bleeding during endoscopic procedures, •WallFlex™ Biliary Stent Systems, used for relieving biliary obstructions by providing bile drainage in both malignant and benign strictures,3•AXIOS™ Stents and Electrocautery Enhanced Delivery Systems, the first, and currently only stents systems in the U.S. indicated for endoscopic drainage of pancreatic pseudocysts,•SpyGlass™ DS II Direct Visualization Systems and SpyGlass™ Discover Digital Catheters, the first single-use scopes to enable physicians to take a single-stage approach to diagnostic and therapeutic procedures in the pancreaticobiliary system, including treating patients with bile duct stones,•EXALT™ Model D Single-Use Duodenoscopes for use in endoscopic retrograde cholangiopancreatography (ERCP) procedures, the first U.S. Food and Drug Administration (FDA)-cleared single-use (disposable) duodenoscopes on the market,•Acquire™ Endoscopic Ultrasound Fine Needle Biopsy Devices, which are designed to obtain larger tissue specimens for histological assessment and diagnosis of diseases such as pancreatic cancer, liver cancer and stomach lesions and•our infection prevention portfolio, designed to minimize the risk of infection transmission and improve operational efficiencies by streamlining manual cleaning or eliminating the need for cleaning and tracking.UrologyOur Urology business develops and manufactures devices to treat various urological and pelvic conditions for both male and female anatomies, including kidney stones, benign prostatic hyperplasia (BPH), prostate cancer, erectile dysfunction and incontinence. Our product offerings include the following:•a comprehensive line of stone management products, including ureteral stents, catheters, baskets, guidewires, sheaths and balloons,•LithoVue™ Single-Use Digital Flexible Ureteroscopes, which deliver detailed high-resolution digital images for high-quality visualization and seamless navigation, •Lumenis Pulse™ Holmium Laser Systems with MOSES™ Technology, complemented by a full line of laser fibers and accessories used in urology and otolaryngology procedures,•our Prosthetic Urology portfolio, which includes AMS 700™, our penile implants to treat erectile dysfunction and AMS 800™, our urinary control systems to treat male urinary incontinence,•GreenLight XPS™ Laser System, MoXy™ Fiber, and Rezūm™ Systems for treatment of BPH and •SpaceOAR™ Hydrogel Systems which help reduce side effects that men may experience after receiving radiotherapy to treat prostate cancer, together with our SpaceOAR VUE™ Hydrogel, providing clinicians with enhanced product visualization.In the third quarter of 2022, we launched the Rezūm™ Water Vapor Therapy System in Japan following regulatory approval from Japan’s Ministry of Health, Labor and Welfare (MHLW) and received approval of a new reimbursement category from Japan’s Central Social Insurance Medical Counsel (Chuikyo) for both the device and procedure.In the first quarter of 2023, we received FDA clearance for and will begin a limited market release of our LithoVue™ Elite Single-Use Digital Flexible Ureteroscope System, the first ureteroscope system with the ability to monitor intrarenal pressure in real-time during ureteroscopy procedures.NeuromodulationOur Neuromodulation business develops and manufactures devices to treat various neurological movement disorders and manage chronic pain. Our product offerings include the following:•Precision Montage™ and WaveWriter Alpha™ Spinal Cord Stimulator (SCS) Systems, designed to provide improved pain relief to a wide range of patients who suffer from chronic pain, with proprietary features such as Multiple Independent Current Control, our Illumina 3D™ Proprietary Programming Software and FAST™ Therapy for profound parathesia-free pain relief in minutes, used by physicians to target specific areas of pain and customize stimulation of nerve fibers more precisely,•our G4™ Generator and consumable portfolio in Radiofrequency Ablation (RFA) for pain management used by physicians to treat patients with chronic pain,•Our Cognita™ Practice Optimization suite of tools designed to increase awareness, streamline patient management, and sustain long-term outcomes for patients,•Vercise Gevia™ and Vercise Genus™ Deep Brain Stimulation (DBS) Systems for the treatment of Parkinson's disease, tremor, and intractable primary and secondary dystonia, a neurological movement disorder characterized by involuntary muscle contractions and4•Superion™ Indirect Decompression Systems, minimally-invasive devices used to improve physical function and reduce pain in patients with moderate lumbar spinal stenosis (LSS).Our Vercise™ DBS Systems are approved in the U.S. as an adjunctive therapy that aids in reducing some of the symptoms of moderate to advanced Parkinson’s disease as well as for patients diagnosed with essential tremor. The Vercise Genus™ DBS platform features a full portfolio of primary cell and rechargeable MRI conditional systems with Bluetooth connectivity and the Cartesia™ Directional Lead, providing multi-directional stimulation designed for greater precision, intended to minimize side effects for patients. In 2022, we further expanded our portfolio with Image Guided Programming with the US release of Stimview™ XT, a proprietary DBS visualization software developed in collaboration with Brainlab AG, providing clinicians with real-time, 3D visualization and stimulation of brain anatomy.CardiovascularCardiologyInterventional Cardiology Therapies (ICTx)Our Interventional Cardiology Therapies business develops and manufactures technologies for diagnosing and treating coronary artery disease and aortic valve conditions. Our product offerings include the following:•OptiCross™ IVUS Imaging Catheters,•iLab™ Ultrasound Imaging Systems with Polaris Software, designed to enhance the diagnosis and treatment of blocked vessels and other heart disorders, compatible with our full line of imaging catheters,•AVVIGO™ Guidance Systems and AVVIGO™ Guidance System II, incorporating high-definition IVUS all in a mobile or integrated platform, •ROTAPRO™ Rotational Atherectomy Systems, which regulate the flow of air to the advancer, controlling burr rotation speed, and also monitor and display burr rotation speed and rotational atherectomy procedural time,•SYNERGY™, SYNERGY MEGATRON™ and SYNERGY™ XD Everolimus-Eluting Platinum Chromium Coronary Stent Systems, featuring an ultra-thin abluminal (outer) bioabsorbable polymer coating,•Safari2™ Pre-Shaped Guidewires, intended to facilitate the introduction and placement of interventional devices within the heart,•ACURATE neo2™ Aortic Valve Systems for use in transcatheter aortic valve replacement (TAVR) procedures and •SENTINEL™ Cerebral Embolic Protection Systems, used to reduce the risk of stroke in TAVR procedures and is clinically proven to decrease cerebral embolization and its associated neurological effects.WatchmanOur WATCHMAN FLX™ Left Atrial Appendage Closure (LAAC) Devices are designed to close the left atrial appendage in patients with non-valvular atrial fibrillation who are at risk for ischemic stroke. WATCHMAN™ is the first device to offer a non-pharmacologic alternative to oral anti-coagulants that has been studied in a randomized clinical trial and is the leading device in percutaneous LAAC globally.Cardiac Rhythm ManagementOur Cardiac Rhythm Management (CRM) business develops and manufactures a variety of implantable devices that monitor the heart and deliver electricity to treat cardiac abnormalities. Our product offerings include the following: •the RESONATE™ family of implantable cardioverter defibrillators (ICD) and implantable cardiac resynchronization therapy defibrillators (CRT-D), including our proprietary HeartLogic™ Heart Failure (HF) Diagnostic and SmartCRT™ Technology with Multisite pacing in CRT-D, •EMBLEM™ MRI S-ICD System, the world's first, and currently only, commercially available subcutaneous implantable cardiac defibrillators (S-ICD), which provides physicians the ability to treat patients who are at risk for sudden cardiac arrest without touching the heart,•ACCOLADE™ family of pacemakers and implantable cardiac resynchronization therapy pacemakers (CRT-P),•ACUITY™ X4 Quadripolar LV Leads, RELIANCE™ family of ICD Leads and our INGEVITY™ Pacing Leads,•LATITUDE™ Remote Patient Management Systems, which allow for more frequent monitoring and better guided treatment decisions by enabling physicians to monitor implantable system performance remotely,5•LUX-Dx™ Insertable Cardiac Monitor (ICM) systems, long-term diagnostic devices implanted in patients to detect arrhythmias associated with conditions such as atrial fibrillation (AF), cryptogenic stroke and syncope and •BodyGuardian™ remote cardiac monitoring systems provide a full range of mobile health solutions and remote monitoring services, ranging from ambulatory cardiac monitors – including short and long-term holter monitors – to cardiac event monitors and mobile cardiac telemetry.Our entire transvenous defibrillator portfolio leverages our EnduraLife™ Battery Technology and has magnetic resonance imaging (MRI) conditional labeling when used with our current generation of leads.ElectrophysiologyOur Electrophysiology business develops and manufactures less-invasive medical technologies used in the diagnosis and treatment of rate and rhythm disorders of the heart, including a broad portfolio of therapeutic and diagnostic catheters and a variety of equipment used in the Electrophysiology lab. Our product offerings include the following:•Rhythmia™ Mapping Systems, catheter-based, 3-D cardiac mapping and navigation solutions designed to help diagnose and guide treatment of a variety of arrhythmias,•cardiac ablation catheters including the Blazer™, IntellaNav™, IntellaNav Stablepoint™ and IntellaTip MiFi Open-Irrigated Ablation Catheter families, featuring a unique Total Tip Cooling™ Design and DIRECTSENSE™ Software for monitoring radiofrequency (RF) energy delivery during procedures, •IntellaMap Orion™ Mapping Catheters, for use with our Rhythmia Mapping System to provide high-density, high-resolution maps of the heart,•Farapulse™ Pulsed Field Ablation (PFA) Systems for the treatment of atrial fibrillation (AF),•POLARx™ Cryoablation Systems for the treatment of AF and •intracardiac ultrasound catheters, delivery sheaths and other accessoriesOn February 14, 2022, we completed our acquisition of Baylis Medical Company, Inc (Baylis Medical), which has developed the radiofrequency (RF) NRG™ and VersaCross™ Transseptal Platforms as well as a family of guidewires, sheaths and dilators used to support left heart access, which expands our electrophysiology and structural heart product portfolios. In the second quarter of 2022, we received FDA 510(k) clearance for and launched the VersaCross Connect™ LAAC Access Solution developed by Baylis Medical, providing safe and efficient access to the left side of the heart.Peripheral InterventionsOur Peripheral Interventions business develops and manufactures products to diagnose and treat peripheral arterial and venous diseases, as well as products to diagnose, treat and ease various forms of cancer. Our broad peripheral portfolio includes stent systems, balloon catheters, guidewires, atherectomy and thrombectomy systems, embolization devices, radioactive microspheres, radiofrequency and cryotherapy ablation systems, microcatheters and drainage catheters. Our peripheral arterial product offerings include:•EPIC™ and Innova™ Self-Expanding Stent Systems,•Eluvia™ Drug Eluting Vascular Stent Systems, innovative stents built on the Innova stent platform, designed to deliver a sustained dosage of paclitaxel during the time when restenosis is most likely to occur,•Mustang™, Coyote™ and Sterling™ PTA Balloon Catheters designed for a wide variety of peripheral angioplasty procedures and•Ranger™ Drug-Coated Balloons, innovative balloons built on the Sterling balloon platform, featuring a low-dose of paclitaxel. In the third quarter of 2022, we launched an ELUVIA™ line extension, introducing the longest-length available for treatment of patients with peripheral artery disease (PAD) in the superficial femoral artery. We are also the first company to provide physicians with both a drug-eluting stent and drug-coated balloon option for the treatment of patients with PAD.6Our venous disease product offerings include the following:•AngioJet™ Thrombectomy Systems, used in endovascular procedures to remove blood clots from blocked arteries and veins and our AngioJet Zelante DVT™ Thrombectomy Catheters to treat deep vein thrombosis,•WOLF Thrombectomy™ Platform, which is designed to mechanically remove the clots without damaging blood vessels, while also minimizing blood loss,•EKOS™ Ultrasound Assisted Thrombolysis systems used to treat pulmonary embolisms and•Varithena™ Polidocanol Injectable Foam used to improve the symptoms of superficial venous incompetence and the appearance of visible varicosities.Our interventional oncology product offerings include the following:•TheraSphere™ Y-90 radioactive glass microspheres used in the treatment of hepatocellular carcinoma (HCC), the most common type of liver cancer, •Renegade™ HI-FLO™ Fathom™ Microcatheter and Guidewire System and Interlock™ - 35 Fibered IDC™ and 18 Fibered IDC™ Occlusion System for peripheral embolization,•EMBOLD™ Detachable Coil System, used for arterial and venous embolizations in the peripheral vasculature, and•ICEFX™ and Visual ICE™ Cryoablation Systems for destruction of tissue, using image-guided needles to enable cryoablation visualization for optimal tumor coverage.MarketsCompetitionWe encounter significant competition across our product lines and in each market in which we sell our products and solutions, some from companies that may have greater financial, sales and marketing resources than we do. Our primary competitors include Abbott Laboratories and Medtronic plc, as well as a wide range of medical device companies that sell a single or limited number of competitive products or participate in only a specific market segment. In certain countries, and particularly in China, we also face competition from domestic medical device companies that may benefit from their status as local suppliers. We also face competition from non-medical device companies, which may offer alternative therapies for disease states that could also be treated using our products, or from companies offering technologies that could augment or replace procedures using our products. We believe that our products and solutions compete primarily on their ability to deliver both differentiated clinical and economic outcomes for our customers by enabling physicians to perform diagnostic and therapeutic procedures safely and effectively often in a less-invasive and cost effective manner. We also compete on ease of use, comparative effectiveness, reliability and physician familiarity. In the current environment of managed care, with economically motivated buyers, consolidation among healthcare providers, increasing prevalence and importance of regional and national tenders, increased competition and declining reimbursement rates, we have been increasingly required to compete on the basis of price, value, reliability and efficiency. We believe the current global economic conditions and healthcare reform measures could continue to put additional competitive pressure on us, including on our average selling prices, overall procedure rates and addressable market sizes. We recognize that our continued competitive success will depend upon our ability to: •offer products and solutions that provide differentiated clinical and economic outcomes,•create or acquire innovative, scientifically advanced technologies,•apply our technology and solutions cost-effectively and with superior quality across product lines and markets,•develop or acquire proprietary products and solutions,•attract and retain qualified personnel, •obtain patent or other protection for our products,•obtain required regulatory and reimbursement approvals,•continually provide quality products and enhance our quality systems, •supply sufficient inventory at competitive prices to meet customer demand.7Research and Development Our investment in research and development is critical to driving our future growth. Our investment in research and development supports the following:•internal research and development programs, regulatory design and clinical science, as well as other programs obtained through our strategic acquisitions and alliances, and•engineering efforts that incorporate customer feedback into continuous improvement efforts for currently marketed and next-generation products.We have directed our development efforts toward innovative technologies designed to expand current markets or enter adjacent markets. We continue to transform how we conduct research and development by identifying best practices, driving efficiencies and optimizing our cost structure, which we believe will enable increased development activity and faster concept-to-market timelines. Focused, cross-functional teams take a formal approach to new product design and development, helping us to manufacture and offer innovative products consistently and efficiently. Involving cross-functional teams early in the process is the cornerstone of our product development cycle. We believe this collaboration allows our teams to concentrate resources on the most viable and clinically relevant new products and technologies and to maximize cost and time savings as we bring them to market.In addition to internal development, we work with hundreds of leading research institutions, universities and clinicians around the world to develop, evaluate and clinically test our products. We continue to expand our collaborations to include research and development teams in our emerging market countries; these teams will focus on both global and local market requirements at a lower cost of development. We believe that these efforts will play a significant role in our future success.Marketing and SalesIn 2022, we marketed our products and solutions to approximately 36,000 hospitals, clinics, outpatient facilities and medical offices in 130 countries worldwide. Large group purchasing organizations, hospital networks and other buying groups have become increasingly important to our business and represent a substantial portion of our net sales. Each of our businesses maintains dedicated sales forces and marketing teams focused on physicians who specialize in the diagnosis and treatment of different medical conditions, as well as on key hospital service line administrators. The majority of our net sales are derived from countries in which we have direct sales organizations. We also have a network of distributors and dealers who offer our products in certain countries and markets. We expect to continue to leverage our infrastructure in markets where commercially appropriate and use third party distributors in those markets where it is not economical or strategic to establish or maintain a direct presence. ResourcesManufacturing and Raw MaterialsWe are focused on continuously improving our supply chain effectiveness, strengthening our manufacturing processes and increasing operational efficiencies within our organization worldwide. In doing so, we seek to focus our internal resources on the development and commercial launch of new products and the enhancement of existing products. We also drive continuous improvement in product quality through process controls and validations, supplier and distribution controls and training and tools for our operations team. In addition, we remain focused on examining our operations and general business activities to enhance our operational effectiveness by identifying cost-improvement opportunities. We remain committed to maintaining appropriate investments to ensure supply chain stability. We have an ongoing supplier resiliency program which identifies and mitigates risk and have taken measures to mitigate the impact of challenges within the global supply chain, including those caused in part by the COVID-19 pandemic. We consistently monitor our inventory levels, manufacturing, sterilization and distribution capabilities and partnerships and maintain recovery plans to address potential disruptions. Many components used in the manufacturing of our products are readily fabricated from commonly available raw materials or off-the-shelf items available from multiple supply sources; however, certain items are custom made to meet our specifications. On an on-going basis, we track supplier status and inventory in risk areas and take action to prevent shortages, monitoring safety stock levels and building up product supplies as warranted, and mitigating risk of technology and material shortages by identifying new vendors.8We have experienced increased levels of unpredictability in the supply of certain raw materials and components used in the manufacturing of our products. While we continue to believe we will have access to the raw materials and components that we need, these supply chain dynamics could result in increased costs to us or an inability to fully meet customer demand for certain of our products. Proprietary Rights and Patent LitigationWe rely on a combination of patents, trademarks, trade secrets and other forms of intellectual property to protect our proprietary rights. We generally file patent applications in the U.S. and other countries where patent protection for our technology is appropriate and available. We hold patents worldwide that cover various aspects of our technology. In addition, we hold exclusive and non-exclusive licenses to a variety of third-party technologies covered by patents and patent applications. In the aggregate, these intellectual property assets and licenses are of material importance to our business; however, we believe that no single patent, technology, trademark, intellectual property asset or license is material in relation to our business as a whole.We rely on non-disclosure and non-competition agreements with employees, consultants and other parties to protect, in part, trade secrets and other proprietary technology. There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry, particularly in the areas in which we compete. We continue to defend ourselves against claims and legal actions alleging infringement of the patent rights of others. Additionally, we may find it necessary to initiate litigation to enforce our patent rights, to protect our trade secrets or know-how and to determine the scope and validity of the proprietary rights of others. Accordingly, we may seek to settle some or all of our pending litigation, particularly to manage risk over time. Settlement may include cross licensing of the patents that are the subject of the litigation as well as our other intellectual property and may involve monetary payments to or from third parties. We maintain insurance policies providing limited coverage against securities claims. We are substantially self-insured with respect to product liability claims and fully self-insured with respect to intellectual property infringement claims. The absence of significant third-party insurance coverage increases our potential exposure to unanticipated claims or adverse decisions. See Note I – Commitments and Contingencies to our 2022 consolidated financial statements included in
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Strategy.”We compete with other worldwide research-based drug companies, smaller research companies and generic drug manufacturers. Our products are sold worldwide, primarily to wholesalers, distributors, specialty pharmacies, and to a lesser extent, directly to retailers, hospitals, clinics and government agencies. We have significant manufacturing operations in the U.S., Puerto Rico, Ireland and Switzerland. Most of our revenues come from products in the following therapeutic classes: hematology, oncology, cardiovascular and immunology.The percentage of revenues by significant region/country were as follows: Year Ended December 31,Dollars in Millions202220212020United States69 %63 %63 %International 29 %35 %36 %Other(a)2 %2 %1 %Total Revenues$46,159 $46,385 $42,518 (a) Other revenues include royalties and alliance-related revenues for products not sold by BMS’s regional commercial organizations.Refer to the Summary of Abbreviated Terms at the end of this 2022 Form 10-K for definitions of capitalized terms used throughout the document.1Acquisitions, Divestitures, Licensing and Other ArrangementsAcquisitions, divestitures and other licensing arrangements allow us to focus our resources behind growth opportunities that drive the greatest long-term value. For additional information relating to our acquisitions, divestitures, licensing and other arrangements refer to “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Acquisitions, Divestitures, Licensing and Other Arrangements” and “
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We provide the following services and solutions through our Investor Communication Solutions segment:Regulatory Solutions We handle the entire proxy materials distribution and voting process for our bank, broker-dealer, corporate issuer and fund clients. We offer traditional hard copy and electronic services for the delivery of proxy materials to investors and collection of consents; maintenance of a rules engine and database that contains the delivery method preferences of our clients’ customers; posting of documents on their websites; email notification to investors notifying them that proxy materials are available; and proxy voting via paper, telephone, online or mobile app. We have the ability to combine stockholder communications for multiple stockholders residing at the same address which we accomplish by having ascertained the delivery preferences of investors. We also offer proxy vote solicitation services for the registered clients of fund companies, efficiently managing the entire proxy campaign. In addition, we provide a complete outsourced solution for the processing of all international institutional and retail proxies, including shareholder disclosure management.A majority of publicly-traded shares are not registered in companies’ records in the names of their ultimate beneficial owners. Instead, a substantial majority of all public companies’ shares are held in “street name,” meaning that they are held of record by broker-dealers or banks through their depositories. Most street name shares are registered in the name “Cede & Co.,” the name used by The Depository Trust and Clearing Corporation (“DTCC”), which holds shares on behalf of its participant broker-dealers and banks. These participant broker-dealers and banks (which are known as “Nominees” because they hold securities in name only) in turn hold the shares on behalf of their customers, the individual beneficial owners. Nominees, upon request, are required to provide companies with the information of beneficial owners who do not object to having their names, addresses, and shareholdings supplied to companies, so called “non-objecting beneficial owners” (or “NOBOs”). Objecting beneficial owners (or “OBOs”) may be contacted directly only by the broker-dealer or bank. As DTCC’s role is only as the custodian, a number of mechanisms have been developed in order to pass the legal rights it holds as the record owner (such as the right to vote) to the beneficial owners. The first step in passing voting rights down the chain is the “omnibus proxy,” which DTCC executes to transfer its voting rights to its participant Nominees. Under applicable rules, Nominees must deliver proxy materials to beneficial owners and request voting instructions.4Given the large number of Nominees involved in the beneficial proxy process resulting from the large number of beneficial shareholders, we play a unique, central and integral role in ensuring that the beneficial proxy process occurs without issue for Nominees, companies, funds and investors. A large number of Nominees have contracted out the processes of distributing proxy materials and tabulating voting instructions to us. Nominees accomplish this by entering into agreements with Broadridge and transferring to us via powers of attorney the authority to execute a proxy, which authority the Nominee receives from the DTCC via an omnibus proxy. Through our agreements with Nominees for the provision of beneficial proxy services, we take on the responsibility of ensuring that the account holders of Nominees receive proxy materials on a timely basis digitally or in print, that their voting instructions are conveyed to the companies and funds conducting solicitations and that these services are fulfilled in accordance with the requirements of their particular solicitation. In order for us to provide the beneficial proxy services effectively, we interface and coordinate directly with each company and/or fund to ensure that the services are performed in an accurate and timely manner. As it would increase the costs for companies and funds to work with all of the Nominees through which their shares are held beneficially, companies and funds work with us for the performance of all the tasks and processes necessary to ensure that proxy materials are distributed on a timely basis to all beneficial owners and that their votes are accurately reported.The SEC’s rules require public companies to reimburse Nominees for the expense of distributing stockholder communications to beneficial owners of securities held in street name. The reimbursement rates are set forth in the rules of self-regulatory organizations (“SROs”), including the New York Stock Exchange (“NYSE”). We bill public companies for the proxy services performed, collect the fees and remit to the Nominee its portion of the fees. In addition, the NYSE rules establish fees for certain services provided by intermediaries such as Broadridge in the proxy process. The preparation and delivery of NOBO information is subject to reimbursement by the corporate issuers requesting the information. The reimbursement rates are based on the number of NOBOs produced pursuant to NYSE or other SRO rules. The rules also determine the fees to be paid to third-party intermediaries, such as Broadridge, who compile the NOBO information on behalf of Nominees who need to respond to corporate issuer requests for NOBO information.We provide institutional investors with a suite of services to manage and track the entire proxy voting process, including meeting their reporting needs. ProxyEdge® (“ProxyEdge”) is our innovative electronic proxy delivery and voting solution for institutional investors and financial advisors that integrates ballots for positions held across multiple custodians and presents them under a single proxy. Voting can be instructed for the entire position, by account vote group or on an individual account basis either manually or automatically based on the recommendations of participating governance research providers. ProxyEdge also provides for client reporting and regulatory reporting. ProxyEdge can be utilized for meetings of U.S. and Canadian companies and for meetings in many non-North American countries based on the holdings of our global custodian clients. ProxyEdge is offered in several languages and there are currently over 7,000 ProxyEdge users worldwide.Our pass-through voting solutions support fund clients in providing individual investors the ability to participate in the proxy voting process, helping them to expand their investor engagement efforts and receive valuable input for important investment decisions. Broadridge’s institutional solution helps asset managers split the vote in portfolio companies and pass directly to institutional investors on a proportional basis. For retail investors, our solutions allow funds to poll their investors on voting preferences and provides investors the ability to give voting instructions, set standard voting preferences, or potentially cast a vote at pre-determined meetings. In addition to our proxy services, we provide regulatory communications services that assist our fund clients in meeting their regulatory requirements. These services include prospectus delivery, distribution of annual and semi-annual shareholder reports, trade confirmations, account statements and other communications. Our clients have the ability to create and distribute these communications via print, e-delivery, online and mobile. In addition to our fund solutions, we also provide a range of other regulatory communications solutions, including reorganization communications notifying investors of U.S. reorganizations or corporate action events such as tender offers, mergers and acquisitions, and bankruptcies, and global class action services for the identification, filing and recovery of class actions and collective redress proceedings involving securities and other financial products.In addition, we provide international corporate governance solutions addressing our clients’ needs within Europe, the Middle East and Africa (“EMEA”) and the Asia-Pacific (“APAC”) region. These solutions include our global proxy and shareholder rights compliance services, as well as environmental, social and governance (“ESG”) offerings and shareholder meeting analytics. Our international solutions help clients sharpen focus on their core businesses while helping them maintain global regulatory compliance, reduce costs, improve efficiency and gain data insights. 5Data-Driven Fund SolutionsWe provide a full range of data-driven solutions that help our asset management and retirement service provider clients grow revenue, operate efficiently, and maintain compliance. Our communications solutions enable global asset managers to communicate with large audiences of investors efficiently and reliably by centralizing all investor communications through one resource. We provide composition, printing, filing, and distribution services for regulatory reports, prospectuses and proxy materials, as well as proxy solicitation services. We manage the entire communications process with both registered and beneficial stockholders. Our marketing and transactional communications solutions provide a content management and omni-channel distribution platform for marketing and sales communications for asset managers and retirement service providers. In addition, our data and analytics solutions provide investment product distribution data, analytical tools, and insights and research to enable asset managers to optimize product distribution across retail and institutional channels globally.Through our Retirement and Workplace Trade Processing Solutions business (“Broadridge Retirement and Workplace”), we provide automated mutual fund and exchange-traded funds trade processing services for financial institutions that submit trades on behalf of their clients such as qualified and non-qualified retirement plans and individual wealth accounts. Our trust, trading and settlement services are integrated into our product suite thereby strengthening Broadridge’s role as a provider of insight, technology and business process outsourcing to the asset management, wealth, and retirement industry. In addition, we provide fiduciary-focused learning and development, software and technology, and data and analytics services to advisors, institutions and asset managers across the retirement and wealth ecosystem.Through our Fund Communication Solutions business, we provide fund managers with a single, integrated provider to manage data, perform calculations, compose documents, manage regulatory compliance and disseminate information across multiple jurisdictions. Our solutions help fund managers increase distribution opportunities, comply with both United Kingdom domestic and European Union regulations such as Solvency II and MiFID II, and makes information easily accessible for investors in a digital format. We also provide support to fund managers with document and data dissemination in the European market. This enables the receipt by distributors and investors of complete, accurate and timely information supporting fund sales.Corporate Issuer Solutions We provide governance and communications services to corporate issuers supporting a full range of public company functions, including the annual meeting of stockholders, SEC reporting, capital markets transactions, transfer agency, shareholder engagement and ESG solutions. Our services provide corporate issuers a single source solution that spans the entire corporate disclosure and shareholder communications lifecycle.Our governance and communications services include a full suite of annual meeting and shareholder engagement solutions:•Proxy services – we provide complete project management for the entire annual meeting process including registered and beneficial proxy materials distribution, vote processing and tabulation through our ShareLink® solution.•Virtual Shareholder Meeting™ – electronic annual meetings via webcast, either on a stand-alone basis, or in conjunction with in-person annual meetings, including shareholder validation and voting services and the ability for shareholders to ask questions and for management to respond during the meetings.•We offer tools for corporate issuers to help them better engage with their shareholders and other stakeholders in connection with the annual meeting process as well as on an ongoing basis throughout the year. These services provide aggregated shareholder data and analytics, shareholder delivery preferences and voting trends. •Our ESG services provide consulting in support of issuers and their ESG journey. The services include peer ESG disclosure benchmarking, ESG strategy and policy development, greenhouse gas emission assessments, and ESG and sustainability report content development. We also offer an ESG dashboard that provides ESG consensus ratings to allow corporate issuers to assess the progress of their ESG ratings and disclosure relative to their selection of peer companies.Our disclosure solutions provide compliance reporting and transactional reporting services for public companies, including the following:•SEC Filing Services: proxy and annual report design and digitization, SEC filing, printing and web hosting services, as well as year-round SEC reporting including document composition, EDGARization and XBRL tagging.•Capital Markets Transactional Services – typesetting, composition, printing and SEC filing services for capital markets transactions such as initial public offerings, spin-offs, acquisitions, and securities offerings. In addition, we provide transaction support services such as virtual deal rooms and translation services.6We also provide registrar, stock transfer and record-keeping services through our transfer agency services. Our transfer agency services address the needs public companies have for more efficient and reliable stockholder record maintenance and communication services. In addition, we provide corporate actions services, including acting as the exchange agent, paying agent, or tender agent in support of acquisitions, initial public offerings and other significant corporate transactions. We also provide abandoned property compliance and reporting services.Customer Communications Solutions We support financial services, healthcare, insurance, consumer finance, telecommunications, utilities, and other service industries with their omni-channel customer communications management strategies for transactional communications, such as statements and bills, marketing communications, such as personalized microsites and campaigns, and regulatory communications, such as trade confirmations and explanation of benefits. These services include digital and physical delivery of critical communications. Our physical delivery services operate through a network of seven highly automated facilities across North America. The Broadridge Communications CloudSM is an omni-channel platform (the “Communications Cloud”) that provides our clients the flexibility to implement only the modules and delivery channels needed to address their specific communication needs. The platform’s open application programming interfaces and self-servicing tools help our clients improve their communications systems’ efficiency and productivity. Through the Communications Cloud, our clients can:•develop transactional, regulatory, and marketing communications with relevant, self-service content that drives customer action;•deliver customer communications across print, digital, email, short message service (SMS) and emerging channels, such as interactive microsites and personal cloud services, with one connection; and•gain comprehensive reporting and analytics to improve communications and increase engagement based on customer behaviors.Global Technology and OperationsTransactions involving securities and other financial market instruments can, for example, originate with an institutional or retail investor who places an order with a broker who in turn routes that order to an appropriate market for execution. At that point, the parties to the transaction coordinate payment and settlement of the transaction through a clearinghouse. The records of the parties involved must then be updated to reflect completion of the transaction. The transaction must comply with tax, custody, accounting and record-keeping requirements, and the customer’s account information must correctly reflect the transaction. The accurate processing of trading activity from its initial inception and custody activity requires effective automation and information flow across multiple systems and functions within the firm and across the systems of the various parties that participate in the execution of a transaction. Our Global Technology and Operations business provides the non-differentiating yet mission-critical infrastructure to the global financial markets. As a leading software as a service (“SaaS”) provider, we offer capital markets, wealth and investment management firms modern technology to enable growth, simplify their technology stacks and mutualize costs. Our highly scalable, resilient, component-based solutions automate the front-to-back transaction lifecycle of equity, mutual fund, fixed income, foreign exchange and exchange-traded derivatives, from order capture and execution through trade confirmation, margin, cash management, clearing and settlement, reference data management, reconciliations, securities financing and collateral management, asset servicing, compliance and regulatory reporting, portfolio accounting and custody-related services. Our Wealth Management business provides solutions for advisors and investors and also streamlines back- and middle-office operations for broker-dealers by providing systems for critical post-trade activities, including books and records, transaction processing, clearance and settlement, and reporting. Our Investment Management business provides portfolio and order management solutions for traditional and alternative asset managers, which bring insights into trading, portfolio construction, risk and analytics. Our solutions connect asset managers to a global network of broker-dealers for trade execution and post-trade matching and confirmation. In addition, we provide business process outsourcing services for our buy- and sell-side clients’ businesses. These services combine our technology with our operations expertise to support the entire trade lifecycle, including securities clearing and settlement, reconciliations, record-keeping, wealth management asset servicing, and custody-related functions.7The Global Technology and Operations segment’s revenues represented approximately 25% and 25% of our total Revenues in fiscal years 2023 and 2022, respectively, which gives effect to the foreign exchange impact from revenues generated in currencies other than the U.S. dollar. See “Analysis of Reportable Segments — Revenues” under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Services and solutions offered through the Global Technology and Operations segment include the following:Capital Markets SolutionsWe provide a set of multi-asset, multi-entity and multi-currency trading, connectivity and post-trade solutions that support processing of securities transactions in equities, options, fixed income securities, foreign exchange, exchange-traded derivatives and mutual funds. Largely provided on a SaaS basis within large user communities, Broadridge’s technology is a global solution, processing trades, clearance and settlement in over 100 countries. Our solutions enable global capital markets firms to access market liquidity, drive more effective market making and efficient front-to-back trade processing. These services include reference data management, securities financing, securities-based lending, collateral management, trade and transaction reporting, reconciliations, financial messaging and asset servicing. Our solutions can be deployed as a complete solution as well as discrete components supporting financial institutions.In addition, we provide comprehensive fixed income transaction processing capabilities to support clearance, settlement, custody, P&L reporting and regulatory reporting for domestic and foreign fixed income instruments. Our solution includes extensive support for mortgage-backed securities and other structured products. It is a multi-currency, multi-entity solution that provides position and balance information, in addition to detailed accounting, financing, collateral management, and repurchase agreement functionality. The solution offers straight-through-processing capabilities, enterprise-wide integration and a robust technology infrastructure - all focused on supporting firms specializing in the fixed income marketplace. Through Broadridge Trading and Connectivity Solutions, we offer a set of global front-office trade order and execution management systems and connectivity solutions that enable market participants to connect and trade. The combination of the front-office solutions from the 2021 acquisition of Itiviti Holding AB (“Itiviti”) and our post-trade product suite and other capital markets capabilities enables our clients to streamline their front-to-back technology platforms and operations and increase straight-through-processing efficiencies, across equities, fixed income, exchange-traded derivatives, and other asset classes.Wealth and Investment Management SolutionsOur Wealth Management business delivers technology solutions, critical data and digital marketing services to enable full-service, regional and independent broker-dealers and investment advisors to better engage with customers to help grow their business. Our wealth solutions are designed to help optimize advisor productivity, improve investor outcomes, reduce friction in investing, increase financial literacy, and deliver more personalized advice and insights.With respect to technology solutions, we offer an integrated, modern open-architecture wealth management platform through which we provide enhanced data-centric capabilities to improve the overall client experience across the entire front-, middle- and back-office wealth management lifecycle, including advisor, investor and operational workflows. This comprehensive wealth management platform streamlines all aspects of the service model, allowing our clients to digitally onboard customers, manage advisor compensation for multiple products and service models, and seamlessly transfer and service accounts. In addition, we provide data-driven, digital solutions to broker-dealers, financial advisors, insurers and other firms with large, distributed salesforces. Our data aggregation solution helps financial advisors manage and build client relationships by providing customer account data aggregation, performance reporting, household grouping, automated report creation, document storage, and integration with popular financial planning and productivity applications. Our digital marketing and content capabilities leverage analytics and machine-learning to enable financial advisors and wealth management firms to grow their businesses and deepen relationships with their customers. Financial advisors and wealth management firms can tap into our digital tools and library of omni-channel content to personalize touchpoints to engage their customers and prospects across digital channels including websites, social media, email and mobile.Our Investment Management business services the global investment management industry with a range of buy-side technology solutions. Our asset management solutions are portfolio management, compliance, fee billing and operational support solutions such as order management, data warehousing, reporting, reference data management, and risk management and portfolio accounting for hedge funds, family offices, alternative asset managers, traditional asset managers and the providers that service this space including prime brokers, fund administrators and custodians. The client base for these services includes institutional asset managers, public funds, start-up or emerging managers through some of the largest global hedge fund complexes and global fund administrators. 8Our Strategy We earn our clients’ confidence every day by delivering real business value through leading technology-driven solutions that help our clients get ahead of today’s challenges and capitalize on future growth opportunities. Our solutions harness people, technology and insights to help transform our clients’ businesses by enriching customer engagement, navigating risk, optimizing efficiency and growing revenue.As financial institutions look to transform and mutualize their mission-critical but non-differentiating operational and support functions, we have the proven technology, scale, innovation, experience and, most importantly, the network to achieve this goal and meet their needs. Our strategy addresses critical industry needs by utilizing our leading platform capabilities. Specifically, our growth strategy is focused on four key themes: (i) extend our strong and growing governance business, (ii) drive further growth in our capital markets business, (iii) build next generation wealth and investment management businesses and (iv) strengthen our international business.Our business modelWe deliver multi-client technology and business process outsourcing services primarily through common SaaS based operations platforms. We create layers of value for clients by harnessing network benefits, providing deep data and analytics, and offering a comprehensive suite of digital capabilities all on a single platform. Our SaaS offerings allow our clients to mutualize key functions and thereby reduce their costs. All of this translates into our core value proposition to be a trusted provider of technology and services across a range of analytical, operational, and reporting functions.Strong positions in a large and growing financial services marketOur technology and associates power the critical infrastructure and services behind investing, investment governance and investor communications. Broadridge makes our clients stronger, and through them, we enable better financial lives for investors around the globe. Our deep industry knowledge enables our clients to successfully solve complex technological and operational challenges, while adapting to the latest technology trends and regulatory standards. While financial services firms have historically kept much of their technology infrastructure work in-house, there are significant trends working in favor of Broadridge. Specifically, financial services firms globally are spending more on technology, and the respective budgets allocated for such technology are consistently growing year-over-year. Moreover, these firms are devoting a growing percentage of this spend to third-party technology, operations, and services. Broadridge, as a trusted outside service provider, can streamline and better integrate our clients’ infrastructure and business processes. We expect the efficiencies that result from such undertaking by Broadridge will lead to growth in the market for our solutions.Three attractive growth platformsOur growth platforms address mission-critical client needs as described below. Through our integrated solutions and scalable infrastructure, we believe we are best positioned to serve them.•Governance. We create an integrated network through our governance platform that links broker-dealers, public companies, mutual funds, shareholders, and regulators. We continue to grow our governance solutions by transforming content and delivery and improving e-product capabilities to drive higher investor engagement. We aim to be an integral partner to broker-dealers, asset managers and retirement service providers by offering data-driven solutions that help them grow revenue, reduce costs and maintain compliance. We are also helping public companies improve their governance functions, offering an expanding suite of capabilities that allows them to provide better information and accessibility to shareholders. We continue to be a leading provider of investor communications and are at the forefront of delivering richer communication experiences, both digitally and through optimized print and mail services.•Capital Markets. Global institutions have a strong need to simplify their complex technology environment, and our SaaS-based, global, multi-asset-class technology platforms address this need. As a leader in global trade lifecycle management, we are driving next-generation solutions that simplify our clients’ operations, improve performance and resiliency, evolve to global operating models, adapt to new technologies, and enable our clients to better manage their data. We plan to continue building on our global platform capabilities, enabling our clients to simplify and improve their global operations across cash equity securities and other asset classes. Our 2021 acquisition of Itiviti, for example, expanded our services across the trade lifecycle for equities and exchange-traded derivatives and grew our international reach. We continue to develop component solutions that meet the regulatory, risk, data, and analytics needs of our clients, while also helping to drive more efficient liquidity, price discovery, and improved execution for the firms we serve.9•Wealth and Investment Management. Wealth and investment management clients, including full-service, regional and independent broker-dealers, investment advisors, insurance companies and retirement solutions providers are all undergoing unprecedented change. These firms are in need of partners to help them navigate the demographic shift of advisors and investors, create more engaging client experiences, and deliver operational technologies that are essential to their business. These market dynamics are driving the need for more seamlessly integrated technology, and as well as data-centric digital wealth solutions that better service advisors and investors. This can be achieved by simplifying and modernizing their complicated and interwoven legacy systems. To address these demands, we have developed a holistic wealth management platform solution that provides seamless systems and data integration capabilities. Our platform enables firms to improve advisor productivity, provide a better investor experience, and realize operational process efficiencies. On-ramp for next-generation technologiesAcross financial services, the pace of change is only accelerating. Our clients understand that next-generation technology is a key driving force for change and efficiency and there is a need among our client base to leverage this technology to address their critical business challenges. However, they face obstacles in making the necessary investments and, more importantly, in applying the right talent and intellectual capital, which may be focused on their most differentiating functions. This continues to create opportunities for Broadridge to assist in the areas where we have scale and domain expertise, which includes areas such as artificial intelligence, blockchain, cloud, digital, and other new technologies. By leveraging our services, firms can benefit from highly skilled, experienced personnel with deep industry expertise, while mutualizing the costs and risks of technology innovation. We approach innovation through three actions: experimenting, partnering, and engaging. In turn, we help our clients stay on the cutting edge and realize the benefits of digital transformation at a quicker pace.High engagement and client-centric cultureBroadridge is client-centric and has created and grown multi-entity infrastructures across a variety of functions with high client satisfaction. We conduct a client satisfaction survey for each of our major business units annually, the results of which are a component of all our associates’ compensation because of the importance of client retention to the achievement of our revenue goals.We have built a talent network focus of engaged and knowledgeable associates dedicated to serving clients well, which in turn creates a real and sustainable advantage for our business. Supporting this excellent client delivery takes engaged associates, and we are passionate about creating an environment in which every associate can thrive and build their knowledge and skills. All of this creates a culture that benefits our associates, our clients, and our stockholders.ClientsWe serve a large and diverse client base including banks, broker-dealers, mutual funds, retirement service providers, corporate issuers and wealth and asset management firms. Our clients in the financial services industry include retail and institutional brokerage firms, global banks, mutual funds, asset managers, insurance companies, annuity companies, institutional investors, specialty trading firms, clearing firms, third-party administrators, hedge funds, and financial advisors. Our corporate issuer clients are typically publicly held companies. In addition to financial services firms, we service corporate clients in the healthcare, insurance, consumer finance, telecommunications, utilities, and other service industries with their essential communications.In fiscal year 2023, we: •managed proxy voting for over 750 million equity proxy positions;•processed over 7 billion investor and customer communications through print and digital channels;•processed on average over $10 trillion in equity and fixed income trades per day of U.S. and Canadian securities; and•provided fixed income trade processing services to 20 of the 25 primary dealers of fixed income securities in the U.S.10CompetitionWe operate in a highly competitive industry. Our Investor Communication Solutions business competes with companies that provide investor communication and corporate governance solutions as well as our clients’ in-house operations. This includes independent proxy distribution service providers, transfer agents, proxy advisory firms, proxy solicitation firms, firms that process proxy votes, and financial printers. We also face competition from numerous firms in the compiling, printing and electronic distribution of statements, bills and other customer communications. Within our Global Technology and Operations business, our capital markets solutions compete with in-house operations and vendors that provide trade processing, back-office record keeping, and sell-side order and execution management systems. Similarly, our wealth management solutions compete with service providers that deliver data, technology solutions, and marketing services, and our investment management solutions compete with firms that provide portfolio management, compliance and operational support solutions.TechnologyWe have several information processing systems that serve as the core foundation of our technology platform. We leverage these systems in order to provide our services. We are committed to maintaining extremely high levels of quality service through our skilled technical employees and the use of our technology within an environment that seeks continual improvement. Our mission-critical applications are designed to provide high levels of availability, scalability, reliability, and flexibility. They operate on industry standard enterprise architecture platforms that provide high degrees of horizontal and vertical scaling. This scalability and redundancy allows us to provide high degrees of system availability. As part of Broadridge’s technology strategy, we leverage traditional data center services as well as private cloud and public cloud services.Most of our systems and applications operate in highly resilient data centers that employ multiple active power and cooling distribution paths and redundant components. Additionally, the data centers provide infrastructure capacity and capability to permit any planned activity without disruption to the critical load, and can sustain at least one worst-case, unplanned failure or event with no critical load impact. Our geographically dispersed processing centers also provide disaster recovery and business continuity processing.Product Development We manage a diverse portfolio of products and services across our core businesses. Our products and services are designed with reliability, availability, scalability, and flexibility so that we can fully meet our clients’ processing needs. These products and services are built in a manner that allows us to meet the breadth and depth of requirements of our clients in a highly efficient manner. We continually upgrade, enhance, and expand our existing products and services, taking into account input from clients, industry-wide initiatives and regulatory changes affecting our clients. We also enter strategic relationships with clients and other third parties to accelerate product development or gain access to capabilities complementary to our product development efforts.Intellectual Property We own a portfolio of more than 150 U.S. and non-U.S. patents and patent applications. We also own registered marks for our trade name and own or have applied for trademark registrations for many of our services and products. We regard our products and services as proprietary and utilize internal security practices and confidentiality restrictions in contracts with employees, clients, and others for protection. We believe that we are the owner or in some cases, the licensee, of all intellectual property and other proprietary rights necessary to conduct our business. CybersecurityOur information security program is designed to meet the needs of our clients who entrust us with their sensitive information. Our program includes encryption, data masking technology, data loss prevention technology, authentication technology, entitlement management, access control, anti-malware software, and transmission of data over private networks, among other systems and procedures designed to protect against unauthorized access to information, including by cyber-attacks. Broadridge utilizes the National Institute of Standards and Technology Framework for Improving Critical Infrastructure Cybersecurity (the “NIST Framework”) issued by the U.S. government as a guideline to manage our cybersecurity-related risk. The NIST Framework outlines 108 subcategories of security controls and outcomes over five functions: identify, protect, detect, respond and recover. 11To further demonstrate our commitment to maintaining the highest levels of quality service, information security, and client satisfaction within an environment that fosters continual improvement, most of our business units and our core applications and facilities for the provision of many services including our proxy services, U.S. equity and fixed income securities processing services, and Kyndryl, Inc.’s data centers, are International Organization for Standardization (“ISO”) 27001 certified. This security standard specifies the requirements for establishing, implementing, operating, monitoring, reviewing, maintaining and improving a documented Information Security Management System within the context of the organization’s overall business risks. It specifies the requirements for the implementation of security controls customized to the needs of individual organizations. The ISO 27001 standard addresses confidentiality, access control, vulnerability, business continuity, and risk assessment.We engage an independent third-party cybersecurity services and consulting firm to review our information security program quarterly and provide a quarterly report on the program to the Audit Committee of our Board of Directors. We also have a third-party firm conduct phishing tests on our associates and perform network penetration tests. In addition, we conduct regular security awareness training and testing of our employees. RegulationThe securities and financial services industries are subject to extensive regulation in the U.S. and in other jurisdictions. As a matter of public policy, regulatory bodies in the U.S. and the rest of the world are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interests of investors participating in those markets. Due to the nature of our services and the markets we serve, these regulatory bodies impact our businesses in various manners.In the U.S., the securities and financial services industries are subject to regulation under both federal and state laws. At the federal level, the SEC regulates the securities industry, along with the Financial Industry Regulatory Authority, Inc. (“FINRA”), the various stock exchanges, and other SROs. In addition, SEC rules require public companies to reimburse banks and broker-dealers for the expense of distributing certain stockholder communications to beneficial owners of securities held in street name, and those reimbursement rates as well as fees that can be charged for proxy services are set by the NYSE. The Department of Labor (“DOL”) enforces the Employee Retirement Income Security Act of 1974 (“ERISA”) regulations on plan fiduciaries and organizations that provide services to qualified retirement plans. As a provider of services to financial institutions and issuers of securities, our services, such as our proxy and shareholder report processing and distribution services, are provided in a manner to assist our clients in complying with the laws and regulations to which they are subject. As a result, the services we provide may be required to change as applicable laws and regulations are adopted or revised. We monitor legislative and rulemaking activity by the SEC, FINRA, DOL, and U.S. Internal Revenue Service (the “IRS”). the stock exchanges and other regulatory bodies that may impact our services, and if new laws or regulations are adopted or changes are made to existing laws or regulations applicable to our services, we expect to adapt our business practices and service offerings to continue to assist our clients in fulfilling their obligations under new or modified requirements.Certain aspects of our business are subject to regulatory compliance or oversight. As a provider of technology services to financial institutions, certain aspects of our U.S. operations are subject to regulatory oversight and examination by the Federal Financial Institutions Examination Council (“FFIEC”), an interagency body of the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the National Credit Union Administration and the Consumer Financial Protection Bureau. Periodic examinations by the FFIEC generally include areas such as internal audit, risk management, business continuity planning, information security, systems development, and third-party vendor management to identify potential risks related to our services that could adversely affect our banking and financial services clients. In addition, our business process outsourcing, mutual fund processing and transfer agency solutions, as well as the entities providing those services, are subject to regulatory oversight. Our business process outsourcing and mutual fund processing services are performed by a broker-dealer, Broadridge Business Process Outsourcing, LLC (“BBPO”). BBPO is registered with the SEC, is a member of FINRA and is required to participate in the Securities Investor Protection Corporation (“SIPC”). Although BBPO’s FINRA membership agreement allows it to engage in clearing and the retailing of corporate securities in addition to mutual fund retailing on a wire order basis, BBPO does not clear customer transactions, process any retail business or carry customer accounts. BBPO is subject to regulations concerning many aspects of its business, including trade practices, capital requirements, record retention, money laundering prevention, the protection of customer funds and customer securities, and the supervision of the conduct of directors, officers and employees. A failure to comply with any of these laws, rules or regulations could result in censure, fine, the issuance of cease-and-desist orders, or the suspension or revocation of SEC or FINRA authorization granted to allow the operation of its business or disqualification of its directors, officers or employees. There has been continual regulatory scrutiny of the securities industry including the outsourcing by firms of their operations or functions. This oversight could result in the future enactment of more restrictive laws or rules with respect to business process outsourcing. As a registered broker-dealer and member of FINRA, BBPO is subject to the Uniform Net Capital Rule 15c3-1 of the Securities Exchange Act of 1934, as amended, which requires BBPO to maintain a minimum net capital amount. At June 30, 2023, BBPO was in compliance with this capital requirement.12Matrix Trust Company (“Matrix Trust”), is a Colorado state chartered, non-depository trust company and National Securities Clearing Corporation trust member, whose primary business is to provide cash agent, custodial and directed trustee services to institutional customers, and investment management services to its collective investment trust funds (“CITs”). As a result, Matrix Trust is subject to various regulatory capital requirements administered by the Colorado Division of Banking and the Arizona Department of Insurance and Financial Institutions, as well as the National Securities Clearing Corporation. Specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items, when applicable, must be met. At June 30, 2023, Matrix Trust was in compliance with its capital requirements. In addition, in connection with the offering of CITs, Matrix Trust acts as a discretionary trustee and an ERISA fiduciary. CITs are subject to regulation by the IRS, SEC, federal and state banking regulators, and the DOL, which impose a number of duties on persons who are fiduciaries under ERISA. Matrix Trust is also subject to regulation by the Colorado Division of Banking and the Arizona Department of Financial Institutions which regulate CITs pursuant to guidance issued by the Office of the Comptroller of the Currency regulation. Matrix Trust maintains an Identity Theft Prevention Program for certain of its services. Our transfer agency business, Broadridge Corporate Issuer Solutions, is subject to certain SEC rules and regulations, including annual reporting, examination, internal controls, proper safeguarding of issuer and shareholder funds and securities, maintaining a written Identity Theft Prevention Program, and obligations relating to its operations. Our transfer agency business is subject to certain NYSE requirements concerning operational standards as a transfer agent or registrar for NYSE-listed companies and is also subject to IRS regulations. In addition, Broadridge Corporate Issuer Solutions complies with all applicable trade control laws and regulations, including country/territory-based sanctions and list-based sanctions maintained by the U.S. and other jurisdictions where we do business. Finally, state laws govern certain services performed by our transfer agency business.In addition, we are required to comply with anti-money laundering laws and regulations, such as, in the U.S., the Bank Secrecy Act, as amended by the USA PATRIOT Act of 2001 (collectively, the “BSA”), and the BSA implementing regulations of the Financial Crimes Enforcement Network (“FinCEN”), a bureau of the U.S. Department of the Treasury. A variety of similar anti-money laundering requirements apply in other countries. We are also subject to the relevant aspects of regulations and guidance published by FinCEN (as discussed below), which includes the Know Your Customer (“KYC”) requirements promulgated by FinCEN.Privacy and Information Security Regulations The processing and transfer of personal information is required to provide certain of our services. Privacy laws and regulations in the U.S. and foreign countries apply to the access, collection, transfer, use, storage, and destruction of personal information. In the U.S., our financial institution clients are required to comply with privacy regulations imposed under the Gramm-Leach-Bliley Act (“GLBA”), in addition to other regulations. As a processor of personal information in our role as a provider of services to financial institutions, we must comply with the Federal Trade Commission (“FTC”) Safeguards Rule implementing certain provisions of GLBA with respect to maintenance of information security safeguards.We perform services for healthcare companies and are, therefore, subject to compliance with laws and regulations regarding healthcare information, including in the U.S., the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”). We also perform credit-related services and agree to comply with payment card standards, including the Payment Card Industry Data Security Standard. In addition, federal and state privacy and information security laws, and consumer protection laws, which apply to businesses that collect or process personal information, also apply to our businesses.Privacy laws and regulations may require notification to affected individuals, federal and state regulators, and consumer reporting agencies in the event of a security breach that results in unauthorized access to, or disclosure of, certain personal information. Privacy laws outside the U.S. may be more restrictive and may require different compliance requirements than U.S. laws and regulations, and they may impose additional duties on us in the performance of our services.The law in this area continues to develop and the changing nature of privacy laws in the U.S., the European Union and elsewhere could impact our processing of personal information of our employees and on behalf of our clients. For example, the European Union Parliament adopted the comprehensive General Data Protection Regulation (“GDPR”) and several U.S. states have also recently adopted new privacy laws or are proposing to pass their own state privacy laws, including California’s recently effective California Privacy Rights Act (“CPRA”).We continually monitor privacy and information security laws and regulations and while we believe that we are compliant with our regulatory responsibilities, information security threats continue to evolve, resulting in increased risk and exposure. In addition, legislation, regulation, litigation, court rulings, or other events could expose Broadridge to increased costs, liability, and possible damage to our reputation.13Legal Compliance Regulations issued by the Office of Foreign Assets Control (“OFAC”) of the U.S. Department of Treasury place prohibitions and restrictions on all U.S. citizens and entities, including the Company, with respect to transactions by U.S. persons with specified countries and individuals and entities identified on OFAC's sanctions lists and Specially Designated Nationals and Blocked Persons List (a published list of individuals and companies owned or controlled by, or acting for or on behalf of, countries subject to certain economic and trade sanctions, as well as terrorists, terrorist organizations and narcotics traffickers identified by OFAC under programs that are not country specific). Similar requirements apply to transactions and dealings with persons and entities specified in lists maintained in other countries. We have developed procedures and controls that are designed to monitor and address legal and regulatory requirements and developments to protect against having direct business dealings with such prohibited countries, individuals or entities.Compliance with laws and regulations that are applicable to our businesses with an international reach can be complex and may increase our cost of doing business in international jurisdictions. Our international business could expose us to fines and penalties if we fail to comply with these regulations. These laws and regulations include import and export requirements, trade restrictions and embargoes, data privacy requirements, labor laws, tax laws, anti-competition regulations, U.S. laws such as the Foreign Corrupt Practices Act, and local laws prohibiting bribery and other improper payments or inducements, such as the U.K. Bribery Act. Although we have implemented policies, procedures and training designed to ensure compliance with applicable laws and regulations, there can be no assurance that our employees, contractors, vendors and agents will not take actions in violation of our policies or applicable laws and regulations, particularly as we expand our operations, including through acquisitions of businesses that were not previously subject to and may not have familiarity with laws and regulations applicable to us or compliance policies similar to ours. Any violations of sanctions or export control regulations or other laws could subject us to civil or criminal penalties, including the imposition of substantial fines and interest or prohibitions on our ability to offer our products and services to one or more countries, and could also damage our reputation, our international expansion efforts and our business, and negatively impact our operating results.Human Capital Management As of June 30, 2023, we had approximately 14,700 full-time associates, of which approximately 48% were employed in the U.S. Of the approximately 52% of associates located outside of the U.S., 37% are in the APAC region, where a substantial number of associates are in India, and 11% are in Europe. None of our U.S. employees are represented by a labor union. In some countries outside the U.S., we have works councils, or we are required by local law to enter into and/or comply with industry-wide collective bargaining agreements. We believe that our employee relations are good. We are driven by the success of each of our associates, and we recognize that it is because of their hard work, talent and commitment that we continue to deliver outstanding results for our clients. That is why we strive to provide a workplace that fosters a collaborative and supportive culture where everyone feels welcomed, accepted, and empowered to be their best. At the center of our associate engagement efforts is the concept of the Service-Profit Chain, where engaged associates deliver world-class service, which creates satisfied clients and, in turn, produces strong, long-term value for stockholders. We survey our associates’ engagement annually and our overall score this year is 81%, a four-point increase over last year’s score. Our human capital strategies are developed and managed by our Chief Human Resources Officer, who reports to the Chief Executive Officer, and are overseen by the Company’s Board of Directors and the Compensation Committee of the Board of Directors. Our Board of Directors believes that human capital management and succession planning are vital to our success. The Board annually reviews the Company’s leadership bench and succession planning. In addition, the Board receives regular updates on talent and other human capital matters such as culture, attrition and retention, and quarterly updates on our progress on our diversity, equity and inclusion (“DEI”) initiatives and practices, including an annual update from our Chief Diversity Officer. The Compensation Committee’s oversight includes initiatives and programs that concern our culture, talent, recruitment, retention and associate engagement.14Diversity, Equity and Inclusion We are dedicated to fostering a diverse, equitable, inclusive and healthy environment. As a leading provider of technology, communications and data and analytics solutions to businesses around the world, we must understand, embrace and operate in a multicultural environment. Every associate has unique strengths, which, when fully appreciated and embraced, enable everyone to perform at their best, leading to our success. Our goal is to ensure our associates at every level of the organization represent the diversity of the clients we serve and the communities in which we work. We are committed to advancing DEI initiatives and values as part of our culture. Our commitment to developing a diverse workforce is evidenced by the fact that a component of our Executive Leadership Team’s compensation is based on achievement of DEI goals. We have an Executive Diversity Council, chaired by our President, that meets quarterly and provides insight and recommendations on critical DEI-related opportunities and challenges. In addition, we support several associate-led employee resource groups (our Associate Networks), where associates with similar backgrounds and interests can find peer support, shape company culture, receive mentorship and sponsorship from senior members and develop their careers. Broadridge’s Associate Networks currently include: B.Pride, Disability Equity Associate Network (DEAN), Lead For Next (LFN), MultiCultural Associate Network (MCAN), Veteran + First Responder Network (VFN), Women’s Leadership Forum (WLF) and BeGreen. Together, these networks support the LQBTQ+ community, associates with disabilities, young professionals, multicultural backgrounds, veterans and first responders, women, and associates with a passion for sustainability. We have a Chief Diversity Officer, who implements a holistic DEI strategy and partners with our business units to develop the resources and competencies needed to drive this strategy. Our Chief Diversity Officer reports to our President, is a member of the Executive Diversity Council and Executive Leadership Team and provides regular updates to our Chief Executive Officer and Board of Directors. In addition, the Chief Diversity Officer serves as an advisor on global initiatives, such as our Associate Networks, and our recruitment and compliance efforts. We continue to progress our DEI initiatives building off the opportunities identified in our inaugural DEI survey in 2022, which ran globally, and over 7,000 associates across 19 countries participated. The results of our inaugural survey revealed that an overwhelming majority of our associates believe that 1) the importance of DEI is reflected in the priorities of Broadridge's business, 2) we were successful in advancing DEI initiatives over the past year, and 3) we create a physically and psychologically safe environment where associates feel they belong, and they are included and treated fairly. In 2023, we ran additional associate engagement surveys, which covered various DEI topics related to workplace culture and associate experience. We are committed to associate feedback to provide a comprehensive view of our organization’s culture, identify areas where improvements can be made to create a more welcoming and inclusive environment for all associates, and measure our progress over time. Talent and Development We believe that our associates are among our most important assets. Encouraging professional development opportunities is a core part of our culture. One important resource we provide our associates is Broadridge University, a comprehensive suite of online courses and virtual and on-site training. We offer career-enhancing programs from top business schools, have a tuition reimbursement program, and support participation in external learning opportunities. We offer our technology associates with resources to supplement their work experience, including a skills inventory to identify strengths and new opportunities, and a Technology Expert Career Track, a transparent dual career path process that allows associates to grow as leaders and experts in the organization. We also empower associates to learn and grow as subject matter experts in the financial markets. In turn, this enables our associates to assist our clients with their expertise and adds value to our associates’ own career development and skill sets. In addition to career-oriented education, we also require all associates to complete a variety of trainings on an annual basis, which focus on our commitment to high ethical standards and a culture of honesty, integrity and compliance.Health, Safety and Wellness We are committed to providing a safe workplace. We continuously strive to meet or exceed all laws, regulations and accepted practices pertaining to workplace safety. We have developed extensive safety policies, standards and procedures to which all associates are required to comply. Our policies are based on both U.S. Occupational Safety and Health Administration standards and site-specific guidelines to ensure that associates work in a safe and healthy environment. At our larger production facilities and at certain other locations, we house on-site Wellness Centers staffed with physicians, nurse practitioners and physician assistants who provide a wide variety of medical services at no cost to our associates.In addition, we are committed to providing competitive health and wellness benefits to our associates. We recognize the importance of work-life balance and have designed our Connected Workplace model, which provides associates with flexible on- and off-site work options. Our other health and wellness benefits include travel allowances for certain types of health care and subsidized emergency backup care services for our U.S.-based associates, various educational health and wellness programs and webinars, and an employee assistance program, which provides free counseling and other mental health services. 15Associate Compensation and BenefitsWe have demonstrated a history of investing in our workforce by offering competitive salaries and wages. In addition, we offer various types of compensation, which vary by associate role and country/region, and may include annual bonuses, stock awards, and retirement savings plans. Also, a portion of every associate’s incentive compensation is tied to client satisfaction goals, which reinforces our commitment to the Service-Profit Chain and rewards associates for their contributions to Broadridge’s overall client satisfaction performance. In addition we offer the following benefits, which may vary by country/region: healthcare and insurance benefits, tax efficient or savings programs, such as health and dependent care flexible spending accounts, health savings account and pretax commuter benefits or green transport tax savings programs, paid time off, including volunteer time off, paid parental leave, and sick time off, life and disability insurance, business travel accident insurance, charitable gift matching, tuition assistance and on-site health centers, among others. Associate Engagement We believe there is a direct connection between associate engagement and the satisfaction of our clients and the creation of stockholder value so we regularly conduct multiple surveys and focus groups to assess associate engagement and determine if and how perspectives have changed over time. Our surveys and focus group practices allow our associates to share their views on our workplace, the importance of various aspects of work life, among other topics. The themes and insights from our associate feedback are shared with our executive leadership and have been instrumental in shaping our workplace. In fiscal year 2023, we received an 81% overall favorable rating in the annual Great Place to Work survey. In addition, 83% of our associates stated that Broadridge is a “great place to work,” and we have received certification from Great Place to Work for our outstanding workplace culture in 14 countries: U.S., Canada, India, the United Kingdom, Ireland, Romania, Poland, Singapore, Japan, Czech Republic, France, Germany, Sweden and the Philippines. In the United Kingdom, we were recognized as one of the Best Workplaces, as well as one of the Best Workplaces for Wellbeing in 2023. The Great Place to Work Institute is a global authority on high-trust, high-performance workplaces. Available InformationOur headquarters are located at 5 Dakota Drive, Lake Success, New York 11042, and our telephone number is (516) 472-5400.We maintain an Investor Relations website at www.broadridge-ir.com. We make available free of charge, on or through this website, our annual, quarterly and current reports, and any amendments to those reports as soon as reasonably practicable following the time they are electronically filed with or furnished to the SEC. To access these reports, just click on the “SEC Filings” link found at the top of our Investor Relations page. You can also access our Investor Relations page through our main website at www.broadridge.com by clicking on the “Investor Relations” link, which is located at the top of our homepage. Information contained on our website is not incorporated by reference into this Annual Report on Form 10-K or any other report filed with or furnished to the SEC.In addition, the SEC maintains a website (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.16ITEM 1A. Risk Factors You should carefully consider each of the following risks and all of the other information set forth in this Annual Report on Form 10-K or incorporated by reference herein. Based on the information currently known to us, we believe that the following information identifies the most significant factors affecting our company. However, additional risks and uncertainties not currently known to us or that we currently believe to be immaterial may also adversely affect our business.If any of the following risks and uncertainties develop into actual events, they could have a material adverse effect on our business, financial condition, or results of operations.Our clients are subject to complex laws and regulations, and new laws or regulations and/or changes to existing laws or regulations could impact our clients and, in turn, adversely impact our business or may reduce our profitability. We provide technology solutions to financial services firms that are generally subject to extensive regulation in the U.S. and in other jurisdictions. As a provider of products and services to financial institutions and issuers of securities, our products and services are provided in a manner designed to assist our clients in complying with the laws and regulations to which they are subject. Therefore, our services, such as our proxy, shareholder report and prospectus distribution, and customer communications services, are particularly sensitive to changes in laws and regulations, including those governing the financial services industry and the securities markets. Changes in laws and regulations could require changes in the services we provide or the manner in which we provide our services, or they could result in a reduction or elimination of the demand for our services.Our investor communications services and the fees we charge our clients for certain services are subject to change if applicable SEC or stock exchange rules or regulations are amended, or new laws or regulations are adopted, which could result in a material negative impact on our business and financial results. For example, the SEC’s recently adopted modifications to the mutual fund and exchange-traded fund shareholder report disclosure framework could have an impact on our services, business and financial results.In addition, new regulations governing our clients could result in significant expenditures that could cause them to reduce their use of our services, seek to renegotiate existing agreements, or cease or curtail their operations, all of which could adversely impact our business. Further, an adverse regulatory action that changes a client’s business or adversely affects its financial condition, could decrease their ability to purchase, or their demand for, our products and services. The loss of business from any of our larger clients could have a material adverse effect on our revenues and results of operations. Consolidation in the financial services industry could adversely affect our revenues by eliminating some of our existing and potential clients and could make us increasingly dependent on a more limited number of clients. There has been and may continue to be consolidation activity in the financial services industry. These mergers or consolidations of financial institutions could reduce the number of our clients and potential clients. For example, in the past few years alone there have been several major consolidations involving our clients. When our clients merge with or are acquired by other firms that are not our clients, or firms that use fewer of our services, they may discontinue or reduce the use of our services. In addition, it is possible that the larger financial institutions resulting from mergers or consolidations could decide to perform in-house some or all of the services that we currently provide or could provide. If we are unable to mitigate the impact of a loss or reduction of business resulting from a client consolidation, we could have a material adverse effect on our business and results of operations.A large percentage of our revenues are derived from a small number of clients in the financial services industry and the loss of any of such clients, a reduction of their demand for our services, or change in the method of delivery of our services could have a material impact on our financial results.In fiscal year 2023, our largest client accounted for approximately 7% of our consolidated revenues. While our clients generally work with multiple business segments, the loss of business from any of our larger clients due to merger or consolidation, financial difficulties or bankruptcy, or the termination or non-renewal of contracts could have a material adverse effect on our revenues and results of operations. Also, a delay in onboarding a client onto our technology would result in a delay in our recognition of revenue from that client. Further, in the event of the loss of a client’s business, a reduction of a client’s demand for our services, or a change in the method of delivery of our services, then in addition to losing the revenue from that client, we could be required to write-off all or a portion of the related client investments or accelerate the amortization of certain costs, including costs incurred to onboard a client or convert a client’s systems to function with our technology. Such costs for all clients represented approximately 11% of our total assets as of June 30, 2023, with one client representing a large portion of this amount. See Note 3, “Revenue Recognition” and Note 11, “Deferred Client Conversion and Start-up Costs” to our consolidated financial statements for more information. 17Security breaches or cybersecurity attacks could adversely affect our ability to operate, could result in personal, confidential or proprietary information being misappropriated, and may cause us to be held liable or suffer harm to our reputation.We process and transfer sensitive data, including personal information, valuable intellectual property and other proprietary or confidential data provided to us by our clients, which include financial institutions, public companies, mutual funds, and healthcare companies. We also handle personal information of our employees in connection with their employment. We maintain systems and procedures including encryption, authentication technology, data loss prevention technology, entitlement management, access control and anti-malware software, and transmission of data over private networks to protect against unauthorized access to physical and electronic information, including by cybersecurity attacks. However, information security threats continue to evolve resulting in increased risk and exposure and increased costs to protect against the threat of information security breaches or to respond to or alleviate problems caused by such breaches. In certain circumstances, our third-party vendors may have access to sensitive data including personal information. It is also possible that a third-party vendor could intentionally or inadvertently disclose sensitive data, including personal information. We require our third-party vendors to have appropriate security controls if they have access to the personal information of our clients’ customers or our employees. However, despite those safeguards, it is possible that unauthorized individuals could improperly access our systems or those of our vendors, or improperly obtain or disclose the sensitive data including personal information that we or our vendors process or handle.Many of our services are provided through the internet, which increases our exposure to potential cybersecurity attacks. We have experienced cybersecurity threats to our information technology infrastructure and have experienced non-material cybersecurity attacks, attempts to breach our systems and other similar incidents. Future threats could cause harm to our business and our reputation and challenge our ability to provide reliable service, as well as negatively impact our results of operations materially. Our insurance coverage may not be adequate to cover all the costs related to cybersecurity attacks or disruptions resulting from such events.Any unauthorized use or disclosure of certain personal information could put individuals at risk of identity theft and financial or other harm and result in costs to us in investigation, remediation, legal defense and in liability to parties who are financially harmed. We may incur significant costs to protect against the threat of information security breaches or to respond to or alleviate problems caused by such breaches. For example, laws may require notification to regulators, clients or employees and enlisting credit monitoring or identity theft protection in the event of a privacy breach. A cybersecurity attack could also be directed at our systems and result in interruptions in our operations or delivery of services to our clients and their customers. Furthermore, a security breach could cause us to lose revenues, lose clients or cause damage to our reputation.Our business and results of operations may be adversely affected if we do not comply with legal and regulatory requirements that apply to our services or businesses, and new laws or regulations and/or changes to existing laws or regulations to which we are subject may adversely affect our ability to conduct our business or may reduce our profitability. The legislative and regulatory environment of the financial services industry is continuously changing. The SEC, FINRA, DOL, various stock exchanges and other U.S. and foreign governmental or regulatory authorities continuously review legislative and regulatory initiatives and may adopt new or revised laws and regulations or provide revised interpretations or they may change the enforcement priorities with respect to existing laws and regulations. These legislative and regulatory initiatives impact the way in which we conduct our business, requiring changes to the way we provide our services or additional investment which may make our business more or less profitable. Further, as a provider of technology services to financial institutions, certain aspects of our U.S. operations are subject to regulatory oversight and examination by the FFIEC. A sufficiently unfavorable review from the FFIEC could have a material adverse effect on our business. With an increased focus on cybersecurity and vendor risk management, the FFIEC and other regulatory agencies provide guidelines for overseeing technology service providers, increasing the contractual requirements with our clients and the cost of providing our services.Our business process outsourcing, mutual fund processing and transfer agency solutions as well as the entities providing those services are subject to regulatory oversight. Our provision of these services must comply with applicable rules and regulations of the SEC, FINRA, DOL, various stock exchanges and other regulatory bodies charged with safeguarding the integrity of the securities markets and other financial markets and protecting the interests of investors participating in these markets. If we fail to comply with any applicable regulations in performing these services, we could be subject to suits for breach of contract or to governmental proceedings, censures and fines. In addition, we could lose clients and our reputation could be harmed, negatively impacting our ability to attract new clients.18As a provider of data and business processing solutions, our systems contain a significant amount of sensitive data, including personal information, related to our clients, customers of our clients, and our employees. We are, therefore, subject to compliance obligations under federal, state and foreign privacy and information security laws, including in the U.S., the GLBA, HIPAA, and the CPRA, and the GDPR in the European Union, and we are subject to compliance with various client industry standards such as PCI DSS as well as Medicare and Medicaid programs related to our clients. We are subject to penalties for failure to comply with such regulations and requirements, and such penalties could have a material adverse effect on our financial condition, results of operations, or cash flows. There has been increased public attention regarding the use of personal information, accompanied by legislation and regulations intended to strengthen data protection, information security and consumer and personal privacy. The law in these areas continues to develop, the number of jurisdictions adopting such laws continues to increase and these laws may be inconsistent from jurisdiction to jurisdiction. Furthermore, the changing nature of privacy laws in the U.S., the European Union and elsewhere could impact our processing of personal information of our employees and on behalf of our clients.Our ability to comply with applicable laws and regulations depends largely upon the maintenance of an effective compliance system which can be time consuming and costly, as well as our ability to attract and retain qualified compliance personnel. Any failure by our employees to comply with our policies and any laws and regulations applicable to our business, even if inadvertent, could have a negative impact on our business.Our revenues may decrease due to declines in the levels of participation and activity in the securities markets. We generate significant revenues from the transaction processing fees we earn from our services. These revenue sources are substantially dependent on the levels of participation and activity in the securities markets. The number of unique securities positions held by investors through our clients and our clients’ customer trading volumes reflect the levels of participation and activity in the markets, which are impacted by market prices, and the liquidity of the securities markets, among other factors. Volatility in the securities markets and sudden sharp or gradual but sustained declines in market participation and activity can result in reduced investor communications activity, including reduced proxy and event-driven communications processing such as mutual fund proxy, mergers and acquisitions and other special corporate event communications processing, and reduced trading volumes. In addition, our event-driven fee revenues are based on the number of special corporate events and transactions we process. Event-driven activity is impacted by financial market conditions and changes in regulatory compliance requirements, resulting in fluctuations in the timing and levels of event-driven fee revenues. As such, the timing and level of event-driven activity and its potential impact on our revenues and earnings are difficult to forecast. The occurrence of any of these events would likely result in reduced revenues and decreased profitability from our business operations. We may be adversely impacted by a failure of third-party service providers to perform their functions. We rely on relationships with third parties, including our service providers and other vendors for certain functions. If we are unable to effectively manage our third-party relationships and the agreements under which our third-party vendors operate, our financial results or reputation could suffer. We rely on these third parties, including for the provision of certain data center and cloud services, to provide services in a timely and accurate manner and to adequately address their own risks, including those related to cybersecurity. Failure by these third parties to adequately perform their services as expected could result in material interruptions in our operations, and negatively impact our services resulting in a material adverse effect on our business and financial results.Certain of our businesses rely on a single or a limited number of service providers or vendors. Changes in the business condition (financial or otherwise) of these service providers or vendors could impact their provision of services to us or they may no longer be able to provide services to us at all, which could have a material adverse effect on our business and financial results. In such circumstances, we cannot be certain that we will be able to replace our key third-party vendors in a timely manner or on terms commercially reasonable to us given, among other reasons, the scope of responsibilities undertaken by some of our service providers, the depth of their experience and their familiarity with our operations generally.If we change a significant vendor, an existing service provider makes significant changes to the way it conducts its operations, or is acquired, or we seek to bring in-house certain services performed today by third parties, we may experience unexpected disruptions in the provision of our solutions and increased expenses, which could have a material adverse effect on our business, profitability, and financial results. Furthermore, certain third-party service providers or vendors may have access to sensitive data including personal information, valuable intellectual property and other proprietary or confidential data, including that provided to us by our clients. It is possible that a third-party vendor could intentionally or inadvertently disclose sensitive data including personal information, which could have a material adverse effect on our business and financial results and damage our reputation.19We rely on the United States Postal Service (“USPS”) and other third-party carriers to deliver communications and changes in our relationships with these carriers or an increase in postal rates or shipping costs may adversely impact demand for our products and services and could have an adverse impact on our business and results of operations.We rely upon the USPS and third-party carriers, including the United Parcel Service, for timely delivery of communications on behalf of our clients. As a result, we are subject to carrier disruptions due to factors that are beyond our control, including employee strikes, inclement weather, and increased fuel costs. Any failure to deliver communications to or on behalf of our clients in a timely and accurate manner may damage our reputation and brand and could cause us to lose clients. In addition, the USPS has incurred significant financial losses in recent years and may, as a result, implement significant changes to the breadth or frequency of its mail delivery, causing disruptions in the service. If our relationship with any of these third-party carriers is terminated or impaired, or if any of these third parties are unable to distribute communications, we would be required to use alternative, and possibly more expensive, carriers to complete our distributions on behalf of our clients. We may be unable to engage alternative carriers on a timely basis or on acceptable terms, if at all, which could have an adverse effect on our business. In addition, future increases in postal rates or shipping costs, as well as changes in customer preferences, may result in decreased demand for our traditional printed and mailed communications resulting in an adverse effect on our business, financial condition and results of operations.In the event of a disaster, our disaster recovery and business continuity plans may fail, which could result in the loss of client data and adversely interrupt operations. Our operations are dependent on our ability to protect our infrastructure against damage from catastrophe, natural disaster, or severe weather, as well as events resulting from unauthorized security breach, power loss, telecommunications failure, terrorist attack, pandemic, or other events that could have a significant disruptive effect on our operations. We have disaster recovery and business continuity plans in place in the event of system failure due to any of these events and we test our plans regularly. In addition, our data center services provider also has disaster recovery plans and procedures in place. However, we cannot be certain that our plans, or those of our data center services provider, will be successful in the event of a disaster. If our disaster recovery or business continuity plans are unsuccessful in a disaster recovery scenario, we could potentially lose client data or experience material adverse interruptions to our operations or delivery of services to our clients, and we could be liable to parties who are financially harmed by those failures. In addition, such failures could cause us to lose revenues, lose clients or damage our reputation.Any slowdown or failure of our computer or communications systems could impact our ability to provide services to our clients and support our internal operations and could subject us to liability for losses suffered by our clients or their customers. Our services depend on our ability to store, retrieve, process, and manage significant databases, and to receive and process transactions and investor communications through a variety of electronic systems. Our systems, those of our data center and cloud services providers, or any other systems with which our systems interact could slow down significantly or fail for a variety of reasons, including:•malware or undetected errors in internal software programs or computer systems;•direct or indirect hacking or denial of service cybersecurity attacks;•inability to rapidly monitor all system activity;•inability to effectively resolve any errors in internal software programs or computer systems once they are detected;•failure to maintain adequate operational systems and infrastructure;•heavy stress placed on systems during peak times or due to high volumes or volatility; or•power or telecommunications failure, fire, flood, pandemic or any other natural disaster or catastrophe.While we monitor system loads and performance and implement system upgrades to handle predicted increases in trading volume and volatility, we may not be able to predict future volume increases or volatility accurately or that our systems and those of our data center services and cloud services providers will be able to accommodate these volume increases or volatility without failure or degradation. In addition, we may not be able to prevent cybersecurity attacks on our systems. 20Moreover, because we have outsourced our data center operations and use third-party cloud services providers for storage of certain data, the operation, performance and security functions of the data center and the cloud system involve factors beyond our control, and we cannot guarantee that our third-party providers will be able to provide their services at a satisfactory level. Any significant degradation or failure of our or our third-party providers’ computer systems, communications systems or any other systems in the performance of our services could cause our clients or their customers to suffer delays in their receipt of our services. These delays could cause substantial losses for our clients or their customers, and we could be liable to parties who are financially harmed by those failures. In addition, such failures could cause us to lose revenues, lose clients or damage our reputation. The inability to properly perform our services or operational errors in the performance of our services could lead to liability for claims, client loss and result in reputational damage.The inability or the failure to properly perform our services could result in our clients and/or certain of our subsidiaries that operate regulated businesses being subjected to losses including censures, fines, or other sanctions by applicable regulatory authorities, and we could be liable to parties who are financially harmed by those errors. In addition, the inability to properly perform our services or errors in the performance of our services could result in a decline in confidence in our products and services and cause us to incur expenses including service penalties, lose revenues, lose clients or damage our reputation. Global economic and political conditions, including global health crises and geopolitical instability, broad trends in business and finance that are beyond our control have had and may have a material impact on our business operations and those of our clients and contribute to reduced levels of activity in the securities markets, which could adversely impact our business and results of operations. As a multinational company, our operations and our ability to deliver our services to our clients could be adversely impacted by general global economic and political conditions. Our business is highly dependent on the global financial services industry and exchanges and market centers around the world. Also, in recent years, we have expanded our operations, entered strategic alliances, and acquired businesses outside the U.S. Compliance with foreign and U.S. laws and regulations that are applicable to our international operations could cause us to incur higher than anticipated costs, and inadequate enforcement of laws or policies such as those protecting intellectual property, could affect our business and the Company’s overall results of operations.These factors may include:•economic, political and market conditions;•legislative and regulatory changes;•social and health conditions, including widespread outbreak of an illness or pandemic such as the Covid-19 pandemic;•acts of war or terrorism and international conflict, such as the conflict between Russia and Ukraine;•natural or man-made disasters or other catastrophes;•extreme or unusual weather patterns caused by climate change;•the availability of short-term and long-term funding and capital;•the level and volatility of interest rates;•currency values and inflation; •financial well-being of our clients; and•taxation levels affecting securities transactions.These factors are beyond our control and may negatively impact our ability to perform our services or the demand for our services or may increase our costs resulting in an adverse impact on our business and results of operations. For example, our services are impacted by the number of unique securities positions held by investors through our clients, the level of investor communications activity we process on behalf of our clients, trading volumes, market prices, and liquidity of the securities markets, which are in turn affected by general national and international economic and political conditions, and broad trends in business and finance that could result in changes in participation and activity in the securities markets. Accordingly, any significant reduction in participation and activity in the securities markets would likely adversely impact our business and results of operations. 21If the operational systems and infrastructure that we depend on fail to keep pace with our growth, we may experience operating inefficiencies, client dissatisfaction and lost revenue opportunities. The growth of our business and expansion of our client base may place a strain on our management and operations. We believe that our current and anticipated future growth will require the implementation of new and enhanced communications and information systems, the training of personnel to operate these systems, and the expansion and upgrade of core technologies. While many of our systems are designed to accommodate additional growth without redesign or replacement, we may nevertheless need to make significant investments in additional hardware and software to accommodate growth, which may impact our profitability and business operations. In addition, we may not be able to predict the timing or rate of this growth accurately or expand and upgrade our systems and infrastructure on a timely basis.Our growth has required and will continue to require increased investments in management personnel and systems, financial systems and controls, and office facilities. We cannot assure you that we will be able to manage or continue to manage our future growth successfully. If we fail to manage our growth, we may experience operating inefficiencies, dissatisfaction among our client base, and lost revenue opportunities.If we are unable to respond to the demands of our existing and new clients, or adapt to technological changes or advances, our business and future growth could be impacted. The global financial services industry is characterized by increasingly complex and integrated infrastructures and products, new and changing business models and rapid technological and regulatory changes. Our clients’ needs and demands for our products and services evolve with these changes. Our future success will depend, in part, on our ability to respond to our clients’ demands for new services, capabilities and technologies on a timely and cost-effective basis. We also need to adapt to technological advancements such as artificial intelligence, machine learning, quantum computing, digital and distributed ledger and cloud computing and keep pace with changing regulatory standards to address our clients’ increasingly sophisticated requirements. Transitioning to these new technologies may require close coordination with our clients, be disruptive to our resources and the services we provide and may increase our reliance on third-party service providers such as our cloud services provider.In addition, we run the risk of disintermediation due to emerging technologies, fintech start-ups and new market entrants. If we fail to adapt or keep pace with new technologies in a timely manner, it could harm our ability to compete, decrease the value of our products and services to our clients, and harm our business and impact our future growth.Intense competition could negatively affect our ability to maintain or increase our business, financial condition, and results of operations. The markets for our products and services continue to evolve and are highly competitive. We compete with a number of firms that provide similar products and services. In addition, our securities processing solutions compete with our clients’ in-house capabilities to perform comparable functions. Our competitors may be able to respond more quickly to new or changing opportunities, technologies, and client requirements and may be able to undertake more extensive promotional activities, offer more attractive terms to clients and adopt more aggressive pricing policies than we will be able to offer or adopt. In addition, we expect that the markets in which we compete will continue to attract new competitors and new technologies. There can be no assurances that we will be able to compete effectively with current or future competitors. If we fail to compete effectively, our business, financial condition, and results of operations could be materially harmed.We may be unable to attract and retain key personnel. Our continued success depends on our ability to attract and retain key personnel such as our senior management and other qualified personnel including highly skilled technical employees to conduct our business. Skilled and experienced personnel in the areas where we compete are in high demand, and competition for their talents is intense. There can be no assurance that we will be successful in our efforts to recruit and retain the required key personnel. If we are unable to attract and retain qualified individuals or our recruiting and retention costs increase significantly, our operations and financial results could be materially adversely affected.The inability to identify, obtain, retain, enforce and protect important intellectual property rights could harm our business. Third parties may infringe or misappropriate our intellectual property, which includes a combination of patents, trademarks, service marks, copyrights, domain names and trade secrets. Our inability to protect our intellectual property and marks could adversely affect our business. In an effort to protect our intellectual property, we enter into confidentiality and invention assignment agreements with our employees, consultants and other third parties, and control access to our services, software and proprietary information. Moreover, we license or acquire technology that we incorporate into our services and products. Additional actions may be required to protect our intellectual property, including legal action, which could be time consuming and expensive and may negatively impact our business, financial condition, and results of operations.22Despite our efforts to identify, obtain, retain, enforce and protect our intellectual property rights and proprietary information, we cannot be certain that they will be effective or sufficient to prevent the unauthorized access, use, copying, theft or the reverse engineering of our intellectual property and proprietary information for a variety of reasons, including: (a) our inability to detect misappropriation by third parties of our intellectual property; (b) disparate legal protections for intellectual property across different countries; (c) constantly evolving intellectual property legal standards as to the scope of protection, validity, non-infringement, enforceability and infringement defenses; (d) failure to maintain appropriate contractual restrictions and other measures to protect our know- how and trade secrets, or contract breaches by others; (e) failure to identify and obtain patents on patentable innovations; (f) potential invalidation, unenforceability, scope narrowing, dilution and opposition, through litigation and administrative processes both in the U.S. and abroad, of our intellectual property rights; and (g) other business or resource limitations on intellectual property enforcement against third parties.Our products and services, and the products and services provided to us by third parties, may infringe upon intellectual property rights of third parties, and any infringement claims, whether initiated by or against us, could require us to incur substantial costs, distract our management, or prevent us from conducting our business. Costly, complex, time-consuming and unpredictable litigation may be necessary to enforce our intellectual property rights, or challenge the purported validity or scope of third-party intellectual property. Further, although we attempt to avoid infringing upon known proprietary rights of third parties, we are subject to the risk of claims alleging infringement of third-party proprietary rights. All intellectual property litigations, even baseless claims, result in significant expense and diversion of resources, our management and time. Any adverse outcome in an intellectual property litigation could prevent us from selling our products or services or require us to license the technology of others on unfavorable terms, which may materially and adversely affect our brand, business, operations and financial condition. Additionally, third parties that provide us with products or services that are integral to the conduct of our business may also be subject to similar infringement allegations from others, which could prevent such third parties from continuing to provide these products or services to us. As a result, we may need to undertake work-arounds or substantial reengineering of our products or services in order to continue offering them, and we may not succeed in doing so. Furthermore, a party asserting such an infringement claim could secure a judgment against us that requires us to pay substantial damages, grant such party injunctive relief, or grant other court ordered remedies that could prevent us from conducting our business.We use third-party open source software in our products and services. Though we have a policy, review board, and review process in place governing the use of open source software, there is a risk that we incorporate into our products and services open source software with onerous licensing terms that purportedly require us to make the source code of our proprietary code, combined with such open source software, available under such license. Furthermore, U.S. courts have not interpreted the terms of various open source licenses, but could interpret them in a manner that imposes unanticipated conditions or restrictions on our products and services. Usage of open source software can lead to greater risks than use of third-party commercial software, given that licensors generally disclaim all warranties on their open source software, and hackers frequently exploit vulnerabilities in open source software. Any use of open source software inconsistent with its license or our policy could harm our business, operations and financial position.Acquisitions and integrating such acquisitions create certain risks and may affect operating results. As part of our overall business strategy, we may make acquisitions and strategic investments in companies, technologies or products, or enter joint ventures. In fact, over the last three fiscal years we have completed 4 acquisitions and made strategic investments in seven firms. These transactions and the integration of acquisitions involve a number of risks. The core risks are in the areas of:•valuation: finding suitable businesses to acquire at affordable valuations or on other acceptable terms; competition for acquisitions from other potential acquirors, and negotiating a fair price for the business based on inherently limited due diligence reviews;•integration: managing the complex process of integrating the acquired company’s people, products, technology, and other assets, and converting their financial, information security, privacy and other systems and controls to meet our standards, so as to achieve intended strategic objectives and realize the projected value, synergies and other benefits in connection with the acquisition; and•legacy issues: protecting against actions, claims, regulatory investigations, losses, and other liabilities related to the predecessor business.23Also, the process of integrating these businesses may be difficult and expensive, disrupt our business and divert our resources. These risks may arise for a number of reasons including, for example:•incurring unforeseen obligations or liabilities in connection with such acquisitions;•devoting unanticipated financial and management resources to an acquired business;•borrowing money from lenders or selling equity or debt securities to the public to finance future acquisitions on terms that may be adverse to us;•additional debt incurred to finance an acquisition could impact our liquidity and may cause a credit downgrade;•loss of clients of the acquired business;•entering markets where we have minimal prior experience; and•experiencing decreases in earnings as a result of non-cash impairment charges.In addition, international acquisitions, such as our 2021 acquisition of Itiviti, often involve additional or increased risks including, for example:•geographically separated organizations, systems, and facilities;•integrating personnel with diverse business backgrounds and organizational cultures;•complying with non-U.S. regulatory requirements;•enforcing intellectual property rights in some non-U.S. countries; and•general economic and political conditions.Our existing and future debt levels, and compliance with our debt service obligations, could have a negative impact on our financing options and liquidity position, which could adversely affect our business.As of June 30, 2023, we had $3,413.3 million in aggregate principal amount of total debt. Additionally, our revolving credit facility has a remaining borrowing capacity of $1,500.0 million as of June 30, 2023. Our overall leverage and the terms of our financing arrangements could:•limit our ability to obtain additional financing in the future for working capital, capital expenditures or acquisitions, to fund growth or for general corporate purposes, even when necessary to maintain adequate liquidity;•make it more difficult for us to satisfy the terms of our debt obligations;•limit our ability to refinance our indebtedness on terms acceptable to us, or at all;•limit our flexibility to plan for and to adjust to changing business and market conditions and implement business strategies; •require us to dedicate a substantial portion of our cash flow from operations to make interest and principal payments on our debt, thereby limiting the availability of our cash flow to fund future investments, capital expenditures, working capital, business activities and other general corporate requirements; and•increase our vulnerability to adverse economic or industry conditions.Our liquidity position may be negatively affected by changes in general economic conditions, regulatory requirements and access to the capital markets, which may be limited if we were to fail to renew any of the credit facilities on their renewal dates or if we were to fail to meet certain ratios. Our ability to meet expenses and debt service obligations will depend on our future performance, which could be affected by financial, business, economic and other factors. If we are not able to pay our debt service obligations or comply with the financial or other restrictive covenants contained in the indenture governing our senior notes, or our credit facility, we may be required to immediately repay or refinance all or part of our debt, sell assets, borrow additional funds or raise additional equity capital, which could also result in a credit rating downgrade. In addition, if the credit ratings of our outstanding indebtedness are downgraded, or if rating agencies indicate that a downgrade may occur, our business, financial position, and results of operations could be adversely affected, and perceptions of our financial strength could be damaged. A downgrade would also have the effect of increasing our borrowing costs and could decrease the availability of funds we are able to borrow, adversely affecting our business, financial position, and results of operations. Further, a downgrade could adversely affect our relationships with our clients.24We may incur non-cash impairment charges in the future associated with our portfolio of intangible assets, including goodwill.As a result of past acquisitions, we carry a significant goodwill and other acquired intangible assets on our balance sheet. In addition, we also defer certain costs to onboard a client or convert a client’s systems to function with our technology. Goodwill, intangible assets, net, and deferred client conversion and start-up costs accounted for approximately 71% of the total assets on our balance sheet as of June 30, 2023. We test goodwill for impairment annually as of March 31st and we test goodwill, intangible assets, net, and deferred client conversion and start-up costs for impairment at other times if events have occurred or circumstances exist that indicate the carrying value of such assets may no longer be recoverable. It is possible we may incur impairment charges in the future, particularly in the event of a prolonged economic recession or loss of a key client or clients. A significant non-cash impairment could have a material adverse effect on our results of operations.Certain of our services may be exposed to risk from our counterparties and third parties.Our mutual fund and exchange-traded fund processing services and our transfer agency services involve the settlement of transactions on behalf of our clients and third parties. With these activities, we may be exposed to risk in the event our clients, or broker-dealers, banks, clearing organizations, or depositories are unable to fulfill contractual obligations. Failure to settle a transaction may affect our ability to conduct these services or may reduce their profitability as a result of the reputational risk associated with failure to settle.ITEM 1B. Unresolved Staff CommentsNone.ITEM 2. PropertiesWe operate our business primarily from 44 facilities. We lease 10 production-related facilities in Edgewood, New York; El Dorado Hills, California; South Windsor, Connecticut; Kansas City, Missouri; Dallas, Texas; Coppell, Texas; and Markham, Canada, with a combined space of 2.3 million square feet which are used in connection with our Investor Communication Solutions business. We also lease one facility in Newark, New Jersey, which houses our principal Global Technology and Operations business operations. We lease space at 32 additional locations, subject to customary lease arrangements and which expire on a staggered basis, and we also own one facility in Mount Laurel, New Jersey. We believe our facilities are currently adequate for their intended purposes and are adequately maintained.ITEM 3. Legal ProceedingsCurrently, there are not any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company is a party or of which any of the Company’s property is the subject. In the normal course of business, the Company is subject to claims and litigation. While the outcome of any claim or litigation is inherently unpredictable, the Company believes that the ultimate resolution of these matters will not, individually or in the aggregate, result in a material impact on its financial condition, results of operations, or cash flows.ITEM 4. Mine Safety DisclosuresNot applicable.25PART II.ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesOur common stock began trading “regular way” on the NYSE under the symbol “BR” on April 2, 2007. There were 8,880 stockholders of record of the Company’s common stock as of August 4, 2023. This figure excludes the beneficial holders whose shares may be held of record by brokerage firms and clearing agencies. Dividend Policy We expect to pay cash dividends on our common stock. On August 7, 2023, our Board of Directors increased our quarterly cash dividend by $0.075 per share to $0.80 per share, an increase in our expected annual dividend amount from $2.90 to $3.20 per share. The declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors, and will depend upon many factors, including our financial condition, earnings, capital requirements of our businesses, legal requirements, regulatory constraints, industry practice, and other factors that the Board of Directors deems relevant.As a holding company, substantially all our assets are comprised of the capital stock of our subsidiaries; therefore, our ability to pay dividends will be dependent on our receiving dividends from our operating subsidiaries. Our subsidiaries through which we provide our business process outsourcing and mutual fund processing services, are regulated and may be subject to restrictions on their ability to pay dividends to us. We do not believe that these restrictions are significant enough to impact the Company’s ability to pay dividends. Performance GraphThe following graph compares the cumulative total return on Broadridge common stock from June 30, 2018 to June 30, 2023, with the comparable cumulative return of the: (i) S&P 500 Index and (ii) S&P 500 Information Technology Index. The graph assumes $100 was invested on June 30, 2018 in our common stock and in each of the indices and assumes that all cash dividends are reinvested. The table below the graph shows the dollar value of those investments as of the dates in the graph. The comparisons in the graph are required by the SEC and are not intended to forecast or be indicative of future performance of our common stock.The following performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or the Exchange Act, each as amended, except to the extent that Broadridge specifically incorporates it by reference into such filing.26Comparison of Five Year Cumulative Total Return Among Broadridge Financial Solutions, Inc., S&P 500 Index, and S&P 500 Information Technology Index (in dollars)June 30, 2018June 30, 2019June 30, 2020June 30, 2021June 30, 2022June 30, 2023Broadridge Financial Solutions. Inc. Common Stock$100.00 $112.82 $113.64 $147.77 $132.58 $157.06 S&P 500 Index$100.00 $110.41 $118.68 $167.07 $149.31 $178.52 S&P 500 Information Technology Index$100.00 $114.32 $155.34 $221.19 $191.19 $268.17 Purchases of Equity Securities by the Issuer and Affiliated PurchasersThe following table contains information about our purchases of our equity securities for each of the three months during our fourth fiscal quarter ended June 30, 2023:PeriodTotal Number ofShares Purchased (1)Average PricePaid per ShareTotal Number of SharesPurchased as Part ofPublicly Announced Plans or Programs (2)Maximum Number of Shares that May Yet Be PurchasedUnder the Plans or Programs (2)April 1, 2023 – April 30, 2023138,522 $146.57 — 9,586,545 May 1, 2023 – May 31, 20232,265 153.70 — 9,586,545 June 1, 2023 – June 30, 2023107 149.00 — 9,586,545 Total140,894 $146.69 — (1)Includes 140,894 shares purchased from employees to pay taxes related to the vesting of restricted stock units. (2)During the fiscal quarter ended June 30, 2023, the Company did not repurchase shares of common stock under its share repurchase program. At June 30, 2023, there were 9,586,545 shares remaining available for repurchase under its share repurchase program. Any share repurchases will be made in the open market or privately negotiated transactions in compliance with applicable legal requirements and other factors.27ITEM 6. [Reserved]ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThis discussion summarizes the significant factors affecting the results of operations and financial condition of Broadridge during the fiscal years ended June 30, 2023 and 2022, and should be read in conjunction with our Consolidated Financial Statements and accompanying Notes thereto included elsewhere herein. Certain information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are not historical in nature and which may be identified by the use of words such as “expects,” “assumes,” “projects,” “anticipates,” “estimates,” “we believe,” “could be,” “on track” and other words of similar meaning, are forward-looking statements. These statements are based on management’s expectations and assumptions and are subject to risks and uncertainties that may cause actual results to differ materially from those expressed. Our actual results, performance or achievements may differ materially from the results discussed in this Item 7 because of various factors, including those set forth elsewhere herein. See “Forward-Looking Statements” and “Risk Factors” included in Part 1 of this Annual Report on Form 10-K.The discussion summarizing the significant factors affecting the results of operations and financial condition of Broadridge during the fiscal year ended June 30, 2022 can be found in Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year 2022 (the “2022 Annual Report”), which was filed with the Securities and Exchange Commission on August 12, 2022.DESCRIPTION OF THE COMPANY AND BUSINESS SEGMENTSBroadridge, a Delaware corporation and a part of the S&P 500® Index, is a global financial technology leader providing investor communications and technology-driven solutions to banks, broker-dealers, asset and wealth managers, public companies, investors and mutual funds. Our services include investor communications, securities processing, data and analytics, and customer communications solutions. With over 60 years of experience, including over 15 years as an independent public company, we provide integrated solutions and an important infrastructure that powers the financial services industry. Our solutions enable better financial lives by powering investing, governance and communications and help reduce the need for our clients to make significant capital investments in operations infrastructure, thereby allowing them to increase their focus on core business activities. Our businesses operate in two reportable segments: Investor Communication Solutions and Global Technology and Operations. ACQUISITIONSAssets acquired and liabilities assumed in business combinations are recorded on the Company’s Consolidated Balance Sheets as of the respective acquisition date based upon the estimated fair values at such date. The results of operations of the business acquired by the Company are included in the Company’s Consolidated Statements of Earnings since the respective date of acquisition. The excess of the purchase price over the estimated fair values of the underlying assets acquired and liabilities assumed is allocated to Goodwill.During the fiscal years ended June 30, 2023 and June 30, 2022, there were no material acquisitions. BASIS OF PRESENTATIONThe Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and in accordance with the SEC requirements for Annual Reports on Form 10-K. These financial statements present the consolidated position of the Company and include the entities in which the Company directly or indirectly has a controlling financial interest as well as various entities in which the Company has investments recorded under the equity method of accounting as well as certain marketable and non-marketable securities. Intercompany balances and transactions have been eliminated. Amounts presented may not sum due to rounding. Certain prior period amounts have been reclassified to conform to the current year presentation where applicable.28In presenting the Consolidated Financial Statements, management makes estimates and assumptions that affect the amounts reported and related disclosures. Management continually evaluates the accounting policies and estimates used to prepare the Consolidated Financial Statements. The estimates, by their nature, are based on judgment, available information, and historical experience and are believed to be reasonable. However, actual amounts and results could differ from those estimates made by management. In management’s opinion, the Consolidated Financial Statements contain all normal recurring adjustments necessary for a fair presentation of results reported. The results of operations reported for the periods presented are not necessarily indicative of the results of operations for subsequent periods.Beginning with the first quarter of fiscal year 2023, the Company changed reporting for segment revenues, segment earnings (loss) before income taxes, and segment amortization of acquired intangibles and purchased intellectual property to reflect the impact of actual foreign exchange rates applicable to the individual periods presented. The presentation of these metrics for the prior periods provided in this Form 10-K has been changed to conform to the current period presentation. Total consolidated revenues and earnings before income taxes were not impacted. Please refer to Note 3, “Revenue Recognition” and Note 21, “Financial Data by Segment” to our Consolidated Financial Statements under Item 8 of Part II of this Annual Report on Form 10-K.SeasonalityProcessing and distributing proxy materials and annual reports to investors comprises a large portion of our Investor Communication Solutions business. We process and distribute the greatest number of proxy materials and annual reports during our third and fourth fiscal quarters. The recurring periodic activity of this business is linked to significant filing deadlines imposed by law on public reporting companies. This has caused our revenues, operating income, net earnings, and cash flows from operating activities to be higher in our third and fourth fiscal quarters. The seasonality of our revenues makes it difficult to estimate future operating results based on the results of any specific fiscal quarter and could affect an investor’s ability to compare our financial condition, results of operations, and cash flows on a fiscal quarter-by-quarter basis.CRITICAL ACCOUNTING ESTIMATESWe continually evaluate the accounting policies and estimates used to prepare the Consolidated Financial Statements. The estimates, by their nature, are based on judgment, available information, and historical experience and are believed to be reasonable. However, actual amounts and results could differ from these estimates made by management. Certain accounting policies that require significant management estimates and are deemed critical to our results of operations or financial position are discussed below.Goodwill. We review the carrying value of all our Goodwill by comparing the carrying value of our reporting units to their fair values. We are required to perform this comparison at least annually or more frequently if circumstances indicate a possible impairment. When determining fair value of a reporting unit, we utilize the income approach which considers a discounted future cash flow analysis using various assumptions, including projections of revenues based on assumed long-term growth rates, estimated costs and appropriate discount rates based on the particular reporting unit’s weighted-average cost of capital. The principal factors used in the discounted cash flow analysis requiring judgment are the projected future operating cash flows based on forecasted earnings before interest and taxes, and the selection of the terminal value growth rate and discount rate assumptions. The weighted-average cost of capital takes into account the relative weight of each component of our consolidated capital structure (equity and long-term debt). Our estimates of long-term growth and costs are based on historical data, various internal estimates and a variety of external sources, and are developed as part of our routine, long-range planning process. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairments in future periods. If the carrying amount of the reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, not to exceed the total amount of Goodwill allocated to that reporting unit. We had $3,461.6 million of Goodwill as of June 30, 2023. Given the significance of our Goodwill, an adverse change to the fair value of one of our reporting units could result in an impairment charge, which could be material to our earnings.The Company performs a sensitivity analysis under the goodwill impairment test assuming hypothetical reductions in the fair values of our reporting units. A 10% change in our estimates of projected future operating cash flows, discount rates, or terminal value growth rates used in our calculations of the fair values of the reporting units would not result in an impairment of our Goodwill. 29Income Taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in addressing the future tax consequences of events that have been recognized in our Consolidated Financial Statements or tax returns (e.g., realization of deferred tax assets, changes in tax laws or interpretations thereof). The Company is subject to regular examination of its income tax returns by the U.S. federal, state and foreign tax authorities. A change in the assessment of the outcomes of such matters could materially impact our Consolidated Financial Statements. The Company has estimated foreign net operating loss carryforwards of approximately $45.1 million as of June 30, 2023 of which $7.6 million are subject to expiration in the June 30, 2026 through June 30, 2042 period. The remaining $37.5 million of carryforwards has an indefinite utilization period. In addition, the Company has estimated U.S. federal net operating loss carryforwards of approximately $35.3 million of which $15.5 million are subject to expiration in the June 30, 2024 through June 30, 2037 period with the balance of $19.8 million having an indefinite utilization period. U.S. federal net operating loss carryforwards resulting from tax losses beginning with the fiscal year ended June 30, 2019 have an indefinite carryforward under the U.S. Tax Cuts and Jobs Act (the “Tax Act”). The Company did not generate federal net operating losses for the fiscal year ended June 30, 2023. Valuation allowances are recognized to reduce deferred tax assets when it is more likely than not that the Company will not be able to utilize the deferred tax assets of certain subsidiaries to offset future taxable earnings. The Company has recorded valuation allowances of $10.3 million and $10.7 million at June 30, 2023 and 2022, respectively. The determination as to whether a deferred tax asset will be recognized is made on a jurisdictional basis and is based on the evaluation of historical taxable income or loss, projected future taxable income, carryforward periods, scheduled reversals of deferred tax liabilities and tax planning strategies. Projected future taxable income is based on expected results and assumptions as to the jurisdiction in which the income will be earned. The assumptions used to project future taxable income requires significant judgment and are consistent with the plans and estimates used to manage the underlying businesses.Share-based Payments. Accounting for stock-based compensation requires the measurement of stock-based compensation expense based on the fair value of the award on the date of grant. We determine the fair value of stock options issued by using a binomial option-pricing model. The binomial option-pricing model considers a range of assumptions related to volatility, dividend yield, risk-free interest rate and employee exercise behavior. Expected volatilities utilized in the binomial option-pricing model are based on a combination of implied market volatilities, historical volatility of our stock price and other factors. Similarly, the dividend yield is based on historical experience and expected future changes. The risk-free rate is derived from the U.S. Treasury yield curve in effect at the time of grant. The binomial option-pricing model also incorporates exercise and forfeiture assumptions based on an analysis of historical data. The expected life of the stock option grants is derived from the output of the binomial model and represents the period of time that options granted are expected to be outstanding. Determining these assumptions are subjective and complex, and therefore, a change in the assumptions utilized could impact the calculation of the fair value of our stock options. A hypothetical change of five percentage points applied to the volatility assumption used to determine the fair value of the fiscal year 2023 stock option grants would result in an approximate $3.1 million change in total pre-tax stock-based compensation expense for the fiscal year 2023 grants, which would be amortized over the vesting period. A hypothetical change of one year in the expected life assumption used to determine the fair value of the fiscal year 2023 stock option grants would result in an approximate $1.7 million change in the total pre-tax stock-based compensation expense for the fiscal year 2023 grants, which would be amortized over the vesting period. A hypothetical change of one percentage point in the forfeiture rate assumption used for the fiscal year 2023 stock option grants would result in an approximate $0.2 million change in the total pre-tax stock-based compensation expense for the fiscal year 2023 grants, which would be amortized over the vesting period. A hypothetical one-half percentage point change in the dividend yield assumption used to determine the fair value of the fiscal year 2023 stock option grants would result in an approximate $1.4 million change in the total pre-tax stock-based compensation expense for the fiscal year 2023 grants, which would be amortized over the vesting period.30KEY PERFORMANCE INDICATORSManagement focuses on a variety of key indicators to plan, measure and evaluate the Company’s business and financial performance. These performance indicators include Revenue and Recurring revenue as well as not generally accepted accounting principles measures (“Non-GAAP”) of Adjusted Operating income, Adjusted Net earnings, Adjusted earnings per share, Free Cash flow, Recurring revenue growth constant currency, and Closed sales. In addition, management focuses on select operating metrics specific to Broadridge of Record Growth and Internal Trade Growth, as defined below.Refer to the section “Explanation and Reconciliation of the Company’s Use of Non-GAAP Financial Measures” for a reconciliation of Adjusted Operating income, Adjusted Net earnings, Adjusted earnings per share, Free Cash flow, and Recurring revenue growth constant currency to the most directly comparable GAAP measures, and an explanation for why these Non-GAAP metrics provide useful information to investors and how management uses these Non-GAAP metrics for operational and financial decision-making. Refer to the section “Results of Operations” for a description of Closed sales and an explanation of why Closed sales is a useful performance metric for management and investors.RevenuesRevenues are primarily generated from fees for processing and distributing investor communications and fees for technology-enabled services and solutions. The Company monitors revenue in each of our two reportable segments as a key measure of success in addressing our clients’ needs. Revenues from fees are derived from both recurring and event-driven activity. The level of recurring and event-driven activity the Company processes directly impacts distribution revenues. While event-driven activity is highly repeatable, it may not recur on an annual basis. Event-driven revenues are based on the number of special events and corporate transactions the Company processes. Event-driven activity is impacted by financial market conditions and changes in regulatory compliance requirements, resulting in fluctuations in the timing and levels of event-driven revenues. Distribution revenues primarily include revenues related to the physical mailing of proxy materials, interim communications, transaction reporting, customer communications and fulfillment services as well as Broadridge Retirement and Workplace administrative services.Recurring revenue growth represents the Company’s total annual revenue growth, less growth from event-driven and distribution revenues. We distinguish recurring revenue growth between organic and acquired:•Organic – We define organic revenue as the recurring revenue generated from Net New Business and Internal Growth.•Acquired – We define acquired revenue as the recurring revenue generated from acquired services in the first twelve months following the date of acquisition. This type of growth comes as a result of our strategy to purchase, integrate, and leverage the value of assets we acquire. Revenues and Recurring revenue are useful metrics for investors in understanding how management measures and evaluates the Company’s ongoing operational performance. See “Results of Operations” as well as Note 2, “Summary of Significant Accounting Policies” and Note 3, “Revenue Recognition” to our Consolidated Financial Statements under Item 8 of Part II of this Annual Report on Form 10-K.31Record Growth and Internal Trade GrowthThe Company uses select operating metrics specific to Broadridge of Record Growth and Internal Trade Growth in evaluating its business results and identifying trends affecting its business. Record Growth is comprised of stock record growth and interim record growth. Stock record growth (also referred to as “SRG” or “equity position growth”) measures the estimated annual change in positions eligible for equity proxy materials. Interim record growth (also referred to as “IRG” or “mutual fund/ETF position growth”) measures the estimated change in mutual fund and exchange traded fund positions eligible for interim communications. These metrics are calculated from equity proxy and mutual fund/ETF position data reported to Broadridge for the same issuers or funds in both the current and prior year periods. Internal Trade Growth represents the estimated change in daily average trade volumes for Broadridge securities processing clients whose contracts are linked to trade volumes and who were on Broadridge’s trading platforms in both the current and prior year periods. Record Growth and Internal Trade Growth are useful non-financial metrics for investors in understanding how management measures and evaluates Broadridge’s ongoing operational performance within its Investor Communication Solutions and Global Technology and Operations reportable segments, respectively.The key performance indicators for the fiscal years ended June 30, 2023, and 2022, are as follows:Select Operating MetricsYears Ended June 30,20232022Record Growth Equity positions (Stock records)9 %18 % Mutual fund / ETF positions (Interim records)8 %14 %Internal Trade Growth4 %1 % RESULTS OF OPERATIONSThe following discussions of Analysis of Consolidated Statements of Earnings and Analysis of Reportable Segments refer to the fiscal year ended June 30, 2023 compared to the fiscal year ended June 30, 2022. The Analysis of Consolidated Statements of Earnings should be read in conjunction with the Analysis of Reportable Segments, which provides a more detailed discussion concerning certain components of the Consolidated Statements of Earnings. Discussions of Analysis of Consolidated Statements of Earnings and Analysis of Reportable Segments for the fiscal year ended June 30, 2022 compared to the fiscal year ended June 30, 2021 is disclosed in Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the 2022 Annual Report.The following references are utilized in the discussions of Analysis of Consolidated Statements of Earnings and Analysis of Reportable Segments:“Amortization of Acquired Intangibles and Purchased Intellectual Property” and “Acquisition and Integration Costs” represent certain non-cash amortization expenses associated with acquired intangible assets and purchased intellectual property assets, as well as certain transaction and integration costs associated with the Company’s acquisition activities, respectively.“Investment Gains” represent non-operating, non-cash gains on privately held investments. “Real Estate Realignment and Covid-19 Related Expenses” are comprised of two major components: Real Estate Realignment Expenses, and Covid-19 Related Expenses. Real Estate Realignment Expenses are expenses associated with the exit of certain of the Company’s leased facilities in response to the Covid-19 pandemic, which consist of the impairment of certain right of use assets, leasehold improvements and equipment, as well as other related facility exit expenses directly resulting from, and attributable to, the exit of these leased facilities. Covid-19 Related Expenses are direct and incremental expenses incurred by the Company to protect the health and safety of Broadridge associates during the Covid-19 outbreak, including expenses associated with monitoring the temperatures for associates entering our facilities, enhancing the safety of our office environment in preparation for workers to return to Company facilities on a more regular basis, ensuring proper social distancing in our production facilities, personal protective equipment, enhanced cleaning measures in our facilities, and other safety related expenses. 32“Restructuring Charges” represent severance costs associated with the Company’s initiative to streamline our management structure, reallocate work to lower cost locations, and reduce headcount in deprioritized areas.“Russia-Related Exit Costs” are direct and incremental costs associated with the Company’s wind down of business activities in Russia in response to Russia’s invasion of Ukraine, including relocation-related expenses of impacted associates.“Net New Business” refers to recurring revenue from Closed sales for the initial twelve-month contract period after which the client goes live with the Company’s service(s), less recurring revenue from client losses. “Internal Growth” is a component of recurring revenue and generally reflects year over year changes in existing services to our existing customers’ multi-year contracts beyond the initial twelve-month period in which it was included in Net New Business.“Recurring revenue growth constant currency” refers to our Recurring revenue growth presented on a constant currency basis to exclude the impact of foreign currency exchange fluctuations.The following definitions describe the Company’s Revenues:Revenues in the Investor Communication Solutions segment are derived from both recurring and event-driven activity, in addition to distribution revenues. The level of recurring and event-driven activity we process directly impacts revenues. While event-driven activity is highly repeatable, it may not recur on an annual basis. The types of services we provide that comprise event-driven activity are:•Mutual Fund Proxy: The proxy and related services we provide to mutual funds when certain events occur requiring a shareholder vote including changes in directors, sub-advisors, fee structures, investment restrictions, and mergers of funds.•Mutual Fund Communications: Mutual fund communications services consist primarily of the distribution on behalf of mutual funds of supplemental information required to be provided to the annual mutual fund prospectus as a result of certain triggering events such as a change in portfolio managers. In addition, mutual fund communications consist of notices and marketing materials such as newsletters.•Equity Proxy Contests and Specials, Corporate Actions, and Other: The proxy services we provide in connection with shareholder meetings driven by special events such as proxy contests, mergers and acquisitions, and tender/exchange offers.Event-driven revenues are based on the number of special events and corporate transactions we process. Event-driven activity is impacted by financial market conditions and changes in regulatory compliance requirements, resulting in fluctuations in the timing and levels of event-driven revenues. As such, the timing and level of event-driven activity and its potential impact on revenues and earnings are difficult to forecast. Generally, mutual fund proxy activity has been subject to a greater level of volatility than the other components of event-driven activity. During fiscal year 2023, mutual fund proxy revenues were 51% lower than the prior fiscal year. During fiscal year 2022, mutual fund proxy revenues were 57% greater than the prior fiscal year. Although it is difficult to forecast the levels of event-driven activity, we expect that the portion of revenues derived from mutual fund proxy activity may continue to experience volatility in the future.Distribution revenues primarily include revenues related to the physical mailing of proxy materials, interim communications, transaction reporting, customer communications and fulfillment services, as well as Broadridge Retirement and Workplace administrative services.Distribution cost of revenues consists primarily of postage-related expenses incurred in connection with our Investor Communication Solutions segment, as well as Broadridge Retirement and Workplace administrative services expenses. These costs are reflected in Cost of revenues.Closed sales represent an estimate of the expected annual recurring revenue for new client contracts that were signed by Broadridge in the current reporting period. Closed sales does not include event-driven or distribution activity. We consider contract terms, expected client volumes or activity, knowledge of the marketplace and experience with our clients, among other factors, when determining the estimate. Management uses Closed sales to measure the effectiveness of our sales and marketing programs, as an indicator of expected future revenues and as a performance metric in determining incentive compensation. Closed sales is not a measure of financial performance under GAAP, and should not be considered in isolation or as a substitute for revenue or other income statement data prepared in accordance with GAAP. Closed sales is a useful metric for investors in understanding how management measures and evaluates our ongoing operational performance.33The inherent variability of transaction volumes and activity levels can result in some variability of amounts reported as actual achieved Closed sales. Larger Closed sales can take up to 12 to 24 months or longer to convert to revenues, particularly for the services provided by our Global Technology and Operations segment. For the fiscal years ended June 30, 2023 and June 30, 2022, we reported Closed sales net of a 5.0% allowance adjustment. Consequently, our reported Closed sales amounts will not be adjusted for actual revenues achieved because these adjustments are estimated in the period the sale is reported. We assess this allowance amount at the end of each fiscal year to establish the appropriate allowance for the subsequent year using the trailing five years actual data as the starting point, normalized for outlying factors, if any, to enhance the accuracy of the allowance.For the fiscal years ended June 30, 2023 and 2022, Closed sales were $245.8 million and $279.5 million, respectively. The fiscal years ended June 30, 2023 and 2022, are net of an allowance adjustment of $12.9 million and $14.8 million, respectively.Recent DevelopmentsNew SEC Rule on Tailored Shareholder ReportsOn October 26, 2022, the SEC adopted a rule modifying mutual fund and exchange-traded fund investor communications. The SEC rule requires that shorter summary documents, referred to as tailored shareholder reports, be distributed in lieu of long-form annual and semi-annual fund reports or notices of the availability of such reports, which the SEC had permitted under Rule 30e-3. The rule went into effect on January 24, 2023 and includes an 18-month transition period for implementation by mutual funds and exchange-traded funds, with a final compliance date of July 24, 2024. We are reviewing the full impact of the new rule, however we currently estimate a reduction in our annual Recurring revenues of approximately $30 million phasing in over fiscal years 2025 and 2026, assuming no offset from new services. See the risk factor titled “Our clients are subject to complex laws and regulations, and new laws or regulations and/or changes to existing laws or regulations could impact our clients and, in turn, adversely impact our business or may reduce our profitability.” in Part I, Item 1A. “Risk Factors” in this Annual Report. Conflict in UkraineWe are monitoring the events related to Russia’s invasion of Ukraine and have been actively managing any exposure we may have through a cross-functional taskforce that includes members of our senior management. We have historically had a limited presence in Russia, and we have no presence in Ukraine. We do not store any client data in Russia. Prior to the conflict, we had approximately 280 associates in St. Petersburg, Russia who provided software development and support services for several of our GTO products, less than 2% of our total associates. As of June 30, 2023, we do not have any associates remaining in Russia. We have historically provided services to a very small number of Russian entities and subsidiaries of Russian entities. The revenues from those services represented less than 0.1% of our total revenues in fiscal year 2022 and 2023 and our outstanding accounts receivable from these entities is de minimis. We are in the process of terminating and winding down these relationships and have closed our operations in Russia. We have moved the services provided in Russia to other locations in Europe and Asia. We are monitoring and believe we are in compliance with all global sanctions arising out of Russia’s invasion of Ukraine. We have taken actions to enhance our information security defenses in response to the Ukraine conflict. At present, we do not expect the Ukraine conflict and the actions we are taking in response to have a material impact on our core operations or financial results. 34ANALYSIS OF CONSOLIDATED STATEMENTS OF EARNINGSFiscal Year 2023 Compared to Fiscal Year 2022 The table below presents Consolidated Statements of Earnings data for the fiscal years ended June 30, 2023 and 2022, and the dollar and percentage changes between periods: Years Ended June 30, 20232022Change ($) (%) (in millions, except for per share amounts)Revenues$6,060.9 $5,709.1 $351.8 6 Cost of revenues4,275.5 4,116.9 158.6 4 Selling, general and administrative expenses849.0 832.3 16.7 2 Total operating expenses5,124.5 4,949.2 175.3 4 Operating income936.4 759.9 176.5 23 Margin15.4 %13.3 %2.1 ptsInterest expense, net(135.5)(84.7)(50.9)60 Other non-operating income (expenses), net(6.0)(3.0)(3.0)100 Earnings before income taxes794.9 672.2 122.7 18 Provision for income taxes164.3 133.1 31.2 23 Effective tax rate20.7 %19.8 %0.9 ptsNet earnings$630.6 $539.1 $91.4 17 Basic earnings per share$5.36 $4.62 $0.74 16 Diluted earnings per share$5.30 $4.55 $0.75 16 Weighted average shares outstanding: Basic117.7116.7 Diluted119.0118.5RevenuesThe table below presents Consolidated Statements of Earnings data for the fiscal years ended June 30, 2023 and 2022, and the dollar and percentage changes between periods: Years Ended June 30,20232022Change $% ($ in millions)Recurring revenues$3,986.7 $3,722.7 $264.0 7 Event-driven revenues211.0 269.4 (58.3)(22)Distribution revenues1,863.1 1,717.0 146.2 9 Total$6,060.9 $5,709.1 $351.8 6 Points of GrowthNet New BusinessInternal GrowthAcquisitionsForeign ExchangeTotalRecurring revenue Growth Drivers4pts4pts0pts-1pt7 %Revenues increased $351.8 million, or 6%, to $6,060.9 million from $5,709.1 million.•Recurring revenues increased $264.0 million, or 7%, to $3,986.7 million. Recurring revenue growth constant currency (Non-GAAP) was 9%, all organic, driven by Net New Business growth and Internal Growth in both ICS and GTO. 35•Event-driven revenues decreased $58.3 million, or 22%, primarily due to the decrease in volume of mutual fund proxy communications.•Distribution revenues increased $146.2 million, or 9%, driven by the impact of postage rate increases of $120.8 million and the impact of modestly higher mail volumes, primarily in Customer Communications Solutions.Total operating expenses. Operating expenses increased $175.3 million, or 4%, to $5,124.5 million from $4,949.2 million primarily as a result of the increase in Cost of revenues:•Cost of revenues - The increase of $158.6 million in Cost of revenues primarily reflects the impact of higher postage and distribution expenses in our Investor Communication Solutions segment of $169.4 million, offset by lower acquisition amortization of $35.8 million.•Selling, general and administrative expenses - The increase of $16.7 million in Selling, general, and administrative expenses primarily reflects higher compensation expenses of $21.8 million and higher technology related expenses of $4.3 million, offset by lower external labor costs. Interest expense, net. Interest expense, net, was $135.5 million, an increase of $50.9 million from $84.7 million in the fiscal year ended June 30, 2022 primarily due to an increase in interest expense from higher borrowing costs.Other non-operating income (expenses), net. Other non-operating expense, net for the fiscal year ended June 30, 2023 was $6.0 million, compared to $3.0 million of Other non-operating expense, net for the fiscal year ended June 30, 2022. The increased expense was primarily due to higher net gains on investments in the prior year period.Provision for income taxes. •Effective tax rate for the fiscal year ended June 30, 2023 - 20.7%.•Effective tax rate for the fiscal year ended June 30, 2022 - 19.8%.The increase in the effective tax rate for the fiscal year ended June 30, 2023 compared to the fiscal year ended June 30, 2022 was driven by the lower excess tax benefit related to equity compensation as compared to the prior year.ANALYSIS OF REPORTABLE SEGMENTSBroadridge has two reportable segments: (1) Investor Communication Solutions and (2) Global Technology and Operations. The primary component of “Other” are certain gains, losses, corporate overhead expenses and non-operating expenses that have not been allocated to the reportable segments, such as interest expense. Certain corporate expenses, as well as certain centrally managed expenses, are allocated based upon budgeted amounts in a reasonable manner. Because the Company compensates the management of its various businesses on, among other factors, segment profit, the Company may elect to record certain segment-related operating and non-operating expense items in Other rather than reflect such items in segment profit.Revenues Years Ended June 30,20232022Change$% ($ in millions)Investor Communication Solutions$4,535.6 $4,256.6 $279.0 7 Global Technology and Operations1,525.2 1,452.4 72.8 5 Total$6,060.9 $5,709.1 $351.8 6 36Earnings Before Income Taxes Years Ended June 30,20232022Change$% ($ in millions)Investor Communication Solutions$811.4 $724.7 $86.8 12 Global Technology and Operations183.9 139.4 44.5 32 Other(200.5)(191.9)(8.6)4 Total$794.9 $672.2 $122.7 18 The amount of amortization of acquired intangibles and purchased intellectual property by segment is as follows: Years Ended June 30,20232022Change$% ($ in millions)Investor Communication Solutions$55.5 $68.7 $(13.2)(19)Global Technology and Operations158.9 181.5 (22.6)(12) Total$214.4 $250.2 $(35.8)(14)Investor Communication SolutionsFiscal Year 2023 Compared to Fiscal Year 2022 Revenues increased $279.0 million to $4,535.6 million from $4,256.6 million, and earnings before income taxes increased $86.8 million to $811.4 million from $724.7 million. Years Ended June 30,20232022Change$% ($ in millions)RevenuesRecurring revenues$2,461.4 $2,270.3 $191.1 8 Event-driven revenues211.0 269.4 (58.3)(22)Distribution revenues1,863.1 1,717.0 146.2 9 Total$4,535.6 $4,256.6 $279.0 7 Earnings before Income TaxesEarnings before income taxes$811.4 $724.7 $86.8 12 Pre-tax Margin17.9 %17.0 %Points of GrowthNet New BusinessInternal GrowthAcquisitionsForeign ExchangeTotalRecurring revenue Growth Drivers4pts5pts0pts0pts8 %For the fiscal year ended June 30, 2023:•Recurring revenues increased $191.1 million, or 8%, to $2,461.4 million. Recurring revenue growth constant currency (Non-GAAP) was 9%, all organic, driven by Internal Growth and Net New Business. 37•By product line, Recurring revenue growth and Recurring revenue growth constant currency (Non-GAAP) were as follows:◦Regulatory rose 6% and 7%, respectively, driven by equity position growth of 9% and mutual fund/ETF position growth of 8%; ◦Data-Driven Fund Solutions rose 11% and 12%, respectively, driven by growth in our mutual fund trade processing business and continued growth in our data and analytics solutions;◦Issuer rose 12% and 13%, respectively, driven by growth in our registered shareholder solutions and disclosure solutions; and◦Customer Communications rose 9% and 10%, respectively, driven by higher print and digital communications. •Event-driven revenues decreased $58.3 million, or 22% primarily due to the decrease in volume of mutual fund proxy communications.•Distribution revenues increased $146.2 million, or 9%, driven by the impact of postage rate increases of $120.8 million and the impact of modestly higher mail volumes, primarily in Customer Communications Solutions.•Earnings before income taxes increased $86.8 million, or 12.0%. The earnings benefit from higher Recurring revenue was partially offset by lower event-driven revenues. Operating expenses rose 5%, or $192.2 million, to $3,724.2 million, primarily driven by distribution and other revenue related expenses. Amortization expense from acquired intangibles decreased by $13.2 million to $55.5 million from $68.7 million in the prior period.•Pre-tax margins increased by 0.9 percentage points to 17.9% from 17.0%. Global Technology and OperationsFiscal Year 2023 Compared to Fiscal Year 2022 Revenues increased $72.8 million to $1,525.2 million from $1,452.4 million, and earnings before income taxes increased $44.5 million to $183.9 million from $139.4 million. Years Ended June 30,20232022Change$% ($ in millions)RevenuesRecurring revenues$1,525.2 $1,452.4 $72.8 5 Earnings before Income TaxesEarnings before income taxes$183.9 $139.4 $44.5 32 Pre-tax Margin12.1 %9.6 %Points of GrowthNet New BusinessInternal GrowthAcquisitionsForeign ExchangeTotalRecurring revenue Growth Drivers4pts4pts0pts-3pts5 %For the fiscal year ended June 30, 2023:•Recurring revenues increased $72.8 million, or 5.0%, to $1,525.2 million. Recurring revenue growth constant currency (Non-GAAP) was 8%, all organic, driven by Net New Business and Internal Growth. •By product line, Recurring revenue growth and Recurring revenue growth constant currency (Non-GAAP) were as follows: ◦Capital markets rose 7% and 11%, respectively, driven by a combination of Internal Growth and Net New Business; and◦Wealth and investment management rose 2% and 4%, respectively, primarily driven by Net New Business.38•Earnings before income taxes increased $44.5 million, driven primarily by the $72.8 million growth in Recurring revenues, partially offset by increased labor costs. Amortization expense from acquired intangibles decreased by $22.6 million to $158.9 million in fiscal year 2023 from $181.5 million in the prior year period due to the impact of changes in foreign currency exchange rates and certain intangible assets now being fully amortized.•Pre-tax margins increased by 2.5 percentage points to 12.1% from 9.6%.OtherLoss before income taxes was $200.5 million for the fiscal year ended June 30, 2023, an increase of $8.6 million, or 4%, compared to $191.9 million for the fiscal year ended June 30, 2022. The impact of a $50.9 million increase in net interest expense and higher severance costs related to the corporate restructuring initiative were partially offset by the absence of the prior year $30.5 million in Real Estate Realignment and Covid-19 related expenses and lower compensation related expenses.Explanation and Reconciliation of the Company’s Use of Non-GAAP Financial Measures The Company’s results in this Annual Report on Form 10-K are presented in accordance with U.S. GAAP except where otherwise noted. In certain circumstances, Non-GAAP results have been presented. These Non-GAAP measures are Adjusted Operating income, Adjusted Operating income margin, Adjusted Net earnings, Adjusted earnings per share, Free cash flow, and Recurring revenue growth constant currency. These Non-GAAP financial measures should be viewed in addition to, and not as a substitute for, the Company’s reported results.The Company believes our Non-GAAP financial measures help investors understand how management plans, measures and evaluates the Company’s business performance. Management believes that Non-GAAP measures provide consistency in its financial reporting and facilitates investors’ understanding of the Company’s operating results and trends by providing an additional basis for comparison. Management uses these Non-GAAP financial measures to, among other things, evaluate our ongoing operations and for internal planning and forecasting purposes. In addition, and as a consequence of the importance of these Non-GAAP financial measures in managing our business, the Company’s Compensation Committee of the Board of Directors incorporates Non-GAAP financial measures in the evaluation process for determining management compensation.Adjusted Operating Income, Adjusted Operating Income Margin, Adjusted Net Earnings and Adjusted Earnings Per ShareThese Non-GAAP measures reflect Operating income, Operating income margin, Net earnings, and Diluted earnings per share, as adjusted to exclude the impact of certain costs, expenses, gains and losses and other specified items the exclusion of which management believes provides insight regarding our ongoing operating performance. Depending on the period presented, these adjusted measures exclude the impact of certain of the following items: (i) Amortization of Acquired Intangibles and Purchased Intellectual Property, (ii) Acquisition and Integration Costs, (iii) Restructuring Charges, (iv) Real Estate Realignment and Covid-19 Related Expenses, (v) Russia-Related Exit Costs, and (vi) Investment Gain. Amortization of Acquired Intangibles and Purchased Intellectual Property represents non-cash amortization expenses associated with the Company’s acquisition activities. Acquisition and Integration Costs represent certain transaction and integration costs associated with the Company’s acquisition activities. Restructuring Charges represent severance costs associated with the Company’s initiative to streamline our management structure, reallocate work to lower cost locations, and reduce headcount in deprioritized areas. Real Estate Realignment and Covid-19 Related Expenses are comprised of two major components: Real Estate Realignment Expenses, and Covid-19 Related Expenses. Real Estate Realignment Expenses are expenses associated with the exit of certain of the Company’s leased facilities in response to the Covid-19 pandemic, which consist of the impairment of certain right of use assets, leasehold improvements and equipment, as well as other related facility exit expenses directly resulting from, and attributable to, the exit of these leased facilities. Covid-19 Related Expense are direct and incremental expenses incurred by the Company to protect the health and safety of Broadridge associates during the Covid-19 outbreak, including expenses associated with monitoring the temperatures for associates entering our facilities, enhancing the safety of our office environment in preparation for workers to return to Company facilities on a more regular basis, ensuring proper social distancing in our production facilities, personal protective equipment, enhanced cleaning measures in our facilities, and other safety related expenses. Russia-Related Exit Costs are direct and incremental costs associated with the Company’s wind down of business activities in Russia in response to Russia’s invasion of Ukraine, including relocation-related expenses of impacted associates. Investment Gain represents a non-operating, non-cash gain on a privately held investment. 39We exclude Acquisition and Integration Costs, Restructuring Charges, Real Estate Realignment and Covid-19 Related Expenses, Russia-Related Exit Costs, and Investment Gain from our Adjusted Operating income (as applicable) and other adjusted earnings measures because excluding such information provides us with an understanding of the results from the primary operations of our business and enhances comparability across fiscal reporting periods, as these items are not reflective of our underlying operations or performance. We also exclude the impact of Amortization of Acquired Intangibles and Purchased Intellectual Property, as these non-cash amounts are significantly impacted by the timing and size of individual acquisitions and do not factor into the Company's capital allocation decisions, management compensation metrics or multi-year objectives. Furthermore, management believes that this adjustment enables better comparison of our results as Amortization of Acquired Intangibles and Purchased Intellectual Property will not recur in future periods once such intangible assets have been fully amortized. Although we exclude Amortization of Acquired Intangibles and Purchased Intellectual Property from our adjusted earnings measures, our management believes that it is important for investors to understand that these intangible assets contribute to revenue generation. Amortization of intangible assets that relate to past acquisitions will recur in future periods until such intangible assets have been fully amortized. Any future acquisitions may result in the amortization of additional intangible assets.Free Cash FlowIn addition to the Non-GAAP financial measures discussed above, we provide Free cash flow information because we consider Free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated that could be used for dividends, share repurchases, strategic acquisitions, other investments, as well as debt servicing. Free cash flow is a Non-GAAP financial measure and is defined by the Company as Net cash flows provided by operating activities less Capital expenditures as well as Software purchases and capitalized internal use software.Recurring Revenue Growth Constant CurrencyAs a multi-national company, we are subject to variability of our reported U.S. dollar results due to changes in foreign currency exchange rates. The exclusion of the impact of foreign currency exchange fluctuations from our Recurring revenue growth, or what we refer to as amounts expressed “on a constant currency basis,” is a Non-GAAP measure. We believe that excluding the impact of foreign currency exchange fluctuations from our Recurring revenue growth provides additional information that enables enhanced comparison to prior periods. Changes in Recurring revenue growth expressed on a constant currency basis are presented excluding the impact of foreign currency exchange fluctuations. To present this information, current period results for entities reporting in currencies other than the U.S. dollar are translated into U.S. dollars at the average exchange rates in effect during the corresponding period of the comparative year, rather than at the actual average exchange rates in effect during the current fiscal year. Reconciliation of such Non-GAAP measures to the most directly comparable GAAP measures (unaudited): Years ended June 30, 20232022 (in millions)Operating income (GAAP)$936.4$759.9Adjustments: Amortization of Acquired Intangibles and Purchased Intellectual Property214.4250.2Acquisition and Integration Costs15.824.5Restructuring Charges20.4— Real Estate Realignment and Covid-19 Related Expenses (a)—30.5Russia-Related Exit Costs (c)12.11.4Adjusted Operating income (Non-GAAP)$1,199.1$1,066.4Operating income margin (GAAP)15.4 %13.3 %Adjusted Operating income margin (Non-GAAP)19.8 %18.7 %40 Years ended June 30, 20232022 (in millions)Net earnings (GAAP)$630.6 $539.1 Adjustments: Amortization of Acquired Intangibles and Purchased Intellectual Property214.4 250.2 Acquisition and Integration Costs15.8 24.5 Restructuring Charges20.4 — Real Estate Realignment and Covid-19 Related Expenses (a)— 30.5 Russia-Related Exit Costs (c)10.9 1.4 Investment Gains— (14.2) Subtotal of adjustments261.6 292.3 Tax impact of adjustments (d)(57.5)(65.7)Adjusted Net earnings (Non-GAAP)$834.6 $765.7 Years ended June 30, 20232022 Diluted earnings per share (GAAP)$5.30 $4.55 Adjustments:Amortization of Acquired Intangibles and Purchased Intellectual Property1.80 2.11 Acquisition and Integration Costs0.13 0.21 Restructuring Charges0.17 — Real Estate Realignment and Covid-19 Related Expenses (b)— 0.26 Russia-Related Exit Costs0.09 0.01 Investment Gains— (0.12) Subtotal of adjustments2.20 2.47 Tax impact of adjustments (d)(0.48)(0.55)Adjusted earnings per share (Non-GAAP)$7.01 $6.46 _________(a)Real Estate Realignment Expenses and Covid-19 Related Expenses were $23.0 million and $7.5 million for the fiscal year ended June 30, 2022, respectively.(b)Real Estate Realignment Expenses and Covid-19 Expenses impacted Adjusted earnings per share by $0.19 and $0.06 for the fiscal year ended June 30, 2022, respectively.(c)Russia-Related Exit Costs were $10.9 million and $1.4 million for the fiscal years ended June 30, 2023 and June 30, 2022, comprised of $12.1 million of operating expenses, offset by a gain of $1.2 million in non-operating income for the fiscal year ended June 30, 2023, and $1.4 million of operating expenses for the fiscal year ended June 30, 2022. (d)Calculated using the GAAP effective tax rate, adjusted to exclude $10.4 million of excess tax benefits (“ETB”) associated with stock-based compensation for the fiscal year ended June 30, 2023, and $18.1 million of ETB associated with stock-based compensation for the fiscal year ended June 30, 2022. For purposes of calculating the Adjusted earnings per share, the same adjustments were made on a per share basis.41 Years ended June 30, 20232022 (in millions)Net cash flows provided by operating activities (GAAP)$823.3 $443.5 Capital expenditures and Software purchases and capitalized internal use software(75.2)(73.1)Free cash flow (Non-GAAP)$748.2 $370.4 Year Ended June 30, 2023 Investor Communication SolutionsRegulatoryData-Driven Fund SolutionsIssuerCustomer Communications TotalRecurring revenue growth (GAAP)6 %11 %12 %9 %8 %Impact of foreign currency exchange— %1 %— %— %— %Recurring revenue growth constant currency (Non-GAAP)7 %12 %13 %10 %9 %Year Ended June 30, 2023 Global Technology and OperationsCapital MarketsWealth and Investment ManagementTotalRecurring revenue growth (GAAP)7 %2 %5 %Impact of foreign currency exchange4 %2 %3 %Recurring revenue growth constant currency (Non-GAAP)11 %4 %8 %Year Ended June 30, 2023ConsolidatedTotalRecurring revenue growth (GAAP)7 %Impact of foreign currency exchange1 %Recurring revenue growth constant currency (Non-GAAP)9 %42FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCESCash and cash equivalents consisted of the following: June 30, 20232022 (in millions)Cash and cash equivalents:Domestic cash$46.1 $43.4 Cash held by foreign subsidiaries141.7 114.3 Cash held by regulated entities64.5 67.0 Total cash and cash equivalents$252.3 $224.7 At June 30, 2023 and 2022, Cash and cash equivalents were $252.3 million and $224.7 million, respectively. Total stockholders’ equity was $2,240.6 million and $1,919.1 million at June 30, 2023 and 2022, respectively. At the current time, and in future periods, we expect cash generated by our operations, together with existing cash, cash equivalents, and borrowings from the capital markets, to be sufficient to cover cash needs for working capital, capital expenditures, strategic acquisitions, dividends and common stock repurchases. We expect existing domestic cash, cash equivalents, cash flows from operations and borrowing capacity to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities, such as regular quarterly dividends, debt repayment schedules, and material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future. In addition, we expect existing foreign cash, cash equivalents, cash flows from operations and borrowing capacity to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities, such as material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future. If these funds are needed for our operations in the U.S., we may be required to pay additional foreign taxes to repatriate these funds. However, while we may do so at a future date, the Company does not need to repatriate future foreign earnings to fund U.S. operations.43Outstanding borrowings and available capacity under the Company’s borrowing arrangements were as follows:ExpirationDatePrincipal amount outstanding at June 30, 2023Carrying value at June 30, 2023Carrying value at June 30, 2022UnusedAvailableCapacity Fair Value at June 30, 2023(in millions)Current portion of long-term debtFiscal 2021 Term Loans (a)May 2024$1,180.0 $1,178.5 $— $— $1,180.0 Total $1,180.0 $1,178.5 $— $— $1,180.0 Long-term debt, excluding current portionFiscal 2021 Revolving Credit Facility:U.S. dollar trancheApril 2026$— $— $25.0 $1,100.0 $— Multicurrency trancheApril 2026— — — 400.0 — Total Revolving Credit Facility$— $— $25.0 $1,500.0 $— Fiscal 2021 Term Loans (a)May 2024$— $— $1,535.8 $— $— Fiscal 2016 Senior NotesJune 2026$500.0 $498.0 $497.4 $— $471.4 Fiscal 2020 Senior NotesDecember 2029750.0 744.3 743.4 — 641.0 Fiscal 2021 Senior NotesMay 20311,000.0 992.5 991.5 — 817.4 Total Senior Notes$2,250.0 $2,234.7 $2,232.3 $— $1,929.8 Total long-term debt$2,250.0 $2,234.7 $3,793.0 $1,500.0 $1,929.8 Total debt$3,430.0 $3,413.3 $3,793.0 $1,500.0 $3,109.8 _________(a)The Fiscal 2021 Term Loans were reclassified from Long-term debt to Current portion of long-term debt in May 2023 to reflect the remaining maturity of less than a year.Future principal payments on the Company’s outstanding debt are as follows:Years ending June 30,20242025202620272028ThereafterTotal(in millions)$1,180.0 $— $500.0 $— $— $1,750.0 $3,430.0 The Company has a $1.5 billion five-year revolving credit facility (as amended on December 23, 2021 and May 23, 2023, the “Fiscal 2021 Revolving Credit Facility”), which is comprised of a $1.1 billion U.S. dollar tranche and a $400.0 million multicurrency tranche. Under the Fiscal 2021 Revolving Credit Facility, revolving loans denominated in U.S. Dollars, Canadian Dollars, Euro, Swedish Kronor, and Yen initially bear interest at Adjusted Term SOFR, CDOR, EURIBOR, TIBOR and STIBOR, respectively, plus 1.200% (subject to step-ups to 1.275% and step-downs to 0.905% based on public debt ratings) and revolving loans denominated in Sterling bears interest at SONIA plus 1.1326% per annum (subject to step-ups to 1.2076% and step-downs to 0.8376% based on ratings). The Fiscal 2021 Revolving Credit Facility also has an annual facility fee equal to 15.0 basis points on the entire facility (subject to step-ups to 20.0 basis points and step-downs to 7.0 basis points based on ratings). On May 23, 2023, we amended the interest rate index from LIBOR to Adjusted SOFR. All other terms remained unchanged.44In March 2021, the Company entered into a term credit agreement (as amended on December 23, 2021 and May 23, 2023, “Term Credit Agreement”), providing for term loan commitments in an aggregate principal amount of $2.55 billion, comprised of a $1.0 billion tranche (“Tranche 1”) and a $1.55 billion tranche (“Tranche 2,” together with Tranche 1, the “Fiscal 2021 Term Loans”). The Tranche 1 Loans were repaid in full in May 2021. The Tranche 2 Loans will mature in May 2024 on the third anniversary of the Funding Date. The proceeds of the Fiscal 2021 Term Loans were used by the Company to solely finance the Itiviti acquisition and pay certain fees and expenses in connection therewith. Interest on the outstanding portion of the Fiscal 2021 Term Loans bears interest at Adjusted Term SOFR plus 1.100% per annum (subject to step-ups to Adjusted Term SOFR plus 1.350% or a step-down to SOFR plus 0.850% based on ratings). On May 23, 2023, we amended the interest rate index from LIBOR to Adjusted SOFR. All other terms remained unchanged.In June 2016, the Company completed an offering of $500.0 million in aggregate principal amount of senior notes (the “Fiscal 2016 Senior Notes”). Interest on the Fiscal 2016 Senior Notes is payable semiannually on June 27 and December 27 of each year based on a fixed per annum rate equal to 3.40%. In December 2019, the Company completed an offering of $750.0 million in aggregate principal amount of senior notes (the “Fiscal 2020 Senior Notes”). Interest on the Fiscal 2020 Senior Notes is payable semiannually on June 1 and December 1 of each year based on a fixed per annum rate equal to 2.90%. In May 2021, the Company completed an offering of $1 billion in aggregate principal amount of senior notes (the “Fiscal 2021 Senior Notes”). Interest on the Fiscal 2021 Senior Notes is payable semi-annually in arrears on May 1 and November 1 of each year based on a fixed per annum rate equal to 2.60%.The Fiscal 2021 Revolving Credit Facility, Fiscal 2021 Term Loans, Fiscal 2016 Senior Notes, Fiscal 2020 Senior Notes and Fiscal 2021 Senior Notes are senior unsecured obligations of the Company and are ranked equally in right of payment.Please refer to Note 14, “Borrowings” to our Consolidated Financial Statements under Item 8 of Part II of this Annual Report on Form 10-K for a more detailed discussion.Cash FlowsFiscal Year 2023 Compared to Fiscal Year 2022 Years Ended June 30, 20232022$ Change (in millions) Net cash flows provided by operating activities$823.3 $443.5 $379.9 Net cash flows used in investing activities(80.4)(110.4)30.0 Net cash flows used in financing activities(714.7)(370.8)(344.0)Effect of exchange rate changes on Cash and cash equivalents(0.6)(12.2)11.6 Net change in Cash and cash equivalents$27.6 $(49.9)$77.5 Free cash flow:Net cash flows provided by operating activities (GAAP)$823.3 $443.5 $379.9 Capital expenditures and Software purchases and capitalized internal use software(75.2)(73.1)(2.1)Free cash flow (Non-GAAP)$748.2 $370.4 $377.8 The increase in cash provided by operating activities of $379.9 million was primarily due to an increase in advance client billings as well as a decrease in client-related platform implementation and development, partially offset by higher cash used in working capital. The decrease in cash used in investing activities of $30.0 million primarily reflects lower acquisition spend in the current fiscal year compared to the prior year period.The increase in cash used in financing activities of $344.0 million primarily reflects higher repayments net of borrowing. 45Income TaxesThe Company, headquartered in the U.S., is routinely examined by the IRS and is also routinely examined by the tax authorities in the U.S. states and foreign countries in which it conducts business. The tax years under audit examination vary by tax jurisdiction. The Company regularly considers the likelihood of assessments in each of the jurisdictions resulting from examinations. To the extent the Company determines it has potential tax assessments in particular tax jurisdictions, the Company has established tax reserves which it believes are adequate in relation to the potential assessments. Once established, reserves are adjusted when there is more information available, when an event occurs necessitating a change to the reserves or the statute of limitations for the relevant taxing authority to examine the tax position has expired. The resolution of tax matters should not have a material effect on the financial condition of the Company or on the Company’s Consolidated Statements of Earnings for a particular future period.Employee Benefit PlansThe Company sponsors a Supplemental Officer Retirement Plan (the “SORP”), a Supplemental Executive Retirement Plan (the “SERP”), an Executive Retiree Health Insurance Plan, and certain non-US benefits-related plans. Please refer to Note 17, “Employee Benefit Plans” to our Consolidated Financial Statements under Item 8 of Part II of this Annual Report on Form 10-K for a discussion on the Company’s Employee Benefit Plans.Contractual Obligations The following table summarizes our contractual obligations to third parties as of June 30, 2023 and the effect such obligations are expected to have on our liquidity and cash flows in future periods: Payments Due by Period TotalLess than 1Year1-3 Years4-5 YearsAfter 5Years (in millions) Debt(1)$3,430.0 $1,180.0 $500.0 $— $1,750.0 Interest and facility fee on debt(2)464.2 128.4 134.0 97.3 104.6 Facility and equipment operating leases(3)278.2 46.7 76.0 62.9 92.6 Purchase obligations(4)564.9 154.5 257.8 111.7 41.0 Capital commitment to fund investment(5)— — — — — Uncertain tax positions(6)— — — — — Total(7)$4,737.3 $1,509.6 $967.7 $271.9 $1,988.1 _________(1)These amounts represent the principal repayments of Long-term debt and are included on our Consolidated Balance Sheets. See Note 14, “Borrowings” to our Consolidated Financial Statements under Item 8 of Part II of this Annual Report on Form 10-K for additional information about our Borrowings and related matters. (2)Includes estimated future interest payments on our current portion of long-term debt and interest and facility fee on the revolving credit facility. (3)We enter into operating leases in the normal course of business relating to facilities and equipment. The majority of our lease agreements have fixed payment terms based on the passage of time. Certain facility and equipment leases require payment of maintenance, real estate taxes and related executory costs, and contain escalation provisions based on future adjustments in price indices. Our future operating lease obligations could change if we exit certain contracts and if we enter into additional operating lease agreements. See Note 8, “Leases” to our Consolidated Financial Statements under Item 8 of Part II of this Annual Report on Form 10-K for additional information about our Leases and related matters. (4)Purchase obligations relate to payments to Kyndryl, Inc. related to the Amended IT Services Agreement (as described below) that expires in fiscal year 2027, the Private Cloud Agreement (as described below) that expires in fiscal year 2030, the AWS Cloud Agreement (as described below) that expires in fiscal year 2027, as well as other data center arrangements and software license agreements including hosted software arrangements, and software and hardware maintenance and support agreements, and certain other related arrangements. Purchase obligations also includes $14.0 million of other liabilities recorded on the Company’s Consolidated Balance Sheet as of June 30, 2023. 46(5)The Company has a future commitment to fund $0.6 million to an investee that is not included in the table above due to the uncertainty of the timing of this future payment.(6)Due to the uncertainty related to the timing of the reversal of uncertain tax positions, only uncertain tax benefits related to certain settlements have been provided in the table above. The Company is unable to make reasonably reliable estimates related to the timing of the remaining gross unrecognized tax benefit liability of $72.9 million (inclusive of interest). See Note 18, “Income Taxes” to our Consolidated Financial Statements under Item 8 of Part II of this Annual Report on Form 10-K for further detail.(7)Certain post-employment benefit obligations reported in our Consolidated Balance Sheets in the amount of $73.8 million as of June 30, 2023 were not included in the table above due to the uncertainty of the timing of these future payments. Data Center AgreementsThe Company is a party to an Amended and Restated IT Services Agreement with Kyndryl, Inc. (“Kyndryl”), an entity formed by IBM’s spin-off of its managed infrastructure services business, under which Kyndryl provides certain aspects of the Company’s information technology infrastructure, including supporting its mainframe, midrange, network and data center operations, as well as providing disaster recovery services. The Amended and Restated IT Services Agreement expires on June 30, 2027, however the Company may renew the agreement for up to one additional 12-month period. Fixed minimum commitments remaining under the Amended and Restated IT Services Agreement at June 30, 2023 are $151.2 million through June 30, 2027, the final year of the Amended and Restated IT Services Agreement. The Company is a party to an information technology agreement for private cloud services (the “Private Cloud Agreement”) under which Kyndryl operates, manages and supports the Company’s private cloud global distributed platforms and products, and operates and manages certain Company networks. The Private Cloud Agreement expires on March 31, 2030. Fixed minimum commitments remaining under the Private Cloud Agreement at June 30, 2023 are $154.6 million through March 31, 2030, the final year of the contract.The following table summarizes the capitalized costs related to data center agreements as of June 30, 2023: Amended and Restated IT Services AgreementOtherTotal (in millions)Capitalized costs, beginning balance$63.0 $7.6 $70.7 Capitalized costs incurred— — — Impact of foreign currency exchange— — — Total capitalized costs, ending balance63.0 7.7 70.7 Total accumulated amortization(49.9)(5.8)(55.7)Net Deferred Kyndryl Costs$13.1 $1.9 $15.0 Cloud Services Resale AgreementOn December 31, 2021, the Company and Presidio Networked Solutions LLC (“Presidio”), a reseller of services of Amazon Web Services, Inc. and its affiliates (collectively, “AWS”), entered into an Order Form and AWS Private Pricing Addendum, dated December 31, 2021 (the “Order Form”), to the Cloud Services Resale Agreement, dated December 15, 2017, as amended (together with the Order Form, the “AWS Cloud Agreement”), whereby Presidio will resell to the Company certain public cloud infrastructure and related services provided by AWS for the operation, management and support of the Company’s cloud global distributed platforms and products. The AWS Cloud Agreement expires on December 31, 2026. Fixed minimum commitments remaining under the AWS Cloud Agreement at June 30, 2023 are $186.5 million in the aggregate through December 31, 2026.InvestmentsThe Company has an equity method investment that is a variable interest in a variable interest entity. The Company is not the primary beneficiary and therefore does not consolidate the investee. The Company’s potential maximum loss exposure related to its unconsolidated investment in this variable interest entity totaled $37.0 million as of June 30, 2023, which represents the carrying value of the Company's investment.In addition, as of June 30, 2023, the Company also has a future commitment to fund $0.6 million to one of the Company’s other investees. 47Other Commercial AgreementsCertain of the Company’s subsidiaries established unsecured, uncommitted lines of credit with banks. There were no outstanding borrowings under these lines of credit at June 30, 2023.Off-balance Sheet ArrangementsIt is not our business practice to enter into off-balance sheet arrangements. However, we are exposed to market risk from changes in foreign currency exchange rates that could impact our financial position, results of operations, and cash flows. We manage our exposure to these market risks through regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. In January 2022, we executed a series of cross-currency swap derivative contracts with an aggregate notional amount of EUR 880 million which are designated as net investment hedges to hedge a portion of our net investment in our subsidiaries whose functional currency is the Euro. The cross-currency swap derivative contracts are agreements to pay fixed-rate interest in Euros and receive fixed-rate interest in U.S. Dollars, thereby effectively converting a portion of our U.S. Dollar denominated fixed-rate debt into Euro denominated fixed-rate debt. The cross-currency swaps mature in May 2031 to coincide with the maturity of the Fiscal 2021 Senior Notes. Accordingly, foreign currency transaction gains or losses on the qualifying net investment hedge instruments are recorded as foreign currency translation within other comprehensive income (loss), net in the Consolidated Statements of Comprehensive Income and will remain in Accumulated other comprehensive income (loss) in the Consolidated Balance Sheets until the sale or complete liquidation of the underlying foreign subsidiary. At June 30, 2023, our position on the cross-currency swaps was an asset of $66.7 million, and is recorded as part of Other non-current assets on the Consolidated Balance Sheets with the offsetting amount recorded as part of Accumulated other comprehensive income (loss), net of tax. We have elected the spot method of accounting whereby the net interest savings from the cross-currency swaps is recognized as a reduction in interest expense in our Consolidated Statements of Earnings. In connection with the acquisition of Itiviti in March 2021 the Company entered into two derivative instruments designed to mitigate the Company’s exposure to the impact of (i) changes in foreign exchange rates on the acquisition of Itiviti purchase consideration, and (ii) changes in interest rates on the Fiscal 2021 Senior Notes.In March 2021, the Company executed a forward foreign exchange derivative instrument (“Forward”) with an aggregate notional amount of EUR 1.955 billion. The Forward acted as an economic hedge against the impact of changes in the Euro on the Company’s purchase consideration for the acquisition of Itiviti. The Company recorded changes in fair value of the Forward as part of Other non-operating income (expenses), net in the Consolidated Statement of Earnings. In May 2021, the Company settled the Forward derivative for a cumulative pre-tax gain of $66.7 million.In May 2021, we settled a forward treasury lock agreement that was designated as a cash flow hedge, for a pre-tax loss of $11.0 million, after which the final settlement loss is being amortized into Interest expense, net ratably over the ten year term of the Fiscal 2021 Senior Notes. The expected amount of the existing loss that will be amortized into earnings before income taxes within the next twelve months is approximately $1.1 million.In the normal course of business, we also enter into contracts in which it makes representations and warranties that relate to the performance of our products and services. We do not expect any material losses related to such representations and warranties, or collateral arrangements.Recently-issued Accounting PronouncementsPlease refer to Note 2, “Summary of Significant Accounting Policies” to our Consolidated Financial Statements under Item 8 of Part II of this Annual Report on Form 10-K for a discussion on the impact of the adoption of new accounting pronouncements. ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk Market RisksIn the ordinary course of business, the financial position of the Company is routinely subject to certain market risks, notably the effects of changes in interest rates and foreign currency exchange rates. We manage our exposure to these market risks through our regular operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. As a result, the Company does not anticipate any material losses from these risks. We do not use derivatives for trading purposes, to generate income or to engage in speculative activity.48Interest Rate Risk As of June 30, 2023, $1,178.5 million, or 35%, of the Company’s total outstanding debt balance of $3,413.3 million is based on floating interest rates. Our $1,178.5 million in variable rate debt at June 30, 2023 consists of the outstanding portion of our Fiscal 2021 Term Loans which bears interest at Adjusted Term SOFR plus 1.100% per annum (subject to step-ups to Adjusted Term SOFR plus 1.350% or a step-down to SOFR plus 0.850% based on ratings). We have assessed our exposure to changes in interest rates by analyzing the sensitivity to our earnings of a change in market interest rates on amounts borrowed from the revolving credit facility and Fiscal 2021 Term Loans during the fiscal year ended June 30, 2023. Assuming a hypothetical increase of one hundred basis points in interest rates on our variable rate debt during the fiscal year ended June 30, 2023 and June 30, 2022, our pre-tax earnings would have decreased by approximately $18.7 million and $19.7 million, respectively; however, for both years, this would have been offset by interest earned on cash balances. Foreign Currency RiskWhile the substantial majority of our business is conducted within the U.S., approximately 13% of our fiscal year 2023 revenues were earned outside of the U.S. Our operations outside of the U.S. primarily reside in Canada, Europe and India. As a result, we are exposed to foreign currency risk from changes in the value of underlying assets and liabilities of our non-U.S. dollar-denominated foreign investments and foreign currency transactions, primarily with respect to the Canadian dollar, the British pound, the Euro, the Indian Rupee and the Swedish Krona.We manage our foreign currency risk primarily by incurring, to the extent practicable, operating and financing expenses in the local currency in the countries in which we operate. In addition, we executed a series of cross-currency swap derivative contracts with an aggregate notional amount of EUR 880 million which are designated as net investment hedges to hedge a portion of our net investment in our subsidiaries whose functional currency is the Euro. At June 30, 2023, the fair value of these derivatives is an asset of $66.7 million. Refer to Note 19, “Contractual Commitments, Contingencies, and Off-Balance Sheet Arrangements” to our Consolidated Financial Statements under Item 8 of Part II of this Annual Report on Form 10-K for additional details on our cross-currency swap derivative contracts.For the fiscal year ended June 30, 2023 and June 30, 2022, a hypothetical 10% decrease in the value of the Canadian dollar, the British pound, the Euro, the Indian Rupee and the Swedish Krona versus the U.S. dollar would have resulted in a decrease in our total pre-tax earnings of approximately $15.2 million and $12.8 million, respectively. 49
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe information required by this Item is set forth in the MD&A and Notes 3, 6, 12, 14, 19, 22 and 23 of the Notes to Consolidated Financial Statements in the Annual Report, which portions are incorporated herein by reference.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKThe information required by this Item is set forth in the “Trading activities and risk management,” “Asset/liability management” and “Risk Management” sections in the MD&A in the Annual Report and “Derivative financial instruments” under Note 1 and Notes 20 and 23 of the Notes to Consolidated Financial Statements in the Annual Report, which portions are incorporated herein by reference.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Organizational Structure.” Effective February 26, 2021, Blackstone effectuated changes to rename its Class A common stock as “common stock,” and to reclassify its Class B and Class C common stock into a new “Series I preferred stock” and “Series II preferred stock,” respectively (the “share reclassification”). Each new stock has the same rights and powers of its predecessor. All references to common stock, Series I preferred stock and Series II preferred stock prior to the share reclassification refer to Class A, Class B and Class C common stock, respectively. See “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Organizational Structure.” “Series I Preferred Stockholder” refers to Blackstone Partners L.L.C., the holder of the sole outstanding share of our Series I preferred stock. “Series II Preferred Stockholder” refers to Blackstone Group Management L.L.C., the holder of the sole outstanding share of our Series II preferred stock. 4 Table of Contents“Blackstone Funds,” “our funds” and “our investment funds” refer to the funds and other vehicles that are managed by Blackstone. “Our carry funds” refers to funds managed by Blackstone that have commitment-based multi-year drawdown structures that pay carry on the realization of an investment. We refer to our real estate opportunistic funds as Blackstone Real Estate Partners (“BREP”) funds and our real estate debt investment funds as Blackstone Real Estate Debt Strategies (“BREDS”) funds. We refer to our real estate investment trusts as “REITs,” to Blackstone Mortgage Trust, Inc., our NYSE-listed REIT, as “BXMT” and to Blackstone Real Estate Income Trust, Inc., our non-listed REIT, as “BREIT.” We refer to our real estate funds that target substantially stabilized assets in prime markets as Blackstone Property Partners (“BPP”) funds and our income-generating European real estate funds as Blackstone European Property Income (“BEPIF”) funds. We refer to BREIT, BPP and BEPIF collectively as our Core+ real estate strategies. We refer to our flagship corporate private equity funds as Blackstone Capital Partners (“BCP”) funds, our energy-focused private equity funds as Blackstone Energy Transition Partners (“BETP”) funds, our core private equity funds as Blackstone Core Equity Partners (“BCEP”), our opportunistic investment platform that invests globally across asset classes, industries and geographies as Blackstone Tactical Opportunities (“Tactical Opportunities”), our secondary fund of funds business as Strategic Partners Fund Solutions (“Strategic Partners”), our infrastructure-focused funds as Blackstone Infrastructure Partners (“BIP”), our life sciences investment platform, Blackstone Life Sciences (“BXLS”), our growth equity investment platform, Blackstone Growth (“BXG”), our multi-asset investment program for eligible high net worth investors offering exposure to certain of our key illiquid investment strategies through a single commitment as Blackstone Total Alternatives Solution (“BTAS”) and our capital markets services business as Blackstone Capital Markets (“BXCM”). “Our hedge funds” refers to our funds of hedge funds, hedge funds, certain of our real estate debt investment funds, including a registered investment company, and certain other credit-focused funds which are managed by Blackstone. We refer to our business development companies as “BDCs,” to Blackstone Private Credit Fund as “BCRED” and to Blackstone Secured Lending Fund as “BXSL.” “BIS” refers to Blackstone Insurance Solutions, which partners with insurers to deliver capital-efficient investments tailored to each insurer's needs and risk profile. We refer to our separately managed accounts as “SMAs.” “Total Assets Under Management” refers to the assets we manage. Our Total Assets Under Management equals the sum of: (a) the fair value of the investments held by our carry funds and our side-by-side and co-investment entities managed by us plus the capital that we are entitled to call from investors in those funds and entities pursuant to the terms of their respective capital commitments, including capital commitments to funds that have yet to commence their investment periods, (b) the net asset value of (1) our hedge funds, real estate debt carry funds, BPP, certain co-investments managed by us, certain credit-focused funds, and our Hedge Fund Solutions drawdown funds (plus, in each case, the capital that we are entitled to call from investors in those funds, including commitments yet to commence their investment periods), and (2) our funds of hedge funds, our Hedge Fund Solutions registered investment companies, BREIT, and BEPIF, (c) the invested capital, fair value or net asset value of assets we manage pursuant to separately managed accounts, (d) the amount of debt and equity outstanding for our collateralized loan obligations (“CLO”) during the reinvestment period, 5 Table of Contents (e) the aggregate par amount of collateral assets, including principal cash, for our CLOs after the reinvestment period, (f) the gross or net amount of assets (including leverage where applicable) for our credit-focused registered investment companies, (g) the fair value of common stock, preferred stock, convertible debt, term loans or similar instruments issued by BXMT, and (h) borrowings under and any amounts available to be borrowed under certain credit facilities of our funds. Our carry funds are commitment-based drawdown structured funds that do not permit investors to redeem their interests at their election. Our funds of hedge funds, hedge funds, funds structured like hedge funds and other open-ended funds in our Real Estate, Credit & Insurance and Hedge Fund Solutions segments generally have structures that afford an investor the right to withdraw or redeem their interests on a periodic basis (for example, annually, quarterly or monthly), typically with 2 to 95 days’ notice, depending on the fund and the liquidity profile of the underlying assets. In our Perpetual Capital vehicles where redemption rights exist, Blackstone has the ability to fulfill redemption requests only (a) in Blackstone’s or the vehicles’ board’s discretion, as applicable, or (b) to the extent there is sufficient new capital. Investment advisory agreements related to certain separately managed accounts in our Credit & Insurance and Hedge Fund Solutions segments, excluding our BIS separately managed accounts, may generally be terminated by an investor on 30 to 90 days’ notice. Our BIS separately managed accounts can generally only be terminated for long-term underperformance, cause and certain other limited circumstances, in each case subject to Blackstone's right to cure. “Fee-Earning Assets Under Management” refers to the assets we manage on which we derive management fees and/or performance revenues. Our Fee-Earning Assets Under Management equals the sum of: (a) for our Private Equity segment funds and Real Estate segment carry funds including certain BREDS and Hedge Fund Solutions funds, the amount of capital commitments, remaining invested capital, fair value, net asset value or par value of assets held, depending on the fee terms of the fund, (b) for our credit-focused carry funds, the amount of remaining invested capital (which may include leverage) or net asset value, depending on the fee terms of the fund, (c) the remaining invested capital or fair value of assets held in co-investment vehicles managed by us on which we receive fees, (d) the net asset value of our funds of hedge funds, hedge funds, BPP, certain co-investments managed by us, certain registered investment companies, BREIT, BEPIF, and certain of our Hedge Fund Solutions drawdown funds, (e) the invested capital, fair value of assets or the net asset value we manage pursuant to separately managed accounts, (f) the net proceeds received from equity offerings and accumulated distributable earnings of BXMT, subject to certain adjustments, (g) the aggregate par amount of collateral assets, including principal cash, of our CLOs, and (h) the gross amount of assets (including leverage) or the net assets (plus leverage where applicable) for certain of our credit-focused registered investment companies. Each of our segments may include certain Fee-Earning Assets Under Management on which we earn performance revenues but not management fees. Our calculations of Total Assets Under Management and Fee-Earning Assets Under Management may differ from the calculations of other asset managers, and as a result this measure may not be comparable to similar measures presented by other asset managers. In addition, our calculation of Total Assets Under Management 6 Table of Contentsincludes commitments to, and the fair value of, invested capital in our funds from Blackstone and our personnel, regardless of whether such commitments or invested capital are subject to fees. Our definitions of Total Assets Under Management and Fee-Earning Assets Under Management are not based on any definition of Total Assets Under Management and Fee-Earning Assets Under Management that is set forth in the agreements governing the investment funds that we manage. For our carry funds, Total Assets Under Management includes the fair value of the investments held and uncalled capital commitments, whereas Fee-Earning Assets Under Management may include the total amount of capital commitments or the remaining amount of invested capital at cost depending on whether the investment period has expired or as specified by the fee terms of the fund. As such, in certain carry funds Fee-Earning Assets Under Management may be greater than Total Assets Under Management when the aggregate fair value of the remaining investments is less than the cost of those investments. “Perpetual Capital” refers to the component of assets under management with an indefinite term, that is not in liquidation, and for which there is no requirement to return capital to investors through redemption requests in the ordinary course of business, except where funded by new capital inflows. Perpetual Capital includes co-investment capital with an investor right to convert into Perpetual Capital. This report does not constitute an offer of any Blackstone Fund. 7 Table of Contents Part I. Item 1. Business Overview Blackstone is one of the world’s leading investment firms, with Total Assets Under Management of $974.7 billion as of December 31, 2022. We seek to create positive economic impact and long-term value for our investors, the companies we invest in, and the communities in which we work. We do this by using extraordinary people and flexible capital to help companies solve problems. Our asset management businesses include investment vehicles focused on real estate, private equity, infrastructure, life sciences, growth equity, credit, real assets and secondary funds, all on a global basis. Our businesses use a solutions-oriented approach to drive better performance. We believe our scale, diversified business, long record of investment performance, rigorous investment process and strong client relationships position us to continue to perform well in a variety of market conditions, expand our assets under management and add complementary businesses. We invest across asset classes on behalf of our investors, including pension funds, insurance companies and individual investors. Our mission is to create long-term value through careful stewardship of their capital. To the extent our funds perform well, we can support a better retirement for tens of millions of pensioners, including teachers, nurses and firefighters. We believe that consideration of appropriate environmental, social and governance (“ESG”) principles can help us further our mission of delivering strong returns for our investors, and we use our scale and expertise to help strengthen our companies, assets and the communities in which they operate. As of December 31, 2022, we employed approximately 4,695 people, including our 222 senior managing directors, at our headquarters in New York and around the world. Our employees are integral to Blackstone’s culture of integrity, professionalism and excellence. We believe hiring, training and retaining talented individuals, coupled with our rigorous investment process, has supported our excellent investment record over many years. This record, in turn, has enabled us to innovate into new strategies, drive growth and better serve our investors. Business Segments Our four business segments are: (a) Real Estate, (b) Private Equity, (c) Credit & Insurance and (d) Hedge Fund Solutions. Information about our business segments should be read together with “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” For more information concerning the revenues and fees we derive from our business segments, see “— Fee Structure/Incentive Arrangements.” Real Estate Our Real Estate business is a global leader in real estate investing, with $326.1 billion of Total Assets Under Management as of December 31, 2022. Our Real Estate segment operates as one globally integrated business with approximately 890 employees and has investments across the globe, including in the Americas, Europe and Asia. Our real estate investment teams seek to utilize our global expertise and presence to generate attractive risk-adjusted returns for our investors. Our Blackstone Real Estate Partners (“BREP”) business is geographically diversified and targets a broad range of opportunistic real estate and real estate-related investments. The BREP funds include global funds as well as funds focused specifically on Europe or Asia investments. BREP seeks to invest thematically in high-quality assets, 8 Table of Contentsfocusing where we see outsized growth potential driven by global economic and demographic trends. BREP has made significant investments in logistics, office, rental housing, hospitality and retail properties around the world, as well as in a variety of real estate operating companies. Our Core+ strategy invests in substantially stabilized real estate globally primarily through perpetual capital vehicles. These include our (a) Blackstone Property Partners funds (“BPP”), which is focused on high-quality assets in the Americas, Europe and Asia and (b) Blackstone Real Estate Income Trust, Inc. (“BREIT”) and our Blackstone European Property Income (“BEPIF”) funds, which provide income-focused individual investors access to institutional quality real estate primarily in the Americas and Europe, respectively. Our Blackstone Real Estate Debt Strategies (“BREDS”) vehicles primarily target real estate-related debt investment opportunities. BREDS invests in both public and private markets, primarily in the U.S. and Europe. BREDS’ scale and investment mandates enable it to provide a variety of lending options for our borrowers and investment options for our investors, including commercial real estate and mezzanine loans, residential mortgage loan pools and liquid real estate-related debt securities. The BREDS platform includes high-yield real estate debt funds, liquid real estate debt funds and Blackstone Mortgage Trust, Inc. (“BXMT”), a NYSE-listed real estate investment trust (“REIT”). Private Equity Our Private Equity segment encompasses global businesses with a total of approximately 590 employees managing $288.9 billion of Total Assets Under Management as of December 31, 2022. Our Private Equity segment includes our corporate private equity business, which consists of: (a) our global private equity funds, Blackstone Capital Partners (“BCP”), (b) our sector-focused funds, including our energy- and energy transition-focused funds, Blackstone Energy Transition Partners (“BETP”), (c) our Asia-focused private equity funds, Blackstone Capital Partners Asia and (d) our core private equity funds, Blackstone Core Equity Partners (“BCEP”). Our Private Equity segment also includes (a) our opportunistic investment platform that invests globally across asset classes, industries and geographies, Blackstone Tactical Opportunities (“Tactical Opportunities”), (b) our secondary fund of funds business, Strategic Partners Fund Solutions (“Strategic Partners”), (c) our infrastructure-focused funds, Blackstone Infrastructure Partners (“BIP”), (d) our life sciences investment platform, Blackstone Life Sciences (“BXLS”), (e) our growth equity investment platform, Blackstone Growth (“BXG”), (f) our multi-asset investment program for eligible high net worth investors offering exposure to certain of Blackstone’s key illiquid investment strategies through a single commitment, Blackstone Total Alternatives Solution (“BTAS”) and (g) our capital markets services business, Blackstone Capital Markets (“BXCM”). We are a global leader in private equity investing. Our corporate private equity business pursues transactions across industries on a global basis. It strives to create value by investing in great businesses where our capital, strategic insight, global relationships and operational support can drive transformation. Our corporate private equity business’s investment strategies and core themes continually evolve in anticipation of, or in response to, changes in the global economy, local markets, regulation, capital flows and geopolitical trends. We seek to construct a differentiated portfolio of investments with a well-defined, post-acquisition value creation strategy. Similarly, we seek investments that can generate strong unlevered returns regardless of entry or exit cycle timing. Blackstone Core Equity Partners pursues control-oriented investments in high-quality companies with durable businesses and seeks to offer a lower level of risk and a longer hold period than traditional private equity. Tactical Opportunities pursues a thematically driven, opportunistic investment strategy. Our flexible, global mandate enables us to find differentiated opportunities across asset classes, industries, and geographies and invest behind them with the frequent use of structure to generate attractive risk-adjusted returns. With a focus on businesses and/or asset-backed investments in market sectors that are benefitting from long term transformational tailwinds, Tactical Opportunities seeks to leverage the full power of Blackstone to help those businesses grow and improve. Tactical Opportunities’ ability to dynamically shift focus to the most compelling 9 Table of Contentsopportunities in any market environment, combined with the business’ expertise in structuring complex transactions, enables Tactical Opportunities to invest behind attractive market areas often with securities that provide downside protection and maintain upside return. Strategic Partners, our secondary fund of funds business, is a total fund solutions provider. As a secondary investor it acquires interests in high-quality private funds from original holders seeking liquidity. Strategic Partners focuses on a range of opportunities in underlying funds such as private equity, real estate, infrastructure, venture and growth capital, credit and other types of funds, as well as general partner-led transactions and primary investments and co-investments with financial sponsors. Strategic Partners also provides investment advisory services to separately managed account clients investing in primary and secondary investments in private funds and co-investments. Blackstone Infrastructure Partners targets a diversified mix of core+, core and public-private partnership investments across all infrastructure sectors, including energy infrastructure, transportation, digital infrastructure, and water and waste with a primary focus in the U.S. BIP applies a disciplined, operationally intensive investment approach to investments, seeking to apply a long-term buy-and-hold strategy to large-scale infrastructure assets with a focus on delivering stable, long-term capital appreciation together with a predictable annual cash flow yield. Blackstone Life Sciences is our investment platform with capabilities to invest across the life cycle of companies and products within the life sciences sector. BXLS primarily focuses on investments in life sciences products in late stage clinical development within the pharmaceutical and biotechnology sectors. Blackstone Growth is our growth equity platform that seeks to deliver attractive risk-adjusted returns by investing in dynamic, growth-stage businesses, with a focus on the consumer, consumer technology, enterprise solutions, financial services and healthcare sectors. Credit & Insurance Our Credit & Insurance segment, with approximately 620 employees and $279.9 billion of Total Assets Under Management as of December 31, 2022, includes Blackstone Credit (“BXC”). BXC is one of the largest credit-oriented managers and CLO managers in the world. The investment portfolios of the funds BXC manages or sub-advises consist primarily of loans and securities of non-investment and investment grade companies spread across the capital structure including senior debt, subordinated debt, preferred stock and common equity. BXC is organized into two overarching strategies: private credit and liquid credit. BXC’s private credit strategies include mezzanine and direct lending funds, private placement strategies, stressed/distressed strategies and energy strategies (including our sustainable resources platform). BXC’s direct lending funds include Blackstone Private Credit Fund (“BCRED”) and Blackstone Secured Lending Fund (“BXSL”), both of which are business development companies (“BDCs”). BXC’s liquid credit strategies consist of CLOs, closed-ended funds, open-ended funds, systematic strategies and separately managed accounts. Our Credit & Insurance segment also includes our insurer-focused platform, Blackstone Insurance Solutions (“BIS”). BIS focuses on providing full investment management services for insurers’ general accounts, seeking to deliver customized and diversified portfolios that include allocations to Blackstone managed products and strategies across asset classes and Blackstone’s private credit origination capabilities. BIS provides its clients tailored portfolio construction and strategic asset allocation, seeking to generate risk-managed, capital-efficient returns, diversification and capital preservation that meets clients’ objectives. BIS also provides similar services to clients through separately managed accounts or by sub-managing assets for certain insurance-dedicated funds and special purpose vehicles. BIS currently manages assets for clients that include Corebridge Financial Inc., Everlake Life Insurance Company, Fidelity & Guaranty Life Insurance Company and Resolution Life Group, among others. 10 Table of Contents In addition, our Credit & Insurance segment includes our asset-based finance platform and our publicly traded midstream energy infrastructure, listed infrastructure and master limited partnership (“MLP”) investment platform, which is managed by Harvest Fund Advisors LLC (“Harvest”). Harvest primarily invests capital raised from institutional investors in separately managed accounts and pooled vehicles, investing in publicly traded energy infrastructure, listed infrastructure, renewables and MLPs holding primarily midstream energy assets in North America. Hedge Fund Solutions Working with our clients for more than 30 years, our Hedge Fund Solutions group is a leading manager of institutional funds with approximately 275 employees managing $79.7 billion of Total Assets Under Management as of December 31, 2022. The principal component of our Hedge Fund Solutions segment is Blackstone Alternative Asset Management (“BAAM”). BAAM is the world’s largest discretionary allocator to hedge funds, managing a broad range of commingled and customized fund solutions since its inception in 1990. The Hedge Fund Solutions segment also includes (a) our GP Stakes business (“GP Stakes”), which targets minority investments in the general partners of private equity and other private-market alternative asset management firms globally, with a focus on delivering a combination of recurring annual cash flow yield and long-term capital appreciation, (b) investment platforms that invest directly, including our Blackstone Strategic Opportunity Fund, which seeks to produce long term, risk-adjusted returns by investing in a wide variety of securities, assets and instruments, often sourced and/or managed by third party subadvisors or affiliated Blackstone managers, (c) our hedge fund seeding business and (d) registered funds that provide alternative asset solutions through daily liquidity products. Hedge Fund Solutions’ overall investment philosophy is to seek to grow investors’ assets through both commingled and custom-tailored investment strategies designed to deliver compelling risk-adjusted returns. Diversification, risk management and due diligence are key tenets of our approach. Perpetual Capital Each of our business segments currently includes Perpetual Capital assets under management, which refers to assets under management with an indefinite term, that are not in liquidation and for which there is no requirement to return capital to investors through redemption requests in the ordinary course of business, except where funded by new capital inflows. In recent years, we have meaningfully increased the number of Perpetual Capital vehicles we offer and the assets under management in such vehicles. Perpetual Capital strategies represent a significant and growing portion of our overall business, and the management fees and performance revenues we receive. Among the strategies in each of our segments, Perpetual Capital strategies include, without limitation, (a) in our Real Estate segment, Core+ real estate (including BREIT and BEPIF) and BXMT, (b) in our Private Equity segment, Blackstone Infrastructure Partners, (c) in our Credit & Insurance segment, BXSL and BCRED and (d) in our Hedge Fund Solutions segment, GP Stakes. In addition, assets managed for certain of our insurance clients are Perpetual Capital assets under management. Private Wealth Strategy Blackstone’s business has historically relied on the provision of investment products, such as traditional drawdown funds, to institutional investors. In recent years, we have considerably expanded the number and type of investment products we offer through various distribution channels to certain mass affluent and high net worth individual investors in the U.S. and other jurisdictions around the world. Our Private Wealth Solutions business is dedicated to building out our distribution capabilities in the retail channel to provide certain individual investors with access to Blackstone products across a broad array of alternative investment strategies. In recent years, capital from the private wealth channel has represented an increasing portion of our Total Assets Under Management, and we expect this trend to continue as we continue to undertake initiatives aimed at growing our private wealth strategies. 11 Table of ContentsInvestment Process and Risk Management We maintain a rigorous investment process across all of our investment vehicles. Each investment vehicle has investment policies and procedures that generally contain requirements, guidelines and limitations for investments, such as limitations relating to the amount that will be invested in any one investment and the types of assets, industries or geographic regions in which the vehicle will invest, as well as limitations required by law. Our investment professionals are responsible for selecting, evaluating, underwriting, diligencing, negotiating, executing, managing and exiting investments. For those of our businesses with review committees and/or investment committees, such committees review and evaluate investment opportunities in a framework that includes a qualitative and quantitative assessment of the key risks of investments. In such businesses, investment professionals generally submit investment opportunities for review and approval by a review committee and/or investment committee, subject to delineated exceptions set forth in the funds’ investment committee charters or resolutions. Review and investment committees are generally comprised of senior leaders and other senior professionals of the applicable investment business, and in many cases, other senior leaders of Blackstone and its businesses. Considerations that review and investment committees take into account when evaluating an investment may include, without limitation and depending on the nature of the investing business and its strategy, the quality of the business or asset in which the fund proposes to invest, the quality of the management team, likely exit strategies and factors that could reduce the value of the business or asset at exit, the ability of the business in which the investment is made to service debt in a range of economic and interest rate environments, macroeconomic trends in the relevant geographic region or industry and the quality of the businesses’ operations. In addition, the majority of our businesses have ESG policies that address, among other things, the review of ESG risks in the respective business's investment process. In addition, before deciding to invest in a new hedge fund or a new alternative asset manager, as applicable, our Hedge Fund Solutions and Strategic Partners teams conduct diligence in a number of areas, which, depending on the nature of the investment, may include, among others, the fund’s/manager’s performance, investment terms, investment strategy and investment personnel, as well as its operations, processes, risk management and internal controls. With respect to liquid credit clients and other clients whose portfolios are actively traded in our Credit & Insurance segment, our industry-focused research analysts provide the review and/or investment committee with a formal and comprehensive review of new investment recommendations and portfolio managers and trading professionals discuss, among other things, risks associated with overall portfolio composition. Our Credit & Insurance segment’s research team monitors the operating performance of underlying issuers, while portfolio managers, together with our traders, focus on optimizing asset composition to maximize value for our investors. This investment process is assisted by a variety of proprietary and non-proprietary research models and methods. Existing investments are reviewed and monitored on a regular basis by investment and asset management professionals. In addition, our investment professionals, Portfolio Operations professionals and, where applicable, ESG teams, work with our portfolio company senior executives to identify opportunities to drive operational efficiencies and growth. As part of our value creation efforts for our investors, select businesses encourage certain of their respective portfolio companies and assets to consider a select number of priority ESG initiatives focused on diversity, decarbonization and good governance. Structure and Operation of Our Investment Vehicles Our private investment funds are generally organized as limited partnerships with respect to U.S. domiciled vehicles and limited partnerships or other similar limited liability entities with respect to non-U.S. domiciled vehicles. In the case of our separately managed accounts, the investor, rather than we, generally controls the investment vehicle that holds or has custody of the investments we advise the vehicle to make. We conduct the sponsorship and management of our carry funds and other similar vehicles primarily through a partnership 12 Table of Contents structure in which limited partnerships organized by us accept commitments and/or subscriptions for investment from institutional investors and, to a more limited extent, high net worth individuals. Such commitments are generally drawn down from investors on an as-needed basis to fund investments (or for other permitted purposes) over a specified term. Our private equity and real estate funds are generally commitment-structured funds, with the exception of certain BPP, BREDS and BIP funds, as well as BREIT and BEPIF. For certain BPP, BREIT, BEPIF and BREDS funds, all or a portion of an investor’s capital may be funded on or promptly after the investor’s subscription date and cash proceeds resulting from the disposition of investments can be reinvested, subject to certain limitations and limited investor withdrawal rights. Our credit-focused funds are generally either commitment-structured funds or open-ended funds where the investor’s capital is fully funded on or promptly after the investor’s subscription date. The CLO vehicles we manage are structured investment vehicles that are generally private companies with limited liability. Most of our funds of hedge funds as well as our hedge funds are structured as funds where the investor’s capital is fully funded on the subscription date. BIS is generally structured around separately managed accounts. Our investment funds, separately managed accounts and other vehicles not domiciled in the European Economic Area (the “EEA”) are each generally advised by a Blackstone entity serving as investment adviser that is registered under the U.S. Investment Advisers Act of 1940, as amended (the “Advisers Act”). For our investment funds, separately managed accounts and other vehicles domiciled in the EEA, a Blackstone entity domiciled in the EEA generally serves as external alternative investment fund manager (“AIFM”), and the AIFM typically delegates its portfolio management function to a Blackstone-affiliated investment adviser registered under the Advisers Act. The Blackstone entity serving as investment adviser or AIFM, as applicable, typically carries out substantially all of the day-to-day operations of each investment vehicle pursuant to an investment advisory, investment management, AIFM or other similar agreement. Generally, the material terms of our investment advisory and AIFM agreements, as applicable, relate to the scope of services to be rendered by the investment adviser or the AIFM to the applicable vehicle, the calculation of management fees to be borne by investors in our investment vehicles, the calculation of and the manner and extent to which other fees received by the investment adviser or the AIFM, as applicable, from funds or fund portfolio companies serve to offset or reduce the management fees payable by investors in our investment vehicles and certain rights of termination with respect to our investment advisory and AIFM agreements. With the exception of the registered funds described below, the investment vehicles themselves do not generally register as investment companies under the U.S. Investment Company Act of 1940, as amended (the “1940 Act”), in reliance on the statutory exemptions provided by Section 3(c)(7), Section 3(c)(5)(C) or, Section 3(c)(1) thereof. Section 3(c)(7) of the 1940 Act exempts from its registration requirements investment vehicles privately placed in the United States whose securities are beneficially owned exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers” as defined under the 1940 Act. In addition, under current interpretations of the SEC, Section 3(c)(7) of the 1940 Act exempts from registration any non-U.S. investment vehicle all of whose outstanding securities are beneficially owned either by non-U.S. residents or by U.S. residents that are qualified purchasers. Section 3(c)(5)(C) of the 1940 Act exempts from its registration requirements certain companies engaged primarily in investment in mortgages and other liens or investments in real estate. Section 3(c)(1) of the 1940 Act exempts from its registration requirements privately placed investment vehicles whose securities are beneficially owned by not more than 100 persons. Additionally, under current interpretations of the SEC, Section 3(c)(1) of the 1940 Act exempts from registration any non-U.S. investment vehicle not publicly offered in the U.S. all of whose outstanding securities are beneficially owned by not more than 100 U.S. residents. BXMT is externally managed by a Blackstone-owned entity pursuant to a management agreement, conducts its operations in a manner that allows it to maintain its REIT qualification and also avail itself of the statutory exemption provided by Section 3(c)(5)(C) of the 1940 Act. BREIT is externally advised by a Blackstone-owned entity pursuant to an advisory agreement, conducts its operations in a manner that allows it to maintain its REIT qualification and also avails itself of the statutory exemption provided by Section 3(c)(5)(C) of the 1940 Act. In some cases, one or more of our investment advisers, including advisers within BXC, BAAM and BREDS, advises or sub-advises funds registered, or regulated as a BDC, under the 1940 Act. 13 Table of ContentsIn addition to having an investment adviser, each investment fund that is a limited partnership, or “partnership” fund, also has a general partner that, apart from partnership funds domiciled in the EEA, generally makes all operational and investment decisions, including the making, monitoring and disposing of investments. The limited partners of the partnership funds generally take no part in the conduct or control of the business of the investment funds, have no right or authority to act for or bind the investment funds and have no influence over the voting or disposition of the securities or other assets held by the investment funds. With the exception of certain of our funds of hedge funds, hedge funds, certain credit-focused and real estate debt funds, and other funds or separately managed accounts for the benefit of one or more specified investors, third party investors in some of our funds have the right to remove the general partner of the fund or to accelerate the termination of the investment fund without cause by a majority or supermajority vote. In addition, the governing agreements of many of our investment funds provide that in the event certain “key persons” in our investment funds do not meet specified time commitments with regard to managing the fund, then (a) investors in such funds have the right to vote to terminate the investment period by a specified percentage (including, in certain cases a simple majority) vote in accordance with specified procedures, or accelerate the withdrawal of their capital on an investor-by-investor basis, or (b) the fund’s investment period will automatically terminate and a specified percentage (including, in certain cases a simple majority) in accordance with specified procedures is required to restart it. In addition, the governing agreements of some of our investment funds provide that investors have the right to terminate the investment period for any reason by a supermajority vote of the investors in such fund. Fee Structure/Incentive Arrangements Management Fees The following is a general description of the management fees earned by Blackstone. • The investment adviser of each of our non-EEA domiciled carry funds and the AIFM of each of our EEA domiciled carry funds generally receives an annual management fee based on a percentage of the fund’s capital commitments, invested capital and/or undeployed capital during the investment period and the fund’s invested capital or investment fair value after the investment period, except that the investment adviser or AIFM to certain of our credit-focused, BPP and BCEP funds receives a management fee based on a percentage of invested capital or net asset value. These management fees are payable on a regular basis (typically quarterly) in the contractually prescribed amounts over the life of the fund. Depending on the base on which management fees are calculated, negative performance of one or more investments in the fund may reduce the total management fee paid for the relevant period, but not the fee rate. Management fees received are not subject to clawback. • The investment adviser of each of our funds that are structured like hedge funds, or of our funds of hedge funds, registered mutual funds, UCITs funds and separately managed accounts that invest in hedge funds, generally receives a management fee based on a percentage of the fund’s or account’s net asset value. These management fees are payable on a regular basis (typically monthly or quarterly). These funds generally permit investors to withdraw or redeem their interests periodically, in some cases following the expiration of a specified period of time when capital may not be withdrawn. Decreases in the net asset value of investor’s capital accounts may reduce the total management fee paid for the relevant period, but not the fee rate. Management fees received are not subject to clawback. In addition, to the extent the mandate of our funds is to invest capital in third party managed funds, as is the case with our funds of hedge funds, our funds will be required to pay management fees to such third party managers, which typically are borne by investors in such investment vehicles. • The investment adviser of each of our CLOs typically receives annual management fees, which are calculated as a percentage of the CLO's assets, and additional incentive management fees subject to a return hurdle being met. These management fees are payable on a regular basis (typically quarterly). Although varying from deal to deal, a CLO will typically be wound down within eight to eleven years of being launched. The amount of fees will decrease as the CLO deleverages toward the end of its term. 14 Table of Contents • The investment adviser of each of our separately managed accounts generally receives annual management fees based on a percentage of each account’s net asset value or invested capital. The management fees we receive from each of our separately managed accounts are generally paid on a regular basis (typically quarterly). Such management fees are generally subject to contractual rights the investor has to terminate our management on generally as short as 30 days’ notice. • The investment adviser of each of our credit-focused registered and non-registered investment companies and our BDCs typically receive an annual management fee based on a percentage of net asset value or total managed assets. The management fees we receive from the registered investment companies we manage are generally paid on a regular basis (typically quarterly). Such management fees are generally subject to contractual rights of the company’s board of directors to terminate our management of an account on as short as 30 days’ notice. • The investment adviser of BXMT receives an annual management fee, paid quarterly, based on a percentage of BXMT’s net proceeds received from equity offerings and accumulated “distributable earnings” (which is generally equal to its net income, calculated under GAAP, excluding certain non-cash and other items), subject to certain adjustments. • The investment adviser of BREIT and AIFM of BEPIF receive a management fee based on a percentage of BREIT’s or BEPIF’s, as applicable, net asset value per annum, payable monthly. For additional information regarding the management fee rates we receive, see “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Revenue Recognition — Management and Advisory Fees, Net.” Incentive Arrangements Our incentive arrangements are composed of (a) contractual incentive fees received from certain investment vehicles upon achieving specified cumulative investment returns (“Incentive Fees”), and (b) a disproportionate allocation of the income generated by investment vehicles otherwise allocable to investors upon achieving certain investment returns (“Performance Allocations”, and, together with Incentive Fees, "Performance Revenues"). In our carry funds, our Performance Revenues consist of the Performance Allocations to which the general partner or an affiliate thereof is entitled, commonly referred to as carried interest. Our ability to generate and realize carried interest is an important element of our business and has historically accounted for a very significant portion of our income. Carried interest is typically structured as a net profits interest in the applicable fund. In the case of our carry funds, carried interest is generally calculated on a “realized gain” basis, and each general partner (or affiliate) is generally entitled to an allocation of up to 20% of the net realized income and gains (generally taking into account realized and unrealized or net unrealized losses) generated by such fund. Net realized income or loss is not generally netted between or among funds, and in some cases our carry funds provide for allocations to be made on current income distributions (subject to certain conditions). For most carry funds, the carried interest is subject to a preferred limited partner return ranging from 5% to 8% per year, subject to a catch-up allocation to the general partner. Some of our carry funds do not provide for a preferred return, and generally the terms of our carry funds vary in certain respects across our business units and vintages. If, at the end of the life of a carry fund (or earlier with respect to certain of our real estate, real estate debt, core+ real estate, credit-focused, multi-asset class and opportunistic investment funds), as a result of diminished performance of later investments in a carry fund’s life, (a) the general partner receives in excess of the relevant carried interest percentage(s) applicable to the fund as applied to the fund’s cumulative net profits over 15 Table of Contentsthe life of the fund, or (in certain cases) (b) the carry fund has not achieved investment returns that exceed the preferred return threshold (if applicable), then we will be obligated to repay an amount equal to the carried interest that was previously distributed to us that exceeds the amounts to which we were ultimately entitled, up to the amount of carried interest received on an after-tax basis. This is known as a “clawback” obligation and is an obligation of any person who received such carried interest, including us and other participants in our carried interest plans. Although a portion of any dividends paid to our stockholder may include any carried interest received by us, we do not intend to seek fulfillment of any clawback obligation by seeking to have our stockholders return any portion of such dividends attributable to carried interest associated with any clawback obligation. To the extent we are required to fulfill a clawback obligation, however, we may determine to decrease the amount of our dividends to our stockholders. The clawback obligation operates with respect to a given carry fund’s own net investment performance only and carried interest of other funds is not netted for determining this contingent obligation. Moreover, although a clawback obligation is several, the governing agreements of most of our funds provide that to the extent another recipient of carried interest (such as a current or former employee) does not fund his or her respective share of the clawback obligation then due, then we and our employees who participate in such carried interest plans may have to fund additional amounts (generally an additional 50% to 70% beyond our pro-rata share of such obligation) although we retain the right to pursue any remedies that we have under such governing agreements against those carried interest recipients who fail to fund their obligations. We have recorded a contingent repayment obligation equal to the amount that would be due on December 31, 2022, if the various carry funds were liquidated at their current carrying value. For additional information concerning the clawback obligations we could face, see “— Item 1A. Risk Factors — Risks Related to Our Business — We may not have sufficient cash to pay back “clawback” obligations if and when they are triggered under the governing agreements with our investors.” In our structures other than carry funds, our Performance Revenues generally consist of performance-based allocations of a vehicle’s net capital appreciation during a measurement period, typically a year, subject to the achievement of minimum return levels, high water marks, and/or other hurdle provisions, in accordance with the respective terms set out in each vehicle’s governing agreements. Such allocations are typically realized at the end of the measurement period and, once realized, are typically not subject to clawback or reversal. In particular, our ability to generate and realize these amounts is an important element of our business. Such allocations in certain of our Perpetual Capital strategies contribute a significant and growing portion to our overall revenues. The following is a general description of the Performance Revenues earned by Blackstone in structures other than carry funds: • In our Hedge Fund Solutions segment, the investment adviser of our funds of hedge funds, certain hedge funds, separately managed accounts that invest in hedge funds and certain non-U.S. registered investment companies, is entitled to an incentive fee of 0% to 20%, as applicable, of the applicable investment vehicle’s net appreciation, subject to “high water mark” provisions and in some cases a preferred return. In addition, to the extent the mandate of our funds is to invest capital in third party managed hedge funds, as is the case with our funds of hedge funds, our funds will be required to pay incentive fees to such third party managers, which typically are borne by investors in such investment vehicles. • The general partners or similar entities of each of our real estate and credit hedge fund structures receive incentive fees of generally up to 20% of the applicable fund’s net capital appreciation per annum. • The investment adviser of our BDCs receives (a) income incentive fees of 12.5% or 15%, as applicable, subject to, in certain cases, certain hurdles, catch-ups and caps, payable quarterly, and (b) capital gains incentive fees (net of realized and unrealized losses) of 12.5% or 15%, as applicable, payable annually. 16 Table of Contents • The investment manager of BXMT receives an incentive fee generally equal to 20% of BXMT’s distributable earnings in excess of a 7% per annum return on stockholders’ equity (excluding stock appreciation or depreciation), provided that BXMT’s distributable earnings over the prior three years is greater than zero. • The special limited partner of each of BREIT and BEPIF receives a performance participation allocation of 12.5% of total return, subject to a 5% hurdle amount with a catch-up and recouping any loss carry forward amounts, payable quarterly. • The general partners of certain open-ended BPP and BIP funds are entitled to an incentive fee allocation generally between 7% and 12.5% of net profit, subject to a hurdle amount generally of between 5.5% and 7%, a loss recovery amount and a catch-up. Incentive allocations for these funds are generally realized every three years from when a limited partner makes its initial investment. Advisory and Transaction Fees Some of our investment advisers or their affiliates receive customary fees (for example, acquisition, origination and other transaction fees) upon consummation of their funds’ transactions, and may from time to time receive advisory, monitoring and other fees in connection with their activities. For most of the funds where we receive such fees, we are required to reduce the management fees charged to the funds’ investors by 50% to 100% of such limited partner’s share of such fees. Capital Invested In and Alongside Our Investment Funds To further align our interests with those of investors in our investment funds, we have invested the firm’s capital and that of our personnel in the investment funds we sponsor and manage. Minimum general partner capital commitments to our investment funds are determined separately with respect to each of our investment funds and, generally, are less than 5% of the limited partner commitments of any particular fund. See “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” for more information regarding our minimum general partner capital commitments to our funds. We determine whether to make general partner capital commitments to our funds in excess of the minimum required commitments based on, among other things, our anticipated liquidity, working capital and other capital needs. In many cases, we require our senior managing directors and other professionals to fund a portion of the general partner capital commitments to our funds. In other cases, we may from time to time offer to our senior managing directors and employees a part of the funded or unfunded general partner commitments to our investment funds. Our general partner capital commitments are funded with cash and not with carried interest or deferral of management fees. Investors in many of our funds also receive the opportunity to make additional “co-investments” with the investment funds. Our personnel, as well as Blackstone itself and certain Blackstone relationships, also have the opportunity to make investments, in or alongside our funds and other vehicles we manage, in some instances without being subject to management fees, carried interest or incentive fees. In certain cases, limited partner investors may pay additional management fees or carried interest in connection with such co-investments. Competition The asset management industry is intensely competitive, and we expect it to remain so. We compete both globally and on a regional, industry and sector basis. We compete on the basis of a number of factors, including investment performance, transaction execution skills, access to capital, access to and retention of qualified personnel, reputation, range of products and services, innovation and price. We face competition both in the pursuit of institutional and individual investors for our investment funds and in acquiring investments in attractive portfolio companies and making other investments. Although many 17 Table of Contentsinstitutional and individual investors have increased the amount of capital they commit to alternative investment funds, such increases may create increased competition with respect to fees charged by our funds. Certain institutional investors have demonstrated a preference to in-source their own investment professionals and to make direct investments in alternative assets without the assistance of private equity advisers like us. We compete for investments with such institutional investors and such institutional investors could cease to be our clients. With respect to the private wealth channel and insurance sector, the market for capital is highly competitive and requires significant investment. Depending on the investment, we face competition primarily from sponsors managing other funds, investment vehicles and other pools of capital, other financial institutions and institutional investors (including sovereign wealth and pension funds), corporate buyers, special purpose acquisition companies and other parties. Several of these competitors have significant amounts of capital and many of them have investment objectives similar to ours, which may create additional competition for investment opportunities. Some of these competitors may also have a lower cost of capital and access to funding sources or other resources that are not available to us, which may create competitive disadvantages for us with respect to investment opportunities. In addition, some of these competitors may have higher risk tolerances, different risk assessments or lower return thresholds, which could allow them to consider a wider variety of investments and to bid more aggressively than us for investments. Corporate buyers may be able to achieve synergistic cost savings with regard to an investment or be perceived by sellers as otherwise being more desirable bidders, which may provide them with a competitive advantage in bidding for an investment. In all of our businesses, competition is also intense for the attraction and retention of qualified employees. Our ability to continue to compete effectively in our businesses will depend upon our ability to attract new employees and retain and motivate our existing employees. For additional information concerning the competitive risks that we face, see “— Item 1A. Risk Factors — Risks Related to Our Business — The asset management business is intensely competitive.” Environmental, Social and GovernanceWe aim to develop resilient companies and competitive assets that deliver long-term value for our investors. ESG principles have long informed the way we run our firm, approach investing and partner with the assets in our portfolio. In recent years we have formalized our approach by building a dedicated corporate ESG team that looks to develop ESG policies and support integration within the business units, and regularly reports progress to stakeholders. ESG at Blackstone is overseen by senior management. Senior management reports quarterly on ESG to our board of directors, which is responsible for reviewing our ESG strategy. We also engage with several organizations to help inform our approach, including the Taskforce on Climate-related Financial Disclosures (“TCFD”).We believe that for certain investment strategies, consideration of appropriate ESG factors can help us identify attractive investment opportunities and assess potential risks in furtherance of our mission to deliver strong returns. Accordingly, we are seeking to develop a tailored approach to consideration of ESG factors in the investment lifecycle that takes into account, among other factors, the asset class and structure of the investment.We are focused on corporate sustainability and pursuing environmental performance improvements at our office locations. We proactively renovate our spaces to provide additional employee amenities and comfort while implementing efficient lighting and HVAC systems. Blackstone also has an Emissions Reduction Program, which aims to decrease energy spend by reducing Scope 1 and Scope 2 carbon emissions by 15% on average across certain new investments where we control energy usage within the first three full calendar years of ownership. We continue to expand our resources to enable us to drive long-term value through sustainability practices, energy efficiency and decarbonization at scale. 18 Table of Contents Human Capital Management Blackstone’s employees are integral to our culture of integrity, professionalism, excellence and cooperation. The intellectual capital collectively possessed by our employees is our most important asset. We hire qualified people, train them and encourage them to work together to provide their best thinking to the firm for the benefit of the investors in the funds we manage. As of December 31, 2022, we employed approximately 4,695 people. During 2022, our total number of employees increased by approximately 900. Our board of directors plays an active role in overseeing our human capital management efforts. To that end, senior management reviews with our board of directors management succession planning and development and other key aspects of our talent management strategy. Employee and Community Engagement Blackstone is committed to ensuring our employees are engaged with their work and with their local communities. To that end, Blackstone regularly gathers feedback from our employees via internal and/or external surveys to assess employee engagement and satisfaction and develop targeted solutions. Blackstone also supports its employee affinity networks which are dedicated to recruiting, retaining and raising awareness of diverse groups through speaker series, networking events, service opportunities and mentoring relationships. In addition, the Blackstone Charitable Foundation (“BXCF”) was established in 2007, and is committed to supporting Blackstone’s goal of helping foster economic opportunity and career mobility for historically underrepresented groups. This includes, among other initiatives, its signature Blackstone LaunchPad network, which helps college and university students gain entrepreneurial experiences and competencies to build successful companies and careers, and BX Connects, a global program that provides Blackstone employees with the opportunity to support their local communities through volunteering and giving. BX Connects uses the firm’s scale, talent and resources to make grants, develop nonprofit partnerships and create employee engagement opportunities. Approximately 80% of our employees engaged globally with BXCF’s charitable initiatives in 2022. Talent Acquisition, Development and Retention We believe the talent of our employees, coupled with our rigorous investment process, has supported our excellent investment record over many years. We are therefore focused on hiring, training, motivating and retaining talented individuals. Across all our businesses, we face intense competition for qualified personnel. We seek to attract candidates from diverse backgrounds and skill sets and to hire the brightest minds in our industry. We believe our reputation, talent development opportunities and compensation make us an attractive employer. We encourage independent thinking and reward initiative while providing training and development opportunities to help our employees grow professionally. In addition, our Respect at Work programs and trainings help maintain an inclusive work environment in which all individuals are treated with respect and dignity. Employee education and training are also critical to maintaining a culture of compliance. Blackstone offers a wide range of learning and professional development opportunities, both formally and informally, to help employees advance their careers and maximize the value they can add to the global firm. Incoming analyst classes are provided with training that spans their first few years. In addition, our new hires are provided with training and other opportunities to help them thrive in our culture, including through our Culture Program and our Leadership Speaker Series. Blackstone employees are trained or enrolled in compliance training when they start at the firm and we retrain employees globally at least once annually. Over the course of their careers at Blackstone, employees are offered learning opportunities in a number of areas including leadership and management development and communication skills, among others. We offer a global development curriculum on key capabilities required to succeed at Blackstone, and we partner with external organizations to deliver training programs for our employees. We consistently seek to create visibility and opportunities for talent to take on roles 19 Table of Contentsbeyond their current positions, and for managers to connect regularly to discuss and match talent with critical roles. These efforts result in cross-pollination of talent that we believe engages our people and generates stronger outcomes for the firm. As discussed below, we seek to retain and incentivize the performance of our employees through our compensation structure. We also enter into non-competition and non-solicitation agreements with certain employees. See “Part III. Item 11. Executive Compensation — Non-Competition and Non-Solicitation Agreements” for a description of the material terms of such agreements. Diversity, Equity and Inclusion (“DEI”) We believe a diverse and inclusive workforce makes us better investors and a better firm. We are committed to attracting, developing and advancing a diverse workforce that represents a spectrum of backgrounds, identities and experiences. We are focused on embedding DEI principles to maintain a culture of equity and inclusion. We believe this will leverage the diversity of our workforce and deliver results for our investors. To that end, our talent acquisition platform includes programs aimed at expanding diversity at Blackstone and in financial services, such as the Blackstone Future Women Leaders program and the Blackstone Diverse Leaders program. Our employees are invited to participate in our internal affinity networks, which seek to engage, connect and create a supportive environment for our employees, including by hosting speaker series, professional development panels and social events. These networks include our Blackstone Women’s Initiative, Working Families Network, OUT Blackstone, Blackstone Veterans Network and Diverse Professionals Network, which was recently expanded to include a community of networks for Black, Hispanic and Latino, Asian and South Asian and Middle Eastern employees and allies. We have also achieved a score of 100% on the Human Rights Campaign Corporate Equality Index, earning the designation as a “Best Place to Work for LGBT+ Equality” for the fourth year in a row in 2022. We believe diversity of thought and experience builds better businesses. We seek to ensure that our board of directors is composed of members whose collective experience, qualifications and skills will allow the board to effectively satisfy its oversight responsibilities. We also recognize that diversity is an important component of effective governance. Over one-third of our board of directors is diverse, based on gender, race and sexual orientation, when known. Likewise, with respect to our portfolio companies, in 2021 we announced that we will target at least one-third diverse representation on new controlled portfolio company boards in the U.S. and Europe. We also launched our Career Pathways pilot program, creating economic opportunity across our portfolio through career mobility and ensuring select portfolio companies have access to the largest pool of talent. Compensation and Benefits Our compensation is designed to motivate and retain employees and align their interests with those of the investors in our funds. In particular, incentive compensation for our senior managing directors and employees involves a combination of annual cash bonus payments and performance interests or deferred equity awards, which we believe encourages them to focus on the performance of our investment funds and the overall performance of the firm. The proportion of compensation that is “at risk” generally increases as an employee’s level of responsibility rises. Employees at higher total compensation levels are generally targeted to receive a greater percentage of their total compensation payable in annual cash bonuses, participation in performance interests, and deferred equity awards and a lesser percentage in the form of base salary compared to employees at lower total compensation levels. To further align their interests with those of investors in our funds, our employees have the opportunity to make investments in or alongside our funds and other vehicles we manage. We also provide our employees robust health and retirement offerings, as well as a variety of quality of life benefits, including time-off options and well-being and family planning resources. We believe our current compensation and benefit allocations for senior professionals are best in class and are consistent with companies in the alternative asset management industry. Our senior management periodically 20 Table of Contents reviews the effectiveness and competitiveness of our compensation program. Most of our current senior managing directors and other senior personnel have equity interests in our business that entitle such personnel to cash distributions. See “Part III. Item 11. Executive Compensation – Compensation Discussion and Analysis – Overview of Compensation Philosophy and Program” for more information on compensation of our senior managing directors and certain other employees. Blackstone also offers comprehensive and competitive benefits to its full-time employees, including primary and secondary caregiver leave, adoption leave, phased back to work, fertility coverage, back up childcare and more. We continually evaluate and enhance our offerings to meet the needs of our employees. For example, we offer additional family planning benefits for U.S. employees such as enhancing infertility benefits to include cryopreservation and primary caregiver leave up to 21 weeks. Health and Wellness We care greatly about the health, safety and wellbeing of our employees. We offer employee well-being programs, including an online therapy program and access to an education platform with coaching to support working parents and caretakers caring for children who have behavioral problems, autism or developmental disabilities. We also provide access to programs to further assist our employees in managing their lives outside of work, such as group legal services to help with estate planning and surrogacy agreements. In addition, during the COVID-19 pandemic we invested over $15.9 million and $28.7 million for the years ended December 31, 2022 and 2021, respectively, in extensive measures to ensure employee safety and wellbeing of our employees and their families and the seamless functioning of the firm. Data Privacy and Security Blackstone is committed to privacy and data protection. These topics are included in routine training received at least once annually by employees. Data privacy is typically addressed in the Global Head of Compliance’s annual update to our board of directors. Blackstone’s approach to data protection is set out in our Online Privacy Notice and its Investor Data Privacy Notice. Our Data Policy and Strategy Officer oversees privacy, data protection and information risk management efforts, leading the privacy and data protection function, which conducts privacy impact assessments, implements privacy-by-design initiatives and reconciles global privacy programs with local privacy requirements. Our privacy function also supports the Data Protection Operating Committee, Blackstone’s global privacy compliance steering committee. Blackstone has built a dedicated cybersecurity team and maintains a comprehensive cybersecurity program to protect our systems, our operations and the data entrusted to us by our investors, employees, portfolio companies and business partners. Blackstone’s cybersecurity program is led by our Chief Information Security Officer, who works closely with our senior management to develop and advance the firm’s cybersecurity strategy and regularly reports to our board of directors and the audit committee of our board of directors on cybersecurity matters. We believe that cybersecurity is a team effort — every employee has a responsibility to help protect the firm and secure its data. We conduct regular testing at least once a year to identify vulnerabilities before they can be exploited by attackers, using automated tools and “white hat” hackers. We examine and validate our program every two to three years with third parties, measuring it against industry standards and established frameworks, such as the National Institute of Standards and Technology and Center for Internet Security. We have a comprehensive Security Incident Response Plan to ensure that any non-routine events are properly escalated. These plans are validated at least annually through a cyber incident tabletop exercise to consider the types of decisions that would need to be made in the event of a cyber incident. We have engaged in scenario planning exercises around cyber incidents. 21 Table of ContentsRegulatory and Compliance Matters Our businesses, as well as the financial services industry generally, are subject to extensive regulation in the United States and in many of the markets in which we operate. Many of our businesses are subject to compliance with laws and regulations of U.S. federal and state governments, non-U.S. governments, their respective agencies and/or various self-regulatory organizations or exchanges. The SEC and various self-regulatory organizations, state securities regulators and international securities regulators have in recent years increased their regulatory activities, including regulation, examination and enforcement in respect of asset management firms, including Blackstone. Any failure to comply with these regulations could expose us to liability and/or damage our reputation. Our businesses have operated for many years within a legal framework that requires us to monitor and comply with a broad range of legal and regulatory developments that affect our activities. However, additional legislation, changes in rules promulgated by financial regulatory authorities or self-regulatory organizations or changes in the interpretation or enforcement of existing laws and rules, either in the United States or abroad, may directly affect our mode of operation and profitability. All of the investment advisers of our investment funds operating in the U.S. are registered as investment advisers with the SEC under the Advisers Act (other investment advisers may be registered in non-U.S. jurisdictions). Registered investment advisers are subject to the requirements and regulations of the Advisers Act. Such requirements relate to, among other things, fiduciary duties to advisory clients, maintaining an effective compliance program and code of ethics, investment advisory contracts, solicitation agreements, conflicts of interest, recordkeeping and reporting requirements, disclosure, advertising and custody requirements, political contributions, limitations on agency cross and principal transactions between an adviser and advisory clients, and general anti-fraud prohibitions. Certain investment advisers are also registered with international regulators in connection with their management of products that are locally distributed and/or regulated. Blackstone Securities Partners L.P. (“BSP”), a subsidiary through which we conduct our capital markets business and certain of our fund marketing and distribution, is registered as a broker-dealer with the SEC and is subject to regulation and oversight by the SEC, is a member of the Financial Industry Regulatory Authority, or “FINRA,” and is registered as a broker-dealer in 50 states, the District of Columbia, the Commonwealth of Puerto Rico and the Virgin Islands. In addition, FINRA, a self-regulatory organization subject to oversight by the SEC, adopts and enforces rules governing the conduct, and examines the activities, of its member firms, including BSP. State securities regulators also have regulatory oversight authority over BSP. Broker-dealers are subject to regulations that cover all aspects of the securities business, including, among others, the implementation of a supervisory control system over the securities business, advertising and sales practices, conduct of and compensation in connection with public securities offerings, maintenance of adequate net capital, record keeping and the conduct and qualifications of employees. In particular, as a registered broker-dealer and member of FINRA, BSP is subject to the SEC’s uniform net capital rule, Rule 15c3-1. Rule 15c3-1 specifies the minimum level of net capital a broker-dealer must maintain and also requires that a significant part of a broker-dealer’s assets be kept in relatively liquid form. The SEC and various self-regulatory organizations impose rules that require notification when net capital of a broker-dealer falls below certain predefined criteria, limit the ratio of subordinated debt to equity in the capital structure of a broker-dealer and constrain the ability of a broker-dealer to expand its business under certain circumstances. Additionally, the SEC’s uniform net capital rule imposes certain requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital and requiring prior notice to the SEC for certain withdrawals of capital. In addition, certain of the closed-end and open-end investment companies we manage, advise or sub-advise are registered, or regulated as a BDC, under the 1940 Act. The 1940 Act and the rules thereunder govern, among other things, the relationship between us and such investment vehicles and limit such investment vehicles’ ability to enter into certain transactions with us or our affiliates, including other funds managed, advised or sub-advised by us. 22 Table of Contents Pursuant to the U.K. Financial Services and Markets Act 2000, or “FSMA,” certain of our subsidiaries are subject to regulations promulgated and administered by the Financial Conduct Authority (“FCA”). The FSMA and rules promulgated thereunder form the cornerstone of legislation which governs all aspects of our investment business in the United Kingdom, including sales, provision of investment advice, use and safekeeping of client funds and securities, regulatory capital, recordkeeping, approval standards for individuals, anti-money laundering, periodic reporting and settlement procedures. The Blackstone Group International Partners LLP (“BGIP”) acts as a sub-advisor to its Blackstone U.S. affiliates in relation to the investment and re-investment of Europe, Middle East and Africa (“EMEA”) based assets of Blackstone Funds, arranging transactions to be entered into by or on behalf of Blackstone Funds, and providing certain related services. Until December 31, 2020, BGIP had a MiFID II (as defined herein) cross-border passport to provide investment services into the European Economic Area (“EEA”). As of January 1, 2021, as a result of the U.K.’s withdrawal from the European Union, BGIP no longer has a MiFID II passport. Consequently, BGIP can only provide investment services in certain EEA jurisdictions where it has obtained a domestic license on a cross-border services basis (currently, Belgium, Denmark, Finland and Italy), or can operate pursuant to an exemption or relief (currently Ireland, Lichtenstein and Norway), although in certain cases with time limitations. BGIP’s principal place of business is in London and it has representative offices or corporate branches in Abu Dhabi and France. Blackstone Ireland Limited (formerly known as Blackstone / GSO Debt Funds Management Europe Limited) (“BIL”) is authorized and regulated by the Central Bank of Ireland (“CBI”) as an Investment Firm under the (Irish) European Union (Markets in Financial Instruments) Regulations 2017, which largely implements MiFID II in Ireland. BIL’s principal activity is the provision of management and advisory services to certain CLO and sub-advisory services to certain affiliates. Blackstone Ireland Fund Management Limited (formerly known as Blackstone / GSO Debt Funds Management Europe II Limited) (“BIFM”) is authorized and regulated by the CBI as an Alternative Investment Fund Manager under the (Irish) European Union (Alternative Investment Fund Managers Regulations) 2013 (“AIFMRs”), which largely implements the EU Alternative Investment Fund Managers Director (“AIFMD”) in Ireland. BIFM acts as AIFM and provides investment management functions including portfolio management, risk management, administration, marketing and related activities to its alternative investment funds in accordance with AIFMRs and the conditions imposed by the CBI as set out in the CBI’s alternative investment fund rulebook. Blackstone Europe Fund Management S.à r.l. (“BEFM”) is an authorized Alternative Investment Fund Manager under the Luxembourg Law of 12 July 2013 on alternative investment fund managers (as amended, the “AIFM Law”), which largely implements AIFMD in Luxembourg. BEFM may also provide discretionary portfolio management services, investment advice and reception and transmission of orders in accordance with article 5(4) of the AIFM Law. BEFM provides investment management functions including portfolio management, risk management, administration, marketing and related activities to the assets of its alternative investment funds, in accordance with the AIFM Law and the regulatory provisions imposed by the Commission de Surveillance du Secteur Financier in Luxembourg. As of January 1, 2021, BEFM promotes Blackstone products and services in European countries where BGIP is not otherwise licensed to do so. BEFM has branches in Paris, Milan and Frankfurt which provides marketing services and where distribution and deal sourcing individuals are based. Certain Blackstone operating entities are licensed and subject to regulation by financial regulatory authorities in Japan, Hong Kong, Australia and Singapore: The Blackstone Group Japan K.K., a financial instruments firm, is registered with Kanto Local Finance Bureau and regulated by the Japan Financial Services Agency; The Blackstone Group (HK) Limited is regulated by the Hong Kong Securities and Futures Commission; The Blackstone Group (Australia) Pty Limited and Blackstone Real Estate Australia Pty Limited each holds an Australian financial services license authorizing it to provide financial services in Australia and is regulated by the Australian Securities and Investments Commission; and Blackstone Singapore Pte. Ltd. is regulated by the Monetary Authority of Singapore. 23 Table of ContentsRigorous legal and compliance analysis of our businesses and investments is endemic to our culture and risk management. Our Chief Legal Officer and Global Head of Compliance, together with the Chief Compliance Officers of each of our businesses, supervise our compliance personnel, who are responsible for addressing the regulatory and compliance matters that affect our activities. We strive to maintain a culture of compliance through the use of policies and procedures including a code of ethics, electronic compliance systems, testing and monitoring, communication of compliance guidance and employee education and training. Our compliance policies and procedures address regulatory and compliance matters such as the handling of material non-public information, personal securities trading, marketing practices, gifts and entertainment, anti-money laundering, anti-bribery and sanctions, valuation of investments on a fund-specific basis, recordkeeping, potential conflicts of interest, the allocation of investment and co-investment opportunities, collection of fees and expense allocation. Our compliance group also monitors the information barriers that we maintain between Blackstone’s businesses. We believe that our various businesses’ access to the intellectual knowledge and contacts and relationships that reside throughout our firm benefits all of our businesses. To maximize that access and related synergies without compromising compliance with our legal and contractual obligations, our compliance group oversees and monitors the communications between groups that are on the private side of our information barrier and groups that are on the public side, as well as between different public side groups. Our compliance group also monitors contractual obligations that may be impacted and potential conflicts that may arise in connection with these inter-group discussions. In addition, disclosure controls and procedures and internal controls over financial reporting are documented, tested and assessed for design and operating effectiveness in accordance with the U.S. Sarbanes-Oxley Act of 2002. Internal Audit, which independently reports to the audit committee of our board of directors, operates with a global mandate and is responsible for the examination and evaluation of the adequacy and effectiveness of the organization’s governance and risk management processes and internal controls, as well as the quality of performance in carrying out assigned responsibilities to achieve the organization’s stated goals and objectives. Our enterprise risk management framework is designed to manage non-investment risk areas across the firm, such as strategic, financial, human capital, legal, operational, regulatory, reputational and technology risks. Our enterprise risk committee assists Blackstone management to identify, assess, monitor and mitigate such key enterprise risks at the corporate, business unit and fund level. The enterprise risk committee is chaired by our Chief Financial Officer and is comprised of senior management across business units, corporate functions and regions. Senior management reports to the audit committee of the board of directors on the agenda of risk topics evaluated by the enterprise risk committee and provides periodic risk reports, a summary of its view on key risks to the firm and detailed assessments of selected risks, as applicable. Our firmwide valuation committee reviews the valuation process for investments held by us and our investment vehicles, including the application of appropriate valuation standards on a consistent basis. The firmwide valuation committee is chaired by our Chief Financial Officer and is comprised of senior heads of Blackstone’s businesses and representatives from legal and finance. The review committees and/or investment committees of our businesses review and evaluate investment opportunities in a framework that includes a qualitative and quantitative assessment of the key risks of investments. See “— Investment Process and Risk Management.” There are a number of pending or recently enacted legislative and regulatory initiatives that could significantly affect our business. Please see “— Item 1A. Risk Factors — Risks Related to Our Business — Financial regulatory changes in the United States could adversely affect our business” and “— Complex regulatory regimes and potential regulatory changes in jurisdictions outside the United States could adversely affect our business.” 24 Table of Contents Available Information Effective August 6, 2021, The Blackstone Group Inc. changed its name to Blackstone Inc. Effective July 1, 2019, Blackstone Inc. converted from a Delaware limited partnership to a Delaware corporation. Blackstone was formed as a Delaware limited partnership on March 12, 2007. We file annual, quarterly and current reports and other information with the SEC. These filings are available to the public over the internet at the SEC’s website at www.sec.gov. Our principal internet address is www.blackstone.com. We make available free of charge on or through www.blackstone.com our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The contents of our website are not, however, a part of this report. Item 1A. Risk Factors Risks Related to Our Business Difficult market and geopolitical conditions can adversely affect our business in many ways, each of which could materially reduce our revenue, earnings and cash flow and adversely affect our financial prospects and condition. Our business is materially affected by financial market and economic conditions and events throughout the world that are outside our control. We may not be able to or may choose not to manage our exposure to these conditions and/or events. Such conditions and/or events can adversely affect our business in many ways, including reducing the ability of our funds to raise or deploy capital, reducing the value or performance of our funds’ investments and making it more difficult for our funds to exist and realize value from existing investment. This could in turn materially reduce our revenue, earnings and cash flow and adversely affect our financial prospects and condition. In addition, in the face of a difficult market or economic environment, we may need to reduce our fixed costs and other expenses in order to maintain profitability, including cutting back or eliminating the use of certain services or service providers, or terminating the employment of a significant number of our personnel that, in each case, could be important to our business and without which our operating results could be adversely affected. A failure to manage or reduce our costs and other expenses within a time frame sufficient to match any decrease in profitability would adversely affect our operating performance. Turmoil in the global financial markets can provoke significant volatility of equity and debt securities prices. This can have a material and rapid impact on our mark-to-market valuations, particularly with respect to our public holdings and credit investments. While inflation in the U.S. has recently shown signs of moderating, record inflation experienced in the U.S. throughout 2022 and steps taken by the Federal Reserve to dramatically increase interest rates in response have contributed to volatility in the debt and equity markets. Heightened competition for workers and rising energy and commodity prices have contributed to increasing wages and other inputs. Higher inflation and rising input costs put pressure on our funds’ portfolio companies’ profit margins, particularly where pricing power is lacking. Similarly, the valuations of our funds’ real estate assets have been and may continue to be adversely impacted by inflation, higher interest rates and a rising cost of capital. In a continued inflationary and high interest rate environment, the performance of our funds’ real estate assets could be adversely affected notwithstanding a sustained level of cash flow growth. Such an adverse macroeconomic environment could be even more challenging for traditional office properties and those with long-term leases that do not provide for short term rent increases to offset higher interest rates and a rising cost of capital. In China, the government has in recent years implemented a number of measures to control the rate of economic growth in the country, including by raising interest rates and adjusting deposit reserve ratios for commercial banks, and through other measures designed to tighten credit and liquidity. The China growth rate has been slowing, and further slowing could have a systemic impact on the global economy and on equity and debt markets. As publicly traded equity securities have in recent years represented an increasingly significant proportion of the assets of many of our funds, stock market volatility, including a sharp decline in the stock market may adversely affect our results, including our revenues and net income. In addition, 25 Table of Contentsour public equity holdings have at times been concentrated in a few large positions, thereby making our unrealized mark-to-market valuations particularly sensitive to sharp changes in the price of any of these positions. Further, although the equity markets are not the only means by which we exit investments, should we continued to experience a period of challenging equity markets, our funds may experience continued difficulty in realizing value from investments. Geopolitical concerns and other global events, including, without limitation, trade conflict, civil unrest, national and international political circumstances (including outbreak of war, terrorist acts or security operations) and pandemics or other severe public health events, have contributed and may continue to contribute to volatility in global equity and debt markets. For example, the ongoing war between Russia and Ukraine and the global response thereto, including the imposition of widespread economic and other sanctions, has significantly impacted the global economy and financial markets. In addition to the factors described above, other market, economic and geopolitical factors described herein that may adversely affect our business include, without limitation: • higher prices for commodities or other goods, • economic slowdown or recession in the U.S. and internationally, • changes in interest rates and/or a lack of availability of credit in the U.S. and internationally, and • changes in law and/or regulation, and uncertainty regarding government and regulatory policy, including in connection with the current administration. A period of economic slowdown, which may be across one or more industries, sectors or geographies, contributes to operating performance challenges for certain of our funds’ investments, which could adversely affect our operating results and cash flows. In recent years, we have experienced periods of economic slowdown and in some instances, contraction, as countries and industries around the globe grappled with the short and long-term economic impacts of the COVID-19 pandemic. Higher interest rates or elevated interest rates for a sustained period could also result in an economic slowdown. Economic contraction or further deceleration in the rate of growth in certain industries, sectors or geographies may contribute to poor financial results at our funds’ portfolio companies, which may result in lower investment returns for our funds. For example, periods of economic weakness have contributed and may in the future contribute to a decline in commodity prices and decreased consumer demand for certain goods and services (including energy), and/or volatility in the oil and natural gas markets, each of which would have an adverse effect on our energy and consumer investments. In addition, historically high rates of inflation, including in the U.S., have contributed to heightened costs of labor, energy and materials, which have put profit margin pressure on and negatively impacted the performance of certain of our funds’ portfolio companies. The performance of such companies would likely be further negatively impacted in a continuing inflationary environment, particularly against a backdrop of economic slowdown or contraction. For example, high rates of inflation and significant interest rate increases contributed to significant market volatility in 2022, which disproportionately negatively impacted the value of future cash flows of technology and growth companies. These companies may be subject to continued depressed, or even further declines in, values in a challenging market environment. To the extent the performance of our funds’ investments in such companies, as well as valuation multiples, do not ultimately improve, our funds may sell those assets at values that are less than we projected or even at a loss, thereby significantly affecting those investment funds’ performance. In addition, as the governing agreements of our funds contain only limited requirements regarding diversification of fund investments (by, for example, sector or geographic region), during periods of economic slowdown in certain sectors or regions, the impact on our funds may be exacerbated by concentration of investments in such sectors or regions. As a result, our ability to raise new funds, as well as our operating results and cash flows, could be adversely affected. 26 Table of Contents In addition, during periods of weakness, our funds’ portfolio companies may also have difficulty expanding their businesses and operations or meeting their debt service obligations or other expenses as they become due, including expenses payable to us. Furthermore, negative market conditions could potentially result in a portfolio company entering bankruptcy proceedings, thereby potentially resulting in a complete loss of the fund’s investment in such portfolio company and a significant negative impact to the fund’s performance and consequently to our operating results and cash flow, as well as to our reputation. In addition, negative market conditions would also increase the risk of default with respect to investments held by our funds that have significant debt investments, such as our credit-focused funds. High interest rates and challenging debt market conditions could negatively impact the values of certain assets or investments and the ability of our funds and their portfolio companies to access the capital markets on attractive terms, which could adversely affect investment and realization opportunities, lead to lower-yielding investments and potentially decrease our net income. In 2022, in light of increasing inflation, the U.S. Federal Reserve increased interest rates seven times. The U.S. Federal Reserve has also indicated that it expects continued increases in interest rates in 2023. Rising interest rates create downward pressure on the price of real estate and the value of fixed-rate debt investments made by our funds. Further, our funds have faced, and could continue to face, difficulty in realizing value from investments due to sustained declines in equity market values as a result of concerns regarding interest rates. An increase in interest rates has and could continue to increase the cost of debt financing for the transactions our funds pursue. Further, a significant contraction or weakening in the market for debt financing or other adverse change relating to the terms of debt financing (such as, for example, higher equity requirements and/or more restrictive covenants), particularly in the area of acquisition financings for private equity and real estate transactions, could have a material adverse impact on our business. For example, a portion of the indebtedness used to finance certain fund investments often includes high-yield debt securities issued in the capital markets. Availability of capital from the high-yield debt markets is subject to significant volatility, and there may be times when we might not be able to access those markets at attractive rates, or at all, when completing an investment. Further, the financing of acquisitions or the operations of our funds’ portfolio companies with debt may become less attractive due to limitations on the deductibility of corporate interest expense. See “— Changes in U.S. and foreign taxation of businesses and other tax laws, regulations or treaties or an adverse interpretation of these items by tax authorities could adversely affect us, including by adversely impacting our effective tax rate and tax liability.” If our funds are unable to obtain committed debt financing for potential acquisitions, can only obtain debt financing at an increased interest rate or on unfavorable terms or the ability to deduct corporate interest expense is substantially limited, our funds may face increased competition from strategic buyers of assets who may have an overall lower cost of capital or the ability to benefit from a higher amount of cost savings following an acquisition, or may have difficulty completing otherwise profitable acquisitions or may generate profits that are lower than would otherwise be the case, each of which could lead to a decrease in our funds’ performance and therefore our revenues. In addition, rising interest rates, coupled with periods of significant equity and credit market volatility may potentially make it more difficult for us to find attractive opportunities for our funds to exit and realize value from their existing investments. Our funds’ portfolio companies also regularly utilize the corporate debt markets to obtain financing for their operations. To the extent monetary policy, tax or other regulatory changes or difficult credit markets render such financing difficult to obtain, more expensive or otherwise less attractive, this may also negatively impact the financial results of those portfolio companies and, therefore, the investment returns on our funds. In addition, to 27 Table of Contentsthe extent that market conditions and/or tax or other regulatory changes make it difficult or impossible to refinance debt that is maturing in the near term, some of our funds’ portfolio companies may be unable to repay such debt at maturity and may be forced to sell assets, undergo a recapitalization or seek bankruptcy protection. Another pandemic or global health crisis like the COVID-19 pandemic may adversely impact our performance and results of operations. From 2020 to 2022, in response to the COVID-19 pandemic, many countries took measures to limit the spread of the virus, including instituting quarantines or lockdowns, imposing travel restrictions and vaccination mandates for certain workers or activities and limiting operations of certain non-essential businesses. Such restrictions caused labor shortages and disrupted global supply chains, which contributed to prolonged disruption of the global economy. A widespread reoccurrence of COVID-19, or the occurrence of another pandemic or global health crisis, could increase the possibility of periods of increased restrictions on business operations, which may adversely impact our business, financial condition, results of operations, liquidity and prospects materially and exacerbate many of the other risks discussed in this “Risk Factors” section. In the event of another pandemic or global health crisis like the COVID-19 pandemic, our funds’ portfolio companies may experience decreased revenues and earnings, which may adversely impact our ability to realize value from such investments and in turn reduce our performance revenues. Investments in certain sectors, including hospitality, location-based entertain, retail, travel, leisure and events, and in certain geographies, office and residential, could be particularly negatively impacted, as was the case during the COVID-19 pandemic. Our funds’ portfolio companies may also face increased credit and liquidity risk due to volatility in financial markets, reduced revenue streams and limited access or higher cost of financing, which may result in potential impairment of our or our funds’ investments. In addition, borrowers of loans, notes and other credit instruments in our credit funds’ portfolios may be unable to meet their principal or interest payment obligations or satisfy financial covenants, and tenants leasing real estate properties owned by our funds may not be able to pay rents in a timely manner or at all, resulting in a decrease in value of our funds’ credit and real estate investments. In the event of significant credit market contraction as a result of a pandemic or similar global health crisis, certain of our funds may be limited in their ability to sell assets at attractive prices or in a timely manner in order to avoid losses and margin calls from credit providers. In our liquid and semi-liquid vehicles, such a contraction could cause investors to seek liquidity in the form of redemptions from our funds, adversely impacting management fees. Our management fees may also be negatively impacted if we experience a decline in the pace of capital deployment or fundraising. In addition, a pandemic or global health crisis may pose enhanced operational risks. For example, our employees may become sick or otherwise unable to perform their duties for an extended period, and extended public health restrictions and remote working arrangements may impact employee morale, integration of new employees and preservation of our culture. Remote working environments may also be less secure and more susceptible to hacking attacks. Moreover, our third party service providers could be impacted by an inability to perform due to pandemic-related restrictions or by failures of, or attacks on, their technology platforms. A decline in the pace or size of investments made by our funds may adversely affect our revenues. The revenues that we earn are driven in part by the pace at which our funds make investments and the size of those investments, and a decline in the pace or the size of such investments may reduce our revenues. In particular, in recent years we have meaningfully increased the number of perpetual capital vehicles we offer and the assets under management in such vehicles, particularly in our Real Estate and Credit & Insurance segments. The fees we earn from our perpetual capital vehicles, including our Core+ real estate strategy, represent a significant and growing portion of our overall revenues. If our funds, including our perpetual capital vehicles, are unable to deploy capital at a sufficient pace, our revenues would be adversely impacted. Many factors could cause a decline in the pace of investment, including a market environment characterized by high prices, the inability of 28 Table of Contents our investment professionals to identify attractive investment opportunities, competition for such opportunities among other potential acquirers, decreased availability of financing on attractive terms or decreased availability of investor capital, including potentially as a result of a challenging fundraising environment or heightened investor requests for repurchases in certain perpetual capital vehicles. A number of our funds, including our real estate and private equity funds, have invested and intend to continue to invest in large transactions or transactions that otherwise have substantial business, regulatory or legal complexity and may be more difficult to execute successfully than smaller or less complex investments. In addition, realizing value from such investments may be more difficult as a result of, among other things, a limited universe of potential acquirers. We may also fail to consummate identified investment opportunities because of regulatory or legal complexities or uncertainty and adverse developments in the U.S. or global economy, financial markets or geopolitical conditions, and our ability to deploy capital in certain countries may be adversely impacted by U.S. and foreign government policy changes and regulations. For example, the ability to deploy capital in China has been adversely impacted by policies and regulations in China and the U.S. This may be exacerbated prospectively. For example, the U.S. House of Representatives passed a bill that, if enacted its current or a similar form, would subject certain outbound investments from the U.S. into China to heightened review by the U.S. government. As a related matter, certain senior administration officials have indicated that the current administration is formulating an approach to address outbound investments in sensitive technologies. There is public speculation that this formulation will involve an outbound investment screening mechanism, particularly relating to China and China-adjacent investments, which could further negatively impact our ability to deploy capital in such countries. See “— Laws and regulations on foreign direct investment applicable to us and our funds’ portfolio companies, both within and outside the U.S., may make it more difficult for us to deploy capital in certain jurisdictions or to sell assets to certain buyers.” Our revenue, earnings, net income and cash flow can all vary materially, which may make it difficult for us to achieve steady earnings growth on a quarterly basis and may cause the price of our common stock to decline. Our revenue, net income and cash flow can all vary materially due to our reliance on Performance Revenues. We may experience fluctuations in our results, including our revenue and net income, from quarter to quarter due to a number of other factors, including timing of realizations, changes in the valuations of our funds’ investments, changes in the amount of distributions, dividends or interest paid in respect of investments, changes in our operating expenses and the degree to which we encounter competition, each of which may be impacted by economic and market conditions. Achieving steady growth in net income and cash flow on a quarterly basis may be difficult, which could in turn lead to large adverse movements or general increased volatility in the price of our common stock. We do not provide guidance regarding our expected quarterly and annual operating results. The lack of guidance may affect the expectations of public market analysts and could cause increased volatility in our common stock price. Our cash flow may fluctuate significantly because we receive Performance Allocations from our carry funds only when investments are realized and achieve a certain preferred return. Performance Allocations in our carry funds depend on our carry funds’ performance and opportunities for realizing gains, which may be limited. It takes a substantial period of time to identify attractive investment opportunities, to raise all the funds needed to make an investment and then to realize the cash value (or other proceeds) of an investment through a sale, public offering, recapitalization or other exit. Even if an investment proves to be profitable, it may be a number of years before any profits can be realized in cash (or other proceeds). We cannot predict when, or if, any realization of investments will occur. The valuations of and realization opportunities for investments made by our funds could also be subject to high volatility as a result of uncertainty regarding governmental policy with respect to, among other things, tax, financial services regulation, international trade, immigration, healthcare, labor, infrastructure and energy. 29 Table of ContentsIn addition, upon the realization of a profitable investment by any of our carry funds and prior to our receiving any Performance Allocations in respect of that investment, 100% of the proceeds of that investment must generally be paid to the investors in that carry fund until they have recovered certain fees and expenses and achieved a certain return on all realized investments by that carry fund as well as a recovery of any unrealized losses. A particular realization event may have a significant impact on our results for that particular quarter that may not be replicated in subsequent quarters. We recognize revenue on investments in our investment funds based on our allocable share of realized and unrealized gains (or losses) reported by such investment funds, and a decline in realized or unrealized gains, or an increase in realized or unrealized losses, would adversely affect our revenue and possibly cash flow, which could further increase the volatility of our quarterly results. Because our carry funds have preferred return thresholds to investors that need to be met prior to our receiving any Performance Allocations, substantial declines in the carrying value of the investment portfolios of a carry fund can significantly delay or eliminate any Performance Allocations paid to us in respect of that fund since the value of the assets in the fund would need to recover to their aggregate cost basis plus the preferred return over time before we would be entitled to receive any Performance Allocations from that fund. The timing and receipt of Performance Allocations also varies with the life cycle of our carry funds. During periods in which a relatively large portion of our assets under management is attributable to carry funds and investments in their “harvesting” period, our carry funds would make larger distributions than in the fundraising or investment periods that precede harvesting. During periods in which a significant portion of our assets under management is attributable to carry funds that are not in their harvesting periods, we may receive substantially lower Performance Allocations. For certain of our vehicles, including our core+ real estate funds, infrastructure funds and other of our perpetual capital vehicles, which have in recent years become increasing large contributors to our earnings, our incentive income is paid between quarterly and every five years. The varying frequency of these payments will contribute to the volatility of our cash flow. Furthermore, we earn this incentive income only if the net asset value of a vehicle has increased or, in the case of certain vehicles, increased beyond a particular return threshold, or if the vehicle has earned a net profit. Certain of these vehicles also have “high water marks” whereby we do not earn incentive income during a particular period even though the vehicle had positive returns in such period as a result of losses in prior periods. If one of these vehicles experiences losses, we will not earn incentive income from it until it surpasses the previous high water mark. The incentive income we earn is therefore dependent on the net asset value or the net profit of the vehicle, which could lead to significant volatility in our results. Adverse economic and market conditions may adversely affect the amount of cash generated by our businesses, the value of our principal investments, and in turn, our ability to pay dividends to our stockholders. We primarily use cash to, without limitation (a) provide capital to facilitate the growth of our existing businesses, which principally includes funding our general partner and co-investment commitments to our funds, (b) provide capital for business expansion, (c) pay operating expenses, including cash compensation to our employees, and other obligations as they arise, including servicing our debt and (d) pay dividends to our stockholders, make distributions to the holders of Blackstone Holdings Partnership Units and make repurchases under our share repurchase program. Our principal sources of cash are: (a) cash we received in connection with our prior bond offerings, (b) management fees, (c) realized incentive fees and (d) realized performance allocations, which is the sum of Realized Principal Investment Income and Realized Performance Revenues less Realized Performance Compensation. We have also entered into a $4.135 billion revolving credit facility with a final maturity date of June 3, 2027. Our long-term debt totaled $11.0 billion in borrowings from our prior bond issuances. As of December 31, 2022, we had no borrowings outstanding under our revolving credit facility. As of December 31, 2022, we had $4.3 billion in Cash and Cash Equivalents, $1.1 billion invested in Corporate Treasury Investments and $3.5 billion in Other Investments. 30 Table of Contents If the global economy and conditions in the financing markets worsen, the investment performance of our funds could suffer, resulting in, for example, the payment of decreased or no Performance Allocations to us. This could materially and adversely affect the amount of cash we have on hand, which could in turn require us to rely on other sources of cash, such as the capital markets, which may not be available to us on acceptable terms for the above purposes. A decrease in the amount of cash we have on hand could also materially and adversely affect our ability to pay dividends to our stockholders and make repurchases under our share repurchase program. Furthermore, during adverse economic and market conditions, we might not be able to renew all or part of our existing revolving credit facility or find alternate financing on commercially reasonable terms. As a result, our uses of cash may exceed our sources of cash, thereby potentially affecting our liquidity position. In addition, we have made and expect to continue to make significant principal investments in our current and future investment funds. Contributing capital to these investment funds is risky, and we may lose some or the entire principal amount of our investments, including, without limitation, as a result of poor investment performance in a challenging economic and market environment. We depend on our founder and other key senior managing directors and the loss of their services would have a material adverse effect on our business, results and financial condition. We depend on the efforts, skill, reputations and business contacts of our founder, Stephen A. Schwarzman, our President, Jonathan D. Gray, and other key senior managing directors, the information and deal flow they generate during the normal course of their activities and the synergies among the diverse fields of expertise and knowledge held by our professionals. Accordingly, our success will depend on the continued service of these individuals, who are not obligated to remain employed with us. Several key senior managing directors have left the firm in the past and others may do so in the future, and we cannot predict the impact that the departure of any key senior managing director will have on our ability to achieve our investment objectives. For example, the governing agreements of many of our funds generally provide investors with the ability to terminate the investment period in the event that certain “key persons” in the fund do not meet the specified time commitment to the fund or our firm ceases to control the general partner. The loss of the services of any key senior managing directors could have a material adverse effect on our revenues, net income and cash flows and could harm our ability to maintain or grow assets under management in existing funds or raise additional funds in the future. We have historically relied in part on the interests of these professionals in the investment funds’ carried interest and incentive fees to discourage them from leaving the firm. However, to the extent our investment funds perform poorly, thereby reducing the potential for carried interest and incentive fees, their interests in carried interest and incentive fees become less valuable to them and become less effective as incentives for them to continue to be employed at Blackstone. Our senior managing directors and other key personnel possess substantial experience and expertise and have strong business relationships with investors in our funds, clients and other members of the business community. As a result, the loss of these personnel could jeopardize our relationships with investors in our funds, our clients and members of the business community and result in the reduction of assets under management or fewer investment opportunities. Our publicly traded structure and other factors may adversely affect our ability to recruit, retain and motivate our senior managing directors and other key personnel, which could adversely affect our business, results and financial condition. Our most important asset is our people, and our continued success is highly dependent upon the efforts of our senior managing directors and other professionals. Our future success and growth depend to a substantial degree on our ability to retain and motivate our senior managing directors and other key personnel and to strategically recruit, retain and motivate new talented personnel. The compensation of senior managing directors and other key personnel generally includes awards of Blackstone equity interests that entitle the holder to distributions or dividends. Such individuals, particularly our current senior managing directors, own a meaningful amount of such 31 Table of Contentsequity interests (including Blackstone Holdings Partnership Units). The value of such equity interests, however, and the distributions or dividends in respect thereof, may not be sufficient to retain and motivate such individuals, nor may they be sufficiently attractive to strategically recruit, retain and motivate new talented personnel. Additionally, the minimum retained ownership requirements and transfer restrictions to which these interests are subject in certain instances lapse over time, may not be enforceable in all cases and can be waived. There is no guarantee that the non-competition and non-solicitation agreements to which our senior managing directors and other key personnel are subject, together with our other arrangements with them, will prevent them from leaving, joining our competitors or otherwise competing with us. In addition, there is no assurance that such agreements will be enforceable in all cases. In addition, these non-competition and non-solicitation agreements expire after a certain period of time, at which point such senior managing directors and other personnel would be free to compete against us and solicit our clients and employees. We might not be able to provide future senior managing directors with interests in our business to the same extent or with the same tax consequences from which our existing senior managing directors previously benefited. For example, U.S. Federal income tax law currently imposes a three-year holding period requirement for carried interest to be treated as long-term capital gains. The holding period requirement may result in some of the carried interest received by such individuals being treated as ordinary income, which would materially increase the amount of taxes that our employees and other key personnel would be required to pay. Moreover, the tax treatment of carried interest continues to be an area of focus for policymakers and government officials, which could result in further regulatory action by federal or state governments. See “— Changes in U.S. and foreign taxation of businesses and other tax laws, regulations or treaties or an adverse interpretation of these items by tax authorities could adversely affect us, including by adversely impacting our effective tax rate and tax liability.” In addition, certain states have temporarily increased the income tax rate for the state’s highest earners, which could subject certain of our personnel to the highest combined state-and-local tax rate in the United States. Potential tax rate increases and changes to the tax treatment of carried interest and in applicable tax laws, along with changing opinions regarding living in some geographies where we have offices, may adversely affect our ability to recruit, retain and motivate our current and future professionals. Alternatively, the value of the equity awards we issue senior managing directors and other key personnel at any given time may subsequently fall (as reflected in the market price of common stock), which could counteract the incentives we are seeking to induce in them. To recruit and retain existing and future senior managing directors and other key personnel, we may need to increase the level of compensation that we pay to them, which would cause our total employee compensation and benefits expense as a percentage of our total revenue to increase and adversely affect our profitability. In addition, any future issuance of equity interests in our business to senior managing directors and other personnel would dilute public common stockholders. We strive to maintain a work environment that reinforces our culture of collaboration, motivation and alignment of interests with investors. If we do not continue to develop and implement the right processes and tools to maintain this culture, particularly in light of rapid and significant growth in our scale, global presence and employee population, our ability to compete successfully and achieve our business objectives could be impaired, which could negatively impact our business, financial condition and results of operations. The asset management business is intensely competitive. The asset management business is intensely competitive, with competition based on a variety of factors, including investment performance, the quality of service provided to clients, investor availability of capital and willingness to invest, fund terms (including fees and liquidity terms), brand recognition and business reputation. Our asset management business competes with a number of private funds, specialized investment funds, funds structured for individual investors, hedge funds, funds of hedge funds and other sponsors managing pools of capital, as well as corporate buyers, traditional asset managers, commercial banks, investment banks and other 32 Table of Contents financial institutions (including sovereign wealth funds), and we expect that competition will continue to increase. For example, certain traditional asset managers have developed their own private equity and retail platforms and are marketing other asset allocation strategies as alternatives to hedge fund investments. Additionally, developments in financial technology, or fintech, such as distributed ledger technology, or blockchain, have the potential to disrupt the financial industry and change the way financial institutions, as well as asset managers, do business. A number of factors serve to increase our competitive risks: • a number of our competitors in some of our businesses have greater financial, technical, research, marketing and other resources and more personnel than we do, • some of our funds may not perform as well as competitors’ funds or other available investment products, • several of our competitors have significant amounts of capital, and many of them have similar investment objectives to ours, which may create additional competition for investment opportunities and may reduce the size and duration of pricing inefficiencies that many alternative investment strategies seek to exploit, • some of our competitors, particularly strategic competitors, may have a lower cost of capital, which may be exacerbated limits on the deductibility of interest expense, • some of our competitors may have access to funding sources that are not available to us, which may create competitive disadvantages for us with respect to investment opportunities, • some of our competitors may be subject to less regulation and accordingly may have more flexibility to undertake and execute certain businesses or investments than we can and/or bear less compliance expense than we do, • some of our competitors may have more flexibility than us in raising certain types of investment funds under the investment management contracts they have negotiated with their investors, • some of our competitors may have higher risk tolerances, different risk assessments or lower return thresholds, which could allow them to consider a wider variety of investments and to bid more aggressively than us for investments that we want to make or to seek exit opportunities through different channels, such as special purpose acquisition vehicles, • some of our competitors may be more successful than us in the development of new products to address investor demand for new or different investment strategies and/or regulatory changes, including with respect to products with mandates that incorporate ESG considerations, or products that developed for individual investors or that target insurance capital, • there are relatively few barriers to entry impeding new alternative asset fund management firms, and the successful efforts of new entrants into our various businesses, including former “star” portfolio managers at large diversified financial institutions as well as such institutions themselves, is expected to continue to result in increased competition, • some of our competitors may have better expertise or be regarded by investors as having better expertise in a specific asset class or geographic region than we do, • some of our competitors may be more successful than us in the development and implementation of new technology to address investor demand for product and strategy innovation, particularly in the hedge fund industry, • our competitors that are corporate buyers may be able to achieve synergistic cost savings in respect of an investment, which may provide them with a competitive advantage in bidding for an investment, • some investors may prefer to invest with an investment manager that is not publicly traded or is smaller with only one or two investment products that it manages, and • other industry participants will from time to time seek to recruit our investment professionals and other employees away from us. 33 Table of ContentsWe may lose investment opportunities in the future if we do not match investment prices, structures and terms offered by competitors. Alternatively, we may experience decreased rates of return and increased risks of loss if we match investment prices, structures and terms offered by competitors. Moreover, if we are forced to compete with other alternative asset managers on the basis of price, we may not be able to maintain our current fund fee and carried interest terms. We have historically competed primarily on the performance of our funds, and not on the level of our fees or carried interest relative to those of our competitors. However, there is a risk that fees and carried interest in the alternative investment management industry will decline, without regard to the historical performance of a manager. Fee or carried interest income reductions on existing or future funds, without corresponding decreases in our cost structure, would adversely affect our revenues and profitability. In addition, the attractiveness of our investment funds relative to investments in other investment products could decrease depending on economic conditions. Furthermore, any new or incremental regulatory measures for the U.S. financial services industry may increase costs and create regulatory uncertainty and additional competition for many of our funds. See “— Financial regulatory changes in the United States could adversely affect our business.” This competitive pressure could adversely affect our ability to make successful investments and limit our ability to raise future investment funds, either of which would adversely impact our business, revenue, results of operations and cash flow. Our business depends in large part on our ability to raise capital from third party investors. A failure to raise capital from third party investors on attractive fee terms or at all, would impact our ability to collect management fees or deploy such capital into investments and potentially collect Performance Revenues, which would materially reduce our revenue and cash flow and adversely affect our financial condition. Our ability to raise capital from third party investors depends on a number of factors, including certain factors that are outside our control. Certain factors, such as economic and market conditions (including the performance of the stock market) and the asset allocation rules or investment policies to which such third party investors are subject, could inhibit or restrict the ability of third party investors to make investments in our investment funds or the asset classes in which our investment funds invest. For example, state politicians and lawmakers across a number of states, including Pennsylvania and Florida, have continued to put forth proposals or expressed intent to take steps to reduce or minimize the ability of their state pension funds to invest in alternative asset classes, including by proposing to increase the reporting or other obligations applicable to their state pension funds that invest in such asset classes. Such proposals or actions would potentially discourage investment by such state pension funds in alternative asset classes by imposing meaningful compliance burdens and costs on them, which could adversely affect our ability to raise capital from such state pension funds. Other states could potentially take similar actions, which may further impair our access to capital from an investor base that has historically represented a significant portion of our fundraising. In addition, volatility in the valuations of investments, has in the past and may in the future affect our ability to raise capital from third party investors. To the extent periods of volatility are coupled with a lack of realizations from investors’ existing portfolios, such investors may be left with disproportionately outsized remaining commitments to a number of investment funds, which significantly limits such investors’ ability to make new commitments to third party managed investment funds such as those managed by us. In addition, we have increasingly undertaken initiatives to increase the number and type of investment products we make available to individual investors, many of which contain terms that permit investors to request redemption or repurchase of their interests in such products on a periodic basis. Subject to certain limitations, these products include limits on the aggregate amount of such interests that may be redeemed in a given period. During periods of market volatility, investor subscriptions to such vehicles are likely to be reduced, and investor redemption or repurchase requests are likely to be elevated, which may negatively impact the fees we earn from such vehicles. To the extent redemptions or repurchases are prorated, this could further dampen subscriptions and may negatively impact such 34 Table of Contents fees. In addition, certain of our investment vehicles that are available to individual investors are subject to state registration requirements that impose limits on the proportion of such investors’ net worth that can be invested in our products. These restrictions may limit such investors’ ability or willingness to allocate capital to such products and adversely affect our fundraising in the retail channel. Our ability to raise new funds could similarly be hampered if the general appeal of real estate, private equity and other alternative investments were to decline. An investment in a limited partner interest in an alternative investment fund is generally more illiquid and the returns on such investment may be more volatile than an investment in securities for which there is a more active and transparent market. In periods of positive markets and low volatility, for example, investors may favor passive investment strategies such as index funds over our actively managed investment vehicles. Similarly, during periods of high interest rates, investors may favor investments that are generally viewed as producing a risk-free return, such as treasury bonds, over investments in our products, particularly if the spread between the products declines. Alternative investments could also fall into disfavor as a result of concerns about liquidity and short-term performance. Such concerns could be exhibited, in particular, by public pension funds, which have historically been among the largest investors in alternative assets. Many public pension funds are significantly underfunded and their funding problems have been, and may in the future be, exacerbated by economic downturn. Concerns with liquidity could cause such public pension funds to reevaluate the appropriateness of alternative investments. Although a number of investors, including certain public pension funds, have increased their allocations to alternative investments in recent years, there is no assurance that this will continue or that our ability to raise capital from investors will not be hampered. In addition, our ability to raise capital from third parties outside of the U.S. could be limited to the extent other countries, such as China, impose restrictions or limitations on outbound foreign investment. Moreover, certain institutional investors are demonstrating a preference to in-source their own investment professionals and to make direct investments in alternative assets without the assistance of alternative asset advisers like us. Such institutional investors may become our competitors and could cease to be our clients. As some existing investors cease or significantly curtail making commitments to alternative investment funds, we may need to identify and attract new investors in order to maintain or increase the size of our investment funds. There are no assurances that we can find or secure commitments from those new investors or that the fee terms of the commitments from such new investors will be consistent with the fees historically paid to us by our investors. If economic conditions were to deteriorate or if we are unable to find new investors, we might raise less than our desired amount for a given fund. Further, as we seek to expand into other asset classes, we may be unable to raise a sufficient amount of capital to adequately support such businesses. A failure to successfully raise capital could materially reduce our revenue and cash flow and adversely affect our financial condition. In connection with raising new funds or making further investments in existing funds, we negotiate terms for such funds and investments with existing and potential investors. The outcome of such negotiations could result in our agreement to terms that are materially less favorable to us than for prior funds we have managed or funds managed by our competitors, including with respect to management fees, incentive fees and/or carried interest, which could have an adverse impact on our revenues. Such terms could also restrict our ability to raise investment funds with investment objectives or strategies that compete with existing funds, add additional expenses and obligations for us in managing the fund or increase our potential liabilities, all of which could ultimately reduce our revenues. In addition, certain institutional investors, including sovereign wealth funds and public pension funds, have demonstrated an increased preference for alternatives to the traditional investment fund structure, such as managed accounts, smaller funds and co-investment vehicles. There can be no assurance that such alternatives will be as profitable for us as the traditional investment fund structure, or as to the impact such a trend could have on the cost of our operations or profitability if we were to implement these alternative investment structures. Although we have no obligation to modify any of our fees with respect to our existing funds, we may experience pressure to do so in our funds, including in response to regulatory focus by the SEC on the quantum and types of fees and expenses charged by private funds. We have confronted and expect to continue to confront requests from a variety of investors and groups representing investors to decrease fees, which could result in a reduction in the fees and Performance Revenues we earn. 35 Table of ContentsWe have increasingly undertaken business initiatives to increase the number and type of investment products we offer to individual investors, which could expose us to new and greater levels of risk. Although retail investors have been part of our historic distribution efforts, we have increasingly undertaken business initiatives to increase the number and type of investment products we offer to high net worth individuals, family offices and mass affluent investors in the U.S. and other jurisdictions around the world. In some cases, our funds are distributed to such investors indirectly through third party managed vehicles sponsored by brokerage firms, private banks or third-party feeder providers, and in other cases directly to the qualified clients of private banks, independent investment advisors and brokers. In other cases, we create investment products specifically designed for direct investment by individual investors in the U.S., some of whom are not accredited investors, or similar investors in non-U.S. jurisdictions, including in Europe. Such investment products are regulated by the SEC in the U.S. and by other similar regulatory bodies in other jurisdictions. Accessing individual investors and selling products directed at such investors exposes us to new and greater levels of risk, including heightened litigation and regulatory enforcement risks. To the extent distribution of such products is through new channels, including through an increasing number of distributors with whom we engage, we may not be able to effectively monitor or control the manner of their distribution, which could result in litigation or regulatory action against us, including with respect to, among other things, claims that products distributed through such channels are distributed to customers for whom they are unsuitable or that they are distributed in an otherwise inappropriate manner. Although we seek to ensure through due diligence and onboarding procedures that the third-party channels through which individual investors access our investment products conduct themselves responsibly, we are exposed to the risks of reputational damage and legal liability to the extent such third parties improperly sell our products to investors. This risk is heightened by the continuing increase in the number of third parties through whom we distribute our investment products around the world and who we do not control. For example, in certain cases, we may be viewed by a regulator as responsible for the content of materials prepared by third-party distributors. Similarly, there is a risk that Blackstone employees involved in the direct distribution of our products, or employees who oversee independent advisors, brokerage firms and other third parties around the world involved in distributing our products, do not follow our compliance and supervisory procedures. In addition, the distribution of retail products, including through new channels whether directly or through market intermediaries, could expose us to allegations of improper conduct and/or actions by state and federal regulators in the U.S. and regulators in jurisdictions outside of the U.S. with respect to, among other things, product suitability, investor classification, compliance with securities laws, conflicts of interest and the adequacy of disclosure to customers to whom our products are distributed through those channels. In addition, many of the investment products that we make available to individual investors contain terms that permit such investors to request redemption or repurchase of their interests on a periodic basis and, subject to certain limitations, include limits on the aggregate amount of such interests that may be redeemed or repurchased in a given period. Challenging market or economic conditions and liquidity needs could cause elevated share redemption or repurchase requests from investors in such products. Such redemption or repurchase requests may be elevated in certain regions, such as Asia, where such vehicles may have a significant number of investors. Recently, certain of such vehicles have limited, and may in the future limit, the amount of such redemption or repurchase request that are fulfilled. Such limitations are particularly possible in the event redemption or repurchase requests are elevated or investor subscriptions to such products are concurrently at reduced levels. Such limitations may subject us to reputational harm and may make such vehicles less attractive to individual investors, which could have a material adverse effect on the cash flows of such vehicles. This may in turn negatively impact the revenues we derive from such vehicles. 36 Table of Contents As we expand the distribution of products to individual investors outside of the U.S., we are increasingly exposed to risks in non-U.S. jurisdictions. While many of the risks we face in non-U.S. jurisdictions are similar to those that we face in the distribution of products to individual investors in the U.S., securities laws and other applicable regulatory regimes can be extensive, complex and vary by jurisdiction. In addition, the distribution of products to individual investors out of the U.S. may involve complex structures (such as distributor-sponsored feeder funds or nominee/omnibus investors) and market practices that vary by local jurisdiction. As a result, this expansion subjects us to additional complexity, litigation and regulatory risk. In addition, our initiatives to expand our individual investor base, including outside of the U.S., requires the investment of significant time, effort and resources, including the potential hiring of additional personnel, the implementation of new operational, compliance and other systems and processes and the development or implementation of new technology. There is no assurance that our efforts to grow the assets we manage on behalf of individual investors will be successful. Changes in U.S. and foreign taxation of businesses and other tax laws, regulations or treaties or an adverse interpretation of these items by tax authorities could adversely affect us, including by adversely impacting our effective tax rate and tax liability. Our effective tax rate and tax liability is based on the application of current income tax laws, regulations and treaties. These laws, regulations and treaties are complex, and the manner which they apply to us and our funds is sometimes open to interpretation. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. Although management believes its application of current laws, regulations and treaties to be correct and sustainable upon examination by the tax authorities, the tax authorities could challenge our interpretation resulting in additional tax liability or adjustment to our income tax provision that could increase our effective tax rate. In addition, recent and future changes to tax laws and regulations may have an adverse impact on us. For example, the recently enacted Inflation Reduction Act imposes, among other things, a minimum “book” tax on certain large corporations and creates a new excise tax on net stock repurchases made by certain publicly traded corporations after December 31, 2022. While the application of this new law is uncertain and we continue to evaluate its potential impact, these changes could materially change the amount and/or timing of tax we may be required to pay. In addition, the U.S. Congress, the Organization for Economic Co-operation and Development (“OECD”) and other government agencies in jurisdictions in which we and our affiliates invest or do business have maintained a focus on issues related to the taxation of multinational companies. The OECD, which represents a coalition of member countries, is contemplating changes to numerous long- standing tax principles through its base erosion and profit shifting (“BEPS”) project, which is focused on a number of issues, including the shifting of profits between affiliated entities in different tax jurisdictions, interest deductibility and eligibility for the benefits of double tax treaties. The OECD also recently finalized guidelines that recommend certain multinational enterprises be subject to a minimum 15% tax rate, effective from 2024. This minimum tax and several of the proposed measures are potentially relevant to some of our structures and could have an adverse tax impact on our funds, investors and/or our funds’ portfolio companies. Some member countries have been moving forward on the BEPS agenda but, because timing of implementation and the specific measures adopted will vary among participating states, significant uncertainty remains regarding the impact of BEPS proposals. If implemented, these proposals could result in a loss of tax treaty benefits and increased taxes on income from our investments. 37 Table of ContentsCybersecurity and data protection risks could result in the loss of data, interruptions in our business, and damage to our reputation, and subject us to regulatory actions, increased costs and financial losses, each of which could have a material adverse effect on our business and results of operations. Our operations are highly dependent on our technology platforms and we rely heavily on our analytical, financial, accounting, communications and other data processing systems. Our systems face ongoing cybersecurity threats and attacks, which could result in the failure of such systems. Attacks on our systems could involve, and in some instances have in the past involved, attempts intended to obtain unauthorized access to our proprietary information, destroy data or disable, degrade or sabotage our systems, or divert or otherwise steal funds, including through the introduction of computer viruses, “phishing” attempts and other forms of social engineering. Cyberattacks and other security threats could originate from a wide variety of external sources, including cyber criminals, nation state hackers, hacktivists and other outside parties. Cyberattacks and other security threats could also originate from the malicious or accidental acts of insiders, such as employees. There has been an increase in the frequency and sophistication of the cyber and security threats we face, with attacks ranging from those common to businesses generally to those that are more advanced and persistent, which may target us because, as an alternative asset management firm, we hold a significant amount of confidential and sensitive information about our investors, our funds’ portfolio companies and potential investments. As a result, we may face a heightened risk of a security breach or disruption with respect to this information. There can be no assurance that measures we take to ensure the integrity of our systems will provide protection, especially because cyberattack techniques used change frequently or are not recognized until successful. If our systems are compromised, do not operate properly or are disabled, or we fail to provide the appropriate regulatory or other notifications in a timely manner, we could suffer financial loss, a disruption of our businesses, liability to our investment funds and fund investors, regulatory intervention or reputational damage. The costs related to cyber or other security threats or disruptions may not be fully insured or indemnified by other means. In addition, we could also suffer losses in connection with updates to, or the failure to timely update, the technology platforms on which we rely. We are reliant on third party service providers for certain aspects of our business, including for the administration of certain funds, as well as for certain technology platforms, including cloud-based services. These third party service providers could also face ongoing cybersecurity threats and compromises of their systems and as a result, unauthorized individuals could gain, and in some past instances have gained, access to certain confidential data. Cybersecurity and data protection have become top priorities for regulators around the world. Many jurisdictions in which we operate have laws and regulations relating to privacy, data protection and cybersecurity, including, as examples the General Data Protection Regulation (“GDPR”) in the European Union and the California Privacy Rights Act (“CPRA”). In addition, in February 2022, the SEC proposed rules regarding registered investment advisers’ and funds’ cybersecurity risk management, which would require them to adopt and implement cybersecurity policies and procedures, enhance disclosures concerning cybersecurity incidents and risks in regulatory filings, and investment advisers to promptly report certain cybersecurity incidents to the SEC. If this proposal is adopted, it could increase our compliance costs and potential regulatory liability related to cybersecurity. See “— Rapidly developing and changing global privacy laws and regulations could increase compliance costs and subject us to enforcement risks and reputational damage.” Some jurisdictions have also enacted or proposed laws requiring companies to notify individuals and government agencies of data security breaches involving certain types of personal data. Breaches in our security or in the security of third party service providers, whether malicious in nature or through inadvertent transmittal or other loss of data, could potentially jeopardize our, our employees’ or our fund investors’ or counterparties’ confidential, proprietary and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in 38 Table of Contents our, our employees’, our fund investors’, our counterparties’ or third parties’ business and operations, which could result in significant financial losses, increased costs, liability to our fund investors and other counterparties, regulatory intervention and reputational damage. Furthermore, if we fail to comply with the relevant laws and regulations or fail to provide the appropriate regulatory or other notifications of breach in a timely matter, it could result in regulatory investigations and penalties, which could lead to negative publicity and reputational harm and may cause our fund investors and clients to lose confidence in the effectiveness of our security measures and Blackstone more generally. Our funds’ portfolio companies also rely on data processing systems and the secure processing, storage and transmission of information, including payment and health information. A disruption or compromise of these systems could have a material adverse effect on the value of these businesses. Our funds may invest in strategic assets having a national or regional profile or in infrastructure, the nature of which could expose them to a greater risk of being subject to a terrorist attack or security breach than other assets or businesses. Such an event may have material adverse consequences on our investment or assets of the same type or may require portfolio companies to increase preventative security measures or expand insurance coverage. Finally, our and our funds’ portfolio companies’ technology platforms, data and intellectual property are also subject to a heightened risk of theft or compromise to the extent we or our funds’ portfolio companies engage in operations outside the United States, in particular in those jurisdictions that do not have comparable levels of protection of proprietary information and assets such as intellectual property, trademarks, trade secrets, know-how and customer information and records. In addition, we and our funds’ portfolio companies may be required to compromise protections or forego rights to technology, data and intellectual property in order to operate in or access markets in a foreign jurisdiction. Any such direct or indirect compromise of these assets could have a material adverse impact on us and our funds’ portfolio companies. Rapidly developing and changing global privacy laws and regulations could increase compliance costs and subject us to enforcement risks and reputational damage. We and our funds’ portfolio companies are subject to various risks and costs associated with the collection, processing, storage and transmission of personally identifiable information (“PII”) and other sensitive and confidential information. This data is wide ranging and relates to our investors, employees, contractors and other counterparties and third parties. Our compliance obligations include those relating to U.S. laws and regulations, including, without limitation, the CPRA, which provides for enhanced consumer protections for California residents, a private right of action for data breaches and statutory fines and damages for data breaches or other CCPA violations, as well as a requirement of “reasonable” cybersecurity. Our compliance obligations also include those relating to foreign data collection and privacy laws, including, for example, the GDPR and U.K. Data Protection Act, as well as laws in many other jurisdictions globally, including Switzerland, Japan, Hong Kong, Singapore, China, Australia, Canada and Brazil. Global laws in this area are rapidly increasing in the scale and depth of their requirements, and are also often extra-territorial in nature. In addition, a wide range of regulators and private actors are seeking to enforce these laws across regions and borders. Furthermore, we frequently have privacy compliance requirements as a result of our contractual obligations with counterparties. These legal, regulatory and contractual obligations heighten our privacy obligations in the ordinary course of conducting our business in the U.S. and internationally. While we have taken various measures and made significant efforts and investment to ensure that our policies, processes and systems are both robust and compliant with these obligations, our potential liability remains, particularly given the continued and rapid development of privacy laws and regulations around the world, and increased criminal and civil enforcement actions and private litigation. Any inability, or perceived inability, by us or our funds’ portfolio companies to adequately address privacy concerns, or comply with applicable laws, regulations, policies, industry standards and guidance, contractual obligations, or other legal obligations, even if unfounded, could result in significant regulatory and third party liability, increased costs, disruption of our and our 39 Table of Contentsfunds’ portfolio companies’ business and operations, and a loss of client (including investor) confidence and other reputational damage. Furthermore, as new privacy- related laws and regulations are implemented, the time and resources needed for us and our funds’ portfolio companies to comply with such laws and regulations continues to increase and become a significant compliance workstream. Our operations are highly dependent on the technology platforms and corresponding infrastructure that supports our business. A disaster or a disruption in the infrastructure that supports our businesses, as a result of a cybersecurity incident or otherwise, including a disruption involving electronic communications or other services used by us or third parties with whom we conduct business, or directly affecting our cloud services providers, could have a material adverse impact on our ability to continue to operate our business without interruption. Our disaster recovery and business continuity programs may not be sufficient to mitigate the harm that may result from such a disaster or disruption. In addition, insurance and other safeguards might only partially reimburse us for our losses, if at all. We are reliant on third party service providers for certain aspects of our business, including the administration of certain funds. We are also reliant on third party service providers for certain technology platforms that facilitate the continued operation of our business, including cloud-based services. In addition to the fact that these third-party service providers could also face ongoing cyber security threats and compromises of their systems, we generally have less control over the delivery of such third party services, and as a result, we may face disruptions to our ability to operate a business as a result of interruptions of such services. A prolonged global failure of cloud services provided by a variety of cloud services providers that we engage could result in cascading systems failures for us. In addition, any interruption or deterioration in the performance of these third parties or failures or compromises of their information systems and technology could impair the operations of us and our funds and adversely affect our reputation and businesses. In addition, our operations are highly dependent on our technology platforms and we rely heavily on our analytical, financial, accounting, communications and other data processing systems, each of which may require updates and enhancements as we grow our business. Our information systems and technology may not continue to be able to accommodate our growth, and the cost of maintaining such systems may increase from its current level. Such a failure to adapt to or accommodate growth, or an increase in costs related to such information systems, could have a material adverse effect on us. See “— Cybersecurity and data protection risks could result in the loss of data, interruptions in our business, and damage to our reputation, and subject us to regulatory actions, increased costs and financial losses, each of which could have a material adverse effect on our business and results of operations” and “— Rapidly developing and changing global privacy laws and regulations could increase compliance costs and subject us to enforcement risks and reputational damage.” Extensive regulation of our businesses affects our activities and creates the potential for significant liabilities and penalties. The possibility of increased regulatory focus, particularly given the current administration, could result in additional burdens on our business. Our business is subject to extensive regulation, including periodic examinations, inquiries and investigations, by governmental agencies and self-regulatory organizations in the jurisdictions in which we operate around the world. These authorities have regulatory powers dealing with many aspects of financial services, including the authority to grant, and in specific circumstances to cancel, permissions to carry on particular activities. Many of these regulators, including U.S. and foreign government agencies and self-regulatory organizations, as well as state securities commissions in the United States, are also empowered to conduct examinations, inquiries, investigations and administrative proceedings that can result in fines, suspensions of personnel, changes in policies, procedures or disclosure or other sanctions, including censure, the issuance of cease-and-desist orders, the suspension or expulsion of a broker-dealer or investment adviser from registration or memberships or the commencement of a civil or criminal lawsuit against us or our personnel. 40 Table of Contents The financial services industry in recent years has been the subject of heightened scrutiny, which is expected to continue to increase, and the SEC has specifically focused on private equity and the private funds industry. In that connection, in recent years the SEC’s stated examination priorities and published observations from examinations have included, among other things, private equity firms’ collection of fees and allocation of expenses, their marketing and valuation practices, allocation of investment opportunities, terms agreed in side letters and similar arrangements with investors, consistency of firms’ practices with disclosures, handling of material non-public information and insider trading, disclosures of investment risk, purported waivers or limitations of fiduciary duties, conflicts around liquidity, risk management and the existence of, and adherence to, compliance policies and procedures with respect to conflicts of interest. Statements by SEC staff in 2022 reiterated a focus on certain of these topics and on bolstering transparency in the private funds industry, including with respect to fees earned and expenses charged by advisers. In 2022, the SEC proposed a number of new rules and amendments to existing rules that, if enacted, would have significant impact on our business and operations. In February 2022, the SEC proposed new rules and amendments to existing rules under the Advisers Act specifically related to registered advisers and their activities with respect to private funds. If enacted, the proposed rules and amendments could have a significant impact on advisers to private funds, including our advisers. In particular, the SEC has proposed to limit circumstances in which a fund manager can be indemnified by a private fund; increase reporting requirements by private funds to investors concerning performance, fees and expenses; require registered advisers to obtain an annual audit for private funds and also require such fund’s auditor to notify the SEC upon the occurrence of certain material events; enhance requirements, including the need to obtain a fairness opinion and make certain disclosures, in connection with adviser-led secondary transactions (also known as general partner-led secondaries); prohibit advisers from engaging in certain practices, such as, without limitation, charging accelerated fees for unperformed services or fees and expenses associated with an examination to private fund clients; and impose limitations and new disclosure requirements regarding preferential treatment of investors in private funds in side letters or other arrangements with an adviser. Amendments to the existing books and records and compliance rules under the Advisers Act would complement new proposals and also require that all registered advisers document their annual compliance review in writing. In addition, the SEC also proposed amendments to rules that would seek to categorize certain types of ESG strategies and require investment funds and advisors to provide disclosures based on ESG strategies they pursue. Further, the SEC proposed rules that, if enacted, would require certain climate-related disclosures by public companies, including disclosure of financed emissions, an extensive and complex category of emissions that is difficult to calculate accurately and for which there is currently no agreed measurement standard or methodology. Furthermore, in October 2022 the SEC proposed a new rule and related amendments that would impose substantial obligations on registered investment advisers to conduct initial due diligence and ongoing monitoring of a broad universe of service providers that we may use in our investment advisory business. If adopted, including with modifications, these new rules could significantly impact us (including certain of our advisers) and our operations, including by increasing compliance burdens and associated regulatory costs and complexity and reducing the ability to receive certain expense reimbursements or indemnification in certain circumstances. In addition, these potential rules enhance the risk of regulatory action, which could adversely impact our reputation and our fundraising efforts, including as a result of public regulatory sanctions. Moreover, in February 2023, the SEC proposed extensive amendments to the custody rule for SEC-registered investment advisers. If adopted, the amendments would require, among other things, the adviser to: obtain certain contractual terms from each advisory client’s qualified custodian; document that privately-offered securities cannot be maintained by a qualified custodian; and promptly obtain verification from an independent public accountant of any purchase, sale or transfer of privately-offered securities. The amendments also would apply to all assets of a client, including real estate and other assets that generally are not considered securities under the federal securities laws. If adopted, these amendments could expose our registered investment advisers to additional regulatory liability, increase compliance costs, and impose limitations on our investing activities. We regularly are subject to requests for information, inquiries and informal or formal investigations by the SEC and other regulatory authorities, with which we routinely cooperate, and which have included review of historical practices that were previously examined. Such investigations have previously and may in the future result in penalties and other sanctions. SEC actions and initiatives can have an adverse effect on our financial results, including as a result of the imposition of a sanction, a limitation on our or our personnel’s activities, or changing our historic practices. Even if an investigation or proceeding did not result in a sanction, or the sanction imposed against us or our personnel by a regulator were small in monetary amount, the adverse publicity relating to the investigation, proceeding or imposition of these sanctions could harm our reputation and cause us to lose existing clients or fail to gain new clients. 41 Table of ContentsIn addition, certain states and other regulatory authorities have required investment managers to register as lobbyists, and we have registered as such in a number of jurisdictions. Other states or municipalities may consider similar legislation or adopt regulations or procedures with similar effect. These registration requirements impose significant compliance obligations on registered lobbyists and their employers, which may include annual registration fees, periodic disclosure reports and internal recordkeeping. We are subject to increasing scrutiny from regulators, elected officials, stockholders, investors and other stakeholders with respect to environmental, social and governance matters, which may adversely impact our ability to raise capital from certain investors, constrain capital deployment opportunities for our funds and harm our brand and reputation. We, our funds and their portfolio companies are subject to increasing scrutiny from regulators, elected officials, stockholders, investors and other stakeholders with respect to environmental, social and governance matters. With respect to the alternative asset management industry, in recent years, certain investors, including public pension funds, have placed increasing importance on the impacts of investments made by the private funds to which they commit capital, including with respect to climate change, among other aspects of ESG. Conversely, certain investors have raised concerns as to whether the incorporation of ESG factors in the investment and portfolio management process may be inconsistent with the fiduciary duty to maximize return for investors. Certain investors have demonstrated increased concern with respect to asset managers taking certain actions that could adversely impact the value of, or, refraining from taking certain actions that could improve the value of, an existing or potential investment. At times, investors, including public pension funds, have limited participation in certain investment opportunities, such as hydrocarbons, and/or conditioned future capital commitments to certain funds on the basis of such factors. Other investors have voiced concern with respect to asset managers’ policies that may result in such managers subordinating the interests of investors based solely or in part on ESG considerations. We may be subject to competing demands from different investors and other stakeholder groups with divergent views on ESG matters, including the role of ESG in the investment process. Investors, including public pension funds, which represent a significant portion of our funds’ investor bases, may decide to withdraw previously committed capital (where such withdrawal is permitted) or not commit capital to future fundraises based on their assessment of how we approach and consider the ESG cost of investments and whether the return-driven objectives of our funds align with their ESG priorities. This divergence increases the risk that any action or lack thereof with respect to ESG matters will be perceived negatively by at least some stakeholders and adversely impact our reputation and business. If we do not successfully manage ESG-related expectations across the varied interests of our stakeholders, including existing or potential investors, our ability to access and deploy capital may be adversely impacted. In addition, a failure to successfully manage ESG-related expectations may negatively impact our reputation and erode stakeholder trust. As part of their increased focus on the allocation of their capital to environmentally sustainable economic activities, certain investors also have begun to request or require data from their asset managers and/or use third-party benchmarks and ESG ratings to allow them to monitor the ESG impact of their investments. In addition, regulatory initiatives to require investors to make disclosures to their stakeholders regarding ESG matters are becoming increasingly common, which may further increase the number and type of investors who place importance on these issues and who demand certain types of reporting from us. In addition, government authorities of certain U.S. states have requested information from and scrutinized certain asset managers with respect to whether such managers have adopted ESG policies that would restrict such asset managers from investing in certain industries or sectors, such as traditional energy. These authorities have indicated that such asset managers may lose opportunities to manage money belonging to these states and their pension funds to the extent the asset managers boycott or take similar actions with respect to certain industries. This may impair our ability to access capital from certain investors, and we may in turn not be able to maintain or increase the size of our funds or raise sufficient capital for new funds, which may adversely impact our revenues. 42 Table of Contents In addition, there has been increased regulatory focus on ESG-related practices by investment managers, particularly with respect to the accuracy of statements made regarding ESG practices, initiatives and investment strategies. The SEC has established an enforcement task force to examine ESG practices and disclosures by public companies and investment managers and identify inaccurate or misleading statements, often referred to as “greenwashing.” In 2022, the SEC commenced enforcement actions against at least two investment advisers relating to ESG disclosures and policies and procedures failures, and we expect that there will be a greater level of enforcement activity in this area in the future. The SEC has also proposed two ESG-related rules for investment advisors that address, among other things, enhanced ESG-related disclosure requirements. There is also generally a higher likelihood of regulatory focus on ESG matters under the current administration, including in the context of examinations by regulators and potential enforcement actions. This could increase the risk that we are perceived as, or accused of, greenwashing. Such perception or accusation could damage our reputation, result in litigation or regulatory actions, and adversely impact our ability to raise capital and attract new investors. Outside of the U.S., the European Commission adopted an action plan on financing sustainable growth, as well as initiatives at the EU level, such as the EU Sustainable Finance Disclosure Regulation (“SFDR). See “— Financial regulatory changes in the United States could adversely affect our business” and “— Complex regulatory regimes and potential regulatory changes in jurisdictions outside the United States could adversely affect our business.” Compliance with the SFDR and other ESG-related rules may subject us, our funds and our funds’ portfolio companies to increased restrictions, disclosure obligations and compliance and other associated costs, as well as potential reputational harm. In addition, under the requirements of SFDR and other ESG-related regulations to which we may become subject, we may be required to classify certain of our funds and their portfolio companies against certain criteria, some of which can be open to subjective interpretation. Our view on the appropriate classification may develop over time, including in response to statutory or regulatory guidance or changes in industry approach to classification. If regulators disagree with the procedures or standards we use, or new regulations or legislation require a methodology of measuring or disclosing ESG impact that is different from our current practice, it could have a material adverse effect on fundraising efforts and our reputation. The complexity and relative nascency of the global regulatory framework with respect to ESG matters increases the risk that any act or lack thereof with respect to ESG matters will be perceived negatively by a governmental authority or regulator. We may also communicate certain initiatives, commitments and goals regarding environmental, diversity, and other ESG-related matters in our SEC filings or in other disclosures by us or our funds. These initiatives, commitments and goals could be difficult and expensive to implement, the personnel, processes and technologies needed to implement them may not be cost effective and may not advance at a sufficient pace, and we may not be able to accomplish them within the timelines we announce or at all. We could, for example, determine that it is not feasible or practical to implement or complete certain of such initiatives, commitments or goals based on cost, timing or other consideration. In addition, we could be criticized for the accuracy, adequacy or completeness of the disclosure related to our or our funds’ ESG-related policies, practices, initiatives, commitments and goals, and progress against those goals, which disclosure may be based on frameworks and standards for measuring progress that are still developing, internal controls and processes that continue to evolve, and assumptions that are subject to change in the future. In addition, we could be criticized for the scope or nature of such initiatives or goals, or for any revisions to these goals. Further, as part of our ESG practices, we rely from time to time on third-party data, services and methodologies and such services, data and methodologies could prove to be incomplete or inaccurate. If our or such third parties’ ESG-related data, processes or reporting are incomplete or inaccurate, or if we fail to achieve progress with respect to our goals within the scope of ESG on a timely basis, or at all, we may be subject to enforcement action and our reputation could be adversely affected, particularly if in connection with such matters we were to be accused of “greenwashing”. 43 Table of ContentsFinancial regulatory changes in the United States could adversely affect our business. The financial services industry continues to be the subject of heightened regulatory scrutiny in the United States. There has been active debate over the appropriate extent of regulation and oversight of private investment funds and their managers. We may be adversely affected as a result of new or revised regulations imposed by the SEC or other U.S. governmental regulatory authorities or self- regulatory organizations that supervise the financial markets. We also may be adversely affected by changes in the interpretation or enforcement of existing laws and regulations by these governmental authorities and self-regulatory organizations. Further, new regulations or interpretations of existing laws may result in enhanced disclosure obligations, including with respect to climate change or ESG matters, which could negatively affect us, our funds or our funds’ portfolio companies and materially increase our regulatory burden. For example, in January and August 2022 the SEC proposed changes to Form PF, a confidential form relating to reporting by private funds and intended to be used by the Financial Stability Oversight Counsel (“FSOC”) for systemic risk oversight purposes. The proposal, which represents an expansion of existing reporting obligations, if adopted, would require private fund managers, including us, to report to the SEC within one business day the occurrence of certain fund-related and portfolio company events. Increased regulations and disclosure obligations generally increase our costs, and we could continue to experience higher costs if new laws or disclosure obligations require us to spend more time, hire additional personnel, or buy new technology to comply effectively. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted in July 2010, imposed significant changes on almost every aspect of the U.S. financial services industry, including aspects of our business, which include, without limitation, protection and compensation of whistleblowers, credit risk retention rules for certain sponsors of asset-backed securities, strengthening the oversight and supervision of the OTC derivatives and securities markets, as well as creating the FSOC, an interagency body charged with identifying and monitoring systemic risk to financial markets. Under the Dodd-Frank Act, the FSOC can designate certain financial companies as nonbank financial companies subject to supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). If we were to be designated as such by the FSOC, or if any of our business activities were to be identified by the FSOC as warranting enhanced regulation or supervision by certain regulators, we could be subject to materially greater regulatory burden, which could adversely impact our compliance and other costs, the implementation of certain of our investment strategies and our profitability. Under the Dodd-Frank Act, whistleblowers who voluntarily provide original information to the SEC can receive compensation and protection. The Dodd-Frank Act established a fund to be used to pay whistleblowers who will be entitled to receive a payment equal to between 10% and 30% of certain monetary sanctions imposed in a successful government action resulting from the information provided by the whistleblower. According to a recent annual report to the U.S. Congress on the Dodd-Frank Whistleblower Program, whistleblower claims have increased significantly since the enactment of these provisions and in the 2022 fiscal year the SEC awarded approximately $229 million to 103 individuals. Addressing such claims could generate significant expenses and take up significant management time for us and our funds’ portfolio companies, even if such claims are frivolous or without merit. The Dodd-Frank Act also authorized federal regulatory agencies to review and, in certain cases, prohibit compensation arrangements at financial institutions that give employees incentives to engage in conduct deemed to encourage inappropriate risk taking by covered financial institutions. In 2016, the SEC re-proposed a rule, as part of a joint rulemaking effort with U.S. federal banking regulators, that would apply to “covered financial institutions,” including registered investment advisers and broker-dealers that have total consolidated assets of at least $1 billion, and would impose substantive and procedural requirements on incentive-based compensation arrangements. While this proposed rule was never adopted, the current administration has included re-proposal of this rule on its regulatory agenda. The possibility that efforts are revived to finalize the rule under the current administration, could limit our ability to recruit and retain senior managing directors and investment professionals. 44 Table of Contents Rule 206(4)-5 under the Advisers Act prohibits investment advisers from providing advisory services for compensation to a government plan investor for two years, subject to limited exceptions, after the investment adviser, its senior executives or its personnel involved in soliciting investments from government entities make political contributions to certain candidates and officials in position to influence the hiring of an investment adviser by such government client. Advisers are required to implement compliance policies designed, among other matters, to comply with this rule. Any failure on our part to comply with the rule could expose us to significant penalties and reputational damage. In addition, there have been similar rules on a state level regarding “pay to play” practices by investment advisers. Additionally, the SEC’s amended rules for investment adviser marketing that went into effect in 2022 impose more prescriptive requirements and will impact the marketing of our funds, as well as placement agent arrangements globally. Compliance with the new rule may result in higher compliance and operational costs and less overall flexibility in our marketing. The SEC has adopted “Regulation Best Interest,” which imposes a “best interest” standard of care for broker-dealers when recommending certain securities transactions to a customer. Regulation Best Interest requires such broker-dealers to evaluate available alternatives, including those that may have lower expenses and/or lower investment risk than our investment funds. The continued regulatory focus on Regulation Best Interest may negatively impact whether certain broker-dealers and their associated persons are willing to recommend investment products, including certain of our funds, to retail customers, which may adversely impact our ability to distribute our products to certain investors. In addition, the U.S. Department of Labor as well as several states have proposed regulations or taken other actions pertaining to conduct standards for investment advisers and broker-dealers that may result in additional requirements related to our business. The potential for governmental policy and/or legislative changes and regulatory reform by the current administration may create regulatory uncertainty for our investment strategies, may make it more difficult to operate our business, and may adversely affect the profitability of our funds’ portfolio companies. Governmental policy and/or legislative changes and regulatory reform could make it more difficult for us to operate our business, including by impeding fundraising, making certain equity or credit investments or investment strategies unattractive or less profitable. In addition, our ability to identify business and other risks associated with new investments depends in part on our ability to anticipate and accurately assess regulatory, legislative and other changes that may have a material impact on the businesses in which we choose to invest. We may face particular difficulty anticipating policy changes and reforms during periods of heightened partisanship at the federal, state and local levels, including due to the divisiveness surrounding populist movements, political disputes and socioeconomic issues. The failure to accurately anticipate the possible outcome of such changes and/or reforms could have a material adverse effect on the returns generated from our funds’ investments and our revenues. In addition, in recent years there have been a number of leadership changes at a number of U.S. federal regulatory agencies with oversight over the industry, which has led to increased regulatory enforcement activity and rulemaking impacting the financial services industry. Given the breadth of initiatives by the current administration and at the SEC and certain other regulatory bodies, policy changes could impose additional costs on the companies in which we have invested or choose to invest in the future, require the attention of senior management or result in limitations on the manner in which the companies in which we have invested or choose to invest in the future conduct business. Such changes or reforms may include, without limitation: • There has been recurring consideration amongst regulators and intergovernmental institutions regarding the role of nonbank institutions in providing credit and, particularly, so-called “shadow banking,” a term generally taken to refer to financial intermediation involving entities and activities outside the regulated banking system. Federal regulatory bodies, such as the FSOC, and international organizations, such as the 45 Table of Contents Financial Stability Board, are assessing financial stability-related risks associated with, among other things, nonbank lending and certain types of open-end funds. At this time, it is unclear whether any rules or regulations related thereto will be proposed. If nonbank financial intermediation became subject to regulations or oversight standards similar to those applicable to traditional banks, certain of our business activities, including nonbank lending, would be adversely affected and the regulatory burden on us would materially increase, which could adversely impact the implementation of our investment strategy and our returns. • In the United States, the FSOC has the authority to designate nonbank financial companies as systemically important financial institutions (“SIFIs”). Currently, there are no nonbank financial companies with a nonbank SIFI designation. The FSOC has, however, designated certain nonbank financial companies as SIFIs in the past, and additional nonbank financial companies, which may include large asset management companies such as us, may be designated as SIFIs in the future. Under its most recent guidance regarding procedures for designating nonbank financial companies as SIFIs, the FSOC shifted from an “entity-based” approach to an “activities-based” approach whereby the FSOC will primarily focus on regulating activities that pose systemic risk to the financial stability of the United States, rather than designations of individual firms. Future reviews by the FSOC of nonbank financial companies for designation as SIFIs may focus on other types of products and activities, such as nonbank lending activities conducted by certain of our businesses. If any of our activities were identified by the FSOC as posing potential risks to U.S. financial stability, such activities could be subject to modified or enhanced regulation or supervision by U.S. regulators with jurisdiction over such activities, although no proposals have been made indicating how such measures would be applied to any such identified activities. • Under the FSOC’s most recent guidance, designation of an individual firm as a nonbank SIFI would only occur if, after engaging with the firm’s primary federal and state regulators, the FSOC determines that those regulators’ actions are inadequate to address the identified potential risk to U.S. financial stability. If we were designated as a nonbank SIFI, including as a result of our asset management or nonbank lending activities, we could become subject to direct supervision by the Federal Reserve Board, and could become subject to enhanced prudential, capital, supervisory and other requirements, such as risk-based capital requirements, leverage limits, liquidity requirements, resolution plan and credit exposure report requirements, concentration limits, a contingent capital requirement, enhanced public disclosures, short-term debt limits and overall risk management requirements. Requirements such as these, which were designed to regulate banking institutions, would likely need to be modified to be applicable to an asset manager, although no proposals have been made indicating how such measures would be adapted for asset managers. Trade negotiations and related government actions may create regulatory uncertainty for our funds’ portfolio companies and our investment strategies and adversely affect the profitability of our funds’ portfolio companies. In recent years, the U.S. government has indicated its intent to alter its approach to international trade policy and in some cases to renegotiate, or potentially terminate, certain existing bilateral or multi-lateral trade agreements and treaties with foreign countries, and has made proposals and taken actions related thereto. For example, the U.S. government has imposed tariffs on certain foreign goods, including from China, such as steel and aluminum. Some foreign governments, including China, have instituted retaliatory tariffs on certain U.S. goods. Furthermore, the U.S. has implemented a number of economic sanctions programs and export controls that specifically target Chinese entities and nationals on national security grounds, including, for example, with respect to China’s response to political demonstrations in Hong Kong and China’s conduct concerning the treatment of Uyghurs and other ethnic minorities in its Xinjiang province. Moreover, the U.S. has implemented additional sanctions against entities participating in China’s military industrial complex and providing support to the country’s military, intelligence, and surveillance apparatuses. These sanctions impose certain restrictions on U.S. persons and entities buying or selling publicly-traded securities of these designated entities. The U.S. has also imposed new 46 Table of Contents trade restrictions and license requirements on advanced computing semiconductor chips and additional restrictions on the exportation of semiconductor manufacturing items to China. These restrictions also add additional license requirements on items destined to certain semiconductor fabrication facilities in China. In return, China has imposed sanctions against certain U.S. nationals engaged in political activities relating to Hong Kong and has implemented countermeasures in response to sanctions imposed on Chinese individuals or entities by foreign governments, such that a company that complies with U.S. sanctions against a Chinese entity may then face penalties in China. Further escalation of the “trade war” between the U.S. and China, the countries’ inability to reach further trade agreements, or the continued use of reciprocal sanctions by each country, may negatively impact opportunities for investment as well as the rate of global growth, particularly in China, which has and continues to exhibit signs of slowing growth. Such slowing growth could adversely affect the revenues and profitability of our funds’ portfolio companies. There is uncertainty as to the actions that may be taken under the current administration with respect to U.S. trade policy, including with China. Further governmental actions related to the imposition of tariffs or other trade barriers or changes to international trade agreements or policies, could further increase costs, decrease margins, reduce the competitiveness of products and services offered by current and future portfolio companies and adversely affect the revenues and profitability of companies whose businesses rely on goods imported from outside of the U.S. Our provision of products and services to insurance companies, including through Blackstone Insurance Solutions, subjects us to a variety of risks and uncertainties. We have increasingly undertaken initiatives to deliver to insurance companies customizable and diversified portfolios of Blackstone products across asset classes, as well as the option for partial or full management of insurance companies’ general account assets. This strategy has in recent years contributed to meaningful growth in our Assets under Management, including in Perpetual Capital Assets Under Management. BIS currently manages assets for Corebridge Financial Inc., Everlake Life Insurance Company, Fidelity & Guaranty Life Insurance Company, Resolution Life Group and certain of their respective affiliates pursuant to several investment management agreements. In addition, in July 2016, Blackstone and AXIS Capital co-sponsored the establishment of Harrington Reinsurance, a Bermuda property and casualty reinsurance company, and BIS currently manages all general account assets of Harrington Reinsurance. BIS also manages or sub-manages assets for certain insurance-dedicated funds and special purpose vehicles, and has developed, and expects to continue to develop, other capital-efficient products for insurance companies. The continued success of BIS will depend in large part on further developing investment partnerships with insurance company clients and maintaining existing asset management arrangements, including those described above. If we fail to deliver high-quality, high- performing products that help our insurance company clients meet long-term policyholder obligations, BIS may not be successful in retaining existing investment partnerships, developing new investment partnerships or originating or selling capital-efficient assets or products and such failure may have a material adverse effect on BIS or on our business, results and financial condition. The U.S. and non-U.S. insurance industries are subject to significant regulatory oversight. Regulatory authorities in many relevant jurisdictions have broad regulatory (including through any regulatory support organization), administrative, and in some cases discretionary, authority with respect to insurance companies and/or their investment advisors, which may include, among other things, the investments insurance companies may acquire and hold, marketing practices, affiliate transactions, reserve requirements and capital adequacy. These requirements are primarily concerned with the protection of policyholders, and regulatory authorities often have wide discretion in applying the relevant restrictions and regulations to insurance companies, which may indirectly affect BIS and other Blackstone businesses that offer products or services to insurance companies. We may be the target or subject of, or may have indemnification obligations related to, litigation (including class action litigation by policyholders), enforcement investigations or regulatory scrutiny. Regulators and other authorities 47 Table of Contentsgenerally have the power to bring administrative or judicial proceedings against insurance companies, which could result in, among other things, suspension or revocation of licenses, cease-and-desist orders, fines, civil penalties, criminal penalties or other disciplinary action. To the extent BIS or another Blackstone business that offers products or services to insurance companies is directly or indirectly involved in such regulatory actions, our reputation could be harmed, we may become liable for indemnification obligations and we could potentially be subject to enforcement actions, fines and penalties. Recently, insurance regulatory authorities and regulatory support organizations have increased scrutiny of alternative asset managers’ involvement in the insurance industry, including with respect to the ownership by such managers or their affiliated funds of, and the management of assets on behalf of, insurance companies. For example, insurance regulators have increasingly focused on the terms and structure of investment management agreements, including whether they are at arms’ length, establish control of the insurance company, grant the asset manager excessive authority or oversight over the investment strategy of the insurance company or provide for management fees that are not fair and reasonable. Regulators have also increasingly focused on the risk profile of certain investments held by insurance companies (including, without limitation, collateralized loan obligations and other structured credit assets), appropriateness of investment ratings and potential conflicts of interest, including affiliated investments, and potential misalignment of incentives and any potential risks from these and other aspects of an insurance company’s relationship with alternative asset managers that may impact the insurance company’s risk profile. This enhanced scrutiny may increase the risk of regulatory actions against us and could result in new or amended regulations that limit our ability, or make it more burdensome or costly, to enter into new investment management agreements with insurance companies and thereby grow our insurance strategy. Some of the arrangements we have or will develop with insurance companies involve complex U.S. and non-U.S. tax structures for which no clear precedent or authority may be available. Such structures may be subject to potential regulatory, legislative, judicial or administrative change or scrutiny and differing interpretations and any adverse regulatory, legislative, judicial or administrative changes, scrutiny or interpretations may result in substantial costs to insurance companies or BIS. In some cases we may agree to indemnify insurance companies for their losses resulting from any such adverse changes or interpretations. Insurance company investment portfolios are often subject to internal and regulatory requirements governing the categories and ratings of investment products and assets they may acquire and hold. Many of the investment products we originate or develop for, or other assets or investments we include in, insurance company portfolios will be rated and a ratings downgrade or any other negative action by a rating agency with respect to such products, assets or investments could make them less attractive and limit our ability to offer such products to, or invest or deploy capital on behalf of, insurers. Furthermore, insurers are subject to a risk-based capital (“RBC”) requirement, which is a statutory minimum level of capital that an insurer must hold in proportion to its risk. Certain proposals or exposure drafts released by insurance regulatory authorities may result in changes to the RBC treatment and/or ratings process of certain assets or investments that are, or may be, held by our insurance company clients, which could potentially make such assets or investments less attractive to insurers and limit our ability to originate, or invest in, them on behalf insurers. Any failure to properly manage or address the foregoing risks may have a material adverse effect on BIS or on our business, results and financial condition. We rely on complex exemptions from statutes in conducting our asset management activities. We regularly rely on exemptions from various requirements of the U.S. Securities Act of 1933, as amended (the “Securities Act”), the Exchange Act, the 1940 Act, the Commodity Exchange Act and the U.S. Employee Retirement Income Security Act of 1974, as amended, in conducting our asset management activities. These exemptions are sometimes highly complex and may in certain circumstances depend on compliance by third parties whom we do not control. If for any reason these exemptions were to become unavailable to us, we could become subject to regulatory action or third-party claims and our business could be materially and adversely 48 Table of Contents affected. For example, the “bad actor” disqualification provisions of Rule 506 of Regulation D under the Securities Act ban an issuer from offering or selling securities pursuant to the safe harbor rule in Rule 506 if the issuer or any other “covered person” is the subject of a criminal, regulatory or court order or other “disqualifying event” under the rule which has not been waived. The definition of “covered person” includes an issuer’s directors, general partners, managing members and executive officers; affiliates who are also issuing securities in the offering; beneficial owners of 20% or more of the issuer’s outstanding equity securities; and promoters and persons compensated for soliciting investors in the offering. Accordingly, our ability to rely on Rule 506 to offer or sell securities would be impaired if we or any “covered person” is the subject of a disqualifying event under the rule and we are unable to obtain a waiver. These regulations often serve to limit our activities and impose burdensome compliance requirements. Complex regulatory regimes and potential regulatory changes in jurisdictions outside the United States could adversely affect our business. Similar to the United States, the jurisdictions outside the United States in which we operate, in particular Europe, have become subject to further regulation. Governmental regulators and other authorities in Europe have proposed or implemented a number of initiatives, rules and regulations that could adversely affect our business, including by imposing additional compliance and administrative burden and increasing the costs of doing business in such jurisdictions. Increasingly, the rules and regulations in the financial sector in Europe are becoming more prescriptive. Rules and regulations in other jurisdictions are often informed by key features of U.S. and European rules and regulations and, as a result, our businesses in all jurisdictions, including across Asia, may become subject to increased regulation in the future. In Europe, the EU Alternative Investment Fund Managers Directive (“AIFMD”) came into effect in 2014 and established a regulatory regime for alternative investment fund managers, including private equity and hedge fund managers. AIFMD is applicable to our AIFMs in Luxembourg and Ireland and in certain other respects to affiliated non-EEA AIFMs in other jurisdictions to the extent that they market interests in alternative investment funds to EEA investors. We have had to comply with these and other requirements of the AIFMD in order to market certain of our investment funds to professional investors in the EEA. The U.K. has “on-shored” AIFMD and therefore similar requirements continue to apply to funds marketed to U.K. investors notwithstanding Brexit. In November 2021, a legislative proposal (commonly referred to as “AIFMD II”) was made that may increase the cost and complexity of raising capital and restrict our ability to structure or market certain types of funds to EEA investors. Subject to the EU ordinary legislative process involving the European Parliament and European Council, the proposal is expected to result in amendments to the AIFMD, which is expected to have a two-year implementation period after the legislation comes into force, possibly in 2025. How the AIFMD II will affect us or our subsidiaries is unclear at this stage, but the regime may slow the pace of fundraising. In addition, on August 2, 2021, Directive (EU) 2019/1160 (the “CBDF Directive”) and Regulation (EU) 2019/1156 (the “CBDF Regulation”) came into effect, which in part amended AIFMD. The CBDF Regulation introduces new standardized requirements for cross-border fund distribution in the EU, including as related to transparency and principles for calculating supervisory fees, new procedures for the de-notification of marketing (including restrictions on pre-marking successor funds), new content requirements for marketing communications and additional regulations with respect to investors who approach our funds seeking to invest on their own initiative. As the CBDF Regulation is implemented across various EU jurisdictions, our ability to raise capital from EEA investors may become more complex and costly. The EU Securitization Regulation (the “Securitization Regulation”), which became effective on January 1, 2019, imposes due diligence and risk retention requirements on “institutional investors” (which includes managers of alternative investment funds assets) which must be satisfied prior to holding a securitization position. These requirements may apply to AIFs managed by not only EEA AIFMs but also non-EEA AIFMs where those AIFs have 49 Table of Contentsbeen registered for marketing in the EU under national private placement regimes. Similar requirements continue to apply in the U.K. notwithstanding Brexit. The Securitization Regulation may impact or limit our funds’ ability to make certain investments that constitute “securitizations” under the regulation. The Securitization Regulation may also constrain certain of our funds’ ability to invest in securitization positions that do not comply with, among other things, the risk retention requirements. Failure to comply with these requirements could result in various penalties. The EU regulation (“EMIR”) on over-the-counter (“OTC”) derivative transactions, central counterparties and trade repositories requires mandatory clearing of certain OTC derivatives through central counterparties, creates additional risk mitigation requirements and imposes reporting and recordkeeping requirements in respect of most derivative transactions. Similar rules apply in the U.K., and compliance with relevant EU and U.K. requirements imposes additional operational burden and cost on our engagement in such transactions. Additional regulation, commonly referred to as “MiFID II” requires us to comply with disclosure, transparency, reporting and record keeping obligations and enhanced obligations in relation to the receipt of investment research, best execution, product governance and marketing communications. Compliance with MiFID II has resulted in greater overall complexity, higher compliance and administration and operational costs and less overall flexibility for us. Certain aspects of MiFID II are subject to review and change in both the EU and the U.K. Associated changes to the prudential regulation of EEA and U.K. MiFID investment firms have increased the regulatory capital and liquidity adequacy requirements for certain of our entities licensed under MiFID. This makes it less capital efficient to run the relevant businesses. Those changes have also required us to make changes to the way in which we remunerate certain senior staff, which may make it harder for us to attract and retain talent, compared to competitors not subject to the same rules. Enhanced internal governance, disclosure and reporting requirements increase the costs of compliance. Certain regulatory requirements and proposals in the EU and U.K. intended to enhance protection for retail investors and impose additional obligations on the distribution of certain products to retail investors may impose additional costs on our operations and limit our ability to access capital from retail investors in such jurisdictions. These include EU and U.K. rules requiring that retail investors in packaged retail investment and insurance products receive key information documents, and U.K rules enhancing duties related to distribution of financial products to retail investors. As with any other organization that holds personal data of EU data subjects, we are required to comply with the GDPR because, among other things, we process European individuals’ personal data in the U.S. via our global technology systems. The U.K. has on-shored GDPR and similar requirements therefore continue to apply in the U.K. notwithstanding Brexit, although transfers of personal data between the EU and U.K. are subject to less safeguards then transfers to third countries. Financial regulators and data protection authorities have significantly increased audit and investigatory powers under GDPR to probe how personal data is being used and processed. Serious breaches of include antitrust-like fines on companies of up to the greater of €20 million / £17.5 million or 4% of global group turnover in the preceding year, regulatory action and reputational risk. See “— Rapidly developing and changing global privacy laws and regulations could increase compliance costs and subject us to enforcement risks and reputational damage.” European regulators are increasing their attention on “greenwashing” and rapidly developing and implementing regimes focused on ESG and sustainability within the financial services sector. In the EU, the key regimes include the EU Sustainable Finance Disclosure Regulation SFDR which currently imposes disclosure requirements on MiFID firms and AIFMs and will affect our EEA operations (including where non-EEA products are marketed to EEA investors). The EU regulation on the establishment of a framework to facilitate sustainable investment (“Taxonomy Regulation”) supplements SFDR’s disclosure requirements for certain entities and sets out a framework for classifying economic activities as “environmentally sustainable.” SFDR primarily impacts our 50 Table of Contents AIFMs by requiring certain disclosures in relation to sustainability risks and consideration of so-called "principal adverse impacts". The majority of the provisions of the SFDR have applied since March 10, 2021. In addition, beginning January 1, 2023, certain template pre-contractual and periodic disclosures must be provided in a uniform template. There is a risk of inadvertent classification of certain of our products, which could lead to claims by investors for mis-selling and/or regulatory enforcement action, which could result in fines or other regulatory sanctions and damage to our reputation. In addition, certain requirements (such as making public disclosures on our website concerning the ESG features of private funds) might conflict with certain of our other regulatory obligations, such as, for example, limitations on general solicitation applicable to many of our funds. As a consequence, we may be unable to, or make a reasoned decision not to, fully comply with some requirements of these new regimes. This too could lead to regulatory enforcement action with similar consequences. The U.K. is not implementing SFDR but has introduced mandatory disclosure requirements aligned with the Task Force on Climate-Related Finance Disclosures (“TCFD”). In addition, a second layer of U.K. regulation has been proposed that will implement additional disclosure requirements (known as “SDR”) and a new “U.K. Green Taxonomy,” which is conceptually similar to but distinct from SFDR and the Taxonomy Regulation, exacerbating the risks arising from mismatch between the EEA and U.K. initiatives. These regimes may impose substantial ESG data collection and disclosure obligations on us, which in turn may impose increased compliance burdens and costs for our funds' operations. It is not yet possible to fully assess how our business will be affected as much of the detail surrounding these initiatives is yet to be revealed. Laws and regulations on foreign direct investment applicable to us and our funds’ portfolio companies, both within and outside the U.S., may make it more difficult for us to deploy capital in certain jurisdictions or to sell assets to certain buyers. A number of jurisdictions, including the U.S., have restrictions on foreign direct investment pursuant to which their respective heads of state and/or regulatory bodies have the authority to block or impose conditions with respect to certain transactions, such as investments, acquisitions and divestitures, if such transaction threatens to impair national security. In addition, many jurisdictions restrict foreign investment in assets important to national security by taking steps including, but not limited to, placing limitations on foreign equity investment, implementing investment screening or approval mechanisms, and restricting the employment of foreigners as key personnel. These U.S. and foreign laws could limit our funds’ ability to invest in certain businesses or entities or impose burdensome notification requirements, operational restrictions or delays in pursuing and consummating transactions. For example, the Committee on Foreign Investment in the United States (“CFIUS”) has the authority to review transactions that could result in potential control of, or certain types of non-controlling investments in, a U.S. business or U.S. real estate by a foreign person. In recent years, legislation has expanded the scope of CFIUS’ jurisdiction to cover more types of transactions and empower CFIUS to scrutinize more closely investments in certain transactions. CFIUS may recommend that the President block, unwind or impose conditions or terms on such transactions, certain of which may adversely affect the ability of the fund to execute on its investment strategy with respect to such transaction as well as limit our flexibility in structuring or financing certain transactions. Additionally, CFIUS or any non-U.S. equivalents thereof may seek to impose limitations on one or more such investments that may prevent us from maintaining or pursuing investment opportunities that we otherwise would have maintained or pursued, which could make it more difficult for us to deploy capital in certain of our funds. In addition, certain senior administration officials have indicated that the current administration is formulating an approach to address outbound investments in sensitive technologies. There is public speculation that this formulation will involve an outbound investment screening mechanism, particularly relating to China and China-adjacent investments, which could further negatively impact our ability to deploy capital in such countries. Further, state regulatory agencies may impose restrictions on private funds’ investments in certain types of assets, which could affect our funds’ ability to find attractive and diversified investments and to complete such investments in a timely manner. For example, California adopted regulations that are scheduled to take effect in April 2024 and would subject certain potential investments in the healthcare sector that transfer a material amount of a healthcare portfolio company’s assets or governance to review by a state regulatory agency. 51 Table of ContentsOur investments outside of the United States may also face delays, limitations, or restrictions as a result of notifications made under and/or compliance with these legal regimes and rapidly-changing agency practices. Other countries continue to establish and/or strengthen their own national security investment clearance regimes, which could have a corresponding effect of limiting our ability to make investments in such countries. Heightened scrutiny of foreign direct investment worldwide may also make it more difficult for us to identify suitable buyers for investments upon exit and may constrain the universe of exit opportunities for an investment in a portfolio company. As a result of such regimes, we may incur significant delays and costs, be altogether prohibited from making a particular investment or impede or restrict syndication or sale of certain assets to certain buyers, all of which could adversely affect the performance of our funds and in turn, materially reduce our revenues and cash flow. Complying with these laws imposes potentially significant costs and complex additional burdens, and any failure by us or our funds’ portfolio companies to comply with them could expose us to significant penalties, sanctions, loss of future investment opportunities, additional regulatory scrutiny, and reputational harm. Climate change, climate change-related regulation and sustainability concerns could adversely affect our businesses and the operations of our funds’ portfolio companies, and any actions we take or fail to take in response to such matters could damage our reputation. We, our funds and our funds’ portfolio companies face risks associated with climate change including risks related to the impact of climate-and ESG-related legislation and regulation (both domestically and internationally), risks related to business trends related to climate change and technology (such as the process of transitioning to a lower-carbon economy), and risks stemming from the physical impacts of climate change. New climate change-related regulations or interpretations of existing laws may result in enhanced disclosure obligations, which could negatively affect us, our funds and our funds’ portfolio companies and materially increase the regulatory burden and cost of compliance. For example, developing and acting on initiatives within the scope of ESG, and collecting, measuring and reporting ESG-related information and metrics can be costly, difficult and time consuming and is subject to evolving reporting standards, including the SEC’s recently proposed climate-related reporting requirements, and similar proposals by other international regulatory bodies. We may also communicate certain climate-related initiatives, commitments and goals in our SEC filings or in other disclosures, which subjects us to additional risks, including the risk of being accused of “greenwashing.” Certain of our funds’ portfolio companies operate in sectors that could face transition risk if carbon-related regulations or taxes are implemented. For certain of our funds’ portfolio companies, business trends related to climate change may require capital expenditures, product or service redesigns, and changes to operations and supply chains to meet changing customer expectations. While this can create opportunities, not addressing these changed expectations could create business risks for portfolio companies, which could negatively impact the returns in our funds. Further, advances in climate science may change society’s understanding of sources and magnitudes of negative effects on climate, which could also negatively impact portfolio company financial performance. Further, significant chronic or acute physical effects of climate change including extreme weather events such as hurricanes or floods, can also have an adverse impact on certain of our funds’ portfolio companies and investments, especially our real asset investments and portfolio companies that rely on physical factories, plants or stores located in the affected areas, or that focus on tourism or recreational travel. As the effects of climate change increase, we expect the frequency and impact of weather and climate related events and conditions to increase as well. 52 Table of Contents In addition, our reputation may be harmed if certain stakeholders, such as our limited partners or stockholders, believe that we are not adequately or appropriately responding to climate change, including through the way in which we operate our business, the composition of our funds’ existing portfolios, the new investments made by our funds, or the decisions we make to continue to conduct or change our activities in response to climate change considerations. In addition, we face business trends related to climate change risks, such as, for example, the increased attention to ESG considerations by our fund investors, including in connection with their determination of whether to invest in our funds. See “— We are subject to increasing scrutiny from regulators, elected officials, stockholders, investors and other stakeholders with respect to environmental, social and governance matters, which may adversely impact our ability to raise capital from certain investors, constrain capital deployment opportunities for our funds and harm our brand and reputation.” We are subject to substantial risk of litigation and regulatory proceedings and may face significant liabilities and damage to our professional reputation as a result of litigation allegations and negative publicity. From time to time we, our funds and our funds’ portfolio companies have been and may be subject to litigation, including securities class action lawsuits by stockholders, as well as class action lawsuits that challenge our acquisition transactions and/or attempt to enjoin them. Please see “Item 3. Legal Proceedings” for a discussion of a certain proceeding to which we are currently a party. In recent years, the volume of claims and amount of damages claimed in litigation and regulatory proceedings against the financial services industry in general have been increasing. The investment decisions we make in our asset management business and the activities of our investment professionals (including in connection with portfolio companies and investment advisory activities) may subject us, our funds and our funds’ portfolio companies to the risk of third party litigation or regulatory proceedings arising from investor dissatisfaction with the performance of those investment funds, alleged conflicts of interest, the suitability or manner of distribution of our products, including to retail investors, the activities of our funds’ portfolio companies and a variety of other claims. In addition, to the extent investors in our investment funds suffer losses resulting from fraud, gross negligence, willful misconduct or other similar misconduct, investors may have remedies against us, our investment funds, our senior managing directors or our affiliates under the federal securities law and/or state law. While the general partners and investment advisers to our investment funds, including their directors, officers, other employees and affiliates, are generally indemnified to the fullest extent permitted by law with respect to their conduct in connection with the management of the business and affairs of our investment funds, such indemnity does not extend to actions determined to have involved fraud, gross negligence, willful misconduct or other similar misconduct. The activities of our capital markets services business may also subject us to the risk of liabilities to our clients and third parties, including our clients’ stockholders, under securities or other laws in connection with transactions in which we participate. Any private lawsuits or regulatory actions brought against us and resulting in a finding of substantial legal liability could materially adversely affect our business, financial condition or results of operations or cause significant reputational harm to us, which could seriously harm our business. We depend to a large extent on our business relationships and our reputation for integrity and high-caliber professional services to attract and retain investors and to pursue investment opportunities for our funds. As a result, allegations of improper conduct by private litigants, regulators, or employees, whether the ultimate outcome is favorable or unfavorable to us, as well as negative publicity and press speculation about us, our investment activities, our lines of business or distribution channels, our workplace environment, or the asset management industry in general, whether or not valid, may harm our reputation, which may be more damaging to our business than to other types of businesses. The pervasiveness of social media and the Internet, coupled with increased public focus on the externalities of business activities, could also lead to faster and wider dissemination of any adverse publicity or inaccurate information about us, making effective remediation more difficult and further magnifying the reputational risks associated with negative publicity. 53 Table of ContentsEmployee misconduct could harm us by impairing our ability to attract and retain clients and subjecting us to significant legal liability and reputational harm. Fraud, deceptive practices or other misconduct at portfolio companies or service providers could similarly subject us to liability and reputational damage and also harm performance. Our employees could engage in misconduct that adversely affects our business. We are subject to a number of obligations and standards arising from our asset management business and our authority over the assets managed by our asset management business. The violation of these obligations and standards by any of our employees would adversely affect our clients and us. Our business often requires that we deal with confidential matters of great significance to companies in which we may invest. If our employees were to improperly use or disclose confidential information, we could suffer serious harm to our reputation, financial position and current and future business relationships. Detecting or deterring employee misconduct is not always possible, and the extensive precautions we take to detect and prevent this activity may not be effective in all cases. In addition, a prolonged period of remote work, such as the one experienced during the COVID-19 pandemic, may require us to develop and implement additional precautions in order to detect and prevent employee misconduct. Such additional precautions, which may include the implementation of security and other restrictions, may make our systems more difficult and costly to operate and may not be effective in preventing employee misconduct in a remote work environment. If one of our employees were to engage in misconduct or were to be accused of such misconduct, our business and our reputation could be adversely affected. In recent years, the U.S. Department of Justice and the SEC have devoted greater resources to enforcement of the Foreign Corrupt Practices Act (“FCPA”). In addition, the U.K. has also significantly expanded the reach of its anti-bribery laws. Local jurisdictions, such as Brazil, have also brought a greater focus to anti-bribery laws. While we have policies and procedures designed to ensure strict compliance by us and our personnel with the FCPA, such policies and procedures may not be effective in all instances to prevent violations. Any determination that we have violated the FCPA, the U.K. anti-bribery laws or other applicable anti-corruption laws could subject us to, among other things, civil and criminal penalties or material fines, profit disgorgement, injunctions on future conduct, securities litigation and a general loss of investor confidence, any one of which could adversely affect our business prospects, financial position or the market value of our common stock. In addition, we may also be adversely affected if there is misconduct by personnel of our funds’ portfolio companies or by such companies’ service providers. For example, financial fraud or other deceptive practices at our funds’ portfolio companies, or failures by personnel at our funds’ portfolio companies to comply with anti-bribery, trade sanctions, anti-harassment, anti-discrimination or other legal and regulatory requirements, could subject us to, among other things, civil and criminal penalties or material fines, profit disgorgement, injunctions on future conduct and securities litigation, and could also cause significant reputational and business harm to us. Such misconduct may undermine our due diligence efforts with respect to such portfolio companies and could negatively affect the valuations of the investments by our funds in such portfolio companies. Losses to our funds and us could also result from misconduct or other actions by service providers, such as administrators, consultants or other advisors, if such service providers improperly use or disclose confidential information, misappropriate funds, or violate legal or regulatory obligations. In addition, we may face an increased risk of such misconduct to the extent our investment in non-U.S. markets, particularly emerging markets, increases. 54 Table of Contents Poor performance of our investment funds would cause a decline in our revenue, income and cash flow, may obligate us to repay Performance Allocations previously paid to us, and could adversely affect our ability to raise capital for future investment funds. In the event that any of our investment funds were to perform poorly, our revenue, income and cash flow would decline because the value of our assets under management would decrease, which would result in a reduction in management fees, and our investment returns would decrease, resulting in a reduction in the Performance Revenues we earn. Moreover, we could experience losses on our investments of our own principal as a result of poor investment performance by our investment funds. Furthermore, if, as a result of poor performance of later investments in a carry fund’s life, the fund does not achieve certain investment returns for the fund over its life, we will be obligated to repay the amount by which Performance Allocations that were previously distributed to us exceed the amount to which the relevant general partner is ultimately entitled. Similarly, certain of our vehicles’ terms require an offset of Performance Revenues related to past performance, often referred to as a “recoupment of loss carryforward”. If recoupment of loss carryforward is triggered, including as a result of a meaningful decline in the vehicles’ revenues following a period of strong performance, such offset would serve to reduce the amount of future Performance Revenues to which we would be entitled in such vehicle. In the event that the offset is insufficient for the vehicle to fully recoup such loss carryforward, we may be required to make a cash payment after a certain period. In addition, in most cases, the companies in which our investment funds invest will have indebtedness or equity securities, or may be permitted to incur indebtedness or to issue equity securities, that rank senior to our investment, which may limit the ability of our investment funds to influence a company’s affairs and to take actions to protect their investments during periods of financial distress or following an insolvency. Poor performance of our investment funds could make it more difficult for us to raise new capital. Investors in funds might decline to invest in future investment funds we raise and investors in hedge funds or other investment funds might withdraw their investments as a result of poor performance of the investment funds in which they are invested. Investors and potential investors in our funds continually assess our investment funds’ performance, and our ability to raise capital for existing and future investment funds and avoid excessive redemption levels will depend on our investment funds’ continued satisfactory performance. Accordingly, poor fund performance may deter future investment in our funds and thereby decrease the capital invested in our funds and ultimately, our management fee revenue. Alternatively, in the face of poor fund performance, investors could demand lower fees or fee concessions for existing or future funds which would likewise decrease our revenue. In addition, from time to time, we may pursue new or different investment strategies and expand into geographic markets and businesses that may not perform as expected and result in poor performance by us and our investment funds. In addition to the risk of poor performance, such activity may subject us to a number of risks and uncertainties, including risks associated with (a) the possibility that we have insufficient expertise to engage in such activities profitably or without incurring inappropriate amounts of risk, (b) the diversion of management’s attention from our core businesses, (c) known or unknown contingent liabilities, which could result in unforeseen losses for us and our funds, (d) the disruption of ongoing businesses and (e) compliance with additional regulatory requirements. Certain policies and procedures implemented to mitigate potential conflicts of interest and address certain regulatory requirements may reduce the synergies across our various businesses. Because of our various asset management businesses and our capital markets services business, we will be subject to a number of actual and potential conflicts of interest and subject to greater regulatory oversight and more legal and contractual restrictions than that to which we would otherwise be subject if we had just one line of business. To mitigate these conflicts and address regulatory, legal and contractual requirements across our various businesses, we have implemented certain policies and procedures (for example, information walls) that may 55 Table of Contentsreduce the positive synergies that we cultivate across these businesses for purposes of identifying and managing attractive investments. For example, certain regulatory requirements require us to restrict access by certain personnel in our funds to information about certain transactions or investments being considered or made by those funds. In addition, we may come into possession of confidential or material non-public information with respect to issuers in which we may be considering making an investment or issuers in which our affiliates may hold an interest. As a consequence of such policies and procedures, we may be precluded from providing such information or other ideas to our other businesses even where it might be of benefit to them. Our failure to deal appropriately with conflicts of interest in our investment business could damage our reputation and adversely affect our businesses. As we have expanded and as we continue to expand the number and scope of our businesses, we increasingly confront potential conflicts of interest relating to our funds’ investment activities. Investment manager conflicts of interest continue to be a significant area of focus for regulators and the media. Because of our size and the variety of businesses and investment strategies that we pursue, we may face a higher degree of scrutiny compared with investment managers that are smaller or focus on fewer asset classes. Certain of our funds may have overlapping investment objectives, including funds that have different fee structures and/or investment strategies that are more narrowly focused. Potential conflicts may arise with respect to allocation of investment opportunities among us, our funds and our affiliates, including to the extent that the fund documents do not mandate a specific investment allocation. For example, we may allocate an investment opportunity that is appropriate for two or more investment funds in a manner that excludes one or more funds or results in a disproportionate allocation based on factors or criteria that we determine, such as sourcing of the transaction, specific nature of the investment or size and type of the investment, among other factors. We may also decide to provide a co-investment opportunity to certain investors in lieu of allocating a piece of the investment to our funds. In addition, the challenge of allocating investment opportunities to certain funds may be exacerbated as we expand our business to include more lines of business, including more public vehicles. Allocating investment opportunities appropriately frequently involves significant and subjective judgments. The risk that fund investors or regulators could challenge allocation decisions as inconsistent with our obligations under applicable law, governing fund agreements or our own policies cannot be eliminated. In addition, the perception of non-compliance with such requirements or policies could harm our reputation with fund investors. We may also cause different funds to invest in a single portfolio company, for example where the fund that made an initial investment no longer has capital available to invest. We may also cause different funds that we manage to purchase different classes of securities in the same portfolio company. For example, one of our CLO funds could acquire a debt security issued by the same company in which one of our private equity funds owns common equity securities. A direct conflict of interest could arise between the debt holders and the equity holders if such a company were to develop insolvency concerns, and we would have to carefully manage that conflict. A decision to acquire material non-public information about a company while pursuing an investment opportunity for a particular fund gives rise to a potential conflict of interest when it results in our having to restrict the ability of other funds to take any action with respect to that company. Our affiliates or portfolio companies may be service providers or counterparties to our funds or portfolio companies and receive fees or other compensation for services that are not shared with our fund investors. In such instances, we may be incentivized to cause our funds or portfolio companies to purchase such services from our affiliates or portfolio companies rather than an unaffiliated service provider despite the fact that a third party service provider could potentially provide higher quality services or offer them at a lower cost. In addition, conflicts of interest may exist in the valuation of our investments, as well as the personal trading of employees and the allocation of fees and expenses among us, our funds and their portfolio companies, and our affiliates. Lastly, in certain, infrequent instances we may purchase an investment alongside one of our investment funds or sell an investment to one of our investment funds and conflicts may arise in respect of the allocation, pricing and timing of such investments and the ultimate disposition of such investments. A failure to appropriately deal with these, among other, conflicts, could negatively impact our 56 Table of Contents reputation and ability to raise additional funds or result in potential litigation or regulatory action against us. Further, any steps taken by the SEC to preclude or limit certain conflicts of interest may make it more difficult for our funds to pursue transactions that may otherwise be attractive to the fund and its investors, which may adversely impact fund performance. Conflicts of interest may arise in our allocation of co-investment opportunities. Potential conflicts will arise with respect to our decisions regarding how to allocate co-investment opportunities among investors and the terms of any such co-investments. As a general matter, our allocation of co-investment opportunities is within our discretion and there can be no assurance that co-investment opportunities of any particular type or amount will become available to any of our investors. We may take into account a variety of factors and considerations we deem relevant in allocating co-investment opportunities, including, without limitation, whether a potential co-investor has expressed an interest in evaluating co-investment opportunities, our assessment of a potential co-investor’s ability to invest an amount of capital that fits the needs of the investment and our assessment of a potential co-investor’s ability to commit to a co-investment opportunity within the required timeframe of the particular transaction. Our fund documents typically do not mandate specific allocations with respect to co-investments. The investment advisers of our funds may have an incentive to provide potential co-investment opportunities to certain investors in lieu of others and/or in lieu of an allocation to our funds, including, for example, as part of an investor’s overall strategic relationship with us, or if such allocations are expected to generate relatively greater fees or Performance Allocations to us than would arise if such co-investment opportunities were allocated otherwise. Co-investment arrangements may be structured through one or more of our investment vehicles, and in such circumstances co-investors will generally bear the costs and expenses thereof (which may lead to conflicts of interest regarding the allocation of costs and expenses between such co-investors and investors in our funds). The terms of any such existing and future co-investment vehicles may differ materially, and in some instances may be more favorable to us, than the terms of certain of our funds or prior co-investment vehicles, and such different terms may create an incentive for us to allocate a greater or lesser percentage of an investment opportunity to such co-investment vehicles. There can be no assurance that any conflicts of interest will be resolved in favor of any particular investment funds or investors (including any applicable co-investors). Valuation methodologies for certain assets in our funds can be subject to a significant degree of subjectivity and judgment, and the fair value of assets established pursuant to such methodologies may never be realized, which could result in significant losses for our funds and the reduction of Management Fees and/or Performance Revenues. Our investment funds make investments in illiquid investments or financial instruments for which there is little, if any, market activity. We determine the value of such investments and financial instruments on at least a quarterly basis based on the fair value of such investments as determined in accordance with GAAP. The fair value of such investments and financial instruments is generally determined using a primary methodology and corroborated by a secondary methodology. Methodologies are used on a consistent basis and described in Blackstone’s and the investment funds’ valuation policies. The determination of fair value using these methodologies takes into consideration a range of factors including, but not limited to, the price at which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for comparable securities, current and projected operating performance and financing transactions subsequent to the acquisition of the investment. These valuation methodologies involve a significant degree of management judgment. For example, as to investments that we share with another sponsor, we may apply a different valuation methodology or derive a different value than the other sponsor on the same investment. In addition, the valuations of our private investments may at times differ significantly from the valuations of publicly traded companies in similar sectors or with similar business models. 57 Table of ContentsFor example, valuations of our private investments do not have an observable market price and may take into account certain long-term financial projections, including those prepared by the management of a portfolio company or other investment. Such projections are based on significant judgments and assumptions at the time they are developed and may not be available to the public. Valuations of publicly traded companies, on the other hand, are based on the observable price in the reference market which are generally subject to a higher degree of market volatility. These differences might cause some investors and/or regulators to question our valuations. In addition, variation in the underlying assumptions, estimates, methodologies and/or judgments we use in the determination of the value of certain investments and financial instruments could potentially produce materially different results. See “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation — Critical Accounting Policies” for an overview of our fair value policy and the significant judgment required in the application thereof. Because there is significant uncertainty in the valuation of, or in the stability of the value of illiquid investments, the fair values of such investments as reflected in an investment fund’s net asset value do not necessarily reflect the prices that would actually be obtained by us on behalf of the investment fund when such investments are realized. Realizations at values lower than the values at which investments have been reflected in prior fund net asset values would result in reduced gains or losses for the applicable fund, a decline in certain asset management fees and the reduction in potential Performance Revenues. Changes in values of investments from quarter to quarter may result in volatility in our investment funds’ net asset value, our investment in, or fees from, those funds and the results of operations and cash flow that we report from period to period. Further, a situation where asset values turn out to be materially different than values reflected in prior fund net asset values could cause investors to lose confidence in us, which would in turn result in difficulty in raising additional funds or redemptions from funds where investors hold redemption rights. If we were unable to consummate or successfully integrate additional development opportunities, acquisitions or joint ventures, we may not be able to implement our growth strategy successfully. Our growth strategy is based, in part, on the selective development or acquisition of asset management businesses or other businesses complementary to our business where we think we can add substantial value or generate substantial returns. The success of this strategy will depend on, among other things: (a) the availability of suitable opportunities, (b) the level of competition from other companies that may have greater financial resources, (c) our ability to value potential development or acquisition opportunities accurately and negotiate acceptable terms for those opportunities, (d) our ability to obtain requisite approvals and licenses from the relevant governmental authorities and to comply with applicable laws and regulations without incurring undue costs and delays and (e) our ability to identify and enter into mutually beneficial relationships with venture partners. Moreover, even if we are able to identify and successfully complete an acquisition, we may encounter unexpected difficulties or incur unexpected costs associated with integrating and overseeing the operations of the new businesses. If we are not successful in implementing our growth strategy, our business, financial results and the market price for our common stock may be adversely affected. Our use of borrowings to finance our business exposes us to risks. We use borrowings to finance our business operations as a public company. We have numerous outstanding notes with various maturity dates as well as a revolving credit facility that matures on June 3, 2027. See “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Sources and Uses of Liquidity” for further information regarding our outstanding borrowings. As borrowings under the credit facility and our outstanding notes mature, we will be required to refinance or repay such borrowings. In order to do so, we may enter into a new facility or issue new notes, each of which could result in higher borrowing costs. We may also issue equity, which would dilute existing stockholders. Further, we may choose to repay such borrowings using cash on hand, cash provided by our continuing operations or cash from the sale of our assets, each of which could reduce the amount of cash available to facilitate the growth and expansion 58 Table of Contents of our businesses, make repurchase under our share repurchase program and pay dividends to our stockholders, operating expenses and other obligations as they arise. In order to obtain new borrowings, or to extend or refinance existing borrowings, we are dependent on the willingness and ability of financial institutions such as global banks to extend credit to us on favorable terms, and on our ability to access the debt and equity capital markets, which can be volatile. There is no guarantee that such financial institutions will continue to extend credit to us or that we will be able to access the capital markets to obtain new borrowings or refinance existing borrowings when they mature. In addition, the use of leverage to finance our business exposes us to the types of risk described in “— Dependence on significant leverage in investments by our funds could adversely affect our ability to achieve attractive rates of return on those investments.” Interest rates on our and our funds’ portfolio companies’ outstanding financial instruments might be subject to change based on regulatory developments, which could adversely affect our revenue, expenses and the value of those financial instruments. The London Interbank Offered Rate (“LIBOR”) and certain other floating rate benchmark indices, including, without limitation, the Euro Interbank Offered Rate, Tokyo Interbank Offered Rate, Hong Kong Interbank Offered Rate and Singapore Interbank Offered Rate (collectively, “IBORs”) have been the subject of national, international and regulatory guidance and proposals for reform. These reforms may cause such benchmarks to perform differently than in the past or have other consequences which cannot be predicted. The FCA, which regulates LIBOR, has ceased publication of the one-week and two-month U.S. dollar LIBOR and is expected to cease publication of the remaining tenors in 2023. The FCA has also proposed potentially continuing to require the publishing of one-, three- and six-month LIBOR on a synthetic basis through the end of September 2024. Additionally, the Federal Reserve Board has advised banks to stop entering into new U.S. dollar LIBOR based contracts. The Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, identified the Secured Overnight Financing Rate (“SOFR”), an index calculated by short-term repurchase agreements, backed by Treasury securities, as its preferred alternative rate for LIBOR. At this time, there remains uncertainty regarding how markets will respond to SOFR or other alternative reference rates as the transition away from the IBOR benchmarks progresses and there remains some uncertainty as to what methods of calculating a replacement benchmark will be established or adopted generally, or whether different industry bodies, such as the loan market and the derivatives market, will adopt the same methodologies. In addition, as part of the transition to a replacement benchmark, parties may seek to adjust the spreads relative to such benchmarks in underlying contractual arrangements. As a result, interest rates on our CLOs and other financial instruments tied to IBOR rates, including those where Blackstone or its funds are exposed as lender or borrower, as well as the revenue and expenses associated with those financial instruments, may be adversely affected. For example, if lenders demand increases to credit spreads in order to migrate to alternative rates due to structural differences in the reference rates, this could increase our, our funds’ portfolio companies’ and/or our funds’ interest expense and cost of capital. Further, any uncertainty regarding the continued use and reliability of any IBOR as a benchmark interest rate could adversely affect the value of our and our funds’ portfolio companies’ financial instruments tied to such rates. There is no guarantee that a transition from any IBOR to an alternative will not result in financial market disruptions or a significant increase in volatility in risk free benchmark rates or borrowing costs to borrowers. Although we have been proactively negotiating provisions in our funds’ portfolio companies’ and lending businesses’ recent debt agreements to provide additional flexibility to address the transition away from IBOR, there is no assurance that we will be able to adequately minimize the risk of disruption from the discontinuation of IBOR or other changes to benchmark indices. In addition, meaningful time and effort is required to transition to the use of new benchmark rates, including with respect to the negotiation and implementation of any necessary changes to existing contractual arrangements and the implementation of changes to our systems and processes. Negotiating and implementing necessary amendments to our existing contractual arrangements may be particularly costly and time-consuming. We are actively managing transition efforts accordingly. 59 Table of ContentsThe historical returns attributable to our funds should not be considered as indicative of the future results of our funds or of our future results or of any returns expected on an investment in common stock. The historical and potential future returns of the investment funds that we manage are not directly linked to returns on our common stock. Therefore, any continued positive performance of the investment funds that we manage will not necessarily result in positive returns on an investment in our common stock. However, poor performance of the investment funds that we manage would cause a decline in our revenue from such investment funds, and would therefore have a negative effect on our performance and in all likelihood the returns on an investment in our common stock. Moreover, with respect to the historical returns of our investment funds: • we may create new funds in the future that reflect a different asset mix and different investment strategies (including funds whose management fees represent a more significant proportion of the fees than has historically been the case), as well as a varied geographic and industry exposure as compared to our present funds, and any such new funds could have different returns from our existing or previous funds, • the rates of returns of our carry funds reflect unrealized gains as of the applicable measurement date that may never be realized, which may adversely affect the ultimate value realized from those funds’ investments, • competition for investment opportunities resulting from, among other things, the increased amount of capital invested in alternative investment funds continues to increase, • our investment funds’ returns in some years benefited from investment opportunities and general market conditions that may not repeat themselves, our current or future investment funds might not be able to avail themselves of comparable investment opportunities or market conditions, and the circumstances under which our current or future funds may make future investments may differ significantly from those conditions prevailing in the past, • newly established funds may generate lower returns during the period in which they initially deploy their capital, and • the rates of return reflect our historical cost structure, which may vary in the future due to various factors enumerated elsewhere in this report and other factors beyond our control, including changes in laws. The future internal rate of return for any current or future fund may vary considerably from the historical internal rate of return generated by any particular fund, or for our funds as a whole. In addition, future returns will be affected by the applicable risks described elsewhere in this Annual Report on Form 10-K, including risks of the industries and businesses in which a particular fund invests. Dependence on significant leverage in investments by our funds could adversely affect our ability to achieve attractive rates of return on those investments. Many of our funds’ investments rely heavily on the use of leverage, and our ability to achieve attractive rates of return on investments will depend on our ability to access sufficient sources of indebtedness at attractive rates. For example, in many private equity and real estate investments, indebtedness may constitute as much as 70% or more of a portfolio company’s or real estate asset’s total debt and equity capitalization, including debt that may be incurred in connection with the investment. The absence of available sources of sufficient senior debt financing for extended periods of time could therefore materially and adversely affect our private equity and real estate businesses. In addition, in March 2013, the Federal Reserve Board and other U.S. federal banking agencies issued updated leveraged lending guidance covering transactions characterized by a degree of financial leverage. Such guidance may limit the amount or cost of financing we are able to obtain for our transactions, and as a result, the 60 Table of Contents returns on our investments may suffer. However, the status of the 2013 leveraged lending guidance remains uncertain following a determination by the Government Accountability Office in October 2017 that resulted in such guidance being required to be submitted to U.S. Congress for review. The possibility exists that, under the current administration, the U.S. federal bank regulatory agencies could apply the leveraged lending guidance in its current form, or implement a revised or new rule that limits leveraged lending. Such regulatory action could limit the amount of funding and increase the cost of financing available for leveraged loan borrowers such as Blackstone Tactical Opportunities and our corporate private equity business overall. Furthermore, limits on the deductibility of corporate interest expense could make it more costly to use debt financing for our acquisitions or otherwise have an adverse impact on the cost structure of our transactions, and could therefore adversely affect the returns on our funds’ investments. See “— Changes in U.S. and foreign taxation of businesses and other tax laws, regulations or treaties or an adverse interpretation of these items by tax authorities could adversely affect us, including by adversely impacting our effective tax rate and tax liability.” In addition, an increase in either the general levels of interest rates or in the risk spread demanded by sources of indebtedness would make it more expensive to finance those businesses’ investments. See “— High interest rates and challenging debt market conditions could negatively impact the values of certain assets or investments and the ability of our funds and their portfolio companies to access the capital markets on attractive terms, which could adversely affect investment and realization opportunities, lead to lower-yielding investments and potentially decrease our net income.” Investments in highly leveraged entities are inherently more sensitive to declines in revenues, increases in expenses and interest rates and adverse economic, market and industry developments. The incurrence of a significant amount of indebtedness by an entity could, among other things: • give rise to an obligation to make mandatory pre-payments of debt using excess cash flow, which might limit the entity’s ability to respond to changing industry conditions to the extent additional cash is needed for the response, to make unplanned but necessary capital expenditures or to take advantage of growth opportunities, • limit the entity’s ability to adjust to changing market conditions, thereby placing it at a competitive disadvantage compared to its competitors who have relatively less debt, • allow even moderate reductions in operating cash flow to render it unable to service its indebtedness, leading to a bankruptcy or other reorganization of the entity and a loss of part or all of the equity investment in it, • limit the entity’s ability to engage in strategic acquisitions that might be necessary to generate attractive returns or further growth, and • limit the entity’s ability to obtain additional financing or increase the cost of obtaining such financing, including for capital expenditures, working capital or general corporate purposes. As a result, the risk of loss associated with a leveraged entity is generally greater than for companies with comparatively less debt. For example, many investments consummated by private equity sponsors during 2005, 2006 and 2007 that utilized significant amounts of leverage subsequently experienced severe economic stress and, in certain cases, defaulted on their debt obligations due to a decrease in revenues and cash flow precipitated by the subsequent economic downturn during 2008 and 2009. When our funds’ existing portfolio investments reach the point when debt incurred to finance those investments matures in significant amounts and must be either repaid or refinanced, those investments may materially suffer if they have generated insufficient cash flow to repay maturing debt and there is insufficient capacity and availability in the financing markets to permit them to refinance maturing debt on satisfactory terms, or at all. If a limited availability of financing for such purposes were to persist for an extended period of time, when 61 Table of Contentssignificant amounts of the debt incurred to finance our private equity and real estate funds’ existing portfolio investments came due, these funds could be materially and adversely affected. Many of the hedge funds in which our funds of hedge funds invest and our credit-focused funds, or CLOs, may choose to use leverage as part of their respective investment programs and regularly borrow a substantial amount of their capital. The use of leverage poses a significant degree of risk and enhances the possibility of a significant loss in the value of the investment portfolio. A fund may borrow money from time to time to purchase or carry securities or may enter into derivative transactions (such as total return swaps) with counterparties that have embedded leverage. The interest expense and other costs incurred in connection with such borrowing may not be recovered by appreciation in the securities purchased or carried and will be lost — and the timing and magnitude of such losses may be accelerated or exacerbated — in the event of a decline in the market value of such securities. Gains realized with borrowed funds may cause the fund’s net asset value to increase at a faster rate than would be the case without borrowings. However, if investment results fail to cover the cost of borrowings, the fund’s net asset value could also decrease faster than if there had been no borrowings. Any of the foregoing circumstances could have a material adverse effect on our financial condition, results of operations and cash flow. The due diligence process that we undertake in connection with investments by our investment funds may not reveal all facts and issues that may be relevant in connection with an investment. When evaluating a potential business or asset for investment, we conduct due diligence that we deem reasonable and appropriate based on the facts and circumstances applicable to such investment. When conducting due diligence, we may be required to evaluate important and complex issues, including but not limited to those related to business, financial, credit risk, tax, accounting, ESG, legal and regulatory and macroeconomic trends. With respect to ESG, the nature and scope of our diligence will vary based on the investment, but may include a review of, among other things: energy management, air and water pollution, land contamination, diversity, human rights, employee health and safety, accounting standards and bribery and corruption. Selecting and evaluating ESG factors is subjective by nature, and there is no guarantee that the criteria utilized or judgment exercised by Blackstone or a third-party ESG specialist (if any) will reflect the beliefs, values, internal policies or preferred practices of any particular investor or align with the beliefs, values or preferred practices of other asset managers or with market trends. The materiality of ESG risks and impacts on an individual potential investment or portfolio as a whole depend on many factors, including the relevant industry, country, asset class and investment style. Outside consultants, legal advisers, accountants and investment banks may be involved in the due diligence process in varying degrees depending on the type of investment. The due diligence investigation that we will carry out with respect to any investment opportunity may not reveal or highlight all relevant facts (including fraud) or risks that may be necessary or helpful in evaluating such investment opportunity and we may not identify or foresee future developments that could have a material adverse effect on an investment, including, for example, potential factors, such as technological disruption of a specific company or asset, or an entire industry. Further, some matters covered by our diligence, such as ESG, are continuously evolving and we may not accurately or fully anticipate such evolution. For instance, our ESG framework does not represent a universally recognized standard for assessing ESG considerations as there are different frameworks and methodologies being implemented by other asset managers, in addition to numerous international initiatives on the subject. For example, recent amendments under AIFMD require us to identify, measure, manage and monitor sustainability risks relevant to the funds managed by our EU AIFMs and take into account sustainability risks when performing investment due diligence. Such requirements may make our funds less attractive to investors, and any non-compliance with such requirements may subject us to regulatory action. In addition, when conducting due diligence on investments, including with respect to investments made by our funds of hedge funds in third party hedge funds, we rely on the resources available to us and information supplied by third parties, including information provided by the target of the investment (or, in the case of investments in a third party hedge fund, 62 Table of Contents information provided by such hedge fund or its service providers). The information we receive from third parties may not be accurate or complete and therefore we may not have all the relevant facts and information necessary to properly assess and monitor our funds’ investment. We and our affiliates from time to time are required to report specified dealings or transactions involving Iran or other sanctioned individuals or entities. The Iran Threat Reduction and Syria Human Rights Act of 2012 (“ITRA”) requires companies subject to SEC reporting obligations under Section 13 of the Exchange Act to disclose in their periodic reports specified dealings or transactions involving Iran or other individuals and entities targeted by certain OFAC sanctions, including, by way of example, the Russian Federal Security Service, engaged in by the reporting company or any of its affiliates during the period covered by the relevant periodic report. In some cases, ITRA requires companies to disclose these types of transactions even if they were permissible under U.S. law. Companies that currently may be or may have been at the time considered our affiliates have from time to time publicly filed and/or provided to us the disclosures reproduced on Exhibit 99.1 of our Quarterly Reports as well as Exhibit 99.1 of this report, which disclosure is hereby incorporated by reference herein. We do not independently verify or participate in the preparation of these disclosures. We are required to separately file with the SEC a notice when such activities have been disclosed in this report, and the SEC is required to post such notice of disclosure on its website and send the report to the President and certain U.S. Congressional committees. The President thereafter is required to initiate an investigation and, within 180 days of initiating such an investigation, determine whether sanctions should be imposed. Disclosure of such activity, even if such activity is not subject to sanctions under applicable law, and any sanctions actually imposed on us or our affiliates as a result of these activities, could harm our reputation and have a negative impact on our business, and any failure to disclose any such activities as required could additionally result in fines or penalties. Our asset management activities involve investments in relatively illiquid assets, and we may fail to realize any profits from these activities for a considerable period of time. Many of our investment funds invest in securities that are not publicly traded. In many cases, our investment funds may be prohibited by contract or by applicable securities laws from selling such securities for a period of time. Our investment funds will generally not be able to sell these securities publicly unless their sale is registered under applicable securities laws, or unless an exemption from such registration is available. The ability of many of our investment funds, particularly our private equity funds, to dispose of investments is heavily dependent on the public equity markets. For example, the ability to realize any value from an investment may depend upon the ability to complete an initial public offering of the portfolio company in which such investment is held. Even if the securities are publicly traded, large holdings of securities can often be disposed of only over a substantial length of time, exposing the investment returns to risks of downward movement in market prices during the intended disposition period. Moreover, because the investment strategy of many of our funds, particularly our private equity and real estate funds, often entails our having representation on our funds’ public portfolio company boards, our funds may be restricted in their ability to effect such sales during certain time periods. Accordingly, under certain conditions, our investment funds may be forced to either sell securities at lower prices than they had expected to realize or defer — potentially for a considerable period of time — sales that they had planned to make. We make investments in companies that are based outside of the United States, which may expose us to additional risks not typically associated with investing in companies that are based in the United States. Many of our investment funds generally invest a significant portion of their assets in the equity, debt, loans or other securities of issuers located outside the United States. International investments have increased and we expect will continue to increase as a proportion of certain of our funds’ portfolios in the future. Investments in non-U.S. securities involve certain factors not typically associated with investing in U.S. securities, including risks relating to: 63 Table of Contents • currency exchange matters, including fluctuations in currency exchange rates and costs associated with conversion of investment principal and income from one currency into another, • less developed or efficient financial markets than in the United States, which may lead to potential price volatility and relative illiquidity, • the absence of uniform accounting, auditing and financial reporting standards, practices and disclosure requirements and less government supervision and regulation, • changes in laws or clarifications to existing laws that could impact our tax treaty positions, which could adversely impact the returns on our investments, • a less developed legal or regulatory environment, differences in the legal and regulatory environment or enhanced legal and regulatory compliance, • heightened exposure to corruption risk in non-U.S. markets, • political hostility to investments by foreign or private equity investors, • reliance on a more limited number of commodity inputs, service providers and/or distribution mechanisms, • higher rates of inflation, • higher transaction costs, • difficulty in enforcing contractual obligations, • fewer investor protections and less publicly available information in respect of companies in non-U.S. markets, • certain economic and political risks, including potential exchange control regulations and restrictions on our non-U.S. investments and repatriation of profits on investments or of capital invested, the risks of war, political, economic or social instability, the possibility of expropriation or confiscatory taxation and adverse economic and political developments, and • the possible imposition of non-U.S. taxes or withholding on income and gains recognized with respect to such securities. In addition, investments in companies that are based outside of the United States may be negatively impacted by restrictions on international trade or the recent or potential further imposition of tariffs. See “— Trade negotiations and related government actions may create regulatory uncertainty for our funds’ portfolio companies and our investment strategies and adversely affect the profitability of our funds’ portfolio companies.” There can be no assurance that adverse developments with respect to such risks will not adversely affect our assets that are held in certain countries or the returns from these assets. We may not have sufficient cash to pay back “clawback” obligations if and when they are triggered under the governing agreements with our investors. In certain circumstances, at the end of the life of a carry fund (and earlier with respect to certain of our funds), we may be obligated to repay the amount by which Performance Allocations that were previously distributed to us exceed the amounts to which the relevant general partner is ultimately entitled on an after-tax basis. This includes situations in which the general partner receives in excess of the relevant Performance Allocations applicable to the fund as applied to the fund’s cumulative net profits over the life of the fund or, in some cases, the fund has not achieved investment returns that exceed the preferred return threshold. This obligation is known as a “clawback” obligation and is an obligation of any person who received such Performance Allocations, including us and other participants in our Performance Allocations plans. Although a portion of any dividends by us to our stockholders may include any Performance Allocations received by us, we do not intend to seek fulfillment of any clawback 64 Table of Contents obligation by seeking to have our stockholders return any portion of such dividends attributable to Performance Allocations associated with any clawback obligation. To the extent we are required to fulfill a clawback obligation, however, our board of directors may determine to decrease the amount of our dividends to our stockholders. The clawback obligation operates with respect to a given carry fund’s own net investment performance only and performance of other funds are not netted for determining this contingent obligation. Adverse economic conditions may increase the likelihood that one or more of our carry funds may be subject to clawback obligations. To the extent one or more clawback obligations were to occur for any one or more carry funds, we might not have available cash at the time such clawback obligation is triggered to repay the Performance Allocations and satisfy such obligation. If we were unable to repay such Performance Allocations, we would be in breach of the governing agreements with our investors and could be subject to liability. Moreover, although a clawback obligation is several, the governing agreements of most of our funds provide that to the extent another recipient of Performance Allocations (such as a current or former employee) does not fund his or her respective share, then we and our employees who participate in such Performance Allocations plans may have to fund additional amounts (generally an additional 50-70% beyond our pro-rata share of such obligations) beyond what we actually received in Performance Allocations, although we retain the right to pursue any remedies that we have under such governing agreements against those Performance Allocations recipients who fail to fund their obligations. Investors in a number of our vehicles, including our hedge funds and certain of our open-ended funds and perpetual capital vehicles, may withdraw their investments in these vehicles. In addition, the investment management agreements related to our separately managed accounts may permit the investor to withdraw capital or terminate our management of such account. Lastly, investors in certain of our other investment funds have the right to cause these investment funds to be dissolved. Any of these events would lead to a decrease in our revenues, which could be substantial. We have a number of vehicles that permit investors in such vehicles to withdraw their investments and/or terminate our management of such capital, as applicable and in certain cases, subject to certain limitations. Investors in our hedge funds may generally redeem their investments on a periodic basis following, in certain cases, the expiration of a specified period of time when capital may not be withdrawn, subject to the applicable fund’s specific redemption provisions. In addition, in certain other open-ended and/or perpetual capital vehicles, including core+ real estate, certain real estate debt funds, BREIT and BCRED, investors may request redemptions or repurchases of their interests on a periodic basis, subject to certain limitations. In a declining market, our liquid or semi-liquid vehicles have and may continue to experience declines in value, and the pace of redemptions and consequent reduction in our assets under management could accelerate. Such declines in value may be both provoked and exacerbated by margin calls and forced selling of assets. Additional factors that could result in investors leaving our funds include changes in interest rates that make other investments more attractive, changes in or rebalancing due to investors’ asset allocation policy, changes in investor perception regarding our focus or alignment of interest, unhappiness with a fund’s performance or investment strategy, changes in our reputation, departures or changes in responsibilities of key investment professionals, and performance and liquidity needs of fund investors. The decrease in revenues that would result from significant redemptions from our funds or other similar investment vehicles could have a material adverse effect on our business, revenues, net income and cash flows. To the extent appropriate and permissible under a vehicle’s constituent documents, we have previously and may in the future limit redemptions or repurchases in such vehicle for a period of time. This may subject us to reputational harm, make such vehicles less attractive to investors in the future and negatively impact future subscriptions to such vehicles. This could have a material adverse effect on the cash flows of such vehicles, which may in turn negatively impact the revenues we derive from such vehicles. The decrease in revenues that would result from significant redemptions in our hedge funds or other open-ended or perpetual capital vehicles could have a material adverse effect on our business, revenues, net income and cash flows. 65 Table of ContentsIn addition, we currently manage a significant portion of investor assets through separately managed accounts whereby we earn management and/or incentive fees, and we intend to continue to seek additional separately managed account mandates. The investment management agreements we enter into in connection with managing separately managed accounts on behalf of certain clients may be terminated by such clients on as little as 30 days’ prior written notice. In addition, the boards of directors of the investment management companies we manage could terminate our advisory engagement of those companies, on as little as 30 days’ prior written notice. In the case of any such terminations, the management and incentive fees we earn in connection with managing such account or company would immediately cease, which could result in a significant adverse impact on our revenues. The governing agreements of most of our investment funds (with the exception of certain of our funds of hedge funds, hedge funds, certain credit-focused and real estate debt funds, and other funds or separately managed accounts for the benefit of one or more specified investors) provide that, subject to certain conditions, third party investors in those funds have the right to remove the general partner of the fund or to accelerate the termination date of the investment fund without cause by a majority or supermajority vote, resulting in a reduction in management fees we would earn from such investment funds and a significant reduction in the amounts of Performance Revenues from those funds. Performance Revenues could be significantly reduced as a result of our inability to maximize the value of investments by an investment fund during the liquidation process or in the event of the triggering of a “clawback” obligation or a recoupment of loss carry forward amounts. In addition, the governing agreements of our investment funds provide that in the event certain “key persons” in our investment funds do not meet specified time commitments with regard to managing the fund, then investors in certain funds have the right to vote to terminate the investment period by a specified percentage (including, in certain cases, a simple majority) vote in accordance with specified procedures, accelerate the withdrawal of their capital on an investor-by-investor basis, or the fund’s investment period will automatically terminate and a specified percentage (including, in certain cases, a simple majority) vote of investors is required to restart it. In addition, the governing agreements of some of our investment funds provide that investors have the right to terminate, for any reason, the investment period by a vote of 75% of the investors in such fund. In addition to having a significant negative impact on our revenue, net income and cash flow, the occurrence of such an event with respect to any of our investment funds would likely result in significant reputational damage to us. In addition, because all of our investment funds have advisers that are registered under the Advisers Act, an “assignment” of the management agreements of all of our investment funds (which may be deemed to occur in the event these advisers were to experience a change of control) would generally be prohibited without investor consent. We cannot be certain that consents required for assignments of our investment management agreements will be obtained if a change of control occurs, which could result in the termination of such agreements. In addition, with respect to our 1940 Act registered funds, each investment fund’s investment management agreement must be approved annually by the independent members of such investment fund’s board of directors and, in certain cases, by its stockholders, as required by law. Termination of these agreements would cause us to lose the fees we earn from such investment funds. Third party investors in our investment funds with commitment-based structures may not satisfy their contractual obligation to fund capital calls when requested by us, which could adversely affect a fund’s operations and performance. Investors in all of our carry funds (and certain of our hedge funds) make capital commitments to those funds that we are entitled to call from those investors at any time during prescribed periods. We depend on investors fulfilling their commitments when we call capital from them in order for those funds to consummate investments and otherwise pay their obligations (for example, management fees) when due. A default by an investor may also limit a fund’s availability to incur borrowings and avail itself of what would otherwise have been available credit. We have not had investors fail to honor capital calls to any meaningful extent. Any investor that did not fund a capital call would generally be subject to several possible penalties, including having a significant amount of its existing investment forfeited in that fund. However, the impact of the forfeiture penalty is directly correlated to 66 Table of Contents the amount of capital previously invested by the investor in the fund and if an investor has invested little or no capital, for instance early in the life of the fund, then the forfeiture penalty may not be as meaningful. Third party investors in private equity, real estate and venture capital funds typically use distributions from prior investments to meet future capital calls. In cases where valuations of investors’ existing investments fall and the pace of distributions slows, investors may be unable to make new commitments to third party managed investment funds such as those advised by us. If investors were to fail to satisfy a significant amount of capital calls for any particular fund or funds, the operation and performance of those funds could be materially and adversely affected. Risk management activities may adversely affect the return on our funds’ investments. When managing our exposure to market risks, we may (on our own behalf or on behalf of our funds) from time to time use forward contracts, options, swaps, caps, collars and floors or pursue other strategies or use other forms of derivative instruments to limit our exposure to changes in the relative values of investments that may result from market developments, including changes in prevailing interest rates, currency exchange rates and commodity prices. The success of any hedging or other derivatives transactions generally will depend on our ability to correctly predict market changes, the degree of correlation between price movements of a derivative instrument, the position being hedged, the creditworthiness of the counterparty and other factors. As a result, while we may enter into a transaction in order to reduce our exposure to market risks, the transaction may result in poorer overall investment performance than if it had not been executed. Such transactions may also limit the opportunity for gain if the value of a hedged position increases. While such hedging arrangements may reduce certain risks, such arrangements themselves may entail certain other risks. These arrangements may require the posting of cash collateral at a time when a fund has insufficient cash or illiquid assets such that the posting of the cash is either impossible or requires the sale of assets at prices that do not reflect their underlying value. Moreover, these hedging arrangements may generate significant transaction costs, including potential tax costs, that reduce the returns generated by a fund. Finally, the CFTC may in the future require certain foreign exchange products to be subject to mandatory clearing, which could increase the cost of entering into currency hedges. Our real estate funds are subject to the risks inherent in the ownership and operation of real estate and the construction and development of real estate. Investments by our real estate funds will be subject to the risks inherent in the ownership and operation of real estate and real estate-related businesses and assets. Such investments are subject to the potential for deterioration of real estate fundamentals and the risk of adverse changes in local market and economic conditions, which may include changes in supply of and demand for competing properties in an area, changes in interest rates and related increases in borrowing costs, fluctuations in the average occupancy and room rates for hotel properties, changes in demand for commercial office properties (including as a result of an increased prevalence of remote work), changes in the financial resources of tenants, defaults by borrowers or tenants, depressed travel activity, and the lack of availability of mortgage funds, which may render the sale or refinancing of properties difficult or impracticable. In addition, investments in real estate and real estate-related businesses and assets may be subject to the risk of environmental liabilities, contingent liabilities upon disposition of assets, casualty or condemnations losses, energy and supply shortages, natural disasters, climate change related risks (including climate- related transition risks and acute and chronic physical risks), acts of god, terrorist attacks, war and other events that are beyond our control, and various uninsured or uninsurable risks. Further, investments in real estate and real estate-related businesses and assets are subject to changes in law and regulation, including in respect of building, environmental and zoning laws, rent control and other regulations impacting our residential real estate investments and changes to tax laws and regulations, including real property and income tax rates and the taxation of business entities and the deductibility of corporate interest expense. For example, we have seen an increasing focus toward rent regulation as a means to address residential affordability caused by undersupply of housing in 67 Table of Contentscertain markets in the U.S. and Europe, which may contribute to adverse operating performance in certain parts of our residential real estate portfolio, including by moderating rent growth in certain geographies and markets. In addition, if our real estate funds acquire direct or indirect interests in undeveloped land or underdeveloped real property, which may often be non-income producing, they will be subject to the risks normally associated with such assets and development activities, including risks relating to the availability and timely receipt of zoning and other regulatory or environmental approvals, the cost and timely completion of construction (including risks beyond the control of our fund, such as weather or labor conditions or material shortages) and the availability of both construction and permanent financing on favorable terms. Certain of our investment funds may invest in securities of companies that are experiencing significant financial or business difficulties, including companies involved in bankruptcy or other reorganization and liquidation proceedings. Such investments are subject to a greater risk of poor performance or loss. Certain of our investment funds, especially our credit-focused funds, may invest in business enterprises involved in work-outs, liquidations, spin-offs, reorganizations, bankruptcies and similar transactions and may purchase high-risk receivables. An investment in such business enterprises entails the risk that the transaction in which such business enterprise is involved either will be unsuccessful, will take considerable time or will result in a distribution of cash or a new security the value of which will be less than the purchase price to the fund of the security or other financial instrument in respect of which such distribution is received. In addition, if an anticipated transaction does not in fact occur, the fund may be required to sell its investment at a loss. Investments in troubled companies may also be adversely affected by U.S. federal and state laws relating to, among other things, fraudulent conveyances, voidable preferences, lender liability and a bankruptcy court’s discretionary power to disallow, subordinate or disenfranchise particular claims. Investments in securities and private claims of troubled companies made in connection with an attempt to influence a restructuring proposal or plan of reorganization in a bankruptcy case may also involve substantial litigation. Because there is substantial uncertainty concerning the outcome of transactions involving financially troubled companies, there is a potential risk of loss by a fund of its entire investment in such company. Moreover, a major economic recession could have a materially adverse impact on the value of such securities. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may also decrease the value and liquidity of securities rated below investment grade or otherwise adversely affect our reputation. In addition, at least one federal Circuit Court has determined that an investment fund could be liable for ERISA Title IV pension obligations (including withdrawal liability incurred with respect to union multiemployer plans) of its portfolio companies, if such fund is a “trade or business” and the fund’s ownership interest in the portfolio company is significant enough to bring the investment fund within the portfolio company’s “controlled group.” While a number of cases have held that managing investments is not a “trade or business” for tax purposes, the Circuit Court in this case concluded the investment fund could be a “trade or business” for ERISA purposes based on certain factors, including the fund’s level of involvement in the management of its portfolio companies and the nature of its management fee arrangements. Litigation related to the Circuit Court’s decision suggests that additional factors may be relevant for purposes of determining whether an investment fund could face “controlled group” liability under ERISA, including the structure of the investment and the nature of the fund’s relationship with other affiliated investors and co-investors in the portfolio company. Moreover, regardless of whether an investment fund is determined to be a “trade or business” for purposes of ERISA, a court might hold that one of the fund’s portfolio companies could become jointly and severally liable for another portfolio company’s unfunded pension liabilities pursuant to the ERISA “controlled group” rules, depending upon the relevant investment structures and ownership interests as noted above. 68 Table of Contents Investments in energy, manufacturing, infrastructure, real estate and certain other assets may expose us to increased environmental liabilities that are inherent in the ownership of real assets. Ownership of real assets in our funds or vehicles may increase our risk of direct and/or indirect liability under environmental laws that impose, regardless of fault, joint and several liability for the cost of remediating contamination and compensation for damages. In addition, changes in environmental laws or regulations (including climate change initiatives) or the environmental condition of an investment may create liabilities that did not exist at the time of acquisition. Even in cases where we are indemnified by a seller against liabilities arising out of violations of environmental laws and regulations, there can be no assurance as to the financial viability of the seller to satisfy such indemnities or our ability to achieve enforcement of such indemnities. See “— Climate change, climate change- related regulation and sustainability concerns could adversely affect our businesses and the operations of our funds’ portfolio companies, and any actions we take or fail to take in response to such matters could damage our reputation.” Investments by our funds in the power and energy industries involve various operational, construction, regulatory and market risks. The development, operation and maintenance of power and energy generation facilities involves many risks, including, as applicable, labor issues, start-up risks, breakdown or failure of facilities, lack of sufficient capital to maintain the facilities and the dependence on a specific fuel source. Power and energy generation facilities in which our funds invest are also subject to risks associated with volatility in the price of fuel sources and the impact of unusual or adverse weather conditions or other natural events, such as droughts, as well as the risk of performance below expected levels of output, efficiency or reliability. The occurrence of any such items could result in lost revenues and/or increased expenses. In turn, such developments could impair a portfolio company’s ability to repay its debt or conduct its operations. We may also choose or be required to decommission a power generation facility or other asset. The decommissioning process could be protracted and result in the incurrence of significant financial and/or regulatory obligations or other uncertainties. Our power and energy sector portfolio companies may also face construction risks typical for power generation and related infrastructure businesses. Such developments could result in substantial unanticipated delays or expenses and, under certain circumstances, could prevent completion of construction activities once undertaken. Delays in the completion of any power project may result in lost revenues or increased expenses, including higher operation and maintenance costs related to such portfolio company. The power and energy sectors are the subject of substantial and complex laws, rules and regulation by various federal and state regulatory agencies. Failure to comply with applicable laws, rules and regulations could result in the prevention of operation of certain facilities or the prevention of the sale of such a facility to a third party, as well as the loss of certain rate authority, refund liability, penalties and other remedies, all of which could result in additional costs to a portfolio company and adversely affect the investment results. In addition, the increased scrutiny placed by regulators, elected officials and certain investors with respect to the incorporation of ESG factors in the investment process and the impact of certain investments made by our energy funds has negatively impacted and is likely to continue to negatively impact our ability to exit certain of our traditional energy investments on favorable terms. The current administration has focused on climate change policies and has re-joined the Paris Agreement, which includes commitments from countries to reduce their greenhouse gas emissions, among other commitments. Executive orders signed by the President placed a temporary moratorium on new oil and gas leasing on public lands and offshore waters. Legislative efforts by the administration or the U.S. Congress to place additional limitations on coal and gas electric generation, mining and/or exploration could adversely affect our traditional energy investments. Conversely, certain investors have raised concerns as to whether the incorporation of ESG factors in the investment and portfolio management process may be inconsistent with the fiduciary duty to maximize returns for investors, which may result in such investors calling into question certain non-traditional energy investments made by our energy funds. 69 Table of ContentsIn addition, the performance of the investments made by our credit and equity funds in the energy and natural resources markets are also subject to a high degree of market risk, as such investments are likely to be directly or indirectly substantially dependent upon prevailing prices of oil, natural gas and other commodities. Oil and natural gas prices are subject to wide fluctuation in response to factors beyond the control of us or our funds’ portfolio companies, including relatively minor changes in the supply and demand for oil and natural gas, market uncertainty, the level of consumer product demand, weather conditions, climate change initiatives, governmental regulation (including with respect to trade and economic sanctions), the price and availability of alternative fuels, political and economic conditions in oil producing countries, foreign supply of such commodities and overall domestic and foreign economic conditions. These factors make it difficult to predict future commodity price movements with any certainty. Our investments in infrastructure assets may expose us to increased risks that are inherent in the ownership of real assets. Investments in infrastructure assets may expose us to increased risks that are inherent in the ownership of real assets. For example, • Ownership of infrastructure assets may present risk of liability for personal and property injury or impose significant operating challenges and costs with respect to, for example, compliance with zoning, environmental or other applicable laws. • Infrastructure asset investments may face construction risks including, without limitation: (a) labor disputes, shortages of material and skilled labor, or work stoppages, (b) slower than projected construction progress and the unavailability or late delivery of necessary equipment, (c) less than optimal coordination with public utilities in the relocation of their facilities, (d) adverse weather conditions and unexpected construction conditions, (e) accidents or the breakdown or failure of construction equipment or processes, and (f) catastrophic events such as explosions, fires, terrorist activities and other similar events. These risks could result in substantial unanticipated delays or expenses (which may exceed expected or forecasted budgets) and, under certain circumstances, could prevent completion of construction activities once undertaken. Certain infrastructure asset investments may remain in construction phases for a prolonged period and, accordingly, may not be cash generative for a prolonged period. Recourse against the contractor may be subject to liability caps or may be subject to default or insolvency on the part of the contractor. • The operation of infrastructure assets is exposed to potential unplanned interruptions caused by significant catastrophic or force majeure events. These risks could, among other effects, adversely impact the cash flows available from investments in infrastructure assets, cause personal injury or loss of life, damage property, or instigate disruptions of service. In addition, the cost of repairing or replacing damaged assets could be considerable. Repeated or prolonged service interruptions may result in permanent loss of customers, litigation, or penalties for regulatory or contractual non-compliance. Force majeure events that are incapable of, or too costly to, cure may also have a permanent adverse effect on an investment. • The management of the business or operations of an infrastructure asset may be contracted to a third party management company unaffiliated with us. Although it would be possible to replace any such operator, the failure of such an operator to adequately perform its duties or to act in ways that are in our best interest, or the breach by an operator of applicable agreements or laws, rules and regulations, could have an adverse effect on the investment’s financial condition or results of operations. Infrastructure investments may involve the subcontracting of design and construction activities in respect of projects, and as a result our investments are subject to the risks that contractual provisions passing liabilities to a subcontractor could be ineffective, the subcontractor fails to perform services which it has agreed to perform and the subcontractor becomes insolvent. 70 Table of Contents Infrastructure investments often involve an ongoing commitment to a municipal, state, federal or foreign government or regulatory agencies. The nature of these obligations exposes us to a higher level of regulatory control than typically imposed on other businesses and may require us to rely on complex government licenses, concessions, leases or contracts, which may be difficult to obtain or maintain. Infrastructure investments may require operators to manage such investments and such operators’ failure to comply with laws, including prohibitions against bribing of government officials, may adversely affect the value of such investments and cause us serious reputational and legal harm. Revenues for such investments may rely on contractual agreements for the provision of services with a limited number of counterparties, and are consequently subject to counterparty default risk. The operations and cash flow of infrastructure investments are also more sensitive to inflation and, in certain cases, commodity price risk. Furthermore, services provided by infrastructure investments may be subject to rate regulations by government entities that determine or limit prices that may be charged. Similarly, users of applicable services or government entities in response to such users may react negatively to any adjustments in rates and thus reduce the profitability of such infrastructure investments. Our investments in the life sciences industry may expose us to increased risks. Investments by BXLS may expose us to increased risks. For example, • BXLS’s strategies include, among others, investments that are referred to as “corporate partnership” transactions. Corporate partnership transactions are risk-sharing collaborations with biopharmaceutical and medical device partners on drug and medical device development programs and investments in royalty streams of pre-commercial biopharmaceutical products. BXLS’s ability to source corporate partnership transactions has been, and will continue to be, in part dependent on the ability of special purpose development companies to identify, diligence, negotiate and in many cases, take the lead in executing the agreed development plans with respect to, a corporate partnership transaction. Moreover, as such special purpose development companies are jointly owned by us or our affiliates and unaffiliated life sciences investors, we (and our funds) are not the sole beneficiaries of such sourcing strategies and capabilities of such special purpose development companies. In addition, payments to BXLS under such corporate partnerships (which can include future royalty or other milestone-based payments) are often contingent upon the achievement of certain milestones, including approvals of the applicable product candidate and/or product sales thresholds, over which BXLS may not have the ability to exercise meaningful control. • Life sciences and healthcare companies are subject to extensive regulation by the U.S. Food and Drug Administration, similar foreign regulatory authorities and, to a lesser extent, other federal and state agencies. These companies are subject to the expense, delay and uncertainty of the product approval process, and there can be no guarantee that a particular product candidate will obtain regulatory approval. In addition, the current regulatory framework may change or additional regulations may arise at any stage during the product development phase of an investment, which may delay or prevent regulatory approval or impact applicable exclusivity periods. If a company in which our funds are invested is unable to obtain regulatory approval for a product candidate, or a product candidate in which our funds are invested does not obtain regulatory approval, in a timely fashion or at all, the value of our investment would be adversely impacted. In addition, in connection with certain corporate partnership transactions, our special purpose development companies will be contractually obligated to run clinical trials. Further, a clinical trial (including enrollment therein) or regulatory approval process for pharmaceuticals has and may in the future be delayed, otherwise hindered or abandoned as a result of epidemics (including COVID-19), which could have a negative impact on the ability of the investment to engage in trials or receive approvals, and thereby could adversely affect the performance of the investment. In the event such clinical trials do not comply with the complicated regulatory requirements applicable thereto, such special purpose development companies may be subject to regulatory actions. 71 Table of Contents • Intellectual property often constitutes an important part of a life sciences company’s assets and competitive strengths, particularly for royalty monetization transactions. To the extent such companies’ intellectual property positions with respect to products in which BXLS invests, whether through a royalty monetization or otherwise, are challenged, invalidated or circumvented, the value of BXLS’s investment may be impaired. The success of a life sciences investment depends in part on the ability of the biopharmaceutical or medical device companies in whose products BXLS invests to obtain and defend patent rights and other intellectual property rights that are important to the commercialization of such products. The patent positions of such companies can be highly uncertain and often involve complex legal, scientific and factual questions. • The commercial success of products could be compromised if governmental or third party payers do not provide coverage and reimbursement, breach, rescind or modify their contracts or reimbursement policies or delay payments for such products. In both the U.S. and foreign markets, the successful sale of a life sciences company’s product depends on the ability to obtain and maintain adequate coverage and reimbursement from third party payers, including government healthcare programs and private insurance plans. Governments and third party payers continue to pursue aggressive initiatives to contain costs and manage drug utilization and are increasingly focused on the effectiveness, benefits and costs of similar treatments, which could result in lower reimbursement rates and narrower populations for whom the products in which BXLS invests will be reimbursed by payers. For example, in the U.S., Federal legislation has passed that modifies coverage, reimbursement and pricing policies for certain products. Although certain components of such legislation have yet to be implemented or defined by regulatory agencies, such legislation may result in the unavailability of adequate third party payer reimbursement to enable BXLS to realize an appropriate return on its investment. Our funds may be forced to dispose of investments at a disadvantageous time. Our funds may make investments of which they do not advantageously dispose of prior to the date the applicable fund is dissolved, either by expiration of such fund’s term or otherwise. Although we generally expect that our funds will dispose of investments prior to dissolution or that investments will be suitable for in-kind distribution at dissolution, we may not be able to do so. The general partners of our funds have only a limited ability to extend the term of the fund with the consent of fund investors or the advisory board of the fund, as applicable, and therefore, we may be required to sell, distribute or otherwise dispose of investments at a disadvantageous time prior to dissolution. This would result in a lower than expected return on the investments and, perhaps, on the fund itself. Hedge fund investments are subject to numerous additional risks. Investments by our funds of hedge funds in other hedge funds, as well as investments by our credit-focused, real estate debt and other hedge funds and similar products, are subject to numerous additional risks, including the following: • Certain of the funds in which we invest are newly established funds without any operating history or are managed by management companies or general partners who may not have as significant track records as a more established manager. • Generally, the execution of third-party hedge funds’ investment strategies is subject to the sole discretion of the management company or the general partner of such funds. As a result, we do not have the ability to control the investment activities of such funds, including with respect to the selection of investment opportunities, any deviation from stated or expected investment strategy, the liquidation of positions and the use of leverage to finance the purchase of investments, each of which may impact our ability to generate a successful return on our investment in such underlying fund. 72 Table of Contents • Hedge funds may engage in speculative trading strategies, including short selling, which is subject to the theoretically unlimited risk of loss because there is no limit on how much the price of a security may appreciate before the short position is closed out. A fund may be subject to losses if a security lender demands return of the lent securities and an alternative lending source cannot be found or if the fund is otherwise unable to borrow securities that are necessary to hedge or cover its positions. • Hedge funds are exposed to the risk that a counterparty will not settle a transaction in accordance with its terms and conditions because of a dispute over the terms of the contract (whether or not bona fide) or because of a credit or liquidity problem or otherwise, thus causing the fund to suffer a loss. Counterparty risk is accentuated for contracts with longer maturities where events may intervene to prevent settlement, or where the fund has concentrated its transactions with a single or small group of counterparties. Generally, hedge funds are not restricted from dealing with any particular counterparty or from concentrating any or all of their transactions with one counterparty. Moreover, the funds’ internal consideration of the creditworthiness of their counterparties may prove insufficient. The absence of a regulated market to facilitate settlement may increase the potential for losses. • Credit risk may arise through a default by one of several large institutions that are dependent on one another to meet their liquidity or operational needs, so that a default by one institution causes a series of defaults by the other institutions. This “systemic risk” may adversely affect the financial intermediaries (such as clearing agencies, clearing houses, banks, securities firms and exchanges) with which the hedge funds interact on a daily basis. • The efficacy of investment and trading strategies depends largely on the ability to establish and maintain an overall market position in a combination of financial instruments. A hedge fund’s trading orders may not be executed in a timely and efficient manner due to various circumstances, including systems failures or human error. In such event, the funds might only be able to acquire some but not all of the components of the position, or if the overall position were to need adjustment, the funds might not be able to make such adjustment. As a result, the funds would not be able to achieve the market position selected by the management company or general partner of such funds, and might incur a loss in liquidating their position. • Hedge funds are subject to risks due to potential illiquidity of assets. Hedge funds may make investments or hold trading positions in markets that are volatile and which may become illiquid. Timely divestiture or sale of trading positions can be impaired by decreased trading volume, increased price volatility, concentrated trading positions, limitations on the ability to transfer positions in highly specialized or structured transactions to which they may be a party, and changes in industry and government regulations. It may be impossible or costly for hedge funds to liquidate positions rapidly in order to meet margin calls, withdrawal requests or otherwise, particularly if there are other market participants seeking to dispose of similar assets at the same time or the relevant market is otherwise moving against a position or in the event of trading halts or daily price movement limits on the market or otherwise. Any “gate” or similar limitation on withdrawals with respect to hedge funds may not be effective in mitigating such risk. Moreover, these risks may be exacerbated for our funds of hedge funds. For example, if one of our funds of hedge funds were to invest a significant portion of its assets in two or more hedge funds that each had illiquid positions in the same issuer, the illiquidity risk for our funds of hedge funds would be compounded. For example, in 2008 many hedge funds, including some of our hedge funds, experienced significant declines in value. In many cases, these declines in value were both provoked and exacerbated by margin calls and forced selling of assets. Moreover, certain of our funds of hedge funds were invested in third party hedge funds that halted redemptions in the face of illiquidity and other issues, which precluded those funds of hedge funds from receiving their capital back on request. • Hedge fund investments are subject to risks relating to investments in commodities, futures, options and other derivatives, the prices of which are highly volatile and may be subject to the theoretically unlimited risk of loss in certain circumstances, including if the fund writes a call option. Price movements of 73 Table of Contents commodities, futures and options contracts and payments pursuant to swap agreements are influenced by, among other things, interest rates, changing supply and demand relationships, trade, fiscal, monetary and exchange control programs and policies of governments and national and international political and economic events and policies. The value of futures, options and swap agreements also depends upon the price of the commodities underlying them and prevailing exchange rates. In addition, hedge funds’ assets are subject to the risk of the failure of any of the exchanges on which their positions trade or of their clearinghouses or counterparties. Most U.S. commodities exchanges limit fluctuations in certain commodity interest prices during a single day by imposing “daily price fluctuation limits” or “daily limits,” the existence of which may reduce liquidity or effectively curtail trading in particular markets. As a result of their affiliation with us, our hedge funds may from time to time be restricted from trading in certain securities (e.g., publicly traded securities issued by our current or potential portfolio companies). This may limit their ability to acquire and/or subsequently dispose of investments in connection with transactions that would otherwise generally be permitted in the absence of such affiliation. We are subject to risks in using prime brokers, custodians, counterparties, administrators and other agents. Many of our funds depend on the services of prime brokers, custodians, counterparties, administrators and other agents to carry out certain securities and derivatives transactions. The terms of these contracts are often customized and complex, and many of these arrangements occur in markets or relate to products that are not subject to regulatory oversight, although the Dodd-Frank Act and the European Market Infrastructure Regulation provide for regulation of the derivatives market. In particular, some of our funds utilize prime brokerage arrangements with a relatively limited number of counterparties, which has the effect of concentrating the transaction volume (and related counterparty default risk) of these funds with these counterparties. Our funds are subject to the risk that the counterparty to one or more of these contracts defaults, either voluntarily or involuntarily, on its performance under the contract. Any such default may occur suddenly and without notice to us. Moreover, if a counterparty defaults, we may be unable to take action to cover our exposure, either because we lack contractual recourse or because market conditions make it difficult to take effective action. This inability could occur in times of market stress, which is when defaults are most likely to occur. In addition, our risk management process may not accurately anticipate the impact of market stress or counterparty financial condition, and as a result, we may not have taken sufficient action to reduce our risks effectively. Default risk may arise from events or circumstances that are difficult to detect, foresee or evaluate. In addition, concerns about, or a default by, one large participant could lead to significant liquidity problems for other participants, which may in turn expose us to significant losses. Although we have risk management processes to ensure that we are not exposed to a single counterparty for significant periods of time, given the large number and size of our funds, we often have large positions with a single counterparty. For example, most of our funds have credit lines. If the lender under one or more of those credit lines were to become insolvent, we may have difficulty replacing the credit line and one or more of our funds may face liquidity problems. In the event of a counterparty default, particularly a default by a major investment bank or a default by a counterparty to a significant number of our contracts, one or more of our funds may have outstanding trades that they cannot settle or are delayed in settling. As a result, these funds could incur material losses and the resulting market impact of a major counterparty default could harm our businesses, results of operation and financial condition. In addition, under certain local clearing and settlement regimes in Europe, we or our funds could be subject to settlement discipline fines. See “— Complex regulatory regimes and potential regulatory changes in jurisdictions outside the United States could adversely affect our business.” 74 Table of Contents In the event of the insolvency of a prime broker, custodian, counterparty or any other party that is holding assets of our funds as collateral, our funds might not be able to recover equivalent assets in full as they will rank among the prime broker’s, custodian’s or counterparty’s unsecured creditors in relation to the assets held as collateral. In addition, our funds’ cash held with a prime broker, custodian or counterparty generally will not be segregated from the prime broker’s, custodian’s or counterparty’s own cash, and our funds may therefore rank as unsecured creditors in relation thereto. If our derivatives transactions are cleared through a derivatives clearing organization, the CFTC has issued final rules regulating the segregation and protection of collateral posted by customers of cleared and uncleared swaps. The CFTC is also working to provide new guidance regarding prime broker arrangements and intermediation generally with regard to trading on swap execution facilities. The counterparty risks that we face have increased in complexity and magnitude as a result of disruption in the financial markets in recent years. For example, in certain areas the number of counterparties we face has increased and may continue to increase, which may result in increased complexity and monitoring costs. Conversely, in certain other areas, the consolidation and elimination of counterparties has increased our concentration of counterparty risk and decreased the universe of potential counterparties, and our funds are generally not restricted from dealing with any particular counterparty or from concentrating any or all of their transactions with one counterparty. In addition, counterparties have in the past and may in the future react to market volatility by tightening underwriting standards and increasing margin requirements for all categories of financing, which may decrease the overall amount of leverage available and increase the costs of borrowing. Underwriting activities by our capital markets services business expose us to risks. Blackstone Securities Partners L.P. may act as an underwriter, syndicator or placement agent in securities offerings and, through affiliated entities, loan syndications. We may incur losses and be subject to reputational harm to the extent that, for any reason, we are unable to sell securities or indebtedness we purchased or placed as an underwriter, syndicator or placement agent at the anticipated price levels or at all. As an underwriter, syndicator or placement agent, we also may be subject to liability for material misstatements or omissions in prospectuses and other offering documents relating to offerings we underwrite, syndicate or place. Risks Related to Our Organizational Structure The significant voting power of holders of our Series I preferred stock and Series II preferred stock may limit the ability of holders of our common stock to influence our business. Holders of our common stock are entitled to vote pursuant to Delaware law with respect to: • A conversion of the legal entity form of Blackstone, • A transfer, domestication or continuance of Blackstone to a foreign jurisdiction, • Any amendment of our certificate of incorporation to change the par value of our common stock or the powers, preferences or special rights of our common stock in a way that would affect our common stock adversely, • Any amendment of our certificate of incorporation that requires for action the vote of a greater number or portion of the holders of common stock than is required by any section of Delaware law, and • Any amendment of our certificate of incorporation to elect to become a close corporation under Delaware law. In addition, our certificate of incorporation provides voting rights to holders of our common stock on the following additional matters: • A sale, exchange or disposition of all or substantially all of our assets, • A merger, consolidation or other business combination, 75 Table of Contents • Any amendment of our certificate of incorporation or bylaws enlarging the obligations of the common stockholders, • Any amendment of our certificate of incorporation requiring the vote of the holders of a percentage of the voting power of the outstanding common stock and Series I preferred stock, voting together as a single class, to take any action in a manner that would have the effect of reducing such voting percentage, and • Any amendments of our certificate of incorporation that are not included in the specified set of amendments that the Series II Preferred Stockholder has the sole right to vote on Furthermore, our certificate of incorporation provides that the holders of at least 66 2/3% of the voting power of the outstanding shares of common stock and Series I preferred stock may vote to require the Series II Preferred Stockholder to transfer its shares of Series II preferred stock to a successor Series II Preferred Stockholder designated by the holders of at least a majority of the voting power of the outstanding shares of common stock and Series I preferred stock. Other matters that are required to be submitted to a vote of the holders of our common stock generally require the approval of a majority of the voting power of our outstanding shares of common stock and Series I preferred stock, voting together as a single class, including certain sales, exchanges or other dispositions of all or substantially all of our assets, a merger, consolidation or other business combination, certain amendments to our certificate of incorporation and the designation of a successor Series II Preferred Stockholder. Holders of our Series I preferred stock, as such, will collectively be entitled to a number of votes equal to the aggregate number of Blackstone Holdings Partnership Units held by the limited partners of the Blackstone Holdings Partnerships on the relevant record date and will vote together with holders of our common stock as a single class. As of February 17, 2023, Blackstone Partners L.L.C., an entity owned by the senior managing directors of Blackstone and controlled by Mr. Schwarzman, owned the only share of Series I preferred stock outstanding, representing approximately 39.7% of the total combined voting power of the common stock and Series I preferred stock, taken together. Our certificate of incorporation and bylaws contain additional provisions affecting the holders of our common stock, including certain limits on the ability of the holders of our common stock to call meetings, to acquire information about our operations and to influence the manner or direction of our management. In addition, any person that beneficially owns 20% or more of the common stock then outstanding (other than the Series II Preferred Stockholder or its affiliates, a direct or subsequently approved transferee of the Series II Preferred Stockholder or its affiliates or a person or group that has acquired such stock with the prior approval of our board of directors) is unable to vote such stock on any matter submitted to such stockholders. We are not required to comply with certain provisions of U.S. securities laws relating to proxy statements and certain related matters. We are not required to file proxy statements or information statements under Section 14 of the Exchange Act except in circumstances where a vote of holders of our common stock is required under our certificate of incorporation or Delaware law, such as a merger, business combination or sale of all or substantially all of our assets. In addition, we will generally not be subject to the “say-on-pay” and “say-on-frequency” provisions of the Dodd-Frank Act. As a result, our common stockholders do not have an opportunity to provide a non-binding vote on the compensation of our named executive officers. Moreover, holders of our common stock are not able to bring matters before our annual meeting of stockholders or nominate directors at such meeting, nor are they generally able to submit stockholder proposals under Rule 14a-8 of the Exchange Act. 76 Table of Contents We are a controlled company and as a result qualify for some exceptions from certain corporate governance and other requirements of the New York Stock Exchange. Because the Series II Preferred Stockholder holds more than 50% of the voting power for the election of directors, we are a “controlled company” and fall within exceptions from certain corporate governance and other requirements of the rules of the New York Stock Exchange. Pursuant to these exceptions, controlled companies may elect not to comply with certain corporate governance requirements of the New York Stock Exchange, including the requirements (a) that a majority of our board of directors consist of independent directors, (b) that we have a nominating and corporate governance committee that is composed entirely of independent directors, (c) that we have a compensation committee that is composed entirely of independent directors, and (d) that the compensation committee be required to consider certain independence factors when engaging compensation consultants, legal counsel and other committee advisers. While we currently have a majority independent board of directors, we have elected to avail ourselves of the other exceptions. Accordingly, our common stockholders generally do not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of the NYSE. Potential conflicts of interest may arise among the Series II Preferred Stockholder and the holders of our common stock. Blackstone Group Management L.L.C., an entity owned by senior managing directors of Blackstone and controlled by Mr. Schwarzman, is the sole holder of the Series II Preferred stock. As a result, conflicts of interest may arise among the Series II Preferred Stockholder, on the one hand, and us and our holders of our common stock, on the other hand. The Series II Preferred Stockholder has the ability to influence our business and affairs through its ownership of Series II Preferred stock, the Series II Preferred Stockholder’s general ability to appoint our board of directors, and provisions under our certificate of incorporation requiring Series II Preferred Stockholder approval for certain corporate actions (in addition to approval by our board of directors). If the holders of our common stock are dissatisfied with the performance of our board of directors, they have no ability to remove any of our directors, with or without cause. Further, through its ability to elect our board of directors, the Series II Preferred Stockholder has the ability to indirectly influence the determination of the amount and timing of our investments and dispositions, cash expenditures, indebtedness, issuances of additional partnership interests, tax liabilities and amounts of reserves, each of which can affect the amount of cash that is available for distribution to holders of Blackstone Holdings Partnership Units. In addition, conflicts may arise relating to the selection, structuring and disposition of investments and other transactions, declaring dividends and other distributions and other matters due to the fact that our senior managing directors hold their Blackstone Holdings Partnership Units directly or through pass-through entities that are not subject to corporate income taxation. See “Part III. Item 13. Certain Relationships and Related Transactions, and Director Independence” and “Part III. Item 10. Directors, Executive Officers and Corporate Governance.” Our certificate of incorporation states that the Series II Preferred Stockholder is under no obligation to consider the separate interests of the other stockholders and contains provisions limiting the liability of the Series II Preferred Stockholder. Subject to applicable law, our certificate of incorporation contains provisions limiting the duties owed by the holder of our Series II preferred stock and contains provisions allowing the Series II Preferred Stockholder to favor its own interests and the interests of its controlling persons over us and the holders of our common stock. Our certificate of incorporation contains provisions stating that the Series II Preferred Stockholder is under no obligation to consider the separate interests of the other stockholders (including, without limitation, the tax 77 Table of Contentsconsequences to such stockholders) in deciding whether or not to authorize us to take (or decline to authorize us to take) any action as well as provisions stating that the Series II Preferred Stockholder shall not be liable to the other stockholders for damages for any losses, liabilities or benefits not derived by such stockholders in connection with such decisions. See “— Potential conflicts of interest may arise among the Series II Preferred Stockholder and the holders of our common stock.” The Series II Preferred Stockholder will not be liable to Blackstone or holders of our common stock for any acts or omissions unless there has been a final and non-appealable judgment determining that the Series II Preferred Stockholder acted in bad faith or engaged in fraud or willful misconduct and we have also agreed to indemnify the Series II Preferred Stockholder to a similar extent. Even if there is deemed to be a breach of the obligations set forth in our certificate of incorporation, our certificate of incorporation provides that the Series II Preferred Stockholder will not be liable to us or the holders of our common stock for any acts or omissions unless there has been a final and non-appealable judgment by a court of competent jurisdiction determining that the Series II Preferred Stockholder or its officers and directors acted in bad faith or engaged in fraud or willful misconduct. These provisions are detrimental to the holders of our common stock because they restrict the remedies available to stockholders for actions of the Series II Preferred Stockholder. In addition, we have agreed to indemnify the Series II Preferred Stockholder and our former general partner and its controlling affiliates and any current or former officer or director of any of Blackstone or its subsidiaries, the Series II Preferred Stockholder or former general partner and certain other specified persons (collectively, the “Indemnitees”), to the fullest extent permitted by law, against any and all losses, claims, damages, liabilities, joint or several, expenses (including legal fees and expenses), judgments, fines, penalties, interest, settlements or other amounts incurred by any Indemnitee. We have agreed to provide this indemnification if the Indemnitee acted in good faith and in a manner the Indemnitee reasonably believed to be in or not opposed to the best interests of Blackstone, and with respect to any alleged conduct resulting in a criminal proceeding against the Indemnitee, such person had no reasonable cause to believe that such person’s conduct was unlawful. We have also agreed to provide this indemnification for criminal proceedings. The Series II Preferred Stockholder may transfer its interest in the sole share of Series II preferred stock which could materially alter our operations. Without the approval of any other stockholder, the Series II Preferred Stockholder may transfer the sole outstanding share of our Series II preferred stock held by it to a third party upon receipt of approval to do so by our board of directors and satisfaction of certain other requirements. Further, the members or other interest holders of the Series II Preferred Stockholder may sell or transfer all or part of their outstanding equity or other interests in the Series II Preferred Stockholder at any time without our approval. A new holder of our Series II preferred stock or new controlling members of the Series II Preferred Stockholder may appoint directors to our board of directors who have a different philosophy and/or investment objectives from those of our current directors. A new holder of our Series II Preferred stock, new controlling members of the Series II Preferred Stockholder and/or the directors they appoint to our board of directors could also have a different philosophy for the management of our business, including the hiring and compensation of our investment professionals. If any of the foregoing were to occur, we could experience difficulty in forming new funds and other investment vehicles and in making new investments, and the value of our existing investments, our business, our results of operations and our financial condition could materially suffer. 78 Table of Contents We intend to pay regular dividends to holders of our common stock, but our ability to do so may be limited by cash flow from operations and available liquidity, our holding company structure, applicable provisions of Delaware law and contractual restrictions. Our intention to pay to holders of common stock a quarterly dividend representing approximately 85% of Blackstone Inc.’s share of Distributable Earnings, subject to adjustment by amounts determined by Blackstone’s board of directors to be necessary or appropriate to provide for the conduct of its business, to make appropriate investments in its business and our funds, to comply with applicable law, any of its debt instruments or other agreements, or to provide for future cash requirements such as tax-related payments, clawback obligations and dividends to stockholders for any ensuing quarter. All of the foregoing is subject to the qualification that the declaration and payment of any dividends are at the sole discretion of our board of directors, and may change at any time, including, without limitation, to reduce such quarterly dividends or to eliminate such dividends entirely. Blackstone Inc. is a holding company and has no material assets other than the ownership of the partnership units in Blackstone Holdings held through wholly owned subsidiaries. Blackstone Inc. has no independent means of generating revenue. Accordingly, we intend to cause Blackstone Holdings to make distributions to its partners, including Blackstone Inc.’s wholly owned subsidiaries, to fund any dividends Blackstone Inc. may declare on our common stock. Our ability to make dividends to our stockholders will depend on a number of factors, including among others general economic and business conditions, our strategic plans and prospects, our business and investment opportunities, our financial condition and operating results, including the timing and extent of our realizations, working capital requirements and anticipated cash needs, contractual restrictions and obligations including fulfilling our current and future capital commitments, legal, tax and regulatory restrictions, restrictions and other implications on the payment of dividends by us to holders of our common stock or payment of distributions by our subsidiaries to us and such other factors as our board of directors may deem relevant. Our ability to pay dividends is also subject to the availability of lawful funds therefor as determined in accordance with the Delaware General Corporation Law. The amortization of finite-lived intangible assets and non-cash equity-based compensation results in expenses that may increase the net loss we record in certain periods or cause us to record a net loss in periods during which we would otherwise have recorded net income. As of December 31, 2022, we have $217.3 million of finite-lived intangible assets (in addition to $1.9 billion of goodwill), net of accumulated amortization. These finite-lived intangible assets are from the initial public offering (“IPO”) and subsequent business acquisitions. We are amortizing these finite-lived intangibles over their estimated useful lives, which range from three to twenty years, using the straight-line method, with a weighted-average remaining amortization period of 7.1 years as of December 31, 2022. We also record non-cash equity-based compensation from grants made in the ordinary course of business and in connection with other business acquisitions. The amortization of these finite-lived intangible assets and of this non-cash equity-based compensation will increase our expenses during the relevant periods. These expenses may increase the net loss we record in certain periods or cause us to record a net loss in periods during which we would otherwise have recorded net income. A substantial and sustained decline in our share price could result in an impairment of intangible assets or goodwill leading to a further reduction in net income or increase to net loss in the relevant period. 79 Table of ContentsWe are required to pay our senior managing directors for most of the benefits relating to any additional tax depreciation or amortization deductions we may claim as a result of the tax basis step-up we received as part of the reorganization we implemented in connection with our IPO or receive in connection with future exchanges of our common stock and related transactions. As part of the reorganization we implemented in connection with our IPO, we purchased interests in our business from our pre-IPO owners. In addition, holders of partnership units in Blackstone Holdings (other than Blackstone Inc.’s wholly owned subsidiaries), subject to the vesting and minimum retained ownership requirements and transfer restrictions set forth in the partnership agreements of the Blackstone Holdings Partnerships, may up to four times each year (subject to the terms of the exchange agreement) exchange their Blackstone Holdings Partnership Units for shares of Blackstone Inc.’s common stock on a one-for-one basis. A Blackstone Holdings limited partner must exchange one partnership unit in each of the Blackstone Holdings Partnerships to effect an exchange for a share of common stock. The purchase and subsequent exchanges are expected to result in increases in the tax basis of the tangible and intangible assets of Blackstone Holdings that otherwise would not have been available. These increases in tax basis may increase (for tax purposes) depreciation and amortization and therefore reduce the amount of tax that we would otherwise be required to pay in the future, although the IRS may challenge all or part of that tax basis increase, and a court could sustain such a challenge. We have entered into a tax receivable agreements with our senior managing directors and other pre-IPO owners that provides for the payment by us to the counterparties of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax or franchise tax that we actually realize as a result of these increases in tax basis and of certain other tax benefits related to entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement. This payment obligation is an obligation of Blackstone Inc. and/or its wholly owned subsidiaries and not of Blackstone Holdings. As such, the cash distributions to public stockholders may vary from holders of Blackstone Holdings Partnership Units (held by Blackstone personnel and others) to the extent payments are made under the tax receivable agreements to selling holders of Blackstone Holdings Partnership Units. As the payments reflect actual tax savings received by Blackstone entities, there may be a timing difference between the tax savings received by Blackstone entities and the cash payments to selling holders of Blackstone Holdings Partnership Units. While the actual increase in tax basis, as well as the amount and timing of any payments under this agreement, will vary depending upon a number of factors, including the timing of exchanges, the price of our common stock at the time of the exchange, the extent to which such exchanges are taxable and the amount and timing of our income, we expect that as a result of the size of the increases in the tax basis of the tangible and intangible assets of Blackstone Holdings, the payments that we may make under the tax receivable agreements will be substantial. The payments under a tax receivable agreement are not conditioned upon a tax receivable agreement counterparty’s continued ownership of us. We may need to incur debt to finance payments under the tax receivable agreement to the extent our cash resources are insufficient to meet our obligations under the tax receivable agreements as a result of timing discrepancies or otherwise. Although we are not aware of any issue that would cause the IRS to challenge a tax basis increase, the tax receivable agreement counterparties will not reimburse us for any payments previously made under the tax receivable agreement. As a result, in certain circumstances payments to the counterparties under the tax receivable agreement could be in excess of our actual cash tax savings. Our ability to achieve benefits from any tax basis increase, and the payments to be made under the tax receivable agreements, will depend upon a number of factors, as discussed above, including the timing and amount of our future income. 80 Table of Contents If Blackstone Inc. were deemed an “investment company” under the 1940 Act, applicable restrictions could make it impractical for us to continue our business as contemplated and could have a material adverse effect on our business. An entity will generally be deemed to be an “investment company” for purposes of the 1940 Act if: (a) it is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities, or (b) absent an applicable exemption, it owns or proposes to acquire investment securities having a value exceeding 40% of the value of its total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. We believe that we are engaged primarily in the business of providing asset management and capital markets services and not in the business of investing, reinvesting or trading in securities. We also believe that the primary source of income from each of our businesses is properly characterized as income earned in exchange for the provision of services. We hold ourselves out as an asset management and capital markets firm and do not propose to engage primarily in the business of investing, reinvesting or trading in securities. Accordingly, we do not believe that Blackstone Inc. is an “orthodox” investment company as defined in section 3(a)(1)(A) of the 1940 Act and described in clause (a) in the first sentence of this paragraph. Furthermore, Blackstone Inc. does not have any material assets other than its equity interests in certain wholly owned subsidiaries, which in turn will have no material assets (other than intercompany debt) other than general partner interests in the Blackstone Holdings Partnerships. These wholly owned subsidiaries are the sole general partners of the Blackstone Holdings Partnerships and are vested with all management and control over the Blackstone Holdings Partnerships. We do not believe the equity interests of Blackstone Inc. in its wholly owned subsidiaries or the general partner interests of these wholly owned subsidiaries in the Blackstone Holdings Partnerships are investment securities. Moreover, because we believe that the capital interests of the general partners of our funds in their respective funds are neither securities nor investment securities, we believe that less than 40% of Blackstone Inc.’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis are comprised of assets that could be considered investment securities. Accordingly, we do not believe Blackstone Inc. is an inadvertent investment company by virtue of the 40% test in section 3(a)(1)(C) of the 1940 Act as described in clause (b) in the first sentence of this paragraph. In addition, we believe Blackstone Inc. is not an investment company under section 3(b)(1) of the 1940 Act because it is primarily engaged in a non-investment company business. The 1940 Act and the rules thereunder contain detailed parameters for the organization and operation of investment companies. Among other things, the 1940 Act and the rules thereunder limit or prohibit transactions with affiliates, impose limitations on the issuance of debt and equity securities, generally prohibit the issuance of options and impose certain governance requirements. We intend to conduct our operations so that Blackstone Inc. will not be deemed to be an investment company under the 1940 Act. If anything were to happen which would cause Blackstone Inc. to be deemed to be an investment company under the 1940 Act, requirements imposed by the 1940 Act, including limitations on our capital structure, ability to transact business with affiliates (including us) and ability to compensate key employees, could make it impractical for us to continue our business as currently conducted, impair the agreements and arrangements between and among Blackstone Inc., Blackstone Holdings and our senior managing directors, or any combination thereof, and materially adversely affect our business, financial condition and results of operations. In addition, we may be required to limit the amount of investments that we make as a principal or otherwise conduct our business in a manner that does not subject us to the registration and other requirements of the 1940 Act. Other anti-takeover provisions in our charter documents could delay or prevent a change in control. In addition to the provisions described elsewhere relating to the Series II Preferred Stockholder’s control, other provisions in our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable by, for example: • permitting our board of directors to issue one or more series of preferred stock, 81 Table of Contents • providing for the loss of voting rights for the common stock, • requiring advance notice for stockholder proposals and nominations if they are ever permitted by applicable law, • placing limitations on convening stockholder meetings, • prohibiting stockholder action by written consent unless such action is consent to by the Series II Preferred Stockholder, and • imposing super-majority voting requirements for certain amendments to our certificate of incorporation. These provisions may also discourage acquisition proposals or delay or prevent a change in control. Risks Related to Our Common Stock The price of our common stock may decline due to the large number of shares of common stock eligible for future sale and for exchange. The market price of our common stock could decline as a result of sales of a large number of shares of common stock in the market in the future or the perception that such sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell shares of common stock in the future at a time and at a price that we deem appropriate. We had a total of 706,369,856 shares of common stock outstanding as of February 17, 2023. Subject to the lock-up restrictions described below, we may issue and sell in the future additional shares of common stock. Limited partners of Blackstone Holdings owned an aggregate of 444,056,162 Blackstone Holdings Partnership Units outstanding as of February 17, 2023. In connection with our initial public offering, we entered into an exchange agreement with holders of Blackstone Holdings Partnership Units (other than Blackstone Inc.’s wholly owned subsidiaries) so that these holders, subject to the vesting and minimum retained ownership requirements and transfer restrictions set forth in the partnership agreements of the Blackstone Holdings Partnerships, may up to four times each year (subject to the terms of the exchange agreement) exchange their Blackstone Holdings Partnership Units for shares of Blackstone Inc. common stock on a one-for-one basis, subject to customary conversion rate adjustments for splits, unit distributions and reclassifications. A Blackstone Holdings limited partner must exchange one partnership unit in each of the Blackstone Holdings Partnerships to effect an exchange for a share of common stock. The common stock we issue upon such exchanges would be “restricted securities,” as defined in Rule 144 under the Securities Act, unless we register such issuances. However, we have entered into a registration rights agreement with the limited partners of the Blackstone Holdings Partnerships that requires us to register these shares of common stock under the Securities Act and we have filed registration statements that cover the delivery of common stock issued upon exchange of Blackstone Holdings Partnership Units. See “Part III. Item 13. Certain Relationships and Related Transactions, and Director Independence — Transactions with Related Persons — Registration Rights Agreement.” While the partnership agreements of the Blackstone Holdings Partnerships and related agreements contractually restrict the ability of Blackstone personnel to transfer the Blackstone Holdings Partnership Units or Blackstone Inc. common stock they hold and require that they maintain a minimum amount of equity ownership during their employ by us, these contractual provisions may lapse over time or be waived, modified or amended at any time. As of February 17, 2023, we had granted 40,265,273 outstanding deferred restricted shares of common stock and 18,107,045 outstanding deferred restricted Blackstone Holdings Partnership Units to our non-senior managing director professionals and senior managing directors under the Blackstone Inc. Amended and Restated 2007 Equity Incentive Plan (“2007 Equity Incentive Plan”). The aggregate number of shares of common stock and Blackstone Holdings Partnership Units (together, “Shares”) covered by our 2007 Equity Incentive Plan is increased on the first day of each fiscal year during its term by a number of Shares equal to the positive difference, if any, of (a) 15% of the aggregate number of Shares outstanding on the last day of the immediately preceding fiscal year (excluding Blackstone Holdings Partnership Units held by Blackstone Inc. or its wholly owned subsidiaries) minus (b) the aggregate number of Shares covered by our 2007 Equity Incentive Plan as of such date (unless the 82 Table of Contents administrator of the 2007 Equity Incentive Plan should decide to increase the number of Shares covered by the plan by a lesser amount). An aggregate of 168,978,288 additional Shares were available for grant under our 2007 Equity Incentive Plan as of February 17, 2023. We have filed a registration statement and intend to file additional registration statements on Form S-8 under the Securities Act to register common stock covered by the 2007 Equity Incentive Plan (including pursuant to automatic annual increases). Any such Form S-8 registration statement will automatically become effective upon filing. Accordingly, common stock registered under such registration statement will be available for sale in the open market. In addition, the Blackstone Holdings partnership agreements authorize the wholly owned subsidiaries of Blackstone Inc. which are the general partners of those partnerships to issue an unlimited number of additional partnership securities of the Blackstone Holdings Partnerships with such designations, preferences, rights, powers and duties that are different from, and may be senior to, those applicable to the Blackstone Holdings Partnership Units, and which may be exchangeable for our shares of common stock. Our certificate of incorporation also provides us with a right to acquire all of the then outstanding shares of common stock under specified circumstances, which may adversely affect the price of our shares of common stock and the ability of holders of shares of common stock to participate in further growth in our stock price. Our certificate of incorporation provides that, if at any time, less than 10% of the total shares of any class of our stock then outstanding (other than Series I preferred stock and Series II preferred stock) is held by persons other than the Series II Preferred Stockholder and its affiliates, we may exercise our right to call and purchase all of the then outstanding shares of common stock held by persons other than the Series II Preferred Stockholder or its affiliates or assign this right to the Series II Preferred Stockholder or any of its affiliates. As a result, a stockholder may have his or her shares of common stock purchased from him or her at an undesirable time or price and in a manner which adversely affects the ability of a stockholder to participate in further growth in our stock price. Our amended and restated bylaws designate the Court of Chancery of the State of Delaware or the federal district courts of the United States of America, as applicable, as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with Blackstone or our directors, officers or other employees. Our amended and restated bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by law, be the sole and exclusive forum for: (a) any derivative action or proceeding brought on our behalf, (b) any action asserting a breach of fiduciary duty owed by any of our current or former directors, officers, stockholders or employees to us or our stockholders, (c) any action asserting a claim against us arising under the Delaware General Corporation Law (the “DGCL”), our certificate of incorporation or our bylaws or as to which the DGCL confers jurisdiction on the Court of Chancery of the State of Delaware, or (d) any action asserting a claim against us that is governed by the internal affairs doctrine. Our amended and restated bylaws further provide that, unless we consent in writing to the selection of an alternative forum, to the fullest extent permitted by law, the federal district courts of the United States of America will be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the federal securities laws of the United States, including, in each case, the applicable rules and regulations promulgated thereunder. Any person or entity purchasing or otherwise acquiring any interest in any shares of our capital stock shall be deemed to have notice of and to have consented to the forum provision in our amended and restated bylaws. This choice-of-forum provision may limit a stockholder’s ability to bring a claim in a different judicial forum, including one that it may find favorable or convenient for a specified class of disputes with Blackstone or our directors, officers, other stockholders or employees, which may discourage such lawsuits. Alternatively, if a court were to 83 Table of Contentsfind this provision of our amended and restated bylaws inapplicable or unenforceable with respect to one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could materially adversely affect our business, financial condition and results of operations and result in a diversion of the time and resources of our management and board of directors. Item 1B. Unresolved Staff Comments None. Item 2. Properties Our principal executive offices are located in leased office space at 345 Park Avenue, New York, New York. As of December 31, 2022, we also leased offices in Cambridge, Dublin, Hong Kong, London, Los Angeles, Luxembourg, Miami, Mumbai, San Francisco, Shanghai, Singapore, Sydney, Tokyo and other cities around the world. We consider these facilities to be suitable and adequate for the management and operations of our business. Item 3. Legal Proceedings We may from time to time be involved in litigation and claims incidental to the conduct of our business. Our businesses are also subject to extensive regulation, which may result in regulatory proceedings against us. See “— Item 1A. Risk Factors” above. We are not currently subject to any pending legal (including judicial, regulatory, administrative or arbitration) proceedings that we expect to have a material impact on our consolidated financial statements. However, given the inherent unpredictability of these types of proceedings and the potentially large and/or indeterminate amounts that could be sought, an adverse outcome in certain matters could have a material effect on Blackstone’s financial results in any particular period. See “Part II.
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+ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThis management's discussion and analysis provides a review of the results of operations, key operating metrics and non-GAAP financial measures, and liquidity and capital resources of Block, Inc. on a historical basis and outlines the factors that have affected recent earnings, as well as those factors that may affect future earnings. The following discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K ("Form 10-K"). This section of this Form 10-K generally discusses fiscal 2022 compared to fiscal 2021. The comparison of the fiscal 2021 results with the fiscal 2020 results that are not included in this Form 10-K can be found in the "Management's Discussion and Analysis Results of Operations" section in the Company's fiscal 2021 Annual Report within Part II, Item 7 of Form 10-K, filed on February 24, 2022.The statements in this discussion regarding our expectations of our future performance, liquidity, and capital resources; our plans, estimates, beliefs, and expectations that involve risks and uncertainties; and other non-historical statements in this discussion are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described under Item 1A. Risk Factors and elsewhere in this Form 10-K. Our actual results may differ materially from those contained in or implied by any forward-looking statements.OverviewOn December 1, 2021, we changed our name as a corporate entity from Square, Inc. to Block, Inc. (together with its subsidiaries, "Block"). We started Block with the Square ecosystem in February 2009 to enable businesses ("sellers") to accept card payments, an important capability that was previously inaccessible to many businesses. However, sellers need a variety of solutions to thrive, and we have expanded to provide them additional products and services and to give them access to a cohesive ecosystem of tools to help them manage and grow their businesses. Similarly, with Cash App, we have built an ecosystem of financial products and services to help individuals manage their money. We also added TIDAL and TBD as businesses to contribute to our purpose of economic empowerment. TIDAL is a global platform for musicians and their fans that uses unique content, experiences, and features to bring fans closer to artists and to provide artists with tools to succeed as entrepreneurs. TBD is an open developer platform focused on making the decentralized financial world accessible for everyone. In January 2022, we completed the acquisition of Afterpay Limited ("Afterpay"), a buy now, pay later ("BNPL") platform that facilitates commerce between retail merchants and consumers by allowing its retail merchant clients to offer their customers the ability to buy goods and services on a BNPL basis.Square is a cohesive commerce ecosystem that helps sellers start, run, and grow their businesses, and consists of more than 30 distinct software, hardware, and financial services products that provide cohesive Commerce, Customer Relationship Management, Staff Management, and Banking capabilities. Our products are designed to be self-serve and intuitive to make initial setup and new employee training fast and easy, although we also offer full-service setup and support. Our products are integrated to create a seamless experience and enable a holistic view of sales, customers, employees, and finances. Our open developer platform enables integrations with third-party applications as well. We monetize these products through a combination of transaction, subscription, and service fees. We have grown rapidly to serve millions of sellers that represent a diverse set of industries including services, food-related businesses, and retail businesses; and sizes, ranging from sole proprietors, such as a single vendor at a farmers’ market, to multi-location enterprise businesses. Square sellers also span geographies, including the United States, Canada, Japan, Australia, New Zealand, the United Kingdom, Ireland, France, and Spain.Cash App provides an ecosystem of financial products and services to help consumers manage their money. Cash App’s goal is to redefine the world’s relationship with money by making it more relatable, instantly available, and universally accessible. While Cash App started with the single ability to send and receive money, it now provides an ecosystem of financial services focused on helping consumers make their money go further — whether that's by storing, sending, receiving, spending, or investing their money with Cash App. We monetize these products through a combination of transaction and service fees. Cash App has a diverse mix of transacting actives across a range of demographics and regions in the United States, as well as a small presence in Europe.64With the acquisition of Afterpay, we added a BNPL platform to our offerings. Our BNPL platform is being integrated into the Cash App and Square ecosystems, strengthening the connection between these ecosystems, expanding access to more sellers and customers, increasing Square’s omnichannel platform, and helping drive more commerce between our sellers and customers. Customers will be able to manage their installments and repayments directly within Cash App, potentially driving increased engagement, while the commerce discovery functionality from the Afterpay app will be integrated with Cash App to help drive lead generation for merchants and customer engagement. As discussed further in Note 21, Segment and Geographical Information within Notes to the Consolidated Financial Statements, the financial results from our BNPL platform have been allocated equally to the Cash App and Square segments. Afterpay results are included in our financial statements from January 31, 2022, the date of acquisition.Components of Results of Operations Revenue Transaction-based RevenueWe charge our sellers a transaction fee that is generally calculated based on a percentage of the total transaction amount processed. We also selectively offer custom pricing for certain larger sellers. Transaction-based revenue also includes amounts we charge our Cash App customers for peer-to-peer transactions to business accounts and payments sent from a credit card.Subscription and Services-based RevenueSubscription and services-based revenue is primarily comprised of revenue we generate from Cash App, Square Loans (formerly known as Square Capital), our BNPL platform, TIDAL, and various other software as a service (“SaaS”) products that we offer through Square. Cash App subscription and services-based revenue is primarily comprised of transaction fees from Cash App Instant Deposit, Cash App Card, and other Cash App financial services offerings. Our other SaaS products include subscription fees on our vertical software solutions (including Square for Restaurants, Square Appointments, and Square for Retail), Customer Engagement products (including Square Loyalty, Square Marketing, Square Gift Cards), staff management products (including Square Team Management and Square Payroll), and other products. Instant Deposit is a functionality within the Cash App and our managed payment solutions that enables customers, including individuals and sellers, to instantly deposit funds into their bank accounts. Cash App Card offers Cash App customers the ability to use their stored funds via a Visa prepaid card that is linked to the balance the customer stores in Cash App. We charge the customer a per transaction fee when they instantly deposit funds to their bank account or withdraw funds from an ATM. We also earn interchange fees when a Cash App Card is used to make a purchase. These transaction and interchange fees are treated as revenue when charged. Square Loans originates loans to sellers that are generally repaid through withholding a percentage of the collections of the seller's receivables processed by us or a specified monthly amount. In April 2021, we began originating loans in the U.S. through our wholly-owned subsidiary bank, Square Financial Services. Prior to the launch of Square Financial Services, the loans were generally originated by a bank partner, from whom we purchased the loans to obtain all rights, title, and interests. We also originate loans to the customers of certain sellers which are generally repaid via ACH. For some of the loans, it is our intention to sell the rights, title, and interest to third-party investors for an upfront fee. We are retained by the third-party investors to service the loans and earn a servicing fee for facilitating the repayment of these loans through our payments solutions. Certain loans, for which we have the intention and ability to hold through maturity, are not immediately sold to third-party investors, in which case, interest and fees earned are recognized as revenue using the effective interest method.Cash App Borrow, the Company’s first credit product for consumers, allows customers to access short-term loans for a small fee. The loans are repaid at the end of the loan term and customers may elect to prepay all or a part of the outstanding balance. If the outstanding balance is not paid when due, late fees in the form of interest may be charged. The short-term loans are facilitated through a partnership with an industrial bank. The loans are originated by the bank partner, from whom the Company purchases the loans obtaining all rights, title, and interest. Net amounts paid to the bank are recorded as the cost of the loans purchased, and amounts collected in excess of the carrying value are recognized as revenue over the life of the loans.65Revenue from our BNPL platform includes fees generated from consumer receivables, late fees, and certain affiliate and advertising fees. Through the use of our BNPL platform, consumers can pay for their purchases over time by splitting their purchase price generally into three or four installments, typically due in two-week increments, without paying fees (if payments are made on time). For the majority of our BNPL products, we do not charge consumers interest or fees, other than late fees, which may be charged in certain regions as an incentive to encourage consumers to pay their outstanding balances as and when they fall due. As of October 2022, we also offer the ability for consumers to pay for larger transaction sizes over a six- or twelve-month period using a monthly payment option, which includes no late fees and no compounding interest with a cap on total interest owed.TIDAL primarily generates revenue from subscriptions to customers, and such subscriptions allow access to the song library, video library, and improved sound quality. Customers can subscribe to services directly from the TIDAL website or through the Apple store. With both offerings, we charge customers a monthly fee for those subscription services.Hardware RevenueHardware revenue includes revenue from sales of magstripe readers, contactless and chip readers, Square Stand, Square Register, Square Terminal, and third-party peripherals. Third-party peripherals include cash drawers, receipt printers, scales, and barcode scanners, all of which can be integrated with Square Stand, Square Register, or Square Terminal to provide a comprehensive point-of-sale solution. Bitcoin RevenueOur Cash App customers have the ability to purchase bitcoin, a cryptocurrency. We recognize revenue when customers purchase bitcoin and it is transferred to the customer's account. We purchase bitcoin from private broker dealers or from Cash App customers and apply a small margin before selling it to our customers. The sale amounts received from our customers are recorded as revenue on a gross basis and the associated bitcoin cost as cost of revenues, as we are the principal in the bitcoin sale transaction. Bitcoin revenue may fluctuate as a result of changes in customer demand or the market price of bitcoin. Cost of RevenueTransaction-based CostsTransaction-based costs consist primarily of interchange and assessment fees, processing fees, and bank settlement fees paid to third-party payment processors and financial institutions.Subscription and Services-based CostsSubscription and services-based costs consist primarily of processing and partnership fees related to Cash App including Instant Deposit and Cash App Card, and our BNPL platform, as well as costs associated with TIDAL.Hardware CostsHardware costs consist primarily of product costs associated with magstripe readers, contactless and chip readers, Square Stand, Square Register, Square Terminal, and third-party peripherals. Product costs include manufacturing-related overhead and personnel-related costs, certain royalties, packaging, and fulfillment costs. Hardware is sold primarily as a means to grow our transaction-based revenue and, as a result, generating positive gross margins from hardware sales is not the primary goal of the hardware business.Bitcoin CostsBitcoin costs consist of the amounts we pay to purchase bitcoin that is sold to customers. These costs fluctuate in line with bitcoin revenue. 66Amortization of Acquired Technology AssetsAmortization of acquired technology assets is primarily comprised of amortization related to the acquired technology assets from the acquisition of Afterpay.Operating ExpensesOperating expenses consist of product development; sales and marketing; general and administrative expenses; transaction, loan, and consumer receivable losses; bitcoin impairment losses; and amortization of customer and other acquired intangible assets. For product development and general and administrative expenses, the largest single component is personnel-related expenses, including salaries, commissions and bonuses, employee benefit costs, and share-based compensation. In the case of sales and marketing expenses, a significant portion is related to the Cash App peer-to-peer transactions and Cash App Card issuance costs, in addition to paid advertising and personnel-related expenses. Operating expenses also include allocated overhead costs for facilities, human resources, and IT.Product Development ExpensesProduct development expenses currently represent the largest component of our operating expenses and consist primarily of expenses related to our engineering, data science, and design personnel; fees and supply costs related to maintenance at third-party data center facilities; hardware related development and tooling costs; and fees for software licenses, consulting, legal, and other services that are directly related to growing and maintaining our portfolio of products and services. Additionally, product development expenses include the depreciation of product-related infrastructure and tools, including data center equipment, internally developed software, and computer equipment. We continue to focus our product development efforts on adding new features and expanding our apps, and on enhancing the functionality and ease of use of our offerings. Our ability to realize returns on these investments is substantially dependent upon our ability to successfully address current and emerging requirements of sellers, buyers, and customers through the development and introduction of these new products and services. Sales and Marketing ExpensesSales and marketing expenses are aggregated into two main components. The first component consists of traditional advertising costs incurred such as direct sales expense, account management, local and product marketing, retail and e-commerce, partnerships, and communications personnel. The second component of sales and marketing expenses consists of costs incurred for services, incentives, and other costs that are not directly related to revenue generating transactions that we consider to be marketing costs to encourage the usage of Cash App. These expenses include, but are not limited to, Cash App peer-to-peer processing costs and transaction losses, card issuance costs, customer referral bonuses, and promotional giveaways that are expensed as incurred.General and Administrative ExpensesGeneral and administrative expenses consist primarily of expenses related to our customer support, finance, legal, risk operations, human resources, and administrative personnel. General and administrative expenses also include costs related to fees paid for professional services, including legal, tax, and accounting services. Transaction, Loan, and Consumer Receivable LossesTransaction losses include chargebacks for unauthorized credit card use and the inability to collect on disputes between buyers and sellers over the delivery of goods or services, as well as losses on Cash App activity related to peer-to-peer payments sent from a credit card, Cash for Business, and Cash App Card. We base our reserve estimates on prior chargeback history and current period data points indicative of transaction loss. We reflect additions to the reserve in current operating results, while realized losses are offset against the reserve. The establishment of appropriate reserves for transaction losses is an inherently uncertain process, and ultimate losses may vary from the current estimates. We regularly update our reserve estimates as new facts become known and events occur that may affect the settlement or recovery of losses.Loan losses relate to Square Loans and Cash App Borrow and are recorded whenever the amortized cost of a loan exceeds its fair value. Such charges are reversed for subsequent increases in fair value, but only to the extent that such reversals do not result in the amortized cost of a loan exceeding its fair value. 67Losses on consumer receivables relate to management's estimate of expected credit losses in the outstanding portfolio of consumer receivables. We reflect additions to the reserve in current operating results, while realized losses are offset against the reserve.Bitcoin Impairment LossesOur investment in bitcoin is accounted for as an indefinite-lived intangible asset, and thus, is subject to impairment losses if the fair value of bitcoin decreases below the carrying value during the assessed period. Impairment losses cannot be reversed for any subsequent increase in fair value until the sale of the asset. Amortization of Customer and Other Acquired Intangible AssetsAmortization of customer and other acquired intangible assets is primarily as a result of the intangible assets from the Afterpay acquisition.Interest Expense, net, and Other Income, netInterest and other income and expense, net consists primarily of gains or losses arising from remeasurements of our investments in equity securities, interest expense related to our long-term debt, interest income on our investments in marketable debt securities, and foreign currency-related gains and losses.Provision (Benefit) for Income TaxesThe provision for income taxes consists primarily of federal, state, local, and foreign tax. Our effective tax rate fluctuates from period to period due to changes in the mix of income and losses in jurisdictions with a wide range of tax rates, the effect of acquisitions, changes resulting from the amount of recorded valuation allowance, permanent differences between U.S. generally accepted accounting principles and local tax laws, certain one-time items, and changes in tax contingencies. 68Results of Operations Revenue (in thousands, except for percentages)Year Ended December 31,20222021$ Change% ChangeTransaction-based revenue$5,701,540 $4,793,146 $908,394 19 %Subscription and services-based revenue4,552,773 2,709,731 1,843,042 68 %Hardware revenue164,418 145,679 18,739 13 %Bitcoin revenue7,112,856 10,012,647 (2,899,791)(29)%Total net revenue$17,531,587 $17,661,203 $(129,616)(1)% Total net revenue for the year ended December 31, 2022, decreased by $129.6 million, or 1%, compared to the year ended December 31, 2021. Bitcoin revenue decreased by $2.9 billion and represented the primary driver of the decrease in the total net revenue. Excluding bitcoin revenue, total net revenue increased by $2.8 billion, or 36%, in the year ended December 31, 2022, compared to the year ended December 31, 2021. Revenue from our BNPL platform was $811.4 million from the date of acquisition through December 31, 2022, representing 5% of our total net revenue for the year ended December 31, 2022.Transaction-based revenue for the year ended December 31, 2022 increased by $908.4 million, or 19%, compared to the year ended December 31, 2021. This increase in revenue was largely in line with the increase in Gross Payment Volume ("GPV") of 21% for the year ended December 31, 2022, compared to the year ended December 31, 2021. GPV increased due to overall Square GPV growth as well as growth in Cash App Business GPV, which is comprised of Cash App activity related to peer-to-peer transactions received by business accounts. Square GPV growth was driven by improvements in both card-present and card-not-present volumes as a result of growth from in-person and online channels, as well as growth in our international markets, and Cash App Business GPV growth was driven by increases in peer-to-peer transactions received by business accounts as well as peer-to-peer payments sent from a credit card. See below in Key Operating Metrics and Non-GAAP Financial Measures for further discussion of GPV.Subscription and services-based revenue for the year ended December 31, 2022 increased by $1.8 billion, or 68%, compared to the year ended December 31, 2021. The increase was driven by:•revenue generated from our BNPL platform of $811.4 million;•an increase in Cash App subscription and services-based revenue primarily due to growth in Cash App Card usage, Cash App Instant Deposit volumes, as well as fees we charge customers who opt to use the faster bitcoin withdrawal options to move their bitcoin out of Cash App; and•seller banking products growth, including the increased origination volumes of Square Loans, as well as software subscriptions.Hardware revenue for the year ended December 31, 2022 increased by $18.7 million, or 13%, compared to the year ended December 31, 2021. The increase was primarily a result of an overall increase in sales of hardware across many of our product offerings including Square Terminal, Square Register, and Square Reader for contactless and chip.Bitcoin revenue for the year ended December 31, 2022 decreased by $2.9 billion, or 29%, compared to the year ended December 31, 2021. As bitcoin revenue is the total sale amount of bitcoin sold to customers, the amount of bitcoin revenue recognized will fluctuate depending on customer demand, as well as changes in the market price of bitcoin. This decrease in the year ended December 31, 2022 was driven by the decline in the market price of bitcoin compared to the year ended December 31, 2021. While bitcoin contributed 41% and 57% of the total revenue in 2022 and 2021, respectively, gross profit generated from bitcoin was only 3% and 5% of the total gross profit in 2022 and 2021, respectively. 69Cost of Revenue (in thousands, except for percentages)Year Ended December 31,20222021$ Change% ChangeTransaction-based costs$3,364,028 $2,719,502 $644,526 24 %Subscription and services-based costs861,745 483,056 378,689 78 %Hardware costs286,995 221,185 65,810 30 %Bitcoin costs6,956,733 9,794,992 (2,838,259)(29)%Amortization of acquired technology assets70,194 22,645 47,549 210 %Total cost of revenue$11,539,695 $13,241,380 $(1,701,685)(13)%Total cost of revenue for the year ended December 31, 2022 decreased by $1.7 billion, or 13%, compared to the year ended December 31, 2021. Bitcoin costs of revenue, which decreased by $2.8 billion, was the primary driver of the decrease in total cost of revenue. The decrease in total cost of revenue was offset by increased transaction-based costs related to an increase in GPV and increased costs as a result of our BNPL platform, which we acquired in the first quarter of 2022. Excluding bitcoin costs of revenue, total cost of revenue increased by approximately $1.1 billion, or 32%, in the year ended December 31, 2022, compared to the year ended December 31, 2021. Transaction-based costs for the year ended December 31, 2022 increased by $644.5 million, or 24%, compared to the year ended December 31, 2021, exceeding GPV growth of 21%, due to an increase in credit card transactions that have a higher cost per transaction as compared to debit card transactions.Subscription and services-based costs for the year ended December 31, 2022 increased by $378.7 million, or 78%, compared to the year ended December 31, 2021. The increase was driven by:•Costs of revenues associated with our BNPL platform of $223.2 million from the date of acquisition through December 31, 2022; and•growth in Cash App Card usage, paper money deposit activity, and related processing costs and fees.Hardware costs for the year ended December 31, 2022 increased by $65.8 million, or 30%, compared to the year ended December 31, 2021. The increase was due to the increased sales of hardware, as well as increased costs due to supply chain disruptions.Bitcoin costs for the year ended December 31, 2022 decreased by $2.8 billion, or 29%, compared to the year ended December 31, 2021 due to the decline in bitcoin revenue. Bitcoin costs are comprised of the total amount we pay to purchase bitcoin, which fluctuates in line with bitcoin revenue.Amortization of acquired technology assets for the year ended December 31, 2022 increased by $47.5 million, or 210% compared to the year ended December 31, 2021. The increase was primarily driven by amortization related to the acquired technology assets from the acquisition of Afterpay of $43.5 million.70Operating Expenses (in thousands, except for percentages)Year Ended December 31,20222021$ Change% ChangeProduct development$2,135,612$1,383,841$751,771 54 %% of total net revenue12 %8 %% of total gross profit 36 %31 %Sales and marketing$2,057,951$1,617,189$440,762 27 %% of total net revenue12 %9 %% of total gross profit 34 %37 %General and administrative$1,686,849$982,817$704,032 72 %% of total net revenue10 %6 %% of total gross profit 28 %22 %Transaction, loan, and consumer receivable losses$550,683$187,991$362,692 193 %% of total net revenue3 %1 %% of total gross profit 9 %4 %Bitcoin impairment losses$46,571$71,126$(24,555)(35)%% of total net revenue— %— %% of total gross profit 1 %2 %Amortization of customer and other acquired intangible assets$138,758$15,747$123,011 781 %% of total net revenue1 %— %% of total gross profit 2 %— %Total operating expenses$6,616,424$4,258,711$2,357,713 55 %Product development expenses for the year ended December 31, 2022, increased by $751.8 million, or 54%, compared to the year ended December 31, 2021, due primarily to the following: •an increase of $560.3 million in personnel-related costs primarily due to an increase in headcount among our engineering, data science, and design teams, as we continue to improve and diversify our products. The increase was additionally driven by employees added from the acquisition of Afterpay in the first quarter of 2022. The increase in product development personnel-related costs includes an increase in share-based compensation expense of $255.1 million for the year ended December 31, 2022; and•an increase of $179.4 million in software and data center costs, consulting, and certain Cash App crypto networks operating costs for the year ended December 31, 2022 as a result of increased capacity needs and expansion of our cloud-based services.Sales and marketing expenses for the year ended December 31, 2022, increased by $440.8 million, or 27%, compared to the year ended December 31, 2021, primarily due to the following:•an increase of $168.4 million in sales and marketing personnel-related costs to enable growth initiatives, including an increase in share-based compensation expense of $48.2 million;•an increase of $101.0 million in Cash App peer-to-peer processing costs, related peer-to-peer transaction losses, and card issuance costs as a result of increased volumes of activity with our Cash App peer-to-peer service and card issuance; and•an increase in sales and marketing expenses due to the acquisition of Afterpay in the first quarter of 2022.71General and administrative expenses for the year ended December 31, 2022, increased by $704.0 million, or 72%, compared to the year ended December 31, 2021, primarily due to the following:•an increase of $482.6 million in general and administrative personnel-related costs, mainly as a result of additions to our customer support, human resources, finance, and legal personnel as we continue to add resources and skills to support our long-term growth. The increase was also a result of employees added from the acquisition of Afterpay in the first quarter of 2022. The increase in personnel-related costs includes an increase in share-based compensation expense of $157.9 million for the year ended December 31, 2022;•acquisition related integration and other expenses related to Afterpay of $67.3 million for the year ended December 31, 2022, as well as a $66.3 million one-time charge related to the acceleration of various share-based arrangements associated with the Afterpay acquisition during the three months ended March 31, 2022, which was in addition to ongoing share-based compensation expense for Afterpay employees; and•an increase in software, subscription costs and other professional fees, and other administrative expenses. Transaction, loan, and consumer receivable losses for the year ended December 31, 2022, increased by $362.7 million, or 193%, compared to the year ended December 31, 2021, primarily due to the following: •an increase in the allowance for credit losses related to consumer receivables of $197.6 million from the date of the acquisition of Afterpay through December 31, 2022;•an increase in transaction losses compared to the year ended December 31, 2021 of $87.0 million, primarily due to growth in Square GPV; and•an increase in loan losses compared to the year ended December 31, 2021 of $78.1 million, primarily due to increased loan volumes.We recorded impairment charges on our investment in bitcoin of $46.6 million in the year ended December 31, 2022 due to the observed market price of bitcoin decreasing below the carrying value of our investment during the period. As of December 31, 2022, the cumulative impairment charges to date were $117.7 million and the fair value of our investment in bitcoin was $132.7 million based on observable market prices, which was $30.4 million in excess of the carrying value of $102.3 million after cumulative impairment charges. Under the current accounting guidance, any unrealized gains on our investment in bitcoin will only be recognized in the financial statements when realized upon the sale of such bitcoin investment.Amortization of customer and other acquired intangible assets increased $123.0 million for the year ended December 31, 2022, compared to the year ended December 31, 2021, primarily due to increased amortization expense of $121.8 million as a result of the intangible assets from the Afterpay acquisition. Refer to Note 11, Acquired Intangible Assets within Notes to the Consolidated Financial Statements for more details.Interest Expense, net, and Other Expense (Income), net (in thousands, except for percentages)Year Ended December 31,20222021$ Change% ChangeInterest expense, net$36,228 $33,124 $3,104 9 %Other income, net(95,443)(29,474)(65,969)NM (i)(i) Not meaningful ("NM")Interest expense, net, for the year ended December 31, 2022 increased by $3.1 million, or 9%, compared to the year ended December 31, 2021. This increase was primarily due to interest expense related to our 2026 Senior Notes and 2031 Senior Notes, which were issued in May 2021. Refer to Note 15, Indebtedness within Notes to the Consolidated Financial Statements for further details.72Other income, net for the year ended December 31, 2022 was primarily comprised of unrealized gains of $96.1 million arising from the revaluation of certain equity investments. Other income, net for the year ended December 31, 2021 was primarily comprised of a $44.4 million mark to market net gain of our equity investment in DoorDash, arising from the revaluation of this investment. We completed the sale of our investment in DoorDash in June 2021, and as a result this investment did not impact our results in subsequent periods.Segment ResultsThe Company has two reportable segments, Square and Cash App. The results of Afterpay have been equally allocated to the Square and Cash App segments as management has determined that our BNPL platform will contribute equally to both the Square and Cash App platforms. Refer to Note 21, Segment and Geographical Information within Notes to the Consolidated Financial Statements for more details.Square ResultsThe following tables provide a summary of the revenue and gross profit for our Square segment for the year ended December 31, 2022 and 2021 (in thousands, except for percentages):Year Ended December 31,20222021$ Change% ChangeSegment net revenue$6,699,830 $5,193,348 $1,506,482 29 %Segment cost of revenue3,698,852 2,876,677 822,175 29 %Segment gross profit$3,000,978 $2,316,671 $684,307 30 %Segment Net RevenueNet revenue for the Square segment for the year ended December 31, 2022 increased by $1.5 billion compared to the year ended December 31, 2021. The increase was primarily due to:•growth in Square GPV and continued improvements in both card-present volumes and growth in higher-priced card-not-present transactions;•an increase in subscription and services-based revenue, which was primarily due to the growth in seller banking products, including the increased origination volumes of Square Loans, as well as software subscriptions; and•revenue generated from our BNPL platform following the acquisition of Afterpay.Segment Cost of RevenueCost of revenue for the Square segment for the year ended December 31, 2022 increased by $822.2 million compared to the year ended December 31, 2021. The increase was primarily due to an increase in Square GPV, as well as an increase in credit card transactions that have a higher cost per transaction than debit card transactions.Cash App ResultsThe following tables provide a summary of the revenue and gross profit for our Cash App segment for the year ended December 31, 2022 and 2021 (in thousands, except for percentages):Year Ended December 31,20222021$ Change% ChangeSegment net revenue$10,626,111 $12,315,499 $(1,689,388)(14)%Segment cost of revenue7,675,144 10,244,652 (2,569,508)(25)%Segment gross profit$2,950,967 $2,070,847 $880,120 43 %73Segment Net RevenueNet revenue for the Cash App segment for the year ended December 31, 2022 decreased by $1.7 billion compared to the year ended December 31, 2021. The primary driver was a decrease in bitcoin revenue, partially offset by growth in Cash App Instant Deposit, Cash App Card, and peer-to-peer transactions received by Cash App Business accounts. The decrease in bitcoin revenue was driven by a decline in the market price of bitcoin as compared to prior year. While bitcoin revenue contributed 67% and 81% of Cash App net revenue in 2022 and 2021, respectively, gross profit generated from bitcoin was only 5% and 11% of Cash App gross profit in 2022 and 2021, respectively. Excluding bitcoin revenue, Cash App net revenue increased $1.2 billion, or 53%, compared to the year ended December 31, 2021, primarily due to growth in the number of active Cash App accounts, an increase in transaction fees related to Cash App Card and Instant Deposit, and revenue generated from our BNPL platform following the acquisition of Afterpay.Segment Cost of RevenueCost of revenue for the Cash App segment for the year ended December 31, 2022 decreased by $2.6 billion compared to the year ended December 31, 2021. The primary driver for the decrease was a decline in bitcoin revenue as well as the associated costs of such bitcoin revenue, as discussed above. Excluding bitcoin cost of revenue, Cash App cost of revenue increased $268.8 million, or 60%, due to the growth in Cash App Card, Cash App Instant Deposit, and Cash for Business. 74Key Operating Metrics and Non-GAAP Financial Measures We collect and analyze operating and financial data to evaluate the health of our business, allocate our resources, and assess our performance. In addition to total net revenue, net income (loss), and other results under generally accepted accounting principles ("GAAP"), the following table sets forth key operating metrics and non-GAAP financial measures we use to evaluate our business. We believe these metrics and measures are useful to facilitate period-to-period comparisons of our business, and to facilitate comparisons of our performance to that of other payment solution providers.Year Ended December 31,20222021202020192018Gross Payment Volume (GPV) (in millions)$203,536 $167,720 $112,295 $106,239 $84,654 Adjusted EBITDA (in thousands)$990,964 $1,013,657 $474,071 $416,853 $256,523 Adjusted Net Income Per Share:Basic$1.05 $1.46 $0.72 $0.70 $0.47 Diluted$1.00 $1.28 $0.64 $0.62 $0.40 Gross Payment Volume ("GPV")GPV includes Square GPV and Cash App Business GPV. Square GPV is defined as the total dollar amount of all card payments processed by sellers using Square, net of refunds, and ACH transfers. Cash App Business GPV is comprised of Cash App activity related to peer-to-peer transactions received by business accounts, Cash App Pay transactions, and peer-to-peer payments sent from a credit card. GPV does not include transactions from our BNPL platform because GPV is related only to transaction-based revenue and not to subscription and services-based revenue.Adjusted EBITDA and Adjusted Net Income (Loss) Per Share ("Adjusted EPS")Adjusted EBITDA and Adjusted EPS are non-GAAP financial measures that represent our net income (loss) and net income (loss) per share, adjusted to eliminate the effect of items as described below. We have included these non-GAAP financial measures in this Form 10-K because they are key measures used by our management to evaluate our operating performance, generate future operating plans, and make strategic decisions, including those relating to operating expenses and the allocation of internal resources. Accordingly, we believe these measures provide useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors. In addition, they provide useful measures for period-to-period comparisons of our business, as they remove the effect of certain non-cash items and certain variable charges that do not vary with our operations.•We believe it is useful to exclude certain non-cash charges, such as amortization of intangible assets, and share-based compensation expenses, from our non-GAAP financial measures because the amount of such expenses in any specific period may not directly correlate to the underlying performance of our business operations.•In connection with the issuance of our convertible senior notes (as described in Note 15, Indebtedness within Notes to the Consolidated Financial Statements), prior to the adoption of ASU No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity's Own Equity ("ASU 2020-06") on January 1, 2021, we were required to recognize non-cash interest expense related to amortization of debt discount and issuance costs. Subsequent to adoption, we only recognize non-cash interest expense related to amortization of debt issuance costs on convertible notes and unsecured notes. We believe that excluding this expense from our non-GAAP measures is useful to investors because such incremental non-cash interest expense does not represent a current or future cash outflow for the Company and is therefore not indicative of our continuing operations or meaningful when comparing current results to past results. Additionally, for purposes of calculating diluted Adjusted EPS we add back cash interest expense on convertible notes, as if converted at the beginning of the period, if the impact is dilutive.75•We exclude the following from non-GAAP financial measures because we do not believe that these items are reflective of our ongoing business operations: gain or loss on the disposal of property and equipment; gain or loss on revaluation of equity investments; bitcoin impairment losses on our investment in bitcoin, as applicable; and prior to the adoption of ASU 2020-06 on January 1, 2021, gain or loss on debt extinguishment related to the conversion of convertible notes, as applicable.•To aid in comparability of our results across periods and with peer companies that may not have similar expenses, we also exclude certain acquisition related and integration costs associated with business combinations, and various other costs that are not normal operating expenses. Acquisition related costs include amounts paid to redeem acquirees’ unvested share-based compensation awards, and legal, accounting, valuation, and due diligence costs. Integration costs include advisory and other professional services or consulting fees necessary to integrate acquired businesses. Other costs that are not reflective of our core business operating expenses may include contingent losses, certain litigation and regulatory charges. We also add back the impact of the acquired deferred revenue and deferred cost adjustment, which was written down to fair value in purchase accounting.In addition to the items above, Adjusted EBITDA as a non-GAAP financial measure also excludes depreciation and amortization, other cash interest income and expense, and other income and expense.Beginning in the first quarter of 2022, we have included the tax impact of the non-GAAP adjustments in determining Adjusted EPS. We determine the adjusted provision (benefit) for income taxes by calculating the estimated annual effective tax rate based on adjusted pre-tax income and applying it to Adjusted Net Income before income taxes. The prior period Adjusted EPS presentation has also been revised to conform with our new calculation and presentation.Non-GAAP financial measures have limitations, should be considered as supplemental in nature, and are not meant as a substitute for the related financial information prepared in accordance with GAAP. These limitations include the following:•share-based compensation expense has been, and will continue to be for the foreseeable future, a significant recurring expense in our business and an important part of our compensation strategy;•the intangible assets being amortized may have to be replaced in the future, and the non-GAAP financial measures do not reflect cash capital expenditure requirements for such replacements or for new capital expenditures or other capital commitments; and•non-GAAP measures do not reflect changes in, or cash requirements for, our working capital needs.In addition to the limitations above, Adjusted EBITDA as a non-GAAP financial measure does not reflect the effect of depreciation and amortization expense and related cash capital requirements, income taxes that may represent a reduction in cash available to us, and the effect of foreign currency exchange gains or losses, which is included in other income and expense.Other companies, including companies in our industry, may calculate the non-GAAP financial measures differently or not at all, which reduces their usefulness as comparative measures.Because of these limitations, you should consider the non-GAAP financial measures alongside other financial performance measures, including net income (loss) and our other financial results presented in accordance with GAAP.76The following table presents a reconciliation of net income (loss) to Adjusted EBITDA for each of the periods indicated (in thousands):Year Ended December 31,20222021202020192018Net income (loss) attributable to common stockholders$(540,747)$166,284 $213,105 $375,446 $(38,453)Net loss attributable to noncontrolling interests(12,258)(7,458)— — — Net income (loss)(553,005)158,826 213,105 375,446 (38,453)Share-based compensation expense1,069,289 608,042 397,500 297,863 216,881 Depreciation and amortization340,523 134,756 84,212 75,598 60,961 Acquisition related, integration, and other costs157,264 35,474 7,482 9,739 4,708 Interest expense, net36,228 33,124 56,943 21,516 17,982 Other expense (income), net(95,443)(29,474)(291,725)273 (18,469)Bitcoin impairment losses46,571 71,126 — — — Provision (benefit) for income taxes(12,312)(1,364)2,862 2,767 2,326 Loss (gain) on disposal of property and equipment1,619 2,633 2,570 1,008 (224)Gain on sale of asset group— — — (373,445)— Acquired deferred revenue adjustment382 744 1,497 7,457 12,853 Acquired deferred costs adjustment(152)(230)(375)(1,369)(2,042)Adjusted EBITDA$990,964 $1,013,657 $474,071 $416,853 $256,523 77The following table presents a reconciliation of net income (loss) to Adjusted Net Income (Loss) Per Share for each of the periods indicated (in thousands, except per share data):Year Ended December 31,20222021202020192018Net income (loss) attributable to common stockholders$(540,747)$166,284 $213,105 $375,446 $(38,453)Net loss attributable to noncontrolling interests(12,258)(7,458)— — — Net income (loss)$(553,005)$158,826 $213,105 $375,446 $(38,453)Share-based compensation expense1,069,289 608,042 397,500 297,863 216,881 Acquisition related, integration, and other costs157,264 35,474 7,482 9,739 4,708 Amortization of intangible assets208,952 40,522 19,239 15,000 13,103 Amortization of debt discount and issuance costs15,162 9,822 67,979 39,139 32,855 Loss (gain) on revaluation of equity investments(73,457)(35,493)(295,297)12,326 (20,342)Bitcoin impairment losses46,571 71,126 — — — Loss on extinguishment of long-term debt— — 6,651 — 5,028 Loss (gain) on disposal of property and equipment1,619 2,633 2,570 1,008 (224)Gain on sale of asset group— — — (373,445)— Acquired deferred revenue adjustment382 744 1,497 7,457 12,853 Acquired deferred cost adjustment(152)(230)(375)(1,369)(2,042)Tax effect of non-GAAP net income adjustments(264,523)(222,104)(102,383)(85,372)(34,371)Adjusted Net Income - basic$608,102 $669,362 $317,968 $297,792 $189,996 Cash interest expense on convertible notes5,014 6,099 6,078 5,108 1,292 Adjusted Net Income - diluted$613,116 $675,461 $324,046 $302,900 $191,288 Weighted-average shares used to compute Adjusted Net Income Per Share:Basic578,949 458,432 443,126 424,999 405,731 Diluted615,034 525,725 507,229 486,381 478,895 Adjusted Net Income Per Share:Basic$1.05 $1.46 $0.72 $0.70 $0.47 Diluted$1.00 $1.28 $0.64 $0.62 $0.40 Diluted Adjusted Net Income Per Share is computed by dividing Adjusted Net Income by the weighted-average number of shares of common stock outstanding adjusted for the dilutive effect of all potential shares of common stock. In periods when we reported an Adjusted Net Loss, diluted Adjusted Net Income Per Share is the same as basic Adjusted Net Income Per Share because the effects of potentially dilutive items were anti-dilutive.The following table presents a reconciliation of the tax effect of non-GAAP net income adjustments to our provision (benefit) for income taxes (in thousands, except effective tax rate):Year Ended December 31,20222021202020192018Provision (benefit) for income taxes, as reported$(12,312)$(1,364)$2,862 $2,767 $2,326 Tax effect of non-GAAP net income adjustments264,523 222,104 102,383 85,372 34,371 Adjusted provision for income taxes, non-GAAP$252,211 $220,740 $105,245 $88,139 $36,697 Non-GAAP effective tax rate29%25%25%23%16%We determined the adjusted provision for income taxes by calculating the estimated annual effective tax rate based on adjusted pre-tax income and applying it to Adjusted Net Income before income taxes.78Liquidity and Capital ResourcesAs of December 31, 2022, we had approximately $7.5 billion in available funds, including an undrawn amount of $600.0 million available under our revolving credit facility. Additionally, we had $389.4 million available under our warehouse funding facilities. We intend to continue focusing on our long-term business initiatives and believe that our available funds are sufficient to meet our liquidity needs for the foreseeable future. As of December 31, 2022, we were in compliance with all covenants associated with our revolving credit facility and senior notes. None of our warehouse funding facilities contain financial covenants.The following table summarizes our cash, cash equivalents, restricted cash, customer funds, and investments in marketable debt securities (in thousands):Year Ended December 31,20222021Cash and cash equivalents$4,544,202 $4,443,669 Short-term restricted cash639,780 18,778 Long-term restricted cash71,600 71,702 Customer funds cash and cash equivalents3,180,324 2,440,941 Cash, cash equivalents, restricted cash, and customer funds8,435,906 6,975,090 Investments in short-term debt securities1,081,851 869,283 Investments in long-term debt securities573,429 1,526,430 Cash, cash equivalents, restricted cash, customer funds, and investments in marketable debt securities$10,091,186 $9,370,803 Our principal sources of liquidity are our cash and cash equivalents, and investments in marketable debt securities. As of December 31, 2022, we had $10.1 billion of cash and cash equivalents, restricted cash, customer funds cash and cash equivalents, and investments in marketable debt securities. Customer funds cash and cash equivalents are separate from the Company's corporate funds and are not used for any corporate purposes. These funds are not used for Company liquidity, but rather to meet the obligations set aside for customers. Investments in marketable debt securities were held primarily in cash deposits, money market funds, reverse repurchase agreements, U.S. government and agency securities, commercial paper, and corporate bonds. We consider all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Our investments in marketable debt securities are classified as available-for-sale. Excluding customer funds, our total liquidity as of December 31, 2022 was $6.9 billion. As of December 31, 2022, we have purchased a cumulative $220.0 million in bitcoin for investment purposes. We believe cryptocurrency is an instrument of economic empowerment that aligns with our corporate purpose. We expect to hold these investments for the long term but will continue to reassess our investment in bitcoin relative to our balance sheet. As bitcoin is considered an indefinite-lived intangible asset, under the accounting policy for such assets, we are required to recognize any decreases in market prices below carrying value as an impairment charge, with any mark up in value or reversal of impairment prohibited if the market price of bitcoin subsequently increases. We recorded impairment charges of $46.6 million in the year ended December 31, 2022 due to the observed market price of bitcoin decreasing below the carrying value during the period. As of December 31, 2022, the fair value of the investment in bitcoin was $132.7 million based on observable market prices, which is $30.4 million in excess of our carrying value of $102.3 million after cumulative impairment charges.In September 2020, we announced our intent to invest $100.0 million in supporting underserved communities, particularly, racial and ethnic minority groups who have been disproportionately affected by COVID-19. This initiative further deepens our commitment toward economic empowerment to help broaden such communities' access to financial services. As of December 31, 2022, we have invested $32.0 million in aggregate towards this initiative, of which $10.1 million and $21.5 million were invested in the years ended December 31, 2022 and 2021, respectively.Our principal commitments consist of convertible notes, senior notes, revolving credit facility, warehouse funding facilities, operating leases, and purchase commitments. Refer to Note 15, Indebtedness and Note 20, Commitments and Contingencies within Notes to the Consolidated Financial Statements for more details on these commitments.79Senior Notes and Convertible NotesAs of December 31, 2022, we held $4.6 billion in aggregate principal amount of debt, comprised of $460.6 million in aggregate principal amount of convertible senior notes that mature on May 15, 2023 ("2023 Convertible Notes"), $1.0 billion in aggregate amount of convertible senior notes that mature on March 1, 2025 ("2025 Convertible Notes"), $575.0 million in aggregate amount of convertible senior notes that mature on May 1, 2026 ("2026 Convertible Notes"), and $575.0 million in aggregate amount of convertible senior notes that mature on November 1, 2027 ("2027 Convertible Notes," and together with the 2023 Convertible Notes, 2025 Convertible Notes, and 2026 Convertible Notes, the “Convertible Notes”). Additionally, on May 20, 2021, we issued $1.0 billion in aggregate principal amount of outstanding senior unsecured notes that mature on June 1, 2026 ("2026 Senior Notes") and $1.0 billion in aggregate principal amount of outstanding senior unsecured notes that mature on June 1, 2031 ("2031 Senior Notes" and, together with the 2026 Senior Notes, the “Senior Notes” and, together with the Convertible Notes, the “Notes”). The 2023 Convertible Notes bear interest at a rate of 0.50% payable semi-annually on May 15 and November 15 of each year, the 2025 Convertible Notes bear interest at a rate of 0.125% payable semi-annually on March 1 and September 1 of each year, the 2026 Convertible Notes bear no interest, and the 2027 Convertible Notes bear interest at a rate of 0.25% payable semi-annually on May 1 and November 1 of each year. These Convertible Notes can be converted or repurchased prior to maturity if certain conditions are met. The 2026 Senior Notes bear interest a rate of 2.75% payable semi-annually on June 1 and December 1, while the 2031 Senior Notes bear interest at a rate of 3.50% payable semi-annually on June 1 and December 1 of each year. These Senior Notes can be redeemed or repurchased prior to maturity if certain conditions are met.On January 31, 2022, we closed the acquisition of Afterpay and assumed Afterpay's outstanding convertible notes of $1.1 billion, which we redeemed in cash on March 4, 2022 at face value. Refer to Note 9, Acquisitions within Notes to the Consolidated Financial Statements for further details.Revolving Credit FacilityWe have entered into a revolving credit agreement with certain lenders, as subsequently amended, which provides a $500.0 million senior unsecured revolving credit facility (the "2020 Credit Facility") maturing in May 2024. On February 23, 2022, the Company entered into a sixth amendment to the Credit Agreement to, among other things, provide for a new tranche of unsecured revolving loan commitments in an aggregate principal amount of up to $100.0 million (the "Tranche B Loans"). Loans under the 2020 Credit Facility, excluding the Tranche B Loans, bear interest at our option of (i) a base rate based on the highest of the prime rate, the federal funds rate plus 0.50%, and the adjusted LIBOR rate plus 1.00%, in each case, plus a margin ranging from 0.25% to 0.75% or (ii) an adjusted LIBOR rate plus a margin ranging from 1.25% to 1.75%. The margin is determined based on our total net leverage ratio, as defined in the agreement. The Tranche B Loans bear interest at the Company's option of (i) an annual rate based on the forward-looking term rate based on the Secured Overnight Financing Rate ("Term SOFR") or (ii) a base rate. Tranche B Loans based on Term SOFR shall bear interest at a rate equal to Term SOFR plus a margin of between 1.25% and 1.75%, depending on the Company's total net leverage ratio. Tranche B Loans based on the base rate shall bear interest at a rate based on the highest of the prime rate, the federal funds rate plus 0.50%, and Term SOFR with a tenor of one-month plus 1.00%, in each case, plus a margin ranging from 0.25% to 0.75%, depending on the Company's total net leverage ratio. We are obligated to pay other customary fees for a credit facility of this size and type including an unused commitment fee of 0.15%. To date, no funds have been drawn and no letters of credit have been issued under the 2020 Credit Facility. Warehouse Funding FacilitiesFollowing the acquisition of Afterpay, we assumed Afterpay's existing warehouse funding facilities ("Warehouse Facilities") with an aggregate commitment amount of $1.7 billion on a revolving basis, of which $1.3 billion was drawn and $0.4 billion remained available as of December 31, 2022. The Warehouse Facilities have been arranged utilizing wholly-owned and consolidated entities formed for the sole purpose of financing the origination of consumer receivables to partly fund our BNPL platform. Borrowings under the Warehouse Facilities are secured against the respective consumer receivables.80Cash, Restricted Cash, and Working CapitalWe believe that our existing cash and cash equivalents, investment in marketable debt securities, and availability under our line of credit will be sufficient to meet our working capital needs, including any expenditures related to strategic transactions and investment commitments that we may from time to time enter into, and planned capital expenditures for at least the next 12 months. From time to time, we have raised capital by issuing equity, equity-linked, or debt securities such as our convertible notes and senior notes; and we may do so in the future, however, such funding may not be available on terms acceptable to us or at all.When we were last rated, in the second half of 2022, we received a non-investment grade rating by S&P Global Ratings (BB), Fitch Ratings, Inc. (BB), and Moody's Corporation (Ba2). We expect that these credit rating agencies will continue to monitor our performance, including our capital structure and results of operations. Our liquidity, access to capital, and borrowing costs could be adversely impacted by declines in our credit rating.We have entered into various non-cancelable operating leases for certain offices with contractual lease periods expiring between 2022 and 2034. We recognized total rental expenses under operating leases of $93.6 million, $80.3 million, and $75.2 million during the years ended December 31, 2022, 2021, and 2020, respectively. As of December 31, 2022, we had non-cancelable purchase obligations related to cloud computing infrastructure of $1.3 billion. We do not have any off-balance sheet arrangements during the periods presented. Short-term restricted cash of $639.8 million as of December 31, 2022 primarily includes cash held by the wholly-owned consolidated entities used in the Warehouse Facilities funding arrangements, that will be used to pay the borrowings under the Warehouse Facilities or will be distributed to us. It also includes pledged cash deposits in accounts at the financial institutions that process our sellers' payment transactions and collateral pursuant to various agreements with banks relating to our products. We use restricted cash to secure letters of credit with the related financial institutions to provide collateral for cash flow timing differences in the processing of payments. We have recorded these amounts as current assets on our consolidated balance sheet given the short-term nature of these cash flow timing differences and that there is no minimum time frame during which the cash must remain restricted.Long-term restricted cash of $71.6 million as of December 31, 2022 is primarily related to cash held as collateral as required by the FDIC for Square Financial Services. We have recorded these amounts as non-current assets on our consolidated balance sheet as the requirement by the FDIC specifies a time frame of 12 months or longer during which the cash must remain restricted.We experience significant day-to-day fluctuations in our cash and cash equivalents due to fluctuations in settlements receivable, and customers payable, and hence working capital. These fluctuations are primarily due to:•Timing of period end. For periods that end on a weekend or a bank holiday, our cash and cash equivalents, settlements receivable, and customers payable balances typically will be higher than for periods ending on a weekday, as we settle to our sellers for payment processing activity on business days; and•Fluctuations in daily GPV. When daily GPV increases, our cash and cash equivalents, settlements receivable, and customers payable amounts increase. Typically our settlements receivable and customers payable balances at period end represent one to four days of receivables and disbursements to be made in the subsequent period. Customers payable, excluding amounts attributable to Cash App stored funds, and settlements receivable balances typically move in tandem, as pay-out and pay-in largely occur on the same business day. However, customers payable balances will be greater in amount than settlements receivable balances due to the fact that a subset of funds are held due to unlinked bank accounts, risk holds, and chargebacks. Also customer funds obligations, which are included in customers payable, may cause customers payable to trend differently than settlements receivable. Holidays and day-of-week may also cause significant volatility in daily GPV amounts.81Safeguarding Obligation Liability and Safeguarding Asset Related to Bitcoin Held for Other PartiesAs detailed in Note 14, Bitcoin Held for Other Parties within Notes to the Consolidated Financial Statements, upon the adoption of SAB 121, we recorded a safeguarding obligation liability and a corresponding safeguarding asset related to the bitcoin held for other parties. As of December 31, 2022, the safeguarding obligation liability related to bitcoin held for other parties was $428.2 million. We have taken steps to mitigate the potential risk of loss for the bitcoin held for other parties, including holding insurance coverage specifically for certain bitcoin incidents and using secure cold storage to store materially all of the bitcoin held for other parties. SAB 121 also asks us to consider the legal ownership of the bitcoin held for other parties, including whether the bitcoin held for other parties would be available to satisfy general creditor claims in the event of Block’s bankruptcy. The legal rights of people with respect to crypto-assets held on their behalf by a custodian, such as us, upon the custodian’s bankruptcy have not yet been settled by courts and are highly fact dependent. Our contractual arrangements state that our customers and trading partners retain legal ownership of the bitcoin custodied by us on their behalf; they have the right to sell, pledge, or transfer the bitcoin; and they also benefit from the rewards and bear the risks associated with the ownership, including as a result of any bitcoin price fluctuations. We do not use any of the bitcoin held for other parties as collateral for our loans or any other financing arrangements, nor do we lend or pledge bitcoin held for others to any third parties. We have been monitoring and will continue to actively monitor legal and regulatory developments and may consider further steps, as appropriate, to support this contractual position so that in the event of Block’s bankruptcy, the bitcoin custodied by us should not be deemed to be part of Block's bankruptcy estate. We do not expect potential future cash flows associated with the bitcoin safeguarding obligation liability.Cash Flow ActivitiesThe following table summarizes our cash flow activities (in thousands):Year Ended December 31,20222021Net cash provided by operating activities$175,903 $847,830 Net cash provided by (used in) investing activities1,225,696 (1,310,879)Net cash provided by financing activities97,580 2,652,034 Effect of foreign exchange rate on cash and cash equivalents(38,363)(7,066)Net increase in cash, cash equivalents, restricted cash, and customer funds$1,460,816 $2,181,919 Cash Flows from Operating ActivitiesFor the year ended December 31, 2022, cash provided by operating activities was $175.9 million, primarily due to net income of $553.0 million, adjusted for the add back of non-cash expenses of $1.4 billion consisting primarily of share-based compensation; transaction, loan, and consumer receivable losses; depreciation and amortization; non-cash interest; and bitcoin impairment losses. This was offset by a net outflow from amortization of discounts and premiums and other non-cash adjustments of $592.5 million and changes in other assets and liabilities of $674.4 million due to timing of period end.For the year ended December 31, 2021, cash provided by operating activities was $847.8 million, primarily due to net income of $158.8 million, adjusted for the add back of non-cash expenses of $1.1 billion consisting primarily of share-based compensation, transaction and loan losses, depreciation and amortization, non-cash interest, bitcoin impairment losses and other expenses. This was offset by a net outflow from changes in other assets and liabilities of $325.2 million due to timing of period end, as well as PPP loans facilitated, less loans sold, of $56.0 million.Cash Flows from Investing Activities Cash flows used in investing activities primarily relate to business acquisitions, consumer receivables, capital expenditures to support our growth, and investments in marketable debt securities.For the year ended December 31, 2022, cash provided by investing activities was $1.2 billion, primarily due to the net proceeds from investments of marketable securities, including investments from customer funds, of $1.1 billion. Additional inflows of cash were as a result of business acquisitions, net of cash acquired, of $539.5 million. These were partially offset by the purchase of property and equipment of $170.8 million, net consumer receivable originations of $169.4 million, and purchases of other investments of $56.7 million.82For the year ended December 31, 2021, cash used in investing activities was $1.3 billion, primarily due to the net proceeds from investments of marketable securities, including investments from customer funds, of $1.2 billion. Additional uses of cash were as a result of business acquisitions, net of cash acquired of $164.0 million, the purchase of bitcoin investments of $170.0 million, the purchase of property and equipment of $134.3 million, and purchases of other investments of $48.5 million. These were partially offset by proceeds from sales of equity investments of $420.6 million.Cash Flows from Financing ActivitiesFor the year ended December 31, 2022, cash provided by financing activities was $97.6 million, primarily as a result of net proceeds from warehouse facilities borrowings of $1.2 billion, a change in customer funds of $349.3 million, as well as proceeds from issuances of common stock from the exercise of options and purchases under our employee share purchase plan of $81.8 million. These were offset by the payment to redeem convertible notes assumed upon the acquisition of Afterpay of $1.1 billion and repayments of the PPPLF advances of $480.7 million.For the year ended December 31, 2021, cash provided by financing activities was $2.7 billion, primarily as a result of $2.0 billion in net proceeds from the 2031 Senior Notes and 2026 Senior Notes offerings, proceeds from issuances of common stock from the exercise of options and purchases under our employee share purchase plan of $126.7 million, offset by payments for employee tax withholding related to vesting of restricted stock units of $323.0 million.Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. GAAP requires us to make certain estimates and judgments that affect the amounts reported in our financial statements. We base our estimates on historical experience, anticipated future trends, and other assumptions we believe to be reasonable under the circumstances. Because these accounting policies require significant judgment, our actual results may differ materially from our estimates.We believe accounting policies and the assumptions and estimates associated with transaction losses and business combinations could potentially have a material effect on our consolidated financial statements, and therefore are critical accounting policies and estimates.83Business CombinationsAs a result of the acquisitions of TIDAL, completed in the second quarter of 2021, and Afterpay, completed on January 31, 2022, we consider accounting for business combinations under ASC 805, Business Combinations, to also be a critical accounting policy and estimate as it requires management to make significant estimates and assumptions, including the valuation of intangible assets acquired, determination of fair values of liabilities assumed including pre-acquisition contingencies and valuation of contingent consideration, where applicable. Although we believe that the assumptions and estimates we have made have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results. The carrying value of our acquired intangible assets as of December 31, 2022 was $2.0 billion. Refer to Note 9, Acquisitions and Note 11, Acquired Intangible Assets within Notes to the Consolidated Financial Statements for further details.Accrued Transaction LossesWe are exposed to credit losses related to transactions processed by sellers that are subsequently subject to chargebacks when we are unable to collect from the sellers primarily due to insolvency, disputes between a seller and their customer, or due to fraudulent transactions. Generally, we estimate the potential loss rates based on historical experience that is continuously adjusted for new information and incorporates, where applicable, reasonable and supportable forecasts about future expectations. We also consider other relevant market data in developing such estimates and assumptions. Accrued transaction losses also include estimated losses on Cash App activity related to peer-to-peer payments sent from a credit card, Cash for Business, and Cash App Card. As of December 31, 2022, we had accrued $64.5 million related to transaction losses. Additions to the reserve are reflected in current operating results, while realized losses are offset against the reserve. These amounts are classified within transaction, loan, and consumer receivable losses on the consolidated statements of operations, except for the amounts associated with the peer-to-peer service offered to Cash App customers for free that are classified within sales and marketing expenses. Refer to Note 1, Description of Business and Summary of Significant Accounting Policies and Note 12, Other Consolidated Balance Sheet Components (Current) within Notes to the Consolidated Financial Statements for further details.Allowance for Credit Losses Related to Consumer ReceivablesWe are exposed to credit losses on our consumer receivables portfolio. We estimate the expected credit losses in the outstanding portfolio of consumer receivables using both quantitative and qualitative methods that analyze portfolio performance, uses judgment regarding the quantitative components of the reserve, and considers all available information relevant to assessing collectibility. As of December 31, 2022, we had accrued $151.3 million related to allowance for credit losses. Refer to Note 1, Description of Business and Summary of Significant Accounting Policies and Note 6, Consumer Receivables, net within Notes to the Consolidated Financial Statements for further details.Recent Accounting PronouncementsSee “Recent Accounting Pronouncements” described in Note 1, Description of Business and Summary of Significant Accounting Policies within Notes to the Consolidated Financial Statements.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe have operations both within the United States and globally, and we are exposed to market risks in the ordinary course of our business, including the effects of interest rate changes and foreign currency fluctuations. Information relating to quantitative and qualitative disclosures about these market risks is described below.84Equity Price RiskMarketable Equity InvestmentsOur marketable equity investments are investments held in publicly-traded companies and are measured using quoted prices in active markets which could result in volatility in our financial results in future periods. As of December 31, 2022, our marketable equity investments were immaterial. Adjustments are recorded in other (expense) income, net on the consolidated statements of operations and establish a new carrying value for the investment. A hypothetical 10% increase or decrease in the fair value of our marketable equity investments would not have a material effect on our financial results.Non-Marketable Equity InvestmentsOur non-marketable equity investments are investments in privately-held companies that we hold for purposes other than trading. These investments are inherently risky because there is no established market for these securities and the markets for the technologies or products these companies are developing are typically in the early stages. As such, we could lose our entire investment in these companies. Adjustments are recorded in other expense (income), net on the consolidated statements of operations and establish a new carrying value for the investment. As of December 31, 2022, the aggregate carrying value of our non-marketable equity investments included in other non-current assets was $208.9 million. A hypothetical 10% increase or decrease in the carrying value of our non-marketable equity investments would not have a material effect on our financial results.Bitcoin Market Price RiskAs of December 31, 2022, we had made cumulative investments in bitcoin of $220.0 million. Our investment in bitcoin is accounted for as an indefinite-lived intangible asset, and thus, is subject to impairment losses if the fair value of bitcoin decreases below the carrying value during the assessed reporting period. Impairment losses cannot be recovered for any subsequent increase in fair value until the sale of the asset. We recorded an impairment charge on our investment in bitcoin of $46.6 million in the year ended December 31, 2022 due to the observed market price of bitcoin decreasing below the carrying value during the period. As of December 31, 2022, the cumulative impairment charges to date were $117.7 million and the fair value of the investment in bitcoin was $132.7 million based on observable market prices, which is $30.4 million in excess of our carrying value of $102.3 million after impairment charges. Any decreases to the carrying value of bitcoin investments are recorded in operating expenses on the consolidated statements of operations. A hypothetical 10% increase or decrease in the market price of bitcoin would not have a material effect on our financial results.Interest Rate SensitivityOur cash and cash equivalents, and marketable debt securities as of December 31, 2022 were held primarily in cash deposits, money market funds, U.S. government and agency securities, commercial paper, and corporate bonds. The fair value of our cash, cash equivalents, and marketable debt securities would not be significantly affected by either an increase or decrease in interest rates due mainly to the short-term nature of a majority of these instruments. Additionally, we have the ability to hold these instruments until maturity if necessary to reduce our risk. Our Warehouse Facilities borrowings and any future borrowings incurred under the 2020 Credit Facility both accrue interest at variable rates based on formulas tied to certain market rates at the time of incurrence. A hypothetical 10% increase or decrease in interest rates would not have a material effect on our financial results.Foreign Currency RiskOur consolidated financial statements are presented in U.S. dollars. Most of our revenue is earned in U.S. dollars and, subsequent to the acquisition of Afterpay, a portion is earned in Australian Dollars. Our foreign operations are denominated in the currencies of the countries in which our operations are located, and may be subject to fluctuations due to changes in foreign currency exchange rates. Our results of operations and cash flows are, therefore, subject to fluctuations in foreign currency exchange rates and may cause us to recognize transaction gains and losses on our financial statements.85From time to time, we use foreign exchange derivative contracts to hedge a portion of our exposure to changes in currency exchange rates, which result from our global operating and financing activities. We do not use derivative financial instruments for trading or speculative purposes. Gains and losses from foreign currency transactions, as well as foreign exchange forward contracts, were not significant for the any period presented in the consolidated financial statements included in this Form 10-K. We did not have any material foreign currency derivatives outstanding as of December 31, 2022. A hypothetical 10% increase or decrease in current exchange rates on our financial instruments would not have a material effect on our financial results.86
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion should be read in conjunction with the consolidated financial statements and notes appearing elsewhere in this report. Historical results and trends which might appear in the consolidated financial statements should not be interpreted as being indicative of future operations.Discussion of our year-to-date comparisons between 2022 and 2021 is presented below. Year-to-date comparisons between 2021 and 2020 can be found in "Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.We consider portions of this report to be "forward-looking" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, both as amended, with respect to our expectations for future periods. Forward-looking statements do not discuss historical fact, but instead include statements related to expectations, projections, intentions, or other items relating to the future; forward-looking statements are not guarantees of future performance, results, or events. Although we believe the expectations reflected in our forward-looking statements are based upon reasonable assumptions, we can give no assurance our expectations will be achieved. Any statements contained herein which are not statements of historical fact should be deemed forward-looking statements. Reliance should not be placed on these forward-looking statements as these statements are subject to known and unknown risks, uncertainties, and other factors beyond our control and could differ materially from our actual results and performance.Factors which may cause our actual results or performance to differ materially from those contemplated by forward-looking statements include, but are not limited to, the following: •Volatility in capital and credit markets, or other unfavorable changes in economic conditions, either nationally or regionally in one or more of the markets in which we operate, could adversely impact us;•Short-term leases could expose us to the effects of declining market rents;•Competition could limit our ability to lease apartments or increase or maintain rental income;•We could be negatively impacted by the risks associated with land holdings and related activities; •Development, repositions, redevelopment and construction risks could impact our profitability;•Our acquisition strategy may not produce the cash flows expected;•Changes in rent control or rent stabilization laws and regulations could adversely affect our operations and property values;•Failure to qualify as a REIT could have adverse consequences;•Tax laws may continue to change at any time and any such legislative or other actions could have a negative effect on us;•A cybersecurity incident and other technology disruptions could negatively impact our business;•We have significant debt, which could have adverse consequences;•Insufficient cash flows could limit our ability to make required payments for debt obligations or pay distributions to shareholders;•Issuances of additional debt may adversely impact our financial condition;•We may be unable to renew, repay, or refinance our outstanding debt;•Rising interest rates could both increase our borrowing costs, thereby adversely affecting our cash flows and the amounts available for distribution to our shareholders, and decrease our share price, if investors seek higher yields through other investments;•Failure to maintain our current credit ratings could adversely affect our cost of funds, related margins, liquidity, and access to capital markets;•Share ownership limits and our ability to issue additional equity securities may prevent takeovers beneficial to shareholders;•The form, timing and amount of dividend distributions in future periods may vary and be impacted by economic and other considerations;17Table of Contents•Environmental, Social and Governance factors may impose additional costs and/or expose us to new risks;•Litigation risks could affect our business;•A pandemic and measures intended to prevent its spread could negatively impact our business;•Damage from catastrophic weather and other natural events could result in losses;•Competition could adversely affect our ability to acquire properties; and•We could be adversely impacted due to our share price fluctuations.These forward-looking statements represent our estimates and assumptions as of the date of this report, and we assume no obligation to update or supplement forward-looking statements because of subsequent events.Executive SummaryWe are primarily engaged in the ownership, management, development, reposition, redevelopment, acquisition, and construction of multifamily apartment communities. Overall, we focus on investing in markets characterized by high-growth economic conditions, strong employment, and attractive quality of life which we believe leads to higher demand and retention of our apartments. As of December 31, 2022, we owned interests in, operated, or were developing 178 multifamily properties comprised of 60,652 apartment homes across the United States as detailed in the Property Portfolio table below. In addition, we own other land holdings which we may develop into multifamily apartment communities in the future.Business Environment and Current OutlookOur results for the year ended December 31, 2022, reflect an increase in same store revenues of approximately 11.2% as compared to the same period in 2021. The increase was primarily due to higher average rental rates which we believe was primarily attributable to improving job growth, favorable demographics with a higher propensity to rent versus buy, higher demand for multifamily housing in our markets, and a manageable supply of new multifamily housing.We currently believe the supply of multifamily homes will remain at manageable levels during 2023. However, if economic conditions were to worsen, our operating results could be adversely affected.Consolidated ResultsNet income attributable to common shareholders was $653.6 million and $303.9 million for the years ended December 31, 2022 and December 31, 2021, respectively. The increase during the year ended December 31, 2022 as compared to the same period in 2021 was primarily due to a $474.1 million gain recognized as a result of the remeasurement of our previously held 31.3% ownership interest in two unconsolidated investment funds (collectively, the "Funds") upon our acquiring the remaining ownership interests in these Funds on April 1, 2022, and an increase in property operations. See further discussion of our 2022 operations as compared to 2021 in "Results of Operations," below. The increase was partially offset by recognizing a higher gain on sale of two operating properties in 2021 of $174.4 million as compared to a $36.4 million gain on sale of one operating property in 2022. The increase was also partially offset by higher depreciation expense and amortization of in-place leases in 2022 related to the consolidation of 22 properties upon acquiring the remaining ownership interests in the Funds in 2022, and the acquisition of four operating properties in 2021. Construction ActivityAt December 31, 2022, we had a total of six projects under construction to be comprised of 1,950 apartment homes. Initial occupancies of these six projects are currently scheduled to occur within the next 18 months. We estimate the additional cost to complete the construction of the six projects to be approximately $306.7 million. AcquisitionsOperating Properties: On April 1, 2022, we purchased the remaining 68.7% ownership interests in the Funds for cash consideration of approximately $1.1 billion, after adjusting for our assumption of approximately $515 million of existing secured mortgage debt of the Funds which remained outstanding. These Funds own 22 multifamily communities comprised of 7,247 units located in Houston, Austin, Dallas, Tampa, Raleigh, Orlando, Washington D.C., Charlotte, and Atlanta. After obtaining 100% of the ownership interests, we consolidated the Funds as of April 1, 2022, and no longer recognize fee and asset management income from property management, construction, and development activities, related expenses or equity in income for these Funds.Land: During the year ended December 31, 2022, we acquired for future development purposes two parcels of land totaling approximately 42.6 acres in Charlotte, North Carolina for an aggregate cost of approximately $32.7 million; 18Table of Contentsapproximately 3.8 acres of land in Nashville, Tennessee for approximately $30.5 million; and approximately 15.9 acres of land in Richmond, Texas for approximately $7.8 million. DispositionsOperating Properties: During the year ended December 31, 2022, we sold one operating property comprised of 245 apartment homes located in Largo, Maryland for approximately $71.9 million and recognized a gain of approximately $36.4 million. Other In April 2022, we issued 2.9 million common shares in a public equity offering and received approximately $490.3 million in net proceeds, which we used to reduce borrowings under our unsecured revolving credit facility.In 2022, we issued approximately 0.2 million common shares under our then current at-the-market ("ATM") programs and received approximately $26.2 million in net proceeds. As of the date of this filing, we had common shares having an aggregate offering amount of up to $500.0 million remaining available for sale under our current 2022 ATM program.In August 2022, we amended and restated our existing credit facility to (i) add a $300 million unsecured term loan with a delayed draw feature with a maturity date of August 2024 (which may be extended at our option to August 2025), (ii) increase our existing unsecured revolving credit facility from $900 million to $1.2 billion, which may be expanded at our option up to three times and up to an additional $500 million upon satisfaction of certain conditions, (iii) amend the maturity date from March 2023 to August 2026, which may be extended at our option for two additional consecutive six-month periods, and (iv) change the interest rate from London Interbank Offered Rate ("LIBOR") plus a margin to Secured Overnight Financing Rate ("SOFR") plus a margin, subject to customary benchmark replacement provisions.In September 2022, we extended the maturity date of our $40 million unsecured floating rate term loan with an unrelated third party from September 2022 to September 2024. Additionally, the interest rate on the term loan was changed from LIBOR plus a margin to SOFR plus a margin.In October 2022, our Board of Trust Managers approved to increase the authorization for our share repurchase plan by approximately $230.5 million to a total of $500.0 million. There were no repurchases in 2022 or through the date of this filing, and the remaining dollar value of our common equity securities authorized to be repurchased under this program is $500.0 million.In December 2022, we used the $300 million unsecured term loan and borrowings from our unsecured revolving credit facility to repay the principal amount of our 3.15% senior unsecured note payable, which matured on December 15, 2022, for a total of $350.0 million, plus accrued interest. Future OutlookSubject to market conditions, we intend to continue to seek opportunities to develop new communities, and to redevelop, reposition and acquire existing communities. We also intend to evaluate our operating property and land development portfolio and plan to continue our practice of selective dispositions as market conditions warrant and opportunities arise. We expect to maintain a strong balance sheet and preserve our financial flexibility by continuing to focus on our core fundamentals which currently are generating positive cash flows from operations, maintaining appropriate debt levels and leverage ratios, and controlling overhead costs. We intend to meet our short-term and long-term liquidity requirements through a combination of one or more of the following: cash flows generated from operations, draws on our unsecured credit facility, the use of debt and equity offerings under our automatic shelf registration statement, proceeds from property dispositions, equity issued from our ATM programs, other unsecured borrowings, or secured mortgages. As of December 31, 2022, we had approximately $1.1 billion available under our $1.2 billion unsecured revolving credit facility. As of December 31, 2022 and through the date of this filing, we also had common shares having an aggregate offering price of up to $500.0 million remaining available for sale under our 2022 ATM program. We believe scheduled repayments of debt during the next 12 months are manageable at approximately $500.0 million which represents approximately 13.6% of our total outstanding debt, and excludes amortization of debt discounts and debt issuance costs. We believe we are well-positioned with a strong balance sheet and sufficient liquidity to fund new development, redevelopment, and other capital funding requirements. We will, however, continue to assess and take further actions we believe are prudent to meet our objectives and capital requirements. 19Table of ContentsProperty PortfolioOur multifamily property portfolio is summarized as follows: December 31, 2022December 31, 2021Number ofHomesPropertiesNumber ofHomesPropertiesOperating PropertiesHouston, Texas 9,154 26 9,154 26 Dallas, Texas6,224 15 6,224 15 Washington, D.C. Metro 6,192 17 6,437 18 Atlanta, Georgia 4,862 15 4,496 14 Phoenix, Arizona 4,029 13 4,029 13 Orlando, Florida 3,954 11 3,954 11 Austin, Texas 3,686 11 3,686 11 Raleigh, North Carolina 3,252 9 3,248 9 Charlotte, North Carolina3,104 14 3,104 14 Tampa, Florida 3,104 8 3,104 8 Southeast Florida 3,050 9 2,781 8 Denver, Colorado 2,873 9 2,865 9 Los Angeles/Orange County, California 2,663 7 2,663 7 San Diego/Inland Empire, California 1,797 6 1,797 6 Nashville, Tennessee758 2 758 2 Total Operating Properties58,702 172 58,300 171 Properties Under ConstructionRaleigh, North Carolina 789 2 354 1 Phoenix, Arizona 397 1 397 1 Charlotte, North Carolina387 1 387 1 Houston, Texas377 2 — — Southeast Florida — — 269 1 Atlanta, Georgia — — 366 1 Total Properties Under Construction1,950 6 1,773 5 Total Properties60,652 178 60,073 176 Less: Unconsolidated Joint Venture Properties (1)Houston, Texas— — 2,756 9 Austin, Texas — — 1,360 4 Dallas, Texas— — 1,250 3 Tampa, Florida — — 450 1 Raleigh, North Carolina — — 350 1 Orlando, Florida— — 300 1 Washington, D.C. Metro — — 281 1 Charlotte, North Carolina— — 266 1 Atlanta, Georgia — — 234 1 Total Unconsolidated Joint Venture Properties— — 7,247 22 Total Properties Fully Consolidated60,652 178 52,826 154 (1)In April 2022, we acquired the remaining 68.7% ownership interests of the Funds which owned these properties. After obtaining 100% of the ownership interests, we consolidated the Funds as of April 1, 2022. Refer to Note 7, "Acquisitions and Dispositions," in the Notes to Consolidated Financial Statements for further discussion of this transaction. 20Table of ContentsStabilized CommunitiesWe generally consider a property stabilized once it reaches 90% occupancy. During the year ended December 31, 2022, stabilization was achieved at three operating properties as follows:Stabilized Properties and LocationsNumber ofHomesDate ofConstructionCompletionDate ofStabilizationOperating PropertiesCamden BuckheadAtlanta, GA3662Q223Q22Camden HillcrestSan Diego, CA132 4Q213Q22Camden Lake EolaOrlando, FL360 3Q211Q22Total858 Completed Construction in Lease-UpAt December 31, 2022, we had one completed operating property in lease-up as follows:($ in millions) Property and LocationNumber ofHomesCostIncurred (1)% Leased at 1/30/2023Date of Construction CompletionEstimated Date of StabilizationOperating PropertyCamden Atlantic269 $100.2 87 %4Q222Q23Plantation, FL(1)Excludes leasing costs, which are expensed as incurred.Properties Under DevelopmentOur consolidated balance sheet at December 31, 2022 included approximately $525.0 million related to properties under development and land. Of this amount, approximately $287.0 million related to our projects currently under construction. In addition, we had approximately $238.0 million primarily invested in land held for future development related to projects we currently expect to begin construction.Communities Under Construction. At December 31, 2022, we had six properties in various stages of construction as follows:($ in millions) Properties and LocationsNumber ofHomesEstimatedCostCostIncurredIncluded inPropertiesUnderDevelopmentEstimatedDate ofConstructionCompletionEstimatedDate ofStabilizationCommunities Under ConstructionCamden Tempe II (1) Tempe, AZ397 $115.0 $101.3 $34.1 3Q231Q25Camden NoDa Charlotte, NC387 108.0 95.6 95.5 4Q231Q25Camden Durham Durham, NC420 145.0 82.6 82.6 2Q244Q25Camden Village District Raleigh, NC369 138.0 41.0 41.0 2Q254Q26Camden Woodmill Creek The Woodlands, TX189 75.0 19.2 19.2 3Q244Q24Camden Long Meadow Farms Richmond, TX188 80.0 14.6 14.6 3Q244Q24Total1,950 $661.0 $354.3 $287.0 (1)Property in lease-up and was 50% leased at January 30, 2023.21Table of Contents Development Pipeline Communities. At December 31, 2022, we had the following communities undergoing development activities:($ in millions)Properties and LocationsProjected HomesTotal Estimated Cost (1)Cost to DateCamden Blakeney349 $120.0 $21.7 Charlotte, NCCamden South Charlotte420 135.0 24.8 Charlotte, NCCamden Nations393 175.0 33.3 Nashville, TNCamden Baker435 165.0 29.5 Denver, COCamden Highland Village II300 100.0 9.7 Houston, TXCamden Gulch480 260.0 43.8 Nashville, TNCamden Paces III350 100.0 20.6 Atlanta, GACamden Arts District354 150.0 41.1 Los Angeles, CACamden Downtown II271 145.0 13.5 Houston, TXTotal3,352 $1,350.0 $238.0 (1)Represents our estimate of total costs we expect to incur on these projects. However, forward-looking statements are not guarantees of future performance, results, or events. Although we believe these expectations are based upon reasonable assumptions, future events rarely develop exactly as forecasted and estimates routinely require adjustment.22Table of ContentsGeographic Diversification At December 31, 2022 and 2021, our real estate assets by various markets, excluding depreciation and investments in joint ventures, were as follows: ($ in thousands)20222021Houston, Texas$1,878,221 14.5 %$1,121,502 10.7 %Washington, D.C. Metro1,619,826 12.5 1,522,337 14.6 Dallas, Texas1,076,941 8.3 699,052 6.7 Atlanta, Georgia1,012,209 7.8 888,521 8.5 Phoenix, Arizona872,695 6.8 817,450 7.8 Los Angeles/Orange County, California810,109 6.3 792,872 7.6 Orlando, Florida761,013 5.9 665,242 6.4 Southeast Florida740,263 5.7 704,679 6.8 Tampa, Florida711,552 5.5 557,875 5.3 Austin, Texas691,830 5.4 363,181 3.5 Charlotte, North Carolina690,767 5.4 493,337 4.7 Raleigh, North Carolina618,157 4.8 457,687 4.4 Denver, Colorado611,147 4.7 599,414 5.7 San Diego/Inland Empire, California463,825 3.6 451,023 4.3 Nashville, Tennessee357,318 2.8 314,895 3.0 Total$12,915,873 100.0 %$10,449,067 100.0 %Results of OperationsChanges in revenues and expenses related to our operating properties from period to period are due primarily to the performance of stabilized properties in the portfolio, the lease-up of newly constructed properties, acquisitions, and dispositions.Management considers property net operating income ("NOI") to be an appropriate supplemental measure of operating performance to net income because it reflects the operating performance of our communities without an allocation of corporate level property management overhead or general and administrative costs. We define NOI as total property income less property operating and maintenance expenses less real estate taxes. NOI is further detailed in the Property-Level NOI table as seen below. NOI is not defined by accounting principles generally accepted in the United States of America ("GAAP") and should not be considered an alternative to net income as an indication of our operating performance, should not be considered an alternative to net cash from operating activities as a measure of liquidity, and should not be considered an indication of cash available to fund cash needs. Additionally, NOI as disclosed by other REITs may not be comparable to our calculation.23Table of ContentsReconciliations of net income to NOI for the year ended December 31, 2022 and 2021 are as follows:(in thousands)20222021Net income$661,508$312,376Less: Fee and asset management income(5,188)(10,532)Less: Interest and other income(3,019)(1,223)Less: (Income)/loss on deferred compensation plans19,637 (14,369)Plus: Property management expense28,601 26,339 Plus: Fee and asset management expense2,516 4,511 Plus: General and administrative expense60,413 59,368 Plus: Interest expense113,424 97,297 Plus: Depreciation and amortization expense577,020 420,692 Plus: Expense/(benefit) on deferred compensation plans(19,637)14,369 Less: Gain on sale of operating properties, including land(36,372)(174,384)Less: Gain on acquisition of unconsolidated joint venture interests(474,146)— Less: Equity in income of joint ventures(3,048)(9,777)Plus: Income tax expense2,966 1,893 Net operating income$924,675 $726,560 Property-Level NOI (1)Property NOI, as reconciled above, is detailed further into the categories below for the year ended December 31, 2022 as compared to 2021: Number ofHomes atYear EndedDecember 31,Change($ in thousands)12/31/202220222021$%Property revenues:Same store communities46,151 $1,144,659 $1,029,585 $115,074 11.2 %Non-same store communities12,282 264,784 82,553 182,231 220.7 Development and lease-up communities2,219 2,173 — 2,173 *Dispositions/other— 11,140 31,447 (20,307)(64.6)Total property revenues60,652 $1,422,756 $1,143,585 $279,171 24.4 %Property expenses:Same store communities46,151 $391,455 $372,600 $18,855 5.1 %Non-same store communities12,282 100,163 31,512 68,651 217.9 Development and lease-up communities2,219 918 (8)926 *Hurricane expenses— 1,000 — 1,000 *Dispositions/other— 4,545 12,921 (8,376)(64.8)Total property expenses60,652 $498,081 $417,025 $81,056 19.4 %Property NOI:Same store communities46,151 $753,204 $656,985 $96,219 14.6 %Non-same store communities12,282 164,621 51,041 113,580 222.5 Development and lease-up communities2,219 1,255 8 1,247 *Hurricane expenses— (1,000)— (1,000)*Dispositions/other— 6,595 18,526 (11,931)(64.4)Total property NOI60,652 $924,675 $726,560 $198,115 27.3 %* Not a meaningful percentage.24Table of Contents(1) Same store communities are communities we owned and were stabilized since January 1, 2021, excluding communities under redevelopment and properties held for sale. Non-same store communities are stabilized communities not owned or stabilized since January 1, 2021, including communities under redevelopment and excluding properties held for sale. We define communities under redevelopment as communities with capital expenditures that improve a community's cash flow and competitive position through extensive unit, exterior building, common area, and amenity upgrades. Management believes same store information is useful as it allows both management and investors to determine financial results over a particular period for the same set of communities. Development and lease-up communities are non-stabilized communities we have developed since January 1, 2021, excluding properties held for sale. Hurricane expenses include storm-related damages related to Hurricane Ian in September 2022. Dispositions/other includes those communities disposed of or held for sale which are not classified as discontinued operations, non-multifamily rental properties, expenses related to land holdings not under active development, and other miscellaneous revenues and expenses.Same Store AnalysisSame store property NOI increased approximately $96.2 million for the year ended December 31, 2022 as compared to the same period in 2021. The increase was due to an increase of approximately $115.1 million in same store property revenues, partially offset by an increase of approximately $18.9 million in same store property expenses, for the year ended December 31, 2022, as compared to the same period in 2021.The $115.1 million increase in same store property revenues for the year ended December 31, 2022, as compared to the same period in 2021, was primarily due to an increase of approximately $108.2 million in rental revenues comprised of a 12.4% increase in average rental rates and higher other rental income, partially offset by a decrease in reletting income, net of uncollectible revenue. The increase was also due to higher income from our utility and other rebilling programs of $5.1 million and higher fees and other income of $1.8 million. The $18.9 million increase in same store property expenses for the year ended December 31, 2022, as compared to the same period in 2021, was primarily due to higher real estate taxes of $5.8 million as a result of increased property valuations, higher repairs and maintenance expenses of $5.0 million, higher property insurance of $4.4 million, and higher utilities and other property expenses of $3.0 million. The increase was also due to an increase of property general and administrative expense of $4.2 million, a portion of which was due to centralizing our workforce to manage certain responsibilities for all of our communities, partially offset by a decrease in salaries of $3.5 million. Non-same Store and Development and Lease-up AnalysisProperty NOI from non-same store and development and lease-up communities increased $114.8 million for the year ended December 31, 2022, as compared to the same period in 2021. The increase was due to higher property NOI from non-same store communities of approximately $113.6 million and higher property NOI from development and lease-up communities of approximately $1.2 million for the year ended December 31, 2022, as compared to the same period in 2021. The increase in property NOI from our non-same store communities was primarily due to our acquiring the remaining ownership interests in the Funds on April 1, 2022, and the acquisition of four operating properties during 2021. The increases were also due to three operating properties reaching stabilization during each of the years ended December 31, 2021 and December 31, 2022. The following table details the changes, described above, relating to non-same store and development and lease-up NOI:For the year ended December 31,(in millions)2022 compared to 2021Property RevenuesRevenues from acquisitions$155.9 Revenues from non-same store stabilized properties21.6 Revenues from development and lease-up properties2.2 Other4.7 $184.4 Property ExpensesExpenses from acquisitions$58.6 Expenses from non-same store stabilized properties9.5 Expenses from development and lease-up properties0.9 Other0.6 $69.6 25Table of ContentsFor the year ended December 31,(in millions)2022 compared to 2021Property NOINOI from acquisitions$97.3 NOI from non-same store stabilized properties12.1 NOI from development and lease-up properties1.3 Other4.1 $114.8 Hurricane ExpensesOur communities impacted by Hurricane Ian in September 2022 incurred approximately $1.0 million of storm related expenses, with no related insurance recoveries for the year ended December 31, 2022.Dispositions/Other Property AnalysisDispositions/other property NOI decreased approximately $11.9 million for the year ended December 31, 2022 as compared to the same period in 2021. The decrease was primarily due to the disposition of three operating properties during the fourth quarter of 2021 and one operating property in March 2022.Non-Property Income Year EndedDecember 31,Change($ in thousands)20222021$%Fee and asset management$5,188 $10,532 $(5,344)(50.7)%Interest and other income3,019 1,223 1,796 146.9 Income/(loss) on deferred compensation plans(19,637)14,369 (34,006)*Total non-property income$(11,430)$26,124 $(37,554)(143.8)%*Not a meaningful percentage.Fee and asset management income from property management, asset management, construction, and development activities at our joint ventures and our third-party construction projects decreased approximately $5.3 million for the year ended December 31, 2022 as compared to 2021. The decrease was primarily due to the consolidation of the Funds on April 1, 2022, and no longer earning the related fee and asset management income. The decrease was also due to lower fees earned related to a decrease in third-party construction activity during 2022 as compared to 2021.Interest and other income increased approximately $1.8 million for the year ended December 31, 2022, as compared to 2021. The increase was primarily due to an earn-out received in 2022 related to a technology joint venture sold in September 2020. Our deferred compensation plans incurred a loss of approximately $19.6 million in 2022 and recognized income of approximately $14.4 million in 2021. The changes were related to the performance of the investments held in deferred compensation plans for participants and were directly offset by the expense/(benefit) related to these plans, as discussed below. 26Table of ContentsOther Expenses Year EndedDecember 31,Change($ in thousands)20222021$%Property management$28,601 $26,339 $2,262 8.6 %Fee and asset management2,516 4,511 (1,995)(44.2)General and administrative60,413 59,368 1,045 1.8 Interest113,424 97,297 16,127 16.6 Depreciation and amortization577,020 420,692 156,328 37.2 Expense/(benefit) on deferred compensation plans(19,637)14,369 (34,006)*Total other expenses$762,337 $622,576 $139,761 22.4 %*Not a meaningful percentage.Property management expenses, which primarily represent regional supervision and accounting costs related to property operations, increased approximately $2.3 million for the year ended December 31, 2022 as compared to 2021. The increase was primarily related to higher salary, benefits, and incentive compensation costs primarily due to higher regional salary related costs which were previously allocated to fee and asset management expense and now recognized in property management expense upon our consolidating the Funds after our acquisition on April 1, 2022. The increase in 2022 was also due to higher travel related expenses as compared to 2021. Property management expenses were 2.0% and 2.3% of total property revenues for the years ended December 31, 2022 and 2021, respectively.Fee and asset management expense from property management, asset management, construction, and development activities at our joint ventures and our third-party projects decreased approximately $2.0 million for the year ended December 31, 2022 as compared to 2021. The decrease was primarily due to our consolidating the Funds on April 1, 2022, and no longer incurring any related fee and asset management expenses. General and administrative expenses increased approximately $1.0 million for the year ended December 31, 2022 as compared to 2021. Excluding deferred compensation plans, general and administrative expenses were 4.2% and 5.1% of total revenues for the years ended December 31, 2022 and 2021, respectively. Interest expense increased approximately $16.1 million for the year ended December 31, 2022 as compared to 2021. The increase in interest expense was primarily related to our assuming approximately $515 million of secured mortgage debt upon completion of the acquisition of the remaining ownership interests in the Funds on April 1, 2022 with average interest rates of approximately 4.7% as of December 31, 2022. The increase was also due to higher interest expense recognized on our unsecured revolving credit facility resulting from an increase in average balances outstanding. The increase was partially offset by higher capitalized interest during 2022 resulting from higher average balances in our development pipeline as compared to 2021.Depreciation and amortization expense increased approximately $156.3 million for the year ended December 31, 2022 as compared to 2021. The increase was primarily due to higher depreciation and amortization related to our acquisition of the remaining ownership interests in the Funds on April 1, 2022, and higher depreciation related to the acquisition of four operating properties during 2021. The increase was also due to the completion of units in our development pipeline and the completion of repositions during 2021 and 2022, and was partially offset by lower depreciation expense related to the disposition of three operating properties during the fourth quarter of 2021 and one operating property during the first quarter of 2022. Our deferred compensation plans recognized a benefit of approximately $19.6 million in 2022 and incurred an expense of approximately $14.4 million in 2021. The changes were related to the performance of the investments held in deferred compensation plans for participants and were directly offset by the income/(loss) related to these plans, as discussed in the Non-Property Income section above. 27Table of ContentsOther Year EndedDecember 31,Change(in thousands)20222021$Gain on sale of operating properties, including land$36,372 $174,384 $(138,012)Gain on acquisition of unconsolidated joint venture interests474,146 — 474,146 Equity in income of joint ventures3,048 9,777 (6,729)Income tax expense(2,966)(1,893)(1,073)The $36.4 million gain on sale for the year ended December 31, 2022 was due to the disposition of one operating property located in Largo, Maryland during the first quarter of 2022. The $174.4 million gain on sale for the year ended December 31, 2021 was due to the sale of two operating properties located in Houston, Texas and the sale of one operating property located in Laurel, Maryland during the fourth quarter of 2021.On April 1, 2022, we acquired the remaining 68.7% ownership interest in the Funds. We had previously owned a 31.3% interest in each of these Funds and accounted for the joint ventures under the equity method. As a result of acquiring the remaining ownership interests, we consolidated the Funds and recorded a gain of approximately $474.1 million which represented the difference between the fair market value and the cost basis of our previously owned equity interests.Equity in income of joint ventures decreased approximately $6.7 million for the year ended December 31, 2022 as compared to 2021. The decrease was primarily due to our consolidating the Funds on April 1, 2022.Income tax expense increased approximately $1.1 million for the year ended December 31, 2022 as compared to the same period in 2021. The increase was primarily due to higher state income taxes due to our acquiring the remaining ownership interests in the Funds on April 1, 2022, partially offset by a decrease in taxable income due to lower third-party construction activities in a taxable REIT subsidiary. Funds from Operations (“FFO”) and Adjusted FFO ("AFFO")Management considers FFO and AFFO to be appropriate supplementary measures of the financial performance of an equity REIT. The National Association of Real Estate Investment Trusts (“NAREIT”) currently defines FFO as net income (computed in accordance with GAAP), excluding gains (or losses) associated with the sale of previously depreciated operating properties, real estate depreciation and amortization, impairments of depreciable assets, and adjustments for unconsolidated joint ventures to reflect FFO on the same basis. Our calculation of diluted FFO also assumes conversion of all potentially dilutive securities, including certain non-controlling interests, which are convertible into common shares. We consider FFO to be an appropriate supplemental measure of operating performance because, by excluding gains or losses on dispositions of operating properties and depreciation, FFO can assist in the comparison of the operating performance of a company’s real estate investments between periods or to different companies.AFFO is calculated utilizing FFO less recurring capitalized expenditures which are necessary to help preserve the value of and maintain the functionality at our communities. We also consider AFFO to be a useful supplemental measure because it is frequently used by analysts and investors to evaluate a REIT's operating performance between periods or different companies. Our definition of recurring capital expenditures may differ from other REITs, and there can be no assurance our basis for computing this measure is comparable to other REITs. To facilitate a clear understanding of our consolidated historical operating results, we believe FFO and AFFO should be examined in conjunction with net income attributable to common shareholders as presented in the consolidated statements of income and comprehensive income and data included elsewhere in this report. FFO and AFFO are not defined by GAAP and should not be considered alternatives to net income attributable to common shareholders as an indication of our operating performance. Additionally, FFO and AFFO as disclosed by other REITs may not be comparable to our calculation.Reconciliations of net income attributable to common shareholders to FFO and AFFO for the years ended December 31, 2022 and 2021 are as follows:28Table of Contents($ in thousands)20222021Funds from operationsNet income attributable to common shareholders (1)$653,613 $303,907 Real estate depreciation and amortization565,913 410,767 Adjustments for unconsolidated joint ventures2,709 10,591 Gain on sale of operating properties(36,372)(174,384)Gain on acquisition of unconsolidated joint venture interests(474,146)— Income allocated to non-controlling interests7,895 8,469 Funds from operations$719,612 $559,350 Less: recurring capitalized expenditures(90,715)(73,603)Adjusted funds from operations $628,897 $485,747 Weighted average shares – basic107,605 101,999 Incremental shares issuable from assumed conversion of:Share awards granted50 87 Common units1,606 1,661 Weighted average shares – diluted (2)109,261 103,747 (1) Net income attributable to common shareholders for the year ended December 31, 2022 includes approximately $1.0 million of storm-related expenses related to Hurricane Ian.(2) FFO diluted shares for the year ended December 31, 2022 includes approximately 2.2 million weighted average share impact related to an equity offering completed in April 2022, and includes approximately 2.3 million weighted average share impact related to activity from our ATM Programs for the year ended December 31, 2021. Liquidity and Capital ResourcesFinancial Condition and Sources of LiquidityWe intend to maintain a strong balance sheet and preserve our financial flexibility, which we believe should enhance our ability to identify and capitalize on investment opportunities as they become available. We intend to maintain what management believes is a conservative capital structure by: •extending and sequencing the maturity dates of our debt where practicable;•managing interest rate exposure using what management believes to be prudent levels of fixed and floating rate debt;•maintaining what management believes to be conservative coverage ratios; and•using what management believes to be a prudent combination of debt and equity.Our interest expense coverage ratio, net of capitalized interest, was approximately 7.4 and 6.7 times for the years ended December 31, 2022 and 2021, respectively. This ratio is a method for calculating the amount of operating cash flows available to cover interest expense and is calculated by dividing interest expense for the period into the sum of property revenues and expenses, non-property income, and other expenses after adding back depreciation, amortization, and interest expense. Approximately 83.9% and 100% of our properties were unencumbered at December 31, 2022 and 2021, respectively. Our weighted average maturity of debt was approximately 6.4 years at December 31, 2022.We also intend to strengthen our capital and liquidity positions by continuing to focus on our core fundamentals, which currently are generating positive cash flows from operations, maintaining appropriate debt levels and leverage ratios, and controlling overhead costs.Our primary sources of liquidity are cash flows generated from operations. Other sources may include one or more of the following: availability under our unsecured credit facility, the use of debt and equity offerings under our automatic shelf registration statement, proceeds from property dispositions, equity issued from our ATM programs, and other unsecured borrowings or secured mortgages. We believe our liquidity and financial condition are sufficient to meet all of our reasonably anticipated cash needs over the next 12 months including: •normal recurring operating expenses;29Table of Contents•current debt service requirements, including debt maturities;•recurring capital expenditures;•reposition expenditures;•funding of property developments, redevelopments, and acquisitions; and•the minimum dividend payments required to maintain our REIT qualification under the Code.Factors which could increase or decrease our future liquidity include but are not limited to volatility in capital and credit markets, changes in rent control or rent stabilization laws, sources of financing, the minimum REIT dividend requirements, our ability to complete asset purchases, sales, or developments, the effect our debt level and changes in credit ratings could have on our cost of funds, and our ability to access capital markets. Cash FlowsThe following is a discussion of our cash flows for the years ended December 31, 2022 and 2021.Net cash from operating activities was approximately $744.7 million during the year ended December 31, 2022 as compared to approximately $577.5 million during the year ended December 31, 2021. The increase was primarily due to the increase in cash from property operations due to our acquiring the remaining interests in the Funds, and the growth attributable to our same store, non-same store and development and lease-up communities. See further discussions of our 2022 operations as compared to 2021 in "Results of Operations." Net cash used in investing activities during the year ended December 31, 2022 totaled approximately $1.5 billion as compared to $804.4 million during the year ended December 31, 2021. Cash outflows during 2022 primarily related to the acquisition of the Funds for cash consideration of approximately $1.1 billion, and amounts paid for property development and capital improvements of approximately $449.4 million. These outflows were partially offset by net proceeds from the sale of one operating property of approximately $70.5 million. Cash outflows during 2021 primarily related to the acquisition of four operating properties for approximately $630.0 million, and amounts paid for property development and capital improvements of approximately $428.7 million. These outflows were partially offset by net proceeds from the sale of three operating properties of approximately $254.7 million. The increase in property development and capital improvements for 2022, as compared to the same period in 2021, was primarily due to higher capital expenditures, capitalized interest, real estate taxes and other capitalized indirect costs, partially offset by the timing and completion of five consolidated operating properties in 2022 and 2021. The property development and capital improvements during 2022 and 2021, included the following:December 31,(in millions)20222021Expenditures for new development, including land$253.0 $265.4 Capital expenditures108.8 87.0 Reposition expenditures53.0 47.6 Capitalized interest, real estate taxes, and other capitalized indirect costs34.6 28.7 Total$449.4 $428.7 Net cash from financing activities totaled approximately $109.9 million during the year ended December 31, 2022 as compared to approximately $421.4 million during the year ended December 31, 2021. Cash inflows during 2022 primarily related to net proceeds of $516.8 million from the issuance of approximately 2.9 million common shares from our equity offering and approximately 0.2 million common shares from our ATM programs, as well as net proceeds of approximately $300.0 million of borrowings under our unsecured term loan, and net proceeds of $42.0 million of borrowings from our unsecured revolving credit facility. These cash inflows were partially offset by approximately $396.8 million to pay distributions to common shareholders and non-controlling interest holders, and the repayment of $350.0 million senior unsecured notes in the fourth quarter of 2022. Cash inflows during 2021 primarily related to net proceeds of approximately $759.2 million from the issuance of approximately 5.4 million common shares from our ATM programs. These cash inflows were partially offset by approximately $343.0 million to pay distributions to common shareholders and non-controlling interest holders. Financial FlexibilityIn August 2022, we amended and restated our existing credit facility to among other things, add a $300 million unsecured term loan with a delayed draw feature that matures in August 2024 (which may be extended at the Company's option to August 2025), and increase the capacity of our existing unsecured revolving credit facility from $900 million to $1.2 billion which may 30Table of Contentsbe expanded, upon the satisfaction of certain conditions, by up to three times and $500 million in the aggregate by requesting increases to the revolving credit facility and term loan or requesting additional term loans. We also extended the maturity date of the revolving credit facility from March 2023 to August 2026, with two options to further extend the facility at our election for two additional consecutive six-month periods. The interest rates on our unsecured revolving credit facility and delayed term loan are based upon SOFR plus a margin which is subject to change as our credit ratings change. Advances under our revolving credit facility may be priced at the scheduled rates, or we may enter into bid rate loans with participating banks at rates below the scheduled rates. These bid rate loans have terms of 180 days or less and may not exceed the lesser of $600 million or the remaining amount available under our revolving credit facility. Our revolving credit facility and delayed term loan are subject to customary financial covenants and limitations. We believe we are in compliance with all such financial covenants and limitations as of December 31, 2022 and through the date of this filing. Our unsecured revolving credit facility provides us with the ability to issue up to $50 million in letters of credit. While our issuance of letters of credit does not increase our borrowings outstanding under our revolving credit facility, it does reduce the amount available. At December 31, 2022, we had outstanding letters of credit totaling $14.2 million, approximately $1.1 billion available under our unsecured revolving credit facility, and approximately $300 million outstanding on our term loan.In May 2022, we created an ATM share offering program through which we can, but have no obligation to, sell common shares for an aggregate offering amount of up to $500.0 million (the "2022 ATM program"), in amounts and at times as we determine, into the existing trading market at current market prices as well as through negotiated transactions. Actual sales from time to time may depend on a variety of factors including, among others, market conditions, the trading price of our common shares, and determinations by management of the appropriate sources of funding for us. The proceeds from any sale of our common shares under the 2022 ATM program are intended to be used for general corporate purposes, which may include reducing future borrowings under our unsecured credit facility, the repayment of other indebtedness, the redemption or other repurchase of outstanding debt or equity securities, funding for development activities, and financing for acquisitions. As of the date of this filing we have not entered into any forward sales agreements and have common shares having an aggregate offering amount of up to $500.0 million remaining available for sale under this ATM program. We currently have an automatic shelf registration statement which allows us to offer, from time to time, common shares, preferred shares, debt securities, or warrants. Our Amended and Restated Declaration of Trust provides we may issue up to 185 million shares of beneficial interest, consisting of 175 million common shares and 10 million preferred shares. At December 31, 2022, we had approximately 106.5 million common shares outstanding, net of treasury shares and shares held in our deferred compensation arrangements, and no preferred shares outstanding.We believe our ability to access the capital markets is enhanced by our senior unsecured debt ratings by Fitch, Moody's, and Standard and Poor's, which were A- with stable outlook, A3 with stable outlook, and A- with stable outlook, respectively, as of December 31, 2022. We believe our ability to access the capital markets is also enhanced by our ability to borrow on a secured basis from various institutions including banks, Fannie Mae, Freddie Mac, or life insurance companies. However, we may not be able to maintain our current credit ratings and may not be able to borrow on a secured or unsecured basis in the future.Future Cash Requirements and Contractual ObligationsOne of our principal long-term liquidity requirements includes the repayment of maturing debt, including any future borrowings under our unsecured credit facility. We believe scheduled repayments of debt during the next 12 months are manageable at approximately $500.0 million which represents approximately 13.6% of our total outstanding debt, and excludes amortization of debt discounts and debt issuance costs. See Note 9, “Notes Payable,” in the notes to Consolidated Financial Statements for further discussion of scheduled maturities beyond 2023. Interest payments related to the debt discussed above and as further discussed in Note 9 will be approximately $111.1 million for the year ended December 31, 2023 and for the years ending 2024 through 2027 will be approximately $92.3 million, $80.3 million, $68.5 million and $67.8 million, respectively, and approximately $310.6 million in the aggregate thereafter.We estimate the additional cost to complete the construction of the six consolidated projects to be approximately $306.7 million. Of this amount, we expect to incur costs between approximately $190 million and $200 million during 2023 and to incur the remaining costs during 2024. Additionally, we expect to incur costs between approximately $85 million and $105 million related to the start of new development activities, between approximately $93 million and $97 million of repositions, redevelopment, repurposes, and revenue enhancing expenditures and between approximately $96 million and $100 million of additional recurring capital expenditures during 2023.We anticipate meeting our short-term and long-term liquidity requirements through a combination of one or more of the following: cash flows generated from operations, draws on our unsecured credit facility, the use of debt and equity offerings under our automatic shelf registration statement, proceeds from property dispositions, equity issued from our ATM programs, 31Table of Contentsother unsecured borrowings, or secured mortgages. We continue to evaluate our operating properties and land development portfolio and plan to continue our practice of selective dispositions as market conditions warrant and opportunities arise.As a REIT, we are subject to a number of organizational and operational requirements, including a requirement to distribute current dividends to our shareholders equal to a minimum of 90% of our annual taxable income. In order to reduce the amount of income taxes, our general policy is to distribute at least 100% of our taxable income. In December 2022, we announced our Board of Trust Managers had declared a quarterly dividend of $0.94 per common share to our common shareholders of record as of December 16, 2022. This dividend was subsequently paid on January 17, 2023, and we paid equivalent amounts per unit to holders of common operating partnership units. When aggregated with previous 2022 dividends, this distribution to common shareholders and holders of the common operating partnership units equates to an annual dividend rate of $3.76 per share or unit for the year ended December 31, 2022. In the first quarter of 2023, the Company's Board of Trust Managers declared a first quarter dividend of $1.00 per common share to our common shareholders of record as of March 31, 2023. Future dividend payments are paid at the discretion of the Board of Trust Managers and depend on cash flows generated from operations, the Company's financial condition and capital requirements, distribution requirements under the REIT provisions of the Code and other factors, including the Company's past performance and future prospects, which may be deemed relevant by our Board of Trust Managers. Assuming similar dividend distributions for the remainder of 2023, our annualized dividend rate for 2023 would be $4.00. Critical Accounting EstimatesThe preparation of our financial statements in conformity with GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the balance sheet date, and the amounts of revenues and expenses recognized during the reporting period. These estimates are based on historical experience and other assumptions believed to be reasonable under the circumstances. The following is a discussion of our critical accounting policies. For a discussion of all of our significant accounting policies, see Note 2, "Summary of Significant Accounting Policies and Recent Accounting Pronouncements," to the accompanying consolidated financial statements.Valuation of Assets. Long-lived assets are reviewed for impairment annually or whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Impairment may exist if estimated future undiscounted cash flows associated with long-lived assets are not sufficient to recover the carrying value of such assets. We consider projected future undiscounted cash flows, trends, strategic decisions regarding future development plans, and other factors in our assessment of whether impairment indicators exist. While we believe our estimates of future cash flows are reasonable, different assumptions regarding a number of factors, including market rents, economic conditions, and occupancies, could significantly affect these estimates. When impairment exists, the long-lived asset is adjusted to its fair value. In estimating fair value, management uses appraisals, management estimates, and discounted cash flow calculations which utilize inputs from a marketplace participant’s perspective. In addition, we evaluate our equity investments in joint ventures, if any, and if we believe there is an other than temporary decline in market value of our investment below our carrying value, we will record an impairment charge. We did not record any impairment charges for the years ended December 31, 2022, 2021, or 2020. The value of our properties under development depends on market conditions, including estimates of the project start date, projected construction costs, as well as estimates of demand for multifamily communities. We have reviewed market trends and other marketplace information and have incorporated this information as well as our current outlook into the assumptions we use in our impairment analyses. Due to the judgment and assumptions applied in the impairment analyses, it is possible actual results could differ substantially from those estimated.We believe the carrying value of our operating real estate assets, properties under development, and land is currently recoverable. However, if market conditions deteriorate or if changes in our development strategy significantly affect any key assumptions used in our fair value estimates, we may need to take material charges in future periods for impairments related to existing assets. Any such material non-cash charges could have an adverse effect on our consolidated financial position and results of operations.Item 7A. Quantitative and Qualitative Disclosures About Market RiskWe believe the primary market risk we face is interest rate risk. We seek to mitigate this risk by following established risk management policies, which includes (i) maintaining prudent levels of fixed and floating rate debt; and (ii) extending and sequencing the maturity dates of our debt where practicable. We also periodically use derivative financial instruments, primarily interest rate swaps with major financial institutions, to manage a portion of this risk. We do not utilize derivative financial instruments for trading or speculative purposes. The table below summarizes our debt as of December 31, 2022 and 2021:32Table of Contents ($ in millions)December 31, 2022December 31, 2021 Carrying AmountEstimated fair market valueWeightedAverageMaturity(in years)WeightedAverageInterestRate% OfTotalCarrying AmountEstimated fair market valueWeightedAverageMaturity(in years)WeightedAverageInterestRate% OfTotalFixed rate debt$3,114.0 $2,806.1 7.13.7 %84.6 %$3,130.5 $3,363.7 7.53.6 %98.7 %Variable rate debt566.9 566.8 3.05.5 %15.4 %39.9 40.1 0.71.9 %1.3 %In order to manage interest rate exposure, we have previously utilized interest rate swap agreements to protect against unfavorable interest rate changes relating to forecasted debt transactions. These swaps, which are settled upon issuance of the related debt, are designated as cash flow hedges and the gains and/or losses are deferred in other comprehensive income and recognized as an adjustment to interest expense over the same period the hedged interest payments affect earnings. As of December 31, 2022, we had no hedges outstanding.At December 31, 2022, we had approximately $42.0 million of borrowings outstanding under our unsecured revolving credit facility and did not have any amounts outstanding under our unsecured revolving credit facility at December 31, 2021. At December 31, 2022 and 2021, we had unsecured term loans outstanding of approximately $339.8 million and $39.9 million, respectively. At December 31, 2022 we also had secured variable rate notes outstanding of approximately $185.1 million and did not have any amounts outstanding at December 31, 2021. If interest rates on the variable rate debt listed in the table above would have been 100 basis points higher throughout 2022 and 2021, our annual interest costs would have increased by approximately $5.7 million and $0.4 million, respectively.For fixed rate debt, interest rate changes affect the fair market value but do not impact net income attributable to common shareholders or cash flows. Holding other variables constant, if interest rates would have been 100 basis points higher as of December 31, 2022, the fair value of our fixed rate debt would have decreased by approximately $139.6 million.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide the reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect future results. This MD&A should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report. Discussion regarding our financial condition and results of operations for the year ended December 31, 2021 and comparisons between the years ended December 31, 2021 and 2020 is included in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the company’s 2021 Annual Report filed with the SEC on February 28, 2022.OverviewWe are the world’s largest commercial real estate services and investment firm, based on 2022 revenue, with leading global market positions in our leasing, property sales, occupier outsourcing and valuation businesses. As of December 31, 2022, the company has approximately 115,000 employees (excluding Turner & Townsend employees) serving clients in more than 100 countries.We provide services to real estate investors and occupiers. For investors, our services include capital markets (property sales and mortgage origination), mortgage sales and servicing, property leasing, investment management, property management, valuation and development services, among others. For occupiers, our services include facilities management, project management and transaction (property sales and leasing) and consulting services, among others. We provide services under the following brand names: “CBRE” (real estate advisory and outsourcing services); “CBRE Investment Management” (investment management); “Trammell Crow Company” (primarily U.S. development); “Telford Homes” (U.K. development); and “Turner & Townsend Holdings Limited” (Turner & Townsend).We generate revenue from stable, recurring sources (large multi-year portfolio and per project contracts) and from cyclical, non-recurring sources, including commissions on transactions. Our revenue mix has become heavily weighted towards stable revenue sources, particularly occupier outsourcing, and our dependence on cyclical property sales and lease transaction revenue has declined. We believe we are well-positioned to capture a substantial and growing share of market opportunities at a time when investors and occupiers increasingly prefer to purchase integrated, account-based services on a national and global basis. In 2022, we generated revenue from a highly diversified base of clients, including more than 95 of the Fortune 100 companies. We have been an S&P 500 company since 2006 and in 2022 we were ranked #126 on the Fortune 500. We have been voted the most recognized commercial real estate brand in the Lipsey Company survey for 22 years in a row (including 2022). We have also been rated a World’s Most Ethical Company by the Ethisphere Institute for nine consecutive years (including 2022, the most recent year the award has been announced), and included in the Dow Jones World Sustainability Index for four years in a row and the Bloomberg Gender-Equality Index for four years in a row (including 2023).Critical Accounting Policies and EstimatesOur consolidated financial statements have been prepared in accordance with GAAP, which require us to make estimates and assumptions that affect reported amounts. The estimates and assumptions are based on historical experience and on other factors that we believe to be reasonable. Actual results may differ from those estimates. We believe that the following critical accounting policies represent the areas where more significant judgments and estimates are used in the preparation of our consolidated financial statements.Revenue RecognitionTo recognize revenue in a transaction with a customer, we evaluate the five steps of the Accounting Standards Codification (ASC) Topic 606 revenue recognition framework: (1) identify the contract; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations and (5) recognize revenue when (or as) the performance obligations are satisfied.Our revenue recognition policies are consistent with this five step framework. Understanding the complex terms of agreements and determining the appropriate time, amount, and method to recognize revenue for each transaction requires significant judgement. These significant judgements include: (i) determining what point in time or what measure of progress depicts the transfer of control to the customer; (ii) applying the series guidance to certain performance obligations satisfied over 30Table of Contentstime; (iii) estimating how and when contingencies, or other forms of variable consideration, will impact the timing and amount of recognition of revenue and (iv) determining whether we control third party services before they are transferred to the customer in order to appropriately recognize the associated fees on either a gross or net basis. The timing and amount of revenue recognition in a period could vary if different judgments were made. Our revenues subject to the most judgment are brokerage commission revenue, incentive-based management fees, development fees and third party fees associated with our occupier outsourcing and property management services. For a detailed discussion of our revenue recognition policies, see the Revenue Recognition section within Note 2 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.Business Combinations, Goodwill and Other Intangible AssetsOur acquisitions require the application of purchase accounting, which results in tangible and identifiable intangible assets and liabilities of the acquired entity being recorded at fair value. The difference between the purchase price and the fair value of net assets acquired is recorded as goodwill. Deferred consideration arrangements granted in connection with a business combination are evaluated to determine whether all or a portion is, in substance, additional purchase price or compensation for services. Additional purchase price is added to the fair value of consideration transferred in the business combination and compensation is included in operating expenses in the period it is incurred. In determining the fair values of assets and liabilities acquired in a business combination, we use a variety of valuation methods including present value, depreciated replacement cost, market values (where available) and selling prices less costs to dispose. We are responsible for determining the valuation of assets and liabilities and for the allocation of purchase price to assets acquired and liabilities assumed.Assumptions must often be made in determining fair values, particularly where observable market values do not exist. Assumptions may include discount rates, growth rates, cost of capital, royalty rates, tax rates and remaining useful lives. These assumptions can have a significant impact on the value of identifiable assets and accordingly can impact the value of goodwill recorded. Different assumptions could result in different values being attributed to assets and liabilities. Since these values impact the amount of annual depreciation and amortization expense, different assumptions could also impact our statement of operations and could impact the results of future asset impairment reviews.We are required to test goodwill and other intangible assets deemed to have indefinite useful lives for impairment at least annually, or more often if circumstances or events indicate a change in the impairment status, in accordance with ASC Topic 350, “Intangibles – Goodwill and Other” (Topic 350). We have the option to perform a qualitative assessment with respect to any of our reporting units to determine whether a quantitative impairment test is needed. We are permitted to assess based on qualitative factors whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the quantitative goodwill impairment test. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we would conduct a quantitative goodwill impairment test. If not, we do not need to apply the quantitative test. The qualitative test is elective and we can go directly to the quantitative test rather than making a more-likely-than-not assessment based on an evaluation of qualitative factors. When performing a quantitative test, we use a discounted cash flow approach to estimate the fair value of our reporting units. Management’s judgment is required in developing the assumptions for the discounted cash flow model. These assumptions include revenue growth rates, profit margin percentages, discount rates, etc. Due to the many variables inherent in the estimation of a business’s fair value and the relative size of our goodwill, if different assumptions and estimates were used, it could have an adverse effect on our impairment analysis.For additional information on business combinations, goodwill and intangible asset impairment testing, see Notes 2 and 9 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.Income TaxesIncome taxes are accounted for under the asset and liability method in accordance with the “Accounting for Income Taxes,” Topic of the FASB ASC (Topic 740). Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax basis of assets and liabilities and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured by applying enacted tax rates and laws and are released in the years in which the temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are provided against deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized.31Table of ContentsAccounting for tax positions requires judgments, including estimating reserves for potential uncertainties. We also assess our ability to utilize tax attributes, including those in the form of carryforwards, for which the benefits have already been reflected in the financial statements. We do not record valuation allowances for deferred tax assets that we believe will be realized in future periods. While we believe the resulting tax balances as of December 31, 2022 and 2021 are appropriately accounted for in accordance with Topic 740, as applicable, the ultimate outcome of such matters could result in favorable or unfavorable adjustments to our consolidated financial statements and such adjustments could be material.Our future effective tax rate could be adversely affected by earnings being lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items.See Note 15 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report for further information regarding income taxes.ContingenciesPursuant to ASC Topic 450, we evaluate whether any existing conditions existed as of the financial statement issuance date which may result in a loss contingent upon one or more future events occurring or not occurring. Assessing contingent liabilities involves significant judgment. If the assessment indicates that a loss is probable and the amount is reasonably estimable, we accrue an estimated liability in our financial statements. If the assessment indicates that a potentially material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability and an estimate of the range of potential losses, if determinable and material, would be disclosed. We determine the amount of estimated liability to accrue, if any, after thorough evaluation of key information available that could impact the size and timing of the potential loss on a case-by-case basis. Given the significant judgment involved with such estimates, the potential liability may change in the future as new information becomes available. We do not recognize gain contingencies until the contingency is completely resolved and the associated amounts are probable of collection. See Notes 13 and 22 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report for further information regarding Commitments and Contingencies and Telford Fire Safety Remediation, respectively.Investments in unconsolidated subsidiaries – fair value optionWe have elected the fair value option for certain of our investments in non-public entities to align with our strategy for these investments. Such investments without readily determinable fair values are classified as Level 3 in the fair value hierarchy. We estimate the fair market value on a recurring basis using significant unobservable inputs which requires judgment due to the absence of market prices or similar assets in active markets. In determining the estimated fair value of these investments, we utilize appropriate valuation techniques including discounted cash flow analyses and Monte Carlo simulations. Key inputs to the discounted cash flow analyses include projected cash flows, terminal growth rate, and discount rate. Key inputs to Monte Carlo simulations include stock price, volatility, risk free rate, and dividend yield.Changes in the fair value of equity investments under the fair value option are recorded as Equity income from unconsolidated subsidiaries in the Consolidated Statements of Operations.New Accounting PronouncementsSee New Accounting Pronouncements discussion within Note 3 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.SeasonalityIn a typical year, a significant portion of our revenue is seasonal, which an investor should keep in mind when comparing our financial condition and results of operations on a quarter-by-quarter basis. Historically, our revenue, operating income, net income and cash flow from operating activities have tended to be lowest in the first quarter and highest in the fourth quarter of each year. Revenue, earnings and cash flow have generally been concentrated in the fourth calendar quarter due to the focus on completing sales, financing and leasing transactions prior to year-end. The sharp rise in interest rates to combat inflation and resultant economic uncertainty may cause seasonality to deviate from historical patterns.32Table of ContentsInflationOur business was affected by high inflation in 2022. Most notably, the central banks’ moves to tame high inflation by rapidly raising interest rates sharply increased the cost of debt and dramatically constrained its availability, resulting in a significant decline in sales and financing transaction activity throughout the year’s second half. In addition, rising price levels across the economy required us to increase compensation expense to retain top talent and our development businesses incurred higher input costs for construction materials. On the other hand, we believe that parts of our business have protections against inflation. The company continues to monitor inflation, monetary policy changes in response to inflation and potentially adverse effects on our business.Items Affecting ComparabilityWhen you read our financial statements and the information included in this Annual Report, you should consider that we have experienced, and continue to experience, several material trends and uncertainties (particularly those caused or exacerbated by Covid-19) that have affected our financial condition and results of operations that make it challenging to predict our future performance based on our historical results. We believe that the following material trends and uncertainties are crucial to an understanding of the variability in our historical earnings and cash flows and the potential for continued variability in the future.Macroeconomic ConditionsEconomic trends and government policies affect global and regional commercial real estate markets as well as our operations directly. These include overall economic activity and employment growth, with specific sensitivity to growth in office-based employment; interest rate levels and changes in interest rates; the cost and availability of credit; and the impact of tax and regulatory policies. Periods of economic weakness or recession, significantly rising interest rates, fiscal uncertainty, declining employment levels, decreasing demand for commercial real estate, falling real estate values, disruption to the global capital or credit markets, or the public perception that any of these events may occur, will negatively affect the performance of our business.Compensation is our largest expense and our sales and leasing professionals generally are paid on a commission and/or bonus basis that correlates with their revenue production. As a result, the negative effects on our operating margins during difficult market conditions, such as the environment that prevailed in the early months of the Covid-19 pandemic, are partially mitigated by the inherent variability of our compensation cost structure. In addition, when negative economic conditions have been particularly severe, like during the Covid-19 pandemic, we have moved decisively to lower operating expenses to improve financial performance. We began efforts in 2022 and will continue to reduce expenses in 2023 in light of the intensifying macroeconomic challenges, including rapidly rising interest rates to combat inflation. Additionally, our contractual revenue has increased primarily as a result of growth in our outsourcing business, and we believe this contractual revenue should partially offset the negative impacts that macroeconomic deterioration could have on other parts of our business. We also believe that we have significantly improved the resiliency of our business by expanding the business strategically across asset types, clients, geographies and lines of business. Nevertheless, adverse global and regional economic trends will pose significant risks to the performance of our consolidated operations and financial condition.Effects of Acquisitions and InvestmentsWe have historically made significant use of strategic acquisitions to add and enhance service capabilities around the world. On November 1, 2021, we acquired a 60% controlling ownership interest in Turner & Townsend Holdings Limited (Turner & Townsend). Turner & Townsend is a leading professional services company specializing in program management, project management, cost and commercial management and advisory services across the real estate, infrastructure and natural resources sectors, and is consolidated and reported in our Global Workplace Solutions segment.Strategic in-fill acquisitions have also played a key role in strengthening our service offerings. The companies we acquired have generally been regional or specialty firms that complement our existing platform, or independent affiliates, which, in some cases, we held a small equity interest.During 2022, we completed eleven in-fill acquisitions: four in the Global Workplace Solutions segment and seven in the Advisory Services segment.33Table of ContentsWe believe strategic acquisitions can significantly decrease the cost, time and resources necessary to attain a meaningful competitive position – or expand our capabilities – within targeted markets or business lines. In general, however, most acquisitions will initially have an adverse impact on our operating income and net income as a result of transaction-related expenditures, including severance, lease termination, transaction and deferred financing costs, as well as costs and charges associated with integrating the acquired business and integrating its financial and accounting systems into our own.Our acquisition structures often include deferred and/or contingent purchase consideration in future periods that are subject to the passage of time or achievement of certain performance metrics and other conditions. As of December 31, 2022, we have accrued deferred purchase and contingent considerations totaling $574.3 million, which is included in “Accounts payable and accrued expenses” and in “Other long-term liabilities” in the accompanying consolidated balance sheets set forth in Item 8 of this Annual Report.We believe there are attractive companies that do not fit seamlessly into our services offering but that would benefit from an investment from and strategic partnership with us. These benefits include for our company, more tools and services with which to meet our clients’ needs, and for the companies with which we partner, more sales channels and faster growth. During 2022, we made a $100.7 million investment in VTS, a technology company that helps leasing agents better serve property owners and enables property managers to create more engaging experiences for building tenants. Also, during 2022, we made an incremental investment of $100 million in Industrious, a leading provider of premium flexible workplace solutions in the U.S., bringing our current non-controlling ownership stake to approximately 45%. During 2021, our company-sponsored SPAC merged with and into Altus Power, Inc. (Altus), which trades on the NYSE under the symbol “AMPS”. We have approximately 15.5% common shares ownership in AMPS at December 31, 2022.International OperationsWe conduct a significant portion of our business and employ a substantial number of people outside the U.S. As a result, we are subject to risks associated with doing business globally. Our Real Estate Investments business has significant euro and British pound denominated assets under management, as well as associated revenue and earnings in Europe. In addition, our Global Workplace Solutions business also derives significant revenue and earnings in foreign currencies, such as the euro and British pound sterling. Our business has been significantly impacted this year by the sharp appreciation of the U.S. dollar against these and other foreign currencies. Further fluctuations in foreign currency exchange rates may continue to produce corresponding changes in our AUM, revenue and earnings.Our businesses could suffer from the effects of public health crises (such as the ongoing Covid-19 pandemic), geopolitical events (such as the war in Ukraine) or economic disruptions (or the perception that such disruptions may occur), rapid changes in interest rates, liquidity, the macroeconomic backdrop or regulatory or financial market uncertainty.During the year ended December 31, 2022, approximately 43.3% of our revenue was transacted in foreign currencies. The following table sets forth our revenue derived from our most significant currencies (dollars in thousands): Year Ended December 31,20222021United States dollar$17,470,227 56.7 %$15,700,279 56.6 %British pound sterling4,084,408 13.2 %3,617,504 13.0 %euro2,854,233 9.3 %2,840,203 10.2 %Canadian dollar1,232,134 4.0 %1,068,838 3.9 %Australian dollar769,244 2.5 %613,847 2.2 %Chinese yuan534,276 1.7 %475,185 1.7 %Indian rupee533,545 1.7 %454,859 1.6 %Japanese yen407,308 1.3 %373,828 1.3 %Swiss franc391,549 1.3 %391,062 1.4 %Singapore dollar353,689 1.1 %309,376 1.1 %Other currencies (1)2,197,633 7.2 %1,901,055 7.0 %Total revenue$30,828,246 100.0 %$27,746,036 100.0 %_______________(1)Approximately 48 currencies comprise 7.2% of our revenue for the year ended December 31, 2022, and approximately 48 currencies comprise 7.0% of our revenue for the year ended December 31, 2021.34Table of ContentsAlthough we operate globally, we report our results in U.S. dollars. As a result, the strengthening or weakening of the U.S. dollar may positively or negatively impact our reported results. For example, we estimate that had the British pound sterling-to-U.S. dollar exchange rates been 10% higher during the year ended December 31, 2022, the net impact would have been a decrease in pre-tax income of $24.1 million. Had the euro-to-U.S. dollar exchange rates been 10% higher during the year ended December 31, 2022, the net impact would have been an increase in pre-tax income of $14.8 million. These hypothetical calculations estimate the impact of translating results into U.S. dollars and do not include an estimate of the impact that a 10% change in the U.S. dollar against other currencies would have had on our foreign operations.Fluctuations in foreign currency exchange rates may result in corresponding fluctuations in revenue and earnings as well as the assets under management for our investment management business, which could have a material adverse effect on our business, financial condition and operating results. Due to the constantly changing currency exposures to which we are subject and the volatility of currency exchange rates, we cannot predict the effect of exchange rate fluctuations upon future operating results. In addition, fluctuations in currencies relative to the U.S. dollar may make it more difficult to perform period-to-period comparisons of our reported results of operations. Our international operations also are subject to, among other things, political instability and changing regulatory environments, which affect the currency markets and which as a result may adversely affect our future financial condition and results of operations. We routinely monitor these risks and related costs and evaluate the appropriate amount of oversight to allocate towards business activities in foreign countries where such risks and costs are particularly significant.35Table of ContentsResults of OperationsThe following table sets forth items derived from our consolidated statements of operations for the years ended December 31, 2022 and 2021 (dollars in thousands):Year Ended December 31,20222021Revenue:Net revenue:Facilities management$5,136,565 16.7 %$4,872,230 17.6 %Property management1,777,477 5.8 %1,691,948 6.1 %Project management2,735,113 8.9 %1,537,215 5.5 %Valuation764,453 2.5 %733,523 2.6 %Loan servicing311,492 1.0 %305,736 1.1 %Advisory leasing3,872,379 12.6 %3,306,548 11.9 %Capital markets:Advisory sales2,522,728 8.2 %2,789,573 10.1 %Commercial mortgage origination562,807 1.8 %701,368 2.5 %Investment management594,867 1.9 %556,154 2.0 %Development services514,742 1.7 %535,562 1.9 %Corporate, other and eliminations(16,090)(0.1)%(20,356)0.0 %Total net revenue18,776,533 60.9 %17,009,501 61.3 %Pass through costs also recognized as revenue12,051,713 39.1 %10,736,535 38.7 %Total revenue30,828,246 100.0 %27,746,036 100.0 %Costs and expenses:Cost of revenue24,239,488 78.6 %21,579,507 77.8 %Operating, administrative and other4,649,460 15.1 %4,074,184 14.7 %Depreciation and amortization613,088 2.0 %525,871 1.9 %Asset impairments58,713 0.2 %— 0.0 %Total costs and expenses29,560,749 95.9 %26,179,562 94.4 %Gain on disposition of real estate244,418 0.8 %70,993 0.3 %Operating income1,511,915 4.9 %1,637,467 5.9 %Equity income from unconsolidated subsidiaries228,998 0.7 %618,697 2.2 %Other (loss) income(11,864)0.0 %203,609 0.7 %Interest expense, net of interest income68,999 0.2 %50,352 0.2 %Write-off of financing costs on extinguished debt1,860 0.0 %— 0.0 %Income before provision for income taxes1,658,190 5.4 %2,409,421 8.7 %Provision for income taxes234,230 0.8 %567,506 2.0 %Net income1,423,960 4.6 %1,841,915 6.6 %Less: Net income attributable to non-controlling interests16,590 0.1 %5,341 0.0 %Net income attributable to CBRE Group, Inc.1,407,370 4.6 %1,836,574 6.6 %Core EBITDA$2,924,264 $2,863,653 Consolidated Adjusted EBITDA$2,749,111 $3,074,412 36Table of ContentsNet revenue, segment operating profit on revenue margin, segment operating profit on net revenue margin, core EBITDA and consolidated adjusted EBITDA are not recognized measurements under accounting principles generally accepted in the United States, or GAAP. When analyzing our operating performance, investors should use these measures in addition to, and not as an alternative for, their most directly comparable financial measure calculated and presented in accordance with GAAP. We generally use these non-GAAP financial measures to evaluate operating performance and for other discretionary purposes. We believe these measures provide a more complete understanding of ongoing operations, enhance comparability of current results to prior periods and may be useful for investors to analyze our financial performance because they eliminate the impact of selected costs and charges that may obscure the underlying performance of our business and related trends. Because not all companies use identical calculations, our presentation of net revenue, core EBITDA and consolidated adjusted EBITDA may not be comparable to similarly titled measures of other companies.Net revenue is gross revenue less costs largely associated with subcontracted vendor work performed for clients and generally has no margin. Segment operating profit on revenue margin is computed by dividing segment operating profit by revenue and provides a comparable profitability measure against our peers. Segment operating profit on net revenue margin is computed by dividing segment operating profit by net revenue and is a better indicator of the segment’s margin since it does not include the diluting effect of pass through revenue which generally has no margin.We use core EBITDA and consolidated adjusted EBITDA as indicators of consolidated financial performance. Consolidated adjusted EBITDA represents earnings before the portion attributable to non-controlling interests, net interest expense, write-off of financing costs on extinguished debt, income taxes, depreciation and amortization, asset impairments, adjustments related to certain carried interest incentive compensation expense (reversal) to align with the timing of associated revenue, fair value adjustments to real estate assets acquired in the Telford acquisition (purchase accounting) that were sold in the period, costs incurred related to legal entity restructuring, integration and other costs related to acquisitions, costs associated with efficiency and cost-reduction initiatives, and a provision associated with Telford’s fire safety remediation efforts. Core EBITDA removes from adjusted EBITDA the impact of fair value changes on certain non-core non-controlling equity investments that are not directly related to our business segments as these could fluctuate significantly period over period and also net gain on deconsolidation upon merger of the SPAC with and into Altus Power, net of associated costs, in 2021. We believe that investors may find these measures useful in evaluating our operating performance compared to that of other companies in our industry because their calculations generally eliminate the effects of acquisitions, which would include impairment charges of goodwill and intangibles created from acquisitions, the effects of financings and income taxes and the accounting effects of capital spending.Consolidated adjusted EBITDA and core EBITDA are not intended to be a measure of free cash flow for our discretionary use because they do not consider certain cash requirements such as tax and debt service payments. These measures may also differ from the amounts calculated under similarly titled definitions in our credit facilities and debt instruments, which are further adjusted to reflect certain other cash and non-cash charges and are used by us to determine compliance with financial covenants therein and our ability to engage in certain activities, such as incurring additional debt. We also use core EBITDA as a significant component when measuring our operating performance under our employee incentive compensation programs.37Table of ContentsConsolidated adjusted EBITDA and core EBITDA are calculated as follows (dollars in thousands):Year Ended December 31,20222021Net income attributable to CBRE Group, Inc.$1,407,370 $1,836,574 Net income attributable to non-controlling interests16,590 5,341 Net income1,423,960 1,841,915 Add:Depreciation and amortization613,088 525,871 Asset impairments58,713 — Interest expense, net of interest income68,999 50,352 Write-off of financing costs on extinguished debt1,860 — Provision for income taxes234,230 567,506 Carried interest incentive compensation (reversal) expense to align with the timing of associated revenue(4,228)49,941 Impact of fair value adjustments to real estate assets acquired in the Telford acquisition (purchase accounting) that were sold in period(5,115)(5,725)Costs incurred related to legal entity restructuring13,447 — Integration and other costs related to acquisitions40,702 44,552 Costs associated with efficiency and cost-reduction initiatives117,534 — Provision associated with Telford’s fire safety remediation efforts185,921 — Consolidated Adjusted EBITDA$2,749,111 $3,074,412 Adjustments:Net fair value adjustments on strategic non-core investments175,153 (54,354)Net gain on deconsolidation upon merger of the SPAC with and into Altus Power, net of associated costs— (156,405)Core EBITDA$2,924,264 $2,863,653 38Table of ContentsYear Ended December 31, 2022 Compared to Year Ended December 31, 2021We reported consolidated net income of $1.4 billion for the year ended December 31, 2022 on revenue of $30.8 billion as compared to consolidated net income of $1.8 billion on revenue of $27.7 billion for the year ended December 31, 2021.Our revenue on a consolidated basis for the year ended December 31, 2022 increased by $3.1 billion, or 11.1%, as compared to the year ended December 31, 2021. Although revenue increased across all three of our segments, Global Workplace Solutions segment (GWS) revenue growth was the main driver. Revenue in our GWS segment increased by $2.8 billion or 16.1% as compared to 2021 primarily due to an increase in the project management revenue stream which also now reflects a full year contribution from our Turner & Townsend partnership, supplemented by modest growth in our facilities management business. Advisory Services revenue increased by $307.7 million, or 3.2%, mainly due to growth in leasing, property management and valuation, offset by challenges experienced by our capital markets (sales and commercial mortgage origination) business. Revenue in the Real Estate Investment segment was relatively flat as higher asset management fees driven by asset appreciation were offset by lower carried interest revenue and decreased development and construction revenue. Foreign currency translation had a 4.2% negative impact on total revenue during the year ended December 31, 2022, primarily driven by weakness in the British pound sterling, euro and Japanese yen.Our cost of revenue on a consolidated basis increased by $2.7 billion, or 12.3%, during the year ended December 31, 2022 as compared to the same period in 2021. This increase was primarily due to higher costs associated with our Global Workplace Solutions segment given the growth in our facilities management and project management businesses, including full year contribution from Turner & Townsend, and higher commission expense associated with our Advisory Services segment primarily due to growth in our leasing business. Foreign currency translation had a 4.1% positive impact on total cost of revenue during the year ended December 31, 2022. Cost of revenue as a percentage of revenue increased slightly from 77.8% for the year ended December 31, 2021 to 78.6% for the year ended December 31, 2022, mainly due to significant growth in the sales and leasing businesses earlier in the year leading to higher commission payouts.Our operating, administrative and other expenses on a consolidated basis increased by $575.3 million, or 14.1%, during the year ended December 31, 2022 as compared to the same period in 2021. The increase was primarily due to an increase in compensation and benefits for support staff given the expansion of the overall business, travel and entertainment related expenses during the first half of the year, provision related to Telford Home’s building and fire safety remediation work, and charges associated with efficiency and cost reduction initiatives as compared to the same period in 2021. In addition, the current year also included operating expenses from our Turner & Townsend business. This increase was partially offset by lower overall incentive compensation in the current year as compared to the prior year. Foreign currency translation also had a 4.6% positive impact on total operating expenses during the year ended December 31, 2022. Operating expenses as a percentage of revenue increased slightly to 15.1% for the year ended December 31, 2022 from 14.7% for the year ended December 31, 2021.Our depreciation and amortization expense on a consolidated basis increased by $87.2 million, or 16.6%, during the year ended December 31, 2022 as compared to the same period in 2021. This increase was primarily attributable to amortization of backlog and customer relationship intangibles from the acquisition of Turner & Townsend, with minimal comparable activity in the prior period.Our asset impairments on a consolidated basis totaled $58.7 million during the year ended December 31, 2022. We recorded $10.4 million in asset impairment related to our exit of the Advisory Services business in Russia; $26.4 million and $21.9 million of non-cash goodwill impairment and trade name impairment charges, respectively, in our Real Estate Investment segment related to Telford Homes. The charges are attributable to the effect of elevated inflation on construction, materials and labor costs, which will reduce Telford Homes’ profitability because the sales prices for the build-to-rent developments are fixed at the time the developments are sold to a long-term investor. This resulted in a need to impair the above assets due to an expected reduction in cash flows and profitability. We did not record any asset impairments during the year ended December 31, 2021.Our gain on disposition of real estate on a consolidated basis increased by $173.4 million during the year ended December 31, 2022 as compared to the same period in 2021 due to significant gains associated with certain property sales on consolidated deals within our Real Estate Investments segment.39Table of ContentsOur equity income from unconsolidated subsidiaries on a consolidated basis decreased by $389.7 million, or 63.0%, during the year ended December 31, 2022 as compared to the same period in 2021, primarily driven by a lower equity pickup and net negative fair value adjustment in our non-core investment portfolio this year. In addition, we recorded higher equity earnings associated with property sales reported in our Real Estate Investments segment last year as compared to this year.Our other losses on a consolidated basis were $11.9 million for the year ended December 31, 2022 versus other income of $203.6 million for the same period in the prior year. In the prior year we recorded a non-cash gain of $187.5 million as part of the deconsolidation of CBRE Acquisition Holdings, Inc. (CBAH) upon its merger with and into Altus Power, Inc.Our consolidated interest expense, net of interest income, increased by $18.6 million, or 37.0%, for the year ended December 31, 2022 as compared to the same period in 2021. This increase was primarily due to interest expense related to deferred purchase consideration associated with the Turner & Townsend acquisition and interest expense associated with the net borrowings on the revolving credit facilities. Our provision for income taxes on a consolidated basis was $234.2 million for the year ended December 31, 2022 as compared to $567.5 million for the same period in 2021. Our effective tax rate decreased from 23.6% for the year ended December 31, 2021 to 14.1% for the year ended December 31, 2022. The decrease is primarily due to the outside basis differences recognized as a result of a legal entity restructuring.On August 16, 2022, the Inflation Reduction Act (IRA), a budget reconciliation package that contained legislation targeting energy security and climate changes, healthcare and taxes, was signed into law. With respect to corporate-level taxes, the IRA included a 1% excise tax on stock buybacks and a 15% minimum corporate minimum tax (CAMT) based on financial statement income of certain U.S. companies that meet the $1 billion profitability threshold criteria, effective after December 31, 2022. We continue to evaluate the impact of the legislation and forthcoming administrative guidance and regulations to our financial statements and results of operations.40Table of ContentsSegment OperationsWe organize our operations around, and publicly report our financial results on, three global business segments: (1) Advisory Services; (2) Global Workplace Solutions; and (3) Real Estate Investments. We also have a Corporate and other segment. Corporate primarily consists of corporate overhead costs. Other consists of activities from strategic non-core non-controlling equity investments and is considered an operating segment but does not meet the aggregation criteria for presentation as a separate reportable segment and is, therefore, combined with Corporate and reported as Corporate and other. It also includes eliminations related to inter-segment revenue. For additional information on our segments, see Note 19 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.Advisory ServicesThe following table summarizes our results of operations for our Advisory Services operating segment for the years ended December 31, 2022 and 2021 (dollars in thousands):Year Ended December 31,20222021Revenue:Net revenue:Property management$1,777,477 18.0 %$1,691,948 17.7 %Valuation764,453 7.7 %733,523 7.7 %Loan servicing311,492 3.2 %305,736 3.2 %Advisory leasing3,872,379 39.2 %3,306,548 34.5 %Capital markets:Advisory sales2,522,728 25.5 %2,789,573 29.1 %Commercial mortgage origination562,807 5.7 %701,368 7.3 %Total segment net revenue9,811,336 99.3 %9,528,696 99.5 %Pass through costs also recognized as revenue72,170 0.7 %47,063 0.5 %Total segment revenue9,883,506 100.0 %9,575,759 100.0 %Costs and expenses:Cost of revenue5,979,935 60.5 %5,642,202 58.9 %Operating, administrative and other2,055,494 20.8 %1,886,308 19.7 %Depreciation and amortization310,823 3.1 %311,397 3.3 %Asset impairments10,351 0.1 %— 0.0 %Total costs and expenses8,356,603 84.5 %7,839,907 81.9 %Gain on disposition of real estate27 0.0 %— 0.0 %Operating income1,526,930 15.5 %1,735,852 18.1 %Equity income from unconsolidated subsidiaries14,662 0.1 %24,778 0.3 %Other income (loss)1,423 0.0 %(8,800)(0.1)%Add-back: Depreciation and amortization310,823 3.1 %311,397 3.3 %Add-back: Asset impairments10,351 0.1 %— 0.0 %Adjustments:Costs associated with efficiency and cost-reduction initiatives45,735 0.5 %— 0.0 %Segment operating profit and segment operating profit on revenue margin$1,909,924 19.3 %$2,063,227 21.5 %Segment operating profit on net revenue margin19.5 %21.7 %41Table of ContentsYear Ended December 31, 2022 Compared to Year Ended December 31, 2021Revenue increased by $307.7 million, or 3.2%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021 driven by growth in leasing, valuation and property management, offset by a significant decline in capital markets (property sales and commercial mortgage origination) business. Leasing revenue increased 17.1%, primarily due to an uptick in office and industrial sectors in the U.S. Our valuation revenue was up 4% driven by increased revenue per assignment and higher demand given the market conditions, mainly in the U.S. and U.K. markets. We also experienced an increase in our property management business in the Americas due to client wins. The above growth was partially offset by a drop in sales revenue and commercial mortgage origination revenue, mainly in the Americas region. The current macroeconomic and fiscal environment has put significant stress on the lending market making it difficult to access capital at a reasonable cost. Sales activity remained strong in the EMEA and APAC region, growing at 4% and 13%, respectively, on a local currency basis. Foreign currency translation had a 3.5% negative impact on total revenue during the year ended December 31, 2022, primarily driven by weakness in the euro, British pound sterling and Japanese yen.Cost of revenue increased by $337.7 million, or 6.0%, for the year ended December 31, 2022 as compared to the same period in 2021, primarily due to increased commission expense resulting from higher sales generated earlier in the year and an overall increase in leasing revenue. Foreign currency translation also had a 3.3% positive impact on total cost of revenue during the year ended December 31, 2022. Cost of revenue as a percentage of revenue increased to 60.5% for the year ended December 31, 2022 from 58.9% for the same period in 2021. This was due to a shift in the composition of total revenue where high margin debt origination revenue decreased as a percentage of total revenue this year versus the same period last year and also due to growth in sales revenue in the earlier part of the year triggering higher commissions for certain producers.Operating, administrative and other expenses increased by $169.2 million, or 9.0%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021. This increase was primarily due to severance expense incurred under the cost savings initiatives, an increase in travel and entertainment expenses during the first half of the year, support staff compensation and related benefits, employee recruitment and temporary help related charges, partially offset by lower incentive compensation expense, as compared to the year ended December 31, 2021. Foreign currency translation also had a 4.6% positive impact on total operating expenses during the year ended December 31, 2022.In connection with the origination and sale of mortgage loans for which the company retains servicing rights, we record servicing assets or liabilities based on the fair value of the retained mortgage servicing rights (MSRs) on the date the loans are sold. Upon origination of a mortgage loan held for sale, the fair value of the mortgage servicing rights to be retained is included in the forecasted proceeds from the anticipated loan sale and results in a net gain (which is reflected in revenue). Subsequent to the initial recording, MSRs are amortized (within amortization expense) and carried at the lower of amortized cost or fair value in other intangible assets in the accompanying consolidated balance sheets. They are amortized in proportion to and over the estimated period that the servicing income is expected to be received. For the year ended December 31, 2022, MSRs contributed to operating income $134.1 million of gains recognized in conjunction with the origination and sale of mortgage loans, offset by $163.7 million of amortization of related intangible assets. For the year ended December 31, 2021, MSRs contributed $185.1 million of gains recognized in conjunction with the origination and sale of mortgage loans, offset by $172.3 million of amortization of related intangible assets. The decline was associated with lower origination activity given the higher cost of debt. Equity income from unconsolidated subsidiaries decreased by $10.1 million, or 40.8%, for the year ended December 31, 2022 compared to the same period in the prior year, due to a lower net fair value adjustment on one of our strategic non-controlling equity investments.Depreciation expense was up by $5.7 million, or 4.5%, due to accelerated depreciation expense associated with certain cost savings initiatives. Amortization expense during the year ended December 31, 2022 decreased by $6.2 million, as compared to the same period in 2021, primarily due to lower amortization on the MSRs.42Table of ContentsGlobal Workplace SolutionsThe following table summarizes our results of operations for our Global Workplace Solutions operating segment for the years ended December 31, 2022 and 2021 (dollars in thousands):Year Ended December 31,20222021Revenue:Net revenue:Facilities management$5,136,565 25.9 %$4,872,230 28.5 %Project management2,735,113 13.8 %1,537,215 9.0 %Total segment net revenue7,871,678 39.7 %6,409,445 37.5 %Pass through costs also recognized as revenue11,979,543 60.3 %10,689,472 62.5 %Total segment revenue19,851,221 100.0 %17,098,917 100.0 %Costs and expenses:Cost of revenue17,947,859 90.4 %15,601,137 91.2 %Operating, administrative and other1,080,493 5.4 %839,117 4.9 %Depreciation and amortization253,013 1.3 %158,757 0.9 %Total costs and expenses19,281,365 97.1 %16,599,011 97.1 %Operating income569,856 2.9 %499,906 3.0 %Equity income from unconsolidated subsidiaries1,118 0.0 %1,720 0.0 %Other income6,615 0.0 %3,104 0.1 %Add-back: Depreciation and amortization253,013 1.3 %158,757 0.9 %Adjustments:Integration and other costs related to acquisitions40,702 0.2 %44,552 0.3 %Costs associated with efficiency and cost-reduction initiatives27,917 0.1 %— 0.0 %Segment operating profit and segment operating profit on revenue margin$899,221 4.5 %$708,039 4.1 %Segment operating profit on net revenue margin11.4 %11.0 %43Table of ContentsYear Ended December 31, 2022 Compared to Year Ended December 31, 2021Revenue increased by $2.8 billion, or 16.1%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021. The increase was primarily attributable to growth in our project management line of business, supplemented by moderate growth in facilities management revenue. We recorded approximately $1.3 billion in revenue from Turner & Townsend during the year with only two months of activity in the prior comparable period. Excluding Turner & Townsend, revenue rose nearly 9.5% with project management up 21.1% due to certain large projects and focused growth initiatives. Foreign currency translation had a 4.4% negative impact on total revenue during the year ended December 31, 2022, primarily driven by weakness in the British pound sterling and euro.Cost of revenue increased by $2.3 billion, or 15.0%, for the year ended December 31, 2022 as compared to the same period in 2021, driven by higher revenue leading to higher pass through costs and increased professional compensation. In addition, we recorded cost of revenue incurred by Turner & Townsend for the year ended December 31, 2022 with only two months of such activity in the prior comparable period. Foreign currency translation had a 4.2% positive impact on total cost of revenue during the year ended December 31, 2022. Cost of revenue as a percentage of revenue decreased slightly to 90.4% for the year ended December 31, 2022 from 91.2% for the same period in 2021, primarily due to an increase in project management revenue which generally has higher margins.Operating, administrative and other expenses increased by $241.4 million, or 28.8%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021. Compensation expense increased due to severance expense incurred under the costs savings initiatives and investment in new roles to drive business growth. We also recorded higher travel and entertainment expenses during the first half of the year, incentive compensation expense, and employee recruitment costs. In addition, we recorded operating expenses incurred by Turner & Townsend for the year ended December 31, 2022 with only two months of such activity in the prior comparable period. Foreign currency translation also had a 5.0% positive impact on total operating expenses during the year ended December 31, 2022.Depreciation and amortization expense increased by $94.3 million, or 59.4%, during the year ended December 31, 2022 as compared to the same period in 2021. This increase was primarily attributable to amortization of backlog and customer relationship intangibles from the acquisition of Turner & Townsend, with minimal comparable activity in the prior period.44Table of ContentsReal Estate InvestmentsThe following table summarizes our results of operations for our Real Estate Investments (REI) operating segment for the years ended December 31, 2022 and 2021 (dollars in thousands):Year Ended December 31,20222021Revenue:Investment management$594,867 53.6 %$556,154 50.9 %Development services514,742 46.4 %535,562 49.1 %Total segment revenue1,109,609 100.0 %1,091,716 100.0 %Costs and expenses:Cost of revenue322,152 29.0 %349,432 32.0 %Operating, administrative and other1,082,231 97.5 %896,375 82.1 %Depreciation and amortization16,250 1.5 %27,111 2.5 %Asset impairments48,362 4.4 %— 0.0 %Total costs and expenses1,468,995 132.4 %1,272,918 116.6 %Gain on disposition of real estate244,391 22.0 %70,993 6.5 %Operating loss(114,995)(10.4)%(110,209)(10.1)%Equity income from unconsolidated subsidiaries380,566 34.3 %555,341 50.9 %Other (loss) income(1,066)(0.1)%3,542 0.3 %Add-back: Depreciation and amortization16,250 1.5 %27,111 2.5 %Add-back: Asset impairments48,362 4.4 %— 0.0 %Adjustments:Carried interest incentive compensation (reversal) expense to align with the timing of associated revenue(4,228)(0.4)%49,941 4.6 %Impact of fair value adjustments to real estate assets acquired in the Telford acquisition (purchase accounting) that were sold in period(5,115)(0.5)%(5,725)(0.5)%Costs associate with efficiency and cost-reduction initiatives12,499 1.1 %— 0.0 %Provision associated with Telford’s fire safety remediation efforts185,921 16.8 %— 0.0 %Segment operating profit and segment operating profit on revenue margin$518,194 46.7 %$520,001 47.6 %Year Ended December 31, 2022 Compared to Year Ended December 31, 2021Revenue increased by $17.9 million, or 1.6%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily driven by an increase in investment management fees supported by net growth in assets under management, offset by lower carried interest revenue, and lower real estate sales, development and construction management fees, in our development business, primarily in the U.K. Foreign currency translation had a 6.7% negative impact on total revenue during the year ended December 31, 2022 primarily driven by weakness in the British pound sterling and euro.Cost of revenue decreased by $27.3 million, or 7.8%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021. Cost of revenue as a percent of revenue was 29.0% for the year ended December 31, 2022 as compared to 32.0% for the year ended December 31, 2021. This was mainly due to a change in composition of overall revenue. Revenue from investment management, which has no associated cost of revenue, contributed 53.6% to total segment revenue as compared to 50.9% last year. Foreign currency translation had a 9.1% positive impact on total cost of revenue during the year ended December 31, 2022.45Table of ContentsOperating, administrative and other expenses increased by $185.9 million, or 20.7%, for the year ended December 31, 2022 as compared to the same period in 2021. We recorded an estimated provision of $185.9 million related to fire and building safety remediation work that our Telford Homes business will undertake based on the pledge signed in the second quarter of 2022. Additionally, we noted an increase in overall compensation, including severance expense related to cost savings initiatives, higher travel and entertainment expenses during the first half of the year, partially offset by lower overall incentive compensation. Foreign currency translation had a 6.5% positive impact on total operating expenses during the year ended December 31, 2022.Equity income from unconsolidated subsidiaries decreased by $174.8 million, or 31.5%, during the year ended December 31, 2022 as compared to the same period in 2021. Gain on disposition of real estate increased by $173.4 million for the year ended December 31, 2022 as compared to the same period in 2021. This was primarily due to the composition of the portfolio, deal structures, and timing. A roll forward of our AUM by product type for the year ended December 31, 2022 is as follows (dollars in billions):FundsSeparate AccountsSecuritiesTotalBalance at December 31, 2021$56.6 $73.6 $11.7 $141.9 Inflows15.6 10.8 2.7 29.1 Outflows(5.1)(8.0)(1.9)(15.0)Market depreciation(0.9)(3.2)(2.6)(6.7)Balance at December 31, 2022$66.2 $73.2 $9.9 $149.3 AUM generally refers to the properties and other assets with respect to which we provide (or participate in) oversight, investment management services and other advice, and which generally consist of real estate properties or loans, securities portfolios and investments in operating companies and joint ventures. Our AUM is intended principally to reflect the extent of our presence in the real estate market, not the basis for determining our management fees. Our assets under management consist of:•the total fair market value of the real estate properties and other assets either wholly-owned or held by joint ventures and other entities in which our sponsored funds or investment vehicles and client accounts have invested or to which they have provided financing. Committed (but unfunded) capital from investors in our sponsored funds is not included in this component of our AUM. The value of development properties is included at estimated completion cost. In the case of real estate operating companies, the total value of real properties controlled by the companies, generally through joint ventures, is included in AUM; and•the net asset value of our managed securities portfolios, including investments (which may be comprised of committed but uncalled capital) in private real estate funds under our fund of funds investments.Our calculation of AUM may differ from the calculations of other asset managers, and as a result, this measure may not be comparable to similar measures presented by other asset managers.46Table of ContentsCorporate and OtherOur Corporate segment primarily consists of corporate overhead costs. Other consists of activities from strategic non-core non-controlling equity investments and is considered an operating segment but does not meet the aggregation criteria for presentation as a separate reportable segment and is, therefore, combined with our core Corporate function and reported as Corporate and other. The following table summarizes our results of operations for our Corporate and other segment for the years ended December 31, 2022 and 2021 (dollars in thousands):Year Ended December 31, (1)20222021Elimination of inter-segment revenue$(16,090)$(20,356)Costs and expenses:Cost of revenue (2)(10,458)(13,264)Operating, administrative and other431,242 452,384 Depreciation and amortization33,002 28,606 Operating loss(469,876)(488,082)Equity (loss) income from unconsolidated subsidiaries(167,348)36,858 Other (loss) income(18,836)205,763 Add-back: Depreciation and amortization33,002 28,606 Adjustments:Costs incurred related to legal entity restructuring13,447 — Costs associated with efficiency and cost-reduction initiatives31,383 — Segment operating loss$(578,228)$(216,855)_______________(1)Percentage of revenue calculations are not meaningful and therefore not included.(2)Primarily relates to inter-segment eliminations.Year Ended December 31, 2022 Compared to Year Ended December 31, 2021Core corporateOperating, administrative and other expenses for our core corporate function remained relatively flat at approximately $430.0 million during the year ended December 31, 2022, as compared to $427.6 million for the prior year. This was primarily due to severance charges associated with efficiency and cost reduction initiatives, partially offset by lower stock compensation and bonus expense as compared to the prior period. In addition, operating expenses associated with our sponsorship of CBRE Acquisition Holdings, Inc. (now known as Altus Power, Inc.) up until its merger with and into Altus on December 9, 2021 were also recorded in this segment.Other loss was approximately $12.2 million for the year ended December 31, 2022 versus an income of $7.1 million in the same period last year. This is primarily comprised of net unfavorable activity related to unrealized and realized gain/loss on equity and available for sale debt securities owned by our wholly-owned captive insurance company. These mark to market adjustments were in a net unfavorable position this year compared to the prior year. Other (non-core)We recorded equity loss of approximately $167.3 million for the year ended December 31, 2022 from unfavorable fair value adjustments related to certain non-core investments as compared to a $36.9 million positive fair value adjustments last year. We recorded other loss of $6.6 million which is mainly due to realized losses on sale of marketable securities this year. In the prior year, we recorded income of $198.7 million, mainly due to a non-cash gain of $187.5 million as part of the deconsolidation of CBAH upon its merger with and into Altus. 47Table of ContentsLiquidity and Capital ResourcesWe believe that we can satisfy our working capital and funding requirements with internally generated cash flow and, as necessary, borrowings under our revolving credit facilities. Our expected capital requirements for 2023 include up to approximately $326.8 million of anticipated capital expenditures, net of tenant concessions. During the year ended December 31, 2022, we incurred $248.5 million of capital expenditures, net of tenant concessions received. As of December 31, 2022, we had aggregate future commitments of $106.9 million related to co-investments funds in our Real Estate Investments segment, $47.3 million of which is expected to be funded in 2023. Additionally, as of December 31, 2022, we are committed to fund additional capital of $81.0 million and $85.9 million to consolidated and unconsolidated projects, respectively, within our Real Estate Investments segment. As of December 31, 2022, we had $3.5 billion of borrowings available under our revolving credit facilities (under both the Revolving Credit Agreement, as described below, and the Turner & Townsend revolving credit facility) and $1.3 billion of cash and cash equivalents.We have historically relied on our internally generated cash flow and our revolving credit facilities to fund our working capital, capital expenditure and general investment requirements (including strategic in-fill acquisitions) and have not sought other external sources of financing to help fund these requirements. In the absence of extraordinary events or a large strategic acquisition, we anticipate that our cash flow from operations and our revolving credit facilities would be sufficient to meet our anticipated cash requirements for the foreseeable future, and at a minimum for the next 12 months. Given compensation is our largest expense and our sales and leasing professionals are generally paid on a commission and/or bonus basis that correlates with their revenue production, the negative effect of difficult market conditions is partially mitigated by the inherent variability of our compensation cost structure. In addition, when negative economic conditions have been particularly severe, we have moved decisively to lower operating expenses to improve financial performance, and then have restored certain expenses as economic conditions improved. We may seek to take advantage of market opportunities to refinance existing debt instruments, as we have done in the past, with new debt instruments at interest rates, maturities and terms we deem attractive. We may also, from time to time in our sole discretion, purchase, redeem, or retire our existing senior notes, through tender offers, in privately negotiated or open market transactions, or otherwise. In March 2021, we took advantage of favorable market conditions and low interest rates and conducted a new issuance for $500.0 million in aggregate principal amount of 2.500% senior notes due 2031. On November 23, 2021, we redeemed the $300.0 million aggregate outstanding principal amount of our tranche A term loan facility due 2024 in full. We funded this redemption using cash on hand. As noted above, we believe that any future significant acquisitions we may make could require us to obtain additional debt or equity financing. In the past, we have been able to obtain such financing for material transactions on terms that we believed to be reasonable. However, it is possible that we may not be able to obtain acquisition financing on favorable terms, or at all, in the future.Our long-term liquidity needs, other than those related to ordinary course obligations and commitments such as operating leases, are generally comprised of three elements. The first is the repayment of the outstanding and anticipated principal amounts of our long-term indebtedness. If our cash flow is insufficient to repay our long-term debt when it comes due, then we expect that we would need to refinance such indebtedness or otherwise amend its terms to extend the maturity dates. We cannot make any assurances that such refinancing or amendments would be available on attractive terms, if at all.The second long-term liquidity need is the payment of obligations related to acquisitions. Our acquisition structures often include deferred and/or contingent purchase consideration in future periods that are subject to the passage of time or achievement of certain performance metrics and other conditions. As of December 31, 2022 and 2021, we had accrued deferred purchase consideration totaling $574.3 million ($117.3 million of which was a current liability) and $630.1 million ($32.0 million of which was a current liability), respectively, which was included in “Accounts payable and accrued expenses” and in “Other liabilities” in the accompanying consolidated balance sheets set forth in Item 8 of this Annual Report.Lastly, as described in Note 16 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report, in 2019, our board of directors authorized a program for the repurchase of up to $500.0 million of our Class A common stock over three years (the 2019 program). During the first quarter of 2022, we fully utilized the remaining capacity under the 2019 program and repurchased 615,108 shares of our Class A common stock with an average price of $101.88 per share using cash on hand for $62.7 million. 48Table of ContentsIn November 2021, our board of directors authorized a new program for the company to repurchase up to $2.0 billion of our Class A common stock over five years, effective November 19, 2021 (the 2021 program). In August 2022, our board of directors authorized an additional $2.0 billion, bringing the total authorized repurchase amount under the 2021 program to a total of $4.0 billion. During the year ended December 31, 2022, we repurchased 22,275,498 shares of our Class A common stock with an average price of $80.74 per share using cash on hand for $1.8 billion under the 2021 program. As of December 31, 2022 and February 16, 2023, respectively, we had $2.1 billion and $2.0 billion of capacity remaining under the 2021 program.Our stock repurchases have been funded with cash on hand and we intend to continue funding future repurchases with existing cash. We may utilize our stock repurchase programs to continue offsetting the impact of our stock-based compensation program and on a more opportunistic basis if we believe our stock presents a compelling investment compared to other discretionary uses. The timing of any future repurchases and the actual amounts repurchased will depend on a variety of factors, including the market price of our common stock, general market and economic conditions and other factors. As more fully described in Note 22 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report, following a request by the U.K. government to the majority of significant residential developers within the U.K. including Telford Homes, Telford Homes signed the U.K. government’s non-binding Fire Safety Pledge (the “Pledge”) on April 28, 2022. The Pledge states that subject to entering into mutually acceptable legally binding agreements with the U.K. government, Telford Homes will (1) take responsibility for performing or funding self-remediation works relating to certain life-critical fire-safety issues on all Telford Homes-constructed buildings of 11 meters in height or greater in England constructed in the last 30 years (in-scope buildings) and (2) withdraw Telford Homes-developed buildings from certain government-sponsored building safety funds or reimburse the government funds for the cost of remediation of in-scope buildings. We believe there is a potential risk of loss attributable to past events, including as a result of retrospective changes in building fire-safety regulations, under the Pledge, and also under existing contracts and/or the U.K.’s Building Safety Act of 2022 (BSA) or its Defective Premises Act of 1972 (DPA). The estimated costs for in-scope buildings are subjective, highly complex and dependent on a number of variables outside of Telford Homes’ control. These include, but are not limited to, the time required for the remediation to be completed, the size and number of buildings that may require remediation, cost of construction or remediation materials, availability of construction materials, potential discoveries made during remediation that could necessitate incremental work, investigation costs, availability of qualified fire safety engineers, potential business disruption costs, potential changes to or new regulations and regulatory approval.As a result of signing the Pledge, the introduction of the BSA, the extension of liability under the DPA, and the potential for us to be required to pay for remediation under any definitive agreements that may be negotiated by the parties under the Pledge or under existing legal contracts, we recorded charges of approximately $138.9 million and $185.9 million for the three months and twelve months ended December 31, 2022, respectively. Of the $185.9 million in estimated liability as of December 31, 2022, approximately $51.6 million was recorded as a current liability in “accounts payable and accrued expenses” and the remaining was recorded as non-current in “other liabilities” in the accompanying consolidated balance sheets. Although the foregoing includes significant subjective judgments, management believes that there is enough information to reasonably estimate the potential liability. The potential liability and number of buildings affected may change as new information becomes available and full cost estimates are assessed and tendered for each building, which is anticipated to be a lengthy process due to the various steps required to fully remediate. We will continue to assess new information as it becomes available and adjust our estimated liability accordingly. For more information, see “Telford Fire Safety Remediation” in Note 22 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report. 49Table of ContentsHistorical Cash FlowsYear Ended December 31, 2022 Compared to Year Ended December 31, 2021Operating ActivitiesNet cash provided by operating activities totaled $1.6 billion for the year ended December 31, 2022, a decrease of $735.1 million as compared to the year ended December 31, 2021. The primary drivers that contributed to the decline were as follows: (1) lower operating performance and (2) the net cash outflow associated with net working capital increased in the current year as compared to last year by approximately $992.9 million. This was primarily due to (i) higher outflow related to net bonus payments, compensation and other employee benefits, (ii) increased issuance of incentive compensation in the form of producer based loans, and (iii) timing of certain cash tax payments and refunds. This change in working capital was partially offset by lower outflow associated with accounts receivable, prepaids and contract assets. Additionally, we had lower distribution of equity income from unconsolidated subsidiaries; a decline in tenant concessions received in the current year; lower net inflows related to mortgage loan activities and associated warehouse line of credit draws.Investing ActivitiesNet cash used in investing activities totaled $832.5 million for the year ended December 31, 2022, a decrease of $448.4 million as compared to the year ended December 31, 2021. This decrease was primarily due to the Turner & Townsend transaction in 2021 as compared a to lower volume of acquisitions in the current year. This was partially offset by the following outflows: a $100.7 million investment in VTS during 2022; higher capital expenditures to support the growth in business; and higher net contributions to unconsolidated subsidiaries. Financing ActivitiesNet cash used in financing activities totaled $1.8 billion for the year ended December 31, 2022, an increase of $1.3 billion as compared to the year ended December 31, 2021. The increased usage during the year was primarily due to $1.9 billion used to repurchase shares of our common stock as compared to $368.6 million in the prior year; as well as net inflows in the prior year from issuance and settlement activities associated with our long term debt thus increasing the year over year usage. This was partially offset by (i) $151.4 million in net proceeds from our revolving credit facility received this year as compared to last year, (ii) payment of $205.1 million for redemption of non-controlling interest for CBAH and (iii) payment of deferred underwriting costs related to CBAH’s initial public offering in the prior year with no comparable activity in the current year.50Table of ContentsSummary of Contractual Obligations and Other CommitmentsThe following is a summary of our various contractual obligations and other commitments as of December 31, 2022 (dollars in thousands):Payments Due by PeriodContractual ObligationsTotalLess than1 yearTotal gross long-term debt (1)$1,527,792 $427,792 Short-term borrowings (2)668,754 668,754 Operating leases (3)2,180,313 229,748 Financing leases (3)299,380 33,213 Total gross notes payable on real estate (4)25,073 10,245 Deferred purchase consideration (5)574,300 117,335 Total contractual obligations$5,275,612 $1,487,087 Amount of Other Commitments ExpirationOther CommitmentsTotalLess than1 yearSelf-insurance reserves (6)$167,918 $167,918 Tax liabilities (7)54,761 — Co-investments (8) (9)192,756 133,197 Letters of credit (8)206,809 206,809 Guarantees (8) (10)79,441 79,441 Total other commitments$701,685 $587,365 The table above excludes estimated payment obligations for our qualified defined benefit pension plans. For information about our future estimated payment obligations for these plans, see Note 14 of our Notes to the Consolidated Financial Statements set forth in Item 8 of this Annual Report._______________(1)Reflects gross outstanding long-term debt balances as of December 31, 2022, assumed to be paid at maturity, excluding unamortized discount, premium and deferred financing costs. See Note 11 of our Notes to the Consolidated Financial Statements set forth in Item 8 of this Annual Report. Figures do not include scheduled interest payments. Assuming each debt obligation is held until maturity, we estimate that we will make $205.1 million of interest payments, $51.1 million of which will be made in 2023.(2)The majority of this balance represents our warehouse lines of credit, which are recourse only to our wholly-owned subsidiary CBRE Capital Markets, Inc. (CBRE Capital Markets) and are secured by our related warehouse receivables. See Notes 5 and 11 of our Notes to the Consolidated Financial Statements set forth in Item 8 of this Annual Report.(3)See Note 12 of our Notes to the Consolidated Financial Statements set forth in Item 8 of this Annual Report.(4)Reflects gross outstanding notes payable on real estate as of December 31, 2022 (none of which is recourse to us, beyond being recourse to the single-purpose entity that held the real estate asset and was the primary obligor on the note payable), assumed to be paid at maturity, excluding unamortized deferred financing costs. Amounts do not include scheduled interest payments. The notes have either fixed or variable interest rates, ranging from 2.25% to 7.50% at December 31, 2022.(5)Represents deferred obligations related to previous acquisitions, which are included in accounts payable and accrued expenses and other long-term liabilities in the consolidated balance sheets at December 31, 2022 set forth in Item 8 of this Annual Report.(6)Represents outstanding reserves for claims under certain insurance programs, which are included in other current and other long-term liabilities in the consolidated balance sheets at December 31, 2022 set forth in Item 8 of this Annual Report. Due to the nature of this item, payments could be due at any time upon the occurrence of certain events. Accordingly, the entire balance has been reflected as expiring in less than one year.(7)As of December 31, 2022, we have a remaining federal tax liability of $54.8 million associated with the Transition Tax on mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. We are paying the federal tax liability for the Transition Tax in annual interest-free installments over a period of eight years through 2025 as allowed by the Tax Act. The next installment is due in 2024 for the 2023 fiscal year.In addition, as of December 31, 2022, our gross unrecognized tax benefits, totaled $391.4 million. Of this amount, we can reasonably estimate that none will require cash settlement in less than one year. We are unable to reasonably estimate the timing of the effective settlement of tax positions for the gross amount. See Note 15 of our Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.(8)See Note 13 of our Notes to the Consolidated Financial Statements set forth in Item 8 of this Annual Report.(9)Includes $106.9 million to fund future co-investments in our Real Estate Investments segment, $47.3 million of which is expected to be funded in 2023, and $85.9 million committed to invest in unconsolidated real estate subsidiaries, which is callable at any time. This amount does not include capital committed to consolidated projects of $81.0 million as of December 31, 2022.(10)Due to the nature of guarantees, payments could be due at any time upon the occurrence of certain triggering events, including default. Accordingly, all guarantees are reflected as expiring in less than one year.51Table of ContentsIndebtednessWe use a variety of financing arrangements, both long-term and short-term, to fund our operations in addition to cash generated from operating activities. We also use several funding sources to avoid becoming overly dependent on one financing source, and to lower funding costs.Long-Term DebtOn July 9, 2021, CBRE Services, Inc. (CBRE Services) entered into an additional incremental assumption agreement with respect to its credit agreement, dated October 31, 2017 (such agreement, as amended by a December 20, 2018 incremental term loan assumption agreement, a March 4, 2019 incremental assumption agreement and such July 9, 2021 incremental assumption agreement, collectively, the 2021 Credit Agreement) for purposes of increasing the revolving credit commitments previously available under the 2021 Credit Agreement by an aggregate principal amount of $350.0 million. On May 21, 2021, we entered into a definitive agreement whereby our subsidiary guarantors were released as guarantors from the 2021 Credit Agreement. On December 10, 2021, CBRE Services and certain of the other borrowers entered into a first amendment to the 2021 Credit Agreement which (i) changed the interest rate applicable to revolving borrowings denominated in Sterling from a LIBOR-based rate to a rate based on the Sterling Overnight Index Average (SONIA) and (ii) changed the interest rate applicable to revolving borrowings denominated in Euros from a LIBOR-based rate to a rate based on EURIBOR. The revised interest rates described above went into effect on January 1, 2022. On August 5, 2022, CBRE Group, Inc., as Holdings, and CBRE Global Acquisition Company, as the Luxembourg Borrower, entered into a second amendment to the 2021 Credit Agreement which, among other things (i) amended certain of the representations and warranties, affirmative covenants, negative covenants and events of default in the 2021 Credit Agreement in a manner consistent with the new 5-year senior unsecured Revolving Credit Agreement (as described below), (ii) terminated all revolving commitments previously available to the subsidiaries of the company thereunder and (iii) reflected the resignation of the previous administrative agent and the appointment of Wells Fargo Bank, National Association as the new administrative agent (the 2021 Credit Agreement, as amended by the first amendment and second amendment is referred to in this Annual Report as the 2022 Credit Agreement). The 2022 Credit Agreement is a senior unsecured credit facility that is guaranteed by CBRE Group, Inc. As of December 31, 2022, the 2022 Credit Agreement provided for a €400.0 million term loan facility due and payable in full at maturity on December 20, 2023. The $300.0 million tranche A term loan facility that was also covered under this agreement was repaid on November 23, 2021. In addition, a $3.15 billion revolving credit facility, which included the capacity to obtain letters of credit and swingline loans and would have terminated on March 4, 2024, was also previously provided under this agreement and was replaced with a new $3.5 billion 5-year senior unsecured Revolving Credit Agreement entered into on August 5, 2022 (as described below). On March 18, 2021, CBRE Services issued $500.0 million in aggregate principal amount of 2.500% senior notes due April 1, 2031 (the 2.500% senior notes) at a price equal to 98.451% of their face value. The 2.500% senior notes are unsecured obligations of CBRE Services and are guaranteed on a senior basis by CBRE Group, Inc. Interest accrues at a rate of 2.500% per year and is payable semi-annually in arrears on April 1 and October 1 of each year, beginning on October 1, 2021. The amount of the 2.500% senior notes, net of unamortized discount and unamortized debt issuance costs, included in the accompanying consolidated balance sheet was $489.3 million and $488.1 million at December 31, 2022 and 2021, respectively.On August 13, 2015, CBRE Services issued $600.0 million in aggregate principal amount of 4.875% senior notes due March 1, 2026 (the 4.875% senior notes) at a price equal to 99.24% of their face value. The 4.875% senior notes are unsecured obligations of CBRE Services and are guaranteed on a senior basis by CBRE Group, Inc. Interest accrues at a rate of 4.875% per year and is payable semi-annually in arrears on March 1 and September 1. The amount of the 4.875% senior notes, net of unamortized discount and unamortized debt issuance costs, included in the accompanying consolidated balance sheet was $596.4 million and $595.5 million at December 31, 2022 and 2021, respectively.The indentures governing our 4.875% senior notes and 2.500% senior notes contain restrictive covenants that, among other things, limit our ability to create or permit liens on assets securing indebtedness, enter into sale/leaseback transactions and enter into consolidations or mergers.52Table of ContentsOn May 21, 2021, all existing subsidiary guarantors were released from their guarantees of our 2022 Credit Agreement, 4.875% senior notes and 2.500% senior notes. Our 2022 Credit Agreement, Revolving Credit Agreement, 4.875% senior notes and 2.500% senior notes remain fully and unconditionally guaranteed by CBRE Group, Inc. Combined summarized financial information for CBRE Group, Inc. (parent) and CBRE Services (subsidiary issuer) is as follows (dollars in thousands):December 31,20222021Balance Sheet Data:Current assets$8,628 $8,604 Non-current assets (1)13,002 34,711 Total assets (1)21,630 43,315 Current liabilities$206,026 $17,610 Non-current liabilities (1)1,804,975 1,083,584 Total liabilities (1)2,011,001 1,101,194 Year Ended December 31,20222021 (2)Statement of Operations Data:Revenue$— $— Operating loss(2,539)(2,246)Net income6,465 27,487 _______________(1)Includes $719.3 million of intercompany loan payables and $25.3 million of intercompany loan receivables from non-guarantor subsidiaries as of December 31, 2022 and 2021, respectively. All intercompany balances and transactions between CBRE Group, Inc. and CBRE Services have been eliminated.(2)Amounts include activity related to our subsidiaries that were still listed as guarantors for the period presented.For additional information on all of our long-term debt, see Note 11 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.Short-Term BorrowingsOn August 5, 2022, we entered into a new 5-year senior unsecured Revolving Credit Agreement (the “Revolving Credit Agreement”). The Revolving Credit Agreement provides for a senior unsecured revolving credit facility available to CBRE Services with a capacity of $3.5 billion and a maturity date of August 5, 2027. Borrowings bear interest at (i) CBRE Services’ option, either (a) a Term SOFR rate published by CME Group Benchmark Administration Limited for the applicable interest period or (b) a base rate determined by reference to the greatest of (1) the prime rate determined by Wells Fargo, (2) the federal funds rate plus 1/2 of 1% and (3) the sum of (x) a Term SOFR rate published by CME Group Benchmark Administration Limited for an interest period of one month and (y) 1.00% plus (ii) 10 basis points, plus (iii) a rate equal to an applicable rate (in the case of borrowings based on the Term SOFR rate, 0.630% to 1.100% and in the case of borrowings based on the base rate, 0.0% to 0.100%, in each case, as determined by reference to our Debt Rating (as defined in the Revolving Credit Agreement)). The applicable rate is also subject to certain increases and/or decreases specified in the Revolving Credit Agreement linked to achieving certain sustainability goals.The Revolving Credit Agreement requires us to pay a fee based on the total amount of the revolving credit facility commitment (whether used or unused). In addition, the Revolving Credit Agreement also includes capacity for letters of credit of an outstanding aggregate amount of $300.0 million.As of December 31, 2022, $178.0 million was outstanding under the Revolving Credit Agreement. No letters of credit were outstanding as of December 31, 2022. As of February 16, 2023, $438.0 million was outstanding under the Revolving Credit Agreement. Letters of credit are issued in the ordinary course of business and would reduce the amount we may borrow under the Revolving Credit Agreement. 53Table of ContentsIn addition, Turner & Townsend maintains a £120.0 million revolving credit facility pursuant to a credit agreement dated March 31, 2022, with an additional accordion option of £20.0 million. As of December 31, 2022 and February 16, 2023, respectively, $31.9 million (£26.3 million) and $31.6 million (£26.3 million) was outstanding under this revolving credit facility and bears interest at SONIA plus 0.75%.We also maintain warehouse lines of credit with certain third-party lenders. For additional information on all of our short-term borrowings, see Notes 5 and 11 of the Notes to Consolidated Financial Statements set forth in Item 8 of this Annual Report.Item 7A. Quantitative and Qualitative Disclosures About Market Risk.Our exposure to market risk primarily consists of foreign currency exchange rate fluctuations related to our international operations and changes in interest rates on debt obligations. We manage such risk primarily by managing the amount, sources, and duration of our debt funding and by using derivative financial instruments. We apply FASB ASC (Topic 815), “Derivatives and Hedging,” when accounting for derivative financial instruments. In all cases, we view derivative financial instruments as a risk management tool and, accordingly, do not use derivatives for trading or speculative purposes. Exchange RatesOur foreign operations expose us to fluctuations in foreign exchange rates. These fluctuations may impact the value of our cash receipts and payments in terms of our functional (reporting) currency, which is the U.S. dollar. See the discussion of international operations, which is included in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “International Operations” and is incorporated by reference herein.Interest RatesWe manage our interest expense by using a combination of fixed and variable rate debt. Historically, we have entered into interest rate swap agreements to attempt to hedge the variability of future interest payments due to changes in interest rates. As of December 31, 2022, we do not have any outstanding interest rate swap agreements.The estimated fair value of our senior term loans was approximately $424.6 million at December 31, 2022. Based on dealers’ quotes, the estimated fair value of our 4.875% and 2.500% senior notes was $595.2 million and $396.8 million, respectively, at December 31, 2022.We utilize sensitivity analyses to assess the potential effect on our variable rate debt. If interest rates were to increase 100 basis points on our outstanding variable rate debt at December 31, 2022, the net impact of the additional interest cost would be a decrease of $6.4 million on pre-tax income and a decrease of $6.4 million in cash provided by operating activities for the year ended December 31, 2022.54Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsUnless otherwise indicated or the context otherwise requires, as used in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the terms “we,” “us,” “the Company,” “our,” “CDW” and similar terms refer to CDW Corporation and its subsidiaries. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” should be read in conjunction with the Consolidated Financial Statements and the related notes included elsewhere in this report. This discussion contains forward-looking statements that are subject to numerous risks and uncertainties. Actual results may differ materially from those contained in any forward-looking statements. See “Forward-Looking Statements” above.OverviewCDW Corporation, a Fortune 500 company and member of the S&P 500 Index, is a leading multi-brand provider of information technology (“IT”) solutions to small, medium and large business, government, education and healthcare customers in the US, the UK and Canada. Our broad array of offerings ranges from discrete hardware and software products to integrated IT solutions and services that include on-premise and cloud capabilities across hybrid infrastructure, digital experience and security.We are vendor, technology, and consumption model “agnostic”, with a solutions portfolio including more than 100,000 products and services from more than 1,000 leading and emerging brands. Our solutions are delivered in physical, virtual and cloud-based environments through approximately 10,600 customer-facing coworkers, including sellers, highly-skilled technology specialists and advanced service delivery engineers. We are a leading sales channel partner for many original equipment manufacturers (“OEMs”), software publishers and cloud providers (collectively, our “vendor partners”), whose products we sell or include in the solutions we offer. We provide our vendor partners with a cost-effective way to reach customers and deliver a consistent brand experience through our established end-market coverage, technical expertise and extensive customer access.On December 1, 2021, we completed the acquisition of Sirius Computer Solutions, Inc. (“Sirius”). Sirius is a leading provider of secure, mission-critical technology-based solutions and is one of the largest IT solutions integrators in the United States, leveraging its services-led approach, broad portfolio of hybrid infrastructure solutions, and deep technical expertise of its 2,600 coworkers to support corporate and public customers. This strategic acquisition has enhanced our breadth and depth of services and solutions offerings.We have three reportable segments, Corporate, Small Business and Public. Our Corporate segment primarily serves US private sector business customers with more than 250 employees. Our Small Business segment primarily serves US private sector business customers with up to 250 employees. Our Public segment is comprised of government agencies and education and healthcare institutions in the US. We also have two other operating segments: CDW UK and CDW Canada, each of which do not meet the reportable segment quantitative thresholds and, accordingly, are included in an all other category (“Other”). The financial results of Sirius have been included in our Consolidated Financial Statements and the results of our Corporate, Small Business and Public segments since the date of the acquisition.We may sell all or only select products that our vendor partners offer. Each vendor partner agreement provides for specific terms and conditions, which may include one or more of the following: product return privileges, price protection policies, purchase discounts and vendor incentive programs, such as purchase or sales rebates and cooperative advertising reimbursements. We also resell software for major software publishers. Our agreements with software publishers allow the end-user customer to acquire software or licensed products and services. In addition to helping our customers determine the best software solutions for their needs, we help them manage their software agreements, including warranties and renewals. A significant portion of our advertising and marketing expenses are reimbursed through cooperative advertising programs with our vendor partners. These programs are at the discretion of our vendor partners and are typically tied to sales or other commitments to be met by us within a specified period of time.For a discussion of results for the year ended December 31, 2021, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the Securities and Exchange Commission on February 28, 2022.26Table of ContentsTrends and Key Factors Affecting our Financial PerformanceWe believe the following key factors may have a meaningful impact on our business performance, influencing our ability to generate sales and achieve our targeted financial and operating results:•General economic conditions are a key factor affecting our results as they can impact our customers’ willingness to spend on information technology. Macroeconomic uncertainty persists as a result of the continued rate of inflation and the corresponding increase in interest rates driven by monetary policy. Additionally, social and geopolitical factors such as resurgences of COVID-19, changes in government administration and laws and the ongoing military conflict between Russia and Ukraine have resulted in business volatility and disruption. The enhanced uncertainty in the current environment may result in a delay or pause on investments in technology by our customers. •Customers’ top priorities continue to be digital transformation, security, hybrid and cloud solutions and end point solutions as hybrid environments become the accepted work model and drive demand for remote collaboration and work-and-learn-from-anywhere capabilities. We have orchestrated solutions by leveraging client devices, accessories, collaboration tools, security, software and hybrid and cloud offerings to help customers build these capabilities and achieve their objectives.•Changes in spending policies, budget priorities and funding levels, including current and future stimulus packages, are key factors influencing the purchasing levels of Government, Healthcare and Education customers. As the duration and ongoing economic impacts of the COVID-19 pandemic remain uncertain, current and future budget priorities and funding levels for Government, Healthcare and Education customers may be adversely affected.•Technology trends drive customer purchasing behaviors in the market. Current technology trends are focused on delivering greater flexibility and efficiency, as well as designing IT securely. These trends are driving customer adoption of solutions such as those delivered via cloud, software defined architectures and hybrid on-premise and off-premise combinations, as well as the evolution of the IT consumption model to more “as a service” offerings, including software as a service and infrastructure as a service, in addition to ongoing managed and professional service arrangements. Technology trends are likely to change as customers prioritize the projects that produce the most important outcomes for their operations.Key Business MetricsWe monitor a number of financial and non-financial measures and ratios on a regular basis in order to track the progress of our business and make adjustments as necessary. We believe that the most important of these measures and ratios include average daily sales, Gross profit, Net income, Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP net income, Net sales growth on a constant currency basis, Net income per diluted share, Non-GAAP net income per diluted share, Free cash flow, Cash and cash equivalents, cash conversion cycle and debt levels including available credit. These measures and ratios are closely monitored by management, so that actions can be taken, as necessary, in order to achieve financial objectives.In this section, we present Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP net income, Non-GAAP net income per diluted share, Net sales growth on a constant currency basis and Free cash flow, which are non-GAAP financial measures.We believe Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP net income, Non-GAAP net income per diluted share and Net sales growth on a constant currency basis provide analysts, investors and management with helpful information regarding the underlying operating performance of our business, as they remove the impact of items that management believes are not reflective of underlying operating performance. Management uses these measures to evaluate period-over-period performance as management believes they provide a more comparable measure of the underlying business. We also present Free cash flow as we believe this measure provides more information regarding our liquidity and capital resources. Certain non-GAAP financial measures are also used to determine certain components of performance-based compensation. For the definitions of Non-GAAP measures and reconciliations to the most directly comparable US GAAP measure, see “Results of Operations - Non-GAAP Financial Measure Reconciliations.”27Table of ContentsThe results of certain key business metrics are as follows:Year Ended December 31,(dollars in millions, except per share amounts)20222021Net sales$23,748.7 $20,820.8 Gross profit4,686.6 3,568.5 Operating income1,735.2 1,419.0 Net income1,114.5 988.6 Non-GAAP operating income2,050.5 1,645.4 Non-GAAP net income1,341.5 1,118.9 Net income per diluted share8.137.04Non-GAAP net income per diluted share9.797.97Average daily sales(1)93.5 82.0 Net debt(2)5,607.5 6,600.4 Cash conversion cycle (in days)(3)21 24 Cash provided by operating activities1,335.9 784.6 Free cash flow1,292.7 476.7 (1) There were 254 selling days for both the years ended December 31, 2022 and 2021.(2) Defined as Total debt minus Cash and cash equivalents.(3) Cash conversion cycle is defined as days of sales outstanding in Accounts receivable and certain receivables due from vendors plus days of supply in Merchandise inventory minus days of purchases outstanding in Accounts payable and Accounts payable-inventory financing, based on a rolling three-month average.28Table of ContentsResults of OperationsResults of operations, in dollars and as a percentage of Net sales are as follows:Year Ended December 31,20222021Dollars inMillionsPercentage ofNet SalesDollars inMillionsPercentage ofNet SalesNet sales$23,748.7 100.0 %$20,820.8 100.0 %Cost of sales19,062.1 80.3 17,252.3 82.9 Gross profit4,686.6 19.7 3,568.5 17.1 Selling and administrative expenses2,951.4 12.4 2,149.5 10.3 Operating income1,735.2 7.3 1,419.0 6.8 Interest expense, net(235.7)(1.0)(150.9)(0.7)Other (expense) income, net(11.7)— 29.7 0.1 Income before income taxes1,487.8 6.3 1,297.8 6.2 Income tax expense(373.3)(1.6)(309.2)(1.5)Net income$1,114.5 4.7 %$988.6 4.7 %Net salesTotal Net sales for the year ended December 31, 2022 increased $2,928 million, or 14.1%, to $23,749 million compared to the prior year. All operating segments contributed to the Net sales growth. For additional information, see the “Segment Results of Operations” below. Gross profitGross profit was $4,687 million for the year ended December 31, 2022, an increase of $1,118 million, or 31.3%, compared to $3,569 million for the year ended December 31, 2021. As a percentage of Net sales, Gross profit margin increased 260 basis points to 19.7% for the year ended December 31, 2022. The increase in Gross profit margin was primarily driven by more favorable product mix and rate and higher mix of netted down revenue, as well as increased Net sales and margins on services as a result of the recent business acquisitions. Selling and administrative expensesSelling and administrative expenses increased $802 million, or 37.3%, to $2,951 million for the year ended December 31, 2022, compared to $2,150 million for the year ended December 31, 2021. The increase was primarily driven by higher payroll expenses consistent with higher Gross profit and higher coworker count, including the impact of the acquisition of Sirius, and higher intangible asset amortization expense from the acquisition of Sirius. Operating incomeOperating income was $1,735 million for the year ended December 31, 2022, an increase of $316 million, or 22.3%, compared to $1,419 million for the year ended December 31, 2021. Operating income increased primarily due to higher Gross profit dollars, partially offset by higher payroll expenses and higher intangible asset amortization from the acquisition of Sirius. Interest expense, netInterest expense, net was $236 million for the year ended December 31, 2022, an increase of $85 million, or 56.2%, compared to $151 million for the year ended December 31, 2021. This increase was primarily driven by additional interest expense from the $2.5 billion aggregate principal amount of unsecured senior notes issued on December 1, 2021, the net proceeds of which were used to fund the acquisition of Sirius.Other (expense) income, netDuring the year ended December 31, 2021, we sold all ownership interests in an equity method investment and recognized a $36 million gain, with no similar activity in 2022.29Table of ContentsIncome tax expenseIncome tax expense was $373 million in 2022, compared to $309 million in 2021. The effective income tax rate, expressed by calculating income tax expense as a percentage of Income before income taxes, was 25.1% and 23.8% for 2022 and 2021, respectively.For 2022, the effective tax rate differed from the US federal statutory rate primarily due to state and local income taxes, partially offset by excess tax benefits on equity-based compensation. For 2021, the effective tax rate differed from the US federal statutory rate primarily due to state and local income taxes and a discrete deferred tax expense as a result of an increase in the UK corporate tax rate effective in 2023, partially offset by excess tax benefits on equity-based compensation. The 2022 effective tax rate was higher than 2021 primarily attributable to lower excess tax benefits on equity-based compensation, partially offset by a prior year discrete deferred tax expense as a result of an increase in the UK corporate tax rate effective in 2023.Segment Results of OperationsNet sales by segment, in dollars and as a percentage of total Net sales, and the year-over-year dollar and percentage change in Net sales are as follows:Year Ended December 31,20222021(dollars in millions)Net SalesPercentageof Total Net SalesNet SalesPercentageof Total Net SalesDollarChangePercentChange(1)Corporate$10,350.1 43.6 %$8,179.7 39.3 %$2,170.4 26.5 %Small Business1,938.9 8.2 1,870.1 9.0 68.8 3.7 Public:Government2,574.3 10.8 2,155.6 10.4 418.7 19.4 Education3,621.4 15.2 4,108.7 19.7 (487.3)(11.9)Healthcare2,355.6 9.9 1,919.3 9.2 436.3 22.7 Total Public8,551.3 35.9 8,183.6 39.3 367.7 4.5 Other2,908.4 12.3 2,587.4 12.4 321.0 12.4 Total Net sales$23,748.7 100.0 %$20,820.8 100.0 %$2,927.9 14.1 %(1)There were 254 selling days for both the years ended December 31, 2022 and 2021.Operating income by segment, in dollars and as a percentage of Net sales, and the year-over-year percentage change was as follows:Year Ended December 31,20222021Dollars inMillionsPercentageof Net SalesDollars inMillionsPercentageof Net SalesPercent Changein Operating IncomeSegments:(1)Corporate$931.7 9.0 %$697.3 8.5 %33.6 %Small Business186.8 9.6 167.7 9.0 11.4 Public681.7 8.0 606.7 7.4 12.4 Other(2)130.7 4.5 115.8 4.5 12.9 Headquarters(3)(195.7)nm*(168.5)nm*16.1 Total Operating income$1,735.2 7.3 %$1,419.0 6.8 %22.3 %* Not meaningful30Table of Contents(1)Segment operating income includes the segment’s direct operating income, allocations for certain Headquarters’ costs, allocations for income and expenses from logistics services, certain inventory adjustments and volume rebates and cooperative advertising from vendors.(2)Includes the financial results for our other operating segments, CDW UK and CDW Canada, which do not meet the reportable segment quantitative thresholds.(3)Includes Headquarters’ function costs that are not allocated to the segments.CorporateCorporate segment Net sales for the year ended December 31, 2022 increased $2,170 million, or 26.5%, compared to the year ended December 31, 2021. This increase in Net sales, which also included the contribution from the acquisition of Sirius, was primarily driven by customers’ priorities on digital transformation and a hybrid work model. These factors resulted in higher Net sales across various categories, including software, netcomm products, services, enterprise storage, notebooks/mobile devices and video.Corporate segment Operating income was $932 million for the year ended December 31, 2022, an increase of $234 million, or 33.6%, compared to $697 million for the year ended December 31, 2021. Corporate segment Operating income increased primarily due to higher Gross profit dollars, partially offset by higher payroll and higher intangible asset amortization from the acquisition of Sirius.Small BusinessSmall Business segment Net sales for the year ended December 31, 2022 increased $69 million, or 3.7%, compared to the year ended December 31, 2021. This increase was primarily driven by customers’ priorities on digital transformation, resulting in increased Net sales in services, software and notebooks/mobile devices.Small Business segment Operating income was $187 million for the year ended December 31, 2022, an increase of $19 million, or 11.4%, compared to $168 million for the year ended December 31, 2021. Small Business segment Operating income increased primarily due to higher Gross profit dollars, partially offset by higher payroll.PublicPublic segment Net sales for the year ended December 31, 2022 increased $368 million, or 4.5%, compared to the year ended December 31, 2021. This increase in Net sales, which also included the contribution from the acquisition of Sirius, was primarily driven by Healthcare and Government customers. Net sales to Healthcare customers increased by 22.7% primarily due to continued focus in digital transformation to enhance patient experiences, which resulted in increased Net sales in services, netcomm products and software. Net sales to Government customers increased 19.4% primarily driven by state and local customers, which resulted in increased Net sales in netcomm products, services and software. These increases were partially offset by decreased Net sales to Education customers of 11.9% primarily driven by decreased Net sales in notebooks/mobile devices with K-12 customers.Public segment Operating income was $682 million for the year ended December 31, 2022, an increase of $75 million, or 12.4%, compared to $607 million for the year ended December 31, 2021. Public segment Operating income increased primarily due to higher Gross profit dollars, partially offset by higher payroll and higher intangible asset amortization from the acquisition of Sirius.OtherNet sales in Other, which is comprised of results from our UK and Canadian operations, for the year ended December 31, 2022 increased $321 million, or 12.4%, compared to the year ended December 31, 2021. This increase was driven by both our UK and Canadian operations as customers continued to focus on digital transformation, resulting in increased Net sales in software, netcomm products, notebooks/mobile devices and services.Other Operating income was $131 million for the year ended December 31, 2022, an increase of $15 million, or 12.9%, compared to $116 million for the year ended December 31, 2021. Other Operating income increased primarily due to higher Gross profit dollars, partially offset by higher payroll.31Table of ContentsNon-GAAP Financial Measure ReconciliationsWe have included reconciliations of Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP income before income taxes, Non-GAAP net income, Non-GAAP net income per diluted share, Net sales growth on a constant currency basis and Free cash flow for the years ended December 31, 2022 and 2021 below.Non-GAAP operating income excludes, among other things, charges related to the amortization of acquisition-related intangible assets, equity-based compensation and the associated payroll taxes, and acquisition and integration expenses. Non-GAAP operating income margin is defined as Non-GAAP operating income as a percentage of Net sales. Non-GAAP income before income taxes and Non-GAAP net income exclude, among other things, charges related to acquisition-related intangible asset amortization, equity-based compensation, acquisition and integration expenses, and the associated tax effects of each. Net sales growth on a constant currency basis is defined as Net sales growth excluding the impact of foreign currency translation on Net sales compared to the prior period. Free cash flow is defined as cash flows from operating activities less capital expenditures, adjusted for the net change in accounts payable-inventory financing and other financed purchases. Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP income before income taxes, Non-GAAP net income, Non-GAAP net income per diluted share, Net sales growth on a constant currency basis and Free cash flow are considered non-GAAP financial measures. Generally, a non-GAAP financial measure is a numerical measure of a company’s performance or financial condition that either excludes or includes amounts that are not normally included or excluded in the most directly comparable measure calculated and presented in accordance with US GAAP. Non-GAAP measures used by management may differ from similar measures used by other companies, even when similar terms are used to identify such measures.We believe Non-GAAP operating income, Non-GAAP operating income margin, Non-GAAP net income, Non-GAAP net income per diluted share and Net sales growth on a constant currency basis provide analysts, investors and management with helpful information regarding the underlying operating performance of our business, as they remove the impact of items that management believes are not reflective of underlying operating performance. Management uses these measures to evaluate period-over-period performance as management believes they provide a more comparable measure of the underlying business. We also present Free cash flow as we believe this measure provides more information regarding our liquidity and capital resources. Certain non-GAAP financial measures are also used to determine certain components of performance-based compensation.Non-GAAP operating income and Non-GAAP operating income marginYear Ended December 31,(dollars in millions)20222021% Change Operating income, as reported$1,735.2 $1,419.0 22.3 %Amortization of intangibles(1)167.9 94.9 Equity-based compensation91.1 72.6 Acquisition and integration expenses48.3 54.3 Other adjustments8.0 4.6 Non-GAAP operating income2,050.5 1,645.4 24.6 %Non-GAAP operating income margin8.6 %7.9 %(1)Includes amortization expense for acquisition-related intangible assets, primarily customer relationships, customer contracts and trade names.32Table of ContentsNon-GAAP net income and Non-GAAP net income per diluted share Year Ended December 31, 2022Year Ended December 31, 2021(dollars in millions)Income before income taxesIncome taxexpense(1)Net incomeIncome before income taxesIncome taxexpense(1)Net incomeNet Income % ChangeUS GAAP, as reported$1,487.8 $(373.3)$1,114.5 $1,297.8 $(309.2)$988.6 12.7 %Amortization of intangibles(2)167.9 (44.6)123.3 94.9 (18.9)76.0 Equity-based compensation91.1 (30.4)60.7 72.6 (42.6)30.0 Acquisition and integration expenses48.3 (12.4)35.9 54.3 (10.4)43.9 Gain on sale of equity method investment— — — (36.0)8.5 (27.5)Net loss on extinguishment of long-term debt1.6 (0.4)1.2 6.0 (1.5)4.5 Other adjustments8.0 (2.1)5.9 4.6 (1.2)3.4 Non-GAAP$1,804.7 $(463.2)$1,341.5 $1,494.2 $(375.3)$1,118.9 19.9 %Net income per diluted share, as reported$8.13 $7.04 Non-GAAP net income per diluted share$9.79 $7.97 Shares used in computing US GAAP and Non-GAAP net income per diluted share137.0 140.5 (1)Income tax on non-GAAP adjustments includes excess tax benefits associated with equity-based compensation.(2)Includes amortization expense for acquisition-related intangible assets, primarily customer relationships, customer contracts and trade names.Net sales growth on a constant currency basisYear Ended December 31,(dollars in millions)20222021% Change(1)Net sales, as reported$23,748.7 $20,820.8 14.1 %Foreign currency translation(2)— (197.3)Net sales, on a constant currency basis$23,748.7 $20,623.5 15.2 %(1)There were 254 selling days for both the years ended December 31, 2022 and 2021. (2)Represents the effect of translating Net sales for the year ended December 31, 2021 of CDW UK and CDW Canada at the average exchange rates applicable in 2022.Free cash flowYear Ended December 31,(dollars in millions)20222021Net cash provided by operating activities$1,335.9 $784.6 Capital expenditures(127.8)(100.0)Net change in accounts payable - inventory financing84.6 (161.8)Financing payments for revenue generating assets— (46.1)Free cash flow$1,292.7 $476.7 33Table of ContentsSeasonalityWhile we have not historically experienced significant seasonality throughout the year, sales in our Corporate segment, which primarily serves US private sector business customers with more than 250 employees, have historically been higher in the fourth quarter than in other quarters due to customers spending their remaining technology budget dollars at the end of the year. Additionally, sales in our Public segment have historically been higher in the third quarter than in other quarters primarily due to the buying patterns of the federal government and education customers. Since the onset of the COVID-19 pandemic, we have experienced variability compared to historic seasonality trends. Seasonality by channel is expected to continue to be different than historical experience.Liquidity and Capital ResourcesOverviewWe finance our operations and capital expenditures with cash from operations and borrowings under our revolving loan facility. As of December 31, 2022, we had $1.1 billion of availability for borrowings under our revolving loan facility. Our liquidity and borrowing plans are established to align with our financial and strategic planning processes and ensure we have the necessary funding to meet our operating commitments, which primarily include the purchase of inventory, payroll and general expenses. We also take into consideration our overall capital allocation strategy, which includes dividend payments, assessment of debt levels, acquisitions and share repurchases. We believe we have adequate sources of liquidity and funding available for at least the next year; however, there are a number of factors that may negatively impact our available sources of funds. The amount of cash generated from operations will be dependent upon factors such as the successful execution of our business plan, general economic conditions and working capital management.Our material contractual obligations consist of debt and related interest payments and operating leases. See Note 9 (Debt) and Note 11 (Leases) to the accompanying Consolidated Financial Statements for additional information regarding future maturities of debt and operating leases.Long-Term Debt and Financing ArrangementsDuring the year ended December 31, 2022, we prepaid $636 million on our senior unsecured term loan facility without penalty. As a result of the prepayment, no additional mandatory payments are required on the remaining principal amount until its maturity date on December 1, 2026. As of December 31, 2022, we had total unsecured indebtedness of $5.9 billion and we were in compliance with the covenants under our various credit agreements and indentures.We may from time to time repurchase one or more series of our outstanding unsecured senior notes, depending on market conditions, contractual commitments, our capital needs and other factors. Repurchases of our senior notes may be made by open market or private transactions and may be pursuant to Rule 10b5-1 plans or otherwise. For additional information regarding our debt and refinancing activities, see Note 9 (Debt) to the accompanying Consolidated Financial Statements.Inventory Financing AgreementsWe have entered into agreements with certain financial intermediaries to facilitate the purchase of inventory from various suppliers under certain terms and conditions. These amounts are classified separately as Accounts payable-inventory financing on the Consolidated Balance Sheets. We do not incur any interest expense associated with these agreements as balances are paid when they are due. For additional information, see Note 7 (Inventory Financing Agreements) to the accompanying Consolidated Financial Statements.Share Repurchase ProgramDuring 2022, we made no share repurchases. For additional information about our share repurchase program, refer to Note 12 (Stockholders’ Equity) to the accompanying Consolidated Financial Statements.34Table of ContentsDividendsA summary of 2022 dividend activity for our common stock is as follows:Dividend AmountDeclaration DateRecord Date Payment Date$0.500February 9, 2022February 25, 2022March 10, 2022$0.500May 4, 2022May 25, 2022June 10, 2022$0.500August 3, 2022August 25, 2022September 9, 2022$0.590November 2, 2022November 25, 2022December 9, 2022$2.090On February 8, 2023, we announced that our Board of Directors declared a quarterly cash dividend on our common stock of $0.590 per share. The dividend will be paid on March 10, 2023 to all stockholders of record as of the close of business on February 24, 2023.The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon our results of operations, financial condition, business prospects, capital requirements, contractual restrictions, any potential indebtedness we may incur, restrictions imposed by applicable law, tax considerations and other factors that our Board of Directors deems relevant. In addition, our ability to pay dividends on our common stock will be limited by restrictions on our ability to pay dividends or make distributions to our stockholders and on the ability of our subsidiaries to pay dividends or make distributions to us, in each case, under the terms of our current and any future agreements governing our indebtedness.Cash FlowsCash flows from operating, investing and financing activities are as follows:Year Ended December 31,(dollars in millions)20222021Net cash provided by (used in):Operating Activities$1,335.9 $784.6 Investing ActivitiesCapital expenditures(127.8)(100.0)Acquisitions of businesses, net of cash acquired(36.7)(2,705.6)Proceeds from sale of equity method investment— 36.0 Cash flows used in investing activities(164.5)(2,769.6)Financing ActivitiesNet change in accounts payable - inventory financing84.6 (161.8)Financing payments on revenue generating assets— (46.1)Other cash flows from financing activities(1,186.7)1,040.7 Cash flows (used in) provided by financing activities(1,102.1)832.8 Effect of exchange rate changes on cash and cash equivalents(12.2)0.1 Net increase (decrease) in cash and cash equivalents$57.1 $(1,152.1)35Table of ContentsOperating ActivitiesCash flows from operating activities are as follows:Year Ended December 31,(dollars in millions)20222021ChangeNet income$1,114.5 $988.6 $125.9 Adjustments for the impact of non-cash items(1)388.0 227.6 160.4 Net income adjusted for the impact of non-cash items1,502.5 1,216.2 286.3 Changes in assets and liabilities:Accounts receivable(2)(34.8)(616.8)582.0 Merchandise inventory(3)111.9 (151.0)262.9 Accounts payable-trade(4)(260.0)374.5 (634.5)Other16.3 (38.3)54.6 Net cash provided by operating activities$1,335.9 $784.6 $551.3 (1)Includes items such as depreciation and amortization, deferred income taxes, provision for credit losses and equity-based compensation expense. (2)The change is primarily due to sales volume and collection performance.(3)The change is primarily driven by shipment activity related to customer stocking positions.(4)The change is primarily due to timing of payments.In order to manage our working capital and operating cash needs, we monitor our cash conversion cycle, defined as days of sales outstanding in accounts receivable plus days of supply in inventory minus days of purchases outstanding in accounts payable, based on a rolling three-month average. Components of our cash conversion cycle are as follows:December 31,(in days)20222021Days of sales outstanding (DSO)(1)71 65 Days of supply in inventory (DIO)(2)17 17 Days of purchases outstanding (DPO)(3)(67)(58)Cash conversion cycle21 24 (1)Represents the rolling three-month average of the balance of Accounts receivable, net at the end of the period, divided by average daily Net sales for the same three-month period. Also incorporates components of other miscellaneous receivables.(2)Represents the rolling three-month average of the balance of Merchandise inventory at the end of the period divided by average daily Cost of sales for the same three-month period.(3)Represents the rolling three-month average of the combined balance of Accounts payable-trade, excluding cash overdrafts, and Accounts payable-inventory financing at the end of the period divided by average daily Cost of sales for the same three-month period.The cash conversion cycle decreased to 21 days at December 31, 2022, compared to 24 days at December 31, 2021. The overall decrease was impacted by the acquisition of Sirius. In addition, netted down revenue increases DSO and DPO as the corresponding receivables and payables reflect the gross amounts due from customers and due to vendors while the corresponding sales and cost of sales are reflected on a net basis. Investing ActivitiesNet cash used in investing activities decreased $2,605 million in 2022 compared to 2021. This decrease was primarily due to the acquisitions of Sirius, Amplified IT LLC and Focal Point Data Risk LLC in 2021, partially offset by increased capital expenditures in 2022 due to increased investment in our information technology systems and proceeds received from the sale of an equity method investment in 2021. For additional information regarding the acquisitions, see Note 3 (Acquisitions) to the accompanying Consolidated Financial Statements.36Table of ContentsFinancing ActivitiesNet cash provided by financing activities decreased $1,935 million in 2022 compared to 2021. The decrease was primarily due to less debt proceeds and higher debt payments in 2022. This decrease was partially offset by the absence of share repurchases and increased volume in our inventory financing arrangements. For additional information regarding the inventory financing and debt activities, see Note 7 (Inventory Financing Agreements) and Note 9 (Debt) to the accompanying Consolidated Financial Statements.Off-Balance Sheet ArrangementsWe have no off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, results of operations or liquidity.Issuers and Guarantors of Debt SecuritiesEach series of our outstanding unsecured senior notes (the “Notes”) are issued by CDW LLC and CDW Finance Corporation (the “Issuers”) and are guaranteed by CDW Corporation (“Parent”) and certain of each CDW LLC’s direct and indirect, 100% owned, domestic subsidiaries (the “Guarantor Subsidiaries” and, together with Parent, the “Guarantors”). All guarantees by Parent and the Guarantors are joint and several, and full and unconditional; provided that guarantees by the Guarantor Subsidiaries are subject to certain customary release provisions contained in the indentures governing the Notes. The Notes and the related guarantees are the Issuers’ and the Guarantors’ senior unsecured obligations and are:•structurally subordinated to all existing and future indebtedness and other liabilities of our non-guarantor subsidiaries and•rank equal in right of payment with all of the Issuers’ and the Guarantors’ existing and future unsecured senior debt.The following tables set forth Balance Sheet information as of December 31, 2022 and December 31, 2021, and Statement of Operations information for the years ended December 31, 2022 and 2021 for the accounts of the Issuers and the accounts of the Guarantors (the “Obligor Group”). The financial information of the Obligor Group is presented on a combined basis and the intercompany balances and transactions between the Obligor Group have been eliminated.Balance Sheet InformationDecember 31,(dollars in millions)20222021Current assets$5,588.3 $4,584.1 Goodwill3,939.7 2,373.1 Other assets2,032.6 1,017.3 Total Non-current assets5,972.3 3,390.4 Current liabilities4,369.3 3,393.0 Long-term debt5,792.9 6,534.6 Other liabilities641.9 562.4 Total Long-term liabilities6,434.8 7,097.0 Statements of Operations InformationYear Ended December 31,(dollars in millions)20222021Net sales$20,741.8 $17,979.4 Gross profit4,156.6 3,078.0 Operating income1,584.7 1,301.9 Net income1,005.8 921.3 37Table of ContentsCommitments and ContingenciesThe information set forth in Note 16 (Commitments and Contingencies) to the accompanying Consolidated Financial Statements included in Part II, Item 8 of this report is incorporated herein by reference.Critical Accounting Policies and EstimatesThe preparation of the Consolidated Financial Statements in accordance with US GAAP requires management to make use of certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as related disclosure of contingent assets and liabilities in the Consolidated Financial Statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Historically, we have not made significant changes to the methods for determining these estimates as our actual results have not differed materially from our estimates. We do not believe it is reasonably likely that the estimates and related assumptions will change materially in the foreseeable future; however, actual results could differ from those estimates under different assumptions, judgments or conditions.Critical accounting policies and estimates are those that are most important to the portrayal of our financial condition and results of operations, and which require us to make our most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and estimates addressed below. For additional information related to significant accounting policies used in the preparation of our Consolidated Financial Statements, see Note 1 (Description of Business and Summary of Significant Accounting Policies) to the accompanying Consolidated Financial Statements.Revenue RecognitionWe sell some of our products and services as part of bundled contract arrangements containing multiple deliverables, which may include a combination of different products and services. Significant judgment may be required when determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together.For contracts consisting of multiple performance obligations, the total transaction price is allocated to each performance obligation based upon its standalone selling price. Judgment is required to determine the standalone selling price for each distinct performance obligation. For certain types of performance obligations, we use a combination of methods to estimate the standalone selling price based on recent transactions. When evidence from recent transactions is not available to confirm that the prices are representative of the standalone selling price, an expected cost plus margin approach is used.Additional judgment is required in determining whether we are the principal, and report revenues on a gross basis, or agent, and report revenues on a net basis. For each identified performance obligation in a transaction, we evaluate the facts and circumstances present to determine whether or not we control the specified good or service prior to transfer to the customer. This evaluation includes, but is not limited to, assessing indicators such as whether: (i) we are primarily responsible for fulfilling the promise to provide the specified goods or service, (ii) we have inventory risk before the specified good or service has been transferred to a customer and (iii) we have discretion in establishing the price for the specified good or service. When the evaluation indicates we control the specified good or service prior to transfer to the customer, we are acting as a principal. When the evaluation indicates we do not control the specified good or service prior transfer to the customer, we are acting as an agent.The nature of our contracts give rise to variable consideration, primarily in the form of volume rebates and sales returns and allowances. We estimate variable consideration at the most likely amount to which we expect to be entitled. The estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based on an assessment of our anticipated performance and all information that is reasonably available.We recognize revenue from performance obligations when, or as, the customer obtains control over the specified good or service. That is, when the customer has the ability to direct the use of and obtain substantially all of the benefits from the good or service. For the sale of hardware and software, this is generally upon delivery to the customer. As a result, we perform an analysis to estimate the amount of Net sales in-transit at the end of the period and adjust revenue and the related costs to reflect only what has been delivered to the customer. This analysis requires judgment whereby we perform an analysis of the estimated number of days of sales in-transit to customers at the end of each reporting period based on a weighted-average analysis of commercial delivery terms that include drop-shipment arrangements. Changes in delivery patterns may result in a different number of business days estimated to make this adjustment. For the sale of professional services, we recognize the revenue over time given that our customers simultaneously receive and consume the benefits from these services as they are performed. Revenues from professional services are primarily recognized using an input method, which requires management to make estimates regarding the amount of resources required for each engagement in order to satisfy the performance obligation. 38Table of ContentsGoodwillGoodwill is allocated to reporting units expected to benefit from the business combination. Goodwill is subject to periodic testing for impairment at the reporting unit level on an annual basis during the fourth quarter, or more frequently if events or changes in circumstances indicate that the asset may be impaired. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition or sale or disposition of a significant portion of a reporting unit.We may elect to utilize a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. As part of our qualitative assessment, judgment is required in weighing the effect of various positive and negative factors that may affect the fair value. We consider various factors, including the excess of fair value over carrying value from the last quantitative test, macroeconomic conditions, industry and market considerations, the projected financial performance and actual financial performance compared to prior year projected financial performance.If we elect to bypass the qualitative assessment, or if indicators of impairment exist, a quantitative impairment test is performed. As part of the quantitative assessment, application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units and determination of the fair value of each reporting unit. Fair value of a reporting unit is determined by using a weighted combination of an income approach and a market approach, as this combination is considered the most indicative of our fair value in an orderly transaction between market participants. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the useful life over which cash flows will occur, determination of our weighted average cost of capital, future market conditions and profitability of future business strategies. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. However, our past estimates of fair value would not have indicated an impairment when revised to include subsequent years’ actual results.We completed our annual impairment analysis during the fourth quarter of 2022. We performed a qualitative analysis for all reporting units and concluded that it was more likely than not that the fair values of all reporting units exceeded their respective carrying values and, therefore, did not result in an impairment. In 2020, we performed a quantitative analysis of goodwill impairment and determined that no impairment existed.Business combinationsWe allocate purchase price consideration to the assets acquired and liabilities assumed based on their fair values as of the acquisition date. Determining the fair value of these assets and liabilities requires the use of significant estimates, particularly in valuing acquired intangible assets and Goodwill. Purchased intangible assets other than goodwill are initially recognized at fair value and amortized over their useful lives. We determine the fair value of purchased intangible using an income approach on an individual asset basis. The fair value measurements were primarily based on significant inputs that are not observable, which are categorized as a Level 3 measurement in the fair value hierarchy. The values assigned to consideration transferred, assets acquired and liabilities assumed may be adjusted during the measurement period as new information arises.We use the multi-period excess earnings method to determine the fair value of customer relationships. This method identifies the portion of revenue expected to be generated through repeat customers existing as of the valuation date and includes an attrition rate to account for the loss of customers over time. Critical estimates utilized in valuing customer relationships include estimated forecasted future revenue and EBITDA margin growth rates, customer attrition rates and market-participant discount rates. The assumptions we apply in forecasting future revenue and customer attrition rates is based on analysis of historical data, assessment of current and anticipated market conditions, estimated growth rates, and management plans.Recent Accounting PronouncementsThe information set forth in Note 2 (Recent Accounting Pronouncements) to the accompanying Consolidated Financial Statements included in Part II, Item 8 of this report is incorporated herein by reference.Item 7A. Quantitative and Qualitative Disclosures of Market RisksInterest Rate RiskOur market risks relate primarily to changes in interest rates. The interest rates on borrowings under our senior unsecured revolving loan facility and our senior unsecured term loan facility are floating and, therefore, are subject to fluctuations. We 39Table of Contentsmanage our exposure to interest rate risk through the proportion of fixed-rate debt and variable-rate debt in our debt portfolio. Additionally, from time to time, we may execute derivative instruments in order to manage the risk associated with changes in interest rates on borrowings under our variable-rate debt facilities. For additional information on our debt, refer to Note 9 (Debt) to the accompanying Consolidated Financial Statements.Foreign Currency RiskWe transact business in foreign currencies other than the US dollar, primarily the British pound and the Canadian dollar, which exposes us to foreign currency exchange rate fluctuations. Revenue and expenses generated from our international operations are generally denominated in the local currencies of the corresponding countries. The functional currency of our international operating subsidiaries is the same as the corresponding local currency. Upon consolidation, as results of operations are translated, operating results may differ from expectations. The direct effect of foreign currency fluctuations on our results of operations has not been material as the majority of our results of operations are denominated in US dollars.40Table of Contents
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+Item 7.Management’s Discussion and Analysis of Financial Condition and Results of OperationsThis Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with management’s perspective on our financial condition, liquidity, results of operations and certain other factors that may affect our future results. This information is intended to provide investors with an understanding of our past performance, current financial condition and outlook for the future and should be read in conjunction with Item 8 of Part II of this report.IntroductionWe are an independent exploration and production company engaged in the acquisition, exploration and development of properties to produce natural gas, oil and NGL from underground reservoirs. We own a large portfolio of onshore U.S. unconventional natural gas and liquids assets, including interests in approximately 8,400 natural gas and oil wells as of December 31, 2022. Our natural gas resource plays are the Marcellus Shale in the northern Appalachian Basin in Pennsylvania (“Marcellus”) and the Haynesville/Bossier Shales in northwestern Louisiana (“Haynesville”). Our liquids-rich resource play is in the Eagle Ford Shale in South Texas (“Eagle Ford”). In August 2022, we announced that we viewed the assets in Eagle Ford as non-core to our future capital allocation strategy, and in January 2023, we entered into an agreement to sell a portion of our Eagle Ford assets to WildFire Energy I LLC for $1.425 billion. Additionally, in February 2023, we entered into an agreement to sell a portion of our remaining Eagle Ford assets to INEOS Energy for $1.4 billion. Our strategy is to create shareholder value through the responsible development of our significant resource plays while continuing to be a leading provider of affordable, reliable, low carbon energy to the United States. We continue to focus on improving margins through operating efficiencies and financial discipline and improving our ESG performance. To accomplish these goals, we intend to allocate our human resources and capital expenditures to projects we believe offer the highest cash return on capital invested, to deploy leading drilling and completion technology throughout our portfolio, and to take advantage of acquisition and divestiture opportunities to strengthen our portfolio. We also intend to continue to dedicate capital to projects that reduce the environmental impact of our natural gas and oil producing activities. We continue to seek opportunities to reduce cash costs (production, gathering, processing and transportation and general and administrative), through operational efficiencies and improving our production volumes from existing wells.Leading a responsible energy future is foundational to Chesapeake's success. Our core values and culture demand we continuously evaluate the environmental impact of our operations and work diligently to improve our ESG performance across all facets of our Company. Our path to answering the call for affordable, reliable, low carbon energy begins with our goal to achieve net zero greenhouse gas emissions (Scope 1 and 2) by 2035. To meet this challenge, we have set meaningful goals including:•Eliminate routine flaring from all new wells completed from 2021 forward, and enterprise-wide by 2025;•Reduce our methane intensity to 0.02% by 2025 (achieved approximately 0.05% in 2022); and•Reduce our GHG intensity to 3.0 metric tons CO2 equivalent per thousand barrel of oil equivalent by 2025 (achieved approximately 3.9 in 2022).In July 2021, we announced our plan to receive independent certification of our natural gas production under the MiQ methane standard and EO100™ Standard for Responsible Energy Development. As of December 31, 2022, we have received certification for all our operated gas assets in Haynesville and Marcellus as responsibly sourced gas. The MiQ certification provides a verified approach to tracking our commitment to reduce our methane intensity, as well as support our overall objective of achieving net-zero Scope 1 and 2 greenhouse gas emissions by 2035. 44TABLE OF CONTENTSOur results of operations as reported in our consolidated financial statements for the 2022 Successor Period, 2021 Successor Period, 2021 Predecessor Period and 2020 Predecessor Period are in accordance with GAAP. Although GAAP requires that we report on our results for the periods January 1, 2021 through February 9, 2021 and February 10, 2021 through December 31, 2021 separately, management views our operating results for the year ended December 31, 2021 by combining the results of the 2021 Predecessor Period and the 2021 Successor Period because management believes such presentation provides the most meaningful comparison of our results to prior periods. We are not able to compare the 40 days from January 1, 2021 through February 9, 2021 operating results to any of the previous periods reported in the consolidated financial statements and do not believe reviewing this period in isolation would be useful in identifying any trends in, or reaching any conclusions regarding, our overall operating performance. We believe the key performance indicators, such as operating revenues and expenses for the 2021 Successor Period combined with the 2021 Predecessor Period, provide more meaningful comparisons to other periods and are useful in understanding operational trends. Additionally, there were no changes in policies between the periods, and any material impacts as a result of fresh start accounting were included within the discussion of these changes. These combined results do not comply with GAAP and have not been prepared as pro forma results under applicable regulations, but are presented because we believe they provide the most meaningful comparison of our results to prior periods.Recent DevelopmentsAcquisitionsOn March 9, 2022, we completed our Marcellus Acquisition pursuant to definitive agreements with Chief, Radler and Tug Hill, Inc. dated January 24, 2022. On November 1, 2021, we completed our Vine Acquisition pursuant to a definitive agreement with Vine dated August 10, 2021. These transactions strengthen Chesapeake’s competitive position, meaningfully increasing our operating cash flows and adding high quality producing assets and a deep inventory of premium drilling locations, while preserving the strength of our balance sheet.Divestitures On March 25, 2022, we completed the sale of our Powder River Basin assets in Wyoming to Continental Resources, Inc. for $450 million in cash, subject to post-closing adjustments, which resulted in the recognition of a gain of approximately $293 million.On January 17, 2023, we entered into an agreement to sell a portion of our Eagle Ford assets to WildFire Energy I LLC for $1.425 billion. This transaction, which is subject to certain customary closing conditions, including certain regulatory approvals, is expected to close in the first quarter of 2023. As of December 31, 2022, the assets and liabilities associated with this transaction were classified as held for sale. On February 17, 2023 we entered into an agreement to sell a portion of our remaining Eagle Ford assets to INEOS Energy for $1.4 billion. This transaction, which is subject to certain customary closing conditions, including certain regulatory approvals, is expected to close in the second quarter of 2023.Investments - Momentum Sustainable Ventures LLC During the fourth quarter of 2022, we entered into an agreement with Momentum Sustainable Ventures LLC to build a new natural gas gathering pipeline and carbon capture and sequestration project, which will gather natural gas produced in the Haynesville Shale for re-delivery to Gulf Coast markets, including LNG export. The pipeline is expected to have an initial capacity of 1.7 Bcf/d expandable to 2.2 Bcf/d. The carbon capture portion of the project anticipates capturing and permanently sequestering up to 2.0 million tons per annum of CO2. The natural gas gathering pipeline in-service is projected for the fourth quarter of 2024, and the carbon sequestration portion of the project is subject to regulatory approvals. As of December 31, 2022, we have made capital contributions of $18 million to the project. 45TABLE OF CONTENTSNew Credit Facility On December 9, 2022, we entered into a new senior secured reserve-based revolving credit agreement providing for the New Credit Facility, which features an initial borrowing base of $3.5 billion and aggregate commitments of $2.0 billion. The New Credit Facility includes terms that change favorably upon us receiving and maintaining investment grade ratings by S&P, Moody’s and/or Fitch and the satisfaction of certain other conditions. The New Credit Facility matures in December 2027.Repurchases of Equity Securities and DividendsIn June 2022, our Board of Directors authorized an increase in the size of our share repurchase program from $1.0 billion to up to $2.0 billion in aggregate value of our common stock and/or warrants. During 2022, we repurchased approximately 11.7 million shares of our common stock pursuant to the share repurchase program and had $927 million available under the share repurchase program as of December 31, 2022. In addition, we have paid dividends of approximately $1.2 billion, in aggregate, on our common stock during 2022. In August 2022, we increased our quarterly base dividend by 10% to $0.55 per share beginning with the dividend that was paid on September 1, 2022. Warrant Exchange OfferIn August 2022, we announced exchange offers relating to our outstanding Class A Warrants, Class B Warrants, and Class C Warrants. The exchange offers expired in October 2022 and resulted in the issuance of 16,305,984 shares of our common stock in exchange for the cancellation of (i) 4,752,207 Class A Warrants, or approximately 51.4% of the outstanding Class A Warrants, at the time of exchange, (ii) 7,879,030 Class B Warrants, or approximately 64.1% of the outstanding Class B Warrants, at the time of exchange, and (iii) 7,252,004 Class C Warrants, or approximately 64.8% of the outstanding Class C Warrants, at the time of exchange.COVID-19 Pandemic and Impact on Global Demand for Natural Gas and OilThe global spread of COVID-19 created significant volatility, uncertainty, and economic disruption commencing in 2020, and threatens to continue to do so in 2023. The ongoing pandemic has resulted in widespread adverse impacts on the global economy and on our customers and other parties with whom we have business relations. To date, we have experienced limited operational impacts as a result of COVID-19 or related governmental restrictions. While we cannot predict the full impact that COVID-19 and its variants, or the related significant disruption and volatility in the natural gas and oil markets will have on our business, cash flows, liquidity, financial condition and results of operations, we believe our cost structure and liquidity position us well to address continued price and demand volatility. For additional discussion regarding risks associated with the COVID-19 pandemic, see Item 1A Risk Factors in this report.Russia’s Invasion of Ukraine; Volatility in Natural Gas, Oil and NGL Prices; and Inflationary Cost Pressures In late February 2022, Russia launched a military invasion against Ukraine. The Russian invasion has caused, and could intensify, volatility in natural gas, oil and NGL prices, and may have an impact on global growth prospects, which could in turn affect demand for natural gas and oil. This overall uncertainty resulted in stronger commodity prices during much of 2022. Toward the end of 2022, markets began to stabilize, and this, coupled with a milder winter, has resulted in an observed decline in pricing in early 2023. Our 2023 estimated cash flow is partially protected from commodity price volatility due to our current hedge positions that cover approximately 56% of our projected natural gas volumes for 2023. In addition to the recent weakening in commodity prices, the industry is experiencing inflationary pressure, including rising fuel costs, a tightening steel market, and labor and supply chain shortages, which could result in increases to our operating and capital costs that are not fixed. We continue to monitor the situation and assess its impact on our business, including our business partners and customers, as we work to limit our supply chain risk.46TABLE OF CONTENTSLiquidity and Capital ResourcesLiquidity OverviewFor the 2022 Successor Period, our primary sources of capital resources and liquidity have consisted of internally generated cash flows from operations and borrowings under our credit agreements, and our primary uses of cash have been for the development of our natural gas and oil properties, acquisitions of additional natural gas properties and return of value to stockholders through dividends and equity repurchases. Historically, our primary sources of capital resources and liquidity have consisted of internally generated cash flows from operations, borrowings under certain credit agreements and dispositions of non-core assets. Our ability to issue additional indebtedness, dispose of assets or access the capital markets was substantially limited during the Chapter 11 Cases and required court approval in most instances. Accordingly, our liquidity in the 2021 and 2020 Predecessor Periods depended mainly on cash generated from operations and available funds under certain credit agreements including the DIP Facility in the 2021 Predecessor Period and revolving credit facility in the 2020 Predecessor Period.We believe we have emerged from the Chapter 11 Cases as a fundamentally stronger company, built to generate sustainable Free Cash Flow with a strengthened balance sheet, large portfolio of onshore U.S. unconventional natural gas and liquids assets and improving ESG performance. As a result of the Chapter 11 Cases, we reduced our total indebtedness by $9.4 billion by issuing equity in a reorganized entity to the holders of our FLLO Term Loan, Second Lien Notes, unsecured notes and allowed general unsecured claimants. In December 2022, we entered into a New Credit Facility and terminated the Exit Credit Facility, repaying all amounts outstanding and extinguishing all commitments thereunder. We believe our cash flow from operations, cash on hand and borrowing capacity under the New Credit Facility, as discussed below, will provide sufficient liquidity during the next 12 months and the foreseeable future. As of December 31, 2022, we had $1.0 billion of liquidity available, including $130 million of cash on hand and $0.9 billion of aggregate unused borrowing capacity available under the New Credit Facility. As of December 31, 2022, we had $1.05 billion of outstanding borrowings under our New Credit Facility and $35 million utilized for various letters of credit. See Note 6 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for further discussion of our debt obligations, including principal and carrying amounts of our senior notes. DividendsWe declared the first quarterly dividend on our New Common Stock in the second quarter of 2021, which consisted of a base dividend per share. In March 2022, we adopted a variable return program that resulted in the payment of an additional variable dividend per share equal to the sum of the Adjusted Free Cash Flow from the prior quarter less the base quarterly dividend, multiplied by 50%. Under this base and variable dividend approach, we paid dividends of $1.2 billion, in aggregate, on our common stock in the 2022 Successor Period. See Note 12 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for further discussion.The declaration and payment of any future dividend, whether fixed or variable, will remain at the full discretion of the Board and will depend on the Company’s financial results, cash requirements, future prospects and other relevant factors. The Company’s ability to pay dividends to its stockholders is restricted by (i) Oklahoma corporate law, (ii) its Certificate of Incorporation, (iii) the terms and provisions of the credit agreement governing its New Credit Facility and (iv) the terms and provisions of the indentures governing its 5.50% Senior Notes due 2026, 5.875% Senior Notes due 2029 and 6.75% Senior Notes due 2029.47TABLE OF CONTENTSDerivative and Hedging ActivitiesOur results of operations and cash flows are impacted by changes in market prices for natural gas, oil and NGL. We enter into various derivative instruments to mitigate a portion of our exposure to commodity price declines, but these transactions may also limit our cash flows in periods of rising commodity prices. Our natural gas, oil and NGL derivative activities, when combined with our sales of natural gas, oil and NGL, allow us to better predict the total revenue we expect to receive. See Item 7A Quantitative and Qualitative Disclosures About Market Risk included in Part II of this report for further discussion on the impact of commodity price risk on our financial position. Contractual Obligations and Off-Balance Sheet ArrangementsAs of December 31, 2022, our material contractual obligations include repayment of senior notes, outstanding borrowings and interest payment obligations under the New Credit Facility, derivative obligations, asset retirement obligations, lease obligations, capital commitments relating to our investments, undrawn letters of credit and various other commitments we enter into in the ordinary course of business that could result in future cash obligations. In addition, we have contractual commitments with midstream companies and pipeline carriers for future gathering, processing and transportation of natural gas, oil and NGL to move certain of our production to market. The estimated gross undiscounted future commitments under these agreements were approximately $4.3 billion as of December 31, 2022. As discussed above, we believe our existing sources of liquidity will be sufficient to fund our near and long-term contractual obligations. See Notes 6, 7, 9, 15, 18 and 22 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for further discussion. New Credit FacilityOn December 9, 2022, the Company, as borrower, entered into a senior secured reserve-based credit agreement providing for the New Credit Facility which features an initial borrowing base of $3.5 billion and aggregate commitments of $2.0 billion. Subject to certain exceptions, the borrowing base will be redetermined semi-annually on or around April 15 and October 15 of each year. The New Credit Facility provides for a $200 million sublimit available for the issuance of letters of credit and a $50 million sublimit available for swingline loans. Borrowings under the credit agreement may be alternate base rate loans or term SOFR loans, at the Company’s election. The New Credit Facility contains certain features that, upon receipt and maintenance of investment grade ratings from S&P, Moody’s and/or Fitch and the satisfaction of certain other conditions, result in the removal or relaxation of specified negative and financial covenants, among other favorable adjustments. See Note 6 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for further discussion. Post-Emergence DebtOn the Effective Date, pursuant to the terms of the Plan, the Company, as borrower, entered into a reserve-based credit agreement providing for the Exit Credit Facility which featured an initial borrowing base of $2.5 billion. The aggregate initial elected commitments of the lenders under the Exit Credit Facility were $1.75 billion of revolving Tranche A Loans and $221 million of fully funded Tranche B Loans.The Exit Credit Facility provided for a $200 million sublimit of the aggregate commitments that were available for the issuance of letters of credit. The Exit Credit Facility bore interest at the ABR (alternate base rate) or LIBOR, at our election, plus an applicable margin (ranging from 2.25–3.25% per annum for ABR loans and 3.25–4.25% per annum for LIBOR loans, subject to a 1.00% LIBOR floor), depending on the percentage of the borrowing base then being utilized. The Tranche A Loans were due to mature 3 years after the Effective Date and the Tranche B Loans were due to mature 4 years after the Effective Date. In December 2022, in conjunction with our entry into the New Credit Facility, the Exit Credit Facility was terminated, repaying all amounts outstanding and extinguishing all commitments thereunder.On February 2, 2021, the Company issued $500 million aggregate principal amount of its 5.50% Senior Notes due 2026 (the “2026 Notes”) and $500 million aggregate principal amount of its 5.875% Senior Notes due 2029 (the “2029 Notes” and, together with the 2026 Notes, the “Notes”). The offering of the Notes was part of a series of exit financing transactions undertaken in connection with the Debtors’ Chapter 11 Cases and meant to provide the exit financing originally intended to be provided by the Exit Term Loan Facility pursuant to the Commitment Letter.48TABLE OF CONTENTSAssumption and Repayment of Vine DebtIn conjunction with the Vine Acquisition, Vine’s Second Lien Term Loan was repaid and terminated for $163 million inclusive of a $13 million make whole premium with cash on hand, due to the agreement containing a change in control provision making the term loan callable upon closing. Vine’s reserve-based loan facility, which had no borrowings as of November 1, 2021, was terminated at the time of the completion of the Vine Acquisition. Additionally, Vine’s 6.75% Senior Notes with a principal amount of $950 million, were assumed by the Company at the time of the completion of the Vine Acquisition. Capital ExpendituresFor the year ending December 31, 2023, we currently expect to bring or have online approximately 145 to 165 gross wells across 10 to 12 rigs and plan to invest between approximately $1.765 – $1.835 billion in capital expenditures. We expect that approximately 85% of our 2023 capital expenditures will be directed toward our natural gas assets. We currently plan to fund our 2023 capital program through cash on hand, expected cash flow from our operations and borrowings under our New Credit Facility. We may alter or change our plans with respect to our capital program and expected capital expenditures based on developments in our business, our financial position, our industry or any of the markets in which we operate. 49TABLE OF CONTENTSSources and (Uses) of Cash and Cash EquivalentsThe following table presents the sources and uses of our cash and cash equivalents for the periods presented:SuccessorPredecessor Year Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Year Ended December 31, 2020Cash provided by (used in) operating activities$4,125 $1,809 $(21)$1,164 Proceeds from New Credit Facility, net1,050 — — — Proceeds from issuance of senior notes, net— — 1,000 — Proceeds from issuance of common stock— — 600 — Proceeds from warrant exercise27 2 — — Proceeds from divestitures of property and equipment407 13 — 150 Proceeds from pre-petition revolving credit facility borrowings, net— — — 339 Capital expenditures(1,823)(669)(66)(1,142)Business combination, net(1,967)(194)— — Contributions to investments(18)— — — Payments on Exit Credit Facility, net(221)(50)(479)— Payments on DIP Facility borrowings— — (1,179)— Debt issuance and other financing costs(17)(3)(8)(109)Cash paid to purchase debt— — — (94)Cash paid for common stock dividends(1,212)(119)— — Cash paid for preferred stock dividends— — — (22)Cash paid to repurchase and retire common stock(1,073)— — — Other— (1)— (13)Net increase (decrease) in cash, cash equivalents and restricted cash$(722)$788 $(153)$273 Cash Flow from Operating ActivitiesCash provided by operating activities was $4.12 billion, $1.81 billion and $1.16 billion in the 2022 Successor Period, 2021 Successor Period and 2020 Predecessor Period, respectively. Cash used in operating activities was $21 million for the 2021 Predecessor Period. The increase in the 2022 Successor Period is primarily due to higher prices for the natural gas, oil and NGL we sold and increased volumes sold due to the Vine Acquisition and Marcellus Acquisition. The increase in the 2021 Successor Period is primarily the result of higher prices for the natural gas, oil and NGL we sold, coupled with a decrease in cash interest and GP&T costs following our emergence from bankruptcy. The cash used in the 2021 Predecessor Period was primarily in connection with the payment of professional fees related to the Chapter 11 Cases. Cash flows from operations are largely affected by the same factors that affect our net income, excluding various non-cash items, such as depreciation, depletion and amortization, certain impairments, gains or losses on sales of assets, deferred income taxes and mark-to-market changes in our open derivative instruments. See further discussion below under Results of Operations.Proceeds from New Credit Facility, netIn the 2022 Successor Period, we borrowed a net $1.05 billion under the New Credit Facility. We utilized these borrowings to terminate the Exit Credit Facility, including the repayment of outstanding Tranche A Loans and Tranche B Loans thereunder, backstopping certain letters of credit, and the payment of fees and expenses in connection with the termination of the Exit Credit Facility and entry into the New Credit Facility. A portion of the borrowings under the New Credit Facility were repaid with internally generated cash provided by operating activities.50TABLE OF CONTENTSProceeds from Issuance of Common Stock and Senior Notes In the 2021 Predecessor Period, we issued $500 million aggregate principal amount of 5.50% 2026 Notes and $500 million aggregate principal amount of 5.875% 2029 Notes for total proceeds of $1.0 billion. Additionally, upon emergence from Chapter 11, we issued 62,927,320 shares of New Common Stock in exchange for $600 million of cash, as agreed upon in the Plan. See Note 6 and Note 2 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for further discussion. Divestitures of Property and EquipmentIn the 2022 Successor Period, we sold our Powder River Basin assets to Continental Resources, Inc. for approximately $450 million, subject to post-close adjustments. In the 2021 Successor Period, we divested certain non-core assets for approximately $13 million. In the 2020 Predecessor Period, we divested our Mid-Continent asset for $130 million and certain non-core assets for approximately $6 million. See Note 4 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for further discussion.Capital ExpendituresOur capital expenditures significantly increased in the 2022 Successor Period compared to the combined 2021 Successor and Predecessor Periods primarily as a result of increased drilling and completion activity in Haynesville and Marcellus, following the Vine Acquisition and Marcellus Acquisition, respectively. Our capital expenditures decreased in the combined 2021 Successor and Predecessor Periods compared to the 2020 Predecessor Period primarily as a result of decreased drilling and completion activity mainly in our liquids-rich plays. In the 2022 Successor Period, our average operated rig count was 14 rigs and 217 spud wells, compared to an average operated rig count of 7 rigs and 121 spud wells in the combined 2021 Successor and Predecessor Periods and 8 rigs and 167 spud wells in the 2020 Predecessor Period. We completed 216 operated wells in the 2022 Successor Period compared to 127 in the combined 2021 Successor and Predecessor Periods and 188 in the 2020 Predecessor Period.Business Combination, net In the 2022 Successor Period, we completed the Marcellus Acquisition for approximately $2 billion and 9.4 million shares of our common stock. In the 2021 Successor Period, we acquired Vine for approximately 18.7 million shares of our New Common Stock and $253 million cash, less $59 million of cash held by Vine as of the acquisition date. See Note 4 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for further discussion of these acquisitions.Contributions to InvestmentsDuring the 2022 Successor Period, we made an initial contribution of $18 million to our investment with Momentum Sustainable Ventures LLC to build a new natural gas gathering pipeline and carbon capture project. See Note 18 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for additional information.Payments on Exit Credit Facility, netIn December 2022, we entered into the New Credit Facility and terminated the Exit Credit Facility, repaying all amounts outstanding and extinguishing all commitments thereunder.Payments on DIP Facility BorrowingsOn the Effective Date, the DIP Facility was terminated, and the holders of obligations under the DIP Facility received payment in full in cash; provided that to the extent such lender under the DIP Facility was also a lender under the Exit Credit Facility, such lender’s allowed DIP claims were first reduced dollar-for-dollar and satisfied by the amount of its Exit RBL Loans provided as of the Effective Date. 51TABLE OF CONTENTSDebt Issuance and Other Financing CostsDuring the 2022 Successor Period, we paid $17 million of one-time fees to lenders to establish the New Credit Facility. In the 2020 Predecessor Period, we paid $109 million of one-time fees to lenders to establish our DIP Credit Facility and Exit Credit Facility.Cash Paid to Purchase DebtIn the 2020 Predecessor Period, we repurchased approximately $160 million aggregate principal amount of our senior notes for $94 million. Cash Paid for Common Stock DividendsAs part of our dividend program, we paid common stock base dividends of $256 million and common stock variable dividends of $956 million in the 2022 Successor Period. During the 2021 Successor Period, we paid common stock base dividends of $119 million. See Note 12 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for further discussion.Cash Paid for Preferred Stock DividendsWe paid dividends of $22 million on our Predecessor preferred stock during the 2020 Predecessor Period. On April 17, 2020, we announced that we were suspending payment of dividends on each series of our outstanding convertible preferred stock. On the Effective Date of the Chapter 11 Cases, each holder of an equity interest in the Predecessor had such interest canceled, released, and extinguished without any distribution. See Note 2 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for additional information about the Chapter 11 Cases.Cash Paid to Repurchase and Retire Common StockIn March 2022, we commenced our share repurchase program, and throughout the 2022 Successor Period, we repurchased 11.7 million shares of our common stock for an aggregate price of $1.1 billion. The shares of common stock that were repurchased during the 2022 Successor Period were retired and recorded as a reduction to common stock and retained earnings.52TABLE OF CONTENTSResults of OperationsYear ended December 31, 2022 compared to the year ended December 31, 2021Below is a discussion of changes in our results of operations for the 2022 Successor Period compared to the combined 2021 Successor and Predecessor Periods. A discussion of changes in our results of operations for the combined 2021 Successor and Predecessor Periods compared to the 2020 Predecessor Period has been omitted from this Form 10-K, but may be found in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2021 as filed with the SEC on February 24, 2022.Natural Gas, Oil and NGL Production and Average Sales PricesSuccessorYear Ended December 31, 2022Natural GasOilNGLTotalMMcf per day$/McfMBbl per day$/BblMBbl per day$/BblMMcfe per day$/McfeMarcellus1,836 6.03 — — — — 1,836 6.03 Haynesville1,611 5.92 — — — — 1,611 5.92 Eagle Ford127 5.64 51 96.10 16 36.76 529 11.76 Powder River Basin10 5.45 2 95.18 1 53.96 26 10.66 Total3,584 5.96 53 96.07 17 37.48 4,002 6.77 Average NYMEX Price6.64 94.23 Average Realized Price (including realized derivatives)3.67 66.36 37.48 4.32 SuccessorPeriod from February 10, 2021 through December 31, 2021Natural GasOilNGLTotalMMcf per day$/McfMBbl per day$/BblMBbl per day$/BblMMcfe per day$/McfeMarcellus1,296 3.25 — — — — 1,296 3.25 Haynesville750 4.10 — — — — 750 4.10 Eagle Ford137 4.02 60 69.25 19 29.76 608 8.65 Powder River Basin53 4.33 9 67.90 3 40.00 129 7.69 Total2,236 3.61 69 69.07 22 31.37 2,783 4.87 Average NYMEX Price3.9769.35Average Realized Price (including realized derivatives)2.6249.0631.423.57 53TABLE OF CONTENTSPredecessorPeriod from January 1, 2021 through February 9, 2021Natural GasOilNGLTotalMMcf per day$/McfMBbl per day$/BblMBbl per day$/BblMMcfe per day$/McfeMarcellus1,233 2.42 — — — — 1,233 2.42 Haynesville543 2.44 — — — — 543 2.44 Eagle Ford165 2.57 74 53.37 18 23.94 721 6.71 Powder River Basin61 2.92 10 51.96 4 34.31 144 5.71 Total2,002 2.45 84 53.21 22 25.92 2,641 3.77 Average NYMEX Price2.4752.10Average Realized Price (including realized derivatives)2.5246.8525.553.65Natural Gas, Oil and NGL SalesSuccessorYear Ended December 31, 2022Natural GasOilNGLTotalMarcellus$4,041 $— $— $4,041 Haynesville3,481 — — 3,481 Eagle Ford261 1,798 212 2,271 Powder River Basin20 66 13 99 Total natural gas, oil and NGL sales$7,803 $1,864 $225 $9,892 SuccessorPeriod from February 10, 2021 through December 31, 2021Natural GasOilNGLTotalMarcellus$1,370 $— $— $1,370 Haynesville998 — — 998 Eagle Ford179 1,354 179 1,712 Powder River Basin75 202 44 321 Total natural gas, oil and NGL sales$2,622 $1,556 $223 $4,401 PredecessorPeriod from January 1, 2021 through February 9, 2021Natural GasOilNGLTotalMarcellus$119 $— $— $119 Haynesville53 — — 53 Eagle Ford17 159 17 193 Powder River Basin7 20 6 33 Total natural gas, oil and NGL sales$196 $179 $23 $398 54TABLE OF CONTENTSNon-GAAP CombinedYear Ended December 31, 2021Natural GasOilNGLTotalMarcellus$1,489 $— $— $1,489 Haynesville1,051 — — 1,051 Eagle Ford196 1,513 196 1,905 Powder River Basin82 222 50 354 Total natural gas, oil and NGL sales$2,818 $1,735 $246 $4,799 Natural gas, oil and NGL sales in the 2022 Successor Period increased $5.093 billion compared to the combined 2021 Successor and Predecessor Periods. The increase was attributable to a $2.773 billion increase in revenues from higher average prices received. Additionally, an increase of $2.320 billion was due to increased volumes in Marcellus and Haynesville primarily due to the Marcellus Acquisition and the Vine Acquisition, respectively. These increases were partially offset by decreased volumes in Eagle Ford, which was primarily due to a natural decline in production, and the Powder River Basin, following the divestiture of the Powder River Basin assets in March 2022. Production ExpensesSuccessorPredecessorNon-GAAP CombinedYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Year Ended December 31, 2021$/Mcfe$/Mcfe$/Mcfe$/McfeMarcellus$76 0.11 $34 0.08 $4 0.08 $38 0.08 Haynesville155 0.26 59 0.24 4 0.19 63 0.24 Eagle Ford234 1.22 173 0.88 21 0.71 194 0.85 Powder River Basin10 0.94 31 0.74 3 0.56 34 0.72 Total production expenses$475 0.33 $297 0.33 $32 0.30 $329 0.33 Production expenses in the 2022 Successor Period increased $146 million as compared to the combined 2021 Successor and Predecessor Periods. The increase was primarily due to the Vine Acquisition in November 2021 and the Marcellus Acquisition in March 2022. The increase was partially offset by the divestiture of the Powder River Basin in March 2022. 55TABLE OF CONTENTSGathering, Processing and Transportation Expenses (“GP&T”)SuccessorPredecessorNon-GAAP CombinedYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Year Ended December 31, 2021$/Mcfe$/Mcfe$/Mcfe$/McfeMarcellus$381 0.57 $287 0.68 $34 0.70 $321 0.68 Haynesville313 0.53 118 0.49 11 0.49 129 0.49 Eagle Ford343 1.78 290 1.46 45 1.55 335 1.48 Powder River Basin22 2.32 85 2.03 12 2.09 97 2.04 Total GP&T$1,059 0.73 $780 0.86 $102 0.96 $882 0.87 Gathering, processing and transportation expenses in the 2022 Successor Period increased $177 million as compared to the combined 2021 Successor and Predecessor Periods. Haynesville increased $184 million primarily due to the Vine Acquisition in November 2021 and increased cost due to higher commodity prices. Marcellus increased $113 million primarily due to the Marcellus Acquisition in March 2022, partially offset by a decrease of $53 million primarily due to lower rates. Eagle Ford increased $70 million due to increased rates with higher commodity prices, which was partially offset by a decrease of $62 million due to reduced volumes primarily due to a natural decline in production. Powder River Basin decreased by $75 million due to the divestiture in March 2022.Severance and Ad Valorem TaxesSuccessorPredecessorNon-GAAP CombinedYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Year Ended December 31, 2021$/Mcfe$/Mcfe$/Mcfe$/McfeMarcellus$17 0.03 $9 0.02 $1 0.01 $10 0.02 Haynesville75 0.13 22 0.09 2 0.09 24 0.09 Eagle Ford139 0.71 96 0.48 13 0.45 109 0.48 Powder River Basin11 1.09 31 0.75 2 0.48 33 0.70 Total severance and ad valorem taxes$242 0.17 $158 0.17 $18 0.17 $176 0.17 Severance and ad valorem taxes in the 2022 Successor Period increased $66 million as compared to the combined 2021 Successor and Predecessor Periods. Higher commodity prices and increases to the Haynesville statutory severance tax rates in the 2022 Successor Period drove $42 million of the increase, and an additional $46 million increase was the result of the Vine Acquisition and Marcellus Acquisition. These increases were partially offset by a $22 million decrease attributable to the divestiture of the Powder River Basin in March 2022. 56TABLE OF CONTENTSAdjusted Gross Margin by Operating AreaThe table below presents the adjusted gross margin for each of our operating areas. Adjusted gross margin is defined as natural gas, oil and NGL sales less production expenses, gathering, processing and transportation expenses, and severance and ad valorem taxes. Adjusted gross margin is a non-GAAP measure, and a reconciliation of gross margin to adjusted gross margin is presented within the “Non-GAAP Measures” section of this Item 7.SuccessorPredecessorNon-GAAP CombinedYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Year Ended December 31, 2021$/Mcfe$/Mcfe$/Mcfe$/McfeMarcellus$3,567 5.32 $1,040 2.47 $80 1.63 $1,120 2.38 Haynesville2,938 5.00 799 3.28 36 1.67 835 3.14 Eagle Ford1,555 8.05 1,153 5.83 114 4.00 1,267 5.59 Powder River Basin56 6.31 174 4.17 16 2.58 190 3.98 Adjusted gross margin$8,116 5.54 $3,166 3.51 $246 2.34 $3,412 3.38 Natural Gas and Oil DerivativesSuccessorPredecessorYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Natural gas derivatives - realized gains (losses)$(2,998)$(715)$6 Natural gas derivatives - unrealized gains (losses)611 70 (179)Total losses on natural gas derivatives$(2,387)$(645)$(173)Oil derivatives - realized losses$(576)$(453)$(19)Oil derivatives - unrealized gains (losses)283 (29)(190)Total losses on oil derivatives(293)(482)(209)Total losses on natural gas and oil derivatives$(2,680)$(1,127)$(382)See Note 15 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for a complete discussion of our derivative activity.57TABLE OF CONTENTSMarketing Revenues and Expenses SuccessorPredecessorYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Marketing revenues$4,231 $2,263 $239 Marketing expenses4,215 2,257 237 Marketing margin$16 $6 $2 Marketing revenues and expenses increased in the 2022 Successor Period as a result of increased natural gas, oil and NGL prices received in our marketing operation. Additionally, during the 2022 Successor Period, marketing revenues and expenses increased due to increased volumes from the Vine Acquisition and Marcellus Acquisition.Exploration Expenses During the 2022 Successor Period, exploration expense charges of $23 million were primarily the result of non-cash impairment charges in unproved properties of $8 million, $6 million of charges related to dry hole expense and $6 million of geological and geophysical expense. We did not have material exploration expenses during the 2021 Successor Period or 2021 Predecessor Period.General and Administrative ExpensesSuccessorPredecessorYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Total G&A, net$142 $97 $21 G&A, net per Mcfe$0.10 $0.11 $0.20 Total general and administrative expenses, net during the 2022 Successor Period increased $24 million compared to the combined 2021 Successor and Predecessor Periods primarily due to adjustments in employee benefits and timing of stock award grants, as well as increases in transaction-related fees. Separation and Other Termination CostsDuring the 2022 Successor Period, 2021 Successor Period and 2021 Predecessor Period, we recognized $5 million, $11 million and $22 million, respectively, of separation and other termination costs related to one-time termination benefits for certain employees.58TABLE OF CONTENTSDepreciation, Depletion and AmortizationSuccessorPredecessorYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021DD&A$1,753 $919 $72 DD&A per Mcfe$1.20 $1.02 $0.68 The absolute and per unit increases in depreciation, depletion and amortization for the 2022 Successor Period compared to the combined 2021 Successor and Predecessor Periods, are primarily the result of the Vine Acquisition and Marcellus Acquisition. Other Operating Expense (Income), NetSuccessorPredecessorYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Other operating expense (income), net$49 $84 $(12)During the 2022 Successor Period, we recognized approximately $41 million of costs related to our Marcellus Acquisition, which included integration costs, consulting fees, financial advisory fees, legal fees and change in control expense in accordance with Chief’s existing employment agreements. In the 2021 Successor Period we recognized approximately $59 million of costs related to the Vine Acquisition, which included consulting fees, financial advisory fees and legal fees. Additionally, we recognized approximately $36 million of severance expense as a result of the Vine Acquisition, which included $15 million of cash severance and $21 million of non-cash severance, primarily related to the issuance of New Common Stock for the acceleration of certain Vine restricted stock unit awards. A majority of Vine executives and employees were terminated on the date the Vine Acquisition was completed. These executives and employees were entitled to severance benefits in accordance with existing employment agreements. Interest ExpenseSuccessorPredecessorYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Interest expense on debt$181 $79 $11 Other13 — — Amortization of premium, issuance costs and other(3)5 — Capitalized interest(31)(11)— Total interest expense$160 $73 $11 The increase in total interest expense in the 2022 Successor Period compared to the combined 2021 Successor and Predecessor Periods, was primarily due to the increase in outstanding debt obligations between periods. In November 2021, we assumed Vine’s $950 million of senior notes as part of the Vine Acquisition, and during the 2022 Successor Period, we had increased borrowings under our various credit agreements, compared to the combined 2021 Successor and Predecessor Periods. During the 2022 Successor Period, borrowings under our credit agreements had an average interest rate of 8.7%. Additionally, $12 million of interest expense was recorded during the 2022 Successor Period pertaining to a tax interest assessment. 59TABLE OF CONTENTSReorganization Items, NetPredecessorPeriod from January 1, 2021 through February 9, 2021Gains on the settlement of liabilities subject to compromise$6,443 Accrual for allowed claims(1,002)Gain on fresh start adjustments201 Gain from release of commitment liabilities55 Professional service provider fees and other(60)Success fees for professional service providers(38)Surrender of other receivable(18)FLLO alternative transaction fee(12)Total reorganization items, net$5,569 In the 2021 Predecessor Period, we recorded a net gain of $5.569 billion in reorganization items, net related to the Chapter 11 Cases. See Note 2 and Note 3 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for a discussion of the Chapter 11 Cases and for discussion of adoption of fresh start accounting. We did not have any reorganization items, net for the 2022 Successor Period or the 2021 Successor Period.Income Tax Expense (Benefit). We recorded an income tax benefit of $1.3 billion in the 2022 Successor Period. In the 2021 Successor and Predecessor Periods, we recorded an income tax benefit of $49 million and $57 million, respectively. Of the $1.3 billion of income tax benefit recorded in the 2022 Successor Period, $1.4 billion is related to the partial release of the valuation allowance, which is partially offset by $47 million in current federal and state income taxes. The income tax benefit recorded in the 2021 Successor Period is related to a $49 million partial release of the valuation allowance maintained against our net deferred tax asset position. The partial release was a consequence of recording a net deferred tax liability of $49 million resulting from the business combination accounting for Vine. The $57 million income tax benefit for the 2021 Predecessor Period consists of the removal of the income tax effects in other comprehensive income related to hedging settlements due to the fair value adjustments made upon emergence from bankruptcy. See Note 11 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for a discussion of income tax expense (benefit). 60TABLE OF CONTENTSNon-GAAP MeasuresManagement uses adjusted gross margin to assess our operating results and financial performance across assets and periods. We define adjusted gross margin as natural gas, oil and NGL sales less production expenses, gathering, processing and transportation expenses, and severance and ad valorem taxes. Adjusted gross margin is not a measure of financial performance under GAAP and should not be considered in isolation or as a substitute for analysis of our results reported under GAAP. Additionally, adjusted gross margin may not be comparable to similarly titled measures used by other companies. We exclude depreciation, depletion and amortization from the calculation of adjusted gross margin as depreciation, depletion and amortization are non-cash expenses that do not necessarily reflect present-day performance. The table below reconciles gross margin, as defined by GAAP, to adjusted gross margin.SuccessorPredecessorNon-GAAP CombinedYear Ended December 31, 2022Period from February 10, 2021 through December 31, 2021Period from January 1, 2021 through February 9, 2021Year Ended December 31, 2021Gross margin (GAAP)Natural gas, oil and NGL sales$9,892 $4,401 $398 $4,799 Less:Production expenses(475)(297)(32)(329)Gathering, processing and transportation expenses(1,059)(780)(102)(882)Severance and ad valorem taxes(242)(158)(18)(176)Depreciation, depletion and amortization(1,753)(919)(72)(991)Gross margin (GAAP)6,363 2,247 174 2,421 Add back: Depreciation, depletion and amortization1,753 919 72 991 Adjusted gross margin (Non-GAAP)$8,116 $3,166 $246 $3,412 61TABLE OF CONTENTSCritical Accounting EstimatesThe preparation of financial statements in accordance with accounting principles generally accepted in the United States require us to make estimates and assumptions. The accounting estimates and assumptions that involve a significant level of estimation uncertainty and have or are reasonably likely to have a material impact on our financial condition or results of operations are discussed below. Our management has discussed each critical accounting estimate with the Audit Committee of our Board of Directors.Natural Gas and Oil Reserves. Estimates of natural gas and oil reserves and their values, future production rates, future development costs and commodity pricing differentials are the most significant of our estimates. The accuracy of any reserve estimate is a function of the quality of data available and of engineering and geological interpretation and judgment. In addition, estimates of reserves may be revised based on actual production, results of subsequent exploration and development activities, recent commodity prices, operating costs and other factors. These revisions could materially affect our financial statements. The volatility of commodity prices results in increased uncertainty inherent in these estimates and assumptions. Changes in natural gas, oil or NGL prices could result in actual results differing significantly from our estimates. See Supplemental Disclosures About Natural Gas, Oil and NGL Producing Activities included in Item 8 of Part II of this report for further information.Accounting for Business Combinations. We account for business combinations using the acquisition method, which is the only method permitted under FASB ASC Topic 805 – Business Combinations, and involves the use of significant judgment. Under the acquisition method of accounting, a business combination is accounted for at a purchase price based on the fair value of the consideration given. The assets and liabilities acquired are measured at their fair values, and the purchase price is allocated to the assets and liabilities based upon these fair values. The excess, if any, of the consideration given to acquire an entity over the net amounts assigned to its assets acquired and liabilities assumed is recognized as goodwill. The excess, if any, of the fair value of assets acquired and liabilities assumed over the cost of an acquired entity is recognized immediately to earnings as a gain from bargain purchase.The Company’s principal assets are its natural gas and oil properties, which are accounted for under the successful efforts accounting method. The Company determines the fair value of acquired natural gas and oil properties based on the discounted future net cash flows expected to be generated from these assets. Discounted cash flow models by operating area are prepared using the estimated future revenues and operating costs for all proved developed properties and undeveloped properties comprising the proved and unproved reserves. Significant inputs associated with the calculation of discounted future net cash flows include estimates of (i) recoverable reserves, (ii) production rates, (iii) future operating and development costs, (iv) future commodity prices escalated by an inflationary rate after five years, adjusted for differentials, and (v) a market-based weighted average cost of capital by operating area. The Company utilizes NYMEX strip pricing, adjusted for differentials, to value the reserves. The NYMEX strip pricing inputs used are classified as Level 1 fair value assumptions and all other inputs are classified as Level 3 fair value assumptions. The discount rates utilized are derived using a weighted average cost of capital computation, which includes an estimated cost of debt and equity for market participants with similar geographies and asset development type by operating area.Income Taxes. Income taxes are accounted for using the asset and liability method as required by GAAP. Deferred tax assets and liabilities arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets for tax attributes such as NOL carryforwards and disallowed business interest carryforwards are also recognized. Deferred tax assets represent potential future tax benefits and are reduced by a valuation allowance if it is more likely than not that such benefits will not be realized. In assessing the need for a valuation allowance or adjustments to existing valuation allowances, one source of evidence is a projection of income exclusive of existing timing differences.Our judgement regarding the realizability of deferred tax assets is thus partially affected by estimates of future financial condition. In interim quarters our tax provision is based upon an estimated annual effective tax rate, which is determined through the usage of full year estimates. Thus, our quarterly income tax expense or benefit can fluctuate throughout the year as a result of changing financial forecasts.62TABLE OF CONTENTSWe also routinely assess potential uncertain tax positions and, if required, establish accruals for such positions. Accounting guidance for recognizing and measuring uncertain tax positions requires that a more likely than not threshold condition be met on a tax position, based solely on its technical merits of being sustained, before any benefit of the uncertain tax position can be recognized in the financial statements. If it is more likely than not a tax position will be sustained, we measure and recognize the position following a cumulative probability estimate.Impairments. Long-lived assets used in operations, including proved gas and oil properties, are assessed for impairment whenever changes in facts and circumstances indicate a possible significant deterioration in future cash flows expected to be generated by an asset group. Individual assets are grouped for impairment purposes based on a judgmental assessment of the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets. If there is an indication the carrying amount of an asset may not be recovered, the asset is assessed by management through an established process in which changes to significant assumptions such as prices, volumes, and future development plans are reviewed. If, upon review, the sum of the undiscounted pre-tax cash flows is less than the carrying value of the asset group, the carrying value is written down to estimated fair value by discounting using a weighted average cost of capital. Because there usually is a lack of quoted market prices for long-lived assets, the fair value of impaired assets is assessed by management using the income approach. Level 3 inputs associated with the calculation of discounted cash flows used in the impairment analysis include our estimate of future natural gas and crude oil prices, production costs, development expenditures, anticipated production of proved reserves and other relevant data. Additionally, we utilize NYMEX strip pricing, adjusted for differentials, to value the reserves. Reorganization and Fresh Start Accounting. Effective June 28, 2020, as a result of the filing of the Chapter 11 Cases we began accounting and reporting according to FASB ASC Topic 852 – Reorganizations (“ASC 852”), which specifies the accounting and financial reporting requirements for entities reorganizing through Chapter 11 bankruptcy proceedings. These requirements include distinguishing and presenting transactions associated with the reorganization and implementation of the plan of reorganization separately from activities related to ongoing operations of the business. Additionally, upon emergence from the Chapter 11 Cases, ASC 852 required us to allocate our reorganization value to our individual assets based on their estimated fair values, resulting in a new entity for financial reporting purposes. After the Effective Date, the accounting and reporting requirements of ASC 852 are no longer applicable and have no impact on the Successor periods.63TABLE OF CONTENTSItem 7A.Quantitative and Qualitative Disclosures About Market RiskThe primary objective of the following information is to provide forward-looking quantitative and qualitative information about our exposure to market risk. The term market risk relates to our risk of loss arising from adverse changes in natural gas, oil and NGL prices and interest rates. These disclosures are not meant to be precise indicators of expected future losses, but rather indicators of reasonably possible losses. The forward-looking information provides indicators of how we view and manage our ongoing market risk exposures.Commodity Price RiskOur results of operations and cash flows are impacted by changes in market prices for natural gas, oil and NGL, which have historically been volatile. To mitigate a portion of our exposure to adverse price changes, we enter into various derivative instruments. Our natural gas, oil and NGL derivative activities, when combined with our sales of natural gas, oil and NGL, allow us to predict with greater certainty the revenue we will receive. We believe our derivative instruments continue to be highly effective in achieving our risk management objectives.We determine the fair value of our derivative instruments utilizing established index prices, volatility curves and discount factors. These estimates are compared to counterparty valuations for reasonableness. Derivative transactions are also subject to the risk that counterparties will be unable to meet their obligations. This non-performance risk is considered in the valuation of our derivative instruments, but to date has not had a material impact on the values of our derivatives. Future risk related to counterparties not being able to meet their obligations has been partially mitigated under our commodity hedging arrangements that require counterparties to post collateral if their obligations to us are in excess of defined thresholds. The values we report in our financial statements are as of a point in time and subsequently change as these estimates are revised to reflect actual results, changes in market conditions and other factors. See Note 15 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for further discussion of the fair value measurements associated with our derivatives.For the 2022 Successor Period, natural gas, oil and NGL revenues, excluding any effect of our derivative instruments, were $7.803 billion, $1.864 billion, and $225 million, respectively. Based on production, natural gas, oil and NGL revenue for the 2022 Successor Period would have increased or decreased by approximately $780 million, $186 million, and $23 million, respectively, for each 10% increase or decrease in prices. As of December 31, 2022, the fair values of our natural gas and oil derivatives were net liabilities of $501 million and $24 million, respectively. A 10% increase in forward natural gas prices would decrease the valuation of natural gas derivatives by approximately $324 million, while a 10% decrease would increase the valuation by $321 million. A 10% increase in forward oil prices would decrease the valuation of oil derivatives by $22 million, while a 10% decrease would increase the valuation by $22 million. This fair value change assumes volatility based on prevailing market parameters at December 31, 2022. See Note 15 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for further information on our open derivative positions.Interest Rate RiskOur exposure to interest rate changes relates primarily to borrowings under our New Credit Facility and Exit Credit Facility for the 2022 Successor Period, the Exit Credit Facility for the 2021 Successor Period and the pre-petition revolving credit facility and DIP Facility for the 2021 and 2020 Predecessor Periods. Interest is payable on borrowings under these credit agreements based on a floating rate. See Note 6 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for additional information. As of December 31, 2022, we had $1.05 billion of outstanding borrowings under our New Credit Facility. A 1.0% increase in interest rates based on the variable borrowings as of December 31, 2022 would result in an increase in our interest expense of approximately $11 million per year.64TABLE OF CONTENTS
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe index to Management’s Discussion and Analysis of Financial Condition and Results of Operations is presented in the Financial Table of Contents.Item 7A. Quantitative and Qualitative Disclosures About Market RiskThe company’s discussion of interest rate, foreign currency and commodity price market risk is contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financial and Derivative Instruments and in Note 10 Financial and Derivative Instruments.
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSINTRODUCTIONManagement’s Discussion and Analysis of Financial Condition and Results of Operations is organized as follows:•Executive Summary: Includes an overview of our business; current economic, competitive and regulatory trends relevant to our business; our current business strategy; and our primary sources of operating and non-operating revenues and expenses.•Critical Accounting Policies: Provides an explanation of accounting policies that may have a significant impact on our financial results and the estimates, assumptions and risks associated with those policies.•Results of Operations: Includes an analysis of our 2022 financial results and a discussion of any known events or trends that are likely to impact future results.•Liquidity and Capital Resources: Includes a discussion of our future cash requirements, capital resources, significant planned expenditures and financing arrangements.References in this discussion and analysis to "we" and "our" are to CME Group Inc. (CME Group) and its consolidated subsidiaries, collectively. References to "exchange" are to Chicago Mercantile Exchange Inc. (CME), the Board of Trade of the City of Chicago, Inc. (CBOT), New York Mercantile Exchange, Inc. (NYMEX) and Commodity Exchange, Inc. (COMEX), collectively, unless otherwise noted. EXECUTIVE SUMMARYBusiness OverviewCME Group, a Delaware stock corporation, is the holding company for CME, CBOT, NYMEX, COMEX, NEX and their respective subsidiaries. The holding company structure is designed to provide strategic and operational flexibility. CME Group's Class A common stock is listed on the Nasdaq Global Select Market (Nasdaq) under the ticker symbol "CME." Our exchange consists of designated contract markets for the trading of futures and options contracts. We also clear futures, options and swaps contracts through our clearing house. Futures contracts, options contracts and swaps contracts provide investors with vehicles for protecting against, and potentially profiting from, price changes in financial instruments and physical commodities. We are a global company with customer access available virtually all over the world. Our customers consist of professional traders, financial institutions, individual and institutional investors, major corporations, manufacturers, producers, governments and central banks. Customers include both members of the exchange and non-members. We offer our customers the opportunity to trade futures contracts and options contracts on a range of products, including those based on interest rates, equity indexes, foreign exchange, agricultural commodities, energy and metals. Through our cash markets business, we offer fixed income trading through BrokerTec and foreign currency trading through EBS. Our products provide a means for hedging, speculating and allocating assets. We identify new products by monitoring economic trends and their impact on the risk management and speculative needs of our existing and prospective customers. Most of our products are available for trading through our electronic trading platforms. These execution facilities offer our customers immediate trade execution and price transparency. In addition, trades can be executed through privately negotiated transactions that are cleared and settled through our clearing house. Prior to September 2021, we provided optimization services that delivered transaction lifecycle management and information services to help our customers optimize their capital, mitigate their risk and reduce operational costs. Optimization services included Traiana, TriOptima and Reset. In September 2021, we contributed the net assets of our optimization business to OSTTRA, our joint venture with IHS Markit (later acquired by S&P Global).Our clearing house clears, settles and guarantees futures and options contracts traded through our exchanges, in addition to cleared swaps products. Our clearing house's performance guarantee is an important function of our business. Because of this guarantee, our customers do not need to evaluate the credit of each potential counterparty or limit themselves to a selected set of counterparties. This flexibility increases the potential liquidity available for each trade. Additionally, the substitution of our clearing house as the counterparty to every transaction allows our customers to establish a position with one party and offset the position with another party. This contract offsetting process provides our customers with flexibility in establishing and adjusting positions and provides for collateral and margining efficiencies. Certain BrokerTec contracts are cleared at third-party clearing houses. 30Table of ContentsBusiness TrendsEconomic Environment. Our customers continue to use our markets as an effective and transparent means to manage risk and meet their investment needs. Trading activity in our centralized markets has fluctuated due to the ongoing uncertainty in the financial markets, fluctuations in the availability of credit, variations in the amount of assets under management as well as the Federal Reserve Bank’s interest rate policy and quantitative easing. We continue to maintain high quality and diverse products as well as various clearing and market data services, which support our customers in any economic environment. Competitive Environment. Our industry is competitive and we continue to encounter competition in all aspects of our business. We expect competition to continue to intensify, especially in light of ongoing regulatory reform in the financial services industry. Competition is influenced by our brand and reputation; the efficiency and security of our settlement, clearing and support services; depth and liquidity of our markets; diversity of product offerings, including frequency and quality of new product development and innovative services; our ability to position and expand upon existing products to address changing market needs; efficient and seamless customer experience; transparency, reliability, anonymity and security of transaction processing; the regulatory environment; connectivity, accessibility, flexibility in execution methods and distribution; and technology capability and innovation, as well as overall transaction costs. We believe we are very well positioned with respect to these factors. Our asset classes contain products designed to address differing risk management needs, and customers are able to achieve operational and capital efficiencies by accessing our diverse products through our platforms and our clearing house. We compete in a large and expanding financial services trading, clearing and settlement marketplace globally. As markets continue to evolve, we will continue to adapt our trading technology and clearing services to meet the needs of our customers. The competitive environment to which we are subject is discussed in "Item 1 - Business" beginning on page 10.Regulatory Environment. Our exchange-traded derivatives exchanges and other businesses are regulated and we serve a customer base that includes regulated institutions and individuals. Developments in the regulatory environment have the potential to significantly impact our business. Compliance with regulations may require us and our customers to dedicate significant financial and operational resources, which could adversely affect our profitability. The regulatory environment to which we are subject is discussed in "Item 1 - Business" beginning on page 11.Business StrategyOur strategy focuses on maximizing futures and options growth globally, diversifying our business and revenues and delivering unparalleled customer efficiencies and operational excellence, including through our partnership with Google Cloud. This strategy allows us to continue to develop into a more broadly diversified financial exchange that provides trading and clearing solutions across a wide range of products and asset classes. Our strategic initiatives are discussed in "Item 1 - Business" beginning on page 7. RevenuesClearing and transaction fees. A majority of our revenue is derived from clearing and transaction fees, which include electronic trading fees, surcharges for privately negotiated transactions and other volume-related charges for exchange-traded and over-the-counter (OTC) contracts. Because clearing and transaction fees are assessed on a per-contract or notional value basis, revenues and profitability fluctuate with changes in contract volume. In addition to the business trends noted earlier, our contract volume, and consequently our revenues, tend to increase during periods of economic and geopolitical uncertainty as our customers seek to manage their exposure to, or speculate on, the market volatility resulting from that uncertainty. While volume has the most significant impact on our clearing and transaction fees revenue, there are four other factors that also influence this source of revenue: •rate structure;•product mix;•venue; and•the percentage of trades executed by customers who are members compared with non-member customers.Rate structure. Customers benefit from volume discounts and limits on fees as part of our effort to increase liquidity in certain products. We offer various incentive programs to promote trading and clearing in various products and geographic locations. We may periodically change fees, volume discounts, fee limits and member discounts, perhaps significantly, based on our review of operations and the business environment. Product mix. We offer exchange-traded futures and options contracts as well as cleared-only interest rate swap contracts. We also offer foreign exchange spot and forward contracts and fixed income products. Rates are varied by product in order to optimize revenue on existing products and to encourage contract volume upon introduction of new products. Venue. Our exchange and platforms are an international marketplace that brings together buyers and sellers mainly through our electronic trading as well as through open outcry trading and privately negotiated transactions. Any customer who is guaranteed by a clearing firm and who agrees to be bound by our exchange rules is able to obtain direct access to our 31Table of Contentselectronic platforms. Open outcry trading is conducted exclusively by our members, who may execute trades on behalf of customers or for themselves. Beginning in May 2021, open outcry trading is now limited to Eurodollar options and Secured Overnight Financing Rate (SOFR) options products following the permanent closure of most of our open outcry pits. Typically, customers submitting trades through our electronic platforms are charged fees for using the platforms in addition to the fees assessed on all transactions executed on our exchange. Customers entering into privately negotiated transactions also incur additional charges beyond the fees assessed on other transactions. Member/non-member mix. Generally, member customers are charged lower fees than our non-member customers. Holding all other factors constant, revenue decreases if the percentage of trades executed by members increases, and increases if the percentage of non-member trades increases. Clearing and transaction fees for cash markets business. Our cash markets business provides matching services whereby we match a buyer and seller of financial instruments to allow both parties to complete the trade bilaterally or through a third-party clearing house. We are not involved in the settlement of the contract but charge a transaction fee generally based on volume or notional value of the trade for providing the matching service. BrokerTec Americas also generates revenue from a matched principal business. This business serves as a fully matched counterparty to offsetting positions entered into by clients on our electronic trading platform to facilitate anonymity and access to clearing and settlement. Revenue is generated from this business generally on a transaction fee basis. Other sources. Revenue is also derived from other sources, including market data and information services and other various services related to our exchange operations. Market data and information services. We receive market data and information services revenue from the dissemination of our market data to subscribers. Subscribers can obtain access to our market data services either directly or through third-party distributors. Our service offerings include access to real-time, delayed and end-of-day quotations, trade and summary market data for our products and other data sources. Users of our basic service receive real-time quotes and pay a flat monthly fee for each screen, or device, displaying our market data. Alternatively, customers can subscribe to market data provided on a limited group of products. The fee for this service is also a flat rate per month.Pricing for our market data services is based on the value of the service provided and the price of comparable services offered by our competitors. Increases or decreases in our market data and information services revenue are influenced by changes in our price structure and incentive programs for existing market data offerings, introduction of new market data services and changes in the number of devices in use. General economic factors that affect the financial services industry, which constitutes our primary customer base, also influence revenue from our market data services. Other revenues. Other revenue includes access and communication fees. Access and communication fees are connectivity fees charged to members and clearing firms that utilize our various telecommunications networks and communications services. Our communication services include our co-location program as well as the connectivity charges to customers of the CME Globex platform. Access fee revenue varies depending on the type of connection provided to customers. Prior to the contribution of the net assets of our optimization business to OSTTRA, other revenues included revenues from our optimization services, which included fees for risk management and information services for the OTC markets, including portfolio reconciliation and post-trade processing. Revenue earned from these services was typically generated through subscriptions or transaction fees. Other revenues also include fees for collateral management, equity subscription fees and fees for trade order routing through agreements from various strategic relationships as well as other services to members and clearing firms.ExpensesThe majority of our expenses do not vary directly with changes in our contract volume. However, licensing and other fee agreements can vary directly with certain equity, energy and swap volumes, and the majority of our employee bonuses vary indirectly with overall contract volume, as bonuses are primarily based on our financial performance. Compensation and benefits. Compensation and benefits expense is our most significant expense and includes employee wages, bonuses, stock-based compensation, benefits and employer taxes. Changes in this expense are driven by fluctuations in the number of employees, increases in wages as a result of labor market conditions, changes in rates for employer taxes and other cost increases affecting benefit plans. In addition, this expense is affected by the composition of our workforce. The expense associated with our bonus and stock-based compensation plans can also have a significant impact on this expense category. 32Table of ContentsThe bonus component of our compensation and benefits expense is based on our financial performance. Under the performance criteria of our annual incentive plans, the bonus funded under the plans is based on achieving certain financial performance targets established by the compensation committee of our board of directors. The compensation committee has discretion to make equitable adjustments to the cash earnings performance calculation to reflect effects of unplanned operating results or capital expenditures to meet intermediate- to long-term growth opportunities. In general, stock-based compensation is a non-cash expense related to restricted stock and performance share grants. Stock-based compensation varies depending on the quantity and fair value of awards granted. The fair value of restricted stock awards and other performance share grants is based on either the share price on the date of the grant or a model of expected future stock prices. Professional fees and outside services. This expense includes fees for consulting services received on strategic and technology initiatives; regulatory and other compliance matters; temporary labor as well as legal and accounting fees. This expense may fluctuate as a result of changes in services required to complete initiatives, handle legal proceedings and comply with regulatory and compliance requirements.Depreciation and amortization. Depreciation and amortization expense results from the depreciation of long-lived assets such as buildings, leasehold improvements, furniture, fixtures and equipment. This expense also includes the amortization of purchased and internally developed software. Amortization of purchased intangibles. Amortization of purchased intangibles includes amortization of intangible assets obtained in our acquisitions of CBOT Holdings, Inc., NYMEX Holdings, Inc. and NEX as well as other asset and business acquisitions. Intangible assets subject to amortization consist primarily of clearing firm, market data and other customer relationships. Other expenses. We incur additional ongoing expenses for communications, technology support services and various other activities necessary to support our operations. •Technology expense consists of costs related to maintenance of the hardware and software required to support our technology. It also includes costs for network connections for our electronic platforms and some market data customers; telecommunications costs of our exchange, and fees paid for access to external market data. This expense may be driven by system capacity, cloud consumption, functionality and redundancy requirements. It also may be impacted by growth in electronic contract volume and changes in the number of telecommunications hubs and connections which allow customers outside the U.S. to access our electronic platforms directly. •Licensing and other fee agreements expense includes license fees paid as a result of contract volume in equity index products. This expense also includes royalty fees and broker rebates on energy and metals products, as well as revenue sharing on cleared swaps contracts and some new product launches. This expense fluctuates with changes in contract volumes as well as changes in fee structures. •Other expenses include occupancy and building operations expenses including rent, maintenance, real estate taxes, utilities and other related costs related to leased property in Chicago, New York, the U.K., and India, as well as other smaller locations throughout the world. Other expenses also include marketing and travel-related expenses as well as general and administrative costs. Marketing, advertising and public relations expense includes media, print and other advertising costs, as well as costs associated with our product promotion. Other expenses also include litigation and customer settlements, impairment charges on operating assets, gains and losses on disposals of certain operating assets, and foreign currency transaction gains and losses resulting from changes in exchange rates on certain foreign monetary assets and liabilities.Non-Operating Income and ExpensesIncome and expenses incurred through activities outside of our core operations are considered non-operating. These activities include non-core investing and financing activities. •Investment income includes income from short-term investment of clearing firms' cash performance bonds and guaranty fund contributions as well as excess operating cash; interest income and realized gains and losses from our marketable securities; realized gains and losses and dividend income from our strategic equity investments, and gains and losses on trading securities in our non-qualified deferred compensation plans. Investment income is influenced by market interest rates, changes in the levels of cash performance bonds deposited by clearing firms, the amount of dividends distributed by our strategic investments and the availability of funds generated by operations. •Interest and other borrowing costs expense includes charges associated with various short-term and long-term funding facilities, including commitment fees on lines of credit agreements.33Table of Contents•Equity in net earnings (losses) of unconsolidated subsidiaries includes income and losses from our investments in S&P Dow Jones Indices LLC, OSTTRA, Shanghai CFETS-NEX International Money Broking Co., Ltd. and Dubai Mercantile Exchange.•Other income (expense) includes expenses related to the distribution of a portion of interest earned on performance bond collateral reinvestment to the clearing firms, gains and losses on derivative contracts and other various income and expenses outside our core operations.CRITICAL ACCOUNTING POLICIESThe notes to our consolidated financial statements include disclosure of our significant accounting policies. In establishing these policies within the framework of accounting principles generally accepted in the U.S., management must make certain assessments, estimates and choices that will result in the application of these principles in a manner that appropriately reflects our financial condition and results of operations. Critical accounting policies are those policies that we believe present the most complex or subjective measurements and have the most potential to affect our financial position and operating results. While all decisions regarding accounting policies are important, there are certain accounting policies that we consider to be critical. These critical policies, which are presented in detail in the notes to our consolidated financial statements, relate to the valuation of financial instruments, goodwill and intangible assets, revenue recognition, income taxes and internal use software costs. Valuation of financial instruments. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, or an exit price. We have categorized financial instruments measured at fair value into the following three-level fair value hierarchy based upon the level of judgment associated with the inputs used to measure the fair value: •Level 1 inputs, which are considered the most reliable evidence of fair value, consist of quoted prices (unadjusted) for identical assets or liabilities in active markets. •Level 2 inputs consist of observable market data, such as quoted prices for similar assets and liabilities in active markets, or inputs other than quoted prices that are directly observable. •Level 3 inputs consist of unobservable inputs, which are derived and cannot be corroborated by market data or other entity-specific inputs.For further discussion regarding the fair value of financial assets and liabilities, see note 2. Summary of Significant Accounting Policies and note 17. Fair Value Measurements to the consolidated financial statements. Goodwill and intangible assets. We review goodwill for impairment on a quarterly basis and whenever events or circumstances indicate that its carrying value may not be recoverable. Goodwill may be tested quantitatively for impairment by comparing the carrying value of a reporting unit to its estimated fair value. Estimating the fair value of a reporting unit involves the use of valuation techniques that rely on significant estimates and assumptions. These estimates and assumptions may include forecasted revenue growth rates; forecasted operating margins; risk-adjusted discount rates; forecasted economic and market conditions; and industry multiples. We base our fair value estimates on assumptions we believe to be reasonable given the information that is available to us at the time of our assessment; however, actual future results may differ significantly from those estimates. Under certain favorable circumstances, goodwill may be reviewed qualitatively for indications of impairment without utilizing valuation techniques to estimate fair value. The qualitative assessment of goodwill may rely on significant assumptions about forecasts of revenue growth, operating margins and economic conditions as well as overall market and industry-specific trends. In addition, the carrying value of goodwill, as denominated in foreign currencies, is adjusted each reporting period as a result of movements in foreign currency exchange rates relative to the U.S. dollar. Such foreign currency translation adjustments are recorded in accumulated other comprehensive income (loss) within shareholders' equity.We also review indefinite-lived intangible assets on a quarterly basis or more frequently when events and circumstances indicate that their carrying values may not be recoverable. Indefinite-lived intangible assets may be tested quantitatively for impairment by comparing their carrying values to their estimated fair values. Estimating the fair value of indefinite-lived intangible assets involves the use of valuation techniques that rely on significant estimates and assumptions. These estimates and assumptions may include forecasted revenue growth rates, forecasted allocations of expense and risk-adjusted discount rates. We base our fair value estimates on assumptions we believe to be reasonable given the information that is available to us at the time of our assessment; however, actual future results may differ significantly from those estimates. Similar to goodwill, under certain favorable circumstances, indefinite-lived intangible assets may be reviewed qualitatively for indications of impairment without utilizing valuation techniques to estimate fair value. The qualitative assessment of indefinite-lived intangible assets may rely on significant assumptions about forecasts of revenue growth, operating margins and economic conditions as well as overall market and industry-specific trends.Intangible assets subject to amortization are also assessed for impairment on a quarterly basis or more frequently when indicated by a change in economic or operational circumstances. The impairment assessment of these assets requires management to first compare the carrying value of the amortizing asset to its undiscounted net cash flows. If the carrying value 34Table of Contentsexceeds the undiscounted net cash flows, management is then required to estimate the fair value of the assets and record an impairment loss for the excess of the carrying value over the fair value. In connection with this impairment assessment, management also challenges the useful lives of our definite-lived intangible assets. Revenue recognition. A significant portion of our revenue is derived from the clearing and transaction fees we assess on each contract executed through our trading venues and cleared through our clearing house. Clearing and transaction fees are recognized as revenue when a buy and sell order are matched, novated and when the trade is cleared. On occasion, the customer's exchange trading privileges may not be properly entered by the clearing firm and incorrect fees are charged for the transactions in the affected accounts. When this information is corrected within the time period allowed by the exchange, a fee adjustment is provided to the clearing firm. A reserve is established for estimated fee adjustments to reflect corrections to customer exchange trading privileges. This reserve has historically been immaterial. The reserve is based on the historical pattern of adjustments processed as well as management's estimate of future adjustment activity.Income taxes. Calculation of the income tax provision includes an estimate of the income taxes that will be paid for the current year, as well as an estimate of income tax liabilities or benefits deferred into future years. Deferred tax assets are reviewed to determine if they will be realized in future periods. To the extent it is determined that some deferred tax assets may not be fully realized, the assets are reduced to their realizable value by a valuation allowance. The calculation of our tax provision involves uncertainty in the application of complex tax regulations and we occasionally may consult with relevant tax authorities or engage third-party expertise where appropriate. We recognize potential liabilities for anticipated tax audit issues in the United States and other applicable foreign tax jurisdictions using a more-likely-than-not recognition threshold based on the technical merits of the tax position taken or expected to be taken. If the actual obligation of these amounts varies from our estimate, our income tax provision would be reduced or increased at the time that determination is made. This determination may not be known for several years. Past tax audits have not resulted in tax adjustments that resulted in a material change to the income tax provision in the year the audit was completed. The effective tax rate, defined as the income tax provision as a percentage of income before income taxes, will vary from year to year based on changes in tax jurisdictions, tax rates and regulations. In addition, the effective tax rate will vary with changes to income that are not subject to income tax and changes in expenses or losses that are not deductible, such as the utilization of foreign net operating losses. Internal use software costs. Certain internal and external costs that are incurred in connection with developing or obtaining software for internal use are capitalized. We also enter into software hosting arrangements for software projects maintained or developed in the cloud. Software development costs incurred during the planning or maintenance stages of a software project are expensed as incurred, while certain costs incurred during the application development stage are capitalized and are amortized over the estimated useful life of the software, which is generally two to four years, but up to eight years for certain trading and clearing applications, depending upon expected useful lives. Amortization of capitalized costs begins only when the software becomes ready for its intended use. In addition, software assets are assessed for impairment when events or circumstances indicate that the carrying values may not be recoverable or that a reduction in the estimated useful lives is warranted.RESULTS OF OPERATIONSFinancial HighlightsThe following summarizes significant changes in our financial performance for the years presented. For a comparison of our results of operations for the fiscal years ended December 31, 2021 to December 31, 2020, see "Part II, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 25, 2022. Year-over-Year Change(dollars in millions, except per share data)202220212022-2021Total revenues$5,019.4 $4,689.7 7 %Total expenses2,003.5 2,044.5 (2)Operating margin60.1 %56.4 %Non-operating income (expense)$474.4 $728.4 (35)Effective tax expense rate22.9 %21.8 %Net income attributable to CME Group$2,691.0 $2,636.4 2 Diluted earnings per common share attributable to CME Group7.40 7.29 2 Cash flows from operating activities3,056.0 2,402.4 27 35Table of ContentsRevenues Year-over-Year Change(dollars in millions)202220212022-2021Clearing and transaction fees$4,142.7 $3,765.1 10 %Market data and information services610.9 576.9 6 Other265.8 347.7 (24)Total Revenues$5,019.4 $4,689.7 7 Clearing and Transaction FeesFutures and Options The following table summarizes our total contract volume, revenue and average rate per contract for futures and options. Total contract volume includes contracts that are traded on our exchange and cleared through our clearing house and certain cleared-only contracts. Volume is measured in round turns, which is considered a completed transaction that involves a purchase and an offsetting sale of a contract. Average rate per contract is determined by dividing total clearing and transaction fees by total contract volume. Contract volume and average rate per contract disclosures below exclude trading volume for the cash markets business as well as interest rate swaps. Year-over-Year Change 202220212022-2021Total contract volume (in millions)5,846.0 4,942.7 18 %Clearing and transaction fees (in millions)$3,758.5 $3,306.3 14 Average rate per contract0.643 0.669 (4)We estimate the following net increase in clearing and transaction fees based on a change in total contract volume and a change in average rate per contract during 2022 compared with 2021. Year-over-Year Change(in millions)2022-2021Increase due to change in total contract volume$580.7 Decrease due to change in average rate per contract(128.5)Net increase in clearing and transaction fees$452.2 Average rate per contract is impacted by our rate structure, including volume-based incentives, product mix, trading venue and the percentage of volume executed by customers who are members compared with non-member customers. Due to the relationship between average rate per contract and contract volume, the change in clearing and transaction fees attributable to changes in each is only an approximation.36Table of ContentsContract VolumeThe following table summarizes average daily contract volume. Contract volume can be influenced by many factors, including political and economic factors, the regulatory environment and market competition. Year-over-Year Change(amounts in thousands)202220212022-2021Average Daily Volume by Product Line:Interest rates10,8189,20018 %Equity indexes7,6505,51739 Foreign exchange98779924 Agricultural commodities1,2891,362(5)Energy2,0262,188(7)Metals521548(5)Aggregate average daily volume23,29119,61419 Average Daily Volume by Venue:CME Globex21,71218,31819 Open outcry80067918 Privately negotiated 77961726 Aggregate average daily volume23,29119,61419 Electronic Volume as a Percentage of Total Volume93 %93 %Interest rate, equity, and foreign exchange volatility were higher in 2022 when compared with 2021 as result of a change in market expectations and uncertainty regarding the Federal Reserve's interest rate policy amid higher than expected inflation levels. The Federal Open Market Committee raised the Federal Funds rate by a total of 425 percentage points in 2022 and has indicated that it intends to further raise interest rates in the near future. The Federal Reserve also began quantitative tightening in the second half of 2022 by reducing its holdings of U.S. Treasury securities. However, the geopolitical uncertainty between Russia and Ukraine led to risk aversion and reduced trading by market participants within the agricultural commodity and energy markets due to global commodity trade uncertainty. We believe these factors led to the changes in contract volume during 2022, when compared with 2021.Interest Rate ProductsThe following table summarizes average daily contract volume for our key interest rate products. Eurodollar front 8 contracts include contracts expiring within two years. Eurodollar back 32 contracts include contracts expiring within three to ten years. Year-over-Year Change(amounts in thousands)202220212022-2021Eurodollar futures and options:Futures expiring within two years1,1001,291(15)%Options8331,059(21)Futures expiring beyond two years4401,085(59)SOFR futures and options:Futures expiring within two years1,479145n.m.Futures expiring beyond two years28213n.m.Options44036n.m.U.S. Treasury futures and options:10-Year2,4972,495— 5-Year1,5431,27821 2-Year68245948 Treasury Bond503580(13)Federal Funds futures and options335112n.m._________n.m. not meaningful37Table of ContentsIn 2022 compared with 2021, overall interest rate contract volume increased as a result of higher overall volatility. We believe this was due to higher than expected inflation levels, the Federal Open Market Committee's decision to increase the Federal Funds rate multiple times in 2022 as well as the Federal Reserve's quantitative tightening in the second half of 2022. The increase in overall SOFR volume was also due to more market participants transitioning to the new reference rate away from LIBOR as well as incentive programs designed to encourage market participation in SOFR options trading.Equity Index ProductsThe following table summarizes average daily contract volume for our key equity index products. Year-over-Year Change(amounts in thousands)202220212022-2021E-mini S&P 500 futures and options (1)4,5353,17943 %E-mini Nasdaq 100 futures and options (1)2,2081,53644 E-mini Russell 2000 futures and options (1)3783683 _______________(1) Futures and options now include respective weekly Micro E-mini options that were previously separated under a unique product category. Prior period amounts have been revised to conform to the current period presentation.Equity index contract volume increased due to higher overall volatility in 2022 when compared with 2021. Volatility within the equity indexes increased as a result of higher than expected inflation levels as well as the Federal Reserve's actions to increase the Federal Funds rate and quantitative tightening in 2022. We believe these factors led to the overall increases in equity contract volumes. Foreign Exchange ProductsThe following table summarizes average daily contract volume for our key foreign exchange products. Year-over-Year Change(amounts in thousands)202220212022-2021Euro26321025 %Japanese yen16711446 British pound12910128 Australian dollar1061023 Overall foreign exchange contract volume increased in 2022 when compared with 2021, which we believe is due to higher overall market volatility. Market volatility increased in 2022 due to the global central banks' interest rate policy decisions as a result of higher than expected inflation. Agricultural Commodity ProductsThe following table summarizes average daily volume for our key agricultural commodity products. Year-over-Year Change(amounts in thousands)202220212022-2021Corn418458(9)%Soybean268281(5)Wheat 175197(11)In 2022 when compared with 2021, overall commodity contract volume decreased, which we believe is largely due to risk aversion by market participants following price increases and global trade uncertainty resulting from the Russia and Ukraine conflict.38Table of ContentsEnergy ProductsThe following table summarizes average daily volume for our key energy products. Year-over-Year Change(amounts in thousands)202220212022-2021WTI crude oil1,1081,181(6)%Natural gas492530(7)Refined products328351(6)Overall energy contract volume decreased in 2022 when compared with 2021. Participant trading activity slowed down largely due to concerns regarding high inflation and an economic downturn. In addition, the sustained conflict between Russia and Ukraine continued to cause disruptions to the global energy markets. We believe these factors led to the overall decrease in energy contract volume.Metal ProductsThe following table summarizes average daily volume for our key metal products.Year-over-Year Change(amounts in thousands)202220212022-2021Gold318330(4)%Copper93101(8)Silver8395(12)In 2022 when compared with 2021, overall metal contract volume decreased, which we believe was attributable to lower overall market volatility within the gold and silver markets. Volume was higher in 2021, as investors were using gold and other precious metals as safe-haven investments following the COVID-19 pandemic. Average Rate per ContractThe average rate per contract was lower in 2022 when compared with 2021. The decrease in the average rate per contract was primarily due to a change in product mix. Equity index contract volume increased by 5 percentage points as a percent of total volume, while agricultural commodity, energy and metal contract volume collectively decreased by 5 percentage points. In general, equity index products have a lower rate per contract compared with the agricultural commodity, energy and metal contracts. Cash Markets BusinessTotal clearing and transaction fees revenue in 2022 included $318.8 million of transaction fees attributable to the cash markets business, compared with $396.2 million in 2021. This revenue primarily includes BrokerTecs's fixed income volume and EBS foreign exchange volume. In September 2021, we contributed the net assets of our optimization business to OSTTRA, our joint venture with IHS Markit.Year-over-Year Change(amounts in millions)202220212022-2021BrokerTec fixed income transaction fees$164.7 $172.0 (4)%EBS foreign exchange transaction fees154.1 164.3 (6)%Optimization transaction fees— 59.9 n.m._________n.m. not meaningful39Table of ContentsThe related average daily notional value for the years ended 2022 and 2021 for key cash markets products were as follows:Year-over-Year Change(amounts in billions)202220212022-2021European Repo (in euros)$345.2 $292.3 18 %U.S. Treasury 126.1 115.0 10 %Spot FX65.7 61.2 7 %Overall average daily notional value for the cash markets business increased in 2022 when compared with 2021. The increases in European Repo and U.S. Treasury transactions were largely due to increased volatility as a result of a change in market expectations regarding the Federal Reserve's interest rate policy, following higher than expected inflation levels in 2022. Despite the increase in average daily notional value, transaction revenue for BrokerTec and EBS decreased slightly due to the tiered pricing structure and incentive rate programs. Concentration of RevenueWe bill a significant portion of our clearing and transaction fees to our clearing firms. The majority of clearing and transaction fees received from clearing firms represent charges for trades executed and cleared on behalf of their customers. One clearing firm represented at least approximately 10% of our clearing and transaction fees in 2022. Should a clearing firm withdraw, we believe that the customer portion of the firm's trading activity would likely transfer to another clearing firm of the exchange. Therefore, we do not believe we are exposed to significant risk from an ongoing loss of revenue received from or through a particular clearing firm. Other Sources of RevenueMarket data and information services. In 2022 when compared with 2021, the increase in market data and information services revenue was largely attributable to price increases for certain products as well as an increase in usage for certain products.The two largest resellers of our market data represented, in aggregate, approximately 33% of our market data and information services revenue in 2022. Despite this concentration, we consider exposure to significant risk of revenue loss to be minimal. In the event that one of these vendors no longer distributes our market data, we believe the majority of that vendor's customers would likely subscribe to our market data through another reseller. Additionally, several of our largest institutional customers that utilize services from our two largest resellers report usage and remit payment of their fees directly to us.Other revenues. In 2022 when compared with 2021, the decrease in other revenue was largely attributable to the deconsolidation of the optimization business in September 2021 as part of the contribution of the business's net assets to OSTTRA, our joint venture with IHS Markit. In 2021, the optimization business generated $115.1 million in other revenue.Expenses Year-over-Year Change(dollars in millions)202220212022-2021Compensation and benefits$753.1 $837.0 (10)%Technology188.6 192.6 (2)Professional fees and outside services137.4 151.7 (9)Amortization of purchased intangibles227.7 237.6 (4)Depreciation and amortization134.9 147.8 (9)Licensing and other fee agreements320.0 236.9 35 Other241.8 240.9 — Total Expenses$2,003.5 $2,044.5 (2)2022 Compared With 2021Operating expenses decreased by $41.0 million in 2022 when compared with 2021. The following table shows the estimated impact of key factors resulting in the net decrease in operating expenses.40Table of Contents(dollars in millions)Year-over-YearChangeChange as aPercentage of2021 ExpensesSalaries, benefits and employer taxes$(63.9)(3)%Non-qualified deferred compensation(28.7)(1)Employee separation and retention costs(25.0)(1)Professional fees and outside services(14.3)(1)Currency fluctuation(12.8)(1)Bonus21.6 1 Licensing and other fee agreements83.1 4 Other expenses, net(1.0)— Total$(41.0)(2)%Overall operating expenses decreased in 2022 when compared with 2021 due to the following reasons:•Salaries, benefits and employer taxes were lower during 2022 when compared with 2021 due to a net decrease in average headcount, including the contribution of employees from CME Group's optimization businesses to the joint venture with IHS Markit in September 2021.•A decrease in our non-qualified deferred compensation liability during 2022, the impact of which does not affect net income because of an equal and offsetting change in investment income, contributed to a decrease in compensation and benefits expense. •Employee separation and retention costs were lower in 2022 compared with 2021 due to a lower reduction in workforce. •Professional fees and outside services expense decreased due to one-time legal and other professional fees incurred in 2021 related to our joint venture with IHS Markit. The decrease in professional fees was partially offset by an increase in consulting fees attributable to CME Group's partnership with Google Cloud, which was signed in November 2021.•In 2022, we recognized a net gain of $13.2 million, compared to a net gain of $0.4 million in 2021, due to currency exchange rate fluctuations. Gains and losses from exchange rate fluctuations are recognized in the consolidated statements of net income when subsidiaries with a U.S. dollar functional currency hold certain monetary assets and liabilities denominated in foreign currencies.Increases in operating expenses in 2022 when compared with 2021 were as follows:•Bonus expense increased in 2022 largely due to performance relative to our 2022 cash earnings target when compared with 2021 performance relative to our 2021 cash earnings target.•Licensing and other fee agreements expense increased in 2022 due to higher volumes for certain equity products during 2022 compared with 2021.Non-Operating Income (Expense) Year-over-Year Change(dollars in millions)202220212022-2021Investment income$2,198.4 $306.9 n.m.Interest and other borrowing costs(162.7)(166.9)(2)Equity in net earnings (losses) of unconsolidated subsidiaries301.1 245.8 22 Other income (expense)(1,862.4)342.6 n.m.Total Non-Operating$474.4 $728.4 (35)_________n.m. not meaningfulInvestment income. In 2022 when compared with 2021, there was an increase in earnings from reinvested cash performance bond and guaranty fund contributions due to a higher rate of interest earned in the cash accounts at the Federal Reserve Bank of Chicago following interest rate hikes in 2022. In 2022 and 2021, earnings from cash performance bond and guaranty fund contributions were $2,169.5 million and $173.9 million, respectively. The increase in income was partially offset by a decrease in net realized and unrealized gains on investments as well as a decrease in earnings on our deferred compensation plan, the impact of which does not affect net income because of an equal and offsetting change in compensation and benefits expense.41Table of ContentsEquity in net earnings (losses) of unconsolidated subsidiaries. Higher income generated from our S&P Dow Jones Indices LLC business venture contributed to an increase in equity in net earnings (losses) of unconsolidated subsidiaries in 2022 when compared with 2021. We also recognized our share of net earnings on our investment in OSTTRA, our joint venture with IHS Markit that was formed in September 2021.Other income (expense). In 2022 when compared with 2021, we recognized higher expenses related to the distribution of interest earned on performance bond collateral reinvestments to the clearing firms in conjunction with higher interest income earned on our reinvestment during the period due to a higher Federal Funds rate in 2022. In 2022 and 2021, expenses related to the distribution of interest earned on collateral reinvestments were $1,889.7 million and $119.6 million, respectively. In 2021, we also recognized a net gain of $400.7 million on the deconsolidation and contribution of our optimization business to OSTTRA.Income Tax ProvisionThe following table summarizes the effective tax rate for the periods presented: 20222021Year-over-Year Change2022-2021Year ended December 3122.9 %21.8 %1.1 %The effective tax rate increased in 2022 when compared with 2021. In 2021, we recognized a gain on the deconsolidation and contribution of our optimization business to OSTTRA, which was not taxable. The impact of the gain in 2021 was partially offset by an increase to the statutory rate in the United Kingdom in 2021. LIQUIDITY AND CAPITAL RESOURCESCash RequirementsWe have historically met our funding requirements with cash generated by our ongoing operations. However, we have used our commercial paper program from time to time to fund large short-term funding needs. While our cost structure is generally fixed in the short term, our sources of operating cash are largely dependent on contract trading volume levels. In addition to using our existing cash, cash equivalents, marketable securities and cash generated from operations, we may continue to utilize our commercial paper program to meet our working capital needs, capital expenditures and other commitments. It is also possible that we may need to raise additional funds to finance our activities through future public debt offerings or by direct borrowings from financial institutions through our committed revolving credit facilities.Cash will also be required for non-cancellable purchase obligations as at December 31, 2022. Commitments include material contractual purchase obligations that are non-cancellable. Purchase obligations relate to advertising, licensing, hardware, software and maintenance as well as telecommunication services. Aside from the table below, we have certain other arrangements that have a perpetual term for which we pay a minimum of $5.0 million per year. At December 31, 2022, future minimum payments due under purchase obligations were payable as follows (in millions): Year 2023$92.6 2024-2025184.0 2026-2027215.1 Thereafter733.0 Total$1,224.7 Future capital expenditures for technology are anticipated as we continue to support our growth through increased system capacity, performance improvements, integration of acquired platforms and improvements to some of our office spaces. Each year, capital expenditures are incurred for improvements to and modification of our offices, remote data centers, telecommunications network and other operating equipment. In 2023, we expect capital expenditures to total approximately $100.0 million, net of any leasehold improvement allowances. We continue to monitor our capital needs and may revise our forecasted expenditures as necessary in the future. We intend to continue to pay a regular quarterly dividend to our shareholders, with a target of between 50% to 60% of the prior year's cash earnings. The decision to pay a dividend and the amount of the dividend, however, remains within the discretion of our board of directors and may be affected by various factors, including our earnings, financial condition, capital requirements, levels of indebtedness and other considerations our board of directors deems relevant. We are also required to comply with restrictions contained in the general corporation laws of our state of incorporation, which could limit our ability to declare and pay dividends. On February 2, 2023, the company declared a regular quarterly dividend of $1.10 per share for all outstanding 42Table of Contentscommon and preferred shares. The dividend will be payable on March 27, 2023 to shareholders of record on March 10, 2023. Assuming no changes in the number of shares outstanding, the first quarter dividend payment will total approximately $400.0 million. The board of directors also declared an additional, annual variable dividend of $4.50 per share on December 8, 2022 paid on January 18, 2023 to the shareholders of record on December 28, 2022. In general, the amount of the annual variable dividend will be determined by the end of each year, and the level will increase or decrease from year to year based on operating results, capital expenditures, potential merger and acquisition activity and other forms of capital return, including regular dividends and share buybacks during the prior year. Sources and Uses of CashThe following is a summary of cash flows from operating, investing and financing activities. Year-over-Year Change(dollars in millions)202220212022-2021Net cash provided by operating activities$3,056.0 $2,402.4 27 %Net cash provided by (used in) investing activities(489.8)58.4 n.m.Net cash provided by financing activities(25,381.7)69,908.7 n.m._________n.m. not meaningfulOperating activitiesNet cash provided by operating activities was higher in 2022 compared with 2021, largely due to an increase in clearing and transaction fee revenue. This was partially offset by income tax payments which were higher in 2022 compared with 2021. Investing activitiesThe increase in cash used in investing activities in 2022 compared with 2021 was largely due to the additional investment in S&P Dow Jones Indices LLC of $410.0 million. In addition, we received $100.7 million from the OSTTRA joint venture transaction and additional proceeds from sales of investments in 2021. Financing activitiesCash used in financing activities was higher in 2022 when compared with 2021 mainly due to a decrease in cash performance bonds and guaranty fund contributions. In addition, there was an increase in dividends paid in 2022. In 2021, we received proceeds of $965.0 million from the issuance of preferred shares in connection with our partnership with Google Cloud. Debt InstrumentsThe following table summarizes our debt outstanding as of December 31, 2022:(in millions)Par ValueFixed rate notes due May 2023, stated rate of 4.30%€15.0 Fixed rate notes due March 2025, stated rate of 3.00% (1)$750.0 Fixed rate notes due June 2028, stated rate of 3.75%$500.0 Fixed rate notes due March 2032, stated rate of 2.65%$750.0 Fixed rate notes due September 2043, stated rate of 5.30% (2)$750.0 Fixed rate notes due June 2048, stated rate of 4.15%$700.0 _______________(1)We maintained a forward-starting interest rate swap agreement that modified the interest obligation associated with these notes so that the interest payable on the notes effectively became fixed at a rate of 3.11%.(2)We maintained a forward-starting interest rate swap agreement that modified the interest obligation associated with these notes so that the interest payable effectively became fixed at a rate of 4.73%.We maintain a $2.3 billion multi-currency revolving senior credit facility with various financial institutions, which matures in November 2026. The proceeds from this facility can be used for general corporate purposes, which includes providing liquidity for our clearing house in certain circumstances at CME Group's discretion and, if necessary, for maturities of commercial paper. As long as we are not in default under this facility, we have the option to increase it up to $3.3 billion with the consent of the agent and lenders providing the additional funds. This facility is voluntarily pre-payable from time to time without premium or penalty. Under this facility, we are required to remain in compliance with a consolidated net worth test, which is defined as our consolidated shareholders' equity at September 30, 2021, giving effect to share repurchases made and special dividends paid 43Table of Contentsduring the term of the agreements (and in no event greater than $2.0 billion in aggregate), multiplied by 0.65. We currently do not have any borrowings outstanding under this facility, but any commercial paper balance if or when outstanding can be backstopped against this facility.We maintain a 364-day multi-currency revolving secured credit facility with a consortium of domestic and international banks to be used in certain situations by the clearing house. The facility provides for borrowings of up to $7.0 billion. We may use the proceeds to provide temporary liquidity in the unlikely event a clearing firm fails to promptly discharge an obligation to CME Clearing, in the event of a liquidity constraint or default by a depositary (custodian for our collateral), in the event of a temporary disruption with the domestic payments system that would delay payment of settlement variation between us and our clearing firms, or in other cases as provided by the CME rulebook. Clearing firm guaranty fund contributions received in the form of cash or U.S. Treasury securities as well as the performance bond assets (pursuant to the CME rulebook) can be used to collateralize the facility. At December 31, 2022, guaranty fund contributions available to collateralize the facility totaled $6.9 billion. We have the option to request an increase in the line from $7.0 billion to $10.0 billion. Our 364-day facility contains a requirement that CME remain in compliance with a consolidated tangible net worth test, defined as CME's consolidated shareholder's equity less intangible assets (as defined in the agreement), of not less than $800.0 million. We currently do not have any borrowings outstanding under this facility. The indentures governing our fixed rate notes, our $2.3 billion multi-currency revolving senior credit facility and our 364-day multi-currency revolving secured credit facility for $7.0 billion do not contain specific covenants that restrict the ability to pay dividends. These documents, however, do contain other customary financial and operating covenants that place restrictions on the operations of the company that could indirectly affect the ability to pay dividends. At December 31, 2022, we have excess borrowing capacity for general corporate purposes of approximately $2.3 billion under our multi-currency revolving senior credit facility.At December 31, 2022, we were in compliance with the various covenant requirements of all our debt facilities.CME Group, as a holding company, has no operations of its own. Instead, it relies on dividends declared and paid to it by its subsidiaries in order to provide the funds that it uses to pay dividends to its shareholders.To satisfy our performance bond obligation with Singapore Exchange Limited, we may pledge irrevocable standby letters of credit. At December 31, 2022, the letters of credit totaled $330.0 million. We also maintain a $350.0 million line of credit to meet our obligations under this agreement.The following table summarizes our credit ratings as of December 31, 2022: Rating AgencyShort-TermDebt RatingLong-TermDebt RatingOutlookStandard & Poor’sA1+AA-StableMoody’s Investors ServiceP1Aa3StableGiven our cash flow generation, our ability to pay down debt levels and our ability to refinance existing debt facilities, if necessary, we expect to maintain an investment grade rating. If our ratings are downgraded below investment grade within certain specified time periods due to a change of control, we are required to make an offer to repurchase our fixed rate notes at a price equal to 101% of the principal amount, plus accrued and unpaid interest. No report of any rating agency is incorporated by reference herein.Liquidity and Cash ManagementCash and cash equivalents, excluding restricted cash, totaled $2.7 billion and $2.8 billion at December 31, 2022 and December 31, 2021, respectively. The balance retained in cash and cash equivalents is a function of anticipated or possible short-term cash needs, prevailing interest rates, our corporate investment policy and alternative investment choices. A majority of our cash and cash equivalents balance is invested in money market mutual funds that invest only in U.S. Treasury securities, U.S. government agency securities and U.S. Treasury security reverse repurchase agreements and short-term bank deposits. Our exposure to credit and liquidity risk is minimal given the nature of the investments. Cash that is not available for general corporate purposes because of regulatory requirements or other restrictions is classified as restricted cash and is included in other current assets or other assets in the consolidated balance sheets.Our practice is to have our pension plan 100% funded at each year end on a projected benefit obligation basis, while also satisfying any minimum required contribution and obtaining the maximum tax deduction. Based on our actuarial projections, we estimate that no additional contribution will be necessary in 2023 to meet our funding goal. However, the amount of the actual contribution is contingent on various factors, including the actual rate of return on our plan assets during 2023 and the December 31, 2023 discount rate. 44Table of ContentsRegulatory Requirements CME is regulated by the CFTC as a Derivatives Clearing Organization (DCO). DCOs are required to maintain capital, as defined by the CFTC, in an amount at least equal to one year of projected operating expenses as well as cash, liquid securities, or a line of credit at least equal to six months of projected operating expenses. CME was designated by the Financial Stability Oversight Council as a systemically important financial market utility under Title VIII of the Dodd-Frank Wall Street Reform and Consumer Protection Act. As a result, CME must comply with CFTC regulations applicable to a systemically important DCO for financial resources and liquidity resources. CME is in compliance with all DCO financial requirements.CME, CBOT, NYMEX and COMEX are regulated by the CFTC as Designated Contract Markets (DCM). DCMs are required to maintain capital, as defined by the CFTC, in an amount at least equal to one year of projected operating expenses as well as cash, liquid securities or a line of credit at least equal to six months of projected operating expenses. Our DCMs are in compliance with all DCM financial requirements. BrokerTec Americas LLC is required to maintain sufficient net capital under Securities Exchange Act of 1934, as amended (Exchange Act), Rule 15c3-1 (the Net Capital Rule). The Net Capital Rule focuses on liquidity and is designed to protect securities customers, counterparties, and creditors by requiring that broker-dealers have sufficient liquid resources on hand at all times to satisfy claims promptly. Rule 15c3-3, or the customer protection rule, which complements Rule 15c3-1, is designed to ensure that customer property (securities and funds) in the custody of broker-dealers is adequately safeguarded. By law, both of these rules apply to the activities of registered broker-dealers, but not to unregistered affiliates. The firm began operating as a (k)(2)(i) broker-dealer in November 2017 following notification to the Financial Industry Regulatory Authority and the SEC. A company operating under the (k)(2)(i) exemption is not required to lock up customer funds as would otherwise be required under Exchange Act Rule 15c3-3.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are subject to various market risks, including those caused by changes in interest rates, credit and foreign currency exchange rates.Interest Rate Risk Debt outstanding at December 31, 2022 consisted of fixed-rate borrowings of $3.4 billion (in U.S. dollar equivalent). Changes in interest rates impact the fair values of fixed-rate debt, but do not impact earnings or cash flows. We did not have any variable-rate borrowings at December 31, 2022. Credit Risk CME Clearing HouseOur clearing house acts as the counterparty to all trades consummated on our exchanges as well as through third-party exchanges and swaps markets for which we provide clearing services. As a result, we are exposed to significant credit risk of third parties, including clearing firms. We are also exposed, indirectly, to the credit risk of customers of our clearing firms. These parties may default on their obligations due to bankruptcy, lack of liquidity, operational failure or other reasons. In order to ensure performance, we establish and monitor financial requirements for our clearing firms. We set minimum performance bond requirements for exchange-traded and interest rate swaps products. For clearing firms, we establish performance bond requirements to cover at least 99% of expected price changes for a given product within a given historical period with further quantitative and qualitative considerations based on market risk. We establish haircuts applied to collateral deposited to meet performance bond requirements to cover at least 99% of expected price changes and foreign currency changes for a given asset within a given historical period with further quantitative and qualitative considerations. Haircuts vary depending on the type of collateral and maturity. We mark-to-market open positions of clearing firms at least once a day (twice a day for futures and options contracts) and require payment from clearing firms whose positions have lost value and make payments to clearing firms whose positions have gained value. We have the capability to mark-to-market more frequently as market conditions warrant. These practices allow our clearing house to quickly identify any clearing firms that may not be able to satisfy the financial obligations resulting from changes in the prices of their open positions before those financial obligations become exceptionally large and jeopardize the ability of our clearing house to ensure performance of their open positions. Although we have policies and procedures to help ensure that our clearing firms can satisfy their obligations, these policies and procedures may not succeed in detecting problems or preventing defaults. We also have in place various measures intended to enable us to cover any default and maintain liquidity. Despite our safeguards, we cannot guarantee that these measures will be sufficient to protect us from a default or that we will not be materially and adversely affected in the event of a significant default.45Table of ContentsWe maintain two separate financial safeguard packages: •a financial safeguard package for all futures, options and over-the-counter swap contracts other than cleared interest rate swap contracts (base package); and•a financial safeguard package for cleared interest rate swap contracts.In the unlikely event of a payment default by a clearing firm, we would first apply assets of the defaulting clearing firm to satisfy its payment obligation. These assets include the defaulting firm's guaranty fund contributions, performance bonds and any other available assets, such as assets required for clearing membership and any associated trading rights. Thereafter, if the payment default remains unsatisfied, we would use our corporate contributions designated for the respective financial safeguard package. We would then use guaranty fund contributions of other clearing firms within the respective financial safeguard package and funds collected through an assessment against non-defaulting clearing firms within the respective financial safeguard package to satisfy the deficit.We maintain a $7.0 billion 364-day multi-currency line of credit with a consortium of domestic and international banks to be used in certain situations by our clearing house. We have the option to request an increase in the line from $7.0 billion to $10.0 billion. We may use the proceeds to provide temporary liquidity in the unlikely event of a clearing firm default, in the event of a liquidity constraint or default by a depositary (custodian of the collateral) or in the event of a temporary disruption with the payments systems that would delay payment of settlement variation between us and our clearing firms. The credit agreement requires us to pledge certain assets to the line of credit custodian prior to drawing on the line of credit. Pledged assets may include clearing firm guaranty fund deposits held by us in the form of cash or U.S. Treasury securities. Performance bond collateral of a defaulting clearing firm may also be used to secure a draw on the line. In addition to the 364-day multi-currency line of credit, we also have the option to use our $2.3 billion multi-currency revolving senior credit facility to provide liquidity for our clearing house in the unlikely event of default. At December 31, 2022, aggregate performance bond deposits for clearing firms for both financial safeguard packages was $231.5 billion, including cash performance bond deposits, non-cash deposits, Interest Earnings Facility funds and letters of credit. A defaulting firm's performance bond deposits can be used in the event of default of that clearing firm. The following shows the available assets at December 31, 2022 in the event of a payment default by a clearing firm for the base financial safeguard package after first utilizing the defaulting firm's available assets: (in millions)Clearing HouseAvailable AssetsDesignated corporate contributions for futures and options(1)$100.0 Guaranty fund contributions(2)4,404.5 Assessment powers(3)12,112.2 _______________(1)Our clearing house designates $100.0 million of corporate contributions to satisfy a clearing firm default in the event that the defaulting clearing firm's guaranty contributions and performance bonds do not satisfy the deficit. (2)Guaranty fund contributions of clearing firms include guaranty fund contributions required of clearing firms, but do not include any excess deposits held by us at the direction of clearing firms. (3)In the event of a clearing firm default, if a loss continues to exist after the utilization of the assets of the defaulted firm, our corporate contribution and the non-defaulting clearing firms' guaranty fund contributions, we would assess all non-defaulting clearing members as provided in the rules governing the guaranty fund. We could assess non-defaulting clearing members 275% of their existing guaranty fund requirements up to a maximum of 550% of their existing guaranty fund requirements as provided in the rules. Assessment powers are calculated to reflect the potential obligation that each clearing member could be called for in the event clearing member defaults exhaust the guaranty fund; however, the total amount available would be reduced by the defaulted clearing members' assessment obligations since they would no longer be able to satisfy their obligations.46Table of ContentsThe following shows the available assets for the interest rate swap financial safeguard package at December 31, 2022 in the event of a payment default by a clearing firm that clears interest rate swap contracts, after first utilizing the defaulting firm's available assets: (in millions)Clearing HouseAvailable AssetsDesignated corporate contributions for interest rate swap contracts(1)$150.0 Guaranty fund contributions(2)2,508.2 Assessment powers(3)528.8 _______________(1)Our clearing house designates $150.0 million of corporate contributions to satisfy a clearing firm default in the event that the defaulting clearing firm's guaranty contributions and performance bonds do not satisfy the deficit. (2)Guaranty fund contributions of clearing firms include guaranty fund contributions required of clearing firms, but do not include any excess deposits held by us at the direction of clearing firms. (3)In the event of a clearing firm default, if a loss continues to exist after the utilization of the assets of the defaulted firm, our corporate contribution and the non-defaulting firms' guaranty fund contributions, we would assess non-defaulting clearing members as provided in the rules governing the interest rate swap guaranty fund. Assessment powers are calculated to reflect the potential obligation that each clearing member could be called for based on potential failure of the third and fourth largest clearing member; however, the total amount available would be reduced by the defaulted clearing members' assessment obligations since they would no longer be able to satisfy their obligations.BrokerTec Americas Matched Principal BusinessBrokerTec Americas maintains a matched principal business, where it serves as a fully matched counterparty to offsetting positions entered into by clients on its electronic trading platform to facilitate anonymity and access to clearing and settlement. BrokerTec Americas uses Fixed Income Clearing Corporation (FICC), a third-party central clearing house as well as a third-party clearing bank for the settlement of transactions and is required to post short-term margin requirements twice a day that can vary based on the size of unsettled transactions and any adverse market changes. At December 31, 2022, the balance of the collateral at FICC was $100.0 million, which was included in other current assets on the consolidated balance sheet. Without sufficient funds to meet its obligations, BrokerTec Americas could be exposed to risk of breach of contract with the counterparties and the inability to continue as a member of the third-party central clearing house. Transactions with clearing house members are typically confirmed and novated shortly after execution, at which point the clearing house assumes the risk of settlement. For transactions with counterparties that are not members of the third-party clearing house, settlement typically occurs on the day following execution and, prior to settlement, BrokerTec Americas is exposed to the risk of loss in the event a counterparty fails to meet its obligations. If that were to occur, BrokerTec Americas would have the right to cover or liquidate the open position but could incur a loss as a result of market movements.Foreign Currency Exchange Rate RiskForeign Currency Transaction Risk We have foreign currency transaction risk related to changes in exchange rates on monetary assets, liabilities, revenues and expenses held at subsidiaries where those balances and activity are denominated in a currency other than the subsidiary's functional currency. Gains and losses on foreign currency transactions result primarily from cash, debt and other monetary assets, liabilities, revenues and expenses denominated in British pounds, euros and Japanese yen. Aggregate transaction gains (losses) for 2022, 2021 and 2020 were $13.2 million, $0.4 million and $(9.3) million, respectively. We expect the foreign currency gain/loss to continue to fluctuate as long as we continue to hold monetary assets and liabilities at those subsidiaries. Market uncertainty could potentially lead to significant volatility with foreign currency exchange rates, which could result in additional foreign currency gain/loss. Foreign Currency Translation Risk We have foreign currency translation risk related to the translation of our foreign consolidated and unconsolidated subsidiaries' assets, liabilities, revenues and expenses from their respective functional currencies to the U.S. dollar at each reporting date. Fluctuations in exchange rates may impact the amount of assets, liabilities, revenues and expenses we report on our consolidated balance sheets and consolidated statements of income. The financial statements of those foreign subsidiaries with functional currencies other than the U.S. dollar are translated into U.S. dollars using a current exchange rate. Gains and losses resulting from this translation are recognized as a foreign currency translation adjustment within accumulated other comprehensive income, which is a component of shareholders' equity and comprehensive income. Aggregate translation gains (losses), net of tax, for 2022, 2021 and 2020 were $(195.4) million, $(62.0) million and $134.3 million, respectively. 47Table of ContentsForeign Currency Exchange Risk Related to Customer CollateralA portion of performance bond deposits is denominated in various foreign currencies. We mark-to-market all deposits daily and require payment from clearing firms whose collateral has lost value due to changes in foreign currency rates and price. Therefore, our exposure to foreign currency risk related to performance bond deposits is considered minimal and is not expected to be material to our financial condition or operating results.48Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsManagement’s Discussion and Analysis is the company’s analysis of its financial performance and of significant trends that may affect future performance. It should be read in conjunction with the financial statements and notes, and supplemental oil and gas disclosures included elsewhere in this report. It contains forward-looking statements including, without limitation, statements relating to the company’s plans, strategies, objectives, expectations and intentions that are made pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The words “anticipate,” “believe,” “budget,” “continue,” “could,” “effort,” “estimate,” “expect,” “forecast,” “goal,” “guidance,” “intend,” “may,” “objective,” “outlook,” “plan,” “potential,” “predict,” “projection,” “seek,” “should,” “target,” “will,” “would,” and similar expressions identify forward-looking statements. The company does not undertake to update, revise or correct any of the forward-looking information unless required to do so under the federal securities laws. Readers are cautioned that such forward-looking statements should be read in conjunction with the company’s disclosures under the heading: “CAUTIONARY STATEMENT FOR THE PURPOSES OF THE ‘SAFE HARBOR’ PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995,” beginning on page 63.The terms “earnings” and “loss” as used in Management’s Discussion and Analysis refer to net income (loss) attributable to ConocoPhillips.Business Environment and Executive OverviewConocoPhillips is one of the world’s leading E&P companies based on both production and reserves with operations and activities in 13 countries. Our diverse, low cost of supply portfolio includes resource-rich unconventional plays in North America; conventional assets in North America, Europe, Africa and Asia; LNG developments; oil sands assets in Canada; and an inventory of global conventional and unconventional exploration prospects. Headquartered in Houston, Texas, at December 31, 2022, we employed approximately 9,500 people worldwide and had total assets of $94 billion.Overview In 2022, the energy landscape continued to improve with commodity prices ultimately reaching a 10-year high before decreasing in the second half of the year due to macroeconomic concerns. We expect prices will continue to be cyclical and volatile. Our view is that a successful business strategy in the E&P industry must be resilient in lower price environments while also retaining upside during periods of higher prices. As such, we are unhedged, remain highly disciplined in our investment decisions and continually monitor market fundamentals, including the impacts associated with the conflict in Ukraine, OPEC Plus supply updates, global demand for our products, oil and gas inventory levels, governmental policies, inflation, supply chain disruptions and the fluctuating global COVID-19 impacts.The macro-environment, including the energy transition, continues to evolve. We believe ConocoPhillips will continue to play an essential role by executing on three objectives: responsibly meeting energy transition pathway demand, delivering competitive returns on and of capital and achieving our net-zero operational emissions ambition. We call this our Triple Mandate, and it represents our commitment to create long-term value for our stakeholders.Our value proposition to deliver competitive returns to stockholders through price cycles is guided by foundational principles that support our Triple Mandate. Our foundational principles consist of maintaining balance sheet strength, providing peer-leading distributions, making disciplined investments, and demonstrating responsible and reliable ESG performance.Our actions throughout 2022 reinforced our differential value proposition. Demonstrating our commitment to maintaining and enhancing balance sheet strength, in 2022, we executed several activities focused on debt reduction, including early retiring and refinancing some of our debt. In aggregate, these transactions along with naturally maturing debt reduced the company's total debt by $3.3 billion. These activities facilitate our ability to achieve our previously announced $5 billion debt reduction target by the end of 2026, while also reducing the company's annual cash interest expense. See Note 9.ConocoPhillips 2022 10-K32Management’s Discussion and AnalysisTable of ContentsTotal company production in 2022 was 1,738 MBOED, yielding cash provided by operating activities of $28.3 billion. We invested $10.2 billion into the business in the form of capital expenditures and investments and provided returns of capital to shareholders of approximately $15.0 billion through our ordinary dividend, share repurchases and our VROC. For 2022, we returned $2.4 billion from our ordinary dividend, which included an increase from 46 cents per share to 51 cents per share, effective in December. We also returned $3.3 billion to shareholders from the VROC in 2022. In the first quarter of 2022, we completed the paced monetization program of our Cenovus Energy (CVE) common shares and used the proceeds for a portion of our share repurchase program. See Note 5. In total for 2022, we returned $9.3 billion to shareholders through share repurchases. In October 2022, our Board of Directors approved an increase to our share repurchase authorization, increasing it from $25 billion to $45 billion to support our plan for future share repurchases. As of December 31, 2022, we have repurchased $23.4 billion of the $45 billion authorized share repurchase program. In February 2023, we announced our 2023 planned return of capital to shareholders of $11 billion through our three-tier return of capital framework. We also declared a first quarter ordinary dividend of $0.51 cents per share and a VROC of $0.60 cents per share. In 2022, we took several steps to expand our global LNG business. In the first quarter, we increased our equity share in Australia Pacific LNG (APLNG) by 10 percent to 47.5 percent. See Note 3. We were also awarded a 25 percent interest in each of two new joint ventures with QatarEnergy that will participate in the North Field East (NFE) and North Field South (NFS) LNG projects. Formation of the NFE joint venture (QG8) closed in December 2022 and we anticipate that the formation of the NFS joint venture (QG12) will close in early 2023. Also, in 2022, we executed a 15-year regasification agreement at the recently announced German LNG Terminal at Brunsbuttel.Domestically, in November 2022, we entered into several agreements with Sempra entities in connection with the Port Arthur LNG (PALNG) facility, including a Sales and Purchase Agreement for 5 MTPA of LNG offtake at the start-up of Phase 1 of the PALNG facility, and an Equity Sale and Purchase Agreement, whereby we will acquire 30 percent of the equity in Phase 1 of Port Arthur LNG. Development of the PALNG facility is subject to completing required commercial agreements and resolving a number of risks and uncertainties, obtaining financing and reaching a final investment decision, among other factors. As part of our ongoing portfolio high-grading and optimization efforts, in the first quarter of 2022, we completed two transactions in our Asia Pacific segment, including the above-mentioned acquisition of additional interest in APLNG as well as the sale of our interests in Indonesia. In addition to those transactions, throughout 2022, we completed the sale of certain noncore assets in our Lower 48 segment. For more information on APLNG, see Note 4 and for more information on dispositions, see Note 3.In 2022, we reaffirmed and improved upon our commitment to demonstrate responsible and reliable ESG performance by publishing our Plan for the Net-Zero Energy Transition (the 'Plan'), which is built upon our Triple Mandate. In addition, we continue to expand upon our Paris-aligned climate risk framework that we adopted in 2020. In July 2022, we joined the Oil and Gas Methane Partnership (OGMP) 2.0 initiative. In October 2022, we demonstrated further evidence of our commitment by setting a new 2030 methane emissions intensity target of approximately 0.15 percent of gas produced, consistent with our commitment to OGMP 2.0. For more information on our commitment to ESG and the Plan, see "Contingencies—Company Response to Climate-Related Risks" section of Management's Discussion and Analysis of Financial Condition and Results of Operation.Operationally, we remain focused on safely executing the business. Production increased 171 MBOED or 11 percent in 2022, compared to 2021. Production for 2022 was 1,738 MBOED. After adjusting for closed acquisitions and dispositions, the conversion of previously acquired Concho-contracted volumes from a two-stream to a three-stream basis and 2021 Winter Storm Uri impacts, production decreased by 16 MBOED or 1 percent. Organic growth from Lower 48 and other development programs more than offset decline; however, production was lower overall, primarily due to fourth quarter weather impacts and downtime in Lower 48.33ConocoPhillips 2022 10-KManagement’s Discussion and AnalysisTable of ContentsKey Operating and Financial SummarySignificant items during 2022 and recent announcements included the following:•Generated cash provided by operating activities of $28.3 billion; ended the year with cash and cash equivalents and restricted cash of $6.7 billion and short-term investments of $2.8 billion;•Distributed $15 billion to shareholders through three-tier framework including $5.7 billion in cash through the ordinary dividend and VROC and $9.3 billion through share repurchases, representing 53 percent of cash provided by operating activities;•Expanded global LNG business through participation in QatarEnergy's NFE and NFS projects; executed 15-year regasification agreement at German LNG Terminal; acquired additional 10 percent interest in APLNG; signed 20-year agreement for 5 MTPA of LNG offtake and executed agreement to purchase 30 percent equity stake in Phase 1 of Port Arthur LNG;•Delivered full-year production of 1,738 MBOED and record Lower 48 production;•Fully integrated acquired Permian assets and executed multiple acreage swaps, coring up approximately 25,000 acres since acquisition to provide over a year's worth of additional two mile-plus long-lateral drilling inventory;•Received license extension for Norway's Greater Ekofisk area to 2048 and license adjustments for China's Bohai Penglai Fields to 2039;•Generated $3.5 billion in disposition proceeds through monetization of the company's CVE shares and noncore asset sales;•Retired $3.3 billion in debt toward the company's $5 billion debt reduction target;•Joined OGMP 2.0; published a Plan for the Net-Zero Energy Transition and set a new 2030 methane emissions intensity target, enhancing our commitment to ESG;•Recorded 2022 year-end proved reserves of 6.6 billion BOE, with a total reserve replacement ratio of 176 percent including closed acquisitions and dispositions.Business EnvironmentWTI crude oil prices averaged $94 per barrel in 2022, compared with $68 per barrel in 2021. The energy industry has periodically experienced this type of volatility due to fluctuating supply-and-demand conditions and such volatility may persist in the future. Commodity prices are the most significant factor impacting our profitability, reinvestment of operating cash flows into our business and distributions to shareholders. We are guided by our Triple Mandate and our foundational principles to deliver on our differential value proposition to create value through price cycles. Our foundational principles include maintaining balance sheet strength, peer leading distributions, disciplined investments and demonstrating responsible and reliable ESG performance, all of which support strong financial returns.•Balance sheet strength. A strong balance sheet is a strategic asset that provides flexibility through price cycles. We strive to maintain our ‘A’-rating, and in 2021 committed to reducing gross debt by $5 billion by the end of 2026. In 2022 we executed several activities focused on debt reduction and, combined with naturally maturing debt, reduced the company's total debt by $3.3 billion. This will reduce interest expense and provide resilience in periods of volatility. We ended the year with cash and cash equivalents and restricted cash of $6.7 billion and short-term investments of $2.8 billion, maintaining balance sheet strength.•Peer leading distributions. We believe in delivering value to our shareholders via our three-tiered return of capital framework, which consists of a growing, sustainable ordinary dividend, share repurchases and our VROC. This framework is how we plan to return greater than 30 percent of our net cash provided by operating activities to shareholders. In 2022, we returned $5.7 billion to shareholders through our ordinary dividend and VROC and $9.3 billion through share repurchases partially sourced from monetization of our CVE common shares. See Note 5. Our combined dividends and share repurchases of $15 billion represented over 50 percent of our net cash provided by operating activities. In October 2022, our Board of Directors approved an increase to our share repurchase authorization from $25 billion to $45 billion to support our plan for future share repurchases. In February 2023, we announced our 2023 planned return of capital to shareholders of $11 billion through our three-tier return of capital framework. See “Item 1A—Risk Factors Our ability to execute our capital return program is subject to certain considerations.”•Disciplined investments. Our goal is to achieve strong free cash flow by exercising capital discipline, controlling our costs, and safely and reliably delivering production. We expect to make capital investments sufficient to sustain production throughout the price cycles. Free cash flow provides funds that are available to return to shareholders, strengthen the balance sheet or reinvest back into the business for future cash flow expansion.ConocoPhillips 2022 10-K34Management’s Discussion and AnalysisTable of Contents◦Exercise capital discipline. We participate in a commodity price-driven and capital-intensive industry, with varying lead times from when an investment decision is made to when an asset is operational and generates cash flow. As a result, we must invest significant capital dollars to develop newly discovered fields, maintain existing fields, and construct pipelines and LNG facilities. We allocate capital across a geographically diverse, low cost of supply resource base, which combined with legacy assets results in low overall production decline. Cost of supply is the WTI equivalent price that generates a 10 percent after-tax return on a point-forward and fully burdened basis. Fully burdened includes capital infrastructure, foreign exchange, cost of carbon, price-related inflation and G&A. In setting our capital plans, we exercise a rigorous approach that evaluates projects using these cost of supply criteria, which we believe will lead to value maximization and cash flow expansion using an optimized investment pace, not production growth for growth’s sake. Our cash allocation priorities call for the investment of sufficient capital to sustain production and provide returns of capital to shareholders. ◦Control our costs. Controlling operating and overhead costs, without compromising safety or environmental stewardship, is a high priority. Using various methodologies, we monitor these costs monthly, on an absolute-dollar basis and a per-unit basis and report to management. Managing operating and overhead costs is critical to maintaining a competitive position in our industry, particularly in a low commodity price environment. The ability to control our operating and overhead costs positively impacts our ability to deliver strong cash from operations. ◦Optimize our portfolio. In 2022, we expanded upon our global LNG business by increasing our ownership in APLNG by 10 percent to 47.5 percent. In addition, we were also awarded interests in the NFE and NFS LNG projects in Qatar, signed agreements to purchase an interest in Port Arthur LNG in the U.S., and signed a 15-year regasification agreement with the German LNG Terminal at Brunsbuttel. See Note 4.We continue to evaluate our assets to determine whether they compete for capital within our portfolio and optimize as necessary, directing capital towards the most competitive investments and disposing of assets that do not compete. As such, in 2022 we completed the sale of Indonesia and certain noncore assets in the Lower 48 segment. See Note 3.◦Add to our proved reserve base. We primarily add to our proved reserve base in three ways:▪Acquire interest in existing or new fields.▪Apply new technologies and processes to improve recovery from existing fields.▪Successfully explore, develop and exploit new and existing fields.As required by current authoritative guidelines, the estimated future date when an asset will reach the end of its economic life is based on historical 12-month first-of-month average prices and current costs. This date estimates when production will end and affects the amount of estimated reserves. Therefore, as prices and cost levels change from year to year, the estimate of proved reserves also changes. Generally, our proved reserves decrease as prices decline and increase as prices rise. Reserve replacement represents the net change in proved reserves, net of production, divided by our current year production, as shown in our supplemental reserve table disclosures. Our reserve replacement was 176 percent in 2022, reflecting a net increase from development drilling activity as well as higher prices. Our organic reserve replacement, which excludes a net decrease of 6 MMBOE from sales and purchases, was 177 percent in 2022. In the three years ended December 31, 2022, our reserve replacement was 180 percent. Our organic reserve replacement during the three years ended December 31, 2022, which excludes a net increase of 1,103 MMBOE related to sales and purchases, was 114 percent. See "Supplementary Data - Oil and Gas Operations" for more information.Access to additional resources may become increasingly difficult as lower commodity price cycles can make projects uneconomic or unattractive. In addition, prohibition of direct investment in some nations, national fiscal terms, political instability, competition from national oil companies, and lack of access to high-potential areas due to environmental or other regulation may negatively impact our ability to increase our reserve base. As such, the timing and level at which we add to our reserve base may, or may not, allow us to fully replace our production over subsequent years. 35ConocoPhillips 2022 10-KManagement’s Discussion and AnalysisTable of Contents•Environmental Social and Governance. ConocoPhillips seeks to fulfill our mission of delivering energy to the world through an integrated management system approach that assesses sustainability-related business risks and opportunities as part of our decision-making process. Recognizing the importance of ESG performance to our stakeholders and company success, we have a governance structure that extends from the board of directors through to executive leadership and business unit managers.In October 2020, we became the first U.S.-based oil and natural gas company to adopt a Paris-aligned climate risk framework that includes an ambition to achieve net-zero Scope 1 and 2 emissions on a gross operated and net equity basis by 2050. We believe that this framework, combined with our success in meeting the business objectives set by our Triple Mandate, represents the most effective way for us to sustainably contribute to society’s transition to a low-carbon economy. In early 2022, we reaffirmed and improved our commitment to demonstrate responsible and reliable ESG performance and address climate-related risks by publishing our Plan for the Net Zero Energy Transition, which outlines our approach and progress to address risks specific to the energy transition. ConocoPhillips believes that natural gas and oil will remain essential to the energy mix throughout the energy transition, and we also recognize the need for continuous reduction in the greenhouse gas intensity of production operations. The energy transition will likely be complex, evolving over multiple decades with many possible pathways and uncertainties. By following our Triple Mandate, we intend to meet this challenge in an economically viable, accountable and actionable way that creates long-term value for our stakeholders. For more information on our commitment to responsible and reliable ESG performance through the energy transition, see "Contingencies—Company Response to Climate-Related Risks" section of Management's Discussion and Analysis of Financial Condition and Results of Operation.Commodity PricesOur earnings and operating cash flows generally correlate with crude oil and natural gas commodity prices. Commodity price levels are subject to factors external to the company and over which we have no control, including but not limited to global economic health, supply disruptions or fears thereof caused by civil unrest or military conflicts, actions taken by OPEC Plus and other producing countries, environmental laws, tax regulations, governmental policies, global health crises and weather-related disruptions. The following graph depicts the average benchmark prices for WTI crude oil, Brent crude oil and U.S. Henry Hub natural gas over the past three years:Brent crude oil prices averaged $101.19 per barrel in 2022, an increase of 43 percent compared with $70.73 per barrel in 2021. Similarly, average WTI crude oil prices increased 39 percent from $67.92 per barrel in 2021 to $94.23 per barrel in 2022. Prices were higher through 2022 due to ongoing global economic recovery following 2020's COVID impacts, supply disruptions caused by Russia's invasion of Ukraine and resulting sanctions, OPEC supply restraint and supply chain bottlenecks limiting U.S. production growth.ConocoPhillips 2022 10-K36Management’s Discussion and AnalysisTable of ContentsHenry Hub natural gas prices increased 73 percent from an average of $3.85 per MMBTU in 2021 to $6.65 per MMBTU in 2022. Natural gas prices increased due to modest growth in domestic production, healthy domestic demand and strong levels of feedgas demand for LNG exports to Europe and Asia.Our realized bitumen price increased 48 percent from an average of $37.52 per barrel in 2021 to $55.56 per barrel in 2022. The increase was largely driven by strength in WTI, reflective of increasing global demand and sanctions on Russian exports. The weakness of WCS to WTI differential at Hardisty was primarily caused by U.S. strategic petroleum reserve release, discounted Russian crude oil and weak heavy fuel pricing. We continue to optimize bitumen price realizations through optimizing diluent recover unit operation, blending and transportation strategies. Our worldwide annual average realized price increased 46 percent from $54.63 per BOE in 2021 to $79.82 per BOE in 2022 primarily due to higher commodity prices. OutlookProduction and Capital2023 operating plan capital expenditure guidance is $10.7 to $11.3 billion, which includes $1.6 to $2.0 billion for anticipated major project spending at NFE, NFS, PALNG and Willow and $9.1 to $9.3 billion for ongoing development drilling programs; exploration and appraisal activities; base maintenance; and projects to reduce the company's Scope 1 and 2 emissions intensity and fund investments in several early-stage low-carbon opportunities that address end-use emissions. Production guidance is 1.76 to 1.80 MMBOED in 2023. First quarter 2023 production is expected to be 1.72 MMBOED to 1.76 MMBOED, which includes 35 MBOED of turnaround and stabilizer expansion in Eagle Ford.Operating SegmentsWe manage our operations through six operating segments, which are primarily defined by geographic region: Alaska; Lower 48; Canada; Europe, Middle East and North Africa; Asia Pacific; and Other International.Corporate and Other represents income and costs not directly associated with an operating segment, such as most interest expense, premiums incurred on the early retirement of debt, corporate overhead, certain technology activities, as well as licensing revenues. Our key performance indicators, shown in the statistical tables provided at the beginning of the operating segment sections that follow, reflect results from our operations, including commodity prices and production.37ConocoPhillips 2022 10-KResults of Operations Table of ContentsResults of OperationsThis section of the Form 10-K discusses year-to-year comparisons between 2022 and 2021. For discussion of year-to-year comparisons between 2021 and 2020, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our 2021 10-K.Consolidated ResultsA summary of the company’s net income (loss) attributable to ConocoPhillips by business segment follows:Millions of DollarsYears Ended December 31202220212020Alaska$2,352 1,386 (719)Lower 4811,015 4,932 (1,122)Canada714 458 (326)Europe, Middle East and North Africa2,244 1,167 448 Asia Pacific2,736 453 962 Other International(51)(107)(64)Corporate and Other(330)(210)(1,880)Net income (loss) attributable to ConocoPhillips$18,680 8,079 (2,701)Net Income (loss) attributable to ConocoPhillips increased $10,601 million in 2022. Earnings were positively impacted by:•Higher realized commodity prices.•Higher sales volumes primarily due to our Shell Permian acquisition, partly offset by assets divested. See Note 3. •Higher equity in earnings of affiliates, primarily due to higher LNG sales prices and volumes as well as the additional 10 percent interest in APLNG we acquired in the first quarter of 2022. See Note 3. •Absence of a $682 million after-tax impairment of our APLNG investment included within our Asia Pacific segment. See Note 7.•Recognition of a $515 million tax benefit related to the closing of an IRS audit. See Note 17.•Gain on dispositions primarily due to a $462 million after-tax gain related to the divestiture of our Indonesia assets, higher contingent payments related to prior dispositions in our Canada and Lower 48 segments and the absence of a $137 million after-tax loss related to the divestiture of noncore assets in our Other International segment from 2021. See Note 3.•Absence of restructuring and transaction expenses of $341 million after-tax related to our Concho and Shell Permian acquisitions.•Absence of realized losses on hedges of $233 million after-tax related to derivative positions acquired in our Concho acquisition. See Note 12.•Lower other expenses primarily related to an after-tax gain of $62 million associated with the extinguishment of debt from the first quarter of 2022. See Note 9.These increases in net income (loss) were partly offset by:•Higher income tax provision.•Higher taxes other than income taxes, production and operating expenses and DD&A expenses due to higher prices, production volumes, primarily from our Shell Permian acquisition, and inflation. Partially offsetting the increase in DD&A expenses were lower rates from reserve revisions.•A gain of $251 million after-tax on our Cenovus Energy (CVE) common shares in 2022, as compared to a $1,040 million after-tax gain on those shares in 2021. See Note 5.•Absence of an after-tax gain of $194 million recognized for a final investment decision (FID) bonus associated with our Australia-West divestiture in 2020. See Note 11.•Higher exploration expenses primarily related to the impairment of certain aged, suspended wells in our Canada segment and increased dry hole expenses in our Europe, Middle East and North Africa segment. See Note 6.ConocoPhillips 2022 10-K38Results of Operations Table of ContentsIncome Statement AnalysisUnless otherwise indicated, all results in Income Statement Analysis are before-tax.Sales and other operating revenues increased $32,666 million in 2022, mainly due to higher realized commodity prices and higher sales volumes, primarily due to our Shell Permian acquisition, partially offset by assets divested. See Note 3. Equity in earnings of affiliates increased $1,249 million in 2022, primarily due to higher earnings driven by higher LNG and crude prices as well as the additional 10 percent interest in APLNG which was acquired in the first quarter of 2022. See Note 3.Gain on dispositions increased $591 million in 2022, primarily due to the recognition of a gain of $534 million from our Indonesia divestiture, the absence of a $179 million loss associated with the sale of noncore assets in our Other International segment and higher contingent payments in our Canada and Lower 48 segments than in 2021. These increases were partially offset by the absence of a $200 million gain for a FID bonus associated with our Australia-West divestiture recognized in the first quarter of 2021. See Note 3.Other income (loss) decreased $699 million in 2022, primarily due to the absence of mark-to-market gains associated with our CVE common shares which were fully divested in the first quarter of 2022. See Note 5. The decrease was partially offset by higher interest income earned due to rising rates and investments.Purchased commodities increased $15,813 million in 2022, primarily in line with higher gas and crude prices and volumes. Production and operating expenses increased $1,312 million in 2022, due to higher volumes, primarily due to our Shell Permian acquisition, inflation and commodity price impacts.Selling, general and administrative expenses decreased $96 million in 2022, primarily due to the absence of transaction and restructuring expenses associated with our Concho and Shell Permian acquisitions, partially offset by higher compensation and benefits costs, including mark-to-market impacts of certain key employee compensation programs.Exploration expenses increased $220 million in 2022, primarily due to the impairment of certain aged, suspended wells in our Canada segment as well as increased dry hole expenses related to our 2022 exploration and appraisal campaign in Norway.DD&A increased $296 million in 2022 mainly due to higher overall production volumes primarily due to our Shell Permian acquisition, partially offset by lower rates from reserve additions from development drilling and higher prices and the absence of DD&A from divested assets.Impairments decreased $686 million in 2022, primarily due to the absence of an impairment of our APLNG investment included within our Asia Pacific segment in 2021. For additional information, see Note 7 and Note 13. Taxes other than income taxes increased $1,730 million in 2022, caused primarily by higher commodity prices and higher sales volumes.Other Expenses decreased $149 million primarily related to a gain of $127 million associated with the extinguishment of debt from the first quarter of 2022. See Note 9.See Note 17—Income Taxes for information regarding our income tax provision and effective tax rate.39ConocoPhillips 2022 10-KResults of Operations Table of ContentsSummary Operating Statistics202220212020Average Net ProductionCrude oil (MBD)Consolidated Operations885 816 555 Equity affiliates13 13 13 Total crude oil898 829 568 Natural gas liquids (MBD)Consolidated Operations244 134 97 Equity affiliates8 8 8 Total natural gas liquids252 142 105 Bitumen (MBD)66 69 55 Natural gas (MMCFD)Consolidated Operations1,939 2,109 1,339 Equity affiliates1,191 1,053 1,055 Total natural gas3,130 3,162 2,394 Total Production (MBOED)1,738 1,567 1,127 Dollars Per UnitAverage Sales PricesCrude oil (per bbl)Consolidated Operations$97.23 67.61 39.56 Equity affiliates97.31 69.45 39.02 Total crude oil97.23 67.64 39.54 Natural gas liquids (per bbl)Consolidated Operations35.67 31.04 12.90 Equity affiliates61.22 54.16 32.69 Total natural gas liquids36.50 32.45 14.61 Bitumen (per bbl)55.56 37.52 8.02 Natural gas (per mcf)Consolidated Operations10.56 6.00 3.17 Equity affiliates10.67 5.31 3.71 Total natural gas10.60 5.77 3.41 Millions of DollarsWorldwide Exploration ExpensesGeneral and administrative; geological and geophysical, lease rental, and other$224 300 374 Leasehold impairment89 10 868 Dry holes251 34 215 Total Exploration Expenses$564 344 1,457 ConocoPhillips 2022 10-K40Results of Operations Table of ContentsWe explore for, produce, transport and market crude oil, bitumen, LNG, natural gas and NGLs on a worldwide basis. At December 31, 2022, our operations were producing in the U.S., Norway, Canada, Australia, China, Malaysia, Qatar and Libya.Total production of 1,738 MBOED increased 171 MBOED or 11 percent in 2022 compared with 2021, primarily due to:•New wells online in the Lower 48, Alaska, Australia, China, Malaysia and Canada.•Acquisitions including Shell Permian in the Lower 48 and additional working interest at APLNG in our Asia Pacific segment. See Note 3.•Conversion of previously acquired Concho contracted volumes from a two-stream to a three-stream basis.The increase in production during 2022 was partly offset by:•Normal field decline.•Divestiture of our Indonesia assets and noncore assets in the Lower 48 segment. See Note 3.Production for 2022 was 1,738 MBOED. After adjusting for closed acquisitions and dispositions, the conversion of previously acquired Concho-contracted volumes from a two-stream to a three-stream basis and 2021 Winter Storm Uri impacts, production decreased by 16 MBOED or 1 percent. Organic growth from Lower 48 and other development programs more than offset decline; however, production was lower overall, primarily due to fourth quarter weather impacts and downtime in Lower 48.41ConocoPhillips 2022 10-KResults of Operations Table of ContentsSegment ResultsUnless otherwise indicated, discussion of Segment Results is after-tax.Alaska202220212020Net Income (Loss) Attributable to ConocoPhillips ($MM)$2,352 1,386 (719)Average Net ProductionCrude oil (MBD)177 178 181 Natural gas liquids (MBD)17 16 16 Natural gas (MMCFD)34 16 10 Total Production (MBOED)200 197 198 Average Sales PricesCrude oil ($ per bbl)$101.72 69.87 42.12 Natural gas ($ per mcf)3.64 2.81 2.91 The Alaska segment primarily explores for, produces, transports and markets crude oil, NGLs and natural gas. In 2022, Alaska contributed 16 percent of our consolidated liquids production and two percent of our consolidated natural gas production.Net Income (Loss) Attributable to ConocoPhillipsAlaska reported earnings of $2,352 million in 2022, compared with earnings of $1,386 million in 2021. Earnings were positively impacted by higher realized commodity prices.Earnings were negatively impacted by:•Higher taxes other than income taxes associated with higher realized commodity prices and higher production volumes.•Higher production and operating expenses driven primarily by response costs associated with a first quarter subsurface gas release at Alpine drill site CD1 and higher activity comprised of well workovers and gas injections.ProductionAverage production increased 3 MBOED in 2022 compared with 2021, primarily due to:•New wells online at our Western North Slope assets.•Increased development activity at Greater Prudhoe Area and Greater Kuparuk Area assets.•Higher produced gas volumes in our Greater Prudhoe Area.The production increase was partly offset by normal field decline.ConocoPhillips 2022 10-K42Results of Operations Table of ContentsLower 48202220212020Net Income (Loss) Attributable to ConocoPhillips ($MM)$11,015 4,932 (1,122)Average Net ProductionCrude oil (MBD)534 447 213 Natural gas liquids (MBD)*221 110 74 Natural gas (MMCFD)*1,402 1,340 585 Total Production (MBOED)989 780 385 Average Sales PricesCrude oil ($ per bbl)$94.46 66.12 35.17 Natural gas liquids ($ per bbl)35.36 30.63 12.13 Natural gas ($ per mcf)5.92 4.38 1.65 *Includes conversion of previously acquired Concho two-stream contracts to three-stream initiated in the fourth quarter of 2021.The Lower 48 segment consists of operations located in the contiguous U.S. and the Gulf of Mexico and commercial operations. During 2022, the Lower 48 contributed 64 percent of our consolidated liquids production and 72 percent of our consolidated natural gas production. Net Income (Loss) Attributable to ConocoPhillipsLower 48 reported earnings of $11,015 million in 2022, compared with earnings of $4,932 million in 2021. Earnings were positively impacted by:•Higher realized prices.•Higher sales volumes primarily related to our Shell Permian Acquisition. See Note 3.•Absence of one-time impacts from our Concho and Shell Permian acquisitions including realized losses on hedges related to derivative positions acquired in our Concho acquisition and higher selling, general and administrative expenses for transaction and restructuring charges. See Note 12.Earnings were negatively impacted by:•Higher production and operating expenses, DD&A expenses and taxes other than income taxes primarily due to higher production volumes, primarily from our Shell Permian acquisition, realized commodity prices and inflation. Partially offsetting the increase in DD&A expenses were lower rates from reserve additions, primarily from additional development drilling in our unconventional plays and certain technical revisions. ProductionTotal average production increased 209 MBOED in 2022 compared with 2021, primarily due to:•New wells online from our development programs in Delaware Basin, Eagle Ford, Midland Basin and Bakken.•Higher volumes due to our Shell Permian acquisition, partially offset by assets divested. See Note 3.•Conversion of previously acquired Concho contracted volumes from a two-stream to a three-stream basis.These production increases were partly offset by normal field decline.Asset Acquisitions and DispositionsWe completed multiple divestitures of noncore oil and gas assets during 2022 totaling approximately $680 million in proceeds after customary adjustments. These divested assets averaged approximately 18 MBOED. We also cored up strategic positions through acquisitions of approximately $250 million after customary adjustments. See Note 3.43ConocoPhillips 2022 10-KResults of Operations Table of ContentsCanada202220212020Net Income (Loss) Attributable to ConocoPhillips ($MM)$714 458 (326)Average Net ProductionCrude oil (MBD)6 8 6 Natural gas liquids (MBD)3 4 2 Bitumen (MBD)66 69 55 Natural gas (MMCFD)61 80 40 Total Production (MBOED)85 94 70 Average Sales PricesCrude oil ($ per bbl)$79.94 56.38 23.57 Natural gas liquids ($ per bbl)37.70 31.18 5.41 Bitumen ($ per bbl)55.56 37.52 8.02 Natural gas ($ per mcf)3.62 2.54 1.21 Average sales prices include unutilized transportation costs.Our Canadian operations consist of the Surmont oil sands development in Alberta and the liquids-rich Montney unconventional play in British Columbia and commercial operations. In 2022, Canada contributed six percent of our consolidated liquids production and three percent of our consolidated natural gas production.Net Income (Loss) Attributable to ConocoPhillipsCanada operations reported earnings of $714 million in 2022 compared with earnings of $458 million in 2021. Earnings were positively impacted by:•Higher realized prices.•Contingent payments of $282 million in 2022 associated with the sale of certain assets to CVE in 2017 compared with $246 million in 2021.Earnings were negatively impacted by:•Higher exploration expenses primarily related to the impairment of certain aged, suspended wells. See Note 6.•Lower sales volumes.•Higher production and operating expenses primarily due to higher fuel gas and electricity prices at Surmont.ProductionTotal average production decreased 9 MBOED in 2022 compared with 2021. The production decrease was primarily due to:•Normal field decline.•Higher royalty rates across the segment due to higher commodity prices.•Planned turnarounds in our Montney assets and at the Surmont Central Processing Facility 1.These production decreases were partly offset by new wells online in our Montney asset.ConocoPhillips 2022 10-K44Results of Operations Table of ContentsEurope, Middle East and North Africa202220212020Net Income (Loss) Attributable to ConocoPhillips ($MM)$2,244 1,167 448 Consolidated OperationsAverage Net ProductionCrude oil (MBD)107 118 86 Natural gas liquids (MBD)3 4 4 Natural gas (MMCFD)328 313 275 Total Production (MBOED)165 175 136 Average Sales PricesCrude oil ($ per bbl)$99.20 68.97 43.30 Natural gas liquids ($ per bbl)54.52 43.97 23.27 Natural gas ($ per mcf)33.39 13.27 3.23 The Europe, Middle East and North Africa segment consists of operations principally located in the Norwegian sector of the North Sea; the Norwegian Sea; Qatar; Libya; and commercial and terminalling operations in the U.K. In 2022, our Europe, Middle East and North Africa operations contributed nine percent of our consolidated liquids production and 17 percent of our consolidated natural gas production.Net Income (Loss) Attributable to ConocoPhillipsThe Europe, Middle East and North Africa segment reported earnings of $2,244 million in 2022 compared with earnings of $1,167 million in 2021. Earnings were positively impacted by:•Higher realized prices. •Higher equity in earnings of affiliates primarily due to higher LNG sale prices. •Foreign exchange gains as the USD strengthened against the Norwegian Kroner.Earnings were negatively impacted by:•Lower sales volumes.Consolidated ProductionAverage consolidated production decreased 10 MBOED in 2022, compared with 2021. The consolidated production decrease was primarily due to:•Normal field decline.•Field-wide turnarounds in the Greater Ekofisk Area of Norway.•Unplanned downtime across our Norway assets.These production decreases were partly offset by:•New wells online, improved performance and higher gas exports in Norway.Qatar InterestDuring 2022, we were awarded a 25 percent interest in a new joint venture with QatarEnergy that will participate in the NFE LNG project. Formation of the NFE joint venture (QG8) closed in December 2022. Once complete, the NFE project will have the capacity to produce 32 MTPA. See Note 3 and Note 4.Libya AcquisitionIn November 2022, we, along with TotalEnergies completed the joint acquisition of Hess Libya Waha Ltd, which increased our interest in the Waha Concession by 4.1 percent to 20.4 percent.Exploration ActivityIn 2022, we drilled four operated wells and participated in one partner operated well, all of which were determined to be dry holes, including the Slagugle appraisal well which effectively delineated the 2020 discovery. Slagugle is a discovery that we are continuing to evaluate.45ConocoPhillips 2022 10-KResults of Operations Table of ContentsAsia Pacific202220212020Net Income (Loss) Attributable to ConocoPhillips ($MM)$2,736 453 962 Consolidated OperationsAverage Net ProductionCrude oil (MBD)61 65 69 Natural gas liquids (MBD)— — 1 Natural gas (MMCFD)114 360 429 Total Production (MBOED)80 125 141 Average Sales PricesCrude oil ($ per bbl)$105.52 70.36 42.84 Natural gas liquids ($ per bbl)— — 33.21 Natural gas ($ per mcf)5.84 6.56 5.39 At December 31, 2022, the Asia Pacific segment had operations in China, Malaysia, and Australia, and commercial operations in China, Singapore and Japan. During 2022, Asia Pacific contributed five percent of our consolidated liquids production and six percent of our consolidated natural gas production. Net Income (Loss) Attributable to ConocoPhillipsAsia Pacific reported earnings of $2,736 million in 2022, compared with $453 million in 2021. The increase in earnings was mainly due to:•Higher equity in earnings of affiliates reflecting higher LNG sales prices as well as our increased interest in APLNG.•Absence of a $688 million after-tax impairment on our APLNG investment. See Note 4 and Note 13.•Higher realized crude prices. •After-tax gain of $534 million associated with the divestiture of our Indonesian assets. See Note 3.•Lower DD&A expenses driven by the divestiture of our Indonesia assets. •Lower production and operating expenses primarily associated with the divestiture of our Indonesia assets and lower production costs in China.Earnings were negatively impacted by:•Absence of an after-tax gain of $200 million recognized in the first quarter of 2021 related to a contingent payment from our Australia-West divestiture in 2020. See Note 3 and Note 11.•Lower sales volumes primarily due to the divestiture of our Indonesia assets.•Higher taxes other than income taxes primarily due to higher realized crude oil prices.Consolidated ProductionAverage consolidated production decreased 45 MBOED in 2022, compared with 2021. The decrease was primarily due to:•The divestiture of our Indonesia assets in the first quarter of 2022. •Normal field decline.These production decreases were partly offset by development activity at Bohai Bay in China and new wells online in Malaysia.Asset Acquisitions and DispositionsIn the first quarter of 2022, we completed the acquisition of an additional 10 percent interest in APLNG increasing our ownership to 47.5 percent. Also in the first quarter, we completed the divestiture of our subsidiaries that held our Indonesia assets and operations. Production from the disposed assets averaged approximately 33 MBOED in the three-months ended March 31, 2022. See Note 3.ConocoPhillips 2022 10-K46Results of Operations Table of ContentsOther International202220212020Net Income (Loss) Attributable to ConocoPhillips ($MM)$(51)(107)(64)The Other International segment includes interests in Colombia as well as contingencies associated with prior operations in other countries. Earnings from our Other International operations improved $56 million in 2022, compared with 2021, primarily due to the absence of a $137 million after-tax loss on divestiture related to our Argentina exploration interests, partially offset by higher taxes related to legal settlements in 2022.Corporate and OtherMillions of Dollars202220212020Net Income (Loss) Attributable to ConocoPhillipsNet interest expense$(600)(801)(662)Corporate general and administrative expenses(244)(317)(200)Technology32 25 (26)Other income (expense)482 883 (992)$(330)(210)(1,880)Net interest consists of interest and financing expense, net of interest income and capitalized interest. Net interest expense improved $201 million in 2022, compared with 2021, primarily due to higher interest income as well as lower interest expenses as a result of our debt reduction transactions. See Note 9.Corporate G&A expenses include compensation programs and staff costs. These expenses decreased by $73 million in 2022 compared with 2021, primarily due to the absence of restructuring expenses associated with our Concho acquisition, partially offset by mark-to-market adjustments associated with certain compensation programs. See Note 16.Technology includes our investment in new technologies or businesses, as well as licensing revenues. Activities are focused on both conventional and tight oil reservoirs, shale gas, heavy oil, oil sands, enhanced oil recovery as well as LNG.Other income (expense) ("Other") includes certain corporate tax-related items, foreign currency transaction gains and losses, environmental costs associated with sites no longer in operation, other costs not directly associated with an operating segment, gains or losses on early retirement of debt, holding gains or losses on equity securities and pension settlement expense. Earnings in “Other” decreased by $401 million in 2022 compared with 2021. This was primarily due to a gain of $251 million on our CVE common shares in 2022, compared with a $1,040 million gain in 2021. Earnings in "Other" also decreased due to a $101 million tax impact associated with the disposition of our Indonesia assets and higher legal accruals of $81 million. Offsetting the decreases to earnings in "Other" include a $474 million federal tax benefit associated with the closing of the 2017 audit of our U.S. federal income tax return, the absence of a release of a $92 million deferred tax asset associated with prior dispositions and recognizing an after-tax gain of $62 million associated with the debt restructuring transactions. 47ConocoPhillips 2022 10-KCapital Resources and LiquidityTable of ContentsCapital Resources and LiquidityFinancial IndicatorsMillions of DollarsExcept as Indicated202220212020Net cash provided by operating activities$28,314 16,996 4,802 Cash and cash equivalents6,458 5,028 2,991 Short-term investments2,785 446 3,609 Short-term debt417 1,200 619 Total debt16,643 19,934 15,369 Total equity48,003 45,406 29,849 Percent of total debt to capital*26 %31 34 Percent of floating-rate debt to total debt2 %4 7 *Capital includes total debt and total equity.To meet our short- and long-term liquidity requirements, we look to a variety of funding sources, including cash generated from operating activities, proceeds from asset sales, our commercial paper and credit facility programs and our ability to sell securities using our shelf registration statement. In 2022, the primary uses of our available cash were $10.2 billion to support our ongoing capital expenditures and investments program, $9.3 billion to repurchase common stock, $5.7 billion to pay the ordinary dividend and VROC, $3.4 billion to reduce debt through refinancing transactions and retirements and $2.6 billion net purchases of investments. In 2022, cash and cash equivalents increased by over $1.4 billion to $6.5 billion.At December 31, 2022, we had cash and cash equivalents of $6.5 billion, short-term investments of $2.8 billion, and available borrowing capacity under our credit facility of $5.5 billion, totaling approximately $14.8 billion of liquidity. We believe current cash balances and cash generated by operations, together with access to external sources of funds as described below in the “Significant Changes in Capital” section, will be sufficient to meet our funding requirements in the near- and long-term, including our capital spending program, dividend payments and required debt payments. Significant Changes in CapitalOperating ActivitiesCash provided by operating activities continued to increase in 2022 totaling $28.3 billion, compared with $17.0 billion for 2021, and $4.8 billion for 2020. The increase in cash provided by operating activities from 2021 is primarily due to higher realized commodity prices, higher sales volumes mostly due to our acquisition of Shell Permian assets and the absence of the 2021 settlement of oil and gas hedging positions acquired from Concho. The increase in cash provided by operating activities was partly offset by foreign tax and royalty payments in Libya and foreign tax payments in Norway in addition to U.S. tax payments.The increase in cash from 2021 compared to 2020 is primarily due to higher realized commodity prices and higher sales volumes, mostly resulting from our acquisition of Concho. The increase was partly offset by the $0.8 billion in settlement of oil and gas hedging positions acquired from Concho and approximately $0.4 billion of transaction and restructuring costs.Our short- and long-term operating cash flows are highly dependent upon prices for crude oil, bitumen, natural gas, LNG and NGLs. Prices and margins in our industry have historically been volatile and are driven by market conditions over which we have no control. Absent other mitigating factors, as these prices and margins fluctuate, we would expect a corresponding change in our operating cash flows.ConocoPhillips 2022 10-K48Capital Resources and LiquidityTable of ContentsThe level of absolute production volumes, as well as product and location mix, impacts our cash flows. Full-year production averaged 1,738 MBOED in 2022, an increase of 171 MBOED or 11 percent compared to 2021. First quarter 2023 production is expected to be 1.72 MMBOED to 1.76 MMBOED. Future production is subject to numerous uncertainties, including, among others, the volatile crude oil and natural gas price environment, which may impact investment decisions; the effects of price changes on production sharing and variable-royalty contracts; acquisition and disposition of fields; field production decline rates; new technologies; operating efficiencies; timing of startups and major turnarounds; political instability; weather-related disruptions; and the addition of proved reserves through exploratory success and their timely and cost-effective development. While we actively manage these factors, production levels can cause variability in cash flows, although generally this variability has not been as significant as that caused by commodity prices.To maintain or grow our production volumes on an ongoing basis, we must continue to add to our proved reserve base. Our proved reserves generally increase as prices rise and decrease as prices decline. Reserve replacement represents the net change in proved reserves, net of production, divided by our current year production. For information on proved reserves, including both developed and undeveloped reserves, see the reserve table disclosures contained in “Supplementary Data – Oil and Gas Operations.” See “Item 1A—Risk Factors – Unless we successfully develop resources, the scope of our business will decline, resulting in an adverse impact to our business.”As discussed in the “Critical Accounting Estimates” section, engineering estimates of proved reserves are imprecise; therefore, reserves may be revised upward or downward each year due to the impact of changes in commodity prices or as more technical data becomes available on reservoirs. It is not possible to reliably predict how revisions will impact future reserve quantities.Investing ActivitiesIn 2022, we invested $10.2 billion in capital expenditures and investments; $2.1 billion of which was acquisition capital for the additional 10 percent interest in APLNG, certain Lower 48 assets and the payments toward our investment in QG8. The remaining $8.1 billion funded our operating capital program inclusive of growth in the Lower 48 segment through the integration of Concho and Shell Permian assets. Capital expenditures invested in 2021 and 2020 were $5.3 billion and $4.7 billion, respectively. See the “Capital Expenditures and Investments” section. In 2022, we completed the monetization of our investment in CVE common shares that we began in May 2021. By the end of the first quarter of 2022, we fully divested of our investment, recognizing proceeds of $1.4 billion and directing proceeds toward our existing share repurchase program. Since inception, we generated total proceeds of $2.5 billion. See Note 5. Other proceeds from dispositions received in the current year include our divestitures in Asia Pacific and Lower 48 segments for approximately $1.5 billion after customary adjustments and $500 million in contingent payments associated with prior divestitures. See Note 3.In December 2021, we completed our acquisition of Shell’s assets in the Delaware Basin for cash consideration of approximately $8.7 billion after customary adjustments. We funded this transaction with cash on hand. We completed our acquisition of Concho on January 15, 2021 in an all-stock transaction. The assets acquired in the transaction included $382 million of cash. The net impact of these items is recognized within “Acquisition of businesses, net of cash acquired” on our consolidated statement of cash flows. See Note 3.In 2021, total proceeds from asset dispositions were $1.7 billion. We received cash proceeds of $250 million from the sale of noncore assets in our Lower 48 segment and $1.1 billion from sales of our investment in CVE common shares and $244 million of contingent payments related to dispositions completed before 2021. See Note 3 and Note 5. In 2020, proceeds from asset sales were $1.3 billion. We received cash proceeds of $765 million for the divestiture of our Australia-West assets and operations. We also received proceeds of $359 million and $184 million from the sale of our Niobrara interests and Waddell Ranch interests in the Lower 48, respectively. See Note 3. We invest in short-term investments as part of our cash investment strategy, the primary objective of which is to protect principal, maintain liquidity and provide yield and total returns; these investments include time deposits, commercial paper, as well as debt securities classified as available for sale. Funds for short-term needs to support our operating plan and provide resiliency to react to short-term price volatility are invested in highly liquid instruments with maturities within the year. Funds we consider available to maintain resiliency in longer term price downturns and to capture opportunities outside a given operating plan may be invested in instruments with maturities greater than one year. See Note 12 and Note 19.49ConocoPhillips 2022 10-KCapital Resources and LiquidityTable of ContentsFinancing ActivitiesIn February 2022, we refinanced our revolving credit facility from a total aggregate principal amount of $6.0 billion to $5.5 billion with an expiration date of February 2027. Our revolving credit facility may be used for direct bank borrowings, the issuance of letters of credit totaling up to $500 million, or as support for our commercial paper program. The revolving credit facility is broadly syndicated among financial institutions and does not contain any material adverse change provisions or any covenants requiring maintenance of specified financial ratios or credit ratings. The facility agreement contains a cross-default provision relating to the failure to pay principal or interest on other debt obligations of $200 million or more by ConocoPhillips, or any of its consolidated subsidiaries. The amount of the facility is not subject to the redetermination prior to its expiration date.Credit facility borrowings may bear interest at a margin above the Secured Overnight Financing Rate (SOFR). The agreement calls for commitment fees on available, but unused, amounts. The agreement also contains early termination rights if our current directors or their approved successors cease to be a majority of the Board of Directors.The revolving credit facility supports ConocoPhillips Company’s ability to issue up to $5.5 billion of commercial paper, which is primarily a funding source for short-term working capital needs. Commercial paper maturities are generally limited to 90 days. With no commercial paper outstanding and no direct borrowings or letters of credit, we had access to $5.5 billion in available borrowing capacity under our revolving credit facility at December 31, 2022.Our debt balance at December 31, 2022 was $16.6 billion compared with $19.9 billion at December 31, 2021. The current portion of debt, including payments for finance leases, is $0.4 billion. In 2022, we repurchased notes, retired floating rate debt, and executed a debt refinancing comprised of concurrent transactions including new debt issuances, a cash tender offer and debt exchange offers. In aggregate, these transactions along with naturally maturing debt, reduced the company's total debt by $3.3 billion. The refinancing facilitates our ability to achieve our previously announced $5 billion debt reduction target by the end of 2026 while also reducing the company's annual cash interest expense. The current credit ratings on our long-term debt are:•Fitch: “A” with a “stable” outlook•S&P: “A-” with a “stable” outlook•Moody's: "A2" with a "stable" outlookSee Note 9 for additional information on debt, revolving credit facility and credit ratings.We do not have any ratings triggers on any of our corporate debt that would cause an automatic default, and thereby impact our access to liquidity, upon downgrade of our credit ratings. If our credit ratings are downgraded from their current levels, it could increase the cost of corporate debt available to us and restrict our access to the commercial paper markets. If our credit rating were to deteriorate to a level prohibiting us from accessing the commercial paper market, we would still be able to access funds under our revolving credit facility. Certain of our project-related contracts, commercial contracts and derivative instruments contain provisions requiring us to post collateral. Many of these contracts and instruments permit us to post either cash or letters of credit as collateral. At December 31, 2022 and December 31, 2021, we had direct bank letters of credit of $368 million and $337 million, respectively, which secured performance obligations related to various purchase commitments incident to the ordinary conduct of business. In the event of a credit rating downgrade, we may be required to post additional letters of credit.Shelf RegistrationWe have a universal shelf registration statement on file with the SEC under which we have the ability to issue and sell an indeterminate amount of various types of debt and equity securities.ConocoPhillips 2022 10-K50Capital Resources and LiquidityTable of ContentsCapital RequirementsFor information about our capital expenditures and investments, see the “Capital Expenditures and Investments” section.Our debt balance at December 31, 2022, was $16.6 billion, a decrease of $3.3 billion from the balance at December 31, 2021 of $19.9 billion. As part of our objective to maintain a strong balance sheet, we announced in 2021 our intention to reduce our total debt by $5 billion by the end of 2026. In 2022, we executed concurrent debt refinancing transactions, repurchased existing notes and retired floating rate notes upon natural maturity, that in aggregate reduced the company's total debt by $3.3 billion and progressed the achievement of our debt reduction target while also lowering our annual cash interest expense and extending the weighted average maturity of our debt portfolio. See Note 9. In February 2023, we announced our 2023 planned return of capital to shareholders of $11 billion through our three-tier return of capital framework. We plan to deliver a compelling, growing ordinary dividend, through-cycle share repurchases and a VROC payment. The VROC provides a flexible tool for meeting our commitment of returning greater than 30 percent of cash from operating activities during periods where commodity prices are meaningfully higher than our planning price range. Our 2022 total capital returned was $15 billion.Consistent with our commitment to deliver value to shareholders, in 2022, we paid ordinary dividends of $1.89 per common share and VROC payments of $2.60 per common share. This was an increase over 2021 and 2020, when we paid only ordinary dividends of $1.75 and $1.69 per common share, respectively. In February 2023, we declared a first quarter ordinary dividend of $0.51 cents per share and a VROC of $0.60 cents per share. The ordinary dividend of $0.51 cents per share is payable March 1, 2023, to shareholders of record on February 14, 2023. The VROC of $0.60 cents per share is payable April 14, 2023, to shareholders of record on March 29, 2023.The ordinary dividend and VROC are subject to numerous considerations and will be determined and approved each quarter by the Board of Directors. If approved, we expect to announce the VROC when we announce our ordinary dividend, but the quarterly payouts will be staggered from the ordinary dividend and paid in the subsequent quarter, resulting in up to eight cash distributions throughout the year. In late 2016, we initiated our current share repurchase program. In October 2022, our Board of Directors approved an increase to our authorization from $25 billion to $45 billion of our common stock to support our plan for future share repurchases. Share repurchases were $9.3 billion, $3.6 billion, and $0.9 billion in 2022, 2021, and 2020, respectively. As of December 31, 2022, share repurchases since the inception of our current program totaled 334.8 million shares and $23.4 billion. Repurchases are made at management’s discretion, at prevailing prices, subject to market conditions and other factors.For more information on factors considered when determining the levels of returns of capital see “Item 1A—Risk Factors – Our ability to execute our capital return program is subject to certain considerations.” As of December 31, 2022, in addition to the priorities described above, we have contractual obligations to purchase goods and services of approximately $19.2 billion. We expect to fulfill $8.8 billion of these obligations in 2023. These figures exclude purchase commitments for jointly owned fields and facilities where we are not the operator. Purchase obligations of $5.0 billion are related to agreements to access and utilize the capacity of third-party equipment and facilities, including pipelines and LNG product terminals, to transport, process, treat and store commodities. Purchase obligations of $12.7 billion are related to market-based contracts for commodity product purchases with third parties. The remainder is primarily our net share of purchase commitments for materials and services for jointly owned fields and facilities where we are the operator. 51ConocoPhillips 2022 10-KCapital Resources and LiquidityTable of ContentsCapital Expenditures and InvestmentsMillions of Dollars202220212020Alaska1,091 982 1,038 Lower 485,630 3,129 1,881 Canada530 203 651 Europe, Middle East and North Africa998 534 600 Asia Pacific1,880 390 384 Other International— 33 121 Corporate and Other30 53 40 Capital Program*10,159 5,324 4,715 * Excludes capital related to acquisitions of businesses, net of capital acquired.Our capital expenditures and investments for the three-year period ended December 31, 2022, totaled $20.2 billion. The 2022 capital expenditures and investments supported key operating activities and acquisitions, primarily: •Development activities in the Lower 48, primarily in the Delaware Basin, Eagle Ford, Midland Basin and Bakken.•Appraisal and development activities in Alaska related to the Western North Slope and development activities in the Greater Kuparuk Area.•Appraisal and development activities at Montney as well as optimization and development of oil sands in Canada. •Development, exploration and appraisal activities across assets in Norway.•Continued development and exploration activities in Malaysia and China.•Acquisition capital associated with additional interest in APLNG and certain Lower 48 assets as well as the payment for our investment in QG8.2023 Capital BudgetIn February 2023, we announced our 2023 operating plan capital is expected to be between $10.7 to $11.3 billion. The plan includes funding for ongoing development drilling programs, major projects, exploration and appraisal activities and base maintenance. ConocoPhillips 2022 10-K52Capital Resources and LiquidityTable of ContentsGuarantor Summarized Financial InformationWe have various cross guarantees among ConocoPhillips, ConocoPhillips Company, and Burlington Resources LLC with respect to publicly held debt securities. ConocoPhillips Company is 100 percent owned by ConocoPhillips. Burlington Resources LLC is 100 percent owned by ConocoPhillips Company. ConocoPhillips and/or ConocoPhillips Company have fully and unconditionally guaranteed the payment obligations of Burlington Resources LLC with respect to its publicly held debt securities. Similarly, ConocoPhillips has fully and unconditionally guaranteed the payment obligations of ConocoPhillips Company with respect to its publicly held debt securities. In addition, ConocoPhillips Company has fully and unconditionally guaranteed the payment obligations of ConocoPhillips with respect to its publicly held debt securities. All guarantees are joint and several. The following tables present summarized financial information for the Obligor Group, as defined below:•The Obligor Group will reflect guarantors and issuers of guaranteed securities consisting of ConocoPhillips, ConocoPhillips Company and Burlington Resources LLC.•Consolidating adjustments for elimination of investments in and transactions between the collective guarantors and issuers of guaranteed securities are reflected in the balances of the summarized financial information.•Non-Obligated Subsidiaries are excluded from this presentation. Transactions and balances reflecting activity between the Obligors and Non-Obligated Subsidiaries are presented separately below:Summarized Income Statement DataMillions of Dollars2022Revenues and Other Income$55,630 Income (loss) before income taxes*18,438 Net income (loss)18,680 Net Income (Loss) Attributable to ConocoPhillips18,680 *Includes approximately $9.0 billion of purchased commodities expense for transactions with Non-Obligated Subsidiaries.Summarized Balance Sheet DataMillions of DollarsDecember 31, 2022Current assets$10,766 Amounts due from Non-Obligated Subsidiaries, current1,892 Noncurrent assets79,269 Amounts due from Non-Obligated Subsidiaries, noncurrent6,552 Current liabilities8,201 Amounts due to Non-Obligated Subsidiaries, current3,248 Noncurrent liabilities40,389 Amounts due to Non-Obligated Subsidiaries, noncurrent24,594 53ConocoPhillips 2022 10-KCapital Resources and LiquidityTable of ContentsContingenciesWe are subject to legal proceedings, claims, and liabilities that arise in the ordinary course of business. We accrue for losses associated with legal claims when such losses are considered probable and the amounts can be reasonably estimated. See “Critical Accounting Estimates” and Note 11 for information on contingencies. Legal and Tax MattersWe are subject to various lawsuits and claims, including but not limited to matters involving oil and gas royalty and severance tax payments, gas measurement and valuation methods, contract disputes, environmental damages, climate change, personal injury, and property damage. Our primary exposures for such matters relate to alleged royalty and tax underpayments on certain federal, state and privately owned properties, claims of alleged environmental contamination and damages from historic operations, and climate change. We will continue to defend ourselves vigorously in these matters.Our legal organization applies its knowledge, experience, and professional judgment to the specific characteristics of our cases, employing a litigation management process to manage and monitor the legal proceedings against us. Our process facilitates the early evaluation and quantification of potential exposures in individual cases. This process also enables us to track those cases that have been scheduled for trial and/or mediation. Based on professional judgment and experience in using these litigation management tools and available information about current developments in all our cases, our legal organization regularly assesses the adequacy of current accruals and determines if adjustment of existing accruals, or establishment of new accruals, is required. See Note 17.EnvironmentalWe are subject to the same numerous international, federal, state, and local environmental laws and regulations as other companies in our industry. The most significant of these environmental laws and regulations include, among others, the:•U.S. Federal Clean Air Act, which governs air emissions.•U.S. Federal Clean Water Act, which governs discharges to water bodies.•European Union Regulation for Registration, Evaluation, Authorization and Restriction of Chemicals (REACH).•U.S. Federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA or Superfund), which imposes liability on generators, transporters and arrangers of hazardous substances at sites where hazardous substance releases have occurred or are threatening to occur.•U.S. Federal Resource Conservation and Recovery Act (RCRA), which governs the treatment, storage, and disposal of solid waste.•U.S. Federal Oil Pollution Act of 1990 (OPA90), under which owners and operators of onshore facilities and pipelines, lessees or permittees of an area in which an offshore facility is located, and owners and operators of vessels are liable for removal costs and damages that result from a discharge of oil into navigable waters of the U.S.•U.S. Federal Emergency Planning and Community Right-to-Know Act (EPCRA), which requires facilities to report toxic chemical inventories with local emergency planning committees and response departments.•U.S. Federal Safe Drinking Water Act, which governs the disposal of wastewater in underground injection wells.•U.S. Department of the Interior regulations, which relate to offshore oil and gas operations in U.S. waters and impose liability for the cost of pollution cleanup resulting from operations, as well as potential liability for pollution damages.•European Union Trading Directive resulting in European Emissions Trading Scheme.These laws and their implementing regulations set limits on emissions and, in the case of discharges to water, establish water quality limits. They also establish standards and impose obligations for the remediation of releases of hazardous substances and hazardous wastes. In most cases, these regulations require permits in association with new or modified operations. These permits can require an applicant to collect substantial information in connection with the application process, which can be expensive and time-consuming. In addition, there can be delays associated with notice and comment periods and the agency’s processing of the application. Many of the delays associated with the permitting process are beyond the control of the applicant.Many states and foreign countries where we operate also have or are developing, similar environmental laws and regulations governing these same types of activities. While similar, in some cases these regulations may impose additional, or more stringent, requirements that can add to the cost and difficulty of marketing or transporting products across state and international borders.ConocoPhillips 2022 10-K54Capital Resources and LiquidityTable of ContentsThe ultimate financial impact arising from environmental laws and regulations is neither clearly known nor easily determinable as new standards, such as air emission standards and water quality standards, continue to evolve. However, environmental laws and regulations, including those that may arise to address concerns about global climate change, are expected to continue to have an increasing impact on our operations in the U.S. and in other countries in which we operate. Notable areas of potential impacts include air emission compliance and remediation obligations in the U.S. and Canada.An example is the use of hydraulic fracturing, an essential completion technique that facilitates production of oil and natural gas otherwise trapped in lower permeability rock formations. A range of local, state, federal, or national laws and regulations currently govern hydraulic fracturing operations, with hydraulic fracturing currently prohibited in some jurisdictions. Although hydraulic fracturing has been conducted for many decades, potential new laws, regulations and permitting requirements from various state environmental agencies, and others could result in increased costs, operating restrictions, operational delays and/or limit the ability to develop oil and natural gas resources. Governmental restrictions on hydraulic fracturing could impact the overall profitability or viability of certain of our oil and natural gas investments. We have adopted operating principles that incorporate established industry standards designed to meet or exceed government requirements. Our practices continually evolve as technology improves and regulations change. We also are subject to certain laws and regulations relating to environmental remediation obligations associated with current and past operations. Such laws and regulations include CERCLA and RCRA and their state equivalents. Longer-term expenditures are subject to considerable uncertainty and may fluctuate significantly.We occasionally receive requests for information or notices of potential liability from the EPA and state environmental agencies alleging that we are a potentially responsible party under CERCLA or an equivalent state statute. On occasion, we also have been made a party to cost recovery litigation by those agencies or by private parties. These requests, notices and lawsuits assert potential liability for remediation costs at various sites that typically are not owned by us, but allegedly contain waste attributable to our past operations. As of December 31, 2022, there were 15 sites around the U.S. in which we were identified as a potentially responsible party under CERCLA and comparable state laws.For most Superfund sites, our potential liability will be significantly less than the total site remediation costs because the percentage of waste attributable to us, versus that attributable to all other potentially responsible parties, is relatively low. Although liability of those potentially responsible is generally joint and several for federal sites and frequently so for state sites, other potentially responsible parties at sites where we are a party typically have had the financial strength to meet their obligations, and where they have not, or where potentially responsible parties could not be located, our share of liability has not increased materially. Many of the sites at which we are potentially responsible are still under investigation by the EPA or the state agencies concerned. Prior to actual cleanup, those potentially responsible normally assess site conditions, apportion responsibility and determine the appropriate remediation. In some instances, we may have no liability or attain a settlement of liability. Actual cleanup costs generally occur after the parties obtain EPA or equivalent state agency approval. There are relatively few sites where we are a major participant, and given the timing and amounts of anticipated expenditures, neither the cost of remediation at those sites nor such costs at all CERCLA sites, in the aggregate, is expected to have a material adverse effect on our competitive or financial condition.Expensed environmental costs were $705 million in 2022 and are expected to be approximately $669 million and $727 million in 2023 and 2024, respectively. Capitalized environmental costs were $239 million in 2022 and are expected to be about $276 million and $314 million in 2023 and 2024, respectively.Accrued liabilities for remediation activities are not reduced for potential recoveries from insurers or other third parties and are not discounted (except those assumed in a purchase business combination, which we do record on a discounted basis).Many of these liabilities result from CERCLA, RCRA, and similar state or international laws that require us to undertake certain investigative and remedial activities at sites where we conduct or once conducted operations or at sites where ConocoPhillips-generated waste was disposed. The accrual also includes a number of sites we identified that may require environmental remediation but which are not currently the subject of CERCLA, RCRA, or other agency enforcement activities. The laws that require or address environmental remediation may apply retroactively and regardless of fault, the legality of the original activities or the current ownership or control of sites. If applicable, we accrue receivables for probable insurance or other third-party recoveries. In the future, we may incur significant costs under both CERCLA and RCRA. 55ConocoPhillips 2022 10-KCapital Resources and LiquidityTable of ContentsRemediation activities vary substantially in duration and cost from site to site, depending on the mix of unique site characteristics, evolving remediation technologies, diverse regulatory agencies and enforcement policies, and the presence or absence of potentially liable third parties. Therefore, it is difficult to develop reasonable estimates of future site remediation costs.At December 31, 2022, our balance sheet included total accrued environmental costs of $182 million, compared with $187 million at December 31, 2021, for remediation activities in the U.S. and Canada. We expect to incur a substantial amount of these expenditures within the next 30 years. Notwithstanding any of the foregoing, and as with other companies engaged in similar businesses, environmental costs and liabilities are inherent concerns in our operations and products, and there can be no assurance that material costs and liabilities will not be incurred. However, we currently do not expect any material adverse effect upon our results of operations or financial position as a result of compliance with current environmental laws and regulations.See Item 1A—Risk Factors – We expect to continue to incur substantial capital expenditures and operating costs as a result of our compliance with existing and future environmental laws and regulations and Note 11 for information on environmental litigation.Climate ChangeContinuing political and social attention to the issue of global climate change has resulted in a broad range of proposed or promulgated state, national and international laws focusing on GHG emissions reduction. These proposed or promulgated laws apply or could apply in countries where we have interests or may have interests in the future. Laws in this field continue to evolve, and while it is not possible to accurately estimate either a timetable for implementation or our future compliance costs relating to implementation, such laws, if enacted, could have a material impact on our results of operations and financial condition. Examples of legislation and precursors for possible regulation that do or could affect our operations include:•European Emissions Trading Scheme (ETS), the program through which many of the EU member states are implementing the Kyoto Protocol. Our cost of compliance with the EU ETS in 2022 was approximately $22 million (net share before-tax).•U.K. Emissions Trading Scheme, the program with which the U.K. has replaced the ETS. Our cost of compliance with the U.K. ETS in 2022 was approximately $0.6 million (net share before-tax).•The Alberta Technology Innovation and Emissions Reduction (TIER) regulation requires any existing facility with emissions equal to or greater than 100,000 metric tonnes of carbon dioxide, or equivalent, per year to meet a facility benchmark intensity. We did not incur costs related to this regulation in 2022.•The U.S. Supreme Court decision in Massachusetts v. EPA, 549 U.S. 497, 127 S.Ct. 1438 (2007), confirmed that the EPA has the authority to regulate carbon dioxide as an “air pollutant” under the Federal Clean Air Act.•The U.S. EPA’s announcement on March 29, 2010 (published as “Interpretation of Regulations that Determine Pollutants Covered by Clean Air Act Permitting Programs,” 75 Fed. Reg. 17004 (April 2, 2010)), and the EPA’s and U.S. Department of Transportation’s joint promulgation of a Final Rule on April 1, 2010, that triggers regulation of GHGs under the Clean Air Act, may trigger more climate-based claims for damages, and may result in longer agency review time for development projects. •The U.S. EPA’s announcement on January 14, 2015, outlining a series of steps it plans to take to address methane and smog-forming volatile organic compound emissions from the oil and gas industry.•The U.S. government has announced on September 17, 2021 the Global Methane Pledge, a global initiative to reduce global methane emissions by at least 30 percent from 2020 levels by 2030.•Carbon taxes in certain jurisdictions. Our cost of compliance with Norwegian carbon legislation in 2022 were fees of approximately $36 million (net share before-tax). We also incur a carbon tax for emissions from fossil fuel combustion in our British Columbia and Alberta operations in Canada, totaling approximately $6 million (net share before-tax).•The agreement reached in Paris in December 2015 at the 21st Conference of the Parties to the United Nations Framework Convention on Climate Change, setting out a process for achieving global emissions reductions. The new administration has recommitted the United States to the Paris Agreement, and a significant number of U.S. state and local governments and major corporations headquartered in the U.S. have also announced related commitments. Accordingly, the U.S. administration set a new target on April 22, 2021 of a 50 to 52 percent reduction in GHG emissions from 2005 levels in 2030.ConocoPhillips 2022 10-K56Capital Resources and LiquidityTable of ContentsIn the U.S., the Council on Environmental Quality's April 19, 2022 revised regulations and January 9, 2023 National Environmental Policy Act Guidance on Consideration of Greenhouse Gas Emissions and Climate Change for implementing the National Environmental Policy Act (NEPA) require federal agencies to evaluate, among other things, the direct, indirect, and cumulative effects of proposed projects subject to federal authorization, including a project's GHG emissions and potential climate change impact. The new NEPA regulations may result in longer agency review time or difficulty obtaining federal approval for development projects in our industry. Furthermore, additional regulations are forthcoming at the federal and state levels with respect to GHG emissions, including EPA’s November 2022 supplemental proposal to strengthen methane emissions standards for new oil and gas facilities and establishing first-time presumptive standards for existing oil and gas facilities, as well as BLM’s November 2022 proposed regulations to reduce the waste of natural gas from venting, flaring, and leaks during oil and gas production activities on Federal and Indian leases. Such regulations, when finalized, may result in the creation of additional costs in the form of taxes, royalty payments, the restriction of output, investments of capital to maintain compliance with laws and regulations, or required acquisition or trading of emission allowances. We are working to continuously improve operational and energy efficiency through resource and energy conservation throughout our operations.Compliance with changes in laws and regulations that create a GHG tax, emission trading scheme or GHG reduction policies could significantly increase our costs, reduce demand for fossil energy derived products, impact the cost and availability of capital and increase our exposure to litigation. Such laws and regulations could also increase demand for less carbon intensive energy sources, including natural gas. The ultimate impact on our financial performance, either positive or negative, will depend on a number of factors, including but not limited to: •Whether and to what extent legislation or regulation is enacted.•The timing of the introduction of such legislation or regulation. •The nature of the legislation (such as a cap and trade system or a tax on emissions) or regulation.•The price placed on GHG emissions (either by the market or through a tax).•The GHG reductions required. •The price and availability of offsets.•The amount and allocation of allowances.•Technological and scientific developments leading to new products or services.•Any potential significant physical effects of climate change (such as increased severe weather events, changes in sea levels and changes in temperature). •Whether, and the extent to which, increased compliance costs are ultimately reflected in the prices of our products and services. See Item 1A—Risk Factors – Existing and future laws, regulations and internal initiatives relating to global climate changes, such as limitations on GHG emissions may impact or limit our business plans, result in significant expenditures, promote alternative uses of energy or reduce demand for our products and Note 11 for information on climate change litigation.57ConocoPhillips 2022 10-KCapital Resources and LiquidityTable of ContentsCompany Response to Climate-Related RisksOur current Climate Risk Strategy and actions for our oil and gas operations are aligned with the aims of the Paris Agreement while being responsive to shareholder interests for long-term value and competitive returns and is also aligned with our Triple Mandate to responsibly meet energy transition pathway demand, deliver competitive returns on and of capital and achieve our net-zero operational emissions ambition.In 2020 we became the first U.S.-based oil and gas company to adopt a Paris-aligned climate-risk strategy with an ambition to become a net-zero company for operational (Scope 1 and 2) emissions by 2050. The objective of our Climate Risk Strategy is to manage climate-related risk, optimize opportunities and equip the company to respond to changes in key uncertainties, including government policies around the world, technologies for emissions reduction, alternative energy technologies and changes in consumer trends. The strategy sets out our choices around portfolio composition, emissions reductions, targets and incentives, emissions-related technology development, and our climate-related policy and finance sector engagement.In early 2022, we published our plan for the Net-Zero Energy Transition (the 'Plan'), to outline how we intend to apply our strategic capabilities and resources to meet the challenges posed by climate change in an economically viable, accountable and actionable way that balances the interests of our stakeholders.Key elements of our plan include:•Maintaining a resilient asset portfolio focused on resources with the low cost of supply and low greenhouse gas intensity needed to remain viable in any scenario.•Setting emissions-reduction targets over the near, medium and long terms for Scope 1 and 2 operational emissions, methane emissions intensity and flaring.•Expanding policy advocacy beyond carbon pricing to include demand-side policy and regulatory action such as direct federal regulation of methane, advocating for alternative transportation and power generation, and national policy recommendations on natural gas across the value chain.•Leveraging our assets and capabilities to develop low-carbon technologies and identify emerging business opportunities.•Tracking and responding to the transition through use of scenario planning to understand alternative pathways and test the resilience of our strategy.•Continuing capital discipline by incorporating scenario planning and a cost of carbon into our capital allocation decisions.Our Plan also recognizes the importance of reducing society’s end-use emissions to meet global climate goals. As an upstream producer, we do not control how the commodities we sell into global markets are converted into different energy products or selected for use by consumers. This is why we have consistently taken a prominent role in advocating for a well-designed, economy wide price on carbon and engaged in development of other policies or legislation that could address end-use emissions from high-carbon intensity energy use. We have also expanded policy advocacy beyond carbon pricing to include regulatory action, such as support for the direct regulation of methane.In support of addressing our Scope 1 and 2 emissions, in 2022, we made progress in several key areas. We continued to refine our Paris-aligned climate risk strategy, joined the Oil and Gas Methane Partnership (OGMP) 2.0 Initiative and set a new near-zero 2030 methane emissions intensity target of approximately 0.15 percent of gas produced. Our emissions reduction efforts and net-zero ambition are supported by our multi-disciplinary Low-Carbon Technologies organization. See Item 1A—Risk Factors – Our ability to successfully execute on our energy transition plans is subject to a number of risks and uncertainties and may be costly to achieve.ConocoPhillips 2022 10-K58Table of ContentsCritical Accounting EstimatesThe preparation of financial statements in conformity with GAAP requires management to select appropriate accounting policies and to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. See Note 1 for descriptions of our major accounting policies. Certain of these accounting policies involve judgments and uncertainties to such an extent there is a reasonable likelihood materially different amounts would have been reported under different conditions, or if different assumptions had been used. These critical accounting estimates are discussed with the Audit and Finance Committee of the Board of Directors at least annually. We believe the following discussions of critical accounting estimates address all important accounting areas where the nature of accounting estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change.Oil and Gas AccountingAccounting for oil and gas activity is subject to special accounting rules unique to the oil and gas industry. The acquisition of G&G seismic information, prior to the discovery of proved reserves, is expensed as incurred, similar to accounting for research and development costs. However, leasehold acquisition costs and exploratory well costs are capitalized on the balance sheet pending determination of whether proved oil and gas reserves have been recognized.Property Acquisition CostsFor individually significant leaseholds, management periodically assesses for impairment based on exploration and drilling efforts to date. For insignificant individual leasehold acquisition costs, management exercises judgment and determines a percentage probability that the prospect ultimately will fail to find proved oil and gas reserves, including estimates of future expirations, and pools that leasehold information with others in similar geographic areas. For prospects in areas with limited, or no, previous exploratory drilling, the percentage probability of ultimate failure is normally judged to be quite high. This judgmental percentage is multiplied by the leasehold acquisition cost, and that product is divided by the contractual period of the leasehold to determine a periodic leasehold impairment charge that is reported in exploration expense. This judgmental probability percentage is reassessed and adjusted throughout the contractual period of the leasehold based on favorable or unfavorable exploratory activity on the leasehold or on adjacent leaseholds, and leasehold impairment amortization expense is adjusted prospectively.At year-end 2022, we held $6.5 billion of net capitalized unproved property costs which consisted primarily of individually significant and pooled leaseholds, mineral rights held in perpetuity by title ownership, exploratory wells currently being drilled, suspended exploratory wells and capitalized interest. Of this amount, approximately $4.7 billion is concentrated in the Delaware and Midland Basins, where we have an ongoing significant and active development program. Outside of the Delaware and Midland Basins, the remaining $1.8 billion is primarily concentrated in Canada and Alaska. Management periodically assesses our unproved property for impairment based on the results of exploration and drilling efforts and the outlook for commercialization.Exploratory CostsFor exploratory wells, drilling costs are temporarily capitalized, or “suspended,” on the balance sheet, pending a determination of whether potentially economic oil and gas reserves have been discovered by the drilling effort to justify development. If exploratory wells encounter potentially economic quantities of oil and gas, the well costs remain capitalized on the balance sheet as long as sufficient progress assessing the reserves and the economic and operating viability of the project is being made. The accounting notion of “sufficient progress” is a judgmental area, but the accounting rules do prohibit continued capitalization of suspended well costs on the expectation future market conditions will improve or new technologies will be found that would make the development economically profitable. Often, the ability to move into the development phase and record proved reserves is dependent on obtaining permits and government or co-venturer approvals, the timing of which is ultimately beyond our control. Exploratory well costs remain suspended as long as we are actively pursuing such approvals and permits, and believe they will be obtained. Once all required approvals and permits have been obtained, the projects are moved into the development phase, and the oil and gas reserves are designated as proved reserves.At year-end 2022, total suspended well costs were $527 million, compared with $660 million at year-end 2021. For additional information on suspended wells, including an aging analysis, see Note 6.59ConocoPhillips 2022 10-KTable of ContentsProved Reserves Engineering estimates of the quantities of proved reserves are inherently imprecise and represent only approximate amounts because of the judgments involved in developing such information. Reserve estimates are based on geological and engineering assessments of in-place hydrocarbon volumes, the production plan, historical extraction recovery and processing yield factors, installed plant operating capacity and approved operating limits. The reliability of these estimates at any point in time depends on both the quality and quantity of the technical and economic data and the efficiency of extracting and processing the hydrocarbons. Despite the inherent imprecision in these engineering estimates, accounting rules require disclosure of “proved” reserve estimates due to the importance of these estimates to better understand the perceived value and future cash flows of a company’s operations. There are several authoritative guidelines regarding the engineering criteria that must be met before estimated reserves can be designated as “proved.” Our geosciences and reservoir engineering organization has policies and procedures in place consistent with these authoritative guidelines. We have trained and experienced internal engineering personnel who estimate our proved reserves held by consolidated companies, as well as our share of equity affiliates. See “Supplementary Data - Oil and Gas Operations” for additional information. Proved reserve estimates are adjusted annually in the fourth quarter and during the year if significant changes occur and take into account recent production and subsurface information about each field. Also, as required by current authoritative guidelines, the estimated future date when an asset will reach the end of its economic life is based on 12-month average prices and current costs. This date estimates when production will end and affects the amount of estimated reserves. Therefore, as prices and cost levels change from year to year, the estimate of proved reserves also changes. Generally, our proved reserves decrease as prices decline and increase as prices rise.Our proved reserves include estimated quantities related to PSCs, reported under the “economic interest” method, as well as variable-royalty regimes, and are subject to fluctuations in commodity prices, recoverable operating expenses and capital costs. If costs remain stable, reserve quantities attributable to recovery of costs will change inversely to changes in commodity prices. We would expect reserves from these contracts to decrease when product prices rise and increase when prices decline. The estimation of proved reserves is also important to the income statement because the proved reserve estimate for a field serves as the denominator in the unit-of-production calculation of the DD&A of the capitalized costs for that asset. At year-end 2022, the net book value of productive PP&E subject to a unit-of-production calculation was approximately $55 billion and the DD&A recorded on these assets in 2022 was approximately $7.3 billion. The estimated proved developed reserves for our consolidated operations were 4.0 billion BOE at the end of 2021 and 3.8 billion BOE at the end of 2022. If the estimates of proved reserves used in the unit-of-production calculations had been lower by 10 percent across all calculations, before-tax DD&A in 2022 would have increased by an estimated $808 million. Business Combination—Valuation of Oil and Gas PropertiesFor business combinations, management applies the principles of acquisition accounting under FASB ASC Topic 805 – “Business Combinations” and allocates the purchase price to assets acquired and liabilities assumed, based on their estimated fair values as of the acquisition date. Estimating the fair values involves making various assumptions, of which the most significant assumptions relate to the fair values assigned to proved and unproved oil and gas properties. For significant business combinations, management generally utilizes a discounted cash flow approach, based on market participant assumptions, and engages third party valuation experts in preparing fair value estimates. Significant inputs incorporated within the valuation include future commodity price assumptions and production profiles of reserve estimates, the pace of drilling plans, future operating and development costs, inflation rates, and discount rates using a market-based weighted average cost of capital determined at the time of the acquisition. When estimating the fair value of unproved properties, additional risk-weighting adjustments are applied to probable and possible reserves.The assumptions and inputs incorporated within the fair value estimates are subject to considerable management judgement and are based on industry, market, and economic conditions prevalent at the time of the acquisition. Although we based these estimates on assumptions believed to be reasonable, these estimates are inherently unpredictable and uncertain and actual results could differ. See Note 3.ConocoPhillips 2022 10-K60Table of ContentsImpairmentsLong-lived assets used in operations are assessed for impairment whenever changes in facts and circumstances indicate a possible significant deterioration in the future cash flows expected to be generated by an asset group. If there is an indication the carrying amount of an asset may not be recovered, a recoverability test is performed using management’s assumptions for prices, volumes and future development plans. If the sum of the undiscounted cash flows before income-taxes is less than the carrying value of the asset group, the carrying value is written down to estimated fair value and reported as an impairment in the periods in which the determination is made. Individual assets are grouped for impairment purposes at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets—generally on a field-by-field basis for E&P assets. Because there usually is a lack of quoted market prices for long-lived assets, the fair value of impaired assets is typically determined based on the present values of expected future cash flows using discount rates and prices believed to be consistent with those used by principal market participants, or based on a multiple of operating cash flow validated with historical market transactions of similar assets where possible.The expected future cash flows used for impairment reviews and related fair value calculations are based on estimated future production volumes, commodity prices, operating costs and capital decisions, considering all available evidence at the date of review. Differing assumptions could affect the timing and the amount of an impairment in any period. See Note 6 and Note 7.Investments in nonconsolidated entities accounted for under the equity method are assessed for impairment whenever changes in the facts and circumstances indicate a loss in value has occurred. Such evidence of a loss in value might include our inability to recover the carrying amount, the lack of sustained earnings capacity which would justify the current investment amount, or a current fair value less than the investment’s carrying amount. When such a condition is judgmentally determined to be other than temporary, an impairment charge is recognized for the difference between the investment’s carrying value and its estimated fair value. When determining whether a decline in value is other than temporary, management considers factors such as the length of time and extent of the decline, the investee’s financial condition and near-term prospects, and our ability and intention to retain our investment for a period that will be sufficient to allow for any anticipated recovery in the market value of the investment. Since quoted market prices are usually not available, the fair value is typically based on the present value of expected future cash flows using discount rates and prices believed to be consistent with those used by principal market participants, plus market analysis of comparable assets owned by the investee, if appropriate. Differing assumptions could affect the timing and the amount of an impairment of an investment in any period. See the “APLNG” section of Note 4.Asset Retirement Obligations and Environmental CostsUnder various contracts, permits and regulations, we have material legal obligations to remove tangible equipment and restore the land or seabed at the end of operations at operational sites. Our largest asset removal obligations involve plugging and abandonment of wells, removal and disposal of offshore oil and gas platforms around the world, as well as oil and gas production facilities and pipelines in Alaska. Fair value is estimated using a present value approach, incorporating assumptions about estimated amounts and timing of settlements and impacts of the use of technologies. Estimating future asset removal costs requires significant judgement. Most of these removal obligations are many years, or decades, in the future and the contracts and regulations often have vague descriptions of what removal practices and criteria must be met when the removal event actually occurs. The carrying value of our asset retirement obligation estimate is sensitive to inputs such as asset removal technologies and costs, regulatory and other compliance considerations, expenditure timing, and other inputs into valuation of the obligation, including discount and inflation rates, which are all subject to change between the time of initial recognition of the liability and future settlement of our obligation. Normally, changes in asset removal obligations are reflected in the income statement as increases or decreases to DD&A over the remaining life of the assets. However, for assets at or nearing the end of their operations, as well as previously sold assets for which we retained the asset removal obligation, an increase in the asset removal obligation can result in an immediate charge to earnings, because any increase in PP&E due to the increased obligation would immediately be subject to impairment, due to the low fair value of these properties. In addition to asset removal obligations, under the above or similar contracts, permits and regulations, we have certain environmental-related projects. These are primarily related to remediation activities required by Canada and various states within the U.S. at exploration and production sites. Future environmental remediation costs are difficult to estimate because they are subject to change due to such factors as the uncertain magnitude of cleanup costs, the unknown time and extent of such remedial actions that may be required, and the determination of our liability in proportion to that of other responsible parties. See Note 8.61ConocoPhillips 2022 10-KTable of ContentsProjected Benefit ObligationsThe actuarial determination of projected benefit obligations and company contribution requirements involves judgment about uncertain future events, including estimated retirement dates, salary levels at retirement, mortality rates, lump-sum election rates, rates of return on plan assets, future health care cost-trend rates, and rates of utilization of health care services by retirees. Due to the specialized nature of these calculations, we engage outside actuarial firms to assist in the determination of these projected benefit obligations and company contribution requirements. Ultimately, we will be required to fund all vested benefits under pension and postretirement benefit plans not funded by plan assets or investment returns, but the judgmental assumptions used in the actuarial calculations significantly affect periodic financial statements and funding patterns over time. Projected benefit obligations are particularly sensitive to the discount rate assumption. A 100 basis-point decrease in the discount rate assumption would increase projected benefit obligations by $600 million. Benefit expense is sensitive to the discount rate and return on plan assets assumptions. A 100 basis-point decrease in the discount rate assumption would increase annual benefit expense by $50 million, while a 100 basis-point decrease in the return on plan assets assumption would increase annual benefit expense by $40 million. In determining the discount rate, we use yields on high-quality fixed income investments matched to the estimated benefit cash flows of our plans. We are also exposed to the possibility that lump sum retirement benefits taken from pension plans during the year could exceed the total of service and interest components of annual pension expense and trigger accelerated recognition of a portion of unrecognized net actuarial losses and gains. These benefit payments are based on decisions by plan participants and are therefore difficult to predict. In the event there is a significant reduction in the expected years of future service of present employees or the elimination of the accrual of defined benefits for some or all of their future services for a significant number of employees, we could recognize a curtailment gain or loss. See Note 16.ContingenciesA number of claims and lawsuits are made against the company arising in the ordinary course of business. Management exercises judgment related to accounting and disclosure of these claims which includes losses, damages, and underpayments associated with environmental remediation, tax, contracts, and other legal disputes. As we learn new facts concerning contingencies, we reassess our position both with respect to amounts recognized and disclosed considering changes to the probability of additional losses and potential exposure. However, actual losses can and do vary from estimates for a variety of reasons including legal, arbitration, or other third-party decisions; settlement discussions; evaluation of scope of damages; interpretation of regulatory or contractual terms; expected timing of future actions; and proportion of liability shared with other responsible parties. Estimated future costs related to contingencies are subject to change as events evolve and as additional information becomes available during the administrative and litigation processes. For additional information on contingent liabilities, see the “Contingencies” section within “Capital Resources and Liquidity” and Note 11.Income TaxesWe are subject to income taxation in numerous jurisdictions worldwide. We record deferred tax assets and liabilities to account for the expected future tax consequences of events that have been recognized in our financial statements and our tax returns. We routinely assess our deferred tax assets and reduce such assets by a valuation allowance if we deem it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. In assessing the need for adjustments to existing valuation allowances, we consider all available positive and negative evidence. Positive evidence includes reversals of temporary differences, forecasts of future taxable income, assessment of future business assumptions and applicable tax planning strategies that are prudent and feasible. Negative evidence includes losses in recent years as well as the forecasts of future net income (loss) in the realizable period. In making our assessment regarding valuation allowances, we weight the evidence based on objectivity. Numerous judgments and assumptions are inherent in the determination of future taxable income, including factors such as future operating conditions and the assessment of the effects of foreign taxes on our U.S. federal income taxes (particularly as related to prevailing oil and gas prices). See Note 17.We regularly assess and, if required, establish accruals for uncertain tax positions that could result from assessments of additional tax by taxing jurisdictions in countries where we operate. We recognize a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, based on the technical merits of the position. These accruals for uncertain tax positions are subject to a significant amount of judgment and are reviewed and adjusted on a periodic basis in light of changing facts and circumstances considering the progress of ongoing tax audits, court proceedings, changes in applicable tax laws, including tax case rulings and legislative guidance, or expiration of the applicable statute of limitations. See Note 17.ConocoPhillips 2022 10-K62Table of ContentsCautionary Statement for the Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995This report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact included or incorporated by reference in this report, including, without limitation, statements regarding our future financial position, business strategy, budgets, projected revenues, projected costs and plans, and objectives of management for future operations, are forward-looking statements. Examples of forward-looking statements contained in this report include our expected production growth and outlook on the business environment generally, our expected capital budget and capital expenditures, and discussions concerning future dividends. You can often identify our forward-looking statements by the words “anticipate,” “believe,” “budget,” “continue,” “could,” “effort,” “estimate,” “expect,” “forecast,” “intend,” “goal,” “guidance,” “may,” “objective,” “outlook,” “plan,” “potential,” “predict,” “projection,” “seek,” “should,” “target,” “will,” “would” and similar expressions. We based the forward-looking statements on our current expectations, estimates and projections about ourselves and the industries in which we operate in general. We caution you these statements are not guarantees of future performance as they involve assumptions that, while made in good faith, may prove to be incorrect, and involve risks and uncertainties we cannot predict. In addition, we based many of these forward-looking statements on assumptions about future events that may prove to be inaccurate. Accordingly, our actual outcomes and results may differ materially from what we have expressed or forecast in the forward-looking statements. Any differences could result from a variety of factors and uncertainties, including, but not limited to, the following: •Fluctuations in crude oil, bitumen, natural gas, LNG and NGLs prices, including a prolonged decline in these prices relative to historical or future expected levels.•Global and regional changes in the demand, supply, prices, differentials or other market conditions affecting oil and gas, including changes as a result of any ongoing military conflict, including the conflict between Russia and Ukraine, and the global response to such conflict, security threats on facilities and infrastructure, or from a public health crisis or from the imposition or lifting of crude oil production quotas or other actions that might be imposed by OPEC and other producing countries and the resulting company or third-party actions in response to such changes.•The impact of significant declines in prices for crude oil, bitumen, natural gas, LNG and NGLs, which may result in recognition of impairment charges on our long-lived assets, leaseholds and nonconsolidated equity investments.•The potential for insufficient liquidity or other factors, such as those described herein, that could impact our ability to repurchase shares and declare and pay dividends, whether fixed or variable.•Potential failures or delays in achieving expected reserve or production levels from existing and future oil and gas developments, including due to operating hazards, drilling risks and the inherent uncertainties in predicting reserves and reservoir performance.•Reductions in reserves replacement rates, whether as a result of the significant declines in commodity prices or otherwise.•Unsuccessful exploratory drilling activities or the inability to obtain access to exploratory acreage.•Unexpected changes in costs, inflationary pressures or technical requirements for constructing, modifying or operating E&P facilities.•Legislative and regulatory initiatives addressing environmental concerns, including initiatives addressing the impact of global climate change or further regulating hydraulic fracturing, methane emissions, flaring or water disposal.•Significant operational or investment changes imposed by existing or future environmental statutes and regulations, including international agreements and national or regional legislation and regulatory measures to limit or reduce GHG emissions.•Substantial investment in and development use of, competing or alternative energy sources, including as a result of existing or future environmental rules and regulations.•The impact of broader societal attention to and efforts to address climate change may impact our access to capital and insurance.•Potential failures or delays in delivering on our current or future low-carbon strategy, including our inability to develop new technologies.•The impact of public health crises, including pandemics (such as COVID-19) and epidemics and any related company or government policies or actions.63ConocoPhillips 2022 10-KTable of Contents•Lack of, or disruptions in, adequate and reliable transportation for our crude oil, bitumen, natural gas, LNG and NGLs.•Inability to timely obtain or maintain permits, including those necessary for construction, drilling and/or development, or inability to make capital expenditures required to maintain compliance with any necessary permits or applicable laws or regulations.•Failure to complete definitive agreements and feasibility studies for, and to complete construction of, announced and future E&P and LNG development in a timely manner (if at all) or on budget.•Potential disruption or interruption of our operations and any resulting consequences due to accidents, extraordinary weather events, supply chain disruptions, civil unrest, political events, war, terrorism, cybersecurity threats, and information technology failures, constraints or disruptions.•Changes in international monetary conditions and foreign currency exchange rate fluctuations.•Changes in international trade relationships, including the imposition of trade restrictions or tariffs relating to crude oil, bitumen, natural gas, LNG, NGLs and any materials or products (such as aluminum and steel) used in the operation of our business, including any sanctions imposed as a result of any ongoing military conflict, including the conflict between Russia and Ukraine.•Liability for remedial actions, including removal and reclamation obligations, under existing and future environmental regulations and litigation.•Liability resulting from litigation, including litigation directly or indirectly related to the transaction with Concho Resources Inc., or our failure to comply with applicable laws and regulations. •General domestic and international economic and political developments, including armed hostilities; expropriation of assets; changes in governmental policies relating to crude oil, bitumen, natural gas, LNG and NGLs pricing, including the imposition of price caps; regulation or taxation; and other political, economic or diplomatic developments, including as a result of any ongoing military conflict, including the conflict between Russia and Ukraine.•Volatility in the commodity futures markets.•Changes in tax and other laws, regulations (including alternative energy mandates) or royalty rules applicable to our business.•Competition and consolidation in the oil and gas E&P industry, including competition for personnel and equipment.•Any limitations on our access to capital or increase in our cost of capital, including as a result of illiquidity or uncertainty in domestic or international financial markets or investment sentiment, including as a result of increased societal attention to and efforts to address climate change.•Our inability to execute, or delays in the completion of, any asset dispositions or acquisitions we elect to pursue. •Potential failure to obtain, or delays in obtaining, any necessary regulatory approvals for pending or future asset dispositions or acquisitions, or that such approvals may require modification to the terms of the transactions or the operation of our remaining business.•Potential disruption of our operations as a result of pending or future asset dispositions or acquisitions, including the diversion of management time and attention.•Our inability to deploy the net proceeds from any asset dispositions that are pending or that we elect to undertake in the future in the manner and timeframe we currently anticipate, if at all.•The operation and financing of our joint ventures.•The ability of our customers and other contractual counterparties to satisfy their obligations to us, including our ability to collect payments when due from the government of Venezuela or PDVSA. •Our inability to realize anticipated cost savings and capital expenditure reductions.•The inadequacy of storage capacity for our products, and ensuing curtailments, whether voluntary or involuntary, required to mitigate this physical constraint.•The risk that we will be unable to retain and hire key personnel.•Uncertainty as to the long-term value of our common stock.•The factors generally described in Part I—Item 1A in this 2022 Annual Report on Form 10-K and any additional risks described in our other filings with the SEC.ConocoPhillips 2022 10-K64Table of ContentsItem 7A. Quantitative and Qualitative Disclosures about Market RiskFinancial Instrument Market RiskWe and certain of our subsidiaries hold and issue derivative contracts and financial instruments that expose our cash flows or earnings to changes in commodity prices, foreign currency exchange rates or interest rates. We may use financial and commodity-based derivative contracts to manage the risks produced by changes in the prices of natural gas, crude oil and related products; fluctuations in interest rates and foreign currency exchange rates; or to capture market opportunities.Our use of derivative instruments is governed by an “Authority Limitations” document approved by our Board of Directors that prohibits the use of highly leveraged derivatives or derivative instruments without sufficient liquidity. The Authority Limitations document also establishes the Value at Risk (VaR) limits for the company, and compliance with these limits is monitored daily. The Executive Vice President and Chief Financial Officer, who reports to the Chief Executive Officer, monitors commodity price risk and risks resulting from foreign currency exchange rates and interest rates. The Commercial organization manages our commercial marketing, optimizes our commodity flows and positions, and monitors risks. Commodity Price RiskOur Commercial organization uses futures, forwards, swaps and options in various markets to accomplish the following objectives:•Consistent with our policy to generally remain exposed to market prices, we use swap contracts to convert fixed-price sales contracts, which are often requested by natural gas consumers, to floating market prices.•Enable us to use market knowledge to capture opportunities such as moving physical commodities to more profitable locations and storing commodities to capture seasonal or time premiums. We may use derivatives to optimize these activities. We use a VaR model to estimate the loss in fair value that could potentially result on a single day from the effect of adverse changes in market conditions on the derivative financial instruments and derivative commodity contracts we hold or issue, including commodity purchases and sales contracts recorded on the balance sheet at December 31, 2022. Using Monte Carlo simulation, a 95 percent confidence level and a one-day holding period, the VaR for those instruments issued or held for trading purposes or held for purposes other than trading at December 31, 2022 and 2021, was immaterial to our consolidated cash flows and net income attributable to ConocoPhillips. 65ConocoPhillips 2022 10-KTable of ContentsInterest Rate RiskThe following table provides information about our debt instruments that are sensitive to changes in U.S. interest rates. The table presents principal cash flows and related weighted-average interest rates by expected maturity dates. Weighted-average variable rates are based on effective rates at the reporting date. The carrying amount of our floating-rate debt approximates its fair value. A hypothetical 10 percent change in prevailing interest rates would not have a material impact on interest expense associated with our floating-rate debt. The fair value of the fixed-rate debt is measured using prices available from a pricing service that is corroborated by market data. Changes to prevailing interest rates would not impact our cash flows associated with fixed rate debt, unless we elect to repurchase or retire such debt prior to maturity. Millions of Dollars Except as Indicated DebtExpected Maturity DateFixedRateMaturityAverageInterestRateFloatingRateMaturityAverageInterestRateYear-End 20222023$110 7.04 %20241,359 2.59 20251,268 3.25 2026104 6.41 2027438 5.79 Remaining years12,293 5.45 283 3.91 %Total$15,572 $283 Fair value$15,262 $283 Year-End 20212022$346 2.53 %$500 1.03 %2023116 6.64 — — 2024459 3.51 — — 2025369 5.32 — — 20261,355 5.06 — — Remaining years14,338 5.80 283 0.11 Total$16,983 $783 Fair value$21,668 $783 ConocoPhillips 2022 10-K66Table of ContentsForeign Currency Exchange RiskWe have foreign currency exchange rate risk resulting from international operations. We do not comprehensively hedge the exposure to currency exchange rate changes although we may choose to selectively hedge certain foreign currency exchange rate exposures, such as firm commitments for capital projects or local currency tax payments, dividends and cash returns from net investments in foreign affiliates to be remitted within the coming year, investments in equity securities and acquisitions.At December 31, 2022 and 2021, we held foreign currency exchange forwards hedging cross-border commercial activity and foreign currency exchange swaps for purposes of mitigating our cash-related exposures. Although these forwards and swaps hedge exposures to fluctuations in exchange rates, we elected not to utilize hedge accounting. As a result, the change in the fair value of these foreign currency exchange derivatives is recorded directly in earnings.At December 31, 2022, we had outstanding foreign currency exchange forward swap contracts. Since the gain or loss on the swaps is offset by the gain or loss from remeasuring cash related balances, and since our aggregate position in the forwards was not material, there would be no material impact to our income from an adverse hypothetical 10 percent change in the December 2022 exchange rates.At December 31, 2021, we had outstanding foreign currency exchange forward contracts to buy $1.9 billion AUD at $0.715 AUD against the U.S. dollar. Based on the assumed volatility in the fair value calculation, the net fair value of these foreign currency contracts at December 31, 2021, was a before-tax gain of $21 million. Based on an adverse hypothetical 10 percent change in the December 31, 2021 exchange rate, this would result in an additional before-tax loss of $134 million. The sensitivity analysis is based on changing one assumption while holding all other assumptions constant, which in practice may be unlikely to occur, as changes in some of the assumptions may be correlated. The contracts settled in the first quarter of 2022. The gross notional and fair value of these positions at December 31, 2022 and 2021, were as follows:Foreign Currency Exchange DerivativesIn MillionsNotionalFair Value*2022202120222021Buy Canadian dollar, sell U.S. dollarCAD15 77 (1)(1)Buy Australian dollar, sell U.S. dollarAUD— 1,850 — 21 Sell British pound, buy euroGBP312 239 7 (8)Buy British pound, sell euroGBP264 394 (10)7 *Denominated in USD.67ConocoPhillips 2022 10-KTable of ContentsItem 8. Financial Statements and Supplementary DataConocoPhillipsIndex to Financial StatementsPageReports of Management69Reports of Independent Registered Public Accounting Firm (PCAOB ID #42)70Consolidated Income Statement for the years ended December 31, 2022, 2021 and 202074Consolidated Statement of Comprehensive Income for the years ended December 31, 2022, 2021 and 202075Consolidated Balance Sheet at December 31, 2022 and 202176Consolidated Statement of Cash Flows for the years ended December 31, 2022, 2021 and 202077Consolidated Statement of Changes in Equity for the years endedDecember 31, 2022, 2021 and 202078Notes to Consolidated Financial Statements79Supplementary InformationOil and Gas Operations134ConocoPhillips 2022 10-K68Table of ContentsReports of ManagementManagement prepared, and is responsible for, the consolidated financial statements and the other information appearing in this annual report. The consolidated financial statements present fairly the company’s financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States. In preparing its consolidated financial statements, the company includes amounts that are based on estimates and judgments management believes are reasonable under the circumstances. The company’s financial statements have been audited by Ernst & Young LLP, an independent registered public accounting firm appointed by the Audit and Finance Committee of the Board of Directors and ratified by stockholders. Management has made available to Ernst & Young LLP all of the company’s financial records and related data, as well as the minutes of stockholders’ and directors’ meetings.Assessment of Internal Control Over Financial ReportingManagement is also responsible for establishing and maintaining adequate internal control over financial reporting. ConocoPhillips’ internal control system was designed to provide reasonable assurance to the company’s management and directors regarding the preparation and fair presentation of published financial statements.All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2022. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework (2013). Based on our assessment, we believe the company’s internal control over financial reporting was effective as of December 31, 2022.Ernst & Young LLP has issued an audit report on the company’s internal control over financial reporting as of December 31, 2022, and their report is included herein./s/ Ryan M. Lance/s/ William L. Bullock, Jr.Ryan M. LanceWilliam L. Bullock, Jr.Chairman andChief Executive OfficerExecutive Vice President and Chief Financial Officer 69ConocoPhillips 2022 10-KTable of ContentsReport of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of ConocoPhillipsOpinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of ConocoPhillips (the Company) as of December 31, 2022 and 2021, the related consolidated income statement, consolidated statements of comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 16, 2023 expressed an unqualified opinion thereon.Basis for OpinionThese financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the Audit and Finance Committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.ConocoPhillips 2022 10-K70Table of ContentsAccounting for asset retirement obligations for certain offshore propertiesDescription of the MatterAt December 31, 2022, asset retirement obligations (ARO) totaled $6.4 billion. As further described in Note 8, the Company records ARO in the period in which they are incurred, typically when the asset is installed at the production location. The estimation of obligations related to certain offshore assets requires significant judgment given the magnitude and higher estimation uncertainty related to plugging and abandonment of wells and removal and disposal of offshore oil and gas platforms and facilities (collectively, removal costs). Furthermore, as certain of these assets are nearing the end of their operations, the impact of changes in these ARO may result in a material impact to earnings given the relatively short remaining useful lives of the assets.Auditing the Company’s ARO for the obligations identified above is complex and highly judgmental due to the significant estimation required by management in determining the obligations. In particular, the estimates were sensitive to significant subjective assumptions such as removal cost estimates and end of field life, which are affected by expectations about future market or economic conditions.How We Addressed the Matter in Our AuditWe obtained an understanding, evaluated the design and tested the operating effectiveness of the Company’s internal controls over its ARO estimation process, including management’s review of the significant assumptions that have a material effect on the determination of the obligations. We also tested management’s controls over the completeness and accuracy of the financial data used in the valuation.To test the ARO for the obligations identified above, our audit procedures included, among others, assessing the significant assumptions and inputs used in the valuation, including removal cost estimates and end of field life assumptions. For example, we evaluated removal cost estimates by comparing to settlements and recent removal activities and costs. We also compared end of field life assumptions to production forecasts. Depreciation, depletion and amortization of proved oil and gas properties, plants and equipmentDescription of the MatterAt December 31, 2022, the net book value of the Company’s proved oil and gas properties, plants and equipment (PP&E) was $55 billion, and depreciation, depletion and amortization (DD&A) expense was $7.3 billion for the year then ended. As described in Note 1, under the successful efforts method of accounting, DD&A of PP&E on producing hydrocarbon properties and steam-assisted gravity drainage facilities and certain pipeline and liquified natural gas assets (those which are expected to have a declining utilization pattern) are determined by the unit-of-production method. The unit-of-production method uses proved oil and gas reserves, as estimated by the Company’s internal reservoir engineers.Proved oil and gas reserves estimates are based on geological and engineering assessments of in-place hydrocarbon volumes, the production plan, historical extraction recovery and processing yield factors, installed plant operating capacity and approved operating limits. Significant judgment is required by the Company’s internal reservoir engineers in evaluating geological and engineering data when estimating proved oil and gas reserves. Estimating proved oil and gas reserves also requires the selection of inputs, including oil and gas price assumptions, future operating and capital costs assumptions and tax rates by jurisdiction, among others. Because of the complexity involved in estimating proved oil and gas reserves, management also used an independent petroleum engineering consulting firm to perform a review of the processes and controls used by the Company’s internal reservoir engineers to determine estimates of proved oil and gas reserves.Auditing the Company’s DD&A calculation is complex because of the use of the work of the internal reservoir engineers and the independent petroleum engineering consulting firm and the evaluation of management’s determination of the inputs described above used by the internal reservoir engineers in estimating proved oil and gas reserves. 71ConocoPhillips 2022 10-KTable of ContentsHow We Addressed the Matter in Our AuditWe obtained an understanding, evaluated the design and tested the operating effectiveness of the Company’s internal controls over its processes to calculate DD&A, including management’s controls over the completeness and accuracy of the financial data provided to the internal reservoir engineers for use in estimating proved oil and gas reserves.Our audit procedures included, among others, evaluating the professional qualifications and objectivity of the Company’s internal reservoir engineers primarily responsible for overseeing the preparation of the proved oil and gas reserves estimates and the independent petroleum engineering consulting firm used to review the Company’s processes and controls. In addition, in assessing whether we can use the work of the internal reservoir engineers, we evaluated the completeness and accuracy of the financial data and inputs described above used by the internal reservoir engineers in estimating proved oil and gas reserves by agreeing them to source documentation and we identified and evaluated corroborative and contrary evidence. We also tested the accuracy of the DD&A calculation, including comparing the proved oil and gas reserves amounts used in the calculation to the Company’s reserve report. /s/ Ernst & Young LLPWe have served as ConocoPhillips’ auditor since 1949.Houston, TexasFebruary 16, 2023ConocoPhillips 2022 10-K72Table of ContentsReport of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of ConocoPhillipsOpinion on Internal Control over Financial ReportingWe have audited ConocoPhillips’ internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, ConocoPhillips (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on the COSO criteria.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated income statement, consolidated statements of comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2022, and the related notes and our report dated February 16, 2023 expressed an unqualified opinion thereon. Basis for OpinionThe Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included under the heading “Assessment of Internal Control Over Financial Reporting” in the accompanying “Reports of Management.” Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial ReportingA company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ Ernst & Young LLPHouston, TexasFebruary 16, 202373ConocoPhillips 2022 10-KFinancial StatementsTable of ContentsConsolidated Income StatementConocoPhillipsYears Ended December 31Millions of Dollars202220212020Revenues and Other IncomeSales and other operating revenues$78,494 45,828 18,784 Equity in earnings of affiliates2,081 832 432 Gain on dispositions1,077 486 549 Other income (loss)504 1,203 (509)Total Revenues and Other Income82,156 48,349 19,256 Costs and ExpensesPurchased commodities33,971 18,158 8,078 Production and operating expenses7,006 5,694 4,344 Selling, general and administrative expenses623 719 430 Exploration expenses564 344 1,457 Depreciation, depletion and amortization7,504 7,208 5,521 Impairments(12)674 813 Taxes other than income taxes3,364 1,634 754 Accretion on discounted liabilities250 242 252 Interest and debt expense805 884 806 Foreign currency transaction gains(100)(22)(72)Other expenses(47)102 13 Total Costs and Expenses53,928 35,637 22,396 Income (loss) before income taxes28,228 12,712 (3,140)Income tax provision (benefit)9,548 4,633 (485)Net income (loss)18,680 8,079 (2,655)Less: net income attributable to noncontrolling interests— — (46)Net Income (Loss) Attributable to ConocoPhillips$18,680 8,079 (2,701)Net Income (Loss) Attributable to ConocoPhillips Per Share of Common Stock (dollars) Basic$14.62 6.09 (2.51)Diluted14.57 6.07 (2.51)Average Common Shares Outstanding (in thousands) Basic1,274,028 1,324,194 1,078,030 Diluted1,278,163 1,328,151 1,078,030 See Notes to Consolidated Financial Statements.ConocoPhillips 2022 10-K74Financial StatementsTable of ContentsConsolidated Statement of Comprehensive IncomeConocoPhillipsYears Ended December 31Millions of Dollars202220212020Net Income (Loss)$18,680 8,079 (2,655)Other comprehensive income (loss)Defined benefit plansPrior service (cost) credit arising during the period(10)— 29 Reclassification adjustment for amortization of prior service credit included in net income (loss)(39)(38)(32)Net change(49)(38)(3)Net actuarial gain (loss) arising during the period(623)357 (210)Reclassification adjustment for amortization of net actuarial losses included in net income (loss)72 178 117 Net change(551)535 (93)Nonsponsored plans*5 5 1 Income taxes on defined benefit plans178 (108)20 Defined benefit plans, net of tax(417)394 (75)Unrealized holding gain (loss) on securities(13)(2)2 Reclassification adjustment for loss included in net income(1)(1)— Income taxes on unrealized holding loss on securities3 1 — Unrealized holding gain (loss) on securities, net of tax(11)(2)2 Foreign currency translation adjustments(623)(124)209 Income taxes on foreign currency translation adjustments1 — 3 Foreign currency translation adjustments, net of tax(622)(124)212 Other Comprehensive Income (Loss), Net of Tax(1,050)268 139 Comprehensive Income (Loss)17,630 8,347 (2,516)Less: comprehensive income attributable to noncontrolling interests— — (46)Comprehensive Income (Loss) Attributable to ConocoPhillips$17,630 8,347 (2,562)*Plans for which ConocoPhillips is not the primary obligor—primarily those administered by equity affiliates.See Notes to Consolidated Financial Statements.75ConocoPhillips 2022 10-KFinancial StatementsTable of ContentsConsolidated Balance SheetConocoPhillipsAt December 31Millions of Dollars20222021AssetsCash and cash equivalents$6,458 5,028 Short-term investments2,785 446 Accounts and notes receivable (net of allowance of $2 and $2, respectively)7,075 6,543 Accounts and notes receivable—related parties13 127 Investment in Cenovus Energy— 1,117 Inventories1,219 1,208 Prepaid expenses and other current assets1,199 1,581 Total Current Assets18,749 16,050 Investments and long-term receivables8,225 7,113 Net properties, plants and equipment (net of accumulated DD&A of $66,630 and $64,735, respectively)64,866 64,911 Other assets1,989 2,587 Total Assets$93,829 90,661 LiabilitiesAccounts payable$6,113 5,002 Accounts payable—related parties50 23 Short-term debt417 1,200 Accrued income and other taxes3,193 2,862 Employee benefit obligations728 755 Other accruals2,346 2,179 Total Current Liabilities12,847 12,021 Long-term debt16,226 18,734 Asset retirement obligations and accrued environmental costs6,401 5,754 Deferred income taxes7,726 6,179 Employee benefit obligations1,074 1,153 Other liabilities and deferred credits1,552 1,414 Total Liabilities45,826 45,255 EquityCommon stock (2,500,000,000 shares authorized at $0.01 par value) Issued (2022—2,100,885,134 shares; 2021—2,091,562,747 shares) Par value21 21 Capital in excess of par61,142 60,581 Treasury stock (at cost: 2022—877,029,062 shares; 2021—789,319,875 shares)(60,189)(50,920)Accumulated other comprehensive loss(6,000)(4,950)Retained earnings53,029 40,674 Total Equity48,003 45,406 Total Liabilities and Equity$93,829 90,661 See Notes to Consolidated Financial Statements.ConocoPhillips 2022 10-K76Financial StatementsTable of ContentsConsolidated Statement of Cash FlowsConocoPhillipsYears Ended December 31Millions of Dollars202220212020Cash Flows From Operating ActivitiesNet income (loss)$18,680 8,079 (2,655)Adjustments to reconcile net income (loss) to net cash provided by operating activitiesDepreciation, depletion and amortization7,504 7,208 5,521 Impairments(12)674 813 Dry hole costs and leasehold impairments340 44 1,083 Accretion on discounted liabilities250 242 252 Deferred taxes2,086 1,346 (834)Undistributed equity earnings942 446 645 Gain on dispositions(1,077)(486)(549)(Gain) loss on investment in Cenovus Energy(251)(1,040)855 Other86 (788)43 Working capital adjustmentsDecrease (increase) in accounts and notes receivable(963)(2,500)521 Increase in inventories(38)(160)(25)Decrease (increase) in prepaid expenses and other current assets(173)(649)76 Increase (decrease) in accounts payable901 1,399 (249)Increase (decrease) in taxes and other accruals39 3,181 (695)Net Cash Provided by Operating Activities28,314 16,996 4,802 Cash Flows From Investing ActivitiesCapital expenditures and investments(10,159)(5,324)(4,715)Working capital changes associated with investing activities520 134 (155)Acquisition of businesses, net of cash acquired(60)(8,290)— Proceeds from asset dispositions3,471 1,653 1,317 Net sales (purchases) of investments(2,629)3,091 (658)Collection of advances/loans—related parties114 105 116 Other2 87 (26)Net Cash Used in Investing Activities(8,741)(8,544)(4,121)Cash Flows From Financing ActivitiesIssuance of debt2,897 — 300 Repayment of debt(6,267)(505)(254)Issuance of company common stock362 145 (5)Repurchase of company common stock(9,270)(3,623)(892)Dividends paid(5,726)(2,359)(1,831)Other(49)7 (26)Net Cash Used in Financing Activities(18,053)(6,335)(2,708)Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash(224)(34)(20)Net Change in Cash, Cash Equivalents and Restricted Cash1,296 2,083 (2,047)Cash, cash equivalents and restricted cash at beginning of period5,398 3,315 5,362 Cash, Cash Equivalents and Restricted Cash at End of Period$6,694 5,398 3,315 Restricted cash of $236 million is included in the “Other assets” line of our Consolidated Balance Sheet as of December 31, 2022.Restricted cash of $152 million and $218 million is included in the “Prepaid expenses and other current assets” and “Other assets” lines, respectively, of our Consolidated Balance Sheet as of December 31, 2021. See Notes to Consolidated Financial Statements.77ConocoPhillips 2022 10-KFinancial StatementsTable of ContentsConsolidated Statement of Changes in EquityConocoPhillipsMillions of DollarsAttributable to ConocoPhillipsCommon StockPar ValueCapital in Excess of ParTreasury StockAccum. Other Comprehensive Income (Loss)Retained EarningsNon-Controlling InterestsTotalBalances at December 31, 2019$18 46,983 (46,405)(5,357)39,742 69 35,050 Net income (loss)(2,701)46 (2,655)Other comprehensive income (loss)139 139 Dividends declared—ordinary ($1.69 per share of common stock)(1,831)(1,831)Repurchase of company common stock(892)(892)Distributions to noncontrolling interests and other(32)(32)Disposition(84)(84)Distributed under benefit plans150 150 Other3 1 4 Balances at December 31, 2020$18 47,133 (47,297)(5,218)35,213 — 29,849 Net income (loss)8,079 8,079 Other comprehensive income (loss)268 268 Dividends declaredOrdinary ($1.75 per share of common stock)(2,359)(2,359)Variable return of cash ($0.20 per share of common stock)(260)(260)Acquisition of Concho3 13,122 13,125 Repurchase of company common stock(3,623)(3,623)Distributed under benefit plans326 326 Other1 1 Balances at December 31, 2021$21 60,581 (50,920)(4,950)40,674 — 45,406 Net income (loss) 18,680 18,680 Other comprehensive income (loss) (1,050) (1,050)Dividends declared Ordinary ($1.89 per share of common stock) (2,419) (2,419)Variable return of cash ($3.10 per share of common stock) (3,908) (3,908)Repurchase of company common stock (9,270) (9,270)Distributed under benefit plans 561 561 Other 1 2 3 Balances at December 31, 2022$21 61,142 (60,189)(6,000)53,029 — 48,003 ConocoPhillips 2022 10-K78Notes to Consolidated Financial StatementsTable of ContentsNotes to Consolidated Financial StatementsNote 1—Accounting Policies•Consolidation Principles and Investments—Our consolidated financial statements include the accounts of majority-owned, controlled subsidiaries and, if applicable, variable interest entities where we are the primary beneficiary. The equity method is used to account for investments in affiliates in which we have the ability to exert significant influence over the affiliates’ operating and financial policies. When we do not have the ability to exert significant influence, the investment is measured at fair value except when the investment does not have a readily determinable fair value. For those exceptions, it will be measured at cost minus impairment, plus or minus observable price changes in orderly transactions for an identical or similar investment of the same issuer. Undivided interests in oil and gas joint ventures, pipelines, natural gas plants and terminals are consolidated on a proportionate basis. Other securities and investments are generally carried at cost. We manage our operations through six operating segments, defined by geographic region: Alaska; Lower 48; Canada; Europe, Middle East and North Africa; Asia Pacific; and Other International. See Note 24.•Foreign Currency Translation—Adjustments resulting from the process of translating foreign functional currency financial statements into U.S. dollars are included in accumulated other comprehensive loss in common stockholders’ equity. Foreign currency transaction gains and losses are included in current earnings. Some of our foreign operations use their local currency as the functional currency.•Use of Estimates—The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosures of contingent assets and liabilities. Actual results could differ from these estimates.•Revenue Recognition—Revenues associated with the sales of crude oil, bitumen, natural gas, LNG, NGLs and other items are recognized at the point in time when the customer obtains control of the asset. In evaluating when a customer has control of the asset, we primarily consider whether the transfer of legal title and physical delivery has occurred, whether the customer has significant risks and rewards of ownership and whether the customer has accepted delivery and a right to payment exists. These products are typically sold at prevailing market prices. We allocate variable market-based consideration to deliveries (performance obligations) in the current period as that consideration relates specifically to our efforts to transfer control of current period deliveries to the customer and represents the amount we expect to be entitled to in exchange for the related products. Payment is typically due within 30 days or less.Revenues associated with transactions commonly called buy/sell contracts, in which the purchase and sale of inventory with the same counterparty are entered into “in contemplation” of one another, are combined and reported net (i.e., on the same income statement line).•Shipping and Handling Costs—We typically incur shipping and handling costs prior to control transferring to the customer and account for these activities as fulfillment costs. Accordingly, we include shipping and handling costs in production and operating expenses for production activities. Transportation costs related to marketing activities are recorded in purchased commodities. Freight costs billed to customers are treated as a component of the transaction price and recorded as a component of revenue when the customer obtains control. •Cash Equivalents—Cash equivalents are highly liquid, short-term investments that are readily convertible to known amounts of cash and have original maturities of 90 days or less from their date of purchase. They are carried at cost plus accrued interest, which approximates fair value.•Short-Term Investments—Short-term investments include investments in bank time deposits and marketable securities (commercial paper and government obligations) which are carried at cost plus accrued interest and have original maturities of greater than 90 days but within one year or when the remaining maturities are within one year. We also invest in financial instruments classified as available for sale debt securities which are carried at fair value. Those instruments are included in short-term investments when they have remaining maturities of one year or less, as of the balance sheet date. •Long-Term Investments in Debt Securities—Long-term investments in debt securities includes financial instruments classified as available for sale debt securities with remaining maturities greater than one year as of the balance sheet date. They are carried at fair value and presented within the “Investments and long-term receivables” line of our consolidated balance sheet.79ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of Contents•Inventories—We have several valuation methods for our various types of inventories and consistently use the following methods for each type of inventory. The majority of our commodity-related inventories are recorded at cost using the LIFO basis. We measure these inventories at the lower-of-cost-or-market in the aggregate. Any necessary lower-of-cost-or-market write-downs at year end are recorded as permanent adjustments to the LIFO cost basis. LIFO is used to better match current inventory costs with current revenues. Costs include both direct and indirect expenditures incurred in bringing an item or product to its existing condition and location, but not unusual/nonrecurring costs or research and development costs. Materials, supplies and other miscellaneous inventories, such as tubular goods and well equipment, are valued using various methods, including the weighted-average-cost method and the FIFO method, consistent with industry practice.•Fair Value Measurements—Assets and liabilities measured at fair value and required to be categorized within the fair value hierarchy are categorized into one of three different levels depending on the observability of the inputs employed in the measurement. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs are observable inputs other than quoted prices included within Level 1 for the asset or liability, either directly or indirectly through market-corroborated inputs. Level 3 inputs are unobservable inputs for the asset or liability reflecting significant modifications to observable related market data or our assumptions about pricing by market participants.•Derivative Instruments—Derivative instruments are recorded on the balance sheet at fair value. If the right of offset exists and certain other criteria are met, derivative assets and liabilities with the same counterparty are netted on the balance sheet and the collateral payable or receivable is netted against derivative assets and derivative liabilities, respectively.Recognition and classification of the gain or loss that results from recording and adjusting a derivative to fair value depends on the purpose for issuing or holding the derivative. Gains and losses from derivatives not accounted for as hedges are recognized immediately in earnings. We do not apply hedge accounting to our derivative instruments.•Oil and Gas Exploration and Development—Oil and gas exploration and development costs are accounted for using the successful efforts method of accounting.Property Acquisition Costs—Oil and gas leasehold acquisition costs are capitalized and included in the balance sheet caption PP&E. Leasehold impairment is recognized based on exploratory experience and management’s judgment. Upon achievement of all conditions necessary for reserves to be classified as proved, the associated leasehold costs are reclassified to proved properties.Exploratory Costs—Geological and geophysical costs and the costs of carrying and retaining undeveloped properties are expensed as incurred. Exploratory well costs are capitalized, or “suspended,” on the balance sheet pending further evaluation of whether economically recoverable reserves have been found. If economically recoverable reserves are not found, exploratory well costs are expensed as dry holes. If exploratory wells encounter potentially economic quantities of oil and gas, the well costs remain capitalized on the balance sheet as long as sufficient progress assessing the reserves and the economic and operating viability of the project is being made. For complex exploratory discoveries, it is not unusual to have exploratory wells remain suspended on the balance sheet for several years while we perform additional appraisal drilling and seismic work on the potential oil and gas field or while we seek government or co-venturer approval of development plans or seek environmental permitting. Once all required approvals and permits have been obtained, the projects are moved into the development phase, and the oil and gas resources are designated as proved reserves.Management reviews suspended well balances quarterly, continuously monitors the results of the additional appraisal drilling and seismic work, and expenses the suspended well costs as dry holes when it judges the potential field does not warrant further investment in the near term. See Note 6.Development Costs—Costs incurred to drill and equip development wells, including unsuccessful development wells, are capitalized.Depletion and Amortization—Leasehold costs of producing properties are depleted using the unit-of-production method based on estimated proved oil and gas reserves. Amortization of development costs is based on the unit-of-production method using estimated proved developed oil and gas reserves.ConocoPhillips 2022 10-K80Notes to Consolidated Financial StatementsTable of Contents•Capitalized Interest—Interest from external borrowings is capitalized on major projects with an expected construction period of one year or longer. Capitalized interest is added to the cost of the underlying asset and is amortized over the useful lives of the assets in the same manner as the underlying assets.•Depreciation and Amortization—Depreciation and amortization of PP&E on producing hydrocarbon properties and SAGD facilities and certain pipeline and LNG assets (those which are expected to have a declining utilization pattern), are determined by the unit-of-production method. Depreciation and amortization of all other PP&E are determined by either the individual-unit-straight-line method or the group-straight-line method (for those individual units that are highly integrated with other units).•Impairment of Properties, Plants and Equipment—Long-lived assets used in operations are assessed for impairment whenever changes in facts and circumstances indicate a possible significant deterioration in the future cash flows expected to be generated by an asset group. If there is an indication the carrying amount of an asset may not be recovered, a recoverability test is performed using management’s assumptions for prices, volumes and future development plans. If the sum of the undiscounted cash flows before income-taxes is less than the carrying value of the asset group, the carrying value is written down to estimated fair value and reported as an impairment in the period in which the determination is made. Individual assets are grouped for impairment purposes at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets—generally on a field-by-field basis for E&P assets. Because there usually is a lack of quoted market prices for long-lived assets, the fair value of impaired assets is typically determined based on the present values of expected future cash flows using discount rates and prices believed to be consistent with those used by principal market participants, or based on a multiple of operating cash flow validated with historical market transactions of similar assets where possible.The expected future cash flows used for impairment reviews and related fair value calculations are based on estimated future production volumes, commodity prices, operating costs and capital decisions, considering all available evidence at the date of review. The impairment review includes cash flows from proved developed and undeveloped reserves, including any development expenditures necessary to achieve that production. Additionally, when probable and possible reserves exist, an appropriate risk-adjusted amount of these reserves may be included in the impairment calculation.Long-lived assets committed by management for disposal within one year are accounted for at the lower of amortized cost or fair value, less cost to sell, with fair value determined using a binding negotiated price, if available, or present value of expected future cash flows as previously described.•Maintenance and Repairs—Costs of maintenance and repairs, which are not significant improvements, are expensed when incurred.•Property Dispositions—When complete units of depreciable property are sold, the asset cost and related accumulated depreciation are eliminated, with any gain or loss reflected in the “Gain on dispositions” line of our consolidated income statement. When partial units of depreciable property are disposed of or retired which do not significantly alter the DD&A rate, the difference between asset cost and salvage value is charged or credited to accumulated depreciation.•Asset Retirement Obligations and Environmental Costs—The fair value of legal obligations to retire and remove long-lived assets are recorded in the period in which the obligation is incurred (typically when the asset is installed at the production location). Fair value is estimated using a present value approach, incorporating assumptions about estimated amounts and timing of settlements and impacts of the use of technologies. See Note 8.Environmental expenditures are expensed or capitalized, depending upon their future economic benefit. Expenditures relating to an existing condition caused by past operations, and those having no future economic benefit, are expensed. Liabilities for environmental expenditures are recorded on an undiscounted basis (unless acquired through a business combination, which we record on a discounted basis) when environmental assessments or cleanups are probable and the costs can be reasonably estimated. Recoveries of environmental remediation costs from other parties are recorded as assets when their receipt is probable and estimable.81ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of Contents•Impairment of Investments in Nonconsolidated Entities—Investments in nonconsolidated entities are assessed for impairment whenever changes in the facts and circumstances indicate a loss in value has occurred. When such a condition is judgmentally determined to be other than temporary, the carrying value of the investment is written down to fair value. The fair value of the impaired investment is based on quoted market prices, if available, or upon the present value of expected future cash flows using discount rates and prices believed to be consistent with those used by principal market participants, plus market analysis of comparable assets owned by the investee, if appropriate.•Guarantees—The fair value of a guarantee is determined and recorded as a liability at the time the guarantee is given. The initial liability is subsequently reduced as we are released from exposure under the guarantee. We amortize the guarantee liability over the relevant time period, if one exists, based on the facts and circumstances surrounding each type of guarantee. In cases where the guarantee term is indefinite, we reverse the liability when we have information indicating the liability is essentially relieved or amortize it over an appropriate time period as the fair value of our guarantee exposure declines over time. We amortize the guarantee liability to the related income statement line item based on the nature of the guarantee. When it becomes probable that we will have to perform on a guarantee, we accrue a separate liability if it is reasonably estimable, based on the facts and circumstances at that time. We reverse the fair value liability only when there is no further exposure under the guarantee.•Share-Based Compensation—We recognize share-based compensation expense over the shorter of the service period (i.e., the stated period of time required to earn the award) or the period beginning at the start of the service period and ending when an employee first becomes eligible for retirement. We have elected to recognize expense on a straight-line basis over the service period for the entire award, whether the award was granted with ratable or cliff vesting.•Income Taxes—Deferred income taxes are computed using the liability method and are provided on all temporary differences between the financial reporting basis and the tax basis of our assets and liabilities, except for deferred taxes on income and temporary differences related to the cumulative translation adjustment considered to be permanently reinvested in certain foreign subsidiaries and foreign corporate joint ventures. Allowable tax credits are applied currently as reductions of the provision for income taxes. Interest related to unrecognized tax benefits is reflected in interest and debt expense, and penalties related to unrecognized tax benefits are reflected in production and operating expenses.•Taxes Collected from Customers and Remitted to Governmental Authorities—Sales and value-added taxes are recorded net.•Net Income (Loss) Per Share of Common Stock—Basic net income (loss) per share (EPS) is calculated using the two-class method. Under the two-class method, all earnings (distributed and undistributed) are allocated to common stock (including fully vested stock and unit awards that have not yet been issued as common stock) and participating securities. ConocoPhillips grants RSUs under its share-based compensation programs, the majority of which entitle recipients to receive non-forfeitable dividends during the vesting period on a basis equivalent to dividends paid to holders of the Company’s common stock. See Note 16. These unvested RSUs meet the definition of participating securities based on their respective rights to receive non-forfeitable dividends and are treated as a separate class of securities in computing basic EPS. Participating securities are not included as incremental shares in computing diluted EPS. Diluted EPS includes the potential impact of contingently issuable shares, including awards which require future service as a condition of delivery of the underlying common stock. Diluted EPS is calculated under both the two-class and treasury stock methods, and the more dilutive amount is reported. Diluted net loss per share does not assume conversion or exercise of securities as that would always have an antidilutive effect. Treasury stock is excluded from the daily weighted-average number of common shares outstanding in both calculations. See Note 23.ConocoPhillips 2022 10-K82Notes to Consolidated Financial StatementsTable of ContentsNote 2—InventoriesInventories at December 31 were:Millions of Dollars20222021Crude oil and natural gas$641 647 Materials and supplies578 561 Total inventories$1,219 1,208 Inventories valued on the LIFO basis$396 395 The estimated excess of current replacement cost over LIFO cost of inventories was approximately $149 million and $251 million at December 31, 2022 and 2021, respectively.Note 3—Acquisitions and DispositionsAll gains or losses on asset dispositions are reported before-tax and are included net in the “Gain on dispositions” line on our consolidated income statement. All cash proceeds and payments are included in the “Cash Flows From Investing Activities” section of our consolidated statement of cash flows.2022Acquisition of Additional Shareholding Interest in Australia Pacific LNG Pty Ltd (APLNG)In February 2022, we completed the acquisition of an additional 10 percent interest in APLNG from Origin Energy for approximately $1.4 billion, after customary adjustments, in an all-cash transaction resulting from the exercise of our preemption right. This increased our ownership in APLNG to 47.5 percent, with Origin Energy and Sinopec owning27.5 percent and 25.0 percent, respectively. APLNG is reported as an equity investment in our Asia Pacific segment. Qatar Liquefied Gas Company Limited (8) (QG8)During 2022, we were awarded a 25 percent interest in a new joint venture (QG8) with QatarEnergy that will participate in the North Field East (NFE) LNG project. QG8 has a 12.5 percent interest in the NFE project and is reported as an equity method investment in our Europe, Middle East and North Africa segment. See Note 4.Asset AcquisitionIn September 2022, we completed the acquisition of an additional working interest in certain Eagle Ford acreage in the Lower 48 segment for cash consideration of $236 million after customary adjustments. This agreement was accounted for as an asset acquisition, with the consideration allocated primarily to PP&E.Assets SoldDuring 2022, we sold our interests in certain noncore assets in our Lower 48 segment for net proceeds of $680 million, with no gain or loss recognized on sale. At the time of disposition, our interest in these assets had a net carrying value of $680 million, consisting of $825 million of assets, primarily related to $818 million of PP&E, and $145 million of liabilities, primarily related to AROs. In March 2022, we completed the divestiture of our subsidiaries that held our Indonesia assets and operations, and based on an effective date of January 1, 2021, we received net proceeds of $731 million after customary adjustments and recognized a $534 million before-tax and $462 million after-tax gain related to this transaction. Together, the subsidiaries sold indirectly held our 54 percent interest in the Indonesia Corridor Block Production Sharing Contract (PSC) and 35 percent shareholding in the Transasia Pipeline Company. At the time of the disposition, the net carrying value was approximately $0.2 billion, excluding $0.2 billion of cash and restricted cash. The net book value consisted primarily of $0.3 billion of PP&E and $0.1 billion of ARO. The before-tax earnings associated with the subsidiaries sold, excluding the gain on disposition noted above, were $138 million and $604 million and $394 million for the years ended December 31, 2022, 2021 and 2020, respectively. Results of operations for the Indonesia interests sold were reported in our Asia Pacific segment.83ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsIn 2022, we recorded contingent payments of $451 million relating to the previous dispositions of our interest in the Foster Creek Christina Lake Partnership and western Canada gas assets and our San Juan assets. The contingent payments are recorded as gain on disposition on our consolidated income statement and are reflected within our Canada and Lower 48 segments. In our Canada segment, the contingent payment, calculated and paid on a quarterly basis, is $6 million CAD for every $1 CAD by which the WCS quarterly average crude price exceeds $52 CAD per barrel. In our Lower 48 segment, the contingent payment, paid on an annual basis, is calculated monthly at $7 million per month in which the U.S. Henry Hub price is at or above $3.20 per MMBTU. The term of contingent payments in our Canada segment ended in the second quarter of 2022 and continues through 2023 for the Lower 48 segment. We recorded contingent payments of $369 million in 2021. No payments were recorded in 2020. 2021During the year, we completed the acquisitions of Concho Resources Inc. (Concho) and of Shell Enterprises LLC’s (Shell) Permian assets. The acquisitions were accounted for as business combinations under FASB Topic ASC 805 using the acquisition method, which requires assets acquired and liabilities assumed to be measured at their acquisition date fair values. Fair value measurements were made for acquired assets and liabilities, and adjustments to those measurements may be made in subsequent periods, up to one year from the acquisition date as we identify new information about facts and circumstances that existed as of the acquisition date to consider.Acquisition of Concho Resources Inc.In January 2021, we completed our acquisition of Concho, an independent oil and gas exploration and production company with operations across New Mexico and West Texas focused in the Permian-based Delaware and Midland Basins. Total consideration for the all-stock transaction was valued at $13.1 billion, in which 1.46 shares of ConocoPhillips common stock were exchanged for each outstanding share of Concho common stock.Total ConsiderationNumber of shares of Concho common stock issued and outstanding (in thousands)*194,243 Number of shares of Concho stock awards outstanding (in thousands)*1,599 Number of shares exchanged195,842 Exchange ratio1.46 Additional shares of ConocoPhillips common stock issued as consideration (in thousands)285,929 Average price per share of ConocoPhillips common stock**$45.9025 Total Consideration (Millions)$13,125 *Outstanding as of January 15, 2021.**Based on the ConocoPhillips average stock price on January 15, 2021.Oil and gas properties were valued using a discounted cash flow approach incorporating market participant and internally generated price assumptions; production profiles; and operating and development cost assumptions. Debt assumed in the acquisition was valued based on observable market prices. The fair values determined for accounts receivable, accounts payable, and most other current assets and current liabilities were equivalent to the carrying value due to their short-term nature. The total consideration of $13.1 billion was allocated to the identifiable assets and liabilities based on their fair values as of January 15, 2021.ConocoPhillips 2022 10-K84Notes to Consolidated Financial StatementsTable of ContentsAssets AcquiredMillions of DollarsCash and cash equivalents$382 Accounts receivable, net745 Inventories45 Prepaid expenses and other current assets37 Investments and long-term receivables333 Net properties, plants and equipment18,923 Other assets62 Total assets acquired$20,527 Liabilities AssumedAccounts payable$638 Accrued income and other taxes56 Employee benefit obligations4 Other accruals510 Long-term debt4,696 Asset retirement obligations and accrued environmental costs310 Deferred income taxes1,071 Other liabilities and deferred credits117 Total liabilities assumed$7,402 Net assets acquired$13,125 With the completion of the Concho transaction, we acquired proved and unproved properties of approximately $11.8 billion and $6.9 billion, respectively. We recognized approximately $157 million of transaction-related costs, all of which were expensed in the first quarter of 2021. These non-recurring costs related primarily to fees paid to advisors and the settlement of share-based awards for certain Concho employees based on the terms of the Merger Agreement.In the first quarter of 2021, we commenced a company-wide restructuring program, the scope of which included combining the operations of the two companies as well as other global restructuring activities. We recognized non-recurring restructuring costs mainly for employee severance and related incremental pension benefit costs.The impact from the transaction and restructuring costs to the lines of our consolidated income statement for the year ended December 31, 2021, are below:Millions of DollarsTransaction CostRestructuring CostTotal CostProduction and operating expenses128 128 Selling, general and administration expenses135 67 202 Exploration expenses18 8 26 Taxes other than income taxes4 2 6 Other expenses— 29 29 $157 234 391 In February 2021, we completed a debt exchange offer related to the debt assumed from Concho. As a result of the debt exchange, we recognized an additional income tax-related restructuring charge of $75 million.85ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsFrom the acquisition date through December 31, 2021, “Total Revenues and Other Income” and “Net Income (Loss) Attributable to ConocoPhillips” associated with the acquired Concho business were approximately $6,571 million and $2,330 million, respectively. The results associated with the Concho business for the same period include a before- and after-tax loss of $305 million and $233 million, respectively, on the acquired derivative contracts. The before-tax loss is recorded within “Total Revenues and Other Income” on our consolidated income statement. See Note 12. Acquisition of Shell Permian AssetsIn December 2021, we completed our acquisition of Shell assets in the Permian based Delaware Basin. The accounting close date used for reporting purposes was December 31, 2021. Assets acquired include approximately 225,000 net acres and producing properties located entirely in Texas. Total consideration for the transaction was $8.6 billion.Oil and gas properties were valued using a discounted cash flow approach incorporating market participant and internally generated price assumptions, production profiles, and operating and development cost assumptions. The fair values determined for accounts receivable, accounts payable, and most other current assets and current liabilities were equivalent to the carrying value due to their short-term nature. The total consideration of $8.6 billion was allocated to the identifiable assets and liabilities based on their fair values at the acquisition date.Assets AcquiredMillions of DollarsAccounts receivable, net$337 Inventories20 Net properties, plants and equipment8,582 Other assets50 Total assets acquired$8,989 Liabilities AssumedAccounts payable$206 Accrued income and other taxes6 Other accruals20 Asset retirement obligations and accrued environmental costs86 Other liabilities and deferred credits36 Total liabilities assumed$354 Net assets acquired$8,635 With the completion of the Shell Permian transaction, we acquired proved and unproved properties of approximately $4.2 billion and $4.3 billion, respectively. We recognized approximately $44 million of transaction-related costs which were expensed in 2021.ConocoPhillips 2022 10-K86Notes to Consolidated Financial StatementsTable of ContentsSupplemental Pro Forma (unaudited)The following tables summarize the unaudited supplemental pro forma financial information for the year ended December 31, 2021, and 2020, as if we had completed the acquisitions of Concho and the Shell Permian assets on January 1, 2020.Millions of DollarsYear Ended December 31, 2021As reportedPro formaShellPro formaCombinedTotal Revenues and Other Income$48,349 3,220 51,569 Income (loss) before income taxes12,712 1,201 13,913 Net Income (Loss) attributable to ConocoPhillips8,079 920 8,999 Earnings per share:Basic net income$6.09 6.78 Diluted net income6.07 6.76 Millions of DollarsYear Ended December 31, 2020As reportedPro formaConchoPro formaShellPro formaCombinedTotal Revenues and Other Income$19,256 3,762 1,685 24,703 Income (loss) before income taxes(3,140)787 (247)(2,600)Net Income (Loss) attributable to ConocoPhillips(2,701)498 (189)(2,392)Earnings per share:Basic net loss$(2.51)(1.75)Diluted net loss(2.51)(1.75)The unaudited supplemental pro forma financial information is presented for illustration purposes only and is not necessarily indicative of the operating results that would have occurred had the transactions been completed on January 1, 2020, nor is it necessarily indicative of future operating results of the combined entity. The unaudited pro forma financial information for the twelve-month period ending December 31, 2020 is a result of combining the consolidated income statement of ConocoPhillips with the results of Concho and the assets acquired from Shell. The pro forma results do not include transaction-related costs, nor any cost savings anticipated as a result of the transactions. The pro forma results include adjustments from Concho’s historical results to reverse impairment expense of $10.5 billion and $1.9 billion related to oil and gas properties and goodwill, respectively. Other adjustments made relate primarily to DD&A, which is based on the unit-of-production method, resulting from the purchase price allocated to properties, plants and equipment. We believe the estimates and assumptions are reasonable, and the relative effects of the transaction are properly reflected.Assets SoldIn 2020, we completed the sale of our Australia-West asset and operations. The sales agreement entitled us to a $200 million payment upon a final investment decision (FID) of the Barossa development project. In March 2021, FID was announced and as such, we recognized a $200 million gain on disposition in the first quarter of 2021. The purchaser failed to pay the FID bonus when due. We have commenced an arbitration proceeding against the purchaser to enforce our contractual right to the $200 million, plus interest accruing from the due date. Results of operations related to this transaction are reflected in our Asia Pacific segment. See Note 11.In the second half of 2021, we sold our interests in certain noncore assets in our Lower 48 segment for approximately $250 million after customary adjustments, recognizing a before-tax gain on sale of approximately $58 million. We also completed the sale of our noncore exploration interests in Argentina, recognizing a before-tax loss on disposition of $179 million. Results of operations for Argentina were reported in our Other International segment. 87ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of Contents2020Asset AcquisitionIn August 2020, we completed the acquisition of additional Montney acreage in Canada from Kelt Exploration Ltd. for $382 million after customary adjustments, plus the assumption of $31 million in financing obligations associated with partially owned infrastructure. This acquisition consisted primarily of undeveloped properties and included 140,000 net acres in the liquids-rich Inga Fireweed asset Montney zone, which is directly adjacent to our existing Montney position. The transaction increased our Montney acreage position to approximately 295,000 net acres with a 100 percent working interest. This agreement was accounted for as an asset acquisition resulting in the recognition of $490 million of PP&E $77 million of ARO and accrued environmental costs; and $31 million of financing obligations recorded primarily to long-term debt. Results of operations for the Montney asset are reported in our Canada segment.Assets SoldIn February 2020, we sold our Waddell Ranch interests in the Permian Basin for $184 million after customary adjustments. No gain or loss was recognized on the sale. Results of operations for the Waddell Ranch interests sold were reported in our Lower 48 segment.In March 2020, we completed the sale of our Niobrara interests for approximately $359 million after customary adjustments and recognized a before-tax loss on disposition of $38 million. At the time of disposition, our interest in Niobrara had a net carrying value of $397 million, consisting primarily of $433 million of PP&E and $34 million of ARO. The before-tax loss associated with our interests in Niobrara, including the loss on disposition noted above, was $25 million for the year ended December 31, 2020. Results of operations for the Niobrara interests sold were reported in our Lower 48 segment.In May 2020, we completed the divestiture of our subsidiaries that held our Australia-West assets and operations, and based on an effective date of January 1, 2019, we received proceeds of $765 million. We recognized a before-tax gain of $587 million related to this transaction in 2020. At the time of disposition, the net carrying value of the subsidiaries sold was approximately $0.2 billion, excluding $0.5 billion of cash. The net carrying value consisted primarily of $1.3 billion of PP&E and $0.1 billion of other current assets offset by $0.7 billion of ARO, $0.3 billion of deferred tax liabilities, and $0.2 billion of other liabilities. The before-tax earnings associated with the subsidiaries sold, including the gain on disposition noted above, was $851 million for the year ended December 31, 2020. The sales agreement entitled us to an additional $200 million upon FID of the Barossa development project. Results of operations for the subsidiaries sold were reported in our Asia Pacific segment.Note 4—Investments, Loans and Long-Term ReceivablesComponents of investments and long-term receivables at December 31 were:Millions of Dollars20222021Equity investments$7,493 6,701 Long-term receivables142 98 Long-term investments in debt securities522 248 Other investments68 66 $8,225 7,113 Equity InvestmentsAffiliated companies in which we had a significant equity investment at December 31, 2022, included:•APLNG—47.5 percent owned joint venture with Origin Energy (27.5 percent) and Sinopec (25 percent)—to produce CBM from the Bowen and Surat basins in Queensland, Australia, as well as process and export LNG.•Qatar Liquefied Gas Company Limited (3) (QG3)—30 percent owned joint venture with affiliates of QatarEnergy (68.5 percent) and Mitsui & Co., Ltd. (1.5 percent)—produces and liquefies natural gas from Qatar’s North Field, as well as exports LNG.•Qatar Liquefied Gas Company Limited (8) (QG8)—25 percent owned joint venture with QatarEnergy (75 percent)—participant in the North Field East (NFE) LNG project. See Note 3.ConocoPhillips 2022 10-K88Notes to Consolidated Financial StatementsTable of ContentsSummarized 100 percent earnings information for equity method investments in affiliated companies, combined, was as follows:Millions of Dollars202220212020Revenues$18,356 11,824 7,931 Income before income taxes8,234 3,946 1,843 Net income5,507 2,557 1,426 Summarized 100 percent balance sheet information for equity method investments in affiliated companies, combined, was as follows:Millions of Dollars20222021Current assets$5,001 4,493 Noncurrent assets37,789 36,602 Current liabilities4,169 3,498 Noncurrent liabilities17,244 17,465 Our share of income taxes incurred directly by an equity method investee is reported in equity in earnings of affiliates, and as such is not included in income taxes on our consolidated financial statements.At December 31, 2022, retained earnings included $42 million related to the undistributed earnings of affiliated companies. Dividends received from affiliates were $3,045 million, $1,279 million and $1,076 million in 2022, 2021 and 2020, respectively. APLNG APLNG is a joint venture focused on producing CBM from the Bowen and Surat basins in Queensland, Australia. Natural gas is sold to domestic customers and LNG is processed and exported to Asia Pacific markets. Our investment in APLNG gives us access to CBM resources in Australia and enhances our LNG position. The majority of APLNG LNG is sold under two long-term sales and purchase agreements, supplemented with sales of additional LNG cargoes targeting the Asia Pacific markets. Origin Energy, an integrated Australian energy company, is the operator of APLNG’s production and pipeline system, while we operate the LNG facility.In 2012, APLNG executed an $8.5 billion project finance facility that became non-recourse following financial completion in 2017. The facility is currently composed of a financing agreement with the Export-Import Bank of the United States, a commercial bank facility and two United States Private Placement note facilities. APLNG principal and interest payments commenced in March 2017 and are scheduled to occur bi-annually until September 2030. At December 31, 2022, a balance of $5.2 billion was outstanding on the facilities. See Note 10. During the fourth quarter of 2021, Origin Energy Limited agreed to the sale of 10 percent of their interest in APLNG for $1.645 billion, before customary adjustments. ConocoPhillips announced in December 2021 that we were exercising our preemption right under the APLNG Shareholders Agreement to purchase an additional 10 percent shareholding interest in APLNG, subject to government approvals. The sales price associated with this preemption right was determined to reflect a relevant observable market participant view of APLNG’s fair value which was below the carrying value of our existing investment in APLNG. Based on a review of the facts and circumstances surrounding this decline in fair value, we concluded in the fourth quarter of 2021 the impairment was other than temporary under the guidance of FASB ASC Topic 323, and the recognition of an impairment of our existing investment was necessary. Accordingly, we recorded a noncash $688 million before-tax and after-tax impairment in the fourth quarter of 2021. The impairment was included in the “Impairments” line on our consolidated income statement. See Note 7.89ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsAt December 31, 2022, the carrying value of our equity method investment in APLNG was approximately $6.2 billion. The historical cost basis of our 47.5 percent share of net assets of APLNG was $6.1 billion, resulting in a basis difference of $41 million on our books. The basis difference, which is substantially all associated with PP&E and subject to amortization, has been allocated on a relative fair value basis to individual production license areas owned by APLNG. Any future additional payments are expected to be allocated in a similar manner. As the joint venture produces natural gas from each license, we amortize the basis difference allocated to that license using the unit-of-production method. Included in net income (loss) attributable to ConocoPhillips for 2022, 2021 and 2020 was after-tax expense of $10 million, $39 million and $41 million, respectively, representing the amortization of this basis difference on currently producing licenses.QG3QG3 is a joint venture that owns an integrated large-scale LNG project located in Qatar. We provided project financing, which was fully repaid in the third quarter of 2022, as described below under “Loans.” At December 31, 2022, the book value of our equity method investment in QG3 was approximately $0.7 billion. We have terminal and pipeline use agreements with Golden Pass LNG Terminal and affiliated Golden Pass Pipeline near Sabine Pass, Texas, intended to provide us with terminal and pipeline capacity for the receipt, storage and regasification of LNG purchased from QG3. Currently, the LNG from QG3 is being sold to markets outside of the U.S.QG8During 2022, we were awarded a 25 percent interest in a new joint venture (QG8) with QatarEnergy that will participate in the NFE LNG project. QG8 has a 12.5 percent interest in the NFE project. At December 31, 2022, the book value of our equity method investment was approximately $0.3 billion. See Note 3.LoansAs part of our normal ongoing business operations and consistent with industry practice, we enter into numerous agreements with other parties to pursue business opportunities. Included in such activity are loans to certain affiliated and non-affiliated companies. At December 31, 2022, there were no outstanding loans to affiliated companies as the final loan payment related to QG3 project financing was received in the third quarter of 2022. QG3 secured project financing of $4.0 billion in December 2005, consisting of $1.3 billion of loans from export credit agencies (ECA), $1.5 billion from commercial banks and $1.2 billion from ConocoPhillips. The ConocoPhillips loan facilities had substantially the same terms as the ECA and commercial bank facilities. On December 15, 2011, QG3 achieved financial completion and all project loan facilities became nonrecourse to the project participants. Semi-annual repayments began in January 2011 and were completed in July 2022, for all loan arrangements.Note 5—Investment in Cenovus EnergyAt December 31, 2021, we held 91 million common shares of Cenovus Energy (CVE), which approximated 4.5 percent of the issued and outstanding common shares of CVE. Those shares were carried on our balance sheet at fair value of $1.1 billion based on NYSE closing price of $12.28 per share on the last day of trading for the period. During the first quarter of 2022, we sold our remaining 91 million shares, recognizing proceeds of $1.4 billion.All gains and losses were recognized within "Other income (loss)" on our consolidated income statement. Proceeds related to the sale of our CVE shares were included within "Cash Flows from Investing Activities" on our consolidated statement of cash flows. See Note 13.Millions of Dollars202220212020Total Net gain (loss) on equity securities$251 1,040 (855)Less: Net gain (loss) on equity securities sold during the period251 473 Unrealized gain (loss) on equity securities still held at the reporting date$ 567 (855)ConocoPhillips 2022 10-K90Notes to Consolidated Financial StatementsTable of ContentsNote 6—Suspended Wells and Exploration ExpensesThe following table reflects the net changes in suspended exploratory well costs during 2022, 2021 and 2020:Millions of Dollars202220212020Beginning balance at January 1$660 682 1,020 Additions pending the determination of proved reserves5 10 164 Reclassifications to proved properties(7)— (42)Sales of suspended wells— — (313)Charged to dry hole expense(131)(32)(147)Ending balance at December 31$527 660 682 The following table provides an aging of suspended well balances at December 31:Millions of Dollars202220212020Exploratory well costs capitalized for a period of one year or less$15 4 156 Exploratory well costs capitalized for a period greater than one year512 656 526 Ending balance$527 660 682 Number of projects with exploratory well costs capitalized for a period greater than one year17 22 22 The following table provides a further aging of those exploratory well costs that have been capitalized for more than one year since the completion of drilling as of December 31, 2022:Millions of DollarsSuspended SinceTotal2019-20212016-20182006-2015Willow—Alaska(2)315 201 114 — PL 1009—Norway(1)39 39 — — PL 891—Norway(1)31 31 — — Narwhal Trend—Alaska(1)25 — 25 — WL4-00—Malaysia(2)24 7 17 — PL782S—Norway(1)19 19 — — Montney—Canada(1)12 4 8 — Other of $10 million or less each(1)(2)47 7 10 30 Total$512 308 174 30 (1)Additional appraisal wells planned.(2)Appraisal drilling complete; costs being incurred to assess development.91ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsExploration ExpensesThe charges discussed below are included in the “Exploration expenses” line on our consolidated income statement.2022In the fourth quarter, we recorded a before-tax expense of $129 million for impairment of certain aged, suspended wells associated with Surmont in our Canada segment.In our Europe, Middle East and North Africa segment, we recorded a before-tax expense of $102 million for dry hole costs associated with four operated exploration and appraisal wells and one partner operated well that were drilled in Norway in 2022.2020In our Alaska segment, we recorded a before-tax impairment of $828 million for the entire associated carrying value of capitalized undeveloped leasehold costs related to our Alaska North Slope Gas asset. We had stopped participating in evaluating gas line projects and did not believe a project would advance. We remain willing to sell our Alaska North Slope gas to interested parties on a competitive basis if a market materializes in the future.In our Other International segment, our interests in the Middle Magdalena Basin of Colombia are in force majeure. Because we had no immediate plans to perform under existing contracts, in 2020, we recorded a before-tax expense totaling $84 million for dry hole costs of a previously suspended well and an impairment of the associated capitalized undeveloped leasehold carrying value.In our Asia Pacific segment, we recorded before-tax expense of $50 million related to dry hole costs of a previously suspended well and an impairment of the associated capitalized undeveloped leasehold carrying value associated with the Kamunsu East Field in Malaysia that is no longer in our development plans.Note 7—ImpairmentsDuring 2022, 2021 and 2020, we recognized the following before-tax impairment charges:Millions of Dollars202220212020Alaska$2 5 — Lower 48(11)(8)804 Canada(2)6 3 Europe, Middle East and North Africa(1)(24)6 Asia Pacific— 695 — $(12)674 813 2021We recorded an impairment of $688 million on our APLNG investment included within the Asia Pacific segment. See Note 4 and Note 13.In our Lower 48 segment, we recorded a credit to impairment of $89 million due to a decreased ARO estimate for a previously sold asset, in which we retained the ARO liability. This was offset by recorded impairments of $84 million during the fourth quarter of 2021, related to certain noncore assets due to changes in development plans. See Note 13.In our Europe, Middle East and North Africa segment, we recorded a credit to impairment of $24 million due to decreased ARO estimates on fields in Norway which ceased production and were fully depreciated in prior years. 2020We recorded impairments of $813 million, primarily related to certain noncore assets in the Lower 48. Due to a significant decrease in the outlook for current and long-term natural gas prices in early 2020, we recorded impairments of $523 million, primarily for the Wind River Basin operations area, consisting of developed properties in the Madden Field and the Lost Cabin Gas Plant, in the first quarter of 2020. Additionally, due primarily to changes in development plans solidified in the last quarter of 2020, we recognized additional impairments of $287 million in the Lower 48 during the fourth quarter.ConocoPhillips 2022 10-K92Notes to Consolidated Financial StatementsTable of ContentsNote 8—Asset Retirement Obligations and Accrued Environmental CostsAsset retirement obligations and accrued environmental costs at December 31 were:Millions of Dollars20222021Asset retirement obligations$6,380 5,926 Accrued environmental costs182 187 Total asset retirement obligations and accrued environmental costs6,562 6,113 Asset retirement obligations and accrued environmental costs due within one year*(161)(359)Long-term asset retirement obligations and accrued environmental costs$6,401 5,754 *Classified as a current liability on the balance sheet under “Other accruals.”Asset Retirement ObligationsWe record the fair value of a liability for an ARO when it is incurred (typically when the asset is installed at the production location). When the liability is initially recorded, we capitalize the associated asset retirement cost by increasing the carrying amount of the related PP&E. Over time, the liability increases for the change in its present value, while the capitalized cost depreciates over the useful life of the related asset. If, in subsequent periods, our estimate of this liability changes, we will record an adjustment to both the liability and PP&E. Reductions to estimated liabilities for assets that are no longer producing are recorded as a credit to impairment. We have numerous AROs we are required to perform under law or contract once an asset is permanently taken out of service. Most of these obligations are not expected to be paid until several years, or decades, in the future and will be funded from general company resources at the time of removal. Our largest individual obligations involve plugging and abandonment of wells and removal and disposal of offshore oil and gas platforms around the world, as well as oil and gas production facilities and pipelines in Alaska.During 2022 and 2021, our overall ARO changed as follows:Millions of Dollars20222021Balance at January 1$5,926 5,573 Accretion of discount245 238 New obligations144 555 Changes in estimates of existing obligations681 (113)Spending on existing obligations(231)(164)Property dispositions(203)(108)Foreign currency translation(182)(55)Balance at December 31$6,380 5,926 Accrued Environmental CostsTotal accrued environmental costs at December 31, 2022 and 2021, were $182 million and $187 million, respectively. We had accrued environmental costs of $107 million and $135 million at December 31, 2022 and 2021, respectively, related to remediation activities in the U.S. and Canada. We had also accrued in Corporate and Other $59 million and $36 million of environmental costs associated with sites no longer in operation at December 31, 2022 and 2021, respectively. In addition, both December 31, 2022 and 2021, included a $16 million accrual, where the company has been named a potentially responsible party under the Federal Comprehensive Environmental Response, Compensation and Liability Act, or similar state laws. Accrued environmental liabilities are expected to be paid over periods extending up to 30 years.Expected expenditures for environmental obligations acquired in various business combinations are discounted using a weighted-average 5 percent discount factor, resulting in an accrued balance for acquired environmental liabilities of $111 million at December 31, 2022. The total expected future undiscounted payments related to the portion of the accrued environmental costs that have been discounted are $147 million.93ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsNote 9—DebtLong-term debt at December 31 was:Millions of Dollars202220212.40% Notes due 2022— 329 7.65% Debentures due 202378 78 3.35% Notes due 2024426 426 2.125% Notes due 2024900 — 8.2% Notes due 2025134 134 3.35% Debentures due 2025199 199 2.40% Notes due 2025900 — 6.875% Debentures due 202667 67 4.95% Notes due 2026— 1,250 7.8% Debentures due 2027203 203 3.75% Notes due 2027196 1,000 4.3% Notes due 2028223 1,000 7.375% Debentures due 202992 92 7.0% Debentures due 2029112 200 6.95% Notes due 20291,195 1,549 8.125% Notes due 2030390 390 7.4% Notes due 2031382 500 7.25% Notes due 2031400 500 7.2% Notes due 2031447 575 2.4% Notes due 2031227 500 5.9% Notes due 2032505 505 4.15% Notes due 2034246 246 5.95% Notes due 2036326 500 5.951% Notes due 2037631 645 5.9% Notes due 2038350 600 6.5% Notes due 20391,588 2,750 3.758% Notes due 2042785 — 4.3% Notes due 2044750 750 5.95% Notes due 2046329 500 7.9% Debentures due 204760 60 4.875% Notes due 2047319 800 4.85% Notes due 2048219 600 3.8% Notes due 20521,100 — 4.025% Notes due 20621,770 — Floating rate notes due 2022 at 1.06% – 1.41% during 2022 and 1.02% – 1.12% during 2021— 500 Marine Terminal Revenue Refunding Bonds due 2031 at 0.07% – 4.10% during 2022 and 0.04% – 0.15% during 2021265 265 Industrial Development Bonds due 2035 at 0.07% – 4.10% during 2022 and 0.04% – 0.12% during 202118 18 Other23 35 Debt at face value15,855 17,766 Finance leases1,320 1,261 Net unamortized premiums, discounts and debt issuance costs(532)907 Total debt16,643 19,934 Short-term debt(417)(1,200)Long-term debt$16,226 18,734 ConocoPhillips 2022 10-K94Notes to Consolidated Financial StatementsTable of ContentsIn December 2022, the company retired $329 million principal amount of our 2.40 percent Notes at the natural maturity date. In May 2022, we redeemed $1,250 million principal amount of our 4.95 percent Notes due 2026. We paid premiums above face value of $79 million to redeem the debt and recognized a loss on debt extinguishment of $83 million which is included in the "Other expenses" line on our consolidated income statement. We also paid $500 million to retire the outstanding principal amount of the floating rate notes due 2022 at maturity.In the first quarter of 2022, we completed a debt refinancing consisting of three concurrent transactions: a tender offer to repurchase existing debt for cash; exchange offers to retire certain debt in exchange for new debt and cash; and a new debt issuance to partially fund the cash paid in the tender and exchange offers. Tender OfferIn March 2022, we repurchased a total of $2,716 million aggregate principal amount of debt as listed below. We paid premiums above face value of $333 million to repurchase these debt instruments and recognized a gain on debt extinguishment of $155 million which is included in the "Other expenses" line on our consolidated income statement. •3.75% Notes due 2027 with principal of $1,000 million (partial repurchase of $804 million)•4.3% Notes due 2028 with principal of $1,000 million (partial repurchase of $777 million)•2.4% Notes due 2031 with principal of $500 million (partial repurchase of $273 million) •4.875% Notes due 2047 with principal of $800 million (partial repurchase of $481 million)•4.85% Notes due 2048 with principal of $600 million (partial repurchase of $381 million)Exchange OffersAlso in March 2022, we completed two concurrent debt exchange offers through which $2,544 million of aggregate principal of existing notes was tendered and accepted in exchange for a combination of new notes and cash. The debt exchange offers were treated as debt modifications for accounting purposes resulting in a portion of the unamortized debt discount, premiums and debt issuance costs of the existing notes being allocated to the new notes on the settlement dates of the exchange offers. We paid premiums above face value of $883 million, comprised of $872 million of cash as well as new notes, which were capitalized as additional debt discount. We incurred expenses of $28 million in the exchanges which are included in the "Other expenses" line on our consolidated income statement. The notes tendered and accepted in the exchange offers were:•7.0% Debentures due 2029 with principal amount of $200 million (partial exchange of $88 million)•6.95% Notes due 2029 with principal amount of $1,549 million (partial exchange of $354 million) •7.4% Notes due 2031 with principal amount of $500 million (partial exchange of $118 million)•7.25% Notes due 2031 with principal amount of $500 million (partial exchange of $100 million)•7.2% Notes due 2031 with principal amount of $575 million (partial exchange of $128 million)•5.95% Notes due 2036 with principal amount of $500 million (partial exchange of $174 million)•5.9% Notes due 2038 with principal amount of $600 million (partial exchange of $250 million)•6.5% Notes due 2039 with principal amount of $2,750 million (partial exchange of $1,162 million)•5.95% Notes due 2046 with principal amount of $500 million (partial exchange of $171 million)The notes tendered and accepted were exchanged for the following new notes: •3.758% Notes due 2042 with principal amount of $785 million•4.025% Notes due 2062 with principal amount of $1,770 millionNew Debt IssuanceIn March 2022, we issued the following new notes consisting of:•2.125% Notes due 2024 with principal of $900 million •2.4% Note due 2025 with principal of $900 million •3.8% Note due 2052 with principal of $1,100 millionIn February 2022, we refinanced our revolving credit facility from a total borrowing capacity of $6.0 billion to $5.5 billion with an expiration date of February 2027. Our revolving credit facility may be used for direct bank borrowings, the issuance of letters of credit totaling up to $500 million, or as support for our commercial paper program. The revolving credit facility is broadly syndicated among financial institutions and does not contain any material adverse change provisions or any covenants requiring maintenance of specified financial ratios or credit ratings. The facility agreement contains a cross-default provision relating to the failure to pay principal or interest on other debt obligations of $200 million or more by ConocoPhillips, or any of its consolidated subsidiaries. The amount of the facility is not subject to redetermination prior to its expiration date.95ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsCredit facility borrowings may bear interest at a margin above the Secured Overnight Financing Rate (SOFR). The facility agreement calls for commitment fees on available, but unused, amounts. The facility agreement also contains early termination rights if our current directors or their approved successors cease to be a majority of the Board of Directors.The revolving credit facility supports our ability to issue up to $5.5 billion of commercial paper. Commercial paper is generally limited to maturities of 90 days and is included in short-term debt on our consolidated balance sheet. With no commercial paper outstanding and no direct borrowings or letters of credit, we had access to $5.5 billion in available borrowing capacity under our revolving credit facility at December 31, 2022. At December 31, 2021, we had no commercial paper outstanding and no direct borrowings or letters of credit issued.In January 2021, we completed the acquisition of Concho in an all-stock transaction. In the acquisition, we assumed Concho’s publicly traded debt, with an outstanding principal balance of $3.9 billion, which was recorded at fair value of $4.7 billion on the acquisition date. The adjustment to fair value of the senior notes of approximately $0.8 billion on the acquisition date will be amortized as an adjustment to interest expense over the remaining contractual terms of the senior notes.In February 2021, we completed a debt exchange offer related to the debt assumed from Concho. Of the approximately $3.9 billion in aggregate principal amount of Concho’s senior notes offered in the exchange, 98 percent, or approximately $3.8 billion, was tendered and accepted. The new debt issued by ConocoPhillips had the same interest rates and maturity dates as the Concho senior notes. The portion not exchanged, approximately $67 million, remained outstanding across five series of senior notes issued by Concho. The debt exchange was treated as a debt modification for accounting purposes resulting in a portion of the unamortized fair value adjustment of the Concho senior notes allocated to the new debt issued by ConocoPhillips on the settlement date of the exchange. The new debt issued in the exchange is fully and unconditionally guaranteed by ConocoPhillips Company. See Note 3.For information on Finance Leases, see Note 15. The current credit ratings on our long-term debt are:•Fitch: “A” with a “stable” outlook•S&P: “A-” with a “stable” outlook•Moody's: "A2" with a "stable" outlookWe do not have any ratings triggers on any of our corporate debt that would cause an automatic default, and thereby impact our access to liquidity upon downgrade of our credit ratings. If our credit ratings are downgraded from their current levels, it could increase the cost of corporate debt available to us and restrict our access to the commercial paper markets. If our credit ratings were to deteriorate to a level prohibiting us from accessing the commercial paper market, we would still be able to access funds under our revolving credit facility. At both December 31, 2022 and 2021, we had $283 million of certain variable rate demand bonds (VRDBs) outstanding with maturities ranging through 2035. The VRDBs are redeemable at the option of the bondholders on any business day. If they are ever redeemed, we have the ability and intent to refinance on a long-term basis, therefore, the VRDBs are included in the “Long-term debt” line on our consolidated balance sheet.ConocoPhillips 2022 10-K96Notes to Consolidated Financial StatementsTable of ContentsNote 10—GuaranteesAt December 31, 2022, we were liable for certain contingent obligations under various contractual arrangements as described below. We recognize a liability, at inception, for the fair value of our obligation as a guarantor for newly issued or modified guarantees. Unless the carrying amount of the liability is noted below, we have not recognized a liability because the fair value of the obligation is immaterial. In addition, unless otherwise stated, we are not currently performing with any significance under the guarantee and expect future performance to be either immaterial or have only a remote chance of occurrence.APLNG GuaranteesAt December 31, 2022, we had outstanding multiple guarantees in connection with our 47.5 percent ownership interest in APLNG. The following is a description of the guarantees with values calculated utilizing December 2022 exchange rates: •During the third quarter of 2016, we issued a guarantee to facilitate the withdrawal of our pro-rata portion of the funds in a project finance reserve account. We estimate the remaining term of this guarantee to be eight years. Our maximum exposure under this guarantee is approximately $210 million and may become payable if an enforcement action is commenced by the project finance lenders against APLNG. At December 31, 2022, the carrying value of this guarantee was approximately $14 million.•In conjunction with our original purchase of an ownership interest in APLNG from Origin Energy Limited in October 2008, we agreed to reimburse Origin Energy Limited for our share of the existing contingent liability arising under guarantees of an existing obligation of APLNG to deliver natural gas under several sales agreements. The final guarantee expires in the fourth quarter of 2041. Our maximum potential liability for future payments, or cost of volume delivery, under these guarantees is estimated to be $780 million ($1.3 billion in the event of intentional or reckless breach) and would become payable if APLNG fails to meet its obligations under these agreements and the obligations cannot otherwise be mitigated. Future payments are considered unlikely, as the payments, or cost of volume delivery, would only be triggered if APLNG does not have enough natural gas to meet these sales commitments and if the co-ventures do not make necessary equity contributions into APLNG.•We have guaranteed the performance of APLNG with regard to certain other contracts executed in connection with the project’s continued development. The guarantees have remaining terms of 14 to 23 years or the life of the venture. Our maximum potential amount of future payments related to these guarantees is approximately $290 million and would become payable if APLNG does not perform. At December 31, 2022, the carrying value of these guarantees was approximately $20 million.QG8 GuaranteeWe have guaranteed our portion of certain fiscal and other joint venture obligations as a shareholder in QG8. This guarantee has an approximate 30-year term with no maximum limit. At December 31, 2022, the carrying value of this guarantee was approximately $7 million. Other GuaranteesWe have other guarantees with maximum future potential payment amounts totaling approximately $600 million, which consist primarily of guarantees of the residual value of leased office buildings and guarantees of the residual value of corporate aircraft. These guarantees have remaining terms of three to four years and would become payable if certain asset values are lower than guaranteed amounts at the end of the lease or contract term, business conditions decline at guaranteed entities, or as a result of nonperformance of contractual terms by guaranteed parties. At December 31, 2022, there was no carrying value associated with these guarantees.IndemnificationsOver the years, we have entered into agreements to sell ownership interests in certain legal entities, joint ventures and assets that gave rise to qualifying indemnifications. These agreements include indemnifications for taxes and environmental liabilities. The carrying amount recorded for these indemnifications at December 31, 2022, was approximately $20 million. Those related to environmental issues have terms that are generally indefinite and the maximum amounts of future payments are generally unlimited. Although it is reasonably possible future payments may exceed amounts recorded, due to the nature of the indemnifications, it is not possible to make a reasonable estimate of the maximum potential amount of future payments. See Note 11 for additional information about environmental liabilities. 97ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsNote 11—Contingencies and CommitmentsA number of lawsuits involving a variety of claims arising in the ordinary course of business have been filed against ConocoPhillips. We also may be required to remove or mitigate the effects on the environment of the placement, storage, disposal or release of certain chemical, mineral and petroleum substances at various active and inactive sites. We regularly assess the need for accounting recognition or disclosure of these contingencies. In the case of all known contingencies (other than those related to income taxes), we accrue a liability when the loss is probable and the amount is reasonably estimable. If a range of amounts can be reasonably estimated and no amount within the range is a better estimate than any other amount, then the low end of the range is accrued. We do not reduce these liabilities for potential insurance or third-party recoveries. We accrue receivables for insurance or other third-party recoveries when applicable. With respect to income tax-related contingencies, we use a cumulative probability-weighted loss accrual in cases where sustaining a tax position is less than certain. See Note 17, for additional information about income tax-related contingencies.Based on currently available information, we believe it is remote that future costs related to known contingent liability exposures will exceed current accruals by an amount that would have a material adverse impact on our consolidated financial statements. As we learn new facts concerning contingencies, we reassess our position both with respect to accrued liabilities and other potential exposures. Estimates particularly sensitive to future changes include contingent liabilities recorded for environmental remediation, tax and legal matters. Estimated future environmental remediation costs are subject to change due to such factors as the uncertain magnitude of cleanup costs, the unknown time and extent of such remedial actions that may be required, and the determination of our liability in proportion to that of other responsible parties. Estimated future costs related to tax and legal matters are subject to change as events evolve and as additional information becomes available during the administrative and litigation processes.EnvironmentalWe are subject to international, federal, state and local environmental laws and regulations and record accruals for environmental liabilities based on management’s best estimates. These estimates are based on currently available facts, existing technology, and presently enacted laws and regulations, taking into account stakeholder and business considerations. When measuring environmental liabilities, we also consider our prior experience in remediation of contaminated sites, other companies’ cleanup experience, and data released by the U.S. EPA or other organizations. We consider unasserted claims in our determination of environmental liabilities, and we accrue them in the period they are both probable and reasonably estimable.Although liability of those potentially responsible for environmental remediation costs is generally joint and several for federal sites and frequently so for other sites, we are usually only one of many companies cited at a particular site. Due to the joint and several liabilities, we could be responsible for all cleanup costs related to any site at which we have been designated as a potentially responsible party. We have been successful to date in sharing cleanup costs with other financially sound companies. Many of the sites at which we are potentially responsible are still under investigation by the EPA or the agency concerned. Prior to actual cleanup, those potentially responsible normally assess the site conditions, apportion responsibility and determine the appropriate remediation. In some instances, we may have no liability or may attain a settlement of liability. Where it appears that other potentially responsible parties may be financially unable to bear their proportional share, we consider this inability in estimating our potential liability, and we adjust our accruals accordingly. As a result of various acquisitions in the past, we assumed certain environmental obligations. Some of these environmental obligations are mitigated by indemnifications made by others for our benefit, and some of the indemnifications are subject to dollar limits and time limits.We are currently participating in environmental assessments and cleanups at numerous federal Superfund and comparable state and international sites. After an assessment of environmental exposures for cleanup and other costs, we make accruals on an undiscounted basis (except those acquired in a purchase business combination, which we record on a discounted basis) for planned investigation and remediation activities for sites where it is probable future costs will be incurred and these costs can be reasonably estimated. We have not reduced these accruals for possible insurance recoveries. In the future, we may be involved in additional environmental assessments, cleanups and proceedings. See Note 8 for a summary of our accrued environmental liabilities.ConocoPhillips 2022 10-K98Notes to Consolidated Financial StatementsTable of ContentsLitigation and Other ContingenciesWe are subject to various lawsuits and claims including but not limited to matters involving oil and gas royalty and severance tax payments, gas measurement and valuation methods, contract disputes, environmental damages, climate change, personal injury, and property damage. Our primary exposures for such matters relate to alleged royalty and tax underpayments on certain federal, state and privately owned properties, claims of alleged environmental contamination and damages from historic operations, and climate change. We will continue to defend ourselves vigorously in these matters.Our legal organization applies its knowledge, experience and professional judgment to the specific characteristics of our cases, employing a litigation management process to manage and monitor the legal proceedings against us. Our process facilitates the early evaluation and quantification of potential exposures in individual cases. This process also enables us to track those cases that have been scheduled for trial and/or mediation. Based on professional judgment and experience in using these litigation management tools and available information about current developments in all our cases, our legal organization regularly assesses the adequacy of current accruals and determines if adjustment of existing accruals, or establishment of new accruals, is required.We have contingent liabilities resulting from throughput agreements with pipeline and processing companies not associated with financing arrangements. Under these agreements, we may be required to provide any such company with additional funds through advances and penalties for fees related to throughput capacity not utilized. In addition, at December 31, 2022, we had performance obligations secured by letters of credit of $368 million (issued as direct bank letters of credit) related to various purchase commitments for materials, supplies, commercial activities and services incident to the ordinary conduct of business.In 2007, ConocoPhillips was unable to reach agreement with respect to the empresa mixta structure mandated by the Venezuelan government’s Nationalization Decree. As a result, Venezuela’s national oil company, Petróleos de Venezuela, S.A. (PDVSA), or its affiliates, directly assumed control over ConocoPhillips’ interests in the Petrozuata and Hamaca heavy oil ventures and the offshore Corocoro development project. In response to this expropriation, ConocoPhillips initiated international arbitration on November 2, 2007, with the ICSID. On September 3, 2013, an ICSID arbitration tribunal held that Venezuela unlawfully expropriated ConocoPhillips’ significant oil investments in June 2007. On January 17, 2017, the Tribunal reconfirmed the decision that the expropriation was unlawful. In March 2019, the Tribunal unanimously ordered the government of Venezuela to pay ConocoPhillips approximately $8.7 billion in compensation for the government’s unlawful expropriation of the company’s investments in Venezuela in 2007. On August 29, 2019, the ICSID Tribunal issued a decision rectifying the award and reducing it by approximately $227 million. The award now stands at $8.5 billion plus interest. The government of Venezuela sought annulment of the award, which automatically stayed enforcement of the award. On September 29, 2021, the ICSID annulment committee lifted the stay of enforcement of the award. The annulment proceedings are underway.In 2014, ConocoPhillips filed a separate and independent arbitration under the rules of the ICC against PDVSA under the contracts that had established the Petrozuata and Hamaca projects. The ICC Tribunal issued an award in April 2018, finding that PDVSA owed ConocoPhillips approximately $2 billion under their agreements in connection with the expropriation of the projects and other pre-expropriation fiscal measures. In August 2018, ConocoPhillips entered into a settlement with PDVSA to recover the full amount of this ICC award, plus interest through the payment period, including initial payments totaling approximately $500 million within a period of 90 days from the time of signing of the settlement agreement. The balance of the settlement is to be paid quarterly over a period of four and a half years. Per the settlement, PDVSA recognized the ICC award as a judgment in various jurisdictions, and ConocoPhillips agreed to suspend its legal enforcement actions. ConocoPhillips sent notices of default to PDVSA on October 14 and November 12, 2019, and to date PDVSA has failed to cure its breach. As a result, ConocoPhillips has resumed legal enforcement actions. To date, ConocoPhillips has received approximately $774 million in connection with the ICC award. ConocoPhillips has ensured that the settlement and any actions taken in enforcement thereof meet all appropriate U.S. regulatory requirements, including those related to any applicable sanctions imposed by the U.S. against Venezuela.In 2016, ConocoPhillips filed a separate and independent arbitration under the rules of the ICC against PDVSA under the contracts that had established the Corocoro Project. On August 2, 2019, the ICC Tribunal awarded ConocoPhillips approximately $33 million plus interest under the Corocoro contracts. ConocoPhillips is seeking recognition and enforcement of the award in various jurisdictions. ConocoPhillips has ensured that all the actions related to the award meet all appropriate U.S. regulatory requirements, including those related to any applicable sanctions imposed by the U.S. against Venezuela.99ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsBeginning in 2017, governmental and other entities in several states/territories in the U.S. have filed lawsuits against oil and gas companies, including ConocoPhillips, seeking compensatory damages and equitable relief to abate alleged climate change impacts. Additional lawsuits with similar allegations are expected to be filed. The amounts claimed by plaintiffs are unspecified and the legal and factual issues are unprecedented, therefore, there is significant uncertainty about the scope of the claims and alleged damages and any potential impact on the Company’s financial condition. ConocoPhillips believes these lawsuits are factually and legally meritless and are an inappropriate vehicle to address the challenges associated with climate change and will vigorously defend against such lawsuits.Several Louisiana parishes and the State of Louisiana have filed 43 lawsuits under Louisiana’s State and Local Coastal Resources Management Act (SLCRMA) against oil and gas companies, including ConocoPhillips, seeking compensatory damages for contamination and erosion of the Louisiana coastline allegedly caused by historical oil and gas operations. ConocoPhillips entities are defendants in 22 of the lawsuits and will vigorously defend against them. On October 17, 2022, the Fifth Circuit affirmed remand of lead cases to state court and the subsequent request for rehearing was denied. Accordingly, the federal district courts have issued remands to state court. Because Plaintiffs’ SLCRMA theories are unprecedented, there is uncertainty about these claims (both as to scope and damages) and we continue to evaluate our exposure in these lawsuits.In October 2020, the Bureau of Safety and Environmental Enforcement (BSEE) ordered the prior owners of Outer Continental Shelf (OCS) Lease P-0166, including ConocoPhillips, to decommission the lease facilities, including two offshore platforms located near Carpinteria, California. This order was sent after the current owner of OCS Lease P-0166 relinquished the lease and abandoned the lease platforms and facilities. BSEE’s order to ConocoPhillips is premised on its connection to Phillips Petroleum Company, a legacy company of ConocoPhillips, which held a historical 25 percent interest in this lease and operated these facilities, but sold its interest approximately 30 years ago. ConocoPhillips continues to evaluate its exposure in this matter.On May 10, 2021, ConocoPhillips filed arbitration under the rules of the Singapore International Arbitration Centre (SIAC) against Santos KOTN Pty Ltd. and Santos Limited for their failure to timely pay the $200 million bonus due upon FID of the Barossa development project under the sale and purchase agreement. Santos KOTN Pty Ltd. and Santos Limited have filed a response and counterclaim, and the arbitration is underway.In July 2021, a federal securities class action was filed against Concho, certain of Concho’s officers, and ConocoPhillips as Concho’s successor in the United States District Court for the Southern District of Texas. On October 21, 2021, the court issued an order appointing Utah Retirement Systems and the Construction Laborers Pension Trust for Southern California as lead plaintiffs (Lead Plaintiffs). On January 7, 2022, the Lead Plaintiffs filed their consolidated complaint alleging that Concho made materially false and misleading statements regarding its business and operations in violation of the federal securities laws and seeking unspecified damages, attorneys’ fees, costs, equitable/injunctive relief, and such other relief that may be deemed appropriate. We believe the allegations in the action are without merit and are vigorously defending this litigation.Long-Term Throughput Agreements and Take-or-Pay AgreementsWe have certain throughput agreements and take-or-pay agreements in support of financing arrangements. The agreements typically provide for natural gas or crude oil transportation to be used in the ordinary course of business. The aggregate amounts of estimated payments under these various agreements are: 2023—$7 million; 2024—$7 million; 2025—$7 million; 2026—$7 million; 2027—$7 million; and 2028 and after—$33 million. Total payments under the agreements were $26 million in 2022, $27 million in 2021 and $25 million in 2020.ConocoPhillips 2022 10-K100Notes to Consolidated Financial StatementsTable of ContentsNote 12—Derivative and Financial InstrumentsWe use futures, forwards, swaps and options in various markets to meet our customer needs, capture market opportunities and manage foreign exchange currency risk. Commodity Derivative InstrumentsOur commodity business primarily consists of natural gas, crude oil, bitumen, LNG and NGLs.Commodity derivative instruments are held at fair value on our consolidated balance sheet. Where these balances have the right of setoff, they are presented on a net basis. Related cash flows are recorded as operating activities on our consolidated statement of cash flows. On our consolidated income statement, gains and losses are recognized either on a gross basis if directly related to our physical business or a net basis if held for trading. Gains and losses related to contracts that meet and are designated with the NPNS exception are recognized upon settlement. We generally apply this exception to eligible crude contracts and certain gas contracts. We do not apply hedge accounting for our commodity derivatives.The following table presents the gross fair values of our commodity derivatives, excluding collateral, and the line items where they appear on our consolidated balance sheet:Millions of Dollars20222021AssetsPrepaid expenses and other current assets$1,795 1,168 Other assets242 75 LiabilitiesOther accruals1,800 1,160 Other liabilities and deferred credits210 63 The gains (losses) from commodity derivatives incurred, and the line items where they appear on our consolidated income statement were:Millions of Dollars202220212020Sales and other operating revenues$(88)(228)19 Other income (loss)(5)25 4 Purchased commodities(91)75 11 On January 15, 2021, we assumed financial derivative instruments consisting of oil and natural gas swaps in connection with the acquisition of Concho. At the acquisition date, these financial derivative instruments acquired were recognized at fair value as a net liability of $456 million with settlement dates under the contracts through December 31, 2022. During 2021, we recognized a loss on settlement of these derivatives contracts of $305 million. This loss is recorded within the “Sales and other operating revenues” line on our consolidated income statement. In connection with the settlement, we issued a cash payment of $761 million during 2021 which is included within “Cash Flows From Operating Activities” on our consolidated statement of cash flows.The table below summarizes our net exposures resulting from outstanding commodity derivative contracts:Open PositionLong/(Short)20222021CommodityNatural gas and power (billions of cubic feet equivalent)Fixed price(14)4 Basis(8)(22)101ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsFinancial InstrumentsWe invest in financial instruments with maturities based on our cash forecasts for the various accounts and currency pools we manage. The types of financial instruments in which we currently invest include:•Time deposits: Interest bearing deposits placed with financial institutions for a predetermined amount of time.•Demand deposits: Interest bearing deposits placed with financial institutions. Deposited funds can be withdrawn without notice.•Commercial paper: Unsecured promissory notes issued by a corporation, commercial bank or government agency purchased at a discount to mature at par. •U.S. government or government agency obligations: Securities issued by the U.S. government or U.S. government agencies.•Foreign government obligations: Securities issued by foreign governments.•Corporate bonds: Unsecured debt securities issued by corporations.•Asset-backed securities: Collateralized debt securities.The following investments are carried on our consolidated balance sheet at cost, plus accrued interest and the table reflects remaining maturities at December 31, 2022 and 2021: Millions of DollarsCarrying AmountCash and CashEquivalentsShort-TermInvestments2022202120222021Cash$593 670 Demand Deposits1,638 1,554 Time Deposits1 to 90 days4,116 2,363 1,288 217 91 to 180 days883 4 Within one year11 4 U.S. Government Obligations1 to 90 days14 431 — — $6,361 5,018 2,182 225 The following investments in debt securities classified as available for sale are carried at fair value on our consolidated balance sheet at December 31, 2022 and 2021:Millions of DollarsCarrying AmountCash and CashEquivalentsShort-TermInvestmentsInvestments and Long-TermReceivables202220212022202120222021Major Security TypeCorporate Bonds$— 3 323 128 309 173 Commercial Paper97 7 156 82 U.S. Government Obligations— — 115 — 63 2 U.S. Government Agency Obligations8 2 5 8 Foreign Government Obligations— 7 7 2 Asset-backed Securities1 2 138 63 $97 10 603 221 522 248 Cash and Cash Equivalents and Short-Term Investments have remaining maturities within one year.Investments and Long-Term Receivables have remaining maturities that vary from greater than one year through five years.ConocoPhillips 2022 10-K102Notes to Consolidated Financial StatementsTable of ContentsThe following table summarizes the amortized cost basis and fair value of investments in debt securities classified as available for sale at December 31:Millions of DollarsAmortized Cost BasisFair Value2022202120222021Major Security TypeCorporate Bonds$641 305 632 304 Commercial Paper253 88 253 89 U.S. Government Obligations181 2 178 2 U.S. Government Agency Obligations13 10 13 10 Foreign Government Obligations7 9 7 9 Asset-backed Securities139 65 139 65 $1,234 479 1,222 479 As of December 31, 2022 and 2021, total unrealized losses for debt securities classified as available for sale with net losses were $12 million and negligible, respectively. No allowance for credit losses has been recorded on investments in debt securities which are in an unrealized loss position. For the years ended December 31, 2022 and 2021, proceeds from sales and redemptions of investments in debt securities classified as available for sale were $644 million and $594 million, respectively. Gross realized gains and losses included in earnings from those sales and redemptions were negligible. The cost of securities sold and redeemed is determined using the specific identification method.Credit RiskFinancial instruments potentially exposed to concentrations of credit risk consist primarily of cash equivalents, short-term investments, long-term investments in debt securities, OTC derivative contracts and trade receivables. Our cash equivalents and short-term investments are placed in high-quality commercial paper, government money market funds, U.S. government and government agency obligations, time deposits with major international banks and financial institutions, high-quality corporate bonds, foreign government obligations and asset-backed securities. Our long-term investments in debt securities are placed in high-quality corporate bonds, asset-backed securities, U.S. government and government agency obligations, foreign government obligations, and time deposits with major international banks and financial institutions. The credit risk from our OTC derivative contracts, such as forwards, swaps and options, derives from the counterparty to the transaction. Individual counterparty exposure is managed within predetermined credit limits and includes the use of cash-call margins when appropriate, thereby reducing the risk of significant nonperformance. We also use futures, swaps and option contracts that have a negligible credit risk because these trades are cleared primarily with an exchange clearinghouse and subject to mandatory margin requirements until settled; however, we are exposed to the credit risk of those exchange brokers for receivables arising from daily margin cash calls, as well as for cash deposited to meet initial margin requirements. Our trade receivables result primarily from our petroleum operations and reflect a broad national and international customer base, which limits our exposure to concentrations of credit risk. The majority of these receivables have payment terms of 30 days or less, and we continually monitor this exposure and the creditworthiness of the counterparties. We may require collateral to limit the exposure to loss including, letters of credit, prepayments and surety bonds, as well as master netting arrangements to mitigate credit risk with counterparties that both buy from and sell to us, as these agreements permit the amounts owed by us or owed to others to be offset against amounts due to us.Certain of our derivative instruments contain provisions that require us to post collateral if the derivative exposure exceeds a threshold amount. We have contracts with fixed threshold amounts and other contracts with variable threshold amounts that are contingent on our credit rating. The variable threshold amounts typically decline for lower credit ratings, while both the variable and fixed threshold amounts typically revert to zero if we fall below investment grade. Cash is the primary collateral in all contracts; however, many also permit us to post letters of credit as collateral, such as transactions administered through the New York Mercantile Exchange.103ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsThe aggregate fair value of all derivative instruments with such credit risk-related contingent features that were in a liability position on December 31, 2022 and December 31, 2021, was $333 million and $281 million, respectively. For these instruments, $42 million of collateral was posted as of December 31, 2022 and no collateral was posted as of December 31, 2021. If our credit rating had been downgraded below investment grade on December 31, 2022, we would have been required to post $270 million of additional collateral, either with cash or letters of credit.Note 13—Fair Value MeasurementWe carry a portion of our assets and liabilities at fair value that are measured at the reporting date using an exit price (i.e., the price that would be received to sell an asset or paid to transfer a liability) and disclosed according to the quality of valuation inputs under the fair value hierarchy.The classification of an asset or liability is based on the lowest level of input significant to its fair value. Those that are initially classified as Level 3 are subsequently reported as Level 2 when the fair value derived from unobservable inputs is inconsequential to the overall fair value, or if corroborated market data becomes available. Assets and liabilities initially reported as Level 2 are subsequently reported as Level 3 if corroborated market data is no longer available. There were no material transfers into or out of Level 3 during 2022 or 2021.Recurring Fair Value MeasurementFinancial assets and liabilities reported at fair value on a recurring basis primarily include our investment in CVE common shares, our investments in debt securities classified as available for sale, and commodity derivatives. •Level 1 derivative assets and liabilities primarily represent exchange-traded futures and options that are valued using unadjusted prices available from the underlying exchange. Level 1 also includes our investment in common shares of CVE, which is valued using quotes for shares on the NYSE, and our investments in U.S. government obligations classified as available for sale debt securities, which are valued using exchange prices. •Level 2 derivative assets and liabilities primarily represent OTC swaps, options and forward purchase and sale contracts that are valued using adjusted exchange prices, prices provided by brokers or pricing service companies that are all corroborated by market data. Level 2 also includes our investments in debt securities classified as available for sale including investments in corporate bonds, commercial paper, asset-backed securities, U.S. government agency obligations and foreign government obligations that are valued using pricing provided by brokers or pricing service companies that are corroborated with market data. •Level 3 derivative assets and liabilities consist of OTC swaps, options and forward purchase and sale contracts where a significant portion of fair value is calculated from underlying market data that is not readily available. The derived value uses industry standard methodologies that may consider the historical relationships among various commodities, modeled market prices, time value, volatility factors and other relevant economic measures. The use of these inputs results in management’s best estimate of fair value. Level 3 activity was not material for all periods presented.The following table summarizes the fair value hierarchy for gross financial assets and liabilities (i.e., unadjusted where the right of setoff exists for commodity derivatives accounted for at fair value on a recurring basis):Millions of DollarsDecember 31, 2022December 31, 2021Level 1Level 2Level 3TotalLevel 1Level 2Level 3TotalAssetsInvestment in Cenovus Energy$ 1,117 — — 1,117 Investments in debt securities178 1,044 — 1,222 2 477 — 479 Commodity derivatives958 951 128 2,037 562 619 62 1,243 Total assets$1,136 1,995 128 3,259 1,681 1,096 62 2,839 LiabilitiesCommodity derivatives$906 843 261 2,010 593 543 87 1,223 Total liabilities$906 843 261 2,010 593 543 87 1,223 ConocoPhillips 2022 10-K104Notes to Consolidated Financial StatementsTable of ContentsThe following table summarizes those commodity derivative balances subject to the right of setoff as presented on our consolidated balance sheet. We have elected to offset the recognized fair value amounts for multiple derivative instruments executed with the same counterparty in our financial statements when a legal right of setoff exists.Millions of DollarsAmounts Subject to Right of SetoffGrossAmountsRecognizedAmounts NotSubject toRight of SetoffGrossAmountsGrossAmountsOffsetNetAmountsPresentedCashCollateralNetAmountsDecember 31, 2022Assets$2,037 39 1,998 1,176 822 37 785 Liabilities2,010 20 1,990 1,176 814 52 762 December 31, 2021Assets$1,243 85 1,158 650 508 — 508 Liabilities1,223 82 1,141 650 491 36 455 At December 31, 2022 and December 31, 2021, we did not present any amounts gross on our consolidated balance sheet where we had the right of setoff.Non-Recurring Fair Value MeasurementThe following table summarizes the fair value hierarchy by major category and date of remeasurement for assets accounted for at fair value on a non-recurring basis:Millions of DollarsFair Value Measurements UsingFair ValueLevel 1InputsLevel 2InputsLevel 3InputsBefore-TaxLossYear ended December 31, 2021Net PP&E (held for use)December 31, 2021$472 — — 472 80 Equity Method InvestmentsDecember 31, 20215,574 — 5,574 — 688 Net PP&E (held for use)During 2021, the estimated fair value of certain noncore assets included in our Lower 48 segment declined to amounts below the carrying values. The carrying values were written down to fair value. The fair values were estimated based on internal discounted cash flow models using the following estimated assumptions: estimated future production, an outlook of future prices from a combination of exchanges (short-term) coupled with pricing service companies and our internal outlook (long-term), future operating costs and capital expenditures, and a discount rate believed to be consistent with those used by principal market participants. The range and arithmetic average of significant unobservable inputs used in the Level 3 fair value measurements for significant assets were as follows: Fair Value(Millions ofDollars)ValuationTechniqueUnobservable InputsRange(Arithmetic Average)December 31, 2021Lower 48 Gulf Coast and Rockies noncore field$472 Discounted cash flowCommodity production (MBOED)0.2 - 17 (5.4)Commodity price outlook* ($/BOE)$41.45 - $93.68 ($64.39)Discount rate**7.3% - 9.7% (8.7%)*Commodity price outlook based on a combination of external pricing service companies' and our internal outlook for years 2024-2050; future prices escalated at 2.0% annually after year 2050.**Determined as the weighted average cost of capital of a group of peer companies, adjusted for risks where appropriate.105ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsEquity Method InvestmentsDuring the fourth quarter of 2021, Origin Energy Limited agreed to the sale of 10 percent of their interest in APLNG for $1.645 billion, before customary adjustments. ConocoPhillips announced in December 2021 that we were exercising our preemption right under the APLNG Shareholders Agreement to purchase an additional 10 percent shareholding interest in APLNG, subject to government approvals. The sales price associated with this preemption right was determined to reflect a relevant observable market participant view of APLNG’s fair value which was below the carrying value of our existing investment in APLNG. As such, our investment in APLNG was written down to its fair value of $5,574 million, resulting in a before-tax charge of $688 million. See Note 4 and Note 7. Reported Fair Values of Financial InstrumentsWe used the following methods and assumptions to estimate the fair value of financial instruments:•Cash and cash equivalents and short-term investments: The carrying amount reported on the balance sheet approximates fair value. For those investments classified as available for sale debt securities, the carrying amount reported on the balance sheet is fair value.•Accounts and notes receivable (including long-term and related parties): The carrying amount reported on the balance sheet approximates fair value. The valuation technique and methods used to estimate the fair value of the current portion of fixed-rate related party loans is consistent with Loans and advances—related parties.•Investment in Cenovus Energy: See Note 5 for a discussion of the carrying value and fair value of our investment in CVE common shares. •Investments in debt securities classified as available for sale: The fair value of investments in debt securities categorized as Level 1 in the fair value hierarchy is measured using exchange prices. The fair value of investments in debt securities categorized as Level 2 in the fair value hierarchy is measured using pricing provided by brokers or pricing service companies that are corroborated with market data. See Note 12. •Loans and advances—related parties: The carrying amount of floating-rate loans approximates fair value. The fair value of fixed-rate loan activity is measured using market observable data and is categorized as Level 2 in the fair value hierarchy. See Note 4.•Accounts payable (including related parties) and floating-rate debt: The carrying amount of accounts payable and floating-rate debt reported on the balance sheet approximates fair value. •Fixed-rate debt: The estimated fair value of fixed-rate debt is measured using prices available from a pricing service that is corroborated by market data; therefore, these liabilities are categorized as Level 2 in the fair value hierarchy.•Commercial paper: The carrying amount of our commercial paper instruments approximates fair value and is reported on the balance sheet as short-term debt.The following table summarizes the net fair value of financial instruments (i.e., adjusted where the right of setoff exists for commodity derivatives):Millions of DollarsCarrying AmountFair Value2022202120222021Financial assetsInvestment in CVE common shares$— 1,117 $— 1,117 Commodity derivatives824 593 824 593 Investments in debt securities1,222 479 1,222 479 Loans and advances—related parties— 114 — 114 Financial liabilitiesTotal debt, excluding finance leases15,323 18,673 15,545 22,451 Commodity derivatives782 537 782 537 ConocoPhillips 2022 10-K106Notes to Consolidated Financial StatementsTable of ContentsNote 14—EquityCommon StockThe changes in our shares of common stock, as categorized in the equity section of the balance sheet, were:Shares202220212020IssuedBeginning of year2,091,562,747 1,798,844,267 1,795,652,203 Acquisition of Concho— 285,928,872 — Distributed under benefit plans9,322,387 6,789,608 3,192,064 End of year2,100,885,134 2,091,562,747 1,798,844,267 Held in TreasuryBeginning of year789,319,875 730,802,089 710,783,814 Repurchase of common stock87,709,187 58,517,786 20,018,275 End of year877,029,062 789,319,875 730,802,089 Preferred StockWe have authorized 500 million shares of preferred stock, par value $0.01 per share, none of which was issued or outstanding at December 31, 2022 or 2021.Noncontrolling Interests In 2020, we completed the divestiture of our subsidiaries that held our Australia-West assets and operations. These assets included the Darwin LNG and Bayu-Darwin Pipeline operating joint ventures in which there was a noncontrolling interest. As a result, as of December 31, 2020, we had no noncontrolling interests. Repurchase of Common StockIn late 2016, we initiated our current share repurchase program. In October 2022, our Board of Directors approved an increase to our authorization from $25 billion to $45 billion of our common stock to support our plan for future share repurchases. In May 2021, we began a paced monetization of our CVE common shares, the proceeds of which have been applied to share repurchases. During the first quarter of 2022, we sold our remaining 91 million CVE common shares. Share repurchases since inception of our current program totaled 335 million shares at a cost of $23 billion through the end of December 2022. 107ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsNote 15—Non-Mineral LeasesThe company primarily leases office buildings and drilling equipment, as well as ocean transport vessels, tugboats, corporate aircraft, and other facilities and equipment. Certain leases include escalation clauses for adjusting rental payments to reflect changes in price indices and other leases include payment provisions that vary based on the nature of usage of the leased asset. Additionally, the company has executed certain leases that provide it with the option to extend or renew the term of the lease, terminate the lease prior to the end of the lease term, or purchase the leased asset as of the end of the lease term. In other cases, the company has executed lease agreements that require it to guarantee the residual value of certain leased office buildings. For additional information about guarantees, see Note 10. There are no significant restrictions imposed on us by the lease agreements with regard to dividends, asset dispositions or borrowing ability.We determine if an arrangement is or contains a lease at contract inception. Certain contractual arrangements may contain both lease and non-lease components. Only the lease components of these contractual arrangements are subject to the provisions of ASC Topic 842, and any non-lease components are subject to other applicable accounting guidance; however, we have elected to adopt the optional practical expedient not to separate lease components apart from non-lease components for existing asset classes (as of the adoption date of ASC 842) for accounting purposes. For contractual arrangements involving a new leased asset class, we determine at contract inception whether it will apply the optional practical expedient to the new leased asset class. Leases are evaluated for classification as operating or finance leases at the commencement date of the lease and right-of-use assets and corresponding liabilities are recognized on our consolidated balance sheet based on the present value of future lease payments relating to the use of the underlying asset during the lease term. Future lease payments include variable lease payments that depend upon an index or rate using the index or rate at the commencement date and probable amounts owed under residual value guarantees. The amount of future lease payments may be increased to include additional payments related to lease extension, termination, and/or purchase options when the company has determined, at or subsequent to lease commencement, generally due to limited asset availability or operating commitments, it is reasonably certain of exercising such options. We use our incremental borrowing rate as the discount rate in determining the present value of future lease payments, unless the interest rate implicit in the lease arrangement is readily determinable. Lease payments that vary subsequent to the commencement date based on future usage levels, the nature of leased asset activities, or certain other contingencies are not included in the measurement of lease right-of-use assets and corresponding liabilities. We have elected not to record assets and liabilities on our consolidated balance sheet for lease arrangements with terms of 12 months or less.We often enter into leasing arrangements acting in the capacity as operator for and/or on behalf of certain oil and gas joint ventures of undivided interests. If the lease arrangement can be legally enforced only against us as operator and there is no separate arrangement to sublease the underlying leased asset to our coventurers, we recognize at lease commencement a right-of-use asset and corresponding lease liability on our consolidated balance sheet on a gross basis. While we record lease costs on a gross basis in our consolidated income statement and statement of cash flows, such costs are offset by the reimbursement we receive from our coventurers for their share of the lease cost as the underlying leased asset is utilized in joint venture activities. As a result, lease cost is presented in our consolidated income statement and statement of cash flows on a proportional basis. If we are a nonoperating coventurer, we recognize a right-of-use asset and corresponding lease liability only if we were a specified contractual party to the lease arrangement and the arrangement could be legally enforced against us. In this circumstance, we would recognize both the right-of-use asset and corresponding lease liability on our consolidated balance sheet on a proportional basis consistent with our undivided interest ownership in the related joint venture. The company has historically recorded certain finance leases executed by investee companies accounted for under the proportionate consolidation method of accounting on its consolidated balance sheet on a proportional basis consistent with its ownership interest in the investee company. In addition, the company has historically recorded finance lease assets and liabilities associated with certain oil and gas joint ventures on a proportional basis pursuant to accounting guidance applicable prior to the adoption date of ASC 842 on January 1, 2019. In accordance with the transition provisions of ASC Topic 842, and since we have elected to adopt the package of optional transition-related practical expedients, the historical accounting treatment for these leases has been carried forward and is subject to reconsideration upon the modification or other required reassessment of the arrangements prior to lease term expiration. ConocoPhillips 2022 10-K108Notes to Consolidated Financial StatementsTable of ContentsThe following table summarizes the right-of-use assets and lease liabilities for both the operating and finance leases on our consolidated balance sheet as of December 31:Millions of Dollars20222021OperatingLeasesFinanceLeasesOperatingLeasesFinanceLeasesRight-of-Use AssetsProperties, plants and equipmentGross2,043 1,812 Accumulated DD&A(1,022)(857)Net PP&E*1,021 955 Prepaid expenses and other current assets16 2 Other assets536 649 Lease LiabilitiesShort-term debt**284 280 Other accruals155 188 Long-term debt***1,036 981 Other liabilities and deferred credits390 479 Total lease liabilities$545 1,320 667 1,261 * Includes proportionately consolidated finance lease assets of $171 million at December 31, 2022 and $208 million at December 31, 2021. ** Includes proportionately consolidated finance lease liabilities of $169 million at December 31, 2022 and $154 million at December 31, 2021.*** Includes proportionately consolidated finance lease liabilities of $399 million at December 31, 2022 and $462 million at December 31, 2021. The following table summarizes our lease costs:Millions of Dollars202220212020Lease Cost*Operating lease cost$212 278 321 Finance lease costAmortization of right-of-use assets189 148 163 Interest on lease liabilities32 27 34 Short-term lease cost**94 21 42 Total lease cost***$527 474 560 * The amounts presented in the table above have not been adjusted to reflect amounts recovered or reimbursed from oil and gas coventurers.** Short-term leases are not recorded on our consolidated balance sheet.*** Variable lease cost and sublease income are immaterial for the periods presented and therefore are not included in the table above.The following table summarizes the lease terms and discount rates as of December 31:20222021Lease Term and Discount RateWeighted-average term (years)Operating leases5.645.97Finance leases6.607.49Weighted-average discount rate (percent)Operating leases2.99 2.66 Finance leases3.40 3.24 109ConocoPhillips 2022 10-KThe following table summarizes other lease information:Millions of Dollars202220212020Other Information*Cash paid for amounts included in the measurement of lease liabilitiesOperating cash flows from operating leases$148 204 232 Operating cash flows from finance leases30 6 11 Financing cash flows from finance leases166 73 255 Right-of-use assets obtained in exchange for operating lease liabilities$114 174 250 Right-of-use assets obtained in exchange for finance lease liabilities256 447 426 *The amounts presented in the table above have not been adjusted to reflect amounts recovered or reimbursed from oil and gas coventurers. In addition, pursuant to other applicable accounting guidance, lease payments made in connection with preparing another asset for its intended use are reported in the "Cash Flows From Investing Activities" section of our consolidated statement of cash flows.The following table summarizes future lease payments for operating and finance leases at December 31, 2022:Millions of DollarsOperatingLeasesFinance LeasesMaturity of Lease Liabilities2023$169 356 2024126 215 202581 210 202659 207 202746 164 Remaining years118 352 Total*599 1,504 Less: portion representing imputed interest(54)(184)Total lease liabilities$545 $1,320 *Future lease payments for operating and finance leases commencing on or after January 1, 2019, also include payments related to non-lease components in accordance with our election to adopt the optional practical expedient not to separate lease components apart from non-lease components for accounting purposes. In addition, future payments related to operating and finance leases proportionately consolidated by the company have been included in the table on a proportionate basis consistent with our respective ownership interest in the underlying investee company or oil and gas venture.ConocoPhillips 2022 10-K110Notes to Consolidated Financial StatementsTable of ContentsNote 16—Employee Benefit PlansPension and Postretirement PlansAn analysis of the projected benefit obligations for our pension plans and accumulated benefit obligations for our postretirement health and life insurance plans follows:Millions of DollarsPension BenefitsOther Benefits2022202120222021U.S.Int’l.U.S.Int’l.Change in Benefit ObligationBenefit obligation at January 1$1,924 4,124 2,548 4,403 137 170 Service cost58 47 73 61 1 2 Interest cost62 77 53 79 4 4 Plan participant contributions— — — — 16 16 Plan amendments— — — — 9 — Actuarial (gain) loss(325)(847)(117)(176)(27)(16)Benefits paid(241)(144)(654)(162)(38)(40)Divestiture— (56)— — — — Curtailment— — 12 — — 1 Recognition of termination benefits— — 9 — — — Foreign currency exchange rate change— (425)— (81)— — Benefit obligation at December 31*$1,478 2,776 1,924 4,124 102 137 *Accumulated benefit obligation portion of above at December 31:$1,384 2,542 1,793 3,658 Change in Fair Value of Plan AssetsFair value of plan assets at January 1$1,664 4,812 1,770 4,793 — — Actual return on plan assets(319)(1,372)97 147 — — Company contributions75 96 451 119 22 24 Plan participant contributions— 1 — 1 16 16 Benefits paid(241)(144)(654)(162)(38)(40)Divestiture— (46)— — — — Foreign currency exchange rate change— (468)— (86)— — Fair value of plan assets at December 31$1,179 2,879 1,664 4,812 — — Funded Status$(299)103 (260)688 (102)(137)111ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsMillions of DollarsPension BenefitsOther Benefits2022202120222021U.S.Int’l.U.S.Int’l.Amounts Recognized in the Consolidated Balance Sheet at December 31Noncurrent assets$— 373 1 991 — — Current liabilities(28)(10)(29)(15)(32)(34)Noncurrent liabilities(271)(260)(232)(288)(70)(103)Total recognized$(299)103 (260)688 (102)(137)Weighted-Average Assumptions Used to Determine Benefit Obligations at December 31Discount rate5.65 %4.20 2.80 2.15 5.65 2.65 Rate of compensation increase5.00 3.65 4.00 3.40 Interest crediting rate for applicable benefits3.55 2.50 Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for Years Ended December 31Discount rate3.85 %2.15 2.60 1.80 2.65 2.35 Expected return on plan assets3.90 2.85 5.20 2.50 Rate of compensation increase4.00 3.40 4.00 3.40 Interest crediting rate for applicable benefits2.50 2.10 For both U.S. and international pension plans, the overall expected long-term rate of return is developed from the expected future return of each asset class, weighted by the expected allocation of pension assets to that asset class. We rely on a variety of independent market forecasts in developing the expected rate of return for each class of assets.During 2022 and 2021, the actuarial gains related to the benefit obligations for U.S. and international plans were primarily related to an increase in the discount rates. During 2020, the actuarial losses related to the benefit obligations for U.S. and international plans were primarily related to a decrease in the discount rates.The following tables summarize information related to the Company's pension plans with projected and accumulated benefit obligations in excess of the fair value of the plans' assets:Millions of DollarsPension Benefits20222021U.S.Int’l.U.S.Int’l.Pension Plans with Projected Benefit Obligation in Excess of Plan AssetsProjected benefit obligation$1,478 277 261 362 Fair value of plan assets1,179 6 — 58 Pension Plans with Accumulated Benefit Obligation in Excess of Plan AssetsAccumulated benefit obligation$1,384 239 234 271 Fair value of plan assets1,179 6 — 9 ConocoPhillips 2022 10-K112Notes to Consolidated Financial StatementsTable of ContentsIncluded in accumulated other comprehensive income (loss) at December 31 were the following before-tax amounts that had not been recognized in net periodic benefit cost:Millions of DollarsPension BenefitsOther Benefits2022202120222021U.S.Int’l.U.S.Int’l.Unrecognized net actuarial loss (gain)$172 681 188 86 (28)(1)Unrecognized prior service cost (credit)— 1 — 1 (98)(145)Millions of DollarsPension BenefitsOther Benefits2022202120222021U.S.Int’l.U.S.Int’l.Sources of Change in Other Comprehensive Income (Loss)Net gain (loss) arising during the period$(44)(606)134 207 27 16 Amortization of actuarial loss included in income (loss)*61 11 145 33 — — Net change during the period$17 (595)279 240 27 16 Prior service credit (cost) arising during the period$— (1)— — (9)— Amortization of prior service (credit) included in income (loss)— (1)— (1)(38)(37)Net change during the period$— (2)— (1)(47)(37)*Includes settlement (gains) losses recognized in 2022 and 2021.The components of net periodic benefit cost of all defined benefit plans are presented in the following table:Millions of DollarsPension BenefitsOther Benefits202220212020202220212020U.S.Int’l.U.S.Int’l.U.S.Int’l.Components of Net Periodic Benefit CostService cost$58 47 73 61 85 54 1 2 2 Interest cost62 77 53 79 66 85 4 4 6 Expected return on plan assets(50)(124)(80)(120)(85)(145)— — — Amortization of prior service credit— (1)— (1)— (1)(38)(37)(31)Recognized net actuarial loss (gain)24 11 43 33 51 22 — — 1 Settlements loss (gain)37 — 102 — 44 (1)— — — Curtailment loss— — 12 — — — — — — Net periodic benefit cost$131 10 203 52 161 14 (33)(31)(22)The components of net periodic benefit cost, other than the service cost component, are included in the “Other expenses” line item on our consolidated income statement.113ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsWe recognized pension settlement losses of $37 million in 2022, $102 million in 2021, and $43 million in 2020 as lump-sum benefit payments from certain U.S. and international pension plans exceeded the sum of service and interest costs for those plans and led to recognition of settlement losses.In determining net pension and other postretirement benefit costs, we amortize prior service costs on a straight-line basis over the average remaining service period of employees expected to receive benefits under the plan. For net actuarial gains and losses, we amortize 10 percent of the unamortized balance each year.We have multiple non-pension postretirement benefit plans for health and life insurance. The health care plans are contributory and subject to various cost sharing features, most with participant and company contributions adjusted annually; the life insurance plans are noncontributory. The measurement of the U.S. pre-65 retiree medical accumulated postretirement benefit obligation assumes a health care cost trend rate of 6.5 percent in 2023 that declines to 5 percent by 2029. The measurement of the U.S. post-65 retiree medical accumulated postretirement benefit obligation assumes a health care cost trend rate of 4.5 percent in 2023 that increases to 5 percent by 2029.Plan AssetsWe follow a policy of broadly diversifying pension plan assets across asset classes and individual holdings. As a result, our plan assets have no significant concentrations of credit risk. Asset classes that are considered appropriate include U.S. equities, non-U.S. equities, U.S. fixed income, non-U.S. fixed income, real estate and private equity investments. Plan fiduciaries may consider and add other asset classes to the investment program from time to time. The target allocations for plan assets are 25 percent equity securities, 71 percent debt securities, and 4 percent real estate. Generally, the plan investments are publicly traded, therefore minimizing liquidity risk in the portfolio. The following is a description of the valuation methodologies used for the pension plan assets. There have been no changes in the methodologies used at December 31, 2022 and 2021.•Fair values of equity securities and government debt securities categorized in Level 1 are primarily based on quoted market prices in active markets for identical assets and liabilities.•Fair values of corporate debt securities, agency and mortgage-backed securities and government debt securities categorized in Level 2 are estimated using recently executed transactions and quoted market prices for similar assets and liabilities in active markets and for identical assets and liabilities in markets that are not active. If there have been no market transactions in a particular fixed income security, its fair value is calculated by pricing models that benchmark the security against other securities with actual market prices. When observable quoted market prices are not available, fair value is based on pricing models that use something other than actual market prices (e.g., observable inputs such as benchmark yields, reported trades and issuer spreads for similar securities), and these securities are categorized in Level 3 of the fair value hierarchy. •Fair values of investments in common/collective trusts are determined by the issuer of each fund based on the fair value of the underlying assets.•Fair values of mutual funds are based on quoted market prices, which represent the net asset value of shares held.•Time deposits are valued at cost, which approximates fair value.•Cash is valued at cost, which approximates fair value. Fair values of international cash equivalents categorized in Level 2 are valued using observable yield curves, discounting and interest rates. U.S. cash balances held in the form of short-term fund units that are redeemable at the measurement date are categorized as Level 2.•Fair values of exchange-traded derivatives classified in Level 1 are based on quoted market prices. For other derivatives classified in Level 2, the values are generally calculated from pricing models with market input parameters from third-party sources.•Fair values of insurance contracts are valued at the present value of the future benefit payments owed by the insurance company to the plans’ participants.•Fair values of real estate investments are valued using real estate valuation techniques and other methods that include reference to third-party sources and sales comparables where available.ConocoPhillips 2022 10-K114Notes to Consolidated Financial StatementsTable of Contents•A portion of U.S. pension plan assets is held as a participating interest in an insurance annuity contract, which is calculated as the market value of investments held under this contract, less the accumulated benefit obligation covered by the contract. The participating interest is classified as Level 3 in the fair value hierarchy as the fair value is determined via a combination of quoted market prices, recently executed transactions, and an actuarial present value computation for contract obligations. At December 31, 2022, the participating interest in the annuity contract was valued at $55 million and consisted of $144 million in debt securities, less $89 million for the accumulated benefit obligation covered by the contract. At December 31, 2021, the participating interest in the annuity contract was valued at $83 million and consisted of $206 million in debt securities, less $123 million for the accumulated benefit obligation covered by the contract. The participating interest is not available for meeting general pension benefit obligations in the near term. No future company contributions are required and no new benefits are being accrued under this insurance annuity contract.The fair values of our pension plan assets at December 31, by asset class were as follows: Millions of DollarsU.S.InternationalLevel 1Level 2Level 3TotalLevel 1Level 2Level 3Total2022Equity securitiesU.S.$4 — — 4 — — — — International36 — — 36 — — — — Mutual funds14 — — 14 201 298 — 499 Debt securitiesCorporate— 1 — 1 — — — — Mutual funds— — — — 365 — — 365 Cash and cash equivalents— — — — 36 — — 36 Real estate— — — — — — 146 146 Total in fair value hierarchy$54 1 — 55 602 298 146 1,046 Investments measured at net asset value*Equity securitiesCommon/collective trusts265 192 Debt securitiesCommon/collective trusts759 1,637 Cash and cash equivalents10 — Real estate34 — Total**$54 1 — 1,123 602 298 146 2,875 *In accordance with FASB ASC Topic 715, “Compensation—Retirement Benefits,” certain investments that are to be measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the Change in Fair Value of Plan Assets. **Excludes the participating interest in the insurance annuity contract with a net asset of $55 million and net receivables related to security transactions of $5 million. 115ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsThe fair values of our pension plan assets at December 31, by asset class were as follows: Millions of DollarsU.S.InternationalLevel 1Level 2Level 3TotalLevel 1Level 2Level 3Total2021Equity securitiesU.S.$3 — 5 8 — — — — International42 — — 42 — — — — Mutual funds17 — — 17 236 403 — 639 Debt securitiesCorporate— 1 — 1 — — — — Mutual funds— — — — 511 — — 511 Cash and cash equivalents— — — — 68 — — 68 Derivatives— — — — — — — — Real estate— — — — — — 157 157 Total in fair value hierarchy$62 1 5 68 815 403 157 1,375 Investments measured at net asset value*Equity securities Common/collective trusts394 417 Debt securitiesCommon/collective trusts1,073 3,015 Cash and cash equivalents9 — Real estate36 1 Total**$62 1 5 1,580 815 403 157 4,808 *In accordance with FASB ASC Topic 715, “Compensation—Retirement Benefits,” certain investments that are to be measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the Change in Fair Value of Plan Assets.**Excludes the participating interest in the insurance annuity contract with a net asset of $83 million and net receivables related to security transactions of $5 million. Level 3 activity was not material for all periods.Our funding policy for U.S. plans is to contribute at least the minimum required by the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986, as amended. Contributions to foreign plans are dependent upon local laws and tax regulations. In 2023, we expect to contribute approximately $90 million to our domestic qualified and nonqualified pension and postretirement benefit plans and $45 million to our international qualified and nonqualified pension and postretirement benefit plans.ConocoPhillips 2022 10-K116Notes to Consolidated Financial StatementsTable of ContentsThe following benefit payments, which are exclusive of amounts to be paid from the insurance annuity contract and which reflect expected future service, as appropriate, are expected to be paid:Millions of DollarsPensionBenefitsOtherBenefitsU.S.Int’l.2023$216 121 17 2024199 123 15 2025188 125 14 2026173 126 12 2027171 128 11 2028–2032685 677 38 The following table summarizes our severance accrual activity:Millions of Dollars202220212020Balance at January 1$78 24 23 Accruals1 170 14 Benefit payments(48)(116)(13)Balance at December 31$31 78 24 Accruals include severance costs associated with our company-wide restructuring program. Of the remaining balance at December 31, 2022, $19 million is classified as short-term.Defined Contribution PlansMost U.S. employees are eligible to participate in the ConocoPhillips Savings Plan (CPSP). Employees can deposit up to 75 percent of their eligible pay, subject to statutory limits, in the CPSP to a choice of 17 investment options. Employees who participate in the CPSP and contribute 1 percent of their eligible pay receive a 6 percent company cash match with a potential company discretionary cash contribution of up to 6 percent. Effective January 1, 2019, new employees, rehires and employees that elected to opt out of Title II of the ConocoPhillips Retirement Plan are eligible to receive a Company Retirement Contribution (CRC) of 6 percent of eligible pay into their CPSP. After three years of service with the company, the employee is 100 percent vested in any CRC. Company contributions charged to expense for the CPSP and predecessor plans were $140 million in 2022, $93 million in 2021 and $62 million in 2020.We have several defined contribution plans for our international employees, each with its own terms and eligibility depending on location. Total compensation expense recognized for these international plans was approximately $24 million in 2022, $26 million in 2021 and $25 million in 2020.Share-Based Compensation PlansThe 2014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips (the Plan) was approved by shareholders in May 2014, replacing similar prior plans and providing that no new awards shall be granted under the prior plans. Over its 10-year life, the Plan allows the issuance of up to 79 million shares of our common stock for compensation to our employees and directors; however, as of the effective date of the Plan, (i) any shares of common stock available for future awards under the prior plans and (ii) any shares of common stock represented by awards granted under the Plan or the prior plans that are forfeited, expire or are cancelled without delivery of shares of common stock or which result in the forfeiture of shares of common stock back to the company shall be available for awards under the Plan. Of the 79 million shares available for issuance under the Plan, no more than 40 million shares of common stock are available for incentive stock options. The Human Resources and Compensation Committee of our Board of Directors is authorized to determine the types, terms, conditions and limitations of awards granted. Awards may be granted in the form of, but not limited to, stock options, restricted stock units and performance share units to employees and non-employee directors who contribute to the company’s continued success and profitability.117ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsTotal share-based compensation expense is measured using the grant date fair value for our equity-classified awards and the settlement date fair value for our liability-classified awards. We recognize share-based compensation expense over the shorter of the service period (i.e., the stated period of time required to earn the award); or the period beginning at the start of the service period and ending when an employee first becomes eligible for retirement, but not less than six months, as this is the minimum period of time required for an award to not be subject to forfeiture. Our share-based compensation programs generally provide accelerated vesting (i.e., a waiver of the remaining period of service required to earn an award) for awards held by employees at the time of their retirement. Some of our share-based awards vest ratably (i.e., portions of the award vest at different times) while some of our awards cliff vest (i.e., all of the award vests at the same time). We recognize expense on a straight-line basis over the service period for the entire award, whether the award was granted with ratable or cliff vesting.Compensation Expense—Total share-based compensation expense recognized in net income (loss) and the associated tax benefit were:Millions of Dollars202220212020Compensation cost$377 304 159 Tax benefit95 76 40 Stock Options—Stock options granted under the provisions of the Plan and prior plans permit purchase of our common stock at exercise prices equivalent to the average fair market value of ConocoPhillips common stock on the date the options were granted. The options have terms of 10 years and generally vest ratably, with one-third of the options awarded vesting and becoming exercisable on each anniversary date following the date of grant. Options awarded to certain employees already eligible for retirement vest within six months of the grant date, but those options do not become exercisable until the end of the normal vesting period. Beginning in 2018, stock option grants were discontinued and replaced with three-year, time-vested restricted stock units which generally will be cash-settled for 2018 and 2019 awards and stock-settled beginning with 2020 awards.The following summarizes our stock option activity for the year ended December 31, 2022:Millions of DollarsOptionsWeighted-AverageExercise PriceAggregateIntrinsic ValueOutstanding at December 31, 202111,973,783 $56.46 $188 Exercised(7,670,208)57.12 (308)Expired or cancelled— — Outstanding at December 31, 20224,303,575 $55.28 $266 Vested at December 31, 20224,303,575 $55.28 $266 Exercisable at December 31, 20224,303,575 $55.28 $266 The weighted-average remaining contractual term of outstanding options, vested options and exercisable options at December 31, 2022, were all 2.57 years. The aggregate intrinsic value of options exercised was $68 million in 2021 and $23 million in 2020. During 2022, we received $438 million in cash and realized a tax benefit of $59 million from the exercise of options. At December 31, 2022, all outstanding stock options were fully vested and there was no remaining compensation cost to be recorded.Stock Unit Program—Generally, restricted stock units (RSU) are granted annually under the provisions of the Plan and vest in an aggregate installment on the third anniversary of the grant date. In addition, RSUs granted under the Plan for a variable long-term incentive program vest ratably in three equal annual installments beginning on the first anniversary of the grant date. Restricted stock units are also granted ad hoc to attract or retain key personnel, and the terms and conditions under which these restricted stock units vest vary by award.ConocoPhillips 2022 10-K118Notes to Consolidated Financial StatementsTable of ContentsStock-SettledUpon vesting, these restricted stock units are settled by issuing one share of ConocoPhillips common stock per unit. Units awarded to retirement eligible employees vest six months from the grant date; however, those units are not issued as common stock until the earlier of separation from the company or the end of the regularly scheduled vesting period. Until issued as stock, most recipients of the RSUs receive a cash payment of a dividend equivalent or an accrued reinvested dividend equivalent that is charged to retained earnings. The grant date fair market value of these RSUs is deemed equal to the average ConocoPhillips stock price on the grant date. The grant date fair market value of units that do not receive a dividend equivalent while unvested is deemed equal to the average ConocoPhillips stock price on the grant date, less the net present value of the dividends that will not be received. The following summarizes our stock-settled stock unit activity for the year ended December 31, 2022:Stock UnitsWeighted-AverageGrant Date Fair ValueMillions of DollarsTotal Fair ValueOutstanding at December 31, 20217,645,311 $53.81 Granted2,139,168 90.57 Forfeited(137,011)71.38 Issued(2,069,275)63.57 $193 Outstanding at December 31, 20227,578,193 $61.20 Not Vested at December 31, 20225,264,282 $61.58 At December 31, 2022, the remaining unrecognized compensation cost from the unvested stock-settled units was $135 million, which will be recognized over a weighted-average period of 1.67 years, the longest period being 2.67 years. The weighted-average grant date fair value of stock unit awards granted during 2021 and 2020 was $46.56 and $57.40, respectively. The total fair value of stock units issued during 2021 and 2020 was $144 million and $143 million, respectively.Cash-SettledCash settled executive restricted stock units granted in 2018 and 2019 replaced the stock option program. These restricted stock units, subject to elections to defer, will be settled in cash equal to the fair market value of a share of ConocoPhillips common stock per unit on the settlement date and are classified as liabilities on the balance sheet. Units awarded to retirement eligible employees vest six months from the grant date; however, those units are not settled until the earlier of separation from the company or the end of the regularly scheduled vesting period. Compensation expense is initially measured using the average fair market value of ConocoPhillips common stock and is subsequently adjusted, based on changes in the ConocoPhillips stock price through the end of each subsequent reporting period, through the settlement date. Recipients receive an accrued reinvested dividend equivalent that is charged to compensation expense. The accrued reinvested dividend is paid at the time of settlement, subject to the terms and conditions of the award. Beginning with executive restricted stock units granted in 2020, awards will be settled in stock. The following summarizes our cash-settled stock unit activity for the year ended December 31, 2022:Stock UnitsWeighted-Average Grant Date Fair ValueMillions of DollarsTotal Fair ValueOutstanding at December 31, 2021226,476 $72.18 Granted531 85.37 Forfeited— — Issued(227,007)91.47 $21 Outstanding at December 31, 2022— $— At December 31, 2022, there was no remaining unrecognized compensation cost to be recorded for the unvested cash-settled units. The weighted-average grant date fair value of stock unit awards granted during 2021 and 2020 were $57.19 and $41.59, respectively. The total fair value of stock units issued during 2021 and 2020 were $20 million and negligible, respectively.119ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsPerformance Share Program—Under the Plan, we also annually grant restricted performance share units (PSUs) to senior management. These PSUs are authorized three years prior to their effective grant date (the performance period). Compensation expense is initially measured using the average fair market value of ConocoPhillips common stock and is subsequently adjusted, based on changes in the ConocoPhillips stock price through the end of each subsequent reporting period, through the grant date for stock-settled awards and the settlement date for cash-settled awards. Stock-SettledFor performance periods beginning before 2009, PSUs do not vest until the employee becomes eligible for retirement by reaching age 55 with five years of service, and restrictions do not lapse until the employee separates from the company. With respect to awards for performance periods beginning in 2009 through 2012, PSUs do not vest until the earlier of the date the employee becomes eligible for retirement by reaching age 55 with five years of service or five years after the grant date of the award, and restrictions do not lapse until the earlier of the employee’s separation from the company or five years after the grant date (although recipients can elect to defer the lapsing of restrictions until separation). We recognize compensation expense for these awards beginning on the grant date and ending on the date the PSUs are scheduled to vest. Since these awards are authorized three years prior to the effective grant date, for employees eligible for retirement by or shortly after the grant date, we recognize compensation expense over the period beginning on the date of authorization and ending on the date of grant. Until issued as stock, recipients of the PSUs receive a cash payment of a dividend equivalent that is charged to retained earnings. Beginning in 2013, PSUs authorized for future grants will vest, absent employee election to defer, upon settlement following the conclusion of the three-year performance period. We recognize compensation expense over the period beginning on the date of authorization and ending on the conclusion of the performance period. PSUs are settled by issuing one share of ConocoPhillips common stock per unit.The following summarizes our stock-settled Performance Share Program activity for the year ended December 31, 2022:Weighted-AverageGrant Date Fair ValueMillions of DollarsStock UnitsTotal Fair ValueOutstanding at December 31, 20211,448,847 $50.69 Granted1,754 91.58 Issued(218,986)51.04 $21 Outstanding at December 31, 20221,231,615 $50.68 At December 31, 2022, there was no remaining unrecognized compensation cost to be recorded on the unvested stock-settled performance shares. There were no stock-settled PSUs granted during 2021; however, the weighted-average grant date fair value of stock-settled PSUs granted during 2020 was $58.61. The total fair value of stock-settled PSUs issued during 2021 and 2020 were $18 million and $13 million, respectively.Cash-SettledIn connection with and immediately following the separation of our Downstream businesses in 2012, grants of new PSUs, subject to a shortened performance period, were authorized. Once granted, these PSUs vest, absent employee election to defer, on the earlier of five years after the grant date of the award or the date the employee becomes eligible for retirement. For employees eligible for retirement by or shortly after the grant date, we recognize compensation expense over the period beginning on the date of authorization and ending on the date of grant. Otherwise, we recognize compensation expense beginning on the grant date and ending on the date the PSUs are scheduled to vest. These PSUs are settled in cash equal to the fair market value of a share of ConocoPhillips common stock per unit on the settlement date and thus are classified as liabilities on the balance sheet. Until settlement occurs, recipients of the PSUs receive a cash payment of a dividend equivalent that is charged to compensation expense.Beginning in 2013, PSUs authorized for future grants will vest upon settlement following the conclusion of the three-year performance period. We recognize compensation expense over the period beginning on the date of authorization and ending at the conclusion of the performance period. These PSUs will be settled in cash equal to the fair market value of a share of ConocoPhillips common stock per unit on the settlement date and are classified as liabilities on the balance sheet. For performance periods beginning before 2018, during the performance period, recipients of the PSUs do not receive a cash payment of a dividend equivalent, but after the performance period ends, until settlement in cash occurs, recipients of the PSUs receive a cash payment of a dividend equivalent that is charged to compensation expense. For the performance period beginning in 2018, recipients of the PSUs receive an accrued reinvested dividend equivalent that is charged to compensation expense. The accrued reinvested dividend is paid at the time of settlement, subject to the terms and conditions of the award.ConocoPhillips 2022 10-K120Notes to Consolidated Financial StatementsTable of ContentsThe following summarizes our cash-settled Performance Share Program activity for the year ended December 31, 2022:Weighted-AverageGrant Date Fair ValueMillions of DollarsStock UnitsTotal Fair ValueOutstanding at December 31, 2021117,679 $72.18 Granted967,151 91.58 Settled(975,007)89.87 $88 Outstanding at December 31, 2022109,823 $117.11 At December 31, 2022, all outstanding cash-settled performance awards were fully vested and there was no remaining compensation cost to be recorded. The weighted-average grant date fair value of cash-settled PSUs granted during 2021 and 2020 was $46.65 and $58.61, respectively. The total fair value of cash-settled performance share awards settled during 2021 and 2020 was $52 million and $116 million, respectively.From inception of the Performance Share Program through 2013, approved PSU awards were granted after the conclusion of performance periods. Beginning in February 2014, initial target PSU awards are issued near the beginning of new performance periods. These initial target PSU awards will terminate at the end of the performance periods and will be settled after the performance periods have ended. Also in 2014, initial target PSU awards were issued for open performance periods that began in prior years. For the open performance period beginning in 2012, the initial target PSU awards terminated at the end of the three-year performance period and were replaced with approved PSU awards. For the open performance period beginning in 2013, the initial target PSU awards terminated at the end of the three-year performance period and were settled after the performance period ended. There is no effect on recognition of compensation expense.Other—In addition to the above active programs, we have outstanding shares of restricted stock and restricted stock units that were either issued as part of our non-employee director compensation program for current and former members of the company’s Board of Directors, as part of an executive compensation program that has been discontinued or acquired as a result of an acquisition. Generally, the recipients of the restricted shares or units receive a dividend or dividend equivalent.The following summarizes the aggregate activity of these restricted shares and units for the year ended December 31, 2022:Weighted-AverageGrant Date Fair ValueMillions of DollarsStock UnitsTotal Fair ValueOutstanding at December 31, 20211,616,367 $47.24 Granted73,450 96.20 Cancelled(1,030)24.61 Issued(449,028)48.28 $40 Outstanding at December 31, 20221,239,759 $49.78 Not Vested at December 31, 2022437,994 $45.90 At December 31, 2022, the remaining compensation cost from the unvested restricted stock was $10 million, which will be recognized over a weighted-average period of 1 year. The weighted-average grant date fair value of awards granted during 2021 and 2020 was $46.43 and $51.46, respectively. The total fair value of awards issued during 2021 and 2020 was $8 million and $6 million, respectively. 121ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsNote 17—Income TaxesComponents of income tax provision (benefit) were:Millions of Dollars202220212020Income TaxesFederalCurrent$1,263 32 3 Deferred1,629 1,161 (625)ForeignCurrent5,813 3,128 350 Deferred387 66 (70)State and localCurrent386 127 (4)Deferred70 119 (139)Total tax provision (benefit)$9,548 4,633 (485)Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes. Major components of deferred tax liabilities and assets at December 31 were:Millions of Dollars20222021Deferred Tax LiabilitiesPP&E and intangibles$11,100 10,170 Inventory48 44 Other190 213 Total deferred tax liabilities11,338 10,427 Deferred Tax AssetsBenefit plan accruals450 321 Asset retirement obligations and accrued environmental costs2,333 2,297 Investments in joint ventures1,917 1,684 Other financial accruals and deferrals736 827 Loss and credit carryforwards6,354 7,402 Other112 399 Total deferred tax assets11,902 12,930 Less: valuation allowance(8,049)(8,342)Total deferred tax assets net of valuation allowance3,853 4,588 Net deferred tax liabilities$7,485 5,839 At December 31, 2022, noncurrent assets and liabilities included deferred taxes of $241 million and $7,726 million, respectively. At December 31, 2021, noncurrent assets and liabilities included deferred taxes of $340 million and $6,179 million, respectively.At December 31, 2022, the loss and credit carryforward deferred tax assets were primarily related to U.S. foreign tax credit carryforwards of $5.3 billion and various jurisdictions net operating loss and credit carryforwards of $1.1 billion. If not utilized, U.S. foreign tax credits and net operating losses will begin to expire in 2023.ConocoPhillips 2022 10-K122Notes to Consolidated Financial StatementsTable of ContentsThe following table shows a reconciliation of the beginning and ending deferred tax asset valuation allowance for 2022, 2021 and 2020:Millions of Dollars202220212020Balance at January 1$8,342 9,965 10,214 Charged to expense (benefit)5 (45)460 Other*(298)(1,578)(709)Balance at December 31$8,049 8,342 9,965 *Represents changes due to originating deferred tax assets that have no impact to our effective tax rate, acquisitions/dispositions/revisions and the effect of translating foreign financial statements.Valuation allowances have been established to reduce deferred tax assets to an amount that will, more likely than not, be realized. At December 31, 2022, we have maintained a valuation allowance with respect to substantially all U.S. foreign tax credit carryforwards, basis differences in our APLNG investment, and certain net operating loss carryforwards for various jurisdictions. During 2022, the valuation allowance movement charged to earnings primarily relates to the impact of 2022 changes to Norway’s Petroleum Tax System which is partly offset by the U.S. tax impact of the disposition of our CVE common shares. Other movements are primarily related to valuation allowances on expiring tax attributes. Based on our historical taxable income, expectations for the future, and available tax-planning strategies, management expects deferred tax assets, net of valuation allowances, will primarily be realized as offsets to reversing deferred tax liabilities.During the second quarter of 2022, Norway enacted changes to the Petroleum Tax System. As a result of the enactment, a valuation allowance of $58 million was recorded during the second quarter to reflect changes to our ability to realize certain deferred tax assets under the new law.During 2021, the valuation allowance movement charged to earnings primarily relates to the fair value measurement of our CVE common shares that are not expected to be realized, and the expected realization of certain U.S. tax attributes associated with our planned disposition of our Indonesia assets. This is partially offset by Australian tax benefits associated with our impairment of APLNG that we do not expect to be realized. Other movements are primarily related to valuation allowances on expiring tax attributes. For more information on our Indonesia disposition see Note 3.During 2020, the valuation allowance movement charged to earnings primarily related to capital losses in Australia and to the fair value measurement of our CVE common shares that are not expected to be realized. Other movements are primarily related to valuation allowances on expiring tax attributes. At December 31, 2022, unremitted income considered to be permanently reinvested in certain foreign subsidiaries and foreign corporate joint ventures totaled approximately $4,477 million. Deferred income taxes have not been provided on this amount, as we do not plan to initiate any action that would require the payment of income taxes. The estimated amount of additional tax, primarily local withholding tax, that would be payable on this income if distributed is approximately $224 million.123ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsThe following table shows a reconciliation of the beginning and ending unrecognized tax benefits for 2022, 2021 and 2020:Millions of Dollars202220212020Balance at January 1$1,345 1,206 1,177 Additions based on tax positions related to the current year6 15 6 Additions for tax positions of prior years6 177 67 Reductions for tax positions of prior years(62)(5)(34)Settlements(510)— (9)Lapse of statute(75)(48)(1)Balance at December 31$710 1,345 1,206 Included in the balance of unrecognized tax benefits for 2022, 2021 and 2020 were $701 million, $1,261 million and $1,128 million respectively, which, if recognized, would impact our effective tax rate. The balance of the unrecognized tax benefits decreased due to the closing of the 2017 audit of our federal income tax return. As a result, we recognized federal and state tax benefits totaling $515 million relating to the recovery of outside tax basis previously offset by a full reserve. The balance of the unrecognized tax benefits increased in 2021 mainly due to U.S. tax credits acquired through our Concho acquisition. See Note 3 and Note 11.At December 31, 2022, 2021 and 2020, accrued liabilities for interest and penalties totaled $35 million, $47 million and $46 million, respectively, net of accrued income taxes. Interest and penalties resulted in an increase to earnings of $12 million in 2022, a reduction of $1 million in 2021 and a reduction to earnings of $4 million in 2020.We file tax returns in the U.S. federal jurisdiction and in many foreign and state jurisdictions. Audits in major jurisdictions are generally complete as follows: Canada (2016), Norway (2021) and U.S. (2018). Issues in dispute for audited years and audits for subsequent years are ongoing and in various stages of completion in the many jurisdictions in which we operate around the world. Consequently, the balance in unrecognized tax benefits can be expected to fluctuate from period to period. Within the next twelve months, we may have audit periods close that could significantly impact our total unrecognized tax benefits. It is reasonably possible such changes could be significant when compared with our total unrecognized tax benefits, but the amount of change is not estimable. The amounts of U.S. and foreign income (loss) before income taxes, with a reconciliation of tax at the federal statutory rate to the provision for income taxes, were:Millions of DollarsPercent of Pre-Tax Income (Loss)202220212020202220212020Income (loss) before income taxesUnited States$16,739 8,024 (3,587)59.3 %63.1 114.2 Foreign11,489 4,688 447 40.7 36.9 (14.2)$28,228 12,712 (3,140)100.0 %100.0 100.0 Federal statutory income tax$5,928 2,670 (659)21.0 %21.0 21.0 Non-U.S. effective tax rates3,866 1,915 194 13.7 15.1 (6.2)Australia disposition— — (349)— — 11.1 Recovery of outside basis(30)(55)(22)(0.1)(0.4)0.7 Adjustment to tax reserves(551)(11)18 (2.0)(0.1)(0.6)Adjustment to valuation allowance5 (45)460 — (0.4)(14.6)State income tax405 194 (112)1.4 1.5 3.6 Enhanced oil recovery credit(37)(99)(6)(0.1)(0.8)0.2 Other(38)64 (9)(0.1)0.5 0.3 Total$9,548 4,633 (485)33.8 %36.4 15.5 ConocoPhillips 2022 10-K124Notes to Consolidated Financial StatementsTable of ContentsOur effective tax rate for 2022 was driven by our jurisdictional tax rates for this profit mix with net favorable impacts from routine tax credits and valuation allowance adjustments. The adjustment to tax reserves primarily relates to the closing of the audit of our 2017 U.S. federal tax return and the recognition of the U.S. federal and state tax benefits described above. Our effective tax rate for 2021 was driven by our jurisdictional tax rates for this profit mix with net favorable impacts from routine tax credits and valuation allowance adjustments. The valuation allowance adjustment is primarily related to the fair value measurement and disposition of our CVE common shares of $218 million and the ability to utilize the U.S. foreign tax credit and capital loss carryforward due to our anticipated disposition of our Indonesia entities of $29 million. This was partially offset by an increase to our valuation allowance related to the tax impact of the impairment of our APLNG investment of $206 million for which we do not expect to receive a tax benefit.Our effective tax rate for 2020 was impacted by the disposition of our Australia-West assets as well as the valuation allowance related to the fair value measurement of our CVE common shares. The Australia-West disposition generated a before-tax gain of $587 million with an associated tax benefit of $10 million and resulted in the de-recognition of deferred tax assets resulting in $92 million of tax expense. The disposition also generated an Australia capital loss tax benefit of $313 million which has been fully offset by a valuation allowance. Due to changes in the fair market value of CVE common shares, the valuation allowance was increased by $178 million to offset the expected capital loss.On August 16, 2022, the U.S. enacted the Inflation Reduction Act of 2022, which among other things, implements a 15 percent minimum tax on book income of certain large corporations, a 1 percent excise tax on net stock repurchases and several tax incentives to promote lower carbon energy. We are continuing to evaluate the impacts of this legislation as additional guidance is released; however, we do not believe any impacts will be material to our consolidated financial statements.Note 18—Accumulated Other Comprehensive LossAccumulated other comprehensive loss in the equity section of the balance sheet included:Millions of DollarsDefinedBenefit PlansNetUnrealizedGain/(Loss)on SecuritiesForeignCurrencyTranslationAccumulatedOtherComprehensiveLossDecember 31, 2019$(350)— (5,007)(5,357)Other comprehensive income (loss)(75)2 212 139 December 31, 2020(425)2 (4,795)(5,218)Other comprehensive income (loss)394 (2)(124)268 December 31, 2021(31)— (4,919)(4,950)Other comprehensive income (loss)(417)(11)(622)(1,050)December 31, 2022$(448)(11)(5,541)(6,000)The following table summarizes reclassifications out of accumulated other comprehensive loss during the years ended December 31:Millions of Dollars20222021Defined Benefit Plans$26 109 Above amounts are included in the computation of net periodic benefit cost and are presented net of tax expense of: $7 31 See Note 16.125ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsNote 19—Cash Flow InformationMillions of Dollars202220212020Noncash Investing ActivitiesIncrease (decrease) in PP&E related to an increase (decrease) in asset retirement obligations$825 442 (116)Cash PaymentsInterest$873 924 785 Income taxes7,368 856 905 Net Sales (Purchases) of InvestmentsShort-term investments purchased$(5,046)(5,554)(12,435)Short-term investments sold3,102 8,810 12,015 Investments and long-term receivables purchased(775)(279)(325)Investments and long-term receivables sold90 114 87 $(2,629)3,091 (658)Income tax payments have increased in 2022 as the company is returning to a tax paying position in the U.S. as well as, increased taxes in Norway, and timing of tax payments in Libya.See Note 3 and Note 12 for additional information on cash and non-cash changes to our consolidated balance sheet associated with our Concho acquisition.ConocoPhillips 2022 10-K126Notes to Consolidated Financial StatementsTable of ContentsNote 20—Other Financial InformationMillions of Dollars202220212020Interest and Debt ExpenseIncurredDebt$791 887 788 Other72 59 73 863 946 861 Capitalized(58)(62)(55)Expensed$805 884 806 Other Income (Loss)Interest income$195 33 100 Gain (loss) on investment in Cenovus Energy*251 1,040 (855)Other, net58 130 246 $504 1,203 (509)*See Note 5.Research and Development Expenditures—expensed$71 62 75 Shipping and Handling Costs$1,595 1,047 857 Foreign Currency Transaction (Gains) Losses—after-taxAlaska$— — — Lower 48— — — Canada(20)(1)(7)Europe, Middle East and North Africa(110)(11)(15)Asia Pacific30 2 (11)Other International(1)1 2 Corporate and Other21 (7)(31)$(80)(16)(62)Millions of Dollars20222021Properties, Plants and EquipmentProved properties$119,609 114,274 *Unproved properties7,325 10,993 Other4,562 4,379 Gross properties, plants and equipment131,496 129,646 Less: Accumulated depreciation, depletion and amortization(66,630)(64,735)*Net properties, plants and equipment$64,866 64,911 *Excludes assets classified as held for sale at December 31, 2021. See Note 3.127ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsNote 21—Related Party TransactionsOur related parties primarily include equity method investments and certain trusts for the benefit of employees. For disclosures on trusts for the benefit of employees, see Note 16.Significant transactions with our equity affiliates were:Millions of Dollars202220212020Operating revenues and other income$88 88 79 Purchases1 5 — Operating expenses and selling, general and administrative expenses189 196 63 Net interest income*(1)(2)(5)*We paid interest to, or received interest from, various affiliates. See Note 4, for additional information on loans to affiliated companies.Note 22—Sales and Other Operating RevenuesRevenue from Contracts with CustomersThe following table provides further disaggregation of our consolidated sales and other operating revenues:Millions of Dollars202220212020Revenue from contracts with customers$61,049 34,590 13,662 Revenue from contracts outside the scope of ASC Topic 606Physical contracts meeting the definition of a derivative17,150 11,500 5,177 Financial derivative contracts295 (262)(55)Consolidated sales and other operating revenues$78,494 45,828 18,784 Revenues from contracts outside the scope of ASC Topic 606 relate primarily to physical gas contracts at market prices, which qualify as derivatives accounted for under ASC Topic 815, “Derivatives and Hedging,” and for which we have not elected NPNS. There is no significant difference in contractual terms or the policy for recognition of revenue from these contracts and those within the scope of ASC Topic 606. The following disaggregation of revenues is provided in conjunction with Note 24—Segment Disclosures and Related Information:Millions of Dollars202220212020Revenue from Outside the Scope of ASC Topic 606by SegmentLower 48$13,919 9,050 3,966 Canada2,717 1,457 727 Europe, Middle East and North Africa514 993 484 Physical contracts meeting the definition of a derivative$17,150 11,500 5,177 Millions of Dollars202220212020Revenue from Outside the Scope of ASC Topic 606by ProductCrude oil$495 757 395 Natural gas15,368 10,034 4,339 Other1,287 709 443 Physical contracts meeting the definition of a derivative$17,150 11,500 5,177 ConocoPhillips 2022 10-K128Notes to Consolidated Financial StatementsTable of ContentsPractical ExpedientsTypically, our commodity sales contracts are less than 12 months in duration; however, in certain specific cases may extend longer, which may be out to the end of field life. We have long-term commodity sales contracts which use prevailing market prices at the time of delivery, and under these contracts, the market-based variable consideration for each performance obligation (i.e., delivery of commodity) is allocated to each wholly unsatisfied performance obligation within the contract. Accordingly, we have applied the practical expedient allowed in ASC Topic 606 and do not disclose the aggregate amount of the transaction price allocated to performance obligations or when we expect to recognize revenues that are unsatisfied (or partially unsatisfied) as of the end of the reporting period.Receivables and Contract LiabilitiesReceivables from Contracts with CustomersAt December 31, 2022, the “Accounts and notes receivable” line on our consolidated balance sheet included trade receivables of $5,241 million compared with $5,268 million at December 31, 2021, and included both contracts with customers within the scope of ASC Topic 606 and those that are outside the scope of ASC Topic 606. We typically receive payment within 30 days or less (depending on the terms of the invoice) once delivery is made. Revenues that are outside the scope of ASC Topic 606 relate primarily to physical gas sales contracts at market prices for which we do not elect NPNS and are therefore accounted for as a derivative under ASC Topic 815. There is little distinction in the nature of the customer or credit quality of trade receivables associated with gas sold under contracts for which NPNS has not been elected compared with trade receivables where NPNS has been elected.Contract Liabilities from Contracts with CustomersWe have entered into certain agreements under which we license our proprietary technology, including the Optimized Cascade® process technology, to customers to maximize the efficiency of LNG plants. These agreements typically provide for milestone payments to be made during and after the construction phases of the LNG plant. The payments are not directly related to our performance obligations under the contract and are recorded as deferred revenue to be recognized when the customer is able to benefit from their right to use the applicable licensed technology. During the year ended December 31, 2022, we recognized revenue of $57 million in the "Sales and other operating revenues" line on our consolidated income statement. We expect to recognize the outstanding contract liabilities of $19 million as of December 31, 2022, as revenue during 2026.129ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsNote 23—Earnings Per ShareThe following table presents the calculation of net income available to common shareholders and basic and diluted EPS for the years ended December 31, 2022, 2021, and 2020. For each of the periods with net income presented in the table below, diluted EPS calculated under the two-class method was more dilutive. Millions of Dollars (except per share amounts)Years Ended December 31202220212020Basic earnings per shareNet Income (Loss) Attributable to ConocoPhillips$18,680 8,079 (2,701)Less: Dividends and undistributed earningsallocated to participating securities60 19 6 Net Income (Loss) available to common shareholders$18,620 8,060 (2,707)Average common shares outstanding (in Millions)1,274 1,324 1,078 Net Income (Loss) Attributable to ConocoPhillips Per Share of Common Stock$14.62 6.09 (2.51)Diluted earnings per shareNet Income (Loss) available to common shareholders$18,620 8,060 (2,707)Average common shares outstanding (in Millions)1,274 1,324 1,078 Add: Dilutive impact of options and unvestednon-participating RSU/PSUs4 4 — Average diluted shares outstanding (in Millions)1,278 1,328 1,078 Net Income (Loss) Attributable to ConocoPhillips Per Share of Common Stock$14.57 6.07 (2.51)Note 24—Segment Disclosures and Related InformationWe explore for, produce, transport and market crude oil, bitumen, natural gas, LNG and NGLs on a worldwide basis. We manage our operations through six operating segments, which are primarily defined by geographic region: Alaska; Lower 48; Canada; Europe, Middle East and North Africa; Asia Pacific; and Other International.Corporate and Other represents income and costs not directly associated with an operating segment, such as most interest expense, premiums on early retirement of debt, corporate overhead and certain technology activities, including licensing revenues. Corporate assets include all cash and cash equivalents and short-term investments. We evaluate performance and allocate resources based on net income (loss) attributable to ConocoPhillips. Segment accounting policies are the same as those in Note 1. Intersegment sales are at prices that approximate market.In 2021, we completed our acquisition of Concho, an independent oil and gas exploration and production company with operations across New Mexico and West Texas as well as our acquisition of Shell’s Permian assets in the Texas Delaware Basin. The accounting close date of the Shell transaction, used for reporting purposes, was December 31, 2021. Results of operations for Concho and assets acquired from Shell are included in our Lower 48 segment. Certain transaction and restructuring costs associated with these acquisitions are included in our Corporate and Other segment. See Note 3.ConocoPhillips 2022 10-K130Notes to Consolidated Financial StatementsTable of ContentsAnalysis of Results by Operating SegmentMillions of Dollars202220212020Sales and Other Operating RevenuesAlaska$7,905 5,480 3,408 Intersegment eliminations— — (11)Alaska7,905 5,480 3,397 Lower 4852,921 29,306 9,872 Intersegment eliminations(18)(12)(51)Lower 4852,903 29,294 9,821 Canada6,159 4,077 1,666 Intersegment eliminations(2,445)(1,583)(405)Canada3,714 2,494 1,261 Europe, Middle East and North Africa11,271 5,902 1,919 Intersegment eliminations(1)— (2)Europe, Middle East and North Africa11,270 5,902 1,917 Asia Pacific2,606 2,579 2,363 Other International— 4 7 Corporate and Other96 75 18 Consolidated sales and other operating revenues$78,494 45,828 18,784 The market for our products is large and diverse, therefore, our sales and other operating revenues are not dependent upon any single customer.Millions of Dollars202220212020Depreciation, Depletion, Amortization and ImpairmentsAlaska$941 1,002 996 Lower 484,854 4,067 3,358 Canada400 392 342 Europe, Middle East and North Africa735 862 775 Asia Pacific518 1,483 809 Other International— — — Corporate and Other44 76 54 Consolidated depreciation, depletion, amortization and impairments$7,492 7,882 6,334 Equity in Earnings of AffiliatesAlaska$4 5 (7)Lower 48(14)(18)(11)Canada— — — Europe, Middle East and North Africa780 502 311 Asia Pacific1,310 343 137 Other International1 — 2 Corporate and Other— — — Consolidated equity in earnings of affiliates$2,081 832 432 131ConocoPhillips 2022 10-KNotes to Consolidated Financial StatementsTable of ContentsMillions of Dollars202220212020Income Tax Provision (Benefit)Alaska$885 402 (256)Lower 483,088 1,390 (378)Canada206 150 (185)Europe, Middle East and North Africa5,445 2,543 136 Asia Pacific480 483 294 Other International53 (53)(20)Corporate and Other(609)(282)(76)Consolidated income tax provision (benefit)$9,548 4,633 (485)Net Income (Loss) Attributable to ConocoPhillipsAlaska$2,352 1,386 (719)Lower 4811,015 4,932 (1,122)Canada714 458 (326)Europe, Middle East and North Africa2,244 1,167 448 Asia Pacific2,736 453 962 Other International(51)(107)(64)Corporate and Other(330)(210)(1,880)Consolidated net income (loss) attributable to ConocoPhillips$18,680 8,079 (2,701)Investments in and Advances to AffiliatesAlaska$55 58 62 Lower 48235 242 25 Canada— — — Europe, Middle East and North Africa1,049 797 918 Asia Pacific6,154 5,603 6,705 Other International— 1 — Corporate and Other— — — Consolidated investments in and advances to affiliates$7,493 6,701 7,710 Total AssetsAlaska$15,126 14,812 14,623 Lower 4842,950 41,699 11,932 Canada6,971 7,439 6,863 Europe, Middle East and North Africa8,263 9,125 8,756 Asia Pacific9,511 9,840 11,231 Other International— 1 226 Corporate and Other11,008 7,745 8,987 Consolidated total assets$93,829 90,661 62,618 ConocoPhillips 2022 10-K132Notes to Consolidated Financial StatementsTable of ContentsMillions of Dollars202220212020Capital Expenditures and InvestmentsAlaska$1,091 982 1,038 Lower 485,630 3,129 1,881 Canada530 203 651 Europe, Middle East and North Africa998 534 600 Asia Pacific1,880 390 384 Other International— 33 121 Corporate and Other30 53 40 Consolidated capital expenditures and investments$10,159 5,324 4,715 Interest Income and ExpenseInterest incomeAlaska$— — — Lower 48— — — Canada— — — Europe, Middle East and North Africa1 2 5 Asia Pacific9 9 7 Other International— — — Corporate and Other185 22 88 Interest and debt expenseCorporate and Other$805 884 806 Sales and Other Operating Revenues by ProductCrude oil$41,492 23,648 9,736 Natural gas26,941 16,904 6,427 Natural gas liquids3,650 1,668 528 Other*6,411 3,608 2,093 Consolidated sales and other operating revenues by product$78,494 45,828 18,784 *Includes LNG and bitumen.Geographic InformationMillions of DollarsSales and Other Operating Revenues(1)Long-Lived Assets(2)202220212020202220212020United States$60,899 34,847 13,230 51,200 50,580 24,034 Australia and Timor-Leste— — 605 6,158 5,579 6,676 Canada3,714 2,494 1,261 6,269 6,608 6,385 China1,135 724 460 1,538 1,476 1,491 Indonesia(3)159 879 689 — 28 464 Libya1,582 1,102 155 714 659 670 Malaysia1,312 975 610 1,107 1,252 1,501 Norway3,415 2,563 1,426 4,369 4,681 5,294 United Kingdom6,273 2,236 336 1 1 1 Other foreign countries5 8 12 1,003 748 1,087 Worldwide consolidated$78,494 45,828 18,784 72,359 71,612 47,603 (1)Sales and other operating revenues are attributable to countries based on the location of the selling operation.(2)Defined as net PP&E plus equity investments and advances to affiliated companies.(3)Assets divested in 2022. See Note 3.133ConocoPhillips 2022 10-KSupplementary DataTable of ContentsOil and Gas Operations (Unaudited)In accordance with FASB ASC Topic 932, “Extractive Activities—Oil and Gas,” and regulations of the SEC, we are making certain supplemental disclosures about our oil and gas exploration and production operations. These disclosures include information about our consolidated oil and gas activities and our proportionate share of our equity affiliates’ oil and gas activities in our operating segments. As a result, amounts reported as equity affiliates in Oil and Gas Operations may differ from those shown in the individual segment disclosures reported elsewhere in this report. Our disclosures by geographic area include the U.S., Canada, Europe, Asia Pacific/Middle East (inclusive of equity affiliates) and Africa.As required by current authoritative guidelines, the estimated future date when an asset will be permanently shut down for economic reasons is based on historical 12-month first-of-month average prices and current costs. This estimated date when production will end affects the amount of estimated reserves. Therefore, as prices and cost levels change from year to year, the estimate of proved reserves also changes. Generally, our proved reserves decrease as prices decline and increase as prices rise. Our proved reserves include estimated quantities related to PSCs, which are reported under the “economic interest” method, as well as variable-royalty regimes, and are subject to fluctuations in commodity prices, recoverable operating expenses and capital costs. If costs remain stable, reserve quantities attributable to recovery of costs will change inversely to changes in commodity prices. For example, if prices increase, then our applicable reserve quantities would decline. At December 31, 2022, approximately 3 percent of our total proved reserves were under PSCs, located in our Asia Pacific/Middle East geographic reporting area, and 4 percent of our total proved reserves were under a variable-royalty regime, located in our Canada geographic reporting area.Reserves GovernanceThe recording and reporting of proved reserves are governed by criteria established by regulations of the SEC and FASB. Proved reserves are those quantities of oil and gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible—from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations—prior to the time at which contracts providing the right to operate expire, unless evidence indicates renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. The project to extract the hydrocarbons must have commenced or the operator must be reasonably certain it will commence the project within a reasonable time. Proved reserves are further classified as either developed or undeveloped. Proved developed reserves are proved reserves that can be expected to be recovered through existing wells with existing equipment and operating methods, or in which the cost of the required equipment is relatively minor compared with the cost of a new well, and through installed extraction equipment and infrastructure operational at the time of the reserves estimate if the extraction is by means not involving a well. Proved undeveloped reserves are proved reserves expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage are limited to those directly offsetting development spacing areas that are reasonably certain of production when drilled, unless evidence provided by reliable technologies exists that establishes reasonable certainty of economic producibility at greater distances. As defined by SEC regulations, reliable technologies may be used in reserve estimation when they have been demonstrated in the field to provide reasonably certain results with consistency and repeatability in the formation being evaluated or in an analogous formation. The technologies and data used in the estimation of our proved reserves include, but are not limited to, performance-based methods, volumetric-based methods, geologic maps, seismic interpretation, well logs, well test data, core data, analogy and statistical analysis.ConocoPhillips 2022 10-K134Supplementary DataTable of ContentsWe have a company-wide, comprehensive, SEC-compliant internal policy that governs the determination and reporting of proved reserves. This policy is applied by the geoscientists and reservoir engineers in our business units around the world. As part of our internal control process, each business unit’s reserves processes and controls are reviewed annually by an internal team which is headed by the company’s Manager of Reserves Compliance and Reporting. This team, composed of internal reservoir engineers, geoscientists, finance personnel and a senior representative from DeGolyer and MacNaughton (D&M), a third-party petroleum engineering consulting firm, reviews the business units’ reserves for adherence to SEC guidelines and company policy through on-site visits, teleconferences and review of documentation. In addition to providing independent reviews, this internal team also ensures reserves are calculated using consistent and appropriate standards and procedures. This team is independent of business unit line management and is responsible for reporting its findings to senior management. The team is responsible for communicating our reserves policy and procedures and is available for internal peer reviews and consultation on major projects or technical issues throughout the year. All of our proved reserves held by consolidated companies and our share of equity affiliates have been estimated by ConocoPhillips.During 2022, our processes and controls used to assess over 90 percent of proved reserves as of December 31, 2022, were reviewed by D&M. The purpose of their review was to assess whether the adequacy and effectiveness of our internal processes and controls used to determine estimates of proved reserves are in accordance with SEC regulations. In such review, ConocoPhillips’ technical staff presented D&M with an overview of the reserves data, as well as the methods and assumptions used in estimating reserves. The data presented included pertinent seismic information, geologic maps, well logs, production tests, material balance calculations, reservoir simulation models, well performance data, operating procedures and relevant economic criteria. Management’s intent in retaining D&M to review its processes and controls was to provide objective third-party input on these processes and controls. D&M’s opinion was the general processes and controls employed by ConocoPhillips in estimating its December 31, 2022, proved reserves for the properties reviewed are in accordance with the SEC reserves definitions. D&M’s report is included as Exhibit 99 of this Annual Report on Form 10-K.The technical person primarily responsible for overseeing the processes and internal controls used in the preparation of the company’s reserves estimates is the Manager of Reserves Compliance and Reporting. This individual holds a master’s degree in petroleum engineering. He is a member of the Society of Petroleum Engineers with over 30 years of oil and gas industry experience and has held positions of increasing responsibility in reservoir engineering, subsurface and asset management in the U.S. and several international field locations. Engineering estimates of the quantities of proved reserves are inherently imprecise. See the “Critical Accounting Estimates” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional discussion of the sensitivities surrounding these estimates.135ConocoPhillips 2022 10-KSupplementary DataTable of ContentsProved ReservesYears EndedDecember 31Crude OilMillions of BarrelsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaTotalConsolidatedEquityAffiliates*TotalDeveloped and UndevelopedEnd of 20191,231 797 2,028 5 198 134 197 2,562 73 2,635 Revisions(297)(126)(423)(2)4 (4)(3)(428)— (428)Improved recovery— — — — — 3 — 3 — 3 Purchases— 5 5 3 — — — 8 — 8 Extensions and discoveries10 108 118 3 — — — 121 — 121 Production(65)(77)(142)(2)(28)(25)(3)(200)(5)(205)Sales— (14)(14)(1)— — — (15)— (15)End of 2020879 693 1,572 6 174 108 191 2,051 68 2,119 Revisions209 (52)157 2 14 37 6 216 — 216 Improved recovery1 — 1 — — — — 1 — 1 Purchases— 691 691 — — — — 691 — 691 Extensions and discoveries10 289 299 5 2 1 — 307 — 307 Production(64)(160)(224)(3)(29)(24)(13)(293)(5)(298)Sales— (9)(9)— — — — (9)— (9)End of 20211,035 1,452 2,487 10 161 122 184 2,964 63 3,027 Revisions(31)24 (7)— 31 19 (3)40 — 40 Improved recovery— — — — — 3 — 3 — 3 Purchases— 6 6 — — — 42 48 — 48 Extensions and discoveries15 250 265 — 8 — — 273 35 308 Production(64)(193)(257)(2)(25)(22)(13)(319)(5)(324)Sales— (31)(31)— — (3)— (34)— (34)End of 2022955 1,508 2,463 8 175 119 210 2,975 93 3,068 Years EndedDecember 31Crude OilMillions of BarrelsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaTotalConsolidatedEquityAffiliates*TotalDevelopedConsolidated operationsEnd of 20191,048 334 1,382 3 149 94 181 1,809 73 1,882 End of 2020765 263 1,028 6 129 77 175 1,415 68 1,483 End of 2021912 916 1,828 4 122 98 171 2,223 63 2,286 End of 2022867 828 1,695 5 124 102 191 2,117 58 2,175 UndevelopedConsolidated operationsEnd of 2019183 463 646 2 49 40 16 753 — 753 End of 2020114 430 544 — 45 31 16 636 — 636 End of 2021123 536 659 6 39 24 13 741 — 741 End of 202288 680 768 3 51 17 19 858 35 893 *All Equity Affiliate reserves are located in our Asia Pacific/Middle East Region.ConocoPhillips 2022 10-K136Supplementary DataTable of ContentsNotable changes in proved crude oil reserves in the three years ended December 31, 2022, included:•Revisions: In 2022, upward revisions in Lower 48 were due to additional development drilling in the unconventional plays of 81 million barrels and higher prices of 33 million barrels, partially offset by increasing operating costs of 72 million barrels and technical revisions of 18 million barrels. Upward revisions in Europe were primarily due to technical revisions of 23 million barrels and 8 million barrels due to higher prices. Upward revisions of 19 million barrels in our consolidated operations in Asia Pacific/Middle East were primarily due to technical revisions.In 2021, Alaska upward revisions were primarily driven by higher prices. Downward revisions in Lower 48 were due to development timing for specific well locations from unconventional plays of 203 million barrels and technical revisions of 35 million barrels, partially offset by upward revisions due to higher prices of 115 million barrels and additional infill drilling in the unconventional plays of 71 million barrels. Upward revisions in Europe were primarily due to higher prices. In Asia Pacific/Middle East, increases were due to higher prices of 21 million barrels and technical revisions of 16 million barrels.In 2020, Alaska downward revisions were primarily driven by lower prices of 243 million barrels and development plan changes of 54 million barrels. Downward revisions in Lower 48 were due to lower prices of 89 million barrels and development timing for specific well locations from unconventional plays of 82 million barrels, partially offset by upward technical revisions and additional infill drilling in the unconventional plays of 45 million barrels.•Purchases: In 2022, crude oil reserve purchases were primarily in Africa, as a result of the acquisition of additional interest in the Libya Waha Concession. In 2021, Lower 48 purchases were due to the Concho and Shell Permian acquisitions.•Extensions and discoveries: In 2022, extensions and discoveries in Lower 48 were primarily within unconventional plays in the Permian Basin. Extensions and discoveries in our equity affiliates were in the Middle East. In 2021, extensions and discoveries in Lower 48 were due to planned development to add specific well locations from the unconventional plays which more than offset the decreases resulting from development plan timing in the revisions category.In 2020, extensions and discoveries in Lower 48 were due to planned development to add specific well locations from the unconventional plays which more than offset the decreases resulting from development plan timing in the revisions category.137ConocoPhillips 2022 10-KSupplementary DataTable of ContentsYears EndedDecember 31Natural Gas LiquidsMillions of BarrelsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastTotal ConsolidatedEquity Affiliates*TotalDeveloped and UndevelopedConsolidated operationsEnd of 2019100 245 345 2 13 1 361 39 400 Revisions— (26)(26)— 1 (1)(26)— (26)Improved recovery— — — — — — — — — Purchases— 2 2 2 — — 4 — 4 Extensions and discoveries— 41 41 1 — — 42 — 42 Production(6)(27)(33)(1)(2)— (36)(3)(39)Sales— (5)(5)— — — (5)— (5)End of 202094 230 324 4 12 — 340 36 376 Revisions(6)213 207 — 1 — 208 — 208 Improved recovery— — — — — — — — — Purchases— 72 72 — — — 72 — 72 Extensions and discoveries— 82 82 2 — — 84 — 84 Production(6)(50)(56)(1)(2)— (59)(3)(62)Sales— (1)(1)— — — (1)— (1)End of 202182 546 628 5 11 — 644 33 677 Revisions1 208 209 1 3 — 213 — 213 Improved recovery— — — — — — — — — Purchases— 3 3 — — — 3 — 3 Extensions and discoveries— 80 80 — 1 — 81 20 101 Production(5)(81)(86)(1)(2)— (89)(3)(92)Sales— (7)(7)— — — (7)— (7)End of 202278 749 827 5 13 — 845 50 895 Years EndedDecember 31Natural Gas LiquidsMillions of BarrelsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastTotal ConsolidatedEquity Affiliates*TotalDevelopedConsolidated operationsEnd of 2019100 99 199 1 10 1 211 39 250 End of 202094 83 177 4 9 — 190 36 226 End of 202182 334 416 3 9 — 428 33 461 End of 202278 409 487 3 10 — 500 31 531 UndevelopedConsolidated operationsEnd of 2019— 146 146 1 3 — 150 — 150 End of 2020— 147 147 — 3 — 150 — 150 End of 2021— 212 212 2 2 — 216 — 216 End of 2022— 340 340 2 3 — 345 19 364 *All Equity Affiliate reserves are located in our Asia Pacific/Middle East Region.ConocoPhillips 2022 10-K138Supplementary DataTable of ContentsNotable changes in proved NGL reserves in the three years ended December 31, 2022, included:•Revisions: In 2022, upward revisions in Lower 48 were due to additional development drilling in the unconventional plays of 88 million barrels, technical revisions of 75 million barrels, continued conversion of acquired Concho Permian two-stream contracts to a three-stream (crude oil, natural gas and natural gas liquids) basis adding 70 million barrels, and higher prices of 13 million barrels. This was partially offset by increasing operating costs of 38 million barrels. In 2021, upward revisions in Lower 48 were due to conversion of acquired Concho Permian two-stream contracts to a three-stream (crude oil, natural gas and natural gas liquids) basis, adding 182 million barrels, additional infill drilling in the unconventional plays of 44 million barrels, technical revisions of 21 million barrels and higher prices of 28 million barrels, partially offset by downward revisions related to development timing for specific well locations from unconventional plays of 62 million barrels.In 2020, downward revisions in Lower 48 were due to lower prices of 33 million barrels and development timing for specific well locations from unconventional plays of 20 million barrels, partially offset by upward technical revisions and additional infill drilling in the unconventional plays of 27 million barrels.•Purchases: In 2021, Lower 48 purchases were due to the Shell Permian acquisition.•Extensions and discoveries: In 2022, extensions and discoveries in Lower 48 were primarily within unconventional plays in the Permian Basin. Extensions and discoveries in our equity affiliates were in the Middle East.In 2021, extensions and discoveries in Lower 48 were due to planned development to add specific well locations from the unconventional plays which more than offset the decreases in the revisions category.In 2020, extensions and discoveries in Lower 48 were due to planned development to add specific well locations from the unconventional plays, which more than offset the decreases in the revisions category.139ConocoPhillips 2022 10-KSupplementary DataTable of ContentsYears EndedDecember 31Natural GasBillions of Cubic FeetAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaTotal ConsolidatedEquity Affiliates*TotalDeveloped and UndevelopedConsolidated operationsEnd of 20192,688 2,431 5,119 43 896 977 224 7,259 4,421 11,680 Revisions(607)(439)(1,046)(15)39 103 2 (917)(382)(1,299)Improved recovery— — — — — — — — — — Purchases— 74 74 29 — — — 103 2 105 Extensions and discoveries— 304 304 33 2 — — 339 78 417 Production(85)(231)(316)(16)(112)(171)(2)(617)(395)(1,012)Sales— (39)(39)— — (58)— (97)— (97)End of 20201,996 2,100 4,096 74 825 851 224 6,070 3,724 9,794 Revisions715 41 756 15 54 60 — 885 247 1,132 Improved recovery— — — — — — — — — — Purchases— 2,438 2,438 — — — — 2,438 — 2,438 Extensions and discoveries— 822 822 46 2 — — 870 116 986 Production(86)(473)(559)(30)(113)(147)(7)(856)(390)(1,246)Sales— (270)(270)— — — — (270)— (270)End of 20212,625 4,658 7,283 105 768 764 217 9,137 3,697 12,834 Revisions(35)361 326 8 108 (2)(14)426 898 1,324 Improved recovery— — — — — — — — — — Purchases— 23 23 — — — 48 71 479 550 Extensions and discoveries— 505 505 4 103 — — 612 1,118 1,730 Production(88)(543)(631)(23)(117)(51)(10)(832)(439)(1,271)Sales— (262)(262)— — (385)— (647)— (647)End of 20222,502 4,742 7,244 94 862 326 241 8,767 5,753 14,520 Years EndedDecember 31Natural GasBillions of Cubic FeetAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaTotal ConsolidatedEquity Affiliates*TotalDevelopedConsolidated operationsEnd of 20192,601 1,398 3,999 30 697 843 224 5,793 3,898 9,691 End of 20201,961 1,051 3,012 74 598 806 224 4,714 3,293 8,007 End of 20212,579 3,100 5,679 52 679 688 217 7,315 3,204 10,519 End of 20222,474 2,628 5,102 64 641 322 241 6,370 3,974 10,344 UndevelopedConsolidated operationsEnd of 201987 1,033 1,120 13 199 134 — 1,466 523 1,989 End of 202035 1,049 1,084 — 227 45 — 1,356 431 1,787 End of 202146 1,558 1,604 53 89 76 — 1,822 493 2,315 End of 202228 2,114 2,142 30 221 4 — 2,397 1,779 4,176 *All Equity Affiliate reserves are located in our Asia Pacific/Middle East Region.Natural gas production in the reserves table may differ from gas production (delivered for sale) in our statistics disclosure, primarily because the quantities above include gas consumed in production operations. Quantities consumed in production operations are not significant in the periods presented. The value of net production consumed in operations is not reflected in net revenues and production expenses, nor do the volumes impact the respective per unit metrics.Reserve volumes include natural gas to be consumed in operations of 2,416 BCF, 2,748 BCF and 2,286 BCF, as of December 31, 2022, 2021 and 2020, respectively. These volumes are not included in the calculation of our Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserve Quantities.Natural gas reserves are computed at 14.65 pounds per square inch absolute and 60 degrees Fahrenheit.ConocoPhillips 2022 10-K140Supplementary DataTable of ContentsNotable changes in proved natural gas reserves in the three years ended December 31, 2022, included:•Revisions: In 2022, upward revisions in Lower 48 were due to additional development drilling in the unconventional plays of 544 BCF, higher prices of 109 BCF, and technical revisions of 41 BCF. These were partially offset by decreases of 233 BCF due to increasing operating costs, and 100 BCF due to the continued conversion of acquired Concho Permian two-stream contracts to a three-stream (crude oil, natural gas and natural gas liquids) basis. Upward revisions in Canada were driven by higher prices of 26 BCF, partially offset by technical revisions of 18 BCF. In Europe, technical revisions contributed 96 BCF, and higher prices 12 BCF of upward revisions. Downward revisions in Africa were primarily due to technical revisions. In our equity affiliates in Asia Pacific/Middle East, upward revisions were due to higher prices of 423 BCF, changing dynamics and improved prices in the regional LNG spot market of 331 BCF, and technical revisions of 204 BCF, partially offset by downward revisions due to increasing operating costs of 60 BCF.In 2021, upward revisions in Alaska were due to higher prices of 587 BCF and technical revisions of 128 BCF. In Lower 48, upward revisions of 614 BCF were due to higher prices, additional infill drilling in the unconventional plays of 277 BCF and technical revisions of 60 BCF, partially offset by downward revisions due to development timing for specific well locations from unconventional plays of 498 BCF and conversion of previously acquired Permian two-stream contracted volumes to a three-stream (crude oil, natural gas and natural gas liquids) basis of 412 BCF. Upward revisions in Canada were due to higher prices of 29 BCF, partially offset by downward revisions due to technical revisions of 14 BCF. In Europe, upward revisions were primarily due to higher prices. Upward revisions in our consolidated operations in Asia Pacific/Middle East were due to technical revisions of 76 BCF, partially offset by price revisions of 16 BCF. In our equity affiliates in Asia Pacific/Middle East, upward revisions were due to higher prices of 124 BCF and technical and cost revisions of 123 BCF.In 2020, downward revisions in Alaska were primarily due to lower prices. In Lower 48, downward revisions of 372 BCF were due to lower prices and 154 BCF were due to development timing for specific well locations from unconventional plays, partially offset by technical revisions of 87 BCF. Downward revisions in our equity affiliates in Asia Pacific/Middle East were due to lower prices of 426 BCF, partially offset by performance revisions of 44 BCF. Upward revisions in our consolidated operations in Asia Pacific/Middle East were due to technical revisions of 88 BCF and price revisions of 15 BCF.•Purchases: In 2022, purchases in Africa were a result of the acquisition of additional interest in the Libya Waha Concession. In our equity affiliates, purchases were due to the acquisition of additional affiliate interest in Asia Pacific.In 2021, Lower 48 purchases were due to the Concho and Shell Permian acquisitions.In 2020, Canada purchases were due to the acquisition of additional Montney acreage.•Extensions and discoveries: In 2022, extensions and discoveries in Lower 48 were primarily within unconventional plays in the Permian Basin. In Europe, extensions and discoveries were due to additional planned development. Extensions and discoveries in our equity affiliates were primarily in the Middle East.In 2021, extensions and discoveries in Lower 48 were due to planned development to add specific well locations from the unconventional plays which more than offset the decreases resulting from development plan timing in the revisions category. Extensions and discoveries in Canada were primarily driven by ongoing drilling successes in Montney.In 2020, extensions and discoveries in Lower 48 were due to planned development to add specific well locations from the unconventional plays which more than offset the decreases resulting from development plan timing in the revisions category. Extensions and discoveries in Canada were primarily driven by ongoing drilling successes in Montney.•Sales: In 2022, Lower 48 sales represent the disposition of noncore assets. Sales in our consolidated operations in Asia Pacific/Middle East represent the disposition of our Indonesia assets.In 2021, Lower 48 sales represent the disposition of noncore assets.In 2020, Asia Pacific/Middle East sales represent the disposition of the Australia-West assets. 141ConocoPhillips 2022 10-KSupplementary DataTable of ContentsYears EndedDecember 31BitumenMillions of BarrelsCanadaTotal ConsolidatedEquity Affiliates*TotalDeveloped and UndevelopedConsolidated operationsEnd of 2019282 282 — 282 Revisions(15)(15)— (15)Improved recovery— — — — Purchases— — — — Extensions and discoveries85 85 — 85 Production(20)(20)— (20)Sales— — — — End of 2020332 332 — 332 Revisions(50)(50)— (50)Improved recovery— — — — Purchases— — — — Extensions and discoveries— — — — Production(25)(25)— (25)Sales— — — — End of 2021257 257 — 257 Revisions(17)(17)— (17)Improved recovery— — — — Purchases— — — — Extensions and discoveries— — — — Production(24)(24)— (24)Sales— — — — End of 2022216 216 — 216 Years EndedDecember 31BitumenMillions of BarrelsCanadaTotal ConsolidatedEquity Affiliates*TotalDevelopedConsolidated operationsEnd of 2019187 187 — 187 End of 2020117 117 — 117 End of 2021150 150 — 150 End of 2022127 127 — 127 UndevelopedConsolidated operationsEnd of 201995 95 — 95 End of 2020215 215 — 215 End of 2021107 107 — 107 End of 202289 89 — 89 *All Equity Affiliate reserves are located in our Asia Pacific/Middle East Region.ConocoPhillips 2022 10-K142Supplementary DataTable of ContentsNotable changes in proved bitumen reserves in the three years ended December 31, 2022, included: •Revisions: In 2022, the impact of variable royalties on price resulted in downward revisions of 30 million barrels, partially offset by upward revisions primarily due to changes in development timing for specific pad locations from the Surmont development program. In 2021, downward revisions of 64 million barrels were driven by changes in carbon tax costs and 39 million barrels due to changes in development timing for specific pad locations from the Surmont development program, partially offset by upward revisions from price of 53 million barrels.In 2020, downward revisions in Canada were due to changes in development timing for specific pad locations from the Surmont development program of 12 million barrels with the remaining revisions primarily related to lower prices.•Extensions and discoveries: In 2021, extensions and discoveries in Canada were primarily due to planned development to add specific pad locations from the Surmont development program, which more than offset the decrease in the revisions category.In 2020, extensions and discoveries in Canada were due to planned development to add specific pad locations from the Surmont development program, which offset the decrease in the revisions category of 31 million barrels.143ConocoPhillips 2022 10-KSupplementary DataTable of ContentsYears EndedDecember 31Total Proved ReservesMillions of Barrels of Oil EquivalentAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaTotal ConsolidatedEquity Affiliates*TotalDeveloped and UndevelopedConsolidated operationsEnd of 20191,779 1,447 3,226 296 360 298 234 4,414 848 5,262 Revisions(398)(226)(624)(20)12 13 (3)(622)(63)(685)Improved recovery— — — — — 3 — 3 — 3 Purchases— 19 19 10 — — — 29 — 29 Extensions and discoveries10 200 210 95 — — — 305 13 318 Production(85)(142)(227)(25)(49)(55)(3)(359)(73)(432)Sales— (25)(25)(1)— (10)— (36)— (36)End of 20201,306 1,273 2,579 355 323 249 228 3,734 725 4,459 Revisions322 168 490 (45)23 47 6 521 42 563 Improved recovery1 — 1 — — — — 1 — 1 Purchases— 1,169 1,169 — — — — 1,169 — 1,169 Extensions and discoveries10 508 518 15 3 1 — 537 19 556 Production(84)(289)(373)(35)(50)(48)(14)(520)(73)(593)Sales— (54)(54)— — — — (54)— (54)End of 20211,555 2,775 4,330 290 299 249 220 5,388 713 6,101 Revisions(35)292 257 (15)52 19 (5)308 149 457 Improved recovery— — — — — 3 — 3 — 3 Purchases— 13 13 — — — 50 63 80 143 Extensions and discoveries15 414 429 1 26 — — 456 241 697 Production(85)(364)(449)(31)(46)(31)(15)(572)(81)(653)Sales— (82)(82)— — (67)— (149)— (149)End of 20221,450 3,048 4,498 245 331 173 250 5,497 1,102 6,599 Years EndedDecember 31Total Proved ReservesMillions of Barrels of Oil EquivalentAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaTotal ConsolidatedEquity Affiliates*TotalDevelopedConsolidated operationsEnd of 20191,582 666 2,248 197 275 236 218 3,174 761 3,935 End of 20201,186 521 1,707 140 238 211 212 2,508 653 3,161 End of 20211,424 1,767 3,191 166 244 212 207 4,020 631 4,651 End of 20221,357 1,676 3,033 147 240 155 231 3,806 751 4,557 UndevelopedConsolidated operationsEnd of 2019197 781 978 99 85 62 16 1,240 87 1,327 End of 2020120 752 872 215 85 38 16 1,226 72 1,298 End of 2021131 1,008 1,139 124 55 37 13 1,368 82 1,450 End of 202293 1,372 1,465 98 91 18 19 1,691 351 2,042 *All Equity Affiliate reserves are located in our Asia Pacific/Middle East Region.Natural gas reserves are converted to barrels of oil equivalent (BOE) based on a 6:1 ratio: six MCF of natural gas converts to one BOE.ConocoPhillips 2022 10-K144Supplementary DataTable of ContentsProved Undeveloped ReservesThe following table shows changes in total proved undeveloped reserves for 2022:Proved Undeveloped ReservesMillions of Barrels of Oil EquivalentEnd of 20211,450 Revisions344 Improved recovery3 Purchases33 Extensions and discoveries627 Sales(24)Transfers to Proved Developed(391)End of 20222,042 Revisions were predominantly driven by changes in development plans in Lower 48. Extensions and discoveries were largely driven by the addition of 344 MMBOE in Lower 48 for the continued development of unconventional plays. Equity affiliates, primarily in the Middle East, contributed 241 MMBOE. The remaining extensions and discoveries were driven by the continued development planned in the other geographic regions. Transfers to proved developed reserves were driven by the ongoing development of our assets. Approximately 82 percent of the transfers were from the development of our Lower 48 unconventional plays. The remainder of transfers were from development across the other geographic regions. At December 31, 2022, our PUDs represented 31 percent of total proved reserves, compared with 24 percent at December 31, 2021. Costs incurred for the year ended December 31, 2022, relating to the development of PUDs were $5.7 billion. A portion of our costs incurred each year relates to development projects where the PUDs will be converted to proved developed reserves in future years.At the end of 2022, approximately 93 percent of total PUDs were under development or scheduled for development within five years of initial disclosure, including all of our Lower 48 PUDs. The remaining PUDs are in major development areas which are currently producing and predominantly within our Canada and Asia Pacific/Middle East geographic areas.Results of OperationsThe company’s results of operations from oil and gas activities for the years 2022, 2021 and 2020 are shown in the following tables. Non-oil and gas activities, such as pipeline and marine operations, LNG operations, crude oil and gas marketing activities, and the profit element of transportation operations in which we have an ownership interest are excluded. Additional information about selected line items within the results of operations tables is shown below:•Sales include sales to unaffiliated entities attributable primarily to the company’s net working interests and royalty interests. Sales are net of fees to transport our produced hydrocarbons beyond the production function to a final delivery point using transportation operations which are not consolidated.•Transportation costs reflect fees to transport our produced hydrocarbons beyond the production function to a final delivery point using transportation operations which are consolidated. •Other revenues include gains and losses from asset sales, certain amounts resulting from the purchase and sale of hydrocarbons, and other miscellaneous income.•Production costs include costs incurred to operate and maintain wells, related equipment and facilities used in the production of petroleum liquids and natural gas.•Taxes other than income taxes include production, property and other non-income taxes.•Depreciation of support equipment is reclassified as applicable. •Other related expenses include inventory fluctuations, foreign currency transaction gains and losses and other miscellaneous expenses. 145ConocoPhillips 2022 10-KSupplementary DataTable of ContentsResults of Operations Year Ended December 31,2022Millions of DollarsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaOtherAreasTotalConsolidated operationsSales$7,210 24,309 31,519 1,622 6,594 2,602 1,339 — 43,676 Transfers6 — 6 — — — — — 6 Transportation costs(647)— (647)— — — — — (647)Other revenues(1)115 114 338 1 536 184 10 1,183 Total revenues6,568 24,424 30,992 1,960 6,595 3,138 1,523 10 44,218 Production costs excluding taxes1,160 3,600 4,760 581 511 342 55 — 6,249 Taxes other than income taxes1,265 1,687 2,952 21 36 243 2 — 3,254 Exploration expenses34 189 223 149 122 49 19 2 564 Depreciation, depletion and amortization833 4,843 5,676 354 693 517 36 — 7,276 Impairments2 (11)(9)(2)(1)— — — (12)Other related expenses(19)4 (15)(41)(178)40 5 6 (183)Accretion78 55 133 11 62 25 — — 231 3,215 14,057 17,272 887 5,350 1,922 1,406 2 26,839 Income tax provision (benefit)866 3,113 3,979 198 4,057 512 1,301 53 10,100 Results of operations$2,349 10,944 13,293 689 1,293 1,410 105 (51)16,739 Equity affiliatesSales$— — — — — 1,000 — — 1,000 Transfers— — — — — 4,272 — — 4,272 Transportation costs— — — — — — — — — Other revenues— — — — — 41 — — 41 Total revenues— — — — — 5,313 — — 5,313 Production costs excluding taxes— — — — — 491 — — 491 Taxes other than income taxes— — — — — 1,536 — — 1,536 Exploration expenses— — — — — — — — — Depreciation, depletion and amortization— — — — — 530 530 Impairments— — — — — — — — — Other related expenses— — — — — (2)— — (2)Accretion— — — — — 27 — — 27 — — — — — 2,731 — — 2,731 Income tax provision (benefit)— — — — — 836 — — 836 Results of operations$— — — — — 1,895 — — 1,895 ConocoPhillips 2022 10-K146Supplementary DataTable of ContentsYear Ended December 31,2021Millions of DollarsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaOtherAreasTotalConsolidated operationsSales$4,832 14,093 18,925 1,219 3,568 2,525 917 — 27,154 Transfers4 — 4 — — — — — 4 Transportation costs(626)— (626)— — — — — (626)Other revenues14 135 149 323 (5)237 141 (161)684 Total revenues4,224 14,228 18,452 1,542 3,563 2,762 1,058 (161)27,216 Production costs excluding taxes1,073 2,414 3,487 518 487 466 43 — 5,001 Taxes other than income taxes442 937 1,379 23 36 91 1 1 1,531 Exploration expenses80 98 178 39 21 51 2 15 306 Depreciation, depletion and amortization864 4,053 4,917 383 844 787 35 — 6,966 Impairments5 (8)(3)6 (24)7 — — (14)Other related expenses(31)12 (19)(22)(42)4 4 12 (63)Accretion71 47 118 10 70 26 — — 224 1,720 6,675 8,395 585 2,171 1,330 973 (189)13,265 Income tax provision (benefit)378 1,467 1,845 145 1,673 494 870 (53)4,974 Results of operations$1,342 5,208 6,550 440 498 836 103 (136)8,291 Equity affiliatesSales$— — — — — 745 — — 745 Transfers— — — — — 1,797 — — 1,797 Transportation costs— — — — — — — — — Other revenues— — — — — 5 — — 5 Total revenues— — — — — 2,547 — — 2,547 Production costs excluding taxes— — — — — 329 — — 329 Taxes other than income taxes— — — — — 824 — — 824 Exploration expenses— — — — — 268 — — 268 Depreciation, depletion and amortization— — — — — 593 593 Impairments— — — — — 718 — — 718 Other related expenses— — — — — 3 — — 3 Accretion— — — — — 17 — — 17 — — — — — (205)— — (205)Income tax provision (benefit)— — — — — (42)— — (42)Results of operations$— — — — — (163)— — (163)147ConocoPhillips 2022 10-KSupplementary DataTable of ContentsYear Ended December 31,2020Millions of DollarsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaOtherAreasTotalConsolidated operationsSales$2,944 3,421 6,365 230 1,560 1,717 129 — 10,001 Transfers4 — 4 — — 191 — — 195 Transportation costs(587)— (587)— — (19)— — (606)Other revenues(1)(20)(21)40 (21)576 11 10 595 Total revenues2,360 3,401 5,761 270 1,539 2,465 140 10 10,185 Production costs excluding taxes1,058 1,399 2,457 366 417 478 21 2 3,741 Taxes other than income taxes296 263 559 16 30 42 3 1 651 Exploration expenses1,099 73 1,172 40 52 71 13 108 1,456 Depreciation, depletion and amortization840 2,544 3,384 335 755 808 8 — 5,290 Impairments— 804 804 3 5 — — — 812 Other related expenses46 5 51 5 (58)(25)(29)2 (54)Accretion72 46 118 8 73 33 — — 232 (1,051)(1,733)(2,784)(503)265 1,058 124 (103)(1,943)Income tax provision (benefit)(271)(430)(701)(191)116 277 88 (20)(431)Results of operations$(780)(1,303)(2,083)(312)149 781 36 (83)(1,512)Equity affiliatesSales$— — — — — 483 — — 483 Transfers— — — — — 1,205 — — 1,205 Transportation costs— — — — — — — — — Other revenues— — — — — 8 — — 8 Total revenues— — — — — 1,696 — — 1,696 Production costs excluding taxes— — — — — 289 — — 289 Taxes other than income taxes— — — — — 502 — — 502 Exploration expenses— — — — — 20 — — 20 Depreciation, depletion and amortization— — — — — 569 569 Impairments— — — — — — — — — Other related expenses— — — — — (2)— — (2)Accretion— — — — — 15 — — 15 — — — — — 303 — — 303 Income tax provision (benefit)— — — — — 39 — — 39 Results of operations$— — — — — 264 — — 264 ConocoPhillips 2022 10-K148Supplementary DataTable of ContentsStatisticsNet Production202220212020Thousands of Barrels DailyCrude OilConsolidated operationsAlaska177 178 181 Lower 48534 447 213 United States711 625 394 Canada6 8 6 Europe71 81 78 Asia Pacific61 65 69 Africa36 37 8 Total consolidated operations885 816 555 Equity affiliates—Asia Pacific/Middle East13 13 13 Total company898 829 568 Delaware Basin Area (Lower 48)*258 162 28 Greater Prudhoe Area (Alaska)*67 67 68 Natural Gas LiquidsConsolidated operationsAlaska17 16 16 Lower 48221 110 74 United States238 126 90 Canada3 4 2 Europe3 4 4 Asia Pacific— — 1 Total consolidated operations244 134 97 Equity affiliates—Asia Pacific/Middle East8 8 8 Total company252 142 105 Delaware Basin Area (Lower 48)*114 27 11 Greater Prudhoe Area (Alaska)*17 16 15 BitumenConsolidated operations—Canada66 69 55 Total company66 69 55 Natural GasMillions of Cubic Feet DailyConsolidated operationsAlaska34 16 10 Lower 481,402 1,340 585 United States1,436 1,356 595 Canada61 80 40 Europe306 298 270 Asia Pacific114 360 429 Africa22 15 5 Total consolidated operations1,939 2,109 1,339 Equity affiliates—Asia Pacific/Middle East1,191 1,053 1,055 Total company3,130 3,162 2,394 Delaware Basin Area (Lower 48)*752 584 99 Greater Prudhoe Area (Alaska)*32 12 4 *At year-end 2022 and 2021, the Delaware Basin Area in Lower 48 contained more than 15 percent of our total proved reserves. At year-end 2021 and 2020, the Greater Prudhoe Area in Alaska contained more than 15 percent of our total proved reserves.149ConocoPhillips 2022 10-KSupplementary DataTable of ContentsAverage Sales Prices202220212020Crude Oil Per BarrelConsolidated operationsAlaska*$92.58 60.81 33.72 Lower 4894.46 66.12 35.17 United States93.96 64.53 34.48 Canada79.94 56.38 23.57 Europe99.88 68.94 42.80 Asia Pacific105.52 70.36 42.84 Africa97.85 69.06 48.64 Total international100.75 68.85 42.39 Total consolidated operations95.27 65.53 36.69 Equity affiliates—Asia Pacific/Middle East97.31 69.45 39.02 Total operations95.30 65.59 36.75 Natural Gas Liquids Per BarrelConsolidated operationsLower 48$35.36 30.63 12.13 United States35.36 30.63 12.13 Canada37.70 31.18 5.41 Europe54.52 43.97 23.27 Asia Pacific— — 33.21 Total international46.16 37.50 20.25 Total consolidated operations35.67 31.04 12.90 Equity affiliates—Asia Pacific/Middle East61.22 54.16 32.69 Total operations36.50 32.45 14.61 Bitumen Per BarrelConsolidated operations—Canada$55.56 37.52 8.02 **Natural Gas Per Thousand Cubic FeetConsolidated operationsAlaska$3.64 2.81 2.91 Lower 485.92 4.38 1.65 United States5.92 4.38 1.66 Canada3.62 2.54 1.21 Europe35.33 13.75 3.23 Asia Pacific*5.84 6.56 5.27 Africa6.59 3.73 3.71 Total international23.54 8.91 4.31 Total consolidated operations10.56 6.00 3.13 Equity affiliates—Asia Pacific/Middle East9.39 5.31 3.71 Total operations10.60 5.77 3.38 *Average sales prices for Alaska crude oil and Asia Pacific natural gas above reflect a reduction for transportation costs in which we have an ownership interest that are incurred subsequent to the terminal point of the production function. Accordingly, the average sales prices differ from those discussed in Item 7 of Management's Discussion and Analysis of Financial Condition and Results of Operations.**Average sales prices include unutilized transportation costs.ConocoPhillips 2022 10-K150Supplementary DataTable of Contents202220212020Average Production Costs Per Barrel of Oil Equivalent*Consolidated operationsAlaska$15.89 14.92 14.60 Lower 489.97 8.48 9.93 United States10.97 9.78 11.51 Canada18.73 15.10 14.29 Europe11.20 9.88 8.97 Asia Pacific11.71 10.21 9.26 Africa3.77 2.95 6.38 Total international12.36 10.53 10.11 Total consolidated operations11.27 9.99 10.99 Equity affiliates—Asia Pacific/Middle East6.14 4.60 4.01 Average Production Costs Per Barrel—BitumenConsolidated operations—Canada$17.62 13.41 12.45 Taxes Other Than Income Taxes Per Barrel of Oil EquivalentConsolidated operationsAlaska$17.33 6.15 4.08 Lower 484.67 3.29 1.87 United States6.80 3.87 2.62 Canada0.68 0.67 0.62 Europe0.79 0.73 0.65 Asia Pacific8.32 1.99 0.81 Africa0.14 0.07 0.91 Total international2.51 1.06 0.72 Total consolidated operations5.87 3.06 1.91 Equity affiliates—Asia Pacific/Middle East19.22 11.52 6.96 Depreciation, Depletion and Amortization Per Barrel of Oil EquivalentConsolidated operationsAlaska$11.41 12.02 11.59 Lower 4813.42 14.24 18.05 United States13.08 13.79 15.86 Canada11.41 11.16 13.08 Europe15.19 17.13 16.24 Asia Pacific17.71 17.25 15.66 Africa2.47 2.40 2.43 Total international13.28 14.25 15.01 Total consolidated operations13.12 13.92 15.54 Equity affiliates—Asia Pacific/Middle East6.63 8.29 7.89 *Includes bitumen.151ConocoPhillips 2022 10-KSupplementary DataTable of ContentsDevelopment and Exploration ActivitiesThe following two tables summarize our net interest in productive and dry exploratory and development wells in the years ended December 31, 2022, 2021 and 2020. A “development well” is a well drilled within the proved area of a reservoir to the depth of a stratigraphic horizon known to be productive. An “exploratory well” is a well drilled to find and produce crude oil or natural gas in an unknown field or a new reservoir within a proven field. Exploratory wells also include wells drilled in areas near or offsetting current production, or in areas where well density or production history have not achieved statistical certainty of results. Excluded from the exploratory well count are stratigraphic-type exploratory wells, primarily relating to oil sands delineation wells located in Canada and CBM test wells located in Asia Pacific/Middle East. Net Wells CompletedProductiveDry202220212020202220212020ExploratoryConsolidated operationsAlaska— — — — 1 3 Lower 48118 87 3 — — — United States118 87 3 — 1 3 Canada6 12 23 — — — Europe— — — 2 — *Asia Pacific/Middle East— **1 **Africa — — — 3 — *Other areas— — — — — *Total consolidated operations124 99 26 6 1 3 Equity affiliatesAsia Pacific/Middle East*3 8 — — — Total equity affiliates*3 8 — — — DevelopmentConsolidated operations Alaska11 1 7 — — — Lower 48388 339 127 — — — United States399 340 134 — — — Canada11 2 — — — — Europe3 7 7 — — — Asia Pacific/Middle East22 21 16 — — — Africa2 1 2 — — — Other areas— — — — — — Total consolidated operations437 371 159 — — — Equity affiliatesAsia Pacific/Middle East28 30 109 — — — Total equity affiliates28 30 109 — — — *Our total proportionate interest was less than one.ConocoPhillips 2022 10-K152Supplementary DataTable of ContentsThe table below represents the status of our wells drilling at December 31, 2022, and includes wells in the process of drilling or in active completion. It also represents gross and net productive wells, including producing wells and wells capable of production at December 31, 2022.Wells at December 31, 2022ProductiveIn ProgressOilGasGrossNetGrossNetGrossNetConsolidated operationsAlaska2 1 1,591 929 — — Lower 48615 300 13,512 6,382 3,716 1,767 United States617 301 15,103 7,311 3,716 1,767 Canada42 30 192 96 147 147 Europe22 5 487 84 58 2 Asia Pacific/Middle East4 2 398 188 6 2 Africa8 2 869 177 10 2 Other areas— — — — — — Total consolidated operations693 340 17,049 7,856 3,937 1,920 Equity affiliatesAsia Pacific/Middle East279 39 — — 4,989 1,505 Total equity affiliates279 39 — — 4,989 1,505 Acreage at December 31, 2022Thousands of AcresDevelopedUndevelopedGrossNetGrossNetConsolidated operationsAlaska715 531 1,261 1,246 Lower 483,654 2,277 10,279 8,064 United States4,369 2,808 11,540 9,310 Canada289 219 3,429 1,944 Europe430 50 1,195 470 Asia Pacific/Middle East422 152 10,451 6,930 Africa358 73 12,545 2,561 Other areas— — 156 125 Total consolidated operations5,868 3,302 39,316 21,340 Equity affiliatesAsia Pacific/Middle East1,045 314 3,943 1,066 Total equity affiliates1,045 314 3,943 1,066 153ConocoPhillips 2022 10-KSupplementary DataTable of ContentsCosts IncurredYear EndedDecember 31Millions of DollarsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaOtherAreasTotal2022Consolidated operationsUnproved property acquisition$— 255 255 — — — — — 255 Proved property acquisition— 249 249 — — — 104 — 353 — 504 504 — — — 104 — 608 Exploration61 1,278 1,339 99 121 59 3 2 1,623 Development1,316 4,559 5,875 475 711 425 4 — 7,490 $1,377 6,341 7,718 574 832 484 111 2 9,721 Equity affiliatesUnproved property acquisition$— — — — — — — — — Proved property acquisition— — — — — 881 — — 881 — — — — — 881 — — 881 Exploration— — — — — 25 — — 25 Development— — — — — 244 — — 244 $— — — — — 1,150 — — 1,150 2021Consolidated operationsUnproved property acquisition$1 11,261 11,262 4 — — — — 11,266 Proved property acquisition— 16,101 16,101 1 — — — — 16,102 1 27,362 27,363 5 — — — — 27,368 Exploration84 765 849 80 31 51 2 40 1,053 Development949 2,461 3,410 175 398 433 24 — 4,440 $1,034 30,588 31,622 260 429 484 26 40 32,861 Equity affiliatesUnproved property acquisition$— — — — — — — — — Proved property acquisition— — — — — — — — — — — — — — — — — — Exploration— — — — — 5 — — 5 Development— — — — — 21 — — 21 $— — — — — 26 — — 26 2020Consolidated operationsUnproved property acquisition$4 10 14 378 — 3 — 9 404 Proved property acquisition— 62 62 129 — — — — 191 4 72 76 507 — 3 — 9 595 Exploration287 116 403 218 110 32 4 38 805 Development745 1,758 2,503 102 451 427 18 — 3,501 $1,036 1,946 2,982 827 561 462 22 47 4,901 Equity affiliatesUnproved property acquisition$— — — — — — — — — Proved property acquisition— — — — — — — — — — — — — — — — — — Exploration— — — — — 12 — — 12 Development— — — — — 282 — — 282 $— — — — — 294 — — 294 ConocoPhillips 2022 10-K154Supplementary DataTable of ContentsCapitalized CostsAt December 31Millions of DollarsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaOtherAreasTotal2022Consolidated operationsProved property$24,041 62,756 86,797 7,487 13,716 10,534 1,075 — 119,609 Unproved property589 5,145 5,734 1,291 100 93 98 9 7,325 24,630 67,901 92,531 8,778 13,816 10,627 1,173 9 126,934 Accumulated depreciation, depletion and amortization11,906 31,455 43,361 2,927 9,774 7,970 458 9 64,499 $12,724 36,446 49,170 5,851 4,042 2,657 715 — 62,435 Equity affiliatesProved property$— — — — — 10,823 — — 10,823 Unproved property— — — — — 2,162 — — 2,162 — — — — — 12,985 — — 12,985 Accumulated depreciation, depletion and amortization— — — — — 8,400 — — 8,400 $— — — — — 4,585 — — 4,585 2021Consolidated operationsProved property$22,750 58,561 81,311 7,380 14,514 12,226 966 — 116,397 Unproved property1,402 7,704 9,106 1,517 155 92 114 9 10,993 24,152 66,265 90,417 8,897 14,669 12,318 1,080 9 127,390 Accumulated depreciation, depletion and amortization11,945 29,975 41,920 2,749 10,166 9,240 422 9 64,506 $12,207 36,290 48,497 6,148 4,503 3,078 658 — 62,884 Equity affiliatesProved property$— — — — — 10,357 — — 10,357 Unproved property— — — — — 2,162 — — 2,162 — — — — — 12,519 — — 12,519 Accumulated depreciation, depletion and amortization— — — — — 8,539 — — 8,539 $— — — — — 3,980 — — 3,980 155ConocoPhillips 2022 10-KSupplementary DataTable of ContentsStandardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserve QuantitiesIn accordance with SEC and FASB requirements, amounts were computed using 12-month average prices (adjusted only for existing contractual terms) and end-of-year costs, appropriate statutory tax rates and a prescribed 10 percent discount factor. Twelve-month average prices are calculated as the unweighted arithmetic average of the first-day-of-the-month price for each month within the 12-month period prior to the end of the reporting period. For all years, continuation of year-end economic conditions was assumed. The calculations were based on estimates of proved reserves, which are revised over time as new data becomes available. Probable or possible reserves, which may become proved in the future, were not considered. The calculations also require assumptions as to the timing of future production of proved reserves and the timing and amount of future development costs, including dismantlement, and future production costs, including taxes other than income taxes.While due care was taken in its preparation, we do not represent that this data is the fair value of our oil and gas properties, or a fair estimate of the present value of cash flows to be obtained from their development and production.Discounted Future Net Cash Flows Millions of DollarsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaTotal2022Consolidated operationsFuture cash inflows$94,332 195,605 289,937 13,768 44,942 13,458 27,067 389,172 Less:Future production costs47,979 63,987 111,966 5,722 7,559 5,582 1,085 131,914 Future development costs8,501 21,379 29,880 960 4,378 1,159 531 36,908 Future income tax provisions8,882 23,136 32,018 863 25,416 1,780 23,615 83,692 Future net cash flows28,970 87,103 116,073 6,223 7,589 4,937 1,836 136,658 10 percent annual discount13,733 31,191 44,924 1,936 1,827 1,505 746 50,938 Discounted future net cash flows$15,237 55,912 71,149 4,287 5,762 3,432 1,090 85,720 Equity affiliatesFuture cash inflows$— — — — — 87,644 — 87,644 Less:— Future production costs— — — — — 51,912 — 51,912 Future development costs— — — — — 2,685 — 2,685 Future income tax provisions— — — — — 8,988 — 8,988 Future net cash flows— — — — — 24,059 — 24,059 10 percent annual discount— — — — — 10,787 — 10,787 Discounted future net cash flows$— — — — — 13,272 — 13,272 Total companyDiscounted future net cash flows$15,237 55,912 71,149 4,287 5,762 16,704 1,090 98,992 ConocoPhillips 2022 10-K156Supplementary DataTable of ContentsMillions of DollarsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaTotal2021Consolidated operationsFuture cash inflows$65,910 125,197 191,107 10,847 21,670 11,583 15,778 250,985 Less:Future production costs34,444 43,034 77,478 4,960 6,090 4,987 801 94,316 Future development costs8,033 13,386 21,419 923 3,960 1,314 413 28,029 Future income tax provisions5,310 13,167 18,477 117 8,345 1,542 13,506 41,987 Future net cash flows18,123 55,610 73,733 4,847 3,275 3,740 1,058 86,653 10 percent annual discount7,963 22,290 30,253 1,639 696 930 440 33,958 Discounted future net cash flows$10,160 33,320 43,480 3,208 2,579 2,810 618 52,695 Equity affiliatesFuture cash inflows$— — — — — 27,851 — 27,851 Less:— Future production costs— — — — — 15,491 — 15,491 Future development costs— — — — — 1,649 — 1,649 Future income tax provisions— — — — — 3,071 — 3,071 Future net cash flows— — — — — 7,640 — 7,640 10 percent annual discount— — — — — 2,640 — 2,640 Discounted future net cash flows$— — — — — 5,000 — 5,000 Total companyDiscounted future net cash flows$10,160 33,320 43,480 3,208 2,579 7,810 618 57,695 157ConocoPhillips 2022 10-KSupplementary DataTable of ContentsMillions of DollarsAlaskaLower48TotalU.S.CanadaEuropeAsia Pacific/Middle EastAfricaTotal2020Consolidated operationsFuture cash inflows$30,145 31,533 61,678 4,198 9,857 7,940 9,997 93,670 Less:Future production costs22,905 17,582 40,487 4,316 4,770 3,838 1,277 54,688 Future development costs7,932 12,799 20,731 750 3,688 1,289 461 26,919 Future income tax provisions— 376 376 — 267 1,075 7,571 9,289 Future net cash flows(692)776 84 (868)1,132 1,738 688 2,774 10 percent annual discount(1,501)(820)(2,321)(396)117 406 294 (1,900)Discounted future net cash flows$809 1,596 2,405 (472)1,015 1,332 394 4,674 Equity affiliatesFuture cash inflows$— — — — — 17,284 — 17,284 Less:Future production costs— — — — — 10,239 — 10,239 Future development costs— — — — — 1,186 — 1,186 Future income tax provisions— — — — — 1,728 — 1,728 Future net cash flows— — — — — 4,131 — 4,131 10 percent annual discount— — — — — 1,269 — 1,269 Discounted future net cash flows$— — — — — 2,862 — 2,862 Total companyDiscounted future net cash flows$809 $1,596 $2,405 $(472)$1,015 $4,194 $394 $7,536 *Undiscounted future net cash flows related to the proved oil and gas reserves disclosed for Canada for the year ending December 31, 2020, are negative due to the inclusion of asset retirement costs and certain indirect costs in the calculation of the standardized measure of discounted future net cash flows. These costs are not required to be included in the economic limit test for proved developed reserves as defined in Regulation S-X Rule 4-10. Future net cash flows for Canada were also impacted by lower 12-month average pricing for bitumen and crude oil in 2020. Commodity prices have since improved in the current environment.ConocoPhillips 2022 10-K158Supplementary DataTable of ContentsSources of Change in Discounted Future Net Cash Flows Millions of DollarsConsolidated OperationsEquity AffiliatesTotal Company202220212020202220212020202220212020Discounted future net cash flows at the beginning of the year$52,695 $4,674 27,372 $5,000 2,862 7,170 $57,695 7,536 34,542 Changes during the yearRevenues less production costs for the year(33,532)(20,000)(5,198)(3,245)(1,389)(897)(36,777)(21,389)(6,095)Net change in prices, and production costs61,902 50,956 (34,307)8,184 3,822 (4,769)70,086 54,778 (39,076)Extensions, discoveries and improved recovery, less estimated future costs7,882 10,420 887 1,472 (44)22 9,354 10,376 909 Development costs for the year6,687 4,396 3,593 272 91 192 6,959 4,487 3,785 Changes in estimated future development costs(4,088)(33)754 189 (104)(205)(3,899)(137)549 Purchases of reserves in place, less estimated future costs3,353 17,833 1 1,282 — (3)4,635 17,833 (2)Sales of reserves in place, less estimated future costs(3,847)(468)(302)— — — (3,847)(468)(302)Revisions of previous quantity estimates13,080 2,985 (2,299)2,193 178 (42)15,273 3,163 (2,341)Accretion of discount7,021 964 3,984 616 344 804 7,637 1,308 4,788 Net change in income taxes(25,433)(19,032)10,189 (2,691)(760)590 (28,124)(19,792)10,779 Total changes33,025 48,021 (22,698)8,272 2,138 (4,308)41,297 50,159 (27,006)Discounted future net cash flows at year end$85,720 $52,695 4,674 $13,272 5,000 2,862 $98,992 57,695 7,536 •The net change in prices and production costs is the beginning-of-year reserve-production forecast multiplied by the net annual change in the per-unit sales price and production cost, discounted at 10 percent.•Purchases and sales of reserves in place, along with extensions, discoveries and improved recovery, are calculated using production forecasts of the applicable reserve quantities for the year multiplied by the 12-month average sales prices, less future estimated costs, discounted at 10 percent. •Revisions of previous quantity estimates are calculated using production forecast changes for the year, including changes in the timing of production, multiplied by the 12-month average sales prices, less future estimated costs, discounted at 10 percent.•The accretion of discount is 10 percent of the prior year’s discounted future cash inflows, less future production and development costs.•The net change in income taxes is the annual change in the discounted future income tax provisions.159ConocoPhillips 2022 10-KTable of ContentsItem 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureNone.Item 9A. Controls and ProceduresWe maintain disclosure controls and procedures designed to ensure information required to be disclosed in reports we file or submit under the Securities Exchange Act of 1934, as amended (the Act), is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure. As of December 31, 2022, with the participation of our management, our Chairman and Chief Executive Officer (principal executive officer) and our Executive Vice President and Chief Financial Officer (principal financial officer) carried out an evaluation, pursuant to Rule 13a-15(b) of the Act, of ConocoPhillips’ disclosure controls and procedures (as defined in Rule 13a-15(e) of the Act). Based upon that evaluation, our Chairman and Chief Executive Officer and our Executive Vice President and Chief Financial Officer concluded our disclosure controls and procedures were operating effectively as of December 31, 2022.There have been no changes in our internal control over financial reporting, as defined in Rule 13a-15(f) of the Act, in the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.Management’s Annual Report on Internal Control Over Financial ReportingThis report is included in Item 8 on page 69 and is incorporated herein by reference.Report of Independent Registered Public Accounting Firm This report is included in Item 8 on page 70 and is incorporated herein by reference.Item 9B. Other InformationNone.Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent InspectionsNot applicable.ConocoPhillips 2022 10-K160Table of ContentsPart IIIItem 10. Directors, Executive Officers and Corporate GovernanceInformation regarding our executive officers appears in Part I of this report on page 28.Code of Business Ethics and Conduct for Directors and EmployeesWe have a Code of Business Ethics and Conduct for Directors and Employees (Code of Ethics), including our principal executive officer, principal financial officer, principal accounting officer and persons performing similar functions. We have posted a copy of our Code of Ethics on the “Corporate Governance” section of our internet website at www.conocophillips.com (within the Investors>Corporate Governance section). Any waivers of the Code of Ethics must be approved, in advance, by our full Board of Directors. Any amendments to, or waivers from, the Code of Ethics that apply to our executive officers and directors will be posted on the “Corporate Governance” section of our internet website.All other information required by Item 10 of Part III will be included in our Proxy Statement relating to our 2023 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2023, and is incorporated herein by reference.* Item 11. Executive CompensationInformation required by Item 11 of Part III will be included in our Proxy Statement relating to our 2023 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2023, and is incorporated herein by reference.*Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersInformation required by Item 12 of Part III will be included in our Proxy Statement relating to our 2023 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2023, and is incorporated herein by reference.*Item 13. Certain Relationships and Related Transactions, and Director IndependenceInformation required by Item 13 of Part III will be included in our Proxy Statement relating to our 2023 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2023, and is incorporated herein by reference.* Item 14. Principal Accounting Fees and ServicesInformation required by Item 14 of Part III will be included in our Proxy Statement relating to our 2023 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A on or before April 30, 2023, and is incorporated herein by reference.* _________________________* Except for information or data specifically incorporated herein by reference under Items 10 through 14, other information and data appearing in our 2023 Proxy Statement are not deemed to be a part of this Annual Report on Form 10-K or deemed to be filed with the Commission as a part of this report.161ConocoPhillips 2022 10-KTable of ContentsPart IVItem 15. Exhibits, Financial Statement Schedules (a)1. Financial Statements and Supplementary DataThe financial statements and supplementary information listed in the Index to Financial Statements, which appears on page 68, are filed as part of this annual report.2. Financial Statement SchedulesAll financial statement schedules are omitted because they are not required, not significant, not applicable or the information is shown in another schedule, the financial statements or the notes to consolidated financial statements.3. ExhibitsThe exhibits listed in the Index to Exhibits, which appears on pages 163 through 167, are filed as part of this annual report.ConocoPhillips 2022 10-K162Table of ContentsConocoPhillipsIndex to ExhibitsIncorporated by ReferenceExhibitNo.DescriptionExhibitFormFile No.2.1Separation and Distribution Agreement Between ConocoPhillips and Phillips 66, dated April 26, 2012.2.18-K001-323952.2†‡Purchase and Sale Agreement, dated March 29, 2017, by and among ConocoPhillips Company, ConocoPhillips Canada Resources Corp., ConocoPhillips Canada Energy Partnership, ConocoPhillips Western Canada Partnership, ConocoPhillips Canada (BRC) Partnership, ConocoPhillips Canada E&P ULC, and Cenovus Energy Inc.2.110-Q001-323952.3†‡Asset Purchase and Sale Agreement Amending Agreement, dated as of May 16, 2017, by and among ConocoPhillips Company, ConocoPhillips Canada Resources Corp., ConocoPhillips Canada Energy Partnership, ConocoPhillips Western Canada Partnership, ConocoPhillips Canada (BRC) Partnership, ConocoPhillips Canada E&P ULC, and Cenovus Energy Inc.2.28-K001-323952.4Agreement and Plan of Merger, dated as of October 18, 2020, among ConocoPhillips, Falcon Merger Sub Corp. and Concho Resources Inc. 2.18-K001-323953.1Amended and Restated Certificate of Incorporation.3.110-Q001-323953.2Certificate of Designations of Series A Junior Participating Preferred Stock of ConocoPhillips.3.28-K000-499873.3Amended and Restated By-Laws of ConocoPhillips, as amended and restated as of October 9, 2015.3.18-K001-323953.4Restated Certificate of Incorporation of ConocoPhillips Company, dated February 6, 2019.3.410-K001-32395ConocoPhillips and its subsidiaries are parties to several debt instruments under which the total amount of securities authorized does not exceed 10 percent of the total assets of ConocoPhillips and its subsidiaries on a consolidated basis. Pursuant to paragraph 4(iii)(A) of Item 601(b) of Regulation S-K, ConocoPhillips agrees to furnish a copy of such instruments to the SEC upon request.4.1Description of Securities of the Registrant.4.110-K001-3239510.1Indemnification and Release Agreement between ConocoPhillips and Phillips 66, dated April 26, 2012.10.18-K001-3239510.2Intellectual Property Assignment and License Agreement between ConocoPhillips and Phillips 66, dated April 26, 2012.10.28-K001-3239510.3Tax Sharing Agreement between ConocoPhillips and Phillips 66, dated April 26, 2012.10.38-K001-3239510.4Employee Matters Agreement between ConocoPhillips and Phillips 66, dated April 12, 2012.10.48-K001-3239510.5.1Rabbi Trust Agreement dated December 17, 1999.10.1110-K001-1452110.5.2Amendment to Rabbi Trust Agreement dated February 25, 2002.10.39.110-K000-4998710.6.1Phillips Petroleum Company Grantor Trust Agreement, dated June 1, 1998.10.17.310-K001-3239510.6.2First Amendment to the Trust Agreement under the Phillips Petroleum Company Grantor Trust Agreement, dated May 3, 1999.10.17.410-K001-32395163ConocoPhillips 2022 10-KTable of Contents10.6.3Second Amendment to the Trust Agreement under the Phillips Petroleum Company Grantor Trust Agreement, dated January 15, 2002.10.17.510-K001-3239510.6.4Third Amendment to the Trust Agreement under the Phillips Petroleum Company Grantor Trust Agreement, dated October 5, 2006.10.17.610-K001-3239510.6.5Fourth Amendment to the Trust Agreement under the ConocoPhillips Company Grantor Trust Agreement, dated May 1, 2012.10.17.710-K001-3239510.6.6Fifth Amendment to the Trust Agreement under the ConocoPhillips Company Grantor Trust Agreement, dated May 20, 2015.10.17.810-K001-3239510.7.1Successor Trustee Agreement of the Deferred Compensation Trust Agreement for Non-Employee Directors of ConocoPhillips dated July 31, 2020.10.110-Q001-3239510.7.2First Amendment to the Successor Trust Agreement of the Deferred Compensation Trust Agreement for Non-Employee Directors of ConocoPhillips, dated August 4, 2020.10.210-Q001-3239510.81986 Stock Plan of Phillips Petroleum Company.10.1110-K004-4998710.91990 Stock Plan of Phillips Petroleum Company.10.1210-K004-4998710.10Omnibus Securities Plan of Phillips Petroleum Company.10.1910-K004-4998710.112002 Omnibus Securities Plan of Phillips Petroleum Company.10.2610-K000-4998710.12.12004 Omnibus Stock and Performance Incentive Plan of ConocoPhillips.Schedule 14AProxy000-4998710.12.2Form of Performance Share Unit Award Agreement under the Performance Share Program under the 2004 Omnibus Stock and Performance Incentive Plan of ConocoPhillips.10.2710-K001-3239510.13Omnibus Amendments to certain ConocoPhillips employee benefit plans, adopted December 7, 2007.10.3010-K001-3239510.142009 Omnibus Stock and Performance Incentive Plan of ConocoPhillips.Schedule 14AProxy001-3239510.15.12011 Omnibus Stock and Performance Incentive Plan of ConocoPhillips.Schedule 14AProxy001-3239510.15.2Form of Stock Option Award Agreement under the Stock Option and Stock Appreciation Rights Program under the 2011 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, effective February 9, 2012.1010-Q001-3239510.15.3Form of Performance Share Unit Agreement under the Restricted Stock Program under the 2011 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated February 5, 2013.10.26.610-K001-3239510.15.4Form of Stock Option Award Agreement under the Stock Option and Stock Appreciation Rights Program under the 2011 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated February 5, 2013.10.26.910-K001-3239510.15.5Form of Key Employee Award Agreement, as part of the ConocoPhillips Stock Option Program granted under the 2011 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated February 18, 2014.10.110-Q001-3239510.15.6Form of Performance Period IX Award Agreement, as part of the ConocoPhillips Performance Share Program granted under the 2011 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated February 18, 2014.10.310-Q001-3239510.15.7Form of Performance Period X Award Agreement, as part of the ConocoPhillips Performance Share Program granted under the 2011 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated February 18, 2014.10.510-Q001-32395ConocoPhillips 2022 10-K164Table of Contents10.15.8Form of Inducement Grant Award Agreement under the 2011 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated March 31, 2014.10.1110-Q001-3239510.16.12014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips.10.18-K001-3239510.16.2Form of Key Employee Award Agreement, as part of the ConocoPhillips Stock Option Program granted under the 2014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated February 16, 2016.10.26.1210-K001-3239510.16.3Form of Performance Share Unit Award Terms and Conditions for Performance Period 18, as part of the ConocoPhillips Performance Share Program granted under the 2014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated February 13, 2018.10.26.2410-K001-3239510.16.4Form of Key Employee Award Terms and Conditions, as part of the ConocoPhillips Stock Option Program granted under the 2014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated February 14, 2017.10.110-Q001-3239510.16.5Form of Key Employee Award Terms and Conditions as part of the ConocoPhillips Restricted Stock Unit Program granted under the 2014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated February 14, 2019.10.27.1610-K001-3239510.16.6Form of Key Employee Award Terms and Conditions, as part of the ConocoPhillips Targeted Variable Long Term Incentive Program, granted under the 2014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated September 23, 2019.10.110-Q001-3239510.16.7Form of Retention Award Terms and Conditions, as part of the Restricted Stock Unit Award, granted under the 2014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips.10.110-Q001-3239510.16.8Form of Inducement Grant Award Agreement under the 2014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated January 15, 2021.10.310-Q001-3239510.16.9Form of Key Employee Award Terms and Conditions, as part of the ConocoPhillips Targeted Variable Long Term Incentive Program, granted under the 2014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips dated August 1, 2022.10.110-Q001-3239510.16.10Form of Executive Restricted Stock Unit Award Terms and Conditions, as part of the ConocoPhillips Executive Restricted Stock Unit Program, granted under the 2014 Omnibus Stock and Performance Incentive Plan of ConocoPhillips, dated February 11, 2020.10.110-Q001-3239510.17Amended and Restated ConocoPhillips Key Employee Supplemental Retirement Plan, dated January 1, 2020.10.10.110-K001-3239510.18.1Amended and Restated Defined Contribution Make-Up Plan of ConocoPhillips—Title I, dated January 1, 2020.10.11.110-K001-3239510.18.2Amended and Restated Defined Contribution Make-Up Plan of ConocoPhillips—Title II, dated January 1, 2020.10.11.210-K001-3239510.19Company Retirement Contribution Make-Up Plan of ConocoPhillips, dated December 28, 2018.10.3910-K001-3239510.20.1Amended and Restated Key Employee Deferred Compensation Plan of ConocoPhillips—Title I, dated January 1, 2020.10.19.110-K001-3239510.20.2Amended and Restated Key Employee Deferred Compensation Plan of ConocoPhillips—Title II, dated January 1, 2020.10.19.210-K001-3239510.20.3*First Amendment to the Key Employee Deferred Compensation Plan of ConocoPhillips—Title II.165ConocoPhillips 2022 10-KTable of Contents10.20.4*Second Amendment to the Key Employee Deferred Compensation Plan of ConocoPhillips—Title II.10.21.1Amendment and Restatement of ConocoPhillips Key Employee Change in Control Severance Plan, effective January 1, 2014.10.2110-K001-3239510.21.2Amendment and Restatement of ConocoPhillips Key Employee Change in Control Severance Plan, effective December 2, 2021.10.20.110-K001-3239510.22Form of Non-Employee Director Restricted Stock Units Terms and Conditions, as part of the Deferred Compensation Plan for Non-Employee Directors of ConocoPhillips, dated January 15, 2016.10.310-Q001-3239510.23Deferred Compensation Plan for Non-Employee Directors of ConocoPhillips.10.1710-K001-3239510.24.1ConocoPhillips Directors’ Charitable Gift Program.10.4010-K000-4998710.24.2First and Second Amendments to the ConocoPhillips Directors’ Charitable Gift Program.1010-Q001-3239510.25Amended and Restated 409A Annex to Nonqualified Deferred Compensation Arrangements of ConocoPhillips, dated January 1, 2020.10.2710-K001-3239510.26ConocoPhillips Clawback Policy dated October 3, 2012.10.310-Q001-3239510.27Amendment and Restatement of ConocoPhillips Executive Severance Plan, dated December 2, 2021.10.4710-K001-3239510.28Amendment and Restatement of the Burlington Resources Inc. Management Supplemental Benefits Plan, dated April 19, 2012.10.910-Q001-3239510.29Purchase and Sale Agreement, dated as of September 20, 2021, by and between Shell Enterprises LLC and ConocoPhillips.10.110-Q001-3239510.30Compensation Resolutions regarding Matthew J. Fox, dated April 8, 2021.10.110-Q001-3239510.31Form of Aircraft Time Sharing Agreement by and between certain executives and ConocoPhillips dated June 21, 2021.10.210-Q001-3239510.32Letter agreement with Timothy A. Leach, dated April 28, 2022.10.110-Q001-32395ConocoPhillips 2022 10-K166Table of Contents21*List of Subsidiaries of ConocoPhillips.22*Subsidiary Guarantors of Guaranteed Securities.23.1*Consent of Ernst & Young LLP.23.2*Consent of DeGolyer and MacNaughton.31.1*Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.31.2*Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.32*Certifications pursuant to 18 U.S.C. Section 1350.99*Report of DeGolyer and MacNaughton.101.INS*Inline XBRL Instance Document.101.SCH*Inline XBRL Schema Document.101.CAL*Inline XBRL Calculation Linkbase Document.101.DEF*Inline XBRL Definition Linkbase Document.101.LAB*Inline XBRL Labels Linkbase Document.101.PRE*Inline XBRL Presentation Linkbase Document.104*Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).* Filed herewith.† The schedules to this exhibit have been omitted pursuant to Item 601(b)(2) of Regulation S-K. ConocoPhillips agrees to furnish a copy of any schedule omitted from this exhibit to the SEC upon request.‡ ConocoPhillips has previously been granted confidential treatment for certain portions of this exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.167ConocoPhillips 2022 10-KTable of ContentsSignaturePursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.CONOCOPHILLIPSFebruary 16, 2023/s/ Ryan M. LanceRyan M. LanceChairman of the Board of Directorsand Chief Executive OfficerPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed, as of February 16, 2023, on behalf of the registrant by the following officers in the capacity indicated and by a majority of directors.SignatureTitle/s/ Ryan M. LanceChairman of the Board of DirectorsRyan M. Lanceand Chief Executive Officer(Principal executive officer)/s/ William L. Bullock, Jr.Executive Vice President andWilliam L. Bullock, Jr.Chief Financial Officer(Principal financial officer)/s/ Christopher P. DelkVice President, ControllerChristopher P. Delk and General Tax Counsel(Principal accounting officer)ConocoPhillips 2022 10-K168Table of Contents/s/ Dennis V. ArriolaDirectorDennis V. Arriola/s/ Caroline M. DevineDirectorCaroline M. Devine/s/ Gay Huey EvansDirectorGay Huey Evans/s/ Jody FreemanDirectorJody Freeman/s/ Jeffrey A. JoerresDirectorJeffrey A. Joerres/s/ Timothy A. LeachDirectorTimothy A. Leach/s/ William H. McRavenDirectorWilliam H. McRaven/s/ Sharmila MulliganDirectorSharmila Mulligan/s/ Eric D. MullinsDirectorEric D. Mullins/s/ Arjun N. MurtiDirectorArjun N. Murti/s/ Robert A. NiblockDirectorRobert A. Niblock/s/ David T. SeatonDirectorDavid T. Seaton/s/ R.A. WalkerDirectorR.A. Walker169ConocoPhillips 2022 10-K EX-10.20 3 2 cop2022123110-kxex10203.htm EX-10.20 3 DocumentExhibit 10.20.3FIRST AMENDMENT TO TITLE II OF THEKEY EMPLOYEE DEFERRED COMPENSATION PLAN OF CONOCOPHILLIPSEffective January 1, 2020, ConocoPhillips Company (the “Company”) amended and restated the Key Employee Deferred Compensation Plan, Title II (“Title II”) for the benefit of certain employees of the Company and its affiliates.The Company desires to amend Title II by the revisions set forth below. Pursuant to the foregoing, Title II is hereby amended as follows, effective March 31, 2020:1.After Subsection (mm) of Section 1, add the following new Subsection (nn):“(nn) "Section 7A Employee" shall mean an Employee who is entitled to the allocation as determined in Section 7A.”2.After Section 7, add the following new Section 7A: “7A. Section 7A Employees.A Participant who would have an allocation greater than zero dollars pursuant to the provisions of this Section 7A shall be considered a Section 7A Employee. A Section 7A Employee shall have an amount credited as an Incentive Compensation Plan Award to such Section 7A Employee’s applicable Deferred Compensation Account as of March 31, 2020, as a one-time additional allocation from the Company. Each such allocation shall be subject to all existing and subsequent elections and other terms and conditions with regard to each such account, as if otherwise made in accordance with Section 4. The amount of each such allocation shall be determined in the following manner:(a)for a Participant whose investment allocation elections for 2018 Incentive Compensation Plan deferrals differed from investment allocations made for 2019 Incentive Compensation Plan deferrals and who made no change in investment allocation elections in the period from February 21, 2020 to March 30, 2020 (inclusive of both such dates), and for which the value of the investment allocation elections made in 2018 would have produced a higher return as of March 31, 2020 than the investment allocations made in 2019, the difference in value between such investment allocations; and1Exhibit 10.20.3(b)for a Participant whose investment allocation elections for 2018 Incentive Compensation Plan deferrals differed from investment allocations made for 2019 Incentive Compensation Plan deferrals and who made a change in investment allocations in the period between February 21, 2020 and March 30, 2020 (inclusive of both such dates), and for which the value of the investment allocation elections made in 2018 would have produced a higher return as of the date of the change in investment allocation elections than the investment allocations made in 2019, the difference in value between such investment allocations as of the date of the change in investment allocations.”Executed April 8, 2020 For ConocoPhillips Company /s/ Heather G. Sirdashney Heather G. SirdashneyVice President, Human ResourcesDavid Pittman: /s/ David Pittman Brian Pittman: /s/ Brian Pittman 2 EX-10.20 4 3 cop2022123110-kxex10204.htm EX-10.20 4 DocumentExhibit 10.20.4SECOND AMENDMENT TO TITLE II OF THEKEY EMPLOYEE DEFERRED COMPENSATION PLAN OF CONOCOPHILLIPSEffective January 1, 2020, ConocoPhillips Company (the “Company”) amended and restated the Key Employee Deferred Compensation Plan, Title II (“Title II”) for the benefit of certain employees of the Company and its affiliates.The Company desires to amend Title II by the revisions set forth below.Pursuant to the foregoing, Title II is hereby amended as follows, effective January 1, 2020:1. In Section 9 change the reference to “Section 18(g) to “Section 17(g).”Executed December 31, 2022For ConocoPhillips Company /s/ Heather G. Sirdashney Heather G. SirdashneySenior Vice President,Human Resources and Real Estate & Facility Services EX-21 4 cop2022123110k-exhibit21.htm EX-21 DocumentExhibit 21SUBSIDIARY LISTING OF CONOCOPHILLIPSListed below are subsidiaries of the registrant at December 31, 2022. Certain subsidiaries are omitted since such companies considered in the aggregate do not constitute a significant subsidiary.Company NameIncorporation LocationAlpine Pipeline CompanyDelawareAshford Energy Capital LimitedCayman IslandsBROG LP LLCDelawareBurlington Resources China LLCDelawareBurlington Resources LLCDelawareBurlington Resources Offshore Inc.DelawareBurlington Resources Oil & Gas Company LPDelawareBurlington Resources Trading LLCDelawareCOG Acreage LPTexasCOG Operating LLCDelawareCOG Production LLCTexasCOG Realty LLCTexasConcho Oil & Gas LLCTexasConcho Resources Inc.DelawareConoco Development Services Inc.DelawareConoco Funding CompanyNova ScotiaConoco Offshore Pipe Line CompanyDelawareConoco Petroleum Operations Inc.DelawareConocoPhillips (U.K.) Marketing and Trading LimitedUnited KingdomConocoPhillips (U.K.) Teesside Operator LimitedUnited KingdomConocoPhillips Alaska II, Inc.DelawareConocoPhillips Alaska, Inc.DelawareConocoPhillips Angola 36 Ltd.Cayman IslandsConocoPhillips Angola 37 Ltd.Cayman IslandsConocoPhillips ANS Marketing CompanyDelawareConocoPhillips Asia Ventures Pte. Ltd.SingaporeConocoPhillips Australia Investments Pty LtdAustraliaConocoPhillips Australia Pacific LNG Pty LtdWestern AustraliaConocoPhillips Bohai LimitedBahamasConocoPhillips Canada (BRC) PartnershipAlbertaConocoPhillips Canada Resources Corp.AlbertaConocoPhillips China Inc.LiberiaConocoPhillips CompanyDelawareConocoPhillips East Malaysia LimitedCayman IslandsConocoPhillips Funding Ltd.BermudaConocoPhillips Hamaca B.V.NetherlandsConocoPhillips Libya Waha Ltd.Cayman IslandsExhibit 21Company NameIncorporation LocationConocoPhillips Marine Containment Holdings LLCDelawareConocoPhillips NorgeDelawareConocoPhillips Norway Funding Ltd.BermudaConocoPhillips Petroleum Holdings B.V.NetherlandsConocoPhillips Petrozuata B.V.NetherlandsConocoPhillips Port Arthur LNG LLCDelawareConocoPhillips Qatar B.V.NetherlandsConocoPhillips Qatar Funding Ltd.Cayman IslandsConocoPhillips Qatar Ltd.Cayman IslandsConocoPhillips Sabah Gas Ltd.Cayman IslandsConocoPhillips Sabah Ltd.BermudaConocoPhillips Sarawak LimitedCayman IslandsConocoPhillips Sarawak Oil LimitedCayman IslandsConocoPhillips Skandinavia ASNorwayConocoPhillips Surmont PartnershipAlbertaConocoPhillips Transportation Alaska, Inc.DelawareConocoPhillips Treasury LimitedEngland & WalesInexco Oil CompanyDelawareMongoose Minerals LLCDelawarePermian Delaware Enterprises Holdings LLCTexasPhillips Coal CompanyNevadaPhillips International Investments, Inc.DelawarePhillips Investment Company LLCNevadaPhillips Petroleum International Corporation LLCDelawarePhillips Petroleum International Investment Company LLCDelawarePhillips Pt. Arguello Production CompanyDelawarePolar Tankers, Inc.DelawareQuail Ranch LLCTexasRSP Permian, Inc.DelawareRSP Permian, L.L.C.DelawareSooner Insurance CompanyVermontThe Louisiana Land and Exploration Company LLCMarylandWarwick-Athena LLCDelaware EX-22 5 cop2022123110k-exhibit22.htm EX-22 DocumentExhibit 22SUBSIDIARY GUARANTORS OF GUARANTEED SECURITIESListed below are subsidiaries serving as an issuer or guarantor, as applicable, for outstanding publicly held debt securities.Company NameIncorporation LocationConocoPhillipsDelawareConocoPhillips CompanyDelawareBurlington Resources LLCDelaware EX-23.1 6 cop2022123110k-exhibit231.htm EX-23.1 DocumentExhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe consent to the incorporation by reference in the following Registration Statements:•ConocoPhillips Form S-3 File No. 333-240978•ConocoPhillips Form S-4 File No. 333-266960•ConocoPhillips Form S-4 File No. 333-262829•ConocoPhillips Form S-4 File No. 333-130967•ConocoPhillips Form S-4 File No. 333-250183•ConocoPhillips Form S-8 File No. 333-130967•ConocoPhillips Form S-8 File No. 333-98681•ConocoPhillips Form S-8 File No. 333-116216•ConocoPhillips Form S-8 File No. 333-133101•ConocoPhillips Form S-8 File No. 333-159318•ConocoPhillips Form S-8 File No. 333-171047•ConocoPhillips Form S-8 File No. 333-174479•ConocoPhillips Form S-8 File No. 333-196349•ConocoPhillips Form S-8 File No. 333-250183of our reports dated February 16, 2023, with respect to the consolidated financial statements of ConocoPhillips and the effectiveness of internal control over financial reporting of ConocoPhillips included in this Annual Report (Form 10-K) of ConocoPhillips for the year ended December 31, 2022./s/ Ernst & Young LLPHouston, TexasFebruary 16, 2023 EX-23.2 7 cop2022123110k-exhibit232.htm EX-23.2 DocumentExhibit 23.2DeGolyer and MacNaughton5001 Spring Valley RoadSuite 800 EastDallas, Texas 75244February 16, 2023ConocoPhillips925 N. Eldridge ParkwayHouston, Texas 77079Ladies and Gentlemen:We hereby consent to the use of the name DeGolyer and MacNaughton, to references to DeGolyer and MacNaughton as an independent petroleum engineering consulting firm in ConocoPhillips’ Annual Report on Form 10-K for the year ended December 31, 2022, under the “Part II” heading “
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is provided to assist the reader in understanding the results of operations, liquidity and capital resources, and critical accounting estimates and policies through the eyes of our management team. The following discussion should be read in conjunction with the consolidated financial statements of the Company and the notes thereto included in Item 8 of this Annual Report on Form 10-K. The following discussion contains forward-looking statements. Actual results could differ materially from the results discussed in the forward-looking statements. See “Risk Factors” and “Forward-Looking Statements” above.A detailed comparison of the Company’s 2021 operating results to its 2020 operating results can be found in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in the Company’s 2021 Annual Report on Form 10-K filed February 18, 2022 at www.sec.gov.INTRODUCTIONManagement’s Discussion and Analysis of Financial Condition and Results of Operations is organized as follows:●Executive Summary – Includes an overview of the Company’s business; a description of notable recent developments, current economic, competitive and regulatory trends relevant to our business; the Company’s current business strategy; and the Company’s primary sources of operating and non-operating revenues and expenses.●Results of Operations – Includes an analysis of the Company’s 2022 and 2021 financial results and a discussion of any known events or trends which are likely to impact future results.●Liquidity and Capital Resources – Includes a discussion of the Company’s future cash requirements, capital resources, and financing arrangements.●Critical Accounting Estimates – Provides an explanation of accounting estimates which may have a significant impact on the Company’s financial results and the judgments, assumptions, and uncertainties associated with those estimates.●Recent Accounting Pronouncements – Includes an evaluation of recent accounting pronouncements and the potential impact of their future adoption on the Company’s financial results.EXECUTIVE SUMMARYOverviewCboe Global Markets, Inc., a leading provider of market infrastructure and tradable products, delivers cutting-edge trading, clearing and investment solutions to market participants around the world. The Company is committed to operating a trusted, inclusive global marketplace, and to providing leading products, technology and data solutions that enable participants to define a sustainable financial future. Cboe provides trading solutions and products in multiple asset classes, including equities, derivatives, FX, and digital assets, across North America, Europe, and Asia Pacific.Cboe’s subsidiaries include the largest options exchange and the third largest stock exchange operator in the U.S. In addition, the Company operates one of the largest stock exchanges by value traded in Europe, and owns Cboe Clear Europe (rebranded from EuroCCP in November of 2022), a leading pan-European equities and derivatives clearinghouse, BIDS Trading, a leading block-trading ATS by volume in the U.S., MATCHNow (operating as TriAct Canada Marketplace LP), a leading equities ATS in Canada, Cboe Australia, an operator of trading venues in Australia, and Cboe Japan, an operator of trading venues in Japan. Cboe also is a leading market globally for exchange-traded products (“ETPs”) listings and trading. On May 2, 2022, Cboe completed its acquisition of ErisX, subsequently rebranded to Cboe Digital, an operator of a U.S. based digital asset spot market, a regulated futures exchange, and a regulated clearinghouse. On June 1, 2022, Cboe completed its acquisition of NEO Exchange Inc. (“NEO”), which is a recognized Canadian securities exchange.The Company is headquartered in Chicago with offices in Amsterdam, Belfast, Hong Kong, Kansas City, London, Manila, New York, San Francisco, Sarasota Springs, Singapore, Sydney, Tokyo and Toronto.64 Table of ContentsRecent DevelopmentsAcquisition of Cboe DigitalOn October 20, 2021, the Company announced it entered into a definitive agreement to acquire ErisX, which was subsequently rebranded Cboe Digital. Cboe Digital operates a U.S. based digital asset spot market, a regulated futures exchange, and a regulated clearinghouse. Ownership of Cboe Digital allows the Company to enter the digital asset spot and derivatives marketplaces through a digital-first platform developed with industry partners to focus on robust regulatory compliance, data and transparency. The transaction closed on May 2, 2022.Acquisition of NEOOn November 15, 2021, the Company announced it entered into a definitive agreement to acquire NEO. NEO is a fintech organization that is comprised of a fully registered Canadian securities exchange with a diverse product and services set ranging from corporate listings to cash equities trading and a non-listed securities distribution platform. With ownership of NEO, the Company expects to further grow Canada as a hub for global equities trading and listings. The transaction closed on June 1, 2022.Business Segments The Company previously operated five reportable business segments prior to the quarter ended June 30, 2022. As a result of the Cboe Digital acquisition during the quarter ended June 30, 2022, the Company operates six reportable segments: Options, North American Equities, Europe and Asia Pacific, Futures, Global FX, and Digital, which is reflective of how the Company's chief operating decision-maker reviews and operates the business, as discussed in Note 1 (“Nature of Operations”). Segment performance is primarily evaluated based on operating income (loss). The Company’s chief operating decision-maker does not use segment-level assets or income and expenses below operating income (loss) as key performance metrics; therefore, such information is not presented below. The Company has aggregated all of its corporate costs, as well as other business ventures, within the Corporate Items and Eliminations totals based on the decision that those activities should not be used to evaluate the operating performance of the segments; however, operating expenses that relate to activities of a specific segment have been allocated to that segment.Options. The Options segment includes options on market indices (“index options”), as well as on the stocks of individual corporations (“equity options”), and options on ETPs, such as exchange-traded funds (“ETFs”) and exchange-traded notes (“ETNs”), which are “multi-listed” options and listed on a non-exclusive basis. These options are eligible to trade, as applicable, on Cboe Options, C2, BZX, EDGX, and/or other U.S. national security exchanges. Cboe Options is the Company’s primary options market and offers trading in listed options through a single system that integrates electronic trading and traditional open outcry trading on the Cboe Options trading floor in Chicago. C2 Options, BZX Options, and EDGX Options are all-electronic options exchanges, and typically operate with different market models and fee structures than Cboe Options. The Options segment also includes applicable market data fees generated from the consolidated tape plans, the licensing of proprietary options market data, index licensing, and access and capacity services. North American Equities. The North American Equities segment includes listed U.S. equities and ETP transaction services that occur on fully electronic exchanges owned and operated by BZX, BYX, EDGX, and EDGA, equities transactions that occur on the BIDS Trading platform, and Canadian equities and other transaction services that occur on or through the MATCHNow ATS, and NEO, as of the June 1, 2022 acquisition. The North American Equities segment also includes listing services on NEO Exchange, ETP listings on BZX, the Cboe Global Markets, Inc. common stock listing, applicable market data fees generated from the consolidated tape plans, the licensing of proprietary equities market data, routing services, and access and capacity services.Europe and Asia Pacific. The Europe and Asia Pacific segment includes the pan-European listed equities and derivatives transaction services, ETPs, exchange-traded commodities, and international depository receipts that are hosted on MTFs operated by Cboe Europe Equities (Cboe Europe and Cboe NL equities exchanges) and Cboe Europe Derivatives (“CEDX”). It also includes the ETP listings business on RMs and clearing activities of Cboe Clear Europe, as well as the equities transaction services of Cboe Australia and Cboe Japan, operators of trading venues in Australia and Japan, respectively. This segment was previously referred to as the European Equities segment but was updated to the Europe segment in the first quarter of 2021 as a result of the launch of Cboe Europe Derivatives, a pan-European derivatives platform in September 2021. The segment was subsequently updated to Europe and Asia Pacific to reflect the acquisition of Chi-X in July 2021. Cboe Europe operates lit and dark books, a periodic auctions book, and Cboe BIDS 65 Table of ContentsEurope, a Large-in-Scale (“LIS”) trading negotiation facility for UK symbols. Cboe NL, launched in October 2019 and based in Amsterdam, operates similar business functionality to that offered by Cboe Europe, and provides for trading only in European Economic Area (“EEA”) symbols. The new Cboe Europe Derivatives venue offers futures and options based on Cboe Europe equity indices. This segment also includes Cboe Europe, Cboe NL, CEDX, Cboe Australia, and Cboe Japan revenue generated from the licensing of proprietary market data and from access and capacity services.Futures. The Futures segment includes transaction services provided by CFE, a fully electronic futures exchange, which includes offerings for trading of VIX futures and other futures products, the licensing of proprietary market data, as well as access and capacity services.Global FX. The Global FX segment includes institutional FX trading services that occur on the Cboe FX fully electronic trading platform, non-deliverable forward FX transactions (“NDFs”) offered for execution on Cboe SEF and Cboe Swiss, transaction services that occur on the electronic trading system for U.S government securities executed by Cboe Fixed Income, as well as revenue generated from the licensing of proprietary market data and from access and capacity services. Digital. The Digital segment includes Cboe Digital, an operator of a U.S. based digital asset spot market and a regulated futures exchange, and Cboe Clear Digital, a regulated clearinghouse, as well as revenue generated from the licensing of proprietary market data and from access and capacity services.General Factors Affecting Results of Operations In broad terms, our business performance is impacted by a number of drivers, including macroeconomic events affecting the risk and return of financial assets, investor sentiment, the regulatory environment for capital markets, geopolitical events, tax policies, central bank policies and changing technology, particularly in the financial services industry. We believe our future revenues and net income will continue to be influenced by a number of domestic and international economic trends, including:​●trading volumes on our proprietary products such as VIX options and futures and SPX options;●trading volumes in listed equity securities, options, futures, and ETPs in North America, Europe, and Asia Pacific, clearing volumes in listed equity securities and ETPs in Europe, volumes in listed equity options, volumes in digital assets, and volumes in institutional FX trading; ●the demand for and pricing structure of the U.S. tape plan market data distributed by the SIPs, which determines the pool size of the industry market data fees we receive based on our market share;●consolidation and expansion of our customers and competitors in the industry; ●the demand for information about, or access to, our markets and products, which is dependent on the products we trade, our importance as a liquidity center, quality and integrity of our proprietary indices, and the quality and pricing of our data and access and capacity services; ●continuing pressure in transaction fee pricing due to intense competition in the North American, European, and Asia Pacific markets;●significant fluctuations in foreign currency translation rates or weakened value of currencies; and●regulatory changes and obligations relating to market structure, digital assets and increased capital requirements, and those which affect certain types of instruments, transactions, products, pricing structures, capital market participants or reporting or compliance requirements.A number of significant structural, political and monetary issues, global conflicts and global pandemics continue to confront the global economy, and instability could continue, resulting in an increased or subdued level of inflation, market volatility, supply chain constraints, changes in trading volumes and greater uncertainty. Inflationary increases in our expenses, such as compensation inflation, and increased costs related to CAT may have an adverse effect on our financial results.Components of RevenuesBeginning in the first quarter of 2022, the Company updated the financial statement captions within its consolidated statements of income to better reflect the Company’s diversified products, expansive geographical reach, and overall business strategy. The changes do not have a financial impact on the Company’s reported revenue, revenues less cost of revenues, reported net income, or cash flows from operations.​66 Table of ContentsThe components of revenues which include the above changes are described below:Cash and Spot MarketsRevenue aggregated into cash and spot markets includes associated transaction and clearing fees, the portion of market data fees relating to associated U.S. tape plan market data fees, associated regulatory fees, and associated other revenue from the Company’s North American Equities, Europe and Asia Pacific, Global FX, and Digital segments. Data and Access SolutionsRevenue aggregated into data and access solutions includes access and capacity fees, proprietary market data fees, and associated other revenue across the Company’s six segments. Derivatives MarketsIncludes associated transaction and clearing fees, the portion of market data fees relating to associated U.S. tape plan market data fees, associated regulatory fees, and associated other fees from the Company’s Options, Futures, Europe and Asia Pacific, and Digital segments. Components of Cost of RevenuesLiquidity PaymentsLiquidity payments are directly correlated to the volume of securities traded on our markets. As stated above, we record the liquidity rebates paid to market participants providing liquidity, in the case of C2, BZX, EDGX, and Cboe Europe Equities and Derivatives, and Cboe Digital, as cost of revenue. BYX and EDGA offer a pricing model where we rebate liquidity takers for executing against an order resting on our book, which is also recorded as a cost of revenues.Routing and ClearingVarious rules require that U.S. options and equities trade executions occur at the NBBO displayed by any exchange. Linkage order routing consists of the cost incurred to provide a service whereby Cboe equities and options exchanges deliver orders to other execution venues when there is a potential for obtaining a better execution price or when instructed to directly route an order to another venue by the order provider. The service affords exchange order flow providers an opportunity to obtain the best available execution price and may also result in cost benefits to those clients. Such an offering improves our competitive position and provides an opportunity to attract orders which would otherwise bypass our exchanges. We utilize third-party brokers or our broker-dealer, Cboe Trading, to facilitate such delivery. Also included within routing and clearing are the Order Management System and Execution Management System (“OMS” and “EMS”, respectively) fees incurred for U.S. Equities Off-Exchange order execution, as well as settlement costs incurred for the settlement process executed by Cboe Clear Europe and Cboe Clear Digital.Section 31 FeesExchanges under the authority of the SEC (Cboe Options, C2, BZX, BYX, EDGX, and EDGA as well as CFE to the extent that CFE offers trading in security futures products) are assessed fees pursuant to the Exchange Act designed to recover the costs to the U.S. government of supervision and regulation of securities markets and securities professionals. We treat these fees as a pass-through charge to customers executing eligible listed equities and listed equity options trades. Accordingly, we recognize the amount that we are charged under Section 31 as a cost of revenues and the corresponding amount that we charge our customers as regulatory transaction fees revenue. Since the regulatory transaction fees recorded in revenues are equal to the Section 31 fees recorded in cost of revenues, there is no impact on our operating income. Cboe Trading, Cboe Europe, Cboe NL, BIDS, MATCHNow, Cboe FX, Cboe Australia, Cboe Japan, Cboe Digital, and NEO are not U.S. national securities exchanges, and accordingly are not charged Section 31 fees.Royalty Fees and Other Cost of RevenuesRoyalty fees primarily consist of license fees paid by us for the use of underlying indices in our proprietary products usually based on contracts traded. The Company has licenses with the owners of the S&P 500 Index, S&P 100 Index and certain other S&P indices, FTSE Russell indices, the DJIA, MSCI, and certain other index products. This category also 67 Table of Contentsincludes fees related to the dissemination of market data related to S&P indices and other products through Cboe Streaming Market Indices (“CSMI”).Other cost of revenues primarily consists of interest expense from clearing operations, electronic access permit fees and other miscellaneous costs associated with other revenue.Components of Operating ExpensesCompensation and BenefitsCompensation and benefits represent our largest expense category and tend to be driven by our staffing requirements, financial performance, and the general dynamics of the employment market. Stock-based compensation is a non-cash expense related to equity awards. Stock-based compensation can vary depending on the quantity and fair value of the award on the date of grant and the related service period.Depreciation and AmortizationDepreciation and amortization expense results from the depreciation of long-lived assets purchased, the amortization of purchased and internally developed software, and the amortization of intangible assets.Technology Support ServicesTechnology support services consists primarily of costs related to the maintenance of computer equipment supporting our system architecture, circuits supporting our wide area network, support for production software, operating system license and support fees, fees paid to information vendors for displaying data and off-site system hosting fees.Professional Fees and Outside ServicesProfessional fees and outside services consist primarily of consulting services, which include supplemental staff activities primarily related to systems development and maintenance, legal, regulatory and audit, and tax advisory services.Travel and Promotional ExpensesTravel and promotional expenses primarily consist of advertising, costs for special events, sponsorship of industry conferences, options education seminars and travel-related expenses.Facilities CostsFacilities costs primarily consist of expenses related to owned and leased properties including rent, maintenance, utilities, real estate taxes and telecommunications costs.Acquisition-Related CostsAcquisition-related costs relate to acquisitions and other strategic opportunities. The acquisition-related costs include fees for investment banking advisors, lawyers, accountants, tax advisors, public relations firms, severance and retention costs, capitalized software and facilities, and other external costs directly related to the mergers and acquisitions.Goodwill ImpairmentGoodwill impairment consists of charges to impair goodwill of our reporting units if the carrying value exceeds the implied fair value.​68 Table of ContentsOther ExpensesOther expenses represent costs necessary to support our operations that are not already included in the above categories, including, but not limited to the impairment of digital assets held presented in intangible assets, net as part of the ordinary operations of the Digital segment and changes in contingent consideration. Non-Operating (Expenses) IncomeIncome and expenses incurred through activities outside of our core operations are considered non-operating and are classified as other (expense) income. These activities primarily include interest earned on the investing of excess cash, interest expense related to outstanding debt facilities, dividend income, income and unrealized gains and losses related to investments held in a trust for the Company’s non-qualified retirement and benefit plans, realized gains and losses related to the Company’s previously held minority investments, equity earnings or losses from our investments in other business ventures, impairment of the Company’s investments, investment establishment costs associated with new business ventures, and loan forgiveness provided under the SBA’s Paycheck Protection Program (“PPP”). See Note 12 (“Debt”) for additional information regarding the PPP.RESULTS OF OPERATIONSThe following are summaries of changes in financial performance and include certain non-GAAP financial measures. Management uses these non-GAAP measures internally in conjunction with GAAP measures to help evaluate our performance and to help make financial and operational decisions. These non-GAAP financial measures assist management in comparing our performance on a consistent basis for purposes of business decision making by removing the impact of certain items management believes do not reflect our underlying operations.We believe our presentation of these measures provides investors with greater transparency into financial measures used by management and is useful to investors for period-to-period comparisons of our ongoing operating performance. These non-GAAP financial measures are not presented in accordance with, or as an alternative to, GAAP financial measures and may be calculated differently from non-GAAP measures used by other companies, which reduces their usefulness as comparative measures. We encourage analysts, investors and other interested parties to use these non-GAAP measures as supplemental information to the GAAP financial measures included herein, including our consolidated financial statements, to enhance their analysis and understanding of our performance and in making comparisons. Please see the footnotes below for definitions, additional information, and reconciliations from the closest GAAP measure.​69 Table of ContentsComparison of Years Ended December 31, 2022 and 2021 Overview The following summarizes changes in financial performance for the year ended December 31, 2022, compared to the year ended December 31, 2022:(1)These are Non-GAAP figures for which reconciliations are provided below (in millions, except percentages, earnings per share, and as noted below).​​​​​​​​​​​​​​​Year Ended ​​ ​ ​​December 31,​Increase/​Percent ​ 2022 2021 (Decrease) Change Total revenues​$ 3,958.5​$ 3,494.8​$ 463.7​ 13%Total cost of revenues ​ 2,216.8 ​ 2,018.7 ​ 198.1 10%Revenues less cost of revenues ​ 1,741.7 ​ 1,476.1 ​ 265.6 18%Total operating expenses ​ 1,252.1 ​ 670.2 ​ 581.9 87%Operating income ​ 489.6 ​ 805.9 ​ (316.3) (39)%Income before income tax provision ​ 432.9 ​ 756.1 ​ (323.2) (43)%Income tax provision ​ 197.9 ​ 227.1 ​ (29.2) (13)%Net income​$ 235.0​$ 529.0​$ (294.0) (56)%Basic earnings per share​$ 2.20​$ 4.93​$ (2.73)​ (55)%Diluted earnings per share​​ 2.19​​ 4.92​​ (2.73)​ (55)%Organic net revenue (1)​$ 1,713.0​$ 1,476.1​$ 236.9​ 16%EBITDA (2)​$ 655.2​$ 969.2​$ (314.0) (32)%EBITDA margin (3)​ 37.6% 65.7% (28.1)% *Adjusted EBITDA (2)​$ 1,135.6​$ 987.1​$ 148.5 15%Adjusted EBITDA margin (4)​ 65.2% 66.9% (1.7)% *Adjusted earnings (5)​$ 739.8​$ 648.8​$ 91.0 14%Adjusted earnings margin (5)​​ 42.5% ​ 44.0% ​ (1.5)% ​*Diluted weighted average shares outstanding​​ 106.7​​ 107.2​​ (0.5)​ (0)%Adjusted Diluted earnings per share (6)​$ 6.93​$ 6.05​$ 0.88 15%* Not meaningful70 Table of Contents(1)Organic net revenue is defined as revenues less cost of revenues excluding revenues less cost of revenues of any acquisition that has been owned for less than one year. Revenues from acquisitions that have been owned at least one year are considered organic and are no longer excluded from organic net revenue from either period for comparative purposes. Organic net revenue does not represent, and should not be considered as, an alternative to revenues less cost of revenues, or net revenue, as determined in accordance with GAAP. We have presented organic net revenue because we consider it an important supplemental measure of our performance and we use it as the basis for monitoring our operating financial performance before the effects of acquisitions. We also believe that it is frequently used by analysts, investors and other interested parties in the evaluation of companies. We believe that investors may find this non-GAAP measure useful in evaluating our performance compared to that of peer companies in our industry. Other companies may calculate organic net revenue differently than we do. Organic net revenue has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP.​​​​​​​​Year Ended ​December 31, ​2022​2021​Revenues less cost of revenues$ 1,741.7​$ 1,476.1​Recent acquisitions:​​​​​​Acquisition revenues less cost of revenues$ (28.7)​$ —​Organic net revenue$ 1,713.0​$ 1,476.1​​(2)EBITDA is defined as income before interest, income taxes, depreciation and amortization. Adjusted EBITDA is defined as EBITDA before acquisition-related costs, impairment of investment, gain on investment, investment establishment costs, impairment of goodwill, loan forgiveness, and change in contingent consideration. EBITDA and adjusted EBITDA do not represent, and should not be considered as, alternatives to net income as determined in accordance with GAAP. We have presented EBITDA and adjusted EBITDA because we consider them important supplemental measures of our performance and believe that they are frequently used by analysts, investors and other interested parties in the evaluation of companies. In addition, we use adjusted EBITDA as a measure of operating performance for preparation of our forecasts and evaluating our leverage ratio for the debt to earnings covenant included in our outstanding credit facility. Other companies may calculate EBITDA and adjusted EBITDA differently than we do. EBITDA and adjusted EBITDA have limitations as analytical tools, and you should not consider them in isolation or as substitutes for analysis of our results as reported under GAAP. (3)EBITDA margin represents EBITDA divided by revenues less cost of revenues.(4)Adjusted EBITDA margin represents adjusted EBITDA divided by revenues less cost of revenues. (5)Adjusted earnings is defined as net income adjusted for amortization of purchased intangibles, acquisition-related costs, impairment of investment, gain on investment, investment establishment costs, impairment of goodwill, loan forgiveness, certain tax reserve changes, deferred tax re-measurements, change in contingent consideration, and net income or loss allocated to participating securities, net of the income tax effects of these adjustments. Adjusted earnings does not represent, and should not be considered as, an alternative to net income, as determined in accordance with GAAP. We have presented adjusted earnings because we consider it an important supplemental measure of our performance and we use it as the basis for monitoring our own core operating financial performance relative to other operators of exchanges. We also believe that it is frequently used by analysts, investors and other interested parties in the evaluation of companies. We believe that investors may find this non-GAAP measure useful in evaluating our performance compared to that of peer companies in our industry. Other companies may calculate adjusted earnings differently than we do. Adjusted earnings has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP.(6)Adjusted diluted earnings per share represents adjusted earnings divided by diluted weighted average shares outstanding.71 Table of ContentsThe following is a reconciliation of net income (loss) allocated to common stockholders to EBITDA and adjusted EBITDA (in millions):​​​​​​​​​​​​​​​​​​​​​​​​​​​Year Ended December 31,​​2022​ Options North American Equities Europe and Asia Pacific Futures Global FX Digital Corporate TotalNet income (loss) allocated to common stockholders​$ 478.1​$ 125.9​$ 22.8​$ 12.8​$ 9.1​$ (369.7)​$ (44.9)​$ 234.1Interest expense (income), net​ —​ (0.4)​ 8.0​ —​ (0.4)​ —​ 49.2​ 56.4Income tax provision (benefit)​ 260.7​ 20.5​ 6.8​ 42.4​ 0.1​ (119.0)​ (13.6)​ 197.9Depreciation and amortization​ 26.5​ 74.1​ 37.0​ 2.6​ 21.9​ 4.7​ —​ 166.8EBITDA​ 765.3​ 220.1​ 74.6​ 57.8​ 30.7​ (484.0)​ (9.3)​ 655.2Acquisition-related costs​ —​ 3.9​ 3.6​ —​ —​ 9.5​ 2.9​ 19.9Impairment of investment​​ —​​ —​​ —​​ —​​ —​​ —​​ 10.6​​ 10.6Loan forgiveness​​ —​​ —​​ —​​ —​​ —​​ (1.3)​​ —​​ (1.3)Gain on investment​​ —​​ —​​ —​​ —​​ —​​ —​​ (7.5)​​ (7.5)Goodwill impairment​​ —​​ —​​ —​​ —​​ —​​ 460.9​​ —​​ 460.9Investment establishment costs​​ —​​ —​​ —​​ —​​ —​​ —​​ 3.0​​ 3.0Change in contingent consideration​​ —​​ (5.2)​​ —​​ —​​ —​​ —​​ —​​ (5.2)Adjusted EBITDA​$ 765.3​$ 218.8​$ 78.2​$ 57.8​$ 30.7​$ (14.9)​$ (0.3)​$ 1,135.6​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​Year Ended December 31,​​2021​​Options North American Equities​Europe and Asia Pacific​Futures​Global FX​Digital​Corporate​TotalNet income (loss) allocated to common stockholders​$ 364.7​$ 133.5​$ 18.6​$ 34.9​$ 2.6​$ —​$ (27.0)​$ 527.3Interest expense, net​ —​ —​ 12.4​ —​ —​ —​ 35.0​ 47.4Income tax provision (benefit)​ 171.3​ 22.1​ 26.5​ 30.9​ —​ —​ (23.7)​ 227.1Depreciation and amortization​ 29.4​ 75.7​ 35.1​ 2.9​ 24.3​ —​ —​ 167.4EBITDA​ 565.4​ 231.3​ 92.6​ 68.7​ 26.9​ —​ (15.7)​ 969.2Acquisition-related costs​ 0.3​ 2.8​ 1.4​ —​ —​ —​ 11.1​ 15.6Impairment of investment​​ —​​ —​​ —​​ —​​ —​​ —​​ 5.0​​ 5.0Change in contingent consideration​​ —​​ (2.7)​​ —​​ —​​ —​​ —​​ —​​ (2.7)Adjusted EBITDA​$ 565.7​$ 231.4​$ 94.0​$ 68.7​$ 26.9​$ —​$ 0.4​$ 987.1​The following is a reconciliation of net income allocated to common stockholders to adjusted earnings (in millions): ​​​​​​​​​Year Ended December 31,​ 2022 2021Net income allocated to common stockholders​$ 234.1​$ 527.3Amortization​ 124.3​ 126.6Acquisition-related costs​ 19.9​ 15.6Impairment of investment​​ 10.6​​ 5.0Loan forgiveness​​ (1.3)​​ —Gain on investment​​ (7.5)​​ —Goodwill impairment​​ 460.9​​ —Investment establishment costs​​ 3.0​​ —Change in contingent consideration​​ (5.2)​​ (2.7)Increase (release) of tax reserves​​ 48.5​​ (5.4)Tax effect of adjustments​ (143.7)​ (31.8)Deferred tax re-measurements​​ (2.0)​​ 14.6Net income allocated to participating securities​​ (1.8)​​ (0.4)Adjusted earnings​$ 739.8​$ 648.8​​72 Table of ContentsThe following summarizes changes in certain operational and financial metrics for the year ended December 31, 2022 compared to the year ended December 31, 2021:​73 Table of ContentsThe following table includes operational and financial metrics for our Options, North American Equities, Europe and Asia Pacific, Futures, and Global FX segments. The metrics listed for Canadian Equities in the table below include NEO as a result of the acquisition completed during 2022. Therefore, the metrics shown in the table below in Canadian Equities do not include NEO for the periods preceding the acquisition. The following summarizes changes in certain operational and financial metrics for the year ended December 31, 2022 compared to the year ended December 31, 2021: ​​​​​​​​​​​​​​​​Year Ended ​​ ​​​​December 31,​Increase/​Percent​​ 2022 2021 (Decrease) Change​​​(in millions, except percentages, trading days, and as noted below)​Options:​ ​Average daily volume (ADV) (in millions of contracts):​ ​ ​ ​Market ADV​ 41.1​​ 39.2​​ 1.9 5%Total touched contracts (1)​ 13.6​​ 12.1​​ 1.5 13%Multi-listed contract ADV​​ 10.8​​ 10.1​​ 0.7​ 7%Index contract ADV​ 2.8​​ 2.0​​ 0.8 44%Number of trading days​​ 251​​ 252​​ (1) (0)%Total Options revenue per contract (RPC) (2)​$ 0.234​$ 0.192​$ 0.042 22%Multi-listed options RPC (2)​​ 0.063​​ 0.067​​ (0.004) (6)%Index options RPC (2)​​ 0.879​​ 0.832​​ 0.047 6%Total Options market share​​ 33.2%​ 30.8%​ 2.4%​*Multi-listed options market share​​ 28.2%​ 27.1%​ 1.1%​*North American Equities:​ ​ ​​ ​ ​U.S. Equities:​​​​​​​​​​​​U.S. Equities - Exchange:​​​​​​​​​​​​ADV:​ ​ ​​ ​ ​Total touched shares (in billions) (1)​ 1.7​ 1.7​ — (1)%Market ADV (in billions)​ 11.9​ 11.4​ 0.5 4%Market share​​ 13.6%​ 14.2%​ (0.6)% ​*U.S. Equities - Exchange (net capture per one hundred touched shares) (3)​$ 0.021​$ 0.020​$ 0.001 7%U.S. ETPs: launches (number of launches)​ 80​​ 117​ (37) (32)%U.S. ETPs: listings (number of listings) ​ 592​​ 539​ 53 10%U.S. Equities - Off-Exchange:​​​​​​​​​​​​ADV:​ ​ ​​ ​ ​Total touched shares (in millions) (1)​ 90.4​ 83.0​ 7.4 9%U.S. Equities - Off-Exchange (net capture per one hundred touched shares) (4)​$ 0.113​$ 0.120​$ (0.007) (6)%Trading days​​ 251​​ 252​​ (1)​ (0)%Canadian Equities:​​​​​​​​​​​​ADV (matched shares, in millions) (5)​​ 91.8​​ 49.4​​ 42.4​ 86%Trading days​​ 250​​ 251​​ (1)​ (0)%Net capture (per 10,000 touched shares, in Canadian dollars) (6)​​ 4.966​​ 7.822​​ (2.856)​ (37)%Europe and Asia Pacific:​ ​ ​ ​ ​European Equities:​​​​​​​​​​​​ADNV:​ ​​ ​​ ​ ​Matched ADNV (in billions) (7)​€ 10.8​€ 7.7​€ 3.1​ 41%Market ADNV (in billions)​​ 46.2​​ 42.6​​ 3.6​ 8%Trading days​ 257​ 258​​ (1)​ (0)%Market share​​ 23.5%​ 18.1%​ 5.4% ​*Net capture (per matched notional value in basis points) (8)​​ 0.231​​ 0.267​​ (0.036)​ (14)%Cboe Clear Europe:​​​​​​​​​​​​Trades cleared (9)​​ 1,493.3​​ 1,244.2​​ 249.1​ 20%Fee per trade cleared (10)​€ 0.009​€ 0.011​€ (0.002)​ (17)%European equities market share cleared (11)​​ 32.7%​ 29.6%​ 3.1​​*Net settlement volume (12)​​ 10.3​​ 9.9​​ 0.4​ 4%Net fee per settlement (13)​€ 0.881​€ 0.871​€ 0.010​ 1%Australian Equities:​​​​​​​​​​​​ADNV (AUD billions)​$ 0.8​$ 0.8​$ —​ 2%Trading days​​ 253​​ 130​​ 123​ 95%Market share - Continuous​​ 16.6%​ 15.9%​ 0.7%​*Net capture (per matched notional value in basis points) (14)​​ 0.164​​ 0.172​​ (0.008)​ (5)%Japanese Equities:​​​​​​​​​​​​ADNV (JPY billions)​¥ 142.9​¥ 100.1​¥ 42.8​ 43%Trading days​​ 244​​ 123​​ 121​ 98%Market share - Lit Continuous​​ 3.6%​ 2.7%​ 0.9% ​*Net capture (per matched notional value in basis points) (15)​​ 0.252​​ 0.361​​ (0.109)​ (30)%Futures:​​​​​​​​​​​​ADV (in thousands)​​ 218.2​​ 230.4​​ (12.2)​ (5)%Trading days​​ 251​​ 252​​ (1)​ (0)%Revenue per contract​$ 1.674​$ 1.641​$ 0.033​ 2%Global FX:​ ​​ ​​ ​ ​ADNV (in billions)​$ 40.9​$ 33.9​$ 7.0​ 21%Market share​​ 17.6%​ 16.6%​ 1.0​​*Trading days​ 260​ 260​​ —​ —%Net capture (per one million dollars traded) (16)​​ 2.69​​ 2.73​​ (0.04)​ (1)%​​​​​​​​​​​​​Average British pound/U.S. dollar exchange rate​$ 1.237​$ 1.375​$ (0.138)​ (10)%Average Canadian dollar/U.S. dollar exchange rate​$ 0.769​$ 0.798​$ (0.029)​ (4)%Average Euro/U.S. dollar exchange rate​$ 1.054​$ 1.183​$ (0.129)​ (11)%Average Euro/British pound exchange rate​£ 0.852​£ 0.860​£ (0.008)​ (1)%Average Australian dollar/U.S. dollar exchange rate​$ 0.694​$ 0.726​$ (0.032)​ (4)%Average Japanese Yen/U.S. dollar exchange rate​$ 0.008​$ 0.009​$ (0.001)​ (14)%* Not meaningfulNote, the percent change listed represents the change in the unrounded metrics figures.74 Table of Contents(1) Touched volume represents the total number of shares of equity securities and ETFs internally matched on our exchanges or routed to and executed on an external market center.(2) Average revenue per contract, for options and futures represents total net transaction fees recognized for the period divided by total contracts traded during the period.(3) Net capture per one hundred touched shares refers to transaction fees less liquidity payments and routing and clearing costs divided by the product of one-hundredth ADV of touched shares on BZX, BYX, EDGX, and EDGA and the number of trading days.(4) Net capture per 100 touched shares refers to transaction fees less order and execution management system (OMS/EMS) fees and clearing costs divided by the product of one-hundredth ADV of touched shares on BIDS Trading and the number of trading days for the period.(5) Matched volume represents the total number of shares of equity securities and ETFs activity executed on our exchanges. (6) Net capture per 10,000 touched shares refers to transaction fees divided by the product of one-ten thousandth ADV of shares for NEO and MATCHNow and the number of trading days. (7) Matched ADNV represents the average daily notional value of shares or contracts executed on our exchanges.(8) Net capture per matched notional value refers to transaction fees less liquidity payments in British pounds divided by the product of ADNV in British pounds of shares matched on Cboe Europe Equities and the number of trading days.(9) Trades cleared refers to the total number of non-interoperable trades cleared.(10) Fee per trade cleared refers to clearing fees divided by number of non-interoperable trades cleared.(11) European Equities market share cleared represents Cboe Clear Europe’s client volume cleared divided by the total volume of the publicly reported European venues.(12) Net settlement volume refers to the total number of settlements executed after netting.(13) Net fee per settlement refers to settlement fees less direct costs incurred to settle divided by the number of settlements executed after netting.(14) Net capture per matched notional value refers to transaction fees less liquidity payments in Australian dollars divided by the product of ADNV in Australian dollars of shares matched on Cboe Australia and the number of Australian Equities trading days.(15) Net capture per matched notional value refers to transaction fees less liquidity payments in Japanese Yen divided by the product of ADNV in Japanese Yen of shares matched on Cboe Japan and the number of Japanese Equities trading days.(16) Net capture per one million dollars traded refers to net transaction fees less liquidity payments, if any, divided by the Spot and SEF products of one-thousandth of ADNV traded on the Cboe FX Markets and the number of trading days, divided by two, which represents the buyer and seller that are both charged on the transaction.75 Table of ContentsRevenueTotal revenues for the year ended December 31, 2022 increased $463.7 million, or 13%, compared to the prior period primarily due to higher revenue across all revenue captions as a result of increased volumes traded on the Options and European Equities exchanges, an increase in the Section 31 fee rate following a rate increase that was effective on May 14, 2022, an increase in data and access solutions revenue primarily related to an increase in access and capacity fees in the Options and North American Equities segments, and additional revenues attributable to acquisitions made in 2022 and the later half of 2021. The following summarizes changes in revenues for the year ended December 31, 2022 compared to the year ended December 31, 2021 (in millions, except percentages): ​​​​​​​​​​​​​​​Year Ended​​​​​ ​​December 31,​Increase/​Percent ​ 2022 2021 (Decrease) Change Cash and spot markets​$ 1,777.6​$ 1,660.5​$ 117.1​ 7%Data and access solutions​ 497.0​ 427.7​ 69.3​ 16%Derivatives markets​​ 1,683.9​​ 1,406.6​​ 277.3​ 20%Total revenues​$ 3,958.5​$ 3,494.8​$ 463.7​ 13% ​Cash and Spot MarketsCash and spot markets revenue increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to increases in regulatory fees and transaction and clearing fees, partially offset by a decrease in industry market data fees. Regulatory fees increased primarily due to an 109% increase in the Section 31 fee rate, from an average rate of $7.80 per million dollars of covered sales for the year ended December 31, 2021 to an average rate of $16.30 per million dollars of covered sales for the year ended December 31, 2022. Transaction and clearing fees increased primarily due to a 41% increase in European Equities matched ADNV, additional transaction and clearing fees attributable to NEO, which was acquired in second quarter of 2022, and a 21% increase in Global FX ADNV, partially offset by a 1% decrease in total touched shares on the U.S. Equities exchanges, a 17% decrease in the fee per trade cleared by Cboe Clear Europe, and adverse changes in foreign currency rates, most notably Euro and British Pounds, for the year ended December 31, 2022 compared to the prior period. Industry market data fees decreased primarily due to a decrease in U.S. tape plan revenue as a result of a 1% decline in market share on the U.S. Equities exchanges. ​Data and Access SolutionsData and access solutions revenue increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to increases in access and capacity fees and proprietary market data fees. Access and capacity fees increased primarily due to increased logical and physical port fees in the Options and North American Equities segments driven by an increase in subscribers, coupled with an increase in access and membership fees across the Europe and Asia Pacific and Options segments driven by an increase in subscribers. Proprietary market data fees increased primarily due to proprietary market data attributable to Cboe Asia Pacific, which was acquired in the third quarter of 2021, and NEO.​Derivatives Markets Derivatives markets revenue increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to increases in transaction and clearing fees and regulatory fees. Transaction and clearing fees increased primarily due to a 44% increase in index options ADV and a 7% increase in multi-listed options ADV, partially offset by a 5% decrease in Futures ADV. Regulatory fees increased primarily due to a 109% increase in the Section 31 fee rate, from an average rate of $7.80 per million dollars of covered sales for the year ended December 31, 2021 to an average rate of $16.30 per million dollars of covered sales for the year ended December 31, 2022.​76 Table of ContentsCost of Revenues The following tables reconcile the cost of revenues captions presented on the consolidated statements of income to the updated net revenue captions discussed in Note 1 (“Nature of Operations”) for the year ended December 31, 2022 and 2021, respectively (in millions):​​​​​​​​​​​​​​​​Year Ended December 31,​​​2022​​Cash andSpot Markets​Data andAccess Solutions​DerivativesMarkets​TotalLiquidity payments​$ 1,024.0​$ —​$ 646.2​$ 1,670.2Routing and clearing fees​​ 56.0​​ —​​ 27.2​​ 83.2Section 31 fees​​ 276.8​​ —​​ 53.0​​ 329.8Royalty fees and other cost of revenues​​ 14.1​​ 9.2​​ 110.3​​ 133.6Total cost of revenues​$ 1,370.9​$ 9.2​$ 836.7​$ 2,216.8​​​​​​​​​​​​​​​​Year Ended December 31,​​​2021​​Cash andSpot Markets​Data andAccess Solutions​DerivativesMarkets​TotalLiquidity payments​$ 1,025.4​$ —​$ 625.3​$ 1,650.7Routing and clearing fees​​ 65.2​​ —​​ 22.6​​ 87.8Section 31 fees​​ 159.7​​ —​​ 19.9​​ 179.6Royalty fees and other cost of revenues​​ 14.3​​ 8.4​​ 77.9​​ 100.6Total cost of revenues​$ 1,264.6​$ 8.4​$ 745.7​$ 2,018.7​Cost of revenues increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to increased cash and spot markets and derivatives markets costs of revenues driven by an increase in Section 31 fees as a result of an increase in the Section 31 fee rate, coupled with an increase in royalty fees and an increase in liquidity payments driven by an increase in volumes traded on the Options and European Equities exchanges. ​The following summarizes changes in the disaggregated cost of revenues for the year ended December 31, 2022 compared to the year ended December 31, 2021 (in millions, except percentages):​​​​​​​​​​​​​​​​Year Ended​​​​​ ​​December 31,​Increase/​Percent ​ 2022 2021 (Decrease) Change Liquidity payments​$ 1,670.2​$ 1,650.7​$ 19.5​ 1% Routing and clearing​ 83.2​ 87.8​ (4.6)​ (5)%Section 31 fees​​ 329.8​​ 179.6​​ 150.2​ 84%Royalty fees and other cost of revenues​​ 133.6​​ 100.6​​ 33.0​ 33%Total​$ 2,216.8​$ 2,018.7​$ 198.1​ 10% ​Liquidity PaymentsLiquidity payments increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to an increase in volumes traded on the Options and European Equities exchanges, partially offset by a decrease in volumes traded on the U.S Equities exchanges.Routing and ClearingRouting and clearing fees decreased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to a decrease in routed shares on the U.S. Equities exchanges and adverse changes in foreign currency rates, most notably Euro and British Pounds, for the year ended December 31, 2022 compared to the prior period, partially offset by an increase in routed trades on the Options exchanges. ​77 Table of ContentsSection 31 FeesSection 31 fees increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to a 109% increase in the Section 31 fee rate, from an average rate of $7.80 per million dollars of covered sales in 2021 to an average rate of $16.30 per million dollars of covered sales in 2022.Royalty Fees and Other Cost of RevenuesRoyalty fees increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to an increase in trading volumes of licensed products in the Options segment.Revenues Less Cost of Revenues Revenues less cost of revenues increased $265.6 million, or 18%, for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to an increase in derivatives markets revenue less cost of revenues attributable to an increase in volumes traded on the Options exchanges, an increase in access and capacity fees in the Options and North American Equities segments, and additional revenues less cost of revenues attributable to acquisitions made in 2022 and the latter half of 2021.The following summarizes the components of revenues less cost of revenues for the year ended December 31, 2022, presented as a percentage of revenues less cost of revenues and compared to the year ended December 31, 2021 (in millions, except percentages):​​​​​​​​​​​​​​​​​​​​​​​​Percentage of ​​​​​​​​​​Revenues Less ​​​​​​​​​​Cost of ​​​​​​​​​​Revenues ​​Year Ended​​​Year Ended ​​December 31, ​Percent​December 31, ​ 2022 2021 Change 2022 2021​Cash and spot markets​$ 406.7​$ 395.9​ 3% 23% 27% Data and access solutions​ 487.8​ 419.3​ 16% 28% 28%Derivatives markets​​ 847.2​​ 660.9​ 28% 49% 45% Revenues less cost of revenues​$ 1,741.7​$ 1,476.1​ 18% 100% 100% ​Cash and Spot Markets Cash and spot markets revenues less cost of revenues increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to increases in transaction and clearing fees less liquidity payments and routing and clearing costs (“net transaction and clearing fees”) in the Global FX and Europe and Asia Pacific segments, partially offset by a decrease in industry market data fees. Net transaction and clearing fees increased primarily due to a 21% increase in Global FX ADNV, 41% increase in European Equities matched ADNV, and net transaction and clearing fees attributable to Cboe Asia Pacific and NEO, partially offset by a 1% decrease in total touched shares on the U.S. Equities exchanges and adverse changes in foreign currency rates, most notably Euro and British Pounds, for the year ended December 31, 2022 compared to the prior period. Industry market data fees decreased primarily due to a decrease in U.S. tape plan revenue driven by a 1% decline in market share on the U.S. Equities exchanges.Data and Access SolutionsData and access solutions revenues less cost of revenues increased for the year ended December 31, 2022 compared the year ended December 31, 2021, primarily due to increases in access and capacity fees and proprietary market data fees. Access and capacity fees increased primarily due to increased logical and physical port fees in the Options and North American Equities segments driven by an increase in subscribers, coupled with an increase in access and membership fees across the Europe and Asia Pacific and Options segments, also driven by an increase in subscribers. Proprietary market data fees increased primarily due to proprietary market data attributable to Cboe Asia Pacific and NEO.​78 Table of ContentsDerivatives Markets Derivatives markets revenues less cost of revenues increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to increases in transaction and clearing fees primarily due to a 44% increase in index options ADV, partially offset by a 5% decrease in Futures ADV and an increase in royalty fees due to an increase in trading volumes of licensed products in the Options segment.Operating Expenses For the year ended December 31, 2022 compared to the year ended December 31, 2021, total operating expenses increased primarily due to goodwill impairment recorded in 2022 and an increase in compensation and benefits compared to the prior period. The following summarizes changes in operating expenses for the year ended December 31, 2022 compared to the year ended December 31, 2021 (in millions, except percentages): ​​​​​​​​​​​​​​​Year Ended​​​​​ ​​December 31,​Increase/​Percent ​ 2022 2021 (Decrease) Change Compensation and benefits​$ 363.0​$ 288.5​$ 74.5​ 26%Depreciation and amortization​ 166.8​ 167.4​ (0.6)​ (0)%Technology support services​ 77.7​ 66.7​ 11.0​ 16%Professional fees and outside services​ 89.0​ 83.7​ 5.3​ 6%Travel and promotional expenses​ 23.7​ 9.7​ 14.0​ 144%Facilities costs​ 25.1​ 22.2​ 2.9​ 13%Acquisition-related costs​ 19.9​ 15.6​ 4.3​ 28%Goodwill impairment​​ 460.9​​ —​​ 460.9​*%Other expenses​ 26.0​ 16.4​ 9.6​ 59% Total operating expenses​$ 1,252.1​$ 670.2​$ 581.9​ 87% * Not meaningfulCompensation and BenefitsCompensation and benefits increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to a $66.1 million increase in salaries, wages, and bonuses, driven by a $24.3 million increase in salaries and wages as a result of merit, cost-of-labor increases, and increased headcount excluding acquisitions, as well as a $23.0 million increase in bonuses from strong Company performance year to date, resulting in higher short-term incentive bonus expense, coupled with an $18.8 million increase related to the acquisitions of Cboe Digital, Cboe Asia Pacific, and NEO. Depreciation and AmortizationDepreciation and amortization was relatively flat for the year ended December 31, 2022 compared to the year ended December 31, 2021, due to an increase in depreciation expense related to the acquisitions of Cboe Asia Pacific, Cboe Digital, and NEO, as well as an increase in depreciation expense related to the former headquarters location, which was not subject to depreciation during four months in 2021, as it was classified as held for sale from May 1, 2019 until May 1, 2021, offset by a decline in amortization under the discounted cash flow method for the intangibles acquired in the Bats acquisition.Technology Support ServicesTechnology support services costs increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to increases in technology support services, including software maintenance support service fees, software licenses and subscriptions, cloud services, and hardware maintenance, partially offset by a decrease in purchased hardware and equipment and purchased software.Professional Fees and Outside ServicesProfessional and outside services fees increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to increases in regulatory costs driven by an increase in CAT expense, as well as 79 Table of Contentsincreases in consulting fees, recruiting fees, contract services, and external audit fees, partially offset by a decrease in legal fees. Travel and Promotional ExpensesTravel and promotional expenses increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to an increase in marketing expenses driven by product promotions and an increase in travel expenses due to changes in travel guidelines following the COVID-19 pandemic.Facilities CostsFacilities costs increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to an increase in rent expense related to the new Amsterdam lease that commenced in February 2022 and additional office space in London that commenced in March 2022, along with additional office locations following acquisitions in 2021 and 2022.Acquisition-Related CostsAcquisition-related costs increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due an increase in general and administrative costs associated with the acquisitions of Cboe Digital and NEO. Goodwill ImpairmentGoodwill impairment increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, due to impairment recognized in the Digital segment in the second quarter of 2022. Other ExpensesOther expenses increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to increased charitable contributions, an increase in VAT taxes, and expenses associated with hosting the Cboe Risk Management Conference. Operating Income As a result of the items above, operating income for the year ended December 31, 2022 was $489.6 million, compared to operating income of $805.9 million for the year ended December 31, 2021, a decrease of $316.3 million.Interest Expense, Net Net interest expense increased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to additional interest expense incurred in connection with the 3.000% Senior Notes issued at the end of the first quarter of 2022, coupled with additional interest expense incurred in connection with the additional borrowings on the Term Loan in the second quarter of 2022, as well as an increase in the SOFR rate, partially offset by principal repayments on the Term Loan and a decrease in interest expense related to the Cboe Clear Europe Credit Facility, which was amended and restated in June 2022. Other (Expense) Income, NetNet other expense decreased for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily due to a $7.5 million gain on the Company’s previous minority ownership of ErisX, which increased in fair value as a result of the Company’s acquisition of Cboe Digital, recorded in the second quarter of 2022, coupled with a $5.0 million impairment adjustment recorded in 2021 related to the Company’s previously held investment in Curve Global, which did not recur in 2022, and a $4.2 million unrealized gain on the Company’s investment in 7Ridge Fund (which owns Trading Technologies) as part of a semi-annual valuation update recorded in 2022, partially offset by a $10.6 million impairment adjustment on the Company’s investment in American Financial Exchange, LLC recorded in 2022.80 Table of ContentsIncome Before Income Tax Provision As a result of the above, income before income tax provision for the year ended December 31, 2022 was $432.9 million compared to income before income tax provision of $756.1 million for the year ended December 31, 2021, a decrease of $323.2 million.Income Tax Provision For the year ended December 31, 2022, the income tax provision was $197.9 million compared to $227.1 million for the year ended December 31, 2021, a decrease of $29.2 million, primarily due to a decrease in income before income tax provision, partially offset by a higher effective tax rate for the year ended December 31, 2022. The effective tax rate for the year ended December 31, 2022 was 45.7%, compared to a rate of 30.0% for the year ended December 31, 2021. The higher effective tax rate in the year ended December 31, 2022 compared to the year ended December 31, 2021, is primarily due to the derecognition of the Company’s Section 199 tax benefits for the tax years 2008 through 2016 upon the unfavorable decision by the United States Tax Court in the matter of Bats Global Markets Holdings, Inc. and Subsidiaries v. Commissioner of Internal Revenue, on March 31, 2022. The following table summarizes the non-GAAP calculation of the effective tax rate for the year ended December 31, 2022:​​​​​​Year Ended​​​December 31, 2022​GAAP effective tax rate​ 45.7%Tax effect of goodwill impairment​ (8.5)%Tax effect of Section 199 related matters​ (5.5)%Effective tax rate excluding goodwill impairment and Section 199 matters​ 31.7%​Net Income As a result of the items above, net income for the year ended December 31, 2022 was $235.0 million, or 14% of revenues less cost of revenues, compared to $529.0 million, or 36% of revenues less cost of revenues, for the year ended December 31, 2021, a decrease of $294.0 million, or 56%. Segment Operating Results We report results from our six segments: Options, North American Equities, Europe and Asia Pacific, Futures, Global FX, and Digital. Segment performance is primarily based on operating income (loss). We have aggregated all corporate costs, as well as other business ventures, within Corporate Items and Eliminations as those activities should not be used to evaluate a segment’s operating performance. All operating expenses that relate to activities of a specific segment have been allocated to that segment. ​81 Table of ContentsThe following summarizes our total revenues by segment (in millions, except percentages): ​​​​​​​​​​​​​​​​​​​​​​​​​​Percentage of ​​​​​​​​​​Total ​​​​​​​​​​Revenues ​​Year Ended​​​Year Ended ​​December 31,​Percent​December 31, ​ 2022 2021 Change 2022 2021 Options​$ 1,823.2​$ 1,505.0​ 21% 46% 43% North American Equities​ 1,681.7​ 1,570.5​ 7% 42% 45%Europe and Asia Pacific​ 264.6​ 240.3​ 10% 7% 7%Futures​ 119.8​ 120.6​ (1)% 3% 3%Global FX​​ 68.9​​ 58.1​ 19% 2% 2%Digital​​ 0.3​​ —​*​ —% —%Corporate​​ —​​ 0.3​ (100)% —% —%Total revenues​$ 3,958.5​$ 3,494.8​ 13% 100% 100%* Not meaningful82 Table of ContentsThe following summarizes our revenues less cost of revenues by segment (in millions, except percentages): ​​​​​​​​​​​​​​​​​​​​​​​​​​Percentage of ​​​​​​​​​​Total Revenues ​​​​​​​​​​less Cost of Revenues ​​Year Ended​​​Year Ended ​​December 31,​Percent​December 31, ​ 2022 2021 Change 2022 2021 Options​$ 983.2​$ 755.0​ 30% 56% 51% North American Equities​ 378.9​ 362.5​ 5% 22% 25%Europe and Asia Pacific​ 196.1​ 183.9​ 7% 11% 12%Futures​ 116.0​ 116.8​ (1)% 7% 8%Global FX​​ 67.9​​ 57.6​ 18% 4% 4%Digital​​ (0.4)​​ —​*​ —% —%Corporate​​ —​​ 0.3​ (100)% —% —%Total revenues less cost of revenues​$ 1,741.7​$ 1,476.1​ 18% 100% 100%* Not meaningful83 Table of ContentsOptionsThe following summarizes revenues less cost of revenues, operating expenses, operating income, EBITDA and EBITDA margin for our Options segment (in millions, except percentages): ​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​Percentage ​​​​​​​​​​​​​of Total ​​​​​​​​​​​​​Revenues ​​Year Ended​​​​​Year Ended ​​December 31,​​Percent​​December 31, ​ 2022 2021 Change 2022 2021 Revenues less cost of revenues​$ 983.2​​$ 755.0 ​ 30%​ 54%​ 50%Operating expenses​ 242.7​​ 217.0 ​ 12%​ 13%​ 14% Operating income​$ 740.5​​$ 538.0 ​ 38%​ 41%​ 36% EBITDA (1)​$ 765.3​​$ 565.4 ​ 35%​ 42%​ 38%EBITDA margin (2)​ 77.8% ​ 74.9% ​*​​*​​*​* Not meaningful(1)See footnote (2) to the table under “Overview” above for a reconciliation of net income to EBITDA, and management’s reasons for using such non-GAAP measures.(2)EBITDA margin represents EBITDA divided by revenues less cost of revenues.Revenues less cost of revenues increased $228.2 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to a 44% increase in index options ADV, coupled with an 6% increase in index options net capture and an increase in logical port fees, partially offset by an increase in royalty fees driven by an increase in trading volumes of licensed products. For the year ended December 31, 2022, operating income for the Options segment increased $202.5 million compared to the year ended December 31, 2021 primarily due to an increase in revenues less cost of revenues, partially offset by an increase in operating expenses. Operating expenses increased $25.7 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to increases in compensation and benefits and travel and promotional expenses, partially offset by a decrease in depreciation and amortization. North American Equities The following summarizes revenues less cost of revenues, operating expenses, operating income, EBITDA and EBITDA margin for our North American Equities segment (in millions, except percentages): ​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​Percentage ​​​​​​​​​​​​​of Total ​​​​​​​​​​​​​Revenues ​​Year Ended​​​​​Year Ended ​​December 31,​​Percent​​December 31, ​ 2022 2021 Change 2022 2021 Revenues less cost of revenues​$ 378.9​​$ 362.5 ​ 5%​ 23%​ 23%Operating expenses​ 232.3​​ 206.4 ​ 13%​ 14%​ 13% Operating income​$ 146.6​​$ 156.1 ​ (6)%​ 9%​ 10% EBITDA (1)​$ 220.1​​$ 231.3 ​ (5)%​ 13%​ 15%EBITDA margin (2)​ 58.1% ​ 63.8% ​*​​*​​*​* Not meaningful(1)See footnote (2) to the table under “Overview” above for a reconciliation of net income to EBITDA, and management’s reasons for using such non-GAAP measures.(2)EBITDA margin represents EBITDA divided by revenues less cost of revenues.Revenues less cost of revenues increased $16.4 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to additional revenue attributable to NEO, coupled with an increase in access and capacity fees driven by an increase in physical and logical port fees and a 7% increase in U.S. Equities net capture, partially offset by a 1% decrease in total touched shares on U.S. Equities exchanges and a decrease in industry market data fees as a result of a decrease in U.S. tape plan revenue due to a 1% decline in market share on the U.S. Equities exchanges. For the year ended December 31, 2022, operating income for the North American Equities segment 84 Table of Contentsdecreased $9.5 million compared to the year ended December 31, 2021 primarily due to an increase in operating expenses, partially offset by an increase in revenues less cost of revenues. Operating expenses increased $25.9 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to increases in compensation and benefits, travel and promotional expenses, professional fees and outside services, and technology support services, partially offset by a decrease in depreciation and amortization.Europe and Asia PacificThe following summarizes revenues less cost of revenues, operating expenses, operating income, EBITDA and EBITDA margin for our Europe and Asia Pacific segment (in millions, except percentages): ​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​Percentage ​​​​​​​​​​​​​of Total ​​​​​​​​​​​​​Revenues ​​Year Ended​​​​​Year Ended ​​December 31,​​Percent​​December 31, ​ 2022 2021 Change 2022 2021 Revenues less cost of revenues​$ 196.1​​$ 183.9 ​ 7%​ 74%​ 77%Operating expenses​ 158.0​​ 127.9 ​ 24%​ 60%​ 53% Operating income​$ 38.1​​$ 56.0 ​ (32)%​ 14%​ 23% EBITDA (1)​$ 74.6​​$ 92.6 ​ (19)%​ 28%​ 39%EBITDA margin (2)​ 38.0% ​ 50.4% ​*​​*​​*​* Not meaningful (1)See footnote (2) to the table under “Overview” above for a reconciliation of net income to EBITDA, and management’s reasons for using such non-GAAP measures.(2)EBITDA margin represents EBITDA divided by revenues less cost of revenues.Revenues less cost of revenues increased $12.2 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to additional revenue attributed to Cboe Asia Pacific, coupled with an increase in transaction and clearing fees as a result of a 41% increase in European Equities matched ADNV, driven by a 5% increase in European Equities market share, partially offset by a 17% decrease in the fee per trade cleared by Cboe Clear Europe. For the year ended December 31, 2022, operating income for the Europe and Asia Pacific segment decreased $17.9 million compared to the year ended December 31, 2021 primarily due to an increase in operating expenses, partially offset by an increase revenues less cost of revenues. Operating expenses increased $30.1 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to increases in compensation and benefits, other expenses, technology support services, facilities costs, depreciation and amortization, and travel and promotional expenses. Operating income was adversely impacted for the year ended December 31, 2022 compared to the prior period by changes in foreign currency rates, most notably Euros and British Pounds. ​85 Table of ContentsFuturesThe following summarizes revenues less cost of revenues, operating expenses, operating income, EBITDA, and EBITDA margin for our Futures segment (in millions, except percentages):​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​Percentage ​​​​​​​​​​​​​of Total ​​​​​​​​​​​​​Revenues ​​Year Ended​​​​​Year Ended ​​December 31,​​Percent​​December 31, ​ 2022 2021 Change 2022 2021 Revenues less cost of revenues​$ 116.0​​$ 116.8 ​ (1)%​ 97%​ 97%Operating expenses​ 60.8​​ 50.8 ​ 20%​ 51%​ 42% Operating income​$ 55.2​​$ 66.0 ​ (16)%​ 46%​ 55% EBITDA (1)​$ 57.8​​$ 68.7 ​ (16)%​ 48%​ 57%EBITDA margin (2)​ 49.8% ​ 58.8%​*​​*​​*​* Not meaningful(1)See footnote (2) to the table under “Overview” above for a reconciliation of net income to EBITDA, and management’s reasons for using such non-GAAP measures.(2)EBITDA margin represents EBITDA divided by revenues less cost of revenues.Revenues less cost of revenues decreased $0.8 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due a decline in transaction and clearing fees as a result of a 5% decrease in ADV, coupled with a decrease in membership fees and logical port fees, partially offset by an increase in physical port fees, an increase in proprietary market data revenue, and a 2% increase in net capture. For the year ended December 31, 2022, operating income for the Futures segment decreased $10.8 million compared to the year ended December 31, 2021 primarily due to an increase in operating expenses. Operating expenses increased $10.0 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to increases in compensation and benefits, travel and promotional expenses, and other expenses, partially offset by a decrease in professional fees and outside services.Global FX The following summarizes revenues less cost of revenues, operating expenses, operating income, EBITDA and EBITDA margin for our Global FX segment (in millions, except percentages): ​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​Percentage ​​​​​​​​​​​​​of Total ​​​​​​​​​​​​​Revenues ​​Year Ended​​​​​Year Ended ​​December 31,​​Percent​​December 31, ​ 2022 2021 Change 2022 2021 Revenues less cost of revenues​$ 67.9​​$ 57.6 ​ 18%​ 99%​ 99%Operating expenses​ 59.1​​ 54.9 ​ 8%​ 86%​ 94% Operating income​$ 8.8​​$ 2.7 ​ 226%​ 13%​ 5% EBITDA (1)​$ 30.7​​$ 26.9 ​ 14%​ 45%​ 46%EBITDA margin (2)​ 45.2% ​ 46.7% ​*​​*​​*​* Not meaningful(1)See footnote (2) to the table under “Overview” above for a reconciliation of net income to EBITDA, and management’s reasons for using such non-GAAP measures.(2)EBITDA margin represents EBITDA divided by revenues less cost of revenues.Revenues less cost of revenues increased $10.3 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 primarily due to a 21% increase in ADNV, partially offset by a 1% decrease in net capture. For the year ended December 31, 2022, operating income for the Global FX segment increased $6.1 million compared to the year ended December 31, 2021 primarily due to an increase in revenues less cost of revenues, partially offset by an increase in operating expenses. Operating expenses increased $4.2 million for the year ended December 31, 2022 86 Table of Contentscompared to the year ended December 31, 2021 primarily due to increases in compensation and benefits, facilities costs, technology support services, and professional fees and outside services, partially offset by a decrease in depreciation and amortization.DigitalThe following summarizes revenues less cost of revenues, operating expenses, operating loss, EBITDA, and EBITDA margin for our Digital segment (in millions, except percentages):​​​​​​​​​​​​​​Percentage​​​​​​​of Total​​​​​​​Revenues ​​​Year Ended​​Year Ended​​​December 31,​​December 31,​​ 2022 2022 Revenues less cost of revenues​$ (0.4)​​*%Operating expenses​ 491.0​​*%Operating income (loss)​$ (491.4)​​*%EBITDA (1)​$ (484.0)​​*%EBITDA margin (2)​ *% ​*​* Not meaningful(1)See footnote (2) to the table under “Overview” above for a reconciliation of net income to EBITDA, and management’s reasons for using such non-GAAP measures.(2)EBITDA margin represents EBITDA divided by revenues less cost of revenues. ​The Digital segment was established in the second quarter of 2022 following the acquisition of ErisX, which was subsequently rebranded to Cboe Digital. Cost of revenues exceeded revenues for the year ended December 31, 2022 primarily due to liquidity payments on spot and futures transactions, partially offset by transaction and clearing fees attributable to spot transactions. For the year ended December 31, 2022, the Digital segment had an operating loss of $491.4 million, primarily due to $460.9 million impairment of goodwill.87 Table of ContentsLIQUIDITY AND CAPITAL RESOURCES Below are charts that reflect elements of our capital allocation:​We expect our cash on hand at December 31, 2022 and other available resources, including cash generated from operations, to be sufficient to continue to meet our cash requirements for the foreseeable future. In the near term, we expect that our cash from operations and availability under the Revolving Credit Facility, and potentially participating in future financing transactions to obtain additional capital will meet our cash needs to fund our operations, capital expenditures, interest payments on debt, debt repayments, such as under the Term Loan Agreement, which matures on December 15, 2023, any dividends, potential strategic acquisitions, opportunities for common stock repurchases under the previously announced program, and payouts related to the unfavorable decision in the Section 199 litigation. See Note 12 (“Debt”) to the consolidated financial statements for further information. Cboe Clear Europe also has a €1.25 billion committed syndicated multicurrency revolving and swingline credit facility agreement with Cboe Clear Europe as borrower and the Company as guarantor of scheduled interest and fees on borrowings (but not the principal amount of any borrowings) (the “Facility”). The Facility is available to be drawn by Cboe Clear Europe towards (a) financing unsettled amounts in connection with the settlement of transactions in securities and other items processed through Cboe Clear Europe’s clearing system and (b) financing any other liability or liquidity requirement of Cboe Clear Europe incurred in the operation of its clearing system. Borrowings under the Facility are secured by cash, eligible bonds and eligible equity assets deposited by Cboe Clear Europe into secured accounts. As a result, should the Facility be drawn by Cboe Clear Europe it could potentially impact Cboe Clear Europe’s liquidity, and we can give no assurance that this Facility will be sufficient to meet all of such obligations or sufficiently mitigate Cboe Clear Europe’s liquidity risk to meet its payment obligations when due. Additionally, a default of the Facility may allow lenders, under certain circumstances, to accelerate any related drawn amounts and may result in the acceleration of the Company’s other outstanding debt to which a cross-acceleration or cross-default provision applies, which may limit the Company’s liquidity, business and financing activities. The Facility was amended on June 30, 2022, which extended the term of the facility through June 29, 2023. Please refer to Note 12 (“Debt”) for further information on the amendment.Our long-term cash needs will depend on many factors, including an introduction of new products, enhancements of current products, the geographic mix of our business and any potential acquisitions. We believe our cash from operations and the availability under our Revolving Credit Facility will meet any long-term needs unless a significant acquisition or acquisitions are identified, in which case we expect that we would be able to borrow the necessary funds and/or issue additional shares of our common stock to complete such acquisition(s).​88 Table of ContentsCash and cash equivalents includes cash in banks and all non-restricted, highly liquid investments with original maturities of three months or less at the time of purchase. Cash and cash equivalents as of December 31, 2022 increased $90.8 million from December 31, 2021 primarily due to additional borrowings on the Term Loan Agreement, issuance of the 3.000% Senior Notes in the first quarter of 2022, and results of operations, partially offset by acquisitions, net of cash acquired and repayments on the Term Loan Agreement. See “Cash Flow” below for further discussion.Our cash and cash equivalents held outside of the United States in various foreign subsidiaries totaled $226.1 million and $185.9 million as of December 31, 2022 and 2021, respectively. The remaining balance was held in the United States and totaled $206.6 million and $156.0 million as of December 31, 2022 and 2021, respectively. The majority of cash held outside the United States is available for repatriation, but under current law, could subject us to additional United States income taxes, less applicable foreign tax credits. See Note 18 (“Regulatory Capital”) for information regarding cash held for purposes of regulatory capital requirements. Our financial investments include deferred compensation plan assets as well as investments with original or acquired maturities longer than three months but that mature in less than one year from the balance sheet date and are recorded at fair value. As of December 31, 2022, financial investments primarily consisted of U.S. Treasury securities and deferred compensation plan assets.Cash FlowThe following table summarizes our cash flow data for the years ended December 31, 2022, 2021 and 2020 (in millions): ​​​​​​​​​​​​For the Year Ended​​December 31,​ 2022 2021 2020Net cash provided by operating activities​$ 651.1​$ 596.8​$ 1,458.8Net cash used in investing activities​ (835.1)​ (352.7)​ (430.5)Net cash provided by (used in) financing activities​ 81.7​ (200.3)​ (201.7)Effect of foreign currency exchange rate changes on cash, cash equivalents, and restricted cash and cash equivalents​ (10.0)​ (9.1)​ 1.6(Decrease) increase in cash, cash equivalents, and restricted cash and cash equivalents​$ (112.3)​$ 34.7​$ 828.2​​​​​​​​​​​​As of December 31,​​2022 2021 2020Reconciliation of cash, cash equivalents, and restricted cash and cash equivalents:​​​​​​​​​Cash and cash equivalents​$ 432.7​$ 341.9​$ 245.4Restricted cash and cash equivalents (margin deposits and clearing funds)​​ 530.3​​ 745.9​​ 812.1Restricted cash and cash equivalents (included in other current assets)​​ 4.2​​ 4.4​​ —Customer bank deposits (included in margin deposits and clearing funds)​​ 12.7​​ —​​ —Total​$ 979.9​$ 1,092.2​$ 1,057.5​Net Cash Flows Provided by Operating Activities During the year ended December 31, 2022, net cash provided by operating activities was $416.1 million higher than net income. The variance is primarily attributable to the adjustment for goodwill impairment of $460.9 million, the adjustment for depreciation and amortization expense of $166.8 million, and the change in Section 31 fees payable of $106.3 million, partially offset by the change in restricted cash and cash equivalents of $217.5 million, driven by the change in margin and clearing funds related to Cboe Clear Europe for the year ended December 31, 2022, and the benefit for deferred income taxes of $155.7 million. Net cash flows provided by operating activities were $651.1 million and $596.8 million for the years ended December 31, 2022 and 2021, respectively. The change in net cash flows provided by operating activities was primarily due to the adjustment for goodwill impairment and the change in Section 31 fees payable, partially offset by the change in net income, the change in restricted cash and cash equivalents, driven by margin deposits and clearing funds related to Cboe Clear Europe, the change in benefit for deferred income taxes, and the change in accounts receivable. 89 Table of ContentsNet cash provided by operating activities was $67.8 million higher than net income for the fiscal year ended December 31, 2021. The variance is primarily attributable to the adjustment for depreciation and amortization expense of $167.4 million, the change in accounts payable and accrued liabilities of $45.0 million, and the change in unrecognized tax benefits of $33.2 million, partially offset by the change in Section 31 fees payable of $112.1 million and the change in restricted cash and cash equivalents, driven by a $66.2 million decrease in margin deposits and clearing funds related to Cboe Clear Europe for the year ended December 31, 2021.Net cash provided by operating activities was $596.8 million and $1,458.8 million for the years ended December 31, 2021 and 2020, respectively. The change in net cash flows provided by operating activities was primarily due to the change in restricted cash and cash equivalents, driven by margin deposits and clearing funds related to Cboe Clear Europe, as well as the change in Section 31 fees payable, partially offset by the change in accounts receivable, the change in net income, the change in the bargain purchase gain, and the change in provision for deferred income taxes for the year ended December 31, 2021 compared to the year ended December 31, 2020.Net Cash Flows Used in Investing ActivitiesDuring the year ended December 31, 2022, net cash used in investing activities primarily consisted of acquisitions, net of cash acquired of $708.3 million, purchases of available-for-sale financial investments of $104.7 million, and purchases of property and equipment and leasehold improvements of $59.8 million, partially offset by proceeds from maturities of available-for-sale financial investments of $51.2 million. Net cash flows used in investing activities were $835.1 million and $352.7 million for the years ended December 31, 2022 and 2021, respectively. The variance is primarily due to the change in acquisitions, net of cash acquired, and the change in proceeds from maturities of available-for-sale financial investments, partially offset by the change in contributions to investments for the year ended December 31, 2022 compared to the year ended December 31, 2021. During the year ended December 31, 2021, net cash used in investing activities primarily consisted of contributions to investments of $209.8 million, acquisitions, net of cash acquired of $151.5 million, and purchases of available-for-sale financial investments of $101.2 million, partially offset by proceeds from maturities of available-for-sale financial investments of $160.2 million.Capital expenditures are expected to be in the range of $60.0 million to $66.0 million, reflecting expenditures associated with the Company’s ongoing capacity and technology-related investments, as well as continued integration of Cboe Asia Pacific and global expansion of data and access solutions. Net Cash Flows Provided by (Used in) Financing ActivitiesDuring the year ended December 31, 2022, net cash provided by financing activities primarily consisted of proceeds from the long-term debt issuance of $663.6 million, partially offset by principal repayments of long-term debt of $220.0 million, cash dividends on common stock, share repurchases, and payments of contingent consideration related to acquisitions.Net cash flows provided by (used in) financing activities were $81.7 million and ($200.3) million for the years ended December 31, 2022 and 2021, respectively. The variance is primarily due to proceeds from the long-term debt issuance, partially offset by principal repayments of long-term debt, the change in payments of contingent consideration related to acquisitions, the change in share repurchases, and the change in cash dividends on common stock.Net cash flows used in financing activities totaled $200.3 million for the year ended December 31, 2021. During the year ended December 31, 2021, net cash used in financing activities primarily consisted of cash dividends paid on common stock of $193.3 million and share repurchases of $81.3 million, partially offset by proceeds from long-term debt of $110.0 million.For the year ended December 31, 2020, the Company received proceeds from long-term debt of $493.7 million, of which $70.0 million was used to pay down the revolving credit facility draw taken in the third quarter of 2020, repurchased $349.1 million of common stock, paid dividends totaling $170.6 million, and paid down $155.0 million of long-term debt. 90 Table of ContentsFinancial Assets The following summarizes our financial assets excluding margin deposits and clearing funds as of December 31, 2022, 2021 and 2020 (in millions): ​​​​​​​​​​​​As of December 31,​ 2022 2021 2020Cash and cash equivalents​$ 432.7​$ 341.9​$ 245.4Financial investments​ 91.7​ 37.1​ 92.4Less deferred compensation plan assets​​ (27.5)​​ (28.0)​​ (24.5)Less cash collected for Section 31 fees​​ (93.7)​​ (25.9)​​ (103.0)Adjusted cash (1)​$ 403.2​$ 325.1​$ 210.3(1)Adjusted cash is a non-GAAP measure and represents cash and cash equivalents plus financial investments, minus deferred compensation plan assets and cash collected for Section 31 fees. We have presented adjusted cash because we consider it an important supplemental measure of our liquidity and believe that it is frequently used by analysts, investors and other interested parties in the evaluation of companies.Debt​The following summarizes our debt obligations as of December 31, 2022, 2021 and 2020 (in millions): ​​​​​​​​​​​​As of December 31,​ 2022 2021 2020Term Loan Agreement​$ 305.0​$ 160.0​$ 70.03.650% Senior Notes​ 650.0​ 650.0​ 650.01.625% Senior Notes​​ 500.0​​ 500.0​​ 500.03.000% Senior Notes​​ 300.0​​ —​​ —Revolving Credit Agreement​​ —​​ —​​ —Cboe Clear Europe Credit Facility​​ —​​ —​​ —Less unamortized discount and debt issuance costs​​ (13.0)​​ (10.7)​​ (16.1)Total debt​$ 1,742.0​$ 1,299.3​$ 1,203.9​At December 31, 2022, we were in compliance with the covenants of our debt agreements. In addition to the debt outstanding, as of December 31, 2022, we had an additional $400.0 million available through our revolving credit facility, with the ability to borrow another $200.0 million by increasing the commitments under the facility. Together with adjusted cash, we had $1.0 billion available to fund our operations, capital expenditures, potential acquisitions, debt repayments and any dividends, net of regulatory capital requirements, as of December 31, 2022. DividendsThe Company’s expectation is to continue to pay dividends. The decision to pay a dividend, however, remains within the discretion of the Company's Board of Directors and may be affected by various factors, including our earnings, financial condition, capital requirements, level of indebtedness and other considerations our Board of Directors deems relevant. Future debt obligations and statutory provisions, among other things, may limit, or in some cases prohibit, our ability to pay dividends.Share Repurchase ProgramIn 2011, the Board of Directors approved an initial authorization for the Company to repurchase shares of its outstanding common stock of $100 million and subsequently approved additional authorizations, for a total authorization of $1.6 billion. The program permits the Company to purchase shares through a variety of methods, including in the open market or through privately negotiated transactions, in accordance with applicable securities laws. It does not obligate the Company to make any repurchases at any specific time or situation. Share repurchases are repurchased to the Company’s Treasury stock and ultimately retired or they are available to be redistributed. Under the program, for the year ended December 31, 2022, the Company repurchased 876,238 shares of common stock at an average cost per share of $115.20, totaling $100.9 million. Since inception of the program through December 91 Table of Contents31, 2022, the Company has repurchased 18,948,367 shares of common stock at an average cost per share of $70.30, totaling $1.3 billion. The Company retired 744,127 and 18,072,129 shares of treasury stock in the years ended December 31, 2022 and 2021, respectively.On August 16, 2022, President Biden signed into law H.R. 5376 (commonly known as the “Inflation Reduction Act of 2022” or simply the “IRA”). Tax measures contained in the new law include, among other items, an excise tax of 1% on corporate stock buy-backs. The IRA imposes a new 1% excise tax on repurchases of stock by domestic corporations with stock traded on established securities markets. The amount on which the tax is imposed is reduced by the value of any stock issued by such corporation during the tax year and the tax generally applies to stock buy-back transactions occurring after December 31, 2022. This new tax is not expected to result in a material impact to the Company.As of December 31, 2022, the Company had $217.9 million of availability remaining under its existing share repurchase authorizations. Lease and ObligationsThe Company currently leases additional office space, data centers and remote network operations center, with lease terms remaining from 5 months to 174 months as of December 31, 2022. Additionally, in October 2021, the Company signed a new lease that commenced in February 2022 for a new principal office space in Amsterdam. See Note 24 (“Leases”) to the consolidated financial statements for additional information.Total rent expense related to current and former lease obligations for the years ended December 31, 2022, 2021 and 2020 totaled $30.0 million, $25.6 million and $20.2 million, respectively. In addition to our lease obligations, we have contractual obligations related to certain operating leases, data and telecommunications agreements, and our long-term debt outstanding. Purchase obligations include our estimate of the minimum outstanding obligations under agreements to purchase goods or services that we believe are enforceable and legally binding and that specify all significant terms, including fixed or minimum quantities to be purchased; fixed or minimum and maximum amounts to be paid; and the approximate timing of the transaction. Purchase obligations include certain licensing agreements with various licensors which contain annual minimum fee requirements as well as payments calculated using agreed upon contract rates and reported cleared volumes. Purchase obligations exclude agreements that are cancellable at any time without penalty. We have excluded from the contractual obligations listed below $543.0 million in cash margin deposits and clearing funds related to Cboe Clear Europe and Cboe Clear Digital. Clearing participants of Cboe Clear Europe are required to make deposits to a clearing fund. The cash deposits made by clearing participants are recorded in the consolidated balance sheet as current assets with equal and offsetting current liabilities. See Note 14 (“Clearing Operations”) to the consolidated financial statements for additional information on Cboe Clear Europe and Cboe Clear Digital and the margin deposits and clearing funds. Future minimum payments under these leases and agreements were as follows as of December 31, 2022:​​​​​​​​​​​​​Payments Due by Period​​​​​​Less than​​More than​ Total ​1 year ​1 yearContractual Obligations​​Operating leases​$ 156.7​$ 22.4​$ 134.3Purchase obligations​​ 883.8​​ 71.3​​ 812.5Principal payments of debt​ 1,755.0​ 305.0​ 1,450.0Interest payments on debt​ 257.3​ 54.9​ 202.4Total​$ 3,052.8​$ 453.6​$ 2,599.2​Commercial Commitments and Contractual ObligationsAs of December 31, 2022, our commercial commitments and contractual obligations included operating leases, data and telecommunications agreements, equipment leases, our long-term debt outstanding, contingent considerations, software development activities and other obligations. See Note 23 (“Commitments, Contingencies, and Guarantees”) to the consolidated financial statements for a discussion of commitments and contingencies, Note 12 (“Debt”) for a 92 Table of Contentsdiscussion of the outstanding debt, Note 14 (“Clearing Operations”) for information on Cboe Clear Europe and Cboe Digital’s clearinghouse exposure guarantees, and Note 24 (“Leases”) for discussion on operating leases and equipment leases.Guarantees We use Wedbush and Morgan Stanley to clear our routed equities transactions for our U.S. Equities exchanges. Wedbush and Morgan Stanley guarantee the trade until one day after the trade date, after which time the National Securities Clearing Corporation (“NSCC”) provides a guarantee. The BIDS Trading ATS platform delivers matched trades to BofA Securities, Inc. (“BOA”), which delivers the matched trades to the NSCC. BOA guarantees the trade until one day after the trade date, after which time the NSCC provides a guarantee. In the case of failure to perform on the part of Wedbush or Morgan Stanley on routed transactions for our U.S. Equities exchanges, we provide the guarantee to the counterparty to the trader. In the case of failure to perform on the part of BOA on transactions for the BIDS Trading ATS platform, BIDS has obligations to the counterparties to satisfy the trades. OCC acts as a central counterparty on all transactions in listed equity options in our Options segment, and as such, guarantees clearance and settlement of all of our options transactions. We believe that any potential requirement for us to make payments under these guarantees is remote and accordingly, have not recorded any liability in the consolidated financial statements for these guarantees. Similarly, with respect to trades in U.S. listed equity options and futures occurring on Cboe Options, C2, BZX, EDGX, and CFE, we deliver matched trades of our customers to the OCC, which acts as a central counterparty on all transactions occurring on these exchanges and, as such, guarantees clearance and settlement of all of those matched options and futures trades. With respect to Canadian equities, we deliver matched trades of our customers to The Canadian Depository for Securities, which acts as a central counterparty on all transactions occurring on MATCHNow and NEO and, as such, guarantees clearance and settlement of all of our matched Canadian equities trades. With respect to Australian equities and derivatives, we deliver matched trades of our customers to ASX Clear Pty Ltd and ASX Settlement Pty Ltd. ASX Clear Pty Ltd acts as a central counterparty on all transactions occurring on Cboe Australia and, as such, guarantees clearance and settlement on all of our matched trades in Australia. With respect to Japanese equities, we deliver matched trades of our customers to the Japanese Securities Clearing Corporation, which acts as a central counterparty on all transactions occurring on Cboe Japan and, as such, guarantees clearance and settlement on all of our matched trades in Japan.CRITICAL ACCOUNTING ESTIMATES The preparation of consolidated financial statements in conformity with U.S. GAAP requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of the amounts of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. On an ongoing basis, the Company evaluates its estimates, including those related to areas that require a significant level of judgment or are otherwise subject to an inherent degree of uncertainty. The Company bases its estimates on historical experience, observance of trends in particular areas, information available from outside sources and various other assumptions that are believed to be reasonable under the circumstances. Information from these sources form the basis for making judgments about the carrying values of assets and liabilities that may not be readily apparent from other sources.We have identified the estimates below as critical to our business operations and the understanding of our results of operations. The impact of, and any associated risks related to, these estimates on our business operations is discussed throughout "Management's Discussion and Analysis of Financial Condition and Results of Operations." For a detailed discussion on these estimates and other accounting policies, see Note 2 (“Summary of Significant Accounting Policies”) to the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.Goodwill and Other Intangible AssetsDescription Our acquisitions of Bats, Silexx Financial Systems, LLC (“Silexx”), Livevol, Inc. (“LiveVol”), Hanweck, FT Options, Trade Alert, MATCHNow, BIDS Holdings, Cboe Asia Pacific, Cboe Digital, and NEO resulted in the recording of goodwill and other intangible assets, while our acquisition of Cboe Clear Europe, resulted in a bargain purchase gain and other intangible assets. In accordance with FASB Accounting Standards Codification (“ASC”) 350 – Intangibles – Goodwill and 93 Table of ContentsOther, we test the carrying values of goodwill and indefinite-lived intangible assets for impairment at least annually, or more frequently when events or changes in circumstances signal indicators of impairment are present.Judgments and UncertaintiesThe estimated fair values of our reporting units are based on the market approach and the income approach (using discounted estimated future cash flows). The estimated fair values of indefinite-lived intangibles are based on the cost method and income approach. The discounted estimated future cash flow analysis requires judgments about the discount rate, forecasted revenue growth rate, and operating expenses, that are inherent in these fair value estimates over the estimated remaining operating period. Additionally, the analysis contains uncertainty surrounding future events. As such, actual results may differ from these estimates and lead to a revaluation of our goodwill and indefinite-lived intangible assets.Effect if Actual Results Differ from Assumptions​If updated estimates indicate that the fair value of goodwill or any indefinite-lived intangibles is less than the carrying value of the asset, an impairment charge is expected to be recorded in the consolidated statements of income in the period of the change in estimate, which could result in a material change to the consolidated financial statements. ​Following the acquisition of Cboe Digital in the quarter ended June 30, 2022, negative events and trends in the broader digital asset environment emerged, such as deleveraging and bankruptcies, and certain negative trends in the broader digital asset environment that started in late 2021 intensified, such as the decline in digital asset prices, overall market activity, and market capitalization. Additionally, following the acquisition of Cboe Digital , the efforts to syndicate minority ownership interests in Cboe Digital to potential investors during the quarter ended June 30, 2022 became more challenging, and the outlook for the Digital segment’s future market growth was negatively impacted. The Company considered these developments, in particular the syndication efforts during the quarter ended June 30, 2022, to be potential indications of impairment and performed an interim impairment test for the goodwill recognized in the Digital reporting unit during the quarter ended June 30, 2022. The Company concluded that the carrying value of the reporting unit exceeded its estimated fair value, which was based on the income approach and corroborated with the market approach, and recorded a goodwill impairment charge of $460.1 million in the consolidated statements of income during the quarter ended June 30, 2022, and also recognized a deferred tax asset of $116.2 million. This deferred tax asset, resulting from the excess of tax-deductible goodwill over book goodwill, relates to future tax deductions the Company expects to realize to reduce potential tax payments on future income. As a result, the carrying value of Cboe Digital decreased by $343.9 million, to $220.0 million as of June 30, 2022. The Company also performed testing over the intangible assets recognized as a result of the Cboe Digital acquisition during the quarter ended June 30, 2022, and based on the results of the assessments, determined there was no impairment required as the fair value approximated the carrying value. No other long lived assets were recognized as a result of the acquisition and subject to further assessment.​As a result of the finalization of the net working capital calculation associated with the acquisition of Cboe Digital during the quarter ended September 30, 2022, the Company recorded additional goodwill of $0.8 million. Subsequently, the Company concluded that the indicators of impairment outlined in the previous paragraph continued to be relevant and recorded an additional goodwill impairment charge of $0.8 million in the consolidated statements of income for the three months ended September 30, 2022, resulting in the write-down of the carrying value of the goodwill associated with the acquisition of Cboe Digital to zero. ​As a result of the Company’s annual impairment analysis, completed in the fourth quarter of 2022, in which all reporting units estimated fair value exceeded their carrying value, we do not consider our goodwill and indefinite-lived intangibles to have a significant risk of additional impairment. ​Income Taxes ​DescriptionThe Company’s consolidated global income tax provision, deferred tax assets and liabilities, valuation allowances, and liabilities for unrecognized tax benefits are determined through the interpretation of tax laws and assumptions of future events to calculate an expectation of future tax consequences. ​94 Table of ContentsJudgments and UncertaintiesOn an ongoing basis, the Company evaluates its tax estimates and judgments. This evaluation is based on factors including historical experience, such as the conclusions of examinations by tax authorities, changes in tax laws or rates, new examination activity, and results of any related legal processes. We use judgment in the evaluation of uncertain tax positions and the estimation of unrecognized tax benefits when determining the largest amount greater than 50% likely to be realized upon ultimate settlement with the taxing authority, assessing the likelihood of the benefit being realized upon settlement, and the calculating expected ultimate settlement amount. Effect if Actual Results Differ from AssumptionsSignificant changes in these estimates or judgments may result in an increase or decrease to our tax provision in a future period. Additionally, it is possible that the ultimate settlement may differ from the liabilities for unrecognized tax benefits currently reported if tax authorities ultimately reach a conclusion that differs from the Company’s expectation. We believe assumptions made regarding income taxes to be reasonable and do not believe any change in the judgments made by management would result in a material change to the consolidated financial statements.RECENT ACCOUNTING PRONOUNCEMENTSSee Note 3 (“Recent Accounting Pronouncements”) to the consolidated financial statements for further discussion of recently adopted and recently issued accounting pronouncements that are applicable to the Company. Item 7A. Quantitative and Qualitative Disclosures about Market RiskAs a result of our operating activities, we are exposed to market risks such as foreign currency exchange rate risk, equity risk, credit risk, interest rate risk, and liquidity risk. We have implemented policies and procedures to measure, manage and monitor and report risk exposures, which are reviewed regularly by management and our Board of Directors.Foreign Currency Exchange Rate Risk Our operations in Europe, Canada and Asia are subject to increased currency translation risk as revenues and expenses are denominated in foreign currencies, primarily the British pound, Canadian dollar, Euro, Australian dollar, and Japanese Yen. We also have de minimis exposure to other foreign currencies, including the Swiss Franc, Norwegian Kroner, Swedish Krona, Danish Kroner, Singapore dollar, Hong Kong dollar, and Philippine Peso.For the year ended December 31, 2022, our exposure to foreign-denominated revenues less cost of revenues and expenses is presented by primary foreign currency in the following table (in millions, except percentages): ​​​​​​​​​​​​​​​Year Ended ​​December 31, 2022​​​British​​​​​Australian​​​Pounds (1)​​Euros (1)​​Dollars (1)​Foreign denominated % of:​​​​​​​​​​​​Revenues less cost of revenues​​ 3.4%​​3.7%​​1.6%Operating expenses​​ 2.5%​​4.3%​​2.6%Impact of 10% adverse currency fluctuation on:​​​​​​​​​​​​Revenues less cost of revenues​$ 6.2​​$6.3​​$2.4​Operating expenses​​ 3.2​​​4.9​​​2.8​(1)An average foreign exchange rate to the U.S. dollar for the period was used. See Item 7 (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”) for the table summarizing the changes in certain operational and financial metrics for more information.Equity RiskOur investment in European, Canadian, and Asia Pacific operations is exposed to volatility in currency exchange rates through translation of our net assets or equity to U.S. dollars. The assets and liabilities of our European businesses are denominated in British pounds or Euros. The assets and liabilities of our Canadian businesses are denominated in Canadian dollars. The assets and liabilities of our Asia Pacific businesses are denominated in Hong Kong dollars, Australian dollars, Japanese Yen, or Philippine Pesos. Fluctuations in currency exchange rates may create volatility in our 95 Table of Contentsreported results as we are required to translate foreign currency reported statements of financial condition and operational results into U.S. dollars for consolidated reporting. The translation of these non-U.S. dollar statements of financial condition into U.S. dollars for consolidated reporting results in a cumulative translation adjustment, which is recorded in accumulated other comprehensive income, net within stockholders' equity on our consolidated balance sheet. Our primary exposure to this equity risk as of December 31, 2022 is presented by foreign currency in the following table (in millions): ​​​​​​​​​​​​British​​​Canadian​ Pounds (1)​Euros (1)​Dollars (1)Net equity investment in Cboe Europe Equities and Derivatives, Cboe Clear Europe, MATCHNow, and NEO $ 579.5​$ 145.8​$ 402.3Impact on consolidated equity of a 10% adverse currency fluctuation ​ 58.0​​ 14.6​​ 40.2(1)Converted to U.S. dollars using the foreign exchange rate of British pounds per U.S. dollar, Euros per U.S. dollar, and Canadian dollars per U.S. dollar, respectively, as of December 31, 2022.Credit Risk We are exposed to credit risk from third parties, including customers, counterparties and clearing agents. These parties may default on their obligations due to bankruptcy, lack of liquidity, operational failure or other reasons. We limit our exposure to credit risk by considering such risk when selecting the counterparties with which we make investments and execute agreements.We do not have counterparty credit risk with respect to trades matched on our exchanges in the U.S., Canada, and Europe. With respect to listed equities, we deliver matched trades of our customers to the NSCC without taking on counterparty risk for those trades. NSCC acts as a central counterparty on all equity transactions occurring on BZX, BYX, EDGX and EDGA and, as such, guarantees clearance and settlement of all of our matched equity trades. Similarly, with respect to U.S. listed equity options and futures, we deliver matched trades of our customers to the OCC, which acts as a central counterparty on all transactions occurring on Cboe Options, C2, BZX, EDGX and CFE and, as such, guarantees clearance and settlement of all of our matched options and futures trades. With respect to Canadian equities, we deliver matched trades of our customers to The Canadian Depository for Securities, which acts as a central counterparty on all transactions occurring on MATCHNow and, as such, guarantees clearance and settlement of all of our matched Canadian equities trades. The BIDS Trading ATS platform delivers matched trades to BOA, which delivers the matched trades to the NSCC. BOA guarantees the trade until one day after the trade date, after which time the NSCC provides a guarantee. Thus, BIDS Trading is potentially exposed to credit risk to the counterparty between the trade date and one day after the trade date in the event BOA fails. With respect to Australian equities and derivatives, we deliver matched trades of our customers to ASX Clear Pty Ltd and ASX Settlement Pty Ltd. ASX Clear Pty Ltd acts as a central counterparty on all transactions occurring on Cboe Australia and, as such, guarantees clearance and settlement on all of our matched trades in Australia. With respect to Japanese equities, we deliver matched trades of our customers to the Japanese Securities Clearing Corporation, which acts as a central counterparty on all transactions occurring on Cboe Japan and, as such, guarantees clearance and settlement on all of our matched trades in Japan.With respect to orders Cboe Trading routes to other markets for execution on behalf of our customers, Cboe Trading is exposed to some counterparty credit risk in the case of failure to perform on the part of our clearing firms, Morgan Stanley or Wedbush. Morgan Stanley and Wedbush guarantee trades until one day after the trade date, after which time NSCC provides a guarantee. The BIDS Trading ATS platform delivers matched trades to BOA, which delivers the matched trades to the NSCC. Thus, Cboe Trading is potentially exposed to credit risk to the counterparty to a trade routed to another market center between the trade date and one day after the trade date in the event that Morgan Stanley or Wedbush fails. The BIDS Trading ATS platform is potentially exposed to counterparty credit risk on equities trades between the trade date and one day after the trade date in the event that BOA fails. We believe that any potential requirement for us to make payments under these guarantees is remote and accordingly, have not recorded any liability in the consolidated financial statements for these guarantees. Historically, we have not incurred any liability due to a customer’s failure to satisfy its contractual obligations as counterparty to a system trade. Credit difficulties or insolvency, or the perceived possibility of credit difficulties or insolvency, of one or more larger or more visible market participants could also result in market-wide credit difficulties or other market disruptions.We do not have counterparty credit risk with respect to institutional spot FX trades occurring on our platform because Cboe FX is not a counterparty to any FX transactions. All transactions occurring on our platform occur bilaterally between 96 Table of Contentstwo banks or prime brokers as counterparties to the trade. While Cboe FX does not have direct counterparty risk, Cboe FX may suffer a decrease in transaction volume if a bank or prime broker experiences an event that causes other prime brokers to decrease or revoke the credit available to the prime broker experiencing the event. Therefore, Cboe FX may have risk that is related to the credit of the banks and prime brokers that trade FX on the Cboe FX platform.We also have credit risk related to transaction fees that are billed in arrears to customers on a monthly basis. Our potential exposure to credit losses on these transactions is represented by the receivable balances in our balance sheet. Our customers are financial institutions whose ability to satisfy their contractual obligations may be impacted by volatile securities markets.The Company is exposed to further credit risk through our clearing operations. Cboe Clear Europe holds material amounts of clearing participant collateral, both cash and non-cash deposits, which are held or invested primarily to provide security of capital while minimizing credit risk as well as liquidity and market risks. Cboe Digital holds amounts of clearing participant collateral including cash and digital assets, which are held primarily to provide security of capital while minimizing credit risk as well as custody, valuation and market risks. The following is a summary of the risks associated with these deposits and how these risks are mitigated:●Credit Risk - The credit risk is predominantly in the event a clearing participant fails to meet a financial or contractual obligation and related to custodians and settlement banks. Cboe Clear Europe attempts to mitigate this risk through minimum participant requirements for clearing participants and monitoring their financial health. To cover potential loss to Cboe Clear Europe in the event of a clearing participant default, collateral is required from clearing participants. Besides potential defaults of clearing participants, the main credit risk faced by the clearinghouse is exposure to clearing participants when a trade fails to settle. To help mitigate this risk, a fail fee is charged to discourage late settlements. This fee covers Cboe Clear Europe’s costs but also acts as a deterrent as required by Regulation (EU) No 236/2012 on short selling, together with certain aspects of credit default swaps. Cboe Clear Digital sets minimum financial requirements on custodian institutions and any clearing member that may expose the clearinghouse to credit risk. The financial strength of custodians and such clearing members are monitored routinely. Furthermore, Cboe Digital requires clearing members to post collateral or other forms of financial guarantee and their trading activities are subject to pre-trade checks enforced by Cboe Digital Exchange and administered by Cboe Clear Digital. As of December 31, 2022, Cboe Digital does not expect a material loss concerning credit risk on any member participant, custodian, or settlement bank. ●Liquidity Risk - Liquidity risk is the risk Cboe Clear Europe may not be able to meet its payment obligations in the right currency, in the right place and at the right time. To help mitigate this risk, Cboe Clear Europe monitors its liquidity requirements closely and maintains funds and assets in a manner which attempt to minimize the risk of loss or delay in the access by the clearinghouse to such funds and assets. For example, holding funds with a central bank where possible or making only short-term investments serves to help reduce liquidity risks. Liquidity is mainly required for securities settlement. The payment and settlement obligations generally stem from the function of Cboe Clear Europe as a cash equity clearinghouse: shares are bought and sold by clearing participants on a trading platform or OTC, and netted to settle two days later. During the settlement the actual payment for and delivery of the shares take place, this process requires intraday liquidity. If counterparties, which receive shares against payment, are unable to settle, an overnight liquidity need arises. The overnight liquidity is typically very short term, and is usually limited to a few days.●Custody Risk – Cboe Digital holds customer’s digital clearing assets custodially through self-custody and it’s accounts with custodians. Cboe Digital’s custody strategy is designed to maximize liquidity and efficient access to assets by making those assets readily available. Cboe Digital monitors its cash and the digital asset balances it maintains with custodians. Digital assets require control of one or more unique public and private keys relating to the local or online digital wallet in which the digital assets are held. The networks require one or more private keys relating to a digital wallet to authorize a spending transaction. If private keys are lost or destroyed, this could prevent the ability to transfer the corresponding digital asset. Security breaches, computer malware, and computer hacking attacks have been a prevalent concern in digital asset markets. Cboe Digital has committed to securely store digital assets it holds on behalf of users. As such, Cboe Digital may be liable to its users for losses arising from theft or loss of user private keys. Cboe Digital has no reason to believe it will incur any expense associated with such potential liability because (i) it has no known or historical experience of claims to use as a basis of measurement, (ii) it accounts for and continually verifies the amount of digital assets within its control, and (iii) it has established security around custodial private keys to minimize the risk of theft or loss. ●Valuation Risk - Cboe Digital is exposed to risk with respect to digital asset prices and valuations which are largely based on the supply and demand for those digital assets in financial markets. Cboe Digital’s valuation 97 Table of Contentsgovernance framework includes numerous controls and other procedural safeguards that are intended to maximize the quality of fair value measurements. New products and valuation techniques are reviewed and approved by senior management. Cboe Digital’s valuation process for digital assets are fair value estimates that are also validated by the finance control function independently. Independent price verification is performed by finance control through benchmarking fair value estimates with observable market prices or other independent sources. Reasonably designed controls and governance framework are in place and are intended to help ensure quality third-party pricing sources were used. ●Market Risk - Cboe Clear Europe is also exposed to market risk in the event that a clearing participant defaults and the market prices of the securities in its open positions have moved adversely so the clearinghouse can only close out the participant’s obligations at a loss. To help mitigate market risk, Cboe Clear Europe collects collateral from clearing participants to cover for the probable loss during normal market conditions, together with contributions to the clearing fund to cover losses if a default occurred during extreme but plausible market conditions. Adverse movements in exchange rates affecting the value of obligations and collateral are factored into the calculation of the amount of collateral to be collected. To help ensure an orderly market, Cboe Digital maintains digital assets to support its clearing operations which may be subject to significant changes in value and therefore exposed to market risk with the fluctuation in market prices. Cboe Digital monitors this risk on a daily, weekly and monthly basis. The business model is such that Cboe Digital earns digital assets and at times may accumulate positions that are subject to market risk. Customer positions do have market risk based on daily activity and settlement prices.On a regular basis, we review and evaluate changes in the status of our counterparties’ creditworthiness. Credit losses such as those described above could adversely affect our consolidated financial position and results of operations. Any such effects to date have been minimal.Interest Rate Risk We have exposure to market risk for changes in interest rates relating to our cash and cash equivalents, financial investments, and indebtedness. As of December 31, 2022 and 2021, our cash and cash equivalents and financial investments were $524.4 million and $379.0 million, respectively, of which $226.1 million and $185.9 million is held outside of the United States in various foreign subsidiaries in 2022 and 2021, respectively. The remaining cash and cash equivalents and financial investments are denominated in U.S. dollars. We do not use our investment portfolio for trading or other speculative purposes. Due to the nature of these investments, we have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in interest rates, assuming no change in the amount or composition of our cash and cash equivalents and financial investments. As of December 31, 2022, we had $1,742.0 million in outstanding debt, of which $1,437.3 million relates to our Senior Notes, which bear interest at fixed interest rates. Changes in interest rates will have no impact on the interest we pay on fixed-rate obligations. $304.7 million of the outstanding debt relates to the Term Loan Agreement, which bears interest at fluctuating rates and, therefore, subjects us to interest rate risk. The overnight Treasury repurchase market underlying SOFR has experienced and may experience disruptions from time to time, which may result in unexpected fluctuations, including potentially higher rates, in SOFR. A hypothetical 100 basis point increase in interest rates relating to the amounts outstanding under the Term Loan Agreement as of December 31, 2022 would decrease annual pre-tax earnings by $3.0 million, assuming no change in the composition of our outstanding indebtedness. We are also exposed to changes in interest rates as a result of borrowings under our Revolving Credit Agreement and the Cboe Clear Europe Credit Facility, as these facilities bear interest at fluctuating rates. As of December 31, 2022, there were no outstanding borrowings under our Revolving Credit Agreement or Cboe Clear Europe Credit Facility, respectively. See Note 12 (“Debt”) to the consolidated financial statements for a discussion of debt agreements. Liquidity RiskWe are exposed to liquidity risk under certain circumstances in relation to the cross-acceleration and cross-default provisions within the Term Loan Agreement and the Revolving Credit Agreement as a result of the Company, as guarantor, entering into the Cboe Clear Europe Credit Facility. A default of the Facility may allow lenders to accelerate any related drawn amounts and may result in the acceleration of the Company’s other outstanding debt to which a cross-acceleration or cross-default provision applies, which may limit the Company’s liquidity, business and financing activities. See Note 12 (“Debt”) to the consolidated financial statements for a discussion of debt agreements.​98 Table of Contents
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+Item 7.•Crop-Hail coverage provides crop protection from damage caused by hail and/or fire, with options in some markets for other perils such as wind or theft. Coverage is provided on an acre-by-acre basis and is available in the U.S. and in some parts of Canada. Crop-Hail can be used in conjunction with MPCI or other comprehensive coverages to offset the deductible and provide protection up to the actual cash value of the crop.Chubb Agribusiness comprises Commercial Agribusiness and Farm and Ranch Agribusiness. •Commercial Agribusiness offers specialty P&C coverages for commercial companies that manufacture, process and distribute agricultural products. Commercial products and services include property, general liability for premises/operations and product liability, commercial automobile, workers' compensation, employment practices liability coverage, built-in coverage for premises pollution, cyber and information security, and product withdrawal. •Farm and Ranch Agribusiness offers an extensive line of coverages for farming operations from Hobby/Gentleman farms to complex corporate farms and equine services including personal use, boarding, and training. Coverages include farm and ranch structures, automobile and other vehicle coverages, and machinery and other equipment coverages. Competitive EnvironmentRain and Hail primarily operates in a federally regulated program where all approved providers offer the same product forms and rates through independent and/or captive agents. We seek a competitive advantage through our ability to provide superior service to our customers, including the development of digital solutions. Chubb Agribusiness competes against both national and regional competitors offering specialty P&C insurance coverages to companies that manufacture, process, and distribute agricultural products.Overseas General Insurance (27 percent of 2022 Consolidated NPE)Overview The Overseas General Insurance segment comprises Chubb International, our retail division, Chubb Global Markets (CGM), our wholesale division, and the international supplemental A&H business of Combined International Insurance. Chubb International comprises our international retail commercial P&C and corporate A&H traditional and specialty lines serving large corporations, middle market and small customers; consumer A&H and traditional and specialty personal lines business serving local territories outside the U.S., Bermuda, and Canada. CGM, our London-based international specialty and excess and surplus lines wholesale business, includes Lloyd's of London (Lloyd's) Syndicate 2488, a wholly-owned Chubb syndicate supported by funds at Lloyd’s provided by Chubb Corporate Members. Syndicate 2488 has an underwriting capacity of £630 million for the Lloyd’s 2023 account year. The syndicate is managed by Chubb’s Lloyd’s managing agency, Chubb Underwriting Agencies Limited. The Overseas General Insurance segment also includes the P&C related operations of our investment in China based Huatai Group.Products and DistributionChubb International maintains a presence in every major insurance market in the world and is organized geographically along product lines as follows: Europe, Middle East and Africa, Asia Pacific, Japan, and Latin America. Products offered include commercial P&C and corporate A&H lines, including specialty coverages and services, and consumer lines, including A&H and personal lines insurance products. Chubb International's P&C business is generally written, on both a direct and assumed basis, 7Table of Contentsthrough major international, regional, and local brokers and agents. Certain branded products are also offered via digital-commerce platforms, allowing agents and brokers to quote, bind, and issue policies at their convenience. Property insurance products include traditional commercial fire coverage, as well as energy industry-related, marine, construction, and other technical coverages. Principal casualty products are commercial primary and excess casualty, environmental, and general liability. A&H and other consumer lines products are distributed through brokers, agents, direct marketing programs, including thousands of telemarketers, and sponsor relationships. The A&H operations primarily offer personal accident and supplemental medical coverages including accidental death, business/holiday travel, specified disease, disability, medical and hospital indemnity, and income protection. We are not in the primary healthcare business. With respect to our supplemental medical and hospital indemnity products, we typically pay fixed amounts for claims and are therefore largely insulated from the direct impact of rising healthcare costs. Chubb International specialty coverages include D&O, professional indemnity, cyber, surety, aviation, political risk, and specialty personal lines products. Chubb International personal lines operations provide a wide range of consumer lines products to meet the needs of specific target markets around the world. Products include high net worth homes, traditional homeowners, automobile, and specialty products that cover smart phones, eyeglasses, and personal cyber risk. As of December 31, 2022, Chubb International’s presence in China included its 47.3 percent ownership interest in Huatai Group. Huatai Group wholly owns Huatai Property & Casualty Insurance Co., Ltd. (Huatai P&C). Therefore, Chubb owned a 47.3 percent indirect ownership interest in Huatai P&C, which provides a range of commercial and personal P&C products in China, including property, professional liability, product liability, employer liability, business interruption, marine cargo, personal accident, and specialty risk. These products are marketed through a variety of distribution channels including over 200 licensed sales locations in 28 Chinese provinces. On January 4, 2023, we increased our ownership interest in Huatai Group to 64.2 percent. Refer to Note 2 to the Consolidated Financial Statements for additional information.CGM offers products through its parallel distribution network via two legal entities, Chubb European Group SE (CEG) and Chubb Underwriting Agencies Limited, managing agent of Syndicate 2488. CGM uses the Syndicate to underwrite P&C business on a global basis through Lloyd's worldwide licenses. They also use CEG to underwrite similar classes, including in the U.S. where they are eligible to write excess and surplus lines business. Factors influencing the decision to place business with the Syndicate or CEG include licensing eligibilities and client/broker preference. CGM also has a presence outside London, in the U.S., Canada, Europe, Asia and Latin America, for certain specialty lines of business (political risk and trade credit as well as aviation) which are underwritten by local Chubb entities. All business underwritten by CGM is accessed through registered brokers. The main lines of business include aviation, property, energy, professional lines, marine, financial lines, political risk, and credit.Combined International Insurance uses an international sales force to distribute a wide range of supplemental A&H products including personal accident, short-term disability, critical conditions and cancer aid, and hospital confinement/recovery. Most of these products are primarily fixed-indemnity obligations and are not subject directly to escalating medical cost inflation.Competitive EnvironmentChubb International's primary competitors include U.S.-based companies with global operations, as well as non-U.S. global carriers and indigenous companies in regional and local markets. For the A&H and personal lines businesses, locally based competitors also include financial institutions and bank owned insurance subsidiaries. Our international operations have the distinct advantage of being part of one of the few international insurance groups with a global network of licensed companies able to write policies on a locally admitted basis. Our international operations also have the advantage of selling products through a variety of distribution channels including partnerships with major international, regional, and local brokers and agents. Additionally, as noted above, certain branded products are also offered via digital-commerce platforms. The principal competitive factors that affect the international operations are underwriting expertise and pricing, relative operating efficiency, product differentiation, producer relations, and the quality of policyholder services. A competitive strength of our international operations is our global network and breadth of insurance programs, which assist individuals and business organizations to meet their risk management objectives, while also having a significant presence in all of the countries in which we operate, giving us the advantage of accessing local technical expertise and regulatory environments, understanding local markets and culture, accomplishing a spread of risk, and offering a global network to service multinational accounts.CGM is one of the preeminent international specialty insurers in London and is an established lead underwriter on a significant portion of the risks it underwrites for all lines of business. All lines of business face competition, depending on the business class, from Lloyd's syndicates, other carriers operating in the London market, and other major international insurers and reinsurers. Competition for international risks is also seen from domestic insurers in the country of origin of the insured. CGM differentiates itself from competitors through long standing experience in its product lines, its multiple insurance entities (Syndicate 2488 and CEG), and the quality of its underwriting and claims service.8Table of ContentsGlobal Reinsurance (2 percent of 2022 Consolidated NPE)OverviewThe Global Reinsurance segment represents Chubb's reinsurance operations comprising Chubb Tempest Re Bermuda, Chubb Tempest Re USA, Chubb Tempest Re International, and Chubb Tempest Re Canada. Global Reinsurance markets its reinsurance products worldwide primarily through reinsurance brokers under the Chubb Tempest Re brand name and provides a broad range of traditional and non-traditional reinsurance coverage to a diverse array of primary P&C companies.Products and DistributionGlobal Reinsurance services clients globally through its major units. Major international brokers submit business to one or more of these units' underwriting teams who have built strong relationships with both key brokers and clients by providing a responsive, client-focused approach to risk assessment and pricing. Global Reinsurance’s diversified portfolio is produced through reinsurance intermediaries.Chubb Tempest Re Bermuda principally provides property catastrophe reinsurance to insurers of commercial and personal property. Property catastrophe reinsurance is on an occurrence or aggregate basis and protects a ceding company against an accumulation of losses covered by its issued insurance policies, arising from a common event or occurrence. Chubb Tempest Re Bermuda underwrites reinsurance principally on an excess of loss basis, meaning that its exposure only arises after the ceding company's accumulated losses have exceeded the attachment point of the reinsurance treaty. Chubb Tempest Re Bermuda also writes other types of reinsurance on a limited basis for some select clients.Chubb Tempest Re USA offers an array of traditional and specialty P&C reinsurance for the North American market, principally on a treaty basis, with a focus on writing property and casualty reinsurance. Chubb Tempest Re USA underwrites reinsurance on both a proportional and excess of loss basis.Chubb Tempest Re International offers an array of traditional and specialty P&C reinsurance to insurance companies worldwide, with emphasis on non-U.S. and non-Canadian risks, including but not limited to property, property catastrophe, casualty, marine, and specialty through its London- and Zurich-based offices. Chubb Tempest Re International underwrites reinsurance on both a proportional and excess of loss basis.Chubb Tempest Re Canada offers an array of traditional and specialty P&C reinsurance for the Canadian market, including but not limited to property, property catastrophe, casualty, surety, and crop-hail. Chubb Tempest Re Canada underwrites reinsurance on both a proportional and excess of loss basis.Competitive EnvironmentThe Global Reinsurance segment competes worldwide with major U.S. and non-U.S. reinsurers as well as reinsurance departments of numerous multi-line insurance organizations. In addition, capital markets participants have developed alternative capital sources intended to compete with traditional reinsurance. Government sponsored or backed catastrophe funds can also affect demand for reinsurance. Global Reinsurance is typically involved in the negotiation and quotation of the terms and conditions of the majority of the contracts in which it participates. Global Reinsurance competes effectively in P&C markets worldwide because of Chubb's strong capital position, analytical capabilities, experienced underwriting team and quality customer service. The key competitors in our markets vary by geographic region and product line. An advantage of our international platform is that we can change our mix of business in response to changes in competitive conditions in the territories in which we operate. Our geographic reach is also sought by multinational ceding companies since our offices, except for Bermuda, provide local reinsurance license capabilities which benefit our clients in dealing with country regulators.Life Insurance (9 percent of 2022 Consolidated NPE)OverviewThe Life Insurance segment comprises our international life operations (Chubb Life), Chubb Tempest Life Re (Chubb Life Re), and the North American supplemental A&H and life business of Combined Insurance.Products and DistributionChubb Life provides individual life and group benefit insurance primarily in Asia, including Hong Kong, Indonesia, South Korea, Taiwan, Thailand, Vietnam, and Myanmar. On July 1, 2022, we expanded our presence in Asia with the acquisition of Cigna’s A&H and life insurance operations. Predominantly writing a portfolio of personal accident and supplemental health insurance and term life, the operations are located in Korea, Taiwan, Hong Kong, New Zealand, and Indonesia. Chubb Life also provides 9Table of Contentscoverage throughout Latin America; selectively in Europe; Egypt; and in China through our direct and indirect investments in Huatai Group, Huatai Life Insurance Co., Ltd. (Huatai Life) and Huatai Asset Management Co., Ltd. Chubb Life offers a broad portfolio of protection and savings products including whole life, endowment plans, individual term life, group term life, medical and health, personal accident, credit life, universal life, Group Employee benefits, unit linked contracts, and credit protection insurance for automobile, motorcycle, and home loans. The policies written by Chubb Life generally provide funds to beneficiaries of insureds after death and/or protection and/or savings benefits while the contract owner is living. We earn income from both insurance contracts subject to mortality and morbidity risks and investment contracts not subject to insurance risks. Funds received from policyholders for investment contracts are not recorded as premium revenue, but rather as a policyholder deposits with an offsetting policy holder account balance liability on the balance sheet. We earn income on investment contracts from both net investment spreads on policy holder account balances and fees for management and administrative services. The size of policyholder account balances will primarily determine the amount of income generated from investment contracts. These investment contracts are an important component of production and are key to our efforts to grow our business. Chubb Life sells to consumers through a variety of distribution channels including captive and independent agencies, bancassurance, worksite marketing, retailers, brokers, telemarketing, mobilassurance, and direct to consumer marketing. We continue to expand Chubb Life with a focus on opportunities in international markets that we believe will result in sustainable operating profits and achieve target returns on invested capital. Our dedicated captive agency distribution channel, whereby agents sell Chubb Life products exclusively, enables us to maintain direct contact with the individual consumer, promote quality sales practices, and exercise greater control over the future of the business. We have developed a substantial sales force of agents principally located in our Asia-Pacific countries. As of December 31, 2022, Chubb had a 57.7 percent direct and indirect ownership interest in Huatai Life, comprising a 20 percent direct ownership interest as well as a 37.7 percent indirect ownership interest through Huatai Group, the parent company of Huatai Life. Huatai Life commenced operations in 2005 and has since grown to become one of the larger life insurance foreign joint ventures in China. Huatai Life offers a broad portfolio of insurance products including whole life, universal life, medical and health, personal accident, and disability. These products are marketed through a variety of distribution channels including over 400 licensed sales locations in 20 Chinese provinces. We also have an indirect investment in Huatai Asset Management, a third-party investment management firm, through our direct ownership in Huatai Group. On January 4, 2023, we increased our direct and indirect ownership interest in Huatai Life to 71.1 percent, through our increased ownership in Huatai Group. Refer to Note 2 to the Consolidated Financial Statements for additional information.Chubb Life Re's core business is a Bermuda-based operation which provides reinsurance to primary life insurers, focusing on guarantees included in certain variable annuity products and also on more traditional mortality reinsurance protection. Chubb Life Re's U.S.-based traditional life reinsurance operation was discontinued for new business in January 2010. Since 2007, Chubb Life Re has not quoted on new opportunities in the variable annuity reinsurance marketplace and our focus has been on managing the current portfolio of risk, both in the aggregate and on a contract basis. This business is managed with a long-term perspective and short-term net income volatility is expected.Combined Insurance distributes specialty supplemental A&H and life insurance products targeted to middle income consumers and businesses in the U.S. and Canada through both direct marketing and worksite sales, through our Chubb Workplace Benefits platform. Combined Insurance's substantial North American sales force distributes a wide range of supplemental accident and sickness insurance products, including personal accident, short-term disability, critical illness, Medicare supplement products, and hospital confinement/recovery. Most of these products are primarily fixed-indemnity benefit obligations and are not directly subject to escalating medical cost inflation.Competitive EnvironmentChubb Life's competition differs by location but generally includes multinational insurers, local insurers, joint ventures, and state-owned insurers. Chubb's financial strength and reputation as an entrepreneurial organization with a global presence gives Chubb Life a strong base from which to compete. While Chubb Life Re is not currently quoting on new opportunities in the variable annuity reinsurance marketplace, we continue to monitor developments in this market. Combined Insurance competes for A&H business in the U.S. against numerous A&H and life insurance companies across various industry segments.10Table of ContentsCorporateCorporate results primarily include results of all run-off asbestos and environmental (A&E) exposures, the results of our run-off Brandywine business, the results of Westchester specialty operations for 1996 and prior years, certain other run-off exposures including molestation exposures, and income and expenses not attributable to reportable segments and the results of our non-insurance companies. The run-off operations do not actively sell insurance products, but are responsible for the management of existing policies and settlement of related claims.Our exposure to A&E, abuse or molestation claims principally arises out of liabilities acquired when we purchased Westchester Specialty in 1998, CIGNA’s P&C business in 1999, and The Chubb Corporation in 2016. The A&E liabilities principally relate to claims arising from bodily-injury claims related to asbestos products and remediation costs associated with hazardous waste sites. UnderwritingChubb is an underwriting company and we strive to emphasize quality of underwriting rather than volume of business or market share. Our underwriting strategy is to manage risk by employing consistent, disciplined pricing and risk selection. This, coupled with writing a number of less cyclical product lines, has helped us develop flexibility and stability of our business, and has allowed us to maintain a profitable book of business throughout market cycles. Clearly defined underwriting authorities, standards, and guidelines coupled with a strong underwriting audit function are in place in each of our local operations and global profit centers. Global product boards ensure consistency of approach and the establishment of best practices throughout the world. Our priority is to help ensure adherence to criteria for risk selection by maintaining high levels of experience and expertise in our underwriting staff. In addition, we employ a business review structure that helps ensure control of risk quality and appropriate use of policy limits and terms and conditions. Underwriting discipline is at the heart of our operating philosophy.Actuaries in each region work closely with the underwriting teams to provide additional expertise in the underwriting process. We use internal and external data together with sophisticated analytical, catastrophe loss and risk modeling techniques to ensure an appropriate understanding of risk, including diversification and correlation effects, across different product lines and territories. We recognize that climate changes and weather patterns, as well as inflationary forces, are integral to our underwriting process and we continually adjust our process to address these changes. This is intended to help ensure that exposures are priced appropriately and resulting losses are contained within our risk tolerance and appetite for individual product lines, businesses, and Chubb as a whole. Our use of such tools and data also reflects an understanding of their inherent limitations and uncertainties. We also purchase protection from third parties, including, but not limited to, reinsurance as a tool to diversify risk and limit the net loss potential of catastrophes and large or unusually hazardous risks. For additional information refer to "Risk Factors" under Item 1A, “Reinsurance Protection”, below, “Catastrophe Management” and “Global Property Catastrophe Reinsurance Program”, under Item 7, and Note 5 to the Consolidated Financial Statements, under
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion and analysis is based on management’s perspective and is intended to assist you in understanding our results of operations and our present financial condition and outlook. Our Consolidated Financial Statements and the accompanying Notes to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K contain additional information that should be referenced when reviewing this material. This discussion and analysis also includes forward-looking statements. Readers are cautioned that such forward-looking statements are based on current expectations and assumptions that involve a number of risks and uncertainties, including those described under “Forward-Looking Statements” in Part I of this report and “Risk Factors” in Part I, Item 1A of this report, which could cause actual results to differ materially from those included in this report.OVERVIEWCimarex MergerOn October 1, 2021, we and Cimarex completed the Merger. Cimarex is an oil and gas exploration and production company with operations in Texas, New Mexico and Oklahoma.Financial and operational information set forth herein does not include the activity of Cimarex for periods prior to the closing of the Merger.Financial and Operating Overview Financial and operating results for the year ended December 31, 2022 compared to the year ended December 31, 2021 are as follows:•Equivalent production increased 64.2 MMBoe from 167.1 MMBoe, or 660.0 MBoepd, in 2021 to 231.3 MMBoe, or 633.8 MBoepd, in 2022. The increase was attributable to production during the year ended 2022 from properties acquired in the Merger, which significantly expanded our operations, partially offset by lower production in the Marcellus Shale due to the timing of drilling and completion activities.•Natural gas production increased 113.2 Bcf from 911.1 Bcf, or 2,492 MMcf per day, in 2021 to 1,024.3 Bcf, or 2,806 MMcf per day, in 2022. The increase was attributable to production from properties acquired in the Merger, partially offset by lower production in the Marcellus Shale due to the timing of drilling and completion activities.•Oil production increased 24 MMBbl from 8 MMBbl in 2021 to 32 MMBbl in 2022. The increase was attributable to production from properties acquired in the Merger.•NGL production increased 22 MMBbl from 7 MMBbl in 2021 to 29 MMBbl in 2022. The increase was attributable to production from properties acquired in the Merger.•Average realized natural gas price for 2022 was $4.91 per Mcf, 80 percent higher than the $2.73 per Mcf price realized in 2021. •Average realized oil price for 2022 was $84.33 per Bbl, 40 percent higher than the $60.35 per Bbl price realized in 2021. •Average realized NGL price for 2022 was $33.58 per Bbl, two percent lower than the $34.18 per Bbl price realized in 2021.•Total capital expenditures were $1.7 billion in 2022 compared to $725 million in 2021. The increase in capital expenditures was attributable to our expanded operations after the Merger.•Drilled 285 gross wells (174.6 net) with a success rate of 99.6 percent in 2022 compared to 114 gross wells (99.9 net) with a success rate of 100 percent in 2021. •Completed 251 gross wells (151.2 net) in 2022 compared to 132 gross wells (108.3 net) in 2021. 39Table of Contents•Average rig count during 2022 was approximately 6.2, 2.9 and 0.9 rigs in the Permian Basin, the Marcellus Shale and the Anadarko Basin, respectively. Average rig count during 2021 was 5.3, 2.5 and 0.9 rigs in the Permian Basin, the Marcellus Shale and the Anadarko Basin, respectively. •Increased our base-plus-variable dividends from $1.12 per common share in 2021 to $2.49 per common share in 2022, as part of the Company’s returns-focused strategy. •Fully executed our share repurchase program and repurchased 48 million shares of common stock for $1.25 billion during 2022. In February 2023, our Board of Directors approved a new share repurchase program which authorizes the purchase of up to $2.0 billion of our common stock.•Redeemed $750 million principal amount of our and Cimarex’s 4.375% senior notes and repaid $37 million principal amount of our 6.51% weighted-average private placement senior notes and $87 million principal amount of our 5.58% weighted-average private placement senior notes during 2022 as part of our efforts to strengthen our balance sheet. Repaid $188 million of private placement senior notes which matured in 2021.Market Conditions and Commodity Prices Our financial results depend on many factors, particularly commodity prices and our ability to find, develop and market our production on economically attractive terms. Commodity prices are affected by many factors outside of our control, including changes in market supply and demand, which are impacted by pipeline capacity constraints, inventory storage levels, basis differentials, weather conditions, geopolitical, economic and other factors. NYMEX oil and natural gas futures prices have strengthened since the reduction of pandemic-related restrictions and increased OPEC+ cooperation. Improving oil and natural gas futures prices in part reflect market expectations of limited U.S. supply growth from publicly traded companies as a result of capital investment discipline and a focus on delivering free cash flow returns to stockholders. In addition, natural gas prices have benefited from strong worldwide liquefied natural gas (“LNG”) demand, which is, in part, a result of buyers shifting from Russian gas due to the Ukraine invasion, sustained higher U.S. exports, lower associated gas growth from oil drilling and improved U.S. economic activity. These pricing increases have been partially offset by reduced gas consumption due to warmer winter weather in the U.S. and Europe and concerns over potential economic recession, negatively impacting natural gas and NGL prices. Oil price futures have improved (although such future prices are still lower than current spot prices) coinciding with recovering global economic activity, lower supply from major oil producing countries, OPEC+ cooperation and moderating inventory levels.Although the current outlook on oil and natural gas prices is generally favorable and our operations have not been significantly impacted in the short-term, in the event further disruptions occur and continue for an extended period of time, our operations could be adversely impacted, commodity prices could decline and our costs may continue to increase further. While oil and natural gas prices have fallen since their peak in 2022, further geopolitical disruptions in 2023, such as those experienced in 2022, may cause such prices to rapidly rise once again. Although we are unable to predict future commodity prices, at current oil, natural gas and NGL price levels, we do not believe that an impairment of our oil and gas properties is reasonably likely to occur in the near future; however, in the event that commodity prices significantly decline or costs increase significantly from current levels, our management would evaluate the recoverability of the carrying value of our oil and gas properties.In addition, the issue of, and increasing political and social attention on, climate change has resulted in both existing and pending national, regional and local legislation and regulatory measures, such as mandates for renewable energy and emissions reductions targeted at limiting or reducing emissions of greenhouse gases. Changes in these laws or regulations may result in delays or restrictions in permitting and the development of projects, may result in increased costs and may impair our ability to move forward with our construction, completions, drilling, water management, waste handling, storage, transport and remediation activities, any of which could have an adverse effect on our financial results. For information about the impact of realized commodity prices on our revenues, refer to “Results of Operations” below. InflationCertain of our capital expenditures and expenses are affected by general inflation, which rose throughout 2022. While rising inflation is typically offset by the higher prices at which we are able to realize on sales of our commodity production, we nevertheless expect to see inflation impact our cost structure into 2023, albeit at a more moderate pace compared to 2022.40ClimateClimate-related regulations and climate-related business trends may impact our business, financial condition and results of our operations, and we may experience the following:•decreased demand for goods or services that produce significant greenhouse gas emissions or are related to carbon-based energy sources;•increased demand for goods that result in lower emissions than competing products;•increased competition to develop innovative new products that result in lower emissions;•increased demand for generation and transmission of energy from alternative energy sources; and•reputational risks resulting from our operations or oil, natural gas and NGLs that we sell as it relates to the production of material greenhouse gas emissions. FINANCIAL CONDITIONLiquidity and Capital ResourcesWe strive to maintain an adequate liquidity level to address commodity price volatility and risk. Our liquidity requirements consist primarily of our planned capital expenditures, payment of contractual obligations (including debt maturity and interest payments), working capital requirements, dividend payments and share repurchases. Although we have no obligation to do so, we may also from time-to-time refinance or retire our outstanding debt through privately negotiated transactions, open market repurchases, redemptions, exchanges, tender offers or otherwise.Our primary sources of liquidity are cash on hand, net cash provided by operating activities and available borrowing capacity under our revolving credit facility. Our liquidity requirements are generally funded with cash flows provided by operating activities, together with cash on hand. However, from time to time, our investments may be funded by bank borrowings (including draws on our revolving credit facility), sales of non-strategic assets, and private or public financing based on our monitoring of capital markets and our balance sheet. Our debt is currently rated as investment grade by the three leading rating agencies, and there are no “rating triggers” in any of our debt agreements that would accelerate the scheduled maturities should our debt rating fall below a certain level. In determining our debt ratings, the agencies consider a number of qualitative and quantitative items including, but not limited to, current commodity prices, our liquidity position, our asset quality and reserve mix, debt levels, cost structure and growth plans. Credit ratings are not recommendations to buy, sell, or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agency. A change in our debt rating could impact our interest rate on any borrowings under our revolving credit facility and our ability to economically access debt markets in the future and could trigger the requirement to post credit support under various agreements, which could reduce the borrowing capacity under our revolving credit facility. We believe that, with operating cash flow, cash on hand and availability under our revolving credit facility, we have the ability to finance our spending plans over the next twelve months and, based on current expectations, for the longer term. We plan to continue our practice of entering into hedging arrangements to reduce the impact of commodity price volatility on our cash flow from operations.Our working capital is substantially influenced by the variables discussed above and fluctuates based on the timing and amount of borrowings and repayments under our revolving credit facility, repayments of debt, the timing of cash collections and payments on our trade accounts receivable and payable, respectively, payment of dividends, repurchases of our securities and changes in the fair value of our commodity derivative activity. From time to time, our working capital will reflect a deficit, while at other times it will reflect a surplus. This fluctuation is not unusual. At December 31, 2022 and 2021, we had a working capital surplus of $1.0 billion and $916 million, respectively. We believe we have adequate liquidity and availability as outlined above to meet our working capital requirements over the next 12 months.We had $1.5 billion of capacity on our revolving credit facility at December 31, 2022, and unrestricted cash on hand of $673 million. 41Table of ContentsCash FlowsOur cash flows from operating activities, investing activities and financing activities are as follows: Year Ended December 31,(In millions)202220212020Cash flows provided by operating activities$5,456 $1,667 $778 Cash flows (used in) provided by investing activities(1,674)313 (584)Cash flows used in financing activities(4,145)(1,086)(256)Operating Activities. Net cash provided by operating activities in 2022 increased by $3.8 billion compared to 2021. This increase was primarily due to higher net income as a result of higher natural gas, oil and NGL revenue, partially offset by higher operating expenses, higher cash paid on derivative settlements and unfavorable changes in working capital and other assets and liabilities. The increase in natural gas, oil and NGL revenue was primarily due to increased production as a result of the Merger and an overall increase in commodity prices. Average oil and natural gas prices increased by $18.86 per Bbl and $2.27 per Mcf, respectively, and average NGL prices decreased $0.60 per Bbl in 2022 compared to 2021. On October 1, 2021, we and Cimarex completed the Merger. Although we expect to achieve certain general and administrative expense synergies over the long-term through cost savings, in the near-term we will continue to incur certain severance costs related to the Merger, which in total are expected to range from $100 million to $110 million. These payments will primarily relate to workforce reductions and the associated employee severance benefits. As of December 31, 2022, we have incurred approximately $96 million of employee severance benefits.Refer to “Results of Operations” for additional information relative to commodity price, production and operating expense fluctuations. We are unable to predict future commodity prices and, as a result, cannot provide any assurance about future levels of net cash provided by operating activities. Investing Activities. Cash flows used in investing activities increased by $2.0 billion from 2021 to 2022. The increase was primarily due to $982 million of higher capital expenditures as a result of our expanded operations after the Merger and $1.0 billion of cash held by Cimarex that was subsequently reflected on our balance sheet after consummation of the Merger in 2021.Financing Activities. Cash flows used in financing activities increased by $3.1 billion from 2021 to 2022. The increase was due to $1.3 billion of higher share repurchases during 2022, $1.2 billion of higher dividend payments in 2022 compared to 2021, and $686 million higher net repayments of debt. These increases were partially offset by $89 million lower tax withholding payments related to share-based awards that vested as a result of the Merger.Revolving Credit FacilityWe had $1.5 billion of capacity on our revolving credit facility at December 31, 2022. The revolving credit facility is scheduled to mature in April 2024, subject to extension up to one year if certain conditions are met. Our revolving credit facility bears interest at a margin above rates offered by certain designated banks in the London interbank market or at a margin above the overnight federal funds rate or prime rates by certain designated banks in the U.S. Additionally, our revolving credit facility includes certain customary covenants, including a covenant limiting our borrowing capacity based on our leverage ratio. Our revolving credit facility also requires us to maintain a leverage ratio of no more than 3.0 to 1.0 until such time as we have no other debt outstanding that has a financial maintenance covenant based on a leverage ratio, and thereafter requires us to maintain a ratio of total debt to total capitalization of no more than 65 percent. At December 31, 2022, we were in compliance with all financial covenants for our revolving credit facility, and had no borrowings outstanding under our revolving credit facility. Refer to Note 4 of the Notes to the Consolidated Financial Statements, “Long-Term Debt and Credit Agreements,” for further details regarding the interest rate on future borrowings under the revolving credit facility and our leverage ratio. Certain Restrictive Covenants Our ability to incur debt, incur liens, pay dividends, repurchase or redeem our equity interests, redeem our senior notes, make certain types of investments, enter into mergers, sell assets, enter into transactions with affiliates, and engage in certain other activities are subject to certain restrictive covenants in our various debt instruments. In addition, the senior note agreements governing various series of senior notes that were issued in separate private placements (the “private placement senior notes”) require us to maintain a minimum annual coverage ratio of consolidated cash flow to interest expense for the trailing four quarters of 2.8 to 1.0 and require a maximum ratio of total debt to consolidated EBITDA for the trailing four quarters of not more than 3.0 to 1.0. At December 31, 2022, we were in compliance with all financial covenants in our private 42Table of Contentsplacement senior notes. Refer to Note 4 of the Notes to the Consolidated Financial Statements, “Long-Term Debt and Credit Agreements,” for further details regarding the restrictive covenants contained in our various debt instruments. CapitalizationInformation about our capitalization is as follows: December 31,(Dollars in millions)20222021Total debt$2,181$3,125Stockholders' equity12,65911,738Total capitalization $14,840$14,863Debt to total capitalization 15%21%Cash and cash equivalents $673$1,036On September 29, 2021, our stockholders approved an amendment to our certificate of incorporation to increase the number of authorized shares of our common stock from 960,000,000 shares to 1,800,000,000 shares. That amendment became effective on October 1, 2021. On October 1, 2021 and following the effectiveness of the Merger, we issued approximately 408.2 million shares of common stock to Cimarex stockholders under the terms of the Merger Agreement (excluding shares that were awarded in replacement of previously outstanding Cimarex restricted share awards).Common stock repurchases. In February 2022, our Board of Directors terminated our previously authorized share repurchase program and approved a share repurchase program which allowed us to purchase up to $1.25 billion of our common stock in the open market or in negotiated transactions. As of December 31, 2022, this repurchase program was fully executed and in February 2023 our Board of Directors approved a new share repurchase program which authorizes the purchase of $2.0 billion of our common stock.During 2022, we repurchased 48 million shares of our common stock for $1.25 billion under our authorized share repurchase program. We did not repurchase any shares of our common stock during 2021 under our previously authorized share repurchase program. During the years ended December 31, 2022 and 2021, 320,236 and 125,067 shares of common stock, respectively, were recorded as treasury stock related to common shares that were retained from vested restricted stock awards for withholding of taxes. In December 2022, our Board of Directors authorized the retirement of our common stock held in treasury and as of December 31, 2022, there were no common shares held in Treasury Stock on the Consolidated Balance Sheet. Prospectively, share repurchases and shares withheld for the vesting of stock awards will be retired in the period in which they are repurchased or withheld.Dividends. In February 2022, our Board of Directors approved an increase in our base quarterly dividend from $0.125 per share to $0.15 per share beginning in the first quarter of 2022. Our Board of Directors previously approved an increase in our base quarterly dividend rate in the fourth quarter of 2021 and second quarter of 2021 from $0.11 per share to $0.125 per share and from $0.10 per share to $0.11 per share, respectively. The following table presents our dividends paid on our common stock for the full year 2022 and 2021. Rate per shareBaseVariableTotalTotal Dividends Paid (In millions)2022$0.60 $1.89 $2.49 $1,991 2021 (1)$0.45 $0.67 $1.12 $779 ________________________________________________________(1)Includes a special dividend of $0.50 per share on our common stock that was paid following the completion of the Merger. In February 2023, our Board of Directors approved an increase in our base quarterly dividend from $0.15 per share to $0.20 per share beginning in the first quarter of 2023, and approved a quarterly base dividend of $0.20 per share and a variable dividend of $0.37 per share, resulting in a total base-plus-variable dividend of $0.57 per share on our common stock. 43Table of ContentsCapital and Exploration ExpendituresOn an annual basis, we generally fund most of our capital expenditures, excluding any significant property acquisitions, with cash generated from operations and, if required, borrowings under our revolving credit facility. We budget these expenditures based on our projected cash flows for the year. The following table presents major components of our capital and exploration expenditures: Year Ended December 31,(In millions)202220212020Acquisitions(1) :Proved$— $7,472 $— Unproved— 5,381 — Total$— $12,853 $— Capital expenditures Drilling and facilities$1,617 $688 $547 Leasehold acquisitions10 5 6 Pipeline and gathering56 9 — Other54 23 17 1,737 725 570 Exploration expenditures(2)29 18 15 Total$1,766 $743 $585 _______________________________________________________________________________(1)These amounts represent the fair value of the proved and unproved properties recorded in the purchase price allocation with respect to the Merger. The purchase was funded through the issuance of our common stock.(2)There were no exploratory dry-hole costs in 2022 or 2021. Exploration expenditures include $4 million of exploratory dry-hole costs in 2020. In 2022, we drilled 285 gross wells (174.6 net) and completed 251 gross wells (151.2 net), of which 58 gross wells (37.2 net) were drilled but uncompleted in prior years. Our 2023 capital program is expected to be approximately $2.0 billion to $2.2 billion. We expect to turn-in-line 150 to 175 total net wells in 2023 across our three operating regions. Approximately 49 percent of our drilling and completion capital will be invested in the Permian Basin, 44 percent in the Marcellus Shale and the balance in the Anadarko Basin. The increase in our year-over-year capital expenditures is primarily driven by our expectations around the impact of inflation on our 2023 capital program and a modest increase in activity. We will continue to assess the commodity price environment and may increase or decrease our capital expenditures accordingly. Contractual ObligationsWe have various contractual obligations in the normal course of our operations. As of December 31, 2022, our material contractual obligations include debt and related interest expense, transportation and gathering agreements, lease obligations, operational agreements, drilling and completion obligations, derivative obligations and asset retirement obligations. Other joint owners in the properties operated by us could incur a portion of these costs. We expect that our sources of capital will be adequate to fund these obligations. Refer to the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report for further details.From time to time, we enter into arrangements that can give rise to material off-balance sheet obligations. As of December 31, 2022, the material off-balance sheet arrangements we had entered into included certain firm transportation and processing commitments and operating lease agreements with terms at commencement of less than 12 months for equipment used in our exploration and development activities. We have no other off-balance sheet debt or other similar unrecorded obligations.44Table of ContentsCritical Accounting EstimatesThe preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the balance sheet, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and changes in our estimates are recorded when known. We consider the following to be our most critical estimates that involve judgement of management.Purchase AccountingFrom time to time we may acquire assets and assume liabilities in transactions accounted for as business combinations, such as the Merger. In connection with the Merger in 2021, we allocated the $9.1 billion of purchase price consideration to the assets acquired and liabilities assumed based on estimated fair values as of the effective date of the Merger. The purchase price allocation is complete and there were no material adjustments to the amounts previously disclosed.We made a number of assumptions in estimating the fair value of assets acquired and liabilities assumed in the Merger. The most significant assumptions related to the fair value estimates of proved and unproved oil and gas properties, which were recorded at fair value of $12.9 billion. Because sufficient market data was not available regarding the fair values of the acquired proved and unproved oil and gas properties, we prepared our estimates using discounted cash flows and engaged third party valuation experts. Significant judgments and assumptions are inherent in these estimates and include, among other things, estimates of reserves quantities and production volumes, future commodity prices and price differentials, expected development costs, lease operating costs, reserves risk adjustment factors and an estimate of an applicable market participant discount rate that reflects the risk of the underlying cash flow estimates.Estimated fair values assigned to assets acquired can have a significant impact on future results of operations, as presented in our financial statements. Fair values are based on estimates of future commodity prices and price differentials, reserves quantities and production volumes, development costs and lease operating costs. In the event that future commodity prices or reserves quantities or production volumes are significantly lower than those used in the determination of fair value as of the effective date of the Merger, the likelihood increases that certain costs may be determined to be unrecoverable.In addition to the fair value of proved and unproved oil and gas properties, other significant fair value assessments for the assets acquired and liabilities assumed in the Merger relate to long-term debt, fixed assets and derivative instruments. The fair value of the assumed Cimarex publicly traded debt was based on available third-party quoted prices. We prepared estimates and engaged third-party valuation experts to assist in the valuation of certain fixed assets, which required significant judgments and assumptions inherent in the estimates and included projected cash flows and comparable companies’ cash flow multiples. The fair value of assumed derivative instrument liabilities included significant judgments and assumptions related to estimates of future commodity prices and related differentials and estimates of volatility factors and interest rates.Successful Efforts Method of AccountingWe follow the successful efforts method of accounting for our oil and gas producing activities. Acquisition costs for proved and unproved properties are capitalized when incurred. Judgment is required to determine the proper classification of wells designated as developmental or exploratory, which ultimately will determine the proper accounting treatment of costs incurred. Exploration costs, including geological and geophysical costs, the costs of carrying and retaining unproved properties and exploratory dry-hole costs are expensed. Development costs, including costs to drill and equip development wells and successful exploratory drilling costs to locate proved reserves, are capitalized. Oil and Gas ReservesThe process of estimating quantities of proved reserves is inherently imprecise, and the reserves data included in this document is only an estimate. The process relies on interpretations and judgment of available geological, geophysical, engineering and production data. The extent, quality and reliability of this technical data can vary. The process also requires certain economic assumptions, some of which are mandated by the SEC, such as commodity prices. Additional assumptions include drilling and operating expenses, capital expenditures, taxes and availability of funds. Any significant variance in the interpretations or assumptions could materially affect the estimated quantity and value of our reserves and can change substantially over time. Periodic revisions to the estimated reserves and future cash flows may be necessary as a result of reservoir performance, drilling activity, commodity prices, fluctuations in operating expenses, technological advances, new geological or geophysical data or other economic factors. Accordingly, reserves estimates are generally different from the quantities ultimately recovered. 45Table of ContentsThe reserves estimates of our oil and gas properties have been prepared by our petroleum engineering staff and certain of our reserves are subject to an evaluation performed by an independent third-party petroleum consulting firm. In 2022, greater than 90 percent of the total future net revenue discounted at 10 percent attributable to our proved reserves were subject to this evaluation. For more information regarding reserves estimation, including historical reserves revisions, refer to the Supplemental Oil and Gas Information included in
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto included in Item 8 “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. This section of this Form 10-K generally discusses fiscal 2023 and 2022 items and year-over-year comparisons between fiscal 2023 and 2022. Discussions of fiscal 2021 items and year-over-year comparisons between fiscal 2022 and 2021 are not included in this Form 10-K, and can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 31, 2022. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties, including those described under the heading “Special Note Regarding Forward-Looking Statements.” You should review the disclosure under Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Our fiscal years ended January 31, 2023, January 31, 2022, and January 31, 2021, are referred to herein as fiscal 2023, fiscal 2022, and fiscal 2021, respectively.OverviewFounded in 2011, CrowdStrike reinvented cybersecurity for the cloud era and transformed the way cybersecurity is delivered and experienced by customers. When we started CrowdStrike, cyberattackers had an asymmetric advantage over legacy cybersecurity products that could not keep pace with the rapid changes in adversary tactics. We took a fundamentally different approach to solve this problem with the CrowdStrike Falcon platform – the first, true cloud-native platform capable of harnessing vast amounts of security and enterprise data to deliver highly modular solutions through a single lightweight agent. Our pioneering platform approach keeps customers ahead of attackers by automatically detecting and preventing threats to stop breaches.We believe our approach has defined a new category called the Security Cloud, which has the power to transform the cybersecurity industry the same way the cloud has transformed the customer relationship management, human resources, and service management industries. Using cloud-scale AI, our Security Cloud enriches and correlates trillions of cybersecurity events per week with indicators of attack, threat intelligence, and enterprise data (including data from across endpoints, workloads, identities, DevOps, IT assets, and configurations) to create actionable data, identify shifts in adversary tactics, and automatically prevent threats in real-time across our customer base. The more data that is fed into our Falcon platform, the more intelligent our Security Cloud becomes, and the more our customers benefit, creating a powerful network effect that increases the overall value we provide.Our Go-To-Market StrategyWe sell subscriptions to our Falcon platform and cloud modules to organizations across multiple industries. We primarily sell subscriptions to our Falcon platform and cloud modules through our direct sales team that leverages our network of channel partners. Our direct sales team is comprised of field sales and inside sales professionals who are segmented by a customer’s number of endpoints.We have a low friction land-and-expand sales strategy. When customers deploy our Falcon platform, they can start with any number of cloud modules and easily add additional cloud modules. Once customers experience the benefits of our Falcon platform, they often expand their adoption over time by adding more endpoints or purchasing additional modules. We also use our sales team to identify current customers who may be interested in free trials of additional cloud modules, which serves as a powerful driver of our land-and-expand model. By segmenting our sales teams, we can deploy a low-touch sales model that efficiently identifies prospective customers.We began as a solution for large enterprises, but the flexibility and scalability of our Falcon platform has enabled us to seamlessly offer our solution to customers of any size. We have expanded our sales focus to include any sized organization without the need to modify our Falcon platform for small and medium sized businesses.57Table of ContentsA substantial majority of our customers purchase subscriptions with a term of one year. Our subscriptions are generally priced on a per-endpoint and per-module basis. We recognize revenue from our subscriptions ratably over the term of the subscription. We also generate revenue from our incident response and proactive professional services, which are generally priced on a time and materials basis. We view our professional services business primarily as an opportunity to cross-sell subscriptions to our Falcon platform and cloud modules.Certain Factors Affecting Our PerformanceAdoption of Our Solutions. We believe our future success depends in large part on the growth in the market for cloud-based SaaS-delivered endpoint security solutions. Many organizations have not yet abandoned the on-premise legacy products in which they have invested substantial personnel and financial resources to design and maintain. As a result, it is difficult to predict customer adoption rates and demand for our cloud-based solutions.New Customer Acquisition. Our future growth depends in large part on our ability to acquire new customers. If our efforts to attract new customers are not successful, our revenue and rate of revenue growth may decline. We believe that our go-to-market strategy and the flexibility and scalability of our Falcon platform allow us to rapidly expand our customer base. Our incident response and proactive services also help drive new customer acquisitions, as many of these professional services customers subsequently purchase subscriptions to our Falcon platform. Many organizations have not yet adopted cloud-based security solutions, and since our Falcon platform has offerings for organizations of all sizes, worldwide, and across industries, we believe this presents a significant opportunity for growth.Maintain Customer Retention and Increase Sales. Our ability to increase revenue depends in large part on our ability to retain our existing customers and increase the ARR of their subscriptions. We focus on increasing sales to our existing customers by expanding their deployments to more endpoints and selling additional cloud modules for increased functionality. Over time we have transitioned our platform from a single offering into highly-integrated offerings of multiple cloud modules. Invest in Growth. We believe that our market opportunity is large and requires us to continue to invest significantly in sales and marketing efforts to further grow our customer base, both domestically and internationally. Our open cloud architecture and single data model have allowed us to rapidly build and deploy new cloud modules, and we expect to continue investing in those efforts to further enhance our technology platform and product functionality. In addition to our ongoing investment in research and development, we may also pursue acquisitions of businesses, technologies, and assets that complement and expand the functionality of our Falcon platform, add to our technology or security expertise, or bolster our leadership position by gaining access to new customers or markets. Furthermore, we expect our general and administrative expenses to increase in dollar amount for the foreseeable future given the additional expenses for accounting, compliance, and investor relations as we grow as a public company.Key MetricsWe monitor the following key metrics to help us evaluate our business, identify trends affecting our business, formulate business plans, and make strategic decisions.Subscription CustomersWe define a subscription customer as a separate legal entity that has entered into a distinct subscription agreement for access to Falcon platform for which the term has not ended or with which we are negotiating a renewal contract. We do not consider our channel partners as customers, and we treat managed service security providers, who may purchase our products on behalf of multiple companies, as a single customer. While initially we focused our sales and marketing efforts on large enterprises, in recent years we have also increased our sales and marketing to small and medium sized businesses. The following table sets forth the number of our subscription customers as of the dates presented:As of January 31,20232022Subscription customers23,019 16,325 Year-over-year growth41 %65 %58Table of ContentsWe added 6,694 net new subscription customers during fiscal 2023, for a total of 23,019 subscription customers as of January 31, 2023, representing 41% growth year-over-year. We added 6,429 net new subscription customers during fiscal 2022 for a total of 16,325 subscription customers as of January 31, 2022, representing 65% growth year-over-year. Given our initiatives to grow customers served through our managed service security provider partners, which are not included in our subscription customer metrics, and to move further down-market, as well as the growing number of smaller end customers that we serve, which tend to contribute significantly less ARR on a per customer basis when compared to larger enterprises, we believe that our subscription customer metric no longer provides valuable insight into the performance of our business. As a result, beginning in the first quarter of fiscal 2024, we will no longer provide a number of subscription customers as a key metric on which to evaluate the strength of our business. Annual Recurring Revenue (“ARR”)ARR is calculated as the annualized value of our customer subscription contracts as of the measurement date, assuming any contract that expires during the next 12 months is renewed on its existing terms. To the extent that we are negotiating a renewal with a customer after the expiration of the subscription, we continue to include that revenue in ARR if we are actively in discussion with such an organization for a new subscription or renewal, or until such organization notifies us that it is not renewing its subscription.The following table sets forth our ARR as of the dates presented (dollars in thousands):As of January 31,20232022Annual recurring revenue$2,559,694$1,731,342Year-over-year growth48 %65 %ARR increased 48% year-over-year and grew to $2.6 billion as of January 31, 2023, of which $828.4 million was net new ARR added during fiscal 2023. ARR increased 65% year-over-year and grew to $1.7 billion as of January 31, 2022, of which $681.3 million was net new ARR added during fiscal 2022, including $4.5 million from the acquisitions of Humio and SecureCircle.Dollar-Based Net Retention RateOur dollar-based net retention rate compares our ARR from a set of subscription customers against the same metric for those subscription customers from the prior year. Our dollar-based net retention rate reflects customer renewals, expansion, contraction, and churn, and excludes revenue from our incident response and proactive services. We calculate our dollar-based net retention rate as of period end by starting with the ARR from all subscription customers as of 12 months prior to such period end, or Prior Period ARR. We then calculate the ARR from these same subscription customers as of the current period end, or Current Period ARR. Current Period ARR includes any expansion and is net of contraction or churn over the trailing 12 months but excludes revenue from new subscription customers in the current period. We then divide the Current Period ARR by the Prior Period ARR to arrive at our dollar-based net retention rate.Our dollar-based net retention rate was above 120% throughout fiscal years 2023 and 2022. Our dollar-based net retention rate can fluctuate from period to period due to large customer contracts in a given period, which may reduce our dollar-based net retention rate in subsequent periods if the customer makes a larger upfront purchase and does not continue to increase purchases.As of January 31,20232022Dollar-based net retention rate125.3 %123.9 %Our dollar-based net retention rate has varied from quarter to quarter due to a number of factors, and we expect that trend to continue. In addition, we have seen strong success with our strategy to land bigger deals with more modules, and we are also seeing an acceleration in our acquisition of new customers. While we view these two trends as positive developments, they have a natural trade off on our ability to expand business with existing customers in the near term.59Table of ContentsComponents of Our Results of OperationsRevenueSubscription Revenue. Subscription revenue primarily consists of subscription fees for our Falcon platform and additional cloud modules that are supported by our cloud-based platform. Subscription revenue is driven primarily by the number of subscription customers, the number of endpoints per customer, and the number of cloud modules included in the subscription. We recognize subscription revenue ratably over the term of the agreement, which is generally one to three years. Because the majority of our subscription customers are billed upfront, we have recorded significant deferred revenue. Consequently, a substantial portion of the revenue that we report in each period is attributable to the recognition of deferred revenue relating to subscriptions that we entered into during previous periods. The majority of our customers are invoiced annually in advance or multi-year in advance.Professional Services Revenue. Professional services revenue includes incident response and proactive services, forensic and malware analysis, and attribution analysis. Professional services are generally sold separately from subscriptions to our Falcon platform, although customers frequently enter into a separate arrangement to purchase subscriptions to our Falcon platform at the conclusion of a professional services arrangement. Professional services are available through hourly rate and fixed fee contracts, one-time and ongoing engagements, and retainer-based agreements. For time and materials and retainer-based arrangements, revenue is recognized as services are performed. Fixed fee contracts account for an immaterial portion of our revenue.Cost of RevenueSubscription Cost of Revenue. Subscription cost of revenue consists primarily of costs related to hosting our cloud-based Falcon platform in data centers, amortization of our capitalized internal-use software, employee-related costs such as salaries and bonuses, stock-based compensation expense, benefits costs associated with our operations and support personnel, software license fees, property and equipment depreciation, amortization of acquired intangibles, and an allocated portion of facilities and administrative costs.As new customers subscribe to our platform and existing subscription customers increase the number of endpoints on our Falcon platform, our cost of revenue will increase due to greater cloud hosting costs related to powering new cloud modules and the incremental costs for storing additional data collected for such cloud modules and employee-related costs. We intend to continue to invest additional resources in our cloud platform and our customer support organizations as we grow our business. The level and timing of investment in these areas could affect our cost of revenue in the future.Professional Services Cost of Revenue. Professional services cost of revenue consists primarily of employee-related costs, such as salaries and bonuses, stock-based compensation expense, technology, property and equipment depreciation, and an allocated portion of facilities and administrative costs.Gross Profit and Gross MarginGross profit and gross margin have been and will continue to be affected by various factors, including the timing of our acquisition of new subscription customers, renewals from existing subscription customers, sales of additional modules to existing subscription customers, the data center and bandwidth costs associated with operating our cloud platform, the extent to which we expand our customer support and cloud operations organizations, and the extent to which we can increase the efficiency of our technology, infrastructure, and data centers through technological improvements. We expect our gross profit to increase in dollar amount and our gross margin to increase modestly over the long term, although our gross margin could fluctuate from period to period depending on the interplay of these factors. Demand for our incident response services is driven by the number of breaches experienced by non-customers. Also, we view our professional services solutions in the context of our larger business and as a significant lead generator for new subscriptions. Because of these factors, our services revenue and gross margin may fluctuate over time.Operating ExpensesOur operating expenses consist of sales and marketing, research and development, and general administrative expenses. For each of these categories of expense, employee-related expenses are the most significant component, which include salaries, 60Table of Contentsemployee bonuses, sales commissions, and employer payroll tax. Operating expenses also include an allocated portion of overhead costs for facilities and IT.Sales and Marketing. Sales and marketing expenses primarily consist of employee-related expenses such as salaries, commissions, and bonuses. Sales and marketing expenses also include stock-based compensation; expenses related to our Fal.Con customer conference and other marketing events; an allocated portion of facilities and administrative expenses; amortization of acquired intangibles, and cloud hosting and related services costs related to proof of value efforts. Sales and marketing expenses also include sales commissions and any other incremental payments made upon the initial acquisition of a subscription or upsells to existing customers, which are capitalized and amortized over the estimated customer life. We also capitalize and amortize any such expenses paid for the renewal of a subscription over the term of the renewal.We expect sales and marketing expenses to increase in dollar amount as we continue to make significant investments in our sales and marketing organization to drive additional revenue, further penetrate the market, and expand our global customer base. However, we anticipate sales and marketing expenses to decrease as a percentage of our total revenue over time, although our sales and marketing expenses may fluctuate as a percentage of our total revenue from period-to-period depending on the timing of these expenses.Research and Development. Research and development expenses primarily consist of employee-related expenses such as salaries and bonuses; stock-based compensation; consulting expenses related to the design, development, testing, and enhancements of our subscription services; and an allocated portion of facilities and administrative expenses. Our cloud platform is software-driven, and our research and development teams employ software engineers in the design, and the related development, testing, certification, and support of these solutions.We expect research and development expenses to increase in dollar amount as we continue to increase investments in our technology architecture and software platform. However, we anticipate research and development expenses to decrease as a percentage of our total revenue over time, although our research and development expenses may fluctuate as a percentage of our total revenue from period-to-period depending on the timing of these expenses.General and Administrative. General and administrative expenses consist of employee-related expenses such as salaries and bonuses; stock-based compensation; and related expenses for our executive, finance, human resources, and legal organizations. In addition, general and administrative expenses include outside legal, accounting, and other professional fees; and an allocated portion of facilities and administrative expenses.We expect general and administrative expenses to increase in dollar amount over time. However, we anticipate general and administrative expenses to decrease as a percentage of our total revenue over time although our general and administrative expenses may fluctuate as a percentage of our total revenue from period-to-period depending on the timing of these expenses.Interest Expense. Interest expense consists primarily of amortization of debt issuance costs, contractual interest expense for our Senior Notes issued in January 2021, and amortization of debt issuance costs on our secured revolving credit facility. Interest Income. Interest income consists primarily of income earned on our cash and cash equivalents and short-term investments.Other Income, Net. Other income, net, consists primarily of gain and losses on strategic investments and foreign currency transaction gains and losses.Provision for Income Taxes. Provision for income taxes consists of state income taxes in the United States, foreign income taxes, including taxes related to the intercompany sale of intellectual property, and withholding taxes related to customer payments in certain foreign jurisdictions in which we conduct business. We maintain a full valuation allowance on our U.S. federal and state and U.K. deferred tax assets, which we have determined are not realizable on a more likely than not basis.Net Income Attributable to Non-controlling Interest. Net income attributable to non-controlling interest consists of the Falcon Funds’ non-controlling interest share of mark-to-market gains and losses and interest income from our strategic investments.61Table of ContentsResults of OperationsThe following tables set forth our consolidated statements of operations for each period presented (in thousands, except percentages):Year Ended January 31,202320222021RevenueSubscription$2,111,660 $1,359,537 $804,670 Professional services129,576 92,057 69,768 Total revenue2,241,236 1,451,594 874,438 Cost of revenueSubscription511,684 321,904 185,212 Professional services89,547 61,317 44,333 Total cost of revenue601,231 383,221 229,545 Gross profit1,640,005 1,068,373 644,893 Operating expensesSales and marketing904,409 616,546 401,316 Research and development608,364 371,283 214,670 General and administrative317,344 223,092 121,436 Total operating expenses1,830,117 1,210,921 737,422 Loss from operations(190,112)(142,548)(92,529)Interest expense(25,319)(25,231)(1,559)Interest income52,495 3,788 4,968 Other income, net3,053 3,968 1,251 Loss before provision for income taxes(159,883)(160,023)(87,869)Provision for income taxes22,402 72,355 4,760 Net loss(182,285)(232,378)(92,629)Net income attributable to non-controlling interest960 2,424 — Net loss attributable to CrowdStrike$(183,245)$(234,802)$(92,629)62Table of ContentsThe following table presents the components of our consolidated statements of operations as a percentage of total revenue for the periods presented:Year Ended January 31,202320222021%%%RevenueSubscription94 %94 %92 %Professional services6 %6 %8 %Total revenue100 %100 %100 %Cost of revenueSubscription23 %22 %21 %Professional services4 %4 %5 %Total cost of revenue27 %26 %26 %Gross profit73 %74 %74 %Operating expensesSales and marketing40 %42 %46 %Research and development27 %26 %25 %General and administrative14 %15 %14 %Total operating expenses82 %83 %84 %Loss from operations(8)%(10)%(11)%Interest expense(1)%(2)%— %Interest income2 %— %1 %Other income, net— %— %— %Loss before provision for income taxes(7)%(11)%(10)%Provision for income taxes1 %5 %1 %Net loss(8)%(16)%(11)%Net income attributable to non-controlling interest— %— %— %Net loss attributable to CrowdStrike(8)%(16)%(11)%Comparison of Fiscal 2023 and Fiscal 2022RevenueThe following shows total revenue from subscriptions and professional services for fiscal 2023, as compared to fiscal 2022 (in thousands, except percentages):Change20232022$%Subscription$2,111,660 $1,359,537 $752,123 55 %Professional services129,576 92,057 37,519 41 %Total revenue$2,241,236 $1,451,594 $789,642 54 %Total revenue increased by $789.6 million, or 54%, in fiscal 2023, compared to fiscal 2022. Subscription revenue accounted for 94% of our total revenue in each of fiscal 2023 and fiscal 2022. Professional services revenue accounted for 6% of our total revenue in each of fiscal 2023 and fiscal 2022.Subscription revenue increased by $752.1 million, or 55%, in fiscal 2023, compared to fiscal 2022, which was primarily driven by a combination of the addition of new customers and the sale of additional endpoints and modules to existing customers. As of January 31, 2023, we had a total of 23,019 subscription customers, which represents 41% growth from January 31, 2022.63Table of ContentsProfessional services revenue increased by $37.5 million, or 41%, in fiscal 2023, compared to fiscal 2022, which was primarily attributable to an increase in the number of professional service hours performed and an increase in services offerings that are not based on billable hours.Cost of Revenue, Gross Profit, and Gross MarginThe following shows cost of revenue related to subscriptions and professional services for fiscal 2023, as compared to fiscal 2022 (in thousands, except percentages):Change20232022$%Subscription$511,684 $321,904 $189,780 59 %Professional services89,547 61,317 28,230 46 %Total cost of revenue$601,231 $383,221 $218,010 57 %Total cost of revenue increased by $218.0 million, or 57%, in fiscal 2023, compared to fiscal 2022. Subscription cost of revenue increased by $189.8 million, or 59%, in fiscal 2023, compared to fiscal 2022. The increase in subscription cost of revenue was primarily due to an increase in cloud hosting and related services cost of $100.0 million driven by increased customer activity, an increase in employee-related expenses of $43.1 million driven by a 47% increase in average headcount, an increase in stock-based compensation expense of $10.0 million, an increase in amortization of internal-use software of $9.1 million, an increase in allocated overhead costs of $8.4 million, an increase in depreciation of data center equipment of $8.2 million, an increase in term-based software licenses of $3.9 million, an increase in amortization of intangible assets of $3.1 million, and an increase in employee health insurance costs of $2.8 million.Professional services cost of revenue increased by $28.2 million, or 46%, in fiscal 2023, compared to fiscal 2022. The increase in professional services cost of revenue was primarily due to an increase in employee-related expenses of $17.0 million driven by an increase in average headcount of 46%, an increase in stock-based compensation expense of $5.6 million, an increase in allocated overhead costs of $2.4 million, an increase in consulting expense of $2.0 million, and an increase in employee health insurance costs of $1.0 million.The following shows gross profit and gross margin for subscriptions and professional services for fiscal 2023, as compared to fiscal 2022 (in thousands, except percentages):Change20232022$%Subscription gross profit$1,599,976 $1,037,633 $562,343 54 %Professional services gross profit40,029 30,740 9,289 30 %Total gross profit$1,640,005 $1,068,373 $571,632 54 %Change20232022Subscription gross margin76 %76 %— %Professional services gross margin31 %33 %(2)%Total gross margin73 %74 %(1)%Subscription gross margin was relatively flat for fiscal 2023, compared to fiscal 2022. Professional services gross margin decreased by 2% in fiscal 2023, compared to fiscal 2022. The decrease in professional services gross margin was primarily due to higher employee-related expenses and higher stock-based compensation, partially offset by an increase in the number of professional service hours performed and an increase in service offerings that are not based on billable hours during fiscal 2023 compared to fiscal 2022.64Table of ContentsOperating ExpensesSales and MarketingThe following shows sales and marketing expenses for fiscal 2023, as compared to fiscal 2022 (in thousands, except percentages):Change20232022$%Sales and marketing expenses$904,409 $616,546 $287,863 47 %Sales and marketing expenses increased by $287.9 million, or 47%, in fiscal 2023, compared to fiscal 2022. The increase in sales and marketing expenses was primarily due to an increase in employee-related expenses of $146.8 million driven by an increase in sales and marketing average headcount of 41%, an increase in stock-based compensation of $62.3 million, an increase in marketing programs of $21.8 million, an increase in allocated overhead costs of $18.6 million, an increase in travel expenses of $9.6 million, an increase in company events expenses of $6.7 million, an increase in employee health insurance costs of $6.4 million, and an increase in term-based software licenses of $2.7 million.Research and DevelopmentThe following shows research and development expenses for fiscal 2023, as compared to fiscal 2022 (in thousands, except percentages):Change20232022$%Research and development expenses$608,364 $371,283 $237,081 64 %Research and development expenses increased by $237.1 million, or 64% in fiscal 2023, compared to fiscal 2022. This increase was primarily due to an increase in employee-related expenses of $110.9 million driven by an increase in research and development average headcount of 53%, an increase in stock-based compensation of $72.7 million, an increase in allocated overhead costs of $17.0 million, an increase in cloud hosting and related costs of $13.5 million, an increase in company events expenses of $10.8 million, an increase in travel expenses of $4.9 million, an increase in employee health insurance costs of $4.8 million, and an increase in term-based software licenses of $3.2 million.General and AdministrativeThe following shows general and administrative expenses for fiscal 2023, as compared to fiscal 2022 (in thousands, except percentages):Change20232022$%General and administrative expenses$317,344 $223,092 $94,252 42 %General and administrative expenses increased by $94.3 million, or 42%, in fiscal 2023, compared to fiscal 2022. The increase in general and administrative expenses was primarily due to an increase in stock-based compensation expense of $65.9 million, an increase in employee-related expenses of $21.7 million driven by an increase in general and administrative average headcount of 46%, an increase in allocated overhead costs of $4.7 million, an increase in facilities expenses of $2.5 million, an increase in term-based software licenses of $1.6 million, an increase in travel expenses of $1.6 million, and an increase in employee health insurance costs of $0.9 million, partially offset by a decrease in legal expense of $5.3 million, and a decrease in consulting expense of $4.3 million.65Table of ContentsInterest Expense, Interest Income and Other Income, NetThe following shows interest expense, interest income, and other income, net, for fiscal 2023, as compared to fiscal 2022 (in thousands, except percentages):Change20232022$%Interest expense$(25,319)$(25,231)$(88)— %Interest income$52,495 $3,788 $48,707 1,286 %Other income, net$3,053 $3,968 $(915)(23)%Interest expense consists primarily of amortization of debt issuance costs, contractual interest expense, and accretion of debt discount for our Senior Notes issued in January 2021.The increase in interest income during fiscal 2023 compared to fiscal 2022 was driven by increases in market interest rates.The decrease in other income, net during fiscal 2023 compared to fiscal 2022 was primarily due to a decrease in net positive mark-to-market adjustments of our strategic investments of $3.2 million, partially offset by a net increase of $2.3 million from foreign currency transaction gains.Provision for Income TaxesThe following shows the provision for income taxes for fiscal 2023, as compared to fiscal 2022 (in thousands, except percentages):Change20232022$%Provision for income taxes$22,402 $72,355 $(49,953)(69)%The decrease in provision for income taxes during fiscal 2023 compared to fiscal 2022 was primarily due to a decrease in tax expense related to gains from the intercompany sale of intellectual property from acquisitions.Liquidity and Capital ResourcesOur primary sources of liquidity as of January 31, 2023, consisted of: (i) $2.5 billion in cash and cash equivalents, which mainly consists of cash on hand and highly liquid investments in time deposits and money market funds, (ii) $250.0 million in short-term investments, which consist of time deposits, (iii) cash we expect to generate from operations, and (iv) available capacity under our $750.0 million senior secured revolving credit facility (the “A&R Credit Agreement”). We expect that the combination of our existing cash and cash equivalents, short-term investments, cash flows from operations, and the A&R Credit Agreement will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.Our short-term and long-term liquidity requirements primarily arise from: (i) business acquisitions and investments we may make from time to time, (ii) working capital requirements, (iii) interest and principal payments related to our outstanding indebtedness, (iv) research and development and capital expenditure needs, and (v) license and service arrangements integral to our business operations. Our ability to fund these requirements will depend, in part, on our future cash flows, which are determined by our future operating performance and, therefore, subject to prevailing global macroeconomic conditions and financial, business and other factors, some of which are beyond our control. Since our inception, we have generated operating losses, as reflected in our accumulated deficit of $1.1 billion as of January 31, 2023. We expect to continue to incur operating losses for the foreseeable future due to the investments we intend to continue to make, particularly in sales and marketing and research and development. As a result, we may require additional capital resources in the future to execute strategic initiatives to grow our business.66Table of ContentsWe typically invoice our subscription customers annually in advance. Therefore, a substantial source of our cash is from such prepayments, which are included on our consolidated balance sheets as deferred revenue. Deferred revenue primarily consists of billed fees for our subscriptions, prior to satisfying the criteria for revenue recognition, which are subsequently recognized as revenue in accordance with our revenue recognition policy. As of January 31, 2023, we had deferred revenue of $2.4 billion, of which $1.7 billion was recorded as a current liability and is expected to be recorded as revenue in the next 12 months, provided all other revenue recognition criteria have been met.We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities. We do not have any outstanding derivative financial instruments, off-balance sheet guarantees, interest rate swap transactions, or foreign currency forward contracts.Cash FlowsThe following table summarizes our cash flows for the periods presented (in thousands):Year Ended January 31,202320222021Net cash provided by operating activities$941,007 $574,784 $356,566 Net cash (used in) provided by investing activities$(556,658)$(564,516)$495,427 Net cash provided by financing activities$77,437 $72,531 $800,135 Operating ActivitiesNet cash provided by operating activities during fiscal 2023 was $941.0 million, which resulted from a net loss of $182.3 million, adjusted for non-cash charges of $802.9 million and net cash inflow of $320.4 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of $526.5 million in stock-based compensation expense, $170.8 million of amortization of deferred contract acquisition costs, $77.2 million of depreciation and amortization, $16.6 million of amortization for intangibles assets, $9.4 million of non-cash operating lease costs, and $2.8 million of non-cash interest expense, partially offset by a $1.8 million change in the fair value of strategic investments. The net cash inflow from changes in operating assets and liabilities was primarily due to a $825.8 million increase in deferred revenue, a $58.9 million increase in accrued expenses and other liabilities, and a $65.2 million increase in accrued payroll and benefits, partially offset by a $298.7 million increase in deferred contract acquisition costs, a $258.1 million increase in accounts receivable, net, a $46.8 million increase in prepaid expenses and other assets, a $15.5 million decrease in accounts payable, and a $10.4 million decrease in operating lease liabilities.Net cash provided by operating activities during fiscal 2022 was $574.8 million, which resulted from a net loss of $232.4 million, adjusted for non-cash charges of $485.4 million and net cash inflow of $321.7 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of $310.0 million in stock-based compensation expense, $113.9 million of amortization of deferred contract acquisition costs, $55.9 million of depreciation and amortization, $12.9 million of amortization for intangibles assets, $9.1 million of non-cash operating lease costs and $2.5 million of non-cash interest expense, partially offset by a $14.0 million change in deferred income taxes and a $4.8 million change in the fair value of strategic investments. The net cash inflow from changes in operating assets and liabilities was primarily due to a $616.4 million increase in deferred revenue, a $38.5 million increase in accrued expenses and other liabilities, a $33.2 million increase in accounts payable, and a $32.7 million increase in accrued payroll and benefits, partially offset by a $234.3 million increase in deferred contract acquisition costs, a $125.4 million increase in accounts receivable, net, a $29.5 million increase in prepaid expenses and other assets, and a $9.9 million decrease in operating lease liabilities.Investing ActivitiesNet cash used in investing activities during fiscal 2023 of $556.7 million was primarily due to purchases of investments of $250.0 million, purchases of property and equipment of $235.0 million, capitalized internal-use software and website development costs of $29.1 million, purchases of strategic investments of $21.8 million, business acquisitions, net of cash acquired, of $18.3 million, which were primarily related to the Reposify acquisition, and purchases of intangible assets of $2.3 million.67Table of ContentsNet cash used in investing activities during fiscal 2022 of $564.5 million was primarily due to the acquisitions of Humio and SecureCircle, net of cash acquired, of $414.5 million, purchases of property and equipment of $112.1 million, capitalized internal-use software and website development costs of $20.9 million, and purchase of strategic investments of $16.3 million.Financing ActivitiesNet cash provided by financing activities of $77.4 million during fiscal 2023 was primarily due to our proceeds from the employee stock purchase plan of $59.4 million, $11.0 million of capital contributions from non-controlling interests, and proceeds from the exercise of stock options of $8.7 million, partially offset by the repayment of a loan acquired through Reposify of $1.6 million.Net cash provided by financing activities of $800.1 million during fiscal 2021 was primarily due to $739.6 million related to the issuance of our Senior Notes, after deducting the underwriting commissions and issuance costs paid as of January 31, 2021, proceeds from our employee stock purchase plan of $34.3 million, and proceeds from the exercise of stock options of $28.8 million, partially offset by $3.3 million debt issuance costs related to the revolving credit facility.Supplemental Guarantor Financial InformationOur Senior Notes are guaranteed on a senior, unsecured basis by CrowdStrike, Inc., a wholly owned subsidiary of CrowdStrike Holdings, Inc. (the “subsidiary guarantor,” and together with CrowdStrike Holdings, Inc., the “Obligor Group”). The guarantee is full and unconditional and is subject to certain conditions for release. See Note 4, Debt, in Part II, Item 8 of this Annual Report on Form 10-K, for a brief description of the Senior Notes.We conduct our operations almost entirely through our subsidiaries. Accordingly, the Obligor Group’s cash flow and ability to service the notes will depend on the earnings of our subsidiaries and the distribution of those earnings to the Obligor Group, whether by dividends, loans, or otherwise. Holders of the guaranteed registered debt securities will have a direct claim only against the Obligor Group.Summarized financial information is presented below for the Obligor Group on a combined basis after elimination of intercompany transactions and balances within the Obligor Group and equity in the earnings from and investments in any non-guarantor subsidiary. The revenue amounts presented in the summarized financial information include all of our consolidated revenue, and there is no intercompany revenue from the non-guarantor subsidiaries. This summarized financial information has been prepared and presented pursuant to Regulation S-X Rule 13-01, “Financial Disclosures about Guarantors and Issuers of Guaranteed Securities” and is not intended to present the financial position or results of operations of the Obligor Group in accordance with U.S. GAAP.Statement of OperationsYear Ended January 31, 2023(in thousands)Revenue$2,241,236 Cost of revenue639,637 Operating expenses1,855,244 Loss from operations(253,644)Net loss(237,920)Net loss attributable to CrowdStrike(237,920)68Table of ContentsBalance SheetJanuary 31, 2023(in thousands)Current assets (excluding intercompany receivables from non-Guarantors) $3,541,670 Intercompany receivables from non-Guarantors5,817 Noncurrent assets1,443,684 Current liabilities2,027,443 Noncurrent liabilities (excluding intercompany payable to non-Guarantors)1,417,627 Intercompany payable to non-Guarantors289,242 Strategic InvestmentsIn July 2019, we agreed to commit up to $10.0 million to a newly formed entity, CrowdStrike Falcon Fund LLC (the “Original Falcon Fund”) in exchange for 50% of the sharing percentage of any distribution by the Original Falcon Fund. In December 2021, we agreed to commit an additional $50.0 million to a newly formed entity, CrowdStrike Falcon Fund II LLC (“Falcon Fund II”) in exchange for 50% of the sharing percentage of any distribution by Falcon Fund II. Further, entities associated with Accel also agreed to commit up to $10.0 million and $50.0 million, respectively, to the Original Falcon Fund and Falcon Fund II (collectively, the “Falcon Funds”), and collectively own the remaining 50% of the sharing percentage of the Falcon Funds. Both Falcon Funds are in the business of purchasing, selling, and investing in minority equity and convertible debt securities of privately-held companies that develop applications that have potential for substantial contribution to us and our platform. We are the manager of the Falcon Funds and control their investment decisions and day-to-day operations and accordingly have consolidated each of the Falcon Funds. Each Falcon Fund has a duration of ten years and may be extended for three additional years. At dissolution, the Falcon Funds will be liquidated, and the remaining assets will be distributed to the investors based on their respective sharing percentage. Contractual Obligations and CommitmentsContractual ObligationsOur commitments consist of obligations under non-cancellable real estate arrangements on an undiscounted basis, of which $11.8 million is due in the next 12 months and $35.2 million is due thereafter. In addition, we have debt obligations related to $750.0 million aggregate principal amount of the Senior Notes due in fiscal 2030 and the interest payments associated with the Senior Notes of $22.5 million due in the next 12 months and $123.8 million due thereafter. As of January 31, 2023, we have $179.9 million of non-cancellable data center commitments in excess of one year, of which $26.0 million is due in the next 12 months and $153.9 million due thereafter. Also, as of January 31, 2023, we have $90.9 million of non-cancelable purchase commitments with various parties to purchase products and services, entered into in the normal course of business, in excess of one year, of which $52.1 million is due in the next 12 months and $38.8 million due thereafter. We expect to fund these obligations with cash flows from operations and cash on our balance sheet.The contractual commitment amounts above are associated with agreements that are enforceable and legally binding. Obligations under contracts, including purchase orders, that we can cancel without a significant penalty are excluded.Other ObligationsIn October 2021, we entered into a new private pricing addendum with Amazon Web Services (“AWS”), which provides us with cloud computing infrastructure. Under the new pricing addendum, we committed to purchase a minimum of $600.0 million of cloud services from AWS through September 2026. As of January 31, 2023, we have utilized $297.6 million of this commitment. We expect to meet our remaining commitment with AWS. As of January 31, 2023, our unrecognized tax benefits included $4.2 million, which were classified as long-term liabilities due to the inherent uncertainty with respect to the timing of future cash outflows associated with our unrecognized tax benefits.69Table of ContentsIndemnificationOur subscription agreements contain standard indemnification obligations. Pursuant to these agreements, we will indemnify, defend, and hold the other party harmless with respect to a claim, suit, or proceeding brought against the other party by a third party alleging that our intellectual property infringes upon the intellectual property of the third party, or results from a breach of our representations and warranties or covenants, or that results from any acts of negligence or willful misconduct. The term of these indemnification agreements is generally perpetual after the execution of the agreement. Typically, these indemnification provisions do not provide for a maximum potential amount of future payments we could be required to make. However, in the past we have not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these obligations on our consolidated balance sheets as of January 31, 2023 or January 31, 2022.We also agreed to indemnify our directors and certain executive officers for certain events or occurrences, subject to certain limits, while the officer is or was serving at our request in such capacity. The maximum amount of potential future indemnification is unlimited. However, our director and officer liability insurance policy mitigates our exposure. Historically, we have not been obligated to make any payments for these obligations, and no liabilities have been recorded for these obligations on our consolidated balance sheets as of January 31, 2023 or January 31, 2022.Critical Accounting Policies and EstimatesOur management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements and notes to our consolidated financial statements, which were prepared in accordance with U.S. GAAP. The preparation of the consolidated financial statements requires our management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. See Note 1, Description of Business and Significant Accounting Policies to our consolidated financial statements included in Item 8, Financial Statements and Supplementary Data of this Annual Report on Form 10-K. We base our estimates and judgments on our historical experience, knowledge of factors affecting our business and our belief as to what could occur in the future considering available information and assumptions that are believed to be reasonable under the circumstances.The accounting estimates we use in the preparation of our consolidated financial statements will change as new events occur, more experience is acquired, additional information is obtained, and our operating environment changes. Changes in estimates are made when circumstances warrant. Such changes in estimates and refinements in estimation methodologies are reflected in our reported results of operations and, if material, the effects of changes in estimates are disclosed in the notes to our consolidated financial statements. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results could differ materially from the amounts reported based on these estimates.The critical accounting estimates, assumptions, and judgments that we believe have the most significant impact on our consolidated financial statements are described below.Revenue RecognitionWe derive our revenue predominately from subscription revenue, which is primarily based on the solutions subscribed to by the customer. We recognize subscription revenue ratably over the contract term. Our professional services are available through time and material and fixed fee agreements. Revenue from professional services is recognized as services are performed. We enter into revenue contracts with multiple performance obligations in which a customer may purchase combinations of subscriptions, support, training, and consulting service. Judgment is required when considering the terms and conditions of these contracts. The transaction price for these contracts is allocated to the separate performance obligations on a relative standalone selling price (“SSP”) basis. The SSP is the price at which we would sell promised subscription or professional services separately to a customer.70Table of ContentsBusiness CombinationsWe allocate the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. The purchase price allocation process requires management to make significant estimates and assumptions with respect to intangible assets. Although we believe the assumptions and estimates we have made are reasonable, they are based in part on historical experience, market conditions, and information obtained from management of the acquired companies and are inherently uncertain. Examples of judgments used to estimate the fair value of intangibles assets include, but are not limited to, future expected cash flows, expected customer attrition rates, estimated obsolescence rates, and discount rates. These estimates are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates.Income TaxesWe account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on differences between the financial statement and tax basis of assets and liabilities and net operating loss and credit carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.We account for unrecognized tax benefits using a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. We establish a liability for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. Our assumptions, judgments, and estimates relative to the current provision for income taxes take into account current tax laws, our interpretation of current tax laws, and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. We have established reserves for income taxes to address potential exposures involving tax positions that could be challenged by tax authorities. In addition, we are subject to the continual examination of our income tax returns by the U.S. Internal Revenue Service (“IRS”) and other domestic and foreign tax authorities. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from such examinations. We believe such estimates to be reasonable; however, the final determination of any of these examinations could significantly impact the amounts provided for income taxes in our consolidated financial statements. Recently Issued Accounting PronouncementsSee Note 1, Description of Business and Significant Accounting Policies, included in Part II, Item 8 of this Annual Report on Form 10-K for more information about the impact of certain recent accounting pronouncements on our consolidated financial statements.71Table of ContentsITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe have operations in the United States and internationally, and we are exposed to market risk in the ordinary course of business.Interest Rate RiskOur cash and cash equivalents primarily consist of cash on hand and highly liquid investments in time deposits and money market funds. Our short-term investments consist of time deposits. Our investments do not have significant interest rate risk, as the yields on our investments are fixed rates. As of January 31, 2023, we had cash and cash equivalents of $2.5 billion, short-term investments of $250.0 million, and no marketable securities. The primary objectives of our investment activities are the preservation of capital, the fulfillment of liquidity needs, and the fiduciary control of cash and investments. We do not enter into investments for trading or speculative purposes. The effect of a hypothetical 100 basis point change in interest rates would not have had a material effect on the fair market value of our portfolio as of January 31, 2023. We therefore do not expect our results of operations or cash flows to be materially affected by a sudden change in market interest rates. Our debt obligations consist of a variety of financial instruments that expose us to interest rate risk, including, but not limited to our revolving credit facility and the Senior Notes. The interest on the revolving credit facility is tied to short-term interest rate benchmarks including the Term SOFR. The interest rate on the Senior Notes is fixed.Foreign Currency RiskTo date, nearly all of our sales contracts have been denominated in U.S. dollars. A portion of our operating expenses are incurred outside the United States, denominated in foreign currencies, and subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the British Pound, Australian Dollar, and Euro. The functional currency of our foreign subsidiaries is that country’s local currency. Foreign currency transaction gains and losses are recorded to other income, net. A hypothetical 10% adverse change in the U.S. dollar against other currencies would have resulted in an increase in operating loss of approximately $55.5 million and $36.3 million for the fiscal years ended January 31, 2023 and January 31, 2022, respectively. We have not entered into derivative or hedging transactions, but we may do so in the future if our exposure to foreign currency becomes more significant.Inflation Rate RiskWe do not believe that inflation had a material effect on our business, financial condition, or results of operations during the fiscal year ended January 31, 2023. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition, and results of operations.72Table of Contents
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+Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations."U.S. dialysis businessOur U.S. dialysis business is a leading provider of kidney dialysis services for patients suffering from ESKD. As of December 31, 2022, we provided dialysis and administrative services in the U.S. through a network of 2,724 outpatient dialysis centers in 46 states and the District of Columbia, serving a total of approximately 199,400 patients. We also have contracts to provide hospital inpatient dialysis services in approximately 820 hospitals and related laboratory services throughout the U.S. According to the United States Renal Data System (USRDS), there were over 562,000 ESKD dialysis patients in the U.S. in 2020. Based on the most recent 2022 annual data report from the USRDS, the underlying ESKD dialysis patient population grew at an approximate compound rate of 3.0% from 2010 to 2020 and 2.1% from 2015 to 2020 as compared to a decline in growth of (1.2)% from 2019 to 2020, which suggests that the rate of growth of the ESKD patient population is declining relative to long term trends. As the USRDS only presents data through December 31, 2020, it does not yet reflect the continued and compounding impact of COVID-19 on this patient base. A number of factors may impact ESKD growth rates, including, among others, mortality rates for dialysis patients or CKD patients, the aging of the U.S. population, transplant rates, incidence rates for diseases that cause kidney failure such as diabetes and hypertension and growth rates of minority populations with higher than average incidence rates of ESKD. Certain of these factors, in particular mortality rates for dialysis or CKD patients, have been impacted by the COVID-19 pandemic.Treatment options for ESKDTreatment options for ESKD are dialysis and kidney transplantation.Dialysis options•HemodialysisHemodialysis, the most common form of ESKD treatment, is usually performed at a freestanding outpatient dialysis center, at a hospital-based outpatient center, in a skilled nursing facility or at the patient’s home. The hemodialysis machine uses an artificial kidney, called a dialyzer, to remove toxins, fluids and salt from the patient’s blood. The dialysis process occurs across a semi-permeable membrane that divides the dialyzer into two distinct chambers. While blood is circulated through one chamber, a pre-mixed fluid is circulated through the other chamber. The toxins, salt and excess fluids from the blood cross the membrane into the fluid, allowing cleansed blood to return back into the patient’s body. Each hemodialysis treatment that occurs in the outpatient dialysis centers typically lasts approximately three and one-half hours and is usually performed three times per week.Hospital inpatient hemodialysis services are required for patients with acute kidney failure primarily resulting from trauma, patients in early stages of ESKD and ESKD patients who require hospitalization for other reasons. Hospital inpatient hemodialysis is generally performed at the patient’s bedside or in a dedicated treatment room in the hospital, as needed.Some ESKD patients may perform hemodialysis with the help of a care partner in their home or residence through the use of a hemodialysis machine designed specifically for home therapy that is portable, smaller and easier to use. Patients receive training, support and monitoring from registered nurses, usually in our outpatient dialysis centers, in connection with their home hemodialysis treatment. Home hemodialysis is typically performed with greater frequency than dialysis treatments performed in outpatient dialysis centers and on varying schedules.•Peritoneal dialysisPeritoneal dialysis uses the patient’s peritoneal or abdominal cavity to eliminate fluid and toxins and is typically performed at home. The most common methods of peritoneal dialysis are continuous ambulatory peritoneal dialysis (CAPD) and continuous cycling peritoneal dialysis (CCPD). Because it does not involve going to an outpatient dialysis center three times a week for treatment, peritoneal dialysis is generally an alternative to hemodialysis for patients who are healthier, more independent and desire more flexibility in their lifestyle. CAPD introduces dialysis solution into the patient’s peritoneal cavity through a surgically placed catheter. Toxins in the blood continuously cross the peritoneal membrane into the dialysis solution. After several hours, the patient drains the used dialysis solution and replaces it with fresh solution. This procedure is usually repeated four times per day.4CCPD is performed in a manner similar to CAPD, but uses a mechanical device to cycle dialysis solution through the patient’s peritoneal cavity while the patient is sleeping or at rest.Kidney transplantationAlthough kidney transplantation, when successful, is considered the most desirable form of therapeutic intervention, the shortage of suitable donors, side effects of immunosuppressive pharmaceuticals given to transplant recipients and dangers associated with transplant surgery for some patient populations have generally limited the use of this treatment option. An executive order signed in July 2019 (the 2019 Executive Order) directed HHS to develop policies addressing, among other things, the goal of making more kidneys available for transplant. As directed by the 2019 Executive Order, the CMS, through its Center for Medicare and Medicaid Innovation (CMMI), subsequently released the framework for certain proposed voluntary payment models that would adjust payment incentives to encourage kidney transplants. For more information regarding the 2019 Executive Order and these payment models, please see the discussion below under the heading "—Integrated Kidney Care and Medicare and Medicaid program reforms."U.S. dialysis services we provideOutpatient hemodialysis services As a condition of our enrollment in Medicare for the provision of dialysis services, we contract with a nephrologist or a group of associated nephrologists to provide medical director services at each of our dialysis centers. In addition, other nephrologists may apply for practice privileges to treat their patients at our centers. Each center has an administrator, typically a registered nurse, who supervises the day-to-day operations of the center and its staff. The staff of each center typically consists of registered nurses, licensed practical or vocational nurses, patient care technicians, a social worker, a registered dietician, biomedical technician support and other administrative and support personnel.Our total patient turnover at centers we consolidate, which is based upon all causes, averaged approximately 27% in both 2022 and 2021. The overall number of patients to whom we provided services in the U.S. in 2022 decreased by approximately 1.8% from 2021, primarily due to an increase in mortality rates, which have been impacted by the COVID-19 pandemic. This was partially offset by new dialysis patients who started treating at our centers acquired during the year.Hospital inpatient hemodialysis services As of December 31, 2022, we have contracts to provide hospital inpatient hemodialysis services, excluding physician services, to patients in approximately 820 hospitals throughout the U.S. We render these services based on a contracted per-treatment fee that is individually negotiated with each hospital. When a hospital requests our services, we typically administer the dialysis treatment at the patient’s bedside or in a dedicated treatment room in the hospital, as needed. Home-based dialysis services Home-based dialysis services includes home hemodialysis and peritoneal dialysis. Many of our outpatient dialysis centers offer certain support services for dialysis patients who prefer and are able to perform either home hemodialysis or peritoneal dialysis in their homes. Home-based hemodialysis support services consist of providing equipment and supplies, training, patient monitoring, on-call support services and follow-up assistance. Registered nurses train patients and their families or other caregivers to perform either home hemodialysis or peritoneal dialysis. The 2019 Executive Order and related HHS guidance described above also included a stated goal of increasing the relative number of new ESKD patients that receive dialysis at home.According to the most recent 2022 annual data report from the USRDS, in 2020 approximately 14% of ESKD dialysis patients in the U.S. perform home-based dialysis.5Treatments and revenues by modality:The following graph summarizes our U.S. dialysis treatments by modality and U.S. dialysis patient services revenues by modality for the year ended December 31, 2022.OtherESKD laboratory services We operate a separately licensed and highly automated clinical laboratory which specializes in ESKD patient testing. This specialized laboratory provides routine laboratory tests for dialysis and other physician-prescribed laboratory tests for ESKD patients. Our laboratory provides these tests predominantly for our ESKD patients throughout the U.S. These tests are performed for a variety of reasons, including to monitor a patient’s ESKD condition, including the adequacy of dialysis, as well as other medical conditions of the patient. Our laboratory utilizes information systems which provide information to certain members of the dialysis centers’ staff and medical directors regarding critical outcome indicators.Management services We currently operate or provide management and administrative services pursuant to management and administrative services agreements to 56 outpatient dialysis centers located in the U.S. in which we either own a noncontrolling interest or which are wholly-owned by third parties. Management fees are established by contract and are recognized as earned typically based on a percentage of revenues or cash collections generated by the outpatient dialysis centers.Sources of revenue—concentrations and risksOur U.S. dialysis revenues represent approximately 91% of our consolidated revenues for the year ended December 31, 2022. Our U.S. dialysis revenues are derived primarily from our core business of providing dialysis services and related laboratory services and, to a lesser extent, the administration of pharmaceuticals and management fees generated from providing management and administrative services to certain outpatient dialysis centers, as discussed above.The sources of our U.S. dialysis revenues are principally from government-based programs, including Medicare and Medicare Advantage plans, Medicaid and managed Medicaid plans, other government-based programs including our agreement with the Veterans Administration, and commercial insurance plans. The following table summarizes our U.S. dialysis revenues by payor source for U.S. dialysis patient services revenues the year ended December 31, 2022:Medicare and Medicare Advantage plans57 %Medicaid and managed Medicaid plans7 %Other government-based programs3 %Total government-based programs67 %Commercial (including hospital dialysis services)33 %Total U.S. dialysis patient service revenues100 %6Medicare revenueMedicare fee for serviceSince 1972, the federal government has provided healthcare coverage for qualified ESRD patients under the Medicare ESRD program regardless of age or financial circumstances. ESRD is the first and only disease state eligible for Medicare coverage both for dialysis and dialysis-related services and for all benefits available under the Medicare program. Government dialysis related payment rates in the U.S. are principally determined by federal Medicare and state Medicaid policy. For patients with Medicare coverage, all ESRD payments for dialysis treatments are made under a single bundled payment rate which provides a fixed payment rate to encompass all goods and services provided during the dialysis treatment that are related to the dialysis treatment, including certain pharmaceuticals, such as erythropoiesis-stimulating agents (ESAs), calcimimetics, vitamin D analogs and iron supplements, irrespective of the level of pharmaceuticals administered to the patient or additional services performed. Most lab services are also included in the bundled payment.Although Medicare reimbursement limits the allowable charge per treatment, it provides industry participants with a relatively predictable and recurring revenue stream for dialysis services provided to patients without commercial insurance. For the year ended December 31, 2022, approximately 90% of our total dialysis patients were covered under some form of government-based program, with approximately 75% of our dialysis patients covered under Medicare and Medicare Advantage plans.Under this ESRD Prospective Payment System (PPS), the bundled payments to a dialysis facility may be reduced by as much as 2% based on the facility’s performance in specified quality measures set annually by CMS through its QIP. CMS established QIP through the Medicare Improvements for Patients and Providers Act of 2008 to promote high quality services in outpatient dialysis facilities treating patients with ESRD. QIP associates a portion of Medicare reimbursement directly with a facility’s performance on quality of care measures. Reductions in Medicare reimbursement result when a facility’s overall score on applicable measures does not meet established standards. For scoring and payment adjustment purposes in the performance year 2022 ESRD QIP, CMS determined that circumstances caused by COVID-19 have significantly affected the validity and reliability of the measures and resulting performance scores. The policies finalized in this rule are intended to ensure that these programs do not penalize facilities based on circumstances caused by COVID-19 that the measures were not designed to accommodate. In this final rule, the CMS finalized its proposal to suppress the use of certain measures impacted by COVID-19. Under these finalized policies, no facility will receive a payment reduction for 2022.Uncertainty about future payment rates remains a material risk to our business, as well as the potential implementation of or changes in coverage determinations or other rules or regulations by CMS or Medicare Administrative Contractors that may impact reimbursement. An important provision in the Medicare ESRD statute is an annual adjustment, or market basket update, to the ESRD PPS base rate. Absent action by Congress, the ESRD PPS base rate is automatically updated annually by a formulaic inflation adjustment, but it does not always cover the actual inflationary increase. On September 18, 2020, pursuant to the 2019 Executive Order, CMS, through CMMI, published the final ESRD Treatment Choices mandatory payment model (ETC). The ETC launched on January 1, 2021, administered through CMMI in approximately 20% of our dialysis clinics across the country.On October 31, 2022, CMS issued a final rule to update the ESRD PPS payment rate and policies. Among other things, the rule updates payment rates under the ESRD PPS for renal dialysis services furnished to beneficiaries on or after January 1, 2023, finalizes updates to the Acute Kidney Injury (AKI) dialysis payment rate for dialysis services furnished by ESRD facilities for calendar year 2023 and updates requirements for the ESRD Quality Incentive Program. CMS estimates the final rule will affect ESRD facilities' average reimbursement by a productivity-adjusted market basket increase of 3.0% in 2023.As a result of the Budget Control Act of 2011 (BCA) and subsequent activity in Congress, a $1.2 trillion sequester (across-the-board spending cuts) in discretionary programs took effect in 2013 reducing Medicare payments by 2%, which was subsequently extended through fiscal year 2027. Federal COVID-19 relief legislation suspended the 2% Medicare sequestration from May 1, 2020 through December 31, 2021. The Protecting Medicare and American Farmers from Sequester Cuts Act, signed into law on December 10, 2021, extended the suspension of the 2% Medicare sequestration from December 31, 2021 through March 31, 2022, with 1% Medicare sequestration beginning April 1, 2022 through June 30, 2022 and 2% Medicare sequestration beginning July 1, 2022 and thereafter. While in effect, the suspension of sequestration significantly increased our revenues.ESRD patients receiving dialysis services become eligible for primary Medicare coverage at various times, depending on their age or disability status, as well as whether they are covered by a commercial insurance plan. Generally, for a patient not covered by a commercial insurance plan, Medicare can become the primary payor for ESRD patients receiving dialysis services 7either immediately or after a three-month waiting period. For a patient covered by a commercial insurance plan, Medicare generally becomes the primary payor after 33 months, which includes the three-month waiting period, or earlier if the patient’s commercial insurance plan coverage terminates or if the patient chooses Medicare over the commercial plan. When Medicare becomes the primary payor, the payment rates we receive for that patient shift from the commercial insurance plan rates to Medicare payment rates, which are on average significantly lower than commercial insurance rates.Medicare pays 80% of the amount set by the Medicare system for each covered dialysis treatment. The patient is responsible for the remaining 20%. In many cases, a secondary payor, such as Medicare supplemental insurance, a state Medicaid program or a commercial health plan, covers all or part of these balances. Some patients who do not qualify for Medicaid, but otherwise cannot afford secondary insurance in the form of a Medicare Supplement Plan, can apply for premium payment assistance from charitable organizations to obtain secondary coverage. If a patient does not have secondary insurance coverage, we are generally unsuccessful in our efforts to collect from the patient the remaining 20% portion of the ESRD composite rate that Medicare does not pay. However, we are able to recover some portion of this unpaid patient balance from Medicare through an established cost reporting process by identifying these Medicare bad debts on each center’s Medicare cost report.Medicare Advantage revenueMedicare Advantage (MA, managed Medicare or Medicare Part C) plans are offered by private health insurers who contract with CMS to provide their members with Medicare Part A, Part B and/or Part D benefits. These MA plans include health maintenance organizations, preferred provider organizations, private fee-for-service (FFS) organizations, special needs plans (SNPs) or Medicare medical savings account plans. The 21st Century Cures Act (the Cures Act) included a provision that, effective January 1, 2021, has allowed Medicare-eligible beneficiaries with ESRD to choose coverage under an MA plan. Prior to the Cures Act, MA plans were only available to ESRD patients if the patient was remaining on an MA plan that they had enrolled in prior to being diagnosed with ESRD, or in certain other limited situations such as a SNP. As a result, this provision under the Cures Act has broadened access for Medicare ESRD patients to certain enhanced benefits offered by MA plans. MA plans usually provide reimbursement to us at a negotiated rate that is generally higher than Medicare FFS rates. In February 2023, CMS released the CY 2024 MA Advance Notice (the Notice). Among other changes, the Notice contains information about potential future MA rate increases and updates certain policies associated with risk adjustments. We are continuing to assess the impact of the Notice and related MA regulations on our business.Medicaid revenueMedicaid programs are state-administered programs partially funded by the federal government. These programs are intended to provide health coverage for patients whose income and assets fall below state-defined levels and who are otherwise uninsured. These programs also serve as supplemental insurance programs for co-insurance payments due from Medicaid-eligible patients with primary coverage under the Medicare program. Some Medicaid programs also pay for additional services, including some oral medications that are not covered by Medicare. We are enrolled in the Medicaid programs in the states in which we conduct our business.Commercial revenueAs discussed above, if a patient has commercial insurance, then that commercial insurance plan is generally responsible for payment of dialysis services for up to the first 33 months before that patient becomes eligible to elect to have Medicare as their primary payor for dialysis services. Although commercial payment rates vary, average commercial payment rates established under commercial contracts are generally significantly higher than Medicare rates. The payments we receive from commercial payors generate nearly all of our profits and all of our non-hospital dialysis profits come from commercial payors. Payment methods from commercial payors can include a single lump-sum per treatment, referred to as bundled rates, or in other cases separate payments for dialysis treatments and pharmaceuticals, if used as part of the treatment, referred to as FFS rates. Commercial payment rates are the result of negotiations between us and commercial payors or third party administrators. Our commercial contracts sometimes contain annual price escalator provisions. We are comprehensively contracted, and the vast majority of patients insured through commercial health plans are covered by one of our commercial contracts, though we also receive payments from a limited set of commercial patients that are covered by a health plan that considers us out-of-network. While our out-of-network payment rates are on average higher than in-network commercial contract payment rates, we have made efforts to be contracted with the majority of commercial payors offering health plans. Approximately 26% of our U.S. dialysis patient services revenues and approximately 10% of our U.S. dialysis patients are associated with non-hospital commercial payors for the year ended December 31, 2022. Non-hospital commercial patients as a percentage of our total U.S. dialysis patients for 2022 were relatively flat compared to 2021. Less than 1% of our U.S. dialysis revenues are due directly from patients. No single commercial payor accounted for more than 10% of total U.S. dialysis 8revenues for the year ended December 31, 2022. See Note 2 to the consolidated financial statements included in this report for disclosure on our concentration related to our commercial payors on a total consolidated revenue basis.Both the number of our patients under commercial plans and the rates under these commercial plans are subject to change based on a number of factors. For additional detail on these factors and other risks associated with on our commercial revenue, see the risk factors in Item 1A. Risk Factors under the headings "Our business is subject to a complex set of governmental laws, regulations and other requirements...;" "Changes in federal and state healthcare legislation or regulations...;" "If the number or percentage of patients with higher-paying commercial insurance declines...;" and "Macroeconomic conditions and global events..." Revenue from other pharmaceuticalsFor the year ended December 31, 2020, the oral and intravenous forms of calcimimetics, a drug class taken by many patients with ESRD to treat mineral bone disorder, were separately reimbursed through the transitional drug add-on payment adjustment (TDAPA) model based on a pass-through rate of the average sales price plus 0%, before sequestration. Effective January 1, 2021, both oral and intravenous forms of calcimimetics were added to the ESRD PPS bundled payment and as a result our operating income from calcimimetics since then has been more stable as compared to the year ended December 31, 2020.Physician relationshipsJoint venture partnersWe own and operate certain of our dialysis centers through entities that are structured as joint ventures. We generally hold controlling interests in these joint ventures, with nephrologists, hospitals, management services organizations, and/or other healthcare providers holding minority equity interests. These joint ventures are typically formed as limited liability companies. For the year ended December 31, 2022, revenues from joint ventures in which we have a controlling interest represented approximately 28% of our U.S. dialysis revenues. We expect to continue to enter into new U.S. dialysis-related joint ventures in the ordinary course of business.Community physiciansAn ESKD patient generally seeks treatment or support for their home treatment at an outpatient dialysis center near their home where their treating nephrologist has practice privileges. Our relationships with local nephrologists and our ability to provide quality dialysis services and to meet the needs of their patients are key factors in the success of our dialysis operations. Over 4,900 nephrologists currently refer patients to our outpatient dialysis centers. Medical directorsParticipation in the Medicare ESRD program requires that dialysis services at an outpatient dialysis center be under the general supervision of a medical director. Per these requirements, this individual is usually a board certified nephrologist. We engage physicians or groups of physicians to serve as medical directors for each of our outpatient dialysis centers. At some outpatient dialysis centers, we also separately contract with one or more other physicians or groups to serve as assistant or associate medical directors over other modalities such as home dialysis. We have over 900 individual physicians and physician groups under contract to provide medical director services.Medical directors for our dialysis centers enter into written contracts with us that specify their duties and fix their compensation generally for periods of ten years. The compensation of our medical directors is the result of arm’s length negotiations, consistent with fair market value, and generally depends upon an analysis of various factors such as the physician’s duties, responsibilities, professional qualifications and experience, as well as the time and effort required to provide such services.Our medical director contracts and joint venture operating agreements generally include covenants not to compete or own interests in dialysis centers operated by other providers within a defined geographic area for various time periods, as applicable. These non-compete agreements do not restrict or limit the physicians from practicing medicine or prohibit the physicians from referring patients to any outpatient dialysis center, including dialysis centers operated by other providers. In January 2023, the Federal Trade Commission proposed a new rule that would generally prohibit employers from using noncompete clauses in contracts with workers that extend beyond the termination of the employment or independent contractor relationship. The proposed rule remains open for comment and a final rule has not been issued. We are monitoring these developments for any potential impact on us, including on our agreements with teammates, our arrangements with medical directors, joint venture operating agreements, or the terms of any of our existing agreements with physicians should the new rules ultimately be finalized and implemented in this area. 9Location of our U.S. dialysis centersWe operated 2,724 outpatient dialysis centers in the U.S. as of December 31, 2022 and 2,668 of these centers are consolidated in our financial statements. Of the remaining 56 nonconsolidated U.S. outpatient dialysis centers, we own noncontrolling interests in 54 centers and provide management and administrative services to two centers that are wholly-owned by third parties. The locations of the 2,668 U.S. outpatient dialysis centers consolidated in our financial statements at December 31, 2022, were as follows:Ancillary services, including our international operations Our ancillary services relate primarily to our core business of providing kidney care services. As of December 31, 2022, these consisted primarily of our U.S. integrated kidney care (IKC) business, certain U.S. other ancillary businesses (including our clinical research programs, transplant software business, and venture investment group), and our international operations. We have made and continue to make investments in building our integrated care capabilities, including the operation of certain strategic business initiatives that are intended to integrate and coordinate care among healthcare participants across the renal care continuum from CKD to ESKD to kidney transplant. Through improved technology and data sharing, as well as an increasing focus on value-based contracting and care, these initiatives seek to bring together physicians, nurses, dieticians, pharmacists, hospitals, dialysis clinics, transplant centers, payors and other specialists with a view towards improving clinical outcomes for our patients and reducing the overall cost of comprehensive kidney care. Certain of our ancillary services are described below.U.S. Integrated Kidney Care•Integrated Kidney Care. VillageHealth DM, LLC, also doing business as DaVita Integrated Kidney Care (DaVita IKC), provides advanced integrated care management services to health plans and government programs for members/beneficiaries diagnosed with ESKD and CKD. Through a combination of health monitoring, clinical coordination, innovative interventions, predictive analytics, medical claims analysis and information technology, we endeavor to assist our health plan and government program customers and patients in obtaining superior renal healthcare and improved clinical outcomes, as well as helping to reduce overall medical costs. Integrated kidney 10care management revenues from commercial and Medicare Advantage insurers can be based upon either an established contract fee recognized as earned for services provided over the contract period, or related to the operation of risk-based and value-based programs, including shared savings, pay-for-performance, and capitation contracts. DaVita IKC also contracts with payors to support Medicare Advantage ESKD special needs plans to provide ESKD patients full service healthcare. DaVita IKC supported our ESKD seamless care organizations (ESCO) joint venture programs until their completion in 2021, and DaVita IKC has commenced participation in both the involuntary and certain voluntary payment models administered by CMMI. As further described below under the heading "—Government regulation—CMMI Payment Models", the Company has invested resources, and expects to continue to invest substantial resources in these models as part of the Company's overall plan to grow its integrated kidney care business and value-based care initiatives. See Note 1, Other revenue, in the Company's consolidated financial statements for more information on how the Company accounts for its integrated care arrangements.The Company is also developing, and has entered into, various forms of technology-based, administrative, financial and other collaboration and incentive arrangements with physician partners and other providers in support of our innovation, developing and expanding integrated kidney care programs and arrangements.•Physician services. Nephrology Practice Solutions (NPS) is an independent business that partners with physicians committed to providing outstanding clinical and integrated care to patients. NPS provides nephrologist recruitment and staffing services in select markets that are billed on a per-search basis. NPS also offers physician practice management services to nephrologists under administrative and management services agreements. These administrative and management services include physician practice management, billing and collections, credentialing, coding and other support services that enable physician practices to increase efficiency and manage their administrative needs. Fees generated from these services are recognized as earned typically based upon flat fees or cash collections generated by the physician practice.U.S. Other Ancillary services•Clinical research programs. DaVita Clinical Research (DCR) is a provider-based specialty clinical research organization with a full spectrum of services for clinical drug research and device development. DCR uses its extensive, applied database and real-world healthcare experience to assist in the design, recruitment and completion of retrospective and prospective pragmatic and clinical trials. Revenues are based upon an established fee per study, as determined by contract with drug companies and other sponsors and are recognized as earned according to the contract terms.•Transplant software business. DaVita's transplant software business, MedSleuth, works with transplant centers across the U.S. to provide greater connectivity among transplant candidates, transplant centers, physicians and care teams to help improve the experience and outcomes for kidney and liver transplant patients. •Venture Group. DaVita Venture Group (DVG) focuses on innovative products, solutions and businesses that improve care for patients with kidney disease and related conditions. DVG identifies companies and products for acquisitions, strategic partnerships, and venture investment opportunities. DVG’s focus includes innovation in digital health, pharmaceuticals, medical devices, and care delivery models. For additional discussion of our ancillary services, see Part II, Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations." International dialysis operationsWe operated 350 outpatient dialysis centers located in 11 countries outside of the U.S. serving approximately 45,600 patients as of December 31, 2022. Of these 350 dialysis centers, 299 are consolidated in our financial statements and we own a noncontrolling interest in the remaining centers. Our international dialysis operations have continued to grow steadily and expand as a result of acquiring and developing outpatient dialysis centers in various strategic markets. Our international operations are included in our ancillary services. 11As of December 31, 2022, the international outpatient dialysis centers we operate were located as follows: Brazil93 Poland63 Germany52 Malaysia(1)40 Colombia31 United Kingdom25 Saudi Arabia25 Portugal10 Japan(1)5 Singapore(1)4 China(1)2 350 (1)Includes centers that are operated or managed by our Asia Pacific joint venture (APAC JV).Corporate administrative supportCorporate administrative support consists primarily of labor, benefits and long-term incentive compensation costs and professional fees for departments which provide support to all of our different operating lines of business. These expenses are included in our consolidated general and administrative expenses.Government regulationWe operate in a complex regulatory environment with an extensive and evolving set of federal, state and local governmental laws, regulations and other requirements. These laws, regulations and other requirements are promulgated and overseen by a number of different legislative, regulatory, administrative and quasi-regulatory bodies, each of which may have varying interpretations, judgments or related guidance. As such, we utilize considerable resources on an ongoing basis to monitor, assess and respond to applicable legislative, regulatory and administrative requirements, but there is no guarantee that we will be successful in our efforts to adhere to all of these requirements. Additional discussion on certain of these laws, regulations and other requirements is set forth below in this section.If any of our personnel, representatives, third party vendors or operations are alleged to have violated these or other laws, regulations or requirements, we could experience material harm to our reputation and stock price, and it could impact our relationships and/or contracts related to our business, among other things. If any of our personnel, representatives, third party vendors or operations are found to violate these or other laws, regulations or requirements, we could suffer additional severe consequences that could have a material adverse effect on our business, results of operations, financial condition and cash flows. The consequences could include, among others:•Loss of required certifications, suspension or exclusion from or termination of our participation in federal or state government programs (including, without limitation, Medicare, Medicaid and CMMI demonstration programs);•Refunds of amounts received in violation of law or applicable payment program requirements dating back to the applicable statute of limitation periods;•Loss of licenses required to operate healthcare facilities or administer pharmaceuticals in the states in which we operate;•Reductions in payment rates or coverage for dialysis and ancillary services and pharmaceuticals;•Criminal or civil liability, fines, damages or monetary penalties;•Imposition of corporate integrity agreements, corrective action plans or consent agreements;•Enforcement actions, investigations, or audits by governmental agencies and/or state law claims for monetary damages by patients who believe their protected health information (PHI) has been used, disclosed or not properly safeguarded in violation of federal or state patient privacy laws, including, among others, the Health Insurance Portability and Accountability Act of 1996 (HIPAA) and the Privacy Act of 1974; 12•Enforcement actions, investigations or audits by government agencies and/or initiated by qui tam relators related to interoperability and related data sharing and access requirements and regulations; •Mandated changes to our practices or procedures that significantly increase operating expenses that could subject us to ongoing audits and reporting requirements as well as increased scrutiny of our billing and business practices, which could lead to potential fines, among other things;•Termination of various relationships and/or contracts related to our business, such as joint venture arrangements, medical director agreements, hospital services and skilled nursing home agreements, real estate leases, value based arrangements, clinical incentive programs, payor contracts and consulting or participating provider agreements with physicians, among others; and•Harm to our reputation which could negatively impact our business relationships and stock price, our ability to attract and retain patients, physicians and teammates, our ability to obtain financing and our access to new business opportunities, among other things.We expect that our industry will continue to be subject to extensive and complex regulation, the scope and effect of which are difficult to predict. We are currently subject to various legal proceedings, such as lawsuits, investigations, audits and inquiries by various government and regulatory agencies, as further described in Note 16 to the consolidated financial statements, and our operations and activities could be reviewed or challenged by regulatory authorities at any time in the future. In addition, each of the laws, regulations and other requirements, including interpretations thereof, that govern our business may continue to change over time, and there is no assurance that we will be able to accurately predict the nature, timing or extent of such changes or the impact of such changes on the markets in which we conduct business or on the other participants that operate in those markets. For additional detail on risks related to each of the foregoing, see the discussion in Item 1A. Risk Factors under the headings, "Our business is subject to a complex set of governmental laws, regulations and other requirements...;" and "We are, and may in the future be, a party to various lawsuits, demands, claims, qui tam suits, governmental investigations and audits and other legal matters..."Licensure and CertificationOur dialysis centers are certified by CMS, as required for the receipt of Medicare payments. Certain of our payor contracts also condition payment on Medicare certification. In some states, our outpatient dialysis centers also are required to secure additional state licenses and permits. Governmental authorities, primarily state departments of health, periodically inspect our centers to determine if we satisfy applicable federal and state standards and requirements, including the conditions for coverage in the Medicare ESRD program.We have experienced some delays in obtaining Medicare certifications from CMS, though changes by CMS in the prioritizing of dialysis providers as well as legislation allowing private entities to perform initial dialysis facility surveys for certification has helped to decrease or limit certain delays.In addition, in September 2019, CMS finalized updates to the Provider Enrollment Rule creating onerous disclosure obligations for all providers enrolling in Medicare, Medicaid and the Children’s Health Insurance Plan (CHIP). The final rule provides CMS with stronger revocation authority, increases the bar for re-enrollment, and permits CMS to impose a Medicare reapplication bar where a prospective provider's Medicare enrollment application is denied because the provider submitted incomplete, false, or misleading information for providers who are terminated from the Medicare program. CMS may also deny enrollment to providers who have affiliations with other providers that CMS has determined pose undue risk of fraud, waste or abuse. If we fail to comply with these and other applicable requirements on our licensure and certification programs, particularly in light of increased penalties that include a 10-year bar to Medicare re-enrollment, under certain circumstances it could have a material adverse impact on our business, results of operations, financial condition, cash flows and reputation. In addition to certification by CMS, our dialysis centers are also certified by each state Medicaid program, are licensed in those states that require licensing for dialysis clinics, and are required to obtain licenses, permits and certificates, including for such areas as biomedical waste. Failure to obtain the correct certifications, permits and certificates as well as a failure to adhere to the requirements thereunder, may result in penalties, fines, and the loss of the right to operate, any of which could have a material adverse impact on our business, results of operations, financial condition, cash flow and reputation.Federal Anti-Kickback StatuteThe federal Anti-Kickback Statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration, directly or indirectly, in cash or kind, to induce or reward either the referral of an individual for, or the 13purchase, or order or recommendation of, any good or service, for which payment may be made under federal and state healthcare programs such as Medicare and Medicaid.Federal criminal penalties for the violation of the federal Anti-Kickback Statute include imprisonment, fines and exclusion of the provider from future participation in the federal healthcare programs, including Medicare and Medicaid. Violations of the federal Anti-Kickback Statute are punishable by imprisonment for up to ten years and statutory fines of up to $100,000 or both. Larger criminal fines can be imposed under the provisions of the U.S. Sentencing Guidelines and the Alternate Fines Statute. Individuals and entities convicted of violating the federal Anti-Kickback Statute are subject to mandatory exclusion from participation in Medicare, Medicaid and other federal healthcare programs for a minimum of five years. Civil penalties for violation of this law include statutory amounts of up to $100,000 (adjusted for inflation) in monetary penalties per violation, assessments of up to three times the total payments between the parties to the arrangement, and permissive exclusion from participation in the federal healthcare programs or suspension from future participation in Medicare and Medicaid. The ACA amended the federal Anti-Kickback Statute to clarify that the defendant may not need to have actual knowledge of the federal Anti-Kickback Statute or have the specific intent to violate it and to provide that any claims for items or services resulting from a violation of the federal Anti-Kickback Statute are considered false or fraudulent for purposes of the False Claims Act (FCA) and can result in treble damages and other penalties under the FCA. In addition, HHS' Office of Inspector General (OIG) and CMS in 2020 released a final rule implementing modifications to the Federal Anti-Kickback Statute and Civil Monetary Penalties Statute intended to promote value-based and coordinated care arrangements as well as reduce other regulatory burdens. Most changes implemented by the final rule went into effect on January 19, 2021.The federal Anti-Kickback Statute includes statutory exceptions and regulatory safe harbors that protect certain arrangements. Business transactions and arrangements that are structured fully within an applicable safe harbor do not violate the federal Anti-Kickback Statute. When an arrangement is not structured fully within a safe harbor, the arrangement must be evaluated on a case-by-case basis in light of the parties’ intent and the arrangement’s potential for abuse, and may be subject to greater scrutiny by enforcement agencies.In the ordinary course of our business operations, DaVita and its ancillary businesses and subsidiaries enter into numerous arrangements with physicians and other potential referral sources, that potentially implicate the Anti-Kickback Statute. Examples of such arrangements include, among other things, medical director agreements, joint ventures, leases and subleases with entities in which physicians, hospitals or medical groups hold ownership interests, consulting agreements, hospital services agreements, discharge planning services agreements, acute dialysis services agreements, value-based care arrangements, employment and coverage agreements, and incentive performance arrangements. In addition, some referring physicians may own DaVita Inc. common stock. Furthermore, our dialysis centers and subsidiaries sometimes enter into certain rebate, pricing, or other contracts to acquire certain discounted items and services that may be reimbursed by a federal healthcare program.Agreements and other arrangements can still be appropriate under the federal Anti-Kickback Statute even if they fail to meet all parameters of a relevant safe harbor provision; and we endeavor to structure our arrangements within applicable safe harbors, although some arrangements are not structured fully within a safe harbor. If any of our current or previous business transactions or arrangements, including but not limited to those described above, were found to violate the federal Anti-Kickback Statute, we, among other things, could face criminal, civil or administrative sanctions, including possible exclusion from participation in Medicare, Medicaid and other state and federal healthcare programs. Any findings that we have violated these laws could have a material adverse impact on our business, results of operations, financial condition, cash flows, reputation and stock price.Stark LawThe Stark Law is a strict liability civil law that prohibits a physician who has a financial relationship, or who has an immediate family member who has a financial relationship, with entities providing Designated Health Services (DHS), from referring Medicare and Medicaid patients to such entities for the furnishing of DHS, unless an exception applies. The types of financial arrangements between a physician and a DHS entity that trigger the self-referral prohibitions of the Stark Law are broad and include direct and indirect ownership and investment interests and compensation arrangements. The Stark Law also prohibits the DHS entity receiving a prohibited referral from presenting, or causing to be presented, a claim or billing for the services arising out of the prohibited referral. If the Stark Law is implicated, the financial relationship must fully satisfy a Stark Law exception. If an exception to the Stark Law is not satisfied, then the parties to the arrangement could be subject to sanctions. Sanctions for violation of the Stark Law include denial of payment for claims for services provided in violation of the prohibition, refunds of amounts collected in violation of the prohibition, a civil penalty of up to $15,000 (adjusted for inflation) for each service arising out of the prohibited referral, a statutory civil penalty of up to $100,000 (adjusted for inflation) against parties that enter into a scheme to circumvent the Stark Law prohibition, civil assessment of up to three times the amount 14claimed, and potential exclusion from the federal healthcare programs, including Medicare and Medicaid. Furthermore, Stark Law violations and failure to return overpayments timely can form the basis for FCA liability as discussed below. In addition, CMS released a final rule implementing modifications to the Stark Law intended to promote value-based and coordinated care arrangements as well as reduce other regulatory burdens. Most changes implemented by the final rule went into effect on January 19, 2021.The definition of DHS under the Stark Law excludes services paid under a composite rate, even if some of the components bundled in the composite rate are DHS. Although the ESRD bundled payment system is no longer titled a composite rate, we believe that the former composite rate payment system and the current bundled system are both composite systems excluded from the Stark Law. Since most services furnished to Medicare beneficiaries provided in our dialysis centers are reimbursed through a bundled rate, we believe that the services performed in our facilities generally are not DHS. Certain separately billable drugs (drugs furnished to an ESRD patient that are not for the treatment of ESRD that CMS allows our centers to bill for using the so-called AY modifier) may be considered DHS. However, we have implemented certain billing controls designed to limit DHS being billed out of our dialysis clinics. Likewise, the definition of inpatient hospital services, for purposes of the Stark Law, also excludes inpatient dialysis performed in hospitals that are not certified to provide ESRD services. Consequently, we believe that our arrangements with such hospitals for the provision of dialysis services to hospital inpatients should not trigger the Stark Law referral prohibition.In addition, although prescription drugs are DHS, there is an exception in the Stark Law for calcimimetics, EPO and other specifically enumerated dialysis drugs when furnished in or by an ESRD facility such that the arrangement for the furnishing of the drugs does not violate the Stark Law. In the ordinary course of business operations, DaVita and its ancillary businesses and subsidiaries have many different types of financial arrangements with referring physicians that potentially implicate the Stark Law, including, but not limited to, medical director agreements, joint ventures, leases and subleases with entities in which physicians, hospitals or medical groups hold ownership interest, consulting agreements, hospital services agreements, discharge planning services agreements, acute dialysis services agreements, value-based care arrangements, employment agreements and incentive performance arrangements. In addition, some referring physicians may own our common stock in reliance on the Stark Law exception for investment interests in large publicly traded companies. If our interpretation of the applicability of the Stark Law to our operations is incorrect, the controls we have implemented fail, an arrangement is entered into outside of our processes, or we were to fail to satisfy an applicable exception to the Stark Law, we could be found to be in violation of the Stark Law and required to change our practices, face civil penalties, pay substantial fines, return certain payments received from Medicare and beneficiaries or otherwise experience a material adverse effect. In addition, it might be necessary to restructure existing compensation agreements with our medical directors and to repurchase or to request the sale of ownership interests in subsidiaries and partnerships held by referring physicians or, alternatively, to refuse to accept referrals for DHS from these physicians, or take other actions to modify our operations. Any finding by CMS or other regulatory or enforcement authorities that we have violated the Stark Law or related penalties and restructuring or other required actions could have a material adverse effect on our business, results of operations, financial condition, cash flows, stock price and reputation.False Claims ActThe federal FCA is a means of policing false claims, false bills or false requests for payment in the healthcare delivery system. In part, the FCA authorizes the imposition of up to three times the government’s damages and civil penalties, plus up to approximately $25,000 per claim, on any person who, among other acts:•Knowingly presents or causes to be presented to the federal government, a false or fraudulent claim for payment or approval;•Knowingly makes, uses or causes to be made or used, a false record or statement material to a false or fraudulent claim;•Knowingly makes, uses, or causes to be made or used, a false record or statement material to an obligation to pay the government, or knowingly conceals or knowingly and improperly, avoids or decreases an obligation to pay or transmit money or property to the federal government; or•Conspires to commit the above acts.15In addition, the FCA imposes severe penalties for the knowing and improper retention of overpayments collected from government payors. Under these provisions, within 60 days of identifying and quantifying an overpayment, a provider is required to follow certain notification and repayment processes. An overpayment impermissibly retained could subject us to liability under the FCA, exclusion from government healthcare programs, and penalties under the federal Civil Monetary Penalty statute. As a result of these provisions, our procedures for identifying and processing overpayments may be subject to greater scrutiny.The federal government has used the FCA to prosecute a wide variety of alleged false claims and fraud allegedly perpetrated against Medicare and state healthcare programs, including coding errors, billing for services not rendered, the submission of false cost reports, billing for services at a higher payment rate than appropriate, billing under a comprehensive code as well as under one or more component codes included in the comprehensive code and billing for care that is not considered medically necessary. The ACA provides that claims tainted by a violation of the federal Anti-Kickback Statute are false for purposes of the FCA. Some courts have held that filing claims or failing to refund amounts collected in violation of the Stark Law can form the basis for liability under the FCA. In addition to the provisions of the FCA, which provide for civil enforcement, the federal government can use several criminal statutes to prosecute persons who are alleged to have submitted false or fraudulent claims for payment to the federal government. In December 2022, proposed modifications relating to the application of FCA under the Medicare program were released. As proposed, the modifications would amend the knowledge requirement and remove references to quantification, among other things. We will monitor the comment process and finalization of the proposed rules, and will assess any changes relating to the FCA that are implemented to the extent they could impact our business. Fraud and abuse under state lawState fraud and abuse laws related to anti-kickback, physician self-referral, beneficiary inducement and false claims often mirror those requirements of the applicable federal laws, or, in some instances contain additional or different requirements. If we were found to violate these state laws and regulations, we, among other things, could face criminal, civil or administrative sanctions, including loss of licensure or possible exclusion for Medicaid and other state and federal healthcare programs. Any findings that we have violated these laws and regulations could have a material adverse impact on our business, operations, financial condition, cash flows, reputation and stock price. In addition to these fraud waste and abuse laws, some states in which we operate dialysis centers have laws prohibiting physicians from holding financial interests in various types of medical facilities to which they refer patients. Some of these laws could potentially be interpreted broadly as prohibiting physicians who hold shares of our publicly traded stock or are physician owners from referring patients to our dialysis centers if the centers use our laboratory subsidiary to perform laboratory services for their patients or do not otherwise satisfy an exception to the law. States also have laws similar to or stricter than the federal Anti-Kickback Statute that may affect our ability to receive referrals from physicians with whom we have financial relationships, such as our medical directors. Some state anti-kickback laws also include civil and criminal penalties. Some of these laws include exemptions that may be applicable to our medical directors and other physician relationships or for financial interests limited to shares of publicly traded stock. Some, however, may include no explicit exemption for certain types of agreements and/or relationships entered into with physicians. If these laws are interpreted to apply to referring physicians with whom we contract for items or services, including medical directors, or to referring physicians with whom we hold joint ownership interests or to referring physicians who hold interests in DaVita Inc. limited solely to our publicly traded stock, and for which no applicable exception exists, we may be required to terminate or restructure our relationships with or refuse referrals from these referring physicians and could be subject to criminal, civil and administrative sanctions, refund requirements and exclusions from participation in government healthcare programs, including Medicare and Medicaid, which could have a material adverse effect on our business, results of operations, financial condition, cash flows, reputation and stock price. Corporate Practice of Medicine and Fee-SplittingThere are states in which we operate that have laws that prohibit business entities not owned by health care providers, such as our Company and our subsidiaries, from practicing medicine, employing physicians and other licensed health care providers providing certain clinical services or exercising control over medical or clinical decisions by physicians and potentially other types of licensed health care providers (known collectively as the corporate practice of medicine). These states may also prohibit entities from engaging in certain financial arrangements, such as fee-splitting, with physicians and potentially other types of licensed health care providers. Violations of the corporate practice of medicine, fee-splitting and related laws vary by state and may result in physicians and potentially other types of licensed health care providers being subject to disciplinary action, as well as to forfeiture of revenues from payors for services rendered. Violations may also bring both civil and, in more extreme cases, criminal liability for engaging in medical practice without a license and violating the corporate 16practice of medicine, fee-splitting and related laws. Some of the relevant laws, regulations, and agency interpretations in states with corporate practice of medicine restrictions have been subject to limited judicial and regulatory interpretation. Civil Monetary Penalties StatuteThe Civil Monetary Penalties Statute, 42 U.S.C. § 1320a-7a, authorizes the imposition of civil money penalties, assessments, and exclusion against an individual or entity based on a variety of prohibited conduct, including, but not limited to:•Presenting, or causing to be presented, claims for payment to Medicare, Medicaid, or other third-party payors that the individual or entity knows or should know are for an item or service that was not provided as claimed or is false or fraudulent; •Offering remuneration to a federal healthcare program beneficiary that the individual or entity knows or should know is likely to influence the beneficiary to order or receive healthcare items or services from a particular provider;•Arranging contracts with an entity or individual excluded from participation in the federal healthcare programs;•Violating the federal Anti-Kickback Statute;•Making, using, or causing to be made or used, a false record or statement material to a false or fraudulent claim for payment for items and services furnished under a federal healthcare program;•Making, using, or causing to be made any false statement, omission, or misrepresentation of a material fact in any application, bid, or contract to participate or enroll as a provider of services or a supplier under a federal healthcare program; and•Failing to report and return an overpayment owed to the federal government.Substantial civil monetary penalties may be imposed under the federal Civil Monetary Penalty Statute and vary, depending on the underlying violation. In addition, an assessment of not more than three times the total amount claimed for each item or service may also apply, and a violator may be subject to exclusion from participation in federal and state healthcare programs.Foreign Corrupt Practices ActWe are subject to the provisions of the Foreign Corrupt Practices Act (FCPA) in the United States and similar laws in other countries, which generally prohibit companies and those acting on their behalf from making improper payments to foreign government officials and others for the purpose of obtaining or retaining business. A violation of the FCPA or other similar laws by us and/or our agents or representatives could result in, among other things, the imposition of fines and penalties, changes to our business practices, the termination of or other adverse impacts under our contracts or debarment from bidding on contracts, and/or harm to our reputation, any of which could have a material adverse effect on our business, results of operations, financial condition, cash flows and stock price.Privacy and SecurityThe Health Insurance Portability and Accountability Act of 1996 and its implementing privacy and security regulations, as amended by the federal Health Information Technology for Economic and Clinical Health Act (HITECH Act) (collectively referred to as HIPAA), require us to provide certain protections to patients and their health information. The HIPAA privacy and security regulations extensively regulate the use and disclosure of PHI and require covered entities, which include healthcare providers, to implement and maintain administrative, physical and technical safeguards to protect the security of such information. Additional security requirements apply to electronic PHI. These regulations also provide patients with substantive rights with respect to their health information.The HIPAA privacy and security regulations also require us to enter into written agreements with certain contractors, known as business associates, to whom we disclose PHI. Covered entities may be subject to penalties for, among other activities, failing to enter into a business associate agreement where required by law or as a result of a business associate violating HIPAA if the business associate is found to be an agent of the covered entity and acting within the scope of the agency. Business associates are also directly subject to liability under the HIPAA privacy and security regulations. In instances where we act as a business associate to a covered entity, there is the potential for additional liability beyond our status as a covered entity.17Covered entities must report breaches of unsecured PHI to affected individuals without unreasonable delay but not to exceed 60 days of discovery of the breach by a covered entity or its agents. Notification must also be made to the HHS and, for breaches of unsecured PHI involving more than 500 residents of a state or jurisdiction, to the media. All non-permitted uses or disclosures of unsecured PHI are presumed to be breaches unless the covered entity or business associate establishes that there is a low probability the information has been compromised. Various state laws and regulations may also require us to notify affected individuals, and U.S. state attorneys general, or other regulators or law enforcement, in the event of a data breach involving individually identifiable information without regard to whether there is a low probability of the information being compromised.Penalties for impermissible use or disclosure of PHI were increased by the HITECH Act by imposing tiered penalties of more than $50,000 per violation and up to $1.5 million per year for identical violations. In addition, HIPAA provides for criminal penalties of up to $250,000 and ten years in prison, with the severest penalties for obtaining and disclosing PHI with the intent to sell, transfer or use such information for commercial advantage, personal gain or malicious harm. Further, state attorneys general may bring civil actions seeking either injunction or damages in response to violations of the HIPAA privacy and security regulations that threaten the privacy of state residents.In addition to the protection of PHI, healthcare companies must meet privacy and security requirements applicable to other categories of personal information. Companies may process consumer information in conjunction with website and corporate operations. They may also handle employee information, including Social Security Numbers, payroll information, and other categories of sensitive information, to further their employment practices. In processing this additional information, companies must comply with the applicable privacy and security requirements of comprehensive privacy and data protection laws, consumer protection laws, labor and employment laws, and its publicly-available notices.Data protection laws and regulations are evolving globally, and may continue to add additional compliance costs and legal risks to our international operations. In the European Union, the General Data Protection Regulation (EU GDPR) imposes a comprehensive data protection regime with the potential for regulatory fines as well as data breach litigation by impacted data subjects. Under the EU GDPR, regulatory penalties may be passed by data protection authorities for up to the greater of 4% of worldwide turnover or €20 million. The United Kingdom has implemented similar legislation (UK GDPR) that may carry similar compliance and operational costs as the EU GDPR, and non-compliance with which carries potential fines of up to the greater of £17.5 million or 4% of global turnover. The costs of compliance with, and other burdens imposed by, the EU GDPR, UK GDPR and other new laws, regulations and policies implementing the EU GDPR and UK GDPR may impact our European and United Kingdom operations and may limit the ways in which we can provide services or use personal data collected while providing services.Privacy and data protection laws are also evolving nationally, providing for enhanced state privacy rights that are broader than the current federal privacy rights, and may add additional compliance costs and legal risks to our U.S. operations. For example, the California Consumer Protection Act (CCPA), which became effective January 1, 2020, requires certain companies doing business in California to enhance privacy disclosures regarding the collection, use and sharing of a consumer's personal data. The CCPA also permits the imposition of civil penalties, grants enforcement authority to the state Attorney General and provides a private right of action for consumers where certain personal information is breached due to unreasonable information security practices. Additionally, the California Privacy Rights Act (CPRA), which took effect on January 1, 2023, significantly expands the data protection obligations imposed by the CCPA on companies doing business in California, including additional consumer rights processes, limitations on data uses, and opt outs for certain uses of sensitive data. California also has a new data protection agency, the California Privacy Protection Agency, which is in the process of promulgating regulations under the CPRA amendments to the CCPA and will have concurrent enforcement powers with the California Department of Justice. Under CPRA amendments, certain businesses with higher risk privacy and security practices are required to submit annual audits to the agency on a regular basis. In addition to California, other states have passed similar privacy laws that will come into effect in 2023. These state data protection laws will likely result in broader increased regulatory scrutiny in applicable states of businesses' privacy and security practices, could lead to a further rise in data protection litigation, and will require additional compliance investment and potential business process changes. In addition to the breach reporting requirements under HIPAA, companies are subject to state breach notification laws. Each state enforces a law requiring companies to provide notice of a breach of certain categories of sensitive personal information, e.g. Social Security Number, financial account information, or username and password. A company impacted by a breach must notify affected individuals, attorney’s general or other agencies within a certain time frame. If a company does not provide timely notice with the required content, it may be subject to civil penalties brought by attorney’s generals or affected individuals. Companies must also safeguard personal information in accordance with federal and state data security laws and requirements. These requirements are akin to the HIPAA requirements to safeguard PHI, described above. The Federal Trade 18Commission, for example, requires companies to implement reasonable data security measures relative to its operations and the volume and complexity of the information it processes. Also, various state data security laws require companies to safeguard data with technical security controls and underlying policies and processes. Due to the constant changes in the data security space, companies must continuously review and update data security practices to seek to mitigate any potential operational or legal liabilities stemming from data security risks. For additional details on the risks of compliance with applicable privacy and security laws, regulations and standards, see the discussion in Item 1A. Risk Factors under the heading "Privacy and information security laws are complex..."Integrated Kidney Care and Medicare and Medicaid program reformsThe regulatory framework of the healthcare marketplace continues to evolve as a result of executive, legislative, regulatory and administrative developments and judicial proceedings. These changes shape the landscape for our current dialysis business as well as for emerging comprehensive and integrated kidney care programs. The following discussion describes certain of these changes in further detail.CMMI Payment Models: The 2019 Executive Order directed CMS to create payment models through CMMI to evaluate the effects of creating payment incentives for the greater use of home-based dialysis and kidney transplants for those already on dialysis, improve quality of care for kidney patients and reduce expenditures. The first of these, the ESRD Treatment Choices (ETC) mandatory payment model launched in approximately 30% of dialysis clinics across the country on January 1, 2021, and CMS subsequently issued several clarifying rules through November 2022. CMS also announced the implementation of two voluntary kidney care payment models, Kidney Care First (KCF) and Comprehensive Kidney Care Contracting (CKCC), with the stated goal of helping healthcare providers reduce the cost and improve the quality of care for patients with late-stage chronic kidney disease and ESRD. CMS has stated these payment models are aimed to prevent or delay the need for dialysis and encourage kidney transplantation. Certain of these payment models, such as the First Performance Period for the Kidney Care Choices Model CKCC Options (the CKCC Model) commenced on January 1, 2022. As described above, the Company has invested substantial resources, and expects to continue to invest substantial resources in these models as part of the Company's overall plan to grow its integrated kidney care business and value-based care initiatives.For additional details on the risks related to integrated kidney care and Medicare and Medicaid program reforms, see the discussion in Item 1A. Risk Factors under the headings "If we are not able to successfully implement our strategy with respect to our integrated kidney care and value-based care initiatives...;" and "If we are unable to compete successfully..."Healthcare Reform, ACA and related regulations: The ACA regulatory framework of the healthcare marketplace continues to evolve as a result of executive, legislative, regulatory and administrative developments and judicial proceedings. For example, the expanded access to healthcare developed under the ACA has been both positively and negatively impacted over time by subsequent legal, regulatory and judicial action. In 2021 and 2022, the American Rescue Plan and Inflation Reduction Act of 2022 included several provisions designed to expand health coverage, including the expansion and extension of premium tax credits that assist consumers who purchase health insurance on marketplaces developed under the ACA and temporarily offering incentives to expand Medicaid coverage for states that have not yet done so. Our revenue and operating income levels are highly sensitive to the percentage of our patients with higher-paying commercial health insurance and any legislative, regulatory or other changes that decrease the accessibility and availability, including the duration, of commercial insurance is likely to have a material adverse impact on our business. Changes to the political environment may increase the likelihood of legislative or regulatory changes that would impact us, such as changes to the healthcare regulatory landscape. Examples of such potential changes also could include, among other things, legislative developments or changes to the eligibility age for Medicare beneficiaries. Some of these or other changes could in turn impact the percentage of our patients with higher-paying commercial health insurance, impact the scope or terms of coverage under commercial health plans and/or increase our expenses, among other things. The timing of legislative or executive action related to these potential initiatives, if any, remains uncertain, particularly in light of the current economic environment, and as such, considerable uncertainty exists surrounding the continued development of the ACA and related regulations, programs and models, as well as similar healthcare reform measures and/or other potential changes at the federal and/or state level to laws, regulations and other requirements that govern our business.21st Century Cures Act: As described above under the heading "—Medicare Advantage revenue," the Cures Act broadened patient access to certain enhanced benefits offered by MA plans. This change in benefit eligibility has increased the percentage of our patients on MA plans as compared to Medicare Part B plans, though it is unclear how many eligible ESRD patients will continue to seek to enroll in MA plans for their ESRD benefits over time. In addition, the Cures Act also includes provisions related to data interoperability, information blocking and patient access. For details on the risks associated with these provisions of the Cures Act, see the risk factors in Item 1A. Risk Factors under the headings, "Our business is subject to a complex set of governmental laws, regulations and other requirements...;" "If the number or percentage of patients with higher-19paying commercial insurance declines...;" and "Failing to effectively maintain, operate or upgrade our information systems or those of third-party service providers upon which we rely..."Health Plan Price Transparency Rules: In addition, recent price transparency regulations require most group health plans, and health insurance issuers in the group and individual markets, to make certain pricing and patient responsibility information publicly available. On July 1, 2022, most group health plans and issuers of group or individual health insurance were required to begin publishing machine-readable files that include negotiated rates for all covered items and services with all providers and out-of-network allowed amounts. For plan years that begin on or after January 1, 2023, most group health plans, and health insurance issuers in the group and individual markets, must provide enrollees with out-of-pocket cost and underlying provider negotiated rate information in a consumer-friendly format for an initial list of 500 designated services (which do not include dialysis). A plan or issuer may choose to include more than these 500 services, and for plan years that begin on or after January 1, 2024, most group health plans, and health insurance issuers in the group and individual markets, must provide enrollees with this information for all covered items and services. Additionally, CMS released regulations associated with "surprise billing" which necessitate, among other requirements, that certain providers provide patients with information regarding patient financial accountability and costs of services in advance of care being provided. While the ultimate impact of these requirements remains uncertain, any changes by group health plans, health insurance issuers in the group and individual markets, or consumer choices resulting from these requirements could have a material adverse impact on our business, results of operations, and financial condition, and could materially harm our reputation. In addition to the aforementioned pricing transparency rules, the government has also implemented certain additional pricing transparency requirements that apply to certain types of providers, including DaVita. Under the No Surprises Act, which went into effect January 1, 2022, certain providers, including DaVita, will be required to develop and disclose a “Good Faith Estimate” (GFE) that details the expected charges for furnishing an item or service to an uninsured or self-pay patient. The GFE must include certain specific information such as, among other things, co-provider service cost estimates, and is subject to certain format, availability and dispute resolution requirements. Similar to the aforementioned pricing transparency rules, the impact of the GFE requirements on DaVita remains uncertain at this time, in part due to ongoing rulemaking around the No Surprises Act as well as uncertainty around operational timeframes, potential penalties and patient reaction, among other things. COVID-19 Response: The COVID-19 pandemic has had a continuing and compounding impact on our community and our business. Through the pandemic, we have continued our focus on the health, safety and well-being of our patients, teammates and physician partners. Most importantly, we have continued to focus on helping to ensure that our patients have the ability to maintain continuity of care throughout this pandemic, whether in the hospital, outpatient or home setting. To that end, we have dedicated and continue to dedicate substantial resources in response to COVID-19, including the implementation of additional protocols and initiatives to help safely maintain continuity of care for our patients and help protect our caregivers. We carefully monitor the efficacy of our response protocols and their impact on our operations and strategic priorities as the pandemic continues.Federal and state governments have also responded to the pandemic through legislation, rule making, interpretive guidance and modifications to agency policies and procedures, designed to provide emergency economic relief measures. These governmental responses include, among other things, regulations from OSHA and CMS that impact our operations. COVID-19-related regulations have shaped our pandemic response, and have impacted our costs and operations. Certain of these increased costs relate to, among other things, personal protective equipment (PPE), fit-testing, paid time off, and surveillance testing of our teammates for COVID-19, as well as other heightened obligations with which we must comply. Compliance with COVID-19-related safety rules and regulations is enforced with sanctions and/or fines, and non-compliance also has the potential for negative publicity or reputational impact. These rules have added complexity and uncertainty to the already complex and highly regulated environment that we operate in, and the novel nature of our COVID-19 response, including, among other things, with respect to waivers of certain regulatory requirements, temporary clinical and operational changes and administration of COVID-19 vaccines, some of which are currently available under emergency use authorizations, as well as our efforts to comply with these evolving rules and regulations, may increase our exposure to legal, regulatory and clinical risks. In addition, in the event any of our temporary clinical and operational changes in response to COVID-19 become permanent, it could have an adverse impact on our business to the extent such changes result in increased costs or otherwise negatively impact our operations.As the COVID-19 pandemic evolves, federal and state regulatory authorities continue to issue additional guidance with respect to COVID-19, and at this time we cannot predict the ultimate impact these government actions may have on our business, results of operations, financial condition and cash flows. We will continue to assess the impact of statutes, regulations and supervisory guidance related to the COVID-19 pandemic. For additional information on the risks to our business associated with COVID-19 and labor market conditions, see the risk factors in Item 1A. Risk Factors under the headings, "Macroeconomic conditions and global events...;" and "Our business is labor intensive and if our labor costs continue to rise..."20Other regulationsOur U.S. dialysis and related lab services operations are subject to various state hazardous waste and non-hazardous medical waste disposal laws. These laws do not classify as hazardous most of the waste produced from dialysis services. OSHA regulations require employers to provide workers who are occupationally subject to blood or other potentially infectious materials with prescribed protections. These regulatory requirements apply to all healthcare facilities, including dialysis centers, and require employers to make a determination as to which employees may be exposed to blood or other potentially infectious materials and to have in effect a written exposure control plan. In addition, employers are required to provide or employ hepatitis B vaccinations, personal protective equipment and other safety devices, infection control training, post-exposure evaluation and follow-up, waste disposal techniques and procedures and work practice controls. Employers are also required to comply with various record-keeping requirements.In addition, a few states in which we do business have certificate of need programs regulating the establishment or expansion of healthcare facilities, including dialysis centers.State initiativesThere have been several state-based policy proposals to limit payments to dialysis providers or impose other burdensome operational requirements, which, if passed, could have a material adverse impact on our business, results of operation, financial condition and cash flows. For instance, in 2022, voters in California considered a statewide ballot initiative proposed by the Service Employees International Union - United Healthcare Workers West (SEIU) that sought to impose certain regulatory requirements on dialysis clinics, including requirements related to physician staffing levels, clinical reporting, clinical treatment options and limitations on the ability to make decisions on closing or reducing services for dialysis clinics. While voters rejected this most recent ballot initiative in 2022, we incurred substantial costs to oppose it. We may continue to face ballot initiatives or other proposed regulations or legislation in California or other states in future years, which may require us to incur further substantial costs and which, if passed, could have a material adverse impact on our business, results of operations, financial condition and cash flows. Evolving proposed or issued laws, requirements, rules and guidance that impact our business, including without limitation as may be described above, and any failure on our part to adequately adjust to any resulting marketplace developments could have a material adverse effect on our business, results of operations, financial condition and cash flows. For additional discussion on the risks associated with the evolving payment and regulatory landscape for kidney care, see the discussion in Item 1A. Risk Factors, including the discussion under the heading, "Our business is subject to a complex set of governmental laws, regulations and other requirements..."Corporate compliance programManagement has designed and implemented a corporate compliance program as part of our commitment to comply fully with applicable criminal, civil and administrative laws and regulations and to maintain the high standards of conduct we expect from all of our teammates. We continuously review this program and work to enhance it as appropriate. The primary purposes of the program include:•Assessing and identifying health care regulatory risks for existing and new businesses;•Training and educating our teammates and affiliated professionals to promote awareness of legal and regulatory requirements, a culture of compliance, and the necessity of complying with all applicable laws, regulations and requirements;•Developing and implementing compliance policies and procedures and creating controls to support compliance with applicable laws, regulations and requirements and our policies and procedures;•Auditing and monitoring the activities of our operating units and business support functions to identify and mitigate risks and potential instances of noncompliance in a timely manner; and•Ensuring that we promptly take steps to resolve any instances of noncompliance and address areas of weakness or potential noncompliance.We have a code of conduct that each of our teammates, members of our Board of Directors, affiliated professionals and certain third parties must follow, and we have an anonymous compliance hotline for teammates and patients to report potential instances of noncompliance that is managed by a third party. Our Chief Compliance Officer administers the compliance program. The Chief Compliance Officer reports directly to our Chief Executive Officer (CEO) and the Chair of the Compliance and Quality Committee of our Board of Directors (Board).21Any future penalties, sanctions or other consequences could be more severe in certain circumstances if the OIG or a similar regulatory authority determines that we knowingly or repeatedly failed to comply with applicable laws, regulations or requirements, including substantial penalties and exclusion from participation in federal healthcare programs that could have a material adverse effect on our business, results of operations, financial condition and cash flows, reputation and stock price.CompetitionThe U.S. dialysis industry remains highly competitive, with many new entrants aggressively entering the kidney healthcare business space. In our U.S. dialysis business, we continue to face intense competition from large and medium-sized providers, among others, which compete directly with us for limited acquisition targets, for individual patients who may choose to dialyze with us and to engage physicians qualified to provide required medical director services. In addition to these large and medium sized dialysis providers with substantial financial resources and other established participants in the dialysis space, we also compete with new dialysis providers, individual nephrologists, former medical directors or physicians that have opened their own dialysis units or facilities. Moreover, as we continue our international dialysis expansion into various international markets, we face competition from large and medium-sized providers, among others, for acquisition targets as well as physician relationships. We also experience competitive pressures from other dialysis and healthcare providers in recruiting and retaining qualified skilled clinical personnel as well as in connection with negotiating contracts with commercial healthcare payors and inpatient dialysis service agreements with hospitals. Acquisitions, developing new outpatient dialysis centers, patient retention and referrals, and referral source relationships, in which such sources understand us to be the clinical and operational leaders in the market are significant components of our growth strategy and our business could be adversely affected if we are not able to continue to make dialysis acquisitions on reasonable and acceptable terms, continue to develop new outpatient dialysis centers, maintain our referral sources' trust in our capabilities or if we experience significant patient attrition or lack of new patient growth relative to our competitors. Our largest competitor, Fresenius Medical Group (FMC), manufactures a full line of dialysis supplies and equipment in addition to owning and operating outpatient dialysis centers worldwide. This may, among other things, give FMC cost advantages over us because of its ability to manufacture its own products. Additionally, FMC has been one of our largest suppliers of dialysis products and equipment over the last several years. In 2021, we entered into and subsequently extended a new agreement with FMC to purchase a certain amount of dialysis equipment, parts and supplies from FMC which extends through December 31, 2024. The amount of purchases from FMC over the remaining term of this agreement will depend upon a number of factors, including the operating requirements of our centers, the number of centers we acquire, and growth of our existing centers.In addition to traditional dialysis providers, there have been a number of announcements, initiatives and capital raises by non-traditional dialysis providers and others along the full continuum of kidney care from CKD to dialysis to transplant. These business entities, certain of which command considerable resources and capital, may increasingly compete with us in the integrated kidney care market as we seek to grow in that space, or they may focus their efforts on the development of more conventional dialysis competition or the commencement of other new business activities or the development of innovative technologies that could be transformative to the industry. For additional discussion on these developments and associated risks, see the risk factor in Item 1A. Risk Factors under the heading, "If we are unable to compete successfully..."InsuranceWe are primarily self-insured with respect to professional and general liability, workers' compensation and automobile risks, and a portion of our employment liability practice risks, through wholly-owned captive insurance companies. We are also predominantly self-insured with respect to employee medical and other health benefits. We also maintain insurance, excess coverage, or reinsurance for property and general liability, professional liability, directors’ and officers’ liability, workers' compensation, cybersecurity and other coverage in amounts and on terms deemed appropriate by management, based on our actual claims experience and expectations for future claims. Future claims could, however, exceed our applicable insurance coverage. Physicians practicing at our dialysis centers are required to maintain their own malpractice insurance, and our medical directors are required to maintain coverage for their individual private medical practices. Our liability policies cover our medical directors for the performance of their duties as medical directors at our outpatient dialysis centers.Human capital managementOverviewAt DaVita, we are guided by our Mission—to be the provider, partner and employer of choice—and a set of Core Values—Service Excellence, Integrity, Team, Continuous Improvement, Accountability, Fulfillment and Fun—which are reinforced at all levels of the organization. Our teammates share a common passion for equitably improving patients' lives and are the cornerstone for the health of DaVita.22We strive to be a community first and a company second, and affectionately call ourselves a Village. To be a healthy Village, we need to attract, retain and develop highly qualified and diverse teammates. To do so, we have implemented strategies that support our mission to be the employer of choice, such as: •Designing programs and processes to cultivate a diverse talent pipeline that can allow us to hire ahead of needs;•Providing development and professional growth opportunities; and•Offering a robust and competitive total rewards program. These efforts are underpinned by a foundational focus on diversity and belonging that starts at the top with our Board and executive leadership and permeates through our Village as further described below. We believe that this intentional investment of time and resources fosters a special community of teammates that, in turn, leads to better care of our patients and the communities we serve.As of December 31, 2022, we employed approximately 70,000 teammates, including our international teammates.Oversight & ManagementOur Board provides oversight on human capital matters, receiving regular updates from our Chief People Officer about People Services’ activities, strategies and initiatives, and through the Board’s annual work with our CEO on management development and succession planning. Among other things, our Board and/or its committees also receive reports related to pay equity, risks and trends related to labor and human capital management issues and general issues pertaining to our teammates. The Board, in conjunction with its committees, also oversees the Company's activities, policies and programs related to corporate environmental and social responsibility, including considering the impact of such activities, policies and programs on the Company, teammates, patients and communities, among others.These reports and recommendations to the Board and its committees are part of our broader People Services leadership and oversight framework, which includes guidance from various stakeholders across the business and benefits from the broad participation of senior leadership.Diversity & BelongingOur investment in our teammates is underscored by our commitment to Diversity & Belonging (D&B). We published our first D&B Report in March 2021, which disclosed our diversity metrics and roadmap for delivering our vision of cultivating "a diverse Village where everyone belongs." Our 3,074 dialysis centers operate in communities large and small, in nearly every state in the U.S. as well as 11 other countries. Our Village's diversity is inherent in the teammates who work in our centers, the patients we care for, the physicians with whom we partner, and the communities where we serve.To help achieve this vision, we empower all leaders and teammates to cultivate D&B in their centers and on their teams. One way we do this is by sharing tools and resources like our Belonging Teammate and Belonging Leader Guides, which encourage teammates to connect with each other to learn about individual experiences with belonging and better understand the impact of unconscious bias. In addition, in 2022, we launched certain employee resource groups to create a community for teammates from underrepresented groups. Based on our most recent internal surveys, 81% of teammates indicated that they feel a sense of belonging within the DaVita community. We also launched our third annual Week of Belonging in 2022, engaging teammates globally with activities and education designed to further create a sense of belonging.We take a collaborative, leader-led approach to building our D&B program. Everyone from our front-line patient care technicians (PCTs) and nurses to our divisional vice presidents, our CEO and our Board has a role in implementing our strategy. It truly does take a Village to bring our vision to life. Over the past several years, our D&B efforts have focused primarily on supporting strong representation of women and people of color in our Company and ensuring that we are creating a welcoming, open environment where all teammates, patients, physicians and care partners belong. As of December 31, 2022, our Village in the U.S. was comprised of 78% women and 56% people of color. We are proud of the fact that in the U.S. as of December 31, 2022, 74% of our managers and 61% of our directors are women and that leaders with profit and loss responsibility are 53% women and 30% people of color. We also are proud that our Board is comprised of 30% women and 20% people of color. With respect to Board leadership positions, we are one of the few companies in the S&P 500 to have a woman serving as the Chair of the Board. We are also among the 11% of a selected group of companies in the Fortune 500 and S&P 500 to have a person of color serve as our CEO. We publish our demographic data in our EEO-1 Report, 23which is included in our Sustainability Accounting Standards Board (SASB) Report. As of December 31, 2022, we are meeting or exceeding 79% of EEO-1 benchmarks.Talent Pipeline and Career DevelopmentWe understand that a key component of developing strong representation of women and people of color in leadership is to have recruiting practices focused on diversity. Our practices include: •Diverse Sourcing: Our recruiters are trained on how to source for diverse candidates to ensure we have a robust pipeline at all levels of the organization.•Diversity In Hiring: We are committed to increasing diverse representation via our hiring practices. One way we do this is with diverse interview panels as well as diverse candidate slates to help ensure a fair and equitable process. •Diverse Partnerships: We have external partnerships with organizations like Forte Foundation and Management Leadership for Tomorrow to help create equal opportunities for diverse candidates.•Redwoods Leadership: We partner closely with diverse student body organizations at colleges and universities to source applicants for our Redwoods leadership development programs. Helping teammates reach the next stage in their career and increasing their earning potential is foundational to our Employer of Choice strategy. We have a robust set of career development offerings to support teammates in reaching their professional ambitions. We have invested in an end-to-end career development pipeline that includes programs and initiatives that provide financial, education and social support to our clinical and operations personnel to help achieve their higher education and leadership goals. We are proud of our Clinical Ladders program that ties performance to career progression. This program is designed to provide our teammates with clear expectations on what's needed to progress to the next level on the ladder and provide them access to tools to do so. Since rolling out Clinical Ladders, we have celebrated more than 9,000 promotions among our nurse and patient care technician teammates. Predominately all of our teammates are clinical field/operations personnel, and we have programs in place to help guide their potential journey at DaVita. Beginning with programs like Bridge to Your Dreams that cover certification fees for PCTs to coaching and tuition programs that help guide PCTs to becoming registered nurses (RNs) to programs that help develop high potential nurses, clinical coordinators and clinic nurse managers into operational managers and ultimately to programs that prepare and coach operational managers for potential regional operations director roles, our goal is to make resources available to teammates at each step of a possible career path. We are proud of the work we have done in this area, with approximately 56% of our Facility Administrators and managers having been promoted internally, and over 1,450 teammates enrolled in the Bridge to Your Dreams program, as of December 31, 2022.Total Rewards ProgramOur total rewards philosophy and practices are designed to be competitive in the local market and reward strong team and individual performance. We believe merit-driven pay encourages teammates to do their best work, including in caring for our patients, and we strive to link pay to performance so we can continue to incentivize the provision of extraordinary care to our patients and grow our Village.To attract, retain and grow our teammates, we have a holistic approach to total rewards that includes financial, physical and emotional support. Highlights include, among other things:•Healthcare benefits including a menu of plan designs and health savings accounts.•Health programs in support of the most prevalent health conditions affecting our teammates, including hypertension, diabetes prevention/maintenance, musculoskeletal issues and weight loss/management. •Financial wellness including 401(k) match, employee stock purchase plan (ESPP), a deferred compensation plan, financial planning support and access to free banking services.•Family support programs to our teammates and their families that include family care programs for back-up child and elder care, family planning support for fertility, adoption and surrogacy, parental support for children’s educational and special needs and parental leave programs. We also offer a number of scholarships for teammates' children and grandchildren.24•Teammate Assistance Program that offers counseling sessions annually to all teammates and their household members, along with work/life resources and tools that include telephonic or face to face legal consultation and expert financial planning/consultation; each household member has access to ten free sessions per life event.•Free access to Headspace, an application for digital meditation and mindfulness, and referrals/consultations on everyday issues such as dependent care, auto repair, pet care and home improvement.•Vitality Points, a voluntary wellness incentive program that encourages teammates and their spouses/domestic partners to engage with their provider to manage their overall health. In addition, it allows participating teammates and spouses/domestic partners to earn credits toward their medical premium for getting a biometric screening with a primary care provider.•Short & Long term disability for full time teammates and Life/AD&D coverage at both the basic and supplemental levels.•DailyPay, a service that provides teammates with financial flexibility by allowing them to access earned but unpaid wages before payday.•Our DaVita Village Network, which provides financial support to eligible teammates experiencing a specific tragedy or hardship and helps cover additional costs that local fundraising and insurance do not fully cover.Pay EquityAt DaVita, we are committed to equal pay for equal work; meaning, teammates in the same position, performing at the same level, and in similar geographies, are paid fairly relative to one another, regardless of their gender, race or ethnicity. We believe that equitable pay is a critical component of establishing a fair work environment where all teammates are valued and feel like they belong. Fair pay is essential to our ability to attract and motivate the highly qualified, and diverse, teammates who are at the center of our current and future success.Continued Response to COVID-19 Public Health CrisisThe COVID-19 pandemic has continued to test our ability to respond to external developments and care for not only our patients, but also our teammates in real time. We have maintained many of our initial COVID-19 practices and have adapted our guidance based on ongoing changes to regulatory requirements. As the pandemic continues into 2023, we are integrating certain COVID-19 response protocols into our standard workflows and monitoring for any change in the Public Health Emergency status. Following the surge in January 2022, we changed our capacity management process during potential surges which was a beneficial operational shift for our facilities. We also continued to include COVID-19 testing, treatments, vaccines and boosters in our teammate communications program. Most importantly, the health, well-being and safety of our teammates, physician partners and their families remains a top priority throughout this ongoing pandemic. We implemented guidance early in the pandemic to help mitigate risks imposed by COVID-19 and maintain many practices, including, among other things, securing necessary supplies of PPE, restricting visitor access to our centers and implementing masking policies.We also converted numerous leadership development programs to virtual delivery, to help ensure that our teammates across our global Village could continue to grow personally and professionally and have access to career development resources despite the ongoing pandemic. Additionally, we have been able to begin gathering in person with COVID-19 meeting guidance in place and opened up our Central Business Offices for teammates.We believe our ability to engage with teammates and respond to these developments has helped us to better care for them. By caring for our teammates, we have been generally able to maintain continuity of care for our patients and support the broader healthcare community throughout this unprecedented public health crisis.For additional information about certain risks associated with our human capital management and our response to the COVID-19 pandemic, see the risk factors in Item 1A. Risk Factors under the headings, "Our business is labor intensive and if our labor costs continue to rise...;" and "Macroeconomic conditions and global events..."We also encourage you to visit our website at davitacommunitycare.com for more detailed information regarding certain aspects of our human capital and ESG related programs and initiatives described herein, including our D&B Report and Community Care Report, as well as our efforts to care for our patients, our community and our world. Nothing on our website, sections thereof or documents linked thereto, shall be deemed incorporated by reference into this report.25Item 1A. Risk FactorsThis Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities laws. Please read the cautionary notice regarding forward-looking statements in Item 7 of Part II of this Annual Report on Form 10-K under the heading "Management’s Discussion and Analysis of Financial Condition and Results of Operations." These forward-looking statements involve risks and uncertainties, including those discussed below, which could have a material adverse effect on our business, cash flows, financial condition, results of operations and/or reputation. The risks and uncertainties discussed below are not the only ones facing our business. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial could also have a material adverse effect on our business, cash flows, financial condition, results of operations and/or reputation.Summary Risk FactorsThe following is a summary of the principal risks and uncertainties that could adversely affect our business, cash flows, financial condition and/or results of operations, and these adverse impacts may be material. This summary is qualified in its entirety by reference to the more detailed descriptions of the risks and uncertainties included in this Item 1A. below and you should read this summary together with those more detailed descriptions.These principal risk and uncertainties relate to, among other things: Risks Related to the Operation of our Business•macroeconomic conditions and global events;•the complex set of governmental laws, regulations and other requirements that impact us, including potential changes thereto;•the various lawsuits, demands, claims, qui tam suits, governmental investigations and audits and other legal matters that we may be subject to from time to time;•the number or percentage of patients with higher-paying commercial insurance, the average rates that commercial payors pay us, any restrictions in plan designs or other contractual terms, including, without limitation, the scope and duration of coverage and in-network benefits;•our ability to successfully implement our strategy with respect to integrated kidney care, value-based care and home-based dialysis;•changes in the structure of and payment rates under government-based programs; •increases in labor costs, including, without limitation, due to shortages, changes in certification requirements and/or higher than normal turnover rates in skilled clinical personnel; currently pending or future governmental laws, rules, regulations or initiatives; our ability to attract and retain key leadership talent or employees; or union organizing activities or other legislative or other changes; •our ability to comply with complex privacy and information security laws that impact us and/or our ability to properly maintain the integrity of our data, protect our proprietary rights to our systems or defend against cybersecurity attacks;•our ability to establish and maintain supply relationships that meet our needs at cost-effective prices or at prices that allow for adequate reimbursement as applicable, our ability to access new technology or superior products in a cost-effective manner and our increasing reliance on third party service providers;•changes in clinical practices, payment rates or regulations impacting pharmaceuticals and/or devices;•our ability to compete successfully, including, without limitation, implementing our growth strategy and/or retaining patients and physicians willing to serve as medical directors;•our U.S. integrated kidney care, ancillary services and our international operations and our ability to expand within markets or to new markets, or invest in new products or services; •political, economic, legal, operational and other risks as we expand our operations and offer our services in markets outside of the U.S., and utilizing third-party suppliers and service providers operating outside of the U.S.;26•our ability to effectively maintain, operate or upgrade our information systems or those of third-party service providers upon which we rely, including, without limitation, our clinical, billing and collections systems, and our ability to adhere to federal and state data sharing and access requirements and regulations; •our acquisitions, mergers, joint ventures, noncontrolling interest investments or dispositions;•our aspirations, goals and disclosures related to environmental, social and governance (ESG) matters; •our ability to appropriately estimate the amount of dialysis revenues and related refund liabilities;General Risks•our current or future level of indebtedness, including, without limitation, our ability to generate cash to service our indebtedness and for other intended purposes and our ability to maintain compliance with debt covenants;•changes in tax laws, regulations and interpretations or challenges to our tax positions;•the effects of natural or other disasters, political instability, public health crises or adverse weather events such as hurricanes, earthquakes, fires or flooding;•liability claims for damages and other expenses that are not covered by insurance or exceed our existing insurance coverage;•our ability to successfully maintain an effective internal control over financial reporting; and•provisions in our organizational documents, our compensation programs and policies and certain requirements under Delaware law that may deter changes of control or make it more difficult for our stockholders to change the composition of our Board of Directors and take other corporate actions that our stockholders would otherwise determine to be in their best interests.Risks Related to the Operation of our BusinessMacroeconomic conditions and global events have impacted and will continue to impact our business and cost structure in a variety of ways, and there can be no assurance that we will be able to successfully execute cost savings initiatives in a manner that will offset the impact of these challenging conditions, which could result in a material adverse impact on us.We continue to be impacted by general conditions in the global economy and marketplace, many of which are interrelated. These conditions relate to, among other things, the COVID-19 pandemic, inflation, rising interest rates, challenging labor market conditions and supply chain challenges. Certain of these impacts could be further intensified by concurrent global events such as the ongoing conflict between Russia and Ukraine, which has continued to drive sociopolitical and economic uncertainty and volatility in Europe and across the globe. The ultimate impact of these and other conditions on our business over time depends on future developments that are highly uncertain and difficult to predict. With respect to COVID-19, these future developments include, among other things, the ultimate severity and duration of the pandemic; the evolution of new strains or variants of the virus that may present varying levels of infectivity or virulence; COVID-19's impact on the chronic kidney disease (CKD) patient population and our patient population, including on the mortality of these patients; the availability, acceptance, impact and efficacy of COVID-19 vaccines, treatments and therapies; the pandemic’s continuing impact on our revenue and non-acquired growth due to lower treatment volumes; the potential negative impact on our commercial mix or the number of patients covered by commercial insurance plans; continued increased COVID-related costs; supply chain challenges and disruptions, including with respect to our clinical supplies; the responses of our competitors to the pandemic and related changes in the marketplace; the timing, scope and effectiveness of federal, state and local government responses; and any potential changes to the extensive set of federal, state and local laws, regulations and requirements that govern our business. COVID-19 has also intensified certain conditions and developments in the U.S. and global economies, labor market conditions, inflation and monetary policies that continue to impact our business as further described below.We have experienced and expect to continue to experience a negative impact on revenue and non-acquired growth from COVID-19 due to lower treatment volumes, including from the negative impact of COVID-19 on the mortality rates of our patients, which has in turn impacted our patient census, as well as the direct and indirect impact of COVID-19 on our missed treatment rate and new admissions. We expect that the impact of COVID-19 is likely to continue to negatively impact our revenue and non-acquired growth for a period of time even as the pandemic subsides due to the compounding impact of mortalities, among other things. Because ESKD patients may be older and generally have comorbidities, several of which are risk factors for COVID-19, we believe the mortality rate of infected patients has been higher in the dialysis population than in 27the general population. Over the longer term, we believe that changes in mortality in both the ESKD and CKD populations due to COVID-19 will continue to depend primarily on the infection rate, case fatality rate, the age and health status of affected patients, and access to and continued efficacy of vaccinations or other treatments or therapies, particularly as it relates to variants of the virus, as well as willingness to be vaccinated. New admission rates, future revenues and non-acquired growth could also continue to be negatively impacted over time to the extent that the CKD population experiences elevated mortality levels due to the pandemic. There remains significant uncertainty as to the ultimate impact of COVID-19 on our treatment volumes, in part due to, among other things, the indeterminate severity and duration of the pandemic and the complexity of factors that may drive new admissions and missed treatment rates over time. Depending on the ultimate severity and duration of the pandemic, the magnitude of these cumulative impacts could have a material adverse impact on our results of operations, financial condition and cash flows. For further information on our growth strategy and the rate of growth of the ESKD population, see the risk factor under the heading, "If we are unable to compete successfully..." COVID-19 and other global conditions have also increased, and will continue to increase, our expenses, including, among others, staffing and labor costs. Our business is labor intensive and our financial and operating results have been and continue to be sensitive to variations in labor-related costs and productivity. We have historically faced and expect to continue to face difficulties in hiring and retaining caregivers due in part to a nationwide shortage of clinical personnel. These challenges have been heightened by the increased demand for and demand upon such personnel by the ongoing pandemic and our COVID-19 response, as well as ongoing volatility and uncertainty in the labor market, particularly in healthcare. In 2022, as part of our continuing efforts in this challenging and highly competitive labor market, we incurred higher than usual wage increases, and higher incentive pay. For additional details on the substantial resources dedicated, and costs incurred in response to COVID-19, see the discussion under Part I, Item 1. Business of this Form 10-K under the heading "COVID-19 and its impact on our business". In addition, potential staffing shortages or disruptions, if material, could ultimately lead to the unplanned closures of certain centers or adversely impact clinical operations, and may otherwise have a material adverse impact on our ability to provide dialysis services or the cost of providing those services, among other things. The staffing and labor cost inflation described above, in addition to higher equipment and clinical supply costs, among other things, have put pressure on our existing cost structure, and we expect that some of these increased costs will continue as labor market conditions remain challenging, global supply chains continue to experience volatility and disruptions and as inflationary pressures continue. Prolonged volatility, uncertainty, labor supply shortages and other challenging labor market conditions could have an adverse impact on our growth and ability to execute on our other strategic initiatives and a material adverse impact on our labor costs, among other things. Prolonged strain on global supply chains may result in equipment and clinical supply shortages, disruptions, delays or associated price increases that could impact our ability to provide dialysis services or the cost of providing those services, among other things. Moreover, to the extent that monetary policies or other factors impacting structural costs over the long term have contributed to or may in the future contribute to inflationary pressures, this may in turn continue to increase our labor and supply costs at a rate that outpaces the Medicare or any other rate increases we may receive. In our value-based care and other programs where we assume financial accountability for total patient cost, an increase in COVID-19 rates among patients could have an impact on total cost of care. This increase may in turn impact the profitability of those programs relative to their respective funding.We continue to implement cost savings opportunities to help mitigate these cost and volume pressures. These include, among other things, anticipated cost savings related to general and administrative cost efficiencies, such as ongoing initiatives that increase our use of third party service providers to perform certain activities, including financial reporting and information technology functions, initiatives relating to clinic optimization, initiatives for capacity utilization improvement, and procurement opportunities, such as our transition to a new erythropoiesis stimulating agent (ESA) contract. We have incurred, and expect to continue to incur charges in connection with the continued implementation of these initiatives, and there can be no assurance that we will be able to successfully execute these initiatives or that they will achieve expectations or succeed in helping offset the impact of these challenging conditions. Any failure on our part to adjust our business and operations in this manner, to adjust to other marketplace developments or dynamics or to appropriately implement these initiatives in accordance with applicable legal, regulatory or compliance requirements could adversely impact our ability to provide dialysis services or the cost of providing those services, among other things, and ultimately could have a material adverse effect on our business, reputation, results of operations, financial condition and cash flows. Deterioration in economic conditions, whether in connection with the COVID-19 pandemic or driven by other macroeconomic conditions or global events, including the aforementioned inflationary and labor market pressures, volatility and uncertainty, as well as rising interest rates, could have a material adverse effect on our business, results of operations, financial condition and cash flows. Among other things, the potential decline in federal and state tax revenues that may result from a deterioration in economic conditions may create additional pressures to contain or reduce reimbursements for our services from Medicare, Medicaid and other government sponsored programs. Increases in job losses in the U.S. as a result of adverse economic conditions, including economic deterioration, could ultimately result in a smaller percentage of our patients being covered by an employer group health plan and a larger percentage being covered by lower-paying government insurance 28programs or being uninsured. In the event a material reduction occurs in the share of our patients covered by commercial insurance plans, it would have a material adverse impact on our business, results of operations, financial condition and cash flows. The extent of these effects will depend upon, among other things, the extent and duration of any increased unemployment levels for our patient population, any economic deterioration or potential recession; the timing and scope of federal, state and local governmental responses to the ongoing pandemic; and patients’ ability to retain existing insurance and their individual choices with respect to their coverage, all of which are highly uncertain and difficult to predict. In a declining economy, employers may also select more restrictive commercial plans with lower reimbursement rates. To the extent that payors are negatively impacted by a decline in the economy, we may experience further pressure on commercial rates, a slowdown in collections and a reduction in the amounts we expect to collect. For additional information on risks regarding the potential impact of decreases to the percentage or number of our patients with commercial insurance, see the risk factor under the heading "If the number or percentage of patients with higher-paying commercial insurance declines..." If general economic conditions deteriorate further or remain uncertain for an extended period of time, we may incur future charges to recognize impairment in the carrying amount of our goodwill and other intangible assets. We may experience an increased need for additional liquidity funded by accessing existing credit facilities, raising new debt in the capital markets, or other sources, and we may seek to refinance existing debt, which may be more difficult or costly in an uncertain or declining economic environment. For additional information regarding the risks related to our indebtedness, see the discussion in the risk factor under the heading "The level of our current and future debt..." Furthermore, any extended billing or collection cycles, or deterioration in collectability of accounts receivable, will adversely impact our results of operations and cash flows.Should our revenues and financial results be materially, unfavorably impacted due to, among other things, a worsening of the economic and labor market conditions in the United States that negatively impacts reimbursement rates or the availability of insurance coverage for our patients, we may incur future charges to recognize impairment in the carrying amount of our goodwill and other intangible assets, which could have a material adverse effect on our business, results of operations and financial condition. As of December 31, 2022, we had approximately $7 billion of goodwill recorded on our consolidated balance sheet. We account for impairments of goodwill in accordance with the provisions of applicable accounting guidance, and record impairment charges when and to the extent a reporting unit's carrying amount is determined to exceed its estimated fair value. We use a variety of factors to assess changes in the financial condition, future prospects and other circumstances concerning our businesses and to estimate their fair value when applicable. These assessments and the related valuations can involve significant uncertainties and require significant judgment on various matters.Any or all of these economic conditions or developments, as well as other consequences of these conditions or developments, none of which we can reasonably predict, could have a material adverse effect on our patients, teammates, physician partners, suppliers, business, results of operations, financial condition and/or cash flows or materially harm our reputation. In addition, these conditions or developments each may heighten many of the other risks and uncertainties discussed herein.Our business is subject to a complex set of governmental laws, regulations and other requirements and any failure to adhere to those requirements, or any changes in those requirements, could have a material adverse effect on our business, results of operations, financial condition and cash flows, could materially harm our stock price, and in some circumstances, could materially harm our reputation.We operate in a complex regulatory environment with an extensive and evolving set of federal, state and local governmental laws, regulations and other requirements that apply to us. These laws, regulations and other requirements are promulgated and overseen by a number of different legislative, regulatory, administrative, and quasi-regulatory bodies, each of which may have varying interpretations, judgments or related guidance. As such, we utilize considerable resources on an ongoing basis to monitor, assess and respond to applicable legislative, regulatory and administrative requirements, but there is no guarantee that we will be successful in our efforts to adhere to all of these requirements. Laws, regulations and other requirements that apply to or impact our business include, but are not limited to:•Medicare and Medicaid reimbursement statutes, and other federal reimbursement statutes, rules and regulations (including, but not limited to, manual provisions, local coverage determinations, national coverage determinations, payment schedules and agency guidance); •Medicare and Medicaid provider requirements, including, but not limited to, requirements associated with providing and updating certain information about the Medicare or Medicaid entity, as applicable, and its direct and indirect affiliates; •Section 1115A of the Social Security Act, which, among other things, authorizes the Center for Medicare and Medicaid Innovation (CMMI) to test certain innovation models;29•Fraud waste and abuse laws;•the 21st Century Cures Act (the Cures Act);•Federal Acquisition Regulations;•the Foreign Corrupt Practices Act (FCPA) and similar laws and regulations; •antitrust and competition laws and regulations;•laws and regulations related to the corporate practice of medicine;•laws and regulations regarding the collection, use and disclosure of patient health information (e.g., Health Insurance Portability and Accountability Act of 1996 (HIPAA)); •the No Surprises Act;•laws and regulations regarding the storage, handling, shipment, disposal and/or dispensing of pharmaceuticals and blood products and other biological materials; and•individualized state laws and regulations associated with the operation of our business. If any of our personnel, representatives, third party vendors, or operations are alleged to have violated these or other laws, regulations or requirements, we could experience material harm to our reputation and stock price, and it could impact our relationships and/or contracts related to our business, among other things. If any of our personnel, representatives, third party vendors or operations are found to violate these or other laws, regulations or requirements, we could suffer additional severe consequences that could have a material adverse effect on our business, results of operations, financial condition and cash flows, including, among others:•Loss of required certifications or suspension or exclusion from or termination of our participation in government programs (including, without limitation, Medicare, Medicaid and CMMI demonstration programs); •Refunds of amounts received in violation of law or applicable payment program requirements dating back to the applicable statute of limitation periods; •Loss of licenses required to operate healthcare facilities or administer pharmaceuticals in the states in which we operate; •Reductions in payment rates or coverage for dialysis and ancillary services and pharmaceuticals; •Criminal or civil liability, fines, damages or monetary penalties; •Imposition of corporate integrity agreements, corrective action plans or consent agreements; •Enforcement actions, investigations, or audits by governmental agencies and/or state law claims for monetary damages by patients who believe their protected health information (PHI) has been used, disclosed or not properly safeguarded in violation of federal or state patient privacy laws, including, among others, HIPAA and the Privacy Act of 1974; •Enforcement actions, investigations, or audits by government agencies related to interoperability and related data sharing and access requirements and regulations;•Mandated changes to our practices or procedures that significantly increase operating expenses that could subject us to ongoing audits and reporting requirements as well as increased scrutiny of our billing and business practices which could lead to potential fines, among other things;•Termination of various relationships and/or contracts related to our business, such as joint venture arrangements, medical director agreements, hospital services and skilled nursing home agreements, real estate leases, value-based care arrangements, clinical incentive programs, payor contracts and consulting or participating provider agreements with physicians, among others; and •Harm to our reputation, which could negatively impact our business relationships and stock price, our ability to attract and retain patients, physicians and teammates, our ability to obtain financing and our access to new business opportunities, among other things.30Any future penalties, sanctions or other consequences could be more severe in certain circumstances if the OIG or a similar regulatory authority determines that we knowingly or repeatedly failed to comply with laws, regulations or requirements that apply to our business. Additionally, the healthcare sector, including the dialysis industry, is regularly subject to negative publicity, including as a result of governmental investigations, adverse media coverage and political debate surrounding the U.S. healthcare system, among other things. Negative publicity, regardless of merit, regarding the dialysis industry generally, the U.S. healthcare system or DaVita in particular may adversely affect us. See Note 16 to the consolidated financial statements included in this report for further details regarding certain pending legal proceedings and regulatory matters to which we are or may be subject from time to time, any of which may include allegations of violations of applicable laws, regulations and requirements.The complex and highly regulated environment that we operate in, the novel nature of our COVID-19 response and rulemaking responses to COVID-19 by certain state and federal agencies, including without limitation OSHA and CMS, may increase our exposure to legal, regulatory compliance and clinical risks. Compliance with COVID-19-related safety rules and regulations is enforced with sanctions and/or fines, and non-compliance also has the potential for negative publicity or reputational impact. In addition, our novel response to the pandemic included implementing certain restrictive operational protocols for an extended period of time. Maintaining these restrictive operational protocols may also have adversely impacted our strategic initiatives, such as our strategy to continue to build our abilities to offer home dialysis options and expanding our integrated care capabilities. Moreover, the expected expiration of the federal government's national emergency and public health emergency declarations in May 2023 may impact the coverage for certain services for Medicare and Medicaid patients and will end waivers for the provision of certain services, and returning our services to a pre-pandemic regulatory state similarly may increase our exposure to legal, regulatory, compliance and clinical risks. If we experience a failure of the fitness of our clinical laboratory, dialysis centers and related operations and/or other facilities as a result of operational changes implemented in connection with the COVID-19 pandemic or for any other reason, or if another event or occurrence adversely impacts the safety of our caregivers or patients (or is alleged to have done so), we could face adverse consequences, including without limitation, material negative impact on our brand, increased litigation, compliance or regulatory investigations, teammate unrest, work stoppages or other workforce disruptions. Any governmental investigations or legal actions brought by patients, teammates, caregivers or others relating to the safety of our caregivers or patients, or alleged exposure to COVID-19 at our facilities or by our caregivers, may involve significant demands and require substantial legal defense costs, which may not be adequately covered by our professional and general liability insurance, and may materially harm our reputation. Changes in federal and state healthcare legislation or regulations could have a material adverse effect on our business, results of operations, financial condition and cash flows. Each of the laws, regulations and other requirements that govern our business may continue to change over time, and there is no assurance that we will be able to accurately predict the nature, timing or extent of such changes or the impact of such changes on the markets in which we conduct business or on the other participants that operate in those markets.Among other things, the regulatory framework of the healthcare marketplace continues to evolve as a result of executive, legislative, regulatory and administrative developments and judicial proceedings. These changes shape the landscape for our current dialysis and ancillary businesses as well as for emerging comprehensive and integrated kidney care markets. For example, as further described below, we have made substantial investments in and dedicated resources to our integrated care business, value-based care initiatives and home-based dialysis business to address recent regulatory developments that include innovative payment models, and there are risks to those investments, or additional investments may be required, in the event the regulatory environment changes and we do not adequately adapt to such changes. In addition, access to healthcare has been both positively and negatively impacted over time by legal, regulatory and judicial action and changes to the political environment may increase the likelihood of regulatory or legislative changes that would impact us. If access to healthcare is significantly altered or if other reforms limiting access to healthcare are enacted in the future, such changes could impact our business in a number of ways, some of which may be material. Considerable uncertainty exists surrounding the continued development of the healthcare regulatory environment including pilot programs and models, as well as similar healthcare reform measures and/or other changes to laws, regulations and other requirements at the federal and/or state level that govern our business.Changes to the continuously evolving healthcare regulatory landscape may also have the potential to generate opportunities with relative ease of entry for certain smaller and/or non-traditional providers and we may be competing with them for patients in an asymmetrical environment with respect to data and/or regulatory requirements given our status as an ESRD service provider. For example, CMS may consider opening for comment its established Medicare ESRD conditions for coverage. In the event that this process results in reductions or other changes in minimum health and safety standards for the provision of dialysis services, it may change the marketplace in which we operate. If we are unable to successfully adapt to 31these marketplace developments in a timely and compliant manner, we may experience a material adverse reduction in our overall number of patients, among other things. For additional detail on our evolving competitive environment, see the risk factor under the heading "If we are unable to compete successfully..." Broader changes to the regulatory landscape may also impact our business. For example, in January 2023, the Federal Trade Commission proposed a new rule that would generally prohibit employers from using noncompete clauses in contracts with workers that extend beyond the termination of the employment or independent contractor relationship. While the rule remains open for comment and the final rule has not been issued, we are monitoring these developments for any potential impact on our agreements with teammates, our arrangements with medical directors, joint venture operating agreements, or the terms of any of our existing agreements with physicians should the proposed rule be finalized and implemented.Although we cannot predict the short- or long-term effects of legislative or regulatory changes, future market changes could result in, among other things, more restrictive commercial plans with lower reimbursement rates or higher deductibles and co-payments that patients may not be able to pay. Because our revenue and operating income levels are highly sensitive to the percentage and number of our patients with higher-paying commercial health insurance, any legislative, regulatory or other changes that decrease the accessibility and availability, including the duration, of commercial insurance is likely to have a material adverse impact on our business. For additional information on the impact of economic conditions or legislative or regulatory changes on the coverage and rates for our services and the percentage or number of our patients with commercial insurance, see the risk factor under the heading "If the number or percentage of patients with higher-paying commercial insurance declines..."There have also been several state initiatives to limit payments to dialysis providers or impose other burdensome operational requirements, which, if passed, could have a material adverse impact on our business, results of operation, financial condition and cash flow. For instance, in 2022, voters in California considered a statewide ballot initiative proposed by the Service Employees International Union - United Healthcare Workers West (SEIU-UHW) that sought to impose certain regulatory requirements on dialysis clinics, including requirements related to physician staffing levels, clinical reporting, clinical treatment options and limitations on the ability to make decisions on closing or reducing services for dialysis clinics. While voters rejected this most recent ballot initiative in 2022, we incurred substantial costs to oppose it. We may face ballot initiatives or other proposed regulations or legislation in California or other states in future years, which may require us to incur further substantial costs and which, if passed, could have a material adverse impact on our business, results of operations, financial condition and cash flows.Finally, there have also been rule making and legislative efforts at both the federal and state level regarding the use of charitable premium assistance for ESRD patients that may establish new conditions for coverage standards for dialysis facilities. For example, on October 13, 2019, a California bill (AB 290) was signed into law that limits the amount of reimbursement paid to certain providers for services provided to patients with commercial insurance who receive charitable premium assistance. The American Kidney Fund (AKF), an organization that provides charitable premium assistance, announced that it would be withdrawing from California as a result of AB 290. The implementation of AB 290 has been stayed pending resolution of legal challenges, but in the event AB 290 becomes effective and the AKF withdraws from California, it may cause other organizations that provide charitable premium assistance to withdraw from California, and we would expect an adverse impact on the ability of patients to afford Medicare premiums and Medicare supplemental and commercial coverage. We expect that such an adverse impact will in turn adversely impact our business, results of operations, financial condition and cash flows. In the past, bills similar to AB 290 have been introduced in other states, but none has become law. If these or similar bills are introduced and implemented in other jurisdictions, and organizations that provide charitable premium assistance in those jurisdictions are similarly impacted, it could in the aggregate have a material adverse impact on our business, results of operations, financial condition and cash flows. For additional information on risks associated with charitable premium assistance for ESRD patients and the potential impact of decreases to the percentage or number of our patients with commercial insurance, see the risk factor under the heading "If the number or percentage of patients with higher-paying commercial insurance declines..."Among other things, legislation, regulations, regulatory guidance, ballot initiatives and any similar initiatives could result in a reduction in the percentage of our patients with commercial insurance; limit the scope or nature of coverage through the exchanges or other health insurance programs or otherwise reduce reimbursement rates for our services from commercial and/or government payors; restrict or prohibit the ability of patients with access to alternative coverage from selecting a marketplace plan on or off exchange; limit the amount of revenue that a dialysis provider can retain for caring for patients with commercial insurance; impose burdensome operational requirements; affect payments made to providers for services provided to patients who receive charitable premium assistance and/or otherwise restrict or prohibit the use of charitable premium assistance; or reduce the standards for network adequacy or require disclosure of certain pricing and patient responsibility information. In turn, these potential impacts could cause us to incur substantial costs to oppose any such proposed requirements or measures, impact our dialysis center development plans, and if passed and/or implemented, could materially reduce our revenues and increase our operating and other costs, adversely impact dialysis centers across the U.S. making certain centers economically 32unviable, lead to the closure of certain centers, restrict the ability of dialysis patients to obtain and maintain optimal insurance coverage and reduce the number of patients that select commercial insurance plans or MA plans for their dialysis care, among other things. The healthcare legislative and regulatory environment is dynamic and evolving, and any such proposed or issued laws, requirements, rules and guidance could impact our business, including as may be described above, and any failure on our part to adequately adjust to any resulting marketplace developments or regulatory compliance requirements, may, among other things, erode our patient base or reimbursement rates and could otherwise have a material adverse effect on our business, results of operations, financial condition and cash flows. To the extent that the information above describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions that are referenced. For additional information related to the laws, rules and other regulations described above, please see Part I, Item 1. Business of this Form 10-K under the heading "Government Regulation."We are, and may in the future be, a party to various lawsuits, demands, claims, qui tam suits, governmental investigations and audits and other legal matters, any of which could result in, among other things, substantial financial penalties or awards against us, mandated refunds, substantial payments made by us, required changes to our business practices, exclusion from future participation in Medicare, Medicaid and other healthcare programs and possible criminal penalties, any of which could have a material adverse effect on our business, results of operations, financial condition, cash flows, reputation and stock price.We are, and may in the future be, subject to investigations and audits by governmental agencies and/or private civil qui tam complaints filed by relators and other lawsuits, demands, claims, legal proceedings and/or other actions, including, without limitation, investigations or other actions resulting from our obligation to self-report certain suspected violations of law. Any allegations against us, our personnel or our representatives in such matters may among other things harm our reputation, stock price, and our various business relationships and/or contracts related to our business, and these impacts may be material.Responding to subpoenas, investigations and other lawsuits, claims and legal proceedings, as well as defending ourselves in such matters, will continue to require management's attention and cause us to incur significant legal expense. Negative developments, findings or terms and conditions that we might agree to accept as part of a negotiated resolution of pending or future legal or regulatory matters could result in, among other things, harm to our reputation, substantial financial penalties or awards against us, substantial payments made by us, required changes to our business practices, impacts on our various relationships and/or contracts related to our business, exclusion from future participation in Medicare, Medicaid and other healthcare programs and, in certain cases, criminal penalties, any of which could have a material adverse effect on us. It is possible that criminal proceedings may be initiated against us and/or individuals in our business in connection with governmental investigations. Other than as may be described in Note 16 to the consolidated financial statements included in this report, we cannot predict the ultimate outcomes of the various legal proceedings and regulatory matters to which we are or may be subject from time to time, or the timing of their resolution or the ultimate losses or impact of developments in those matters, which could have a material adverse effect on our business, results of operations, financial condition, cash flows, reputation and stock price. See Note 16 to the consolidated financial statements included in this report for further details regarding these and other legal proceedings and regulatory matters.If the number or percentage of patients with higher-paying commercial insurance declines, if the average rates that commercial payors pay us decline, if commercial plans subject patients to restriction in plan designs, or if we are unable to maintain contracts with payors with competitive terms, including, without limitation, reimbursement rates, scope and duration of coverage and in-network benefits, it could have a material adverse effect on our business, results of operations, financial condition and cash flows.A substantial portion of our U.S. dialysis net patient services revenues for the year ended December 31, 2022 was generated from patients who have commercial payors as their primary payor. The majority of these patients have insurance policies that pay us on terms and at rates that are generally significantly higher than Medicare rates. As such our revenue and net income levels are sensitive to the number of our patients with higher-paying commercial insurance coverage and the percentage of our patients under higher-paying commercial plans relative to government-based programs. The payments we receive from commercial payors generate nearly all of our profit and all of our nonacute dialysis profits come from commercial payors. When traditional or original Medicare (Medicare) becomes the primary payor for a patient, the payment rate we receive for that patient decreases from the employer group health plan or commercial plan rate to the lower Medicare payment rate. If the number of our patients who have Medicare or another government-based program as their primary payor increases, it could negatively impact the percentage of our patients covered under commercial insurance plans. There are a number of factors that could drive a decline in the number or percentage of our patients covered under commercial insurance plans, including, among 33others, a continued decline in the rate of growth of the ESRD patient population, improved mortality, changes in the patient's or a family member's employment status, reduced availability of commercial health plans or reduced coverage by such plans through the ACA exchanges or otherwise due to changes to the laws, marketplace, healthcare regulatory system or otherwise. Commercial payors could also cease paying in the primary position after providing 30 months of coverage resulting in potentially material reductions in payment as the patient moves to Medicare primary. Declining macroeconomic conditions could also negatively impact the percentage of our patients covered under commercial insurance plans. To the extent there are job losses in the U.S., we could experience a decrease in the number of patients covered under commercial plans and/or an increase in uninsured and underinsured patients independent of whether general economic conditions improve. If we experience higher numbers of uninsured or underinsured patients, it also would result in an increase in uncollectible accounts. Our arrangements and negotiations with payors also impact the number or percentage of patients with higher-paying commercial insurance. We continuously are in the process of negotiating existing and potential new agreements with commercial payors who aggressively negotiate terms with us, and we can make no assurances about the ultimate results of these negotiations or the timing of any potential rate changes resulting from these negotiations. Sometimes many significant agreements are being renegotiated at the same time. We believe payor consolidations have significantly increased the negotiating leverage of commercial payors, and ongoing consolidations may continue to increase this leverage in the future. In addition, our agreements and rates with commercial payors may be impacted by new business activities of these commercial payors as well as steps that these commercial payors have taken and may continue to take to control the cost of and/or the eligibility for access to the services that we provide, including, without limitation, relative to products on and off the healthcare exchanges. These efforts could impact the number of our patients who are eligible to enroll in commercial insurance plans, and remain on the plans, including plans offered through healthcare exchanges. We continue to experience downward pressure on some of our rates with commercial payors as a result of these and other general conditions in the market, including, among other things, as employers seek to shift to less expensive options for medical services or as commercial payors dedicate increased focus on dialysis services.Our negotiations with commercial payors may relate to commercial fee-for-service contracts, value-based care (VBC) contracts in which we share risk with commercial payors or other structures that allow the parties to share in cost savings upon the achievement of certain outcomes, as well as contracts to provide dialysis services to Medicare Advantage (MA) patients. If we fail to maintain contracts with payors and other healthcare providers with competitive or favorable terms, either with respect to commercial plans, commercial VBC contracts, MA plans or otherwise, including, without limitation, with respect to reimbursement rates, scope and duration of coverage and in-network benefits, contract term or termination rights, or if we fail to accurately estimate the price for and manage our medical costs in an effective manner, whether due to inflationary pressures or otherwise, such that the profitability of our commercial or other value-based products is negatively impacted, it could have a material adverse effect on our business, results of operations, financial condition and cash flows. The ultimate result of our negotiations with payors cannot be predicted as they occur in a highly competitive environment and are influenced by marketplace dynamics such as those previously discussed. Among other things, these negotiations may result in termination or non-renewals of existing agreements, decreases in contracted rates, and reduction in the number of our patients that are covered by commercial plans, and we may not be able to enter into new agreements on competitive terms or at all. In the event that our ongoing negotiations with commercial payors result in overall rate reductions in excess of overall rate increases, the cumulative effect could have a material adverse effect on our business, results of operations, financial condition and cash flows. In addition, to the extent that these negotiations result in a reduction in the number of our patients covered by plans with commercial payors, it could have a material adverse effect on our business, results of operations, financial condition and cash flows. A material portion of both our commercial revenue and MA revenue is concentrated with a limited number of commercial payors, and any changes impacting our highest paying commercial payors or our relationships with these payors will have a disproportionate impact on us.Certain payors have been attempting to design and implement plans that restrict access to ESRD coverage both in the commercial and individual market. Among other things, these restrictive plan designs seek to limit the duration and/or the breadth of ESRD benefits, limit the number of in-network providers, set arbitrary provider reimbursement rates, or otherwise restrict access to care, all of which may result in a decrease in the number of patients covered by commercial insurance or the reimbursement rate for ESRD services, among other things. Payors have also disputed the scope and duration of ESRD benefit coverage under their plans, and, among other things, have required patients to seek Medicare coverage for ESRD treatments. On June 21, 2022, the U.S. Supreme Court issued a decision in the matter of Marietta Memorial Hospital Employee Health Benefit Plan, et al. v. DaVita Inc., et al., a case evaluating the scope of the Medicare Secondary Payor Act (MSPA), deciding that a group health plan that provides limited benefits for outpatient dialysis, but does so uniformly for all plan participants, does not violate the terms of the MSPA because the plan treats all patients uniformly, regardless of whether a participant has ESRD and regardless of whether the participant is eligible for Medicare. For additional information, see Note 16 to the consolidated financial statements included in this report. We cannot reasonably estimate the ultimate impact of the U.S. Supreme Court’s decision at this time, as there is significant uncertainty as to, among other things, whether and to what extent 34payors, including, among others employer group health plans, may seek to design and implement plans to restrict access to ESRD in light of the decision; whether and how regulators and legislators will respond to the decision, including whether they will issue regulatory guidance or adopt new legislation; how courts will interpret other anti-discriminatory provisions that may apply; whether there could be other potential negative impacts of the decision and any resultant plan behavior on our commercial or government mix or the number of our patients covered by commercial insurance; and the timing of each of these items. If more commercial or employer group health plans seek to implement or utilize plan designs that discourage or prevent ESRD patients from retaining their commercial coverage, it may lead to a decrease in the number of patients with commercial plans, the duration of benefits for patients under commercial plans and/or a decrease in the payment rates we receive, any of which could have a material adverse effect on our business, results of operations, financial condition and cash flows. In addition, some commercial payors are pursuing or have incorporated policies into their provider manuals limiting or refusing to accept charitable premium assistance from non-profit organizations, such as the American Kidney Fund, which may impact the number of patients who are able to afford commercial plans. Paying for coverage is a significant financial burden for many patients, and ESRD disproportionately affects the low-income population. Charitable premium assistance supports continuity of coverage and access to care for patients, many of whom are unable to continue working full-time as a result of their severe health condition. Many patients with commercial and government insurance also rely on financial assistance from charitable organizations, such as the American Kidney Fund. Certain payors have challenged our patients' and other providers' patients' ability to utilize assistance from charitable organizations for the payment of premiums, including, without limitation, through litigation and other legal proceedings. The use of charitable premium assistance for ESRD patients has also faced challenges and inquiries from legislators, regulators and other governmental authorities, and this may continue. In addition, CMS or another regulatory agency or legislative authority may issue a new rule or guidance that challenges or restricts charitable premium assistance. If any of these challenges to kidney patients' use of premium assistance is successful or restrictions are imposed on the use of financial assistance from such charitable organizations or if organizations providing such assistance are no longer available such that kidney patients are unable to obtain, or continue to receive or receive for a limited duration, such financial assistance, it may restrict the ability of dialysis patients to obtain and maintain optimal insurance coverage and could have a material adverse effect on our business, results of operations, financial condition and cash flows. In addition, if our assumptions about how kidney patients will respond to any change in financial assistance from charitable organizations are incorrect, it could have a material adverse effect on our business, results of operations, financial condition and cash flows.Our negotiations and relationships with payors may also be impacted by legislative or regulatory developments and associated legal rulings. For example, the final rules for the Cures Act, which are described in detail in Part I, Item 1. Business of this Form 10-K under the heading "Government Regulation—21st Century Cures Act," broadened ESRD patient access to certain enhanced benefits offered by MA plans. While these rules increased our MA plan enrollment for ESRD benefits in their first year, the potential ultimate impact of this change in benefit eligibility remains subject to change as market participants continue to adjust to this new regulatory environment. As an example, the removal of objective time and distance standards relating to network adequacy for outpatient dialysis centers for MA plans that was included in the final rules may adversely impact the number of ESRD patients that select MA plans and also may result in the Company not being an in-network provider for significant MA plans in the event MA plans attempt to use this revision to the rules to limit or restrict their networks. If kidney patients choose not to enroll in MA plans or choose to leave MA plans, whether due to network adequacy standards or otherwise, or if we fail to provide education to kidney patients in the manner specified by CMS, we could be subject to certain clinical, operational, financial and legal risks, which could have a material adverse effect on our business, results of operations, financial condition and cash flows. In addition, recent price transparency regulations require most group health plans and health insurance issuers in the group and individual markets to make certain pricing and patient responsibility information publicly available. For further detail on these regulations see the discussion in Part I, Item 1. Business of this Form 10-K under the heading "Government Regulation—Health Plan Price Transparency Rules." On July 1, 2022, enforcement began of the requirement that plans publish machine readable files that include negotiated rates for all covered items and services with all providers and out-of-network allowed amounts. To comply with these requirements, plans have begun to publish these files and make them available to the public. The information that has been made available to date is highly diverse and complex. While the ultimate impact of these requirements remains uncertain, any changes by group health plans, health insurance issuers in the group and individual markets, or consumer choices resulting from these requirements could have a material adverse impact on our business, results of operations, and financial condition, and our reputation could be materially harmed. We could also experience a further decrease in the payments we receive for services if changes to the marketplace or the healthcare regulatory system result in fewer patients covered under commercial plans or an increase of patients covered under more restrictive commercial plans, or plans with lower reimbursement rates, among other things. For additional details regarding potential legislative or regulatory changes, the specific risks we face in connection with any decrease in payments we receive for services due to, for example, fewer patients being covered under commercial plans or an increase of patients covered under more restrictive commercial plans, or plans with lower reimbursement rates, please see Part I, Item 1. Business of this 35Form 10-K under the heading "Government Regulation" and the discussion in the risk factor under the heading "Changes in federal and state healthcare legislation or regulations..."In addition to the aforementioned pricing transparency rules, the government has also implemented certain additional pricing transparency requirements that apply to certain types of providers, including DaVita. Under the No Surprises Act, which went into effect January 1, 2022, certain providers, including DaVita, will be required to develop and disclose a “Good Faith Estimate” (GFE) that details the expected charges for furnishing an item or service to an uninsured or self-pay patient. The GFE must include certain specific information such as, among other things, co-provider service cost estimates, and is subject to certain format, availability and dispute resolution requirements. Similar to the aforementioned pricing transparency rules, the impact of the GFE requirements on DaVita remains uncertain at this time, in part due to ongoing rulemaking around the No Surprises Act as well as uncertainty around operational timeframes, potential penalties and patient reaction, among other things. Patient dissatisfaction with the GFE process, whether with respect to the level of charges, how such charges are communicated or otherwise, may impact patient choices and over time could have a material adverse impact on our business, results of operations and financial condition, and could materially harm our reputation.As noted, the foregoing dynamics of our arrangements and negotiations with commercial payors each may have an impact on, among other things, our ability to enter into and maintain contracts with payors with competitive terms, including, without limitation, reimbursement rates, scope and duration of coverage and in-network benefits as well as the number or percentage of our patients with higher-paying commercial insurance. If, as a result of these or other dynamics, we experience a decline in the average rates that commercial payors pay us or a reduction in the number of patients with ESRD coverage under higher-paying commercial plans either in total or relative to the number of patients under government-based programs that pay at lower rates or an increase in the number of patients that are uninsured or underinsured, it could have a material adverse effect on our business, results of operations, financial condition and cash flows. If we are not able to successfully implement our strategy with respect to our integrated kidney care and value-based care initiatives, including maintaining our existing business and further developing our capabilities in a complex and highly regulated environment, it could result in a loss of our investments and have a material adverse effect on our growth strategy, could adversely impact our business, results of operations, financial condition and cash flows, and could materially harm our reputation.Our integrated kidney care business manages patients and coordinates their care through value-based care arrangements with commercial payors and through government programs. We have continued to grow this portion of our business both with commercial payors, including as MA has expanded, and with government programs as CMS and CMMI implement new payment models focused on comprehensive and integrated kidney care. As part of our growth strategy, we have invested and expect to continue to invest substantial resources in the further development of our integrated care business and value-based care initiatives. There can be no assurances that we will be able to successfully implement our strategies with respect to integrated kidney care and value-based care in a complex, evolving and highly competitive and regulated environment, including, among other things, maintaining our existing business; recovering our investments; entering into agreements with payors, physicians, third party vendors and others on competitive terms, as appropriate, that prove actuarially sound; structuring these agreements and arrangements to comply with evolving rules and regulations, including, among other things, rules and regulations related to fraud and abuse and the use of protected health information. Implementing our expanded integrated kidney care strategies and value-based care initiatives at scale also increases certain execution and compliance risks associated with developing our operational, IT, billing and telehealth systems, including our ability to accurately capture relevant patient care data, among other things. For additional details on risks associated with information systems and new technology generally, see the risk factor under the heading "Failing to effectively maintain, operate or upgrade our information systems or those of third-party service providers upon which we rely..."New entrants are aggressively pursuing opportunities to participate in the new CMMI payment models or otherwise establish value-based care programs, and with increasing investment and funding, these new entrants may adopt strategies that increase our costs to participate in these payment models and/or adversely impact our ability to enter into competitive arrangements with payors, physicians and hospitals. For additional detail on our evolving competitive environment, see the risk factor under the heading "If we are unable to compete successfully..." If any of these or other of our integrated kidney care and value-based care initiatives are unsuccessful, it could result in a loss of our investments and have a material adverse effect on our growth strategy, could adversely impact our business, results of operations, financial condition and cash flows, and could materially harm our reputation.In addition, future legislative or regulatory action related to, among other things, integrated kidney care, including among others, CMMI, and/or full capitation demonstration for ESRD may impact our ability to provide a competitive and successful integrated care program at scale. There can be no assurances that any other legislation or regulation that aligns with our strategy and investments will be passed into law or enacted, and the ongoing COVID-19 pandemic may delay the progress of such 36initiatives. Additionally, the ultimate terms and conditions of any potential legislative or regulatory action impacting integrated kidney care, full capitation demonstrations or the existing CMMI program remain unclear. For example, our costs of care could exceed our associated reimbursement rates under such legislation. Irrespective of whether such laws are passed or regulations enacted, there can be no assurances that we will be able to successfully execute on the required strategic initiatives that would allow us to provide a competitive and successful integrated care program on a broad scale, and in the desired time frame. Any failure on our part to adequately implement strategic initiatives to adjust to any marketplace developments resulting from executive, legislative, regulatory or administrative changes could have a material adverse impact on our business.If we are not able to successfully implement our strategy with respect to home-based dialysis, including maintaining our existing business and further developing our capabilities in a complex and highly regulated environment, it could have a material adverse effect on our business, results of operations, financial condition and cash flows, and could materially harm our reputation.Our home-based dialysis services, which include home hemodialysis and peritoneal dialysis (PD), represented approximately 18% of our U.S. dialysis patient services revenues for the year ended December 31, 2022, and have increasingly become an important part of our overall strategy. In addition, home-based dialysis recently has been the subject of increased political and industry focus. For example, in connection with the 2019 Executive Order, HHS set out specific goals related to home dialysis and CMMI’s ESRD Treatment Choices (ETC) mandatory payment model and voluntary payment models included new incentives to encourage dialysis at home. More recently, CMS finalized changes to the ETC model and other regulations to encourage dialysis facilities and healthcare providers to seek to decrease disparities in health equity across racial and socioeconomic status in rates of home dialysis and kidney transplants among ESRD patients. We are a leader in home-based dialysis and have made investments in processes and infrastructure to continue to grow this modality. There are, however, risks associated with this growth, including, among other things, financial, legal and operational risks related to our ability to design and develop infrastructure and to plan for capacity in a modality that is part of an evolving marketplace. We may also be subject to associated risks related to our ability to successfully manage related operational initiatives, find, train and retain appropriate staff, contract with payors for appropriate reimbursement, and maintain processes to adhere to the complex regulatory and legal requirements, including without limitation those associated with billing Medicare. For additional detail on risks associated with operating in a highly regulated environment, see the risk factor under the heading "Our business is subject to a complex set of governmental laws, regulations and other requirements..." In addition to the above risks, certain risks inherent to home-based dialysis will increase as we expand our home-based dialysis offerings, including risks related to managing transitions between in-center and home-based dialysis, billing and telehealth systems, among others. For additional detail on risks associated with information systems and new technology generally, see the risk factor under the heading "Failing to effectively maintain, operate or upgrade our information systems or those of third-party service providers upon which we rely..."An increased focus on home-based dialysis is also indicative of the generally evolving market for kidney care. This developing market may create additional opportunities for competition with relative ease of entry, and if we are unable to successfully adapt to these or other marketplace developments, which, among other things, may include regulatory changes with respect to conditions of coverage, in a timely and compliant manner, we may experience a material adverse impact on our growth in home-based dialysis or a reduction in our overall number of patients, among other things. Our response to the COVID-19 pandemic has also required us to impose certain operational restrictions that may adversely impact certain home-based dialysis initiatives, and the extent of this impact may depend on the severity or duration of the pandemic, among other things. For additional detail on the competitive landscape in kidney care, see the risk factor under the heading "If we are unable to compete successfully..." and for additional detail on the impact of COVID-19 on our home-based dialysis business, see the risk factor under the heading "Macroeconomic conditions and global events..." If we are not able to successfully implement our strategy with respect to home-based dialysis, including maintaining our existing business and further developing our capabilities in a complex and highly regulated environment, it could have a material adverse effect on our business, results of operations, financial condition and cash flows, and could materially harm our reputation.Changes in the structure of and payment rates under the Medicare ESRD program or changes in state Medicaid or other non-Medicare government-based programs or payment rates could have a material adverse effect on our business, results of operations, financial condition and cash flows. A substantial portion of our dialysis revenues are generated from patients who have Medicare as their primary payor. For patients with Medicare coverage, all ESRD payments for dialysis treatments are currently made under a single bundled payment rate which provides a fixed payment rate to encompass all goods and services provided during the dialysis treatment that are related to the treatment of dialysis, subject to certain adjustments as described below. Most lab services are also included in the bundled payment. 37Under the ESRD Prospective Payment System (PPS), bundled payments to a dialysis facility may be reduced by as much as 2% based on the facility's performance in specified quality measures set annually by CMS through the ESRD Quality Incentive Program, which was established by the Medicare Improvements for Patients and Providers Act of 2008. The bundled payment rate is also adjusted for certain patient characteristics, a geographic usage index and certain other factors. In addition, the ESRD PPS is subject to rebasing, which can have a positive financial effect, or a negative one if the government fails to rebase in a manner that adequately addresses the costs borne by dialysis facilities. Similarly, as new drugs, services or labs are added to the ESRD bundle, CMS' failure to adequately calculate or fund the costs associated with the drugs, services or labs could have a material adverse effect on our business, results of operations, financial condition and cash flows. In certain instances, new injectable, intravenous or oral products may be reimbursed separately from the bundled payment for a defined period of time through a transitional drug add-on payment adjustment (TDAPA). For a discussion of certain risks associated with this transitional pricing process, see the risk factor under the heading, "Changes in clinical practices, payment rates or regulations impacting pharmaceuticals and/or devices..."The current bundled payment system presents certain operating, clinical and financial risks, which include, without limitation:•Risk that our rates are reduced by CMS. CMS publishes a final rule for the ESRD PPS each year and uncertainty about future payment rates remains a material risk to our business.•Risk that CMS, on its own or through its contracted Medicare Administrative Contractors (MACs) or otherwise, implements Local Coverage Determinations (LCDs) or implements payment provisions, policy or regulatory mandates, including changes to the existing or future PPS, that limit our ability to either be paid for covered dialysis services or bill for treatments or other drugs and services or other rules that may impact reimbursement. Such payment rules and regulations and coverage determinations or related decisions could have an adverse impact on our operations and revenue. There is also risk that commercial insurers could seek to incorporate the requirements or limitations associated with such LCDs or CMS guidance into their contracted terms with dialysis providers, which could have an adverse impact on our revenue. •Risk that a MAC, or multiple MACs, change their interpretations of existing regulations, manual provisions and/or guidance, or seek to implement or enforce new interpretations that are inconsistent with how we have interpreted existing regulations, manual provisions and/or guidance.•Risk that CMS implements data and related reporting requirements that result in decreased reimbursement and/or increased technology and operational costs.•Risk that increases in our operating costs will outpace the Medicare rate increases we receive. We expect operating costs to continue to increase due to inflationary factors, such as increases in labor and supply costs, including, without limitation, increases in maintenance costs and capital expenditures to improve, renovate and maintain our facilities, equipment and information technology to meet changing regulatory requirements and business needs, regardless of whether there is a compensating inflation-based increase in Medicare payment rates or in payments under the bundled payment rate system. •Risk of continued federal budget sequestration cuts or other disruptions in federal government operations and funding. As a result of the Budget Control Act of 2011, the Bipartisan Budget Act (BBA) and the CARES Act, an annual 2% reduction to Medicare payments took effect on April 1, 2013, and has been extended through 2030. These across-the-board spending cuts have affected and will continue to adversely affect our business, results of operations, financial condition and cash flows. Any extended disruption in federal government operations and funding, including an extended government shutdown, U.S. government debt default and/or failure of the U.S. government to enact annual appropriations could have a material adverse effect on our business, results of operations, financial condition and cash flows. Additionally, disruptions in federal government operations may delay or negatively impact regulatory approvals and guidance that are important to our operations, and create uncertainty about the pace of upcoming regulatory developments.•Risk that failure to adequately develop and maintain our clinical or other operational systems or failure of our clinical or operational systems to operate effectively could have a material adverse effect on our business, results of operations, financial condition and cash flows. For example, in connection with claims for which at least part of the government's payments to us is based on clinical performance or patient outcomes or co-morbidities, if our clinical systems fail to accurately capture the data we report to CMS or we otherwise have data integrity issues with respect to the reported information, we might be over-reimbursed by the government, which could, among other things, subject us to liability exclusion from participation in federal healthcare programs and penalties under the federal Civil Monetary Penalty statute, and could adversely impact our reputation. 38We are subject to similar risks for services billed separately from the ESRD bundled payment, including, without limitation, the risk that a MAC, or multiple MACs, change their interpretations of existing regulations, manual provisions and/or guidance; or seek to implement or enforce new interpretations that are inconsistent with how we have interpreted existing regulations, manual provisions and/or guidance.In addition to the above risks under the current Medicare ESRD program, changing legislation and other regulatory and executive developments have led and may continue to lead to the emergence of new models of care and other initiatives in both the government and private sector that, among other things, may impact the structure of, and payment rates under, the Medicare ESRD program. Moreover, the number of our patients with primary Medicare coverage may be subject to change, particularly with the effectiveness of the Cures Act, which allows Medicare-eligible individuals with ESRD to enroll in MA managed care plans. For additional details regarding the risks we face for failing to adhere to our Medicare and Medicaid regulatory compliance obligations or failing to adequately implement strategic initiatives to adjust to marketplace developments, see the risk factors above under the headings "Our business is subject to a complex set of governmental laws, regulations and other requirements...;" and "Changes in federal and state healthcare legislation or regulations..."Primary coverage for a significant number of our patients also comes from state Medicaid programs partially funded by the federal government as well as other non-Medicare government-based programs, such as coverage through the Department of Veterans Affairs (VA). As state governments and other governmental organizations face increasing financial hardship and budgetary pressure, including as a result of the COVID-19 pandemic or changes in the political environment, we may in turn face reductions in payment rates, delays in the receipt of payments, limitations on enrollee eligibility or other changes to the applicable programs. For example, certain state Medicaid programs and the VA have recently considered, proposed or implemented payment rate reductions, such as the VA's adoption of Medicare's bundled PPS pricing methodology for any veterans receiving treatment from non-VA providers under a national contracting initiative. Since we are a non-VA provider, these reimbursements are tied to a percentage of Medicare reimbursement, and we have exposure to any dialysis reimbursement changes made by CMS. Approximately 3% of our U.S. dialysis patient services revenues for the year ended December 31, 2022 were generated by the VA. In addition, in 2019, we entered into a Nationwide Dialysis Services contract with the VA that includes five separate one-year renewal periods throughout the term of the contract. The term structure is similar to our prior five-year agreement with the VA, and is consistent with VA practice for similar provider agreements. With this contract award, the VA has agreed to keep our percentage of Medicare reimbursement consistent with that under our prior agreement with the VA during the term of the contract. As with that prior agreement, this agreement provides the VA with the right to terminate the agreements without cause on short notice, among other things. Should the VA renegotiate, not renew or cancel these agreements for any reason, we may cease accepting patients under this program and may be forced to close centers or experience lower reimbursement rates, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.State Medicaid programs are increasingly adopting Medicare-like bundled payment systems, but sometimes these payment systems are poorly defined and are implemented without any claims processing infrastructure, or patient or facility adjusters. If these payment systems are implemented without any adjusters and claims processing infrastructure, Medicaid payments will be substantially reduced and the costs to submit such claims may increase, which will have a negative impact on our business, results of operations, financial condition and cash flows. In addition, some state Medicaid program eligibility requirements mandate that citizen enrollees in such programs provide documented proof of citizenship. If our patients cannot meet these proof of citizenship documentation requirements, they may be denied coverage under these programs, resulting in decreased patient volumes and revenue. These Medicaid payment and enrollment changes, along with similar changes to other non-Medicare government programs, could reduce the rates paid by these programs for dialysis and related services, delay the receipt of payment for services provided and further limit eligibility for coverage which could have a material adverse effect on our business, results of operations, financial condition and cash flows.Our business is labor intensive and if our labor costs continue to rise, including due to shortages, changes in certification requirements and/or higher than normal turnover rates in skilled clinical personnel; or currently pending or future governmental laws, rules, regulations or initiatives impose additional requirements or limitations on our operations or profitability; or, if we are unable to attract and retain employees; or if union organizing activities or legislative or other changes result in significant increases in our operating costs or decreases in productivity, we may experience disruptions in our business operations and increases in operating expenses, among other things, any of which could have a material adverse effect on our business, results of operations, financial condition, cash flows and reputation.We face increasing labor costs generally, and in particular, we continue to face increased labor costs and difficulties in hiring nurses due to a nationwide shortage of skilled clinical personnel that has been exacerbated by the ongoing COVID-19 pandemic and recent developments in the labor market. As referenced above, the current labor market is challenging and continues to experience volatility, uncertainty and labor supply shortages, particularly in healthcare. Our business is labor intensive, and our financial and operating results have been and continue to be sensitive to variations in labor-related costs, 39productivity and the number of pending or potential claims against us related to labor and employment practices. We have incurred and expect to continue to incur increased labor costs and experience staffing challenges, including without limitation those related to COVID-19, the ultimate extent of which will depend on the severity and duration of the pandemic and ancillary impacts on the economy and labor market, among other things. For additional discussion of the risks facing us related to the current labor environment and COVID-19, see the risk factor under the heading "Macroeconomic conditions and global events..." Additionally, to the extent that general inflationary pressures continue or further increase, this may in turn increase our labor and supply costs at a rate that outpaces the Medicare or any other rate increases we may receive. We compete for nurses with hospitals and other healthcare providers. The ongoing nursing shortage may limit our ability to expand our operations. Furthermore, changes in certification requirements can impact our ability to maintain sufficient staff levels, including to the extent our teammates are not able to meet new requirements, among other things. In addition, if we experience a higher than normal turnover rate for our skilled clinical personnel, our operations and treatment growth may be negatively impacted, which could adversely affect our business, results of operations, financial condition and cash flows. For example, in 2022, we did experience elevated rates of teammate turnover, which led to increased training costs and costs related to contract labor, among other things. We also face competition in attracting and retaining talent for key leadership positions. If we are unable to attract and retain qualified individuals, we may experience disruptions in our business operations, including, without limitation, our ability to achieve strategic goals, which could have a material adverse effect on our business, results of operations, financial condition, cash flows and reputation.Political or other efforts at the national or local level could result in actions or proposals that increase the likelihood of success of union organizing activities at our facilities and ongoing union organizing activities at our facilities could continue or increase for other reasons. We could experience an upward trend in wages and benefits and labor and employment claims, including, without limitation, the filing of class action suits, or adverse outcomes of such claims, or face work stoppages. In addition, we are and may continue to be subject to targeted corporate campaigns by union organizers in response to which we have been and expect to continue to be required to expend substantial resources, both time and financial. Any of these events or circumstances could have a material adverse effect on our employee relations, treatment growth, productivity, business, results of operations, financial condition, cash flows and reputation.Privacy and information security laws are complex, and if we fail to comply with applicable laws, regulations and standards, including with respect to third-party service providers that utilize sensitive personal information on our behalf, or if we fail to properly maintain the integrity of our data, protect our proprietary rights to our systems or defend against cybersecurity attacks, we may be subject to government or private actions due to privacy and security breaches or suffer losses to our data and information technology assets, any of which could have a material adverse effect on our business, results of operations, financial condition and cash flows or materially harm our reputation.We must comply with numerous federal and state laws and regulations in both the U.S. and the foreign jurisdictions in which we operate governing the collection, dissemination, access, use, security and privacy of PHI, including, without limitation, HIPAA and its implementing privacy, security, and related regulations, as amended by the federal Health Information Technology for Economic and Clinical Health Act (HITECH) and collectively referred to as HIPAA. We are also required to report known breaches of PHI and other certain personal information consistent with applicable breach reporting requirements set forth in applicable laws and regulations. From time to time, we may be subject to both federal and state inquiries or audits related to HIPAA, HITECH and other state privacy laws associated with complaints, desk audits, and data breaches. Requirements under HIPAA also continue to evolve. If we fail to comply with applicable privacy and security laws, regulations and standards, including with respect to third-party service providers that utilize sensitive personal information, including PHI, or financial information or payroll data on our behalf, properly maintain the integrity of our data, protect our proprietary rights, or defend against cybersecurity attacks, it could materially harm our reputation and/or have a material adverse effect on our business, results of operations, financial condition and cash flows. These risks may be intensified to the extent that the laws change or to the extent that we increase our use of third-party service providers that utilize sensitive personal information, including PHI, on our behalf.Data protection laws are evolving globally, and may continue to add additional compliance costs and legal risks to our international operations. For more details on certain international data protection laws and regulations affecting our business, see Part I, Item 1. Business of this Form 10-K under the heading "Government Regulation." The costs of compliance with, and other burdens imposed by these international data protection laws and regulations including, among others, the General Data Protection Regulation (GDPR) in the EU and UK, and other new laws, regulations and policies implementing these regulations may impact our international operations and may limit the ways in which we can provide services or use personal data collected while providing services.Privacy and data protection laws are also evolving nationally, providing for enhanced state privacy rights that are broader than the current federal privacy rights, and may add additional compliance costs and legal risks to our U.S. operations. The 40costs of compliance with, and the burdens imposed by, these and other new federal and state laws, regulations or policies may impact our operations and/or limit the ways in which we can provide services or use personal data collected while providing services. If we fail to comply with the requirements of these and other new laws, regulations or policies, we could be subject to penalties that, in some cases, would have a material adverse impact on our business, results of operations, financial condition and cash flows. For more details on the privacy and other regulations affecting our business, see Part I, Item 1. Business of this Form 10-K under the heading "Government Regulation." Scrutiny over cybersecurity standards in the health sector is also increasing, and ongoing developments in this area may cause us to invest additional resources in technology, personnel and programmatic cybersecurity controls as the cybersecurity risks we face continue to evolve.Information security risks have significantly increased in recent years in part because of the proliferation of new technologies, the increasing use of the Internet and telecommunications technologies to conduct our operations, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including, among others, foreign state agents. Our business and operations rely on the secure and continuous processing, transmission and storage of confidential, proprietary and other information in our computer systems and networks, including sensitive personal information, such as PHI, social security numbers, and/or credit card information of our patients, teammates, physicians, business partners and others. Our business and operations also rely on certain critical IT vendors that support such processing, transmission and storage (which have become more relevant and important given the information security issues and risks that are intensified through remote work arrangements).We regularly review, monitor and implement multiple layers of security measures through technology, processes and our people. We utilize security technologies designed to protect and maintain the integrity of our information systems and data, and our defenses are monitored and routinely tested internally and by external parties. Despite these efforts, our facilities and systems and those of our third-party service providers may be vulnerable to privacy and security incidents; security attacks and breaches; acts of vandalism or theft; computer viruses and other malicious code; coordinated attacks by a variety of actors, including, among others, activist entities or state sponsored cyberattacks; emerging cybersecurity risks; cyber risk related to connected devices; misplaced or lost data; programming and/or human errors; or other similar events that could impact the security, reliability and availability of our systems. Internal or external parties have attempted to, and will continue to attempt to, circumvent our security systems, and we have in the past, and expect that we will in the future, defend against, experience, and respond to attacks on our network including, without limitation, reconnaissance probes, denial of service attempts, malicious software attacks including ransomware or other attacks intended to render our internal operating systems or data unavailable, and phishing attacks or business email compromise. Cybersecurity requires ongoing investment and diligence against evolving threats. Emerging and advanced security threats, including, without limitation, coordinated attacks, require additional layers of security which may disrupt or impact efficiency of operations. As with any security program, there always exists the risk that employees will violate our policies despite our compliance efforts or that certain attacks may be beyond the ability of our security and other systems to detect. There can be no assurance that investments, diligence and/or our internal controls will be sufficient to prevent or timely discover an attack.Any security breach involving the misappropriation, loss or other unauthorized disclosure or use of confidential information, including, among others, PHI, financial data, competitively sensitive information, or other proprietary data, whether by us or a third party, could have a material adverse effect on our business, results of operations, financial condition, and cash flows and materially harm our reputation. We may be required to expend significant additional resources to modify our protective measures, to investigate and remediate vulnerabilities or other exposures, or to make required notifications. The occurrence of any of these events could, among other things, result in interruptions, delays, the loss or corruption of data, cessations in the availability of systems and liability under privacy and security laws, all of which could have a material adverse effect on our business, results of operations, financial condition and cash flows, or materially harm our reputation and trigger regulatory actions and private party litigation. If we are unable to protect the physical and electronic security and privacy of our databases and transactions, we could be subject to potential liability and regulatory action, our reputation and relationships with our patients, physicians, vendors and other business partners would be harmed, and our business, results of operations, financial condition and cash flows could be materially and adversely affected. Failure to adequately protect and maintain the integrity of our information systems (including our networks) and data, or to defend against cybersecurity attacks, could subject us to monetary fines, civil suits, civil penalties or criminal sanctions and requirements to disclose the breach publicly, and could further result in a material adverse effect on our business, results of operations, financial condition and cash flows or harm our reputation. As malicious cyber activity escalates, including activity that originates outside of the U.S., and as we continue with certain remote work arrangements and a broadened technology footprint, the risks we face relating to transmission of data and our use of service providers outside of our network, as well as the storing or processing of data within our network, have intensified. There have been increased international, federal and state and other privacy, data protection and security enforcement efforts and we expect this trend to continue. While we plan to maintain cyber liability insurance, there can be no assurance that we will successfully be able to obtain such insurance on terms and conditions that are favorable to us or at all. 41Additionally, any cyber liability insurance may not cover us for all types of losses or harms and may not be sufficient to protect us against the amount of all losses.If certain of our suppliers do not meet our needs, if there are material price increases on supplies, if we are not reimbursed or adequately reimbursed for drugs we purchase or if we are unable to effectively access new technology or superior products, it could negatively impact our ability to effectively provide the services we offer and could have a material adverse effect on our business, results of operations, financial condition and cash flows and could materially harm our reputation. We are also subject to the risk associated with our increased reliance on third party service providers.We have significant suppliers, with a substantial portion of our total vendor spend concentrated with a limited number of third party suppliers. These third party suppliers include, without limitation, suppliers of pharmaceuticals or clinical products that may be the primary source of products critical to the services we provide, or to which we have committed obligations to make purchases, sometimes at particular prices. We and other dialysis providers have experienced supply chain shortages with respect to certain of our equipment and clinical supplies, such as dialysate, which is the fluid solution used in hemodialysis to filter toxins and fluid from the blood, and in certain cases, we have had to make significant operational changes in response. Separately, the ongoing COVID-19 pandemic also has resulted in global supply chain challenges and has materially impacted global supply chain reliability, as further described in the risk factor under the heading, "Macroeconomic conditions and global events..." If any of our suppliers do not meet our needs for the products they supply, including, without limitation, in the event of COVID-19 related global supply chain challenges, a product recall, other shortage or dispute, and we are not able to find adequate alternative sources at competitive prices; if we experience material price increases from these suppliers or otherwise in connection with our actions to secure needed products that we are unable to mitigate; if some of the drugs that we purchase from our suppliers are not reimbursed or not adequately reimbursed by commercial or government payors; or if we are unable to secure products, including pharmaceuticals at competitive rates and within the desired time frame; it could negatively impact our ability to effectively provide the services we offer, have a material adverse impact on our business, results of operations, financial condition and cash flows, and could materially harm our reputation. In addition, the technology related to the products critical to the services we provide is subject to new developments which may result in superior products. If we are not able to access superior products on a cost-effective basis, either due to competitive conditions in the marketplace or otherwise, or if suppliers are not able to fulfill our requirements for such products, we could face patient attrition and other negative consequences which could have a material adverse effect on our business, results of operations, financial condition and cash flows.We also rely increasingly on third party service providers to perform certain functions, including, among others, finance and accounting and information technology functions. This reliance subjects us to risks arising from the loss of control over these services, changes in pricing that may affect our operating results, and potentially, termination of provisions of these services by our providers. There can be no assurance that our third party service providers will provide, or continue to provide, the level of services we require. Any failure by our third party service providers to adequately perform their obligations could negatively impact our ability to effectively execute certain important corporate functions and have a material adverse effect on our business, results of operations, financial condition and cash flows.Changes in clinical practices, payment rates or regulations impacting pharmaceuticals and/or devices could have a material adverse effect on our business, results of operations, financial condition, and cash flows and negatively impact our ability to care for patients.Medicare bundles certain pharmaceuticals into the ESRD PPS payment rate at industry average doses and prices. Variations above the industry average may be subject to partial reimbursement through the PPS outlier reimbursement policy. Changes to industry averages, which can be caused by, among other things, changes in physician prescribing practices, including in response to the introduction of new drugs, treatments or technologies, changes in best and/or accepted clinical practice, changes in private or governmental payment criteria regarding pharmaceuticals and/or devices, or the introduction of administration policies may negatively impact our ability to obtain sufficient reimbursement levels for the care we provide, which could have a material adverse effect on our business, results of operations, financial condition and cash flows. Physician practice patterns, including their independent determinations as to appropriate pharmaceuticals and dosing, are subject to change, including, for example, as a result of changes in labeling of pharmaceuticals or the introduction of new pharmaceuticals. Additionally, commercial payors have increasingly examined their administration policies for pharmaceuticals and, in some cases, have modified those policies. If such policy and practice trends or other changes to private and governmental payment criteria make it more difficult to preserve our margins per treatment, it could have a material adverse effect on our business, results of operations, financial condition and cash flows. Further, increased utilization of certain pharmaceuticals whose costs are included in a bundled reimbursement rate, or decreases in reimbursement for pharmaceuticals 42whose costs are not included in a bundled reimbursement rate, could also have a material adverse effect on our business, results of operation, financial condition and cash flows.Regulations and processes impacting reimbursement for pharmaceuticals and/or devices and any changes thereto could similarly affect our operating results. Among other things, as new kidney care drugs, treatments or technologies are introduced over time, we expect that the use of transitional payment adjustments to incorporate certain of these new drugs, treatments or technologies as defined by the CMS policy into the bundled Medicare Part B ESRD payment may lead to fluctuations in associated levels of operating income and risk that the reimbursement levels of such drugs, treatments or technologies may not adequately cover our cost to obtain the drug or other associated costs. Drivers of these risks include, among other things, the risk that CMS may not provide adequate funding in the Medicare Part B ESRD payment in the post-transitional period or such items are not covered by transitional add on pricing, in which case there may be less clarity on the reimbursement, either of which may in turn materially adversely impact our business, results of operations, financial condition and cash flows. For example, in the event that a hypoxia-inducible factor (HIF) product is approved by the FDA we expect that HIF products will be subject to a TDAPA period prior to being incorporated into the payment bundle. We are developing operational and clinical processes designed to provide the drug as may be required under the applicable regulations and as may be prescribed by physicians and also are working to contract with manufacturers of drug(s) to establish terms and access to the product, as well as payors, as applicable, for reimbursement and/or administration of the drug. While the timing and details of a potential approval, including the contents of the applicable FDA label, remain uncertain, if HIF products are approved, we could experience significant fluctuations in our associated levels of operating income and could be subject to material financial, operational and/or legal risk if we are not adequately reimbursed for the cost of the drug, if we are unable to implement effective and appropriate operational measures to distribute the drug, if we fail to implement appropriate storage and diversion controls or if we cannot obtain competitive pricing for the HIF, the aggregate impact of these risks could have a material adverse effect on our business, results of operation, financial condition and cash flows. Similar operating and clinical rigor and appropriate processes will be needed for other potential new drugs, treatments or technologies that are approved and come onto the market, as well as for drugs, treatments or technologies that we contract to receive from different suppliers. In 2022, for example, a new medication that assists with uremic pruritus in dialysis patients was available to patients, and we began our transition to our new ESA contract. In both cases, we developed systems and processes for all facets of operationalizing the availability and reimbursement of each medication. We anticipate other drugs and/or biologics to continue to come onto the market in subsequent years. Any failure to successfully contract with manufacturers for competitive pricing, failure to successfully contract with the government or other payors for appropriate reimbursement, or failure to prepare, develop and implement processes that provide for appropriate availability and use in our clinics in compliance with applicable laws, including those related to controlled substances, could have a material adverse impact on our business, results of operations, financial condition and cash flows. We may also be subject to increased inquiries or audits from a variety of governmental bodies or claims by third parties related to pharmaceuticals, which would require management's attention and could result in significant legal expense. Any negative findings could result in, among other things, substantial financial penalties or repayment obligations, the imposition of certain obligations on and changes to our practices and procedures as well as the attendant financial burden on us to comply with the obligations, or exclusion from future participation in the Medicare and Medicaid programs, and could have a material adverse effect on our business, results of operations, financial condition, cash flows and reputation. For additional details, see the risk factor under the heading "Our business is subject to a complex set of governmental laws, regulations and other requirements..."If we are unable to compete successfully, including, without limitation, implementing our growth strategy and/or retaining patients and developing and maintaining relationships with physicians and hospitals, it could materially adversely affect our business, results of operations, financial condition and cash flows.We operate in a highly competitive and continuously evolving environment across the spectrum of kidney care, and operating in this market requires us to successfully execute on strategic initiatives which, among other things, build or retain our patient population through acquisition or referrals, or that develop and maintain our relationships with physicians and hospitals in both the dialysis and pre-dialysis space. Competition for relationships with certain referral sources, including nephrologists and hospitals, in existing and expanding geographies or areas is intense, and we continue to face intense competition from large and medium-sized providers, among others, which compete directly with us for physicians qualified to serve as medical directors, for limited acquisition targets and for individual patients. In addition to these large and medium-sized competitors with substantial financial resources and other established participants in the dialysis space, we also compete with individual nephrologists who have opened their own dialysis units or facilities. Our largest competitor, Fresenius Medical Group, manufactures a full line of dialysis supplies 43and equipment in addition to owning and operating dialysis centers, which may, among other things, give it cost advantages over us because of its ability to manufacture its own products. We continuously compete for maintaining or developing relationships with physicians that can serve as medical directors at our centers. Physicians, including medical directors, choose where they refer their patients, and neither of our current or former medical directors have an obligation to refer their patients to our centers. Certain physicians prefer to have their patients treated at dialysis centers where they or other members of their practice supervise the overall care provided as medical director of the center. As a result, referral sources for many of our centers include the physician or physician group providing medical director services to the center. Moreover, because Medicare regulations require medical directors for each of our Medicare certified dialysis centers, our ability to operate our centers depends in part on our ability to secure medical director agreements with a sufficient number of nephrologists. Our medical director contracts are for fixed periods, generally ten years, and at any given time a large number of them could be up for renewal at the same time. Medical directors have no obligation to extend their agreements with us and, under certain circumstances, our former medical directors may choose to provide medical director services for competing providers or establish their own dialysis centers in competition with ours. If we are unable to contract with nephrologists to provide medical director services, then we may be unable to satisfy the federal Medicare requirements associated with medical directors and to operate our centers. The aging of the nephrologist population and opportunities presented by our competitors may negatively impact a medical director's decision to enter into or extend his or her agreement with us. In addition, if the terms of any existing agreement are found to violate applicable laws, there can be no assurances that we would be successful in restructuring the relationship, which would lead to the early termination of the agreement. If we are unable to obtain qualified medical directors to provide supervision of the operations and care provided at our dialysis centers, it could affect not only our ability to operate the center and for other physicians to feel confident in referring patients to our dialysis centers. If a significant number of physicians were to cease referring patients to our dialysis centers, whether due to law, rule or regulation, new competition, a perceived decrease in the quality of service levels at our centers or other reasons, it would have a material adverse effect on our business, results of operations, financial condition and cash flows.In addition, as we continue to expand our offerings across the kidney care continuum, our ability to enter into and maintain integrated kidney care relationships with payors, physicians and other providers may have an impact on dialysis patient retention and the continued referrals of patients from referral sources such as hospitals and nephrologists. This environment is highly competitive and has been evolving. For example, there have been a number of announcements, initiatives and capital raises by non-traditional dialysis providers and others, which relate to entry into the dialysis and pre-dialysis space, the development of innovative technologies, or the commencement of new business activities that could be transformative to the industry. Some of these new entrants have considerable financial resources. Although these and other potential competitors may face operational or financial challenges, the evolving nature of the dialysis and pre-dialysis marketplaces have presented some opportunities for relative ease of entry for these and other potential competitors. As a result, we may compete with these smaller or non-traditional providers or others in an asymmetrical environment with respect to data and regulatory requirements that we face as an ESRD service provider, thereby negatively impacting our ability to effectively compete. These and other factors have continued to drive change in the dialysis and pre-dialysis space, and if we are unable to successfully adapt to these dynamics, it could have a material adverse impact on our business, results of operations, financial condition and cash flows. As an example, new entrants are aggressively pursuing opportunities to participate in the new CMMI payment models or otherwise establish value-based care programs, and increasing investment in and availability of funding to new entrants in the dialysis and pre-dialysis marketplace that are not subject to the same regulatory restrictions as the Company, could adversely impact our ability to enter into competitive arrangements. Each of the aforementioned competitive pressures and related risks may be impacted by a continued decline in the rate of growth of the ESRD patient population, higher mortality rates for dialysis patients or other reductions in demand for dialysis treatments, whether due to the development of innovative technologies or otherwise. The recent 2022 annual data report from the United States Renal Data System (USRDS) suggests that the rate of growth of the ESRD patient population is declining relative to long-term trends. A number of factors may impact ESRD growth rates, including, without limitation, the aging of the U.S. population, incidence rates for diseases that cause kidney failure such as diabetes and hypertension, transplant rates, mortality rates for dialysis patients or CKD patients and growth rates of minority populations with higher than average incidence rates of ESRD. Certain of these factors, in particular the mortality rates for dialysis patients, have been impacted by the COVID-19 pandemic. The magnitude of these cumulative COVID-19 related impacts on our patient census and treatment volumes has been material and depending on the ultimate severity and duration of the pandemic, could continue to be material. While we have continued efforts to seek growth opportunities, such as by expanding our business into various international markets, we face ongoing competition from large and medium-sized providers, among others, for acquisition targets in those markets. Providers may reduce pricing in an attempt to capture more volume in the face of declining ESRD patient growth. Any failure on our part to appropriately adjust our business and operations in light of these complicated marketplace dynamics could have a material adverse effect on our business, results of operations, financial condition and cash flows and could materially harm our reputation. 44If we are not able to effectively compete in the markets in which we operate, including by implementing our growth strategy, effectively adjusting our business and operations in light of evolving marketplace dynamics, building or retaining our patient population, maintaining and developing relationships with nephrologists and hospitals, particularly medical director relationships, or making acquisitions at the desired pace or at all; if we are not able to continue to maintain the expected or desired level of non-acquired growth; or if we experience significant patient attrition either as a result of new business activities in the dialysis or pre-dialysis space by our existing competitors, other market participants, new entrants, new technology or other forms of competition, or as a result of reductions in demand for dialysis treatments, including, without limitation, due to increased mortality rates for dialysis patients resulting from COVID-19 or otherwise, reduced prevalence of ESRD, the development of innovative technologies or an increase in the number of kidney transplants, it could materially adversely affect our business, results of operations, financial condition and cash flows.The U.S. integrated kidney care, U.S. other ancillary services and international operations that we operate or invest in now or in the future may generate losses and may ultimately be unsuccessful. In the event that one or more of these activities is unsuccessful, our business, results of operations, financial condition and cash flows may be negatively impacted and we may have to write off our investment and incur other exit costs.Our U.S. integrated kidney care and U.S. other ancillary services are subject to many of the same risks, regulations and laws, as described in the risk factors related to our dialysis business set forth in Part I, Item 1A. of this Form 10-K, and are also subject to additional risks, regulations and laws specific to the nature of the particular strategic initiative. We have added, and expect to continue to add additional service offerings to our business and pursue additional strategic initiatives in the future as circumstances warrant, which could include healthcare products or services not directly related to dialysis. Many of these initiatives require or would require investments of both management and financial resources and can generate significant losses for a substantial period of time and may not become profitable in the expected timeframe or at all. There can be no assurance that any such strategic initiative will ultimately be successful. Any significant change in market conditions or business performance, including, without limitation, as a result of the COVID-19 pandemic, or in the political, legislative or regulatory environment, may impact the performance or economic viability of any of these strategic initiatives. If any of our U.S. integrated kidney care, U.S. ancillary services or international operations are unsuccessful, it may have a negative impact on our business, results of operations, financial condition and cash flows, and if we determine to exit that line of business we may incur significant termination costs. For discussion of risks and potential impacts specific to our integrated kidney care business and related growth strategy, see the risk factor under the heading "If we are not able to successfully implement our strategy with respect to our integrated kidney care and value-based care initiatives..." In addition, we may incur material write-offs or impairments of our investments, including, without limitation, goodwill or other assets, in one or more of our U.S. integrated kidney care, U.S. ancillary services or international operations. In that regard, we have taken, and may in the future take, impairment and restructuring charges in addition to those described above related to our U.S. integrated kidney care, U.S. ancillary services and international operations, including, without limitation, in our prior pharmacy businesses.Expansion of our operations to and offering our services in markets outside of the U.S., and utilizing third-party suppliers and service providers operating outside of the U.S., subjects us to political, economic, legal, operational and other risks that could have a material adverse effect on our business, results of operations, financial condition, cash flows and reputation.We are continuing to expand our operations by offering our services and entering new lines of business in certain markets outside of the U.S., and we have increased our utilization of third-party suppliers and service providers operating outside of the U.S., which increases our exposure to the inherent risks of doing business in international markets. Depending on the market, these risks include those relating to:•changes in the local economic environment including, among other things, labor cost increases and other general inflationary pressures;•political instability, armed conflicts or terrorism;•public health crises, such as pandemics or epidemics, including the COVID-19 pandemic;•social changes;•intellectual property legal protections and remedies;•trade regulations;•procedures and actions affecting approval, production, pricing, reimbursement and marketing of products and services;45•foreign currency;•additional U.S. and foreign taxes;•export controls;•antitrust and competition laws and regulations;•lack of reliable legal systems which may affect our ability to enforce contractual rights;•changes in local laws or regulations, or interpretation or enforcement thereof;•potentially longer ramp-up times for starting up new operations and for payment and collection cycles;•financial and operational, and information technology systems integration;•failure to comply with U.S. laws, such as the FCPA, or local laws that prohibit us, our partners, or our partners' or our agents or intermediaries from making improper payments to foreign officials or any third party for the purpose of obtaining or retaining business; and•data and privacy restrictions, among other things.Issues relating to the failure to comply with applicable non-U.S. laws, requirements or restrictions may also impact our domestic business and/or raise scrutiny on our domestic practices.Additionally, some factors that will be critical to the success of our international business and operations will be different than those affecting our domestic business and operations. For example, conducting international operations requires us to devote significant management resources to implement our controls and systems in new markets, to comply with local laws and regulations, including to fulfill financial reporting and records retention requirements among other things, and to overcome the numerous new challenges inherent in managing international operations, including, without limitation, challenges based on differing languages and cultures, challenges related to establishing clinical operations in differing regulatory and compliance environments, and challenges related to the timely hiring, integration and retention of a sufficient number of skilled personnel to carry out operations in an environment with which we are not familiar.Any expansion of our international operations through acquisitions or through organic growth could increase these risks. Additionally, while we may invest material amounts of capital and incur significant costs in connection with the growth and development of our international operations, including to start up or acquire new operations, we may not be able to operate them profitably on the anticipated timeline, or at all.These risks could have a material adverse effect on our business, results of operations, financial condition and cash flows and could materially harm our reputation.Failing to effectively maintain, operate or upgrade our information systems or those of third-party service providers upon which we rely, including, without limitation, our clinical, billing and collections systems, or failure to adhere to federal and state data sharing and access requirements and regulations could materially adversely affect our business, results of operations, financial condition, cash flows and reputation.Our business depends significantly on effective information systems. Our information systems require an ongoing commitment of significant resources to maintain, upgrade and enhance existing systems and develop or contract for new systems in order to keep pace with continuing changes in information processing technology, emerging cybersecurity risks and threats, evolving industry, legal and regulatory standards and requirements, new models of care, and other changes in our business, among other things. For example, the provisions related to data interoperability, information blocking, and patient access in the Cures Act and No Surprises Act include, among other things, changes to the Office of the National Coordinator for Health Information Technology’s (ONC's) Health IT Certification Program and requirements that CMS-regulated payors make relevant claims/care data and provider directory information available through standardized patient access and provider directory application programming interfaces (APIs) that connect to provider electronic health records. We have made and expect to continue to make significant investments in updating and integrating our clinical IT systems and continuing to build our data interoperability capabilities. Any failure to adequately comply with these and other provisions related to data interoperability, information blocking, and patient access may, among other things, result in fines and sanctions, adversely impact our Medicare business, our ability to scale our integrated care business and our ability to compete with certain smaller and/or non-traditional providers taking advantage of an asymmetrical environment with respect to data and/or regulatory requirements given our status as an ESRD service provider; or otherwise have a material adverse effect on our business, 46financial condition, results of operations and cash flows. Rulemaking in these areas is ongoing, and there can be no assurances that the implementation of planned enhancements to our systems, such as our implementation of these data interoperability provisions or our other ongoing efforts to upgrade and better integrate our clinical systems, will be successful once the regulatory environment settles or that we will ultimately realize anticipated benefits from investments in new or existing information systems. In addition, we may from time to time obtain significant portions of our systems-related support, technology or other services from independent third parties, which may make our operations vulnerable if such third parties fail to perform adequately.Failure to successfully implement, operate and maintain effective and efficient information systems with adequate technological capabilities, deficiencies or defects in the systems and related technology, or our failure to efficiently and effectively implement ongoing system upgrades or consolidate our information systems to eliminate redundant or obsolete applications, could result in increased legal and compliance risks and competitive disadvantages, among other things, which could have a material adverse effect on our business, financial condition, results of operations and reputation. For additional information on the risks we face in a highly competitive market, see the risk factor under the heading, "If we are unable to compete successfully..." If the information we rely upon to run our business was found to be inaccurate or unreliable or if we or third parties on which we rely fail to adequately maintain information systems and data integrity effectively, whether due to software deficiencies, human coding or implementation error or otherwise, we could experience difficulty meeting clinical outcome goals, face regulatory problems, including sanctions and penalties, incur increases in operating expenses or suffer other adverse consequences, any of which could be material. Moreover, failure to adequately protect and maintain the integrity of our information systems (including our networks) and data, or information systems and data hosted by third parties upon which we rely, could subject us to severe consequences as described in the risk factor under the heading "Privacy and information security laws are complex..."Our billing systems, among others, are critical to our billing operations. This includes our systems for our dialysis clinics as well as our systems for our ancillary businesses including hospital services. If there are defects in our billing systems, or billing systems or services of third parties upon which we rely, we may experience difficulties in our ability to successfully bill and collect for services rendered, including, without limitation, a delay in collections, a reduction in the amounts collected, increased risk of retractions from and refunds to commercial and government payors, an increase in our provision for uncollectible accounts receivable and noncompliance with reimbursement laws and related requirements, any or all of which could materially adversely affect our results of operations.In the clinical environment, a failure of our clinical systems, or the systems of our third-party service providers, to operate effectively could have a material adverse effect on our business, the clinical care provided to patients, results of operations, financial condition and cash flows. For example, in connection with claims for which at least part of the government's payments to us is based on clinical performance or patient outcomes or co-morbidities, if relevant clinical systems fail to accurately capture the data we report to CMS or we otherwise have data integrity issues with respect to the reported information, this could impact our payments from government payors.Additionally, we expect the highly competitive environment in which we operate to become increasingly more competitive as the market evolves and new technologies are introduced. This dynamic environment requires continuous investment in new technologies and clinical applications. Machine learning and artificial intelligence are increasingly driving innovations in technology, and parts of our operations may employ robotics. If these technologies or applications fail to operate as anticipated or do not perform as specified, including due to potential design defects and defects in the development of algorithms or other technologies, human error or otherwise, our clinical operations, business and reputation may be harmed. If we are unable to successfully maintain, enhance or operate our information systems, including through the implementation of such technologies or applications in our clinical operations and laboratory, we may be, among other things, unable to efficiently adapt to evolving laws and requirements, unable to remain competitive with others who successfully implement and advance this technology, subject to increased risk under existing laws, regulations and requirements that apply to our business, and our patients' safety may be adversely impacted, any of which could have a material adverse impact on our business, results of operations and financial condition and could materially harm our reputation. For additional detail, see the discussion in the risk factor under the heading "Our business is subject to a complex set of governmental laws, regulations and other requirements..."We may engage in acquisitions, mergers, joint ventures, noncontrolling interest investments, or dispositions, which may materially affect our results of operations, debt-to-capital ratio, capital expenditures or other aspects of our business, and, under certain circumstances, could have a material adverse effect on our business, results of operations, financial condition and cash flows and could materially harm our reputation.Our business strategy includes growth through acquisitions of dialysis centers and other businesses, as well as through entry into joint ventures. We may engage in acquisitions, mergers, joint ventures or dispositions or expand into new business lines or models, which may affect our results of operations, debt-to-capital ratio, capital expenditures or other aspects of our 47business. For example, in 2022 we entered into an agreement with Medtronic, Inc. and one of its subsidiaries (collectively, Medtronic) to form a new, independent kidney care-focused medical device company (NewCo). The transaction is expected to close in 2023, subject to customary closing conditions and regulatory approvals, and is expected to require us to make significant cash investments to help fund the business and fund additional consideration to Medtronic in certain circumstances. See the discussion under "Off-balance sheet arrangements and aggregate contractual obligations" in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." There can be no assurance that we will be able to identify suitable acquisition or joint venture targets or merger partners or buyers for dispositions or that, if identified, we will be able to agree to acceptable terms or on the desired timetable. There can also be no assurance that we will be successful in completing any acquisitions, joint ventures, mergers or dispositions that we announce, executing new business lines or models or integrating any acquired business into our overall operations. There is no guarantee that we will be able to operate acquired businesses successfully as stand-alone businesses, or that any such acquired business will operate profitably or will not otherwise have a material adverse effect on our business, results of operations, financial condition and cash flows or materially harm our reputation. In addition, acquisition, merger or joint venture activity conducted as part of our overall growth strategy is subject to antitrust and competition laws, and antitrust regulators can investigate future (or pending) and consummated transactions. These laws could impact our ability to pursue these transactions, and under certain circumstances, could result in mandated divestitures, among other things. If a proposed transaction or series of transactions is subject to challenge under antitrust or competition laws, we may incur substantial legal costs, management’s attention and resources may be diverted, and if we are found to have violated these or other related laws, regulations or requirements, we could suffer severe consequences that could have a material adverse effect on our business, results of operations, financial condition and cash flows and could materially harm our reputation and stock price. For additional detail, see the risk factor under the heading "Our business is subject to a complex set of governmental laws, regulations and other requirements..." Further, we cannot be certain that key talented individuals at the business being acquired will continue to work for us after the acquisition or that they will be able to continue to successfully manage or have adequate resources to successfully operate any acquired business. In addition, certain of our acquired dialysis centers and facilities have been in service for many years, which may result in a higher level of maintenance costs. Further, our facilities, equipment and information technology may need to be improved or renovated to maintain or increase operational efficiency, compete for patients and medical directors, or meet changing regulatory requirements. Increases in maintenance costs and/or capital expenditures could have, under certain circumstances, a material adverse effect on our business, results of operations, financial condition and cash flows.Businesses we acquire may have unknown or contingent liabilities or liabilities that are in excess of the amounts that we originally estimated, and may have other issues, including, without limitation, those related to internal control over financial reporting or issues that could affect our ability to comply with healthcare laws and regulations and other laws applicable to our expanded business, which could harm our reputation. As a result, we cannot make any assurances that the acquisitions we consummate will be successful. Although we generally seek indemnification from the sellers of businesses we acquire for matters that are not properly disclosed to us, we are not always successful. In addition, even in cases where we are able to obtain indemnification, we may discover liabilities greater than the contractual limits, the amounts held in escrow for our benefit (if any), or the financial resources of the indemnifying party. In the event that we are responsible for liabilities substantially in excess of any amounts recovered through rights to indemnification or alternative remedies that might be available to us, or any applicable insurance, we could suffer severe consequences that would have a material adverse effect on our business, results of operations, financial condition and cash flows and could materially harm our reputation.In addition, under the terms of the equity purchase agreement for the DMG sale (the DMG sale agreement), we agreed to certain indemnification obligations, including with respect to claims for breaches of our representations and warranties regarding compliance with law, litigation, absence of undisclosed liabilities, employee benefit matters, labor matters, or taxes, among others, and other claims for which we provided the buyer with a special indemnity. As a result, we may become obligated to make payments to the buyer relating to our previous ownership and operation of the DMG business. Any such post-closing liabilities and required payments under the DMG sale agreement, or otherwise, or in connection with any other past or future disposition of material assets or businesses could individually or in the aggregate have a material adverse effect on our business, results of operations, financial condition and cash flows and could materially harm our reputation.Additionally, joint ventures or noncontrolling interest investments, including, without limitation, our Asia Pacific joint venture, inherently involve a lesser degree of control over business operations, thereby potentially increasing the financial, legal, operational and/or compliance risks associated with the joint venture or noncontrolling interest investment. In addition, we may be dependent on joint venture partners, controlling shareholders or management who may have business interests, strategies or goals that are inconsistent with ours. Business decisions or other actions or omissions of the joint venture partner, controlling shareholders or management may require us to make capital contributions or necessitate other payments, result in litigation or regulatory action against us, result in reputational harm to us or adversely affect the value of our investment or partnership, among other things. In addition, we have potential obligations to purchase the interests held by third parties in 48many of our joint ventures as a result of put provisions that are exercisable at the third party's discretion within specified time periods, pursuant to the applicable agreement. If these put provisions were exercised, we would be required to purchase the third party owner's equity interest, generally at the appraised market value. There can be no assurances that these joint ventures and/or noncontrolling interest investments, including, without limitation, our Asia Pacific joint venture, ultimately will be successful.If our joint ventures were found to violate the law, we could suffer severe consequences that would have a material adverse effect on our business, results of operations, financial condition and cash flows and could materially harm our reputation.As of December 31, 2022, we owned a controlling interest in numerous dialysis-related joint ventures, which represented approximately 28% of our U.S. dialysis revenues for the year ended December 31, 2022. In addition, we also owned noncontrolling equity investments in several other dialysis related joint ventures. We expect to continue to increase the number of our joint ventures. Many of our joint ventures with physicians or physician groups also have certain physician owners providing medical director services to centers we own and operate. Because our relationships with physicians are governed by the federal and state anti-kickback statutes, we have sought to structure our joint venture arrangements to satisfy as many federal safe harbor requirements as we believe are commercially reasonable. Our joint venture arrangements do not satisfy all of the elements of any safe harbor under the federal Anti-Kickback Statute, however, and therefore are susceptible to government scrutiny. Additionally, our joint ventures and minority investments inherently involve a lesser degree of control over business operations, thereby potentially increasing the financial, legal, operational and/or compliance risks associated with the joint venture or minority investment. If our joint ventures are found to violate applicable laws or regulations, we could suffer severe consequences that would have a material adverse effect on our business, results of operations, financial condition and cash flows and could materially harm our reputation. For additional information on these risks, see the risk factors under the headings "Our business is subject to a complex set of governmental laws, regulations and other requirements...;" and "We may engage in acquisitions, mergers, joint ventures, noncontrolling interest investments, or dispositions..."Our aspirations, goals and disclosures related to environmental, social and governance (ESG) matters expose us to numerous risks, including without limitation risks to our reputation and stock price.We have a longstanding ESG program and have engaged with key stakeholders to develop ESG focus areas and to set ESG-related goals, many of which are aspirational. We have set and disclosed these focus areas, goals and related objectives as part of our continued commitment to ESG matters, but our goals and objectives reflect our current plans and aspirations and are not guarantees that we will be able to achieve them. Our efforts to accomplish and accurately report on these goals and objectives present numerous operational, reputational, financial, legal and other risks, certain of which are outside of our control, and could have, under certain circumstances, a material adverse impact on us, including on our reputation and stock price. Examples of such risks include, among others: the availability and cost of low- or non-carbon-based energy sources and technologies for us and our vendors, evolving regulatory requirements affecting ESG standards, frameworks and disclosures, including evolving standards for measuring and reporting on related metrics, the availability of suppliers that can meet our sustainability and other standards, our ability to recruit, develop and retain diverse talent in our labor markets, and our ability to grow our home based dialysis business. If our ESG practices do not meet evolving investor or other stakeholder expectations and standards, then our reputation, our ability to attract or retain employees and our attractiveness as an investment, business partner or acquirer could be negatively impacted. Similarly, our failure or perceived failure to adequately pursue or fulfill our goals and objectives or to satisfy various reporting standards within the timelines we announce, or at all, could also have similar negative impacts and expose us to other risks, which under certain circumstances could be material. If we are not able to adequately recognize and respond to the rapid and ongoing developments and governmental and social expectations relating to ESG matters, this failure could result in missed corporate opportunities, additional regulatory, social or other scrutiny of us, the imposition of unexpected costs, or damage to our reputation with governments, patients, teammates, third parties and the communities in which we operate, which in turn could have a material adverse effect on our business, financial condition, cash flows and results of operations and could cause the market value of our common stock to decline.There are significant risks associated with estimating the amount of dialysis revenues and related refund liabilities that we recognize, and if our estimates of revenues and related refund liabilities are materially inaccurate, it could impact the timing and the amount of our revenues recognition or have a material adverse effect on our business, results of operations, financial condition and cash flows.There are significant risks associated with estimating the amount of U.S. dialysis net patient services revenues and related refund liabilities that we recognize in a reporting period. The billing and collection process is complex due to ongoing insurance coverage changes, geographic coverage differences, differing interpretations of contract coverage and other payor 49issues, such as ensuring appropriate documentation. Determining applicable primary and secondary coverage for approximately 199,400 U.S. patients at any point in time, together with the changes in patient coverage that occur each month, requires complex, resource-intensive processes. Errors in determining the correct coordination of benefits may result in refunds to payors. Revenues associated with Medicare and Medicaid programs are also subject to estimating risk related to the amounts not paid by the primary government payor that will ultimately be collectible from other government programs paying secondary coverage, the patient's commercial health plan secondary coverage or the patient. Collections, refunds and payor retractions typically continue to occur for up to three years and longer after services are provided. We generally expect our range of U.S. dialysis patient services revenues estimating risk to be within 1% of revenues for the segment. If our estimates of U.S. dialysis patient services revenues and related refund liabilities are materially inaccurate, it could impact the timing and the amount of our revenues recognition and have a material adverse impact on our business, results of operations, financial condition and cash flows.General Risk FactorsThe level of our current and future debt could have an adverse impact on our business, and our ability to generate cash to service our indebtedness and for other intended purposes and our ability to maintain compliance with debt covenants depends on many factors beyond our control.We have a substantial amount of indebtedness outstanding and we may incur substantial additional indebtedness in the future, including indebtedness incurred to finance repurchases of our common stock pursuant to our share repurchase authorization discussed under "Stock Repurchases" in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." As described in Note 13 to the consolidated financial statements included in this report, we are party to a senior secured credit agreement (the Credit Agreement), which consists of an up to $1 billion secured revolving line of credit, a secured term loan A facility and a secured term loan B-1 facility. Our long-term indebtedness also includes $4.250 billion aggregate principal amount of senior notes.Our senior secured credit facilities bear, and other indebtedness we may incur in the future may bear, interest at a variable rate. As a result, at any given time interest rates on the senior secured credit facilities and any other variable rate debt could be higher or lower than current levels. If interest rates increase, our debt service obligations on our variable rate indebtedness will increase even though the amount borrowed remains the same, and therefore net income and associated cash flows, including cash available for servicing our indebtedness, will correspondingly decrease.Our indebtedness levels and the required payments on such indebtedness may also be impacted by developments related to LIBOR replacement. The variable interest rates payable under our senior secured credit facilities have historically been linked to LIBOR as the benchmark for establishing such rates. We expect that the LIBOR benchmark will cease to exist after June 30, 2023. Our senior secured credit facilities include mechanics to facilitate the adoption by us and our lenders of an alternative benchmark rate for use in place of LIBOR and through this mechanism or other amendments or agreements with our lenders we expect to reference a replacement index that measures the cost of borrowing cash overnight, backed by U.S. Treasury securities (Secured Overnight Financing Rate or SOFR) or a variation thereof; however, no assurance can be made that we and our lenders, or any lenders in a subsequent refinancing of our credit facilities, will agree on such an alternative rate and, even if agreed upon, such alternative rate may not perform in a manner similar to LIBOR and may result in interest rates that are higher or lower than those that would have resulted had LIBOR remained in effect, which could impact our cost of capital.Our ability to make payments on our indebtedness, to fund planned capital expenditures and expansion efforts, including, without limitation, any strategic acquisitions or investments we may make in the future, to repurchase our stock at the levels intended or announced and to meet our other liquidity needs such as for working capital or capital expenditures, will depend on our ability to generate cash. This depends not only on the success of our business but is also subject to economic, financial, competitive, regulatory and other factors that are beyond our control. We cannot provide assurances that our business will generate sufficient cash flows from operations in the future or that future borrowings will be available to us in amounts sufficient to enable us to service our indebtedness or to fund our working capital and other liquidity needs, including those described above. If we are unable to generate sufficient funds to service our outstanding indebtedness or to meet our working capital or other liquidity needs, including those described above, we would be required to refinance, restructure, or otherwise amend some or all of such indebtedness, sell assets, change or reduce our intended or announced uses or strategy for capital deployment, including, without limitation, for stock repurchases, reduce capital expenditures, planned expansions or other strategic initiatives, or raise additional cash through the sale of our equity or equity-related securities. We cannot make any assurances that any such refinancing, restructurings, amendments, sales of assets, or issuances of equity or equity-related securities can be accomplished or, if accomplished, will be on favorable terms or would raise sufficient funds to meet these obligations or our other liquidity needs. 50In addition, we may continue to incur indebtedness in the future, and the amount of that additional indebtedness may be substantial. Although the Credit Agreement includes covenants that could limit our indebtedness, we currently have, and expect to continue to have, the ability to incur substantial additional debt. The risks described in this risk factor could intensify as new debt is added to current debt levels or if we incur any new debt obligations that subject us to restrictive covenants that limit our financial and operational flexibility. Any breach or failure to comply with any of these covenants could result in a default under our indebtedness. Other risks related to our ability to generate sufficient cash to service our indebtedness and for other intended purposes, include, for example:•increase our vulnerability to general adverse economic and industry conditions;•limit our flexibility in planning for, or reacting to, changes in our business and the markets in which we operate;•expose us to interest rate volatility that could adversely affect our business, results of operations, financial condition and cash flows, and our ability to service our indebtedness;•place us at a competitive disadvantage compared to our competitors that have less debt; and•limit our ability to borrow additional funds, or to refinance existing debt on favorable terms when otherwise available or at all.Any failure to pay any of our indebtedness when due or any other default under our credit facilities or our other indebtedness could have a material adverse effect on our business, results of operations, financial condition and cash flows, and could trigger cross default or cross acceleration provisions in our other debt instruments, thereby permitting the holders of that other indebtedness to demand immediate repayment or cease to make future extensions of credit, and, in the case of secured indebtedness, to take possession of and sell the collateral securing such indebtedness to satisfy our obligations.The borrowings under our senior secured credit facilities and senior indentures are guaranteed by certain of our domestic subsidiaries, and borrowings under our senior secured credit facilities are secured by substantially all of our and certain of our domestic subsidiaries' assets. Such guarantees and the fact that we have pledged such assets may make it more difficult and expensive for us to make, or under certain circumstances could effectively prevent us from making, additional secured and unsecured borrowings.We could be subject to adverse changes in tax laws, regulations and interpretations or challenges to our tax positions.We are subject to tax laws and regulations of the U.S. federal, state and local governments as well as various foreign jurisdictions. We compute our income tax provision based on enacted tax rates in the jurisdictions in which we operate. As the tax rates vary among jurisdictions, a change in earnings attributable to the various jurisdictions in which we operate could result in a change in our overall tax provision.Changes in tax laws or regulations may be proposed or enacted that could adversely affect our overall tax liability. There can be no assurance that changes in tax laws or regulations, both within the domestic and foreign jurisdictions in which we operate, will not materially and adversely affect our effective tax rate, tax payments, results of operations, financial condition and cash flows. Similarly, changes in tax laws and regulations that impact our patients, business partners and counterparties or the economy may also impact our results of operations, financial condition and cash flows.In addition, tax laws and regulations are complex and subject to varying interpretations, and any significant failure to comply with applicable tax laws and regulations in all relevant jurisdictions could give rise to material penalties and liabilities. We are regularly subject to audits by various tax authorities. For example, our current audits include an audit by the Internal Revenue Service for the years 2016–2017, and it is possible that the final determination of this and any other tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. Any changes in enacted tax laws, rules or regulatory or judicial interpretations; any adverse development or outcome in connection with tax audits in any jurisdiction; or any change in the pronouncements relating to accounting for income taxes could materially and adversely impact our effective tax rate, tax payments, results of operations, financial condition and cash flows.The effects of natural or other disasters, political instability, public health crises or adverse weather events such as hurricanes, earthquakes, fires or flooding could have a material adverse effect on our business, results of operations, financial condition and cash flows.Some of our operations, including our clinical laboratory, dialysis centers and other facilities, may be adversely impacted by the effects of natural or other disasters, political instability, public health crises such as global pandemics or epidemics, including the COVID-19 pandemic, or adverse weather events such as hurricanes, earthquakes, fires or flooding. Each of these effects and risks may be further intensified by the increasing impact of climate change on a global scale. In addition, these risks 51are particularly heightened for our patients in part because individuals with chronic illness may be more susceptible to the adverse effects of epidemics or other public health crises and also because any natural or other disaster, political instability or adverse weather event that disrupts or limits the operation of any of our centers or other facilities or services may delay or otherwise impact the critical services we provide to dialysis patients. Further, any such event or other occurrence that results in a failure of the fitness of our clinical laboratory, dialysis centers and related operations and/or other facilities or otherwise adversely impacts the safety of our teammates or patients at any of those locations could lead us to face adverse consequences, including, without limitation, the potential loss of data, including PHI or PII, compliance or regulatory investigations, any of which could materially impact our business, results of operations and financial condition, and could materially harm our reputation. For example, our clinical laboratory is located in Florida, a state that has in the past experienced and may in the future experience hurricanes. Natural or other disasters or adverse weather events could significantly damage or destroy our facilities, disrupt operations, increase our costs to maintain operations and require substantial expenditures and recovery time to fully resume operations. In addition, as the effects of climate change progressively surface, such as through potential increases in the frequency and intensity of natural or other disasters or adverse weather events or through laws or regulations adopted in response, we may face increased costs associated with operating our clinics, including, without limitation, with respect to supplies of water or energy costs.Our presence in markets outside the U.S. may increase our exposure to these and similar risks related to natural disasters, public health crises, political instability, climate change or other catastrophic events outside our control. For additional information regarding the risks related to our international business, see the discussion in the risk factor under the heading "Expansion of our operations to and offering our services in markets outside of the U.S...."Any or all of these factors, as well as other consequences of these events, none of which we can currently predict, could have a material adverse effect on our business, results of operations, financial condition and cash flows or materially harm our reputation.We may be subject to liability claims for damages and other expenses that are not covered by insurance or exceed our existing insurance coverage that could have a material adverse effect on our business, results of operations, financial condition and cash flows and could materially harm our reputation.Our operations and how we manage our business may subject us, as well as our officers and directors to whom we owe certain defense and indemnity obligations, to litigation and liability. Our business, profitability and growth prospects could suffer if we face negative publicity or we pay damages or defense costs in connection with a claim that is outside the scope or limits of coverage of any applicable insurance coverage, including, without limitation, claims related to adverse patient events, cybersecurity incidents, contractual disputes, antitrust and competition laws and regulations, professional and general liability and directors' and officers' duties. In addition, we have received notices of claims from commercial payors and other third parties, as well as subpoenas and civil investigative demands from the federal government, related to our business practices, including, without limitation, our historical billing practices and the historical billing practices of acquired businesses. Although the ultimate outcome of these claims cannot be predicted, an adverse result with respect to one or more of these claims could have a material adverse effect on our business, results of operations, financial condition and cash flows, and could materially harm our reputation. We maintain insurance coverage for those risks we deem are appropriate to insure against and make determinations about whether to self-insure as to other risks or layers of coverage. However, a successful claim, including, without limitation, a professional liability, malpractice or negligence claim or a claim related to antitrust and competition laws or a cybersecurity incident, which is in excess of any applicable insurance coverage, that is outside the scope or limits of any applicable insurance coverage, or that is subject to our self-insurance retentions, could have a material adverse effect on our business, results of operations, financial condition, cash flows and reputation.In addition, if our costs of insurance and claims increase, then our earnings could decline. Market rates for insurance premiums and deductibles have been steadily increasing. Our business, results of operations, financial condition and cash flows could be materially and adversely affected by any of the following:•the collapse or insolvency of our insurance carriers;•further increases in premiums and deductibles;•increases in the number of liability claims against us or the cost of settling or trying cases related to those claims; •obtaining insurance with exclusions for things such as communicable diseases; or•an inability to obtain one or more types of insurance on acceptable terms, if at all.52If we fail to successfully maintain an effective internal control over financial reporting, the integrity of our financial reporting could be compromised, which could have a material adverse effect on our ability to accurately report our financial results, the market's perception of our business and our stock price.The integration of acquisitions and addition of new business lines into our internal control over financial reporting has required and will continue to require significant time and resources from our management and other personnel and has increased, and is expected to continue to increase, our compliance costs. Failure to maintain an effective internal control environment could have a material adverse effect on our ability to accurately report our financial results, the market's perception of our business and our stock price. In addition, we could be required to restate our financial results in the event of a significant failure of our internal control over financial reporting or in the event of inappropriate application of accounting principles.Provisions in our organizational documents, our compensation programs and policies and certain requirements under Delaware law may deter changes of control and may make it more difficult for our stockholders to change the composition of our Board of Directors and take other corporate actions that our stockholders would otherwise determine to be in their best interests.Our organizational documents include provisions that may deter hostile takeovers, delay or prevent changes of control or changes in our management, or limit the ability of our stockholders to approve transactions that they may otherwise determine to be in their best interests. These include provisions prohibiting our stockholders from acting by written consent, advance notice requirements for director nominations and stockholder proposals and granting our Board of Directors the authority to issue preferred stock and to determine the rights and preferences of the preferred stock without the need for further stockholder approval.Most of our outstanding employee stock-based compensation awards include a provision accelerating the vesting of the awards in the event of a change of control. These and any other change of control provisions may affect the price an acquirer would be willing to pay for our Company.We are also subject to Section 203 of the Delaware General Corporation Law that, subject to exceptions, prohibits us from engaging in any business combinations with any interested stockholder, as defined in that section, for a period of three years following the date on which that stockholder became an interested stockholder.The provisions described above may discourage, delay or prevent an acquisition of our Company at a price that our stockholders may find attractive. These provisions could also make it more difficult for our stockholders to elect directors and take other corporate actions and could limit the price that investors might be willing to pay for shares of our common stock.Item 1B. Unresolved Staff Comments.None.Item 2. Properties.Our corporate headquarters are located in Denver, Colorado, consisting of one owned 240,000 square foot building and one leased 345,900 square foot location. Our headquarters are occupied by teammates engaged in management, finance, marketing, strategy, legal, compliance and other administrative functions. We lease six business offices located in California, Pennsylvania, Tennessee, and Washington in the U.S. In addition, our international headquarters is located in the United Kingdom and consists of one leased business office. Our laboratory is based in Florida where we operate our lab services out of one leased building. We also lease other administrative offices in the U.S. and worldwide. The vast majority of our U.S. outpatient dialysis centers are located on premises that we lease. We regularly own an insignificant population of properties for development, including operating outpatient dialysis centers and properties we hold for sale.The majority of our leases for our U.S. dialysis business cover periods from five years to 15 years and typically contain renewal options of five years to ten years at the fair rental value at the time of renewal. Our leases are generally subject to fixed escalation clauses, or contain consumer price index increases. Our outpatient dialysis centers range in size from approximately 1,000 to 33,000 square feet, with an average size of approximately 7,800 square feet. Our international leases generally range from one to ten years.Some of our outpatient dialysis centers are operating at or near capacity. However, we believe that we have adequate capacity within most of our existing dialysis centers to accommodate additional patient volume through increased hours and/or days of operation, or, if additional space is available within an existing facility, by adding dialysis stations. We can usually 53relocate existing centers to larger facilities or open new centers if existing centers reach capacity. With respect to relocating centers or building new centers, we believe that we can generally lease space at economically reasonable rates in the areas planned for each of these centers, although there can be no assurances in this regard. Expansion of existing centers or relocation of our dialysis centers is subject to review for compliance with conditions relating to participation in the Medicare ESRD program, among other things. In states that require a certificate of need or center license, additional approvals would generally be necessary for expansion or relocation.Item 3. Legal Proceedings.The information required by this Part I, Item 3 is incorporated herein by reference to the information set forth under the caption "Contingencies" in Note 16 to the consolidated financial statements included in this report.Item 4. Mine Safety Disclosures.Not applicable.54PART IIItem 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.Our common stock is traded on the New York Stock Exchange under the symbol DVA. The closing price of our common stock on January 31, 2023 was $82.39 per share. According to Computershare, our registrar and transfer agent, as of January 31, 2023, there were 6,987 holders of record of our common stock. This figure does not include the indeterminate number of beneficial holders whose shares are held of record by brokerage firms and clearing agencies.Our initial public offering was in 1994, and we have not declared or paid cash dividends to holders of our common stock since going public. We have no current plans to pay cash dividends and there are certain limitations on our ability to pay dividends under the terms of our senior secured credit facilities. See "Liquidity and capital resources" under Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and the notes to the consolidated financial statements.Stock RepurchasesThe following table summarizes our repurchases of our common stock during 2022:PeriodTotal numberof sharespurchasedAverage pricepaid per shareTotal number of shares purchased as part of publicly announced plans or programsApproximate dollar valueof shares that may yet be purchased under the plans or programs(dollars and shares in thousands, except per share data)January 1 - March 31, 20222,104 $110.90 2,104 $2,150,621 April 1 - June 30, 20223,869 95.56 3,869 $1,780,881 July 1 - September 30, 20222,122 87.10 2,122 $1,596,085 October 1 - December 31, 2022— — — $1,596,085 Total8,095 $97.33 8,095 Effective on December 10, 2020, the Board terminated all remaining prior share repurchase authorizations available to the Company and approved a new share repurchase authorization of $2.0 billion. Effective on December 17, 2021, the Board increased the Company's existing authorization by $2.0 billion. We are authorized to make purchases from time to time in the open market or in privately negotiated transactions, including without limitation, through accelerated share repurchase transactions, derivative transactions, tender offers, Rule 10b5-1 plans or any combination of the foregoing, depending upon market conditions and other considerations.As of February 22, 2023, we have a total of $1.596 billion available under the current repurchase authorization for additional share repurchases. Although this share repurchase authorization does not have an expiration date, we remain subject to share repurchase limitations, including under the terms of our senior secured credit facilities.Item 6. Reserved55Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.Forward-looking statementsThis Annual Report on Form 10-K, including this Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains statements that are forward-looking statements within the meaning of the federal securities laws and as such are intended to be covered by the safe harbor for "forward-looking statements" provided by the Private Securities Litigation Reform Act of 1995. These forward-looking statements could include, among other things, DaVita's response to and the expected future impacts of the coronavirus (COVID-19), including statements about our balance sheet and liquidity, our expenses and expense offsets, revenues, billings and collections, availability or cost of supplies, treatment volumes, mix expectation, such as the percentage or number of patients under commercial insurance, the availability, acceptance, impact, administration and efficacy of COVID-19 vaccines, treatments and therapies, the continuing impact on the U.S. and global economies, labor market conditions, and overall impact on our patients and teammates, as well as other statements regarding our future operations, financial condition and prospects, expenses, strategic initiatives, government and commercial payment rates, expectations related to value-based care, integrated kidney care and Medicare Advantage (MA) plan enrollment and our ongoing stock repurchase program. All statements in this report, other than statements of historical fact, are forward-looking statements. Without limiting the foregoing, statements including the words "expect," "intend," "will," "could," "plan," "anticipate," "believe," and similar expressions are intended to identify forward-looking statements. These forward-looking statements are based on DaVita's current expectations and are based solely on information available as of the date of this report. DaVita undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of changed circumstances, new information, future events or otherwise, except as may be required by law. Actual future events and results could differ materially from any forward-looking statements due to numerous factors that involve substantial known and unknown risks and uncertainties. These risks and uncertainties include, among other things:•the continuing impact of the COVID-19 pandemic, current macroeconomic and marketplace conditions, and global events, many of which are interrelated and which relate to, among other things, the impact of the COVID-19 pandemic on our patients, teammates, physician partners, suppliers, business, operations, reputation, financial condition and results of operations; the government's response to the ongoing pandemic; the pandemic's continuing impact on the U.S. and global economies, labor market conditions, interest rates, inflation and evolving monetary policies; the availability, acceptance, impact and efficacy of COVID-19 vaccines, treatments and therapies; further spread or resurgence of the virus, including as a result of the emergence of new strains of the virus; the continuing impact of the pandemic on our revenues and non-acquired growth due to lower treatment volumes; COVID-19's impact on the chronic kidney disease (CKD) population and our patient population including on the mortality of these patients; any potential negative impact on our commercial mix or the number of our patients covered by commercial insurance plans; continued increased COVID-19-related costs; our ability to successfully implement cost savings initiatives; supply chain challenges and disruptions; and elevated teammate turnover and training costs and higher salary and wage expense, including, among other things, increased contract wages, driven in part by persisting labor market conditions and a high demand for our clinical personnel, any of which may also have the effect of heightening many of the other risks and uncertainties discussed below, and in many cases, the impact of the pandemic and the aforementioned global economic conditions on our business may persist even after the pandemic subsides; •the extent to which the ongoing implementation of healthcare reform, or changes in or new legislation, regulations or guidance, enforcement thereof or related litigation result in a reduction in coverage or reimbursement rates for our services, a reduction in the number of patients enrolled in or that select higher-paying commercial plans, including for example MA plans or other material impacts to our business or operations; or our making incorrect assumptions about how our patients will respond to any such developments;•risks arising from potential changes in laws, regulations or requirements applicable to us, such as potential and proposed federal and/or state legislation, regulation, ballot, executive action or other initiatives, including without limitation those related to healthcare and/or labor matters;•the concentration of profits generated by higher-paying commercial payor plans for which there is continued downward pressure on average realized payment rates; a reduction in the number or percentage of our patients under such plans, including, without limitation, as a result of restrictions or prohibitions on the use and/or availability of charitable premium assistance, which may result in the loss of revenues or patients, as a result of our making incorrect assumptions about how our patients will respond to any change in financial assistance from charitable organizations; or as a result of payors’ implementing restrictive plan designs, including, without limitation, actions taken in response to the U.S. Supreme Court’s decision in Marietta Memorial Hospital Employee Health Benefit Plan, et al. v. DaVita Inc. et al. ("Marietta"); how and whether regulators and legislators will 56respond to the Marietta decision including, without limitation, whether they will issue regulatory guidance or adopt new legislation; how courts will interpret other anti-discriminatory provisions that may apply to restrictive plan designs; whether there could be other potential negative impacts of the Marietta decision; and the timing of each of these items;•our ability to attract, retain and motivate teammates and our ability to manage operating cost increases or productivity decreases whether due to union organizing activities, legislative or other changes, demand for labor, volatility and uncertainty in the labor market, the current challenging and highly competitive labor market conditions, or other reasons; •U.S. and global economic and marketplace conditions, interest rates, inflation, unemployment, labor market conditions, and evolving monetary policies, and our ability to respond to these challenging conditions, including among other things our ability to successfully identify cost savings opportunities and to implement cost savings initiatives such as ongoing initiatives that increase our use of third-party service providers to perform certain activities, initiatives that relate to clinic optimization and capacity utilization improvement, and procurement opportunities, among other things; •our ability to successfully implement our strategies with respect to integrated kidney care and value-based care initiatives and home based dialysis in the desired time frame and in a complex, dynamic and highly regulated environment, including, among other things, maintaining our existing business; meeting growth expectations; recovering our investments; entering into agreements with payors, third party vendors and others on terms that are competitive and, as appropriate, prove actuarially sound; structuring operations, agreements and arrangements to comply with evolving rules and regulations; finding, training and retaining appropriate staff; and further developing our integrated care and other capabilities to provide competitive programs at scale; •a reduction in government payment rates under the Medicare End Stage Renal Disease program, state Medicaid or other government-based programs and the impact of the Medicare Advantage benchmark structure;•noncompliance by us or our business associates with any privacy or security laws or any security breach by us or a third party involving the misappropriation, loss or other unauthorized use or disclosure of confidential information;•legal and compliance risks, such as our continued compliance with complex, and at times, evolving government regulations and requirements;•the impact of the political environment and related developments on the current healthcare marketplace and on our business, including with respect to the Affordable Care Act, the exchanges and many other core aspects of the current healthcare marketplace, as well as the composition of the U.S. Supreme Court and the current presidential administration and congressional majority;•changes in pharmaceutical practice patterns, reimbursement and payment policies and processes, or pharmaceutical pricing, including with respect to hypoxia inducible factors, among other things;•our ability to develop and maintain relationships with physicians and hospitals, changing affiliation models for physicians, and the emergence of new models of care or other initiatives introduced by the government or private sector that, among other things, may erode our patient base and impact reimbursement rates;•our ability to complete acquisitions, mergers, dispositions, joint ventures or other strategic transactions that we might announce or be considering, on terms favorable to us or at all, or to successfully integrate any acquired businesses, or to successfully operate any acquired businesses, joint ventures or other strategic transactions, or to successfully expand our operations and services in markets outside the United States, or to businesses or products outside of dialysis services;•continued increased competition from dialysis providers and others, and other potential marketplace changes, including without limitation increased investment in and availability of funding to new entrants in the dialysis and pre-dialysis marketplace;•the variability of our cash flows, including without limitation any extended billing or collections cycles; the risk that we may not be able to generate or access sufficient cash in the future to service our indebtedness or to fund our other liquidity needs; and the risk that we may not be able to refinance our indebtedness as it becomes due, on terms favorable to us or at all;57•factors that may impact our ability to repurchase stock under our stock repurchase program and the timing of any such stock repurchases, as well as our use of a considerable amount of available funds to repurchase stock;•risks arising from the use of accounting estimates, judgments and interpretations in our financial statements;•impairment of our goodwill, investments or other assets; •our aspirations, goals and disclosures related to environmental, social and governance (ESG) matters, including, among other things, evolving regulatory requirements affecting ESG standards, measurements and reporting requirements; the availability of suppliers that can meet our sustainability standards; and our ability to recruit, develop and retain diverse talent in our labor markets; and•the other risk factors, trends and uncertainties set forth in Part I, Item 1A. of this Annual Report on Form 10-K, and the other risks and uncertainties discussed in any subsequent reports that we file or furnish with the SEC from time to time.The following should be read in conjunction with our consolidated financial statements.58Company overviewOur principal business is to provide dialysis and related lab services to patients in the United States, which we refer to as our U.S. dialysis business. We also operate our U.S. integrated kidney care (IKC) business, our U.S. other ancillary services, and our international operations, which we collectively refer to as our ancillary services, as well as our corporate administrative support. Our U.S. dialysis business is a leading provider of kidney dialysis services in the U.S. for patients suffering from chronic kidney failure, also known as end stage renal disease (ESRD) or end stage kidney disease (ESKD).On June 19, 2019, we completed the sale of our prior DaVita Medical Group (DMG) business to Collaborative Care Holdings, LLC, a subsidiary of UnitedHealth Group Inc. The effects of the DMG sale have been reported in discontinued operations for all periods presented and DMG is not included below in this Management's Discussion and Analysis.We continued to experience challenges related to the coronavirus pandemic (COVID-19) and certain interrelated macroeconomic developments and conditions which negatively impacted our year-over-year revenue and treatment volumes in 2022. We also incurred higher compensation expense and advocacy spend in 2022, as well as increases in severance costs and center closures costs as we continue to focus on cost savings initiatives. In addition, 2022 was negatively impacted by our increased investment in our integrated care support functions needed to support the IKC patient growth. These negative trends were partially offset by increased U.S. dialysis average patient services revenue per treatment and continued growth in international businesses. In addition our 2022 financial performance benefited from lower pharmaceutical unit costs and intensity, health benefits expenses and medical supply expense as compared to the prior year. Operational and financial highlights for 2022 include, among other things:•total U.S. dialysis revenue benefited from an increase in average patient services revenue per treatment growth of $6.00 per treatment offset by a decrease in the number of treatments primarily due to increased mortality due to COVID-19's impact on our patient population;•total revenue growth of 8.3% in our IKC business and 3.6% in our international operations; •operating income of $1,339 million and adjusted operating income of $1,450 million;•operating cash flows of $1,565 million and free cash flows of $817 million; and•repurchase of 8,094,661 shares of our common stock for aggregate consideration of $788 million, and a 7.1% reduction in our share count year-over-year.Additional highlights include:•net decrease of 91 U.S. dialysis centers to improve center capacity and utilization, as well as a net increase of 11 international dialysis centers from acquisitions; •continued patient growth in IKC to 42,000 patients in risk-based integrated care arrangements and an additional 15,000 patients in other integrated care arrangements; and•the continued impact of COVID-19 and other macroeconomic conditions.In 2023, we expect that COVID-19 and certain macroeconomic conditions will continue to impact our business and financial performance though the cumulative magnitude of these impacts remains difficult to predict and subject to significant uncertainty due to a number of factors, as described in further detail below under the heading "COVID-19, General Economic and Marketplace Conditions, and Legal and Regulatory Developments." On treatment volume, we continue to face pressure primarily driven by the impact of COVID-19 on the mortality rates of dialysis patients, as well as the direct and indirect impact of COVID-19 on our missed treatment rate and new admissions. We anticipate that this pressure also will be magnified by continued slowing industry growth and continued competitive activity in 2023. On reimbursement rate, we expect growth in aggregate, primarily due to the increase in Medicare payment rates under the ESRD Prospective Payment System as well as a continuing increase in anticipated Medicare Advantage enrollment due to the 21st Century Cures Act, partially offset by a full year of the resumption of Medicare sequestration. On cost, we continue to expect increasing pressure on wage rates and other costs due to the challenging labor market and inflationary conditions and increased severance costs as we focus on efficiencies in our administrative support functions partially offset by continued anticipated savings on pharmaceutical costs and a decrease in depreciation and amortization. We expect to incur significantly less advocacy costs in 2023 than we experienced in 2022. We also expect to continue making investments to expand our ability to offer home-based dialysis service options and further advance our integrated care and value-based care initiatives in 2023. Finally, considerable uncertainty exists surrounding the continued development of the various governmental laws, regulations and other requirements that impact our business.59The discussion below includes analysis of our financial condition and results of operations for the years ended December 31, 2022 compared to December 31, 2021. Our Annual Report on Form 10-K for the year ended December 31, 2021, includes a discussion and analysis of our financial condition and results of operations for the year ended December 31, 2020, in its Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations".References to the "Notes" in the discussion below refer to the notes to the Company's consolidated financial statements included in this Annual Report on Form 10-K at Item 15, "Exhibits, Financial Statement Schedules" as referred from Part II Item 8, "Financial Statements and Supplementary Data."COVID-19, General Economic and Marketplace Conditions, and Legal and Regulatory DevelopmentsAs noted above and described in further detail below, the continued impacts on our business in connection with the COVID-19 pandemic and general economic and market conditions could have a material adverse impact on our patients, teammates, physician partners, suppliers, business, operations, reputation, financial condition, results of operations, cash flows and/or liquidity. Many of these external factors and conditions are interrelated, including, among other things, supply chain challenges, inflation, rising interest rates, labor market conditions and wage pressure. Certain of these impacts could be further intensified by concurrent global events such as the ongoing conflict between Russia and Ukraine, which has continued to drive sociopolitical and economic uncertainty and volatility in Europe and across the globe.Operational and Financial ImpactsIn 2022 we continued to experience a negative impact on revenue and non-acquired growth from COVID-19 due to lower treatment volumes. As noted above, these lower treatment volumes were driven primarily by the negative impact of COVID-19 on the mortality rates of our patients, which has in turn impacted our patient census, as well as the direct and indirect impact of COVID-19 on our missed treatment rate and new admissions. We expect that the impact of COVID-19 is likely to continue to negatively impact our revenue and non-acquired growth for a period of time even as the pandemic subsides due to the compounding impact of mortalities, among other things. During 2022, lower treatment volumes were also driven in part by declining new admissions and elevated missed treatment rates. New admission rates, future revenues and non-acquired growth could also continue to be negatively impacted over time to the extent that the CKD population experiences elevated mortality levels due to the pandemic. There remains significant uncertainty as to the ultimate impact of COVID-19 on our treatment volumes, in part due to, among other things, the indeterminate severity and duration of the pandemic and the complexity of factors that may drive new admissions and missed treatment rates over time. Depending on the ultimate severity and duration of the pandemic, the magnitude of these cumulative impacts could have a material adverse impact on our results of operations, financial condition and cash flows.COVID-19 and other global conditions have also increased, and will continue to increase, our expenses, including, among others, staffing and labor costs. In 2022, we incurred higher than usual wage increases, and higher incentive pay. During 2022 we also incurred increased costs due to an increased utilization of contract labor, inefficient productivity and increased investment in training expenses. Each of those cost drivers were in turn primarily the result of the combination of our ongoing COVID-19-related clinical protocols and general labor, supply chain and inflationary pressures. As noted above, we expect certain of these increased costs to continue, and the cumulative impact of these costs could be material. In addition, potential staffing shortages or disruptions, if material, could ultimately lead to the unplanned closures of certain centers or adversely impact clinical operations, and may otherwise have a material adverse impact on our ability to provide dialysis services or the cost of providing those services, among other things. In 2022, we also saw a continued increase, relative to pre-pandemic conditions, in the effort and cost needed to procure certain of our equipment and clinical supplies, including pharmaceuticals and personal protective equipment (PPE), and some of which have been substantial.The staffing and labor cost inflation described above, in addition to higher equipment and clinical supply costs, have put pressure on our existing cost structure, and as noted above, we expect that certain of those increased costs will persist as global supply chains continue to experience volatility and disruptions and as inflationary pressures and challenging labor market conditions continue. Prolonged volatility, uncertainty, labor supply shortages and other challenging labor market conditions could have an adverse impact on our growth and ability to execute on our other strategic initiatives and a material adverse impact on our labor costs. Prolonged strain on global supply chains may result in equipment and clinical supply shortages, disruptions, delays or associated price increases that could impact our ability to provide dialysis services or the cost of providing those services, among other things. Moreover, to the extent that inflationary pressure persists, this may in turn continue to increase our labor and supply costs at a rate that outpaces the Medicare or any other rate increases we may receive. In our value-based care and other programs where we assume financial accountability for total patient cost, an increase in COVID-19 rates among patients could have an impact on total cost of care. This increase may in turn impact the profitability of those programs relative to their respective funding.60As referenced above, we continue to implement cost savings opportunities to help mitigate these cost and volume pressures. These include, among other things, anticipated cost savings related to certain general and administrative cost efficiencies, such as ongoing initiatives that increase our use of third party service providers to perform certain activities, including, among others, finance and accounting functions as well as related information technology functions; initiatives relating to clinic optimization and initiatives for capacity utilization improvement; and procurement opportunities. We have incurred, and expect to continue to incur, charges in connection with the continued implementation of these initiatives, and there can be no assurance that we will be able to successfully execute these initiatives or that they will achieve expectations or succeed in helping offset the impact of these challenging conditions. Any failure on our part to adjust our business and operations in this manner, to adjust to other marketplace developments or dynamics or to appropriately implement these initiatives in accordance with applicable legal, regulatory or compliance requirements could adversely impact our ability to provide dialysis services or the cost of providing those services, among other things, and ultimately could have a material adverse effect on our business, reputation, results of operations, financial condition and cash flows. Federal, State and Local Government ResponseThe government response to COVID-19 has been wide-ranging and will continue to develop over time. As a result, we may not be able to accurately predict the nature, timing or extent of the impact of such changes on the markets in which we conduct business or on the other participants that operate in those markets, or any potential changes to the extensive set of federal, state and local laws, regulations and requirements that govern our business. For example, federal COVID-19 relief legislation suspended the 2% Medicare sequestration from May 1, 2020 through March 31, 2022. The Medicare sequestration was reinstated in stages until the full 2% level was resumed as of July 1, 2022. While in effect, the suspension of sequestration significantly increased our revenues.We believe the ultimate impact of the COVID-19 pandemic and the aforementioned general economic and marketplace conditions on the Company over time will depend on future developments that are highly uncertain and difficult to predict. With respect to COVID-19, these future developments include, among other things, the ultimate severity and duration of the pandemic; the evolution of new strains or variants of the virus that may present varying levels of infectivity or virulence; COVID-19's impact on the CKD patient population and our patient population, including on the mortality of these patients; the availability, acceptance, impact and efficacy of COVID-19 vaccines, treatments and therapies; the pandemic’s continuing impact on our revenue and non-acquired growth due to lower treatment volumes; the potential negative impact on our commercial mix or the number of patients covered by commercial insurance plans; continued increased COVID-related costs; supply chain challenges and disruptions, including with respect to our clinical supplies; the responses of our competitors to the pandemic and related changes in the marketplace; the timing, scope and effectiveness of federal, state and local government responses; and any potential changes to the extensive set of federal, state and local laws, regulations and requirements that govern our business. In certain cases, the impact of the pandemic on us may persist even after the pandemic subsides. COVID-19 has also intensified certain of the aforementioned general economic and marketplace conditions and developments in the U.S. and global economies, including labor market conditions, inflation and monetary policies, among others. We expect that these conditions will continue to impact our business in 2023.For additional discussion of the COVID-19 pandemic and our response, the various general economic and marketplace conditions that may impact our business, and the risks and uncertainties related to each of these, please see the discussion in Part I Item 1. Business under the headings, "COVID-19 and its impact on our business" and "Human Capital Management," as well as the risk factors in Part I Item 1A. Risk Factors, including, among others, the risks under the headings, "Macroeconomic conditions and global events..." and "If we are unable to compete successfully...".Legal and Regulatory DevelopmentsIn 2022, the U.S. Supreme Court issued a decision in the matter of Marietta Memorial Hospital Employee Health Benefit Plan, et al. v. DaVita Inc., et al., a case evaluating the scope of the Medicare Secondary Payor Act (MSPA), deciding that a group health plan that provides limited benefits for outpatient dialysis, but does so uniformly for all plan participants, does not violate the terms of the MSPA because the plan treats all patients uniformly, regardless of whether a participant has ESRD and regardless of whether the participant is eligible for Medicare. For additional information, see Note 16 to the consolidated financial statements included in this report and the risk factor in Part I Item 1A. Risk Factors under the heading "If the number or percentage of patients with higher-paying commercial insurance declines..." There is significant uncertainty as to the ultimate impact of the decision, but if a significant number of commercial plans, including employer group health plans, implement or utilize plan designs that discourage or prevent ESRD patients from retaining their commercial coverage, it may lead to a decrease in the number of patients with commercial plans, the duration of benefits for patients under commercial plans and/or decrease in the payment rates we receive, any of which could have a material adverse effect on our business, results of operations, financial condition and cash flows.61Consolidated results of operationsThe following table summarizes our revenues, operating income (loss) and adjusted operating income (loss) by line of business. See the discussion of our results for each line of business following this table. When multiple drivers are identified in the following discussion of results, they are listed in order of magnitude: Year ended December 31,Annual change 20222021AmountPercent (dollars in millions)Revenues: U.S. dialysis$10,600 $10,667 $(67)(0.6)%Other - Ancillary services1,101 1,047 54 5.2 %Elimination of intersegment revenues(91)(95)4 4.2 %Total consolidated revenues$11,610 $11,619 $(9)(0.1)%Operating income (loss):U.S. dialysis$1,565 $1,975 $(410)(20.8)%Other - Ancillary services(97)(66)(31)(47.0)%Corporate administrative support(130)(112)(18)(16.1)%Operating income$1,339 $1,797 $(458)(25.5)%Adjusted operating income (loss):(1)U.S. dialysis$1,668 $1,993 $(325)(16.3)%Other - Ancillary services(89)(66)(23)(34.8)%Corporate administrative support(129)(112)(17)(15.2)%Adjusted operating income$1,450 $1,815 $(365)(20.1)%Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers. (1)For a reconciliation of adjusted operating income (loss) by reportable segment, see the "Reconciliations of non-GAAP measures" section below. U.S. dialysis businessAs of December 31, 2022, our U.S. dialysis business is a leading provider of kidney dialysis services, operating 2,724 outpatient dialysis centers serving a total of approximately 199,400 patients, and contracted to provide hospital inpatient dialysis services in approximately 820 hospitals. We estimate that we have approximately a 36% share of the U.S. dialysis market based upon the number of patients we serve. Approximately 91% of our 2022 consolidated revenues were derived directly from our U.S. dialysis business. The principal drivers of our U.S. dialysis revenues include :•our number of treatments, which is primarily a function of the number of chronic patients requiring approximately three in-center treatments per week as well as, to a lesser extent, the number of treatments for home-based dialysis and hospital inpatient dialysis; and•our average dialysis patient service revenue per treatment, including the mix of patients with commercial plans and government programs as primary payor.Within our U.S. dialysis business, our home-based dialysis and hospital inpatient dialysis services are operationally integrated with our outpatient dialysis centers and related laboratory services. Our outpatient, home-based and hospital inpatient dialysis services comprise approximately 76%, 18% and 6% of our U.S. dialysis revenues, respectively.In the U.S., government dialysis-related payment rates are principally determined by federal Medicare and state Medicaid policy. For 2022, approximately 67% of our total U.S. dialysis patient services revenues were generated from government-based programs for services to approximately 90% of our total U.S. patients. These government-based programs are principally Medicare and Medicare Advantage, Medicaid and managed Medicaid plans, and other government plans, representing approximately 57%, 7% and 3% of our U.S. dialysis patient services revenues, respectively. 62On October 31, 2022, CMS issued a final rule to update the ESRD PPS payment rate and policies, as described further above. CMS estimates the final rule will affect ESRD facilities' average reimbursement by a productivity-adjusted market basket increase of 3.0% in 2023.Dialysis payment rates from commercial payors vary and a major portion of our commercial rates are set at contracted amounts with payors and are subject to intense negotiation pressure. On average, dialysis-related payment rates from contracted commercial payors are significantly higher than Medicare, Medicaid and other government program payment rates, and therefore the percentage of commercial patients in relation to total patients represents a significant driver of our total average dialysis patient service revenue per treatment. Commercial payors (including hospital dialysis services) represent approximately 33% of U.S. dialysis patient services revenues.For discussion of government reimbursement, the Medicare ESRD bundled payment system, Medicare Advantage and commercial reimbursement, see the discussion in Part I. Item 1. Business under the heading "U.S. dialysis business – Sources of revenue-concentrations and risks." For a discussion of operational, clinical and financial risks and uncertainties that we face in connection with the Medicare ESRD bundled payment system, see the risk factor in Part I. Item 1A. Risk Factors under the heading "Our business is subject to a complex set of governmental laws, regulations and other requirements and any failure to adhere to those requirements, or any changes in those requirements..." For a discussion of operational, clinical and financial risks and uncertainties that we face in connection with commercial payors, see the risk factor in Item 1A. Risk Factors under the heading "If the number or percentage of patients with higher-paying commercial insurance declines, if the average rates that commercial payors pay us declines..."Approximately 1% of our total U.S. dialysis patient services revenues for each of the years 2022 and 2021 were associated with the administration of separately-billable physician-prescribed pharmaceuticals, the majority of which relate to the administration of calcimimetics. We anticipate that we will continue to experience increases in our operating costs in 2023 that may outpace any net Medicare, commercial or other rate increases that we may receive, which could significantly impact our operating results. In particular, we expect to continue experiencing increases in operating costs that are subject to inflation, such as labor and supply costs, including increases in maintenance costs, regardless of whether there is a compensating inflation-based increase in Medicare, commercial or other payor payment rates. We also continue to expect to incur additional COVID-19-related costs while the pandemic continues. In addition, we expect to continue to incur capital expenditures and associated depreciation and amortization to improve, renovate and maintain our facilities, equipment and information technology to meet evolving regulatory requirements and otherwise.U.S. dialysis patient care costs are those costs directly associated with operating and supporting our dialysis centers, home-based dialysis programs and hospital inpatient dialysis programs, and consist principally of labor, benefits, pharmaceuticals, medical supplies and other operating costs of the dialysis centers. The principal drivers of our U.S. dialysis patient care costs include:•clinical hours per treatment, labor rates and benefit costs;•vendor pricing and utilization levels of pharmaceuticals;•business infrastructure costs, which include the operating costs of our dialysis centers; and •medical supply costs. Other cost categories that can present significant variability include insurance costs and professional fees. In addition, proposed ballot initiatives or referendums, legislation, regulations or policy changes could cause us to incur substantial costs to prepare for, or implement changes required. Any such changes could result in, among other things, increases in our labor costs or limitations on the amount of revenue that we can retain. For additional information on risks associated with potential and proposed ballot initiatives, referendums, legislation, regulations or policy changes, see the risk factor in Item 1A. Risk Factors under the heading, "Changes in federal and state healthcare legislation or regulations..."Our average clinical hours per treatment increased in 2022 compared to 2021. We are always striving for improved productivity levels, however, changes in factors such as federal and state policies or regulatory billing requirements can lead to increased labor costs. In 2022, the demand for skilled clinical personnel continued, exacerbated by the nationwide shortage caused by the continuing COVID-19 pandemic on these resources. In 2022 and 2021, we experienced increases in our clinical labor rates of approximately 7.4% and 3.9%, respectively. We expect to continue to see higher clinical labor rates and continued use of contract labor in 2023 due to the labor market conditions and the continued competition for skilled clinical personnel. In 2022, our overall clinical teammate turnover increased from 2021. We also continue to experience increases in the 63infrastructure and operating costs of our dialysis centers and general increases in rent and repairs and maintenance. In 2022, we continued to implement certain cost control initiatives to help manage our overall operating costs, including labor productivity, and we expect to continue these initiatives in 2023.Our U.S. dialysis general and administrative expenses represented 9.8% and 8.7% of our U.S. dialysis revenues in 2022 and 2021, respectively. Increases in general and administrative expenses over the last several years were primarily related to strengthening our dialysis business and related compliance and operational processes, responding to certain legal and compliance matters, professional fees associated with enhancing our information technology (IT) systems, such as our new clinical system, and more recently advocacy costs in 2022 related to countering union policy efforts and severance costs related to planned administrative efficiencies. We expect that these levels of general and administrative expenses will be impacted by lower advocacy costs in 2023 compared to 2022, continued investment in developing our capabilities and executing on our strategic priorities, as well as additional severance costs as we implement the planned administrative efficiencies, among other things.U.S. dialysis results of operationsTreatment volume: Year ended December 31,Annual change 20222021AmountPercentDialysis treatments28,954,433 29,622,188 (667,755)(2.3)%Average treatments per day92,506 94,640 (2,134)(2.3)%Treatment days313.0 313.0 — — %Normalized non-acquired treatment growth(1)(2.0)%(1.9)%(0.1)%Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers. (1)Normalized non-acquired treatment growth reflects year over year growth in treatment volume, adjusted to exclude acquisitions and other similar transactions, and further adjusted to normalize for the number and mix of treatment days in a given period versus the prior period.Our U.S. dialysis treatment volume is directly correlated with our operating revenues and expenses. The decrease in our U.S. dialysis treatments in 2022 was primarily driven by the impact of increased mortality over recent periods on our patient population, and higher missed treatment rates, slightly offset by acquisition related growth. We believe the increased mortality rate is largely attributable to the impact of COVID-19 on our patient population.Revenues: Year ended December 31,Annual change 20222021AmountPercent (dollars in millions, except per treatment data)Total revenues$10,600 $10,667 $(67)(0.6)%Average patient service revenue per treatment$365.24 $359.24 $6.00 1.7 %Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers.U.S. dialysis average patient service revenue per treatment increased primarily driven by increases in both commercial mix and rates, an increase in the Medicare base rate in 2022, and the continued shift to Medicare Advantage plans, partially offset by the reinstatement of 1% Medicare sequestration beginning April 1, 2022 through June 30, 2022 and 2% Medicare sequestration beginning July 1, 2022 and thereafter.64Operating expenses and charges: Year ended December 31,Annual change 20222021AmountPercent (dollars in millions, except per treatment data)Patient care costs$7,334 $7,153 $181 2.5 %General and administrative(1)1,038 926 111 12.0 %Depreciation and amortization691 643 48 7.5 %Equity investment income(28)(30)2 6.7 %Total operating expenses and charges$9,034 $8,692 $343 3.9 %Patient care costs per treatment$253.31 $241.47 $11.84 4.9 %Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers (1)General and administrative expenses for the year ended December 31, 2022 included advocacy costs of approximately $51 million incurred to counter union policy efforts, including a California statewide ballot initiative (CA Proposition 29).Charges impacting operating incomeClosure costs. During the year ended December 31, 2022, we incurred higher than normal charges for center capacity closures. These closures were the result of a strategic review of our outpatient clinic capacity requirements and utilization, which have been impacted both by declines in our patient census in some markets due to the COVID-19 pandemic, as well as by our initiatives toward, and advances in, increasing the proportion of our home dialysis patients.Our 2022 charges for U.S. dialysis center closures were approximately $86 million, which increased our patient care costs by $21 million, our general and administrative expenses by $19 million and our depreciation and amortization expense by $46 million. By comparison, 2021 charges for U.S. dialysis center closures were approximately $18 million, which increased our patient care costs by $2 million, our general and administrative expenses by $3 million and our depreciation and amortization expense by $12 million. These capacity closures costs included net losses on assets retired, lease costs, asset impairments and accelerated depreciation and amortization.We will continue to optimize our U.S. dialysis center footprint through center mergers and/or closures and expect our center closure rates to remain at elevated levels over the next several quarters.Severance costs. During the fourth quarter of 2022, we committed to a plan to increase efficiencies and cost savings in certain general and administrative support functions. As a result of this plan, we recognized expenses related to termination and other benefit commitments in our U.S. dialysis business of $17 million. Patient care costs. U.S. dialysis patient care costs are those costs directly associated with operating and supporting our dialysis centers and consist principally of compensation expenses including labor and benefits, pharmaceuticals, medical supplies and other operating costs of the dialysis centers. U.S. dialysis patient care costs per treatment increased primarily due to increases in compensation expenses including increased wage rates and contract wages. Other drivers of this increase include increases in other direct operating expenses associated with our dialysis centers, including increases in utilities expense partially due to lower expense in 2021 related to our virtual power purchase arrangements, as well as center closure costs, as described above, insurance expenses and costs related to travel. In addition, our fixed other direct operating expenses negatively impacted patient care costs per treatment due to our decrease in treatments in 2022. These increases were partially offset by decreases in pharmaceutical unit costs, health benefit expenses and medical supply costs. General and administrative expenses. U.S. dialysis general and administrative expenses increased primarily due to increases in advocacy costs to counter union policy efforts, compensation expenses including increased wage rates and severance costs, as described above, travel costs, center closure, as described above, and higher IT-related costs. This increase in U.S. dialysis general and administrative expenses was partially offset by gains recognized on the sale of our self-developed properties, and decreases in professional fees and contributions to our charitable foundation.Depreciation and amortization. Depreciation and amortization expense is directly impacted by the number of dialysis centers and the information technology that we develop and acquire as well as changes in useful lives. U.S. dialysis depreciation and amortization expense increased in 2022 primarily due to accelerated depreciation for expected center closures, as described above, increased depreciation and amortization for hardware associated with our new clinical system and other corporate technology projects and the development of new centers.65Equity investment income. U.S. dialysis equity investment income decreased primarily due to a decline in profitability at certain nonconsolidated dialysis partnerships.Operating income and adjusted operating income Year ended December 31,Annual change 20222021AmountPercent(dollars in millions)Operating income$1,565 $1,975 $(410)(20.8)%Adjusted operating income(1)$1,668 $1,993 $(325)(16.3)%Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers. (1)For a reconciliation of adjusted operating income by reportable segment, see the "Reconciliations of non-GAAP measures" section below. U.S. dialysis operating income was negatively impacted by center closure and severance costs, as described above. Operating income and adjusted operating income decreased compared to 2021 primarily due to decreased dialysis treatments and increases in compensation expenses, advocacy costs, other direct operating expenses associated with our dialysis centers, costs related to travel, depreciation expense related to IT projects and insurance expenses, each described above. Operating income and adjusted operating income were positively impacted by an increase in our average patient service revenue per treatment, as described above, as well as decreases in pharmaceutical unit costs, gains on sale of our self-developed properties and decreases in health benefit expenses and medical supply costs.Other - Ancillary servicesOur other operations include ancillary services that are primarily aligned with our core business of providing dialysis services to our network of patients. As of December 31, 2022, these consisted primarily of our U.S. integrated kidney care (IKC) business, certain U.S. other ancillary businesses (including our clinical research programs, transplant software business, and venture investment group), and our international operations. These ancillary services, including our international operations, generated revenues of approximately $1.101 billion in 2022, representing approximately 9% of our consolidated revenues.As of December 31, 2022, DaVita IKC provided integrated care and disease management services to approximately 42,000 patients in risk-based integrated care arrangements and to an additional 15,000 patients in other integrated care arrangements. We also expect to add additional service offerings to our business and pursue additional strategic initiatives in the future as circumstances warrant, which could include, among other things, healthcare services not related to dialysis.For a discussion of the risks related to IKC and our ancillary services, see the discussion in the risk factors in Item 1A. Risk Factors under the headings, "The U.S. ancillary services and strategic initiatives and international operations that we operate or invest in now or in the future..." and "If we are not able to successfully implement our strategy with respect to our integrated kidney care and value-based care initiatives..." As of December 31, 2022, our international dialysis business owned or operated 350 outpatient dialysis centers located in 11 countries outside of the U.S. For 2022, total revenues generated from our international operations were approximately 6% of our consolidated revenues.66Ancillary services results of operations Year ended December 31,Annual change 20222021AmountPercent(dollars in millions)Revenues:U.S. IKC$378 $349 $29 8.3 %U.S. other ancillary23 22 1 4.5 %International700 676 24 3.6 %Total ancillary services revenues$1,101 $1,047 $54 5.2 %Operating (loss) income:U.S. IKC$(125)$(111)$(14)(12.6)%U.S. other ancillary(9)3 (12)(400.0)%International(1)37 42 (5)(11.9)%Total ancillary services loss$(97)$(66)$(31)(47.0)%Adjusted operating (loss) income(2):U.S. IKC$(124)$(111)$(13)(11.7)%U.S. other ancillary(9)3 (12)(400.0)%International(1)44 42 2 4.8 %Total adjusted operating loss:$(89)$(66)$(23)(34.8)%Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers. (1)The reported operating income and adjusted operating income for the years ended December 31, 2022 and December 31, 2021, includes foreign currency (losses) gains embedded in equity method income recognized from our APAC joint venture of approximately $(0.3) million and $3.3 million, respectively.(2)For a reconciliation of adjusted operating (loss) income by reportable segment, see the "Reconciliations of non-GAAP measures" section below. Revenues:Our IKC revenues were impacted by an increase in shared savings, including savings from new programs, partially offset by a decrease in revenues from our special needs plans. Our other U.S. ancillary services revenues increased due to revenues from our newly acquired transplant software business, partially offset by decreased revenues in our clinical research programs. Our international revenues increased primarily due to acquisition-related growth, partially offset by the impact of increased mortality over recent periods on our patient population.Charges impacting operating income - Severance and other costs.During the fourth quarter of 2022, similar to U.S. dialysis, we committed to a plan to increase efficiencies and cost savings in certain general and administrative support functions and other overhead costs. As a result of this plan, we recognized expenses related to termination and other benefit commitments in our IKC business and these expenses and other charges in our international operations of $0.5 million and $7.5 million, respectively.Operating loss and adjusted operating loss:Our IKC operating loss and adjusted operating loss increased primarily due to continued investments in our integrated care support functions, partially offset by an increase in shared savings and improved performance in our special needs plans. Our other U.S. ancillary services operating loss was impacted by a benefit received from run-off of a legacy business recognized in 2021 and decreased revenues in our clinical research programs in 2022. Our international operating income was impacted by severance and other costs in one of our international businesses, as described above. International operating income and adjusted operating income were impacted by acquisition-related growth, partially offset by the impact of increased mortality over recent periods on our patient population and losses on foreign exchange compared to gains in the prior year.67Corporate administrative supportCorporate administrative support consists primarily of labor, benefits and long-term incentive compensation expense, as well as professional fees, for departments which provide support to all of our various operating lines of business. Corporate administrative support expenses are included in general and administrative expenses on our consolidated income statement. Corporate administrative support expenses increased $18 million primarily driven by increased legal fees and compensation expenses. These increases were partially offset by decreased long-term incentive compensation expense.Corporate-level charges Year ended December 31,Annual change 20222021AmountPercent(dollars in millions)Debt expense$357 $285 $72 25.3 %Other (loss) income, net$(16)$6 $(22)366.7 %Effective income tax rate20.5 %20.2 %0.3 %Effective income tax rate from continuing operations attributable to DaVita Inc.(1)26.5 %23.8 %2.7 %Net income attributable to noncontrolling interests$221 $233 $(12)(5.2)%Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers. (1)For a reconciliation of our effective income tax rate from continuing operations attributable to DaVita Inc., see the "Reconciliations of non-GAAP measures" section below. Debt expenseDebt expense increased primarily due to an increase in our overall weighted average effective interest rate and weighted average credit facility balance outstanding, which included draws on our revolving line of credit during 2022. Our overall weighted average effective interest rate on all debt, including the effect of interest rate caps and amortization of debt discount, was 3.96% in 2022 compared to 3.28% in 2021. See Note 13 to the consolidated financial statements for further information on the components of our debt and changes in them since 2021. Other (loss) income Other (loss) income consists primarily of interest income on cash and cash equivalents and short- and long-term investments, realized and unrealized gains and losses recognized on investments, and foreign currency transaction gains and losses. Other income decreased primarily due to increased losses on investments in 2022, partially offset by an increase in interest income.Provision for income taxes Our effective income tax rate and effective income tax rate from continuing operations attributable to DaVita Inc. increased in 2022 primarily due to increases in nondeductible advocacy expenses, foreign tax provision expense and a reduction in benefits from stock-based compensation. These increases were partially offset by benefits recognized in 2022 for uncertain tax positions outside the statute of limitations and a reduction in tax expense recognized in 2021 for deferred re-measurement. Additionally, our effective income tax rate was impacted by the portion of earnings attributable to our non-controlling interests.Net income attributable to noncontrolling interestsThe decrease in income attributable to noncontrolling interests in 2022 compared to 2021 was due to a decrease in earnings at certain U.S. dialysis partnerships. Accounts receivableOur consolidated accounts receivable balances at December 31, 2022 and December 31, 2021 were $2.132 billion and $1.958 billion, respectively, representing approximately 68 days and 62 days of revenue (DSO), respectively. The increase in consolidated DSO resulted primarily from an increase of five days of DSO in our U.S. dialysis business, primarily due to delays in collections related to certain payors, temporary billing holds and changes in payor mix related to the continued shift to Medicare Advantage plans for which average collection times are longer than that of Medicare. Our DSO calculation is based on the most recent quarter’s average revenues per day. There were no significant changes during 2022 from 2021 in the 68carrying amount of accounts receivable outstanding over one year old or in the amounts pending approval from third-party payors.As of December 31, 2022 and 2021, our patient services accounts receivable balances that are more than six months old represented approximately 18% and 16%, respectively, of our total accounts receivable balances outstanding. Substantially all revenue realized for patient services is received from government and commercial payors, as discussed above. Less than 1% of our revenues in both periods were classified as patient pay.Amounts pending approval from third-party payors associated with Medicare bad debt claims as of December 31, 2022 and 2021, other than the standard monthly billing, consisted of approximately $111 million and $133 million, respectively, and are classified as other receivables. A significant portion of our Medicare bad debt claims are typically paid to us before the Medicare fiscal intermediary audits the claims but are subject to subsequent adjustment based upon the actual results of those audits. Such audits typically occur one to four years after the claims are filed.Liquidity and capital resourcesThe following table summarizes our major sources and uses of cash, cash equivalents and restricted cash:Year ended December 31,Annual change20222021AmountPercent(dollars in millions)Net cash provided by operating activities:Net income$782 $1,212 $(430)(35.5)%Non-cash items in net income783 860 (77)(9.0)%Other working capital changes66 (108)174 161.1 %Other(66)(33)(33)(100.0)%$1,565 $1,931 $(366)(19.0)%Net cash used in investing activities:Capital expenditures:Routine maintenance/IT/other$(431)$(421)$(10)(2.4)%Developments and relocations(172)(220)48 21.8 %Acquisition expenditures(57)(187)130 69.5 %Proceeds from sale of self-developed properties109 56 53 94.6 %Other(78)(12)(66)(550.0)%$(630)$(785)$155 19.7 %Net cash used in financing activities:Debt (payments) issuances, net$(11)$754 $(765)(101.5)%Deferred financing and debt redemption costs— (9)9 100.0 %Distributions to noncontrolling interests(268)(244)(24)(9.8)%Contributions from noncontrolling interests15 32 (17)(53.1)%Stock award exercises and other share issuances(37)(60)23 38.3 %Share repurchases(802)(1,539)737 47.9 %Other(17)(17)— — %$(1,121)$(1,083)$(38)(3.5)%Total number of shares repurchased8,094,661 13,877,193 (5,782,532)(41.7)%Free cash flow(1)$817 $1,133 $(316)(27.9)%Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers. (1)For a reconciliation of our free cash flow, see the "Reconciliations of Non-GAAP measures" section below.69Consolidated cash flowsConsolidated cash flows from operating activities for 2022 and 2021 were $1,565 million and $1,931 million, respectively. The decrease in cash flow from continuing operations was primarily driven by decreased earnings from operations and increases in tax and interest payments, partially offset by timing of working capital items.Cash flows used for investing activities in 2022 decreased $155 million compared to 2021 primarily due to decreases in acquisition expenditures combined with an increase in proceeds from the sale of self-developed properties, which was principally driven by the sale of one of our self-developed properties.Cash flows used in financing activities increased $38 million in 2022 compared to 2021. Significant sources of cash during 2022 included a net draw of $165 million on our revolving line of credit. Significant uses of cash during 2022 consisted primarily of regularly scheduled mandatory principal payments under our senior secured credit facilities totaling approximately $98 million on Term Loan A and $27 million on Term Loan B-1 and additional required principal payments under other debt arrangements. In addition, during the year ended December 31, 2022 we used cash to repurchase 8,094,661 shares of our common stock.By comparison, 2021 included the issuance of $1,000 million in aggregate principal amount of senior notes as an add-on offering to our 4.625% senior notes due 2030 which were issued at an offering price of 101.750% of the principal amount in February 2021. Significant uses of cash during 2021 consisted primarily of the repayment in full of $75 million of borrowings under our revolving line of credit, net payments of regularly scheduled mandatory principal amounts due under our senior secured credit facilities totaling approximately $88 million on Term Loan A and $27 million on Term Loan B-1 and additional required principal payments under other debt arrangements. In addition, we incurred bond issuance costs of approximately $9 million. During the year ended December 31, 2021 we used cash to repurchase 13,877,193 shares of our common stock.Dialysis center capacity and growthWe are typically able to increase our capacity by extending hours at our existing dialysis centers, expanding our existing dialysis centers, relocating our dialysis centers, developing new dialysis centers and by acquiring dialysis centers. The development of a typical new outpatient dialysis center generally requires approximately $2.0 million for leasehold improvements and other capital expenditures. Based on our experience, a new outpatient dialysis center typically opens within a year after the property lease is signed, normally achieves operating profitability in the second year after Medicare certification, and normally reaches maturity within three to five years. Acquiring an existing outpatient dialysis center requires a substantially greater initial investment, but profitability and cash flows are generally accelerated and more predictable. To a limited extent, we enter into agreements to provide management and administrative services to outpatient dialysis centers in which we own a noncontrolling interest or which are wholly-owned by third parties in return for management fees.The table below shows the growth in our dialysis operations by number of dialysis centers owned or operated:U.S.International 2022202120222021Number of centers operated at beginning of year2,815 2,816 339 321 Acquired centers5 19 11 17 Developed centers39 42 6 7 Net change in non-owned managed or administered centers(1)(1)3 5 — Sold and closed centers(2)(22)(11)(9)(5)Closed centers(3)(112)(54)(2)(1)Number of centers operated at end of year2,724 2,815 350 339 (1)Represents dialysis centers which we manage or provide administrative services to but in which we own a noncontrolling equity interest or which are wholly-owned by third parties, including our Asia Pacific joint venture centers.(2)Represents dialysis centers that were sold and/or closed for which the majority of patients were not retained.(3)Represents dialysis centers that were closed for which the majority of patients were retained and transferred to one of our other existing outpatient dialysis centers.70Stock repurchasesThe following table summarizes our common stock repurchases during the years ended December 31, 2022 and 2021:Year ended December 31,20222021(dollars in millions and shares in thousands, except per share data)Shares8,095 13,877 Amounts paid$788 $1,546 Average paid per share$97.33 $111.41 Subsequent to December 31, 2022, we did not repurchase any shares through February 22, 2023. We retired all shares of common stock held in treasury effective December 31, 2022 and 2021.See further discussion of our share repurchase activity and authorizations in Note 19 to the consolidated financial statements.Available liquidityAs of December 31, 2022, our cash balance was $244 million and we held approximately $78 million in short-term investments. At that time we also had $165 million outstanding and $835 million available on our $1.0 billion revolving line of credit under our senior secured credit facilities. Credit available under this revolving line of credit is reduced by the amount of any letters of credit outstanding thereunder, of which there were none as of December 31, 2022. As of December 31, 2022 we separately had approximately $109 million in letters of credit outstanding under a separate bilateral secured letter of credit facility.See Note 13 to the consolidated financial statements for components of our long-term debt and their interest rates.The COVID-19 pandemic and certain economic and marketplace conditions, including inflationary and labor pressures, have driven increased pressure on our cash flows. As of the date of this report, we have not experienced a material deterioration in our liquidity position as a result of COVID-19 or those global economic and market conditions. The ultimate impact of the pandemic and those economic and market conditions will depend on future developments that are highly uncertain and difficult to predict.We believe that our cash flow from operations and other sources of liquidity, including from amounts available under our senior secured credit facilities and our access to the capital markets, will be sufficient to fund our scheduled debt service under the terms of our debt agreements and other obligations for the foreseeable future, including the next 12 months. Our primary recurrent sources of liquidity are cash from operations and cash from borrowings, which are subject to general, economic, financial, competitive, regulatory and other factors that are beyond our control, as described in Item 1A. Risk Factors under the heading "The level of our current and future debt..."Reconciliations of non-GAAP measuresThe following tables provide reconciliations of adjusted operating income (loss) to operating income (loss) as presented on a U.S. generally accepted accounting principles (GAAP) basis for our U.S. dialysis reportable segment as well as for our U.S. IKC business, our U.S. other ancillary services, our international business, and for our total ancillary services which combines them and is disclosed as our other segments category, in addition to our corporate administrative support. These non-GAAP or "adjusted" measures are presented because management believes these measures are useful adjuncts to, but not alternatives for, our GAAP results.Specifically, management uses adjusted operating income (loss) to compare and evaluate our performance period over period and relative to competitors, to analyze the underlying trends in our business, to establish operational budgets and forecasts and for incentive compensation purposes. We believe this non-GAAP measure is also useful to investors and analysts in evaluating our performance over time and relative to competitors, as well as in analyzing the underlying trends in our business. We also believe this presentation enhances a user's understanding of our normal operating income by excluding certain items which we do not believe are indicative of our ordinary results of operations.In addition, our effective income tax rate on income from continuing operations attributable to DaVita Inc. excludes noncontrolling owners' income, which primarily relates to non-tax paying entities. We believe this adjusted effective income tax rate is useful to management, investors and analysts in evaluating our performance and establishing expectations for income taxes incurred on our ordinary results attributable to DaVita Inc.71Finally, our free cash flow from continuing operations represents net cash provided by operating activities from continuing operations less distributions to noncontrolling interests and all capital expenditures (including development capital expenditures, routine maintenance and information technology), plus contributions from noncontrolling interests and proceeds from the sale of self-developed properties. Management uses this measure to assess our ability to fund acquisitions and meet our debt service obligations and we believe this measure is equally useful to investors and analysts as an adjunct to cash flows from operating activities from continuing operations and other measures under GAAP.It is important to bear in mind that these non-GAAP "adjusted" measures are not measures of financial performance under GAAP and should not be considered in isolation from, nor as substitutes for, their most comparable GAAP measures.Year ended December 31, 2022U.S. dialysisAncillary servicesCorporate administrationU.S. IKCU.S. OtherInternationalTotalConsolidated(dollars in millions)Operating income (loss)$1,565 $(125)$(9)$37 $(97)$(130)$1,339 Center closure charges86 3 3 89 Severance and other costs17 — 5 5 1 23 Adjusted operating income (loss)$1,668 $(124)$(9)$44 $(89)$(129)$1,450 Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers.Year ended December 31, 2021U.S. dialysisAncillary servicesCorporate administrationU.S. IKCU.S. OtherInternationalTotalConsolidated(dollars in millions)Operating income (loss)$1,975 $(111)$3 $42 $(66)$(112)$1,797 Center closure charges18 18 Adjusted operating income (loss)$1,993 $(111)$3 $42 $(66)$(112)$1,815 Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers.Year ended December 31,20222021(dollars in millions)Income from continuing operations before income taxes$966 $1,518 Less: Noncontrolling owners’ income primarily attributable to non-tax paying entities(222)(234)Income from continuing operations before income taxes attributable to DaVita Inc.$744 $1,284 Income tax expense for continuing operations$198 $307 Income tax attributable to noncontrolling interests(1)(1)Income tax expense from continuing operations attributable to DaVita Inc.$197 $306 Effective income tax rate on income from continuing operations attributable to DaVita Inc.26.5 %23.8 %Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers.72Year ended December 31,20222021(dollars in millions)Net cash provided by operating activities$1,565 $1,931 Adjustments to reconcile net cash provided by continuing operating activities to free cash flow from continuing operations:Distributions to noncontrolling interests(268)(244)Contributions from noncontrolling interests15 32 Expenditures for routine maintenance and information technology(431)(421)Expenditures for development(172)(220)Proceeds from sale of self-developed properties109 56 Free cash flow$817 $1,133 Certain columns or rows may not sum or recalculate due to the presentation of rounded numbers.Off-balance sheet arrangements and aggregate contractual obligationsIn addition to the debt obligations and operating lease liabilities reflected on our balance sheet, we have commitments associated with letters of credit as well as certain working capital funding obligations associated with our equity investments in nonconsolidated dialysis ventures that we manage and some we manage that are wholly-owned by third parties.We also have potential obligations to purchase the noncontrolling interests held by third parties in many of our majority-owned dialysis partnerships and other nonconsolidated entities. These obligations are in the form of put provisions that are exercisable at the third-party owners’ discretion within specified periods as outlined in each specific put provision. For additional information see Note 17 to the consolidated financial statements.The following is a summary of these cash contractual obligations and commitments as of December 31, 2022: 20232024-20252026-2027ThereafterTotal(dollars in millions)Debt and leases: Long-term debt(1):Principal payments$205 $1,599 $2,602 $4,289 $8,695 Interest payments on credit facilities and senior notes354 701 465 515 2,035 Financing leases(2)26 57 60 131 274 Operating leases, including imputed interest(2)493 953 734 1,175 3,355 $1,078 $3,310 $3,861 $6,110 $14,359 Partnership interests subject to put provisions:(3) On-balance sheet:Noncontrolling interests subject to put provisions1,129 123 55 42 1,349 Off-balance sheet:Non-owned and minority owned put provisions88 3 — — 91 $1,217 $126 $55 $42 $1,440 (1)See Note 13 to the consolidated financial statements for components of our long-term debt and related interest rates. (2)See Note 14 to the consolidated financial statements for components of our leases and related interest rates. (3)Represents amounts for which we are contractually committed, should the outside partner exercise its put option.As of December 31, 2022 we had outstanding letters of credit in the aggregate amount of approximately $109 million under a separate bilateral secured letter of credit facility.As of December 31, 2022 we have outstanding purchase agreements with various suppliers to purchase set amounts of dialysis equipment, parts, pharmaceuticals, and supplies. If we fail to meet the minimum purchase commitments under these contracts during any year, we are required to pay the difference to the supplier. For additional information see Note 17 to the consolidated financial statements.73We also have certain potential commitments to provide working capital funding, if necessary, to certain nonconsolidated dialysis businesses that we manage and in which we own a noncontrolling equity interest or which are wholly-owned by third parties. For additional information see Note 17 to the consolidated financial statements.Additionally, we expect our 2023 capital expenditures to be in alignment with 2022 capital expenditures.In addition, we have approximately $54 million of existing long-term income tax liabilities for unrecognized tax benefits, including interest and penalties, which are excluded from the table above as reasonably reliable estimates of their timing cannot be made.Finally, on May 25, 2022, we entered into an agreement with Medtronic, Inc. and one of its subsidiaries (collectively, Medtronic) to form a new, independent kidney care-focused medical device company (NewCo). The transaction is expected to close in 2023, subject to customary closing conditions and regulatory approvals. At close, we will make a cash payment to Medtronic of approximately $75 million, subject to certain customary adjustments prior to the closing, and will contribute certain other non-cash assets to NewCo valued at approximately $25 million. Additionally, at close, each of DaVita and Medtronic will contribute approximately $200 million in cash to launch NewCo. We also agreed to pay Medtronic additional consideration of up to $300 million if certain regulatory and commercial milestones are achieved between 2024 and 2028.ContingenciesThe information in Note 16 to the consolidated financial statements included in this report is incorporated by reference in response to this item.Critical accounting policies, estimates and judgmentsOur consolidated financial statements and accompanying notes are prepared in accordance with United States generally accepted accounting principles. These accounting principles require us to make estimates, judgments and assumptions that affect the reported amounts of revenues, expenses, assets, liabilities, contingencies and noncontrolling interests subject to put provisions (redeemable equity interests). All significant estimates, judgments and assumptions are developed based on the best information available to us at the time made and are regularly reviewed and updated when necessary. Actual results will generally differ from these estimates, and such differences may be material. Changes in estimates are reflected in our financial statements in the period of change based upon on-going actual experience trends or subsequent settlements and realizations depending on the nature and predictability of the estimates and contingencies. Certain accounting estimates, including those concerning revenue recognition and accounts receivable, fair value estimates for goodwill and noncontrolling interests, accounting for income taxes, and loss contingencies are considered to be critical to evaluating and understanding our financial results because they involve inherently uncertain matters and their application requires the most difficult and complex judgments and estimates. For additional information, see Part II Item 15, "Exhibits, Financial Statement Schedules" – Note 1 – "Organization and summary of significant accounting policies" as referred from Part II Item 8, "Financial Statements and Supplementary Data."U.S. dialysis revenue recognition and accounts receivable. There are significant estimating risks associated with the amount of U.S. dialysis revenue that we recognize in a given reporting period. Payment rates are often subject to significant uncertainties related to wide variations in the coverage terms of the commercial healthcare plans under which we receive payments. In addition, ongoing insurance coverage changes, geographic coverage differences, differing interpretations of contract coverage, and other payor issues complicate the billing and collection process. The measurement and recognition of revenue requires the use of estimates of the amounts that will ultimately be realized considering, among other items, retroactive adjustments that may be associated with regulatory reviews, audits, billing reviews and other matters.Revenues associated with Medicare and Medicaid programs are recognized based on (a) the payment rates that are established by statute or regulation for the portion of the payment rates paid by the government payor (e.g., 80% for Medicare patients) and (b) for the portion not paid by the primary government payor, the estimated amounts that will ultimately be collectible from other government programs providing secondary coverage (e.g., Medicaid secondary coverage), the patient’s commercial health plan secondary coverage, or the patient. Our dialysis-related reimbursements from Medicare are subject to certain variations under Medicare’s single bundled payment rate system whereby our reimbursements can be adjusted for certain patient characteristics and other variable factors. Our revenue recognition depends upon our ability to effectively capture, document and bill for Medicare’s base payment rate and these other factors. In addition, as a result of the potential range of variations that can occur in our dialysis-related reimbursements from Medicare under the single bundled payment rate system, our revenue recognition is subject to a greater degree of estimating risk.74Commercial healthcare plans, including contracted managed-care payors, are billed at our usual and customary rates; however, revenue is recognized based on estimated net realizable revenue for the services provided. Net realizable revenue is estimated based on contractual terms for the patients covered under commercial healthcare plans with which we have formal agreements, non-contracted commercial healthcare plan coverage terms if known, estimated secondary collections, historical collection experience, historical trends of refunds and payor payment adjustments (retractions), inefficiencies in our billing and collection processes that can result in denied claims for payments, the estimated timing of collections, changes in our expectations of the amounts that we expect to collect and regulatory compliance matters. Determining applicable primary and secondary coverage for our approximately 199,400 U.S. dialysis patients at any given point in time, together with the changes in patient coverages that occur each month, requires complex, resource-intensive processes. Collections, refunds and payor retractions typically continue to occur for up to three years or longer after services are provided.We generally expect the range of our U.S. dialysis revenue estimating risk to be within 1% of revenue, which can represent as much as approximately 5% of our U.S. dialysis business’s adjusted operating income. Changes in estimates are reflected in the then-current financial statements based on on-going actual experience trends, or subsequent settlements and realizations depending on the nature and predictability of the estimates and contingencies. Changes in revenue estimates for prior periods are separately disclosed and reported if material to the current reporting period and longer term trend analyses, and have not been significant.Revenues for laboratory services, which are integrally related to our dialysis services, are recognized in the period services are provided at the estimated net realizable amounts to be received.Certain fair value estimates. Fair value measurements and estimates affect, or potentially affect, a variety of elements in the Company's financial statements. Two of the elements most significantly impacted by fair value estimates are the Company's goodwill impairment assessments and remeasurements of its noncontrolling interests subject to put provisions balance.Goodwill is not amortized, but is assessed for impairment when changes in circumstances warrant and at least annually. An impairment charge is recorded when and to the extent a reporting unit's carrying amount is determined to exceed its estimated fair value. Changes in circumstance that may trigger a goodwill impairment assessment for one of our business units can include, among others, changes in the legal environment, addressable market, business strategy, development or business plans, reimbursement structure or rates, operating performance, future prospects, relationships with partners, interest rates and/or market value indications for the subject business. We use a variety of factors to assess changes in the financial condition, future prospects and other circumstances for businesses subject to goodwill impairment assessment. However, these assessments and the related valuations can involve significant uncertainties and require significant judgment on various matters. See Note 10 to the consolidated financial statements for a sensitivity summary on the Company's reporting units considered at risk of goodwill impairment as of December 31, 2022.The Company is also required to remeasure its noncontrolling interests subject to put provisions to estimated fair value each reporting period. These estimates also require substantive judgment on meaningful uncertainties concerning this significant balance. See Notes 17 and 24 to the consolidated financial statements for a summary of the Company's approach to these valuations, the variables and uncertainties involved, and the sensitivity of these valuations to changes in a primary aggregate valuation metric.Accounting for income taxes. Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. We are subject to income taxes in the United States and numerous state and foreign jurisdictions, and changes in tax laws or regulations may be proposed or enacted that could adversely affect our overall tax liability. The actual impact of any such laws or regulations could be materially different from our current estimates.Significant judgments and estimates are required in determining our consolidated income tax expense. Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to recover our deferred tax assets within the jurisdictions from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, results of recent operations, and assumptions about the amount of future federal, state, and foreign pre-tax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require significant judgments and are consistent with the plans and estimates we use to manage the underlying businesses. To the extent that recovery is not likely, a valuation allowance is established. The allowance is regularly reviewed and updated for changes in circumstances that would cause a change in judgment about the realizability of the related deferred tax assets.Loss contingencies. As discussed in Notes 1 and 16 to the consolidated financial statements, we operate in a highly regulated industry and are party to various lawsuits, claims, qui tam suits, governmental investigations and audits (including, 75without limitation, investigations or other actions resulting from our obligation to self-report suspected violations of law), contract disputes and other legal proceedings. Assessments of such matters can involve a series of complex judgments about future events and can rely heavily on estimates and assumptions. We record accruals for loss contingencies on such matters to the extent that we determine an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. See Note 16 to the consolidated financial statements included in this report for further discussion.Significant new accounting standardsSee Note 1 to the consolidated financial statements included in this report for information regarding certain recent financial accounting standards that have been issued by the Financial Accounting Standards Board (FASB).Item 7A. Quantitative and Qualitative Disclosures about Market Risk.Interest rate sensitivityThe tables below provide information about our financial instruments that are sensitive to changes in interest rates. The first table below presents scheduled principal repayments and current weighted average interest rates on our debt obligations as of December 31, 2022. The variable rates presented reflect the weighted average LIBOR rates in effect for all debt tranches plus the interest rate margins in effect as of December 31, 2022. At December 31, 2022, the Term Loan A interest rate margin in effect was 1.75% and the Term Loan B-1 interest rate margin in effect was also 1.75%. The interest rates in effect on our Term Loan A and revolving line of credit are subject to adjustment depending upon changes in our leverage ratio. Expected maturity dateAverageinterestrateFair value(1) 20232024202520262027ThereafterTotal (dollars in millions)Long term debt: Fixed rate$41 $32 $33 $43 $31 $4,418 $4,598 4.43 %$3,414 Variable rate$190 $1,556 $35 $2,584 $4 $2 $4,371 4.61 %$4,268 (1)Represents the fair value of our long-term debt excluding financing leases.The scheduled principal payments for all debt that bears a variable rate by its terms, including all of Term Loan B-1 and Term Loan A, have been included on the variable rate line of the schedule of expected maturities above. Additionally, the principal amounts of Term Loan B-1 and Term Loan A have been included in the calculation of the average variable interest rate presented.However, principal amounts of $2,661 million for Term Loan B-1 and $839 million of Term Loan A (the capped debt) are hedged by our 2019 interest rate cap agreements through June 30, 2024. As of December 31, 2022, applicable LIBOR rates were above the 2.00% threshold of our cap agreements making the interest rates on this capped debt “economically fixed", unless or until applicable LIBOR rates were to fall back below 2.00% during the remaining term of the caps. As a result, as of December 31, 2022, total fixed and economically fixed debt was $8,098 million, with an average interest rate of 4.28%, while total variable rate debt not subject to caps was $871 million with an average rate of 6.71%. Notional amountContract maturity dateReceive variableFair value 20232024202520262027 (dollars in millions)2019 interest rate cap agreements$3,500 $— $3,500 $— $— $— LIBOR above 2.0%$139.8 For a further discussion of our debt and interest rate cap agreements, see Note 13 to our consolidated financial statements at Part II Item 15, "Exhibits, Financial Statement Schedules" – Note 13 as referred from Part II Item 8, "Financial Statements and Supplementary Data."We believe that our cash flow from operations and other sources of liquidity, including from amounts available under our current credit facilities and our access to the capital markets, will be sufficient to fund our scheduled debt service under the terms of our debt agreements and other obligations for the foreseeable future, including the next 12 months. Our primary recurrent sources of liquidity are cash from operations and cash from borrowings.One means of assessing exposure to debt-related interest rate changes is a duration-based analysis that measures the potential loss in net income resulting from a hypothetical increase in interest rates of 100 basis points across all variable rate maturities (referred to as a parallel shift in the yield curve). Under this model, with all else held constant, it is estimated that 76such an increase would have reduced net income by approximately $21.4 million, $33.8 million, and $34.8 million, net of tax and the effect of our interest rate caps, for the years ended December 31, 2022, 2021, and 2020, respectively.Exchange rate sensitivityWhile our business is predominantly conducted in the U.S., we have developing operations in 11 other countries as well. For financial reporting purposes, the U.S. dollar is our reporting currency. However, the functional currencies of our operating businesses in other countries are typically those of the countries in which they operate. Therefore, changes in the rate of exchange between the U.S. dollar and the local currencies in which our international operations are conducted affect our results of operations and financial position as reported in our consolidated financial statements.We have consolidated the balance sheets of our non-U.S. dollar denominated operations into U.S. dollars at the exchange rates prevailing at the balance sheet dates and have translated their revenues and expense at average exchange rates during each period. Additionally, our individual subsidiaries are exposed to transactional risks mainly resulting from intercompany transactions between and among subsidiaries with different functional currencies. This exposes the subsidiaries to fluctuations in the rate of exchange between the invoicing or obligation currencies and the currency in which their local operations are conducted.We evaluate our exposure to foreign exchange risk through the judgment of our international and corporate management teams. Through 2022, our international operations have remained fairly small relative to the size of our consolidated financial statements, constituting approximately 10% of our consolidated assets and approximately 6% of our consolidated revenues for the year ended December 31, 2022, with no single country constituting more than 4% of consolidated assets. In addition, our unrealized foreign currency translation losses were approximately 2.2%, 4.7%, and 0.4% of our consolidated operating income for the years ended December 31, 2022, 2021 and 2020, respectively.Given the relatively small size of our international operations, management does not consider our exposure to foreign exchange risk to be significant to the consolidated enterprise. As such, through December 31, 2022, we have not engaged in transactions to hedge the exposure of our international transactions or net investments to foreign currency risk.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Form 10-K.We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements. Moreover, new risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on our forward-looking statements. We do not undertake to publicly update or revise any forward-looking statements after the date of this Form 10-K, whether as a result of new information, future events, or otherwise.Investors should also be aware that while we do, from time to time, communicate with securities analysts and others, it is against our policy to disclose to them any material, nonpublic information or other confidential commercial information. Accordingly, shareholders should not assume that we agree with any statement or report issued by any securities analyst regardless of the content of the statement or report. Furthermore, we have a policy against confirming projections, forecasts or opinions issued by others. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.Introductory NoteUnless otherwise stated, references to “we,” “our” and “us” generally refer to Dollar Tree, Inc. and its direct and indirect subsidiaries on a consolidated basis. Unless specifically indicated otherwise, any references to “2023” or “fiscal 2023,” “2022” or “fiscal 2022,” “2021” or “fiscal 2021,” and “2020” or “fiscal 2020,” relate to as of or for the years ended February 3, 2024, January 28, 2023, January 29, 2022 and January 30, 2021, respectively.5Table of ContentsPART IItem 1. BusinessOverviewWe are a leading operator of discount variety stores with a solid history of growth and performance. Our stores operate under the brand names of Dollar Tree, Family Dollar and Dollar Tree Canada. At January 28, 2023, we operated 16,340 discount variety retail stores across 48 states and five Canadian provinces and over the long-term, we believe that the market can support more than 10,000 Dollar Tree stores and 15,000 Family Dollar stores across the United States, and approximately 1,000 Dollar Tree stores in Canada. We believe the convenience and value we offer are key factors in serving and growing our base of loyal customers.We operate in two reporting business segments: Dollar Tree and Family Dollar. For discussion of the operating results of our reporting business segments, refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Segment Information” and Note 11 to our consolidated financial statements.We execute a dual-banner strategy that aims to offer the best of our brands in various store formats to serve customers in all types of geographic markets. Dollar Tree is the leading operator of discount variety stores offering merchandise predominantly at the fixed price point of $1.25. Dollar Tree stores serve customers with a broad range of income levels in suburban locations, striving continuously to “Wow” the customer with a compelling, fun and fresh merchandise assortment comprised of a variety of the things the customer wants and needs, all at incredible values in bright, clean and friendly stores. Family Dollar operates general merchandise retail discount stores providing customers with a selection of competitively-priced merchandise in convenient neighborhood stores. Family Dollar primarily serves a lower than average income customer in urban and rural locations, offering great values on everyday items.We are committed to growing our combined business through new store openings and through our store relocation, expansion and remodel program. We plan to open new stores in underserved markets and to strategically increase our presence in our existing markets. We are executing our strategic initiatives including Dollar Tree Plus and the Family Dollar H2 and Combination Store (or Combo Store) format initiatives. We are focused on refining our assortment in every store by leveraging the complementary merchandise expertise of each segment, including Dollar Tree’s sourcing and product development expertise and Family Dollar’s consumer package goods and national brands sourcing expertise. These initiatives are discussed further in the overview of each segment below.Corporate Culture We believe that honesty and integrity, and treating people fairly and with respect are core values within our corporate culture. We believe that running a business, and certainly a public company, carries with it a responsibility to be above reproach when making operational and financial decisions. Our executive management team visits and shops at our stores like every customer, and ideas and individual creativity on the part of our associates are encouraged, particularly from our store managers who best know their stores and their customers. We have standards for store displays, merchandise presentation, and store operations. We maintain an open-door policy for all associates. Our distribution centers are operated based on objective measures of performance and our store support center associates are available to assist associates in our stores and distribution centers. For more information, see Human Capital Resources below.Dollar TreeThe Dollar Tree segment includes 8,134 stores operating under the Dollar Tree and Dollar Tree Canada brands, 15 distribution centers in the United States and two in Canada. Our stores predominantly range from 8,000 - 10,000 selling square feet. During the third quarter of 2021, we announced our new $1.25 price point initiative and we completed the rollout of this initiative to all Dollar Tree stores in the United States during the first quarter of fiscal 2022, increasing the price point on a majority of our $1.00 merchandise to $1.25. During fiscal 2022, we began investing in new products and modifying existing products to provide greater value for our customers and increase customer traffic and store productivity. We continue to expand our Dollar Tree Plus initiative which provides our customers with extraordinary value in discretionary and consumable categories priced at the $3, $4 and $5 price points. During 2021, we entered into a partnership with Instacart and as of January 28, 2023, our customers can shop online and receive same-day delivery from more than 7,800 Dollar Tree stores without having to visit a store. We are the owners of several trademarks including “Dollar Tree” and the “Dollar Tree” logo.In our Dollar Tree Canada stores, we sell items principally for $1.50(CAD) or less. Our revenue and assets in Canada are not material. We strive to exceed our customers’ expectations of the variety and quality of products they can purchase by offering items we believe typically sell for higher prices elsewhere. Merchandise imported directly typically accounts for approximately 41%-43% of our total retail value purchases, with the remaining merchandise purchased domestically. Our domestic purchases include basic, home, 6Table of Contentscloseouts and promotional merchandise. We believe our mix of imported and domestic merchandise affords our buyers flexibility that enables them to consistently exceed our customers’ expectations. In addition, direct relationships with manufacturers permit us to select from a broad range of products and customize packaging, product sizes and package quantities that best meet our customers’ needs.We carry approximately 8,000 items in our Dollar Tree stores and as of the end of fiscal 2022 approximately 25% of our items were automatically replenished. The remaining items are pushed to the stores and a portion can be reordered by our store managers on a weekly basis. Through automatic replenishment and our store managers’ ability to order product, each store manager is able to satisfy the demands of their particular customer base.We maintain a balanced selection of products within traditional variety store categories. We offer a wide selection of everyday basic products and we supplement these basic, everyday items with seasonal, closeout and promotional merchandise. We attempt to keep certain basic consumable merchandise in our stores continuously to establish our stores as a destination and increase traffic in our stores. Closeout and promotional merchandise is purchased opportunistically and represents less than 10% of our purchases.The merchandise mix in our Dollar Tree stores consists of:•consumable merchandise, which includes everyday consumables such as household paper and chemicals, food, candy, health and personal care products, and in most stores, frozen and refrigerated food;•variety merchandise, which includes toys, durable housewares, gifts, stationery, party goods, greeting cards, softlines, arts and crafts supplies and other items; and•seasonal goods, which include, among others, Christmas, Easter, Halloween and Valentine’s Day merchandise.For information regarding the amounts and percentages of our net sales contributed by the above merchandise categories for the last three fiscal years, please refer to Note 11 to our consolidated financial statements.Family DollarIn our 8,206 Family Dollar stores, we sell merchandise at prices that generally range from $1.00 to $10.00. Our stores predominantly range from 6,000 - 8,000 selling square feet. The Family Dollar segment consists of our store operations under the Family Dollar brand and ten distribution centers. We have two primary initiatives for our Family Dollar stores, the H2 format and our Combo Store format, both of which incorporate elements of our Dollar Tree stores into Family Dollar stores. The H2 model stores include Dollar Tree $1.25 merchandise items and establish a minimum number of freezer and cooler doors throughout the store. As of January 28, 2023, we operated approximately 4,360 H2 stores. The Combo Store format, which was designed specifically for small towns and rural communities with populations of 3,000 to 4,000 residents, blends Family Dollar’s great value and assortment with select Dollar Tree merchandise categories under one roof. As of January 28, 2023, we operated approximately 810 Combo Stores. Our new and renovated H2 and Combo Stores have higher sales and operating income margins compared with legacy Family Dollar stores. During 2021, we entered into a partnership with Instacart and as of January 28, 2023, our customers can shop online and receive same-day delivery from more than 7,500 Family Dollar stores without having to visit a store. We are the owners of the trademarks “Family Dollar,” “Family Dollar Stores” and other names and designs of certain merchandise sold in Family Dollar stores.Our Family Dollar stores provide customers with a quality, high-value assortment of basic necessities and seasonal merchandise. We offer competitively-priced national brands from leading manufacturers alongside name brand equivalent-value, lower-priced private labels. We purchase merchandise from a wide base of suppliers and generally have not experienced difficulty in obtaining adequate quantities of merchandise. In fiscal 2022, we purchased approximately 15% of our merchandise through our relationship with McLane Company, Inc., which distributes consumable merchandise from multiple manufacturers. In addition, merchandise imported directly typically accounts for approximately 15%-17% of our total retail value purchases.While the number of items in a given store can vary based on the store’s size, geographic location, merchandising initiatives and other factors, our typical Family Dollar store generally carries approximately 7,600 basic items alongside items that are ever-changing and seasonally-relevant throughout the year.The merchandise mix in our Family Dollar stores consists of:•consumable merchandise, which includes food and beverages, tobacco, health and personal care products, household chemicals, paper products, hardware and automotive supplies, diapers, batteries, and pet food and supplies;•home products, which include housewares, home décor, giftware, and domestics, including comforters, sheets and towels;•apparel and accessories merchandise, which includes clothing, fashion accessories and shoes; and7Table of Contents•seasonal and electronics merchandise, which includes Christmas, Easter, Halloween and Valentine’s Day merchandise, personal electronics, including pre-paid cellular phones and services, stationery and school supplies, and toys.For information regarding the amounts and percentages of our net sales contributed by the above merchandise categories for the last three fiscal years, please refer to Note 11 to our consolidated financial statements.PurchasingWe believe our substantial buying power and our flexibility in making sourcing decisions contributes to our successful purchasing strategy, which includes targeted merchandise margin goals by category. We leverage our merchandising team to source products that can be sold in both Dollar Tree and Family Dollar stores. We also believe our ability to negotiate with our vendor partners enables us to manage the margin impact of economic pressures. We buy products on an order-by-order basis and have no material long-term purchase contracts or other assurances of continued product supply or guaranteed product cost. Historically, no vendor has accounted for more than 10% of total merchandise purchased by us.Our merchandise systems provide us with valuable sales information to assist our buyers and improve product allocation to our stores. We use this information to target our inventory levels in our distribution centers and stores in order to plan for capacity and labor needs.DistributionA strong and efficient distribution network is critical to our ability to grow and to maintain a low-cost operating structure. We currently operate 25 distribution centers in the United States, 15 of which are primarily dedicated to serving our Dollar Tree stores and ten distribution centers primarily serve our Family Dollar stores. We expect future distribution centers to be built with the capability to service both Dollar Tree and Family Dollar stores. New distribution sites are strategically located to reduce the distance between the distribution centers and stores, maintain flexibility and improve efficiency in our store service areas. We expect to complete a significant expansion of our Ocala, Florida distribution center in 2024 which will include enhanced automation.Our Dollar Tree stores receive approximately 92% of their inventory from our distribution centers via contract carriers and our Family Dollar stores receive approximately 70% of their inventory from our distribution centers. The remaining store inventory, primarily perishable consumable items and other vendor-maintained display items, are delivered directly to our stores from vendors or third party distributors. Our Family Dollar stores receive approximately 15% of their merchandise from McLane Company, Inc. For more information on our distribution center network, see “Item 2. Properties.”SeasonalityFor information on the impact of seasonality, see “Item 1A. Risk Factors” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”CompetitionOur segment of the retail industry is fragmented and highly competitive and we expect competition to increase in the future. We operate in the discount retail sector, which is currently and is expected to continue to be highly competitive with respect to price, store location, merchandise quality, assortment and presentation, and customer service, including merchandise delivery and checkout options. Our competitors include single-price dollar stores, multi-price dollar stores, mass merchandisers, online retailers, discount retailers, drug stores, convenience stores, independently-operated discount stores, grocery stores and a wide variety of other retailers. In addition, several competitors have sections within their stores devoted to “one dollar” price point merchandise, which further increases competition. We believe we differentiate ourselves from other retailers by providing high-value, high-quality, low-cost merchandise in attractively-designed stores that are conveniently located. Our sales and profits could be reduced by increases in competition. There are no significant economic barriers for others to enter our retail sector.Government RegulationWe are subject to a wide variety of local, state and federal laws and regulations within the United States and Canada. Compliance with these laws and regulations often requires the dedication of our associates’ time and attention, as well as financial resources. Historically, compliance with these laws and regulations did not have a material effect on our capital expenditures, earnings or competitive position; however, in fiscal 2022, we closed our West Memphis, Arkansas distribution center (“DC 202”) following observations of rodent infestation at the facility as well as other items that required remediation. During the first quarter of fiscal 2022, approximately 400 stores serviced by DC 202 were temporarily closed in connection with a retail-level product recall. We incurred costs related to the product recall, remediation efforts and asset impairment during fiscal 2022. Remediation-related costs included merchandise disposal costs, payroll and legal costs as well as incremental freight costs resulting from stores being serviced by distribution centers which are farther away.8Table of ContentsHuman Capital ResourcesOur business success is built upon our dedicated, passionate and diverse associates who work and live in the communities we serve. Our goal is to provide a working environment that is welcoming and inclusive, offers competitive pay and benefits, supports the growth and development of our associates, and affirms our corporate values and mission. We recruit and hire in the communities we serve using local job fairs, social media as well as local community service partners to provide part-time and full-time jobs that can become lasting careers. Our Human Resources team, with oversight from our Board of Directors and its committees, develops and executes programs for compensation and benefits, onboarding and training, professional development, performance management, retention and succession planning. We greatly value our people and invest in their personal well-being and professional growth through various human capital programs and initiatives, including the following:•Compensation, benefits and well-being. We are committed to providing market-competitive pay for all positions and we are a pay-for-performance organization, offering performance-based compensation opportunities at nearly all levels of the organization, including certain hourly-paid positions. We strive to ensure gender and racial pay equity for employees performing equal or substantially similar work. Eligible associates can participate in our Retirement Savings Plan, which provides a dollar for dollar match on the first 5% of employee contributions and all associates can participate in our Employee Stock Purchase Plan. All full-time and part-time associates are eligible for competitive health and welfare benefits, including medical, dental and vision. Associates may be eligible for other benefits including disability and life insurance as well as primary caregiver and parental leave. We have a program that provides financial support to associates recovering from natural disasters and personal hardships as well as a scholarship program for associates with children pursuing higher education. We also offer a voluntary benefit called “pay any day,” which allows associates to advance their payday earnings for flexibility in meeting their bills and expenses.•Talent development and retention. We believe in the growth and development of our associates and are committed to building a culture of learning in which associates are given the opportunity to enhance their skills at every stage of their career. To support this objective, we provide a multitude of professional and leadership development experiences, including online and instructor-led trainings, tuition reimbursement for graduate, undergraduate, GED and English as a Second Language classes, and discounted tuition at over 200 colleges and universities for our associates and their families. Retention of our associates is a focus for all leaders and we continue to strive to improve our turnover rate. To identify high-potential talent, leadership assesses talent at the store manager level and above on a regular basis through structured talent reviews and succession planning paired with customized development plans. This focus on talent resulted in more than 52,600 promotions in fiscal 2022.•Diversity, equity and inclusion. We believe our associates should mirror our diverse customer base and the communities we serve. Our goal is to create and support a culture of inclusion within a diverse workforce where the unique skills and perspectives of our associates and customers are understood, respected and appreciated. To further this goal, we established a Diversity, Equity and Inclusion (DEI) Executive Council comprised of senior leaders from every department. The DEI Executive Council provides strategic and tactical leadership support to our Chief Diversity Officer (CDO) on all matters related to DEI. The CDO is charged with creating and implementing DEI-focused strategies consistent with our business goals, catalyzing cultural change throughout the organization and driving accountability at the senior management level for progress on key DEI objectives. In addition, we provide associate training on DEI topics and have formed a number of associate resource groups. Our objective is to build a platform to encourage professional development, support community outreach, cultivate mentoring, attract diverse talent and promote cross-functional teamwork for all employees. Each associate resource group will be supported by an executive sponsor who is a member of the DEI Executive Council or senior leadership team.•Workplace safety. We strive to maintain a safe working environment for our associates with a safety program designed to promote accident prevention. Among other things, our environmental health and safety department establishes standard safety protocols and operating procedures across the company, and our field managers are responsible for overseeing associate safety training and conducting store safety audits. In response to the COVID-19 pandemic, we implemented several changes to protect our associates and our customers and to ensure adherence to Centers for Disease Control and Prevention recommendations. •Communication and Engagement. We believe that our associates are the most critical part of our business, and supporting an engaging culture where people can do their best work is a top priority for our leaders. Over the last year we have added new channels to foster two-way dialogue and ensure we are listening to our associates and taking action on their feedback. A recent culture assessment helped identify areas of focus and prepare the organization for a robust employee engagement survey process to close the gap between our current culture and the culture we aspire to have. 9Table of ContentsAs of January 28, 2023, we employed more than 207,500 associates, as follows: Store and Distribution Center AssociatesDollar TreeFamily DollarStore Support Center AssociatesTotalFull-time Associates29,669 32,602 2,754 65,025 Part-time Associates95,473 47,043 7 142,523 Total125,142 79,645 2,761 207,548 Part-time associates work an average of less than 30 hours per week and the number of part-time associates fluctuates depending on seasonal needs. We consider our relationship with our associates to be good, and have not experienced significant interruptions of operations due to labor disagreements.Available InformationOur annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our website at www.dollartree.com as soon as reasonably practicable after electronic filing of such reports with the Securities and Exchange Commission (“SEC”).Item 1A. Risk FactorsAn investment in our common stock involves a high degree of risk. Any failure to meet market expectations, including our comparable store sales growth rate, earnings and earnings per share or new store openings, could cause the market price of our stock to decline. You should carefully consider the specific risk factors listed below together with all other information included or incorporated in this report and other filings that we make from time to time with the SEC, including our consolidated financial statements and accompanying notes. However, the risks and uncertainties that we face are not limited to those described below and those set forth in our SEC filings. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also arise. In such event, our business, financial condition, results of operations or prospects could be materially adversely affected.Profitability and Operational RisksOur profitability is vulnerable to increases in merchandise, shipping, freight and fuel costs, wage and benefit costs and other operating costs.Future increases in costs such as the cost of merchandise (including the substitution of higher cost domestic goods), wage and benefit costs, ocean shipping rates, domestic freight costs, fuel and energy costs, duties and tariffs, merchandise loss (due to theft, damage, or errors) and store occupancy costs would reduce our profitability. We experienced material increases in wage rates and labor costs as well as in shipping rates, freight and fuel costs in 2022, and we expect further increases in certain cost categories in 2023. We have incurred additional costs as a result of recent minimum wage increases by certain states and localities and we expect additional minimum wage increases by states and localities in 2023. In addition, the federal minimum wage may increase depending on the outcome of legislation proposed in Congress, and the current administration may consider raising the minimum salary for store managers who have exempt status under the Fair Labor Standards Act. Separately, government or industry actions addressing the impact of climate change, or shifts in customer preferences for more sustainable, energy-efficient products, may result in increases in our merchandise or operating costs. In our Dollar Tree segment, we raised our primary price point on merchandise to $1.25 in fiscal 2021. In addition, we continue to implement our Dollar Tree Plus initiative which provides our customers with discretionary categories priced at the $3 and $5 price points and beginning in fiscal 2022, we added $3, $4 and $5 frozen and refrigerated product in 3,500 stores. Although we have increased our price points at our Dollar Tree stores, our ability to adjust our product assortment, to operate more efficiently or to increase our comparable store net sales in order to offset cost increases is critical to maintaining our profitability levels. Supply chain constraints and higher commodity costs could make it more difficult for us to obtain sufficient quantities of certain products and could negatively affect our product assortment and merchandise costs. We can give no assurance that we will be able to adjust our product assortment, operate more efficiently or increase our comparable store net sales in the future. Although Family Dollar, unlike Dollar Tree, can more easily raise the price of merchandise, customers may buy fewer products if prices were to increase. Please see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion of the effect of economic factors on our operations.10Table of ContentsWe are experiencing higher costs and disruptions in our distribution network, which have had and could have an adverse impact on our sales, margins and profitability.Our success is dependent on our ability to import or transport merchandise to our distribution centers and store, pick and ship merchandise to our stores in a timely and cost-effective manner. We rely heavily on third parties including ocean carriers and truckers in these processes. We may not anticipate, respond to or control all of the challenges of operating our distribution network. Additionally, when our distribution centers fail to operate effectively, we could experience increased freight or operational costs or merchandise shortages that could lead to lost sales. We have also experienced trucking shortages, and increased trucking and fuel costs. Some of the factors that have had and could have an adverse effect on our distribution network or costs in 2023 are:•Shipping costs. We have experienced significantly higher international and domestic freight costs. Domestically, diesel fuel prices have been and are expected to remain higher and may increase further because of international tensions. A significant increase in our freight costs could have a material adverse impact on our business and results of operations. Changes in import duties, import quotas and other trade sanctions could also increase our costs.•Shipping disruptions. We have experienced disruptions in the global supply chain, including issues with shipping capacity, port congestion and pandemic-related port closings and ship diversions. Our receipt of imported merchandise has been and may be further disrupted or delayed as a result of these or other factors. Delays could potentially have a material adverse impact on future product availability, product mix, sales and merchandise margin, especially at Dollar Tree. In addition, our supply chain may be disrupted as a result of other international events such as armed conflict, war, economic sanctions or acts of terrorism.•Efficient operations and management. Distribution centers and other aspects of our distribution network are complex and difficult to operate efficiently, and we have experienced and could continue to experience a reduction in operating efficiency resulting in delayed shipments of merchandise to our stores as a result of challenges in attracting and retaining an adequate and reliable workforce. Although we have offered sign-on bonuses, enhanced wages and other inducements in certain markets to address the shortage of labor at our distribution centers, such measures have increased our costs and are expected to continue to increase our costs, which could have an adverse effect on our margins and profitability. There can be no assurances that such measures will be adequate to attract and retain the workforce necessary for the efficient operation of our distribution centers.•Trucking costs. We have experienced significant increases in trucking costs in recent years due to a truck driver shortage and other factors. The truck driver shortage also required us to increase our use of more expensive surge carriers to transport our merchandise.•Diesel fuel costs. We have experienced volatility in diesel fuel costs and are expecting increases to continue in fiscal 2023 and may worsen, for example, because of the impact of international events such as trade restrictions on Russia on oil prices.•Vulnerability to natural or man-made disasters, including climate change. A fire, explosion or natural disaster at a port or any of our distribution or store support facilities could result in a loss of merchandise and impair our ability to adequately stock our stores. Some facilities are vulnerable to earthquakes, hurricanes, tornadoes or floods, and an increase in the severity and frequency of extreme weather events and patterns may increase our operating costs, disrupt manufacturing or our supply chain, change customer buying patterns, result in closures of our stores or distribution and store support centers and impede physical access to our stores.•Labor disagreement. Labor disagreements, disruptions or strikes, including at ports, rail networks or transportation companies, may result in lost sales due to shipping delays or disruptions in the delivery of merchandise to our distribution centers or stores and increase our costs. •Direct-to-store deliveries. We rely on a limited number of suppliers for certain consumable merchandise, including frozen and refrigerated products. In fiscal 2022, we purchased and delivered approximately 15% of our merchandise for our Family Dollar segment, and to a lesser extent for our Dollar Tree segment, through our relationship with McLane Company, Inc., which distributes consumable merchandise from multiple manufacturers. We also rely on third parties to deliver frozen and refrigerated product, as well as chocolate in the summer, to our Dollar Tree stores. To the extent that supply chain disruptions and higher costs affect our suppliers, we may be subject to delays or reductions in deliveries and higher costs for merchandise. A substantial disruption in our relationship with or in service levels from these suppliers could have a material adverse impact on our business and results of operations.11Table of ContentsWe may stop selling or recall certain products for safety-related or other issues.We may stop selling or recall certain products, including our private label brands, for safety-related or other issues, including product contamination, product content, improper manufacturing processes, improper testing, product mislabeling or product tampering. We may also stop selling or recall products if the products, the operations of our suppliers, or our operations violate applicable laws or regulations, including food, drug and cosmetic safety laws, or raise potential health and safety-related issues, including improper storage, product mishandling, contamination or other adulteration, or when products could cause injury, illness or death. Any recall may require significant management attention, and we could experience significant costs, lost sales, compliance or enforcement actions by governmental authorities which could result in fines or other penalties, and/or product liability legal claims and consumer lawsuits. Recalls may also subject us to public claims of false or deceptive advertising and other criticism. A significant product liability or other legal judgment against us, a regulatory enforcement action or a product recall could materially and adversely affect our reputation, financial condition and/or results of operations. Moreover, the negative publicity surrounding assertions against the products we sell or the standards we uphold could materially and adversely affect our business, reputation and/or profitability. Additionally, any product recall may lead to increased scrutiny of our operations by regulatory agencies, requiring further management attention and potential legal fees and other expenses. We have experienced the foregoing risks in connection with a retail-level recall that was initiated on February 18, 2022 in relation to our Family Dollar Distribution Center 202 in Arkansas (“DC 202”). For more information, see “Litigation, arbitration and government proceedings may adversely affect our business, financial condition and/or results of operations” on page 17 which includes, among other things, a description of legal proceedings relating to issues associated with DC 202.Our business and results of operations could be materially harmed if we experience a decline in consumer confidence and spending as a result of consumer concerns about the quality and safety of our products or our brand standards.We could experience a decline in consumer confidence and spending if our customers become concerned about the quality and safety of the products we sell. To date, other than with respect to the stores temporarily closed to permit the removal and destruction of relevant inventory, we have not experienced significant lost sales in connection with the Recall, but there can be no assurances that consumer confidence in the quality and safety of our products resulting from the Recall will not decline in the future. If there is a decline in consumer confidence in our products or brands, our reputation may be adversely affected and we may experience additional lost sales which could have a material adverse impact on our business and results of operations.Inflation or other adverse change or downturn in economic conditions could impact our sales or profitability.A deterioration in economic conditions could reduce consumer spending or cause customers to shift their spending to products we either do not sell or do not sell as profitably. Adverse economic conditions such as a recession could disrupt consumer spending and significantly reduce our sales, decrease our inventory turnover, cause greater markdowns or reduce our profitability due to lower margins. Other factors that could result in or exacerbate adverse economic conditions include inflation, higher unemployment, consumer debt levels, trade disputes, as well as adverse climate or weather conditions, worsening or new epidemics, terrorism or international tensions, including armed conflict and economic sanctions.Furthermore, factors that could adversely affect consumer disposable income could decrease our customers’ spending on products we sell most profitably. In fiscal 2022, we experienced a material shift in consumer purchasing from higher-margin discretionary merchandise to lower-margin consumable goods which has negatively impacted our product mix and margins. Factors that could reduce our customers’ disposable income and over which we exercise no influence include but are not limited to, inflation in food, housing, fuel or other energy costs, increased unemployment, increases in interest rates, lack of available credit, higher tax rates and other changes in tax laws, increasing healthcare costs, and changes in, decreases in, or elimination of, government subsidies such as unemployment and food assistance programs.Although governmental authorities adopted substantial measures, including fiscal and monetary stimulus, to provide economic assistance to individual households and businesses and support economic stability during the COVID-19 pandemic, certain of the government assistance payments to households were temporary and were permitted to expire. There can be no assurance that current or future governmental efforts to support the economy during the pandemic or a recession will be sufficient to support future consumer spending at levels experienced previously or mitigate the negative effect of the pandemic on the economy. If consumer spending on the goods we sell declines as a result, there could be a material adverse impact on our business and results of operations.Many of the factors identified above that affect disposable income, as well as merchandise costs, commodity rates, transportation costs (including the costs of diesel fuel), costs of labor, insurance and healthcare, foreign exchange rate fluctuations, lease costs, barriers or increased costs associated with international trade and other economic factors also affect our ability to implement our corporate strategy effectively, our cost of goods sold and our selling, general and administrative expenses, and may have other adverse consequences which we are unable to fully anticipate or control, all of which may adversely affect our sales or profitability. We have limited or no ability to control many of these factors.12Table of ContentsIf the COVID-19 pandemic and associated disruptions worsen or continue longer than expected, there could be a material adverse impact on our business and results of operations.The continuing COVID-19 pandemic arising from a novel strain of coronavirus and its variants has caused on-going direct and indirect economic disruptions that have adversely affected, and are expected to continue to adversely affect, elements of our business. The COVID-19 pandemic, related public health measures and associated economic and social impacts have already contributed to, among other things, significant increases in the cost of operating our stores and distribution centers, disruptions in the patterns of consumer demand and traffic, and an increase in demand for online sales (which is an insignificant part of our business), home deliveries (which we began providing in 2021 through our partnership with Instacart) or curbside deliveries (which we do not offer), and changes in the labor markets.There continues to be uncertainty and unpredictability about the lingering impact of COVID-19-related issues on our financial and operating results in future periods. If the pandemic worsens or continues longer than expected (as new variants emerge), governments may reinstate or extend business or personal restrictions, and we could be forced to curtail or restrict operations or incur additional costs. If major new variants emerge, we might also experience new disruptions in our supply chain and sources of supply, suffer facility closures or encounter additional difficulties in hiring or retaining the workforce required for our business. These circumstances, if applicable for an extended duration or across significant parts of our operating footprint, or if they fall during particularly meaningful holiday seasons, could have a material adverse effect on our business and results of operations. We are unable to predict the full extent to which COVID-19-related issues will affect the economy and our customers, associates, suppliers, vendors, other business partners or our business, results of operations and financial condition. If the economic consequences of the pandemic linger and/or worsen, it could amplify many of the other risks described in this report.Risks associated with our domestic and foreign suppliers could adversely affect our financial performance.We are dependent on our vendors, including direct ship vendors, to supply merchandise in a timely and efficient manner. If a vendor fails to deliver on its commitments due to financial or other difficulties, we could experience merchandise shortages which could lead to lost sales or increased merchandise costs if alternative sources must be used.We rely on the timely availability of imported goods at favorable wholesale prices. Merchandise imported directly typically accounts for approximately 41%-43% of our Dollar Tree segment’s total retail value purchases and approximately 15%-17% of our Family Dollar segment’s total retail value purchases. In addition, we believe that a significant portion of our goods purchased from domestic vendors is imported. Imported goods are generally less expensive than domestic goods and result in higher profit margins. A disruption in the flow of our imported merchandise or an increase in the cost of those goods may significantly decrease our profits. Risks associated with our reliance on imported goods may include disruptions in the flow of or increases in the cost of imported goods because of factors such as:•duties, tariffs or other restrictions on trade, including Section 301 tariffs that have already been imposed on imported Chinese goods;•raw material shortages, work stoppages, government restrictions, strikes and political unrest, including any impact on vendors or shipping arising from epidemics, such as the COVID-19 pandemic;•economic crises in the United States or abroad and international disputes or conflicts, including war and economic sanctions;•changes in currency exchange rates or government policies and local economic conditions, including inflation (including energy prices and raw material costs) in the country of origin;•potential changes to international trade agreements or the failure of the United States to maintain normal trade relations with China and other countries;•changes in leadership and the political climate in countries from which we import products and their relations with the United States; and•failure of manufacturers outside the United States to meet food, drug and cosmetic safety and labeling requirements or environmental standards set by government regulators or consumer expectations.Our supply chain may be disrupted by changes in United States trade policy with China.We rely on domestic and foreign suppliers to provide us with merchandise in a timely manner and at favorable prices. Among our foreign suppliers, China is the source of a substantial majority of our imports. A disruption in the flow of our imported merchandise from China or an increase in the cost of those goods may significantly decrease our profits.13Table of ContentsWhile the United States scaled back punitive Section 301 tariffs on certain Chinese imports based on an agreement reached with China in 2020, the imposition of any new U.S. tariffs on Chinese imports or the taking of other actions against China in the future, and any responses by China, could impair our ability to meet customer demand and could result in lost sales or an increase in our cost of merchandise, which would have a material adverse impact on our business and results of operations.Our growth is dependent on our ability to increase sales in existing stores and to expand our square footage profitably.Existing store sales growth is critical to good operating results and is dependent on a variety of factors, including merchandise quality, relevance and availability, store operations and customer satisfaction. In addition, increased competition could adversely affect our sales. Failure to meet our sales targets could result in our needing to record material non-cash impairment charges related to our intangible assets. We believe increasing sales at Family Dollar depends in significant part on several initiatives, including price reductions, some of which remain in the early stages.Our highest sales periods are during the Christmas and Easter seasons, and we generally realize a disproportionate amount of our net sales and our operating and net income during the fourth quarter. In anticipation, we stock extra inventory and hire many temporary employees to prepare our stores and help ship product from our distribution centers. A reduction in sales during these periods could adversely affect our operating results, particularly operating and net income, to a greater extent than if a reduction occurred at other times of the year. Untimely merchandise delays due to receiving or distribution problems could have a similar effect.When Easter is observed earlier in the year, the selling season is shorter and, as a result, our sales could be adversely affected. Easter was observed on April 17, 2022 and will be observed on April 9, 2023.Expanding our square footage profitably depends on a number of uncertainties, including our ability to locate, lease, build out and open or expand stores in suitable locations on a timely basis under favorable economic terms. We also open or expand stores within our established geographic markets, where new or expanded stores may draw sales away from our existing stores. Obtaining an increasing number of profitable stores is an ever-increasing challenge. In addition, our expansion is dependent upon third-party developers’ abilities to acquire land, obtain financing, and secure necessary permits and approvals. We have experienced higher commodity and other costs associated with the build-out of new stores and the renovation of existing stores. We have also experienced delays in new store openings and the renovation of existing stores due to inspection, permitting and contractor delays. In addition, we have experienced delays in new store openings due to limitations on the availability of certain fixtures and equipment. We anticipate these increased costs and delays may continue for the foreseeable future, which could adversely affect our sales and profitability. Further, we may not manage our expansion effectively, and our failure to achieve our expansion plans could materially and adversely affect our business, financial condition and results of operations.Our profitability is affected by the mix of products we sell.Our gross profit margin decreases when we increase the proportion of higher cost goods we sell. For example, some of our consumable products carry higher costs than other goods, so our gross profit margin will be negatively impacted as the percentage of our sales from higher cost consumable products increases. Imported merchandise and private label goods generally carry lower costs than domestic goods. Our product mix is affected by the supply of goods, including imported goods, and could be negatively impacted by various factors, including those described under “We are experiencing higher costs and disruptions in our distribution network, which have had and could have an adverse impact on our sales, margins and profitability” on page 11.In our Family Dollar segment, our success also depends on our ability to select and obtain sufficient quantities of relevant merchandise at prices that allow us to sell such merchandise at profitable and appropriate prices. A sales price that is too high causes products to be less attractive to our customers and our sales at Family Dollar could suffer. We are continuing to refine our pricing strategy at Family Dollar to drive customer loyalty and have a strategic pricing team to improve our value and to increase profitability. Our inability to successfully implement our pricing strategies at Family Dollar could have a negative effect on our business.In addition, our Family Dollar segment has a substantial number of private brand items and the number of such items has been increasing. We believe our success in maintaining broad market acceptance of our private brands depends on many factors, including our pricing, costs, quality and customer perception. We may not achieve or maintain our expected sales for our private brands and, as a result, our business and results of operations could be adversely impacted. Additionally, the increased number of private brands could negatively impact our existing relationships with our non-private brand suppliers.Pressure from competitors may reduce our sales and profits.The retail industry is highly competitive. The marketplace is highly fragmented as many different retailers compete for market share by utilizing a variety of store formats and merchandising strategies, including mobile and online shopping. We expect competition to increase in the future. There are no significant economic barriers for others to enter our retail sector. Some of our current or potential competitors have greater financial resources than we do. We cannot guarantee that we will continue to be able to 14Table of Contentscompete successfully against existing or future competitors, and we believe that doing so may require substantial capital expenditures. Please see “Item 1. Business” for further discussion of the effect of competition on our operations.Our business could be adversely affected if we fail to attract and retain qualified associates and key personnel.Our growth and performance are dependent on the skills, experience and contributions of our associates, executives and key personnel for both Dollar Tree and Family Dollar. Various factors, including the pandemic, constraints on overall labor availability, wage rates, regulatory or legislative impacts, and benefit costs could impact our ability to attract and retain qualified associates at our stores, distribution centers and corporate offices.We are experiencing a shortage of associates and applicants to fill staffing requirements at our distribution centers, stores and corporate offices due to the current labor shortage affecting businesses. This has adversely affected the operating efficiency of our distribution centers and stores and our ability to transport merchandise from our distribution centers to our stores. If we are unable to attract and retain qualified associates for our distribution centers and stores in the future, our business and results of operations may be adversely affected. Risks Relating to Strategic Initiatives We may not be successful in implementing or in anticipating the impact of important strategic initiatives, and our plans for implementing such initiatives may be altered or delayed due to various factors, which may have an adverse impact on our business and financial results.We completed the conversion of our predominant product price from $1.00 to $1.25 for the vast majority of merchandise in all Dollar Tree stores during the first quarter of fiscal 2022. Although to date the increase in the price point has more than offset the decline in the number of units sold, there can be no assurances that the price increase will not have an adverse effect on our business in the future. In addition, we are continuing to implement our important strategic initiatives that are designed to create growth, improve our results of operations and drive long-term shareholder value, including:•the expansion of a multi-price initiative in Dollar Tree stores;•the introduction of selected Dollar Tree merchandise into Family Dollar stores; •the roll-out of the Combo Store format that combines a Dollar Tree store and Family Dollar store in a single location;•the renovation of Family Dollar stores to the H2 and other formats;•our partnership with Instacart to provide home delivery of merchandise purchased online; and•our plans relating to new store openings for Dollar Tree and Family Dollar generally.The implementation, timing and results of these strategic initiatives are subject to various risks and uncertainties, including the acceptance of multi-priced merchandise by Dollar Tree customers; customer acceptance of new store concepts and merchandise offerings; construction and permitting delays relating to new and renovated stores; the availability of desirable real estate locations for lease at reasonable rates; the lingering impact of the COVID-19 pandemic and associated economic issues; the success of our strategies; and other factors beyond our control. In addition, several of these initiatives depend on the timeliness, cost and availability of adequate levels of the appropriate domestic and imported merchandise, our ability to execute on our plans and expectations with respect to those initiatives and our ability to implement those initiatives within budget and with the expected return. To the extent that shipping delays, supply chain disruptions and other distribution logistics adversely affect the availability of merchandise necessary to implement our strategic initiatives, we may delay or reduce our planned rate of implementation of one or more of those initiatives.In addition, building on our current initiatives, we are currently developing plans to make additional multi-year strategic investments across the Dollar Tree and Family Dollar banners to further position the company for long-term sustained growth. We anticipate that these investments will relate to four key areas of our business: our associates, our distribution center network and supply chain, our product pricing and value proposition, and our technology infrastructure. Within these areas, the focus of these investments is expected to be on associate wages, improved store execution, enhanced safety and working conditions, increased supply chain efficiencies, competitive pricing at Family Dollar, and enhancements to our systems infrastructure. There is a risk that our investments in these initiatives may increase our costs and reduce our margins and profitability if the initiatives do not achieve their intended purposes. There can be no assurance that we will be able to implement important strategic initiatives in accordance with our expectations or that they will generate expected returns, which may result in an adverse impact on our business and financial results.15Table of ContentsWe could incur losses due to impairment of long-lived assets, goodwill and intangible assets. Under U.S. generally accepted accounting principles, we review our long-lived assets for impairment whenever economic events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Identifiable intangible assets with an indefinite useful life, including goodwill, are not amortized but are evaluated annually for impairment. A more frequent evaluation is performed if events or circumstances indicate that impairment could have occurred.Should we experience business challenges or significant negative industry or general economic trends, we could recognize impairments to our goodwill, intangible assets and other long-lived assets. We monitor key assumptions and other factors utilized in our goodwill impairment analysis, and if business or other market conditions develop that are materially different than we currently anticipate, we will conduct an additional impairment evaluation. Any reduction in or impairment of the value of goodwill or intangible assets will result in a charge against earnings, which could have a material adverse impact on our reported results of operations and financial condition. For additional information on goodwill impairments, please refer to Note 1 to our consolidated financial statements under the caption “Goodwill and Nonamortizing Intangible Assets.”Cybersecurity and Technology RisksWe rely on computer and technology systems in our operations, and any material failure, inadequacy, interruption or security failure of those systems, including because of a cyber-attack, could harm our ability to effectively operate and grow our business and could adversely affect our financial results.We rely extensively on our computer and technology systems and, in certain cases, those of third-party service providers to support nearly all key functions in our business, including managing inventory, operating our stores, processing credit card and customer transactions and summarizing results. Our ability to effectively manage our business and coordinate the distribution and sale of our merchandise depends significantly on the capabilities, confidentiality, integrity and availability of these systems and on our ability to successfully acquire and integrate upgraded or replacement systems as needed to support our business requirements and strategic initiatives. We also rely on third-party providers and platforms for many of these computer and technology systems and support.Although we have operational safeguards in place, they may not be effective in preventing the failure of these systems or platforms to operate effectively and be available to us. This may be as the result of deliberate breach in the security of these systems or platforms by bad actors, including through malicious software, ransomware and other cyber-attacks, which may originate from state actors and may increase during times of international tensions. Failures may also be caused by various other factors, including power outages, catastrophic events, physical theft, computer and network failures, inadequate or ineffective redundancy, obsolescence or failure of vendor support, problems with transitioning to upgraded or replacement systems or platforms and related business process changes, flaws in third-party software or services, errors or improper use by our employees or third-party service providers.We plan to make investments in our information technology systems in fiscal 2023 to support the growth of our business. If our information technology systems are not adequate to support our strategic initiatives, our growth and the success of our initiatives may be adversely affected. If these systems are damaged or fail to function adequately, we may incur substantial costs to repair or replace them, may experience loss of critical data and interruptions or delays in our ability to manage inventories or process customer transactions and may receive negative publicity, which could adversely affect our results of operations and business. In addition, remediation of any problems with our systems could take an extensive amount of time and could result in significant, unplanned expenses.The potential unauthorized access to customer information may violate privacy laws and could damage our business reputation, subject us to negative publicity, litigation and costs, and adversely affect our results of operations or business.Many of our information technology systems, such as those we use for our point-of-sale, web and mobile platforms, including online and mobile payment systems, and for administrative functions, including human resources, payroll, accounting, and internal and external communications, contain personal, financial or other confidential information that is entrusted to us by our customers and associates as well as proprietary and other confidential information related to our business and suppliers.The security measures that we and/or our third-party suppliers put in place cannot provide absolute security to safeguard our customers’ personal information (including debit and credit card information), our associates’ private data, suppliers’ data, and our business records and intellectual property and other sensitive information. Cybercriminals, who may include well-funded state actors or organized criminal groups, are rapidly evolving their cyberattack techniques and tactics, which are becoming increasingly more sophisticated and challenging to detect. We and/or our third-party suppliers may be vulnerable to and unable to anticipate, detect, and appropriately respond to cyber-security attacks, including data security breaches and data loss.16Table of ContentsWe are also subject to laws and regulations in various jurisdictions in which we operate regarding privacy, data protection and data security, including those related to the collection, storage, handling, use, disclosure, transfer and security of personal data. These laws permit regulators to assess potentially significant fines for data privacy violations and may create a right for individuals to bring class action suits seeking damages for violations. Our efforts to comply with consumer privacy laws and other similar privacy and data protection laws may impose significant costs and challenges that are likely to increase over time, and we could incur substantial penalties or be subject to litigation related to violation of existing or future data privacy laws and regulations.Likewise, we are subject to the Payment Card Industry Data Security Standards (“PCI-DSS”) which is mandated by the card brands and administered through the Payment Card Industry Security Standards Council. As a Level 1 Merchant, we are subject to assessment and attestation for PCI-DSS compliance on an annual basis. A failure to meet and maintain compliance with PCI-DSS requirements could result in our inability to continue to accept credit cards as a form of payment, which would materially impact our ability to sell our products. In addition, our credibility and reputation within the business community and with our customers may be affected, which could result in our customers discontinuing the use of debit or credit cards in our stores or not shopping in our stores altogether. Non-compliance with PCI-DSS requirements also may subject us to recurring and accumulating fines until compliance is achieved. Considerable investments to strengthen our information security could also be required should we ever be deemed to be non-compliant. Moreover, significant additional capital investments and other expenditures could also be required to continue to strengthen our overall cyber-security posture and prevent future security breaches, including costs associated with additional security technologies, personnel, experts and services (e.g., credit-monitoring services) for those whose data has been breached. These costs, which could be material, could adversely impact our results of operations in the period in which they are incurred and may not meaningfully limit the success of future attempts to breach our information technology systems.The unavailability of our information technology systems or the failure of those systems or software to perform as required to support our business needs for any reason and any inability to respond to, or recover from, such events, could disrupt our business, decrease performance and increase overhead costs. If we are unable to secure our customers’ credit card and confidential information, or other private data relating to our associates, suppliers or our business, we could be subject to negative publicity, costly government enforcement actions or private litigation and increased costs. If our information technology systems and processes are insufficiently provisioned or improperly designed and implemented to support our business, our strategic initiatives may not deliver anticipated results. Any of these factors could have a material adverse effect on our results of operations or business.Legal and Regulatory RisksLitigation, arbitration and government proceedings may adversely affect our business, financial condition and/or results of operations.Our business is subject to the risk of litigation and arbitration involving employees, consumers, suppliers, competitors, shareholders, government agencies, or others through private actions, class actions, derivative actions, governmental investigations, administrative proceedings, regulatory actions, mass arbitration or other similar actions. In addition, due to the types of products that we sell, our operations are subject to regulatory oversight by the FDA, the USDA, the Occupational Health and Safety Administration, and other federal, state, local and applicable foreign governmental authorities. If such authorities believe that we have failed to comply with applicable regulations and/or procedures, they may require prompt corrective action, and/or proceed directly to other forms of enforcement action, including the imposition of operating restrictions, including a ceasing of operations in one or more facilities, enjoining and restraining certain violations of applicable law pertaining to products, seizure of products, and assessing civil or criminal sanctions or penalties. Any adverse regulatory action, depending on its magnitude, may restrict us from effectively selling our products and could have a material adverse effect on our business, financial condition and/or results of operations. From January 11, 2022 through February 11, 2022, DC 202 was inspected by the FDA and USDA. On February 11, 2022, the FDA issued Form 483 observations primarily regarding rodent infestation at DC 202, as well as other items that require remediation. In connection therewith, on February 18, 2022, we initiated a retail-level product recall of FDA and USDA-regulated products stored and shipped to approximately 400 stores from DC 202 from January 1, 2021 through such date (the “Recall”). We temporarily closed DC 202 for extensive cleaning, temporarily closed the affected stores to permit the removal and destruction of inventory subject to the Recall, ceased sales of relevant inventory subject to the Recall, committed to the FDA to continue to cease the shipment of FDA-regulated products from DC 202 until FDA approval is received, and initiated corrective actions at DC 202. In June 2022, we stopped shipping to stores from DC 202 and have since closed the facility and disposed of all of the inventory that was in the facility. On November 9, 2022 we received an FDA warning letter in connection with the DC 202 inspection. The conditions and issues detailed in the warning letter are generally the same as those described in the Form 483 observations or were otherwise observed during the inspection. The warning letter acknowledged certain remedial actions we have taken in response to the Form 483 observations, including conducting the recall and closing the facility. We are taking this matter extremely seriously and continue to cooperate with the FDA. If the FDA and/or other governmental authorities are not satisfied with these corrective actions or observe issues in our other 17Table of Contentsdistribution centers or stores, they may initiate other enforcement or administrative actions, which may have a material adverse effect on our business, financial condition and/or results of operations. Also see “We may stop selling or recall certain products for safety-related or other issues” on page 12.Since February 22, 2022, we have received 14 putative class action complaints related to issues noted above associated with DC 202. The lawsuits are proceeding in federal court in Tennessee using the federal court’s multi-district litigation (“MDL”) process. An amended consolidated complaint seeking class action status was filed October 17, 2022 alleging violations of the Mississippi, Arkansas, Louisiana, Tennessee, Alabama and Missouri consumer protection laws, breach of warranty, negligence, misrepresentation, deception and unjust enrichment related to the sale of products that may be contaminated by virtue of rodent infestation and other unsanitary conditions. Plaintiffs seek damages, attorney fees and costs, punitive damages and the replacement of, or refund of, money paid to purchase the relevant products, and any other legal relief available for their claims (in each case in unspecified amounts), including equitable and injunctive relief. On April 28, 2022, the State of Arkansas filed a complaint in state court alleging violations of the Arkansas Deceptive Trade Practices Act, gross negligence and negligence, strict liability in tort, unjust enrichment and civil conspiracy related to the same underlying matters as the putative class actions above. The State of Arkansas is seeking injunctive relief, restitution, disgorgement, damages, civil penalties, punitive damages and suspension or revocation of our authorization to do business in Arkansas.We have defended and intend to continue defending ourselves vigorously in the foregoing litigations. We filed a motion to dismiss the amended consolidated complaint and a ruling on the motion by the court is expected in early 2023. If our motion is denied in whole or in part (including on appeal), the case would move to class certification, which we intend to oppose. We are unable to determine at this time whether our motion to dismiss will be granted or whether a class can be certified. We do not believe that the cases will, individually or in the aggregate, have a material adverse effect on our business or financial condition. However, we cannot assure that these litigations, individually or in the aggregate, will not have a material adverse effect on our results of operations for the period or year in which they are reserved or resolved. On March 1, 2022, a federal grand jury subpoena was issued to us by the Eastern District of Arkansas requesting the production of information, documents and records pertaining to pests, sanitation and compliance with law regarding certain of our procedures and products. In connection with this matter, we have been investigating the condition of FDA-regulated product shipped from DC 202. We are cooperating fully with the U.S. Department of Justice investigation, including having produced documents and provided additional information. As part of this cooperation, we may engage in discussions with the government in an effort to reach a negotiated resolution. Due to the inherent uncertainties associated with this matter, no assurance can be given as to the timing or outcome of this matter, which could include penalties and company undertakings.Our products could also cause illness or injury, harm our reputation, and subject us to litigation. We are dependent on our vendors to ensure that the products we buy comply with all applicable safety standards. However, product liability, personal injury or other claims may be asserted against us relating to product adulteration, product tampering, mislabeling, recall and other safety issues with respect to the products that we sell, or with respect to our handling or storage of such products, including as a result of the issues raised by the pending Arkansas FDA Matter (which has led to increased scrutiny of our operations by regulatory agencies, requiring further management attention and potential legal fees and other expenses). A significant product liability, consumer fraud, or other legal judgment against us, a related regulatory compliance or enforcement action or a product recall could materially and adversely affect our reputation, financial condition and/or results of operations. Moreover, even if a product liability, consumer fraud or other claim is unsuccessful, has no merit or is not pursued, the negative publicity surrounding assertions against the products we sell could materially and adversely affect our reputation. We seek but may not be successful in obtaining contractual indemnification from our vendors, where appropriate, or insurance coverage, and if we do not have adequate contractual indemnification or insurance available, such claims could adversely affect our business, financial condition and/or results of operations. Our ability to obtain the benefit of contractual indemnification from vendors may be hindered by our ability to enforce contractual indemnification obligations against such vendors, for example because the vendors are overseas or lack financial resources. Our litigation-related expenses could increase as well, which also could have a materially negative impact on our financial condition and/or results of operations even if a claim is unsuccessful or is not fully pursued. The outcome of such matters is difficult to assess or quantify. Plaintiffs in these types of lawsuits or proceedings may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss may remain unknown for substantial periods of time. In addition, certain of these matters, if decided adversely to us or settled by us, may result in an expense that may be material to our financial statements as a whole or may negatively affect our operating results if changes to our business operations are required. If we experienced a material loss arising from these matters, we could also become subject to shareholder derivative suits and securities litigation. The cost to defend current and future litigation or proceedings, including arbitrations, may be significant. There also may be adverse publicity associated with litigation, including litigation related to product or food safety, customer information and environmental or safety requirements, which could negatively affect customer perception of our business, regardless of whether the allegations are valid or whether we are ultimately found liable.18Table of ContentsFor a discussion of current legal matters, please see “Item 3. Legal Proceedings” and Note 4 to our consolidated financial statements under the caption “Contingencies.” Resolution of these matters, if decided against us, could have a material adverse effect on our results of operations, accrued liabilities or cash flows.Changes in laws and government regulations or in other stakeholder expectations concerning business conduct, or our failure to adequately estimate the impact of such changes or expectations, could increase our expenses, expose us to legal risks or otherwise adversely affect us. Our business is subject to a wide array of laws and regulations, and changes to those laws and regulations could have an adverse effect on our business. For example, various municipalities regulate the placement or proximity of our stores or may place requirements on the types of products we sell. In addition, the adoption of new environmental laws and regulations in connection with climate change and the proposed transition to a low carbon economy, including any federal or state laws enacted to regulate or tax greenhouse gas emissions, could significantly increase our operating or merchandise costs or reduce the demand for our products. These laws and regulations may include, but are not limited to, requirements relating to hazardous waste materials, recycling, single-use plastics, extended producer responsibility, use of refrigerants, carbon pricing or carbon taxes, product energy efficiency standards and product labeling. If carbon pricing or carbon taxes are adopted, there is a significant risk that the cost of merchandise from our suppliers will increase and adversely affect our business and results of operations. In addition, significant changes in laws or regulations that impact our relationship with our workforce, such as minimum wage increases, health care, labor laws or workplace safety, could increase our expenses and adversely affect our operations. An increase in federal corporate tax rates also could adversely affect our profitability. Changes in other regulatory areas, such as consumer credit, privacy and information security, product and food safety, energy or environmental protection, and tariff and other trade restrictions, among others, could cause our expenses to increase or result in product recalls. Further, if we fail to comply with applicable laws and regulations, including wage and hour laws, we could be subject to legal risk, including government enforcement action and class action civil litigation, which could adversely affect our results of operations.We operate in an increasingly regulated environment across a large and diverse geographic footprint, and we devote substantial resources to ensure effective compliance. If our programs do not adequately anticipate emerging regulatory expectations or requirements, or if we fail to appropriately design and maintain an effective enterprise compliance program and system of controls to prevent and detect non-compliance, including implementing and communicating a strong culture of compliance, there is a possibility any failure to comply with applicable laws and regulations would subject us to enhanced legal risks and adverse outcomes. In addition to the legal requirements above, we are subject to the influence of a wide range of non-governmental stakeholders whose expectations on topics related to those described above may impact our business. We may be pressured by our shareholders, associates or customers, or others in the communities where we operate to adopt practices or policies that are more prescriptive than those required by law. Similar influences may impact our merchandise and other vendors which would indirectly affect our business. To the extent that these influences result in changes to our operations, we could experience higher costs, and there can be no assurance we will experience offsetting positive effects on our results of operations. If our stakeholders perceive that we have not adequately addressed their expectations, our reputation could be negatively affected which could have an adverse impact on our business and results of operations.Risks Relating to IndebtednessOur substantial indebtedness could adversely affect our financial condition, limit our ability to obtain additional financing, restrict our operations and make us more vulnerable to economic downturns and competitive pressures.Our substantial level of indebtedness could adversely affect our ability to fulfill our obligations and have a negative impact on our financing options and liquidity position. As of January 28, 2023, our total indebtedness is $3.45 billion. We may in the future incur substantial additional indebtedness. In addition, we have $1.5 billion of additional borrowing availability under our revolving credit facility, less amounts outstanding for letters of credit totaling $4.4 million. In addition, our credit ratings impact the cost and availability of future borrowings and, accordingly, our cost of capital. Our ratings reflect the opinions of the ratings agencies of our financial strength, operating performance and ability to meet our debt obligations. There can be no assurance that we will achieve a particular rating or maintain a particular rating in the future.The terms of the agreements governing our indebtedness may restrict our current and future operations, particularly our ability to respond to changes or to pursue our business strategies, and could adversely affect our capital resources, financial condition and liquidity.The agreements that govern our indebtedness contain a number of restrictive covenants that impose significant operating and financial restrictions on us and may limit our ability to engage in acts that may be in our long-term best interests, including, among 19Table of Contentsother things, restrictions on our ability to incur liens; make changes in lines of business, subject to certain exceptions; and consolidate or merge with or into, or sell all or substantially all of our assets to, another person.In addition, certain of these agreements require us to comply with certain financial maintenance covenants. Our ability to satisfy these financial maintenance covenants can be affected by events beyond our control, and we cannot assure you that we will meet them.A breach of the covenants under these agreements could result in an event of default under the applicable indebtedness, which, if not cured or waived, could result in us having to repay our borrowings before their due dates. Such default may allow the debt holders to accelerate the related debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. If we are forced to refinance these borrowings on less favorable terms or if we were to experience difficulty in refinancing the debt prior to maturity, our results of operations or financial condition could be materially affected. In addition, an event of default under our credit facilities may permit the lenders to terminate all commitments to extend further credit. In the event our lenders or holders of notes accelerate the repayment of such borrowings, we cannot assure you that we will have sufficient assets to repay such indebtedness.As a result of these restrictions, we may be limited in how we conduct our business; unable to raise additional debt financing to operate during general economic or business downturns; or unable to compete effectively, take advantage of new business opportunities or grow in accordance with our plans.Our variable-rate indebtedness subjects us to interest rate risk, which could cause our annual debt service obligations to increase significantly.Our revolving credit facility is subject to variable rates that expose us to interest rate risk. We may also incur additional indebtedness subject to variable rates in the future. Interest rates have increased in fiscal 2022 and further increases are anticipated. When interest rates increase, our debt service obligations on the variable rate indebtedness increase even though the amount borrowed remains the same, and our net income decreases. Although we may enter into interest rate swaps involving the exchange of floating for fixed-rate interest payments, to reduce interest rate volatility, we cannot assure you we will choose to or be able to do so.Borrowings under our revolving credit facility bear interest at a rate derived from the Secured Overnight Financing Rate (“SOFR”). As a result of the discontinuation of LIBOR as a reference rate in June 2023, there is uncertainty as to whether the transition from LIBOR to SOFR or another reference rate will result in financial market disruptions or higher interest costs to borrowers, which could increase our interest expense and have an adverse effect on our business and results of operations. Additionally, any successor rate to SOFR under our revolving credit facility may not have the same characteristics as SOFR or LIBOR. As a result, the amount of interest we may pay on our revolving credit facility is difficult to predict. Risks Relating to Our Common StockOur business or the value of our common stock could be negatively affected as a result of actions by shareholders.We value constructive input from investors and regularly engage in dialogue with our shareholders regarding strategy and performance. The Board of Directors and management team are committed to acting in the best interests of all of our shareholders. There is no assurance that the actions taken by the Board of Directors and management in seeking to maintain constructive engagement with our shareholders will be successful. Shareholders who disagree with our strategy or the way we are managed may seek to effect change in the future, through various strategies that could include private engagement, publicity campaigns, proxy contests, and litigation. Responding to these actions may be costly and time-consuming, disrupt our operations, divert the attention of our Board of Directors, management and employees, and impact our relationship with investors, vendors, and other third parties. Shareholder engagement also may result in changes to our business plans, operations, strategies, initiatives, governance, management and risk factors. The perceived uncertainty as to our future direction resulting from these actions of shareholders could also affect the market price and volatility of our common stock.The price of our common stock is subject to market and other conditions and may be volatile.The market price of our common stock may fluctuate significantly in response to a number of factors. These factors, some of which may be beyond our control, include the perceived prospects and actual results of operations of our business; changes in estimates of our results of operations by analysts, investors or us; trading activity by our large shareholders; trading activity by sophisticated algorithms (high-frequency trading); our actual results of operations relative to estimates or expectations; actions or announcements by us or our competitors; litigation and judicial decisions; legislative or regulatory actions or changes; and changes in general economic or market conditions. In addition, the stock market in general has from time to time experienced extreme price and volume fluctuations. These market fluctuations could reduce the market price of our common stock for reasons unrelated to our operating performance.20Table of ContentsCertain provisions in our Articles of Incorporation and By-Laws could delay or discourage a change of control transaction that may be in a shareholder’s best interest.Our Articles of Incorporation and By-Laws contain provisions that may delay or discourage a takeover attempt that a shareholder might consider in his/her best interest. These provisions, among other things:•provide that only the Board of Directors, the chairman or vice chairman of the Board, the chief executive officer or shareholders who own 15% or more of the outstanding shares of our common stock may call special meetings of the shareholders; •establish certain advance notice procedures for nominations of candidates for election as directors and for shareholder proposals to be considered at shareholders’ meetings; and•permit the Board of Directors, without further action of the shareholders, to issue and fix the terms of preferred stock, which may have rights senior to those of the common stock.However, we believe that these provisions allow our Board of Directors to negotiate a higher price in the event of a takeover attempt which would be in the best interest of our shareholders.Item 1B. Unresolved Staff CommentsNone.Item 2. PropertiesAs of January 28, 2023, we operated 16,096 stores across the contiguous United States and the District of Columbia and operated 244 stores within five Canadian provinces. The Dollar Tree segment includes 8,134 stores operating under the Dollar Tree and Dollar Tree Canada brands with stores predominantly ranging from 8,000 - 10,000 selling square feet. The Family Dollar segment includes 8,206 stores operating under the Family Dollar brand with stores predominantly ranging from 6,000 - 8,000 selling square feet. For additional information on store counts and square footage by segment for the years ended January 28, 2023 and January 29, 2022, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Overview.”We lease the vast majority of our stores and expect to lease the majority of our new stores as we expand. Our leases typically provide for a short initial lease term, generally between five and ten years, with options to extend; in some cases we have initial lease terms of up to fifteen years. We believe this leasing strategy enhances our flexibility to pursue various expansion opportunities resulting from changing market conditions. As current leases expire, we believe that we will be able to obtain lease renewals, if desired, for present store locations, or to obtain leases for equivalent or better locations in the same general area.Our network of distribution centers is strategically located throughout the United States to support our stores. As of January 28, 2023, we operated 25 distribution centers occupying a total of 23.2 million square feet, 15 of which are primarily dedicated to serving our Dollar Tree stores and ten distribution centers primarily serve our Family Dollar stores. We expect future distribution centers to be built with the capability to service both Dollar Tree and Family Dollar stores. Our distribution network supports multiple store formats including H2, Combo Stores and Dollar Tree Plus. We ship to our H2 format stores from our Family Dollar distribution centers and we ship to our Dollar Tree Plus format stores from our Dollar Tree distribution centers. Our Combo Stores receive shipments from both Dollar Tree and Family Dollar distribution centers. Except for 0.4 million square feet of our distribution center in San Bernardino, California and short-term leases for offsite facilities, all of our distribution center capacity is owned.Each of our distribution centers contains advanced materials handling technologies, including radio-frequency inventory tracking equipment and specialized information systems. With the exception of three of our facilities, each of our distribution centers in the United States also contains automated conveyor and sorting systems.Distribution services in Canada are provided by a third party from facilities in British Columbia and Ontario.Our store support center in Chesapeake, Virginia is located in an approximately 0.5 million square foot office tower that we own.For more information on financing of our new, expanded and renovated stores, and distribution centers, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Funding Requirements.”21Table of ContentsItem 3. Legal ProceedingsFor information regarding legal proceedings in which we are involved, please see Note 4 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, under the caption “Contingencies.” For a further description of certain of these matters and their impact, see “Item 1A. Risk Factors”: “We may stop selling or recall certain products for safety-related or other issues” on page 12 and “Litigation, arbitration and government proceedings may adversely affect our business, financial condition and/or results of operations” on page 17.Item 4. Mine Safety DisclosuresNone.22Table of ContentsPART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesOur common stock is traded on The Nasdaq Global Select Market® under the symbol “DLTR.” As of March 3, 2023, we had 2,125 shareholders of record.Issuer Purchases of Equity SecuritiesDuring fiscal 2022, fiscal 2021 and fiscal 2020, we repurchased 4,613,696, 9,156,898 and 3,982,478 shares of common stock, respectively, on the open market at a total cost of $647.5 million, $950.0 million and $400.0 million, respectively. The fiscal 2022 share repurchases occurred prior to the fourth quarter. As of January 28, 2023, we had $1.85 billion remaining under our Board repurchase authorization. The repurchase authorization does not have an expiration date.Stockholder MattersWe anticipate that substantially all of our cash flow from operations in the foreseeable future will be retained for the development and expansion of our business, the repayment of indebtedness and, as authorized by our Board of Directors, the repurchase of stock. We do not anticipate paying cash dividends on our common stock in the foreseeable future. 23Table of ContentsStock Performance GraphThe following graph sets forth the yearly percentage change in the cumulative total shareholder return on our common stock during the five fiscal years ended January 28, 2023, compared with the cumulative total returns of the S&P 500 Index and the S&P 500 Retailing Index. The comparison assumes that $100 was invested in our common stock on February 3, 2018, and, in each of the foregoing indices on February 3, 2018, and that dividends were reinvested. The stock price performance shown in the graph is not necessarily indicative of future price performance.Year EndedFebruary 3, 2018February 2, 2019February 1, 2020January 30, 2021January 29, 2022January 28, 2023Dollar Tree, Inc.$100.00 $88.84 $80.01 $93.41 $118.06 $138.17 S&P 500 Index100.00 97.69 118.87 139.37 171.83 157.71 S&P 500 Retailing Index100.00 108.42 127.45 180.19 195.77 160.10 Item 6. Reserved24Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThis section of Form 10-K generally discusses 2022 and 2021 events and results and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 29, 2022.In Management’s Discussion and Analysis, we explain the general financial condition and the results of operations for our company, including, factors that affect our business, analysis of annual changes in certain line items in the consolidated financial statements, performance of each of our operating segments, expenditures incurred for capital projects and sources of funding for future expenditures. As you read Management’s Discussion and Analysis, please refer to our consolidated financial statements and related notes, included in “
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+Item 7. Government Regulation We, along with our franchisees, are subject to various federal, state and local laws affecting the operation of our business. Each store is subject to licensing and regulation by a number of governmental authorities, which include zoning, health, safety, sanitation, building and fire agencies in the jurisdiction in which the store is located. In connection with maintaining our stores, we may be required to expend funds to meet certain federal, state and local regulations, including regulations requiring that remodeled or altered stores be accessible to persons with disabilities. Difficulties in obtaining, or the failure to obtain, required licenses or approvals could delay or prevent the opening of a new store in a particular area or cause an existing store to cease operations. Our supply chain facilities are also licensed and subject to similar regulations by federal, state and local health and fire codes. We are also subject to the Fair Labor Standards Act and various other federal and state laws governing such matters as minimum wage requirements, overtime and other working conditions and citizenship requirements. Labor costs are largely a function of the minimum wage for a majority of our store personnel and certain supply chain personnel. A significant number of both our and our franchisees’ food service personnel are paid at rates related to the applicable minimum wage, and past increases in the minimum wage have increased labor costs, as would future increases. We are subject to the rules and regulations of the Federal Trade Commission (“FTC”) and various state laws regulating the offer and sale of franchises. The FTC and various state laws require that we furnish a franchise disclosure document containing certain information to prospective franchisees, and a number of states require registration of the franchise disclosure document with state authorities. We are operating under exemptions from registration in several states based on the net worth of our subsidiary, Domino’s Pizza Franchising LLC, and experience. We believe our franchise disclosure document, together with any applicable state versions or supplements, and franchising procedures comply in all material respects with both the FTC guidelines and all applicable state laws regulating franchising in those states in which we have offered franchises. Internationally, our franchise stores are subject to national and local laws and regulations that are often similar to those affecting our U.S. stores, including laws and regulations concerning franchises, labor, health, sanitation and safety. Our international stores are also often subject to tariffs and regulations on imported commodities and equipment, and laws regulating foreign investment. We believe our international disclosure statements, franchise offering documents and franchising procedures comply in all material respects with the laws of the foreign countries in which we have offered franchises. Privacy and Data Protection We are subject to a number of privacy and data protection laws and regulations both in the U.S. and globally. The legislative and regulatory landscape for privacy and data protection continues to evolve, and there has been an increase in attention given to privacy and data protection issues with the potential to directly affect our business. This includes recently-enacted laws and regulations in the U.S. and internationally requiring notification to individuals and government authorities of security breaches involving certain categories of personal information. Any changes in privacy or data protection laws or regulations could also impact our marketing techniques and could change our marketing strategies. We have a privacy policy posted on our website at dominos.com. The security of our financial data, customer information and other personal information is a priority for us. Trademarks We have many registered trademarks and believe that the Domino’s mark and Domino’s Pizza names and logos, in particular, have significant value and are important to our business. Our policy is to pursue registration of our trademarks and to vigorously oppose the infringement of any of our trademarks. We license the use of our registered marks to franchisees through franchise agreements. 13 Environmental Matters We are not aware of any federal, state or local environmental laws or regulations that we would expect to materially affect our earnings or competitive position or result in material capital expenditures. However, we cannot predict the effect of possible future environmental legislation or regulations. During 2022, there were no material environmental compliance-related capital expenditures, and no such material expenditures are anticipated in 2023. Available Information The Company makes available, free of charge, through its internet website ir.dominos.com, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those reports filed or furnished pursuant to Section 13(a), 15(d), or 16 of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after electronically filing such material with the Securities and Exchange Commission. Materials filed with the Securities and Exchange Commission are available at sec.gov. Retail orders from Domino’s stores can be made through its website dominos.com. The reference to these website addresses anywhere in this Annual Report on Form 10-K (the “Form 10-K”) does not constitute incorporation by reference of the information contained on the websites and information appearing on those websites, including ir.dominos.com, stewardship.dominos.com and dominos.com, should not be considered a part of this document. 14 Item 1A. Risk Factors. For a business as large and globally diverse as the Company, a wide range of factors could materially affect future developments and performance. In addition to the factors affecting specific business operations identified in connection with the description of these operations and the financial results of these operations elsewhere in this report and our other filings with the SEC, we believe the most significant risk factors affecting our business include the following: Business, Operational and Industry Risks The quick service restaurant (“QSR”) pizza category and the food service and food delivery markets in general are highly competitive and such competition could adversely affect our operating results. In the U.S., we compete primarily against regional and local companies as well as national chains Pizza Hut®, Papa John’s® and Little Caesars Pizza®. Internationally, we compete primarily with Pizza Hut®, Papa John’s® and country-specific national, regional and local companies. We may experience increased competition from existing or new companies in the delivery and carryout pizza categories, in addition to competition from order and delivery aggregators both in the pizza category and more broadly, that may create increasing pressures to grow our business in order to maintain our market share. Competition for both customers and drivers from these order and delivery aggregators and other food delivery services has substantially increased as order and delivery aggregators have continued to grow in size and scale. Additionally, we face competition from the supermarket industry and meal kit and food delivery providers, with the improvement of prepared food and meal kit offerings, expansion in meal delivery platforms and services and the trend towards convergence in grocery, deli, retail and restaurant services. We also compete on a broader scale with quick service and other international, national, regional and local restaurants. The overall food service market, food delivery market and the QSR market are intensely competitive with respect to food quality, price, service, image, convenience and concept, and are often affected by changes in: •consumer tastes; •international, national, regional or local economic conditions; •marketing, advertising and pricing, including both price increases and discounting; •disposable purchasing power and demographic trends; and •currency fluctuations related to international operations. We compete within the food service market and the QSR market not only for customers, but also for management and hourly employees, including store team members, drivers and qualified franchisees, as well as suitable real estate sites. We and our franchisees have faced an increasingly competitive labor market due to sustained labor shortages and increased turnover resulting in part from the ongoing COVID-19 pandemic which has caused us and our franchisees to in certain cases reduce store hours and delay store openings, and has in the past prevented us from running promotions, which has impacted our sales, service levels and customer acquisition and experience and could ultimately impact our growth and competitive position. Our success is also dependent in large part upon our ability to maintain and enhance the goodwill and reputation of our brand, our customers’ connection to our brand, and a positive relationship with our franchisees and the communities in which we and our franchisees operate. Our supply chain segment is also subject to competition from outside suppliers. While substantially all U.S. franchisees purchased food, equipment and supplies from us in 2022, U.S. franchisees are not required to purchase food, equipment or supplies from us and they may choose to purchase from outside suppliers. If other suppliers who meet our qualification standards were to offer lower prices or better service to our franchisees for their ingredients and supplies and, as a result, our franchisees chose not to purchase from our U.S. supply chain centers, our financial condition, business and results of operations would be adversely affected. If we are unable to maintain our competitive position, we could experience downward pressure on prices, lower demand for our products, reduced margins, loss of management or hourly employees, reduced service levels, disruption in our supply chain, the inability to take advantage of new business opportunities and the loss of market share, all of which would have an adverse effect on our operating results and could cause our stock price to decline. If we fail to successfully implement our growth strategy, which includes opening new U.S. and international stores, our ability to increase our revenues and operating profits could be adversely affected. A significant component of our growth strategy includes the opening of new U.S. (both Company-owned as well as franchised stores) and international franchised stores. We and our franchisees face many challenges in opening new stores, including, among others: 15 •construction, permitting or development delays, including those relating to the ongoing COVID-19 pandemic; •employment and training of qualified personnel, including availability of store team members; •selection and availability of suitable new store sites and the ability to renew leases in quality locations; •availability and negotiation of leases and financing with acceptable terms; •securing required U.S. or foreign governmental permits, licenses and approvals; and •general economic and business conditions, including increases in food costs and labor costs which could impact profitability and demand for new stores. The opening of additional franchise stores also depends, in part, upon the availability of prospective franchisees who meet our criteria, the ability of these franchisees to attract and retain qualified personnel and their desire to open new stores. Our failure to add a significant number of new stores would adversely affect our ability to increase revenues and operating income. Additionally, our growth strategy and the success of new stores depend in large part on the availability of suitable store sites and leases. We and our franchisees are currently planning to expand our U.S. and international operations in many of the markets where we currently operate and in select new markets. This may require considerable management time as well as start-up expenses for market development before any significant revenues and earnings are generated. Operations in new markets may achieve low margins or may be unprofitable, and expansion in existing markets may be affected by local economic and market conditions. In addition, we expect to continue our strategy of building additional stores in markets and regions where we have existing stores, a strategy we refer to as “fortressing,” which may negatively impact sales at existing stores. Therefore, as we continue to expand, we or our franchisees may not experience the gross margins we expect, our results of operations may be negatively impacted, and our stock price may decline. Additionally, we have an equity investment in DPC Dash Ltd (“DPC Dash”), as further discussed elsewhere in this report. Through its subsidiaries, DPC Dash serves as the Company’s master franchisee in China that owns and operates Domino’s Pizza stores in that market. These types of investments are inherently risky. If DPC Dash does not succeed or is unable to successfully execute its growth strategy, we may be forced to record impairment charges and could lose some or all of our investment. As part of our growth strategy, we may decide to increase or decrease the number of Company-owned stores, either by refranchising existing Company-owned stores or by purchasing existing franchised stores, as we have done in the past. Our failure to successfully execute these transactions could have an adverse effect on our operating results and could cause our stock price to decline. Increases in food, labor and other costs, labor shortages or negative economic conditions could adversely affect our profitability and operating results. Given the inflation rates in fiscal 2022, which we anticipate may continue, there has been and may continue to be significant increases in food costs and labor costs which have impacted and could further impact our profitability and that of our franchisees and which could impact the opening of new U.S. and international franchised stores and adversely affect our operating results. Inflationary pressures may also impact the discretionary purchasing power of our customers, especially customers with less disposable income or for whom discretionary spending represents a smaller portion of their disposable income, resulting in decreased demand for our products. Matters having a broad global economic impact may also significantly impact particular costs, such as the ongoing Russia-Ukraine conflict’s impact on our transportation and energy costs. We have experienced increased labor shortages at many of our stores and supply chain centers and our franchisees have experienced similar labor shortages at their stores. While there historically has been some level of ordinary course turnover of employees, the ongoing COVID-19 pandemic and resulting actions and impacts have exacerbated labor shortages and increased turnover. Labor shortages and increased turnover rates within our team members and the employees of our franchisees have led to and could in the future lead to increased costs, such as increased overtime to meet demand and increased wage rates to attract and retain team members and could negatively affect our and our franchisees’ ability to efficiently operate our respective businesses and result in a negative impact on service and customer experience. Factors such as inflation, increased food costs, increased labor and employee health and benefit costs, increased rent costs, increased transportation costs and increased energy costs may adversely affect our operating costs and profitability and those of our franchisees and could result in menu price increases, which could impact consumer demand. An economic environment characterized by high unemployment, rising interest rates, cautious consumer spending, or changes in consumer practices due to a possible recession could also impact consumer spending or demand and our operating results. Most of the factors affecting costs are beyond our control and, in many cases, we may not be able to pass along these increased costs to our customers or franchisees and to the extent we were to raise menu prices to offset these costs, could result in decreased consumer demand, sales and profitability. 16 Most ingredients used in our pizza, particularly cheese, are subject to significant price fluctuations as a result of seasonality, weather, demand and other factors. For example, we have experienced increased volatility in prices for some ingredients in recent years and during the ongoing COVID-19 pandemic, which may continue even if the pandemic recedes. Cheese is a significant cost to us, representing approximately 25% of the market basket purchased by our Company-owned stores. Additionally, while we strive to engage in a competitive bidding process for our ingredients, because certain of these ingredients, including meat products, may only be available from a limited number of vendors, we may not always be able to do so effectively. Furthermore, if we need to seek new suppliers, including as a result of expiration of existing supply agreements, we may be subject to pricing or other terms less favorable to us than those reflected in our current supply arrangements. Labor costs are largely a function of the minimum wage for a majority of our store personnel and certain supply chain center personnel and, generally, are also a function of the availability of labor. In addition to the increases in labor costs described above, several jurisdictions in which we and our franchisees operate have recently approved minimum wage increases. Federal, state and local proposals that increase minimum wage requirements or mandate other employee matters could, to the extent implemented, materially increase labor and other costs. As more jurisdictions implement minimum wage increases, we expect that labor costs will continue to increase. For example, labor and regulatory compliance costs could be adversely impacted as a result of California Assembly Bill No. 257, the Fast Food Accountability and Standards Recovery Act (“FAST Act”), which was signed into law in September 2022. The FAST Act, which is currently subject to a referendum campaign, authorizes the creation of a council to set minimum standards for workers in the industry, including for wages, working hours and other health and safety conditions. The implementation of the FAST Act could result in increased labor cost at franchised restaurants in California, thereby potentially impacting their profitability. Further, this bill could prompt similar legislation in other states or localities. The advent of legislation aimed at predictive scheduling may impact labor for our stores and our franchisees’ stores. Additionally, while we do not currently have any unionized employees, certain employees of other companies in our industry have recently become unionized. If a significant portion of our employees were to become unionized, our labor costs could increase and our business could be negatively affected by other union requirements that increase our costs, disrupt our business, reduce our flexibility and impact our employee culture. Further, our responses to any union organizing efforts could negatively impact how our brand is perceived. Labor costs and food costs, including cheese, generally represent approximately 55% to 65% of the sales at a typical Company-owned store. Worldwide economic activity has been and is expected to continue to be adversely affected by the ongoing COVID-19 pandemic, the scale and scope of which is ultimately unknown, which could adversely affect our business, financial condition and results of operations. The ongoing global COVID-19 pandemic continues to impact worldwide economic activity and create uncertainty. A public health pandemic such as COVID-19 poses the risk that we and/or our employees, franchisees, supply chain centers, suppliers, customers and other partners may be prevented from, or be limited in, conducting business activities for an indefinite period of time, including due to restrictions that have been or may be suggested or mandated by governmental authorities, or due to the impact of the disease itself on a business’ workforces. In response to governmental requirements, we and our franchisees have in the past implemented a number of measures, including, among others, temporarily closing certain stores, modifying stores’ hours and closing locations to in-store dining. We continue to monitor ongoing developments, and future potential federal, state or local COVID-19-related mandates could materially impact our results, including due to additional compliance costs as a result of any imposed mandate. While it is not possible at this time to estimate the full impact that COVID-19 could have on our business going forward, the continued spread of the virus and the measures taken in response have in the past disrupted, and in the future may disrupt, our operations and could disrupt our supply chain, which could adversely impact our business, financial condition and results of operations. The COVID-19 pandemic and mitigation measures have also impacted global economic conditions, which could have an adverse effect on our business and financial condition. The Company’s sales and operating results may be affected by uncertain or changing economic and market conditions arising in connection with and in response to the COVID-19 pandemic, including inflation, changes to consumer demand, availability of labor or other changes. While the Company has seen an increase in sales in certain markets, including within the U.S., at times during the COVID-19 pandemic, including increased sales related to heightened reliance on delivery and carryout businesses, future sales and same store sales are not possible to estimate and it is unclear whether and to what extent sales will return to more normalized levels or lessen if and when consumer behavior and general economic and business activity return to pre-pandemic levels. The significance of the operational and financial impact to the Company will depend on how long and widespread the disruptions caused by COVID-19, and the corresponding response to contain the virus and treat those affected by it, prove to be. 17 Shortages, interruptions or disruptions in the supply or delivery of fresh food products and store equipment could adversely affect our operating results. We and our franchisees are dependent on frequent deliveries of food products that meet our specifications as well as adequate supply of store equipment. We have single suppliers or a limited number of suppliers for certain of our ingredients, including pizza cheese and meat toppings. While we believe there are adequate reserve quantities and potential alternative suppliers, shortages, interruptions, or disruptions in the supply of food products and store equipment caused by increased demand, capacity constraints, expiration of existing agreements, problems in production or distribution, product recalls, financial or other difficulties of suppliers, inclement weather or other conditions could adversely affect the availability, quality and cost of ingredients and equipment. We have in the past experienced disruptions within our supply chain resulting from, among other things, capacity, volume, systems, staffing, operational and COVID-19-related challenges and may experience such supply chain disruptions again in the future, which could materially and adversely affect our business and operational results. Additionally, the effects of climate change could increase the frequency and duration of weather impacts on our operations and could adversely affect our operating results. The food service market is affected by consumer preferences and perceptions. Changes in these preferences and perceptions may reduce the demand for our products, which would reduce sales and harm our business. Food service businesses are affected by changes in consumer tastes, international, national, regional and local economic conditions, marketing, advertising, pricing, including both price increases and discounting, and demographic trends. For instance, if prevailing health or dietary preferences cause consumers to avoid pizza and other products we offer in favor of foods that are perceived as healthier, or consumers shift away from delivery or carryout food, our business and operating results would be harmed. Moreover, because we are primarily dependent on a single product, if consumer demand for pizza should decrease, our business would suffer more than if we had a more diversified menu, as many other food service businesses do. The preferences of customers also may change as a result of advances in technology or alternative delivery methods or channels. If we are not able to respond to these changes, or our competitors respond to these changes more effectively than us, our business and operating results could be adversely affected. Reports of product contamination, food-borne illness or food tampering or other events which may impact our reputation may reduce sales and harm our business. Reports, whether true or not, of product contamination, food-borne illnesses (such as E. coli, avian flu, bovine spongiform encephalopathy, hepatitis A, trichinosis or salmonella) and injuries caused by food tampering have in the past severely injured the reputations of participants in the QSR market and could in the future as well. These events could occur both at the store and supply chain center levels. If such an event was to occur, we may not be able to respond to it quickly and effectively. The potential for acts of terrorism affecting our global food supply also exists and, if such an event occurs, could have a negative impact on us and could severely hurt sales and profits. In addition, our reputation is an important asset; as a result, anything that damages our reputation could immediately and severely affect our sales and profits. Further, a boycott or other campaign critical of us, through social media or otherwise, could negatively impact our brand’s reputation and, consequently, sales. Media reports of product contamination, illnesses and injuries, whether accurate or not, could force some stores to close or otherwise reduce sales at such stores. Moreover, as further described below, social media has dramatically increased the rate at which negative publicity, including as it relates to food-borne illness, can be disseminated before there is any meaningful opportunity to respond to or address an issue. Even reports of food-borne illnesses or food tampering occurring solely at the restaurants of competitors could, by resulting in negative publicity about the restaurant industry in general, adversely affect us on a local, regional, national or international basis. Our international operations expose us to further risk as our master franchisees are responsible for obtaining their own supply of food and equipment, subject to their compliance with our quality standards. A decrease in sales due to these health concerns, any negative publicity or as a result of the closure of any Domino’s stores could adversely affect our results of operations. We do not have long-term contracts with certain of our suppliers, or have contracts which are set to expire, and as a result they could seek to significantly increase prices or fail to deliver. We do not have long-term contracts or arrangements, or have contracts which are set to expire, with certain of our suppliers. Although in the past we have not experienced significant problems with our suppliers, our suppliers may implement significant price increases or may not meet our requirements, including those that may result from increases in volume, in a timely fashion or at all. The occurrence of any of the foregoing could have a material adverse effect on the ability of our supply chain centers to deliver necessary products to our stores and those of our franchisees and on our results of operations. 18 Any prolonged disruption in the operations of any of our dough manufacturing and supply chain centers could harm our business. In the U.S., we operate 22 regional dough manufacturing and supply chain centers, two thin crust manufacturing facilities, one vegetable processing center and one center providing equipment and supplies to our U.S. and certain international stores. We also operate five dough manufacturing and supply chain centers in Canada. We plan to continue investing in supply chain productivity initiatives in the future. Our U.S. dough manufacturing and supply chain centers service all of our Company-owned and substantially all of our U.S. franchise stores. As a result, any prolonged disruption in the operations of any of these facilities, whether due to technical, systems, operational or labor difficulties, destruction or damage to the facility, real estate issues, limited capacity or other reasons, or our failure to successfully increase capacity and open new centers, could adversely affect our business and operating results. Our inability or failure to recognize, respond to and effectively manage the accelerated impact of social media could adversely impact our business. The use of social media platforms and other consumer-oriented technologies has increased the speed and accessibility of information dissemination and given users the ability to more effectively organize collective actions such as boycotts and other brand-damaging behaviors. Negative publicity related to our food products, operations, or stores or related to our operations or actions by our executives, team members or franchisees and their team members or others perceived to be associated with our brand could harm our business, brand, reputation, marketing partners, financial condition and results of operations, regardless of the accuracy of such negative publicity. Failure to use or respond to social media campaigns effectively could lead to a decline in brand value and revenue. Our success depends in part upon effective advertising, and lower advertising funds may reduce our ability to adequately market the Domino’s Pizza brand. We have been routinely named a Leading National Advertiser by Advertising Age and our success depends in part on continued effective advertising. Each Domino’s store located in the U.S. is obligated to contribute 6% of its sales to DNAF, which uses such fees for national advertising in addition to contributions for local market-level advertising. We currently anticipate that this 6% obligation will remain in place for the foreseeable future, though the actual contribution rate could be lower in certain instances due to certain incentives and waivers. While additional funds for advertising in the past have been provided by us, our franchisees and other third parties, none of these additional funds are legally required. The lack of continued financial support for advertising activities could significantly curtail our marketing efforts, which may in turn affect our business and our operating results. Loss of key employees or our inability to attract and retain new qualified employees could hurt our business and inhibit our ability to operate and grow successfully. Our success in the highly competitive pizza delivery and carryout business will continue to depend to a significant extent on our leadership team and other key management personnel. Although we have entered into employment agreements with Russell J. Weiner and Joseph H. Jordan, each of these executives may terminate his agreement on ninety days’ notice. Our other executive officers may terminate their employment pursuant to their employment agreements at any time. As a result, we may not be able to retain our executive officers and key personnel or attract additional qualified management. While we do not have long-term employment agreements with our executive officers, for all of our executive officers we have non-compete and non-solicitation agreements that extend for 24 months following the termination of such executive officer’s employment, although the FTC has proposed a new rule that would ban the use of non-compete agreements. Our success will also continue to depend on our ability to attract and retain qualified personnel to operate our stores, dough manufacturing and supply chain centers and international operations. The loss of these employees or our inability to recruit and retain qualified personnel, including general managers or other store-level team members, or our inability to adequately respond to changes in the labor market, could adversely affect our operating results. Changes we make to our current and future work environments may not meet the needs or expectations of our employees and may be perceived as less favorable compared to other companies' policies, which could negatively impact our ability to hire and retain qualified personnel. 19 Our international operations subject us to additional risk. Such risks and costs may differ in each country in which we and our franchisees do business and may cause our profitability to decline due to increased costs. We conduct a significant and growing portion of our business outside the U.S. Our financial condition and results of operations may be adversely affected if global markets in which our franchised stores compete are affected by changes in political, economic or other factors. These factors, many over which neither we nor our master franchisees have control, may include both internal and external factors including: •recessionary or expansive trends in international markets and global markets and economic downturns; •changing labor conditions and difficulties in staffing and managing our foreign operations; •increases in the taxes we pay and other changes in applicable tax laws both in the U.S. and globally; •tariffs and trade barriers or foreign policy changes; •legal and regulatory changes, and the burdens and costs of our compliance with a variety of foreign laws; •changes in inflation rates or foreign exchange rates and the imposition of restrictions on currency conversion or the transfer of funds; •ongoing and new relationships between our master franchisees and order and delivery aggregators our master franchisees may partner with internationally and the success of those aggregators and relationships; •difficulty in collecting our royalties and longer payment cycles; •expropriation of private enterprises; •the inherent risk of doing business in China resulting from our equity investment in DPC Dash; •national and international conflicts, sanctions, acts of war or terrorist acts; •increases in anti-American sentiment and the identification of Domino’s as an American brand; and •political and economic instability and uncertainty around the world. Our earnings and business growth strategy depend on the success of our franchisees, and we may be harmed by actions taken by our franchisees, or employees of our franchisees, that are outside of our control. A significant portion of our earnings comes from royalties and fees generated by our franchise stores. Franchisees are independent operators, and their employees are not our employees. We provide tools that franchisees can consider using in training their employees, but the quality of franchise store operations and our brand and branded products may be diminished by numerous factors beyond our control. Consequently, franchisees may not operate stores in a manner consistent with our standards and requirements or they or their employees may take other actions that adversely affect the value of our brand. In such event, our business and reputation may suffer, and as a result our revenues and stock price could decline. Our success also depends in part on continuing positive relationships with our franchisees (and positive relationships between our international master franchisees and their corresponding sub-franchisees) and if those relationships were to deteriorate, our revenues and stock price could decline. While we try to ensure that franchisees maintain the quality of the Domino’s brand and branded products and comply with their franchise agreements, franchisees may take actions that adversely affect the value of our intellectual property or reputation or that are inconsistent with their contractual obligations. Although our franchise arrangements permit the applicable franchisor to terminate a franchise agreement under certain circumstances, including the failure by franchisees to uphold product or operating standards, there can be no assurance that such remedy will be available or sufficient to prevent harm to our brand and protect our intellectual property. As of January 1, 2023, we had 725 U.S. franchisees operating 6,400 U.S. stores. As of that same date, 22 of these franchisees each owned and operated more than 50 U.S. stores, including our largest U.S. franchisee who owned and operated 162 stores and the average U.S. franchisee owned and operated approximately nine stores. Our international master franchisees are generally responsible for the development of significantly more stores than our U.S. franchisees. As a result, our international operations are more closely tied to the success of a smaller number of franchisees than our U.S. operations. As of January 1, 2023, our largest international master franchisee operated 3,751 stores in 13 markets, which accounted for approximately 28% of our total international store count. Our U.S. and international franchisees may not operate their franchises successfully. If one or more of our key franchisees were to become insolvent or otherwise were unable or unwilling to pay us our royalties or other amounts owed, our business and results of operations would be adversely affected. 20 We may not be able to adequately protect our intellectual property, which could harm the value of our brand and branded products and adversely affect our business. We depend in large part on our brand and branded products and believe that they are very important to our business. We rely on a combination of trademarks, copyrights, domain names, patents, trade secrets and similar intellectual property rights to protect our brand and branded products. The success of our business depends on our continued ability to use our existing trademarks in order to capitalize on our name recognition, increase brand awareness and further develop our branded products in both U.S. and international markets. We have registered certain trademarks and have other trademark applications pending in the U.S. and foreign jurisdictions. Not all of the trademarks or domain names that we currently use or contemplate using have been registered in all of the countries in which we do business, and they may never be registered in all of these countries. Some countries’ laws do not protect unregistered trademarks at all, or make them more difficult to enforce, and third parties may have filed for “Domino’s” or similar marks in countries where Domino’s has not registered its brand for reasons including lack of presence by the brand where actual use is required to obtain trademark registration. Accordingly, we may not be able to adequately protect our trademarks everywhere in the world and our use of these trademarks may result in liability for trademark infringement, trademark dilution or unfair competition. All of the steps we have taken to protect our intellectual property globally may not be adequate. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the U.S. We may, from time to time, be required to institute or defend litigation to enforce our intellectual property rights, or to protect our trade secrets. Such litigation could result in substantial costs and diversion of resources and could negatively affect our sales, profitability and prospects regardless of whether we are able to successfully enforce our rights. The occurrence of cyber incidents, or a deficiency in cybersecurity, could negatively impact our business by causing a disruption to our operations, a compromise or corruption of confidential information, or damage to our employee and business relationships, any of which could subject us to loss and harm our brand. A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of information resources. More specifically, a cyber incident is an intentional attack or an unintentional event that can include gaining unauthorized access to systems to disrupt operations, corrupt data or steal confidential information about customers, franchisees, suppliers or employees. Many retailers and other companies have recently experienced serious cyber incidents and breaches of their information technology systems. As our reliance on technology has increased, so have the risks posed to our systems, both internal and those we have outsourced and we may further be negatively impacted to the extent outdated or legacy systems cease to function appropriately. We have in the past been and in the future may also be subject to negative impacts to our business caused by cyber incidents relating to our third-party service providers or the service providers of those third parties or our franchisees. The primary risks that could directly result from the occurrence of a cyber incident include operational interruption, damage to our relationships with customers, franchisees and employees, private data exposure, including payment card or other financial data, public relations impact and regulatory fines. In addition to maintaining insurance coverage to address cyber incidents, we have also implemented processes, procedures and controls to help mitigate these risks. However, our cyber insurance coverage may not fully cover all of the costs associated with a cyber incident and these measures, as well as our increased awareness of the risk of a cyber incident, do not guarantee that our reputation and financial results will not be materially and adversely affected by such an incident. Our and our franchisees’ operations depend upon our ability and the ability of franchisees, third-party service providers and the service providers of those third parties (as well as franchisees’ third-party service providers and the service providers of those third parties), to protect computer equipment and systems against damage from theft, fire, power loss, telecommunications failure and other catastrophic or unanticipated events, as well as internal and external security incidents, viruses, denial-of-service attacks, phishing attacks, ransomware attacks and other intentional or unintentional disruptions. A significant portion of our retail sales depends on the continuing operation of our information technology and communications systems, including Domino’s PULSE™, our online and mobile ordering platforms and our credit card processing systems. The failure of these systems to operate effectively, stemming from maintenance problems, upgrading or transitioning to new platforms, a compromise in our security or other unanticipated problems has at times in the past and in the future could result in interruptions to or delays in our and our franchisees’ operations, and some of our systems are not fully redundant. The occurrence of a natural disaster, intentional sabotage or other unanticipated problems could result in lengthy interruptions in service. In addition, the implementation of technology changes and upgrades to maintain and upgrade our systems, errors or vulnerabilities in our systems, or damage to or failure of our systems, including because of systems becoming obsolete, could result in interruptions in our services and non-compliance with certain laws or regulations, which could reduce our sales, revenues and profits and damage our business and brand. 21 Additionally, we have seen a significant increase in remote working that, particularly in light of such remote working continuing for an extended period of time, could exacerbate certain risks to our business, including an increased risk of cyber incidents and improper dissemination of personal or confidential information. Because we and our franchisees accept electronic forms of payment from customers including credit cards, our business requires the collection and retention of customer data, including sensitive financial data and other personally identifiable information in various information systems that are maintained by third parties with whom we and our franchisees contract to provide payment processing. A weakness in such third party’s systems or software products (or in the systems or software products in the service providers of those third parties) may provide a mechanism for a cyber threat. In recent years, a significant number of companies have experienced security data breaches in which customer information was stolen through vendor access channels. Cyber-attacks and security data breaches at a payment processing contractor could compromise confidential information or adversely affect our ability to deliver products and services to our customers. There is also a potential heightened risk of cyber security incidents as a result of geopolitical events outside of our control, such as the ongoing Russia-Ukraine conflict. These problems could negatively affect our results of operations, and remediation could result in significant, unplanned capital investments. We also maintain important internal Company data, such as personally identifiable information about our employees and franchisees and information relating to our operations. In addition, more than 80% of our U.S. retail sales in 2022 were derived from digital channels, primarily through our online ordering website and mobile applications, where customers enter personally identifiable information that we retain. Our use and retention of personally identifiable information is regulated by foreign, federal and state laws and regulations, as well as by certain third-party agreements. For example, the Court of Justice of the European Union invalidated the U.S. – E.U. Privacy Shield framework, which was a commonly relied upon mechanism for exchanging personal data from the European Union to the U.S., in the July 16, 2020 “Schrems II” decision (Case C-311/18 Data Protection Commissioner v. Facebook Ireland and Maximillian Schrems) and the State of California has adopted the California Privacy Rights Act of 2020, an amendment to the California Consumer Privacy Act, both of which may require companies to change their practices for handling of personal data. In addition, the State of New York promulgated the New York SHIELD Act which has imposed obligations on businesses to implement physical, administrative and technical security measures to protect personal data. As privacy and information security laws and regulations change, we may incur additional costs to ensure that we remain in compliance with those laws and regulations, and our current and future planned uses of personal and other data may be adversely affected by future adopted privacy and information security laws, regulations and rulings. If our security and information systems are compromised or if we, our employees or franchisees fail to comply with these laws, regulations or contract terms, or to successfully implement processes related to requirements, laws and regulations governing cyber incidents could require us to notify customers, employees or other groups, and could result in adverse publicity, loss of sales and cash flows, increased fees payable to third parties and fines, penalties or remediation and other costs that could adversely affect our reputation, business and results of operations. Any other material disruption or other adverse event affecting one or more of our digital ordering platforms, including, for instance, power loss, technological or systems failures, user error or cyber-attacks, could similarly result in adverse publicity, loss of sales and cash flows and other costs, which could in turn materially and adversely affect our reputation, business and results of operations. We cannot predict the impact that new or improved technologies, alternative methods of delivery, including autonomous vehicle delivery, or changes in consumer or employee behavior facilitated by these technologies and alternative methods of delivery will have on our business. Advances in technologies or alternative methods of delivery, including advances in digital ordering technology and autonomous vehicle delivery, or certain changes in consumer behavior driven by these or other technologies and methods of delivery could have a negative effect on our business and market position. Moreover, technology and consumer offerings continue to develop, and we expect that new or enhanced technologies and consumer offerings will be available in the future. We may pursue certain of those technologies and consumer offerings if we believe they offer a sustainable customer proposition and can be successfully integrated into our business model. However, we cannot predict consumer acceptance of these delivery channels or their impact on our business. In addition, our competitors, some of whom have greater resources than we do, may be able to benefit from changes in technologies or consumer acceptance of alternative methods of delivery, which could harm our competitive position. There can be no assurance that we will be able to successfully respond to changing consumer preferences, including with respect to new technologies and alternative methods of delivery, or to effectively adjust our product mix, service offerings, and marketing and merchandising initiatives for products and services that address, and anticipate advances in, technology and market trends. Alternative methods of delivery may also impact the potential labor pool from which we recruit our delivery experts and could reduce the available supply of labor. 22 If we are not able to successfully respond to these challenges, our business, market share, financial condition, and operating results could be materially and adversely affected. We are subject to a variety of additional risks associated with our franchisees. Our franchise system subjects us to a number of additional risks, any one of which may impact our ability to collect royalty payments and fees from our franchisees, may harm the goodwill associated with our brand, and/or may materially and adversely impact our business and results of operations. Such risks may also apply to us as owners of stores. These risks include, but are not limited to: •those relating to the application of local, state, federal and foreign bankruptcy laws and other applicable laws governing creditors’ rights generally and the impact such laws could have on our ability to collect payments and fees under applicable franchise agreements; •those relating to franchisees that are operating entities, which generally are not limited-purpose entities, including business, credit, financial and other risks in addition to risks related to unions; •those relating to franchisee changes in control and succession in general and the ability to find acceptable successors who are able to perform a former franchisee’s obligations under applicable franchise agreements or successfully operate impacted stores in the event of a change of control or other succession event; •those relating to franchisee insurance, including the inadequacy of, or inability to obtain, insurance coverage, losses in excess of policy limits or payments not being made on a timely basis, extraordinary hazards not being subject to coverage (or only being subject to coverage at prohibitively high rates) or third parties seeking to recover losses from us to the extent those losses experienced by such third parties are either not covered by the franchisee’s insurance or exceed the policy limits of the franchisee’s insurance; •those relating to instances of termination of or default under a franchisee’s franchise agreement or the non-renewal thereof at the end of such agreement’s expiration date and the corresponding impact on the franchisee’s or our operations; •those relating to product liability exposure or noncompliance with labor and employment, health and safety regulations and the impact such events could have on a franchisee’s ability to make payments under applicable franchise agreements, on us if an aggrieved party seeks to recover their losses from us and on our brand’s reputation; •the imposition of injunctive relief, fines, damage awards or capital expenditures under laws or regulations that could adversely affect the ability of a franchisee to make payments under applicable franchise agreements; •litigation involving franchisees, including litigation involving us or litigation involving a third-party directed at a franchisee, which could impede the ability of a defendant-franchisee to make its royalty payments and divert our resources regardless of whether the allegations in such litigation are valid or whether we are liable; and •those relating to the reliance of a franchised store business on its franchisees and the nature of franchisees in general, including the retention of franchisees (especially including our top-performing franchisees) in the future or our ability to attract, retain, and motivate sufficient numbers of franchisees of the same caliber in the future as well as our ability to maintain a positive and constructive relationship with our franchisees. Our current insurance coverage may not be adequate, insurance premiums for such coverage may increase and we may not be able to obtain insurance at acceptable rates, or at all. For certain periods prior to December 1998 and for periods after December 2001, we maintain insurance coverage for workers’ compensation, general liability and owned and non-owned automobile liabilities. We are generally responsible for up to $2.0 million per occurrence under these retention programs for workers’ compensation and general liability, depending on policy year and line of coverage. We are generally responsible for up to between $500,000 and $5.5 million per occurrence under these retention programs for owned and non-owned automobile liabilities, depending on policy year and line of coverage. Total insurance limits under these retention programs vary depending upon the period covered and range up to $110.0 million per occurrence for general liability and owned and non-owned automobile liabilities and up to the applicable statutory limits for workers’ compensation. These insurance policies may not be adequate to protect us from liabilities that we incur in our business. In addition, in the future our insurance premiums may increase, and we may not be able to obtain similar levels of insurance on reasonable terms, or at all. Any such inadequacy of, or inability to obtain insurance coverage could have a material adverse effect on our business, financial condition and results of operations. 23 Environmental, social and governance matters may impact our business and reputation. Increasingly, in addition to the importance of their financial performance, companies are being judged by their performance on a variety of environmental, social and governance (“ESG”) matters, which are considered to contribute to the long-term sustainability of companies’ performance. A variety of organizations measure the performance of companies on such ESG topics, and the results of these assessments are widely publicized. In addition, major institutional investors have publicly emphasized the importance of such ESG matters to their investment decisions. Further, we recently announced our goal to set and reach Science Based Targets by 2032 and achieve net zero carbon emissions by 2050. Execution of these strategies and achievement of these goals are subject to risks and uncertainties, many of which are outside of our control and may prove to be more costly than we anticipate. These risks and uncertainties include, but are not limited to, our ability to execute our strategies and achieve our goals within the currently projected costs and the expected timeframes; unforeseen design, operational and technological difficulties; the outcome of research efforts and future technology developments; the success of our collaboration with franchisees and other third parties; and the actions of competitors and competitive pressures. There is no assurance that we will be able to successfully execute our strategies and achieve our goals. Failure to achieve our goals could damage our reputation and customer, investor and other stakeholder relationships. Such conditions could have an adverse effect on our business, results of operations and financial condition, as well as on our stock price. There also has been increased political focus, including by U.S. and foreign governmental authorities, on environmental sustainability matters, such as climate change, the reduction of greenhouse gases and water consumption. The SEC has included in its regulatory agenda proposed rulemaking on climate change disclosures that, if adopted, could significantly increase compliance burdens and associated regulatory costs and the complexity of the regulatory framework. Legislative, regulatory or other efforts to combat climate change or other ESG concerns could also result in new or more stringent forms of oversight and expanding mandatory and voluntary reporting, diligence and disclosure, which could increase costs, bring additional focus and further impact our business, results of operations and financial condition. Any failure or perceived failure by us to manage ESG issues successfully could have a material adverse effect on our reputation and on our business, results of operations, financial condition or stock price, including the sustainability of our business over time. Risks Related to Our Indebtedness Our substantial indebtedness could adversely affect our business and limit our ability to plan for or respond to changes in our business. We have a substantial amount of indebtedness. As of January 1, 2023, our consolidated total indebtedness was approximately $5.02 billion. We may also incur additional debt, which would not be prohibited under the terms of our current securitized debt agreements. Our substantial indebtedness could have important consequences for our business and our shareholders. For example, it could: •make it more difficult for us to satisfy our obligations with respect to our debt agreements; •increase our vulnerability to general adverse economic and industry conditions; •require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow for other purposes; and •limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, thereby placing us at a competitive disadvantage compared to our peers that may have less debt. Further, our 2021 Variable Funding Notes bear interest at fluctuating interest rates that in certain circumstances is based on the London interbank offered rate (“LIBOR”). In 2021, ICE Benchmark Administration Limited, the administrator for LIBOR, confirmed its intention to cease the publication of any U.S. dollar LIBOR settings immediately following the LIBOR publication on June 30, 2023. Our 2021 Variable Funding Notes loan documents provide that after the date on which the administrator for LIBOR permanently or indefinitely ceases to provide all available settings of U.S. dollar LIBOR, any new advances under the 2021 Variable Funding Notes that would otherwise have borne interest based on LIBOR, as well as any existing LIBOR advances for which the interest period has expired, will instead bear interest at a forward-looking term rate based on the Secured Overnight Financing Rate (“Term SOFR”), plus a spread adjustment, that in each case have been selected or recommended by the Board of Governors of the Federal Reserve System or the Federal Reserve Bank of New York. The loan documents also permit the lenders to effect a transition from LIBOR to Term SOFR at an earlier date, subject to certain conditions. Because the composition and characteristics of Term SOFR are not the same as those of LIBOR, there can be no assurance that Term SOFR will perform the same way LIBOR would have at any given time or for any applicable period. 24 As a result, our interest expense could increase, in which event we may have difficulties making interest payments and funding our other fixed costs, and our available cash flow for general corporate requirements may be adversely affected. Our interest expense could also be increased by the rising interest rate environment, which could potentially have an adverse impact on our 2021 Variable Funding Notes, as well as on our 2022 Variable Funding Notes, which bear interest at fluctuating interest rates that in certain circumstances are based on Term SOFR. In addition, the financial and other covenants we agreed to with our lenders may limit our ability to incur additional indebtedness, make investments, pay dividends and engage in other transactions, and the leverage may cause potential lenders to be less willing to loan funds to us in the future. Our failure to comply with these covenants could result in an event of default that, if not cured or waived, could result in the acceleration of repayment of all of our indebtedness. Downgrades in our credit ratings could impact our ability to access capital and materially and adversely affect our business, financial condition and results of operations. Our debt is rated by credit rating agencies. These agencies may downgrade their credit ratings for us based on the performance of our business, our capital strategies or their overall view of our industry. There can be no assurance that any rating assigned to our currently outstanding indebtedness will remain in effect for any given period of time or that any such ratings will not be lowered, suspended or withdrawn entirely by a rating agency if, in that agency’s judgment, circumstances so warrant. A downgrade of our credit ratings could, among other things, increase our cost of borrowing, limit our ability to access capital or result in more restrictive covenants in agreements governing the terms of any future indebtedness that we may incur, and thereby could adversely impact our business and operations. We may be unable to generate sufficient cash flow to satisfy our significant debt service obligations, which would adversely affect our financial condition and results of operations. Our ability to make principal and interest payments on and to refinance our indebtedness will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If our business does not generate sufficient cash flow from operations, in the amounts projected or at all, or if future borrowings are not available to us under our variable funding notes in amounts sufficient to fund our other liquidity needs, our financial condition and results of operations may be adversely affected. If we cannot generate sufficient cash flow from operations to make scheduled principal amortization and interest payments on our debt obligations in the future, we may need to refinance all or a portion of our indebtedness on or before maturity, sell assets, delay capital expenditures or seek additional equity. If we are unable to refinance any of our indebtedness on commercially reasonable terms or at all or to affect any other action relating to our indebtedness on satisfactory terms or at all, our business may be harmed. The terms of our securitized debt financing of certain of our wholly-owned subsidiaries have restrictive terms and our failure to comply with any of these terms could put us in default, which would have an adverse effect on our business and prospects. Unless and until we repay all outstanding borrowings under our securitized debt, we will remain subject to the restrictive terms of these borrowings. The securitized debt, under which certain of our wholly-owned subsidiaries issued and guaranteed fixed rate notes and variable funding senior revolving notes, contain a number of covenants, with the most significant financial covenant being a debt service coverage calculation. These covenants limit the ability of certain of our subsidiaries to, among other things: •sell assets; •alter the business we conduct and engage in mergers, acquisitions and other business combinations; •declare dividends or redeem or repurchase capital stock; •incur, assume or permit to exist additional indebtedness or guarantees and make loans and investments; •incur liens; and •enter into transactions with affiliates. The securitized debt also requires us to maintain specified financial ratios at the end of each fiscal quarter. These restrictions could affect our ability to pay dividends or repurchase shares of our common stock. Our ability to meet these financial ratios can be affected by events beyond our control, and we may not satisfy such a test. A breach of this covenant could result in a rapid amortization event or default under the securitized debt. If amounts owed under the securitized debt are accelerated because of a default under the securitized debt and we are unable to pay such amounts, the investors may have the right to assume control of substantially all of the securitized assets. 25 During the term following issuance, the outstanding senior notes will accrue interest in accordance with the terms of the debt agreements. Additionally, our senior notes have original scheduled principal payments of $51.5 million in each of 2023 and 2024, $1.17 billion in 2025, $39.3 million in 2026, $1.31 billion in 2027, $811.5 million in 2028, $625.9 million in 2029, $10.0 million in 2030 and $905.0 million in 2031. In accordance with our debt agreements, the payment of principal on the outstanding senior notes may be suspended if the leverage ratio for the Company is less than or equal to 5.0x total debt, as defined, to adjusted EBITDA, as defined in the indenture governing our securitized debt, and no catch-up provisions are applicable. If we are unable to refinance or repay amounts under the securitized debt prior to the expiration of the term, our cash flow would be directed to the repayment of the securitized debt and, other than a weekly management fee sufficient to cover minimal selling, general and administrative expenses, would not be available for operating our business. No assurance can be given that any refinancing or additional financing will be possible when needed or that we will be able to negotiate acceptable terms. In addition, our access to capital is affected by prevailing conditions in the financial and capital markets and other factors beyond our control. There can be no assurance that market conditions will be favorable at the times that we require new or additional financing. The indenture governing the securitized debt will restrict the cash flow from the entities subject to the securitization to any of our other entities and upon the occurrence of certain events, cash flow would be further restricted. In the event that a rapid amortization event occurs under the indenture (including, without limitation, upon an event of default under the indenture or the failure to repay the securitized debt at the end of its term), the funds available to us would be reduced or eliminated, which would in turn reduce our ability to operate or grow our business. Regulatory, Legal and Compliance Risks We face risks of litigation, investigations, enforcement actions and negative publicity from customers, franchisees, suppliers, employees, regulators and others in the ordinary course of business, which could divert our financial and management resources. Litigation, investigations, enforcement actions or publicity may adversely impact our financial condition and results of operations. Claims of illness or injury relating to food quality or food handling are common in the food service industry, and vehicular accidents and injuries occur in the food delivery business. We are currently subject to these types of claims and have been subject to these types of claims in the past. Claims within our industry of improper supplier actions also occasionally arise that, if made against one of our suppliers, could potentially damage our brand image. In addition, class action lawsuits have been filed, and may continue to be filed, against various QSRs alleging, among other things, that QSRs have failed to disclose the health risks associated with high-fat foods and that QSR marketing practices have encouraged obesity. State attorney general offices or other regulators have initiated and may in the future initiate investigations or enforcement actions against us. In addition to decreasing our sales and profitability and diverting our management resources, adverse publicity resulting from such allegations may materially and adversely affect us and our brand, regardless of whether such allegations are valid or whether we are liable, and could result in a substantial settlement, fine, penalty or judgment against us. Further, we may be subject to employee, franchisee and other claims in the future based on, among other things, discrimination, harassment, working and safety conditions, wrongful termination and wage, expense reimbursement, rest break and meal break issues, including claims relating to minimum wage and overtime compensation. We and our international master franchisees have been and continue to be subject to these types of claims. If one or more of these claims were to be successful or if there is a significant increase in the number of these claims or if we receive significant negative publicity, our business, financial condition and operating results could be harmed. We and our franchisees are subject to extensive laws and government regulation and requirements issued by other groups and our failure to comply with existing or increased laws and regulations could adversely affect our business and operating results. 26 We are subject to numerous federal, state, local and foreign laws and regulations, as well as requirements issued by other groups, including those relating to: •the preparation, sale and labeling of food; •building and zoning requirements and environmental protection; •labor and employment, including minimum wage, overtime, insurance, discrimination and other labor requirements as well as working and safety conditions; •franchise arrangements; •taxation; •antitrust; •payment card industry standards and requirements; and •social media, information privacy and consumer protection. We are subject to an FTC rule and to various state and foreign laws that govern the offer and sale of franchises. These laws regulate various aspects of the franchise relationship, including terminations and the refusal to renew franchises. The failure to comply with these laws and regulations in any jurisdiction or to obtain required government approvals could result in a ban or temporary suspension on future franchise sales, fines or other penalties or require us to make offers of rescission or restitution, any of which could adversely affect our business. We and our franchisees face various regulatory and legislative efforts to enforce employment laws, such as efforts to categorize franchisors as the co-employers or joint employers of their franchisees’ employees or to aggregate individual franchised businesses and classify them as large employers for minimum wage or other employment-related purposes. In August 2015, the National Labor Relations Board (“NLRB”) adopted a new and broader standard for determining when two or more otherwise unrelated employers may be found to be a joint employer of the same employees under the National Labor Relations Act. The NLRB issued a final rule which became effective April 27, 2020 that reinstates the standard that was in place before August 2015. In December 2019, the NLRB directed an administrative law judge to approve settlement agreements (rather than rejecting the settlement and allowing the claims asserting that the franchisor should be the joint employer of its franchisees’ employees to proceed) in a decision related to another franchise system. On April 22, 2022, a federal appellate court rejected an appeal seeking to overturn that decision. The NLRB issued a proposed rule on September 6, 2022 that largely reestablishes the August 2015 joint employer standard. If the NLRB’s September 2022 proposed rule goes into effect or is adopted by other government agencies and/or applied generally to franchise relationships, it could cause us to be liable or held responsible for unfair labor practices and other violations of our franchisees and subject us to other liabilities, and require us to conduct collective bargaining negotiations regarding employees of totally separate, independent employers, most notably our franchisees. In such event, our operating expenses may increase as a result of required modifications to our business practices, increased litigation, governmental investigations or proceedings, administrative enforcement actions, fines and civil liability. Additionally, depending upon the outcome and application of certain legal proceedings pending or concluded in federal court in California involving the California wage and hour laws in another franchise system, franchisors may be subject to claims that their franchisees should be treated as employees and not as independent contractors under the wage and hour laws of that state and, potentially, certain other states and localities with similar wage and hour laws. The California legislature has enacted a statute known as Assembly Bill 5 (AB-5), which went into effect on January 1, 2020. AB-5 requires “gig economy” workers to be reclassified as employees instead of independent contractors. However, depending upon the application of AB-5, franchisors in certain industries could be deemed to be covered by the statute, in which event certain franchisees could be deemed employees of the franchisors. While active efforts to narrow the reach of AB-5 continue, a bill (SB 967), which was introduced specifically to exempt the relationship between a franchisor and franchisee from the scope of AB-5, was not successful in the legislature. On November 3, 2020, the California electorate approved proposition 22, the effect of which is to exempt app-based transportation (ride shares) and delivery drivers from the application of AB-5 by treating these workers as independent contractors, rather than employees, provided certain conditions are met. The ballot measure does not affect how AB-5 applies to other businesses and workers. If misclassification claims are successful against or applied to a franchisor under AB-5 or any other similar state law, a franchisor could be liable to its franchisees (and potentially their employees) based the rights and remedies available to employees under such laws and, thereafter, have to treat its franchisees (and their employees) as the franchisor’s employees under these laws. 27 We and our franchisees are subject to the Fair Labor Standards Act of 1938, as amended (the “Fair Labor Standards Act”), which, along with the Family and Medical Leave Act, governs such matters as minimum wage and overtime requirements and other working conditions and various family leave mandates, as well as a variety of other laws enacted, or rules and regulations promulgated, by federal, state and local governmental authorities that govern these and other employment matters. We and our franchisees have experienced and expect further increases in payroll expenses as a result of government-mandated increases in the minimum wage, and although such increases are not currently expected to be material, there may be material increases in the future, including as a result of the FAST Act. Enactment and enforcement of various federal, state and local laws, rules and regulations on immigration and labor organizations may adversely impact the availability and costs of labor for Domino’s and franchisees’ stores in a particular area or across the United States. In addition, third-party suppliers may be affected by higher minimum wage standards, which may increase the price of goods and services they supply to us. Such increased expenses may cause our franchisees to exit the business or cause us to reduce the number of Company-owned stores, or otherwise adversely affect the amount of royalty payments and license fees we receive. On January 12, 2020, the U.S. Department of Labor announced a final rule to update and clarify the definition of joint employer under the Fair Labor Standards Act. Under the final rule, the general test for assessing whether a party can be deemed a joint employer would be based upon whether that party (i) hires or fires the employee; (ii) supervises and controls the employee’s work schedule or conditions of employment; (iii) determines the employee’s rate and method of payment; and (iv) maintains the employee’s employment records. In the final rule, the Department of Labor describes instances in which joint employment would not be more or less likely to be found to exist under the Fair Labor Standards Act, which, according to the Department of Labor, includes the relationships that exist under the typical franchise business model. This rule may reduce a franchisor’s risk of liability that currently exists under the joint employer standard now in effect under the Fair Labor Standards Act (though ultimately, the facts specific to the franchisor-franchisee model at issue would be considered when determining liability). On September 8, 2020, a federal district court struck down a significant portion of the final rule. On July 29, 2021, the current administration’s Department of Labor issued a final rule rescinding the 2020 rule. The Department of Labor may revert to the more expansive interpretation of joint employer that existed prior to the adoption of the 2020 rule and/or interpretations that could result in franchisors being held liable or responsible for Fair Labor Standards Act violations by their franchisees. The rules of the Department of Labor are separate from the joint employer standard under the National Labor Relations Act or, as described above, potential liability as a joint employer under the National Labor Relations Act. Certain governmental authorities and private litigants have recently asserted claims against franchisors, including us, for provisions in our prior franchise agreements that restrict franchisees from soliciting or hiring the employees of other franchisees or the applicable franchisor. Claims against franchisors for such clauses include allegations that these clauses violate state and federal antitrust and unfair practices laws by restricting the free movement of employees of franchisees and/or franchisor (including the employees of Company-owned stores), thereby depressing the wages of those employees. The Patient Protection and Affordable Care Act (as amended, the “Affordable Care Act”) requires employers such as us to provide health insurance for all qualifying employees or pay penalties for not providing coverage. The majority of the increases in these costs began in 2015, and while the incremental costs of this program have not been material to us to date, we cannot predict what effect these costs will have on our results of operations and financial position, or the effects of the Affordable Care Act on some of our larger franchisees. Modifications to, or repeal of, all or certain provisions of the Affordable Care Act are also possible. Changes in tax laws or tax policy more broadly, increases in the enacted tax rates, adverse outcomes in connection with tax audits in any jurisdiction or any change in the pronouncements relating to accounting for income taxes could also impact our financial condition and results of operations. We may also become subject to legislation or regulation seeking to tax and/or regulate high-fat foods, foods with high sugar and salt content, or foods otherwise deemed to be “unhealthy,” and our capital expenditures could increase due to remediation and compliance measures related to these laws or regulations. Adverse government regulations and enforcement efforts or non-compliance by us or our franchisees with any of the foregoing laws and regulations could lead to various claims or governmental or judicial fines, sanctions or other enforcement measures, which could negatively impact our business. 28 Market and General Risks Fluctuations in value of the U.S. dollar in relation to other currencies may lead to lower revenues and earnings. Exchange rate fluctuations could have an adverse effect on our results of operations and we have in the past experienced significant adverse changes in foreign currency rates. International franchise royalties and fees represented approximately 6.5%, 6.8% and 6.1% of our total revenues in 2022, 2021 and 2020, respectively, a majority of which were denominated in foreign currencies. We also operate dough manufacturing and distribution facilities in Canada, which generate revenues denominated in Canadian dollars. Sales made by franchise stores outside the U.S. are denominated in the currency of the country in which the store is located, and this currency could become less valuable in U.S. dollars as a result of exchange rate fluctuations. Unfavorable currency fluctuations could lead to increased prices to customers outside the U.S. or lower profitability to our franchisees outside the U.S., or could result in lower revenues for us, on a U.S. dollar basis, from such customers and franchisees. A hypothetical 10% adverse change in the foreign currency rates in our international markets would have resulted in a negative impact on international royalty revenues of approximately $26.1 million in 2022. Our annual and quarterly financial results are subject to significant fluctuations depending on various factors, many of which are beyond our control, and if we fail to meet the expectations of securities analysts or investors, our stock price may decline significantly or be subject to significant fluctuations. Our annual and quarterly financial results, including our sales and operating results, can vary significantly from quarter-to-quarter and year-to-year depending on various factors, many of which are beyond our control. These factors include, among other things: •variations in the timing and volume of our sales and our franchisees’ sales, including same store sales; •the timing of expenditures in anticipation of future sales; •changes in the cost or availability of our ingredients or labor; •planned or actual changes to our capital or debt structure; •strategic actions by us or our competitors, such as sales promotions, acquisitions or restructurings; •changes in our dividend policy or any share repurchase program; •significant litigation or legislation or other regulatory developments affecting us or our industry; •changes in competitive and economic conditions generally as well as general market conditions; and •foreign currency exposure. As a result, our operational performance may decline quickly and significantly in response to changes in order patterns or rapid decreases in demand for our products. Any such decline may cause us and our franchisees to experience lower sales revenue. We anticipate that fluctuations in operating results will continue in the future, and such fluctuations may result in significant fluctuations or a significant decline in our stock price. 29 Item 1B. Unresolved Staff Comments. None. Item 2. Properties. We lease approximately 285,000 square feet for our World Resource Center, including our Domino’s Innovation Garage, located in Ann Arbor, Michigan under an operating lease with Domino’s Farms Office Park, L.L.C., an unrelated company. The lease, as amended, expires in 2029 and has two five-year renewal options. We own five supply chain center buildings. All other U.S. and Canadian supply chain centers are leased by us, under leases ranging between five and 21 years with one or two five-year renewal options. All buildings for U.S. Company-owned stores are leased by us, typically under ten-year leases with one or two five-year renewal options. All franchise stores are leased or owned directly by the respective franchisees. We believe that our existing headquarters and other leased and owned facilities are adequate to meet our current requirements, but we plan to continue investing in additional supply chain productivity initiatives in the future. Item 3. Legal Proceedings. We are a party to lawsuits, revenue agent reviews by taxing authorities and administrative proceedings in the ordinary course of business which include, without limitation, workers' compensation, general liability, automobile and franchisee claims. We are also subject to suits related to employment practices. Litigation is subject to many uncertainties, and the outcome of individual litigated matters is not predictable with assurance. These matters referenced above could be decided unfavorably to us and could require us to pay damages or make other expenditures in amounts or a range of amounts that cannot be estimated with accuracy. In management’s opinion, these matters, individually and in the aggregate, should not have a significant adverse effect on the financial condition of the Company, and the established accruals adequately provide for the estimated resolution of such claims. While we may occasionally be party to large claims, including class action suits, we do not believe that any existing matters, individually or in the aggregate, will materially affect our financial position, results of operations or cash flows. Item 4. Mine Safety Disclosures. Not applicable. Item 4A. Executive Officers of the Registrant. The listing of executive officers of the Company is set forth under Part III Item 10. Directors, Executive Officers and Corporate Governance, which is incorporated herein by reference. 30 Part II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. As of February 16, 2023, Domino’s Pizza, Inc. had 170,000,000 authorized shares of common stock, par value $0.01 per share, of which 35,419,653 were issued and outstanding. As of February 16, 2023, there were 1,507 registered holders of record of Domino’s Pizza, Inc.’s common stock. Domino’s Pizza, Inc.’s common stock is traded on the New York Stock Exchange (“NYSE”) under the ticker symbol “DPZ.” Our Board of Directors declared a quarterly dividend of $1.21 per common share on February 21, 2023 payable on March 30, 2023 to shareholders of record at the close of business on March 15, 2023. We currently anticipate continuing the payment of quarterly cash dividends. The actual amount of such dividends, if any, will depend upon future earnings, results of operations, capital requirements, our financial condition and certain other factors. There can be no assurance as to the amount of free cash flow that we will generate in future years and, accordingly, dividends will be considered after reviewing returns to shareholders, profitability expectations and financing needs and will be declared at the discretion of our Board of Directors. As of January 1, 2023, we had a Board of Directors-approved share repurchase program for up to $1.0 billion of our common stock, of which $410.4 million remained available for future purchases of our common stock. Any future purchases of our common stock would be funded by current cash amounts, available borrowings or future excess cash flow. The following table summarizes our repurchase activity during the fourth quarter ended January 1, 2023: Period TotalNumberof SharesPurchased(1) AveragePrice Paidper Share TotalNumber ofSharesPurchased asPart ofPubliclyAnnouncedProgram(2) MaximumApproximateDollar Valueof Sharesthat May YetBe PurchasedUnder theProgram(in thousands) Period #10 (September 12, 2022 to October 9, 2022) 1,651 $ 310.40 — $ 410,358 Period #11 (October 10, 2022 to November 6, 2022) 1,052 338.17 — 410,358 Period #12 (November 7, 2022 to December 4, 2022) — — — 410,358 Period #13 (December 5, 2022 to January 1, 2023) 854 380.09 — 410,358 Total 3,557 $ 335.34 — $ 410,358 (1)3,557 shares were purchased as part of the Company’s employee stock purchase discount plan. During the fourth quarter, the shares were purchased at an average price of $335.34. (2)Authorization for the repurchase program may be modified, suspended, or discontinued at any time. The repurchase of shares in any particular period and the actual amount of such purchases remain at the discretion of the Board of Directors, and no assurance can be given that shares will be repurchased in the future. 31 The following comparative stock performance line graph compares the cumulative shareholder return on the common stock of Domino’s Pizza, Inc. (NYSE: DPZ) for the five-year period between December 31, 2017 and December 31, 2022, with the cumulative total return on (i) the Standard & Poor’s 500 Index (the “S&P 500”), (ii) the Standard & Poor’s 400 Restaurant Index (the “S&P 400 Restaurant Index”), which was the Company’s previously-utilized comparison index, and (iii) the Company’s current comparison index, the Standard & Poor’s Composite 1500 Restaurant Index (the “S&P 1500 Restaurant Index”). Management believes that the companies included in the S&P 1500 Restaurant Index more appropriately reflect the scope and scale of the Company’s operations and better match the competitive market in which the Company operates than the S&P 400 Restaurant Index. Due to the change in selected comparative indices, we are presenting the current comparative index and the comparative index that was used in the prior year. The cumulative total return computations set forth in the performance graph assume the investment of $100 in each of the Company’s common stock, the S&P 500, the S&P 400 Restaurant Index and the S&P 1500 Restaurant Index on December 31, 2017. Item 6. [Reserved]. 32 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Overview Our fiscal year typically includes 52 weeks, comprised of three twelve-week quarters and one sixteen-week quarter. Every five or six years our fiscal year includes an extra (or 53rd) week in the fourth quarter. Fiscal 2022 and 2021 each consisted of 52 weeks and fiscal 2020 consisted of 53 weeks. In this section, we discuss the results of our operations for the fiscal year ended January 1, 2023 compared to the fiscal year ended January 2, 2022. For a discussion of the fiscal year ended January 2, 2022 compared to the fiscal year ended January 3, 2021, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended January 2, 2022. Description of the Business Domino’s is the largest pizza company in the world, with more than 19,800 locations in over 90 markets around the world as of January 1, 2023, and operates two distinct service models within its stores with a significant business in both delivery and carryout. Founded in 1960, we are a highly-recognized global brand, and we focus on value while serving neighborhoods locally through our large network of franchise owners and Company-owned stores through both the delivery and carryout service models. We are primarily a franchisor, with approximately 99% of Domino’s global stores owned and operated by our independent franchisees as of January 1, 2023. Our business model is straightforward: Domino’s stores handcraft and serve quality food at a competitive price, with easy ordering access and efficient service, enhanced by our technological innovations. Our hand-tossed dough is made fresh and distributed to stores around the world by us and our franchisees. Domino’s generates revenues and earnings by charging royalties and fees to our independent franchisees. We also generate revenues and earnings by selling food, equipment and supplies to franchisees primarily in the U.S. and Canada and by operating a number of Company-owned stores in the U.S. Franchisees profit by selling pizza and other complementary items to their local customers. In our international markets, we generally grant geographical rights to the Domino’s Pizza brand to master franchisees. These master franchisees are charged with developing their geographical area, and they can profit by sub-franchising and selling food and equipment to those sub-franchisees, as well as by running pizza stores directly. We believe that everyone in the system can benefit, including the end consumer, who can feed their family conveniently and economically. Our financial results are driven largely by retail sales at our franchised and Company-owned stores. Changes in retail sales are driven by changes in same store sales and store counts. We monitor both of these metrics very closely, as they directly impact our revenues and profits, and we strive to consistently increase both metrics. Retail sales drive royalty payments from franchisees, as well as Company-owned store and supply chain revenues. Retail sales are primarily impacted by the strength of the Domino’s Pizza brand, the results of our extensive advertising through various media channels, the impact of technological innovation and digital ordering, our ability to execute our strong and proven business model and the overall global economic environment. Our business model can yield strong returns for our franchise owners and our Company-owned stores. It can also yield significant cash flow to us, through a consistent franchise royalty payment and supply chain revenue stream, with moderate capital expenditures. We have historically returned cash to shareholders through dividend payments and share repurchases since becoming a publicly-traded company in 2004. We believe we have a proven business model for success, which includes leading with technology, service and product innovation and leveraging our global scale, which has historically provided strong returns for our shareholders. Critical accounting estimates The following discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, our management evaluates its estimates, including those related to long-lived assets, casualty insurance reserves and income taxes. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates, and changes in estimates could materially affect our results of operations and financial condition for any particular period. 33 We believe that our most critical accounting estimates are: Long-lived assets We record long-lived assets, including property, plant and equipment and capitalized software, at cost. For acquisitions of franchise operations, we estimate the fair values of the assets and liabilities acquired based on physical inspection of assets, historical experience and other information available to us regarding the acquisition. We depreciate and amortize long-lived assets using useful lives determined by us based on historical experience and other information available to us. We evaluate the potential impairment of long-lived assets at least annually or whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Our periodic evaluation is based on various analyses, including, on an annual basis, the projection of undiscounted cash flows. If we determine that the carrying amount of an asset (or asset group) may not be recoverable, we compare the net carrying value of the asset group to the undiscounted net cash flows to be generated from the use and eventual disposition of that asset group. For Company-owned stores, we perform related impairment tests on an operating market basis, which we have determined to be the lowest level for which identifiable cash flows are largely independent of other cash flows. If the carrying amount of a long-lived asset exceeds the amount of the expected future undiscounted cash flows of that asset, we estimate the fair value of the asset. If the carrying amount of the asset exceeds the estimated fair value of the asset, an impairment loss is recognized, and the asset is written down to its estimated fair value. We have not made any significant changes in the methodology used to project the future market cash flows of Company-owned stores during the years presented. Same store sales fluctuations and the rates at which operating costs will fluctuate in the future are key factors in determining projected cash flows used to evaluate recoverability of the related assets. If our same store sales significantly decline or if operating costs increase and we are unable to recover these costs, the carrying value of our Company-owned stores, by market, may be unrecoverable and we may be required to recognize an impairment charge. There were no triggering events in 2022, 2021 or 2020, and accordingly, we did not record any impairment losses on long-lived assets in 2022, 2021 and 2020. Casualty insurance reserves For certain periods prior to December 1998 and for periods after December 2001, we maintain insurance coverage for workers’ compensation, general liability and owned and non-owned auto liabilities. We are generally responsible for up to $2.0 million per occurrence under these retention programs for workers’ compensation and general liability, depending on policy year and line of coverage. We are generally responsible for up to between $500,000 and $5.5 million per occurrence under these retention programs for owned and non-owned automobile liabilities, depending on policy year and line of coverage. The related insurance reserves are based on undiscounted independent actuarial estimates, which are based on historical information along with assumptions about future events. There is inherent uncertainty in the ultimate cost for known claims under our insurance coverages, and for incidents that have occurred that will be subject to a claim, but have yet to be reported to us. Analyses of historical trends and actuarial valuation methods are utilized to estimate the ultimate claim costs for claims incurred as of the balance sheet date and for claims incurred but not yet reported. When estimating these liabilities, several factors are considered, including the severity, duration and frequency of claims, legal cost associated with claims, healthcare trends and projected inflation. Our methodology for determining our exposure has remained consistent throughout the years presented. Management believes that the various assumptions developed, and actuarial methods used to determine our casualty insurance reserves are reasonable and provide meaningful data that management uses to make its best estimate of our exposure to these risks. Changes in assumptions for such factors as medical costs and legal actions, as well as changes in actual experience, could cause our estimates to change in the near term which could result in an increase or decrease in the related expense in future periods. A 10% change in our casualty insurance liability at January 1, 2023 would have affected our income before provision for income taxes by approximately $5.8 million in 2022. We had accruals for casualty insurance reserves of $57.6 million and $56.5 million at January 1, 2023 and January 2, 2022, respectively. 34 Income taxes The U.S. Federal statutory income tax rate was 21% in each of 2022, 2021 and 2020. Our Federal income tax provision calculated based on the Federal statutory rate was $120.3 million, $131.4 million and $116.6 million in 2022, 2021 and 2020, respectively. We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax basis of assets and liabilities. We measure deferred taxes using current enacted tax rates that will apply in the years in which we expect the temporary differences to be recovered or paid. Judgment is required in determining the provision for income taxes, related reserves and deferred taxes. These include establishing a valuation allowance related to the ability to realize certain deferred tax assets, if necessary. On an ongoing basis, management will assess whether it remains more likely than not that the deferred tax assets will be realized. Our accounting for deferred taxes represents our best estimate of future events. Except with respect to certain foreign tax credits and interest deductibility in separately filed states, our deferred tax assets assume that we will generate sufficient taxable income in specific tax jurisdictions, based on our estimates and assumptions. As of January 1, 2023 and January 2, 2022, we had total foreign tax credits of $13.5 million and $10.2 million, respectively, each of which were fully offset with a corresponding valuation allowance. We also had valuation allowances related to interest deductibility in separately filed states of $1.5 million and $1.2 million as of January 1, 2023 and January 2, 2022, respectively. We believe our remaining deferred tax assets will be realized. Changes in our current estimates due to unanticipated events could have a material impact on our financial condition and results of operations. Fiscal 2022 Highlights •Global retail sales, excluding foreign currency impact (which includes total retail sales at Company-owned and franchised stores worldwide) increased 3.9% as compared to 2021. U.S. retail sales increased 1.3% and international retail sales, excluding foreign currency impact, increased 6.3% each as compared to 2021. •Same store sales declined 0.8% in our U.S. stores and increased 0.1% in our international stores, excluding foreign currency impact. •Revenues increased 4.1%. •Income from operations decreased 1.6%. •Net income decreased 11.4%. •Diluted earnings per share decreased 7.5%. Excluding the negative impact of foreign currency, Domino’s experienced global retail sales growth during 2022. U.S. same store sales declined 0.8% during 2022, rolling over an increase in U.S. same store sales of 3.5% in 2021. The decline in U.S. same store sales in 2022 was attributable to lower order counts due in part to labor shortages affecting store hours and staffing levels in many of our markets and economic stimulus activity in the U.S in 2021 in response to the COVID-19 pandemic which did not recur in 2022. A higher average ticket per transaction resulting from higher menu and national offer pricing as well as increases to our average delivery fee partially offset the decline in U.S. same store sales in 2022. International same store sales (excluding foreign currency impact) increased 0.1% during 2022, rolling over an increase in international same store sales (excluding foreign currency impact) of 8.0% in 2021. International same store sales (excluding foreign currency impact) were pressured in 2022 due in part to a value added tax holiday in the United Kingdom in 2021 that expired during the first quarter of 2022. Our U.S. and international same store sales (excluding foreign currency impact) continue to be pressured by our fortressing strategy, which includes increasing store concentration in certain markets where we compete, as well as from aggressive competitive activity. During fiscal 2022, we experienced significant inflationary pressures in our commodity, labor and fuel costs resulting from the macroeconomic environment in the U.S., which had a significant impact on our overall operating results as compared to 2021. Our overall operating results in fiscal 2022 were also negatively impacted by changes in foreign currency exchange rates resulting from the global macroeconomic environment. During 2022, we continued our global expansion with the opening of 1,032 net stores. We had 126 net stores open in the U.S. comprised of 141 store openings and 15 closures. We had 906 net stores open internationally comprised of 1,135 store openings and 229 closures, primarily in Brazil, Russia and Italy. We remained focused on improving the customer experience through our technology initiatives, including our GPS delivery tracking technology, which allows customers to monitor the progress of their food, from the preparation stages to the time it is in the oven to the time it arrives at their doors. Our emphasis on technological innovation helped the Domino’s system generate approximately two-thirds of global retail sales from digital channels in 2022. Overall, we believe our continued global store growth, along with our global retail sales growth (excluding foreign currency impact), emphasis on technology and marketing initiatives, have combined to strengthen our brand. 35 Statistical Measures The tables below outline certain statistical measures we utilize to analyze our performance. This historical data is not necessarily indicative of results to be expected for any future period. Global Retail Sales Growth (excluding foreign currency impact) Global retail sales growth (excluding foreign currency impact) is a commonly used statistical measure in the quick-service restaurant industry that is important to understanding performance. Global retail sales growth refers to total worldwide retail sales at Company-owned and franchised stores. We believe global retail sales information is useful in analyzing revenues because franchisees pay royalties and, in the U.S., advertising fees that are based on a percentage of franchise retail sales. We review comparable industry global retail sales information to assess business trends and to track the growth of the Domino’s Pizza brand. In addition, supply chain revenues are directly impacted by changes in franchise retail sales in the U.S. and Canada. Retail sales for franchise stores are reported to us by our franchisees and are not included in our revenues. Global retail sales growth, excluding foreign currency impact, is calculated as the change of international local currency global retail sales against the comparable period of the prior year. Global retail sales growth in 2021 and 2020 reflect the impact of the 53rd week in 2020. 2022 2021 2020 U.S. stores + 1.3% + 4.3% + 17.6% International stores (excluding foreign currency impact) + 6.3% + 13.9% + 8.8% Total (excluding foreign currency impact) + 3.9% + 8.9% + 13.2% Same Store Sales Growth Same store sales growth is a commonly used statistical measure in the quick-service restaurant industry that is important to understanding performance. Same store sales growth is calculated for a given period by including only sales from stores that also had sales in the comparable weeks of both periods. International same store sales growth is calculated similarly to U.S. same store sales growth. Changes in international same store sales are reported on a constant dollar basis, which reflects changes in international local currency sales. The 53rd week in fiscal 2020 had no impact on reported same store sales growth amounts. 2022 2021 2020 U.S. Company-owned stores (1) (2.6)% (3.6)% + 11.0% U.S. franchise stores (1) (0.7)% + 3.9% + 11.5% U.S. stores (0.8)% + 3.5% + 11.5% International stores (excluding foreign currency impact) + 0.1% + 8.0% + 4.4% (1) During the first quarter of 2022, we purchased 23 U.S. franchised stores from certain of our existing U.S. franchisees (the “2022 Store Purchase”). The same store sales growth for these stores is reflected in U.S. Company-owned stores in 2022. During the fourth quarter of 2022, we refranchised 114 U.S. Company-owned stores (the “2022 Store Sale”). The same store sales growth for these stores is reflected in U.S. franchise stores in 2022. Store Growth Activity Store counts and net store growth are commonly used statistical measures in the quick-service restaurant industry that are important to understanding performance. U.S.Company-owned Stores U.S.FranchiseStores TotalU.S.Stores International Stores Total Store count at December 29, 2019 342 5,784 6,126 10,894 17,020 Openings 22 218 240 718 958 Closings (1 ) (10 ) (11 ) (323 ) (334 ) Store count at January 3, 2021 363 5,992 6,355 11,289 17,644 Openings 13 201 214 1,094 1,308 Closings (1 ) (8 ) (9 ) (95 ) (104 ) Store count at January 2, 2022 375 6,185 6,560 12,288 18,848 Openings 5 136 141 1,135 1,276 Closings (3 ) (12 ) (15 ) (229 ) (244 ) Transfers (91 ) 91 — — — Store count at January 1, 2023 286 6,400 6,686 13,194 19,880 36 Income Statement Data (tabular amounts in millions, except percentages) 2022 2021 2020 Revenues: U.S. Company-owned stores $ 445.8 $ 479.0 $ 485.6 U.S. franchise royalties and fees 556.3 539.9 503.2 Supply chain 2,754.7 2,561.0 2,416.7 International franchise royalties and fees 295.0 298.0 249.8 U.S. franchise advertising 485.3 479.5 462.2 Total revenues 4,537.2 100.0 % 4,357.4 100.0 % 4,117.4 100.0 % Cost of sales: U.S. Company-owned stores 378.0 374.1 379.6 Supply chain 2,510.5 2,295.0 2,143.3 Total cost of sales 2,888.6 63.7 % 2,669.1 61.3 % 2,522.9 61.3 % Gross margin 1,648.6 36.3 % 1,688.2 38.7 % 1,594.5 38.7 % General and administrative 416.5 9.2 % 428.3 9.8 % 406.6 9.9 % U.S. franchise advertising 485.3 10.7 % 479.5 11.0 % 462.2 11.2 % Refranchising gain (21.2 ) (0.5 )% — 0.0 % — 0.0 % Income from operations 767.9 16.9 % 780.4 17.9 % 725.6 17.6 % Other income — 0.0 % 36.8 0.8 % — 0.0 % Interest expense, net (195.1 ) (4.3 )% (191.5 ) (4.3 )% (170.5 ) (4.1 )% Income before provision for income taxes 572.8 12.6 % 625.7 14.4 % 555.1 13.5 % Provision for income taxes 120.6 2.6 % 115.2 2.7 % 63.8 1.6 % Net income $ 452.3 10.0 % $ 510.5 11.7 % $ 491.3 11.9 % 2022 compared to 2021 (tabular amounts in millions, except percentages) Revenues 2022 2021 U.S. Company-owned stores $ 445.8 9.8 % $ 479.0 11.0 % U.S. franchise royalties and fees 556.3 12.3 % 539.9 12.4 % Supply chain 2,754.7 60.7 % 2,561.0 58.8 % International franchise royalties and fees 295.0 6.5 % 298.0 6.8 % U.S. franchise advertising 485.3 10.7 % 479.5 11.0 % Total revenues $ 4,537.2 100.0 % $ 4,357.4 100.0 % Revenues primarily consist of retail sales from our Company-owned stores, royalties and fees and advertising contributions from our U.S. franchised stores, royalties and fees from our international franchised stores and sales of food, equipment and supplies from our supply chain centers to substantially all of our U.S. franchised stores and certain international franchised stores. Company-owned store and franchised store revenues may vary from period to period due to changes in store count mix. Supply chain revenues may vary significantly as a result of fluctuations in commodity prices as well as the mix of products we sell. Consolidated revenues increased $179.8 million, or 4.1%, in 2022 due primarily to higher supply chain revenues due to increases in our market basket pricing to stores. U.S. franchise royalties and fee revenues increased primarily due to retail sales growth resulting from net store growth and the 2022 Store Sale as well as an increase in revenues from fees paid by our franchisees for the use of our technology platforms, but were partially offset by lower same store sales and, to a lesser extent, the 2022 Store Purchase. U.S. franchise advertising revenues increased primarily due to retail sales growth resulting from net store growth and the 2022 Store Sale as well as lower advertising incentives related to brand promotions, but were partially offset by lower same store sales and, to a lesser extent, the 2022 Store Purchase. International franchise royalties and fee revenues declined primarily due to the negative impact of foreign currency exchange rates. U.S. Company-owned store revenues declined primarily due to the 2022 Store Sale as well as lower same store sales, but were partially offset by higher revenues resulting from the 2022 Store Purchase. These changes in revenues are described in more detail below. 37 U.S. Stores 2022 2021 U.S. Company-owned stores $ 445.8 30.0 % $ 479.0 32.0 % U.S. franchise royalties and fees 556.3 37.4 % 539.9 36.0 % U.S. franchise advertising 485.3 32.6 % 479.5 32.0 % Total U.S. stores revenues $ 1,487.4 100.0 % $ 1,498.4 100.0 % U.S. Company-owned Stores Revenues from U.S. Company-owned store operations decreased $33.2 million, or 6.9%, in 2022 primarily driven by the 2022 Store Sale. This decrease was partially offset by an increase in revenues resulting from the 2022 Store Purchase. The decrease in U.S. Company-owned store revenue was also a result of lower U.S. Company-owned same store sales in 2022. U.S. Company-owned same store sales declined 2.6% in 2022 and declined 3.6% in 2021. U.S. Franchise Royalties and Fees Revenues from U.S. franchise royalties and fees increased $16.4 million, or 3.0%, in 2022, due primarily to an increase in the average number of U.S. franchised stores open during the period resulting from net store growth as well as an increase in fees paid by our franchisees for the use of our technology platforms. The 2022 Store Sale also contributed to the increase in U.S. franchise royalties and fee revenues. These increases were partially offset by a decline in U.S. franchise same store sales in 2022 and, to a lesser extent, the 2022 Store Purchase. U.S. franchise same store sales decreased 0.7% in 2022 and increased 3.9% in 2021. U.S. Franchise Advertising Revenues from U.S. franchise advertising increased $5.8 million, or 1.2%, in 2022 due primarily to an increase in the average number of U.S. franchised stores open during the period resulting from net store growth and the 2022 Store Sale. Additionally, the Company recorded approximately $3.7 million less in advertising incentives related to certain brand promotions in 2022 as compared to 2021, which also contributed to the increase in U.S. franchise advertising revenues. These increases were partially offset by a decline in U.S. franchise same store sales in 2022 and, to a lesser extent, the 2022 Store Purchase. Supply Chain Supply chain revenues increased $193.8 million, or 7.6%, in 2022 due to higher market basket pricing to stores, and was partially offset by lower order volumes at our U.S. franchised stores during 2022. The market basket pricing change, a statistical measure utilized by management, is calculated as the percentage change of the market basket purchased by an average U.S. store (based on average weekly unit sales) from our U.S. supply chain centers against the comparable period of the prior year. We believe this measure is important to understanding Company performance because as our market basket prices fluctuate, our revenues, cost of sales and gross margin percentages in our supply chain segment also fluctuate. Our market basket pricing to stores increased 13.2% during 2022, which resulted in an estimated $296.1 million increase in supply chain revenues. International Franchise Royalties and Fees Revenues from international franchise royalties and fees decreased $3.0 million, or 1.0%, in 2022 due primarily to the negative impact of changes in foreign currency exchange rates of approximately $28.4 million in 2022 which was partially offset by an increase in the average number of international franchised stores open during the period resulting from net store growth. The impact of changes in foreign currency exchange rates on international franchise royalty revenues, a statistical measure utilized by management, is calculated as the difference in international franchise royalty revenues resulting from translating current year local currency results to U.S. dollars at current year exchange rates as compared to prior year exchange rates. We believe this measure is important to understanding Company performance given the significant variability in international franchise royalty revenues that can be driven by changes in foreign currency exchange rates. Excluding the impact of foreign currency exchange rates, international same store sales increased 0.1% in 2022 and increased 8.0% in 2021. 38 Cost of Sales / Gross Margin 2022 2021 Total revenues $ 4,537.2 100.0 % $ 4,357.4 100.0 % Total cost of sales 2,888.6 63.7 % 2,669.1 61.3 % Gross margin $ 1,648.6 36.3 % $ 1,688.2 38.7 % Consolidated cost of sales consists primarily of U.S. Company-owned store and supply chain costs incurred to generate related revenues. Components of consolidated cost of sales primarily include food, labor, delivery and occupancy costs. Consolidated gross margin (which we define as revenues less cost of sales) decreased $39.6 million, or 2.3%, in 2022 due primarily to lower U.S. Company-owned store revenues, as well as higher food, delivery and labor costs. Franchise revenues do not have a cost of sales component, so changes in these revenues have a disproportionate effect on gross margin. Additionally, as our market basket prices fluctuate, our revenues, cost of sales and gross margin percentages in our supply chain segment also fluctuate; however, actual product-level dollar gross margins remain unchanged. As a percentage of revenues, the consolidated gross margin decreased 2.4 percentage points to 36.3% in 2022 from 38.7% in 2021. Company-owned store gross margin decreased 6.7 percentage points in 2022 and supply chain gross margin decreased 1.5 percentage points in 2022. These changes in gross margin are described in more detail below. U.S. Company-owned Stores Gross Margin 2022 2021 Revenues $ 445.8 100.0 % $ 479.0 100.0 % Cost of sales 378.0 84.8 % 374.1 78.1 % Store gross margin $ 67.8 15.2 % $ 104.9 21.9 % U.S. Company-owned store gross margin (which does not include other store-level costs such as royalties and advertising) decreased $37.1 million, or 35.4%, in 2022 due primarily to the 2022 Store Sale and higher market basket prices and, to a lesser extent, higher occupancy costs. These decreases were partially offset by lower labor and delivery costs, primarily attributable to the decrease in the average number of U.S. Company-owned stores open during the period resulting from the 2022 Store Sale. As a percentage of U.S. Company-owned store revenues, the U.S. Company-owned store gross margin decreased 6.7 percentage points in 2022. These changes in U.S. Company-owned store gross margin as a percentage of revenues are discussed in more detail below. •Food costs increased 3.3 percentage points to 31.4% in 2022 due to higher market basket prices. •Labor costs increased 1.5 percentage points to 30.5% in 2022 due primarily to continued investments in frontline team member wage rates in our U.S. Company-owned stores, as well as lower sales leverage. •Occupancy costs, which include rent, telephone, utilities and depreciation, increased 1.2 percentage points to 9.2% in 2022 due primarily to lower sales leverage, as well as higher utility rates in our U.S. Company-owned stores. Supply Chain Gross Margin 2022 2021 Revenues $ 2,754.7 100.0 % $ 2,561.0 100.0 % Cost of sales 2,510.5 91.1 % 2,295.0 89.6 % Supply chain gross margin $ 244.2 8.9 % $ 266.0 10.4 % Supply chain gross margin decreased $21.7 million, or 8.2%, in 2022 due primarily to higher delivery and labor costs. As a percentage of supply chain revenues, the supply chain gross margin decreased 1.5 percentage points in 2022, due primarily to higher food and delivery costs. The increases in food and delivery costs as a percentage of supply chain revenues resulted from macroeconomic inflationary pressures in the U.S., as well as lower sales leverage. 39 General and Administrative Expenses General and administrative expenses decreased $11.8 million, or 2.8%, in 2022 driven primarily by lower labor costs, partially offset by higher amortization expense for capitalized software. U.S. Franchise Advertising Expenses U.S. franchise advertising expenses increased $5.8 million, or 1.2%, in 2022 due to higher U.S. franchise advertising revenues as discussed above. U.S. franchise advertising costs are accrued and expensed when the related U.S. franchise advertising revenues are recognized, as our consolidated not-for-profit advertising fund is obligated to expend such revenues on advertising and other activities that promote the Domino’s brand and these revenues cannot be used for general corporate purposes. Refranchising Gain During 2022, we completed the 2022 Store Sale in which we refranchised 114 U.S. Company-owned stores in Arizona and Utah for proceeds of $41.1 million. In connection with the 2022 Store Sale, we recorded a $21.2 million pre-tax refranchising gain on the sale of the related assets and liabilities, including a $4.3 million reduction in goodwill. Other Income Other income was $36.8 million in 2021, representing the unrealized gains recorded on the Company’s investment in DPC Dash Ltd resulting from the observable changes in price from the valuation of the Company’s additional $40.0 million investment made in the first quarter of 2021 and the additional $9.1 million investment made in the fourth quarter of 2021. We did not record any adjustments to the carrying amount of $125.8 million in fiscal 2022. Interest Expense, Net Interest expense, net, increased $3.6 million, or 1.9%, in 2022 driven primarily by higher average borrowings resulting from our recapitalization transaction completed on April 16, 2021 (the “2021 Recapitalization”), as well as borrowings on our variable funding notes. These increases were partially offset by higher interest income earned on our cash equivalents and restricted cash equivalents in 2022 as well as lower debt issuance cost expense recognized in 2022 due to the 2021 Recapitalization in which we expensed $2.0 million of the remaining unamortized debt issuance costs associated with the 2017 Five-Year Notes and 2017 Floating Rate Notes (each defined in the “2017 Recapitalization” section, below). Our weighted average borrowing rate was 3.8% in both 2022 and 2021. Provision for Income Taxes Provision for income taxes increased $5.3 million, or 4.6% in 2022 due to a higher effective tax rate, partially offset by a decrease in income before provision for income taxes. The effective tax rate increased to 21.0% during 2022 as compared to 18.4% in 2021. The higher effective tax rate in 2022 was driven in part by a 2.6 percentage point change in excess tax benefits from equity-based compensation, which are recorded as a reduction to the provision for income taxes. The decrease in excess tax benefits from equity-based compensation was a result of fewer stock option exercises in 2022 as compared to 2021. The increase in the effective tax rate was also a result of lower foreign tax credits in 2022. These increases were partially offset by the release of certain unrecognized tax benefits related to one of our foreign subsidiaries during 2022. 40 Segment Income We evaluate the performance of our reportable segments and allocate resources to them based on earnings before interest, taxes, depreciation, amortization and other, referred to as Segment Income. Segment Income for each of our reportable segments is summarized in the table below. Other Segment Income primarily includes corporate administrative costs that are not allocable to a reportable segment, including labor, computer expenses, professional fees, travel and entertainment, rent, insurance and other corporate administrative costs. 2022 2021 U.S. Stores $ 438.6 $ 454.9 Supply Chain 208.8 229.9 International Franchise 236.1 241.9 Other (26.0 ) (42.9 ) U.S. Stores U.S. stores Segment Income decreased $16.3 million, or 3.6%, in 2022, primarily as a result of the $37.1 million decrease in U.S. Company-owned store gross margin, and was partially offset by the increase in revenues from U.S. franchise royalties and fees of $16.4 million, each as discussed above. U.S. franchise revenues do not have a cost of sales component, so changes in these revenues have a disproportionate effect on U.S. stores Segment Income. U.S. franchise advertising costs are accrued and expensed when the related U.S. franchise advertising revenues are recognized and had no impact on U.S. stores Segment Income. Supply Chain Supply chain Segment Income decreased $21.1 million, or 9.2%, in 2022 due primarily to the $21.7 million decrease in supply chain gross margin described above. International Franchise International franchise Segment Income decreased $5.7 million, or 2.4%, in 2022 due primarily to the $3.0 million decrease in international franchise revenues discussed above, as well as higher provision for losses on accounts receivable. International franchise revenues do not have a cost of sales component, so changes in these revenues have a disproportionate effect on international franchise Segment Income. Other Other Segment Income increased $16.9 million, or 39.4%, in 2022 due primarily to lower labor costs as well as higher corporate administrative costs allocated to our segments as compared to 2021. The increase in allocated costs in 2022 was due primarily to higher investments in technological initiatives to support technology for our U.S. and international franchise stores. New Accounting Pronouncements The impact of new accounting pronouncements adopted and the estimated impact of new accounting pronouncements that we will adopt in future years is included in Note 1 to the consolidated financial statements. COVID-19 Impact During the COVID-19 pandemic, we have made certain investments related to safety and cleaning equipment, enhanced sick pay and compensation for frontline team members and support for our franchisees and their communities. While we have seen an increase in sales in certain markets during the COVID-19 pandemic, including increased sales related to heightened reliance on delivery and carryout businesses, future sales are not possible to estimate and it is unclear whether and to what extent sales and same store sales will be impacted if and when consumer behavior and general economic and business activity return to pre-pandemic levels. While it is not possible at this time to estimate the full continued impact that COVID-19 could have on our business, the continued spread of COVID-19 and the measures taken by the governments of countries affected could disrupt our continuing operations and supply chain and, as a result, could adversely impact our business, financial condition or results of operations. 41 Liquidity and Capital Resources Historically, our receivable collection periods and inventory turn rates are faster than the normal payment terms on our current liabilities resulting in efficient deployment of working capital. We generally collect our receivables within three weeks from the date of the related sale and we generally experience multiple inventory turns per month. In addition, our sales are not typically seasonal, which further limits variations in our working capital requirements. These factors allow us to manage our working capital and our ongoing cash flows from operations to invest in our business and other strategic opportunities, pay dividends and repurchase and retire shares of our common stock. As of January 1, 2023, we had working capital of $58.0 million, excluding restricted cash and cash equivalents of $191.3 million, advertising fund assets, restricted of $162.7 million and advertising fund liabilities of $157.9 million. Working capital includes total unrestricted cash and cash equivalents of $60.4 million. Our primary sources of liquidity are cash flows from operations and availability of borrowings under our variable funding notes. During 2022, we experienced global retail sales growth, excluding foreign currency impact, in both our U.S. and international businesses. These factors contributed to our continued ability to generate positive operating cash flows. In addition to our cash flows from operations, we have two variable funding note facilities. The facilities include our 2022 Variable Funding Notes (defined in the “2022 Variable Funding Notes” section, below), which allows for advances of up to $120.0 million, as well as our 2021 Variable Funding Notes (defined in the “2021 Recapitalization” section, below), which allows for advances of up to $200.0 million and certain other credit instruments, including letters of credit (collectively, with the 2022 Variable Funding Notes, the “2022 and 2021 Variable Funding Notes”). The letters of credit primarily relate to our casualty insurance programs and certain supply chain center leases. During 2022, we borrowed and repaid $120.0 million under our 2021 Variable Funding Notes. As of January 1, 2023, we had no outstanding borrowings and $120.0 million of available borrowing capacity under our 2022 Variable Funding Notes. As of January 1, 2023, we had no outstanding borrowings and $157.8 million of available borrowing capacity under our 2021 Variable Funding Notes, net of letters of credit issued of $42.2 million. We expect to continue to use our unrestricted cash and cash equivalents, cash flows from operations, excess cash from our recapitalization transactions and available borrowings under our 2022 and 2021 Variable Funding Notes to, among other things, fund working capital requirements, invest in our core business and other strategic opportunities, pay dividends and repurchase and retire shares of our common stock. Our ability to continue to fund these items and continue to service our debt could be adversely affected by the occurrence of any of the events described in Item 1A. Risk Factors. There can be no assurance that our business will generate sufficient cash flows from operations or that future borrowings will be available under our 2022 and 2021 Variable Funding Notes or otherwise to enable us to service our indebtedness, or to make anticipated capital expenditures. Our future operating performance and our ability to service, extend or refinance the 2021, 2019, 2018, 2017 and 2015 Notes and to service, extend or refinance the 2022 and 2021 Variable Funding Notes will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. Restricted Cash As of January 1, 2023, we had $141.2 million of restricted cash and cash equivalents held for future principal and interest payments and other working capital requirements of our asset-backed securitization structure, $49.9 million of restricted cash equivalents held in a three-month interest reserve as required by the related debt agreements and $0.2 million of other restricted cash for a total of $191.3 million of restricted cash and cash equivalents. As of January 1, 2023, we also held $143.6 million of advertising fund restricted cash and cash equivalents which can only be used for activities that promote the Domino’s brand. 42 Long-Term Debt 2022 Variable Funding Notes On September 16, 2022, certain of our subsidiaries issued a new variable funding note facility which allows for advances of up to $120.0 million of Series 2022-1 Variable Funding Senior Secured Notes, Class A-1 Notes (the “2022 Variable Funding Notes”). Additional information related to our 2022 Variable Funding Notes is included in Note 3 to our consolidated financial statements. 2021 Recapitalization On April 16, 2021, we completed the 2021 Recapitalization in which certain of our subsidiaries issued notes pursuant to an asset-backed securitization. The notes consist of $850.0 million Series 2021-1 2.662% Fixed Rate Senior Secured Notes, Class A-2-I with an anticipated term of 7.5 years (the “2021 7.5-Year Notes”) and $1.0 billion Series 2021-1 3.151% Fixed Rate Senior Secured Notes, Class A-2-II with an anticipated term of 10 years (the “2021 Ten-Year Notes”, and, collectively with the 2021 7.5-Year Notes, the “2021 Notes”). Gross proceeds from the issuance of the 2021 Notes were $1.85 billion. Concurrently, certain of our subsidiaries also issued a new variable funding note facility which allows for advances of up to $200.0 million of Series 2021-1 Variable Funding Senior Secured Notes, Class A-1 Notes and certain other credit instruments, including letters of credit (the “2021 Variable Funding Notes”). In connection with the issuance of the 2021 Variable Funding Notes, our 2019 variable funding notes were canceled. The proceeds from the 2021 Recapitalization were used to repay the remaining $291.0 million in outstanding principal under our 2017 Floating Rate Notes and $582.0 million in outstanding principal under our 2017 Five-Year Notes, prefund a portion of the interest payable on the 2021 Notes, pay transaction fees and expenses and repurchase and retire shares of our common stock. Additional information related to the 2021 Recapitalization is included in Note 3 to our consolidated financial statements. 2019 Recapitalization On November 19, 2019, we completed the 2019 Recapitalization in which certain of our subsidiaries issued $675.0 million Series 2019-1 3.668% Fixed Rate Senior Secured Notes, Class A-2 with an anticipated term of 10 years (the “2019 Notes”) pursuant to an asset-backed securitization. Concurrently, we also issued the 2019 variable funding notes. Gross proceeds from the issuance of the 2019 Notes was $675.0 million. Additional information related to the 2019 Recapitalization is included in Note 3 to our consolidated financial statements. 2018 Recapitalization On April 24, 2018, we completed the 2018 Recapitalization in which certain of our subsidiaries issued notes pursuant to an asset-backed securitization. The notes consist of $425.0 million Series 2018-1 4.116% Fixed Rate Senior Secured Notes, Class A-2-I with an anticipated term of 7.5 years (the “2018 7.5-Year Notes”), and $400.0 million Series 2018-1 4.328% Fixed Rate Senior Secured Notes, Class A-2-II with an anticipated term of 9.25 years (the “2018 9.25-Year Notes” and, collectively with the 2018 7.5-Year Notes, the “2018 Notes”) in an offering exempt from registration under the Securities Act of 1933, as amended. Gross proceeds from the issuance of the 2018 Notes were $825.0 million. Additional information related to the 2018 Recapitalization is included in Note 3 to our consolidated financial statements. 2017 Recapitalization On July 24, 2017, we completed the 2017 Recapitalization in which certain of our subsidiaries issued notes pursuant to an asset-backed securitization. The notes consisted of $300.0 million Series 2017-1 Floating Rate Senior Secured Notes, Class A-2-I with an anticipated term of five years (the “2017 Floating Rate Notes”), $600.0 million Series 2017-1 3.082% Fixed Rate Senior Secured Notes, Class A-2-II with an anticipated term of five years (the “2017 Five-Year Notes”), and $1.0 billion Series 2017-1 4.118% Fixed Rate Senior Secured Notes, Class A-2-III with an anticipated term of 10 years (the “2017 Ten-Year Notes” and, collectively with the 2017 Floating Rate Notes and the 2017 Five-Year Notes, the “2017 Notes”). The interest rate on the 2017 Floating Rate Notes was payable at a rate equal to LIBOR plus 125 basis points. Gross proceeds from the issuance of the 2017 Notes were $1.9 billion. The 2017 Floating Rate Notes and the 2017 Five-Year Notes were repaid in connection with the 2021 Recapitalization. Additional information related to the 2017 Recapitalization is included in Note 3 to our consolidated financial statements. 43 2015 Recapitalization On October 21, 2015, we completed the 2015 Recapitalization in which certain of our subsidiaries issued notes pursuant to an asset-backed securitization. The notes consisted of $500.0 million of Series 2015-1 3.484% Fixed Rate Senior Secured Notes, Class A-2-I (the “2015 Five-Year Notes”), $800.0 million Series 2015-1 4.474% Fixed Rate Senior Secured Notes, Class A-2-II (the “2015 Ten-Year Notes” and collectively with the 2015 Five-Year Notes, the “2015 Notes”). Gross proceeds from the issuance of the 2015 Notes were $1.3 billion. The 2015 Five-Year Notes were repaid in connection with the 2018 Recapitalization. Additional information related to the 2015 Recapitalization is included in Note 3 to our consolidated financial statements. 2021, 2019, 2018, 2017 and 2015 Notes The 2021 Notes, 2019 Notes, 2018 Notes, 2017 Notes and the 2015 Notes are collectively referred to as the “Notes.” The Notes have original scheduled principal payments of $51.5 million in each of 2023 and 2024, $1.17 billion in 2025, $39.3 million in 2026, $1.31 billion in 2027, $811.5 million in 2028, $625.9 million in 2029, $10.0 million in 2030 and $905.0 million in 2031. However, in accordance with our debt agreements, the payment of principal on the outstanding senior notes may be suspended if our leverage ratio is less than or equal to 5.0x total debt, as defined, to adjusted EBITDA, as defined, and no catch-up provisions are applicable. As of the fourth quarter of 2020, we had a leverage ratio of less than 5.0x, and accordingly, did not make the previously scheduled debt amortization payment beginning in the first quarter of 2021. Subsequent to the closing of the 2021 Recapitalization, the Company had a leverage ratio of greater than 5.0x and, accordingly, the Company resumed making the scheduled amortization payments in the second quarter of 2021. The Notes are subject to certain financial and non-financial covenants, including a debt service coverage ratio calculation. The covenant requires a minimum coverage ratio of 1.75x total debt service to securitized net cash flow, as defined in the related agreements. In the event that certain covenants are not met, the Notes may become due and payable on an accelerated schedule. Leases We lease certain retail store and supply chain center locations, supply chain vehicles, various equipment and our World Resource Center under leases with expiration dates through 2041. Refer to Note 5 to the consolidated financial statements for additional information regarding our leases, including future minimum rental commitments. Capital Expenditures In the past three years, we have spent approximately $270.2 million on capital expenditures. In 2022, we spent $87.2 million on capital expenditures which primarily related to investments in our technology initiatives, including our proprietary internally developed point-of-sale system (Domino’s PULSE), our supply chain centers, new Company-owned stores and asset upgrades for our existing Company-owned stores and other assets. We did not have any material commitments for capital expenditures as of January 1, 2023. Investments During the second quarter of 2020, we acquired a non-controlling interest in DPC Dash Ltd (“DPC Dash”), a privately-held company limited by shares incorporated with limited liability under the laws of the British Virgin Islands, for $40.0 million. Through its subsidiaries, DPC Dash serves as the Company’s master franchisee in China that owns and operates Domino’s Pizza stores in that market. Our investment in DPC Dash’s senior ordinary shares, which are not in-substance common stock, represents an equity investment without a readily determinable fair value and is recorded at cost with adjustments for observable changes in prices resulting from orderly transactions for the identical or a similar investment of the same issuer or impairments. In the first quarter of 2021, we invested an additional $40.0 million in DPC Dash based on DPC Dash’s achievement of certain pre-established performance conditions and recorded a positive adjustment of $2.5 million to the original carrying amount of $40.0 million resulting from the observable change in price from the valuation of the additional investment, resulting in a net carrying amount of $82.5 million as of the end of the first quarter of 2021. In the fourth quarter of 2021, we invested an additional $9.1 million in DPC Dash and recorded a positive adjustment of $34.3 million to the carrying amount of $82.5 million resulting from the observable change in price from the valuation of the additional investment, resulting in a net carrying amount of $125.8 million as of January 2, 2022. We did not record any adjustments to the carrying amount of $125.8 million in fiscal 2022. 44 Share Repurchase Programs Our share repurchase programs have historically been funded by excess operating cash flows, excess proceeds from our recapitalization transactions and borrowings under our variable funding notes. We used cash of $293.7 million in 2022, $1.32 billion in 2021 and $304.6 million in 2020 for share repurchases. On October 4, 2019, our Board of Directors authorized a share repurchase program to repurchase up to $1.0 billion of the Company’s common stock. On February 24, 2021, our Board of Directors authorized a new share repurchase program to repurchase up to $1.0 billion of the Company's common stock, which was fully utilized in connection with the ASR Agreement, described below. On April 30, 2021, we entered into an accelerated share repurchase agreement with a counterparty (the “ASR Agreement”). Pursuant to the terms of the ASR Agreement, on May 3, 2021, we used a portion of the proceeds from the 2021 Recapitalization to pay the counterparty $1.0 billion in cash and received and retired 2,012,596 shares of our common stock. Final settlement of the ASR Agreement occurred on July 21, 2021. In connection with the ASR Agreement, we received and retired a total of 2,250,786 shares of our common stock at an average price of $444.29, including the 2,012,596 shares of our common stock received and retired during the second quarter of 2021. On July 20, 2021, our Board of Directors authorized a new share repurchase program to repurchase up to $1.0 billion of our common stock. This repurchase program replaced our previously approved $1.0 billion share repurchase program, which was fully utilized in connection with the ASR Agreement. We had $410.4 million remaining under this share repurchase authorization as of January 1, 2023. Dividends We declared dividends of $157.5 million (or $4.40 per share) in 2022, $139.6 million (or $3.76 per share) in 2021 and $122.2 million (or $3.12 per share) in 2020. We paid dividends of $157.5 million, $139.4 million and $121.9 million in 2022, 2021 and 2020, respectively. On February 21, 2023, the Company’s Board of Directors declared a quarterly dividend of $1.21 per common share payable on March 30, 2023 to shareholders of record at the close of business on March 15, 2023. Sources and Uses of Cash The following table illustrates the main components of our cash flows: Fiscal Year Ended (In millions) January 1, 2023 January 2, 2022 Cash flows provided by (used in) Net cash provided by operating activities $ 475.3 $ 654.2 Net cash used in investing activities (53.7 ) (142.7 ) Net cash used in financing activities (515.9 ) (522.8 ) Effect of exchange rate changes on cash (1.0 ) (0.3 ) Change in cash and cash equivalents, restricted cash and cash equivalents $ (95.3 ) $ (11.7 ) Operating Activities Cash provided by operating activities decreased $178.9 million in 2022 primarily due to the negative impact of changes in operating assets and liabilities of $80.8 million. The negative impact of changes in operating assets and liabilities primarily related to the timing of payments on accrued liabilities and higher cash paid for income taxes in 2022 as compared to 2021. The decrease was also a result of a $62.7 million negative impact of changes in advertising fund assets and liabilities, restricted, in 2022 as compared to 2021 due to payments for advertising activities outpacing contributions. Additionally, net income decreased $58.2 million. However, this decrease in net income was partially offset by a $22.8 million increase in non-cash adjustments, resulting in an overall decrease to cash provided by operating activities in 2022 as compared to 2021 of $35.4 million. We are focused on continually improving our net income and cash flow from operations and management expects to continue to generate positive cash flows from operating activities for the foreseeable future. 45 Investing Activities Cash used in investing activities was $53.7 million in 2022 which consisted primarily of capital expenditures of $87.2 million (driven primarily by investments in technological initiatives, supply chain centers and Company-owned store operations). In connection with the 2022 Store Sale, we refranchised 114 U.S. Company-owned stores for $41.1 million. Additionally, in connection with the 2022 Store Purchase, we acquired 23 U.S. franchised stores from certain of our U.S. franchisees for $6.8 million. Cash used in investing activities was $142.7 million in 2021 which consisted primarily of capital expenditures of $94.2 million (driven primarily by investments in technological initiatives, supply chain centers and Company-owned stores) and our investments in DPC Dash of $49.1 million. Financing Activities Cash used in financing activities was $515.9 million in 2022. We repurchased and retired $293.7 million in shares of our common stock under our Board of Directors-approved share repurchase program and we also made dividend payments to our shareholders of $157.5 million. We borrowed and repaid $120.0 million under our 2021 Variable Funding Notes and also made $55.7 million in repayments on our long-term debt and finance lease obligations. We made $10.7 million of tax payments for restricted stock upon vesting and we also paid $1.6 million in financing costs associated with the issuance of our 2022 Variable Funding Notes. We also received proceeds from the exercise of stock options in 2022 of $3.3 million. Cash used in financing activities was $522.8 million in 2021. We completed the 2021 Recapitalization and issued $1.9 billion under the 2021 Notes. We made $910.2 million of payments on our long-term debt (of which $291.0 million related to the repayment of outstanding principal under our 2017 Floating Rate Notes and $582.0 million related the repayment of outstanding principal under our 2017 Five-Year Notes in connection with the 2021 Recapitalization). We also repurchased and retired $1.32 billion in shares of our common stock under our Board of Directors-approved share repurchase program (including $1.0 billion under the ASR Agreement). We also made dividend payments to our shareholders of $139.4 million, paid $14.9 million in financing cost associated with our 2021 Recapitalization and made tax payments of $6.8 million for restricted stock upon vesting. These uses of cash were partially offset by proceeds from the exercise of stock options of $19.7 million. Impact of Inflation Given the inflation rates in fiscal 2022, there have been and may continue to be increases in food costs and labor costs which have and could further impact our profitability and that of our franchisees and which could impact the opening of new U.S. and international franchised stores and adversely affect our operating results. Factors such as inflation, increased food costs, increased labor and employee health and benefit costs, increased rent costs and increased energy costs may adversely affect our operating costs and profitability and those of our franchisees and could result in menu price increases. The impact of inflation is described with respect to our market basket pricing to stores and our labor cost, in the discussion of supply chain revenues and gross margin, above. Severe increases in inflation could affect the global and U.S. economies and could have an adverse impact on our business, financial condition and results of operations. Further discussion on the impact of commodities and other cost pressures is included above, as well as in Item 7A. Quantitative and Qualitative Disclosures About Market Risk. 46 SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This Form 10-K includes various forward-looking statements about the Company within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”) that are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. The following cautionary statements are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the “safe harbor” provisions of the Act. These forward-looking statements generally can be identified by the use of words such as “anticipate,” “believe,” “could,” “should,” “estimate,” “expect,” “intend,” “may,” “will,” “plan,” “predict,” “project,” “seek,” “approximately,” “potential,” “outlook” and similar terms and phrases that concern our strategy, plans or intentions, including references to assumptions. These forward-looking statements address various matters including information concerning future results of operations and business strategy, the expected demand for future pizza delivery, our expectation that we will meet the terms of our agreement with our third-party supplier of pizza cheese, our belief that alternative third-party suppliers are available for our key ingredients in the event we are required to replace any of our supply partners, our intention to continue to enhance and grow online ordering, digital marketing and technological capabilities, our expectation that there will be no material environmental compliance-related capital expenditures, our plans to expand U.S. and international operations in many of the markets where we currently operate and in selected new markets, our expectation that the obligation for advertising fees payable to DNAF will remain in place for the foreseeable future, and the availability of our borrowings under the 2021 Variable Funding Notes and 2022 Variable Funding Notes for, among other things, funding working capital requirements, paying capital expenditures and funding other general corporate purposes, including payment of dividends. Forward-looking statements relating to our anticipated profitability, estimates in same store sales growth, store growth and the growth of our U.S. and international business in general, ability to service our indebtedness, our future cash flows, our operating performance, trends in our business and other descriptions of future events reflect management’s expectations based upon currently available information and data. While we believe these expectations and projections are based on reasonable assumptions, such forward-looking statements are inherently subject to risks, uncertainties and assumptions about us, including the risk factors listed under Item 1A. Risk Factors, as well as other cautionary language in this Form 10-K. Actual results may differ materially from those expressed or implied in the forward-looking statements as a result of various factors, including but not limited to, the following: •our substantial increased indebtedness as a result of the 2021 Recapitalization, 2019 Recapitalization, 2018 Recapitalization, 2017 Recapitalization and 2015 Recapitalization and our ability to incur additional indebtedness or refinance or renegotiate key terms of that indebtedness in the future; •the impact a downgrade in our credit rating may have on our business, financial condition and results of operations; •our future financial performance and our ability to pay principal and interest on our indebtedness; •the strength of our brand, including our ability to compete in the U.S. and internationally in our intensely competitive industry, including the food service and food delivery markets; •our ability to successfully implement our growth strategy; •labor shortages or changes in operating expenses resulting from increases in prices of food (particularly cheese), fuel and other commodity costs, labor, utilities, insurance, employee benefits and other operating costs or negative economic conditions; •our ability to manage difficulties associated with or related to the ongoing COVID-19 pandemic and the effects of COVID-19 and related regulations and policies on our business and supply chain, including impacts on the availability of labor; •the effectiveness of our advertising, operations and promotional initiatives; •shortages, interruptions or disruptions in the supply or delivery of fresh food products and store equipment; •the impact of social media and other consumer-oriented technologies on our business, brand and reputation; •the impact of new or improved technologies and alternative methods of delivery on consumer behavior; 47 •new product, digital ordering and concept developments by us, and other food-industry competitors; •our ability to maintain good relationships with and attract new franchisees and franchisees’ ability to successfully manage their operations without negatively impacting our royalty payments and fees or our brand’s reputation; •our ability to successfully implement cost-saving strategies; •our ability and that of our franchisees to successfully operate in the current and future credit environment; •changes in the level of consumer spending given general economic conditions, including interest rates, energy prices and consumer confidence or negative economic conditions in general; •our ability and that of our franchisees to open new restaurants and keep existing restaurants in operation and maintain demand for new stores; •the impact that widespread illness, health epidemics or general health concerns, severe weather conditions and natural disasters may have on our business and the economies of the countries where we operate; •changes in foreign currency exchange rates; •changes in income tax rates; •our ability to retain or replace our executive officers and other key members of management and our ability to adequately staff our stores and supply chain centers with qualified personnel; •our ability to find and/or retain suitable real estate for our stores and supply chain centers; •changes in government legislation or regulation, including changes in laws and regulations regarding information privacy, payment methods and consumer protection and social media; •adverse legal judgments or settlements; •food-borne illness or contamination of products or food tampering or other events that may impact our reputation; •data breaches, power loss, technological failures, user error or other cyber risks threatening us or our franchisees; •the impact that environmental, social and governance matters may have on our business and reputation; •the effect of war, terrorism, catastrophic events or climate change; •our ability to pay dividends and repurchase shares; •changes in consumer taste, spending and traffic patterns and demographic trends; •changes in accounting policies; and •adequacy of our insurance coverage. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Form 10-K might not occur. All forward-looking statements speak only as of the date of this Form 10-K and should be evaluated with an understanding of their inherent uncertainty. Except as required under federal securities laws and the rules and regulations of the Securities and Exchange Commission, we will not undertake, and specifically disclaim any obligation to publicly update or revise any forward-looking statements to reflect events or circumstances arising after the date of this Form 10-K, whether as a result of new information, future events or otherwise. Readers are cautioned not to place undue reliance on the forward-looking statements included in this Form 10-K or that may be made elsewhere from time to time by, or on behalf of, us. All forward-looking statements attributable to us are expressly qualified by these cautionary statements. 48 Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Market risk We do not engage in speculative transactions nor do we hold or issue financial instruments for trading purposes. In connection with the recapitalizations of our business, we have issued fixed rate notes and entered into variable funding notes and, at January 1, 2023, we are exposed to interest rate risk on borrowings under our variable funding notes. As of January 1, 2023, we did not have any outstanding borrowings under our 2022 and 2021 Variable Funding Notes. Our 2021 Variable Funding Notes bear interest at fluctuating interest rates based on LIBOR. Our 2021 Variable Funding Notes loan documents provide that after the date on which the administrator for LIBOR permanently or indefinitely ceases to provide all available settings of U.S. dollar LIBOR, any new advances under the 2021 Variable Funding Notes that would otherwise have borne interest based on LIBOR, as well as any existing LIBOR advances for which the interest period has expired, will instead bear interest at a forward-looking term rate based on the Secured Overnight Financing Rate (“Term SOFR”), plus a spread adjustment, that in each case have been selected or recommended by the Board of Governors of the Federal Reserve System or the Federal Reserve Bank of New York. The loan documents also permit the lenders to effect a transition from LIBOR to Term SOFR at an earlier date, subject to certain conditions. Because the composition and characteristics of Term SOFR are not the same as those of LIBOR, there can be no assurance that Term SOFR will perform the same way LIBOR would have at any given time or for any applicable period. As a result, our interest expense could increase, in which event we may have difficulties making interest payments and funding our other fixed costs, and our available cash flow for general corporate requirements may be adversely affected. Our interest expense could also be increased by the rising interest rate environment, which could potentially have an adverse impact on our 2021 Variable Funding Notes, as well as on our 2022 Variable Funding Notes, which bear interest at fluctuating interest rates that are based on Term SOFR. Our fixed-rate debt exposes the Company to changes in market interest rates reflected in the fair value of the debt and to the risk that the Company may need to refinance maturing debt with new debt at a higher rate. We are exposed to market risks from changes in commodity prices. During the normal course of business, we purchase cheese and certain other food products that are affected by changes in commodity prices and, as a result, we are subject to volatility in our food costs. Severe increases in commodity prices or food costs, including as a result of inflation, could affect the global and U.S. economies and could also adversely impact our business, financial condition or results of operations. We may periodically enter into financial instruments to manage this risk, although we have not done so historically. We do not engage in speculative transactions or hold or issue financial instruments for trading purposes. In instances when we use fixed pricing agreements with our suppliers, these agreements cover our physical commodity needs, are not net-settled and are accounted for as normal purchases. Foreign currency exchange rate risk We have exposure to various foreign currency exchange rate fluctuations for revenues generated by our operations outside the U.S., which can adversely impact our net income and cash flows. Approximately 6.5% of our total revenues in 2022, 6.8% of our total revenues in 2021 and 6.1% of our total revenues in 2020 were derived from our international franchise segment, a majority of which were denominated in foreign currencies. We also operate dough manufacturing and distribution facilities in Canada, which generate revenues denominated in Canadian dollars. We do not enter into financial instruments to manage this foreign currency exchange risk. A hypothetical 10% adverse change in the foreign currency rates for our international markets would have resulted in a negative impact on royalty revenues of approximately $26.1 million in 2022. 49
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following combined discussion is separately filed by DTE Energy and DTE Electric. However, DTE Electric does not make any representations as to information related solely to DTE Energy or the subsidiaries of DTE Energy other than itself.EXECUTIVE OVERVIEWDTE Energy is a diversified energy company with 2022 Operating Revenues of approximately $19.2 billion and Total Assets of approximately $42.7 billion. DTE Energy is the parent company of DTE Electric and DTE Gas, regulated electric and natural gas utilities engaged primarily in the business of providing electricity and natural gas sales, distribution, and storage services throughout Michigan. DTE Energy also operates two energy-related non-utility segments with operations throughout the United States.On July 1, 2021, DTE Energy completed the separation of DT Midstream, its former natural gas pipeline, storage, and gathering non-utility business. Financial results of DT Midstream are presented as discontinued operations in the Consolidated Financial Statements. Refer to Note 4 to the Consolidated Financial Statements, “Discontinued Operations,” for additional information.Management’s Discussion and Analysis of Financial Condition and Results of Operations below reflect DTE Energy’s continuing operations, unless noted otherwise. The following table summarizes DTE Energy's financial results:Years Ended December 31,202220212020(In millions, except per share amounts)Net Income Attributable to DTE Energy Company — Continuing operations$1,083 $796 $1,054 Diluted Earnings per Common Share — Continuing operations$5.52 $4.10 $5.45 The increase in 2022 Net Income Attributable to DTE Energy Company was primarily due to higher earnings in the Electric, Gas, and Corporate and Other segments, partially offset by lower earnings in the DTE Vantage and Energy Trading segments. The decrease in 2021 Net Income Attributable to DTE Energy Company was primarily due to lower earnings in the Corporate and Other segment, driven primarily by losses on the extinguishment of debt incurred in 2021. The decrease was also due to lower earnings in the Energy Trading segment, partially offset by higher earnings in the Electric, Gas, and DTE Vantage segments.STRATEGYDTE Energy's strategy is to achieve long-term earnings per share growth with a strong balance sheet and attractive dividend.DTE Energy's utilities are investing capital to support a modern, reliable grid and cleaner, affordable energy through investments in base infrastructure and new generation. Increasing intensity of wind storms and other weather events, coupled with increasing electric vehicle adoption, will drive a continued need for substantial grid investment over the long-term.DTE Energy plans to reduce the carbon emissions of its electric utility operations by 32% by 2023, 65% in 2028, 85% in 2035, and 90% by 2040 from 2005 carbon emissions levels. These represent accelerated goals compared to the electric utility's prior targets to reduce carbon emissions by 50% by 2028 and 80% by 2040. DTE Energy plans to end its use of coal-fired power plants in 2035 and is committed to a net zero carbon emissions goal by 2050 for its electric and gas utility operations.To achieve the targeted carbon reduction goals at the electric utility, DTE Energy will continue its transition away from coal-powered energy sources and is replacing or offsetting the generation from these facilities with renewable energy, natural gas, battery storage, and energy waste reduction initiatives. Refer to the "Capital Investments" section below for further discussion regarding DTE Energy's retirement of its aging coal-fired plants and transition to renewable energy and other sources. Over the long-term, DTE Energy is also monitoring the advancement of emerging technologies such as long-duration storage, modular nuclear reactors, hydrogen, and carbon capture and sequestration, and how these technologies may support clean, reliable generation and customer affordability.28Table of ContentsFor the gas utility, DTE Energy aims to cut carbon emissions across the entire value chain. DTE Energy plans to reduce the carbon emissions from its gas utility operations by 65% by 2030 and 80% by 2040, and is committed to a goal of net zero emissions by 2050 from internal gas operations and gas suppliers. To achieve net zero, DTE Energy is working to source gas with lower methane intensity, reduce emissions through its gas main renewal and pipeline integrity programs, and if necessary, use carbon offsets to address any remaining emissions. DTE Energy also aims to help DTE Gas customers reduce their emissions by 35% by 2040 by increasing energy efficiency, pursuing advanced technologies such as hydrogen and carbon capture and sequestration, and through the CleanVision Natural Gas Balance program which provides customers the option to use carbon offsets and renewable natural gas.DTE Energy expects that these initiatives at the electric and gas utilities will continue to provide significant opportunities for capital investments and result in earnings growth. DTE Energy is focused on executing its plans to achieve operational excellence and customer satisfaction with a focus on customer affordability. DTE Energy expects its goals for customer affordability to be aided by operational efficiencies and new opportunities resulting from the Inflation Reduction Act enacted in August 2022. Such opportunities include tax credits for renewable energy, nuclear generation, energy storage, and carbon capture and sequestration, which are expected to reduce the cost of owning related assets and reduce customer rate impacts from any future cost recoveries. DTE Energy's utilities operate in a constructive regulatory environment and have solid relationships with their regulators.DTE Energy also has significant investments in non-utility businesses and expects growth opportunities in its DTE Vantage segment. DTE Energy employs disciplined investment criteria when assessing growth opportunities that leverage its assets, skills, and expertise, and provides attractive returns and diversity in earnings and geography. Specifically, DTE Energy invests in targeted markets with attractive competitive dynamics where meaningful scale is in alignment with its risk profile.A key priority for DTE Energy is to maintain a strong balance sheet which facilitates access to capital markets and reasonably priced financing. Growth will be funded through internally generated cash flows and the issuance of debt and equity. DTE Energy has an enterprise risk management program that, among other things, is designed to monitor and manage exposure to earnings and cash flow volatility related to commodity price changes, interest rates, and counterparty credit risk.CAPITAL INVESTMENTSDTE Energy's utility businesses will require significant capital investments to maintain and improve the electric generation and electric and natural gas distribution infrastructure and to comply with environmental regulations and achieve goals for carbon emission reductions. Capital plans may be regularly updated as these requirements and goals evolve and may be subject to regulatory approval.DTE Electric's capital investments over the 2023-2027 period are estimated at $18 billion, comprised of $9 billion for distribution infrastructure, $4 billion for base infrastructure, and $5 billion for cleaner generation including renewables. DTE Electric has retired all eleven coal-fired generation units at the Trenton Channel, River Rouge, and St. Clair facilities, including five units that were retired in the third quarter 2022, and has announced plans to retire its remaining six coal-fired generating units. DTE Electric plans to convert the two units at the Belle River facility from a base load coal plant to a natural gas peaking resource in 2025-2026. The four units at the Monroe facility are expected to be retired in two stages in 2028 and 2035. Generation from the retired facilities will continue to be replaced or offset with a combination of renewables, energy waste reduction, demand response, battery storage, and natural gas fueled generation, including the Blue Water Energy Center which commenced operations in June 2022.DTE Gas' capital investments over the 2023-2027 period are estimated at $3.6 billion, comprised of $2 billion for base infrastructure and $1.6 billion for the gas renewal program, which includes main and service renewals, meter move-out, and pipeline integrity projects.DTE Electric and DTE Gas plan to seek regulatory approval for capital expenditures consistent with ratemaking treatment.DTE Energy's non-utility businesses' capital investments are primarily for expansion, growth, and ongoing maintenance in the DTE Vantage segment, including approximately $1 billion to $1.5 billion from 2023-2027 for renewable energy and custom energy solutions, while expanding into carbon capture and sequestration.29Table of ContentsENVIRONMENTAL MATTERSThe Registrants are subject to extensive environmental regulations, including those addressing climate change. Additional costs may result as the effects of various substances on the environment are studied and governmental regulations are developed and implemented. Actual costs to comply could vary substantially. The Registrants expect to continue recovering environmental costs related to utility operations through rates charged to customers, as authorized by the MPSC.Increased costs for energy produced from traditional coal-based sources due to recent, pending, and future regulatory initiatives could also increase the economic viability of energy produced from renewable, natural gas fueled generation, and/or nuclear sources, energy waste reduction initiatives, and the potential development of market-based trading of carbon instruments.Refer to the "Environmental Matters" section within Items 1. and 2. Business and Properties and Note 18 to the Consolidated Financial Statements, "Commitments and Contingencies," for further discussion of Environmental Matters.OUTLOOKThe next few years will be a period of rapid change for DTE Energy and for the energy industry. DTE Energy's strong utility base, combined with its integrated non-utility operations, position it well for long-term growth.Looking forward, DTE Energy will focus on several areas that are expected to improve future performance:•electric and gas customer satisfaction;•electric distribution system reliability;•new electric generation and storage;•gas distribution system renewal;•reducing carbon emissions at the electric and gas utilities;•rate competitiveness and affordability;•regulatory stability and investment recovery for the electric and gas utilities;•strategic investments in growth projects at DTE Vantage;•employee engagement, health, safety and wellbeing, and diversity, equity, and inclusion;•cost structure optimization across all business segments; and•cash, capital, and liquidity to maintain or improve financial strength.DTE Energy will continue to pursue opportunities to grow its businesses in a disciplined manner if it can secure opportunities that meet its strategic, financial, and risk criteria.RESULTS OF OPERATIONSManagement’s Discussion and Analysis of Financial Condition and Results of Operations includes financial information prepared in accordance with GAAP, as well as the non-GAAP financial measures, Utility Margin and Non-utility Margin, discussed below, which DTE Energy uses as measures of its operational performance. Generally, a non-GAAP financial measure is a numerical measure of financial performance, financial position or cash flows that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP.DTE Energy uses Utility Margin and Non-utility Margin, non-GAAP financial measures, to assess its performance by reportable segment.30Table of ContentsUtility Margin includes electric utility and gas utility Operating Revenues net of Fuel, purchased power, and gas expenses. The utilities’ fuel, purchased power, and natural gas supply are passed through to customers, and therefore, result in changes to the utilities’ revenues that are comparable to changes in such expenses. As such, DTE Energy believes Utility Margin provides a meaningful basis for evaluating the utilities’ operations across periods, as it excludes the revenue effect of fluctuations in these expenses. For the Electric segment, non-utility Operating Revenues are reported separately so that Utility Margin can be used to assess utility performance.The Non-utility Margin relates to the DTE Vantage and Energy Trading segments. For the DTE Vantage segment, Non-utility Margin primarily includes Operating Revenues net of Fuel, purchased power, and gas expenses. Operating Revenues include sales of renewable natural gas and related credits, metallurgical coke and related by-products, petroleum coke, and electricity, as well as rental income and revenues from utility-type consulting, management, and operational services. For the prior periods, Operating revenues also include sales of refined coal to third parties and the affiliated Electric utility. For the Energy Trading segment, Non-utility Margin includes revenue and realized and unrealized gains and losses from physical and financial power and gas marketing, optimization, and trading activities, net of Purchased power and gas related to these activities. DTE Energy evaluates its operating performance of these non-utility businesses using the measure of Operating Revenues net of Fuel, purchased power, and gas expenses.Utility Margin and Non-utility Margin are not measures calculated in accordance with GAAP and should be viewed as a supplement to and not a substitute for the results of operations presented in accordance with GAAP. Utility Margin and Non-utility Margin do not intend to represent operating income, the most comparable GAAP measure, as an indicator of operating performance and are not necessarily comparable to similarly titled measures reported by other companies.The following sections provide a detailed discussion of the operating performance and future outlook of DTE Energy's segments. Segment information, described below, includes intercompany revenues and expenses, and other income and deductions that are eliminated in the Consolidated Financial Statements.202220212020(In millions)Net Income (Loss) Attributable to DTE Energy by SegmentElectric$956 $864 $777 Gas272 214 186 DTE Vantage92 168 134 Energy Trading(92)(83)36 Corporate and Other(145)(367)(79)Income From Continuing Operations1,083 796 1,054 Discontinued Operations— 111 314 Net Income Attributable to DTE Energy Company$1,083 $907 $1,368 31Table of ContentsELECTRICThe Results of Operations discussion for DTE Electric is presented in a reduced disclosure format in accordance with General Instruction I(2)(a) of Form 10-K for wholly-owned subsidiaries.The Electric segment consists principally of DTE Electric. Electric results and outlook are discussed below:202220212020(In millions)Operating Revenues — Utility operations$6,397 $5,809 $5,506 Fuel and purchased power — utility1,978 1,531 1,386 Utility Margin4,419 4,278 4,120 Operating Revenues — Non-utility operations15 12 14 Operation and maintenance1,564 1,556 1,489 Depreciation and amortization1,218 1,122 1,057 Taxes other than income339 321 297 Asset (gains) losses and impairments, net8 1 41 Operating Income1,305 1,290 1,250 Other (Income) and Deductions324 322 365 Income Tax Expense25 104 108 Net Income Attributable to DTE Energy Company$956 $864 $777 See DTE Electric's Consolidated Statements of Operations in Item 8 of this Report for a complete view of its results. Differences between the Electric segment and DTE Electric's Consolidated Statements of Operations are primarily due to non-utility operations at DTE Sustainable Generation and the classification of certain benefit costs. Refer to Note 20 to the Consolidated Financial Statements, "Retirement Benefits and Trusteed Assets" for additional information.Utility Margin increased $141 million in 2022 and $158 million in 2021. Revenues associated with certain mechanisms and surcharges are offset by related expenses elsewhere in the Registrants' Consolidated Statements of Operations.The following table details changes in various Utility Margin components relative to the comparable prior period:20222021(In millions)Voluntary refunds(a)$90 $(60)Regulatory mechanism — RPS36 57 COVID-19 voluntary refund amortization30 — Regulatory mechanism — EWR29 61 Regulatory mechanism — DTE Securitization29 — Implementation of new rates3 71 Weather(10)14 Regulatory mechanism — TRM(20)6 Base sales / rate mix(68)13 Other22 (4)Increase in Utility Margin$141 $158 ______________________________(a)Variances reflect the $90 million voluntary refund recognized in 2021 for the incremental tree trim surge and the $30 million COVID-19 voluntary refund recognized in 2020. Refer to Note 9 to the Consolidated Financial Statements, "Regulatory Matters," for additional information regarding these refunds and the related regulatory liabilities.32Table of Contents202220212020(In thousands of MWh)DTE Electric SalesResidential15,844 16,386 16,315 Commercial16,296 16,393 15,648 Industrial8,548 8,487 8,446 Other210 216 220 40,898 41,482 40,629 Interconnection sales(a)6,615 4,263 1,808 Total DTE Electric Sales47,513 45,745 42,437 DTE Electric DeliveriesRetail and wholesale40,898 41,482 40,629 Electric retail access, including self-generators(b)4,486 4,357 3,746 Total DTE Electric Sales and Deliveries45,384 45,839 44,375 ______________________________(a)Represents power that is not distributed by DTE Electric.(b)Represents deliveries for self-generators that have purchased power from alternative energy suppliers to supplement their power requirements.DTE Electric sales and deliveries decreased in 2022, primarily due to a decrease in residential sales as customers resumed more pre-pandemic activities and worked less from their homes. The increase in 2021 was primarily due to commercial customers which were impacted more significantly in 2020 by the COVID-19 pandemic and temporary shut-downs of certain commercial operations.Operating Revenues — Non-utility operations increased $3 million in 2022 and decreased $2 million in 2021. The increase in 2022 was primarily due to higher sales volumes and prices at DTE Sustainable Generation. The decrease in 2021 was primarily due to lower sales volumes at DTE Sustainable Generation.Operation and maintenance expense increased $8 million in 2022 and $67 million in 2021. The increase in 2022 was primarily due to higher EWR expense of $29 million and higher distribution operations expense of $7 million, partially offset by lower benefits and other compensation expense of $17 million and lower legal and environmental expense of $12 million.The increase in 2021 was primarily due to higher EWR expense of $45 million, higher distribution operations expense of $42 million (primarily due to higher storm costs), higher corporate support costs of $21 million, higher legal and environmental expense of $15 million, and higher benefits and other compensation expense of $13 million. These increases were partially offset by lower COVID-19 related expenses of $43 million, lower uncollectible expense of $26 million, and lower plant generation expense of $4 million.Depreciation and amortization expense increased $96 million in 2022 and $65 million in 2021. In 2022, the increase was primarily due to a $101 million increase from a higher depreciable base, partially offset by a decrease of $9 million associated with the TRM. In 2021, the increase was primarily due to a $64 million increase resulting from a higher depreciable base.Taxes other than income increased $18 million in 2022 and $24 million in 2021. In 2022, the increase was primarily due to higher property taxes of $16 million as a result of a higher tax base. In 2021, the increase was primarily due to higher property taxes of $22 million as a result of an increase in tax base and a favorable property tax settlement in 2020.Asset (gains) losses and impairments, net increased $7 million in 2022 and decreased $40 million in 2021. The increase in 2022 was primarily due to previously recorded capital expenditures of $8 million that were disallowed in the November 18, 2022 rate order from the MPSC. The decrease in 2021 was primarily due to a $41 million write-off of capital expenditures related to incentive compensation in 2020.Other (Income) and Deductions increased $2 million in 2022 and decreased $43 million in 2021. The increase in 2022 was primarily due to a change in rabbi trust and other investment earnings (net loss of $10 million in 2022 compared to a net gain of $9 million in 2021) and higher net interest of $27 million, partially offset by lower non-operating retirement benefits expense of $37 million and a $4 million decrease in non-operational costs that ceased with the retirement of a power plant. The decrease in 2021 was primarily due to lower contributions to the DTE Energy Foundation and other not-for-profit organizations of $28 million, a change in rabbi trust investment earnings (net gain of $7 million in 2021 compared to a net loss of $3 million in 2020), and lower non-operating retirement benefits expense of $4 million.33Table of ContentsIncome Tax Expense decreased $79 million in 2022 and $4 million in 2021. The decreases in both periods were primarily due to higher amortization of the TCJA regulatory liability and higher production tax credits, partially offset by higher earnings.Outlook — DTE Electric will continue to move forward in its efforts to achieve operational excellence, sustain strong cash flows, and earn its authorized return on equity. DTE Electric expects that planned significant capital investments will result in earnings growth. DTE Electric will maintain a strong focus on customers by increasing reliability and satisfaction while keeping customer rate increases affordable. Looking forward, additional factors may impact earnings such as weather, the outcome of regulatory proceedings, benefit plan design changes, uncertainty of legislative or regulatory actions regarding climate change, and effects of energy waste reduction programs.DTE Electric filed a rate case with the MPSC on February 10, 2023 requesting an increase in base rates of $622 million based on a projected twelve-month period ending November 30, 2024, and in increase in return on equity from 9.9% to 10.25%. The requested increase in base rates is primarily due to increased investments in plant involving generation and the electric distribution system, as well as related increases to depreciation and property tax expenses. These investments will support DTE Energy's goals to reduce carbon emissions and improve power reliability. The requested increase in base rates is also due to a projected sales decline from the level included in current rates and inflationary impacts on operating and interest costs. A final MPSC order in this case is expected in December 2023.GASThe Gas segment consists principally of DTE Gas. Gas results and outlook are discussed below:202220212020(In millions)Operating Revenues — Utility operations$1,924 $1,553 $1,414 Cost of gas — utility632 422 356 Utility Margin1,292 1,131 1,058 Operation and maintenance552 521 496 Depreciation and amortization192 177 157 Taxes other than income101 93 84 Asset (gains) losses and impairments, net— 4 14 Operating Income447 336 307 Other (Income) and Deductions87 84 73 Income Tax Expense88 38 48 Net Income Attributable to DTE Energy Company$272 $214 $186 Utility Margin increased $161 million in 2022 and $73 million in 2021. Revenues associated with certain mechanisms and surcharges are offset by related expenses elsewhere in DTE Energy's Consolidated Statements of Operations.The following table details changes in various Utility Margin components relative to the comparable prior period:20222021(In millions)Implementation of new rates$80 $75 Weather47 (7)Base sales20 7 Regulatory mechanism — EWR8 3 Home protection program6 6 Infrastructure recovery mechanism1 (15)Voluntary refund(a)(5)— Other4 4 Increase in Utility Margin$161 $73 ______________________________(a)Refer to Note 9 to the Consolidated Financial Statements, "Regulatory Matters," for additional information regarding the voluntary refund.34Table of Contents202220212020(In Bcf)Gas MarketsGas sales145 128 126 End-user transportation168 165 180 313 293 306 Intermediate transportation527 488 477 Total Gas sales840 781 783 The change in sales in 2022 was primarily due to favorable weather. The change in sales in 2021 was primarily due to a decrease in End-user transportation volumes, including lower generation needs at certain industrial customers. Intermediate transportation volumes fluctuate period to period based on available market opportunities.Operation and maintenance expense increased $31 million in 2022 and $25 million in 2021. The increase in 2022 was primarily due to higher gas operations expense of $17 million, higher corporate support costs of $10 million, and higher EWR expense of $7 million, partially offset by lower benefits and other compensation expense of $4 million. The increase in 2021 was primarily due to higher gas operations expense of $41 million, partially offset by lower uncollectible expense of $15 million.Depreciation and amortization expense increased $15 million in 2022 and $20 million in 2021. The increase in 2022 was primarily due to a higher depreciable base. The increase in 2021 was primarily due to a higher depreciable base and change in depreciation rates effective October 2020.Taxes other than income increased $8 million in 2022 and $9 million in 2021. The 2022 increase was primarily due to higher property taxes of $7 million. The 2021 increase was primarily due to higher property taxes of $6 million and employee retention credits of $3 million recognized in 2020 pursuant to the CARES Act.Asset (gains) losses and impairments, net decreased $4 million in 2022 and $10 million in 2021. The decrease in 2022 was primarily due to capital write-offs of $4 million in 2021. The decrease in 2021 was primarily due to the $4 million of capital write-offs compared to $14 million of capital write-offs in 2020 related to incentive compensation.Other (Income) and Deductions increased $3 million in 2022 and $11 million in 2021. The increase in 2022 was primarily due to a change in investment earnings (loss of $6 million in 2022 compared to a gain of $3 million in 2021) and higher net interest expense of $7 million, partially offset by 2021 contributions to the DTE Energy Foundation and other not-for-profit organizations of $12 million. The increase in 2021 was primarily due to contributions to the DTE Energy Foundation and other not-for-profit organizations.Income Tax Expense increased $50 million in 2022 and decreased $10 million in 2021. The increase in 2022 was primarily due to higher earnings and lower amortization of the TCJA regulatory liability. The decrease in 2021 was primarily due to higher amortization of the TCJA regulatory liability, partially offset by higher earnings.Outlook — DTE Gas will continue to move forward in its efforts to achieve operational excellence, sustain strong cash flows, and earn its authorized return on equity. DTE Gas expects that planned significant infrastructure capital investments will result in earnings growth. Looking forward, additional factors may impact earnings such as weather, the outcome of regulatory proceedings, and benefit plan design changes. DTE Gas expects to continue its efforts to improve productivity and decrease costs while improving customer satisfaction with consideration of customer rate affordability.35Table of ContentsDTE VANTAGEThe DTE Vantage segment is comprised primarily of renewable energy projects that sell electricity and pipeline-quality gas and projects that deliver custom energy solutions to industrial, commercial, and institutional customers. DTE Vantage formerly included projects that produced reduced emissions fuel; however, these projects were closed as planned in 2022 upon REF facilities exhausting their eligibility for generating production tax credits. DTE Vantage results and outlook are discussed below:202220212020(In millions)Operating Revenues — Non-utility operations$848 $1,482 $1,224 Fuel, purchased power, and gas — non-utility431 1,086 901 Non-utility Margin417 396 323 Operation and maintenance267 301 294 Depreciation and amortization52 71 72 Taxes other than income10 11 10 Asset (gains) losses and impairments, net(7)28 (18)Operating Income (Loss)95 (15)(35)Other (Income) and Deductions(15)(142)(120)Income TaxesExpense27 37 26 Production Tax Credits(9)(68)(66)18 (31)(40)Net Income92 158 125 Less: Net Loss Attributable to Noncontrolling Interests— (10)(9)Net Income Attributable to DTE Energy Company$92 $168 $134 Operating Revenues — Non-utility operations decreased $634 million in 2022 and increased $258 million in 2021. The changes were due to the following:2022(In millions)Closure of the REF business$(766)Termination of a contract in the Steel business in 2021(39)Higher sales in the Renewables business9 New contract in the Renewables business18 Higher prices partially offset by a terminated contract in the On-site business27 Higher demand and prices in the Steel business117 $(634)2021(In millions)Higher production partially offset by the sale of membership interests in the REF business$175 Higher demand partially offset by lower prices in the Steel business104 New projects in the Renewables business42 Recognition of revenues from termination of a contract in the Steel business17 Higher volumes partially offset by a terminated contract in the On-site business15 Closed projects in the Renewables business(7)Site closures in the REF business(88)$258 36Table of ContentsNon-utility Margin increased $21 million in 2022 and $73 million in 2021. The changes were due to the following:2022(In millions)Higher demand and prices in the Steel business$16 New contract in the Renewables business14 Higher sales in the Renewables business7 Closure of the REF business7 Termination of a contract in the Steel business in 2021(23)$21 2021(In millions)New projects in the Renewables business$42 Higher demand partially offset by lower prices in the Steel business18 Recognition of revenues from termination of a contract in the Steel business17 Closed projects in the Renewables business(6)Other2 $73 Operation and maintenance expense decreased $34 million in 2022 and increased $7 million in 2021. The 2022 decrease was primarily due to $37 million associated with the closure of the REF business and $6 million of lower corporate overhead costs, partially offset by an $8 million increase due to a new contract in the Renewables business. The 2021 increase was primarily due to higher production and new projects, partially offset by closed projects.Depreciation and amortization decreased $19 million in 2022 and $1 million in 2021. The decrease in 2022 was primarily due to the closure of the REF business.Asset (gains) losses and impairments, net changed by $35 million in 2022 from the net loss of $28 million in 2021, and changed by $46 million in 2021 from the net gain of $18 million in 2020. The change in 2022 was primarily due to an asset impairment of $27 million recorded in the Steel business in 2021 for the anticipated closure of a pulverized coal facility, as well as a $5 million gain recorded in the Renewables business in 2022 related to lower future contingent obligations.The change in 2021 was primarily due to the asset impairment of $27 million recorded in the Steel business compared to $18 million of gain activity in 2020, which included $11 million in the Steel business for an asset sale and write-off of environmental liabilities, $4 million for the sale of assets in the On-site business, and $2 million for the divestiture of a project in the Renewables business.Other (Income) and Deductions decreased $127 million in 2022 and increased $22 million in 2021. The 2022 decrease was primarily due to $143 million lower income associated with the closure of the REF business, partially offset by $14 million lower interest expense. The 2021 increase was primarily due to a $22 million settlement charge associated with a qualified pension plan in the Steel business recorded in 2020. The 2021 increase also included higher production in the REF business, offset by profit recognized from the sale of membership interests recorded in 2020.Income Taxes — Expense decreased $10 million in 2022 and increased $11 million in 2021. The change in both periods was primarily due to changes in pre-tax income, inclusive of pre-tax income (loss) at non-controlling interests.Income Taxes — Production Tax Credits decreased by $59 million in 2022 and increased by $2 million in 2021. The decrease in 2022 was primarily due to the closure of the REF business. The increase in 2021 was primarily due to higher production, partially offset by the sale of membership interests in the REF business.Net Loss Attributable to Noncontrolling Interests decreased by $10 million in 2022 and increased by $1 million in 2021. The decrease in 2022 was primarily due to the closure of the REF business.37Table of ContentsOutlook — In December 2022, DTE Vantage entered into a series of agreements with a large industrial customer to design, construct, own, and operate certain energy infrastructure assets at the customer's planned electric vehicle and battery manufacturing plant in Tennessee. The project is expected to begin construction in early 2023 and achieve commercial operations in late 2024 for a term of 20 years. DTE Vantage will continue to leverage its extensive energy-related operating experience and project management capability to develop additional renewable natural gas projects and other projects that provide customer specific energy solutions. DTE Vantage is also developing decarbonization opportunities relating to carbon capture and sequestration projects.ENERGY TRADINGEnergy Trading focuses on physical and financial power, natural gas and environmental marketing and trading, structured transactions, enhancement of returns from its asset portfolio, and optimization of contracted natural gas pipeline transportation and storage positions. Energy Trading also provides natural gas, power, environmental and related services, which may include the management of associated storage and transportation contracts on the customers' behalf and the supply or purchase of environmental attributes to various customers. Energy Trading results and outlook are discussed below:202220212020(In millions)Operating Revenues — Non-utility operations$10,308 $6,831 $3,863 Purchased power and gas — non-utility10,331 6,825 3,725 Non-utility Margin(23)6 138 Operation and maintenance64 81 77 Depreciation and amortization5 6 5 Taxes other than income7 5 4 Asset (gains) losses and impairments, net2 — — Operating Income (Loss)(101)(86)52 Other (Income) and Deductions22 24 4 Income Tax Expense (Benefit)(31)(27)12 Net Income (Loss) Attributable to DTE Energy Company$(92)$(83)$36 Operating Revenues — Non-utility operations and Purchased power and gas — non-utility increased in both periods primarily due to significantly higher gas prices in the gas structured and gas transportation strategies.Non-utility Margin decreased by $29 million in 2022 and $132 million in 2021. The following tables detail changes in Non-Utility margin relative to the comparable prior periods:2022(In millions)Unrealized Margins(a)Favorable results, primarily in power trading, gas full requirements, and gas trading strategies$46 Unfavorable results, primarily in gas structured and power full requirements strategies(b)(88)(42)Realized Margins(a)Favorable results, primarily in gas transportation, gas full requirements, and environmental trading strategies(c)92 Unfavorable results, primarily in power full requirements and gas trading strategies(79)13 Decrease in Non-utility Margin$(29)_______________________________________(a)Natural gas structured transactions typically involve a physical purchase or sale of natural gas in the future and/or natural gas basis financial instruments which are derivatives and a related non-derivative pipeline transportation contract. These gas structured transactions can result in significant earnings volatility as the derivative components are marked-to-market without revaluing the related non-derivative contracts.(b)Amount includes $35 million of timing related losses related to gas strategies which will reverse in future periods as the underlying contracts settle.(c)Amount includes $71 million of timing related losses related to gas strategies recognized in previous periods that reversed as the underlying contracts settled.38Table of Contents2021(In millions)Unrealized Margins(a)Favorable results, primarily in gas and power trading strategies$36 Unfavorable results, primarily in gas structured, environmental trading, and gas storage strategies (b)(215)(179)Realized Margins(a)Favorable results, primarily in gas structured and gas transportation strategies(c)126 Unfavorable results, primarily in power ERCOT trading and power full requirements strategies(79)47 Decrease in Non-utility Margin$(132)_______________________________________(a)Natural gas structured transactions typically involve a physical purchase or sale of natural gas in the future and/or natural gas basis financial instruments which are derivatives and a related non-derivative pipeline transportation contract. These gas structured transactions can result in significant earnings volatility as the derivative components are marked-to-market without revaluing the related non-derivative contracts.(b)Amount includes $200 million of timing related losses related to gas strategies which will reverse in future periods as the underlying contracts settle.(c)Amount includes $20 million of timing related losses related to gas strategies recognized in previous periods that reversed as the underlying contracts settled.Operation and maintenance expense decreased $17 million in 2022 and increased $4 million in 2021. The decrease in 2022 and increase in 2021 were primarily due to lower and higher compensation costs, respectively.Other (Income) and Deductions decreased $2 million in 2022 and increased $20 million in 2021. The decrease in 2022 was primarily due to $10 million of lower contributions to not-for-profit organizations, partially offset by higher net interest expense of $7 million. The increase in 2021 was primarily due to contributions to the DTE Energy Foundation and other not-for-profit organizations.Outlook — In the near-term, Energy Trading expects market conditions to remain challenging. The profitability of this segment may be impacted by the volatility in commodity prices and the uncertainty of impacts associated with regulatory changes, and changes in operating rules of RTOs. Significant portions of the Energy Trading portfolio are economically hedged. Most financial instruments, physical power and natural gas contracts, and certain environmental contracts are deemed derivatives; whereas, natural gas and environmental inventory, contracts for pipeline transportation, storage assets, and some environmental contracts are not derivatives. As a result, Energy Trading will experience earnings volatility as derivatives are marked-to-market without revaluing the underlying non-derivative contracts and assets. Energy Trading's strategy is to economically manage the price risk of these underlying non-derivative contracts and assets with futures, forwards, swaps, and options. This results in gains and losses that are recognized in different interim and annual accounting periods.See also the "Fair Value" section herein and Notes 12 and 13 to the Consolidated Financial Statements, "Fair Value" and "Financial and Other Derivative Instruments," respectively.CORPORATE AND OTHERCorporate and Other includes various holding company activities, holds certain non-utility debt, and holds certain investments, including funds supporting regional development and economic growth. The 2022 net loss of $145 million represents a decrease of $222 million from the 2021 net loss of $367 million. This decrease was primarily due to one-time items following the separation of DT Midstream in 2021, including a $294 million earnings impact from losses on debt extinguishment, partially offset by a reduction to Income Tax Expense of $85 million for the remeasurement of state deferred taxes. The remaining decrease of $13 million in 2022 was primarily due to lower state income taxes, lower valuation allowances, and a gain on sale of assets, partially offset by equity investment losses and one-time benefits expenses.39Table of ContentsThe 2021 net loss of $367 million represents an increase of $288 million from the 2020 net loss of $79 million. This increase was primarily due to higher losses on the extinguishment of debt in 2021 following the separation of DT Midstream, which reduced earnings by $294 million, higher net interest expense, and a valuation allowance established in 2021 for certain charitable contribution carryforwards. The higher loss was also due to the carryback of 2018 net operating losses to 2013 pursuant to the CARES Act, which resulted in a $34 million reduction to Income Tax Expense in 2020. The losses in 2021 were partially offset by the remeasurement of state deferred taxes following the separation of DT Midstream, which resulted in an $85 million reduction to Income Tax Expense in 2021.CAPITAL RESOURCES AND LIQUIDITYCash RequirementsDTE Energy uses cash to maintain and invest in the electric and natural gas utilities, to grow the non-utility businesses, to retire and pay interest on long-term debt, and to pay dividends. DTE Energy believes it will have sufficient internal and external capital resources to fund anticipated capital and operating requirements. DTE Energy expects that cash from operations in 2023 will be approximately $3.2 billion. DTE Energy anticipates base level utility capital investments, including environmental, renewable, and energy waste reduction expenditures, and expenditures for non-utility businesses of approximately $4.2 billion in 2023. DTE Energy plans to seek regulatory approval to include utility capital expenditures in regulatory rate base consistent with prior treatment. Capital spending for growth of existing or new non-utility businesses will depend on the existence of opportunities that meet strict risk-return and value creation criteria.Refer below for analysis of cash flows relating to operating, investing, and financing activities, which reflect DTE Energy's change in financial condition. Any significant non-cash items are included in the Supplemental disclosure of non-cash investing and financing activities within the Consolidated Statements of Cash Flows.202220212020(In millions)Cash, Cash Equivalents, and Restricted Cash at Beginning of Period$35 $516 $93 Net cash from operating activities1,977 3,067 3,697 Net cash used for investing activities(3,431)(3,863)(4,070)Net cash from financing activities1,462 315 796 Net Increase (Decrease) in Cash, Cash Equivalents, and Restricted Cash8 (481)423 Cash, Cash Equivalents, and Restricted Cash at End of Period$43 $35 $516 Cash from Operating ActivitiesA majority of DTE Energy's operating cash flows are provided by the electric and natural gas utilities, which are significantly influenced by factors such as weather, electric retail access, regulatory deferrals, regulatory outcomes, economic conditions, changes in working capital, and operating costs.Net cash from operations decreased $1.1 billion in 2022. The reduction was primarily due to lower cash from working capital items. The reduction was also partially due to changes in Net income, which decreased year-over-year if adjusted for the Loss on extinguishment of debt in 2021, primarily driven by the separation of DT Midstream in July 2021 and the closure of the REF business at DTE Vantage in 2022.Net cash from operations decreased $630 million in 2021. The reduction was primarily due to a decrease in Deferred income taxes, working capital items, and Net Income, adjusted for the Loss on extinguishment of debt. The decrease was partially offset by an increase in Depreciation and amortization.The change in working capital items in 2022 was primarily due to a decrease in cash related to Regulatory assets and liabilities, Accounts receivable, net, and Accounts payable, partially offset by increases related to Prepaid postretirement benefit costs, Accrued pension liability, and Other current and noncurrent assets and liabilities. The change in working capital items in 2021 was primarily due to a decrease related to Accrued pension liability, Accounts receivable, net, Inventories, Accrued postretirement liability, and Other current and noncurrent assets and liabilities, partially offset by an increase related to Regulatory assets and liabilities, Accounts payable, and Derivative assets and liabilities.40Table of ContentsChanges in working capital during 2022 were significantly impacted by higher prices for natural gas and electricity, including Accounts receivable at the utilities, Accounts payable in the Electric and Energy Trading segments, and Regulatory assets attributed to the PSCR mechanism at DTE Electric. Refer to "Quantitative and Qualitative Disclosures About Market Risk" within Item 7A of this Report for additional information regarding DTE Energy's management of commodity price and other market risks.Cash used for Investing ActivitiesCash inflows associated with investing activities are primarily generated from the sale of assets, while cash outflows are the result of plant and equipment expenditures and acquisitions. In any given year, DTE Energy looks to realize cash from under-performing or non-strategic assets or matured, fully valued assets.Capital spending within the utility businesses is primarily to maintain and improve electric generation and the electric and natural gas distribution infrastructure, and to comply with environmental regulations and renewable energy requirements.Capital spending within the non-utility businesses is primarily for ongoing maintenance, expansion, and growth. DTE Energy looks to make growth investments that meet strict criteria in terms of strategy, management skills, risks, and returns. All new investments are analyzed for their rates of return and cash payback on a risk adjusted basis. DTE Energy has been disciplined in how it deploys capital and will not make investments unless they meet the criteria. For new business lines, DTE Energy initially invests based on research and analysis. DTE Energy starts with a limited investment, evaluates the results, and either expands or exits the business based on those results. In any given year, the amount of growth capital will be determined by the underlying cash flows of DTE Energy, with a clear understanding of any potential impact on its credit ratings.Net cash used for investing activities decreased $432 million in 2022 due primarily to decreases in utility plant and equipment expenditures and non-utility plant and equipment expenditures.Net cash used for investing activities decreased $207 million in 2021 due primarily to decreases in non-utility plant and equipment expenditures and Acquisitions related to business combinations, net of cash acquired, partially offset by an increase in utility plant and equipment expenditures.Cash from Financing ActivitiesDTE Energy relies on both short-term borrowing and long-term financing as a source of funding for capital requirements not satisfied by its operations.DTE Energy's strategy is to have a targeted debt portfolio blend of fixed and variable interest rates and maturity. DTE Energy targets balance sheet financial metrics to ensure it is consistent with the objective of a strong investment grade debt rating.Net cash from financing activities increased $1.1 billion in 2022. The increase was primarily due to the Issuance of common stock in 2022, decreases in Redemption of long-term debt and Prepayment costs for extinguishment of long-term debt, and lower Dividends on common stock. The increase was partially offset by decreases in Issuance of long-term debt, net of issuance costs and Short-term borrowings, net. The lower amount of long-term debt activity was primarily due to $3.1 billion of new issuances and $2.6 billion of redemptions in 2021 related to the separation of DT Midstream. Net cash used for financing activities decreased $481 million in 2021. The decrease was primarily due to an increase in Redemption of long-term debt, Prepayment costs for redemption of long-term debt, Repurchase of common stock, and Dividends paid on common stock, partially offset by increases in the Issuance of long-term debt, net of issuance costs and Short-term borrowings, net, as well as the Acquisition related deferred payment made in 2020.41Table of ContentsOutlookSources of CashDTE Energy expects cash flows from operations to increase over the long-term, primarily as a result of growth from the utility and non-utility businesses. Growth in the utilities is expected to be driven primarily by capital spending which will increase the base from which rates are determined. DTE Energy expects long-term growth in sales related to vehicle electrification, but no significant impacts in the near-term. Non-utility growth is expected from additional investments in the DTE Vantage segment, primarily related to renewable energy and custom energy solutions, while expanding into carbon capture and sequestration. DTE Vantage expects enhanced growth opportunities in decarbonization as a result of the Inflation Reduction Act enacted in August 2022, including tax credits for renewable natural gas and carbon capture projects.DTE Energy's utilities may be impacted by the timing of collection or refund of various recovery and tracking mechanisms as a result of timing of MPSC orders. Energy prices are likely to be a source of volatility with regard to working capital requirements for the foreseeable future. DTE Energy continues its efforts to identify opportunities to improve cash flows through working capital initiatives and maintaining flexibility in the timing and extent of long-term capital projects.At the discretion of management and depending upon economic and financial market conditions, DTE Energy expects to issue up to $100 million of equity in 2023. If issued, DTE Energy anticipates these discretionary equity issuances would be made through contributions to the dividend reinvestment plan and/or employee benefit plans.Over the long-term, DTE Energy does not have any equity commitments and will continue to evaluate equity needs on an annual basis. DTE Energy currently expects its primary source of long-term financing to be the issuance of debt and is monitoring the impact of rising interest rates on the cost of borrowing.Uses of CashDTE Energy has $1.1 billion in long-term debt, including finance leases, maturing in the next twelve months. Repayment of the debt is expected to be made through internally generated funds and the issuance of short-term and/or long-term debt.DTE Energy has paid quarterly cash dividends for more than 100 consecutive years and expects to continue paying regular cash dividends in the future, including approximately $0.8 billion in 2023. Any payment of future dividends is subject to approval by the Board of Directors and may depend on DTE Energy's future earnings, capital requirements, and financial condition. Over the long-term, DTE Energy expects continued dividend growth and is targeting a payout ratio consistent with pure-play utility companies. Dividends are subject to certain restrictions as discussed in Note 16 to the Consolidated Financial Statements, "Short-Term Credit Arrangements and Borrowings." However, these restrictions are not expected to impact DTE Energy's planned dividend payments.Various subsidiaries and equity investees of DTE Energy have entered into derivative and non-derivative contracts which contain ratings triggers and are guaranteed by DTE Energy. These contracts contain provisions which allow the counterparties to require that DTE Energy post cash or letters of credit as collateral in the event that DTE Energy's credit rating is downgraded below investment grade. Certain of these provisions (known as "hard triggers") state specific circumstances under which DTE Energy can be required to post collateral upon the occurrence of a credit downgrade, while other provisions (known as "soft triggers") are not as specific. For contracts with soft triggers, it is difficult to estimate the amount of collateral which may be requested by counterparties and/or which DTE Energy may ultimately be required to post. The amount of such collateral which could be requested fluctuates based on commodity prices (primarily natural gas, power, and environmental) and the provisions and maturities of the underlying transactions. As of December 31, 2022, DTE Energy's contractual obligation to post collateral in the form of cash or letters of credit in the event of a downgrade to below investment grade, under both hard trigger and soft trigger provisions, was $571 million.For cash obligations related to leases and future purchase commitments, refer to Note 17 and Note 18 to the Consolidated Financial Statements, "Leases." and "Commitments and Contingencies," respectively. Purchase commitments include capital expenditures that are contractually obligated. Also refer to the "Capital Investments" section above for additional information on DTE Energy's capital strategy and estimated spend over the next five years.42Table of ContentsOther obligations are further described in the following Combined Notes to the Consolidated Financial Statements:NoteTitle1Organization and Basis of Presentation9Regulatory Matters10Income Taxes13Financial and Other Derivative Instruments14Long-Term Debt16Short-Term Credit Arrangements and Borrowings18Commitments and Contingencies20Retirement Benefits and Trusteed Assets21Stock-Based CompensationLiquidityDTE Energy has approximately $2.1 billion of available liquidity at December 31, 2022, consisting primarily of cash and cash equivalents and amounts available under unsecured revolving credit agreements and term loans.DTE Energy believes it will have sufficient operating flexibility, cash resources and funding sources to maintain adequate liquidity and to meet future operating cash and capital expenditure needs. However, virtually all DTE Energy's businesses are capital intensive, or require access to capital, and the inability to access adequate capital could adversely impact earnings and cash flows.Credit RatingsCredit ratings are intended to provide banks and capital market participants with a framework for comparing the credit quality of securities and are not a recommendation to buy, sell, or hold securities. DTE Energy, DTE Electric, and DTE Gas' credit ratings affect their costs of capital and other terms of financing, as well as their ability to access the credit and commercial paper markets. DTE Energy, DTE Electric, and DTE Gas' management believes that the current credit ratings provide sufficient access to capital markets. However, disruptions in the banking and capital markets not specifically related to DTE Energy, DTE Electric, and DTE Gas may affect their ability to access these funding sources or cause an increase in the return required by investors.As part of the normal course of business, DTE Electric, DTE Gas, and various non-utility subsidiaries of DTE Energy routinely enter into physical or financially settled contracts for the purchase and sale of electricity, natural gas, coal, capacity, storage, and other energy-related products and services. Certain of these contracts contain provisions which allow the counterparties to request that DTE Energy posts cash or letters of credit in the event that the senior unsecured debt rating of DTE Energy is downgraded below investment grade. The amount of such collateral which could be requested fluctuates based upon commodity prices and the provisions and maturities of the underlying transactions and could be substantial. Also, upon a downgrade below investment grade, DTE Energy, DTE Electric, and DTE Gas could have restricted access to the commercial paper market, and if DTE Energy is downgraded below investment grade, the non-utility businesses could be required to restrict operations due to a lack of available liquidity. A downgrade below investment grade could potentially increase the borrowing costs of DTE Energy, DTE Electric, and DTE Gas and their subsidiaries and may limit access to the capital markets. The impact of a downgrade will not affect DTE Energy, DTE Electric, and DTE Gas' ability to comply with existing debt covenants. While DTE Energy, DTE Electric, and DTE Gas currently do not anticipate such a downgrade, they cannot predict the outcome of current or future credit rating agency reviews.CRITICAL ACCOUNTING ESTIMATESThe preparation of the Registrants' Consolidated Financial Statements in conformity with generally accepted accounting principles requires that management apply accounting policies and make estimates and assumptions that affect the results of operations and the amounts of assets and liabilities reported in the Consolidated Financial Statements. The Registrants' management believes that the areas described below require significant judgment in the application of accounting policy or in making estimates and assumptions in matters that are inherently uncertain and that may change in subsequent periods. Additional discussion of these accounting policies can be found in the Combined Notes to Consolidated Financial Statements in Item 8 of this Report.43Table of ContentsRegulationA significant portion of the Registrants' businesses are subject to regulation. This results in differences in the application of generally accepted accounting principles between regulated and non-regulated businesses. DTE Electric and DTE Gas are required to record regulatory assets and liabilities for certain transactions that would have been treated as revenue or expense in non-regulated businesses. Future regulatory changes or changes in the competitive environment could result in the discontinuance of this accounting treatment for regulatory assets and liabilities for some or all of the Registrants' businesses. The Registrants' management believes that currently available facts support the continued use of regulatory assets and liabilities and that all regulatory assets and liabilities are recoverable or refundable in the current rate environment.See Note 9 to the Consolidated Financial Statements, "Regulatory Matters."DerivativesDerivatives are generally recorded at fair value and shown as Derivative assets or liabilities. Changes in the fair value of the derivative instruments are recognized in earnings in the period of change. The normal purchases and normal sales exception requires, among other things, physical delivery in quantities expected to be used or sold over a reasonable period in the normal course of business. Contracts that are designated as normal purchases and normal sales are not recorded at fair value. Substantially all of the commodity contracts entered into by DTE Electric and DTE Gas meet the criteria specified for this exception.Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date in a principal or most advantageous market. Fair value is a market-based measurement that is determined based on inputs, which refer broadly to assumptions that market participants use in pricing assets or liabilities. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Registrants make certain assumptions they believe that market participants would use in pricing assets or liabilities, including assumptions about risk, and the risks inherent in the inputs to valuation techniques. Credit risk of the Registrants and their counterparties is incorporated in the valuation of assets and liabilities through the use of credit reserves, the impact of which was immaterial at December 31, 2022 and 2021. The Registrants believe they use valuation techniques that maximize the use of observable market-based inputs and minimize the use of unobservable inputs.The fair values the Registrants calculate for their derivatives may change significantly as inputs and assumptions are updated for new information. Actual cash returns realized on derivatives may be different from the results the Registrants estimate using models. As fair value calculations are estimates based largely on commodity prices, the Registrants perform sensitivity analyses on the fair values of forward contracts. See the sensitivity analysis in Item 7A. of this report, "Quantitative and Qualitative Disclosures About Market Risk." See also the "Fair Value" section herein.See Notes 12 and 13 to the Consolidated Financial Statements, "Fair Value" and "Financial and Other Derivative Instruments," respectively.GoodwillCertain of DTE Energy's reporting units have goodwill or allocated goodwill resulting from business combinations. DTE Energy performs an impairment test for each of the reporting units with goodwill annually or whenever events or circumstances indicate that the value of goodwill may be impaired.In performing the impairment test, DTE Energy compares the fair value of the reporting unit to its carrying value including goodwill. If the carrying value including goodwill were to exceed the fair value of a reporting unit, an impairment loss would be recognized. A goodwill impairment loss is measured as the amount by which a reporting unit's carrying value exceeds fair value, not to exceed the carrying amount of goodwill.DTE Energy estimates the reporting unit's fair value using standard valuation techniques, including techniques which use estimates of projected future results and cash flows to be generated by the reporting unit. For certain reporting units, the fair values were calculated using a weighted combination of the income approach, which estimates fair value based on discounted cash flows, and the market approach, which estimates fair value based on market comparables within the utility and energy industries. The income approach includes a terminal value that utilizes an assumed long-term growth rate approach, which incorporates management's assumptions regarding sustainable long-term growth of the reporting units. The income approach cash flow valuations involve a number of estimates that require broad assumptions and significant judgment by management regarding future performance. 44Table of ContentsOne of the most significant assumptions utilized in determining the fair value of reporting units under the market approach is implied market multiples for certain peer companies. Management selects comparable peers based on each peer’s primary business mix, operations, and market capitalization compared to the applicable reporting unit and calculates implied market multiples based on available projected earnings guidance and peer company market values as of the test date. DTE Energy performs an annual impairment test each October. In between annual tests, DTE Energy monitors its estimates and assumptions regarding estimated future cash flows, including the impact of movements in market indicators in future quarters, and will update the impairment analyses if a triggering event occurs. While DTE Energy believes the assumptions are reasonable, actual results may differ from projections. To the extent projected results or cash flows are revised downward, the reporting unit may be required to write down all or a portion of its goodwill, which would adversely impact DTE Energy's earnings.DTE Energy performed its annual impairment test as of October 1, 2022 and determined that the estimated fair value of each reporting unit exceeded its carrying value, and no impairment existed.The results of the test and key estimates that were incorporated are as follows as of the October 1, 2022 valuation date:Reporting UnitGoodwillFair Value Reduction %(a)Discount RateValuation Methodology(b)(c)(In millions)Electric$1,208 38 %7.6 %DCF and market multiples analysisGas743 29 %7.7 %DCF and market multiples analysisDTE Vantage25 75 %9.2 %DCF and market multiples analysisEnergy Trading17 94 %10.7 %DCF$1,993 ______________________________________(a)Percentage by which the fair value of equity of the reporting unit would need to decline to equal its carrying value, including goodwill.(b)Discounted cash flows (DCF) incorporated 2023-2027 projected cash flows plus a calculated terminal value. For each of the reporting units, DTE Energy capitalized the terminal year cash flows at the weighted average cost of capital (WACC) less an assumed long-term growth rate of 2.5%. Management applied equal weighting to the DCF and market multiples analysis, where applicable, to determine the fair value of the respective reporting units.(c)Due to lack of market comparable information for the Energy Trading reporting unit, DTE Energy did not perform a market multiples analysis.Long-Lived AssetsThe Registrants evaluate the carrying value of long-lived assets, excluding goodwill, when circumstances indicate that the carrying value of those assets may not be recoverable. Conditions that could have an adverse impact on the cash flows and fair value of the long-lived assets are deteriorating business climate, condition of the asset, or plans to dispose of the asset before the end of its useful life. The review of long-lived assets for impairment requires significant assumptions about operating strategies and estimates of future cash flows, which require assessments of current and projected market conditions. An impairment evaluation is based on an undiscounted cash flow analysis at the lowest level for which independent cash flows of long-lived assets can be identified from other groups of assets and liabilities. Impairment may occur when the carrying value of the asset exceeds the future undiscounted cash flows. When the undiscounted cash flow analysis indicates a long-lived asset is not recoverable, the amount of the impairment loss is determined by measuring the excess of the long-lived asset over its fair value. An impairment would require the Registrants to reduce both the long-lived asset and current period earnings by the amount of the impairment, which would adversely impact their earnings.Pension and Other Postretirement CostsDTE Energy sponsors both funded and unfunded defined benefit pension plans and other postretirement benefit plans for eligible employees of the Registrants. The measurement of the plan obligations and cost of providing benefits under these plans involve various factors, including numerous assumptions and accounting elections. When determining the various assumptions that are required, DTE Energy considers historical information as well as future expectations. The benefit costs are affected by, among other things, the actual rate of return on plan assets, the long-term expected return on plan assets, the discount rate applied to benefit obligations, the incidence of mortality, the expected remaining service period of plan participants, level of compensation and rate of compensation increases, employee age, length of service, the anticipated rate of increase of health care costs, benefit plan design changes, and the level of benefits provided to employees and retirees. Pension and other postretirement benefit costs attributed to the segments are included with labor costs and ultimately allocated to projects within the segments, some of which are capitalized.45Table of ContentsDTE Energy had pension costs of $123 million in 2022, $139 million in 2021, and $148 million in 2020. Other postretirement benefit credits were $66 million in 2022, $59 million in 2021, and $49 million in 2020. Pension costs and other postretirement benefit credits for 2022 were calculated based upon several actuarial assumptions, including an expected long-term rate of return on plan assets of 6.80% for the pension plans and 6.40% for the other postretirement benefit plans. In developing the expected long-term rate of return assumptions, DTE Energy evaluated asset class risk and return expectations, as well as inflation assumptions. Projected returns are based on broad equity, bond, and other markets. DTE Energy's 2023 expected long-term rate of return on pension plan assets is based on an asset allocation assumption utilizing active and passive investment management of 30% in equity markets, 48% in fixed income markets, including long duration bonds, and 22% invested in other assets. DTE Energy's 2023 expected long-term rate of return on other postretirement plan assets is based on an asset allocation assumption utilizing active and passive investment management of 10% in equity markets, 61% in fixed income markets - including long duration bonds, and 29% invested in other assets. Because of market volatility, DTE Energy periodically reviews the asset allocation and rebalances the portfolio when considered appropriate. DTE Energy is increasing its long-term rate of return assumption for the pension plans to 7.60% and increasing the other postretirement plans to 7.20% for 2023. DTE Energy believes these rates are reasonable assumptions for the long-term rates of return on the plans' assets for 2023 given their respective asset allocations and DTE Energy's capital market expectations. DTE Energy will continue to evaluate the actuarial assumptions, including its expected rate of return, at least annually.DTE Energy calculates the expected return on pension and other postretirement benefit plan assets by multiplying the expected return on plan assets by the market-related value (MRV) of plan assets at the beginning of the year, taking into consideration anticipated contributions and benefit payments that are to be made during the year. Current accounting rules provide that the MRV of plan assets can be either fair value or a calculated value that recognizes changes in fair value in a systematic and rational manner over not more than five years. For the pension plans, DTE Energy uses a calculated value when determining the MRV of the pension plan assets and recognizes changes in fair value over a three-year period. Accordingly, the future value of assets will be impacted as previously deferred gains or losses are recognized. Unfavorable asset performance in 2022 resulted in unrecognized net losses. As of December 31, 2022, DTE Energy had $895 million of cumulative losses related to investment performance in prior years that were not yet recognized in the calculation of the MRV of pension assets. For other postretirement benefit plans, DTE Energy uses fair value when determining the MRV of plan assets; therefore, all investment gains and losses have been recognized in the calculation of MRV for these plans.The discount rate that DTE Energy utilizes for determining future pension and other postretirement benefit obligations is based on a yield curve approach and a review of bonds that receive one of the two highest ratings given by a recognized rating agency. The yield curve approach matches projected pension plan and other postretirement benefit payment streams with bond portfolios reflecting actual liability duration unique to the plans. The discount rate determined on this basis was 5.19% for both the pension and other postretirement plans at December 31, 2022 compared to 2.91% for both the pension and other postretirement plans at December 31, 2021.DTE Energy periodically changes its mortality assumptions to reflect any updated projection scales published by the Society of Actuaries. The mortality assumptions used at December 31, 2022 are the PRI-2012 mortality table projected to 2018 using Scale MP-2019, and projected forward from 2018 using Scale MP-2021 with generational projection. The base mortality tables vary by type of plan, employee's union status and employment status, with additional adjustments to reflect the actual experience and credibility of each population.DTE Energy estimates a total pension credit of approximately $70 million for 2023, compared to the total pension cost of $123 million in 2022. The expected change is primarily related to one-time settlement charges in 2022 that are not expected to occur in 2023, along with a higher discount rate and higher expected rate of return on plan assets. The 2023 other postretirement benefit credit is estimated at approximately $40 million compared to $66 million in 2022. The expected decrease in the credit is primarily due to recognition of asset returns that were less than expected, partially offset by a higher discount rate and higher expected rate of return on plan assets.The health care trend rates for DTE Energy assume 6.75% for pre-65 participants and 7.25% for post-65 participants for 2023, trending down to 4.50% for both pre-65 and post-65 participants in 2035.Future actual pension and other postretirement benefit costs or credits will depend on future investment performance, changes in future discount rates, and various other factors related to plan design.46Table of ContentsLowering the expected long-term rate of return on the plan assets by one percentage point would have increased the 2022 pension costs by approximately $51 million. Lowering the discount rate and the salary increase assumptions by one percentage point would have increased the 2022 pension costs by approximately $21 million. Lowering the expected long-term rate of return on plan assets by one percentage point would have decreased the 2022 other postretirement credit by approximately $20 million. Lowering the discount rate and the salary increase assumptions by one percentage point would have decreased the 2022 other postretirement credit by approximately $13 million.The value of the qualified pension and other postretirement benefit plan assets was $5.5 billion at December 31, 2022 and $7.5 billion at December 31, 2021. At December 31, 2022, DTE Energy's qualified pension plans were underfunded by $282 million and its other postretirement benefit plans were over-funded by $284 million. In 2022, the funded status of the pension plans and other postretirement benefit plans remained relatively stable, as significant losses in plan assets were largely offset by increases in discount rates.Pension and other postretirement costs and pension cash funding requirements may increase in future years without typical returns in the financial markets. Any required pension funding will be made by contributing amounts consistent with the provisions of the Pension Protection Act of 2006. DTE Energy did not make contributions to its qualified pension plans in 2022 or 2021, and does not anticipate making any such contributions in 2023. DTE Gas transferred $50 million of qualified pension plan funds to DTE Electric in 2022 in exchange for cash consideration, and anticipates transferring up to $50 million again in 2023. DTE Energy does not expect a material amount of contributions to its qualified pension plans over the next five years. DTE Energy did not make other postretirement benefit plan contributions in 2022 or 2021 and does not anticipate making any contributions to the other postretirement plans in 2023 or over the next five years. All planned contributions will be at the discretion of management and subject to any changes in financial market conditions. See Note 20 to the Consolidated Financial Statements, "Retirement Benefits and Trusteed Assets."Legal ReservesThe Registrants are involved in various legal proceedings, claims, and litigation arising in the ordinary course of business. The Registrants regularly assess their liabilities and contingencies in connection with asserted or potential matters and establish reserves when appropriate. Legal reserves are based upon the Registrants' management’s assessment of pending and threatened legal proceedings and claims against the Registrants.Accounting for Tax ObligationsThe Registrants are required to make judgments regarding the potential tax effects of various financial transactions and results of operations in order to estimate their obligations to taxing authorities. The Registrants account for uncertain income tax positions using a benefit recognition model with a two-step approach, a more-likely-than-not recognition criterion, and a measurement attribute that measures the position as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement. If the benefit does not meet the more likely than not criteria for being sustained on its technical merits, no benefit will be recorded. Uncertain tax positions that relate only to timing of when an item is included on a tax return are considered to have met the recognition threshold. The Registrants also have non-income tax obligations related to property, sales and use, and employment-related taxes, and ongoing appeals related to these tax matters.Accounting for tax obligations requires judgments, including assessing whether tax benefits are more likely than not to be sustained, and estimating reserves for potential adverse outcomes regarding tax positions that have been taken. The Registrants also assess their ability to utilize tax attributes, including those in the form of carry-forwards, for which the benefits have already been reflected in the Consolidated Financial Statements. The Registrants believe the resulting tax reserve balances as of December 31, 2022 and 2021 are appropriate. The ultimate outcome of such matters could result in favorable or unfavorable adjustments to the Registrants' Consolidated Financial Statements, and such adjustments could be material.See Note 10 to the Consolidated Financial Statements, "Income Taxes."NEW ACCOUNTING PRONOUNCEMENTSSee Note 3 to the Consolidated Financial Statements, "New Accounting Pronouncements."47Table of ContentsFAIR VALUEDerivatives are generally recorded at fair value and shown as Derivative assets or liabilities. Contracts DTE Energy typically classifies as derivative instruments include power, natural gas, some environmental contracts, and certain forwards, futures, options and swaps, and foreign currency exchange contracts. Items DTE Energy does not generally account for as derivatives include natural gas and environmental inventory, pipeline transportation contracts, storage assets, and some environmental contracts. See Notes 12 and 13 to the Consolidated Financial Statements, "Fair Value" and "Financial and Other Derivative Instruments," respectively.The tables below do not include the expected earnings impact of non-derivative natural gas storage, transportation, certain power contracts, and some environmental contracts which are subject to accrual accounting. Consequently, gains and losses from these positions may not match with the related physical and financial hedging instruments in some reporting periods, resulting in volatility in the Registrants' reported period-by-period earnings; however, the financial impact of the timing differences will reverse at the time of physical delivery and/or settlement.The Registrants manage their MTM risk on a portfolio basis based upon the delivery period of their contracts and the individual components of the risks within each contract. Accordingly, the Registrants record and manage the energy purchase and sale obligations under their contracts in separate components based on the commodity (e.g. electricity or natural gas), the product (e.g. electricity for delivery during peak or off-peak hours), the delivery location (e.g. by region), the risk profile (e.g. forward or option), and the delivery period (e.g. by month and year).The Registrants have established a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value in three broad levels. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). For further discussion of the fair value hierarchy, see Note 12 to the Consolidated Financial Statements, "Fair Value."The following table provides details on changes in DTE Energy's MTM net asset (or liability) position:Total(In millions)MTM at December 31, 2021$(159)Reclassified to realized upon settlement(48)Changes in fair value recorded to income(106)Amounts recorded to unrealized income(154)Changes in fair value recorded in Regulatory liabilities21 Amounts recorded in other comprehensive income, pretax3 Change in collateral65 MTM at December 31, 2022$(224)The table below shows the maturity of DTE Energy's MTM positions. The positions from 2026 and beyond principally represent longer tenor gas structured transactions:Source of Fair Value2023202420252026 and BeyondTotal Fair Value(In millions)Level 1$78 $37 $12 $2 $129 Level 25 (58)(17)(29)(99)Level 3(101)(68)(39)(69)(277)MTM before collateral adjustments$(18)$(89)$(44)$(96)(247)Collateral adjustments23 MTM at December 31, 2022$(224)48Table of ContentsItem 7A. Quantitative and Qualitative Disclosures About Market RiskMarket Price RiskThe Electric and Gas businesses have commodity price risk, primarily related to the purchases of coal, natural gas, uranium, and electricity. However, the Registrants do not bear significant exposure to earnings risk, as such changes are included in the PSCR and GCR regulatory rate-recovery mechanisms. Earnings may be indirectly impacted if PSCR or GCR charges increase such that it impacts the collectability of receivables and increases uncollectible expense. Refer to the Allowance for Doubtful Accounts section below for additional information.Changes in the price of natural gas can also impact the valuation of lost and unaccounted for gas, storage sales, and transportation services revenue at the Gas segment. The Gas segment manages its market price risk related to storage sales revenue primarily through the sale of long-term storage contracts. The Registrants are exposed to short-term cash flow or liquidity risk as a result of the time differential between actual cash settlements and regulatory rate recovery.The DTE Vantage segment is subject to price risk for electricity, natural gas, coal products, and environmental attributes generated from its renewable natural gas investments. DTE Energy manages its exposure to commodity price risk through the use of long-term contracts and hedging instruments, when available.DTE Energy's Energy Trading business segment has exposure to electricity, natural gas, environmental, crude oil, heating oil, and foreign currency exchange price fluctuations. These risks are managed by the energy marketing and trading operations through the use of forward energy, capacity, storage, options, and futures contracts, within predetermined risk parameters.Credit RiskAllowance for Doubtful AccountsThe Registrants regularly review contingent matters, existing and future economic conditions, customer trends and other factors relating to customers and their contracts and record provisions for amounts considered at risk of probable loss in the allowance for doubtful accounts. The Registrants believe their accrued amounts are adequate for probable loss. The Registrants manage this risk by working at the state and federal levels to promote funding programs for low-income customers, providing energy assistance programs and support, and promoting timely customer payments through adherence to MPSC billing practice rules relating to payment arrangements, energy disconnects, and restores.Trading ActivitiesDTE Energy is exposed to credit risk through trading activities. Credit risk is the potential loss that may result if the trading counterparties fail to meet their contractual obligations. DTE Energy utilizes both external and internal credit assessments when determining the credit quality of trading counterparties.49Table of ContentsThe following table displays the credit quality of DTE Energy's trading counterparties as of December 31, 2022:Credit ExposureBefore CashCollateralCashCollateralNet CreditExposure(In millions)Investment Grade(a)A- and Greater$525 $— $525 BBB+ and BBB397 (87)310 BBB-92 — 92 Total Investment Grade1,014 (87)927 Non-investment grade(b)39 (6)33 Internally Rated — investment grade(c)749 (5)744 Internally Rated — non-investment grade(d)35 — 35 Total$1,837 $(98)$1,739 _______________________________________(a)This category includes counterparties with minimum credit ratings of Baa3 assigned by Moody’s Investors Service (Moody’s) or BBB- assigned by Standard & Poor’s Rating Group, a division of McGraw-Hill Companies, Inc. (Standard & Poor’s). The five largest counterparty exposures, combined, for this category represented 13% of the total gross credit exposure.(b)This category includes counterparties with credit ratings that are below investment grade. The five largest counterparty exposures, combined, for this category represented 2% of the total gross credit exposure.(c)This category includes counterparties that have not been rated by Moody’s or Standard & Poor’s but are considered investment grade based on DTE Energy’s evaluation of the counterparty’s creditworthiness. The five largest counterparty exposures, combined, for this category represented 17% of the total gross credit exposure.(d)This category includes counterparties that have not been rated by Moody’s or Standard & Poor’s and are considered non-investment grade based on DTE Energy’s evaluation of the counterparty’s creditworthiness. The five largest counterparty exposures, combined, for this category represented 1% of the total gross credit exposure.OtherThe Registrants engage in business with customers that are non-investment grade. The Registrants closely monitor the credit ratings of these customers and, when deemed necessary and permitted under the tariffs, request collateral or guarantees from such customers to secure their obligations.Interest Rate RiskDTE Energy is subject to interest rate risk in connection with the issuance of debt. In order to manage interest costs, DTE Energy may use treasury locks and interest rate swap agreements. DTE Energy's exposure to interest rate risk arises primarily from changes in U.S. Treasury rates, commercial paper rates, credit spreads, and SOFR. As of December 31, 2022, DTE Energy had floating rate debt of $2.0 billion and a floating rate debt-to-total debt ratio of 10.4%.Foreign Currency Exchange RiskDTE Energy has foreign currency exchange risk arising from market price fluctuations associated with fixed priced contracts. These contracts are denominated in Canadian dollars and are primarily for the purchase and sale of natural gas and power, as well as for long-term transportation capacity. To limit DTE Energy's exposure to foreign currency exchange fluctuations, DTE Energy has entered into a series of foreign currency exchange forward contracts through December 2032.Summary of Sensitivity AnalysesSensitivity analyses were performed on the fair values of commodity contracts for DTE Energy and long-term debt obligations for the Registrants. The commodity contracts listed below principally relate to energy marketing and trading activities. The sensitivity analyses involved increasing and decreasing forward prices and rates at December 31, 2022 and 2021 by a hypothetical 10% and calculating the resulting change in the fair values. The hypothetical losses related to long-term debt would be realized only if DTE Energy transferred all of its fixed-rate long-term debt to other creditors.50Table of ContentsThe results of the sensitivity analyses:Assuming a10% Increase in Prices/RatesAssuming a10% Decrease in Prices/RatesAs of December 31,As of December 31,Activity2022202120222021Change in the Fair Value of(In millions)Gas contracts$16 $33 $(16)$(33)Commodity contractsPower contracts$4 $9 $(4)$(10)Commodity contractsEnvironmental contracts$(5)$(8)$5 $8 Commodity contractsOil contracts$2 $— $(2)$— Commodity contractsInterest rate risk — DTE Energy$(650)$(662)$699 $687 Long-term debtInterest rate risk — DTE Electric$(419)$(329)$458 $348 Long-term debtFor further discussion of market risk, see Management's Discussion and Analysis in Item 7 of this Report and Note 13 to the Consolidated Financial Statements, "Financial and Other Derivative Instruments."51Table of Contents
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+Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations36Item 7A.Quantitative and Qualitative Disclosures About Market Risk71
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+Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.” These risks are not the only risks we face. We could also face additional risks and uncertainties not currently known to us or that we currently deem to be immaterial. If any of these risks actually occurs, it could materially harm our business, financial condition or results of operations and the trading price of our shares could decline.The following is a summary of the principal risks that could adversely affect our business, operations and financial results:Risks Related to the Oil and Natural Gas Industry and Our Business•Market conditions and particularly volatility in prices for oil and natural gas may continue to adversely affect our revenue, cash flows, profitability, growth, production and the present value of our estimated reserves.•Our business and operations have been and will likely continue to be adversely affected by the war in Ukraine, COVID-19 pandemic and volatility in the oil and natural gas markets.•Our commodity price derivatives could result in financial losses, may fail to protect us from declines in commodity prices, prevent us from fully benefiting from commodity price increases and may expose us to other risks, including counterparty credit risk.•The IRA and other risks relating to climate change could accelerate the transition to a low carbon economy and could impose new costs on our operations that may have a material and adverse effect on us.•Climate change-related regulations, policies and initiatives may have other adverse effects, such as a greater potential for governmental investigations or litigation.25Table of Contents•We may be unable to obtain needed capital or financing on satisfactory terms or at all to fund our acquisitions or development activities, which could lead to a loss of properties and a decline in our oil and natural gas reserves and future production. •Our failure to successfully identify, complete and integrate pending and future acquisitions of properties or businesses could reduce our earnings, and title defects in the properties in which we invest may lead to losses.•Our identified potential drilling locations are susceptible to uncertainties that could materially alter the occurrence or timing of their drilling.•If production from our Permian Basin acreage decreases, we may fail to meet our obligations to deliver specified quantities of oil under our oil purchase contract, which may adversely affect our operations.•The inability of one or more of our customers to meet their obligations, or loss of one or more of our significant purchasers, may adversely affect our financial results.•Our method of accounting for investments in oil and natural gas properties may result in impairment of asset value. •Any material inaccuracies in reserve estimates or underlying assumptions will materially affect the quantities and present value of our reserves.•We are vulnerable to risks associated with our primary operations concentrated in a single geographic area.•If transportation or other facilities, certain of which we do not control, or rigs, equipment, raw materials, oil services or personnel are unavailable, our operations could be interrupted and our revenues reduced.•Our operations are subject to various governmental laws and regulations which require compliance that can be burdensome and expensive and may impose restrictions on our operations.•U.S. tax legislation, including recently adopted IRA, may negatively affect our business, results of operations, financial condition and cash flow.•Drilling for and producing oil and natural gas are high-risk activities with many uncertainties that may result in a total loss of investment and adversely affect our business, financial condition or results of operations.•A terrorist attack or armed conflict could harm our business and could adversely affect our business.•A cyber incident could result in information theft, data corruption, operational disruption and/or financial loss. Risks Related to Our Indebtedness•Our substantial level of indebtedness could adversely affect our financial condition and prevent us from fulfilling our obligations under our indebtedness, and we and our subsidiaries may be able to incur substantial additional indebtedness in the future.•Implementing our capital programs may require, under some circumstances, an increase in our total leverage through additional debt issuances, and any significant reduction in availability under our revolving credit facility or inability to otherwise obtain financing for our capital programs could require us to curtail our capital expenditures.•Restrictive covenants in certain of our existing and future debt instruments may limit our ability to respond to changes in market conditions or pursue business opportunities.•We depend on our subsidiaries for dividends, distributions and other payments.•If we experience liquidity concerns, we could face a downgrade in our debt ratings which could restrict our access to, and negatively impact the terms of, current or future financings or trade credit.•Borrowings under our and Viper LLC’s revolving credit facilities expose us to interest rate risk. Risks Related to Our Common Stock•The corporate opportunity provisions in our certificate of incorporation could enable affiliates of ours to benefit from corporate opportunities that might otherwise be available to us.•If the price of our common stock fluctuates significantly, an investment in us could lose value.•The declaration of dividends and any repurchases of our common stock are each within the discretion of our board of directors, and there is no guarantee that we will pay any dividends on or repurchases of our common stock in the future or at levels anticipated by our stockholders.•A change of control could limit our use of net operating losses.•If our operating results do not meet expectations of securities or industry analysts, our stock price could decline.•We may issue preferred stock whose terms could adversely affect the voting power or value of our common stock.•Provisions in our certificate of incorporation and bylaws and Delaware law make it more difficult to effect a change in control of the company, which could adversely affect the price of our common stock.26Table of ContentsRisks Related to the Oil and Natural Gas Industry and Our BusinessMarket conditions for oil and natural gas, and particularly volatility in prices for oil and natural gas, have in the past adversely affected, and may in the future adversely affect, our revenue, cash flows, profitability, growth, production and the present value of our estimated reserves.Our revenues, operating results, profitability, future rate of growth and the carrying value of our oil and natural gas properties depend significantly upon the prevailing prices for oil and natural gas. Historically, oil and natural gas prices have been volatile and are subject to fluctuations in response to changes in supply and demand, market uncertainty and a variety of additional factors that are beyond our control, including the domestic and foreign supply of oil and natural gas; the level of prices and expectations about future prices of oil and natural gas; the level of global oil and natural gas exploration and production; the cost of exploring for, developing, producing and delivering oil and natural gas; the price and quantity of foreign imports; political and economic conditions in oil producing countries, including the Middle East, Africa, South America and Russia; the potential impact of the war in Ukraine on the global energy markets; the continued threat of terrorism and the impact of military and other action, including U.S. military operations in the Middle East; the ability of members of the OPEC+ to agree to and maintain oil price and production controls; speculative trading in crude oil and natural gas derivative contracts; the level of consumer product demand; extreme weather conditions and other natural disasters; risks associated with operating drilling rigs; technological advances affecting energy consumption; the price and availability of alternative fuels; domestic and foreign governmental regulations and taxes, including the Biden Administration’s energy and environmental policies; global or national health concerns, including the outbreak of pandemic or contagious disease, such as COVID-19 and its variants; the proximity, cost, availability and capacity of oil and natural gas pipelines and other transportation facilities; and overall domestic and global economic conditions. Our results of operations may also be adversely impacted by any future government rule, regulation or order that may impose production limits, as well as pipeline capacity and storage constraints, in the Permian Basin where we operate.These factors and the volatility of the energy markets make it extremely difficult to predict future oil and natural gas price movements with any certainty. During 2022, 2021 and 2020, NYMEX WTI prices ranged from $(37.63) to $123.70 per Bbl and the NYMEX Henry Hub price of natural gas ranged from $1.48 to $9.68 per MMBtu. If the prices of oil and natural gas decline, our operations, financial condition and level of expenditures for the development of our oil and natural gas reserves may be materially and adversely affected. We cannot predict the impact of the ongoing military war between Russia and Ukraine and the related humanitarian crisis on the global economy, energy markets, geopolitical stability and our business.Our leasehold acreage is located primarily in the Permian Basin in West Texas. However, the broader consequences of the war in Ukraine, which may include further sanctions, embargoes, supply chain disruptions, regional instability and geopolitical shifts, may have adverse effects on global macroeconomic conditions, increase volatility in the price and demand for oil and natural gas, increase exposure to cyberattacks, cause disruptions in global supply chains, increase foreign currency fluctuations, cause constraints or disruption in the capital markets and limit sources of liquidity. We cannot predict the extent of the war’s effect on our business and results of operations as well as on the global economy and energy markets.In prior periods, our business and operations were adversely impacted by the COVID-19 pandemic and volatility in the oil and natural gas markets, compounded by the global effects of the war in Ukraine, and we may experience such adverse effects in future periods. If commodity prices decrease, our production, estimates of proved reserves and liquidity may be adversely affected.The COVID-19 pandemic, combined with the global effects of the war in Ukraine, contributed to economic and pricing volatility that adversely impacted in prior periods, and may in the future adversely impact, our business and our industry. Despite the recovery and overall strength in demand and pricing for oil in 2022, using excess cash flow for debt repayment and/or returning capital to our stockholders rather than expanding our drilling program. We intend to continue exercising capital discipline and expect to maintain flat oil production in 2023 at the fourth quarter 2022 level, excluding production from recent acquisitions. We cannot reasonably predict whether production levels will remain at current levels or the full extent of the events above and any subsequent recovery may have on our industry and our business.Due to the improvement in commodity pricing environment and industry conditions, we did not record any impairments in 2022. However, if commodity prices fall below current levels, we may be required to record impairments in future periods and such impairments could be material. Further, if commodity prices decrease, our production, proved reserves and cash flows will be adversely impacted. Reductions in our reserves could also negatively impact the borrowing base under our revolving credit facility, which could limit our liquidity and ability to conduct additional exploration and development activities.27Table of ContentsThe COVID-19 pandemic continues to present operational, health, labor, logistics and other challenges, and it is difficult to assess the ultimate impact of the COVID-19 pandemic on our business, financial condition and cash flows.There continue to be many variables and uncertainties regarding the COVID-19 pandemic, including the emergence, contagiousness and threat of new and different strains of the virus and their severity; the effectiveness of current treatments and vaccines against the virus or its new strains; any travel restrictions, business closures and other measures that are or may be imposed in affected areas or countries by governmental authorities; disruptions in the supply chain; competitive labor market; logistics costs; remote working arrangements, social distancing guidelines and other COVID-19-related challenges. Further, there remain increased risks of cyberattacks on information technology systems used in a remote working environment; increased privacy-related risks due to processing health-related personal information; absence of workforce due to illness; the impact of the pandemic on any of our contractual counterparties; and other factors that are currently unknown or considered immaterial. It is difficult to assess the ultimate impact of the COVID-19 pandemic on our business, financial condition and cash flows.Our commodity price derivatives could result in financial losses, may fail to protect us from declines in commodity prices, prevent us from fully benefiting from commodity price increases and may expose us to other risks, including counterparty credit risk.We use commodity price derivatives, including swaps, basis swaps, swaptions, roll hedges, costless collars, puts and basis puts, to reduce price volatility associated with certain of our oil, natural gas liquids and natural gas sales. Currently, we have hedged a portion of our estimated 2023 and 2024 production. To the extent that the prices of oil, natural gas liquids and natural gas remain at current levels or decline further, we may not be able to economically hedge additional future production at the same level as our current commodity price derivatives, and our results of operations and financial condition may be negatively impacted. While these commodity price derivatives are intended to mitigate risk from commodity price volatility, we may be prevented from fully realizing the benefits of increases in the prices of oil, natural gas liquids and natural gas above the price levels of the commodity price derivatives used to manage price risk.At settlement, market prices for commodities may exceed the contract prices in our commodity price derivatives agreements, resulting in our need to make significant cash payments to our counterparties. Further, by using commodity derivative instruments, we expose ourselves to credit risk if we are in a positive position at contract settlement and the counterparty fails to perform under the terms of the derivative contract. We do not require collateral from our counterparties. For additional information regarding our outstanding derivative contracts as of December 31, 2022, see Note 12—Derivatives to our consolidated financial statements included elsewhere in this report, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 7A. Quantitative and Qualitative Disclosures About Market Risk—Commodity Price Risk.The IRA and other risks relating to climate change could accelerate the transition to a low carbon economy and could impose new costs on our operations that may have a material and adverse effect on us.Governmental and regulatory bodies, investors, consumers, industry and other stakeholders have been increasingly focused on climate change matters in recent years. This focus, together with changes in consumer and industrial/commercial behavior, preferences and attitudes with respect to the generation and consumption of energy, the use of hydrocarbons, and the use of products manufactured with, or powered by, hydrocarbons, may result in:•the enactment of climate change-related regulations, policies and initiatives by governments, investors, and other companies, including alternative energy or “zero carbon” requirements and fuel or energy conservation measures;•technological advances with respect to the generation, transmission, storage and consumption of energy (including advances in wind, solar and hydrogen power, as well as battery technology);•increased availability of, and increased demand from consumers and industry for, energy sources other than oil and natural gas (including wind, solar, nuclear, and geothermal sources as well as electric vehicles); and•development of, and increased demand from consumers and industry for, lower-emission products and services (including electric vehicles and renewable residential and commercial power supplies) as well as more efficient products and services.Any of these developments may reduce the demand for products manufactured with (or powered by) hydrocarbons and the demand for, and in turn the prices of, the oil and natural gas that we produce and sell, which would likely have a material adverse impact on us.28Table of ContentsIf any of these developments reduce the desirability of participating in the oilfield services, midstream or downstream portions of the oil and gas industry, then these developments may also reduce the availability to us of necessary third-party services and facilities that we rely on, which could increase our operational costs and adversely affect our ability to explore for, produce, transport and process oil and natural gas and successfully carry out our business and financial strategy. The enactment of climate change-related regulations, policies and initiatives may also result in increases in our compliance costs and other operating costs and have other adverse effects, such as a greater potential for governmental investigations or litigation.On August 16, 2022, President Biden signed into law the IRA, which includes billions of dollars in incentives for the development of renewable energy, clean hydrogen, clean fuels, electric vehicles, investments in advanced biofuels and supporting infrastructure and carbon capture and sequestration. These incentives could accelerate the transition of the economy away from the use of fossil fuels towards lower- or zero-carbon emissions alternatives, which could decrease demand for, and in turn the prices of, the oil and natural gas that we produce and sell and adversely impact our business. In addition, the IRA imposes the first ever federal fee on the emission of greenhouse gases through a methane emissions charge, which could increase our operating costs and thereby adversely impact our business, financial condition and cash flows. In addition to potentially reducing demand for our oil and natural gas and potentially reducing the availability of oilfield services and midstream and downstream customers, any of these developments may also create reputational risks associated with the exploration for, and production of, hydrocarbons, which may adversely affect the availability and cost to us of capital. For example, a number of prominent investors have publicly announced their intention to no longer invest in the oil and gas sector in response to concerns related to climate change, and other financial institutions and investors may decide to do likewise in the future. If financial institutions and other investors refuse to invest in or provide capital to the oil and gas sector in the future because of these reputational risks, that could result in capital being unavailable to us, or only at significantly increased cost. For further discussion regarding the risks to us of climate change-related regulations, policies and initiatives, please see the section entitled “Item 1 and 2. Business and Properties—Regulation—Climate Change.”Continuing political and social concerns relating to climate change may result in significant litigation and related expenses.Increasing attention to global climate change has resulted in increased investor attention and an increased risk of public and private litigation, which could increase our costs or otherwise adversely affect us. For example, shareholder activism has recently been increasing in our industry, and shareholders may attempt to effect changes to our business or governance to deal with climate change-related issues, whether by shareholder proposals, public campaigns, proxy solicitations or otherwise, which may result in significant management distraction and potentially significant expense. Additionally, cities, counties, and other governmental entities in several states in the U.S. have filed lawsuits against energy companies seeking damages allegedly associated with climate change. Similar lawsuits may be filed in other jurisdictions. If any such lawsuits were to be filed against us, we could incur substantial legal defense costs and, if any such litigation were adversely determined, we could incur substantial damages. Any of these climate change-related litigation risks could result in unexpected costs, negative sentiments about our company, disruptions in our operations, and increases to our operating expenses, which in turn could have an adverse effect on our business, financial condition and results of operations.Our targets related to sustainability and emissions reduction initiatives, including our public statements and disclosures regarding them, may expose us to numerous risks.We have developed, and will continue to develop, targets related to our ESG initiatives, including our emissions reduction targets and strategy. Statements in this and other reports we file with the SEC and other public statements related to these initiatives reflect our current plans and expectations and are not a guarantee the targets will be achieved or achieved on the currently anticipated timeline. Our ability to achieve our ESG targets, including emissions reductions, is subject to numerous factors and conditions, some of which are outside of our control, and failure to achieve our announced targets or comply with ethical, environmental or other standards, including reporting standards, may expose us to government enforcement actions or private litigation and adversely impact our business. Further, our continuing efforts to research, establish, accomplish and accurately report on these targets may create additional operational risks and expenses and expose us to reputational, legal and other risks. Investor and regulatory focus on ESG matters continues to increase. If our ESG initiatives do not meet our investors’ or other stakeholders’ evolving expectations and standards, investment in our stock may be viewed as less attractive and our reputation, contractual, employment and other business relationships may be adversely impacted.29Table of ContentsConservation measures and technological advances could reduce demand for oil and natural gas. Fuel conservation measures, alternative fuel requirements, increasing consumer demand for alternatives to oil and natural gas, technological advances in fuel economy and energy generation devices could reduce demand for oil and natural gas. The impact of the changing demand for oil and natural gas services and products may have a material adverse effect on our business, financial condition, results of operations and cash flows.A significant portion of our net leasehold acreage is undeveloped, and that acreage may not ultimately be developed or become commercially productive, which could cause us to lose rights under our leases as well as have a material adverse effect on our oil and natural gas reserves and future production and, therefore, our future cash flow and income. A significant portion of our net leasehold acreage is undeveloped, or acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil and natural gas regardless of whether such acreage contains proved reserves. In addition, many of our oil and natural gas leases require us to drill wells that are commercially productive and to maintain the production in paying quantities, and if we are unsuccessful in drilling such wells and maintaining such production, we could lose our rights under such leases. Our future oil and natural gas reserves and production and, therefore, our future cash flow and income are highly dependent on successfully developing our undeveloped leasehold acreage. Our development and exploration operations and our ability to complete acquisitions require substantial capital and we may be unable to obtain needed capital or financing on satisfactory terms or at all, which could lead to a loss of properties and a decline in our oil and natural gas reserves. The oil and natural gas industry is capital intensive. We make and expect to continue to make substantial capital expenditures in our business and operations for the exploration for and development, production and acquisition of oil and natural gas reserves. In 2022, our total capital expenditures, including expenditures for drilling, completion, infrastructure and additions to midstream assets, were approximately $1.9 billion. Our 2023 capital budget for drilling, completion and infrastructure, including investments in water disposal infrastructure and gathering line projects, is currently estimated to be approximately $2.50 billion to $2.70 billion, representing an increase of 37% from our 2022 capital expenditures. Since completing our initial public offering in October 2012, we have financed capital expenditures primarily with borrowings under our revolving credit facility, cash generated by operations and the net proceeds from public offerings of our common stock and our senior notes.We intend to finance our future capital expenditures with cash flow from operations, while future acquisitions may also be funded from operations as well as proceeds from offerings of our debt and equity securities and borrowings under our revolving credit facility. Our cash flow from operations and access to capital are subject to a number of variables, including our proved reserves; the volume of oil and natural gas we are able to produce from existing wells; the prices at which our oil and natural gas are sold; our ability to acquire, locate and produce economically new reserves; and our ability to borrow under our credit facility.We cannot assure you that our operations and other capital resources will provide cash in sufficient amounts to maintain planned or future levels of capital expenditures. Further, our actual capital expenditures in 2023 could exceed our capital expenditure budget. In the event our capital expenditure requirements at any time are greater than the amount of capital we have available, we could be required to seek additional sources of capital, which may include traditional reserve base borrowings, debt financing, joint venture partnerships, production payment financings, sales of assets, offerings of debt or equity securities or other means. We cannot assure you that we will be able to obtain debt or equity financing on terms favorable to us, or at all. If we are unable to fund our capital requirements or our costs of capital increase, we may be required to curtail our operations relating to the exploration and development of our prospects, which in turn could lead to a possible loss of properties and a decline in our oil and natural gas reserves, or we may be otherwise unable to implement our development plan, complete acquisitions or take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our production, revenues and results of operations. In addition, a delay in or the failure to complete proposed or future infrastructure projects could delay or eliminate potential efficiencies and related cost savings. 30Table of ContentsOur success depends on finding, developing or acquiring additional reserves. Our future success depends upon our ability to find, develop or acquire additional oil and natural gas reserves that are economically recoverable. Our proved reserves will generally decline as reserves are depleted, except to the extent that we conduct successful exploration or development activities or acquire properties containing proved reserves, or both. To increase reserves and production, we undertake development, exploration and other replacement activities or use third parties to accomplish these activities. If we are unable to replace our current production, the value of our reserves will decrease, and our business, financial condition and results of operations would be adversely affected. Furthermore, although our revenues may increase if prevailing oil and natural gas prices increase significantly, our finding costs for additional reserves could also increase. Our failure to successfully identify, complete and integrate pending and future acquisitions of properties or businesses could reduce our earnings and slow our growth. There is intense competition for acquisition opportunities in our industry. The successful acquisition of producing properties requires an assessment of several factors, including recoverable reserves, future oil and natural gas prices and their applicable differentials, operating costs, and potential environmental and other liabilities.The accuracy of these assessments is inherently uncertain, and we may not be able to identify attractive acquisition opportunities. In connection with these assessments, we perform a review of the subject properties that we believe to be generally consistent with industry practices. Our review will not reveal all existing or potential problems, including title or environmental issues, nor will it permit us to become sufficiently familiar with the properties to assess fully their deficiencies and capabilities. Inspections may not always be performed on every well, and environmental problems, such as groundwater contamination, are not necessarily observable even when an inspection is undertaken. Even when problems are identified, the seller may be unwilling or unable to provide effective contractual protection against all or part of the problems. Even if we do identify attractive acquisition opportunities, we may not be able to complete the acquisition or do so on commercially acceptable terms.Competition for acquisitions may increase the cost of, or cause us to refrain from, completing acquisitions. Our ability to complete acquisitions is dependent upon, among other things, our ability to obtain debt and equity financing and, in some cases, regulatory approvals. If these acquisitions include geographic regions in which we do not currently operate, we could be subject to unforeseen operating difficulties and difficulties in coordinating geographically dispersed operations, personnel and facilities. In addition, if we enter into new geographic markets, we may be subject to additional and unfamiliar legal and regulatory requirements. Compliance with regulatory requirements may impose substantial additional obligations on us and our management, cause us to expend additional time and resources in compliance activities and increase our exposure to penalties or fines for non-compliance with such additional legal requirements. Further, the success of any completed acquisition will depend on our ability to integrate effectively the acquired business into our existing operations. The process of integrating acquired businesses may involve unforeseen difficulties and may require a disproportionate amount of our managerial and financial resources. In addition, possible future acquisitions may be larger and for purchase prices significantly higher than those paid for earlier acquisitions. Any of these factors could have a material adverse effect on our financial condition and results of operations. Our financial position and results of operations may also fluctuate significantly from period to period, based on whether or not significant acquisitions are completed in particular periods.We may incur losses as a result of title defects in the properties in which we invest.It is our practice in acquiring oil and natural gas leases or interests not to incur the expense of retaining lawyers to examine the title to the mineral interest. Rather, we rely upon the judgment of oil and gas lease brokers or landmen who perform the fieldwork in examining records in the appropriate governmental office before attempting to acquire a lease in a specific mineral interest. The existence of a material title deficiency can render a lease worthless and can adversely affect our results of operations and financial condition.Prior to the drilling of an oil or natural gas well, however, it is the normal practice in our industry for the person or company acting as the operator of the well to obtain a preliminary title review to ensure there are no obvious defects in title to the well. Frequently, as a result of such examinations, certain curative work must be done to correct defects in the marketability of the title, and such curative work entails expense. Our failure to cure any title defects may delay or prevent us from utilizing the associated mineral interest, which may adversely impact our ability in the future to increase production and reserves. Additionally, undeveloped acreage has greater risk of title defects than developed acreage. If there are any title 31Table of Contentsdefects or defects in the assignment of leasehold rights in properties in which we hold an interest, we will suffer a financial loss. Our identified potential drilling locations, which are part of our anticipated future drilling plans, are susceptible to uncertainties that could materially alter the occurrence or timing of their drilling. Drilling for oil and natural gas often involves unprofitable efforts, not only from dry wells but also from wells that are productive but do not produce sufficient oil or natural gas to return a profit at then realized prices after deducting drilling, operating and other costs.As of December 31, 2022, we have approximately 8,276 gross (6,055 net) identified economic potential horizontal drilling locations in multiple horizons on our acreage at an assumed price of approximately $50.00 per Bbl WTI. As of December 31, 2022, only 703 of our gross identified economic potential horizontal drilling locations were attributed to proved reserves. These drilling locations, including those without proved undeveloped reserves, represent a significant part of our growth strategy. Our ability to drill and develop these locations depends on a number of uncertainties, including the availability of capital, construction of infrastructure, unusual or unexpected geological formations, title problems, facility or equipment malfunctions, unexpected operational events, inclement weather, environmental and other regulatory requirements and approvals, oil and natural gas prices, costs, drilling results and the availability of water. Further, our identified potential drilling locations are in various stages of evaluation, ranging from locations that are ready to drill to locations that will require substantial additional interpretation. In addition, as of December 31, 2022, we have identified approximately 2,148 horizontal drilling locations in intervals in which we have drilled very few or no wells, which are necessarily more speculative and based on results from other operators whose acreage may not be consistent with ours. We cannot predict in advance of drilling and testing whether any particular drilling location will yield oil or natural gas in sufficient quantities to recover drilling or completion costs or to be economically viable. The use of technologies and the study of producing fields in the same area will not enable us to know conclusively prior to drilling whether oil or natural gas will be present or, if present, whether oil or natural gas will be present in sufficient quantities to be economically viable. Even if sufficient amounts of oil or natural gas exist, we may damage the potentially productive hydrocarbon bearing formation or experience mechanical difficulties while drilling or completing the well, possibly resulting in a reduction in production from the well or abandonment of the well. If we drill additional wells that we identify as dry holes in our current and future drilling locations, our drilling success rate may decline and materially harm our business. Through December 31, 2022, we are the operator of, have participated in, or have acquired working interest in a total of 3,254 horizontal producing wells completed on our acreage. We cannot assure you that the analogies we draw from available data from these or other wells, more fully explored locations or producing fields will be applicable to our drilling locations. Further, initial production rates reported by us or other operators in the Permian Basin may not be indicative of future or long-term production rates. Because of these uncertainties, we do not know if the potential drilling locations we have identified will ever be drilled or if we will be able to produce oil or natural gas from these or any other potential drilling locations. As such, our actual drilling activities may materially differ from those presently identified, which could adversely affect our business. Our acreage must be drilled before lease expiration, generally within three to five years, in order to hold the acreage by production. In a highly competitive market for acreage, failure to drill sufficient wells to hold acreage may result in a substantial lease renewal cost or, if renewal is not feasible, loss of our lease and prospective drilling opportunities. Leases on oil and natural gas properties typically have a term of three to five years, after which they expire unless, prior to expiration, production is established within the spacing units covering the undeveloped acres. The cost to renew such leases may increase significantly, and we may not be able to renew such leases on commercially reasonable terms or at all. Any reduction in our current drilling program, either through a reduction in capital expenditures or the unavailability of drilling rigs, could result in the loss of acreage through lease expirations. Any non-renewal or other loss of leases could materially and adversely affect the growth of our asset basis, cash flows and results of operations. If production from our Permian Basin acreage decreases due to decreased developmental activities, production related difficulties or otherwise, we may fail to meet our obligations to deliver specified quantities of oil under our oil purchase contracts, which will result in deficiency payments to the counterparty and may have an adverse effect on our operations.We are a party to long-term crude oil agreements under which, subject to certain terms and conditions, we are obligated to deliver specified quantities of oil to our counterparties. Our maximum delivery obligation under these agreements varies for different periods and depends in some cases upon certain conditions beyond our control. If production from our Permian Basin acreage decreases due to reduced developmental activities, as a result of the low commodity price environment, production related difficulties or otherwise, we may be unable to meet our obligations under our oil purchase agreements, which may result in deficiency payments to certain counterparties or a default under such agreements and may have an adverse effect on our company.32Table of ContentsThe inability of one or more of our customers to meet their obligations may adversely affect our financial results.In addition to credit risk related to receivables from commodity derivative contracts, our principal exposure to credit risk is through receivables from joint interest owners on properties we operate (approximately $93 million at December 31, 2022) and receivables from purchasers of our oil and natural gas production (approximately $618 million at December 31, 2022). Joint interest receivables arise from billing entities that own partial interests in the wells we operate. These entities participate in our wells primarily based on their ownership in leases on which we wish to drill. We are generally unable to control which co-owners participate in our wells. We are also subject to credit risk due to the concentration of our oil and natural gas receivables with several significant customers. See “Item 1 and 2. Business and Properties—Oil and Natural Gas Production Prices and Production Costs—Marketing and Customers” for additional information regarding these customers. This concentration of customers may impact our overall credit risk in that these entities may be similarly affected by any adverse changes in economic and other conditions. We do not require our customers to post collateral. Under certain circumstances, the revenue due to them can be offset by any unpaid receivables. The inability or failure of our significant customers or joint working interest owners to meet their obligations to us or their insolvency or liquidation may materially adversely affect our financial results. Our method of accounting for investments in oil and natural gas properties may result in impairment of asset value. We account for our oil and natural gas producing activities using the full cost method of accounting. Accordingly, all costs incurred in the acquisition, exploration and development of proved oil and natural gas properties, including the costs of abandoned properties, dry holes, geophysical costs and annual lease rentals are capitalized. We also capitalize direct operating costs for services performed with internally owned drilling and well servicing equipment.The net capitalized costs of proved oil and natural gas properties are subject to a full cost ceiling limitation in which the costs are not allowed to exceed their related estimated future net revenues discounted at 10%. To the extent capitalized costs of evaluated oil and natural gas properties, net of accumulated depreciation, depletion, amortization and impairment, exceed the discounted future net revenues of proved oil and natural gas reserves, the excess capitalized costs are charged to expense. We use the unweighted arithmetic average first day of the month price for oil and natural gas for the 12-month period preceding the calculation date in estimating discounted future net revenues. No impairments were recorded on our proved oil and natural gas properties for the years ended December 31, 2022 and 2021. An impairment of $6.0 billion was recorded for our proved oil and natural gas properties for the year ended December 31, 2020. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates—Method of Accounting for Oil and Natural Gas Properties.” If the prices of oil and natural gas decline, we may be required to further write-down the value of our oil and natural gas properties in the future, which could negatively affect our results of operations.Our estimated reserves and EURs are based on many assumptions that may turn out to be inaccurate. Any material inaccuracies in these reserve estimates or underlying assumptions will materially affect the quantities and present value of our reserves. Oil and natural gas reserve engineering is not an exact science and requires subjective estimates of underground accumulations of oil and natural gas and assumptions concerning future oil and natural gas prices, production levels, ultimate recoveries and operating and development costs. As a result, estimated quantities of proved reserves, projections of future production rates and the timing of development expenditures may be incorrect. The EURs for our horizontal wells are based on management’s internal estimates. Over time, we may make material changes to reserve estimates taking into account the results of actual drilling, testing and production. Also, certain assumptions regarding future oil and natural gas prices, production levels and operating and development costs may prove incorrect. Any significant variance from these assumptions to actual figures could greatly affect our estimates of reserves, the economically recoverable quantities of oil and natural gas attributable to any particular group of properties, the classifications of reserves based on risk of recovery and estimates of future net cash flows. A substantial portion of our reserve estimates are made without the benefit of a lengthy production history, which are less reliable than estimates based on a lengthy production history. Numerous changes over time to the assumptions on which our reserve estimates are based, as described above, often result in the actual quantities of oil and natural gas that we ultimately recover being different from our reserve estimates. Reserve estimates do not include any value for probable or possible reserves that may exist, nor do they include any value for unproved undeveloped acreage. The reserve estimates represent our net revenue interest in our properties.33Table of ContentsThe timing of both our production and our incurrence of costs in connection with the development and production of oil and natural gas properties will affect the timing of actual future net cash flows from proved reserves. The standardized measure of our estimated proved reserves are not necessarily the same as the current market value of our estimated proved oil reserves. The present value of future net cash flow from our proved reserves, or standardized measure may not represent the current market value of our estimated proved oil reserves. In accordance with SEC requirements, we base the estimated discounted future net cash flow from our estimated proved reserves on the 12-month average oil index prices, calculated as the unweighted arithmetic average for the first-day-of-the-month price for each month and costs in effect as of the date of the estimate, holding the prices and costs constant throughout the life of the properties. Actual future prices and costs may differ materially from those used in the net present value estimate, and future net present value estimates using then current prices and costs may be significantly less than current estimates. In addition, the 10% discount factor we use when calculating discounted future net cash flow for reporting requirements in compliance with the Financial Accounting Standard Board Codification 932, “Extractive Activities—Oil and Gas,” may not be the most appropriate discount factor based on interest rates in effect from time to time and risks associated with us or the oil and natural gas industry in general. The development of our proved undeveloped reserves may take longer and may require higher levels of capital expenditures than we currently anticipate. Approximately 31% of our total estimated proved reserves as of December 31, 2022, were proved undeveloped reserves and may not be ultimately developed or produced. Recovery of proved undeveloped reserves requires significant capital expenditures and successful drilling and completion operations. The reserve data included in the reserve reports of our independent petroleum engineers assume that substantial capital expenditures are required to develop such reserves. We cannot be certain that the estimated costs of the development of these reserves are accurate, that development will occur as scheduled or that the results of such development will be as estimated. Delays in the development of our reserves, increases in costs to drill and develop such reserves, or further decreases in commodity prices will reduce the future net revenues of our estimated proved undeveloped reserves and may result in some projects becoming uneconomical. In addition, delays in the development of reserves could force us to reclassify certain of our proved reserves as unproved reserves. Our producing properties are located in the Permian Basin of West Texas, making us vulnerable to risks (including weather-related risks) associated with operating in a single geographic area. In addition, we have a large amount of proved reserves attributable to a small number of producing horizons within this area. Our producing properties are currently geographically concentrated in the Permian Basin of West Texas. As a result of this concentration, we may be disproportionately exposed to the impact of regional supply and demand factors, delays or interruptions of production from wells in this area caused by governmental regulation, processing or transportation capacity constraints, availability of equipment, facilities, personnel or services market limitations or interruption of the processing or transportation of crude oil, natural gas or natural gas liquids, and extreme weather conditions and their adverse impact on production volumes, availability of electrical power, road accessibility and transportation facilities. Extreme regional weather events may occur that can affect our suppliers or customers, which could adversely affect us. For example, a significant hurricane or similar weather event could damage refining and other oil and natural gas-related facilities on the Gulf Coast of Texas and Louisiana, which (if significant enough) could limit the availability of gathering and transportation facilities across Texas and could then cause production in the Permian Basin (including potentially our production) to be curtailed or shut in or (in the case of natural gas) flared. Further, any increase in flaring of our natural gas production due to weather-related events or otherwise could make it difficult for us to achieve our publicly-announced sustainability and emissions reduction targets, which could expose us to reputational risks and adversely impact our contractual and other business relationships. Any of the above-referenced events could have a material adverse effect on us. Likewise, a weather event could reduce the availability of electrical power, road accessibility, and transportation facilities, which could have an adverse impact on our production volumes (and therefore on our financial condition and results of operations).In addition, the effect of fluctuations on supply and demand may become more pronounced within specific geographic oil and natural gas producing areas such as the Permian Basin, which may cause these conditions to occur with greater frequency or magnify the effects of these conditions. Due to the concentrated nature of our portfolio of properties, a number of our properties could experience any of the same conditions at the same time, resulting in a relatively greater impact on our results of operations than they might have on other companies that have a more diversified portfolio of 34Table of Contentsproperties. Such delays or interruptions could have a material adverse effect on our financial condition and results of operations.In addition to the geographic concentration of our producing properties described above, as of December 31, 2022, most of our proved reserves are concentrated in the Wolfberry play in the Midland Basin. This concentration of assets within a small number of producing horizons exposes us to additional risks, such as changes in field-wide rules and regulations that could cause us to permanently or temporarily shut-in all of our wells within a field. We depend upon several significant purchasers for the sale of most of our oil and natural gas production. The loss of one or more of these purchasers could, among other factors, limit our access to suitable markets for the oil and natural gas we produce. The availability of a ready market for any oil and/or natural gas we produce depends on numerous factors beyond the control of our management, including but not limited to the extent of domestic production and imports of oil, the proximity and capacity of natural gas pipelines, the availability of skilled labor, materials and equipment, the effect of state and federal regulation of oil and natural gas production and federal regulation of natural gas sold in interstate commerce. We cannot assure you that we will continue to have ready access to suitable markets for our future oil and natural gas production. In addition, we depend upon several significant purchasers for the sale of most of our oil and natural gas production. See “Item 1 and 2. Business and Properties—Oil and Natural Gas Production Prices and Production Costs—Marketing and Customers” for additional information regarding these customers. The loss of one or more of these customers, and our inability to sell our production to other customers on terms we consider acceptable, could materially and adversely affect our business, financial condition, results of operations and cash flow.The unavailability, high cost or shortages of rigs, equipment, raw materials, supplies, oilfield services or personnel may restrict our operations. The oil and natural gas industry is cyclical, which can result in shortages of drilling rigs, equipment, raw materials (particularly sand and other proppants), supplies and personnel. When shortages occur, the costs and delivery times of rigs, equipment and supplies increase and demand for, and wage rates of, qualified drilling rig crews also rise with increases in demand. We cannot predict whether these conditions will exist in the future and, if so, what their timing and duration will be. In accordance with customary industry practice, we rely on independent third party service providers to provide most of the services necessary to drill new wells. If we are unable to secure a sufficient number of drilling rigs at reasonable costs, our financial condition and results of operations could suffer, and we may not be able to drill all of our acreage before our leases expire. In addition, we do not have long-term contracts securing the use of our existing rigs, and the operators of those rigs may choose to cease providing services to us. Shortages of drilling rigs, equipment, raw materials (particularly sand and other proppants), supplies, personnel, trucking services, tubulars, fracking and completion services and production equipment could delay or restrict our exploration and development operations, which in turn could impair our financial condition and results of operations. Our operations are substantially dependent on the availability of water. Restrictions on our ability to obtain water may have an adverse effect on our financial condition, results of operations and cash flows. Water is an essential component of deep shale oil and natural gas production during both the drilling and hydraulic fracturing processes. Historically, we have been able to purchase water from local land owners for use in our operations. Over the past several years, Texas has experienced extreme drought conditions. As a result of this severe drought, some local water districts have begun restricting the use of water subject to their jurisdiction for hydraulic fracturing to protect local water supply. If we are unable to obtain water to use in our operations from local sources, or we are unable to effectively utilize flowback water, we may be unable to economically drill for or produce oil and natural gas, which could have an adverse effect on our financial condition, results of operations and cash flows. Recent regulatory restrictions on the disposal of produced water and additional monitoring and reporting requirements related to existing and additional monitoring new produced water disposal wells in the Permian Basin to stem rising seismic activity and earthquakes could increase our operating costs and adversely impact our business, results of operations and financial condition.In September 2021, the Texas Railroad Commission curtailed the amount of produced water companies were permitted to inject into some wells near Midland and Odessa in the Permian Basin, and has since indefinitely suspended some permits there and expanded the restrictions to other areas. These actions were taken in an effort to control induced seismic activity and recent increases in earthquakes in the Permian Basin, which have been linked by the U.S. and local seismologists to wastewater disposal in oil fields. The Texas Railroad Commission has since adopted rules governing the permitting or re-35Table of Contentspermitting of wells used to dispose of produced water and other fluids resulting from the production of oil and gas in order to address these seismic activity concerns within the state. Among other things, these rules require companies seeking permits for disposal wells to provide seismic activity data in permit applications, provide for more frequent monitoring and reporting for certain wells and allow the state to modify, suspend or terminate permits on grounds that a disposal well is likely to be, or determined to be, causing seismic activity. These restrictions on the disposal of produced water and additional monitoring and reporting requirements related to existing and new disposal of produced water and additional monitoring and reporting requirements related to existing and new produced water disposal wells could result in increased operating costs, requiring us or our service providers to truck produced water, recycle it or dispose of it by other means, all of which could be costly. We or our service providers may also need to limit disposal well volumes, disposal rates and pressures or locations, or require us or our service providers to shut down or curtail the injection of produced water into disposal wells. These factors may make drilling activity in the affected parts of the Permian Basin less economical and adversely impact our business, results of operations and financial condition. In response to recent seismic activity in the Midland Basin over the past couple of years, the Texas Railroad Commission has pursued a series of actions commencing in the latter half of 2021, including suspending deep disposal activity and curtailing certain shallow disposal activities in the areas of heightened seismic activity. Such restrictions have not had a material impact on our operations to date, but further restrictions across the basin as a result of more stringent regulations or legal directives, potential litigation or other developments could increase our operating costs and materially impact our ability to dispose of produced water, which could have a material adverse effect on our business, results of operations and financial condition.We have incurred losses from operations during certain periods since our inception and may do so in the future. Our development of and participation in an increasingly larger number of drilling locations has required and will continue to require substantial capital expenditures. The uncertainty and risks described in this report may impede our ability to economically find, develop and acquire oil and natural gas reserves. As a result, we may not be able to achieve or sustain profitability or positive cash flows from our operating activities in the future. Part of our strategy involves drilling in existing or emerging shale plays using the latest available horizontal drilling and completion techniques; therefore, the results of our planned exploratory drilling in these plays are subject to risks associated with drilling and completion techniques and drilling results may not meet our expectations for reserves or production. Our operations involve developing and utilizing the latest drilling and completion techniques. Risks that we face while drilling include, but are not limited to, the following:•spacing of wells to maximize economic return;•landing our well bore in the desired drilling zone;•staying in the desired drilling zone while drilling horizontally through the formation;•running our casing the entire length of the well bore; and •being able to run tools and other equipment consistently through the horizontal well bore. Risks that we face while completing our wells include, but are not limited to, being able to:•fracture stimulate the planned number of stages; •run tools the entire length of the well bore during completion operations;•successfully clean out the well bore after completion of the final fracture stimulation stage; and•prevent unintentional communication with other wells.Furthermore, certain of the new techniques we are adopting, such as infill drilling and multi-well pad drilling, may cause irregularities or interruptions in production due to, in the case of infill drilling, offset wells being shut in and, in the case of multi-well pad drilling, the time required to drill and complete multiple wells before any such wells begin producing. The results of our drilling in new or emerging formations are more uncertain initially than drilling results in areas that are more developed and have a longer history of established production. Newer or emerging formations and areas often have limited or no production history and consequently we are less able to predict future drilling results in these areas. Ultimately, the success of these drilling and completion techniques can only be evaluated as more wells are drilled and production profiles are established over a sufficiently long time period. If our drilling results are less than anticipated or we are unable to execute our drilling program because of capital constraints, lease expirations, access to gathering systems, and/or declines in natural gas and oil prices, the return on our investment in these areas may not be as attractive as we 36Table of Contentsanticipate. Further, as a result of any of these developments we could incur material write-downs of our oil and natural gas properties and the value of our undeveloped acreage could decline in the future. The marketability of our production is dependent upon transportation and other facilities, certain of which we do not control. If these facilities are unavailable, our operations could be interrupted and our revenues reduced.The marketability of our oil and natural gas production depends in part upon the availability, proximity and capacity of transportation facilities owned by third parties. Our oil production is transported from the wellhead to our tank batteries by our gathering line, which interconnects with third party pipelines. Our natural gas production is generally transported by our gathering lines from the wellhead to an interconnection point with a purchaser or into a third-party gathering system. We do not control third party transportation facilities and our access to them may be limited or denied. Insufficient production from our wells to support the construction of pipeline facilities by our purchasers or a significant disruption in the availability of our or third party transportation facilities or other production facilities could adversely impact our ability to deliver to market or produce our oil and natural gas and thereby cause a significant interruption in our operations. For example, on certain occasions we have experienced high line pressure at our tank batteries with occasional flaring due to the inability of the gas gathering systems in the areas in which we operate to support the increased production of natural gas in the Permian Basin. If, in the future, we are unable, for any sustained period, to implement acceptable delivery or transportation arrangements or encounter production related difficulties, we may be required to shut in or curtail production. In addition, the amount of oil and natural gas that can be produced and sold may be subject to curtailment in certain other circumstances outside of our control, such as pipeline interruptions due to maintenance, excessive pressure, ability of downstream processing facilities to accept unprocessed gas, physical damage to the gathering or transportation system or lack of contracted capacity on such systems. The curtailments arising from these and similar circumstances may last from a few days to several months, and in many cases, we are provided with limited, if any, notice as to when these circumstances will arise and their duration. Any such shut in or curtailment, or an inability to obtain favorable terms for delivery of the oil and natural gas produced from our fields, would adversely affect our financial condition and results of operations. Our operations are subject to various governmental laws and regulations which require compliance that can be burdensome and expensive. Our oil and natural gas operations are subject to various federal, state and local governmental regulations that may be changed from time to time in response to economic and political conditions. Matters subject to regulation include discharge permits for drilling operations, drilling bonds, reports concerning operations, the spacing of wells, unitization and pooling of properties and taxation. From time to time, regulatory agencies have imposed price controls and limitations on production by restricting the rate of flow of oil and natural gas wells below actual production capacity to conserve supplies of oil and natural gas. In addition, the production, handling, storage, transportation, remediation, emission and disposal of oil and natural gas, by-products thereof and other substances and materials produced or used in connection with oil and natural gas operations are subject to regulation under federal, state and local laws and regulations primarily relating to protection of human health and the environment. Failure to comply with these laws and regulations may result in the assessment of sanctions, including administrative, civil or criminal penalties, permit revocations, requirements for additional pollution controls and injunctions limiting or prohibiting some or all of our operations. Further, these laws and regulations imposed strict requirements for water and air pollution control and solid waste management. Significant expenditures may be required to comply with governmental laws and regulations applicable to us. In addition, federal and state legislation and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional operating restrictions or delays. Even if federal regulatory burdens temporarily ease, the historic trend of more expansive and stricter environmental legislation and regulations may continue in the long-term, and at the state and local levels. See “Item 1 and 2. Business and Properties—Regulation” for a detailed description of certain laws and regulations that affect us. Restrictions on drilling activities intended to protect certain species of wildlife may adversely affect our ability to conduct drilling activities in some of the areas where we operate. Oil and natural gas operations in our operating areas can be adversely affected by seasonal or permanent restrictions on drilling activities designed to protect various wildlife. Seasonal restrictions may limit our ability to operate in protected areas and can intensify competition for drilling rigs, oilfield equipment, services, supplies and qualified personnel, which may lead to periodic shortages when drilling is allowed. These constraints and the resulting shortages or high costs could delay our operations and materially increase our operating and capital costs. Permanent restrictions imposed to protect threatened or endangered species could prohibit drilling in certain areas or require the implementation of expensive mitigation measures. The designation of previously unprotected species in areas where we operate as threatened or endangered, such as the recent designation of lesser prairie chickens in southwestern Texas as endangered, could cause us to incur increased costs arising from species protection measures or could result in limitations on our exploration and production activities that could have an adverse impact on our ability to develop and produce our reserves. 37Table of ContentsDerivatives reform legislation and related regulations could have an adverse effect on our ability to hedge risks associated with our business.The Dodd-Frank Act established federal oversight of the over-the-counter derivatives market and entities, including us, that participate in that market. The Dodd-Frank Act required the Commodity Futures Trading Commission (CFTC), the SEC, and certain federal regulators of financial institutions (Prudential Regulators), to adopt rules or regulations implementing the Dodd-Frank Act. The Dodd-Frank Act established margin requirements and requires clearing and trade execution practices for certain market participants and may result in certain market participants needing to curtail or cease their derivatives activities. Although some of the rules necessary to implement the Dodd-Frank Act remain to be adopted, the CFTC, the SEC and the Prudential Regulators have issued a number of rules, including rules requiring clearing of certain swaps through registered clearing facilities (Mandatory Clearing Rule), requiring the posting of collateral for uncleared swaps (Margin Rule) and imposing position limits (Position Limit Rule). There are exceptions, subject to meeting certain filing, recordkeeping and reporting requirements, to the Mandatory Clearing Rule, the Margin Rule and the Position Limit Rule.We qualify for the “end user” exception to the Mandatory Clearing Rule and the “non-financial end user” exception to the Margin Rule and we believe that the majority, if not all, of our hedging activities qualify for the “bona fide hedging transaction or position” exception to the Position Limit Rule. We intend to satisfy the applicable filing, recordkeeping and reporting requirements to use these exceptions, so we do not expect to be directly affected by any of such rules. However, most if not all of our swap counterparties will be subject to mandatory clearing and collateral requirements in connection with their hedging activities with other counterparties that do not qualify for exceptions to these rules, which could significantly increase the cost of our derivative contracts or reduce the availability of derivatives to us that we have historically used to protect against risks that we encounter in our business.In addition, the European Union and other non-U.S. jurisdictions have enacted laws and regulations (collectively, Foreign Regulations), which may apply to our transactions with counterparties subject to such Foreign Regulations (Foreign Counterparties). The Foreign Regulations, the Dodd-Frank Act, the rules which have been adopted and not vacated and other regulations could significantly increase the cost of our derivative contracts, materially alter the terms of our derivative contracts, reduce the availability of derivatives to us that we have historically used to protect against risks that we encounter in our business, reduce our ability to monetize or restructure our existing derivative contracts and increase our exposure to less creditworthy counterparties. If we reduce our use of derivatives as a result of the Dodd-Frank Act, the Foreign Regulations or other regulations, our results of operations and cash flows may become more volatile and less predictable, which could adversely affect our ability to plan for and fund capital expenditures. Finally, the Dodd-Frank Act was intended, in part, to reduce the volatility of oil and natural gas prices, which some legislators attributed to speculative trading in derivatives and commodity contracts related to oil and natural gas. Our revenues could therefore be adversely affected if a consequence of the Dodd-Frank Act and regulations is to lower commodity prices. Any of these consequences could have a material adverse effect on us, our financial condition and our results of operations.U.S. tax legislation may adversely affect our business, results of operations, financial condition and cash flow. From time to time, legislation has been proposed that, if enacted into law, would make significant changes to U.S. federal and state income tax laws affecting the oil and natural gas industry, including (i) eliminating the immediate deduction for intangible drilling and development costs, (ii) the repeal of the percentage depletion allowance for oil and natural gas properties; and (iii) an extension of the amortization period for certain geological and geophysical expenditures. No accurate prediction can be made as to whether any such legislative changes will be proposed or enacted in the future or, if enacted, what the specific provisions or the effective date of any such legislation would be. These proposed changes in the U.S. tax law, if adopted, or other similar changes that would impose additional tax on our activities or reduce or eliminate deductions currently available with respect to natural gas and oil exploration, development or similar activities, could adversely affect our business, results of operations, financial condition and cash flow.On August 16, 2022, President Biden signed into law the IRA, which, among other changes, imposes a 15% corporate alternative minimum tax (“CAMT”) on the “adjusted financial statement income” of certain large corporations (generally, corporations reporting at least $1 billion average adjusted pre-tax net income on their consolidated financial statements) as well as an excise tax of 1% on the fair market value of certain public company stock repurchases for tax years beginning after December 31, 2022. If we are or become subject to CAMT, our cash obligations for U.S. federal income taxes could be significantly accelerated. To the extent the 1% excise tax applies to repurchases of shares under our common stock repurchase program, the number of shares we repurchase and our cash flow may be affected.The U.S. Treasury Department, the Internal Revenue Service and other standard-setting bodies are expected to issue guidance on how the CAMT, stock buyback excise tax and other provisions of the IRA will be applied or otherwise 38Table of Contentsadministered that may differ from our interpretations. We continue to evaluate the IRA and its effect on our financial results and operating cash flow.We operate in areas of high industry activity, which may affect our ability to hire, train or retain qualified personnel needed to manage and operate our assets.Our operations and drilling activity are concentrated in the Permian Basin in West Texas, an area in which industry activity has increased rapidly. As a result, demand for qualified personnel in this area, and the cost to attract and retain such personnel, has increased over the past few years due to competition and may increase substantially in the future. Moreover, our competitors may be able to offer better compensation packages to attract and retain qualified personnel than we are able to offer.Any delay or inability to secure the personnel necessary for us to continue or complete our current and planned development activities could lead to a reduction in production volumes. Any such negative effect on production volumes, or significant increases in costs, could have a material adverse effect on our business, financial condition and results of operations.We rely on a few key employees whose absence or loss could adversely affect our business. Many key responsibilities within our business have been assigned to a small number of employees. The loss of their services could adversely affect our business. In particular, the loss of the services of one or more members of our executive team, including our Chief Executive Officer, Travis D. Stice, could disrupt our operations. We do not have employment agreements with our executives and may not be able to assure their retention. Further, we do not maintain “key person” life insurance policies on any of our employees. As a result, we are not insured against any losses resulting from the death of our key employees. Operating hazards and uninsured risks may result in substantial losses and could prevent us from realizing profits. Our operations are subject to all of the hazards and operating risks associated with drilling for and production of oil and natural gas, including the risk of fire, explosions, blowouts, surface cratering, uncontrollable flows of natural gas, oil and formation water, pipe or pipeline failures, abnormally pressured formations, casing collapses and environmental hazards such as oil spills, gas leaks and ruptures or discharges of toxic gases. In addition, our operations are subject to risks associated with hydraulic fracturing, including any mishandling, surface spillage or potential underground migration of fracturing fluids, including chemical additives. The occurrence of any of these events could result in substantial losses to us due to injury or loss of life, severe damage to or destruction of property, natural resources and equipment, pollution or other environmental damage, clean-up responsibilities, regulatory investigations and penalties, suspension of operations and repairs required to resume operations. We endeavor to contractually allocate potential liabilities and risks between us and the parties that provide us with services and goods, which include pressure pumping and hydraulic fracturing, drilling and cementing services and tubular goods for surface, intermediate and production casing. Under our agreements with our vendors, to the extent responsibility for environmental liability is allocated between the parties, (i) our vendors generally assume all responsibility for control and removal of pollution or contamination which originates above the surface of the land and is directly associated with such vendors’ equipment while in their control and (ii) we generally assume the responsibility for control and removal of all other pollution or contamination which may occur during our operations, including pre-existing pollution and pollution which may result from fire, blowout, cratering, seepage or any other uncontrolled flow of oil, gas or other substances, as well as the use or disposition of all drilling fluids. In addition, we generally agree to indemnify our vendors for loss or destruction of vendor-owned property that occurs in the well hole (except for damage that occurs when a vendor is performing work on a footage, rather than day work, basis) or as a result of the use of equipment, certain corrosive fluids, additives, chemicals or proppants. However, despite this general allocation of risk, we might not succeed in enforcing such contractual allocation, might incur an unforeseen liability falling outside the scope of such allocation or may be required to enter into contractual arrangements with terms that vary from the above allocations of risk. As a result, we may incur substantial losses which could materially and adversely affect our financial condition and results of operations. In accordance with what we believe to be customary industry practice, we historically have maintained insurance against some, but not all, of our business risks. Our insurance may not be adequate to cover any losses or liabilities we may suffer. Also, insurance may no longer be available to us or, if it is, its availability may be at premium levels that do not justify its purchase. The occurrence of a significant uninsured claim, a claim in excess of the insurance coverage limits maintained by us or a claim at a time when we are not able to obtain liability insurance could have a material adverse effect on our ability to conduct normal business operations and on our financial condition, results of operations or cash flow. In addition, we may 39Table of Contentsnot be able to secure additional insurance or bonding that might be required by new governmental regulations. This may cause us to restrict our operations, which might severely impact our financial position. We may also be liable for environmental damage caused by previous owners of properties purchased by us, which liabilities may not be covered by insurance. Since hydraulic fracturing activities are part of our operations, we maintain insurance to protect against claims made for bodily injury and property damage, and that insurance includes coverage for clean-up costs stemming from a sudden and accidental pollution event. However, we may not have coverage if we are unaware of the pollution event and unable to report the “occurrence” to our insurance company within the time frame required under our insurance policy. We have limited coverage for gradual, long-term pollution events. In addition, these policies do not provide coverage for all liabilities, and we cannot assure you that the insurance coverage will be adequate to cover claims that may arise, or that we will be able to maintain adequate insurance at rates we consider reasonable. A loss not fully covered by insurance could have a material adverse effect on our financial position, results of operations and cash flows. Our use of 2-D and 3-D seismic data is subject to interpretation and may not accurately identify the presence of oil and natural gas, which could adversely affect the results of our drilling operations. Even when properly used and interpreted, 2-D and 3-D seismic data and visualization techniques are only tools used to assist geoscientists in identifying subsurface structures and hydrocarbon indicators and do not enable the interpreter to know whether hydrocarbons are, in fact, present in those structures. In addition, the use of 3-D seismic and other advanced technologies requires greater predrilling expenditures than traditional drilling strategies, and we could incur losses as a result of such expenditures. As a result, our drilling activities may not be successful or economical. We own interests in certain pipeline projects and other joint ventures, and we may in the future enter into additional joint ventures, and our control of such entities is limited by provisions of the governing documents of such entities and by our percentage ownership in such entities.We have ownership interests in several joint ventures, including the EPIC, Wink to Webster, BANGL, WTG and OMOG joint ventures, and we may enter into other joint venture arrangements in the future. While we own equity interests and have certain voting rights with respect to our joint ventures, we do not act as operator of or control our joint ventures (including our 43% interest in the OMOG joint venture), each of which is operated by another joint venture partner. We have limited ability to influence the business decisions of these entities, and it may therefore be difficult or impossible for us to cause the joint venture to take actions that we believe would be in our or the relevant joint venture’s best interests. Moreover, joint venture arrangements involve various risks and uncertainties, such as committing us to fund operating and/or capital expenditures, the timing and amount of which we may not control. In addition, our joint venture partners may not satisfy their financial obligations to the joint venture and may have economic, business or legal interests or goals that are inconsistent with ours, or those of the joint venture.We are also unable to control the amount of cash we receive from the operation of these entities. Further, certain of these joint ventures have incurred substantial debt and servicing such debt or complying with debt covenants may limit the ability of the joint ventures to make distributions to us and the other joint venture partners. These joint ventures also have internal control environments independent of our oversight and review. If our joint venture partners have control deficiencies in their accounting or financial reporting environments, it may result in inaccuracies in the reporting for our percentage of the financial results for the joint venture.We may not own in fee the land on which our pipelines and facilities are located, which could result in disruptions to our midstream services.The majority of the land on which our midstream systems have been constructed is owned by third parties or held by surface use agreements, rights-of-way, surface leases or other easement rights, which may limit or restrict our rights or access to or use of the surface estates. Accommodating these competing rights of the surface owners may adversely affect our midstream operations. In addition, we are subject to the possibility of more onerous terms or increased costs to retain necessary land use if we do not have valid rights-of-way, surface leases or other easement rights or if such usage rights lapse or terminate. We may obtain the rights to construct and operate our pipelines on land owned by third parties and governmental agencies for a specific period of time. Our loss of these rights, through our inability to renew rights-of-way, surface leases or other easement rights or otherwise, could have an adverse effect on our business, financial condition, results of operations and cash flow.40Table of ContentsWe may not be able to keep pace with technological developments in our industry. The oil and natural gas industry is characterized by rapid and significant technological advancements and introductions of new products and services using new technologies. As others use or develop new technologies, we may be placed at a competitive disadvantage or may be forced by competitive pressures to implement those new technologies at substantial costs. In addition, other oil and natural gas companies may have greater financial, technical and personnel resources that allow them to enjoy technological advantages and that may in the future allow them to implement new technologies before we can. We may not be able to respond to these competitive pressures or implement new technologies on a timely basis or at an acceptable cost. If one or more of the technologies we use now or in the future were to become obsolete, our business, financial condition or results of operations could be materially and adversely affected. A terrorist attack or armed conflict could harm our business. Terrorist activities, anti-terrorist efforts and other armed conflicts involving the United States or other countries may adversely affect the United States and global economies and could prevent us from meeting our financial and other obligations. If any of these events occur, the resulting political instability and societal disruption could reduce overall demand for oil and natural gas causing a reduction in our revenues. Oil and natural gas related facilities could be direct targets of terrorist attacks, and our operations could be adversely impacted if infrastructure integral to our customers’ operations is destroyed or damaged. Costs for insurance and other security may increase as a result of these threats, and some insurance coverage may become more difficult to obtain, if available at all. Our operations depend heavily on electrical power, internet and telecommunication infrastructure and information and computer systems. If any of these systems are compromised or unavailable, our business could be adversely affected.We are heavily dependent on electrical power, internet and telecommunications infrastructure and our information systems and computer-based programs, including our well operations information, seismic data, electronic data processing and accounting data. If any of such infrastructure, systems or programs were to fail or become unavailable or compromised, or create erroneous information in our hardware or software network infrastructure, our ability to safely and effectively operate our business will be limited and any such consequence could have a material adverse effect on our business. We are subject to cybersecurity risks. A cyber incident could occur and result in information theft, data corruption, operational disruption and/or financial loss. As an exploration and production company, we rely extensively on information technology systems, including internally developed software, data hosting platforms, real-time data acquisition systems, third-party software, cloud services and other internally or externally hosted hardware and software platforms, to (i) estimate our oil and natural gas reserves, (ii) process and record financial and operating data, (iii) process and analyze all stages of our business operations, including exploration, drilling, completions, production, transportation, pipelines and other related activities and (iv) communicate with our employees and vendors, suppliers and other third parties. Further, our reliance on technology has increased due to the increased use of personal devices, remote communications and work-from-home or hybrid work practices that evolved in response to the COVID-19 pandemic.Our systems and networks, and those of our vendors, service providers and other third party providers, may become the target of cybersecurity attacks, including, without limitation, denial-of-service attacks; malicious software; data privacy breaches by employees, insiders or others with authorized access; cyber or phishing-attacks; ransomware; attempts to gain unauthorized access to our data and systems; and other electronic security breaches. If any of these security breaches were to occur, we could suffer disruptions to our normal operations, including our exploration, completion, production and corporate functions, which could materially and adversely affect us in a variety of ways, including, but not limited to, the following:•unauthorized access to, and release of, our business data, reserves information, strategic information or other sensitive or proprietary information, which could have a material and adverse effect on our ability to compete for oil and gas resources, or reduce our competitive advantage over other companies;•data corruption, communication interruption, or other operational disruptions during our drilling activities, which could result in our failure to reach the intended target or a drilling incident;•data corruption or operational disruptions of our production-related infrastructure, which could result in loss of production or accidental discharges;•unauthorized access to, and release of, personal information of our employees, vendors, service providers or other third parties, which could expose us to allegations that we did not sufficiently protect such information;41Table of Contents•a cybersecurity attack on a vendor or service provider, which could result in supply chain disruptions and could delay or halt our operations;•a cybersecurity attack on third-party gathering, transportation, processing, fractionation, refining or other facilities, which could result in reduced demand for our production or delay or prevent us from transporting and marketing our production, in either case resulting in a loss of revenues;•a cybersecurity attack involving commodities exchanges or financial institutions could slow or halt commodities trading, thus preventing us from marketing our production or engaging in hedging activities, resulting in a loss of revenues;•a deliberate corruption of our financial or operating data could result in events of non-compliance which could then lead to regulatory enforcement actions, fines or penalties;•a cybersecurity attack on a communications network or power grid, which could cause operational disruptions resulting in a loss of revenues; and•a cybersecurity attack on our automated and surveillance systems, which could cause a loss of production and potential environmental hazards.We have implemented and invested in, and will continue to implement and invest in, controls, procedures and protections (including internal and external personnel) that are designed to protect our systems, identify and remediate on a regular basis vulnerabilities in our systems and related infrastructure and monitor and mitigate the risk of data loss and other cybersecurity threat. Such measures, however, cannot entirely eliminate cybersecurity threats and the controls, procedures and protections we have implemented and invested in may prove to be ineffective. We maintain specialized insurance for possible liability resulting from a cyberattack on our assets, however, we cannot assure you that the insurance coverage will be adequate to cover claims that may arise, or that we will be able to maintain adequate insurance at rates we consider reasonable. A loss not fully covered by insurance could have a material adverse effect on our financial position, results of operations and cash flows. Risks Related to Our Indebtedness References in this section to “us, “we” or “our” shall mean Diamondback Energy, Inc. and Diamondback E&P LLC, collectively, unless otherwise specified. Implementing our capital programs may require, under some circumstances, an increase in our total leverage through additional debt issuances, and any significant reduction in availability under our revolving credit facility or inability to otherwise obtain financing for our capital programs could require us to curtail our capital expenditures.We have historically relied on availability under our revolving credit facility to fund a portion of our capital expenditures. We expect that we will continue to fund a portion of our capital expenditures with borrowings under the revolving credit facility, cash flow from operations and the proceeds from debt and equity offerings. In the past, we have created availability under the revolving credit facility by repaying outstanding borrowings with the proceeds from debt or equity offerings. We cannot assure you that we will choose to or be able to access the capital markets to repay any such future borrowings. Instead, we may be required or choose to finance our capital expenditures through additional debt issuances, which would increase our total amount of debt outstanding. If the availability under the revolving credit facility were reduced, and we were otherwise unable to secure other sources of financing, we may be required to curtail our capital expenditures, which could limit our ability to fund our drilling activities and acquisitions or otherwise finance the capital expenditures necessary to replace our reserves.Restrictive covenants in certain of our existing and future debt instruments may limit our ability to respond to changes in market conditions or pursue business opportunities.Certain of our debt instruments contain, and the terms of any future indebtedness may contain, restrictive covenants that limit our ability to, among other things: incur or guarantee additional indebtedness; make certain investments; create liens; sell or transfer assets; issue preferred stock; merge or consolidate with another entity; pay dividends or make other distributions; create unrestricted subsidiaries; and engage in transactions with affiliates. A breach of any of these restrictive covenants could result in default under the applicable debt instrument.Under our revolving credit facility we are allowed, among other things, to designate one or more of our subsidiaries as “unrestricted subsidiaries” that are not subject to certain restrictions contained in the revolving credit facility. Under our revolving credit facility, we designated Viper, Viper’s General Partner, Viper’s subsidiary, Rattler, Rattler’s GP and Rattler’s subsidiaries as unrestricted subsidiaries, and upon such designation, they were automatically released from any and all obligations under the revolving credit facility, including the related guaranty. Further Viper, Viper’s General Partner, Viper’s 42Table of Contentssubsidiaries, Rattler, Rattler’s GP and Rattler’s subsidiaries are designated as unrestricted subsidiaries under the indentures governing our outstanding Guaranteed Senior Notes.We and our subsidiaries may be prevented from taking advantage of business opportunities that arise because of the limitations imposed on us by the restrictive covenants and financial covenants contained in our and our subsidiaries’ debt instruments. As an example, our revolving credit facility requires us to maintain a total net debt to capitalization ratio. The requirement that we and our subsidiaries comply with these provisions may materially adversely affect our and our subsidiaries ability to react to changes in market conditions, take advantage of business opportunities we believe to be desirable, obtain future financing, fund needed capital expenditures or withstand a continuing or future downturn in our business. If a default occurs under our revolving credit facility, the lenders thereunder may elect to declare all borrowings outstanding, together with accrued interest and other fees, to be immediately due and payable, which would result in an event of default under the indentures governing our senior notes. The lenders will also have the right in these circumstances to terminate any commitments they have to provide further borrowings. If the indebtedness under our revolving credit facility and our senior notes were to be accelerated, we cannot assure you that our assets would be sufficient to repay in full that indebtedness.Our indebtedness is structurally subordinated to the indebtedness and other liabilities of our subsidiaries, and our obligations are not obligations of any of our subsidiaries.Our senior indebtedness obligations are obligations exclusively of Diamondback Energy, Inc. and Diamondback E&P LLC, and not of any of our other subsidiaries. None of our other subsidiaries is a guarantor of our senior indebtedness. Any assets of those subsidiaries will not be directly available to satisfy the claims of our creditors, including lenders under our revolving credit facility and holders of the senior notes. Except to the extent we are a creditor with recognized claims against our subsidiaries, all claims of creditors of our subsidiaries will have priority over our equity interests in such subsidiaries (and therefore the claims of our creditors, including lenders under our revolving credit facility and holders of the senior notes) with respect to the assets of such subsidiaries. Even if we are recognized as a creditor of one or more of our subsidiaries, our claims would still be effectively subordinated to any security interests in the assets of any such subsidiary and to any indebtedness or other liabilities of any such subsidiary senior to our claims. Consequently, our senior indebtedness will be structurally subordinated to all indebtedness and other liabilities of any of our subsidiaries (other than Diamondback E&P LLC) and any subsidiaries that we may in the future acquire or establish. For additional information regarding our subsidiaries’ outstanding debt as of December 31, 2022, see Note 8—Debt to our consolidated financial statements included elsewhere in this Annual Report.Servicing our indebtedness requires a significant amount of cash, and we may not have sufficient cash flow from our business to pay our substantial indebtedness.Our ability to make scheduled payments of the principal, to pay interest on or to refinance our indebtedness, including our senior notes, depends on our future performance, which is subject to economic, financial, competitive and other factors beyond our control. If we are unable to generate sufficient cash flow to service our debt, we may be required to adopt one or more alternatives, such as reducing or delaying capital expenditures, selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. However, we cannot assure you that undertaking alternative financing plans, if necessary, would allow us to meet our debt obligations. In the absence of such cash flows, we could have substantial liquidity problems and might be required to sell material assets or operations to attempt to meet our debt service and other obligations. We may not be able to consummate those asset sales to raise capital or sell assets at prices that we believe are fair, and proceeds that we do receive may not be adequate to meet any debt service obligations then due. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at the time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations and have an adverse effect on our financial condition.We depend on our subsidiaries for dividends, distributions and other payments.We depend on our subsidiaries for dividends, distributions and other payments. We are a legal entity separate and distinct from our operating subsidiaries. There are statutory and regulatory limitations on the payment of dividends or distributions by certain of our subsidiaries to us. If our subsidiaries are unable to make dividend or distribution payments to us and sufficient cash or liquidity is not otherwise available, we may not be able to make dividend payments to our stockholders or principal and interest payments on our outstanding indebtedness.43Table of ContentsWe and our subsidiaries may still be able to incur substantial additional indebtedness in the future, which could further exacerbate the risks that we and our subsidiaries face.We and our subsidiaries may be able to incur substantial additional indebtedness in the future. The terms of our and our subsidiaries’ revolving credit facilities and the indentures restrict, but in each case do not completely prohibit, us from doing so. Further, the indentures governing our and our subsidiaries’ notes allow us to issue additional notes, incur certain other additional debt and to have subsidiaries that do not guarantee the senior notes and which may incur additional debt, which would be structurally senior to the senior notes. In addition, the indentures governing the senior notes do not prevent us from incurring other liabilities that do not constitute indebtedness. If we or a guarantor incur any additional indebtedness that ranks equally with the senior notes (or with the guarantees thereof), including additional unsecured indebtedness or trade payables, the holders of that indebtedness will be entitled to share ratably with holders of the senior notes in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding-up of us or a guarantor. If new debt or other liabilities are added to our current debt levels, the related risks that we and our subsidiaries now face could intensify.If we experience liquidity concerns, we could face a downgrade in our debt ratings which could restrict our access to, and negatively impact the terms of, current or future financings or trade credit.Our ability to obtain financings and trade credit and the terms of any financings or trade credit is, in part, dependent on the credit ratings assigned to our debt by independent credit rating agencies. We cannot provide assurance that any of our current ratings will remain in effect for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances so warrant. Factors that may impact our credit ratings include debt levels, planned asset purchases or sales and near-term and long-term production growth opportunities, liquidity, asset quality, cost structure, product mix and commodity pricing levels. A ratings downgrade could adversely impact our ability to access financings or trade credit and increase our borrowing costs.Borrowings under our and Viper LLC’s revolving credit facilities expose us to interest rate risk. Our earnings are exposed to interest rate risk associated with borrowings under our and Viper LLC’s revolving credit facilities. The terms of our and Viper LLC’s revolving credit facilities provide for interest on borrowings at a floating rate equal to an alternate base rate tied to the secured overnight financing rate (“SOFR”). SOFR tends to fluctuate based on multiple factors, including general short-term interest rates, rates set by the U.S. Federal Reserve, which may increase further in 2023, and other central banks and general economic conditions. From time to time, we use interest rate swaps to reduce interest rate exposure with respect to our fixed and/or floating rate debt. The weighted average interest rate on borrowings under our revolving credit facility was 3.91% during the year ended December 31, 2022. Viper LLC’s weighted average interest rate on borrowings from its revolving credit facility was 4.22% during the year ended December 31, 2022. If interest rates increase, so will our interest costs, which may have a material adverse effect on our results of operations and financial condition. Risks Related to Our Common Stock The corporate opportunity provisions in our certificate of incorporation could enable affiliates of ours to benefit from corporate opportunities that might otherwise be available to us.Subject to the limitations of applicable law, our certificate of incorporation, among other things: permits us to enter into transactions with entities in which one or more of our officers or directors are financially or otherwise interested; permits any of our stockholders, officers or directors to conduct business that competes with us and to make investments in any kind of property in which we may make investments; and provides that if any director or officer of one of our affiliates who is also one of our officers or directors becomes aware of a potential business opportunity, transaction or other matter (other than one expressly offered to that director or officer in writing solely in his or her capacity as our director or officer), that director or officer will have no duty to communicate or offer that opportunity to us, and will be permitted to communicate or offer that opportunity to such affiliates and that director or officer will not be deemed to have (i) acted in a manner inconsistent with his or her fiduciary or other duties to us regarding the opportunity or (ii) acted in bad faith or in a manner inconsistent with our best interests. These provisions create the possibility that a corporate opportunity that would otherwise be available to us may be used for the benefit of one of our affiliates. 44Table of ContentsIf the price of our common stock fluctuates significantly, your investment could lose value.Although our common stock is listed on the Nasdaq Global Select Market, we cannot assure you that an active public market will continue for our common stock. If an active public market for our common stock does not continue, the trading price and liquidity of our common stock will be materially and adversely affected. If there is a thin trading market or “float” for our stock, the market price for our common stock may fluctuate significantly more than the stock market as a whole. Without a large float, our common stock would be less liquid than the stock of companies with broader public ownership and, as a result, the trading prices of our common stock may be more volatile. In addition, in the absence of an active public trading market, investors may be unable to liquidate their investment in us. Furthermore, the stock market is subject to significant price and volume fluctuations, and the price of our common stock could fluctuate widely in response to several factors, including our quarterly or annual operating results; changes in our earnings estimates; investment recommendations by securities analysts following our business or our industry; additions or departures of key personnel; changes in the business, earnings estimates or market perceptions of our competitors; our failure to achieve operating results consistent with securities analysts’ projections; changes in industry, general market or economic conditions; and announcements of legislative or regulatory changes. The stock market has experienced extreme price and volume fluctuations in recent years that have significantly affected the quoted prices of the securities of many companies, including companies in our industry. The changes often appear to occur without regard to specific operating performance. The price of our common stock could fluctuate based upon factors that have little or nothing to do with our company and these fluctuations could materially reduce our stock price. The declaration of base and variable dividends and any repurchases of our common stock are each within the discretion of our board of directors based upon a review of relevant considerations, and there is no guarantee that we will pay any dividends on or repurchase shares of our common stock in the future or at levels anticipated by our stockholders. On February 13, 2018, we initiated payment of quarterly cash dividends on our common stock payable beginning with the first quarter of 2018. The decision to pay any future base and variable dividends, however, is solely within the discretion of, and subject to approval by, our board of directors. Our board of directors’ determination with respect to any such dividends, including the record date, the payment date and the actual amount of the dividend, will depend upon our profitability and financial condition, contractual restrictions, restrictions imposed by applicable law and other factors that the board deems relevant at the time of such determination. Based on its evaluation of these factors, the board of directors may determine not to declare a dividend, whether base or variable, or declare dividends at rates that are less than currently anticipated, either of which could reduce returns to our stockholders.In September 2021, our board of directors approved a stock repurchase program to acquire up to $2.0 billion of our outstanding common stock, and on July 28, 2022, approved an increase in the repurchase program to $4.0 billion. We may be limited in our ability to repurchase shares of our common stock by various governmental laws, rules and regulations which prevent us from purchasing our common stock during periods when we are in possession of material non-public information. Through December 31, 2022, approximately $1.5 billion has been repurchased through the repurchase program. Even though this program is in place, we may not repurchase any shares through the program and any such repurchases are completely within the discretion of our board of directors. In addition, the stock repurchase program has no time limit and may be suspended, modified, or discontinued by the board of directors at any time. Any elimination of, or reduction in, the Company’s base or variable dividend or common stock repurchase program could adversely affect the total return of an investment in and have a material adverse effect on the market price of our common stock.In June 2022, our board of directors approved an increase to our return of capital commitment to at least 75% of free cash flow to be distributed quarterly to our stockholders in the primary form of a base dividend with additional return of capital expected to be in the form of a variable dividend and through our stock repurchase program. The amount of cash available to return to our stockholders, if any, can vary significantly from quarter to quarter for a number of reasons, including, commodity prices, liquidity, debt levels, capital resources and other factors. The price of our common stock may deteriorate if we are unable to meet investor expectations with respect to the timing and amount of our return of capital commitment to our stockholders, and such deterioration may be material.A change of control could limit our use of net operating losses and certain other tax attributes.Under Section 382 of the Code, a corporation that experiences an “ownership change” (as defined in the Code) may be subject to limitations on its ability to offset taxable income arising after the ownership change with net operating losses (“NOLs”) or tax credits generated prior to the ownership change. In general, an ownership change occurs if there is a cumulative increase in the ownership of a corporation’s stock totaling more than 50 percentage points by one or more “5% shareholders” (as defined in the Code) at any time during a rolling three-year period. An ownership change would establish 45Table of Contentsan annual limitation on the amount of a corporation’s pre-change NOLs or tax credits that could be utilized to offset taxable income in any future taxable year. The amount of the limitation is generally equal to the value of the corporation’s stock immediately prior to the ownership change multiplied by an interest rate, referred to as the long-term tax-exempt rate, periodically promulgated by the IRS. This limitation, however, may be significantly increased if there is “net unrealized built-in gain” in the assets of the corporation undergoing the ownership change. As of December 31, 2022, we had an NOL carryforward of approximately $1.3 billion and tax credits of $4 million for federal income tax purposes. As a result of ownership changes for Diamondback Energy, Inc., QEP and Rattler, which occurred in connection with the acquisition of QEP and the Rattler Merger, our NOLs and other carryforwards, including those acquired from QEP and Rattler, are subject to an annual limitation under Section 382 of the Code. However, we have determined that our fair market value and our net unrealized built-in gain position resulted in a significant increase in our Section 382 limits. Accordingly, we believe that the application of Section 382 as a result of these ownership changes will not have an adverse effect on our ability to utilize our NOLs and credits.Future changes in our stock ownership, however, could result in an additional ownership change under Section 382 of the Code. Any such ownership change may limit our ability to offset taxable income arising after such an ownership change with NOLs or other tax attributes generated prior to such an ownership change, possibly substantially.If securities or industry analysts do not publish research or reports about our business, if they adversely change their recommendations regarding our stock or if our operating results do not meet their expectations, our stock price could decline.The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, if one or more of the analysts who cover our company downgrade our stock or if our operating results do not meet their expectations, our stock price could decline. We may issue preferred stock whose terms could adversely affect the voting power or value of our common stock. Our certificate of incorporation authorizes us to issue, without the approval of our stockholders, one or more classes or series of preferred stock having such designations, preferences, limitations and relative rights, including preferences over our common stock respecting dividends and distributions, as our board of directors may determine. The terms of one or more classes or series of preferred stock could adversely impact the voting power or value of our common stock. For example, we might grant holders of preferred stock the right to elect some number of our directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences we might assign to holders of preferred stock could affect the residual value of the common stock. Provisions in our certificate of incorporation and bylaws and Delaware law make it more difficult to effect a change in control of our company, which could adversely affect the price of our common stock.The existence of some provisions in our certificate of incorporation and bylaws and Delaware corporate law could delay or prevent a change in control of our company, even if that change would be beneficial to our stockholders. Our certificate of incorporation and bylaws contain provisions that may make acquiring control of our company difficult, including provisions regulating the ability of our stockholders to nominate directors for election or to bring matters for action at annual meetings of our stockholders; limitations on the ability of our stockholders to call a special meeting and act by written consent; the ability of our board of directors to adopt, amend or repeal bylaws, and the requirement that the affirmative vote of holders representing at least 66 2/3% of the voting power of all outstanding shares of capital stock be obtained for stockholders to amend our bylaws; the requirement that the affirmative vote of holders representing at least 66 2/3% of the voting power of all outstanding shares of capital stock be obtained to remove directors; the requirement that the affirmative vote of holders representing at least 66 2/3% of the voting power of all outstanding shares of capital stock be obtained to amend our certificate of incorporation; and the authorization given to our board of directors to issue and set the terms of preferred stock without the approval of our stockholders. These provisions also could discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. As a result, these provisions could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders, which may limit the price that investors are willing to pay in the future for shares of our common stock. 46Table of ContentsITEM 1B. UNRESOLVED STAFF COMMENTSNone.ITEM 3. LEGAL PROCEEDINGSWe are a party to various routine legal proceedings, disputes and claims arising in the ordinary course of our business, including those that arise from interpretation of federal and state laws and regulations affecting the natural gas and crude oil industry, personal injury claims, title disputes, royalty disputes, contract claims, contamination claims relating to oil and natural gas exploration and development and environmental claims, including claims involving assets previously sold to third parties and no longer part of our current operations. While the ultimate outcome of the pending proceedings, disputes or claims, and any resulting impact on us, cannot be predicted with certainty, we believe that none of these matters, if ultimately decided adversely, will have a material adverse effect on our financial condition, results of operations or cash flows. For additional information regarding environmental matters, see Note 15—Commitments and Contingencies included in notes to the consolidated financial statements included elsewhere in this Annual Report.ITEM 4. MINE SAFETY DISCLOSURESNot applicable.PART IIITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESListing and Holders of RecordOur common stock is listed on the Nasdaq Global Select Market under the symbol “FANG”. There were 5,321 holders of record of our common stock on February 17, 2023.Dividend Policy Future base and variable dividends are at the discretion of our board of directors, and the board of directors may change the dividend amount from time to time based on the Company's outlook for commodity prices, liquidity, debt levels, capital resources, free cash flow and other factors. Our board of directors intends to continue the payment of dividends to the holders of the Company’s common stock in the future; however, the Company can provide no assurance that dividends will be authorized or declared in the future or as to the amount or type of any future dividends. Our board of directors’ determination with respect to any such dividends, whether base or variable, including the record date, the payment date and the actual amount of the dividend, will depend upon our profitability and financial condition, contractual restrictions, restrictions imposed by applicable law and other factors that the board deems relevant at the time of such determination. Recent Sales of Unregistered SecuritiesNone.Issuer Repurchases of Equity SecuritiesOur common stock repurchase activity for the three months ended December 31, 2022 was as follows:PeriodTotal Number of Shares PurchasedAverage Price Paid Per Share(1)Total Number of Shares Purchased as Part of Publicly Announced PlanApproximate Dollar Value of Shares that May Yet Be Purchased Under the Plan(2)($ In millions, except per share amounts, shares in thousands)October 1, 2022 - October 31, 202253$130.39 43$2,782 November 1, 2022 - November 30, 2022—$— —$2,782 December 1, 2022 - December 31, 20222,302$134.58 2,302$2,472 Total2,355$134.49 2,345(1)The average price paid per share includes any commissions paid to repurchase stock.(2)In September 2021, the Company’s board of directors authorized a $2.0 billion common stock repurchase program. On July 28, 2022, our board of directors approved an increase in our common stock repurchase program from $2.0 billion to $4.0 billion. The stock repurchase program has no time limit and may be suspended, modified, or discontinued by the board of directors at any time.ITEM 6. [RESERVED.]47Table of ContentsITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion and analysis should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this Annual Report. The following discussion contains “forward-looking statements” that reflect our future plans, estimates, beliefs, and expected performance. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors. See Item 1A. “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.” OverviewWe are an independent oil and natural gas company focused on the acquisition, development, exploration and exploitation of unconventional, onshore oil and natural gas reserves in the Permian Basin in West Texas. As of December 31, 2022, we have one reportable segment, the upstream segment. See Note 1—Description of the Business and Basis of Presentation and Note 17—Segment Information of the notes to the consolidated financial statements included elsewhere in this Annual Report for further discussion.2022 Financial and Operating Highlights•We recorded net income of $4.4 billion for the year ended December 31, 2022.•Increased our annual base dividend by 50% to $3.00 per share and paid dividends to stockholders of $1.6 billion during 2022 and in February 2023 declared a combined base and variable cash dividend of $2.95 per share of common stock, payable in the first quarter of 2023. Additionally on February 16, 2023, our board of directors approved an increase to the Company’s annual base dividend to $3.20 per share.•Repurchased $1.1 billion of our common stock, leaving approximately $2.5 billion available for future purchases under our common stock repurchase program at December 31, 2022. •During the year ended December 31, 2022, we issued $2.5 billion in principal amount of senior notes and retired an aggregate of $2.4 billion in principal amount of our then-outstanding senior notes. •Our average production was 386,005 MBOE/d during the year ended December 31, 2022.•During the year ended December 31, 2022, we drilled 240 gross horizontal wells (including 197 in the Midland Basin and 43 in the Delaware Basin).•We turned 255 gross operated horizontal wells (including 213 in the Midland Basin and 42 in the Delaware Basin) to production and had capital expenditures, excluding acquisitions, of $1.9 billion during the year ended December 31, 2022.•As of December 31, 2022, we had approximately 508,767 net acres, which primarily consisted of 325,540 net acres in the Midland Basin and 150,719 net acres in the Delaware Basin. As of December 31, 2022, we had an estimated 8,276 gross horizontal locations that we believe to be economic at $50.00 per Bbl WTI. In addition, our publicly traded subsidiary Viper owns mineral interests underlying approximately 775,180 gross acres and 26,315 net royalty acres in the Permian Basin. We operate approximately 57% of these net royalty acres.2022 Transactions and Recent DevelopmentsPending Divestiture TransactionsIn February 2023, we entered into definitive agreements with unrelated third-party buyers to divest non-core assets consisting of approximately 19,000 net acres in Glasscock County and approximately 4,900 net acres in Ward and Winkler counties for combined total consideration of $439 million, subject to certain closing adjustments. The assets being sold in these pending transactions include approximately 2 MBO/d (7 MBOE/d) of 2023 production. Both of these transactions are expected to close in the second quarter of 2023, subject to completion of diligence and satisfaction of customary closing conditions.48Table of ContentsLario AcquisitionOn January 31, 2023, we closed on the Lario Acquisition, which included approximately 25,000 gross (15,000 net) acres in the Midland Basin and certain related oil and gas assets in exchange for 4.33 million shares of our common stock and $814 million, including certain customary closing adjustments. Gray Oak Divestiture On January 9, 2023, we divested our 10% non-operating equity investment in Gray Oak for $172 million in cash proceeds and recorded a gain on the sale of equity method investments of approximately $53 million in the first quarter of 2023.2022 Acquisition ActivityOn January 18, 2022, we acquired, from an unrelated third-party seller, approximately 6,200 net acres in the Delaware Basin for $232 million in cash, including customary closing adjustments. On August 24, 2022, we completed the merger with Rattler pursuant to which we acquired all of the approximately 38.51 million publicly held outstanding common units of Rattler in exchange for approximately 4.35 million shares of our common stock.On November 30, 2022, we acquired all leasehold interests and related assets of FireBird Energy LLC, which included approximately 75,000 gross (68,000 net) acres in the Midland Basin and certain related oil and gas assets, in exchange for 5.92 million shares of our common stock and $787 million of cash, including certain customary closing adjustments.Additionally during the year ended December 31, 2022, we acquired, from unrelated third-party sellers, approximately 4,000 net acres in the Permian Basin for an aggregate purchase price of approximately $220 million in cash, including customary closing adjustments.2022 Divestiture ActivityIn October 2022, we completed the divestiture of non-core Delaware Basin acreage consisting of approximately 3,272 net acres, with net production of approximately 550 BO/d (800 BOE/d) for $155 million of net proceeds. We used the net proceeds from this transaction towards debt reduction.See Note 4—Acquisitions and Divestitures and Note 16—Subsequent Events of the notes to the consolidated financial statements included elsewhere in this Annual Report for additional discussion of these transactions.Commodity Prices and Certain Other Market ConsiderationsPrices for oil, natural gas and natural gas liquids are determined primarily by prevailing market conditions. Regional and worldwide economic activity, including any economic downturn or recession that has occurred or may occur in the future, extreme weather conditions and other substantially variable factors, influence market conditions for these products. These factors are beyond our control and are difficult to predict. During 2022, 2021 and 2020 the NYMEX WTI price for crude oil ranged from $(37.63) to $123.70 per Bbl, and the NYMEX Henry Hub price of natural gas ranged from $1.48 to $9.68 per MMBtu, with seven-year highs reached in 2022. The war in Ukraine, the COVID-19 pandemic, rising interest rates, global supply chain disruptions, concerns about a potential economic downturn or recession and recent measures to combat persistent inflation contributed to economic and pricing volatility during 2022 and may continue to impact prices in 2023. Although the impact of inflation on our business has been insignificant in prior periods, inflation in the U.S. has been rising at its fastest rate in over 40 years, creating inflationary pressure on the cost of services, equipment and other goods in the energy industry and other sectors, which is contributing to labor and materials shortages across the supply-chain. Additionally, OPEC and its non-OPEC allies, known collectively as OPEC+, continues to meet regularly to evaluate the state of global oil supply, demand and inventory levels. However, pricing may remain volatile during of 2023.OutlookAfter giving effect for the recently completed the FireBird and Lario acquisitions, we expect to hold our pro forma oil production levels essentially flat in 2023. During 2022, we had total capital expenditures of $1.9 billion, which was consistent with our guidance presented in November of 2022. During the second quarter of 2022, we announced an increase to our quarterly return of capital commitment to at least 75% of our free cash flow beginning in the third quarter of 2022. 49Table of ContentsAccordingly, we are utilizing our free cash flow to meet our quarterly return of capital commitment and for debt repayment rather than expanding our drilling program. During 2022, we continued to pay down debt and believe we have a strong balance sheet that can withstand another down cycle. We are focused on maintaining high cash margins and a low-cost structure to drive an increasing return on capital and operational excellence, and to mitigate inflationary pressures through improvements and efficiencies in our drilling and completion programs. Going forward, we intend to continue to remain flexible and use a combination of our growing and sustainable base dividend, variable dividend and opportunistic share repurchase program to generate the highest value proposition for our stockholders. In the Midland Basin, we continued to have positive results across our core development areas located within Midland, Martin, Howard, Glasscock and Andrews counties, where development has primarily focused on drilling long-lateral, multi-well pads targeting the Spraberry and Wolfcamp formations.In the Delaware Basin, we continued to target the Wolfcamp and Bone Spring formations across our primary development areas located in Pecos, Reeves and Ward counties. Collectively, the Delaware Basin accounted for approximately 15% of our total development in 2022, and we expect a similar portion of our total development to be focused in these areas in 2023. As of December 31, 2022, we were operating 19 drilling rigs and four completion crews and currently intend to operate between 13 and 19 drilling rigs and between four and seven completion crews in 2023 on average across our current acreage position in the Midland and Delaware Basins.Additionally, in the first quarter of 2023, we announced a target to sell at least $1.0 billion of non-core assets by year-end 2023, up from the previously announced target of $500 million. Environmental Responsibility Initiatives and HighlightsIn September 2022, we announced our medium-term goal to reduce Scope 1 and Scope 2 GHG intensity reduction by at least 50% from our 2020 level by 2030 and a short-term goal to implement continuous emission monitoring systems (“CEMS”) on our facilities to cover at least 90% of operated oil production by the end of 2023. As of December 31, 2022, we had installed CEMS that cover approximately 85% of our operated oil production.In September 2021, we announced our near-term goal to end routine flaring (as defined by the World Bank) by 2025 and a near-term target to source over 65% of our water used for drilling and completion operations from recycled sources by 2025. For the full year ended 2022, we flared approximately 2.3% of our gross natural gas production and sourced approximately 41% of our water used for drilling and completion operations from recycled sources.In February 2021, we announced significant enhancements to our commitment to environmental, social responsibility and governance, or ESG, performance and disclosure, including Scope 1 and methane emission intensity reduction targets. Our goals include the reduction of our Scope 1 greenhouse gas intensity by at least 50% and methane intensity by at least 70%, in each case by 2024 from the 2019 levels. To further underscore our commitment to carbon neutrality, we have also implemented our “Net Zero Now” initiative under which, effective January 1, 2021, we strive to produce every hydrocarbon molecule with zero net Scope 1 emissions. To the extent our greenhouse gas and methane intensity targets do not eliminate our carbon footprint, we have purchased carbon credits to offset the remaining emissions. We have also increased the weighting of ESG metrics from 20% to 25% in our annual short-term incentive compensation plan to motivate our executives and our employees to advance our environmental responsibility goals.2023 Capital BudgetWe have currently budgeted 2023 total capital spend of $2.50 billion to $2.70 billion. Should commodity prices weaken, we intend to act responsibly and, consistent with our prior practices, reduce capital spending. If commodity prices strengthen, we intend to maintain flat oil production, pay down indebtedness and return cash to our stockholders. 50Table of ContentsResults of Operations The following discussion focuses primarily on a comparison of the results of operations between the years ended December 31, 2022 and 2021. For a discussion of the results of operations for the year ended December 31, 2021 as compared to the year ended December 31, 2020, please refer to “Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2021 (filed with the SEC on February 24, 2022), which is incorporated in this report by reference from such prior report on Form 10-K. The following table sets forth selected historical operating data for the periods indicated:Year Ended December 31,20222021Revenues (in millions):Oil sales$7,660 $5,396 Natural gas sales858 569 Natural gas liquid sales1,048 782 Total oil, natural gas and natural gas liquid revenues$9,566 $6,747 Production Data:Oil (MBbls)81,616 81,522 Natural gas (MMcf)176,376 169,406 Natural gas liquids (MBbls)29,880 27,246 Combined volumes (MBOE)(1)140,892 137,002 Daily oil volumes (BO/d)223,605 223,348 Daily combined volumes (BOE/d)(1)386,005 375,349 Average Prices:Oil ($ per Bbl)$93.85 $66.19 Natural gas ($ per Mcf)$4.86 $3.36 Natural gas liquids ($ per Bbl)$35.07 $28.70 Combined ($ per BOE)$67.90 $49.25 Oil, hedged ($ per Bbl)(2)$86.76 $52.56 Natural gas, hedged ($ per Mcf)(2)$4.12 $2.39 Natural gas liquids, hedged ($ per Bbl)(2)$35.07 $28.33 Average price, hedged ($ per BOE)(2)$62.85 $39.87 (1)Bbl equivalents are calculated using a conversion rate of six Mcf per Bbl.(2)Hedged prices reflect the effect of our commodity derivative transactions on our average sales prices and include gains and losses on cash settlements for matured commodity derivatives, which we do not designate for hedge accounting. Hedged prices exclude gains or losses resulting from the early settlement of commodity derivative contracts.51Table of ContentsProduction DataSubstantially all of our revenues are generated through the sale of oil, natural gas and natural gas liquids production. The following table provides information on the mix of our production for the years ended December 31, 2022 and 2021:Year Ended December 31,20222021Oil (MBbls)58 %60 %Natural gas (MMcf)21 %20 %Natural gas liquids (MBbls)21 %20 %100 %100 %See “Items 1 and 2. Business and Properties— Oil and Natural Gas Production Prices and Production Costs” for further discussion of production by basin.Comparison of the Years Ended December 31, 2022 and 2021 Oil, Natural Gas and Natural Gas Liquids Revenues. Our revenues are a function of oil, natural gas and natural gas liquids production volumes sold and average sales prices received for those volumes. Our oil, natural gas and natural gas liquids revenues increased by approximately $2.8 billion, or 42%, to $9.6 billion for the year ended December 31, 2022 from $6.7 billion for the year ended December 31, 2021. Higher average oil prices, and to a lesser extent natural gas and natural gas liquids prices, contributed $2.7 billion of the total increase. The remainder of the overall change is due to a 3% increase in combined volumes sold.Higher commodity prices during 2022 compared to 2021 primarily reflect the increase in demand for oil due to economic recovery from the COVID-19 pandemic and other macroeconomic factors such as the war in Ukraine as discussed in “—Commodity Prices and Certain Other Market Considerations” above. The increase in production for the year ended December 31, 2022 compared to the same period in 2021 resulted primarily from recognizing a full year of production in the current period associated with production from the Guidon Acquisition and the QEP Merger, which occurred late in the first quarter 2021, and new well additions between periods.Lease Operating Expenses. The following table shows lease operating expenses for the years ended December 31, 2022 and 2021:Year Ended December 31,20222021(In millions, except per BOE amounts)AmountPer BOEAmountPer BOELease operating expenses$652 $4.63 $565 $4.12 Lease operating expenses for the year ended December 31, 2022 as compared to the year ended December 31, 2021 increased by $87 million, or $0.51 per BOE, primarily due to an overall increase in utility and service costs driven by continued inflation. As a result of inflationary pressures, we expect our total lease operating expenses in 2023 to range from approximately $785 million to $883 million.Production and Ad Valorem Tax Expense. The following table shows production and ad valorem tax expense for the years ended December 31, 2022 and 2021:Year Ended December 31,20222021(In millions, except per BOE amounts)AmountPer BOEAmountPer BOEProduction taxes$483 $3.43 $349 $2.55 Ad valorem taxes128 0.91 76 0.55 Total production and ad valorem expense$611 $4.34 $425 $3.10 Production taxes as a % of oil, natural gas, and natural gas liquids revenue5.0 %5.2 %52Table of ContentsIn general, production taxes are directly related to production revenues and are based upon current year commodity prices. Production taxes as a percentage of production revenues remained consistent for the year ended December 31, 2022 compared to the same period in 2021.Ad valorem taxes are based, among other factors, on property values driven by prior year commodity prices. Ad valorem taxes for the year ended December 31, 2022 compared to the year ended December 31, 2021 increased by $52 million primarily due to higher overall valuations resulting from an increase in commodity prices between valuation periods.We expect production and ad valorem taxes to be approximately 7% to 8% of oil, natural gas and natural gas liquids revenue during 2023.Gathering and Transportation Expense. The following table shows gathering and transportation expense for the years ended December 31, 2022 and 2021:Year Ended December 31,20222021(In millions, except per BOE amounts)AmountPer BOEAmountPer BOEGathering and transportation$258 $1.83 $212 $1.55 The increase in gathering and transportation expenses for the year ended December 31, 2022 compared to the same period in 2021 is primarily due to the increase in production between periods as well as an overall increase in the cost per BOE. The increase in cost is largely attributable to higher third-party gas gathering expenses of approximately $30 million related to gathering fees incurred after we divested certain gas gathering assets during the fourth quarter of 2021, and minimum volume commitment fees of approximately $8 million. The remaining increase primarily related to rate escalations on our gathering and transportation contracts.We expect gathering and transportation expenses to range from approximately $283 million to $321 million in 2023.Depreciation, Depletion, Amortization and Accretion. The following table provides the components of our depreciation, depletion and amortization expense for the years ended December 31, 2022 and 2021:Year Ended December 31,(In millions, except BOE amounts)20222021Depletion of proved oil and natural gas properties$1,250 $1,202 Depreciation of other property and equipment77 48 Other amortization3 16 Asset retirement obligation accretion14 9 Depreciation, depletion, amortization and accretion expense$1,344 $1,275 Oil and natural gas properties depletion rate per BOE$8.87 $8.77 The increase in depletion of proved oil and natural gas properties of $48 million for the year ended December 31, 2022 as compared to the year ended December 31, 2021 resulted largely from higher production volumes and a slight increase in the average depletion rate. Impairment of Oil and Natural Gas Properties. No impairment expense was recorded for the year ended December 31, 2022. In connection with the QEP Merger and the Guidon Acquisition, we recorded the oil and natural gas properties acquired at fair value. Pursuant to SEC guidance, we determined the fair value of the properties acquired in the QEP Merger and the Guidon Acquisition clearly exceeded the related full cost ceiling limitation beyond a reasonable doubt. As such, we requested and received a waiver from the SEC to exclude the acquired properties from the first quarter 2021 ceiling test calculation. As a result, no impairment expense related to the QEP Merger and the Guidon Acquisition was recorded for the three months ended March 31, 2021. Had we not received the waiver from the SEC, an impairment charge of approximately $1.1 billion would have been recorded in the first quarter of 2021. The properties acquired in the QEP Merger and the Guidon Acquisition had total unamortized costs at March 31, 2021 of $3.0 billion and $1.1 billion, respectively.Impairment charges affect our results of operations but do not reduce our cash flow. See Note 5—Property and Equipment of the notes to the consolidated financial statements included elsewhere in this Annual Report and “— Critical Accounting Estimates” for further details regarding factors that impact the impairment of oil and natural gas properties.53Table of ContentsGeneral and Administrative Expenses. The following table shows general and administrative expenses for the years ended December 31, 2022 and 2021:Year Ended December 31,20222021(In millions, except per BOE amounts)AmountPer BOEAmountPer BOEGeneral and administrative expenses$89 $0.63 $95 $0.69 Non-cash stock-based compensation55 0.39 51 0.37 Total general and administrative expenses$144 $1.02 $146 $1.06 Total general and administrative expenses for the year ended December 31, 2022 were consistent with the same period in 2021 and there were no significant individual contributing factors to the change between periods.We expect cash general and administrative expenses to range from approximately $102 million to $128 million in 2023, and non-cash stock-based compensation to range from approximately $63 million to $80 million in 2023.Merger and Integration Expense. The following table shows merger and integration expense for the years ended December 31, 2022 and 2021:Year Ended December 31,20222021(In millions)AmountPer BOEAmountPer BOEMerger and integration expenses$14 $0.10 $78 $0.57 Total merger and integration expense for the year ended December 31, 2022 relates to banking, legal and advisory fees of $11 million for the Rattler Merger, $2 million for the FireBird Acquisition, and $1 million for the Lario Acquisition. Merger and integration expense for the year ended December 31, 2021 includes $69 million in costs incurred for the QEP Merger and $9 million in costs incurred for the Guidon Acquisition. The QEP Merger related expenses primarily consist of $39 million in severance costs and $30 million in banking, legal and advisory fees, and the Guidon Acquisition related expenses consist primarily of advisory and legal fees. See Note 4—Acquisitions and Divestitures of the notes to the consolidated financial statements included elsewhere in this Annual Report for further details regarding the QEP Merger and the Guidon Acquisition.Derivative Instruments. The following table shows the net gain (loss) on derivative instruments and the net cash received (paid) on settlements of derivative instruments for the years ended December 31, 2022 and 2021:Year Ended December 31,(In millions)20222021Gain (loss) on derivative instruments, net(1)$(586)$(848)Net cash received (paid) on settlements(2)(3)$(850)$(1,225)(1)The year ended December 31, 2022 includes $57 million in losses related to interest rate swaps.(2)The year ended December 31, 2022 includes cash paid on commodity contracts terminated prior to their contractual maturity of $138 million. (3)The year ended December 31, 2021 includes cash paid on commodity contracts terminated prior to their contractual maturity of $16 million and cash received on interest rate swap contracts terminated prior to their contractual maturity of $80 million.At December 31, 2022, we have a short-term derivative asset of $132 million, a long-term derivative asset of $23 million, a short-term derivative liability due in 2023 of $47 million and a long-term derivative liability due in 2024 of $148 million.See Note 12—Derivatives of the notes to the consolidated financial statements included elsewhere in this Annual report for further details regarding our derivative instruments and interest rate swaps.54Table of ContentsOther Income (Expense). The following table shows other income and expenses for the year ended December 31, 2022 and 2021:Year Ended December 31,(In millions)20222021Interest expense, net$(159)$(199)Other income (expense), net$(5)$(10)Gain (loss) on sale of equity method investments$— $23 Gain (loss) on extinguishment of debt$(99)$(75)Income (loss) from equity investments$77 $15 The decrease in net interest expense for the year ended December 31, 2022 compared to the same period in 2021, primarily reflects a $36 million increase in capitalized interest costs, which reduce interest expense, and a $26 million decrease in interest expense on our senior notes due largely to redemptions and repurchases of principal between the periods. These reductions were partially offset by an $18 million increase in interest expense on our revolving credit facility. We expect interest expense to range from approximately $204 million to $225 million in 2023.Gain (loss) on extinguishment of debt reflects the difference between the carrying value and reacquisition price for the repurchases and redemptions of various senior notes during the 2022 and 2021 periods. See Note 8—Debt of the notes to the consolidated financial statements included elsewhere in this Annual report for further details outstanding borrowings, interest expense and gain (loss) on extinguishment of debt.The increase in income from our equity investments primarily reflects higher capacity utilization and price realizations for our midstream investees in 2022 compared to 2021, as well as increase of $38 million in income from our investment in an interconnected gas gathering system in the Midland Basin, which was acquired in the fourth quarter of 2021. Provision for (Benefit from) Income Taxes. The following table shows the provision for (benefit from) income taxes for the years ended December 31, 2022 and 2021:Year Ended December 31,(In millions)20222021Provision for (benefit from) income taxes$1,174 $631 The change in our income tax provision for the year ended December 31, 2022 compared to the same period in 2021 was primarily due to the increase in pre-tax income which resulted largely from the changes in revenues from oil, natural gas and natural gas liquids. See Note 11—Income Taxes of the notes to the consolidated financial statements included elsewhere in this Annual Report for further discussion of our income tax expense. Liquidity and Capital ResourcesOverview of Sources and Uses of CashHistorically, our primary sources of liquidity include cash flows from operations, proceeds from our public equity offerings, borrowings under our revolving credit facility, proceeds from the issuance of senior notes and sales of non-core assets. Our primary uses of capital have been for the acquisition, development and exploration of oil and natural gas properties, payments to retire debt and interest expense on debt, dividends and share repurchases, and income taxes, At December 31, 2022, we had approximately $1.8 billion of liquidity consisting of $157.0 million in cash and cash equivalents and $1.6 billion available under our credit facility. As discussed below, our capital budget for 2023 is $2.50 billion to $2.70 billion. Future cash flows are subject to a number of variables, including the level of oil and natural gas production, volatility of commodity prices, and significant additional capital expenditures will be required to more fully develop our properties. Prices for our commodities are determined primarily by prevailing market conditions, regional and worldwide economic activity, weather and other substantially variable factors. These factors are beyond our control and are difficult to predict. See Item 1A. “Risk Factors” above. In order to mitigate this volatility, we enter into derivative contracts with a number of financial institutions, all of which are participants in our credit facility, to economically hedge a portion of our 55Table of Contentsestimated future crude oil and natural gas production through the end of 2023 as discussed further in Note 12—Derivatives of the notes to the consolidated financial statements included elsewhere in this Annual Report and Item 7A. Quantitative and Qualitative Disclosures About Market Risk—Commodity Price Risk. The level of our hedging activity and duration of the financial instruments employed depend on our desired cash flow protection, available hedge prices, the magnitude of our capital program and our operating strategy.Cash Flow Our cash flows for the years ended December 31, 2022 and 2021 are presented below: Year Ended December 31,20222021(In millions)Net cash provided by (used in) operating activities$6,325 $3,944 Net cash provided by (used in) investing activities(3,330)(1,539)Net cash provided by (used in) financing activities(3,503)(1,841)Net change in cash$(508)$564 Operating Activities The increase in operating cash flows for the year ended December 31, 2022 compared to the same period in 2021 primarily resulted from (i) an increase of $2.8 billion in our total revenue, (ii) a decrease of $397 million in net cash paid on settlements of derivative contracts, and (iii) fluctuations in other working capital balances due primarily to the timing of when collections are made on accounts receivable and payments are made on accounts payable and accrued liabilities. These net cash inflows were partially offset by (i) a change of $856 million in cash paid for taxes due to making payments of $718 million in 2022 compared to receiving net refunds of $138 million in federal taxes under the 2020 CARES act in 2021, and (ii) an increase in our cash operating expenses of approximately $266 million. See “—Results of Operations” for discussion of significant changes in our revenues and expenses.Investing Activities Net cash used in investing activities was $3.3 billion compared to $1.5 billion for the years ended December 31, 2022 and 2021, respectively. The majority of our net cash used for investing activities during the year ended December 31, 2022 was for the purchase and development of oil and natural gas properties and related assets, including the FireBird Acquisition. These expenditures were partially offset by proceeds from the sale of certain non-core Delaware Basin assets and other assets discussed in Note 4—Acquisitions and Divestitures.The majority of our net cash used in investing activities during the year ended December 31, 2021 was for the purchase and development of oil and natural gas properties and related assets, including the acquisition of certain leasehold interests as part of the Guidon Acquisition. These expenditures were partially offset by proceeds from the divestiture of our Williston Basin assets, leasehold acreage and other gathering assets discussed in Note 4—Acquisitions and Divestitures. Our capital expenditures for each period are discussed further below.Capital Expenditure ActivitiesOur capital expenditures excluding acquisitions and equity method investments (on a cash basis) were as follows for the specified period:Year Ended December 31,20222021(In millions)Drilling, completions and non-operated additions to oil and natural gas properties$1,685 $1,334 Infrastructure additions to oil and natural gas properties169 123 Additions to midstream assets84 30 Total$1,938 $1,487 For further discussion regarding our development program, please see the section entitled “Item 1 and 2. Business and Properties—Wells Drilled and Completed in 2022.”56Table of ContentsFinancing Activities Net cash used in financing activities for the year ended December 31, 2022 was $3.5 billion compared to net cash used in financing activities for the year ended December 31, 2021 of $1.8 billion. During the year ended December 31, 2022, the amount used in financing activities was primarily attributable to (i) $2.4 billion paid for the retirement of outstanding principal on certain senior notes, as well as $63 million of additional premiums paid in connection with the repurchases, (ii) $1.3 billion of repurchases as part of the share and unit repurchase programs, (iii) $1.6 billion of dividends paid to stockholders, and (iv) $217 million in distributions to non-controlling interest. The cash outflows were partially offset by (i) $2.5 billion in proceeds from our senior notes issued in 2022, and (ii) $347 million of borrowings under our and our subsidiaries’ credit facilities, net of repayments.Net cash used in financing activities for the year ended December 31, 2021 was primarily attributable to (i) $3.2 billion paid for the retirement of outstanding principal on certain senior notes, as well as $178 million of additional premiums paid in connection with the repurchases, (ii) $525 million of repurchases as part of the share and unit repurchase programs, (iii) $312 million of dividends paid to stockholders, and (iv) $112 million in distributions to non-controlling interest. The cash outflows were partially offset by (i) $2.2 billion in proceeds our senior notes issued in 2021, (ii) $313 million of borrowings under our and our subsidiaries’ credit facilities, net of repayments and (iii) $22 million in net cash receipts from the early settlement of interest rate swaps and commodity derivative contracts that contained an other-than-insignificant financing element.Capital ResourcesOur working capital requirements are supported by our cash and cash equivalents and available borrowings under our revolving credit facility. We may draw on our revolving credit facility to meet short-term cash requirements, or issue debt or equity securities as part of our longer-term liquidity and capital management program. Because of the alternatives available to us, we believe that our short-term and long-term liquidity are adequate to fund not only our current operations, but also our near-term and long-term capital requirements.As we pursue our business and financial strategy, we regularly consider which capital resources, including cash flow and equity and debt financings, are available to meet our future financial obligations, planned capital expenditure activities and liquidity requirements. Our future ability to grow proved reserves and production will be highly dependent on the capital resources available to us. Continued prolonged volatility in the capital, financial and/or credit markets due to the war in Ukraine, the COVID-19 pandemic and/or adverse macroeconomic conditions may limit our access to, or increase our cost of, capital or make capital unavailable on terms acceptable to us or at all. Revolving Credit Facilities and Senior Notes As of December 31, 2022, the maximum credit amount available under our credit agreement was $1.6 billion, which may be increased in an amount up to $1.0 billion (for a total maximum commitment amount of $2.6 billion), with no outstanding borrowings and an aggregate of $3 million in outstanding letters of credit which reduce available borrowings on a dollar for dollar basis. During the second quarter of 2022, we extended the maturity date on our credit agreement by one year to June 2, 2027, and may further extend it by two one-year extensions pursuant to the terms set forth in the credit agreement. During the year ended December 31, 2022, we issued $2.5 billion in principal amount of senior notes with extended maturity dates ranging from 2033 through 2053. See Note 8—Debt of the notes to the consolidated financial statements included elsewhere in this Annual Report for further discussion of our revolving credit facility and senior notes.Viper’s Revolving Credit FacilityViper’s credit agreement, as amended to date, matures on June 2, 2025 and provides for a revolving credit facility in the maximum credit amount of $2.0 billion, with a borrowing base of $580 million as of December 31, 2022, although Viper had an elected commitment amount of $500 million, based on Viper LLC’s oil and natural gas reserves and other factors. At December 31, 2022, there were $152 million of outstanding borrowings and $348 million available for future borrowings under Viper’s credit agreement. 57Table of ContentsCapital RequirementsIn addition to future operating expenses and working capital commitments discussed in “—Results of Operations”, our primary short and long-term liquidity requirements consist primarily of (i) capital expenditures, (ii) payments of principal and interest on our revolving credit agreements and senior notes, (ii) payments of other contractual obligations, (iii) cash commitments for dividends and share repurchases, and (iv) income taxes.2023 Capital Spending Plan Our board of directors approved a 2023 capital budget for drilling, midstream and infrastructure of $2.50 billion to $2.70 billion. We estimate that, of these expenditures, approximately:•$2.25 billion to $2.41 billion will be spent primarily on drilling 325 to 345 gross (293 to 311 net) horizontal wells and completing 330 to 350 gross (297 to 315 net) horizontal wells across our operated and non-operated leasehold acreage in the Northern Midland and Southern Delaware Basins, with an average lateral length of approximately 10,500 feet;•$80 million to $100 million will be spent on midstream infrastructure, excluding joint venture investments; and•$170 million to $190 million will be spent on infrastructure and environmental expenditures, excluding the cost of any leasehold and mineral interest acquisitions.We do not have a specific acquisition budget since the timing and size of acquisitions cannot be accurately forecasted.The amount and timing of our capital expenditures are largely discretionary and within our control. We could choose to defer a portion of these planned capital expenditures depending on a variety of factors, including but not limited to the success of our drilling activities, prevailing and anticipated prices for oil and natural gas, the availability of necessary equipment, infrastructure and capital, the receipt and timing of required regulatory permits and approvals, seasonal conditions, drilling and acquisition costs and the level of participation by other interest owners. We will continue monitoring commodity prices and overall market conditions and can adjust our rig cadence and our capital expenditure budget up or down in response to changes in commodity prices and overall market conditions.Payments of Principal and Interest on Senior NotesDuring the year ended December 31, 2022 we retired $2.4 billion in principal amount of our then-outstanding senior notes with a portion of the net proceeds from our senior notes offerings completed in March and October of 2022, cash on hand and borrowings under Viper’s revolving credit facilities, as applicable, as discussed further in Note 8—Debt of the notes to the consolidated financial statements included elsewhere in this Annual Report.At December 31, 2022, we have total principal payments due on our outstanding senior notes, including those of Viper, of $10 million in 2023, $1.2 billion cumulatively in the years 2026 and 2027, and $5.0 billion thereafter. Additionally, we expect to incur future cash interest costs on these senior notes of approximately $265 million in 2023, $530 million cumulatively in the years from 2024 through 2025, $504 million cumulatively in the years from 2026 and 2027, and $2.9 billion cumulatively between 2028 and 2053.Other Contractual Obligations and CommitmentsAt December 31, 2022, our other significant contractual obligations consist primarily of (i) minimum transportation commitments totaling $856 million, (ii) asset retirement obligations totaling $347 million, (iii) electronic fracturing fleet and related power generation services commitments totaling $140 million and (iv) minimum purchase commitments for quantities of sand used in our drilling operations totaling $91 million. We expect to make aggregate payments of approximately $166 million for these commitments during 2023. See Note 6—Asset Retirement Obligations and Note 15—Commitments and Contingencies of the notes to the consolidated financial statements included elsewhere in this Annual Report for further discussion of these and other contractual obligations and commitments.Dividends and Share RepurchasesIn addition to our base dividend program, in the first quarter of 2022 we initiated a variable dividend strategy whereby we may pay a quarterly variable dividend based on the prior quarter’s free cash flow remaining after the payment of the base dividend. Beginning in the third quarter of 2022, our board of directors approved an increase to this return of capital commitment to at least 75% of free cash flow. On February 16, 2023, our board of directors approved an increase to the 58Table of ContentsCompany’s annual base dividend to $3.20 per share. We have declared a base plus variable cash dividend for the fourth quarter of 2022 of $2.95 per share of common stock.Free cash flow is a non-GAAP financial measure. As used by us, free cash flow is defined as cash flow from operating activities before changes in working capital in excess of cash capital expenditures. We believe that free cash flow is useful to investors as it provides a measure to compare both cash flow from operating activities and additions to oil and natural gas properties across periods on a consistent basis.Future base and variable dividends are at the discretion of our board of directors, and the board of directors may change the dividend amount from time to time based on our outlook for commodity prices, liquidity, debt levels, capital resources, free cash flow and other factors. We can provide no assurance that dividends will be authorized or declared in the future or as to the amount and type of any future dividends. Any future variable dividends, whether base or variable, if declared and paid, will by their nature fluctuate based on our free cash flow, which will depend on a number of factors beyond the our control, including commodity prices.As of February 17, 2023, we have repurchased 13.2 million shares of our common stock for a total cost of $1.6 billion since the inception of the repurchase program. We intend to continue to opportunistically purchase shares under this repurchase program with available funds primarily from cash flow from operations and liquidity events such as the sale of assets while maintaining sufficient liquidity to fund our capital expenditure programs. See Note 9—Stockholders' Equity and Earnings Per Share of the notes to the consolidated financial statements included elsewhere in this report for further discussion of the repurchase program. Income TaxesWe expect our cash tax rate to be 10% to 15% of pre-tax income for the year ended December 31, 2023. See Note 11—Income Taxes of the notes to the consolidated financial statements included elsewhere in this Annual report for further discussion of our income taxes.Debt RatingsWe receive debt ratings from the major ratings agencies in the U.S. In determining our debt ratings, the agencies consider a number of qualitative and quantitative items including, but not limited to, commodity pricing levels, our liquidity, asset quality, reserve mix, debt levels, cost structure, planned asset sales and production growth opportunities. Our credit ratings from the three main credit rating agencies are as follows:•Standard and Poor’s Global Ratings Services (BBB-);•Fitch Investor Services (BBB); and•Moody’s Investor Services (Baa2). Any rating downgrades may result in additional letters of credit or cash collateral being posted under certain contractual arrangements.Guarantor Financial InformationDiamondback E&P is the sole guarantor under the indentures governing the outstanding Guaranteed Senior Notes. Guarantees are “full and unconditional,” as that term is used in Regulation S-X, Rule 3-10(b)(3), except that such guarantees will be released or terminated in certain circumstances set forth in the indentures governing the Guaranteed Senior Notes, such as, with certain exceptions, (i) in the event Diamondback E&P (or all or substantially all of its assets) is sold or disposed of, (ii) in the event Diamondback E&P ceases to be a guarantor of or otherwise be an obligor under certain other indebtedness, and (iii) in connection with any covenant defeasance, legal defeasance or satisfaction and discharge of the relevant indenture. Diamondback E&P’s guarantees of the Guaranteed Senior Notes are senior unsecured obligations and rank senior in right of payment to any of its future subordinated indebtedness, equal in right of payment with all of its existing and future senior indebtedness, including its obligations under its revolving credit facility, and effectively subordinated to any of its existing and future secured indebtedness, to the extent of the value of the collateral securing such indebtedness.59Table of ContentsThe rights of holders of the Guaranteed Senior Notes against Diamondback E&P may be limited under the U.S. Bankruptcy Code or state fraudulent transfer or conveyance law. Each guarantee contains a provision intended to limit Diamondback E&P’s liability to the maximum amount that it could incur without causing the incurrence of obligations under its guarantee to be a fraudulent conveyance. However, there can be no assurance as to what standard a court will apply in making a determination of the maximum liability of Diamondback E&P. Moreover, this provision may not be effective to protect the guarantee from being voided under fraudulent conveyance laws. There is a possibility that the entire guarantee may be set aside, in which case the entire liability may be extinguished.The following tables present summarized financial information for Diamondback Energy, Inc., as the parent, and Diamondback E&P, as the guarantor subsidiary, on a combined basis after elimination of (i) intercompany transactions and balances between the parent and the guarantor subsidiary and (ii) equity in earnings from and investments in any subsidiary that is a non-guarantor. The information is presented in accordance with the requirements of Rule 13-01 under the SEC’s Regulation S-X. The financial information may not necessarily be indicative of results of operations or financial position had the guarantor subsidiary operated as an independent entity.December 31, 2022Summarized Balance Sheets:(In millions)Assets:Current assets$1,191 Property and equipment, net$18,252 Other noncurrent assets$164 Liabilities:Current liabilities$1,547 Intercompany accounts payable, non-guarantor subsidiary$2,253 Long-term debt$5,647 Other noncurrent liabilities$2,509 Year Ended December 31, 2022Summarized Statement of Operations:(In millions)Revenues$7,630 Income (loss) from operations$5,023 Net income (loss)$3,095 Critical Accounting EstimatesThe discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Certain amounts included in or affecting our consolidated financial statements and related disclosures must be estimated by our management, requiring certain assumptions to be made with respect to values or conditions that cannot be known with certainty at the time the consolidated financial statements are prepared. These estimates and assumptions affect the amounts we report for assets and liabilities and our disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions on a regular basis. Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the registrant. Any effects on our business, financial position or results of operations resulting from revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known. We consider the following to be our most critical accounting estimates and have reviewed these critical accounting estimates with the Audit Committee of our board of directors.60Table of ContentsOil and Natural Gas Accounting and ReservesWe account for our oil and natural gas producing activities using the full cost method of accounting, which is dependent on the estimation of proved reserves to determine the rate at which we record depletion on our oil and natural gas properties and whether the value of our evaluated oil and natural gas properties is permanently impaired based on the quarterly full cost ceiling impairment test. Further, we utilize estimated proved reserves to assign fair value to acquired proved oil and natural gas properties including mineral and royalty interests. As such, we consider the estimation of proved reserves to be a critical accounting estimate. Oil and natural gas reserve engineering is a subjective process of estimating underground accumulations of oil and natural gas that cannot be precisely measured and the accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Proved oil and natural gas reserve estimates and their associated future net cash flows were prepared by our internal reservoir engineers and audited by Ryder Scott Company, L.P., independent petroleum engineers, as of December 31, 2022 and prepared by Ryder Scott as of December 31, 2021 and 2020. The process of estimating oil and natural gas reserves is complex, requiring significant decisions in the evaluation of available geological, geophysical, engineering and economic data. Significant inputs included in the calculation of future net cash flows include our estimate of operating and development costs, anticipated production of proved reserves and other relevant data. The data for a given property may also change substantially over time as a result of numerous factors, including additional development activity, evolving production history and a continual reassessment of the viability of production under changing economic conditions. As a result, material revisions to existing reserve estimates occur from time to time, and reserve estimates are often different from the quantities of oil and natural gas that are ultimately recovered. Although every reasonable effort is made to ensure that reported reserve estimates represent the most accurate assessments possible, the subjective decisions and variances in available data for various properties increase the likelihood of significant changes in these estimates. If such changes are material, they could significantly affect future depletion of capitalized costs and result in impairment of assets that may be material. Revisions of previous reserve estimates accounted for approximately $102 million, or 1% of the change in the standardized measure of our total reserves from December 31, 2021 to December 31, 2022. No impairments were recorded for our proved oil and gas properties during the years ended December 31, 2022 and 2021; however, a material impairment was recorded during the year ended December 31, 2020 as discussed further in Note 5—Property and Equipment of the notes to the consolidated financial statements included elsewhere in this Annual Report. Due to an increase in the historical 12-month average trailing SEC prices for oil and natural throughout 2021 and into 2022, we are not currently projecting a full cost ceiling impairment in the first quarter of 2023. Additionally, costs associated with unevaluated properties are excluded from the full cost pool until we have made a determination as to the existence of proved reserves. We assess all items classified as unevaluated property (on an individual basis or as a group if properties are individually insignificant) at least annually for possible impairment. This assessment is subjective and includes consideration of the following factors, among others: intent of the operator to drill, remaining lease term with the current operator; geological and geophysical evaluations; drilling results and activity; the assignment of proved reserves; and the economic viability of development if proved reserves are assigned. At December 31, 2022, our unevaluated properties totaled $8.4 billion, which consisted of 236,253 net undeveloped leasehold acres with approximately 465 net acres set to expire in 2023. We did not record any impairment on our unevaluated properties during the year ended December 31, 2022, but any such future impairment could potentially be material to our consolidated financial statements.Commodity DerivativesFrom time to time, we use commodity derivatives for the purpose of mitigating the risk resulting from fluctuations in the market price of crude oil and natural gas. We exercise significant judgment in determining the types of instruments to be used, the level of production volumes to include in our commodity derivative contracts, the prices at which we enter into commodity derivative contracts and the counterparties’ creditworthiness. We do not use these instruments for speculative or trading purposes.We have not designated our derivative instruments as hedges for accounting purposes and, as a result, mark our derivative instruments to fair value and recognize the cash and non-cash change in fair value on derivative instruments for each period in the consolidated statements of operations. We are also required to recognize our derivative instruments on the consolidated balance sheets as assets or liabilities at fair value with such amounts classified as current or long-term based on their anticipated settlement dates. The accounting for the changes in fair value of a derivative depends on the intended use of the derivative and resulting designation, and is generally determined using various inputs and assumptions including established index prices and other sources which are based upon, among other things, futures prices, time to maturity, implied volatilities and counterparty credit risk.61Table of ContentsThese fair values are recorded by netting asset and liability positions, including any deferred premiums, that are with the same counterparty and are subject to contractual terms which provide for net settlement. Changes in the fair values of our commodity derivative instruments have a significant impact on our net income because we follow mark-to-market accounting and recognize all gains and losses on such instruments in earnings in the period in which they occur.See Item 7A. Quantitative and Qualitative Disclosures About Market Risk—Commodity Price Risk for additional sensitivity analysis of our open derivative positions at December 31, 2022.Business CombinationsWe account for business combinations using the acquisition method of accounting. Accordingly, identifiable assets acquired and liabilities assumed are recognized at the date of acquisition at their respective estimated fair values.We make various assumptions in estimating the fair values of assets acquired and liabilities assumed. Fair value estimates are determined based on information that existed at the time of the acquisition, utilizing expectations and assumptions that would be available to and made by a market participant. When market-observable prices are not available to value assets and liabilities, the Company may use the cost, income, or market valuation approaches depending on the quality of information available to support management’s assumptions.The most significant assumptions relate to the estimated fair values assigned to our proved and unproved oil and natural gas properties. The assumptions made in performing these valuations include future production volumes, future commodity prices and costs, future operating and development activities, projections of oil and gas reserves and a weighted average cost of capital rate. The market-based weighted average cost of capital rate is subjected to additional project-specific risking factors. In addition, when appropriate, we review comparable purchases and sales of natural gas and oil properties within the same regions, and use that data as a proxy for fair market value; for example, the amount a willing buyer and seller would enter into in exchange for such properties. Changes in key assumptions may cause the acquisition accounting to be revised, including the recognition of additional goodwill or discount on acquisition. There is no assurance the underlying assumptions or estimates associated with the valuation will occur as initially expected. See Note 4—Acquisitions and Divestitures of the notes to the consolidated financial statements included elsewhere in this Annual Report for further discussion of the estimated fair value of assets acquired and liabilities assumed in the QEP Merger, Guidon Acquisition and FireBird Acquisition, including any significant changes in these estimates from the date of acquisition.Estimated fair values assigned to assets acquired can have a significant effect on results of operations in the future. In addition, differences between the future commodity prices when acquiring assets and the historical 12-month average trailing price to calculate ceiling test impairments of upstream assets may impact net earnings.Income TaxesThe amount of income taxes we record requires interpretations of complex rules and regulations of federal, state, and provincial tax jurisdictions. We use the asset and liability method of accounting for income taxes, under which deferred tax assets and liabilities are recognized for the future tax consequences of (1) temporary differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities and (2) operating loss and tax credit carryforwards. Deferred income tax assets and liabilities are based on enacted tax rates applicable to the future period when those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period the rate change is enacted. A valuation allowance is provided for deferred tax assets when it is more likely than not the deferred tax assets will not be realized after considering all positive and negative evidence available concerning the realizability of our deferred tax assets. Positive evidence may include forecasts of future taxable income, assessment of future business assumptions and any applicable tax planning strategies available to the Company. Negative evidence may include losses in recent years, if any, or the projection of losses in future periods. Estimating future taxable income requires numerous judgments and assumptions, including projections of future operating conditions which may be impacted by volatile future prices for our oil, natural gas and natural gas production, the expected timing and quantity of future production volumes, and the impact of our commodity derivative instruments on our income.In 2022, management’s assessment of all available evidence, both positive and negative, supporting realizability of Viper’s deferred tax assets as required by applicable accounting standards, resulted in recognition of an income tax benefit of $50 million for the portion of Viper’s deferred tax assets considered more likely than not to be realized. The positive evidence assessed included recent cumulative income due in part to higher commodity prices and an expectation of future taxable income based upon recent actual and forecasted production volumes and prices. Viper retained a partial valuation allowance on its deferred tax assets due in part to potential future volatility in commodity prices impacting the likelihood of future realizability. As of December 31, 2022, Viper had a deferred tax asset of $148 million offset by an allowance of $98 62Table of Contentsmillion. The valuation allowance remains in place based on the uncertainty of future events, including Viper’s ability to generate future taxable income in excess of special allocations to be made to Diamondback, and management considered this and other factors in evaluating the realizability of Viper’s deferred tax assets. Any changes in the positive or negative evidence evaluated when determining if Viper’s deferred tax assets will be realized, including projected future income, could result in a material change to our consolidated financial statements. In addition, the determination to record a valuation allowance on certain tax attributes acquired from QEP and certain state NOL carryforwards which the Company does not believe are realizable prior to expiration was based on an evaluation of available positive and negative evidence, including the annual limitation imposed by IRC Section 382 subsequent to an ownership change and the anticipated timing of reversal of the Company’s deferred tax liabilities in the applicable jurisdictions. As of December 31, 2022, our balance of taxable temporary differences anticipated to reverse within the carryforward period provides significant positive evidence for the determination that our remaining deferred tax assets are more likely than not to be realized. Any change in the positive or negative evidence evaluated when determining if our deferred tax assets will be realized, including projected future taxable income primarily related to the excess of book carrying value over tax basis of our oil and natural gas properties, could result in a material change to our consolidated financial statements.The accruals for deferred tax assets and liabilities are often based on uncertain tax positions and assumptions that are subject to a significant amount of judgment by management. These assumptions and judgments are reviewed and adjusted as facts and circumstances change. At December 31, 2022, our uncertain tax positions were insignificant, however, material changes to our income tax accruals may occur in the future based on the progress of ongoing audits, changes in legislation or resolution of pending matters.Recent Accounting PronouncementsSee Note 2—Summary of Significant Accounting Policies of the notes to the consolidated financial statements included elsewhere in this Annual Report for recent accounting pronouncements not yet adopted, if any. Off-Balance Sheet ArrangementsSee Note 15—Commitments and Contingencies of the notes to the consolidated financial statements included elsewhere in this Annual Report for a discussion of our significant commitments and contingencies, some of which are not recognized in the consolidated balance sheets under GAAP.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKCommodity Price Risk Our major market risk exposure in our exploration and production business is in the pricing applicable to our oil and natural gas production. Realized pricing is primarily driven by the prevailing worldwide price for crude oil and spot market prices applicable to our natural gas production. Pricing for oil and natural gas production has been volatile and unpredictable for several years. Although demand and market prices for oil and natural gas have recently increased, we cannot predict events, including the outcome of the war in Ukraine, rising interest rates, global supply chain disruptions, a potential economic downturn or recession, the COVID-19 pandemic, that may lead to future price volatility and the near term energy outlook remains subject to heightened levels of uncertainty. Further, the prices we receive for production depend on many other factors outside of our control.We use derivatives, including swaps, basis swaps, swaptions, roll hedges, costless collars, puts and basis puts, to reduce price volatility associated with certain of our oil and natural gas sales. At December 31, 2022, we had a net asset commodity derivative position of $153 million related to our commodity price derivatives. Utilizing actual derivative contractual volumes under our commodity price derivatives as of December 31, 2022, a 10% increase in forward curves associated with the underlying commodity would have increased the net asset position by $11 million to $164 million, while a 10% decrease in forward curves associated with the underlying commodity would have reduced the net asset derivative position by $8 million to $145 million. However, any cash derivative gain or loss would be substantially offset by a decrease or increase, respectively, in the actual sales value of production covered by the derivative instrument.For additional information on our open commodity derivative instruments at December 31, 2022, see Note 12—Derivatives of the notes to the consolidated financial statements included elsewhere in this Annual Report.63Table of ContentsCounterparty and Customer Credit Risk Our principal exposures to credit risk are due to the concentration of receivables from the sale of our oil and natural gas production (approximately $618 million at December 31, 2022), and to a lesser extent, receivables resulting from joint interest receivables (approximately $93 million at December 31, 2022). We do not require our customers to post collateral, and the failure or inability of our significant customers to meet their obligations to us due to their liquidity issues, bankruptcy, insolvency or liquidation may adversely affect our financial results.Joint operations receivables arise from billings to entities that own partial interests in the wells we operate. These entities participate in our wells primarily based on their ownership in leases on which we intend to drill. We have little ability to control whether these entities will participate in our wells.Interest Rate Risk We are subject to market risk exposure related to changes in interest rates on our indebtedness under our revolving credit facilities and changes in the fair value of our fixed rate debt. Outstanding borrowings under the credit agreement bear interest at a per annum rate elected by Diamondback E&P. At December 31, 2022, the applicable margin ranges from 0.125% to 1.000% per annum in the case of the alternate base rate, and from 1.125% to 2.000% per annum in the case of Adjusted Term SOFR, in each case based on the pricing level. The pricing level depends on certain rating agencies’ ratings of our long-term senior unsecure debt. We believe significant interest rate changes would not have a material near-term impact on our future earnings or cash flows. For additional information on our variable interest rate debt at December 31, 2022, see Note 8—Debt of the notes to the consolidated financial statements included elsewhere in this Annual Report.Historically, we have at times used interest rates swaps to manage our exposure to (i) interest rate changes on our floating-rate date and (ii) fair value changes on our fixed rate debt. At December 31, 2022, we have interest rate swap agreements for a notional amount of $1.2 billion to manage the impact of changes to the fair value of our fixed rate senior notes due to changes in market interest rates through December 2029. We pay an average variable rate of interest for these swaps based on three month LIBOR plus 2.1865% and receive a fixed interest rate of 3.50% from our counterparties. At December 31, 2022, our receive-fixed, pay-variable interest rate swaps were in a net liability position of $193 million, and the weighted average variable rate was 5.97%. For additional information on our interest rate swaps, see Note 12—Derivatives of the notes to the consolidated financial statements included elsewhere in this Annual Report.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our estimates and forward-looking statements are mainly based on our current expectations and estimates of future events and trends, which affect or may affect our businesses and operations. Those future events and trends may relate to, among other things, developments relating to the war in Ukraine and escalation of the war in the surrounding region, political and civil unrest or military action in the geographies where we conduct business and operate, difficult conditions in global capital markets, foreign exchange markets and the broader economy, including those caused by COVID-19, and the effect that these events may have on our revenues, operations, access to capital, profitability and customer demand. Although we believe that these estimates and forward-looking statements are based upon reasonable assumptions, they are subject to several risks, uncertainties and assumptions as to future events that may not prove to be accurate and are made in light of information currently available to us. Important factors, in addition to the factors described in this annual report, may materially and adversely affect our results as indicated in forward-looking statements. You should read this annual report and the documents that we have filed as exhibits hereto completely and with the understanding that our actual future results may be materially different from what we expect.The words “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential,” “might,” “would,” “continue” or the negative of these terms or other comparable terminology and similar words are intended to identify estimates and forward-looking statements. Estimates and forward-looking statements speak only as of the date they were made and, except to the extent required by law, we undertake no obligation to update, to revise or to review any estimate and/or forward-looking statement because of new information, future events or other factors. Estimates and forward-looking statements involve risks and uncertainties and are not guarantees of future performance. As a result of the risks and uncertainties described above, the estimates and forward-looking statements discussed in this annual report might not occur and our future results, level of activity, performance or achievements may differ materially from those expressed in these forward-looking statements due to, including, but not limited to, the factors mentioned above, and the differences may be material and adverse. Because of these uncertainties, you should not place undue reliance on these forward-looking statements.PART IItem 1. BusinessCompany BackgroundEPAM is a leading digital transformation services and product engineering company, providing digital platform engineering and software development services to customers located around the world, primarily in North America, Europe, and Asia. We deliver business and technology transformation from start to finish, leveraging agile methodologies, proven customer collaboration frameworks, engineering excellence tools, hybrid teams and our award-winning proprietary global delivery platform. We leverage our software engineering heritage with strategic business and innovation consulting, design thinking, and physical-digital capabilities to deliver real business value to our customers. We support our customers while enabling them to reimagine their businesses through a digital lens. We focus on building long-term partnerships with our customers in a market that is constantly challenged by the pressures of digitization through our innovative strategy and scalable software solutions, integrated advisory, business consulting and experience design, and a continually evolving mix of advanced capabilities. Our historical core competency, software development and product engineering services, combined with our work with global leaders in enterprise software platforms and emerging technology companies, created our foundation for the evolution of our other offerings, which include advanced technology software solutions, intelligent enterprise services and digital engagement. Our strategic acquisitions have expanded our geographic reach and service capabilities to include digital strategy and design, consulting and test automation and we expect our strategic acquisitions will continue to enable us to offer a broader range of services to our customers from a wide variety of locations.Business StrategyOur service offerings continuously evolve to provide more customized and integrated solutions to our customers where we combine best-in-class software engineering with customer experience design, business consulting and technology innovation services. We are continually expanding our service capabilities, moving beyond our traditional services into business consulting, design and physical product development and areas such as artificial intelligence, robotics and virtual reality. 1Table of ContentsEPAM’s key service offerings and solutions include the following practice areas:EngineeringOur engineering foundation underpins how we architect, build and scale next-generation software solutions and agile delivery teams. Our engineering expertise allows us to build enterprise technologies that improve business processes, offer smarter analytics and result in greater operational excellence through requirements analysis and platform selection, deep and complex customization, cross-platform migration, implementation and integration. We use our experience, custom tools and specialized knowledge to integrate our customers’ chosen application platforms with their internal systems and processes and to create custom solutions filling the gaps in their platforms’ functionality in order to address the needs of the customers’ users and customers. We address our customers’ increased need for tighter enterprise integration between software development, testing and maintenance with private, public and mobile infrastructures through our infrastructure management services. These solutions cover the full lifecycle of infrastructure management including application, database, network, server, storage and systems operations management, as well as monitoring, incident notification and resolution. We deliver maintenance and support services through our proprietary distributed project management processes and tools, which reduce the time and costs related to maintenance, enhancement and support activities.We have deep expertise and the ability to offer a comprehensive set of software product development services including product research, customer experience design and prototyping, program management, component design and integration, full lifecycle software testing, product deployment and end-user customization, performance tuning, product support and maintenance, managed services, as well as porting and cross-platform migration. We focus on software products covering a wide range of business applications as well as product development for multiple mobile platforms and embedded software product services.OperationsWe turn our customers’ operations into intelligent enterprise hubs with our proprietary platforms, integrated engineering practices and smart automation. Developing a digital experience or product from end-to-end requires input and expertise from a variety of professionals with a broad range of skills. Our multi-disciplinary teams and global delivery framework come together to deliver well-rounded technology solutions that bring a competitive advantage to our customers. In addition to utilizing our dedicated delivery centers, which allow us to deploy key delivery talent, we work closely with leading companies in various industries to enable our customers to better leverage technology and address the simultaneous pressures of driving value for their consumer and offering a more engaging experience. OptimizationWe turn process optimization into real transformation by using process automation and cognitive techniques to transform legacy processes and deliver streamlined operations that increase revenues and reduce costs for our customers. We rely on our teams, methodologies and tools to optimize every stage of software delivery for improved quality and better features with each release. We maintain a dedicated group of testing and quality assurance professionals with experience across a wide range of technology platforms and industry verticals, who perform software application testing, test management, automation and consulting services focused on helping customers improve their existing software testing and quality assurance practices. We employ industry-recognized and proprietary defect tracking tools and frameworks to deliver a comprehensive range of testing services that identify threats and close loopholes to protect our customers’ business systems from information loss. ConsultingOver the years, as a complement to our core engineering skills, we have added capabilities in business consulting to give us an agile, hybrid approach to the market. Our consulting services drive deeper relationships as we help our customers with larger and more complex challenges. Our integrated consulting teams – across Business, Experience, Technology and Data – apply a systems thinking mindset to get to the core of our clients’ challenges. The functional business expertise of our professionals is supplemented by a thorough understanding of technology platforms and their interactions as well as application of data science and machine learning to deliver our best insights into our customers’ business. Our technical advisory services help customers stay ahead of current technology changes and innovate, where innovation beyond technology is also delivered through collaborative workshops, challenges and new organizational models. 2Table of ContentsDesignWe apply design thinking to digital and service strategy, user experience and the product lifecycle with a focus on innovative design ideas and product development. Our digital and service design practice provides strategy, design, creative and program management services for customers looking to improve the user experience. We are continuously looking to strengthen and grow our design and consulting practices as evidenced by our strategic acquisitions, which enhanced our consulting, physical design and product development capabilities, global product and design offerings, and our ability to deliver creative solutions, personalized experiences, and next generation digital products. Industry Expertise Strong industry-specific knowledge, backed by extensive experience merging technology with the business processes of our customers, allows us to deliver tailored solutions to various industry verticals. Our customers operate in five main industry verticals as well as a number of other emerging verticals in which we are increasing our presence. Financial Services. We have significant experience working with global investment banks, commercial and retail lending institutions, credit card and payment solution companies, trading platforms, exchanges and brokerages, capital markets, wealth and investment management institutions, insurers and various other providers of financial services and financial technology. We assist these customers with challenges stemming from new regulations, compliance requirements, customer-based needs and risk management. Our financial services domain experts have been recognized with industry awards for engineering and deploying unique applications and business solutions that facilitate growth, competitiveness, regulatory compliance and customer interaction while driving cost efficiency and digital transformation. Travel and Consumer. Our capabilities span a range of platforms, applications and solutions that businesses in travel and hospitality use to enhance their customers’ experience, control operating expenses and efficiently manage their business. Some of the world’s leading airlines, global hotel brands and online travel agencies rely on our expertise in creating high-quality tools for becoming more adaptive and addressing market challenges. Within this vertical, we also serve global, regional and local retailers, online retail brands and marketplaces, consumer goods manufacturers, as well as distributors and supply chain organizations. We deliver a wide range of services to these customers from complex system modernization, brand strategy and space design, digital marketing, payments and loyalty programs to inventory and order management, leading edge innovations in multi-channel sales and distribution. We have transformed organizations to use technology to expand and revolutionize their business models. Our services directly impact strategy, breakthrough products and compelling brand and employee experiences that help retailers outpace competitors. Software and Hi-Tech. We provide complex software product development services to meet software and technology companies’ constant need for innovation and agility. Some of the most prominent software brands in the world partner with us to build technology consulting, core engineering and full-scale integration capabilities. Through our extensive experience with many industry leaders in Hi-Tech research and development, software engineering and integration, we have developed proprietary internal processes, methodologies and information technology infrastructure, which give us an edge when it comes to serving customers in the Hi-Tech and Software product markets. Our services span the complete software development lifecycle for software product development using our comprehensive development methodologies, testing, performance tuning, deployment, maintenance and support. Business Information and Media. We help our business information and media customers build products and solutions for all modern platforms including web media streaming, mobile information delivery, print to digital transformations and information discovery and search. Our solutions help customers develop new revenue sources, accelerate content management, delivery and monetization and reach broader audiences. We serve varied customers in this vertical including entertainment media, news and sports broadcasting companies, financial data and legal information providers, content distributors, educational materials publishers, game developers and advertising networks. Life Sciences and Healthcare. In the Life Sciences category, we partner with global pharmaceutical, medical and scientific technology, biotechnology companies and retail pharmacies to deliver sophisticated scientific informatics and innovative enterprise technology solutions. Our personnel in Life Sciences leverage their vast technology expertise to offer deep scientific and mathematical knowledge to broad-based initiatives. Our Life Sciences solutions enable customers to speed research and accelerate time-to-market while improving collaboration, knowledge management and operational excellence. We help our customers in the Healthcare industry respond to changing regulatory environments and improve the quality of care while managing the cost of care through integrated health solutions for patients and providers and human-centered design. Our professionals deliver an end-to-end experience that includes strategy, architecture, development and managed services to customers ranging from the traditional healthcare providers to innovative startups. 3Table of ContentsEmerging Verticals. We also serve the diverse technology needs of customers in the energy, telecommunications, real estate, automotive and various manufacturing industries, as well as government customers. For these customers we develop tools such as plant management platforms, energy saving applications, inventory management mechanisms, connected vehicle platforms and undertake various industry specific aspects of intelligent automation and operational efficiency. These customers are included in our Emerging Verticals, which are further discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of this Annual Report on Form 10-K.CustomersWe maintain a geographically diverse client base in multiple industries. Our focus on delivering quality service is reflected in established relationships with many of our customers, with 54.7% and 26.4% of our revenues in 2022 coming from customers that had used our services for at least five and ten years, respectively. Our sustained growth and increased capabilities are furthered by both organic growth and strategic acquisitions. We continually evaluate potential acquisition targets that can expand our vertical-specific domain expertise, geographic footprint, service portfolio, client base and management expertise. The following table shows revenues from the top five and ten customers in the respective year as a percentage of revenues for that year: % of Revenues for Year Ended December 31,202220212020Top five customers16.4 %18.2 %22.0 %Top ten customers23.8 %25.7 %30.9 %As we remain committed to diversifying our client base and adding more customers to our client mix, we expect revenue concentration from our top customers to continue to decrease over the long-term. During 2022 and 2021, we continued to diversify our customer base and decrease our concentration from our top customers, notably as compared to 2020 when, in response to the COVID-19 pandemic, the Company capitalized on demand for our services at our larger customers.See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II of this Annual Report on Form 10-K for additional information related to revenues. See Note 17 “Segment Information” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for information regarding long-lived assets and customer revenues by geographic location as well as financial information related to our reportable segments.Global Delivery ModelOur global delivery model and centralized support functions, combined with the benefits of scale from the shared use of fixed-cost resources, have created a delivery base whereby our applications, tools, methodologies and infrastructure allow us to seamlessly deliver services and solutions from our delivery centers to global customers across all geographies. Over the years we have developed a robust global delivery model that serves as a key competitive advantage, enabling us to better meet our customers’ diverse needs and to provide a compelling value proposition. We continuously grow our delivery platform both organically and through strategic acquisitions, which allows us to expand in existing and new locations and engage personnel with diversified skills that support our strategy. As of December 31, 2022, we had approximately 52,850 delivery personnel consisting mainly of our core information technology professionals as well as designers, consultants, product experts and scientists. We serve our customers through on-site, off-site and offshore locations across the world and use strategically located delivery centers to offer a strong, diversified and cost-effective delivery platform. In the normal course of business, we may relocate or assist in relocating our employees as business needs arise, new office geographies are added or customer engagements require teams to be available in particular locations. 4Table of ContentsHistorically, our largest delivery locations, measured by the number of delivery professionals, have been Ukraine, Belarus and Russia; however, the attack on Ukraine and its people by Russian forces beginning on February 24, 2022 shifted the way we operate in those locations. Our highest priority is the safety and security of our employees and their families in Ukraine as well as in the broader region, and we have continued to support relocating our employees to lower risk locations, both inside Ukraine and to other countries where we operate. The vast majority of our Ukraine employees are in safe locations and operating at levels of productivity consistent with those achieved prior to the war, and Ukraine remains our largest delivery location with the most delivery professionals, 10,500 as of December 31, 2022. Additionally, in response to the war in Ukraine, we continue to execute our business continuity plans and have sustained our hiring efforts across multiple locations in Central and Eastern Europe, Central and Western Asia, India, and Latin America. Our global delivery centers have sufficient resources, including infrastructure and capital, to support ongoing operations. On April 7, 2022, EPAM announced the beginning of a phased exit of our operations in Russia in close collaboration with our employees, contractors, and customers. We have discontinued services to certain customers located in Russia and on September 7, 2022, we executed an agreement to sell substantially all of our remaining holdings in Russia to a third-party. As of December 31, 2022 and through the date of issuing this Annual Report, the long stop date of the agreement has passed and we are currently renegotiating the terms of that sale agreement as well as exploring other strategic alternatives. The timing and completion of a sale is uncertain and any sale would be subject to customary closing conditions, including regulatory approval by the Russian Government. See Note 2 “Impact of the Invasion of Ukraine” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for more information regarding our Ukraine and Russia locations. We expect to continue operating in Belarus while executing on our Belarus-specific business continuity plans. As of December 31, 2022, Belarus had approximately 4,500 delivery professionals. During 2022, a significant number of our employees in Russia and Belarus have relocated, thus increasing the size of our other delivery locations. Outside of Ukraine and Belarus, our largest delivery locations are India and Poland with approximately 5,900 and 5,650 delivery professionals, respectively, as of December 31, 2022.Human Capital Our employees are a key factor in our ability to grow our revenues and serve our customers. We believe the quality of our employees serves as a key point of differentiation in how we deliver a superior value proposition to our customers and investors. Therefore, it is critical to our success that we are able to identify, attract, hire and retain delivery professionals who are highly skilled in information technology to execute our services, as well as individuals with appropriate skills to fill our executive, finance, legal, human resources and other key management positions. To attract, retain and motivate our employees, we offer a challenging work environment, a culture that values the individual, ongoing skills development initiatives, attractive career advancement with continuous rotation and promotion opportunities while providing an environment and culture that rewards entrepreneurial initiative and performance. As of December 31, 2022, 2021 and 2020, we had approximately 59,300, 58,800, and 41,150 employees, respectively, of which approximately 52,850, 52,600, and 36,750 were delivery professionals, respectively. Health, Safety, and Wellness: We invest in programs designed to improve the physical, mental, and social well-being of our employees so we can offer a safe, welcoming, and productive workplace that supports and enhances the work-life balance and wellness of our employees. Our health and safety programs are designed to comply with the regulations in the multiple cities and countries where we operate, but also provide working conditions that are compatible with the necessities of our delivery and administrative operations. For those employees who continue to work remotely and for those employees who choose or need to work in EPAM’s or our customer’s offices, we have implemented COVID-19-related safety measures, policies and technologies for their safety and the safety of their colleagues.Recruitment, Training and Utilization: As an innovation-driven business in a competitive industry, our success depends on hiring the most talented employees, training and developing that talent, and deploying them to satisfy customer demand. We have dedicated full-time employees who oversee all aspects of our human capital management process including talent acquisition teams to locate and attract qualified and experienced professionals around the world. Our employees are a critical asset, necessary for our continued success and, therefore, we are continuously exploring new geographies, markets, and sources to locate talented personnel and present them with competitive compensation programs and educational opportunities. We actively monitor how we utilize our delivery professionals and specialists to balance the needs of our customers with the availability, location, and skill sets of our employees and their need for diverse and challenging work. We manage utilization through strategic hiring and efficient staffing of projects for our customers. For the years ended December 31, 2022, 2021 and 2020, the utilization rates of our delivery professionals were approximately 75.8%, 78.7%, and 79.8%, respectively. 5Table of ContentsEPAM invests significant resources in training and developing our employees through our learning and development programs. Our largest learning and development investment has been directed towards developing our engineering talent, including targeted training programs, innovation labs, and significant internal production projects. Our employees consumed over 2.6 million learning hours in 2022. We deliver training and development opportunities and content through our unique learning ecosystem that promotes learning in the daily workflow to improve retention and productivity, and through dedicated events, including our week-long global learning event, which delivered approximately 130 online sessions. We deliver learning and development content through proprietary platforms that are available to all of our employees. Our digital learning platform provides our employees with a recommendation engine that suggests courses and materials based on employee role, level, location and skills. Our electronic library platform makes books and publications available to all of our employees and we celebrate learning achievements through our recognition portal, where we promote our employees’ learning accomplishments and employees can recognize each other for their teamwork, initiative, and unique, valuable skills.Diversity and Inclusion: EPAM provides our customers with the skills of our talented personnel, which includes people with varied and diverse backgrounds and characteristics, to drive innovation and thought diversity in delivering our services. We believe that innovation comes from the unique perspectives, knowledge, and experiences of our global employees, so we strive to create diversity and inclusivity by supporting employee affinity groups, offering comprehensive language learning programs, highlighting and sharing our varied cultures, and empowering women and underrepresented groups to celebrate their achievements in the workplace. Increasing diversity in executive and key operational leadership roles is an organizational priority that starts at the top of our organization. Women currently represent approximately 29% of the independent directors on our Board and we have developed programs to identify, retain, mentor, and supply a pipeline of qualified, diverse candidates at all levels of our company. Our programs include dedicating resources and personnel in our talent acquisition team to identify, recognize, and use diverse and inclusive sources for hiring, including associating with organizations that are focused on promoting underrepresented groups in engineering, IT, and business. Our Emerging Engineers Lab is an internship program for entry-level talent sourced from a variety of diverse technology programs across the U.S., Canada and Mexico. We also supplemented our mandatory annual training and global learning week event with materials geared towards eliminating unconscious bias in our professional interactions and recognizing the value of diversity in organizational success.We encouraged the creation of employee affinity groups to build an inclusive and supportive culture at EPAM for groups of employees with similar backgrounds, interests, and identities to grow and thrive professionally. Recognizing that improving the number of underrepresented people in the software and technology industries starts with access to science, technology, engineering, and mathematics (“STEM”) education, EPAM has created post-secondary STEM education certification programs and is investing in universities that offer degree programs. We also created the EPAM E-KIDS program where our employees volunteer their time to teach elementary school age children of any gender, race, or ethnic identity STEM concepts and introductory software coding skills. As of the end of 2022, we offered the EPAM E-KIDS program in 25 countries.Employee Engagement and Retention: As a participant in the United Nations Global Compact, we are committed to respecting our employees' fundamental human rights at work. We believe that retaining skilled talent requires substantially more than meeting basic employment and labor rights, and that employees who are fairly compensated, feel supported in their career development, and are engaged with their employer are more likely to remain with that employer. That is why we strive to provide pay and benefits that demonstrate the value of our employees to us, including a competitive salary, flexible work-life balance, paid time off, health coverage, ongoing training programs, relocation options, and recognition opportunities for open-source software contributions. Our career development programs create detailed and progressive training plans for our employees and help them choose from internal and external training options, mentoring programs, and hands-on opportunities to experience emerging technology areas. We designed our career development programs to enable our employees to develop their engineering skills, influence our culture, develop thought leadership, and introduce them to leaders in our industry. Our career development programs also give our employees opportunities to earn accreditation and relevant expertise in various technology fields, including software and project management certifications and recognition and credentialing from the industry’s primary software and cloud services providers. 6Table of ContentsWe focus on retaining and engaging top talent by hiring people with the skill sets our customers need and who also share our values so we can build long-term employee satisfaction, which is supported by our voluntary attrition rate of 13.8%, 13.3%, and 10.8% in 2022, 2021 and 2020, respectively. We endeavor to recruit for careers, not for short-term projects, and actively foster feedback from our employees so we can improve the EPAM employee experience. Receiving and learning from employee feedback plays a critical role in engaging and retaining our employees because it offers us insights on how we can improve our operations and enhance the skills of our employees. In our 2022 global employee survey, 91% of the employees who responded demonstrated their satisfaction with their employee experience by agreeing or strongly agreeing that they are proud to work at EPAM, with 84% of responders noting that they plan to have a long career with EPAM. Our focus on our employees’ experience is recognized inside and outside of EPAM. In 2022, the employee experience we create was recognized with awards from a number of different organizations in North America, Europe, and Asia, and we were named on Newsweek’s list of Top 100 Most Loved Workplaces for the second consecutive year. Sales and MarketingWe market and sell our services through our senior management, sales and business development teams, account managers, and professional staff. Our client service professionals and account managers, who maintain direct customer relationships, play an integral role in engaging with current customers to identify and pursue potential business opportunities. This strategy has been effective in promoting repeat business and growth from within our existing customer base and we believe that our reputation as a reliable provider of software engineering solutions drives additional business from inbound requests and referrals. In addition to effective client management, our sales model also utilizes an integrated sales and marketing approach that leverages a dedicated sales team to identify and acquire new accounts. We maintain a marketing team, which coordinates corporate-level branding efforts such as participation in and hosting of industry conferences and events as well as sponsorship of programming competitions. We have been recognized by many top global independent research agencies, such as Forrester and Gartner and by publications such as Newsweek, Forbes and Fortune. As a recognized leader, EPAM is listed among the top 15 companies in Information Technology Services on the Fortune 1000 and ranked four times as the top IT services company on Fortune’s 100 Fastest Growing Companies list. EPAM is also listed among Ad Age’s top 25 World’s Largest Agency Companies for three consecutive years, and Consulting Magazine named EPAM Continuum a top 20 Fastest Growing Firm.CompetitionThe markets in which we compete are changing rapidly and we face competition from multiple market participants such as other global technology solutions providers, specialized consulting firms, boutique digital companies and outsourcing companies based primarily in specific geographies with lower cost labor such as Eastern Europe, India and China. We believe that the principal competitive factors in our business include technical expertise and industry knowledge, end-to-end solution offerings, a reputation for and a track record of high-quality and on-time delivery of work, effective employee recruiting, training and retention, responsiveness to customers’ business needs, ability to scale, financial stability and price.We face competition from various technology services providers such as Accenture, Atos, Capgemini, Cognizant Technology Solutions, Deloitte Digital, DXC Technology, Endava, Genpact, GlobalLogic, Globant, Grid Dynamics, HCL Technologies, Infosys, Tata Consultancy Services, and Wipro, among others. Additionally, we compete with numerous smaller local companies in the various geographic markets in which we operate.We believe that our focus on complex and innovative software product development solutions, our technical employee base, and our development and continuous improvement in process methodologies, applications and tools position us well to compete effectively in the future. Quality Management and Information Security We are continuously investing in systems, applications, tools and infrastructure to manage all aspects of our global delivery process in order to manage quality and information security risks, while providing control and visibility across all project lifecycle stages both internally and to our customers. We have developed sophisticated project management techniques and procedures facilitated through our proprietary project management tools, a web-based collaborative environment for software development, which we consider critical for visibility into project deliverables, resource management, team messaging and project-related documents. These tools promote collaboration and effective oversight, reduce work time and costs, and increase quality for our IT management and our customers. 7Table of ContentsWe maintain, monitor, and improve processes and infrastructure to protect our, our customers’ and their customers’ confidential and sensitive information and allocate internal and external resources to assess and ensure information security, cybersecurity and data privacy. We have made significant investments in the appropriate people, processes and technology to establish and manage information security, confidentiality requirements, and laws and regulations governing our activities, such as the European Union data protection legal framework referred to as the General Data Protection Regulation (“GDPR”), the California Consumer Privacy Act and California Privacy Rights Act, and others.We maintain a focus on adhering to stringent security, privacy and quality standards as well as internal controls which are compliant with ISO 27001, ISO 27701 and ISO 9001 standards. For certain services, EPAM obtains SOC1, SOC2, and/or SOC3 reports and shares them with our customers. These audits are performed by an independent auditor utilizing globally recognized attestation standards (ISAE 3402 and ISAE 3000). Our SOC reports, along with other certifications we hold, provide our customers with independent third-party assurance and validation of our information security, privacy management, quality management and general controls practices.Corporate and Social Responsibility and Environmental, Social, and Governance InitiativesWe are committed to integrating positive social, environmental and ethical practices into our business operations, corporate governance, and strategy. This commitment is key to our continual development as a business and drives value for our employees, customers, business partners, the community and other stakeholders. We practice the principles established in our Code of Ethical Conduct by making positive contributions to the communities in which we operate and championing corporate social responsibility efforts. Through our focused efforts in the areas of Education, Environment, and Community, we are committed to sharing the expertise and attributes of our highly skilled global workforce to effectively support the needs of, and positively add to the world at large and the communities where we work and live. By understanding our impact on local, regional and global communities, we strive to create positive change and opportunities in areas where it is needed most. We believe responsible stewardship of the environment is critical, and we take this responsibility seriously. We continually strive to improve our environmental performance through implementation of sustainable development and environmental practices including recycling and upcycling electronics and computers, designing and releasing a carbon footprint calculator to our employees and the general public, and building new offices according to the conservation standards of the Leadership in Energy and Environmental Design rating system. EPAM was named one of Barron's 100 Most Sustainable Companies in 2022. Intellectual PropertyProtecting our intellectual property rights is important to our business. We have invested, and will continue to invest, in research and development to enhance our knowledge, create solutions for our customers, and continuously advance our information security. We rely on a combination of intellectual property laws, trade secrets, cybersecurity, and confidentiality obligations to protect our intellectual property. We require our employees, vendors and independent contractors to enter into written agreements upon the commencement of their relationships with us, which assign to us all deliverable intellectual property and work product made, developed or conceived by them in connection with their employment or provision of services and to keep any disclosed information confidential.We also enter into confidentiality agreements with our customers and suppliers to protect information and maintain information security. Our agreements with our customers cover our use of their software systems and platforms as our customers usually own the intellectual property in the software, products, and solutions we develop for them. Furthermore, we often grant our customers a nonexclusive license to use relevant technologies in our pre-existing intellectual property portfolio, but only to the extent necessary to use the software or systems we develop for them. Our suppliers are generally bound by our supplier code of conduct, which imposes an obligation to protect our and our customers’ intangible assets, including confidential information, personal information, and intellectual property, and to protect the security of those assets.RegulationsDue to the industry and geographic diversity of our operations and services, our operations are subject to a variety of rules and regulations. Several foreign and U.S. federal and state agencies regulate various aspects of our business. See “Item 1A. Risk Factors — Risks Related to Regulation and Legislation and Risks Related to Information Security and Data Protection.” We are subject to laws and regulations in the United States and other countries in which we operate, including export restrictions, economic sanctions, the Foreign Corrupt Practices Act (“FCPA”) and similar anti-corruption laws and data privacy regulations. Compliance with these laws requires significant resources and non-compliance may result in civil or criminal penalties and other remedial measures. 8Table of Contents Corporate InformationEPAM Systems, Inc. was incorporated in the State of Delaware on December 18, 2002. Our predecessor entity was founded in 1993. Our principal executive offices are located at 41 University Drive, Suite 202, Newtown, Pennsylvania 18940 and our telephone number is 267-759-9000. We maintain a website at https://www.epam.com. Our website and the information accessible through our website are not incorporated into this Annual Report on Form 10-K. We make certain filings with the Securities and Exchange Commission (“SEC”), including our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments and exhibits to those reports. These filings are available through the SEC’s website at https://www.sec.gov which contains reports, proxy and information statements, and other information regarding issuers that file electronically through the SEC’s EDGAR System. We also make such filings available free of charge through the Investor Relations section of our website, https://investors.epam.com, as soon as reasonably practicable after they are filed with the SEC. Item 1A. Risk FactorsOur operations and financial results are subject to various risks and uncertainties, which could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock. Listed below, not necessarily in order of importance or probability of occurrence, are the most significant risk factors applicable to us. Additionally, forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. See “Forward-Looking Statements.”Risks Related to Geopolitical EventsInstability in geographies where we have significant operations and personnel or where we derive substantial amounts of revenue could have a material adverse effect on our business, customers, service delivery, and financial results.We have significant operations and personnel in Ukraine and Belarus, and continue to wind down our operations in Russia. Conflict in the region has had and could continue to have a material adverse effect on our business, customers, service delivery, and financial results.Economic, civil, military, energy supply and political uncertainty exists and may increase in many of the regions where we operate and derive our revenues. In particular, as of December 31, 2022, approximately 15,000 of our global delivery, administrative and support personnel were based in Ukraine and Belarus, both of which are involved in or affected by the military action in Ukraine. We also have significant operations in countries bordering Ukraine and in countries allied with Russia in the nearby emerging market economies of Eastern Europe and Central Asia, which currently are, and in the future may be, adversely impacted by regional instability.On February 24, 2022, Russian military forces attacked Ukraine, and sustained conflict and disruption in the region is ongoing. In addition to a significant number of personnel and operations in Ukraine, we also own an office building and lease office space in a number of cities in Ukraine, all or some of which may be damaged or destroyed as a result of the continued attacks against Ukraine. Any escalation of the conflict that includes Belarus or its military could jeopardize our personnel, facilities, and operations in Belarus. The impact to Ukraine, as well as actions taken by other countries, including arms shipments and new and stricter sanctions by Canada, the United Kingdom, the European Union and its member countries, the U.S. and other countries and organizations against officials, individuals, regions, and industries in Russia, the annexed portions of Ukraine, and Belarus, and each country’s potential response to such shipments, sanctions, tensions, and military actions has and could continue to have a material adverse effect on our operations. In order to protect against potential cyberattacks or other information security threats, some of our customers have implemented steps to block internet communications with Russia, Ukraine, and Belarus, which has had a material adverse effect on our ability to deliver our services from those locations. Our customers have and may continue to seek altered terms, conditions, and delivery locations for the performance of services, delay planned work or seek services from alternate providers, or suspend, terminate, fail to renew, or reduce existing contracts or services, all of which could have a material adverse effect on our financial condition. The material adverse effects from the conflict, enhanced sanctions activity, and counter-sanctions may continue to disrupt our delivery of services, has caused us to shift portions of our work occurring in the region to other countries, and may continue to restrict our ability to engage in certain projects or with certain customers in the region. 9Table of ContentsWe discontinued services to certain customers located in Russia and we hope to complete the sale of substantially all of our holdings in Russia as soon as feasible, subject to customary closing conditions including regulatory approval. The completion of the sale of substantially all of our Russian holdings is not assured and we could incur additional significant charges in the future related to the exit or effort to exit our operations in Russia. We expect to continue operating in Belarus. A significant number of our employees in Russia and Belarus have relocated, and we expect more employees may relocate to delivery locations outside their countries in the future.EPAM is actively monitoring and enhancing the security of our people and the stability of our infrastructure, including communications, physical assets, energy supply, and internet availability. We continue to execute our business continuity plans in response to developments as they occur and to protect the safety of our personnel and address potential impacts to our delivery infrastructure. To date we have not experienced any material interruptions in our infrastructure, utility supply or internet connectivity needed to support our customers. We have implemented additional contingency plans to relocate work and/or personnel to other geographies within our global footprint and add new locations, as appropriate. Increased operations, service delivery, and hiring in existing or new geographies, including in more developed economies, is likely to increase our expenses, especially compensation expenses for technology professionals in those markets, which could reduce the profitability of our business.Our business continuity plans are designed to address known contingency scenarios to ensure that we have adequate processes and practices in place to protect the safety of our people and to handle potential impacts to our delivery capabilities. Our crisis management procedures, business continuity plans, and disaster recovery capabilities may not be effective at preventing or mitigating the effects of prolonged or multiple crises, such as civil unrest, military conflict, energy instability and a pandemic in a concentrated geographic area or in multiple geographies. The current events in the regions where we operate and where we derive a significant amount of our business pose security risks to our people, our facilities, our operations, and infrastructure, such as utilities and network services, and the further disruption of any or all of them could materially adversely affect our operations and financial results, cause additional volatility in the price of our stock, and reduce our profitability. We have no way to predict the progress or outcome of the military action in Ukraine or its impacts in Russia, Belarus, or the region because the conflict and government reactions are rapidly changing and beyond our control. Whether in these countries or in others in which we operate, prolonged civil unrest, political instability or uncertainty, military activities, broad-based sanctions or counter-sanctions, should they continue for the long term or escalate, could require us to further rebalance our geographic concentrations and could have a material adverse effect on our personnel, operations, financial results and business outlook.Risks Related to COVID-19Our results of operations have been adversely affected and could in the future be materially adversely affected by the COVID-19 pandemic.The COVID-19 pandemic has contributed to significant volatility in the price of our common stock, created uncertainty in customer demand for, and ability to supply, our services and caused widespread economic disruption. The extent to which the coronavirus pandemic will continue to impact our business, operations and financial results will depend on numerous factors that are unknown and that we may not be able to accurately predict. Those factors include: the impact of the pandemic on economic activity, supply chains, and inflation; any interventions or government measures intended to mitigate economic and supply disruptions; our ability to sell and provide our products, services, and solutions, including as a result of travel restrictions and personnel availability; and bankruptcy or other insolvency procedures among our customers or suppliers. Broad disruptions in our customers’ markets have disrupted and could continue to disrupt the demand for our products, services, and solutions and result in, among other things, termination of customer contracts, delays or interruptions in the performance of contracts, losses of revenues, reduced profitability, and an increase in bad debt expense. Remote working arrangements increase information security, cyber security and connectivity vulnerabilities and new coronavirus variants could affect our ability to deliver services to our customers because of an outbreak of illness among our employees, our customers’ employees, or at a facility. To the extent the COVID-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in this section of this Annual Report on Form 10-K for the year ended December 31, 2022, each of which could materially adversely affect our business, financial condition, results of operations and/or stock price. 10Table of ContentsRisks Related to Our Personnel and GrowthWe may be unable to effectively manage our rapid growth or achieve anticipated growth, which could place significant strain on our management, systems, resources, and results of operations.We have grown rapidly and significantly expanded our businesses over the past several years, both organically and through strategic acquisitions and investments. Our growth has resulted in part from managing larger and more complex projects for our customers, but consequently requires that we invest substantial amounts of cash in human capital and the infrastructure to support them, including training, administration, and facilities in existing and new geographies. Our rapid growth places significant demands on our management and our administrative, operational and financial infrastructure, and creates challenges, including:•recruiting, training and retaining sufficiently skilled professionals and management personnel;•planning resource utilization rates on a consistent basis and efficiently using on-site, off-site and offshore staffing;•maintaining close and effective relationships with a larger number of customers in a greater number of industries and locations;•controlling costs and minimizing cost overruns and project delays in delivery center and infrastructure expansion;•effectively maintaining productivity levels and implementing process improvements across geographies and business units; and•evolving our information security and our internal administrative, operational and financial infrastructure.We intend to continue our expansion and pursue available opportunities for the foreseeable future. We have and will continue to invest in new lines of business, such as software development education and expanded consulting services. As we introduce new services, enter into new markets, and take on increasingly large and complex projects, our business may face new risks and challenges. If customers do not choose us for large and complex projects or we do not effectively manage those projects, our reputation may be damaged and our business and financial goals may not be realized. Direct-to-consumer offerings in the highly regulated education industry could result in increased liability and compliance costs. We need to generate business and revenues to support new investments and infrastructure projects. If the challenges associated with expansion negatively impact our anticipated growth and margins, our business, prospects, financial condition and results of operations could be materially adversely affected.We must successfully attract, hire, train and retain qualified personnel to service our customers’ projects and we must productively utilize those personnel to remain profitable.Identifying, recruiting, hiring and retaining professionals with diverse skill sets across our broad geography of operations is critical to maintaining existing engagements and obtaining new business and has become more challenging in the present economic and labor climate. If we are unable to recruit skilled professionals and if we do not deploy those professionals and use our physical infrastructure and fixed-cost resources productively, our profitability will be significantly impacted. We must manage the utilization levels of the professionals that we hire and train by planning for future needs effectively and staffing projects appropriately while accurately predicting the general economy and our customers’ need for our services. If we are unable to attract, hire, train, and retain highly skilled personnel and productively deploy them on customer projects, we will jeopardize our ability to meet our customers’ expectations and develop ongoing and future business, which could adversely affect our financial condition and results of operations.Competition for highly skilled professionals has intensified in the markets where we operate, and we may experience significant employee turnover rates due to such competition. Higher wage expectations driven by wage inflation could also create challenges for our recruiting efforts. If we are unable to retain professionals with specialized skills, our revenues, operating efficiency and profitability will decrease, as will our ability to meet emerging technological challenges. Cost reductions, such as reducing headcount, or voluntary departures that result from our failure to retain the professionals we hire, could negatively affect our reputation as an employer and our ability to hire personnel to meet our business requirements. Price increases resulting from increasing compensation to retain personnel could lead to a decline in demand for our services. 11Table of ContentsThere may be adverse tax and employment law consequences if the independent contractor status of some of our personnel or the exempt status of our employees is successfully challenged.In several countries, certain of our personnel and certain of the personnel of companies that we have acquired are retained as independent contractors. The criteria to determine whether an individual is considered an independent contractor or an employee are typically fact sensitive, vary by jurisdiction, and are subject to the interpretation of the applicable laws. If a government authority changes the applicable laws or a court makes any adverse determination with respect to independent contractors in general or one or more of our independent contractors specifically, we could incur significant costs, including for prior periods, for tax withholding, social security taxes or payments, workers’ compensation and unemployment contributions, and recordkeeping, or we may be required to modify our business model, any of which could materially adversely affect our business, financial condition and results of operations and increase the difficulty in attracting and retaining personnel.Our success depends substantially on the continuing efforts of our senior executives and other key personnel, and our business may be severely disrupted if we lose their services.Our future success heavily depends upon the continued services of our senior executives and other key employees. If one or more of our senior executives or key employees are unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all. If any of our senior executives or key personnel joins a competitor or forms a competing company, we may lose customers, suppliers, know-how and other key personnel to those competitors. If we are unable to attract new senior executives or key personnel due to the intense competition for talent in our industry, it could disrupt our business operations and growth. If we fail to integrate or manage acquired companies efficiently and effectively, or if acquisitions do not perform to our expectations, our overall profitability and growth plans could be materially adversely affected.Strategic acquisitions are part of our expansion strategy, but these transactions involve significant risks. Acquired companies may not advance our business strategy or achieve a satisfactory return on our investment and we may not be able to successfully integrate acquired employees and business culture, customer relationships, or operations. Acquisitions divert significant management attention and financial resources from our ongoing business. Furthermore, contracts between our acquired companies and their customers may lack terms and conditions that adequately protect us against the risks associated with the services we provide, and our acquired companies' business operations can expose us to potential liability before integration is complete. If not effectively managed, the disruption of our ongoing business, increases in our expenses, including significant one-time expenses and write-offs, and difficulty and complexity of effectively integrating acquired operations may adversely affect our overall growth and profitability.Risks Related to Our Operations Increases in wages, equity compensation, and other compensation expenses could prevent us from sustaining our competitive advantage, increase our costs, and result in dilution to our stockholders.Wages for technology professionals in the emerging markets where we have significant operations and delivery centers are lower than comparable wages in more developed countries. However, wages in general, and in the technology industry in these countries in particular, have increased at a faster rate than in the past, which may make us less competitive unless we are able to increase the efficiency and productivity of our people. If we increase operations and hiring in more developed economies, our compensation expenses will increase because of the higher wages demanded by technology professionals in those markets. Wage inflation, whether driven by competition for talent, ordinary course pay increases, or broader market forces, may also increase our cost of providing services and reduce our profitability if we are not able to pass those costs on to our customers or adjust prices when justified by market demand.We expect to continue our practice of granting equity-based awards under our stock incentive plans and paying other stock-based compensation. The expenses associated with stock-based compensation may make issuing equity awards under our equity incentive plans less attractive to us, but if we reduce the amount or value of equity award grants, we may not be able to attract and retain key personnel. Conversely, if we grant more or higher value equity awards to attract and retain key personnel, the equity compensation expenses could materially adversely affect our results of operations. New regulations, volatility in our stock, and dilution to our stockholders could diminish our use and the value of our equity-based awards. This could put us at a competitive disadvantage or cause us to reconsider our compensation practices. 12Table of ContentsOur operations in emerging markets subject us to greater economic, financial, and banking risks than we would face in more developed markets.Our significant operations in emerging market economies in Eastern Europe, Latin and South America, India, and certain other Asian countries are vulnerable to market and economic volatility to a greater extent than more developed markets, which presents risks to our business and operations. A majority of our revenues are generated in North America and Western Europe. However, most of our personnel and delivery centers are located in lower cost locations, including emerging markets. This exposes us to foreign exchange risks relating to revenues, compensation, purchases, capital expenditures, receivables and other balance-sheet items. As we continue to leverage and expand our global delivery model into other emerging markets, a larger portion of our revenues and incurred expenses may be in currencies other than U.S. dollars. Currency exchange volatility caused by economic instability or other factors could materially impact our results. See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.”The economies of certain emerging market countries where we operate have experienced periods of considerable instability and have been subject to abrupt downturns. We have cash in banks in countries such as Belarus, Russia, Ukraine, Kazakhstan, Georgia, Armenia and Uzbekistan, where the banking sector generally does not meet the banking standards of more developed markets, bank deposits made by corporate entities are not insured, and the banking system remains subject to instability and changes in regulations that complicate business transactions. Russia’s invasion of Ukraine and the resulting sanctions and counter-sanctions against Russia have increased the difficulty in accessing cash held in Russian banks, severely limited our ability to move funds out of Russia, and prolonged or escalating military conflict and further sanctions or counter-sanctions could contribute to a banking crisis in these countries and in Belarus. A banking crisis, or the bankruptcy or insolvency of banks that receive or hold our funds may result in the loss of our deposits or adversely affect our liquidity and our ability to complete banking transactions in that region. In addition, some countries where we operate may impose regulatory or practical restrictions on the movement of cash and the exchange of foreign currencies within their banking systems, which would limit our ability to use cash across our global operations and increase our exposure to currency fluctuations. Emerging market vulnerability, and especially its impact on currency exchange volatility and banking systems, could have a material adverse effect on our business, financial condition and results of operations.We face intense and increasing competition for customers and opportunities from onshore and offshore IT services and other consulting companies. If we are unable to compete successfully against competitors, pricing pressures or loss of market share could have a material adverse effect on our business.The market for our services is highly competitive, and we expect competition to persist and intensify. We face competition from offshore IT services providers in other outsourcing destinations with low wage costs such as India and China, as well as competition from large, global consulting and outsourcing firms and in-house IT departments of large corporations. Customers tend to engage multiple IT services providers instead of using an exclusive IT services provider, which could reduce our revenues or place significant downward pressure on pricing among competing IT services providers. Customers may prefer service providers that have more locations, more personnel, more experience in a particular country or market, or that are based in countries that are more cost-competitive or have the perception of being more stable than some of the emerging markets in which we operate.Current or prospective customers may elect to perform certain services themselves or may be discouraged from transferring services from onshore to offshore service providers, which could harm our ability to compete effectively with competitors that provide services from within the countries in which our customers operate.Some of our present and potential competitors may have substantially greater financial, marketing or technical resources; therefore, we may be unable to retain our customers or successfully attract new customers. Increased competition, our inability to compete successfully, pricing pressures or loss of market share could have a material adverse effect on our business. 13Table of ContentsComplying with a wide variety of legal requirements in the jurisdictions where we operate can create risks to our operations and financial condition, including liquidation of the subsidiaries that operate our major delivery centers.Our global operations require us to comply with a wide variety of foreign laws and regulations, trade or foreign exchange restrictions or sanctions, inflation, unstable civil, political and military situations, labor issues, and legal systems that make it more difficult to enforce intellectual property, contractual, or corporate rights. Certain legal provisions in Belarus and Ukraine, where our local subsidiaries operate important delivery centers and employ a significant number of billable and support professionals, may allow a court to order liquidation of a locally organized legal entity on the basis of its formal noncompliance with certain requirements during formation, reorganization or during its operations. Russia, where we are currently winding down our business operations, has similar legal provisions and additional restrictions on sales of assets and repatriation of cash. Belarus recently authorized government seizures of property and assets or the takeover of management of commercial organizations owned by or affiliated with specified foreign states if those states or their affiliated companies or actors commit actions deemed unfriendly to Belarus. If we fail to comply with certain requirements, including those relating to minimum net assets, governmental or local authorities can impose fines or seek the involuntary liquidation of our local subsidiaries in court, and creditors will have the right to accelerate their claims, demand early performance of legal obligations, and demand compensation for any damages. Involuntary liquidation of any of our subsidiaries could materially adversely affect our financial condition and results of operations.The focus on environmental, social and governance topics, including commitments and disclosures we have made and may need to make, may result in additional operational costs and negative reputational impacts.Customer, investor, employee, and regulatory interest in environmental, social, and governance (“ESG”) strategy and commitments has grown and is expected to continue to grow. As investor policy, regulations, and legislation related to ESG disclosure and climate change initiatives are adopted and implemented regionally and globally, we may be required to comply or potentially face limited access to certain markets, fines, or reputational injury. Such policies and laws may require disclosures and commitments that we are not able to meet, and regulations, treaties or initiatives in response to climate change could result in increased operational costs associated with environmental regulations and increased compliance and energy costs, each of which could harm our business and results of operations by increasing our expenses or requiring us to alter our operations. Additionally, if we are unable to meet our ESG goals and objectives, we may suffer reputational harm with investors, our customers, and current or potential employees.Our operating results may be negatively impacted by the loss of certain tax benefits provided to companies in our industry by the governments of Belarus and other countries.In Belarus, one local subsidiary is a member, along with other technology companies, of High-Technologies Park. Members have a full exemption from Belarus income tax and value added tax until 2049 and are taxed at reduced amounts on obligatory social contributions and a variety of other taxes. If the tax policies in Belarus or other countries where we operate are changed, terminated, not extended or comparable new tax incentives are not introduced, we expect that our operating expenses and/or our effective income tax rate could increase significantly, which could materially adversely affect our financial condition and results of operations. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Provision for Income Taxes.”Risks Related to Regulation and LegislationExisting policy and substantial changes to fiscal, political, regulatory and other federal policies may adversely affect our business and financial results.Changes in general economic or political conditions in the United States, including a recession or a sovereign debt default, could adversely affect our business. U.S. policy with respect to a variety of issues, including international trade agreements, conducting business offshore, inflation mitigation, import and export regulations, tariffs and customs duties, foreign relations, immigration laws and travel restrictions, antitrust controls and enforcement, and corporate governance laws, could have a positive or negative impact on our business. The majority of our professionals are offshore. Companies that outsource services to organizations operating in other countries remains a topic of political discussion in many countries, including the United States, which is our largest source of revenues. The United States Congress periodically proposes legislation that could impose restrictions on offshore outsourcing and on our ability to deploy employees holding U.S. work visas to customer locations, both of which could adversely impact our business. Such legislative measures could broaden restrictions on outsourcing by federal and state government agencies and contracts and impact private industry with tax disincentives, intellectual property transfer restrictions, and restrictions on the use or availability of certain work visas. 14Table of ContentsSome of our projects require our personnel to obtain visas to travel and work at customer sites outside of our personnel’s home countries and often in the United States. Our reliance on visas to staff projects with employees who are not citizens of the country where the work is to be performed makes us vulnerable to legislative and administrative changes in the number of visas to be issued in any particular year and other work permit laws and regulations. The process to obtain the required visas and work permits can be lengthy and difficult and variations due to political forces and economic conditions in the number of permitted applications, as well as application and enforcement processes, may cause delays or rejections when trying to obtain visas. Delays in obtaining visas or other work authorizations may result in delays in the ability of our personnel to travel to meet with and provide services to our customers or to continue to provide services on a timely basis. In addition, the availability of a sufficient number of visas without significant additional costs could limit our ability to provide services to our customers on a timely and cost-effective basis or manage our sales and delivery centers as efficiently as we otherwise could. Delays in or the unavailability of visas and work permits could have a material adverse effect on our business, results of operations, financial condition and cash flows.We are subject to laws and regulations in the United States and other countries in which we operate, including export restrictions, economic sanctions, the FCPA, and similar anti-corruption laws. Compliance with these laws requires significant resources and non-compliance may result in civil or criminal penalties and other remedial measures.We are subject to many laws and regulations that restrict our international operations, including laws that prohibit activities involving restricted countries, organizations, entities and persons that have been identified as unlawful actors or that are subject to U.S. sanctions. The U.S. Office of Foreign Assets Control, or OFAC, and other international bodies have imposed sanctions that prohibit us from engaging in trade or financial transactions with certain countries, businesses, organizations and individuals. We are also subject to the FCPA and anti-bribery and anti-corruption laws in other countries, all of which prohibit companies and their intermediaries from bribing government officials for the purpose of obtaining or keeping business or otherwise obtaining favorable treatment. We operate in many parts of the world that have experienced government corruption to some degree, and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices, although adherence to local customs and practices is generally not a defense under U.S. and other anti-bribery laws.Our compliance program contains controls and procedures designed to ensure our compliance with the FCPA, OFAC and other sanctions, and laws and regulations. The continuing implementation and ongoing development and monitoring of our compliance program may be time consuming, expensive, and could result in the discovery of compliance issues or violations by us or our employees, independent contractors, subcontractors or agents of which we were previously unaware.Any violations of these or other laws, regulations and procedures by our employees, independent contractors, subcontractors and agents, including third parties we associate with or companies we acquire, could expose us to administrative, civil or criminal penalties, fines or business restrictions, which could have a material adverse effect on our results of operations and financial condition and would adversely affect our reputation and the market for shares of our common stock and may require certain of our investors to disclose their investment in us under certain state laws.Risks Related to Our Industry and CustomersWe generally do not have long-term commitments from our customers, our customers may terminate contracts before completion or choose not to renew contracts, and we are not guaranteed payment for services performed under contract. A loss of business or non-payment from significant customers could materially affect our results of operations.Our ability to maintain continuing relationships with our major customers and successfully obtain payment for our services is essential to the growth and profitability of our business. However, the volume of work performed for any specific customer is likely to vary from year to year, especially since we generally are not our customers’ exclusive IT services provider and we generally do not have long-term commitments from customers to purchase our services. We may also fail to assess the creditworthiness of our customers adequately or accurately. Our customers’ ability to terminate engagements with or without cause and our customers’ inability or unwillingness to pay for services we performed makes our future revenues and profitability uncertain. Although a substantial majority of our revenues are generated from customers who also contributed to our revenues during the prior year, our engagements with our customers are typically for projects that are singular in nature. Therefore, we must seek to obtain new engagements when our current engagements end. 15Table of ContentsThere are a number of factors relating to our customers that are outside of our control, which might lead them to terminate or not renew a contract or project with us, or be unable to pay us, including:•financial difficulties;•corporate restructuring, or mergers and acquisitions activity;•our inability to complete our contractual commitments and invoice and collect our contracted revenues;•change in strategic priorities or economic conditions, resulting in elimination of the impetus for the project or a reduced level of technology related spending;•change in outsourcing strategy resulting in moving more work to the customer’s in-house technology departments or to our competitors; and•replacement of existing software with packaged software supported by licensors.Termination or non-renewal of a customer contract could cause us to experience a higher-than-expected number of unassigned employees and thus compress our margins until we are able to reallocate our headcount. Customers that delay payment, request modifications to their payment arrangements, or fail to meet their payment obligations to us could increase our cash collection time, cause us to incur bad debt expense, or cause us to incur expenses in collections actions. The loss of any of our major customers, a significant decrease in the volume of work they outsource to us or price they are willing or able to pay us, if not replaced by new service engagements and revenues, could materially adversely affect our revenues and results of operations.Our revenues are highly dependent on a limited number of industries, and any decrease in demand for outsourced services in these industries could reduce our revenues and adversely affect our results of operations.A substantial portion of our customers are concentrated in five specific industry verticals: Financial Services; Software & Hi-Tech; Business Information & Media; Travel & Consumer; and Life Sciences & Healthcare. Our business growth largely depends on continued demand for our services from customers in these five industry verticals and other industries that we target or may target in the future, and also depends on trends in these industries to outsource the type of services we provide.A downturn in any of our targeted industries, a slowdown or reversal of the trend to outsource IT services in any of these industries or the introduction of regulations that restrict or discourage companies from outsourcing could result in a decrease in the demand for our services and could have a material adverse effect on our business, financial condition and results of operations. Our customers in the Financial Services industry vertical that depend on the steady functioning of the global capital and credit markets may be particularly susceptible to the adverse effects of a threatened or actual U.S. sovereign debt default, which could cause those customers to reduce spending on our services. Other developments in the industries in which we operate may increase the demand for lower cost or lower quality IT services and decrease the demand for our services or increase the pressure our customers put on us to reduce pricing. We may not be able to successfully anticipate and prepare for any such changes, which could adversely affect our results of operations.Furthermore, developments in the industries we serve could shift customer demand to new services, solutions or technology. If our customers demand new services, solutions or technologies, we may be less competitive in these new areas or may need to make significant investments to meet that demand. Additionally, as we expand into serving new industry verticals, our solutions and technology may be used by, or generally affect, a broader base of customers and end users, which may expose us to new business and operational risks. 16Table of ContentsIf our pricing structures are based on inaccurate expectations and assumptions regarding the cost and complexity of performing our work, or if we are not able to maintain favorable pricing for our services, then our contracts could be unprofitable.We face a number of risks when pricing our contracts and setting terms with our customers. Our pricing is highly dependent on our internal forecasts, assumptions and predictions about our projects, the marketplace, global economic conditions (including foreign exchange volatility and inflation) and the coordination of operations and personnel in multiple locations with different skill sets and competencies. Larger and more complex projects that involve multiple engagements or stages heighten those pricing risks because a customer may choose not to retain us for additional stages or delay forecasted engagements, which disrupts our planned project resource requirements. If our pricing for a project includes dedicated personnel or facilities and the customer were to slow or stop that project, we may not be able to reallocate resources to other customers. Our pricing and cost estimates for the work that we perform may include anticipated long-term cost savings that we expect to achieve and sustain over the life of the contract. Because of such inherent uncertainties, we may underprice our projects, fail to accurately estimate the costs of performing the work or fail to accurately assess the risks associated with potential contracts, such as defined performance goals, service levels, and completion schedules. The risk of underpricing our services or underestimating the costs of performing the work is heightened in fixed-price contracts and in contracts that require our customer to receive a productivity benefit as a result of the services performed under the contract. If we fail to accurately estimate the resources, time or quality levels required to complete such engagements, or if the cost to us of employees, facilities, or technology unexpectedly increases, we could be exposed to cost overruns. Any increased or unexpected costs, delays or failures to achieve anticipated cost savings, or unexpected risks we encounter in connection with the performance of the services, including those caused by factors outside our control, could make these contracts less profitable or unprofitable. Our industry is sensitive to the economic environment and the industry tends to decline during general economic downturns. Given our significant revenues from North America and Europe, if those economies weaken or enter a recession, pricing for our services may be depressed and our customers may reduce or postpone their technology related spending significantly, which may in turn lower the demand for our services and negatively affect our revenues and profitability.We face risks associated with having a long selling and implementation cycle for our services that require us to make significant resource commitments prior to realizing revenues for those services.We have a long selling cycle for our services. Before potential customers commit to use our services, they require us to expend substantial time and resources educating them on the value of our services and our ability to meet their requirements. Therefore, our selling cycle is subject to many risks and delays over which we have little or no control, including our customers’ decision to select another service provider or in-house resources to perform the services, the timing of our customers’ budget cycles, and customer procurement and approval processes. If our sales cycle unexpectedly lengthens for one or more large projects, it could negatively affect the timing of our revenues and our revenue growth. In certain cases, we may begin work and incur costs prior to executing a contract, which may cause fluctuations in recognizing revenues between periods or jeopardize our ability to collect payment from customers.Implementing our services also involves a significant commitment of resources over an extended period of time from both our customers and us. Our current and future customers may not be willing or able to invest the time and resources necessary to implement our services, and we may fail to close sales with potential customers despite devoting significant time and resources. Any significant failure to generate revenues or delays in recognizing revenues after incurring costs related to our sales or services processes could have a material adverse effect on our business. 17Table of ContentsIf we are unable to adapt to rapidly changing technologies, methodologies and evolving industry standards, we may lose customers and our business could be materially adversely affected.Rapidly changing technologies, methodologies and evolving industry standards are inherent in the market for our products and services. Our ability to anticipate developments in our industry, enhance our existing services, develop and introduce new services, provide enhancements and new features for our products, and keep pace with changes and developments are critical to meeting changing customer needs. Developing solutions for our customers is extremely complex and is expected to become increasingly complex and expensive in the future due to the introduction of new platforms, operating systems, technologies and methodologies. Our ability to keep pace with, anticipate or respond to changes and developments is subject to a number of risks, including that:•we may not be able to develop new, or update existing services, applications, tools and software quickly or inexpensively enough to meet our customers’ needs;•we may find it difficult or costly to make existing software and products work effectively and securely over the internet or with new or changed operating systems;•we may find it challenging to develop new, or update existing software, services, and products to keep pace with evolving industry standards, methodologies, technologies, and regulatory developments in the industries where our customers operate at a pace and cost that is acceptable to our customers; and•we may find it difficult to maintain high quality levels with new technologies and methodologies.We may not be successful in anticipating or responding to these developments in a timely manner, or if we do respond, the services, products, technologies or methodologies we develop or implement may not be successful in the marketplace. Further, services, products, technologies or methodologies that our competitors develop may render our services or products non-competitive or obsolete. Our failure to enhance our existing services and products and to develop and introduce new services and products to promptly address the needs of our customers could have a material adverse effect on our business.If we cause disruptions to our customers’ businesses, provide inadequate service, or breach contractual obligations, our customers may have claims for substantial damages against us and our reputation may be damaged. Our insurance coverage may be inadequate to protect us against such claims.If our professionals make errors in the course of delivering services or we fail to meet contractual obligations to a customer, these errors or failures could disrupt the customer’s business or expose confidential or personally identifiable information. Any of these events could result in a reduction in our revenues, damage to our reputation, and could also result in a customer terminating our engagement and making claims for substantial damages against us. Some of our customer agreements do not limit our potential liability for occurrences such as breaches of confidentiality and intellectual property infringement indemnity, and we cannot generally limit liability to third parties with which we do not have a contractual relationship. In some cases, breaches of confidentiality obligations, including obligations to protect personally identifiable information, may entitle the aggrieved party to equitable remedies, including injunctive relief.Although we maintain professional liability insurance, product liability insurance, cyber incident insurance, commercial general and property insurance, business interruption insurance, workers’ compensation coverage, and umbrella insurance for certain of our operations, our insurance coverage does not insure against all risks in our operations or all claims we may receive. Damage claims from customers or third parties brought against us or claims that we initiate due to the disruption of our business, information security systems, litigation, or natural disasters, may not be covered by our insurance, may exceed the limits of our insurance coverage, and may result in substantial costs and diversion of resources even if insured. Some types of insurance are not available on reasonable terms or at all in some countries in which we operate, and we cannot insure against damage to our reputation. The assertion of one or more large claims against us, whether or not successful and whether or not insured, could materially adversely affect our reputation, business, financial condition and results of operations. 18Table of ContentsA significant failure in our systems, telecommunications or IT infrastructure could harm our service model, which could result in a reduction of our revenues and otherwise disrupt our business.Our service model relies on maintaining active and stable utility connections, voice and data communications, online resource management, financial and operational record management, customer service and data processing systems between our customer sites, our delivery centers and our customer management locations. Our business activities may be materially disrupted in the event of a partial or complete failure of any of these technologies or systems, which could be due to software malfunction, computer virus attacks, conversion errors due to system upgrades, damage from fire, earthquake, power loss, military action, telecommunications failure, unauthorized entry, government shutdowns, demands placed on internet infrastructure by growing numbers of users, increased bandwidth requirements or other events beyond our control. Our crisis management procedures, business continuity, and disaster recovery plans may not be effective at preventing or mitigating the effects of such disruptions, particularly in the case of multiple or catastrophic events. Loss of all or part of the infrastructure or systems for a period of time could hinder our performance or our ability to complete customer projects on time which, in turn, could lead to a reduction of our revenues or otherwise materially adversely affect our business and business reputation.Our ability to generate and retain business could depend on our reputation in the marketplace.Our services are marketed to customers and prospective customers based on a number of factors, including reputation. Our corporate reputation is a significant factor in our customers’ evaluation of whether to engage our services. Our customers’ perception of our ability to add value through our services is critical to the profitability of our engagements. We believe the EPAM brand name and our reputation are important corporate assets that help distinguish our services from those of our competitors and contribute to our efforts to recruit and retain talented employees.Our corporate reputation is potentially susceptible to damage by actions or statements made by current or former customers and employees, competitors, vendors, adversaries in legal proceedings, government regulators, as well as members of the investment community and the media. There is a risk that negative information about us, even if untrue, could adversely affect our business, could cause damage to our reputation and be challenging to repair, could make potential or existing customers reluctant to select us for new engagements, and could adversely affect our recruitment and retention efforts. Damage to our reputation could also reduce the value and effectiveness of the EPAM brand name and could reduce investor confidence in us.We may not be able to prevent unauthorized use of our intellectual property, and our intellectual property rights may not be adequate to protect our business and competitive position.We rely on a combination of copyright, trademark, patent, unfair competition and trade secret laws, as well as intellectual property assignment and confidentiality agreements and other methods to protect our intellectual property rights. Protection of intellectual property rights and confidentiality in some countries in which we operate may not be as effective as in other countries with more developed intellectual property protections.We require our employees and independent contractors to assign to us all intellectual property and work product they create in connection with their employment or engagement. These assignment agreements also obligate our personnel to keep proprietary information confidential. If these agreements are not enforceable in any of the jurisdictions in which we operate, or are breached, we cannot ensure that we will solely own the intellectual property they create or that our proprietary information will not be disclosed. Our customers and certain vendors are generally obligated to keep our information confidential, but if these contractual obligations are not entered, or are breached or deemed unenforceable, our trade secrets, know-how or other proprietary information may be subject to unauthorized use, misappropriation or disclosure. Reverse engineering, unauthorized copying or other misappropriation of our and our customers’ proprietary technologies, tools and applications could enable unauthorized parties to benefit from our or our customers’ technologies, tools and applications without payment and may make us liable to our customers for damages and compensation, which could harm our business and competitive position.We rely on our trademarks, trade names, service marks and brand names to distinguish our services and solutions from the services of our competitors. We have registered or applied to register many of these trademarks. Third parties may oppose our trademark applications, or otherwise challenge our use of our trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our services and solutions, which could result in loss of brand recognition, and could require us to devote additional resources to advertising and marketing new brands. Further, we cannot provide assurance that competitors will not infringe our trademarks, or that we will have adequate knowledge of infringement or resources to enforce our trademarks. If we do enforce our trademarks and our other intellectual property rights through litigation, we may not be successful and the litigation may result in substantial costs and diversion of resources and management attention. 19Table of ContentsWe may face intellectual property infringement claims that could be time-consuming and costly to defend. If we fail to defend ourselves against such claims, we may lose significant intellectual property rights and may be unable to continue providing our existing services.Our success largely depends on our ability to use and develop our technology, tools, code, methodologies, products, and services without infringing the intellectual property rights, including patents, copyrights, trade secrets and trademarks, of third parties. We may be unaware of intellectual property rights relating to our products or services that may give rise to potential infringement claims against us. If those intellectual property rights are potentially relevant to our service offerings, we may need to license those rights in order to continue to use the applicable technology, but the holders of those intellectual property rights may be unwilling to license those rights to us on commercially acceptable terms, if at all. There may also be technologies licensed to and relied on by us that if subject to infringement or misappropriation claims by third parties, may become unavailable to us if such third parties obtain an injunction to prevent us from delivering our services or using technology involving the allegedly infringing intellectual property. We typically indemnify customers who purchase our products, services and solutions against potential infringement of third-party intellectual property rights, which subjects us to the risk and cost of defending the underlying infringement claims. These claims may require us to initiate or defend protracted and costly litigation on behalf of our customers, regardless of the merits of these claims, and our indemnification obligations are often not subject to liability limits or exclusion of consequential, indirect or punitive damages. Intellectual property litigation could also divert our management’s attention from our business and existing or potential customers could defer or limit their purchase or use of our software product development services or solutions until we resolve such litigation. If any of these claims succeed, we may be forced to pay damages on behalf of our customers, redesign or cease offering our allegedly infringing products, services, or solutions, or obtain licenses for the intellectual property that such services or solutions allegedly infringe. If we cannot obtain all necessary licenses on commercially reasonable terms, our customers may be forced to stop using our services or solutions. Any of these actions, regardless of the outcome of litigation or merits of the claim, could damage our reputation and materially adversely affect our business, financial condition and results of operations.Risks Related to Information Security and Data ProtectionSecurity breaches and other disruptions to network security could compromise our information and expose us to liability, which would cause our business and reputation to suffer.In the ordinary course of business, we collect, store, process, transmit, and view sensitive or confidential data, including intellectual property, proprietary business information and personally identifiable information belonging to us, our customers, our respective employees, and other end users. This information is stored in our data centers and networks or in the data centers and networks of third-party providers. Physical security and the secure storage, processing, maintenance and transmission of this information is critical to our operations and business strategy. Some of our customers seek additional assurances for the protection of their sensitive information, including personally identifiable information, and will seek greater liability in the event that their sensitive information is disclosed. At times, to achieve commercial objectives, we may agree to greater liability exposure to such customers. In addition, government regulators may impose fines, penalties, and other civil or criminal consequences for security breaches and inadequate information security. Other parties, such as our customers’ customers, may have a private right of action to seek damages for any information security breach on an individual or collective basis.Individuals, including employees, contractors and other third parties in our information security supply chain, as well as groups and larger, sophisticated collections of hackers, such as state-sponsored organizations, all pose threats to our information security. These individual, group, and organized actors have a variety of methods at their disposal, including deploying malicious software, exploiting vulnerabilities in hardware, software, or infrastructure, using social engineering or deceptive techniques, and executing coordinated attacks to compromise our services, disrupt our operations or gain access to our networks and data centers. 20Table of ContentsThreats to information security evolve constantly and are increasingly sophisticated and complex, which makes detecting and successfully defending against them more difficult. Undetected vulnerabilities may persist in our network environment over long periods of time and could come from or spread to the networks and systems of our suppliers and customers. We frequently update and improve our information security environment and assess and adopt new methods, devices, and technologies, but our policies and information security controls may not keep pace with emerging threats. We have in the past been subject to cyberattacks and expect to continue to be the target of malicious attacks. Despite our multiple security measures, any breach of our facilities, network, or information security defenses compromises the information stored in those locations and allows the accessed information to be held for ransom, publicly disclosed, misappropriated, lost or stolen. Such a breach, misappropriation, or disruption could also disrupt our operations and the services we provide to customers, damage our reputation, and cause a loss of confidence in our products and services, as well as require us to expend significant resources to protect against further breaches and to rectify problems caused by these events. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under applicable laws, and regulatory penalties and could adversely affect our business, revenues and competitive position.Development and deployment of measures to protect our information security or that of our customers may be inadequate and could adversely affect our results of operations.To defend against information security threats internally, at our third-party providers, and on our customers’ systems, we must continuously engineer or purchase more secure products and services, enhance security and reliability features, improve deployment and compliance with software updates, assess and develop mitigation strategies and technologies to help secure information, hire information security specialists, and maintain a security infrastructure that protects our network, products, and services, and the software we build for our customers. We must also educate our employees, contractors, and customers about the need to effectively use security measures. Our customers, particularly those in the Financial Services and Life Sciences & Healthcare industry verticals, may have enhanced or particular security requirements which we must address in our engineering and development services.The cost of information security measures, either to protect our information or the information of our customers, could reduce our profitability. Actual or perceived security vulnerabilities in our software and services, even if those vulnerabilities are the result of hardware or software developed by third parties, could harm our reputation and lead customers to use our competitors, reduce or delay future purchases of our services, or to seek compensation or damages. Changes in privacy and data protection regulations could expose us to risks of noncompliance and costs associated with compliance.EPAM is subject to the GDPR, the substantially similar U.K. GDPR, the privacy laws of California and other U.S. states, and the privacy laws of the countries where we operate, each of which imposes significant restrictions and requirements relating to the processing of personal data. These and other state, national and international data protection laws that are or will soon be effective are more burdensome than historical privacy standards, especially in the United States. California’s privacy laws, the U.K. GDPR, and GDPR each established complex legal obligations that organizations must follow with respect to the processing of personal data, including a prohibition on the transfer of personal information to third parties or to other countries, and the imposition of additional notification, security and other control measures.Enforcement actions taken by data protection authorities, as well as audits or investigations by one or more individuals, organizations, or foreign government agencies could result in penalties and fines for non-compliance or direct claims against us in the event of any loss or damage as a result of a breach of these regulations. The burden of compliance with additional data protection requirements may result in significant additional costs, complexity and risk in our services and customers may seek to shift the potential risks resulting from the implementation of data privacy legislation to us. We are required to establish processes and change certain operations in relation to the processing of personal data as a result of privacy laws, which may involve substantial expense and distraction from other aspects of our business.Undetected software design defects, errors or failures may result in loss of business or in liabilities that could materially adversely affect our business.Our software development solutions involve a high degree of technological complexity, have unique specifications and could contain design defects or software errors that are difficult to detect or correct. Errors or defects may result in the loss of current customers, revenues, market share, or customer data, a failure to attract new customers or achieve market acceptance and could divert development resources and increase support or service costs. We cannot provide assurance that, despite testing by our customers and us, errors will not be found in the software products we develop or the services we perform. Any such errors could result in claims for damages against us, litigation, and reputational harm that could materially adversely affect our business. 21Table of ContentsGeneral Risk FactorsOur stock price is volatile.Our common stock has at times experienced substantial price volatility as a result of variations between our actual and anticipated financial results, announcements by our competitors, third parties, or us, projections or speculation about our business or that of our competitors or industry by the media or investment analysts, geopolitical events or uncertainty about inflation or other current global economic conditions. The stock market, as a whole, also has experienced price and volume fluctuations that have affected the market price of many technology companies in ways that may have been unrelated to these companies’ operating performance. Furthermore, we believe our stock price should reflect future growth and profitability expectations and, if we fail to meet these expectations, our stock price may significantly decline.Expense related to our liability-classified restricted stock units, which are subject to mark-to-market accounting, and the calculation of the weighted average diluted shares outstanding in accordance with the treasury method are both affected by our stock price. Any fluctuations in the price of our stock will affect our future operating results.We may need additional capital, and a failure to raise additional capital on terms favorable to us, or at all, could limit our ability to grow our business and develop or enhance our service offerings to respond to market demand or competitive challenges.We believe that our current cash, cash flow from operations and revolving line of credit are sufficient to meet our anticipated cash needs for at least the next twelve months. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions that we may decide to pursue. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain another credit facility, and we cannot be certain that such additional financing would be available on terms acceptable to us or at all. The sale of additional equity securities could result in dilution to our stockholders, and additional indebtedness would result in increased debt service costs and obligations and could impose operating and financial covenants that would further restrict our operations. Our hedging program is subject to counterparty default risk.We enter into foreign currency forward contracts with a number of counterparties. As a result, we are subject to the risk that the counterparty to one or more of these contracts defaults on its performance under the contract. During an economic downturn, the counterparty’s financial condition may deteriorate rapidly and with little notice and we may be unable to take action to protect our exposure. In the event of a counterparty default, we could incur significant losses, which may harm our business and financial condition. In the event that one or more of our counterparties becomes insolvent or files for bankruptcy, our ability to eventually recover any losses suffered as a result of that counterparty’s default may be limited by the liquidity of the counterparty.War, terrorism, other acts of violence or natural or man-made disasters may affect the markets in which we operate, our customers, and our service delivery.Our business may be negatively affected by instability, disruption or destruction in the geographic regions where we operate. War, terrorism, riot, civil insurrection or social unrest; man-made and natural disasters, the severity and frequency of which have increased due to climate change, and include famine, flood, fire, earthquake, pandemics and other regional or global health crises, storm or disease, may cause customers to delay their decisions on spending for the services we provide and give rise to sudden significant changes in regional and global economic conditions and cycles. Our crisis management procedures, business continuity, and disaster recovery plans may not be effective at preventing or mitigating the effects of such disasters, particularly in the case of simultaneous or catastrophic events. These events pose significant security risks to our people, the facilities where they work, our operations, electricity and other utilities, communications, travel, and network services, and the disruption of any or all of them could materially adversely affect our financial results. Travel restrictions resulting from natural or man-made disruptions and political or social conflict increase the difficulty of obtaining and retaining highly skilled and qualified professionals and could unexpectedly increase our labor costs and expenses, both of which could also adversely affect our ability to serve our customers. 22Table of ContentsOur effective tax rate could be materially adversely affected by several factors.We conduct business globally and file income tax returns in multiple jurisdictions. Our effective tax rate could be materially adversely affected by several factors, including changes in the amount of income taxed by or allocated to the various jurisdictions in which we operate that have differing statutory tax rates; changing tax laws, regulations and interpretations of such tax laws in one or more jurisdictions; and the resolution of issues arising from tax audits or examinations and any related interest or penalties. The determination of our provision for income taxes and other tax liabilities requires estimation, judgment and calculations where the ultimate tax determination may not be certain. Our determination of tax liability is always subject to review or examination by authorities in various jurisdictions. If a tax authority in any jurisdiction reviews any of our tax returns and proposes an adjustment, including, but not limited to, a determination that the transfer prices and terms we have applied are not appropriate, such an adjustment could have a negative impact on our results of operations, business, and profitability. Item 1B. Unresolved Staff CommentsNone. Item 2. PropertiesOur corporate headquarters are located in Newtown, Pennsylvania. We own and lease office buildings used as delivery centers, client management locations and space for administrative and support functions. These facilities are located in numerous cities worldwide and are strategically positioned in relation to our talent sources and key in-market locations to align with the needs of our operations. We believe that our existing properties are adequate to meet the current requirements of our business, and that suitable additional or substitute space will be available, if necessary. Our facilities are used interchangeably among our segments. See Note 17 “Segment Information” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for information regarding the geographical locations and values of our long-lived assets. See Note 7 “Property and Equipment, Net” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for information regarding our long-lived assets and buildings we own. See Note 9 “Leases” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for information regarding our leased assets. See Note 2 “Impact of the Invasion of Ukraine” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for more information regarding the assets in Ukraine and Russia. Item 3. Legal ProceedingsFrom time to time, we are involved in litigation and claims arising out of our business and operations in the normal course of business. We are not currently a party to any material legal proceeding, nor are we aware of any material legal or governmental proceedings pending or contemplated to be brought against us.Item 4. Mine Safety DisclosuresNone. 23Table of ContentsPART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesMarket InformationOur common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “EPAM.”As of February 10, 2023, we had approximately 17 stockholders of record of our common stock. The number of record holders does not include holders of shares in “street name” or persons, partnerships, associations, corporations or other entities identified in security position listings maintained by depositories.Dividend PolicyWe have not declared or paid any cash dividends on our common stock and currently do not anticipate paying any cash dividends in the foreseeable future. Instead, we intend to retain all available funds and any future earnings for use in the operation and expansion of our business, and to repurchase our common stock. In addition, our revolving credit facility restricts our ability to make or pay dividends (other than certain intercompany dividends) unless no potential or actual event of default has occurred or would be triggered thereby. Any future determination relating to our dividend policy will be made at the discretion of our Board of Directors and will depend on our future earnings, capital requirements, financial condition, future prospects, applicable Delaware law, which provides that dividends are only payable out of surplus or current net profits, and other factors that our Board of Directors deems relevant. Equity Compensation Plan InformationSee “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” in Part III of this Annual Report on Form 10-K for our equity compensation plan information. 24Table of ContentsPerformance GraphThe following graph compares the cumulative total stockholder return on our common stock with the cumulative total return on a Peer Group Index (capitalization weighted) and the S&P 500 Index for the period beginning December 31, 2017 and ending December 31, 2022. The stock performance shown on the graph below is not indicative of future price performance. The following performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing. COMPARISON OF CUMULATIVE TOTAL RETURN (1)(2)Among EPAM, a Peer Group (3) and the S&P 500 Index Company/IndexBase period12/31/201712/31/201812/31/201912/31/202012/31/202112/31/2022EPAM Systems, Inc. $100.00 $107.99 $197.49 $333.57 $622.22 $305.07 Peer Group Index$100.00 $71.71 $70.23 $103.74 $133.18 $76.06 S&P 500 Index$100.00 $95.62 $125.73 $148.86 $191.59 $156.89 (1)Graph assumes $100 invested on December 31, 2017 in our common stock, a Peer Group and the S&P 500 Index.(2)Cumulative total return assumes reinvestment of dividends.(3)The Peer Group includes Cognizant Technology Solutions Corp. (NASDAQ:CTSH), DXC Technology Company (NYSE:DXC), Endava plc (NYSE:DAVA), Globant S.A. (NYSE:GLOB), Infosys Ltd. (NYSE:INFY), Perficient, Inc. (NASDAQ:PRFT), and Wipro Limited (NYSE:WIT).Unregistered Sales of Equity SecuritiesThere were no unregistered sales of equity securities by the Company during the year ended December 31, 2022. 25Table of ContentsPurchases of Equity Securities by the Issuer and Affiliated PurchasersUnder our equity-based compensation plans, the Company withholds a number of shares of vested stock as payment to satisfy tax withholding obligations arising on the date of vesting of stock-based compensation awards. The number of shares of stock to be withheld is calculated based on the closing price of the Company’s common stock on the vesting date. The following table provides information about shares withheld by the Company during the year ended December 31, 2022:PeriodTotal Number ofShares PurchasedAverage PricePaid Per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Dollar Amount of Shares That May Yet Be Purchased Under the ProgramJanuary 1, 2022 to January 31, 20221,023 $624.01 — — February 1, 2022 to February 28, 20221,267 $470.95 — — March 1, 2022 to March 31, 202263,954 $268.02 — — April 1, 2022 to April 30, 20225,560 $276.79 — — May 1, 2022 to May 31, 2022453 $340.35 — — June 1, 2022 to June 30, 2022477 $313.19 — — July 1, 2022 to July 31, 2022871 $317.75 — — August 1, 2022 to August 31, 2022415 $396.68 — — September 1, 2022 to September 30, 20221,092 $362.43 — — October 1, 2022 to October 31, 2022252 $348.91 — — November 1, 2022 to November 30, 20221,448 $348.44 — — December 1, 2022 to December 31, 20226,134 $326.37 — — Total82,946 $285.13 — — Item 6.ReservedItem 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsYou should read the following discussion and analysis of our financial condition and results of operations together with our audited consolidated financial statements and the related notes included elsewhere in this annual report. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the sections entitled “Forward-Looking Statements” and “Part I. Item 1A. Risk Factors.” We assume no obligation to update any of these forward-looking statements.Executive SummaryWe are a leading global provider of digital platform engineering and software development services to many of the world’s leading organizations. Our customers depend on us to solve their complex technical challenges and rely on our expertise in core engineering, advanced technology, digital design and intelligent enterprise development.We continuously explore opportunities in new industries to expand our core industry client base in software and technology, financial services, business information and media, travel and consumer, and life sciences and healthcare. Our teams of developers, architects, consultants, strategists, engineers, designers, and product experts have the capabilities and skill sets to deliver business results. Through increased specialization in focused verticals and a continued emphasis on strategic partnerships, we are leveraging our roots in software engineering to grow as a recognized brand in software development and end-to-end digital transformation services for our customers. 26Table of ContentsOur global delivery model and centralized support functions, combined with the benefits of scale from the shared use of fixed-cost resources, enhance our productivity levels and enable us to better manage the efficiency of our global operations. As a result, we have created a delivery base whereby our applications, tools, methodologies and infrastructure allow us to seamlessly deliver services and solutions from our delivery centers to global customers across all geographies, further strengthening our relationships with them. To ensure safety and business continuity in the environment introduced by the COVID-19 global pandemic, many of our personnel have worked and continue to work productively through secure remote working arrangements so they can respond to the rapidly changing needs and demands of our customers. For further information on the various risks posed by the disruptions to our business structure, please read “Part I. Item 1A. Risk Factors” included in this Annual Report on Form 10-K.Business Update Regarding the War in Ukraine On February 24, 2022, Russian forces attacked Ukraine and its people and EPAM has repeatedly called for an immediate end to this unlawful and unconscionable attack. EPAM’s highest priority is the safety and security of its employees and their families in Ukraine as well as the broader region, and we have continued to support relocating our employees to lower risk locations, both in Ukraine and to other countries where we operate. The vast majority of our Ukraine employees are in safe locations and operating at levels of productivity consistent with those achieved in 2021. As of December 31, 2022, Ukraine remains our largest delivery location with the most delivery professionals. Furthermore, we have maintained our $100 million humanitarian aid commitment to our people in Ukraine in addition to our other donations and volunteer efforts. Prior to the attack in February 2022, Belarus and Russia were our second and third largest delivery locations by the number of delivery professionals, respectively. On April 7, 2022, the Company announced the beginning of a phased exit of our operations in Russia in close collaboration with our employees, contractors, and customers. We have discontinued services to certain customers located in Russia and on September 7, 2022, we executed an agreement to sell substantially all of our remaining holdings in Russia to a third party. As of December 31, 2022 and through the date of issuance of the financial statements, the long stop date of the agreement has passed and we are currently renegotiating the terms of that sale agreement as well as exploring other strategic alternatives. The timing and completion of a sale is uncertain and any sale would be subject to customary closing conditions, including regulatory approvals by the Russian government.We expect to continue operating in Belarus while executing on our Belarus-specific business continuity plans. A significant number of our employees in Russia and Belarus have relocated, and we may assist in relocating employees to delivery locations in other countries in the future. Additionally, we continue to execute our business continuity plans and have sustained our hiring efforts across multiple locations in Eastern Europe, Central and Western Asia, India, and Latin America. We own office buildings and lease office space in a number of cities in both Ukraine and in Belarus that we use for both internal functions and for delivering services to our customers. The impact of the war on our operations, personnel, and physical assets in Ukraine has had, and, along with any escalation of the war that includes Belarus’ territory or military, could continue to have, a material adverse effect on our operations. Actions taken by other countries, including new and stricter sanctions by Canada, the United Kingdom, the European Union, the U.S. and other companies and organizations against officials, individuals, regions, and industries in Russia and Belarus, and each of those country’s responses to such sanctions, including counter-sanctions and other actions, has had and could continue to have a material adverse effect on our operations. Customers have and may continue to seek altered terms, conditions, and delivery locations for the performance of services, delay planned work or seek services from alternate providers, or suspend, terminate, fail to renew, or reduce existing contracts or services, which could have a material adverse effect on our financial condition. Some of our customers have implemented steps to block internet communications with Russia, Ukraine, and Belarus to protect against potential cyberattacks or other information security threats, which has caused a material adverse effect on our ability to deliver our services to these customers from those locations. Such material adverse effects disrupt our delivery of services, cause us to shift all or portions of our work occurring in the region to other countries, restrict our ability to engage in certain projects in the region and serve certain customers in or from the region, and could negatively impact our personnel, operations, financial results and business outlook. Our Board of Directors continues its oversight of our strategic, geopolitical, and cybersecurity risks and the risks related to our geographic expansion. Our Board has received updates from management during both regular and special meetings, while also providing oversight of the risks associated with Russia’s invasion of Ukraine and other strategic areas of importance related to the war. 27Table of ContentsMoving ForwardWe continue to execute our business continuity plans and adapt to developments as they occur to protect the safety of our people and address impacts on our delivery infrastructure, including reallocating work to other geographies within our global footprint. We have engaged both our personnel and our customers to meet their needs and to mitigate delivery challenges. EPAM continues to operate productively in more than 50 countries and provides consistent high-quality delivery to our customers. Our global delivery centers have sufficient resources, including infrastructure and capital, to support ongoing operations. EPAM continues to rapidly respond to the difficult conditions in Ukraine while maintaining a focus on customers and long-term growth. Implementation and execution of our business continuity plans, relocation costs, our humanitarian commitment to our people in Ukraine, and the cost of our phased exit from Russia have resulted in materially increased expenses during 2022. We expect some of those expenses will continue to occur in subsequent quarters for some time in the future. In addition to the charges recorded during 2022 related to our exit from Russia, based on the information available through the date of issuance of the financial statements, we expect to record a loss upon the earlier of classification of the assets and liabilities to be sold as held for sale or closing of a sale, and such loss is not expected to be material. Fluctuations in foreign currency exchange rates could impact the gain or loss the Company could recognize in the future. If unable to complete a sale, the Company could recognize other charges including restructuring costs.We have no way to predict the progress or outcome of the attack against Ukraine because the conflict and government reactions change quickly and are beyond our control. Prolonged military activities, broad-based sanctions and counter-sanctions could have a material adverse effect on our operations and financial condition and there is significant uncertainty for our business outlook for 2023. The information contained in this section is accurate as of the date hereof but may become outdated due to changing circumstances beyond our control or present awareness. For additional information on the various risks posed by the attack against Ukraine and the impact in the region, please read “Part I. Item 1A. Risk Factors” included in this Annual Report on Form 10-K. Overview of 2022 and Financial HighlightsThe following table presents a summary of our results of operations for the years ended December 31, 2022, 2021 and 2020: Year Ended December 31, 202220212020% of revenues% of revenues% of revenues (in millions, except percentages and per share data) Revenues$4,824.7 100.0 %$3,758.1 100.0 %$2,659.5 100.0 %Income from operations$573.0 11.9 %$542.3 14.4 %$379.3 14.3 %Net income$419.4 8.7 %$481.7 12.8 %$327.2 12.3 %Effective tax rate17.3 %9.7 %13.6 %Diluted earnings per share$7.09 $8.15 $5.60 The key highlights of our consolidated results for 2022 were as follows:•We recorded revenues of $4.825 billion, or a 28.4% increase from $3.758 billion in the previous year, negatively impacted by $151.1 million or 4.0% due to changes in certain foreign currency exchange rates as compared to the previous year.•Income from operations grew 5.7% to $573.0 million in 2022 from $542.3 million in 2021. Expressed as a percentage of revenues, income from operations was 11.9% compared to 14.4%. During the year ended December 31, 2022, income from operations as a percentage of revenues was negatively impacted by incremental expenses associated with EPAM’s humanitarian efforts in Ukraine, the global repositioning of our workforce, unbilled business continuity resources, the costs associated with our phased exit from operations in Russia, and impairment of long-lived asset charges triggered by the decision to discontinue services to customers in Russia. 28Table of Contents•Our effective tax rate was 17.3% compared to 9.7% in the previous year. The increase in the effective tax rate for 2022 as compared to the prior year is primarily attributable to the decrease in excess tax benefits recorded upon vesting or exercise of stock-based awards and tax charges in 2022 resulting from changes to certain U.S. tax regulations, partially offset by one-time tax benefits in 2022 resulting from the Company’s decision to change the tax status and to classify certain of its foreign subsidiaries as disregarded entities for U.S. income tax.•Net income decreased 12.9% to $419.4 million compared to $481.7 million in 2021. Expressed as a percentage of revenues, net income decreased 4.1% during 2022 compared to last year. Net income during 2022 was impacted by net foreign exchange losses, partially offset by the improvement in income from operations. Foreign exchange loss during 2022 was primarily driven by the impact of appreciation of the Russian ruble on the Company’s intercompany payables denominated in Russian rubles and U.S. dollar denominated assets held by our subsidiaries in Russia and losses from our foreign exchange forward contracts associated with the Russian ruble. •Diluted earnings per share decreased 13.0% to $7.09 for the year ended December 31, 2022 from $8.15 in 2021.•Cash provided by operations decreased $108.2 million, or 18.9%, to $464.1 million during 2022 as compared to last year. The decrease was largely driven by an increase in days sales outstanding during 2022, higher level of variable compensation payments made in 2022 based on 2021 performance, and cash outflows related to EPAM’s humanitarian support efforts in Ukraine and geographic repositioning. The operating results in any period are not necessarily indicative of the results that may be expected for any future period.Critical Accounting PoliciesWe prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”), which require us to make judgments, estimates and assumptions that affect: (i) the reported amounts of assets and liabilities, (ii) the disclosure of contingent assets and liabilities at the end of each reporting period and (iii) the reported amounts of revenues and expenses during each reporting period. We evaluate these estimates and assumptions based on historical experience, knowledge and assessment of current business and other conditions, and expectations regarding the future based on available information and reasonable assumptions, which together form a basis for making judgments about matters not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of our accounting policies require higher degrees of judgment than others in their application. When reviewing our audited consolidated financial statements, you should consider (i) our selection of critical accounting policies, (ii) the judgment and other uncertainties affecting the application of such policies and (iii) the sensitivity of reported results to changes in conditions and assumptions. We consider the policies discussed below to be critical to an understanding of our consolidated financial statements as their application places significant demands on the judgment of our management.An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. We believe that the following critical accounting policies are the most sensitive and require more significant estimates and assumptions used in the preparation of our consolidated financial statements. You should read the following descriptions of critical accounting policies, judgments and estimates in conjunction with our audited consolidated financial statements and other disclosures included elsewhere in this annual report. Additional information on our policies is in Note 1 “Business and Summary of Significant Accounting Policies” in the notes to our consolidated financial statements in this Annual Report on Form 10-K.Revenues — We recognize revenues when control of goods or services is passed to a customer in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Such control may be transferred over time or at a point in time depending on satisfaction of obligations stipulated by the contract. Consideration expected to be received may consist of both fixed and variable components and is allocated to each separately identifiable performance obligation based on the performance obligation’s relative standalone selling price. Variable consideration usually takes the form of volume-based discounts, service level credits, price concessions or incentives. Determining the estimated amount of such variable consideration involves assumptions and judgment that can have an impact on the amount of revenues reported. 29Table of ContentsWe derive revenues from a variety of service arrangements, which have been evolving to provide more customized and integrated solutions to customers by combining software engineering with customer experience design, business consulting and technology innovation services. Fees for these contracts may be in the form of time-and-materials or fixed-price arrangements. We generate the majority of our revenues under time-and-material contracts, which are billed using hourly, daily or monthly rates to determine the amounts to be charged directly to the customer. We apply a practical expedient and revenues related to time-and-material contracts are recognized based on the right to invoice for services performed.Fixed-price contracts include maintenance and support arrangements, which may exceed one year in duration. Maintenance and support arrangements generally relate to the provision of ongoing services and revenues for such contracts are recognized ratably over the expected service period. Fixed-price contracts also include application development arrangements, where progress towards satisfaction of the performance obligation is measured using input or output methods and input methods are used only when there is a direct correlation between hours incurred and the end product delivered. Assumptions, risks and uncertainties inherent in the estimates used to measure progress could affect the amount of revenues, receivables and deferred revenues at each reporting period. Revenues from licenses which have significant stand-alone functionality are recognized at a point in time when control of the license is transferred to the customer. Revenues from licenses which do not have stand-alone functionality are recognized over time. If there is an uncertainty about the receipt of payment for the services, revenue recognition is deferred until the uncertainty is sufficiently resolved. We apply a practical expedient and do not assess the existence of a significant financing component if the period between transfer of the service to a customer and when the customer pays for that service is one year or less.We report gross reimbursable “out-of-pocket” expenses incurred as both revenues and cost of revenues in the consolidated statements of income.Business Combinations — We account for business combinations using the acquisition method which requires us to estimate the fair value of identifiable assets acquired and liabilities assumed, including any contingent consideration, to properly allocate purchase price to the individual assets acquired and liabilities assumed. A substantial portion of the purchase price is typically allocated to goodwill and other intangible assets, which typically include customer relationships, software, trade names, non-competition agreements, and assembled workforce. The allocation of the purchase price utilizes significant estimates in determining the fair values of identifiable assets acquired and liabilities assumed, especially with respect to intangible assets. The significant estimates and assumptions used include the timing and amount of forecasted revenues and cash flows, anticipated growth rates, customer attrition rates, the discount rate reflecting the risk inherent in future cash flows, and the useful lives for finite-lived assets. There are different valuation models for each component, the selection of which requires considerable judgment. These determinations will affect the amount of amortization expense recognized in future periods. We base our fair value estimates on assumptions we believe are reasonable but recognize that the assumptions are inherently uncertain. We determine the fair value of contingent consideration using Monte Carlo simulations (which involve a simulation of future revenues and earnings during the earn-out period using management's best estimates) or probability-weighted expected return methods. Changes in financial projections, market risk assumptions, discount rates or probability assumptions related to achieving the various earn-out criteria would result in a change in the fair value of contingent consideration. Such changes, if any, are recorded within Interest and other income/(loss), net in the Company’s consolidated statements of income.If the initial accounting for the business combination has not been completed by the end of the reporting period in which the business combination occurs, provisional amounts are reported to present information about facts and circumstances that existed as of the acquisition date. Once the measurement period ends, which in no case extends beyond one year from the acquisition date, revisions to the accounting for the business combination are recorded in earnings.Recent Accounting PronouncementsSee Note 1 “Business and Summary of Significant Accounting Policies” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for information regarding recent accounting pronouncements. 30Table of ContentsResults of OperationsThe following table sets forth a summary of our consolidated results of operations for the periods indicated. This information should be read together with our consolidated financial statements and related notes included elsewhere in this annual report. The operating results in any period are not necessarily indicative of the results that may be expected for any future period. Year Ended December 31, 202220212020% of revenues% of revenues% of revenues (in thousands, except percentages and per share data)Revenues$4,824,698 100.0%$3,758,144 100.0 %$2,659,478 100.0 %Operating expenses: Cost of revenues (exclusive of depreciation and amortization)(1)3,286,68368.12,483,697 66.11,732,522 65.1Selling, general and administrative expenses(2)872,777 18.1648,736 17.3484,758 18.2Depreciation and amortization expense92,272 1.983,395 2.262,874 2.4Income from operations572,966 11.9542,316 14.4379,324 14.3Interest and other income/(loss), net10,025 0.2(1,727)—3,822 0.1Foreign exchange loss(75,733)(1.6)(7,197)(0.2)(4,667)(0.2)Income before provision for income taxes507,258 10.5533,392 14.2378,479 14.2Provision for income taxes87,842 1.851,740 1.451,319 1.9Net income$419,416 8.7%$481,652 12.8 %$327,160 12.3 %Effective tax rate17.3 %9.7 %13.6 %Diluted earnings per share$7.09 $8.15 $5.60 (1) Includes $47,470, $51,580 and $32,785 of stock-based compensation expense for the years ended December 31, 2022, 2021 and 2020, respectively.(2) Includes $52,439, $60,075 and $42,453 of stock-based compensation expense for the years ended December 31, 2022, 2021 and 2020, respectively.RevenuesWe continue to expand our presence across multiple geographies and verticals, both organically and through strategic acquisitions. During the year ended December 31, 2022, our total revenues grew 28.4% over the previous year to $4.825 billion. This growth resulted from our ability to retain existing customers and increase the level of services we provide to them and our ability to produce revenues from new customer relationships. During the year ended December 31, 2022 we experienced a decrease in customer concentration as compared to the previous year, with revenues from our top five, top ten and top twenty customer groups decreasing as a percentage of total revenues. Revenues have been positively impacted by our acquisitions, which contributed 5.1% to our revenue growth, and negatively impacted by our decision to exit Russia and discontinue services to customers there by 3.7% and fluctuations in foreign currency exchange rates which decreased our revenue growth by 4.0% during the year ended December 31, 2022 as compared to the previous year. We discuss below the breakdown of our revenues by vertical, customer location, service arrangement type, and customer concentration.Revenues by VerticalWe assign our customers into one of our five main vertical markets or a group of various industries where we are increasing our presence, which we label as “Emerging Verticals.” Emerging Verticals include customers in multiple industries such as energy, utilities, manufacturing, automotive, telecommunications and several others. 31Table of ContentsThe following table presents our revenues by vertical and revenues as a percentage of total revenues by vertical for the periods indicated: Year Ended December 31,202220212020(in thousands, except percentages)Travel & Consumer$1,092,224 22.7 %$741,128 19.7 %$458,789 17.2 %Financial Services1,026,686 21.3 848,370 22.6 555,235 20.9 Business Information & Media809,952 16.8 666,941 17.7 560,680 21.1 Software & Hi-Tech793,261 16.4 664,597 17.7 496,813 18.7 Life Sciences & Healthcare507,367 10.5 391,309 10.4 296,313 11.1 Emerging Verticals595,208 12.3 445,799 11.9 291,648 11.0 Revenues$4,824,698 100.0 %$3,758,144 100.0 %$2,659,478 100.0 %Travel & Consumer became our largest vertical during 2022, growing 47.4% as compared to 2021. Except for Software & Hi-Tech, which grew at a rate of 19.4% in 2022 over the prior year, all of our verticals grew over 20% in 2022 over the prior year. Revenues by Customer LocationOur revenues are sourced from multiple countries, which we assign into four geographic markets and identify as Americas, EMEA, APAC and CEE. We present and discuss our revenues by customer location based on the location of the specific customer site that we serve, irrespective of the location of the headquarters of the customer or the location of the delivery center where the work is performed. Revenues by customer location is different from revenues by reportable segment in our consolidated financial statements included elsewhere in this annual report. Segments are not based on the geographic location of the customers, but instead they are based on the location of the Company’s management responsible for a particular customer or market. The following table sets forth revenues by customer location by amount and as a percentage of our revenues for the periods indicated: Year Ended December 31,202220212020(in thousands, except percentages)Americas (1)$2,887,204 59.9 %$2,226,830 59.3 %$1,595,136 60.0 %EMEA (2)1,737,919 36.0 1,259,717 33.4 879,842 33.1 APAC (3)120,370 2.5 103,559 2.8 69,798 2.6 CEE (4)79,205 1.6 168,038 4.5 114,702 4.3 Revenues$4,824,698 100.0 %$3,758,144 100.0 %$2,659,478 100.0 %(1)Americas includes revenues from customers in North, Central and South America.(2)EMEA includes revenues from customers in Western Europe and the Middle East.(3)APAC, or Asia Pacific, includes revenues from customers in East Asia, Southeast Asia and Australia.(4)CEE includes revenues from customers in Russia, Belarus, Kazakhstan, Ukraine, Uzbekistan and Georgia. During the year ended December 31, 2022, revenues in the Americas, our largest geography, were $2.887 billion, growing $660.4 million, or 29.7%, from $2.227 billion reported for the year ended December 31, 2021. Revenues from this geography accounted for 59.9% of total revenues in 2022, an increase from 59.3% in the prior year. The United States continued to be our largest customer location contributing revenues of $2.761 billion in 2022 compared to $2.125 billion in 2021. 32Table of ContentsRevenues in our EMEA geography were $1.738 billion, an increase of $478.2 million, or 38%, over $1.260 billion in the previous year. Revenues in this geography accounted for 36.0% of consolidated revenues in 2022 as compared to 33.4% in the previous year. The top three revenue contributing customer location countries in EMEA were the United Kingdom, Switzerland and the Netherlands generating revenues of $619.3 million, $323.4 million and $215.4 million in 2022, respectively, compared to $474.9 million, $271.2 million and $154.8 million in 2021, respectively. Fluctuations in foreign currency exchange rates with the U.S. dollar, particularly the euro and the British pound, during 2022 compared to the same period in the prior year negatively impacted revenue growth in the EMEA geography by 10.0%. Revenues in the region benefited from acquisitions which contributed $160.9 million to revenue growth in 2022. During 2022, revenues in our CEE geography decreased $88.8 million, or 52.9%, from the previous year. The decrease in CEE revenues came primarily from customers in Russia, contributing a decrease of $90.4 million in 2022 compared to the previous year. On March 4, 2022, we announced that we will discontinue our services to customers located in Russia and have been providing transition support for customers in this market while administering the transition. On September 7, 2022, we executed an agreement to sell substantially all of our remaining holdings in Russia to a third party. As of December 31, 2022 and through the date of issuance of these financial statements, the long stop date of the agreement has passed and we are currently renegotiating the terms of that sale agreement as well as exploring other strategic alternatives. The timing and completion of a sale is uncertain and any sale would be subject to customary closing conditions, including regulatory approvals by the Russian government. As a result, the revenues from this geography are expected to continue to materially decline in the future. Revenues from customers in locations in our APAC region comprised 2.5% of total revenues in 2022, a level consistent with the prior year.Discussion of revenues from 2021 as compared to 2020 is included in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021.Revenues by Customer ConcentrationWe have long-standing relationships with many of our customers and we seek to grow revenues from our existing customers by continually expanding the scope and size of our engagements. Revenues derived from these customers may fluctuate as these accounts mature, upon beginning or completion of multi-year projects or due to external economic environment trends. We believe there is a significant potential for future growth as we expand our capabilities and offerings within existing customers. In addition, we remain committed to diversifying our client base and adding more customers to our client mix through organic growth and strategic acquisitions, and over the long-term, we expect revenue concentration from our top customers to decrease. The following table presents revenues contributed by our customers by amount and as a percentage of our revenues for the periods indicated: Year Ended December 31,202220212020(in thousands, except percentages)Top five customers$793,603 16.4 %$682,147 18.2 %$584,303 22.0 %Top ten customers$1,149,966 23.8 %$966,486 25.7 %$822,824 30.9 %Top twenty customers$1,698,916 35.2 %$1,394,546 37.1 %$1,124,552 42.3 %Customers below top twenty $3,125,782 64.8 %$2,363,598 62.9 %$1,534,926 57.7 %The following table shows the number of customers grouped by revenues recognized by the Company for each year presented: Year Ended December 31,202220212020Over $20 Million 494028$10 - $20 Million513827$5 - $10 Million856343$1 - $5 Million303271225$0.5 - $1 Million185133107 33Table of ContentsRevenues by Service OfferingOur service arrangements have been evolving to provide more customized and integrated solutions to our customers where we combine software engineering with customer experience design, business consulting and technology innovation services. We are continually expanding our service capabilities, moving beyond traditional services into business consulting, design and physical product development.The following table shows revenues by service offering as an amount and as a percentage of our revenues for the years indicated: Year Ended December 31,202220212020(in thousands, except percentages)Professional services$4,800,047 99.5 %$3,739,143 99.5 %$2,643,016 99.4 %Licensing and other revenues24,651 0.5 %19,001 0.5 %16,462 0.6 %Revenues$4,824,698 100.0 %$3,758,144 100.0 %$2,659,478 100.0 %See Note 12 “Revenues” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for more information regarding our contract types and related revenue recognition policies. Cost of Revenues (Exclusive of Depreciation and Amortization)The principal components of our cost of revenues (exclusive of depreciation and amortization) are salaries, bonuses, fringe benefits, stock-based compensation, project-related travel costs and fees for subcontractors who are assigned to customer projects. Salaries and other compensation expenses of our delivery professionals are reported as cost of revenues regardless of whether the employees are actually performing customer services during a given period. Our employees are a critical asset, necessary for our continued success and therefore we expect to continue hiring talented employees and providing them with competitive compensation programs. We manage the utilization levels of our delivery professionals through strategic hiring and efficient staffing of projects. Some of these professionals are hired and trained to work for specific customers or on specific projects and some of our offshore development centers are dedicated to specific customers or projects. Our staff utilization also depends on the general economy and its effect on our customers and their business decisions regarding the use of our services.During the year ended December 31, 2022, cost of revenues (exclusive of depreciation and amortization) was $3,286.7 million, representing an increase of 32.3% from $2,483.7 million reported last year. The increase was primarily due to an increase in compensation costs as a result of an 18.0% growth in the average number of production professionals and the geographic repositioning of our professionals to higher cost geographies in response to the war in Ukraine, a 4.8% unfavorable impact from changes in foreign currency exchange rates, as well as $29.0 million of incremental costs associated with our humanitarian efforts in Ukraine and $14.7 million of unbilled business continuity resources, partially offset by the reversal of $21.4 million of previously accrued discretionary compensation expenses during the first quarter of 2022.Expressed as a percentage of revenues, cost of revenues (exclusive of depreciation and amortization) was 68.1% and 66.1% during the years ended December 31, 2022 and 2021, respectively. The year-over-year increase is primarily due to higher personnel-related costs and the ongoing transition of customer work to higher cost geographies, increased costs associated with our humanitarian efforts in Ukraine, and unbilled business continuity resources, partially offset by the reversal of previously accrued discretionary compensation expenses in the first quarter of 2022. Discussion of cost of revenues (exclusive of depreciation and amortization) from 2021 as compared to 2020 is included in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021.Selling, General and Administrative ExpensesSelling, general and administrative expenses represent expenditures associated with promoting and selling our services and general and administrative functions of our business. These expenses include the costs of salaries, bonuses, fringe benefits, stock-based compensation, severance, bad debt, travel, legal and accounting services, insurance, facilities including operating leases, advertising, and other promotional activities. Additionally, selling, general and administrative expenses contain costs of relocating our employees and various one-time and unusual expenses such as impairment charges. 34Table of ContentsOur selling, general and administrative expenses have increased due to our continuously expanding operations, strategic business acquisitions, and the hiring of necessary personnel to support our growth. During the year ended December 31, 2022, selling, general and administrative expenses were $872.8 million, representing an increase of 34.5% as compared to $648.7 million reported last year. The increase in selling, general and administrative expenses in 2022 was primarily due to a $105.4 million increase in personnel-related costs, which include stock-based compensation expense, primarily driven by an increase in headcount. Additionally, selling, general and administrative expenses for the year ended December 31, 2022 were impacted by $38.7 million of expenses associated with our geographic repositioning of our workforce, $15.8 million of expenses associated with our humanitarian efforts in Ukraine, $17.1 million of charges related to employee separation costs in Russia, $19.6 million of impairment charges related to our long-lived assets in Russia and $5.1 million of bad debt expense attributable to customers located in Russia.Expressed as a percentage of revenues, selling, general and administrative expenses increased 0.8% to 18.1% for the year ended December 31, 2022. The increase was primarily driven by impairment charges related to our long-lived assets in Russia, higher bad debt expenses attributable to customers located in Russia, employee separation costs in Russia, increased costs associated with geographic repositioning of our workforce as well as our humanitarian efforts in Ukraine, partially offset by reduced facilities-related expenses. Discussion of selling, general and administrative expenses from 2021 as compared to 2020 is included in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021.Depreciation and Amortization ExpenseDepreciation and amortization expense includes depreciation of physical assets used in the operation of our business such as computer equipment, software, buildings we purchased, leasehold improvements as well as various office furniture and equipment. Depreciation and amortization expense also includes amortization of acquired finite-lived intangible assets.During the year ended December 31, 2022, depreciation and amortization expense was $92.3 million, representing an increase of $8.9 million from $83.4 million reported in the prior year. The increase in depreciation and amortization expense was primarily driven by an increased investment in computer equipment used by our employees and amortization of acquired finite-lived intangible assets, which contributed $4.6 million to the year over year increase in depreciation and amortization expense. Expressed as a percentage of revenues, depreciation and amortization expense decreased to 1.9% during the year ended December 31, 2022 as compared to 2.2% in 2021. Discussion of depreciation and amortization expense from 2021 as compared to 2020 is included in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021.Interest and Other Income/(Loss), NetInterest and other income/(loss), net includes interest earned on cash and cash equivalents, short-term investments and employee loans, gains and losses from certain financial instruments, interest expense related to our borrowings, government grant income, and changes in the fair value of contingent consideration. Interest and other income/(loss), net increased from a loss of $1.7 million during the year ended December 31, 2021 to a gain of $10.0 million during the year ended December 31, 2022. This change was largely driven by a $6.5 million increase in government grant income and an increase in interest income from our cash and cash equivalents and short-term investments, partially offset by a $2.3 million increase in loss due to the change in fair value of contingent consideration, $0.8 million charge related to the impairment of an investment and a $1.3 million charge related to the impairment of a financial asset in Ukraine recorded during the year ended December 31, 2022.Discussion of Interest and other income/(loss) from 2021 as compared to 2020 is included in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021.Provision for Income TaxesDetermining the consolidated provision for income tax expense, deferred income tax assets and liabilities and any potential related valuation allowances involves judgment. We consider factors that may contribute, favorably or unfavorably, to the overall annual effective tax rate in the current year as well as the future. These factors include statutory tax rates and tax law changes in the countries where we operate and excess tax benefits upon vesting or exercise of equity awards as well as consideration of any significant or unusual items. 35Table of ContentsAs a global company, we are required to calculate and provide for income taxes in each of the jurisdictions in which we operate. During 2022, 2021 and 2020, we had $428.7 million, $404.9 million and $278.1 million, respectively, in income before provision for income taxes attributed to our foreign jurisdictions. Changes in the geographic mix or level of annual pre-tax income can also affect our overall effective income tax rate. Our provision for income taxes includes the impact of provisions established for uncertain income tax positions, as well as the related net interest and penalty expense. Tax exposures can involve complex issues and may require an extended period to resolve. Although we believe we have adequately reserved for our uncertain tax positions, we cannot provide assurance that the final tax outcome of these matters will not be different from our current estimates. We adjust these reserves after consideration of changes in facts and circumstances, such as the closing of a tax audit, statute of limitation lapse or the refinement of an estimate. To the extent that the final tax outcome of these matters differs from the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made.The provision for income taxes was $87.8 million in 2022 and $51.7 million in 2021. The increase was primarily driven by a significant decrease in excess tax benefits recorded upon vesting or exercise of stock-based awards which were $35.1 million in 2022 compared to $71.6 million in 2021. The effective tax rate increased from 9.7% in 2021 to 17.3% in 2022 primarily due to the decrease in excess tax benefits recorded upon vesting or exercise of stock-based awards and tax charges in 2022 resulting from changes to certain U.S. tax regulations, partially offset by one-time tax benefits in 2022 resulting from the Company’s decision to change the tax status and to classify certain of its foreign subsidiaries as disregarded entities for U.S. income tax purposes. Discussion of the provision for income taxes from 2021 as compared to 2020 is included in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021.Foreign Exchange LossFor discussion of the impact of foreign exchange fluctuations see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk — Foreign Exchange Risk.”Results by Business SegmentOur operations consist of three reportable segments: North America, Europe, and Russia. The segments represent components of EPAM for which separate financial information is available and used on a regular basis by our chief executive officer, who is also our chief operating decision maker (“CODM”), to determine how to allocate resources and evaluate performance. Our CODM makes business decisions based on segment revenues and segment operating profits. Segment operating profit is defined as income from operations before unallocated costs. Expenses included in segment operating profit consist principally of direct selling and delivery costs as well as an allocation of certain shared services expenses. Certain corporate expenses are not allocated to specific segments as these expenses are not controllable at the segment level. Such expenses include certain types of professional fees, certain taxes included in operating expenses, compensation to non-employee directors and certain other general and administrative expenses, including compensation of specific groups of non-production employees. In addition, the Company does not allocate stock-based compensation, amortization of intangible assets acquired through business combinations, goodwill and other asset impairment charges, acquisition-related costs and certain other one-time charges and benefits. These unallocated amounts are combined with total segment operating profit to arrive at consolidated income from operations. We manage our business primarily based on the managerial responsibility for the client base and market. As managerial responsibility for a particular customer relationship generally correlates with the customer’s geographic location, there is a high degree of similarity between customer locations and the geographic boundaries of our reportable segments. In some cases, managerial responsibility for a particular customer is assigned to a management team in another region and is usually based on the strength of the relationship between customer executives and particular members of EPAM’s senior management team. In such cases, the customer’s activity would be reported through the respective management team member’s reportable segment. Our Europe segment includes our business in the APAC region, which is managed by the same management team. 36Table of ContentsSegment revenues from external customers and segment operating profit, before unallocated expenses, for the North America, Europe and Russia segments for the years ended December 31, 2022, 2021 and 2020 were as follows: Year Ended December 31, 202220212020 (in thousands) Segment revenues:North America$2,898,554 $2,242,248 $1,601,820 Europe1,853,056 1,350,484 947,305 Russia73,088 165,412 110,353 Total segment revenues$4,824,698 $3,758,144 $2,659,478 Segment operating profit/(loss): North America$589,412 $462,798 $345,196 Europe223,276 233,727 152,902 Russia(13,460)32,547 5,811 Total segment operating profit$799,228 $729,072 $503,909 North America SegmentDuring 2022, North America segment revenues increased $656.3 million, or 29.3%, over the previous year. Revenues from our North America segment represented 60.1% of total segment revenues, an increase from 59.7% reported in the corresponding period of 2021. During 2022 as compared to 2021, North America segment operating profits increased $126.6 million, or 27.4%, to $589.4 million. Expressed as a percentage of revenue, North America segment operating profit decreased to 20.3% in 2022 as compared to 20.6% in 2021. This decrease is primarily attributable to increased personnel-related costs in part attributable to supplementing delivery resources on certain projects with standby resources able to support projects if delivery resources impacted by the invasion of Ukraine become unable to work and lower utilization, partially offset by a decrease in variable compensation expense as a percentage of segment revenues during 2022 compared to 2021.The following table presents North America segment revenues by industry vertical for the periods indicated:Year Ended December 31,Change20222021Dollars Percentage Industry Vertical(in thousands, except percentages)Software & Hi-Tech$655,122 $559,707 $95,415 17.0 %Financial Services522,970 361,611 161,359 44.6 %Travel & Consumer505,227 359,306 145,921 40.6 %Business Information & Media467,664 389,613 78,051 20.0 %Life Sciences & Healthcare454,102 340,706 113,396 33.3 %Emerging Verticals293,469 231,305 62,164 26.9 % Revenues$2,898,554 $2,242,248 $656,306 29.3 %Software & Hi-Tech remained the largest industry vertical in the North America segment during the year ended December 31, 2022, growing 17.0% as compared to the prior year, which was a result of the continued focus on engaging with our technology customers. Financial services grew 44.6% in 2022 compared to the prior year primarily due to growth in a group of wealth management customers and growth from insurance customers added in the last 18 months. Travel and Consumer grew 40.6% during 2022 compared to the prior year primarily due to growth from retail customers. During the year ended December 31, 2022, revenues from the Business Information & Media vertical experienced growth of 20.0% and largely benefited from growth from existing customers in our top 20 customers. Life Sciences & Healthcare grew 33.3% during 2022 compared to the prior year primarily due to growth from an existing customer in our top 20 customers and growth from customers added in the last 24 months. Emerging Verticals experienced 26.9% growth during 2022 compared to the prior year largely due to an increase in services provided to several customers in various industries in the group. 37Table of ContentsEurope SegmentDuring 2022, Europe segment revenues were $1,853.1 million, reflecting an increase of $502.6 million, or 37.2%, from last year. Acquisitions contributed $166.3 million to Europe segment revenues during 2022. Revenues were negatively impacted by changes in foreign currency exchange rates during 2022. Had our Europe segment revenues been expressed in constant currency terms using the exchange rates in effect during 2021, we would have reported revenue growth of 47.3%. Revenues from our Europe segment represent 38.4% and 35.9% of total segment revenues during 2022 and 2021, respectively. During 2022, this segment’s operating profits decreased $10.5 million, or 4.5% as compared to last year, to $223.3 million. Europe’s operating profit represented 12.0% of Europe segment revenues as compared to 17.3% in 2021. Europe’s segment operating profit was negatively impacted by changes in foreign currency exchanges rates, increased personnel-related costs partially attributable to supplementing delivery resources on certain projects with standby resources able to support projects if delivery resources impacted by the invasion of Ukraine become unable to work, lower utilization during 2022 compared to 2021, and lower profit margins from businesses acquired in the prior year, partially offset by a decrease in variable compensation expense as a percentage of segment revenues during 2022 compared to 2021.The following table presents Europe segment revenues by industry vertical for the periods indicated:Year Ended December 31,Change20222021Dollars Percentage Industry Vertical(in thousands, except percentages)Travel & Consumer$571,437 $354,041 $217,396 61.4 %Financial Services460,858 372,394 88,464 23.8 %Business Information & Media341,344 275,502 65,842 23.9 %Software & Hi-Tech136,273 102,270 34,003 33.2 %Life Sciences & Healthcare52,465 49,900 2,565 5.1 %Emerging Verticals290,679 196,377 94,302 48.0 % Revenues$1,853,056 $1,350,484 $502,572 37.2 %Travel & Consumer became the largest industry vertical in the Europe segment during the year ended December 31, 2022. The Europe segment benefited from 61.4% growth in Travel & Consumer during the year ended December 31, 2022 as compared to 2021 primarily due to increased demand from customers in the retail and distribution industries and revenues from acquisitions which contributed $89.4 million to revenue growth during 2022. During the year ended December 31, 2022, revenues in Financial Services experienced 23.8% growth primarily driven by increased revenues from commercial and investment banking customers and revenues from recent acquisitions which contributed $18.3 million to revenue growth during 2022. For the year ended December 31, 2022 as compared to 2021, Business Information & Media vertical growth was largely attributable to the expansion of services provided to one of our top 5 customers compared to the prior year. Revenue growth in Software & Hi-Tech during the year ended December 31, 2022 as compared to 2021 was attributable to the expansion of services provided to one of our top 20 customers as well as growth in customers outside of our top 100 customers. Revenues in Emerging Verticals experienced higher growth primarily attributable to growth in existing customers in the energy and automotive industries, a new customer that we added in 2022 as well as revenues from recent acquisitions which contributed $32.3 million to revenue growth during 2022.Russia SegmentDuring 2022, revenues from our Russia segment decreased $92.3 million relative to 2021 and represent 1.5% of total segment revenues during 2022 compared with 4.4% in 2021. The decrease in revenues was primarily attributable to decreased operations in Russia as we proceed with the phased exit from Russia while discontinuing services to customers there. Operating loss of our Russia segment was $13.5 million in 2022 compared to operating profit of $32.5 million in 2021. This decrease was largely driven by discontinuance of services to certain customers in Russia which led to reduced revenues, increased bad debt expense, and expenses incurred for services provided to those customers for which revenue was not recognized as collectability was not considered probable after announcing the discontinuance of services to customers in Russia. 38Table of ContentsThe following table presents Russia segment revenues by industry vertical for the periods indicated:Year Ended December 31,Change20222021Dollars Percentage Industry Vertical(in thousands, except percentages)Financial Services$42,858 $114,365 $(71,507)(62.5)%Travel & Consumer15,560 27,781 (12,221)(44.0)%Software & Hi-Tech1,866 2,620 (754)(28.8)%Business Information & Media944 1,826 (882)(48.3)%Life Sciences & Healthcare800 703 97 13.8 %Emerging Verticals11,060 18,117 (7,057)(39.0)% Revenues$73,088 $165,412 $(92,324)(55.8)%Revenues in the Russia segment are generally subject to fluctuations and are impacted by the timing of revenue recognition associated with the execution of contracts and the fluctuations in the foreign currency exchange rate of the Russian ruble to the U.S. dollar. On March 4, 2022, EPAM announced that it will discontinue services to customers located in Russia and will provide transition support for the customers in this market. On April 7, 2022, the Company announced that it would begin the process of a phased exit of its operations in Russia and on September 7, 2022, the Company executed an agreement to sell substantially all of its remaining holdings in Russia to a third party. As of December 31, 2022 and through the date of issuing this Annual Report, the long stop date of the agreement has passed and the Company is currently renegotiating the terms of that sale agreement as well as exploring other strategic alternatives. The timing and completion of a sale is uncertain and any sale would be subject to customary closing conditions, including regulatory approvals by the Russian government. As a result, the revenues from this segment are expected to dissipate in the future. See Note 2 “Impact of the Invasion of Ukraine” for more information regarding the Company’s decisions to exit its operations in Russia. Discussion of segment results from 2021 as compared to 2020 is included in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021.Effects of InflationEconomies in many countries where we operate have periodically experienced high rates of inflation, including during 2022. Periods of higher inflation may affect various economic sectors in those countries and increase our cost of doing business there. We do not believe that inflation has had a material impact on our business, results of operations or financial condition to date. We continue to track the impact of inflation, particularly on wages, while attempting to minimize its effects through pricing and cost management strategies. A higher-than-normal rate of inflation in the future could adversely affect our operations and financial condition. Liquidity and Capital ResourcesCapital ResourcesOur cash generated from operations has been our primary source of liquidity to fund operations and investments to support the growth of our business. As of December 31, 2022, our principal sources of liquidity were cash and cash equivalents totaling $1.681 billion, short-term investments totaling $60.3 million as well as $675.0 million of available borrowings under our revolving credit facility. See Note 10 “Debt” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for information regarding the terms of our revolving credit facility and information about debt. 39Table of ContentsCash Flows The following table summarizes our cash flows for the periods indicated: For the Years Ended December 31, 202220212020 (in thousands)Consolidated Statements of Cash Flow Data:Net cash provided by operating activities$464,104 $572,327 $544,407 Net cash used in investing activities(182,927)(368,924)(167,154)Net cash used in financing activities(2,021)(59,557)(765)Effect of exchange rate changes on cash, cash equivalents and restricted cash(44,867)(18,032)9,357 Net increase in cash, cash equivalents and restricted cash$234,289 $125,814 $385,845 Cash, cash equivalents and restricted cash, beginning of period1,449,347 1,323,533 937,688 Cash, cash equivalents and restricted cash, end of period$1,683,636 $1,449,347 $1,323,533 Operating ActivitiesNet cash provided by operating activities during the year ended December 31, 2022 decreased $108.2 million, or 18.9%, to $464.1 million, as compared to 2021. This decrease was largely driven by an increase in days sales outstanding during 2022, higher level of variable compensation payments made in 2022 based on 2021 performance, and cash outflows related to EPAM’s humanitarian support efforts in Ukraine and geographic repositioning.Investing ActivitiesNet cash used in investing activities during the year ended December 31, 2022 was $182.9 million compared to $368.9 million used in the same period in 2021. The cash used in investing activities was primarily attributable to $81.6 million used for capital expenditures and an investment of $60.0 million in time deposits in 2022 compared to cash used for capital expenditures of $111.5 million partially offset by the maturity of $60.0 million of time deposits during 2021. Additionally, during 2022 the cash used for the acquisitions of businesses, net of cash acquired was $10.6 million compared to $315.0 million used for the acquisitions of businesses, net of cash acquired, during 2021. Financing ActivitiesDuring the year ended December 31, 2022, net cash used in financing activities was $2.0 million, compared to $59.6 million net cash used in financing activities in 2021. During 2022, we received cash from the exercises of stock options issued under our long-term incentive plans and proceeds from the purchases of shares under our ESPP of $50.7 million, compared to $26.3 million received in the corresponding period of 2021. These cash inflows were offset by cash used for the payments of withholding taxes related to net share settlements of restricted stock units of $26.6 million in 2022, compared to $41.6 million paid in 2021, and net cash repayments of debt of $13.8 million in 2022, compared to net borrowings of $0.1 million in 2021. Additionally, the year ended December 31, 2022 included payments of $6.6 million attributable to the acquisition-date fair value of contingent consideration compared to payments of $40.2 million attributable to acquisition-date fair value of contingent consideration during the year ended December 31, 2021. Discussion of the comparison of the cash flows between 2021 and 2020 is included in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” of our Annual Report on Form 10-K for the year ended December 31, 2021.Future Capital RequirementsWe believe that our existing cash, cash equivalents and short-term investments, combined with our expected cash flow from operations will be sufficient to meet our projected operating and capital expenditure requirements for at least the next twelve months and that we possess the financial flexibility to execute our strategic objectives, including the ability to make acquisitions and strategic investments in the foreseeable future. However, the invasion of Ukraine, COVID-19 and the consequences and related measures to contain their impact have caused material disruptions in both national and global financial markets and economies. The future impact of the invasion of Ukraine and COVID-19 and responsive measures cannot be predicted with certainty and may increase our borrowing costs and other costs of capital and otherwise adversely affect our business, results of operations, financial condition and liquidity. 40Table of ContentsOur ability to expand and grow our business in accordance with current plans and to meet our long-term capital requirements will depend on many factors, including the rate at which our cash flows increase or decrease and the availability of public and private debt and equity financing. We may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. Our ability to generate cash is subject to our performance, general economic conditions, industry trends and other factors including the impact of the invasion of Ukraine and COVID-19 pandemic, each as described elsewhere in this Management’s Discussion and Analysis of Financial Condition and Results of Operations. To the extent that existing cash, cash equivalents, short-term investments, and operating cash flows are insufficient to fund our future activities and requirements, we may need to raise additional funds through public or private equity or debt financing. If we issue equity securities in order to raise additional funds, substantial dilution to existing stockholders may occur. If we raise cash through the issuance of additional indebtedness, we may be subject to additional contractual restrictions on our business. There is no assurance that we would be able to raise additional funds on favorable terms or at all.See Note 9 “Leases”, Note 10 “Debt”, Note 16 “Commitments and Contingencies” in the notes to our consolidated financial statements in this Annual Report on Form 10-K for information regarding our various contractual obligations and capital expenditure requirements. Off-Balance Sheet Commitments and ArrangementsWe do not have any material obligations under guarantee contracts or other contractual arrangements other than as disclosed in Note 16 “Commitments and Contingencies” in the notes to our consolidated financial statements in this Annual Report on Form 10-K. We have not entered into any transactions with unconsolidated entities where we have financial guarantees, subordinated retained interests, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to us, or engages in leasing, hedging, or research and development services with us. Item 7A. Quantitative and Qualitative Disclosures About Market RiskWe are exposed to certain market risks in the ordinary course of our business. These risks primarily result from changes in concentration of credit risks, interest rates and foreign currency exchange rates. In addition, our global operations are subject to risks related to differing economic conditions, civil unrest, political instability or uncertainty, military activities, broad-based sanctions, differing tax structures, and other regulations and restrictions.Concentration of Credit and Other Credit RisksFinancial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and trade receivables.We maintain our cash, cash equivalents and short-term investments with financial institutions. We believe that our credit policies reflect normal industry terms and business risk. We do not anticipate non-performance by the counterparties. We have cash in several countries, including Ukraine, Russia and Belarus, which could be impacted by the invasion of Ukraine and where the banking sector remains subject to periodic instability, banking and other financial systems in these countries generally do not meet the banking standards of more developed markets, and bank deposits made by corporate entities are not insured. As of December 31, 2022, we had $47.1 million of cash and cash equivalents in banks in Ukraine, $29.0 million of cash and cash equivalents in banks in Russia, and $28.0 million of cash and cash equivalents in banks in Belarus. Cash in Ukraine and Belarus is used for the operational needs of the local entities and cash balances change with the expected operating needs of these entities. We regularly monitor cash held in these countries and, to the extent the cash held exceeds amounts required to support our operations in these countries, the Company distributes the excess funds into markets with more developed banking sectors to the extent it is possible to do so. Due to restrictions imposed by the Russian government, our ability to distribute excess funds from Russia to other countries is limited. On September 7, 2022, we executed an agreement to sell substantially all of our remaining holdings in Russia, including cash and cash equivalents, to a third party. As of December 31, 2022 and through the date of issuance of these financial statements, the long stop date of the agreement has passed and we are currently renegotiating the terms of that sale agreement as well as exploring other strategic alternatives. The timing and completion of a sale is uncertain and any sale would be subject to customary closing conditions, including regulatory approvals by the Russian government. We place our cash and cash equivalents with financial institutions considered stable in the region, limit the amount of credit exposure with any one financial institution and conduct ongoing evaluations of the credit worthiness of the financial institutions with which we do business. However, a banking crisis, bankruptcy or insolvency of banks that process or hold the Company’s funds, or sanctions may result in the loss of our deposits or adversely affect the Company’s ability to complete banking transactions, which could adversely affect our business and financial condition. 41Table of ContentsTrade receivables are generally dispersed across many customers operating in different industries; therefore, concentration of credit risk is limited and we do not believe significant credit risks existed at December 31, 2022. Though our results of operations depend on our ability to successfully collect payment from our customers for work performed, historically, credit losses and write-offs of trade receivables have not been material to our consolidated financial statements. If any of our customers enter bankruptcy protection or otherwise take steps to alleviate their financial distress, our credit losses and write-offs of trade receivables could increase, which would negatively impact our results of operations. Reflecting the deterioration of credit-worthiness of its customers in Russia after Russia’s invasion of Ukraine, the Company evaluated its trade receivables and contract assets for estimated future credit losses from customers located in Russia and recorded net bad debt expense of $5.1 million during the year 2022, which is included in Selling, general and administrative expenses. The Company is actively monitoring its trade receivables from its customers in Russia for any further deterioration of creditworthiness. Interest Rate RiskWe are exposed to market risk from changes in interest rates. Exposure to interest rate risk results primarily from variable rates related to the cash and cash equivalent deposits, short-term investments, and our borrowings, mainly under our 2021 Credit Agreement, which is subject to a variety of rates depending on the currency and timing of funds borrowed. We do not believe we are exposed to material direct risks associated with changes in interest rates related to these deposits, investments and borrowings. Foreign Exchange RiskOur global operations are conducted predominantly in U.S. dollars. Other than U.S. dollars, the Company generates revenues in various currencies, principally, euros, British pounds, Swiss francs, Canadian dollars, and Russian rubles and incurs expenditures principally in euros, Polish zlotys, Russian rubles, Indian rupees, British pounds, Swiss francs, Hungarian forints, Mexican pesos, Colombian pesos, Canadian dollars, and Chinese yuan renminbi. As a result, currency fluctuations, specifically the depreciation of the euro, British pound, and Canadian dollar and the appreciation of the Russian ruble, Hungarian forint, Polish zloty, Indian rupee and Chinese yuan renminbi relative to the U.S. dollar, could negatively impact our results of operations. During the year ended December 31, 2022, approximately 33.4% of consolidated revenues and 53.7% of operating expenses were denominated in currencies other than the U.S. dollar. During the year ended December 31, 2022, our foreign exchange loss was $75.7 million compared to a $7.2 million loss reported last year. Foreign exchange loss was primarily driven by the impact of appreciation of the Russian ruble on the Company’s intercompany payables denominated in Russian rubles and U.S. dollar denominated assets held by our subsidiaries in Russia, and losses from our foreign exchange forward contracts associated with the Russian ruble during the first quarter of 2022.To manage the risk of fluctuations in foreign currency exchange rates and hedge a portion of our forecasted foreign currency denominated operating expenses in the normal course of business, we implemented a hedging program through which we enter into a series of foreign exchange forward contracts with durations of twelve months or less that are designated as cash flow hedges of forecasted Polish zloty, Hungarian forint, and Indian rupee transactions. As of December 31, 2022, all of our foreign exchange forward contracts, except the Russian ruble foreign exchange forward contracts, were designated as hedges and there is no financial collateral (including cash collateral) required to be posted related to the foreign exchange forward contracts. As of December 31, 2022, the net unrealized gain from these hedges was $2.8 million. During the first quarter of 2022, in response to the invasion of Ukraine, we de-designated our Russian ruble foreign exchange forward contracts as hedges and entered into offsetting foreign exchange forward contracts with the same counterparty. We determined it was probable the underlying forecasted foreign currency transactions which were hedged would not occur and reclassified the accumulated loss of $43.9 million on the underlying hedge into income which is classified as foreign exchange loss in the consolidated statement of income.Management supplements results reported in accordance with United States generally accepted accounting principles, referred to as GAAP, with non-GAAP financial measures. Management believes these measures help illustrate underlying trends in our business and uses the measures to establish budgets and operational goals, communicated internally and externally, for managing our business and evaluating its performance. When important to management’s analysis, operating results are compared on the basis of “constant currency,” which is a non-GAAP financial measure. This measure excludes the effect of foreign currency exchange rate fluctuations by translating the current period revenues and expenses into U.S. dollars at the weighted average exchange rates of the prior period of comparison. 42Table of ContentsDuring the year ended December 31, 2022, we reported revenue growth of 28.4% over the prior year. Had our consolidated revenues been expressed in constant currency terms using the exchange rates in effect during 2021, we would have reported revenue growth of 32.4%. During 2022, our revenues were negatively impacted mainly by the depreciation of the euro and British pound relative to the U.S. dollar. During the year ended December 31, 2022, we reported a decrease in net income of 12.9% as compared to the previous year. Had our consolidated results been expressed in constant currency terms using the exchange rates in effect during 2021, we would have reported a decrease in net income of 17.1%. Net income was most positively impacted by the depreciation of the Polish zloty and the Hungarian forint, partially offset by the depreciation of the euro and British pound relative to the U.S. dollar.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of the results of operations and financial condition of the Company and the Operating Partnership should be read in connection with the Consolidated Financial Statements and Notes thereto. Due to the Company’s ability to control the Operating Partnership and its subsidiaries, the Operating Partnership and each such subsidiary entity has been consolidated with the Company for financial reporting purposes, except for any unconsolidated properties/entities. Capitalized terms used herein and not defined are as defined elsewhere in this Annual Report on Form 10-K. In addition, please refer to the Definitions section below for various capitalized terms not immediately defined in this Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. Forward-Looking Statements Forward-looking statements are intended to be made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations, estimates, projections and assumptions made by management. While the Company’s management believes the assumptions underlying its forward-looking statements are reasonable, such information is inherently subject to uncertainties and may involve certain risks, which could cause actual results, performance or achievements of the Company to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Many of these uncertainties and risks are difficult to predict and beyond management’s control. Additional factors that might cause such differences are discussed in Part I of this Annual Report on Form 10-K, particularly those under Item 1A, Risk Factors. Forward-looking statements and related uncertainties are also included in the Notes to Consolidated Financial Statements in this report. Forward-looking statements are not guarantees of future performance, results or events. The forward-looking statements contained herein are made as of the date hereof and the Company undertakes no obligation to update or supplement these forward-looking statements. Overview See Item 1, Business, for discussion regarding the Company’s overview. Business Objectives and Operating and Investing Strategies See Item 1, Business, for discussion regarding the Company’s business objectives and operating and investing strategies. COVID-19 Impact The Company continues to monitor and respond to the ongoing effects of the COVID-19 pandemic. For additional details, see Item 1A, Risk Factors. 25 Table of Contents Results of Operations 2021 and 2022 Transactions In conjunction with our business objectives and operating and investing strategies, the following table provides a rollforward of the transactions that occurred during the years ended December 31, 2021 and 2022: Portfolio Rollforward ($ in thousands) Properties ApartmentUnits Purchase Price AcquisitionCap Rate 12/31/2020 304 77,889 Acquisitions: Consolidated Rental Properties 13 3,533 $ 1,249,679 3.7 % Consolidated Rental Properties – Not Stabilized (1) 4 1,214 $ 459,700 4.0 % Sales Price DispositionYield Dispositions: Consolidated Rental Properties (14 ) (3,053 ) $ (1,716,775 ) (3.7 )% Completed Developments – Consolidated 3 824 12/31/2021 310 80,407 Purchase Price AcquisitionCap Rate Acquisitions: Consolidated Rental Properties 1 172 $ 113,000 3.5 % Unconsolidated Land Parcels (2) — — $ 56,886 Sales Price DispositionYield Dispositions: Consolidated Rental Properties (3 ) (945 ) $ (746,150 ) (3.4 )% Configuration Changes — (37 ) 12/31/2022 308 79,597 (1)The Company acquired four properties during the year ended December 31, 2021, one each in the Denver, Atlanta, Seattle and Dallas/Ft. Worth markets, that were in lease-up and are expected to stabilize in their second year of ownership at the combined Acquisition Cap Rate listed above. (2)The purchase price listed represents the total consideration for the closing of the respective joint ventures. Acquisitions •The consolidated properties acquired in 2021 are located in the Atlanta (4), Austin (3), Boston, Dallas/Ft. Worth (4), Denver (3), Seattle and Washington, D.C. markets. The Atlanta, Austin and Dallas/Ft. Worth acquisitions marked the Company’s re-entry into these markets; •Approximately $1.4 billion, or 82.0% of all acquisition activity in 2021, was in expansion markets; •The Company funded the 2021 acquisitions by selling older assets located within established markets that no longer met our long-term investment criteria; •The consolidated property acquired in 2022 is located in the San Diego market; and •In 2022, the Company acquired its joint venture partner’s 25% interest in a 432-unit apartment property located in the Washington, D.C. market for $32.2 million, and the property is now wholly owned. Dispositions •The consolidated properties disposed of in 2021 were located in the Los Angeles (6), New York, San Francisco (5), Seattle and Washington, D.C. markets and the sales generated an Unlevered IRR of 10.4%; and •The consolidated properties disposed of in 2022 were located in the New York (2) and Washington, D.C. markets and the sales generated an Unlevered IRR of 5.3%. 26 Table of Contents Developments •The Company completed construction on three consolidated apartment properties during 2021, located in the San Francisco, Washington, D.C. and Boston markets, consisting of 824 apartment units totaling approximately $602.8 million of development costs; •The Company commenced construction on one consolidated and three unconsolidated apartment properties during 2021, located in the Denver (2), New York and Washington, D.C. markets, consisting of 1,241 apartment units totaling approximately $452.7 million of expected development costs; •The Company commenced construction on one consolidated and three unconsolidated apartment properties during 2022, located in the San Francisco and Dallas/Ft. Worth (3) markets, consisting of 1,278 apartment units totaling approximately $417.7 million of expected development costs; •The Company stabilized two consolidated apartment properties during 2022, located in the Washington, D.C. and Boston markets, consisting of 624 apartment units totaling approximately $482.1 million of development costs; and •The Company spent approximately $203.6 million during 2022, primarily for consolidated and unconsolidated development projects. Investments in Unconsolidated Entities •The Company entered into six separate unconsolidated joint ventures during 2021 for the purpose of developing vacant land parcels in Texas (3), Colorado (2) and New York. The Company’s total investment in these six joint ventures was approximately $72.2 million and $150.4 million as of December 31, 2021 and 2022, respectively. Three of the projects are related to the Company’s joint venture development program with Toll, two of which commenced construction during the second and third quarters of 2022; and •The Company entered into three separate unconsolidated joint ventures during 2022 for the purpose of developing vacant land parcels in the Dallas/Ft. Worth and Boston (2) markets. The Company’s total investment in these three joint ventures was approximately $66.8 million as of December 31, 2022. One of the projects is related to the Company’s joint venture development program with Toll, which commenced construction during the first quarter of 2022 prior to our entrance into the joint venture. See Notes 4 and 6 in the Notes to Consolidated Financial Statements for additional discussion regarding the Company’s real estate investments and investments in partially owned entities. Comparison of the year ended December 31, 2022 to the year ended December 31, 2021 The following table presents a reconciliation of diluted earnings per share/unit for the year ended December 31, 2022 as compared to the same period in 2021: Year Ended December 31 Diluted earnings per share/unit for full year 2021 $ 3.54 Property NOI 0.60 Interest expense (0.02 ) Corporate overhead (1) (0.03 ) Net gain/loss on property sales (1.95 ) Non-operating asset gains/losses (0.07 ) Impairment – non-operating real estate assets 0.04 Depreciation expense (0.11 ) Other 0.05 Diluted earnings per share/unit for full year 2022 $ 2.05 (1)Corporate overhead includes property management and general and administrative expenses. The Company’s primary financial measure for evaluating each of its apartment communities is net operating income (“NOI”). NOI represents rental income less direct property operating expenses (including real estate taxes and insurance). The Company believes that NOI is helpful to investors as a supplemental measure of its operating performance because it is a direct measure of the actual operating results of the Company’s apartment properties. 27 Table of Contents The following tables present reconciliations of operating income per the consolidated statements of operations to NOI, along with rental income, operating expenses and NOI per the consolidated statements of operations allocated between same store and non-same store/other results (amounts in thousands): Year Ended December 31, 2022 vs. 2021 2022 2021 $ Change % Change Operating income $ 1,116,046 $ 1,675,841 $ (559,795 ) (33.4 )% Adjustments: Property management 110,304 98,155 12,149 12.4 % General and administrative 58,710 56,506 2,204 3.9 % Depreciation 882,168 838,272 43,896 5.2 % Net (gain) loss on sales of real estate properties (304,325 ) (1,072,183 ) 767,858 (71.6 )% Impairment — 16,769 (16,769 ) (100.0 )% Total NOI $ 1,862,903 $ 1,613,360 $ 249,543 15.5 % Rental income: Same store $ 2,533,577 $ 2,291,604 $ 241,973 10.6 % Non-same store/other 201,603 172,393 29,210 16.9 % Total rental income 2,735,180 2,463,997 271,183 11.0 % Operating expenses: Same store 802,291 774,504 27,787 3.6 % Non-same store/other 69,986 76,133 (6,147 ) (8.1 )% Total operating expenses 872,277 850,637 21,640 2.5 % NOI: Same store 1,731,286 1,517,100 214,186 14.1 % Non-same store/other 131,617 96,260 35,357 36.7 % Total NOI $ 1,862,903 $ 1,613,360 $ 249,543 15.5 % Note: See Note 17 in the Notes to Consolidated Financial Statements for detail by reportable segment/market. Non-same store/other NOI results consist primarily of properties acquired in calendar years 2021 and 2022, operations from the Company’s development properties and operations prior to disposition from 2021 and 2022 sold properties. •The increase in same store rental income is primarily driven by strong Physical Occupancy and continued growth in pricing. •The increase in same store operating expenses is due primarily to: •Utilities – A $13.9 million increase from gas and electric, primarily driven by higher commodity prices; and •Repairs and maintenance – A $9.8 million increase primarily driven by volume and timing of maintenance and repairs along with increases in minimum wage on contracted services. •The increase in non-same store/other NOI is due primarily to a positive impact of higher NOI from properties acquired during 2021 and 2022 of $54.5 million and higher NOI from development properties in lease-up of $20.6 million, partially offset by a negative impact of lost NOI from 2021 and 2022 dispositions of $52.2 million and a negative impact of $1.2 million in lower NOI from one former master-leased property and two properties that have been removed from same store while undergoing major renovations. •The increase in consolidated total NOI is primarily a result of the Company’s higher NOI from same store properties, largely due to improvement in same store revenues as noted above. Operating expense growth remains modest due to a combination of continued success in managing controllable expenses, favorable growth in real estate tax expense (increased by only $3.2 million) and declines in payroll expense (decreased by $3.1 million) primarily due to the Company's various innovation and centralization initiatives, leading to 14.1% same store NOI growth for the year ended December 31, 2022 as compared to the prior year period. See the Same Store Results section below for additional discussion of those results. 28 Table of Contents Property management expenses include off-site expenses associated with the self-management of the Company’s properties as well as management fees paid to any third-party management companies. These expenses increased approximately $12.1 million or 12.4% during the year ended December 31, 2022 as compared to 2021. This increase is primarily attributable to increases in payroll-related costs, training/conference costs, temporary help/contractors costs and third-party management fees. General and administrative expenses, which include corporate operating expenses, increased approximately $2.2 million or 3.9% during the year ended December 31, 2022 as compared to 2021, primarily due to increases in payroll-related costs, legal and professional fees and training/conference costs. Depreciation expense, which includes depreciation on non-real estate assets, increased approximately $43.9 million or 5.2% during the year ended December 31, 2022 as compared to 2021, primarily as a result of additional depreciation expense on properties acquired in 2021 and 2022 and development properties placed in service during 2021, partially offset by lower depreciation from properties sold in 2021 and 2022. Net gain on sales of real estate properties decreased approximately $767.9 million or 71.6% during the year ended December 31, 2022 as compared to 2021, primarily as a result of a lower sales volume with the sale of three consolidated apartment properties in 2022 as compared to the sale of fourteen consolidated apartment properties in the same period in 2021. Impairment decreased approximately $16.8 million during the year ended December 31, 2022 as compared to 2021, due to an impairment charge in 2021 on one land parcel held for development compared to no impairment charges taken during 2022. Interest and other income decreased approximately $23.5 million or 91.5% during the year ended December 31, 2022 as compared to 2021. The decrease is primarily due to a gain of $23.6 million on the sale of various investment securities that occurred during 2021 but not during 2022. Other expenses decreased approximately $5.6 million or 29.1% during the year ended December 31, 2022 as compared to 2021, primarily due to a decline in construction defect and litigation reserves and pursuit costs recorded between 2022 and 2021, partially offset by increases in advocacy contributions, demolition/abatement costs and data transformation project costs. Interest expense, including amortization of deferred financing costs, increased approximately $10.4 million or 3.7% during the year ended December 31, 2022 as compared to 2021. The increase is primarily due to higher overall interest rates and lower capitalized interest. The effective interest cost on all indebtedness, excluding debt extinguishment costs/prepayment penalties, for the year ended December 31, 2022 was 3.68% as compared to 3.52% in 2021. The Company capitalized interest of approximately $7.1 million and $15.9 million during the years ended December 31, 2022 and 2021, respectively. Net (income) loss attributable to Noncontrolling Interests in partially owned properties decreased approximately $14.2 million or 79.0% during the year ended December 31, 2022 as compared to 2021, primarily as a result of noncontrolling interest allocations related to the sale of one partially owned apartment property in 2021 as compared to no sales in 2022. For comparison of the year ended December 31, 2021 to the year ended December 31, 2020, refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s and the Operating Partnership’s Annual Report on Form 10-K for the year ended December 31, 2021. Same Store Results Properties that the Company owned and were stabilized for all of both 2022 and 2021 (the “2022 Same Store Properties”), which represented 72,872 apartment units, drove the Company’s results of operations. Properties are considered “stabilized” when they have achieved 90% occupancy for three consecutive months. Properties are included in same store when they are stabilized for all of the current and comparable periods presented. 29 Table of Contents The following table provides comparative total same store results and statistics for the 2022 Same Store Properties: 2022 vs. 2021 Same Store Results/Statistics Including 72,872 Same Store Apartment Units $ in thousands (except for Average Rental Rate) 2022 2021 Residential % Change Non-Residential % Change Total % Change Residential Non-Residential Total Revenues $ 2,441,522 10.7 % $ 92,055 5.8 % $ 2,533,577 10.6 % Revenues $ 2,204,625 $ 86,979 $ 2,291,604 Expenses $ 778,206 3.6 % $ 24,085 3.6 % $ 802,291 3.6 % Expenses $ 751,250 $ 23,254 $ 774,504 NOI $ 1,663,316 14.4 % $ 67,970 6.7 % $ 1,731,286 14.1 % NOI $ 1,453,375 $ 63,725 $ 1,517,100 Average Rental Rate $ 2,898 10.4 % Average Rental Rate $ 2,625 Physical Occupancy 96.4 % 0.3 % Physical Occupancy 96.1 % Turnover 42.8 % (1.9 %) Turnover 44.7 % Note: Same store revenues for all leases are reflected on a straight-line basis in accordance with GAAP for the current and comparable periods. The following table provides results and statistics related to our Residential same store operations for the years ended December 31, 2022 and 2021: 2022 vs. 2021 Same Store Residential Results/Statistics by Market Increase (Decrease) from Prior Year Markets/Metro Areas ApartmentUnits 2022 % of Actual NOI 2022 Average Rental Rate 2022 Weighted Average Physical Occupancy % 2022 Turnover AverageRental Rate PhysicalOccupancy Turnover Los Angeles 14,662 19.8 % $ 2,733 96.6 % 38.4 % 9.0 % (0.2 %) (3.1 %) Orange County 4,028 5.8 % 2,614 97.0 % 34.5 % 12.8 % (0.7 %) (0.1 %) San Diego 2,706 4.0 % 2,766 96.7 % 38.1 % 11.4 % (0.9 %) (5.0 %) Subtotal – Southern California 21,396 29.6 % 2,715 96.7 % 37.6 % 10.0 % (0.4 %) (2.8 %) San Francisco 11,368 17.4 % 3,152 96.1 % 41.5 % 8.3 % 0.9 % (6.5 %) Washington, D.C. 14,187 16.2 % 2,456 96.8 % 43.1 % 5.5 % 0.3 % (2.2 %) New York 8,536 13.5 % 4,068 96.9 % 42.4 % 17.6 % 1.8 % 4.2 % Seattle 9,331 11.4 % 2,497 95.1 % 51.6 % 10.7 % (0.5 %) 0.7 % Boston 6,430 10.0 % 3,208 96.2 % 45.3 % 11.2 % 0.5 % (1.8 %) Denver 1,624 1.9 % 2,299 96.7 % 60.3 % 11.3 % 0.1 % 0.1 % Total 72,872 100.0 % $ 2,898 96.4 % 42.8 % 10.4 % 0.3 % (1.9 %) Note: The above table reflects Residential same store results only. Residential operations account for approximately 96.3% of total revenues for the year ended December 31, 2022. Despite geopolitical and economic uncertainties, demand to live in our apartment communities remained healthy, which our financial results reflected, as we continued to capture the gap between in-place rent levels and market rent levels. Demand for our apartments continues to support strong Physical Occupancy with pricing that is largely in-line with expectations, including modest use of Leasing Concessions. Key operating drivers for this performance during 2022 include: •Pricing – Pricing (net of Leasing Concessions) in 2022 was strong, driven by continued improvement across the portfolio, especially in New York. After unprecedented growth earlier in the year, pricing began to moderate in late August 2022, which is typical, but slightly more pronounced than we had expected. Regardless, pricing remained positive during the fourth quarter of 2022 which is stronger than historical trends. •Physical Occupancy – Physical Occupancy of 96.4% for the year ended December 31, 2022 remained strong, contributing to growth in Same Store Residential Revenues. 30 Table of Contents •Percentage of Residents Renewing and Turnover – We continue to see a high Percentage of Residents Renewing in our portfolio, which we believe reflects both the strength of demand and quality of our product. The Percentage of Residents Renewing has been strong at 56.5% for the fourth quarter of 2022. Turnover has been the lowest in the Company’s history at 42.8% for the full year of 2022, reflecting a healthy and consistent trend of historically high resident retention. In addition to these stronger fundamentals, bad debt, net moderated during the first half of 2022 with improvement in resident collections primarily driven by receipt of governmental rental assistance payments on behalf of our residents. Bad debt, net increased in the second half of 2022 primarily due to the governmental rental assistance programs winding down. Transaction activity has slowed as buyers and sellers adjust their expectations to a volatile economic climate and rising interest rates. While this type of environment can be challenging, the Company has traditionally found investment opportunities during periods of market dislocation as our ability to move quickly and our relatively low cost of capital creates flexibility that can provide us a competitive advantage. Overall, the fundamentals of our business remain strong. Long-term, we expect elevated single family home ownership costs, positive household formation trends and the overall deficit in housing across the country to buffer the impact on our business from the risks of potential economic weakness. We also see our affluent resident base as being more resilient to rising inflation due to higher levels of disposable income and lower relative rent-to-income ratios. Liquidity and Capital Resources With approximately $2.4 billion in readily available liquidity, a strong balance sheet, limited near-term maturities, very strong credit metrics and ample access to capital markets, the Company believes it is well positioned to meet its future obligations and opportunities. See further discussion below. Statements of Cash Flows The following table sets forth our sources and uses of cash flows for the years ended December 31, 2022, 2021 and 2020 (amounts in thousands): Year Ended December 31, 2022 2021 2020 Cash flows provided by (used for): Operating activities $ 1,454,756 $ 1,260,184 $ 1,265,536 Investing activities $ 107,792 $ (434,620 ) $ 663,586 Financing activities $ (1,785,612 ) $ (565,056 ) $ (1,946,393 ) The following provides information regarding the Company’s cash flows from operating, investing and financing activities for the year ended December 31, 2022. Operating Activities Our operating cash flows are primarily impacted by NOI and its components, such as Average Rental Rates, Physical Occupancy levels and operating expenses related to our properties. Cash provided by operating activities for the year ended December 31, 2022 as compared to 2021, increased by approximately $194.6 million as a direct result of the NOI and other changes discussed above in Results of Operations. Investing Activities Our investing cash flows are primarily impacted by our transaction activity (acquisitions/dispositions), development spend and capital expenditures. For 2022, key drivers were: •Acquired one consolidated rental property for approximately $113.0 million in cash; •Disposed of three consolidated rental properties, receiving net proceeds of approximately $720.3 million; •Invested $109.3 million primarily in development projects; 31 Table of Contents •Invested $159.7 million primarily in unconsolidated development joint venture entities as well as unconsolidated investments in real estate technology funds/companies for various technology initiatives; and •Invested $221.1 million in capital expenditures to real estate presented in the table below. For the year ended December 31, 2022, our actual capital expenditures to real estate included the following (amounts in thousands except for apartment unit and per apartment unit amounts): Capital Expenditures to Real Estate For the Year Ended December 31, 2022 Same Store Properties Non-Same Store Properties/Other Total Same Store Avg. Per Apartment Unit Total Apartment Units 72,872 6,725 79,597 Building Improvements $ 102,079 $ 16,335 (2) $ 118,414 $ 1,401 Renovation Expenditures 43,197 (1) 6,730 (2) 49,927 592 Replacements 49,834 2,911 52,745 684 Total Capital Expenditures to Real Estate $ 195,110 $ 25,976 $ 221,086 $ 2,677 (1)Renovation Expenditures – Amounts for 1,794 same store apartment units approximated $24,079 per apartment unit renovated. (2)Includes expenditures for two properties that have been removed from same store while undergoing major renovations requiring a significant number of apartment units to be vacated to accommodate the extensive planned improvements. The renovations are expected to continue through at least the end of 2023 at both properties. Financing Activities Our financing cash flows primarily relate to our borrowing activity (debt proceeds or repayment), distributions/dividends to shareholders and other Common Share activity. For 2022, key drivers were: •Obtained $48.1 million in variable rate construction mortgage debt that is non-recourse to the Company; •Repaid $289.9 million of mortgage loans (inclusive of scheduled principal repayments); •Repaid $500.0 million of unsecured notes by using disposition proceeds; •Settled all 1.7 million Common Shares under the ATM forward sale agreements for cash proceeds of $139.6 million; •Acquired our joint venture partner’s 25% interest in an apartment property for $32.2 million; •Issued Common Shares related to share option exercises and ESPP purchases and received net proceeds of $29.2 million; and •Paid dividends/distributions on Common Shares, Preferred Shares, Units (including OP Units and restricted units) and noncontrolling interests in partially owned properties totaling approximately $982.8 million. Short-Term Liquidity and Cash Proceeds The Company generally expects to meet its short-term liquidity requirements, including capital expenditures related to maintaining its existing properties and scheduled unsecured note and mortgage note repayments, through its working capital, net cash provided by operating activities and borrowings under the Company’s revolving credit facility and commercial paper program. Currently, the Company considers its cash provided by operating activities to be adequate to meet operating requirements and payments of distributions. The following table presents the Company’s balances for cash and cash equivalents, restricted deposits and the available borrowing capacity on its revolving credit facility as of December 31, 2022 and 2021 (amounts in thousands): December 31, 2022 December 31, 2021 Cash and cash equivalents $ 53,869 $ 123,832 Restricted deposits $ 83,303 $ 236,404 Unsecured revolving credit facility availability $ 2,366,537 $ 2,181,372 32 Table of Contents Credit Facility and Commercial Paper Program The Company has a $2.5 billion unsecured revolving credit facility maturing October 26, 2027. The Company has the ability to increase available borrowings by an additional $750.0 million by adding lenders to the facility, obtaining the agreement of existing lenders to increase their commitments or incurring one or more term loans. The interest rate on advances under the facility will generally be the Secured Overnight Financing Rate ("SOFR") plus a spread (currently 0.725%), or based on bids received from the lending group, and the Company pays an annual facility fee (currently 0.125%). Both the spread and the facility fee are dependent on the Company’s senior unsecured credit rating. The Revolving Credit Agreement also contains a sustainability-linked pricing component which provides for interest rate margin reductions upon achieving certain sustainability ratings. See Note 9 in the Notes to Consolidated Financial Statements for additional discussion of the Company’s credit facility. The Company may borrow up to a maximum of $1.0 billion under its commercial paper program subject to market conditions. The notes will be sold under customary terms in the United States commercial paper note market and will rank pari passu with all of the Company’s other unsecured senior indebtedness. The Company limits its utilization of the revolving credit facility in order to maintain liquidity to support its $1.0 billion commercial paper program along with certain other obligations. The following table presents the availability on the Company’s unsecured revolving credit facility as of February 10, 2023 (amounts in thousands): February 10, 2023 Unsecured revolving credit facility commitment $ 2,500,000 Commercial paper balance outstanding (130,000 ) Unsecured revolving credit facility balance outstanding — Other restricted amounts (3,484 ) Unsecured revolving credit facility availability $ 2,366,516 Dividend Policy The Company declared a dividend/distribution for each quarter in 2022 of $0.625 per share/unit, an annualized increase of 3.7% over the amount paid in 2021. All future dividends/distributions remain subject to the discretion of the Company’s Board of Trustees. Total dividends/distributions paid in January 2023 amounted to $244.6 million (excluding distributions on Partially Owned Properties), which consisted of certain distributions declared during the quarter ended December 31, 2022. Long-Term Financing and Capital Needs The Company expects to meet its long-term liquidity requirements, such as lump sum unsecured note and mortgage debt maturities, property acquisitions and financing of development activities, through the issuance of secured and unsecured debt and equity securities (including additional OP Units), proceeds received from the disposition of certain properties and joint ventures, along with cash generated from operations after all distributions. The Company has a significant number of unencumbered properties available to secure additional mortgage borrowings should unsecured capital be unavailable or the cost of alternative sources of capital be too high. The value of and cash flow from these unencumbered properties are in excess of the requirements the Company must maintain in order to comply with covenants under its unsecured notes and line of credit. Of the $28.1 billion in investment in real estate on the Company’s balance sheet at December 31, 2022, $24.5 billion or 87.1% was unencumbered. However, there can be no assurances that these sources of capital will be available to the Company in the future on acceptable terms or otherwise. For additional details, see Item 1A, Risk Factors. EQR issues equity and guarantees certain debt of the Operating Partnership from time to time. EQR does not have any indebtedness as all debt is incurred by the Operating Partnership. 33 Table of Contents The Company’s total debt summary schedule as of December 31, 2022 is as follows: Debt Summary as of December 31, 2022 ($ in thousands) DebtBalances % of Total Secured $ 1,953,438 26.3 % Unsecured 5,472,284 73.7 % Total $ 7,425,722 100.0 % Fixed Rate Debt: Secured – Conventional $ 1,608,838 21.7 % Unsecured – Public 5,342,329 71.9 % Fixed Rate Debt 6,951,167 93.6 % Floating Rate Debt: Secured – Conventional 108,378 1.4 % Secured – Tax Exempt 236,222 3.2 % Unsecured – Revolving Credit Facility — — Unsecured – Commercial Paper Program 129,955 1.8 % Floating Rate Debt 474,555 6.4 % Total $ 7,425,722 100.0 % The following table summarizes the Company’s debt maturity schedule as of December 31, 2022: Debt Maturity Schedule as of December 31, 2022 ($ in thousands) Year FixedRate FloatingRate Total % of Total 2023 (2) $ 800,000 $ 198,275 (1) $ 998,275 13.3 % 2024 — 6,100 6,100 0.1 % 2025 450,000 53,180 503,180 6.7 % 2026 592,025 9,000 601,025 8.0 % 2027 400,000 9,800 409,800 5.5 % 2028 900,000 10,700 910,700 12.1 % 2029 888,120 11,500 899,620 12.0 % 2030 1,095,000 12,600 1,107,600 14.8 % 2031 528,500 39,700 568,200 7.6 % 2032 — 28,000 28,000 0.4 % 2033+ 1,350,850 110,900 1,461,750 19.5 % Subtotal 7,004,495 489,755 7,494,250 100.0 % Deferred Financing Costs and Unamortized (Discount) (53,328 ) (15,200 ) (68,528 ) N/A Total $ 6,951,167 $ 474,555 $ 7,425,722 100.0 % (1)Includes $130.0 million in principal outstanding on the Company’s commercial paper program. (2)During 2022, the Company entered into $450.0 million of ten-year forward starting SOFR swaps at a weighted average rate of 2.90% (currently equivalent to a ten-year U.S. Treasury of approximately 3.23%) to hedge the U.S. Treasury risk for the refinancing of 2023 maturities. Interest expected to be incurred on the Company’s secured and unsecured debt based on obligations outstanding at December 31, 2022, inclusive of capitalized interest, approximates $210.0 million annually for the next five years, with total remaining obligations of approximately $2.3 billion. For floating rate debt, the current rate in effect for the most recent payment through December 31, 2022 is assumed to be in effect through the respective maturity date of each instrument. See Note 9 in the Notes to Consolidated Financial Statements for additional discussion of debt at December 31, 2022. See also Notes 8 and 16 in the Notes to Consolidated Financial Statements for additional discussion of contractual obligations and commitments as of December 31, 2022. 34 Table of Contents Capital Structure The Company’s “Consolidated Debt-to-Total Market Capitalization Ratio” as of December 31, 2022 is presented in the following table. The Company calculates the equity component of its market capitalization as the sum of (i) the total outstanding Common Shares and assumed conversion of all Units at the equivalent market value of the closing price of the Company’s Common Shares on the New York Stock Exchange and (ii) the liquidation value of all perpetual preferred shares outstanding. Equity Residential Capital Structure as of December 31, 2022 (Amounts in thousands except for share/unit and per share amounts) Secured Debt $ 1,953,438 26.3 % Unsecured Debt 5,472,284 73.7 % Total Debt 7,425,722 100.0 % 24.3 % Common Shares (includes Restricted Shares) 378,429,708 96.8 % Units (includes OP Units and Restricted Units) 12,429,737 3.2 % Total Shares and Units 390,859,445 100.0 % Common Share Price at December 31, 2022 $ 59.00 23,060,707 99.8 % Perpetual Preferred Equity 37,280 0.2 % Total Equity 23,097,987 100.0 % 75.7 % Total Market Capitalization $ 30,523,709 100.0 % The Operating Partnership’s “Consolidated Debt-to-Total Market Capitalization Ratio” as of December 31, 2022 is presented in the following table. The Operating Partnership calculates the equity component of its market capitalization as the sum of (i) the total outstanding Units at the equivalent market value of the closing price of the Company’s Common Shares on the New York Stock Exchange and (ii) the liquidation value of all perpetual preference units outstanding. ERP Operating Limited Partnership Capital Structure as of December 31, 2022 (Amounts in thousands except for unit and per unit amounts) Secured Debt $ 1,953,438 26.3 % Unsecured Debt 5,472,284 73.7 % Total Debt 7,425,722 100.0 % 24.3 % Total Outstanding Units 390,859,445 Common Share Price at December 31, 2022 $ 59.00 23,060,707 99.8 % Perpetual Preference Units 37,280 0.2 % Total Equity 23,097,987 100.0 % 75.7 % Total Market Capitalization $ 30,523,709 100.0 % Financial Flexibility EQR and ERPOP currently have an active universal shelf registration statement for the issuance of equity and debt securities that automatically became effective upon filing with the SEC in May 2022 and expires in May 2025. Per the terms of ERPOP’s partnership agreement, EQR contributes the net proceeds of all equity offerings to the capital of ERPOP in exchange for additional OP Units (on a one-for-one Common Share per OP Unit basis) or preference units (on a one-for-one preferred share per preference unit basis). The Company has an ATM share offering program which allows EQR to issue Common Shares from time to time into the existing trading market at current market prices or through negotiated transactions, including under forward sale arrangements. In May 2022, the Company replaced the prior program with a new program which extended the maturity to May 2025 and gives us the authority to issue up to 13.0 million shares, all of which remain available for issuance as of December 31, 2022. Forward sale agreements under the ATM program allow the Company, at its election, to settle the agreements by issuing Common Shares in exchange for net proceeds at the then-applicable forward sale price specified by the agreement or, alternatively, to settle the 35 Table of Contents agreements in whole or in part through the delivery or receipt of Common Shares or cash. Issuances of shares under these forward sale agreements are classified as equity transactions. Accordingly, no amounts relating to the forward sale agreements are recorded in the consolidated financial statements until settlement occurs. Prior to any settlements, the only impact to the consolidated financial statements is the inclusion of incremental shares, if any, within the calculation of diluted net income per share using the treasury stock method (see Note 11 in the Notes to Consolidated Financial Statements for additional discussion). The actual forward price per share to be received by the Company upon settlement will be determined on the applicable settlement date based on adjustments made to the initial forward price to reflect the then-current overnight federal funds rate and the amount of dividends paid to holders of the Company’s Common Shares over the term of the forward sale agreement. During the quarter ended September 30, 2021, the Company entered into forward sale agreements under the prior program for a total of approximately 1.7 million Common Shares at a weighted average initial forward price per share of $83.25. During the quarter ended December 31, 2022, the Company settled all of the outstanding forward sale agreements, at a weighted average forward price per share of $80.22, which is inclusive of adjustments made to reflect the then-current federal funds rate and the amount of dividends paid to holders of the Company's Common Shares, for net proceeds of approximately $139.6 million. Concurrent with this transaction, ERPOP issued the same amount of OP Units to EQR in exchange for the net proceeds. The Company may repurchase up to 13.0 million Common Shares under its share repurchase program. No open market repurchases have occurred since 2008. As of February 10, 2023, EQR has remaining authorization to repurchase up to 13.0 million of its shares. We believe our ability to access capital markets is enhanced by ERPOP’s long-term senior debt ratings and short-term commercial paper ratings, as well as EQR’s long-term preferred equity ratings. As of February 10, 2023, the ratings are as follows: Standard & Poor’s Moody's ERPOP's long-term senior debt rating A- A3 ERPOP's short-term commercial paper rating A-2 P-2 EQR's long-term preferred equity rating BBB Baa1 See Note 18 in the Notes to Consolidated Financial Statements for discussion of the events, if any, which occurred subsequent to December 31, 2022. Definitions The definition of certain terms described above or below are as follows: •Acquisition Cap Rate – NOI that the Company anticipates receiving in the next 12 months (or the year two or three stabilized NOI for properties that are in lease-up at acquisition) less an estimate of property management costs/management fees allocated to the project (generally ranging from 2.0% to 4.0% of revenues depending on the size and income streams of the asset) and less an estimate for in-the-unit replacement capital expenditures (generally ranging from $100-$450 per apartment unit depending on the age and condition of the asset) divided by the gross purchase price of the asset. The weighted average Acquisition Cap Rate for acquired properties is weighted based on the projected NOI streams and the relative purchase price for each respective property. •Average Rental Rate – Total Residential rental revenues reflected on a straight-line basis in accordance with GAAP divided by the weighted average occupied apartment units for the reporting period presented. •Building Improvements – Includes roof replacement, paving, building mechanical equipment systems, exterior siding and painting, major landscaping, furniture, fixtures and equipment for amenities and common areas, vehicles and office and maintenance equipment. •Disposition Yield – NOI that the Company anticipates giving up in the next 12 months less an estimate of property management costs/management fees allocated to the project (generally ranging from 2.0% to 4.0% of revenues depending on the size and income streams of the asset) and less an estimate for in-the-unit replacement capital expenditures (generally ranging from $150-$450 per apartment unit depending on the age and condition of the asset) divided by the gross sales price of the asset. The weighted average Disposition Yield for sold properties is weighted based on the projected NOI streams and the relative sales price for each respective property. •Leasing Concessions – Reflects upfront discounts on both new move-in and renewal leases on a straight-line basis. •Non-Residential – Consists of revenues and expenses from retail and public parking garage operations. 36 Table of Contents •Non-Same Store Properties – For annual comparisons, primarily includes all properties acquired during 2021 and 2022, plus any properties in lease-up and not stabilized as of January 1, 2021. •Percentage of Residents Renewing – Leases renewed expressed as a percentage of total renewal offers extended during the reporting period. •Physical Occupancy – The weighted average occupied apartment units for the reporting period divided by the average of total apartment units available for rent for the reporting period. •Renovation Expenditures – Apartment unit renovation costs (primarily kitchens and baths) designed to reposition these units for higher rental levels in their respective markets. •Replacements – Includes appliances, mechanical equipment, fixtures and flooring (including hardwood and carpeting). •Residential – Consists of multifamily apartment revenues and expenses. •Same Store Properties – For annual comparisons, primarily includes all properties acquired or completed that are stabilized prior to January 1, 2021, less properties subsequently sold. Properties are included in Same Store when they are stabilized for all of the current and comparable periods presented. •Same Store Residential Revenues – Revenues from our Same Store Properties presented on a GAAP basis which reflects the impact of Leasing Concessions on a straight-line basis. •% of Stabilized Budgeted NOI – Represents original budgeted 2023 NOI for stabilized properties and projected annual NOI at stabilization (defined as having achieved 90% occupancy for three consecutive months) for properties that are in lease-up. •Total Budgeted Capital Cost – Estimated remaining cost for projects under development and/or developed plus all capitalized costs incurred to date, including land acquisition costs, construction costs, capitalized real estate taxes and insurance, capitalized interest and loan fees, permits, professional fees, allocated development overhead and other regulatory fees, plus any estimates of costs remaining to be funded for all projects, all in accordance with GAAP. Amounts for partially owned consolidated and unconsolidated properties are presented at 100% of the project. •Turnover – Total Residential move-outs (including inter-property and intra-property transfers) divided by total Residential apartment units. •Unlevered Internal Rate of Return (“IRR”) – The Unlevered IRR on sold properties is the compound annual rate of return calculated by the Company based on the timing and amount of: (i) the gross purchase price of the property plus any direct acquisition costs incurred by the Company; (ii) total revenues earned during the Company’s ownership period; (iii) total direct property operating expenses (including real estate taxes and insurance) incurred during the Company’s ownership period; (iv) capital expenditures incurred during the Company’s ownership period; and (v) the gross sales price of the property net of selling costs. 37 Table of Contents Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to use judgment in the application of accounting policies, including making estimates and assumptions. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different or different assumptions were made, it is possible that different accounting policies would have been applied, resulting in different financial results or different presentation of our financial statements. The Company’s significant accounting policies are described in Note 2 in the Notes to Consolidated Financial Statements. These policies were followed in preparing the consolidated financial statements at and for the year ended December 31, 2022. The Company has identified the significant accounting policies below as critical accounting policies. These critical accounting policies are those that have the most impact on the reporting of our financial condition and those requiring significant judgments and estimates. With respect to these critical accounting policies, management believes that the application of judgments and estimates is consistently applied and produces financial information that fairly presents the results of operations for all periods presented. Impairment of Long-Lived Assets The Company evaluates its long-lived assets, including its investment in real estate, for indicators of impairment at least quarterly. The judgments regarding the existence of impairment indicators are based on factors such as operational performance, market conditions, legal, regulatory and environmental concerns, the Company’s intent and ability to hold the related asset, as well as any significant cost overruns on development properties. Future events could occur which would cause the Company to conclude that impairment indicators exist and an impairment loss is warranted. Assessing impairment can be complex and involves a high degree of subjectivity in determining if indicators are present and in estimating the future undiscounted cash flows or the fair value of an asset. In particular, these estimates are sensitive to significant assumptions, including the estimation of future rental revenues, operating expenses, discount and capitalization rates and our intent and ability to hold the related asset, all of which could be affected by our expectations about future market or economic conditions. Assumptions are primarily subject to property-specific characteristics, especially with respect to our intent and ability to hold the related asset. While these property-specific assumptions can have a significant impact on the undiscounted cash flows or estimated fair value of a particular asset, our evaluation of the reported carrying values of long-lived assets during the current year were not particularly sensitive to external or market assumptions. Acquisition of Investment Properties The Company allocates the purchase price of properties that meet the definition of an asset acquisition to net tangible and identified intangible assets acquired based on their relative fair values using assumptions primarily based upon property-specific characteristics. In making estimates of relative fair values for purposes of allocating purchase price, the Company utilizes a number of sources, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property, our own analysis of recently acquired or developed and existing comparable properties in our portfolio and other market data. The Company also considers information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the relative fair value of the tangible and intangible assets/liabilities acquired. 38 Table of Contents Funds From Operations and Normalized Funds From Operations The following is the Company’s and the Operating Partnership’s reconciliation of net income to FFO available to Common Shares and Units / Units and Normalized FFO available to Common Shares and Units / Units for each of the three years ended December 31, 2022: Funds From Operations and Normalized Funds From Operations (Amounts in thousands) Year Ended December 31, 2022 2021 2020 Net income $ 806,995 $ 1,396,714 $ 962,501 Net (income) loss attributable to Noncontrolling Interests – Partially Owned Properties (3,774 ) (17,964 ) (14,855 ) Preferred/preference distributions (3,090 ) (3,090 ) (3,090 ) Net income available to Common Shares and Units / Units 800,131 1,375,660 944,556 Adjustments: Depreciation 882,168 838,272 820,832 Depreciation – Non-real estate additions (4,306 ) (4,277 ) (4,564 ) Depreciation – Partially Owned Properties (2,640 ) (3,673 ) (3,345 ) Depreciation – Unconsolidated Properties 2,898 2,487 2,454 Net (gain) loss on sales of unconsolidated entities - operating assets (9 ) (1,304 ) (1,636 ) Net (gain) loss on sales of real estate properties (304,325 ) (1,072,183 ) (531,807 ) Noncontrolling Interests share of gain (loss) on sales of real estate properties — 15,650 11,655 FFO available to Common Shares and Units / Units (1) (3) (4) 1,373,917 1,150,632 1,238,145 Adjustments: Impairment – non-operating real estate assets — 16,769 — Write-off of pursuit costs 4,780 6,526 6,869 Debt extinguishment and preferred share redemption (gains) losses 4,664 744 39,292 Non-operating asset (gains) losses 2,368 (22,283 ) (32,590 ) Other miscellaneous items (13,901 ) 8,976 4,652 Normalized FFO available to Common Shares and Units / Units (2) (3) (4) $ 1,371,828 $ 1,161,364 $ 1,256,368 FFO (1) (3) $ 1,377,007 $ 1,153,722 $ 1,241,235 Preferred/preference distributions (3,090 ) (3,090 ) (3,090 ) FFO available to Common Shares and Units / Units (1) (3) (4) $ 1,373,917 $ 1,150,632 $ 1,238,145 Normalized FFO (2) (3) $ 1,374,918 $ 1,164,454 $ 1,259,458 Preferred/preference distributions (3,090 ) (3,090 ) (3,090 ) Normalized FFO available to Common Shares and Units / Units (2) (3) (4) $ 1,371,828 $ 1,161,364 $ 1,256,368 (1)The National Association of Real Estate Investment Trusts (“Nareit”) defines funds from operations (“FFO”) (December 2018 White Paper) as net income (computed in accordance with accounting principles generally accepted in the United States (“GAAP”)), excluding gains or losses from sales and impairment write-downs of depreciable real estate and land when connected to the main business of a REIT, impairment write-downs of investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity and depreciation and amortization related to real estate. Adjustments for partially owned consolidated and unconsolidated partnerships and joint ventures are calculated to reflect funds from operations on the same basis. (2)Normalized funds from operations (“Normalized FFO”) begins with FFO and excludes: •the impact of any expenses relating to non-operating real estate asset impairment; •pursuit cost write-offs; •gains and losses from early debt extinguishment and preferred share redemptions; •gains and losses from non-operating assets; and •other miscellaneous items. 39 Table of Contents (3)The Company believes that FFO and FFO available to Common Shares and Units / Units are helpful to investors as supplemental measures of the operating performance of a real estate company, because they are recognized measures of performance by the real estate industry and by excluding gains or losses from sales and impairment write-downs of depreciable real estate and excluding depreciation related to real estate (which can vary among owners of identical assets in similar condition based on historical cost accounting and useful life estimates), FFO and FFO available to Common Shares and Units / Units can help compare the operating performance of a company’s real estate between periods or as compared to different companies. The Company also believes that Normalized FFO and Normalized FFO available to Common Shares and Units / Units are helpful to investors as supplemental measures of the operating performance of a real estate company because they allow investors to compare the Company’s operating performance to its performance in prior reporting periods and to the operating performance of other real estate companies without the effect of items that by their nature are not comparable from period to period and tend to obscure the Company’s actual operating results. FFO, FFO available to Common Shares and Units / Units, Normalized FFO and Normalized FFO available to Common Shares and Units / Units do not represent net income, net income available to Common Shares / Units or net cash flows from operating activities in accordance with GAAP. Therefore, FFO, FFO available to Common Shares and Units / Units, Normalized FFO and Normalized FFO available to Common Shares and Units / Units should not be exclusively considered as alternatives to net income, net income available to Common Shares / Units or net cash flows from operating activities as determined by GAAP or as a measure of liquidity. The Company’s calculation of FFO, FFO available to Common Shares and Units / Units, Normalized FFO and Normalized FFO available to Common Shares and Units / Units may differ from other real estate companies due to, among other items, variations in cost capitalization policies for capital expenditures and, accordingly, may not be comparable to such other real estate companies. (4)FFO available to Common Shares and Units / Units and Normalized FFO available to Common Shares and Units / Units are calculated on a basis consistent with net income available to Common Shares / Units and reflects adjustments to net income for preferred distributions and premiums on redemption of preferred shares/preference units in accordance with GAAP. The equity positions of various individuals and entities that contributed their properties to the Operating Partnership in exchange for OP Units are collectively referred to as the “Noncontrolling Interests – Operating Partnership”. Subject to certain restrictions, the Noncontrolling Interests – Operating Partnership may exchange their OP Units for Common Shares on a one-for-one basis. Item 7A. Quantitative and Qualitative Disclosures about Market Risk The Company is exposed to market risk from financial instruments primarily from changes in interest rates. Such risks derive from the refinancing of debt maturities, from exposure to interest rate fluctuations on floating rate debt and from derivative instruments utilized to swap fixed rate debt to floating or to hedge rates in anticipation of future debt issuances. Our operating results are, therefore, affected by changes in short-term interest rates, primarily SOFR, London Interbank Offered Rate ("LIBOR") and Securities Industry and Financial Markets Association (“SIFMA”) indices, which directly impact borrowings under our revolving credit facility and/or interest on secured and unsecured borrowings contractually tied to such rates. Short-term interest rates also indirectly affect the discount on notes issued under our commercial paper program. Additionally, we have exposure to long-term interest rates, particularly U.S. Treasuries, as they are utilized to price our long-term borrowings and therefore affect the cost of refinancing existing debt or incurring additional debt. The Alternative Reference Rates Committee (the “ARRC”) has identified SOFR as the preferred alternative rate for USD LIBOR. As part of the transition process that is now under way, LIBOR is no longer published for certain tenors and key USD settings are expected to be discontinued by June 2023. SOFR is now the primary basis for determining interest payments on borrowings on the Company’s $2.5 billion revolving credit facility. We are closely monitoring the evolution of practices in the credit markets and we do not expect such transition to have a material impact on the Company’s financial position or cash flows. The Company monitors and manages interest rates as part of its risk management process, by targeting adequate levels of floating rate exposure and an appropriate debt maturity profile. From time to time, we may utilize derivative instruments to manage interest rate exposure and to comply with the requirements of certain lenders, but not for trading or speculative purposes. The Company had total variable rate debt of $0.5 billion, representing 6.4% of total debt, and $0.6 billion, representing 7.3% of total debt, as of December 31, 2022 and 2021, respectively. If interest rates had been 100 basis points higher in 2022 and 2021 and average balances coincided with year end balances, our annual interest expense would have been $4.7 million and $6.1 million higher, respectively. Unsecured notes issued under the Company’s commercial paper program are treated as variable rate debt for the purposes of this calculation even though they do not have a stated interest rate, given their short-term nature. The effect of derivatives, if applicable, is also considered when computing the total amount of variable rate debt. Changes in interest rates also affect the estimated fair market value of our fixed rate debt, computed using a discounted cash flow model. As of December 31, 2022, the Company had total outstanding fixed rate debt of $7.0 billion, or 93.6% of total debt, with an estimated fair market value of $6.2 billion. If interest rates had been 100 basis points lower as of December 31, 2022, the estimated fair market value would have increased by approximately $397.5 million. As of December 31, 2021, the Company had total outstanding fixed rate debt of $7.7 billion, or 92.7% of total debt, with an estimated fair market value of $8.4 billion. If interest rates had been 100 basis points lower as of December 31, 2021, the estimated fair market value would have increased by approximately $637.2 million. 40 Table of Contents As of December 31, 2022, the Company’s derivative instruments had a net asset fair value of approximately $20.7 million. If interest rates increased by 35 basis points across the curve relative to market quotes as of December 31, 2022 (a 10% upward “parallel shift”), the net asset fair value of the Company’s derivative instruments would be approximately $39.4 million. If interest rates decreased by 35 basis points (a 10% downward “parallel shift”), the net asset fair value of the Company’s derivative instruments would be approximately $1.5 million. These amounts were determined by considering the impact of hypothetical interest rates on the Company’s financial instruments. These analyses do not consider the effects of the changes in overall economic activity that could exist in such an environment. Further, in the event of changes of such magnitude, management would likely take actions to further mitigate its exposure to these changes. However, due to the uncertainty of the specific actions that would be taken and their possible effects, this analysis assumes no changes in the Company’s financial structure or results. The Company cannot predict the effect of adverse changes in interest rates on its debt and derivative instruments and, therefore, its exposure to market risk, nor can there be any assurance that long-term debt will be available at advantageous pricing. Consequently, future results may differ materially from the estimated adverse changes discussed above.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto. These consolidated financial statements include all adjustments which are, in the opinion of management, necessary to reflect a fair statement of the results and all such adjustments are of a normal recurring nature.OVERVIEWEssex is a self-administered and self-managed REIT that acquires, develops, redevelops, and manages apartment communities in selected residential areas located on the West Coast of the United States. Essex owns all of its interests in its real estate investments, directly or indirectly, through the Operating Partnership. Essex is the sole general partner of the Operating Partnership and, as of December 31, 2022, had an approximately 96.6% general partner interest in the Operating Partnership.The Company’s investment strategy has two components: constant monitoring of existing markets, and evaluation of new markets to identify areas with the characteristics that underlie rental growth. The Company’s strong financial condition supports its investment strategy by enhancing its ability to quickly shift acquisition, development, redevelopment, and disposition activities to markets that will optimize the performance of the Company's portfolio.As of December 31, 2022, the Company owned or had ownership interests in 252 operating apartment communities, comprising 62,147 apartment homes, excluding the Company's ownership in preferred equity co-investments, loan investments, three operating commercial buildings, and a development pipeline comprised of one unconsolidated joint venture project.The Company’s apartment communities are predominately located in the following major regions:Southern California (primarily Los Angeles, Orange, San Diego, and Ventura counties)Northern California (the San Francisco Bay Area)Seattle Metro (Seattle metropolitan area)As of December 31, 2022, the Company’s development pipeline was comprised of one unconsolidated joint venture project under development aggregating 264 apartment homes and various predevelopment projects, with total incurred costs of $102.0 million. The estimated remaining project costs are approximately $25.0 million, $12.8 million of which represents the Company's estimated remaining costs, for total estimated project costs of $127.0 million. As of December 31, 2022, the Company also had an ownership interest in three operating commercial buildings (totaling approximately 283,000 square feet).By region, the Company's operating results for 2022 and 2021 and projection for 2023 new housing supply (defined as new multifamily apartment homes and single family homes, excluding developments with fewer than 50 apartment homes as well as student, senior and 100% affordable housing), projection for 2023 job growth, and 2023 estimated Same-Property revenue growth are as follows:Southern California Region: As of December 31, 2022, this region represented 43% of the Company’s consolidated operating apartment homes. Revenues for "2022 Same-Properties" (as defined below), or "Same-Property revenues," increased 11.3% in 2022 as compared to 2021. In 2023, the Company projects new residential supply of 30,300 apartment homes and single family homes, which represents 0.5% of the total housing stock. The Company projects an increase of 2,000 jobs or 0.3% in the Southern California region. Northern California Region: As of December 31, 2022, this region represented 37% of the Company’s consolidated operating apartment homes. Same-Property revenues increased 8.4% in 2022 as compared to 2021. In 2023, the Company projects new residential supply of 12,750 apartment homes and single family homes, which represents 0.5% of the total housing stock. The Company projects an increase of 4,500 jobs or 0.7% in the Northern California region. Seattle Metro Region: As of December 31, 2022, this region represented 20% of the Company’s consolidated operating apartment homes. Same-Property revenues increased 12.0% in 2022 as compared to 2021. In 2023, the Company projects new residential supply of 14,450 apartment homes and single family homes, which represents 1.1% of the total housing stock. The Company projects an increase of 3,000 jobs or 0.4% in the Seattle Metro region. In total, the Company projects an increase in 2023 Same-Property revenues of between 3.25% to 4.75%. Same-Property operating expenses are projected to increase in 2023 by 4.50% to 5.50%. 35Table of ContentsThe Company’s consolidated operating communities are as follows: As of As of December 31, 2022December 31, 2021 Apartment Homes%Apartment Homes%Southern California22,151 43 %22,190 43 %Northern California19,230 37 %19,123 37 %Seattle Metro10,341 20 %10,341 20 %Total51,722 100 %51,654 100 %Co-investments, developments under construction, and preferred equity interest co-investment communities are not included in the table presented above for both periods.Market Considerations, including the COVID-19 PandemicThough diminishing, the COVID-19 pandemic and its related variants continue to impact the U.S. and world economies. In an effort to mitigate its impact on affected populations, federal, state and local jurisdictions implemented varying forms of requirements which may continue to negatively affect profitability. While the California eviction moratorium sunsetted during the third quarter of 2021, other state and local eviction moratoriums and laws that limit rent increases during times of emergency and impair the ability to collect unpaid rent during certain timeframes continue to be in effect in various formats at various regions in which our communities are located, impacting the Company and its properties. The Company continues to work to comply with the stated intent of local, county, state and federal laws.While COVID-19’s impact begins to dissipate, geopolitical tensions between Russian and Ukraine increased uncertainty during2022. Inflation has caused an increase in consumer prices, thereby reducing purchasing power and elevating the risks of arecession. Due to increased inflation, the U.S. Federal Reserve raised the federal funds rate a total of seven times during 2022. In response, market interest rates have increased significantly during this time. At the same time, the labor market remains historically tight and companies continue to look to add employees, pushing unemployment lower.The long-term impact of these developments will largely depend on new information which may emerge concerning theCOVID-19 pandemic, future laws that may be enacted, geopolitical tensions, inflation, the impact on job growth and the broader economy, and reactions by consumers, companies, governmental entities and capital markets.Primarily as a result of the impact of the COVID-19 pandemic, the Company's cash delinquencies as a percentage of scheduled rental income for the Company’s stabilized apartment communities or "Same-Property" (stabilized properties consolidated by the Company for the years ended December 31, 2022 and 2021) have generally remained higher than the pre-pandemic period due to on-going eviction moratoria related to the COVID-19 pandemic, and above the typical historical range of 0.3% to 0.4% since the second quarter of 2020. Cash delinquencies remained elevated at 1.9% for 2021 but decreased to 1.2% in 2022, attributable to government payments for Emergency Rental Assistance which was mostly depleted by December 31, 2022. The Company continues to work with residents to collect such cash delinquencies. As of December 31, 2022, the delinquencies have not had a material adverse impact to the Company's liquidity position. The Company's average financial occupancy for the Company's Same-Property portfolio decreased slightly from 96.4% for the year ended December 31, 2021 to 96.1% for the year ended December 31, 2022. The COVID-19 pandemic and the resulting macroeconomic conditions have not negatively impacted the Company's ability to access traditional funding sources on the same or reasonably similar terms as were available in recent periods prior to the pandemic, as demonstrated by the Company's financing activity during the year ended December 31, 2022 discussed in the “Liquidity and Capital Resources" section below. The Company is not at material risk of not meeting the covenants in its credit agreements and is able to timely service its debt and other obligations.RESULTS OF OPERATIONSComparison of Year Ended December 31, 2022 to the Year Ended December 31, 2021 The Company’s average financial occupancy for the Company’s stabilized apartment communities or "2022 Same-Property" (stabilized properties consolidated by the Company for the years ended December 31, 2022 and 2021) decreased 30 36Table of Contentsbasis points to 96.1% in 2022 from 96.4% in 2021. Financial occupancy is defined as the percentage resulting from dividing actual rental income by total scheduled rental income. Actual rental income represents contractual rental income pursuant to leases without considering delinquency and concessions. Total scheduled rental income represents the value of all apartment homes, with occupied apartment homes valued at contractual rental rates pursuant to leases and vacant apartment homes valued at estimated market rents. The Company believes that financial occupancy is a meaningful measure of occupancy because it considers the value of each vacant apartment home at its estimated market rate.Market rates are determined using the recently signed effective rates on new leases at the property and are used as the starting point in the determination of the market rates of vacant apartment homes. The Company may increase or decrease these rates based on a variety of factors, including overall supply and demand for housing, concentration of new apartment deliveries within the same submarket which can cause periodic disruption due to greater rental concessions to increase leasing velocity, and rental affordability. Financial occupancy may not completely reflect short-term trends in physical occupancy and financial occupancy rates, and the Company's calculation of financial occupancy may not be comparable to financial occupancy disclosed by other REITs.The Company does not take into account delinquency and concessions to calculate actual rent for occupied apartment homes and market rents for vacant apartment homes. The calculation of financial occupancy compares contractual rates for occupied apartment homes to estimated market rents for unoccupied apartment homes, and thus the calculation compares the gross value of all apartment homes excluding delinquency and concessions. For apartment communities that are development properties in lease-up without stabilized occupancy figures, the Company believes the physical occupancy rate is the appropriate performance metric. While an apartment community is in the lease-up phase, the Company’s primary motivation is to stabilize the property, which may entail the use of rent concessions and other incentives, and thus financial occupancy, which is based on contractual income is not considered the best metric to quantify occupancy.The regional breakdown of the Company’s 2022 Same-Property portfolio for financial occupancy for the years ended December 31, 2022 and 2021 is as follows:Years endedDecember 31, 20222021Southern California96.2 %96.7 %Northern California96.1 %96.2 %Seattle Metro95.8 %96.2 %The following table provides a breakdown of revenue amounts, including the revenues attributable to 2022 Same-Properties.Number of ApartmentYears EndedDecember 31,DollarPercentageProperty Revenues ($ in thousands)Homes20222021ChangeChange2022 Same-Properties:Southern California21,006 $624,907 $561,326 $63,581 11.3 %Northern California17,895 591,556 545,535 46,021 8.4 %Seattle Metro10,218 268,512 239,819 28,693 12.0 %Total 2022 Same-Property Revenues49,119 1,484,975 1,346,680 138,295 10.3 %2022 Non-Same Property Revenues 110,700 84,738 25,962 30.6 %Total Property Revenues $1,595,675 $1,431,418 $164,257 11.5 % 2022 Same-Property Revenues increased by $138.3 million or 10.3% to $1.5 billion for 2022 compared to $1.3 billion in 2021. The increase was primarily attributable to an increase of 7.2% in average rental rates from $2,320 for 2021 to $2,486 for 2022 and 2.3% of the increase was attributable to a decrease in cash concessions in 2022 compared to 2021.2022 Non-Same Property Revenues increased by $26.0 million or 30.6% to $110.7 million in 2022 compared to $84.7 million in 2021. The increase was primarily due to the acquisitions of The Village at Toluca Lake and Canvas in 2021, the acquisitions of Regency Palm Court and Windsor Court in 2022, and an increase in average rental rates.37Table of ContentsManagement and other fees from affiliates increased by $2.0 million or 22.0% to $11.1 million in 2022 from $9.1 million in 2021. The increase was primarily due to the addition of Martha Lake Apartments, Monterra in Mill Creek, The Rexford, and Silver communities to the Company's joint venture portfolio in 2021 and Vela in 2022, partially offset by the Company's purchases of BEX III, LLC's 50.0% interest in The Village at Toluca Lake in 2021, and its joint venture partner's 49.8% interest in Essex JV LLC co-investment that owned Regency Palm Court and Windsor Court, in 2022.Property operating expenses, excluding real estate taxes increased by $18.5 million or 7.0% to $283.4 million in 2022 compared to $264.9 million in 2021, primarily due to increases of $9.2 million in utilities expenses, $7.4 million in maintenance and repairs expenses, and $1.9 million in administrative expenses. 2022 Same-Property operating expenses, excluding real estate taxes, increased by $15.5 million or 6.1% to $268.6 million in 2022 compared to $253.1 million in 2021, primarily due to increases of $8.0 million in utilities expenses, $6.2 million in maintenance and repairs expenses, $0.8 million in insurance and other expenses, and $0.5 million in administrative expenses. Real estate taxes increased by $3.5 million or 1.9% to $183.9 million in 2022 compared to $180.4 million in 2021, primarily due to real estate taxes from the completion of development properties Wallace on Sunset in 2021 and Station Park Green (Phase IV) in 2022, as well as the acquisitions of The Village at Toluca Lake, Canvas, and 7 S Linden Commercial properties during 2021. 2022 Same-Property real estate taxes increased by $0.3 million or 0.2% to $164.0 million in 2022 compared to $163.7 million in 2021 primarily due to increased valuations and tax rates. Corporate-level property management expenses increased by $4.5 million or 12.4% to $40.7 million in 2022 compared to $36.2 million in 2021 due to costs pertaining to the centralization of certain property level functions.Depreciation and amortization expense increased by $19.2 million or 3.7% to $539.3 million in 2022 compared to $520.1 million in 2021, primarily due to an increase in depreciation expense from the completion of development properties Mylo and Wallace on Sunset in 2021, Station Park Green (Phase IV) in 2022, as well as the acquisitions of The Village at Toluca Lake and Canvas in 2021, and Regency Palm Court and Windsor Court in 2022.Gain on sale of real estate and land of $94.4 million in 2022 was attributable to the sale of Anavia in the fourth quarter of 2022. The Company's $143.0 million gain on sale of real estate and land in 2021 was attributable to the sale of Hidden Valley, Axis 2300, Park 20, and Devonshire Apartments during 2021.Interest expense increased by $1.7 million or 0.8% to $204.8 million in 2022 compared to $203.1 million in 2021, primarily due to the issuance of new senior unsecured notes in 2021 which resulted in an increase in interest expense of $4.8 million and increased borrowing on the Company's unsecured lines of credit, and higher average interest rates, which resulted in an increase in interest expense of $3.0 million. Additionally, there was a $3.9 million decrease in capitalized interest in 2022, due to a decrease in development activity as compared to the same period in 2021. These increases in interest expense were partially offset by various debts that were paid off, matured, or regular principal payments during and after 2021 which resulted in a decrease in interest expense of $10.0 million for 2022.Total return swap income of $7.9 million in 2022 consists of monthly settlements related to the Company's four total return swap contracts with an aggregate notional amount of $223.6 million. Interest and other (loss) income decreased by $117.7 million or 119.3% to a loss of $19.0 million in 2022 compared to an income of $98.7 million in 2021, primarily due to unrealized losses resulting from a decrease in the fair value of marketable securities. Equity income from co-investments decreased by $85.7 million or 76.7% to $26.0 million in 2022 compared to $111.7 million in 2021, primarily due to decreases of $93.6 million in equity income from non-core co-investments, $5.3 million in income from preferred equity investments including income from early redemptions, and a $2.1 million impairment loss from an unconsolidated co-investment. These decreases were offset by $17.1 million in co-investment promote income during 2022 and an increase of $1.0 million in loss on early retirement of debt from unconsolidated co-investments.Deferred tax benefit on unconsolidated co-investments of $10.2 million in 2022 is primarily due to net unrealized losses from non-core unconsolidated co-investments.Gain on remeasurement of co-investment of $17.4 million in 2022 resulted from the Company's purchase of its joint venture partner's 49.8% membership interest in Essex JV, LLC co-investment that owned Regency Palm Court and Windsor Court. Gain on remeasurement of $2.3 million in 2021 resulted from the Company's purchase of BEX III's 50.0% interest in The Village at Toluca Lake community in the second quarter of 2021. 38Table of ContentsComparison of Year Ended December 31, 2021 to the Year Ended December 31, 2020 For the comparison of the years ended December 31, 2021 and December 31, 2020, refer to Part II, Item 7 “Management's Discussion and Analysis of Financial Condition and Results of Operations" on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 25, 2022 under the subheading "Comparison of Year Ended December 31, 2021 to the Year Ended December 31, 2020."Liquidity and Capital Resources The following table sets forth the Company’s cash flows for 2022, 2021 and 2020 ($ in thousands): For the year ended December 31, 202220212020Cash flow provided by (used in):Operating activities$975,649 $905,259 $803,108 Investing activities$145,958 $(397,397)$(416,900)Financing activities$(1,137,564)$(533,265)$(383,261)Essex’s business is operated primarily through the Operating Partnership. Essex issues public equity from time to time, but does not otherwise generate any capital itself or conduct any business itself, other than incurring certain expenses from operating as a public company which are fully reimbursed by the Operating Partnership. Essex itself does not hold any indebtedness, and its only material asset is its ownership of partnership interests of the Operating Partnership. Essex’s principal funding requirement is the payment of dividends on its common stock. Essex’s sole source of funding for its dividend payments is distributions it receives from the Operating Partnership.As of December 31, 2022, Essex owned a 96.6% general partner interest and the limited partners owned the remaining 3.4% interest in the Operating Partnership.The liquidity of Essex is dependent on the Operating Partnership’s ability to make sufficient distributions to Essex. The primary cash requirement of Essex is its payment of dividends to its stockholders. Essex also guarantees some of the Operating Partnership’s debt, as discussed further in Notes 7 and 8 to our consolidated financial statements included in Part IV, Item 15 of this Annual Report on Form 10-K. If the Operating Partnership fails to fulfill certain of its debt requirements, which trigger Essex’s guarantee obligations, then Essex will be required to fulfill its cash payment commitments under such guarantees. However, Essex’s only significant asset is its investment in the Operating Partnership.For Essex to maintain its qualification as a REIT, it must pay dividends to its stockholders aggregating annually at least 90% of its REIT taxable income, excluding net capital gains. While historically Essex has satisfied this distribution requirement by making cash distributions to its stockholders, it may choose to satisfy this requirement by making distributions of other property, including, in limited circumstances, Essex’s own stock. As a result of this distribution requirement, the Operating Partnership cannot rely on retained earnings to fund its ongoing operations to the same extent that other companies whose parent companies are not REITs can. Essex may need to continue to raise capital in the equity markets to fund the Operating Partnership’s working capital needs, acquisitions and developments.At December 31, 2022, the Company had $33.3 million of unrestricted cash and cash equivalents and $112.7 million in marketable securities. The Company believes that cash flows generated by its operations, existing cash and cash equivalents, marketable securities balances and availability under existing lines of credit are sufficient to meet all of its anticipated cash needs during 2023. Additionally, the capital markets continue to be available and the Company is able to generate cash from the disposition of real estate assets to finance additional cash flow needs, including continued development and select acquisitions. In the event that economic disruptions occur, the Company may further utilize other resources such as its cash reserves, lines of credit, or decreased investment in redevelopment activities to supplement operating cash flows. The Company is carefully monitoring and managing its cash position in light of ongoing conditions and levels of operations. The timing, source and amounts of cash flows provided by financing activities and used in investing activities are sensitive to changes in interest rates and other fluctuations in the capital markets environment, which can affect the Company’s plans for acquisitions, dispositions, development and redevelopment activities.As of December 31, 2022, the Company had $5.4 billion of fixed rate public bonds outstanding at an average interest rate of 3.3% with maturity dates ranging from 2023 to 2050.39Table of ContentsAs of December 31, 2022, the Company’s mortgage notes payable totaled $593.9 million, net of unamortized premiums and debt issuance costs, which consisted of $371.8 million in fixed rate debt at an average interest rate of 3.6% and maturity dates ranging from 2025 to 2028 and $222.1 million of tax-exempt variable rate demand notes with a weighted average interest rate of 3.5%. The tax-exempt variable rate demand notes have maturity dates ranging from 2027 to 2046. $223.6 million is subject to total return swaps.As of December 31, 2022, the Company had two unsecured lines of credit aggregating $1.24 billion, including a $1.2 billion unsecured line of credit and a $35.0 million working capital unsecured line of credit. As of December 31, 2022, there was $40.0 million outstanding on the $1.2 billion unsecured line of credit. The underlying interest rate is based on a tiered rate structure tied to the Company's credit ratings, adjusted for the Company's sustainability metric grid, and was at Adjusted SOFR plus 0.75% as of December 31, 2022. This facility is scheduled to mature in January 2027, with two six-month extensions, exercisable at the Company's option. As of December 31, 2022, there was $12.1 million outstanding on the Company's $35.0 million working capital unsecured line of credit. The underlying interest rate is based on a tiered rate structure tied to the Company's credit ratings, adjusted for the Company's sustainability metric grid, and was at Adjusted SOFR plus 0.75% as of December 31, 2022. This facility is scheduled to mature in July 2024.The Company’s unsecured lines of credit and unsecured debt agreements contain debt covenants related to limitations on indebtedness and liabilities and maintenance of minimum levels of consolidated earnings before depreciation, interest and amortization. The Company was in compliance with the debt covenants as of December 31, 2022 and 2021.The Company pays quarterly dividends from cash available for distribution. Until it is distributed, cash available for distribution is invested by the Company primarily in investment grade securities held available for sale or is used by the Company to reduce balances outstanding under its lines of credit.Derivative ActivityThe Company uses interest rate swaps, interest rate caps, and total return swap contracts to manage certain interest rate risks. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair values of interest rate swaps and total return swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty's nonperformance risk in the fair value measurements. The Company has four total return swap contracts, with an aggregate notional amount of $223.6 million, that effectively converts $223.6 million of fixed mortgage notes payable to a floating interest rate based on the Securities Industry and Financial Markets Association Municipal Swap Index ("SIFMA") plus a spread. The total return swaps provide fair market value protection on the mortgage notes payable to our counterparties during the initial period of the total return swap until the Company's option to call the mortgage notes at par can be exercised. The Company can currently call all four of the total return swaps, with $223.6 million of the outstanding debt at par. These derivatives do not qualify for hedge accounting.As of December 31, 2022 and 2021, the aggregate carrying value of the interest rate swap contracts were an asset of $5.6 million and zero, respectively. As of December 31, 2022 and 2021, the swap contracts were presented in the consolidated balance sheets as an asset of $5.6 million and zero, respectively, and were included in prepaid expenses and other assets on the consolidated balance sheets. The aggregate carrying and fair value of the total return swaps was zero at both December 31, 2022 and 2021.Hedge ineffectiveness related to cash flow hedges, which is reported in current year income as interest expense, net was zero for the years ended December 31, 2022, 2021, and 2020.Issuance of Common StockIn September 2021, the Company entered into the 2021 ATM Program, a new equity distribution agreement pursuant to which the Company may offer and sell shares of its common stock having an aggregate gross sales price of up to $900.0 million. In connection with the 2021 ATM Program, the Company may also enter into related forward sale agreements, and may sell shares of its common stock pursuant to these agreements. The use of a forward sale agreement would allow the Company to 40Table of Contentslock in a share price on the sale of shares of its common stock at the time the agreement is executed, but defer receipt of the proceeds from the sale of shares until a later date should the Company elect to settle such forward sale agreement, in whole or in part, in shares of common stock. The 2021 ATM Program replaced the prior equity distribution agreement entered into in September 2018 (the "2018 ATM Program"), which was terminated upon the establishment of the 2021 ATM Program. For the year ended December 31, 2022, the Company did not sell any shares of its common stock through the 2021 ATM Program. As of December 31, 2022, there were no outstanding forward purchase agreements, and $900.0 million of shares of common stock remain available to be sold under the 2021 ATM Program. For the years ended December 31, 2021 and 2020, the Company did not issue any shares of its common stock through the 2021 ATM Program or through the 2018 ATM Program. Capital ExpendituresNon-revenue generating capital expenditures are improvements and upgrades that extend the useful life of the property. For the year ended December 31, 2022, non-revenue generating capital expenditures totaled approximately $2,670 per apartment home. These expenditures do not include expenditures for deferred maintenance on acquisition properties, expenditures for property renovations and improvements which are expected to generate additional revenue or cost savings, and do not include expenditures incurred due to changes in government regulations that the Company would not have incurred otherwise, retail, furniture and fixtures, or expenditures for which the Company expects to be reimbursed. The Company expects that cash from operations and/or its lines of credit will fund such expenditures. Development and Predevelopment PipelineThe Company defines development projects as new communities that are being constructed, or are newly constructed and are in a phase of lease-up and have not yet reached stabilized operations. As of December 31, 2022, the Company's development pipeline was comprised of one unconsolidated joint venture project under development aggregating 264 apartment homes and various predevelopment projects, with total incurred costs of $102.0 million. Estimated remaining project costs are approximately $25.0 million, $12.8 million of which represents the Company's estimated remaining costs, for total estimated project costs of $127.0 million. The Company defines predevelopment projects as proposed communities in negotiation or in the entitlement process with an expected high likelihood of becoming entitled development projects. The Company may also acquire land for future development purposes or sale. The Company expects to fund the development and predevelopment communities by using a combination of some or all of the following sources: its working capital, amounts available on its lines of credit, construction loans, net proceeds from public and private equity and debt issuances, and proceeds from the disposition of assets, if any.Alternative Capital SourcesThe Company utilizes co-investments as an alternative source of capital for acquisitions of both operating and development communities. As of December 31, 2022, the Company had an interest in 264 apartment homes in communities actively under development with joint ventures for total estimated costs of $102.0 million. Total estimated remaining costs total approximately $25.0 million, of which the Company estimates that its remaining investment in these development joint ventures will be approximately $12.8 million. In addition, the Company had an interest in 10,425 apartment homes in operating communities with joint ventures and other investments for a total book value of $491.8 million.Real Estate and Other CommitmentsThe following table summarizes the Company's unfunded real estate and other future commitments at December 31, 2022 ($ in thousands):41Table of ContentsNumber of PropertiesInvestmentRemaining CommitmentJoint ventures (1):Preferred equity investments2 $98,000 $38,000 Non-core co-investments— 87,000 50,120 Consolidated:Mezzanine loans2 82,110 60,932 $267,110 $149,052 (1) Excludes approximately $12.8 million of the Company's share of estimated project costs for LIVIA (fka Scripps Mesa Apartments) which have been fully funded.At December 31, 2022, the Company had operating lease commitments of $162.1 million for ground, building and garage leases with maturity dates ranging from 2025 to 2083. $7.0 million of this commitment is due within the next twelve months.Variable Interest EntitiesIn accordance with accounting standards for consolidation of variable interest entities ("VIEs"), the Company consolidated the Operating Partnership, 18 DownREIT entities (comprising nine communities) and six co-investments as of December 31, 2022 and 2021. The Company consolidates these entities because it is deemed the primary beneficiary. Essex has no assets or liabilities other than its investment in the Operating Partnership. The consolidated total assets and liabilities related to the above consolidated co-investments and DownREIT entities, net of intercompany eliminations, were approximately $939.4 million and $324.3 million, respectively, as of December 31, 2022, and $909.3 million and $320.1 million, respectively, as of December 31, 2021. Noncontrolling interests in these entities were $121.5 million and $122.4 million as of December 31, 2022 and 2021, respectively. The Company's financial risk in each VIE is limited to its equity investment in the VIE. As of December 31, 2022, the Company did not have any other VIEs of which it was deemed to be the primary beneficiary.Critical Accounting EstimatesThe preparation of consolidated financial statements, in accordance with U.S. GAAP, requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. The Company defines critical accounting estimates as those estimates that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the Company. The Company’s critical accounting estimates relate principally to the following key areas: (i) accounting for the acquisition of investments in real estate (specifically, the allocation between land and buildings during the year ended December 31, 2020); and (ii) evaluation of events and changes in circumstances indicating whether the Company’s rental properties may be impaired. The Company bases its estimates on historical experience, current market conditions, and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from those estimates made by management.The Company accounts for its acquisitions of investments in real estate by assessing each acquisition to determine if it meets the definition of a business or if it qualifies as an asset acquisition. We expect that acquisitions of individual operating communities will generally be viewed as asset acquisitions, and result in the capitalization of acquisition costs, and the allocation of purchase price to the assets acquired and liabilities assumed based on the relative fair value of the respective assets and liabilities.In making estimates of fair values for purposes of allocating purchase price, the Company utilizes a number of sources, including independent land appraisals which consider comparable market transactions, its own analysis of recently acquired or developed comparable properties in our portfolio for land comparables and building replacement costs, and other publicly available market data. In calculating the fair value of identified intangible assets of an acquired property, the in-place leases are valued based on in-place rent rates and amortized over the average remaining term of all acquired leases. The allocation of the total consideration exchanged for a real estate acquisition between the identifiable assets and liabilities and the depreciation we recognize over the estimated useful life of the asset could be impacted by different assumptions and estimates used in the calculation. The reasonable likelihood that the estimate could have a material impact on the financial condition of the Company is based on the total consideration exchanged for real estate during any given year. The allocation of the value between land and 42Table of Contentsbuilding was a critical accounting estimate during the year ended December 31, 2020 as result of the potential material impact of the Company's acquisition of a land parcel and six communities for a total purchase price of $463.4 million. The Company periodically assesses the carrying value of its real estate investments for indicators of impairment. The judgments regarding the existence of impairment indicators are based on monitoring investment market conditions and performance for operating properties including the net operating income for the most recent 12 month period, monitoring estimated costs for properties under development, the Company's ability to hold and its intent with regard to each asset, and each property's remaining useful life. Although each of these may result in an impairment indicator, the shortening of an expected holding period due to the potential sale of a property is the most likely impairment indicator. Whenever events or changes in circumstances indicate that the carrying amount of a property held for investment may not be fully recoverable, the carrying amount is evaluated. If the sum of the property’s expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the property, then the Company will recognize an impairment loss equal to the excess of the carrying amount over the fair value of the property. Changes in operating and market conditions may result in a change of our intent to hold the property through the end of its useful life and may impact the assumptions utilized to determine the future cash flows of the real estate investment. The Company bases its accounting estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could be different under different assumptions or conditions.Funds from Operations Attributable to Common Stockholders and Unitholders Funds from Operations Attributable to Common Stockholders and Unitholders ("FFO") is a financial measure that is commonly used in the REIT industry. The Company presents FFO and FFO excluding non-core items (referred to as "Core FFO") as supplemental operating performance measures. FFO and Core FFO are not used by the Company as, nor should they be considered to be, alternatives to net income computed under U.S. GAAP as an indicator of the Company’s operating performance or as alternatives to cash from operating activities computed under U.S. GAAP as an indicator of the Company's ability to fund its cash needs.FFO and Core FFO are not meant to represent a comprehensive system of financial reporting and do not present, nor do they intend to present, a complete picture of the Company's financial condition and operating performance. The Company believes that net income computed under U.S. GAAP is the primary measure of performance and that FFO and Core FFO are only meaningful when they are used in conjunction with net income. The Company considers FFO and Core FFO to be useful financial performance measurements of an equity REIT because, together with net income and cash flows, FFO and Core FFO provide investors with additional bases to evaluate operating performance and ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures and to pay dividends. By excluding gains or losses related to sales of depreciated operating properties and excluding real estate depreciation (which can vary among owners of identical assets in similar condition based on historical cost accounting and useful life estimates), FFO can help investors compare the operating performance of a real estate company between periods or as compared to different companies. By further adjusting for items that are not considered part of the Company’s core business operations, Core FFO allows investors to compare the core operating performance of the Company to its performance in prior reporting periods and to the operating performance of other real estate companies without the effect of items that by their nature are not comparable from period to period and tend to obscure the Company’s actual operating results. The Company believes that its consolidated financial statements, prepared in accordance with U.S. GAAP, provide the most meaningful picture of its financial condition and its operating performance. In calculating FFO, the Company follows the definition for this measure published by NAREIT, which is the leading REIT industry association. The Company believes that, under the NAREIT FFO definition, the two most significant adjustments made to net income are (i) the exclusion of historical cost depreciation and (ii) the exclusion of gains and losses from the sale of previously depreciated properties. The Company agrees that these two NAREIT adjustments are useful to investors for the following reasons: (a)historical cost accounting for real estate assets in accordance with U.S. GAAP assumes, through depreciation charges, that the value of real estate assets diminishes predictably over time. NAREIT stated in its White Paper on Funds from Operations “since real estate asset values have historically risen or fallen with market conditions, many industry investors have considered presentations of operating results for real estate companies that use historical cost accounting to be insufficient by themselves." Consequently, NAREIT’s definition of FFO reflects the fact that real 43Table of Contentsestate, as an asset class, generally appreciates over time and depreciation charges required by U.S. GAAP do not reflect the underlying economic realities.(b)REITs were created as a legal form of organization in order to encourage public ownership of real estate as an asset class through investment in firms that were in the business of long-term ownership and management of real estate. The exclusion, in NAREIT’s definition of FFO, of gains and losses from the sales of previously depreciated operating real estate assets allows investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT’s activity and assists in comparing those operating results between periods.Management believes that it has consistently applied the NAREIT definition of FFO to all periods presented. However, there is judgment involved and other REITs' calculation of FFO may vary from the NAREIT definition for this measure, and thus their disclosure of FFO may not be comparable to the Company’s calculation.The table below is a reconciliation of net income available to common stockholders to FFO and Core FFO for the years ended December 31, 2022, 2021, and 2020.44Table of Contents As of and for the years ended December 31, 202220212020 ($ in thousands, except per share amounts)OTHER DATA:Funds from operations attributable to common stockholders and unitholders:Net income available to common stockholders$408,315 $488,554 $568,870 Adjustments:Depreciation and amortization539,319 520,066 525,497 Gains not included in FFO attributable to common stockholders and unitholders(111,839)(145,253)(301,886)Impairment loss from unconsolidated co-investments2,105 — 1,825 Depreciation and amortization from unconsolidated co-investments72,585 61,059 51,594 Noncontrolling interest related to Operating Partnership units14,297 17,191 19,912 Depreciation attributable to third party ownership and other (1)(1,421)(571)(539)Funds from operations attributable to common stockholders and unitholders$923,361 $941,046 $865,273 Non-core items: Expensed acquisition and investment related costs2,132 203 1,591 Deferred tax (benefit) expense on unconsolidated co-investments (2)(10,236)15,668 1,531 Gain on sale of marketable securities(12,436)(3,400)(2,131)Change in unrealized losses (gains) on marketable securities, net57,983 (33,104)(12,515)Provision for credit losses(381)141 687 Equity loss (income) from non-core co-investments (3)38,045 (55,602)(5,289) Loss on early retirement of debt, net 2 19,010 22,883 Loss (gain) on early retirement of debt from unconsolidated co-investment988 25 (38)Co-investment promote income(17,076)— (6,455)Income from early redemption of preferred equity investments and notes receivable(1,669)(8,469)(210)Accelerated interest income from maturity of investment in mortgage backed security— — (11,753)General and administrative and other, net2,536 1,026 14,958 Insurance reimbursements, legal settlements, and other, net(5,392)(35,234)(81)Core funds from operations attributable to common stockholders and unitholders$977,857 $841,310 $868,451 Weighted average number of shares outstanding, diluted (FFO) (4)67,375 67,335 67,726 Funds from operations attributable to common stockholders and unitholders per share - diluted$13.70 $13.98 $12.78 Core funds from operations attributable to common stockholders and unitholders per share - diluted$14.51 $12.49 $12.82 (1)The Company consolidates certain co-investments. The noncontrolling interest's share of net operating income in these investments for the twelve months ended December 31, 2022 was $3.3 million. (2)Represents deferred tax (benefit) expense related to net unrealized gains or losses on technology co-investments.(3)Represents the Company's share of co-investment loss (income) from technology co-investments.(4)Assumes conversion of all outstanding OP Units into shares of the Company's common stock and excludes DownREIT limited partnership units.45Table of ContentsNet Operating IncomeNet operating income ("NOI") and Same-Property NOI are considered by management to be important supplemental performance measures to earnings from operations included in the Company’s consolidated statements of income. The presentation of Same-Property NOI assists with the presentation of the Company’s operations prior to the allocation of depreciation and any corporate-level or financing-related costs. NOI reflects the operating performance of a community and allows for an easy comparison of the operating performance of individual communities or groups of communities. In addition, because prospective buyers of real estate have different financing and overhead structures, with varying marginal impacts to overhead by acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure for determining the value of a real estate asset or group of assets. The Company defines Same-Property NOI as Same-Property revenues less Same-Property operating expenses, including property taxes. Please see the reconciliation of earnings from operations to NOI and Same-Property NOI, which in the table below is the NOI for stabilized properties consolidated by the Company for the periods presented ($ in thousands): 202220212020Earnings from operations$595,229 $529,995 $491,441 Adjustments: Corporate-level property management expenses40,704 36,211 34,361 Depreciation and amortization539,319 520,066 525,497 Management and other fees from affiliates(11,139)(9,138)(9,598)General and administrative56,577 51,838 65,388 Expensed acquisition and investment related costs2,132 203 1,591 Impairment loss— — 1,825 Gain on sale of real estate and land(94,416)(142,993)(64,967)NOI1,128,406 986,182 1,045,538 Less: Non Same-Property NOI(76,027)(56,267)(89,865)Same-Property NOI$1,052,379 $929,915 $955,673 Forward-Looking StatementsCertain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this Annual Report on Form 10-K which are not historical facts may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act") and Section 21E of the Exchange Act, including statements regarding the Company's expectations, estimates, assumptions, hopes, intentions, beliefs and strategies regarding the future. Words such as "expects," "assumes," "anticipates," "may," "will," "intends," "plans," "projects," "believes," "seeks," "future," "estimates," and variations of such words and similar expressions are intended to identify such forward-looking statements. Such forward-looking statements include, among other things, statements regarding the Company's expectations related to the continued evolution of the work-from-home trend in light of the COVID-19 pandemic, the Company's intent, beliefs or expectations with respect to the timing of completion of current development and redevelopment projects and the stabilization of such projects, the timing of lease-up and occupancy of its apartment communities, the anticipated operating performance of its apartment communities, the total projected costs of development and redevelopment projects, co-investment activities, qualification as a REIT under the Internal Revenue Code of 1986, as amended, 2022 Same-Property revenue and operating expenses generally and in specific regions, the real estate markets in the geographies in which the Company's properties are located and in the United States in general, the adequacy of future cash flows to meet anticipated cash needs, its financing activities and the use of proceeds from such activities, the availability of debt and equity financing, general economic conditions including the potential impacts from such economic conditions, inflation, the labor market, supply chain impacts and ongoing hostilities between Russia and Ukraine, trends affecting the Company's financial condition or results of operations, changes to U.S. tax laws and regulations in general or specifically related to REITs or real estate, changes to laws and regulations in jurisdictions in which communities the Company owns are located, and other information that is not historical information. While the Company's management believes the assumptions underlying its forward-looking statements are reasonable, such forward-looking statements involve known and unknown risks, uncertainties and other factors, many of which are beyond the Company’s control, which could cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The Company cannot assure the future results or outcome of the matters described in these statements; rather, these statements merely reflect the Company’s current expectations of the approximate outcomes of the matters discussed. Factors that might 46Table of Contentscause the Company’s actual results, performance or achievements to differ materially from those expressed or implied by these forward-looking statements include, but are not limited to, the following: potential future outbreaks of infectious diseases or other health concerns, which could adversely affect the Company's business and its tenants, and cause a significant downturn in general economic conditions, the real estate industry, and the markets in which the Company's communities are located; the Company may fail to achieve its business objectives; the actual completion of development and redevelopment projects may be subject to delays; the stabilization dates of such projects may be delayed; the Company may abandon or defer development or redevelopment projects for a number of reasons, including changes in local market conditions which make development less desirable, increases in costs of development, increases in the cost of capital or lack of capital availability, resulting in losses; the total projected costs of current development and redevelopment projects may exceed expectations; such development and redevelopment projects may not be completed; development and redevelopment projects and acquisitions may fail to meet expectations; estimates of future income from an acquired property may prove to be inaccurate; occupancy rates and rental demand may be adversely affected by competition and local economic and market conditions; uncertainties regarding ongoing hostilities between Russia and Ukraine and the related impacts on macroeconomic conditions, including, among other things, interest rates and inflation; the Company may be unsuccessful in the management of its relationships with its co-investment partners; future cash flows may be inadequate to meet operating requirements and/or may be insufficient to provide for dividend payments in accordance with REIT requirements; changes in laws or regulations; the terms of any refinancing may not be as favorable as the terms of existing indebtedness; unexpected difficulties in leasing of development projects; volatility in financial and securities markets; the Company’s failure to successfully operate acquired properties; unforeseen consequences from cyber-intrusion; the Company’s inability to maintain our investment grade credit rating with the rating agencies; government approvals, actions and initiatives, including the need for compliance with environmental requirements; and those further risks, special considerations, and other factors discussed in Item 1A, Risk Factors, of this Form 10-K, and those risk factors and special considerations set forth in the Company’s other filings with the SEC which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. All forward-looking statements are made as of the date hereof, the Company assumes no obligation to update or supplement this information for any reason, and therefore, they may not represent the Company's estimates and assumptions after the date of this report.Item 7A. Quantitative and Qualitative Disclosures About Market RisksInterest Rate Hedging ActivitiesThe Company’s objective in using derivatives is to add stability to interest expense and to manage its exposure to interest rate movements or other identified risks. To accomplish this objective, the Company uses interest rate swaps as part of its cash flow hedging strategy. As of December 31, 2022, the Company had one interest rate swap contract to mitigate the risk of changes in the interest-related cash outflows on $300.0 million of the unsecured term loan that had not been drawn and had a balance of zero. As of December 31, 2022, the Company also had $223.6 million of secured variable rate indebtedness. The Company’s interest rate swap is designated as a cash flow hedge as of December 31, 2022. The following table summarizes the notional amount, carrying value, and estimated fair value of the Company’s cash flow hedge derivative instruments used to hedge interest rates as of December 31, 2022. The notional amount represents the aggregate amount of a particular security that is currently hedged at one time, but does not represent exposure to credit, interest rates or market risks. The table also includes a sensitivity analysis to demonstrate the impact on the Company’s derivative instruments from an increase or decrease in 10-year Treasury bill interest rates by 50 basis points, as of December 31, 2022. NotionalAmountMaturityDate RangeCarrying andEstimatedFair ValueEstimated Carrying Value +50-50($ in thousands)Basis PointsBasis PointsCash flow hedges: Interest rate swaps$300,000 2026$5,556 $10,107 $851 Total cash flow hedges$300,000 2026$5,556 $10,107 $851 Additionally, the Company has entered into total return swap contracts, with an aggregate notional amount of $223.6 million that effectively convert $223.6 million of fixed mortgage notes payable to a floating interest rate based on the SIFMA plus a spread and have a carrying value of zero at December 31, 2022. The Company is exposed to insignificant interest rate risk on these swaps as the related mortgages are callable, at par, by the Company, co-terminus with the termination of any related swap. These derivatives do not qualify for hedge accounting.Interest Rate Sensitive Liabilities47Table of ContentsThe Company is exposed to interest rate changes primarily as a result of its lines of credit and long-term debt used to maintain liquidity and fund capital expenditures and expansion of the Company’s real estate investment portfolio and operations. The Company’s interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve its objectives, the Company borrows primarily at fixed rates and may enter into derivative financial instruments such as interest rate swaps, caps and treasury locks in order to mitigate its interest rate risk on a related financial instrument. The Company does not enter into derivative or interest rate transactions for speculative purposes.The Company’s interest rate risk is monitored using a variety of techniques. The table below presents the principal amounts and weighted average interest rates by year of expected maturity to evaluate the expected cash flows. Management has estimated the fair value of the Company’s $5.7 billion of fixed rate debt at December 31, 2022, to be $5.2 billion. Management has estimated the fair value of the Company’s $275.7 million of variable rate debt at December 31, 2022, to be $273.2 million based on the terms of existing mortgage notes payable and variable rate demand notes compared to those available in the marketplace. The following table represents scheduled principal payments ($ in thousands): For the Years Ended December 31, ($ in thousands, except for interest rates)20232024202520262027ThereafterTotalFair valueFixed rate debt $302,093 $402,177 $632,035 $548,291 $419,558 $3,417,000 $5,721,154 $5,195,981 Average interest rate3.4 %4.0 %3.5 %3.5 %3.8 %3.0 % Variable rate debt (1)$852 $13,005 $1,019 $1,114 $84,397 $175,269 $275,656 $273,160 Average interest rate3.6 %4.3 %3.6 %3.6 %3.4 %3.7 % (1)$223.6 million of variable rate debt is tax exempt to the note holders.The table incorporates only those exposures that exist as of December 31, 2022; it does not consider those exposures or positions that could arise after that date. As a result, the Company’s ultimate realized gain or loss, with respect to interest rate fluctuations and hedging strategies would depend on the exposures that arise prior to settlement.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Cautionary Note Regarding Forward-Looking Information.” In addition, there is a discussion of risks associated with an investment in our securities, see “Item 1A. Risk Factors.”Unless the context requires otherwise, references to “we,” “us,” “our” and the “Company” refer to The Estée Lauder Companies Inc. and its subsidiaries.PART IItem 1. Business.The Estée Lauder Companies Inc., founded in 1946 by Estée and Joseph Lauder, is one of the world’s leading manufacturers, marketers and sellers of quality skin care, makeup, fragrance and hair care products, and is a steward of luxury and prestige brands globally. Our products are sold in approximately 150 countries and territories under a number of well-known brand names including: Estée Lauder, Clinique, Origins, M·A·C, Bobbi Brown Cosmetics, La Mer, Aveda, Jo Malone London, TOM FORD, Too Faced, Dr.Jart+, and The Ordinary. We are also the global licensee of the AERIN and BALMAIN brand names for fragrances and cosmetics. Each brand is distinctly positioned within the market for cosmetics and other beauty products.We believe we are a leader in the beauty industry due to the global recognition of our brand names, our excellence in product innovation, our strong position in key geographic markets and the consistently high quality of our products and “High-Touch” services. We sell our prestige products through distribution channels that complement the luxury image and prestige status of our brands, and we provide “High-Touch” consumer experiences across our distribution channels. Our products are sold on our own and authorized retailer websites, on third-party online malls, in stores in airports, in duty-free locations and in our own and authorized freestanding stores. In addition, our products are sold in brick-and-mortar retail stores, including department stores, specialty-multi retailers, upscale perfumeries and pharmacies and prestige salons and spas. We believe that our strategy of pursuing selective distribution heightens the aspirational quality of our brands.We have been controlled by the Lauder family since the founding of our Company. Members of the Lauder family, some of whom are directors, executive officers and/or employees, beneficially own, directly or indirectly, as of August 11, 2023, shares of our Company's Class A Common Stock and Class B Common Stock having approximately 84% of the outstanding voting power of the Common Stock.2Table of ContentsProducts Skin Care - Our broad range of skin care products address various skin care needs. These products include moisturizers, serums, cleansers, toners, body care, exfoliators, acne and oil correctors, facial masks and sun care products.Makeup - Our full array of makeup products includes lipsticks, lip glosses, mascaras, foundations, eyeshadows, nail polishes and powders. Many of the products are offered in an extensive palette of shades and colors. We also sell related items such as compacts, brushes and other makeup tools.Fragrance - We offer a variety of fragrance products. The fragrances are sold in various forms, including eau de parfum sprays and colognes, as well as lotions, powders, creams, candles and soaps that are based on a particular fragrance.Hair Care - Our hair care products include shampoos, conditioners, styling products, treatment, finishing sprays and hair color products.Other - We also sell ancillary products and services that do not fit the definition of skin care, makeup, fragrance, and hair care. The other category also includes royalty revenue from our licensing of the TOM FORD trademark to third parties since our fiscal 2023 acquisition of the TOM FORD brand.3Table of ContentsOur BrandsGiven the personal nature of our products and the wide array of consumer preferences and tastes, as well as competition for the attention of consumers, our strategy has been to market and promote our products through distinctive brands seeking to address broad preferences and tastes. Each brand has a single global image that is promoted with consistent logos, packaging and advertising designed to enhance its image and differentiate it from other brands in the market. Beauty brands are differentiated by numerous factors, including quality, performance, a particular lifestyle, where they are distributed (e.g., prestige or mass) and price point. Below is a chart showing the brands that we sell and how we view them based on lifestyle and price point: 4Table of Contents Estée Lauder brand products, which have been sold since 1946, have a reputation for innovation, sophistication and superior quality. Estée Lauder is one of the world’s most renowned beauty brands, producing iconic skin care, makeup and fragrances. We pioneered the marketing of prestige men’s fragrance, grooming and skin care products with the introduction of Aramis products in 1964. Introduced in 1968, Clinique skin care and makeup products are all allergy tested and 100% fragrance free and have been designed to address individual skin types and needs. Clinique also offers select fragrances. The skin care and makeup products are based on the research and related expertise of leading dermatologists. Lab Series, introduced in 1987, is a series of high performance, specialized skin care solutions uniquely created to improve the look and feel of men’s skin. Introduced in 1990, Origins is known for high-performance natural skin care that is “powered by nature and proven by science.” The brand also sells makeup and fragrance products and is distributed primarily through online, specialty-multi and freestanding Origins stores. Origins has a license agreement to develop and sell beauty products using the name of Dr. Andrew Weil. M·A·C, the leading brand of professional cosmetics, was created in Toronto, Canada. We completed our acquisition of M·A·C in 1998. The brand’s popularity has grown through a tradition of word-of-mouth endorsement from professional makeup artists, models, photographers and journalists around the world. Acquired in 1995, Bobbi Brown is a global prestige beauty brand known for its high quality and undertone-correct makeup and skin care products that celebrate individual beauty and confidence. Reflecting its artistry roots, the brand is focused on creating a teaching and learning community of women around the world.5Table of Contents Acquired in 1995, La Mer is a leading global luxury skin care brand that is available in limited distribution worldwide. The brand is known for its iconic Crème de la Mer moisturizer, serums and lotions, as well as other skin care and foundation products that are created around the original “Miracle Broth.” Acquired in 1997, Aveda sells high-performance, naturally-derived hair care products, as well as skin care, makeup and fragrance. The brand is known for its innovative plant-based products and its commitment to environmental sustainability and corporate responsibility. It is distributed primarily through top-tier hair salons and direct-to-consumer, via online and Aveda stores. Acquired in 1999, Jo Malone London is a scented British lifestyle brand with understated elegance, offering enchanted story-telling and “High-Touch” boutique services. The brand’s famous colognes are perfect alone or artfully layered with Fragrance Combining. Jo Malone London embodies the spirit of gifting generosity and inspires emotional elevation. Acquired in 2006, Bumble and bumble is a New York-based hair care brand that creates high-quality hair care and styling products. The brand is distributed primarily through top-tier salons, including Bumble and bumble’s own flagship salons, specialty-multi retailers and online. Acquired in 2003, Darphin is a Paris-based, prestige skin care brand known for its high-performance botanical skin care. The brand is distributed primarily through high-end independent pharmacies and online brand and retailer channels. On April 28, 2023, we acquired the TOM FORD brand and related intellectual property. The TOM FORD brand is a luxury brand created in 2005, encompassing fashion, fragrance, eyewear and other accessories. From 2005 until the closing of the acquisition, we developed, manufactured and distributed luxury fragrances and beauty products as a licensee. As the current owner and steward of the brand, we are continuing with the beauty products and have licensed the fashion brand and operations and eyewear to third parties. Consistent with the fashion brand, our products exude seductive modern-day glamour and include luxury fragrance, color cosmetics, men’s grooming products and skin care products for discerning consumers globally. Acquired in 2010, Smashbox Cosmetics is a Los Angeles-based, photo studio-inspired makeup brand with high performance products created for our consumer’s everyday life in the spotlight.6Table of Contents Launched in 2012, AERIN is a luxury lifestyle beauty and fragrance brand inspired by the signature style of its founder, Aerin Lauder. Acquired in 2014, Le Labo is a sensory and experiential lifestyle brand, deeply rooted in the craft of slow perfumery. Born in Grasse, France and raised in downtown NYC, it offers hand-crafted and personalized fragrances, as well as ‘alternative’ and genuine experiences celebrating craftsmanship. Acquired in 2015, Les Editions de Parfums Frédéric Malle is a collection of exclusive, sophisticated, ultraluxury fragrances crafted by some of the world’s most talented perfumers and published by the brand. Acquired in 2015, GLAMGLOW started as a behind-the-scenes Hollywood secret to instant glow. The brand is known for bold, sensorial products that deliver instant results, and its unconventional philosophy that high performance skin care should also be fun and sexy. Acquired in 2016, Kilian Paris is a prestige fragrance brand that embodies timeless sophistication and modern luxury. Acquired in 2016, Too Faced is a serious makeup brand that knows how to have fun. The brand is unabashedly pink, pretty and feminine with a playful wink that is beloved for its high-quality formulas, cheeky product names and distinctive packaging.Acquired in 2019, Dr.Jart+ is a Seoul-based, global skin care brand known for its innovative formulations and unique combination of dermatological science and art. Its high-quality masks, moisturizers and serums are distributed primarily through travel retail, specialty-multi and online channels. In 2021, we increased our investment in Deciem Beauty Group Inc. (“DECIEM”) to approximately 76%. Known as “The Abnormal Beauty Company,” DECIEM is a Toronto-based, vertically integrated multi-brand beauty company rooted in a consumer-focused and functional approach. Its portfolio includes The Ordinary, an ingredient-focused brand, and NIOD, a science-driven skin care brand.7Table of ContentsIn fiscal 2021, we made the decision to exit the global distribution of BECCA products, a makeup brand we acquired in 2016 and substantially completed this exit during fiscal 2022. In fiscal 2022, we negotiated early termination agreements for our previous license agreements for the Donna Karan New York, DKNY, Michael Kors, Tommy Hilfiger and Ermenegildo Zegna product lines effective June 30, 2022 and continued to sell products under these licenses through such time.From time to time, we also make strategic minority investments in other companies, mainly in the beauty industry. In some cases, we have acquired the remaining interest or a majority interest (e.g., Have & Be Co. Ltd. (i.e. Dr.Jart+) and Deciem Beauty Group Inc., respectively). Our current minority investments include a company based in India that manufactures, markets and sells Ayurvedic skin care and other products under the Forest Essentials brand name, primarily in India.Our “luxury brands” are La Mer, Jo Malone London, TOM FORD, AERIN Beauty, Le Labo, Editions de Parfums Frédéric Malle and Kilian Paris. Our “large brands” are Estée Lauder, La Mer, M·A·C and Clinique. Our “scaling brands” are Jo Malone London, TOM FORD, Aveda, Bobbi Brown Cosmetics and The Ordinary. Our “developing brands” are Le Labo, Too Faced, Dr.Jart+, Origins, Kilian Paris, Bumble and bumble, Smashbox, Darphin Paris, Lab Series, Editions de Parfums Frédéric Malle and GLAMGLOW. Social Impact and SustainabilityWe continue to integrate social impact and sustainability into our strategy and business operations. Our social impact and sustainability initiatives help drive innovation, growth and efficiency across the business and within our brand portfolio. These initiatives also aim to foster employee engagement and build consumer trust and loyalty.Areas of focus include climate and energy; packaging; sourcing; green chemistry and ingredient transparency; inclusion, diversity and equity; employee health and safety; and social investments. We have set goals or made commitments within these focus areas. For example, our goals related to climate and energy support efficiency and conservation within our facilities, internal supply chain and value chain. Certain goals are also intended to help us reduce cost and waste. Our Nominating and ESG Committee, one of our Board committees, has oversight responsibility for our Company’s environmental, social and governance (“ESG”) activities and practices, including citizenship and sustainability matters. Our social impact and sustainability efforts are led by our Executive Chairman and our President and Chief Executive Officer. Other members of senior management, along with employees across the organization, help to drive our strategic initiatives concerning social impact and sustainability.Additional information related to our social impact and sustainability matters can be found at www.elcompanies.com.8Table of ContentsDistributionWe sell our prestige products through distribution channels that complement the luxury image and prestige status of our brands, and we provide “High-Touch” consumer experiences across our distribution channels. Our products are sold on our own and authorized retailer websites, on third-party online malls, in stores in airports, in duty-free locations and in our own and authorized freestanding stores. In addition, our products are sold in brick-and-mortar retail stores, including department stores, specialty-multi retailers, upscale perfumeries and pharmacies and prestige salons and spas. Our general practice is to accept returns of our products from customers if properly requested and approved.Online, we sell products from most of our brands direct-to-consumer through our brand.com sites and third-party online malls. We also sell our products wholesale to authorized retailers that resell online through retailer.com and pure-play sites. Our sites are in approximately 50 countries. While today a majority of these online sales are generated in mainland China, the United States and the United Kingdom, we continue to expand in other markets globally.As of June 30, 2023, we operated approximately 1,600 freestanding stores. The total reflects the net impact during fiscal 2023 of store closures related to the Post-COVID Business Acceleration Program and closures due to natural lease expirations, offset by new door openings. Most freestanding stores are operated by us under a single brand name, such as M·A·C, Jo Malone London and Aveda. We also operate over 250 multi-branded company stores in outlet malls. We maintain dedicated sales teams that manage our retail accounts. We have wholly-owned operations in over 50 countries through which we market, sell and distribute our products. In certain countries, we sell our products through carefully selected distributors who we believe share our commitment to protecting the image and position of our brands. For information regarding our net sales and long-lived assets by geographic region, see
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.Information required by this Item is presented in “Management's Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.Item 7A. Quantitative and Qualitative Disclosures about Market Risk. Information regarding market risk is presented in “Market Risk Disclosure” of this Form 10-K.
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diff --git a/Elevance Health, Inc._10-K_2023-02-15_1156039-0001156039-23-000007.html b/Elevance Health, Inc._10-K_2023-02-15_1156039-0001156039-23-000007.html
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. (In Millions, Except Per Share Data or As Otherwise Stated Herein)On May 18, 2022, our shareholders approved a proposal to amend our amended and restated articles of incorporation to change our name from Anthem, Inc. to Elevance Health, Inc. This amendment and name change went into effect on June 27, 2022. We began operating as Elevance Health, Inc. and trading under our new ticker symbol “ELV” on June 28, 2022. References to the terms “we,” “our,” “us,” “Elevance Health” or the “Company” used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) refer to Elevance Health, Inc., an Indiana corporation, and, unless the context otherwise requires, its direct and indirect subsidiaries. References to the “states” include the District of Columbia and Puerto Rico, unless the context otherwise requires. This MD&A should be read in conjunction with our audited consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K. This section of this Annual Report on Form 10-K generally discusses 2022 and 2021 items and year-over-year comparisons between 2022 and 2021. A detailed discussion of 2020 items and year-over-year comparisons between 2021 and 2020 that are not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021. OverviewElevance Health is a health company with the purpose of improving the health of humanity. We are one of the largest health insurers in the United States in terms of medical membership, serving approximately 47.5 million medical members through our affiliated health plans as of December 31, 2022. We are an independent licensee of the Blue Cross and Blue Shield Association (“BCBSA”), an association of independent health benefit plans. We serve our members as the Blue Cross licensee for California and as the Blue Cross and Blue Shield (“BCBS”) licensee for Colorado, Connecticut, Georgia, Indiana, Kentucky, Maine, Missouri (excluding 30 counties in the Kansas City area), Nevada, New Hampshire, New York (in the New York City metropolitan area and upstate New York), Ohio, Virginia (excluding the Northern Virginia suburbs of Washington, D.C.) and Wisconsin. In a majority of these service areas, we do business as Anthem Blue Cross, Anthem Blue Cross and Blue Shield, and Empire Blue Cross Blue Shield or Empire Blue Cross. In addition, we conduct business through arrangements with other BCBS licensees as well as other strategic partners. Through our subsidiaries, we also serve customers in numerous states across the country as AIM Specialty Health, Amerigroup, Aspire Health, Beacon, CareMore, Freedom Health, HealthLink, HealthSun, MMM, Optimum Healthcare, Simply Healthcare, Unicare and/or Wellpoint. We offer pharmacy benefits management (“PBM”) services through our CarelonRx, Inc. (“CarelonRx”) subsidiary, which was known as IngenioRx, Inc. prior to January 1, 2023. We are licensed to conduct insurance operations in all 50 states, the District of Columbia and Puerto Rico through our subsidiaries. As part of our name change to Elevance Health, in June 2022, we announced that over the next several years we will organize our brand portfolio into the following core go-to-market brands:•Anthem Blue Cross/Anthem Blue Cross and Blue Shield — represents our existing Anthem-branded and affiliated Blue Cross and/or Blue Shield licensed plans;•Wellpoint — we intend to unite select non-BCBSA licensed Medicare, Medicaid and Commercial plans under the Wellpoint name; and•Carelon — this brand brings together our healthcare-related services and capabilities, including our formerly named Diversified Business Group and IngenioRx businesses, under a single brand name.In 2022, we managed our operations by customer type through four reportable segments: Commercial & Specialty Business, Government Business, CarelonRx (formerly known as IngenioRx) and Other. As we continue our journey to evolve our business from a traditional health insurance company into a lifetime, trusted health partner, we are evaluating and making changes to how we manage our business. This included a review of the products in each of our operating segments, which resulted in restructurings between some of our operating segments. Therefore, our reportable segment presentation in 2023 -39-and its composition will reflect how we began managing our operations and monitoring performance, aligning strategies and allocating resources on January 1, 2023. As a result of these changes, beginning with our Quarterly Report on Form 10-Q for the first quarter of 2023, we will report our results in the following four reportable segments: (i) Health Benefits, which will combine our existing Commercial & Specialty Business and Government Business segments; (ii) our existing CarelonRx segment; (iii) Carelon Services (our former Diversified Business Group), which will be carved out from our existing Other segment; and (iv) Corporate and Other, which will include businesses that do not individually meet the quantitative thresholds for an operating segment, as well as corporate expenses not allocated to our other reportable segments. We expect to reclassify previously reported information to conform to the new presentation.Our results of operations discussed throughout this MD&A are determined in accordance with generally accepted accounting principles (“GAAP”). We also calculate operating gain and operating margin to further aid investors in understanding and analyzing our core operating results. Operating gain is calculated as total operating revenue less benefit expense, cost of products sold and selling, general and administrative expense. Operating margin is calculated as operating gain divided by operating revenue. Our definition of operating gain and operating margin may not be comparable to similarly titled measures reported by other companies. We use these measures as a basis for evaluating segment performance, allocating resources, forecasting future operating periods and setting incentive compensation targets. This information is not intended to be considered in isolation or as a substitute for income before income tax expense, net income or fully-diluted earnings per share (“EPS”) prepared in accordance with GAAP. For additional details on operating gain, see our “Reportable Segments Results of Operations” discussion included in this MD&A. For a reconciliation of reportable segment operating revenue to the amounts of total revenue included in the consolidated statements of income and a reconciliation of reportable segment operating gain to income before income tax expense, see Note 20, “Segment Information,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.Our operating revenue consists of premiums, product revenue, and administrative fees and other revenue. Premium revenue is generated from risk-based contracts where we indemnify our policyholders against costs for covered health and life insurance benefits. Product revenue represents services performed by CarelonRx for unaffiliated PBM customers and includes ingredient costs (net of any rebates or discounts), including co-payments made by or on behalf of the customer, and administrative fees. Unaffiliated PBM customers include our fee-based groups that contract with CarelonRx for PBM services and external customers outside of the health plans we own. Administrative fees and other revenue come from fees from our fee-based customers for the processing of transactions or network discount savings realized, revenues from our Medicare processing business and revenues from other health-related businesses, including care management programs and miscellaneous other income. Our benefit expense primarily includes costs of care for health services consumed by our risk-based members, such as outpatient care, inpatient hospital care, professional services (primarily physician care) and pharmacy benefit costs. All four components are affected both by unit costs and utilization rates. Unit costs include the cost of outpatient medical procedures per visit, inpatient hospital care per admission, physician fees per office visit and prescription drug prices. Utilization rates represent the volume of consumption of health services and typically vary with the age and health status of our members and their social and lifestyle choices, along with clinical protocols and medical practice patterns in each of our markets. A portion of benefit expense recognized in each reporting period consists of actuarial estimates of claims incurred but not yet paid by us. Any changes in these estimates are recorded in the period the need for such an adjustment arises. While we offer a diversified mix of managed care products and services through our managed care plans, our aggregate cost of care can fluctuate based on a change in the overall mix of these products and services. Our managed care plans include: Preferred Provider Organizations; Health Maintenance Organizations; Point-of-Service plans; traditional indemnity plans and other hybrid plans, including Consumer-Driven Health Plans; and hospital only and limited benefit products. We classify certain quality improvement costs as benefit expense. Quality improvement activities are those designed to improve member health outcomes, prevent hospital readmissions and improve patient safety. They also include expenses for wellness and health promotion provided to our members. These quality improvement costs may be comprised of expenses incurred for: (i) medical management, including care coordination and case management; (ii) health and wellness, including disease management services for such conditions as diabetes, high-risk pregnancies, congestive heart failure and asthma management and wellness initiatives like weight-loss programs and smoking cessation treatments; and (iii) clinical health policy, such as identification and use of best clinical practices to avoid harm, identifying clinical errors and safety concerns, and identifying potential adverse drug interactions. -40-Our cost of products sold represents the cost of pharmaceuticals dispensed by CarelonRx for our unaffiliated PBM customers (net of rebates or discounts), including any co-payments made by or on behalf of the customer, per-claim administrative fees for prescription fulfillment and certain direct costs related to sales and administration of customer contracts.Our selling, general and administrative expenses consist of fixed and variable costs. Examples of fixed costs are depreciation, amortization and certain facilities expenses. Certain variable costs, such as premium taxes, vary directly with premium volume. Commission expense generally varies with premium or membership volume. Other variable costs, such as salaries and benefits, do not vary directly with changes in premium but are more aligned with changes in membership. The acquisition or loss of a significant block of business would likely impact staffing levels and thus, associated compensation expense. Other variable costs include professional and consulting expenses and advertising. Other factors can impact our administrative cost structure, including systems efficiencies, inflation and changes in productivity.Our results of operations depend in large part on our ability to accurately predict and effectively manage healthcare costs through effective contracting with providers of care to our members, product pricing, medical management and health and wellness programs, innovative product design and our ability to maintain or achieve improvement in our Centers for Medicare and Medicaid Services Star ratings. Several economic factors related to healthcare costs, such as regulatory mandates of coverage as well as direct-to-consumer advertising by providers and pharmaceutical companies, have a direct impact on the volume of care consumed by our members. The potential effect of escalating healthcare costs, any changes in our ability to negotiate competitive rates with our providers and any regulatory or market-driven restrictions on our ability to obtain adequate premium rates to offset overall inflation in healthcare costs, including increases in unit costs and utilization resulting from the aging of the population and other demographics, the impact of epidemics and pandemics, as well as advances in medical technology, may impose further risks to our ability to profitably underwrite our business and may have a material adverse impact on our results of operations.We intend to expand through a combination of organic growth, strategic acquisitions and efficient use of capital in both existing and new markets. Our growth strategy is designed to enable us to take advantage of additional economies of scale, as well as provide us access to new and evolving technologies and products. In addition, we believe geographic and product diversity reduces our exposure to local or regional regulatory, economic and competitive pressures and provides us with increased opportunities for growth. We use our subsidiary CarelonRx (formerly IngenioRx) to market and offer PBM services, and we expect CarelonRx to continue to improve our ability to integrate pharmacy benefits within our medical and specialty platform. We continued growing our government-sponsored business through organic growth and the acquisitions of MMM Holdings, LLC (“MMM”) in 2021 and Integra MLTC, Inc. (“Integra”) in 2022. In all other markets, we intend to maintain our position by delivering excellent service, offering competitively priced products, providing access to high-quality provider networks and effectively capitalizing on the brand strength of the Blue Cross and Blue Shield names and marks. For additional information about our business and reportable segments, see Part I, Item 1, “Business” and Note 20, “Segment Information” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.COVID-19The COVID-19 pandemic continues to evolve, putting pressure on the healthcare system, and it has impacted, and may continue to impact, our membership, benefit expense and member behavior. The full extent of the impact of the COVID-19 pandemic will depend on future developments, which remain uncertain and cannot be predicted at this time. We will continue to monitor the COVID-19 pandemic as well as resulting legislative and regulatory changes to manage our response and assess and mitigate potential adverse impacts to our business. For additional discussion regarding the impact of and our risks and trends related to the COVID-19 pandemic, see “Business Trends” and Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K.Business TrendsIn 2022, we made the decision to modestly expand our participation in the Individual state- or federally-facilitated marketplaces (the “Public Exchange”) for 2023 after also expanding in 2022. As a result, for 2023 we are offering Individual Public Exchange products in 138 of the 143 rating regions in which we operate, in comparison to 122 of 143 rating regions in 2022. Our strategy has been, and will continue to be, to only participate in rating regions where we have an appropriate level -41-of confidence that these markets are on a path toward sustainability, including, but not limited to, factors such as expected financial performance, regulatory environment and underlying market characteristics. Changes to our business environment are likely to continue as elected officials at the national and state levels continue to enact, and both elected officials and candidates for election continue to propose, significant modifications to existing laws and regulations, including changes to taxes and fees. In addition, the continuing growth in our government-sponsored business exposes us to increased regulatory oversight.Our CarelonRx subsidiary markets and offers PBM services to our affiliated health plan customers throughout the country, as well as to customers outside of the health plans we own. Our comprehensive PBM services portfolio includes features such as formulary management, pharmacy networks, a prescription drug database, member services and mail order capabilities. CarelonRx delegates certain PBM administrative functions, such as claims processing and prescription fulfillment, to CaremarkPCS Health, L.L.C., which is a subsidiary of CVS Health Corporation, pursuant to a five-year agreement that is set to terminate on December 31, 2024. With CarelonRx, we retain the responsibilities for clinical and formulary strategy and development, member and employer experiences, operations, sales, marketing, account management and retail network strategy. Pricing Trends: We strive to price our health benefit products consistent with anticipated underlying medical cost trends. We continue to closely monitor the COVID-19 pandemic (including new COVID-19 variants, which may be more contagious or severe, or less responsive to treatment or vaccines) and the impacts it may have on our pricing, such as surges in COVID-19 related hospitalizations, infection rates, the cost of COVID-19 vaccines, testing and treatment and the return of non-COVID-19 healthcare utilization to our estimate of normal levels, based on historical utilization patterns. We frequently make adjustments to respond to legislative and regulatory changes as well as pricing and other actions taken by existing competitors and new market entrants. Product pricing in our Commercial & Specialty Business segment remains competitive. Revenues from the Medicare and Medicaid programs are dependent, in whole or in part, upon annual funding from the federal government and/or applicable state governments. The Patient Protection and Affordable Care Act (the “ACA”) imposed an annual Health Insurance Provider Fee (“HIP Fee”) on health insurers that write certain types of health insurance on U.S. risks. We priced our affected products to cover the impact of the HIP Fee when it was in effect. The HIP Fee was in effect for 2020 but was permanently repealed beginning in 2021.Medical Cost Trends: Our medical cost trends are primarily driven by increases in the utilization of services across all provider types and the unit cost increases of these services. We work to mitigate these trends through various medical management programs such as care and condition management, program integrity and specialty pharmacy management and utilization management, as well as benefit design changes. There are many drivers of medical cost trends that can cause variance from our estimates, such as changes in the level and mix of services utilized, regulatory changes, aging of the population, health status and other demographic characteristics of our members, epidemics, pandemics, advances in medical technology, new high cost prescription drugs, provider contracting inflation, labor costs and healthcare provider or member fraud.At its onset, the COVID-19 pandemic caused a decrease in utilization of non-COVID-19 health services, which decreased our claim costs in 2020. As the pandemic continued through 2021, our non-COVID-19 healthcare utilization experience gradually increased and largely normalized, and our COVID-19 related healthcare expenses increased as new variants (Delta and Omicron) emerged and vaccinations and boosters became available.The Omicron variant increased confirmed COVID-19 cases to significant levels at the end of 2021 and the beginning of 2022. The COVID-19 surge quickly declined during the first quarter of 2022, with COVID-19 inpatient hospitalizations, provider-based tests, visits and vaccinations all decreasing to lower levels by the end of the first half of 2022; concurrently, non-COVID-19 healthcare utilization recovered from lower levels earlier in the year. Omicron sub-variant viruses as well as costs associated with updated bivalent vaccinations drove modest increases in COVID-19 related healthcare expenses in the second half of 2022, but the expected paid claims impact for the second half of 2022 are significantly lower than the winter surge experienced in each of the prior two years. The ongoing cost and volume of covered services related to the COVID-19 pandemic and a future shift of government supplied vaccinations and treatments to privatized, full cost price points may have an adverse effect on our future claim costs. We continue to closely monitor the COVID-19 pandemic and its impacts on our medical cost trends. For additional discussion regarding business trends, see Part I, Item 1, “Business” of this Annual Report on Form 10-K.-42-Regulatory Trends and UncertaintiesWith the declaration of COVID-19 as a public health emergency (“PHE”), the federal and state governments enacted, and may continue to enact, legislation and regulations in response to the COVID-19 pandemic that have had, and we expect will continue to have, a significant impact on health benefits, consumer eligibility for public programs and our cash flows for all of our lines of business and which have introduced increased uncertainty around our cost structure. These actions, which are or have been in effect for various durations, provide, among other things: mandates to waive cost-sharing for COVID-19 testing, vaccines and related services; financial support to healthcare providers; and mandates related to prior authorizations, payment levels to providers, consumer enrollment windows and telehealth services. The Biden administration renewed the PHE on January 11, 2023 and has indicated that they intend for the PHE to expire on May 11, 2023.Under the Consolidated Appropriations Act of 2023 (the “2023 Appropriations Act”), Congress decoupled Medicaid eligibility recertification from the PHE. As a result, states may begin removing ineligible beneficiaries from their Medicaid programs starting April 1, 2023. When recertifications resume, we expect a decline in our Medicaid membership. At the same time, we expect growth in our Commercial risk-based and fee-based plans and Medicare, including through the Public Exchanges, as members exiting Medicaid in our 14 Commercial states seek coverage elsewhere.The Inflation Reduction Act of 2022, which was signed into law in August 2022, contains a variety of provisions that impact our business including an extension of the American Rescue Plan Act of 2021's enhanced Premium Tax Credits (“PTC”) through 2025; imposing a new corporate alternative minimum tax; providing a one percent excise tax on repurchases of stock made after December 31, 2022; allowing the Centers for Medicare and Medicaid Services (“CMS”) to negotiate prices on a limited set of prescription drugs in Medicare Parts B and D beginning in 2026; instituting caps on insulin cost sharing in Medicare Parts B and D; redesigning of the Medicare Part D benefit; adding a requirement that drug manufacturers pay rebates if prices increase beyond inflation; and delaying the implementation of the Trump Administration Medicare drug rebate rule to 2032. The extension of the enhanced PTC will likely allow for growth in Individual exchange market enrollment as Medicaid eligibility recertifications resume, supporting continuity of coverage for more people.The Consolidated Appropriations Act of 2021 (the “2021 Appropriations Act”) has impacted and in the future may have a material effect upon our business, including procedures and coverage requirements related to surprise medical bills and new mandates for continuity of care for certain patients, price comparison tools, disclosure of broker compensation, mental health parity reporting and reporting on pharmacy benefits and drug costs. The requirements of the 2021 Appropriations Act applicable to us have varying effective dates, some of which were effective in December 2021 and during 2022, and others of which have been extended into 2023 since the enactment of the 2021 Appropriations Act. The health plan price transparency regulations issued in October 2020 by the U.S. Departments of Health and Human Services, Labor and Treasury required us to begin disclosing in July 2022, on a monthly basis, detailed pricing information regarding negotiated rates for all covered items and services between the plan or issuer and in-network providers and historical payments to, and billed charges from, out-of-network providers. Additionally, beginning in 2023, we are now required to make available to members personalized out-of-pocket cost information and the underlying negotiated rates for 500 covered healthcare items and services, including prescription drugs. In 2024, this requirement will expand to all items and services.Since its enactment in 2010, the ACA has introduced new risks, regulatory challenges and uncertainties, has impacted our business model and strategy and has required changes in the way our products are designed, underwritten, priced, distributed and administered. We expect the ACA will continue to significantly impact our business and results of operations, including pricing, minimum medical loss ratios and the geographies in which our products are available. We also expect further and ongoing regulatory guidance on a number of issues related to Medicare, including evolving methodology for ratings and quality bonus payments. CMS also frequently proposes changes to its program that audits data submitted under the risk adjustment programs in ways that could increase financial recoveries from plans. We will continue to evaluate the impact of the ACA as any further developments occur.For additional discussion regarding regulatory trends and uncertainties, and risk factors that could cause actual results to differ materially from those contained in forward-looking statements made in this Annual Report on Form 10-K, see Part I, Item 1, “Business — Regulation” and Part I, Item 1A, “Risk Factors.”-43-Other Significant ItemsBusiness and Operational MattersAs mentioned above, we began operating as Elevance Health on June 28, 2022. This name change is intended to better reflect our business and our journey from a traditional health benefits organization to a lifetime, trusted health partner. Elevance Health supports health at every stage, offering health plans and clinical, behavioral, pharmacy and complex-care solutions that promote whole health.On January 23, 2023, we announced our entrance into an agreement to acquire Louisiana Health Service & Indemnity Company, d/b/a Blue Cross and Blue Shield of Louisiana, an independent licensee of the BCBSA that provides healthcare plans to the Individual, Group, Medicaid and Medicare markets, primarily in the State of Louisiana. This acquisition aligns with our vision to be an innovative, valuable, and inclusive healthcare partner by providing care management programs that improve the lives of the people we serve. The acquisition is expected to close by the end of the fourth quarter of 2023 and is subject to standard closing conditions and customary approvals.On November 9, 2022, we announced our entrance into an agreement with CarepathRx Aggregator, LLC to acquire its specialty pharmacy division, which includes BioPlus Parent, LLC (“BioPlus”) and subsidiaries. BioPlus is one of the largest independent specialty pharmacy organizations in the United States and seeks to connect payors and providers of specialty pharmaceuticals to meet the medication therapy needs of patients with complex medical conditions. This acquisition aligns with our vision to be an innovative, valuable and inclusive healthcare partner by providing care management programs that improve the lives of the people we serve. The acquisition closed on February 15, 2023, and initial purchase accounting has not been finalized.On May 5, 2022, we completed our acquisition of Integra. Integra is a managed long-term care plan that serves New York state Medicaid members, enabling adults with long-term care needs and disabilities to live safely and independently in their own homes.On June 29, 2021, we completed our acquisition of MMM, including its Medicare Advantage plan, Medicaid plan and other affiliated companies. MMM is a Puerto Rico-based integrated healthcare organization and seeks to provide its Medicare Advantage and Medicaid members with a whole health experience through its network of specialized clinics and wholly owned independent physician associations. This acquisition aligns with our vision to be an innovative, valuable and inclusive healthcare partner by providing care management programs that improve the lives of the people we serve.On April 28, 2021, we completed our acquisition of myNEXUS, Inc. (“myNEXUS”). myNEXUS is a comprehensive home-based nursing management company for payors and, at the time of acquisition, delivered integrated clinical support services for Medicare Advantage members across twenty states. This acquisition aligns with our strategy to manage integrated, whole person multi-site care and support by providing national, large-scale expertise to manage nursing services in the home and facilitate transitions of care. For additional information, see Note 3, “Business Acquisitions,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.In 2020, we introduced enterprise-wide initiatives to optimize our business and as a result, recorded a charge of $653 in selling, general and administrative expenses. We believe these initiatives largely represent the next step forward in our progression towards becoming a more agile organization, including process automation and a reduction in our office space footprint. In the fourth quarters of 2022 and 2021, we identified additional office space reductions and related fixed asset impairments due to the continuing COVID-19 pandemic and recorded net charges of $39 and $202, respectively, in selling, general and administrative expenses. For additional information, see Note 4, “Business Optimization Initiatives” and Note 18, “Leases,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.Litigation Matters In the consolidated multi-district proceeding in the United States District Court for the Northern District of Alabama (the “Court”) captioned In re Blue Cross Blue Shield Antitrust Litigation (“BCBSA Litigation”), the BCBSA and Blue Cross and/or Blue Shield licensees, including us (the “Blue plans”) previously approved a settlement agreement and release with the -44-plaintiffs representing a putative nationwide class of health plan subscribers (the “Subscriber Settlement Agreement”), which agreement required the Court’s approval to become effective. Generally, the lawsuits in the BCBSA Litigation challenge elements of the licensing agreements between the BCBSA and the independently owned and operated Blue plans. The cases were brought by two putative nationwide classes of plaintiffs, health plan subscribers and providers. The Subscriber Settlement Agreement applies only to the subscriber class. The defendants continue to contest the consolidated cases brought by the provider plaintiffs.In August 2022, the Court issued a final order approving the Subscriber Settlement Agreement (the “Final Approval Order”). In compliance with the Subscriber Settlement Agreement, the Company paid $506 into an escrow account in September 2022, for an aggregate and full settlement payment by the Company of $596, which was previously accrued in 2020. Four notices of appeal of the Final Approval Order were filed by the September 2022 appeal deadline. Those appeals are proceeding in the United States Court of Appeals for the Eleventh Circuit. In the event all appellate rights are exhausted in a manner that affirms the Court’s Final Approval Order, the defendants’ payment and non-monetary obligations under the Subscriber Settlement Agreement will become effective and the funds held in escrow will be distributed in accordance with the Subscriber Settlement Agreement. For additional information regarding the BCBSA Litigation, see Note 14, “Commitments and Contingencies – Litigation and Regulatory Proceedings – Blue Cross Blue Shield Antitrust Litigation,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.Selected Operating PerformanceDuring the year ended December 31, 2022, total medical membership increased by 2.2 million, or 4.8%. The increase in medical membership was driven primarily by organic growth in our Government Business segment primarily driven by the continued temporary suspension of Medicaid eligibility recertification during the COVID-19 pandemic, as well as organic growth in our Commercial & Specialty Business segment, and in particular in our Group fee-based membership.Operating revenue for the year ended December 31, 2022 was $155,660, an increase of $18,717, or 13.7%, from the year ended December 31, 2021. The increase in operating revenue was primarily driven by higher premium revenue in our Medicaid business due to organic membership growth from the continued temporary suspension of Medicaid eligibility recertification during the COVID-19 pandemic, the acquisition of Integra in the second quarter of 2022 and the acquisition of Ohio Medicaid members through the purchase of a Medicaid contract in the first quarter of 2022. Membership growth in our Medicare Advantage and Commercial & Specialty Business risk-based businesses, as well as premium rate increases to cover medical cost trends, also generated higher premium revenue. Finally, the increase in operating revenue was further attributable to increased pharmacy product revenue in our CarelonRx segment, resulting from growth in membership and higher script volume. Net income for the year ended December 31, 2022 was $6,019, a decrease of $76, or 1.2%, from the year ended December 31, 2021. The decrease in net income was primarily due to realized losses on financial instruments in 2022, as compared to gains in 2021, and increased intangible amortization in 2022 related to recent acquisitions and the rebranding of our products, as we expect to retire certain trade names in the future. These items were partially offset by operating gain increases in all of our business segments.Our fully-diluted shareholders' earnings per share (“EPS”) for the year ended December 31, 2022 was $24.81, an increase of $0.08, or 0.3%, from the year ended December 31, 2021. Our diluted shares for the year ended December 31, 2022 were 242.8, a decrease of 4.0, or 1.6%, compared to the year ended December 31, 2021. The increase in EPS resulted from lower average shares outstanding in 2022, partially offset by the decrease in net income.Operating cash flow for the year ended December 31, 2022 was $8,399, or approximately 1.4 times net income. Operating cash flow for the year ended December 31, 2021 was $8,364, or approximately 1.4 times net income. The slight increase in operating cash flow was primarily due to higher net income in 2022, when adjusted for the impact of investment losses and gains, partially offset by the timing of working capital changes and the payment pursuant to the Subscriber Settlement Agreement made in September 2022.-45-Membership Our medical membership includes the following customer types: Individual, Group risk-based, Group fee-based, BlueCard®, Medicare, Medicaid and our Federal Employees Health Benefits (“FEHB”) Program. We refer to members in our service areas licensed by the BCBSA as our BCBS-branded, or Anthem BCBS, business. Non-BCBS-branded business refers to members in our non-BCBS-branded, or Wellpoint plans, which include Amerigroup, Freedom Health, HealthSun, MMM, Optimum Healthcare and Simply Healthcare plans, as well as HealthLink and UniCare members. In addition to the above medical membership, we also serve customers who purchase one or more of our other products or services that are often ancillary to our health business.•Individual consists of individual customers under age 65 and their covered dependents. Individual policies are generally sold through independent agents and brokers, retail partnerships, our in-house sales force or via the Public Exchanges. Individual business is sold on a risk-based basis. We offer on-exchange products through Public Exchanges and off-exchange products. Federal premium subsidies are available only for certain Public Exchange Individual products. Unsubsidized Individual customers are generally more sensitive to product pricing and, to a lesser extent, the configuration of the network and the efficiency of administration. Customer turnover is generally higher with Individual as compared to Group risk-based. Individual business accounted for 1.7%, 1.7% and 1.6% of our medical members at December 31, 2022, 2021 and 2020, respectively.•Group risk-based consists of employer customers who purchase products on a full-risk basis, which are products for which we charge a premium and indemnify our policyholders against costs for health benefits. Group risk-based accounts include Local Group customers and National Accounts. Local Group consists of those employer customers with less than 5% of eligible employees located outside of the headquarter state, as well as customers with more than 5% of eligible employees located outside of the headquarter state with up to 5,000 eligible employees. In addition, Local Group includes Student Health members. National Accounts generally consist of multi-state employer groups primarily headquartered in an Elevance Health service area with at least 5% of the eligible employees located outside of the headquarter state and with more than 5,000 eligible employees. Some exceptions are allowed based on broker and consultant relationships. Group risk-based accounts are generally sold through brokers or consultants who work with industry specialists from our in-house sales force and are offered both on and off the Public Exchanges. Group risk-based accounted for 8.4%, 8.8% and 8.9% of our medical members at December 31, 2022, 2021 and 2020, respectively.•Group fee-based customers represent employer groups, Local Group, including UniCare members, and National Accounts, who purchase fee-based products and elect to retain most or all of the financial risk associated with their employees’ healthcare costs. Some fee-based customers choose to purchase stop loss coverage to limit their retained risk. Group fee-based accounts are generally sold through independent brokers or consultants retained by the customer working with our in-house sales force. Group fee-based accounted for 42.4%, 42.7% and 45.5% of our medical members at December 31, 2022, 2021 and 2020, respectively.•BlueCard® host customers represent enrollees of Blue Cross and/or Blue Shield plans not owned by Elevance Health who receive healthcare services in our BCBSA licensed markets. BlueCard® membership consists of estimated host members using the national BlueCard® program. Host members are generally members who reside in or travel to a state in which an Elevance Health subsidiary is the Blue Cross and/or Blue Shield licensee and who are covered under an employer-sponsored health plan issued by a non-Elevance Health controlled BCBSA licensee (the “home plan”). We perform certain functions, including claims pricing and administration, for BlueCard® members, for which we receive administrative fees from the BlueCard® members’ home plans. Other administrative functions, including maintenance of enrollment information and customer service, are performed by the home plan. Host members are computed using, among other things, the average number of BlueCard® claims received per month. BlueCard® host membership accounted for 13.6%, 13.6% and 14.1% of our medical members at December 31, 2022, 2021 and 2020, respectively.•Medicare customers are Medicare-eligible individual members age 65 and over who have enrolled in Medicare Advantage, including Special Needs Plans (“SNPs”), also known as Medicare Advantage SNPs; dual-eligible programs through Medicare-Medicaid Plans (“MMPs”); Medicare Supplement plans; and Medicare Part D Prescription Drug Plans (“Medicare Part D”). Medicare Advantage plans provide Medicare beneficiaries with a managed care alternative to traditional Medicare and often include a Medicare Part D benefit. In addition, our -46-Medicare Advantage SNPs provide tailored benefits to special needs individuals who are institutionalized or have severe or disabling chronic conditions and to dual-eligible customers, who are low-income seniors and persons under age 65 with disabilities. Medicare Advantage SNPs are coordinated care plans specifically designed to provide targeted care, covering all the healthcare services considered medically necessary for members and often providing professional care coordination services, with personal guidance and programs that help members maintain their health. Medicare Advantage membership also includes Medicare Advantage members in our Group Retiree Solutions business who are retired members of Commercial accounts or retired members of groups who are not affiliated with our Commercial accounts who have selected a Medicare Advantage product through us. Medicare Supplement plans typically pay the difference between healthcare costs incurred by a beneficiary and amounts paid by Medicare. Medicare Part D offers a prescription drug plan to Medicare and MMP beneficiaries. MMP, which was established as a result of the passage of the ACA, is a demonstration program focused on serving members who are dually eligible for Medicaid and Medicare. Medicare Supplement and Medicare Advantage products are marketed in the same manner, primarily through independent agents and brokers. Medicare program business accounted for 6.2%, 6.2% and 5.5% of our medical members at December 31, 2022, 2021 and 2020, respectively.•Medicaid membership represents eligible members who receive health benefits through publicly funded healthcare programs, including Medicaid, ACA-related Medicaid expansion programs, Temporary Assistance for Needy Families, programs for seniors and people with disabilities, Children’s Health Insurance Programs, and specialty programs such as those focused on long-term services and support, HIV/AIDS, foster care, behavioral health and/or substance abuse disorders, and intellectual disabilities or developmental disabilities, among others. Total Medicaid program business accounted for 24.3%, 23.4% and 20.6% of our medical members at December 31, 2022, 2021 and 2020, respectively.•FEHB members consist of United States government employees and their dependents who receive health benefits within our geographic markets through our participation in the national contract between the BCBSA and the U.S. Office of Personnel Management. FEHB business accounted for 3.4%, 3.6% and 3.8% of our medical members at December 31, 2022, 2021 and 2020, respectively.-47-The following table presents our medical membership by reportable segment and customer type as of December 31, 2022, 2021 and 2020. Also included below is other membership by product. The medical membership and other membership presented are unaudited and in certain instances include estimates of the number of members represented by each contract at the end of the period. December 312022 vs. 20212021 vs. 2020(In thousands)202220212020Change% ChangeChange% ChangeMedical MembershipCommercial & Specialty Business:Individual789 759 680 30 4.0 %79 11.6 %Group Risk-Based3,988 4,006 3,799 (18)(0.4)%207 5.4 %Commercial Risk-Based4,777 4,765 4,479 12 0.3 %286 6.4 %BlueCard®6,462 6,178 6,059 284 4.6 %119 2.0 %Group Fee-Based20,174 19,395 19,551 779 4.0 %(156)(0.8)%Commercial Fee-Based26,636 25,573 25,610 1,063 4.2 %(37)(0.1)%Total Commercial & Specialty Business31,413 30,338 30,089 1,075 3.5 %249 0.8 %Government Business:Medicare Advantage1,977 1,859 1,428 118 6.3 %431 30.2 %Medicare Supplement947 952 933 (5)(0.5)%19 2.0 %Total Medicare2,924 2,811 2,361 113 4.0 %450 19.1 %Medicaid11,571 10,600 8,852 971 9.2 %1,748 19.7 %Federal Employees Health Benefits1,623 1,625 1,623 (2)(0.1)%2 0.1 %Total Government Business16,118 15,036 12,836 1,082 7.2 %2,200 17.1 %Total Medical Membership47,531 45,374 42,925 2,157 4.8 %2,449 5.7 %Other MembershipLife and Disability Members4,834 4,782 5,064 52 1.1 %(282)(5.6)%Dental Members6,692 6,674 6,385 18 0.3 %289 4.5 %Dental Administration Members1,586 1,491 1,316 95 6.4 %175 13.3 %Vision Members9,813 8,031 7,536 1,782 22.2 %495 6.6 %Medicare Part D Standalone Members271 438 413 (167)(38.1)%25 6.1 %December 31, 2022 Compared to December 31, 2021Medical Membership Total medical membership increased in both our Government Business and Commercial & Specialty Business segments primarily due to organic growth. Our Government Business segment’s organic growth was primarily driven by the continued temporary suspension of Medicaid eligibility recertification during the COVID-19 pandemic. In addition, Medicaid membership was positively impacted by the acquisition of Ohio Medicaid members through the purchase of a Medicaid contract in the first quarter of 2022 and the acquisition of Integra in the second quarter of 2022. Medicare Advantage organic growth due to sales exceeding lapses also contributed to the overall Government Business segment growth. Our Commercial & Specialty Business segment growth included Group fee-based membership increases due to sales exceeding lapses and positive in-group changes. BlueCard® membership increased due to membership activity at other BCBSA plans whose members reside in or travel to our licensed areas. Individual membership increased due to our Public Exchange expansion in 2022. -48-Other MembershipOur other membership can be impacted by changes in our medical membership, as our medical members often purchase our other products that are ancillary to our health business. Life and disability membership increased primarily due to new sales of disability products, partially offset by declines in our life membership. Dental membership increased primarily due to new sales in our Group risk-based accounts and penetration increases in our FEHB program, partially offset by the loss of a significant Group fee-based account. Dental administration membership increased primarily due to increased sales to other BCBS plans associated with the FEHB program. Vision membership increased primarily due to the launch of a new entry-level vision product in our Group markets. Medicare Part D Standalone membership declined as we discontinued certain legacy products.Consolidated Results of OperationsOur consolidated summarized results of operations and other information for the years ended December 31, 2022, 2021 and 2020 are as follows: Change Years Ended December 312022 vs. 20212021 vs. 2020 202220212020$%$%Total operating revenue$155,660 $136,943 $120,808 $18,717 13.7 %$16,135 13.4 %Net investment income1,485 1,378 877 107 7.8 %501 57.1 %Net (losses) gains on financial instruments(550)318 182 (868)(273.0)%136 74.7 %Total revenues156,595 138,639 121,867 17,956 13.0 %16,772 13.8 %Benefit expense116,487 102,645 88,045 13,842 13.5 %14,600 16.6 %Cost of products sold13,035 10,895 8,953 2,140 19.6 %1,942 21.7 %Selling, general and administrative expense17,686 15,914 17,450 1,772 11.1 %(1,536)(8.8)%Other expense1 1,618 1,260 1,181 358 28.4 %79 6.7 %Total expenses148,826 130,714 115,629 18,112 13.9 %15,085 13.0 %Income before income tax expense 7,769 7,925 6,238 (156)(2.0)%1,687 27.0 %Income tax expense1,750 1,830 1,666 (80)(4.4)%164 9.8 %Net income6,019 6,095 4,572 (76)(1.2)%1,523 33.3 %Net loss attributable to noncontrolling interests 6 9 — (3)(33.3)%9 — %Shareholders’ net income$6,025 $6,104 $4,572 $(79)(1.3)%$1,532 33.5 %Average diluted shares outstanding242.8 246.8 254.3 (4.0)(1.6)%(7.5)(2.9)%Diluted shareholders' net income per share$24.81 $24.73 $17.98 $0.08 0.3 %$6.75 37.5 %Effective tax rate22.5 %23.1 %26.7 %(60)bp3(360)bp3Benefit expense ratio287.4 %87.5 %84.6 %(10)bp3290bp3Selling, general and administrative expense ratio4 11.4 %11.6 %14.4 %(20)bp3(280)bp3Income before income tax expense as a percentage of total revenues5.0 %5.7 %5.1 %(70)bp360bp3Shareholders’ net income as a percentage of total revenues3.8 %4.4 %3.8 %(60)bp360bp3Certain of the following definitions are also applicable to all other results of operations tables in this discussion:NM Not meaningful.1Includes interest expense, amortization of other intangible assets and loss on extinguishment of debt.2Benefit expense ratio represents benefit expense as a percentage of premium revenue. Premiums for the years ended December 31, 2022, 2021 and 2020 were $133,229, $117,373 and $104,109, respectively. Premiums are included in total operating revenue presented above.3bp = basis point; one hundred basis points = 1%.4Selling, general and administrative expense ratio represents selling, general and administrative expense as a percentage of total operating revenue.-49-Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021Total operating revenue increased primarily as a result of higher premium revenue in our Medicaid business due to organic membership growth from the continued temporary suspension of Medicaid eligibility recertification during the COVID-19 pandemic, the acquisition of Integra in the second quarter of 2022 and the acquisition of Ohio Medicaid members through the purchase of a Medicaid contract in the first quarter of 2022. Membership growth in our Medicare Advantage and our Commercial & Specialty Business risk-based businesses, as well as premium rate increases to cover medical cost trends also generated higher premium revenue. Finally, the increase in operating revenue was further attributable to increased pharmacy product revenue in our CarelonRx segment, resulting from growth in membership and higher script volume. Net investment income increased primarily due to higher income from fixed maturity securities, partially offset by reduced investment income from alternative investments.We had net losses on financial instruments in 2022, as compared to net gains in 2021, as a result of increased net losses on the sale of fixed maturity securities, reduced gains on the sale of equity securities and lower net gains on other invested assets. These losses were partially offset by lower mark-to-market losses on equity securities still held.Benefit expense increased primarily due to healthcare costs associated with organic membership growth in our Medicaid and Medicare businesses and the acquisition of MMM in the second quarter of 2021. Membership growth and higher healthcare costs in our Commercial risk-based business, the acquisition of Integra in the second quarter of 2022 and the acquisition of Ohio Medicaid members through the purchase of a Medicaid contract in the first quarter of 2022 also contributed to higher benefit expense.Our benefit expense ratio decreased slightly primarily due to the realignment during 2022 of certain quality improvement costs, from benefit expenses to administrative expenses, due to regulatory clarification. This decline was partially offset by the impact of continued membership increases in our Government Business segment, which has a higher benefit expense ratio than our Commercial & Specialty Business segment.Cost of products sold reflects the cost of pharmaceuticals dispensed by CarelonRx for our unaffiliated PBM customers. Cost of products sold increased as the corresponding pharmacy product revenues increased.Selling, general and administrative expense increased primarily due to increased costs to support membership growth and from our acquisitions, partially offset by lower business optimization charges in 2022 as compared to 2021.Our selling, general and administrative expense ratio decreased primarily due to operating revenue growth in 2022 and lower business optimization charges in 2022 as compared to 2021, partially offset by increased costs to support membership growth and the impact of the realignment of certain quality improvement costs described above.Other expense increased primarily due to additional amortization of intangible assets related to recent acquisitions and the rebranding of our products. The amortization period of certain intangible assets was shortened to align with anticipated dates the new branding will take place. In addition, certain indefinite-lived intangible assets have been reclassified as definite-lived, and therefore, are now being amortized. For additional information regarding intangible asset amortization, see Note 10, "Goodwill and Other Intangible Assets" of the Notes to Consolidated Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K.Our effective income tax rate decreased primarily due to the impact of geographic changes in our mix of earnings in 2022.Our shareholders' net income as a percentage of total revenues decreased in 2022 as compared to 2021 as a result of all the factors discussed above.-50-Reportable Segments Results of OperationsThe following table presents a summary of our reportable segment financial information for the years ended December 31, 2022, 2021 and 2020: Change Years Ended December 312022 vs. 20212021 vs. 2020 202220212020$%$%Operating RevenueCommercial & Specialty Business$41,674 $38,809 $36,699 $2,865 7.4 %$2,110 5.7 %Government Business96,810 82,919 71,572 13,891 16.8 %11,347 15.9 %CarelonRx28,526 25,431 21,911 3,095 12.2 %3,520 16.1 %Other13,294 10,250 6,057 3,044 29.7 %4,193 69.2 %Eliminations(24,644)(20,466)(15,431)(4,178)20.4 %(5,035)32.6 %Total operating revenue$155,660 $136,943 $120,808 $18,717 13.7 %$16,135 13.4 %Operating Gain (Loss)Commercial & Specialty Business1$2,933 $2,753 $2,681 $180 6.5 %$72 2.7 %Government Business23,297 3,061 2,444 236 7.7 %617 25.2 %CarelonRx31,868 1,684 1,361 184 10.9 %323 23.7 %Other4354 (9)(126)363 NM117 NMOperating MarginCommercial & Specialty Business7.0 %7.1 %7.3 %(10)bp5(20)bp5Government Business3.4 %3.7 %3.4 %(30)bp530bp5CarelonRx6.5 %6.6 %6.2 %(10)bp540bp5NM Not meaningful.1Includes expenses of $20 for business optimization initiatives in 2022; $106 for business optimization initiatives in 2021; $311 for business optimization initiatives and $524 for the BCBSA Litigation in 2020.2 Includes expenses of $16 for business optimization initiatives in 2022; $47 for business optimization initiatives in 2021; $205 for business optimization initiatives and $24 for the BCBSA Litigation in 2020.3 Includes expenses of $2 for business optimization initiatives in 2021; $4 for business optimization initiatives in 2020.4 Includes expenses of $3 for business optimization initiatives in 2022; $32 for business optimization initiatives in 2021; $133 for business optimization initiatives in 2020.5 bp = basis point; one hundred basis points = 1%.Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021Commercial & Specialty BusinessOperating revenue increased primarily due to higher premiums in our Commercial risk-based business due to membership growth, premium rate increases in our Commercial risk-based business to cover medical cost trends and increased administrative fees in our Commercial fee-based business.The increase in operating gain was primarily due to improved medical underwriting performance in our Commercial risk-based business and reduced business optimization charges in 2022 as compared to 2021. These items were partially offset by increased costs to support membership growth.Government BusinessOperating revenue increased primarily due to higher premium revenue in our Medicaid business, including due to organic membership growth from the continued temporary suspension of Medicaid eligibility recertification during the -51-COVID-19 pandemic, the acquisition of MMM at the end of the second quarter of 2021, the acquisition of Integra during the second quarter of 2022 and the acquisition of Ohio Medicaid members through the purchase of a Medicaid contract in the first quarter of 2022. Membership growth and premium rate increases to cover medical cost trends in our Medicare Advantage business also contributed to higher premium revenue.The increase in operating gain was primarily driven by premium rate increases to cover medical cost trends in our Medicare business, organic membership growth in our Medicaid business from the continued suspension of eligibility recertifications during the COVID-19 pandemic and the acquisition of MMM in the second quarter of 2021. These increases were partially offset by additional administrative spend to support the growth in our Government business. CarelonRxOperating revenue increased as a result of growth in membership and higher script volume. The increase in operating gain was primarily a result of higher script volume, driven by growth in integrated medical and pharmacy members in 2022 and favorable out-of-period adjustments to fee-based revenue in the second half of 2022.OtherOperating revenue increased primarily due to higher revenue for expanded services performed by Carelon Services for our Commercial & Specialty Business segment in 2022 and the acquisition of myNEXUS in the second quarter of 2021. These increases were partially offset by the reduction of external revenue due to the loss of a behavioral health contract in 2022.The increase in operating gain was driven by improved performance in Carelon Services, the acquisition of myNEXUS in the second quarter of 2021, and a decline in unallocated corporate expenses in 2022.Critical Accounting Policies and EstimatesWe prepare our consolidated financial statements in conformity with GAAP. Application of GAAP requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes and within this MD&A. We consider our most important accounting policies that require significant estimates and management judgment to be those policies with respect to liabilities for medical claims payable, income taxes, goodwill and other intangible assets, investments and retirement benefits, which are discussed below. Our other significant accounting policies are summarized in Note 2, “Basis of Presentation and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.We continually evaluate the accounting policies and estimates used to prepare the consolidated financial statements. In general, our estimates are based on historical experience, evaluation of current trends, information from third-party professionals and various other assumptions that we believe to be reasonable under the known facts and circumstances. Estimates can require a significant amount of judgment, and a different set of assumptions could result in material changes to our reported results.Medical Claims PayableThe most subjective accounting estimate in our consolidated financial statements is our liability for medical claims payable. At December 31, 2022, this liability was $15,596 and represented 23% of our total consolidated liabilities. We record this liability and the corresponding benefit expense for incurred but not paid claims, including the estimated costs of processing such claims. Incurred but not paid claims include (1) an estimate for claims that are incurred but not reported, as well as claims reported to us but not yet processed through our systems, which approximated 94%, or $14,736, of our total medical claims liability as of December 31, 2022; and (2) claims reported to us and processed through our systems but not yet paid, which approximated 6%, or $860, of the total medical claims payable as of December 31, 2022. The level of claims payable processed through our systems but not yet paid may fluctuate from one period-end to the next, from approximately 1% to 6% of our total medical claims liability, due to timing of when claim payments are made.-52-Liabilities for both claims incurred but not reported and reported but not yet processed through our systems are determined in the aggregate, employing actuarial methods that are commonly used by health insurance actuaries and meet Actuarial Standards of Practice. Our reserving practice for claim liabilities is to consistently recognize the appropriate amount of reserve within a level of confidence required by Actuarial Standards of Practice. We determine the amount of the liability for incurred but not paid claims by following a detailed actuarial process that uses both historical claim payment patterns as well as emerging medical cost trends to project our best estimate of claim liabilities. Under this process, historical paid claims data is formatted into “claim triangles,” which compare claim incurred dates to the dates of claim payments. This information is analyzed to create “completion factors” that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Completion factors are applied to claims paid through the period-end date to estimate the ultimate claim expense incurred for the period. Actuarial estimates of incurred but not paid claim liabilities are then determined by subtracting the actual paid claims from the estimate of the ultimate incurred claims. For the most recent incurred months (typically the most recent two months), the percentage of claims paid for claims incurred in those months is generally low. This makes the completion factor methodology less reliable for such months. Therefore, incurred claims for recent months are not projected from historical completion and payment patterns; rather, they are projected by estimating the claims expense for those months based on recent claims expense levels and healthcare trend levels (“trend factors”). Because the reserve methodology is based upon historical information, it must be adjusted for known or suspected operational and environmental changes. These adjustments are made by our actuaries based on their knowledge and their estimate of emerging impacts to benefit costs and payment speed. Circumstances to be considered in developing our best estimate of reserves include changes in utilization levels, unit costs, mix of business, benefit plan designs, provider reimbursement levels, processing system conversions and changes, claim inventory levels, claim processing patterns, claim submission patterns and operational changes resulting from business combinations. A comparison of prior period liabilities to re-estimated claim liabilities based on subsequent claims development is also considered in making the liability determination. In our comparison to prior periods, the methods and assumptions are not changed as reserves are recalculated; rather, the availability of additional paid claims information drives changes in the re-estimate of the unpaid claim liability. To the extent appropriate, changes in such development are recorded as a change to current period benefit expense. We had increased estimation uncertainty on our incurred but not reported liability at December 31, 2022 and December 31, 2021. Slowdowns in claims submission patterns and increases in utilization levels for COVID-19 testing and treatment are the primary factors that lead to the increased estimation uncertainty.We regularly review and set assumptions regarding cost trends and utilization when initially establishing claim liabilities. We continually monitor and adjust the claims liability and benefit expense based on subsequent paid claims activity. If it is determined that our assumptions regarding cost trends and utilization are materially different than actual results, our income statement and financial position could be impacted in future periods. Adjustments of prior year estimates may result in additional benefit expense or a reduction of benefit expense in the period an adjustment is made. Further, due to the considerable variability of healthcare costs, adjustments to claim liabilities occur each period and are sometimes significant as compared to the net income recorded in that period. Prior period development is recognized immediately upon the actuary’s judgment that a portion of the prior period liability is no longer needed or that an additional liability should have been accrued. That determination is made when sufficient information is available to ascertain that the re-estimate of the liability is reasonable.Although there are many factors that are used as a part of the estimation of our medical claims payable liability, the two key assumptions having the most significant impact on our incurred but not paid claims liability as of December 31, 2022 were the completion and trend factors. As discussed above, these two key assumptions can be influenced by utilization levels, unit costs, mix of business, benefit plan designs, provider reimbursement levels, processing system conversions and changes, claim inventory levels, claim processing patterns, claim submission patterns and operational changes resulting from business combinations.There is variation in the reasonable choice of completion factors by duration for durations of three months through twelve months where the completion factors have the most significant impact. As previously discussed, completion factors tend to be less reliable for the most recent months and therefore are not specifically utilized for months one and two. In our analysis for the claim liabilities at December 31, 2022, the variability in months three to five was estimated to be between 40 -53-and 90 basis points, while months six through twelve have much lower estimated variability ranging from 0 to 30 basis points.The difference in completion factor assumptions results in variability of 2%, or approximately $266, in the December 31, 2022 incurred but not paid claims liability, depending on the completion factors chosen. It is important to note that the completion factor methodology inherently assumes that historical completion rates will be reflective of the current period. However, it is possible that the actual completion rates for the current period will develop differently from historical patterns and therefore could fall outside the possible variations described herein.The other major assumption used in the establishment of the December 31, 2022 incurred but not paid claim liability was the trend factors. In our analysis for the period ended December 31, 2022, there was a 310 basis point differential in the high and low trend factors. This range of trend factors would imply variability of 3%, or approximately $522, in the incurred but not paid claims liability, depending upon the trend factors used. Because historical trend factors are often not representative of current claim trends, the trend experience for the most recent six to nine months, plus knowledge of recent events likely affecting current trends, have been taken into consideration in establishing the incurred but not paid claims liability at December 31, 2022. The COVID-19 pandemic continues to have an impact on claim costs for recent dates of service, which could have an influence on our trend factors. We will continue to monitor emerging experience in order to better understand the possible implications to our reserves.See Note 12, “Medical Claims Payable,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, for a reconciliation of the beginning and ending balance for medical claims payable for the years ended December 31, 2022, 2021 and 2020. Components of the total incurred claims for each year include amounts accrued for current year estimated claims expense as well as adjustments to prior year estimated accruals. In Note 12, “Medical Claims Payable,” the line labeled “Net incurred medical claims: Prior years redundancies” accounts for those adjustments made to prior year estimates. The impact of any reduction of “Net incurred medical claims: Prior years redundancies” may be offset as we establish the estimate of “Net incurred medical claims: Current year.” Our reserving practice is to consistently recognize the actuarial best estimate of our ultimate liability for our claims. When we recognize a release of the redundancy, we disclose the amount that is not in the ordinary course of business, if material. The ratio of current year medical claims paid as a percent of current year net medical claims incurred was 87.3% for 2022, 87.8% for 2021 and 87.7% for 2020. This ratio serves as an indicator of claims processing speed whereby 2022 claims were processed at a slightly slower speed than 2021 and 2020.We calculate the percentage of prior year redundancies in the current year as a percent of prior year net incurred claims payable less prior year redundancies in the current year in order to demonstrate the development of the prior year reserves. For the year ended December 31, 2022, this metric was 7.0%, largely driven by favorable trend factor development at the end of 2021. For the year ended December 31, 2021, this metric was 18.1%, reflecting the estimation uncertainty due to COVID-19 at the end of 2020, and was largely driven by favorable trend factor development at the end of 2020 as well as favorable completion factor development from 2020. For the year ended December 31, 2020, this metric was 8.0%, largely driven by favorable trend factor development at the end of 2019 as well as favorable completion factor development from 2019. We calculate the percentage of prior year redundancies in the current year as a percent of prior year net incurred medical claims to indicate the percentage of redundancy included in the preceding year calculation of current year net incurred medical claims. We believe this calculation supports the reasonableness of our prior year estimate of incurred medical claims and the consistency in our methodology. For the year ended December 31, 2022, this metric was 0.9%, which was calculated using the redundancy of $869. This metric was 2.0% for 2021 and 0.8% for 2020. We believe these metrics support the reasonableness of our estimates. The 2021 metric was impacted by the estimation uncertainty due to COVID-19.The following table shows the variance between total net incurred medical claims as reported in Note 12, “Medical Claims Payable,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, for each of 2021 and 2020 and the incurred claims for such years had it been determined retrospectively (computed as -54-the difference between “net incurred medical claims – current year” for the year shown and “net incurred medical claims – prior years redundancies” for the immediately following year): Years Ended December 31 20212020Total net incurred medical claims, as reported$98,737 $84,457 Retrospective basis, as described above99,571 83,391 Variance$(834)$1,066 Variance to total net incurred medical claims, as reported(0.8)%1.3 %Given that our business is primarily short tailed (which means that medical claims are generally paid within twelve months of the member receiving service from the provider), the variance to total net incurred medical claims, as reported above, is used to assess the reasonableness of our estimate of ultimate incurred medical claims for a given calendar year with the benefit of one year of experience. We expect that substantially all of the development of the 2022 estimate of medical claims payable will be known during 2023.The 2021 variance to total net incurred medical claims, as reported of (0.8)% was less than the 2020 percentage of 1.3%. This was primarily driven by the fact that the change in the prior year redundancy reported for 2021 as compared to 2020 was less than the change in the prior year redundancy reported for 2020 as compared to 2019.Income TaxesWe account for income taxes in accordance with the Financial Accounting Standards Board (“FASB”) guidance, which requires, among other things, the separate recognition of deferred tax assets and deferred tax liabilities. Such deferred tax assets and deferred tax liabilities represent the tax effect of temporary differences between financial reporting and tax reporting measured at tax rates enacted at the time the deferred tax asset or liability is recorded. A valuation allowance must be established for deferred tax assets if it is “more likely than not” that all or a portion may be unrealized. Our judgment is required in determining an appropriate valuation allowance.At each financial reporting date, we assess the adequacy of the valuation allowance by evaluating each of our deferred tax assets based on the following:•the types of temporary differences that created the deferred tax asset;•the amount of taxes paid in prior periods and available for a carry-back claim;•the tax rate at which the deferred tax assets will likely be utilized in the future;•the forecasted future taxable income, and therefore, likely future deduction of the deferred tax item; •the implementation of tax planning strategies to recover those deferred tax assets; and•any significant other issues impacting the likely realization of the benefit of the temporary differences.Although realization is not assured, we believe it is more likely than not that the deferred tax assets will be realized.We, like other companies, frequently face challenges from tax authorities regarding the amount of taxes due. These challenges include questions regarding the timing and amount of deductions that we have taken on our tax returns. In evaluating any additional tax liability associated with various positions taken in our tax return filings, we record additional liabilities for potential adverse tax outcomes. Based on our evaluation of our tax positions, we believe we have appropriately accrued for uncertain tax benefits, as required by the applicable guidance. To the extent we prevail in matters we have accrued for, our future effective tax rate would be reduced and net income would increase. If we are required to pay more than accrued, our future effective tax rate would increase and net income would decrease. Our effective tax rate and net income in any given future period could be materially impacted.In the ordinary course of business, we are regularly audited by federal and other tax authorities, and from time to time, these audits result in proposed assessments. We believe our tax positions comply with applicable tax law, and we intend to defend our positions vigorously through the federal, state and local, and foreign appeals processes. We believe we have -55-adequately provided for any reasonably foreseeable outcome related to these matters. Accordingly, although their ultimate resolution may require additional tax payments, we do not anticipate any material impact on our results of operations or financial condition from these matters.For additional information, see Note 8, “Income Taxes,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.Goodwill and Other Intangible AssetsOur consolidated goodwill at December 31, 2022 was $24,383 and other intangible assets were $10,315. The sum of goodwill and other intangible assets represented 33.8% of our total consolidated assets and 95.6% of our consolidated shareholders’ equity at December 31, 2022.We follow FASB guidance for business combinations and goodwill and other intangible assets, which specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill. Under the guidance, goodwill and other intangible assets (with indefinite lives) are not amortized but are tested for impairment at least annually. Furthermore, goodwill and other intangible assets are allocated to reporting units for purposes of the annual impairment test. Our impairment tests require us to make assumptions and judgments regarding the estimated fair value of our reporting units, which include goodwill and other intangible assets. In addition, certain other intangible assets with indefinite lives, such as trademarks, are also tested separately.We complete our annual impairment tests of existing goodwill and other intangible assets with indefinite lives during the fourth quarter of each year. These tests involve the use of estimates related to the fair value of goodwill at the reporting unit level and other intangible assets with indefinite lives, and require a significant degree of management judgment and the use of subjective assumptions. Certain interim impairment tests are also performed when potential impairment indicators exist or changes in our business or other triggering events occur. We have the option of first performing a qualitative assessment for each reporting unit to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, which is an indication that our goodwill may be impaired. These qualitative impairment tests include assessing events and factors that could affect the fair value of the indefinite-lived intangible assets. Our procedures include assessing our financial performance, macroeconomic conditions, industry and market considerations, various asset specific factors and entity specific events. If we determine that a reporting unit’s goodwill may be impaired after utilizing these qualitative impairment analysis procedures, we are required to perform a quantitative impairment test.Our quantitative impairment test utilizes the projected income and market valuation approaches for goodwill and the projected income approach for our indefinite lived intangible assets. Use of the projected income and market valuation approaches for our goodwill impairment test reflects our view that both valuation methodologies provide a reasonable estimate of fair value. The projected income approach is developed using assumptions about future revenue, expenses and net income derived from our internal planning process. These estimated future cash flows are then discounted. Our assumed discount rate is based on our industry’s weighted-average cost of capital. Market valuations are based on observed multiples of certain measures including revenue; earnings before interest, taxes, depreciation and amortization; and book value of invested capital (debt and equity) and include market comparisons to publicly traded companies in our industry.We did not incur any impairment losses as a result of our 2022 annual impairment tests, as it was determined that it is more likely than not that the estimated fair values of our reporting units were substantially in excess of the carrying values as of December 31, 2022. Additionally, we do not believe that the estimated fair values of our reporting units are at risk of becoming impaired in the next twelve months. If estimated fair values are less than the carrying values of goodwill and other intangibles with indefinite lives in future annual impairment tests, or if significant impairment indicators are noted relative to other intangible assets subject to amortization, we may be required to record impairment losses against future income.For additional information, see Note 3, “Business Acquisitions” and Note 10, “Goodwill and Other Intangible Assets,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. -56-InvestmentsCurrent and long-term marketable investment securities were $27,657 at December 31, 2022 and represented 26.9% of our total consolidated assets at December 31, 2022. We classify fixed maturity securities in our investment portfolio as “available-for-sale” and report those securities at fair value. Certain fixed maturity securities are available to support current operations and, accordingly, we classify such investments as current assets without regard to their contractual maturity. Investments used to satisfy contractual, regulatory or other requirements are classified as long-term, without regard to contractual maturity.Our impairment review is subjective and requires a high degree of judgment. We conduct this review on a quarterly basis, using both qualitative and quantitative factors. Such factors considered include the extent to which a security’s market value has been less than its cost, the reasons for the decline in value (i.e., credit event compared to liquidity, general credit spread widening, currency exchange rate or interest rate factors), financial condition and near term prospects of the issuer, including the credit ratings and changes in the credit ratings of the issuer, recommendations of investment advisors, and forecasts of economic, market or industry trends. If a fixed maturity security is in an unrealized loss position and we have the intent to sell the fixed maturity security, or it is more likely than not that we will have to sell the fixed maturity security before recovery of its amortized cost basis, we write down the fixed maturity security’s cost basis to fair value and record an impairment loss in our consolidated statements of income. For impaired fixed maturity securities that we do not intend to sell or if it is more likely than not that we will not have to sell such securities, but we expect that we will not fully recover the amortized cost basis, we recognize the credit component of the impairment as an allowance for credit loss in our consolidated balance sheets and record an impairment loss in our consolidated statements of income. The non-credit component of the impairment is recognized in accumulated other comprehensive (loss) income. Furthermore, unrealized losses entirely caused by non-credit-related factors related to fixed maturity securities for which we expect to fully recover the amortized cost basis continue to be recognized in accumulated other comprehensive (loss) income. The credit component of an impairment is determined primarily by comparing the net present value of projected future cash flows with the amortized cost basis of the fixed maturity security. The net present value is calculated by discounting our best estimate of projected future cash flows at the effective interest rate implicit in the fixed maturity security at the date of purchase. For mortgage-backed and asset-backed securities, cash flow estimates are based on assumptions regarding the underlying collateral, including prepayment speeds, vintage, type of underlying asset, geographic concentrations, default rates, recoveries and changes in value. For all other securities, cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings and estimates regarding timing and amount of recoveries associated with a default.We have a committee of accounting and investment associates and management that is responsible for managing the impairment review process. We believe that we have adequately reviewed our investment securities for impairment and that our investment securities are carried at fair value. We have established an allowance for credit loss and recorded credit loss expense as a reflection of our expected impairment losses. Given the inherent uncertainty of changes in market conditions and the significant judgments involved, there is continuing risk that declines in fair value may occur and additional impairment losses on investments may be recorded in future periods. In addition to marketable investment securities, we held additional long-term investments of $5,685, or 5.5% of total consolidated assets, at December 31, 2022. These long-term investments consisted primarily of certain other equity investments, the cash surrender value of corporate-owned life insurance policies and mortgage loans. Due to their less liquid nature, these investments are classified as long-term.Through our investing activities, we are exposed to financial market risks, including those resulting from changes in interest rates and changes in equity market valuations. We manage market risks through our investment policy, which establishes credit quality limits and limits on investments in individual issuers. Ineffective management of these risks could have an impact on our future results of operations and financial condition. Our investment portfolio includes fixed maturity securities with a fair value of $26,704 at December 31, 2022. The weighted-average credit rating of these securities was “A” as of December 31, 2022. Included in this balance are investments in fixed maturity securities of states, municipalities and political subdivisions of $890 that are guaranteed by third parties. With the exception of 16 securities with a fair value of $9, -57-these securities are all investment-grade and carry a weighted-average credit rating of “AA” as of December 31, 2022. The securities are guaranteed by a number of different guarantors, and we do not have any material exposure to any single guarantor, neither indirectly through the guarantees, nor directly through investment in the guarantor. Further, due to the high underlying credit rating of the issuers, the weighted-average credit rating of the fixed maturity securities without a guarantee, for which such information is available, was “A” as of December 31, 2022.Fair values of fixed maturity and equity securities are based on quoted market prices, where available. These fair values are obtained primarily from third-party pricing services, which generally use Level I or Level II inputs for the determination of fair value in accordance with FASB guidance for fair value measurements and disclosures. We have controls in place to review the pricing services’ qualifications and procedures used to determine fair values. In addition, we periodically review the pricing services’ pricing methodologies, data sources and pricing inputs to ensure the fair values obtained are reasonable.We obtain quoted market prices for each security from the pricing services, which are derived through recently reported trades for identical or similar securities, making adjustments through the reporting date based upon available market observable information. For securities not actively traded, the pricing services may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in these valuation methodologies include, but are not limited to, broker quotes, benchmark yields, credit spreads, default rates and prepayment speeds. As we are responsible for the determination of fair value, we perform analysis on the prices received from the pricing services to determine whether the prices are reasonable estimates of fair value. Our analysis includes procedures such as a review of month-to-month price fluctuations and price comparisons to secondary pricing services. There were no adjustments to quoted market prices obtained from the pricing services during the years ended December 31, 2022 and 2021.In certain circumstances, it may not be possible to derive pricing model inputs from observable market activity, and therefore, such inputs are estimated internally. Such securities are designated Level III in accordance with FASB guidance. Securities designated Level III at December 31, 2022 totaled $581 and represented approximately 1.7% of our total assets measured at fair value on a recurring basis. Our Level III securities primarily consisted of certain corporate securities and equity securities for which observable inputs were not always available and the fair values of these securities were estimated using inputs including, but not limited to, prepayment speeds, credit spreads, default rates and benchmark yields.For additional information, see Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk,” and Note 2, “Basis of Presentation and Significant Accounting Policies,” Note 5, “Investments,” and Note 7, “Fair Value,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.Retirement BenefitsPension BenefitsWe sponsor defined benefit pension plans for some of our employees. These plans are accounted for in accordance with FASB guidance for retirement benefits, which requires that amounts recognized in financial statements be determined on an actuarial basis. As permitted by the guidance, we calculate the value of plan assets as described below. Further, the difference between our expected rate of return and the actual performance of plan assets, as well as certain changes in pension liabilities, are amortized over future periods. An important factor in determining our pension expense is the assumption for expected long-term return on plan assets. As of our December 31, 2022 measurement date, we selected a weighted-average long-term rate of return on plan assets of 6.58%. We use a total portfolio return analysis in the development of our assumption. Factors such as past market performance, the long-term relationship between fixed maturity and equity securities, interest rates, inflation and asset allocations are considered in the assumption. The assumption includes an estimate of the additional return expected from active management of the investment portfolio. Peer data and an average of historical returns are also reviewed for appropriateness of the selected assumption. We believe our assumption of future returns is reasonable. However, if we lower our expected long-term return on plan assets, future contributions to the pension plan and pension expense would likely increase.This assumed long-term rate of return on assets is applied to a calculated value of plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over three years, producing the expected return on plan assets that is -58-included in the determination of pension expense. We apply a corridor approach to amortize unrecognized actuarial gains or losses. Under this approach, only accumulated net actuarial gains or losses in excess of 10% of the greater of the projected benefit obligation or the fair value of plan assets are amortized over the average remaining service or lifetime of the workforce as a component of pension expense. The net deferral of past asset gains or losses affects the calculated value of plan assets and, ultimately, future pension expense. The discount rate reflects the current rate at which the pension liabilities could be effectively settled at the end of the year based on our most recent measurement date. We use the annual spot rate approach for setting our discount rate. Under the spot rate approach, individual spot rates from a full yield curve of published rates are used to discount each plan’s cash flows to determine the plan’s obligation. At the December 31, 2022 measurement date, the weighted-average discount rate under the annual spot rate approach was 5.18%, compared to 2.70% at the December 31, 2021 measurement date. The net effect of changes in the discount rate, as well as the net effect of other changes in actuarial assumptions and experience, have been deferred and amortized as a component of pension expense in accordance with FASB guidance.In managing the plan assets, our objective is to be a responsible fiduciary while minimizing financial risk. Plan assets include a diversified mix of equity securities, investment grade fixed maturity securities and other types of investments across a range of sectors and levels of capitalization to maximize long-term return for a prudent level of risk. In addition to producing a reasonable return, the investment strategy seeks to minimize the volatility in our expense and cash flow.Other Postretirement BenefitsWe provide some associates with certain medical, vision and dental benefits upon retirement. We use various actuarial assumptions, including a discount rate and the expected trend in healthcare costs, to estimate the costs and benefit obligations for our retiree benefits.At our December 31, 2022 measurement date, the selected discount rate for all plans was 5.12%, compared to a discount rate of 2.49% at the December 31, 2021 measurement rate. We developed this rate using the annual spot rate approach as described above. The assumed healthcare cost trend rates used to measure the expected cost of pre-Medicare (those who are not currently eligible for Medicare benefits) other benefits at our December 31, 2022 measurement date was 8.00% for 2023 with a gradual decline to 4.50% by the year 2035. The assumed healthcare cost trend rates used to measure the expected cost of post-Medicare (those who are currently eligible for Medicare benefits) other benefits at our December 31, 2022 measurement date was 6.50% for 2023 with a gradual decline to 4.50% by the year 2035. These estimated trend rates are subject to change in the future.For additional information regarding our retirement benefits, see Note 11, “Retirement Benefits,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.New Accounting PronouncementsFor information regarding new accounting pronouncements that were issued or became effective during the year ended December 31, 2022 that had, or are expected to have, a material impact on our financial position, results of operations or financial statement disclosures, see the “Recently Adopted Accounting Guidance” and “Recent Accounting Guidance Not Yet Adopted” sections of Note 2, “Basis of Presentation and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.Liquidity and Capital ResourcesIntroductionOur cash receipts result primarily from premiums, product revenue, administrative fees and other revenue, investment income, proceeds from the sale or maturity of our investment securities, proceeds from borrowings, and proceeds from the issuance of common stock under our employee stock plans. Cash disbursements result mainly from claims payments, administrative expenses, taxes, purchases of investment securities, interest expense, payments on borrowings, acquisitions, capital expenditures, repurchases of our debt securities and common stock and the payment of cash dividends. Cash outflows -59-fluctuate with the amount and timing of settlement of these transactions. Any future decline in our profitability would likely have an unfavorable impact on our liquidity.We manage our cash, investments and capital structure so we are able to meet the short-term and long-term obligations of our business while maintaining financial flexibility and liquidity. We forecast, analyze and monitor our cash flows to enable investment and financing within the overall constraints of our financial strategy.A substantial portion of the assets held by our regulated subsidiaries are in the form of cash and cash equivalents and investments. After considering expected cash flows from operating activities, we generally invest cash that exceeds our near term obligations in longer term marketable fixed maturity securities to improve our overall investment income returns. Our investment strategy is to make investments consistent with insurance statutes and other regulatory requirements, while preserving our asset base. Our investments are generally available-for-sale to meet liquidity and other needs. Our subsidiaries pay out excess capital annually in the form of dividends to their respective parent companies for general corporate use, as permitted by applicable regulations.The availability of financing in the form of debt or equity is influenced by many factors, including our profitability, operating cash flows, debt levels, debt ratings, contractual restrictions, regulatory requirements and market conditions. The securities and credit markets have in the past experienced higher than normal volatility. Interest rates on fixed debt income securities increased in 2022 and may continue to do so in 2023, which could increase our borrowing costs if we elect to issue debt. During recent years, the federal government and various governmental agencies have taken a number of steps to strengthen the regulation of the financial services market. In addition, governments around the world have developed their own plans to provide stability and security in the credit markets and to ensure adequate capital in certain financial institutions. A summary of our major sources and uses of cash and cash equivalents for the years ended December 31, 2022, 2021 and 2020 is as follows: Years Ended December 31$ Change 2022202120202022 vs. 20212021 vs. 2020Sources of Cash:Net cash provided by operating activities$8,399 $8,364 $10,688 $35 $(2,324)Issuances of commercial paper and short- and long-term debt, net of repayments862 2,719 — (1,857)2,719 Issuances of common stock under employee stock plans182 203 176 (21)27 Other sources of cash, net762 — 315 762 (315)Total sources of cash10,205 11,286 11,179 (1,081)107 Uses of Cash:Purchases of investments, net of proceeds from sales, maturities, calls and redemptions(2,338)(4,056)(3,433)1,718 (623)Repurchase and retirement of common stock(2,316)(1,900)(2,700)(416)800 Purchases of subsidiaries, net of cash acquired(649)(3,476)(1,976)2,827 (1,500)Purchases of property and equipment(1,152)(1,087)(1,021)(65)(66)Repayments of commercial paper and short- and long-term debt, net of issuances— — (298)— 298 Cash dividends(1,229)(1,104)(954)(125)(150)Other uses of cash, net— (514)— 514 (514)Total uses of cash(7,684)(12,137)(10,382)4,453 (1,755)Effect of foreign exchange rates on cash and cash equivalents(14)(10)7 (4)(17)Net increase (decrease) in cash and cash equivalents$2,507 $(861)$804 $3,368 $(1,665)-60-Liquidity—Year Ended December 31, 2022 Compared to Year Ended December 31, 2021The slight increase in cash provided by operating activities was primarily due to higher net income in 2022, when adjusted for the impact of investment losses and gains, partially offset by the timing of working capital changes and the payment pursuant to the Subscriber Settlement Agreement made in September 2022.Other significant changes in sources and uses of cash year-over-year included lower amounts used for purchases of subsidiaries, net of cash acquired and reduced cash used for purchases of investments, net of proceeds from sales, maturities, calls and redemptions. These decreased uses of cash were partially offset by reduced net proceeds received from the issuance of commercial paper and short-term and long-term debt and increased use of cash for share repurchases.Financial ConditionWe maintained a strong financial condition and liquidity position, with consolidated cash, cash equivalents and investments in fixed maturity and equity securities of $35,044 at December 31, 2022. Since December 31, 2021, total cash, cash equivalents and investments in fixed maturity and equity securities increased by $1,384, primarily due to cash generated from operations. This increase was partially offset by cash used for acquisitions, common stock repurchases, purchases of property and equipment and cash dividends paid to shareholders.Many of our subsidiaries are subject to various government regulations that restrict the timing and amount of dividends and other distributions that may be paid to their respective parent companies. Certain accounting practices prescribed by insurance regulatory authorities, or statutory accounting practices, differ from GAAP. Changes that occur in statutory accounting practices, if any, or other regulatory requirements, could impact our subsidiaries’ future dividend capacity. In addition, we have agreed to certain undertakings to regulatory authorities, including the requirement to maintain certain capital levels in certain of our subsidiaries.At December 31, 2022, we held $1,209 of cash, cash equivalents and investments at the parent company, which are available for general corporate use, including investment in our businesses, acquisitions, potential future common stock repurchases and dividends to shareholders, repurchases of debt securities and debt and interest payments. Periodically, we access capital markets and issue debt (“Notes”) for long-term borrowing purposes, for example, to refinance debt, to finance acquisitions or for share repurchases. Certain of these Notes may have a call feature that allows us to redeem the Notes at any time at our option and/or a put feature that allows a Note holder to redeem the Notes upon the occurrence of both a change in control event and a downgrade of the Notes below an investment grade rating. For more information on our debt, including redemptions and issuances, see Note 13, “Debt” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.We calculate our consolidated debt-to-capital ratio, a non-GAAP measure, from the amounts presented on our audited consolidated balance sheets included in Part II, Item 8 of this Annual Report on Form 10-K. Our debt-to-capital ratio is calculated as total debt divided by total debt plus total shareholders’ equity. Total debt is the sum of short-term borrowings, current portion of long-term debt and long-term debt, less current portion. We believe our debt-to-capital ratio assists investors and rating agencies in measuring our overall leverage and additional borrowing capacity. In addition, our bank covenants include a maximum debt-to-capital ratio that we cannot and did not exceed. Our debt-to-capital ratio may not be comparable to similarly titled measures reported by other companies. Our consolidated debt-to-capital ratio was 39.9% and 38.9% as of December 31, 2022 and 2021, respectively.Our senior debt is rated “A” by S&P Global Ratings, “BBB” by Fitch Ratings, Inc., “Baa2” by Moody’s Investor Service, Inc. and “bbb+” by AM Best Company, Inc. We intend to maintain our senior debt investment grade ratings. If our credit ratings are downgraded, our business, liquidity, financial condition and results of operations could be adversely impacted by limitations on future borrowings and a potential increase in our borrowing costs.Capital ResourcesWe have a shelf registration statement on file with the Securities and Exchange Commission to register an unlimited amount of any combination of debt or equity securities in one or more offerings. Specific information regarding terms and securities being offered will be provided at the time of an offering. Proceeds from future offerings are expected to be used for -61-general corporate purposes, including, but not limited to, the repayment of debt, investments in or extensions of credit to our subsidiaries and the financing of possible acquisitions or business expansions.We have a senior revolving credit facility (the “5-Year Facility”) with a group of lenders for general corporate purposes. In April 2022, we amended and restated the credit agreement for the 5-Year Facility to, among other things, extend the maturity date of the 5-Year Facility from June 2024 to April 2027 and increase the amount of credit available under the 5-Year Facility from $2,500 to $4,000. Also in April 2022, concurrently with the amendment and restatement of the 5-Year Facility, we terminated our 364-day senior revolving credit facility that provided for credit in the amount of $1,000, which was scheduled to mature in June 2022. Our ability to borrow under the 5-Year Facility is subject to compliance with certain covenants, including covenants requiring us to maintain a defined debt-to-capital ratio of not more than 60%, subject to increase in certain circumstances set forth in the credit agreement for the 5-Year Facility. We do not believe the restrictions contained in our 5-Year Facility covenants materially affect our financial or operating flexibility. As of December 31, 2022, we were in compliance with all of our debt covenants under the 5-Year Facility. There were no amounts outstanding under the 5-Year Facility at December 31, 2022.Through certain subsidiaries, we have entered into multiple 364-day lines of credit (the “Subsidiary Credit Facilities”) with separate lenders for general corporate purposes. The Subsidiary Credit Facilities provide combined credit up to $200. Our ability to borrow under the Subsidiary Credit Facilities is subject to compliance with certain covenants. At December 31, 2022, we had no outstanding borrowings under the Subsidiary Credit Facilities.We have an authorized commercial paper program of up to $4,000, the proceeds of which may be used for general corporate purposes. In July 2022, we increased the amount available under the commercial paper program from $3,500 to $4,000. Should commercial paper issuance become unavailable, we have the ability to use a combination of cash on hand and/or our 5-Year Facility, which provides for credit in the amount of $4,000, to redeem any outstanding commercial paper upon maturity. At December 31, 2022, we had $0 outstanding under our commercial paper program.While there is no assurance in the current economic environment, we believe the lenders participating in our 5-Year Facility and Subsidiary Credit Facilities, if market conditions allow, would be willing to provide financing in accordance with their legal obligations.We are a member, through certain subsidiaries, of the Federal Home Loan Bank of Indianapolis, the Federal Home Loan Bank of Cincinnati, the Federal Home Loan Bank of Atlanta and the Federal Home Loan Bank of New York (collectively the “FHLBs”). As a member, we have the ability to obtain short-term cash advances, subject to certain minimum collateral requirements. At December 31, 2022, we had $265 of outstanding short-term borrowings from the FHLBs.As discussed in “Financial Condition” above, many of our subsidiaries are subject to various government regulations that restrict the timing and amount of dividends and other distributions that may be paid. Based upon these requirements, we currently estimate that approximately $3,500 of dividends will be paid to us by our subsidiaries during 2023. During 2022, we received $3,097 of dividends from our subsidiaries.In addition to regulations regarding the timing and amount of dividends, our regulated subsidiaries’ states of domicile have statutory risk-based capital (“RBC”) requirements for health and other insurance companies and health maintenance organizations largely based on the National Association of Insurance Commissioners (“NAIC”) Risk-Based Capital (RBC) For Health Organizations Model Act (“RBC Model Act”). These RBC requirements are intended to measure capital adequacy, taking into account the risk characteristics of an insurer’s investments and products. The NAIC sets forth the formula for calculating the RBC requirements, which are designed to take into account asset risks, insurance risks, interest rate risks and other relevant risks with respect to an individual insurance company’s business. In general, under the RBC Model Act, an insurance company must submit a report of its RBC level to the state insurance department or insurance commissioner, as appropriate, at the end of each calendar year. Our regulated subsidiaries’ respective RBC levels as of December 31, 2022, which was the most recent date for which reporting was required, were in excess of all applicable mandatory RBC requirements. In addition to exceeding these RBC requirements, we are in compliance with the liquidity and capital requirements for a licensee of the BCBSA and with the tangible net worth requirements applicable to certain of our California subsidiaries. For additional information, see Note 22, “Statutory Information,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.-62-Future Sources and Uses of LiquidityShort-Term Liquidity RequirementsAs previously described, our cash disbursements result mainly from claims payments, administrative expenses, taxes, purchases of investment securities, interest expense, payments on borrowings, acquisitions, capital expenditures, repurchases of our debt securities and common stock and the payment of cash dividends. We believe cash on hand, operating cash receipts, investments and amounts available under our commercial paper program, our 5-Year Facility and our Subsidiary Credit Facilities and borrowings available from the FHLBs will be adequate to fund our expected cash disbursements over the next twelve months.Long-Term Liquidity RequirementsAs of December 31, 2022, our long-term cash disbursements required under various contractual obligations and commitments were:•Debt and interest expense: Future debt and estimated interest payments were $25,804, with $2,674 due within the next twelve months. For additional information, see Note 13 “Debt” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.•Operating leases: We lease office space and certain computer equipment, for which the future estimated payments were $1,028, with $206 due within the next twelve months. For additional information, see Note 18 “Leases” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.•Other liabilities: These liabilities primarily consist of future policy reserves, projected other postretirement benefits, deferred compensation, supplemental executive retirement plan liabilities and certain other miscellaneous long-term obligations. Amounts due within twelve months were $26, with $1,040 due in future periods. Estimated future payments for funded pension benefits have been excluded from these numbers, as we had no funding requirements under the Employee Retirement Income Security Act of 1974, as amended, at December 31, 2022, as a result of the value of the assets in the plans. In addition, gross liabilities for uncertain tax positions and interest for which we cannot reasonably estimate the timing of the resolutions with the respective taxing authorities have not been included. For further information, see Note 8, “Income Taxes,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.•Purchase obligations: These obligations include estimated payments for future services under contractual arrangements from third-party service vendors. Amounts due within the next twelve months for these purchase obligations were $1,124, while longer term payments were $2,927. For further information, see Note 14, “Commitments and Contingencies,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.•Investment commitments: These include unfunded capital commitments for alternative investments and low-income housing tax credits. Estimated amounts due were $1,504, including $314 due within the next twelve months. In addition to the contractual obligations and commitments discussed above, we have a variety of other contractual agreements related to acquiring materials and services used in our operations. However, we do not believe these other agreements contain material noncancelable commitments. We regularly review the appropriate use of capital, including acquisitions, common stock and debt security repurchases and dividends to shareholders. The declaration and payment of any dividends or repurchases of our common stock or debt is at the discretion of our Board of Directors and depends upon our financial condition, results of operations, future liquidity needs, regulatory and capital requirements and other factors deemed relevant by our Board of Directors.On January 24, 2023, our Audit Committee declared a quarterly cash dividend to shareholders of $1.48 per share on the outstanding shares of our common stock. This quarterly dividend is payable on March 24, 2023 to the shareholders of record as of March 10, 2023.Under our Board of Directors’ authorization, we maintain a common stock repurchase program. As of December 31, 2022, we had Board authorization of $1,876 to repurchase our common stock. On January 24, 2023, our Audit Committee, -63-pursuant to authorization granted by the Board of Directors, authorized a $5,000 increase to our common stock repurchase program. No duration has been placed on our common stock repurchase program, and we reserve the right to discontinue the program at any time. We intend to utilize this authorization over a multi-year period, subject to market and industry conditions.We believe that funds from future operating cash flows, cash and investments and funds available under our credit facilities and/or from public or private financing sources will be sufficient for future operations and commitments, and for capital acquisitions and other strategic transactions.We do not have any off-balance sheet derivative instruments, guarantee transactions, agreements or other contractual arrangements or any indemnification agreements that will require funding in future periods. We have not transferred assets to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not hold any variable interest in an unconsolidated entity where such entity provides us with financing, liquidity, market risk or credit risk support. See Note 2 “Subsidiary Transactions” of the Notes to Condensed Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K for additional detail on the Elevance Health, Inc. parent guarantees of certain subsidiaries.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. (In Millions, Except As Otherwise Stated Herein)As a result of our investing and borrowing activities, we are exposed to financial market risks, including those resulting from changes in interest rates and changes in market valuations. Potential impacts discussed below are based upon sensitivity analyses performed on our financial position as of December 31, 2022. Actual results could vary from these estimates. Our primary objectives with our investment portfolio are to provide safety and preservation of capital, sufficient liquidity to meet cash flow requirements, the integration of investment strategy with the business operations and an attainment of a competitive after-tax total return.InvestmentsOur investment portfolio is exposed to three primary sources of risk: credit quality risk, interest rate risk and market valuation risk.The primary risks associated with our fixed maturity securities, which are classified as available-for-sale, are credit quality risk and interest rate risk. Credit quality risk is defined as the risk of a credit event, such as a ratings downgrade or default, to an individual fixed maturity security and the potential loss attributable to that event. Credit quality risk is managed through our investment policy, which establishes credit quality limitations on the overall portfolio as well as diversification and percentage limits on securities of individual issuers. The result is a well-diversified portfolio of fixed maturity securities, with an average credit rating of approximately “A.” Interest rate risk is defined as the potential for economic losses on fixed maturity securities due to a change in market interest rates. Our fixed maturity portfolio is invested primarily in U.S. government securities, corporate bonds, asset-backed bonds, mortgage-related securities and municipal bonds, all of which have exposure to changes in the level of market interest rates. Interest rate risk is managed by maintaining asset duration within a band based upon our liabilities, operating performance and liquidity needs. Additionally, we have the capability of holding any security to maturity, which would allow us to realize full par value.Investments in fixed maturity securities include corporate securities, which account for 46.9% of our total fixed maturity securities at December 31, 2022 and are subject to credit/default risk. In a declining economic environment, corporate yields will usually increase, prompted by concern over the ability of corporations to make interest payments, thus causing a decrease in the price of corporate securities, and the decline in value of the corporate fixed maturity portfolio. We manage this risk through fundamental credit analysis, diversification of issuers and industries and an average credit rating of our corporate fixed maturity portfolio of approximately “BBB.”Market risk for fixed maturity securities is addressed by actively managing the duration, allocation and diversification of our investment portfolio. We have evaluated the impact on the fixed maturity portfolio’s fair value considering an immediate 100 basis point change in interest rates. A 100 basis point increase in interest rates would result in an approximate $1,088 decrease in fair value, whereas a 100 basis point decrease in interest rates would result in an approximate $1,154 increase in fair value. While we classify our fixed maturity securities as “available-for-sale” for accounting purposes, we believe our -64-cash flows and the duration of our portfolio should allow us to hold securities to maturity, thereby avoiding the recognition of losses should interest rates rise significantly.Our equity portfolio is comprised of large capitalization and small capitalization domestic equities, foreign equities, exchange-traded funds and index mutual funds. Our equity portfolio is subject to the volatility inherent in the stock market, driven by concerns over economic conditions, earnings and sales growth, inflation, and consumer confidence. These systemic risks cannot be managed through diversification alone. However, more routine risks, such as stock/industry specific risks, are managed by investing in a diversified equity portfolio.Our other invested assets, reported within our long-term investments, are primarily subject to private market exposures, including private equity and private credit investments. These investments are also indirectly subject to market valuation risk, as public market valuations will form a basis for valuations for these investments. Given their illiquid nature, we focus on appropriate sizing of these investments relative to our liquidity needs and risk tolerance. Our risk tolerance is formed by the level of illiquidity and short-term price movements from market valuation risk we are willing to accept relative to the higher long-term expected returns over the life of these investments.As of December 31, 2022, 3.4% of our marketable investments were equity securities. An immediate 10% decrease in each equity investment’s value, arising from market movement, would result in a fair value decrease of $95. Alternatively, an immediate 10% increase in each equity investment’s value, attributable to the same factor, would result in a fair value increase of $95.For additional information regarding our investments, see Note 5, “Investments,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 and “Critical Accounting Policies and Estimates - Investments” within Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Annual Report on Form 10-K.Long-Term DebtOur total long-term debt at December 31, 2022 consisted of senior unsecured notes, convertible debentures, commercial paper and subordinated surplus notes issued by one of our insurance subsidiaries. At December 31, 2022, the carrying value and estimated fair value of our long-term debt was $23,849 and $22,324 respectively. This debt is subject to interest rate risk, as these instruments have fixed interest rates and the fair value is affected by changes in market interest rates. Should interest rates increase or decrease in the future, the estimated fair value of our fixed rate debt would decrease or increase accordingly. For additional information regarding our long-term debt, see Note 7, “Fair Value” and Note 13, “Debt,” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K.Derivatives We have exposure to economic losses due to interest rate risk arising from changes in the level or volatility of interest rates. We attempt to mitigate our exposure to interest rate risk through the use of derivative financial instruments. These strategies include the use of interest rate swaps and forward contracts, which are used to lock-in interest rates or to hedge (on an economic basis) interest rate risks associated with variable rate debt. We have used these types of instruments as designated hedges against specific liabilities.Changes in interest rates will affect the estimated fair value of these derivatives. As of December 31, 2022, we recorded a net liability of $57, the estimated fair value of the swaps at that date. We have evaluated the impact on the interest rate swaps’ fair value considering an immediate 100 basis point change in interest rates. A 100 basis point increase in interest rates would result in an approximate $39 decrease in fair value, whereas a 100 basis point decrease in interest rates would result in an approximate $39 increase in fair value.For additional information regarding our derivatives, see Note 6, “Derivative Financial Instruments” of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K. -65-
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsOverviewExpedia Group's mission is to power global travel for everyone, everywhere. We believe travel is a force for good. Travel is an essential human experience that strengthens connections, broadens horizons and bridges divides. We help reduce the barriers to travel, making it easier, more enjoyable, more attainable and more accessible. We bring the world within reach for customers and partners around the globe. We leverage our supply portfolio, platform and technology capabilities across an extensive portfolio of consumer brands, and provide solutions to our business partners, to empower travelers to efficiently research, plan, book and experience travel. We make available, on a stand-alone and package basis, travel services provided by numerous lodging properties, airlines, car rental companies, activities and experiences providers, cruise lines, alternative accommodations property owners and managers, and other travel product and service companies. We also offer travel and non-travel advertisers access to a potential source of incremental traffic and transactions through our various media and advertising offerings on our websites. For additional information about our portfolio of brands, see the disclosure set forth in Part I, Item 1, Business, under the caption “Market Opportunity and Business Strategy.” This section of this Form 10-K generally discusses the years ended December 31, 2022 and 2021 items and year over year comparisons between 2022 and 2021. Discussions of the year ended December 31, 2020 items and the year over year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2021. All percentages within this section are calculated on actual, unrounded numbers.TrendsThe COVID-19 pandemic, and measures to contain the virus, including government travel restrictions and quarantine orders, had an unprecedented impact on the global travel industry and materially and negatively impacted our business, financial results and financial condition. With the evolution of milder COVID-19 variants, availability of multiple vaccine booster doses and increasing familiarity with the virus, many COVID-19 related travel restrictions have been lifted, and countries around the world reopened their borders for foreign travel.However, we note that the recovery has been uneven, with different regions experiencing different rates of recovery. Despite positive developments, the full duration and total impact of COVID-19 remains uncertain, and therefore it is difficult to predict any future impact on the travel industry and, in particular, our business.More recently, inflation and other macroeconomic pressures in the U.S. and the global economy, such as rising interest rates, appreciation of the dollar, energy price volatility and inflationary pressures, have contributed to an increasingly complex macroeconomic environment. Our future operational results may be subject to volatility, particularly in the short-term, due to the impact of the aforementioned trends. Broad, sustained negative economic impacts could put strain on our suppliers, business and service partners, which increases the risk of credit losses and service level or other disruptions. Additionally, further health-related events, political instability, geopolitical conflicts, acts of terrorism, significant fluctuations in currency values, sustained levels of increased inflation, sovereign debt issues, and natural disasters, are examples of other events that could have a negative impact on the travel industry in the future. Despite these factors, we have witnessed a healthy recovery of travel demand, which remains strong and is attributable to factors including pent-up demand from the COVID-19 pandemic, and consumers prioritizing spend on travel and experiences over other discretionary spending.We have also executed cost savings initiatives aimed at simplifying the organization and increasing efficiency, achieving by 2021 forward annualized run-rate fixed cost savings of $700 to $750 million compared to the fourth quarter of 2019 exit rate, as well as greater than $200 million in variable costs savings, at 2019 volume levels. We also believe we have improved our marketing efficiency and continue to evaluate additional opportunities to increase efficiency and improve operational effectiveness across the Company. As a result of these initiatives, and a near full recovery in travel bookings, we have experienced increases in Adjusted EBITDA margins, profitability and operating cash flows in excess of historic levels. For additional information about our business strategy for Expedia Group, see the disclosure set forth in Part I. Item 1. Business, under the caption “Market Opportunity and Business Strategy.” Online TravelIncreased usage and familiarity with the internet have continued to drive rapid growth in online penetration of travel expenditures. Online penetration is higher in the U.S. and Western European markets with online penetration rates in some emerging markets, such as Latin America and Eastern European regions, lagging behind those regions. Emerging market online penetration rates increased through the COVID-19 pandemic, and are expected to continue growing, which presents an attractive growth opportunity for our business, while also attracting many competitors to online travel. This competition 29Table of Contentsintensified in recent years, and the industry is expected to remain highly competitive for the foreseeable future. In addition to the growth of online travel agencies, we have seen increased interest in the online travel industry from search engine companies such as Google, evidenced by continued product enhancements, and prioritizing its own AdWords and metasearch products such as, Google Hotel Ads and Google Flights, in search results. Competitive entrants such as “metasearch” companies, including Kayak.com (owned by Booking Holdings), trivago (in which Expedia Group owns a majority interest) as well as TripAdvisor, introduced differentiated features, pricing and content compared with the legacy online travel agency companies, as well as various forms of direct or assisted booking tools. Further, airlines and lodging companies are aggressively pursuing direct online distribution of their products and services. In addition, the increasing popularity of the “sharing economy,” accelerated by online penetration, has had a direct impact on the travel and lodging industry. Businesses such as Airbnb, Vrbo and Booking.com have emerged as the leaders, bringing incremental alternative accommodation and vacation rental inventory to the market. Other competitors have arisen, including vacation rental property managers such as Vacasa, who operate their own booking sites in addition to listing on Airbnb, Vrbo, and Booking.com, and are expected to continue to grow as a percentage of the global accommodation market. Additionally, traditional consumer ecommerce players have expanded their local offerings by adding hotel offers to their websites. Most recently, ride sharing app Uber has added transportation and experience offerings to its app via partnerships with other travel providers. The online travel industry also saw the development of alternative business models and variations in the timing of payment by travelers and to suppliers, which in some cases place pressure on historical business models. In particular, the agency hotel model saw rapid adoption in Europe. Expedia Group facilitates both merchant (Expedia Collect) and agency (Hotel Collect) hotel offerings with our hotel supply partners through both agency-only contracts as well as our hybrid ETP program, which offers travelers the choice of whether to pay Expedia Group at the time of booking or pay the hotel at the time of stay.In 2022, we began evolving our strategy from being largely transactionally focused, where we were primarily focused on acquiring customers through performance channels, to building a direct relationship with our customers by allocating more marketing spend towards our loyalty programs, paid app downloads, and brand awareness. While we maintain a large portfolio of consumer brands, we put the majority of our marketing efforts towards our three core consumer brands: Expedia, Hotels.com, and Vrbo.For more detail, see Part I, Item 1A, Risk Factors - "We rely on the value of our brands, and the costs of maintaining and enhancing our brand awareness are increasing” and “Our international operations involve additional risks and our exposure to these risks will increase as our business expands globally.”LodgingLodging includes both hotel and alternative accommodations. As a percentage of our total worldwide revenue in 2022, lodging accounted for 76%. As a result of the impact on travel demand from the COVID-19 outbreak, room nights stayed grew 29% in 2022, as compared to a growth of 35% in 2021 and a decline of 55% in 2020. ADRs for rooms stayed for Expedia Group increased 3% in 2020, increased 20% in 2021 and increased 7% in 2022. Over the last couple of years, our lodging business saw a significant increase in ADRs compared to pre-pandemic levels, which were driven by broader industry trends, a mix shift to Vrbo and high ADR geographies. Vrbo carries a higher ADR than hotels and has accounted for a higher percentage of room nights due to the faster recovery and shift to alternative accommodations during these periods. As of December 31, 2022, our global lodging marketplace had approximately 3 million lodging properties available, including over 2 million online bookable alternative accommodations listings through Vrbo and approximately 900,000 hotels and alternative accommodations through our other brands.Hotel. We generate the majority of our revenue through the facilitation of hotel reservations (stand-alone and package bookings). Our relationships and overall economics with hotel supply partners have been broadly stable in recent years. As we continue to expand the breadth and depth of our global hotel offering, in some cases we have reduced our economics in various geographies based on local market conditions. These impacts are due to specific initiatives intended to drive greater global size and scale through faster overall room night growth. Additionally, increased promotional activities such as growing loyalty programs, discounting, and couponing have contributed to declines in revenue per room night and profitability in certain cases.Since our hotel supplier agreements are generally negotiated on a percentage basis, any increase or decrease in ADRs has an impact on the revenue we earn per room night. Strong pent-up demand and high operating costs during 2022 drove a 14% increase in the U.S. hotel industry ADRs versus 2019, according to Smith Travel Research (STR). In the future, we could see macroeconomic factors influence hotel ADR trends, including as the rising living costs due to inflation and higher interest rates. Other factors that could lead to moderating ADRs include growth in hotel supply and the increase in alternative accommodation inventory. Further, while the global lodging industry remains very fragmented, there has been consolidation in the hotel space among chains as well as ownership groups. In the meantime, certain hotel chains have been focusing on driving direct bookings 30Table of Contentson their own websites and mobile applications by advertising lower rates than those available on third-party websites as well as incentives such as loyalty programs, increased or exclusive product availability and complimentary benefits.Alternative Accommodations. With our acquisition of Vrbo (previously HomeAway) and all of its brands in December 2015, we expanded into the fast-growing alternative accommodations market. Vrbo is a leader in this market, specializing in unique whole home inventory, primarily in North American leisure markets, and represents an attractive growth opportunity for Expedia Group.Vrbo has transitioned from a listings-based classified advertising model to an online transactional model that optimizes for both travelers and homeowner and property manager partners, with a goal of increasing monetization and driving growth through investments in marketing as well as in product and technology. Vrbo offers hosts subscription-based listing or pay-per-booking service models. It also generates revenue from a traveler service fee for bookings. AirSimilar to the rest of travel, the airlines experienced a surge in pent-up demand, however they have been operating at reduced capacity due to staffing shortages, supply chain disruptions, and elevated fuel costs. In 2022, the reduced airline capacity and high operating costs drove average U.S. domestic airfares up approximately 10% compared to pre-pandemic levels, according to Airlines Reporting Corporation (ARC) data. While air bookings improved in 2022 relative to 2021, our air business continues to lag lodging bookings and remains below 2019 levels.In addition, we could encounter pressure on air remuneration as air carriers combine, certain supply agreements renew, and as we continue to add airlines to ensure local coverage in new markets.Air ticket volumes increased 8% in 2022 and increased 43% during 2021, compared to a decline of 63% in 2020. As a percentage of our total worldwide revenue in 2022, air accounted for 3%.Advertising & MediaOur advertising and media business is principally driven by revenue generated by trivago, a leading hotel metasearch website, and Expedia Group Media Solutions, which is responsible for generating advertising revenue on our global online travel brands. In 2022, we generated $777 million of advertising and media revenue, a 29% increase from 2021, representing 7% of our total worldwide revenue.Since the onset of COVID-19, online travel agencies, including ourselves, have reduced marketing spend on trivago. In response, trivago has reduced its own marketing spend and lowered operating costs to preserve profitability. We expect trivago to continue to experience revenue pressure going forward.SeasonalityWe generally experience seasonal fluctuations in the demand for our travel services. For example, traditional leisure travel bookings are generally the highest in the first three quarters as travelers plan and book their spring, summer and winter holiday travel. The number of bookings typically decreases in the fourth quarter. Since revenue for most of our travel services, including merchant and agency hotel, is recognized as the travel takes place rather than when it is booked, revenue typically lags bookings by several weeks for our hotel business and can be several months or more for our alternative accommodations business. Historically, Vrbo has seen seasonally stronger bookings in the first quarter of the year, with the relevant stays occurring during the peak summer travel months. The seasonal revenue impact is exacerbated with respect to income by the nature of our variable cost of revenue and direct sales and marketing costs, which we typically realize in closer alignment to booking volumes, and the more stable nature of our fixed costs. As a result on a consolidated basis, revenue and income are typically the lowest in the first quarter and highest in the third quarter. The growth in our B2B segment, international operations, advertising business or a change in our product mix, among others, may also influence the typical trend of seasonality in the future. Significantly higher cancellations and reduced booking volumes from COVID-19 disrupted our typical seasonal pattern for bookings, revenue, profit and cash flows from 2020 through early 2022, but have generally returned to historic seasonality. Critical Accounting Policies and EstimatesCritical accounting policies and estimates are those that we believe are important in the preparation of our consolidated financial statements because they require that we use judgment and estimates in applying those policies. We prepare our consolidated financial statements and accompanying notes in accordance with generally accepted accounting principles in the United States (“GAAP”). Preparation of the consolidated financial statements and accompanying notes requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements as well as revenue and expenses during the periods reported. 31Table of ContentsWe base our estimates on historical experience, where applicable, and other assumptions that we believe are reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions.There are certain critical estimates that we believe require significant judgment in the preparation of our consolidated financial statements. We consider an accounting estimate to be critical if:•It requires us to make an assumption because information was not available at the time or it included matters that were highly uncertain at the time we were making the estimate; and•Changes in the estimate or different estimates that we could have selected may have had a material impact on our financial condition or results of operations.For more information on each of these policies, see NOTE 2 — Significant Accounting Policies, in the notes to consolidated financial statements. We discuss information about the nature and rationale for our critical accounting estimates below.Accounting for Certain Merchant RevenueWe accrue the cost of certain merchant revenue based on the amount we expect to be billed by suppliers. In certain instances when a supplier invoices us for less than the cost we accrued, we generally reduce our merchant accounts payable and the supplier costs within net revenue six months in arrears, net of an allowance, when we determine it is not probable that we will be required to pay the supplier, based on historical experience. Actual revenue could be greater or less than the amounts estimated due to changes in hotel billing practices or changes in traveler behavior.Deferred Loyalty RewardsWe currently offer certain internally administered traveler loyalty programs to our travelers, such as our Hotels.com Rewards program, our Expedia Rewards program and our Orbitz Rewards program. Hotels.com Rewards offers travelers one free night at any Hotels.com partner property after that traveler stays 10 nights, subject to certain restrictions. Expedia Rewards enables participating travelers to earn points on all hotel, flight, package and activities made on various Brand Expedia websites. Orbitz Rewards allows travelers to earn Orbucks, the currency of Orbitz Rewards, on flights, hotels and vacation packages and instantly redeem those Orbucks on future bookings at various hotels worldwide. In 2021, we announced plans to unify and expand our existing loyalty programs into one global rewards platform called "One Key" spanning all our main brands, which we expect to launch in 2023. As travelers accumulate points towards free travel products, we defer the relative standalone selling price of earned points, net of expected breakage, as deferred loyalty rewards within deferred merchant bookings on the consolidated balance sheet. In order to estimate the standalone selling price of the underlying services on which points can be redeemed for all loyalty programs, we use an adjusted market assessment approach and consider the redemption values expected from the traveler. We then estimate the number of rewards that will not be redeemed based on historical activity in our members' accounts as well as statistical modeling techniques. Revenue is recognized when we have satisfied our performance obligation relating to the points, that is when the travel service purchased with the loyalty award is satisfied. Both the actual standalone selling price of the underlying services and ultimate redemption rates could differ materially from our estimates due to a number of factors, including fluctuations in reward value, product utilization and divergence from historical member behavior.Recoverability of Goodwill and Indefinite and Definite-Lived Intangible AssetsGoodwill. We assess goodwill for impairment annually as of October 1, or more frequently, if events and circumstances indicate impairment may have occurred. During 2020, as a result of the significant turmoil related to COVID-19, we concluded that sufficient indicators existed to require us to perform multiple interim impairment assessments. In the evaluation of goodwill for impairment, we typically perform a quantitative assessment and compare the fair value of the reporting unit to the carrying value and, if applicable, record an impairment charge based on the excess of the reporting unit's carrying amount over its fair value. Periodically, we may choose to perform a qualitative assessment, prior to performing the quantitative analysis, to determine whether the fair value of the goodwill is more likely than not impaired. We generally base our measurement of fair value of reporting units, except for trivago, which is a separately listed company on the Nasdaq Global Select Market, on a blended analysis of the present value of future discounted cash flows and market valuation approach with the exception of our standalone publicly traded subsidiary, which is based on market valuation. The discounted cash flows model indicates the fair value of the reporting units based on the present value of the cash flows that we expect the reporting units to generate in the future. Our significant estimates in the discounted cash flows model include: our weighted average cost of capital; long-term rate of growth and profitability of our business; and working capital effects. The market valuation approach indicates the fair value of the business based on a comparison of the Company to comparable publicly traded firms in similar lines of business. Our significant estimates in the market approach model include identifying 32Table of Contentssimilar companies with comparable business factors such as size, growth, profitability, risk and return on investment and assessing comparable revenue and operating income multiples in estimating the fair value of the reporting units. The fair value estimate for the trivago reporting unit was based on trivago's stock price, a Level 1 input, adjusted for an estimated control premium.We believe the weighted use of discounted cash flows and market approach is the best method for determining the fair value of our reporting units because these are the most common valuation methodologies used within the travel and internet industries; and the blended use of both models compensates for the inherent risks associated with either model if used on a stand-alone basis.In addition to measuring the fair value of our reporting units as described above, we consider the combined carrying and fair values of our reporting units in relation to the Company’s total fair value of equity plus debt as of the assessment date. Our equity value assumes our fully diluted market capitalization, using either the stock price on the valuation date or the average stock price over a range of dates around the valuation date, plus an estimated acquisition premium which is based on observable transactions of comparable companies. The debt value is based on the highest value expected to be paid to repurchase the debt, which can be fair value, principal or principal plus a premium depending on the terms of each debt instrument.Indefinite-Lived Intangible Assets. We base our measurement of fair value of indefinite-lived intangible assets, which primarily consist of trade name and trademarks, using the relief-from-royalty method. This method assumes that the trade name and trademarks have value to the extent that their owner is relieved of the obligation to pay royalties for the benefits received from them. This method requires us to estimate the future revenue for the related brands, the appropriate royalty rate and the weighted average cost of capital.Definite-Lived Intangible Assets. We review the carrying value of long-lived assets or asset groups to be used in operations whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Factors that would necessitate an impairment assessment include a significant adverse change in the extent or manner in which an asset is used, a significant adverse change in legal factors or the business climate that could affect the value of the asset, or a significant decline in the observable market value of an asset, among others. If such facts indicate a potential impairment, we would assess the recoverability of an asset group by determining if the carrying value of the asset group exceeds the sum of the projected undiscounted cash flows expected to result from the use and eventual disposition of the assets over the remaining economic life of the primary asset in the asset group. If the recoverability test indicates that the carrying value of the asset group is not recoverable, we will estimate the fair value of the asset group using appropriate valuation methodologies, which would typically include an estimate of discounted cash flows. Any impairment would be measured as the difference between the asset groups carrying amount and its estimated fair value.The use of different estimates or assumptions in determining the fair value of our goodwill, indefinite-lived and definite-lived intangible assets may result in different values for these assets, which could result in an impairment or, in the period in which an impairment is recognized, could result in a materially different impairment charge.For additional information on our goodwill and intangible asset impairments recorded in 2022, 2021 and 2020, see NOTE 3 — Fair Value Measurements in the notes to the consolidated financial statements.Income TaxesWe record income taxes under the liability method. Deferred tax assets and liabilities reflect our estimation of the future tax consequences of temporary differences between the carrying amounts of assets and liabilities for book and tax purposes. We determine deferred income taxes based on the differences in accounting methods and timing between financial statement and income tax reporting. Accordingly, we determine the deferred tax asset or liability for each temporary difference based on the enacted tax rates expected to be in effect when we realize the underlying items of income and expense. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent earnings experience by jurisdiction, expectations of future taxable income, and the carryforward periods available to us for tax reporting purposes, as well as other relevant factors. We may establish a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. Due to inherent complexities arising from the nature of our businesses, future changes in income tax law, tax sharing agreements or variances between our actual and anticipated operating results, we make certain judgments and estimates. Therefore, actual income taxes could materially vary from these estimates. All deferred income taxes are classified as long-term on our consolidated balance sheets.We account for uncertain tax positions based on a two-step process of evaluating recognition and measurement criteria. The first step assesses whether the tax position is more likely than not to be sustained upon examination by the tax authority, including resolution of any appeals or litigation, based on the technical merits of the position. If the tax position meets the more 33Table of Contentslikely than not criteria, the portion of the tax benefit greater than 50% likely to be realized upon settlement with the tax authority is recognized in the financial statements. The ultimate resolution of these tax positions may be greater or less than the liabilities recorded.Other Long-Term LiabilitiesVarious Legal and Tax Contingencies. We record liabilities to address potential exposures related to business and tax positions we have taken that have been or could be challenged by taxing authorities. In addition, we record liabilities associated with legal proceedings and lawsuits. These liabilities are recorded when the likelihood of payment is probable and the amounts can be reasonably estimated. The determination for required liabilities is based upon analysis of each individual tax issue, or legal proceeding, taking into consideration the likelihood of adverse judgments and the range of possible loss. In addition, our analysis may be based on discussions with outside legal counsel. The ultimate resolution of these potential tax exposures and legal proceedings may be greater or less than the liabilities recorded.Occupancy and Other Taxes. Some states and localities impose taxes (e.g. transient occupancy, accommodation tax, sales tax and/or business privilege tax) on the use or occupancy of hotel accommodations or other traveler services. Generally, hotels collect taxes based on the rate paid to the hotel and remit these taxes to the various tax authorities. When a customer books a room through one of our travel services, we collect a tax recovery charge from the customer which we pay to the hotel. We calculate the tax recovery charge by applying the applicable tax rate supplied to us by the hotels to the amount that the hotel has agreed to receive for the rental of the room by the consumer. In most jurisdictions, we do not collect or remit taxes, nor do we pay taxes to the hotel operator, on the portion of the customer payment we retain. Some jurisdictions have questioned our practice in this regard. While the applicable tax provisions vary among the jurisdictions, we generally believe that we are not required to pay such taxes. A limited number of taxing jurisdictions have made similar claims against certain of our companies for tax amounts due on the rental amounts charged by owners of alternative accommodations properties or for taxes on our services. We are an intermediary between a traveler and a party renting an alternative accommodations property and we believe are similarly not liable for such taxes. We are engaged in discussions with tax authorities in various jurisdictions to resolve these issues. Some tax authorities have brought lawsuits or have levied assessments asserting that we are required to collect and remit tax. The ultimate resolution in all jurisdictions cannot be determined at this time. Certain jurisdictions may require us to pay tax assessments, including occupancy and other transactional tax assessments, prior to contesting any such assessments.We have established a reserve for the potential settlement of issues related to hotel occupancy and other tax litigation for prior and current periods, consistent with applicable accounting principles and in light of all current facts and circumstances. A variety of factors could affect the amount of the liability (both past and future), which factors include, but are not limited to, the number of, and amount of revenue represented by, jurisdictions that ultimately assert a claim and prevail in assessing such additional tax or negotiate a settlement and changes in relevant statutes.We note that there are more than 10,000 taxing jurisdictions in the United States, and it is not feasible to analyze the statutes, regulations and judicial and administrative rulings in every jurisdiction. Rather, we have obtained the advice of state and local tax experts with respect to tax laws of certain states and local jurisdictions that represent a large portion of our hotel revenue. Many of the statutes and regulations that impose these taxes were established before the emergence of the internet and ecommerce. Certain jurisdictions have enacted, and others may enact, legislation regarding the imposition of taxes on businesses that facilitate the booking of hotel or alternative accommodations. We continue to work with the relevant tax authorities and legislators to clarify our obligations under new and emerging laws and regulations. We will continue to monitor the issue closely and provide additional disclosure, as well as adjust the level of reserves, as developments warrant. Additionally, certain of our businesses are involved in tax related litigation, which is discussed in Part I, Item 3, Legal Proceedings. New Accounting PronouncementsFor a discussion of new accounting pronouncements, see NOTE 2 — Significant Accounting Policies in the notes to consolidated financial statements.Occupancy and Other TaxesWe are currently involved in eight lawsuits brought by or against states, cities and counties over issues involving the payment of hotel occupancy and other taxes. We continue to defend these lawsuits vigorously. With respect to the principal claims in these matters, we believe that the statutes and/or ordinances at issue do not apply to us or the services we provide, namely the facilitation of travel planning and reservations, and, therefore, that we do not owe the taxes that are claimed to be owed. We believe that the statutes and ordinances at issue generally impose occupancy and other taxes on entities that own, operate or control hotels (or similar businesses) or furnish or provide hotel rooms or similar accommodations.34Table of ContentsFor additional information and other recent developments on these and other legal proceedings, see Part I, Item 3, Legal Proceedings.We have established a reserve for the potential settlement of issues related to hotel occupancy and other tax litigation, consistent with applicable accounting principles and in light of all current facts and circumstances, in the amount of $44 million as of December 31, 2022 and $50 million as of December 31, 2021.Certain jurisdictions, including without limitation the states of New York, New Jersey, North Carolina, Minnesota, Oregon, Rhode Island, Maryland, Pennsylvania, Hawaii, Iowa, Massachusetts, Arizona, Wisconsin, Idaho, Arkansas, Indiana, Maine, Nebraska, Vermont, Mississippi, Virginia, the city of New York, and the District of Columbia, have enacted legislation seeking to tax online travel company services as part of sales or other taxes for hotel and/or other accommodations and/or car rental. In addition, in certain jurisdictions, we have entered into voluntary collection agreements pursuant to which we have agreed to voluntarily collect and remit taxes to state and/or local taxing jurisdictions. We are currently remitting taxes to a number of jurisdictions, including without limitation the states of New York, New Jersey, South Carolina, North Carolina, Minnesota, Georgia, Wyoming, West Virginia, Oregon, Rhode Island, Montana, Maryland, Kentucky, Maine, Pennsylvania, Hawaii, Iowa, Massachusetts, Arizona, Wisconsin, Idaho, Arkansas, Indiana, Nebraska, Vermont, Colorado, Mississippi, Virginia, the city of New York and the District of Columbia, as well as certain other jurisdictions.Pay-to-PlayCertain jurisdictions may assert that we are required to pay any assessed taxes prior to being allowed to contest or litigate the applicability of the ordinances. This prepayment of contested taxes is referred to as “pay-to-play.” Payment of these amounts is not an admission that we believe we are subject to such taxes and, even when such payments are made, we continue to defend our position vigorously. If we prevail in the litigation, for which a pay-to-play payment was made, the jurisdiction collecting the payment will be required to repay such amounts and also may be required to pay interest. However, any significant pay-to-play payment or litigation loss could negatively impact our liquidity. Other Jurisdictions. We are also in various stages of inquiry or audit with various tax authorities, some of which, including the City of Los Angeles regarding hotel occupancy taxes, may impose a pay-to-play requirement to challenge an adverse inquiry or audit result in court.SegmentsWe have the following reportable segments: Retail, B2B, and trivago. Our Retail segment provides a full range of travel and advertising services to our worldwide customers through a variety of consumer brands including: Expedia.com and Hotels.com in the United States and localized Expedia and Hotels.com websites throughout the world, Vrbo, Orbitz, Travelocity, Wotif Group, ebookers, CheapTickets, Hotwire.com, and CarRentals.com. Our B2B segment is comprised of Expedia Partner Solutions, which offers private label and co-branded products to make travel services available to travelers through third-party company branded websites, and, through its sale in November 2021, Egencia, a full-service travel management company that provided travel services to businesses and their corporate customers. Our trivago segment generates advertising revenue primarily from sending referrals to online travel companies and travel service providers from its hotel metasearch websites. Operating MetricsOur operating results are affected by certain metrics, such as gross bookings and revenue margin, which we believe are necessary for understanding and evaluating us. Gross bookings generally represent the total retail value of transactions booked for agency and merchant transactions, recorded at the time of booking reflecting the total price due for travel by travelers, including taxes, fees and other charges, and are reduced for cancellations and refunds. Revenue margin is defined as revenue as a percentage of gross bookings.Gross Bookings and Revenue Margin Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Gross BookingsGross bookings$95,049 $72,425 $36,796 31 %97 %Revenue margin (1)12.3 %11.9 %14.1 %___________________________________35Table of Contents(1)trivago, which is comprised of a hotel metasearch business that differs from our transaction-based websites, does not have associated gross bookings or revenue margin. However, third-party revenue from trivago is included in revenue used to calculate total revenue margin. Gross bookings increased 31% in 2022 compared to 2021 as gross bookings for lodging, air and other travel products grew as travel demand continued to recover. Revenue margin in 2022 was higher than 2021 as a result of improved margins at our lodging business. Results of OperationsRevenue Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Revenue by SegmentRetail$8,741 $6,821 $3,993 28 %71 %B2B2,546 1,460 942 74 %55 %trivago (Third-party revenue)380 317 205 20 %54 %Corporate (Bodybuilding.com)— — 59 N/AN/ATotal revenue$11,667 $8,598 $5,199 36 %65 %Similar to the gross bookings increase, revenue increased 36% in 2022 compared to 2021, with all segment's growth reflecting the continued improvement in travel demand.Year Ended December 31, % Change2022202120202022 vs 20212021 vs 2020($ in millions) Revenue by Service TypeLodging$8,905 $6,449 $4,051 38 %59 %Air362 254 105 43 %141 %Advertising and media(1)777 603 405 29 %49 %Other1,623 1,292 638 25 %103 %Total revenue$11,667 $8,598 $5,199 36 %65 %___________________________________(1)Includes third-party revenue from trivago as well as our transaction-based websites.Lodging revenue increased 38% in 2022 on a 29% increase in room nights stayed and as well as stayed ADR growth of 7%. Air revenue increased 43% in 2022 driven by an increase in air tickets sold of 8% and revenue per ticket of 32% due primarily to higher average ticket prices of 30% and an increased mix of international tickets.Advertising and media revenue increased 29% in 2022 due to increases at both Expedia Group Media Solutions and trivago. All other revenue, which includes car rental, insurance, destination services, fee revenue related to our corporate travel business (through Egencia's sale in November 2021), increased 25% in 2022 from growth in travel insurance products as well as car.36Table of ContentsIn addition to the above segment and product revenue discussion, our revenue by business model is as follows: Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Revenue by Business ModelMerchant$7,762 $5,537 $3,261 40 %70 %Agency2,994 2,307 1,267 30 %82 %Advertising, media and other911 754 671 21 %12 %Total revenue$11,667 $8,598 $5,199 36 %65 %The increase in merchant revenue in 2022 was primarily due to an increase in merchant hotel revenue driven by an increase in room nights stayed as well as increases in merchant alternative accommodations revenue and travel insurance revenue.The increase in agency revenue in 2022 was primarily due to an increase in agency hotel, air and alternative accommodations.Advertising, media and other increased 21% in 2022 compared to 2021 primarily due to an increase in advertising revenue.Cost of Revenue Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Direct costs$1,353 $1,118 $1,148 21 %(3)%Personnel and overhead304 404 501 (25)%(19)%Total cost of revenue$1,657 $1,522 $1,649 9 %(8)%% of revenue14.2 %17.7 %31.7 %Cost of revenue primarily consists of direct costs to support our customer operations, including our customer support and telesales as well as fees to air ticket fulfillment vendors; credit card processing, including merchant fees, fraud and chargebacks; and other costs, primarily including data center and cloud costs to support our websites, supplier operations, destination supply, certain transactional level taxes, costs related to Bodybuilding.com during our period of ownership as well as related personnel and overhead costs, including stock-based compensation.Cost of revenue increased $135 million during 2022 compared to 2021, primarily due to higher merchant fees, cloud costs and customer service costs as a result of increased transaction volumes, which offset lower personnel costs related to the sale of Egencia in November 2021. Selling and Marketing Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Direct costs$5,428 $3,499 $1,728 55 %103 %Indirect costs672 722 799 (7)%(10)%Total selling and marketing$6,100 $4,221 $2,527 45 %67 %% of revenue52.3 %49.1 %48.6 %Selling and marketing expense primarily relates to direct costs, including traffic generation costs from search engines and internet portals, television, radio and print spending, private label and affiliate program commissions, public relations and other costs. The remainder of the expense relates to indirect costs, including personnel and related overhead in our various brands and global supply organization as well as stock-based compensation costs.Selling and marketing expenses increased $1.9 billion during 2022 compared to 2021 primarily driven by an increase in B2B partner commissions as well as increased spend in Retail marketing channels. In addition, the decrease in indirect costs in 37Table of Contentsthe current year was primarily driven by lower personnel costs related to the sale of Egencia in November 2021 as well as lower stock-based compensation. Technology and Content Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Personnel and overhead$874 $785 $744 11 %6 %Other307 289 324 6 %(11)%Total technology and content$1,181 $1,074 $1,068 10 %1 %% of revenue10.1 %12.5 %20.5 %Technology and content expense includes product development and content expense, as well as information technology costs to support our infrastructure, back-office applications and overall monitoring and security of our networks, and is principally comprised of personnel and overhead, including stock-based compensation, as well as other costs including cloud expense and licensing and maintenance expense.Technology and content expense increased $107 million for 2022 compared to 2021 primarily due to higher personnel costs due to increased headcount as well as an increase in average salaries, including the prior year's compensation change, which shifted discretionary bonuses to salary beginning in the second quarter of 2021.General and Administrative Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Personnel and overhead$591 $562 $434 5 %30 %Professional fees and other157 143 155 9 %(8)%Total general and administrative$748 $705 $589 6 %20 %% of revenue6.4 %8.2 %11.3 %General and administrative expense consists primarily of personnel-related costs, including our executive leadership, finance, legal and human resource functions and related stock-based compensation, as well as fees for external professional services.General and administrative expense increased $43 million in 2022 compared to 2021 primarily due to higher personnel costs due to increased headcount as well as an increase in average salaries, including the prior year's compensation change, which shifted discretionary bonuses to salary beginning in the second quarter of 2021. Depreciation and Amortization Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Depreciation$704 $715 $739 (2)%(3)%Amortization of intangible assets88 99 154 (11)%(36)%Total depreciation and amortization$792 $814 $893 (3)%(9)%Depreciation decreased $11 million in 2022 compared to 2021. Amortization of intangible assets decreased $11 million in 2022 compared to 2021 primarily due to the completion of amortization related to certain intangible assets.38Table of ContentsImpairment of Goodwill, Intangible and Other Long-term AssetsDuring 2022, we recognized intangible impairment charges of $81 million related to an indefinite-lived trade name within our trivago segment. During 2021, we recognized a goodwill impairment charge of $14 million and intangible and other long-term asset impairment charges of $6 million related to our B2B segment. See NOTE 3 — Fair Value Measurements in the notes to the consolidated financial statements for further information.Legal Reserves, Occupancy Tax and Other Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Legal reserves, occupancy tax and other$23 $1 $(13)N/AN/ALegal reserves, occupancy tax and other primarily consists of increases in our reserves for court decisions and the potential and final settlement of issues related to hotel occupancy and other taxes, expenses recognized related to monies paid in advance of occupancy and other tax proceedings (“pay-to-play”) as well as certain other legal reserves.Legal reserves, occupancy tax and other for year ended December 31, 2022 primarily included charges related to certain other legal reserves for trivago as described in NOTE 15 — Commitments and Contingencies in the notes to the consolidated financial statements. Legal reserves, occupancy tax and other for year ended December 31, 2021 included a charge for certain other legal reserves, mostly offset by net reductions to our reserve related to hotel occupancy and other taxes. Restructuring and Related Reorganization ChargesIn 2020, we committed to restructuring actions intended to simplify our businesses and improve operational efficiencies, which resulted in headcount reductions and office consolidations. As a result, we recognized $55 million in restructuring and related reorganization charges during 2021. We did not recognize any such costs in 2022, but we continue to actively evaluate additional cost reduction efforts and should we make decisions in future periods to take further actions we may incur additional reorganization charges.Operating Income (Loss) Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Operating income (loss)$1,085 $186 $(2,719)484 %N/A% of revenue9.3 %2.2 %(52.3)%In 2022, the improvement in operating income was primarily due to growth in revenue in excess of operating costs.Adjusted EBITDA by SegmentYear ended December 31, % Change2022202120202022 vs 20212021 vs 2020($ in millions)Retail$2,124 $1,782 $298 19 %498 %B2B(1)599 110 (190)445 %N/Atrivago113 39 (14)191 %N/AUnallocated overhead costs (Corporate)(2)(487)(454)(462)7 %(2)% Total Adjusted EBITDA(3)$2,349 $1,477 $(368)59 %N/A______________________________________(1) Includes operating results of Egencia through its sale in November 2021.(2) Includes immaterial operating results of Bodybuilding.com through its sale in May 2020.(3) Adjusted EBITDA is a non-GAAP measure. See "Definition and Reconciliation of Adjusted EBITDA" below for more information.Adjusted EBITDA is our primary segment operating metric. See NOTE 18 — Segment Information in the notes to the consolidated financial statements for additional information on intersegment transactions, unallocated overhead costs and for a 39Table of Contentsreconciliation of Adjusted EBITDA by segment to net income (loss) attributable to Expedia Group, Inc. for the periods presented above.Our Retail, B2B and trivago segments all experienced improvements in Adjusted EBITDA in 2022 as a result of the recovering travel demand. In addition, the B2B segment improved in part due to the absence of the prior year Adjusted EBITDA loss related to Egencia. Unallocated overhead costs increased $33 million during 2022 primarily due to an increase in general and administrative expenses. Interest Income and Expense Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Interest income60 $9 $18 543 %(48)%Interest expense(277)(351)(360)(21)%(2)%Gain (loss) on debt extinguishment, net49 (280)— N/AN/AInterest income increased in 2022 compared to 2021 as a result of higher rates of return. Interest expense decreased in 2022 compared to 2021, as a result of lower average senior notes outstanding in the current year. During 2022, we settled a tender offer to purchase $500 million in aggregate principal of our 2.95% senior unsecured notes, which resulted in the recognition of a net gain on debt extinguishment of $73 million. In addition, as a result of the early redemption of the 3.6% and 4.5% senior unsecured notes in 2022, we recognized a loss on debt extinguishment of $24 million. See NOTE 7 — Debt in the notes to the consolidated financial statements for further information.As a result of debt refinancing transactions during 2021, we recognized a loss on debt extinguishment of $280 million, which included the payment of early payment premiums and fees as well as the write-off of unamortized debt issuance costs. Gain (Loss) on Sale of Business, NetIn 2022, we recognized an immaterial gain of $6 million primarily related to the sale of Egencia in the prior year. In 2021, we had a net gain on sale of businesses of $456 million. In November 2021, we completed the sale of Egencia to GBT and, as a result, we recognized a $401 million gain on the sale. Additionally, in 2021, we completed the sale of certain of our smaller businesses within our Retail segment, which resulted in net gains of $57 million. For additional information on these and other transactions, see NOTE 16 – Divestitures in the notes to the consolidated financial statements.Other, NetOther, net is comprised of the following: Year ended December 31, 202220212020 (In millions)Foreign exchange rate gains (losses), net$(40)$(48)$71 Gains (losses) on minority equity investments, net(345)(29)(142)Other— 19 (6)Total other, net$(385)$(58)$(77)During 2022, losses on minority equity investments, net included $300 million of losses related to mark-to-market adjustments in the fair value for our GBT investment as well as $45 million related to changes in our publicly traded marketable equity investment, Despegar. During 2021, losses on minority equity investments, net related to changes in our Despegar investment. See NOTE 3 — Fair Value Measurements in the notes to the consolidated financial statements for further information.40Table of ContentsProvision for Income Taxes Year ended December 31, % Change 2022202120202022 vs 20212021 vs 2020 ($ in millions) Provision for income taxes$195 $(53)$(423)N/A(88)%Effective tax rate36.2 %139.9 %13.4 %Our effective tax rate for 2022 was higher than the 21% federal statutory income tax rate due to a valuation allowance on minority investments and nondeductible compensation, partially offset by research and experimentation credits. Our effective tax rate for 2021 was higher than the 21% federal statutory income tax rate due to excess tax benefits related to stock-based compensation, release of valuation allowance and research and experimentation credits, partially offset by nondeductible compensation, measured against a pre-tax loss. For additional information, see NOTE 10 — Income Taxes in the notes to the consolidated financial statements.We are subject to taxation in the United States and foreign jurisdictions. Our income tax filings are regularly examined by federal, state and foreign tax authorities. During the fourth quarter of 2019, the Internal Revenue Service (“IRS”) issued final adjustments related to transfer pricing with our foreign subsidiaries for our 2011 to 2013 tax years. The adjustments would increase our U.S. taxable income by $696 million, which would result in federal tax of approximately $244 million, subject to interest. We do not agree with the position of the IRS. We have formally filed a protest for our 2011 to 2013 tax years and the case has been transferred to Appeals. During the fourth quarter of 2022, the IRS issued similar proposed adjustments related to transfer pricing with our foreign subsidiaries for our 2014 to 2016 tax years. The adjustments would increase our U.S. taxable income by $1.413 billion, which would result in federal tax of approximately $494 million, subject to interest. The proposed adjustments provided by the IRS exclude any offsetting adjustments that may reduce the amount of federal tax. We do not agree with the position of the IRS and intend to formally protest. We are also under examination by the IRS for our 2017-2020 years. We believe it is reasonably possible that the audit of the 2011 and 2013 tax years will conclude within the next 12 months. For more detail on our tax risk factors, see Part I, Item 1A, Risk Factors - "A failure to comply with current laws, rules and regulations or changes to such laws, rules and regulations and other legal uncertainties may adversely affect our business, financial performance, results of operations or business growth” and “Application of existing tax laws, rules or regulations are subject to interpretation by taxing authorities.”Definition and Reconciliation of Adjusted EBITDAWe report Adjusted EBITDA as a supplemental measure to U.S. generally accepted accounting principles ("GAAP"). Adjusted EBITDA is among the primary metrics by which management evaluates the performance of the business and on which internal budgets are based. Management believes that investors should have access to the same set of tools that management uses to analyze our results. This non-GAAP measure should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for or superior to GAAP. Adjusted EBITDA has certain limitations in that it does not take into account the impact of certain expenses to our consolidated statements of operations. We endeavor to compensate for the limitation of the non-GAAP measure presented by also providing the most directly comparable GAAP measure and a description of the reconciling items and adjustments to derive the non-GAAP measure. Adjusted EBITDA also excludes certain items related to transactional tax matters, which may ultimately be settled in cash, and we urge investors to review the detailed disclosure regarding these matters included above, in the Legal Proceedings section, as well as the notes to the financial statements. The non-GAAP financial measure used by the Company may be calculated differently from, and therefore may not be comparable to, similarly titled measures used by other companies.Adjusted EBITDA is defined as net income (loss) attributable to Expedia Group, Inc. adjusted for (1) net income (loss) attributable to non-controlling interests; (2) provision for income taxes; (3) total other expenses, net; (4) stock-based compensation expense, including compensation expense related to certain subsidiary equity plans; (5) acquisition-related impacts, including (i) amortization of intangible assets and goodwill and intangible asset impairment, (ii) gains (losses) recognized on changes in the value of contingent consideration arrangements, if any, and (iii) upfront consideration paid to settle employee compensation plans of the acquiree, if any; (6) certain other items, including restructuring; (7) items included in legal reserves, occupancy tax and other; (8) that portion of gains (losses) on revenue hedging activities that are included in other, net that relate to revenue recognized in the period; and (9) depreciation.The above items are excluded from our Adjusted EBITDA measure because these items are noncash in nature, or because the amount and timing of these items is unpredictable, not driven by core operating results and renders comparisons with prior periods and competitors less meaningful. We believe Adjusted EBITDA is a useful measure for analysts and investors to evaluate our future on-going performance as this measure allows a more meaningful comparison of our performance and projected cash earnings with our historical results from prior periods and to the results of our competitors. Moreover, our management uses this measure internally to evaluate the performance of our business as a whole and our individual business segments. In addition, we believe that by excluding certain items, such as stock-based compensation and acquisition-related 41Table of Contentsimpacts, Adjusted EBITDA corresponds more closely to the cash operating income generated from our business and allows investors to gain an understanding of the factors and trends affecting the ongoing cash earnings capabilities of our business, from which capital investments are made and debt is serviced.The reconciliation of net income (loss) attributable to Expedia Group, Inc. to Adjusted EBITDA is as follows:Year ended December 31, 202220212020(In millions)Net income (loss) attributable to Expedia Group, Inc.$352 $12 $(2,612)Net income (loss) attributable to non-controlling interests(9)3 (116)Provision for income taxes195 (53)(423)Total other expense, net547 224 432 Operating income (loss)1,085 186 (2,719)Gain (loss) on revenue hedges related to revenue recognized(6)(17)61 Restructuring and related reorganization charges— 55 231 Legal reserves, occupancy tax and other23 1 (13)Stock-based compensation374 418 205 Depreciation and amortization792 814 893 Impairment of goodwill— 14 799 Intangible and other long-term asset impairment81 6 175 Adjusted EBITDA$2,349 $1,477 $(368)Financial Position, Liquidity and Capital ResourcesOur principal sources of liquidity are typically cash flows generated from operations, cash available under our credit facility as well as our cash and cash equivalents and short-term investment balances, which were $4.1 billion and $4.3 billion at December 31, 2022 and 2021. Our revolving credit facility with aggregate commitments of $2.5 billion was essentially untapped at December 31, 2022.As of December 31, 2022, the total cash and cash equivalents and short-term investments held outside the United States was $770 million ($456 million in wholly-owned foreign subsidiaries and $314 million in majority-owned subsidiaries). The amount of undistributed earnings in foreign subsidiaries where the foreign subsidiary has or will invest undistributed earnings indefinitely outside of the Unites States, and for which future distributions could be taxable, was $65 million as of December 31, 2022. The unrecognized deferred tax liability related to the U.S. federal income tax consequences of these earnings was $17 million as of December 31, 2022. In 2022, we took the following action to reduce our debt outstanding:•Redemption of 2.5% Senior Notes. In March 2022, we early redeemed all of the €650 million of outstanding aggregate principal amount of our 2.5% senior notes due in June 2022. The redemption price for the 2.5% senior notes equaled 100% of the aggregate principal amount thereof plus accrued and unpaid interest thereon through the redemption date.•Redemption of 3.6% and 4.5% Senior Notes. In May 2022, we early redeemed all of our $500 million 3.6% senior notes due 2023, and in June 2022, we early redeemed all of our $500 million 4.5% senior notes due 2024, which resulted in the recognition of a loss on debt extinguishment of $24 million primarily comprised of “make-whole” premiums as well as the write-off of unamortized discount and debt issuance costs.•Redemption of 2.95% Senior Notes. In September 2022, we settled the tender offer to purchase $500 million in aggregate principal of our 2.95% senior notes due 2031 for an aggregate cash repurchase price of approximately $418 million, which resulted in the recognition of a net gain on debt extinguishment of $73 million. The net gain included the write-off of unamortized discount and debt issuance costs as well as related fees.Our credit ratings are periodically reviewed by rating agencies. As of December 31, 2022, Moody’s rating was Baa3 with an outlook of “stable,” S&P’s rating was BBB- with an outlook of “stable” and Fitch’s rating was BBB- with an outlook of “stable.” Changes in our operating results, cash flows, financial position, capital structure, financial policy or capital allocations to share repurchase, dividends, investments and acquisitions could impact the ratings assigned by the various rating agencies. 42Table of ContentsShould our credit ratings be adjusted downward, we may incur higher costs to borrow and/or limited access to capital markets and interest rates on our 6.25% senior notes, 4.625% senior notes as well as our 2.95% senior notes will increase, which could have a material impact on our financial condition and results of operations.As of December 31, 2022, we were in compliance with the covenants and conditions in our revolving credit facilities and outstanding debt as detailed in NOTE 7 — Debt in the notes to the consolidated financial statements. Under the merchant model, we receive cash from travelers at the time of booking and we record these amounts on our consolidated balance sheets as deferred merchant bookings. We pay our airline suppliers related to these merchant model bookings generally within a few weeks after completing the transaction. For most other merchant bookings, which is primarily our merchant lodging business, we generally pay after the travelers’ use and, in some cases, subsequent billing from the hotel suppliers. Therefore, generally we receive cash from the traveler prior to paying our supplier, and this operating cycle represents a working capital source of cash to us. Typically, the seasonal fluctuations in our merchant hotel bookings have affected the timing of our annual cash flows. Generally, during the first half of the year, hotel bookings have traditionally exceeded stays, resulting in much higher cash flow related to working capital. During the second half of the year, this pattern typically reverses and cash flows are typically negative. During 2020, impacts of COVID-19 disrupted our typical working capital trends. Significantly higher cancellations and reduced booking volumes, particularly in the first half of 2020, resulted in material operating losses and negative cash flow. During 2022, booking and travel trends have nearly normalized resulting in working capital benefits and positive cash flow in the current period akin to typical historical trends. However, it remains difficult to forecast the working capital trends for the upcoming quarters, given the uncertainty related to the full duration and total impact of COVID-19. Prior to COVID-19, we embarked on an ambitious cost reduction initiative to simplify the organization and increase efficiency. In response to COVID-19, we took several additional actions to further reduce costs to help mitigate the financial impact from COVID-19 and continue to improve our long-term cost structure. For 2023, we expect total capital expenditures for the full year to increase relative to our 2022 spending levels as we look to continue to improve our technology platforms, infrastructure, operational capabilities, and in the development of service offerings and expansion of our operations. Our cash flows are as follows: Year ended December 31, $ Change 2022202120202022 vs 20212021 vs 2020 (In millions)Cash provided by (used in) operations:Operating activities$3,440 $3,748 $(3,834)$(308)$7,582 Investing activities(580)(931)(263)351 (668)Financing activities(2,624)(973)4,077 (1,651)(5,050)Effect of foreign exchange rate changes on cash and cash equivalents(190)(177)61 (13)(238)In 2022, net cash provided by operating activities decreased by $308 million primarily due to a decrease in benefits from working capital changes driven mostly from a change in deferred merchant booking, which was largely offset by higher operating income after adjusting for impacts of depreciation and amortization. In 2022, $351 million less cash was used in investing activities primarily due to net sales and maturities of investments of $145 million in 2022 compared to net purchases of investments of $178 million in 2021.Cash used in financing activities in 2022 primarily included payments of $2.2 billion related to the extinguishment of our 2.5% senior notes, 3.6% senior notes, 4.5% senior notes and the tender offer for a portion of our 2.95% senior notes discussed above as well as $607 million of cash paid to acquire shares, including the repurchased shares under the authorizations discussed below and for treasury stock activity related to the vesting of equity instruments. These uses of cash were partially offset by $131 million of proceeds from the exercise of options and employee stock purchase plans. Cash used in financing activities in 2021 primarily included payments of approximately $2 billion related to the extinguishment of debt and $1.2 billion for the redemption of preferred stock as well as $165 million of cash paid for treasury stock activity related to the vesting of equity instruments and $67 million in preferred stock dividends. These uses of cash were largely offset by approximately $2 billion of net proceeds from the issuance of convertible notes and 2.95% senior notes issued in February and March 2021, respectively, as well as $503 million of proceeds from the exercise of options and employee stock purchase plans. Our Board of Directors and the Executive Committee, pursuant to a delegation of authority from the Board, have authorized share repurchases under authorized programs. These programs were temporarily halted in early 2020 with the onset of the COVID-19 pandemic but resumed in the second half of 2022. Shares repurchased under the authorized programs were as 43Table of Contentsfollows: Year ended December 31, 202220212020Number of shares repurchased5.2 million— 3.4 millionAverage price per share$96.09 $— $109.88 Total cost of repurchases (in millions)(1)$500 $— $370 ______________________________________(1)Amount excludes transaction costs.As of December 31, 2022, 18.1 million shares remain authorized for repurchase with no fixed termination date for the repurchases.During 2022, we didn't pay any common stock dividends. During 2021, while we also didn't pay common stock dividends, we did pay $67 million (or $74.96 per share of Series A Preferred Stock) of dividends on the Series A Preferred Stock. At this time, we do not expect to make quarterly dividend payments on our common stock. Future declarations of dividends are subject to final determination by our Board of Directors.Foreign exchange rate changes resulted in a decrease of our cash and restricted cash balances denominated in foreign currency in both 2022 and 2021 of $190 million and $177 million, respectively, reflecting a net depreciation in foreign currencies relative to the U.S. dollar during each year.Contractual Obligations and Commercial Commitments. Our material cash requirements as of December 31, 2022 include the following contractual obligations and commercial commitments arising in the normal course of business:•Principal payments related to our debt that is included in our consolidated balance sheet and the related periodic interest payments. The Company had Senior Notes and Convertible Notes, as described in NOTE 7 — Debt in the notes to our consolidated financial statements, with varying maturities and an aggregate principal amount of $6.3 billion, none of which is payable within 12 months. Based on current stated fixed rates, future interest payments associated with the Senior Notes total approximately $1.1 billion, with approximately $231 million payable within 12 months;•Our operating leases had fixed lease payment obligations, including imputed interest, of $443 million, with $88 million payable within 12 months; and•Purchase obligations representing the minimum obligations we have under agreements with certain of our vendors and marketing partners. These minimum obligations are less than our projected use for those periods, and payments may be more than the minimum obligations based on actual use. The Company had purchase obligations of $466 million, with $292 million payable within 12 months.In addition, we had $284 million of net unrecognized tax benefits recorded on our balance sheet as of December 31, 2022, for which we cannot make a reasonably reliable estimate of the amount and period of payment. See NOTE 15 — Commitments and Contingencies in the notes to the consolidated financial statements for further information related to our purchase obligations as well as amounts outstanding as of December 31, 2022 related to letters of credit and guarantees. Other than the items described above, we do not have any off-balance sheet arrangements as of December 31, 2022.In our opinion, our liquidity position provides sufficient capital resources to meet our foreseeable cash needs. There can be no assurance, however, that the cost or availability of future borrowings, including refinancings, if any, will be available on terms acceptable to us.Certain Relationships and Related Party TransactionsFor a discussion of certain relationships and related party transactions, see NOTE 17 — Related Party Transactions in the notes to the consolidated financial statements.Summarized Financial Information for Guarantors and the Issuer of Guaranteed SecuritiesSummarized financial information of Expedia Group, Inc. (the “Parent”) and our subsidiaries that are guarantors of our debt facility and instruments (the “Guarantor Subsidiaries”) is shown below on a combined basis as the “Obligor Group.” The debt facility and instruments are guaranteed by certain of our wholly-owned domestic subsidiaries and rank equally in right of payment with all of our existing and future unsecured and unsubordinated obligations. The guarantees are full, unconditional, joint and several with the exception of certain customary automatic subsidiary release provisions. In this summarized financial information of the Obligor Group, all intercompany balances and transactions between the Parent and Guarantor Subsidiaries 44Table of Contentshave been eliminated and all information excludes subsidiaries that are not issuers or guarantors of our debt facility and instruments, including earnings from and investments in these entities. December 31, 2022 (In millions)Combined Balance Sheets Information: Current Assets$6,720 Non-Current Assets10,458 Current Liabilities(1)10,407 Non-Current Liabilities6,777 Year EndedDecember 31, 2022Combined Statements of Operations Information: Revenue$9,431 Operating income (2)747 Net income150 Net income attributable to Obligors146 (1)Current liabilities include intercompany payables with non-guarantors of $466 million as of December 31, 2022.(2)Operating income includes intercompany income with non-guarantors of $35 million for the year ended December 31, 2022.Part II. Item 7A. Quantitative and Qualitative Disclosures About Market RiskMarket Risk ManagementMarket risk is the potential loss from adverse changes in interest rates, foreign exchange rates and market prices. Our exposure to market risk includes our long-term debt, our revolving credit facilities, derivative instruments and cash and cash equivalents, accounts receivable, intercompany receivables, investments, merchant accounts payable and deferred merchant bookings denominated in foreign currencies. We manage our exposure to these risks through established policies and procedures. Our objective is to mitigate potential income statement, cash flow and market exposures from changes in interest and foreign exchange rates.Interest Rate RiskAs of December 31, 2022 and 2021, the outstanding aggregate principal amount of our debt was $6.3 billion and $8.5 billion, respectively. As of December 31, 2022, the aggregate principal of our debt included:•$1.044 billion of senior unsecured notes due May 2025 that bear interest at 6.25%;•$750 million of senior unsecured notes due February 2026 that bear interest at 5.0%;•$1 billion of convertible senior unsecured notes due February 2026 with a fixed rate of 0% (the “Convertible Notes”);•$750 million of senior unsecured notes due August 2027 that bear interest at 4.625%; •$1 billion of senior unsecured notes due February 2028 that bear interest at 3.8%; •$1.25 billion of senior unsecured notes due February 2030 that bear interest at 3.25%; and •$500 million of senior unsecured notes due March 2031 that bear interest at 2.95%. The 6.25%, 5.0%, 4.625%, 3.8%, 3.25%, and 2.95% senior unsecured notes are collectively the “Senior Notes.” If market interest rates decline, our required payments will exceed those based on market rates. Additionally, the 6.25%, 4.625% and 2.95% senior unsecured notes are subject to interest rate adjustments should our credit ratings be adjusted downwards, which would result in increased interest expense in the future. The total estimated fair value of our Senior Notes and Convertible Notes was approximately $5.8 billion and $9.2 billion as of December 31, 2022 and December 31, 2021, respectively. The fair value was determined based on quoted market prices in less active markets and is categorized accordingly as Level 2 in the fair value hierarchy. A 50 basis point increase or decrease in interest rates would decrease or increase the fair value of our debt by approximately $115 million. We maintain a revolving credit facility of $2.5 billion, which bears interest based on market rates plus a spread determined by our credit ratings. Because our interest rate is tied to a market rate, we will be susceptible to fluctuations in 45Table of Contentsinterest rates if, consistent with our practice to date, we do not hedge the interest rate exposure arising from any borrowings under our revolving credit facilities. We had no revolving credit facilities borrowings outstanding as of both December 31, 2022 and 2021.Foreign Exchange RiskWe conduct business in certain international markets, primarily in Australia, Canada, China, the United Kingdom, and the European Union. Because we operate in international markets, we have exposure to different economic climates, political arenas, tax systems and regulations that could affect foreign exchange rates. Our primary exposure to foreign currency risk relates to transacting in foreign currency and recording the activity in U.S. dollars. Changes in exchange rates between the U.S. dollar and these other currencies will result in transaction gains or losses, which we recognize in our consolidated statements of operations.To the extent practicable, we minimize our foreign currency exposures by maintaining natural hedges between our current assets and current liabilities in similarly denominated foreign currencies. Additionally, we use foreign currency forward contracts to economically hedge certain merchant revenue exposures, foreign denominated liabilities related to certain of our loyalty programs and our other foreign currency-denominated operating liabilities. These instruments are typically short-term and are recorded at fair value with gains and losses recorded in other, net. As of December 31, 2022 and 2021, we had net forward assets of $15 million and $3 million, respectively, included in prepaid expenses and other current assets. We may enter into additional foreign exchange derivative contracts or other economic hedges in the future. Our goal in managing our foreign exchange risk is to reduce to the extent practicable our potential exposure to the changes that exchange rates might have on our earnings, cash flows and financial position. We make a number of estimates in conducting hedging activities including in some cases the level of future bookings, cancellations, refunds, customer stay patterns and payments in foreign currencies. In the event those estimates differ significantly from actual results, we could experience greater volatility as a result of our hedges.In March 2022, we entered into two fixed-to-fixed cross-currency interest rate swaps (“the swaps”) with an aggregate notional amount of €300 million. The swaps were designated as net investment hedges of Euro assets with the objective to protect the U.S. dollar value of our net investments in the Euro foreign operations due to movements in foreign currency. During the term of each contract, we receive interest payments in U.S. dollars at a fixed rate of 5% and make interest payments in Euros at an average fixed rate of 3.38%. The maturity date of both swaps is February 2026, whereby, we will receive U.S. dollars from and pay Euros to the contract counterparties. The fair value of the cross-currency interest rate swaps was a $21 million asset as of December 31, 2022 recorded in long-term investments and other assets.Future net transaction gains and losses are inherently difficult to predict as they are reliant on how the multiple currencies in which we transact fluctuate in relation to the U.S. dollar, the relative composition and denomination of current assets and liabilities each period, and our effectiveness at forecasting and managing, through balance sheet netting or the use of derivative contracts, such exposures. As an example, if the foreign currencies in which we hold net asset balances were to all weaken 10% against the U.S. dollar and foreign currencies in which we hold net liability balances were to all strengthen 10% against the U.S. dollar, we would recognize foreign exchange losses of approximately $31 million based on our foreign currency forward positions (including the impact of forward positions economically hedging our merchant revenue exposures) and the net asset or liability balances of our foreign denominated cash and cash equivalents, accounts receivable, deferred merchant bookings and merchant accounts payable balances as of December 31, 2022. As the net composition of these balances fluctuate frequently, even daily, as do foreign exchange rates, the example loss could be compounded or reduced significantly within a given period.During 2022, 2021 and 2020, we recorded net foreign exchange rate losses of approximately $40 million ($37 million loss excluding the contracts economically hedging our forecasted merchant revenue), net foreign exchange rate losses of approximately $48 million ($37 million loss excluding the contracts economically hedging our forecasted merchant revenue) and net foreign exchange rate gains of approximately $71 million ($2 million gain excluding the contracts economically hedging our forecasted merchant revenue). As we increase our operations in international markets, our exposure to fluctuations in foreign currency exchange rates increases. The economic impact to us of foreign currency exchange rate movements is linked to variability in real growth, inflation, interest rates, governmental actions and other factors. These changes, if material, could cause us to adjust our financing and operating strategies.Equity Investment RiskWe are exposed to equity price risk as it relates to changes in fair values of our investments in equity securities of publicly-traded companies, investments in which we’ve elected the fair value option, and minority investments without readily determinable fair values. We recorded net losses of $345 million, $29 million, and $142 million related to these investments for the years ended December 31, 2022, 2021, and 2020, respectively (See NOTE 3 — Fair Value Measurements in the notes to the consolidated financial statements for further information). The fair values of our investments in equity securities of publicly-46Table of Contentstraded companies (combined with our investments in which we’ve elected the fair value option) and minority investments without readily determinable fair values, were $564 million and $330 million, respectively, at December 31, 2022, and $909 million and $330 million, respectively, at December 31, 2021. A hypothetical 10% decrease in the fair values at December 31, 2022 of our investments in equity securities of publicly-traded companies and minority investments without readily determinable fair values would have resulted in a loss, before tax, of approximately $89 million, being recognized within other, net in our consolidated statements of operations.Part II.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this Form 10-K entitled “Statements Regarding Forward-Looking Information.” Certain risk factors may cause actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. For a discussion of such risk factors, see the section in this Form 10-K entitled “Risk Factors.” Dollar amounts in thousands, except share and per share data, unless otherwise stated.OVERVIEWWe are a fully integrated, self-administered and self-managed real estate investment trust (“REIT”), formed to own, operate, manage, acquire, develop and redevelop self-storage properties (“stores”). We derive substantially all of our revenues from our two segments: storage operations and tenant reinsurance. Primary sources of revenue for our storage operations segment include rents received from tenants under leases at each of our wholly-owned stores. Our operating results depend materially on our ability to lease available self-storage units, to actively manage unit rental rates, and on the ability of our tenants to make required rental payments. Consequently, management spends a significant portion of their time maximizing cash flows from our diverse portfolio of stores. Revenue from our tenant reinsurance segment consists of insurance revenues from the reinsurance of risks relating to the loss of goods stored by tenants in our stores. Our stores are generally situated in highly visible locations clustered around large population centers. The clustering of our assets around these population centers enables us to reduce our operating costs through economies of scale. To maximize the performance of our stores, we employ industry-leading revenue management systems. Developed by our management team, these systems enable us to analyze, set and adjust rental rates in real time across our portfolio in order to respond to changing market conditions. We believe our systems and processes allow us to more pro-actively manage revenues.We operate in competitive markets, often where consumers have multiple stores from which to choose. Competition has impacted, and will continue to impact, our store results. We experience seasonal fluctuations in occupancy levels, with occupancy levels generally higher in the summer months due to increased moving activity. We believe that we are able to respond quickly and effectively to changes in local, regional and national economic conditions by adjusting rental rates through the combination of our revenue management team and our industry-leading technology systems. We consider a store to be in the lease-up stage after it has been issued a certificate of occupancy, but before it has achieved stabilization. We consider a store to be stabilized once it has achieved either an 80% occupancy rate for a full year measured as of January 1 of the current year, or has been open for three years prior to January 1 of the current year.CRITICAL ACCOUNTING POLICIES AND ESTIMATESOur financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and assumptions, including those that impact our most critical accounting policies. We base our estimates and assumptions on historical experience and on various other factors that we believe are reasonable under the circumstances. A summary of significant accounting policies is also provided in the notes to our consolidated financial statements (see Note 2 to our consolidated financial statements). Actual results may differ from these estimates. We believe the following are our most critical accounting policies and estimates:CONSOLIDATION: Arrangements that are not controlled through voting or similar rights are accounted for as variable interest entities (“VIEs”). An enterprise is required to consolidate a VIE if it is the primary beneficiary of the VIE.Under certain circumstances when we enter into arrangements for the formation of joint ventures, a VIE may be created. The primary factors that require the most judgment in determining whether the joint venture is a VIE are whether the decisions that most significantly impact the entity’s economic performance were controlled by the equity holders as a group, and whether the joint venture has sufficient equity to finance its activities without additional subordinated support.If the joint venture is determined to be a VIE, we perform a qualitative analysis, including considering which party, if any, has the power to direct the activities most significant to the economic performance of each VIE and whether that party has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could be significant to the VIE. If we are determined to be the primary beneficiary of the VIE, the assets, liabilities and operations of the VIE are consolidated within 18our financial statements. Otherwise, our investment is generally accounted for under the equity method. Our ability to correctly assess the influence or control over an entity affects the presentation of the investment in our consolidated financial statements.REAL ESTATE ASSETS: We account for the acquisition of stores, including by merger and other acquisitions of real estate, in accordance with ASC 805-10, "Business Combinations." We use our judgment to determine if assets acquired meet the definition of a business or if the acquisition should be considered an asset acquisition. We must make significant assumptions and estimates in determining the fair value of the tangible and intangible assets and liabilities acquired and consideration transferred. These fair value estimates are sensitive to: price of land per square foot and current replacement cost estimates, including adjustments for the age, class, height, square footage, condition, location, and turnkey factor. These assumptions and estimates require judgment, and therefore others could come to materially different conclusions as to the estimated fair values, which could result in differences in depreciation and amortization expense, gains and losses on the sale of real estate assets, and real estate and intangible asset values. EVALUATION OF ASSET IMPAIRMENT: Long lived assets held for use are evaluated for impairment when events or circumstances indicate that there may be impairment. We review each store at least annually to determine if any such events or circumstances have occurred or exist. We focus on stores where occupancy and/or rental income have decreased by a significant amount. For these stores, we determine whether the decrease is temporary or permanent and whether the store will likely recover the lost occupancy and/or revenue in the short term. In addition, we review stores in the lease-up stage and compare actual operating results to original projections. We may not have identified all material facts and circumstances that affect impairment of our stores. No material impairments were recorded in the year ended December 31, 2022.We evaluate goodwill for impairment at least annually and whenever events, circumstances, and other related factors indicate that fair value of the related reporting unit may be less than the carrying value. If the fair value of the reporting unit is determined to exceed the aggregate carrying amount, no impairment charge is recorded. Otherwise, an impairment charge is recorded to the extent the carrying amount of the goodwill exceeds the amount that would be allocated to goodwill if the reporting unit were acquired for estimated fair value. No impairments were recorded in our evaluations for any period presented herein.DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: We hold a number of derivative instruments which we use to hedge our exposure to variability in expected future cash flows, mainly related to our interest rates on variable interest debt. We do not use derivatives for trading or speculative purposes. We assess our derivatives both at inception, and on an ongoing quarterly basis, for whether the derivatives used in hedging transactions are effective. The rules and interpretations relating to the accounting for derivatives are complex. Failure to apply this guidance correctly may require us to recognize all changes in fair value of the hedged derivative in earnings, which may materially impact our results. INCOME TAXES: We have elected to be treated as a REIT under Sections 856 through 860 of the Internal Revenue Code. In order to maintain our qualification as a REIT, among other requirements, we are required to distribute at least 90% of our REIT taxable income to our stockholders and meet certain tests regarding the nature of our income and assets. As a REIT, we are not subject to U.S. federal income tax with respect to that portion of our income which meets certain criteria and is distributed annually to our stockholders. We plan to continue to operate so that we meet the requirements for taxation as a REIT. Many of these requirements, however, are highly technical and complex. For any taxable year that we fail to qualify as a REIT and for which applicable statutory relief provisions did not apply, we would be subject to U.S. federal corporate income tax on all of our taxable income for at least that year and the ensuing four years. We could also be subject to penalties and interest, and our net income may be materially different from the amounts reported in our financial statements.We have elected to treat certain corporate subsidiaries, including Extra Space Management, Inc., as a TRS. In general, a TRS may perform additional services for tenants and generally may engage in any real estate or non-real estate related business. A TRS is subject to U.S. federal corporate income tax and may also be subject to state and local income taxes. Interest and penalties relating to uncertain tax positions will be recognized in income tax expense when incurred. If tax authorities determine that amounts paid by any of our TRSs to us are not reasonable compared to similar arrangements among unrelated parties, we could be subject to a penalty tax on the excess payments. RECENT ACCOUNTING PRONOUNCEMENTSFor a discussion of recent accounting pronouncements affecting our business, see Item 8, “Financial Statements and Supplementary Data–Recently Issued Accounting Standards.”19RESULTS OF OPERATIONSComparison of the Year Ended December 31, 2022 to the Year Ended December 31, 2021 OverviewResults for the year ended December 31, 2022 included the operations of 1,451 stores (1,132 wholly-owned, one in a consolidated joint venture, and 318 in joint ventures accounted for using the equity method) compared to the results for the year ended December 31, 2021, which included the operations of 1,268 stores (981 wholly-owned, four in a consolidated joint venture, and 283 in joint ventures accounted for using the equity method). Material or unusual changes in the results of our operations are discussed below.RevenuesThe following table presents information on revenues earned for the years indicated: For the Year Ended December 31, 20222021$ Change% ChangeProperty rental$1,654,735 $1,340,990 $313,745 23.4 %Tenant reinsurance185,531 170,108 15,423 9.1 %Management fees and other income83,904 66,264 17,640 26.6 %Total revenues$1,924,170 $1,577,362 $346,808 22.0 %Property Rental—The increase in property rental revenues for the year ended December 31, 2022 was primarily the result of an increase of $220,629 at our stabilized stores related to high occupancy and increased rents to existing customers. Property rental revenue also increased by $100,601 associated with acquisitions completed in 2022 and 2021. We acquired 153 stores during the year ended December 31, 2022 and we acquired 74 stores during the year ended December 31, 2021. Property rental revenue also increased by $5,431 during the year ended December 31, 2022 as a result of increases in occupancy at our lease-up stores. These increases were offset by approximately $15,460 related to the sale of 16 stores into a new joint venture and 16 stores to a third party during 2021.Tenant Reinsurance—The increase in tenant reinsurance revenues was due primarily to an increase in the number of stores operated and the higher average occupancy across the portfolio. We operated 2,338 stores at December 31, 2022, compared to 2,096 stores at December 31, 2021. Management Fees and Other Income—Management fees and other income represent the fees collected for our management of stores owned by third parties and unconsolidated joint ventures and other transaction fee income. The increase for the year ended December 31, 2022 was primarily due to an increase in the number of stores managed. As of December 31, 2022, we managed 1,206 stores for third parties and joint ventures compared to 1,115 stores as of December 31, 2021.20ExpensesThe following table presents information on expenses for the years indicated: For the Year Ended December 31, 20222021$ Change% ChangeProperty operations$435,342 $368,608 $66,734 18.1 %Tenant reinsurance 33,560 29,488 4,072 13.8 %Transaction related costs 1,548 — 1,548 — General and administrative129,251 102,194 27,057 26.5 %Depreciation and amortization288,316 241,879 46,437 19.2 %Total expenses$888,017 $742,169 $145,848 19.7 %Property Operations—The increase in property operations expense consists primarily of an increase of $32,242 at stabilized stores due to increased payroll, credit card processing fees, utilities, property taxes and insurance. The increase was also attributed to $34,547 related to acquisitions completed in 2022 and 2021. We acquired 153 stores during the year ended December 31, 2022 and acquired 74 stores during the year ended December 31, 2021. The increase was partially offset by a decrease in expense of $6,934 related to property sales. Tenant Reinsurance—Tenant reinsurance expense represents the costs that are incurred to provide tenant reinsurance. The increase in tenant reinsurance expense for the year ended December 31, 2022 was due primarily to the increase in total number of stores operated compared to the prior year and major storm events that occurred causing an increase in claim payouts. Tenant reinsurance expense included a $3,000 charge for tenant reinsurance claims related to damages incurred from Hurricane Ian. We operated 2,338 stores at December 31, 2022, compared to 2,096 stores at December 31, 2021. Transaction Related Costs—This represents the costs that were incurred as part of the acquisition of Bargold Storage Systems, LLC ("Bargold"). General and Administrative—General and administrative expenses primarily include all expenses not directly related to our stores, including corporate payroll, travel and professional fees. These expenses are recognized as incurred. Our overall expense has increased due to acquisitions, business combinations and growth through our joint venture partners and managed portfolio. During 2021, we experienced higher than average turnover and extended times to fill. We experienced wage pressure which led to increases in wages of approximately 10% nationwide. During 2022, we continued to see these trends but to a lesser extent and as such we do not expect these trends to continue in 2023. No other material trends in specific travel or other expenses were observed. Depreciation and Amortization—Depreciation and amortization expense increased as a result of the acquisition of new stores. We acquired 153 stores during the year ended December 31, 2022, and acquired 74 stores during the year ended December 31, 2021.21Other Income and ExpensesThe following table presents information on other revenues and expenses for the years indicated: For the Year Ended December 31, 20222021$ Change% ChangeGain on real estate transactions$14,249 $140,760 $(126,511)(89.9)%Interest expense(219,171)(166,183)(52,988)31.9 %Interest income69,422 49,703 19,719 39.7 %Equity in earnings and dividend income from unconsolidated real estate entities41,428 32,358 9,070 28.0 %Equity in earnings of unconsolidated real estate ventures - gain on sale of real estate assets— 6,251 (6,251)100.0 %Income tax expense(20,925)(20,324)(601)3.0 %Total other expense, net$(114,997)$42,565 $(157,562)(370.2)%Gain on Real Estate Transactions — During the year ended December 31, 2022 we sold two stores. We recognized a total gain of $14,249 related to the sale of these assets. During the first quarter of 2021, we sold 16 stores to a newly established unconsolidated joint venture for a total sales price of $168,885 resulting in a gain of $63,477. Additionally, we sold 16 stores during the fourth quarter of 2021 to a third party for a total sales price of $204,500 resulting in a gain of $73,854. Interest Expense—The increase in interest expense during the year ended December 31, 2022 was the result of higher overall debt and a higher average interest rate when compared to the same period in the prior year. Information on the total face value of debt and the average interest rate for the years ended December 31, 2022 and December 31, 2021 is set forth in the following table: For the Year Ended December 31, 20222021Total face value of debt$7,364,424 $5,984,113 Average interest rate4.1 %2.6 %Interest Income—Interest income represents interest earned on bridge loans and debt securities, income earned on notes receivable from common and preferred Operating Partnership unit holders and amounts earned on cash and cash equivalents deposited with financial institutions. The total principal balance of bridge loans receivable as of December 31, 2022 was $491,879, compared to $279,042 as of December 31, 2021. The increase in interest income during the year ended December 31, 2022 was primarily the result of the higher bridge loan balances along with higher interest rates.Equity in Earnings and Dividend Income from Unconsolidated Real Estate Entities—Equity in earnings of unconsolidated real estate ventures represents the income earned through our ownership interests in unconsolidated real estate ventures. In joint ventures, we and our joint venture partners generally receive a preferred return on our invested capital. To the extent that cash or profits in excess of these preferred returns are generated, we receive a higher percentage of the excess cash or profits, as applicable. We added a total of 37 stores to new and existing joint ventures for the year ended December 31, 2022 resulting in higher earnings when compared to the prior year. Dividend income represents dividends from our $200,000 investment in preferred stock of SmartStop.Equity in Earnings of Unconsolidated Real Estate Ventures—Gain on Sale of Real Estate Assets and Purchase of Joint Venture Partner's Interest—In June 2021, we sold our interest in two unconsolidated single store joint ventures to our joint ventures partner. We received proceeds of $1,888 in cash and recorded a gain of $525. Also, as of June 2021, the WICNN JV LLC and GFN JV LLC joint ventures sold all 17 of the stores owned by the joint ventures to a third party. Subsequent to the sales, these joint ventures were dissolved. As a result of these transactions, we recorded a gain of $5,739. Income Tax Expense—For the year ended December 31, 2022, the increase in income tax expense was the result of an increase in income earned by our TRS when compared to the same period in the prior year. 22Comparison of the Year Ended December 31, 2021 to the Year Ended December 31, 2020 The results of operations for the years ended December 31, 2021 compared to December 31, 2020 was included in our Annual Report on Form 10-K for the year ended December 31, 2021 on page 21, under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which was filed with the SEC on February 28, 2022.FUNDS FROM OPERATIONSFunds from operations ("FFO") provides relevant and meaningful information about our operating performance that is necessary, along with net income and cash flows, for an understanding of our operating results. We believe FFO is a meaningful disclosure as a supplement to net earnings. Net earnings assume that the values of real estate assets diminish predictably over time as reflected through depreciation and amortization expenses. The values of real estate assets fluctuate due to market conditions and we believe FFO more accurately reflects the value of our real estate assets. FFO is defined by the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) as net income computed in accordance with U.S. generally accepted accounting principles (“GAAP”), excluding gains or losses on sales of operating stores and impairment write-downs of depreciable real estate assets, plus real estate related depreciation and amortization and after adjustments to record unconsolidated partnerships and joint ventures on the same basis. We believe that to further understand our performance, FFO should be considered along with the reported net income and cash flows in accordance with GAAP, as presented in the consolidated financial statements. FFO should not be considered a replacement of net income computed in accordance with GAAP.The computation of FFO may not be comparable to FFO reported by other REITs or real estate companies that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently. FFO does not represent cash generated from operating activities determined in accordance with GAAP, and should not be considered as an alternative to net income as an indication of our performance, as an alternative to net cash flow from operating activities as a measure of our liquidity, or as an indicator of our ability to make cash distributions.The following table presents the calculation of FFO for the periods indicated: For the Year Ended December 31, 202220212020Net income attributable to common stockholders$860,688 $827,649 $481,779 Adjustments:Real estate depreciation263,923 229,133 214,345 Amortization of intangibles13,623 4,420 1,900 Gain on real estate transactions(14,249)(140,760)(18,075)Unconsolidated joint venture real estate depreciation and amortization16,644 11,954 9,021 Unconsolidated joint venture gain on sale of real estate assets and purchase of partner's interest— (6,251)— Distributions paid on Series A Preferred Operating Partnership units(2,288)(2,288)(2,288)Income allocated to Operating Partnership noncontrolling interests 60,468 50,109 35,803 Funds from operations attributable to common stockholders and unit holders$1,198,809 $973,966 $722,485 23SAME-STORE RESULTSComparison of the Year Ended December 31, 2022 to the Year Ended December 31, 2021 Our same-store pool for the periods presented consists of 867 stores that are wholly-owned and operated and that were stabilized by the first day of the earliest calendar year presented. We consider a store to be stabilized once it has been open for three years or has sustained average square foot occupancy of 80% or more for one calendar year. We believe that by providing same-store results from a stabilized pool of stores, with accompanying operating metrics including, but not limited to: occupancy, rental revenue growth, operating expense growth, net operating income growth, etc., stockholders and potential investors are able to evaluate operating performance without the effects of non-stabilized occupancy levels, rent levels, expense levels, acquisitions or completed developments. Same-store results should not be used as a basis for future same-store performance or for the performance of our stores as a whole. The following table presents operating data for our same-store portfolio: For the Year Ended December 31,Percent 20222021ChangeSame-store rental revenues$1,443,327 $1,229,688 17.4%Same-store operating expenses$339,195 $311,718 8.8%Same-store net operating income$1,104,132 $917,970 20.3% Same-store square foot occupancy as of year end94.2 %95.3 %Properties included in same-store867 867 Same-store revenues for the year ended December 31, 2022 increased compared to the same periods in 2021due to higher average rates to existing customers and higher other operating income partially offset by lower occupancy.Same-store expenses increased for the three months and year ended December 31, 2022 compared to the same periods in 2021due to increases in payroll, credit card processing fees, utilities, property taxes and insurance. The same-store expense growthrate for the year ended December 31, 2022 is amplified by negative expense growth in the 2021 comparable period.24The following table presents a reconciliation of same-store net operating income to net income as presented on our condensed consolidated statements of operations for the periods indicated:For the Year Ended December 31,20222021Net Income$921,156 $877,758 Adjusted to exclude:Gain on real estate transactions(14,249)(140,760)Equity in earnings and dividend income from unconsolidated real estate entities(41,428)(32,358)Equity in earnings of unconsolidated real estate ventures - gain on sale of real estate assets— (6,251)Interest expense219,171 166,183 Depreciation and amortization288,316 241,879 Income tax expense20,925 20,324 Transaction related costs 1,548 — General and administrative129,251 102,194 Management fees, other income and interest income(153,326)(115,967)Net tenant insurance(151,971)(140,620)Non same-store rental revenue(211,408)(111,302)Non same-store operating expense96,147 56,890 Total same-store net operating income$1,104,132 $917,970 Comparison of the Year Ended December 31, 2021 to the Year Ended December 31, 2020The same-store results for the years ended December 31, 2021 compared to December 31, 2020 was included in our Annual Report on Form 10-K for the year ended December 31, 2021 on page 21, under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which was filed with the SEC on February 28, 2022.25CASH FLOWSCash flows from operating activities increased as expected due to our continued growth in revenues and through the increase in the number of properties we own and operate. Cash flows used in investing activities relate primarily to our acquisitions and development of new stores, sales of stores, investments in unconsolidated real estate entities and notes receivable from bridge loans, and fluctuate depending on our actions in those areas. Cash flows from financing activities depend primarily on our debt and equity financing activities. A summary of cash flows along with significant components are as follows:For the Year Ended December 31,202220212020Net cash provided by operating activities$1,238,139 $952,436 $771,232 Net cash used in investing activities$(1,648,459)$(837,540)$(955,427)Net cash provided by (used in) financing activities$431,861 $(166,711)$241,471 Significant components of net cash flow included:Net income$921,156 $877,758 $517,582 Depreciation and amortization$288,316 $241,879 $224,444 Acquisition, development and redevelopment of stores$(1,353,510)$(1,289,524)$(387,448)Cash paid for business combination$(157,302)$— $— Gain on real estate transactions$(14,249)$(140,760)$(18,075)Investment in unconsolidated real estate entities$(118,963)$(54,602)$(64,792)Issuance and purchase of notes receivable$(529,245)$(317,482)$(313,355)Investment in debt securities$— $— $(300,000)Proceeds from sale of notes receivable$210,048 $172,002 $62,764 Principal payments received from notes receivable$283,636 $51,463 $10,102 Proceeds from the sale of common stock, net of offering costs$— $273,189 $103,468 Proceeds from sale of real estate assets and investments in real estate ventures$39,367 $572,728 $44,024 Net proceeds from our debt financing and repayment activities$1,376,411 $206,691 $691,270 Repurchase of common stock$(63,008)$— $(67,873)Proceeds from issuance of public bonds, net$396,100 $1,040,349 $— Dividends paid on common stock$(805,311)$(600,994)$(467,765)We believe that cash flows generated by operations, along with our existing cash and cash equivalents, the availability of funds under our existing lines of credit, and our access to capital markets will be sufficient to meet all of our reasonably anticipated cash needs during the next twelve months. These cash needs include operating expenses, monthly debt service payments, recurring capital expenditures, acquisitions, funding for the bridge loan program, building redevelopments and expansions, distributions to unit holders and dividends to stockholders necessary to maintain our REIT qualification.We expect to generate positive cash flow from operations and we consider projected cash flows in our sources and uses of cash. These cash flows are principally derived from rents paid by our tenants. A significant deterioration in projected cash flows from operations could cause us to increase our reliance on available funds under our existing lines of credit, curtail planned capital expenditures, or seek other additional sources of financing.26LIQUIDITY AND CAPITAL RESOURCESFinancing StrategyWe will continue to employ leverage in our capital structure in amounts reviewed from time to time by our board of directors. Although our board of directors has not adopted a policy which limits the total amount of indebtedness that we may incur, we will consider a number of factors in evaluating our level of indebtedness from time to time, as well as the amount of such indebtedness that will be either fixed or variable rate. In making financing decisions, we will consider factors including but not limited to: •the interest rate of the proposed financing;•the extent to which the financing impacts flexibility in managing our stores;•prepayment penalties and restrictions on refinancing;•the purchase price of stores acquired with debt financing;•long-term objectives with respect to the financing;•target investment returns;•the ability of particular stores, and our company as a whole, to generate cash flow sufficient to cover expected debt service payments;•overall level of consolidated indebtedness;•timing of debt maturities;•provisions that require recourse and cross-collateralization; and•corporate credit ratios including fixed charge coverage ratio and max secured/unsecured indebtedness.Our indebtedness may be recourse, non-recourse, cross-collateralized, cross-defaulted, secured or unsecured. In addition, we may invest in stores subject to existing loans collateralized by mortgages or similar liens, or may refinance stores acquired on a leveraged basis. We may use the proceeds from any borrowings to refinance existing indebtedness, to refinance investments, including the redevelopment of existing stores, for general working capital or to purchase additional interests in partnerships or joint ventures or for other purposes when we believe it is advisable.As of December 31, 2022, we had $92,868 available in cash and cash equivalents. Our cash and cash equivalents are held in accounts managed by third party financial institutions and consist of invested cash and cash in our operating accounts. During 2022 and 2021, we experienced no loss or lack of access to our cash or cash equivalents; however, there can be no assurance that access to our cash and cash equivalents will not be impacted by adverse conditions in the financial markets.As of December 31, 2022, we had $7,364,424 face value of debt, resulting in a debt to total enterprise value ratio of 25.8%. As of December 31, 2021, we had $5,984,113 face value of debt, resulting in a debt to total enterprise value ratio of 15.6%. As of December 31, 2022, the ratio of total fixed-rate debt and other instruments to total debt was 64.7% (including $1,837,714 on which we have interest rate swaps that have been included as fixed-rate debt). As of December 31, 2021, the ratio of total fixed-rate debt and other instruments to total debt was 75.3% (including $1,983,145 on which we have interest rate swaps that have been included as fixed-rate debt). The weighted average interest rate of total debt at December 31, 2022 and 2021 was 4.1% and 2.6%, respectively. As of December 31, 2022, the weighted average interest rate for all fixed rate debt was 3.4%, and the weighted average interest rate on all variable rate debt was 5.5%. As of December 31, 2021, the weighted average interest rate for all fixed rate debt was 3.1%, and the weighted average interest rate on all variable rate debt was 1.3%.In January 2021, we received a Baa2 rating from Moody's Investors Service and in July 2019, we obtained a BBB/Stable rating from S&P. We intend to manage our balance sheet to preserve such ratings. Certain of our real estate assets are pledged as collateral for our debt. We have a total of 908 unencumbered stores as defined by our public bonds. Our unencumbered asset value is calculated as $17,142,473 and our total asset value is calculated as $22,155,942 according to the calculations as defined by our public bonds. We are subject to certain restrictive covenants relating to our outstanding debt. We were in compliance with all financial covenants at December 31, 2022.We expect to fund our short-term and long-term liquidity requirements, including operating expenses, recurring capital expenditures, dividends to stockholders, distributions to holders of Operating Partnership units and interest on our outstanding indebtedness, out of our operating cash flow, cash on hand and borrowings under our revolving lines of credit. In addition, we are pursuing additional sources of financing based on anticipated funding needs.Our liquidity needs consist primarily of operating expenses, monthly debt service payments, recurring capital expenditures, distributions to unit holders and dividends to stockholders necessary to maintain our REIT qualification. We may from time to time seek to repurchase our outstanding debt, shares of common stock or other securities in open market purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market 27conditions, our liquidity requirements, contractual restrictions and other factors. In addition, we evaluate, on an ongoing basis, the merits of strategic acquisitions and other relationships, which may require us to raise additional funds. We may also use Operating Partnership units as currency to fund acquisitions from self-storage owners who desire tax-deferral in their exiting transactions.CONTRACTUAL OBLIGATIONSFor more information on our contractual obligations related to real estate acquisitions, refer to our commitments and contingencies footnote in the notes to the consolidated financial statements in Item 8 of this Form 10-K.SEASONALITYThe self-storage business has been subject to seasonal fluctuations. A greater portion of revenues and profits is typically realized from May through September. Historically, our highest level of occupancy has been at the end of July, while our lowest level of occupancy has been in late February and early March. Results for any quarter may not be indicative of the results that may be achieved for the full fiscal year.Item 7A. Quantitative and Qualitative Disclosures About Market RiskMarket RiskMarket risk refers to the risk of loss from adverse changes in market prices and interest rates. Our future income, cash flows and fair values of financial instruments are dependent upon prevailing market interest rates.Interest Rate RiskInterest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.As of December 31, 2022, we had approximately $7,364,424 in total face value debt, of which approximately $2,602,228 was subject to variable interest rates (excluding debt with interest rate swaps). If benchmark index rates were to increase or decrease by 100 basis points, the increase or decrease in interest expense on the variable rate debt would increase or decrease future earnings and cash flows by approximately $26,022 annually.Interest rate risk amounts were determined by considering the impact of hypothetical interest rates on our financial instruments. These analyses do not consider the effect of any change in overall economic activity that could occur. Further, in the event of a change of that magnitude, we may take actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.Derivative InstrumentsWe use derivative instruments to help manage interest rate risk using designated hedge relationships. Interest rate swaps involve the exchange of fixed-rate and variable-rate interest payments between two parties based on a contractual underlying notional amount, but do not involve the exchange of the underlying notional amounts. See our Derivatives footnote in our Notes to consolidated financial statements in Item 8 for additional information about our use of derivative contracts.28
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+ITEM 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition 45 ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 71
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+Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Certain Trends and Uncertainties.”•Investment Tax Credit. At the federal level, investment tax credits for business and residential solar systems have gone through several cycles of enactment and expiration since the 1980s. The current federal energy investment tax credit (“ITC”) for solar energy property requires projects to meet certain wage and apprenticeship requirements and to have commenced construction by a certain date, which may be achieved by certain qualifying procurement activities. In 2020, the U.S. Congress extended the 26% ITC through 2022 as part of its COVID-19 relief efforts, and such credit was scheduled to step down to 22% for projects that commence construction in 2023. However, during 2022, the U.S. Congress reinstated the 30% ITC through 2032 as part of the IRA discussed above. Such credit is currently scheduled to step down to 26% for projects that commence construction in 2033, 22% for projects that commence construction in 2034, and will expire thereafter. The ITC has been an important economic driver of solar installations and qualifying procurement activities in the United States, and its extension is expected to contribute to greater long-term demand. The positive impact of the ITC depends on the availability of tax equity for project financing or the ability to transfer the ITC to other taxpayers.8Table of Contents•R&D grants. In July 2022, the U.S. Department of Energy Solar Energy Technologies Office announced the 2022 Solar Manufacturing Incubator Funding Opportunity, which provides up to $27 million for qualifying solar R&D projects, particularly those related to CdTe. These grants are intended to accelerate and expand domestic solar R&D to strengthen U.S. solar manufacturing and contribute to renewable energy targets. Award recipients are expected to be announced in early 2023.•Renewable portfolio standards. Many states have enacted legislation adopting Renewable Portfolio Standard (“RPS”) mechanisms. Under an RPS, regulated utilities and other load serving entities are required to procure a specified percentage of their total retail electricity sales to end-user customers from eligible renewable resources, such as solar energy generation facilities, by a specified date. For example, California’s RPS program, which is one of the most significant in the United States in terms of the volume of renewable electricity required to meet its RPS mandate, currently requires utilities and other obligated load serving entities to procure 60% of their total retail electricity demand from eligible renewable resources by 2030 and 100% of such electricity demand from carbon-free resources by 2045. Some programs may further require that a specified portion of the total percentage of renewable energy must come from solar generation facilities or other technologies. RPS mechanisms and other legislation vary significantly from state to state, particularly with respect to the percentage of renewable energy required to achieve the state’s RPS, the definition of eligible renewable energy resources, and the extent to which renewable energy credits qualify for RPS compliance.India. In India, incentives at both the federal and state levels have contributed to growth in domestic PV solar module manufacturing and solar energy installations. Such incentives include the following:•Production Linked Incentive. In September 2022, the Indian government announced an expansion of the Production Linked Incentive (“PLI”) scheme to INR 195 billion ($2.6 billion), which is intended to promote the manufacturing of high efficiency solar modules in India and to reduce India’s dependency on foreign imports of solar modules. Under the PLI scheme, manufacturers are selected through a competitive bid process and receive certain cash incentives over a five-year period following the commissioning of their manufacturing facilities. Among other things, such incentives are based on the efficiency and temperature coefficient of the modules produced, the proportion of raw materials sourced from the domestic market, the extent to which the manufacturer’s operations are fully integrated within India, and the quantity of modules sold from such manufacturing operations.•Import duty tariffs. In April 2022, the Indian government began imposing import duty tariffs of 40% on solar modules and 25% on solar cells. In connection with such tariffs, the Indian government has also implemented a regulation mandating that any solar project with federal utility, state utility, or commercial and industrial off-takers that interconnects through government owned transmission lines only use solar modules from an approved list of module manufacturers, and a requirement that all federal procurement of solar modules be only from cells and modules produced domestically.•Green hydrogen targets. In January 2023, the Indian government announced its National Green Hydrogen Mission (“NGHM”), which is intended to make India a hub for the production and export of green hydrogen and to contribute to the broader energy transition from fossil fuels to renewable energy sources. The NGHM provides for an initial outlay of approximately $225 million for pilot projects and R&D, which, among other program investments, is expected to result in 5 million metric tons of annual green hydrogen production capacity and 125 GWAC of incremental renewable energy capacity, among other initiatives, by 2030. The Ministry of New and Renewable Energy (“MNRE”) will be responsible for overall coordination and implementation of the NGHM, including formulating programs for financial incentives, and other central and state government agencies will be responsible for implementing various policies, regulations, and compliance standards.9Table of ContentsEurope. In Europe, renewable energy targets, in conjunction with tenders for utility-scale PV solar and other support measures, have contributed to growth in PV solar markets. Renewable energy targets prescribe how much energy consumption must come from renewable sources, while incentive policies and competitive tender policies are intended to support new supply development by providing certainty to investors. Such targets and policies include the following:•REPowerEU plan. In May 2022, the European Commission set forth its REPowerEU plan, which aims to reduce dependence on Russian fossil fuels by 2027. The REPowerEU plan supports the EU’s rapid deployment of renewable energy sources, including solar energy, as a means to establish greater energy independence. Such plan sets forth targets for all EU member states, which includes an EU energy mix with a 45% share of energy from renewable sources by 2030. Solar targets for the same period include 300 GWAC installed by 2025 and 600 GWAC by 2030. The REPowerEU plan also aims to facilitate solar deployment through easier access to land and a framework to expedite permitting at national and local levels.•Renewable energy tenders. Certain markets in Europe, such as France, have adopted regulations for public tenders of renewable energy to prioritize PV solar power systems that utilize solar modules produced in low-carbon manufacturing processes. Such regulations require developers to provide information about the carbon footprint of PV solar modules used in their utility-scale projects and precludes the use of module technology that does not meet certain minimum carbon footprint thresholds.Various proposed and contemplated environmental and tax policies may create regulatory uncertainty in the renewable energy sector, including the solar energy sector, and may lead to a reduction or removal of various clean energy programs and initiatives designed to curtail climate change. For more information about the risks associated with these potential government actions, see Item 1A. “Risk Factors – The reduction, elimination, or expiration of government subsidies, economic incentives, tax incentives, renewable energy targets, and other support for on-grid solar electricity applications, or the impact of other public policies, such as tariffs or other trade remedies imposed on solar cells and modules, could negatively impact demand and/or price levels for our solar modules and limit our growth or lead to a reduction in our net sales or increase our costs, thereby adversely impacting our operating results.”Modules BusinessOur primary segment is our modules business, which involves the design, manufacture, and sale of CdTe solar modules, which convert sunlight into electricity. Since the inception of First Solar, our modules have used our advanced thin film semiconductor technology. Each of our currently produced Series 6 and Series 6 Plus modules is a glass laminate approximately 4ft x 6ft in size that encapsulates thin film semiconductor materials. Our Series 7 modules, which we began producing in early 2023 at our newest manufacturing facility in the U.S. and expect to begin producing in India in the second half of 2023, are expected to have a larger form factor of approximately 4ft x 7ft in size. At the end of 2022, our modules had an average power output of 467 watts.Raw MaterialsOur module manufacturing process uses approximately 30 types of raw materials and components to construct a solar module, including CdTe, front glass coated with transparent conductive oxide, other semiconductor materials, organics such as photo resist, tempered back glass, frames, packaging components such as interlayer, cord plate/cord plate cap, lead wire, and solar connectors. Before we use these materials and components in our manufacturing process, a supplier must undergo rigorous qualification procedures, and we continually evaluate new suppliers as part of our cost reduction roadmap and expansion activities. When possible, we attempt to use suppliers that can provide a raw material supply source that is near our manufacturing locations, reducing the cost and lead times for such materials. For more information about the risks associated with our supply chain, see Item 1A. “Risk Factors – Several of our key raw materials and components are either single-sourced or sourced from a limited number of 10Table of Contentssuppliers, and their failure to perform could cause manufacturing delays and impair our ability to deliver solar modules to customers in the required quality and quantities and at a price that is profitable to us.”CustomersOur customers include developers and operators of systems, utilities, independent power producers, commercial and industrial companies, and other system owners. During 2022, our third-party module sales represented approximately 93% of our total net sales, and we sold the majority of our solar modules to developers and operators of systems in the United States. During 2022, Intersect Power, Lightsource BP, and NextEra Energy each accounted for more than 10% of our modules business net sales. For more information about risks related to our customers, see Item 1A. “Risk Factors – The loss of any of our large customers, or the inability of our customers and counterparties to perform under their contracts with us, could significantly reduce our net sales and negatively impact our results of operations.We continue to focus on certain key geographic markets, particularly in areas with abundant solar resources and sizable electricity demand, and additional customer relationships to diversify our customer base. The wholesale commercial and industrial market continues to represent a promising opportunity for the widespread adoption of PV solar technology as corporations undertake certain sustainability commitments. The demand for corporate renewables continues to accelerate, with corporations worldwide committing to the RE100 campaign. We believe we also have a competitive advantage in the commercial and industrial market due to many customers’ sensitivity to the sustainability, experience, and financial stability of their suppliers and geographically diverse operating locations. With our sustainability advantage, financial strength, and global footprint, we are well positioned to meet these needs.Additionally, the increase of utility-owned generation has expanded the number of potential buyers of our modules as such utility customers benefit from a potentially low cost of capital available through rate-based utility investments. Given their long-term ownership profile, utility-owned generation customers typically seek to partner with stable companies that can provide low-cost alternatives to or replacements for aging fossil fuel-based generation resources, including reliable PV solar technology, thereby mitigating their long-term ownership risks.CompetitionThe solar energy and renewable energy sectors are highly competitive and continually evolving as participants in these sectors strive to distinguish themselves within their markets and compete within the larger electric power industry. Among PV solar module manufacturers, the principal method of competition is sales price per watt, which may be influenced by several module value attributes, including wattage (through a larger form factor or an improved conversion efficiency), energy yield, degradation, sustainability, and reliability. Sales price per watt may also be influenced by warranty terms and customer payment terms. We face intense competition for sales of solar modules, which may result in reduced selling prices and loss of market share. Our primary source of competition is crystalline silicon module manufacturers, the majority of which are linked to China. Allegations of forced labor in the Chinese solar supply chain have emerged in recent years, which means we also compete on our approach to responsible sourcing and supply chain due diligence. Our differentiated technology, integrated manufacturing process, and tightly controlled supply chain helps limit the risks associated with outsourcing and the multiple supply tiers of conventional crystalline silicon module manufacturing.We also expect to compete with future entrants into the PV solar industry and existing market participants that offer new or differentiated technological solutions. For additional information, see Item 1A. “Risk Factors – Our failure to further refine our technology and develop and introduce improved PV products, including as a result of delays in implementing planned advancements, could render our solar modules uncompetitive and reduce our net sales, profitability, and/or market share.”11Table of ContentsCertain of our existing or future competitors, including many linked to China, may have direct or indirect access to sovereign capital or other forms of state support, which could enable such competitors to operate at minimal or negative operating margins for sustained periods of time. Our results of operations could be adversely affected if competitors reduce module pricing to levels below their costs, bid aggressively low prices for module sale agreements, or are able to operate at minimal or negative operating margins for sustained periods of time. We believe the solar industry may experience periods of structural imbalance between supply and demand, which could lead to periods of pricing volatility. For additional information, see Item 1A. “Risk Factors – Competition in solar markets globally and across the solar value chain is intense and could remain that way for an extended period of time. The solar industry may experience periods of structural imbalance between global PV module supply and demand that result in periods of pricing volatility, which could have a material adverse effect on our business, financial condition, and results of operations.”Solar Module WarrantiesWe provide a limited PV solar module warranty covering defects in materials and workmanship under normal use and service conditions for up to 12.5 years. We also typically warrant that modules installed in accordance with agreed-upon specifications will produce at least 98% of their labeled power output rating during the first year, with the warranty coverage reducing by a degradation factor every year thereafter throughout the limited power output warranty period of up to 30 years. Among other things, our solar module warranty also covers the resulting power output loss from cell cracking. For additional information on our solar module warranty programs, refer to Item 1A. “Risk Factors – Problems with product quality or performance may cause us to incur significant and/or unexpected contractual damages and/or warranty and related expenses, damage our market reputation, and prevent us from maintaining or increasing our market share.”Solar Module Collection and RecyclingWe are committed to mitigating the environmental impact of our products over their entire life cycle. As part of such efforts, we offer recycling services to help module owners meet their end-of-life (“EOL”) obligations. In 2005, we voluntarily established the industry’s first global and comprehensive module collection and recycling program, and in 2013 we implemented a “pay-as-you-go” recycling service. We continue to invest in module recycling technology improvements to increase recycling efficiency and reduce recycling prices for our customers. Our module recycling process is designed to maximize the recovery of materials, including the glass and encapsulated semiconductor material, for use in new modules or other products and enhances the sustainability profile of our modules. Approximately 90% of each collected First Solar module can be recycled into materials for reuse. We currently operate recycling facilities at our manufacturing sites in the United States, Malaysia, and Vietnam and at our former manufacturing facility in Germany.For certain legacy customer sales contracts that were covered under the 2005 module collection and recycling program, which has since been discontinued, we agreed to pay the costs for the collection and recycling of qualifying solar modules, and the end users agreed to notify us, disassemble their solar power systems, package the solar modules for shipment, and revert ownership rights over the modules back to us at the end of the modules’ service lives.For modules covered under our program that were previously sold into and installed in the EU, we continue to maintain a commitment to cover the estimated collection and recycling costs consistent with our historical program. The EU’s Waste Electrical and Electronic Equipment (“WEEE”) Directive places the obligation of recycling (including collection, treatment, and environmentally sound disposal) of electrical and electronic equipment products upon producers and is applicable to all PV solar modules in EU member states. As a result of the transposition of the WEEE Directive by the EU member states, we have adjusted our recycling offerings, as required, to ensure compliance with specific EU member state WEEE regulations.12Table of ContentsIntellectual PropertyOur success depends, in part, on our ability to maintain and protect our proprietary technology and to conduct our business without infringing on the proprietary rights of others. We rely primarily on a combination of patents, trademarks, and trade secrets, as well as associate and third-party confidentiality agreements, to safeguard our intellectual property. We regularly file patent applications to protect inventions arising from our R&D activities in the United States and other countries. Our patent applications and any future patent applications may not result in a patent being issued with the scope of the claims we seek, or at all, and any patents we may receive may be challenged, invalidated, or declared unenforceable. In addition, we have registered and/or have applied to register trademarks and service marks in the United States and a number of foreign countries for “First Solar.”With respect to proprietary know-how that is not patentable and processes for which patents are difficult to enforce, we rely on, among other things, trade secret protection and confidentiality agreements to safeguard our interests. We believe that many elements of our PV solar module manufacturing processes, including our unique materials sourcing, involve proprietary know-how, technology, or data that are not covered by patents or patent applications, including technical processes, equipment designs, algorithms, and procedures. We have taken security measures to protect these elements. Our R&D personnel have entered into confidentiality and proprietary information agreements with us. These agreements address intellectual property protection issues and require our associates, to the extent permitted by law, to assign to us all of the inventions, designs, and technologies they develop during the course of their employment with us that are directed towards our actual or anticipated business. We also require our customers and business partners to enter into confidentiality agreements before we disclose sensitive aspects of our modules, technology, or business plans.Regulatory, Environmental, Health, and Safety MattersWe are subject to various federal, state, local, and international laws and regulations, and are often subject to oversight and regulation in accordance with national and local ordinances relating to building codes, safety, and other matters. The impact of these laws and requirements may increase our overall costs and may delay, prevent, or increase the cost of manufacturing PV modules. As we operate in the U.S. and internationally, we are also subject to the application of U.S. trade laws and trade laws of other countries. Such tariffs and policies, or any other U.S. or global trade remedies or other trade barriers that apply to us given our global operations, may directly or indirectly affect our business, financial condition, and results of operations. See Item 1A. “Risk Factors – Existing regulations and policies, changes thereto, and new regulations and policies may present technical, regulatory, and economic barriers to the purchase and use of PV solar products, which may significantly reduce demand for our modules.”We are also subject to the application of various anti-bribery laws, some of which prohibit improper payments to government and non-government persons and entities, and others (e.g., the U.S. Foreign Corrupt Practices Act (the “FCPA”) and the U.K. Bribery Act) that extend their application to activities outside their country of origin. From time to time, we may compete against companies for contracts in China, India, South America, and the Middle East, which require substantial government contact and where norms can differ from U.S. standards, and not all competitors are subject to compliance with the same anti-bribery laws. See Item 1A. Risk Factors – “We could be adversely affected by any violations of the FCPA, the U.K. Bribery Act, and other foreign anti-bribery laws.”We are also subject to various federal, state, local, and international laws and regulations relating to the protection of the environment, including those governing the discharge of pollutants into the air and water; the use, management, and disposal of hazardous materials and wastes; occupational health and safety; and the cleanup of contaminated sites. Our operations include the use, handling, storage, transportation, generation, and disposal of hazardous materials and wastes. Therefore, we could incur substantial costs, including cleanup costs, fines, and civil or criminal sanctions and costs arising from third-party property damage or personal injury claims as a result of violations of, or liabilities under, environmental and occupational health and safety laws and regulations or non-compliance with environmental permits required for our operations. We believe we are currently in substantial compliance with applicable environmental and occupational health and safety requirements and do not expect to 13Table of Contentsincur material expenditures for environmental and occupational health and safety controls in the foreseeable future. However, future developments such as the implementation of new, more stringent laws and regulations, more aggressive enforcement policies, or the discovery of unknown environmental conditions may require expenditures that could have a material adverse effect on our business, financial condition, or results of operations. See Item 1A. “Risk Factors – Environmental obligations and liabilities could have a substantial negative impact on our business, financial condition, and results of operations.”From time to time, we may also be subject to government policies or laws intended to protect human rights. For example, in late 2021 the U.S. President signed the Uyghur Forced Labor Prevention Act, which bans the import of goods from China’s Xinjiang region into the United States due to concerns about forced labor practices in the region, which provides approximately half of the world’s polysilicon supply. While we do not use polysilicon in our solar modules, which mitigates the potential supply chain disruptions and human rights risks associated with such import ban, the implementation of similar restrictions or trade embargoes on the purchase of certain materials or equipment necessary to sustain our manufacturing operations may require expenditures and process changes to ensure our supply chain remains free of such materials, which could have a material adverse effect on our business, financial condition, or results of operations. We are committed to protecting human rights, enforcing fair labor practices, and addressing the potential risks of forced labor across our own operations and the operations of our suppliers.Human CapitalAs of December 31, 2022, we had approximately 5,500 associates (our term for full and part-time employees), including approximately 4,700 in our modules business that work primarily in the United States, Malaysia, and Vietnam. The remainder of our associates are in R&D, sales and marketing, and general and administrative positions.Our company’s success depends, to a significant extent, on our ability to attract, train, and retain management, operations, sales, and technical talent, including associates in foreign jurisdictions. We strive to attract, hire, and retain qualified individuals globally to further our mission of providing cost-advantaged solar technology through rigorous safety practices, innovation, customer engagement, industry leadership, and operational excellence. We take a consciously inclusive approach to our hiring practices, which we monitor through a review of applicant and new-hire metrics on a quarterly basis. We prohibit discrimination based on race, color, religion, sex, age, national origin, veteran status, disability, sexual orientation, or gender identity. As part of our global talent management process, we engage in succession planning by prioritizing the development and retention of associates in critical roles.We follow a pay-for-performance model in which associates are compensated for achieving goals and associated metrics and demonstrating First Solar values. We review associate compensation on a regular basis to ensure internal and external equity, including, among other things, minimum wage and living wage assessments across our global operations. We offer competitive compensation and benefits to our associates, including, for example, health care and other insurance benefits, retirement programs, paid time off, paid parental leave, flexible work schedules, and education assistance, depending on eligibility.We are committed to developing and providing career growth opportunities for our associates. We believe a strong culture of inclusiveness is essential to the success of our company. We gather and respond to associate feedback in a variety of ways, including through anonymous, periodic associate engagement and inclusion surveys, pulse surveys, and one-on-one interactions. Additionally, we support career advancement, mentorship, and leadership development programs to ensure the professional growth of our diverse talent.None of our associates are currently represented by labor unions or covered by a collective bargaining agreement. As we continue to expand domestically and internationally, we may encounter regional laws that mandate union representation or associates who desire union representation or a collective bargaining agreement. We recognize that 14Table of Contentsin the locations where we operate, employees have the right to freely associate or not associate with third-party labor organizations, along with the right to bargain or not to bargain collectively in accordance with local laws.Available InformationWe maintain a website at www.firstsolar.com. We make available free of charge on our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such materials with, or furnish them to, the SEC. The information contained in or connected to our website is not incorporated by reference into this report. We use our website as one means of disclosing material non-public information and for complying with our disclosure obligations under the SEC’s Regulation FD. Such disclosures are typically included within the Investor Relations section of our website at investor.firstsolar.com. Accordingly, investors should monitor such portions of our website in addition to following our press releases, SEC filings, and public conference calls and webcasts. The SEC also maintains a website at www.sec.gov that contains reports and other information regarding issuers, such as First Solar, that file electronically with the SEC.Information about Our Executive OfficersOur executive officers and their ages and positions as of February 28, 2023 were as follows:NameAgePositionMark R. Widmar57Chief Executive OfficerAlexander R. Bradley41Chief Financial OfficerGeorges Antoun60Chief Commercial Officer Michael Koralewski51Chief Supply Chain OfficerKuntal Kumar Verma50Chief Manufacturing OfficerPatrick Buehler45Chief Product OfficerMarkus Gloeckler49Chief Technology OfficerCaroline Stockdale59Chief People and Communications OfficerJason Dymbort45General Counsel and SecretaryMark R. Widmar was appointed Chief Executive Officer in July 2016. He joined First Solar in April 2011 as Chief Financial Officer and also served as First Solar’s Chief Accounting Officer from February 2012 through June 2015. From March 2015 to June 2016, Mr. Widmar served as the Chief Financial Officer and through June 2018, served as a director on the board of the general partner of 8point3 Energy Partners LP (“8point3”), the joint yieldco formed by First Solar and SunPower Corporation in 2015 to own and operate a portfolio of selected solar generation assets. Prior to joining First Solar, Mr. Widmar served as Chief Financial Officer of GrafTech International Ltd., a leading global manufacturer of advanced carbon and graphite materials, from May 2006 through March 2011. Prior to joining GrafTech, Mr. Widmar served as Corporate Controller of NCR Inc. from 2005 to 2006, and was a Business Unit Chief Financial Officer for NCR from November 2002 to his appointment as Controller. He also served as a Division Controller at Dell, Inc. from August 2000 to November 2002. Mr. Widmar also held various financial and managerial positions with Lucent Technologies Inc., Allied Signal, Inc., and Bristol Myers/Squibb, Inc. He began his career in 1987 as an accountant with Ernst & Young. Mr. Widmar holds a Bachelor of Science in business accounting and a Master of Business Administration from Indiana University.15Table of ContentsAlexander R. Bradley was appointed Chief Financial Officer in October 2016. He joined First Solar in May 2008, and previously served as Vice President of both Treasury and Project Finance, leading or supporting the structuring, sale, and financing of over $10 billion and approximately 2.7 GWDC of the Company’s worldwide development assets, including several of the largest PV power plant projects in North America. From June 2016 to June 2018, Mr. Bradley also served as an officer and board member of the general partner of 8point3. Prior to joining First Solar, Mr. Bradley worked at HSBC in investment banking and leveraged finance, in London and New York, covering the energy and utilities sector. He received his Master of Arts from the University of Edinburgh, Scotland.Georges Antoun was appointed Chief Commercial Officer in July 2016. He joined First Solar in July 2012 as Chief Operating Officer before being appointed as President, U.S. in July 2015. Mr. Antoun has over 30 years of operational and technical experience, including leadership positions at several global technology companies. Prior to joining First Solar, Mr. Antoun served as Venture Partner at Technology Crossover Ventures (“TCV”), a private equity and venture firm that he joined in July 2011. Before joining TCV, Mr. Antoun was the Head of Product Area IP & Broadband Networks for Ericsson, based in San Jose, California. Mr. Antoun joined Ericsson in 2007, when Ericsson acquired Redback Networks, a telecommunications equipment company, where Mr. Antoun served as the Senior Vice President of World Wide Sales & Operations. After the acquisition, Mr. Antoun was promoted to Chief Executive Officer of the Redback Networks subsidiary. Prior to Redback Networks, Mr. Antoun spent five years at Cisco Systems, where he served as Vice President of Worldwide Systems Engineering and Field Marketing, Vice President of Worldwide Optical Operations, and Vice President of Carrier Sales. Prior to Cisco Systems, he was the Director of Systems Engineering at Newbridge Networks, a data and voice networking company. Mr. Antoun started his career at Nynex (now Verizon Communications), where he was part of its Science and Technology Division. Mr. Antoun serves as a member of the board of directors of Marathon Digital Holdings. He is also the Chairman of the University of Louisiana’s College of Engineering Dean’s Advisory Council board. He earned a Bachelor of Science degree in engineering from the University of Louisiana at Lafayette and a Master’s degree in information systems engineering from NYU Poly.Michael Koralewski was appointed Chief Supply Chain Officer in November 2022 and is accountable for maintaining executive oversight of First Solar’s strategic global supply chain. He previously served as First Solar’s Chief Manufacturing Operations Officer and provides over 25 years of global operational experience to the executive leadership team. Mr. Koralewski joined First Solar in 2006, serving in several senior roles in operations and quality management, including Senior Vice President, Global Manufacturing since 2015; Vice President, Global Site Operations and Plant Manager since 2011; and Vice President, Global Quality since 2009. In all of these roles Mr. Koralewski has been significantly involved since the beginning of First Solar’s manufacturing scaling and expansion from site selection through sustaining operations and supply chain development. Prior to joining First Solar, Mr. Koralewski worked at Dana Incorporated where he held several positions with global responsibility in operations and quality management. He earned a Bachelor of Science in chemical engineering from Case Western Reserve University and a Master of Business Administration from Bowling Green State University.Kuntal Kumar Verma was appointed Chief Manufacturing Officer in November 2022 and previously served as First Solar’s Chief Manufacturing Engineering Officer. He is responsible for First Solar’s global manufacturing operations and engineering, including its performance and improvement roadmap, global technology scaling, new plant start-ups, and strategic initiatives. Mr. Verma joined First Solar in 2002, serving in progressively more senior roles in engineering and manufacturing, including Vice President, Global Manufacturing Engineering since 2012. Prior to joining First Solar, Mr. Verma held several engineering and operations positions at Reliance Industries Limited, India. He is a Master Black Belt in Six Sigma/Lean Manufacturing with an expert certification in Taguchi Methods (Robust Engineering) and a Certification in Production and Inventory Management from American Production and Inventory Control Society. He earned a Bachelor of Science in mechanical engineering from the National Institute of Technology in India, a Master of Science in industrial engineering from the University of Toledo, and a Master of Business Administration from Bowling Green State University.16Table of ContentsPatrick Buehler was appointed Chief Product Officer in December 2022, having previously served as Chief Quality and Reliability Officer. Mr. Buehler has over 20 years of operational and technical experience. In his role, Mr. Buehler is responsible for all aspects of product lifecycle management, including understanding market demands, technology trends, and competition to facilitate implementation of new or enhanced products. Mr. Buehler maintains global leadership responsibility for quality and reliability, environmental, health, safety, and security, recycling technology process development and operations, customer service, program management, and strategic initiatives. Mr. Buehler joined First Solar in 2006, serving in progressively more senior technical and operations roles, including Vice President, Quality and Reliability since 2019. Prior to joining First Solar, Mr. Buehler held several roles in manufacturing, engineering, maintenance, and product development at DuPont de Nemours, Inc. and Cummins, Inc. He earned a Bachelor of Science in mechanical engineering from the University of Cincinnati and a Master of Science in mechanical engineering from Purdue University.Markus Gloeckler was appointed Chief Technology Officer in November 2020 after being appointed Co-Chief Technology Officer in July 2020. He is focused on driving First Solar’s thin film PV module technology. Mr. Gloeckler has extensive experience guiding strategic research and development activities and served First Solar as Vice President and Chief Scientist before being promoted to Senior Vice President, Module Research and Development. He was instrumental in enabling First Solar’s achievement of various world records relating to conversion efficiency for CdTe solar cells. In his role as Vice President of Research, he led the thin film technology transfer from General Electric to First Solar following the intellectual property acquisition in 2013. He joined First Solar in 2005 in an engineering function supporting First Solar’s technology development after the initial launch of the Series 2 module. Mr. Gloeckler holds an undergraduate degree in microsystems engineering from the Regensburg University of Applied Sciences in Germany, and a Doctor of Philosophy in physics from Colorado State University.Caroline Stockdale joined First Solar in October 2019 as Executive Vice President, Human Resources and Communications and was appointed Chief People and Communications Officer in October 2020. Prior to joining First Solar, she served as the Chief Executive Officer for First Perform, a provider of human resources services for a variety of customers, from Fortune 100 companies to cyber start-ups. Previously, she served as Chief Human Resources Officer for Medtronic from 2010 to 2013 and Warner Music Group from 2005 to 2009. Before joining Warner Music Group, she served as the senior human resources leader in global divisions of American Express from 2002 to 2005 and General Electric from 1997 to 2002. Ms. Stockdale is a member of the Forbes Human Resources Council. Ms. Stockdale holds a Bachelor of Arts in political theories and institutions, and philosophy, from the University of Sheffield, England.Jason Dymbort joined First Solar in March 2008, serving in a broad range of legal roles before being appointed General Counsel and Secretary in July 2020. Between 2015 and 2018, Mr. Dymbort served as General Counsel and Secretary for the general partner of 8point3 Energy Partners, then a publicly-traded yieldco and affiliate of First Solar. Before joining First Solar, Mr. Dymbort was a corporate attorney at Cravath, Swaine & Moore LLP. He holds a Juris Doctor degree from the University of Pennsylvania Law School, where he was a member of the Penn Law Review, and a bachelor’s degree from Brandeis University.17Table of ContentsItem 1A. Risk FactorsAn investment in our stock involves a high degree of risk. You should carefully consider the following information, together with the other information in this Annual Report on Form 10-K, before buying shares of our stock. If any of the following risks or uncertainties occur, our business, financial condition, and results of operations could be materially and adversely affected and the trading price of our stock could decline.Summary of Risk FactorsThe following is a summary of the principal risks and uncertainties that could materially adversely affect our business, financial condition, and results of operations and make an investment in our stock speculative or risky. You should read this summary together with the more detailed description of each risk factor contained below.Risks Related to Our Markets and Customers•Competition in solar markets globally and across the solar value chain is intense and could remain that way for an extended period of time. The solar industry may experience periods of structural imbalance between global PV module supply and demand that result in periods of pricing volatility. If our competitors reduce module pricing to levels near or below their manufacturing costs, or are able to operate at minimal or negative operating margins for sustained periods of time, or if global demand for PV modules decreases relative to installed production capacity, our business, financial condition, and results of operations could be adversely affected.•The reduction, elimination, or expiration of government subsidies, economic incentives, tax incentives, renewable energy targets, and other support for on-grid solar electricity applications, or other public policies could negatively impact demand and/or price levels for our solar modules. The imposition of tariffs on our products could materially increase our costs to perform under our contracts with customers, which could adversely affect our results of operations.•The loss of any of our large customers, or the inability of our customers and counterparties to perform under their contracts with us, could significantly reduce our net sales and negatively impact our results of operations.Risks Related to Our Operations, Manufacturing, and Technology•We face intense competition from manufacturers of crystalline silicon solar modules; if global supply exceeds global demand, it could lead to a further reduction in the average selling price for PV solar modules, which could reduce our net sales and adversely affect our results of operations.•Problems with product quality or performance may cause us to incur significant and/or unexpected contractual damages and/or warranty and related expenses, damage our market reputation, and prevent us from maintaining or increasing our market share.•Our failure to further refine our technology and develop and introduce improved PV products, including as a result of delays in implementing planned advancements, could render our solar modules uncompetitive and reduce our net sales, profitability, and/or market share.•Several of our key raw materials and components, in particular CdTe and substrate glass, and manufacturing equipment are either single-sourced or sourced from a limited number of suppliers, and their failure to perform could cause manufacturing delays, especially as we expand or seek to expand our business, and/or impair our ability to deliver solar modules to customers in the required quality and quantities and at a price that is profitable to us.18Table of Contents•Our failure to effectively manage module manufacturing production and selling costs, including costs related to raw materials and logistics services, could render our solar modules uncompetitive and reduce our net sales, profitability, and/or market share.•Our future success depends on our ability to effectively balance manufacturing production with market demand, effectively manage our cost per watt, and, when necessary, continue to build new manufacturing plants over time in response to market demand, all of which are subject to risks and uncertainties.•We may be unable to generate sufficient cash flows or have access to the sources of external financing necessary to fund planned capital investments in manufacturing capacity and product development.Risks Related to Regulations•We expect certain financial benefits as a result of tax incentives provided by the Inflation Reduction Act of 2022. If these expected financial benefits vary significantly from our assumptions, our business, financial condition, and results of operations could be adversely affected.•Existing regulations and policies, changes thereto, and new regulations and policies may present technical, regulatory, and economic barriers to the purchase and use of PV solar products, which may significantly reduce demand for our modules.Risks Related to Our Markets and CustomersCompetition in solar markets globally and across the solar value chain is intense and could remain that way for an extended period of time. The solar industry may experience periods of structural imbalance between global PV module supply and demand that result in periods of pricing volatility, which could have a material adverse effect on our business, financial condition, and results of operations.In the aggregate, we believe manufacturers of solar cells and modules have significant installed production capacity, relative to global demand, and the ability for additional capacity expansion. For example, we estimate that in 2022 approximately 160 GWDC of capacity was added by solar module manufacturers, primarily in China. We believe the solar industry may from time to time experience periods of structural imbalance between supply and demand, and that excess capacity will continue to put pressure on pricing. Although module average selling prices in many global markets have declined for several years, recent module spot pricing has increased, in part, due to trade measures and policies, government regulations, raw material availability, and supply chain disruptions. There may be additional pressure on global demand and average selling prices in the future resulting from fluctuating demand in certain major solar markets, such as China. If our competitors reduce module pricing to levels near or below their manufacturing costs, or are able to operate at minimal or negative operating margins for sustained periods of time, or if global demand for PV modules decreases relative to installed production capacity, our business, financial condition, and results of operations could be adversely affected.The reduction, elimination, or expiration of government subsidies, economic incentives, tax incentives, renewable energy targets, and other support for on-grid solar electricity applications, or the impact of other public policies, such as tariffs or other trade remedies imposed on solar cells and modules, could negatively impact demand and/or price levels for our solar modules and limit our growth or lead to a reduction in our net sales or increase our costs, thereby adversely impacting our operating results.Although we believe that solar energy will experience widespread adoption in those applications where it competes economically with traditional forms of energy without any support programs, in certain markets our net sales and profits remain subject to variability based on the availability and size of government subsidies and economic incentives. Federal, state, and local governmental bodies in many countries have provided subsidies in the form of feed-in-tariff structures, rebates, tax incentives, and other incentives to end users, distributors, system integrators, 19Table of Contentsand manufacturers of PV solar products. Many of these support programs expire, phase down over time, require renewal by the applicable authority, or may be amended. A summary of certain recent developments in the major government support programs that may impact our business appears under Item 1. “Business – Support Programs.” To the extent these support programs are reduced earlier than previously expected, are changed retroactively, or are not renewed, such changes could negatively impact demand and/or price levels for our solar modules, lead to a reduction in our net sales, and adversely impact our operating results.Current regulatory policies, or any future changes or threatened changes to such policies, may subject us to significant risks, including the following:•a reduction or removal of clean energy programs and initiatives and the incentives they provide may diminish the market for future solar energy off-take agreements, slow the retirement of aging fossil fuel plants, including the retirements of coal generation plants, and reduce the ability for solar project developers to compete for off-take agreements, which may reduce PV solar module sales;•any limitations on the value or availability to manufacturers or potential investors of tax incentives that benefit solar energy production, sales, or projects, such as the Section 45X advanced manufacturing production credit, ITC, and PTC, could result in reducing such manufacturers’ or investors’ economic returns and could cause a reduction in the availability of financing, thereby reducing demand for PV solar modules;•any incentives contingent upon domestic production of modules, such as tax incentives set forth under the IRA, could limit our ability to sell modules manufactured in certain foreign jurisdictions, which may adversely impact our module average selling prices and could require us to record significant charges to earnings should we determine that the manufacturing equipment in such foreign jurisdictions is impaired; and•any effort to overturn federal and state laws, regulations, or policies that are supportive of solar energy generation or that remove costs or other limitations on other types of electricity generation that compete with solar energy projects could negatively impact our ability to compete with traditional forms of electricity generation and materially and adversely affect our business.Application of trade laws may also impact, either directly or indirectly, our operating results. In some instances, the application of trade laws is currently beneficial to the Company, and changes in their application could have an adverse impact. Recent developments include the following:•United States — Tariffs on certain imported crystalline silicon PV cells and modules. The United States currently imposes different types of tariffs and/or other trade remedies on certain imported crystalline silicon PV cells and modules from various countries. In February 2022, the U.S. President proclaimed a four-year extension of a global safeguard measure imposed pursuant to Section 201 of the Trade Act of 1974 that provides for tariffs on imported crystalline silicon solar modules and a tariff-rate quota on imported crystalline silicon solar cells. Thin film solar cell products, such as our CdTe technology, are specifically excluded from the tariffs. Moreover, the extension measure does not apply tariffs to imports of bifacial modules. The extension measure’s tariff rate was originally set at 14.75%, with annual reductions of 0.25 percentage points over the remainder of its four-year term. The current rate is 14.5%. The extension measure also provides an annual tariff-rate quota, whereby tariffs apply to imported crystalline silicon solar cells above the first 5.0 GWDC of imports.•United States — Antidumping and countervailing duties on certain imported crystalline silicon PV cells and modules. The United States currently imposes antidumping and countervailing duties on certain imported crystalline silicon PV cells and modules from China and Taiwan. Such antidumping and countervailing duties can change over time pursuant to annual reviews conducted by the U.S. Department 20Table of Contentsof Commerce (“USDOC”), and a decline in duty rates or USDOC failure to fully enforce U.S. antidumping and countervailing duty laws could have an adverse impact on our operating results. In March 2022, the USDOC initiated inquiries concerning alleged circumvention of antidumping and countervailing duties on Chinese imports by crystalline silicon PV cells and module imports assembled and completed in Cambodia, Malaysia, Thailand, and Vietnam. In June 2022, the U.S. President declared an emergency with respect to threats to electricity generation capacity and authorized the U.S. Secretary of Commerce to consider permitting the importation of crystalline silicon PV products from those four countries free of antidumping and countervailing duties for 24 months, or until the emergency has terminated. The USDOC has issued regulations implementing that moratorium on antidumping and countervailing duties in the event that it finds circumvention with respect to crystalline silicon PV products assembled and completed in those four countries. In December 2022, the USDOC issued affirmative preliminary determinations finding “country-wide” circumvention with respect to those four countries, but it also found that certain companies were not circumventing the antidumping and countervailing duties. The USDOC is scheduled to issue its final circumvention determinations in May 2023, subject to possible extension. We cannot predict what further actions the USDOC will take with respect to these circumvention inquiries. Our operating results could be adversely impacted if the USDOC makes negative circumvention determinations or refrains from imposing antidumping and countervailing duties on imports covered by affirmative circumvention determinations. Conversely, affirmative final circumvention determinations could positively impact our operating results.•United States — Tariffs on certain Chinese imports. The United States currently imposes tariffs on various articles imported from China at a rate of 25%, including crystalline silicon solar cells and modules, based on an investigation under Section 301 of the Trade Act of 1974. In May 2022, the Office of the United States Trade Representative initiated a statutory four-year review of those tariff actions, which could result in the termination or modification of the tariffs. The review remains pending, and we cannot predict its outcome. Our operating results could be adversely impacted if the review results in a termination or reduction in tariffs on crystalline silicon solar cells and modules from China.•United States — Tariffs on certain foreign-imported aluminum and steel. The United States currently imposes tariffs on certain imported aluminum and steel articles from certain foreign jurisdictions, generally at rates of 10% and 25%, respectively, under Section 232 of the Trade Expansion Act of 1962. Such tariffs and policies, or any other U.S. or global trade remedies or other trade barriers, may directly or indirectly affect U.S. or global markets for solar energy and our business, financial condition, and results of operations.•India — Domestic and foreign imports. India maintains an Approved List of Module Manufacturers (“ALMM”), which is set by the MNRE. Only PV modules and module manufacturers listed on the ALMM can be used for certain solar projects in India, including government projects or government-assisted projects. Our ability to sell modules in the Indian market depends on the inclusion of our modules on the ALMM, and we currently expect that we will be included in the ALMM once we begin manufacturing solar panels in India. However, our operating results could be adversely impacted if the ALMM restriction is significantly relaxed to allow modules to be imported from countries that are part of the Association of Southeast Asian Nations.•European Union — Foreign subsidies. In January 2023, the EU adopted the Foreign Subsidies Regulation (“FSR”), which was established to provide the European Commission with authority to investigate financial contributions granted by foreign governments to businesses operating within the EU. Because the FSR is not effective until July 2023 and the European Commission has not yet issued any application guidance, it is not currently clear whether, and to what extent, the FSR could impact our business, financial condition, or results of operations.These examples show that established markets for PV solar development face uncertainties arising from policy, regulatory, and governmental actions. While the expected potential of the markets we are targeting is significant, 21Table of Contentspolicy promulgation and market development are especially vulnerable to governmental inertia, political instability, the imposition or lowering of trade remedies and other trade barriers, geopolitical risk, fossil fuel subsidization, potentially stringent localization requirements, and limited available infrastructure.The loss of any of our large customers, or the inability of our customers and counterparties to perform under their contracts with us, could significantly reduce our net sales and negatively impact our results of operations.Our customers include developers and operators of systems, utilities, independent power producers, commercial and industrial companies, and other system owners, who may experience intense competition at the system level, thereby constraining the ability for such customers to sustain meaningful and consistent profitability. The loss of any of our large customers, their inability to perform under their contracts, or their default in payment could significantly reduce our net sales and/or adversely impact our operating results. While our contracts with customers typically have certain firm purchase commitments and may include provisions for the payment of amounts to us in certain events of contract termination, these contracts may be subject to amendments made by us or requested by our customers. These amendments may reduce the volume of modules to be sold under the contract, adjust delivery schedules, or otherwise decrease the expected revenue under these contracts. Although we believe that we can mitigate this risk, in part, by reallocating modules to other customers if the need arises, we may be unable, in whole or in part, to do so on similar terms or at all. We may also mitigate this risk by requiring some form of payment security from our customers, such as cash deposits, parent guarantees, bank guarantees, surety bonds, or commercial letters of credit. However, in the event the providers of such payment security fail to perform their obligations, our operating results could be adversely impacted.An increase in interest rates or tightening of the supply of capital in the global financial markets (including a reduction in total tax equity availability) could make it difficult for customers to finance the cost of a PV solar power system and could reduce the demand for our modules and/or lead to a reduction in the average selling price for our modules.Many of our customers depend on debt and/or equity financing to fund the initial capital expenditure required to develop, build, and/or purchase a PV solar power system. As a result, an increase in interest rates, or a reduction in the supply of project debt financing or tax equity investments, could reduce the number of solar projects that receive financing or otherwise make it difficult for our customers to secure the financing necessary to develop, build, purchase, or install a PV solar power system on favorable terms, or at all, and thus lower demand for our solar modules, which could limit our growth or reduce our net sales. For additional information, see the Risk Factor entitled, “The reduction, elimination, or expiration of government subsidies, economic incentives, tax incentives, renewable energy targets, and other support for on-grid solar electricity applications, or the impact of other public policies, such as tariffs or other trade remedies imposed on solar cells and modules, could negatively impact demand and/or price levels for our solar modules and limit our growth or lead to a reduction in our net sales or increase our costs, thereby adversely impacting our operating results.” In addition, we believe that a significant percentage of our customers install systems as an investment, funding the initial capital expenditure through a combination of equity and debt. An increase in interest rates could lower an investor’s return on investment in a system, increase equity return requirements, or make alternative investments more attractive relative to PV solar power systems and, in each case, could cause these customers to seek alternative investments.22Table of ContentsWe may be unable to fully execute on our long-term strategic plans, which could have a material adverse effect on our business, financial condition, or results of operations.We face numerous difficulties in executing on our long-term strategic plans, particularly in new foreign jurisdictions, including the following:•difficulty in competing against companies who may have greater financial resources and/or a more effective or established localized business presence and/or an ability to operate with minimal or negative operating margins for sustained periods of time;•difficulty in competing successfully with other technologies, such as hybrid perovskites, tandem solar cells, or other thin films;•difficulty in accurately prioritizing geographic markets that we can most effectively and profitably serve with our solar module offerings, including miscalculations in overestimating or underestimating addressable market demand;•adverse public policies in countries we operate in and/or are pursuing, including local content requirements, the imposition of trade remedies, the removal of trade barriers, or capital investment requirements;•business climates, such as that in China, that may have the effect of putting foreign companies at a disadvantage relative to domestic companies;•unstable or adverse economic, social, and/or operating environments, including social unrest, currency, inflation, and interest rate uncertainties;•the possibility of applying an ineffective commercial approach to targeted markets, including product offerings that may not meet market needs;•difficulty in generating sufficient sales volumes at economically sustainable profitability levels;•difficulty in timely identifying, attracting, training, and retaining qualified sales, technical, and other talent in geographies targeted for expansion;•difficulty in maintaining proper controls and procedures as we expand our business operations in terms of geographical reach, including transitioning certain business functions to low-cost geographies, with any material control failure potentially leading to reputational damage and loss of confidence in our financial reporting;•difficulty in competing successfully for market share in overall solar markets as a result of the success of companies participating in other solar segments in which we do not have significant historical experience, such as residential;•difficulty in establishing and implementing a commercial and operational approach adequate to address the specific needs of the markets we are pursuing;•difficulty in identifying effective local partners and developing any necessary partnerships with local businesses on commercially acceptable terms; and•difficulty in balancing market demand and manufacturing production in an efficient and timely manner, potentially causing our manufacturing capacity to be constrained in some future periods or over-supplied in others.23Table of ContentsRefer also to the Risk Factors entitled, “Our substantial international operations subject us to a number of risks, including unfavorable political, regulatory, labor, and tax conditions in the United States and/or foreign countries,” “The reduction, elimination, or expiration of government subsidies, economic incentives, tax incentives, renewable energy targets, and other support for on-grid solar electricity applications, or the impact of other public policies, such as tariffs or other trade remedies imposed on solar cells and modules, could negatively impact demand and/or price levels for our solar modules and limit our growth or lead to a reduction in our net sales or increase our costs, thereby adversely impacting our operating results,” and “We may be unable to generate sufficient cash flows or have access to the sources of external financing necessary to fund planned capital investments in manufacturing capacity and product development.”Risks Related to Our Operations, Manufacturing, and TechnologyWe face intense competition from manufacturers of crystalline silicon solar modules; if global supply exceeds global demand, it could lead to a further reduction in the average selling price for PV solar modules, which could reduce our net sales and adversely affect our results of operations.The solar and renewable energy industries are highly competitive and are continually evolving as participants strive to distinguish themselves within their markets and compete with the larger electric power industry. Within the global PV solar industry, we face intense competition from crystalline silicon module manufacturers. Existing or future module manufacturers might be acquired by larger companies with significant capital resources, thereby further intensifying competition with us. In addition, the introduction of a low-cost disruptive technology could adversely affect our ability to compete, which could reduce our net sales and adversely affect our results of operations.We expect to compete with future entrants into the PV solar industry and existing market participants that offer new or differentiated technological solutions. For example, while conventional solar modules are monofacial, meaning their ability to produce energy is a function of direct and diffuse irradiance on their front side, most module manufacturers offer bifacial modules that also capture diffuse irradiance on the back side of a module. Such technology can improve the overall energy production of a module relative to nameplate efficiency when applied in certain applications, which could potentially lower the overall LCOE of a system when compared to systems using conventional solar modules, including the modules we currently produce. Additionally, certain module manufacturers have introduced n-type mono-crystalline modules, such as tunnel oxide passivated contact (“TOPCon”) modules, which are expected to provide certain improvements to module efficiency, temperature coefficient, and bifacial performance, and claim to provide certain degradation advantages compared to other mono-crystalline modules. Finally, many of our competitors are promoting modules with larger overall area based on the use of larger silicon wafers. While the transition to such larger wafers would increase nameplate wattage, we believe the associated production cost would not improve significantly.Even if demand for solar modules continues to grow, the rapid manufacturing capacity expansion undertaken by many module manufacturers in China and certain parts of Southeast Asia, particularly manufacturers of crystalline silicon wafers, cells, and modules, has created and may continue to cause periods of structural imbalances between supply and demand. For additional information, see the Risk Factor entitled, “Competition in solar markets globally and across the solar value chain is intense and could remain that way for an extended period of time. The solar industry may experience periods of structural imbalance between global PV module supply and demand that result in periods of pricing volatility, which could have a material adverse effect on our business, financial condition, and results of operations.” In addition, we believe any significant decrease in the cost of silicon feedstock or polysilicon would reduce the manufacturing cost of crystalline silicon modules and lead to further pricing pressure for solar modules and potentially an oversupply of solar modules.Our competitors could decide to reduce their sales prices in response to competition, even below their manufacturing costs, in order to generate sales, and may do so for a sustained period. Certain competitors, including many in China, may have direct or indirect access to sovereign capital or other forms of state support, which could enable such competitors to operate at minimal or negative operating margins for sustained periods of time. As a result, we may 24Table of Contentsbe unable to sell our solar modules at attractive prices, or for a profit, during any period of excess supply of solar modules, which would reduce our net sales and adversely affect our results of operations. Additionally, we may decide to lower our average selling prices to customers in certain markets in response to competition, which could also reduce our net sales and adversely affect our results of operations.Problems with product quality or performance may cause us to incur significant and/or unexpected contractual damages and/or warranty and related expenses, damage our market reputation, and prevent us from maintaining or increasing our market share.We perform a variety of module quality and life tests under different environmental conditions upon which we base our assessments of future module performance over the duration of the warranty. However, if our thin film solar modules perform below expectations, we could experience significant warranty and related expenses, damage to our market reputation, and erosion of our market share. With respect to our modules, we provide a limited warranty covering defects in materials and workmanship under normal use and service conditions for up to 12.5 years. We also typically warrant that modules installed in accordance with agreed-upon specifications will produce at least 98% of their labeled power output rating during the first year, with the warranty coverage reducing by a degradation factor every year thereafter throughout the limited power output warranty period of up to 30 years. Among other things, our solar module warranty also covers the resulting power output loss from cell cracking. As an alternative form of our standard limited module power output warranty, we have also offered an aggregated or system-level limited module performance warranty. This system-level limited module performance warranty is designed for utility-scale systems and provides 25-year system-level energy degradation protection. This warranty represents a practical expedient to address the challenge of identifying, from the potential millions of modules installed in a utility-scale system, individual modules that may be performing below warranty thresholds by focusing on the aggregate energy generated by the system rather than the power output of individual modules. The system-level limited module performance warranty is typically calculated as a percentage of a system’s expected energy production, adjusted for certain actual site conditions, with the warranted level of performance declining each year in a linear fashion, but never falling below 80% during the term of the warranty. As a result of these warranty programs, we bear the risk of product warranty claims long after we have sold our solar modules and recognized net sales.If any of the assumptions used in estimating our module warranties prove incorrect, we could be required to accrue additional expenses, which could adversely impact our financial position, operating results, and cash flows. Although we have taken significant precautions to avoid a manufacturing excursion from occurring, any manufacturing excursions, including any commitments made by us to take remediation actions in respect of affected modules beyond the stated remedies in our warranties, could adversely impact our reputation, financial position, operating results, and cash flows.Although our module performance warranties extend for up to 30 years, our oldest solar modules manufactured during the qualification of our pilot production line have only been in use since 2001. Accordingly, our warranties are based on a variety of quality and life tests that enable predictions of durability and future performance. These predictions, however, could prove to be materially different from the actual performance during the warranty period, causing us to incur substantial expense to repair or replace defective solar modules or provide financial remuneration in the future. For example, our solar modules could suffer various failures, including breakage, delamination, corrosion, or performance degradation in excess of expectations, and our manufacturing operations or supply chain could be subject to materials or process variations that could cause affected modules to fail or underperform compared to our expectations. These risks could be amplified as we implement design and process changes in connection with our efforts to improve our products and accelerate module wattage as part of our long-term strategic plans. In addition, if we increase the number of installations in extreme climates, we may experience increased failure rates due to deployment into such field conditions. Any widespread product failures may damage our market reputation, cause our net sales to decline, require us to repair or replace the defective modules or provide financial remuneration, and result in us taking voluntary remedial measures beyond those required by our standard warranty terms to enhance customer satisfaction, which could have a material adverse effect on our operating results.25Table of ContentsIn resolving claims under both the limited defect and power output warranties, we typically have the option of either repairing or replacing the covered modules or, under the limited power output warranty, providing additional modules to remedy the power shortfall or making certain cash payments; however, historical versions of our module warranty did not provide a refund remedy. Consequently, we may be obligated to repair or replace the covered modules under such historical programs. As our manufacturing process may change from time-to-time in accordance with our technology roadmap, we may elect to stop production of older versions of our modules that would constitute compatible replacement modules. In some jurisdictions, our inability to provide compatible replacement modules could potentially expose us to liabilities beyond the limitations of our module warranties, which could adversely impact our reputation, financial position, operating results, and cash flows.In addition to our limited solar module warranties described above, for PV solar power systems we have constructed for customers in prior periods, we have provided limited warranties for defects in engineering design, installation, and balance of systems (“BoS”) part workmanship for a period of one to two years following the substantial completion of a system or a block within the system. BoS parts represent mounting, electrical, and other parts used in PV solar power systems. In resolving claims under such BoS warranties, we have the option of remedying the defect through repair or replacement. As with our modules, these warranties are based on a variety of quality and life tests that enable predictions of durability and future performance. Any failures in BoS equipment beyond our expectations may also adversely impact our reputation, financial position, operating results, and cash flows.In addition, our contracts with customers may include provisions with particular product specifications, minimum wattage requirements, and specified delivery schedules. These contracts may be terminated, or we may incur significant liquidated damages or other damages, if we fail to perform our contractual obligations. In addition, our costs to perform under these contracts may exceed our estimates, which could adversely impact our profitability. Any failures to comply with our contracts for the sale of our modules could adversely impact our reputation, financial position, operating results, and cash flows.Our failure to further refine our technology and develop and introduce improved PV products, including as a result of delays in implementing planned advancements, could render our solar modules uncompetitive and reduce our net sales, profitability, and/or market share.We need to continue to invest significant financial resources in R&D to continue to improve our module conversion efficiencies and otherwise keep pace with technological advances in the solar industry. However, R&D activities are inherently uncertain, and we could encounter difficulties in commercializing our research results. We seek to continuously improve our products and processes, including, for example, certain planned improvements to our CdTe module technology and manufacturing capabilities, such as the increase to our module form factor (which we refer to as Series 7), and the resulting changes carry potential risks in the form of delays, performance, additional costs, or other unintended contingencies. For example, the successful launch of our Series 7 module technology, which we began producing at our third manufacturing facility in the U.S. and we expect to produce at our first manufacturing facility in India, is sensitive to changes in the final product size and module mounting structure, among others. While we believe that we will be able to manage these uncertainties, we may encounter unanticipated challenges as we implement design and process changes in connection with this new module series.We may expand our portfolio of offerings to include solutions that build upon our core competencies but for which we have not had significant historical experience, including variations in our traditional product offerings or other offerings related to certain markets. There can be no guarantee that our significant R&D expenditures will produce corresponding benefits. Other companies are developing a variety of competing PV technologies, including advanced mono-crystalline silicon cells, advanced p-type crystalline silicon cells, high-efficiency n-type crystalline silicon cells, and new emerging technologies such as hybrid perovskites, tandem solar cells, or other thin films, which could result in solar modules that prove to be more cost-effective or have better performance than our solar modules. If we are unable to achieve the necessary technology improvements to remain competitive, our overall growth and financial performance may be limited relative to our competitors and our operating results could be adversely impacted.26Table of ContentsWe often forward price our products in anticipation of future technology improvements. Furthermore, certain of our contracts with customers may include transaction price adjustments associated with future module technology improvements, including new product designs and enhancements to certain energy related attributes. Accordingly, an inability to further refine our technology and execute our module technology roadmap, or changes to the expected timing such technology improvements are incorporated into our manufacturing process, could adversely affect our operating results.Some of our manufacturing equipment is customized and sole sourced. If our manufacturing equipment fails or if our equipment suppliers fail to perform under their contracts, we could experience production disruptions and be unable to satisfy our contractual requirements.Some of our manufacturing equipment is customized to our production lines based on designs or specifications that we provide to equipment manufacturers, which then undertake a specialized process to manufacture the custom equipment. As a result, the equipment is not readily available from multiple vendors and would be difficult to repair or replace if it were to become delayed, damaged, or stop working. If any piece of equipment fails, production along the entire production line could be interrupted. In addition, the failure of our equipment manufacturers to supply equipment in a timely manner or on commercially reasonable terms could delay our expansion or conversion plans, otherwise disrupt our production schedule, and/or increase our manufacturing costs, all of which would adversely impact our operating results.Several of our key raw materials and components are either single-sourced or sourced from a limited number of suppliers, and their failure to perform could cause manufacturing delays and impair our ability to deliver solar modules to customers in the required quality and quantities and at a price that is profitable to us.Our failure to obtain raw materials and components that meet our quality, quantity, and cost requirements in a timely manner could interrupt or impair our ability to manufacture our solar modules, or increase our manufacturing costs. Several of our key raw materials and components, in particular CdTe and substrate glass, are either single-sourced or sourced from a limited number of suppliers. As a result, the failure of any of our suppliers to perform could disrupt our supply chain and adversely impact our operations. In addition, some of our suppliers are smaller companies that may be unable to supply our increasing demand for raw materials and components as we expand or seek to expand our business. We may be unable to identify new suppliers or qualify their products for use on our production lines in a timely manner and on commercially reasonable terms. A constraint on our production may result in our inability to meet our capacity plans and/or our obligations under our customer contracts, which would have an adverse impact on our business. Additionally, reductions in our production volume may put pressure on suppliers, resulting in increased material and component costs.A disruption in our supply chain for CdTe, other key raw materials, or equipment could interrupt or impair our ability to manufacture solar modules and could adversely impact our profitability and long-term growth prospects.A key raw material used in our module production process is a CdTe compound. Tellurium, one of the main components of CdTe, is mainly produced as a by-product of copper refining, and therefore, its supply is largely dependent upon demand for copper. If our competitors begin to use or increase their demand for tellurium, our requirements for tellurium increase, new applications for tellurium emerge, or adverse trade laws or policies restrict our ability to obtain tellurium from foreign vendors or make doing so cost prohibitive, the supply of tellurium and related CdTe compounds could be reduced and prices could increase.Furthermore, our supply chain could be limited if any of our current or future suppliers fail to perform or are unable to acquire an adequate supply in a timely manner or at commercially reasonable prices. If our current or future suppliers cannot obtain sufficient raw materials or key equipment, they could substantially increase prices or be unable to perform under their contracts. Additionally, we may also be unable to effectively manage fluctuations in the availability and cost of logistics services associated with the procurement of raw materials or equipment used in our manufacturing process. If we are unable to pass such cost increases to our customers, a substantial increase in 27Table of Contentsprices or any limitations or disruptions in our supply chain could adversely impact our profitability and long-term growth objectives.Our failure to effectively manage module manufacturing production and selling costs, including costs related to raw materials and logistics services, could render our solar modules uncompetitive and reduce our net sales, profitability, and/or market share.Certain of our key raw material purchase contracts include variable pricing terms, which are driven by underlying indices for certain commodities, including aluminum, steel, and natural gas, among others. Fluctuations in such underlying commodity indices may increase our raw material costs. Additionally, an increase in price levels generally, such as inflation related to the cost of raw materials, key manufacturing equipment, labor, and logistics services, could adversely impact our profitability. From time to time, we may utilize derivative hedging instruments to mitigate price changes related to our raw materials or key manufacturing equipment. Our profitability could be adversely impacted if we are unable to effectively hedge such prices or pass these cost increases through to our customers. We often forward price our products in anticipation of future cost reductions, and thus, an inability to execute our cost reduction roadmap could adversely affect our operating results.Our future success depends on our ability to effectively balance manufacturing production with market demand, effectively manage our cost per watt, and, when necessary, continue to build new manufacturing plants over time in response to market demand, all of which are subject to risks and uncertainties.Our future success depends on our ability to effectively balance manufacturing production with market demand, effectively manage our cost per watt, and increase our manufacturing capacity in a cost-effective and efficient manner. If we cannot do so, we may incur damages under our contracts with our customers or be unable to decrease our cost per watt, maintain our competitive position, sustain profitability, expand our business, or create long-term shareholder value. Our ability to effectively manage our cost per watt or successfully expand production capacity is subject to significant risks and uncertainties, including the following:•failure to reduce manufacturing material, labor, or overhead costs;•an inability to increase production throughput or the average power output per module, or minimize manufacturing yield losses;•failure to effectively manage the availability and cost of logistics services associated with the procurement of raw materials or equipment used in our manufacturing process and the shipping, handling, storage, and distribution of our modules;•delays and cost overruns as a result of a number of factors, many of which may be beyond our control, such as our inability to secure economical contracts with equipment vendors;•our custom-built equipment taking longer and costing more to manufacture than expected and not operating as designed;•delays or denial of required approvals by relevant government authorities;•an inability to hire qualified staff;•capital expenditures exceeding our initial estimates with respect to expanding and building our manufacturing and R&D facilities;28Table of Contents•difficulty in balancing market demand and manufacturing production in an efficient and timely manner, potentially causing our manufacturing capacity to be constrained in some future periods or over-supplied in others; and•incurring manufacturing asset write-downs, write-offs, and other charges and costs, which may be significant, during those periods in which we idle, slow down, shut down, or otherwise adjust our manufacturing capacity.We may be unable to generate sufficient cash flows or have access to the sources of external financing necessary to fund planned capital investments in manufacturing capacity and product development.Our business and our future plans for expansion are capital-intensive, and we anticipate that our operating and capital expenditure requirements may increase. To develop new products, support future growth, and maintain product quality, we may need to make significant capital investments in manufacturing technology, facilities and capital equipment, and research and development. Consequently, we may seek to raise additional funds through the issuance of equity, equity-related, or debt securities or through obtaining credit from financial institutions to fund, together with our traditional sources of liquidity, the costs of developing and manufacturing our current or future products. We cannot be certain that we will be able to generate sufficient cash flows, or that additional funds will be available to us on favorable terms when required, or at all. If we cannot fund the required investments from our operating cash flows or raise additional funds when we need them, we may be unable to fully execute our business plan and our financial condition, results of operations, and business prospects could be materially and adversely affected.If our estimates regarding the future costs of collecting and recycling CdTe solar modules covered by our solar module collection and recycling program are incorrect, we could be required to accrue additional expenses and face a significant unplanned cash burden.As necessary, we fund any incremental amounts for our estimated collection and recycling obligations on an annual basis based on the estimated costs of collecting and recycling covered modules, estimated rates of return on our restricted marketable securities, and an estimated solar module life of 25 years less amounts already funded in prior years. We estimate the cost of our collection and recycling obligations based on the present value of the expected future cost of collecting and recycling the solar modules, which includes estimates for the cost of packaging materials; the cost of freight from the solar module installation sites to a recycling center; material, labor, and capital costs; by-product credits for certain materials recovered during the recycling process; the estimated useful lives of modules covered by the program; and the number of modules expected to be recycled. We base these estimates on our experience collecting and recycling solar modules and certain assumptions regarding costs at the time the solar modules will be collected and recycled. If our estimates prove incorrect, we could be required to accrue additional expenses and could also face a significant unplanned cash burden at the time we realize our estimates are incorrect or end users return their modules, which could adversely affect our operating results. Participating end users can return their modules covered under the collection and recycling program at any time. As a result, we could be required to collect and recycle covered CdTe solar modules earlier than we expect.Our failure to protect or successfully commercialize our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights or defend against third-party allegations of infringement may be costly.Protection of our proprietary processes, methods, and other technology is critical to our business. Failure to protect and monitor the use of our existing intellectual property rights or to successfully commercialize future intellectual property rights could result in the loss of valuable technologies. We rely primarily on patents, trademarks, trade secrets, copyrights, and contractual restrictions to protect our intellectual property. We regularly file patent applications to protect certain inventions arising from our R&D and are currently pursuing such patent applications in various countries in accordance with our strategy for intellectual property in that jurisdiction. Our existing patents 29Table of Contentsand future patents could be challenged, invalidated, circumvented, or rendered unenforceable. Our pending patent applications may not result in issued patents, or if patents are issued to us, such patents may not be sufficient to provide meaningful protection against competitors or against competitive technologies.We also rely on unpatented proprietary manufacturing expertise, continuing technological innovation, and other trade secrets to develop and maintain our competitive position. Although we generally enter into confidentiality agreements with our associates and third parties to protect our intellectual property, such confidentiality agreements are limited in duration and could be breached and may not provide meaningful protection for our trade secrets or proprietary manufacturing expertise. Adequate remedies may not be available in the event of unauthorized use or disclosure of our trade secrets and manufacturing expertise. In addition, others may obtain knowledge of our trade secrets through independent development or legal means. The failure of our patents or confidentiality agreements to protect our processes, equipment, technology, trade secrets, and proprietary manufacturing expertise, methods, and compounds could have a material adverse effect on our business. In addition, effective patent, trademark, copyright, and trade secret protection may be unavailable or limited in some foreign countries, especially any developing countries into which we may expand our operations. In some countries, we have not applied for patent, trademark, or copyright protection.Third parties may infringe or misappropriate our proprietary technologies or other intellectual property rights, which could have a material adverse effect on our business, financial condition, and operating results. Policing unauthorized use of proprietary technology can be difficult and expensive. Additionally, litigation may be necessary to enforce our intellectual property rights, protect our trade secrets, or determine the validity and scope of the proprietary rights of others. We cannot ensure that the outcome of such potential litigation will be in our favor, and such litigation may be costly and may divert management attention and other resources away from our business. An adverse determination in any such litigation may impair our intellectual property rights and may harm our business, prospects, and reputation. In addition, we have no insurance coverage against such litigation costs and would have to bear all costs arising from such litigation to the extent we are unable to recover them from other parties.If any future production lines are not built in line with committed schedules, it may adversely affect our future growth plans. If any future production lines do not achieve operating metrics similar to our existing production lines, our solar modules could perform below expectations and cause us to lose customers.If we are unable to systematically replicate our production lines over time and achieve operating metrics similar to our existing production lines, our manufacturing capacity could be substantially constrained, our manufacturing costs per watt could increase, our growth could be limited, and we may be in breach of our contracts with customers for failure to deliver modules. Such factors may result in lower net sales, and/or lower net income than we anticipate. Future production lines could produce solar modules that have lower conversion efficiencies, higher failure rates, and/or higher rates of degradation than solar modules from our existing production lines, and we could be unable to determine the cause of the lower operating metrics or develop and implement solutions to improve performance.We are in the process of expanding our manufacturing capacity by approximately 11 GWDC including the construction of our third manufacturing facility in the United States, which commenced commercial production of modules in early 2023; our first manufacturing facility in India, which is expected to commence operations in the second half of 2023; our fourth manufacturing facility in the United States, which is expected to commence operations in late 2024; and the expansion of our manufacturing footprint at our existing facilities in Ohio. If we cannot successfully execute on our current capacity expansion plans, we may incur significant costs in excess of our current plans to invest approximately $2.7 billion in the aggregate for these new facilities. If we are not able to effectively manage current or future expansion activities or realize their anticipated benefits, it may adversely impact our results of operations.30Table of ContentsOur substantial international operations subject us to a number of risks, including unfavorable political, regulatory, labor, and tax conditions in the United States and/or foreign countries.We have significant manufacturing, sales, and marketing operations both within and outside the United States and expect to continue to expand our operations worldwide. Our global business requires us to respond to rapid changes in market conditions worldwide. Our overall success depends, in part, on our ability to succeed in differing legal, regulatory, economic, social, and political conditions. We may not be able to timely develop and implement policies and strategies that will be effective in each location where we do business. Risks inherent to international operations include, but are not limited to, the following:•difficulty in enforcing agreements in foreign legal systems;•varying degrees of protection afforded to foreign investments in the countries in which we operate and irregular interpretations and enforcement of laws and regulations in such jurisdictions;•foreign countries may impose additional income and withholding taxes or otherwise tax our foreign operations, impose tariffs, or adopt other restrictions on foreign trade and investment, including currency exchange controls;•fluctuations in exchange rates may affect demand for our products and services and may adversely affect our profitability and cash flows in U.S. dollars to the extent that our net sales or our costs are denominated in a foreign currency and the cost associated with hedging the U.S. dollar equivalent of such exposures is prohibitive; the longer the duration of such foreign currency exposure, the greater the risk;•anti-corruption compliance issues, including the costs related to the mitigation of such risk;•risk of nationalization or other expropriation of private enterprises;•changes in general economic and political conditions in the countries in which we operate, including changes in government incentive provisions;•unexpected adverse changes in U.S. or foreign laws or regulatory requirements, including those with respect to environmental protection, import or export duties, and quotas;•opaque approval processes in which the lack of transparency may cause delays and increase the uncertainty of project approvals;•difficulty in staffing and managing widespread operations;•difficulty in repatriating earnings;•difficulty in negotiating a successful collective bargaining agreement in applicable foreign jurisdictions;•trade barriers such as export requirements, tariffs, taxes, local content requirements, anti-dumping regulations and requirements, and other restrictions and expenses, which could increase the effective price of our solar modules and make us less competitive in some countries or increase the costs to perform under our existing contracts; and•difficulty of, and costs relating to, compliance with the different commercial and legal requirements of the overseas countries in which we offer and sell our solar modules.31Table of ContentsRisks Related to RegulationsWe expect certain financial benefits as a result of tax incentives provided by the Inflation Reduction Act of 2022. If these expected financial benefits vary significantly from our assumptions, our business, financial condition, and results of operations could be adversely affected.In August 2022, the U.S. President signed the IRA into law, which is intended to accelerate the country’s ongoing transition to clean energy. The provisions of the IRA are generally effective for tax years beginning after 2022. We continue to evaluate the extent of benefits available to us, which we expect will favorably impact our results of operations in future periods. For example, we currently expect to qualify for the advanced manufacturing production credit under Section 45X of the IRC, which provides certain specified benefits for solar modules and solar module components manufactured in the United States and sold to third parties. For eligible components, the credit is equal to (i) $12 per square meter for a PV wafer, (ii) 4 cents multiplied by the capacity of a PV cell, and (iii) 7 cents multiplied by the capacity of a PV module. Based on the current form factor of our modules, we expect to qualify for a credit of approximately 17 cents per watt for each module produced in the United States and sold to a third party. Such credit may be refundable or transferable to a third party and is available from 2023 to 2032, subject to phase down beginning in 2030.There are currently several critical and complex aspects of the IRA pending technical guidance and regulations from the Internal Revenue Service (“IRS”) and U.S. Treasury Department, including, but not limited to, the following:•Total credit under Section 45X. The guidance is expected to confirm that a vertically-integrated solar module manufacturer is entitled to the sum of the credit amounts for each eligible component that is integrated into the solar module, including the credit amounts for the PV wafer, cell, and module, provided such components are produced in the United States. This clarification may impact to what extent we qualify for a credit of approximately 17 cents per watt based on the current form factor of our modules.•Standardization of per-watt measurements. The guidance is expected to confirm and/or clarify the method by which wattage is calculated to determine the applicable credit amounts for PV cells and modules. Our current evaluation of the benefits available to us is based on the use of industry-wide standard test conditions to determine the nameplate capacity of PV cells and modules. The guidance is expected to create meaningful consistency for credit calculation by standardizing the process for determining solar module nameplate capacity. These clarifications may impact the extent of the credit available to us for eligible PV cells and modules.•Direct payment and transfer elections. The guidance is expected to clarify whether a taxpayer’s direct payment election with respect to the Section 45X credit applies only to a single 5-year period or whether the taxpayer is entitled to make a second direct payment election for a subsequent 5-year period during the 10-year credit period. This clarification will impact whether we can monetize the credit in the form of cash payments directly from the government throughout the 10-year credit period, or whether we would be required to monetize the credit through a sale to another taxpayer or taxpayers during the subsequent 5-year period. The guidance is also expected to clarify whether the taxpayer is entitled to make the direct payment election on a facility-by-facility basis, especially with respect to new manufacturing facilities that commence production after the taxpayer has made the initial direct payment election. Such clarification may impact the extent to which we will be able to make additional direct payment elections across multiple years for multiple manufacturing facilities. Furthermore, the guidance is expected to address (i) how and when the credit is claimed by the taxpayer, including the type of information necessary to verify the credit amount, (ii) whether the credit must be applied as a reduction to any quarterly estimated tax payments or as an offset to any taxes that are reported on the taxpayer’s income tax return for any taxable year in which a direct payment election is made, and (iii) the degree of review or examination by the IRS or any other agency, including whether such review or examination would be a condition to receiving any direct payment. These clarifications may impact the timing and extent of cash benefits available to us and, if the 32Table of Contentsdirect payment election cannot be made a second time, our ability to transfer the tax credits to another taxpayer or taxpayers, which depends on the future demand for such credits.•Domestic content requirements. The guidance is expected to confirm that domestic content rules are applied separately with respect to steel and iron as compared to manufactured products, which would require that only a certain percentage of the total costs of such manufactured product components are of U.S. origin. These clarifications may impact whether our modules meet domestic content requirements, which is a key value proposition for current and future customers. Alternatively, if the domestic content rules as defined by the final guidance are defined broadly, we may face significant additional competition for module sales within the U.S. If our modules manufactured in the U.S. do not meet the domestic content requirements as defined by the final guidance or if the guidance definition is defined broadly, this may adversely impact demand and/or price levels for our solar modules and future expansion plans within the United States.Any modifications to the law or its effects arising, for example, through (i) technical guidance and regulations from the IRS and U.S. Treasury Department, including the certain aspects disclosed above, (ii) subsequent amendments to or interpretations of the law, and/or (iii) future laws or regulations rendering certain provisions of the IRA less effective or ineffective, in whole or in part, could result in changes to the expected and/or actual benefits in the future, which could have a material adverse effect on demand and/or price levels for our solar modules, our net sales, and future expansion plans within the United States, and/or otherwise adversely impact our business, financial condition, and results of operations.Existing regulations and policies, changes thereto, and new regulations and policies may present technical, regulatory, and economic barriers to the purchase and use of PV solar products, which may significantly reduce demand for our modules.The market for electricity generation products is heavily influenced by federal, state, local, and foreign government regulations and policies concerning the electric utility industry, as well as policies promulgated by electric utilities. These regulations and policies often relate to electricity pricing and interconnection of customer-owned electricity generation. In the United States and certain other countries, these regulations and policies have been modified in the past and may be modified again in the future, which could deter end-user purchases of PV solar products. For example, without a mandated regulatory exception for PV solar power systems, system owners are often charged interconnection or standby fees for putting distributed power generation on the electric utility grid. To the extent these interconnection standby fees are applicable to PV solar power systems, it is likely that they would increase the cost of such systems, which could make the systems less desirable, thereby adversely affecting our business, financial condition, and results of operations. Another example is the effect of governmental land-use planning policies and environmental policies on utility-scale PV solar development. The adoption of restrictive land-use designations or environmental regulations that proscribe or restrict the siting of utility-scale solar facilities could adversely affect the marginal cost of such development.Our modules are often subject to oversight and regulation in accordance with national and local ordinances relating to building codes, safety, environmental protection, and other matters, and tracking the requirements of individual jurisdictions is complex. Any new government regulations or utility policies pertaining to our modules may result in significant additional expenses to us or our customers and, as a result, could cause a significant reduction in demand for our products. In addition, any regulatory compliance failure could result in significant management distraction, unplanned costs, and/or reputational damage.We could be adversely affected by any violations of the FCPA, the U.K. Bribery Act, and other foreign anti-bribery laws.The FCPA generally prohibits companies and their intermediaries from making improper payments to non-U.S. government officials for the purpose of obtaining or retaining business. Other countries in which we operate also have anti-bribery laws, some of which prohibit improper payments to government and non-government persons and 33Table of Contentsentities, and others (e.g., the FCPA and the U.K. Bribery Act) extend their application to activities outside their country of origin. Our policies mandate compliance with all applicable anti-bribery laws. We currently operate in, and may further expand into, key parts of the world that have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices. In addition, due to the level of regulation in our industry, our operations in certain jurisdictions where norms can differ from U.S. standards, including China, India, South America, and the Middle East, require substantial government contact, either directly by us or through intermediaries over whom we have less direct control, such as subcontractors, agents, and partners (such as joint venture partners). Although we have implemented policies, procedures, and, in certain cases, contractual arrangements designed to facilitate compliance with these anti-bribery laws, our officers, directors, associates, subcontractors, agents, and partners may take actions in violation of our policies, procedures, contractual arrangements, and anti-bribery laws. Any such violation, even if prohibited by our policies, could subject us and such persons to criminal and/or civil penalties or other sanctions potentially by government prosecutors from more than one country, which could have a material adverse effect on our business, financial condition, cash flows, and reputation.Environmental obligations and liabilities could have a substantial negative impact on our business, financial condition, and results of operations.Our operations involve the use, handling, generation, processing, storage, transportation, and disposal of hazardous materials and are subject to extensive environmental laws and regulations at the national, state, local, and international levels. These environmental laws and regulations include those governing the discharge of pollutants into the air and water, the use, management, and disposal of hazardous materials and wastes, the cleanup of contaminated sites, and occupational health and safety. As we expand our business into foreign jurisdictions worldwide, our environmental compliance burden may continue to increase both in terms of magnitude and complexity. We have incurred and may continue to incur significant costs in complying with these laws and regulations. In addition, violations of, or liabilities under, environmental laws or permits may result in restrictions being imposed on our operating activities or in our being subject to substantial fines, penalties, criminal proceedings, third-party property damage or personal injury claims, cleanup costs, or other costs. While we believe we are currently in substantial compliance with applicable environmental requirements, future developments such as more aggressive enforcement policies, the implementation of new, more stringent laws and regulations, or the discovery of presently unknown environmental conditions may require expenditures that could have a material adverse effect on our business, financial condition, and results of operations.Our solar modules contain CdTe and other semiconductor materials. Elemental cadmium and certain of its compounds are regulated as hazardous materials due to the adverse health effects that may arise from human exposure. Based on existing research, the risks of exposure to CdTe are not believed to be as serious as those relating to exposure to elemental cadmium due to CdTe’s limited bioavailability. In our manufacturing operations, we maintain engineering controls to minimize our associates’ exposure to cadmium compounds and require our associates who handle cadmium compounds to follow certain safety procedures, including the use of personal protective equipment such as respirators, chemical goggles, and protective clothing. Relevant studies and third-party peer reviews of our technology have concluded that the risk of exposure to cadmium or cadmium compounds from our end-products is negligible. In addition, the risk of exposure is further minimized by the encapsulated nature of these materials in our products, the physical properties of cadmium compounds used in our products, and the recycling or responsible disposal of our modules. While we believe that these factors and procedures are sufficient to protect our associates, end users, and the general public from adverse health effects that may arise from cadmium exposure, we cannot ensure that human or environmental exposure to cadmium or cadmium compounds used in our products will not occur. Any such exposure could result in future third-party claims against us, damage to our reputation, and heightened regulatory scrutiny, which could limit or impair our ability to sell and distribute our products. The occurrence of future events such as these could have a material adverse effect on our business, financial condition, and results of operations.34Table of ContentsThe use of cadmium or cadmium compounds in various products is also coming under increasingly stringent governmental regulation. Future regulation in this area could impact the manufacturing, sale, collection, and recycling of solar modules and could require us to make unforeseen environmental expenditures or limit our ability to sell and distribute our products. Examples of such regulations include the following:•European Union Directive 2011/65/EU on the Restriction of the Use of Hazardous Substances (“RoHS”) in electrical and electronic equipment (the “RoHS Directive”) restricts the use of certain hazardous substances, including cadmium and its compounds, in all electronic equipment sold into the European market, unless excluded from the law. Currently, PV solar modules are explicitly excluded from the scope of RoHS (Article 2), as adopted in June 2011. Other jurisdictions have adopted similar legislation or are considering doing so. The next revision of the RoHS Directive is expected in 2025. If PV modules were to be included in the scope of future RoHS revisions without an exemption, we would be required to redesign our solar modules to reduce cadmium and other affected hazardous substances to the maximum allowable concentration thresholds in the RoHS Directive in order to continue to offer them for sale within the EU. As such actions would be impractical, this type of regulatory development would effectively close the EU market to us, which could have a material adverse effect on our business, financial condition, and results of operations.•In November 2022, the government of India, through its Ministry of Environment, Forest and Climate Change and MNRE, introduced legislation intended to expand the scope of existing electronic waste (“e-waste”) regulations, including PV solar modules. This regulation, as subsequently amended in January 2023, will also create extended producer obligations for mandatory recycling of PV solar waste at the end of its useful life. These regulations are expected to come into effect on April 1, 2023. At this time, the recycling targets, monitoring mechanism, and determination of who finances the recycling costs are unclear, and, depending on the final procedures and rules, such regulations could negatively impact our financial condition and results of operations in India.General Risk FactorsCyber-attacks or other breaches of our information systems, or those of third parties with which we do business, could have a material adverse effect on our business, financial condition, and results of operations.Our operations rely on our computer systems, hardware, software, and networks, as well as those of third parties with which we do business, to securely process, store, and transmit proprietary, confidential, and other information, including intellectual property and personally identifiable information. We also rely heavily on these information systems to operate our manufacturing lines. These information systems may be compromised by cyber-attacks, computer viruses, and other events that could be materially disruptive to our business operations and could put the security of our information, and that of the third parties with which we do business, at risk of misappropriation or destruction. In recent years, such cyber incidents have become increasingly frequent and sophisticated, targeting or otherwise affecting a wide range of companies. While we have instituted security measures and procured insurance to mitigate the likelihood and impact of a cyber incident, there is no assurance that these measures, or those of the third parties with which we do business, will be adequate in the future. If these measures fail, valuable information may be lost; our operations may be disrupted; we may be unable to fulfill our customer obligations; and our reputation may suffer. Additionally, any cyber incident affecting our automated manufacturing lines could adversely affect our ability to produce solar modules or otherwise affect the quality and performance of the modules produced. We may also be subject to litigation, regulatory action, remedial expenses, and financial losses beyond the scope or limits of our insurance coverage. These consequences of a failure of security measures could, individually or in the aggregate, have a material adverse effect on our business, financial condition, and results of operations.35Table of ContentsThe severity and duration of public health threats (including pandemics such as COVID-19 or similarly infectious diseases) could materially impact our business, financial condition, and results of operations.The COVID-19 pandemic continues to impact various countries throughout the world, including those in which we do business or have operations, though the scope and severity of COVID-19 continues to evolve. With the exception of certain manufacturing charges incurred in 2020 and 2021, the COVID-19 pandemic and its effects on the economy did not materially impact our business, financial condition, and/or results of operations. However, the extent to which public health threats (including pandemics such as COVID-19 or similarly infectious diseases) could impact us in the future is highly uncertain and cannot be predicted, and will depend largely on subsequent developments, including but not limited to (i) the severity and duration of any public health threat, (ii) measures taken to contain the spread of any public health threat, such as restrictions on travel and gatherings of people and temporary closures of or limitations on businesses and other commercial activities, (iii) the timing and nature of policies implemented by governmental authorities, and (iv) any future variants of any public health threat, which may surge over time.As a result of any public health threat and any related containment measures and reopening policies, we may be subject to significant risks, which have the potential to materially and adversely impact our business, financial condition, and results of operations, including the following:•we may at any time be ordered by governmental authorities, or we may determine, based on our understanding of the recommendations or orders of governmental authorities, that we have to curtail or cease business operations or activities, including manufacturing and R&D activities; and•the failure of our suppliers or vendors to supply materials or equipment, or the failure of our vendors to install, repair, or replace our specialized equipment, due to any public health threat and related containment measures, may idle, slowdown, shutdown, or otherwise cause us to adjust our manufacturing capacity, and the availability and cost of logistics services associated with the procurement of raw materials or equipment used in our manufacturing process and the shipping, handling, storage, and distribution of our modules may require us to adjust our module manufacturing plans or module delivery commitments, which may result in additional unplanned charges.If we are unable to attract, train, retain, and successfully integrate key talent into our management team, our business may be materially and adversely affected.Our future success depends, to a significant extent, on our ability to attract, train, and retain management, operations, sales, and technical talent, including associates in foreign jurisdictions. Recruiting and retaining capable individuals, particularly those with expertise in the PV solar industry across a variety of technologies, are vital to our success. We are also dependent on the services of our executive officers and other members of our senior management team. The loss of one or more of these key associates or any other member of our senior management team could have a material adverse effect on our business. Although we have a succession planning process in place, we may not be able to retain or replace these key associates in a timely manner. Several of our current key associates, including our executive officers, are subject to employment conditions or arrangements that contain post-employment non-competition provisions. However, these arrangements permit the associates to terminate their employment with us upon little or no notice. In addition, on January 5, 2023, the U.S. Federal Trade Commission (“FTC”) voted to issue a notice of proposed rulemaking that, if adopted, would ban non-competition provisions. The proposed rule would make it illegal for an employer to enter into, attempt to enter into, or maintain a non-competition provision. It would also require an employer to rescind any existing non-competition provisions. The proposed rule is subject to a public comment period through March 10, 2023, after which the FTC may vote to implement the proposed rule or may update or revise it based on the comments received and the FTC’s further analysis of the issue. Although it is uncertain if the rule will be adopted or what the final language of the rule, if adopted, will be, the implementation of a ban on non-competition provisions could make it more difficult for us to retain qualified associates.36Table of ContentsThere is substantial competition for qualified technical and manufacturing personnel, and while we continue to benchmark our organization against a broad spectrum of businesses in our market space to remain economically competitive, there can be no assurances that we will be able to attract and retain technical personnel. As we continue to expand domestically and internationally, we may encounter regional laws that mandate union representation or associates who desire union representation or a collective bargaining agreement. If we are unable to attract and retain qualified associates, or otherwise experience unexpected labor disruptions within our business, we may be materially and adversely affected.We may be exposed to infringement or misappropriation claims by third parties, which, if determined adversely to us, could cause us to pay significant damage awards or prohibit us from the manufacture and sale of our solar modules or the use of our technology.Our success depends largely on our ability to use and develop our technology and know-how without infringing or misappropriating the intellectual property rights of third parties. The validity and scope of claims relating to PV solar technology patents involve complex scientific, legal, and factual considerations and analysis and, therefore, may be highly uncertain. We may be subject to litigation involving claims of patent infringement or violation of intellectual property rights of third parties. For example, during 2022, we received various indemnification demands from certain customers, for whom we provided EPC services, regarding claims that such customers’ PV tracker systems infringe, in part, on patents owned by Rovshan Sade (“Sade”), the owner of a company called Trabant Solar, Inc. See Note 12. “Commitments and Contingencies – Legal Proceedings” to our consolidated financial statements for more information on our legal proceedings. The defense and prosecution of intellectual property suits, patent opposition proceedings, and related legal and administrative proceedings can be both costly and time consuming and may significantly divert the efforts and resources of our technical and management personnel. An adverse determination in any such litigation or proceedings to which we may become a party could subject us to significant liability to third parties, require us to seek licenses from third parties, which may not be available on reasonable terms, or at all, or pay ongoing royalties, require us to redesign our solar modules, or subject us to injunctions prohibiting the manufacture and sale of our solar modules or the use of our technologies. Protracted litigation could also result in our customers or potential customers deferring or limiting their purchase or use of our solar modules until the resolution of such litigation.Currency translation and transaction risk may negatively affect our results of operations.Although our reporting currency is the U.S. dollar, we conduct certain business and incur costs in the local currency of most countries in which we operate. As a result, we are subject to currency translation and transaction risk. For example, certain of our net sales in 2022 were denominated in foreign currencies, such as Japanese yen and Euro, and we expect to continue to have net sales denominated in foreign currencies in the future, such as Indian rupee. Certain business arrangements outside the United States have involved and may involve significant investments denominated in local currencies. Changes in exchange rates between foreign currencies and the U.S. dollar could affect our results of operations and result in exchange gains or losses. We cannot accurately predict the impact of future exchange rate fluctuations on our results of operations.We could also expand our business into emerging markets, many of which have an uncertain regulatory environment relating to currency policy. Conducting business in such emerging markets could cause our exposure to changes in exchange rates to increase, due to the relatively high volatility associated with emerging market currencies and potentially longer payment terms for our proceeds.Our ability to hedge foreign currency exposure is dependent on our credit profile with the banks that are willing and able to do business with us. Deterioration in our credit position or a significant tightening of the credit market conditions could limit our ability to hedge our foreign currency exposures; and therefore, result in exchange gains or losses.37Table of ContentsUnanticipated changes in our tax provision, the enactment of new tax legislation, or exposure to additional income tax liabilities could affect our profitability.We are subject to income taxes in the various jurisdictions in which we operate. Accordingly, we are subject to a variety of tax laws and interpretations of such laws by local tax authorities. For example, in January 2022, the U.S. government published new regulations in the U.S. Federal Register to address various aspects of foreign tax credit regimes, including, among other things, guidance related to the disallowance of credits or deductions for foreign income taxes. These regulations, which became effective in March 2022, contain certain provisions that are applicable for periods prior to the effective date, and the final effects could result in material income tax expense in future periods. Furthermore, longstanding international tax laws that determine each country’s jurisdictional tax rights in cross-border international trade continue to evolve as a result of the base erosion and profit shifting reporting requirements and the introduction of the global minimum tax recommended by the Organization for Economic Co-operation and Development. Additionally, in August 2022, the U.S. President signed into law the IRA, which revised U.S. tax law by, among other things, including a new corporate alternative minimum tax (the “CAMT”) of 15% on certain large corporations, imposing a 1% excise tax on stock buybacks, and providing various incentives to address climate change, including the introduction of the advanced manufacturing production credit. The provisions of the IRA are generally effective for tax years beginning after 2022. Given the complexities of the IRA, which is pending technical guidance and regulations from the IRS and U.S. Treasury Department, we will continue to monitor these developments and evaluate the potential future impact to our results of operations. For further information, see the Risk Factor entitled, “We expect certain financial benefits as a result of tax incentives provided by the Inflation Reduction Act of 2022. If these expected financial benefits vary significantly from our assumptions, our business, financial condition, and results of operations could be adversely affected.” Changes to these and other tax laws and regulations could have a material adverse impact on our business, financial condition, and results of operations.We are subject to potential tax examinations in various jurisdictions, and taxing authorities may disagree with our interpretations of U.S. and foreign tax laws and may assess additional taxes. We regularly assess the likely outcomes of these examinations in order to determine the appropriateness of our tax provision; however, the outcome of tax examinations cannot be predicted with certainty. Therefore, the amounts ultimately paid upon resolution of such examinations could be materially different from the amounts previously included in our income tax provision, which could have a material adverse impact on our business, financial condition, and results of operations.In addition, our future effective tax rate could be adversely affected by changes to our operating structure, losses of tax holidays, changes in the jurisdictional mix of earnings among countries with tax holidays or differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, and the discovery of new information in the course of our tax return preparation process. Any changes in our effective tax rate may have a material adverse impact on our business, financial conditions, and results of operations.We have been and may be subject to or involved in litigation or threatened litigation, the outcome of which may be difficult to predict, and which may be costly to defend, divert management attention, require us to pay damages, or restrict the operation of our business.From time to time, we have been and may be subject to disputes and litigation, with and without merit, that may be costly and which may divert the attention of our management and our resources in general, whether or not any dispute actually proceeds to litigation. The results of complex legal proceedings are difficult to predict. Moreover, complaints filed against us may not specify the amount of damages that plaintiffs seek, and we therefore may be unable to estimate the possible range of damages that might be incurred should these lawsuits be resolved against us. Even if we are able to estimate losses related to these actions, the ultimate amount of loss may be materially higher than our estimates. Any resolution of litigation, or threatened litigation, could involve the payment of damages or expenses by us, which may be significant or involve an agreement with terms that restrict the operation of our business. Even if any future lawsuits are not resolved against us, the costs of defending such lawsuits may be significant. These costs may exceed the dollar limits of our insurance policies or may not be covered at all by our 38Table of Contentsinsurance policies. Because the price of our common stock has been, and may continue to be, volatile, we can provide no assurance that additional securities or other litigation will not be filed against us in the future. See Note 12. “Commitments and Contingencies – Legal Proceedings” to our consolidated financial statements for more information on our legal proceedings.Changes in, or any failure to comply with, privacy laws, regulations, and standards may adversely affect our business.Personal privacy and data security have become significant issues in the United States, India, Europe, and in many other jurisdictions in which we operate. The regulatory framework for privacy and security issues worldwide is rapidly evolving and is likely to remain uncertain for the foreseeable future. Furthermore, federal, state, or foreign government bodies or agencies have in the past adopted, and may in the future adopt, laws and regulations affecting data privacy, all of which may be subject to invalidation by relevant foreign judicial bodies. Industry organizations also regularly adopt and advocate for new standards in this area.In the United States, these include rules and regulations promulgated or pending under the authority of federal agencies, state attorneys general, legislatures, and consumer protection agencies. Internationally, many jurisdictions in which we operate have established their own data security and privacy legal framework with which we, relevant suppliers, and customers must comply. For example, the General Data Protection Regulation, a broad-based data privacy regime enacted by the European Parliament, which became effective in May 2018, imposed new requirements on how we collect, process, transfer, and store personal data, and also imposed additional obligations, potential penalties, and risk upon our business. Additionally, the California Consumer Privacy Act, which became effective in January 2020, imposed similar data privacy requirements. In many jurisdictions, enforcement actions and consequences for noncompliance are also rising. In addition to government regulation, privacy advocates and industry groups may propose new and different self-regulatory standards that either legally or contractually apply to us. Although we have implemented policies, procedures, and, in certain cases, contractual arrangements designed to facilitate compliance with applicable privacy and data security laws and standards, any inability or perceived inability to adequately address privacy and security concerns, even if unfounded, or comply with applicable privacy and data security laws, regulations, and policies, could result in additional fines, costs, and liabilities to us, damage our reputation, inhibit sales, and adversely affect our business.Our Amended and Restated Bylaws designate a state or federal court located within the State of Delaware as the exclusive forum for substantially all disputes between us and our stockholders, and the federal district courts of the United States as the exclusive forum for the resolution of any complaint asserting a cause of action under the Securities Act of 1933, which could limit our stockholders’ ability to choose the judicial forum for disputes with us or our directors, officers, employees, agents or stockholders.Our Amended and Restated Bylaws (“Bylaws”) provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware (or, if the Court of Chancery of the State of Delaware lacks subject matter jurisdiction, the federal district court for the District of Delaware) is the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action or proceeding asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, other employees, agents or stockholders to us or our stockholders, (iii) any action or proceeding against us or any of our directors, officers, other employees, agents or stockholders arising pursuant to any provision of the Delaware General Corporation Law (“DGCL”), our Amended and Restated Certificate of Incorporation or our Bylaws, (iv) any action or proceeding against us or any of our directors, officers or other employees asserting a claim that is governed by the internal affairs doctrine, or (v) any action or proceeding asserting an “internal corporate claim,” as defined in the DGCL. Our Bylaws also provide that, unless we consent in writing to the selection of an alternative forum, the federal district courts of the United States are the exclusive forum for resolving any complaint asserting a cause of action under the Securities Act. Nothing in our Bylaws precludes stockholders that assert claims under the Exchange Act from bringing such claims in any court, subject to applicable law.39Table of ContentsAny person or entity holding, owning or otherwise acquiring any interest in any of our securities shall be deemed to have notice of and consented to these provisions. These exclusive forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum of its choosing for disputes with us or our directors, officers, other employees, agents or stockholders, which may discourage lawsuits against us and our directors, officers, other employees, agents or stockholders. The enforceability of similar choice of forum provisions in other companies’ governing documents has been challenged in legal proceedings, and it is possible that a court could find these types of provisions to be inapplicable or unenforceable. For example, in December 2018, the Court of Chancery of the State of Delaware determined that a provision stating that federal district courts of the United States are the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act is not enforceable. Although this decision was reversed by the Delaware Supreme Court in March 2020, courts in other states may still find these provisions to be inapplicable or unenforceable. If a court were to find the exclusive forum provisions in our Bylaws to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving the dispute in other jurisdictions, which could adversely affect our results of operations.Item 1B. Unresolved Staff CommentsNone.Item 2. PropertiesAs of December 31, 2022, our principal properties consisted of the following:NaturePrimary Segment(s) Using PropertyLocationHeldCorporate headquartersModules & OtherTempe, Arizona, United StatesLeaseManufacturing plants, R&D facilities, and administrative officesModulesPerrysburg and Lake Township, Ohio, United StatesOwnR&D facilityModulesSanta Clara, California, United StatesLeaseManufacturing plant and administrative officesModulesKulim, Kedah, MalaysiaLease land, own buildingsAdministrative officesModules & OtherGeorgetown, Penang, MalaysiaLeaseManufacturing plant ModulesHo Chi Minh City, VietnamLease land, own buildingsManufacturing plant (1)ModulesTamil Nadu, IndiaLease land, own buildingsManufacturing plant (2)ModulesFrankfurt/Oder, GermanyOwnManufacturing plant (3)ModulesTrinity, Alabama, United StatesOwn——————————(1)Manufacturing plant currently under construction; operations are expected to commence in the second half of 2023.(2)In December 2012, we ceased manufacturing at our German plant. Since its closure, we have, from time to time, marketed such property for sale.(3)Manufacturing plant currently under construction; operations are expected to commence in late 2024.Item 3. Legal ProceedingsSee Note 12. “Commitments and Contingencies – Legal Proceedings” to our consolidated financial statements for information regarding legal proceedings and related matters.Item 4. Mine Safety DisclosuresNone.40Table of ContentsPART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity SecuritiesMarket InformationOur common stock is listed on The Nasdaq Stock Market LLC under the symbol FSLR.HoldersAs of February 24, 2023, there were 44 record holders of our common stock, which does not reflect beneficial owners of our shares.Dividend PolicyWe have never paid and do not expect to pay dividends on our common stock for the foreseeable future. The declaration and payment of dividends is subject to the discretion of our board of directors and depends on various factors, including our net income, financial condition, cash requirements, future prospects, and other factors considered relevant by our board of directors. We expect to prioritize our working capital requirements, capacity expansion and other capital expenditure needs, R&D and technology investments, and merger and acquisition opportunities prior to returning capital to our shareholders.Stock Price Performance GraphThe following graph compares the five-year cumulative total return on our common stock relative to the cumulative total returns of the S&P 500 Index and the Invesco Solar ETF, which represents a peer group of solar companies. For purposes of the graph, an investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock, the S&P 500 Index, and the Invesco Solar ETF on December 31, 2017, and its relative performance is tracked through December 31, 2022. This graph is not “soliciting material,” is not deemed filed with the SEC, and is not to be incorporated by reference in any filing by us under the Securities Act or the Exchange Act, whether made before or after the date hereof, and irrespective of any general incorporation language in any such filing. The stock price performance shown in the graph represents past performance and is not necessarily indicative of future stock price performance.41Table of ContentsRecent Sales of Unregistered SecuritiesNone.Purchases of Equity Securities by the Issuer and Affiliate PurchasesNone.Item 6. ReservedNone.Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes thereto included in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions as described under the “Note Regarding Forward-Looking Statements” that appears earlier in this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under Item 1A. “Risk Factors,” and elsewhere in this Annual Report on Form 10-K. This discussion and analysis does not address certain items in respect of the year ended December 31, 2020. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2021 for comparative discussions of our results of operations and liquidity and capital resources for the years ended December 31, 2021 and 2020.Executive OverviewWe are a leading American solar technology company and global provider of PV solar energy solutions. Developed at our R&D labs in California and Ohio, we manufacture and sell PV solar modules with an advanced thin film semiconductor technology that provide a high-performance, lower-carbon alternative to conventional crystalline silicon PV solar modules. From raw material sourcing through end-of-life module recycling, we are committed to reducing the environmental impacts and enhancing the social and economic benefits of our products across their life cycle. We are the world’s largest thin film PV solar module manufacturer and the largest PV solar module manufacturer in the Western Hemisphere.Certain of our financial results and other key operational developments for the year ended December 31, 2022 include the following:•Net sales for 2022 decreased by 10% to $2.6 billion compared to $2.9 billion in 2021. The decrease in net sales was primarily attributable to sales of certain projects in the United States and Japan in the prior period, the prior period settlement of an outstanding indemnification arrangement associated with the sale of one of our projects, and a decrease in the average selling price per watt, partially offset by an increase in the volume of modules sold to third parties.•Gross profit decreased 22.3 percentage points to 2.7% in 2022 from 25.0% in 2021 primarily due to a decrease in the average selling price per watt of our modules, the volume of higher gross profit projects sold during the prior period, an increase in sales freight, demurrage, and detention charges, an impairment loss for our Luz del Norte PV solar power plant, and the prior period settlement of the indemnification matter mentioned above. These decreases to gross profit were partially offset by the higher volume of modules sold and continued module cost reductions.42Table of Contents•As of December 31, 2022, we had approximately 9.8 GWDC of total installed nameplate module production capacity across all our facilities. We produced 9.1 GWDC of solar modules during 2022, which represented a 15% increase in module production from 2021. The increase in production was primarily driven by higher throughput at our manufacturing facilities. We expect to produce between 11.5 GWDC and 12.2 GWDC of solar modules during 2023.•During 2022, we announced plans to expand our manufacturing capacity by an additional 4.4 GWDC by constructing our fourth manufacturing facility in the United States and increasing our manufacturing footprint at our existing facilities in Ohio. Such expansion plans, in combination with our previously announced expansion plans, are expected to increase our manufacturing capacity by approximately 11 GWDC by 2025.•In May 2022, we entered into various agreements with certain subsidiaries of PAG Real Assets (“PAG”), a private investment firm, for the sale of our Japan project development business. In June 2022, we completed the sale and, following certain customary post-closing adjustments, received total consideration of ¥66.4 billion ($490.8 million) and transferred cash and restricted cash of ¥8.4 billion ($61.9 million) to PAG. As a result of this transaction, we recognized a gain of $245.2 million, net of transaction costs, which was included in “Gain on sales of businesses, net” in our consolidated statements of operations for the year ended December 31, 2022. In September 2022, we also completed the sale of our Japanese O&M operations to a subsidiary of PAG and, following certain customary post-closing adjustments, received total consideration of ¥692.7 million ($4.8 million). As a result of this transaction, we recognized a gain of $1.4 million, net of transaction costs and post-closing adjustments, which was included in “Gain on sales of businesses, net” in our consolidated statements of operations for the year ended December 31, 2022.Market OverviewSolar energy is one of the fastest growing forms of renewable energy with numerous economic and environmental benefits that make it an attractive complement to and/or substitute for traditional forms of energy generation. In recent years, the cost of producing electricity from PV solar power systems has decreased to levels that are competitive with or below the wholesale price of electricity in many markets. This price decline has opened new possibilities to develop systems in many locations with limited or no financial incentives, thereby promoting the widespread adoption of solar energy. Additionally, recently enacted government support programs, such as the IRA discussed above, have contributed to this momentum by providing solar module manufacturers, project developers, and project owners with various incentives to accelerate the ongoing transition to clean energy. For more information about these support programs, see Item 1. “Business - Support Programs.”Supply and demand. As a result of the market opportunities described above, we are in the process of expanding our manufacturing capacity by approximately 11 GWDC, including the construction of our third manufacturing facility in the United States, which commenced commercial production of modules in early 2023; our first manufacturing facility in India, which is expected to commence operations in the second half of 2023; our fourth manufacturing facility in the United States, which is expected to commence operations in late 2024; and the expansion of our manufacturing footprint at our existing facilities in Ohio. In the aggregate, we believe manufacturers of solar cells and modules, particularly those in China, have significant installed production capacity, relative to global demand, and the ability for additional capacity expansion. Accordingly, we believe the solar industry may experience periods of structural imbalance between supply and demand, which could lead to periods of pricing volatility. In light of such market realities, we continue to focus on our strategies and points of differentiation, which include our advanced module technology, our manufacturing process, our R&D capabilities, the sustainability advantage of our modules, and our financial stability.43Table of ContentsPricing competition. The solar industry has been characterized by intense pricing competition, both at the module and system levels. This competition may result in an environment in which pricing falls rapidly, thereby potentially increasing demand for solar energy solutions but constraining the ability for project developers and module manufacturers to sustain meaningful and consistent profitability. Our results of operations could be adversely affected if competitors reduce pricing to levels below their costs, bid aggressively low prices for module sale agreements, or are able to operate at minimal or negative operating margins for sustained periods of time. For certain of our competitors, including many in China, these practices may be enabled by their direct or indirect access to sovereign capital or other forms of state support. Although module average selling prices in many global markets have declined for several years, recent module spot pricing has increased, in part, due to trade measures and policies, government regulations, raw material availability, and supply chain disruptions. For example, module spot pricing in the United States has increased, in part, due to elevated commodity and logistics costs and, more recently, due to the rising demand for modules manufactured in the United States as a result of the IRA. The duration of this elevated period of pricing is uncertain.Diverse offerings. We face intense competition from manufacturers of crystalline silicon solar modules and other emerging technologies. Solar module manufacturers compete with one another on sales price per watt, which may be influenced by several module value attributes, including wattage (through a larger form factor or an improved conversion efficiency), energy yield, degradation, sustainability, and reliability. Sales price per watt may also be influenced by warranty terms and customer payment terms. While conventional solar modules are monofacial, meaning their ability to produce energy is a function of direct and diffuse irradiance on their front side, most module manufacturers offer bifacial modules that also capture diffuse irradiance on the back side of a module. We currently produce monofacial solar modules and, based on recent R&D activities, expect to produce bifacial solar modules in the near term. Bifaciality compromises nameplate efficiency, but by converting both front and rear side irradiance, such technology may improve the overall energy production of a module relative to nameplate efficiency when applied in certain applications, which could potentially lower the overall LCOE of a system when compared to systems using conventional solar modules, including the modules we currently produce. Additionally, certain module manufacturers have introduced n-type mono-crystalline modules, such as TOPCon modules, which are expected to provide certain improvements to module efficiency, temperature coefficient, and bifacial performance, and claim to provide certain degradation advantages compared to other mono-crystalline modules.Product efficiencies. We believe we are among the lowest cost module manufacturers in the solar industry on a module cost per watt basis, based on publicly available information. This cost competitiveness allows us to compete favorably in markets where pricing for modules and systems is highly competitive. Our cost competitiveness is based in large part on our advanced thin film semiconductor technology, module wattage (or conversion efficiency), proprietary manufacturing process (which enables us to produce a CdTe module in a matter of hours using a continuous and highly automated industrial manufacturing process, as opposed to a batch process), and our focus on operational excellence. In addition, our CdTe modules use approximately 2% to 3% of the amount of semiconductor material that is used to manufacture conventional crystalline silicon solar modules. The cost of polysilicon is a significant driver of the manufacturing cost of crystalline silicon solar modules, and the timing and rate of change in the cost of silicon feedstock and polysilicon could lead to changes in solar module pricing levels. In recent years, polysilicon consumption per cell has been reduced through various initiatives, which have contributed to declines in our relative manufacturing cost competitiveness over conventional crystalline silicon module manufacturers.Energy performance. In many climates our solar modules provide certain energy production advantages relative to competing crystalline silicon solar modules. As a result, our solar modules can produce more annual energy in real world operating conditions than conventional crystalline silicon modules with the same nameplate capacity. For more information about these advantages, see Item 1. “Business – Business Strategy.” Additionally, we warrant that our solar modules will produce at least 98% of their labeled power output rating during the first year, with the warranty coverage reducing by a degradation factor between 0.3% and 0.5%, depending on the module series, every year thereafter throughout the limited power output warranty period of up to 30 years.44Table of ContentsWhile our modules are generally competitive in cost, reliability, and performance attributes, there can be no guarantee such competitiveness will continue to exist in the future to the same extent or at all. Any declines in the competitiveness of our products could result in further declines in the average selling prices of our modules and additional margin compression. We continue to focus on enhancing the competitiveness of our solar modules through our module technology and cost reduction roadmaps.Certain Trends and UncertaintiesWe believe that our business, financial condition, and results of operations may be favorably or unfavorably impacted by the following trends and uncertainties. See Item 1A. “Risk Factors” and elsewhere in this Annual Report on Form 10-K for discussions of other risks that may affect us.Our business is evolving worldwide and is shaped by the varying ways in which our offerings can be compelling and economically viable solutions to energy needs in various markets. In addressing electricity demands, we are focused on providing utility-scale module offerings in key geographic markets that we believe have a significant need for mass-scale PV solar electricity, including markets throughout the United States, India, and Europe. We closely evaluate and monitor the appropriate level of resources required to support such markets and their associated sales opportunities. When deployed in utility-scale applications, our modules provide energy at a lower LCOE compared to traditional forms of energy generation, making them an attractive alternative to or replacement for aging fossil fuel-based generation resources. Accordingly, future retirements of aging energy generation resources represent a significant increase in the potential market for solar energy.This focus on utility-scale module offerings exists within a current market environment that includes rooftop and distributed generation solar. We believe that utility-scale solar will continue to be a compelling offering for companies with technology and cost leadership and will continue to represent an increasing portion of the overall electricity generation mix. However, our module offerings in certain markets may be driven, in part, by future demand for rooftop and distributed generation solar solutions. For example, we continue to evaluate opportunities to develop and leverage other solar cell technologies in multi-junction applications that utilize our thin film PV technology. We believe such applications have the potential to enable our module conversion efficiency to reach 28% by 2030.Demand for our PV solar module offerings depends, in part, on market factors outside our control. For example, many governments have proposed or enacted policies or support programs intended to encourage renewable energy investments to achieve decarbonization objectives and/or establish greater energy independence. While we compete in markets that do not require solar-specific government subsidies or support programs, our net sales and profits remain subject to variability based on the availability and size of government subsidies and economic incentives. Adverse changes in these factors could increase the cost of utility-scale systems, which could reduce demand for our solar modules. Recent developments to government support programs include the following:•United States. In August 2022, the U.S. President signed the IRA into law, which is intended to accelerate the country’s ongoing transition to clean energy. The provisions of the IRA are generally effective for tax years beginning after 2022. Among other things, the financial incentives provided by the IRA are expected to significantly increase demand for modules manufactured in the United States. Accordingly, the demand for these solar modules is expected to increase domestic manufacturing in the near term, which may result in localized supply chain constraints and periods of inflationary pricing for certain of our key raw materials, including substrate glass and cover glass. The financial incentives provided by the IRA are also expected to significantly increase demand for solar modules in general due to the incremental tax credit available for the qualified production of clean hydrogen that is powered by renewable resources. Given the complexities of the IRA, which is pending technical guidance and regulations from the IRS and U.S. Treasury Department, we continue to evaluate the extent of benefits available to us, which we expect will favorably impact our results of operations in future periods. For example, we currently expect to qualify for the advanced manufacturing production credit under Section 45X of the IRC, which provides certain specified 45Table of Contentsbenefits for solar modules and solar module components manufactured in the United States and sold to third parties. Such credit, which may be refundable to us or transferable to a third party, is available through 2032, subject to phase down beginning in 2030. For more information about certain risks associated with the benefits available to us under the IRA, see Item 1A. “Risk Factors – We expect certain financial benefits as a result of tax incentives provided by the Inflation Reduction Act of 2022. If these expected financial benefits vary significantly from our assumptions, our business, financial condition, and results of operations could be adversely affected.”•India. In September 2022, the government of India approved an expansion to its PLI scheme to INR 195 billion ($2.5 billion), which is intended to promote the manufacturing of high efficiency solar modules in India and to reduce India’s dependency on foreign imports of solar modules. Under the PLI scheme, manufacturers are selected through a competitive bid process and receive certain cash incentives over a five-year period following the commissioning of their manufacturing facilities. Among other things, such incentives are based on the efficiency and temperature coefficient of the modules produced, the proportion of raw materials sourced from the domestic market, the extent to which the manufacturer’s operations are fully integrated within India, and the quantity of modules sold from such manufacturing operations. At this time, it is uncertain whether and to what extent we may qualify for such incentives.Demand for our solar energy solutions also depends on domestic or international trade policies and government regulations, which may be proposed, revised, and/or enacted across short- and long-term time horizons with varying degrees of impact to our net sales, profit, and manufacturing operations. Changes in these policies and regulations could adversely impact the competitive landscape of solar markets, which could reduce demand for our solar modules. Recent revisions or proposed changes to trade policy and government regulations include the following:•United States. In June 2022, the U.S. President authorized the U.S. Secretary of Commerce to provide a 24-month antidumping and countervailing duty tariff exemption for imported solar panels from certain Southeast Asian countries. For more information about this development, see Item 1A. “Risk Factors – The reduction, elimination, or expiration of government subsidies, economic incentives, tax incentives, renewable energy targets, and other support for on-grid solar electricity applications, or the impact of other public policies, such as tariffs or other trade remedies imposed on solar cells and modules, could negatively impact demand and/or price levels for our solar modules and limit our growth or lead to a reduction in our net sales or increase our costs, thereby adversely impacting our operating results.” Separately, the U.S. President also authorized the use of the Defense Production Act to expand domestic production of clean energy technologies. At this time, it is uncertain what impact, if any, these developments will have on future investments in solar module manufacturing in the United States.•United States. In June 2022, the U.S. Supreme Court issued a ruling in West Virginia, et al. v. Environmental Protection Agency, et al., which limited the Environmental Protection Agency’s (“EPA”) ability to regulate greenhouse gas (“GHG”) emissions under the Clean Air Act using a “generation shifting” approach from coal-fired power plants to renewable energy sources over time. At this time, it is unclear what effect this ruling will have on future EPA regulation of GHG emissions, the U.S. President’s climate change initiatives, internationally agreed-upon climate goals, the extent and timing of future coal plant retirements in the United States, and/or future investments in renewable energy.•India. The ALMM was introduced in 2021 as a non-tariff barrier to incentivize domestic manufacturing of PV modules by approving the list of models and manufacturers who can participate in certain solar development projects. The ALMM is approved by the MNRE, and any modifications to the ALMM and its application may affect future investments in solar module manufacturing in India. For more information about the ALMM, see Item 1A. “Risk Factors – The reduction, elimination, or expiration of government subsidies, economic incentives, tax incentives, renewable energy targets, and other support for on-grid solar electricity applications, or the impact of other public policies, such as tariffs or other trade remedies imposed on solar cells and modules, could negatively impact demand and/or price levels for our solar 46Table of Contentsmodules and limit our growth or lead to a reduction in our net sales or increase our costs, thereby adversely impacting our operating results.”Our ability to provide solar modules on economically attractive terms is also affected by the availability and cost of logistics services associated with the procurement of raw materials or equipment used in our manufacturing process and the shipping, handling, storage, and distribution of our modules. For example, although the cost of ocean freight throughout many parts of the world has recently decreased, such costs remain at elevated levels relative to pre-COVID-19 pandemic rates. Such factors may disrupt our supply chain and adversely impact our manufacturing operations as several of our key raw materials and components are either single-sourced or sourced from a limited number of international suppliers. We may also incur additional logistics costs, such as demurrage and detention, to the extent we are unable to retrieve or return our shipping containers in a timely manner. To mitigate such costs and better meet our customer commitments, we may adjust our shipping plans to include additional lead times for module deliveries and/or utilize our network of U.S. distribution centers. We are also employing module contract structures that provide additional consideration to us if the cost of logistics services, excluding demurrage and detention, exceeds a defined threshold. Additionally, our manufacturing capacity expansions in the U.S. and India are expected to bring manufacturing activities closer to customer demand, further mitigating our exposure to the cost of ocean freight. While it is currently unclear how long these issues will persist, they may be further exacerbated by the disruption of major shipping routes or other economic disruptions.We generally price and sell our solar modules on a per watt basis. As of December 31, 2022, we had entered into contracts with customers for the future sale of 61.4 GWDC of solar modules for an aggregate transaction price of $17.7 billion, which we expect to recognize as revenue through 2029 as we transfer control of the modules to the customers. Such volume includes contracts for the sale of 31.5 GWDC of solar modules that include transaction price adjustments associated with future module technology improvements, including new product designs and enhancements to certain energy related attributes. Based on these potential technology improvements, the contracted module volumes as of December 31, 2022, the expected timing such technology improvements are incorporated into our manufacturing process, and the expected timing of module deliveries, such adjustments, if realized, could result in additional revenue of up to $0.5 billion, the majority of which would be recognized in 2025, 2026, and 2027. In addition to these price adjustments, certain of our contracts with customers may include favorable price adjustments associated with the extension of the ITC and/or sales freight in excess of a defined threshold. Certain of our contracts with customers may also include favorable or unfavorable price adjustments associated with changes to certain commodity prices and/or the module wattage committed for delivery. As a result, the revenue recognized from such contracts may increase or decrease in future periods relative to the original transaction price.We continue to increase the nameplate production capacity of our existing manufacturing facilities by improving our production throughput, increasing module wattage (or conversion efficiency), and reducing manufacturing yield losses. Additionally, we are in the process of expanding our manufacturing capacity by approximately 11 GWDC, including the construction of our third manufacturing facility in the United States, which commenced commercial production of modules in early 2023; our first manufacturing facility in India, which is expected to commence operations in the second half of 2023; our fourth manufacturing facility in the United States, which is expected to commence operations in late 2024; and the expansion of our manufacturing footprint at our existing facilities in Ohio. This additional capacity, and any other potential investments to add to or otherwise modify our existing manufacturing capacity in response to market demand and competition, may require significant internal and possibly external sources of capital, and may be subject to certain risks and uncertainties described in Item 1A. “Risk Factors,” including those described under the headings “Our future success depends on our ability to effectively balance manufacturing production with market demand, effectively manage our cost per watt, and, when necessary, continue to build new manufacturing plants over time in response to market demand, all of which are subject to risks and uncertainties” and “If any future production lines are not built in line with committed schedules, it may adversely affect our future growth plans. If any future production lines do not achieve operating metrics similar to our existing production lines, our solar modules could perform below expectations and cause us to lose customers.”47Table of ContentsResults of OperationsThe following table sets forth our consolidated statements of operations as a percentage of net sales for the years ended December 31, 2022, 2021, and 2020: Years Ended December 31,202220212020Net sales100.0 %100.0 %100.0 %Cost of sales97.3 %75.0 %74.9 %Gross profit2.7 %25.0 %25.1 %Selling, general and administrative6.3 %5.8 %8.2 %Research and development4.3 %3.4 %3.5 %Production start-up2.8 %0.7 %1.5 %Litigation loss— %— %0.2 %Gain on sales of businesses, net9.7 %5.0 %— %Operating (loss) income(1.0)%20.1 %11.7 %Foreign currency loss, net(0.6)%(0.3)%(0.2)%Interest income1.3 %0.2 %0.6 %Interest expense, net(0.5)%(0.4)%(0.9)%Other income (expense), net1.2 %— %(0.4)%Income tax (expense) benefit(2.0)%(3.5)%4.0 %Net (loss) income(1.7)%16.0 %14.7 %Segment OverviewOur primary segment is our modules business, which involves the design, manufacture, and sale of CdTe solar modules, which convert sunlight into electricity. Third-party customers of our modules segment include developers and operators of systems, utilities, independent power producers, commercial and industrial companies, and other system owners. Our residual business operations include certain project development activities, O&M services, the results of operations from PV solar power systems we owned and operated in certain international regions, and the sale of such systems to third-party customers.Net salesWe generally price and sell our solar modules on a per watt basis. During 2022, Intersect Power, Lightsource BP, and NextEra Energy each accounted for more than 10% of our modules business net sales, and the majority of our solar modules were sold to developers and operators of systems in the United States. Substantially all of our modules business net sales during 2022 were denominated in U.S. dollars. We recognize revenue for module sales at a point in time following the transfer of control of the modules to the customer, which typically occurs upon shipment or delivery depending on the terms of the underlying contracts. The revenue recognition policies for module sales are further described in Note 2. “Summary of Significant Accounting Policies” to our consolidated financial statements. Net sales from our residual business operations primarily consists of revenue recognized for sales of development projects or completed systems, including any modules installed in such systems and any revenue from energy generated by such systems. In certain prior periods, our residual business operations also included O&M services we provided to third parties.48Table of ContentsThe following table shows net sales by reportable segment for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Modules$2,428,278 $2,331,380 $1,736,060 $96,898 4 %$595,320 34 %Other191,041 591,997 975,272 (400,956)(68)%(383,275)(39)%Net sales$2,619,319 $2,923,377 $2,711,332 $(304,058)(10)%$212,045 8 %Net sales from our modules segment increased by $96.9 million in 2022 primarily due to a 20% increase in the volume of watts sold, partially offset by a 13% decrease in the average selling price per watt. Net sales from our residual business operations decreased by $401.0 million in 2022 primarily due to sales of certain projects in the United States and Japan in the prior period and the settlement of an outstanding indemnification arrangement associated with the sale of one of our projects. Under the terms of the indemnification arrangement, we received $65.1 million for our portion of the settlement payment, which we recorded as revenue in the prior period. These decreases in net sales from our residual business operations were partially offset by the sale of our Luz del Norte PV solar power plant in the current period. See Note 12. “Commitments and Contingencies” to our consolidated financial statements for discussion of our indemnification arrangements.Cost of salesOur modules business cost of sales includes the cost of raw materials and components for manufacturing solar modules, such as glass, transparent conductive coatings, CdTe and other thin film semiconductors, laminate materials, connector assemblies, edge seal materials, and frames. In addition, our cost of sales includes direct labor for the manufacturing of solar modules and manufacturing overhead, such as engineering, equipment maintenance, quality and production control, and information technology. Our cost of sales also includes depreciation of manufacturing plant and equipment, facility-related expenses, environmental health and safety costs, and costs associated with shipping, warranties, and solar module collection and recycling (excluding accretion). Cost of sales for our residual business operations primarily consists of project-related costs, such as development costs (legal, consulting, transmission upgrade, interconnection, permitting, and other similar costs), engineering, procurement, and construction (“EPC”) costs (consisting primarily of solar modules, inverters, electrical and mounting hardware, project management and engineering, and construction labor), and site specific costs.The following table shows cost of sales by reportable segment for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Modules$2,312,881 $1,858,454 $1,306,929 $454,427 24 %$551,525 42 %Other236,580 334,969 723,730 (98,389)(29)%(388,761)(54)%Cost of sales$2,549,461 $2,193,423 $2,030,659 $356,038 16 %$162,764 8 %% of net sales97.3 %75.0 %74.9 % Cost of sales increased $356.0 million, or 16%, and increased 22.3 percentage points as a percent of net sales when comparing 2022 with 2021. The increase in cost of sales was driven by a $454.4 million increase in our modules segment cost of sales primarily as a result of the following:•higher costs of $350.9 million from an increase in the volume of modules sold;•higher sales freight, demurrage, and detention charges of $167.2 million; and•a reduction to our product warranty liability of $33.1 million in 2021 due to reductions to our projected module return rates; partially offset by•continued module cost reductions, which decreased cost of sales by $60.9 million;•manufacturing charges of $15.7 million in the prior period associated with the COVID-19 pandemic;49Table of Contents•an increase to our module collection and recycling liability of $10.8 million in 2021 due to lower estimated by-product credits for certain semiconductor materials recovered during the recycling process and updates to certain valuation assumptions;•a reduction to our product warranty liability of $10.2 million in 2022 due to reductions to our projected module return rates; and•a reduction to our module collection and recycling liability of $7.5 million in 2022 due to lower estimated capital and chemical costs resulting from improvements to our module recycling technology.Such increase in our modules segment cost of sales was partially offset by a $98.4 million decrease in our residual business operations cost of sales primarily due to the sales of certain projects in the United States and Japan in the prior period, partially offset by the impairment loss in the current period for our Luz del Norte PV solar power plant. See Note 7. “Consolidated Balance Sheet Details” to our consolidated financial statements for discussion of the impairment of our Luz del Norte project.Gross profitGross profit may be affected by numerous factors, including the selling prices of our modules and the selling prices of projects and services included in our residual business operations, our manufacturing costs, the capacity utilization of our manufacturing facilities, and foreign exchange rates. Gross profit may also be affected by the mix of net sales from our modules business and residual business operations.The following table shows gross profit for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Gross profit$69,858 $729,954 $680,673 $(660,096)(90)%$49,281 7 %% of net sales2.7 %25.0 %25.1 % Gross profit decreased 22.3 percentage points to 2.7% in 2022 from 25.0% in 2021 primarily due to a decrease in the average selling price per watt of our modules, the volume of higher gross profit projects sold during the prior period, an increase in sales freight, demurrage, and detention charges, the impairment loss in the current period for our Luz del Norte PV solar power plant described above, and the prior period indemnification matter descried above. These decreases to gross profit were partially offset by the higher volume of modules sold and continued module cost reductions.Selling, general and administrativeSelling, general and administrative expense consists primarily of salaries and other personnel-related costs, professional fees, insurance costs, and other business development and selling expenses.The following table shows selling, general and administrative expense for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Selling, general and administrative$164,724 $170,320 $222,918 $(5,596)(3)%$(52,598)(24)%% of net sales6.3 %5.8 %8.2 % 50Table of ContentsSelling, general and administrative expense in 2022 decreased compared to 2021 primarily due to higher charges for impairments of certain project assets in the prior period, a decrease in employee compensation expense primarily driven by reductions in headcount from the sales of our North American O&M operations and U.S. project development business in the prior period, and lower professional fees, partially offset by an increase in employee compensation expense driven by higher share-based compensation and employee bonus expenses.Research and developmentResearch and development expense consists primarily of salaries and other personnel-related costs; the cost of products, materials, and outside services used in our R&D activities; and depreciation and amortization expense associated with R&D specific facilities and equipment. We maintain a number of programs and activities to improve our technology and processes in order to enhance the performance and reduce the costs of our solar modules.The following table shows research and development expense for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Research and development$112,804 $99,115 $93,738 $13,689 14 %$5,377 6 %% of net sales4.3 %3.4 %3.5 % Research and development expense in 2022 increased compared to 2021 primarily due to higher employee compensation expense resulting from an increase in headcount, lower share-based compensation expense in the prior period driven by the forfeiture of unvested shares by our former Chief Technology Officer, who retired in March 2021, increased freight costs, and increased material and module testing costs.Production start-upProduction start-up expense consists of costs associated with operating a production line before it is qualified for commercial production, including the cost of raw materials for solar modules run through the production line during the qualification phase, employee compensation for individuals supporting production start-up activities, and applicable facility related costs. Production start-up expense also includes costs related to the selection of a new site and implementation costs for manufacturing process improvements to the extent we cannot capitalize these expenditures.The following table shows production start-up expense for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Production start-up$73,077 $21,052 $40,528 $52,025 247 %$(19,476)(48)%% of net sales2.8 %0.7 %1.5 % During 2022, we incurred production start-up expense primarily for our third manufacturing facility in the U.S. and for certain manufacturing upgrades at our Malaysian facilities. During 2021, we incurred production start-up expense primarily for the transition to Series 6 module manufacturing at our second facility in Kulim, Malaysia, which commenced commercial production in early 2021, and for certain manufacturing upgrades at our Malaysian facilities.51Table of ContentsGain on sales of businesses, netThe following table shows gain on sales of businesses, net for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Gain on sales of businesses, net$253,511 $147,284 $— $106,227 72 %$147,284 100 %% of net sales9.7 %5.0 %— % In 2022, we completed the sales of our Japan project development business and our Japan O&M operations to PAG and the sales of certain other international O&M operations to a subsidiary of Clairvest Group, Inc. (“Clairvest”). During 2021, we completed the sales of our North American O&M operations to a subsidiary of Clairvest and our U.S. project development business to Leeward Renewable Energy Development, LLC (“Leeward”). See Note 3. “Sales of Businesses” to our consolidated financial statements for further information related to these transactions.Foreign currency loss, netForeign currency loss, net consists of the net effect of gains and losses resulting from holding assets and liabilities and conducting transactions denominated in currencies other than our subsidiaries’ functional currencies.The following table shows foreign currency loss, net for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Foreign currency loss, net$(16,414)$(7,975)$(4,890)$(8,439)106 %$(3,085)63 %Foreign currency loss increased in 2022 compared to 2021 primarily due to the differences between our economic hedge positions and the underlying exposures and higher costs associated with hedging activities related to our subsidiaries in India.Interest incomeInterest income is earned on our cash, cash equivalents, marketable securities, restricted cash, and restricted marketable securities. Interest income also includes interest earned from late customer payments.The following table shows interest income for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Interest income$33,284 $6,179 $16,559 $27,105 439 %$(10,380)(63)%Interest income during 2022 increased compared to 2021 primarily due to higher interest rates on cash, marketable securities, and restricted marketable securities.Interest expense, netInterest expense, net is primarily comprised of interest incurred on long-term debt, settlements of interest rate swap contracts, and changes in the fair value of interest rate swap contracts that do not qualify for hedge accounting in accordance with Accounting Standards Codification (“ASC”) 815. We may capitalize interest expense to our project assets or property, plant and equipment when such costs qualify for interest capitalization, which reduces the amount of net interest expense reported in any given period.52Table of ContentsThe following table shows interest expense, net for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Interest expense, net$(12,225)$(13,107)$(24,036)$882 (7)%$10,929 (45)%Interest expense, net in 2022 was consistent with 2021.Other income (expense), netOther income (expense), net is primarily comprised of miscellaneous items and realized gains and losses on the sale of marketable securities and restricted marketable securities.The following table shows other income (expense), net for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Other income (expense), net$31,189 $314 $(11,932)$30,875 >100%$12,246 103 %Other income, net increased in 2022 compared to 2021 primarily due to the partial loan forgiveness of the Luz del Norte Credit Facilities in connection with the sale of our Luz del Norte PV solar power plant. See Note 11. “Debt” to our consolidated financial statements for further information related to this transaction.Income tax (expense) benefitIncome tax expense or benefit, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect our best estimate of current and future taxes to be paid. We are subject to income taxes in both the United States and numerous foreign jurisdictions in which we operate, principally Singapore, Malaysia, and Vietnam. Significant judgments and estimates are required to determine our consolidated income tax expense. The statutory federal corporate income tax rate in the United States is 21%, and the tax rates in Singapore, Malaysia, and Vietnam are 17%, 24%, and 20%, respectively. In Malaysia, we have been granted a long-term tax holiday, scheduled to expire in 2027, pursuant to which substantially all of our income earned in Malaysia is exempt from income tax, conditional upon our continued compliance with certain employment and investment thresholds. In Vietnam, we have been granted a long-term tax incentive, scheduled to expire at the end of 2036, pursuant to which income earned in Vietnam is subject to reduced annual tax rates, conditional upon our continued compliance with certain revenue and R&D spending thresholds.The following table shows income tax (expense) benefit for the years ended December 31, 2022, 2021, and 2020: Years EndedChange(Dollars in thousands)2022202120202022 over 20212021 over 2020Income tax (expense) benefit$(52,764)$(103,469)$107,294 $50,705 49 %$(210,763)(196)%Effective tax rate613.7 %18.1 %(36.6)% Our tax rate is affected by recurring items, such as tax rates in foreign jurisdictions and the relative amounts of income we earn in those jurisdictions. The rate is also affected by discrete items that may occur in any given period, but are not consistent from period to period. Income tax expense decreased by $50.7 million during 2022 compared to 2021 primarily due to lower pretax income in the current year, partially offset by higher tax expense of $37.3 million associated with the sale of our Luz del Norte PV solar power plant during 2022.53Table of ContentsLiquidity and Capital ResourcesAs of December 31, 2022, we believe that our cash, cash equivalents, marketable securities, cash flows from operating activities, and contracts with customers for the future sale of solar modules will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. As necessary, we also believe we will have adequate access to the capital markets. We monitor our working capital to ensure we have adequate liquidity, both domestically and internationally. We intend to maintain appropriate debt levels based upon cash flow expectations, our overall cost of capital, and expected cash requirements for operations, including near-term construction activities and purchases of manufacturing equipment for our newest manufacturing and R&D facilities in India and the United States. However, our ability to raise capital on terms commercially acceptable to us could be constrained if there is insufficient lender or investor interest due to company-specific, industry-wide, or broader market concerns. Any incremental debt financings could result in increased debt service expenses and/or restrictive covenants, which could limit our ability to pursue our strategic plans.As of December 31, 2022, we had $2.6 billion in cash, cash equivalents, and marketable securities compared to $1.8 billion as of December 31, 2021. The increase in cash, cash equivalents, and marketable securities was primarily driven by cash receipts from module sales, including advance payments for future sales, proceeds from the sales of our Japan project development business and certain international O&M operations, and proceeds from borrowings, partially offset by purchases of property, plant and equipment, expenditures for the construction of certain projects in Japan, and other operating expenditures. As of December 31, 2022 and 2021, $1.2 billion and $0.8 billion, respectively, of our cash, cash equivalents, and marketable securities was held by our foreign subsidiaries and was primarily based in U.S. dollar, Japanese yen, Indian rupee, and Euro denominated holdings.We utilize a variety of tax planning and financing strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed. If certain international funds were needed for our operations in the United States, we may be required to accrue and pay certain U.S. and foreign taxes to repatriate such funds. We maintain the intent and ability to permanently reinvest our accumulated earnings outside the United States, with the exception of our subsidiaries in Canada and Germany. In addition, changes to foreign government banking regulations may restrict our ability to move funds among various jurisdictions under certain circumstances, which could negatively impact our access to capital, resulting in an adverse effect on our liquidity and capital resources.Although we compete in markets that do not require solar-specific government subsidies or support programs, such incentives continue to influence the demand for PV solar energy around the world. For example, the financial incentives provided by the IRA are expected to increase both the demand for and the domestic manufacturing of solar modules in the United States. We continue to evaluate the extent of benefits available to us by the IRA, which are expected to favorably impact our liquidity and capital resources in future periods. For example, we currently expect to qualify for the advanced manufacturing production credit under Section 45X of the IRC, which provides certain specified benefits for solar modules and solar module components manufactured in the United States and sold to third parties. Such credit may be refundable or transferable to a third party and is available from 2023 to 2032, subject to phase down beginning in 2030. Based on the current form factor of our modules, we expect to qualify for a credit of approximately 17 cents per watt for each module produced in the United States and sold to a third party. Accordingly, we expect the advanced manufacturing production credit will provide us with a significant source of funding throughout its 10-year period. For more information about certain risks associated with the benefits available to us under the IRA, see Item 1A. “Risk Factors – “We expect certain financial benefits as a result of tax incentives provided by the Inflation Reduction Act of 2022. If these expected financial benefits vary significantly from our assumptions, our business, financial condition, and results of operations could be adversely affected.”54Table of ContentsAs a result of such market opportunities and increased demand for our products, we are in the process of expanding our capacity by approximately 11 GWDC, including the construction of our third manufacturing facility in the United States, which commenced commercial production of modules in early 2023; our first manufacturing facility in India, which is expected to commence operations in the second half of 2023; our fourth manufacturing facility in the United States, which is expected to commence operations in late 2024; and the expansion of our manufacturing footprint at our existing facilities in Ohio. Our newest factory in the United States began producing and our newest factory in India is expected to produce our next generation Series 7 modules, which combine our thin film CdTe technology with a larger form factor and an innovative steel back rail mounting structure that reduces module installation time. In aggregate, we currently expect to invest approximately $2.7 billion for these facilities and upgrades. As we expand our manufacturing capacity, we expect to continue to receive advance payments from customers for the future sale of modules. Such advance payments are reflected as deferred revenue in our consolidated balance sheets. As of December 31, 2022, our deferred revenue was approximately $1.2 billion. Accordingly, the capital expenditures necessary to expand our capacity in the near term are expected to be financed, in part, by advance payments for module sales in future periods and by the advanced manufacturing production credit described above.In addition to the expansion plans described above, we continue to increase the nameplate production capacity of our existing manufacturing facilities by improving our production throughput, increasing module wattage (or conversion efficiency), and reducing manufacturing yield losses. We have a demonstrated history of innovation, continuous improvement, and manufacturing success driven by our significant investments in various R&D initiatives. We continue to invest significant financial resources in such initiatives, including approximately $0.3 billion for a dedicated R&D facility in the United States to support the implementation of our technology roadmap. We expect such R&D facility to feature a high-tech pilot manufacturing line, allowing for the production of full-sized prototypes of thin film and tandem PV modules. Such R&D facility is expected to be completed in 2024. During 2023, we expect to spend $1.9 billion to $2.1 billion for capital expenditures, including the new facilities mentioned above and upgrades to machinery and equipment that we believe will further increase our module wattage and expand capacity and throughput at our manufacturing facilities.We have also committed and expect to continue committing significant working capital to purchase various raw materials used in our module manufacturing process. Our failure to obtain raw materials and components that meet our quality, quantity, and cost requirements in a timely manner could interrupt or impair our ability to manufacture our solar modules, or increase our manufacturing costs. Accordingly, we may enter into long-term supply agreements to mitigate potential risks related to the procurement of key raw materials and components, and such agreements may be noncancelable or cancelable with a significant penalty. For example, we have entered into long-term supply agreements for the purchase of certain specified minimum volumes of substrate glass and cover glass for our PV solar modules. Our remaining purchases under these supply agreements are expected to be approximately $3.7 billion of substrate glass and approximately $301 million of cover glass. We have the right to terminate these agreements upon payment of specified termination penalties (which, in aggregate, are up to $251 million as of December 31, 2022 and decline over the remaining supply periods). Additionally, for certain strategic suppliers, we have made, and may in the future be required to make, certain advance payments to secure the raw materials necessary for our module manufacturing.We have also committed certain financial resources to fulfill our solar module collection and recycling obligations and have established a trust under which these funds are put into custodial accounts with an established and reputable bank. As of December 31, 2022, such funds were comprised of restricted marketable securities of $182.1 million and restricted cash and cash equivalents balances of $6.7 million. As of December 31, 2022, our module collection and recycling liability was $128.1 million. Trust funds may be disbursed for qualified module collection and recycling costs (including capital and facility related recycling costs), payments to customers for assuming collection and recycling obligations, and reimbursements of any overfunded amounts. Investments in the trust must meet certain investment quality criteria comparable to highly rated government or agency bonds. As necessary, we adjust the funded amounts for our estimated collection and recycling obligations based on the 55Table of Contentsestimated costs of collecting and recycling covered modules, estimated rates of return on our restricted marketable securities, and an estimated solar module life of 25 years, less amounts already funded in prior years.As of December 31, 2022, we had no off-balance sheet debt or similar obligations, other than financial assurance related instruments, which are not classified as debt. We do not guarantee any third-party debt. See Note 12. “Commitments and Contingencies” to our consolidated financial statements for further information about our financial assurance related instruments.Cash FlowsThe following table summarizes key cash flow activity for the years ended December 31, 2022, 2021, and 2020 (in thousands): 202220212020Net cash provided by operating activities$873,369 $237,559 $37,120 Net cash used in investing activities(1,192,574)(99,040)(131,227)Net cash provided by (used in) financing activities309,392 40,550 (82,587)Effect of exchange rate changes on cash, cash equivalents, restricted cash and restricted cash equivalents47,438 3,174 3,778 Net increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents$37,625 $182,243 $(172,916)Operating ActivitiesThe increase in net cash provided by operating activities during 2022 was primarily driven by higher cash receipts from module sales, including advance payments for future sales, partially offset by higher expenditures for the construction of certain projects in Japan and certain advance payments for raw materials in the current year.Investing ActivitiesThe increase in net cash used in investing activities during 2022 was primarily due to higher net purchases of marketable securities, higher purchases of property, plant and equipment, and proceeds from the sales of our North American O&M operations and U.S. project development business in the prior year, partially offset by proceeds from the sales of our Japan project development business and certain international O&M operations in the current year.Financing ActivitiesThe increase in net cash provided by financing activities during 2022 was primarily due to higher net borrowings under project specific debt financings for the construction of certain projects in Japan. Such project specific debt financings were assumed by PAG when we completed the sale of our Japan project development business in June 2022. The increase is also due to borrowings under the India Credit Facility in the current year for the development and construction of our first manufacturing facility in India.Recent Accounting PronouncementsNone.56Table of ContentsCritical Accounting EstimatesIn preparing our consolidated financial statements in conformity with generally accepted accounting principles in the United States (“U.S. GAAP”), we make estimates and assumptions that affect the amounts of reported assets, liabilities, revenues, and expenses, as well as the disclosure of contingent liabilities. Some of our accounting policies require the application of significant judgment in the selection of the appropriate assumptions for making these estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. We base our judgments and estimates on our historical experience, our forecasts, and other available information as appropriate. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected. Our significant accounting policies are described in Note 2. “Summary of Significant Accounting Policies” to our consolidated financial statements. The accounting policies that require the most significant judgment and estimates include the following:Accrued Solar Module Collection and Recycling Liability. We previously established a module collection and recycling program, which has since been discontinued, to collect and recycle modules sold and covered under such program once the modules reach the end of their service lives. For legacy customer sales contracts that were covered under this program, we recognized expense at the time of sale for the estimated cost of our obligations to collect and recycle such modules. We estimate the cost of our collection and recycling obligations based on the present value of the expected future cost of collecting and recycling the solar modules, which includes estimates for the cost of packaging materials; the cost of freight from the solar module installation sites to a recycling center; material, labor, and capital costs; and by-product credits for certain materials recovered during the recycling process. We base these estimates on our experience collecting and recycling solar modules and certain assumptions regarding the estimated useful lives of modules covered by the program and the number of modules expected to be recycled. In the periods between the time of sale and the related settlement of the collection and recycling obligation, we accrete the carrying amount of the associated liability and classify the corresponding expense within “Selling, general and administrative” expense on our consolidated statements of operations.We periodically review our estimates of expected future recycling costs and may adjust our liability accordingly. Such adjustments are presented within “Cost of Sales” on our consolidated statements of operations. During the year ended December 31, 2022, we completed our annual cost study of obligations under our module collection and recycling program and reduced the associated liability by $7.5 million primarily due to lower estimated capital and chemical costs resulting from improvements to our module recycling technology. As of December 31, 2022, a 10% increase in the expected future recycling costs would increase the liability by $13.7 million.Product Warranties. We provide a limited PV solar module warranty covering defects in materials and workmanship under normal use and service conditions for up to 12.5 years. We also typically warrant that modules installed in accordance with agreed-upon specifications will produce at least 98% of their labeled power output rating during the first year, with the warranty coverage reducing by a degradation factor every year thereafter throughout the limited power output warranty period of up to 30 years. Among other things, our solar module warranty also covers the resulting power output loss from cell cracking.As an alternative form of our standard limited module power output warranty, we have also offered an aggregated or system-level limited module performance warranty. This system-level limited module performance warranty is designed for utility-scale systems and provides 25-year system-level energy degradation protection. This warranty represents a practical expedient to address the challenge of identifying, from the potential millions of modules installed in a utility-scale system, individual modules that may be performing below warranty thresholds by focusing on the aggregate energy generated by the system rather than the power output of individual modules. The system-level limited module performance warranty is typically calculated as a percentage of a system’s expected energy production, adjusted for certain actual site conditions, with the warranted level of performance declining each year in a linear fashion, but never falling below 80% during the term of the warranty.57Table of ContentsWhen we recognize revenue for sales of modules or projects, we accrue liabilities for the estimated future costs of meeting our limited warranty obligations. We make and revise these estimates based primarily on the number of solar modules under warranty installed at customer locations, our historical experience with and projections of warranty claims, and our estimated per-module replacement costs. We also monitor our expected future module performance through certain quality and reliability testing and actual performance in certain field installation sites. During the year ended December 31, 2022, we revised this estimate based on updated information regarding our warranty claims, which reduced our product warranty liability by $10.2 million. This updated information reflected lower-than-expected warranty claims for our older series of module technology as well as the evolving claims profile of our newest series of module technology, resulting in reductions to our projected module return rates. In general, we expect the return rates for our Series 6 modules to be lower than our older series, and we estimate that the return rate for such newer series of module technology will be less than 1%. As of December 31, 2022, a 1% increase in the return rate across all series of module technology would increase our product warranty liability by $147.0 million.Income Taxes. We are subject to the income tax laws of the United States, its states and municipalities, and those of the foreign jurisdictions in which we have significant business operations. Such tax laws are complex and subject to different interpretations by the taxpayer and the relevant taxing authorities. We make judgments and interpretations regarding the application of these inherently complex tax laws when determining our provision for income taxes and also make estimates about when in the future certain items are expected to affect taxable income in the various tax jurisdictions. Disputes over interpretations of tax laws may be settled with the relevant taxing authority upon examination or audit. We regularly evaluate the likelihood of assessments in each of our taxing jurisdictions resulting from current and future examinations, and we record tax liabilities as appropriate.In preparing our consolidated financial statements, we calculate our income tax provision based on our interpretation of the tax laws and regulations in the various jurisdictions where we conduct business. This requires us to estimate our current tax obligations, evaluate our ability and intent to permanently reinvest our accumulated earnings in jurisdictions outside the United States, assess uncertain tax positions, and assess temporary differences between the financial statement carrying amounts and the tax basis of assets and liabilities. These temporary differences result in deferred tax assets and liabilities. We must also assess the likelihood that each of our deferred tax assets will be realized. To the extent we believe that realization of any of our deferred tax assets is not more likely than not, we establish a valuation allowance. When we establish a valuation allowance or increase this allowance in a reporting period, we generally record a corresponding tax expense. Conversely, to the extent circumstances indicate that a valuation allowance is no longer necessary, that portion of the valuation allowance is reversed, which generally reduces our overall income tax expense.We establish liabilities for potential additional taxes based on our assessment of the outcome of our tax positions. Once established, we adjust these liabilities when additional information becomes available or when an event occurs requiring an adjustment. Significant judgment is required in making these estimates and the actual cost of a tax assessment, fine, or penalty may ultimately be materially different from our recorded liabilities, if any.We continually explore initiatives to better align our tax and legal entity structure with the footprint of our global operations and recognize the tax impact of these initiatives, including changes in the assessment of uncertain tax positions, indefinite reinvestment exception assertions, and the realizability of deferred tax assets, in the period when we believe all necessary internal and external approvals associated with such initiatives have been obtained, or when the initiatives are materially complete.Asset Impairments. We assess long-lived assets classified as “held and used,” including our property, plant and equipment; operating lease assets; intangible assets; project assets; and PV solar power systems, for impairment whenever events or changes in circumstances arise, including consideration of technological obsolescence, that may indicate that the carrying amount of such assets may not be recoverable, and these assessments require significant judgment in determining whether such events or changes have occurred. These events or changes in circumstances may include a significant decrease in the market price of a long-lived asset; a significant adverse change in the 58Table of Contentsextent or manner in which a long-lived asset is being used or in its physical condition; a significant adverse change in the business climate that could affect the value of a long-lived asset; an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset; a current-period operating or cash flow loss combined with a history of such losses or a projection of future losses associated with the use of a long-lived asset; or a current expectation that, more likely than not, a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. For purposes of recognition and measurement of an impairment loss, long-lived assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities, and we must also exercise judgment in assessing such groupings and levels.When impairment indicators are present, we compare undiscounted future cash flows, including the eventual disposition of the asset group at market value, to the asset group’s carrying value to determine if the asset group is recoverable. If the carrying value of the asset group exceeds the undiscounted future cash flows, we measure any impairment by comparing the fair value of the asset group to its carrying value. Fair value is generally determined by considering (i) internally developed discounted cash flows for the asset group, (ii) third-party valuations, and/or (iii) information available regarding the current market value for such assets. If the fair value of an asset group is determined to be less than its carrying value, an impairment in the amount of the difference is recorded in the period that the impairment indicator occurs. Estimating future cash flows requires significant judgment, and such projections may vary from the cash flows eventually realized.Item 7A. Quantitative and Qualitative Disclosures about Market RiskForeign Currency Exchange RiskCash Flow Exposure. We expect certain of our subsidiaries to have future cash flows that will be denominated in currencies other than the subsidiaries’ functional currencies. Changes in the exchange rates between the functional currencies of our subsidiaries and the other currencies in which they transact will cause fluctuations in the cash flows we expect to receive or pay when these cash flows are realized or settled. Accordingly, we enter into foreign exchange forward contracts to hedge a portion of these forecasted cash flows. These foreign exchange forward contracts qualify for accounting as cash flow hedges in accordance with ASC 815 and we designated them as such. We initially report unrealized gains or losses for such contracts in “Accumulated other comprehensive loss” and subsequently reclassify amounts into earnings when the hedged transaction occurs and impacts earnings. For additional details on our derivative hedging instruments and activities, see Note 8. “Derivative Financial Instruments” to our consolidated financial statements.Certain of our international operations, such as our manufacturing facilities in Malaysia and Vietnam, pay a portion of their operating expenses, including associate wages and utilities, in local currencies, which exposes us to foreign currency exchange risk for such expenses. Our manufacturing facilities are also exposed to foreign currency exchange risk for purchases of certain equipment and raw materials from international vendors. To the extent we expand into new markets, particularly emerging markets, our total foreign currency exchange risk, in terms of both size and exchange rate volatility, and the number of foreign currencies we are exposed to could increase significantly.For the year ended December 31, 2022, 5% of our net sales were denominated in foreign currencies, including Japanese yen and Euro. As a result, we may, from time to time, have exposure to foreign currencies with respect to our net sales, which has historically represented one of our primary foreign currency exchange risks. A 10% change in the U.S. dollar to Japanese yen and Euro exchange rates would have had an aggregate impact on our net sales of $9.1 million, excluding the effect of our hedging activities.Transaction Exposure. Many of our subsidiaries have assets and liabilities (primarily cash, receivables, deferred taxes, payables, accrued expenses, long-term debt, and solar module collection and recycling liabilities) that are denominated in currencies other than the subsidiaries’ functional currencies. Changes in the exchange rates between 59Table of Contentsthe functional currencies of our subsidiaries and the other currencies in which these assets and liabilities are denominated will create fluctuations in our reported consolidated statements of operations and cash flows. We may enter into foreign exchange forward contracts or other financial instruments to economically hedge assets and liabilities against the effects of currency exchange rate fluctuations. The gains and losses on such foreign exchange forward contracts will economically offset all or part of the transaction gains and losses that we recognize in earnings on the related foreign currency denominated assets and liabilities. For additional details on our economic hedging instruments and activities, see Note 8. “Derivative Financial Instruments” to our consolidated financial statements.As of December 31, 2022, a 10% change in the U.S. dollar relative to our primary foreign currency exposures would not have had a significant impact to our net foreign currency income or loss, including the effect of our hedging activities.Interest Rate RiskCustomer Financing Exposure. We are also indirectly exposed to interest rate risk because many of our customers depend on debt financings to purchase modules. An increase in interest rates could make it challenging for our customers to obtain the capital necessary to make such purchases on favorable terms, or at all. Such factors could reduce demand or lower the price we can charge for our modules, thereby reducing our net sales and gross profit.Marketable Securities and Restricted Marketable Securities Exposure. We invest in various debt securities, which exposes us to interest rate risk. The primary objectives of our investment activities are to preserve principal and provide liquidity, while at the same time maximizing the return on our investments. Many of the securities in which we invest may be subject to market risk. Accordingly, a change in prevailing interest rates may cause the market value of such investments to fluctuate. For example, if we hold a security that was issued with an interest rate fixed at the then-prevailing rate and the prevailing interest rate subsequently rises, the market value of our investment may decline.For the year ended December 31, 2022, our marketable securities earned a return of 2%, including the impact of fluctuations in the price of the underlying securities, and had a weighted-average maturity of 6 months as of the end of the period. Based on our investment positions as of December 31, 2022, a hypothetical 100 basis point change in interest rates would have resulted in a $0.5 million change in the market value of our marketable securities investment portfolio. For the year ended December 31, 2022, our restricted marketable securities incurred a loss of 22%, including the impact of fluctuations in the price of the underlying securities, and had a weighted-average maturity of approximately 12 years as of the end of the period. Based on our restricted marketable securities positions as of December 31, 2022, a hypothetical 100 basis point change in interest rates would have resulted in a $17.6 million change in the market value of our restricted marketable securities portfolio.Commodity and Component RiskSome of our raw materials and components are sourced from a limited number of suppliers or a single supplier. Although we may enter into long-term supply contracts for certain raw materials and components, we may be exposed to price changes for certain raw materials and components used to manufacture our solar modules for which we are unable to secure long-term supply contracts or if our demand exceeds our committed supply. From time to time, we may utilize derivative hedging instruments to mitigate such raw material price changes. In addition, the failure of a key supplier could disrupt our supply chain, which could result in higher prices and/or a disruption in our manufacturing process. As a result, we may be in default of our delivery obligations if we experience a manufacturing disruption. In addition to price changes in the raw materials and components used in our manufacturing process, we are also exposed to price changes associated with the shipping, handling, storage, and distribution of our modules. To mitigate such price changes, we have used and expect to continue using module contract structures that provide additional consideration to us if the cost of certain raw materials or logistics services 60Table of Contentsexceeds a defined threshold. However, we may be unable to pass along the full amount of cost increases we experience for such raw materials, components, and logistics services to our customers.Credit RiskWe have certain financial and derivative instruments that subject us to credit risk. These consist primarily of cash, cash equivalents, marketable securities, accounts receivable, restricted cash, restricted cash equivalents, restricted marketable securities, foreign exchange forward contracts, and commodity swap contracts. We are exposed to credit losses in the event of nonperformance by the counterparties to our financial and derivative instruments. We place these instruments with various high-quality financial institutions and limit the amount of credit risk from any one counterparty. We monitor the credit standing of our counterparty financial institutions. Our net sales are primarily concentrated among a limited number of customers. We monitor the financial condition of our customers and perform credit evaluations whenever considered necessary. We typically require some form of payment security from our customers, including, but not limited to, advance payments, parent guarantees, letters of credit, bank guarantees, or surety bonds.
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONSThe following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this report. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management’s expectations. Factors that could cause such differences include, but are not limited to, those identified below and those described in Item 1A “Risk Factors” appearing elsewhere in this report. All foreign currency amounts that have been converted into U.S. dollars in this discussion are based on the exchange rate as reported by Oanda for the applicable periods. The following discussion and analysis of our financial condition and results of operations generally discusses 2022 and 2021 items, with year-over-year comparisons between these two years. A detailed discussion of 2021 items and year-over-year comparisons between 2021 and 2020 that are not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021.Executive OverviewFLEETCOR is a leading global business payments company that helps businesses spend less by enabling them to better manage their expense-related purchasing and vendor payments processes. FLEETCOR’s smarter payment and spend management solutions are delivered in a variety of ways depending on the needs of the customer. From physical payment cards to software that includes customizable controls and robust payment capabilities, we provide businesses with a better way to pay. FLEETCOR has been a member of the S&P 500 since 2018 and trades on the New York Stock Exchange under the ticker FLT. Businesses spend an estimated $135 trillion each year with other businesses. In many instances, they lack the proper tools to monitor what is being purchased, and employ manual, paper-based, disparate processes and methods to both approve and make payments for their purchases. This often results in wasted time and money due to unnecessary or unauthorized spending, fraud, receipt collection, data input and consolidation, report generation, reimbursement processing, account reconciliations, employee disciplinary actions, and more. FLEETCOR’s vision is that every payment is digital, every purchase is controlled, and every related decision is informed. Digital payments are faster and more secure than paper-based methods such as checks, and provide timely and detailed data that can be utilized to effectively reduce unauthorized purchases and fraud, automate data entry and reporting, and eliminate reimbursement processes. Combining this payment data with analytical tools delivers powerful insights, which managers can use to better run their businesses. Our wide range of modern, digitized solutions generally provides control, reporting, and automation benefits superior to many of the payment methods businesses often use such as cash, paper checks, general purpose credit cards, as well as employee pay and reclaim processes. Impact of COVID-19 on Our BusinessThe novel strain of coronavirus (including variants thereof, "COVID-19") negatively impacted our results of operations and liquidity and various aspects of the world economy and our customers, suppliers and vendors. The extent to which the COVID-19 pandemic continues to impact our business operations, financial results, and liquidity through the remainder of 2023 will depend on numerous evolving factors that we may not be able to accurately predict or assess, including the continued duration and scope of the pandemic and the geographies most affected; the transmissibility and severity of new variants of the virus; vaccine availability globally, distribution, efficacy to new strains of the virus, the effectiveness of vaccines and treatments over the long term and against new variants, and the public's willingness to get vaccinated, potential disruptions impacting our suppliers and vendors resulting, directly or indirectly, from new outbreaks of COVID-19, vaccine mandates and/or vaccine hesitancy; the negative impact the COVID-19 pandemic has on global and regional economies and general economic activity, including the duration and magnitude of its impact on unemployment rates and business spending levels; its short- and longer-term impact on the levels of consumer confidence; the effectiveness of actions that governments, businesses and individuals, including FLEETCOR, take in response to the pandemic; the inflationary impact of actions taken in connection with government and business responses to the COVID-19 pandemic; and how quickly economies recover after any new or continuing outbreak of COVID-19 subsides. Impact of Russia's Invasion of Ukraine on Our BusinessThe current conflict between Russia and Ukraine is creating substantial uncertainty about the role Russia will play in the global economy in the future. Although the length, impact and outcome of the ongoing military conflict between Russia and Ukraine is highly unpredictable, this conflict could lead to significant market and other disruptions. The escalation or continuation of this conflict presents heightened risks and has resulted and could continue to result in volatile commodity markets, supply chain disruptions, increased risk of cyber incidents or other disruptions to information systems, heightened risks to employee safety, significant volatility of the Russian ruble, limitations on access to credit markets, increased operating costs (including fuel and other input costs), the frequency and volume of failures to settle securities transactions, inflation, potential for increased volatility in commodity, currency and other financial markets, safety risks, and restrictions on the transfer of funds to and from Russia. We cannot predict how and the extent to which the conflict will affect our customers, operations or business partners or 34the demand for our products and our global business. Depending on the actions we take or are required to take, the ongoing conflict could also result in loss of cash, assets or impairment charges. Additionally, we may also face negative publicity and reputational risk based on the actions we take or are required to take as a result of the conflict, which could damage our brand image or corporate reputation. The extent of the impact of these tragic events on our business remains uncertain and will continue to depend on numerous evolving factors that we are not able to accurately predict, including the extent, severity, duration and outcome of the conflict. We are actively monitoring the situation and assessing its impact on our business, analyzing options as they develop, pursuing the potential disposition of our Russian operations, and refining crisis response materials designed to mitigate the impact of disruptions to our business. Subject to ongoing negotiations, we currently expect to complete the disposition of the Russia business in the second or third quarter of 2023. There can be no assurance that our plan will successfully mitigate all disruptions. To date we have not experienced any material interruptions in our infrastructure, technology systems or networks needed to support our operations. The extent, severity, duration and outcome of the military conflict, sanctions and resulting market disruptions could be significant and could potentially have substantial impact on the global economy and our business for an unknown period of time. Any such disruptions may also magnify the impact of other risks described herein.Our business in Russia accounted for approximately 3.3% and 2.8% of our consolidated net revenues and 7.2% and 5.0% of our net income for the years ended December 31, 2022 and 2021, respectively. Our assets in Russia were approximately 3.2% and 2.4% of our consolidated assets at December 31, 2022 and 2021, respectively. The net book value of our assets in Russia at December 31, 2022 was approximately $226.1 million of which $215.8 million is restricted cash. As described in Note 4 to our consolidated financial statements, we currently have not recognized any impairment charges related to the assets of our Russian business. However, the extent, severity, duration and outcome of the conflict between Russia and Ukraine and related sanctions could potentially impact the value of our assets in Russia as the conflict continues. Our Russian business is part of our Fleet segment.Performance Revenues, net, Net Income and Net Income Per Diluted Share. Set forth below are revenues, net, net income and net income per diluted share for the years ended December 31, 2022 and 2021 (in millions, except per share amounts). Year Ended December 31,20222021Revenues, net$3,427 $2,834 Net income$954 $839 Net income per diluted share$12.42 $9.99 Adjusted Net Income and Adjusted Net Income Per Diluted Share. Set forth below are adjusted net income and adjusted net income per diluted share for the years ended December 31, 2022 and 2021 (in millions, except per share amounts). Year Ended December 31, 20222021Adjusted net income$1,237 $1,110 Adjusted net income per diluted share$16.10 $13.21 Adjusted net income and adjusted net income per diluted share are supplemental non-GAAP financial measures of operating performance. See the heading entitled “Management’s Use of Non-GAAP Financial Measures” for more information and a reconciliation of the non-GAAP financial measure to the most directly comparable financial measure calculated in accordance with U.S. generally accepted accounting principles, or GAAP. We use adjusted net income and adjusted net income per diluted share to eliminate the effect of items that we do not consider indicative of our core operating performance on a consistent basis. Sources of Revenue FLEETCOR offers a variety of business payment solutions that help to simplify, automate, secure, digitize and effectively control the way businesses manage and pay their expenses. We provide our payment solutions to our business, merchant, consumer and payment network customers in more than 165 countries around the world today, although we operate primarily in three geographies, with approximately 85% of our business in the U.S., Brazil, and the U.K. Our customers may include commercial businesses (obtained through direct and indirect channels) and partners for whom we manage payment programs, as well as individual consumers. In the second quarter of 2022, in order to align with recent changes in the organizational structure and management reporting, the Company updated its segment structure. The presentation of segment information has been recast for the prior years to align with this segment presentation for 2022. We manage and report our operating results through the following reportable segments, Fleet, Corporate Payments, Lodging, Brazil and Other, which aligns with how the Chief Operating Decision Maker (CODM) allocates resources, assesses performance and reviews financial information. 35To help facilitate an understanding of our expansive range of solutions around the world, we describe them in two solution-driven categories: Vehicle and Mobility solutions and Corporate Payments solutions. Our Vehicle and Mobility solutions are purpose-built to enable our business and consumer customers to pay for vehicle and mobility-related expenses, while providing greater control and visibility of employee spending when compared with less specialized payment methods, such as cash or general-purpose credit cards. Our Vehicle and Mobility solutions include fuel, lodging, tolls and other complementary products. Our Corporate Payments solutions simplify and automate vendor payments and are designed to help businesses streamline the back-office operations associated with making outgoing payments. Companies save time, cut costs, and manage B2B payment processing more efficiently with our suite of corporate payment solutions, including AP automation, virtual cards, cross-border, and purchasing and T&E cards. We provide other payments solutions that are not considered within our Vehicle and Mobility and Corporate Payments solutions, including gift and payroll card.Our revenue is generally reported net of the cost for underlying products and services purchased. In this report, we refer to this net revenue as “revenue". See “Results of Operations” for additional segment information. Revenues, net, by Segment. For the years ended December 31, 2022 and 2021, our segments generated the following revenues, net (in millions): Year Ended December 31, 20222021Revenues by Segment*Revenues,net% of TotalRevenues, netRevenues,net% of TotalRevenues, netFleet$1,504.9 44 %$1,320.1 47 %Corporate Payments772.4 23 %600.0 21 %Lodging456.5 13 %309.6 11 %Brazil442.2 13 %368.1 13 %Other251.0 7 %235.9 8 %Consolidated revenues, net$3,427.1 100 %$2,833.7 100 %*Columns may not calculate due to rounding. Other includes our Gift and Payroll card businesses.Revenues, net, by Geography and Solution. Revenues, net by geography and solution category for the years ended December 31, 2022 and 2021, were as follows (in millions): Year Ended December 31,20222021Revenues by Geography*Revenues,net% of totalrevenues, netRevenues,net% of totalrevenues, netUnited States$2,093.9 61 %$1,785.2 63 %Brazil442.2 13 %368.1 13 %United Kingdom363.3 11 %321.8 11 %Other527.7 15 %358.6 13 %Consolidated revenues, net$3,427.1 100 %$2,833.7 100 %*Columns may not calculate due to rounding. Year Ended December 31,20222021Revenues by Solution Category*Revenues,net% of total revenues, netRevenues,net% of totalrevenues, netFuel$1,378.3 40 %$1,180.1 42 %Corporate Payments772.4 23 %600.0 21 %Tolls362.2 11 %306.0 11 %Lodging456.5 13 %309.6 11 %Gift194.5 6 %179.5 6 %Other263.2 8 %258.5 9 %Consolidated revenues, net$3,427.1 100 %$2,833.7 100 % *Columns may not calculate due to rounding. 36We generate revenue in our Fuel solutions through a variety of program fees, including transaction fees, card fees, network fees and charges, as well as from interchange. These fees may be charged as fixed amounts, costs plus a mark-up, based on a percentage of the transaction purchase amounts, or a combination thereof. Our programs also include other fees and charges associated with late payments and based on customer credit risk.In our Corporate Payments solutions, the primary measure of volume is spend, the dollar amount of payments processed on behalf of customers through our various networks. We primarily earn revenue from the difference between the amount charged to the customer and the amount paid to the third party for a given transaction, as interchange or spread revenue. Our programs may also charge fixed fees for access to the network and ancillary services provided. In our cross-border payments business, the majority of revenue is from exchanges of currency at spot rates, which enables customers to make cross-currency payments. Our performance obligation in our foreign exchange payment services is providing a foreign currency payment to a customer’s designated recipient and therefore, we recognize revenue on foreign exchange payment services when the underlying payment is made. Revenues from foreign exchange payment services are primarily comprised of the difference between the exchange rate set by the Company to the customer and the rate available in the wholesale foreign exchange market.In our Tolls solution, the relevant measure of volume is average monthly tags active during the period. We primarily earn revenue from fixed fees for access to the network and ancillary services provided. We also earn interchange on certain non-toll products. In our Lodging solutions, we primarily earn revenue from the difference between the amount charged to the customer and the amount paid to the hotel for a given transaction and commissions paid by hotels. We may also charge fees for access to the network and ancillary services provided.In our Gift solutions, we primarily earn revenue from the processing of gift card transactions sold by our customers to end users, as well as from the sale of the plastic cards. We may also charge fixed fees for ancillary services provided.The remaining revenues represent other products that due to their nature or size, are not considered primary products. These include telematics offerings, fleet maintenance, food and transportation employee benefits related offerings, payroll cards and long-haul transportation services. 37The following table presents revenue per key performance metric by solution for the years ended December 31, 2022 and 2021 (in millions except revenues, net per key performance indicator).*As ReportedPro Forma and Macro Adjusted2Year Ended December 31,Year Ended December 31,20222021Change% Change20222021Change% ChangeFUEL '- Revenues, net$1,378 $1,180 $198 17 %$1,261 $1,182 $79 7 %'- Transactions471 463 9 2 %471 469 3 1 %'- Revenues, net per transaction$2.92 $2.55 $0.38 15 %$2.68 $2.52 $0.16 6 %CORPORATE PAYMENTS'- Revenues, net$772 $600 $172 29 %$796 $664 $132 20 %'- Spend volume$116,866 $92,368 $24,499 27 %$116,866 $104,046 $12,821 12 %'- Revenues, net per spend $0.66 %0.65 %0.01 %2 %0.68 %0.64 %0.04 %7 %TOLLS - Revenues, net$362 $306 $56 18 %$346 $306 $40 13 % - Tags 6.2 5.9 0.3 5 %6.2 5.9 0.3 5 % - Revenues, net per tag$58.41 $51.59 $6.82 13 %$55.85 $51.59 $4.26 8 %LODGING'- Revenues, net$457 $310 $147 47 %$458 $365 $93 26 %'- Room nights37 29 8 28 %37 33 4 12 %'- Revenues, net per room night$12.24 $10.63 $1.62 15 %$12.29 $10.99 $1.30 12 %GIFT'- Revenues, net$195 $179 $15 8 %$199 $179 $19 11 %'- Transactions1,193 1,187 6 1 %1,193 1,187 6 1 %'- Revenues, net per transaction$0.16 $0.15 $0.01 8 %$0.17 $0.15 $0.02 10 %OTHER1'- Revenues, net$263 $259 $5 2 %$271 $259 $12 5 %'- Transactions42 37 5 14 %42 37 5 14 %'- Revenues, net per transaction$6.34 $7.07 $(0.73)(10)%$6.52 $7.07 $(0.54)(8)%FLEETCOR CONSOLIDATED REVENUES, NET'- Revenues, net$3,427 $2,834 $593 21 %$3,332 $2,956 $376 13 %1 Other includes telematics, maintenance, food, payroll card and transportation related businesses.2 See heading entitled "Managements' Use of Non-GAAP Financial Measures" for a reconciliation of pro forma and macro adjusted revenue by product and metric non-GAAP measures to the comparable financial measure calculated in accordance with GAAP. * Columns may not calculate due to rounding.Organic revenue growth is a supplemental non-GAAP financial measure of operating performance. Organic revenue growth is calculated as revenue growth in the current period adjusted for the impact of changes in the macroeconomic environment (to include fuel price, fuel price spreads and changes in foreign exchange rates) over revenue in the comparable prior period adjusted to include or remove the impact of acquisitions and/or divestitures and non-recurring items that have occurred subsequent to that period. See the heading entitled “Management’s Use of Non-GAAP Financial Measures” for more information and a reconciliation of the non-GAAP financial measure to the most directly comparable financial measure calculated in accordance with GAAP. We believe that organic revenue growth on a macro-neutral, one-time item, and consistent acquisition/divestiture/non-recurring item basis is useful to investors for understanding the performance of FLEETCOR. Revenue per relevant key performance indicator (KPI), which may include transaction, spend volume, monthly tags, room nights, or other metrics, is derived from the various revenue types as discussed above and can vary based on geography, the relevant merchant relationship, the payment product utilized and the types of products or services purchased, the mix of which would be influenced by our acquisitions, organic growth in our business, and the overall macroeconomic environment, including fluctuations in foreign currency exchange rates, fuel prices and fuel price spreads. Revenue per KPI per customer may change as the level of services we provide to a customer increases or decreases, as macroeconomic factors change and as 38adjustments are made to merchant and customer rates. See “Results of Operations” for further discussion of transaction volumes and revenue per transaction.Sources of ExpensesWe incur expenses in the following categories: •Processing—Our processing expenses consist of expenses related to processing transactions, servicing our customers and merchants, credit losses and cost of goods sold related to our hardware and card sales in certain businesses.•Selling—Our selling expenses consist primarily of wages, benefits, sales commissions (other than merchant commissions) and related expenses for our sales, marketing and account management personnel and activities.•General and administrative—Our general and administrative expenses include compensation and related expenses (including stock-based compensation and bonuses) for our employees, finance and accounting, information technology, human resources, legal and other administrative personnel. Also included are facilities expenses, third-party professional services fees, travel and entertainment expenses, and other corporate-level expenses.•Depreciation and amortization—Our depreciation expenses include depreciation of property and equipment, consisting of computer hardware and software (including proprietary software development amortization expense), card-reading equipment, furniture, fixtures, vehicles and buildings and leasehold improvements related to office space. Our amortization expenses include amortization of intangible assets related to customer and vendor relationships, trade names and trademarks, software and non-compete agreements. We are amortizing intangible assets related to business acquisitions and certain private label contracts associated with the purchase of accounts receivable.•Other operating, net—Our other operating, net includes other operating expenses and income items that do not relate to our core operations or that occur infrequently. •Other expense (income), net—Our other expense (income), net includes gains or losses from the following: sales of assets, foreign currency transactions, extinguishment of debt, and investments. This category also includes other miscellaneous non-operating costs and revenue. Certain of these items may be presented separately on the Consolidated Statements of Income. •Interest expense, net—Our interest expense, net includes interest expense on our outstanding debt, interest income on operating cash balances and interest on our interest rate swaps.•Provision for income taxes—Our provision for income taxes consists of corporate income taxes related primarily to profits resulting from the sale of our products and services on a global basis.Factors and Trends Impacting our BusinessWe believe that the following factors and trends are important in understanding our financial performance: •Global economic conditions—Our results of operations are materially affected by conditions in the economy generally, in North America, Brazil, and internationally, including the current conflict between Russia and Ukraine, as discussed elsewhere in this Annual Report on Form 10-K, and the ultimate impact of the COVID-19 pandemic. Factors affected by the economy include our transaction volumes, the credit risk of our customers and changes in tax laws across the globe. These factors affected our businesses in each of our segments.•Foreign currency changes—Our results of operations are significantly impacted by changes in foreign currency exchange rates; namely, by movements of the Australian dollar, Brazilian real, British pound, Canadian dollar, Czech koruna, euro, Mexican peso, New Zealand dollar and Russian ruble, relative to the U.S. dollar. Approximately 61%, and 63% of our revenue in 2022 and 2021, respectively, was derived in U.S. dollars and was not affected by foreign currency exchange rates. See “Results of Operations” for information related to foreign currency impact on our total revenue, net.Our cross-border foreign risk management business aggregates foreign currency exposures arising from customer contracts and economically hedges the resulting net currency risks by entering into offsetting contracts with established financial institution counterparties. These contracts are subject to counterparty credit risk.•Fuel prices—Our fleet customers use our products and services primarily in connection with the purchase of fuel. Accordingly, our revenue is affected by fuel prices, which are subject to significant volatility. A change in retail fuel prices could cause a decrease or increase in our revenue from several sources, including fees paid to us based on a percentage of each customer’s total purchase. Changes in the absolute price of fuel may also impact unpaid account balances and the late fees and charges based on these amounts. We estimate approximately 13% and 12% of revenues, net were directly impacted by changes in fuel price in 2022 and 2021, respectively. •Fuel price spread volatility—A portion of our revenue involves transactions where we derive revenue from fuel price spreads, which is the difference between the price charged to a fleet customer for a transaction and the price paid to the merchant for the same transaction. In these transactions, the price paid to the merchant is based on the wholesale cost of fuel. The merchant’s wholesale cost of fuel is dependent on several factors including, among others, the factors 39described above affecting fuel prices. The fuel price that we charge to our customer is dependent on several factors including, among others, the fuel price paid to the merchant, posted retail fuel prices and competitive fuel prices. We experience fuel price spread contraction when the merchant’s wholesale cost of fuel increases at a faster rate than the fuel price we charge to our customers, or the fuel price we charge to our customers decreases at a faster rate than the merchant’s wholesale cost of fuel. The inverse of these situations produces fuel price spread expansion. We estimate approximately 6% and 5% of revenues, net were directly impacted by fuel price spreads in 2022 and 2021, respectively. •Acquisitions—Since 2002, we have completed over 95 acquisitions of companies and commercial account portfolios. Acquisitions have been an important part of our growth strategy, and it is our intention to continue to seek opportunities to increase our customer base and diversify our service offering through further strategic acquisitions. The impact of acquisitions has, and may continue to have, a significant impact on our results of operations and may make it difficult to compare our results between periods.•Interest rates—From January 1, 2022 to February 13, 2023, the U.S. Federal Open Market Committee has increased the target federal funds rate eight times for a total rate increase of 4.50%. Additional increases are possible in future periods. We are exposed to market risk changes in interest rates on our cash investments and debt, particularly in rising interest rate environments. On January 22, 2019, we entered into three interest rate swap contracts. One contract (which matured in January 2022) had a notional value of $1.0 billion, while the two remaining contracts each have a notional value of $500 million. One of the remaining contracts matured on January 31, 2023 and the other will mature on December 19, 2023. The objective of these swap contracts was to reduce the variability of cash flows in the previously unhedged interest payments associated with $2.0 billion of unspecified variable rate debt, the sole source of which is due to changes in the LIBOR and/or SOFR benchmark interest rate. For each of these swap contracts, we pay a fixed monthly rate and receive one month LIBOR and/or SOFR. On January 30, 2023, we entered into five new interest rate swap contracts totaling $1.5 billion. The objective of these contracts is to eliminate the variability of cash flows in interest payments associated with $1.5 billion of unspecified variable rate debt, the sole source of which is due to changes in SOFR benchmark interest rate. For each of these swap contracts, we pay a fixed monthly rate and receive one month term SOFR. In February 2023, to further manage the impact of the current interest rate environment, we entered into a cross-currency interest rate swap on $500 million of notional value of investments in various euro-functional subsidiaries. This swap matures in February 2024.•Expenses—Over the long term, we expect that our expense will decrease as a percentage of revenue as our revenue increases, except for expenses related to transaction volume processed. To support our expected revenue growth, we plan to continue to incur additional sales and marketing expense by investing in our direct marketing, third-party agents, internet marketing, telemarketing and field sales force.•Taxes—We pay taxes in various taxing jurisdictions, including the U.S., most U.S. states and many non-U.S. jurisdictions. The tax rates in most non-U.S. taxing jurisdictions are different than the U.S. tax rate. Consequently, as our earnings fluctuate between taxing jurisdictions, our effective tax rate fluctuates.Acquisitions and Investments2023•In January 2023, we acquired Global Reach, a U.K.-based cross border payments provider for an immaterial amount.•In February 2023, we acquired a European-based vehicle maintenance provider and a cloud-based EV charging software platform for an immaterial amount.2022•On November 1, 2022, we completed the acquisition of Roomex, a European workforce lodging provider serving the U.K. and German markets for approximately $56.8 million.•In September 2022, we made an investment of $6.1 million in a U.K.-based EV search and pay mapping service.•On September 6, 2022, we completed the acquisition of Plugsurfing, a European EV software and network provider, for $75.8 million.•On August 3, 2022, we completed the acquisition of Accrualify, an AP automation software company, for $41.2 million.•On March 1, 2022, we completed the acquisition of Levarti, a U.S.-based airline software platform company, for $23.7 million.•In February 2022, we made an investment of $7.8 million in an EV charging payments business and $5.0 million in an EV data analytics business.402021•On December 15, 2021, we completed the acquisition of a mobile fuel payments solution in Russia for an immaterial amount. •On September 1, 2021, we completed the acquisition of ALE Solutions, Inc. (ALE), a U.S. based provider of lodging solutions to the insurance industry, for $421.8 million.•On June 1, 2021, we completed the acquisition of Associated Foreign Exchange (AFEX), a U.S. based, cross-border payment solutions provider, for $459.8 million, including cash. •On January 13, 2021, we completed the acquisition of Roger, which has been rebranded as Corpay One, a global accounts payable (AP) cloud software platform for small businesses, for $39.0 million. •During 2021, we made an investment of $37.8 million in a joint venture in Brazil with CAIXA. We made investments in other businesses of $6.8 million. Results from our ALE, Levarti and Roomex acquisitions are included in our Lodging segment, and results from our Accrualify, AFEX and Roger acquisitions are reported in our Corporate Payments segment, from the dates of acquisition. Results from our Plugsurfing and Russian acquisitions are reported in our Fleet segment from the dates of acquisition.41Results of OperationsYear ended December 31, 2022 compared to the year ended December 31, 2021 The following table sets forth selected consolidated statements of income for the years ended December 31, 2022 and 2021 (in millions, except percentages)*.Year EndedDecember 31,2022% of TotalRevenueYear EndedDecember 31,2021% of TotalRevenueIncrease(Decrease)% ChangeRevenues, net:Fleet$1,504.9 43.9 %$1,320.1 46.6 %$184.8 14.0 %Corporate Payments772.4 22.5 %600.0 21.2 %172.4 28.7 %Lodging456.5 13.3 %309.6 10.9 %146.9 47.4 %Brazil442.2 12.9 %368.1 13.0 %74.2 20.1 %Other251.0 7.3 %235.9 8.3 %15.1 6.4 %Total revenues, net3,427.1 100.0 %2,833.7 100.0 %593.4 20.9 %Consolidated operating expenses:Processing764.7 22.3 %559.8 19.8 %204.9 36.6 %Selling309.1 9.0 %262.1 9.2 %47.0 17.9 %General and administrative584.1 17.0 %485.8 17.1 %98.3 20.2 %Depreciation and amortization322.3 9.4 %284.2 10.0 %38.1 13.4 %Other operating, net0.3 — %(0.8)— %1.1 NMOperating income1,446.6 42.2 %1,242.6 43.8 %204.1 16.4 %Investment loss1.4 — %— — %1.4 NMOther expense, net3.0 0.1 %3.9 0.1 %0.9 NMInterest expense, net164.7 4.8 %113.7 4.0 %51.0 44.8 %Loss on extinguishment of debt1.9 0.1 %16.2 0.6 %(14.3)NMProvision for income taxes321.3 9.4 %269.3 9.5 %52.0 19.3 %Net income$954.3 27.8 %$839.5 29.6 %$114.8 13.7 %Operating income by segments:Fleet$728.0 $670.3 $57.7 8.6 %Corporate Payments255.4 197.6 57.8 29.3 %Lodging218.6 149.0 69.7 46.8 %Brazil174.7 154.3 20.4 13.2 %Other69.9 71.5 (1.5)(2.1)%Operating income$1,446.6 $1,242.6 $204.1 16.4 %*The sum of the columns and rows may not calculate due to rounding. NM - not meaningfulConsolidated revenues, netOur consolidated revenues were $3,427.1 million in 2022, an increase of 20.9% compared to the prior year. Consolidated revenues increased primarily due to organic growth of 13% driven by increases in transaction volumes, the impact of acquisitions completed in 2021 and 2022 of approximately $121.8 million and the positive impact of the macroeconomic environment.Although we cannot precisely measure the impact of the macroeconomic environment, in total we estimate it had a positive impact on our consolidated revenue for 2022 over 2021 of approximately $96 million, driven primarily by the favorable impact of fuel prices of approximately $99 million and favorable fuel price spreads of approximately $43 million. These increases were partially offset by unfavorable foreign exchange rates of approximately $47 million, mostly in our U.K. and European businesses. 42Consolidated operating incomeOperating income was $1,446.6 million in 2022, an increase of 16.4% compared to the prior year. The increase in operating income was primarily due to organic growth driven by increases in transaction volume, acquisitions completed in 2022 and 2021, the favorable impact of fuel prices of $99 million and favorable fuel price spreads of approximately $43 million. The increase in operating income was partially offset by additional bad debt of approximately $92 million, stock compensation of $41 million and unfavorable movements in the foreign exchange rates of $24 million. Consolidated operating expenses Processing. Processing expenses were $764.7 million in 2022, an increase of 36.6% compared to the prior year. Increases were primarily due to higher variable expenses driven by larger transaction volumes, incremental credit losses of approximately $92 million and approximately $39 million of expenses related to acquisitions completed in 2021 and 2022. Bad debt expense has increased as customer spend increased due to higher fuel prices and new sales, which generally tend to have a higher loss rate, and higher losses among micro-SMB (small-medium business) customers who are feeling the brunt of negative economic conditions.Selling. Selling expenses were $309.1 million in 2022, an increase of 17.9% compared to the prior year. Increases in selling expenses were primarily associated with higher marketing and other variable costs due to increased sales volumes in 2022 and approximately $16 million of expenses related to acquisitions completed in 2021 and 2022. General and administrative. General and administrative expenses were $584.1 million in 2022, an increase of 20.2% compared to the prior year. The increases were primarily due to increased stock based compensation expense of $41 million, the impact of acquisitions completed in 2021 and 2022 of approximately $30 million, and various other increases associated with the growth of our business over the comparable prior period.Depreciation and amortization. Depreciation and amortization expenses were $322.3 million in 2022, an increase of 13.4%. The increase was primarily due to expenses related to acquisitions completed in 2021 and 2022 of approximately $24 million. Interest expense, net. Interest expense was $164.7 million in 2022, an increase of 44.8% compared to the prior year. The increase in interest expense is primarily due to rising interest rates on increased borrowings, partially offset by the benefit of interest earned on higher operating cash balances. The following table sets forth the weighted average interest rates paid on borrowings under our Credit Facility, excluding the related unused facility fees and swaps. (Unaudited)20222021Term loan A3.22 %1.60 %Term loan B3.46 %1.85 %Revolving line of credit A & B (USD)3.50 %1.60 %Revolving line of credit B (GBP)— %1.52 %Foreign swing line (GBP)2.06 %1.54 %On January 22, 2019, we entered into three interest rate swap cash flow contracts. The objective of these interest rate swap contracts is to reduce the variability of cash flows in the previously unhedged interest payments associated with $2 billion of unspecified variable rate debt, tied to the one month LIBOR benchmark interest rate. During 2022, as a result of these swap contracts, we incurred additional interest expense of $10.6 million or 0.97% over the average LIBOR rates on $2 billion of borrowings from January 1, 2022 to January 31, 2022 and $1 billion of borrowings from January 31, 2022 through December 31, 2022. In January 2022 and 2023, $1.0 billion and $500 million, respectively, of our interest rate swaps matured. Provision for income taxes. The provision for income taxes and effective tax rate were $321.3 million and 25.2% in 2022, an increase of $52.0 million and 0.9%, respectively, compared to the prior year. The increase in the provision for income taxes was driven primarily by an increase in pre-tax earnings, less excess tax benefit on stock option exercises, and higher rates paid on certain foreign earnings compared to prior year. The increases were partially offset by the impact of a COVID-related tax benefit in Brazil realized during the fourth quarter of 2022, resulting in a $14 million tax benefit, which lowered our 2022 rate by 1.1%, and the determination that certain foreign income was permanently invested during the second quarter of 2022, resulting in a $9 million tax benefit that lowered our 2022 effective tax rate by 0.7%.Net income. For the reasons discussed above, our net income was $954.3 million in 2022, an increase of 13.7% compared to the prior year.Segment ResultsFleetFleet revenues were $1,504.9 million in 2022, an increase of 14.0% compared to the prior year. Fleet operating income was $728.0 million in 2022, an increase of 8.6% compared to the prior year. Fleet revenues and operating income increased primarily due to organic growth driven by increases in transaction volumes and new sales growth, as well as the positive impact of the macroeconomic environment, partially offset by incremental bad debt of $61 million. 43Although we cannot precisely measure the impact of the macroeconomic environment, in total we estimate it had a positive impact on our Fleet revenues and operating income in 2022 over the comparable prior year of approximately $106 million and $120 million, respectively. This impact was driven primarily by the favorable impact of fuel prices of approximately $97 million and favorable fuel spread margins of approximately $43 million. These increases were partially offset by unfavorable changes in foreign exchange rates on revenues and operating income of $35 million and $21 million, respectively, mostly in our U.K. and European businesses.Corporate PaymentsCorporate Payments revenues were $772.4 million in 2022, an increase of 28.7% compared to the prior year. Corporate Payments operating income was $255.4 million in 2022, an increase of 29.3% compared to the prior year. Corporate Payments revenues and operating income increased primarily due to organic growth, with strong new sales in our AP and cross-border solutions, higher spend volume, as well as the impact of the AFEX acquisition, which were partially offset by the unfavorable impact of the macroeconomic environment. Although we cannot precisely measure the impact of the macroeconomic environment, in total we estimate it had a negative impact on our Corporate Payments revenues and operating income in 2022 over the comparable prior year of approximately $24 million and $7 million, respectively, driven primarily by the unfavorable impact of foreign exchange rates.Lodging Lodging revenues were $456.5 million in 2022, an increase of 47.4% compared to the prior year. Lodging operating income was $218.6 million in 2022, an increase of 46.8% compared to the prior year. Lodging revenues and operating income increased primarily due to increases in transaction volume driving organic growth, as well as the impact of the ALE and Levarti acquisitions. Organic growth was driven by higher new sales and volumes in our workforce lodging product and continued recovery from the impact of COVID-19 of our airline product, producing increased domestic travel volumes. Brazil Brazil revenues were $442.2 million in 2022, an increase of 20.1% compared to the prior year. Brazil operating income was $174.7 million in 2022, an increase of 13.2% compared to the prior year. Brazil revenues and operating income increased primarily due to organic growth driven by increases in toll tags sold and expanded product utility, with the differentiated value proposition of our products. Brazil revenues and operating income were also impacted by favorable changes in foreign exchange rates of approximately $19 million and $8 million, respectively, over the prior year. Other Other revenues were $251.0 million in 2022, an increase of 6.4% compared to the prior year. Other operating income was $69.9 million in 2022, a decrease of 2.1% compared to the prior year. Other revenues increased primarily due to organic growth driven by increases in transaction volumes and early retail ordering of gift cards, as retailers seek to ensure adequate card stock in advance of holiday season. Other operating income remained relatively the same year over year. Liquidity and capital resourcesOur principal liquidity requirements are to service and repay our indebtedness, make acquisitions of businesses and commercial account portfolios, repurchase shares of our common stock and meet working capital, tax and capital expenditure needs.Sources of liquidity. We believe that our current level of cash and borrowing capacity under our Credit Facility and Securitization Facility (each defined below), together with expected future cash flows from operations, will be sufficient to meet the needs of our existing operations and planned requirements for the foreseeable future, based on our current assumptions. At December 31, 2022, we had approximately $2.0 billion in total liquidity, consisting of approximately $0.6 billion available under our Credit Facility (defined below) and unrestricted cash of $1.4 billion. Restricted cash primarily represents customer deposits in our corporate payments businesses in the U.S., as well as certain types of cash collateral received from customers for derivative transactions in our cross-border risk management business. Cross-border deposits are restricted from use other than to repay customer deposits, as well as to secure and settle cross-currency transactions. Cash collateral posted with financial institution counterparties is also reported in restricted cash. Based on our assessment of the current capital market conditions and related impact on our access to cash, we have classified all cash held at our Russian businesses of $215.8 million as restricted cash as of December 31, 2022. We also utilize an accounts receivable Securitization Facility to finance a portion of our domestic receivables, to lower our cost of borrowing and more efficiently use capital. Accounts receivable collateralized within our Securitization Facility relate to trade receivables resulting primarily from charge card activity in the U.S. We also consider the undrawn amounts under our Securitization Facility and Credit Facility as funds available for working capital purposes and acquisitions. At December 31, 2022, we had no additional liquidity under our Securitization Facility. We have determined that outside basis differences associated with our investments in foreign subsidiaries would not result in a material deferred tax liability, and, consistent with our assertion that these amounts continue to be indefinitely invested, have not recorded incremental income taxes for the additional outside basis differences. We cannot predict how and the extent to which the conflict between Russia and Ukraine will affect our customers, supply chain, operations or business partners or the demand for our products and our global business. Depending on the actions we 44take or are required to take, the ongoing conflict could also result in loss of cash flows, assets or impairment charges. The extent of the impact of these tragic events on our business remains uncertain and will continue to depend on numerous evolving factors that we are not able to accurately predict, including the duration and scope of the conflict. We are actively monitoring the situation and assessing its impact on our business, analyzing options as they develop, pursuing the potential disposition of our Russian operations, and refining crisis response materials designed to mitigate the impact of disruptions to our business. Subject to ongoing negotiations, we currently expect to complete the disposition of the Russia business in the second or third quarter of 2023.Cash flowsThe following table summarizes our cash flows for the years ended December 31, 2022 and 2021. Year Ended December 31,(in millions)20222021Net cash provided by operating activities$754.8 $1,197.1 Net cash used in investing activities$(368.3)$(715.9)Net cash (used in) provided by financing activities$(311.2)$343.9 Operating activities. Net cash provided by operating activities was $754.8 million in 2022, a decrease from $1,197.1 million in 2021. The decrease in operating cash flows was primarily due to unfavorable movement in working capital resulting mostly from the increase in fuel prices and volumes, as well as the timing of cash receipts and payments around year-end in 2022 versus 2021.Investing activities. Net cash used in investing activities was $368.3 million in 2022, a decrease from $715.9 million in 2021. The decreased use of cash was primarily due to smaller acquisitions completed in 2022, partially offset by an increased investment in technology of $40 million in 2022 over 2021. Financing activities. Net cash used in financing activities was $311.2 million in 2022, compared to net cash provided by financing activities of $343.9 million in 2021. This change of $655 million was primarily due to decreases in net borrowings on our credit facility and securitization facility of $386 million and $249 million, respectively, and increased repurchases of common stock of $49 million. Capital spending summaryOur capital expenditures were $151.4 million in 2022, an increase of 35.8%, compared to the prior year due to the impact of acquisitions and continued investments in technology. Credit FacilityFLEETCOR Technologies Operating Company, LLC, and certain of our domestic and foreign owned subsidiaries, as designated co-borrowers (the “Borrowers”), are parties to a $6.4 billion Credit Agreement (the “Credit Agreement”), with Bank of America, N.A., as administrative agent, swing line lender and letter of credit issuer, and a syndicate of financial institutions (the “Lenders”), which has been amended multiple times. The Credit Agreement provides for senior secured credit facilities (collectively, the "Credit Facility") consisting of a revolving credit facility in the amount of $1.5 billion, a term loan A facility in the amount of $3.0 billion and a term loan B facility in the amount of $1.9 billion as of December 31, 2022. The revolving credit facility consists of (a) a revolving A credit facility in the amount of $1 billion with sublimits for letters of credit and swing line loans and (b) a revolving B facility in the amount of $500 million with borrowings in U.S. dollars, euros, British pounds, Japanese yen or other currency as agreed in advance and a sublimit for swing line loans. The Credit Agreement also includes an accordion feature for borrowing an additional $750 million in term loan A, term loan B, revolving A or revolving B facility debt and an unlimited amount when the leverage ratio on a pro-forma basis is less than 3.75 to 1.00. Proceeds from the credit facilities may be used for working capital purposes, acquisitions, and other general corporate purposes.On June 24, 2022, the Company entered into the twelfth amendment to the Credit Agreement. The amendment replaced the then-existing term loan A with the $3 billion term loan A described above and the then-existing revolving credit facility with the $1.5 billion revolving credit facility described above, resulting in net increases of $273 million and $215 million to the capacities of the term loan A and revolving credit facility, respectively. In addition, the amendment replaced LIBOR for USD borrowings with the SOFR plus a SOFR adjustment of 0.10% for the term loan A and the revolving Credit Facility and extended the maturity date. The maturity date for the new term loan A and revolving credit facilities A and B is June 24, 2027. The term loan B has a maturity date of April 30, 2028.Interest on amounts outstanding under the Credit Agreement (other than the term loan B) accrues as follows: For loans denominated in U.S. dollars, based on SOFR plus a SOFR adjustment of 0.10%, in British pounds, based on the SONIA plus a SONIA adjustment of 0.0326%, in euros, based on the EURIBOR, or in Japanese yen, at the TIBOR plus a margin based on a leverage ratio, or our option (for U.S. dollar borrowings only), the Base Rate (defined as the rate equal to the highest of (a) the Federal Funds Rate plus 0.50%, (b) the prime rate announced by Bank of America, N.A., or (c) SOFR plus 1.00% plus a margin based on a leverage ratio). Interest on the term loan B facility accrues based on the British Bankers Association LIBOR Rate 45(the "Eurocurrency Rate") plus 1.75%. In addition, the Company pays a quarterly commitment fee at a rate per annum ranging from 0.25% to 0.30% of the daily unused portion of the credit facility.At December 31, 2022, the interest rate on the term loan A was 5.80%, the interest rate on the term loan B was 6.13% and the interest rate on the revolving A facility was 5.79%. There were no amounts outstanding under the revolving B facility at December 31, 2022. The unused credit facility fee was 0.25% for all revolving facilities at December 31, 2022. The term loans are payable in quarterly installments due on the last business day of each March, June, September, and December with the final principal payment due on the respective maturity date. Borrowings on the revolving line of credit are repayable at the maturity of the facility. Borrowings on the domestic swing line of credit are due on demand, and borrowings on the foreign swing line of credit are due no later than twenty business days after such loan is made. The obligations of the Borrowers under the Credit Agreement are secured by substantially all of the assets of FLEETCOR and its domestic subsidiaries, pursuant to a security agreement and includes a pledge of (i) 100% of the issued and outstanding equity interests owned by us of each Domestic Subsidiary and (2) 66% of the voting shares of the first-tier foreign subsidiaries, but excluding real property, personal property located outside of the U.S., accounts receivables and related assets subject to the Securitization Facility and certain investments required under money transmitter laws to be held free and clear of liens. At December 31, 2022, we had $3.0 billion in borrowings outstanding on term loan A, net of discounts, $1.9 billion in borrowings outstanding on term loan B, net of discounts, and $0.9 billion in borrowings outstanding on the revolving credit facility. We have unamortized debt issuance costs of $4.6 million related to the revolving credit facility as of December 31, 2022 recorded in other assets within the Consolidated Balance Sheets. We have unamortized debt discounts and debt issuance costs of $23.9 million related to the term loans as of December 31, 2022 recorded in notes payable and other obligations, net of current potion within the Consolidated Balance Sheets. As a result of the amortization of debt discounts and debt issuance costs, the effective interest rate incurred on the term loans was 3.41% during 2022. During 2022, as a result of the amendment described above, we made principal payments of $2.8 billion on the term loans, and $6.5 billion on the revolving facilities.As of December 31, 2022, we were in compliance with each of the covenants under the Credit Agreement.Cash Flow HedgesOn January 22, 2019, we entered into three interest rate swap contracts. One contract (which matured in January 2022) had a notional value of $1.0 billion, while the two remaining contracts each have a notional value of $500 million. One of the remaining contracts matured on January 31, 2023 and the other will mature on December 19, 2023. The objective of these swap contracts is to reduce the variability of cash flows in the previously unhedged interest payments associated with $2.0 billion of unspecified variable rate debt, the sole source of which is due to changes in the LIBOR and/or SOFR benchmark interest rate. These swap contracts qualify as hedging instruments and have been designated as cash flow hedges. For each of these swap contracts, we pay a fixed monthly rate and receive one month LIBOR and/or SOFR. We reclassified approximately $11 million of gains from accumulated other comprehensive income into earnings during the year ended December 31, 2022 as a result of these hedging instruments.During January 2023, we entered into five receive-variable, pay-fixed interest rate swap derivative contracts with U.S. dollar notional amounts as follows (in millions): Notional Amount Fixed RatesMaturity Date$2504.01%7/31/2025$2504.02%7/31/2025$5003.80%1/31/2026$2503.71%7/31/2026$2503.72%7/31/2026The purpose of these contracts is to eliminate the variability of cash flows in interest payments associated with the Company's unspecified variable rate debt, the sole source of which is due to changes in the SOFR benchmark interest rate. The Company has designated these derivative instruments as cash flow hedging instruments, which are expected to be highly effective at offsetting changes in cash flows of the related underlying exposure.46Net Investment HedgeIn February 2023, we entered into a cross currency interest rate swap that we designate as a net investment hedge of our investments in euro-denominated operations. This contract effectively converts $500 million of U.S. dollar equivalent to an obligation denominated in euro, and partially offsets the impact of changes in currency rates on our euro denominated net investments. This contract also creates a positive interest differential on the U.S. dollar-denominated portion of the swap, resulting in a 1.96% interest rate savings on the USD notional.Securitization FacilityWe are a party to a $1.7 billion receivables purchase agreement among FleetCor Funding LLC, as seller, PNC Bank, National Association as administrator, and various purchaser agents, conduit purchasers and related committed purchasers parties thereto. We refer to this arrangement as the Securitization Facility. There have been multiple amendments to the Securitization Facility in 2022. On March 23, 2022, we entered into the tenth amendment to the Securitization Facility. The amendment increased the Securitization Facility commitment from $1.3 billion to $1.6 billion and replaced LIBOR with SOFR plus a SOFR adjustment of 0.10%. On August 18, 2022, we entered into the eleventh amendment to the Securitization Facility. The amendment increased the Securitization Facility commitment from $1.6 billion to $1.7 billion, reduced the program fee margin and extended the maturity of the Securitization Facility to August 18, 2025.The Securitization Facility provides for certain termination events, which includes nonpayment, upon the occurrence of which the administrator may declare the facility termination date to have occurred, may exercise certain enforcement rights with respect to the receivables, and may appoint a successor servicer, among other things. We were in compliance with all financial and non-financial covenant requirements related to our Securitization Facility as of December 31, 2022.Stock Repurchase ProgramGiven the Company’s returns on its capital investments and significant cash provided by operations, management believes it is prudent to reinvest in the business to drive profitable growth and use excess cash flow to return cash to shareholders over time through stock repurchases. The Company's Board of Directors (the "Board") has approved a stock repurchase program (as updated from time to time, the "Program") authorizing the Company to repurchase its common stock from time to time until February 1, 2024. On January 25, 2022, the Board increased the aggregate size of the Program by $1.0 billion, to $6.1 billion, and on October 25, 2022, the Board increased the aggregate size of the Program again by $1.0 billion to $7.1 billion. Since the beginning of the Program through December 31, 2022, 26,280,908 shares have been repurchased for an aggregate purchase price of $5.9 billion, leaving the Company up to $1.2 billion of remaining authorization available under the Program for future repurchases in shares of its common stock. There were 6,212,410 common shares totaling $1.4 billion in 2022; 5,451,556 common shares totaling $1.4 billion in 2021 and 3,497,285 common shares totaling $940.8 million in 2020; repurchased under the Program. Any stock repurchases may be made at times and in such amounts as deemed appropriate. The timing and amount of stock repurchases, if any, will depend on a variety of factors including the stock price, market conditions, corporate and regulatory requirements, and any additional constraints related to material inside information the Company may possess. Any repurchases have been and are expected to be funded by a combination of available cash flow from the business, working capital and debt. Material Cash Requirements and Uses of CashMaterial cash requirements primarily consist of debt obligations and related interest payments, along with lease obligations. Refer to the Debt footnote on page 84 and Leases footnote on page 89 of this Form 10-K for more information.Deferred income tax liabilities as of December 31, 2022 were approximately $527.5 million. Refer to Income Taxes footnote on page 87 of this Form 10-K for more information. Deferred income tax liabilities are calculated based on temporary differences between the tax bases of assets and liabilities and their respective book bases, which will result in taxable amounts in future years when the liabilities are settled at their reported financial statement amounts. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, scheduling deferred income tax liabilities as payments due by period could be misleading, as this scheduling would not relate to liquidity needs. At December 31, 2022, we had approximately $60.7 million of unrecognized income tax benefits related to uncertain tax positions. We cannot reasonably estimate when all of these unrecognized income tax benefits may be settled. We do not expect reductions to unrecognized income tax benefits within the next 12 months as a result of projected resolutions of income tax uncertainties. Critical Accounting Policies and Estimates, Adoption of New Accounting Standards, and Pending Adoption of Recently Issued Accounting StandardsIn applying the accounting policies that we use to prepare our consolidated financial statements, we necessarily make accounting estimates that affect our reported amounts of assets, liabilities, revenue and expenses. Some of these estimates require us to make assumptions about matters that are highly uncertain at the time we make the accounting estimates. We base these assumptions and the resulting estimates on historical information and other factors that we believe to be reasonable under the circumstances, and we evaluate these assumptions and estimates on an ongoing basis. In many instances, however, we 47reasonably could have used different accounting estimates and, in other instances, changes in our accounting estimates could occur from period to period, with the result in each case being a material change in the financial statement presentation of our financial condition or results of operations. We refer to estimates of this type as critical accounting estimates. Our significant accounting policies are summarized in the consolidated financial statements contained elsewhere in this report. The critical accounting estimates that we discuss below are those that we believe are most important to an understanding of our consolidated financial statements.See the Summary of Significant Accounting Policies footnote on page 65 of this Form 10-K for additional information.Revenue recognition and presentation. We provide payment solutions to our business, merchant, consumer and payment network customers. Our payment solutions are primarily focused on specific commercial spend categories, including Fuel, Corporate Payments, Tolls and Lodging, as well as Gift solutions (stored value cards and e-cards). We provide solutions that help businesses of all sizes control, simplify and secure payment of various domestic and cross-border payables using specialized payment products. We also provide other payment solutions for fleet maintenance, employee benefits and long-haul transportation-related services. Payment ServicesOur primary performance obligation for the majority of our payment solutions (Corporate Payments, Fuel, Lodging, and Gift, among others) is to stand-ready to provide authorization and processing services (payment services) for an unknown or unspecified quantity of transactions and the consideration received is contingent upon the customer’s use (e.g., number of transactions submitted and processed) of the related payment services. Accordingly, the total transaction price is variable. Payment services involve a series of distinct daily services that are substantially the same, with the same pattern of transfer to the customer. As a result, we allocate and recognize variable consideration in the period we have the contractual right to invoice the customer. For the tolls payment solution, our primary performance obligation is to stand-ready each month to provide access to the toll network and process toll transactions. Each period of access is determined to be distinct and substantially the same as the customer benefits over the period of access. In our cross-border payments business, a portion of revenue is from exchanges of currency at spot rates, which enables customers to make cross-currency payments. Gift Card Products and ServicesOur Gift solutions deliver both stored value cards and e-cards (cards), and card-based services primarily in the form of gift cards to retailers. These activities each represent performance obligations that are separate and distinct. Revenue for stored value cards is recognized (gross of the underlying cost of the related card, recorded in processing expenses within the Consolidated Statements of Income) at the point in time when control passes to our customer, which is generally upon shipment. OtherWe account for revenue from late fees and finance charges, in jurisdictions where permitted under local regulations, primarily in the U.S. and Canada in accordance with Accounting Standards Codification (ASC) 310, "Receivables". Such fees are recognized net of a provision for estimated uncollectible amounts, at the time the fees and finance charges are assessed and services are provided. We cease billing and accruing for late fees and finance charges approximately 30 - 40 days after the customer’s balance becomes delinquent. In addition, in our cross-border payments business, we write foreign currency forward and option contracts for our customers to facilitate future payments in foreign currencies. The duration of these derivative contracts at inception is generally less than one year. We aggregate our foreign exchange exposures arising from customer contracts, including forwards, options and spot exchanges of currency, as necessary, and economically hedge the net currency risks by entering into offsetting derivatives with established financial institution counterparties. The changes in fair value related to these instruments are recorded in revenues, net in the Consolidated Statements of Income. Refer to the Revenue footnote on page 71 of this Form 10-K for additional information.Financial Instruments-Credit Losses. Our current expected credit loss methodology for measurement of credit losses on financial assets measured at amortized cost basis, replaces the previous incurred loss impairment methodology. Our financial assets subject to credit losses are primarily trade receivables. We utilize a combination of aging and loss-rate methods to develop an estimate of current expected credit losses, depending on the nature and risk profile of the underlying asset pool, based on product, size of customer and historical losses. Expected credit losses are estimated based upon an assessment of risk characteristics, historical payment experience, and the age of outstanding receivables, adjusted for forward-looking economic conditions. The allowances for remaining financial assets measured at amortized cost basis are evaluated based on underlying financial condition, credit history, and current and forward-looking economic conditions. The estimation process for expected credit losses includes consideration of qualitative and quantitative risk factors associated with the age of asset balances, expected timing of payment, contract terms and conditions, changes in specific customer risk profiles or mix of customers, geographic risk, economic trends and relevant environmental factors. Refer to the Financial Instruments-Credit Losses section in the Summary of Significant Accounting Policies footnote on page 63 of this Form 10-K for additional information.48Impairment of goodwill and indefinite-lived assets. We complete an impairment test of goodwill at least annually or more frequently if facts or circumstances indicate that goodwill might be impaired. Goodwill is tested for impairment at the reporting unit level. We first perform a qualitative assessment of certain of our reporting units. Factors considered in the qualitative assessment include general macroeconomic conditions, industry and market conditions, cost factors, overall financial performance of our reporting units, events or changes affecting the composition or carrying amount of the net assets of our reporting units, sustained decrease in our share price, and other relevant entity-specific events. If we elect to bypass the qualitative assessment or if we determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, a quantitative test would be required. We then perform the quantitative goodwill impairment test for the applicable reporting units by comparing the reporting unit’s carrying amount, including goodwill, to its fair value which is measured based upon, among other factors, a discounted cash flow analysis and, to a lesser extent, market multiples for comparable companies. Estimates critical to our evaluation of goodwill for impairment include forecasts for revenues, net, and earnings before interest, taxes, depreciation and amortization (EBITDA) growth, and long-term growth rates, as well as the discount rates. If the carrying amount of the reporting unit is greater than its fair value, a goodwill impairment loss is recognized.We also evaluate indefinite-lived intangible assets (primarily trademarks and trade names) for impairment annually. We test for impairment if events and circumstances indicate that it is more likely than not that the fair value of an indefinite-lived intangible asset is below its carrying amount. Estimates critical to our evaluation of indefinite-lived intangible assets for impairment include the discount rate, royalty rates used in our evaluation of trade names, projected revenue growth and projected long-term growth rates in the determination of terminal values. An impairment loss is recorded if the carrying amount of an indefinite-lived intangible asset exceeds the estimated fair value on the measurement date.Refer to the Impairment of long-lived assets, intangibles and investments section in the Summary of Significant Accounting Policies footnote on page 64 of this Form 10-K and the Goodwill and Other Intangible Assets footnote on page 82 of this Form 10-K for additional information.Income taxes. We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. We have elected to treat the Global Intangible Low Taxed Income (GILTI) inclusion as a current period expense. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the associated temporary differences become deductible. We evaluate on a quarterly basis whether it is more likely than not that our deferred tax assets will be realized in the future and conclude whether a valuation allowance must be established.We account for uncertainty in income taxes recognized in an entity’s financial statements and prescribe thresholds and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. The impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more likely than not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50 percent likelihood of being sustained. We include any estimated interest and penalties on tax related matters in income tax expense. Refer to the Income Taxes footnote on page 87 of this Form 10-K for additional information.Business combinations. Business combinations completed by us have been accounted for under the acquisition method of accounting, which requires that the acquired assets and liabilities, including contingencies, be recorded at fair value determined as of the acquisition date. The excess of the purchase price over the fair values of the tangible and intangible assets acquired and liabilities assumed represents goodwill. The results of the acquired businesses are included in our results of operations beginning from the completion date of the transaction.The estimates we use to determine the fair value of long-lived assets, such as intangible assets, can be complex and require significant judgments. We use information available to us to make fair value determinations and engage independent valuation specialists, when necessary, to assist in the fair value determination of significant acquired long-lived assets. The estimated fair values of customer-related and contract-based intangible assets are generally determined using the income approach, which is based on projected cash flows discounted to their present value using discount rates that consider the timing and risk of the forecasted cash flows. The discount rates used represented a risk adjusted market participant weighted-average cost of capital, derived using customary market metrics. These measures of fair value also require considerable judgments about future events, including forecasted revenue growth rates, forecasted customer attrition rates, contract renewal estimates and technology changes. Acquired technologies are generally valued using the replacement cost method, which requires us to estimate the costs to construct an asset of equivalent utility at prices available at the time of the valuation analysis, with adjustments in value for physical deterioration and functional and economic obsolescence. Trademarks and trade names are generally valued using the "relief-from-royalty" approach. This method assumes that trademarks and trade names have value to the extent that their owner is relieved of the obligation to pay royalties for the benefits received from them. This method requires us to estimate the future revenues for the related brands, the appropriate royalty rate and the weighted-average cost of capital. This measure of fair value requires considerable judgment about the value a market participant would be willing to pay in order to achieve the benefits associated with the trade name.49While we use our best estimates and assumptions to determine the fair values of the assets acquired and the liabilities assumed, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed. Upon the conclusion of the measurement period, any subsequent adjustments are recorded in our Consolidated Statements of Income. We also estimate the useful lives of intangible assets to determine the period over which to recognize the amount of acquisition-related intangible assets as an expense. Certain assets may be considered to have indefinite useful lives. We periodically review the estimated useful lives assigned to our intangible assets to determine whether such estimated useful lives continue to be appropriate. Refer to the Acquisitions footnote on pages 79 of this Form 10-K for additional information and the Goodwill and Other Intangible Assets footnote on page 82 of this Form 10-K for additional information.Management’s Use of Non-GAAP Financial Measures We have included in the discussion above certain financial measures that were not prepared in accordance with GAAP. Any analysis of non-GAAP financial measures should be used only in conjunction with results presented in accordance with GAAP. Below, we define the non-GAAP financial measures, provide a reconciliation of each non-GAAP financial measure to the most directly comparable financial measure calculated in accordance with GAAP, and discuss the reasons that we believe this information is useful to management and may be useful to investors. We have defined the non-GAAP measure adjusted net income as net income as reflected in our statement of income, adjusted to eliminate a) non-cash share based compensation expense related to share based compensation awards, (b) amortization of deferred financing costs, discounts, intangible assets and amortization of the premium recognized on the purchase of receivables, (c) integration and deal related costs, and (d) other non-recurring items, including the impact of discrete tax items, impairment charges, asset write-offs, restructuring and related costs, loss on extinguishment of debt, and legal settlements and regulatory-related legal fees. We have defined the non-GAAP measure adjusted net income per diluted share as the calculation previously noted divided by the weighted average diluted shares outstanding as reflected in our statement of income.We calculate adjusted net income and adjusted net income per diluted share to eliminate the effect of items that we do not consider indicative of our core operating performance. We believe it is useful to exclude non-cash share based compensation expense from adjusted net income because non-cash equity grants made at a certain price and point in time do not necessarily reflect how our business is performing at any particular time and share based compensation expense is not a key measure of our core operating performance. We also believe that amortization expense can vary substantially from company to company and from period to period depending upon their financing and accounting methods, the fair value and average expected life of their acquired intangible assets, their capital structures and the method by which their assets were acquired; therefore, we have excluded amortization expense from our adjusted net income. Integration and deal related costs represent business acquisition transaction costs, professional services fees, short-term retention bonuses and system migration costs, etc., that are not indicative of the performance of the underlying business. We also believe that certain expenses, the impact of discrete tax items, impairment charges, asset write-offs, restructuring and related costs, losses on extinguishment of debt, and legal settlements and regulatory-related legal fees do not necessarily reflect how our business is performing. We adjust net income for the tax effect of each of these non-tax items using our effective income tax rate during the period, exclusive of discrete tax items. Adjusted net income and adjusted net income per diluted share are supplemental measures of operating performance that do not represent and should not be considered as an alternative to net income, net income per diluted share or cash flow from operations, as determined by GAAP. Adjusted net income and adjusted net income per diluted share are not intended to be a substitute for GAAP financial measures, and our calculation thereof may not be comparable to that reported by other companies.Organic revenue growth is calculated as revenue growth in the current period adjusted for the impact of changes in the macroeconomic environment (to include fuel price, fuel price spreads and changes in foreign exchange rates) over revenue in the comparable prior period adjusted to include or remove the impact of acquisitions and/or divestitures and non-recurring items that have occurred subsequent to that period. We believe that organic revenue growth on a macro-neutral and consistent acquisition/divestiture/non-recurring item basis is useful to investors for understanding the performance of FLEETCOR.Management uses adjusted net income, adjusted net income per diluted share and organic revenue growth: •as measurements of operating performance because they assist us in comparing our operating performance on a consistent basis; •for planning purposes, including the preparation of our internal annual operating budget; •to allocate resources to enhance the financial performance of our business; and •to evaluate the performance and effectiveness of our operational strategies. Reconciliation of Non-GAAP Revenue and Key Performance Metric by Solution to GAAP. Set forth below is a reconciliation of organic growth by component, calculated using pro forma and macro adjusted revenue and transactions to the most directly comparable GAAP measure, revenue, net and transactions (in millions): 50 RevenueKey Performance Indicators Year Ended December 31,*Year Ended December 31,*(Unaudited)2022202120222021FUEL - TRANSACTIONSPro forma and macro adjusted$1,261 $1,182 471 469 Impact of acquisitions/dispositions— (2)— (6)Impact of fuel prices/spread141 — — — Impact of foreign exchange rates(24)— — — As reported$1,378 $1,180 471 463 CORPORATE PAYMENTS - SPENDPro forma and macro adjusted$796 $664 $116,866 $104,046 Impact of acquisitions/dispositions— (64)— (11,678)Impact of fuel prices/spread2 — — — Impact of foreign exchange rates(26)— — — As reported$772 $600 $116,866 $92,368 TOLLS - TAGSPro forma and macro adjusted$346 $306 6 6 Impact of acquisitions/dispositions— — — — Impact of fuel prices/spread— — — — Impact of foreign exchange rates16 — — — As reported$362 $306 6 6 LODGING - ROOM NIGHTSPro forma and macro adjusted$458 $365 37 33 Impact of acquisitions/dispositions— (55)— (4)Impact of fuel prices/spread— — — — Impact of foreign exchange rates(2)— — — As reported$457 $310 37 29 GIFT - TRANSACTIONSPro forma and macro adjusted$199 $179 1,193 1,187 Impact of acquisitions/dispositions— — — — Impact of fuel prices/spread— — — — Impact of foreign exchange rates(4)— — — As reported$195 $179 1,193 1,187 OTHER1 - TRANSACTIONSPro forma and macro adjusted$271 $259 42 37 Impact of acquisitions/dispositions— — — — Impact of fuel prices/spread— — — — Impact of foreign exchange rates(8)— — — As reported$263 $259 42 37 FLEETCOR CONSOLIDATED REVENUESPro forma and macro adjusted$3,332 $2,956 Intentionally Left BlankImpact of acquisitions/dispositions— (122)Impact of fuel prices/spread2143 — Impact of foreign exchange rates2(47)— As reported$3,427 $2,834 * Columns may not calculate due to rounding.1 Other includes telematics, maintenance, food, payroll card and transportation related businesses.2 Revenues reflect an estimated $99 million positive impact from fuel prices and approximately $43 million positive impact from fuel price spreads, partially offset by the negative impact of movements in foreign exchange rates of approximately $47 million.51Reconciliation of Non-GAAP Organic Growth by Segment to GAAP. Set forth below is a reconciliation of organic growth by segment, calculated using pro forma and macro adjusted revenue to the most directly comparable GAAP measure, revenue, net and transactions (in millions):Revenue Year Ended December 31,*(Unaudited)20222021FLEETPro forma and macro adjusted$1,399 $1,322 Impact of acquisitions/dispositions— (2)Impact of fuel prices/spread141 — Impact of foreign exchange rates(35)— As reported$1,505 $1,320 CORPORATE PAYMENTSPro forma and macro adjusted$796 $664 Impact of acquisitions/dispositions— (64)Impact of fuel prices/spread2 — Impact of foreign exchange rates(26)— As reported$772 $600 LODGINGPro forma and macro adjusted$458 $365 Impact of acquisitions/dispositions— (55)Impact of fuel prices/spread— — Impact of foreign exchange rates(2)— As reported$457 $310 BRAZILPro forma and macro adjusted$423 $368 Impact of acquisitions/dispositions— — Impact of fuel prices/spread— — Impact of foreign exchange rates19 — As reported$442 $368 OTHER1Pro forma and macro adjusted$255 $236 Impact of acquisitions/dispositions— — Impact of fuel prices/spread— — Impact of foreign exchange rates(4)— As reported$251 $236 FLEETCOR CONSOLIDATED REVENUESPro forma and macro adjusted$3,332 $2,956 Impact of acquisitions/dispositions— (122)Impact of fuel prices/spread143 — Impact of foreign exchange rates(47)— As reported$3,427 $2,834 * Columns may not calculate due to rounding.1 Other includes Gift and Payroll Card operating segments.52Reconciliation of Non-GAAP Measures. Set forth below is a reconciliation of adjusted net income and adjusted net income per diluted share to the most directly comparable GAAP measure, net income and net income per diluted share (in thousands, except per share amounts)*: Year Ended December 31,(Unaudited)2022 2021Net income$954,327 $839,497 Net income per diluted share$12.42 $9.99 Stock-based compensation121,416 80,071 Amortization1238,020 215,456 Loss on extinguishment of debt1,934 16,194 Integration and deal related costs18,895 30,632 Restructuring and related costs (subsidies)6,690 (2,112)Legal settlements/litigation6,051 5,772 Total pre-tax adjustments393,006 346,013 Income taxes2(110,634)(75,703)Adjusted net income$1,236,699 $1,109,807 Adjusted net income per diluted share$16.10 $13.21 Diluted shares76,862 84,0611 Includes amortization related to intangible assets, premium on receivables, deferred financing costs and debt discounts. 2 Includes $9 million adjustment for tax benefit of certain income determined to be permanently invested in Q2 2022. * Columns may not calculate due to rounding.53ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKForeign currency riskForeign EarningsOur international businesses expose us to foreign currency exchange rate changes that can impact translations of foreign-denominated assets and liabilities into U.S. dollars and future earnings and cash flows from transactions denominated in different currencies. Revenues from our international businesses were 38.9% and 37.0% of total revenues for the years ended December 31, 2022, and 2021, respectively. We measure foreign currency exchange risk based on changes in foreign currency exchange rates using a sensitivity analysis. The sensitivity analysis measures the potential change in earnings based on a hypothetical 10% change in currency exchange rates. Such analysis indicated that a hypothetical 10% change in foreign currency exchange rates would have increased or decreased consolidated operating income during the year ended December 31, 2022 by approximately $68.4 million had the U.S. dollar exchange rate increased or decreased relative to the currencies to which we had exposure. Similarly, the analysis for the prior year indicated that a hypothetical 10% change in currency exchange rates would have increased or decreased consolidated operating income for the years ended December 31, 2021 by approximately $48.0 million had the U.S. dollar exchange rate increased or decreased relative to the currencies to which we had exposure. Unhedged Cross-Currency RiskWith our cross-border payment solutions, we have additional foreign exchange risk and associated foreign exchange risk management requirements due to the nature of our cross-border payments provider business. The majority of cross-border payments revenue is from exchanges of currency at spot rates, which enable customers to make cross-currency payments. In our cross-border payment solutions, we also write foreign currency forward and option contracts for customers to facilitate future payments. The duration of these derivative contracts at inception is generally less than one year. We aggregate foreign exchange exposures arising from customer contracts, including the derivative contracts described above, and hedge (economic hedge) the resulting net currency risks by entering into offsetting contracts with established financial institution counterparties. Interest rate riskWe are exposed to the risk of changing interest rates on our cash investments and on the unhedged portion of our variable rate debt. As of December 31, 2022, and 2021, we had $5.8 billion and $4.9 billion, respectively, of variable rate debt outstanding under our Credit Agreement. See Note 11 of the accompanying consolidated financial statements for information about the Credit Agreement. We use derivative financial instruments to reduce our exposure related to changes in interest rates. In January 2019, we entered into three interest rate swap cash flow contracts with U.S. dollar notional amounts of $1 billion with a fixed rate of 2.56%, $500 million with a fixed rate of 2.56%, and $500 million with a fixed rate of 2.55% maturing on January 31, 2022, January 31, 2023 and December 19, 2023, respectively. For each of these swap contracts, we receive one month LIBOR. While these agreements are intended to lessen the impact of rising interest rates on us, they also expose us to the risk that the other parties to the agreements will not perform, we could incur significant costs associated with the settlement of the agreements, the agreements will be unenforceable and the underlying transactions will fail to qualify as highly-effective cash flow hedges under GAAP. See Note 16 of the accompanying consolidated financial statements for information about the swap contracts. Based on the amounts and mix of our fixed and floating rate debt (exclusive of our Securitization Facility) at December 31, 2022 and 2021, if market interest rates had increased or decreased an average of 100 basis points, our interest expense for the years ended December 31, 2022 and 2021 would have changed by approximately $43 million and $29 million, respectively. We determined these amounts by considering the impact of the hypothetical interest rates on our borrowing costs. These analyses do not consider the effects of changes in the level of overall economic activity that could exist in such an environment.Fuel price riskOur fleet customers use our products and services primarily in connection with the purchase of fuel. Accordingly, our revenue is affected by fuel prices, which are subject to significant volatility. A decline in retail fuel prices could cause a change in our revenue from several sources, including fees paid to us based on a percentage of each customer’s total purchase. Changes in the absolute price of fuel may also impact unpaid account balances and the late fees and charges based on these amounts. The impact of changes in fuel price is somewhat mitigated by our agreements with certain merchants, where the price paid to the merchant is equal to the lesser of the merchant’s cost plus a markup or a percentage of the transaction purchase price. We do not enter into any fuel price derivative instruments.Fuel price spread riskFrom our merchant and network relationships, we derive revenue from the difference between the price charged to a fleet customer for a transaction and the price paid to the merchant or network for the same transaction. For certain of our payment products, the price paid to a merchant or network is calculated as the merchant’s wholesale cost of fuel plus a markup. The merchant’s wholesale cost of fuel is dependent on several factors including, among others, the factors described above affecting fuel prices. The fuel price that we charge to our customer is dependent on several factors including, among others, the fuel price paid to the fuel merchant, posted retail fuel prices and competitive fuel prices. We experience fuel price spread contraction 54when the merchant’s wholesale cost of fuel increases at a faster rate than the fuel price we charge to our customers, or the fuel price we charge to our customers decreases at a faster rate than the merchant’s wholesale cost of fuel. Accordingly, if fuel price spreads contract, we may generate less revenue, which could adversely affect our operating results. The impact of volatility in fuel spreads is somewhat mitigated by our agreements with certain merchants, where the price paid to the merchant is equal to cost plus a markup or a percentage of the transaction purchase price.55
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+ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsIn addition to historical information, this Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. These statements include, among other things, statements concerning our expectations regarding:•supply chain constraints, the global chip and component shortages, and other factors affecting our manufacturing capacity, delivery, cost and inventory management;•increased inflation or stagflation, and rising interest rates in many geographies and changes in currency exchange rates and currency regulations;•the duration and impact of the COVID-19 pandemic, including various COVID-19 variants and “return to office” plans;•continued growth and market share gains;•variability in sales in certain product and service categories from year to year and between quarters;•expected impact of sales of certain products and services;•macroeconomic, geopolitical factors and other disruption on our manufacturing or sales, including the impact of the COVID-19 pandemic and other public health issues, wars and natural disasters; •government regulation, tariffs and other policies;•drivers of long-term growth and operating leverage, such as sales productivity and capacity, functionality and value in our service offerings;•growing our solution sales through channel partners to businesses, service providers and government organizations, our ability to execute these sales and the complexity of providing solutions to all segments (including the increased competition and unpredictability of timing associated with sales to larger enterprises), the impact of sales to these organizations on our long-term growth, expansion and operating results, and the effectiveness of our sales organization;•our ability to hire properly qualified and effective sales, support and engineering employees;•risks and expectations related to acquisitions and equity interests in private and public companies, including integration issues related to go-to-market plans, product plans, employees of such companies, controls and processes and the acquired technology, and risks of negative impact by such acquisitions and equity investments on our financial results; •trends in revenue, cost of revenue and gross margin; •trends in our operating expenses, including sales and marketing expense, research and development expense, general and administrative expense, and expectations regarding these expenses;•expectations that our operating expense will increase in absolute dollars during 2023;•expectations that proceeds from the exercise of stock options in future years will be adversely impacted by the increased mix of restricted stock units versus stock options granted;•expectations regarding uncertain tax benefits and our effective domestic and global tax rates, and the impact of the Tax Cuts and Jobs Act of 2017 (“TCJA”), the Coronavirus Aid, Relief, and Economic Security Act of 2020 and the Inflation Reduction Act of 2022 (“IRA”);•expectations regarding spending related to real estate acquisitions and development, data center investments, as well as other capital expenditures and to the impact on free cash flow;51Table of Contents•estimates of a range of 2023 spending on capital expenditures;•competition in our markets;•statements regarding expected outcomes and liabilities in litigation;•our intentions regarding share repurchases and the sufficiency of our existing cash, cash equivalents and investments to meet our cash needs, including our debt servicing requirements, for at least the next 12 months; •other statements regarding our future operations, financial condition and prospects and business strategies; and•adoption and impact of new accounting standards. These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Annual Report on Form 10-K and, in particular, the risks discussed under the heading “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K and those discussed in other documents we file with the SEC. We undertake no obligation, and specifically disclaim any obligation, to revise or publicly release the results of any revision to these and any other forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.Business Overview Fortinet is a global leader in cybersecurity solutions provided to a wide variety of organizations, including enterprises, communication service providers and security service providers, government organizations and small businesses. Our cybersecurity solutions are designed to provide broad visibility and segmentation of the digital attack surface through our integrated cybersecurity platform products and services providing a mesh architecture, which feature automated protection, detection and response along with consolidated visibility across both Fortinet-developed solutions and a broad ecosystem of third-party solutions and technologies. Our cybersecurity platform portfolio leverages a common operating system or integration to this operating system across our product offerings and helps organizations better secure their environments and reduce their security and network complexities. The Fortinet operating system has an open architecture designed to integrate Fortinet solutions with third-party solutions in a single ecosystem, enabling automated detection and response across the attack surface.Our product offerings consist of our Core Platform (previously referred to as FortiGate network security) and our Enhanced Platform Technologies (previously referred to as Platform Extension). The Enhanced Platform includes Secure Networking (Secure Switching, Access Points, 5G and Network Access Control), Network and Security Operations (Management, Analytics, Security Information and Event Management, Security Operations, Orchestration and Response and Email Security), Endpoint Security (Enhanced Detection and Response and Identity) and Cloud Security (Web Application Firewall, Cloud Network Security and Cloud-native Application Protection).Our cloud- and hosted- Enhanced Platform Technology products and services include sandboxing, endpoint detection and response (“EDR”), email security, web application and application programming interface (“API”) security, cloud networking security and cloud-native protection as well as management and analytics. Our FortiGuard security subscription services are enabled by FortiGuard Labs, which provides threat research and artificial intelligence capabilities from a cloud network to deliver coordinated protection for the ever-expanding attack surface through Core Platform appliance and virtual machine as well as all Enhanced Platform Technology products that are registered by the end-customer.Our FortiCare support services provide both technical support and professional services to help our customers deploy, maintain, and operationalize our Core Platform and Enhanced Platform Technology products and services.Our proprietary Application-Specific Integrated Circuits (“ASIC”) are implemented in our physical Core Platform appliances and are designed to enhance the security processing capabilities implemented in software by accelerating computationally intensive tasks such as firewall policy enforcement, software-defined wide-area network (“SD-WAN”), network address translation, Intrusion Prevention Systems (“IPS”), threat detection and encryption. We also provide Fortinet 52Table of Contentsvirtualized Application-Specific Integrated Circuits (“vASICs”) across our Core Platform virtual appliances to deliver similar accelerated capabilities when run in virtualized environments.Our FortiOS operating system provides the foundation for the operation of Core Platform and Enhanced Platform Technology products, whether physical, virtual, private- or public-cloud based. FortiOS directs the operations of processors and ASICs and provides system management functions. We make regular updates to FortiOS available through our FortiCare support services.Networking functionality and security capabilities are integrated into the FortiOS operating system to run both the Core Platform and Enhanced Platform Technology capabilities of our cybersecurity mesh architecture (“Fortinet Security Fabric”). This approach to security combines discrete security solutions together into an integrated operating system which provides centralized management, visibility, automation and intelligence sharing to simplify operations and respond rapidly to threats.The focus areas of our business consist of:•Secure Networking—Our Security-Driven Networking solutions enables the convergence of networking and security across all edges to provide next-generation firewall (“NGFW”), SD-WAN, LAN Edge (Wi-Fi and switch) and secure access service edge (“SASE”). We derive a majority of product sales from our Core Platform network security appliances. Core Platform network security appliances include a broad set of built-in security and networking features and functionalities, including firewall, next-generation firewall, secure web gateway, secure sockets layer (“SSL”) inspection, SD-WAN, Intrusion Prevention system (“IPS”), sandboxing, data leak prevention, virtual private network (“VPN”), switch and wireless controller and wide area network (“WAN”) edge. Our network security appliances are managed by our FortiOS network operating system, which provides the foundation for Core Platform security functions. We enhance the performance of our network security appliances from branch to data center by designing and implementing ASICs technology within our appliances, enabling us to add security and network functionality with minimal impact to network throughput performance. Along with our secure Wi-Fi access points and switches, we help organizations secure their networks across campuses, branches and work from anywhere (“WFA”) deployments. For the Japanese market, we also offer high performance network switches marketed under Alaxala for data center switching.FortiOS supports many more secure networking markets and applications than just Firewall. These include:•Network Firewall (“NFW”)•Software-Defined Wide Area Network (“SD-WAN”)•Secure LAN/WLAN (Wi-Fi and Switch) (SD-Branch/Campus)•Secure Access Service Edge (“SASE”)•Universal Zero Trust Network Access (“ZTNA”)•Encryption Applications (SSL Inspection, Virtual Private Network (“VPN”), and IPsec Connectivity)Further each security application has number of customer use cases. For example, Network Firewall has the following use cases:•Data Center Perimeter NGFW•North–South Internal Segmentation Firewall•Distributed Network Edge Firewall•East–West Micro Segmentation Firewall•Virtual Firewall (“VM”)•Cloud Native Firewall (“CNF”)•Firewall as a Service (“FWaaS”)•Containerized Firewall•Endpoint Firewall•SMB Firewall•Home Firewall•Zero Trust Access—Fortinet’s Enhanced Platform Technology products and services extend beyond the network to create a cybersecurity mesh architecture to cover other attack vectors. Our Zero Trust Access solutions enable 53Table of Contentscustomers to know and control who and what is on their network, in addition to providing security for WFA. Zero Trust Access solutions include FortiNAC, FortiAuthenticator, FortiClient and FortiToken. Additionally, the proliferation of OT and internet of things (“IoT”) devices has generated new opportunities for us to grow our business. Our network access control solutions provide visibility, control and automated event responses in order to secure OT and IoT devices.•Cloud Security—We help customers connect securely to and across their individual, hybrid cloud, multi-cloud and virtualized data center environments by offering security through our virtual firewall and other software products and through integrated cloud-native capabilities with major cloud platforms. Our public and private cloud security solutions, including virtual appliances and hosted solutions, bring our Enhanced Platform Technology products and services into and across cloud environments, delivering security that follows their applications and data. Our solutions include network security, web application firewall and API protection, cloud-native security and workload protection. Our Secure SD-WAN for multi-Cloud solution automates deployment of an overlay network across different cloud networks and offers visibility, control and centralized management that integrates functionality across multiple cloud environments. Our cloud security portfolio also includes securing applications in all environments in which they can be deployed, including physical and virtual data centers, clouds, and edge compute instances. Fortinet cloud security offerings are available for deployment in major public and private cloud environments, including Amazon Web Services, Google Cloud, IBM Cloud, Microsoft Azure, Oracle Cloud and VMWare Cloud. We also offer managed web application firewall (“WAF”) rules delivered by FortiGuard Labs as an overlay service to native security offerings offered by Amazon Web Services.•Security Operations—We develop and provide a range of products and services that enable the security operations center (“SOC”) teams to identify, investigate and remediate potential incidents in which cybercriminals bypass prevention-oriented controls. Given the breadth of the attack surface to monitor, as well as the volume and sophistication of cyber threats, artificial intelligence is a key part of these offerings, which include: FortiGuard and other security subscription services, modern endpoint security with EDR, a range of breach-protection technologies plus our security information and event management (“SIEM”) and security orchestration, automation and response (“SOAR”), all of which can be applied across the entire set of Platform Extension products and services. These solutions automatically deliver security intelligence and insights that enable organizations to protect against and respond to threats faster through integration with Fortinet and third-party controls.•Security as a Service—Our customers purchase our natively integrated FortiGuard security subscription services as an add-on to products and solutions across many of the Enhanced Platform Technology products and services with the goal of receiving real-time threat intelligence and protection updates. The rich set of FortiGuard security subscription services is built from the ground up to provide comprehensive protection for users and applications, including market leading offerings for IPS, Web, video and DNS filtering, AV and cloud sandbox as well as OT and IoT Security. The FortiGuard security subscription services are provided from our FortiGuard Labs and cloud-delivered to provide real-time unified protection across network endpoint and cloud.•Support and Professional Services—We offer technical support, FortiOS updates and extended product warranty through our FortiCare support services. In addition to our technical support services, we offer a range of advanced services, including premium support, professional services and expedited warranty replacement. Our advanced support service offerings include technical account managers that act as a single point of contact and customer advocate within Fortinet. Our professional service offerings include resident engineers and professional service consultants for implementations or trainings.Financial Highlights•Total revenue was $4.42 billion in 2022, an increase of 32% compared to $3.34 billion in 2021. •Product revenue was $1.78 billion in 2022, an increase of 42% compared to $1.26 billion in 2021. •Service revenue was $2.64 billion in 2022, an increase of 26% compared to $2.09 billion in 2021.•Total gross profit was $3.33 billion in 2022, an increase of 30% compared to $2.56 billion in 2021. •Operating income was $969.6 million in 2022, an increase of 49% compared to $650.4 million in 2021. •Cash, cash equivalents, investments and marketable equity securities were $2.26 billion as of December 31, 2022, a decrease of $736.0 million, or 25%, from December 31, 2021.54Table of Contents•Long-term debt, net of unamortized discount and debt issuance costs, was $990.4 million and $988.4 million as of December 31, 2022 and 2021, respectively.•In 2022, we repurchased 36.0 million shares of common stock under the Repurchase Program for an aggregate purchase price of $1.99 billion. In 2021, we repurchased 12.9 million shares of common stock for a total purchase price of $741.8 million.•Deferred revenue was $4.64 billion as of December 31, 2022, an increase of $1.19 billion, or 34%, from December 31, 2021. Short-term deferred revenue was $2.35 billion as of December 31, 2022, an increase of $571.9 million, or 32%, from December 31, 2021. •Cash flows from operating activities were $1.73 billion in 2022, an increase of $230.9 million, or 15%, compared to 2021.•In October 2022, we acquired the remaining 25% of equity interests in Alaxala for $13.5 million in cash, and Alaxala became a wholly owned subsidiary.•Our loss related to our equity method investment in Linksys Holdings, Inc. (“Linksys”) in fiscal 2022 totaled $68.1 million, which comprised of our proportionate share of Linksys’ financial results as well as the amortization of the basis differences of $45.9 million, which included a $17.5 million charge in connection with a valuation allowance established on deferred tax assets at Linksys, and the other-than-temporary impairment (“OTTI”) charge of $22.2 million.Our revenue growth was driven by both product and service revenue. On a geographic basis, revenue continues to be diversified globally, which remains a key strength of our business. In 2022, the Americas region, the Europe, Middle East and Africa (“EMEA”) region and the Asia Pacific (“APAC”) region contributed 41%, 38% and 21% of our total revenue, respectively, and increased by 31%, 33% and 33% compared to 2021, respectively. Product revenue grew 42% in 2022. Product revenue growth was consistent with an elevated cyber threat landscape and changes in our pricing model. The product revenue growth was primarily due to strong growth across many of our Enhanced Platform Technology products, including our secure access products and software licenses. In addition, our product revenue growth was driven by a strong demand for the wide range operating system capabilities embedded in our Core Platform products.Service revenue growth has accelerated over the past three years from 22% in 2020, to 24% in 2021, to 26% in 2022. Service revenue growth of 26% in 2022 was driven by the strength of our FortiGuard and other security subscription revenue and FortiCare technical support and other service revenue, which grew 27% and 26%, respectively. The increases were primarily due to the recognition of revenue from our growing deferred revenue balance related to FortiGuard and other security subscriptions delivered to on-premise and cloud-based environments, as well as FortiCare and other technical support, including our customers moving to higher-tier support offerings and the early effects of certain pricing actions.Our billings were diversified on a geographic basis. In 2022, six countries represented approximately 50% of our billings and the remaining 50% in the aggregate were from over 100 countries that individually contributed less than 4% of our billings. Operating expenses as a percentage of revenue decreased by approximately 3.6 percentage points in 2022 compared to 2021, which benefited from the favorable impact of foreign currency fluctuations. Headcount increased by 24% to 12,595 employees as of December 31, 2022, up from 10,195 as of December 31, 2021. Impact of Macroeconomic Developments and COVID-19 Pandemic UpdateOur overall performance depends in part on worldwide economic and geopolitical conditions and their impact on customer behavior. Worsening economic conditions, including inflation, higher interest rates, slower growth, fluctuations in foreign exchange rates and other changes in economic conditions, may adversely affect our results of operations and financial performance.We continue to monitor and respond to developments relating to the COVID-19 pandemic. In response to the COVID-19 pandemic, we undertook a number of actions to protect our employees, including restricting travel and directing 55Table of Contentsmany of our employees to work from home. In certain geographies, we have transitioned back to an in-person working mode, allowing increasing numbers of employees to work from our offices with reasonable precautions and, in all cases, subject to abiding by local legal restrictions. We intend to continue to monitor and abide by local employee health and safety protocols and other regulations as applicable to each local office.We have seen certain impacts on our business and operations, results of operations, financial condition, cash flows, liquidity and capital and financial resources as of and during the year ended December 31, 2022. Conversely, some aspects of our business do not appear to have been significantly affected. During the year ended December 31, 2022, we observed the following:•We saw continued supply chain challenges, including chip and other component shortages and increased costs for certain chips and other components and shipping, and we did not have enough inventory to promptly meet all demand for all products.•In many countries, our employees’ ability to travel was reduced and certain in-person sales and marketing events or meetings that would normally have been held were canceled, postponed or converted into virtual events. However, as certain country’s restrictions continued to ease, we have started to see an increase in expenses related to travel and marketing events. Although we cannot predict if or when such expenses will return to pre-pandemic levels, as of December 31, 2022, we had started to see an increase in such expenses as compared to the same period last year.•In order to mitigate supply chain disruptions and other supply chain risks and in anticipation of future demand, we increased our commitments with certain suppliers to secure capacity and are meeting regularly with our contract manufacturers and component suppliers to manage future commitments, address component shortages and monitor delivery. We have also transitioned primarily to air shipping to avoid port congestion and extended ocean freight time.•Our days sales outstanding increased to 89 days for the year ended December 31, 2022, compared to 75 days for the year ended December 31, 2021, primarily due to the sales linearity. The accounts receivable allowance for credit losses was $3.6 million as of December 31, 2022, an increase of $1.2 million compared to $2.4 million as of December 31, 2021, primarily due to an increase in past due invoices over 60 and 90 days.The COVID-19 pandemic may have a material negative impact on our future periods. If we experience component, shipping, inventory or customer payment challenges, it will negatively impact billings and product revenue in the current quarter and FortiGuard and FortiCare service revenues in subsequent quarters, as we sell annual and multi-year service contracts that are recognized ratably over the service term, generally starting on the contract registration date. In addition, the broader implications of the pandemic on our business and operations and our financial results, including the extent to which the effects of the pandemic may impact future results and growth in the cybersecurity industry, remain uncertain. The extent of the impact of the COVID-19 pandemic on our operational and financial performance will depend on ongoing developments, including the duration and spread of the virus and its variants, the impact on our end-customers’ spending, the volume of sales and length of our sales cycles, the impact on our partners, suppliers, and employees, actions that may be taken by governmental authorities and other factors identified in Part I, Item 1A “Risk Factors” in this Form 10-K. Given the dynamic nature of these circumstances, the full impact of the COVID-19 pandemic on our business and operations, results of operations, financial condition, cash flows, liquidity and capital and financial resources cannot be reasonably estimated at this time.Business Model We typically sell our security solutions to distributors that sell to networking security focused resellers and to certain service providers, who, in turn, sell to end-customers or use our products and services to provide hosted solutions to other enterprises. At times, we also sell directly to certain large enterprise customers, large service providers and major systems integrators. Our end-customers are located in over 100 countries and include small, medium and large enterprises and government organizations across a wide range of industries, including education, financial services, government, healthcare, manufacturing, retail, technology and telecommunications. An end-customer deployment may involve as few as one or as many as thousands of Core Platform products as well as Enhanced Platform Technology products, depending on the end-customer’s size and security requirements. We also offer our products hosted in our own data centers and through co-locations and major cloud providers, including Amazon Web Services, Google Cloud, IBM Cloud, Microsoft Azure and Oracle Cloud. We have also recognized revenue from customers who deploy our products in a bring-your-own-license (“BYOL”) arrangements at cloud providers or at private clouds. In a BYOL arrangement, a customer purchases a software license through our channel partners and deploys the software in a cloud provider’s environment in third-party clouds or in their private cloud. 56Table of ContentsOur customers purchase our hardware products and software licenses, as well as our FortiGuard and other security subscription and FortiCare technical support services. We generally invoice at the time of our sale for the total price of the products and services. Standard payment terms are generally no more than 60 days, though we may offer extended payment terms to certain distributors or related to certain transactions.Key MetricsWe monitor several key metrics, including the key financial metrics set forth below, in order to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts, and assess operational efficiencies. The following table summarizes revenue, deferred revenue, billings (non-GAAP), net cash provided by operating activities, and free cash flow (non-GAAP). We discuss revenue below under “—Components of Operating Results,” and we discuss net cash provided by operating activities below under “—Liquidity and Capital Resources.” Deferred revenue, billings (non-GAAP), and free cash flow (non-GAAP) are discussed immediately below the following table. Year Ended or As of December 31,202220212020(in millions)Revenue$4,417.4 $3,342.2 $2,594.4 Deferred revenue$4,640.3 $3,452.9 $2,605.3 Billings (non-GAAP)$5,594.0 $4,181.4 $3,090.0 Net cash provided by operating activities$1,730.6 $1,499.7 $1,083.7 Free cash flow (non-GAAP)$1,449.4 $1,203.8 $907.8 Deferred revenue. Our deferred revenue consists of amounts that have been invoiced but that have not yet been recognized as revenue. The majority of our deferred revenue balance consists of the unrecognized portion of service revenue from FortiGuard and other security subscription and FortiCare technical support service contracts, which is recognized as revenue ratably over the service term. We monitor our deferred revenue balance, short term and total deferred revenue growth and the mix of short-term and long-term deferred revenue because deferred revenue represents a significant portion of free cash flow and of revenue to be recognized in future periods. Deferred revenue was $4.64 billion as of December 31, 2022, an increase of $1.19 billion, or 34%, from December 31, 2021. Short term deferred revenue was $2.35 billion as of December 31, 2022, and increase of $571.9 million, or 32%, from December 31, 2021.Billings (non-GAAP). We define billings as revenue recognized in accordance with generally accepted accounting principles in the United States (“GAAP”) plus the change in deferred revenue from the beginning to the end of the period, less any deferred revenue balances acquired from business combination(s) and adjustment due to adoption of new accounting standard during the period. We consider billings to be a useful metric for management and investors because billings drive current and future revenue, which is an important indicator of the health and viability of our business. There are several limitations related to the use of billings instead of GAAP revenue. First, billings include amounts that have not yet been recognized as revenue and are impacted by the term of FortiGuard security subscription and FortiCare and other support agreements. Second, we may calculate billings in a manner that is different from peer companies that report similar financial measures. Management accounts for these limitations by providing specific information regarding GAAP revenue and evaluating billings together with GAAP revenue. Total billings were $5.59 billion in 2022, an increase of 34% compared to $4.18 billion in 2021.57Table of ContentsA reconciliation of revenue, the most directly comparable financial measure calculated and presented in accordance with GAAP, to billings is provided below: Year Ended December 31,202220212020(in millions)Billings: Revenue $4,417.4 $3,342.2 $2,594.4 Add: Change in deferred revenue 1,187.4 847.6 496.2 Less: Deferred revenue balance acquired in business combinations(10.8)(4.1)(0.6)Less: Adjustment due to adoption of ASU 2021-08— (4.3)— Total billings (non-GAAP)$5,594.0 $4,181.4 $3,090.0 Free cash flow (non-GAAP). We define free cash flow as net cash provided by operating activities minus purchases of property and equipment and excluding any significant non-recurring items. We believe free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that, after capital expenditures, can be used for strategic opportunities, including repurchasing outstanding common stock, investing in our business, making strategic acquisitions, and strengthening the balance sheet. A limitation of using free cash flow rather than the GAAP measures of cash provided by or used in operating activities, investing activities, and financing activities is that free cash flow does not represent the total increase or decrease in the cash and cash equivalents balance for the period because it excludes cash flows from investing activities other than capital expenditures and cash flows from financing activities. Management accounts for this limitation by providing information about our capital expenditures and other investing and financing activities on the consolidated statements of cash flows and under “—Liquidity and Capital Resources” and by presenting cash flows from investing and financing activities in our reconciliation of free cash flow. In addition, it is important to note that other companies, including companies in our industry, may not use free cash flow, may calculate free cash flow in a different manner than we do or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of free cash flow as a comparative measure. A reconciliation of net cash provided by operating activities, the most directly comparable financial measure calculated and presented in accordance with GAAP, to free cash flow is provided below: Year Ended December 31,202220212020(in millions)Free Cash Flow:Net cash provided by operating activities$1,730.6 $1,499.7 $1,083.7 Less: Purchases of property and equipment(281.2)(295.9)(125.9)Less: Proceeds from intellectual property matter— — (50.0)Free cash flow (non-GAAP)$1,449.4 $1,203.8 $907.8 Net cash provided by (used in) investing activities$763.9 $(1,325.1)$(72.8)Net cash provided by (used in) financing activities$(2,130.3)$82.8 $(1,171.6)58Table of ContentsComponents of Operating Results Revenue. We generate the majority of our revenue from sales of our hardware and software products and amortization of amounts included in deferred revenue related to previous sales of FortiGuard security subscription and FortiCare technical support services. We also recognize revenue from cloud security solutions, professional services, and training.Our total revenue is comprised of:•Product revenue. Product revenue is primarily generated from sales of our physical and virtual machine appliances. The majority of our product revenue continues to be generated by our Core Platform product line. Product revenue also includes revenue from sales of Enhanced Platform Technologies. As a percentage of total revenue, our product revenue has varied from quarter to quarter.•Service revenue. Service revenue is generated primarily from FortiGuard security subscription services and FortiCare technical support services. We recognize revenue from FortiGuard security subscription and FortiCare technical support services ratably over the service term. Our typical contractual support and subscription term is one to five years. We also generate a small portion of our revenue from other services, for which we recognize revenue as the services are provided, and cloud-based services, for which we recognize revenue as the services are delivered or on a monthly usage basis. As a percentage of total revenue, we continue to expect service revenue to be higher than product revenue. Our service revenue growth rate depends significantly on the growth of our customer base, the expansion of our service bundle offerings, the mix of our product revenue, pricing actions, the expansion and introduction of new service offerings, the attach rate of service contracts to new product sales, and the renewal of service contracts by our existing customers.Our total cost of revenue is comprised of:•Cost of product revenue. The majority of the cost of product revenue consists of third-party contract manufacturers’ costs and the costs of materials used in production. Our cost of product revenue also includes supplies, shipping costs, personnel costs associated with logistics and quality control, facility-related costs, excess and obsolete inventory costs, warranty costs and amortization of intangible assets. Personnel costs include compensation benefits and stock-based compensation.•Cost of service revenue. Cost of service revenue is primarily comprised of personnel costs, third-party repair and contract fulfillment, data center costs, colocation expenses and cloud hosting, supplies, facility-related costs and amortization of intangible assets.Gross margin. Gross profit as a percentage of revenue, or gross margin, has been and will continue to be affected by a variety of factors, including the average sales price of our products, product costs, the mix of products sold and the mix of revenue between hardware products, software licenses and services and any excess inventory or other charges. Service revenue and software licenses have higher gross margins compared to hardware products. During 2022, product gross margin benefited from gains in average selling price, partially offset by higher component costs due to supply chain constraints and the consolidation of Alaxala Networks Corporation (“Alaxala”) starting from August 31, 2021. It also benefited from software revenue growth. Service gross margin decreased due to data center expansion, increased labor cost and our consolidation of Alaxala, partially offset by favorable impact of foreign currency exchange rates and higher average selling prices. Overall gross margin in 2023 will be impacted by service and product revenue mix.Operating expenses. Our operating expenses consist of research and development, sales and marketing and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist primarily of salaries, benefits, bonuses, sales commissions and stock-based compensation. We expect personnel costs to continue to increase in absolute dollars as we expand our workforce. •Research and development. Research and development expense consists primarily of personnel costs. Additional research and development expenses include ASIC and system prototypes and certification-related expenses, depreciation of property and equipment and facility-related expenses. The majority of our research and development is focused on software development and the ongoing development of our hardware products. We record research and development expenses as incurred. As of December 31, 2022, approximately 89% of our research and development teams were located in Canada, the United States and India. As of December 31, 2022, approximately two-thirds of our engineers worked on software development while the remainder worked on hardware development.59Table of Contents•Sales and marketing. Sales and marketing expense is the largest component of our operating expenses and primarily consists of personnel costs. Additional sales and marketing expenses include product marketing, public relations, field marketing and events and channel marketing programs (e.g., partner cooperative marketing arrangements), as well as travel, depreciation of property and equipment and facility-related expenses. We intend to hire additional personnel focused on sales and marketing and expand our sales and marketing efforts worldwide in order to capture market share. •General and administrative. General and administrative expense consists of personnel costs, as well as professional fees, depreciation of property and equipment and software and facility-related expenses. General and administrative personnel include our executive, finance, human resources, information technology and legal organizations. Our professional fees principally consist of outside legal, auditing, tax, information technology and other consulting costs. •Gain on intellectual property matter. Gain on intellectual property matter consists of the amortization of the deferred component of an agreement with a competitor in the network security industry, whereby, the competitor party paid us a lump sum of $50.0 million for a seven-year mutual covenant-not-to-sue for patent claims. Interest income. Interest income consists primarily of interest earned on our cash equivalents and investments. Historically, our investments include corporate debt securities, certificates of deposit and term deposits, commercial paper, money market funds, U.S. government and agency securities and municipal bonds.Interest expense. Interest expense consists primarily of interest expense due to the senior notes and other miscellaneous interest expense.Other expense—net. Other expense—net consists primarily of foreign exchange gains and losses related to foreign currency remeasurement, gains or losses due to the changes in fair value of our marketable equity securities, realized gains and losses of available-for-sale securities, net rental income from real estate, as well as the gain on the sale or the impairment charges of our investments in privately held companies without readily determinable fair values, which are not accounted for under the equity method.Provision for income taxes. We are subject to income taxes in the United States, as well as other tax jurisdictions or countries in which we conduct business. Earnings from our non-U.S. activities are subject to income taxes in local countries and may be subject to U.S. income taxes. Our effective tax rate differs from the U.S. statutory rate primarily due to foreign income subject to different tax rates than in the U.S., federal research and development tax credit, state income taxes, withholding taxes, excess tax benefits related to stock-based compensation expense and the tax impacts of the foreign-derived intangible income (“FDII”) deduction.Critical Accounting Policies and EstimatesOur discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. These principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, cost of revenue and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.We believe that, of the significant accounting policies described in Note 1 to our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, we believe these are the most critical to fully understand and evaluate our financial condition and results of operations.Revenue Recognition Revenues are recognized when control of goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We determine revenue recognition through the following steps:•identification of a contract or contracts with a customer;60Table of Contents•identification of the performance obligations in a contract, including evaluation of performance obligations as to being distinct goods or services in a contract;•determination of a transaction price;•allocation of a transaction price to the performance obligations in a contract; and•recognition of revenue when, or as, we satisfy a performance obligation.Our sales contracts typically contain multiple deliverables, such as hardware, software license, security subscription, technical support services and other services, which are generally capable of being distinct and accounted for as separate performance obligations. Our hardware and software licenses have significant standalone functionalities and capabilities. Accordingly, the hardware and software licenses are distinct from the security subscription and technical support services, as a customer can benefit from the product without the services and the services are separately identifiable within a contract. We allocate a transaction price to each performance obligation based on relative standalone selling price. We establish standalone selling price using the prices charged for a deliverable when sold separately. If not observable through past transactions, we determine standalone selling price by considering multiple historical factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies and the term of a service contract. Deferred Contract Costs and Commission ExpenseWe defer contract costs that are recoverable and incremental to obtaining customer sales contracts. Contract costs, which primarily consist of sales commissions, are amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. Costs for initial contracts that are not commensurate with commissions on renewal contracts are amortized on a straight-line basis over the period of benefit of five years. Estimates, assumptions, and judgments in accounting for deferred contract costs include, but are not limited to, identification of contract costs, anticipated billings and the expected period of benefit. Business CombinationsWe include the results of operations of the businesses that we acquire as of the respective dates of acquisition. We allocate the fair value of the purchase price of our business acquisitions to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair values of these identifiable assets and liabilities is recorded as goodwill. We often continue to gather additional information throughout the measurement period, and if we make changes to the amounts recorded, such changes are recorded in the period in which they are identified.Contingent LiabilitiesFrom time to time, we are involved in disputes, litigation and other legal actions. However, there are many uncertainties associated with any litigation, and these actions or other third-party claims against us may cause us to incur substantial settlement charges, which are inherently difficult to estimate and could adversely affect our results of operations. We periodically review significant claims and litigation matters for the probability of an adverse outcome. We accrue for a loss contingency if a loss is probable and the amount of the loss can be reasonably estimated. These accruals are generally based on a range of possible outcomes that require significant judgement. Estimates can change as individual claims develop. The actual liability in any such matters may be materially different from our estimates, which could result in the need to adjust our liability and record additional expenses.Accounting for Income Taxes We record income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. In addition, deferred tax assets are recorded for the future benefit of utilizing net operating losses and research and development credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets and liabilities are expected to be realized or settled. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount expected to be realized.As part of the process of preparing our consolidated financial statements, we are required to estimate our taxes in each of the jurisdictions in which we operate. We estimate actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as accruals and allowances not currently deductible for tax purposes. These differences result in deferred tax assets, which are included in our consolidated balance sheets. In general, deferred tax assets 61Table of Contentsrepresent future tax benefits to be received when certain expenses previously recognized in our consolidated statements of income become deductible expenses under applicable income tax laws, or loss or credit carryforwards are utilized.In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We continue to assess the need for a valuation allowance on the deferred tax assets by evaluating both positive and negative evidence that may exist. Any adjustment to the valuation allowance on deferred tax assets would be recorded in the consolidated statements of income for the period that the adjustment is determined to be required. We recognize tax benefits from an uncertain tax position only if it is more likely than not, based on the technical merits of the position that the tax position will be sustained on examination by the tax authorities. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Investments in privately held companiesOur investments in privately held companies consist of investments in common stock or in-substance common stock. One of these investments provides us with the ability to exercise significant influence over the investee, but not an absolute controlling financial interest. The investment is accounted for under the equity method of accounting. Determining that we do not control but exercise significant influence over the operating and financial policies of the investee requires significant judgement when considering many factors, including but not limited to, the ownership interest in the investee, board representation, participation in policy-making processes, and participation rights in certain significant financial and operating decisions of the investee in the ordinary course of business. Our investment in Linksys is our only equity method investment. We record our proportionate share of the net earnings or losses of Linksys based on the most recently available financial statements of Linksys, which are provided to us on a three-month lag. We evaluate if there are material transactions or events that occur during the intervening period that materially affect the financial position or results of operations. We also record our share of the amortization of any basis differences, as well as any OTTI as gain or loss from equity method investment in our consolidated statements of income and as an adjustment to the investment balance. We evaluate our equity method investment at the end of each reporting period to determine whether events or changes in business circumstances indicate that the carrying value of the investment may not be recoverable. Evidence of a loss in value might include, but would not necessarily be limited to, series of operating losses, current expected performance relative to expected performance when we initially invested, performance relative to peers and the results of a discounted cash flow analysis. We consider various factors in determining whether an OTTI has occurred, including Linksys financial results and operating history, our ability and intent to hold the investment until its fair value recovers, the implied revenue valuation multiples compared to guideline public companies, Linksys’ ability to achieve milestones and any notable operational and strategic changes.62Table of ContentsResults of OperationsThe following tables set forth our results of operations for the periods presented and as a percentage of our total revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods. Year Ended December 31, 202220212020 (in millions)Consolidated Statements of Income Data:Revenue:Product$1,780.5 $1,255.0 $916.4 Service2,636.9 2,087.2 1,678.0 Total revenue4,417.4 3,342.2 2,594.4 Cost of revenue:Product691.3 487.7 352.4 Service393.6 295.3 217.6 Total cost of revenue1,084.9 783.0 570.0 Gross profit:Product1,089.2 767.3 564.0 Service2,243.3 1,791.9 1,460.4 Total gross profit3,332.5 2,559.2 2,024.4 Operating expenses:Research and development512.4 424.2 341.4 Sales and marketing1,686.1 1,345.7 1,071.9 General and administrative169.0 143.5 119.5 Gain on intellectual property matter(4.6)(4.6)(40.2)Total operating expenses2,362.9 1,908.8 1,492.6 Operating income969.6 650.4 531.8 Interest income17.4 4.5 17.7 Interest expense(18.0)(14.9)— Other expense—net(13.5)(11.6)(7.8)Income before income taxes and loss from equity method investment955.5 628.4 541.7 Provision for income taxes30.8 14.1 53.2 Loss from equity method investment(68.1)(7.6)— Net income including non-controlling interests856.6 606.7 488.5 Less: net loss attributable to non-controlling interests, net of tax(0.7)(0.1)— Net income attributable to Fortinet, Inc.$857.3 $606.8 $488.5 63Table of Contents Year Ended December 31, 202220212020(as percentage of revenue)Revenue:Product40 %38 %35 %Service60 62 65 Total revenue100 100 100 Cost of revenue:Product16 15 14 Service9 9 8 Total cost of revenue25 23 22 Gross margin:Product61 61 62 Service85 86 87 Total gross margin75 77 78 Operating expenses:Research and development12 13 13 Sales and marketing38 40 41 General and administrative4 4 5 Gain on intellectual property matter— — (2)Total operating expenses53 57 58 Operating margin22 19 20 Interest income— — 1 Interest expense— — — Other expense—net— — — Income before income taxes and loss from equity method investment22 19 21 Provision for income taxes1 — 2 Loss from equity method investment(2)— — Net income including non-controlling interests19 18 19 Less: net loss attributable to non-controlling interests, net of tax— — — Net income attributable to Fortinet, Inc.19 %18 %19 %Percentages have been rounded for presentation purposes and may differ from unrounded results. Discussion regarding our financial condition and results of operations for 2021 as compared to 2020 can be found in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 25, 2022.64Table of Contents2022 and 2021 Revenue Year Ended December 31, 20222021 Amount% ofRevenueAmount% ofRevenueChange% Change(in millions, except percentages)Revenue:Product$1,780.5 40 %$1,255.0 38 %$525.5 42 %Service2,636.9 60 2,087.2 62 549.7 26 Total revenue$4,417.4 100 %$3,342.2 100 %$1,075.2 32 %Revenue by geography:Americas$1,785.0 41 %$1,358.8 41 %$426.2 31 %EMEA1,691.8 38 1,275.9 38 415.9 33 APAC940.6 21 707.5 21 233.1 33 Total revenue$4,417.4 100 %$3,342.2 100 %$1,075.2 32 %Total revenue increased by $1.08 billion, or 32%, in 2022 compared to 2021. We continued to experience significant organic revenue growth (i.e., revenue growth excluding attribution from recent acquisitions) with diversification of revenue geographically, and across both customer and industry segments. Revenue from all regions grew, with the Americas contributing the largest portion of the increase on an absolute dollar basis and APAC, which included Alaxala, contributing the largest portion of the increase on a percentage basis.Product revenue increased by $525.5 million, or 42%, in 2022 compared to 2021. Product revenue growth was consistent with an elevated cyber threat landscape, the convergence of security and networking and included the benefit of certain pricing actions. The product revenue growth was primarily due to strong growth across many of our Enhanced Platform Technology products, including our secure access products and software licenses. In addition, our product revenue growth was driven by a strong demand for the wide range operating system capabilities embedded in our Core Platform products.Service revenue increased by $549.7 million, or 26%, in 2022 compared to 2021. Service revenue growth has accelerated over the past three years from 22% in 2020, to 24% in 2021 to 26% in 2022. Compared to 2021, FortiGuard security subscription revenue increased by $302.0 million, or 27% and FortiCare, other technical support and other revenues increased by $247.7 million, or 26%, in 2022. The increases were primarily due to the recognition of revenue from our growing deferred revenue balance related to FortiGuard and other security subscriptions delivered to on-premise and cloud-based environments as well as FortiCare and other technical support. Our growing deferred revenue balance was primarily due to our growth in customer base, expansion of our service offerings, and impact of pricing actions. Of the service revenue recognized in 2022, 66% was included in the deferred revenue balance as of December 31, 2021. Of the service revenue recognized in 2021, 65% was included in the deferred revenue balance as of December 31, 2020.Of the service revenue recognized in each quarter of 2022, from 87% to 88% was included in deferred revenue as of the beginning of the respective quarter.65Table of ContentsCost of revenue and gross margin Year Ended December 31, 20222021Change% Change(in millions, except percentages)Cost of revenue:Product$691.3 $487.7 $203.6 42 %Service393.6 295.3 98.3 33 Total cost of revenue$1,084.9 $783.0 $301.9 39 %Gross margin (%):Product61.2 %61.1 %Service85.1 %85.9 %Total gross margin75.4 %76.6 %Total gross margin decreased by 1.2 percentage points in 2022 compared to 2021, primarily driven by a change in revenue mix to lower margin product revenue from higher margin service revenue and the consolidation of Alaxala starting from August 31, 2021 and partially offset by favorable impact of foreign currency fluctuations. Revenue mix shifted by 2.0 percentage points from service revenue to product revenue, as a percentage of total revenue. Product gross margin increased by 0.1 percentage points in 2022 compared to 2021, primarily driven by higher average selling prices and partially offset by higher expedite fees and other component costs due to supply chain constraints and the consolidation of Alaxala. Cost of product revenue was comprised primarily of third-party contract manufacturers’ costs and the costs of materials used in production.Service gross margin decreased by 0.8 percentage points in 2022 compared to 2021, primarily driven by data center expansion, increased labor cost and our consolidation of Alaxala and partially offset by favorable impact of foreign currency fluctuation and higher average selling prices. Cost of service revenue was comprised primarily of personnel costs, third-party repair and contract fulfillment, data center costs, colocation expenses and cloud hosting, supplies and facility-related costs.Operating expenses Year Ended December 31, Change% Change20222021Amount% ofRevenueAmount% ofRevenue(in millions, except percentages)Operating expenses: Research and development$512.4 12 %$424.2 13 %$88.2 21 %Sales and marketing1,686.1 38 1,345.7 40 340.4 25 General and administrative169.0 4 143.5 4 25.5 18 Gain on intellectual property matter(4.6)— (4.6)— — — Total operating expenses$2,362.9 53 %$1,908.8 57 %$454.1 24 %Percentages have been rounded for presentation purposes and may differ from unrounded results.Research and developmentResearch and development expense increased by $88.2 million, or 21%, in 2022 compared to 2021, primarily due to an increase of $63.1 million in personnel-related costs as a result of increased compensation rates and headcount to support the development of new products and continued enhancements to our existing products. In addition, we incurred increases in depreciation and other occupancy costs of $16.6 million and product development costs of $4.9 million, partially offset by the favorable impact of foreign currency fluctuations. We currently intend to continue to invest in our research and development organization, and expect research and development expense to increase in absolute dollars in 2023.66Table of ContentsSales and marketingSales and marketing expense increased by $340.4 million, or 25%, in 2022 compared to 2021, primarily due to an increase of $208.5 million in personnel-related costs. We significantly increased our sales capacity, including newer non-tenured salespeople. The increase in headcount is expected to help drive global revenue increases. In addition, we incurred increases in marketing-related expenses of $52.6 million, travel expense of $38.8 million, depreciation and other occupancy-related expense of $17.8 million and supplies expense of $10.6 million, partially offset by the favorable impact of foreign currency fluctuations. We currently intend to continue to make investments in sales and marketing resources, which are critical to support our future growth, and expect sales and marketing expense to increase in absolute dollars in 2023.General and administrativeGeneral and administrative expense increased by $25.5 million, or 18%, in 2022 compared to 2021, primarily due to an increase in personnel-related costs of $17.3 million. In addition, we incurred increases in depreciation and other occupancy costs of $3.5 million, subscriptions and other expense of $3.2 million, professional services fee of $2.9 million and provision for expected credit losses of $1.4 million, partially offset by a decrease in legal-related costs of $6.1 million and the favorable impact of foreign currency fluctuations. We currently expect general and administrative expense to increase in absolute dollars in 2023.Operating income and marginWe generated operating income of $969.6 million in 2022, an increase of $319.2 million, or 49%, compared to $650.4 million in 2021. Operating income as a percentage of revenue increased to 22% in 2022 compared to 19% in 2021. The increase in our operating margin primarily benefits from a 2.1 percentage point decrease in sales and marketing expense as a percentage of revenue, primarily due to the favorable impact of foreign currency fluctuations, as well as improvement in sales productivity compared to prior year. In addition, research and development expense and general and administrative expense decreased 1.1 percentage points and 0.5 percentage points, respectively, as percentage of revenue. The benefit from lower operating expense as a percentage of revenue was partially offset by a 1.2 percentage point decrease in gross margin.Interest income, interest expense and other expense—net Year Ended December 31, 20222021Change% Change(in millions, except percentages)Interest income$17.4 $4.5 $12.9 287 %Interest expense(18.0)(14.9)(3.1)21 %Other expense—net(13.5)(11.6)(1.9)16 %Interest income increased by $12.9 million in 2022 as compared to 2021, primarily as a result of higher interest rates, partially offset by lower investment balances. Interest income varies depending on our average investment balances during the period, types and mix of investments, and market interest rates. Interest expense increased by $3.1 million in 2022 as compared to 2021, primarily due to our senior notes issued in the first quarter of 2021. Other expense—net increased by $1.9 million in 2022 as compared to 2021 due to an $8.0 million increase in loss on marketable equity securities, partially offset by a $3.6 million decrease in foreign exchange losses and a $2.5 million increase in net rental income from real estate. Provision for income taxes Year Ended December 31,Change% Change20222021(in millions, except percentages)Provision for income taxes $30.8 $14.1 $16.7 118 %Effective tax rate (%)3 %2 %Our provision for income taxes for 2022 reflects an effective tax rate of 3%, compared to an effective tax rate of 2% for 2021. The provision for income taxes for 2022 was comprised primarily of a $233.4 million tax expense related to U.S. federal and state income taxes, other foreign income taxes, foreign withholding taxes and unrecognized tax benefits. The provision was partially offset by excess tax benefits of $75.8 million from stock-based compensation expense, a tax benefit of $115.2 million from the FDII deduction, and a tax benefit of $11.6 million from federal research and development tax credits.67Table of ContentsOur provision for income taxes for 2021 reflects an effective tax rate of 2%, compared to an effective tax rate of 10% for 2020. The provision for income taxes for 2021 was comprised primarily of a $140.8 million tax expense related to U.S. federal and state income taxes, other foreign income taxes, foreign withholding taxes and unrecognized tax benefits. The provision was partially offset by excess tax benefits of $82.0 million from stock-based compensation expense, a tax benefit of $33.6 million from the FDII deduction, and a tax benefit of $11.1 million from federal research and development tax credits.Loss from Equity Method Investment Year Ended December 31,Change% Change20222021(in millions, except percentages)Loss from equity method investment$(68.1)$(7.6)$(60.5)796 %Loss from equity method investment increased by $60.5 million in 2022 as compared to 2021, due to $38.3 million increase in our proportionate share of Linksys’ financial results as well as the amortization of the basis differences, which included a $17.5 million charge in connection with a valuation allowance established on deferred tax assets at Linksys, and the OTTI charge of $22.2 million recorded in the three months ended December 31, 2022.Seasonality, Cyclicality and Quarterly Revenue TrendsOur quarterly results reflect a pattern of increased customer buying at year-end, which has positively impacted billings and product revenue activity in the fourth quarter. In the first quarter, we generally experience lower sequential customer product buying, followed by an increase in buying in the second and third quarters. Although these seasonal factors may be common in the technology sector, historical patterns should not be considered a reliable indicator of our future sales activity or performance. On a quarterly basis, we have usually generated the majority of our product revenue in the final month of each quarter and a significant amount in the last two weeks of each quarter. We believe this is due to customer buying patterns typical in this industry.Consistent with the seasonality note above, our quarterly revenue over the past two years has increased sequentially each year. Product revenue increased year-over-year as compared to 2021, as we have continued product innovation and launched new product models, expanded our solution sales, including SD-WAN and OT solutions and increased our investments in our sales and marketing organizations. Total gross margin has fluctuated on a quarterly basis primarily due to the relative product and service mix as well as the timing of supplier cost increases and our own price increases. Product gross margin varies based on the types of products sold, their cost profile and their average selling prices. In 2022, product gross margin was impacted by new product introductions, the mix of high-end, mid-range and entry-level Core Platform products and the mix of other Enhanced Platform Technologies products, software sales and the timing and impact of supplier cost increases and our own price list increases. In 2022, we experienced an unusual level of component suppliers charging new expedite fees and increases in freight costs. Historically, we have been able to improve our direct cost of appliances and our product gross margin. Service gross margin is impacted by revenue growth and our personnel-related costs, third-party repair and contract fulfillment, data center, colocation fees, cloud hosting, supplies, facility-related costs and foreign currency fluctuations.68Table of ContentsLiquidity and Capital Resources As of December 31, 202220212020 (in millions)Cash and cash equivalents$1,682.9 $1,319.1 $1,061.8 Short-term and long-term investments548.1 1,634.8 893.8 Marketable equity securities25.5 38.6— Total cash, cash equivalents, investments and marketable equity securities$2,256.5 $2,992.5 $1,955.6 Working capital$732.0 $1,282.5 $910.9 Year Ended December 31, 202220212020 (in millions)Net cash provided by operating activities$1,730.6 $1,499.7 $1,083.7 Net cash provided by (used in) investing activities763.9 (1,325.1)(72.8)Net cash provided by (used in) financing activities(2,130.3)82.8 (1,171.6)Effect of exchange rate changes on cash and cash equivalents(0.4)(0.1)— Net increase (decrease) in cash and cash equivalents$363.8 $257.3 $(160.7)69Table of ContentsLiquidity and capital resources are primarily impacted by our operating activities, including cash tax payments, proceeds from issuance of our investment grade debt, as well as cash used on stock repurchases, real estate purchases and other capital expenditures, investments in various companies and business acquisitions.In recent years, we have received significant capital resources from our billings to customers, issuance of investment grade debt and, to some extent, from the exercise of stock options by our employees. Additional increases in billings may depend on a number of factors, including demand for and availability of our products and services, competition, market or industry changes, macroeconomic events such as rising inflation and interest rates, the COVID-19 pandemic, supply chain capacity and disruptions, international conflicts, including the war in Ukraine, and our ability to execute. We expect proceeds from the exercise of stock options in future years to be impacted by the increased mix of restricted stock units versus stock options granted to our employees and to vary based on our share price. We expect our cash tax payments to increase as a result of a provision in the TCJA requiring taxpayers to capitalize and amortize research and development expenses for tax purposes, other tax law changes and our expected growth.In July 2022, our board of directors authorized a $1.0 billion increase in the authorized stock repurchase under the Repurchase Program, bringing the aggregate amount of authorized to be repurchased to $5.25 billion of our outstanding common stock through February 28, 2023. In 2022, we repurchased 36.0 million shares of common stock under the Repurchase Program for an aggregate purchase price of $1.99 billion. As of December 31, 2022, $529.6 million remained available for future share repurchases under the Repurchase Program. In February 2023, our board of directors approved an extension of the Repurchase Program to February 29, 2024.In March 2021, we issued $1.0 billion aggregate principal amount of senior notes, consisting of $500.0 million aggregate principal amount of 1.0% notes due March 15, 2026 and $500.0 million aggregate principal amount of 2.2% notes due March 15, 2031, in an underwritten registered public offering. We do not currently intend to retire these senior notes early. Refer to Note 11. Debt in Part II, Item 8 of this Annual Report on Form 10-K for information on the senior notes. We expect to continue to increase our data center, office and warehouse capacity to support growth and the expansion of existing services or introduction of new services. As we purchase new properties, we will work to incorporate these properties into the environmental goals we have established. We estimate 2023 capital expenditures to be between $400.0 million and $450.0 million. Our principal commitments consist of obligations under our senior notes, inventory purchase and other contractual commitments. As of December 31, 2022, the long-term debt, net of unamortized discount and debt issuance costs, was $990.4 million. $500.0 million in aggregate principal amount of senior notes is due on March 15, 2026 and $500.0 million in aggregate principal amount of senior notes is due on March 15, 2031. In addition, we enter into non-cancellable agreements with contract manufacturers to procure inventory based on our requirements in order to reduce manufacturing lead times, plan for adequate component supply or incentivize suppliers to deliver. In certain instances, these agreements allow us the option to reschedule and adjust our requirements based on our business needs prior to firm orders being placed. In 2022, we significantly increased these commitments as contract manufacturers and component suppliers significantly increased their pricing and lead times. Inventory purchase commitments as of December 31, 2022, were $1.34 billion, an increase of $194.5 million compared to $1.14 billion as of December 31, 2021. We estimate payments of $1.27 billion due on or before December 31, 2023 related to these commitments. We also have open purchase orders and contractual obligations in the ordinary course of business for which we have not received goods or services. As of December 31, 2022, we had $108.1 million in other contractual commitments having a remaining term in excess of one year that are non-cancelable.As of December 31, 2022, our cash, cash equivalents, investments and marketable equity securities of $2.26 billion were invested primarily in deposit accounts, commercial paper, corporate debt securities, U.S. government and agency securities, certificates of deposit and term deposits, money market funds, municipal bonds and marketable equity securities. It is our investment policy to invest excess cash in a manner that preserves capital, provides liquidity and generates return without significantly increasing risk. We do not enter into investments for trading or speculative purposes.The amount of cash, cash equivalents and investments held by our international subsidiaries was $218.1 million and $132.4 million as of December 31, 2022 and 2021, respectively.We believe that our existing cash and cash equivalents and cash flow from operations will be sufficient for at least the next 12 months to meet our requirements and plans for cash, including meeting our working capital requirements and capital expenditure requirements. In the long term, our ability to support our requirements and plans for cash, including our working capital and capital expenditure requirements will depend on many factors, including our growth rate, the timing and amount of our share repurchases, the expansion of sales and marketing activities, the introduction of new and enhanced products and services offerings, the continuing market acceptance of our products, the timing and extent of spending to support development efforts, our investments in purchasing or leasing real estate, cash tax payments and macroeconomic impacts such as rising inflation and interest rates, the war in Ukraine and the COVID-19 pandemic. Historically, we have required capital principally 70Table of Contentsto fund our working capital needs, share repurchases, capital expenditures and acquisition activities. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all.During 2022, 2021 and 2020, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.Operating ActivitiesCash generated by operating activities is our primary source of liquidity. It is primarily comprised of net income, as adjusted for non-cash items and changes in operating assets and liabilities. Non-cash adjustments consist primarily of amortization of deferred contract costs, stock-based compensation and depreciation and amortization. Changes in operating assets and liabilities consist primarily of changes in deferred revenue, accounts receivable, net, deferred contract costs and deferred tax assets.Our operating activities during 2022 provided cash flows of $1.73 billion as a result of the continued growth of our business and our ability to successfully manage our working capital. Changes in operating assets and liabilities primarily resulted from an increase in sales of our FortiGuard and other security subscription services and FortiCare technical support services to new and existing customers, as reflected by an increase of $1.18 billion in our deferred revenue during 2022.Investing Activities The changes in cash flows from investing activities primarily relate to timing of purchases, maturities and sales of investments, purchases of property and equipment, investments in various companies and business acquisitions. Historically, in making a lease-versus-ownership decision related to warehouse, office or data center space, we have considered various factors including financial metrics and expected long-term growth rates. In certain cases, we have elected to own the facility if we believed that purchasing or developing buildings rather than leasing is more in line with our long-term strategy. We may make similar decisions in the future. We may also make cash payments in connection with future business combinations.During 2022, cash provided by investing activities was primarily driven by $1.08 billion cash proceeds from maturities and sales of investments, net of purchases of investments, $281.2 million of purchases of property and equipment, and $30.8 million used for the acquisitions of certain assets and liabilities in a network detection and response business and the remaining 25% equity interests in Alaxala, net of cash.Financing Activities The changes in cash flows from financing activities primarily relate to repurchase and retirement of common stock, and taxes paid related to net share settlement of equity awards, net of proceeds from the issuance of common stock under our Amended and Restated 2009 Equity Incentive Plan (the “2009 EIP”).During 2022, cash used in financing activities was $2.13 billion, primarily driven by $1.99 billion used to repurchase shares of our common stock and $134.3 million used to pay tax withholding, net of proceeds from the issuance of common stock. Recent Accounting PronouncementsRefer to Note 1 of the notes to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for a full description of recently adopted accounting pronouncements.ITEM 7A. Quantitative and Qualitative Disclosures about Market RiskInvestment and Interest Rate Fluctuation RiskWe are exposed to interest rate risks related to our investment portfolio and outstanding debt.The primary objectives of our investment activities are to preserve principal, provide liquidity and maximize income without significantly increasing risk. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash, cash equivalents, investments and marketable equity securities in a variety of securities, including commercial paper, corporate debt securities, U.S. government and agency securities, certificates of deposit and term deposits, money market 71Table of Contentsfunds, municipal bonds and marketable equity securities. The risk associated with fluctuating interest rates is limited to our investment portfolio. A 10% decrease in interest rates in 2022, 2021 and 2020 would have resulted in an insignificant decrease in our interest income in each of these periods.On March 5, 2021, we issued $1.0 billion aggregate principal amount of senior notes, consisting of $500.0 million aggregate principal amount of 1.0% notes due March 15, 2026 and $500.0 million aggregate principal amount of 2.2% notes due March 15, 2031. We carry the senior notes at face value less unamortized discount on our consolidated balance sheets. As the senior notes bear interest at a fixed rate, we have no financial statement risk associated with changes in interest rates. Refer to Note 11. Debt in Part II, Item 8 of this Annual Report on Form 10-K.Foreign Currency Exchange RiskOur sales contracts are primarily denominated in U.S. dollars and therefore substantially all of our revenue is not subject to foreign currency translation risk. However, a substantial portion of our operating expenses incurred outside the United States are denominated in foreign currencies and are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro (“EUR”), the Japanese yen (“JPY”), the Canadian dollar (“CAD”) and the British pound (“GBP”). To help protect against significant fluctuations in value and the volatility of future cash flows caused by changes in currency exchange rates, we engage in foreign currency risk management activities to minimize the impact of balance sheet items denominated in CAD. We do not use these contracts for speculative or trading purposes. All of the derivative instruments are with high quality financial institutions and we monitor the credit worthiness of these parties. These contracts typically have a maturity of one month and settle on the last day of each month. We record changes in the fair value of forward exchange contracts related to balance sheet accounts in other expense—net in the consolidated statements of income. We recognized an expense of $4.6 million in 2022 due to foreign currency transaction losses.Our use of forward exchange contracts is intended to reduce, but not eliminate, the impact of currency exchange rate movements. Our forward exchange contracts are relatively short-term in nature and are focused on the CAD. Long-term material changes in the value of the U.S. dollar against other foreign currencies, such as the EUR, JPY and GBP, could adversely impact our operating expenses in the future. We assessed the risk of loss in fair values from the impact of hypothetical changes in foreign currency exchange rates. For foreign currency exchange rate risk, a 10% increase or decrease of foreign currency exchange rates against the U.S. dollar with all other variables held constant would have resulted in a $16.4 million change in the value of our foreign currency cash balances as of December 31, 2022.Inflation RiskOur monetary assets, consisting primarily of cash, cash equivalents and short-term investments, are not affected significantly by inflation because they are predominantly short-term. We believe the impact of inflation on replacement costs of equipment, furniture and leasehold improvements will not materially affect our operations. The rate of inflation, however, affects our cost of revenue and expenses, such as those for employee compensation, which may not be readily recoverable in the price of products and services offered by us.72Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information regarding the impact of COVID-19 and other macroeconomic factors. See “Item 1A. Risk Factors” for additional factors that can influence our supply of raw materials, components and equipment. Competition The market for power generation equipment, energy storage systems, grid services solutions and other engine powered products is competitive. We face competition from a variety of large diversified industrial companies as well as smaller generator manufacturers, along with mobile equipment, engine powered tools, solar inverter, battery storage and grid services providers, both domestic and internationally. Specifically in the generator market, most of the traditional participants compete on a more focused basis, targeting specific applications within their larger diversified product mix. We are the only significant market participant with a primary focus on power equipment with a key emphasis on standby, portable and mobile generators with broad capabilities across the residential, light-commercial and industrial markets. We believe that our engineering capabilities and core focus on generators provide us with manufacturing flexibility and enables us to maintain a competitive advantage for product innovation. We also believe our broad product offering, diverse omni-channel distribution model and strong factory support provide additional advantages as well. The Company in recent years has been evolving its business model toward more of a focus on energy technology solutions and services, which has introduced a new set of competitors. 11 Table of Contents A summary of the primary competitors across our main product classes is as follows: Residential products – Kohler, Briggs & Stratton, Cummins, Honda, Champion, Techtronics International, Husqvarna, Ariens, LG Chem, Tesla, Enphase, Solar Edge, Google, Honeywell, and Emerson along with a number of smaller domestic and foreign competitors; certain of which also have broad operations in other manufacturing businesses. C&I products – Caterpillar, Cummins, Kohler, IGSA, AKSA, MultiQuip, Wacker, Doosan, Atlas Copco, Himoinsa, FG Wilson, Woodward, and Co-map, as well as other domestic and foreign competitors; certain of which focus on the market for diesel generators as they are also diesel engine manufacturers. Also, we compete against other regional packagers that serve local markets throughout the world. Other products – Relative to service parts and extended warranty revenue, all of the above-named companies are primary competitors. Relative to grid services optimization software, Autogrid and Energy Hub, along with other grid service solution providers, are primary competitors. In a continuously evolving market, we believe our scale and broad capabilities make us well positioned to remain competitive. We compete primarily based on brand reputation, quality, reliability, pricing, innovative features, breadth of product offering, product availability and factory support. Government Incentives and Regulation, including Environmental Matters Generac’s growing presence in energy technology solutions has increased our exposure to renewable energy mandates, investment tax credits and other demand-creation subsidies from certain existing and potential government incentives, such as incentives included in the Inflation Reduction Act that was passed in 2022. These incentives cover a wide range of products and solutions, including MLPE solutions, solar plus storage systems, grid services, and grid-edge devices, and the availability, size, and outlook for such incentives can impact the markets for these products and solutions. As a manufacturing company, our operations are subject to a variety of federal, state, local and foreign laws and regulations covering environmental, health and safety matters. Applicable laws and regulations include those governing, among other things, emissions to air, discharges to water, noise and employee safety, as well as the generation, handling, storage, transportation, treatment, and disposal of waste and other materials. In addition, our products are subject to various laws and regulations relating to, among other things, emissions and fuel requirements, as well as labeling, storage, transport, and marketing. Our products sold in the United States are regulated by the U.S. Environmental Protection Agency (EPA), California Air Resources Board (CARB) and various other state and local air quality management districts. These governing bodies continue to pass regulations that require us to meet more stringent emission standards, and all of our engines and engine-driven products are regulated within the United States and its territories. In addition, certain products in the United States are subject to safety standards as established by various other standards and rulemaking bodies, or state and local agencies, including the U.S. Consumer Product Safety Commission (CPSC). Similarly, other countries have varying degrees of regulation for our products, depending upon product application and fuel types. See “Item 1A. Risk Factors” for additional legal and regulatory factors that can affect the products we sell and the results of our operations. Environment, Social, and Governance Program Building on our inaugural Environmental, Social, and Governance (ESG) report in 2021, we published our second ESG report in April of 2022 to update our progress in executing the various ESG goals and initiatives that align with our “Powering a Smarter World” enterprise strategy and our purpose statement: Lead the evolution to more resilient, efficient, and sustainable energy solutions. Importantly, we’ve also continued our commitment to building out an effective ESG Program to help us identify material ESG topics that deserve attention and resources, define metrics to measure our performance with respect to those topics, and work towards setting goals to improve that performance. This includes making progress in further building out our extended ESG organization by adding a number of resources to our ESG Steering Committee and ESG Task Force, which is comprised of subject matter experts from across the Company and receives board-level oversight from our Nominating and Corporate Governance Committee. The information provided within our ESG Report published in April of 2022, or any future ESG Report in 2023, is not part of this report and is therefore not incorporated herein by reference. A copy of the ESG Report is available from our Investor Relations webpage at Generac.com. We plan to publish an updated ESG Report in April of 2023 that coincides with the filing of our annual Proxy Statement. 12 Table of Contents Human Capital "Our People" is one of the foundational elements to our “Powering a Smarter World” enterprise strategy and is a corporate value as well. We foster a culture of diversity and engagement to strengthen our company while supporting individual achievement, equity, inclusivity and good corporate citizenship globally. We believe our success is directly tied to our employees’ professional growth and personal well-being, combined with strong families and communities. Some examples of key human capital programs and initiatives that we are focused on include: Health, wellness and safety – Employee health and safety is the Company’s top priority. Generac’s Healthy & Thriving Total Rewards are based on the four pillars of balance, security, well-being and community. These programs are designed to meet the varied and evolving needs of our diverse workforce. We maintain an employee wellness program, incentivize healthy-living activities, and we develop and administer company-wide policies to help ensure the safety of each employee and compliance with government agency and other standards. Diversity, equity and inclusion (DEI) – At Generac, people with diverse backgrounds and points of view work together to support our customers around the globe. As an inclusive workplace, our employees embrace diversity in all forms, celebrate differences, and treat others with equality and respect. Generac is also focused on building understanding and awareness of DEI through education and open communication. We sponsor employee-led Business Employee Resource Groups (BERGs) to facilitate networking and strong connections with peers and leadership and to increase the listening and learning opportunities across our workforce. We have expanded our DEI Learning Library and we partner with community job agencies representing disabled clients and workforce release programs to provide job opportunities to those who face barriers to employment. Talent development & employee engagement – Our success is directly tied to our employees and what we can accomplish together. We prioritize creating opportunities to help employees build careers and support their growth as part of a meaningful and valuable employee experience. We hold internal career development events as well as partner with local educational resources to offer on the job learning, collaborative work experiences and formal learning programs on lean methodology and project management skills to support progressions and advancement of our workforce. Further, we maintain an ongoing global employee engagement initiative with targeted action plans by region, function, and business group. Action plans and their progress are measured by global employee engagement surveys. As of December 31, 2022, we had 9,500 employees (9,160 full time and 340 part-time and temporary employees). Of those, approximately 4,500 employees were directly or indirectly involved in manufacturing at our manufacturing facilities. Domestically, we have had an “open shop” bargaining agreement for the past 50 years. The current agreement, which expires October 17, 2026, covers our Eagle, Wisconsin facility. Additionally, our plants in Mexico, Italy and Spain are operated under various local or national union groups. Our other facilities are not unionized. Available Information The Company’s principal executive offices are located at S45 W29290 Highway 59, Waukesha, Wisconsin, 53189 and the Company’s telephone number is (262) 544-4811. The Company’s website is www.generac.com. The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are available free of charge through the “Investor Relations” portion of the Company’s web site, as soon as reasonably practicable after they are filed with the Securities and Exchange Commission (SEC). The information provided on these websites is not part of this report and is therefore not incorporated herein by reference. Information About Our Executive Officers The following table sets forth information regarding our executive officers: Name Age Position Aaron P. Jagdfeld 51 President, Chief Executive Officer and Chairman York A. Ragen 51 Chief Financial Officer Erik Wilde 48 Executive Vice President, Industrial, Americas Patrick Forsythe 55 Chief Technical Officer Raj Kanuru 52 Executive Vice President, General Counsel and Secretary Norman Taffe 56 President, Energy Technology Kyle Raabe 48 President, Consumer Power 13 Table of Contents Aaron P. Jagdfeld has served as our Chief Executive Officer since September 2008, as a director since November 2006 and was named Chairman in February 2016. Prior to becoming Chief Executive Officer, Mr. Jagdfeld worked for Generac for 15 years. He began his career in the finance department in 1994 and became our Chief Financial Officer in 2002. In 2007, he was appointed President and was responsible for sales, marketing, engineering and product development. Prior to joining Generac, Mr. Jagdfeld worked in the audit practice of the Milwaukee, Wisconsin office of Deloitte and Touche. Mr. Jagdfeld holds a Bachelor of Business Administration in Accounting from the University of Wisconsin-Whitewater. York A. Ragen has served as our Chief Financial Officer since September 2008. Prior to becoming Chief Financial Officer, Mr. Ragen held Director of Finance and Vice President of Finance positions at Generac. Prior to joining Generac in 2005, Mr. Ragen was Vice President, Corporate Controller at APW Ltd., a spin-off from Applied Power Inc., now known as Enerpac Tool Group. Mr. Ragen began his career at Arthur Andersen in the Milwaukee, Wisconsin office audit practice. Mr. Ragen holds a Bachelor of Business Administration in Accounting from the University of Wisconsin-Whitewater. Erik Wilde began serving as our Executive Vice President, Industrial, Americas in July 2016. Mr. Wilde was Vice President and General Manager of the Mining Division for Komatsu America Corp., a manufacturer of construction, mining, and compact construction equipment, from 2013 until he joined Generac. Prior to that role, he held leadership positions as Vice President of the ICT Business Division and Product Marketing at Komatsu America Corp. beginning in 2005. Mr. Wilde holds a Bachelor of Business Administration in Management from Boise State University and an M.B.A. from the Keller Graduate School of Management. Patrick Forsythe has served as our Chief Technical Officer since January 2021. He previously served as our Executive Vice President of Global Engineering beginning in July 2015. Prior to re-joining Generac, Mr. Forsythe was Vice President, Global Engineering & Technology of Hayward Industries from 2008 to 2015, Vice President, Global Engineering at Ingersoll Rand Company (and the acquired Doosan Infracore International) from 2004 to 2008, and Director of Engineering at Ingersoll Rand Company from 2002 to 2004. Prior to 2002, Mr. Forsythe worked in various engineering management capacities with Generac from 1995 to 2002. Mr. Forsythe holds a Higher National Diploma (HND) in Mechanical Engineering from the University of Ulster (United Kingdom), a B.S. in Mechanical Engineering, and an M.S. in Manufacturing Management & Technology from The Open University (United Kingdom). Raj Kanuru is our Executive Vice President, General Counsel & Secretary and is the Company’s principal legal and compliance officer, roles that he has held since joining Generac in 2013. Prior to joining Generac, Mr. Kanuru served as in-house counsel at Caterpillar Inc. for almost 14 years within various leadership roles, including in Caterpillar’s Securities, Regulatory and Tax group, in Caterpillar Financial, and in Caterpillar’s Energy & Transportation group. From 2009 to 2013, Mr. Kanuru served as Vice President, General Counsel and Secretary of Progress Rail Services Inc., and its subsidiaries (a Caterpillar company). He began his legal career as a senior associate in the tax consulting practice of Arthur Andersen LLP. Mr. Kanuru holds a Bachelor of Science in Finance degree from Birmingham-Southern College and received his Juris Doctor degree from the University of Alabama. Norman Taffe began serving as President – Energy Technology in August 2022. Prior to joining Generac, Mr. Taffe was Executive Vice President North America Residential of SunPower Corporation from 2018 to 2021. Prior to this, Mr. Taffe was Executive Vice President - Products and Vice President of Power Plant Products and Solutions from 2013 to 2018. Mr. Taffe also worked in various engineering and marketing management capacities at Cypress Semiconductor from 1989 to 2012, including Executive Vice President – Consumer & Computation Devices from 2005 to 2012. Mr. Taffe holds a Bachelor of Science in Electrical Engineering from the University of Michigan and an Executive MBA from Harvard Business School. Kyle Raabe has served as our President, Consumer Power since November 2019. Prior to rejoining Generac, Mr. Raabe was Senior Vice President of North American Sales, Demand Planning and Sales Operations from 2018 through 2019 and Vice President of Sales for the Commercial Security and Safety groups from 2015 through 2018 at The Master Lock Corporation, a manufacturer of locks, combination padlocks and other security products. Prior to working at The Master Lock Corporation, Mr. Raabe led multiple groups at Generac Power Systems from 2007 through 2015 as Director of Wholesale and Dealer Distribution, Vice President Wholesale Distribution Sales and Vice President, Industrial Distribution Sales. Before joining Generac, Kyle served at Veolia North America, Environmental Services leading Midwest Regional Service Operations. Mr. Raabe holds a BA, Biological Science from Lawrence University. Item 1A. Risk Factors You should carefully consider the following risks. These risks could materially affect our business, results of operations or financial condition, cause the trading price of our common stock to decline materially or cause our actual results to differ materially from those expected or those expressed in any forward-looking statements made by us. These risks are not exclusive, and additional risks to which we are subject include, but are not limited to, the factors mentioned under “Forward-Looking Statements” and the risks of our businesses described elsewhere in this Annual Report. 14 Table of Contents Risk factors related to our business and industry Decreases in the availability and quality, or increases in the cost, of raw materials, key components and labor we use to make our products could materially reduce our earnings. The principal raw materials that we use to produce our products are steel, copper and aluminum as well as batteries and advanced electronic components. We also source a significant number of component parts from third parties that we utilize to manufacture our products. The prices of those raw materials and components are susceptible to significant fluctuations due to trends in supply and demand, commodity prices, currencies, transportation costs, government regulations and tariffs, price controls, economic conditions and other unforeseen circumstances beyond our control. In fact, we have recently seen such trends significantly impact our business resulting in higher costs and shortages in materials, components and labor, and such impacts may continue for the foreseeable future. We typically do not have long-term supply contracts in place to ensure the raw materials and components we use are available in necessary amounts or at fixed prices. In the short term, we have been unable to fully mitigate raw material or component price increases through product design improvements, price increases to our customers, manufacturing productivity improvements, or hedging transactions, and if our mitigation efforts continue to not be fully effective in the short or long term, our profitability could be adversely affected. We implemented multiple rounds of price increases in 2021 and 2022 to combat rising input costs, and the realization of these pricing actions in 2022 have partially offset the margin impact from these rising input costs. Also, our ability to continue to obtain quality materials and components is subject to the continued reliability and viability of our suppliers, including in some cases, suppliers who are the sole source of certain important components. It has been challenging to consistently obtain adequate, cost efficient or timely deliveries of certain required raw materials and components, or sufficient labor resources while we ramp up production to meet higher levels of demand, and if this trend continues, we may be unable to manufacture sufficient quantities of products on a timely basis. This could cause us to lose additional sales, incur additional costs, delay new product introductions or suffer harm to our reputation. We depend upon a small number of outside contract manufacturers and component suppliers for certain products, and our business and operations could be disrupted if we encounter problems with these parties. For certain products we do not have internal manufacturing capabilities and rely upon a small number of contract manufacturers to build these products or supply these components, including but not limited to certain clean energy products or components. The timing of purchases in future periods could differ materially from our estimates due to fluctuations in demand requirements related to varying sales levels as well as changes in economic conditions. Further, the revenues that our contract manufacturers generate from our orders may represent a relatively small percentage of their overall revenues. As a result, fulfilling our orders may not be considered a priority in the event of constrained ability to fulfill all of their customer obligations in a timely manner. If any of these contract manufacturers or component suppliers were unable or unwilling to manufacture or produce our products in required volumes and at high quality levels or renew existing terms under supply agreements, we would have to identify, qualify and select acceptable alternative contract manufacturers, which may not be available to us on favorable terms, if at all. Our reliance on such contract manufacturers makes us vulnerable to possible capacity constraints and reduced control over component availability, delivery schedules, quality issues, manufacturing yields and costs. If any of these suppliers reduce or eliminate the supply of the components to us in the future, our revenues, business, financial condition and results of operations would be adversely impacted. Our business could be negatively impacted if we fail to adequately protect our intellectual property rights or if third parties claim that we are in violation of their intellectual property rights. We consider our intellectual property rights to be important assets, and seek to protect them through a combination of patent, trademark, copyright and trade secret laws, as well as licensing and confidentiality agreements. These protections may not be adequate to prevent third parties from using our intellectual property without our authorization, breaching any confidentiality agreements with us, copying or reverse engineering our products, or developing and marketing products that are substantially equivalent to or superior to our own. The unauthorized use of our intellectual property by others could reduce our competitive advantage and harm our business. Not only are intellectual property-related proceedings burdensome and costly, but they could span years to resolve and we might not ultimately prevail. We cannot guarantee that any patents, issued or pending, will provide us with any competitive advantage or will not be challenged by third parties. Moreover, the expiration of our patents may lead to increased competition with respect to certain products. If we fail to protect our intellectual property and other proprietary rights, or if such intellectual property and proprietary rights are infringed, misappropriated or otherwise violated, our business, results of operations or financial condition could be materially harmed. In addition, we cannot be certain that we do not or will not infringe third parties' intellectual property rights. We currently are, and have previously been, subject to such third party infringement claims, and may continue to be in the future. Any such claim, even if it is believed to be without merit, may be expensive and time-consuming to defend, subject us to damages, cause us to cease making, using or selling certain products that incorporate the disputed intellectual property, require us to redesign our products, divert management time and attention, and/or require us to enter into costly royalty or licensing arrangements. In addition, we may not prevail in such proceedings. An adverse outcome of any such proceeding may reduce our competitive advantage or otherwise harm our financial condition and our business. 15 Table of Contents We may incur costs and liabilities as a result of product liability and other claims. We face a risk of exposure to current and future product liability claims alleging to arise from the use of our products and that may purportedly result in injury or other damage. Although we currently maintain product liability insurance coverage, we may not be able to obtain such insurance on acceptable terms in the future, if at all, or obtain insurance that will provide adequate coverage against potential claims. Product liability claims can be expensive to defend and can divert the attention of management and other personnel for long periods of time, regardless of the ultimate outcome. A significant unsuccessful product liability defense could have a material adverse effect on our financial condition and results of operations. In addition, we believe our business depends on the strong brand reputation we have developed. If our reputation is damaged, we may face difficulty in maintaining our market share and pricing with respect to some of our products, which could reduce our sales and profitability. We have experienced, and may continue to experience, product liability claims or other product related claims, including higher warranty costs or product recalls, which may impact our reputation and resulting sales and profitability. For example, we have and may continue to experience product liability, product quality or reliability claims, or warranty claims with respect to certain clean energy products, including being subject to certain consumer product class action lawsuits in relation to such products. In the third quarter of 2022, we recognized a charge of $37.3 million related to clean energy product warranty costs. In the event such product or warranty related claims were to be significantly higher in the future, or we incur losses or other damages associated with current or future product liability lawsuits or product related claims, this may continue to adversely affect our reputation or brand quality in relation to such products, subject us to significantly increased costs, and otherwise materially harm our results of operation, financial condition and our business. For further information, see footnote “18. Commitments and Contingencies”. Demand for the majority of our products is significantly affected by unpredictable power outage activity that can lead to substantial variations in, and uncertainties regarding, our financial results from period to period. Sales of our products are subject to consumer buying patterns, and demand for the majority of our products is affected by power outage events caused by thunderstorms, hurricanes, ice storms, blackouts, public safety power shutoffs, and other power grid reliability issues. The impact of these outage events on our sales can vary depending on the location, frequency and severity of the outages. Sustained periods without major power disruptions can lead, and in the past have led, to reduced consumer awareness of the benefits of standby and portable generator products and can result and have previously resulted in reduced sales growth rates and excess inventory. There are smaller, more localized power outages that occur frequently that drive a baseline level of demand for back-up power solutions. The lack of major power outage events and fluctuations to the baseline levels of power outage activity are part of managing our business, and these fluctuations could have, and previously have had, an adverse effect on our net sales and profits. Despite their unpredictable nature, we believe power disruptions create awareness and accelerate adoption of our home standby products. Demand for our products is significantly affected by durable goods spending by consumers and businesses, and other macroeconomic conditions. Our business is affected by general economic conditions, and uncertainty or adverse changes, such as the prolonged downturn in U.S. residential investment and the impact of more stringent credit standards and rising interest rates or inflation. These have previously led and could lead again to a decline in demand for our products and pressure to reduce our prices. Our sales of light-commercial and industrial generators are affected by conditions in the non-residential construction sector and by the capital investment trends for small and large businesses and municipalities. If these businesses and municipalities cannot access credit markets or do not utilize discretionary funds to purchase our products as a result of the economy or other factors, our business could suffer and our ability to realize benefits from our strategy of increasing sales in the light-commercial and industrial sectors could be adversely affected. In addition, consumer confidence and home remodeling expenditures have a significant impact on sales of our residential products, and prolonged periods of weakness in consumer durable goods spending has previously had, and could again have a material impact on our business. We currently do not have any material contracts with our customers which call for committed volume, and we cannot guarantee that our current customers will continue to purchase our products at the same level, if at all. If general economic conditions or consumer confidence were to worsen, or if the non-residential construction sector or rate of capital investments were to decline, our net sales and profits would likely be adversely affected. Changes in government monetary or fiscal policies may negatively impact our results, including increases in interest rates or sustained inflationary pressure which could negatively affect overall growth and impact sales of our products. Additionally, timing of capital spending by our national account customers can vary from quarter-to-quarter based on capital availability and internal capital spending budgets. Also, the availability of renewable energy mandates and investment tax credits and other subsidies can have an impact on the demand for energy storage systems. Our global operations are exposed to political and economic risks, commercial instability and events beyond our control in the countries in which we operate. Such risks or events may disrupt our supply chain and not enable us to produce products to meet customer demand. The industries in which we compete are highly competitive, and our failure to compete successfully could adversely affect our results of operations and financial condition. We operate in markets that are highly competitive. Some of our competitors have established brands and are larger in size or are divisions of large, diversified companies which have substantially greater financial resources than we do. Some of our competitors have and may continue to be willing to reduce prices and accept lower margins in order to compete with us. In addition, we could face new competition from large international or domestic companies with established brands that enter our end markets. Demand for our products may also be affected by our ability to respond to changes in design and functionality, to respond to downward pricing pressure, and to provide shorter lead times for our products than our competitors. If we are unable to respond successfully to these competitive pressures, we could lose market share, which could have an adverse impact on our results. For further information, see “Item 1—Business—Competition”. Our industry is subject to technological change, and our failure to continue developing new and improved products and to bring these products rapidly to market could have an adverse impact on our business. New products, or refinements and improvements to our existing products, may have technical failures, delayed introductions, higher than expected production costs or may not be well accepted by our customers. If we are not able to anticipate, identify, develop and market high-quality products in line with technological advancements that respond to changes in customer preferences, demand for our products could decline and our operating results could be adversely affected. 16 Table of Contents We rely on independent dealers and distribution partners, and the loss of these dealers and distribution partners, or of any of our sales arrangements with significant private label, national, retail or equipment rental customers, would adversely affect our business. We depend on the services of independent distributors and dealers to sell and install our products and provide service and aftermarket support to our end customers. Their capacity constraints and/or inability to install and service our products could limit our ability to maintain and grow our sales. For example, since the second half of 2022 we experienced, and will continue to experience through the first half of 2023 or until inventory levels normalize, higher field inventories and lower orders from our channel partners for home standby generators given installation capacity constraints in our distribution network. We also rely on our distribution channels to drive awareness for our product categories and our brands. In addition, we sell our products to end users through private label arrangements with leading home equipment, electrical equipment and construction machinery companies; arrangements with top retailers and equipment rental companies; and our direct national accounts with telecommunications and other industrial customers. Our distribution agreements and any contracts we have with large national, retail and other customers are typically not exclusive, and many of the distributors with whom we do business also offer competitors’ products and services. Impairment of our relationships with our distributors, dealers or large customers, loss of a substantial number of these distributors or dealers or of one or more large customers, or an increase in our distributors' or dealers' sales of our competitors' products to our customers or of our large customers' purchases of our competitors' products could materially reduce our sales and profits. For example, we have had, and may continue to have, disputes with one or more customers, distributors or dealers to whom we sell our products, including clean energy products, and this may reduce or limit the sales growth for such products. In the third quarter of 2022, we had a key clean energy product customer that filed for Chapter 7 bankruptcy, which adversely impacted our clean energy sales in the last six months of the year. Additionally, our ability to successfully realize our growth strategy is dependent in part on our ability to identify, attract and retain new distributors at all layers of our distribution platform, including increasing the number of energy storage distributors, and we cannot be certain that we will be successful in these efforts. For further information, see “Item 1—Business—Distribution Channels and Customers”. We are unable to determine the specific impact of changes in selling prices or changes in volumes or mix of our products on our net sales. Because of the wide range of products that we sell, the level of customization for many of our products, the frequent rollout of new products, the different accounting systems utilized, and the fact that we do not apply pricing changes uniformly across our entire portfolio of products, we are unable to determine with specificity the effect of volume or mix changes or changes in selling prices on our net sales. Policy changes affecting international trade could adversely impact the demand for our products and our competitive position. Changes in government policies on foreign trade and investment can affect the demand for our products, impact the competitive position of our products or prevent us from being able to sell products in certain countries. Our business benefits from free trade agreements, and efforts to withdraw from, or substantially modify such agreements, in addition to the implementation of more restrictive trade policies, such as more detailed inspections, higher tariffs, import or export licensing requirements, exchange controls or new barriers to entry, could have a material adverse effect on our results of operations, financial condition or cash flows. For example, we are experiencing increased tariffs on certain of our products and product components. However, these tariffs have not ultimately had a material adverse effect on our results due to the implementation of various mitigation efforts in conjunction with our supply chain and end market partners. In addition, certain of our products have and may continue to be subject to the imposition of higher duties as a result of anti-dumping and countervailing duties applied against them. To the extent such governmental actions, duties or tariffs are applied to such products, it could adversely affect our results of operations, financial condition and business. Risk factors related to our operations The loss of any key members of our senior management team or key employees could disrupt our operations and harm our business. Our success depends, in part, on the efforts of certain key individuals, including the members of our senior management team, who have significant experience in the energy products and solutions industry. If, for any reason, our senior executives do not continue to be active in management, or if key employees leave our company, our business, financial condition or results of operations could be adversely affected. Failure to continue to attract or retain these individuals at reasonable compensation levels could have a material adverse effect on our business, liquidity and results of operations. If we need to replace any of these individuals in the near future, the loss of the services could disrupt our operations and have a material adverse effect on our business if we do not have effective succession plans in place. Disruptions caused by labor disputes or organized labor activities could harm our business. We may from time to time experience union organizing activities in our non-union facilities. Disputes with the current labor union or new union organizing activities could lead to work slowdowns or stoppages and make it difficult or impossible for us to meet scheduled delivery times for product shipments to our customers, which could result in loss of business. In addition, union activity could result in higher labor costs, which could harm our financial condition, results of operations and competitive position. A work stoppage or limitations on production at our facilities for any reason could have an adverse effect on our business, results of operations and financial condition. In addition, many of our suppliers have unionized work forces. Strikes or work stoppages experienced by our customers or suppliers could have an adverse effect on our business, results of operations and financial condition. 17 Table of Contents We may experience material disruptions to our manufacturing operations. While we seek to operate our facilities in compliance with applicable rules and regulations and take measures to minimize the risks of disruption at our facilities, a material disruption at one of our manufacturing facilities could prevent us from meeting customer demand, reduce our sales and/or negatively impact our financial results. Any of our manufacturing facilities, or any of our equipment within an otherwise operational facility, could cease operations unexpectedly due to a number of events, including: ● equipment or information technology infrastructure failure; ● disruptions in the transportation infrastructure including roads, bridges, railroad tracks and container ports; ● fires, floods, tornadoes, earthquakes, disease, pandemics, acts of violence, or other catastrophes; and ● other operational problems. In addition, a significant portion of our manufacturing and production facilities are in Wisconsin within a 100-mile radius of each other. We could experience prolonged periods of reduced production due to unforeseen events occurring in or around our manufacturing facilities in Wisconsin. In the event of a business interruption at our facilities, in particular our Wisconsin facilities, we may be unable to shift manufacturing capabilities to alternate locations, accept materials from suppliers or meet customer shipment needs, among other severe consequences. Such an event could have a material and adverse impact on our financial condition and results of our operations. We are vulnerable to supply disruptions from single-sourced suppliers. We single-source certain types of parts in our product designs. Delays in our suppliers' deliveries have impaired, and may continue to impair, our ability to deliver products to our customers. A wide variety of factors could cause such delays including, but not limited to, lack of capacity, economic downturns, availability of credit, logistical challenges, labor or material shortages, trade restrictions, weather events, political instability, wars, terrorism, civil unrest, disease or natural disasters. We may not realize all of the anticipated benefits of our acquisitions or those benefits may take longer to realize than expected. We may also encounter significant unexpected difficulties in integrating acquired businesses. Our ability to realize the anticipated benefits of our acquisitions will depend, to a large extent, on our ability to integrate the acquired businesses with our business. The integration of independent businesses is a complex, costly and time-consuming process. Further, integrating and managing businesses with international operations may pose challenges not previously experienced by our management. As a result, we may be required to devote significant management attention and resources to integrating the business practices and operations of any acquired businesses with ours. The integration process may disrupt our business and, if implemented ineffectively, could preclude realization of the full benefits expected by us. Our failure to meet the challenges involved in integrating an acquired business into our existing operations or otherwise to realize the anticipated benefits of the transaction could cause an interruption of, or a loss of momentum in, our activities and could adversely affect our results of operations. In addition, the overall integration of our acquired businesses may result in material unanticipated problems, expenses, liabilities, competitive responses, loss of customer relationships, and diversion of management's attention, and may cause our stock price to decline. The difficulties of combining the operations of acquired businesses with ours include, among others: ● managing a larger company; ● maintaining employee morale and retaining key management and other employees; ● complying with newly applicable domestic and foreign regulations as we enter new product and geographic markets; ● integrating two business cultures, which may prove to be incompatible; ● the possibility of faulty assumptions underlying expectations regarding the integration process; ● retaining existing customers and attracting new customers; ● consolidating corporate and administrative infrastructures and eliminating duplicative operations; ● the diversion of management's attention from ongoing business concerns and performance shortfalls as a result of management's attention to the acquisition; ● unanticipated issues in integrating information technology, communications and other systems; ● complying with changes in applicable or new laws and regulations; ● managing tax costs or inefficiencies associated with integrating the operations or supply chain of the combined company; ● unforeseen liabilities, expenses or delays associated with the acquisition; ● difficulty comparing financial reports due to differing financial and/or internal reporting systems; and ● making any necessary modifications to internal financial control standards to comply with the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated thereunder. Many of these factors will be outside of our control and any one of them could result in increased costs, decreases in the amount of expected revenues and diversion of management's time and energy, which could materially impact our business, financial condition and results of operations. In addition, even if the operations of our acquired businesses are integrated successfully with our operations, we may not realize the full benefits of the transaction, including the synergies, cost savings or sales or growth opportunities that we expect. These benefits may not be achieved within the anticipated time frame, or at all, and additional unanticipated costs may be incurred in the integration or management of our businesses. All these factors could cause dilution to our earnings per share, decrease or delay the expected accretive effect of the acquisition, and cause a decrease in the price of our common stock. As a result, we cannot be assured that the combination of our acquisitions with our business will result in the realization of the full benefits anticipated from the transaction. 18 Table of Contents A significant portion of our purchased components are sourced in foreign countries, exposing us to additional risks that may not exist in the United States. We source a significant portion of our purchased components overseas, primarily in Asia and Europe. Our international sourcing subjects us to a number of potential risks in addition to the risks associated with third-party sourcing generally. Such risks include: ● inflation or changes in political and economic conditions; ● logistical challenges, including extended container port congestion, and higher logistics costs; ● unstable regulatory environments; ● changes in import and export duties; ● domestic and foreign customs and tariffs; ● currency rate fluctuations; ● trade restrictions; ● labor or civil unrest; ● disputes in our relationships with certain contract manufacturers or suppliers; ● communications challenges; and ● other restraints and burdensome taxes. These factors have had in the past and are currently having an adverse effect on our ability to efficiently and cost effectively source our purchased components overseas. In addition, we are experiencing higher logistics costs due to the current challenging supply chain environment. Additionally, if the U.S. dollar were to depreciate significantly against the currencies in which we purchase raw materials from foreign suppliers, our cost of goods sold could increase materially, which would adversely affect our results of operations. Risk factors related to legal and regulatory matters As a U.S. corporation that conducts business in a variety of foreign countries, we are subject to the Foreign Corrupt Practices Act and a variety of anti-corruption laws worldwide. A determination that we violated any of these laws may affect our business and operations adversely. The U.S. Foreign Corrupt Practices Act (FCPA) generally prohibits U.S. companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or keeping business. The United Kingdom Bribery Act (UKBA) prohibits domestic and foreign bribery of the private sector as well as public officials. Any determination that we have violated any anti-corruption laws could have a material adverse effect on our financial position, operating results and cash flows. Costs associated with lawsuits, investigations or adverse rulings in enforcement or other legal proceedings may have an adverse effect on our results of operations. We are subject to a variety of legal proceedings and legal compliance risks. We currently face risk of exposure to various types of claims, lawsuits and government investigations, and may continue to face such risks in the future. We are currently and, may in the future be, involved in various claims and lawsuits related to product design, safety, manufacture and performance liability, contracts, employment issues, environmental matters, intellectual property rights, tax, securities, regulatory compliance, and other legal proceedings that arise in and outside of the ordinary course of our business. The industries in which we operate are also periodically reviewed or investigated by regulators, and we are subject to and may continue to be subject to such investigations and claims, including by the CPSC and EPA, which could lead to enforcement actions, fines and penalties or the assertion of private litigation claims. For example, on November 30, 2022, the CPSC notified the Company of its intention to recommend the imposition of a penalty for failing to timely submit a report under section 19(a)(4) of the Consumer Product Safety Act (“CPSA”), 15 U.S.C. § 2068(a)(4), in relation to certain portable generators that were subject to a recall announcement on July 29, 2021. In addition, on October 28, 2022, Generac Power received a grand jury subpoena from the U.S. Attorney for the Eastern District of Michigan, as a result of which the Company became aware of an enforcement investigation by the U.S. Department of Justice (“DOJ”). The subpoena requests similar documents and information provided by the Company to the U.S. EPA and the CARB in response to civil document requests related to the Company’s compliance with emissions regulations for approximately 1,850 portable generators produced by the Company in 2019 and 2020 and sold in 2020. The Company is cooperating with both the DOJ and the EPA and CARB inquiries. It is not possible to predict with certainty the outcome of such claims, or any other current or future claims, investigations and lawsuits, and we could in the future incur judgments, fines or penalties or enter into settlements of lawsuits and claims that could have an adverse effect on our reputation, business, results of operations or financial condition in any particular period. The nature of our operations means that legal and compliance risks will continue to exist and additional legal proceedings and other contingencies, the outcome of which cannot be predicted with certainty, may arise from time to time. In addition, subsequent developments in legal proceedings or investigations may affect our assessment and estimates of loss contingencies recorded as a reserve and require us to make payments in excess of our reserves, which could have an adverse effect on our reputation, business and results of operations or financial condition. For further information, see footnote “18. Commitments and Contingencies”. Our operations are subject to various environmental, health and safety laws and regulations, and non-compliance with or liabilities under such laws and regulations could result in substantial costs, fines, sanctions and claims. Our operations are subject to a variety of foreign, federal, state and local environmental, health and safety laws and regulations including those governing, among other things, emissions to air; discharges to water; noise; and the generation, handling, storage, transportation, treatment and disposal of waste and other materials. In addition, under federal and state environmental laws, we could be required to investigate, remediate and/or monitor the effects of the release or disposal of materials both at sites associated with past and present operations and at third-party sites where wastes generated by our operations were disposed. This liability may be imposed retroactively and whether or not we caused, or had any knowledge of, the existence of these materials and may result in our paying more than our fair share of the related costs. Violations of or liabilities under such laws and regulations could result in substantial costs, fines and civil or criminal proceedings or personal injury and workers' compensation claims. Our products are subject to substantial government regulation. Our products are subject to extensive statutory and regulatory requirements governing, among other things, emissions, noise, labeling, transport, product content, product safety, and data privacy, including standards imposed by the EPA, CARB, CPSC and other regulatory agencies around the world. Also, as we increase our connectivity with our products and customers, we may be required to comply with additional data privacy and cybersecurity regulations. For example, personal privacy and data security have become significant issues in the United States, Europe, and in many other jurisdictions in which we operate. The regulatory framework for privacy and security issues worldwide is rapidly evolving and is likely to remain uncertain for the foreseeable future. In the United States, these include rules and regulations promulgated or pending under the authority of federal agencies, state attorneys general, legislatures, and consumer protection agencies. Internationally, many jurisdictions in which we operate have established their own data security and privacy legal framework with which we, relevant suppliers, and customers must comply. Although we have implemented certain policies, procedures, and, in other cases, contractual arrangements designed to facilitate compliance with applicable privacy and data security laws and standards, any inability or perceived inability to adequately address privacy and security concerns, even if unfounded, or comply with applicable privacy and data security laws, regulations, and policies, could result in additional fines, costs, and liabilities to us, damage our reputation, inhibit sales, and adversely affect our business. These laws are constantly evolving and many are becoming increasingly stringent. As a further example, recent CARB regulations that will prohibit future sales in California of certain small off-road engines may negatively affect the long-term sales of certain products we sell today in that state. In addition, some cities or municipalities have imposed, or are considering, limiting natural gas connections to new buildings or imposing additional permitting restrictions which could adversely affect the sales of certain products we sell in such jurisdictions. Changes in applicable laws or regulations, or in the enforcement thereof, could require us to redesign or recall our products and could adversely affect our business or financial condition in the future. Developing and marketing products to meet such new requirements could result in substantial additional costs that may be difficult to recover in some markets. In some cases, we may be required to modify our products or develop new products to comply with new regulations, particularly those relating to air emissions and carbon monoxide. Typically, additional costs associated with significant compliance modifications are passed on to the market. We have also recently been, and continue to be, subject to product recall actions and related applicable regulatory compliance inquiries by regulatory authorities. The failure to comply with existing and future regulatory standards or requirements could adversely affect our position in the markets we serve, our reputation, business, results of operations or financial condition in any particular period. 19 Table of Contents Risk factors related to cybersecurity Failures or security breaches of our networks or information technology systems could have an adverse effect on our business. We rely heavily on information technology (IT) both in our products and services for customers and in our IT systems used to run our business. Further, we collect and store sensitive information in cloud-based data centers and on our networks. Government agencies and security experts have warned about growing risks of hackers, cyber-criminals, malicious insiders and other actors targeting confidential information and all types of IT systems. These actors may engage in fraudulent activities, theft of confidential or proprietary information and sabotage or ransomware. Our IT systems, our connected products, and our confidential information may be vulnerable to damage or intrusion from a variety of attacks including computer viruses, worms or other malicious software programs. The risk of such attacks may increase as we integrate newly acquired companies or develop new connected products and related software. These attacks pose a risk to the security of our products, private data, systems and networks and those of our customers, suppliers and third-party service providers, as well as to the confidentiality of our information and the integrity and availability of our data. While we attempt to mitigate these risks through board oversight, hiring additional internal cyber-security professionals to manage these risks, enhancing controls, due diligence, employee training and communication, third party intrusion testing, system hardening, email and web filters, regular patching, multi-factor authentication, surveillance, encryption, and other measures, we remain vulnerable to information security threats. We monitor certain cyber security threats and vulnerabilities in our systems, and we have experienced viruses and attacks targeting our IT systems and networks. Such prior events, to date, have not had a material impact on our financial condition, results of operations or liquidity. Despite the precautions we take, we have had, and could have again, an intrusion or infection of our systems or connected products. While such intrusions or infections to date have not resulted in the significant disruption of our business, or a loss of proprietary or confidential information, we cannot guarantee the same for future intrusions or infections. Similarly, an attack on our IT systems or connected products could result in theft or disclosure of trade secrets or other intellectual property, a breach of confidential customer or employee information, or product failure or misuse. Any such events could have an adverse impact on sales, harm our reputation and cause us to incur legal liability and increased costs to address such events and related security concerns. As the threats evolve and become more potent, we may incur additional costs to secure the products that we sell, as well as our data and infrastructure of networks and devices. Risk factors related to COVID-19 The duration and scope of the impacts of the COVID-19 pandemic are uncertain and may continue to adversely affect our operations, supply chain, distribution, and demand for certain of our products and services. The global outbreak of COVID-19 and related variants has created and may continue to create significant uncertainty within the global markets that we serve to the extent the COVID-19 outbreak may continue to spread, including the impact of identified or potential new variants. We have operations, customers and suppliers in countries significantly impacted by COVID-19. Governmental authorities around the world have taken or may take again in the future a variety of measures to slow the spread of COVID-19, including travel bans or restrictions, increased border controls or closures, quarantines, shelter-in-place orders and business shutdowns and such authorities may impose additional restrictions in the future. We have also taken actions to protect our employees and to mitigate the spread of COVID-19 within our business. There can be no assurance that the measures implemented by governmental authorities or our own actions will be effective or achieve their desired results in a timely fashion. The impact of COVID-19 has resulted in and may in the future result in disruptions to our manufacturing operations and supply chain, which could negatively impact our ability to meet customer demand. Our forward-looking statements assume that our production facilities, supply chain and distribution partners continue to operate during the pandemic. To date, we have been able to operate the majority of our facilities. If we were to encounter a significant work stoppage, disruption, or outbreak due to COVID-19 at one or more of our locations or suppliers, we may not be able to satisfy customer demand for a period of time. Furthermore, the impact of COVID-19 on the economy, demand for our products and impacts to our operations, including the measures taken by governmental authorities to address it, may precipitate or exacerbate other risks and/or uncertainties, including specifically many of the risk factors set forth in this Annual Report, including inflationary costs, disruptions due to labor shortages, supply chain disruptions, and risks related to the fair market value of intangible assets that could lead to an impairment, which may have a significant impact on the Company's operating results and financial condition, although we are unable to predict the extent or nature of these impacts at this time. Risk factors related to our capital structure We have indebtedness which could adversely affect our cash flow and our ability to make payments on our indebtedness. As of December 31, 2022 we had total indebtedness of $1,430.8 million. Our level of indebtedness increases the possibility that we may be unable to generate cash sufficient to pay, when due, the principal of, interest on or other amounts due in respect of our indebtedness. While we maintain interest rate swaps covering a portion of our outstanding debt, our interest expense could increase if interest rates increase because debt under our credit facilities bears interest at a variable rate based on Secured Overnight Financing Rate (SOFR) or other base rate. In connection with our credit agreement amendment in June 2022, SOFR became the new benchmark interest rate for the new Tranche A Term Loan Facility and the Revolving Facility, and all LIBOR provisions applicable to the existing Tranche B Term Loan Facility were replaced with SOFR provisions. If we do not have sufficient earnings to service our debt, we may be required to refinance all or part of our existing debt, sell assets, borrow more money or sell securities, none of which we can guarantee we will be able to do. Our Term Loan B matures on December 13, 2026, and our Term Loan A as well as our Revolving Facility mature on June 29, 2027. The terms of our credit facilities restrict our current and future operations, particularly our ability to respond to changes in our business or to take certain actions. Our credit facilities contain, and any future indebtedness of ours or our subsidiaries would likely contain, a number of restrictive covenants that impose operating and financial restrictions on us and our subsidiaries, including limitations on our ability to engage in acts that may be in our best long-term interests. These restrictions set limitations on, among other things, our ability to: ● incur liens; ● incur or assume additional debt or guarantees or issue preferred stock; ● pay dividends, or make redemptions and repurchases, with respect to capital stock; ● prepay, or make redemptions and repurchases of, subordinated debt; ● make loans and investments; ● make capital expenditures; ● engage in mergers, acquisitions, asset sales, sale/leaseback transactions and transactions with affiliates; ● change the business conducted by us or our subsidiaries; and ● amend the terms of subordinated debt. The operating and financial restrictions in our credit facilities and any future financing agreements may adversely affect our ability to finance future operations or capital needs or to engage in other business activities. A breach of any of the restrictive covenants in our credit facilities would result in a default. If any such default occurs, the lenders under our credit facilities may elect to declare all outstanding borrowings, together with accrued interest and other fees, to be immediately due and payable, or enforce their security interest, any of which would result in an event of default. The lenders will also have the right in these circumstances to terminate any commitments they have to provide further borrowings. Our existing credit facilities do not contain any financial maintenance covenants. 20 Table of Contents We may need additional capital to finance our growth strategy or to refinance our existing credit facilities, and we may not be able to obtain it on acceptable terms, or at all, which may limit our ability to grow. We may require additional financing to expand our business. Financing may not be available to us or may be available to us only on terms that are not favorable. The terms of our senior secured credit facilities limit our ability to incur additional debt. In addition, economic conditions, including a downturn in the credit markets, could impact our ability to finance our growth on acceptable terms or at all. If we are unable to raise additional funds or obtain capital on acceptable terms, we may have to delay, modify or abandon some or all of our growth strategies. In the future, if we are unable to refinance our credit facilities on acceptable terms, our liquidity could be adversely affected. Our total assets include goodwill and other indefinite-lived intangibles. If we determine these have become impaired, our net income could be materially adversely affected. Goodwill represents the excess of cost over the fair market value of net assets acquired in business combinations. Indefinite-lived intangibles are comprised of certain tradenames. At December 31, 2022, goodwill and other indefinite-lived intangibles totaled $1,529.2 million. We review goodwill and other intangibles at least annually for impairment and any excess in carrying value over the estimated fair value is charged to the statement of comprehensive income. Future impairment may result from, among other things, deterioration in the performance of an acquired business or product line, adverse market conditions, a significant increase in interest rate, changes in the competitive landscape, adverse changes in applicable laws or regulations, including changes that restrict the activities of an acquired business or product line, and a variety of other circumstances including any of the risk factors noted above. A reduction in net income resulting from the write-down or impairment of goodwill or indefinite-lived intangibles could have a material adverse effect on our financial statements. Refer to the Critical Accounting Policies and Estimates in Item 7 of this Annual Report on Form 10-K for further information regarding the Company’s process for evaluating its goodwill for impairment. Item 1B. Unresolved Staff Comments None. Item 2. Properties We own or lease manufacturing, distribution, R&D, and office facilities globally totaling over five million square feet. We also utilize third party inventory warehouses that accommodate material storage and rapid response requirements of our customers. The following table provides information about our principal owned or leased facilities exceeding 20,000 square feet: Location Owned/ Leased Activities Segment Waukesha, WI Owned Corporate headquarters, R&D Domestic Pewaukee, WI Owned Sales, office Domestic Eagle, WI Owned Manufacturing, office, training Domestic Whitewater, WI Owned Manufacturing, office, distribution Domestic Oshkosh, WI Owned Manufacturing, office, warehouse, R&D Domestic Berlin, WI Owned Manufacturing, office, warehouse, R&D Domestic Jefferson, WI Owned Manufacturing, office, distribution, R&D Domestic Janesville, WI Leased Distribution Domestic Richfield, WI Leased Warehouse Domestic Trenton, SC Owned Manufacturing, office, warehouse, distribution Domestic Stockton, CA Leased Sales, office, warehouse, training Domestic Corona, CA Leased Sales, office, storage Domestic Hamilton, OH Leased Manufacturing, office, warehouse, R&D Domestic Maquoketa, IA Owned Storage, rental property Domestic South Burlington, VT Leased Office, sales, R&D Domestic South Portland, ME Leased Sales, office, R&D Domestic Marlborough, MA Leased Sales, office, warehouse Domestic Toronto, Canada Leased Office, sales, R&D Domestic Mexico City, Mexico Owned Storage International Hidalgo, Mexico Owned Manufacturing, sales, distribution, warehouse, office, R&D International Casole d’Elsa, Italy Leased Manufacturing, office, warehouse, R&D International Balsicas, Spain Leased Manufacturing, office, warehouse, R&D International Foshan, China Owned Manufacturing, office, warehouse, R&D International Saint-Nizier-sous-Charlieu, France Leased Sales, office, warehouse International Cravinhos, Brazil Leased Manufacturing, office, warehouse International Stoke-on-Trent, United Kingdom Leased Sales, office, warehouse International Sydney, Australia Leased Sales, office, warehouse International Fellbach, Germany Leased Sales, office, warehouse International Suzhou, China Leased Office, R&D International Rugby, United Kingdom Leased Manufacturing, office, warehouse, R&D International Celle, Germany Leased Manufacturing, office, warehouse, R&D International Charzyno, Poland Owned Manufacturing International West Bengal, India Leased Manufacturing, warehouse International Villanova d'Ardenghi, Italy Owned Manufacturing, warehouse International Hunmanby, United Kingdom Owned Manufacturing, warehouse, sales, distribution, office, R&D International In addition to the countries represented above, the Company has other operations or sales offices in the United Arab Emirates, Romania, Bahrain, and Colombia. As of December 31, 2022, substantially all of our domestically-owned and a portion of our internationally-owned properties are subject to collateral provisions under our senior secured credit facilities. 21 Table of Contents Item 3. Legal Proceedings See Note 18, "Commitments and Contingencies," to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further information on the Company's legal proceedings. Item 4. Mine Safety Disclosures Not Applicable. PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Shares of our common stock are traded on the New York Stock Exchange (NYSE) under the symbol “GNRC.” Purchases of Equity Securities By the Issuer and Affiliated Purchasers The following table summarizes the stock repurchase activity for the three months ended December 31, 2022, which consisted of stock repurchases made as authorized under previously announced stock repurchase programs, as well as the withholding of shares upon the vesting of restricted stock awards to pay related withholding taxes on behalf of the recipient: Total Number of Shares Purchased Average Price Paid per Share Total Number Of Shares Purchased As Part Of Publicly Announced Plans Or Programs Approximate Dollar Value Of Shares That May Yet Be Purchased Under The Plans Or Programs 10/01/22 - 10/31/22 1,394 $ 158.98 - $ 500,000,000 11/01/22 - 11/30/22 1,070,647 104.75 1,070,183 $ 387,897,261 12/01/22 - 12/31/22 1,116,456 98.49 1,115,191 $ 278,059,869 Total 2,188,497 $ 101.59 2,185,374 For equity compensation plan information, refer to Note 17, “Share Plans,” to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K. For information on the Company’s stock repurchase plans, refer to Note 13, “Stock Repurchase Programs,” to the consolidated financial statements. 22 Table of Contents Stock Performance Graph The line graph below compares the cumulative total stockholder return on our common stock with the cumulative total return of the Standard & Poor’s (“S&P 500”) Index, the S&P MidCap 400 Index, the Russell 2000 Index, and the S&P 500 Industrial Index, for the five-year period ended December 31, 2022. The graph and table assume that $100 was invested on December 31, 2017 in each of our common stock, the S&P 500 Index, the S&P MidCap 400 Index, the Russell 2000 Index, and the S&P 500 Industrial Index, and that all dividends were reinvested. Cumulative total stockholder returns for our common stock, the S&P 500 Index, the S&P MidCap 400 Index, the Russell 2000 Index, and the S&P 500 Industrial Index, are based on our fiscal year. We commenced reporting the S&P 500 Industrial Index as our industry index and will not be reporting the Russell 2000 Index in future filings. Company / Market / Peer Group 12/31/2017 12/31/2018 12/31/2019 12/31/2020 12/31/2021 12/31/2022 Generac Holdings Inc. $100.00 $100.35 $203.08 $459.04 $710.28 $203.14 S&P 500 Index - Total Returns 100.00 95.62 125.72 148.85 191.58 156.88 S&P MidCap 400 Index 100.00 88.92 112.21 127.54 159.12 138.34 Russell 2000 Index 100.00 88.99 111.70 134.00 153.85 122.41 S&P 500 Industrials Index 100.00 86.71 112.17 124.59 150.89 142.63 Holders As of February 17, 2023, there were1,048 registered holders of record of Generac’s common stock. A substantially greater number of holders of Generac common stock are “street name” or beneficial holders, whose shares are held of record by banks, brokers and other financial institutions. Dividends We do not have plans to pay dividends on our common stock in the foreseeable future. However, in the future, subject to factors such as general economic and business conditions, our financial condition and results of operations, our capital requirements, our future liquidity and capitalization, and other such factors that our Board of Directors may deem relevant, we may change this policy and choose to pay dividends. Our ability to pay dividends on our common stock is currently limited by the terms of our senior secured credit facilities and may be further restricted by any future indebtedness we incur. Dividends from, and cash generated by our subsidiaries will be our principal sources of cash to repay indebtedness, fund operations, repurchase shares of common stock and pay dividends. Accordingly, our ability to pay dividends to our stockholders is dependent on the earnings and distributions of funds from our subsidiaries. Securities Authorized for Issuance Under Equity Compensation Plans For information on securities authorized for issuance under our equity compensation plans, refer to “Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters,” which is incorporated herein by reference. Recent Sales of Unregistered Securities None. Use of Proceeds from Registered Securities Not applicable. Item 6. [Reserved] 23 Table of Contents Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read together with “Item 1 – Business,” the consolidated financial statements and the related notes thereto in Item 8 of this Annual Report on Form 10-K. This discussion contains forward-looking statements, based on current expectations and related to future events and our future financial performance, that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under “Item 1A. - Risk Factors.” Overview Generac is a leading energy technology solutions company that provides backup and prime power generation systems for residential and commercial & industrial (C&I) applications, solar + battery storage solutions, smart home energy management devices and energy services, advanced power grid software platforms, and engine- & battery-powered tools and equipment. As an energy technology solutions company that is “Powering a Smarter World”, our corporate purpose is to lead the evolution to more resilient, efficient, and sustainable energy solutions around the world. Further information regarding our business is provided in “Part I, Item 1. Business” of this Annual Report. Business Drivers and Operational Factors “Part I, Item 1. Business” of this Annual Report contains information regarding business drivers, including key mega-trends and strategic growth themes under the subheading “Mega-Trends, Strategic Growth Themes, and Additional Business Drivers.” Factors Affecting Results of Operations We are subject to various factors that can affect our results of operations, which we attempt to mitigate through factors we can control, including continued product development, expanded distribution, pricing, cost control and hedging. Certain operational and other factors that affect our business include the following: Effect of commodity, currency, component price fluctuations, and resource availability. Industry-wide price fluctuations of key commodities, such as steel, copper and aluminum, and other components we use in our products, as well as changes in labor costs required to produce our products, can have a material impact on our results of operations. Acquisitions in recent years have increased our use of advanced electronic components and battery cells, as well as further expanded our commercial and operational presence outside of the United States. Our international acquisitions, and our existing global supply chain, expose us to fluctuations in foreign currency exchange rates and regulatory tariffs that can also have a material impact on our results of operations. Additionally, significant volatility in raw material prices and other costs, ongoing logistics challenges, and various supply chain constraints, are leading to fluctuations in input costs and delays for certain of our products that are adversely impacting our margins. We have historically attempted to mitigate the impact of inflationary pressures through improved product design and sourcing, manufacturing efficiencies, price increases, and select hedging transactions. We have implemented multiple price increases to help mitigate the impact of rising costs, and we continued to realize the benefit of these pricing actions in 2022. Our results are also influenced by changes in fuel prices in the form of higher freight rates, which in some cases are accepted by our customers and in other cases are absorbed by us. 24 Table of Contents Seasonality. Although there is demand for our products throughout the year, in each of the past five years, approximately 19% to 25% of our net sales occurred in the first quarter, 22% to 28% in the second quarter, 24% to 28% in the third quarter and 23% to 31% in the fourth quarter, with different seasonality depending primarily on the occurrence, timing and severity of major power outage activity in each year. Major outage activity is unpredictable by nature and, as a result, our sales levels and profitability may fluctuate from period to period. The seasonality experienced during a major power outage, and for the subsequent quarters following the event, will vary relative to other periods where no major outage events occurred. For Residential products, we are currently experiencing higher field inventories of home standby generators given installation capacity constraints in our distribution network that has resulted in lower orders from our channel partners in the second half of 2022, and this headwind is expected to persist into the first half of 2023, resulting in expected lower seasonality weighting in the first half of 2023 relative to historical norms. Russia-Ukraine Conflict. In February 2022, Russia commenced military action against Ukraine. In response, the U.S. and certain other countries imposed significant sanctions and export controls against Russia, Belarus and certain individuals and entities connected to Russian or Belarusian political, business, and financial organizations. In March 2022, we announced our suspension of operations and sales in Russia. Our sales to customers in Russia and Ukraine represented less than 1% of our total revenue for the year ended December 31, 2021, and therefore the impact on our financial results is not expected to be material. However, the situation remains uncertain and it is difficult to predict the impact that the conflict and actions taken in response to it will have on our business. In particular, the situation could increase our costs, disrupt our supply chain, significantly hinder our ability to find materials or key single-sourced components we need to make certain products, or otherwise adversely affect our business and results of operations. Impact of the COVID-19 pandemic. The COVID-19 pandemic has influenced various trends we have experienced and may experience in future periods involving supply chain and operations constraints. We manufacture and provide essential products and services to a variety of critical infrastructure customers around the globe. Substantially all of our operations and production activities have been operational during the pandemic. If we were to encounter a significant work stoppage, disruption, or COVID-19 outbreak at one or more of our locations or suppliers, we may not be able to satisfy customer demand for a period of time. To date, we have experienced various interruptions to our supply chain as a result of the COVID-19 pandemic. We have experienced inbound and outbound logistics delays and increased costs; however, we continue to monitor scheduled material receipts to mitigate these delays. This could change if freight carriers are delayed or not able to operate. The future impact of COVID-19 on our business is dependent on future developments, including the duration of the pandemic, our ability to continue to operate during the pandemic, actions taken by domestic and foreign governments to contain the spread of the virus, and the related length of its impact on the global economy and our customers. Refer to the COVID-19 related risk factor disclosed in “Item 1A. Risk Factors” of this Annual Report on Form 10-K. Factors influencing interest expense. Interest expense can be impacted by a variety of factors, including market fluctuations in SOFR, interest rate election periods, interest rate swap agreements, repayments or borrowings of indebtedness, and amendments to our credit agreements. In connection with our credit agreement amendment in June 2022, SOFR became the new benchmark interest rate for the new Tranche A Term Loan Facility and the Revolving Facility, and all LIBOR provisions applicable to the existing Tranche B Term Loan Facility were replaced with SOFR provisions. Interest expense increased during 2022 compared to 2021, primarily due to increased borrowings, higher interest rates, and interest accretion on contingent acquisition consideration. Refer to Note 12, “Credit Agreements,” to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further information. Factors influencing provision for income taxes and cash income taxes paid. As of December 31, 2021, the tax-deductible goodwill and intangible assets from our acquisition by CCMP Capital Advisors, LLC in 2006 were fully amortized. The expiration of this tax shield resulted in a higher cash income tax obligation in 2022 and will continue to result in a higher income tax obligation on a go-forward basis. On August 16, 2022, the U.S. government enacted the Inflation Reduction Act (the Act). The Act in part provides funding and tax incentives for certain clean energy products and projects. While the Act did not impact 2022 second half results, we will continue to review the Act and any regulations or guidance issued by the U.S. Treasury Department or by a state which may provide a tax benefit or expense. We will update our future tax provisions based on new regulations or guidance accordingly. Components of Net Sales and Expenses Net Sales Our net sales primarily consist of product sales to our customers. This includes sales of our power generation equipment, energy storage systems, and other power products to the residential, commercial and industrial markets, as well as service parts to our dealer network. Net sales also include shipping and handling charges billed to customers, with the related freight costs included in cost of goods sold. Additionally, we offer other services, including extended warranties, installation, maintenance, data center and telecom design and build, remote monitoring, and grid services to utilities in certain circumstances. These services accounted for less than 3% of our net sales for the year ended December 31, 2022. Refer to Note 2, “Summary of Accounting Policies - Revenue Recognition,” to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further information on our revenue streams and related revenue recognition accounting policies. We are not dependent on any one channel or customer for our net sales, with no single customer representing more than 4% of our sales, and our top ten customers representing less than 20% of our net sales in aggregate for the year ended December 31, 2022. Costs of Goods Sold The principal elements of costs of goods sold are component parts, raw materials, inbound and outbound freight, factory overhead and labor. Component parts and raw materials comprised approximately 72% of costs of goods sold for the year ended December 31, 2022. The principal component parts are engines, alternators, batteries, electronic controls, and steel enclosures. We design and manufacture air-cooled engines for certain of our generators up to 26kW, along with certain liquid-cooled, natural gas engines. We source engines for certain of our smaller products and all of our diesel products. For certain natural gas engines, we source the base engine block, and then add a significant amount of value engineering, sub-systems and other content to the point that we are recognized as the original equipment manufacturer (OEM) of those engines. We design and manufacture many of the alternators for our generators. We also manufacture other generator components where we believe we have a design and cost advantage. We source component parts from an extensive global network of reliable, high-quality suppliers. In some cases, these relationships are proprietary. For certain energy technology products, we source these products complete from certain contract manufacturers. The principal sourced raw materials used in the manufacturing process are steel, copper and aluminum. We are susceptible to fluctuations in the cost of these commodities, impacting our costs of goods sold. We seek to mitigate the impact of commodity prices on our business through a continued focus on global sourcing, product design improvements, manufacturing efficiencies, price increases and select hedging transactions. We are also impacted by foreign currency fluctuations given our global supply chain. There is typically a lag between raw material price fluctuations and their effect on our costs of goods sold. In 2021 and 2022, we experienced higher input costs resulting from supply chain challenges and the overall inflationary environment, including increased commodity prices, logistics costs, and labor. We have implemented multiple price increases to help mitigate the impact of these rising commodity costs, and the realization of these price increases have partially offset the higher input costs. The balance of cost of goods sold include our manufacturing and warehousing facilities, factory overhead, labor and shipping costs. Factory overhead includes utilities, insurance, support personnel, depreciation, general supplies, and maintenance. Although we attempt to maintain a flexible manufacturing cost structure, our margins can be impacted if we cannot timely adjust labor and manufacturing costs to match fluctuations in net sales. Operating Expenses Our operating expenses consist of costs incurred to support our sales, marketing, distribution, service parts, warranty, engineering, information systems, human resources, accounting, finance, risk management, legal and tax functions, among others. These expenses include personnel costs such as salaries, bonuses, employee benefit costs, payroll taxes, and share-based compensation cost, and are classified into three categories: selling and service, research and development, and general and administrative. Additionally, the amortization expense related to our finite-lived intangible assets is included within operating expenses. 25 Table of Contents Selling and service. Our selling and service expenses consist primarily of personnel expense, marketing expense, standard assurance warranty expense, bad debt provisions, and other sales expenses. Our personnel expense recorded in selling and services expenses includes the expense of our sales force and other personnel involved in the marketing, sales and service of our products. Standard warranty expense is estimated based on historical trends or based on specific warranty matters as they become known and reasonably estimable. Our marketing expenses include media advertising, promotional expenses, co-op advertising costs, direct mail costs, printed material costs, product display costs, market research expenses, and trade show expenses. Marketing expenses are generally related to the launch of new product offerings, opportunities to create market awareness for our products, and general brand awareness marketing efforts. Research and development. Our research and development expenses include mechanical engineering, electronics engineering, and software development costs and they support numerous projects covering all of our product lines. They also support our connectivity, grid services, remote monitoring, and energy management initiatives. We operate engineering facilities with extensive capabilities at many locations globally and employ approximately 1,000 personnel with focus on new product development, existing product improvement and cost containment. We are committed to research and development and rely on a combination of patents and trademarks to establish and protect our proprietary rights. Our research and development costs are expensed as incurred. General and administrative. Our general and administrative expenses include personnel costs for general and administrative employees; accounting, legal and professional services fees; information technology costs; insurance; travel and entertainment expense; adjustments to contingent acquisition consideration; and other corporate expenses. Acquisition related costs. Acquisition related costs are external costs incurred in connection with a business combination including legal fees, professional and advisory services, stamp tax, and indemnity and warranty insurance premiums. Amortization of intangibles. Our amortization of intangibles expense includes the straight-line amortization of finite-lived tradenames, customer lists, patents and technology, and other intangibles assets. Other (Expense) Income Other (expense) income includes the interest expense on our outstanding borrowings, amortization of debt financing costs and original issue discount, and interest accretion on contingent acquisition consideration. Other (expense) income also includes other financial items such as losses on extinguishment of debt, investment income earned on our cash and cash equivalents, and gains/losses on the sale of certain investments. Results of Operations A detailed discussion of the year-over-year changes from the Company's fiscal 2020 to fiscal 2021 can be found in the Management's Discussion and Analysis section of the Company's fiscal 2021 Annual Report on Form 10-K filed February 22, 2022. Year ended December 31, 2022 compared to year ended December 31, 2021 The following table sets forth our consolidated statement of operations data for the periods indicated: Year Ended December 31, (U.S. Dollars in thousands) 2022 2021 $ Change % Change Net sales $ 4,564,737 $ 3,737,184 827,553 22.1 % Cost of goods sold 3,042,733 2,377,102 665,631 28.0 % Gross profit 1,522,004 1,360,082 161,922 11.9 % Operating expenses: Selling and service 496,260 319,020 177,240 55.6 % Research and development 159,774 104,303 55,471 53.2 % General and administrative 194,861 144,272 50,589 35.1 % Acquisition related costs 1,459 21,465 (20,006 ) -93.2 % Amortization of intangible assets 103,320 49,886 53,434 107.1 % Total operating expenses 955,674 638,946 316,728 49.6 % Income from operations 566,330 721,136 (154,806 ) -21.5 % Total other expense, net (57,864 ) (29,610 ) (28,254 ) 95.4 % Income before provision for income taxes 508,466 691,526 (183,060 ) -26.5 % Provision for income taxes 99,596 134,957 (35,361 ) -26.2 % Net income 408,870 556,569 (147,699 ) -26.5 % Net income attributable to noncontrolling interests 9,368 6,075 3,293 54.2 % Net income attributable to Generac Holdings Inc. $ 399,502 $ 550,494 (150,992 ) -27.4 % 26 Table of Contents The following sets forth our reportable segment information for the periods indicated: Net Sales by Reportable Segment Year Ended December 31, (U.S. Dollars in thousands) 2022 2021 $ Change % Change Domestic $ 3,867,866 $ 3,164,050 $ 703,816 22.2 % International 696,871 573,134 123,737 21.6 % Total net sales $ 4,564,737 $ 3,737,184 $ 827,553 22.1 % Total Sales by Reportable Segment Year Ended December 31, 2022 Year Ended December 31, 2021 External Net Sales Intersegment Sales Total Sales External Net Sales Intersegment Sales Total Sales Domestic $ 3,867,866 $ 60,731 $ 3,928,597 $ 3,164,050 $ 39,339 $ 3,203,389 International 696,871 93,699 790,570 573,134 26,123 599,257 Intercompany elimination - (154,430 ) (154,430 ) - (65,462 ) (65,462 ) Total net sales $ 4,564,737 $ - $ 4,564,737 $ 3,737,184 $ - $ 3,737,184 Adjusted EBITDA by Reportable Segment Year Ended December 31, 2022 2021 $ Change % Change Domestic $ 716,302 $ 795,417 $ (79,115 ) -9.9 % International 109,065 66,008 43,057 65.2 % Total Adjusted EBITDA $ 825,367 $ 861,425 $ (36,058 ) -4.2 % The following table sets forth our net sales by product class for the periods indicated: Net Sales by Product Class Year Ended December 31, (U.S. Dollars in thousands) 2022 2021 $ Change % Change Residential products $ 2,911,871 $ 2,456,765 $ 455,106 18.5 % Commercial & industrial products 1,260,737 998,998 261,739 26.2 % Other 392,129 281,421 110,708 39.3 % Total net sales $ 4,564,737 $ 3,737,184 $ 827,553 22.1 % Net sales. The increase in Domestic segment sales for the year ended December 31, 2022 was primarily driven by growth in residential product sales, highlighted by a robust increase in home standby generator shipments in the first three quarters of the year. Home standby generator sales decreased in the fourth quarter compared to the prior year due to higher field inventories and lower home standby generator orders from our channel partners given installation capacity constraints in our distribution network. In addition, sales of clean energy products declined compared to the prior year in the second half of 2022 due to the loss of a key customer that filed for bankruptcy. C&I product sales also grew at a robust rate during the year with strength across all channels, including national rental equipment, telecom, and industrial distribution customers. The increase in International segment sales for the year ended December 31, 2022 was driven by strong growth across all major regions as compared to the prior year, most notably in Europe and Latin America. This was partially offset by unfavorable foreign exchange impacts of approximately $43 million. In addition, total contribution from non-annualized acquisitions for the year ended December 31, 2022 was $271 .6 million, including $213.7 million for the domestic segment and $57.9 million for the international segment. Gross profit. Gross profit margin for the year ended December 31, 2022 was 33.3% compared to 36.4% for the year ended December 31, 2021. The gross profit margin decrease was primarily driven by higher input costs resulting from supply chain challenges and the overall inflationary environment. These higher costs were partially offset by favorable price realization of previously implemented pricing actions. Operating expenses. Operating expenses increased $316.7 million, or 49.6%, as compared to the prior year. The increase includes pre-tax charges comprised of $17.9 million of provision for a credit loss related to a clean energy product customer that filed for bankruptcy, and $37.3 million of provision for clean energy product warranty-related matters, and a provision of $10.0 million for a specific pending and unresolved matter with the CPSC concerning the imposition of potential penalty fines for allegedly failing to timely submit a report under the CPSA in relation to certain portable generators that were subject to a voluntary recall previously announced on July 29, 2021. In addition, amortization of intangibles increased $53.4 million over the prior year. The remaining increase was primarily driven by the impact of recurring operating expenses from recent acquisitions, increased employee costs, and additional variable expenses from increased sales volumes. These increases were partially offset by lower acquisition-related transaction costs compared to the prior year. Other expense. The increase in other expense was driven by higher interest costs due to increased borrowings and interest rates compared to the prior year, higher interest accretion on contingent acquisition consideration in the current year, and a $3.7 million loss on extinguishment of debt incurred in the second quarter of 2022. Provision for income taxes. The effective income tax rates for the years ended December 31, 2022 and 2021 were 19.6% and 19.5%, respectively. The slight increase in the effective tax rate was primarily due to a lower net stock compensation deduction reported in the current year compared to the prior year. This was largely offset by prior year non-deductible transaction fees and a discrete tax item created by a legislative increase in the tax rate in a foreign jurisdiction which revalued certain deferred tax liabilities reported in the prior year. Net income attributable to Generac Holdings Inc. Net income attributable to Generac Holdings Inc. was $399.5 million as compared to $550.5 million in the prior year period. The decrease was primarily driven by lower gross profit margin, increased expenses, and other items noted above. Adjusted EBITDA. Adjusted EBITDA is defined and reconciled to net income in, “Non-GAAP Measures - Adjusted EBITDA” included below in Item 7 of this Annual Report on Form 10-K. Adjusted EBITDA margins for the Domestic segment for the year ended December 31, 2022 were 18.2% of domestic segment total sales as compared to 24.8% of domestic segment total sales for the year ended December 31, 2021. The Adjusted EBITDA margin decrease was driven by higher input costs, partially offset by pricing benefits. In addition, continued operating expense investments for future growth and the impact of acquisitions had an unfavorable impact on margins during the current year. Adjusted EBITDA margins for the International segment, before deducting for non-controlling interests, for the year ended December 31, 2022 were 13.8% of international segment total sales as compared to 11.0% of international segment total sales for the year ended December 31, 2021. The Adjusted EBITDA margin increase was driven by the positive impact of recent acquisitions and improved operating leverage on increased sales volumes. Adjusted net income. Adjusted Net Income is defined and reconciled to net income in, “Non-GAAP Measures - Adjusted Net Income” included below in Item 7 of this Annual Report on Form 10-K. Adjusted Net Income of $538.8 million for the year ended December 31, 2022 decreased 12.9% from $618.9 million for the year ended December 31, 2021. This decrease was driven by decreased net income due to the factors outlined above, partially offset by the impact of various add-backs in the 2022 period. 27 Table of Contents Liquidity and Financial Position Our primary cash requirements include payment for our raw materials and components, salaries & benefits, facility and lease costs, operating expenses, interest and principal payments on our debt and capital expenditures. We finance our operations primarily through cash flow generated from operations and, if necessary, borrowings under our revolving credit facility. Our credit agreements originally provided for a $1.2 billion term loan B credit facility (Tranche B Term Loan Facility) and currently include a $300.0 million uncommitted incremental term loan facility. Additionally, our credit agreements also previously provided for a $500.0 million ABL facility (ABL Facility) that was paid off and terminated in June 2022. In June 2022, we amended and restated our existing credit agreements (Amended Credit Agreement) resulting in a term loan facility in an aggregate principal amount of $750 million (Tranche A Term Loan Facility and, together with the Tranche B Term Loan Facility, the “Term Loans”), established a new revolving facility in an aggregate principal amount of $1.25 billion (Revolving Facility), terminated the ABL Facility, and replaced all LIBOR provisions to the existing Tranche B Term Loan Facility with SOFR provisions. Proceeds received from the Tranche A Term Loan Facility were used to repay the total existing outstanding balance on our former ABL Facility and make a $250 million voluntary prepayment on our Tranche B Term Loan Facility, with the remaining funds to be used for future general corporate purposes. As a result of the prepayments, we wrote off $3.5 million of original issue discount and capitalized debt issuance costs during the second quarter of 2022 as a loss on extinguishment of debt in the consolidated statements of comprehensive income. The Revolving Facility was unfunded at closing. The Tranche B Term Loan Facility matures on December 13, 2026, while the Tranche A Term Loan Facility and Revolving Facility mature on June 29, 2027. The Tranche A Term Loan Facility principal is repayable in quarterly installments beginning in September 2023. Principal payments are due on these facilities as follows: 2023 $ 9,375 2024 28,125 2025 46,875 2026 595,625 2027 690,000 Total $ 1,370,000 As of December 31, 2022, there was $530 million outstanding under the Tranche B Term Loan Facility, $750 million outstanding under the Tranche A Term Loan Facility, and $90.0 million of borrowings on our Revolving Facility, leaving $1,158.7 million of availability, net of outstanding letters of credit. Our Tranche B Term Loan Facility bears interest at rates based on either a base rate plus an applicable margin of 0.75% or adjusted SOFR rate plus an applicable margin of 1.75%, subject to a SOFR floor of 0.0%. Our Tranche A Term Loan Facility and the Revolving Facility initially bear interest at a rate based on adjusted SOFR plus an applicable margin of 1.5% through December 31, 2022, subject to a SOFR floor of 0.0%. Beginning on January 1, 2023, the Tranche A Term Loan Facility and Revolving Facility bear interest at a rate based on adjusted SOFR plus an applicable margin between 1.25% and 1.75%, based on the Company's total leverage ratio and subject to a SOFR floor of 0.0%. At December 31, 2022 The interest rates for the Tranche A Term Loan Facility and Tranche B Term Loan Facility were 5.72% and 5.97%, respectively. The Tranche B Term Loan Facility does not require an Excess Cash Flow payment (as defined in the Amended Credit Agreement) if our secured leverage ratio is maintained below 3.75 to 1.00 times. As of December 31, 2022, our secured leverage ratio was 1.55 to 1.00 times. As of December 31, 2022, we had $1,291.4 million of available liquidity comprised of $132.7 million of cash and cash equivalents and $1,158.7 million available under our Revolving Facility, net of outstanding letters of credit. We believe we have a strong liquidity position that allows us to execute our strategic plan and provides the flexibility to continue to invest in future growth opportunities. In September 2020, the Company’s Board of Directors approved a stock repurchase program, which commenced on October 27, 2020, and allowed for the repurchase of up to $250 million of the Company's common stock over a 24-month period. That program was exhausted in the third quarter of 2022. In July 2022, the Company's Board of Directors approved another stock repurchase program, which commenced on August 5, 2022, and allows for the repurchase of up to $500 million of the Company's common stock over a 24-month period. The Company may repurchase its common stock from time to time, in amounts and at prices the Company deems appropriate, subject to market conditions and other considerations. The repurchases may be executed using open market purchases, privately negotiated agreements or other transactions. The actual timing, number and value of shares repurchased under the program will be determined by management at its discretion and will depend on a number of factors, including the market price of the Company’s common stock, general market and economic conditions, applicable legal requirements, and compliance with the terms of the Company’s outstanding credit agreements. The repurchases may be funded with cash on hand, available borrowings, or proceeds from potential debt or other capital markets sources. The stock repurchase program may be suspended or discontinued at any time without prior notice. During the year ended December 31, 2022, the Company repurchased 2,722,007 shares of its common stock for $345,840. Since the inception of all stock repurchase programs (starting in August 2015), the Company has repurchased 11,748,713 shares of its common stock for $777.4 million (at an average cost per share of $66.17). See Note 12, “Credit Agreements,” and Note 13, “Stock Repurchase Program,” to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for more information on our credit agreements and stock repurchase programs. We have an arrangement with a finance company to provide floor plan financing for selected dealers. This arrangement provides liquidity for our dealers by financing dealer purchases of products with credit availability from the finance company. We receive payment from the finance company after shipment of product to the dealer, and our dealers are given a longer period of time to pay the finance company. If our dealers do not pay the finance company, we may be required to repurchase the applicable inventory held by the dealer. We do not indemnify the finance company for any credit losses they may incur. Total dealer purchases financed under this arrangement accounted for approximately 15% of net sales for the years ended December 31, 2022 and 2021. The amount financed by dealers which remained outstanding was $212.2 million and $115.9 million as of December 31, 2022 and 2021, respectively. Long-term Liquidity We believe that our cash and cash equivalents, cash flow from operations, and availability under our Revolving Facility and other short-term lines of credit will provide us with sufficient capital to continue to grow our business in the future. We may use a portion of our cash flow to pay principal on our outstanding debt, as well as repurchase shares of our common stock, impacting the amount available for working capital, capital expenditures, acquisitions, and other general corporate purposes. As we continue to expand our business, we may require additional capital to fund working capital, capital expenditures or acquisitions. Cash Flow Year ended December 31, 2022 compared to year ended December 31, 2021 The following table summarizes our cash flows by source (use) for the periods presented: Year Ended December 31, (U.S. Dollars in thousands) 2022 2021 $ Change % Change Net cash provided by operating activities $ 58,516 $ 411,156 $ (352,640 ) -85.8 % Net cash used in investing activities (134,232 ) (817,287 ) 683,055 -83.6 % Net cash provided by (used in) financing activities 64,043 (102,970 ) 167,013 -162.2 % The decrease in net cash provided by operating activities primarily reflects increased working capital investment as well as lower operating earnings in the current year period. The higher working capital investment was primarily driven by higher inventory levels at the end of the current year. Net cash used in investing activities for the year ended December 31, 2022 primarily consisted of cash payments of $86.2 million for the purchase of property and equipment, $25.1 million related to the acquisition of businesses, $15.0 million investment in WATT Fuel Cell Corporation, and $14.9 million for contributions to an equity method investment, which were partially offset by cash proceeds from the sale of an investment of $1.3 million. Net cash used in investing activities for the year ended December 31, 2021 primarily consisted of cash payments of $713.5 million related to the acquisition of businesses and $110.0 million for the purchase of property and equipment, which were partially offset by cash proceeds of $5.0 million from the sale of an investment. Net cash provided by financing activities for the year ended December 31, 2022 primarily includes proceeds of $1,026.3 million from long-term borrowings, $248.2 million from short-term borrowings, and $13.8 million from the exercise of stock options. These cash proceeds were partially offset by $810.3 million of debt repayments ($268.1 million of short-term borrowings and $542.2 million of long-term borrowings and finance lease obligations), $345.8 million of stock repurchases, $40.9 million of taxes paid related to equity awards, $16.1 million of contingent consideration for acquired businesses, and $10.3 million for payment of debt issuance costs. Net cash used in financing activities for the year ended December 31, 2021 primarily consisted of $347.7 million of debt repayments ($239.1 million of short-term borrowings and $108.6 million of long-term borrowings), $126.0 million of stock repurchases, $58.9 million of taxes paid related to equity awards, $27.2 million as a purchase of additional ownership interest of PR Industrial S.r.l. and its subsidiaries (Pramac), and $3.8 million of contingent consideration for acquired businesses. These payments were partially offset by $272.8 million cash proceeds from short-term borrowings, $150.1 million cash proceeds from long-term borrowings and $38.8 million of proceeds from the exercise of stock options. 28 Table of Contents Senior Secured Credit Facilities Refer to Note 12, “Credit Agreements,” to the consolidated financial statements in Item 8 and the “Liquidity and Financial Position” section included in Item 7 of this Annual Report on Form 10-K for information on our senior secured credit facilities. Covenant Compliance The Term Loans contain restrictions on the Company’s ability to pay distributions and dividends. Payments can be made to the Company or other parent companies for certain expenses such as operating expenses in the ordinary course, fees and expenses related to any debt or equity offering and to pay franchise or similar taxes. Dividends can be used to repurchase equity interests, subject to limitations in certain circumstances. The Term Loans restrict the aggregate amount of dividends and distributions that can be paid and, in certain circumstances, requires pro forma compliance with certain fixed charge coverage ratios or gross leverage ratios, as applicable, in order to pay certain dividends and distributions. The Term Loans also contain other affirmative and negative covenants that, among other things, limit the incurrence of additional indebtedness, liens on property, sale and leaseback transactions, investments, loans and advances, mergers or consolidations, asset sales, acquisitions, transactions with affiliates, prepayments of certain other indebtedness and modifications of our organizational documents. The Tranche A Term Loan Facility and the Revolving Facility added certain financial covenants that require the Company to maintain a total leverage ratio below 3.75 to 1.00 as well as an interest coverage ratio above 3.00 to 1.00. As of December 31, 2022, the Company’s total leverage ratio was 1.74 to 1.00 times, and the Company's interest coverage ratio was 14.81 to 1.00. The Company was in compliance with all other covenants of the Amended Credit Agreement as of December 31, 2022. The Tranche B Term Loan Facility does not contain any financial maintenance covenants. The Term Loans contain customary events of default, including, among others, nonpayment of principal, interest or other amounts, failure to perform covenants, inaccuracy of representations or warranties in any material respect, cross-defaults with other material indebtedness, certain undischarged judgments, the occurrence of certain ERISA, bankruptcy or insolvency events, or the occurrence of a change in control (as defined in the Term Loan). A bankruptcy or insolvency event of default will cause the obligations under the Term Loans to automatically become immediately due and payable. The Revolving Facility also contains covenants and events of default substantially similar to those in the Term Loans, as described above. Contractual Obligations The following table summarizes our expected payments for significant contractual obligations as of December 31, 2022, using the interest rates in effect as of that date: (U.S. Dollars in thousands) Total 2023 2024 2025 2026 2027 After 2027 Long-term debt, including current portion (1) $ 1,370,966 $ 10,083 $ 28,178 $ 46,931 $ 595,711 $ 690,032 $ 31 Finance lease obligations, including current portion 27,420 2,650 2,455 1,996 1,604 1,504 17,211 Interest on long-term debt and finance lease obligations 362,415 88,429 84,951 82,476 77,501 21,892 7,166 Operating leases 118,360 34,208 30,834 20,386 9,855 8,334 14,743 Short-term borrowings (2) 48,990 48,990 - - - - - Total contractual cash obligations $ 1,928,151 $ 184,360 $ 146,418 $ 151,789 $ 684,671 $ 721,762 $ 39,151 (1) The Tranche B Term Loan matures on December 13, 2026. The Tranche A Term Loan and the Revolving Facility mature on June 29, 2027. As of December 31, 2022, there was $90 million outstanding under the Revolving Facility classified as long-term debt. (2) Short-term borrowings consist of borrowings by our foreign subsidiaries on local lines of credit. Capital Expenditures Our operations require capital expenditures for facilities and related improvements, technology, research & development, tooling, equipment, capacity expansion, IT systems & infrastructure and upgrades. Capital expenditures were $86.2 million, $110.0 million, and $62.1 million in the years ended December 31, 2022, 2021 and 2020, respectively, and were funded primarily through cash from operations. 29 Table of Contents Critical Accounting Policies and Estimates In preparing the financial statements, management is required to make estimates and assumptions that have an impact on the asset, liability, revenue and expense amounts reported. These estimates can also affect our supplemental information disclosures, including information about contingencies, risk and financial condition. We believe, given current facts and circumstances, that our estimates and assumptions are reasonable, adhere to U.S. GAAP, and are consistently applied. Inherent in the nature of an estimate or assumption is the fact that actual results may differ from estimates and estimates may vary as new facts and circumstances arise. We make routine estimates and judgments in determining net realizable value of accounts receivable, inventories, property and equipment, prepaid expenses, product warranties and other reserves. Management believes our most critical accounting estimates and assumptions are in the following areas: business combinations and purchase accounting; goodwill and other indefinite-lived intangible asset impairment assessment; and income taxes. Business Combinations and Purchase Accounting We account for business combinations using the acquisition method of accounting, and accordingly, the assets and liabilities of an acquired business are recorded at their respective fair values. The excess of the purchase price over the estimated fair value of assets and liabilities is recorded as goodwill. Assigning fair market values to the assets acquired and liabilities assumed at the date of an acquisition requires knowledge of current market values, the values of assets in use, and often requires the application of judgment regarding estimates and assumptions. While the ultimate responsibility resides with management, for material acquisitions we retain the services of certified valuation specialists to assist with assigning estimated values to certain acquired assets and assumed liabilities, including intangible assets, tangible long-lived assets, and contingent consideration. Acquired intangible assets, excluding goodwill, are valued using certain discounted cash flow methodologies based on future cash flows specific to the type of intangible asset purchased. This methodology incorporates various estimates and assumptions, the most significant being projected revenue growth rates, profit margins, forecasted cash flows, discount rates and terminal growth rates. If the contingent consideration is deemed significant or absent an agreed upon payout amount, the initial measurement of contingent consideration and the corresponding liability is evaluated using the Monte Carlo Method. For this valuation method, management develops projections during the contingent consideration period utilizing various potential pay-out scenarios. Probabilities are applied to each potential scenario and the resulting values are discounted using a rate that considers weighted average cost of capital as well as a specific risk premium associated with the riskiness of the contingent consideration itself, the related projections, and the overall business. Refer to Note 1, “Description of Business,” and Note 3, “Acquisitions,” to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further information on the Company’s business acquisitions. Goodwill and Other Indefinite-Lived Intangible Assets Refer to Note 2, “Summary of Accounting Policies – Goodwill and Other Indefinite-Lived Intangible Assets,” to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further information on the Company’s policy regarding the accounting for goodwill and other indefinite-lived intangible assets. The Company performed the required annual impairment tests for goodwill and other indefinite-lived intangible assets for the fiscal years 2022, 2021 and 2020, and found no impairment. When preparing a discounted cash flow analysis for purposes of our annual impairment test, we make a number of key estimates and assumptions. We estimate the future cash flows of the business based on historical and forecasted revenues and operating costs. In addition, we apply a discount rate to the estimated future cash flows for the purpose of the valuation. This discount rate is based on the estimated weighted average cost of capital for the business and may change from year to year. Weighted average cost of capital includes certain assumptions such as market capital structures, market betas, risk-free rate of return and estimated costs of borrowing. In our 2022 impairment test calculation performed as of October 31, 2022, the Latin America reporting unit had an estimated fair value that exceeded its carrying value by approximately 18%. The carrying value of the Latin America goodwill was $46.5 million. Key financial assumptions utilized to determine the fair value of the reporting unit include revenue growth levels that reflect the impact of increasing telecom production for the U.S. market, improving profit margins, a 3% terminal growth rate and a 14.4% discount rate. The reporting unit’s fair value would approximate its carrying value with a 175 basis point increase in the discount rate or a 130 basis point reduction in the average earnings margin and 100 basis point reduction in the terminal growth rate. For all reporting units, a considerable amount of management judgment and assumptions are required in performing the goodwill and indefinite-lived intangible asset impairment tests. While we believe our judgments and assumptions are reasonable, different assumptions could change the estimated fair values. A number of factors, many of which we have no ability to control, could cause actual results to differ from the estimates and assumptions we employed. These factors include: ● a rising interest rate environment; ● a negative impact from the COVID-19 pandemic; ● a prolonged global or regional economic downturn; ● a significant decrease in the demand for our products; ● the inability to develop new and enhanced products and services in a timely manner; ● a significant adverse change in legal factors or in the business climate; ● an adverse action or assessment by a regulator; ● successful efforts by our competitors to gain market share in our markets; ● disruptions to the Company’s business; ● inability to effectively integrate acquired businesses; ● unexpected or unplanned changes in the use of assets or entity structure; and ● business divestitures. If management's estimates of future operating results change or if there are changes to other assumptions due to these factors, the estimate of the fair values may change significantly. Such change could result in impairment charges in future periods, which could have a significant impact on our operating results and financial condition. 30 Table of Contents Income Taxes We account for income taxes in accordance with Accounting Standards Codification (ASC) 740, Income Taxes. Our estimate of income taxes payable, deferred income taxes and the effective tax rate is based on an analysis of many factors including interpretations of federal, state and international income tax laws; the difference between tax and financial reporting bases of assets and liabilities; estimates of amounts currently due or owed in various jurisdictions; and current accounting standards. We review and update our estimates on a quarterly basis as facts and circumstances change and actual results are known. In assessing the net realizable value of the deferred tax assets on our balance sheet, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the years in which those temporary differences become deductible. We consider the taxable income in prior carryback years, scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Refer to Note 15, “Income Taxes,” to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further information on the Company’s income taxes and income tax positions. New Accounting Standards For information with respect to new accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, refer to Note 2, “Summary of Accounting Policies - New Accounting Pronouncements,” to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K. Non-GAAP Measures Adjusted EBITDA To supplement our consolidated financial statements presented in accordance with U.S. GAAP, we provide the computation of Adjusted EBITDA attributable to the Company, which is defined as net income before noncontrolling interests adjusted for the following items: interest expense, depreciation expense, amortization of intangible assets, income tax expense, certain non-cash gains and losses including certain purchase accounting adjustments and contingent consideration adjustments, share-based compensation expense, losses on extinguishment of debt, certain transaction costs and credit facility fees, business optimization expenses, certain specific provisions, and adjusted EBITDA attributable to noncontrolling interests, as set forth in the reconciliation table below. We view Adjusted EBITDA as a key measure of our performance. We present Adjusted EBITDA not only due to its importance for purposes of our credit agreements, but also because it assists us in comparing our performance across reporting periods on a consistent basis as it excludes items that we do not believe are indicative of our core operating performance. Our management uses Adjusted EBITDA: ● for planning purposes, including the preparation of our annual operating budget and developing and refining our internal projections for future periods; ● to allocate resources to enhance the financial performance of our business; ● as a benchmark for the determination of the bonus component of compensation for our senior executives under our management incentive plan, as described further in our Proxy Statement; ● to evaluate the effectiveness of our business strategies and as a supplemental tool in evaluating our performance against our budget for each period; and ● in communications with our Board of Directors and investors concerning our financial performance. 31 Table of Contents We believe Adjusted EBITDA is used by securities analysts, investors and other interested parties in the evaluation of the Company. Management believes the disclosure of Adjusted EBITDA offers an additional financial metric that, when coupled with results prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and the reconciliation to U.S. GAAP results, provides a more complete understanding of our results of operations and the factors and trends affecting our business. We believe Adjusted EBITDA is useful to investors for the following reasons: ● Adjusted EBITDA and similar non-GAAP measures are widely used by investors to measure a company's operating performance without regard to items that can vary substantially from company to company depending upon financing and accounting methods, book values of assets, tax jurisdictions, capital structures and the methods by which assets were acquired; ● investors can use Adjusted EBITDA as a supplemental measure to evaluate the overall operating performance of our Company, including our ability to service our debt and other cash needs; and ● by comparing our Adjusted EBITDA in different historical periods, our investors can evaluate our operating performance excluding the impact of items described below. The adjustments included in the reconciliation table listed below are presented to illustrate the operating performance of our business in a manner consistent with the presentation used by our management and Board of Directors. These adjustments eliminate the impact of a number of items that: ● we do not consider indicative of our ongoing operating performance, such as non-cash write-downs and other charges, non-cash gains, write-offs relating to the retirement of debt, severance costs and other restructuring-related business optimization expenses; ● we believe to be akin to, or associated with, interest expense, such as administrative agent fees, revolving credit facility commitment fees and letter of credit fees; or ● are non-cash in nature, such as share-based compensation expense. We explain in more detail in footnotes (a) through (f) below why we believe these adjustments are useful in calculating Adjusted EBITDA as a measure of our operating performance. Adjusted EBITDA does not represent, and should not be a substitute for, net income or cash flows from operations as determined in accordance with U.S. GAAP. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under U.S. GAAP. Some of the limitations are: ● Adjusted EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments; ● Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; ● Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments on our debt; ● although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements; ● several of the adjustments that we use in calculating Adjusted EBITDA, such as non-cash write-downs and other charges, while not involving cash expense, do have a negative impact on the value of our assets as reflected in our consolidated balance sheet prepared in accordance with U.S. GAAP; and ● other companies may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure. 32 Table of Contents Furthermore, as noted above, one of our uses of Adjusted EBITDA is as a benchmark for determining elements of compensation for our senior executives. At the same time, some or all of these senior executives have responsibility for monitoring our financial results, generally including the adjustments in calculating Adjusted EBITDA (subject ultimately to review by our Board of Directors in the context of the Board's review of our financial statements). While many of the adjustments (for example, transaction costs and credit facility fees), involve mathematical application of items reflected in our financial statements, others involve a degree of judgment and discretion. While we believe all of these adjustments are appropriate, and while the calculations are subject to review by our Board of Directors in the context of the Board's review of our financial statements, and certification by our Chief Financial Officer in a compliance certificate provided to the lenders under our Term Loan and Revolving Facility, this discretion may be viewed as an additional limitation on the use of Adjusted EBITDA as an analytical tool. Because of these limitations, Adjusted EBITDA should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our U.S. GAAP results and using Adjusted EBITDA only supplementally. The following table presents a reconciliation of net income to Adjusted EBITDA attributable to Generac Holdings Inc.: Year Ended December 31, (U.S. Dollars in thousands) 2022 2021 2020 Net income attributable to Generac Holdings Inc. $ 399,502 $ 550,494 $ 350,576 Net income attributable to noncontrolling interests 9,368 6,075 (3,358 ) Net income 408,870 556,569 347,218 Interest expense 54,826 32,953 32,991 Depreciation and amortization 156,141 92,041 68,773 Provision for income taxes 99,596 134,957 98,973 Non-cash write-down and other adjustments (a) (2,091 ) (3,070 ) (327 ) Non-cash share-based compensation expense (b) 29,481 23,954 20,882 Loss on extinguishment of debt (c) 3,743 831 - Transaction costs and credit facility fees (d) 5,026 22,357 2,151 Business optimization and other charges (e) 4,371 33 12,158 Provision for regulatory and clean energy product charges (f) 65,265 - - Other 139 800 954 Adjusted EBITDA 825,367 861,425 583,773 Adjusted EBITDA attributable to noncontrolling interests 15,087 9,351 2,358 Adjusted EBITDA attributable to Generac Holdings Inc. $ 810,280 $ 852,074 $ 581,415 (a) Represents the following non-cash charges, gains, and other adjustments: gains/losses on disposals of assets and sales of certain investments, unrealized mark-to-market adjustments on commodity contracts, certain foreign currency related adjustments, and certain purchase accounting and contingent consideration related adjustments. We believe that adjusting net income for these items is useful for the following reasons: ● The gains/losses on disposals of assets and sales of certain investments resulting from the sale of assets that are no longer useful in our business and therefore represent gains or losses that are not from our core operations; ● The adjustments for unrealized mark-to-market gains and losses on commodity contracts represent non-cash items to reflect changes in the fair value of forward contracts that have not been settled or terminated. We believe it is useful to adjust net income for these items because the charges do not represent a cash outlay in the period in which the charge is incurred, although Adjusted EBITDA must always be used together with our U.S. GAAP statements of comprehensive income and cash flows to capture the full effect of these contracts on our operating performance; ● The purchase accounting adjustments represent non-cash items to reflect fair value at the date of acquisition, and therefore do not reflect our ongoing operations. Fair value adjustments to contingent consideration obligations related to business acquisitions are added back as they are akin to purchase price. (b) Represents share-based compensation expense to account for stock options, restricted stock and other stock awards over their respective vesting period. (c) Represents the non-cash write-off of original issue discount and deferred financing costs due to voluntary prepayments of debt. Refer to Note 12, “Credit Agreements,” to the consolidated financial statements in Item 8 of this Annual Report on Form 10-K for further information on the losses on extinguishment of debt. (d) Represents transaction costs incurred directly in connection with any investment, as defined in our credit agreement, equity issuance or debt issuance or refinancing, together with certain fees relating to our senior secured credit facilities, such as administrative agent fees and credit facility commitment fees under our Amended Credit Agreement, which we believe to be akin to, or associated with, interest expense and whose inclusion in Adjusted EBITDA is therefore similar to the inclusion of interest expense in that calculation. (e) For the year ended December 31, 2022, predominantly represents severance charges related to certain headcount reductions, as well as other restructuring charges related to the suspension of operations at certain of our facilities. For the year ended December 31, 2020, represents severance, non-cash asset write-downs and other charges to address the impact of the COVID-19 pandemic and decline in oil prices on demand for C&I products. (f) For the year ended December 31, 2022, represents a specific credit loss provision of $17.9 million for a clean energy product customer that filed for bankruptcy, as well as a warranty provision of $37.3 million to address certain clean energy product warranty-related matters. The amount also includes a provision of $10.0 million for a pending and unresolved matter with the CPSC concerning the imposition of potential penalty fines for allegedly failing to timely submit a report under the CPSA in relation to certain portable generators that were subject to a voluntary recall previously announced on July 29, 2021. 33 Table of Contents Adjusted Net Income To further supplement our consolidated financial statements in accordance with U.S. GAAP, we provide the computation of Adjusted Net Income attributable to the Company, which is defined as net income before noncontrolling interest adjusted for the following items: amortization of intangible assets, amortization of deferred financing costs and original issue discount related to our debt, intangible impairment charges (if any), certain transaction costs and other purchase accounting adjustments, losses on extinguishment of debt, business optimization expenses, certain specific provisions, other non-cash gains and losses or charges, and adjusted net income attributable to noncontrolling interests, as set forth in the reconciliation table below. In addition, for periods prior to 2022, adjusted net income reflects cash income tax expense due to the existence of the tax shield from the amortization of tax-deductible goodwill and intangible assets from our acquisition by CCMP Capital Advisors, LLC in 2006. Due to the expiration of this tax shield in the fourth quarter of 2021, there is no similar reconciling item starting in 2022. We believe Adjusted Net Income is used by securities analysts, investors and other interested parties in the evaluation of our company’s operations. Management believes the disclosure of Adjusted Net Income offers an additional financial metric that, when used in conjunction with U.S. GAAP results and the reconciliation to U.S. GAAP results, provides a more complete understanding of our ongoing results of operations, and the factors and trends affecting our business. The adjustments included in the reconciliation table listed below are presented to illustrate the operating performance of our business in a manner consistent with the presentation used by investors and securities analysts. Similar to the Adjusted EBITDA reconciliation, these adjustments eliminate the impact of a number of items we do not consider indicative of our ongoing operating performance or cash flows, such as amortization costs, transaction costs and write-offs relating to the retirement of debt. Prior to the expiration of our tax shield in the fourth quarter of 2021, we also made adjustments to present cash taxes paid as a result of our favorable tax attributes. Similar to Adjusted EBITDA, Adjusted Net Income does not represent, and should not be a substitute for, net income or cash flows from operations as determined in accordance with U.S. GAAP. Adjusted Net Income has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under U.S. GAAP. Some of the limitations are: ● Adjusted Net Income does not reflect changes in, or cash requirements for, our working capital needs; ● although amortization is a non-cash charge, the assets being amortized may have to be replaced in the future, and Adjusted Net Income does not reflect any cash requirements for such replacements; and ● other companies may calculate Adjusted Net Income differently than we do, limiting its usefulness as a comparative measure. The following table presents a reconciliation of net income to Adjusted Net Income attributable to Generac Holdings Inc.: Year Ended December 31, (U.S. Dollars in thousands) 2022 2021 2020 Net income attributable to Generac Holdings Inc. $ 399,502 $ 550,494 $ 350,576 Net income attributable to noncontrolling interests 9,368 6,075 (3,358 ) Net income 408,870 556,569 347,218 Provision for income taxes (a) - 134,957 98,973 Amortization of intangible assets 103,320 49,886 32,280 Amortization of deferred finance costs and original issue discount 3,234 2,589 2,598 Loss on extinguishment of debt 3,743 831 - Transaction costs and other purchase accounting adjustments (b) 3,588 19,655 (1,328 ) (Gain)/loss attributable to business or asset dispositions (c) (229 ) (4,383 ) - Business optimization and other charges (see above) 4,371 33 12,158 Provision for regulatory and clean energy product charges (see above) 65,265 - - Tax effect of add backs (43,638 ) - - Cash income tax expense (a) - (136,231 ) (79,723 ) Adjusted net income 548,524 623,906 412,176 Adjusted net income attributable to noncontrolling interests 9,675 4,971 (32 ) Adjusted net income attributable to Generac Holdings Inc. $ 538,849 $ 618,935 $ 412,208 (a) For the years ended December 31, 2021 and 2020, the amount is based on a cash income tax rate of 19.7% and 17.9%, respectively, due to the existence of the tax shield from the amortization of tax-deductible goodwill and intangible assets from our acquisition by CCMP Capital Advisors, LLC in 2006. Due to the expiration of this tax shield in the fourth quarter of 2021, there is no similar reconciling item for the 2022 period. For comparative purposes to the current year, using the GAAP income tax expense for the years ended December 31, 2021 and 2020, would result in an adjusted net income per diluted share of $9.36 and $5.97, respectively, on a pro forma basis. (b) Represents transaction costs incurred directly in connection with any investment, as defined in our credit agreement, equity issuance or debt issuance or refinancing, and certain purchase accounting and contingent consideration adjustments. (c) Represents gains and losses attributable to the disposition of a business or assets occurring in other than ordinary course, as defined in our credit agreement. 34 Table of Contents Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to market risk from changes in foreign currency exchange rates, commodity prices and interest rates. To reduce the risk from these changes, we use financial instruments from time to time. We do not hold or issue financial instruments for trading purposes. Foreign Currency We are exposed to foreign currency exchange risk as a result of transactions denominated in currencies other than the U.S. Dollar, as well as operating businesses and supply chains in foreign countries. Periodically, we utilize foreign currency forward purchase and sales contracts to manage the volatility associated with certain foreign currency purchases and sales in the normal course of business. Contracts typically have maturities of twelve months or less. Realized gains and losses on transactions denominated in foreign currency are recorded as a component of cost of goods sold in the statements of comprehensive income. The following is a summary of the thirty-four foreign currency contracts outstanding as of December 31, 2022 (notional amount in thousands): Currency Denomination Trade Dates Effective Dates Notional Amount Expiration Date GBP 11/21/22 - 12/20/22 11/21/22 - 12/20/22 $ 1,625 1/18/23 - 2/22/23 AUD 11/15/22 - 12/20/22 11/15/22 - 12/20/22 $ 11,975 1/18/23 - 2/22/23 Commodity Prices We are a purchaser of commodities and components manufactured from commodities including steel, aluminum, copper and others. As a result, we are exposed to fluctuating market prices for those commodities. While such materials are typically available from numerous suppliers, commodity raw materials are subject to price fluctuations. We generally buy these commodities and components based on market prices that are established with the supplier as part of the purchase process. Depending on the supplier, these market prices may reset on a periodic basis based on negotiated lags and calculations. To the extent that commodity prices increase and we do not have firm pricing from our suppliers, or our suppliers are not able to honor such prices, we may experience a decline in our gross margins to the extent we are not able to increase selling prices of our products or obtain manufacturing efficiencies or supply chain savings to offset increases in commodity costs. In 2021 and 2022, we experienced an increase in commodity and component costs resulting from supply chain challenges and the overall inflationary environment. We implemented multiple price increases to help mitigate the impact of these rising commodity costs, and the realization of these price increases in 2022 helped to partially offset the higher commodity costs. Periodically, we engage in certain commodity risk management activities to mitigate the impact of potential price fluctuations on our financial results. These derivatives typically have maturities of less than eighteen months. As of December 31, 2022, we had no commodity contracts outstanding. Interest Rates As of December 31, 2022, all of the outstanding debt under our Term Loans and Revolving Facility was subject to floating interest rate risk. As of December 31, 2022, we had the following interest rate swap contracts outstanding (notional amount in thousands of US dollars): Hedged Item Contract Date Effective Date Notional Amount Fixed SOFR Rate Expiration Date Interest Rate June 19, 2017 July 1, 2022 125,000 2.4120% May 31, 2023 Interest Rate June 30, 2017 July 1, 2022 125,000 2.4790% May 31, 2023 Interest Rate August 9, 2017 July 1, 2022 125,000 2.2948% May 31, 2023 Interest Rate August 30, 2017 July 1, 2022 125,000 2.23440% May 31, 2023 Interest Rate March 4, 2020 May 31, 2023 200,000 1.1360% December 14, 2026 Interest Rate March 5, 2020 May 31, 2023 100,000 1.0700% December 14, 2026 Interest Rate March 6, 2020 May 31, 2023 200,000 0.9560% December 14, 2026 In June 2022, in conjunction with the amendments to the Company's credit agreements discussed further in Note 12, “Credit Agreements,” to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K, the Company amended its interest rate swaps to match that of the underlying debt and reconfirmed hedge effectiveness. The Company formally documented all relationships between interest rate hedging instruments and the related hedged items, as well as its risk-management objectives and strategies for undertaking various hedge transactions. These interest rate swap agreements qualify as cash flow hedges and therefore, the effective portions of their gains or losses are reported as a component of accumulated other comprehensive loss (AOCL) in the consolidated balance sheets. At December 31, 2022, the fair value of these interest rate swaps was an asset of $49.3 million. Even after giving effect to these swaps, we are exposed to risks due to changes in interest rates with respect to the portion of our Term Loans and Revolving Facility that is not covered by the swaps. A hypothetical change in the SOFR interest rate of 100 basis points would have changed annual cash interest expense by approximately $5.4 million (or, without the swaps in place, $10.4 million) in 2022. For additional information on the Company’s foreign currency and commodity forward contracts and interest rate swaps, including amounts charged to the statements of comprehensive income during 2022, 2021, and 2020, refer to Note 5, “Derivative Instruments and Hedging Activities,” and Note 6, “Accumulated Other Comprehensive Loss,” to our consolidated financial statements in Item 8 of this Annual Report on Form 10-K. 35 Table of Contents
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion and analysis is intended to provide material information around events and uncertainties knownto management relevant to an assessment of the financial condition and results of operations of Gilead and should therefore be read in conjunction with our audited Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements and other disclosures included in this Annual Report on Form 10-K (including the disclosures under Part I, Item 1A. Risk Factors) where other material events and uncertainties not otherwise discussed below are disclosed. Certain amounts and percentages herein may not sum or recalculate due to rounding. Additional information related to the comparison of our results of operations between the years 2021 and 2020 is included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our 2021 Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”). Management OverviewStrategy and OutlookGilead Sciences, Inc. (“Gilead,” “we,” “our” or “us”) is a biopharmaceutical company that has pursued and achieved breakthroughs in medicine for more than three decades, with the goal of creating a healthier world for all people. We are committed to advancing innovative medicines to prevent and treat life-threatening diseases, including HIV, viral hepatitis and cancer. We operate in more than 35 countries worldwide, with headquarters in Foster City, California. Since 2019, our strategic ambitions have been to (i) bring 10+ transformative therapies to patients by 2030; (ii) be the biotech employer and partner of choice; and (iii) deliver shareholder value in a sustainable and responsible manner. Our strategic priorities for 2023 and beyond, reflecting how we plan to deliver those ambitions, are: (i) maximize near-term revenue growth; (ii) maximize impact of long-active HIV; (iii) expand and deliver on oncology programs; (iv) champion an environment of inclusion and employee growth; and (v) remove barriers to speed in execution. We plan to provide consistent execution on a portfolio with quality, depth and breadth, including continued growth in our leading HIV portfolio, which is poised to shape the long-acting market following our first lenacapavir approvals, as well as strong commercial performance and clinical momentum for our fast-growing oncology business.Key Business UpdatesDuring 2022, we continued to advance our portfolio, receiving approvals across various therapeutic areas, indications and geographies. We ended the year with Sunlenca receiving its first approval in the U.S. for heavily-treatment experienced individuals, following the first European market approval by the European Commission (“EC”). This is the first twice-yearly, subcutaneous HIV medicine to be approved. We also continued to broaden therapies available in oncology, receiving approvals for additional indications of Yescarta and Tecartus, and the 2023 approval of Trodelvy for the treatment of adult patients with unresectable locally advanced or metastatic hormone receptor-positive, human epidermal growth factor receptor 2-negative (“HR+/HER2-”) breast cancer who have received endocrine-based therapy and at least two additional systemic therapies in the metastatic setting.In terms of capital resources, we continued to invest in our business and research and development (“R&D”) pipeline through acquisitions and collaborations. We also continued to provide shareholder returns in the form of dividends and share repurchases.The following highlights are taken from press releases recently issued. Readers are encouraged to review all press releases available on our website at www.gilead.com. The content on the referenced website does not constitute a part of and is not incorporated by reference into this Annual Report on Form 10-K.Virology•In December 2022, we announced U.S. Food and Drug Administration (“FDA”) approval of Sunlenca, in combination with other antiretroviral(s), for the treatment of HIV-1 infection in heavily treatment-experienced adults with multi-drug resistant HIV-1 infection.•In November 2022, we announced the EC authorized an extended indication and line extension for a low-dosage tablet form of Biktarvy for the treatment of HIV in virologically suppressed children who are at least 2 years of age and weigh at least 14 kg.•In November 2022, we announced FDA approval of Vemlidy for the treatment of chronic hepatitis B virus (“HBV”) infection in pediatric patients 12 years and older with compensated liver disease.•In October 2022, we announced that Merck & Co., Inc. (“Merck”) and Gilead plan to resume their Phase 2 study under an amended protocol. The study will evaluate an investigational once-weekly oral combination treatment regimen of Merck’s islatravir at a lower weekly dose and Gilead’s lenacapavir.34•In August 2022, we announced that EC has granted marketing authorization for Sunlenca (lenacapavir) for the treatment of HIV infection, in combination with other antiretroviral(s), in adults with multi-drug resistant HIV infection for whom it is otherwise not possible to construct a suppressive antiviral regimen.•In July 2022, we received a positive opinion from European Medicines Agency’s (“EMA”) Committee for Medicinal Products for Human Use (“CHMP”) for Veklury to be granted full marketing authorization for the treatment of coronavirus disease 2019 (“COVID-19”) in adults and adolescents with pneumonia requiring supplemental oxygen and adults who do not require supplemental oxygen and are at increased risk of developing severe COVID-19.•In May 2022, we announced FDA lifted the clinical hold placed on the Investigational New Drug Application to evaluate injectable lenacapavir for HIV treatment and pre-exposure prophylaxis following the agency’s review of the storage and compatibility data of lenacapavir injection with an alternate vial made from aluminosilicate glass.•In April 2022, FDA approved a supplemental new drug application for Veklury for the treatment of pediatric patients under 12 years of age for the treatment of COVID-19.OncologyCell Therapy•In December 2022, we entered into an agreement to acquire Tmunity Therapeutics Inc. (“Tmunity”), a clinical stage private biotech company, which will provide us with preclinical and clinical programs, including an “armored” CAR T technology platform that has the potential to be applied to a variety of CAR Ts to enhance anti-tumor activity, as well as rapid manufacturing processes. The transaction closed in February 2023.•In December 2022, we entered into a strategic collaboration with Arcellx, Inc. (“Arcellx”) to co-develop and co-commercialize CART-ddBCMA, a late-stage clinical asset in development for the treatment of multiple myeloma. The transaction closed in January 2023.•In December 2022, we announced the transfer of the marketing authorization for Yescarta in Japan from Daiichi Sankyo Co., Ltd. to Gilead K.K. in 2023.•In December 2022, we received approval from the Ministry of Health, Labour and Welfare in Japan for Yescarta for the initial treatment of relapsed or refractory (“R/R”) large B-cell lymphoma (“LBCL”).•In October 2022, we received European marketing authorization for Yescarta use in adults with second-line diffuse LBCL. Additionally, EC granted marketing authorization for Tecartus for the treatment of adult R/R B-cell precursor acute lymphoblastic leukemia (“ALL”), and in Canada, we received conditional marketing authorization for Yescarta for R/R follicular lymphoma (“FL”) after two or more lines of systemic therapy.•In July 2022, we received a positive opinion from EMA’s CHMP for Tecartus for the treatment of adult patients 26 years of age and above with R/R B-cell precursor ALL.•In June 2022, EC approved Yescarta for the treatment of adult patients with R/R FL after three or more lines of systemic therapy.•In April 2022, FDA approved commercial production at our new CAR T-cell therapy manufacturing facility in Frederick, Maryland.•In April 2022, FDA granted approval to Yescarta as initial treatment for adults with LBCL that is refractory to or relapses within 12 months of first-line chemoimmunotherapy.Other•In February 2023, we announced that FDA has approved Trodelvy for the treatment of adult patients with unresectable locally advanced or metastatic HR+/HER2- breast cancer who have received endocrine-based therapy and at least two additional systemic therapies in the metastatic setting.•In January 2023, we announced that EMA has validated a Type II variation of the Marketing Authorization Application for Trodelvy for the treatment of adult patients unresectable or metastatic HR+/HER2- breast cancer who have received endocrine-based therapy and at least two additional systemic therapies in the metastatic setting.•In December 2022, we acquired the remaining rights to GS-1811, an anti-CCR8 antibody developed by Jounce Therapeutics, Inc. (“Jounce”) for the treatment of solid tumors.•In October 2022, we announced a strategic collaboration with MacroGenics, Inc. (“MacroGenics”) to develop bispecific antibodies to treat various cancers. The agreement includes an upfront payment by us of $60 million to MacroGenics and an exclusive option granted to us on MGD024, an investigational CD123 and CD3 bispecific.•In August 2022, we announced an agreement with Everest Medicines (“Everest”) to transfer all development and commercialization rights to Gilead for Trodelvy in Greater China, South Korea, and other Asian markets.35•In April 2022, we entered into a strategic research collaboration agreement with Dragonfly Therapeutics, Inc. (“Dragonfly”) to develop natural killer cell engager-based immunotherapies for oncology and inflammation indications.•In March 2022, we announced results from the Phase 3 TROPiCS-02 study evaluating Trodelvy in patients with HR+/HER2- mBC who received prior endocrine therapy, cyclin-dependent kinase (“CDK”) 4/6 inhibitors and two to four lines of chemotherapy.Inflammation•In January 2023, we announced a collaboration and licensing agreement with EVOQ Therapeutics, Inc. (“EVOQ”) to advance EVOQ’s proprietary NanoDisc technology for the treatment of rheumatoid arthritis and lupus.•In September 2022, we completed the acquisition of MiroBio Ltd. (“MiroBio”) for $414 million in cash. MiroBio is a U.K.-based biotechnology company focused on restoring immune balance with agonists targeting immune inhibitory receptors.Key Financial Results(in millions, except percentages and per share amounts)20222021ChangeTotal revenues$27,281 $27,305 — %Net income attributable to Gilead$4,592 $6,225 (26)%Diluted earnings per share attributable to Gilead$3.64 $4.93 (26)%Total revenues were $27.3 billion in 2022 and remained relatively flat compared to 2021, primarily due to increased sales in HIV, cell therapy and Trodelvy, offset by lower sales of Veklury.Net income attributable to Gilead was $4.6 billion or $3.64 diluted earnings per share attributable to Gilead in 2022, compared to $6.2 billion or $4.93 diluted earnings per share attributable to Gilead in 2021. The decrease was primarily due to the following items net of their related tax effect: a partial in-process research and development (“IPR&D”) impairment charge of $2.7 billion during the three months ended March 31, 2022 related to assets we acquired from Immunomedics, Inc. (“Immunomedics”) in 2020, a $406 million charge related to the termination of the Trodelvy collaboration agreement with Everest and higher R&D expenses, partially offset by a $1.25 billion charge for a settlement related to bictegravir litigation in the fourth quarter of 2021 that did not repeat in 2022.Results of OperationsRevenuesThe following table summarizes the period-over-period changes in our Total revenues:Year Ended December 31, 2022Year Ended December 31, 2021(in millions, except percentages)U.S.EuropeOther InternationalTotalU.S.EuropeOther InternationalTotalChangeProduct sales:HIV$13,820 $2,219 $1,155 $17,194 $12,828 $2,366 $1,121 $16,315 5 %Veklury1,575 702 1,628 3,905 3,640 1,095 830 5,565 (30)%HCV1,005 413 392 1,810 1,018 421 442 1,881 (4)%HBV/HDV435 112 441 988 397 104 468 969 2 %Cell Therapy968 430 60 1,459 542 293 36 871 68 %Trodelvy525 143 12 680 370 10 — 380 79 %Other388 323 235 946 381 389 257 1,027 (8)%Total product sales18,716 4,342 3,924 26,982 19,176 4,678 3,154 27,008 — %Royalty, contract and other revenues168 127 4 299 91 196 10 297 1 %Total revenues$18,884 $4,469 $3,928 $27,281 $19,267 $4,874 $3,164 $27,305 — %________________________________See Note 2. Revenues of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further disaggregation of revenue by product.HIVHIV product sales increased by 5% to $17.2 billion in 2022, compared to 2021, primarily due to continued higher demand for Biktarvy worldwide and favorable pricing dynamics, partially offset by the impact of the loss of exclusivity for Truvada in the U.S., channel inventory dynamics and unfavorable foreign currency exchange impact. Part of our favorable pricing dynamics resulted from shifts in channel mix, and we expect channel mix to remain similar in 2023.36VekluryVeklury product sales decreased by 30% to $3.9 billion in 2022, compared to 2021, primarily due to lower demand driven by reduced hospitalization rates in the U.S. and Europe, partially offset by higher demand in Other International. Sales of Veklury generally reflect COVID-19 related rates and severity of infections and hospitalizations, as well as the availability, uptake and effectiveness of vaccinations and alternative treatments for COVID-19. As a result, future sales of Veklury are difficult to predict and may vary significantly from one period to the next.HCVHCV product sales decreased by 4% to $1.8 billion in 2022, compared to 2021, primarily due to unfavorable foreign currency exchange impact, fewer patient starts and unfavorable pricing dynamics.HBV / HDVHBV and HDV product sales increased by 2% to $988 million in 2022, compared to 2021, primarily due to higher demand for Vemlidy and the continued adoption of Hepcludex in Europe.Cell TherapyCell therapy product sales, which include Yescarta and Tecartus, increased by 68% to $1.5 billion in 2022, compared to 2021, primarily due to higher demand for Yescarta in R/R LBCL in the U.S. and Europe, as well as for Tecartus in R/R ALL and mantle cell lymphoma.TrodelvyTrodelvy product sales increased by 79% to $680 million in 2022, compared to 2021, primarily due to the continued adoption in metastatic triple-negative breast cancer in the U.S. and Europe.OtherOther product sales decreased by 8% to $946 million in 2022, as compared to 2021, primarily due to lower demand for AmBisome and loss of exclusivity for Letairis.Gross-to-Net DeductionsThe following table summarizes the period-over-period changes in gross-to-net deductions:(in millions, except percentages)20222021ChangeGross product sales$41,564 $41,381 — %Gross-to-net deductions:Rebates and chargebacks$12,622 $12,594 — %Sales returns, discounts and other$1,960 $1,779 10 %Total gross-to-net deductions$14,582 $14,373 1 %% of gross product sales35 %35 %Net product sales$26,982 $27,008 — %Foreign Currency Exchange ImpactWe generally face exposure to movements in foreign currency exchange rates, primarily in the Euro. We use foreign currency exchange contracts to hedge a portion of our foreign currency exposures. Of our total product sales, 31% and 29% were generated outside the U.S. in 2022 and 2021, respectively. Foreign currency exchange, net of hedges, had an unfavorable impact on our total product sales of $608 million in 2022, based on a comparison using foreign currency exchange rates from 2021.37Costs and ExpensesThe following table summarizes the period-over-period changes in our costs and expenses: (in millions, except percentages)20222021ChangeCost of goods sold$5,657 $6,601 (14)%Product gross margin79.0 %75.6 %347 bpsResearch and development expenses$4,977 $4,601 8 %Acquired in-process research and development expenses$944 $939 1 %In-process research and development impairment$2,700 $— NMSelling, general and administrative expenses$5,673 $5,246 8 %________________________________NM - Not MeaningfulProduct Gross MarginProduct gross margin increased to 79.0% in 2022 as compared to 75.6% in 2021, primarily driven by a $1.25 billion charge for a settlement related to bictegravir litigation in the fourth quarter of 2021 that did not repeat in 2022. The increase was partially offset by higher royalty expenses driven by Biktarvy royalties, the reversal of a $175 million litigation reserve in the third quarter of 2021 that did not repeat in 2022, and changes in product mix.Research and Development ExpensesResearch and development expenses increased by $376 million in 2022 compared to 2021, primarily due to higher clinical development spend related mostly to Trodelvy and the Arcus Biosciences, Inc. (“Arcus”) collaboration, as well as inflationary increases.Acquired In-Process Research and Development ExpensesAcquired in-process research and development expenses of $944 million in 2022 were primarily related to a $389 million charge associated with our acquisition of MiroBio, a $315 million charge associated with the Dragonfly collaboration, an $82 million charge associated with the Jounce collaboration and acquisition of GS-1811, and a $60 million charge associated with the MacroGenics collaboration. Acquired in-process research and development expenses of $939 million in 2021 were primarily related to a $625 million charge associated with an option exercised under the Arcus collaboration. See Note 6. Acquisitions and Note 10. Collaborations and Other Arrangements of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information.In-Process Research and Development ImpairmentIn connection with our acquisition of Immunomedics in 2020, we allocated a portion of the purchase price to acquired IPR&D intangible assets. Approximately $8.8 billion was assigned to IPR&D intangible assets related to Trodelvy for treatment of patients with HR+/HER2- breast cancer. In March 2022, we received data from the Phase 3 TROPiCS-02 study evaluating Trodelvy in patients with HR+/HER2- mBC who have received prior endocrine therapy, CDK4/6 inhibitors and two to four lines of chemotherapy (“third-line plus patients”). Based on our evaluation of the study results, and in connection with the preparation of the financial statements for the first quarter, we updated our estimate of the fair value of our HR+/HER2- IPR&D intangible asset to $6.1 billion as of March 31, 2022. Our estimate of fair value used a probability weighted income approach that discounts expected future cash flows to the present value. The expected cash flows included cash flows from HR+/HER2- mBC for third-line plus patients and patients in earlier lines of therapy which are the subject of separate clinical studies. Our revised discounted cash flows were lower primarily due to a delay in launch timing for third-line plus patients which caused a decrease in our market share assumptions based on the expected competitive environment. There were no changes in our plans or assumptions related to our estimated cash flows for patients in the earlier lines of therapy. We determined the revised estimated fair value was below the carrying value of the asset and, as a result, we recognized a partial impairment charge of $2.7 billion in In-process research and development impairment on our Consolidated Statements of Income during the three months ended March 31, 2022. The remaining balance of the HR+/HER2- IPR&D intangible asset at the time of the assessment related to cash flows from earlier lines of therapy, where we have Phase 3 pivotal studies in development, in addition to the revised cash flows related to the third-line plus patient setting. If future events result in adverse changes in the key assumptions used in determining fair value, including the timing of product launches, information on the competitive landscape of treatments in this indication, changes to the probability of technical or regulatory success, failure to obtain anticipated regulatory approval or discount rate, among others, additional impairments may be recorded and could be material to our financial statements. No other IPR&D impairment charges were recorded in 2022 or 2021.38Selling, General and Administrative ExpensesSelling, general and administrative expenses increased by $427 million in 2022 compared to 2021, primarily due to a $406 million charge associated with the termination of the Trodelvy license collaboration agreement with Everest, which had provided Everest with broad commercialization and development rights to Trodelvy in certain Asia territories. We terminated the existing agreement and reacquired the Trodelvy rights in these territories. Other spending increases in 2022 included increased promotional and marketing investing, mostly in Trodelvy and cell therapy, as well as higher corporate activities and inflationary increases, slightly offset by a decrease in donations to the Gilead Foundation in 2022 as compared to 2021.Interest Expense and Other Income (Expense), NetThe following table summarizes the period-over-period changes in our Interest expense and Other income (expense), net:(in millions, except percentages)20222021ChangeInterest expense$(935)$(1,001)(7)%Other income (expense), net$(581)$(639)(9)%Interest expense decreased by $66 million in 2022 compared to 2021, primarily due to lower outstanding debt balances.The changes in Other income (expense), net for 2022, compared to 2021, primarily reflects higher interest income due to rising interest rates, partially offset by higher net unrealized losses from equity securities.Income TaxesThe following table summarizes the period-over-period changes in our Income tax expense:(in millions, except percentages)20222021ChangeIncome before income taxes$5,814 $8,278 $(2,464)Income tax expense$(1,248)$(2,077)$829 Effective tax rate21.5 %25.1 %(3.6)%Our effective tax rate decreased in 2022, compared to 2021, primarily due to a beneficial change in jurisdictional mix of income and lower state taxes.Liquidity and Capital ResourcesWe continually evaluate our liquidity and capital resources, including our access to external capital, to ensure that we can adequately and efficiently finance our operations.LiquidityCash, cash equivalents, and marketable debt securities were $7.6 billion and $7.8 billion as of December 31, 2022 and 2021, respectively. Cash and cash equivalents increased by $74 million from December 31, 2021 to December 31, 2022. The following table summarizes our cash flow activities:(in millions)20222021Net cash provided by (used in): Operating activities$9,072 $11,384 Investing activities$(2,466)$(3,131)Financing activities$(6,469)$(8,877)Effect of exchange rate changes on cash and cash equivalents$(63)$(35)Operating ActivitiesNet cash provided by operating activities is derived by adjusting our net income for non-cash items and changes in operating assets and liabilities. Net cash provided by operating activities was $9.1 billion in 2022, compared to $11.4 billion in 2021. The decrease was primarily due to the $1.25 billion payment made in the first quarter of 2022 in connection with the legal settlement related to bictegravir litigation as well as higher income tax payments made and higher operating expenses in 2022.Investing ActivitiesNet cash used in investing activities was $2.5 billion in 2022, compared to $3.1 billion in 2021. The decrease was primarily due to lower net purchases of marketable debt and equity securities, partially offset by higher capital expenditures and other acquisitions.39Financing ActivitiesNet cash used in financing activities was $6.5 billion in 2022, compared to $8.9 billion in 2021. In 2022, we utilized cash for $1.5 billion of debt repayments, $3.7 billion of dividend payments and $1.4 billion of common stock repurchases. In 2021, we utilized cash for $4.75 billion of debt repayments, $3.6 billion of dividend payments, and $546 million of common stock repurchases.Capital ResourcesWe believe our existing capital resources, including cash and cash equivalents, marketable debt securities and our revolving credit facility, supplemented by cash flows generated from our operations, will be adequate to satisfy our capital needs for the foreseeable future.As of December 31, 2022, our material cash requirements consisted primarily of the repayment of outstanding borrowings, income tax payments, including the remaining obligations for the one-time repatriation transition tax from the Tax Cuts and Jobs Act, purchases of inventory, operating lease obligations, capital expenditures and milestone and other payments related to our collaborative agreements. See Notes 6. Acquisitions, 10. Collaborations and Other Arrangements, 11. Debt and Credit Facilities, 12. Leases, 13. Commitments and Contingencies and 17. Income Taxes of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information. We enter into certain unconditional purchase obligations, capital expenditure projects and other commitments in the normal course of business. There have been no changes to these commitments during the year that would have a material impact on the company’s ability to meet either short-term or long-term cash requirements. Our future capital requirements will depend on many factors, including but not limited to the following:•the commercial performance of our current and future products;•the progress and scope of our R&D efforts, including preclinical studies and clinical trials;•the cost, timing and outcome of regulatory reviews;•the expansion of our sales and marketing capabilities;•the possibility of acquiring additional manufacturing capabilities or office facilities;•the possibility of acquiring other companies or new products;•debt service requirements;•future dividends subject to declaration by our Board of Directors;•the establishment of additional collaborative relationships with other companies; and•costs associated with the defense, settlement and adverse results of government investigations and litigation.We may in the future require additional funding, which could be in the form of proceeds from equity or debt financings. If such funding is required, we cannot guarantee that it will be available to us on favorable terms, if at all. We may choose to repay certain of our long-term debt obligations prior to maturity dates based on our assessment of current and long-term liquidity and capital requirementsCritical Accounting EstimatesSee Note 1. Organization and Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for information about our significant accounting policies and how estimates are involved in the preparation of our financial statements. We believe the following reflect the critical accounting estimates used in the preparation of our Consolidated Financial Statements.Rebates and Chargebacks Rebates and chargebacks are determined using a complex estimation process and are subject to uncertainty in part due to the lag between the date of the product sales and the date the related rebates or chargeback claims are settled. In developing our estimates of rebates and chargebacks, we consider the following: •product sales, including product mix and pricing;•historical and estimated payer mix;•statutory discount requirements and contractual terms;•historical claims experience and processing time lags;•estimated patient population;•known market events or trends; 40•market research;•channel inventory data obtained from our major U.S. wholesalers; and•other pertinent internal or external information.The following table summarizes the consolidated activities and ending balances in our rebates and chargebacks accounts, including adjustments made relating to previous years’ sales as a result of changes in estimates:(in millions)Balance at Beginning of YearDecrease/(Increase) to Product SalesPaymentsBalance at End of YearYear ended December 31, 2022: Activity related to 2022 sales$— $13,040 $(9,442)$3,598 Activity related to sales prior to 20223,915 (418)(3,067)430 Total$3,915 $12,622 $(12,509)$4,028 Year ended December 31, 2021: Activity related to 2021 sales$— $13,211 $(9,714)$3,497 Activity related to sales prior to 20214,012 (617)(2,977)418 Total$4,012 $12,594 $(12,691)$3,915 Our net product sales in 2022 include the impact of $418 million for changes in rebate and chargeback estimates related to sales prior to 2022. Historically, our actual rebates and chargebacks claimed for prior periods have varied by less than 5% from our estimates. Valuation of Intangible AssetsDetermining the fair values of intangible assets, whether as part of a business combination or impairment assessment, involves the use of a probability-weighted income approach that discounts expected future cash flows to present value and requires the use of critical estimated inputs, including:•identification of product candidates with sufficient substance requiring separate recognition;•estimates of projected future cash flows, including revenues and operating profits related to the products or product candidates, which, for example, include significant inputs such as addressable patient population, treatment duration and projected market share;•the probability of technical and regulatory success for unapproved product candidates considering their stages of development;•the time and resources needed to complete the development and approval of product candidates;•an appropriate discount rate based on the estimated weighted-average cost of capital for companies with profiles similar to our profile, representing the rate that market participants would use to value the intangible assets;•the life of the potential commercialized products and associated risks, including the inherent difficulties and uncertainties in developing a product candidate such as obtaining FDA and other regulatory approvals; and•risks related to the viability of and potential alternative treatments in any future target markets.These estimates are subject to uncertainty due to the high rate of failure inherent in the discovery and development of new products; delays that can occur in development, approval and product launch processes; unanticipated decisions made by regulatory agencies; advent of competing products; unexpected changes in U.S. and global financial markets and other unanticipated events and circumstances. If future events result in adverse changes in the critical assumptions used in determining fair value, impairment charges on our intangible assets may be recorded and could be material to our financial statements. For example, in 2022, we recognized a $2.7 billion impairment charge related to our HR+/HER2- IPR&D intangible asset related to an expected delay in launch timing which caused a decrease in our market share assumptions based on the expected competitive environment.Legal ContingenciesWe are a party to various legal actions. Certain significant matters are described in Note 13. Commitments and Contingencies of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. 41Critical inputs to the accruals recorded and disclosures provided in relation to these matters include the probability of a certain outcome of the case, the determination as to whether an exposure is reasonably estimable and the amount of potential exposure. These inputs are subject to uncertainty due to changes in the legal facts and circumstances of the case, status of the proceedings, applicable law, the views of legal counsel and the views of any judges or jury involved in the case. Upon the final resolution of such matters, it is possible that there may be a loss in excess of the amount recorded, and such amounts could have a material adverse effect on our results of operations, cash flows or financial position. We periodically reassess these matters when additional information becomes available and adjust our estimates and assumptions when facts and circumstances indicate the need for any changes. For example, in the fourth quarter of 2021, we recorded an accrual of $1.25 billion in Other current liabilities on our Consolidated Balance Sheets for the settlement related to bictegravir litigation.Income TaxesWe are subject to income taxes in the U.S. and various foreign jurisdictions, including Ireland. Critical inputs in determining our provision for income taxes and related tax balances include forecasts of our future income and expenses, potential tax planning strategies and determination of the probability of certain tax positions being sustained upon examination by tax authorities. These inputs are subject to uncertainty due to potential changes in facts and circumstances, economic and political conditions, changes to existing tax laws and new regulations or interpretations by tax authorities. Changes in these conditions could have a material adverse impact on our results of operations and financial position.42ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are exposed to market risks that may result from changes in foreign currency exchange rates, interest rates and credit, and equity prices. To reduce certain of these risks, we enter into various types of foreign currency derivative hedging transactions, follow investment guidelines and monitor outstanding receivables as part of our risk management program. We may also enter into other transactions, such as interest rate derivative hedges, as needed.Foreign Currency Exchange Rate Risk We have operations in more than 35 countries worldwide. As a result, our financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we distribute our products. Our operating results are exposed to changes in foreign currency exchange rates between the U.S. dollar and various foreign currencies, the most significant of which is the Euro. When the U.S. dollar strengthens against these currencies, the relative value of sales made in the respective foreign currency decreases. Conversely, when the U.S. dollar weakens against these currencies, the relative value of such sales increases. Overall, we are a net receiver of foreign currencies and, therefore, we benefit from a weaker U.S. dollar and are adversely affected by a stronger U.S. dollar. Approximately 29% of our product sales were denominated in foreign currencies during 2022. To partially mitigate the impact of changes in currency exchange rates on net cash flows from our foreign currency denominated sales, we enter into foreign currency exchange forward contracts. We also hedge certain monetary assets and liabilities denominated in foreign currencies, which reduces but does not eliminate our exposure to currency fluctuations between the date a transaction is recorded and the date that cash is collected or paid. In general, the market risks of these contracts are offset by corresponding gains and losses on the transactions being hedged. As of December 31, 2022 and 2021, we had open foreign currency forward contracts with notional amounts of $3.0 billion and $2.9 billion, respectively. A hypothetical 10% adverse movement in foreign currency exchange rates compared with the U.S. dollar relative to exchange rates as of December 31, 2022 and 2021 would have resulted in a reduction in fair value of these contracts of approximately $299 million and $333 million, respectively, and if realized, would have negatively affected earnings over the remaining life of the contracts. The analysis does not consider the impact that hypothetical changes in foreign currency exchange rates would have on anticipated transactions that these foreign currency sensitive instruments were designed to offset.Interest Rate and Credit Risk Our portfolio of available-for-sale debt securities and our senior unsecured notes create an exposure to interest rate and credit risk. With respect to our investment portfolio, we adhere to an investment policy that requires us to limit amounts invested in securities based on credit rating, maturity, industry group and investment type and issuer, except for securities issued by the U.S. government. The goals of our investment policy, in order of priority, are as follows: • safety and preservation of principal and diversification of risk; • liquidity of investments sufficient to meet cash flow requirements; and • a competitive after-tax rate of return. The following table summarizes the expected maturities and average interest rates of our interest-generating assets and interest-bearing liabilities as of December 31, 2022: Expected MaturityTotal Fair Value(in millions, except percentages)20232024202520262027ThereafterTotalAssetsAvailable-for-sale debt securities$1,048 $830 $382 $19 $4 $9 $2,293 $2,293 Average interest rate2.55 %3.41 %3.83 %5.09 %2.42 %2.07 %LiabilitiesSenior unsecured fixed rate notes, including current portion(1)$2,250 $1,750 $1,750 $2,750 $2,000 $13,750 $24,250 $21,872 Average interest rate1.33 %3.70 %3.50 %3.65 %2.29 %4.07 %_______________________________(1) Amounts represent principal balances. In addition to the senior unsecured fixed rate notes, we have a $2.5 billion five-year revolving credit facility that matures in June 2025. There were no amounts outstanding under the five-year revolving credit facility as of December 31, 2022. See Note 11. Debt and Credit Facilities of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information. 43Equity Price Risk We hold shares of common stock of certain publicly traded biotechnology companies primarily in connection with license and collaboration agreements. These equity securities are measured at fair value with any changes in fair value recognized in earnings. The fair value of these equity securities was approximately $1.2 billion and $1.8 billion as of December 31, 2022 and 2021, respectively. Changes in fair value of these equity securities are impacted by the volatility of the stock market and changes in general economic conditions, among other factors. A hypothetical 20% increase or decrease in the stock prices of these equity securities would have increased or decreased their fair value as of December 31, 2022 and 2021 by approximately $239 million and $364 million, respectively.44
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsIntroduction The Goldman Sachs Group, Inc. (Group Inc. or parent company), a Delaware corporation, together with its consolidated subsidiaries, is a leading global financial institution that delivers a broad range of financial services to a large and diversified client base that includes corporations, financial institutions, governments and individuals. Founded in 1869, we are headquartered in New York and maintain offices in all major financial centers around the world. We manage and report our activities in three business segments: Global Banking & Markets, Asset & Wealth Management and Platform Solutions. See “Results of Operations” for further information about our business segments. When we use the terms “we,” “us” and “our,” we mean Group Inc. and its consolidated subsidiaries. When we use the term “our subsidiaries,” we mean the consolidated subsidiaries of Group Inc. References to “this Form 10-K” are to our Annual Report on Form 10-K for the year ended December 31, 2022. All references to “the consolidated financial statements” or “Supplemental Financial Information” are to Part II, Item 8 of this Form 10-K. All references to 2022, 2021 and 2020 refer to our years ended, or the dates, as the context requires, December 31, 2022, December 31, 2021 and December 31, 2020, respectively. Any reference to a future year refers to a year ending on December 31 of that year. Group Inc. is a bank holding company (BHC) and a financial holding company regulated by the Board of Governors of the Federal Reserve System (FRB). In this discussion and analysis of our financial condition and results of operations, we have included information that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts or statements of current conditions, but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results, financial condition, liquidity and capital actions may differ, possibly materially, from the anticipated results, financial condition, liquidity and capital actions in these forward-looking statements. Important factors that could cause our results, financial condition, liquidity and capital actions to differ from those in these statements include, among others, those described in “Risk Factors” in Part I, Item 1A of this Form 10-K and “Forward-Looking Statements” in Part I, Item 1 of this Form 10-K. Goldman Sachs 2022 Form 10-K57THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThese statements may relate to, among other things, (i) our future plans and results, including our target ROE, ROTE, efficiency ratio, Common Equity Tier 1 (CET1) capital ratio and firmwide assets under supervision (AUS) inflows, and how they can be achieved, (ii) trends in or growth opportunities for our businesses, including the timing, costs, profitability, benefits and other aspects of business and strategic initiatives and their impact on our efficiency ratio, (iii) our level of future compensation expense, including as a percentage of both operating expenses and revenues, net of provision for credit losses, (iv) our Investment banking fees backlog and future results, (v) our expected interest income and interest expense, (vi) our expense savings and strategic locations initiatives, (vii) expenses we may incur, including future litigation expense and expenses from investing in our platform solutions business, (viii) the projected growth of our deposits and other funding, asset liability management and funding strategies and related interest expense savings, (ix) our business initiatives, including transaction banking and new products in our consumer platforms business, (x) our planned 2023 benchmark debt issuances, (xi) the amount, composition and location of global core liquid assets (GCLA) we expect to hold, (xii) our credit exposures, (xiii) our expected provisions for credit losses, (xiv) the adequacy of our allowance for credit losses, (xv) the projected growth of our platform solutions business, (xvi) the objectives and effectiveness of our business continuity planning (BCP), information security program, risk management and liquidity policies, (xvii) our resolution plan and strategy and their implications for stakeholders, (xviii) the design and effectiveness of our resolution capital and liquidity models and triggers and alerts framework, (xix) the results of stress tests, the effect of changes to regulations, and our future status, activities or reporting under banking and financial regulation, (xx) our expected tax rate, (xxi) the future state of our liquidity and regulatory capital ratios, and our prospective capital distributions (including dividends and repurchases), (xxii) our expected SCB and global systemically important bank (G-SIB) surcharge, (xxiii) legal proceedings, governmental investigations or other contingencies, (xxiv) the asset recovery guarantee and our remediation activities related to our 1Malaysia Development Berhad (1MDB) settlements, (xxv) the replacement of IBORs and our transition to alternative risk-free reference rates, (xxvi) the impact of the coronavirus (COVID-19) pandemic on our business, results, financial position and liquidity, (xxvii) the effectiveness of our management of our human capital, including our diversity goals, (xxviii) our sustainability and carbon neutrality targets and goals, (xxix) future inflation and (xxx) the impact of Russia’s invasion of Ukraine and related sanctions and other developments on our business, results and financial position. Executive Overview We generated net earnings of $11.26 billion for 2022, compared with $21.64 billion for 2021. Diluted earnings per common share (EPS) was $30.06 for 2022, compared with $59.45 for 2021. Return on average common shareholders’ equity (ROE) was 10.2% for 2022, compared with 23.0% for 2021. Book value per common share was $303.55 as of December 2022, 6.7% higher compared with December 2021. Net revenues were $47.37 billion for 2022, 20% lower than a strong 2021, reflecting significantly lower net revenues in Asset & Wealth Management and lower net revenues in Global Banking & Markets, partially offset by significantly higher net revenues in Platform Solutions. Net revenues in Asset & Wealth Management primarily reflected significantly lower net revenues in Equity investments and Debt investments. Net revenues in Global Banking & Markets primarily reflected significantly lower Investment banking fees compared with a strong prior year, partially offset by significantly higher net revenues in Fixed Income, Currency, and Commodities (FICC). Net revenues in Platform Solutions were significantly higher, primarily reflecting significantly higher net revenues in Consumer platforms.Provision for credit losses was $2.72 billion for 2022, compared with $357 million for 2021. Provisions for 2022 primarily reflected growth in the credit card portfolio, the impact of macroeconomic and geopolitical concerns and net charge-offs. Provisions for 2021 reflected growth in the credit card and wholesale portfolios, largely offset by reserve reductions as the broader economic environment continued to improve following the initial impact of the COVID-19 pandemic. Operating expenses were $31.16 billion for 2022, 2% lower than 2021, primarily due to lower compensation and benefits expenses (reflecting a decline in operating performance compared with a strong prior year). This decrease was partially offset by higher non-compensation expenses, reflecting the inclusion of NN Investment Partners (NNIP) and GreenSky, Inc. (GreenSky) and increases in transaction based expenses and technology expenses. Our efficiency ratio (total operating expenses divided by total net revenues) was 65.8% for 2022, compared with 53.8% for 2021. During 2022, we returned a total of $6.70 billion to shareholders, including common stock repurchases of $3.50 billion and common stock dividends of $3.20 billion. As of December 2022, our CET1 capital ratio was 15.1% under the Standardized Capital Rules and 14.4% under the Advanced Capital Rules. See Note 20 to the consolidated financial statements for further information about our capital ratios. 58Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisBusiness Environment In 2022, the global economy was impacted by persistent broad macroeconomic and geopolitical concerns, including Russia’s invasion of Ukraine and the ongoing war, and inflationary and labor market pressures. Governments around the world responded to Russia’s invasion of Ukraine by imposing economic sanctions, and global central banks sought to address inflation by increasing policy interest rates several times over the course of the year. These factors contributed to increased market volatility during the year, as well as a decrease in global equity and bond prices and wider corporate credit spreads compared with the end of 2021.The economic outlook remains uncertain, reflecting concerns about the continuation or escalation of the war between Russia and Ukraine and other geopolitical risks, inflation, and supply chain complications. See “Results of Operations — Segment Assets and Operating Results — Segment Operating Results” for further information about the operating environment for each of our business segments.Critical Accounting Policies Fair Value Fair Value Hierarchy. Trading assets and liabilities, certain investments and loans, and certain other financial assets and liabilities, are included in our consolidated balance sheets at fair value (i.e., marked-to-market), with related gains or losses generally recognized in our consolidated statements of earnings. The use of fair value to measure financial instruments is fundamental to our risk management practices and is our most critical accounting policy. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We measure certain financial assets and liabilities as a portfolio (i.e., based on its net exposure to market and/or credit risks). In determining fair value, the hierarchy under U.S. generally accepted accounting principles (U.S. GAAP) gives (i) the highest priority to unadjusted quoted prices in active markets for identical, unrestricted assets or liabilities (level 1 inputs), (ii) the next priority to inputs other than level 1 inputs that are observable, either directly or indirectly (level 2 inputs), and (iii) the lowest priority to inputs that cannot be observed in market activity (level 3 inputs). In evaluating the significance of a valuation input, we consider, among other factors, a portfolio’s net risk exposure to that input. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. The fair values for substantially all of our financial assets and liabilities are based on observable prices and inputs and are classified in levels 1 and 2 of the fair value hierarchy. Certain level 2 and level 3 financial assets and liabilities may require appropriate valuation adjustments that a market participant would require to arrive at fair value for factors, such as counterparty and our credit quality, funding risk, transfer restrictions, liquidity and bid/offer spreads. Instruments classified in level 3 of the fair value hierarchy are those which require one or more significant inputs that are not observable. Level 3 financial assets represented 1.8% as of December 2022 and 1.6% as of December 2021 of our total assets. See Notes 4 and 5 to the consolidated financial statements for further information about level 3 financial assets, including changes in level 3 financial assets and related fair value measurements. Absent evidence to the contrary, instruments classified in level 3 of the fair value hierarchy are initially valued at transaction price, which is considered to be the best initial estimate of fair value. Subsequent to the transaction date, we use other methodologies to determine fair value, which vary based on the type of instrument. Estimating the fair value of level 3 financial instruments requires judgments to be made. These judgments include: •Determining the appropriate valuation methodology and/or model for each type of level 3 financial instrument; •Determining model inputs based on an evaluation of all relevant empirical market data, including prices evidenced by market transactions, interest rates, credit spreads, volatilities and correlations; and •Determining appropriate valuation adjustments, including those related to illiquidity or counterparty credit quality. Regardless of the methodology, valuation inputs and assumptions are only changed when corroborated by substantive evidence. Controls Over Valuation of Financial Instruments. Market makers and investment professionals in our revenue-producing units are responsible for pricing our financial instruments. Our control infrastructure is independent of the revenue-producing units and is fundamental to ensuring that all of our financial instruments are appropriately valued at market-clearing levels. In the event that there is a difference of opinion in situations where estimating the fair value of financial instruments requires judgment (e.g., calibration to market comparables or trade comparison, as described below), the final valuation decision is made by senior managers in independent risk oversight and control functions. This independent price verification is critical to ensuring that our financial instruments are properly valued. Goldman Sachs 2022 Form 10-K59THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisPrice Verification. All financial instruments at fair value classified in levels 1, 2 and 3 of the fair value hierarchy are subject to our independent price verification process. The objective of price verification is to have an informed and independent opinion with regard to the valuation of financial instruments under review. Instruments that have one or more significant inputs which cannot be corroborated by external market data are classified in level 3 of the fair value hierarchy. Price verification strategies utilized by our independent risk oversight and control functions include: •Trade Comparison. Analysis of trade data (both internal and external, where available) is used to determine the most relevant pricing inputs and valuations. •External Price Comparison. Valuations and prices are compared to pricing data obtained from third parties (e.g., brokers or dealers, S&P Global Services, Bloomberg, ICE Data Services, Pricing Direct, TRACE). Data obtained from various sources is compared to ensure consistency and validity. When broker or dealer quotations or third-party pricing vendors are used for valuation or price verification, greater priority is generally given to executable quotations. •Calibration to Market Comparables. Market-based transactions are used to corroborate the valuation of positions with similar characteristics, risks and components. •Relative Value Analyses. Market-based transactions are analyzed to determine the similarity, measured in terms of risk, liquidity and return, of one instrument relative to another or, for a given instrument, of one maturity relative to another. •Collateral Analyses. Margin calls on derivatives are analyzed to determine implied values, which are used to corroborate our valuations. •Execution of Trades. Where appropriate, market-making desks are instructed to execute trades in order to provide evidence of market-clearing levels. •Backtesting. Valuations are corroborated by comparison to values realized upon sales. See Note 4 to the consolidated financial statements for further information about fair value measurements. Review of Net Revenues. Independent risk oversight and control functions ensure adherence to our pricing policy through a combination of daily procedures, including the explanation and attribution of net revenues based on the underlying factors. Through this process, we independently validate net revenues, identify and resolve potential fair value or trade booking issues on a timely basis and seek to ensure that risks are being properly categorized and quantified. Review of Valuation Models. Our independent model risk management group (Model Risk), consisting of quantitative professionals who are separate from model developers, performs an independent model review and validation process of our valuation models. New or changed models are reviewed and approved prior to implementation. Models are reviewed annually to assess the impact of any changes in the product or market and any market developments in pricing theories. See “Risk Management — Model Risk Management” for further information about the review and validation of our valuation models. Allowance for Credit Losses We estimate and record an allowance for credit losses related to our loans held for investment that are accounted for at amortized cost. To determine the allowance for credit losses, we classify our loans accounted for at amortized cost into wholesale and consumer portfolios. These portfolios represent the level at which we have developed and documented our methodology to determine the allowance for credit losses. The allowance for credit losses is measured on a collective basis for loans that exhibit similar risk characteristics using a modeled approach and on an asset-specific basis for loans that do not share similar risk characteristics. The allowance for credit losses takes into account the weighted average of a range of forecasts of future economic conditions over the expected life of the loans and lending commitments. The expected life of each loan or lending commitment is determined based on the contractual term adjusted for extension options or demand features, or is modeled in the case of revolving credit card loans. The forecasts include baseline, favorable and adverse economic scenarios over a three-year period. For loans with expected lives beyond three years, the model reverts to historical loss information based on a non-linear modeled approach. We apply judgment in weighting individual scenarios each quarter based on a variety of factors, including our internally derived economic outlook, market consensus, recent macroeconomic conditions and industry trends. The forecasted economic scenarios consider a number of risk factors relevant to the wholesale and consumer portfolios. Risk factors for wholesale loans include internal credit ratings, industry default and loss data, expected life, macroeconomic indicators (e.g., unemployment rates and GDP), the borrower’s capacity to meet its financial obligations, the borrower’s country of risk and industry, loan seniority and collateral type. In addition, for loans backed by real estate, risk factors include loan-to-value ratio, debt service ratio and home price index. Risk factors for installment and credit card loans include Fair Isaac Corporation (FICO) credit scores, delinquency status, loan vintage and macroeconomic indicators. 60Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe allowance for credit losses also includes qualitative components which allow management to reflect the uncertain nature of economic forecasting, capture uncertainty regarding model inputs, and account for model imprecision and concentration risk. Our estimate of credit losses entails judgment about collectability at the reporting dates, and there are uncertainties inherent in those judgments. The allowance for credit losses is subject to a governance process that involves review and approval by senior management within our independent risk oversight and control functions. Personnel within our independent risk oversight and control functions are responsible for forecasting the economic variables that underlie the economic scenarios that are used in the modeling of expected credit losses. While we use the best information available to determine this estimate, future adjustments to the allowance may be necessary based on, among other things, changes in the economic environment or variances between actual results and the original assumptions used. Loans are charged off against the allowance for loan losses when deemed to be uncollectible. We also record an allowance for credit losses on lending commitments which are held for investment that are accounted for at amortized cost. Such allowance is determined using the same methodology as the allowance for loan losses, while also taking into consideration the probability of drawdowns or funding, and whether such commitments are cancellable by us. To estimate the potential impact of an adverse macroeconomic environment on our allowance for credit losses, we, among other things, compared the expected credit losses under the weighted average forecast used in the calculation of allowance for credit losses as of December 2022 (which was weighted towards the baseline and adverse economic scenarios) to the expected credit losses under a 100% weighted adverse economic scenario. The adverse economic scenario of the forecast model reflects a global recession in 2023 and a more aggressive tightening of monetary policy by central banks, resulting in an economic contraction and rising unemployment rates. A 100% weighting to the adverse economic scenario would have resulted in an approximate $1.0 billion increase in our allowance for credit losses as of December 2022. This hypothetical increase does not take into consideration any potential adjustments to qualitative reserves. The forecasts of macroeconomic conditions are inherently uncertain and do not take into account any other offsetting or correlated effects. The actual credit loss in an adverse macroeconomic environment may differ significantly from this estimate. See Note 9 to the consolidated financial statements for further information about the allowance for credit losses.Use of Estimates U.S. GAAP requires us to make certain estimates and assumptions. In addition to the estimates we make in connection with fair value measurements and the allowance for credit losses on loans and lending commitments held for investment and accounted for at amortized cost, the use of estimates and assumptions is also important in determining the accounting for goodwill and identifiable intangible assets, provisions for losses that may arise from litigation and regulatory proceedings (including governmental investigations), and accounting for income taxes. Goodwill is assessed for impairment annually in the fourth quarter or more frequently if events occur or circumstances change that indicate an impairment may exist. When assessing goodwill for impairment, first, a qualitative assessment can be made to determine whether it is more likely than not that the estimated fair value of a reporting unit is less than its carrying value. If the results of the qualitative assessment are not conclusive, a quantitative goodwill test is performed. Alternatively, a quantitative goodwill test can be performed without performing a qualitative assessment. Estimating the fair value of our reporting units requires judgment. Critical inputs to the fair value estimates include projected earnings and allocated equity. There is inherent uncertainty in the projected earnings. The carrying value of each reporting unit reflects an allocation of total shareholders’ equity and represents the estimated amount of total shareholders’ equity required to support the activities of the reporting unit under currently applicable regulatory capital requirements. The estimated fair value of our Consumer platforms reporting unit, which represents approximately 7.5% of our goodwill, was not substantially in excess of its carrying value. This reporting unit has been adversely impacted by the recent operating environment generally characterized by broad macroeconomic concerns. We will continue to closely monitor it to determine whether an impairment is required in the future. As of December 2022, the goodwill related to the Consumer platforms reporting unit was $482 million. See Note 12 to the consolidated financial statements for further information about goodwill. If we experience a prolonged or severe period of weakness in the business environment, financial markets, the performance of one or more of our reporting units or our common stock price, or additional increases in capital requirements, our goodwill could be impaired in the future. Identifiable intangible assets are tested for impairment when events or changes in circumstances suggest that an asset’s or asset group’s carrying value may not be fully recoverable. Judgment is required to evaluate whether indications of potential impairment have occurred, and to test identifiable intangible assets for impairment, if required. An impairment is recognized if the estimated undiscounted cash flows relating to the asset or asset group is less than the corresponding carrying value. See Note 12 to the consolidated financial statements for further information about identifiable intangible assets. Goldman Sachs 2022 Form 10-K61THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisWe also estimate and provide for potential losses that may arise out of litigation and regulatory proceedings to the extent that such losses are probable and can be reasonably estimated. In addition, we estimate the upper end of the range of reasonably possible aggregate loss in excess of the related reserves for litigation and regulatory proceedings where we believe the risk of loss is more than slight. See Notes 18 and 27 to the consolidated financial statements for information about certain judicial, litigation and regulatory proceedings. Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total estimated liability in respect of litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses after considering, among other factors, the progress of each case, proceeding or investigation, our experience and the experience of others in similar cases, proceedings or investigations, and the opinions and views of legal counsel. In accounting for income taxes, we recognize tax positions in the financial statements only when it is more likely than not that the position will be sustained on examination by the relevant taxing authority based on the technical merits of the position. As of December 2022, our net liability for unrecognized tax benefits was $1.22 billion. We use estimates to recognize current and deferred income taxes in the U.S. federal, state and local and non-U.S. jurisdictions in which we operate. The income tax laws in these jurisdictions are complex and can be subject to different interpretations between taxpayers and taxing authorities. Disputes may arise over these interpretations and can be settled by audit, administrative appeals or judicial proceedings. Our interpretations are reevaluated quarterly based on guidance currently available, tax examination experience and the opinions of legal counsel, among other factors. We recognize deferred taxes based on the amount that will more likely than not be realized in the future based on enacted income tax laws. As of December 2022, we had $8.93 billion of deferred tax assets with a related valuation allowance of $1.57 billion. Our estimate for deferred taxes includes estimates for future taxable earnings, including the level and character of those earnings, and various tax planning strategies. See Note 24 to the consolidated financial statements for further information about income taxes. Recent Accounting Developments See Note 3 to the consolidated financial statements for information about Recent Accounting Developments. Results of Operations The composition of our net revenues has varied over time as financial markets and the scope of our operations have changed. The composition of net revenues can also vary over the shorter term due to fluctuations in U.S. and global economic and market conditions. See “Risk Factors” in Part I, Item 1A of this Form 10-K for further information about the impact of economic and market conditions on our results of operations. Financial Overview The table below presents an overview of our financial results and selected financial ratios. Year Ended December$ in millions, except per share amounts202220212020Net revenues$47,365 $59,339 $44,560 Pre-tax earnings$13,486 $27,044 $12,479 Net earnings$11,261 $21,635 $9,459 Net earnings to common$10,764 $21,151 $8,915 Diluted EPS$30.06 $59.45 $24.74 ROE10.2 %23.0 %11.1 %ROTE11.0 %24.3 %11.8 %Net earnings to average assets0.7 %1.6 %0.8 %Return on shareholders’ equity9.7 %21.3 %10.3 %Average equity to average assets7.5 %7.4 %8.2 %Dividend payout ratio29.9 %10.9 %20.2 %In the table above: •Net earnings to common represents net earnings applicable to common shareholders, which is calculated as net earnings less preferred stock dividends. •ROE is calculated by dividing net earnings to common by average monthly common shareholders’ equity. Tangible common shareholders’ equity is calculated as total shareholders’ equity less preferred stock, goodwill and identifiable intangible assets. •Return on average tangible common shareholders' equity (ROTE) is calculated by dividing net earnings to common by average monthly tangible common shareholders’ equity. We believe that tangible common shareholders’ equity is meaningful because it is a measure that we and investors use to assess capital adequacy and that ROTE is meaningful because it measures the performance of businesses consistently, whether they were acquired or developed internally. Tangible common shareholders’ equity and ROTE are non-GAAP measures and may not be comparable to similar non-GAAP measures used by other companies. 62Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe table below presents our average equity and the reconciliation of average common shareholders’ equity to average tangible common shareholders’ equity. Average for the Year Ended December$ in millions202220212020Total shareholders’ equity$115,990 $101,705 $91,779 Preferred stock(10,703)(9,876)(11,203)Common shareholders’ equity105,287 91,829 80,576 Goodwill(5,726)(4,327)(4,238)Identifiable intangible assets(1,583)(536)(617)Tangible common shareholders’ equity$97,978 $86,966 $75,721 •Net earnings to average assets is calculated by dividing net earnings by average total assets. •Return on shareholders’ equity is calculated by dividing net earnings by average monthly shareholders’ equity. •Average equity to average assets is calculated by dividing average total shareholders’ equity by average total assets. •Dividend payout ratio is calculated by dividing dividends declared per common share by diluted EPS. Net Revenues The table below presents our net revenues by line item. Year Ended December$ in millions202220212020Investment banking$7,360 $14,136 $9,100 Investment management9,005 8,171 6,986 Commissions and fees4,034 3,590 3,539 Market making18,634 15,357 15,428 Other principal transactions654 11,615 4,756 Total non-interest revenues39,687 52,869 39,809 Interest income29,024 12,120 13,689 Interest expense21,346 5,650 8,938 Net interest income7,678 6,470 4,751 Total net revenues$47,365 $59,339 $44,560 In the table above: •Investment banking consists of revenues (excluding net interest) from financial advisory and underwriting assignments. These activities are included in Global Banking & Markets. •Investment management consists of revenues (excluding net interest) from providing asset management and wealth advisory services across all major asset classes to a diverse set of clients. These activities are included in Asset & Wealth Management.•Commissions and fees consists of revenues from executing and clearing client transactions on major stock, options and futures exchanges worldwide, as well as over-the-counter (OTC) transactions. Substantially all of these activities are included in Global Banking & Markets. •Market making consists of revenues (excluding net interest) from client execution activities related to making markets in interest rate products, credit products, mortgages, currencies, commodities and equity products. These activities are included in Global Banking & Markets. •Other principal transactions consists of revenues (excluding net interest) from our equity investing activities, including revenues related to our consolidated investments (included in Asset & Wealth Management), and debt investing and lending activities (included across our three segments). Operating Environment. During 2022, the operating environment was characterized by broad macroeconomic and geopolitical concerns and market volatility, which contributed to a decrease in global equity and bond prices and wider corporate credit spreads compared with the end of 2021. These factors contributed to solid market-making activity levels and a decline in industry-wide investment banking activity, particularly for underwriting. In the U.S., the rate of unemployment remained low and consumer spending increased slightly compared with 2021.If concerns about the economic outlook grow, including those about the continuation or escalation of geopolitical concerns, inflation and supply chain complications, and the persistence of COVID-19-related effects, it may lead to a continued decline in asset prices, or a decline in market-making activity levels, or a continued decline in investment banking activity levels, and net revenues and provision for credit losses would likely be negatively impacted. See “Segment Assets and Operating Results — Segment Operating Results” for information about the operating environment and material trends and uncertainties that may impact our results of operations. 2022 versus 2021 Net revenues in the consolidated statements of earnings were $47.37 billion for 2022, 20% lower than a strong 2021, primarily reflecting significantly lower other principal transactions revenues and investment banking revenues, partially offset by significantly higher market making revenues. Non-Interest Revenues. Investment banking revenues in the consolidated statements of earnings were $7.36 billion for 2022, 48% lower than a strong 2021, due to significantly lower revenues in both equity and debt underwriting, reflecting a significant decline in industry-wide volumes, and lower revenues in advisory, reflecting a decline in industry-wide completed mergers and acquisitions transactions from elevated activity levels in the prior year. Goldman Sachs 2022 Form 10-K63THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisInvestment management revenues in the consolidated statements of earnings were $9.01 billion for 2022, 10% higher than 2021, due to higher management and other fees, reflecting the inclusion of NNIP and a reduction in fee waivers on money market funds. Commissions and fees in the consolidated statements of earnings were $4.03 billion for 2022, 12% higher than 2021, primarily due to higher commissions and fees in Equities, reflecting generally higher volumes. Market making revenues in the consolidated statements of earnings were $18.63 billion for 2022, 21% higher than 2021, primarily reflecting significantly higher revenues in interest rate products, currencies and commodities, partially offset by lower revenues in equity products. Other principal transactions revenues in the consolidated statements of earnings were $654 million for 2022, compared with $11.62 billion for 2021, primarily reflecting significantly lower net gains from investments in private equities, significant mark-to-market net losses from investments in public equities and net mark-downs in debt investments compared with net mark-ups in 2021. Net Interest Income. Net interest income in the consolidated statements of earnings was $7.68 billion for 2022, 19% higher than 2021, reflecting an increase in interest income primarily related to collateralized agreements, other interest-earning assets and deposits with banks, each reflecting the impact of higher average interest rates, and loans, reflecting the impact of higher average balances and higher average interest rates. The increase in interest income was partially offset by an increase in interest expense primarily related to other interest-bearing liabilities, collateralized financings, and borrowings, each reflecting the impact of higher average interest rates, and deposits, reflecting the impact of higher average interest rates and higher average balances. See “Statistical Disclosures – Distribution of Assets, Liabilities and Shareholders’ Equity” for further information about our sources of net interest income.2021 versus 2020 Net revenues in the consolidated statements of earnings were $59.34 billion for 2021, 33% higher than 2020, reflecting significantly higher other principal transactions revenues, investment banking revenues and net interest income, and higher investment management revenues.Non-Interest Revenues. Investment banking revenues in the consolidated statements of earnings were $14.14 billion for 2021, 55% higher than 2020, due to significantly higher revenues in advisory, reflecting a significant increase in completed mergers and acquisitions volumes, in equity underwriting, primarily driven by strong industry-wide initial public offerings activity, and in debt underwriting, primarily reflecting elevated industry-wide leveraged finance activity. Investment management revenues in the consolidated statements of earnings were $8.17 billion for 2021, 17% higher than 2020, primarily due to higher management and other fees, reflecting the impact of higher average assets under supervision, partially offset by higher fee waivers on money market funds. In addition, incentive fees were significantly higher, primarily driven by harvesting. Commissions and fees in the consolidated statements of earnings were $3.59 billion for 2021, essentially unchanged compared with 2020. Market making revenues in the consolidated statements of earnings were $15.36 billion for 2021, essentially unchanged compared with 2020, as significantly lower revenues in interest rate products and credit products were largely offset by significantly higher revenues in equity products (primarily in derivatives) and commodities, and improved results in mortgages. Other principal transactions revenues in the consolidated statements of earnings were $11.62 billion for 2021, compared with $4.76 billion for 2020, primarily reflecting significantly higher net gains from investments in private equities and in debt instruments, partially offset by net losses from investments in public equities compared with significant net gains in 2020.Net Interest Income. Net interest income in the consolidated statements of earnings was $6.47 billion for 2021, 36% higher than 2020, reflecting a decrease in interest expense, partially offset by a decrease in interest income. The decrease in interest expense is primarily related to other interest-bearing liabilities, deposits and long-term borrowings, each reflecting the impact of lower interest rates. The decrease in interest income primarily related to collateralized agreements and trading assets, both reflecting the impact of lower interest rates, partially offset by the impact of higher average balances for loans. See “Supplemental Financial Information — Statistical Disclosures — Distribution of Assets, Liabilities and Shareholders’ Equity” for further information about our sources of net interest income.Provision for Credit Losses Provision for credit losses consists of provision for credit losses on loans and lending commitments held for investment and accounted for at amortized cost. See Note 9 to the consolidated financial statements for further information about the provision for credit losses. The table below presents our provision for credit losses. Year Ended December$ in millions202220212020Provision for credit losses$2,715 $357 $3,098 64Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and Analysis2022 versus 2021. Provision for credit losses in the consolidated statements of earnings was $2.72 billion for 2022, compared with $357 million for 2021. Provisions for 2022 primarily reflected growth in the credit card portfolio, the impact of macroeconomic and geopolitical concerns and net charge-offs. Provisions for 2021 reflected portfolio growth in the credit card and wholesale portfolios, largely offset by reserve reductions as the broader economic environment continued to improve following the initial impact of the COVID-19 pandemic. 2021 versus 2020. Provision for credit losses in the consolidated statements of earnings was $357 million for 2021, compared with $3.10 billion for 2020. Provisions for 2021 reflected portfolio growth (primarily in credit cards, including approximately $185 million of provisions related to the commitment to acquire the General Motors co-branded credit card portfolio), largely offset by reserve reductions on wholesale and consumer loans reflecting continued improvement in the broader economic environment. This followed challenging conditions in the prior year as a result of the COVID-19 pandemic, which contributed to significant provisions in 2020.Operating Expenses Our operating expenses are primarily influenced by compensation, headcount and levels of business activity. Compensation and benefits includes salaries, year-end discretionary compensation, amortization of equity awards and other items such as benefits. Discretionary compensation is significantly impacted by, among other factors, the level of net revenues, net of provision for credit losses, overall financial performance, prevailing labor markets, business mix, the structure of our share-based compensation programs and the external environment. The table below presents our operating expenses by line item and headcount. Year Ended December$ in millions202220212020Compensation and benefits$15,148 $17,719 $13,309 Transaction based5,312 4,710 4,141 Market development812 553 401 Communications and technology1,808 1,573 1,347 Depreciation and amortization2,455 2,015 1,902 Occupancy1,026 981 960 Professional fees1,887 1,648 1,306 Other expenses2,716 2,739 5,617 Total operating expenses$31,164 $31,938 $28,983 Headcount at period-end48,50043,90040,5002022 versus 2021. Operating expenses in the consolidated statements of earnings were $31.16 billion for 2022, 2% lower than 2021. Our efficiency ratio was 65.8% for 2022, compared with our medium-term target efficiency ratio of approximately 60%. Our efficiency ratio was 53.8% for 2021. The decrease in operating expenses compared with 2021 was primarily due to lower compensation and benefits expenses (reflecting a decline in operating performance compared with a strong prior year). This decrease was partially offset by higher non-compensation expenses, reflecting the inclusion of NNIP and GreenSky and increases in transaction based expenses and technology expenses. While certain expenses (e.g., compensation and benefits, occupancy and market development) were impacted by inflationary pressures, the overall impact of higher inflation was not material to our operating expenses for 2022.Net provisions for litigation and regulatory proceedings were $576 million for 2022 compared with $534 million for 2021.Headcount increased 10% during 2022, primarily reflecting investments in growth initiatives and the acquisitions of NNIP and GreenSky. 2021 versus 2020. Operating expenses in the consolidated statements of earnings were $31.94 billion for 2021, 10% higher than 2020. Our efficiency ratio was 53.8% for 2021, compared with 65.0% for 2020. In 2020, net provisions for litigation and regulatory proceedings increased our efficiency ratio by 7.6 percentage points.The increase in operating expenses compared with 2020 primarily reflected significantly higher compensation and benefits expenses (reflecting strong performance). In addition, technology expenses and professional fees were significantly higher and transaction based expenses were higher. These increases were partially offset by significantly lower net provisions for litigation and regulatory proceedings and lower expenses related to consolidated investments (including impairments). Net provisions for litigation and regulatory proceedings were $534 million for 2021 compared with $3.42 billion for 2020. Charitable contributions to Goldman Sachs Gives were approximately $250 million for 2021. Headcount increased 8% during 2021, reflecting investments in growth initiatives and an increase in technology professionals.Goldman Sachs 2022 Form 10-K65THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisProvision for Taxes The effective income tax rate for 2022 was 16.5%, down from the full year income tax rate of 20.0% for 2021, primarily due to an increase in the impact of permanent tax benefits, partially offset by changes in the geographic mix of earnings in 2022 compared with 2021. The U.K. Finance Act 2021 increased the corporate income tax rate by six percent and the Finance Act 2022 decreased the U.K. bank surcharge tax rate by five percent effective from April 1, 2023. As a result, beginning April 1, 2023, the U.K. tax rate for our U.K. regulated broker-dealer and bank subsidiaries and branches, including Goldman Sachs International (GSI) and Goldman Sachs International Bank (GSIB), will increase by one percent and the U.K. tax rate for all other U.K. subsidiaries and branches will increase by six percent. During 2022, following Royal Assent of Finance Act 2022, certain U.K. deferred tax assets and liabilities were remeasured and a net reduction in deferred tax assets of approximately $50 million was recognized.In August 2022, the Inflation Reduction Act of 2022 was signed into law. The Inflation Reduction Act of 2022 includes income tax incentives to encourage investments in clean energy and a new 15% corporate alternative minimum tax (CAMT). The CAMT applies to corporations with average annual profits over $1 billion and is calculated on their financial statement income, with certain adjustments, for years beginning after December 31, 2022. The legislation had no impact on our 2022 annual effective tax rate and based on our current understanding of the CAMT, is not expected to have a material impact on our 2023 annual effective tax rate.Segment Assets and Operating Results Segment Assets. The table below presents assets by segment. As of December$ in millions20222021Global Banking & Markets$1,169,539 $1,201,996 Asset & Wealth Management214,970 221,150 Platform Solutions57,290 40,842 Total$1,441,799 $1,463,988 The allocation process for segment assets is based on the activities of these segments. The allocation of assets includes allocation of GCLA (which consists of unencumbered, highly liquid securities and cash), which is generally included within cash and cash equivalents, collateralized agreements and trading assets on our balance sheet. Due to the integrated nature of these segments, estimates and judgments are made in allocating these assets. See “Risk Management — Liquidity Risk Management” for further information about our GCLA. Segment Operating Results. The table below presents our segment operating results. Year Ended December$ in millions202220212020Global Banking & MarketsNet revenues$32,487 $36,734 $30,469 Provision for credit losses468 (171)1,216 Operating expenses17,851 19,542 18,884 Pre-tax earnings$14,168 $17,363 $10,369 Net earnings to common$11,458 $13,535 $7,428 Average common equity$69,951 $60,064 $54,749 Return on average common equity16.4 %22.5 %13.6 %Asset & Wealth ManagementNet revenues$13,376 $21,965 $13,757 Provision for credit losses519 (169)1,395 Operating expenses11,550 11,406 9,469 Pre-tax earnings$1,307 $10,728 $2,893 Net earnings to common$979 $8,459 $2,083 Average common equity$31,762 $29,988 $24,963 Return on average common equity3.1 %28.2 %8.3 %Platform SolutionsNet revenues$1,502 $640 $334 Provision for credit losses1,728 697 487 Operating expenses1,763 990 630 Pre-tax earnings/(loss)$(1,989)$(1,047)$(783)Net earnings/(loss) to common$(1,673)$(843)$(596)Average common equity$3,574 $1,777 $864 Return on average common equity(46.8)%(47.4)%(69.0)%TotalNet revenues$47,365 $59,339 $44,560 Provision for credit losses2,715 357 3,098 Operating expenses31,164 31,938 28,983 Pre-tax earnings$13,486 $27,044 $12,479 Net earnings to common$10,764 $21,151 $8,915 Average common equity$105,287 $91,829 $80,576 Return on average common equity10.2 %23.0 %11.1 %Net revenues in our segments include allocations of interest income and expense to specific positions in relation to the cash generated by, or funding requirements of, such positions. See Note 25 to the consolidated financial statements for further information about our business segments. The allocation of common shareholders’ equity and preferred stock dividends to each segment is based on the estimated amount of equity required to support the activities of the segment under relevant regulatory capital requirements. Net earnings for each segment is calculated by applying the firmwide tax rate to each segment’s pre-tax earnings. Compensation and benefits expenses within our segments reflect, among other factors, our overall performance, as well as the performance of individual businesses. Consequently, pre-tax margins in one segment of our business may be significantly affected by the performance of our other business segments. A description of segment operating results follows. 66Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisGlobal Banking & MarketsGlobal Banking & Markets generates revenues from the following: Investment banking fees. We provide advisory and underwriting services and help companies raise capital to strengthen and grow their businesses. Investment banking fees includes the following:•Advisory. Includes strategic advisory assignments with respect to mergers and acquisitions, divestitures, corporate defense activities, restructurings and spin-offs. •Underwriting. Includes public offerings and private placements of a wide range of securities and other financial instruments, including local and cross-border transactions and acquisition financing. FICC. FICC generates revenues from intermediation and financing activities. •FICC intermediation. Includes client execution activities related to making markets in both cash and derivative instruments, as detailed below. Interest Rate Products. Government bonds (including inflation-linked securities) across maturities, other government-backed securities, and interest rate swaps, options and other derivatives. Credit Products. Investment-grade and high-yield corporate securities, credit derivatives, exchange-traded funds (ETFs), bank and bridge loans, municipal securities, distressed debt and trade claims. Mortgages. Commercial mortgage-related securities, loans and derivatives, residential mortgage-related securities, loans and derivatives (including U.S. government agency-issued collateralized mortgage obligations and other securities and loans), and other asset-backed securities, loans and derivatives. Currencies. Currency options, spot/forwards and other derivatives on G-10 currencies and emerging-market products. Commodities. Commodity derivatives and, to a lesser extent, physical commodities, involving crude oil and petroleum products, natural gas, agricultural, base, precious and other metals, electricity, including renewable power, environmental products and other commodity products. •FICC financing. Includes secured lending to our clients through structured credit and asset-backed lending, including warehouse loans backed by mortgages (including residential and commercial mortgage loans), corporate loans and consumer loans (including auto loans and private student loans). We also provide financing to clients through securities purchased under agreements to resell (resale agreements). Equities. Equities generates revenues from intermediation and financing activities. •Equities intermediation. We make markets in equity securities and equity-related products, including ETFs, convertible securities, options, futures and OTC derivative instruments. We also structure and make markets in derivatives on indices, industry sectors, financial measures and individual company stocks. Our exchange-based market-making activities include making markets in stocks and ETFs, futures and options on major exchanges worldwide. In addition, we generate commissions and fees from executing and clearing institutional client transactions on major stock, options and futures exchanges worldwide, as well as OTC transactions.•Equities financing. Includes prime brokerage and other equities financing activities, including securities lending, margin lending and swaps. We earn fees by providing clearing, settlement and custody services globally. We provide services that principally involve borrowing and lending securities to cover institutional clients’ short sales and borrowing securities to cover our short sales and to make deliveries into the market. In addition, we are an active participant in broker-to-broker securities lending and third-party agency lending activities. We provide financing to our clients for their securities trading activities through margin loans that are collateralized by securities, cash or other acceptable collateral and provide securities-based loans to individuals. In addition, we execute swap transactions to provide our clients with exposure to securities and indices. Goldman Sachs 2022 Form 10-K67THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisMarket-Making ActivitiesAs a market maker, we facilitate transactions in both liquid and less liquid markets, primarily for institutional clients, such as corporations, financial institutions, investment funds and governments, to assist clients in meeting their investment objectives and in managing their risks. In this role, we seek to earn the difference between the price at which a market participant is willing to sell an instrument to us and the price at which another market participant is willing to buy it from us, and vice versa (i.e., bid/offer spread). In addition, we maintain (i) market-making positions, typically for a short period of time, in response to, or in anticipation of, client demand, and (ii) positions to actively manage our risk exposures that arise from these market-making activities (collectively, inventory). Our inventory is recorded in trading assets (long positions) or trading liabilities (short positions) in our consolidated balance sheets. Our results are influenced by a combination of interconnected drivers, including (i) client activity levels and transactional bid/offer spreads (collectively, client activity), and (ii) changes in the fair value of our inventory and interest income and interest expense related to the holding, hedging and funding of our inventory (collectively, market-making inventory changes). Due to the integrated nature of our market-making activities, disaggregation of net revenues into client activity and market-making inventory changes is judgmental and has inherent complexities and limitations. The amount and composition of our net revenues vary over time as these drivers are impacted by multiple interrelated factors affecting economic and market conditions, including volatility and liquidity in the market, changes in interest rates, currency exchange rates, credit spreads, equity prices and commodity prices, investor confidence, and other macroeconomic concerns and uncertainties. In general, assuming all other market-making conditions remain constant, increases in client activity levels or bid/offer spreads tend to result in increases in net revenues, and decreases tend to have the opposite effect. However, changes in market-making conditions can materially impact client activity levels and bid/offer spreads, as well as the fair value of our inventory. For example, a decrease in liquidity in the market could have the impact of (i) increasing our bid/offer spread, (ii) decreasing investor confidence and thereby decreasing client activity levels, and (iii) widening of credit spreads on our inventory positions. Other. We lend to corporate clients, including through relationship lending and acquisition financing. The hedges related to this lending and financing activity are also reported as part of Other. Other also includes equity and debt investing activities related to our Global Banking & Markets activities.The table below presents our Global Banking & Markets assets. As of December$ in millions20222021Cash and cash equivalents$167,203 $178,359 Collateralized agreements380,157 359,100 Customer and other receivables122,037 147,958 Trading assets272,788 351,920 Investments103,229 56,228 Loans107,648 94,597 Other assets16,477 13,834 Total$1,169,539 $1,201,996 The table below presents details about our Global Banking & Markets loans. As of December$ in millions20222021Corporate$25,776 $22,068 Real estate33,215 34,986 Securities-based3,857 3,017 Other collateralized45,407 33,077 Other561 2,311 Loans, gross108,816 95,459 Allowance for loan losses(1,168)(862)Total loans$107,648 $94,597 Our average Global Banking & Markets gross loans were $105.11 billion for 2022 and $74.34 billion for 2021.The table below presents our Global Banking & Markets operating results. Year Ended December$ in millions202220212020Advisory$4,704 $5,654 $3,064 Equity underwriting848 4,985 3,376 Debt underwriting1,808 3,497 2,660 Investment banking fees7,360 14,136 9,100 FICC intermediation11,890 8,714 10,106 FICC financing2,786 1,897 1,347 FICC14,676 10,611 11,453 Equities intermediation6,662 7,707 7,069 Equities financing4,326 4,015 2,815 Equities10,988 11,722 9,884 Other(537)265 32 Net revenues32,487 36,734 30,469 Provision for credit losses468 (171)1,216 Operating expenses17,851 19,542 18,884 Pre-tax earnings14,168 17,363 10,369 Provision for taxes2,338 3,473 2,509 Net earnings11,830 13,890 7,860 Preferred stock dividends372 355 432 Net earnings to common$11,458 $13,535 $7,428 Average common equity$69,951 $60,064 $54,749 Return on average common equity16.4 %22.5 %13.6 %68Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe table below presents our FICC and Equities net revenues by line item in the consolidated statements of earnings. $ in millionsFICCEquitiesYear Ended December 2022Market making$12,422 $6,212 Commissions and fees– 3,791 Other principal transactions377 41 Net interest income1,877 944 Total$14,676 $10,988 Year Ended December 2021Market making$7,690 $7,667 Commissions and fees– 3,514 Other principal transactions362 72 Net interest income2,559 469 Total$10,611 $11,722 Year Ended December 2020Market making$8,941 $6,487 Commissions and fees– 3,339 Other principal transactions96 9 Net interest income2,416 49 Total$11,453 $9,884 In the table above: •See “Net Revenues” for information about market making revenues, commissions and fees, other principal transactions revenues and net interest income. See Note 25 to the consolidated financial statements for net interest income by segment. •The primary driver of net revenues for FICC intermediation for all periods was client activity. The table below presents our unaudited quarterly Global Banking & Markets operating results. FirstSecondThirdFourth$ in millionsQuarterQuarterQuarterQuarter2022Advisory$1,127 $1,197 $972 $1,408 Equity underwriting276 145 244 183 Debt underwriting741 457 328 282 Investment banking fees2,144 1,799 1,544 1,873 FICC intermediation4,099 2,921 2,896 1,974 FICC financing631 721 721 713 FICC4,730 3,642 3,617 2,687 Equities intermediation2,178 1,767 1,608 1,109 Equities financing1,061 1,177 1,124 964 Equities3,239 2,944 2,732 2,073 Other(51)(43)(329)(114)Net revenues10,062 8,342 7,564 6,519 Provision for credit losses191 208 63 6 Operating expenses4,973 4,431 4,224 4,223 Pre-tax earnings$4,898 $3,703 $3,277 $2,290 2021Advisory$1,117 $1,257 $1,649 $1,631 Equity underwriting1,539 1,256 1,167 1,023 Debt underwriting877 949 724 947 Investment banking fees3,533 3,462 3,540 3,601 FICC intermediation3,472 1,922 2,007 1,313 FICC financing435 395 512 555 FICC3,907 2,317 2,519 1,868 Equities intermediation2,620 1,795 1,949 1,343 Equities financing1,084 887 1,207 837 Equities3,704 2,682 3,156 2,180 Other170 239 (85)(59)Net revenues11,314 8,700 9,130 7,590 Provision for credit losses(99)(46)(10)(16)Operating expenses5,892 5,470 4,090 4,090 Pre-tax earnings$5,521 $3,276 $5,050 $3,516 2020Advisory$780 $687 $506 $1,091 Equity underwriting377 1,050 843 1,106 Debt underwriting576 988 571 525 Investment banking fees1,733 2,725 1,920 2,722 FICC intermediation2,496 3,831 2,232 1,547 FICC financing435 302 278 332 FICC2,931 4,133 2,510 1,879 Equities intermediation1,533 2,217 1,497 1,822 Equities financing729 900 580 606 Equities2,262 3,117 2,077 2,428 Other351 (151)(36)(132)Net revenues7,277 9,824 6,471 6,897 Provision for credit losses564 702 (9)(41)Operating expenses4,007 7,777 3,510 3,590 Pre-tax earnings$2,706 $1,345 $2,970 $3,348 The table below presents our financial advisory and underwriting transaction volumes. Year Ended December$ in billions202220212020Announced mergers and acquisitions$1,237 $1,771 $904 Completed mergers and acquisitions$1,355 $1,588 $1,037 Equity and equity-related offerings$33 $140 $115 Debt offerings$222 $341 $352 Goldman Sachs 2022 Form 10-K69THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisIn the table above:•Volumes are per Dealogic. •Announced and completed mergers and acquisitions volumes are based on full credit to each of the advisors in a transaction. Equity and equity-related and debt offerings are based on full credit for single book managers and equal credit for joint book managers. Transaction volumes may not be indicative of net revenues in a given period. In addition, transaction volumes for prior periods may vary from amounts previously reported due to the subsequent withdrawal or a change in the value of a transaction. •Equity and equity-related offerings includes Rule 144A and public common stock offerings, convertible offerings and rights offerings. •Debt offerings includes non-convertible preferred stock, mortgage-backed securities, asset-backed securities and taxable municipal debt. It also includes publicly registered and Rule 144A issues and excludes leveraged loans.Operating Environment. During 2022, Global Banking & Markets operated in an environment generally characterized by broad macroeconomic and geopolitical concerns and market volatility, which negatively affected industry-wide investment banking activity levels, particularly for underwriting, but contributed to solid market-making activity levels.In investment banking, compared with 2021, industry-wide equity underwriting volumes were low amid volatile equity markets and a decline in prices, and industry-wide debt underwriting volumes declined across leveraged finance and investment grade issuances amid rising interest rates. Additionally, industry-wide completed mergers and acquisitions transactions declined from elevated levels in the prior year. For volatility, the average daily VIX was 30% higher compared with 2021. In equities, the S&P 500 Index decreased by 19% and the MSCI World Index decreased by 20%, compared with the end of 2021. Additionally, global central banks sought to address inflation by increasing policy interest rates several times over the course of the year.In the future, if market and economic conditions deteriorate further, and activity levels or volatility decline, or credit spreads related to hedges on our relationship lending portfolio tighten, net revenues in Global Banking & Markets would likely be negatively impacted. In addition, if economic conditions deteriorate further or if the creditworthiness of borrowers deteriorates, provision for credit losses would likely be negatively impacted. 2022 versus 2021. Net revenues in Global Banking & Markets were $32.49 billion for 2022, 12% lower than a strong 2021. Investment banking fees were $7.36 billion, 48% lower than a strong 2021, due to significantly lower net revenues in both Equity and Debt underwriting, reflecting a significant decline in industry-wide volumes, and lower net revenues in Advisory, reflecting a decline in industry-wide completed mergers and acquisitions transactions from elevated activity levels in the prior year. As of December 2022, our Investment banking fees backlog decreased significantly compared with the end of 2021, primarily due to significantly lower estimated net revenues from both potential advisory transactions and potential debt underwriting transactions (primarily from leveraged finance transactions). Our backlog represents an estimate of our net revenues from future transactions where we believe that future revenue realization is more likely than not. We believe changes in our backlog may be a useful indicator of client activity levels which, over the long term, impact our net revenues. However, the time frame for completion and corresponding revenue recognition of transactions in our backlog varies based on the nature of the assignment, as certain transactions may remain in our backlog for longer periods of time. In addition, our backlog is subject to certain limitations, such as assumptions about the likelihood that individual client transactions will occur in the future. Transactions may be cancelled or modified, and transactions not included in the estimate may also occur. Net revenues in FICC were $14.68 billion, 38% higher than 2021, primarily reflecting significantly higher net revenues in FICC intermediation, driven by significantly higher net revenues in interest rate products, currencies and commodities, partially offset by significantly lower net revenues in mortgages and lower net revenues in credit products. In addition, net revenues in FICC financing were significantly higher, primarily driven by secured lending.The increase in FICC intermediation net revenues reflected significantly higher client activity as we supported clients amid an evolving macroeconomic environment. The following provides information about our FICC intermediation net revenues by business, compared with 2021 results:•Net revenues in interest rate products, currencies and commodities primarily reflected higher client activity.•Net revenues in mortgages and credit products primarily reflected the impact of challenging market-making conditions on our inventory. 70Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisNet revenues in Equities were $10.99 billion, 6% lower than 2021, due to lower net revenues in Equities intermediation, reflecting significantly lower net revenues in cash products and lower net revenues in derivatives. Net revenues in Equities financing were higher, primarily reflecting increased client activity.Net revenues in Other were $(537) million for 2022, compared with $265 million for 2021, reflecting significantly lower net gains from investments in equities and net mark-downs on acquisition financing activities.Provision for credit losses was $468 million for 2022, compared with a net benefit of $171 million for 2021. Provisions for 2022 primarily reflected the impact of broad macroeconomic and geopolitical concerns, while the net benefit for 2021 reflected reserve reductions as the broad economic environment continued to improve following the initial impact of the COVID-19 pandemic, partially offset by growth in the portfolio.Operating expenses were $17.85 billion for 2022, 9% lower than 2021, reflecting lower compensation and benefits expenses (reflecting a decline in operating performance compared with a strong prior year). Pre-tax earnings were $14.17 billion for 2022, 18% lower than 2021.2021 versus 2020. Net revenues in Global Banking & Markets were $36.73 billion for 2021, 21% higher than 2020.Investment banking fees were $14.14 billion, 55% higher than 2020, due to significantly higher net revenues in Advisory, reflecting a significant increase in completed mergers and acquisitions volumes, in Equity underwriting, primarily driven by strong industry-wide initial public offerings activity, and in Debt underwriting, primarily reflecting elevated industry-wide leveraged finance activity.As of December 2021, our Investment banking fees backlog increased significantly compared with December 2020, due to significantly higher estimated net revenues from potential advisory transactions and potential debt underwriting transactions (particularly from leveraged finance transactions), and higher estimated net revenues from potential equity underwriting transactions.Net revenues in FICC were $10.61 billion, 7% lower than 2020, due to lower net revenues in FICC intermediation, reflecting significantly lower net revenues in interest rate products and credit products and slightly lower net revenues in currencies, partially offset by significantly higher net revenues in mortgages and higher net revenues in commodities. Net revenues in FICC financing were significantly higher, reflecting significantly higher net revenues from secured lending, partially offset by significantly lower net revenues from resale agreements.The decrease in FICC intermediation net revenues reflected strong but significantly lower client activity compared with very strong activity levels in the prior year due to high volatility amid the COVID-19 pandemic. This was partially offset by the impact of improved market-making conditions on our inventory compared with challenging conditions in the prior year. The following provides information about our FICC intermediation net revenues by business, compared with 2020 results:•Net revenues in interest rate products primarily reflected lower client activity.•Net revenues in credit products and currencies reflected lower client activity, partially offset by the impact of improved market-making conditions on our inventory.•Net revenues in mortgages reflected the impact of improved market-making conditions on our inventory.•Net revenues in commodities primarily reflected higher client activity.Net revenues in Equities were $11.72 billion, 19% higher than 2020, due to significantly higher net revenues in Equities financing, primarily reflecting increased activity (including higher average client balances), and higher net revenues in Equities intermediation, primarily reflecting higher net revenues in derivatives. Net revenues in Other were $265 million for 2021, compared with $32 million for 2020, primarily reflecting significantly higher net gains from investments in equities.Provision for credit losses was a net benefit of $171 million for 2021, compared with net provisions of $1.22 billion for 2020, primarily due to reserve reductions in the year reflecting continued improvement in the broad economic environment following challenging conditions in 2020 resulting from the COVID-19 pandemic, partially offset by portfolio growth.Operating expenses were $19.54 billion for 2021, 3% higher than 2020, primarily due to significantly higher compensation and benefits expenses (reflecting strong performance) and higher transaction based expenses, largely offset by significantly lower net provisions for litigation and regulatory proceedings. Pre-tax earnings were $17.36 billion, 67% higher than 2020. ROE was 22.5% for 2021, compared with 13.6% for 2020 (which included the impact of net provisions for litigation and regulatory proceedings that reduced ROE by 5.4 percentage points).Goldman Sachs 2022 Form 10-K71THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisAsset & Wealth Management Asset & Wealth Management provides investment services to help clients preserve and grow their financial assets and achieve their financial goals. We provide these services to our clients, both institutional and individuals, including investors who primarily access our products through a network of third-party distributors around the world.We manage client assets across a broad range of investment strategies and asset classes, including equity, fixed income and alternative investments. We provide investment solutions, including those managed on a fiduciary basis by our portfolio managers, as well as those managed by third-party managers. We offer our investment solutions in a variety of structures, including separately managed accounts, mutual funds, private partnerships and other commingled vehicles. We also provide tailored wealth advisory services to clients across the wealth spectrum. We operate globally serving individuals, families, family offices, and foundations and endowments. Our relationships are established directly or introduced through companies that sponsor financial wellness programs for their employees. We offer personalized financial planning to individuals and also provide customized investment advisory solutions, and offer structuring and execution capabilities in securities and derivative products across all major global markets. In addition, we offer clients a full range of private banking services, including a variety of deposit alternatives and loans that our clients use to finance investments in both financial and nonfinancial assets, bridge cash flow timing gaps or provide liquidity and flexibility for other needs.We invest in alternative investments across a range of asset classes that seek to deliver long-term accretive risk-adjusted returns. Our investing activities, which are typically longer-term, include investments in corporate equity, credit, real estate and infrastructure assets.We also raise deposits and have issued unsecured loans to consumers through Marcus by Goldman Sachs (Marcus). We have started a process to cease offering new loans through Marcus. Asset & Wealth Management generates revenues from the following: •Management and other fees. We receive fees related to managing assets for institutional and individual clients, providing investing and wealth advisory solutions, providing financial planning and counseling services via Ayco Personal Financial Management, and executing brokerage transactions for wealth management clients. The majority of revenues in management and other fees consists of asset-based fees on client assets that we manage. For further information about assets under supervision, see “Assets Under Supervision” below. The fees that we charge vary by asset class, client channel and the types of services provided, and are affected by investment performance, as well as asset inflows and redemptions. •Incentive fees. In certain circumstances, we also receive incentive fees based on a percentage of a fund’s or a separately managed account’s return, or when the return exceeds a specified benchmark or other performance targets. Such fees include overrides, which consist of the increased share of the income and gains derived primarily from our private equity and credit funds when the return on a fund’s investments over the life of the fund exceeds certain threshold returns. •Private banking and lending. Our private banking and lending activities include issuing loans to our wealth management clients. We also accept deposits from wealth management clients, including through Marcus. We have also issued unsecured loans to consumers through Marcus and have started a process to cease offering new loans. Additionally, we provide investing services through Marcus Invest to U.S. customers. Private banking and lending revenues include net interest income allocated to deposits and net interest income earned on loans to individual clients. •Equity investments. Includes investing activities related to our asset management activities primarily related to public and private equity investments in corporate, real estate and infrastructure assets. We also make investments through consolidated investment entities (CIEs), substantially all of which are engaged in real estate investment activities. •Debt investments. Includes lending activities related to our asset management activities, including investing in corporate debt, lending to middle-market clients, and providing financing for real estate and other assets. These activities include investments in mezzanine debt, senior debt and distressed debt securities. 72Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe table below presents our Asset & Wealth Management assets. As of December$ in millions20222021Cash and cash equivalents$54,065 $62,652 Collateralized agreements23,723 18,737 Customer and other receivables13,409 12,712 Trading assets19,860 17,739 Investments27,400 32,491 Loans56,338 56,676 Other assets20,175 20,143 Total$214,970 $221,150 The table below presents details about our Asset & Wealth Management loans. As of December$ in millions20222021Corporate$14,359 $15,575 Real estate18,699 18,688 Securities-based12,814 13,635 Other collateralized6,295 5,186 Installment4,474 3,646 Other1,700 1,708 Loans, gross58,341 58,438 Allowance for loan losses(2,003)(1,762)Total loans$56,338 $56,676 The average Asset & Wealth Management gross loans were $59.35 billion for 2022 and $56.85 billion for 2021. The table below presents our Asset & Wealth Management operating results. Year Ended December$ in millions202220212020Management and other fees$8,781 $7,750 $6,750 Incentive fees359 616 401 Private banking and lending2,458 1,661 1,372 Equity investments610 8,794 3,902 Debt investments1,168 3,144 1,332 Net revenues13,376 21,965 13,757 Provision for credit losses519 (169)1,395 Operating expenses11,550 11,406 9,469 Pre-tax earnings1,307 10,728 2,893 Provision for taxes215 2,146 700 Net earnings1,092 8,582 2,193 Preferred stock dividends113 123 110 Net earnings to common$979 $8,459 $2,083 Average common equity$31,762 $29,988 $24,963 Return on average common equity3.1 %28.2 %8.3 %The table below presents our Asset management and Wealth management net revenues by line item in Asset & Wealth Management.$ in millionsAsset managementWealth managementAsset & Wealth ManagementYear Ended December 2022Management and other fees$3,817 $4,964 $8,781 Incentive fees359 – 359 Private banking and lending– 2,458 2,458 Equity investments610 – 610 Debt investments1,168 – 1,168 Total$5,954 $7,422 $13,376 Year Ended December 2021Management and other fees$2,918 $4,832 $7,750 Incentive fees616 – 616 Private banking and lending– 1,661 1,661 Equity investments8,794 – 8,794 Debt investments3,144 – 3,144 Total$15,472 $6,493 $21,965 Year Ended December 2020Management and other fees$2,782 $3,968 $6,750 Incentive fees401 – 401 Private banking and lending– 1,372 1,372 Equity investments3,902 – 3,902 Debt investments1,332 – 1,332 Total$8,417 $5,340 $13,757 In the table above, incentive fees previously included in Wealth management have been reclassified to Asset management to better reflect the activities of the reporting unit that generated the underlying revenues. Previously, incentive fees related to wealth management clients were reflected in Wealth management. Prior periods have been conformed to the current presentation.The table below presents our Equity investments net revenues by equity type and asset class. Year Ended December$ in millions202220212020Equity TypePrivate equity$2,078 $8,826 $2,329 Public equity(1,468)(32)1,573 Total$610 $8,794 $3,902 Asset ClassReal estate$1,482 $2,489 $1,621 Corporate(872)6,305 2,281 Total$610 $8,794 $3,902 The table below presents details about our Debt investments net revenues. Year Ended December$ in millions202220212020Fair value net gains/(losses)$(415)$1,216 $(268)Net interest income1,583 1,928 1,600 Total$1,168 $3,144 $1,332 Goldman Sachs 2022 Form 10-K73THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe table below presents our unaudited quarterly Asset & Wealth Management operating results. FirstSecondThirdFourth$ in millionsQuarterQuarterQuarterQuarter2022Management and other fees$2,035 $2,243 $2,255 $2,248 Incentive fees79 185 56 39 Private banking and lending492 538 675 753 Equity investments(294)(104)721 287 Debt investments291 317 326 234 Net revenues2,603 3,179 4,033 3,561 Provision for credit losses203 149 (13)180 Operating expenses2,409 2,823 2,955 3,363 Pre-tax earnings/(loss)$(9)$207 $1,091 $18 2021Management and other fees$1,839 $1,879 $1,985 $2,047 Incentive fees68 93 220 235 Private banking and lending416 387 432 426 Equity investments2,965 3,425 957 1,447 Debt investments963 765 711 705 Net revenues6,251 6,549 4,305 4,860 Provision for credit losses(140)(159)58 72 Operating expenses3,315 2,983 2,232 2,876 Pre-tax earnings$3,076 $3,725 $2,015 $1,912 2020Management and other fees$1,603 $1,642 $1,708 $1,797 Incentive fees223 44 35 99 Private banking and lending377 245 341 409 Equity investments(56)896 1,377 1,685 Debt investments(710)557 728 757 Net revenues1,437 3,384 4,189 4,747 Provision for credit losses281 781 203 130 Operating expenses2,307 2,471 2,550 2,141 Pre-tax earnings/(loss)$(1,151)$132 $1,436 $2,476 Operating Environment. During 2022, Asset & Wealth Management operated in an environment generally characterized by broad macroeconomic and geopolitical concerns and market volatility, which contributed to a decrease in asset prices compared to the end of 2021, negatively affecting assets under supervision and investments. Additionally, global central banks sought to address inflation by increasing policy interest rates several times over the course of the year.In the future, if market and economic conditions deteriorate further, it may lead to a continued decline in asset prices, or investors transitioning to asset classes that typically generate lower fees or withdrawing their assets or deposits, and net revenues in Asset & Wealth Management would likely continue to be negatively impacted. 2022 versus 2021. Net revenues in Asset & Wealth Management were $13.38 billion for 2022, 39% lower than 2021, primarily reflecting significantly lower net revenues in Equity investments and Debt investments. Broad macroeconomic and geopolitical concerns during the year led to a decline in global equity prices and wider credit spreads. As a result, net revenues in Equity investments reflected significantly lower net gains from investments in private equities and significant mark-to-market net losses from investments in public equities. The decrease in Debt investments net revenues reflected net mark-downs compared with net mark-ups in the prior year and lower net interest income. Incentive fees were significantly lower, primarily driven by harvesting in the prior year. Management and other fees were higher, reflecting the inclusion of NNIP and a reduction in fee waivers on money market funds. Private banking and lending net revenues were significantly higher, primarily reflecting higher deposit spreads, as well as higher loan and deposit balances.Provision for credit losses was $519 million for 2022, compared with a net benefit of $169 million for 2021. Provisions for 2022 primarily reflected the impact of macroeconomic and geopolitical concerns, while the net benefit for 2021 reflected reserve reductions as the broad economic environment continued to improve following the initial impact of the COVID-19 pandemic.Operating expenses were $11.55 billion for 2022, essentially unchanged compared with 2021, reflecting the inclusion of operating expenses related to NNIP, largely offset by lower compensation and benefits expenses. Pre-tax earnings were $1.31 billion for 2022, compared with $10.73 billion for 2021. 2021 versus 2020. Net revenues in Asset & Wealth Management were $21.97 billion for 2021, 60% higher than 2020, primarily reflecting significantly higher net revenues in Equity investments and Debt investments, and higher Management and other fees.The increase in Equity investments net revenues reflected significantly higher net gains from investments in private equities, driven by company-specific events and improved corporate performance compared with 2020, partially offset by net losses from investments in public equities compared with significant net gains in the prior year. The increase in Debt investments net revenues reflected net mark-ups compared with net mark-downs in the prior year, and significantly higher net interest income. The increase in management and other fees reflected the impact of higher average assets under supervision, partially offset by higher fee waivers on money market funds. Private banking and lending net revenues were higher, primarily reflecting higher deposit balances. Incentive fees were significantly higher, primarily driven by harvesting.Provision for credit losses was a net benefit of $169 million for 2021, compared with net provisions of $1.40 billion for 2020, primarily due to reserve reductions in the year reflecting continued improvement in the broad economic environment following challenging conditions in 2020 resulting from the COVID-19 pandemic.74Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisOperating expenses were $11.41 billion for 2021, 20% higher than 2020, primarily due to significantly higher compensation and benefits expenses (reflecting strong performance). Pre-tax earnings were $10.73 billion for 2021, compared with $2.89 billion for 2020. Assets Under Supervision. AUS includes our institutional clients’ assets, assets sourced through third-party distributors and high-net-worth clients’ assets where we earn a fee for managing assets on a discretionary basis. This includes net assets in our mutual funds, hedge funds, credit funds, private equity funds, real estate funds, and separately managed accounts for institutional and individual investors. AUS also includes client assets invested with third-party managers, private bank deposits and advisory relationships where we earn a fee for advisory and other services, but do not have investment discretion. AUS does not include the self-directed brokerage assets of our clients. The table below presents information about our firmwide period-end AUS by asset class, client channel, region and vehicle.As of December$ in billions202220212020Asset ClassAlternative investments$263 $236 $191 Equity563 613 475 Fixed income1,010 940 896 Total long-term AUS1,836 1,789 1,562 Liquidity products711 681 583 Total AUS$2,547 $2,470 $2,145 Client ChannelInstitutional$905 $824 $761 Wealth management712 751 615 Third-party distributed930 895 769 Total AUS$2,547 $2,470 $2,145 RegionAmericas$1,806 $1,930 $1,656 EMEA548 354 318 Asia193 186 171 Total AUS$2,547 $2,470 $2,145 VehicleSeparate accounts$1,388 $1,347 $1,186 Public funds862 811 707 Private funds and other297 312 252 Total AUS$2,547 $2,470 $2,145 In the table above: •Liquidity products includes money market funds and private bank deposits. •EMEA represents Europe, Middle East and Africa. The table below presents changes in our AUS. Year Ended December$ in billions202220212020Beginning balance$2,470 $2,145 $1,859 Net inflows/(outflows):Alternative investments19 33 (1)Equity13 41 (4)Fixed income18 56 47 Total long-term AUS net inflows/(outflows)50 130 42 Liquidity products16 98 121 Total AUS net inflows/(outflows)66 228 163 Acquisitions316 – – Net market appreciation/(depreciation)(305)97 123 Ending balance$2,547 $2,470 $2,145 In the table above, acquisitions for 2022 included inflows from the acquisitions of NNIP and NextCapital Group, Inc., and from the acquisition of the assets of Bombardier Global Pension Asset Management Inc. For each, substantially all of the inflows were in fixed income and equity assets.The table below presents information about our average monthly firmwide AUS by asset class. Average for theYear Ended December$ in billions202220212020Asset ClassAlternative investments$253 $211 $183 Equity581 547 409 Fixed income992 919 829 Total long-term AUS1,826 1,677 1,421 Liquidity products693 625 573 Total AUS$2,519 $2,302 $1,994 In addition to our AUS, we have discretion over alternative investments where we currently do not earn management fees (non-fee-earning alternative assets). We earn management fees on client assets that we manage and also receive incentive fees based on a percentage of a fund’s or a separately managed account’s return, or when the return exceeds a specified benchmark or other performance targets. These incentive fees are recognized when it is probable that a significant reversal of such fees will not occur. Our estimated unrecognized incentive fees were $3.33 billion as of December 2022, $3.39 billion as of December 2021 and $1.79 billion as of December 2020. Such amounts are based on the completion of the funds’ financial statements, which is generally one quarter in arrears. These fees will be recognized, assuming no decline in fair value, if and when it is probable that a significant reversal of such fees will not occur, which is generally when such fees are no longer subject to fluctuations in the market value of the assets. Our target is to achieve annual firmwide management and other fees of more than $10 billion (including more than $2 billion from alternatives) in 2024. Goldman Sachs 2022 Form 10-K75THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe table below presents our average effective management fee (which excludes non-asset-based fees) earned on our firmwide AUS by asset class. Year Ended DecemberEffective fees (bps)202220212020Alternative investments646361Equity576058Fixed income171718Liquidity products14514Total average effective fee312929In the table above, our average effective management fee for liquidity products increased during 2022 compared to 2021, primarily reflecting higher management fee waivers in 2021. The table below presents details about our monthly average AUS for alternative investments and the average effective management fee we earned on such assets. $ in billionsDirectStrategiesFund ofFundsTotalYear Ended December 2022Average AUSCorporate equity$27 $61 $88 Credit36 2 38 Real estate10 8 18 Hedge funds and other45 22 67 Funds and discretionary accounts$118 $93 $211 Advisory accounts42 Total average AUS for alternative investments$253 Effective Fees (bps)Corporate equity133 61 83 Credit81 51 80 Real estate87 50 70 Hedge funds and other64 49 59 Funds and discretionary accounts87 57 74 Advisory accounts16 Total average effective fee64 Year Ended December 2021Average AUSCorporate equity$20 $59 $79 Credit18 2 20 Real estate8 7 15 Hedge funds and other43 19 62 Funds and discretionary accounts$89 $87 $176 Advisory accounts35 Total average AUS for alternative investments$211 Effective Fees (bps)Corporate equity118 57 72 Credit102 53 98 Real estate94 55 76 Hedge funds and other65 55 62 Funds and discretionary accounts87 56 72 Advisory accounts17 Total average effective fee63 Year Ended December 2020Average AUSCorporate equity$15 $58 $73 Credit13 2 15 Real estate7 6 13 Hedge funds and other37 17 54 Funds and discretionary accounts$72 $83 $155 Advisory accounts28 Total average AUS for alternative investments$183 Effective Fees (bps)Corporate equity132 57 73 Credit95 52 89 Real estate88 62 75 Hedge funds and other63 53 60 Funds and discretionary accounts86 57 70 Advisory accounts13 Total average effective fee61 In the table above, •Direct strategies primarily includes our private equity, growth equity, private credit, liquid alternatives and real estate strategies. Fund of funds primarily includes our Alternative Investments & Manager Selection (AIMS) business. AIMS invests in leading private equity, hedge fund, real estate and credit third-party managers as a limited partner, secondary-market investor, co-investor or management company partner. •Certain AUS previously reported in Direct Strategies were reclassified to Fund of Funds to better reflect the nature of the underlying strategy. Prior periods amounts have been conformed to the current presentation.The table below presents information about our period-end AUS for alternative investments, non-fee-earning alternative investments and total alternative investments. $ in billionsAUSNon-fee-earningalternativeassetsTotalalternativeassetsAs of December 2022Corporate equity$94 $76 $170 Credit4473117Real estate183654Hedge funds and other65267Funds and discretionary accounts221187408Advisory accounts42–42Total alternative investments$263 $187 $450 As of December 2021Corporate equity$87 $78 $165 Credit2579104Real estate163955Hedge funds and other70272Funds and discretionary accounts198198396Advisory accounts38240Total alternative investments$236 $200 $436 As of December 2020Corporate equity$74 $50 $124 Credit188098Real estate134356Hedge funds and other56258Funds and discretionary accounts161175336Advisory accounts30131Total alternative investments$191 $176 $367 In the table above: •Corporate equity primarily includes private equity. •Total alternative investments included uncalled capital that is available for future investing of $54 billion as of December 2022, $42 billion as of December 2021 and $44 billion as of December 2020. •Non-fee-earning alternative investments primarily includes investments that we hold on our balance sheet, our unfunded commitments, unfunded commitments of our clients (where we do not charge fees on commitments), credit facilities collateralized by fund assets and employee funds. Our calculation of non-fee-earning alternative investments may not be comparable to similar calculations used by other companies. 76Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and Analysis•Non-fee-earning alternative investments primarily includes our direct investing strategies, including private equity, growth equity, private credit and real estate strategies.We have announced a strategic objective of growing our third-party alternatives business, and have established a target of achieving gross inflows of $225 billion for alternative investments from 2020 through the end of 2024. The table below presents information about third-party commitments raised in our alternatives business from 2020 through 2022. As of$ in billionsDecember 2022Included in AUS$118 Included in non-fee-earning alternative assets61 Third-party commitments raised$179 In the table above, commitments included in non-fee-earning alternative investments included approximately $44 billion, which will begin to earn fees (and become AUS) if and when the commitments are drawn and assets are invested. The table below presents information about alternative investments in Asset & Wealth Management that we hold on our balance sheet. $ in billionsLoansDebtsecuritiesEquitysecuritiesCIEinvestmentsand otherTotalAs of December 2022Corporate equity$– $– $10 $– $10 Credit14 11 – – 25 Real estate5 1 5 12 23 Other– – – 1 1 Total$19 $12 $15 $13 $59 As of December 2021Corporate equity$– $– $14 $– $14 Credit15 11 – – 26 Real estate7 2 4 14 27 Other– – – 1 1 Total$22 $13 $18 $15 $68 As of December 2020Corporate equity$– $– $16 $– $16 Credit16 12 – – 28 Real estate9 2 3 19 33 Other– – – 1 1 Total$25 $14 $19 $20 $78 As we continue to grow our third-party alternatives business, we remain focused on our strategic objective to reduce the capital intensity of our alternative investments in Asset & Wealth Management that we hold on our balance sheet. During 2022, we reduced our on-balance sheet alternative investments by $9 billion to $59 billion. Loans and Debt Securities. The table below presents the concentration of loans and debt securities within our alternative investments by accounting classification, region and industry. As of December$ in billions20222021Loans$19 $22 Debt securities12 13 Total$31 $35 Accounting ClassificationDebt securities at fair value39 %38 %Loans at amortized cost49 %53 %Loans at fair value6 %9 %Loans held for sale6 %—Total100 %100 %RegionAmericas51 %50 %EMEA35 %34 %Asia14 %16 %Total100 %100 %IndustryConsumer & Retail10 %9 %Financial Institutions7 %6 %Healthcare13 %12 %Industrials16 %16 %Natural Resources & Utilities2 %4 %Real Estate20 %25 %Technology, Media & Telecommunications25 %22 %Other7 %6 %Total100 %100 %Equity Securities. The table below presents the concentration of equity securities within our alternative investments by region and industry. As of December$ in billions20222021Equity securities$15 $18 RegionAmericas67 %57 %EMEA15 %23 %Asia18 %20 %Total100 %100 %IndustryConsumer & Retail6 %8 %Financial Institutions10 %9 %Healthcare9 %11 %Industrials7 %8 %Natural Resources & Utilities14 %11 %Real Estate30 %23 %Technology, Media & Telecommunications23 %29 %Other1 %1 %Total100 %100 %Goldman Sachs 2022 Form 10-K77THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisIn the table above: •Equity securities included $13 billion as of December 2022 and $14 billion as of December 2021 of private equity positions, and $2 billion as of December 2022 and $4 billion as of December 2021 of public equity positions that converted from private equity upon the initial public offerings of the underlying companies. •The concentrations for real estate equity securities as of December 2022 were 9% for multifamily (5% as of December 2021), 5% for office (5% as of December 2021), 8% for mixed use (7% as of December 2021) and 8% for other real estate equity securities (6% as of December 2021). The table below presents the concentration of equity securities within our alternative investments by vintage. VintageAs of December 20222015 or earlier26 %2016 - 201826 %2019 - thereafter48 %Total100 %As of December 20212014 or earlier20 %2015 - 201732 %2018 - thereafter48 %Total100 %CIE Investments and Other. CIE investments and other included assets held by CIEs of $12 billion as of December 2022 and $14 billion as of December 2021, which were funded with liabilities of approximately $6 billion as of December 2022 and $7 billion as of December 2021. Substantially all such liabilities were nonrecourse, thereby reducing our equity at risk.The table below presents the concentration of CIE assets, net of financings, within our alternative investments by region and asset class. As of December$ in billions20222021CIE assets, net of financings$6 $7 RegionAmericas65 %63 %EMEA25 %25 %Asia10 %12 %Total100 %100 %Asset ClassHospitality4 %4 %Industrials10 %10 %Multifamily23 %23 %Office22 %24 %Retail3 %5 %Senior Housing14 %16 %Student Housing7 %6 %Other17 %12 %Total100 %100 %The table below presents the concentration of CIE assets, net of financings, within our alternative investments by vintage. VintageAs of December 20222015 or earlier5 %2016 - 201845 %2019 - thereafter50 %Total100 %As of December 20212014 or earlier2 %2015 - 201729 %2018 - thereafter69 %Total100 %Platform SolutionsPlatform Solutions includes our consumer platforms, such as partnerships offering credit cards and point-of-sale financing, and transaction banking and other platform businesses.Platform Solutions generates revenues from the following:Consumer platforms. Our Consumer platforms business issues credit cards and provides point-of-sale financing to consumers to finance the purchases of goods or services. Consumer platforms revenues primarily includes net interest income earned on credit card lending and point-of-sale financing activities.Transaction banking and other. We provide transaction banking and other services, including cash management services, such as deposit-taking and payment solutions for corporate and institutional clients. Transaction banking revenues include net interest income attributed to transaction banking deposits. The table below presents our Platform Solutions assets. As of December$ in millions20222021Cash and cash equivalents$20,557 $20,025 Collateralized agreements10,278 6,637 Customer and other receivables2 3 Trading assets8,597 6,257 Loans15,300 7,289 Other assets2,556 631 Total$57,290 $40,842 The table below presents details about our Platform Solutions loans. As of December$ in millions20222021Installment$1,852 $26 Credit cards15,820 8,212 Loans, gross17,672 8,238 Allowance for loan losses(2,372)(949)Total loans$15,300 $7,289 The average Platform Solutions gross loans were $12.43 billion for 2022 and $5.51 billion for 2021.78Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe table below presents our Platform Solutions operating results. Year Ended December$ in millions202220212020Consumer platforms$1,176 $424 $188 Transaction banking and other326 216 146 Net revenues1,502 640 334 Provision for credit losses1,728 697 487 Operating expenses1,763 990 630 Pre-tax earnings/(loss)(1,989)(1,047)(783)Provision for taxes(328)(210)(189)Net earnings/(loss)(1,661)(837)(594)Preferred stock dividends12 6 2 Net earnings/(loss) to common$(1,673)$(843)$(596)Average common equity$3,574 $1,777 $864 Return on average common equity(46.8)%(47.4)%(69.0)%The table below presents our unaudited quarterly Platform Solutions operating results. FirstSecondThirdFourth$ in millionsQuarterQuarterQuarterQuarter2022Consumer platforms$201 $252 $290 $433 Transaction banking and other67 91 88 80 Net revenues268 343 378 513 Provision for credit losses167 310 465 786 Operating expenses334 399 525 505 Pre-tax earnings/(loss)$(233)$(366)$(612)$(778)2021Consumer platforms$90 $90 $119 $125 Transaction banking and other49 49 54 64 Net revenues139 139 173 189 Provision for credit losses169 113 127 288 Operating expenses230 187 269 304 Pre-tax earnings/(loss)$(260)$(161)$(223)$(403)2020Consumer platforms$21 $50 $70 $47 Transaction banking and other8 37 51 50 Net revenues29 87 121 97 Provision for credit losses92 107 84 204 Operating expenses144 166 144 176 Pre-tax earnings/(loss)$(207)$(186)$(107)$(283)Operating Environment. During 2022, Platform Solutions operated in an environment generally characterized by broad macroeconomic concerns. In the U.S., the rate of unemployment remained low and consumer spending increased slightly compared with 2021. Additionally, global central banks sought to address inflation by increasing policy interest rates several times over the course of the year. In the future, if market and economic conditions deteriorate further, it may lead to a decrease in consumer spending or a deterioration in consumer credit, and net revenues and provision for credit losses in Platform Solutions would likely be negatively impacted.2022 versus 2021. Net revenues in Platform Solutions were $1.50 billion for 2022, 135% higher than 2021, reflecting significantly higher net revenues in both Consumer platforms and Transaction banking and other.The increase in Consumer platforms net revenues primarily reflected significantly higher credit card balances. The increase in Transaction banking and other net revenues reflected higher deposit balances.Provision for credit losses was $1.73 billion for 2022, compared with $697 million for 2021. Provisions for 2022 primarily reflected growth in the credit card portfolio and net charge offs, while 2021 primarily reflected growth in the credit card portfolio, which was partially offset by reserve reductions as the broad economic environment continued to improve following the initial impact of the COVID-19 pandemic.Operating expenses were $1.76 billion for 2022, 78% higher than 2021, reflecting higher spend on growth initiatives in Consumer platforms, primarily from the inclusion of operating expenses related to GreenSky. Pre-tax loss was $1.99 billion for 2022, compared with $1.05 billion for 2021.2021 versus 2020. Net revenues in Platform Solutions were $640 million for 2021, 92% higher than 2020, reflecting significantly higher net revenues in Consumer platforms and higher net revenues in Transaction banking and other.Net revenues in Consumer platforms reflected higher credit card balances. Net revenues in Transaction banking and other reflected higher deposit balances. Provision for credit losses was $697 million for 2021, 43% higher than 2020, primarily reflecting growth in the credit card portfolio, including approximately $185 million of the provisions related to the commitment to acquire the General Motors co-branded credit card portfolio, partially offset by reserve reductions in the year reflecting continued improvement in the broad economic environment following challenging conditions in 2020 resulting from the COVID-19 pandemic.Operating expenses were $990 million for 2021, 57% higher than 2020, primarily reflecting higher spend on growth initiatives in Consumer platforms. Pre-tax loss was $1.05 billion for 2021, compared with $783 million for 2020.Geographic Data See Note 25 to the consolidated financial statements for a summary of our total net revenues, pre-tax earnings and net earnings by geographic region.Goldman Sachs 2022 Form 10-K79THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisBalance Sheet and Funding Sources Balance Sheet Management One of our risk management disciplines is our ability to manage the size and composition of our balance sheet. While our asset base changes due to client activity, market fluctuations and business opportunities, the size and composition of our balance sheet also reflects factors, including (i) our overall risk tolerance, (ii) the amount of capital we hold and (iii) our funding profile, among other factors. See “Capital Management and Regulatory Capital — Capital Management” for information about our capital management process. Although our balance sheet fluctuates on a day-to-day basis, our total assets at quarter-end are generally not materially different from those occurring within our reporting periods. In order to ensure appropriate risk management, we seek to maintain a sufficiently liquid balance sheet and have processes in place to dynamically manage our assets and liabilities, which include (i) balance sheet planning, (ii) balance sheet limits, (iii) monitoring of key metrics and (iv) scenario analyses. Balance Sheet Planning. We prepare a balance sheet plan that combines our projected total assets and composition of assets with our expected funding sources over a three-year time horizon. This plan is reviewed quarterly and may be adjusted in response to changing business needs or market conditions. The objectives of this planning process are: •To develop our balance sheet projections, taking into account the general state of the financial markets and expected business activity levels, as well as regulatory requirements; •To allow Treasury and our independent risk oversight and control functions to objectively evaluate balance sheet limit requests from our revenue-producing units in the context of our overall balance sheet constraints, including our liability profile and capital levels, and key metrics; and •To inform the target amount, tenor and type of funding to raise, based on our projected assets and contractual maturities. Treasury and our independent risk oversight and control functions, along with our revenue-producing units, review current and prior period information and expectations for the year to prepare our balance sheet plan. The specific information reviewed includes asset and liability size and composition, limit utilization, risk and performance measures, and capital usage. Our consolidated balance sheet plan, including our balance sheets by business, funding projections and projected key metrics, is reviewed and approved by the Firmwide Asset Liability Committee and the Firmwide Risk Appetite Committee. See “Risk Management — Overview and Structure of Risk Management” for an overview of our risk management structure. Balance Sheet Limits. The Firmwide Asset Liability Committee and the Firmwide Risk Appetite Committee have the responsibility to review and approve balance sheet limits. These limits are set at levels which are close to actual operating levels, rather than at levels which reflect our maximum risk appetite, in order to ensure prompt escalation and discussion among our revenue-producing units, Treasury and our independent risk oversight and control functions on a routine basis. Requests for changes in limits are evaluated after giving consideration to their impact on our key metrics. Compliance with limits is monitored by our revenue-producing units and Treasury, as well as our independent risk oversight and control functions. Monitoring of Key Metrics. We monitor key balance sheet metrics both by business and on a consolidated basis, including asset and liability size and composition, limit utilization and risk measures. We attribute assets to businesses and review and analyze movements resulting from new business activity, as well as market fluctuations. Scenario Analyses. We conduct various scenario analyses, including as part of the Comprehensive Capital Analysis and Review (CCAR) and U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act Stress Tests (DFAST), as well as our resolution and recovery planning. See “Capital Management and Regulatory Capital — Capital Management” for further information about these scenario analyses. These scenarios cover short- and long-term time horizons using various macroeconomic and firm-specific assumptions, based on a range of economic scenarios. We use these analyses to assist us in developing our longer-term balance sheet management strategy, including the level and composition of assets, funding and capital. Additionally, these analyses help us develop approaches for maintaining appropriate funding, liquidity and capital across a variety of situations, including a severely stressed environment. 80Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisBalance Sheet Analysis and Metrics As of December 2022, total assets in our consolidated balance sheets were $1.44 trillion, a decrease of $22.19 billion from December 2021, reflecting decreases in trading assets of $74.67 billion (primarily due to decreases in equity securities, corporate debt instruments, reflecting the impact of our and our clients' activities), customer and other receivables of $25.23 billion (primarily reflecting client activity), cash and cash equivalents of $19.21 billion (primarily reflecting our activity), partially offset by increases in investments of $41.91 billion (primarily due to an increase in U.S. government obligations accounted for as held-to-maturity), collateralized agreements of $29.68 billion (primarily reflecting the impact of our and our clients' activities), and loans of $20.72 billion (reflecting increases in other collateralized and consumer loans).As of December 2022, total liabilities in our consolidated balance sheets were $1.32 trillion, a decrease of $29.45 billion from December 2021, reflecting decreases in collateralized financings of $75.91 billion (primarily reflecting the impact of our and our clients' activities), partially offset by increases in deposits of $22.44 billion (primarily due to increases in transaction banking and private bank and consumer deposits, partially offset by other deposits), customer and other payables of $10.11 billion (primarily reflecting client activity), and trading liabilities of $9.90 billion (primarily due to an increase in equity securities, partially offset by a decrease in government obligations, both reflecting the impact of our and our clients' activities).Our total repurchase agreements, accounted for as collateralized financings, were $110.35 billion as of December 2022 and $165.88 billion as of December 2021, which were 15% lower as of December 2022 and 3% higher as of December 2021 than the average daily amount of repurchase agreements over the respective quarters, and 27% lower as of December 2022 and 14% higher as of December 2021 than the average daily amount of repurchase agreements over the respective years. As of December 2022, the decrease in our repurchase agreements relative to the average daily amount of repurchase agreements during the quarter and year resulted from lower levels of our and our clients’ activities at the end of the period. The level of our repurchase agreements fluctuates between and within periods, primarily due to providing clients with access to highly liquid collateral, such as certain government and agency obligations, through collateralized financing activities. The table below presents information about our balance sheet and leverage ratios. As of December$ in millions20222021Total assets$1,441,799 $1,463,988 Unsecured long-term borrowings$247,138 $254,092 Total shareholders’ equity$117,189 $109,926 Leverage ratio12.3x13.3xDebt-to-equity ratio2.1x2.3xIn the table above: •The leverage ratio equals total assets divided by total shareholders’ equity and measures the proportion of equity and debt we use to finance assets. This ratio is different from the leverage ratios included in Note 20 to the consolidated financial statements. •The debt-to-equity ratio equals unsecured long-term borrowings divided by total shareholders’ equity. The table below presents information about our shareholders’ equity and book value per common share, including the reconciliation of common shareholders’ equity to tangible common shareholders’ equity. As of December$ in millions, except per share amounts20222021Total shareholders’ equity$117,189 $109,926 Preferred stock(10,703)(10,703)Common shareholders’ equity106,486 99,223 Goodwill(6,374)(4,285)Identifiable intangible assets(2,009)(418)Tangible common shareholders’ equity$98,103 $94,520 Book value per common share$303.55 $284.39 Tangible book value per common share$279.66 $270.91 In the table above: •Tangible common shareholders’ equity is calculated as total shareholders’ equity less preferred stock, goodwill and identifiable intangible assets. We believe that tangible common shareholders’ equity is meaningful because it is a measure that we and investors use to assess capital adequacy. Tangible common shareholders’ equity is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies. •Book value per common share and tangible book value per common share are based on common shares outstanding and restricted stock units granted to employees with no future service requirements and not subject to performance or market conditions (collectively, basic shares) of 350.8 million as of December 2022 and 348.9 million as of December 2021. We believe that tangible book value per common share (tangible common shareholders’ equity divided by basic shares) is meaningful because it is a measure that we and investors use to assess capital adequacy. Tangible book value per common share is a non-GAAP measure and may not be comparable to similar non-GAAP measures used by other companies.Goldman Sachs 2022 Form 10-K81THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisFunding Sources Our primary sources of funding are deposits, collateralized financings, unsecured short- and long-term borrowings, and shareholders’ equity. We seek to maintain broad and diversified funding sources globally across products, programs, markets, currencies and creditors to avoid funding concentrations. The table below presents information about our funding sources. As of December$ in millions20222021Deposits$386,665 40 %$364,227 36 %Collateralized financings155,022 16 %230,932 23 %Unsecured short-term borrowings60,961 6 %46,955 5 %Unsecured long-term borrowings247,138 26 %254,092 25 %Total shareholders’ equity117,189 12 %109,926 11 %Total$966,975 100 %$1,006,132 100 %Our funding is primarily raised in U.S. dollar, Euro, British pound and Japanese yen. We generally distribute our funding products through our own sales force and third-party distributors to a large, diverse creditor base in a variety of markets in the Americas, Europe and Asia. We believe that our relationships with our creditors are critical to our liquidity. Our creditors include banks, governments, securities lenders, corporations, pension funds, insurance companies, mutual funds and individuals. We have imposed various internal guidelines to monitor creditor concentration across our funding programs. Deposits. Our deposits provide us with a diversified source of funding and reduce our reliance on wholesale funding. We raise deposits, including savings, demand and time deposits, from private bank clients, consumers, transaction banking clients, other institutional clients, and through internal and third-party broker-dealers. Substantially all of our deposits are raised through GS Bank USA, GSIB and Goldman Sachs Bank Europe SE (GSBE). See Note 13 to the consolidated financial statements for further information about our deposits, including a maturity profile of our time deposits. Secured Funding. We fund a significant amount of inventory and a portion of investments on a secured basis. Secured funding includes collateralized financings in the consolidated balance sheets. See Note 11 to the consolidated financial statements for further information about our collateralized financings, including its maturity profile. We may also pledge our inventory and investments as collateral for securities borrowed under a securities lending agreement. We also use our own inventory and investments to cover transactions in which we or our clients have sold securities that have not yet been purchased. Secured funding is less sensitive to changes in our credit quality than unsecured funding, due to our posting of collateral to our lenders. Nonetheless, we analyze the refinancing risk of our secured funding activities, taking into account trade tenors, maturity profiles, counterparty concentrations, collateral eligibility and counterparty rollover probabilities. We seek to mitigate our refinancing risk by executing term trades with staggered maturities, diversifying counterparties, raising excess secured funding and pre-funding residual risk through our GCLA. We seek to raise secured funding with a term appropriate for the liquidity of the assets that are being financed, and we seek longer maturities for secured funding collateralized by asset classes that may be harder to fund on a secured basis, especially during times of market stress. Our secured funding, excluding funding collateralized by liquid government and agency obligations, is primarily executed for tenors of one month or greater and is primarily executed through term repurchase agreements and securities loaned contracts. Assets that may be harder to fund on a secured basis during times of market stress include certain financial instruments in the following categories: mortgage- and other asset-backed loans and securities, non-investment-grade corporate debt securities, equity securities and emerging market securities. We also raise financing through other types of collateralized financings, such as secured loans and notes. GS Bank USA has access to funding from the Federal Home Loan Bank. We had no outstanding borrowings from the Federal Home Loan Bank as of December 2022 and $100 million as of December 2021. Additionally, we have access to funding through the Federal Reserve discount window. However, we do not rely on this funding in our liquidity planning and stress testing. 82Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisUnsecured Short-Term Borrowings. A significant portion of our unsecured short-term borrowings was originally long-term debt that is scheduled to mature within one year of the reporting date. We use unsecured short-term borrowings, including U.S. and non-U.S. hybrid financial instruments and commercial paper, to finance liquid assets and for other cash management purposes. In accordance with regulatory requirements, Group Inc. does not issue debt with an original maturity of less than one year, other than to its subsidiaries. See Note 14 to the consolidated financial statements for further information about our unsecured short-term borrowings. Unsecured Long-Term Borrowings. Unsecured long-term borrowings, including structured notes, are raised through syndicated U.S. registered offerings, U.S. registered and Rule 144A medium-term note programs, offshore medium-term note offerings and other debt offerings. We issue in different tenors, currencies and products to maximize the diversification of our investor base. The table below presents our quarterly unsecured long-term borrowings maturity profile. $ in millionsFirstQuarterSecondQuarterThirdQuarterFourthQuarterTotalAs of December 20222024$18,136 $11,053 $9,964 $11,858 $51,011 2025$12,131 $10,681 $6,443 $7,887 37,142 2026$5,862 $3,835 $3,278 $9,227 22,202 2027$8,580 $3,435 $6,568 $11,777 30,360 2028 - thereafter106,423 Total$247,138 The weighted average maturity of our unsecured long-term borrowings as of December 2022 was approximately six years. To mitigate refinancing risk, we seek to limit the principal amount of debt maturing over the course of any monthly, quarterly, semi-annual or annual time horizon. We enter into interest rate swaps to convert a portion of our unsecured long-term borrowings into floating-rate obligations to manage our exposure to interest rates. See Note 14 to the consolidated financial statements for further information about our unsecured long-term borrowings. We issued approximately $28 billion of benchmark debt during 2022, and we intend to issue significantly less benchmark debt in 2023 compared to our benchmark debt issuance in 2022, though actual issuances may differ due to business needs and market opportunities. Shareholders’ Equity. Shareholders’ equity is a stable and perpetual source of funding. See Note 19 to the consolidated financial statements for further information about our shareholders’ equity.Capital Management and Regulatory Capital Capital adequacy is of critical importance to us. We have in place a comprehensive capital management policy that provides a framework, defines objectives and establishes guidelines to assist us in maintaining the appropriate level and composition of capital in both business-as-usual and stressed conditions. Capital Management We determine the appropriate amount and composition of our capital by considering multiple factors, including our current and future regulatory capital requirements, the results of our capital planning and stress testing process, the results of resolution capital models and other factors, such as rating agency guidelines, subsidiary capital requirements, the business environment and conditions in the financial markets. We manage our capital requirements and the levels of our capital usage principally by setting limits on the balance sheet and/or limits on risk, in each case at both the firmwide and business levels. We principally manage the level and composition of our capital through issuances and repurchases of our common stock. We may issue, redeem or repurchase our preferred stock and subordinated debt or other forms of capital as business conditions warrant. Prior to such redemptions or repurchases, we must receive approval from the FRB. See Notes 14 and 19 to the consolidated financial statements for further information about our preferred stock and subordinated debt. Capital Planning and Stress Testing Process. As part of capital planning, we project sources and uses of capital given a range of business environments, including stressed conditions. Our stress testing process is designed to identify and measure material risks associated with our business activities, including market risk, credit risk, operational risk and liquidity risk, as well as our ability to generate revenues. Our capital planning process incorporates an internal capital adequacy assessment with the objective of ensuring that we are appropriately capitalized relative to the risks in our businesses. We incorporate stress scenarios into our capital planning process with a goal of holding sufficient capital to ensure we remain adequately capitalized after experiencing a severe stress event. Our assessment of capital adequacy is viewed in tandem with our assessment of liquidity adequacy and is integrated into our overall risk management structure, governance and policy framework. Goldman Sachs 2022 Form 10-K83THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisOur stress tests incorporate our internally designed stress scenarios, including our internally developed severely adverse scenario, and those required by the FRB, and are designed to capture our specific vulnerabilities and risks. We provide further information about our stress test processes and a summary of the results on our website as described in “Business — Available Information” in Part I, Item 1 of this Form 10-K. As required by the FRB’s CCAR rules, we submit an annual capital plan for review by the FRB. The purpose of the FRB’s review is to ensure that we have a robust, forward-looking capital planning process that accounts for our unique risks and that permits continued operation during times of economic and financial stress. The FRB evaluates us based, in part, on whether we have the capital necessary to continue operating under the baseline and severely adverse scenarios provided by the FRB and those developed internally. This evaluation also takes into account our process for identifying risk, our controls and governance for capital planning, and our guidelines for making capital planning decisions. In addition, the FRB evaluates our plan to make capital distributions (i.e., dividend payments and repurchases or redemptions of stock, subordinated debt or other capital securities) and issue capital, across the range of macroeconomic scenarios and firm-specific assumptions. The FRB determines the stress capital buffer (SCB) applicable to us based on its own annual stress test. The SCB under the Standardized approach is calculated as (i) the difference between our starting and minimum projected CET1 capital ratios under the supervisory severely adverse scenario and (ii) our planned common stock dividends for each of the fourth through seventh quarters of the planning horizon, expressed as a percentage of risk-weighted assets (RWAs). Based on our 2022 CCAR submission, the FRB reduced our SCB from 6.4% to 6.3% for the period from October 1, 2022 through September 30, 2023. As a result, beginning on October 1, 2022, our Standardized CET1 capital ratio requirement was 13.3%. Additionally, effective January 1, 2023, our G-SIB surcharge increased from 2.5% to 3.0%, resulting in a Standardized CET1 capital ratio requirement of 13.8%. See “Share Repurchase Program” for further information about common stock repurchases and dividends and “Consolidated Regulatory Capital” for further information about the G-SIB surcharge. We published a summary of our annual DFAST results in June 2022. See “Business — Available Information” in Part I, Item 1 of this Form 10-K.GS Bank USA is required to conduct stress tests on an annual basis and publish a summary of certain results. GS Bank USA published a summary of its annual DFAST results in June 2022. See “Business — Available Information” in Part I, Item 1 of this Form 10-K.GSI, GSIB and GSBE also have their own capital planning and stress testing processes, which incorporate internally designed stress tests developed in accordance with the guidelines of their respective regulators. Contingency Capital Plan. As part of our comprehensive capital management policy, we maintain a contingency capital plan. Our contingency capital plan provides a framework for analyzing and responding to a perceived or actual capital deficiency, including, but not limited to, identification of drivers of a capital deficiency, as well as mitigants and potential actions. It outlines the appropriate communication procedures to follow during a crisis period, including internal dissemination of information, as well as timely communication with external stakeholders. Capital Attribution. We assess the capital usage of each of our businesses based on our attributed equity framework. This framework considers many factors, including our internal assessment of risks as well as the regulatory capital requirements related to our business activities. These regulatory capital requirements take into consideration our most binding capital constraints. Our most binding capital constraint is our CET1 capital ratio requirement under the Standardized Capital Rules. This requirement includes the SCB which is determined by the FRB based on its own annual stress test. Share Repurchase Program. We use our share repurchase program to help maintain the appropriate level of common equity. The repurchase program is effected primarily through regular open-market purchases (which may include repurchase plans designed to comply with Rule 10b5-1 and accelerated share repurchases), the amounts and timing of which are determined primarily by our current and projected capital position and our capital plan submitted to the FRB as part of CCAR. The amounts and timing of the repurchases may also be influenced by general market conditions and the prevailing price and trading volumes of our common stock. In the third quarter of 2022, the Board of Directors of Group Inc. (Board) approved an increase in our common stock dividend from $2.00 to $2.50 per share. During 2022, we returned a total of $6.70 billion to shareholders, including common stock repurchases of $3.50 billion and common stock dividends of $3.20 billion. During the fourth quarter of 2022, we returned a total of $2.38 billion to shareholders, including common stock repurchases of $1.50 billion and common stock dividends of $880 million. Consistent with our capital management philosophy, we will continue prioritizing deployment of capital for our clients where returns are attractive and return any excess capital to shareholders through dividends and share repurchases. During the first quarter of 2023 through February 23, 2023, our common stock repurchases were approximately $2.25 billion.84Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisSee “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in Part II, Item 5 of this Form 10-K and Note 19 to the consolidated financial statements for further information about our share repurchase program, and see above for information about our capital planning and stress testing process.In August 2022, the Inflation Reduction Act of 2022 introduced a one percent non-deductible excise tax (buyback tax) on the fair market value of certain corporate share repurchases after December 31, 2022. The fair market value of share repurchases subject to the tax is reduced by the fair market value of any stock issued during the calendar year, including stock issued to employees. Based on our current understanding, we do not expect the buyback tax to have a material impact on our financial condition, results of operations or cash flows in 2023. Resolution Capital Models. In connection with our resolution planning efforts, we have established a Resolution Capital Adequacy and Positioning framework, which is designed to ensure that our major subsidiaries (GS Bank USA, Goldman Sachs & Co. LLC (GS&Co.), GSI, GSIB, GSBE, Goldman Sachs Japan Co., Ltd. (GSJCL), Goldman Sachs Asset Management, L.P. and Goldman Sachs Asset Management International) have access to sufficient loss-absorbing capacity (in the form of equity, subordinated debt and unsecured senior debt) so that they are able to wind down following a Group Inc. bankruptcy filing in accordance with our preferred resolution strategy. In addition, we have established a triggers and alerts framework, which is designed to provide the Board with information needed to make an informed decision on whether and when to commence bankruptcy proceedings for Group Inc. Rating Agency Guidelines The credit rating agencies assign credit ratings to the obligations of Group Inc., which directly issues or guarantees substantially all of our senior unsecured debt obligations. GS&Co. and GSI have been assigned long- and short-term issuer ratings by certain credit rating agencies. GS Bank USA, GSIB and GSBE have also been assigned long- and short-term issuer ratings, as well as ratings on their long- and short-term bank deposits. In addition, credit rating agencies have assigned ratings to debt obligations of certain other subsidiaries of Group Inc. The level and composition of our capital are among the many factors considered in determining our credit ratings. Each agency has its own definition of eligible capital and methodology for evaluating capital adequacy, and assessments are generally based on a combination of factors rather than a single calculation. See “Risk Management — Liquidity Risk Management — Credit Ratings” for further information about credit ratings of Group Inc., GS Bank USA, GSIB, GSBE, GS&Co. and GSI. Consolidated Regulatory Capital We are subject to consolidated regulatory capital requirements which are calculated in accordance with the regulations of the FRB (Capital Framework). Under the Capital Framework, we are an “Advanced approaches” banking organization and have been designated as a G-SIB.The capital requirements calculated under the Capital Framework include the capital conservation buffer requirements, which are comprised of a 2.5% buffer (under the Advanced Capital Rules), the SCB (under the Standardized Capital Rules), a countercyclical capital buffer (under both Capital Rules) and the G-SIB surcharge (under both Capital Rules). Our G-SIB surcharge was 2.5% for 2022 and is 3.0% for 2023 and 2024. The G-SIB surcharge and countercyclical capital buffer in the future may differ due to additional guidance from our regulators and/or positional changes, and our SCB is likely to change from year to year based on the results of the annual supervisory stress tests. Our target is to maintain capital ratios equal to the regulatory requirements plus a buffer of 50 to 100 basis points.See Note 20 to the consolidated financial statements for further information about our risk-based capital ratios and leverage ratios, and the Capital Framework. Total Loss-Absorbing Capacity (TLAC) We are also subject to the FRB’s TLAC and related requirements. Failure to comply with the TLAC and related requirements would result in restrictions being imposed by the FRB and could limit our ability to repurchase shares, pay dividends and make certain discretionary compensation payments. Goldman Sachs 2022 Form 10-K85THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe table below presents TLAC and external long-term debt requirements. RequirementsTLAC to RWAs21.5 %TLAC to leverage exposure9.5 %External long-term debt to RWAs8.5 %External long-term debt to leverage exposure4.5 %In the table above: •The TLAC to RWAs requirement included (i) the 18% minimum, (ii) the 2.5% buffer, (iii) the countercyclical capital buffer, which the FRB has set to zero percent and (iv) the 1.0% G-SIB surcharge (Method 1). Beginning in January 2023, our TLAC to RWAs requirement increased to 22.0%.•The TLAC to leverage exposure requirement includes (i) the 7.5% minimum and (ii) the 2.0% leverage exposure buffer.•The external long-term debt to RWAs requirement includes (i) the 6% minimum and (ii) the 2.5% G-SIB surcharge (Method 2). Beginning in January 2023, our external long-term debt to RWAs requirement increased to 9.0%.•The external long-term debt to total leverage exposure is the 4.5% minimum. The table below presents information about our TLAC and external long-term debt ratios. For the Three MonthsEnded or as of December$ in millions20222021TLAC$297,100 $297,765 External long-term debt$172,845 $174,500 RWAs$679,450 $676,863 Leverage exposure$1,867,358 $1,910,521 TLAC to RWAs43.7 %44.0 %TLAC to leverage exposure15.9 %15.6 %External long-term debt to RWAs25.4 %25.8 %External long-term debt to leverage exposure9.3 %9.1 %In the table above: •TLAC includes common and preferred stock, and eligible long-term debt issued by Group Inc. Eligible long-term debt represents unsecured debt, which has a remaining maturity of at least one year and satisfies additional requirements. •External long-term debt consists of eligible long-term debt subject to a haircut if it is due to be paid between one and two years. •RWAs represent Advanced RWAs as of December 2022 and Standardized RWAs as of December 2021. In accordance with the TLAC rules, the higher of Advanced or Standardized RWAs are used in the calculation of TLAC and external long-term debt ratios and applicable requirements. •Leverage exposure consists of average adjusted total assets and certain off-balance sheet exposures.In the second half of 2022, based on regulatory feedback, we revised certain interpretations of the Capital Rules underlying the calculation of Standardized RWAs. As of December 2021, this change would have reduced our TLAC to RWAs ratio of 44.0% by 0.8 percentage points and our External long-term debt to RWAs ratio of 25.8% by 0.5 percentage points.See “Business — Regulation” in Part I, Item 1 of this Form 10-K for further information about TLAC. Subsidiary Capital Requirements Many of our subsidiaries, including our bank and broker-dealer subsidiaries, are subject to separate regulation and capital requirements of the jurisdictions in which they operate. Bank Subsidiaries. GS Bank USA is our primary U.S. banking subsidiary and GSIB and GSBE are our primary non-U.S. banking subsidiaries. These entities are subject to regulatory capital requirements. See Note 20 to the consolidated financial statements for further information about the regulatory capital requirements of our bank subsidiaries. U.S. Regulated Broker-Dealer Subsidiaries. GS&Co., our primary U.S. regulated broker-dealer subsidiary, is also a registered futures commission merchant and a registered swap dealer with the CFTC, and a registered security-based swap dealer with the SEC, and therefore is subject to regulatory capital requirements imposed by the SEC, the Financial Industry Regulatory Authority, Inc., the CFTC, the Chicago Mercantile Exchange and the National Futures Association. Rule 15c3-1 of the SEC and Rules 1.17 and Part 23 Subpart E of the CFTC specify uniform minimum net capital requirements, as defined, for their registrants, and also effectively require that a significant part of the registrants’ assets be kept in relatively liquid form. GS&Co. has elected to calculate its minimum capital requirements in accordance with the “Alternative Net Capital Requirement” as permitted by Rule 15c3-1 of the SEC. 86Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisGS&Co. had regulatory net capital, as defined by Rule 15c3-1, of $22.21 billion as of December 2022 and $22.18 billion as of December 2021, which exceeded the amount required by $17.46 billion as of December 2022 and $17.74 billion as of December 2021. In addition to its alternative minimum net capital requirements, GS&Co. is also required to hold tentative net capital in excess of $5 billion and net capital in excess of $1 billion in accordance with Rule 15c3-1. GS&Co. is also required to notify the SEC in the event that its tentative net capital is less than $6 billion. As of both December 2022 and December 2021, GS&Co. had tentative net capital and net capital in excess of both the minimum and the notification requirements. Non-U.S. Regulated Broker-Dealer Subsidiaries. Our principal non-U.S. regulated broker-dealer subsidiaries include GSI and GSJCL. GSI, our U.K. broker-dealer, is regulated by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). GSI is subject to the U.K. capital framework, which is largely based on the Basel Committee on Banking Supervision’s (Basel Committee) capital framework for strengthening international capital standards (Basel III). The table below presents GSI’s risk-based capital requirements. As of December20222021Risk-based capital requirementsCET1 capital ratio8.7 %8.1 %Tier 1 capital ratio10.7 %9.9 %Total capital ratio13.3 %12.4 %In the table above, the risk-based capital requirements incorporate capital guidance received from the PRA and could change in the future. The table below presents information about GSI’s risk-based capital ratios. As of December$ in millions20222021Risk-based capital and risk-weighted assetsCET1 capital$31,780 $28,810 Tier 1 capital$40,080 $37,110 Tier 2 capital$5,377 $5,377 Total capital$45,457 $42,487 RWAs$247,653 $269,762 Risk-based capital ratiosCET1 capital ratio12.8%10.7%Tier 1 capital ratio16.2%13.8%Total capital ratio18.4%15.7%In the table above, the risk-based capital ratios as of December 2022 reflected profits after foreseeable charges that are still subject to audit by GSI’s external auditors and approval by GSI's Board of Directors for inclusion in risk-based capital. These profits contributed approximately 9 basis points to the CET1 capital ratio as of December 2022. GSI is also subject to the minimum leverage ratio requirement of 3.25% established by the PRA, which became effective in January 2023. GSI had a leverage ratio of 6.1% as of December 2022. The leverage ratio as of December 2022 reflected profits after foreseeable charges that are still subject to audit by GSI’s external auditors and approval by GSI's Board of Directors for inclusion in risk-based capital. These profits contributed approximately 7 basis points to the leverage ratio as of December 2022. GSI is a registered swap dealer with the CFTC and a registered security-based swap dealer with the SEC. As of both December 2022 and December 2021, GSI was subject to and in compliance with applicable capital requirements for swap dealers and security-based swap dealers. GSI is also subject to a minimum requirement for own funds and eligible liabilities issued to affiliates. This requirement is subject to a transitional period which began to phase in from January 2019 and became fully effective beginning in January 2022. As of both December 2022 and December 2021, GSI was in compliance with this requirement. GSJCL, our Japanese broker-dealer, is regulated by Japan’s Financial Services Agency. GSJCL and certain other non-U.S. subsidiaries are also subject to capital requirements promulgated by authorities of the countries in which they operate. As of both December 2022 and December 2021, these subsidiaries were in compliance with their local capital requirements. Regulatory and Other Matters Regulatory Matters Our businesses are subject to extensive regulation and supervision worldwide. Regulations have been adopted or are being considered by regulators and policy makers worldwide. Given that many of the new and proposed rules are highly complex, the full impact of regulatory reform will not be known until the rules are implemented and market practices develop under the final regulations. See “Business — Regulation” in Part I, Item 1 of this Form 10-K for further information about the laws, rules and regulations and proposed laws, rules and regulations that apply to us and our operations. Goldman Sachs 2022 Form 10-K87THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisOther Matters Replacement of Interbank Offered Rates (IBORs), including LIBOR. On January 1, 2022, the publication of all EUR, CHF, JPY and GBP LIBOR (non-USD LIBOR) settings along with certain USD LIBOR settings ceased. The publication of the most commonly used USD LIBOR settings as representative rates will cease after June 2023. The FCA has allowed the publication and use of synthetic rates for certain GBP LIBOR settings in legacy GBP LIBOR-based derivative contracts through March 2024. The FCA has proposed to allow the publication and use of synthetic rates for certain USD LIBOR settings in legacy USD LIBOR-based derivative contracts through September 2024. The U.S. federal banking agencies’ guidance strongly encourages banking organizations to cease using USD LIBOR. The International Swaps and Derivatives Association (ISDA) 2020 IBOR Fallbacks Protocol (IBOR Protocol) has provided derivatives market participants with amended fallbacks for legacy and new derivative contracts to mitigate legal or economic uncertainty. Both counterparties have to adhere to the IBOR Protocol or engage in bilateral amendments for the terms to be effective for derivative contracts. ISDA has confirmed that the FCA’s formal announcement to cease both non-USD and USD LIBOR settings fixed the spread adjustment for all LIBOR rates and as a result fallbacks applied automatically for non-USD LIBOR settings following December 31, 2021 and will apply automatically for USD LIBOR settings following June 30, 2023. The Adjustable Interest Rate (LIBOR) Act, that was enacted in March 2022, provides a statutory framework to replace USD LIBOR with a benchmark rate based on the Secured Overnight Financing Rate (SOFR) for contracts governed by U.S. law that have no fallbacks or fallbacks that would require the use of a poll or LIBOR-based rate. In December 2022, the FRB adopted a final rule that implements the LIBOR Act, which will become effective on February 27, 2023. The final rule identifies different SOFR-based replacement rates for derivative contracts, for cash instruments such as floating-rate notes and preferred stock, for consumer contracts, for certain government-sponsored enterprise contracts and for certain student loan securitizations that lack a fallback to an alternative rate when USD LIBOR ceases to be published on June 30, 2023. We facilitated an orderly transition from non-USD LIBORs to alternative risk-free reference rates and synthetic rates for us and our clients, and continue to make progress on our transition program as it relates to USD LIBOR. Our risk exposure to USD LIBOR is primarily in connection with our derivative contracts and, to a lesser extent, our unsecured debt, preferred stock and loan portfolio. As of December 2022, the notional amount of our USD LIBOR-based derivative contracts was approximately $6 trillion, of which approximately $5 trillion will mature after June 2023 based on their contractual terms. Substantially all of such derivative contracts are with counterparties under bilateral agreements subject to the IBOR Protocol, or with central clearing counterparties or exchanges which have incorporated fallbacks consistent with the IBOR Protocol in their rulebooks and have announced that they plan to convert USD LIBOR contracts to alternative risk-free reference rates. Our unsecured benchmark debt and preferred stock with USD LIBOR exposure was approximately $29.0 billion as of December 2022, of which $26.4 billion will contractually mature after June 2023 or is perpetual and has no stated maturity date. Under the FRB’s final rule and the LIBOR Act, we will replace our USD LIBOR-based unsecured benchmark debt and preferred stock with term SOFR plus the statutorily prescribed tenor spread. This transition will take place following USD LIBOR cessation on June 30, 2023. In addition, our USD LIBOR-based loans were approximately $33.1 billion as of December 2022, of which approximately $30.5 billion will mature after June 2023 based on their contractual terms. A vast majority of such loans contain fallback provisions in the related loan agreements and we are actively engaging with our clients and syndicate partners to remediate the remaining loans agreements.We have also issued debt and deposits linked to SOFR and Sterling Overnight Index Average (SONIA) and executed SOFR- and SONIA-based derivative contracts to make markets and facilitate client activities. When appropriate, we continue to execute transactions in the market to reduce our USD LIBOR exposures arising from hedges to our fixed-rate debt issuances and replace them with alternative risk-free reference rate exposures. 88Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisOff-Balance Sheet Arrangements In the ordinary course of business, we enter into various types of off-balance sheet arrangements. Our involvement in these arrangements can take many different forms, including: •Purchasing or retaining residual and other interests in special purpose entities, such as mortgage-backed and other asset-backed securitization vehicles; •Holding senior and subordinated debt, interests in limited and general partnerships, and preferred and common stock in other nonconsolidated vehicles; •Entering into interest rate, foreign currency, equity, commodity and credit derivatives, including total return swaps; and •Providing guarantees, indemnifications, commitments, letters of credit and representations and warranties. We enter into these arrangements for a variety of business purposes, including securitizations. The securitization vehicles that purchase mortgages, corporate bonds and other types of financial assets are critical to the functioning of several significant investor markets, including the mortgage-backed and other asset-backed securities markets, since they offer investors access to specific cash flows and risks created through the securitization process. We also enter into these arrangements to underwrite client securitization transactions; provide secondary market liquidity; make investments in performing and nonperforming debt, distressed loans, power-related assets, equity securities, real estate and other assets; and provide investors with credit-linked and asset-repackaged notes. The table below presents where information about our various off-balance sheet arrangements may be found in this Form 10-K. In addition, see Note 3 to the consolidated financial statements for information about our consolidation policies. Off-Balance Sheet ArrangementDisclosure in Form 10-K Variable interests and other obligations, including contingent obligations, arising from variable interests in nonconsolidated variable interest entities (VIEs) See Note 17 to the consolidated financial statements. Guarantees, and lending and other commitments See Note 18 to the consolidated financial statements. Derivatives See “Risk Management — Credit Risk Management — Credit Exposures — OTC Derivatives” and Notes 4, 5, 7 and 18 to the consolidated financial statements. Goldman Sachs 2022 Form 10-K89THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisRisk Management Risks are inherent in our businesses and include liquidity, market, credit, operational, model, legal, compliance, conduct, regulatory and reputational risks. For further information about our risk management processes, see “Overview and Structure of Risk Management,” and for information about our areas of risk, see “Liquidity Risk Management,” “Market Risk Management,” “Credit Risk Management,” “Operational Risk Management,” “Model Risk Management” and “Other Risk Management,” as well as “Risk Factors” in Part I, Item 1A of this Form 10-K.Overview and Structure of Risk Management Overview We believe that effective risk management is critical to our success. Accordingly, we have established an enterprise risk management framework that employs a comprehensive, integrated approach to risk management, and is designed to enable comprehensive risk management processes through which we identify, assess, monitor and manage the risks we assume in conducting our activities. Our risk management structure is built around three core components: governance, processes and people. Governance. Risk management governance starts with the Board, which both directly and through its committees, including its Risk Committee, oversees our risk management policies and practices implemented through the enterprise risk management framework. The Board is also responsible for the annual review and approval of our risk appetite statement. The risk appetite statement describes the levels and types of risk we are willing to accept or to avoid, in order to achieve our objectives included in our strategic business plan, while remaining in compliance with regulatory requirements. The Board reviews our strategic business plan and is ultimately responsible for overseeing and providing direction about our strategy and risk appetite. The Board receives regular briefings on firmwide risks, including liquidity risk, market risk, credit risk, operational risk, model risk and climate risk, from our independent risk oversight and control functions, including the chief risk officer, and on compliance risk and conduct risk from Compliance, on legal and regulatory enforcement matters from the chief legal officer, and on other matters impacting our reputation from the chair and vice-chairs of our Firmwide Reputational Risk Committee. The chief risk officer reports to our chief executive officer and to the Risk Committee of the Board. As part of the review of the firmwide risk portfolio, the chief risk officer regularly advises the Risk Committee of the Board of relevant risk metrics and material exposures, including risk limits and thresholds established in our risk appetite statement. The implementation of our risk governance structure and core risk management processes is overseen by Enterprise Risk, which reports to our chief risk officer, and is responsible for ensuring that our enterprise risk management framework provides the Board, our risk committees and senior management with a consistent and integrated approach to managing our various risks in a manner consistent with our risk appetite. Our revenue-producing units, as well as Treasury, Engineering, Human Capital Management, Operations, and Corporate and Workplace Solutions, are considered our first line of defense. They are accountable for the outcomes of our risk-generating activities, as well as for assessing and managing those risks within our risk appetite. Our independent risk oversight and control functions are considered our second line of defense and provide independent assessment, oversight and challenge of the risks taken by our first line of defense, as well as lead and participate in risk committees. Independent risk oversight and control functions include Compliance, Conflicts Resolution, Controllers, Legal, Risk and Tax. Internal Audit is considered our third line of defense, and our director of Internal Audit reports to the Audit Committee of the Board and administratively to our chief executive officer. Internal Audit includes professionals with a broad range of audit and industry experience, including risk management expertise. Internal Audit is responsible for independently assessing and validating the effectiveness of key controls, including those within the risk management framework, and providing timely reporting to the Audit Committee of the Board, senior management and regulators. 90Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe three lines of defense structure promotes the accountability of first line risk takers, provides a framework for effective challenge by the second line and empowers independent review from the third line. Processes. We maintain various processes that are critical components of our risk management framework, including (i) risk identification and control assessment, (ii) risk appetite, limit and threshold setting, (iii) risk metrics, reporting and monitoring, and (iv) risk decision-making. •Risk Identification and Control Assessment. We believe the identification of our risks and related control assessment is a critical step in providing our Board and senior management transparency and insight into the range and materiality of our risks. We have a comprehensive data collection process, including firmwide policies and procedures that require all employees to report and escalate risk events. Our approach for risk identification and control assessment is comprehensive across all risk types, is dynamic and forward-looking to reflect and adapt to our changing risk profile and business environment, leverages subject matter expertise, and allows for prioritization of our most critical risks. This approach also encompasses our control assessment, led by our second line of defense, to review and challenge the control environment to ensure it supports our strategic business plan.To effectively assess our risks, we maintain a daily discipline of marking substantially all of our inventory to current market levels. We carry our inventory at fair value, with changes in valuation reflected immediately in our risk management systems and in net revenues. We do so because we believe this discipline is one of the most effective tools for assessing and managing risk and that it provides transparent and realistic insight into our inventory exposures. An important part of our risk management process is firmwide stress testing. It allows us to quantify our exposure to tail risks, highlight potential loss concentrations, undertake risk/reward analysis, and assess and mitigate our risk positions. Firmwide stress tests are performed on a regular basis and are designed to ensure a comprehensive analysis of our vulnerabilities and idiosyncratic risks combining financial and nonfinancial risks, including, but not limited to, credit, market, liquidity and funding, operational and compliance, strategic, systemic and emerging risks into a single combined scenario. We also perform ad hoc stress tests in anticipation of market events or conditions. Stress tests are also used to assess capital adequacy as part of our capital planning and stress testing process. See “Capital Management and Regulatory Capital — Capital Management” for further information. •Risk Appetite, Limit and Threshold Setting. We apply a rigorous framework of limits and thresholds to control and monitor risk across transactions, products, businesses and markets. The Board, directly or indirectly through its Risk Committee, approves limits and thresholds included in our risk appetite statement at firmwide, business and product levels. In addition, the Firmwide Risk Appetite Committee, through delegated authority from the Firmwide Enterprise Risk Committee, is responsible for approving our risk limits and thresholds policy, subject to the overall limits approved by the Risk Committee of the Board, and monitoring these limits. The Firmwide Risk Appetite Committee is responsible for approving limits at firmwide, business and product levels. Certain limits may be set at levels that will require periodic adjustment, rather than at levels that reflect our maximum risk appetite. This fosters an ongoing dialogue about risk among our first and second lines of defense, committees and senior management, as well as rapid escalation of risk-related matters. Additionally, through delegated authority from the Firmwide Risk Appetite Committee, Market Risk sets limits at certain product and desk levels, and Credit Risk sets limits for individual counterparties and their subsidiaries, industries and countries. Limits are reviewed regularly and amended on a permanent or temporary basis to reflect changing market conditions, business conditions or risk tolerance. •Risk Metrics, Reporting and Monitoring. Effective risk reporting and risk decision-making depends on our ability to get the right information to the right people at the right time. As such, we focus on the rigor and effectiveness of our risk systems, with the objective of ensuring that our risk management technology systems provide us with complete, accurate and timely information. Our risk metrics, reporting and monitoring processes are designed to take into account information about both existing and emerging risks, thereby enabling our risk committees and senior management to perform their responsibilities with the appropriate level of insight into risk exposures. Furthermore, our limit and threshold breach processes provide means for timely escalation. We evaluate changes in our risk profile and our businesses, including changes in business mix or jurisdictions in which we operate, by monitoring risk factors at a firmwide level. Goldman Sachs 2022 Form 10-K91THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and Analysis•Risk Decision-Making. Our governance structure provides the protocol and responsibility for decision-making on risk management issues and ensures implementation of those decisions. We make extensive use of risk committees that meet regularly and serve as an important means to facilitate and foster ongoing discussions to manage and mitigate risks. We maintain strong and proactive communication about risk and we have a culture of collaboration in decision-making among our first and second lines of defense, committees and senior management. While our first line of defense is responsible for management of their risk, we dedicate extensive resources to our second line of defense in order to ensure a strong oversight structure and an appropriate segregation of duties. We regularly reinforce our strong culture of escalation and accountability across all functions. People. Even the best technology serves only as a tool for helping to make informed decisions in real time about the risks we are taking. Ultimately, effective risk management requires our people to interpret our risk data on an ongoing and timely basis and adjust risk positions accordingly. The experience of our professionals, and their understanding of the nuances and limitations of each risk measure, guides us in assessing exposures and maintaining them within prudent levels.We reinforce a culture of effective risk management, consistent with our risk appetite, in our training and development programs, as well as in the way we evaluate performance, and recognize and reward our people. Our training and development programs, including certain sessions led by our most senior leaders, are focused on the importance of risk management, client relationships and reputational excellence. As part of our performance review process, we assess reputational excellence, including how an employee exercises good risk management and reputational judgment, and adheres to our code of conduct and compliance policies. Our review and reward processes are designed to communicate and reinforce to our professionals the link between behavior and how people are recognized, the need to focus on our clients and our reputation, and the need to always act in accordance with our highest standards. Structure Ultimate oversight of risk is the responsibility of our Board. The Board oversees risk both directly and through its committees, including its Risk Committee. We also have a series of committees with specific risk management mandates that have oversight or decision-making responsibilities for risk management activities. Committee membership generally consists of senior managers from both our first and second lines of defense. We have established procedures for these committees to ensure that appropriate information barriers are in place. Our primary risk committees, most of which also have additional sub-committees, councils or working groups, are described below. In addition to these committees, we have other risk committees that provide oversight for different businesses, activities, products, regions and entities. All of our committees have responsibility for considering the impact on our reputation of the transactions and activities that they oversee. Membership of our risk committees is reviewed regularly and updated to reflect changes in the responsibilities of the committee members. Accordingly, the length of time that members serve on the respective committees varies as determined by the committee chairs and based on the responsibilities of the members. The chart below presents an overview of our risk management governance structure. 92Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisManagement Committee. The Management Committee oversees our global activities. It provides this oversight directly and through authority delegated to committees it has established. This committee consists of our most senior leaders, and is chaired by our chief executive officer. Most members of the Management Committee are also members of other committees. The following are the committees that are principally involved in firmwide risk management. Firmwide Enterprise Risk Committee. The Firmwide Enterprise Risk Committee is responsible for overseeing all of our financial and nonfinancial risks. As part of such oversight, the committee is responsible for the ongoing review, approval and monitoring of our enterprise risk management framework, as well as our risk limits and thresholds policy, through delegated authority to the Firmwide Risk Appetite Committee. This committee also reviews new significant strategic business initiatives to determine whether they are consistent with our risk appetite and risk management capabilities. Additionally, the Firmwide Enterprise Risk Committee performs enhanced reviews of significant risk events, the top residual and emerging risks, and the overall risk and control environment in each of our business units in order to propose uplifts, identify elements that are common to all business units and analyze the consolidated residual risks that we face. This committee, which reports to the Management Committee, is co-chaired by our president and chief operating officer and our chief risk officer, who are appointed as chairs by our chief executive officer, and the vice-chair is our chief financial officer, who is appointed as vice-chair by the chairs of the Firmwide Enterprise Risk Committee. The following are the primary committees or councils that report to the Firmwide Enterprise Risk Committee (unless otherwise noted): •Firmwide Risk Council. The Firmwide Risk Council is responsible for the ongoing monitoring of relevant financial risks and related risk limits at the firmwide, business and product levels. This council is co-chaired by our chief financial officer and our chief risk officer. •Firmwide New Activity Committee. The Firmwide New Activity Committee is responsible for reviewing new activities and for establishing a process to identify and review previously approved activities that are significant and that have changed in complexity and/or structure or present different reputational and suitability concerns over time to consider whether these activities remain appropriate. This committee is co-chaired by our controller and chief accounting officer and our chief operating and strategy officer for Engineering, who are appointed as chairs by the chairs of the Firmwide Enterprise Risk Committee. •Firmwide Operational Risk and Resilience Committee. The Firmwide Operational Risk and Resilience Committee is responsible for overseeing operational risk, and for ensuring our business and operational resilience. To assist the Firmwide Operational Risk and Resilience Committee in carrying out its mandate, other risk committees with dedicated oversight for technology-related risks, including cybersecurity matters, report into the Firmwide Operational Risk and Resilience Committee. This committee is co-chaired by our chief administrative officer for EMEA and our head of Operational Risk, who are appointed as chairs by the chairs of the Firmwide Enterprise Risk Committee. •Firmwide Conduct Committee. The Firmwide Conduct Committee is responsible for the ongoing approval and monitoring of the frameworks and policies which govern our conduct risks. Conduct risk is the risk that our people fail to act in a manner consistent with our Business Principles and related core values, policies or codes, or applicable laws or regulations, thereby falling short in fulfilling their responsibilities to us, our clients, colleagues, other market participants or the broader community. This committee is chaired by our chief legal officer, who is appointed as chair by the chairs of the Firmwide Enterprise Risk Committee. •Firmwide Risk Appetite Committee. The Firmwide Risk Appetite Committee (through delegated authority from the Firmwide Enterprise Risk Committee) is responsible for the ongoing approval and monitoring of risk frameworks, policies and parameters related to our core risk management processes, as well as limits and thresholds, at firmwide, business and product levels. In addition, this committee is responsible for overseeing our financial risks and reviews the results of stress tests and scenario analyses. To assist the Firmwide Risk Appetite Committee in carrying out its mandate, a number of other risk committees with dedicated oversight for stress testing, model risks, Volcker Rule compliance, as well as our investments or other capital commitments that may give rise to financial risk, report into the Firmwide Risk Appetite Committee. This committee is chaired by our chief risk officer, who is appointed as chair by the chairs of the Firmwide Enterprise Risk Committee. The Firmwide Capital Committee and Firmwide Commitments Committee report to the Firmwide Risk Appetite Committee.Firmwide Capital Committee. The Firmwide Capital Committee provides approval and oversight of debt-related transactions, including principal commitments of our capital. This committee aims to ensure that business, reputational and suitability standards for underwritings and capital commitments are maintained on a global basis. This committee is co-chaired by our head of Credit Risk and a co-head of our Global Financing Group, who are appointed as chairs by the chair of the Firmwide Risk Appetite Committee. Goldman Sachs 2022 Form 10-K93THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisFirmwide Commitments Committee. The Firmwide Commitments Committee reviews our underwriting and distribution activities with respect to equity and equity-related product offerings, and sets and maintains policies and procedures designed to ensure that legal, reputational, regulatory and business standards are maintained on a global basis. In addition to reviewing specific transactions, this committee periodically conducts general strategic reviews of sectors and products and establishes policies in connection with transaction practices. This committee is co-chaired by our chief equity underwriting officer for the Americas, a co-chairman of our Global Financial Institutions Group and a co-head of our Global Investment Grade Capital Markets and Risk Management Group in Global Banking & Markets, who are appointed as chairs by the chair of the Firmwide Risk Appetite Committee. •Firmwide Reputational Risk Committee. The Firmwide Reputational Risk Committee is responsible for assessing reputational risks arising from transactions that have been identified as having potential heightened reputational risk pursuant to the criteria established by the Firmwide Reputational Risk Committee and as determined by committee leadership. This committee is also responsible for overseeing client-related business standards and addressing client-related reputational risk. This committee is chaired by our president and chief operating officer, who is appointed as chair by our chief executive officer, and the vice-chairs are our chief legal officer and the head of Conflicts Resolution, who are appointed as vice-chairs by the chair of the Firmwide Reputational Risk Committee. This committee periodically provides updates to, and receives guidance from, the Public Responsibilities Committee of the Board. The Firmwide Suitability Committee reports to the Firmwide Reputational Risk Committee.Firmwide Suitability Committee. The Firmwide Suitability Committee is responsible for setting standards and policies for product, transaction and client suitability and providing a forum for consistency across functions, regions and products on suitability assessments. This committee also reviews suitability matters escalated from other committees. This committee is co-chaired by our chief compliance officer, and the head of Net Zero Transition Solutions in Global Banking & Markets, who are appointed as chairs by the chair of the Firmwide Reputational Risk Committee. Firmwide Asset Liability Committee. The Firmwide Asset Liability Committee reviews and approves the strategic direction for our financial resources, including capital, liquidity, funding and balance sheet. This committee has oversight responsibility for asset liability management, including interest rate and currency risk, funds transfer pricing, capital allocation and incentives, and credit ratings. This committee makes recommendations as to any adjustments to asset liability management and financial resource allocation in light of current events, risks, exposures, and regulatory requirements and approves related policies. This committee is co-chaired by our chief financial officer and our global treasurer, who are appointed as chairs by our chief executive officer, and reports to the Management Committee. Liquidity Risk Management Overview Liquidity risk is the risk that we will be unable to fund ourselves or meet our liquidity needs in the event of firm-specific, broader industry or market liquidity stress events. We have in place a comprehensive and conservative set of liquidity and funding policies. Our principal objective is to be able to fund ourselves and to enable our core businesses to continue to serve clients and generate revenues, even under adverse circumstances. Treasury, which reports to our chief financial officer, has primary responsibility for developing, managing and executing our liquidity and funding strategy within our risk appetite. Liquidity Risk, which is independent of our revenue-producing units and Treasury, and reports to our chief risk officer, has primary responsibility for identifying, monitoring and managing our liquidity risk through firmwide oversight across our global businesses and the establishment of stress testing and limits frameworks. 94Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisLiquidity Risk Management Principles We manage liquidity risk according to three principles: (i) hold sufficient excess liquidity in the form of GCLA to cover outflows during a stressed period, (ii) maintain appropriate Asset-Liability Management and (iii) maintain a viable Contingency Funding Plan. GCLA. GCLA is liquidity that we maintain to meet a broad range of potential cash outflows and collateral needs in a stressed environment. A primary liquidity principle is to pre-fund our estimated potential cash and collateral needs during a liquidity crisis and hold this liquidity in the form of unencumbered, highly liquid securities and cash. We believe that the securities held in our GCLA would be readily convertible to cash in a matter of days, through liquidation, by entering into repurchase agreements or from maturities of resale agreements, and that this cash would allow us to meet immediate obligations without needing to sell other assets or depend on additional funding from credit-sensitive markets. Our GCLA reflects the following principles: •The first days or weeks of a liquidity crisis are the most critical to a company’s survival; •Focus must be maintained on all potential cash and collateral outflows, not just disruptions to financing flows. Our businesses are diverse, and our liquidity needs are determined by many factors, including market movements, collateral requirements and client commitments, all of which can change dramatically in a difficult funding environment; •During a liquidity crisis, credit-sensitive funding, including unsecured debt, certain deposits and some types of secured financing agreements, may be unavailable, and the terms (e.g., interest rates, collateral provisions and tenor) or availability of other types of secured financing may change and certain deposits may be withdrawn; and •As a result of our policy to pre-fund liquidity that we estimate may be needed in a crisis, we hold more unencumbered securities and have larger funding balances than our businesses would otherwise require. We believe that our liquidity is stronger with greater balances of highly liquid unencumbered securities, even though it increases our total assets and our funding costs. We maintain our GCLA across Group Inc., Goldman Sachs Funding LLC (Funding IHC) and Group Inc.’s major broker-dealer and bank subsidiaries, asset types and clearing agents to provide us with sufficient operating liquidity to ensure timely settlement in all major markets, even in a difficult funding environment. In addition to the GCLA, we maintain cash balances and securities in several of our other entities, primarily for use in specific currencies, entities or jurisdictions where we do not have immediate access to parent company liquidity. Asset-Liability Management. Our liquidity risk management policies are designed to ensure we have a sufficient amount of financing, even when funding markets experience persistent stress. We manage the maturities and diversity of our funding across markets, products and counterparties, and seek to maintain a diversified funding profile with an appropriate tenor, taking into consideration the characteristics and liquidity profile of our assets. Our approach to asset-liability management includes: •Conservatively managing the overall characteristics of our funding book, with a focus on maintaining long-term, diversified sources of funding in excess of our current requirements. See “Balance Sheet and Funding Sources — Funding Sources” for further information; •Actively managing and monitoring our asset base, with particular focus on the liquidity, holding period and ability to fund assets on a secured basis. We assess our funding requirements and our ability to liquidate assets in a stressed environment while appropriately managing risk. This enables us to determine the most appropriate funding products and tenors. See “Balance Sheet and Funding Sources — Balance Sheet Management” for further information about our balance sheet management process and “— Funding Sources — Secured Funding” for further information about asset classes that may be harder to fund on a secured basis; and •Raising secured and unsecured financing that has a long tenor relative to the liquidity profile of our assets. This reduces the risk that our liabilities will come due in advance of our ability to generate liquidity from the sale of our assets. Because we maintain a highly liquid balance sheet, the holding period of certain of our assets may be materially shorter than their contractual maturity dates. Goldman Sachs 2022 Form 10-K95THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisOur goal is to ensure that we maintain sufficient liquidity to fund our assets and meet our contractual and contingent obligations in normal times, as well as during periods of market stress. Through our dynamic balance sheet management process, we use actual and projected asset balances to determine secured and unsecured funding requirements. Funding plans are reviewed and approved by the Firmwide Asset Liability Committee. In addition, our independent risk oversight and control functions analyze, and the Firmwide Asset Liability Committee reviews, our consolidated total capital position (unsecured long-term borrowings plus total shareholders’ equity) so that we maintain a level of long-term funding that is sufficient to meet our long-term financing requirements. In a liquidity crisis, we would first use our GCLA in order to avoid reliance on asset sales (other than our GCLA). However, we recognize that orderly asset sales may be prudent or necessary in a severe or persistent liquidity crisis. Subsidiary Funding Policies The majority of our unsecured funding is raised by Group Inc., which provides the necessary funds to Funding IHC and other subsidiaries, some of which are regulated, to meet their asset financing, liquidity and capital requirements. In addition, Group Inc. provides its regulated subsidiaries with the necessary capital to meet their regulatory requirements. The benefits of this approach to subsidiary funding are enhanced control and greater flexibility to meet the funding requirements of our subsidiaries. Funding is also raised at the subsidiary level through a variety of products, including deposits, secured funding and unsecured borrowings. Our intercompany funding policies assume that a subsidiary’s funds or securities are not freely available to its parent, Funding IHC or other subsidiaries unless (i) legally provided for and (ii) there are no additional regulatory, tax or other restrictions. In particular, many of our subsidiaries are subject to laws that authorize regulatory bodies to block or reduce the flow of funds from those subsidiaries to Group Inc. or Funding IHC. Regulatory action of that kind could impede access to funds that Group Inc. needs to make payments on its obligations. Accordingly, we assume that the capital provided to our regulated subsidiaries is not available to Group Inc. or other subsidiaries and any other financing provided to our regulated subsidiaries is not available to Group Inc. or Funding IHC until the maturity of such financing. Group Inc. has provided substantial amounts of equity and subordinated indebtedness, directly or indirectly, to its regulated subsidiaries. For example, as of December 2022, Group Inc. had $39.33 billion of equity and subordinated indebtedness invested in GS&Co., its principal U.S. registered broker-dealer; $47.74 billion invested in GSI, a regulated U.K. broker-dealer; $2.62 billion invested in GSJCL, a regulated Japanese broker-dealer; $52.55 billion invested in GS Bank USA, a regulated New York State-chartered bank; and $4.25 billion invested in GSIB, a regulated U.K. bank. Group Inc. also provides financing, directly or indirectly, in the form of: $108.14 billion of unsubordinated loans (including secured loans of $52.93 billion) and $30.16 billion of collateral and cash deposits to these entities as of December 2022. In addition, as of December 2022, Group Inc. had significant amounts of capital invested in and loans to its other regulated subsidiaries. Contingency Funding Plan. We maintain a contingency funding plan to provide a framework for analyzing and responding to a liquidity crisis situation or periods of market stress. Our contingency funding plan outlines a list of potential risk factors, key reports and metrics that are reviewed on an ongoing basis to assist in assessing the severity of, and managing through, a liquidity crisis and/or market dislocation. The contingency funding plan also describes in detail our potential responses if our assessments indicate that we have entered a liquidity crisis, which include pre-funding for what we estimate will be our potential cash and collateral needs, as well as utilizing secondary sources of liquidity. Mitigants and action items to address specific risks which may arise are also described and assigned to individuals responsible for execution. The contingency funding plan identifies key groups of individuals and their responsibilities, which include fostering effective coordination, control and distribution of information, implementing liquidity maintenance activities and managing internal and external communication, all of which are critical in the management of a crisis or period of market stress. 96Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisStress Tests In order to determine the appropriate size of our GCLA, we model liquidity outflows over a range of scenarios and time horizons. One of our primary internal liquidity risk models, referred to as the Modeled Liquidity Outflow, quantifies our liquidity risks over a 30-day stress scenario. We also consider other factors, including, but not limited to, an assessment of our potential intraday liquidity needs through an additional internal liquidity risk model, referred to as the Intraday Liquidity Model, the results of our long-term stress testing models, our resolution liquidity models and other applicable regulatory requirements and a qualitative assessment of our condition, as well as the financial markets. The results of the Modeled Liquidity Outflow, the Intraday Liquidity Model, the long-term stress testing models and the resolution liquidity models are reported to senior management on a regular basis. We also perform firmwide stress tests. See “Overview and Structure of Risk Management” for information about firmwide stress tests. Modeled Liquidity Outflow. Our Modeled Liquidity Outflow is based on conducting multiple scenarios that include combinations of market-wide and firm-specific stress. These scenarios are characterized by the following qualitative elements: •Severely challenged market environments, which include low consumer and corporate confidence, financial and political instability, and adverse changes in market values, including potential declines in equity markets and widening of credit spreads; and •A firm-specific crisis potentially triggered by material losses, reputational damage, litigation and/or a ratings downgrade. The following are key modeling elements of our Modeled Liquidity Outflow: •Liquidity needs over a 30-day scenario; •A two-notch downgrade of our long-term senior unsecured credit ratings; •Changing conditions in funding markets, which limit our access to unsecured and secured funding; •No support from additional government funding facilities. Although we have access to various central bank funding programs, we do not assume reliance on additional sources of funding in a liquidity crisis; and •A combination of contractual outflows and contingent outflows arising from both our on- and off-balance sheet arrangements. Contractual outflows include, among other things, upcoming maturities of unsecured debt, term deposits and secured funding. Contingent outflows include, among other things, the withdrawal of customer credit balances in our prime brokerage business, increase in variation margin requirements due to adverse changes in the value of our exchange-traded and OTC-cleared derivatives, draws on unfunded commitments and withdrawals of deposits that have no contractual maturity. See notes to the consolidated financial statements for further information about contractual outflows, including Note 11 for collateralized financings, Note 13 for deposits, Note 14 for unsecured long-term borrowings and Note 15 for operating lease payments, and “Off-Balance Sheet Arrangements” for further information about our various types of off-balance sheet arrangements. Intraday Liquidity Model. Our Intraday Liquidity Model measures our intraday liquidity needs using a scenario analysis characterized by the same qualitative elements as our Modeled Liquidity Outflow. The model assesses the risk of increased intraday liquidity requirements during a scenario where access to sources of intraday liquidity may become constrained. Long-Term Stress Testing. We utilize longer-term stress tests to take a forward view on our liquidity position through prolonged stress periods in which we experience a severe liquidity stress and recover in an environment that continues to be challenging. We are focused on ensuring conservative asset-liability management to prepare for a prolonged period of potential stress, seeking to maintain a diversified funding profile with an appropriate tenor, taking into consideration the characteristics and liquidity profile of our assets. Resolution Liquidity Models. In connection with our resolution planning efforts, we have established our Resolution Liquidity Adequacy and Positioning framework, which estimates liquidity needs of our major subsidiaries in a stressed environment. The liquidity needs are measured using our Modeled Liquidity Outflow assumptions and include certain additional inter-affiliate exposures. We have also established our Resolution Liquidity Execution Need framework, which measures the liquidity needs of our major subsidiaries to stabilize and wind down following a Group Inc. bankruptcy filing in accordance with our preferred resolution strategy. In addition, we have established a triggers and alerts framework, which is designed to provide the Board with information needed to make an informed decision on whether and when to commence bankruptcy proceedings for Group Inc. Goldman Sachs 2022 Form 10-K97THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisLimits We use liquidity risk limits at various levels and across liquidity risk types to manage the size of our liquidity exposures. Limits are measured relative to acceptable levels of risk given our liquidity risk tolerance. See “Overview and Structure of Risk Management” for information about the limit approval process. Limits are monitored by Treasury and Liquidity Risk. Liquidity Risk is responsible for identifying and escalating to senior management and/or the appropriate risk committee, on a timely basis, instances where limits have been exceeded. GCLA and Unencumbered Metrics GCLA. Based on the results of our internal liquidity risk models, described above, as well as our consideration of other factors, including, but not limited to, a qualitative assessment of our condition, as well as the financial markets, we believe our liquidity position as of both December 2022 and December 2021 was appropriate. We strictly limit our GCLA to a narrowly defined list of securities and cash because they are highly liquid, even in a difficult funding environment. We do not include other potential sources of excess liquidity in our GCLA, such as less liquid unencumbered securities or committed credit facilities. The table below presents information about our GCLA. Average for theThree MonthsYear EndedEnded DecemberDecember$ in millions2022202120222021DenominationU.S. dollar$312,414 $230,720 $281,427 $217,797 Non-U.S. dollar96,404 122,401 116,655 116,723 Total$408,818 $353,121 $398,082 $334,520 Asset ClassOvernight cash deposits$217,141 $188,223 $228,203 $173,000 U.S. government obligations149,519 107,898 126,349 108,260 U.S. agency obligations12,789 13,154 11,007 10,183 Non-U.S. government obligations29,369 43,846 32,523 43,077 Total$408,818 $353,121 $398,082 $334,520 Entity TypeGroup Inc. and Funding IHC$69,386 $54,489 $64,579 $53,205 Major broker-dealer subsidiaries109,502 107,279 113,887 104,326 Major bank subsidiaries229,930 191,353 219,616 176,989 Total$408,818 $353,121 $398,082 $334,520 In the table above: •The U.S. dollar-denominated GCLA consists of (i) unencumbered U.S. government and agency obligations (including highly liquid U.S. agency mortgage-backed obligations), all of which are eligible as collateral in Federal Reserve open market operations and (ii) certain overnight U.S. dollar cash deposits. •The non-U.S. dollar-denominated GCLA consists of non-U.S. government obligations (only unencumbered German, French, Japanese and U.K. government obligations) and certain overnight cash deposits in highly liquid currencies. We maintain our GCLA to enable us to meet current and potential liquidity requirements of our parent company, Group Inc., and its subsidiaries. Our Modeled Liquidity Outflow and Intraday Liquidity Model incorporate a requirement for Group Inc., as well as a standalone requirement for each of our major broker-dealer and bank subsidiaries. Funding IHC is required to provide the necessary liquidity to Group Inc. during the ordinary course of business, and is also obligated to provide capital and liquidity support to major subsidiaries in the event of our material financial distress or failure. Liquidity held directly in each of our major broker-dealer and bank subsidiaries is intended for use only by that subsidiary to meet its liquidity requirements and is assumed not to be available to Group Inc. or Funding IHC unless (i) legally provided for and (ii) there are no additional regulatory, tax or other restrictions. In addition, the Modeled Liquidity Outflow and Intraday Liquidity Model also incorporate a broader assessment of standalone liquidity requirements for other subsidiaries and we hold a portion of our GCLA directly at Group Inc. or Funding IHC to support such requirements. Other Unencumbered Assets. In addition to our GCLA, we have a significant amount of other unencumbered cash and financial instruments, including other government obligations, high-grade money market securities, corporate obligations, marginable equities, loans and cash deposits not included in our GCLA. The fair value of our unencumbered assets averaged $273.49 billion for the three months ended December 2022, $271.65 billion for the three months ended December 2021, $275.69 billion for the year ended December 2022 and $249.32 billion for the year ended December 2021. We do not consider these assets liquid enough to be eligible for our GCLA. Liquidity Regulatory Framework As a BHC, we are subject to a minimum Liquidity Coverage Ratio (LCR) under the LCR rule approved by the U.S. federal bank regulatory agencies. The LCR rule requires organizations to maintain an adequate ratio of eligible high-quality liquid assets (HQLA) to expected net cash outflows under an acute, short-term liquidity stress scenario. Eligible HQLA excludes HQLA held by subsidiaries that is in excess of their minimum requirement and is subject to transfer restrictions. We are required to maintain a minimum LCR of 100%. We expect that fluctuations in client activity, business mix and the market environment will impact our LCR. The table below presents information about our average daily LCR. Average for theThree Months EndedDecemberSeptemberDecember$ in millions202220222021Total HQLA$401,836 $407,969 $342,047 Eligible HQLA$291,118 $279,121 $248,570 Net cash outflows$226,532 $224,408 $203,623 LCR129 %124 %122 %98Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisAs a BHC, we are subject to a net stable funding ratio (NSFR) requirement established by the U.S. federal bank regulatory agencies, which requires large U.S. banking organizations to ensure they have access to stable funding over a one-year time horizon. The rule also requires disclosure of our quarterly average daily NSFR on a semi-annual basis and a description of the banking organization’s stable funding sources. We will begin doing so in August 2023. Our NSFR as of December 2022 exceeded the minimum requirement. The following provides information about our subsidiary liquidity regulatory requirements: •GS Bank USA. GS Bank USA is subject to a minimum LCR of 100% under the LCR rule approved by the U.S. federal bank regulatory agencies. As of December 2022, GS Bank USA’s LCR exceeded the minimum requirement. The NSFR requirement described above also applies to GS Bank USA. As of December 2022, GS Bank USA’s NSFR exceeded the minimum requirement. •GSI and GSIB. GSI and GSIB are subject to a minimum LCR of 100% under the LCR rule approved by the U.K. regulatory authorities. GSI’s and GSIB’s average monthly LCR for the trailing twelve-month period ended December 2022 exceeded the minimum requirement. GSI and GSIB are subject to the applicable NSFR requirement in the U.K. As of December 2022, both GSI’s and GSIB’s NSFR exceeded the minimum requirement. •GSBE. GSBE is subject to a minimum LCR of 100% under the LCR rule approved by the European Parliament and Council. GSBE’s average monthly LCR for the trailing twelve-month period ended December 2022 exceeded the minimum requirement. GSBE is subject to the applicable NSFR requirement in the E.U. As of December 2022, GSBE’s NSFR exceeded the minimum requirement. •Other Subsidiaries. We monitor local regulatory liquidity requirements of our subsidiaries to ensure compliance. For many of our subsidiaries, these requirements either have changed or are likely to change in the future due to the implementation of the Basel Committee’s framework for liquidity risk measurement, standards and monitoring, as well as other regulatory developments. The implementation of these rules and any amendments adopted by the regulatory authorities could impact our liquidity and funding requirements and practices in the future. Credit Ratings We rely on the short- and long-term debt capital markets to fund a significant portion of our day-to-day operations and the cost and availability of debt financing is influenced by our credit ratings. Credit ratings are also important when we are competing in certain markets, such as OTC derivatives, and when we seek to engage in longer-term transactions. See “Risk Factors” in Part I, Item 1A of this Form 10-K for information about the risks associated with a reduction in our credit ratings. The table below presents the unsecured credit ratings and outlook of Group Inc. As of December 2022DBRSFitchMoody’sR&IS&PShort-term debtR-1 (middle)F1P-1a-1A-2Long-term debtA (high)AA2ABBB+Subordinated debtABBB+Baa2A-BBBTrust preferredABBB-Baa3N/ABB+Preferred stockBBB (high)BBB-Ba1N/ABB+Ratings outlookStableStableStableStableStableIn the table above: •The ratings and outlook are by DBRS, Inc. (DBRS), Fitch, Inc. (Fitch), Moody’s Investors Service (Moody’s), Rating and Investment Information, Inc. (R&I), and Standard & Poor’s Ratings Services (S&P). •The ratings for trust preferred relate to the guaranteed preferred beneficial interests issued by Goldman Sachs Capital I. •The DBRS, Fitch, Moody’s and S&P ratings for preferred stock include the APEX issued by Goldman Sachs Capital II and Goldman Sachs Capital III. Goldman Sachs 2022 Form 10-K99THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe table below presents the unsecured credit ratings and outlook of GS Bank USA, GSIB, GSBE, GS&Co. and GSI. As of December 2022FitchMoody’sS&PGS Bank USAShort-term debtF1P-1A-1Long-term debtA+A1A+Short-term bank depositsF1+P-1N/ALong-term bank depositsAA-A1N/ARatings outlookStableStableStableGSIBShort-term debtF1P-1A-1Long-term debtA+A1A+Short-term bank depositsF1P-1N/ALong-term bank depositsA+A1N/ARatings outlookStableStableStableGSBEShort-term debtF1P-1A-1Long-term debtA+A1A+Short-term bank depositsN/AP-1N/ALong-term bank depositsN/AA1N/ARatings outlookStableStableStableGS&Co.Short-term debtF1N/AA-1Long-term debtA+N/AA+Ratings outlookStableN/AStableGSIShort-term debtF1P-1A-1Long-term debtA+A1A+Ratings outlookStableStableStableWe believe our credit ratings are primarily based on the credit rating agencies’ assessment of: •Our liquidity, market, credit and operational risk management practices;•Our level and variability of earnings;•Our capital base; •Our franchise, reputation and management; •Our corporate governance; and •The external operating and economic environment, including, in some cases, the assumed level of government support or other systemic considerations, such as potential resolution. Certain of our derivatives have been transacted under bilateral agreements with counterparties who may require us to post collateral or terminate the transactions based on changes in our credit ratings. We manage our GCLA to ensure we would, among other potential requirements, be able to make the additional collateral or termination payments that may be required in the event of a two-notch reduction in our long-term credit ratings, as well as collateral that has not been called by counterparties, but is available to them. See Note 7 to the consolidated financial statements for further information about derivatives with credit-related contingent features and the additional collateral or termination payments related to our net derivative liabilities under bilateral agreements that could have been called by counterparties in the event of a one- or two-notch downgrade in our credit ratings. Cash Flows As a global financial institution, our cash flows are complex and bear little relation to our net earnings and net assets. Consequently, we believe that traditional cash flow analysis is less meaningful in evaluating our liquidity position than the liquidity and asset-liability management policies described above. Cash flow analysis may, however, be helpful in highlighting certain macro trends and strategic initiatives in our businesses. Year Ended December 2022. Our cash and cash equivalents decreased by $19.21 billion to $241.83 billion at the end of 2022, primarily due to net cash used for investing activities, partially offset by net cash provided by financing activities. The net cash used for investing activities primarily reflected purchases of investments (primarily U.S. government obligations accounted for as held-to-maturity) and an increase in net lending activities (reflecting increases in other collateralized and consumer loans). The net cash provided by financing activities primarily reflected cash inflows from net issuances of unsecured long-term borrowings and deposits (reflecting increases in transaction banking and private bank and consumer deposits, partially offset by a decrease in other deposits). The net cash provided by operating activities primarily reflected cash inflows from trading assets and liabilities, customer and other receivables and payables, net (reflecting both a decrease in customer and other receivables and an increase in customer and other payables), net earnings and loans held for sale, net, partially offset by cash outflows from collateralized transactions (reflecting both a decrease in collateralized financings and an increase in collateralized agreements). The decrease in cash and cash equivalents as a result of changes in foreign exchange rates was due to the U.S. dollar strengthening during the year. Such amount was $11.56 billion for 2022 ($3.42 billion for the three months ended March 2022, $10.34 billion for the six months ended June 2022 and $18.17 billion for the nine months ended September 2022).Year Ended December 2021. Our cash and cash equivalents increased by $105.19 billion to $261.04 billion at the end of 2021, primarily due to net cash provided by financing activities, partially offset by net cash used for investing activities. The net cash provided by financing activities primarily reflected an increase in net deposits (reflecting increases across channels) and net issuances of unsecured long-term borrowings. The net cash used for investing activities primarily reflected purchases of investments and an increase in net lending activities, partially offset by sales and paydowns of investments. For an analysis of cash flows for the year ended December 2020, see Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2021.100Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisMarket Risk Management Overview Market risk is the risk of an adverse impact to our earnings due to changes in market conditions. Our assets and liabilities that give rise to market risk primarily include positions held for market making for our clients and for our investing and financing activities, and these positions change based on client demands and our investment opportunities. We employ a variety of risk measures, each described in the respective sections below, to monitor market risk. Categories of market risk include the following: •Interest rate risk: results from exposures to changes in the level, slope and curvature of yield curves, the volatilities of interest rates, prepayment speeds and credit spreads;•Equity price risk: results from exposures to changes in prices and volatilities of individual equities, baskets of equities and equity indices; •Currency rate risk: results from exposures to changes in spot prices, forward prices and volatilities of currency rates; and •Commodity price risk: results from exposures to changes in spot prices, forward prices and volatilities of commodities, such as crude oil, petroleum products, natural gas, electricity, and precious and base metals. Market Risk, which is independent of our revenue-producing units and reports to our chief risk officer, has primary responsibility for assessing, monitoring and managing our market risk through firmwide oversight across our global businesses. Managers in revenue-producing units, Treasury and Market Risk discuss market information, positions and estimated loss scenarios on an ongoing basis. Managers in revenue-producing units and Treasury are accountable for managing risk within prescribed limits. These managers have in-depth knowledge of their positions, markets and the instruments available to hedge their exposures. Market Risk Management Process Our process for managing market risk includes the critical components of our risk management framework described in the “Overview and Structure of Risk Management,” as well as the following: •Monitoring compliance with established market risk limits and reporting our exposures; •Diversifying exposures; •Controlling position sizes; and •Evaluating mitigants, such as economic hedges in related securities or derivatives. Our market risk management systems enable us to perform an independent calculation of Value-at-Risk (VaR), Earnings-at-Risk (EaR) and other stress measures, capture risk measures at individual position levels, attribute risk measures to individual risk factors of each position, report many different views of the risk measures (e.g., by desk, business, product type or entity) and produce ad hoc analyses in a timely manner. Risk Measures We produce risk measures and monitor them against established market risk limits. These measures reflect an extensive range of scenarios and the results are aggregated at product, business and firmwide levels. We use a variety of risk measures to estimate the size of potential losses for both moderate and more extreme market moves over both short- and long-term time horizons. Our primary risk measures are VaR, EaR and other stress tests. Our risk reports detail key risks, drivers and changes for each desk and business, and are distributed daily to senior management of both our revenue-producing units and our independent risk oversight and control functions. Value-at-Risk. VaR is the potential loss in value due to adverse market movements over a defined time horizon with a specified confidence level. For assets and liabilities included in VaR, see “Financial Statement Linkages to Market Risk Measures.” We typically employ a one-day time horizon with a 95% confidence level. We use a single VaR model, which captures risks, including interest rates, equity prices, currency rates and commodity prices. As such, VaR facilitates comparison across portfolios of different risk characteristics. VaR also captures the diversification of aggregated risk at the firmwide level. Goldman Sachs 2022 Form 10-K101THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisWe are aware of the inherent limitations to VaR and therefore use a variety of risk measures in our market risk management process. Inherent limitations to VaR include: •VaR does not estimate potential losses over longer time horizons where moves may be extreme; •VaR does not take account of the relative liquidity of different risk positions; and •Previous moves in market risk factors may not produce accurate predictions of all future market moves. To comprehensively capture our exposures and relevant risks in our VaR calculation, we use historical simulations with full valuation of market factors at the position level by simultaneously shocking the relevant market factors for that position. These market factors include spot prices, credit spreads, funding spreads, yield curves, volatility and correlation, and are updated periodically based on changes in the composition of positions, as well as variations in market conditions. We sample from five years of historical data to generate the scenarios for our VaR calculation. The historical data is weighted so that the relative importance of the data reduces over time. This gives greater importance to more recent observations and reflects current asset volatilities, which improves the accuracy of our estimates of potential loss. As a result, even if our positions included in VaR were unchanged, our VaR would increase with increasing market volatility and vice versa. Given its reliance on historical data, VaR is most effective in estimating risk exposures in markets in which there are no sudden fundamental changes or shifts in market conditions. Our VaR measure does not include: •Positions that are not accounted for at fair value, such as held-to-maturity securities and loans, deposits and unsecured borrowings that are accounted for at amortized cost;•Available-for-sale securities for which the related unrealized fair value gains and losses are included in accumulated other comprehensive income/(loss);•Positions that are best measured and monitored using sensitivity measures; and •The impact of changes in counterparty and our own credit spreads on derivatives, as well as changes in our own credit spreads on financial liabilities for which the fair value option was elected. We perform daily backtesting of our VaR model (i.e., comparing daily net revenues for positions included in VaR to the VaR measure calculated as of the prior business day) at the firmwide level and for each of our businesses and major regulated subsidiaries. Earnings-at-Risk. Beginning in the fourth quarter of 2022, we started managing our interest rate risk using the EaR metric. EaR measures the estimated impact of changes in interest rates to our net revenues and preferred stock dividends over a defined time horizon. EaR complements the VaR metric, which measures the impact of interest rate changes that have an immediate impact on the fair values of our assets and liabilities (i.e., mark-to-market changes). Our exposure to interest rate risk occurs due to a variety of factors, including, but not limited to:•Differences in maturity or repricing dates of assets, liabilities, preferred stock and certain off-balance sheet instruments.•Differences in the amounts of assets, liabilities, preferred stock and certain off-balance sheet instruments with the same maturity or repricing dates. •Certain interest rate sensitive fees.Treasury manages the aggregated interest rate risk from all businesses through our investment securities portfolio and interest rate derivatives. We measure EaR over a one-year time horizon following a 100-basis point instantaneous parallel shock in both short- and long-term interest rates. This sensitivity is calculated relative to a baseline market scenario, which takes into consideration, among other things, the market’s expectation of forward rates, as well as our expectation of future business activity. This scenario includes contractual elements of assets, liabilities, preferred stock, and certain off-balance sheet instruments, such as rates of interest, principal repayment schedules, maturity and reset dates, and any interest rate ceilings or floors, as well as assumptions with respect to our balance sheet size and composition, deposit repricing and prepayment behavior. We manage EaR with a goal to reduce potential volatility resulting from changes in interest rates so it remains within our EaR risk appetite. Our EaR scenario is regularly evaluated and updated, if necessary, to reflect changes in our business plans, market conditions and other macroeconomic factors. While management uses the best information available to estimate EaR, actual results may differ materially as a result of, among other things, changes in the economic environment or assumptions used in the process.Risk, which is independent of our revenue-producing units, and Treasury, have primary responsibility for assessing and monitoring EaR through firmwide oversight, including oversight of EaR stress testing and assumptions, and the establishment of our EaR risk appetite.102Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisStress Testing. Stress testing is a method of determining the effect of various hypothetical stress scenarios. In addition to EaR, we use other stress tests to examine risks of specific portfolios, as well as the potential impact of our significant risk exposures. We use a variety of stress testing techniques to calculate the potential loss from a wide range of market moves on our portfolios, including firmwide stress tests, sensitivity analysis and scenario analysis. The results of our various stress tests are analyzed together for risk management purposes. See “Overview and Structure of Risk Management” for information about firmwide stress tests. Sensitivity analysis is used to quantify the impact of a market move in a single risk factor across all positions (e.g., equity prices or credit spreads) using a variety of defined market shocks, ranging from those that could be expected over a one-day time horizon up to those that could take many months to occur. We also use sensitivity analysis to quantify the impact of the default of any single entity, which captures the risk of large or concentrated exposures. Scenario analysis is used to quantify the impact of a specified event, including how the event impacts multiple risk factors simultaneously. For example, for sovereign stress testing we calculate potential direct exposure associated with our sovereign positions, as well as the corresponding debt, equity and currency exposures associated with our non-sovereign positions that may be impacted by the sovereign distress. When conducting scenario analysis, we often consider a number of possible outcomes for each scenario, ranging from moderate to severely adverse market impacts. In addition, these stress tests are constructed using both historical events and forward-looking hypothetical scenarios. Unlike VaR measures, which have an implied probability because they are calculated at a specified confidence level, there may not be an implied probability that our stress testing scenarios will occur. Instead, stress testing is used to model both moderate and more extreme moves in underlying market factors. When estimating potential loss, we generally assume that our positions cannot be reduced or hedged (although experience demonstrates that we are generally able to do so). Limits We use market risk limits at various levels to manage the size of our market exposures. These limits are set based on VaR, EaR and on a range of stress tests relevant to our exposures. See “Overview and Structure of Risk Management” for information about the limit approval process. Limits are monitored by Treasury and Risk. Risk is responsible for identifying and escalating to senior management and/or the appropriate risk committee, on a timely basis, instances where limits have been exceeded (e.g., due to positional changes or changes in market conditions, such as increased volatilities or changes in correlations). Such instances are remediated by a reduction in the positions we hold and/or a temporary or permanent increase to the limit, if warranted. Metrics We analyze VaR at the firmwide level and a variety of more detailed levels, including by risk category, business and region. Diversification effect in the tables below represents the difference between total VaR and the sum of the VaRs for the four risk categories. This effect arises because the four market risk categories are not perfectly correlated. The table below presents our average daily VaR. Year Ended December$ in millions20222021CategoriesInterest rates$97 $60 Equity prices33 43 Currency rates32 13 Commodity prices47 25 Diversification effect(95)(55)Total$114 $86 Our average daily VaR increased to $114 million in 2022 from $86 million in 2021, due to higher levels of volatility, partially offset by reduced exposures. The total increase was driven by increases in the interest rates, commodity prices and currency rates categories, partially offset by an increase in the diversification effect and a decrease in the equity prices category.The table below presents our period-end VaR. As of December$ in millions20222021CategoriesInterest rates$108 $69 Equity prices27 31 Currency rates35 19 Commodity prices18 30 Diversification effect(85)(58)Total$103 $91 Our period-end VaR increased to $103 million as of December 2022 from $91 million as of December 2021, due to higher levels of volatility, partially offset by reduced exposures. The total increase was primarily driven by increases in the interest rates and currency rates categories, partially offset by an increase in the diversification effect and a decrease in the commodity prices category.During 2022, the firmwide VaR risk limit was exceeded on six occasions (all of which occurred during March 2022) primarily due to higher levels of volatility generally resulting from broad macroeconomic and geopolitical concerns. These limit breaches were resolved by temporary increases in the firmwide VaR risk limit and subsequent risk reductions. During this period, the firmwide VaR risk limit was also permanently increased due to higher levels of volatility. During 2021, the firmwide VaR risk limit was not exceeded and there were no permanent or temporary changes to the firmwide VaR risk limit. Goldman Sachs 2022 Form 10-K103THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe table below presents our high and low VaR. Year Ended December20222021$ in millionsHighLowHighLowCategoriesInterest rates$139 $57 $74 $49 Equity prices$48 $25 $71 $30 Currency rates$55 $16 $20 $8 Commodity prices$82 $18 $45 $14 FirmwideVaR$158 $76 $105 $69 The chart below presents our daily VaR for 2022.The table below presents, by number of business days, the frequency distribution of our daily net revenues for positions included in VaR. Year Ended December$ in millions20222021>$1009253$75 – $1002545$50 – $752942$25 – $503333$0 – $253645$(25) – $01724$(50) – $(25)136$(75) – $(50)12$(100) – $(75)31<$(100)21Total251252Daily net revenues for positions included in VaR are compared with VaR calculated as of the end of the prior business day. Net losses incurred on a single day for such positions exceeded our 95% one-day VaR (i.e., a VaR exception) on two occasions during 2022 and on one occasion during 2021.During periods in which we have significantly more positive net revenue days than net revenue loss days, we expect to have fewer VaR exceptions because, under normal conditions, our business model generally produces positive net revenues. In periods in which our franchise revenues are adversely affected, we generally have more loss days, resulting in more VaR exceptions. The daily net revenues for positions included in VaR used to determine VaR exceptions reflect the impact of any intraday activity, including bid/offer net revenues, which are more likely than not to be positive by their nature. Sensitivity Measures Certain portfolios and individual positions are not included in VaR because VaR is not the most appropriate risk measure. Other sensitivity measures we use to analyze market risk are described below. 10% Sensitivity Measures. The table below presents our market risk by asset category for positions accounted for at fair value, that are not included in VaR. As of December$ in millions20222021Equity$1,621 $1,953 Debt1,9862,244Total$3,607 $4,197 In the table above: •The market risk of these positions is determined by estimating the potential reduction in net revenues of a 10% decline in the value of these positions. •Equity positions relate to private and restricted public equity securities, including interests in funds that invest in corporate equities and real estate and interests in hedge funds. •Debt positions include interests in funds that invest in corporate mezzanine and senior debt instruments, loans backed by commercial and residential real estate, corporate bank loans and other corporate debt, including acquired portfolios of distressed loans. •Funded equity and debt positions are included in our consolidated balance sheets in investments and loans. See Note 8 to the consolidated financial statements for further information about investments and Note 9 to the consolidated financial statements for further information about loans. •These measures do not reflect the diversification effect across asset categories or across other market risk measures. 104Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisCredit and Funding Spread Sensitivity on Derivatives and Financial Liabilities. VaR excludes the impact of changes in counterparty credit spreads, our own credit spreads and unsecured funding spreads on derivatives, as well as changes in our own credit spreads (debt valuation adjustment) on financial liabilities for which the fair value option was elected. The estimated sensitivity to a one basis point increase in credit spreads (counterparty and our own) and unsecured funding spreads on derivatives (including hedges) was a loss of $1 million as of both December 2022 and December 2021. In addition, the estimated sensitivity to a one basis point increase in our own credit spreads on financial liabilities for which the fair value option was elected was a gain of $37 million as of December 2022 and $33 million as of December 2021. However, the actual net impact of a change in our own credit spreads is also affected by the liquidity, duration and convexity (as the sensitivity is not linear to changes in yields) of those financial liabilities for which the fair value option was elected, as well as the relative performance of any hedges undertaken. Earnings-at-Risk. The table below presents the impact of a parallel shift in rates on our net revenues and preferred stock dividends over the next 12 months relative to the baseline scenario. As of December$ in millions20222021+100 basis points parallel shift in rates$104 $782 -100 basis points parallel shift in rates$(104)N.M.In the table above:•The EaR metric utilized various assumptions, including, among other things, balance sheet size and composition, deposit repricing and prepayment behavior, all of which have inherent uncertainties. The EaR metric does not represent a forecast of our net revenues and preferred stock dividends. •The change in our sensitivities as of December 2022 compared to December 2021 primarily reflects the impact of changes in our investment securities portfolio and interest rate derivatives.•The -100 basis points parallel shift in rates scenario was not meaningful as of December 2021 given the low interest rate environment.Other Market Risk Considerations We make investments in securities that are accounted for as available-for-sale, held-to-maturity or under the equity method which are included in investments in the consolidated balance sheets. See Note 8 to the consolidated financial statements for further information. Direct investments in real estate are accounted for at cost less accumulated depreciation. See Note 12 to the consolidated financial statements for further information about other assets. Financial Statement Linkages to Market Risk Measures We employ a variety of risk measures, each described in the respective sections above, to monitor market risk across the consolidated balance sheets and consolidated statements of earnings. The related gains and losses on these positions are included in market making, other principal transactions, interest income and interest expense in the consolidated statements of earnings, and debt valuation adjustment and unrealized gains/(losses) on available-for-sale securities in the consolidated statements of comprehensive income. The table below presents certain assets and liabilities accounted for at fair value in our consolidated balance sheets and the market risk measures used to assess those assets and liabilities. Assets or LiabilitiesMarket Risk MeasuresCollateralized agreements and financingsVaRCustomer and other receivables10% Sensitivity MeasuresTrading assets and liabilitiesVaR Credit Spread SensitivityInvestmentsVaR10% Sensitivity MeasuresLoansVaR10% Sensitivity MeasuresOther assets and liabilitiesVaRDepositsVaRCredit Spread SensitivityUnsecured borrowingsVaRCredit Spread SensitivityIn addition to the above, we measure the interest rate risk for all positions within our consolidated balance sheets using the EaR metric. Goldman Sachs 2022 Form 10-K105THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisCredit Risk Management Overview Credit risk represents the potential for loss due to the default or deterioration in credit quality of a counterparty (e.g., an OTC derivatives counterparty or a borrower) or an issuer of securities or other instruments we hold. Our exposure to credit risk comes mostly from client transactions in OTC derivatives and loans and lending commitments. Credit risk also comes from cash placed with banks, securities financing transactions (i.e., resale and repurchase agreements and securities borrowing and lending activities) and customer and other receivables. Credit Risk, which is independent of our revenue-producing units and reports to our chief risk officer, has primary responsibility for assessing, monitoring and managing our credit risk through firmwide oversight across our global businesses. In addition, we hold other positions that give rise to credit risk (e.g., bonds and secondary bank loans). These credit risks are captured as a component of market risk measures, which are monitored and managed by Market Risk. We also enter into derivatives to manage market risk exposures. Such derivatives also give rise to credit risk, which is monitored and managed by Credit Risk. Credit Risk Management Process Our process for managing credit risk includes the critical components of our risk management framework described in the “Overview and Structure of Risk Management,” as well as the following: •Monitoring compliance with established credit risk limits and reporting our credit exposures and credit concentrations; •Establishing or approving underwriting standards; •Assessing the likelihood that a counterparty will default on its payment obligations; •Measuring our current and potential credit exposure and losses resulting from a counterparty default; •Using credit risk mitigants, including collateral and hedging; and •Maximizing recovery through active workout and restructuring of claims. We also perform credit analyses, which incorporate initial and ongoing evaluations of the capacity and willingness of a counterparty to meet its financial obligations. For substantially all of our credit exposures, the core of our process is an annual counterparty credit evaluation or more frequently if deemed necessary as a result of events or changes in circumstances. We determine an internal credit rating for the counterparty by considering the results of the credit evaluations and assumptions with respect to the nature of and outlook for the counterparty’s industry and the economic environment. The internal credit rating does not take into consideration collateral received or other credit support arrangements. Senior personnel, with expertise in specific industries, inspect and approve credit reviews and internal credit ratings. Our risk assessment process may also include, where applicable, reviewing certain key metrics, including, but not limited to, delinquency status, collateral value, FICO credit scores and other risk factors. Our credit risk management systems capture credit exposure to individual counterparties and on an aggregate basis to counterparties and their subsidiaries. These systems also provide management with comprehensive information about our aggregate credit risk by product, internal credit rating, industry, country and region. Risk Measures We measure our credit risk based on the potential loss in the event of non-payment by a counterparty using current and potential exposure. For derivatives and securities financing transactions, current exposure represents the amount presently owed to us after taking into account applicable netting and collateral arrangements, while potential exposure represents our estimate of the future exposure that could arise over the life of a transaction based on market movements within a specified confidence level. Potential exposure also takes into account netting and collateral arrangements. For loans and lending commitments, the primary measure is a function of the notional amount of the position. 106Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisStress Tests We conduct regular stress tests to calculate the credit exposures, including potential concentrations that would result from applying shocks to counterparty credit ratings or credit risk factors (e.g., currency rates, interest rates, equity prices). These shocks cover a wide range of moderate and more extreme market movements, including shocks to multiple risk factors, consistent with the occurrence of a severe market or economic event. In the case of sovereign default, we estimate the direct impact of the default on our sovereign credit exposures, changes to our credit exposures arising from potential market moves in response to the default, and the impact of credit market deterioration on corporate borrowers and counterparties that may result from the sovereign default. Unlike potential exposure, which is calculated within a specified confidence level, stress testing does not generally assume a probability of these events occurring. We also perform firmwide stress tests. See “Overview and Structure of Risk Management” for information about firmwide stress tests. To supplement these regular stress tests, as described above, we also conduct tailored stress tests on an ad hoc basis in response to specific market events that we deem significant. We also utilize these stress tests to estimate the indirect impact of certain hypothetical events on our country exposures, such as the impact of credit market deterioration on corporate borrowers and counterparties along with the shocks to the risk factors described above. The parameters of these shocks vary based on the scenario reflected in each stress test. We review estimated losses produced by the stress tests in order to understand their magnitude, highlight potential loss concentrations, and assess and mitigate our exposures where necessary. Limits We use credit risk limits at various levels, as well as underwriting standards to manage the size and nature of our credit exposures. Limits for industries and countries are based on our risk appetite and are designed to allow for regular monitoring, review, escalation and management of credit risk concentrations. See “Overview and Structure of Risk Management” for information about the limit approval process. Credit Risk is responsible for monitoring these limits, and identifying and escalating to senior management and/or the appropriate risk committee, on a timely basis, instances where limits have been exceeded. Risk Mitigants To reduce our credit exposures on derivatives and securities financing transactions, we may enter into netting agreements with counterparties that permit us to offset receivables and payables with such counterparties. We may also reduce credit risk with counterparties by entering into agreements that enable us to obtain collateral from them on an upfront or contingent basis and/or to terminate transactions if the counterparty’s credit rating falls below a specified level. We monitor the fair value of the collateral to ensure that our credit exposures are appropriately collateralized. We seek to minimize exposures where there is a significant positive correlation between the creditworthiness of our counterparties and the market value of collateral we receive. For loans and lending commitments, depending on the credit quality of the borrower and other characteristics of the transaction, we employ a variety of potential risk mitigants. Risk mitigants include collateral provisions, guarantees, covenants, structural seniority of the bank loan claims and, for certain lending commitments, provisions in the legal documentation that allow us to adjust loan amounts, pricing, structure and other terms as market conditions change. The type and structure of risk mitigants employed can significantly influence the degree of credit risk involved in a loan or lending commitment. When we do not have sufficient visibility into a counterparty’s financial strength or when we believe a counterparty requires support from its parent, we may obtain third-party guarantees of the counterparty’s obligations. We may also mitigate our credit risk using credit derivatives or participation agreements. Goldman Sachs 2022 Form 10-K107THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisCredit Exposures As of December 2022, our aggregate credit exposure decreased compared with December 2021, primarily reflecting decreases in receivables from clearing organizations and cash deposits with central banks, partially offset by an increase in loans and lending commitments. The percentage of our credit exposures arising from non-investment-grade counterparties (based on our internally determined public rating agency equivalents) decreased compared with December 2021, primarily reflecting a decrease in non-investment-grade loans and lending commitments. Our credit exposures are described further below. Cash and Cash Equivalents. Our credit exposure on cash and cash equivalents arises from our unrestricted cash, and includes both interest-bearing and non-interest-bearing deposits. To mitigate the risk of credit loss, we place substantially all of our deposits with highly rated banks and central banks. The table below presents our credit exposure from unrestricted cash and cash equivalents, and the concentration by industry, region and internally determined public rating agency equivalents. As of December$ in millions20222021Cash and Cash Equivalents$224,889 $236,168 IndustryFinancial Institutions6 %5 %Sovereign94 %95 %Total100 %100 %RegionAmericas77 %55 %EMEA19 %36 %Asia4 %9 %Total100 %100 %Credit Quality (Credit Rating Equivalent)AAA89 %64 %AA5 %24 %A6 %11 %BBB–1 %Total100 %100 %The table above excludes cash segregated for regulatory and other purposes of $16.94 billion as of December 2022 and $24.87 billion as of December 2021. OTC Derivatives. Our credit exposure on OTC derivatives arises primarily from our market-making activities. As a market maker, we enter into derivative transactions to provide liquidity to clients and to facilitate the transfer and hedging of their risks. We also enter into derivatives to manage market risk exposures. We manage our credit exposure on OTC derivatives using the credit risk process, measures, limits and risk mitigants described above. We generally enter into OTC derivatives transactions under bilateral collateral arrangements that require the daily exchange of collateral. As credit risk is an essential component of fair value, we include a credit valuation adjustment (CVA) in the fair value of derivatives to reflect counterparty credit risk, as described in Note 7 to the consolidated financial statements. CVA is a function of the present value of expected exposure, the probability of counterparty default and the assumed recovery upon default. The table below presents our net credit exposure from OTC derivatives and the concentration by industry and region. As of December$ in millions20222021OTC derivative assets$53,399 $58,637 Collateral (not netted under U.S. GAAP)(15,823)(17,245)Net credit exposure$37,576 $41,392 IndustryConsumer & Retail3 %2 %Diversified Industrials8 %10 %Financial Institutions20 %15 %Funds19 %13 %Healthcare1 %1 %Municipalities & Nonprofit2 %5 %Natural Resources & Utilities34 %33 %Sovereign7 %8 %Technology, Media & Telecommunications4 %8 %Other (including Special Purpose Vehicles)2 %5 %Total100 %100 %RegionAmericas49 %53 %EMEA43 %37 %Asia8 %10 %Total100 %100 %Our credit exposure (before any potential recoveries) to OTC derivative counterparties that defaulted during 2022 remained low, representing less than 2% of our total credit exposure from OTC derivatives. In the table above: •OTC derivative assets, included in the consolidated balance sheets, are reported on a net-by-counterparty basis (i.e., the net receivable for a given counterparty) when a legal right of setoff exists under an enforceable netting agreement (counterparty netting) and are accounted for at fair value, net of cash collateral received under enforceable credit support agreements (cash collateral netting). •Collateral represents cash collateral and the fair value of securities collateral, primarily U.S. and non-U.S. government and agency obligations, received under credit support agreements, that we consider when determining credit risk, but such collateral is not eligible for netting under U.S. GAAP. 108Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisThe table below presents the distribution of our net credit exposure from OTC derivatives by tenor. $ in millionsInvestment-GradeNon-Investment-Grade / UnratedTotalAs of December 2022Less than 1 year$23,112 $8,812 $31,924 1 – 5 years26,627 8,355 34,982 Greater than 5 years58,354 4,342 62,696 Total108,093 21,509 129,602 Netting(83,531)(8,495)(92,026)Net credit exposure$24,562 $13,014 $37,576 As of December 2021Less than 1 year$27,668 $11,203 $38,871 1 – 5 years21,746 9,515 31,261 Greater than 5 years64,670 6,590 71,260 Total114,084 27,308 141,392 Netting(89,244)(10,756)(100,000)Net credit exposure$24,840 $16,552 $41,392 In the table above: •Tenor is based on remaining contractual maturity. •Netting includes counterparty netting across tenor categories and collateral that we consider when determining credit risk (including collateral that is not eligible for netting under U.S. GAAP). Counterparty netting within the same tenor category is included within such tenor category. The tables below present the distribution of our net credit exposure from OTC derivatives by tenor and internally determined public rating agency equivalents. Investment-Grade$ in millionsAAAAAABBBTotalAs of December 2022Less than 1 year$521 $2,113 $10,516 $9,962 $23,112 1 – 5 years1,684 5,383 9,057 10,503 26,627 Greater than 5 years5,594 16,063 21,060 15,637 58,354 Total7,799 23,559 40,633 36,102 108,093 Netting(5,025)(20,582)(31,956)(25,968)(83,531)Net credit exposure$2,774 $2,977 $8,677 $10,134 $24,562 As of December 2021Less than 1 year$1,017 $4,926 $12,481 $9,244 $27,668 1 – 5 years1,150 3,071 8,298 9,227 21,746 Greater than 5 years13,777 5,421 23,867 21,605 64,670 Total15,944 13,418 44,646 40,076 114,084 Netting(13,535)(9,501)(36,005)(30,203)(89,244)Net credit exposure$2,409 $3,917 $8,641 $9,873 $24,840 Non-Investment-Grade / Unrated$ in millionsBB or lower UnratedTotalAs of December 2022Less than 1 year$8,245 $567 $8,812 1 – 5 years8,150 205 8,355 Greater than 5 years4,232 110 4,342 Total20,627 882 21,509 Netting(8,436)(59)(8,495)Net credit exposure$12,191 $823 $13,014 As of December 2021Less than 1 year$10,446 $757 $11,203 1 – 5 years9,210 305 9,515 Greater than 5 years6,320 270 6,590 Total25,976 1,332 27,308 Netting(10,683)(73)(10,756)Net credit exposure$15,293 $1,259 $16,552 Lending Activities. We manage our lending activities using the credit risk process, measures, limits and risk mitigants described above. Other lending positions, including secondary trading positions, are risk-managed as a component of market risk. In the fourth quarter of 2022, we changed the classification of our lending portfolio to better reflect the nature of the underlying collateral. Loans and lending commitments types in the table below include the addition of securities-based and other collateralized, as well as the removal of wealth management. This also resulted in reclassifications of certain loans and lending commitments in corporate and other to other collateralized. Prior periods have been conformed to the current presentation.The table below presents our loans and lending commitments. $ in millionsLoansLendingCommitmentsTotalAs of December 2022Corporate$40,135 $139,718 $179,853 Commercial real estate28,879 4,271 33,150 Residential real estate23,035 3,192 26,227 Securities-based16,671 508 17,179 Other collateralized51,702 14,407 66,109 Consumer:Installment6,326 1,882 8,208 Credit cards15,820 62,216 78,036 Other2,261 944 3,205 Total$184,829 $227,138 $411,967 Allowance for loan losses$(5,543)$(774)$(6,317)As of December 2021Corporate$37,643 $146,694 $184,337 Commercial real estate29,000 6,736 35,736 Residential real estate24,674 4,031 28,705 Securities-based16,652 454 17,106 Other collateralized38,263 17,253 55,516 Consumer:Installment3,672 9 3,681 Credit cards8,212 35,932 44,144 Other4,019 443 4,462 Total$162,135 $211,552 $373,687 Allowance for loan losses$(3,573)$(776)$(4,349)In the table above, lending commitments excluded $4.85 billion as of December 2022 and $4.14 billion as of December 2021 relating to issued letters of credit which are classified as guarantees in our consolidated financial statements. See Note 18 to the consolidated financial statements for further information about guarantees. See Note 9 to the consolidated financial statements for information about net charge-offs on wholesale and consumer loans, as well as past due and nonaccrual loans accounted for at amortized cost.Goldman Sachs 2022 Form 10-K109THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisCorporate. Corporate loans and lending commitments include term loans, revolving lines of credit, letter of credit facilities and bridge loans, and are principally used for operating and general corporate purposes, or in connection with acquisitions. Corporate loans are secured (typically by a senior lien on the assets of the borrower) or unsecured, depending on the loan purpose, the risk profile of the borrower and other factors. The table below presents our credit exposure from corporate loans and lending commitments, and the concentration by industry, region, internally determined public rating agency equivalents and other credit metrics. $ in millionsLoansLendingCommitmentsTotalAs of December 2022Corporate$40,135 $139,718 $179,853 IndustryConsumer & Retail10 %13 %12 %Diversified Industrials18 %18 %18 %Financial Institutions7 %8 %8 %Funds3 %4 %4 %Healthcare10 %12 %12 %Natural Resources & Utilities9 %18 %16 %Real Estate11 %5 %7 %Technology, Media & Telecommunications26 %20 %21 %Other (including Special Purpose Vehicles)6 %2 %2 %Total100 %100 %100 %RegionAmericas57 %77 %73 %EMEA34 %21 %24 %Asia9 %2 %3 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)AAA–2 %1 %AA1 %5 %4 %A5 %21 %18 %BBB19 %38 %34 %BB or lower75 %34 %43 %Total100 %100 %100 %As of December 2021Corporate$37,643 $146,694 $184,337 IndustryConsumer & Retail11 %14 %13 %Diversified Industrials17 %17 %17 %Financial Institutions7 %7 %7 %Funds2 %3 %3 %Healthcare10 %10 %10 %Natural Resources & Utilities13 %17 %16 %Real Estate10 %5 %6 %Technology, Media & Telecommunications24 %25 %25 %Other (including Special Purpose Vehicles)6 %2 %3 %Total100 %100 %100 %RegionAmericas52 %76 %71 %EMEA38 %21 %25 %Asia10 %3 %4 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)AAA–1 %1 %AA1 %5 %4 %A6 %17 %14 %BBB15 %37 %33 %BB or lower78 %40 %48 %Total100 %100 %100 %Commercial Real Estate. Commercial real estate includes originated loans and lending commitments that are directly or indirectly secured by hotels, retail stores, multifamily housing complexes and commercial and industrial properties. Commercial real estate also includes loans and lending commitments extended to clients who warehouse assets that are directly or indirectly backed by commercial real estate. In addition, commercial real estate includes loans purchased by us. The table below presents our credit exposure from commercial real estate loans and lending commitments, and the concentration by region, internally determined public rating agency equivalents and other credit metrics. $ in millionsLoansLendingCommitmentsTotalAs of December 2022Commercial Real Estate$28,879 $4,271 $33,150 RegionAmericas79 %74 %78 %EMEA16 %17 %16 %Asia5 %9 %6 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)Investment-grade18 %27 %19 %Non-investment-grade82 %72 %80 %Unrated–1 %1 %Total100 %100 %100 %As of December 2021Commercial Real Estate$29,000 $6,736 $35,736 RegionAmericas82 %78 %81 %EMEA13 %10 %13 %Asia5 %12 %6 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)Investment-grade22 %20 %21 %Non-investment-grade77 %80 %78 %Unrated1 %–1 %Total100 %100 %100 %In the table above, credit exposure includes loans and lending commitments of $10.28 billion as of December 2022 and $11.65 billion as of December 2021 which are extended to clients who warehouse assets that are directly or indirectly backed by commercial real estate. In addition, we also have credit exposure to commercial real estate loans held for securitization of $119 million as of December 2022 and $922 million as of December 2021. Such loans are included in trading assets in our consolidated balance sheets. 110Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisResidential Real Estate. Residential real estate loans and lending commitments are primarily extended to wealth management clients and to clients who warehouse assets that are directly or indirectly secured by residential real estate. In addition, residential real estate includes loans purchased by us. The table below presents our credit exposure from residential real estate loans and lending commitments, and the concentration by region, internally determined public rating agency equivalents and other credit metrics. $ in millionsLoansLendingCommitmentsTotalAs of December 2022Residential Real Estate$23,035 $3,192 $26,227 RegionAmericas96 %93 %95 %EMEA3 %7 %4 %Asia1 %–1 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)Investment-grade16 %8 %15 %Non-investment-grade61 %91 %64 %Other metrics23 %1 %21 %Total100 %100 %100 %As of December 2021Residential Real Estate$24,674 $4,031 $28,705 RegionAmericas96 %82 %94 %EMEA2 %16 %4 %Asia2 %2 %2 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)Investment-grade13 %21 %14 %Non-investment-grade65 %70 %66 %Other metrics21 %9 %19 %Unrated1 %–1 %Total100 %100 %100 %In the table above:•Credit exposure includes loans and lending commitments of $14.62 billion as of December 2022 and $16.89 billion as of December 2021 which are extended to clients who warehouse assets that are directly or indirectly secured by residential real estate. •Other metrics category consists of loans where we use other key metrics to assess the borrower's credit quality, such as loan-to-value ratio, delinquency status, collateral value, expected cash flows and other risk factors. In addition, we also have credit exposure to residential real estate loans held for securitization of $8.07 billion as of December 2022 and $11.57 billion as of December 2021. Such loans are included in trading assets in our consolidated balance sheets. Securities-Based. Securities-based includes loans and lending commitments that are secured by stocks, bonds, mutual funds, and exchange-traded funds. These loans and commitments are primarily extended to our wealth management clients and used for purposes other than purchasing, carrying or trading margin stocks. Securities-based loans require borrowers to post additional collateral based on changes in the underlying collateral's fair value. The table below presents our credit exposure from securities-based loans and lending commitments, and the concentration by region, internally determined public rating agency equivalents and other credit metrics. $ in millionsLoansLendingCommitmentsTotalAs of December 2022Securities-based$16,671 $508 $17,179 RegionAmericas83 %98 %83 %EMEA15 %2 %15 %Asia2 %–2 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)Investment-grade77 %18 %76 %Non-investment-grade5 %2 %4 %Other metrics18 %80 %20 %Total100 %100 %100 %As of December 2021Securities-based$16,652 $454 $17,106 RegionAmericas77 %100 %78 %EMEA16 %–15 %Asia7 %–7 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)Investment-grade83 %46 %82 %Non-investment-grade3 %–3 %Other metrics14 %54 %15 %Total100 %100 %100 %In the table above, other metrics category consists of loans where we use other key metrics to assess the borrower's credit quality, such as collateral value, loan-to-value ratio and delinquency status.Goldman Sachs 2022 Form 10-K111THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisOther Collateralized. Other collateralized includes loans and lending commitments that are backed by specific collateral (other than securities and real estate). Such loans and lending commitments are extended to clients who warehouse assets that are directly or indirectly secured by corporate loans, consumer loans and other assets. Other collateralized also includes loans and lending commitments to investment funds (managed by third parties) that are collateralized by capital commitments of the funds' investors or assets held by the fund, as well as other secured loans and lending commitments extended to our wealth management clients.The table below presents our credit exposure from other collateralized loans and lending commitments, and the concentration by region, internally determined public rating agency equivalents and other credit metrics. $ in millionsLoansLendingCommitmentsTotalAs of December 2022Other Collateralized$51,702 $14,407 $66,109 RegionAmericas86 %93 %87 %EMEA12 %7 %11 %Asia2 %–2 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)Investment-grade64 %66 %65 %Non-investment-grade35 %31 %34 %Other metrics1 %––Unrated–3 %1 %Total100 %100 %100 %As of December 2021Other Collateralized$38,263 $17,253 $55,516 RegionAmericas74 %92 %79 %EMEA23 %7 %18 %Asia3 %1 %3 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)Investment-grade58 %69 %62 %Non-investment-grade41 %30 %38 %Other metrics1 %––Unrated–1 %–Total100 %100 %100 %In the table above, credit exposure included loans and lending commitments extended to clients who warehouse assets of $16.89 billion as of December 2022 and $13.73 billion as of December 2021.Installment and Credit Cards. We originate unsecured installment loans (including point-of-sale loans that we began to originate through the GreenSky platform in the third quarter of 2022) and credit card loans (pursuant to revolving lines of credit) to consumers in the Americas. The credit card lines are cancellable by us and therefore do not result in credit exposure. The tables below present our credit exposure from originated installment and credit card funded loans, and the concentration by the five most concentrated U.S. states. $ in millionsInstallmentAs of December 2022Loans, gross$6,326 California10 %Texas9 %Florida7 %New York6 %Illinois4 %Other64 %Total100 %As of December 2021Loans, gross$3,672 California11 %Texas9 %Florida7 %New York7 %Illinois4 %Other62 %Total100 %$ in millionsCredit CardsAs of December 2022Loans, gross$15,820 California16 %Texas9 %New York8 %Florida8 %Illinois4 %Other55 %Total100 %As of December 2021Loans, gross$8,212 California18 %Texas9 %New York8 %Florida8 %New Jersey4 %Other53 %Total100 %In addition, we had credit exposure of $1.88 billion as of December 2022 and $9 million as of December 2021 related to our commitments to provide unsecured installment loans to consumers. See Note 9 to the consolidated financial statements for further information about the credit quality indicators of installment and credit card loans. 112Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisOther. Other includes unsecured loans extended to wealth management clients and unsecured consumer and credit card loans purchased by us. The table below presents our credit exposure from other loans and lending commitments, and the concentration by region, internally determined public rating agency equivalents and other credit metrics. $ in millionsLoansLendingCommitmentsTotalAs of December 2022Other$2,261 $944 $3,205 RegionAmericas89 %99 %92 %EMEA11 %1 %8 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)Investment-grade47 %93 %60 %Non-investment-grade26 %7 %21 %Other metrics27 %–19 %Total100 %100 %100 %As of December 2021Other$4,019 $443 $4,462 RegionAmericas89 %100 %90 %EMEA11 %–10 %Total100 %100 %100 %Credit Quality (Credit Rating Equivalent)Investment-grade24 %78 %29 %Non-investment-grade23 %14 %22 %Other metrics51 %–46 %Unrated2 %8 %3 %Total100 %100 %100 %In the table above, other metrics primarily includes consumer and credit card loans purchased by us. Our risk assessment process for such loans includes reviewing certain key metrics, such as expected cash flows, delinquency status and other risk factors. In addition, we also have credit exposure to other loans held for securitization of $1.76 billion as of December 2022 and $467 million as of December 2021. Such loans are included in trading assets in our consolidated balance sheets. Credit Hedges. To mitigate the credit risk associated with our lending activities, we obtain credit protection on certain loans and lending commitments through credit default swaps, both single-name and index-based contracts, and through the issuance of credit-linked notes. Securities Financing Transactions. We enter into securities financing transactions in order to, among other things, facilitate client activities, invest excess cash, acquire securities to cover short positions and finance certain activities. We bear credit risk related to resale agreements and securities borrowed only to the extent that cash advanced or the value of securities pledged or delivered to the counterparty exceeds the value of the collateral received. We also have credit exposure on repurchase agreements and securities loaned to the extent that the value of securities pledged or delivered to the counterparty for these transactions exceeds the amount of cash or collateral received. Securities collateral for these transactions primarily includes U.S. and non-U.S. government and agency obligations. The table below presents our credit exposure from securities financing transactions and the concentration by industry, region and internally determined public rating agency equivalents. As of December$ in millions20222021Securities Financing Transactions$34,762 $34,505 IndustryFinancial Institutions43 %34 %Funds23 %23 %Municipalities & Nonprofit5 %5 %Sovereign28 %35 %Other (including Special Purpose Vehicles)1 %3 %Total100 %100 %RegionAmericas47 %36 %EMEA34 %44 %Asia19 %20 %Total100 %100 %Credit Quality (Credit Rating Equivalent)AAA20 %19 %AA31 %28 %A31 %33 %BBB8 %9 %BB or lower10 %11 %Total100 %100 %The table above reflects both netting agreements and collateral that we consider when determining credit risk. Goldman Sachs 2022 Form 10-K113THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisOther Credit Exposures. We are exposed to credit risk from our receivables from brokers, dealers and clearing organizations and customers and counterparties. Receivables from brokers, dealers and clearing organizations primarily consist of initial margin placed with clearing organizations and receivables related to sales of securities which have traded, but not yet settled. These receivables generally have minimal credit risk due to the low probability of clearing organization default and the short-term nature of receivables related to securities settlements. Receivables from customers and counterparties generally consist of collateralized receivables related to customer securities transactions and generally have minimal credit risk due to both the value of the collateral received and the short-term nature of these receivables. The table below presents our other credit exposures and the concentration by industry, region and internally determined public rating agency equivalents. As of December$ in millions20222021Other Credit Exposures$48,916 $61,187 IndustryFinancial Institutions80 %86 %Funds12 %9 %Other (including Special Purpose Vehicles)8 %5 %Total100 %100 %RegionAmericas41 %50 %EMEA49 %43 %Asia10 %7 %Total100 %100 %Credit Quality (Credit Rating Equivalent)AAA7 %4 %AA32 %47 %A33 %29 %BBB10 %6 %BB or lower16 %13 %Unrated2 %1 %Total100 %100 %The table above reflects collateral that we consider when determining credit risk. Selected Exposures We have credit and market exposures, as described below, that have had heightened focus given recent events and broad market concerns. Credit exposure represents the potential for loss due to the default or deterioration in credit quality of a counterparty or borrower. Market exposure represents the potential for loss in value of our long and short positions due to changes in market prices. Country Exposures. The Russian invasion of Ukraine continues to negatively affect the global economy and has resulted in significant disruptions in financial markets and increased macroeconomic uncertainty. Governments around the world have responded to Russia’s invasion by imposing economic sanctions and export controls on specific industry sectors, companies and individuals in Russia. Retaliatory restrictions against investors, non-Russian owned businesses and other sovereign states have been implemented by Russia. Businesses in the U.S. and globally continue to experience shortages in materials and increased costs for transportation, energy and raw materials due, in part, to the negative effects of the war on the global economy. The escalation or continuation of the war between Russia and Ukraine presents heightened risks relating to cyber attacks, limited ability to settle securities transactions, third-party and agent bank dependencies, supply chain disruptions, and inflation, as well as the potential for increased volatility in commodity, currency and other financial markets. Complying with economic sanctions and restrictions imposed by governments has resulted in increased operational risk. The extent and duration of the war, sanctions and resulting market disruptions, as well as the potential adverse consequences for our business, liquidity and results of operations, are difficult to predict. Our senior management, risk committees and the Board receive regular briefings from our independent risk oversight and control functions, including our chief risk officer, on Russian and Ukrainian exposures, as well as other relevant risk metrics. We have significantly reduced our exposure to Russia and Ukraine and have curtailed our operations in Russia to those necessary to meet our legal and regulatory obligations. The overall direct financial impact to our net revenues for 2022 from Russian and Ukrainian counterparties, borrowers, issuers and related instruments was not material. We have established a firmwide working group to identify and assess the operational risk associated with complying with economic sanctions and restrictions as a result of this invasion. In addition, to mitigate the risk of increased cyber attacks, we liaise with government agencies in order to update our monitoring processes with the latest information. Our total credit exposure to Russian or Ukrainian counterparties or borrowers and our total market exposure relating to Russian or Ukrainian issuers was not material as of December 2022. In addition, economic and/or political uncertainties in Argentina, Ethiopia, Ghana, Lebanon, Pakistan, Sri Lanka and Venezuela have led to concerns about their financial stability. Our credit exposure to counterparties or borrowers and our market exposure to issuers relating to each of these countries was not material as of December 2022. 114Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisWe have a comprehensive framework to monitor, measure and assess our country exposures and to determine our risk appetite. We determine the country of risk by the location of the counterparty, issuer’s assets, where they generate revenue, the country in which they are headquartered, the jurisdiction where a claim against them could be enforced, and/or the government whose policies affect their ability to repay their obligations. We monitor our credit exposure to a specific country both at the individual counterparty level, as well as at the aggregate country level. See “Stress Tests” for information about stress tests that are designed to estimate the direct and indirect impact of events involving the above countries. Operational Risk Management Overview Operational risk is the risk of an adverse outcome resulting from inadequate or failed internal processes, people, systems or from external events. Our exposure to operational risk arises from routine processing errors, as well as extraordinary incidents, such as major systems failures or legal and regulatory matters. Potential types of loss events related to internal and external operational risk include: •Execution, delivery and process management; •Business disruption and system failures; •Employment practices and workplace safety; •Clients, products and business practices; •Damage to physical assets; •Internal fraud; and •External fraud. Operational Risk, which is independent of our revenue-producing units and reports to our chief risk officer, has primary responsibility for developing and implementing a formalized framework for assessing, monitoring and managing operational risk with the goal of maintaining our exposure to operational risk at levels that are within our risk appetite. Operational Risk Management Process Our process for managing operational risk includes the critical components of our risk management framework described in the “Overview and Structure of Risk Management,” including a comprehensive data collection process, as well as firmwide policies and procedures, for operational risk events. We combine top-down and bottom-up approaches to manage and measure operational risk. From a top-down perspective, our senior management assesses firmwide and business-level operational risk profiles. From a bottom-up perspective, our first and second lines of defense are responsible for risk identification and risk management on a day-to-day basis, including escalating operational risks and risk events to senior management. We maintain a comprehensive control framework designed to provide a well-controlled environment to minimize operational risks. The Firmwide Operational Risk and Resilience Committee is responsible for overseeing operational risk, and for ensuring operational resilience of our business. Our operational risk management framework is designed to comply with the operational risk measurement rules under the Capital Framework and has evolved based on the changing needs of our businesses and regulatory guidance. We have established policies that require all employees and consultants to report and escalate operational risk events. When operational risk events are identified, our policies require that the events be documented and analyzed to determine whether changes are required in our systems and/or processes to further mitigate the risk of future events. We use operational risk management applications to capture, analyze, aggregate and report operational risk event data and key metrics. One of our key risk identification and control assessment tools is an operational risk and control self-assessment process, which is performed by our managers. This process consists of the identification and rating of operational risks, on a forward-looking basis, and the related controls. The results from this process are analyzed to evaluate operational risk exposures and identify businesses, activities or products with heightened levels of operational risk. Goldman Sachs 2022 Form 10-K115THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisRisk Measurement We measure our operational risk exposure using both statistical modeling and scenario analyses, which involve qualitative and quantitative assessments of internal and external operational risk event data and internal control factors for each of our businesses. Operational risk measurement also incorporates an assessment of business environment factors, including: •Evaluations of the complexity of our business activities; •The degree of automation in our processes; •New activity information; •The legal and regulatory environment; and •Changes in the markets for our products and services, including the diversity and sophistication of our customers and counterparties. The results from these scenario analyses are used to monitor changes in operational risk and to determine business lines that may have heightened exposure to operational risk. These analyses are used in the determination of the appropriate level of operational risk capital to hold. We also perform firmwide stress tests. See “Overview and Structure of Risk Management” for information about firmwide stress tests. Types of Operational Risks Increased reliance on technology and third-party relationships has resulted in increased operational risks, such as information and cybersecurity risk, third-party risk and business resilience risk. We manage those risks as follows: Information and Cybersecurity Risk. Information and cybersecurity risk is the risk of compromising the confidentiality, integrity or availability of our data and systems, leading to an adverse impact to us, our reputation, our clients and/or the broader financial system. We seek to minimize the occurrence and impact of unauthorized access, disruption or use of information and/or information systems. We deploy and operate preventive and detective controls and processes to mitigate emerging and evolving information security and cybersecurity threats, including monitoring our network for known vulnerabilities and signs of unauthorized attempts to access our data and systems. There is increased information risk through diversification of our data across external service providers, including use of a variety of cloud-provided or -hosted services and applications. See “Risk Factors” in Part I, Item 1A of this Form 10-K for further information about information and cybersecurity risk. Third-Party Risk. Third-party risk, including vendor risk, is the risk of an adverse impact due to reliance on third parties performing services or activities on our behalf. These risks may include legal, regulatory, information security, reputational, operational or any other risks inherent in engaging a third party. We identify, manage and report key third-party risks and conduct due diligence across multiple risk domains, including information security and cybersecurity, resilience and additional supply chain dependencies. The Third-Party Risk Program monitors, reviews and reassesses third-party risks on an ongoing basis. See “Risk Factors” in Part I, Item 1A of this Form 10-K for further information about third-party risk. Business Resilience Risk. Business resilience risk is the risk of disruption to our critical processes. We monitor threats and assess risks and seek to ensure our state of readiness in the event of a significant operational disruption to the normal operations of our critical functions or their dependencies, such as critical facilities, systems, third parties, data and/or personnel. Our resilience framework defines the fundamental principles for BCP and crisis management to ensure that critical functions can continue to operate in the event of a disruption. The business continuity program is comprehensive, consistent on a firmwide basis, and up-to-date, incorporating new information, including updated resilience capabilities as and when they become available. Our resilience assurance program encompasses testing of response and recovery strategies on a regular basis with the objective of minimizing and preventing significant operational disruptions. See “Business — Business Continuity and Information Security” in Part I, Item 1 of this Form 10-K for further information about business continuity.Model Risk Management Overview Model risk is the potential for adverse consequences from decisions made based on model outputs that may be incorrect or used inappropriately. We rely on quantitative models across our business activities primarily to value certain financial assets and liabilities, to monitor and manage our risk, and to measure and monitor our regulatory capital. Model Risk, which is independent of our revenue-producing units, model developers, model owners and model users, and reports to our chief risk officer, has primary responsibility for assessing, monitoring and managing our model risk through firmwide oversight across our global businesses, and provides periodic updates to senior management, risk committees and the Risk Committee of the Board. 116Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisOur model risk management framework is managed through a governance structure and risk management controls, which encompass standards designed to ensure we maintain a comprehensive model inventory, including risk assessment and classification, sound model development practices, independent review and model-specific usage controls. The Firmwide Model Risk Control Committee oversees our model risk management framework. Model Review and Validation Process Model Risk consists of quantitative professionals who perform an independent review, validation and approval of our models. This review includes an analysis of the model documentation, independent testing, an assessment of the appropriateness of the methodology used, and verification of compliance with model development and implementation standards. We regularly refine and enhance our models to reflect changes in market or economic conditions and our business mix. All models are reviewed on an annual basis, and new models or significant changes to existing models and their assumptions are approved prior to implementation. The model validation process incorporates a review of models and trade and risk parameters across a broad range of scenarios (including extreme conditions) in order to critically evaluate and verify: •The model’s conceptual soundness, including the reasonableness of model assumptions, and suitability for intended use; •The testing strategy utilized by the model developers to ensure that the models function as intended; •The suitability of the calculation techniques incorporated in the model; •The model’s accuracy in reflecting the characteristics of the related product and its significant risks; •The model’s consistency with models for similar products; and •The model’s sensitivity to input parameters and assumptions. See “Critical Accounting Policies — Fair Value — Review of Valuation Models,” “Liquidity Risk Management,” “Market Risk Management,” “Credit Risk Management” and “Operational Risk Management” for further information about our use of models within these areas. Other Risk Management In addition to the areas of risks discussed above, we also manage other risks, including capital, climate, compliance and conflicts. These areas of risks are discussed below. Capital Risk Management Capital risk is the risk that our capital is insufficient to support our business activities under normal and stressed market conditions or we face capital reductions or RWA increases, including from new or revised rules or changes in interpretations of existing rules, and are therefore unable to meet our internal capital targets or external regulatory capital requirements. Capital adequacy is of critical importance to us. Accordingly, we have in place a comprehensive capital management policy that provides a framework, defines objectives and establishes guidelines to maintain an appropriate level and composition of capital in both business-as-usual and stressed conditions. Our capital management framework is designed to provide us with the information needed to identify and comprehensively manage risk, and develop and apply projected stress scenarios that capture idiosyncratic vulnerabilities with a goal of holding sufficient capital to remain adequately capitalized even after experiencing a severe stress event. See “Capital Management and Regulatory Capital” for further information about our capital management process. We have established a comprehensive governance structure to manage and oversee our day-to-day capital management activities and to ensure compliance with capital rules and related policies. Our capital management activities are overseen by the Board and its committees. The Board is responsible for approving our annual capital plan and the Risk Committee of the Board approves our capital management policy, which details the risk committees and members of senior management who are responsible for the ongoing monitoring of our capital adequacy and evaluation of current and future regulatory capital requirements, the review of the results of our capital planning and stress tests processes, and the results of our capital models. In addition, our risk committees and senior management are responsible for the review of our contingency capital plan, key capital adequacy metrics, including regulatory capital ratios, and capital plan metrics, such as the payout ratio, as well as monitoring capital targets and potential breaches of capital requirements. Our process for managing capital risk also includes independent review by Risk that, among other things, assesses regulatory capital policies and related interpretations, escalates certain interpretations to senior management and/or the appropriate risk committee, and performs calculation testing to corroborate alignment with applicable capital rules. Climate Risk Management We categorize climate risk into physical risk and transition risk. Physical risk is the risk that asset values may decline or operations may be disrupted as a result of changes in the climate, while transition risk is the risk that asset values may decline because of changes in climate policies or changes in the underlying economy due to decarbonization. Goldman Sachs 2022 Form 10-K117THE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESManagement’s Discussion and AnalysisAs a global financial institution, climate-related risks manifest in different ways across our businesses and we have continued to make significant enhancements to our climate risk management framework, including steps to further integrate climate into our broader risk management processes. We have integrated oversight of climate-related risks into our risk management governance structure, from senior management to our Board and its committees, including the Risk and Public Responsibilities Committees. The Risk Committee of the Board oversees firmwide financial and nonfinancial risks, which include climate risk, and, as part of its oversight, receives updates on our risk management approach to climate risk, including our approaches towards scenario analysis and integration into existing risk management processes. The Public Responsibilities Committee of the Board assists the Board in its oversight of our firmwide sustainability strategy and sustainability issues affecting us, including with respect to climate change. As part of its oversight, the Public Responsibilities Committee receives periodic updates on our sustainability strategy, and also periodically reviews our governance and related policies and processes for sustainability and climate change-related risks. Senior management within Risk is responsible for the development of our climate risk program. We have begun incorporating climate risk into our credit evaluation and underwriting processes for select industries. Climate risk factors are now evaluated as part of transaction due diligence for select loan commitments. See “Business — Sustainability” in Part I, Item 1 and “Risk Factors” in Part I, Item 1A of this Form 10-K for information about our sustainability initiatives, including in relation to climate transition. Compliance Risk Management Compliance risk is the risk of legal or regulatory sanctions, material financial loss or damage to our reputation arising from our failure to comply with the requirements of applicable laws, rules and regulations, and our internal policies and procedures. Compliance risk is inherent in all activities through which we conduct our businesses. Our Compliance Risk Management Program, administered by Compliance, assesses our compliance, regulatory and reputational risk; monitors for compliance with new or amended laws, rules and regulations; designs and implements controls, policies, procedures and training; conducts independent testing; investigates, surveils and monitors for compliance risks and breaches; and leads our responses to regulatory examinations, audits and inquiries. We monitor and review business practices to assess whether they meet or exceed minimum regulatory and legal standards in all markets and jurisdictions in which we conduct business. Conflicts Management Conflicts of interest and our approach to dealing with them are fundamental to our client relationships, our reputation and our long-term success. The term “conflict of interest” does not have a universally accepted meaning, and conflicts can arise in many forms within a business or between businesses. The responsibility for identifying potential conflicts, as well as complying with our policies and procedures, is shared by all of our employees. We have a multilayered approach to resolving conflicts and addressing reputational risk. Our senior management oversees policies related to conflicts resolution and, in conjunction with Conflicts Resolution, Legal and Compliance, and internal committees, formulates policies, standards and principles, and assists in making judgments regarding the appropriate resolution of particular conflicts. Resolving potential conflicts necessarily depends on the facts and circumstances of a particular situation and the application of experienced and informed judgment. As a general matter, Conflicts Resolution reviews financing and advisory assignments in Global Banking & Markets and certain of our investing, lending and other activities. In addition, we have various transaction oversight committees, such as the Firmwide Capital, Commitments and Suitability Committees and other committees that also review new underwritings, loans, investments and structured products. These groups and committees work with internal and external counsel and Compliance to evaluate and address any actual or potential conflicts. The head of Conflicts Resolution reports to our chief legal officer, who reports to our chief executive officer. We regularly assess our policies and procedures that address conflicts of interest in an effort to conduct our business in accordance with the highest ethical standards and in compliance with all applicable laws, rules and regulations. For further information about our risk management processes, see “Overview and Structure of Risk Management” and “Risk Factors” in Part I, Item 1A of this Form 10-K.118Goldman Sachs 2022 Form 10-KTHE GOLDMAN SACHS GROUP, INC. AND SUBSIDIARIESItem 7A. Quantitative and Qualitative Disclosures About Market RiskQuantitative and qualitative disclosures about market risk are set forth in “Management's Discussion and Analysis of Financial Condition and Results of Operations — Risk Management” in Part II, Item 7 of this Form 10-K.
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and Note 23 to our consolidated financial statements for financial information about our segments. Except for per share amounts or as otherwise specified, amounts presented within tables are stated in millions. Certain columns and rows may not add due to rounding. Forward-looking statements in this Business section are not guarantees of future performance and may involve risks and uncertainties that could cause actual results to differ materially from those projected. Refer to Item 1A. Risk Factors and the "Forward-Looking Statements" section of Part II, Item 7. MD&A for a discussion of these risks and uncertainties.Our vision for the future is a world with zero crashes, zero emissions and zero congestion, which guides our growth-focused strategy to invest in electric vehicles (EVs) and autonomous vehicles (AVs), software-enabled services and subscriptions and new business opportunities, while strengthening our market position in profitable internal combustion engine (ICE) vehicles, such as trucks and sport utility vehicles (SUVs).We have an opportunity to grow our vehicle and financing revenue by continuing to capitalize on the strength of our established vehicle franchises and customer base and scaling our EV production through this decade. We also have the potential of growing our revenue through our software-enabled services and subscriptions, including OnStar, our advanced driver-assistance systems (ADAS), including Super Cruise, and future offerings, such as our next-generation ADAS, Ultra Cruise, and Ultifi, our end-to-end software platform. Additionally, we are incubating several new businesses with a start-up mindset that we believe will enable us to attract new customers and generate revenues in new areas.Electric Vehicles We plan to rapidly scale our capacity to build one million EVs in North America and more than two million EVs globally by the end of 2025. A key element in our EV strategy is Ultium, our dedicated electric vehicle propulsion architecture. This platform is flexible and will be leveraged across multiple brands and vehicle sizes, styles and drive configurations, allowing for quick response to customer preferences and a shorter design and development lead time compared to our ICE vehicles. Our first Ultium-based products launched in 2021 with the GMC HUMMER EV and BrightDrop Zevo 600, followed by the Cadillac LYRIQ in 2022. We plan to leverage the versatility and flexibility of Ultium to expand our EV portfolio over a wide variety of segments and price points including the Chevrolet Equinox EV, the Chevrolet Blazer EV, the Chevrolet Silverado EV and the GMC Sierra EV, which are expected to be launched over 2023 and 2024.In 2021, we began production at GM’s Factory ZERO Detroit-Hamtramck Assembly Center (Factory ZERO), which was re-tooled into a fully dedicated EV facility to produce the GMC HUMMER EV, the upcoming Cruise Origin, the Chevrolet Silverado EV and the GMC Sierra EV. In January 2022, we announced that we will convert our assembly plant in Orion Township, Michigan for fully dedicated EV production, including the Chevrolet Silverado EV and the GMC Sierra EV. Additionally, we have announced plans to mass-produce battery cells for these and other future EVs through Ultium Cells Holdings LLC (an equally owned joint venture with LG Energy Solution) in Warren, Ohio, Spring Hill, Tennessee and Lansing, Michigan. A fourth U.S.-based battery cell plant is also planned. To support mass market adoption of EVs, we are working to ensure that our customers will have access to comprehensive charging solutions. For personal vehicles, this means strategically addressing charging needs at home, the workplace and in public locations, for which we have committed to invest nearly $750 million through 2025. For example, in November 2021, we announced a collaboration with EVgo to install 3,250 DC fast charging stalls in more than 50 U.S. metropolitan markets. In July 2022, we announced a collaboration with EVgo and Pilot Company targeting the installation of a coast-to-coast network of 2,000 DC fast charging stalls at 50-mile intervals across the U.S., enabling long-distance corridor charging. This network will be open to all EV brands at up to 500 Pilot and Flying J travel centers. For fleet vehicles, we are developing turnkey charging solutions and fleet and facility energy management services. In addition, we have announced collaborative work with several 1Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIEScharge network operators to filter real-time data on their respective networks and charge station health into a holistic charging approach that integrates charging networks, GM vehicle mobile apps and other products and services to simplify the overall charging experience for GM EV owners in North America.BrightDrop BrightDrop is developing a suite of solutions, including the BrightDrop Zevo all-electric delivery vans, BrightDrop Trace electrically propelled smart containers and the BrightDrop Core software platform, which is focused on helping companies better visualize and optimize their fleet operations. We expect these solutions will help the world's largest delivery and logistics companies do more with less, while helping to improve operating efficiencies, eliminate operating emissions and reduce congestion. BrightDrop's Zevo 600 and Zevo 400 full-scale production facility, CAMI Assembly, launched in late 2022, with start of regular production (SORP) targeted for the first quarter of 2023. BrightDrop delivered the first Zevo 600s to FedEx Express, our launch customer, and generated reservations and expressions of interest for Zevo vans from several major companies, including DHL Express Canada, Walmart and Merchants Fleet.OnStar and Vehicle Connectivity We offer OnStar and connected services to more than 21 million connected vehicles globally through subscription-based and complimentary services. We are among the leaders in the industry, with global real-world experience in delivering connected services and advanced safety features. OnStar offers safety and security services for retail and fleet customers, including automatic crash response, emergency services, roadside assistance, crisis assist, stolen vehicle assistance and turn-by-turn navigation. Additionally, we offer OnStar Guardian in select markets, a mobile app that allows customers to access key OnStar safety and security services from their compatible mobile device. Fleet customers in some markets can leverage OnStar Vehicle Insights, our telematics solution across their entire fleet, regardless of vehicle make or model. We also offer a variety of connected services in certain markets, including mobile apps for owners to remotely control certain vehicle features and EV owners to locate charging stations, on-demand vehicle diagnostics, GM Smart Driver, Amazon Alexa in-vehicle voice, Google's Voice Assistant, navigation and app ecosystem, connected navigation, SiriusXM with 360L, 4G LTE wireless connectivity and 5G connectivity which will be available in select model year 2024 vehicles.Super Cruise and Ultra Cruise We offer Super Cruise, the industry's first true hands-free driver assistance technology that enables drivers of eligible vehicles to travel hands-free on more than 400,000 miles of compatible roads in the U.S. and Canada. We will make Super Cruise available on 22 vehicles in North America and China by the end of 2023. Ultra Cruise is a significant next step in advanced driver assistance technology, designed to ultimately enable a hands-free driving experience in 95 percent of all driving scenarios, that will debut on the Cadillac CELESTIQ. Ultifi Ultifi is our end-to-end software platform that will provide customers with software-defined features, apps and services over-the-air starting in 2023. Ultifi and the apps it enables will empower customers to update their ownership experiences with desirable features such as services and subscriptions, vehicle performance, Super Cruise and, when launched, Ultra Cruise, safety and security features, climate and comfort options, personal themes and EV ownership experience elements. Cruise General Motors and Cruise are pursuing what we believe is the most comprehensive path to autonomous mobility in the industry. In September 2021, Cruise began operating a driverless ride hail service in San Francisco, California, and in June 2022, began charging the public for driverless rides. Cruise continues to make regulatory progress in California. In December 2022, Cruise received regulatory approval to expand its operational design domain in California. Cruise is also seeking regulatory approval to add the Cruise Origin to its driverless test permit. Additionally, in September 2022, Cruise acquired regulatory permits to operate driverless ride hail services in Phoenix, Arizona and began pursuing ride hail operations in Austin, Texas. Given the potential of all-electric self-driving vehicles to help save lives, reshape our cities and reduce emissions, the goal of Cruise is to deliver its self-driving services as soon as possible, but as Cruise continues to expand and scale its operations, safety will continue to be the gating metric, supported by Cruise's Safety Management System and its other risk identification, assessment and mitigation processes.We believe that building all-electric vehicles with autonomous capabilities integrated from the beginning, rather than through retrofits, is the most efficient way to unlock the tremendous potential societal benefits of self-driving cars. The Cruise Origin, a purpose-built, all-electric, self-driving vehicle that is being co-developed by GM, Cruise and Honda Motor Company, Ltd. (Honda) will be built on GM’s all-new modular architecture, powered by the Ultium platform, at Factory ZERO starting in 2023 pending government approvals. GM and Cruise are awaiting a decision on an exemption petition that was filed with the National Highway Traffic Safety Administration (NHTSA) seeking regulatory approval for the Origin’s deployment.HYDROTEC We are developing hydrogen fuel cell applications across transportation types and industries, including mobile power generation, class 7/8 truck, locomotive and aerospace. The development of HYDROTEC technology is another element of our long-term commitment toward a world with zero emissions. We believe hydrogen fuel cells will play an important role in many automotive and other mobility applications where customers will derive additional benefits from the ability to refuel quickly, an extended range, suitability for heavier payloads and central refueling of large fleets. GM and Honda, through our 2Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESlong-term strategic alliance to collaborate in research and advanced engineering efforts, are developing and commercializing fuel cell systems. In 2021, we announced a number of commercial relationships and, in November 2022, we announced a joint development agreement with Nel Hydrogen US to help enable cost competitive renewable hydrogen production. OnStar Insurance Services OnStar Insurance is currently available in all 50 states. This innovative startup leverages GM's expertise in data and vehicle technology to learn, scale and move the company forward. As technology evolves, OnStar Insurance expects to transform traditional models to make the insurance process easier, smarter and more personalized for customers. GM Defense GM Defense is developing products and solutions for global government and military customers by leveraging GM's commercial investments in vehicle, electrification, autonomy and connected vehicle technologies. GM Defense's growth strategy is focused on building a portfolio of products, including the Infantry Squad Vehicle and the armored Heavy Duty SUV.Competitive Position and Vehicle Sales The principal factors that determine consumer vehicle preferences in the markets in which we operate include overall vehicle design, price, quality, available options, safety, reliability, fuel economy and functionality. Market leadership in individual countries in which we compete varies widely.We present both wholesale and total vehicle sales data to assist in the analysis of our revenue and our market share. Wholesale vehicle sales data consists of sales to GM's dealers and distributors, as well as sales to the U.S. Government, and excludes vehicles sold by our joint ventures. Wholesale vehicle sales data correlates to our revenue recognized from the sale of vehicles, which is the largest component of Automotive net sales and revenue. In the year ended December 31, 2022, 30.5% of our wholesale vehicle sales volume was generated outside the U.S. The following table summarizes wholesale vehicle sales by automotive segment (vehicles in thousands): Years Ended December 31,202220212020GMNA2,926 81.8 %2,308 80.7 %2,707 80.3 %GMI653 18.2 %551 19.3 %663 19.7 %Total3,579 100.0 %2,859 100.0 %3,370 100.0 %Total vehicle sales data represents: (1) retail sales (i.e., sales to consumers who purchase new vehicles from dealers or distributors); (2) fleet sales (i.e., sales to large and small businesses, governments and daily rental car companies); and (3) vehicles used by dealers in their businesses. Total vehicle sales data for periods presented prior to 2022 reflect courtesy transportation vehicles used by U.S. dealers in their business. Beginning in 2022, we stopped including such dealership courtesy transportation vehicles in total vehicle sales until such time as those vehicles were sold to the end customer. Total vehicle sales data includes all sales by joint ventures on a total vehicle basis, not based on our percentage ownership interest in the joint venture. Certain joint venture agreements in China allow for the contractual right to report vehicle sales of non-GM trademarked vehicles by those joint ventures, which are included in the total vehicle sales we report for China. While total vehicle sales data does not correlate directly to the revenue we recognize during a particular period, we believe it is indicative of the underlying demand for our vehicles. Total vehicle sales data represents management's good faith estimate based on sales reported by GM's dealers, distributors, and joint ventures, commercially available data sources such as registration and insurance data, and internal estimates and forecasts when other data is not available.3Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIES The following table summarizes industry and GM total vehicle sales and our related competitive position by geographic region (vehicles in thousands): Years Ended December 31, 202220212020 IndustryGMMarket ShareIndustryGMMarket ShareIndustryGMMarket ShareNorth AmericaUnited States14,200 2,274 16.0 %15,410 2,218 14.4 %14,882 2,547 17.1 %Other3,071 406 13.2 %3,081 355 11.5 %2,804 377 13.4 %Total North America17,270 2,680 15.5 %18,491 2,574 13.9 %17,686 2,924 16.5 %Asia/Pacific, Middle East and AfricaChina(a)23,464 2,303 9.8 %25,843 2,892 11.2 %24,926 2,901 11.6 %Other20,040 502 2.5 %19,516 435 2.2 %17,996 530 2.9 %Total Asia/Pacific, Middle East and Africa43,504 2,805 6.4 %45,359 3,326 7.3 %42,922 3,431 8.0 %South AmericaBrazil2,103 291 13.8 %2,119 242 11.4 %2,055 338 16.4 %Other1,563 161 10.3 %1,490 152 10.2 %1,106 132 12.0 %Total South America3,666 452 12.3 %3,609 394 10.9 %3,160 470 14.9 %Total in GM markets64,440 5,937 9.2 %67,459 6,294 9.3 %63,769 6,826 10.7 %Total Europe14,101 2 — %15,108 2 — %15,043 1 — %Total Worldwide(b)(c)78,542 5,939 7.6 %82,567 6,296 7.6 %78,812 6,826 8.7 %United StatesCars2,806 214 7.6 %3,277 138 4.2 %3,331 239 7.2 %Trucks3,965 1,246 31.4 %4,038 1,223 30.3 %4,045 1,257 31.1 %Crossovers7,428 814 11.0 %8,095 857 10.6 %7,506 1,051 14.0 %Total United States14,200 2,274 16.0 %15,410 2,218 14.4 %14,882 2,547 17.1 %China(a)SGMS1,037 1,277 1,407 SGMW1,266 1,615 1,494 Total China23,464 2,303 9.8 %25,843 2,892 11.2 %24,926 2,901 11.6 %__________ (a) Includes sales by the Automotive China Joint Ventures (Automotive China JVs): SAIC General Motors Sales Co., Ltd. (SGMS) and SAIC GM Wuling Automobile Co., Ltd. (SGMW).(b) Cuba, Iran, North Korea, Sudan and Syria are subject to broad economic sanctions. Accordingly, these countries are excluded from industry sales data and corresponding calculation of market share. (c) As of March 2022, GM is no longer importing vehicles or parts to Russia, Belarus and other sanctioned provinces in Ukraine.4Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESAs discussed above, total vehicle sales and market share data provided in the table above includes fleet vehicles. We sell vehicles directly or through our dealer network to fleet customers, including daily rental car companies, commercial fleet customers, leasing companies and governments. Certain fleet transactions, particularly sales to daily rental car companies, are generally less profitable than retail sales to end customers. The following table summarizes estimated fleet sales and those sales as a percentage of total vehicle sales (vehicles in thousands): Years Ended December 31,202220212020GMNA564 399 493 GMI426 311 351 Total fleet sales990 710 844 Fleet sales as a percentage of total vehicle sales16.7 %11.3 %12.4 %Product Pricing Several methods are used to promote our products, including the use of dealer, retail and fleet incentives, such as customer rebates and finance rate support. The level of incentives is dependent upon the level of competition in the markets in which we operate and the level of demand for our products. Cyclical and Seasonal Nature of Business The market for vehicles is cyclical and depends in part on general economic conditions, credit availability and consumer spending. Vehicle markets are also seasonal. Production varies from month to month. Vehicle model changeovers occur throughout the year as a result of new market entries. Relationship with Dealers We market vehicles and automotive parts worldwide primarily through a network of independent authorized retail dealers. These outlets include distributors, dealers and authorized sales, service and parts outlets. Our customers can obtain a wide range of after-sale vehicle services and products through our dealer network, such as maintenance, light repairs, collision repairs, vehicle accessories and extended service warranties. The number of authorized dealerships and other agents performing similar functions were 4,639 in GMNA and 7,318 in GMI at December 31, 2022.We, and our joint ventures, enter into a contract with each authorized dealer agreeing to sell to the dealer one or more specified product lines at wholesale prices and granting the dealer the right to sell those products to customers from an approved location. Our dealers often offer more than one GM brand at a single dealership in a number of our markets. Authorized dealers offer parts, accessories, service and repairs for GM vehicles in the product lines that they sell using GM parts and accessories. Our dealers are authorized to service GM vehicles under our limited warranty, and those repairs are made almost exclusively with GM parts. Our dealers generally provide their customers with access to credit or lease financing, vehicle insurance and extended service contracts, which may be provided by GM Financial and other financial institutions. The quality of GM dealerships and our relationship with our dealers are critical to our success, now, and as we transition to our all-electric future, given that they maintain the primary sales and service interface with the end consumer of our products. In addition to the terms of our contracts with our dealers, we are regulated by various country and state franchise laws and regulations that may supersede those contractual terms and impose specific regulatory requirements and standards for initiating dealer network changes, pursuing terminations for cause and other contractual matters. Research, Product Development and Intellectual Property Costs for research, manufacturing engineering, product engineering and design and development activities primarily relate to developing new products or services or improving existing products or services, including activities related to vehicle and greenhouse gas (GHG) emissions control, improved fuel economy, EVs, AVs and the safety of drivers and passengers. Research and development expenses were $9.8 billion, $7.9 billion and $6.2 billion in the years ended December 31, 2022, 2021 and 2020. Product Development The Global Product Development organization is responsible for designing, developing and integrating all global products and their components while aiming to maximize part sharing across multiple vehicle segments. Our global vehicle architecture development is headquartered at our Global Technical Center in Warren, Michigan, where our global teams in Design, Program Management & Execution, Component & Subsystem Engineering, Product Safety, Systems & Integration, Software Defined Vehicle & Embedded Platforms, Electrification & Battery Systems, Technology Acceleration & Commercialization and Purchasing & Supply Chain collaborate to meet customer requirements and maximize global economies of scale.5Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESWe continue to invest in key ICE segments, which are critical to fund our all-electric future. Cross-segment part sharing is an essential enabler to optimize our vehicle portfolio profitability, with more than 75% of our global internal combustion vehicle sales volume expected to come from five internal combustion vehicle architectures through this decade. We will continue to leverage our ICE portfolio to accommodate our customers around the world while achieving our financial goals.In 2021, we announced our investment in the Wallace Battery Cell Innovation Center, an all-new facility that has significantly expanded the Company's battery technology operations and will continue to accelerate the development and commercialization of longer range, more affordable EV batteries. The Wallace Center is located on the campus of the Global Technical Center in Warren, Michigan.Intellectual Property We are constantly innovating and hold a significant number of patents, copyrights, trade secrets and other intellectual property that protect those innovations in numerous countries. While no single piece of intellectual property is individually material to our business as a whole, our intellectual property is important to our operations and continued technological development. Additionally, we hold a number of trademarks and service marks that are very important to our identity and recognition in the marketplace. Raw Materials, Services and Supplies We purchase a wide variety of raw materials, systems, components, parts, supplies, energy, freight, transportation and other services from numerous suppliers to manufacture our products. The raw materials primarily include steel, aluminum, resins, copper, lead, precious metals and raw materials used in EVs. We do not normally carry substantial inventories of these raw materials in excess of levels reasonably required to meet our production requirements, and while we have not experienced any significant shortages of raw materials, we have recently experienced supply disruptions resulting in temporary production stoppages. In addition, our transition to EVs will require developing a more resilient, scalable and sustainable North America-focused EV supply chain, which includes advancing our strategic sourcing initiatives to secure supply through investments in raw materials suppliers and the execution of strategic, multi-year supply agreements with suppliers throughout the value chain. This includes securing supply through offtake agreements for EV raw materials, such as lithium, cathode active material, synthetic and natural graphite, nickel, cobalt, rare earth elements and permanent motor magnets. These EV-related agreements may require us to hold higher than normal levels of EV raw materials inventory. Expected demand for these raw materials currently exceeds the capacity of the existing supply chain and our raw material sourcing strategy aims to secure raw material supply to support our EV transition.Commodity costs are expected to remain elevated due to the macro-economic environment and the continuing existence of tariffs. In addition, global supply chain disruptions have had, and are continuing to have, wide-ranging effects across multiple industries, particularly the automotive industry. Refer to Item 1A. Risk Factors and to Part II, Item 7. MD&A for further discussion on the effect global supply chain disruptions have had on our results of operations. Furthermore, an increased demand for rare earth minerals is increasing scrutiny of the sustainability and human rights implications of rare earth mineral supply chains.In some instances, we purchase systems, components, parts and supplies from a single source, which may increase risk to supply disruptions. The inability or unwillingness of these sources to provide us with parts and supplies could have a material adverse effect on our production. Combined purchases from our two largest suppliers were approximately 11% of our total purchases in the year ended December 31, 2022, approximately 12% of our total purchases in the year ended December 31, 2021, and approximately 11% of our total purchases in the year ended December 31, 2020. Refer to Item 1A. Risk Factors for further discussion of these risks. Automotive Financing - GM Financial GM Financial is our global captive automotive finance company and our global provider of automobile finance solutions. GM Financial conducts its business in North America, South America and through joint ventures in China. GM Financial provides retail loan and lease lending across the credit spectrum to support vehicle sales. Additionally, GM Financial offers commercial lending products to dealers including floorplan financing, which is lending to finance new and used vehicle inventory; and dealer loans, which are loans to finance improvements to dealership facilities, to provide working capital, or to purchase and/or finance dealership real estate. Other commercial lending products include financing for parts and accessories, dealer fleets and storage centers.In North America, GM Financial offers a sub-prime lending program. The program is primarily offered to consumers with a FICO score or its equivalent of less than 620 who have limited access to automobile financing through banks and credit unions and is expected to sustain a higher level of credit losses than prime lending. 6Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESGM Financial generally seeks to fund its operations in each country through local sources of funding to minimize currency and country risk. GM Financial primarily finances its loan, lease and commercial origination volume through the use of secured and unsecured credit facilities, securitization transactions and the issuance of unsecured debt in the capital markets.Human Capital The foundation of GM’s business is our Purpose: We pioneer the innovations that move and connect people to what matters. It is why we exist. Our Purpose, growth strategy and culture all help us on our path towards achieving our vision of — a world with zero crashes, zero emissions and zero congestion. Our people are our most valuable asset, and we must continue to attract and retain the best talent in the world in order to achieve this vision. As a result, we strive to create a Workplace of Choice to attract, retain and develop top talent by adhering to a responsible employer philosophy, which includes, among other things, commitments to create job opportunities, pay workers fairly, ensure safety and well-being, and promote diversity, equity and inclusion (DEI). Fundamental to these commitments are our company values. 7Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIES Our eight GM behaviors are the foundation of our culture; and how we behave encompasses key measures of our performance, including the ways we conduct ourselves as we work with one another.Diversity, Equity and Inclusion At GM, we are committed to fostering a culture of diversity, equity and inclusion. In every moment, we must decide what we can do — individually and collectively — to drive meaningful, deliberate and long-lasting change. GM’s unwavering commitment in this regard includes taking steps to ensure that all areas of our business are supportive of a world-class inclusive, equitable and diverse organization. Our ability to meet the needs of a diverse and global customer base is tied closely to the behaviors of the people within our company, which is why we are committed to fostering a culture that celebrates our differences. This commitment is embraced at all levels of the organization, including our diverse Board of Directors, which is currently made up of almost 50% women (6 out of 13 members) and is more than 30% racially or ethnically diverse (4 out of 13 members). Based on these longstanding values, our Chair and CEO, Mary Barra, chairs an Inclusion Advisory Board (IAB) of internal and external leaders who guide our work to improve diversity and inclusion in our Company. The purpose of the IAB is to consult with GM’s Senior Leadership Team with the long-term goal of inspiring the Company to be inclusive through our words, deeds and culture. We also have a number of programs and partnerships aimed at enhancing our culture of inclusion throughout the Company. For example, we have 12 voluntary, employee-led resource groups that provide a forum for diverse employees and allies from a variety of different backgrounds to share experiences and contribute to our collective cultural intelligence and growth. Each group also works to attract and retain new talent and offers employees opportunities to support our company’s diversity initiatives within the community.GM has added resources skilled in new areas like inclusive leadership coaching, workforce design, accessibility and community partnerships. These investments are designed to help increase DEI overall maturity, increasing pathways for talent entry and development in the company and fostering partnerships that improve equity inside and outside of GM. As an example, in January 2021, GM welcomed the industry’s first chief engineer of accessibility to lead a new Accessibility Center of Excellence, driving GM’s approach toward increasing inclusivity in products and services. The team works across four main areas: researching and innovating with the customer, defining what it means to have accessible solutions in our vehicles, working to create customizable solutions for a variety of customer needs and creating an ecosystem to grow the culture around accessibility. Develop and Retain Talented People Today, we compete for talent against other automotive companies and against businesses in other sectors, such as technology. To win and keep top talent, we must provide a workplace culture that encourages employee behaviors aligned with our values, fulfills employees' long-term individual aspirations and provides experiences that make individuals feel valued, included and engaged. In furtherance of this goal, we invest significant resources to retain and develop our talent. In addition to mentoring and networking opportunities, we offer a vast array of career development resources to help develop, grow and enable employees to make the most of their careers at GM. Formal resources 8Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESinclude, among other things, the Technical Education Program, which offers our employees an opportunity to complete corporate strategically aligned degrees and certificate programs at leading universities, and our Degreed Learning Platform, which brings forth a variety of external and in-house content in learning pathways and other micro learnings. It is also tied to our GM competency and skills model. Employees in some of our technical roles also have the opportunity to participate in the GM Technical Learning University — a training and upskilling program designed to expand and update the technical prowess of our workforce.GM recognizes that leadership effectiveness is a critical business need. All new managers in the Company are automatically entered into a six-month immersive learning program and all new executives come together for an upskilling and targeted development program designed around the GM leadership profile.Safety and Well-Being The safety and well-being of our employees is also a critical component of our ability to transform the future of personal mobility. At GM, we pride ourselves on our commitment to live values that return people home safely — Every Person, Every Site, Every Day. Our unwavering commitment to safety is manifested through empowering employees to “Speak Up for Safety” and the Employee Safety Concern Process. These resources make it easier for salaried, hourly or represented and contract employees to report potential vehicle or workplace safety issues, or to suggest safety related improvements without fear of retaliation. The well-being of our employees is equally as important to entice and stimulate creativity and innovation. In addition to traditional healthcare, paid time off, paid parental leave, wellness programs, flextime scheduling and telecommuting arrangements and retirement benefits, including a 401(k) company contribution and matching program, GM offers a variety of benefits and resources to support employees' physical and mental health, including access to fitness facilities in certain locations, which help us both attract talent and reap the benefits of a healthier workforce. Beginning January 1, 2023, where permissible, United States salaried employees are able to add their domestic partners and their children to various benefits plans and policies under the specific terms of such plans and policies.Employees At December 31, 2022, we employed approximately 86,000 (52%) hourly employees and approximately 81,000 (48%) salaried employees. At December 31, 2022, approximately 46,000 (44%) of our U.S. employees were represented by unions, a majority of which were represented by the International Union, United Automobile, Aerospace and Agricultural Implement Workers of America (UAW). The following table summarizes worldwide employment (in thousands): December 31, 2022GMNA(a)124 GMI34 GM Financial9 Total Worldwide167 U.S. - Salaried58 U.S. - Hourly46 __________ (a)Includes Cruise.9Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESInformation About our Executive Officers As of January 31, 2023, the names and ages of our executive officers and their positions with GM are as follows: Name (Age)Present GM Position (Effective Date)Positions Held During the Past Five Years (Effective Date)Mary T. Barra (61)Chair and Chief Executive Officer (2016)Julian Blissett (56)Executive Vice President and President, GM China (2020)Senior Vice President, International Operations (2019)Vice President, Executive Shanghai GM (2014)Stephen K. Carlisle (60)Executive Vice President and President, North America (2020)Senior Vice President and President, Cadillac (2018)President and Managing Director, GM Canada (2015)Craig B. Glidden (65)Executive Vice President, Global Public Policy, General Counsel and Corporate Secretary (2021)Executive Vice President and General Counsel (2015)Christopher T. Hatto (52)Vice President, Global Business Solutions and Chief Accounting Officer (2020)Vice President, Controller and Chief Accounting Officer (2018)Chief Financial Officer, U.S. Sales Operations (2016)Paul A. Jacobson (51)Executive Vice President and Chief Financial Officer (2020)Delta Air Lines, Executive Vice President — Chief Financial Officer (2013)Gerald Johnson (60) Executive Vice President, Global Manufacturing and Sustainability (2019)Vice President, North America Manufacturing and Labor Relations (2017)Douglas L. Parks (61)Executive Vice President, Global Product Development, Purchasing and Supply Chain (2019)Vice President, Autonomous and Electric Vehicles (2017)Mark L. Reuss (59)President (2019)Executive Vice President and President, Global Product Development Group and Cadillac (2018)Executive Vice President, Global Product Development, Purchasing & Supply Chain (2014)There are no family relationships between any of the officers named above and there is no arrangement or understanding between any of the officers named above and any other person pursuant to which he or she was selected as an officer. Each of the officers named above was elected by the Board of Directors to hold office until his or her successor is elected and qualified or until his or her earlier resignation or removal. Environmental and Regulatory MattersAutomotive Criteria Emissions Control Our products are subject to laws and regulations globally that require us to control certain non-GHG automotive emissions, including vehicle and engine exhaust emission standards, vehicle evaporative emission standards and onboard diagnostic (OBD) system requirements. Emission requirements have become more stringent as a result of stricter standards and new diagnostic requirements that have come into force in many markets around the world, often with very little harmonization. Regulatory authorities may conduct ongoing evaluations of products from all manufacturers. For additional information, refer to Item 1A. Risk Factors.The U.S. federal government, through the Environmental Protection Agency (EPA), imposes stringent exhaust and evaporative emission control requirements on vehicles sold in the U.S. The California Air Resources Board (CARB) likewise imposes stringent exhaust and evaporative emission standards. The Clean Air Act permits states that have areas with air quality compliance issues to adopt California emission standards in lieu of federal requirements. Seventeen states have adopted California emission standards, and there is a possibility that additional U.S. jurisdictions could adopt California emission requirements in the future.For each model year we must obtain certification that our vehicles and heavy-duty engines will meet emission requirements of the EPA before we can sell vehicles in the U.S. and Canada, and of CARB before we can sell vehicles in California and the states that have adopted California emission requirements.The Canadian federal government's current vehicle pollutant emission requirements are generally aligned with U.S. federal requirements. 10Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESIn 2019, certain areas within China began implementation of the China 6 emission standard (China 6) requirements. China 6 combines elements of both European Union (EU) and U.S. standards and increases the time and mileage periods over which manufacturers are responsible for a vehicle's emission performance. Nationwide implementation of China 6a for new registrations occurred in January 2021, and the more stringent China 6b is expected to be implemented in July 2023. Finally in 2022, China began studies regarding the next generation of vehicle emission standards (China 7), which will likely be influenced by the European (Euro 7) standards.Brazil has approved a set of national emission standards referred to as L7, implemented in 2022, and L8, to be implemented from 2025 onward. L7 standards cover tailpipe exhaust gases, durability for emissions, evaporative emissions and noise limits, and include additional OBD requirements and a phase-in for onboard refueling vapor recovery systems. L8 standards include targets for vehicle emissions and reduce corporate exhaust limits every two years until 2031. Some of the requirements are aligned with those of the EPA. As a result of the sale of the Opel and Vauxhall businesses and certain other assets in Europe (the Opel/Vauxhall Business), GM’s vehicle presence in Europe is smaller, but GM may still be affected by actions taken by regulators related both to Opel/Vauxhall vehicles sold before the sale of the Opel/Vauxhall Business as well as to other vehicles GM continues to sell in Europe. In the EU, increased scrutiny of compliance with emission standards may result in changes to these standards, as well as stricter interpretations or redefinition of these standards and more rigorous enforcement. Beyond this, as a part of the EU’s desire to accelerate the shift to sustainable mobility, the EU is looking to develop stricter emission standards (Euro 7) for all petrol and diesel cars, vans, lorries and buses, as it is moving to end the sale of ICE vehicles past 2035, and place requirements on batteries to be used in EVs. For additional information, refer to Note 16 to our consolidated financial statements.Automotive Fuel Economy and GHG Emissions In the U.S., NHTSA promulgates and enforces Corporate Average Fuel Economy (CAFE) standards for three separate fleets: domestic cars, import cars and light-duty trucks. Manufacturers may use one or a combination of the following to resolve fleet deficits: credits from the five prior model years, expected credits for the next three model years, credits obtained from other manufacturers, and payment of civil penalties. Manufacturers that do not resolve deficits for a model year may be subject to substantial civil penalties. In addition to federal CAFE standards, the EPA promulgates and enforces GHG emission standards. NHTSA and the EPA have separately finalized standards with differing stringency levels and affected model years, with the CAFE standards addressing the 2024–2026 model years and the GHG standards addressing the 2023–2026 model years. Both the CAFE and GHG standards have been challenged through litigation. NHTSA and the EPA also regulate the fuel efficiency and GHG emissions of medium- and heavy-duty vehicles, imposing more stringent standards over time.In addition, CARB has asserted the right to promulgate and enforce its own state GHG standards for motor vehicles, and other states have asserted the right to adopt CARB's standards. CARB regulations previously stated that compliance with the light-duty EPA GHG program is deemed compliance with CARB standards. However, in December 2018 CARB amended this regulation to state that, in the event the EPA were to alter federal GHG stringency, which it now has, compliance with the EPA's GHG emission standards will no longer be deemed compliance with CARB's separate requirements. While NHTSA and the EPA previously took actions to preempt California’s GHG standards, NHTSA repealed its assertion of preemption and the EPA rescinded its withdrawal of California’s preemption waiver, enabling CARB to enforce GHG standards from the Advanced Clean Cars (ACC) program for the 2021–2025 model years. As a result, GM is required to meet state GHG standards in California and 17 states that have adopted California’s GHG standards. The EPA’s rescission of its withdrawal of California’s waiver has been challenged through litigation. CARB has also imposed a requirement that increases percentages of Zero Emission Vehicles (ZEVs) that must be sold in California. While NHTSA and the EPA previously took actions to preempt California’s ZEV standards, NHTSA repealed its assertion of preemption and the EPA rescinded its withdrawal of California’s waiver, enabling CARB and 15 adopting states to enforce ZEV standards from the ACC program. The EPA’s rescission of its withdrawal of California’s waiver has been challenged through litigation. Further, in August 2022, CARB finalized its Advanced Clean Cars II (ACC II) program, including ZEV standards requiring increasing percentages of ZEVs for the 2026–2035 model years, ending with a 100% sales target in the 2035 model year. CARB must obtain a waiver from EPA to implement its ACC II program. Additional U.S. jurisdictions could adopt CARB’s ACC and ACC II requirements in the future.In Canada, federal light- and heavy-duty GHG regulations are currently patterned after the EPA GHG emission standards given the integrated nature of the auto sector between Canada and the United States. The Canadian light-duty GHG standards continue to largely align with the U.S. GHG standards for the 2023–2025 model years. Additionally, the Canadian federal government issued an Emissions Reduction Plan requiring the implementation of increasingly stringent ZEV sales requirements for the 2026–2035 model years, ending with a 100% sales target in the 2035 model year. The Canadian province of Quebec has ZEV requirements regulating the 2018–2025 model years, largely based on California program requirements, and the province 11Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESof British Columbia has similar ZEV regulations that were completed in July 2020 and cover the 2020–2039 model years. Both provinces have proposed amendments to their ZEV regulations for the 2026–2035 model years ending with a 100% ZEV sales target in the 2035 model year. A first draft of Canada’s national ZEV sales regulations was issued in December 2022.China has two fuel economy requirements for passenger vehicles: an individual vehicle pass-fail type approval requirement and a fleet average fuel consumption requirement. With a focus on the fleet average fuel consumption requirement, the China Phase 5 launched in 2021 and full compliance is required by 2025. In addition, China has established a mandate that requires passenger car manufacturers to produce a certain volume of plug-in hybrid, battery electric and fuel cell vehicles, which are referred to as New Energy Vehicles (NEVs), to generate credits in 2019 and beyond. The number of credits per car is based on the level of electric range and energy efficiency, with the goal of increasing NEV volume penetrations and improving technological sophistication over time. Uncommitted NEV credits may be used to assist compliance with the fleet average fuel consumption requirement. China has issued NEV credit targets between 2019 and 2023 and is setting new NEV credit targets aimed at further increasing volumes of NEVs in 2024 and 2025. China has provided various levels of subsidies for NEVs, and certain subsidies were extended to the end of 2022. Also in 2022, China began to study the fleet average fuel consumption requirement and NEV credit mandate for 2026–2030 (Phase 6). These standards can potentially be more stringent, aligned with the trend we are seeing in other key global markets. In Brazil, the Secretary of Industry and Development promulgates and enforces CAFE standards and has enforced a new CAFE program for the period October 2020–September 2026 for light-duty and mid-size trucks and SUVs, including diesel vehicles. The second and third phases of the program are yet to be finalized and are expected to gradually become more stringent for each period.We have several options to comply with existing and potential new regulations that we have utilized and may continue to utilize, including increasing production and sale of certain vehicles, such as EVs, and curtailing production of others, which could include profitable ICE vehicles; technology changes, including fuel consumption efficiency and engine upgrades; payment of penalties; and/or the purchase of credits from third parties. We regularly evaluate our current and future product plans and strategies for compliance with fuel economy and GHG regulations. We plan to be carbon neutral by 2040 in our global products and operations, supported by a commitment to science-based targets. In addition, the Company envisions an all-electric future and plans to eliminate tailpipe emissions from new U.S. light-duty vehicles by 2035. These targets align with our growth and transformation plan including our commitment to an all-electric future, which will be enabled by our Ultium platform and HYDROTEC technology as previously detailed. We also announced that we anticipate our total annual capital spending and our investments in our battery cell manufacturing joint ventures to be in the range of $11.0 to $13.0 billion through 2025 primarily to accelerate this transformation plan.Industrial Environmental Control Our operations are subject to a wide range of environmental protection laws including those regulating air emissions, water discharge, waste management and environmental cleanup. Certain environmental statutes require that responsible parties fund remediation actions regardless of fault, legality of original disposal or ownership of a disposal site. Under certain circumstances these laws impose joint and several liability as well as liability for related damages to natural resources. To further mitigate the impacts of our worldwide operations on the environment, including climate change, we are supplementing our compliance programs with sustainability efforts focused on reducing operational GHG emissions, water consumption and discharge and operational waste.We aim to continue our progress toward becoming a Zero Waste company by diverting greater than 90% of our total operational waste from landfills, incinerators, and energy recovery facilities by 2025. We also continue our efforts to increase our use of renewable energy, improve our energy efficiency and work to drive growth and scale of renewables. We recently announced the finalization of energy sourcing agreements required to secure 100% of the energy needed to power all our U.S. facilities with renewable energy by 2025. This is in line with the accelerated target announced in September 2021 and 25 years ahead of the initial target of 2050, set in 2016. We are on target to meet the remaining needs of our global operations with 100% renewable energy by 2035. Chemical Regulations We continually monitor the implementation of chemical regulations to maintain compliance and evaluate their effect on our business, suppliers and the automotive industry.Globally, governments continue to introduce new legislation and regulations related to the selection and use of chemicals by mandating broad prohibitions or restrictions and implementing vehicle interior air quality, green chemistry, life cycle analysis 12Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESand product stewardship initiatives. These initiatives give broad regulatory authority to ban or restrict the use of certain chemical substances and potentially affect automobile manufacturers' responsibilities for vehicle components at the end of a vehicle's life, as well as chemical selection for product development and manufacturing. Global treaties and initiatives such as the Stockholm, Basel and Rotterdam Conventions on Chemicals and Waste, the Minamata Convention on Mercury and EU Registration, Evaluation, Authorization and Restriction of Chemicals (REACH), are driving chemical regulations across signatory countries. Increases in the use of circuit boards and other electronics may require additional assessment under the Restriction on Hazardous Substances and Waste from Electrical and Electronic Equipment directives. New European requirements require suppliers of parts and vehicles to the European market to disclose substances of concern in parts. Chemical regulations are increasing in North America. In the U.S., the EPA is moving forward with risk analysis and management of high priority chemicals under the authority of the 2016 Lautenberg Chemical Safety for the 21st Century Act. In addition, several U.S. states have chemical management regulations that can affect vehicle design and manufacturing such as chemical restriction and use requirements. For example, Maine will likely require the reporting of per- and polyfluoroalkyl substances (PFAS) in 2023, and the elimination of PFAS in 2030, except for unavoidable uses. Chemical restrictions and export controls in Canada continue to steadily progress under the Environment and Climate Change Canada's Chemical Management Plan to assess existing substances and implement risk management controls on any chemical deemed toxic. These emerging laws and regulations will potentially lead to increases in costs and supply chain complexity. Manufacturers, including joint venture partners and suppliers, that do not comply with global and specific country regulations could be subject to civil penalties, production disruptions, or limitations on the sale of affected products. We believe we are materially in compliance with substantially all these requirements or expect to be materially in compliance by the required dates.Vehicle Safety U.S. Requirements The National Traffic and Motor Vehicle Safety Act of 1966 (the Safety Act) regulates the vehicles and items of motor vehicle equipment that we manufacture and sell. The Safety Act prohibits the sale in the United States of any new vehicle or equipment that does not conform to applicable federal motor vehicle safety standards established by NHTSA. Meeting or exceeding the many safety standards is costly as global compliance and non-governmental assessment requirements continue to evolve and grow more complex, and lack harmonization globally. The Safety Act further requires that if we or NHTSA determine a vehicle or an item of vehicle equipment does not comply with a safety standard, or that vehicle or equipment contains a defect that poses an unreasonable safety risk, we must conduct a safety recall to remedy that condition in the affected vehicles. Should we or NHTSA determine a safety defect or noncompliance issue exists with respect to any of our vehicles, the cost of such recall campaigns could be substantial. Other National Requirements Outside of the U.S., many countries have established vehicle safety standards and regulations and are likely to adopt additional, more stringent requirements in the future. The European General Safety Regulation has introduced United Nations Economic Commission for Europe (UN-ECE) regulations, which are required for the European Type Approval process. Globally, governments generally have been adopting UN-ECE based regulations with some variations to address local concerns. Any difference between North American and UN-ECE based regulations can add complexity and costs to vehicle development, and we continue to support efforts to harmonize regulations to reduce complexity. New safety and recall requirements in various countries around the world, including in China, Brazil, and Gulf Cooperation Council countries, also may add substantial costs and complexity to our safety and field action activities globally. In Canada, vehicle regulatory requirements are currently aligned with U.S. regulations; however, under the Canadian Motor Vehicle Safety Act, recall thresholds are different and the Minister of Transport has broad powers to order manufacturers to submit a notice of defect or non-compliance when the Minister considers it to be in the interest of safety. Further, various governments are beginning to mandate e-Call and other features that can be market-specific and add complexity and increase our cost of compliance globally. Crash Test Ratings and New Car Assessment Programs Organizations in various regions around the world, including in the U.S., rate and compare motor vehicles through various New Car Assessment Programs (NCAPs) to provide consumers and businesses with additional information about the safety of new vehicles. NCAPs use crash tests and other evaluations that are different than what is required by applicable regulations, and use stars or other grading systems, depending on the region, to rate vehicle safety. Achieving high NCAP ratings, which can vary by country and region, can add complexity and cost to vehicles. Website Access to Our Reports Our internet website address is https://www.gm.com. In addition to the information about us and our subsidiaries contained in this 2022 Form 10-K, information about us can be found on our website including information on our corporate governance principles and practices. Our Investor Relations website at https://investor.gm.com contains a 13Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESsignificant amount of information about us, including financial and other information for investors. We encourage investors to visit our website, as we frequently update and post new information about our company on our website and it is possible that this information could be deemed to be material information. Our website and information included in or linked to our website are not part of this 2022 Form 10-K.Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are available free of charge through our website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (SEC). The SEC maintains a website that contains reports, proxy and information statements, and other information regarding our filings at https://www.sec.gov. * * * * * * *Item 1A. Risk FactorsWe have listed below the most material risk factors applicable to us. These risk factors are not necessarily in the order of importance or probability of occurrence:Risks related to our competition and strategyIf we do not deliver new products, services, technologies and customer experiences in response to increased competition and changing consumer preferences in the automotive industry, our business could suffer. We believe that the automotive industry will continue to experience significant change in the coming years, particularly as traditional automotive original equipment manufacturers continue to shift resources to the development of EVs. In addition to our traditional competitors, we must also be responsive to the entrance of start-ups and other non-traditional competitors in the automotive industry, such as ridesharing services. These new competitors, as well as established industry participants, are disrupting the historic business model of our industry through the introduction of new technologies, products, services, direct-to-consumer sales channels, methods of transportation and vehicle ownership. To successfully execute our long-term strategy, we must continue to develop new products and services, including products and services that are outside of our historically core ICE business, such as EVs and AVs, software-enabled connected services and other new businesses. Our vehicles and connected services increasingly rely on software and hardware that is highly technical and complex. The process of designing and developing new technology, products and services is costly and uncertain and requires extensive capital investment and the ability to retain and recruit the best talent. If our access to capital were to become significantly constrained, if costs of capital increased significantly, or if our ability to raise capital is challenged relative to our peers, in each case including as a result of any constraints on lending due to concerns about climate change, our ability to execute on our strategic plans could be adversely affected. Further, the market for highly skilled workers and leaders in our industry is extremely competitive. Failure to attract, hire, develop, motivate and retain highly qualified and diverse employees could disrupt our operations and adversely affect our strategic plans.There can be no assurance that advances in technology will occur in a timely or feasible way, if at all, that others will not acquire similar or superior technologies sooner than we do, or that we will acquire technologies on an exclusive basis or at a significant price advantage. Further, if we are unable to prevent or effectively remedy errors, bugs, vulnerabilities or defects in our software and hardware, or fail to deploy updates to our software properly, or if we do not adequately prepare for and respond to new kinds of technological innovations, market developments and changing customer needs, our sales, profitability and long-term competitiveness may be harmed.Our ability to maintain profitability is dependent upon our ability to timely fund and introduce new and improved vehicle models, including EVs, that are able to attract a sufficient number of consumers. We operate in a very competitive industry with market participants routinely introducing new and improved vehicle models and features designed to meet rapidly evolving consumer expectations. Producing new and improved vehicle models, including EVs, that preserve our reputation for designing, building and selling safe, high-quality cars, crossovers, trucks and SUVs is critical to our long-term profitability. Successful launches of our new vehicles are critical to our short-term profitability. The new vehicle development process can take two years or more, and a number of factors may lengthen that time period. Because of this product development cycle and the various elements that may contribute to consumers’ acceptance of new vehicle designs, including competitors’ product introductions, technological innovations, fuel prices, general economic conditions, regulatory developments, transportation infrastructure and changes in quality, safety, reliability and styling demands and preferences, an initial product concept or design may not result in a saleable vehicle or a vehicle that generates sales in sufficient quantities and at high enough prices to be profitable. Our high proportion of fixed costs, both due to our significant investment in property, plant and equipment as 14Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESwell as other requirements of our collective bargaining agreements, which limit our flexibility to adjust personnel costs to changes in demands for our products, may further exacerbate the risks associated with incorrectly assessing demand for our vehicles.Our long-term strategy is dependent upon our ability to profitably deliver a broad portfolio of EVs. The production and profitable sale of EVs has become increasingly important to our long-term business as we accelerate our transition to an all-electric future. Our EV strategy is dependent on our ability to deliver a broad portfolio of high-quality EVs that are competitive and meet consumer demands; scale our EV manufacturing capabilities; reduce the costs associated with the manufacture of EVs, particularly with respect to battery cells and packs; increase vehicle range and the energy density of our batteries; efficiently source sufficient materials for the manufacture of EV battery cells; license and monetize our proprietary platforms and related innovations; successfully invest in new technologies relative to our peers; develop new software and services; and leverage our scale, manufacturing capabilities and synergies with existing ICE vehicles. In addition, consumer adoption of EVs will be critical to the success of our strategy. Consumer adoption of EVs could be impacted by numerous factors, including the breadth of the portfolio of EVs available; perceptions about EV features, quality, safety, performance and cost relative to ICE vehicles; the range over which EVs may be driven on a given battery charge; the proliferation of charging infrastructure, in particular with respect to public EV charging stations, and the success of the Company's charging infrastructure programs and strategic joint ventures and other relationships; cost and availability of high fuel-economy ICE vehicles; volatility, or a sustained decrease, in the cost of petroleum-based fuel; failure by governments and other third parties to make the investments necessary to make infrastructure improvements, such as greater availability of cleaner energy grids and EV charging stations, and to provide economic incentives promoting the adoption of EVs, including those contemplated by the Inflation Reduction Act; and negative feedback from stakeholders impacting investor and consumer confidence in our company or industry. If we are unable to successfully deliver on our EV strategy, it could materially and adversely affect our results of operations, financial condition and growth prospects, and could negatively impact our brand and reputation.Our near-term profitability is dependent upon the success of our current line of full-size ICE SUVs and full-size ICE pickup trucks. While we offer a broad portfolio of cars, crossovers, SUVs and trucks, and we have announced significant plans to design, build and sell a broad portfolio of EVs, we currently recognize the highest profit margins on our full-size ICE SUVs and full-size ICE trucks. As a result, our near-term success is dependent upon our ability to sell higher margin vehicles in sufficient volumes. We are also using the cash generated by our ICE vehicles to fund our growth strategy, including with respect to EVs and AVs. Any near-term shift in consumer preferences toward smaller, more fuel-efficient vehicles, whether as a result of increases in the price of oil or any sustained shortage of oil, including as a result of global political instability (such as related to Russia's invasion of Ukraine), concerns about fuel consumption or GHG emissions, or other reasons, could weaken the demand for our higher margin vehicles. More stringent fuel economy regulations could also impact our ability to sell these vehicles or could result in additional costs associated with these vehicles. See “Our operations and products are subject to extensive laws, regulations and policies, including those related to vehicle emissions and fuel economy standards, which can significantly increase our costs and affect how we do business.”We operate in a highly competitive industry that has historically had excess manufacturing capacity, and attempts by our competitors to sell more vehicles could have a significant negative effect on our vehicle pricing, market share and operating results. The global automotive industry is highly competitive in terms of the quality, innovation, new technologies, pricing, fuel economy, reliability, safety, customer service and financial services offered. Additionally, overall manufacturing capacity in the industry has historically far exceeded demand. In addition, we have made, and plan to continue to make, significant investments in EV manufacturing capacity based on our expectations for EV demand, which is subject to various risks and uncertainties as described above. Many manufacturers, including GM, have relatively high fixed labor costs as well as limitations on their ability to efficiently close facilities and reduce fixed costs, often as a result of collective bargaining agreements. In light of any excess capacity and high fixed costs, many industry participants have attempted to sell more vehicles by providing subsidized financing or leasing programs, offering marketing incentives or reducing vehicle prices. As a result, we have had, and may in the future need, to offer similar incentives, which may result in vehicle prices that do not offset our costs, including any cost increases or the impact of adverse currency fluctuations, which could affect our profitability. Our competitors may also seek to benefit from economies of scale by consolidating or entering into other strategic agreements such as alliances or joint ventures intended to enhance their competitiveness.Manufacturers in countries that have lower production costs, such as China and India, have become competitors in key emerging markets and have announced their intention to export their products to established markets as a low-cost alternative to established entry-level automobiles. In addition, foreign governments may decide to implement tax and other policies that favor their domestic manufacturers at the expense of international manufacturers, including GM and its joint venture partners. These actions have had, and are expected to continue to have, a significant negative effect on our vehicle pricing, market share and operating results in these markets.15Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESOur AV strategy is dependent upon our ability to successfully mitigate unique technological, operational and regulatory risks. GM Cruise Holdings LLC (Cruise Holdings), our majority-owned subsidiary, is responsible for the development and commercialization of AV technology. Our AV operations are capital intensive and subject to a variety of risks inherent with the development of new technologies, including our ability to continue to develop self-driving software and hardware, such as Light Detection and Ranging (LiDAR) sensors and other components; access to sufficient capital; risks related to the manufacture of purpose-built AVs; and significant competition from both established automotive companies and technology companies, some of which may have more resources and capital to devote to AV technologies than we do. In addition, we face risks related to the commercial deployment of AVs on our targeted timeline or at all, including consumer acceptance, achievement of adequate safety and other performance standards and compliance with uncertain, evolving and potentially conflicting federal, state, provincial or local regulations. Advanced technologies such as AVs present novel issues with which domestic and foreign regulators have only limited experience, and will be subject to evolving regulatory frameworks. Any current or future regulations in these areas could impede the successful commercialization of these technologies and impact whether and how these technologies are designed and integrated into our products, and may ultimately subject us to increased costs and uncertainty. In order for Cruise to successfully execute its business plan and achieve its revenue targets, legislation and regulations must evolve to permit widespread commercial AV deployment. To the extent accidents, cybersecurity breaches or other adverse events associated with our autonomous driving systems occur, we could be subject to liability, reputational harm, government scrutiny and further regulation, and it could deter consumer adoption of AV technology. Any of the foregoing could materially and adversely affect our results of operations, financial condition and growth prospects.We are subject to risks associated with climate change, including increased regulation of GHG emissions, changing consumer preferences and other risks related to our transition to EVs and the potential increased impacts of severe weather events on our operations and infrastructure. Increasing attention to climate change, increasing societal expectations on companies to address climate change and changes in consumer preferences may result in increased costs, reduced demand for our products, reduced profits, risks associated with new regulatory requirements, risks to our reputation and the potential for increased litigation and governmental investigations. Climate change regulations at the federal, state or local level or in international jurisdictions could require us to further limit emissions associated with customer use of products we sell, change our manufacturing processes or product portfolio or undertake other activities that may require us to incur additional expense, which may be material. These requirements may increase the cost of, and/or diminish demand for, our ICE vehicles. See “Our operations and products are subject to extensive laws, regulations and policies, including those related to vehicle emissions and fuel economy standards, which can significantly increase our costs and affect how we do business.” In addition, in the U.S. and abroad there are an increasing number of sustainability-related rules and regulations that have been adopted or proposed. Such regulations may also subject us to new disclosure requirements, which could result in risks to our reputation or consumer demand for our products if we do not meet increasingly demanding stakeholder expectations and standards.Part of our strategy to address these risks includes our transition to EVs, which presents additional risks, including reduced demand for, and therefore profits from, our ICE vehicles, which we are using to fund our growth strategy; higher costs or reduced availability of materials related to EV technologies impacting profitability, particularly with respect to batteries and battery raw material; and risks related to the success of our EV strategy, particularly with respect to advancement of battery cell technology, charging infrastructure and competition. See “Our long-term strategy is dependent upon our ability to profitably deliver a broad portfolio of EVs” and “Our near-term profitability is dependent upon the success of our current line of full-size ICE SUVs and full-size ICE pickup trucks.”Finally, increased intensity, frequency or duration of storms, droughts or other severe weather events as a result of climate change may disrupt our production and the production, logistics, cost and procurement of products from our suppliers and timely delivery of vehicles to customers, and could negatively impact working conditions at our plants and those of our suppliers. Such weather events may also adversely impact the financial condition of our customers, and thereby reduce demand for our products and services. Any of the foregoing could have a material adverse effect on our financial condition and results of operations.Risks related to our operationsOur business is highly dependent upon global automobile market sales volume, which can be volatile. Because we have a high proportion of relatively fixed structural costs, small changes in sales volume can have a disproportionately large effect on our profitability. A number of economic and market conditions drive changes in new vehicle sales, including disruptions in the new vehicle supply chain, the availability and prices of used vehicles, levels of unemployment and inflation, availability of affordable financing, fluctuations in the cost of fuel, consumer confidence and demand for vehicles, political unrest or uncertainty, the occurrence of a public health crisis, barriers to trade and other global economic conditions. For a discussion of economic and market trends, see the "Overview" section in Part II, Item 7. MD&A. If our operating environment deteriorates for these or other reasons, such as a moderate to severe recession, it could lead to a significant decrease in new vehicle sales, which could materially and adversely affect our results of operations and financial condition.16Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESInflationary pressures and persistently high prices and uncertain availability of commodities, raw materials or other inputs used by us and our suppliers, or instability in logistics and related costs, could negatively impact our profitability. Increases in prices, including as a result of inflation and rising interest rates, for commodities, raw materials or other inputs that we and our suppliers use in manufacturing products, systems, components and parts, such as steel, precious metals, non-ferrous metals, critical minerals or other similar raw materials, or increases in logistics and related costs, have led and may continue to lead to higher production costs for parts, components and vehicles. In addition, any increase in the cost, or reduced availability, of critical materials for our EV propulsion systems, including lithium, nickel, cobalt and certain rare earth metals, could lead to higher production costs for our EVs and could impede our ability to successfully deliver on our EV strategy. Further, increasing global demand for, and uncertain supply of, such materials could disrupt our or our suppliers’ ability to obtain such materials in a timely manner and/or could lead to increased costs. Geopolitical risk, fluctuations in supply and demand, fluctuations in interest rates, any weakening of the U.S. dollar and other economic and political factors have created and may continue to create pricing pressure for commodities, raw materials and other inputs. These inflationary pressures could, in turn, negatively impact our profitability because we may not be able to pass all of those costs on to our customers or require our suppliers to absorb such costs.Our business in China subjects us to unique operational, competitive and regulatory risks. Our business in China is subject to aggressive competition from many of the largest global manufacturers and numerous domestic manufacturers as well as non-traditional market participants, such as domestic technology companies. In addition, our success in China depends upon our ability to adequately address unique market and consumer preferences driven by advancements related to EVs, infotainment, software-enabled connected services and other new technologies. Our ability to fully deploy our technologies in China may be impacted by evolving laws and regulations in the U.S. and China. Increased competition, continued U.S.-China trade tensions or weakening economic conditions in China, among other factors, may result in cost increases, price reductions, reduced sales, profitability and margins, and challenges to gaining or holding market share. In addition, the public health and policy response to COVID-19 in China may continue to present geopolitical, macroeconomic and operating challenges. Certain risks and uncertainties of doing business in China are solely within the control of the Chinese government, and Chinese law regulates the scope of our investments and business conducted within China. The Chinese government may adopt new regulations that may impact entities operating in China, potentially with little advance notice. In order to maintain access to the Chinese market, we may be required to comply with significant technical and other regulatory requirements, including under such regulatory actions, that are unique to the Chinese market, at times with short notice. These actions may increase the cost of doing business in China or limit how we may do business in China, which could materially and adversely affect the profitability and financial condition of our China business.We benefit from many ongoing strategic business relationships, and a significant amount of our operations are conducted by joint ventures, which we cannot operate solely for our benefit. We are engaged in many strategic business relationships, and we expect that such arrangements will continue to be an important factor in the growth and success of our business, particularly in light of industry consolidation. However, there are no assurances that we will be able to identify or secure suitable business relationships in the future or that our competitors will not capitalize on such opportunities before we do, or that any strategic business relationships that we enter into will be successful. If we are unable to successfully source and execute on strategic business relationships in the future, our overall growth could be impaired, and our business, prospects and results of operations could be materially adversely affected. In particular, to secure critical materials for production of EVs, we have entered, and plan to continue to enter, into offtake agreements with raw material suppliers and make investments in certain raw material suppliers. The terms of these offtake agreements may obligate us to purchase defined quantities of output over a specified period of time, subject to certain conditions. If we are unable to utilize or otherwise monetize the raw materials we are obligated to purchase under these offtake agreements, it could materially adversely affect our cash flows and increase our inventory. In addition, many of our operations, primarily in China and Korea as well as certain of our battery manufacturing operations in the U.S. and Canada, are carried out by joint ventures. In joint ventures we share ownership and management of a company with one or more parties who may not have the same goals, strategies, priorities or resources as we do and may compete with us outside the joint venture. Joint ventures are intended to be operated for the benefit of all co-owners, rather than for our exclusive benefit. Operating a business as a joint venture often requires additional organizational formalities as well as time-consuming procedures for sharing information and making decisions that must further take into consideration our partners' interests. In joint ventures we are required to foster our relationships with our co-owners as well as promote the overall success of the joint venture, and if a co-owner changes, relationships deteriorate or strategic objectives diverge, our success in the joint venture may be materially adversely affected. Further, some of the benefits from a successful joint venture are shared among the co-owners, therefore we do not receive all the benefits from our successful joint ventures.In addition, because we share ownership and management with one or more parties, we may have limited control over the actions of a joint venture, particularly when we own a minority interest. As a result, we may be unable to prevent violations of applicable laws or other misconduct by a joint venture or the failure to satisfy contractual obligations by one or more parties. Moreover, a joint venture may not be subject to the same financial reporting, corporate governance, or compliance approaches 17Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESthat we follow. To the extent another party makes decisions that negatively impact the joint venture or internal control issues arise within the joint venture, we may have to take responsive actions, or we may be subject to penalties, fines or other punitive actions for these activities.The international scale and footprint of our operations expose us to additional risks. We manufacture, sell and service products globally and rely upon an integrated global supply chain to deliver the raw materials, components, systems and parts that we need to manufacture our products. Our global operations subject us to extensive domestic and foreign legal and regulatory requirements, and a variety of other political, economic and regulatory risks, which may have a material adverse effect on our financial condition or results of operations, including: (1) changes in government leadership; (2) changes in trade compliance, labor, employment, tax, privacy, environmental and other laws, regulations or government policies impacting our overall business model or practices or restricting our ability to manufacture, purchase or sell products consistent with market demand and our business objectives; (3) political pressures to change any aspect of our business model or practices or that impair our ability to source raw materials, services, components, systems and parts, or manufacture products on competitive terms in a manner consistent with our business objectives (including with respect to full utilization of the incentives contemplated by the Inflation Reduction Act); (4) political uncertainty, instability, civil unrest, government controls over certain sectors (including as a result of Russia's invasion of Ukraine and related impacts of the global supply of oil and other raw materials) or human rights concerns; (5) political and economic tensions between governments and changes in international economic policies, including restrictions on the repatriation of dividends or in the export of technology, especially between China and the U.S.; (6) changes to customs requirements or procedures (e.g., inspections) or new or higher tariffs, for example, on products imported into or exported from the U.S., including under U.S. or other trade laws or measures; (7) new or evolving non-tariff barriers or domestic preference procurement requirements, or enforcement of, changes to, withdrawals from or impediments to implementing free trade agreements, or preferences of foreign nationals for domestically manufactured products; (8) changes in foreign currency exchange rates, particularly in Brazil and Argentina, and interest rates; (9) economic downturns or significant changes in conditions in the countries in which we operate; (10) differing local product preferences and product requirements, including government certification requirements related to, among other things, fuel economy, vehicle emissions, EVs and AVs, connected services and safety; (11) impact of changes to and compliance with U.S. and foreign countries’ export controls, economic sanctions and other similar measures; (12) liabilities resulting from U.S. and foreign laws and regulations, including, but not limited to, those related to the Foreign Corrupt Practices Act and certain other anti-corruption laws; (13) differing labor regulations, agreements, requirements and union relationships; (14) differing dealer and franchise regulations and relationships; (15) difficulties in obtaining financing in foreign countries for local operations; and (16) natural disasters, public health crises, including the occurrence of a contagious disease or illness, such as COVID-19, and other catastrophic events.Any significant disruption at one of our manufacturing facilities could disrupt our production schedule. We assemble vehicles at various facilities around the world. Our facilities are typically designed to produce particular models for particular geographic markets. No single facility is designed to manufacture our full range of vehicles. In some cases, certain facilities produce products, systems, components and parts that disproportionately contribute a greater degree to our profitability than others and create significant interdependencies among manufacturing facilities around the world. When these or other facilities become unavailable either temporarily or permanently for any number of reasons, including labor disruptions, supply chain disruptions, the occurrence of a contagious disease or illness or catastrophic weather events, whether or not as a result of climate change, the inability to manufacture at the affected facility has resulted, and may in the future result, in harm to our reputation, increased costs, lower revenues and the loss of customers. We may not be able to easily shift production to other facilities or to make up for lost production. Any new facility needed to replace an inoperable manufacturing facility would need to comply with the necessary regulatory requirements, need to satisfy our specialized manufacturing requirements and require specialized equipment.In addition, substantially all of our hourly employees are represented by unions and covered by collective bargaining agreements that must be negotiated from time-to-time, including at the local facility level. In 2023, our collective bargaining agreements with the UAW in the United States and Unifor in Canada, as well as collective bargaining agreements in Mexico, will expire, which will require negotiation of new agreements. As a result, we may be subject to an increased risk of strikes, work stoppages or other types of conflicts with labor unions and employees. Disruption in our suppliers’ operations have disrupted, and could in the future disrupt, our production schedule. Our automotive operations are dependent upon the continued ability of our suppliers to deliver the systems, components, raw materials and parts that we need to manufacture our products. Our use of “just-in-time” manufacturing processes allows us to maintain minimal inventory. As a result, our ability to maintain production is dependent upon our suppliers delivering sufficient quantities of systems, components, raw materials and parts on time to meet our production schedules. In some instances, we purchase systems, components, raw materials and parts that are ultimately derived from a single source and may be at an increased risk for supply disruptions. Any number of factors, including labor disruptions, catastrophic weather events, the occurrence of a public health crisis, such as a global pandemic, contractual or other disputes, unfavorable economic or industry conditions, delivery delays or other performance problems or financial difficulties or solvency problems, could disrupt our 18Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESsuppliers’ operations and lead to uncertainty in our supply chain or cause supply disruptions for us, which could, in turn, disrupt our operations, including the production of certain higher margin vehicles. If the COVID-19 pandemic continues to spread or reemerges and results in a prolonged period of travel, commercial, social and other similar restrictions, we could experience continued and/or additional global supply disruptions. When we experience supply disruptions, we may not be able to develop alternate sourcing quickly. Any disruption of our production schedule caused by an unexpected shortage of systems, components, raw materials or parts even for a relatively short period of time could cause us to alter production schedules, increase work-in-process inventory or suspend production entirely, which could cause a loss of revenues or an increase in working capital, which would adversely affect our profitability and financial condition.In particular, while the global semiconductor supply shortage is easing, it has had, and is continuing to have, wide-ranging effects across multiple industries, particularly the automotive industry, and it has impacted multiple suppliers that incorporate semiconductors into the parts they supply to us. As a result, the semiconductor supply shortage has had, and depending on how long it persists, could continue to have, a material impact on our operations.Pandemics, epidemics, disease outbreaks and other public health crises, such as the COVID-19 pandemic, have disrupted our business and operations, and future public health crises could materially adversely impact our business, financial condition, liquidity and results of operations. Pandemics, epidemics or disease outbreaks in the U.S. or globally, including the COVID-19 pandemic, has disrupted, and may in the future disrupt, our business, which could materially affect our results of operations, financial condition, liquidity and future expectations. Any such events may adversely impact our global supply chain and global manufacturing operations and cause us to again suspend our operations in the U.S., China and elsewhere. In particular, we could experience among other things: (1) continued or additional global supply disruptions, including a delayed recovery from the global semiconductor supply shortage; (2) labor disruptions; (3) an inability to manufacture; (4) an inability to sell to our customers; (5) a decline in showroom traffic and customer demand during and following the pandemic; (6) customer defaults on automobile loans and leases; (7) lower than expected pricing on vehicles sold at auction; and (8) an impaired ability to access credit and the capital markets. Any new pandemic or other public health crises, or future public health crises, could have a material impact on our business, financial condition and results of operations going forward.Risks related to our intellectual property, cybersecurity, information technology and data management practicesCompetitors may independently develop products and services similar to ours, and there are no guarantees that GM’s intellectual property rights would prevent competitors from independently developing or selling those products and services. There may be instances where, notwithstanding our intellectual property position, competitive products or services may impact the value of our brands and other intangible assets, and our business may be adversely affected. Moreover, although GM takes reasonable steps to maintain the confidentiality of GM proprietary information, there can be no assurance that such efforts will completely deter or prevent misappropriation or improper use of our intellectual property. We sometimes face attempts to gain unauthorized access to our information technology networks and systems for the purpose of improperly acquiring our trade secrets or confidential business information. The theft or unauthorized use or publication of our trade secrets and other confidential business information as a result of such an incident could adversely affect our competitive position. In addition, we have been, and in the future may be, the target of patent enforcement actions by third parties, including aggressive and opportunistic enforcement claims by non-practicing entities. Regardless of the merit of such claims, responding to infringement claims can be expensive and time-consuming. Although we have taken steps to mitigate such risks, if we are found to have infringed any third-party intellectual property rights, we could be required to pay substantial damages, or we could be enjoined from offering some of our products and services. In addition, to prevent unauthorized use of our intellectual property, it may be necessary to prosecute actions for infringement, misappropriation or other violation of our intellectual property against third parties. Any such action could result in significant costs and diversion of our resources and management’s attention, and there can be no assurance that we will be successful in any such action.Security breaches and other disruptions to information technology systems and networked products, including connected vehicles, owned or maintained by us, GM Financial, or third-parties, such as vendors or suppliers, could interfere with our operations and could compromise the confidentiality of private customer data or our proprietary information. We rely upon information technology systems and manufacture networked and connected products, some of which are managed by third parties, to process, transmit and store electronic information and to manage or support a variety of our business processes, activities and products. Additionally, we and GM Financial collect and store sensitive data, including intellectual property and proprietary business information (including that of our dealers and suppliers), as well as personally identifiable information of our customers and employees, in data centers and on information technology networks (including networks that may be controlled or maintained by third parties). The secure operation of these systems and products, and the processing and maintenance of the information processed by these systems and products, is critical to our business operations and strategy. Further, customers using our systems rely on the security of our infrastructure, including hardware and other elements provided by third parties, to ensure the reliability of our products and the protection of their data. We also face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that facilitate our business activities, including vendors, service providers, suppliers, customers, counterparties, exchanges, clearing agents, clearinghouses or other financial 19Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESintermediaries. Such parties and other third parties who provide us services or with whom we communicate could also be the source of a cyberattack on, or breach of, our operational systems, network, data or infrastructure. Despite our security measures and business continuity plans, our information technology systems and networked and connected products may be vulnerable to damage, disruptions or shutdowns caused by attacks by hackers, computer viruses, malware (including “ransomware”), phishing attacks or breaches due to errors or malfeasance by employees, contractors and others who have access to these systems and products. Techniques used in cybersecurity attacks to obtain unauthorized access, disable or sabotage information technology systems change frequently, as data breaches and other cybersecurity events have become increasingly commonplace, including as a result of the intensification of state-sponsored cybersecurity attacks during periods of geopolitical conflict, such as the ongoing conflict in Ukraine. The occurrence of any of these events could compromise the confidentiality, operational integrity and accessibility of these systems and products and the data that resides within them. Similarly, such an occurrence could result in the compromise or loss of the information processed by these systems and products. Such events could result in, among other things, the loss of proprietary data, interruptions or delays in our business operations and damage to our reputation. In addition, such events could increase the risk of claims alleging that we are non-compliant with applicable laws or regulations, subjecting us to potential liability or regulatory penalties and related costs under laws protecting the privacy of personal information; disrupt our operations; or reduce the competitive advantage we hope to derive from our investment in advanced technologies. Various events described above have occurred in the past and may occur in the future. Although impacts of past events have been immaterial, the impacts of such events in the future may be material.Security breaches and other disruptions of our in-vehicle systems could impact the safety of our customers and reduce confidence in GM and our products. Our vehicles contain complex information technology systems. These systems control various vehicle functions including engine, transmission, safety, steering, navigation, acceleration, braking, window, door lock functions and battery and electric motors. We have designed, implemented and tested security measures intended to prevent unauthorized access to these systems. However, hackers have reportedly attempted, and may attempt in the future, to gain unauthorized access to modify, alter and use such systems to gain control of, or to change, our vehicles’ functionality, user interface and performance characteristics, or to gain access to data stored in or generated by the vehicle. Any unauthorized access to or control of our vehicles or their systems could adversely impact the safety of our customers or result in legal claims or proceedings, liability or regulatory penalties. Laws that would permit third-party access to vehicle data and related systems could expose our vehicles and vehicle systems to third-party access without appropriate security measures in place, leading to new safety and security risks for our customers and reducing customer trust and confidence in our products. In addition, regardless of their veracity, reports of unauthorized access to our vehicles or their systems could negatively affect our brand and harm our reputation, which could adversely impact our business and operating results.Our enterprise data practices, including the collection, use, sharing and security of the Personal Identifiable Information of our customers, employees and suppliers, are subject to increasingly complex and restrictive regulations in all key market regions. Under these regulations, the failure to maintain compliant data practices could result in consumer complaints and regulatory inquiry, resulting in civil or criminal penalties, as well as brand impact or other harm to our business. In addition, increased consumer sensitivity to real or perceived failures in maintaining acceptable data practices could damage our reputation and deter current and potential users or customers from using our products and services. The cost of compliance with these laws and regulations will be high and is likely to increase in the future. The growing patchwork of state and country regulations imposes burdensome obligations on companies to quickly respond to consumer requests, such as requests to delete, disclose and stop selling personal information, with significant fines for noncompliance. Complying with these new laws has significantly increased, and may continue to increase, our operating costs and is driving increased complexity in our operations.Risks related to government regulations and litigationOur operations and products are subject to extensive laws, regulations and policies, including those related to vehicle emissions and fuel economy standards, which can significantly increase our costs and affect how we do business. We are significantly affected by governmental regulations on a global basis that can increase costs related to the production of our vehicles and affect our product portfolio, particularly regulations relating to fuel economy standards and GHG emissions. Meeting or exceeding the requirements of these regulations is costly, often technologically challenging and may require phase-out of internal combustion propulsion in certain major jurisdictions, and these standards are often not harmonized across jurisdictions. We anticipate that the number and extent of these and other regulations, laws and policies, and the related costs and changes to our product portfolio, may increase significantly in the future, primarily motivated by efforts to reduce GHG emissions. Specifically, fuel economy and GHG emission regulations at the federal, state or local level or in international jurisdictions could require us to further limit the sale of certain profitable products, subsidize the sale of less profitable ones, change our manufacturing processes, pay penalties or undertake other activities that may require us to incur additional expense, which may be material. These requirements may increase the cost of, and/or diminish demand for, our vehicles. These regulatory requirements, among others, could significantly affect our plans for global product development and, given the uncertainty surrounding enforcement and regulatory definitions and interpretations, may result in substantial costs, including civil or criminal penalties. In addition, an evolving but un-harmonized emissions and fuel economy regulatory framework that could include specific sales mandates may limit or dictate the types of vehicles we sell and where we sell them, which can 20Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESaffect our revenues. Refer to the “Environmental and Regulatory Matters” section of Item 1. Business for further information on regulatory and environmental requirements.We expect that to comply with fuel economy and GHG emission standards and mandates to sell specific volumes of ZEV in certain jurisdictions, we will be required to sell a significant volume of EVs, and potentially develop and implement new technologies for conventional internal combustion engines, all of which will require substantial investment and expense. There are limits on our ability to achieve fuel economy improvements over a given time frame, primarily relating to the cost and effectiveness of available technologies, lack of sufficient consumer acceptance of new technologies and of changes in vehicle mix, lack of willingness of consumers to absorb the additional costs of new technologies, the appropriateness (or lack thereof) of certain technologies for use in particular vehicles, the widespread availability (or lack thereof) of supporting infrastructure for new technologies, especially for EVs, and the human, engineering and financial resources necessary to deploy new technologies across a wide range of products and powertrains in a short time. There is no assurance that we will be able to produce and sell vehicles that use such new technologies on a profitable basis or that our customers will purchase such vehicles in the quantities necessary for us to comply with current or future regulatory requirements.In the current uncertain regulatory framework, compliance costs for which we may be responsible and that are not reasonably estimable could be substantial. Alleged violations of fuel economy or emission standards could result in legal proceedings, the recall of one or more of our products, negotiated remedial actions, fines, restricted product offerings or a combination of any of those items. Any of these actions could have a material adverse effect on our profitability, financial condition and operations, including facility idling, reduced employment, increased costs and loss of revenue.In addition, many of our advanced technologies, including AVs, present novel issues with which domestic and foreign regulators have only limited experience, and will be subject to evolving regulatory frameworks. Any current or future regulations in these areas could impede the successful commercialization of these technologies and impact whether and how these technologies are designed and integrated into our products, and may ultimately subject us to increased costs and uncertainty.We could be materially adversely affected by unusual or significant litigation, governmental investigations or other proceedings. We are subject to legal proceedings in the U.S. and elsewhere involving various issues, including product liability lawsuits, warranty litigation, class action litigations alleging product defects, emissions litigation, stockholder litigation, labor and employment litigation and claims and actions arising from restructurings and divestitures of operations and assets. In addition, we are subject to governmental proceedings and investigations. A negative outcome in one or more of these legal proceedings could result in the imposition of damages, including punitive damages, fines, reputational harm, civil lawsuits and criminal penalties, interruptions of business, modification of business practices, equitable remedies and other sanctions against us or our personnel as well as legal and other costs, all of which may be significant. For a further discussion of these matters refer to Note 16 to our consolidated financial statements.The costs and effect on our reputation of product safety recalls and alleged defects in products and services could materially adversely affect our business. Government safety standards require manufacturers to remedy certain product safety defects through recall campaigns and vehicle repurchases. Under these standards, we could be subject to civil or criminal penalties or may incur various costs, including significant costs for repairs made at no cost to the consumer. The costs we incur in connection with these recalls typically include the cost of the part being replaced and labor to remove and replace the defective part. The costs to complete a recall could be exacerbated to the extent that such action relates to a global platform. Concerns about the safety of our products, including advanced technologies like AVs, whether raised internally or by regulators or consumer advocates, and whether or not based on scientific evidence or supported by data, can result in product delays, recalls, field actions, lost sales, governmental investigations, regulatory action, private claims, lawsuits and settlements and reputational damage. These circumstances can also result in damage to brand image, brand equity and consumer trust in our products and ability to lead the disruption occurring in the automotive industry.We currently source a variety of systems, components, raw materials and parts from third parties. From time to time these items may have performance or quality issues that could harm our reputation and cause us to incur significant costs, particularly if the affected items relate to global platforms or involve defects that are identified years after production. Our ability to recover costs associated with recalls or other campaigns caused by parts or components purchased from suppliers may be limited by the suppliers’ financial condition or a number of other reasons or defenses.We may incur additional tax expense or become subject to additional tax exposure. We are subject to the tax laws and regulations of the U.S. and numerous other jurisdictions in which we do business. Many judgments are required in determining our worldwide provision for income taxes and other tax liabilities, and we are regularly under audit by the U.S. Internal Revenue Service and other tax authorities, which may not agree with our tax positions. In addition, our tax liabilities are subject to other significant risks and uncertainties, including those arising from potential changes in laws and regulations in the countries in which we do business, the possibility of adverse determinations with respect to the application of existing laws (in 21Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESparticular with respect to full realization of the incentives contemplated by the Inflation Reduction Act), changes in our business or structure and changes in the valuation of our deferred tax assets and liabilities. Any unfavorable resolution of these and other uncertainties may have a significant adverse impact on our tax rate and results of operations. If our tax expense were to increase, or if the ultimate determination of our taxes owed is for an amount in excess of amounts previously accrued, our operating results, cash flows and financial condition could be adversely affected.Risks related to Automotive Financing - GM Financial We rely on GM Financial to provide financial services to our customers and dealers. GM Financial faces a number of business, economic and financial risks that could impair its access to capital and negatively affect its business and operations, which in turn could impede its ability to provide leasing and financing to customers and commercial lending to our dealers. Any reduction in GM Financial’s ability to provide such financial services would negatively affect our efforts to support additional sales of our vehicles and expand our market penetration among customers and dealers.The primary factors that could adversely affect GM Financial’s business and operations and reduce its ability to provide financing services at competitive rates include the sufficiency, availability and cost of sources of financing, including credit facilities, securitization programs and secured and unsecured debt issuances; the performance of loans and leases in its portfolio, which could be materially affected by charge-offs, delinquencies and prepayments; wholesale auction values of used vehicles; vehicle return rates and the residual value performance on vehicles GM Financial leases to customers; fluctuations in interest rates and currencies; competition for customers from commercial banks, credit unions and other financing and leasing companies; and changes to regulation, supervision, enforcement and licensing across various jurisdictions.In addition, GM Financial has certain floating-rate obligations, hedging transactions and floating-rate dealer loans that determine their applicable interest rate or payment amount by reference to the London Interbank Offered Rate (LIBOR). The United Kingdom Financial Conduct Authority, which regulates LIBOR, has announced that it will no longer persuade or compel banks to submit rates for the calculation of LIBOR. In March 2021, the ICE Benchmark Administration Limited, the administrator of LIBOR, extended the transition dates of certain U.S. Dollar LIBOR tenors to June 30, 2023, after which LIBOR reference rates will cease to be provided. Despite this deferral, the LIBOR administrator has advised that no new contracts using U.S. Dollar LIBOR should be entered into after December 31, 2021. It is unknown whether LIBOR will continue to be published by its administrator based on continued bank submissions or on any other basis, after such dates. There is a risk that continued developments, modifications, or other reforms effecting the discontinuation of LIBOR may impact GM Financial's ability to manage interest rate risk effectively. Further, as an entity operating in the financial services sector, GM Financial is required to comply with a wide variety of laws and regulations that may be costly to adhere to and may affect our consolidated operating results. Compliance with these laws and regulations requires that GM Financial maintain forms, processes, procedures, controls and the infrastructure to support these requirements, and these laws and regulations often create operational constraints both on GM Financial’s ability to implement servicing procedures and on pricing. Laws in the financial services industry are designed primarily for the protection of consumers. The failure to comply with these laws could result in significant statutory civil and criminal penalties, monetary damages, attorneys’ fees and costs, possible revocation of licenses and damage to reputation, brand and valued customer relationships.Risks related to defined benefit pension plansOur pension funding requirements could increase significantly due to a reduction in funded status as a result of a variety of factors, including weak performance of financial markets, declining interest rates, changes in laws or regulations, or changes in assumptions or investments that do not achieve adequate returns. Our employee benefit plans currently hold a significant amount of equity and fixed income securities. A detailed description of the investment funds and strategies and our potential funding requirements are disclosed in Note 15 to our consolidated financial statements, which also describes significant concentrations of risk to the plan investments.Our future funding requirements for our defined benefit pension plans depend upon the future performance of assets placed in trusts for these plans, the level of interest rates used to determine funding levels, the level of benefits provided for by the plans and any changes in laws and regulations. Future funding requirements generally increase if the discount rate decreases or if actual asset returns are lower than expected asset returns, assuming other factors are held constant. We estimate future contributions to these plans using assumptions with respect to these and other items. Changes to those assumptions could have a significant effect on future contributions.There are additional risks due to the complexity and magnitude of our investments. Examples include implementation of significant changes in investment policy, insufficient market liquidity in particular asset classes and the inability to quickly rebalance illiquid and long-term investments.22Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESFactors that affect future funding requirements for our U.S. defined benefit plans generally affect the required funding for non-U.S. plans. Certain plans outside the U.S. do not have assets and therefore the obligation is funded as benefits are paid. If local legal authorities increase the minimum funding requirements for our non-U.S. plans, we could be required to contribute more funds, which could negatively affect our liquidity and financial condition.* * * * * * *Item 1B. Unresolved Staff CommentsNone.* * * * * * *Item 2. Properties At December 31, 2022, we had over 100 locations in the U.S. (excluding our automotive financing operations and dealerships), which are primarily for manufacturing, assembly, distribution, warehousing, engineering and testing. We, our subsidiaries or associated companies in which we own an equity interest, own most of these properties and/or lease a portion of these properties. Leased properties are primarily composed of warehouses and administration, engineering and sales offices.We have manufacturing, assembly, distribution, office or warehousing operations in 29 countries, including equity interests in associated companies, which perform manufacturing, assembly or distribution operations. The major facilities outside the U.S., which are principally vehicle manufacturing and assembly operations, are located in Brazil, Canada, China, Mexico and South Korea.GM Financial owns or leases facilities for administration and regional credit centers. GM Financial has 35 facilities, of which 22 are located in the U.S. The major facilities outside the U.S. are located in Brazil, Canada, China and Mexico. * * * * * * *Item 3. Legal ProceedingsSEC regulations require us to disclose certain information about environmental proceedings if a governmental authority is a party to such proceedings and such proceedings involve potential monetary sanctions that we reasonably believe will exceed a stated threshold. Pursuant to the SEC regulations, the Company will use a threshold of $1 million for purposes of determining whether disclosure of any such proceedings is required. The discussion under Note 16 to our consolidated financial statements is incorporated by reference into this Part I, Item 3.* * * * * * *Item 4. Mine Safety DisclosuresNot applicable.* * * * * * *PART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesMarket Information Shares of our common stock are publicly traded on the New York Stock Exchange under the symbol "GM". Holders At January 17, 2023, we had 1.4 billion issued and outstanding shares of common stock held by 472 holders of record.23Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESDividends In September 2022, our Board of Directors reinstated a quarterly dividend of $0.09 per share of our common stock. We anticipate that we will continue to declare and pay dividends on our common stock quarterly. However, the declaration of any dividend on our common stock is a matter to be acted upon by our Board of Directors in its sole discretion and will depend on various factors, including our financial condition, operating results, available cash, and current and anticipated cash needs, as described further in the "Liquidity and Capital Resources" section of the MD&A.Stock Performance Graph The following graph compares the performance of our common stock to the Standard & Poor's 500 Stock Index and the Dow Jones Automobile & Parts Titans 30 Index for the last five years. It assumes $100 was invested on December 31, 2017, with dividends being reinvested.The following table summarizes stock performance graph data points in dollars:Years ended December 31, 201720182019202020212022General Motors Company$100 $85 $97 $113 $159 $91 S&P 500 Stock Index $100 $96 $126 $149 $192 $157 Dow Jones Automobile & Parts Titans 30 Index $100 $79 $89 $135 $169 $115 24Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESPurchases of Equity Securities The following table summarizes our purchases of common stock in the three months ended December 31, 2022:Total Number of Shares Purchased(a)(b)Weighted Average Price Paid per Share(c)Total Number of Shares Purchased Under Announced Programs(b)Approximate Dollar Value of Shares That May Yet be Purchased Under Announced ProgramsOctober 1, 2022 through October 31, 2022313,425 $32.09 — $3.5 billionNovember 1, 2022 through November 30, 20228,540,718 $39.71 8,540,718 $3.2 billionDecember 1, 2022 through December 31, 202217,604,218 $37.57 17,591,600 $2.5 billionTotal26,458,361 $38.20 26,132,318 __________(a) Shares purchased include shares delivered by employees or directors to us for the payment of taxes resulting from issuance of common stock upon the vesting of Restricted Stock Units (RSUs) and Performance Stock Units (PSUs) relating to compensation plans. In June 2020, our shareholders approved the 2020 Long-Term Incentive Plan (LTIP), which authorizes awards of stock options, stock appreciation rights, RSUs, PSUs or other stock-based awards to selected employees, consultants, advisors and non-employee Directors of the Company. Refer to Note 22 to our consolidated financial statements for additional details on employee stock incentive plans.(b) In January 2017, we announced that our Board of Directors had authorized the purchase of up to $5.0 billion of our common stock with no expiration date. In August 2022, the Board of Directors increased the capacity to $5.0 billion from the $3.3 billion that remained as of June 30, 2022, with no expiration date.(c) The weighted-average price paid per share excludes broker commissions. * * * * * * *Item 6. [Reserved]* * * * * * *Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThis MD&A should be read in conjunction with the accompanying audited consolidated financial statements and notes. Forward-looking statements in this MD&A are not guarantees of future performance and may involve risks and uncertainties that could cause actual results to differ materially from those projected. Refer to the "Forward-Looking Statements" section of this MD&A and Part I, Item 1A. Risk Factors for a discussion of these risks and uncertainties. The discussion of our financial condition and results of operations for the year ended December 31, 2020 included in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2021 is incorporated by reference into this MD&A. Non-GAAP Measures Our non-GAAP measures include: earnings before interest and taxes (EBIT)-adjusted, presented net of noncontrolling interests; earnings before income taxes (EBT)-adjusted for our GM Financial segment; earnings per share (EPS)-diluted-adjusted; effective tax rate-adjusted (ETR-adjusted); return on invested capital-adjusted (ROIC-adjusted) and adjusted automotive free cash flow. Our calculation of these non-GAAP measures may not be comparable to similarly titled measures of other companies due to potential differences between companies in the method of calculation. As a result, the use of these non-GAAP measures has limitations and should not be considered superior to, in isolation from, or as a substitute for, related U.S. GAAP measures. These non-GAAP measures allow management and investors to view operating trends, perform analytical comparisons and benchmark performance between periods and among geographic regions to understand operating performance without regard to items we do not consider a component of our core operating performance. Furthermore, these non-GAAP measures allow investors the opportunity to measure and monitor our performance against our externally communicated targets and evaluate the investment decisions being made by management to improve ROIC-adjusted. Management uses these measures in its financial, investment and operational decision-making processes, for internal reporting and as part of its forecasting and budgeting processes. Further, our Board of Directors uses certain of these and other measures as key metrics to determine management performance under our performance-based compensation plans. For these reasons, we believe these non-GAAP measures are useful for our investors. 25Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESEBIT-adjusted EBIT-adjusted is presented net of noncontrolling interests and is used by management and can be used by investors to review our consolidated operating results because it excludes automotive interest income, automotive interest expense and income taxes as well as certain additional adjustments that are not considered part of our core operations. Examples of adjustments to EBIT include, but are not limited to, impairment charges on long-lived assets and other exit costs resulting from strategic shifts in our operations or discrete market and business conditions, and certain costs arising from legal matters. For EBIT-adjusted and our other non-GAAP measures, once we have made an adjustment in the current period for an item, we will also adjust the related non-GAAP measure in any future periods in which there is an impact from the item. Our corresponding measure for our GM Financial segment is EBT-adjusted because interest income and interest expense are part of operating results when assessing and measuring the operational and financial performance of the segment. EPS-diluted-adjusted EPS-diluted-adjusted is used by management and can be used by investors to review our consolidated diluted EPS results on a consistent basis. EPS-diluted-adjusted is calculated as net income attributable to common stockholders-diluted less adjustments noted above for EBIT-adjusted and certain income tax adjustments divided by weighted-average common shares outstanding-diluted. Examples of income tax adjustments include the establishment or reversal of significant deferred tax asset valuation allowances. ETR-adjusted ETR-adjusted is used by management and can be used by investors to review the consolidated effective tax rate for our core operations on a consistent basis. ETR-adjusted is calculated as Income tax expense less the income tax related to the adjustments noted above for EBIT-adjusted and the income tax adjustments noted above for EPS-diluted-adjusted divided by Income before income taxes less adjustments. When we provide an expected adjusted effective tax rate, we do not provide an expected effective tax rate because the U.S. GAAP measure may include significant adjustments that are difficult to predict. ROIC-adjusted ROIC-adjusted is used by management and can be used by investors to review our investment and capital allocation decisions. We define ROIC-adjusted as EBIT-adjusted for the trailing four quarters divided by ROIC-adjusted average net assets, which is considered to be the average equity balances adjusted for average automotive debt and interest liabilities, exclusive of finance leases; average automotive net pension and other postretirement benefits (OPEB) liabilities; and average automotive net income tax assets during the same period.Adjusted automotive free cash flow Adjusted automotive free cash flow is used by management and can be used by investors to review the liquidity of our automotive operations and to measure and monitor our performance against our capital allocation program and evaluate our automotive liquidity against the substantial cash requirements of our automotive operations. We measure adjusted automotive free cash flow as automotive operating cash flow from operations less capital expenditures adjusted for management actions. Management actions can include voluntary events such as discretionary contributions to employee benefit plans or nonrecurring specific events such as a closure of a facility that are considered special for EBIT-adjusted purposes. Refer to the “Liquidity and Capital Resources” section of this MD&A for additional information.26Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESThe following table reconciles Net income attributable to stockholders under U.S. GAAP to EBIT-adjusted: Years Ended December 31,202220212020Net income attributable to stockholders$9,934 $10,019 $6,427 Income tax expense1,888 2,771 1,774 Automotive interest expense987 950 1,098 Automotive interest income(460)(146)(241)AdjustmentsCruise compensation modifications(a)1,057 — — Russia exit(b)657— — Buick dealer strategy(c)511— — Patent royalty matters(d)(100)250 — GM Brazil indirect tax matters(e)— 194 — Cadillac dealer strategy(f)— 175 99 GM Korea wage litigation(g)— 82 — GMI restructuring(h)— — 683 Ignition switch recall and related legal matters(i)— — (130)Total adjustments2,125 701 652 EBIT-adjusted$14,474 $14,295 $9,710 ________(a)This adjustment was excluded because it relates to the one-time modification of Cruise stock incentive awards.(b)This adjustment was excluded because it relates to the shutdown of our Russia business including the write off of our net investment and release of accumulated translation losses into earnings.(c)This adjustment was excluded because it relates to strategic activities to transition certain Buick dealers out of our dealer network as part of Buick’s EV strategy. In 2023, we expect to incur additional charges as we continue to optimize our Buick dealer network. The ultimate amount of any future charges will depend on negotiations with our dealers.(d)These adjustments were excluded because they relate to certain royalties accrued with respect to past-year vehicle sales in 2021 and the resolution of substantially all of these matters in 2022.(e)This adjustment was excluded because it relates to a settlement with third parties relating to retrospective recoveries of indirect taxes in Brazil realized in prior periods. (f)These adjustments were excluded because they relate to strategic activities to transition certain Cadillac dealers out of our dealer network as part of Cadillac's EV strategy.(g)This adjustment was excluded because of the unique events associated with Supreme Court of the Republic of Korea (Korea Supreme Court) decisions related to our salaried workers.(h)This adjustment was excluded because of a strategic decision to rationalize our core operations by exiting or significantly reducing our presence in various international markets to focus resources on opportunities expected to deliver higher returns. The adjustments primarily consist of dealer restructurings, asset impairments, inventory provisions and employee separation charges in Australia, New Zealand, Thailand and India.(i)This adjustment was excluded because of the unique events associated with the ignition switch recall.27Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESThe following table reconciles diluted earnings per common share under U.S. GAAP to EPS-diluted-adjusted:Years Ended December 31,202220212020AmountPer ShareAmountPer ShareAmountPer ShareDiluted earnings per common share$8,915 $6.13 $9,837 $6.70 $6,247 $4.33 Adjustments(a)2,125 1.46 701 0.47 652 0.46 Tax effect on adjustments(b)(423)(0.29)(105)(0.07)(70)(0.05)Tax adjustments(c)(482)(0.33)(51)(0.03)236 0.16 Deemed dividend adjustment(d)909 0.63 — — — — EPS-diluted-adjusted$11,044 $7.59 $10,382 $7.07 $7,065 $4.90 ________(a) Refer to the reconciliation of Net income attributable to stockholders under U.S. GAAP to EBIT-adjusted within this section of the MD&A for adjustment details. (b) The tax effect of each adjustment is determined based on the tax laws and valuation allowance status of the jurisdiction to which the adjustment relates. (c) In the year ended December 31, 2022, the adjustment consists of tax benefit related to the release of a valuation allowance against deferred tax assets considered realizable as a result of Cruise tax reconsolidation. In the year ended December 31, 2021, the adjustments consist of tax benefits related to a deduction for an investment in a subsidiary and resolution of uncertainty relating to an indirect tax refund claim in Brazil, partially offset by tax expense related to the establishment of a valuation allowance against Cruise deferred tax assets. In the year ended December 31, 2020, the adjustment consists of tax expense related to the establishment of a valuation allowance against deferred tax assets in Australia and New Zealand. This adjustment was excluded because significant impacts of valuation allowances are not considered part of our core operations. (d) This adjustment consists of a deemed dividend related to the redemption of Cruise preferred shares from SoftBank Vision Fund (AIV M2) L.P. (SoftBank) in the year ended December 31, 2022.The following table reconciles our effective tax rate under U.S. GAAP to ETR-adjusted: Years Ended December 31,202220212020Income before income taxesIncome tax expenseEffective tax rateIncome before income taxesIncome tax expenseEffective tax rateIncome before income taxesIncome tax expenseEffective tax rateEffective tax rate$11,597 $1,888 16.3 %$12,716 $2,771 21.8 %$8,095 $1,774 21.9 %Adjustments(a)2,221 423 726 105 652 70 Tax adjustments(b) 482 51 (236)ETR-adjusted$13,818 $2,793 20.2 %$13,442 $2,927 21.8 %$8,747 $1,608 18.4 %________(a) Refer to the reconciliation of Net income attributable to stockholders under U.S. GAAP to EBIT-adjusted within this section of the MD&A for adjustment details. Net income attributable to noncontrolling interests for these adjustments is included in the years ended December 31, 2022 and 2021. The tax effect of each adjustment is determined based on the tax laws and valuation allowance status of the jurisdiction to which the adjustment relates. (b) Refer to the reconciliation of diluted earnings per common share under U.S. GAAP to EPS-diluted-adjusted within this section of the MD&A for adjustment details.We define return on equity (ROE) as Net income attributable to stockholders for the trailing four quarters divided by average equity for the same period. Management uses average equity to provide comparable amounts in the calculation of ROE. The following table summarizes the calculation of ROE (dollars in billions):Years Ended December 31,202220212020Net income attributable to stockholders$9.9 $10.0 $6.4 Average equity(a)$66.6 $56.5 $43.3 ROE14.9 %17.7 %14.9 %________(a) Includes equity of noncontrolling interests where the corresponding earnings (loss) are included in Net income attributable to stockholders. 28Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESThe following table summarizes the calculation of ROIC-adjusted (dollars in billions): Years Ended December 31,202220212020EBIT-adjusted(a)$14.5 $14.3 $9.7 Average equity(b)$66.6 $56.5 $43.3 Add: Average automotive debt and interest liabilities (excluding finance leases)17.6 17.1 27.8 Add: Average automotive net pension & OPEB liability9.4 15.8 17.6 Less: Average automotive net income tax asset(21.2)(22.2)(24.0)ROIC-adjusted average net assets$72.3 $67.2 $64.7 ROIC-adjusted20.0 %21.3 %15.0 %________(a) Refer to the reconciliation of Net income attributable to stockholders under U.S. GAAP to EBIT-adjusted within this section of the MD&A.(b) Includes equity of noncontrolling interests where the corresponding earnings (loss) are included in EBIT-adjusted. Overview Our vision for the future is a world with zero crashes, zero emissions and zero congestion, which guides our growth-focused strategy to invest in EVs and AVs, software-enabled services and subscriptions and new business opportunities, while strengthening our market position in profitable ICE vehicles, such as trucks and SUVs. We will execute our strategy with a diverse team and a steadfast commitment to good citizenship through sustainable operations and a leading health and safety culture.The automotive industry and GM continue to experience supply chain and logistics disruptions from multiple suppliers that have impacted, and may continue to impact, our planned production schedules. Despite these challenges, in the second half of 2022, we experienced improved parts availability that enabled us to increase production and improve dealer inventory levels for certain vehicles.In addition, we faced significant inflationary pressure in 2022 that resulted in approximately $5.5 billion in higher commodity and logistics costs. These increases were more than offset by strong product pricing. While we anticipate incentives to increase from the low levels in 2022, we expect product pricing to remain strong in 2023, particularly for our full-size SUVs, full-size trucks and expected new launches. We also expect commodity and logistics cost to improve, but be partially offset by costs we expect to incur as we strategically localize our battery raw materials supply chain in North America. Refer to the Consolidated Results and regional analysis sections of this MD&A for additional information.In 2022, the Board of Governors of the Federal Reserve System raised interest rates to lower the rate of inflation. The higher interest rate environment did not have a material impact on our 2022 financial results, but we expect it will have an approximately $1.0 billion unfavorable impact on our results of operations in 2023, as a result of lower forecasted pension income. Refer to the Critical Accounting Estimates section of this MD&A for additional information including our interest rate sensitivity analysis. We expect higher interest rates to have an immaterial impact on our Automotive interest expense in 2023, as substantially all of our debt instruments are fixed rate. For a discussion of the net interest income sensitivity of GM Financial, see Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Furthermore, holding other factors constant, the higher interest rate environment may decrease the affordability of our vehicles for customers who rely on financing to purchase a vehicle.We also face continuing market, operating and regulatory challenges in several countries across the globe due to, among other factors, competitive pressures, our product portfolio offerings, heightened emission standards, potentially weakening economic conditions, labor disruptions, foreign exchange volatility, evolving trade policy and political uncertainty. Refer to Part I, Item 1A. Risk Factors for a discussion of these challenges. We also continue to monitor the impact of the COVID-19 pandemic, and government actions and measures taken to prevent its spread, and the potential to affect our operations. Refer to Part I, Item 1A. Risk Factors for further discussion of these risks.29Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESAs we continue to assess our performance and the needs of our evolving business, additional restructuring and rationalization actions could be required. These actions could give rise to future asset impairments or other charges, which may have a material impact on our operating results.On August 16, 2022, the Inflation Reduction Act of 2022 (the “Act”) was signed into law. The Act implements a new 15% corporate minimum tax based on modified U.S. financial statement net income that is effective beginning in 2023. The new corporate minimum tax is not expected to have a significant impact on our net earnings or cash flow in 2023. The Act also modified climate and clean energy corporate tax provisions, including the consumer credit for EV purchases, and beginning in 2023, new tax credits for commercial EV purchases and investments in clean energy production, supply chains and manufacturing facilities became effective. We expect to generate commercial EV tax credits and credits from our production of battery components that will increase net income and impact income tax cash payments. While waiting on pending Department of Treasury regulatory guidance, we are continuing to evaluate the ultimate impact of the tax credits on our financial results, including our net earnings and cash flow.For the year ending December 31, 2023, we expect EPS-diluted and EPS-diluted-adjusted of between $6.00 and $7.00, Net income attributable to stockholders of between $8.7 billion and $10.1 billion and EBIT-adjusted of between $10.5 billion and $12.5 billion. We do not consider the potential impact of future adjustments on our expected financial results.The following table reconciles expected Net income attributable to stockholders under U.S. GAAP to expected EBIT-adjusted (dollars in billions):Year Ending December 31, 2023Net income attributable to stockholders$ 8.7-10.1Income tax expense 1.6-2.2Automotive interest expense, net0.2EBIT-adjusted(a)$ 10.5-12.5________(a)We do not consider the potential future impact of adjustments on our expected financial results.GMNA Industry sales in North America were 17.3 million units in the year ended December 31, 2022, representing a decrease of 6.6% compared to the corresponding period in 2021. U.S. industry sales were 14.2 million units in the year ended December 31, 2022, representing a decrease of 7.9% compared to the corresponding period in 2021. The COVID-19 pandemic originally resulted in a contraction of total North America industry volumes in 2020 that continued through 2022. Dealer inventory remains constrained for several critical vehicles, including our full-size SUVs.Our total vehicle sales in the U.S., our largest market in North America, were 2.3 million units for a market share of 16.0% in the year ended December 31, 2022, representing an increase of 1.6 percentage points compared to the corresponding period in 2021. We expect to sustain relatively strong EBIT-adjusted margins in 2023 on the continued strength of vehicle pricing and healthy U.S. industry light vehicle demand, partially offset by elevated costs associated with commodities, raw materials and logistics. Our outlook is dependent on the pricing environment, continuing improvement of supply chain availability and overall economic conditions. As a result of supply chain disruptions in 2022, we experienced interruptions to our planned production schedules and prioritized production of our most popular and in-demand products, including our full-size trucks, full-size SUVs and EVs.In 2023, our collective bargaining agreements with the UAW in the United States and Unifor in Canada, as well as collective bargaining agreements in Mexico, will expire, which will require negotiation of new agreements. Refer to Part I, Item 1A. Risk Factors for a discussion of the risks related to any significant disruption at one of our manufacturing facilities.GMI Industry sales in China were 23.5 million units in the year ended December 31, 2022, representing a decrease of 9.2% compared to the corresponding period in 2021. Our total vehicle sales in China were 2.3 million units resulting in a market share of 9.8% in the year ended December 31, 2022, representing a decrease of 1.4 percentage points compared to the corresponding period in 2021. The ongoing supply chain disruptions, macro-economic impact of COVID-19 and geopolitical tensions continue to place pressure on China's automotive industry and our vehicle sales in China. Our Automotive China JVs 30Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESgenerated equity income of $0.7 billion in the year ended December 31, 2022. Although price competition, higher costs associated with commodities and raw materials, and a more challenging regulatory environment related to emissions, fuel consumption and NEV requirements will place pressure on our operations in China, we will continue to build upon our strong brands, network, and partnerships in China as well as drive improvements in vehicle mix and cost.Outside of China, industry sales were 23.7 million units in the year ended December 31, 2022, representing an increase of 2.5% compared to the corresponding period in 2021. Our total vehicle sales outside of China were 1.0 million units for a market share of 4.0% in the year ended December 31, 2022, representing an increase of 0.4 percentage points compared to the corresponding period in 2021.We historically operated a small import business in Russia and sold GM-badged vehicles into Russia through GM’s alliance partner in Uzbekistan. GM’s direct and indirect profitability in Russia was insignificant. With Russia’s invasion of Ukraine, western sanctions on Russia have and may continue to progressively increase. In addition, reputational, legal and other concerns impacted our ability to continue to operate in Russia. In February 2022, we suspended our exports into Russia and instructed our Russian sales company to cease selling vehicles within Russia. In April 2022, we took additional actions to extend the suspension of our Russian business, including the cessation of commercial operations. In November 2022, we shut down our Russia business and recorded a $0.7 billion charge to write off our net investment and release accumulated translation losses into earnings. The predominately non-cash charge associated with our exit is considered special for EBIT-adjusted, adjusted automotive free cash flow and EPS-diluted-adjusted purposes. Currently, we do not believe any loss contingencies arising from our exit are probable and we are unable to estimate any reasonably possible losses that may result from claims that may be asserted against us by third parties, including retail customers or government authorities in Russia.We continue to monitor the situation and its macroeconomic impacts on our financial position and results of operations. Although we have limited supply chain exposure to Russia and Ukraine, we are working closely with our supply base to mitigate any potential risks.Cruise Gated by safety and regulation, Cruise continues to make significant progress towards commercialization of a network of on-demand AVs in the United States and globally. In 2021, Cruise received a driverless test permit from the California Public Utilities Commission (CPUC) to provide unpaid rides to the public in driverless vehicles and received approval of its Autonomous Vehicle Deployment Permit from the California Department of Motor Vehicles to commercially deploy driverless AVs. In June 2022, Cruise received the first ever Driverless Deployment Permit granted by the CPUC, which allows them to charge a fare for the driverless rides they are providing to members of the public in certain parts of San Francisco. Additionally, in September 2022, Cruise acquired regulatory permits to operate driverless ride hail services in Phoenix, Arizona and began pursuing ride hail operations in Austin, Texas. GM and Cruise are also awaiting a decision on an exemption petition that was filed with NHTSA seeking regulatory approval for the deployment of the Cruise Origin. Refer to the "Liquidity and Capital Resources" section of this MD&A for information about GM's additional investment in Cruise.Automotive Financing - GM Financial Summary and Outlook We believe that offering a comprehensive suite of financing products will generate incremental sales of our vehicles, drive incremental GM Financial earnings and help support our sales throughout various economic cycles. GM Financial's leasing program is exposed to residual values, which are heavily dependent on used vehicle prices. Used vehicle prices were generally higher than contractual residual values in 2022, primarily due to low new vehicle inventory. In 2023, we expect used vehicle prices to continue moderating through the year as market prices on used vehicles fall below contractual residual values. The increase in used vehicle prices resulted in gains on terminations of leased vehicles of $1.2 billion in GM Financial interest, operating and other expenses for the year ended December 31, 2022, and $2.0 billion in the corresponding period in 2021. The following table summarizes the estimated residual value based on GM Financial's most recent estimates and the number of units included in GM Financial Equipment on operating leases, net by vehicle type (units in thousands):December 31, 2022December 31, 2021Residual ValueUnitsPercentageResidual ValueUnitsPercentageCrossovers$14,207 736 67.3 %$16,696 897 67.3 %Trucks6,961 228 20.9 %7,886 264 19.8 %SUVs2,595 66 6.0 %3,104 80 5.9 %Cars964 63 5.8 %1,430 93 7.0 %Total$24,727 1,092 100.0 %$29,116 1,334 100.0 %31Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESGM Financial's penetration of our retail sales in the U.S. was 43% in the year ended December 31, 2022 and 44% in the corresponding period in 2021. Penetration levels vary depending on incentive financing programs available and competing third-party financing products in the market. GM Financial's prime loan originations as a percentage of total loan originations in North America was 80% in the year ended December 31, 2022 and 73% in the corresponding period in 2021. In the year ended December 31, 2022, GM Financial's revenue consisted of leased vehicle income of 61%, retail finance charge income of 32% and commercial finance charge income of 3%.Consolidated Results We review changes in our results of operations under five categories: volume, mix, price, cost and other. Volume measures the impact of changes in wholesale vehicle volumes driven by industry volume, market share and changes in dealer stock levels. Mix measures the impact of changes to the regional portfolio due to product, model, trim, country and option penetration in current year wholesale vehicle volumes. Price measures the impact of changes related to Manufacturer’s Suggested Retail Price and various sales allowances. Cost primarily includes: (1) material and freight; (2) manufacturing, engineering, advertising, administrative and selling and warranty expense; and (3) non-vehicle related activity. Other primarily includes foreign exchange and non-vehicle related automotive revenues as well as equity income or loss from our nonconsolidated affiliates. Refer to the regional sections of this MD&A for additional information. Total Net Sales and Revenue Years Ended December 31,Favorable/ (Unfavorable)Variance Due To20222021%VolumeMixPriceOther(Dollars in billions)GMNA$128,378 $101,308 $27,070 26.7 %$24.9 $(5.3)$7.1 $0.3 GMI15,420 12,172 3,248 26.7 %$2.0 $0.1 $1.4 $(0.3)Corporate177 104 73 70.2 %$— $0.1 Automotive 143,974 113,584 30,390 26.8 %$26.9 $(5.1)$8.5 $0.1 Cruise102 106 (4)(3.8)%$— GM Financial12,766 13,419 (653)(4.9)%$(0.7)Eliminations/reclassifications(107)(105)(2)(1.9)%$— $— Total net sales and revenue$156,735 $127,004 $29,731 23.4 %$26.9 $(5.1)$8.5 $(0.6)Refer to the regional sections of this MD&A for additional information on volume, mix and price.Automotive and Other Cost of Sales Years Ended December 31,Favorable/ (Unfavorable)Variance Due To20222021%VolumeMixCostOther(Dollars in billions)GMNA$109,651 $87,419 $(22,232)(25.4)%$(16.7)$(0.3)$(5.7)$0.4 GMI14,166 11,802 (2,364)(20.0)%$(1.6)$— $(1.0)$0.2 Corporate500 200 (300)n.m.$— $(0.3)$— Cruise2,576 1,124 (1,452)n.m.$(1.5)Eliminations(2)(1)1 n.m.$— Total automotive and other cost of sales$126,892 $100,544 $(26,348)(26.2)%$(18.3)$(0.2)$(8.4)$0.6 ________n.m. = not meaningfulThe most significant element of our Automotive and other cost of sales is material cost, which makes up approximately two-thirds of the total amount. The remaining portion includes labor costs, depreciation and amortization, engineering, freight and product warranty and recall campaigns.Factors that most significantly influence a region's profitability are industry volume, market share, and the relative mix of vehicles (trucks, crossovers, cars) sold. Variable profit is a key indicator of product profitability. Variable profit is defined as 32Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESrevenue less material cost, freight, the variable component of manufacturing expense and warranty and recall-related costs. Vehicles with higher selling prices generally have higher variable profit. Refer to the regional sections of this MD&A for additional information on volume and mix.In the year ended December 31, 2022, increased Cost was primarily due to: (1) increased material and freight costs of $5.5 billion; (2) increased costs of $1.1 billion primarily related to parts and accessories; (3) increased manufacturing costs of $1.1 billion; (4) increased engineering costs of $1.0 billion primarily related to accelerating our EV portfolio and an increase in development costs as Cruise progresses towards the commercialization of a network of on-demand AVs in the United States and globally; and (5) increased costs of $0.8 billion related to modification of Cruise stock incentive awards; partially offset by (6) decreased campaigns and other warranty-related costs of $0.4 billion; and (7) a decrease of $0.4 billion related to the resolution of substantially all patent royalty matters accrued with respect to past-year vehicle sales. In the year ended December 31, 2022, favorable Other was due to the weakening of the Korean Won and other currencies against the U.S. Dollar, partially offset by the strengthening of the Brazilian Real and other currencies against the U.S. Dollar.Automotive and Other Selling, General and Administrative ExpenseYears Ended December 31,Year Ended2022 vs. 2021 Change202220212020Favorable/ (Unfavorable)%Automotive and other selling, general and administrative expense$10,667 $8,554 $7,038 $(2,113)(24.7)%In the year ended December 31, 2022, Automotive and other selling, general and administrative expense increased primarily due to: (1) increased advertising, selling, and administrative costs of $1.3 billion; (2) charges of $0.5 billion for strategic activities related to Buick dealerships; and (3) increased costs of $0.3 billion related to modification of Cruise stock incentive awards.Interest Income and Other Non-operating Income, netYears Ended December 31,Year Ended2022 vs. 2021 Change202220212020Favorable/ (Unfavorable)%Interest income and other non-operating income, net$1,432 $3,041 $1,885 $(1,609)(52.9)%In the year ended December 31, 2022, Interest income and other non-operating income, net decreased primarily due to: (1) $0.4 billion in losses in 2022 compared to $0.3 billion in gains in 2021 related to Stellantis N.V. (Stellantis) warrants; and (2) $0.7 billion related to the shutdown of our Russia business.Income Tax ExpenseYears Ended December 31,Year Ended2022 vs. 2021 Change202220212020Favorable/ (Unfavorable)%Income tax expense$1,888 $2,771 $1,774 $883 31.9 %In the year ended December 31, 2022, Income tax expense decreased primarily due to Cruise valuation allowance adjustments, lower effective tax rate as a result of Cruise reconsolidation and lower pre-tax income. The decrease was partially offset by absence of tax benefit related to a deduction for an investment in a subsidiary, which occurred in the year ended December 31, 2021. For the year ended December 31, 2022 our ETR-adjusted was 20.2%. We expect our adjusted effective tax rate to be between 16% and 18% for the year ending December 31, 2023. Refer to Note 17 to our consolidated financial statements for additional information related to Income tax expense.33Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESGM North America Years Ended December 31,Favorable/ (Unfavorable)Variance Due To20222021%VolumeMixPriceCostOther(Dollars in billions)Total net sales and revenue$128,378 $101,308 $27,070 26.7 %$24.9 $(5.3)$7.1 $0.3 EBIT-adjusted$12,988 $10,318 $2,670 25.9 %$8.2 $(5.5)$7.1 $(6.9)$(0.1)EBIT-adjusted margin10.1 %10.2 %(0.1)%(Vehicles in thousands)Wholesale vehicle sales2,926 2,308 618 26.8 %GMNA Total Net Sales and Revenue In the year ended December 31, 2022, Total net sales and revenue increased primarily due to: (1) increased net wholesale volumes primarily due to increased sales of crossover vehicles, passenger cars, full-size pickup trucks, vans, mid-size pickup trucks and full-size SUVs due to improved parts availability that allowed us to increase production in 2022; (2) favorable price as a result of low dealer inventory levels and strong demand for our products; and (3) favorable Other due to increased sales of parts and accessories, partially offset by the foreign currency effect resulting from the weakening of the Canadian Dollar against the U.S. Dollar; partially offset by (4) unfavorable mix associated with increased sales of crossover vehicles, passenger cars, vans and mid-size pickup trucks, partially offset by increased sales of full-size pickup trucks and full-size SUVs.GMNA EBIT-Adjusted The most significant factors that influence profitability are industry volume and market share. While not as significant as industry volume and market share, another factor affecting profitability is the relative mix of vehicles sold. Trucks, crossovers and cars sold currently have a variable profit of approximately 150%, 50% and 40% of our GMNA portfolio on a weighted-average basis. In the year ended December 31, 2022, EBIT-adjusted increased primarily due to: (1) favorable volume; and (2) favorable price; partially offset by (3) increased Cost primarily due to increased material and freight cost of $4.7 billion, increased selling, general and administrative costs of $1.2 billion, increased manufacturing cost of $0.8 billion and increased engineering cost of $0.4 billion including accelerating our EV portfolio, partially offset by a decrease in campaigns and other warranty-related costs of $0.4 billion; and (4) unfavorable mix.GM InternationalYears Ended December 31,Favorable/ (Unfavorable)Variance Due To20222021%VolumeMixPriceCostOther(Dollars in billions)Total net sales and revenue$15,420 $12,172 $3,248 26.7 %$2.0 $0.1 $1.4 $(0.3)EBIT-adjusted$1,143 $827 $316 38.2 %$0.4 $0.2 $1.4 $(1.1)$(0.6)EBIT-adjusted margin7.4 %6.8 %0.6 %Equity income — Automotive China$677 $1,098 $(421)(38.3)%EBIT (loss)-adjusted — excluding Equity income$466 $(271)$737 n.m.(Vehicles in thousands)Wholesale vehicle sales653 551 102 18.5 %________n.m. = not meaningfulThe vehicle sales of our Automotive China JVs are not recorded in Total net sales and revenue. The results of our joint ventures are recorded in Equity income, which is included in EBIT-adjusted above.GMI Total Net Sales and Revenue In the year ended December 31, 2022, Total net sales and revenue increased primarily due to: (1) increased net wholesale volumes due to improved parts availability that allowed us to increase production in 2022; (2) favorable pricing across multiple vehicle lines in South America and the Middle East; and (3) favorable mix in the Middle East and Asia/Pacific, partially offset by unfavorable mix in South America; partially offset by (4) unfavorable Other primarily due to the foreign currency effect resulting from the weakening of various currencies against the U.S. dollar, partially offset by increased components, parts and accessories sales. 34Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESGMI EBIT-Adjusted In the year ended December 31, 2022, EBIT-adjusted increased primarily due to: (1) favorable price; (2) increased net wholesale volumes; and (3) favorable mix; partially offset by (4) unfavorable Cost primarily due to increased material and logistic costs; and (5) unfavorable Other primarily due to foreign currency effect resulting from the weakening of various currencies against the U.S. dollar and decreased equity income.We view the Chinese market as important to our global growth strategy and are employing a multi-brand strategy. In the coming years, we plan to leverage our global architectures to increase the number of product offerings under the Buick, Chevrolet and Cadillac brands in China and continue to grow our business under the local Baojun and Wuling brands while we are accelerating the development and rollout of EVs across our brands in China in response to our commitment to an all-electric future. We operate in the Chinese market through a number of joint ventures and maintaining strong relationships with our joint venture partners is an important part of our China growth strategy.The following table summarizes certain key operational and financial data for the Automotive China JVs (vehicles in thousands): Years Ended December 31,202220212020Wholesale vehicle sales including vehicles exported to markets outside of China2,639 3,007 3,029 Total net sales and revenue$35,857 $42,776 $38,736 Net income$1,407 $2,109 $1,239 December 31, 2022December 31, 2021Cash and cash equivalents$8,552 $10,254 Debt$197 $374 CruiseYears Ended December 31,2022 vs. 2021 Change202220212020Favorable/ (Unfavorable)%Total net sales and revenue(a)$102 $106 $103 $(4)(3.8)%EBIT (loss)-adjusted(b)$(1,890)$(1,196)$(887)$(694)(58.0)%________(a) Primarily reclassified to Interest income and other non-operating income, net in our consolidated income statements in each of the years ended December 31, 2022, 2021 and 2020. (b) Excludes $1.1 billion in compensation expense in the year ended December 31, 2022 resulting from modification of the Cruise stock incentive awards.Cruise EBIT (Loss)-Adjusted In the year ended December 31, 2022, EBIT (loss)-adjusted increased primarily due to an increase in development costs as we progress towards the commercialization of a network of on-demand rideshare and delivery AVs in the U.S. and globally.GM FinancialYears Ended December 31,2022 vs. 2021 Change202220212020Amount%Total revenue$12,766 $13,419 $13,831 $(653)(4.9)%Provision for loan losses$654 $248 $881 $406 n.m.EBT-adjusted$4,076 $5,036 $2,702 $(960)(19.1)%Average debt outstanding (dollars in billions)$93.8 $94.1 $91.4 $(0.3)(0.3)%Effective rate of interest paid3.1 %2.7 %3.3 %0.4 %________n.m. = not meaningfulGM Financial Revenue In the year ended December 31, 2022, Total revenue decreased primarily due to decreased leased vehicle income of $1.2 billion primarily due to a decrease in the average balance of the leased vehicles portfolio; partially offset 35Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESby increased finance charge income of $0.4 billion primarily due to growth in the retail finance receivables portfolio, partially offset by a decrease in the effective yield due to increased lending to borrowers with prime credit; and an increase in the effective yield on commercial finance receivables as a result of higher benchmark rates, as well as an increase in the size of the portfolio.GM Financial EBT-Adjusted In the year ended December 31, 2022, EBT-adjusted decreased primarily due to: (1) decreased leased vehicle income net of leased vehicle expenses of $0.7 billion primarily due to decreased depreciation on leased vehicles resulting from increased residual value estimates and a decrease in the size of the portfolio, decreased lease vehicle income primarily due to a decrease in the average balance of the leased vehicles portfolio, and decreased lease termination gains; (2) increased provision for loan losses of $0.4 billion primarily due to increased loan origination volume in 2022, and the reduction in reserve levels recorded in 2021 as a result of actual credit performance that was better than forecast and favorable expectations for future charge-offs and recoveries, as well as an economic forecast weighted more heavily to a weaker outlook as of December 31, 2022; and (3) increased interest expense of $0.3 billion primarily due to an increased effective rate of interest on our debt; partially offset by (4) increased finance charge income of $0.4 billion primarily due to growth in the retail finance receivables portfolio, partially offset by a decrease in the effective yield due to increased lending to borrowers with prime credit; and an increase in the effective yield on commercial finance receivables as a result of higher benchmark rates, as well as an increase in the size of the portfolio.Liquidity and Capital Resources We believe our current levels of cash, cash equivalents, marketable debt securities, available borrowing capacity under our revolving credit facilities and other liquidity actions currently available to us are sufficient to meet our liquidity requirements. We also maintain access to the capital markets and may issue debt or equity securities, which may provide an additional source of liquidity. We have substantial cash requirements going forward, which we plan to fund through our total available liquidity, cash flows from operating activities and additional liquidity measures, if determined to be necessary. Our known current material uses of cash include, among other possible demands: (1) capital spending and our investments in our battery cell manufacturing joint ventures of approximately $11.0 billion to $13.0 billion per year through 2025; (2) payments for engineering and product development activities; (3) payments associated with previously announced vehicle recalls and any other recall-related contingencies; (4) payments to service debt and other long-term obligations, including discretionary and mandatory contributions to our pension plans; (5) payments associated with the liquidity program for holders of equity-based incentive awards issued to employees of Cruise; (6) dividend payments on our common stock that are declared by our Board of Directors; and (7) payments to purchase shares of our common stock authorized by our Board of Directors. Refer to Note 7, Note 13 and Note 15 to our consolidated financial statements for additional funding requirements for our operating leases, debt and pension plans. Our material future uses of cash, which may vary from time to time based on market conditions and other factors, are focused on the three objectives of our capital allocation program: (1) grow our business at an average target ROIC-adjusted rate of 20% or greater; (2) maintain a strong investment-grade balance sheet, including a target average automotive cash balance of $18.0 billion; and (3) after the first two objectives are met, return available cash to shareholders. Our senior management evaluates our capital allocation program on an ongoing basis and recommends any modifications to the program to our Board of Directors not less than once annually. We continue to monitor and evaluate opportunities to strengthen our competitive position over the long term while maintaining a strong investment-grade balance sheet. These actions may include opportunistic payments to reduce our long-term obligations, as well as the possibility of acquisitions, dispositions and investments with joint venture partners, as well as strategic alliances that we believe would generate significant advantages and substantially strengthen our business. To support our transition to EVs, we anticipate making investments in suppliers or providing funding towards the execution of strategic, multi-year supply agreements to secure critical materials. In addition, we have entered, and plan to continue to enter, into offtake agreements that generally obligate us to purchase defined quantities of output. These arrangements could have a short-term adverse impact on our cash and increase our inventory.Our liquidity plans are subject to a number of risks and uncertainties, including those described in the "Forward-Looking Statements" section of this MD&A and Part I, Item 1A. Risk Factors, some of which are outside of our control. In August 2022, our Board of Directors increased the capacity under our previously announced common stock repurchase program to $5.0 billion from the $3.3 billion that remained under the program as of June 30, 2022. During the year ended December 31, 2022, we completed $2.5 billion of repurchases under the program and retired approximately 64 million shares of our common stock.36Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESIn September 2022, we reinstated a quarterly dividend of $0.09 per share of our common stock. During the year ended December 31, 2022, we paid dividends of $0.3 billion to holders of our common stock.In November 2022, Ultium Cells LLC, a wholly owned subsidiary of Ultium Cells Holding LLC, entered into a loan agreement with the U.S. Department of Energy (DOE) through the Advanced Technology Vehicles Manufacturing program, pursuant to which Ultium Cells LLC may borrow up to $2.5 billion. The proceeds of the loans will be used to finance the construction of new battery cell manufacturing facilities in the U.S. Under the terms of the loan agreement, the DOE will not have recourse on the principal and interest of the loan against General Motors Company or any of its consolidated subsidiaries.In December 2022, we early redeemed our $1.0 billion 5.40% senior unsecured notes with a maturity date of October 2023 and recorded an insignificant loss. Additionally, during 2022, we paid, prior to maturity, $0.5 billion of unsecured term loans in GMI.In January 2023, we gave notice to early redeem our $1.5 billion 4.875% senior unsecured notes with a maturity date of October 2023. The settlement of the early redemption of these senior unsecured notes is expected to occur during the first quarter of 2023 and is expected to have an immaterial impact on our 2023 results.Cash flows that occur amongst our Automotive, Cruise and GM Financial operations are eliminated when we consolidate our cash flows. Such eliminations include, among other things, collections by Automotive on wholesale accounts receivables financed by dealers through GM Financial, payments between Automotive and GM Financial for accounts receivables transferred by Automotive to GM Financial, loans to Automotive and Cruise from GM Financial, dividends issued by GM Financial to Automotive, tax payments by GM Financial to Automotive and Automotive cash injections in Cruise. The presentation of Automotive liquidity, Cruise liquidity and GM Financial liquidity presented below includes the impact of cash transactions amongst the sectors that are ultimately eliminated in consolidation.Automotive Liquidity Total available liquidity includes cash, cash equivalents, marketable debt securities and funds available under credit facilities. The amount of available liquidity is subject to seasonal fluctuations and includes balances held by various business units and subsidiaries worldwide that are needed to fund their operations. We manage our liquidity primarily at our treasury centers as well as at certain of our significant consolidated overseas subsidiaries. Over 90% of our cash and marketable debt securities were managed within North America and at our regional treasury centers at December 31, 2022. We have used, and will continue to use, other methods including intercompany loans to utilize these funds across our global operations as needed.Our cash equivalents and marketable debt securities balances are primarily denominated in U.S. Dollars and include investments in U.S. government and agency obligations, foreign government securities, time deposits, corporate debt securities and mortgage and asset-backed securities. Our investment guidelines, which we may change from time to time, prescribe certain minimum credit worthiness thresholds and limit our exposures to any particular sector, asset class, issuance or security type. The majority of our current investments in debt securities are with A/A2 or better rated issuers. We use credit facilities as a mechanism to provide additional flexibility in managing our global liquidity. Our Automotive borrowing capacity under credit facilities totaled $15.5 billion at December 31, 2022 and 2021, which consisted primarily of two credit facilities. Total Automotive borrowing capacity under our credit facilities does not include our 364-day, $2.0 billion facility allocated for exclusive use of GM Financial. We did not have any borrowings against our primary facilities, but had letters of credit outstanding under our sub-facility of $0.4 billion and $0.3 billion at December 31, 2022 and 2021.In April 2022, we renewed our 364-day, $2.0 billion revolving credit facility allocated for the exclusive use of GM Financial, which now matures on April 4, 2023. If available capacity permits, GM Financial continues to have access to our automotive credit facilities. GM Financial did not have borrowings outstanding against any of these facilities at December 31, 2022 and 2021. We had intercompany loans from GM Financial of $0.2 billion at December 31, 2022 and 2021, which primarily consisted of commercial loans to dealers we consolidate. We did not have intercompany loans to GM Financial at December 31, 2022 and 2021. Refer to Note 5 to our consolidated financial statements for additional information.In August 2022, we issued $2.25 billion in aggregate principal amount of senior unsecured notes under our new Sustainable Finance Framework with a weighted average interest rate of 5.51% and maturity dates in 2029 and 2032. We intend to allocate an amount equal to the net proceeds from these senior unsecured notes to finance or refinance, in whole or in part, new or existing green projects, assets or activities undertaken or owned by the Company that meet one or more eligibility criteria outlined in our Sustainable Finance Framework.37Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESSeveral of our loan facilities, including our revolving credit facilities, require compliance with certain financial and operational covenants as well as regular reporting to lenders. We have reviewed our covenants in effect as of December 31, 2022 and determined we are in compliance and expect to remain in compliance in the future. In March 2022, under the Share Purchase Agreement, we acquired SoftBank's equity ownership stake in Cruise for $2.1 billion and, separately, we made an additional $1.35 billion investment in Cruise in place of SoftBank. During the year ended December 31, 2022, we made additional investments in Cruise of $1.1 billion.In September 2022, we exercised our 39.7 million warrants in Stellantis. Upon exercise, the warrants converted into 69.1 million common shares of Stellantis, which we immediately sold back to Stellantis. Total net pre-tax proceeds, including dividends received, in connection with this transaction were approximately $1.1 billion.GM Financial's Board of Directors declared and paid dividends of $1.7 billion, $3.5 billion, and $0.8 billion on its common stock in 2022, 2021, and 2020. Future dividends from GM Financial will depend on several factors including business and economic conditions, its financial condition, earnings, liquidity requirements and leverage ratio. The following table summarizes our Automotive available liquidity (dollars in billions): December 31, 2022December 31, 2021Automotive cash and cash equivalents$13.6 $14.5 Marketable debt securities10.8 7.1 Automotive cash, cash equivalents and marketable debt securities24.4 21.6 Available under credit facilities(a)15.1 15.2 Total Automotive available liquidity$39.5 $36.8 _________ (a) We had letters of credit outstanding under our sub-facility of $0.4 billion and $0.3 billion at December 31, 2022 and 2021.The following table summarizes the changes in our Automotive available liquidity (dollars in billions): Year Ended December 31, 2022Operating cash flow$19.1 Capital expenditures(9.0)Dividends paid and payments to purchase common stock(2.8)GM investment in Cruise(2.4)Purchase of SoftBank's equity stake in Cruise(2.1)Issuance of senior unsecured notes2.2 Net proceeds from sale of Stellantis common shares(a)0.9 Payment of senior unsecured note(1.0)Investment in Ultium Cells Holdings LLC(0.8)Payment of GMI unsecured term debt(0.5)Other non-operating(0.9)Total change in automotive available liquidity$2.7 _________(a) Excludes dividends received and tax withholding.38Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIES Automotive Cash Flow (Dollars in billions)Years Ended December 31,2022 vs. 2021 Change202220212020Operating ActivitiesNet income$8.5 $7.8 $5.0 $0.7 Depreciation, amortization and impairment charges6.3 5.9 5.5 0.4 Pension and OPEB activities(2.0)(2.4)(1.6)0.4 Working capital0.5 (4.0)(1.7)4.5 Accrued and other liabilities and income taxes3.1 0.9 (1.4)2.2 Other2.7 1.5 1.7 1.2 Net automotive cash provided by (used in) operating activities$19.1 $9.7 $7.5 $9.4 In the year ended December 31, 2022, the increase in Net automotive cash provided by operating activities was primarily due to: (1) lower sales incentive payments of $4.7 billion; and (2) working capital; partially offset by (3) lower dividends received from GM Financial of $1.8 billion.Years Ended December 31,2022 vs. 2021 Change202220212020Investing ActivitiesCapital expenditures$(9.0)$(7.4)$(5.3)$(1.6)Acquisitions and liquidations of marketable securities, net(a)(3.9)1.0 (3.6)(4.9)Other(b)(4.5)(1.8)0.1 (2.7)Net automotive cash provided by (used in) investing activities$(17.5)$(8.2)$(8.8)$(9.3)__________ (a)Amount includes $0.6 billion of proceeds for the sale of our share in Lyft, Inc. in the year ended December 31, 2020.(b)Includes $2.4 billion and $1.0 billion for GM's investment in Cruise in the years ended December 31, 2022 and 2021, $2.1 billion related to the redemption of Cruise preferred shares from SoftBank in the year ended December 31, 2022, $0.9 billion related to the sale of Stellantis common shares, excluding dividends received and tax withholding, in the year ended December 31, 2022, and a $0.8 billion and $0.5 billion investment in Ultium Cells Holdings LLC in the years ended December 31, 2022 and 2021.In the year ended December 31, 2022, cash used in acquisitions and liquidations of marketable securities, net increased due to acquisitions of securities and investments compared to liquidations of securities to fund operating activities and investments during the year ended December 31, 2021.Years Ended December 31,2022 vs. 2021 Change202220212020Financing ActivitiesNet proceeds (payments) from short-term debt$(1.4)$(0.5)$(0.5)$(0.9)Issuance of senior notes2.3 — 4.0 2.3 Other(a)(3.3)(0.4)(1.4)(2.9)Net automotive cash provided by (used in) financing activities$(2.5)$(0.9)$2.1 $(1.6)__________(a)Includes $2.8 billion and $0.6 billion for dividends paid and payments to purchase common stock in the years ended December 31, 2022 and December 31, 2020, and $0.5 billion for repayments of senior unsecured notes for the years ended December 31, 2021 and 2020.Adjusted Automotive Free Cash Flow We measure adjusted automotive free cash flow as automotive operating cash flow from operations less capital expenditures adjusted for management actions. For the year ended December 31, 2022, net automotive cash provided by operating activities under U.S. GAAP was $19.1 billion, capital expenditures were $9.0 billion and adjustments for management actions were $0.4 billion. For the year ended December 31, 2021, net automotive cash provided by operating activities under U.S. GAAP was $9.7 billion, capital expenditures were $7.4 billion and adjustments for management actions, were $0.3 billion.39Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESStatus of Credit Ratings We receive ratings from four independent credit rating agencies: DBRS Limited (DBRS), Fitch Ratings (Fitch), Moody's Investor Service (Moody's) and Standard & Poor's (S&P). All four credit rating agencies currently rate our corporate credit at investment grade. The following table summarizes our credit ratings at January 17, 2023:CorporateRevolving Credit FacilitiesSenior UnsecuredOutlookDBRSBBB (high)BBB (high)N/AStableFitchBBB-BBB-BBB-PositiveMoody'sInvestment GradeBaa2Baa3StableS&PBBBBBBBBBStableCruise Liquidity In January 2022, Cruise Holdings met the requirements for commercial deployment under its agreements with SoftBank, which triggered SoftBank's obligation to purchase additional Cruise convertible preferred shares for $1.35 billion. In March 2022, GM made the additional $1.35 billion investment in Cruise in place of SoftBank following GM's acquisition of SoftBank's equity ownership stake in Cruise pursuant to the Share Purchase Agreement. Additionally, in March 2022, GM and Cruise announced a liquidity program for holders of equity-based incentive awards issued to the employees of Cruise pursuant to Cruise's 2018 Employee Incentive Plan, under which GM will purchase newly issued Cruise Class B Common Shares to fund the tax withholding on vested awards and GM will conduct tender offers for Cruise Class B Common Shares issued to settle vested awards. During the year ended December 31, 2022, Cruise issued approximately $0.5 billion of Cruise Class B Common Shares, primarily to us, to fund the payment of statutory tax withholding obligations resulting from the settlement or exercise of vested awards. Also, GM conducted quarterly tender offers, and paid approximately $0.6 billion in cash to settle tendered Cruise Class B Common Shares under the announced liquidity program during the year ended December 31, 2022. Refer to Note 20 to our consolidated financial statements for additional information.The following table summarizes Cruise's available liquidity (dollars in billions):December 31, 2022December 31, 2021Cruise cash and cash equivalents$1.5 $1.6 Cruise marketable securities1.4 1.5 Total Cruise available liquidity(a)$2.9 $3.1 __________ (a)Excludes a multi-year credit agreement between Cruise and GM Financial whereby Cruise can request to borrow, over time, up to an additional aggregate of $4.5 billion, through 2024, to fund exclusively the purchase of AVs from GM.The following table summarizes the changes in Cruise's available liquidity (dollars in billions):Year Ended December 31, 2022Operating cash flow(a)$(1.8)GM investment in Cruise2.4 Employee Incentive Plan(0.6)Other non-operating(0.1)Total change in Cruise available liquidity$(0.2)__________ (a)Includes $0.4 billion cash outflows related to tendered Cruise Class B Common Shares classified as liabilities.Cruise Cash Flow (Dollars in billions)Years Ended December 31,2022 vs. 2021 Change202220212020Net cash provided by (used in) operating activities$(1.8)$(1.2)$(0.8)$(0.6)Net cash provided by (used in) investing activities$— $(0.7)$(0.7)$0.7 Net cash provided by (used in) financing activities$1.8 $2.6 $— $(0.8)40Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESAutomotive Financing – GM Financial Liquidity GM Financial's primary sources of cash are finance charge income, leasing income and proceeds from the sale of terminated leased vehicles, net distributions from credit facilities, securitizations, secured and unsecured borrowings and collections and recoveries on finance receivables. GM Financial's primary uses of cash are purchases and funding of finance receivables and leased vehicles, repayment or repurchases of secured and unsecured debt, funding credit enhancement requirements in connection with securitizations and secured credit facilities, interest costs, operating expenses, income taxes and dividend payments. GM Financial continues to monitor and evaluate opportunities to optimize its liquidity position and the mix of its debt between secured and unsecured debt. The following table summarizes GM Financial's available liquidity (dollars in billions): December 31, 2022December 31, 2021Cash and cash equivalents$4.0 $4.0 Borrowing capacity on unpledged eligible assets22.0 19.2 Borrowing capacity on committed unsecured lines of credit0.5 0.5 Borrowing capacity on revolving credit facility, exclusive to GM Financial2.0 2.0 Total GM Financial available liquidity$28.5 $25.7 In the year ended December 31, 2022, GM Financial's available liquidity increased primarily due to increased available borrowing capacity on unpledged eligible assets, resulting from the issuance of securitization transactions and unsecured debt. GM Financial structures liquidity to support at least six months of GM Financial's expected net cash flows, including new originations, without access to new debt financing transactions or other capital markets activity. GM Financial has access to $15.5 billion of our revolving credit facilities with exclusive access to the 364-day, $2.0 billion facility. Refer to the "Automotive Liquidity" section of this MD&A for additional details. We have a support agreement with GM Financial which, among other things, establishes commitments of funding from us to GM Financial. This agreement also provides that we will continue to own all of GM Financial’s outstanding voting shares so long as any unsecured debt securities remain outstanding at GM Financial. In addition, we are required to use our commercially reasonable efforts to ensure GM Financial remains a subsidiary borrower under our corporate revolving credit facilities. Credit Facilities In the normal course of business, in addition to using its available cash, GM Financial utilizes borrowings under its credit facilities, which may be secured or unsecured, and GM Financial repays these borrowings as appropriate under its cash management strategy. At December 31, 2022, secured, committed unsecured and uncommitted unsecured credit facilities totaled $26.2 billion, $0.5 billion and $1.4 billion with advances outstanding of $3.9 billion, an insignificant amount and $1.4 billion. GM Financial Cash Flow (Dollars in billions)Years Ended December 31,2022 vs. 2021 Change202220212020Net cash provided by (used in) operating activities$5.5 $7.3 $8.0 $(1.8)Net cash provided by (used in) investing activities$(10.0)$(5.5)$(9.3)$(4.5)Net cash provided by (used in) financing activities$4.0 $(2.6)$2.4 $6.6 In the year ended December 31, 2022, Net cash provided by operating activities decreased primarily due to: (1) a decrease in leased vehicle income of $1.2 billion; and (2) a net increase in cash used in counterparty derivative collateral posting activities of $0.9 billion.In the year ended December 31, 2022, Net cash used in investing activities increased primarily due to: (1) an increase in purchases and originations of finance receivables of $6.1 billion; (2) a decrease in collections and recoveries on finance receivables of $0.7 billion; and (3) a decrease in the proceeds from termination of leased vehicles of $0.2 billion; partially offset by (4) a decrease in purchases of leased vehicles of $2.7 billion. In the year ended December 31, 2022, Net cash provided by financing activities increased primarily due to: (1) a decrease in debt repayments of $8.8 billion; and (2) a decrease in dividend payments of $1.8 billion; partially offset by (3) a decrease in borrowings of $4.0 billion.41Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESLIBOR Transition As discussed in Part I, Item 1A. Risk Factors, banks will no longer be persuaded or compelled to submit rates for the calculation of LIBOR. GM Financial established a LIBOR transition initiative in 2019 to evaluate the potential impacts of the transition, and continues to implement strategies to mitigate the risks associated with the LIBOR discontinuation such as amending existing LIBOR-based transactions where feasible. GM Financial has only a limited amount of LIBOR-based debt outstanding that is currently scheduled to mature after June 30, 2023 and if not amendable, would utilize the Alternative Reference Rates Committee fallback process where applicable. Furthermore, GM Financial has adhered to the International Swaps and Derivatives Association’s Fallbacks Protocol and is transitioning its existing LIBOR-based derivative exposure in advance of the June 30, 2023 date when applicable LIBOR will no longer be published. For any residual exposure after the end of 2022, GM Financial expects to leverage relevant contractual and statutory solutions to transition such exposure.Critical Accounting Estimates The consolidated financial statements are prepared in conformity with U.S. GAAP, which requires the use of estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses in the periods presented. We believe the accounting estimates employed are appropriate and the resulting balances are reasonable; however, due to the inherent uncertainties in developing estimates, actual results could differ from the original estimates, requiring adjustments to these balances in future periods. Refer to Note 2 to our consolidated financial statements for our significant accounting policies related to our critical accounting estimates. Product Warranty and Recall Campaigns The estimates related to product warranties are established using historical information on the nature, frequency and average cost of claims of each vehicle line or each model year of the vehicle line and assumptions about future activity and events. When little or no claims experience exists for a model year or a vehicle line, the estimate is based on comparable models. We accrue the costs related to product warranty at the time of vehicle sale and we accrue the estimated cost of recall campaigns when they are probable and estimable.The estimates related to recall campaigns accrued at the time of vehicle sale are established by applying a paid loss approach that considers the number of historical recall campaigns and the estimated cost for each recall campaign. These estimates consider the nature, frequency and magnitude of historical recall campaigns, and use key assumptions including the number of historical periods and the weighting of historical data in the reserve studies. Costs associated with recall campaigns not accrued at the time of vehicle sale are estimated based on the estimated cost of repairs and the estimated vehicles to be repaired. Depending on part availability and time to complete repairs we may, from time to time, offer courtesy transportation at no cost to our customers. These estimates are re-evaluated on an ongoing basis and based on the best available information. Revisions are made when necessary based on changes in these factors. The estimated amount accrued for recall campaigns at the time of vehicle sale is most sensitive to the estimated number of recall events, the number of vehicles per recall event, the assumed number of vehicles that will be brought in by customers for repair (take rate) and the cost per vehicle for each recall event. The estimated cost of a recall campaign that is accrued on an individual basis is most sensitive to our estimated assumed take rate that is primarily developed based on our historical take rate experience. A 10% increase in the estimated take rate for all recall campaigns would increase the estimated cost by approximately $0.4 billion.Actual experience could differ from the amounts estimated requiring adjustments to these liabilities in future periods. Due to the uncertainty and potential volatility of the factors contributing to developing estimates, changes in our assumptions could materially affect our results of operations.Sales Incentives The estimated effect of sales incentives offered to dealers and end customers is recorded as a reduction of Automotive net sales and revenue at the time of sale. There may be numerous types of incentives available at any particular time. Incentive programs are generally specific to brand, model or sales region and are for specified time periods, which may be extended. Significant factors used in estimating the cost of incentives include type of program, forecasted sales volume, product mix, and the rate of customer acceptance of incentive programs, all of which are estimated based on historical experience and assumptions concerning future customer behavior and market conditions. A change in any of these factors affecting the estimate could have a significant effect on recorded sales incentives. A 10% increase in the cost of incentives would increase the sales incentive liability by an insignificant amount. Subsequent adjustments to incentive estimates are possible as facts and circumstances change over time, which could affect the revenue previously recognized in Automotive net sales and revenue.42Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESGM Financial Allowance for Loan Losses The GM Financial retail finance receivables portfolio consists of smaller-balance, homogeneous loans that are carried at amortized cost, net of allowance for loan losses. The allowance for loan losses on retail finance receivables reflects net credit losses expected to be incurred over the remaining life of the retail finance receivables, which have a weighted average remaining life of approximately two years. GM Financial forecasts net credit losses based on relevant information about past events, current conditions and forecast economic performance. GM Financial believes that the allowance is adequate to cover expected credit losses on the retail finance receivables; however, because the allowance for loan losses is based on estimates, there can be no assurance that the ultimate charge-off amount will not exceed such estimates or that our credit loss assumptions will not increase.GM Financial incorporates its outlook on forecast recovery rates and overall economic performance in its allowance estimate. Each 5% relative decrease/increase in the forecast recovery rates would increase/decrease the allowance for loan losses by $0.1 billion. At December 31, 2022, the weightings applied to the economic forecast scenarios considered resulted in an allowance for loan losses on the retail finance receivables portfolio of $2.1 billion. If the forecast economic conditions were based entirely on the weakest scenario considered, the allowance for loan losses would increase by $74 million. Actual economic data and recovery rates that are lower than those forecasted by GM Financial could result in an increase to the allowance for loan losses.The GM Financial commercial finance receivables portfolio consists of floorplan financing as well as dealer loans, which are loans to finance improvements to dealership facilities, to provide working capital, or to purchase and/or finance dealership real estate. The allowance for loan losses on commercial finance receivables is based on historical loss experience for the consolidated portfolio, in addition to forecasted industry vehicle sales. There can be no assurance that the ultimate charge-off amount will not exceed such estimates or that GM Financial's credit loss assumptions will not increase.Valuation of GM Financial Equipment on Operating Lease Assets and Residuals GM Financial has investments in leased vehicles recorded as operating leases. Each leased asset in the portfolio represents a vehicle that GM Financial owns and has leased to a customer. At lease inception, an estimate is made of the expected residual value for the vehicle at the end of the lease term, which typically ranges from two to five years. GM Financial estimates the expected residual value based on third-party data that considers various data points and assumptions, including, but not limited to, recent auction values, the expected future volume of returning leased vehicles, significant liquidation of rental or fleet inventory, used vehicle prices, manufacturer incentive programs and fuel prices. During the term of a lease, GM Financial periodically evaluates the estimated residual value and may adjust the value downward, which increases the prospective depreciation, or upward (limited to the contractual residual value), which decreases the prospective depreciation. The customer is obligated to make payments during the lease term for the difference between the purchase price and the contract residual value plus a money factor. However, since the customer is not obligated to purchase the vehicle at the end of the contract, GM Financial is exposed to a risk of loss to the extent the customer returns the vehicle prior to or at the end of the lease term and the proceeds GM Financial receives on the disposition of the vehicle are lower than the residual value estimated at lease inception. Realization of the residual values is dependent on GM Financial's future ability to market the vehicles under prevailing market conditions.At December 31, 2022, the estimated residual value of GM Financial's leased vehicles was $24.7 billion. Depreciation reduces the carrying value of each leased asset in GM Financial's operating lease portfolio over time from its original acquisition value to its expected residual value at the end of the lease term. If used vehicle prices weaken compared to estimates, GM Financial would increase depreciation expense and/or record an impairment charge on the lease portfolio. If an impairment exists, GM Financial would determine any shortfall in recoverability of the leased vehicle asset groups by year, make and model. Recoverability is calculated as the excess of: (1) the sum of remaining lease payments plus estimated residual value; over (2) leased vehicles, net less deferred revenue. Alternatively, if used vehicle prices outperform GM Financial's latest estimates, it may record gains on sales of off-lease vehicles and/or decreased depreciation expense. 43Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESThe following table illustrates the effect of a 1% relative change in the estimated residual values at December 31, 2022, which could increase or decrease depreciation expense over the remaining term of the leased vehicle portfolio, holding all other assumptions constant (dollars in millions):Impact to Depreciation Expense2023$181 202452 202513 2026 and thereafter1 Total$247 Changes to residual values are rarely simultaneous across all maturities and segments, and also may impact return rates. If a decrease in residual values is concentrated among specific asset groups, the decrease could result in an immediate impairment charge. GM Financial reviewed the leased vehicle portfolio for indicators of impairment and determined that no impairment indicators were present at December 31, 2022 and 2021.Used vehicle prices decreased since the end of 2021 due to normalization of supply and demand; however, prices remain above pre-pandemic levels. In 2023, GM Financial expects used vehicle prices to continue moderating through the year.Pension and OPEB Plans Our defined benefit pension plans are accounted for on an actuarial basis, which requires the selection of various assumptions, including an expected long-term rate of return on plan assets, a discount rate, mortality rates of participants and expectation of mortality improvement. Our pension obligations include Korean statutory pension payments that are valued on a walk away basis. The expected long-term rate of return on U.S. plan assets that is utilized in determining pension expense is derived from periodic studies, which include a review of asset allocation strategies, anticipated future long-term performance of individual asset classes, risks using standard deviations and correlations of returns among the asset classes that comprise the plans' asset mix. While the studies give appropriate consideration to recent plan performance and historical returns, the assumptions are primarily long-term, prospective rates of return. In December 2022, an investment policy study was completed for the U.S. pension plans. As a result of changes to our capital market assumptions, the weighted-average long-term rate of return on assets increased from 5.4% at December 31, 2021 to 6.3% at December 31, 2022. The expected long-term rate of return on plan assets used in determining pension expense for non-U.S. plans is determined in a similar manner to the U.S. plans.Another key assumption in determining net pension and OPEB expense is the assumed discount rate used to discount plan obligations. We estimate the assumed discount rate for U.S. plans using a cash flow matching approach, which uses projected cash flows matched to spot rates along a high quality corporate bond yield curve to determine the weighted-average discount rate for the calculation of the present value of cash flows. We apply the individual annual yield curve rates instead of the assumed discount rate to determine the service cost and interest cost, which more specifically links the cash flows related to service cost and interest cost to bonds maturing in their year of payment. The Society of Actuaries (SOA) issued mortality improvement tables in the three months ended December 31, 2022. We reviewed our recent mortality experience and we determined our current mortality assumptions are appropriate to measure our U.S. pension and OPEB plans obligations as of December 31, 2022.Significant differences in actual experience or significant changes in assumptions may materially affect the pension obligations. The effects of actual results differing from assumptions and the changing of assumptions are included in unamortized net actuarial gains and losses that are subject to amortization to pension expense over future periods. The unamortized pre-tax actuarial loss on our pension plans was $3.3 billion and $3.7 billion at December 31, 2022 and 2021. The year-over-year change is primarily due to an increase in discount rates partially offset by lower than expected asset returns. The funded status of the U.S. pension plans improved in the year ended December 31, 2022 to $0.1 billion overfunded status from $0.3 billion underfunded status primarily due to: (1) the favorable effect of an increase in discount rates of $11.9 billion; and (2) changes in actuarial assumptions, demographic data updates and contributions of $0.3 billion; partially offset by (3) the unfavorable effect of negative actual returns on plan assets of $10.3 billion; and (4) service and interest costs of $1.5 billion. 44Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESThe following table illustrates the sensitivity to a change in certain assumptions for the pension plans, holding all other assumptions constant:U.S. Plans(a)Non-U.S. Plans(a)Effect on 2023 Pension ExpenseEffect on December 31, 2022 PBOEffect on 2023 Pension ExpenseEffect on December 31, 2022 PBO25 basis point decrease in discount rate-$48+$918-$4+$29625 basis point increase in discount rate+$32-$885+$9-$28425 basis point decrease in expected rate of return on assets+$116N/A+$25N/A25 basis point increase in expected rate of return on assets-$116N/A-$25N/A__________(a)The sensitivity does not include the effects of the individual annual yield curve rates applied for the calculation of the service and interest cost.Refer to Note 15 to our consolidated financial statements for additional information on pension contributions, investment strategies, assumptions, the change in benefit obligations and related plan assets, pension funding requirements and future net benefit payments. Refer to Note 2 to our consolidated financial statements for a discussion of the inputs used to determine fair value for each significant asset class or category. Valuation of Deferred Tax Assets The ability to realize deferred tax assets depends on the ability to generate sufficient taxable income within the carryback or carryforward periods provided for in the tax law for each applicable tax jurisdiction. The assessment regarding whether a valuation allowance is required or should be adjusted is based on an evaluation of possible sources of taxable income and also considers all available positive and negative evidence factors. Our accounting for the valuation of deferred tax assets represents our best estimate of future events. Changes in our current estimates, due to unanticipated market conditions, governmental legislative actions or events, could have a material effect on our ability to utilize deferred tax assets. Refer to Note 17 to our consolidated financial statements for additional information on the composition of valuation allowances.Forward-Looking Statements This report and the other reports filed by us with the SEC from time to time, as well as statements incorporated by reference herein and related comments by our management, may include "forward-looking statements" within the meaning of the U.S. federal securities laws. Forward-looking statements are any statements other than statements of historical fact. Forward-looking statements represent our current judgment about possible future events and are often identified by words like “aim,” “anticipate,” “appears,” “approximately,” “believe,” “continue,” “could,” “designed,” “effect,” “estimate,” “evaluate,” “expect,” “forecast,” “goal,” “initiative,” “intend,” “may,” “objective,” “outlook,” “plan,” “potential,” “priorities,” “project,” “pursue,” “seek,” “should,” “target,” “when,” “will,” “would,” or the negative of any of those words or similar expressions. In making these statements, we rely on assumptions and analysis based on our experience and perception of historical trends, current conditions and expected future developments as well as other factors we consider appropriate under the circumstances. We believe these judgments are reasonable, but these statements are not guarantees of any future events or financial results, and our actual results may differ materially due to a variety of important factors, many of which are beyond our control. These factors, which may be revised or supplemented in subsequent reports we file with the SEC, include, among others, the following: (1) our ability to deliver new products, services, technologies and customer experiences in response to increased competition and changing consumer preferences in the automotive industry; (2) our ability to timely fund and introduce new and improved vehicle models, including electric vehicles, that are able to attract a sufficient number of consumers; (3) our ability to profitably deliver a broad portfolio of electric vehicles that will help drive consumer adoption; (4) the success of our current line of full-size SUVs and full-size pickup trucks; (5) our highly competitive industry, which has been historically characterized by excess manufacturing capacity and the use of incentives, and the introduction of new and improved vehicle models by our competitors; (6) the unique technological, operational, regulatory and competitive risks related to the timing and commercialization of autonomous vehicles; (7) risks associated with climate change, including increased regulation of GHG emissions, our transition to electric vehicles and the potential increased impacts of severe weather events; (8) global automobile market sales volume, which can be volatile; (9) inflationary pressures and persistently high prices and uncertain availability of raw materials and commodities used by us and our suppliers, and instability in logistics and related costs; (10) our business in China, which is subject to unique operational, competitive, regulatory and economic risks; (11) the success of our ongoing strategic business relationships and of our joint ventures, which we cannot operate solely for our benefit and over which we may have limited control; (12) the international scale and footprint of our operations, which exposes us to a variety of unique political, economic, competitive and regulatory risks, including the risk of changes in government leadership 45Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESand laws (including labor, trade, tax and other laws), political uncertainty or instability and economic tensions between governments and changes in international trade policies, new barriers to entry and changes to or withdrawals from free trade agreements, changes in foreign exchange rates and interest rates, economic downturns in the countries in which we operate, differing local product preferences and product requirements, changes to and compliance with U.S. and foreign countries' export controls and economic sanctions, differing labor regulations, requirements and union relationships, differing dealer and franchise regulations and relationships, difficulties in obtaining financing in foreign countries, and public health crises, including the occurrence of a contagious disease or illness, such as the COVID-19 pandemic; (13) any significant disruption, including any work stoppages, at any of our manufacturing facilities; (14) the ability of our suppliers to deliver parts, systems and components without disruption and at such times to allow us to meet production schedules; (15) pandemics, epidemics, disease outbreaks and other public health crises, including the COVID-19 pandemic; (16) the possibility that competitors may independently develop products and services similar to ours, or that our intellectual property rights are not sufficient to prevent competitors from developing or selling those products or services; (17) our ability to manage risks related to security breaches and other disruptions to our information technology systems and networked products, including connected vehicles and in-vehicle systems; (18) our ability to comply with increasingly complex, restrictive and punitive regulations relating to our enterprise data practices, including the collection, use, sharing and security of the Personal Identifiable Information of our customers, employees, or suppliers; (19) our ability to comply with extensive laws, regulations and policies applicable to our operations and products, including those relating to fuel economy, emissions and autonomous vehicles; (20) costs and risks associated with litigation and government investigations; (21) the costs and effect on our reputation of product safety recalls and alleged defects in products and services; (22) any additional tax expense or exposure or failure to fully realize available tax incentives; (23) our continued ability to develop captive financing capability through GM Financial; and (24) any significant increase in our pension funding requirements. For a further discussion of these and other risks and uncertainties, refer to Part I, Item 1A. Risk Factors.We caution readers not to place undue reliance on forward-looking statements. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update publicly or otherwise revise any forward-looking statements, whether as a result of new information, future events or other factors, except where we are expressly required to do so by law.* * * * * * *Item 7A. Quantitative and Qualitative Disclosures About Market RiskThe overall financial risk management program is under the responsibility of the Chief Financial Officer with support from the Financial Risk Council, which reviews and, where appropriate, approves strategies to be pursued to mitigate these risks. The Financial Risk Council comprises members of our management and functions under the oversight of the Audit Committee and Finance Committee of the Board of Directors. The Audit Committee and Finance Committee assist and guide the Board of Directors in its oversight of our financial and risk management strategies. A risk management control framework is utilized to monitor the strategies, risks and related hedge positions in accordance with the policies and procedures approved by the Financial Risk Council. Our financial risk management policy is designed to protect against risk arising from extreme adverse market movements on our key exposures. Automotive The following analyses provide quantitative information regarding exposure to foreign currency exchange rate risk and interest rate risk. Sensitivity analysis is used to measure the potential loss in the fair value of financial instruments with exposure to market risk. The models used assume instantaneous, parallel shifts in exchange rates and interest rate yield curves. For options and other instruments with nonlinear returns, models appropriate to these types of instruments are utilized to determine the effect of market shifts. There are certain shortcomings inherent in the sensitivity analyses presented, primarily due to the assumption that interest rates change in a parallel fashion and that spot exchange rates change instantaneously. In addition, the analyses are unable to reflect the complex market reactions that normally would arise from the market shifts modeled and do not contemplate the effects of correlations between foreign currency exposures and offsetting long-short positions in currency or other exposures, such as interest rates, which may significantly reduce the potential loss in value.Foreign Currency Exchange Rate Risk We have foreign currency exposures related to buying, selling and financing in currencies other than the functional currencies of our operations. At December 31, 2022, our most significant foreign currency exposures were between the U.S. Dollar and the Canadian Dollar, Chinese Yuan, Korean Won, Brazilian Real, and Mexican Peso. Derivative instruments such as foreign currency forwards, swaps and options are primarily used to hedge exposures with respect to forecasted revenues, costs and commitments denominated in foreign currencies. Such contracts had remaining maturities of up to 12 months at December 31, 2022. 46Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESThe net fair value liability of financial instruments with exposure to foreign currency risk was $0.2 billion and $0.7 billion at December 31, 2022 and 2021. These amounts are calculated utilizing a population of foreign currency exchange derivatives and foreign currency denominated debt and exclude the offsetting effect of foreign currency cash, cash equivalents and other assets. The potential loss in fair value for such financial instruments from a 10% adverse change in all quoted foreign currency exchange rates would have been insignificant at December 31, 2022 and 2021.We are exposed to foreign currency risk due to the translation and remeasurement of the results of certain international operations into U.S. Dollars as part of the consolidation process. We had foreign currency derivatives with notional amounts of $4.1 billion and $4.2 billion at December 31, 2022 and 2021. The fair value of these derivative financial instruments was insignificant. Fluctuations in foreign currency exchange rates can therefore create volatility in the results of operations and may adversely affect our financial condition.The following table summarizes the amounts of automotive foreign currency translation and transaction and remeasurement (gains) losses:Years Ended December 31,20222021Translation (gains) losses recorded in Accumulated other comprehensive loss$(37)$(132)Transaction and remeasurement (gains) losses recorded in earnings$173 $(15)Interest Rate Risk We are subject to market risk from exposure to changes in interest rates related to certain financial instruments, primarily debt, finance lease obligations and certain marketable debt securities. We did not have any interest rate swap positions to manage interest rate exposures in our automotive operations at December 31, 2022 and 2021. The fair value of debt and finance leases was $16.8 billion and $20.6 billion at December 31, 2022 and 2021. The potential increase in fair value resulting from a 10% decrease in quoted interest rates would have been $0.8 billion and $0.6 billion at December 31, 2022 and 2021. We had marketable debt securities, including those held by Cruise, of $12.2 billion and $8.6 billion classified as available-for-sale at December 31, 2022 and 2021. The potential decrease in fair value from a 50 basis point increase in interest rates would have been insignificant at December 31, 2022 and 2021.Automotive Financing - GM FinancialInterest Rate Risk Fluctuations in market interest rates can affect GM Financial's gross interest rate spread, which is the difference between interest earned on finance receivables and interest paid on debt. GM Financial is exposed to interest rate risks as financial assets and liabilities have different characteristics that may impact financial performance. These differences may include tenor, yield, re-pricing timing, and prepayment expectations. Typically, retail finance receivables and leases purchased by GM Financial earn fixed interest and commercial finance receivables originated by GM Financial earn variable interest. GM Financial funds its business with variable or fixed rate debt. The variable rate debt is subject to adjustments to reflect prevailing market interest rates. To help mitigate interest rate risk or mismatched funding, GM Financial may employ hedging.Quantitative Disclosure GM Financial measures the sensitivity of its net interest income to changes in interest rates by using interest rate scenarios that assume a hypothetical, instantaneous parallel shift of one hundred basis points in all interest rates across all maturities, as well as a base case that assumes that rates perform at the current market forward curve. However, interest rate changes are rarely instantaneous or parallel and rates could move more or less than the one percentage point assumed in our analysis. Therefore, the actual impact to net interest income could be higher or lower than the results detailed in the table below. These interest rate scenarios are purely hypothetical and do not represent our view of future interest rate movements. At December 31, 2022 and 2021, GM Financial was liability-sensitive, meaning that more liabilities than assets were expected to re-price within the next 12 months. During a period of rising interest rates, the interest paid on liabilities would increase more than the interest earned on assets, which would initially decrease net interest income. During a period of falling interest rates, net interest income would be expected to initially increase. GM Financial's hedging strategies approved by its Global Asset Liability Committee are used to manage interest rate risk within policy guidelines. 47Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIESThe following table presents GM Financial's net interest income sensitivity to interest rate movement:Years Ended December 31,20222021One hundred basis points instantaneous increase in interest rates$(4.3)$(5.1)One hundred basis points instantaneous decrease in interest rates(a)$4.3 $5.1 __________(a) Net interest income sensitivity given a one hundred basis point decrease in interest rates requires an assumption of negative interest rates in markets where existing interest rates are below one percent.Additional Model Assumptions The sensitivity analysis presented is GM Financial's best estimate of the effect of the hypothetical interest rate scenarios; however, actual results could differ. The estimates are also based on assumptions including the amortization and prepayment of the finance receivable portfolio, originations of finance receivables and leases, refinancing of maturing debt, replacement of maturing derivatives and exercise of options embedded in debt and derivatives. The prepayment projections are based on historical experience. If interest rates or other factors change, actual prepayment experience could be different than projected.Foreign Currency Exchange Rate Risk GM Financial is exposed to foreign currency risk due to the translation and remeasurement of the results of certain international operations into U.S. Dollars as part of the consolidation process. Fluctuations in foreign currency exchange rates can therefore create volatility in the results of operations and may adversely affect GM Financial's financial condition. GM Financial primarily finances its receivables and leased assets with debt in the same currency. When a different currency is used, GM Financial may use foreign currency swaps to convert substantially all of its foreign currency debt obligations to the local currency of the receivables and leased assets to minimize any impact to earnings. As a result, GM Financial believes its market risk exposure relating to changes in currency exchange rates at December 31, 2022 was insignificant.GM Financial had foreign currency swaps with notional amounts of $6.9 billion and $8.2 billion at December 31, 2022 and 2021. The net fair value of these derivative financial instruments was a liability of $0.6 billion and $0.2 billion at December 31, 2022 and 2021.The following table summarizes GM Financial's foreign currency translation and transaction and remeasurement (gains) losses:Years Ended December 31,20222021Translation (gains) losses recorded in Accumulated other comprehensive loss$156 $44 Transaction and remeasurement (gains) losses recorded in earnings$(1)$(3)* * * * * * *48Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and the Board of Directors of General Motors CompanyOpinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of General Motors Company and subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income, cash flows, and equity for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated January 31, 2023 expressed an unqualified opinion thereon.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MattersThe critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Product warranty and recall campaignsDescription of the matterAs discussed in Note 12 to the financial statements, the liabilities for product warranty and recall campaigns amount to $8.5 billion at December 31, 2022. The Company accrues for costs related to product warranty at the time of vehicle sale and accrues the estimated cost of recall campaigns when they are probable and estimable.Auditing these liabilities involved a high degree of subjectivity in evaluating management’s estimates, due to the size, uncertainties, and potential volatility related to the estimated liabilities. Management’s estimates consider historical claims experience, including the nature, frequency, and average cost of claims of each vehicle line or each model year of the vehicle line, and the key assumptions of historical data being predictive of future activity and events, in particular, the number of historical periods used and the weighing of historical data in the reserve studies.49Table of ContentsHow we addressed the matter in our auditWe evaluated the design and tested the operating effectiveness of internal controls over the Company’s product warranty and recall campaign processes. We tested internal controls over management’s review of the valuation models and significant assumptions for product warranty and recall, including the warranty claims forecasted based on the frequency and average cost per warranty claim for product warranty, and the cost estimates related to recall campaigns. Our audit also included the evaluation of controls that address the completeness and accuracy of the data utilized in the valuation models.Our audit procedures related to product warranty and recall campaigns also included, among others, evaluating the Company’s estimation methodology, the related significant assumptions and underlying data, and performing analytical procedures to corroborate cost per vehicle based on historical claims data. Furthermore, we performed sensitivity analyses to evaluate the significant judgments made by management, including cost estimates to evaluate the impact on reserves from changes in assumptions. We performed analysis over the vehicle lines and model years that had little or no claims experience to ensure the vehicle and model substitutions are comparable. We also involved actuarial specialists to evaluate the methodologies and assumptions, and to test the actuarial calculations used by the Company.Sales incentivesDescription of the matterAutomotive sales and revenue represents the amount of consideration to which the Company expects to be entitled in exchange for transferring goods or providing services, which is net of dealer and customer sales incentives the Company expects to pay. As discussed in Note 2 to the financial statements, provisions for dealer and customer incentives are recorded as a reduction to Automotive net sales and revenue at the time of vehicle sale. The liabilities for dealer and customer allowances, claims and discounts amount to $4.8 billion at December 31, 2022. Auditing the estimate of sales incentives involved a high degree of judgment. Significant factors used by the Company in estimating its liability for retail incentives include type of program, forecasted sales volumes, product mix, and the rate of customer acceptance of incentive programs, all of which are estimated based on historical experience and assumptions concerning future customer behavior and market conditions. The Company’s estimation model reflects the best estimate of the total incentive amount that the Company reasonably expects to pay at the time of sale. The estimated cost of incentives is forward-looking, and could be materially affected by future economic and market conditions.How we addressed the matter in our auditWe evaluated the design and tested the operating effectiveness of internal controls over the Company’s sales incentive process, including management’s review of the estimation model, the significant assumptions (e.g., incentive cost per unit, customer take rate, and market conditions), and the data inputs used in the model. Our audit procedures included, among others, the performance of analytical procedures to develop an independent range of the liability for retail incentives as of the balance sheet date. Our independent range was developed for comparison to the Company’s recorded liability, and is based on historical claims, forecasted spend, and the specific vehicle mix of current dealer stock. In addition, we performed sensitivity analyses over the cost per unit assumption developed by management to evaluate the impact on the liability resulting from a change in the assumption. Lastly, we assessed management’s forecasting process by performing quarterly hindsight analyses to assess the adequacy of prior forecasts.Valuation of GM Financial Equipment on Operating LeasesDescription of the matterGM Financial has recorded investments in vehicles leased to retail customers under operating leases. As discussed in Note 2 to the financial statements, at the beginning of the lease, management establishes an expected residual value for each vehicle at the end of the lease term. The Company’s estimated residual value of leased vehicles at the end of lease term was $24.7 billion as of December 31, 2022. 50Table of ContentsAuditing management’s estimate of the residual value of leased vehicles involved a high degree of judgment. Management’s estimate is based, in part, on third-party data which considers inputs including recent auction values and significant assumptions regarding the expected future volume of leased vehicles that will be returned to the Company, used car prices, manufacturer incentive programs and fuel prices. Realization of the residual values is dependent on the future ability to market the vehicles under future prevailing market conditions.How we addressed the matter in our auditWe evaluated the design and tested the operating effectiveness of the Company’s controls over the lease residual estimation process, including controls over management’s review of residual value estimates obtained from the Company’s third-party provider and other significant assumptions. Our procedures also included, among others, independently recalculating depreciation related to equipment on operating leases and performing sensitivity analyses related to significant assumptions. We also performed hindsight analyses to assess the propriety of management’s estimate of residual values, as well as tested the completeness and accuracy of data from underlying systems and data warehouses that are used in the estimation models./s/ ERNST & YOUNG LLPWe have served as the Company's auditor since 2017.Detroit, MichiganJanuary 31, 202351Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and the Board of Directors of General Motors Company Opinion on Internal Control over Financial ReportingWe have audited General Motors Company and subsidiaries’ internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, General Motors Company and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on the COSO criteria.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income, cash flows and equity for each of the three years in the period ended December 31, 2022, and the related notes and our report dated January 31, 2023 expressed an unqualified opinion thereon.Basis for OpinionThe Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control Over Financial ReportingA company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ ERNST & YOUNG LLPDetroit, MichiganJanuary 31, 202352Table of ContentsGENERAL MOTORS COMPANY AND SUBSIDIARIES
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and related notes included in "Financial Statements and Supplementary Data." Some of the information contained in this discussion and analysis, including information with respect to our plans and strategies for our business, includes forward-looking statements involving significant risks and uncertainties. As a result of many factors, such as those set forth in "Risk Factors," actual results may differ materially from the results described in, or implied by, these forward-looking statements.This section generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussion of 2020 items and comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Form 10-K for the year ended December 31, 2021.(Throughout the tables and this discussion and analysis, dollars are in millions, excluding average revenue per user (ARPU), and shares are in thousands.)OverviewWe are a global leader in serving a large market of everyday entrepreneurs, delivering simple, easy-to-use products, and outcome-driven, personalized guidance to small businesses, individuals, organizations, developers, designers and domain investors. We manage and report our business in the following two segments:•Applications and Commerce (A&C), which primarily consists of sales of products containing proprietary software, commerce products and third-party email and productivity solutions as well as sales of certain products when they are included in bundled offerings of our proprietary software products.•Core Platform (Core), which primarily consists of sales of domain registrations and renewals, aftermarket domain sales, website hosting products and website security products when not included in bundled offerings of our proprietary software products as well as sales of products not containing a software component.60Table of ContentsFinancial HighlightsBelow are key consolidated financial highlights for 2022, with comparisons to 2021.•Total revenue of $4,091.3 million, an increase of 7.2%, or approximately 8.4% on a constant currency basis(1).•International revenue of $1,334 million, an increase of 5.0%, or approximately 8.4% on a constant currency basis(1).•Total bookings of $4,413.8 million, an increase of 4.3%, or approximately 6.0% on a constant currency basis(1).•Operating income of $498.8 million, an increase of 30.5%.•Net income of $352.9 million, an increase of 45.3%. •Normalized EBITDA(2) of $1,013.0 million, an increase of 16.1%.•Net cash provided by operating activities of $979.7 million, an increase of 18.1%.(1) Discussion of constant currency is set forth in "Quantitative and Qualitative Disclosures about Market Risk."(2) A reconciliation of Normalized EBITDA to net income, its most directly comparable GAAP financial measure, is set forth in "Reconciliation of Normalized EBITDA" below.COVID-19 PandemicThe extent to which the ongoing COVID-19 pandemic may impact our future results and operations will depend on future developments, including the duration of the pandemic and the parameters of global governmental measures put in place to control the spread of the virus as well as the continuing economic impact of the pandemic. We continue to monitor the pandemic and the potential impacts it may have on our future financial position, results of operations and cash flows. See "Risk Factors" for additional information.Our Financial ModelWe have developed a stable and predictable business model driven by efficient customer acquisition, high customer retention rates and increasing lifetime spend. We have broadened our business model over the past several years to encompass a meaningful set of transactional relationships with our customers in areas such as aftermarket, commerce and payments and reseller agreements where one account may give us access to many users. We have also observed an increase in users that have converted from owning paid to free subscriptions during this time, coinciding with our experimentation with freemium services as our customers engage in more varied types of business with us. This has changed the way in which we interact with and target our customers, and, as such, in 2022 we reevaluated our definition of a customer based on our current business model. Under this new definition, we include all customer accounts with paid transactions in the trailing twelve months or with paid subscriptions as of the end of a period, but exclude customer accounts that have active free versions of our products but have not paid us in the trailing twelve months or do not have any paid subscriptions as of the end of the period. As a result of this reevaluation, we revised both our customer and related ARPU disclosures to retrospectively present total customers and ARPU under our updated customer definition, as shown in the table below:Year Ended December 31,20212020Total customers at period end (in thousands):Previous definition21,233 20,646 New definition20,704 20,148 Average revenue per user:Previous definition$182 $166 New definition$187 $170 We grew our total customers from 18.8 million as of December 31, 2019 to 20.9 million as of December 31, 2022, through a combination of our industry leading products built on a cloud platform, brand advertising, direct marketing efforts, customer referrals, world-class customer care and acquisitions. In each of the five years ended December 31, 2022, our customer retention rate exceeded 85%, and in 2022, our retention rate for customers who had been with us for over three years was 61Table of Contentsapproximately 93%. We believe the breadth and depth of our product offerings and the high quality and responsiveness of our customer care team build strong relationships with our customers and are key to our high level of customer retention.We generate bookings and revenue from sales of product subscriptions. We offer our subscriptions on a variety of terms, which average approximately one year, but can range from monthly to multi-annual terms of up to ten years depending on the product. We monitor total bookings as we typically collect payment at the time of sale and generally recognize revenue ratably over the term of our customer contracts. Accordingly, we believe total bookings is an indicator of the expected growth in our revenue and is a supplemental measure of the operating performance of our business. Applications and Commerce. We generated 31.3% of our 2022 total revenue from the sale of A&C products. A&C revenue primarily consists of revenue from sales of products containing proprietary software such as Websites + Marketing and Managed WordPress and commerce products such as payment processing fees and point-of-sale (POS) hardware as well as sales of third-party email and productivity solutions such as Microsoft Office 365. Total revenue from A&C products grew at a compound annual growth rate (CAGR) of 11.4% over the three years ended December 31, 2022.Core Platform. We generated 68.7% of our 2022 total revenue from our Core platform. Core revenue primarily consists of revenue from sales of domain registrations and renewals, aftermarket domain sales, website hosting products and website security products when not included in bundled offerings of our proprietary software products. Total revenue from Core Platform products grew at a compound annual growth rate (CAGR) of 5.6% over the three years ended December 31, 2022.Revenue derived from both of our product categories has increased in each of the last three years, with many of our non-domains products growing faster in recent periods.In each of the five years ended December 31, 2022, greater than 85% of our total revenue was generated by customers who were also customers in the prior year. To track our growth and the stability of our customer base, we monitor, among other things, revenue and retention rates generated by our annual customer cohorts over time, as well as corresponding marketing and advertising spend. We define an annual customer cohort to include each customer who first became a customer during a calendar year. For example, in 2016, we acquired approximately 3 million gross customers, who we collectively refer to as our 2016 cohort, and spent $229 million in marketing and advertising expenses. By the end of 2022, the 2016 cohort had generated an aggregate of approximately $1.6 billion of total bookings and we expect this cohort will continue to generate bookings and revenue in the future. For the five years ended December 31, 2022, the average annual revenue retention rate of the 2016 cohort was more than 98%, which is calculated by averaging the ratio of the cohort's annual revenue for each of the five years to its annual revenue for each respective preceding year. We selected the 2016 cohort as an example for this analysis, which we believe helps to illustrate the long-term value of our customers.62Table of ContentsResults of OperationsThe following table sets forth our results of operations for the periods presented and as a percentage of our total revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of future results.Year Ended December 31,202220212020$% of Total Revenue$% of Total Revenue$% of Total RevenueRevenue: A&C$1,279.7 31.3 %$1,128.3 29.6 %$926.1 27.9 %Core2,811.6 68.7 %2,687.4 70.4 %2,390.6 72.1 %Total revenue4,091.3 100.0 %3,815.7 100.0 %3,316.7 100.0 %Costs and operating expenses:Cost of revenue (excluding depreciation and amortization)1,484.5 36.3 %1,372.2 36.0 %1,158.6 34.9 %Technology and development794.0 19.4 %706.3 18.5 %560.4 16.9 %Marketing and advertising412.3 10.1 %503.9 13.2 %438.5 13.2 %Customer care305.9 7.5 %306.1 8.0 %316.9 9.6 %General and administrative385.5 9.4 %345.8 9.1 %323.8 9.8 %Restructuring and other15.7 0.4 %(0.3)— %43.6 1.3 %Depreciation and amortization194.6 4.7 %199.6 5.2 %202.7 6.1 %Total costs and operating expenses3,592.5 87.8 %3,433.6 90.0 %3,044.5 91.8 %Operating income498.8 12.2 %382.1 10.0 %272.2 8.2 %Interest expense(146.3)(3.6)%(126.0)(3.3)%(91.3)(2.8)%Loss on debt extinguishment(3.6)(0.1)%— — %— — %Tax receivable agreements liability adjustment— — %— — %(674.7)(20.3)%Other income (expense), net7.6 0.2 %(2.5)(0.1)%(1.6)— %Income (loss) before income taxes356.5 8.7 %253.6 6.6 %(495.4)(14.9)%Benefit (provision) for income taxes(3.6)(0.1)%(10.8)(0.3)%1.3 — %Net income (loss)352.9 8.6 %242.8 6.3 %(494.1)(14.9)%Less: net income attributable to non-controlling interests0.7 — %0.5 — %1.0 — %Net income (loss) attributable to GoDaddy Inc.$352.2 8.6 %$242.3 6.3 %$(495.1)(14.9)%Non-GAAP Financial Measure and Other Operating MetricsIn addition to our results determined in accordance with GAAP, we believe the following non-GAAP financial measure and other operating metrics are useful as supplements in evaluating our ongoing operational performance and help provide an enhanced understanding of our business:Year Ended December 31, 202220212020Normalized EBITDA$1,013.0 $872.2 $722.2 Annualized recurring revenue$3,570.1 $3,433.7 $3,136.8 Total bookings$4,413.8 $4,231.7 $3,775.5 Total customers at period end (in thousands)20,897 20,704 20,148 Average revenue per user$197 $187 $170 63Table of ContentsNormalized EBITDA (NEBITDA). NEBITDA is a supplemental measure of our operating performance used by management and investors to evaluate our business. We calculate NEBITDA as net income excluding depreciation and amortization, interest expense (net), provision or benefit for income taxes, equity-based compensation expense, acquisition-related costs, restructuring-related expenses and certain other items. We believe that the inclusion or exclusion of certain recurring and non-recurring items provides a supplementary measure of our core operating results and permits useful alternative period-over-period comparisons of our operations but should not be viewed as a substitute for comparable GAAP measures.Annualized recurring revenue (ARR). ARR is an operating metric defined as quarterly recurring revenue (QRR) multiplied by four. QRR represents the quarterly recurring GAAP revenue, net of refunds, from new and renewed subscription-based services. ARR is exclusive of any revenue that is non-recurring, including, without limitation, domain aftermarket, domain transfers, one-time set-up or migration fees and non-recurring professional website services fees. We believe ARR helps illustrate the scale of certain of our products and facilitates comparisons to other companies in our industry.Total bookings. Total bookings is an operating metric representing the total value of customer contracts entered into during the period, excluding refunds. We believe total bookings provides additional insight into the performance of our business and the effectiveness of our marketing efforts since we typically collect payment at the inception of a customer contract but recognize revenue ratably over the term of the contract.Total customers. We define a customer as an individual or entity with paid transactions in the trailing twelve months or with paid subscriptions as of the end of the period. A single user may be counted as a customer more than once if they maintain paid subscriptions or transactions in multiple accounts. Total customers is one way we measure the scale of our business and is an important part of our ability to increase our revenue base.Average revenue per user. We calculate ARPU as total revenue during the preceding 12 month period divided by the average of the number of total customers at the beginning and end of the period. ARPU provides insight into our ability to sell additional products to customers, though the impact to date has been muted due to our continued growth in total customers.Reconciliation of NEBITDAThe following table reconciles NEBITDA to net income, its most directly comparable GAAP financial measure:Year Ended December 31, 202220212020Net income (loss)$352.9 $242.8 $(494.1)Depreciation and amortization194.6 199.6 202.7 Equity-based compensation264.4 207.9 191.5 Interest expense, net135.0 124.9 86.9 Tax receivable agreements liability adjustment— — 674.7 Acquisition-related expenses35.1 78.2 25.0 Restructuring and other(1)27.4 8.0 36.8 Provision (benefit) for income taxes3.6 10.8 (1.3)NEBITDA$1,013.0 $872.2 $722.2 _________________________________(1)Includes lease-related expenses associated with closed facilities, charges related to certain legal matters, and expenses incurred in relation to the refinancing of our long-term debt.Year-Over-Year ComparisonRevenueWe generate substantially all of our revenue from sales of product subscriptions, as described in Note 2 to our financial statements. Our subscriptions can range from monthly terms to multi-annual terms of up to ten years, depending on the product. Revenue is presented net of refunds, and we maintain a reserve to provide for refunds granted to customers.64Table of ContentsBeginning in the first quarter of 2022, we revised the presentation of revenue, as described in Note 2 to our financial statements, and accordingly, have revised the prior period amounts in the table below to retrospectively present revenue in the new format.The following table presents our revenue for the periods indicated:Year Ended December 31,2022 to 20212021 to 2020202220212020$ change% change$ change% changeApplications & commerce$1,279.7 $1,128.3 $926.1 $151.4 13 %$202.2 22 %Core platform$2,811.6 $2,687.4 $2,390.6 $124.2 5 %$296.8 12 %Total revenue$4,091.3 $3,815.7 $3,316.7 $275.6 7 %$499.0 15 %2022 compared to 2021Total revenue increased 7.2%, due to the increases in our A&C and Core revenues, as described below:A&C. The 13.4% increase in A&C revenue was primarily driven by: (i) 13.1% growth in revenue related to our productivity applications, most notably our email solutions; (ii) 8.7% growth in revenues due to increased customer adoption of our subscription-based products designed to establish and grow online presence, such as Websites + Marketing and Managed WordPress hosting; and (iii) 103.2% growth in commerce-related revenue primarily associated with our acquisition of Poynt Co. (now known as GoDaddy Payments).Core. The 4.6% increase in Core revenue was primarily driven by: (i) 8.5% growth in domain-related revenues as a result of our continued enhancement of online presence and offerings and the continued growth of our registry business; (ii) a 5.8% growth in aftermarket revenues due to our continued innovation in auction technologies as well as contributions from our Dan.com acquisition; and (iii) 4.0% growth in our security and SSL product offerings resulting from higher customer renewals year over year, specifically with respect to Website Security. Partially offsetting these increases was a 5.9% decrease in hosting revenues, which was primarily due to end-of-life migrations from certain products and lower demand for these products amid the uncertain macroeconomic environment. 2021 compared to 2020Total revenue increased 15.0% due to the increases in our A&C and Core revenues, as described below:A&C. The 21.8% increase in A&C revenue was primarily driven by: (i) 15.5% growth in revenue related to our productivity applications, most notably our email solutions; (ii) 29.2% growth in revenues due to increased customer adoption of our subscription-based products designed to establish and grow online presence; and (iii) new commerce-related revenue primarily associated with our acquisition of Poynt Co in 2021. Core. The 12.4% increase in Core revenue was primarily driven by: (i) 9.8% growth in domain-related revenues as a result of a 1.7 million increase in domains under management and the continued growth of our registry business; (ii) 69.2% growth in aftermarket revenues due to continued innovation in our auction technologies; and (iii) 7.9% growth in our security and SSL product offerings resulting from increased customer adoption and higher customer renewals year over year. Partially offsetting these increases was a 33.6% decrease in certain higher-priced subscriptions, specifically GoDaddy Social, due to lower demand for such products.BookingsThe following table presents our total bookings for the periods indicated: Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeTotal bookings$4,413.8 $4,231.7 $3,775.5 $182.1 4 %$456.2 12 %The 4.3% increase in total bookings was primarily driven by increased aftermarket domain sales, broadened customer adoption of our productivity solutions and our Websites + Marketing and Managed WordPress products as well as an increase in ARPU due to a higher product attach rate and contributions from recent acquisitions, partially offset by approximately 170 basis 65Table of Contentspoints due to adverse movements in foreign currency exchange rates due to the strength of the U.S. dollar. In addition to the currency headwinds, our bookings growth rate was also impacted by uneven demand patterns related to inflation and continued economic uncertainty.Costs and Operating ExpensesCost of revenueCosts of revenue are the direct costs incurred in connection with selling an incremental product to our customers. Substantially all cost of revenue relates to domain registration fees, payment processing fees, third-party commissions and licensing fees for third-party productivity applications. Similar to our billing practices, we pay domain costs at the time of purchase for the life of each subscription, but recognize the costs of service ratably over the term of our customer contracts. The terms of registry pricing are established by agreements between registries and registrars, and can vary significantly depending on the TLD. We expect cost of revenue to increase in absolute dollars in future periods related to the expansion of our domains business, higher sales of third-party productivity applications and growth in our customer base. However, cost of revenue may fluctuate as a percentage of total revenue, depending on the mix of products sold in a particular period. Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeCost of revenue $1,484.5 $1,372.2 $1,158.6 $112.3 8 %$213.6 18 %The 8.2% increase in cost of revenue was primarily attributable to (i) higher domain costs, which were driven by increased aftermarket domain sales, cost increases implemented by various TLD registries and costs associated with our growing registry business, (ii) increased software licensing fees resulting from higher sales of productivity solutions and (iii) increased costs associated with the growth of our payment processing business.Technology and developmentTechnology and development expenses represent the costs associated with the creation, development and distribution of our products and websites. These expenses primarily consist of personnel costs associated with the design, development, deployment, testing, operation and enhancement of our products, as well as costs associated with the data centers and systems infrastructure supporting those products, excluding depreciation expense. We expect technology and development expense to increase in absolute dollars as we continue to invest in product development and migrate our infrastructure to a cloud-based third-party provider. Technology and development expenses may fluctuate as a percentage of total revenue depending on our level of investment in additional personnel and the pace of our infrastructure transition. Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeTechnology and development $794.0 $706.3 $560.4 $87.7 12 %$145.9 26 %The 12.4% increase in technology and development expenses was primarily due to (i) increased personnel costs driven by higher average headcount associated with our continued investment in product development and (ii) increased technology costs associated with the growth of our business, advancement of our commerce and innovation strategies and our migration to a cloud-based infrastructure. The increase was partially offset by a $27.0 million decrease in compensation expense related to prior acquisitions, primarily Poynt.66Table of ContentsMarketing and advertisingMarketing and advertising expenses represent the costs associated with attracting and acquiring customers, primarily consisting of fees paid to third parties for marketing and advertising campaigns across a variety of channels. These expenses also include personnel costs and affiliate program commissions. We expect marketing and advertising expenses to fluctuate depending on both the mix of internal and external marketing resources used, the size and scope of our future campaigns and the level of discretionary investments we make in marketing to drive future sales. Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeMarketing and advertising $412.3 $503.9 $438.5 $(91.6)(18)%$65.4 15 %The 18.2% decrease in marketing and advertising expenses were primarily attributable to a lower level of discretionary spending in 2022 as compared to the significant additional marketing investments we made in 2021 to drive growth during a period of high demand. Customer careCustomer care expenses represent the costs to guide and service our customers, primarily consisting of personnel costs. We expect customer care expenses to fluctuate depending on the level of personnel required to support our business. Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeCustomer care $305.9 $306.1 $316.9 $(0.2)0 %$(10.8)(3)%There were no material changes in customer care expenses.General and administrativeGeneral and administrative expenses primarily consist of personnel costs for our administrative functions, professional service fees, office rent for all locations, all employee travel expenses, acquisition-related expenses and other general costs. We expect general and administrative expenses to fluctuate depending on the level of personnel and other administrative costs required to support our business as well as the significance of any strategic acquisitions we choose to pursue. Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeGeneral and administrative $385.5 $345.8 $323.8 $39.7 11 %$22.0 7 %The 11.5% increase in general and administrative expenses was primarily due to (i) increased personnel costs driven by higher average headcount and the reversal of equity-based compensation expense in 2021 due to the forfeiture of unvested awards related to certain executive departures; (ii) increased legal and professional fees; and (iii) the reversal of an indirect tax reserve as a result of a settlement agreement in 2021. These increases were partially offset by lower acquisition related expenses and office rent expense.Restructuring and other Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeRestructuring and other$15.7 $(0.3)$43.6 $16.0 (5333)%$(43.9)(101)%Restructuring and other of $15.7 million during 2022 primarily includes the impairment and loss on disposition of certain assets.Restructuring and other during 2021 includes (i) the $15.4 million gain on sale of the land and buildings of our former corporate headquarters and (ii) a $15.1 million charge related to the impairment of certain operating lease assets and related leasehold improvements associated with the decision to close one of our leased offices.67Table of ContentsDepreciation and amortizationDepreciation and amortization expenses consist of charges relating to the depreciation of the property and equipment used in our operations and the amortization of acquired intangible assets. These expenses may increase or decrease in absolute dollars in future periods depending on our future level of capital investments in hardware and other equipment as well as the significance of any future acquisitions. Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeDepreciation and amortization $194.6 $199.6 $202.7 $(5.0)(3)%$(3.1)(2)%There were no material changes in depreciation and amortization. Interest expense Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeInterest expense $146.3 $126.0 $91.3 $20.3 16 %$34.7 38 %The 16.1% increase in interest expense was primarily driven by the higher effective interest rates on our variable-rate debt in 2022, as further discussed in Note 10 to our financial statements.Loss on debt extinguishmentIn 2022, we recognized a loss on debt extinguishment of $3.6 million, primarily related to the refinancing of the 2029 Term Loans. See Note 10 to our financial statements for additional discussion.Segment Results of OperationsOur two operating segments, A&C and Core, reflect the way we manage and evaluate the performance of our business. Our chief operating decision maker evaluates segment performance based upon several factors, of which the primary financial measures are revenue and Segment EBITDA. See Note 18 to our financial statements for a reconciliation of Segment EBITDA to net income, its most directly comparable GAAP financial measure.Applications & CommerceThe following table presents the results for our A&C segment for the periods indicated: Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeRevenue$1,279.7 $1,128.3 $926.1 $151.4 13 %$202.2 22 %Segment EBITDA$522.8 $447.7 $349.7 $75.1 17 %$98.0 28 %2022 compared to 2021The 13.4% increase in A&C revenue was primarily driven by: (i) 13.1% growth in revenue related to our productivity applications, most notably our email solutions; (ii) 8.7% growth in revenues due to increased customer adoption of our subscription-based products designed to establish and grow online presence, such as Websites + Marketing and Managed WordPress hosting; and (iii) 103.2% growth in commerce-related revenue primarily associated with our acquisition of Poynt Co. (now known as GoDaddy Payments).The 16.8% increase in A&C Segment EBITDA for the year ended December 31, 2022 primarily resulted from the revenue increases noted above, in conjunction with lower discretionary marketing spend in 2022. These increases were partially offset by higher personnel costs resulting from headcount additions made to support the continued development of our A&C products.68Table of Contents2021 compared to 2020The 21.8% increase in A&C revenue was primarily driven by: (i) 15.5% growth in revenue related to our productivity applications, most notably our email solutions; and (ii) 29.2% growth in revenues due to increased customer adoption of our subscription-based products designed to establish and grow online presence; and (iii) new commerce-related revenue associated with our acquisition of Poynt Co in 2021.The 28.0% increase in A&C Segment EBITDA for the year ended December 31, 2021 primarily resulted from the revenue increases noted above, partially offset by higher personnel costs resulting from headcount additions made to support the continued development of our A&C products as well as increased discretionary marketing spending associated with investments made to drive additional growth.Core PlatformThe following table presents the results for our Core segment for the periods indicated: Year Ended December 31,2022 to 20212021 to 2020 202220212020$ change% change$ change% changeRevenue$2,811.6 $2,687.4 $2,390.6 $124.2 5 %$296.8 12 %Segment EBITDA$783.7 $679.7 $628.2 $104.0 15 %$51.5 8 %2022 compared to 2021The 4.6% increase in Core revenue was primarily driven by: (i) 8.5% growth in domain-related revenues as a result of our continued enhancement of online presence and offerings and the continued growth of our registry business; (ii) 5.8% growth in aftermarket revenues due to our continued innovation in auction technologies as well as contributions from our Dan.com acquisition; and (iii) 4.0% growth in our security and SSL product offerings resulting from higher customer renewals year over year, specifically with respect to Website Security. Partially offsetting these increases was a 5.9% decrease in hosting revenues, which was primarily due to end-of-life migrations from certain products and lower demand for these products amid the uncertain macroeconomic environment. The 15.3% increase in Core Segment EBITDA for the year ended December 31, 2022 primarily resulted from the revenue increases noted above, in conjunction with lower discretionary marketing spend in 2022. These increases were partially offset by higher third-party commissions associated with the increased aftermarket domain sales as well as cost increases implemented by various TLD registries.2021 compared to 2020The 12.4% increase in Core revenue was primarily driven by: (i) 9.8% growth in domain-related revenues as a result of a 1.7 million increase in domains under management and the continued growth of our registry business; (ii) 69.2% growth in aftermarket revenues due to continued innovation in our auction technologies; and (iii) 7.9% growth in our security and SSL product offerings resulting from increased customer adoption and higher customer renewals year over year. Partially offsetting these increases was a 33.6% decrease in certain higher-priced subscriptions, specifically GoDaddy Social, due to lower demand for such products.The 8.2% increase in Core Segment EBITDA for the year ended December 31, 2021 primarily resulted from the revenue increases noted above, partially offset by increased discretionary marketing spend in 2021 and higher third-party commissions associated with the increased aftermarket domain sales.69Table of ContentsLiquidity and Capital ResourcesOverviewOur principal sources of liquidity have been cash flow generated from operations, long-term debt borrowings and stock option exercises. Our principal uses of cash have been to fund operations, acquisitions and capital expenditures, as well as to make mandatory principal and interest payments on our long-term debt and to repurchase shares of our Class A common stock.In general, we seek to deploy our capital in a prioritized manner focusing first on requirements for our operations, then on growth investments, and finally on stockholder returns. Our strategy is to deploy capital, whether debt, equity or internally generated cash, depending on the adequacy and availability of the source of capital and which source may be used most efficiently and at the lowest cost at such time. Therefore, while cash from operations is our primary source of operating liquidity and we believe our internally-generated cash flows are sufficient to support our day-to-day operations, we may use a variety of capital sources to fund our needs for less predictable investment decisions such as strategic acquisitions and share repurchases.We have incurred significant long-term debt, primarily to fund acquisitions, share repurchases and the settlement of our prior tax receivable agreements. As a result, we are limited as to how we conduct our business and may be unable to raise additional debt or equity financing to compete effectively or to take advantage of new business opportunities, strategic acquisitions or share repurchases. However, the restrictions under our long-term debt agreements are subject to a number of qualifications and may be amended with the consent of the lenders and the holders of the senior notes, as applicable.We believe our existing cash and cash equivalents and cash generated by operating activities will be sufficient to meet our anticipated operating cash needs for at least the next 12 months. However, our future capital requirements will depend on many factors, including our growth rate, macroeconomic activity, the timing and extent of spending to support domestic and international development efforts, continued brand development and advertising spend, the level of customer care and general and administrative activities, the introduction of new and enhanced product offerings, the costs to support new and replacement capital equipment, the completion of strategic acquisitions or share repurchases and other factors. Should we pursue additional strategic acquisitions or share repurchases, we may need to raise additional capital, which may be in the form of long-term debt or equity financings.Credit Facility and Senior NotesOur long-term debt obligations consist of our Credit Facility, which includes our secured credit agreement and a revolving credit facility (the Revolver), and the senior notes. In November 2022, we amended our Credit Facility to provide for a new $1.8 billion tranche of term loans maturing in 2029, the proceeds of which were used to refinance all of the outstanding previously-issued term loans maturing in 2024. In addition, we increased the borrowing capacity under our revolving credit facility from $600.0 million to $1.0 billion and extended its maturity to November 2027. Estimated future interest payments associated with our long-term debt totaled $1,455.3 million as of December 31, 2022, with $241.6 million payable within 12 months. See Note 10 to our financial statements for additional information regarding our long-term debt.Our long-term debt agreements contain covenants restricting, among other things, our ability, or the ability of our subsidiaries, to incur indebtedness, issue certain types of equity, incur liens, enter into fundamental changes including mergers and consolidations, sell assets, make restricted payments including dividends, distributions and investments, prepay junior indebtedness and engage in operations other than in connection with acting as a holding company, subject to customary exceptions. As of December 31, 2022, we were in compliance with all such covenants and had no amounts drawn on our Revolver.As further discussed in Note 11 to our financial statements, we have hedged a portion of our long-term debt through the use of cross-currency and interest rate swap derivative instruments. These instruments help us manage and mitigate our risk of exposure to changes in foreign currency exchange rates and interest rates. See "Quantitative and Qualitative Disclosures About Market Risk" for additional discussion of our hedging activities.Share RepurchasesAs discussed in Note 5 to our financial statements, in January 2022, our board of directors approved the repurchase of up to an additional $2,251.0 million of our Class A common stock. Such approval was in addition to the amount remaining available 70Table of Contentsfor repurchases under prior approvals of our board of directors, such that we have authority to repurchase up to $3,000.0 million of shares of our Class A common stock. Under this authority, in February 2022, we entered into a ASRs to repurchase shares of our Class A common stock in exchange for an up-front aggregate payment of $750.0 million. We completed the ASRs in May 2022, repurchasing a total of 9,202 shares of our Class A common stock at an average price of $81.50 per share under these arrangements.In addition to the ASRs discussed above, during the year ended December 31, 2022, we also repurchased a total of 7,642 shares of our Class A common stock in the open market for an aggregate purchase price of $550.1 million.As of December 31, 2022, we had $1,699.9 million of remaining authorization available for repurchases.AcquisitionsIn July 2022, we completed an acquisition for $69.6 million in net cash consideration. See Note 3 to our financial statements for a discussion of this acquisition.RestructuringAs discussed in Note 20 to our financial statements, on February 8, 2023, the audit and finance committee of our board of directors authorized a restructuring plan to reduce future operating expenses and improve cash flows through a combination of a reduction in force and a rationalization of our portfolio. As part of this plan, we announced a reduction in our current workforce of approximately 550 employees, representing approximately 8% of our total employees. We estimate we will incur approximately $55.0 million to $65.0 million of pre-tax restructuring and exit related charges, of which $30.0 million to $40.0 million represents future cash expenditures for the payment of severance and related benefit costs.Cash FlowsThe following table summarizes our cash flows for the periods indicated: Year Ended December 31, 202220212020Net cash provided by operating activities$979.7 $829.3 $764.6 Net cash used in investing activities(132.0)(635.6)(482.3)Net cash provided by (used in) financing activities(1,326.7)298.1 (581.7)Effect of exchange rate changes on cash and cash equivalents(2.7)(1.3)1.8 Net increase (decrease) in cash and cash equivalents$(481.7)$490.5 $(297.6)Operating ActivitiesOur primary source of cash from operating activities has been cash collections from our customers. Our primary uses of cash from operating activities have been for domain registration costs paid to registries, software licensing fees related to third-party productivity solutions, personnel costs, discretionary marketing and advertising costs, technology and development costs and interest payments. We expect cash outflows from operating activities to be affected by the timing of payments we make to registries as well as increases in personnel and other operating costs as we continue to grow our business.Net cash provided by operating activities increased $150.4 million from $829.3 million in 2021 to $979.7 million in 2022, primarily driven by the growth in total bookings as well as lower acquisition-related payments and discretionary marketing spending. These increases were partially offset by higher personnel costs to support our growth, increased domain costs and higher software licensing fees related to increased sales of third-party productivity solutions.71Table of ContentsInvesting ActivitiesOur investing activities generally consist of strategic acquisitions and purchases of property and equipment to support the overall growth of our business. We expect our investing cash flows to be affected by the timing of payments we make for capital expenditures, strategic acquisitions or other growth opportunities we decide to pursue.Net cash used in investing activities decreased $503.6 million from $635.6 million in 2021 to $132.0 million in 2022, primarily due to a $295.2 million decrease in spending for business acquisitions and a $201.7 million decrease in purchases of intangible assets.Financing ActivitiesOur financing activities generally consist of long-term debt borrowings, the repayment of principal on long-term debt, stock option exercise proceeds and share repurchases.Net cash from financing activities decreased $1,624.8 million from $298.1 million provided in 2021 to $1,326.7 million used in 2022, primarily due to $800.0 million in proceeds received from the issuance of the 2029 Senior Notes in 2021 as well as a $768.6 million increase in share repurchases.Deferred RevenueSee Note 8 to our financial statements for details regarding the expected future recognition of deferred revenue.Off-Balance Sheet ArrangementsAs of December 31, 2022 and 2021, we had no off-balance sheet arrangements that had, or which are reasonably likely to have, a material effect on our financial statements.Critical Accounting Policies and EstimatesWe prepare our financial statements in accordance with GAAP, and in doing so, we make estimates, assumptions and judgments affecting the reported amounts of assets, liabilities, revenues and expenses, as well as the related disclosure of contingent assets and liabilities. We base our estimates, assumptions and judgments on historical experience and on various other factors we believe to be reasonable under the circumstances, and we evaluate these estimates, assumptions and judgments on an ongoing basis. Different assumptions and judgments would change the estimates used in the preparation of our financial statements, which, in turn, could change our results from those reported. We refer to estimates, assumptions and judgments of this type as our critical accounting policies and estimates, which we discuss further below. We review our critical accounting policies and estimates with the audit and finance committee of our board of directors on an annual basis.See Note 2 to our financial statements for a summary of our significant accounting policies.Revenue RecognitionWe recognize revenue when control of the promised products is transferred to a customer, in an amount reflecting the consideration we expect to be entitled to in exchange for those products. Payments received in advance of our performance are recorded as deferred revenue. Revenue is recognized net of allowances for returns and transaction-based taxes collected.We generally sell our products with a right of return, which we account for as variable consideration when estimating the amount of revenue to recognize. Refunds are estimated at contract inception using the expected value method based on historical refund experience and updated each reporting period as additional information becomes available. Our annual refund rate has declined from 6.5% of total bookings in 2020 to 4.7% in 2022.We may sell multiple products to customers at the same time. For example, we may design a customer website and separately offer other products such as hosting and an SSL certificate, or a customer may combine a domain registration with other products such as Websites + Marketing or email. Judgment may be required in determining whether products contain multiple distinct performance obligations that should each be accounted for separately or as one combined performance 72Table of Contentsobligation. The majority of our revenue arrangements consist of multiple performance obligations, with revenue recognized over the period in which each performance obligation is satisfied, which is generally over the contract term.For arrangements with multiple performance obligations, we allocate revenue to each distinct performance obligation based on its relative stand-alone selling price (SSP). Our process for determining SSP requires judgment and considers multiple factors that may vary over time depending upon the unique facts and circumstances related to each performance obligation. We determine SSP based on prices charged to customers for individual products, taking into consideration other factors, which may include (i) historical and expected discounting practices; (ii) the size, volume and term length of transactions; (iii) customer demographics; (iv) the geographic areas in which our products are sold; and (v) our overall go-to-market strategy.We sell our products directly to customers and also through a network of resellers. In certain cases, such as for aftermarket domain sales, we act as a reseller of products provided by others. The determination of gross or net revenue recognition is reviewed on a product-by-product basis and is dependent on whether we act as principal or agent in the transaction.See Notes 2 and 8 to our financial statements for additional information regarding revenue recognition and deferred revenue.AcquisitionsWe determine whether substantially all of the fair value of assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If this threshold is met, the single asset or group of assets, as applicable, is accounted for as an asset acquisition. If the threshold is not met, further assessment is undertaken to ascertain whether the acquisition meets the definition of a business.We include the results of operations of acquired businesses in our financial statements as of the respective dates of acquisition. Accounting for business acquisitions requires us to make significant estimates and assumptions, especially at the acquisition date, with respect to tangible and intangible assets acquired, liabilities assumed and pre-acquisition contingencies. The purchase price, including estimates of the fair value of contingent consideration when applicable, is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values on the respective acquisition dates, with the excess recorded as goodwill. Critical estimates used in valuing certain acquired intangible assets include, but are not limited to, future expected cash flows (primarily from customer relationships and developed technology) and discount rates.Contingent consideration liabilities, which relate to future earn-out payments associated with our acquisitions, are generally valued using discounted cash flow valuation methods. Critical estimates used in valuing these liabilities include estimated operating results scenarios for the applicable performance periods, probability weightings assigned to operating results scenarios and discount rates.We use our best estimates and assumptions to determine acquisition-date fair values. These estimates are inherently uncertain and subject to refinement. We continue to collect information and reevaluate our preliminary estimates and assumptions and record any qualifying measurement period adjustments to goodwill. Contingent consideration is adjusted to fair value in subsequent periods as an increase or decrease in general and administrative expenses.See Notes 2 and 3 to our financial statements for additional information regarding business acquisitions.Goodwill and Indefinite-Lived Intangible AssetsWe make estimates, assumptions and judgments when valuing goodwill and other intangible assets in connection with the initial purchase price allocations of business acquisitions, as well as when evaluating the recoverability of our goodwill and other intangible assets on an ongoing basis. We assess our goodwill and indefinite-lived intangible assets for impairment at least annually during the fourth quarter. We will also perform an assessment at other times if and when events or changes in circumstances indicate the carrying value of these assets may not be recoverable.We perform our impairment assessment based on qualitative analysis, which includes considering various factors including macroeconomic conditions, industry and market conditions and our historical and projected operating results. If, based on our qualitative analysis, we were to determine it is more-likely-than-not the fair value of either of our reporting units is less than its carrying amount, a quantitative impairment test would be performed to determine if an impairment loss should be recorded. 73Table of ContentsOur qualitative analyses during 2022, 2021 and 2020 did not indicate any impairment. As of December 31, 2022, we believe such assets are recoverable; however, there can be no assurance these assets will not be impaired in future periods. Any future impairment charges could adversely impact our results of operations.See Notes 2 and 4 to our financial statements for additional information regarding goodwill and indefinite-lived intangible assets.Income TaxesWe are subject to U.S. federal, state and foreign income taxes with respect to our allocable share of any taxable income or loss of Desert Newco, as well as any stand-alone income or loss we generate. Significant judgment is required in determining our provision or benefit for income taxes and in evaluating uncertain tax positions.We account for income taxes under the asset and liability method, which requires the recognition of DTAs and DTLs for the expected future tax consequences of events included in our financial statements. Under this method, we determine DTAs and DTLs on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on DTAs and DTLs is recognized in income in the period in which the enactment date occurs.We recognize DTAs to the extent we believe these assets are more-likely-than-not to be realized. In evaluating our ability to realize our DTAs, in full or in part, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, prudent and feasible tax planning strategies and recent results of operations. The assumptions utilized in determining future taxable income require significant judgment and are consistent with the plans and estimates we use to manage our business. Actual operating results in future years could differ from our current assumptions, judgments and estimates, which could have a material impact on the amount of DTAs we ultimately realize.We recognize tax benefits from uncertain tax positions only if it is more-likely-than-not the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized from such positions are measured based on the largest benefit having a greater than 50% likelihood of being realized.See Notes 2 and 16 to our financial statements for additional information regarding income taxes and the considerations that could lead to a release of substantially all of the valuation allowance against our DTAs.Loss ContingenciesWe are subject to the possibility of various loss contingencies arising from uncertain and unresolved matters in the ordinary course of business and from events or actions by others having the potential to result in a future loss. Such contingencies may include, but are not limited to, intellectual property claims, putative class actions, commercial and consumer protection claims, labor and employment claims, breach of contract claims, regulatory proceedings, product service level commitments and losses resulting from other events and developments. We consider the likelihood of loss, the impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies.When a loss is considered probable and reasonably estimable, we record a liability in the amount of our best estimate for the ultimate loss. When there appears to be a range of possible costs with equal likelihood, a liability is recorded based on the low-end of such range. However, the likelihood of a loss with respect to a particular contingency is often difficult to predict and determining a meaningful estimate of the loss or a range of loss may not be practicable based on the information available and the potential effect of future events and decisions by third parties impacting the ultimate resolution of the contingency. It is also not uncommon for such matters to be resolved over many years, during which time relevant developments and new information must be continuously evaluated to determine both the likelihood of potential loss and whether it is possible to reasonably estimate a range of possible loss. When a loss is probable but a reasonable estimate cannot be made, disclosure is provided. Disclosure is also provided when it is reasonably possible a loss will be incurred or when it is reasonably possible the amount of a loss will exceed the recorded amounts.We regularly review all contingencies to determine whether the likelihood of loss has changed and to assess whether a reasonable estimate of the loss or range of loss can be made. Development of a meaningful estimate of loss, or a range of potential loss, is complex when the outcome is directly dependent on negotiations with, or decisions by, third parties such as regulatory 74Table of Contentsagencies, court systems in various jurisdictions and other interested parties. Such factors bear directly on whether it is possible to reasonably estimate a range of potential loss and boundaries of high and low estimates. Until the final resolution of such matters, there may be an exposure to loss in excess of the amounts recorded, and such amounts could be material. Should any of our estimates and assumptions change or prove to have been incorrect, it could have a material impact on our business, operating results or financial condition.See Note 13 to our financial statements for additional information regarding loss contingencies.Recent Accounting PronouncementsFor information regarding recent accounting pronouncements, see Note 2 to our financial statements.Item 7A. Quantitative and Qualitative Disclosures About Market RiskWe are exposed to market risk in the ordinary course of business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in foreign currency exchange rates and variable interest rates. Consequently, we may employ policies and procedures to mitigate such risks, including the use of derivative financial instruments, which are discussed in more detail in Note 11 to our financial statements. We do not enter into derivative transactions for speculative or trading purposes.As a result of the use of derivative instruments, we are exposed to the risk that counterparties to our contracts may fail to meet their contractual obligations. To mitigate such counterparty credit risk, we enter into contracts only with carefully selected financial institutions based upon ongoing evaluations of their creditworthiness. As a result, we do not believe we are exposed to any undue concentration of counterparty risk with respect to our derivative contracts as of December 31, 2022.Foreign Currency RiskWe manage our exposure to changes in foreign currency exchange rates through the use of foreign exchange forward contracts and cross-currency swap contracts. See Note 11 to our financial statements for a summary of the notional amounts and fair values of such arrangements. The effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would not have had a material impact on our cash and cash equivalents.Foreign Exchange Forward ContractsA portion of our bookings, revenue and operating expenses is denominated in foreign currencies, which are subject to exchange rate fluctuations. Our most significant foreign currency exposures are the British pound, the Euro and the Canadian dollar. Our reported bookings, revenues and operating results may be impacted by fluctuations in foreign currency exchange rates. Fluctuations in exchange rates may also cause us to recognize transaction gains and losses in our statements of operations; however, such amounts were not material during the current period. As our international operations continue to grow, our exposure to fluctuations in exchange rates will increase, which may increase the costs associated with this growth. During 2022, our total bookings growth in constant currency would have been approximately 170 basis points higher and our total revenue growth would have been approximately 120 basis points higher. Constant currency is calculated by translating bookings and revenue for each month in the current period using the foreign currency exchange rates for the corresponding month in the prior period, excluding any hedging gains or losses realized during the period. We believe constant currency information is useful in analyzing underlying trends in our business by eliminating the impact of fluctuations in foreign currency exchange rates and allows for period-to-period comparisons of our performance.From time-to-time, we may utilize foreign exchange forward contracts to manage the volatility of our bookings and revenue related to foreign currency transactions. These forward contracts reduce, but do not eliminate, the impact of adverse currency exchange rate fluctuations. We generally designate these forward contracts as cash flow hedges for accounting purposes. Changes in the intrinsic value of designated hedges are recorded as a component of accumulated other comprehensive income (loss) (AOCI). Gains and losses, once realized, are recorded as a component of AOCI and are amortized to revenue over the same period in which the underlying hedged amounts are recognized. At December 31, 2022, the realized and unrealized gains included in AOCI were $15.6 million and $7.3 million, respectively.75Table of ContentsCross-Currency Swap ContractIn order to manage variability due to movements in foreign currency exchange rates related to a Euro-denominated intercompany loan, we entered into five-year cross-currency swaps in April 2017. In March 2022, we entered into a transaction to extend the maturity of these swaps to August 31, 2027, as described in Note 11 to our financial statements. The cross-currency swaps had an aggregate amortizing notional amount of €1,171.8 million at December 31, 2022 (approximately $1,254.3 million).The swaps designated as cash flow hedging relationships convert the Euro-denominated interest and principal receipts on the intercompany loan into fixed U.S. dollar interest and principal receipts, thereby reducing our exposure to fluctuations between the Euro and U.S. dollar. Changes to the fair value of the cross-currency swaps due to changes in the value of the U.S. dollar relative to the Euro would be largely offset by the net change in the fair values of the underlying hedged items.The swaps designated as net investment hedging relationships hedge the foreign currency exposure of our net investment in certain Euro denominated functional currency subsidiaries. At maturity, the Euro notional value will be exchanged for the U.S. dollar notional value.Interest Rate RiskInterest rate risk reflects our exposure to movements in interest rates associated with our variable-rate debt. See Note 10 to our financial statements for additional information regarding our long-term debt.Total borrowings under our 2027 Term Loans were $731.3 million as of December 31, 2022. These borrowings bear interest at a rate equal to, at our option, either (a) LIBOR plus 2.00% per annum or (b) 1.0% per annum plus the highest of (i) the Federal Funds Rate plus 0.5%, (ii) the Prime Rate or (iii) one-month LIBOR plus 1.0%.Total borrowings under our 2029 Term Loans were $1,770.0 million as of December 31, 2022. These borrowings bear interest at a rate equal to, at our option, either (a) Secured Overnight Financing Rate (SOFR) for an interest period of one month plus an initial margin of 3.25% per annum or (b) an initial margin of 2.25% per annum plus the highest of (i) the Federal Funds Rate plus 0.5%, (ii) the Prime Rate or (iii) SOFR for an interest period of one month plus 1.0%. All LIBOR- and SOFR-based interest rates under the Credit Facility are subject to a 0.0% floor.In April 2017, we entered into a five-year pay-fixed rate, receive-floating rate interest rate swap arrangement to effectively convert a portion of the variable-rate borrowings under the 2029 Term Loans to a fixed rate. Prior to this arrangement's contractual maturity date of April 3, 2022, in March 2022, we entered into a transaction to extend the maturity of these swaps to August 31, 2027, as described in Note 11 to our financial statements. In addition, in conjunction with the refinancing of a portion of our debt in November 2022, the hedged debt index of the swaps was changed from LIBOR to SOFR. The 2022 Interest Rate Swaps, which had a notional amount of $1,249.2 million as of December 31, 2022, serve to convert a portion of the variable-rate borrowings under the 2029 Term Loans to a fixed rate of 4.81%.In August 2020, we entered into seven-year pay-fixed rate, receive-floating rate interest rate swap arrangements to effectively convert the variable one-month LIBOR interest rate on the 2027 Term Loans borrowings to a fixed rate of 0.705%. These interest rate swaps, which mature on August 10, 2027, had an aggregate notional amount of $731.3 million at December 31, 2022.The objective of our interest rate swaps, all of which are designated as cash flow hedges, is to manage the variability of cash flows in the interest payments related to the portion of variable-rate debt designated as being hedged.For the balance of our long-term debt not subject to interest rate swaps, the effect of a hypothetical 10% change in interest rates would not have had a material impact on our interest expense.76Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The accompanying consolidated financial statements present certain information with respect to the financial position, results of operations and cash flows of HCA Healthcare, Inc. which should be read in conjunction with the following discussion and analysis. The terms “HCA,” “Company,” “we,” “our,” or “us,” as used herein, refer to HCA Healthcare, Inc. and its affiliates. The term “affiliates” means direct and indirect subsidiaries of HCA Healthcare, Inc. and partnerships and joint ventures in which such subsidiaries are partners. Forward-Looking Statements This annual report on Form 10-K includes certain disclosures that contain “forward-looking statements,” within the meaning of the federal securities laws, which involve risks and uncertainties. Forward-looking statements include statements regarding expected share-based compensation expense, expected capital expenditures, expected dividends, expected share repurchases, expected net claim payments, expected inflationary pressures and all other statements that do not relate solely to historical or current facts, and can be identified by the use of words like “may,” “believe,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan,” “initiative” or “continue.” These forward-looking statements are based on our current plans and expectations and are subject to a number of known and unknown uncertainties and risks, many of which are beyond our control, which could significantly affect current plans and expectations and our future financial position and results of operations. These factors include, but are not limited to, (1) developments related to COVID-19, including, without limitation, the length and severity of its impact and the spread of virus strains with new epidemiological characteristics; the volume of canceled or rescheduled procedures and the volume and acuity of COVID-19 patients cared for across our health systems; measures we are taking to respond to COVID-19; the impact and terms (including the termination or expiration) of government and administrative regulation and stimulus and relief measures (including the Families First Coronavirus Response Act, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, the Paycheck Protection Program and Health Care Enhancement Act, the Consolidated Appropriations Act, 2021, the American Rescue Plan Act of 2021 (“ARPA”) and other enacted and potential future legislation) and whether various stimulus and relief programs continue or new similar programs are enacted in the future; changes in revenues due to declining patient volumes, changes in payer mix, deteriorating macroeconomic conditions (including increases in uninsured and underinsured patients) and capacity constraints; potential increased expenses related to inflation or labor, supply chain or other expenditures; supply shortages and disruptions; and the timing, availability and adoption of effective medical treatments and vaccines (including boosters), (2) the impact of our substantial indebtedness and the ability to refinance such indebtedness on acceptable terms, (3) the impact of current and future federal and state health reform initiatives and possible changes to other federal, state or local laws and regulations affecting the health care industry, including but not limited to, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the “Affordable Care Act”), additional changes to the Affordable Care Act, its implementation, or interpretation (including through executive orders and court challenges), and proposals to expand coverage of federally-funded insurance programs as an alternative to private insurance or establish a single-payer system (such reforms often referred to as “Medicare for All”), (4) the effects related to the implementation of sequestration spending reductions required under the Budget Control Act of 2011, related legislation extending these reductions and those required under the Pay-As-You-Go Act of 2010 (“PAYGO Act”) as a result of the federal budget deficit impact of the ARPA, and the potential for future deficit reduction legislation that may alter these spending reductions, which include cuts to Medicare payments, or create additional spending reductions, (5) increases in the amount and risk of collectability of uninsured accounts and deductibles and copayment amounts for insured accounts, (6) the ability to achieve operating and financial targets, and attain expected levels of patient volumes and control the costs of providing services, (7) possible changes in Medicare, Medicaid and other state programs, including Medicaid supplemental payment programs or Medicaid waiver programs, that may impact reimbursements to health care providers and insurers and the size of the uninsured or underinsured population, (8) personnel related capacity constraints; increases in wages and the ability to attract, utilize and retain qualified management and other personnel, including affiliated physicians, nurses and medical and technical support personnel; and workforce disruptions, (9) the highly competitive nature of the health care business, (10) changes in service mix, revenue mix and surgical volumes, including potential declines in the population covered under third-party payer agreements, the ability to enter into and renew third-party payer provider agreements on acceptable terms and the impact of consumer-driven health plans and physician utilization trends and practices, (11) the efforts of health insurers, health care providers, large employer groups and others to contain health care costs, (12) the outcome of our continuing efforts to monitor, maintain and comply with appropriate laws, regulations, policies and procedures, (13) the availability and terms of capital to fund the expansion of our business and improvements to our existing facilities, (14) changes in accounting practices, (15) changes in general economic conditions nationally and regionally in our markets, including inflation and economic and business conditions (and the impact thereof on the economy and financial markets), (16) the emergence of and effects related to pandemics, epidemics and infectious diseases, (17) future divestitures which may result in charges and possible impairments of long-lived assets, (18) changes in business strategy or development plans, (19) delays in receiving payments for 56 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Forward-Looking Statements (continued) services provided, (20) the outcome of pending and any future tax audits, disputes and litigation associated with our tax positions, (21) potential adverse impact of known and unknown government investigations, litigation and other claims that may be made against us, (22) the impact of potential cybersecurity incidents or security breaches, (23) our ongoing ability to demonstrate meaningful use of certified electronic health record (“EHR”) technology and the impact of interoperability requirements, (24) the impact of natural disasters, such as hurricanes and floods, physical risks from climate change or similar events beyond our control, (25) changes in U.S. federal, state, or foreign tax laws including interpretive guidance that may be issued by taxing authorities or other standard setting bodies, and (26) other risk factors described in this annual report on Form 10-K. As a consequence, current plans, anticipated actions and future financial position and results of operations may differ from those expressed in any forward-looking statements made by or on behalf of HCA. You are cautioned not to unduly rely on such forward-looking statements when evaluating the information presented in this report, which forward-looking statements reflect management’s views only as of the date of this report. We undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise. COVID-19 We believe the extent of COVID-19’s impact on our operating results and financial condition has been and could continue to be driven by many factors, most of which are beyond our control and ability to forecast. Because of these uncertainties, we cannot estimate how long or to what extent COVID-19 will impact our operations. 2022 Operations Summary Net income attributable to HCA Healthcare, Inc. totaled $5.643 billion, or $19.15 per diluted share, for 2022, compared to $6.956 billion, or $21.16 per diluted share, for 2021. The 2022 results include gains on sales of facilities of $1.301 billion, or $2.46 per diluted share, and losses on retirement of debt of $78 million, or $0.20 per diluted share. The 2021 results include gains on sales of facilities of $1.620 billion, or $3.69 per diluted share, and losses on retirement of debt of $12 million, or $0.03 per diluted share. Our provisions for income taxes for 2022 and 2021 include tax benefits of $77 million, or $0.26 per diluted share, and $119 million, or $0.36 per diluted share, respectively, related to employee equity award settlements. All “per diluted share” disclosures are based upon amounts net of the applicable income taxes. Shares used for diluted earnings per share were 294.666 million shares and 328.752 million shares for the years ended December 31, 2022 and 2021, respectively. During 2022 and 2021, we repurchased 30.747 million and 37.812 million shares, respectively, of our common stock. Revenues increased to $60.233 billion for 2022 from $58.752 billion for 2021. Revenues increased 2.5% and 3.2%, respectively, on a consolidated basis and on a same facility basis for 2022, compared to 2021. The consolidated revenues increase can be attributed to the combined impact of a 0.4% increase in revenue per equivalent admission and a 2.1% increase in equivalent admissions. The same facility revenues increase resulted from the net impact of a 3.3% increase in equivalent admissions and a 0.1% decline in revenue per equivalent admission. During 2022, consolidated admissions declined 0.7% and same facility admissions increased 0.5%, compared to 2021. Inpatient surgical volumes were flat on a consolidated basis and increased 0.9% on a same facility basis during 2022, compared to 2021. Outpatient surgical volumes increased 1.5% on a consolidated basis and increased 1.8% on a same facility basis during 2022, compared to 2021. Emergency room visits increased 5.9% on a consolidated basis and increased 7.6% on a same facility basis during 2022, compared to 2021. The estimated cost of total uncompensated care increased $141 million for 2022, compared to 2021. Consolidated and same facility uninsured admissions declined 6.0% and 4.6%, respectively, and consolidated and same facility uninsured emergency room visits increased 4.4% and 6.6%, respectively, for 2022, compared to 2021. Interest expense totaled $1.741 billion for 2022, compared to $1.566 billion for 2021. The $175 million increase in interest expense for 2022 was primarily due to an increase in the average debt balance, which was partially offset by a decline in the average effective interest rate. Cash flows from operating activities declined $437 million, from $8.959 billion for 2021 to $8.522 billion for 2022. The decline in cash flows from operating activities was related primarily to a negative change in working capital items of $649 million, mainly from a decline in accounts payable and accrued expenses, and a decline in net income of $687 million, excluding gains on sales of facilities and losses on retirement of debt, offset by a decline in cash payments for interest and income taxes of $847 million for 2022 compared to 2021. 57 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Business Strategy We are committed to providing the communities we serve with high quality, convenient and cost-effective health care while growing our business and creating long-term value for our stockholders. We strive to be the health care system of choice in the communities we serve by developing comprehensive networks locally and supporting these networks with enterprise expertise and economies of scale. Our strategy is organized around a framework that seeks to drive sustained growth by delivering operational excellence, attracting exceptional physicians and other health care professionals, developing comprehensive services, creating greater access, and coordinating higher quality care for patients. To achieve these objectives, we align our efforts around the following growth agenda: Grow Our Presence in Existing Markets. We believe we are well positioned in a number of large and growing markets that will allow us the opportunity to generate long-term, attractive growth through the expansion of our presence in these markets. We plan to continue recruiting and strategically collaborating with the physician community and developing comprehensive service lines such as cardiology, neurology, oncology, orthopedics and women’s services. Additional components of our growth strategy include providing access and convenience through developing various outpatient facilities, including, but not limited to surgery centers, urgent care clinics, freestanding emergency care facilities, imaging centers and home health and hospice services, as well as seeking to improve coordination of care and patient retention across our markets. Achieve Industry-Leading Performance in Clinical, Operational and Satisfaction Measures. Achieving high levels of patient safety, patient satisfaction and clinical quality are central goals of our business. To achieve these goals, we have implemented a number of initiatives including infection reduction initiatives, hospitalist programs, advanced health information technology and evidence-based medicine programs. We routinely analyze operational practices from our best-performing hospitals to identify ways to implement organization-wide performance improvements and reduce clinical variation. We believe these initiatives will continue to improve patient care, help us achieve cost efficiencies and favorably position us in an environment where our constituents are increasingly focused on quality, efficacy and efficiency. Recruit and Retain Physicians and Other Health Care Professionals to Meet the Need for High Quality Health Services. We depend on the quality and dedication of the health care providers and other team members who serve at our facilities. We believe a critical component of our growth strategy is our ability to successfully recruit and strategically collaborate with physicians and other health care professionals to provide high quality care. We attract and retain physicians and other health care professionals by providing high quality, convenient facilities with advanced technology, by expanding our specialty services and by building our outpatient operations. We believe our continued investment in the employment, recruitment and retention of physicians and other health care professionals will improve the quality of care at our facilities. Continue to Utilize Economies of Scale to Grow the Company. We believe there is significant opportunity to continue to grow our company by fully utilizing the scale and scope of our organization. We continue to invest in initiatives such as care navigators, clinical data exchange and centralized patient transfer operations, which will enable us to improve coordination of care and patient retention across our markets. We believe our centrally managed business processes and ability to leverage cost-saving practices across our extensive network will enable us to continue to manage costs effectively. We continue to invest in our Parallon subsidiary group to deploy key components of our support infrastructure, including revenue cycle management, health care group purchasing, supply chain management and staffing functions. Pursue a Disciplined Development Strategy. We continue to believe there are significant growth opportunities in our markets. We will continue to provide financial and operational resources to analyze and develop our in-market opportunities. To complement our in-market growth agenda and achieve cost savings and other benefits for the patients and communities we serve, we intend to focus on selectively developing and acquiring new hospitals, outpatient facilities and other health care service providers. Our strategy also emphasizes investments that advance our clinical systems and digital capabilities, transform care models with innovative care solutions, expand our workforce development programs and enhance our health care networks and partnerships. 58 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Critical Accounting Policies and Estimates The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenues and expenses. Our estimates are based on historical experience and various other assumptions we believe are reasonable under the circumstances. We evaluate our estimates on an ongoing basis and make changes to the estimates and related disclosures as experience develops or new information becomes known. Actual results may differ from these estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. Revenues Revenues are recorded during the period the health care services are provided, based upon the estimated amounts due from payers. Estimates of contractual allowances under managed care health plans are based upon the payment terms specified in the related contractual agreements. Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. The estimated reimbursement amounts are made on a payer-specific basis and are recorded based on the best information available regarding management’s interpretation of the applicable laws, regulations and contract terms. Management continually reviews the contractual estimation process to consider and incorporate updates to laws and regulations and the frequent changes in managed care contractual terms resulting from contract renegotiations and renewals. We have invested significant resources to refine and improve our billing systems and the information system data used to make contractual allowance estimates. We have developed standardized calculation processes and related employee training programs to improve the utility of our patient accounting systems. Patients treated at hospitals for non-elective care, who have income at or below 400% of the federal poverty level, are eligible for charity care, and we limit the patient responsibility amounts for these patients to a percentage of their annual household income, computed on a sliding scale based upon their annual income and the applicable percentage of the federal poverty level. Patients treated at hospitals for non-elective care, who have income above 400% of the federal poverty level, are eligible for certain other discounts which limit the patient responsibility amounts for these patients to a percentage of their annual household income, computed on a sliding scale based upon their annual income and the applicable percentage of the federal poverty level. We apply additional discounts to limit patient responsibility for certain emergency services. The federal poverty level is established by the federal government and is based on income and family size. Because we do not pursue collection of amounts determined to qualify as charity care, they are not reported in revenues. We provide discounts to uninsured patients who do not qualify for Medicaid or charity care. We may attempt to provide assistance to uninsured patients to help determine whether they may qualify for Medicaid, other federal or state assistance, or charity care. If an uninsured patient does not qualify for these programs, the uninsured discount is applied. Implicit price concessions relate primarily to amounts due directly from patients. Estimated implicit price concessions are recorded for all uninsured accounts, regardless of the age of those accounts. Accounts are written off when all reasonable collection efforts have been performed. The estimates for implicit price concessions are based upon management’s assessment of historical writeoffs and expected net collections, business and economic conditions, trends in federal, state and private employer health care coverage and other collection indicators. Management relies on the results of detailed reviews of historical writeoffs and collections at facilities that represent a majority of our revenues and accounts receivable (the “hindsight analysis”) as a primary source of information in estimating the collectability of our accounts receivable. We perform the hindsight analysis quarterly, utilizing rolling twelve-months accounts receivable collection and writeoff data. We believe our quarterly updates to the estimated implicit price concession amounts at each of our hospital facilities provide reasonable estimates of our revenues and valuations of our accounts receivable. These routine, quarterly changes in estimates have not resulted in material adjustments to the valuations of our accounts receivable or period-to-period comparisons of our revenues. 59 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Critical Accounting Policies and Estimates (Continued) Revenues (continued) To quantify the total impact of and trends related to uninsured patient accounts, we believe it is beneficial to view total uncompensated care, which is comprised of charity care, uninsured discounts and implicit price concessions. A summary of the estimated cost of total uncompensated care for the years ended December 31, follows (dollars in millions): 2022 2021 2020 Patient care costs (salaries and benefits, supplies, other operating expenses and depreciation and amortization) $ 51,180 $ 49,074 $ 44,271 Cost-to-charges ratio (patient care costs as percentage of gross patient charges) 11.0 % 11.3 % 12.0 % Total uncompensated care $ 31,734 $ 29,642 $ 29,029 Multiply by the cost-to-charges ratio 11.0 % 11.3 % 12.0 % Estimated cost of total uncompensated care $ 3,491 $ 3,350 $ 3,483 Management expects a continuation of the challenges related to the collection of the patient due accounts. Adverse changes in the percentage of our patients having adequate health care coverage, increases in patient responsibility amounts under certain health care coverages, general economic conditions, patient accounting service center operations, payer mix, or trends in federal, state, and private employer health care coverage could affect the collection of accounts receivable, cash flows and results of operations. Professional Liability Claims We, along with virtually all health care providers, operate in an environment with professional liability risks. Our facilities are insured by our insurance subsidiary for losses up to $75 million per occurrence, subject, in most cases, to a $15 million per occurrence self-insured retention. The insurance subsidiary has obtained reinsurance for professional liability risks generally above a retention level of either $25 million or $35 million per occurrence, depending on the jurisdiction for the related claim. We purchase excess insurance on an occurrence reported basis for losses in excess of amounts insured by our insurance subsidiary. Provisions for losses related to professional liability risks were $517 million, $453 million and $435 million for the years ended December 31, 2022, 2021 and 2020, respectively. During 2022, 2021 and 2020, we recorded reductions to the provision for professional liability risks of $55 million, $87 million and $112 million, respectively, due to the receipt of updated actuarial information. Reserves for professional liability risks represent the estimated ultimate cost of all reported and unreported losses incurred through the respective consolidated balance sheet dates. The estimated ultimate cost includes estimates of direct expenses and fees paid to outside counsel and experts, but does not include the general overhead costs of our insurance subsidiary or corporate office. Individual case reserves are established based upon the particular circumstances of each reported claim and represent our estimates of the future costs that will be paid on reported claims. Case reserves are reduced as claim payments are made and are adjusted upward or downward as our estimates regarding the amounts of future losses are revised. Once the case reserves for known claims are determined, information is stratified by loss layers and retentions, accident years, reported years, and geographic location of our hospitals. Several actuarial methods are employed to utilize this data to produce estimates of ultimate losses and reserves for incurred but not reported claims, including: paid and incurred extrapolation methods utilizing paid and incurred loss development to estimate ultimate losses; frequency and severity methods utilizing paid and incurred claims development to estimate ultimate average frequency (number of claims) and ultimate average severity (cost per claim); and Bornhuetter-Ferguson methods which add expected development to actual paid or incurred experience to estimate ultimate losses. These methods use our company-specific historical claims data and other information. Company-specific claim reporting and payment data collected over an approximate 20-year period is used in our reserve estimation process. This company-specific data includes information regarding our business, including historical paid losses and loss adjustment expenses, historical and current case loss reserves, actual and projected hospital statistical data, professional liability retentions for each policy year, geographic information and other data. 60 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Critical Accounting Policies and Estimates (Continued) Professional Liability Claims (continued) Reserves and provisions for professional liability risks are based upon actuarially determined estimates. The estimated reserve ranges, net of amounts receivable under reinsurance contracts, were $1.802 billion to $2.159 billion at December 31, 2022 and $1.752 billion to $2.098 billion at December 31, 2021. Our estimated reserves for professional liability claims may change significantly if future claims differ from expected trends. We perform sensitivity analyses which model the volatility of key actuarial assumptions and monitor our reserves for adequacy relative to all our assumptions in the aggregate. Based on our analysis, we believe the estimated professional liability reserve ranges represent the reasonably likely outcomes for ultimate losses. We consider the number and severity of claims to be the most significant assumptions in estimating reserves for professional liabilities. A 2.5% change in the expected frequency trend could be reasonably likely and would increase the reserve estimate by $29 million or reduce the reserve estimate by $28 million. A 2.5% change in the expected claim severity trend could be reasonably likely and would increase the reserve estimate by $135 million or reduce the reserve estimate by $123 million. We believe adequate reserves have been recorded for our professional liability claims; however, due to the complexity of the claims, the extended period of time to resolve the claims and the wide range of potential outcomes, our ultimate liability for professional liability claims could change by more than the estimated sensitivity amounts and could change materially from our current estimates. The reserves for professional liability risks cover approximately 2,000 and 2,100 individual claims at December 31, 2022 and 2021, respectively, and estimates for unreported potential claims. The time period required to resolve these claims can vary depending upon the jurisdiction and whether the claim is settled or litigated. The average time period between the occurrence and final resolution for our professional liability claims is approximately five years, although the facts and circumstances of each individual claim can result in an occurrence-to-resolution timeframe that varies from this average. The estimation of the timing of payments beyond a year can vary significantly. Reserves for professional liability risks were $2.043 billion and $2.022 billion at December 31, 2022 and 2021, respectively. The current portion of these reserves, $515 million and $508 million at December 31, 2022 and 2021, respectively, is included in “other accrued expenses.” Obligations covered by reinsurance and excess insurance contracts are included in the reserves for professional liability risks, as we remain liable to the extent reinsurers and excess insurance carriers do not meet their obligations. Reserves for professional liability risks (net of $60 million and $55 million receivable under reinsurance and excess insurance contracts at December 31, 2022 and 2021, respectively) were $1.983 billion and $1.967 billion at December 31, 2022 and 2021, respectively. The estimated total net reserves for professional liability risks at December 31, 2022 and 2021 are comprised of $793 million and $874 million, respectively, of case reserves for known claims and $1.190 billion and $1.093 billion, respectively, of reserves for incurred but not reported claims. Changes in our professional liability reserves, net of reinsurance recoverable, for the years ended December 31, are summarized in the following table (dollars in millions): 2022 2021 2020 Net reserves for professional liability claims, January 1 $ 1,967 $ 1,924 $ 1,781 Provision for current year claims 538 530 519 Favorable development related to prior years’ claims (21 ) (77 ) (84 ) Total provision 517 453 435 Payments for current year claims 4 5 5 Payments for prior years’ claims 493 379 287 Total claim payments 497 384 292 Effect of new retroactive reinsurance contracts (4 ) (26 ) — Net reserves for professional liability claims, December 31 $ 1,983 $ 1,967 $ 1,924 61 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Critical Accounting Policies and Estimates (Continued) Income Taxes We calculate our provision for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized by identifying the temporary differences that arise from the recognition of items in different periods for tax and accounting purposes. Deferred tax assets generally represent the tax effects of amounts expensed in our income statement for which tax deductions will be claimed in future periods. Interest and penalties payable to taxing authorities are included as a component of our provision for income taxes. We have elected to treat taxes incurred on global intangible low-taxed income as a period expense. Although we believe we have properly reported taxable income and paid taxes in accordance with applicable laws, federal, state or foreign taxing authorities may challenge our tax positions upon audit. Significant judgment is required in determining and assessing the impact of uncertain tax positions. We report a liability for unrecognized tax benefits from uncertain tax positions taken or expected to be taken in our income tax returns. During each reporting period, we assess the facts and circumstances related to uncertain tax positions. If the realization of unrecognized tax benefits is deemed probable based upon new facts and circumstances, the estimated liability and the provision for income taxes are reduced in the current period. Final audit results may vary from our estimates. Results of Operations Revenue/Volume Trends Our revenues depend upon inpatient occupancy levels, the ancillary services and therapy programs ordered by physicians and provided to patients, the volume of outpatient procedures and the charge and negotiated payment rates for such services. Patient volumes and the related revenues were negatively impacted by COVID-19 beginning in the first half of 2020, and subsequent periods through the first half of 2022 have experienced fluctuations in COVID-19 volumes and revenues through the various surges, impacting comparisons for most of our patient volume and revenues operating statistics. Gross charges typically do not reflect what our facilities are actually paid. Our facilities have entered into agreements with third-party payers, including government programs and managed care health plans, under which the facilities are paid based upon the cost of providing services, predetermined rates per diagnosis, fixed per diem rates or discounts from gross charges. We do not pursue collection of amounts related to patients who meet our guidelines to qualify for charity care; therefore, they are not reported in revenues. We provide discounts to uninsured patients who do not qualify for Medicaid or charity care. Revenues increased 2.5% to $60.233 billion for 2022 from $58.752 billion for 2021 and increased 14.0% for 2021 from $51.533 billion for 2020. The increase in revenues in 2022 can be attributed to the combined impact of a 0.4% increase in revenue per equivalent admission and a 2.1% increase in equivalent admissions compared to the prior year. The increase in revenues in 2021 can be primarily attributed to the combined impact of a 6.8% increase in revenue per equivalent admission and a 6.8% increase in equivalent admissions compared to the prior year. Same facility revenues increased 3.2% for the year ended December 31, 2022 compared to the year ended December 31, 2021 and increased 14.4% for the year ended December 31, 2021 compared to the year ended December 31, 2020. The 3.2% increase for 2022 can be attributed to the net impact of a 3.3% increase in equivalent admissions and a 0.1% decline in revenue per equivalent admission. The 14.4% increase for 2021 can be primarily attributed to the combined impact of a 6.3% increase in revenue per equivalent admission and a 7.6% increase in equivalent admissions. Consolidated admissions declined 0.7% during 2022 compared to 2021 and increased 4.0% during 2021 compared to 2020. Consolidated surgeries increased 1.0% during 2022 compared to 2021 and increased 8.9% during 2021 compared to 2020. Consolidated emergency room visits increased 5.9% during 2022 compared to 2021 and increased 13.8% during 2021 compared to 2020. Same facility admissions increased 0.5% during 2022 compared to 2021 and increased 4.8% during 2021 compared to 2020. Same facility surgeries increased 1.5% during 2022 compared to 2021 and increased 9.0% during 2021 compared to 2020. Same facility emergency room visits increased 7.6% during 2022 compared to 2021 and increased 15.1% during 2021 compared to 2020. 62 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (continued) Revenue/Volume Trends (continued) Same facility uninsured emergency room visits increased 6.6% and same facility uninsured admissions declined 4.6% during 2022 compared to 2021. Same facility uninsured emergency room visits declined 6.3% and same facility uninsured admissions declined 3.5% during 2021 compared to 2020. The approximate percentages of our admissions related to Medicare, managed Medicare, Medicaid, managed Medicaid, managed care and insurers and the uninsured for the years ended December 31, 2022, 2021 and 2020 are set forth below. Years Ended December 31, 2022 2021 2020 Medicare 22 % 23 % 26 % Managed Medicare 23 21 20 Medicaid 4 5 5 Managed Medicaid 14 13 12 Managed care and insurers 30 31 29 Uninsured 7 7 8 100 % 100 % 100 % The approximate percentages of our inpatient revenues related to Medicare, managed Medicare, Medicaid, managed Medicaid, and managed care and insurers for the years ended December 31, 2022, 2021 and 2020 are set forth below. Years Ended December 31, 2022 2021 2020 Medicare 23 % 23 % 27 % Managed Medicare 17 16 15 Medicaid 7 6 5 Managed Medicaid 8 6 6 Managed care and insurers 45 49 47 100 % 100 % 100 % At December 31, 2022, we owned and operated 46 hospitals and 30 surgery centers in the state of Florida. Our Florida facilities’ revenues totaled $13.812 billion, $13.670 billion and $11.442 billion for the years ended December 31, 2022, 2021 and 2020, respectively. At December 31, 2022, we owned and operated 45 hospitals and 37 surgery centers in the state of Texas. Our Texas facilities’ revenues totaled $16.450 billion, $15.344 billion and $13.528 billion for the years ended December 31, 2022, 2021 and 2020, respectively. During 2022, 2021 and 2020, 58%, 56% and 56%, respectively, of our admissions and 50%, 49% and 49%, respectively, of our revenues were generated by our Florida and Texas facilities. Uninsured admissions in Florida and Texas represented 74%, 72% and 72%, respectively, of our uninsured admissions each year during 2022, 2021 and 2020. We receive a significant portion of our revenues from government health programs, principally Medicare and Medicaid, which are highly regulated and subject to frequent and substantial changes. Some state Medicaid programs use, or have applied to use, waivers granted by CMS to implement Medicaid expansion, impose different eligibility or enrollment restrictions, or otherwise implement programs that vary from federal standards. We receive supplemental payments in several states. We are aware these supplemental payment programs are currently being reviewed by certain state agencies and some states have made requests to CMS to replace their existing supplemental payment programs. It is possible these reviews and requests will result in the restructuring of such supplemental payment programs and could result in the payment programs being reduced or eliminated. Because deliberations about these programs are ongoing, we are unable to estimate the financial impact the program structure modifications, if any, may have on our results of operations. 63 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (continued) Key Performance Indicators We present certain metrics and statistical information that management uses when assessing our results of operations. We believe this information is useful to investors as it provides insight to how management evaluates operational performance and trends between reporting periods. Information on how these metrics and statistical information are defined is provided in the following tables summarizing operating results and operating data. Operating Results Summary The following are comparative summaries of operating results and certain operating data for the years ended December 31, 2022, 2021 and 2020 (dollars in millions): 2022 2021 2020 Amount Ratio Amount Ratio Amount Ratio Revenues $ 60,233 100.0 $ 58,752 100.0 $ 51,533 100.0 Salaries and benefits 27,685 46.0 26,779 45.6 23,874 46.3 Supplies 9,371 15.6 9,481 16.1 8,369 16.2 Other operating expenses 11,155 18.5 9,961 17.0 9,307 18.1 Equity in earnings of affiliates (45 ) (0.1 ) (113 ) (0.2 ) (54 ) (0.1 ) Depreciation and amortization 2,969 5.0 2,853 4.9 2,721 5.3 Interest expense 1,741 2.9 1,566 2.7 1,584 3.1 Losses (gains) on sales of facilities (1,301 ) (2.2 ) (1,620 ) (2.8 ) 7 — Losses on retirement of debt 78 0.1 12 — 295 0.6 51,653 85.8 48,919 83.3 46,103 89.5 Income before income taxes 8,580 14.2 9,833 16.7 5,430 10.5 Provision for income taxes 1,746 2.9 2,112 3.6 1,043 2.0 Net income 6,834 11.3 7,721 13.1 4,387 8.5 Net income attributable to noncontrolling interests 1,191 1.9 765 1.3 633 1.2 Net income attributable to HCA Healthcare, Inc. $ 5,643 9.4 $ 6,956 11.8 $ 3,754 7.3 % changes from prior year: Revenues 2.5 % 14.0 % 0.4 % Income before income taxes (12.7 ) 81.1 3.6 Net income attributable to HCA Healthcare, Inc. (18.9 ) 85.3 7.1 Admissions(a) (0.7 ) 4.0 (4.7 ) Equivalent admissions(b) 2.1 6.8 (9.2 ) Revenue per equivalent admission 0.4 6.8 10.5 Same facility % changes from prior year(c): Revenues 3.2 14.4 (0.1 ) Admissions(a) 0.5 4.8 (4.8 ) Equivalent admissions(b) 3.3 7.6 (9.3 ) Revenue per equivalent admission (0.1 ) 6.3 10.1 (a)Represents the total number of patients admitted to our hospitals and is used by management and certain investors as a general measure of inpatient volume. (b)Equivalent admissions are used by management and certain investors as a general measure of combined inpatient and outpatient volume. Equivalent admissions are computed by multiplying admissions (inpatient volume) by the sum of gross inpatient revenue and gross outpatient revenue and then dividing the resulting amount by gross inpatient revenue. The equivalent admissions computation “equates” outpatient revenue to the volume measure 64 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) (admissions) used to measure inpatient volume, resulting in a general measure of combined inpatient and outpatient volume. (c)Same facility information excludes the operations of hospitals and their related facilities that were either acquired, divested or removed from service during the current and prior year. Results of Operations (continued) Operating Results Summary (continued) Operating Data: 2022 2021 2020 Number of hospitals at end of period 182 182 185 Number of freestanding outpatient surgical centers at end of period(a) 126 125 121 Number of licensed beds at end of period(b) 49,281 48,803 49,265 Weighted average beds in service(c) 41,982 42,148 42,246 Admissions(d) 2,075,459 2,089,975 2,009,909 Equivalent admissions(e) 3,611,299 3,536,238 3,312,330 Average length of stay (days)(f) 5.1 5.2 5.1 Average daily census(g) 28,778 29,752 27,734 Occupancy(h) 72 % 74 % 69 % Emergency room visits(i) 8,971,951 8,475,345 7,450,307 Outpatient surgeries(j) 1,023,239 1,008,236 882,483 Inpatient surgeries(k) 522,151 522,069 522,385 Days revenues in accounts receivable(l) 53 49 45 Outpatient revenues as a % of patient revenues(m) 38 % 37 % 35 % (a)Excludes freestanding endoscopy centers (21 at December 31, 2022, 2021 and 2020). (b)Licensed beds are those beds for which a facility has been granted approval to operate from the applicable state licensing agency. (c)Represents the average number of beds in service, weighted based on periods owned. (d)Represents the total number of patients admitted to our hospitals and is used by management and certain investors as a general measure of inpatient volume. (e)Equivalent admissions are used by management and certain investors as a general measure of combined inpatient and outpatient volume. Equivalent admissions are computed by multiplying admissions (inpatient volume) by the sum of gross inpatient revenue and gross outpatient revenue and then dividing the resulting amount by gross inpatient revenue. The equivalent admissions computation “equates” outpatient revenue to the volume measure (admissions) used to measure inpatient volume, resulting in a general measure of combined inpatient and outpatient volume. (f)Represents the average number of days admitted patients stay in our hospitals. (g)Represents the average number of admitted patients in our hospital beds each day. (h)Represents the percentage of hospital beds in service that are occupied by patients (admitted and observations). Both average daily census and occupancy rate provide measures of the utilization of inpatient rooms. (i)Represents the number of patients treated in our emergency rooms. (j)Represents the number of surgeries performed on patients who were not admitted to our hospitals. Pain management and endoscopy procedures are not included in outpatient surgeries. (k)Represents the number of surgeries performed on patients who have been admitted to our hospitals. Pain management and endoscopy procedures are not included in inpatient surgeries. (l)Revenues per day is calculated by dividing the revenues for the fourth quarter of each year by the days in the quarter. Days revenues in accounts receivable is then calculated as accounts receivable at the end of the period divided by revenues per day. (m)Represents the percentage of patient revenues related to patients who are not admitted to our hospitals. 65 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (continued) Years Ended December 31, 2022 and 2021 Net income attributable to HCA Healthcare, Inc. totaled $5.643 billion, or $19.15 per diluted share, for 2022, compared to $6.956 billion, or $21.16 per diluted share, for 2021. The 2022 results include gains on sales of facilities of $1.301 billion, or $2.46 per diluted share, and losses on retirement of debt of $78 million, or $0.20 per diluted share. The 2022 results include additional expenses and lost revenues estimated at approximately $85 million associated with the impact of Hurricane Ian primarily on our Florida facilities. This amount is prior to any insurance recoveries. Revenues for 2022 include $244 million and other operating expenses include $90 million from provider tax assessments related to the period September through December 2021 for the Texas directed payment program that was approved by CMS in March 2022 for the program year that began September 1, 2021. The 2021 results include gains on sales of facilities of $1.620 billion, or $3.69 per diluted share, and losses on retirement of debt of $12 million, or $0.03 per diluted share. Our provisions for income taxes for 2022 and 2021 include tax benefits of $77 million, or $0.26 per diluted share, and $119 million, or $0.36 per diluted share, respectively, related to employee equity award settlements. All “per diluted share” disclosures are based upon amounts net of the applicable income taxes. Shares used for diluted earnings per share were 294.666 million shares and 328.752 million shares for the years ended December 31, 2022 and 2021, respectively. During 2022 and 2021, we repurchased 30.747 million and 37.812 million shares, respectively, of our common stock. During 2022, consolidated admissions declined 0.7% and same facility admissions increased 0.5% compared to 2021. Consolidated inpatient surgeries were flat and same facility inpatient surgeries increased 0.9% during 2022 compared to 2021. Emergency room visits increased 5.9% on a consolidated basis and increased 7.6% on a same facility basis during 2022 compared to 2021. Revenues increased 2.5% to $60.233 billion for 2022 from $58.752 billion for 2021. The increase in revenues was due to the combined impact of a 0.4% increase in revenue per equivalent admission and a 2.1% increase in equivalent admissions compared to 2021. Same facility revenues increased 3.2% due primarily to the net impact of a 3.3% increase in equivalent admissions and a 0.1% decline in revenue per equivalent admission compared to 2021. Salaries and benefits, as a percentage of revenues, were 46.0% in 2022 and 45.6% in 2021. Salaries and benefits per equivalent admission increased 1.2% in 2022 compared to 2021. Same facility salaries and benefits per full time equivalent increased 3.3% for 2022 compared to 2021 as inflation has impacted our labor costs and as we continue to utilize certain contract, overtime and other premium rate labor costs to support our clinical staff and patients. We expect inflationary pressures will continue to impact our labor costs in the future. We intend to continue reducing our utilization of and rates paid for premium rate labor, but our ability to mitigate labor cost challenges may be affected by labor market conditions and other factors. Share-based compensation expense was $341 million in 2022 and $440 million in 2021. Supplies, as a percentage of revenues, were 15.6% in 2022 and 16.1% in 2021. Supply costs per equivalent admission declined 3.2% in 2022 compared to 2021. Supply costs per equivalent admission increased 2.4% for medical devices, but declined 18.8% for pharmacy supplies and 1.6% for general medical and surgical items in 2022 compared to 2021. The decline in pharmacy supplies is primarily related to higher utilization of certain COVID-19 therapies during 2021. Other operating expenses, as a percentage of revenues, were 18.5% in 2022 and 17.0% in 2021. Other operating expenses are primarily comprised of contract services, professional fees, repairs and maintenance, rents and leases, utilities, insurance (including professional liability insurance) and nonincome taxes. The 1.5% increase in other operating expenses, as a percentage of revenues for 2022 compared to 2021, was primarily related to increased costs for supplemental payment programs in certain states, as well as increased professional fees, utilities and insurance premiums. We have seen inflation have a negative impact on certain of these expenses and expect inflationary pressures will continue to impact operating expenses in 2023. Provisions for losses related to professional liability risks were $517 million and $453 million for 2022 and 2021, respectively. During 2022 and 2021, we recorded reductions of $55 million, or $0.14 per diluted share, and $87 million, or $0.20 per diluted share, respectively, to our provision for professional liability risks related to the receipt of updated actuarial information. Equity in earnings of affiliates was $45 million for 2022 and $113 million for 2021. The decline of $68 million is primarily related to the sale of an equity investment during 2021. 66 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Results of Operations (continued) Years Ended December 31, 2022 and 2021 (continued) Depreciation and amortization, as a percentage of revenues, were 5.0% in 2022 and 4.9% in 2021. Depreciation expense was $2.941 billion for 2022 and $2.826 billion for 2021. The increase of $115 million in depreciation expense relates primarily to capital expenditures at our existing facilities (same facility depreciation expense increased $134 million). Interest expense increased to $1.741 billion for 2022 from $1.566 billion for 2021. The $175 million increase in interest expense was due to an increase in the average debt balance, which was partially offset by a decline in the average effective interest rate. Our average debt balance was $37.363 billion for 2022 compared to $32.109 billion for 2021. The average effective interest rate for our long-term debt was 4.7% for 2022 and 4.9% for 2021. Gains on sales of facilities were $1.301 billion and $1.620 billion for 2022 and 2021, respectively. The gains on sales of facilities for 2022 are primarily related to the sales of controlling interests in a subsidiary of our group purchasing organization and subsidiaries of our research entities. The gains on sales of facilities for 2021 are primarily related to the sales of five hospitals in Georgia and other health care entity investments. During 2022, we issued $6.000 billion aggregate principal amount of senior notes. We used a portion of the net proceeds to pay down our revolving credit facilities, and we redeemed all $1.250 billion outstanding aggregate principal amount of our 4.75% senior notes due 2023 and all $1.250 billion outstanding aggregate principal amount of our 5.875% senior notes due 2023. The pretax loss on retirement of debt for these two redemptions was $78 million. During 2021, we issued $2.350 billion aggregate principal amount of senior notes. We also amended and restated our senior secured revolving credit facility and our senior secured asset-based revolving credit facility, including increasing availability under the asset-based revolving credit facility to $4.500 billion, extending the maturity date on both facilities to June 30, 2026 and entering into a new $1.500 billion term loan A facility and a new $500 million term loan B facility (the “Credit Agreement Transactions”). We used the net proceeds from the senior notes issuance and the Credit Agreement Transactions to retire $3.657 billion of term loan facilities. The pretax loss on retirement of debt was $12 million. The effective income tax rates were 23.6% and 23.3% for 2022 and 2021, respectively. The effective tax rate computations exclude net income attributable to noncontrolling interests as it relates to consolidated partnerships. Net income attributable to noncontrolling interests increased from $765 million for 2021 to $1.191 billion for 2022. The increase in net income attributable to noncontrolling interests related primarily to the gain on the sale of a controlling interest in a subsidiary of our group purchasing organization and the partnership operations of two of our Texas markets. For results of operations comparisons relating to years ending December 31, 2021 and 2020, refer to our annual report on Form 10-K, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2021, filed with the Securities and Exchange Commission (“SEC”) on February 18, 2022. Liquidity and Capital Resources Our primary cash requirements are paying our operating expenses, servicing our debt, capital expenditures on our existing properties, acquisitions of hospitals and health care entities, repurchases of our common stock, dividends to stockholders and distributions to noncontrolling interests. Our primary cash sources are cash flows from operating activities, issuances of debt and equity securities and sales of hospitals and health care entities. Cash provided by operating activities totaled $8.522 billion in 2022 compared to $8.959 billion in 2021 and $9.232 billion in 2020. The $437 million decline in cash provided by operating activities for 2022, compared to 2021, was related primarily to a negative change in working capital items of $649 million, mainly from a decline in accounts payable and accrued expenses, and a decline in net income of $687 million, excluding gains on sales of facilities and losses on retirement of debt, offset by a decline in cash payments for interest and income taxes of $847 million for 2022 compared to 2021. The $273 million decline in cash provided by operating activities for 2021, compared to 2020, was related to a negative change in working capital items of $1.781 billion, primarily from an increase in accounts receivable, offset by the increase in net income, excluding the non-cash impact of losses and gains on sales of facilities, losses on retirement of debt and depreciation and amortization. Cash payments for interest and income taxes increased $1.075 billion for 2021 compared to 2020. During 2020, we deferred $688 million of Social Security taxes as allowed for under the CARES Act. Half of these taxes were paid in January 2022 and the remainder was paid in January 2023. Working capital totaled $3.741 billion at December 31, 2022 and $3.960 billion at December 31, 2021. 67 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (continued) Cash used in investing activities was $3.389 billion, $2.643 billion and $3.393 billion in 2022, 2021 and 2020, respectively. Excluding acquisitions, capital expenditures were $4.395 billion in 2022, $3.577 billion in 2021 and $2.835 billion in 2020. In response to the risks COVID-19 presented to our business, we reduced certain planned projects and capital expenditures during 2020. Planned capital expenditures are expected to approximate $4.3 billion in 2023. At December 31, 2022, there were projects under construction which had an estimated additional cost to complete and equip over the next five years of approximately $4.707 billion. We expect to finance capital expenditures with internally generated and borrowed funds. We expended $224 million, $1.105 billion and $568 million for acquisitions of hospitals and health care entities during 2022, 2021 and 2020, respectively. Cash flows from sales of hospitals and health care entities declined from $2.160 billion for 2021 (primarily related to the proceeds from our sales of five hospitals in Georgia and other health care entity investments) to $1.237 billion of net proceeds for 2022 (primarily related to proceeds from our sales of other health care entities). Cash used in financing activities totaled $5.656 billion in 2022, $6.655 billion in 2021 and $4.677 billion in 2020. During 2022, we had a net increase of $3.287 billion in our indebtedness, paid dividends of $653 million and paid $7.000 billion for repurchases of common stock. During 2021, we had a net increase of $3.255 billion in our indebtedness, paid dividends of $624 million and paid $8.215 billion for repurchases of common stock. During 2020, we made net payments of $3.217 billion related to our indebtedness, paid dividends of $153 million and paid $441 million for repurchases of our common stock. During 2022, 2021 and 2020, we made distributions to noncontrolling interests of $1.025 billion, $749 million and $626 million, respectively. The increase in distributions in 2022 is related to the sale of a controlling interest in a subsidiary of our group purchasing organization. We, or our affiliates, may in the future repurchase portions of our debt or equity securities, subject to certain limitations, from time to time in either the open market or through privately negotiated transactions, in accordance with applicable SEC and other legal requirements. The timing, prices, and sizes of purchases depend upon prevailing trading prices, general economic and market conditions, and other factors, including applicable securities laws. During February 2021, January 2022 and January 2023, our Board of Directors authorized $6 billion, $8 billion and $3 billion, respectively, for share repurchases of the Company’s outstanding common stock. The February 2021 authorization was completed during 2022, and at December 31, 2022, there was $1.586 billion of share repurchase authorization that remained available under the January 2022 authorization. Funds for the repurchase of debt or equity securities have, and are expected to, come primarily from cash generated from operations and borrowed funds. During 2022, our Board of Directors declared four quarterly dividends of $0.56 per share, or $2.24 per share in the aggregate, on our common stock. On January 26, 2023, our Board of Directors declared a quarterly dividend of $0.60 per share on our common stock payable on March 31, 2023 to stockholders of record at the close of business on March 17, 2023. The timing and amount of future cash dividends will vary based on a number of factors, including future capital requirements for strategic transactions, share repurchases and investing in our existing markets, the availability of financing on acceptable terms, debt service requirements, changes to applicable tax laws or corporate laws, changes to our business model and periodic determinations by our Board of Directors that cash dividends are in the best interest of stockholders and are in compliance with all applicable laws and agreements of the Company. In addition to cash flows from operations, available sources of capital include amounts available under our senior secured credit facilities ($3.535 billion as of December 31, 2022 and $4.445 billion as of January 31, 2023) and anticipated access to public and private debt and equity markets. Effective in January 2023, availability under our senior secured revolving credit facility was increased by $1.500 billion to total $3.500 billion. Investments of our insurance subsidiaries, held to maintain statutory equity levels and to provide liquidity to pay claims, totaled $473 million and $541 million at December 31, 2022 and 2021, respectively. The insurance subsidiary maintained net reserves for professional liability risks of $147 million and $154 million at December 31, 2022 and 2021, respectively. Our facilities are insured by our insurance subsidiary for losses up to $75 million per occurrence; however, this coverage is subject, in most cases, to a $15 million per occurrence self-insured retention. Net reserves for the self-insured professional liability risks retained were $1.836 billion and $1.813 billion at December 31, 2022 and 2021, respectively. Claims payments, net of reinsurance recoveries, during the next 12 months are expected to approximate $503 million. We estimate that approximately $459 million of the expected net claim payments during the next 12 months will relate to claims subject to the self-insured retention. 68 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Liquidity and Capital Resources (continued) Financing Activities We are a highly leveraged company with significant debt service requirements. Our debt totaled $38.084 billion and $34.579 billion at December 31, 2022 and 2021, respectively. Our interest expense was $1.741 billion for 2022 and $1.566 billion for 2021. During 2022, we issued $6.000 billion aggregate principal amount of senior notes comprised of (i) $1.000 billion aggregate principal amount of 3 1/8% senior notes due 2027, (ii) $500 million aggregate principal amount of 3 3/8% senior notes due 2029, (iii) $2.000 billion aggregate principal amount of 3 5/8% senior notes due 2032, (iv) $500 million aggregate principal amount of 4 3/8% senior notes due 2042 and (v) $2.000 billion aggregate principal amount of 4 5/8% senior notes due 2052. We used a portion of the net proceeds to pay down our revolving credit facilities, and we redeemed all $1.250 billion outstanding aggregate principal amount of our 4.75% senior notes due 2023 and all $1.250 billion outstanding aggregate principal amount of our 5.875% senior notes due 2023. Management believes that cash flows from operations, amounts available under our senior secured credit facilities and our anticipated access to public and private debt markets will be sufficient to meet expected liquidity needs for the foreseeable future. HCA Inc., a direct wholly-owned subsidiary of HCA Healthcare, Inc., is the primary obligor under a substantial portion of our indebtedness, including our senior secured credit facilities and senior notes. The senior secured credit facilities are fully and unconditionally guaranteed on a senior secured basis by substantially all existing and future, direct and indirect, 100% owned material domestic subsidiaries that are “Unrestricted Subsidiaries” under our Indenture dated December 16, 1993 (except for certain special purpose subsidiaries that only guarantee and pledge their assets under our senior secured asset-based revolving credit facility). On May 25, 2022, Standard & Poor’s Rating Services (“S&P”) announced it had issued an investment grade rating with respect to the issuer credit rating of HCA Healthcare, Inc. and its subsidiaries. S&P’s announcement, in conjunction with previously disclosed events, constituted an “Investment Grade Rating Event” or a “Ratings Event,” as applicable, under the terms of the indentures governing HCA Inc.’s outstanding senior secured notes and, as a result, the conditions in the senior secured indentures to permit the permanent release of the subsidiary guarantees and all collateral securing the senior secured notes were met. The subsidiary guarantees and collateral securing our senior secured credit facilities are not affected. Following this release of the subsidiary guarantees and collateral securing the senior secured notes, the subsidiary guarantors deregistered with the SEC. As a result, summarized financial information for HCA Healthcare, Inc., HCA Inc. and the subsidiary guarantors, and information about the subsidiary guarantees and affiliates whose securities were pledged as collateral will no longer be presented. All of the senior notes issued by HCA Inc. in 2014 or later continue to be fully and unconditionally guaranteed on an unsecured basis by HCA Healthcare, Inc. The combined assets, liabilities, and results of operations of HCA Healthcare, Inc. and HCA Inc. are not materially different than the corresponding amounts presented in the consolidated financial statements of HCA Healthcare, Inc. As a result, summarized financial information of HCA Healthcare, Inc. and HCA Inc. is not required to be presented under Rule 13-01 of Regulation S-X. Market Risk We are exposed to market risk related to changes in market values of securities. Our insurance subsidiaries held $473 million of investment securities at December 31, 2022. These investments are carried at fair value, with changes in unrealized gains and losses being recorded as adjustments to other comprehensive income. At December 31, 2022, we had unrealized losses of $38 million on the insurance subsidiaries’ investment securities. We are exposed to market risk related to market illiquidity. Investments in debt and equity securities of our insurance subsidiaries could be impaired by the inability to access the capital markets. Should the insurance subsidiaries require significant amounts of cash in excess of normal cash requirements to pay claims and other expenses on short notice, we may have difficulty selling these investments in a timely manner or be forced to sell them at a price less than what we might otherwise have been able to in a normal market environment. We may be required to recognize credit-related impairments on our investment securities in future periods should issuers default on interest payments or should the fair market valuations of the securities deteriorate due to ratings downgrades or other issue-specific factors. 69 HCA HEALTHCARE, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Market Risk (continued) We are also exposed to market risk related to changes in interest rates. With respect to our interest-bearing liabilities, approximately $4.780 billion of long-term debt at December 31, 2022 was subject to variable rates of interest, while the remaining balance in long-term debt of $33.304 billion at December 31, 2022 was subject to fixed rates of interest. Both the general level of interest rates and, for the senior secured credit facilities, our leverage affect our variable interest rates. Our variable debt is comprised primarily of amounts outstanding under the senior secured credit facilities. The average effective interest rate for our long-term debt was 4.7% for 2022 and 4.9% for 2021. The estimated fair value of our total long-term debt was $35.555 billion at December 31, 2022. The estimates of fair value are based upon the quoted market prices for the same or similar issues of long-term debt with the same maturities. Based on a hypothetical 1% increase in interest rates, the potential annualized reduction to future pretax earnings would be approximately $48 million. To mitigate the impact of fluctuations in interest rates, we generally target a majority of our debt portfolio to be maintained at fixed rates. We are exposed to currency translation risk related to our foreign operations. We currently do not consider the market risk related to foreign currency translation to be material to our consolidated financial statements or our liquidity. Tax Examinations The Internal Revenue Service (“IRS”) was conducting an examination of the Company’s 2016, 2017 and 2018 federal income tax returns and the 2019 return for one affiliated partnership at December 31, 2022. We are also subject to examination by state and foreign taxing authorities. Management believes HCA Healthcare, Inc., its predecessors, subsidiaries and affiliates properly reported taxable income and paid taxes in accordance with applicable laws and agreements established with the IRS, state and foreign taxing authorities, and final resolution of any disputes will not have a material, adverse effect on our results of operations or financial position. However, if payments due upon final resolution of any issues exceed our recorded estimates, such resolutions could have a material, adverse effect on our results of operations or financial position. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Information with respect to this Item is provided under the caption “Market Risk” under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” 70
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Key Business and Financial Metrics Used by Management" for additional information on our financial and performance metrics. Social MediaWe use our website at newsroom.hilton.com, our Facebook page at facebook.com/hiltonnewsroom and our corporate Twitter account at twitter.com/hiltonnewsroom as channels of distribution of company information. The information we post through these channels may be deemed material. Accordingly, investors should monitor these channels, in addition to following our press releases, our filings with the U.S. Securities and Exchange Commission (the "SEC") and our webcasts. The contents of our website and social media channels are not, however, part of this report.Item 1. BusinessOverviewHilton is one of the largest hospitality companies in the world, with 7,165 properties comprising 1,127,430 rooms in 123 countries and territories as of December 31, 2022. Founded in 1919, Hilton has been an innovator in the industry for more than 100 years, driven by the vision of founder Conrad Hilton, "to fill the earth with the light and warmth of hospitality." Our premier brand portfolio includes: our luxury hotel brands, Waldorf Astoria Hotels & Resorts, LXR Hotels & Resorts and Conrad Hotels & Resorts; our lifestyle hotel brands, Canopy by Hilton, Curio Collection by Hilton, Tapestry Collection by Hilton, Tempo by Hilton and Motto by Hilton; our full service hotel brands, Signia by Hilton, Hilton Hotels & Resorts and DoubleTree by Hilton; our focused service hotel brands, Hilton Garden Inn, Hampton by Hilton and Tru by Hilton; our all-suites hotel brands, Embassy Suites by Hilton, Homewood Suites by Hilton and Home2 Suites by Hilton; our new premium economy brand, Spark by Hilton, launched in January 2023; and our timeshare brand, Hilton Grand Vacations. As of December 31, 2022, we had 152 million members in our award-winning guest loyalty program, Hilton Honors, a 19 percent increase from December 31, 2021; refer to "—Our Brand Portfolio" and "—Our Guest Loyalty Program" below for additional information on our brands, including Hilton Honors.The COVID-19 pandemic significantly affected the global economy and strained the hospitality industry beginning in 2020. Since the beginning of the pandemic, the pervasiveness and severity of travel restrictions and stay-at-home directives have varied by country and state; however, as of December 31, 2022, most of the countries we operate in had eased or completely lifted such restrictions. While the pandemic negatively affected certain of our results for the years ended December 31, 2022 and 2021, we have experienced strong signs of recovery since early 2021, with comparable system-wide RevPAR in the third and fourth quarters of 2022 exceeding levels achieved in the same periods in 2019. Although all periods included in 3our consolidated financial statements presented in this Form 10-K were impacted by the COVID-19 pandemic, none of these periods are considered comparable, and no periods affected by the pandemic are expected to be comparable to future periods. We operate our business through: (i) a management and franchise segment; and (ii) an ownership segment, each of which is reported as a segment based on (a) delivering a similar set of products and services and (b) being managed separately given its distinct economic characteristics. The management and franchise segment includes all of the hotels we manage for third-party owners, as well as all franchised hotels that license our intellectual property ("IP"), including our brand names, trademarks and service marks, and where we provide other contracted services to third-party owners, but the day-to-day services of the hotels are operated or managed by someone other than us. Revenues from this segment include: (i) management and franchise fees charged to third-party hotel owners; (ii) licensing fees from our strategic partners, including co-branded credit card providers, and HGV for the right to use our IP; and (iii) fees for managing hotels in our ownership segment. The ownership segment primarily derives revenues from nightly hotel room sales, food and beverage sales and other services at our consolidated owned and leased hotels. For more information regarding our segments, refer to "—Our Business—Management and Franchise" and "—Our Business—Ownership" below.In addition to our current hotel portfolio, we are focused on the growth of our business by expanding our global hotel network through our development pipeline, which represents hotels that we expect to add to our system in the future. The following table summarizes our development activity: As of or for the Year Ended December 31, 2022HotelsRooms(1)Hotel systemOpenings355 58,200 Net additions(2)308 48,300 Development pipeline(3)Additions664 89,900 Count as of period end(4)2,821 416,400 ____________(1)Rounded to the nearest hundred.(2)Represents room additions, net of rooms removed from our system, during the period, which contributed to net unit growth for the year ended December 31, 2022 of 4.7 percent.(3)Hotels in our system were under development throughout 118 countries and territories, including 30 countries and territories where we did not currently have any existing hotels.(4)In our development pipeline, as of December 31, 2022, 205,400 of the rooms were under construction and 243,500 of the rooms were located outside of the U.S. Nearly all of the rooms in our development pipeline will be in our management and franchise segment. We do not consider any individual development project to be material to us.Overall, we believe that our experience in the hospitality industry, which spans more than a century of customer service and entrepreneurship, and continues to evolve to meet the tastes, preferences and demands of our hotel guests; our strong, well-defined brands that operate throughout the hospitality industry chain scales; our diverse, inclusive workforce, built to focus on providing exceptional customer experiences; and our commercial service offerings will continue to drive customer loyalty, including participation in our Hilton Honors guest loyalty program. We believe that satisfied customers will generate additional business at our properties, yielding strong overall hotel performance for us and our hotel owners. Strong results at our existing properties will encourage further development of additional hotels under our brands and conversions of existing hotels to our brands with both (i) owners who currently have properties in our system and (ii) new owners who sign management or franchise contracts with us in the future, which further supports our growth and future financial performance. We believe that our existing hotel system and development pipeline, which will require minimal capital investment from us, positions us to further improve our business, allocate capital effectively and meet our customers' demands and preferences in the future.4Our Brand PortfolioThe goal of each of our brands is to deliver exceptional customer experiences and superior operating performance. December 31, 2022Brand(1)Chain ScaleCountries/ TerritoriesPropertiesRoomsPercentage of Total RoomsSelected Competitors(1)Luxury17349,4010.8%Four Seasons, Mandarin Oriental, Peninsula, Ritz Carlton, Rosewood Hotels & Resorts, St. RegisLuxury8111,4120.1%Leading Hotels of the World, Legend Preferred Hotels & Resorts, Small Luxury Hotels of The World, The Luxury CollectionLuxury234516,2101.5%Fairmont, Intercontinental, JW Marriott, Park Hyatt, SofitelUpper Upscale10386,6160.6%25hours Hotels, Hyatt Centric, Kimpton, Le Meridien, Thompson HotelsUpper Upscale121,8140.2%Grand Hyatt, JW MarriottUpper Upscale94604224,37019.9%Hyatt Regency, Marriott, Omni, Sheraton, WestinUpper Upscale3413826,6672.4%Autograph Collection, Design Hotels,Destination Hotels, The Unbound CollectionUpscale51660150,15713.3%Courtyard by Marriott, Crowne Plaza, Delta, Holiday Inn, Radisson, Sheraton, WyndhamUpscale139511,1111.0%Joie de Vivre, Tribute PortfolioUpper Upscale626360,9285.4%Hyatt Regency, Marriott, Sheraton, WestinUpscale————%AC Hotels, Aloft, Cambria, Hotel IndigoUpper Midscale351,0940.1%CitizenM, Freehand, Generator, Hoxton, Moxy, tommie, YotelUpscale57971143,34212.7%Aloft, Courtyard by Marriott, Four Points, Holiday Inn, Hyatt PlaceUpper Midscale362,863312,04327.7%Comfort Suites, Courtyard by Marriott, Fairfield Inn, Holiday Inn Express, Springhill SuitesMidscale423523,0222.0%Avid, Best Western, Comfort Inn & Suites, La Quinta, Quality Inn, Sleep Inn, Wingate by WyndhamUpscale453561,2895.4%Element, Hyatt House, Residence Inn, Staybridge SuitesUpper Midscale357661,3525.4%Candlewood Suites, Comfort Suites, TownePlace SuitesTimeshare(2)88013,7031.2% Bluegreen Vacations, Disney Vacation Club, Holiday Inn Club Vacations, Marriott Vacations Worldwide, Travel & Leisure Co.___________(1)The table above excludes 10 unbranded properties with 2,899 rooms, representing approximately 0.3 percent of total rooms, as well as our new premium economy brand, Spark by Hilton, which launched in January 2023. Also, the selected competitors exclude lesser-known regional competitors. (2)HGV has the exclusive right to use our Hilton Grand Vacations brand, subject to the terms of a license agreement with us.5Waldorf Astoria Hotels & Resorts: What began as an iconic hotel in New York City is today a global portfolio of iconic properties in sought-out destinations. Each Waldorf Astoria property provides a unique sense of place with a relentless commitment to personalized service, sophisticated accommodations, once-in-a-lifetime experiences and culinary expertise, enabling guests to create unforgettable moments. In addition, Waldorf Astoria boasts a residential portfolio that provides the comfort of a private home combined with luxury amenities and service synonymous with the brand. LXR Hotels & Resorts: Found in alluring destinations, LXR Hotels & Resorts is a collection of independent luxury properties that each represent their unique location and offer a singular travel experience native to its place, history and tradition. LXR connects legendary properties into an exclusive network of hotels that are set apart by an unrivaled commitment to personalized service and elegant, yet locally immersive experiences for their guests. Each hotel in the collection features its own pedigree, story and character that is steeped in the originality of its locale and provides a luxurious base of exploration for the intrigued, yet discerning, adventurer. Conrad Hotels & Resorts: Spanning five continents, Conrad Hotels & Resorts has created a seamless connection between bold design, impactful experiences and curated contemporary art to inspire the conscientious traveler. Conrad is a place where guests are empowered to explore through intuitive service and experiences that authentically connect them with local culture. In addition, the brand also features an expanding residential portfolio combining sophisticated design, best-in-class amenities and purposeful service in inspiring destinations. Canopy by Hilton: Canopy by Hilton is a vibrant boutique lifestyle brand, providing guests a place in the neighborhood to relax and recharge with simple, guest-directed service, comfortable spaces, an energizing atmosphere and thoughtful local choices. Each hotel is designed as a natural extension of its neighborhood and delivers a fresh approach to hospitality and the guest experience. Signia by Hilton: Signia by Hilton is a portfolio of premier hotels in highly sought-after urban and resort destinations, offering sophisticated business and leisure travelers an elevated hotel experience combined with exceptional full-service amenities and premium meetings and events spaces.Hilton Hotels & Resorts: For more than 100 years, Hilton Hotels & Resorts, Hilton’s flagship brand and one of the most globally recognized hotel brands, has set the benchmark for hospitality around the world, providing new product innovations and services to meet guests' evolving needs. With hotels on six continents, Hilton Hotels & Resorts properties are located in sought-after destinations and offer exceptional travel experiences to every guest. Hilton Hotels & Resorts are full service properties that feature advanced meeting and event spaces and services; award-winning restaurants; and mindful fitness/wellness facilities.Curio Collection by Hilton: Curio Collection by Hilton is a global portfolio of one-of-a-kind hotels and resorts handpicked for their distinct character. Curio Collection properties offer guests the ability to experience independent hotels that offer authentic, curated experiences through local offerings and elevated amenities, while providing the benefits of Hilton and its award-winning guest loyalty program Hilton Honors. DoubleTree by Hilton: DoubleTree by Hilton is a fast-growing, global portfolio of upscale hotels. For more than 50 years, DoubleTree has maintained its philosophy of making guests feel welcome through contemporary accommodations and thoughtful amenities, including diverse food and beverage experiences, state-of-the-art fitness offerings and meetings and event spaces. Whether traveling for business or leisure, every guest is welcomed with the signature, warm DoubleTree chocolate chip cookie at check in, a hallmark of the brand's hospitable service.Tapestry Collection by Hilton: Tapestry Collection by Hilton is a portfolio of original hotels that offer guests unique style and vibrant personality, encouraging travelers to make an authentic connection to their destination. While each property is unique, every Tapestry Collection property is united by the reliability that comes with the Hilton name, in addition to the benefits of the award-winning Hilton Honors program.Embassy Suites by Hilton: Embassy Suites by Hilton offers both leisure and business travelers an approachable, upscale experience with best-in-class customer service that anticipates travelers' needs and delivers what matters most to them. All guests are welcomed with a spacious two-room suite with separate areas to work and play, free made-to-order breakfast each morning and complimentary drinks and snacks every night.Tempo by Hilton: Tempo by Hilton is a stylish and contemporary lifestyle hotel brand with more than 20 properties under development. Thoughtfully designed and uplifting, Tempo by Hilton is dedicated to exceeding the expectations of the 6ambitious, modern traveler by offering accommodations and public spaces to help guests relax and recharge, including an open lobby concept with dedicated spaces to lounge, work and dine, as well as premium culinary options, such as a casual breakfast cafe and an inviting coffee experience. Each Tempo by Hilton experience will include well-being offerings, state-of-the-art fitness facilities and programs, flexible meeting and working spaces and more.Motto by Hilton: Motto by Hilton is an urban, lifestyle hotel brand designed to help guests live like a local in prime locations globally. Motto by Hilton caters to travelers looking for one-of-a-kind experiences by bringing together the best elements of a lifestyle hotel — centrally located urban locations, modern design, the best of the neighborhood food and beverage and a local vibe. Motto by Hilton delivers a flexible and innovative hospitality experience through elements like first-of-its-kind connecting rooms for group travel, vibrant communal spaces with access to check-in and a coffee house and bar for work and social use by guests and locals alike.Hilton Garden Inn: Hilton Garden Inn is an award-winning brand where guests find an open, inviting atmosphere with warm, glowing service and simple, thoughtful touches that allow them to socialize and unwind. As a recognized leader in food and beverage offerings, Hilton Garden Inn caters to guests' dining needs by serving cooked-to-order breakfast and offering handcrafted cocktails, shareable small plates and full meals at its on-site restaurants and bars. Flexible meeting space, free Wi-Fi, wireless printing and fitness centers are offered to help guests stay productive. Hampton by Hilton: Hampton by Hilton is our largest brand and includes both Hampton Inn and Hampton Inn & Suites hotels, with properties located on four continents. Recognized as a leading upper midscale brand in the lodging industry, Hampton has been ranked the #1 lodging brand to franchise by Entrepreneur for 14 consecutive years. Hampton by Hilton hotels around the world provide guests high-quality and thoughtfully designed accommodations, friendly and authentic service and value-added amenities, like complimentary hot breakfast and free Wi-Fi, all backed by the 100% Hampton Guarantee.Tru by Hilton: Tru by Hilton is a game-changing hotel brand where guests don't have to compromise between a consistent, fun and affordable hotel stay. Spirited, simplified and grounded in value, Tru by Hilton is designed for cross-generational appeal, with a large, reimagined public space where guests can work, play, lounge and eat. Efficiently designed modern guest rooms feature a rolling desk, oversized windows for natural light and bright, spacious bathrooms. Guests can enjoy complimentary amenities, including a build-your-own "Top It" hot breakfast, a multifunctional fitness center and fast Wi-Fi. Premium snacks, light meal options and single-serve wine and beer are available for purchase at the 24/7 Eat. & Sip. market. Tru by Hilton, launched in 2016, had over 230 hotels in the pipeline as of December 31, 2022.Homewood Suites by Hilton: Homewood Suites by Hilton is the upscale extended-stay hotel brand that delivers the comforts of home for guests and their pets. Homewood Suites by Hilton offers inviting, generous-sized suites featuring separate living and sleeping areas and fully equipped kitchens with full-size refrigerators for guests seeking home-like accommodations when traveling for extended or quick overnight stays. Additional value-driven amenities include complimentary Wi-Fi and free breakfast.Home2 Suites by Hilton: Home2 Suites by Hilton is a dynamic and savvy brand designed to make guests and their pets feel at home regardless of their length of stay. Our forward-thinking design strikes the perfect balance of being modern and playful, while at the same time remaining functional and comfortable. Our flexible spaces empower guests to maintain their lifestyle with just the right benefits of home and stylish nods to their spirit of adventure. We are committed to empowering our guests by supporting sustainable communities. By packaging amenities and services that enable wellness and environmental health, we create value where it matters for our guests, our communities and our planet. Spark by Hilton: The newest addition to the Hilton portfolio, Spark by Hilton is a premium economy hotel brand at the intersection of value and consistency. Spark by Hilton provides a reliable and comfortable stay with friendly service for every guest, all at an accessible price. Offering simple design with splashes of color and cheer, Spark by Hilton hotels provide a welcoming sense of arrival with colorful exterior statement walls and inspiring artwork. The public spaces provide multi-functional seating, from communal tables to rocking chairs, and guest rooms are comfortable and relaxing with simple, streamlined furniture. Travelers can enjoy complimentary breakfast with premium coffee and a signature bagel bar.Hilton Grand Vacations: A premier vacation ownership brand, Hilton Grand Vacations is known for delivering a consistently exceptional standard of service, maximum flexibility for owners and guests and elegant, family-friendly resorts in desirable locations around the world. Signature elements include spacious, well-appointed accommodations and resorts with extensive on-site amenities. A special points-based reservation system gives owners the flexibility to vacation when, where and how they prefer.7Our Guest Loyalty ProgramHilton Honors is our award-winning guest loyalty program that supports our portfolio of brands. The program generates significant repeat business by rewarding guests with points for each stay at our properties, which are then redeemable for free or discounted room nights at our properties and other goods and services. Hilton Honors members can also use points earned to transact with many strategic partners, including credit card providers, such as American Express, airlines, rail and car rental companies, Amazon, Lyft and others. Hilton Honors members who book through preferred Hilton channels also have access to instant benefits, including a flexible payment slider that allows members to choose nearly any combination of points and money to book a stay, an exclusive member discount and free standard Wi-Fi. Members also have access to contactless technology exclusively through the Hilton Honors app, where members can check in, choose their room and access their room using Digital Key. The program provides targeted marketing, promotions and customized guest experiences to 152 million members. Affiliation with our loyalty program encourages members to allocate more of their travel spend to our hotels. The percentage of travel spend we capture from loyalty members increases as they move up the tiers of our program. The program is funded by contributions from eligible revenues generated by Hilton Honors members and collected from properties in our system, as well as our strategic partnerships. The funds collected by the Hilton Honors program are subsequently applied to reimburse hotels and strategic partners for Hilton Honors points redemptions by loyalty members and to pay for administrative expenses and marketing initiatives that support the program. 8Our BusinessAs of December 31, 2022, our system included the following properties and rooms, by type, brand and region:Owned / Leased(1)ManagedFranchisedTotalPropertiesRoomsPropertiesRoomsPropertiesRoomsPropertiesRoomsWaldorf Astoria Hotels & ResortsU.S.— — 12 4,489 — — 12 4,489 Americas (excluding U.S.)— — 3 425 — — 3 425 Europe2 463 4 898 — — 6 1,361 Middle East and Africa— — 7 1,867 — — 7 1,867 Asia Pacific— — 6 1,259 — — 6 1,259 LXR Hotels & ResortsU.S.— — — — 3 522 3 522 Americas (excluding U.S.)— — — — 1 76 1 76 Europe— — 1 70 1 307 2 377 Middle East and Africa— — 1 41 3 282 4 323 Asia Pacific— — — — 1 114 1 114 Conrad Hotels & ResortsU.S.— — 6 2,227 2 1,730 8 3,957 Americas (excluding U.S.)— — 3 787 — — 3 787 Europe— — 4 1,155 1 107 5 1,262 Middle East and Africa1 614 4 1,689 — — 5 2,303 Asia Pacific1 164 22 7,078 1 659 24 7,901 Canopy by HiltonU.S.— — — — 26 4,490 26 4,490 Americas (excluding U.S.)— — 2 272 — — 2 272 Europe— — 1 123 4 917 5 1,040 Middle East and Africa— — 1 200 — — 1 200 Asia Pacific— — 4 614 — — 4 614 Signia by HiltonU.S.— — 2 1,814 — — 2 1,814 Hilton Hotels & ResortsU.S.— — 60 44,578 186 58,188 246 102,766 Americas (excluding U.S.)1 405 30 11,559 24 7,241 55 19,205 Europe38 11,262 46 15,580 43 11,280 127 38,122 Middle East and Africa4 1,705 39 13,668 4 1,738 47 17,111 Asia Pacific5 2,999 115 40,610 9 3,557 129 47,166 Curio Collection by HiltonU.S.— — 10 4,000 64 14,003 74 18,003 Americas (excluding U.S.)— — 2 99 17 2,196 19 2,295 Europe— — 6 516 27 3,534 33 4,050 Middle East and Africa— — 4 741 2 557 6 1,298 Asia Pacific— — 4 773 2 248 6 1,021 DoubleTree by HiltonU.S.— — 31 10,397 348 79,122 379 89,519 Americas (excluding U.S.)— — 3 587 39 7,822 42 8,409 Europe— — 14 3,580 109 18,610 123 22,190 Middle East and Africa— — 19 4,939 6 825 25 5,764 Asia Pacific— — 83 22,174 8 2,101 91 24,275 (continued on next page)9Owned / Leased(1)ManagedFranchisedTotalPropertiesRoomsPropertiesRoomsPropertiesRoomsPropertiesRoomsTapestry Collection by HiltonU.S.— — — — 78 9,382 78 9,382 Americas (excluding U.S.)— — 1 138 7 740 8 878 Europe— — — — 6 360 6 360 Middle East and Africa— — 1 50 — — 1 50 Asia Pacific— — 1 266 1 175 2 441 Embassy Suites by HiltonU.S.— — 38 10,121 216 48,653 254 58,774 Americas (excluding U.S.)— — 2 354 6 1,649 8 2,003 Middle East and Africa— — — — 1 151 1 151 Motto by HiltonU.S.— — — — 3 871 3 871 Americas (excluding U.S.)— — — — 1 115 1 115 Europe— — — — 1 108 1 108 Hilton Garden InnU.S.— — 6 689 737 101,796 743 102,485 Americas (excluding U.S.)— — 13 1,992 51 7,664 64 9,656 Europe— — 18 3,486 61 9,849 79 13,335 Middle East and Africa— — 17 3,555 3 474 20 4,029 Asia Pacific— — 58 12,688 7 1,149 65 13,837 Hampton by HiltonU.S.— — 23 2,986 2,309 228,576 2,332 231,562 Americas (excluding U.S.)— — 12 1,537 115 13,931 127 15,468 Europe— — 16 2,697 109 16,965 125 19,662 Middle East and Africa— — 5 1,459 — — 5 1,459 Asia Pacific— — — — 274 43,892 274 43,892 Tru by HiltonU.S.— — — — 231 22,569 231 22,569 Americas (excluding U.S.)— — — — 4 453 4 453 Homewood Suites by HiltonU.S.— — 9 1,131 499 57,064 508 58,195 Americas (excluding U.S.)— — 3 406 24 2,688 27 3,094 Home2 Suites by HiltonU.S.— — 2 210 545 57,080 547 57,290 Americas (excluding U.S.)— — — — 7 753 7 753 Asia Pacific— — — — 22 3,309 22 3,309 Other— — 4 1,463 6 1,436 10 2,899 Total hotels52 17,612 778 244,037 6,255 852,078 7,085 1,113,727 Hilton Grand Vacations— — — — 80 13,703 80 13,703 Total system52 17,612 778 244,037 6,335 865,781 7,165 1,127,430 ________(1)Includes hotels owned or leased by entities in which we own a noncontrolling financial interest. Management and FranchiseWe manage hotels and license our brands through our management and franchise segment, which included 778 managed hotels and 6,255 franchised hotels consisting of 1,096,115 total rooms, as of December 31, 2022. This segment generates its revenue primarily from fees charged to hotel owners under management and franchise contracts, as well as from fees associated with license agreements. We grow our management and franchise business by attracting owners to become a part of our system and participate in our commercial services to support their properties. Our management and franchise contracts provide significant return on investment for us as fees are earned and paid.10Hotel ManagementOur core management services consist of operating hotels under management contracts for the benefit of third parties who either own or lease the hotels and the associated personal property. Often, particularly in the U.S., we employ the individuals working at these locations. Terms of our management contracts vary, but our fees generally consist of a base management fee, which is generally based on a percentage of the hotel’s monthly gross revenue, and, when applicable, an incentive management fee, which is generally based on a percentage of the hotel's operating profits, normally over a one-year calendar period, and, in some cases, may be subject to a stated return threshold to the hotel owner. In general, the owner pays all operating and other expenses and reimburses our out-of-pocket expenses. In turn, our managerial discretion typically is subject to approval by the owner in certain major areas, including the approval of annual operating and capital expenditure budgets and the appointment of certain key personnel. Additionally, the owners generally pay a monthly program fee based on the underlying hotel's sales or usage, as reimbursement for the costs related to our: (i) advertising and marketing programs; (ii) internet, technology and reservation systems; and (iii) quality assurance programs. Owners are also responsible for various other fees and charges, including payments for participation in our Hilton Honors guest loyalty program, training, consultation and procurement of certain goods and services. As of December 31, 2022, we managed 778 hotels with 244,037 rooms, which does not include hotels in our ownership segment. The initial terms of our management contracts are typically 20 to 30 years. In certain cases, we are both the franchisor and manager of the hotel, when we enter into a franchise contract in addition to the management contract, and, in these cases, we classify the hotel as managed in our system. Extension options for our management contracts are negotiated and vary, but typically are more prevalent in full service hotels. Generally, these contracts contain one or two extension options that are for either five or 10 years and can be exercised at our or the hotel owner's option or by mutual agreement, as specified by the contract.Some of our management contracts provide early termination rights to hotel owners upon certain events, including the failure to meet certain financial or performance criteria. Performance test measures typically are based upon the hotel’s performance individually and/or in comparison to specified competitive hotels. We often have an optional cure right to pay an amount equal to the performance shortfall over a specified period, although in some cases our cure rights are limited. FranchisingWe license our IP, including our brand names, trademarks and service marks, and our operating systems to hotel owners under franchise contracts. We do not own, manage or operate franchised properties, do not employ the individuals working at these properties and do not have any legal responsibility for the employees or the liabilities associated with operating these properties. We conduct periodic inspections of our franchised hotels to ensure that brand standards that we establish are maintained. For newly franchised hotels, including both new construction and conversions of existing hotels outside of our system, we approve the location, as well as the plans for the facilities, to ensure the hotels meet our brand standards. For existing franchised hotels, we provide franchisees with property improvement plans that must be completed to keep the hotels in compliance with our brand standards, so that they can remain in our hotel system. We also earn license fees from license agreements with strategic partners, including co-branded credit card providers, and HGV for the use of our IP. Each franchisee pays us an application, initiation or other fee in conjunction with the inception of a franchise contract. Franchisees also pay a royalty fee, generally based on a percentage of the hotel’s monthly gross room revenue and, in some cases, may also include a percentage of gross food and beverage revenues and other revenues, as applicable. Additionally, the franchisees generally pay a monthly program fee based on the underlying hotel's sales or usage, as reimbursement for the costs related to our: (i) advertising and marketing programs; (ii) internet, technology and reservation systems; and (iii) quality assurance programs. Franchisees are also responsible for various other fees and charges, including payments for participation in our Hilton Honors guest loyalty program, training, consultation and procurement of certain goods and services. As of December 31, 2022, we franchised 6,335 hotels and resorts, including timeshare properties, with 865,781 rooms.Our franchise contracts typically have initial terms of approximately 20 years for new hotels and approximately 10 to 20 years for hotels converting from hotels outside of our system. At the expiration of the initial term, we may have a contractual right or obligation to relicense the hotel to the franchisee for an additional term generally ranging from 10 to 15 years. We have the right to terminate a franchise contract upon specified events of default, including nonpayment of fees or noncompliance with brand standards. If a franchise contract is terminated by us because of a franchisee’s default, the franchisee is contractually required to pay us liquidated damages.11OwnershipAs a hotel owner and lessee, we focus on maximizing cost efficiency and profitability of the portfolio by, among other things, maximizing hotel revenues, implementing cost-effective labor management practices and systems and reducing fixed costs. Through our disciplined approach to hotel and asset management, we develop and execute on strategic plans for each of our hotels to enhance their competitive position and, at many of our hotels, we invest in renovating guest rooms and public spaces and adding or enhancing meeting and retail space to improve profitability. As of December 31, 2022, the segment included 52 hotels totaling 17,612 rooms, comprising 45 hotels that we leased, two hotels that were each leased by a consolidated variable interest entity ("VIE") and five hotels owned or leased by unconsolidated affiliates. Environmental, Social and GovernanceHilton strives to create long-term value for all of our stakeholders through: (i) our resilient business model; (ii) our ESG efforts to support the long-term viability of our business; and (iii) our more than 100-year history of filling the earth with the light and warmth of hospitality and making the world a better place through travel and connection.As one of the world’s largest hospitality companies, we recognize Hilton has a responsibility to protect the planet and support the communities we serve to ensure our hotel destinations remain vibrant and resilient for generations of travelers to come. Hilton is committed to driving responsible travel and tourism globally and furthering positive environmental and social impact across our operations and communities through our ESG strategy, Travel with Purpose. We believe that the need for responsible leadership commensurate with our global scale will continue to be of great importance in the years to come. In 2022, Hilton was named to the Dow Jones Sustainability Indices ("DJSI") for the sixth consecutive year, scoring in the 100th percentile in our industry, reflecting Hilton's significant investment in building a leading ESG strategy. We continue to make progress in our ESG commitments and, in 2022, refreshed our ESG strategic framework to focus and communicate our ESG strategy across all three ESG pillars: (i) environmental — aiming toward a net zero future with well-defined targets for watts (carbon and energy), water and waste; (ii) social — supporting and advancing careers, communities and responsible conduct; and (iii) governance — advancing and measuring our goals with a focus on integrity and transparency and leveraging our public affairs and advocacy work, our partnerships and our policies and reporting. As part of the 2022 update to our ESG strategic framework, we launched new environmental and social impact goals, including updated emissions reduction targets. Our updated 2030 Goals align with the global Sustainable Development Goals ("SDGs") adopted by the United Nations in 2015 and are guided by our evaluation of the social and environmental issues that are critical to our business and our long-term success. Further, our ESG efforts are supported by a robust governance structure, designed to ensure our ESG objectives are an important part of our business and strategic priorities as we work towards our 2030 Goals. Our Chief ESG Officer reports directly to our Chief Executive Officer, and our executive committee receives at least quarterly updates on our ESG programs and progress towards our 2030 Goals. The Nominating & ESG Committee, one of the three standing committees of Hilton's board of directors, receives quarterly reports on progress toward our 2030 Goals, reviews and assesses our ESG strategy and makes recommendations to the board and management as appropriate. The board of directors also receives annual updates on progress towards our 2030 Goals. Significant ESG risks, including risks related to climate change, natural disasters, supply chain disruption, health and safety and ethics, fraud and corruption are integrated in Hilton's Enterprise Risk Management program as part of Hilton's annual Enterprise Risk assessment process. The results of this process are reviewed by our executive committee and our board of directors, including the Audit Committee, to inform enterprise-wide strategic planning. We also engage with stakeholders on an ongoing basis to refine and enhance our strategy, to help align our programs with the issues that matter the most to our business and stakeholders. As part of this effort, we completed a thorough ESG materiality assessment in 2020, leveraging guidance from the Global Reporting Initiative ("GRI"), Sustainability Accounting Standards Board ("SASB") and the World Economic Forum. Of the more than 200 ESG issues considered, our stakeholders were most focused on the following: climate action; employee development and well-being; diversity, equity and inclusion ("DE&I"); employee and guest health, safety and security; human rights; and ethical business practices and regulatory compliance. We used the results of this materiality assessment to advance our Travel with Purpose strategy in alignment with organizational priorities, inform management of ESG risks and drive long-term value for our business and our stakeholders.We remain committed to reducing our carbon and other greenhouse gas emissions in line with climate science. We evaluate our climate change risks and report annually on our ESG performance, with our reporting prepared in accordance with the GRI 12standards, while integrating the recommendations of the SASB and the Task Force on Climate-related Financial Disclosures ("TCFD").LightStay, our proprietary and award-winning ESG management system, is aligned with the criteria of the Global Sustainable Tourism Council ("GSTC") and is used to measure, manage and report many of Hilton's key environmental and social performance metrics, including, but not limited to, carbon emissions, energy, water, waste, volunteer hours, in-kind donations and efficiency projects. Our hotels use LightStay to track and report environmental and social impact data, assess performance and recognize performance improvement opportunities and achievements.We recognize that achieving meaningful progress towards our 2030 Goals and the SDGs requires collaboration across a wide range of partners and external stakeholders, including the Sustainable Hospitality Alliance ("SHA"), an organization that represents the hotel industry’s collective efforts to support and protect destinations and communities for future generations. Hilton leaders continue to engage with SHA and its membership and have participated in recent efforts to advance the Hotel Carbon Measurement Initiative and the Hotel Water Measurement Initiative methodologies, which are designed to enable the industry to more consistently measure and report on carbon emissions and water consumption in hotels. The Hilton Global Foundation (formerly known as the Hilton Effect Foundation), which was launched in 2019, supports nonprofits and local community organizations that serve as partners to amplify our environmental and social impact around the world. The Hilton Global Foundation is our primary international philanthropic arm and is registered as a U.S.-based 501(c)(3) charitable organization. In 2022, we launched the Hilton UK Foundation to support Hilton's mission to support a sustainable future in the UK. Hilton has a long history of partnering with organizations in the UK whose environmental and social priorities align with Hilton's, and we expect to continue these partnerships through the work of the Hilton UK Foundation. The Hilton Global Foundation and Hilton UK Foundation are collectively referred to as the Foundation.In 2022, the Foundation awarded more than $2 million in grants to organizations supporting destination stewardship, climate action, career development and community resilience. Since 2019, the Foundation has awarded more than $8 million in grants to more than 130 nongovernmental and community-based organizations. Environmental ImpactIn 2022, we reevaluated our environmental impact 2030 Goals and set more ambitious targets. Hilton was the first major hospitality company to set science-based targets that were approved by the Science Based Targets initiative ("SBTi") and the first major hotel brand to obtain revalidation by SBTi. In June 2022, SBTi verified our near-term targets (1.5°C by 2030), which are in alignment with our updated environmental 2030 Goals to cut emissions intensity of our managed hotel portfolio by 75 percent and of our franchised hotel portfolio by 56 percent, with 2008 as our baseline. We continue to work toward our 2030 Goal of reducing water and waste intensity at the hotels we operate, including those that are owned, leased and managed, by 50 percent, with 2008 as our baseline. To achieve our reduction targets, we partnered with a global leader in the field of sustainability and energy procurement to help map out a phased implementation strategy to help us make informed decisions and chart a path to achieving our energy reduction goals. Although we believe that our environmental impact 2030 Goals are ambitious yet attainable, there can be no assurance that we will be able to meet them. As climate science continues to evolve we may further refine our environmental impact 2030 Goals. In 2022, we continued the certification of our portfolio of hotels to ISO 9001 (Quality), ISO 14001 (Environmental) and ISO 50001 (Energy) standards, which marks 11 years of our properties certified to ISO 14001 and ISO 9001 and eight years for ISO 50001. Further, in alignment with our science-based targets, we continue to take steps to increase our sourcing of renewable energy at our hotels around the world. In the Europe, Middle East and Africa ("EMEA") region, one third of the hotels we operated, as well as our Watford and Glasgow corporate offices, were supplied with 100 percent renewable energy during 2022. In the U.S., we continue to have a renewable energy option for our managed hotels. Additionally, we provide our customers with the opportunity to make their meetings and events sustainable through our Meet with Purpose offering, a program launched to help customers gather responsibly, incorporate food donations into their programs and positively impact their destinations, or offset their meeting through our carbon neutral meeting offering at select participating hotels.We continued our focus on our food waste reduction and food donation initiatives, with many of our managed hotels in the U.S. and EMEA piloting donation programs and analytical software to help reduce food waste and associated costs. We also operate a soap recycling program, with over 5,500 of our hotels partnered with soap recycling organizations to donate soap bars and other unused supplies from our hotels to those in need, consistent with our effort to reduce waste. We have made progress on our commitment to reduce single use plastics at our hotels, offering Digital Keys at more than 80 percent of our hotels and requiring all hotels to comply with the adoption of bulk amenities by 2023.13In 2022, the Foundation partnered with organizations, such as the Global Water Challenge, One Tree Planted and the Ocean Conservancy, that are making a positive impact in our communities and on the environment. Specifically, the Foundation works with partners that advance: (i) climate action with initiatives that combat urgent climate change and its impact, reducing carbon footprint, energy, water and waste; and (ii) destination stewardship with initiatives that improve travel destinations and positively impact the environment, including conducting clean up, conservation and preservation activities.We primarily generate carbon emissions from the operation of our hotels. During 2022, our hotels continued to recover from the impact of the COVID-19 pandemic and occupancy at our owned, leased and managed properties exceeded 2021 levels, and, by the second half of 2022, it approached 2019 levels. As such, we experienced a year-over-year increase in consumption of energy, water and waste in 2022 in-line with the year-over-year increase in occupancy. However, this consumption, on both a per square meter and absolute basis, remained below 2019 levels, and we remain on track to achieve our updated 2030 Goals.We have achieved the following reductions in environmental impact since 2008:Percent Reduction Achieved Since 2008(1)Reduction in water consumption per square meter(2)33 %Reduction in landfilled waste per square meter(2)65 Reduction in carbon dioxide emissions per square meter(2)47 Energy consumption per square meter(2)36 ____________(1)Reflects data as of December 31, 2022 that has been reviewed by an independent third party. (2)Reflects performance across Hilton's owned, leased and managed properties, which totaled approximately 28.4 million square meters as of December 31, 2022. Although consumption and waste generation were higher in 2022 than in 2021 and 2020, correlated with the increase in occupancy resulting from our recovery from the COVID-19 pandemic, they remain below 2019 levels.The data in the following tables, which have been reviewed by an independent third party, reflect the key sustainability metrics for our managed, owned and leased properties, as well as recommendations of the SASB within their Hotel & Lodging and Restaurant Standards:Year Ended December 31,Metric2022(1)2021(1)2020(1)2019(1)Energy managementTotal energy consumed, in gigajoules per square meter0.860.810.721.03Percent total energy from grid electricity56.7 %56.3 %56.3 %53.8 %Carbon emissionsTotal emissions (Scope 1 and 2), in metric tons CO2e per square meter(2)0.0830.0790.0690.101Water managementAmount withdrawn, in cubic meters per square meter1.941.791.552.35Amount consumed, in cubic meters per square meter0.4850.4470.3880.586Percent in regions with high or extremely high baseline water stress(3)39 %37 %37 %32 %Waste managementAmount generated, in metric tons per square meter0.00510.00420.00390.0080Percent diverted from landfills(4)35.7 %32.0 %33.9 %34.8 %14Year Ended December 31,Absolute Consumption(5)2022(1)2021(1)2020(1)2019(1)Total energy consumed, in million gigajoules24.522.217.824.6Direct emissions (Scope 1), in million metric tons CO2e0.450.420.330.48Indirect emissions (Scope 2), in million metric tons CO2e(2)1.901.761.391.93Water withdrawn, in million cubic meters (m3)55.149.138.756.1Water consumed, in million cubic meters (m3)13.812.39.714.0Waste generated, in million metric tons0.140.110.100.19____________(1)The decreases in consumption reflected in these measures during the year ended December 31, 2020 and then the increases in consumption reflected in these measures, if applicable, during the years ended December 31, 2021 and 2022 were primarily attributable to the reduction in occupancy as a result of the COVID-19 pandemic during 2020, followed by Hilton's recovery from the impact of the pandemic during 2021 and 2022 and the related increases in occupancy. During the year ended December 31, 2020, the hotel operations at approximately 380 of our managed, owned and leased hotels were completely or partially suspended for some period of time, while only approximately 120 had suspended operations for some period of time during 2021. Substantially all of our hotels had re-opened by the end of 2021 and have remained open and operating since then. The changes in occupancy and the number of hotel suspensions were directly correlated with and impacted the consumption of energy, water and waste at our hotels around the world.(2)Scope 2 market-based emissions as defined by The Greenhouse Gas Protocol: A Corporate Accounting and Reporting Standard (Revised Edition).(3)Water stress as defined by the World Resources Institute ("WRI"). Represents the percentage (by square meter) of owned, leased and managed hotels, in regions with baseline water stress, that have high or extremely high baseline water stress. (4)Amount of waste not diverted from landfills in metric tons per square meter was 0.0033, 0.0029, 0.0026 and 0.0052 for the years ended December 31, 2022, 2021, 2020 and 2019. Although the amount was higher in 2022 than in 2021 and 2020, correlated with the increase in the amount of waste generated resulting from our recovery from the COVID-19 pandemic, it remained below 2019 levels. (5)Total floor area of Hilton's owned, leased and managed properties, for which absolute consumption is reflected, was 28.4 million square meters, 27.5 million square meters, 24.9 million square meters and 23.9 million square meters as of December 31, 2022, 2021, 2020 and 2019, respectively. Absolute consumption increased during the years ended December 31, 2022 and 2021 due to our increased floor area and increased occupancy, as described above. Social ImpactWith a presence in 123 countries and territories, we use our global scale to focus on creating learning and career growth opportunities, positively impacting our communities and promoting responsible, inclusive conduct across our value chain, all with consideration for human rights and DE&I.As such, in 2022, we updated our social impact 2030 Goals to the following: (i) to provide 5 million learning and career growth opportunities for our employees and our communities with a focus on underrepresented groups; (ii) to meaningfully impact 20 million community members; and (iii) to promote responsible, inclusive conduct across 100 percent of our value chain operations. We used these goals to guide our social impact initiatives in 2022.Through our Foundation, we partner with the International Youth Foundation by providing our Passport to Success Concierge program, an online course that is free to youth around the globe who are interested in building the core skills for a career in travel and tourism. Since its launch in August 2021, over 22,000 youth and Hilton employees have accessed the program through 2022. We partner with organizations around the globe supporting career development including Jobs for America's Graduates, Travis Early College High School Hospitality College, The Punlaan School and R.O.L.E. Foundation.Hilton also remains committed to combating human trafficking, and we require all hotel-based employees to complete an annual training on identifying signs of trafficking. We partner with expert organizations, including Vital Voices, It’s a Penalty and ECPAT, to help prevent and mitigate such risks, including at an industry level through the Sustainable Hospitality Alliance, World Travel and Tourism Council, American Hotel & Lodging Association and United Kingdom ("U.K.") Stop Slavery Hotel Industry Network. The Foundation furthered these efforts by committing to grant $500,000 in total over the next three years to the AHLA Foundation's No Room for Trafficking ("NRFT") Survivor Fund, starting in 2023. The NRFT Survivor Fund aims to equip community-based organizations with the resources to engage and support trafficking survivors – from direct financial support of their short-term, baseline needs to career-related support.Further, we have reached more than 35,000 refugees since 2015 through volunteering, in-kind donations, purchasing, training, shelter and employment. In addition, in 2022, in partnership with #HospitalityHelps and the United Nations High Commissioner for Refugees (a UN Refugee Agency), we supported the Ukraine refugee crisis by providing accommodations to more than 42,000 refugees seeking shelter across our EMEA region. Further, Hilton is part of the Tent Coalition for Refugees ("Tent") in the U.S. and Canada, and in 2022, we expanded our hiring commitment in partnership with Tent to hire 1,500 refugees in the U.S. over the next three years.During 2022, Hilton and the Foundation supported our hotel teams and surrounding communities through disasters and crises, including Hurricane Ian and the Ukraine refugee crisis. This approach included donating to organizations at the 15frontlines of the crises, supporting the delivery of meals, medical care and other basic needs, as well as support for the families of impacted employees through Hilton's third-party operated Team Member Assistance Fund ("TMAF"). In August 2022, Hilton expanded its TMAF program to provide further assistance to its employees. In addition to continuing to support Team Members following disasters, the expanded program enables the TMAF to support employees experiencing undue financial hardship due to unexpected personal circumstances and larger crisis situations. Hilton employees, as well as individuals working at managed and franchised hotels who are not employed by Hilton, can apply for financial assistance when impacted by disaster and extreme hardship. In 2022, the TMAF provided assistance grants to more than 1,400 individuals. In addition to collaboration across our industry and within the business community, we are focused on achieving change by leveraging the scale of our supply chain. We remain committed to embedding robust due diligence across our supply chain and partnering with suppliers to advance positive impact in our communities. Furthermore, by leveraging our size and scale, we also aim to expand local sourcing from small businesses and strengthen business with diverse suppliers. Through our award-winning Supplier Diversity Program, we engage women-, minority-, veteran-, disabled- and LGTBQ+ owned businesses in sourcing opportunities across Hilton in all categories.During 2022, our employees around the world reported nearly 345,000 volunteer hours in their local communities, including during our Travel with Purpose Week, an annual week of volunteering focused on destination stewardship, including beach cleanups, tree planting, trash pickup and clothing donations.Human Capital ManagementAs of December 31, 2022, we employed or managed approximately 159,000 individuals working at our owned, leased and managed properties and corporate offices. There were an additional 259,000 individuals employed by third-party owners working at our franchised properties.We strive to be the most hospitable company in the world, and we believe that an effective human capital management strategy is an essential component of that effort. Our strategy focuses on attracting, developing and retaining the best talent in the industry, and our executive committee reviews talent strategy and succession plans on a quarterly basis to assess current and future talent needs. We want to build a strong employee-centered culture that creates connectivity, camaraderie and trust among all employees, which then supports our employees to deliver positive experiences to guests at our hotels.Attracting and retaining talent remains a leading area of focus, as competition for talent across industries remains strong. While our hiring levels in 2022 were higher than they were before the onset of the COVID-19 pandemic, we have been affected by global labor shortages, making it more difficult to recruit talent. In response, we continue to review our compensation policies to maintain competitiveness and we have invested in employee programs and offerings and enhanced our recruiting strategies to tap into new pools of talent.DE&IOur workforce should represent the communities where we live and work, which is why we are committed to achieving global gender parity and 25 percent U.S. ethnic representation at our corporate leadership levels by the end of 2027. Our leaders are committed to our diversity and inclusion efforts, and we hold them accountable through our organizational objectives that measure their performance against our commitments.As of December 31, 2022, the global workforce that we employ or manage was 43 percent women. Globally, corporate leadership was 40 percent women and hotel leadership was 25 percent women. As of December 31, 2022, in the U.S., our workforce was 72 percent ethnically diverse, with U.S. corporate leadership being 19 percent ethnically diverse and U.S. hotel leadership being 23 percent ethnically diverse. As of December 31, 2022, our board of directors, excluding management directors, was 50 percent women and 25 percent ethnically diverse.Hilton has a long legacy of supporting the military dating back to our founder, Conrad Hilton, a World War I veteran. Since the launch of our Operation Opportunity program in 2015, we have hired more than 35,000 veterans, spouses, caregivers and dependents. Veterans and their spouses are valuable assets for our company as they bring a unique set of highly transferable skills, experience and values.16As part of our commitment to an inclusive environment, we offer the following resources to our employees: •Team Member Resource Groups ("TMRG") – Our nine TMRGs have global reach and each one is sponsored by an executive leader. They provide members with opportunities for career development and the chance to share their unique perspectives and viewpoints with leadership and other colleagues to drive important conversations about inclusion and equity across the enterprise.•Courageous Conversations – Courageous Conversations is a global, virtual learning series featuring internal and external thought leaders who explore elements of DE&I to help drive greater awareness, understanding and a more inclusive workplace.•Pathway Programs – Hilton helps foster economic mobility for historically underrepresented talent and supports diversity efforts across our organization. We have partnerships with racial and social justice organizations, university scholarship programs and a Pathways Program Office, which is focused on expanding our current pathways programs and stewarding the creation of new pathways for future employees to join Hilton. •Annual trainings – We require all employees to complete training as part of our Inclusive and Respectful Workplace curriculum, which is based on the underlying principles of our Code of Conduct. This annual requirement includes training on unconscious bias, DE&I, preventing human trafficking and anti-harassment. Our Code of Conduct states that we do not tolerate any form of discrimination or harassment on the basis of any characteristic protected by applicable law. For our guest-facing employees, our mandatory DE&I training is scenario-driven training designed to promote positive, inclusive behaviors. Thrive at HiltonThrive at Hilton is our value proposition designed to enable employees to grow and flourish in both their professional and personal lives. To make that happen, we offer programs designed to provide our employees with tools to excel in their roles. We offer a range of benefits and programs to help our employees thrive at work and at home. Such benefits and programs include paid time off, parental leave, adoption assistance, subsidized health insurance, education assistance and flexible work arrangements, including remote work opportunities for our corporate employees, and Go Hilton Travel programs, which make discounted rooms available to hotel and corporate employees, as well as their families and friends.We strive to provide medical and mental health care that is convenient, accessible and affordable for our employees. Our programs include: •Care for All – a global platform launched in 2022 focused on caregiving that provides resources for employee self-care, as well as enabling employees to care for others, including sick, disabled or elderly family members, children and pets. This benefit is also extended to employees' families and friends.•Wellthy – a caregiving concierge service which provides assistance to employees working through the logistical and administrative tasks related to care, such as finding the right in-home aide, contesting medical bills, evaluating care providers or finding care options for veterans for eligible employees in the U.S., U.K. and Ireland.•Employee Assistance Program – offers free and confidential services, such as counseling and recommending resources to find services such as child and eldercare, legal advice and apartment hunting and relocation.We regularly survey our employees to gauge the level of job satisfaction and effective relationships with management, among other things and use their feedback to inspire program enhancements and new offerings. We strive to maximize employee retention and minimize attrition with these and other measures. Approximately 35 percent of our U.S. employees have been with Hilton for at least 10 years. Compensation and BenefitsHilton offers competitive pay and benefits to its employees, including a variety of compensation programs and comprehensive benefit programs. Hilton has hired consulting firms to independently evaluate the effectiveness of executive compensation and benefit programs and utilized their feedback to further our commitment to deliver competitive levels of 17compensation and benefits. We regularly review gender and diversity pay parity among our employees as part of our ongoing talent processes.We also want our employees to share in our success and, as a result of employee feedback, we offer an employee stock purchase plan ("ESPP") for eligible employees in the U.S., U.K. and United Arab Emirates. Through our ESPP, eligible employees can purchase Hilton stock through after-tax payroll deductions at a 15 percent discount from the market stock price and benefit from the hard work they put into making Hilton a success. As of December 31, 2022, approximately 30 percent of people employed or managed by us globally and approximately 40 percent of people working in the U.S. were covered by various collective bargaining agreements that generally address pay rates, working hours, other terms and conditions of employment, certain employee benefits and orderly settlement of labor disputes.Development and TrainingOur career development approach emphasizes customized experiences so that employees can follow a training and career path best suited to their goals. Hilton University, our global learning platform, gives employees access to a robust library of learning resources. We partner with leading educational institutions and content providers across the globe to deliver high-quality, relevant content to our employees, including a wide array of general business, industry or function-specific technical skills and leadership development courses and programs. Our Hilton University platform, Job Skills Hubs and LinkedIn Learnings Playlists provide flexible, accessible learning designed to help our employees learn and grow. Our employees have the opportunity to grow their leadership skills and careers through our Lead@Hilton framework, which is designed to develop leaders throughout their careers and features the Hilton Leaders Teaching Leaders video series, as well as content from partners such as Cornell University and Harvard University. Curriculums curated for varying levels of experience aim to provide foundational tools, as well as coaching, mentoring and wellness resources. Our GM Academy curriculum is centered on nine core General Manager ("GM") business capabilities, some of which include leadership and people management, asset management, customer engagement and commercial performance. Additionally, Hilton's Signature Leadership Development programs focus on building effective leaders across the enterprise to grow our leadership bench strength. These programs provide opportunities for participants to develop key capabilities, network with and learn from senior leaders and enhance leadership and business acumen.In 2022, we launched our partnership with Guild Education to provide our U.S. employees with a continuing education platform to help them pursue and attain their educational goals debt-free. Through this partnership, employees have access to a wide variety of educational credentials from leading universities and learning providers including high school completion, English language learning, college degrees and professional certifications.Awards and RecognitionWe have consistently been recognized for our Hilton culture, and our awards for 2022 included: Following our placement as #1 in 2021, an induction into DiversityInc's Hall of Fame for the Top Companies for Diversity, Military Times Best for Vets #14 (Overall) and #1 (Hospitality), Military Friendly Employer with Gold distinction, Veteran Magazine Best of the Best Veteran Friendly Company, Great Place to Work Institute ("GPTW") #2 World’s Best Workplace, GPTW & Fortune #2 Best Place to Work in the U.S., GPTW & Fortune #1 Best Place to Work for Women in the U.S. (for the fourth consecutive year) and GPTW & Fortune #1 Best Place to Work in six countries (Austria, China, Ireland, Peru, Turkiye and Uruguay). Additionally, we received a 100 percent rating in the Corporate Equality Index from the Human Rights Campaign for our commitment to corporate policies, practices and benefits pertinent to LGBTQ+ employees for the ninth consecutive year.Governance, Ethics and Regulatory ComplianceAs a core underpinning of our entire organization, our ethics and compliance program is overseen by our board of directors, which expects all Hilton employees to conduct themselves at high standards with respect to all ethics and compliance matters. Our Code of Conduct establishes a set of global business principles, with our compliance organization, training, risk management and monitoring activities tailored to address unique risks by geography, business line, function and level. Our Code of Conduct is supported by a robust set of compliance policies addressing risk areas such as corruption, trade sanctions, insider trading, privacy, confidential information, antitrust and escalation of concerns. Our legal and compliance training program, which is an annual requirement for all of our employees, provides the ability to convey a consistent set of compliance 18standards across the organization in formats designed to target different knowledge levels, learning styles and functional needs. Our annual training calendar includes mandatory training and supplemental training that is supported by company-wide awareness campaigns highlighting Hilton-specific risks and scenarios. We also use passive communication channels, including electronic bulletin board screens in the employee break room areas of our hotels, and internal newsletters, including a publication that highlights real Hilton Hotline matters and their resolutions. In governing the physical safety of our properties and teams, to help ensure the safety and security of our employees and guests, we constantly monitor threats and incidents around the world through online tools and external networks and partnerships; support our properties globally with crisis alert communications, crisis plans and area crisis teams; provide employees with safety and security training resources; and conduct safety and security audits annually using a risk-based approach.Our legal compliance team administers a third-party risk management program so that we understand the qualifications, reputation and associations of third parties with whom we transact, particularly third parties who interface with government officials and third parties who act in Hilton’s name, such as owners of our hotels. The third-party risk management program includes due diligence, education materials for third parties, ongoing monitoring of relationships and appropriate contract audit and termination rights. Our legal compliance team also monitors EthicsPoint, a comprehensive and confidential reporting tool to assist management and employees address fraud, abuse and other misconduct in the workplace. The Audit Committee of our board of directors receives regular updates from our legal compliance team.CompetitionWe encounter active and robust competition as a hotel and resort manager, franchisor, owner and lessee. Competition in the hospitality industry is based on several criteria, generally including: the attractiveness of the facility; location; level of service; quality of accommodations; amenities; food and beverage options and outlets; public and meeting spaces and other guest services; consistency of service; room rate; brand reputation; and the ability to earn and redeem loyalty program points through a global system. Our properties and brands compete with other hotels, resorts, motels, inns and other accommodation rental services in their respective geographic markets or customer segments, including facilities owned by local interests, individuals, national and international chains, institutions, investment and pension funds and real estate investment trusts ("REITs"). We believe that our position as a multi-branded manager, franchisor, owner and lessee of hotels with an associated global, system-wide guest loyalty and commercial platform helps us continue to maintain our position as one of the largest and most geographically diverse hospitality companies in the world. Our principal competitors include other branded and independent hotel operating companies, national and international hotel brands and ownership companies. While local and independent brand competitors vary, on a global scale, our primary competitors are Accor S.A., Choice Hotels International, Hongkong and Shanghai Hotels, Hyatt Hotels Corporation, Intercontinental Hotel Group, Marriott International, Radisson Hotel Group and Wyndham Hotels & Resorts.SeasonalityThe hospitality industry is seasonal in nature. The periods during which our properties experience higher or lower levels of demand vary from property to property, depending principally upon their location, type of property and competitive mix within the specific location. While results were less predictable as a result of COVID-19 and related travel restrictions, based on historical results, we generally expect our revenues to be lower in the first quarter of each year than in each of the three subsequent quarters.CyclicalityThe hospitality industry is cyclical, and demand generally follows, on a lagged basis, key macroeconomic indicators. There is a history of increases and decreases in the development and supply of and demand for hotel rooms, occupancy levels and room rates realized by hotel owners through economic cycles. The combination of changes in economic conditions and in the supply of hotel rooms can result in significant volatility in results for owners and managers of hotel properties. The costs of running a hotel, including personnel costs, rent, property taxes, insurance and utilities, tend to be more fixed than variable. As a result of such fixed costs, in a negative economic environment, the rate of decline in earnings can be higher than the rate of decline in revenues. In 2020, we and our hotel owners experienced a downturn in the current industry cycle driven by the COVID-19 pandemic, which continued into the beginning of 2021. However, the level of travel in 2021 and 2022 recovered substantially when compared to that of 2020, and in the third and fourth quarters of 2022, such performance exceeded performance for the same periods in 2019.19Intellectual PropertyIn the highly competitive hospitality industry in which we operate, trademarks, service marks, trade names, logos and patents are very important to the success of our business. We have a significant number of trademarks, service marks, trade names, logos, patents and pending registrations and expend significant resources each year on surveillance, registration and protection of our IP, which we believe has become synonymous in the hospitality industry with a reputation for excellence in service and authentic hospitality.Government RegulationOur business is subject to various foreign and U.S. federal and state laws and regulations, including laws and regulations that govern the offer and sale of franchises, many of which impose substantive requirements on franchise contracts and require that certain materials be registered before franchises can be offered or sold in a particular jurisdiction.In addition, a number of states regulate the activities of hospitality properties and restaurants, including safety and health standards, as well as the sale of liquor at such properties, by requiring licensing, registration, disclosure statements and compliance with specific standards of conduct. Operators of hospitality properties also are subject to laws governing their relationship with employees, including minimum wage requirements, overtime, working conditions and work permit requirements. Our franchisees are responsible for their own compliance with laws, including with respect to their employees, minimum wage requirements, overtime, working conditions and work permit requirements. Compliance with, or changes in, these laws could reduce the revenue and profitability of our properties and could otherwise adversely affect our operations.We also manage hotels with casino gaming operations as part of or adjacent to the hotels. However, with the exception of casinos at certain properties in Puerto Rico and Egypt, third parties manage and operate the casinos. We hold and maintain the casino gaming license and manage the casinos located in Puerto Rico and Egypt and employ third-party compliance consultants and service providers. As a result, our business operations at these facilities are subject to the licensing and regulatory control of the local regulatory agency responsible for gaming licenses and operations in those jurisdictions.For additional information on government regulation, including environmental regulations and requirements, refer to "Part I—Item 1A. Risk Factors." InsuranceU.S. hotels that we manage are permitted to participate in certain of our insurance programs by mutual agreement with our hotel owners. If not participating in our programs, hotel owners must purchase insurance programs consistent with our requirements. Generally, U.S. franchised hotels are not permitted to participate in our insurance programs, but rather must purchase insurance programs consistent with our requirements. Foreign managed and franchised hotels are generally required to participate in certain of our insurance programs. In addition, our management and franchise contracts typically include provisions requiring the owner of any hotel to indemnify us against losses arising from the design, development and operation of such hotel.Most of our insurance policies are written with self-insured retentions or deductibles that are common in the insurance market for similar risks, and we believe such risks are prudent for us to assume. Our third-party insurance policies provide coverage for claim amounts that exceed our self-insurance retentions or deductible obligations. We maintain insurance coverage for general liability, property, business interruption, terrorism and other risks with respect to our business for all of our owned and leased hotels, and we maintain workers' compensation or equivalent coverage for all of our employees. We also are self-insured for health coverages for some of our U.S. and Puerto Rico employees, which include those working at our corporate operations and managed hotels, with purchased insurance protection for costs over specified thresholds. In general, our insurance provides coverage related to any claims or losses arising out of the design, development and operation of our hotels.Where You Can Find More InformationWe file annual, quarterly and current reports, proxy statements and other information with the SEC. Our SEC filings are available to the public over the internet at the SEC's website at www.sec.gov. Our SEC filings are also available free of charge on our website at ir.hilton.com as soon as reasonably practicable after they are filed with or furnished to the SEC. Our website and the information contained on or connected to that site are not incorporated into this Annual Report on Form 10-K.20Item 1A. Risk FactorsIn addition to the other information in this Annual Report on Form 10-K, the following risk factors should be considered carefully in evaluating our company and our business.Risks Related to Our Industry We are subject to the business, financial and operating risks inherent to the hospitality industry, any of which could reduce our revenues and limit opportunities for growth. Our business is subject to a number of business, financial and operating risks inherent to the hospitality industry, including: •significant competition from multiple hospitality providers in all parts of the world; •the financial condition of third-party property owners, developers and joint venture partners; •relationships with third-party property owners, developers and joint venture partners, including the risk that owners may terminate our management, franchise or joint venture contracts;•decreases in the frequency of business travel that may result from alternatives to in-person meetings, including virtual meetings hosted online or over private teleconferencing networks; •decreases in the availability and/or increases in the cost of capital necessary for us and third-party hotel owners to fund investments, capital expenditures and service debt obligations;•changes in operating costs, including employee compensation and benefits, energy, insurance, food and beverage and other supplies; •increases in costs due to inflation or other factors that may not be fully offset by increases in revenues in our business, as well as increases in overall prices and the prices of our offerings due to inflation, which could weaken consumer demand for travel and the other products we offer and adversely affect our revenues; •changes in taxes and governmental regulations that influence or set wages, prices, interest rates or construction and maintenance procedures and costs; •the costs and administrative burdens associated with complying with applicable laws and regulations; •the costs or desirability of complying with local practices and customs; •significant increases in cost for health care coverage for employees and potential government regulation with respect to health care coverage; •shortages of labor or labor disruptions; •the ability of third-party internet and other travel intermediaries who sell our hotel rooms to guests to attract and retain customers; •the quality of services provided by franchisees, including ability to comply with relevant regulations and contractual requirements relating to a variety of issues including environment, human rights and labor; •delays in or cancellations of planned or future development or refurbishment projects; •cyclical over-building in the hospitality industry; •changes in desirability of geographic regions of the hotels in our business, geographic concentration of our operations and customers and shortages of desirable locations for development; 21•changes in the supply and demand for hotel services, including rooms, food and beverage and other products and services; and•the costs required for climate change initiatives, including those resulting from regulatory changes or stakeholder or customer expectations.Any of these factors could increase our costs or limit or reduce the prices we are able to charge third-party hotel owners for providing management and franchise services or hotel customers for hospitality products and services, or otherwise affect our ability to maintain existing properties or develop new properties. As a result, any of these factors can reduce our revenues and limit opportunities for growth. Macroeconomic and other factors beyond our control can adversely affect and reduce demand for our products and services. Macroeconomic and other factors beyond our control can reduce demand for hospitality products and services, including demand for rooms at our hotels. These factors include, but are not limited to: •changes in general economic conditions, including inflation, supply chain disruptions, low consumer confidence, increases in unemployment levels and depressed real estate prices resulting from the severity and duration of any downturn in the U.S. or global economy and financial markets;•conditions that negatively shape public perception of travel or result in temporary closures or other disruption at our hotel properties, including travel-related accidents, outbreaks of pandemic or contagious diseases, such as COVID-19, Ebola, Zika, avian flu, severe acute respiratory syndrome (SARS), H1N1 (swine flu) and Middle East Respiratory Syndrome (MERS);•geo-political activity, political and social unrest and governmental action and uncertainty resulting from U.S. and global political and social trends and policies, including potential barriers to travel, trade and immigration; •wars, such as Russia's invasion of Ukraine, political instability or civil unrest, terrorist activities or threats and resulting heightened travel security measures, any of which may foreclose travel to certain locales or decrease the appeal of travel among the general population; •the impact of U.S. Federal government shutdowns and other similar governmental budgetary impasses or reductions;•decreased corporate or government travel-related budgets and spending, as well as cancellations, deferrals or renegotiations of group business, such as industry conventions; •statements, actions or interventions by governmental officials related to travel and corporate travel-related activities and the resulting negative public perception of such travel and activities;•the financial and general business condition of the airline, automotive and other transportation-related industries and its effect on travel, including decreased airline capacity and routes and increased travel costs; •perceived negative impacts of tourism on local cultures, human rights and the environment; •cyber-attacks; •the impact of climate change or availability of natural resources; •natural, climate-related or man-made disasters and extreme weather conditions, including earthquakes, tsunamis, tornadoes, hurricanes, typhoons, floods, wildfires, volcanic eruptions, oil spills and nuclear incidents; •labor shortages, which could restrict our ability to efficiently operate or grow our business and/or increase our costs;•organized labor activities, which could cause a diversion of business from hotels involved in labor negotiations and loss of business for our hotels generally as a result of certain labor tactics; and22•other changes in the overall demand for what we offer, including the desirability of particular locations or travel patterns of customers.Any one or more of these factors could limit or reduce overall demand for our products and services or could negatively affect our revenue sources, which could adversely affect our business, financial condition and results of operations. Contraction in the global economy or low levels of economic growth could adversely affect our revenues and profitability, as well as limit or slow our future growth. Consumer demand for our services is closely linked to the performance of the general economy and is sensitive to business and personal discretionary spending levels. Decreased global or regional demand for hospitality products and services can be especially pronounced during periods of economic contraction or low levels of economic growth, and the recovery period in our industry may lag overall economic improvement. Declines in demand for our products and services due to general economic conditions could negatively affect our business by limiting the amount of fee revenues we are able to generate from our managed and franchised properties and decreasing the revenues and profitability of our owned and leased properties. In addition, many of the expenses associated with our business, including personnel costs, interest, rent, property taxes, insurance and utilities, are relatively fixed. During a period of overall economic weakness, if we are unable to meaningfully decrease these costs as demand for our hotels decreases, our business operations and financial performance and results may be adversely affected. The COVID-19 pandemic negatively affected our business, financial condition and results of operations and COVID-19 or other outbreaks of contagious diseases or other adverse public health developments may negatively affect future results.The COVID-19 pandemic significantly affected the global economy and strained the hospitality industry due to travel restrictions and advisories, stay-at-home directives, limitations on public gatherings and modified work arrangements, all of which resulted in cancellations and reduced travel around the world, as well as complete and partial suspensions of certain hotel operations. Although distribution of approved vaccines for COVID-19 continued throughout 2022, access to and acceptance of vaccines has varied across regions and within individual countries. In addition, new strains of the virus have had increased transmissibility, complicating treatment and vaccination programs. As such, the COVID-19 pandemic had an adverse impact on certain of our results for the year ended December 31, 2022, when compared to prior years, and COVID-19 or outbreaks of other contagious diseases or other adverse public health developments may continue to negatively affect future results. In particular, the continued impact of COVID-19 and the related restrictions in China have limited demand in that market. The long-term effects of the pandemic on our business and the travel industry at large remain uncertain and will depend on future developments, including, but not limited to, the duration and severity of potential future serious illnesses, if any, the availability and public acceptance of vaccinations and other treatments to combat COVID-19 and the length of time it takes for demand to stabilize and normal economic and operating conditions to fully resume. The current and uncertain future impact of the COVID-19 pandemic, including its effect on the ability or desire of people to travel and use our hotel properties for lodging, food and beverage and other services, may negatively affect our results, operations, outlook, plans, growth, cash flows and liquidity. The steps we took in 2020 to reduce operating costs for us and our owners, including temporarily reducing compensation, reducing our workforce and furloughing a substantial number of our employees, negatively affected our ability to attract and retain employees. Some hotels have faced challenges restaffing to pre-pandemic levels, which in some cases negatively affected guest experience and loyalty and, in turn, certain hotel results. We could still experience long-term impacts on our operating costs as a result of attempts to counteract future outbreaks of COVID-19 or other viruses through, for example, enhanced health and hygiene requirements or other such measures in one or more regions.The COVID-19 pandemic had a negative impact on our partners, including third-party owners of our properties, third-party service providers, travel agencies, suppliers and other vendors. In particular, third-party owners of our hotels experienced financing difficulties and significant declines in revenues during the pandemic, thereby making it more difficult for them to maintain their hotels and service their indebtedness. 23Risks Related to Operating Our BusinessBecause we operate in a highly competitive industry, our revenues or profits could be harmed if we are unable to compete effectively. The segments of the hospitality industry in which we operate are subject to intense competition. Our principal competitors are other operators of luxury, full-service and focused-service hotels, including other major hospitality chains with well-established and recognized brands. We also compete against smaller hotel chains, independent and local hotel owners and operators, home and apartment sharing services and timeshare operators. If we are unable to compete successfully, our revenues or profits may decline. Competition for hotel guests We face competition for individual guests, group reservations and conference business at our hotels. We compete for these customers based primarily on brand name recognition and reputation, as well as location, rates for hotel rooms, food and beverage and other services, property size and availability of rooms and conference and meeting space, accommodations and technology, quality of the accommodations, customer satisfaction, amenities and the ability to earn and redeem loyalty program points. Our competitors may have greater commercial, financial and marketing resources and more efficient technology platforms, which could allow them to improve their properties and expand and improve their marketing efforts in ways that could affect our ability to compete for guests effectively, or they could offer a type of lodging product that customers find attractive but that we do not offer. Competition for management and franchise contracts We compete to enter into management and franchise contracts. Our ability to compete effectively is based primarily on the value and quality of our management services, brand name recognition and reputation, our access to and willingness to invest capital, availability of suitable properties in certain geographic areas, the overall economic terms of our contracts and the economic advantages to the third-party hotel owner of retaining our management services and/or using our brands. If the properties that we manage or franchise perform less successfully than those of our competitors, if we are unable to offer terms as favorable as those offered by our competitors or if the availability of suitable properties is limited, we may not be able to compete effectively for new management or franchise contracts. Any deterioration in the quality or reputation of our brands could have an adverse effect on our reputation, business, financial condition or results of operations. Our brands are among our most important assets. Our ability to attract and retain guests depends, in part, on the public recognition of our brands and their associated reputation. In addition, the success of our hotel owners’ businesses and the amount of payments to us for the assets and services we provide them may depend on the strength and reputation of our brands. If our brands become obsolete or consumers view them as unfashionable, unsustainable or lacking in consistency and quality, we may be unable to attract guests to our hotels and may further be unable to attract or retain our hotel owners.Changes in ownership or management practices, perceptions of our ESG practices, perception of guest or employee health or safety, the occurrence of accidents or injuries, cyber-attacks, security breaches, natural disasters, crime, failure of suppliers, franchisees or business partners to comply with relevant regulations and contractual requirements relating to a variety of issues including environmental, human rights and labor, individual guest, owner or employee notoriety or similar events at our hotels and resorts can harm our reputation, create adverse publicity and cause a loss of consumer confidence in our business. Because of the global nature of our brands and the broad expanse of our business and hotel locations, events occurring in one location could negatively affect the reputation and operations of otherwise successful individual locations. In addition, the expansion of social media has compounded the potential scope of negative publicity by increasing the speed and expanse of information dissemination. Many social media platforms publish content immediately and without filtering or verifying the accuracy of that content. A negative incident or the perception of occurrence of a negative incident at one hotel could have far-reaching effects, including lost sales, customer boycotts, loss of development opportunities and employee difficulties. Such incidents have in the past and could in the future subject us to legal actions, including litigation, governmental investigations or penalties, along with the resulting additional adverse publicity. A perceived decline in the quality of our brands or damage to our reputation could adversely affect our business, financial condition and results of operations. 24Our business is subject to risks related to doing business with third-party property owners that could adversely affect our reputation, operational results or prospects for growth. Unless we maintain good relationships with third-party hotel owners and renew or enter into new management and franchise contracts, we may be unable to maintain or expand our presence and our business, financial condition and results of operations may suffer. Our business depends on our ability to: (i) establish and maintain long-term, positive relationships with third-party hotel owners; and (ii) enter into new, and renew, management and franchise contracts. Although our management and franchise contracts are typically long-term arrangements, hotel owners may be able to terminate the contracts under certain circumstances, including the failure to meet specified financial or performance criteria. Our ability to meet these financial and performance criteria is subject to, among other things, risks common to the overall hospitality industry, including factors outside of our control. In addition, negative management and franchise pricing trends in the industry more broadly could adversely affect our ability to negotiate with hotel owners. If we fail to maintain and renew existing management and franchise contracts or enter into new contracts on favorable terms, we may be unable to expand our presence and our business, and our financial condition and results of operations may suffer. Our business is subject to real estate investment risks for third-party hotel owners that could adversely affect our operational results and our prospects for growth. Growth of our business is affected, and may potentially be limited, by factors influencing real estate development generally, including site availability, financing availability and cost, planning, zoning and other local approvals. In addition, market factors such as projected room occupancy, changes in growth in demand for customers compared to projected supply, geographic area restrictions in management and franchise contracts, costs and availability of construction labor and materials and anticipated room rate structure, if not managed effectively by our third-party hotel owners could adversely affect the growth of our management and franchise business. If our third-party hotel owners are unable to repay or refinance loans secured by properties, or to obtain financing adequate to fund current operations or growth plans, our revenues, profits and capital resources could be reduced and our business could be harmed. Many of our third-party hotel owners pledged their properties as collateral for loans entered into at the time of development, purchase or refinancing. If our third-party hotel owners are unable to repay or refinance maturing indebtedness on favorable terms or at all, which could be more difficult in the current interest rate environment, their lenders could declare a default, accelerate the related debt and repossess the property and we could also be required to make cash payments for any debt that we guarantee. While we maintain certain contractual protections, repossession could result in the termination of our management or franchise contract or eliminate revenues and cash flows from the property. In addition, the owners of managed and franchised hotels depend on financing to develop or buy and improve hotels and, in some cases, fund operations during down cycles. Our hotel owners’ inability to obtain adequate funding or to do so at interest rates that they are willing to accept could materially adversely affect the operation, maintenance and improvement plans of existing hotels, result in the delay or stoppage of the development of our existing development pipeline and limit additional development to further expand our hotel portfolio. Hotel owners with financial difficulties have been and may continue to be unable or unwilling to pay us amounts that we are entitled to under our existing contracts on a timely basis or at all. Unfavorable economic conditions also could affect our ability to enter into management and franchise contracts with potential third-party owners of our hotels, who may be unable to obtain financing or face other delays or cost pressures in developing hotel projects. As a result, some properties in our development pipeline have entered our system later than we anticipated, and new hotels have entered our pipeline at a slower rate than in the past, thereby negatively affecting our overall growth. Likewise, if we or our hotel owners or franchisees are unable to access capital to make physical improvements to our hotels, the quality of our hotels may suffer, which may negatively impact our reputation and guest loyalty, and our performance may suffer as a result.If our third-party property owners fail to make investments necessary to maintain or improve their properties, guest preference for Hilton brands, Hilton's reputation and performance results could suffer. Substantially all of our management and franchise contracts, as well as our license agreement with HGV, require third-party property owners to comply with quality and reputation standards of our brands, which include requirements related to the physical condition, use of technology, safety standards and appearance of the properties, as well as the service levels provided 25by hotel employees. These standards may evolve with customer preference, or we may introduce new requirements over time. If our property owners fail to make investments necessary to maintain or improve the properties in accordance with our standards, or based on customer demand more broadly, guest preference for our brands could diminish. In addition, if third-party property owners fail to observe standards or meet their contractual requirements, we may elect to exercise our termination rights, which would eliminate revenues from these properties and cause us to incur expenses related to terminating these contracts. We may be unable to find suitable or offsetting replacements for any individually terminated hotels or broader third-party owner relationships. Contractual and other disagreements with third-party property owners could make us liable to them or result in litigation costs or other expenses or termination of existing management or franchise contracts. Our management and franchise contracts require us and our hotel owners to comply with operational and performance conditions that are subject to interpretation and could result in disagreements. Any dispute with a property owner could be very expensive for us, even if the outcome is ultimately in our favor. We cannot predict the outcome of any arbitration or litigation, the effect of any negative judgment against us or the amount of any settlement that we may enter into with any third party. Furthermore, specific to our industry, some courts have applied principles of agency law and related fiduciary standards to managers of third-party hotel properties, which means that property owners may assert the right to terminate contracts even where the contracts do not expressly provide for termination. Our fees from any property permitted to be terminated would be eliminated, and accordingly, may negatively affect our results of operations. Some of our existing development pipeline may not be developed into new hotels, which could materially adversely affect our growth prospects. As of December 31, 2022, we had 2,821 hotels in our development pipeline, which we define as hotels under construction or approved for development under one of our brands. The commitments of owners and developers with whom we have contracts are subject to numerous conditions, and the eventual development and construction of our development pipeline, in particular for hotels not currently under construction, is subject to numerous risks, including, in certain cases, the owner's or developer's ability to obtain adequate financing and governmental or regulatory approvals. As a result, not every hotel in our development pipeline may develop into a new hotel that enters our system.New hotel brands or non-hotel branded concepts that we launch in the future may not be as successful as we anticipate, which could have a material adverse effect on our business, financial condition or results of operations. Since 2011, we have launched ten new brands: Home2 Suites by Hilton; Curio Collection by Hilton; Canopy by Hilton; Tru by Hilton; Tapestry Collection by Hilton; Motto by Hilton; LXR Hotels & Resorts; Signia by Hilton; Tempo by Hilton; and, most recently, Spark by Hilton. We may continue to build our portfolio by launching new hotel and non-hotel brands in the future. In addition, the Hilton Garden Inn, DoubleTree by Hilton and Hampton by Hilton brands have been expanding into new jurisdictions outside the U.S. over the past several years. We may continue to expand existing brands into new international markets. New hotel products or concepts or brand expansions may not be accepted by hotel owners, franchisees or customers and we cannot guarantee the level of acceptance any new brand will have in the development and consumer marketplaces. If new branded hotel products, non-hotel branded concepts or brand expansions are not as successful as we anticipate, we may not recover the costs we incurred in their development or expansion, which could have a material adverse effect on our business, financial condition and results of operations. The risks resulting from investments in owned and leased real estate could increase our costs, reduce our profits and limit our ability to respond to market conditions. Our investments in owned and leased real property (including through joint ventures) subject us to various risks that may not be applicable to managed or franchised properties, including:•governmental regulations relating to real estate ownership or operations, including tax, environmental, zoning and eminent domain laws; •fluctuations or loss in value of real estate or potential impairments in the value of our assets due to changes in market conditions and expectations of future hotels revenues and costs of operations in the area in which real estate or assets are located; •increased potential civil liability for accidents or other occurrences on owned or leased properties; 26•the ongoing need for capital improvements and expenditures funded by us to maintain or upgrade properties, some of which were constructed many years ago, and contractual requirements to deliver properties back to landlords in a particular state of repair and condition at the end of a lease term; •construction delays, lack of availability of required construction materials or cost overruns (including labor and materials) related to necessary capital improvements of owned and leased properties;•periodic total or partial closures due to renovations and facility improvements; •risks associated with any mortgage debt, including the possibility of default, fluctuating interest rate levels, particularly in the current interest rate environment, and uncertainties in the availability of replacement financing; •the inability to rebuild a property that has been damaged or destroyed by casualty, including a climate-related weather event, as a result of governmental regulations or other restrictions;•the inability to renew our leases on favorable terms or at all;•our limited ability to influence the decisions and operations of joint ventures in which we have a minority interest;•force majeure events, including earthquakes, tornadoes, hurricanes, wildfires, floods, tsunamis, climate-related weather events, outbreaks of pandemic or contagious diseases or acts of terrorism;•contingent liabilities that exist after we have exited a property; •costs linked to the employment and management of staff to run and operate an owned or leased property; •increased operating costs including energy, insurance, food and beverage, supplies and other operating costs; and •the relative illiquidity of real estate compared to some other assets. The negative effect on profitability and cash flow from declines in revenues is more pronounced in owned and leased properties because we, as the owner or lessee, bear the risk of the costs required to own and operate a hotel. Further, during times of economic distress, declining demand and declining earnings often result in declining asset values, and we or our joint ventures may not be able to sell properties or exit leasing arrangements on favorable terms or at all. Accordingly, we may not be able to adjust our owned and leased property portfolio promptly in response to changes in economic or other conditions. Failures in, material damage to or interruptions in our information technology systems, software or websites, including as a result of cyber-attacks on our systems or systems operated by third parties that provide operational and technical services to us, costs associated with protecting the integrity and security of personal data and other sensitive information and difficulties in updating our existing software or developing or implementing new software could have a material adverse effect on our business or results of operations. We depend heavily upon our information technology systems in the conduct of our business. We develop, own and license or otherwise contract for sophisticated technology systems and services for property management, procurement, finance, human resources, reservations, distribution and the operation of the Hilton Honors guest loyalty program. Such systems are subject to, among other things, damage or interruption from power outages, computer and telecommunications failures, computer viruses, third-party criminal activity including "ransomware" or other malware and natural and man-made disasters. Although we have a cold disaster recovery site in a separate location and cloud backup processes to back up our core reservation, property management, distribution and financial systems, certain of our data center operations are currently located in a single facility or with a single cloud-based provider. Although we continue to renovate and migrate portions of our operations to cloud-based providers while simultaneously building and operating new applications and services with those cloud-based providers, any loss or damage to our primary physical or cloud-based facilities could result in operational disruption and data loss as we transfer production operations to our disaster recovery site or cloud providers. Damage or interruption to our information systems may require a significant investment to update, remediate or replace with alternate systems, and we may suffer interruptions in our operations as a result. In addition, costs and potential problems or interruptions associated with the implementation of new or upgraded systems and technology or with maintenance or support of existing systems could also disrupt or reduce the efficiency of our operations. Any material interruptions or failures in our systems, including those that may result from our failure to adequately develop, implement and maintain a robust disaster recovery plan and backup systems could severely affect our 27ability to conduct normal business operations and, as a result, have a material adverse effect on our business operations and financial performance. We rely on third parties for the performance of a significant portion of our information technology functions worldwide. In particular, our loyalty platform, property management, reservation and distribution systems rely on data communications networks and systems operated by unaffiliated third parties and cloud providers. The success of our business depends in part on maintaining our relationships with these third parties and their continuing ability to perform these functions and services in a timely and satisfactory manner. If we experience a loss or disruption in the provision of any of these functions or services, or they are not performed in a satisfactory manner, we may have difficulty in finding alternate providers on terms favorable to us, in a timely manner or at all, and our business could be adversely affected. We rely on certain vendors for traditional software and cloud/software-as-a-service operations to maintain and periodically upgrade many of these systems and applications so that they can continue to support our business. The software programs supporting many of our systems were licensed to us by independent software developers. The inability of these developers or us to continue to maintain and upgrade these information systems and software programs would disrupt or reduce the efficiency of our operations if we were unable to convert to alternate systems in an efficient and timely manner. We are vulnerable to various risks and uncertainties associated with our websites and mobile applications, including changes in required technology interfaces, website and mobile application downtime and other technical failures, unexpected costs and changes and issues as we upgrade our website software and mobile applications. Additional risks include computer malware, changes in applicable federal, state and international regulations, security breaches, legal claims related to our website operations, e-commerce fulfillment and other consumer privacy concerns. Our failure to successfully respond to these risks and uncertainties could reduce website and mobile application sales and have a material adverse effect on our business or results of operations.Cyber-attacks could have a disruptive effect on our business.From time to time we and our third-party service providers experience cyber-attacks, attempted and actual breaches of our or their information technology systems and networks or similar events, which could result in a loss of sensitive business or customer information, systems interruption or the disruption of our operations. The techniques that are used to obtain unauthorized access, disable or degrade service or sabotage systems change frequently and may be difficult to detect for long periods of time, and despite our deployment of cyber-attack prevention and detection techniques, we are accordingly unable to anticipate and prevent all data security incidents. We have in the past been subject to cyber-attacks and expect that we will be subject to additional cyber-attacks in the future and may experience data breaches. Even if we are fully compliant with legal standards and contractual or other requirements, we still may not be able to prevent security breaches involving sensitive data. The sophistication of efforts by hackers to gain unauthorized access to information systems has continued to increase in recent years and may continue to do so. Breaches, thefts, losses or fraudulent uses of customer, employee or company data could cause consumers to lose confidence in the security of our websites, mobile applications, point of sale systems and other information technology systems and, as a result of this loss in confidence, choose not to purchase from us. Such security breaches also could expose us to risks of data loss, business disruption, litigation, fines, regulatory charges and other costs or liabilities, any of which could adversely affect our business.We are exposed to risks and costs associated with protecting the integrity and security of personal data and other sensitive information. We are subject to various risks and costs associated with the collection, handling, storage and transmission of sensitive information, including costs related to compliance with U.S. and foreign data collection and privacy laws and other contractual obligations, as well as risks associated with the compromise of our systems collecting such information. Many jurisdictions, including the European Union ("E.U."), the U.K., China and certain states within the U.S., have passed laws that require companies to meet specific requirements regarding the handling of personal data. We collect internal and customer data, including credit card numbers and other personally identifiable information for a variety of important business purposes, including managing our workforce, providing requested products and services and maintaining guest preferences to enhance customer service and for marketing and promotion purposes. We could be exposed to fines, penalties, restrictions, litigation, reputational harm or other expenses, or other adverse effects on our business, due to failure to protect personal data and other sensitive information or failure to maintain compliance with the various U.S. and foreign data collection and privacy laws or with credit card industry standards or other applicable data security standards. 28In addition, U.S. states and the federal government have enacted additional laws and regulations to protect consumers against identity theft. These laws and similar laws in other jurisdictions have increased the costs of doing business, and failure on our part to implement appropriate safeguards or to detect and provide prompt notice of unauthorized access as required by some of these laws could subject us to potential claims for damages and other remedies. If we were required to pay any significant amounts in satisfaction of claims under these laws, or if we were forced to cease our business operations for any length of time as a result of our inability to comply fully with any such law, our business, operating results and financial condition could be adversely affected.Failure to keep pace with developments in technology could adversely affect our operations or competitive position. The hospitality industry demands the use of sophisticated technology and systems for property management, brand assurance and compliance, procurement, reservation systems, operation of our guest loyalty programs, distribution of hotel resources to current and future customers and guest amenities. These technologies may require refinements and upgrades, and third parties may cease support of systems that are currently in use. The development and maintenance of these technologies may require significant investment by us. As various systems and technologies become outdated or new technology is required, we may not be able to replace or introduce them as quickly as needed or in a cost-effective and timely manner. In some cases, hotel owners may refuse to upgrade systems or deploy new technology to replace aging or end-of-life software and/or hardware. As a result, our business operations could be disrupted and our competitive position could decline, adversely affecting our financial performance, or we may not achieve the benefits we may have been anticipating from any new technology or system. Because third parties provide us with a number of operational and technical services, third-party security incidents could expose us to liability, harm our reputation, damage our competitiveness and adversely affect our financial performance.Third parties provide us with certain operational and technical services. These third parties may have access to our systems, provide hosting services, or otherwise process data about us or our guests, employees or partners. Any third-party security incident could compromise the integrity or availability of or result in the theft of confidential or otherwise sensitive data, which could negatively impact our operations. Unauthorized access to data and other confidential or proprietary information may be obtained through break-ins, network breaches by unauthorized parties, employee theft or misuse or other misconduct. We rely on the internal processes and controls of third-party software and application vendors to maintain the security of all software code provided to or used by Hilton. Should those vendors fail to secure their products then we are at risk of unintentionally injecting malware into our systems via compromised software code they provide. The occurrence of any of the foregoing could negatively affect our reputation, our competitive position and our financial performance, and we could face lawsuits and potential liability.Delays in service from third-party service providers could expose us to liability, harm our reputation, damage our competitiveness and adversely affect our financial performance.From time to time, we may rely on a single or limited number of suppliers for the provision of various goods or services that we use in the operation of our business. The inability of such third parties to satisfy our or our guests' requirements could disrupt our business operations or make it more difficult for us to implement our business strategy. If any of these situations were to occur, our reputation could be harmed, we could be subject to third-party liability, including under data protection and privacy laws in certain jurisdictions, and our financial performance could be negatively affected.Failure to comply with marketing and advertising laws, including with regard to direct marketing, could result in fines or place restrictions on our business. We rely on a variety of direct marketing techniques, including telemarketing, email and social media marketing and postal mailings, and we are subject to various laws and regulations in the U.S. and internationally that govern marketing and advertising practices. Any further restrictions in laws and court or agency interpretations of such laws, such as the Telephone Consumer Protection Act of 1991, the Telemarketing Sales Rule, the CAN-SPAM Act of 2003, various U.S. state laws, such as the California Privacy Rights Act, international data protection laws, such as the E.U. General Data Protection Regulation ("GDPR"), and laws limiting the cross-border transfer of data that govern these activities or new laws that become effective in the future could adversely affect current or planned marketing activities and cause us to change our marketing strategy. If this occurs, we may not be able to develop adequate alternative marketing strategies, which could affect our ability to maintain relationships with our customers and acquire new customers. We also obtain access to names of potential customers from travel service providers or other companies, and we market to some individuals on these lists directly or through other companies’ marketing materials. If access to these lists were prohibited or otherwise restricted, our ability to develop new customers and introduce them to products could be impaired. 29The growth of internet reservation channels could adversely affect our business and profitability. A significant percentage of hotel rooms for individual guests are booked through internet travel intermediaries, to whom we commit to pay various commissions and transaction fees for sales of our rooms through their systems. Search engines and peer-to-peer inventory sources also provide online travel services that compete with our business. If these bookings increase, these hospitality intermediaries may be able to obtain higher commissions or other significant concessions from us or our franchisees. These hospitality intermediaries also may reduce bookings at our hotel properties by de-ranking our hotels in search results on their platforms, and other online providers may divert business away from our hotels. Although our contracts with many hospitality intermediaries limit transaction fees for hotels, there can be no assurance that we will be able to renegotiate these contracts upon their expiration with terms as favorable as the provisions that existed before the expiration, replacement or renegotiation. Moreover, hospitality intermediaries generally employ aggressive marketing strategies, including expending significant resources for online and television advertising campaigns to drive consumers to their websites. As a result, consumers may develop brand loyalties to the intermediaries’ brands, websites and reservations systems rather than to the Hilton brands and systems. If this happens, our business and profitability may be significantly affected over time as shifting customer loyalties divert bookings away from our websites, which increases costs to hotels in our system. Internet travel intermediaries also have been subject to regulatory scrutiny, particularly in Europe. The outcome of this regulatory activity may affect our ability to compete for direct bookings through our own internet channels.In addition, although internet travel intermediaries have traditionally competed to attract individual leisure consumers or transient business rather than group business for meetings and events, in recent years they have expanded their business to include marketing to group business and also to corporate transient business. If that growth continues, it could both divert group and corporate transient business away from our hotels and also increase our cost of sales for group and corporate transient business. Consolidation of internet travel intermediaries, or the entry of major internet companies into the internet travel bookings business, also could divert bookings away from our websites and increase our hotels' cost of sales. Our reservation system is an important component of our business operations and a disruption to its functioning could have an adverse effect on our performance and results. We manage a global reservation system that communicates reservations to our branded hotels when made by individuals directly, either online, by telephone to our call centers, through devices via our mobile application, or through intermediaries like travel agents, internet travel websites and other distribution channels. The cost, speed, efficacy and efficiency of the reservation system are important aspects of our business and are important considerations of hotel owners in choosing to affiliate with our brands. Any disruption to the continuity of our reservation system, including any failure to maintain or upgrade such system, may adversely affect our ability to serve customers effectively and support reservations at our hotels. The cessation, reduction or taxation of program benefits of our Hilton Honors guest loyalty program could adversely affect the Hilton brands and guest loyalty. We manage the Hilton Honors guest loyalty program for all of the brands that we operate. Program members accumulate points primarily based on eligible stays and hotel charges and redeem the points for a range of benefits including free rooms and other items of value. The program is an important aspect of our business and of the affiliation value for hotel owners under management and franchise contracts. System hotels, including, without limitation, third-party hotels under management and franchise contracts, contribute a percentage of the charges incurred by members of the loyalty program for each stay of a program member. In addition to the accumulation of points for future hotel stays at our brands, Hilton Honors arranges with third parties, such as airlines, other transportation services, online vendors, retailers and credit card companies, to sell Hilton Honors points for the use of their customers and/or to allow Hilton Honors members to use or exchange points for products or services made available to loyalty program members by those third parties. Currently, the program benefits are not taxed as income to members. If the program awards and benefits are materially altered, curtailed or taxed such that a material number of Hilton Honors members choose to no longer participate in the program, our business could be adversely affected. 30Because we derive a portion of our revenues from operations outside the U.S., the risks of doing business internationally could lower our revenues, increase our costs, reduce our profits or disrupt our business. We currently manage, franchise, own or lease hotels and resorts in 123 countries and territories around the world. Our rooms outside the U.S. represented approximately 31 percent, 30 percent and 28 percent of our system-wide rooms for the years ended December 31, 2022, 2021 and 2020, respectively. We expect that our international operations will continue to account for a material portion of our results. As a result, we are subject to the risks of doing business outside the U.S., including: •rapid changes in governmental, economic or political policy, wars, political or civil unrest, acts of terrorism or the threat of international boycotts or U.S. anti-boycott legislation; •increases in anti-American sentiment and the identification of our licensed brands as an American brand; •recessionary trends or economic instability in international markets; •changes in foreign currency exchange rates or currency restructurings and hyperinflation or deflation in the countries in which we operate;•the effect of disruptions, including the temporary closure of hotel properties, caused by severe weather or climate-related events, natural disasters (including as a result of climate change), outbreak of disease, such as COVID-19, or other events that make travel to a particular region less attractive or more difficult; •the presence and acceptance of varying levels of business corruption in international markets and the effect of various anti-corruption and other laws; • •the imposition of restrictions on currency conversion or the transfer of funds or limitations on our ability to repatriate non-U.S. earnings in a tax-efficient manner; •the ability to comply with or the effect of complying with complex and changing laws, sanctions, regulations and policies of foreign governments that may affect investments or operations, including foreign ownership restrictions, import and export controls, tariffs, embargoes, increases in taxes paid and other changes in applicable tax laws;•the ability to comply with or the effect of complying with developing laws, regulations and policies of foreign governments with respect to human rights, including in the supply chain; •instability or changes in a country's or region's economic, regulatory or political conditions, including inflation, recession, interest rate fluctuations and actual or anticipated military or political conflicts or any other change;•political, economic and other uncertainty resulting from the U.K.'s exit from the E.U. (commonly known as "Brexit"), the terms of which could adversely affect our business;•uncertainties as to local laws regarding, and enforcement of, contract and IP rights;•forced nationalization of our properties by local, state or national governments; and •the difficulties involved in managing an organization doing business in many different countries. These factors may adversely affect the revenues earned from our hotels and resorts (as well as the market value of properties that we own or lease) located in international markets. While these factors and the effect of these factors are difficult to predict, any one or more of them could lower our revenues, increase our costs, reduce our profits or disrupt our business operations. Failure to comply with laws and regulations applicable to our international operations may increase costs, reduce profits, limit growth or subject us to broader liability. Our business operations in countries outside the U.S. are subject to a number of laws and regulations, including restrictions imposed by the Foreign Corrupt Practices Act ("FCPA"), as well as trade sanctions administered by the Office of Foreign Assets Control ("OFAC"). Although we have policies in place designed to comply with applicable sanctions, rules and 31regulations, it is possible that hotels we manage, own or lease in the countries and territories in which we operate may provide services to or receive funds from persons subject to sanctions. Where we have identified potential violations in the past, we have taken appropriate remedial action including filing voluntary disclosures to OFAC. In addition, some of our operations may be subject to the laws and regulations of non-U.S. jurisdictions, including the U.K.’s Bribery Act 2010, which contains significant prohibitions on bribery and other corrupt business activities, and other local anti-corruption laws in the countries and territories in which we conduct operations. If we fail to comply with these laws and regulations, we could be exposed to claims for damages, financial penalties, reputational harm and incarceration of employees or restrictions on our operation or ownership of hotels and other properties, including the termination of management, franchising and ownership rights. In addition, in certain circumstances, the actions of parties affiliated with us (including our owners, joint venture partners, employees and agents) may expose us to liability under the FCPA, U.S. sanctions or other laws. These restrictions could increase costs of operations, reduce profits or cause us to forgo development opportunities that would otherwise support growth. In addition, we are subject to a number of modern slavery, human trafficking and forced labor reporting, training and mandatory due diligence laws in various jurisdictions and expect additional statutory regimes to combat these crimes to be enacted in the future. The impact of these laws, such as the U.K's Modern Slavery Act 2015 and the German Supply Chain Due Diligence Act, and similar legislation on hotel operations could increase costs of operations and reduce our profits.Collective bargaining activity could disrupt our operations, increase our labor costs or interfere with the ability of our management to focus on executing our business strategies. A significant number of our employees and employees of our hotel owners are covered by collective bargaining agreements and similar agreements, including approximately 30 percent of people employed or managed by us globally. If relationships with our employees or employees of our hotel owners or the unions that represent them become adverse, the properties we manage, franchise, own or lease could experience labor disruptions such as strikes, lockouts, boycotts and public demonstrations. A number of our collective bargaining agreements are in the process of being renegotiated, and, if more employees become unionized, we may be required to negotiate additional collective bargaining agreements in the future. Labor disputes, which may be more likely when collective bargaining agreements are being negotiated, could harm our relationship with our employees or employees of our hotel owners, result in increased regulatory inquiries and enforcement by governmental authorities and deter guests. Further, adverse publicity related to a labor dispute could harm our reputation and reduce customer demand for our services. Labor regulation and the negotiation of new or existing collective bargaining agreements could lead to higher wage and benefit costs, changes in work rules that raise operating expenses, legal costs and limitations on our ability or the ability of our third-party property owners to take cost saving measures during economic downturns. We do not have the ability to influence the negotiations of collective bargaining agreements covering unionized labor employed by third-party property owners. Increased unionization of our workforce, new labor legislation or changes in regulations could disrupt our operations and our ability to promote services expected by customers, reduce our profitability or interfere with the ability of our management to focus on executing our business strategies. Labor shortages could restrict our ability to operate our properties or grow our business or result in increased labor costs that could adversely affect our results of operations. Our success depends in large part on our ability to attract, retain, train, manage and engage employees. The COVID-19 pandemic has negatively affected the labor market for employers. Labor shortages have affected the ability of our hotels to hire or re-hire employees during the ongoing recovery from the downturn caused by the pandemic. Among the factors that caused the labor shortages are the relative reduced appeal of working in the hospitality industry in a downturn, alternatives available in other industries and perceived health and safety concerns. As of December 31, 2022, we employed or managed approximately 159,000 individuals at our managed, owned and leased hotels and corporate offices around the world. If we are unable to attract, retain, train, manage and engage skilled individuals, our ability to staff and operate the hotels that we manage, own and lease could be diminished, which could reduce customer satisfaction, and our ability to manage our corporate business could be adversely affected. In addition, the inability of our franchisees to attract, retain, train, manage and engage skilled employees for the franchised hotels could adversely affect the reputation of our brands. Staffing shortages in various parts of the world also could hinder our ability to grow and expand our businesses. Because payroll costs are a major component of the operating expenses at our owned, leased and managed hotels, as well as our franchised hotels, a shortage of skilled labor could also require higher wages that would increase labor costs, which could adversely affect our results of operations and the results of hotels that we manage on behalf of third-party owners. Additionally, an increase in minimum wage rates could increase costs and reduce profits for us and our franchisees, which could, in turn, lower demand from third-party owners to add hotels to our system. We also face challenges with respect to retaining corporate employees. If we lost the services of one or more senior 32executives, this could adversely affect strategic relationships, including relationships with third-party hotel owners, significant customers, joint venture partners and vendors, and limit our ability to execute our business strategies. Any failure to protect our trademarks and other IP could reduce the value of the Hilton brands and harm our business. The recognition and reputation of our brands are important to our success. We have a significant number of trademark registrations in jurisdictions around the world for use in connection with our services, plus at any given time, a number of pending applications for trademarks and other IP. However, those trademark or other IP registrations may not be granted or the steps we take to use, control or protect our trademarks or other IP in the U.S. and other jurisdictions may not always be adequate to prevent third parties from copying or using the trademarks or other IP without authorization. We may also fail to obtain and maintain trademark protection for all of our brands in all jurisdictions. For example, in certain jurisdictions, third parties have registered or otherwise have the right to use certain trademarks that are the same as or similar to our trademarks, which could prevent us from registering trademarks and opening hotels in those jurisdictions. Third parties may also challenge our rights to certain trademarks or oppose our trademark applications. Defending against any such proceedings may be costly, and if unsuccessful, could result in the loss of important IP rights. Obtaining and maintaining trademark protection for multiple brands in multiple jurisdictions is also expensive, and we may therefore elect not to apply for or to maintain certain trademarks. Our IP is also vulnerable to unauthorized copying or use where local law, or lax enforcement of law, may not provide adequate protection. If our trademarks or other IP are improperly used, the value and reputation of the Hilton brands could be harmed. There are times where we may need to resort to litigation to enforce our IP rights. Litigation of this type could be unsuccessful, costly, force us to divert our resources, lead to counterclaims or other claims against us or otherwise harm our business or reputation. In addition, we license certain of our trademarks to third parties. For example, we have granted HGV the right to use certain of our IP in its timeshare business and we grant our franchisees a right to use certain of our IP in connection with their operation of the licensed hotel property. If HGV, a franchisee or other licensee fails to maintain the quality of the goods and services used in connection with the licensed trademarks, our rights to, and the value of, our trademarks could be harmed. Failure to maintain, control and protect our trademarks and other IP could likely adversely affect our ability to attract guests or third-party owners, and could adversely affect our results. In addition, we license the right to use certain IP from unaffiliated third parties, including the right to grant sublicenses to franchisees. If we are unable to use this IP, our ability to generate revenue from such properties may be diminished. Third-party claims that we infringe IP rights of others could subject us to damages and other costs and expenses. Third parties may make claims against us for infringing their patent, trademark, copyright or other IP rights or for misappropriating their trade secrets. We have been and are currently party to a number of such claims and may receive additional claims in the future. Any such claims, even those without merit, could: •be expensive and time consuming to defend, and result in significant damages; •force us to stop using the IP that is being challenged or to stop providing products or services that use the challenged IP; •force us to redesign or rebrand our products or services; •require us to enter into royalty, licensing, co-existence or other contracts to obtain the right to use a third party’s IP; •limit our ability to develop new IP; and•limit the use or the scope of our IP or other rights. In addition, we may be required to indemnify third-party owners of the hotels that we manage for any losses they incur as a result of any infringement claims against them. All necessary royalty, licensing or other contracts may not be available to us on acceptable terms. Any adverse results associated with third-party IP claims could negatively affect our business. 33Exchange rate fluctuations and foreign exchange hedging arrangements could result in significant foreign currency gains and losses that affect our business results. Conducting business in currencies other than the U.S. dollar ("USD") subjects us to fluctuations in foreign currency exchange rates that could have a negative effect on our financial results. We earn revenues and incur expenses in foreign currencies as part of our operations outside of the U.S. As a result, fluctuations in foreign currency exchange rates may significantly increase the amount of USD required for foreign currency denominated expenses or significantly decrease the USD received from foreign currency denominated revenues. We also have exposure to currency translation risk because, generally, the results of our business outside of the U.S. are reported in local currencies and then translated to USD for inclusion in our consolidated financial statements. As a result, changes between the foreign currency exchange rates and the USD will affect the recorded amounts of our foreign assets, liabilities, revenues and expenses and could have a negative effect on our financial results. Our exposure to foreign currency exchange rate fluctuations will grow if the relative contribution of our operations outside the U.S. increases. To mitigate foreign currency exposure, we may enter into foreign exchange derivatives with financial institutions. However, these derivatives may not eliminate foreign currency exchange rate risk entirely and involve costs and risks of their own in the form of transaction costs, credit requirements, interest rate differentials and counterparty risk. If the insurance that we or our owners carry does not sufficiently cover damage or other potential losses or liabilities to third parties involving properties that we manage, franchise, own or lease, our profits could be reduced. We operate in certain areas where the risk of natural or climate-related disaster or other catastrophic losses exists, and the occasional incidence of such an event could cause substantial damage to us, our owners or the surrounding area. We carry, and/or we require our owners to carry, insurance from solvent insurance carriers that we believe is adequate for foreseeable first-party and third-party losses and with terms and conditions that are reasonable and customary. Nevertheless, market forces beyond our control, such as the natural, climate-related and man-made disasters that occurred in recent years, could limit the scope of the insurance coverage that we and our owners can obtain or may otherwise restrict our or our owners' ability to buy insurance coverage at reasonable rates. We anticipate increased costs of property, general liability and excess liability insurance across the portfolio in 2023 due to the significant losses that insurers suffered globally in recent years. In the event of a substantial loss, the insurance coverage that we and/or our owners carry may not be sufficient to pay the full value of our financial obligations, our liabilities or the replacement cost of any lost investment or property. Additionally, certain types of losses may be uninsurable or prohibitively expensive to insure. In addition, other types of losses or risks that we may face could fall outside of the general coverage terms and limits of our policies. The U.S. Terrorism Risk Insurance Program (the "Program") provides insurance capacity for terrorist acts and is currently authorized through December 31, 2027. If the Program is not extended or renewed upon its expiration in 2027, or if there are changes to the Program that would negatively affect insurance carriers, premiums for terrorism insurance coverage will likely increase and/or the terms of such insurance may be materially amended to increase stated exclusions or to otherwise effectively decrease the scope of coverage available, perhaps to the point where it is effectively unavailable. In some cases, these factors could result in certain losses being completely uninsured. As a result, we or owners of hotels that we manage or franchise could lose some or all of the capital we or they have invested in a property, as well as the anticipated future revenues, profits, management fees or franchise fees from the property. Climate change could adversely affect our business.As an operator and franchisor of hotel properties in 123 countries, we are subject to the physical effects of climate change, including sea level rise, droughts and intensified storms and other weather events. Damage to our hotels resulting from the physical effects of climate change could lower demand for travel to certain locales and affect the performance of certain of our hotels, which could in turn have a negative impact on our results of operations.Our business is subject to evolving corporate governance and public disclosure regulations and expectations, including with respect to ESG matters, that could expose us to numerous risks.We are subject to the evolving rules and regulations with respect to ESG matters of a number of governmental and self-regulatory bodies and organizations, including the SEC, the New York Stock Exchange ("NYSE") and the Financial Accounting Standards Board, that could make compliance more difficult and uncertain. In addition, regulators, guests, investors, employees and other stakeholders are increasingly focused on ESG matters and related disclosures. These changing 34rules, regulations and stakeholder expectations have resulted in, and are likely to continue to result in, increased general and administrative expenses and increased management time and attention to comply with or meet those regulations and expectations. Developing and acting on ESG initiatives and collecting, measuring and reporting ESG related information and metrics can be costly, difficult and time consuming. Further, ESG related information is subject to evolving reporting standards, including the SEC's proposed climate-related reporting requirements. Our ESG initiatives and goals could be difficult and expensive to implement, and we could be criticized for the accuracy, adequacy or completeness of our ESG disclosures. Further, statements about our ESG related initiatives and goals, and progress against those goals, may be based on standards for measuring progress that are still developing, internal controls and processes that continue to evolve and assumptions that are subject to change in the future. In addition, we could be criticized for the scope or nature of such initiatives or goals, or for revisions to these goals. If our ESG-related data, processes and reporting are incomplete or inaccurate, or if we fail to achieve progress with respect to our ESG goals on a timely basis, or at all, our reputation and financial results could be adversely affected.Legal and Regulatory RisksGovernmental regulation may adversely affect the operation of our properties. In many jurisdictions, the hospitality industry is subject to extensive foreign or U.S. federal, state and local governmental regulations, including those relating to the service of alcoholic beverages, the preparation and sale of food and those relating to building and zoning requirements. We are also subject to licensing and regulation by foreign or U.S. state and local departments relating to health, sanitation, fire and safety standards, and to laws governing our relationships with employees, including minimum wage requirements, overtime, working conditions status and citizenship requirements. These requirements are complex and subject to frequent revision, with changes at the U.S. federal level often accompanying new U.S. presidential administrations. We or our third-party owners may be required to expend funds to meet foreign or U.S. federal, state and local regulations in connection with the construction, continued operation or remodeling of certain of our properties. The failure to meet the requirements of applicable regulations and licensing requirements, or publicity resulting from actual or alleged failures, could have an adverse effect on our results of operations. For instance, in 2010, we entered into a settlement with the U.S. Department of Justice related to compliance with the Americans with Disabilities Act ("ADA"). Although the bulk of our obligations under this settlement expired in 2015, certain managed and franchised hotels remain under an obligation to remove architectural barriers at their facilities. We have an obligation to have an independent consultant to monitor those barrier removal efforts. If we fail to comply with any of the requirements of the ADA, we could be subject to fines, penalties, injunctive action, reputational harm, guest, advocacy group or employee lawsuits, and other business effects that could materially and negatively affect our performance and results of operations.Changes in U.S. federal, state and local or foreign tax law, interpretations of existing tax law or adverse determinations by tax authorities, could increase our tax burden or otherwise adversely affect our financial condition or results of operations. We are subject to taxation at the federal, state or provincial and local levels in the U.S. and various other countries and jurisdictions. Our future effective tax rate could be affected by changes in the composition of earnings in jurisdictions with differing tax rates, changes in statutory rates and other legislative changes, changes in the valuation of our deferred tax assets and liabilities, or changes in determinations regarding the jurisdictions in which we are subject to tax. From time to time, the U.S. federal, state and local and foreign governments make substantive changes to tax rules and their application, which could result in materially higher corporate taxes than would be incurred under existing tax law and could adversely affect our financial condition or results of operations. We are subject to ongoing and periodic tax audits and disputes in U.S. federal and various state, local and foreign jurisdictions. In particular, our consolidated U.S. federal income tax returns for the fiscal years ended December 31, 2011 through December 31, 2018 are actively under audit by the Internal Revenue Service ("IRS"). The IRS previously proposed material increases to our income tax liability related to our Hilton Honors guest loyalty program through the tax year ended December 31, 2013, which we resolved through a settlement. The taxation of the Hilton Honors program continues to be subject to audit. We may in the future be assessed tax on issues similar to those which were resolved through the 2013 tax year, and the amounts of any such future assessments may be material. An unfavorable outcome from any tax audit could result in higher tax costs, penalties and interest, thereby adversely affecting our financial condition or results of operations. 35Foreign or U.S. environmental laws and regulations may cause us to incur substantial costs or subject us to potential liabilities. We are subject to certain compliance costs and potential liabilities under various foreign and U.S. federal, state and local environmental, health and safety laws and regulations. These laws and regulations govern actions including air emissions, the use, storage and disposal of hazardous and toxic substances and wastewater disposal. Our failure to comply with such laws, including obtaining and maintaining any required permits or licenses, could result in substantial fines or possible revocation of our authority to conduct some of our operations. We could also be liable under such laws for the costs of investigation, removal or remediation of hazardous or toxic substances at our currently or formerly owned, leased or operated real property (including managed and franchised properties) or at third-party locations in connection with our waste disposal operations, regardless of whether or not we knew of, or caused, the presence or release of such substances. From time to time, we may be required to remediate such substances or remove, abate or manage asbestos, mold, radon gas, lead or other hazardous conditions at our properties. The presence or release of such toxic or hazardous substances could result in third-party claims for personal injury, property or natural resource damages, business interruption or other losses. Such claims and the need to investigate, remediate or otherwise address hazardous, toxic or unsafe conditions could adversely affect our operations, the value of any affected real property, or our ability to sell, lease or assign our rights in any such property, or could otherwise harm our business or reputation. Environmental, health and safety requirements have also become increasingly stringent, and our costs to comply with such requirements may increase as a result. New or revised laws and regulations or new interpretations of existing laws and regulations, such as those intended to lessen the impact of climate change, could affect the operation of our properties or result in significant additional expense and operating restrictions on us. Risks Related to Our Spin-offs The spin-offs could result in substantial tax liability to us and our stockholders.We received a private letter ruling from the IRS on certain issues relevant to qualification of the spin-offs as tax-free distributions under Section 355 of the Internal Revenue Code of 1986, as amended (the "Code"). Although the private letter ruling generally is binding on the IRS, the continued validity of the private letter ruling will be based upon and subject to the accuracy of factual statements and representations made to the IRS by us. Further, the private letter ruling is limited to specified aspects of the spin-offs under Section 355 of the Code and does not represent a determination by the IRS that all of the requirements necessary to obtain tax-free treatment to holders of our common stock and to us have been satisfied. Moreover, if any statement or representation upon which the private letter ruling was based was incorrect or untrue in any material respect, or if the facts upon which the private letter ruling was based were materially different from the facts that prevailed at the time of the spin-offs, the private letter ruling could be invalidated. The opinion of tax counsel we received in connection with the spin-offs regarding the qualification of the spin-offs as tax-free distributions under Section 355 of the Code similarly relied on, among other things, the continuing validity of the private letter ruling and various assumptions and representations as to factual matters made by each of the spun-off companies and us which, if inaccurate or incomplete in any material respect, would jeopardize the conclusions reached by counsel in its opinion. The opinion is not binding on the IRS or the courts, and there can be no assurance that the IRS or the courts will not challenge the conclusions stated in the opinion or that any such challenge would not prevail. Additionally, recently enacted legislation denies tax-free treatment to a spin-off in which either the distributing corporation or the spun-off corporation is a REIT and prevents a distributing corporation or a spun-off corporation from electing REIT status for a 10-year period following a tax-free spin-off. Under an effective date provision, the legislation does not apply to distributions described in a ruling request initially submitted to the IRS before December 7, 2015. Because our initial request for the private letter ruling was submitted before that date and because we believe the distribution has been described in that initial request, we believe the legislation does not apply to the spin-off of Park. However, no ruling was obtained on that issue and thus no assurance can be given in that regard. In particular, the IRS or a court could disagree with our view regarding the effective date provision based on any differences that exist between the description in the ruling request and the actual facts relating to the spin-offs. If the legislation applied to the spin-off of Park, either the spin-off would not qualify for tax-free treatment or Park would not be eligible to elect REIT status for a 10-year period following the spin-off.If the spin-offs and certain related transactions were determined to be taxable, the Company would be subject to a substantial tax liability that would have a material adverse effect on our financial condition, results of operations and cash flows. In addition, if the spin-offs were taxable, each holder of our common stock who received shares of Park and HGV would generally be treated as receiving a taxable distribution of property in an amount equal to the fair market value of the shares received.36Park or HGV may fail to perform under various transaction agreements that we executed as part of the spin-offs.In connection with the spin-offs, we, Park and HGV entered into a distribution agreement and various other agreements, including a tax matters agreement, and, as to Park, management agreements, and, as to HGV, a license agreement. We are relying on Park and HGV to satisfy their performance and payment obligations under these agreements. In addition, it is possible that a court would disregard the allocation agreed to between us, Park and HGV and require that we assume responsibility for certain obligations allocated to Park and to HGV, particularly if Park or HGV were to refuse or were unable to pay or perform such obligations. In connection with the spin-offs, each of Park and HGV indemnified us with respect to such parties’ assumed or retained liabilities pursuant to the distribution agreement and breaches of the distribution agreement or other agreements related to the spin-offs. There can be no assurance that the indemnities from each of Park and HGV will be sufficient to protect us against the full amount of these and other liabilities. Third parties also could seek to hold us responsible for any of the liabilities that Park and HGV have agreed to assume. Even if we ultimately succeed in recovering from Park or HGV any amounts for which we are held liable, we may be temporarily required to bear those losses ourselves. Each of these risks could negatively affect our business, financial condition, results of operations and cash flows. In addition, we agreed to indemnify each of Park and HGV from certain liabilities. Indemnities that we may be required to provide Park and/or HGV may be significant and could negatively affect our business.Risks Related to Our Indebtedness Our substantial indebtedness and other contractual obligations could adversely affect our financial condition, our ability to raise additional capital to fund our operations, our ability to operate our business, our ability to react to changes in the economy or our industry and our ability to pay our debts, and could require us to divert our cash flows from operations to make required debt or interest payments. We have a significant amount of indebtedness. As of December 31, 2022, our total indebtedness, excluding the deduction for unamortized deferred financing costs and discount, was approximately $8.8 billion, and our contractual debt maturities of our long-term debt for the years ending December 31, 2023, 2024 and 2025 are $39 million, $33 million and $526 million, respectively. Our substantial debt and other contractual obligations could have important consequences, including: •requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures or dividends to stockholders and to pursue future business opportunities;•increasing our vulnerability to adverse economic, industry or competitive developments; •exposing us to increased interest expense, as our degree of leverage may cause the interest rates of any future indebtedness (whether fixed or floating rate interest) to be higher than they would be otherwise; •exposing us to the risk of increased interest rates because certain of our indebtedness is at variable rates of interest; •making it more difficult for us to satisfy our obligations with respect to our indebtedness, and any failure to comply with the obligations of any of our debt instruments, including restrictive covenants, could result in an event of default that accelerates our obligation to repay indebtedness; •restricting us from making strategic acquisitions or causing us to make non-strategic divestitures; •limiting our ability to obtain additional financing for working capital, capital expenditures, product development, satisfaction of existing debt service requirements, acquisitions and general corporate or other purposes; and •limiting our flexibility in planning for, or reacting to, changes in our business or market conditions and placing us at a competitive disadvantage compared to our competitors who may be better positioned to take advantage of opportunities that our leverage prevents us from exploiting. In December 2022, we amended the credit agreement that governs our senior secured credit facilities to reference the Secured Overnight Financing Rate ("SOFR") as the primary benchmark rate for our variable-rate indebtedness under this agreement in lieu of the London Interbank Offered Rate ("LIBOR"). SOFR is a relatively new reference rate with a limited history, and changes in SOFR have, on occasion, been more volatile than changes in other benchmark or market rates. As a result, the amount of interest we may pay on our variable-rate indebtedness may be difficult to predict.37We are a holding company, and substantially all of our consolidated assets are owned by, and most of our business is conducted through, our subsidiaries. Revenues from these subsidiaries are our primary source of funds for debt payments and operating expenses. If our subsidiaries are restricted from making distributions to us, that may impair our ability to meet our debt service obligations or otherwise fund our operations. Moreover, there may be restrictions on payments by subsidiaries to their parent companies under applicable laws, including laws that require companies to maintain minimum amounts of capital and to make payments to stockholders only from profits. As a result, although a subsidiary of ours may have cash, we may not be able to obtain that cash to satisfy our obligation to service our outstanding debt or fund our operations. Servicing our indebtedness will require a significant amount of cash. Our ability to generate sufficient cash depends on many factors, some of which are not within our control. Our ability to make payments on our indebtedness, to fund planned capital expenditures, to pay future dividends, if any, to our stockholders and repurchase our common stock will depend on our ability to generate cash in the future. To a certain extent, this is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If we are unable to generate sufficient cash flow to service our debt and meet our other commitments, we may need to restructure or refinance all or a portion of our debt, sell material assets or operations or raise additional debt or equity capital. We may not be able to effect any of these actions on a timely basis, on commercially reasonable terms or at all, and these actions may not be sufficient to meet our capital requirements. In addition, the terms of our existing or future debt arrangements may restrict us from effecting any of these alternatives. Certain of our debt agreements impose significant operating and financial restrictions on us and our subsidiaries, which may prevent us from capitalizing on business opportunities. The indentures that govern our senior notes and the credit agreement that governs our senior secured credit facilities impose significant operating and financial restrictions on us. These restrictions limit our ability and/or the ability of our subsidiaries to, among other things: •incur or guarantee additional debt or issue disqualified stock or preferred stock; •pay dividends, including our subsidiaries paying dividends to us, and make other distributions on, or redeem or repurchase, capital stock; •make certain investments; •incur certain liens; •enter into transactions with affiliates; •merge or consolidate; •enter into agreements that restrict the ability of restricted subsidiaries to make dividends or other payments to us; •designate restricted subsidiaries as unrestricted subsidiaries; and •transfer or sell assets. In addition, the credit agreement requires us to maintain a consolidated secured net leverage ratio not to exceed 5.0 to 1.0 as of the last day of any period of four consecutive quarters. As a result of these restrictions, we are limited as to how we conduct our business and we may be unable to raise additional debt or equity financing to compete effectively or to take advantage of new business opportunities. The terms of any future indebtedness we may incur could include more restrictive covenants. We may not be able to maintain compliance with these covenants in the future and, if we fail to do so, we may not be able to obtain waivers from the lenders and/or amend the covenants. Our failure to comply with the restrictive covenants described above, as well as other terms of our other indebtedness and/or the terms of any future indebtedness from time to time, could result in an event of default, which, if not cured or waived, could result in our being required to repay these borrowings before their due date. If we are forced to refinance these 38borrowings on less favorable terms or are unable to refinance these borrowings, our results of operations and financial condition could be adversely affected. Despite our current level of indebtedness, we may be able to incur substantially more debt and enter into other transactions, which could further exacerbate the risks to our financial condition described above. We may be able to incur significant additional indebtedness, including secured debt, in the future. Although the credit agreements and indentures that govern substantially all of our indebtedness contain restrictions on the incurrence of additional indebtedness and entering into certain types of other transactions, these restrictions are subject to a number of qualifications and exceptions. Additional indebtedness incurred in compliance with these restrictions could be substantial. These restrictions also do not prevent us from incurring obligations, such as trade payables, that do not constitute indebtedness as defined under our debt instruments. To the extent new debt is added to our current debt levels, the substantial leverage risks described in the preceding three risk factors would increase. Risks Related to Ownership of Our Common Stock Although we currently pay a quarterly cash dividend to holders of our common stock, we may change our dividend policy at any time. Our dividend policy may change at any time without notice to our stockholders. As a result of the COVID-19 pandemic, we suspended payment of our quarterly cash dividend to holders of our common stock beginning in 2020, but resumed our quarterly dividend payments in June 2022. The declaration and payment of any future dividends is at the discretion of our board of directors in accordance with applicable law after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs, limitations imposed by our indebtedness, legal requirements and other factors that our board of directors deems relevant. If we were to cease dividend payments, you may not receive any return on an investment in our common stock unless you sell your common stock for a price greater than that which you paid for it. Anti-takeover provisions in our organizational documents and Delaware law might discourage or delay acquisition attempts for us that one might consider favorable. Our amended and restated certificate of incorporation and amended and restated by-laws contain provisions that may make the merger or acquisition of our company more difficult without the approval of our board of directors. Among other things: •although we do not have a stockholder rights plan, and would either submit any such plan to stockholders for ratification or cause such plan to expire within a year, these provisions would allow us to authorize the issuance of undesignated preferred stock in connection with a stockholder rights plan or otherwise, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend or other rights or preferences superior to the rights of the holders of common stock; •these provisions prohibit stockholder action by written consent unless such action is recommended by all directors then in office; •these provisions provide that our board of directors is expressly authorized to make, alter or repeal our by-laws and that our stockholders may only amend our by-laws with the approval of 80 percent or more of all the outstanding shares of our capital stock entitled to vote; and•these provisions establish advance notice requirements for nominations for elections to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings.Further, as a Delaware corporation, we are subject to provisions of Delaware law, which may impair a takeover attempt that our stockholders may find beneficial. These anti-takeover provisions and other provisions under Delaware law could discourage, delay or prevent a transaction involving a change in control of our company, including actions that our stockholders may deem advantageous, or negatively affect the trading price of our common stock. These provisions could also discourage proxy contests and make it more difficult for our stockholders to elect directors of their choosing and to cause us to take other corporate actions they desire.39Item 1B. Unresolved Staff CommentsNone.40Item 2. PropertiesHotel PropertiesJoint Venture HotelsAs of December 31, 2022, we had a minority or noncontrolling financial interest in the entities that own or lease the following 5 properties, representing 2,244 rooms, and we manage each of the hotels for these entities. We have a right of first refusal to purchase additional equity interests in certain of these joint ventures. PropertyLocationOwnership PercentageRoomsConrad Hotels & ResortsConrad CairoCairo, Egypt10%614Hilton Hotels & ResortsHilton Tokyo BayUrayasu-shi, Japan24%828Hilton NagoyaNagoya, Japan24%460Hilton Mauritius Resort & SpaFlic-en-Flac, Mauritius20%193Hilton Imperial DubrovnikDubrovnik, Croatia18%149Leased HotelsAs of December 31, 2022, we leased the following 47 hotels, representing 15,368 rooms.PropertyLocationRoomsWaldorf Astoria Hotels & ResortsRome Cavalieri, Waldorf Astoria Hotels & ResortsRome, Italy370Waldorf Astoria AmsterdamAmsterdam, Netherlands93Conrad Hotels & ResortsConrad OsakaOsaka, Japan164Hilton Hotels & ResortsHilton Tokyo(1)(Shinjuku-ku) Tokyo, Japan830Ramses HiltonCairo, Egypt811Hilton ViennaVienna, Austria663Hilton London KensingtonLondon, United Kingdom601Hilton Osaka(1)Osaka, Japan562Hilton Tel AvivTel Aviv, Israel560Hilton Istanbul BosphorusIstanbul, Turkiye500Hilton Munich ParkMunich, Germany484Hilton Munich CityMunich, Germany483London Hilton on Park LaneLondon, United Kingdom453Hilton Diagonal Mar BarcelonaBarcelona, Spain433Hilton MainzMainz, Germany431Hilton Trinidad & Conference CentrePort of Spain, Trinidad405Hilton London Heathrow AirportLondon, United Kingdom398Hilton Addis AbabaAddis Ababa, Ethiopia372Hilton Vienna Danube WaterfrontVienna, Austria367Hilton FrankfurtFrankfurt, Germany342Hilton SandtonSandton, South Africa329Hilton GlasgowGlasgow, United Kingdom322Hilton MilanMilan, Italy320Hilton BrisbaneBrisbane, Australia319The Waldorf Hilton, LondonLondon, United Kingdom298Hilton CologneCologne, Germany296(continued on next page)41PropertyLocationRoomsHilton Stockholm SlussenStockholm, Sweden289Hilton Madrid AirportMadrid, Spain284Hilton London Canary WharfLondon, United Kingdom282Hilton AmsterdamAmsterdam, Netherlands271Hilton Newcastle GatesheadNewcastle Upon Tyne, United Kingdom254Hilton Vienna PlazaVienna, Austria254Hilton London Tower BridgeLondon, United Kingdom248Hilton Antwerp Old TownAntwerp, Belgium210Hilton ReadingReading, United Kingdom210Hilton Leeds CityLeeds, United Kingdom208Hilton WatfordWatford, United Kingdom200Hilton NottinghamNottingham, United Kingdom176Hilton London CroydonCroydon, United Kingdom168Hilton CobhamCobham, United Kingdom158Hilton Paris La DefenseParis, France153Hilton East Midlands AirportDerby, United Kingdom152Hilton NorthamptonNorthampton, United Kingdom139Hilton London Hyde ParkLondon, United Kingdom136Hilton YorkYork, United Kingdom131Hilton Mainz CityMainz, Germany127Hilton Puckrup Hall, TewkesburyTewkesbury, United Kingdom112____________(1)We own a controlling financial interest, but less than a 100 percent interest, in the entity that leases the property. Corporate Headquarters and Regional OfficesOur corporate headquarters is located at 7930 Jones Branch Drive, McLean, Virginia 22102, which is under a lease agreement that expires in April 2037. We also own or lease corporate offices or centralized operations centers in Memphis, Tennessee; Glasgow, Scotland (Europe); Watford, England (Europe); Dubai, United Arab Emirates (Middle East and Africa); Singapore (Asia Pacific); Tokyo, Japan; Shanghai, China; and Mexico City, Mexico. Additionally, we have support operations and other commercial services at a leased office in Addison, Texas. We believe that our existing office properties are in good condition and are sufficient and suitable for the conduct of our business. In the event we need to expand our operations, or upon expiration of our current leases, we believe that suitable space will be available on commercially reasonable terms. Item 3. Legal ProceedingsWe are involved in various claims and lawsuits arising in the ordinary course of business, some of which include claims for substantial sums, including proceedings involving tort and other general liability claims, employee claims, consumer protection claims and claims related to our management of certain hotels. We recognize a liability when we believe the loss is probable and can be reasonably estimated. Most occurrences involving liability, claims of negligence and employees are covered by policies that we hold with solvent insurance carriers. The ultimate results of claims and litigation cannot be predicted with certainty. We believe we have adequate reserves against such matters. We currently believe that the ultimate outcome of such lawsuits and proceedings will not, individually or in the aggregate, have a material adverse effect on our consolidated financial position, results of operations or cash flows. However, depending on the amount and timing, an unfavorable resolution of some or all of these matters could materially affect our future results of operations in a particular period. Item 4. Mine Safety DisclosuresNot applicable.42PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of EquitySecuritiesMarket Information and DividendsOur common stock is listed for trading on the NYSE under the symbol "HLT." As of December 31, 2022, there were seven holders of record of our common stock, which does not include a substantially greater number of beneficial holders whose shares are held of record by banks, brokers and other financial institutions.In June 2022, we resumed payment of our regular quarterly cash dividends, which we had suspended in 2020 as a result of the COVID-19 pandemic, and we expect to continue paying regular cash dividends on a quarterly basis. Any decision to declare and pay dividends in the future will be made at the sole discretion of our board of directors, whose decision will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions and other factors that our board of directors may deem relevant. Because we are a holding company and have no direct operations, we will only be able to pay dividends from funds we receive from our subsidiaries.Performance GraphThe following graph compares Hilton's cumulative total stockholder return since December 31, 2017 with the Standard and Poor's ("S&P") 500 Index ("S&P 500") and the S&P Hotels, Resorts & Cruise Lines Index ("S&P Hotel"). The graph assumes that the value of the investment in our common stock and each index was $100 on December 31, 2017 and that all dividends and other distributions were reinvested. The comparisons in the graph below are based on historical data and are not indicative of, or intended to forecast, future performance of our common stock.12/31/201712/31/201812/31/201912/31/202012/31/202112/31/2022Hilton$100.00 $90.61 $140.84 $141.59 $198.51 $161.40 S&P 500100.00 93.76 120.84 140.49 178.27 143.61 S&P Hotel100.00 80.63 108.59 80.08 95.97 72.56 Recent Sales of Unregistered SecuritiesNone.43Issuer Purchases of Equity Securities The following table sets forth information regarding our purchases of shares of our common stock during the three months ended December 31, 2022:Total Number of Shares PurchasedAverage Price Paid per Share(1)Total Number of Shares Purchased as Part of Publicly Announced Program(2)Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program(2) (in millions)October 1, 2022 to October 31, 20221,253,085 $125.71 1,253,085 $972 November 1, 2022 to November 30, 20221,157,159 136.13 1,157,159 3,314 December 1, 2022 to December 31, 20221,404,298 132.47 1,404,298 3,128 Total3,814,542 131.36 3,814,542 ____________(1)Includes commissions paid.(2)In November 2022, our board of directors authorized the repurchase of an additional $2.5 billion of our common stock under our stock repurchase program, which was initially announced in February 2017 and subsequently increased in November 2017, February 2019 and March 2020. As such, our stock repurchase program allows for the repurchase of up to a total of $8 billion of our common stock. Under this publicly announced program, we are authorized to repurchase shares through open market purchases, privately-negotiated transactions or otherwise in accordance with applicable federal securities laws, including through Rule 10b5-1 trading plans and under Rule 10b-18 of the Exchange Act. The repurchase program does not have an expiration date and may be suspended or discontinued at any time.Item 6. [Reserved]44Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. For the discussion of the financial condition and results of operations for the year ended December 31, 2021 compared to the year ended December 31, 2020, refer to "Part II—Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 filed with the SEC on February 16, 2022, which is incorporated herein by reference.COVID-19 PandemicThe COVID-19 pandemic significantly affected the global economy and strained the hospitality industry beginning in 2020. Since the beginning of the pandemic, the pervasiveness and severity of travel restrictions and stay-at-home directives have varied by country and state; however, as of December 31, 2022, most of the countries we operate in had eased or completely lifted such restrictions. While the pandemic negatively affected certain of our results for the years ended December 31, 2022 and 2021, we have experienced strong signs of recovery since early 2021, with comparable system-wide RevPAR in the third and fourth quarters of 2022 exceeding levels achieved in the same periods in 2019. Although all periods included in our consolidated financial statements presented in this Form 10-K were impacted by the COVID-19 pandemic, none of these periods are considered comparable, and no periods affected by the pandemic are expected to be comparable to future periods. OverviewOur BusinessHilton is one of the largest hospitality companies in the world, with 7,165 properties comprising 1,127,430 rooms in 123 countries and territories as of December 31, 2022. Our premier brand portfolio includes: our luxury hotel brands, Waldorf Astoria Hotels & Resorts, LXR Hotels & Resorts and Conrad Hotels & Resorts; our lifestyle hotel brands, Canopy by Hilton, Curio Collection by Hilton, Tapestry Collection by Hilton, Tempo by Hilton and Motto by Hilton; our full service hotel brands, Signia by Hilton, Hilton Hotels & Resorts and DoubleTree by Hilton; our focused service hotel brands, Hilton Garden Inn, Hampton by Hilton and Tru by Hilton; our all-suites hotel brands, Embassy Suites by Hilton, Homewood Suites by Hilton and Home2 Suites by Hilton; our new premium economy brand, Spark by Hilton, launched in January 2023; and our timeshare brand, Hilton Grand Vacations. As of December 31, 2022, we had 152 million members in our award-winning guest loyalty program, Hilton Honors, a 19 percent increase from December 31, 2021. Segments and RegionsWe analyze our operations and business by both operating segments and geographic regions. Our operations consist of two reportable segments that are based on similar products and services: (i) management and franchise; and (ii) ownership. The management and franchise segment provides services, including hotel management and licensing of our IP. Revenues from this segment include: (i) management and franchise fees charged to third-party hotel owners; (ii) licensing fees from our strategic partners, including co-branded credit card providers, and HGV for the right to use our IP; and (iii) fees for managing hotels in our ownership segment. As a manager of hotels, we typically are responsible for supervising or operating the hotel in exchange for management fees. As a franchisor of hotels, we charge franchise fees in exchange for the use of one of our brand names and related commercial services, such as our reservation system, marketing and information technology services, while a third party manages or operates such franchised hotels. The ownership segment primarily derives revenues from nightly hotel room sales, food and beverage sales and other services at our consolidated owned and leased hotels. Geographically, we conduct business through three distinct geographic regions: (i) the Americas; (ii) EMEA; and (iii) Asia Pacific. The Americas region includes North America, South America and Central America, including all Caribbean nations. Although the U.S., which represented 69 percent of our system-wide hotel rooms as of December 31, 2022, is included in the Americas region, it is often analyzed separately and apart from the Americas region and, as such, it is presented separately within the analysis herein. The EMEA region includes Europe, which represents the western-most peninsula of Eurasia stretching from Iceland in the west to Russia in the east, and the Middle East and Africa ("MEA"), which represents the Middle East region and all African nations, including the Indian Ocean island nations. Europe and MEA are often analyzed separately and, as such, are presented separately within the analysis herein. The Asia Pacific region includes the eastern and southeastern nations of Asia, as well as India, Australia, New Zealand and the Pacific Island nations.45System Growth and Development PipelineOur strategic objectives include the continued expansion of our global hotel network, as well as of our fee-based business. As we enter into new management and franchise contracts, we expand our business with limited or no capital investment by us as the manager or franchisor, since the capital required to build and maintain hotels is typically provided by the third-party owner of the hotel with whom we contract to provide management services or license our IP. Prior to approving the addition of new hotels to our management and franchise development pipeline, we evaluate the economic viability of the hotel based on its geographic location, the credit quality of the third-party owner and other factors. By increasing the number of management and franchise contracts with third-party owners, over time we expect to increase revenues, overall return on invested capital and cash available to support our business needs. See further discussion on our cash management policy, as detailed in "—Liquidity and Capital Resources." While these objectives have not changed as a result of the COVID-19 pandemic, the current economic environment has posed certain challenges to the execution of our growth strategy, which have included and may continue to include delays in openings and new development.In addition to our current hotel portfolio, we are focused on the growth of our business by expanding our global hotel network through our development pipeline, which represents hotels that we expect to add to our system in the future. The following table summarizes our development activity:As of or for the Year Ended December 31, 2022HotelsRooms(1)Hotel systemOpenings355 58,200 Net additions(2)308 48,300 Development pipeline(3)Additions664 89,900 Count as of period end(4)2,821 416,400 ____________(1)Rounded to the nearest hundred.(2)Represents room additions, net of rooms removed from our system, during the period, which contributed to net unit growth for the year ended December 31, 2022 of 4.7 percent.(3)Hotels in our system were under development throughout 118 countries and territories, including 30 countries and territories where we did not currently have any existing hotels.(4)In our development pipeline, as of December 31, 2022, 205,400 of the rooms were under construction and 243,500 of the rooms were located outside of the U.S. Nearly all of the rooms in our development pipeline will be in our management and franchise segment. We do not consider any individual development project to be material to us.Principal Components and Factors Affecting our Results of OperationsRevenuesPrincipal ComponentsWe primarily derive our revenues from the following sources:•Franchise and licensing fees. Represents fees earned in connection with the licensing of one of our brands, as well as fees from licensing agreements to use our IP. Under our long-term franchise contracts with hotel owners, franchisees typically pay us franchise fees that include: (i) monthly royalty fees, generally based on a percentage of the hotel's monthly gross room revenue, and, in some cases, may also include a percentage of gross food and beverage revenues and other revenues, as applicable; and (ii) application, initiation and other fees for when new hotels enter the system, when there is a change of ownership of a hotel or when contracts with properties already in our system are extended. Consideration provided to incentivize hotel owners to enter into franchise contracts with us is amortized over the life of the applicable contract as a reduction to franchise and licensing fees. Our non-hotel licensing agreements, for which we receive licensing fees, are predominantly with strategic partners, including co-branded credit card providers, and HGV. •Base and incentive management fees. Represents fees earned in connection with the management of hotels. Terms of our management contracts vary, but our fees generally consist of a base fee, which is typically based on a percentage 46of the hotel's monthly gross revenue and, when applicable, an incentive fee, which is typically based on a percentage of the hotel's operating profits, normally over a one-calendar year period, and, in some cases, may be subject to a stated return threshold to the hotel owner. Outside of the U.S., our fees are often more dependent on hotel profitability measures, either because of a single management fee structure where the entire fee is an incentive fee, or because our two-tier fee structure is more heavily weighted toward the incentive fee than the base fee. Consideration provided to incentivize hotel owners to enter into management contracts with us is amortized over the life of the applicable contract as a reduction to base and other management fees.•Owned and leased hotels. Represents revenues derived from the operations of our consolidated owned and leased hotels, including hotel room sales, accommodations sold in conjunction with other services, food and beverage sales and other ancillary goods and services. These revenues are primarily derived from two categories of customers: transient and group. Transient guests are individual travelers who are traveling for business or leisure. Group guests are traveling for group events that reserve rooms for meetings, conferences or social functions, which may be sponsored by corporate, social, military, educational, religious or other organizations or associations. Group business usually includes a block of room accommodations, as well as other ancillary services, such as meetings facilities and catering and banquet services. A majority of our food and beverage sales and other ancillary goods and services are provided to customers who are also occupying rooms at our hotels. As a result, occupancy affects all components of our owned and leased hotels revenues.•Other revenues. Represents revenues generated by the incidental support of hotel operations for owned, leased, managed and franchised hotels, including our purchasing operations, and other operating income.•Other revenues from managed and franchised properties. Represents amounts that are contractually reimbursed to us by hotel owners, either directly as costs are incurred or indirectly through monthly program fees related to certain costs and expenses supporting the operations of the related properties. The direct reimbursements by hotel owners are primarily for payroll and related costs if the property employees are legally employed by us and certain other operating costs of the managed properties' operations. We have no legal responsibility for the employees or the liabilities associated with operating franchised properties or certain of our managed properties, predominately those located outside of the U.S. Revenues and expenses for these direct reimbursements have no net effect on operating income (loss) or net income (loss). The monthly program fee that is paid by hotel franchisees and property owners of hotels that we manage is based on the underlying hotel's sales or usage, as reimbursement for the costs related to our: (i) advertising and marketing programs; (ii) internet, technology and reservation systems; and (iii) quality assurance programs. Other revenues from managed and franchised properties also includes revenues related to our Hilton Honors guest loyalty program, which are primarily derived from payments from hotel franchisees and third-party owners of hotels we manage that participate in the program, as well as co-branded credit card providers. We are contractually required to use these fees that we collect solely for these programs.Factors Affecting our RevenuesThe following factors affect the revenues we derive from our operations:•Consumer demand and global economic conditions. Consumer demand for our products and services, as well as the products and services of the third parties from which we earn licensing fees, is closely linked to the performance of the general economy and is sensitive to business and personal discretionary spending levels. Among other factors, declines in consumer demand due to adverse general economic conditions, risks reducing or otherwise negatively affecting travel patterns, lower consumer confidence and adverse political conditions can reduce the amount of management and franchise fee revenues we are able to generate and/or reduce the revenues and profitability of the operations of our owned and leased hotels. Further, competition for hotel guests and the supply of hotel services affect our ability to sustain or increase rates charged to customers of our hotels. As a result of the COVID-19 pandemic, several of these factors, as well as health and safety concerns, had a significant effect on global economic conditions and consumer demand for our products and services; however, we have experienced significant recovery in demand during 2022. Also, declines in hotel profitability during an economic downturn directly affect the incentive portion of our management fees, which is based on hotel profitability measures. As a result, changes in consumer demand and general business cycles have historically subjected, are currently subjecting and could in the future subject our revenues to significant volatility.•Contracts with third-party hotel owners and franchisees and relationships with developers. We depend on our long-term management and franchise contracts with third-party hotel owners and hotel franchisees for our management and 47franchise fee revenues. The success and sustainability of our management and franchise business depends on our ability to perform under our management and franchise contracts and maintain good relationships with third-party hotel owners and franchisees. Our relationships with these third parties allow us to maintain our current presence as contracts mature and also generate new incremental opportunities for property development that can support our growth. Growth and maintenance of our hotel system and earning fees related to hotels in development are dependent on the ability of developers and owners to access capital for the development, maintenance and renovation of properties. We believe that we generally have good relationships with our third-party hotel owners, franchisees and developers and are committed to the continued growth and development of these relationships. These relationships exist with a diverse group of owners, franchisees and developers and are not significantly concentrated with any one particular third party. ExpensesPrincipal ComponentsWe primarily incur the following expenses:•Owned and leased hotels. Reflects the operating expenses of our consolidated owned and leased hotels, including room expenses, food and beverage costs, other support costs and property expenses. Room expenses include compensation costs for housekeeping, laundry and front desk staff, as well as supply costs for guest room amenities and laundry. Food and beverage costs include costs for wait and kitchen staff and food and beverage inventory. Other support expenses include: costs associated with property-level management; utilities; sales and marketing; operating hotel spas; operating telephones, parking and other guest recreation; entertainment; and other services. Property expenses include property taxes, repairs and maintenance, rent and insurance.•Depreciation and amortization. These are non-cash expenses that primarily consist of: (i) amortization of intangible assets that were recorded at their fair value at the time of the 2007 transaction whereby we became a wholly owned subsidiary of affiliates of Blackstone Inc. (the "Merger"), which primarily include values assigned to management contracts, leases and our Hilton Honors guest loyalty program intangible asset; (ii) amortization of capitalized software costs; and (iii) depreciation and amortization of property and equipment, including our finance lease right-of-use ("ROU") assets, such as buildings and furniture and equipment that are used in corporate operations or at our consolidated owned and leased hotels.•General and administrative. Consists primarily of compensation costs for our corporate employees, including share-based compensation; professional fees, including consulting, audit and legal fees; travel and entertainment expenses; bad debt expenses for uncollectible management, franchise and other fees; and administrative and related expenses. •Other expenses. Consists of expenses incurred by our purchasing operations and other ancillary businesses, along with other operating expenses of the business. •Other expenses from managed and franchised properties. Represents certain costs and expenses that are contractually reimbursed to us by hotel owners for payroll and related costs for properties that we manage where the property employees are legally employed by us, or paid from program fees collected from properties for certain other operating costs of the managed properties' operations, including those related to our brands and shared services programs. We are contractually required to use these fees solely for these programs. We have no legal responsibility for the employees or the liabilities associated with operating franchised properties or certain of our managed hotels, predominately those located outside of the U.S. Other expenses from managed and franchised properties also includes expenses for the operation of our Hilton Honors guest loyalty program. Factors Affecting our Costs and ExpensesThe following are principal factors that affect the costs and expenses we incur in the course of our operations: •Fixed expenses. Many of the expenses associated with owning and leasing hotels are relatively fixed. These expenses include personnel costs, rent, property taxes, insurance and utilities. If we are unable to decrease these costs significantly or rapidly when demand for our hotels decreases, the resulting decline in our revenues can have an adverse effect on our net cash flows, margins and profits. This effect can be especially pronounced during periods of economic contraction or slow economic growth, including that which resulted from the COVID-19 pandemic. 48Economic downturns generally affect the results of our ownership segment more significantly than the results of our management and franchise segment due to the high fixed costs associated with operating an owned or leased hotel. Employees at some of our owned and leased hotels are parties to collective bargaining agreements that may also limit our ability to make timely staffing or labor changes in response to declining revenues. In addition, any efforts to reduce costs, including the deferral or cancellation of capital improvements, could adversely affect the economic value of our hotels and brands. Additionally, the general and administrative expenses of operating a global business also include fixed personnel costs, rent, property taxes, insurance and utilities. The effectiveness of any cost-cutting efforts related to owning and leasing hotels or corporate operations is limited by the amount of inherent fixed costs. However, we have taken steps to reduce our fixed costs to levels we believe are appropriate to maximize profitability and respond to expected future market conditions, while continuing to optimize value for the experiences of our customers, owners and Hilton employees, supporting the long-term sustainability of our brands and business. •Changes in depreciation and amortization expenses. We capitalize costs associated with certain software development projects and, as those projects are completed and placed into service, amortization expense will increase. As the finite-lived intangible assets that were recorded at the Merger become fully amortized, amortization expense will decrease. Additionally, changes in depreciation expense may be driven by renovations of existing hotels, acquisition or development of new hotels, the disposition of existing hotels or corporate facilities through sale, closure or lease termination, lease renewals, expenditures related to our corporate facilities or changes in estimates of the useful lives of our assets. As we place new assets into service, we will be required to recognize additional depreciation expense on those assets. If we are required to recognize impairment losses related to our depreciable assets or finite-lived intangible assets, the related depreciation or amortization expense, respectively, will decrease. Other ItemsEffect of foreign currency exchange rate fluctuationsSignificant portions of our operations are conducted in functional currencies other than our reporting currency, which is USD, and we have assets and liabilities, including those that are payable or receivable by consolidated subsidiaries, denominated in a variety of foreign currencies. As a result, we are required to translate the results of those operations, assets and liabilities from their functional currency into USD at market-based foreign currency exchange rates for each reporting period. When comparing our results of operations between periods, there may be material portions of the changes in our revenues or expenses that are derived from fluctuations in foreign currency exchange rates experienced between those periods. We hedge foreign currency exchange-based cash flow variability of certain of our fees using forward contracts designated as hedging instruments. We also hold short-term forward contracts to offset exposure to fluctuations in certain of our foreign currency denominated cash balances and intercompany financing arrangements, and we have not currently elected to designate these forward contracts as hedging instruments.SeasonalityThe hospitality industry is seasonal in nature. The periods during which our properties experience higher or lower levels of demand vary from property to property, depending principally upon their location, type of property and competitive mix within the specific location. While results were less predictable as a result of COVID-19 and related travel restrictions, based on historical results, we generally expect our revenues to be lower in the first quarter of each year than in each of the three subsequent quarters.Key Business and Financial Metrics Used by ManagementComparable HotelsWe define our comparable hotels as those that: (i) were active and operating in our system for at least one full calendar year as of the end of the current period, and open January 1st of the previous year; (ii) have not undergone a change in brand or ownership type during the current or comparable periods reported; and (iii) have not sustained substantial property damage, business interruption, undergone large-scale capital projects or for which comparable results were not available. Of the 7,085 hotels in our system as of December 31, 2022, 5,797 hotels were classified as comparable hotels. Our 1,288 non-comparable hotels included 272 hotels, or less than four percent of the total hotels in our system, that were removed from the comparable group during the last twelve months because they sustained substantial property damage, business interruption, underwent large-scale capital projects or comparable results were otherwise not available. 49When considering business interruption in the context of our definition of comparable hotels, no hotel that had completely or partially suspended operations on a temporary basis at any time as a result of the COVID-19 pandemic was excluded from the definition of comparable hotels on that basis alone. Despite these temporary suspensions of hotel operations, we believe that including these hotels within our hotel operating statistics of occupancy, average daily rate ("ADR") and revenue per available room ("RevPAR"), if they would have otherwise been included, reflects the underlying results of our business for the years ended December 31, 2022 and 2021.OccupancyOccupancy represents the total number of room nights sold divided by the total number of room nights available at a hotel or group of hotels for a given period. Occupancy measures the utilization of available capacity at a hotel or group of hotels. Management uses occupancy to gauge demand at a specific hotel or group of hotels in a given period. Occupancy levels also help management determine achievable ADR pricing levels as demand for hotel rooms increases or decreases.ADRADR represents hotel room revenue divided by the total number of room nights sold for a given period. ADR measures the average room price attained by a hotel, and ADR trends provide useful information concerning the pricing environment and the nature of the customer base of a hotel or group of hotels. ADR is a commonly used performance measure in the industry, and we use ADR to assess pricing levels that we are able to generate by type of customer, as changes in rates charged to customers have different effects on overall revenues and incremental profitability than changes in occupancy, as described above.RevPARRevPAR is calculated by dividing hotel room revenue by the total number of room nights available to guests for a given period. We consider RevPAR to be a meaningful indicator of our performance as it provides a metric correlated to two primary and key drivers of operations at a hotel or group of hotels, as previously described: occupancy and ADR. RevPAR is also a useful indicator in measuring performance over comparable periods for comparable hotels.References to occupancy, ADR and RevPAR are presented on a comparable basis, based on the comparable hotels as of December 31, 2022, and references to ADR and RevPAR are presented on a currency neutral basis, unless otherwise noted. As such, comparisons of these hotel operating statistics for the years ended December 31, 2022 and 2021 or 2019 use the foreign currency exchange rates used to translate the results of the Company's foreign operations within its consolidated financial statements for the year ended December 31, 2022.EBITDA and Adjusted EBITDAEBITDA reflects net income (loss), excluding interest expense, a provision for income tax benefit (expense) and depreciation and amortization expenses. Adjusted EBITDA is calculated as EBITDA, as previously defined, further adjusted to exclude certain items, including gains, losses, revenues and expenses in connection with: (i) asset dispositions for both consolidated and unconsolidated investments; (ii) foreign currency transactions; (iii) debt restructurings and retirements; (iv) furniture, fixtures and equipment ("FF&E") replacement reserves required under certain lease agreements; (v) share-based compensation; (vi) reorganization, severance, relocation and other expenses; (vii) non-cash impairment; (viii) amortization of contract acquisition costs; (ix) the net effect of reimbursable costs included in other revenues and other expenses from managed and franchised properties; and (x) other items.We believe that EBITDA and Adjusted EBITDA provide useful information to investors about us and our financial condition and results of operations for the following reasons: (i) these measures are among the measures used by our management team to evaluate our operating performance and make day-to-day operating decisions; and (ii) these measures are frequently used by securities analysts, investors and other interested parties as a common performance measure to compare results or estimate valuations across companies in our industry. Additionally, these measures exclude certain items that can vary widely across different industries and among competitors within our industry. For instance, interest expense and income taxes are dependent on company specifics, including, among other things, capital structure and operating jurisdictions, respectively, and, therefore, could vary significantly across companies. Depreciation and amortization expenses, as well as amortization of contract acquisition costs, are dependent upon company policies, including the method of acquiring and depreciating assets and the useful lives that are assigned to those depreciating or amortizing assets for accounting purposes. For Adjusted EBITDA, we also exclude items such as: (i) FF&E replacement reserves for leased hotels to be consistent with the treatment of capital expenditures for property and equipment, where depreciation of such capitalized assets is reported within depreciation and 50amortization expenses; (ii) share-based compensation, as this could vary widely among companies due to the different plans in place and the usage of them; (iii) the net effect of our cost reimbursement revenues and reimbursed expenses, as we contractually do not operate the related programs to generate a profit over the terms of the respective contracts; and (iv) other items, such as amounts related to debt restructurings and debt retirements and reorganization and related severance costs, that are not core to our operations and are not reflective of our operating performance.EBITDA and Adjusted EBITDA are not recognized terms under U.S. generally accepted accounting principles ("GAAP") and should not be considered as alternatives, either in isolation or as a substitute, for net income (loss) or other measures of financial performance or liquidity, including cash flows, derived in accordance with GAAP. Further, EBITDA and Adjusted EBITDA have limitations as analytical tools, including:•EBITDA and Adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs;•EBITDA and Adjusted EBITDA do not reflect our interest expense, or the cash requirements necessary to service interest or principal payments, on our indebtedness;•EBITDA and Adjusted EBITDA do not reflect income tax expenses or the cash requirements to pay our taxes;•EBITDA and Adjusted EBITDA do not reflect historical cash expenditures or future requirements for capital expenditures or contractual commitments;•EBITDA and Adjusted EBITDA do not reflect the effect on earnings or changes resulting from matters that we consider not to be indicative of our future operations;•although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements; and•other companies in our industry may calculate EBITDA and Adjusted EBITDA differently, limiting their usefulness as comparative measures.Because of these limitations, EBITDA and Adjusted EBITDA should not be considered as discretionary cash available to us to reinvest in the growth of our business or as measures of cash that will be available to us to meet our obligations. 51Results of OperationsThe hotel operating statistics by region for our system-wide comparable hotels were as follows:Year EndedChangeDecember 31, 20222022 vs. 2021U.S.Occupancy69.9 %8.8 %pts.ADR$157.4419.3 %RevPAR$110.0936.5 %Americas (excluding U.S.)Occupancy63.8 %20.6 %pts.ADR$138.5528.5 %RevPAR$88.4489.8 %EuropeOccupancy67.0 %25.6 %pts.ADR$147.0043.8 %RevPAR$98.51132.5 %MEAOccupancy66.6 %14.6 %pts.ADR$154.5721.7 %RevPAR$102.9956.0 %Asia PacificOccupancy53.2 %2.4 %pts.ADR$103.7313.8 %RevPAR$55.1719.1 %System-wideOccupancy67.5 %10.3 %pts.ADR$151.0120.6 %RevPAR$101.9042.5 %We experienced significant improvement in our results during the year ended December 31, 2022 with the continued recovery of the travel and hospitality industry from the COVID-19 pandemic and the rebound of cross-border international travel. On a regional basis, the Europe region had the most significant improvement when compared to 2021, with continental Europe leading the region with meaningful increases in both ADR and occupancy. Further, despite the impact of the limited demand in China due to prolonged travel restrictions, the remainder of the APAC region demonstrated a strong recovery, particularly during the second half of the year. Overall, leisure transient was the primary driver of improved performance during the year, but all customer segments, including business and group travel, contributed to our recovery.On a system-wide basis, our recovery was particularly strong during the second half of 2022, driven by an upward trend in both ADR and occupancy. The third quarter of 2022 was the first period since the beginning of the pandemic that system-wide RevPAR on a comparable and currency neutral basis exceeded system-wide RevPAR for the same period in 2019, and system-wide RevPAR for the fourth quarter of 2022 also exceeded the same period in 2019. During the year ended December 31, 2022 as compared to 2019, RevPAR was down 1.3 percent due to a decrease in occupancy of 6.2 percentage points, partially offset by an increase in ADR of 7.8 percent. All regions showed improvement in ADR during the year ended December 31, 2022 when compared to 2019, with the exception of Asia Pacific, primarily as a result of limitations on travel in China.52The table below provides a reconciliation of net income to EBITDA and Adjusted EBITDA:Year Ended December 31,20222021(in millions)Net income$1,257 $407 Interest expense415 397 Income tax expense477 153 Depreciation and amortization expenses162 188 EBITDA2,311 1,145 Loss on sales of assets, net— 7 Loss (gain) on foreign currency transactions(5)7 Loss on debt extinguishment— 69 FF&E replacement reserves54 48 Share-based compensation expense162 193 Amortization of contract acquisition costs38 32 Net other expenses from managed and franchised properties39 110 Other adjustments(1)— 18 Adjusted EBITDA$2,599 $1,629 ____________(1)Amount for the year ended December 31, 2022 was less than $1 million and includes net losses (gains) related to certain of Hilton's investments in unconsolidated affiliates. Amount for the year ended December 31, 2021 includes costs recognized for certain legal settlements. All periods include severance and other items. RevenuesYear Ended December 31,Percent Change202220212022 vs. 2021(in millions)Franchise and licensing fees$2,068 $1,493 38.5Base and other management fees$294 $176 67.0Incentive management fees196 98 100.0Total management fees$490 $274 78.8During the year ended December 31, 2022, revenue recognized from fees increased primarily as a result of improved demand for travel and tourism, including the ability and desire of our customers to travel, due to the ongoing recovery that began in early 2021 from the negative impacts of the COVID-19 pandemic. Accordingly, on a comparable basis, franchise and management fees increased as a result of increases in RevPAR of 34.8 percent and 69.0 percent at our comparable franchised and managed properties, respectively. These increases were a result of increased occupancy of 8.7 percentage points and 15.0 percentage points, respectively, and increased ADR of 18.0 percent and 27.1 percent, respectively.Further, as new hotels enter our system, we expect such hotels to increase our franchise and management fees. Including new development and ownership type transfers, from January 1, 2021 to December 31, 2022, we added over 670 franchised and managed properties on a net basis, providing an additional 105,300 rooms to our management and franchise segment, which also contributed to the increases in franchise and management fees.The rise in travel and tourism and increased overall consumer spending during the year ended December 31, 2022 also contributed to a significant increase in licensing and other fees from our strategic partnerships and HGV. Increased fees from our strategic partnerships resulted from new cardholder acquisitions, as well as increased cardholder spend under our co-branded credit card arrangements and increased fees from HGV resulted from increased timeshare revenues, which, in addition to the recovery from the pandemic, were attributable to the increase in timeshare properties in our system during the period.53Incentive management fees increased as they are based on hotels' operating profits, which have improved from the prior year as a result of increased demand in line with the recovery from the COVID-19 pandemic and higher revenues driving higher managed hotel profits.Year Ended December 31,Percent Change202220212022 vs. 2021(in millions)Owned and leased hotels revenues$1,076 $598 79.9The increase in owned and leased hotels revenues included increases of $489 million and $74 million, on a currency neutral basis, from our comparable and non-comparable owned and leased hotels, respectively, which were partially offset by an $85 million decrease as a result of unfavorable fluctuations in foreign currency exchange rates. The currency neutral increase in revenues from our comparable leased hotels was primarily the result of increased RevPAR of 168.2 percent, due to increases in occupancy of 30.8 percentage points and ADR of 34.1 percent, reflective of the ongoing recovery from the COVID-19 pandemic, which was particularly strong during 2022 in Europe where the majority of our leased properties are located. The currency neutral increase in revenues from our non-comparable owned and leased hotels, which also benefited from an increase in RevPAR, was partially offset by a $35 million decrease, on a currency neutral basis, from properties which were sold or for which the lease agreements were terminated during 2021.Year Ended December 31,Percent Change202220212022 vs. 2021(in millions)Other revenues$102 $79 29.1The increase in other revenues was primarily due to increased revenues from our purchasing operations related to improved hotel demand resulting from the rise in travel and tourism during 2022.Operating ExpensesYear Ended December 31,Percent Change202220212022 vs. 2021(in millions)Owned and leased hotels expenses$999 $679 47.1The increase in owned and leased hotels expenses included increases of $358 million and $49 million, on a currency neutral basis, from our comparable and non-comparable owned and leased hotels, respectively, which were partially offset by a $87 million decrease as a result of favorable fluctuations in foreign currency exchange rates. The currency neutral increase in expenses from our non-comparable owned and leased hotels was net of a $30 million currency neutral decrease from properties which were sold or for which the lease agreements were terminated during 2021. Our owned and leased hotels had currency neutral increases in certain operating expenses as a result of increased occupancy, including labor costs, utilities and variable rent, which is generally based on a percentage of hotel revenues or profits, which increased in line with the recovery from the COVID-19 pandemic. Additionally, we incurred increased expenses related to FF&E replacement reserves, which are generally computed as a percentage of hotel revenues.Year Ended December 31,Percent Change202220212022 vs. 2021(in millions)Depreciation and amortization expenses$162 $188 (13.8)General and administrative expenses382 405 (5.7)Other expenses60 45 33.354The decrease in depreciation and amortization expenses was primarily due to a decrease in amortization expense, driven by the full amortization of certain software project costs during 2021 and 2022.The decrease in general and administrative expenses was primarily due to continued cost control and decreased share-based compensation expense, as well as costs recognized during the year ended December 31, 2021 for certain legal settlements, for which no such expenses were recognized during 2022.The increase in other expenses was primarily due to higher volume in our purchasing operations related to improved hotel demand.Non-operating Income and ExpensesYear Ended December 31,Percent Change202220212022 vs. 2021(in millions)Interest expense$(415)$(397)4.5Gain (loss) on foreign currency transactions5 (7)NM(1)Loss on debt extinguishment— (69)(100.0)Other non-operating income, net50 23 NM(1)Income tax expense(477)(153)NM(1)____________(1)Fluctuation in terms of percentage change is not meaningful.The increase in interest expense included increases related to the interest rate increase on the variable rate senior secured term loan facility (the "Term Loan") during the period and the amortization of previously dedesignated interest rate swaps. These increases were partially offset by a decrease related to our senior secured revolving credit facility (the "Revolving Credit Facility"), which was partially drawn during 2021, but was fully repaid as of June 30, 2021 with no outstanding balance for the remainder of 2021 or at all during 2022, as well as a decrease resulting from the February 2021 issuance of new senior unsecured notes and the use of such proceeds for the redemption of previously outstanding senior unsecured notes, which reduced the weighted average interest rate on our outstanding senior unsecured notes. See Note 8: "Debt" in our consolidated financial statements for additional information on our indebtedness and the associated interest rates. The gains and losses on foreign currency transactions included the impact of changes in foreign currency exchange rates on certain intercompany financing arrangements, including short-term cross-currency intercompany loans, and other transactions denominated in foreign currencies.Loss on debt extinguishment related to the February 2021 redemption of senior unsecured notes and included a redemption premium of $55 million and the accelerated recognition of unamortized deferred financing costs on those senior unsecured notes of $14 million.Other non-operating income, net consists of interest income, equity in earnings (losses) from unconsolidated affiliates, certain components of net periodic pension cost or credit related to our employee defined benefit pension plans and other non-operating gains and losses. The increase in other non-operating income, net was primarily due to an $11 million gain recognized during the year ended December 31, 2022 resulting from the remeasurement of certain investments in unconsolidated affiliates, as well as an increase in interest income due to increases in interest rates during the period.The increase in income tax expense was primarily attributable to the increase in income before income taxes. Further, during the year ended December 31, 2021, we recognized tax benefits as a result of the change in tax rate implemented as part of the United Kingdom's Finance Act 2021. For additional information, see Note 12: "Income Taxes" in our consolidated financial statements.Segment ResultsRefer to Note 17: "Business Segments" in our consolidated financial statements for reconciliations of revenues for our reportable segments to consolidated total revenues and of segment operating income to consolidated income (loss) before income taxes.55Refer to "—Revenues" for further discussion of the increase in revenues from our managed and franchised properties, which is correlated to our management and franchise segment revenues and segment operating income. Refer to "—Revenues" and "—Operating Expenses" for further discussion of the increases in revenues and operating expenses at our owned and leased hotels, the net of which are correlated with our ownership segment revenues and segment operating income (loss).Liquidity and Capital ResourcesOverviewAs of December 31, 2022, we had total cash and cash equivalents of $1,286 million, including $77 million of restricted cash and cash equivalents. The majority of our restricted cash and cash equivalents is related to cash collateral and cash held for FF&E reserves.Our known short-term liquidity requirements primarily consist of funds necessary to pay for operating and other expenditures, including: •costs associated with the management and franchising of hotels;•corporate expenses;•payroll and compensation costs;•taxes and compliance costs;•scheduled debt maturities and interest payments on our outstanding indebtedness, which, excluding finance lease liabilities, are estimated to be approximately $427 million in 2023;•lease payments under our finance and operating leases, which include minimum lease payments that are estimated to be approximately $47 million and $147 million, respectively, in 2023;•costs, other than compensation and rent as noted separately, associated with the operations of owned and leased hotels, including, but not limited to, utilities and operating supplies;•committed contract acquisition costs;•capital and maintenance expenditures for required renovations and maintenance at the hotels within our ownership segment;•dividends as declared; and•share repurchases.Our known long-term liquidity requirements primarily consist of funds necessary to pay for: •scheduled debt maturities and interest payments on our outstanding indebtedness, which, excluding finance lease liabilities, are estimated to total an aggregate of $10.5 billion after December 31, 2023;•lease payments under our finance and operating leases, which include minimum lease payments that are estimated to total an aggregate of $150 million and $1,068 million, respectively, after December 31, 2023;•committed contract acquisition costs;•capital improvements to the hotels within our ownership segment;•corporate capital and information technology expenditures;•dividends as declared;56•share repurchases; and•commitments to owners in our management and franchise segment made in the normal course of business for which we are reimbursed by these owners through program fees to operate our marketing, sales and brands programs. In March 2022, we resumed share repurchases, which we had previously suspended in an effort to preserve cash during the COVID-19 pandemic. Since they were resumed, as of December 31, 2022, we had repurchased approximately 12.3 million shares of our common stock for $1,608 million. As of December 31, 2022, approximately $3.1 billion remained available for share repurchases under our stock repurchase program. In June 2022, we resumed payment of regular quarterly cash dividends, which we had also previously suspended in an effort to preserve cash during the pandemic.In circumstances where we have the opportunity to support our strategic objective of growing our global hotel network, we may provide performance or debt guarantees or loan commitments, as necessary, to owners of certain hotels that we currently or in the future will manage or franchise, as applicable, as well as letters of credit that support hotel financing or other obligations of hotel owners. See Note 18: "Commitments and Contingencies" in our consolidated financial statements for additional information on these commitments that were outstanding as of December 31, 2022.We have a long-term investment policy that is focused on the preservation of capital and maximizing the return on new and existing investments and returning available capital to stockholders through dividends and share repurchases. Within the framework of our investment policy, we currently intend to continue to finance our business activities primarily with cash on our balance sheet as of December 31, 2022, cash generated from our operations and, as needed, the use of the available capacity of our Revolving Credit Facility. Additionally, we have continued access to debt markets and expect to be able to obtain financing as a source of liquidity as required and to extend maturities of existing borrowings, as necessary.After considering our approach to liquidity and our available sources of cash, we believe that our cash position and sources of liquidity will meet anticipated requirements for operating and other expenditures, including corporate expenses, payroll and other compensation costs, taxes and compliance costs and other commitments for the foreseeable future based on current conditions. The objectives of our cash management policy are maintaining the availability of liquidity and minimizing operational costs. We may from time to time issue or incur or increase our capacity to incur new debt and/or purchase our outstanding debt through underwritten offerings, open market transactions, privately negotiated transactions or otherwise. Issuances or incurrence of new debt (or an increase in our capacity to incur new debt) and/or purchases or retirements of outstanding debt, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.Sources and Uses of Our Cash and Cash EquivalentsThe following table summarizes our net cash flows:Year Ended December 31,Percent Change202220212022 vs. 2021(in millions)Net cash provided by operating activities$1,681 $109 NM(1)Net cash used in investing activities(123)(57)NM(1)Net cash used in financing activities(1,765)(1,793)(1.6)____________(1)Fluctuation in terms of percentage change is not meaningful; see additional details below.Operating Activities The increase in cash provided by operating activities was primarily due to the increase in cash inflows generated from our management and franchise segment, largely as a result of an increase in RevPAR at our comparable managed and franchised properties of 41.2 percent. Additionally, there was a $119 million decrease in payments of contract acquisition costs based on the timing of certain strategic hotel developments supporting our net unit growth. The increase in cash provided by operating activities was partially offset by a $208 million increase in cash paid for income taxes primarily due to the increase in income before income taxes.57In April 2020, we pre-sold Hilton Honors points to American Express and, before the end of the second quarter of 2022, all of those points had been used by American Express. As such, American Express resumed purchasing Hilton Honors points with cash in connection with a co-branded credit card arrangement with them, which contributed approximately $400 million to the increase in our operating cash flows during the year ended December 31, 2022. We expect American Express to continue to purchase points with cash under the co-branded credit card arrangement in future periods.Investing ActivitiesNet cash used in investing activities primarily included: (i) capitalized software costs that were related to various systems initiatives for the benefit of both our hotel owners and our overall corporate operations; (ii) capital expenditures for property and equipment related to our corporate facilities and the renovation of certain hotels in our ownership segment; and (iii) equity and debt financing that we provided to unconsolidated affiliates and owners of hotels that we currently or in the future will manage or franchise to support our strategic objectives. During the year ended December 31, 2022, net cash used in investing activities was partially offset by the net cash inflows resulting from our undesignated derivative financial instruments that we have in place to hedge against changes in foreign currency exchange rates, primarily as a result of the British pound depreciating against the USD during the year ended December 31, 2022. Financing ActivitiesNet cash used in financing activities during the year ended December 31, 2022 primarily related to the return of capital to shareholders, including share repurchases, which resumed in March 2022, and quarterly dividend payments, which resumed in June 2022, after both programs were suspended in 2020. Net cash used in financing activities during the year ended December 31, 2021 primarily comprised the full repayment of the $1.69 billion outstanding debt balance on our Revolving Credit Facility, as well as the debt issuance costs and redemption premiums associated with the issuance of new senior unsecured notes and the use of such proceeds for the redemption of previously outstanding senior unsecured notes. Debt and Borrowing CapacityAs of December 31, 2022, our total indebtedness, excluding the deduction for unamortized deferred financing costs and discount, was approximately $8.8 billion, and we had $60 million of letters of credit outstanding under our Revolving Credit Facility, resulting in an available borrowing capacity of $1,690 million. In January 2023, we amended the credit agreement governing our Revolving Credit Facility to increase the borrowing capacity from $1.75 billion to $2.0 billion, $250 million of which is available in the form of letters of credit, and, based on the terms of the agreement, we expect the extended maturity date to be January 2028. As of February 3, 2023, after considering $60 million letters of credit outstanding and no borrowings outstanding, we had an available borrowing capacity on the Revolving Credit Facility of $1,940 million. For additional information on our total indebtedness, including any applicable guarantees, refer to Note 8: "Debt" in our consolidated financial statements.If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may be required to reduce capital expenditures or issue additional equity securities. However, we do not have any material indebtedness outstanding that matures prior to May 2025. Our ability to make scheduled principal payments and to pay interest on our debt depends on our future operating performance, which is subject to general conditions in or affecting the hospitality industry that may be beyond our control.Critical Accounting EstimatesThe preparation of our consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, the reported amounts of revenues and expenses during the reporting periods and the related disclosures in the consolidated financial statements and accompanying footnotes. On an ongoing basis, we evaluate these estimates and judgments based on historical experiences and various other factors that we believe reflect the current circumstances. While we believe our estimates, assumptions and judgments are reasonable, they are based on information presently available. Actual results may differ significantly from these estimates due to changes in judgments, assumptions and conditions as a result of unforeseen events or otherwise, which could have a material effect on our financial position or results of operations.We believe that the following estimates, which are used in conjunction with our significant accounting policies, are critical because they involve a higher degree of judgment and are based on information that is inherently uncertain; refer to Note 2: "Basis of Presentation and Summary of Significant Accounting Policies" in our consolidated financial statements for 58information on our significant accounting policies. Management has discussed the development and selection of the following critical accounting estimates with the Audit Committee of the board of directors: Impairment of Goodwill and Brands Intangible AssetsWe evaluate goodwill and brands intangible assets for potential impairment on an annual basis or at other times during the year if indicators of impairment exist. Our reporting units are the same as our operating segments as described in Note 17: "Business Segments" in our consolidated financial statements.As part of the evaluation of goodwill and brands intangible assets for potential impairment, we exercise judgment to:•perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit or brand intangible asset is less than its carrying value. Factors we consider when making this determination include assessing the overall effect of trends in the hospitality industry and the general economy, regional performance and expectations and historical experience;•decide whether to bypass the qualitative assessment and perform a quantitative assessment. Factors we consider when making this determination include changes in the Company or general economic conditions since the previous quantitative assessment was performed, the amount by which the fair value exceeded the carrying value at that time and the period of time that has passed since such quantitative assessment; and•perform a quantitative analysis to identify both the existence of impairment and the amount of the impairment loss. The estimated fair value is based on internal projections of expected future cash flows and operating plans, as well as market conditions relative to the operations of the reporting unit or brand, as applicable. Changes in the estimates and assumptions used in our impairment analysis, or changes in the factors that we consider that would affect these estimates and assumptions, such as those described above, could result in impairment losses, which could be material.Impairment of Certain Finite-Lived AssetsWe evaluate the carrying value of our specifically identifiable lease intangible assets, operating and finance lease ROU assets and property and equipment for indicators of impairment, and, if such indicators exist, we perform an analysis to determine the recoverability of the determined asset group, by comparing the expected undiscounted future cash flows to the net carrying value of the asset group. As part of the process, we exercise judgment to:•determine if there are indicators of impairment present. Factors we consider when making this determination include assessing the overall effect of trends in the hospitality industry and the general economy, regional performance and expectations, historical experience, capital costs and other asset-specific information;•determine the projected undiscounted future cash flows when indicators of impairment are present. Judgment is required when developing projections of future revenues and expenses based on estimated performance over the expected useful life of the asset group. Forward-looking estimates of future performance are based on historical operating results, adjusted for current and expected future market conditions, as well as various internal projections and external sources; and•determine the asset group fair value when required. In determining the fair value, we often use internally-developed discounted cash flow models, appraisals, recent similar transactions in the market and, if appropriate and available for a specific asset group, current estimated net sales proceeds from pending offers. Assumptions used in the discounted cash flow models include estimating cash flows, which may require us to adjust for specific market conditions, as well as capitalization rates, which are based on location, property or asset type, market-specific dynamics and overall economic performance. The discount rate applied to forward-looking projections takes into account market-specific considerations.59Changes in the estimates and assumptions used in our impairment analysis, or changes in the factors that we consider that would affect these estimates and assumptions, such as those described above, could result in impairment losses, which could be material.Hilton HonorsWe record a point redemption liability for amounts received from properties participating in our Hilton Honors guest loyalty program and from strategic partners affiliated with the loyalty program, in an amount equal to the estimated cost per point of the future redemption obligation. We engage third-party actuaries annually to assist in determining the fair value of the future reward redemption obligation using a discount rate and statistical formulas that project future point redemptions based on factors that require judgment, including: (i) an estimate of points that will eventually be redeemed, which includes an estimate of breakage (i.e., points that will never be redeemed); (ii) the expectation of when such points will be redeemed; and (iii) the cost of reimbursing properties and other third parties when points are redeemed. The cost of the points expected to be redeemed includes further estimates of available room nights, occupancy rates, room rates and any changes to the Hilton Honors program, including devaluation or appreciation of points based on changes in the number of points required to redeem a reward. Any amounts received related to the issuance of points that are in excess of the actuarial determined cost per point are recorded as deferred revenue in our consolidated balance sheets and recognized as revenue upon point redemption. We recognize revenue for point redemptions in the amount we expect to retain in excess of the cost per point, inclusive of estimated breakage, and limit the revenue recognized to an amount that is probable to not result in a significant reversal in the cumulative revenue recognized when breakage occurs.In addition to the Hilton Honors fees we receive from hotel owners to operate the program, we earn fees from strategic partnerships, including co-branded credit card arrangements, for a license to use our IP and the issuance of Hilton Honors points. The allocation of the overall fees from the strategic partnerships between the IP license and the Hilton Honors points is based on their estimated standalone selling prices. The estimated standalone selling price of the IP license is determined using a relief-from-royalty valuation method incorporating statistical formulas based on factors that require significant judgment, including estimates of the usage of the strategic partner's goods or services, an appropriate royalty rate and a discount rate applied to the projected cash flows. The estimated standalone selling price of the future reward redemptions of Hilton Honors points under the strategic partnerships is calculated using a discounted cash flow analysis with the same assumptions as the point redemption liability discussed above, adjusted for an appropriate margin.Changes in our estimates and assumptions that are used to determine our estimated cost per point and the allocation of fees from strategic partnerships between the IP license fee and the Hilton Honors points could result in material changes in the balances of our liability for guest loyalty program and deferred revenues in our consolidated balance sheets. Further, the estimates and assumptions used for the allocation of fees could result in material changes to our licensing fees and other revenues from managed and franchised properties recognized in our consolidated statements of operations.Income TaxesWe recognize deferred tax assets and liabilities based on the differences between the financial statement carrying values and the tax basis of assets and liabilities using currently enacted tax rates. We regularly review our deferred tax assets to assess their potential realization and establish a valuation allowance for portions of such assets that we believe will not be ultimately realized. In performing this review, we make estimates and assumptions regarding projected future taxable income, the expected timing of reversals of existing temporary differences and the implementation of tax planning strategies. A change in these assumptions may increase or decrease our valuation allowance resulting in an increase or decrease in our effective tax rate, which could materially affect our consolidated financial statements. Refer to Note 12: "Income Taxes" for information on the balances of our deferred tax assets and respective valuation allowances as of December 31, 2022. We use a prescribed more-likely-than-not recognition threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return if there is uncertainty in income taxes recognized in the consolidated financial statements. When determining the amount of tax benefit to be recognized, we assume, among other items, the position will be examined, the examiner will have all relevant information and the evaluation of the position will be based on its technical merits. Further, estimates based on the technical merits of each evaluated tax position and the amounts we would ultimately accept in a negotiated settlement with the tax authorities are used to measure the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. Changes to these assumptions and estimates can lead to an additional income tax benefit (expense), which could materially affect our consolidated financial statements.60Legal ContingenciesWe are subject to various legal proceedings and claims, the outcomes of which are subject to significant uncertainty. An estimated loss from a loss contingency will be accrued as a charge to income if it is probable and the amount of the loss can be reasonably estimated. Significant judgment is required when we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss in determining whether an accrual of an estimated loss is appropriate. Changes in these factors could materially affect our consolidated financial statements.61Item 7A. Quantitative and Qualitative Disclosures About Market RiskWe are exposed to market risk primarily from changes in interest rates and foreign currency exchange rates. These rate changes may affect future income, cash flows and the fair value of the Company, its assets and its liabilities. In certain situations, we may seek to reduce volatility associated with changes in interest rates and foreign currency exchange rates by entering into derivative financial instruments intended to provide a hedge against a portion of the risks associated with such volatility. We continue to have exposure to such risks to the extent they are not hedged. We enter into derivative financial instruments to the extent they meet the objectives described above, and we do not use derivatives for speculative purposes.Interest Rate RiskWe are exposed to interest rate risk on our variable-rate indebtedness. Our primary sensitivity in 2022 was to changes in one-month LIBOR, as the interest rate on our Term Loan, which represents the majority of our variable-rate indebtedness, was based on this benchmark rate until we amended the credit agreement that governs our Term Loan in December 2022 to adjust our LIBOR-based variable rate to a SOFR-based variable rate. We use an interest rate swap in order to maintain what we believe to be an appropriate level of exposure to interest rate variability. As of December 31, 2022, we held an interest rate swap for a portion of the Term Loan, for which we executed an amendment concurrent with the amendment for our Term Loan, through which we receive one-month term SOFR and pay a fixed rate. We elected to designate this interest rate swap as a cash flow hedge for accounting purposes and applied the practical expedient as prescribed in ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting that allowed us to maintain hedge accounting with the transition to SOFR.The following table sets forth the current carrying values of our contractual maturities, total fair values and interest rates as of December 31, 2022 for our financial instruments that are materially affected by interest rate risk, including long-term debt and our interest rate swap:Maturities by Period20232024202520262027ThereafterCarrying ValueFair Value(dollars in millions)Long-term debt(1):Fixed-rate long-term debt$— $— $500 $— $600 $4,900 $6,000 $5,292 Weighted average fixed interest rate(2)4.37 %Variable-rate long-term debt$— $— $— $2,619 $— $— $2,619 $2,616 Variable interest rate(2)(3)6.17 %Interest rate swap(4):Variable to fixed$— $— $— $1,600 $— $— $1,600 $108 Variable interest rate receivable(3)4.32 %Fixed interest rate payable1.76 %____________(1)The carrying values exclude the deduction for unamortized deferred financing costs and any applicable discounts, as well as all finance lease liabilities and other debt of consolidated VIEs totaling $164 million and $37 million, respectively, as of December 31, 2022.(2)The fixed interest rate is the weighted average of actual rates, and the variable interest rate is based on the market rate prevailing as of December 31, 2022.(3)The variable interest rate receivable on the interest rate swap does not include fixed components of the overall variable interest rate, including applicable spreads. (4)The carrying value reflects the notional amount and the variable interest rate receivable is based on the market rate prevailing as of December 31, 2022. We measure our derivative instruments at fair value and, as of December 31, 2022, our interest rate swap was in an asset position.Refer to Note 10: "Fair Value Measurements" in our consolidated financial statements for additional information on the fair value measurements of our long-term debt and interest rate swap.Foreign Currency Exchange Rate RiskWe conduct business in various currencies and are exposed to earnings and cash flow volatility associated with changes in foreign currency exchange rates. Our principal exposure results from management and franchise fees earned in foreign currencies, as well as revenues and expenses from our international leased hotels. The value of these revenues and expenses could change materially in relation to the functional currencies of the exposed entities and to our reporting currency, USD. We also have exposure from our international financial assets and liabilities, including certain intercompany financing arrangements 62not deemed to be permanently invested, the value of which could change materially in relation to the functional currencies of the exposed entities. As of December 31, 2022, our largest net exposures were to GBP and EUR.We use forward contracts designated as cash flow hedges to offset exposure from foreign currency exchange rate risks associated with certain of our management, franchise and other fees denominated in certain foreign currencies. We use forward contracts not designated as hedging instruments to offset exposure to foreign currency exchange rate fluctuations in certain cash and intercompany loan balances. We do not consider the fair value or earnings effect of these forward contracts to be material to our consolidated financial statements.63
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.The following discussion and analysis should be read in conjunction with the Company’s Consolidated Financial Statements and related notes in this annual report. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. The Company’s actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under Item 1A, “Risk Factors” and elsewhere in this annual report.This discussion includes certain non-GAAP financial measures that have been defined and reconciled to their most directly comparable measures that are in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) later in this Item under the headings “Non-GAAP Disclosures” and “Free Cash Flow.” This discussion also includes Operating working capital which has been defined later in this Item under the heading “Cash Flow Summary.” The non-GAAP financial measures disclosed by the Company should not be considered a substitute for, or superior to, financial measures prepared in accordance with U.S. GAAP. The financial results prepared in accordance with U.S. GAAP and the reconciliations from these results should be carefully evaluated.2022 OverviewIDEX is an applied solutions provider specializing in the manufacture of fluid and metering technologies, health and science technologies and fire, safety and other diversified products built to customers’ specifications. IDEX’s products are sold in niche markets across a wide range of industries throughout the world. Accordingly, IDEX’s businesses are affected by levels of industrial activity and economic conditions in the U.S. and in other countries where it does business and by the relationship of the U.S. dollar to other currencies. Levels of capacity utilization and capital spending in certain industries and overall industrial activity are important factors that influence the demand for IDEX’s products. In 2022, the Company achieved a record year in sales driven by robust demand. The Company’s ability to capture price amid inflation pressures and its focus on execution drove record earnings per share. Finally, the Company deployed record capital, within its existing portfolio, with the acquisition of three businesses - Nexsight, KZValve and Muon Group - and through share repurchases to support our future goals.Select key financial results for the year ended December 31, 2022 when compared to 2021 were as follows:•Sales of $3.2 billion increased 15%; organic sales were up 13%.•Net income of $586.7 million increased 31%; Net income margin of 18.4% increased 210 basis points.•Diluted EPS attributable to IDEX of $7.71 increased $1.83, or 31%; Adjusted diluted EPS attributable to IDEX of $8.12 increased $1.25, or 18%.•Adjusted EBITDA of $884.2 million increased 16%; Adjusted EBITDA margin of 27.9% increased 20 basis points.•Cash flows provided by operating activities of $557.4 million were down as higher earnings were more than offset by an increased investment in working capital. Free cash flow of $489.4 million was 79% of adjusted net income attributable to IDEX. Focus for 2023During 2023, the Company’s primary focus will be on: •Foundational Execution. During 2021 and 2022, the Company experienced both double-digit organic growth and a challenging operating environment characterized by global supply chain constraints, record inflation and continuing effects of the COVID-19 environment. In 2023, the Company will renew its focus on the core elements of its operating model that are designed to drive efficiency, innovation and growth. As market conditions continue to evolve, the Company believes it will leverage its process-driven fundamental business practices to drive above-market growth and operational excellence.•Building Great Global Teams. The Company’s teams have demonstrated their ability to quickly adapt to challenges and changing conditions as well as to solve critical problems for customers. The Company is committed to cultivating talent to fuel future growth and onboarding leaders who are committed to IDEX core values, talent development and creating an inspiring Company culture. Diversity, Equity and Inclusion continues to be an area of focus, creating environments where people feel they belong and can bring their true selves to work every day.•Capital Deployment. The Company deployed $1.5 billion over the last two years on growth business opportunities, will continue to identify both organic and inorganic opportunities and believes there will be a high quality pipeline for potential acquisitions. The Company believes that its strong operating cash flow and balance sheet enable deployment 24Table of Contentsof additional capital to acquire IDEX-like businesses in 2023 to further strengthen its portfolio. The Company anticipates that 2023 organic investment opportunities will be in line with 2022 spending.Results of OperationsThe following is a discussion and analysis of the Company’s results of operations for the year ended December 31, 2022 compared with the year ended December 31, 2021. For the discussion related to the consolidated results of operations for the year ended December 31, 2021 compared with the year ended December 31, 2020, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the Securities and Exchange Commission (“SEC”) on February 24, 2022. Performance in 2022 Compared with 2021Year Ended December 31, Change(Dollars in millions, except per share amounts)20222021$% / bpsNet sales$3,181.9$2,764.8$417.1 15 %Cost of sales1,755.01,540.3214.7 14 %Gross profit1,426.91,224.5202.4 17 %Gross margin44.8 %44.3 %n/a50 bpsSelling, general and administrative expenses652.7578.274.5 13 %Restructuring expenses and asset impairments22.89.313.5 145 %Operating income751.4637.0114.4 18 %Operating margin23.6 %23.0 %n/a60 bpsGain on sale of business(34.8)—(34.8)100 %Other (income) expense - net(3.9)16.2(20.1)(124 %)Interest expense40.741.0(0.3)(1 %)Income before income taxes749.4579.8169.6 29 %Provision for income taxes162.7130.532.2 25 %Effective tax rate21.7 %22.5 %n/a(80) bpsNet income attributable to IDEX$586.9$449.4$137.5 31 %Diluted earnings per common share attributable to IDEX$7.71$5.88$1.83 31 %Net SalesSales increased 15%, reflecting a 13% increase in organic sales, a 5% increase from acquisitions (Muon Group - November 2022, KZValve - May 2022, Nexsight - February 2022, Airtech - June 2021 and ABEL - March 2021) net of divestitures (Knight LLC and its related affiliates (“Knight”) - September 2022), a 1% increase from the acceleration of previously deferred revenue related to the exit of a COVID-19 testing application (see Note 15 in the Notes to the Consolidated Financial Statements for further detail) and a 4% unfavorable impact from foreign currency translation. Sales increased 23% domestically and 7% internationally, and sales to customers outside the U.S. were approximately 48% and 52% of total sales in 2022 and 2021, respectively. Cost of Sales and Gross MarginCost of sales increased due to higher sales volume, inflation and acquisitions. Both Gross profit and Gross margin increased primarily due to higher volume leverage, favorable price/cost and productivity and the acceleration of previously deferred revenue related to the exit of a COVID-19 testing application, partially offset by increases in employee-related costs. Gross profit also increased as a result of acquisitions, net of the Knight divestiture, partially offset by an unfavorable impact from foreign currency translation. Selling, General and Administrative ExpensesSelling, general and administrative (“SG&A”) expenses increased primarily due to the impact from acquisitions, including amortization, as well as higher discretionary spending, resource investments and employee-related costs. Additionally, the prior year included a $3.5 million impact of a settlement for a corporate transaction indemnity that did not reoccur in 2022.25Table of ContentsRestructuring Expenses and Asset ImpairmentsRestructuring expenses and asset impairments increased primarily due to an asset impairment related to the exit of a COVID-19 testing application, partially offset by lower severance costs in 2022. See Note 15 in the Notes to the Consolidated Financial Statements for further detail.Operating IncomeOperating income increased 18%, reflecting a 19% increase in organic operating income, a 2% increase from acquisitions net of divestitures (Knight - September 2022), a 1% favorable net impact from the exit of a COVID-19 testing application, partially offset by a 4% unfavorable impact from foreign currency translation. The increase in organic operating income is attributable to higher volume leverage, favorable price/cost and operational productivity, partially offset by increases in employee-related costs, discretionary spending and resource investments. Operating MarginOperating margin increased 60 basis points, reflecting a 130 basis point increase in organic operating margin, partially offset by a 70 basis point decrease due to acquisitions primarily driven by higher amortization. The increase in organic operating margin is primarily due to higher volume leverage, favorable price/cost and operational productivity, partially offset by increases in employee-related costs, discretionary spending and resource investments. Gain on Sale of Business In the third quarter of 2022, the Company completed the sale of Knight for proceeds of $49.4 million, net of cash remitted, resulting in a pre-tax gain on the sale of $34.8 million. The Company recorded $5.5 million of income tax expense associated with this transaction as Provision for income taxes in the Consolidated Statements of Income during the year ended December 31, 2022.Other (Income) Expense - NetOther (income) expense - net was $3.9 million of income in 2022 compared to $16.2 million of expense in 2021. The prior year included an $8.6 million noncash loss related to the termination of the U.S. pension plan, net of curtailment and an $8.6 million loss on early debt redemption. Additionally, 2022 included $3.1 million of gains on the sale of assets and $2.5 million of foreign currency transaction gains, partially offset by $2.3 million of losses on trading securities. Interest ExpenseInterest expense decreased primarily due to lower weighted average interest rates on the Company’s indebtedness, partially offset by an increase in the amount of debt outstanding compared with 2021 due to borrowings under the Term Facility and the Revolving Facility, both of which were used to fund the acquisition of Muon Group. Additionally, the prior year included $1.6 million of interest expense for the interest rate contract associated with the 4.20% Senior Notes that did not reoccur in 2022.Income TaxesThe Company’s provision for income taxes is based upon estimated annual tax rates for the year applied to federal, state, and foreign income. The provision for income taxes increased $32.2 million to $162.7 million in 2022 as compared with $130.5 million in 2021 due to higher earnings. The 2022 effective tax rate of 21.7% decreased compared with the 2021 effective tax rate of 22.5% primarily due to tax benefits realized from the divestiture of Knight as well as from realizing foreign currency impacts in connection with the funding of the acquisition of Muon Group. Results of Reportable Business SegmentsThe Company has three reportable segments: Fluid & Metering Technologies (“FMT”), Health & Science Technologies (“HST”) and Fire & Safety/Diversified Products (“FSDP”). For a detailed description of the operations within each segment, please refer to Part I, Item 1, “Business” of this Annual Report on Form 10-K. 26Table of ContentsWithin its three reportable segments, the Company maintains 13 reporting units where the Company focuses on organic growth and strategic acquisitions. Management’s primary measurements of segment performance are sales, Adjusted EBITDA and Adjusted EBITDA margin. During the fourth quarter of 2022, the Company changed the segment measure of profit and loss used by the Chief Operating Decision Maker ("CODM") in accordance with Accounting Standards Codification ("ASC") 280, Segment Reporting, from operating income to Adjusted EBITDA. The change in segment measure of profit and loss aligns with how the CODM allocates resources and evaluates the performance of the business. It also allows the Company to better assess operating results over time since it excludes items that are not reflective of ongoing operations. For further discussion related to the Company’s change in the segment measure of profit and loss used by the CODM as well as the definition of Adjusted EBITDA, refer to Note 14 in Part II, Item 8, “Financial Statements and Supplementary Data.” Fluid & Metering Technologies SegmentYear Ended December 31, Components of Change(Dollars in millions)20222021ChangeOrganicAcq/Div(1)Foreign CurrencyTotalNet sales$1,167.3$998.717 %13 %7 %(3 %)17 %Adjusted EBITDA374.2297.026 %23 %6 %(3 %)26 %Adjusted EBITDA margin32.1 %29.7 %240 bps280 bps(40) bps—240 bps(1) Acquisitions included KZValve in May 2022, Nexsight in February 2022 and ABEL in March 2021. Divestitures included Knight in September 2022. Based on the timing of its acquisition, ABEL results for the first two months of 2022 are reflected in the acquisitions/divestitures column while the remaining year-over-year impact is included in the organic column.•Sales increased 24% domestically and 9% internationally. Sales to customers outside the U.S. were approximately 43% and 47% of total segment sales in 2022 and 2021, respectively.•The change in organic sales was attributed to increases in the Pumps reporting unit due to continued favorable demand in the industrial and energy markets as well as strong price capture. Additionally, there were increases in the Energy reporting unit due to a continued rebound in the refined fuel, liquefied petroleum gas and aviation markets as well as improved operational performance, increases in the Agriculture reporting unit due to strong market performance driven by favorable commodity prices and global demand for crops and increases in the Water reporting unit due to an overall positive municipal water market and water-saving targeted growth initiatives.•Adjusted EBITDA margin of 32.1% increased 240 basis points compared with 29.7% in 2021. The change in Adjusted EBITDA margin was attributed to the following: ◦Organic Adjusted EBITDA margin increased 280 basis points due to strong price/cost, favorable productivity and higher volume leverage, partially offset by increases in employee-related costs, discretionary spending and resource investments.◦Acquisitions negatively impacted Adjusted EBITDA margin by 40 basis points due to the dilutive impact from acquisitions on overall FMT Adjusted EBITDA margin. Health & Science Technologies SegmentYear Ended December 31,Components of Change(Dollars in millions)20222021ChangeOrganicAcq/Div(1)Other(2)Foreign CurrencyTotalNet sales$1,339.2$1,121.819 %15 %6 %2 %(4 %)19 %Adjusted net sales(3)1,321.31,121.817 %15 %6 %—(4 %)17 %Adjusted EBITDA411.8355.916 %13 %6 %—(3 %)16 %Adjusted EBITDA margin31.2 %31.7 %(50) bps(70) bps——20 bps(50) bps(1) Acquisitions included Muon Group in November 2022 and Airtech in June 2021. Based on the timing of its acquisition, Airtech results for the first six months of 2022 are reflected in the acquisitions/divestitures column while the remaining year-over-year impact is included in the organic column.27Table of Contents(2) Includes the impact of the acceleration of previously deferred revenue of $17.9 million as a result of a customer’s decision to discontinue further investment in commercializing its COVID-19 testing application. See Note 15 in the Notes to Consolidated Financial Statements for further detail. (3) Adjusted net sales is calculated as net sales less the acceleration of previously deferred revenue related to the exit of a COVID-19 testing application. It is used in the calculation of Adjusted EBITDA margin for the full year 2022. Refer to Non-GAAP Disclosures in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further details.•Sales increased 32% domestically and 10% internationally. Sales to customers outside the U.S. were approximately 52% and 56% of total segment sales in 2022 and 2021, respectively.•The change in organic sales was attributed to increases in the Scientific Fluidics & Optics reporting unit due to strong demand across the analytical instrumentation and life sciences markets, favorable but slowing demand in the semiconductor market and targeted growth initiatives tied to Next Gen Sequencing and satellite broadband, in the Performance Pneumatics Technologies reporting unit driven by strength in the industrial market, price capture and targeted growth initiatives tied to fuel cells and in the Sealing Solutions reporting unit due to favorable performance in the semiconductor, oil and gas and automotive markets.•Adjusted EBITDA margin of 31.2% decreased 50 basis points compared with 31.7% in 2021. The change in Adjusted EBITDA margin was attributed to the following: ◦Organic Adjusted EBITDA margin decreased 70 basis points due to increases in employee-related costs, discretionary spending and resource investments, partially offset by higher volume leverage and favorable price/cost.◦Foreign currency positively impacted Adjusted EBITDA margin by 20 basis points. Fire & Safety/Diversified Products SegmentYear Ended December 31,Components of Change(Dollars in millions)20222021ChangeOrganicAcq/DivOtherForeign CurrencyTotalNet sales$679.2$647.95 %9 %——(4 %)5 %Adjusted EBITDA183.9185.7(1 %)4 %——(5 %)(1 %)Adjusted EBITDA margin27.1 %28.7 %(160) bps(140) bps—(10) bps(10) bps(160) bps•Sales increased 8% domestically and 2% internationally. Sales to customers outside the U.S. were approximately 50% and 51% of total segment sales in 2022 and 2021, respectively.•The change in organic sales was attributed to increases in the Fire & Safety reporting unit due to acceptance of targeted growth initiatives, price realization and backlog execution, in the BAND-IT reporting unit due to strength in the energy market driven by increases in oil prices and in the automotive market driven by share gain as well as continued favorable industrial performance and in the Dispensing reporting unit due to continued favorable paint market, North American project volume and strong performance in India.•Adjusted EBITDA margin of 27.1% decreased 160 basis points compared with 28.7% in 2021. The change in Adjusted EBITDA margin was primarily attributed to organic Adjusted EBITDA margin which decreased 140 basis points due to increases in employee-related costs and discretionary spending as well as compressed price/cost, partially offset by higher volume leverage.Performance in 2021 Compared with 2020Due to the change in segment measure of profit and loss discussed above, the following discussion and analysis of the Company’s segment results of operations for the year ended December 31, 2021 compared with the year ended December 31, 2020 has been updated to include Adjusted EBITDA margin for comparative purposes. 28Table of ContentsFluid & Metering Technologies SegmentYear Ended December 31, Components of Change(Dollars in millions)20212020ChangeOrganicAcq/Div(1)OtherForeign CurrencyTotalNet sales$998.7$896.311 %6 %4 %—1 %11 %Adjusted EBITDA297.0271.59 %6 %2 %—1 %9 %Adjusted EBITDA margin29.7 %30.3 %(60) bps(10) bps(40) bps—(10) bps(60) bps(1) Acquisitions included ABEL in March 2021 and Flow MD in February 2020. Based on the timing of its acquisition, Flow MD results for the first quarter of 2021 are reflected in the acquisitions/divestitures column while the remaining year-over-year impact is included in the organic column. •Sales increased 5% domestically and 19% internationally. Sales to customers outside the U.S. were approximately 47% and 44% of total segment sales in 2021 and 2020, respectively.•The change in organic sales was attributed to increases in the Pumps reporting unit due to recovery within the industrial market, in the Water reporting unit due to recovery of the municipal water market and water-saving growth projects and in the Agriculture reporting unit due to increased global demand, partially offset by a decrease in the Energy reporting unit due to a decline in capital spending in the oil and gas markets.•Adjusted EBITDA margin of 29.7% decreased 60 basis points compared with 30.3% in 2020. The change in Adjusted EBITDA margin was attributed to the following: ◦Organic Adjusted EBITDA margin decreased 10 basis points due to increases to inventory reserves associated with COVID-19 new product development opportunities not materializing and resource investments, partially offset by higher volume leverage and favorable price/cost.◦Acquisitions negatively impacted Adjusted EBITDA margin by 40 basis points due to the dilutive impact from acquisitions on overall FMT Adjusted EBITDA margin, which was primarily driven by the Flow MD acquisition. ◦Foreign currency negatively impacted Adjusted EBITDA margin by 10 basis points.Health & Science Technologies SegmentYear Ended December 31,Components of Change(Dollars in millions)20212020ChangeOrganicAcq/Div(1)OtherForeign CurrencyTotalNet sales$1,121.8$896.025 %18 %5 %—2 %25 %Adjusted EBITDA355.9250.942 %33 %7 %—2 %42 %Adjusted EBITDA margin31.7 %28.0 %370 bps390 bps——(20) bps370 bps(1) Acquisitions included Airtech in June 2021. •Sales increased 27% domestically and 24% internationally. Sales to customers outside the U.S. were approximately 56% and 57% of total segment sales in 2021 and 2020, respectively.•The change in organic sales was attributed to increases in the Scientific Fluidics & Optics reporting unit due to recovery within the analytical instrumentation market as well as increased microfluidics and optics demand, in the Sealing Solutions reporting unit due to strength in the semiconductor market and improvements in the automotive market and in the Material Processing Technologies reporting unit due to increased demand in the food and pharmaceutical markets.•Adjusted EBITDA margin of 31.7% increased 370 basis points compared with 28.0% in 2020. The change in Adjusted EBITDA margin was attributed to the following: ◦Organic Adjusted EBITDA margin increased 390 basis points due to volume leverage and favorable price/cost, partially offset by targeted reinvestment.◦Foreign currency negatively impacted Adjusted EBITDA margin by 20 basis points.29Table of ContentsFire & Safety/Diversified Products SegmentYear Ended December 31,Components of Change(Dollars in millions)20212020ChangeOrganicAcq/DivOtherForeign CurrencyTotalNet sales$647.9$562.915 %13 %——2 %15 %Adjusted EBITDA185.7161.515 %13 %——2 %15 %Adjusted EBITDA margin28.7 %28.7 %—(10) bps——10 bps—•Sales increased 17% domestically and 13% internationally. Sales to customers outside the U.S. were approximately 51% and 52% of total segment sales in 2021 and 2020, respectively.•The change in organic sales was attributed to increases in the Dispensing reporting unit due to strong demand in the paint market and in the BAND-IT reporting unit due to improvements in the aerospace, energy and industrial markets, partially offset by a decrease in the Fire & Safety reporting unit due to a lack of large tenders for rescue tools and North America Fire OEM supply chain constraints slowing order to revenue conversion.•Adjusted EBITDA margin of 28.7% was flat compared with 2020. The change in Adjusted EBITDA margin was attributed to the following: ◦Organic Adjusted EBITDA margin decreased 10 basis points due to unfavorable price/cost and mix, partially offset by higher volume.◦Foreign currency positively impacted Adjusted EBITDA margin by 10 basis points.Liquidity and Capital ResourcesLiquidityBased on management’s current expectations and currently available information, the Company believes current cash, cash from operations and cash available under the Revolving Facility will be sufficient to meet its operating cash requirements, planned capital expenditures, interest and principal payments on all borrowings, pension and postretirement funding requirements, share repurchases and quarterly dividend payments to holders of the Company’s common stock for the foreseeable future. Additionally, in the event that suitable businesses are available for acquisition upon acceptable terms, the Company may obtain all or a portion of the financing for these acquisitions through the incurrence of additional borrowings. At December 31, 2022, working capital was $855.7 million and the Company’s current ratio was 2.6 to 1. At December 31, 2022, the Company’s cash and cash equivalents totaled $430.2 million, of which $373.1 million was held outside of the United States. At December 31, 2022, there was $77.7 million outstanding under the Revolving Facility and $7.9 million of outstanding letters of credit, resulting in a net available borrowing capacity under the Revolving Facility of $714.4 million. The Company believes that additional borrowings through various financing alternatives remain available, if required. Cash Flow SummaryThe following table is derived from the Consolidated Statements of Cash Flows:Year Ended December 31, (In millions)20222021Net cash flows provided by (used in): Operating activities$557.4 $565.3 Investing activities(917.2)(698.1)Financing activities(37.8)(9.5)Operating ActivitiesCash flows provided by operating activities decreased $7.9 million to $557.4 million in 2022 as higher earnings were more than offset by an increased investment in working capital.Operating working capital, calculated as Receivables - net plus Inventories minus Trade accounts payable, is used by management as a measurement of operational results as well as the short-term liquidity of the Company. The following table details operating working capital as of December 31, 2022 and 2021: 30Table of Contents(In millions)20222021Receivables - net$442.8 $356.4 Inventories470.9370.4Less: Trade accounts payable208.9178.8Operating working capital$704.8 $548.0 Operating working capital increased $156.8 million to $704.8 million at December 31, 2022. Acquisitions, divestitures and foreign currency translation contributed $31.9 million to the increase in operating working capital. Excluding those items, Receivables - net increased $63.1 million as a result of higher volume; Inventories increased $79.0 million to support production amid supply chain challenges; and Trade accounts payable increased $17.2 million due to higher inventory purchases. Investing ActivitiesCash flows used in investing activities increased $219.1 million to $917.2 million in 2022, primarily due to higher cash outflows for acquisitions with the addition of Muon Group, KZValve and Nexsight in 2022 compared to Airtech and ABEL in 2021, partially offset by proceeds received from both the sale of Knight and the sale of marketable securities in 2022 as well as higher proceeds from asset sales in 2022 compared to 2021.Financing ActivitiesCash flows used in financing activities increased $28.3 million from $9.5 million in 2021 to $37.8 million in 2022. During 2022, the Company repurchased 795,423 shares at a cost of $148.1 million, paid $177.4 million in dividends, borrowed $210.4 million under the Revolving Facility and $200.0 million under the Term Facility and repaid $135.0 million of the Revolving Facility. During 2021, the Company issued $500.0 million of 2.625% Senior Notes, redeemed $350.0 million of 4.20% Senior Notes and paid $161.1 million in dividends.Free Cash FlowThe Company believes free cash flow, a non-GAAP measure, is an important measure of performance because it provides a measurement of cash generated from operations that is available for payment obligations such as operating cash requirements, planned capital expenditures, interest and principal payments on all borrowings, pension and postretirement funding requirements and quarterly dividend payments to holders of the Company’s common stock as well as for funding acquisitions and share repurchases. Free cash flow is calculated as cash flows provided by operating activities less capital expenditures. The following table reconciles free cash flow to cash flows provided by operating activities:Year Ended December 31, (Dollars in millions)20222021Cash flows provided by operating activities$557.4$565.3Less: capital expenditures (68.0)(72.7)Free cash flow$489.4$492.6Free cash flow as a percent of adjusted net income attributable to IDEX(1)79.2 %93.8 %(1) Free cash flow as a percent of adjusted net income attributable to IDEX reflects the impact of excluding acquisition-related intangible asset amortization, net of related taxes, from adjusted net income attributable to IDEX in both periods presented.The decrease in free cash flow as compared to 2021 is due to the increases in working capital discussed above, which more than offset higher earnings.31Table of ContentsCash RequirementsContractual ObligationsThe Company’s contractual obligations include borrowings and related interest, purchase obligations, pension and post-retirement medical benefit plans, rental payments under operating leases, payments under capital leases, a transition tax payable and other obligations arising in the ordinary course of business (such as acquisition commitments). There are no identifiable events or uncertainties, including the lowering of the Company’s credit rating, which would accelerate payment or maturity of any of these commitments or obligations. For a description of the funding requirements related to the Company’s contractual obligations, refer to Note 4 (transition tax payable), Note 7 (borrowings and related interest), Note 10 (lease obligations) and Note 18 (pension and post-retirement obligations) in the Notes to Consolidated Financial Statements, respectively. As of December 31, 2022, the Company’s purchase obligations, consisting primarily of inventory commitments, totaled approximately $364.4 million, of which $336.4 million is expected to be settled during 2023 and the remainder thereafter. Capital ExpendituresCapital expenditures generally include machinery and equipment that support growth and improved productivity, tooling, business system technology, replacement of equipment and investments in new facilities. The Company believes it has sufficient operating cash flows to continue to meet current obligations and invest in planned capital expenditures. In 2022 and 2021, cash flows from operations were more than adequate to fund capital expenditures of $68.0 million and $72.7 million, respectively. The Company recently invested a significant amount of capital to expand the China facility which was completed in late 2022 and the India facility which is expected to be completed in early 2023, ultimately doubling the Company’s historic capacity in each of these countries. Otherwise, management considers its facilities suitable and adequate for the Company’s operations and believes it has ample capacity in its plants and equipment to meet demand increases for future growth in the intermediate term, especially given its operational improvement initiatives that usually increase capacity.Debt RepaymentAs of December 31, 2022, the Company has $100.0 million of 3.20% Senior Notes due June 2023. The Company expects to either refinance or repay the Notes using the available borrowing capacity of the Revolving Facility, due November 2027. Share RepurchasesThe Company repurchased 795,423 shares at a cost of $148.1 million in 2022. There were no share repurchases in 2021. As of December 31, 2022, the amount of share repurchase authorization remaining was $563.8 million. For additional information regarding the Company’s share repurchase program, refer to Note 12 in the Notes to Consolidated Financial Statements.CovenantsThe key financial covenants that the Company is required to maintain in connection with the Revolving Facility, the Term Facility and the 2016 Private Placement Notes, are a minimum interest coverage ratio of 3.0 to 1 and a maximum leverage ratio of 3.50 to 1. At December 31, 2022, the Company was in compliance with both of these financial covenants, as the Company’s interest coverage ratio was 24.39 to 1 for covenant calculation purposes and the leverage ratio was 1.55 to 1. There are no financial covenants relating to the 2.625% Senior Notes or the 3.00% Senior Notes; however, both are subject to cross-default provisions. For a discussion of the Company’s Revolving Facility and Senior Notes as well as the associated covenants, refer to Note 7 in the Notes to Consolidated Financial Statements.Credit RatingsThe Company’s credit ratings, which were independently developed by the following credit agencies, are detailed below:•S&P Global Ratings affirmed the Company’s corporate credit rating of BBB (stable outlook) in August 2022.•Moody’s Investors Service affirmed the Company’s corporate credit rating of Baa2 (stable outlook) in December 2021.•Fitch Ratings affirmed the Company’s corporate credit rating of BBB+ (stable outlook) in March 2022.32Table of ContentsDividends The Company increased its quarterly cash dividend by 11% from $0.54 per common share in 2021 to $0.60 per common share in 2022. Total dividend payments to common shareholders were $177.4 million in 2022 compared with $161.1 million in 2021.Critical Accounting EstimatesThe Company believes that the application of the following accounting policy, which is important to its financial position and results of operations, requires significant judgments and estimates on the part of management. For a summary of all of the Company’s accounting policies, including the accounting policy discussed below, see Note 1 in the Notes to Consolidated Financial Statements in Part II, Item 8, “Financial Statements and Supplementary Data.”Goodwill and intangible assets — The Company’s business acquisitions result in recording goodwill and other intangible assets, which affect the amount of amortization expense and possible impairment expense that the Company will incur in future periods. The Company evaluates the recoverability of certain noncurrent assets utilizing various estimation processes. The Company follows the guidance prescribed in Accounting Standards Codification (“ASC”) 350, Goodwill and Other Intangible Assets, to test goodwill and intangible assets for impairment. The Company determines the fair value of each reporting unit utilizing an income approach (discounted cash flows) weighted 50% and a market approach (consisting of a comparable public company multiples methodology) weighted 50%. The Company uses the relief-from-royalty method, a form of the income approach, to determine the fair value of its indefinite-lived intangible assets. The relief-from-royalty method is dependent on a number of significant management assumptions, including estimates of revenues, royalty rates and discount rates. To determine the reasonableness of the calculated fair values, the Company reviews the assumptions to ensure that neither the income approach nor the market approach yielded significantly different valuations. Based on the results of the Company’s annual impairment test at October 31, 2022, all reporting units had fair values substantially in excess of their carrying values.The key assumptions are updated every year for each reporting unit for the income and market approaches used to determine the fair value. Various assumptions are utilized including forecasted operating results, annual operating plans, strategic plans, economic projections, anticipated future cash flows, the weighted average cost of capital, market data and market multiples. The assumptions that have the most significant effect on the fair value calculations are the weighted average cost of capital, market multiples, forecasted EBITDA and terminal growth rates. The following assumption ranges were utilized by the Company in 2022 and 2021:Assumptions2022Range2021RangeWeighted average cost of capital9.75% to 11.50%8.25% to 9.75%Market multiples10.0x to 19.0x13.0x to 22.0xTerminal growth rates2.5% to 3.5%2.5% to 3.5%See Note 6 for further discussion on goodwill and indefinite-lived intangible assets.33Table of ContentsNon-GAAP DisclosuresSet forth below are reconciliations of each of Organic sales, Adjusted net sales, Adjusted net income attributable to IDEX, Adjusted diluted earnings per share (“EPS”) attributable to IDEX, Consolidated Adjusted earnings before interest, income taxes, depreciation and amortization (“Adjusted EBITDA”) and Consolidated Adjusted EBITDA margin to its respective most directly comparable U.S. GAAP measure. Management uses these metrics to measure performance of the Company since they exclude items that are not reflective of ongoing operations, such as fair value inventory step-up charges, restructuring expenses and asset impairments, the impact from the exit of a COVID-19 testing application, gain on sale of a business, gains on sales of assets, the impact of the settlement of a corporate transaction indemnity, the loss on early debt redemption, the noncash loss related to the termination of the U.S. pension plan, net of curtailment and acquisition-related intangible asset amortization. Management also supplements its U.S. GAAP financial statements with adjusted information to provide investors with greater insight, transparency and a more comprehensive understanding of the information used by management in its financial and operational decision making. This report references organic sales and organic operating income, non-GAAP measures, that exclude (1) the impact of foreign currency translation and (2) sales and operating income, respectively, from acquired or divested businesses during the first 12 months of ownership or prior to divestiture and (3) the impact from the exit of a COVID-19 testing application. The portion of sales and operating income attributable to foreign currency translation is calculated as the difference between (a) the period-to-period change in organic sales and organic operating income, respectively, and (b) the period-to-period change in organic sales and organic operating income, respectively, after applying prior period foreign exchange rates to the current year period. Management believes that reporting organic sales and organic operating income provides useful information to investors by helping to identify underlying growth trends in the Company’s business and facilitating easier comparisons of the Company’s revenue and operating performance with prior and future periods and to its peers. The Company excludes the effect of foreign currency translation from organic sales and organic operating income because foreign currency translation is not under management’s control, is subject to volatility and can obscure underlying business trends. The Company excludes the effect of acquisitions and divestitures because they can obscure underlying business trends and make comparisons of long-term performance difficult due to the varying nature, size and number of transactions from period to period and between the Company and its peers. The Company excludes the impact from the exit of a COVID-19 testing application because it is not reflective of ongoing operations and can obscure underlying business trends.Management believes that Adjusted EBITDA, which is EBITDA adjusted for items that are not reflective of ongoing operations, is useful as a performance indicator of ongoing operations. The Company believes that Adjusted EBITDA is useful to investors as an indicator of the strength and performance of the Company and its segments’ ongoing business operations and a way to evaluate and compare operating performance and value companies within the Company’s industry. Management believes that Adjusted EBITDA margin is useful for the same reason as Adjusted EBITDA. The definition of Adjusted EBITDA used here may differ from that used by other companies.This report also references free cash flow. This non-GAAP measure is discussed and reconciled to its most directly comparable GAAP measure in the section above titled “Free Cash Flow.”The non-GAAP financial measures disclosed by the Company should not be considered a substitute for, or superior to, financial measures prepared in accordance with U.S. GAAP. Due to rounding, numbers presented throughout this and other documents may not add up or recalculate precisely. The financial results prepared in accordance with U.S. GAAP and the reconciliations from these results should be carefully evaluated.1. Reconciliations of the Change in Net Sales to Organic Net SalesFor the Years Ended December 31,20222021FMTHSTFSDPIDEXFMTHSTFSDPIDEXChange in net sales17 %19 %5 %15 %11 %25 %15 %18 % - Net impact from acquisitions/divestitures7 %6 %— %5 %4 %5 %— %4 % - Impact from foreign currency(3 %)(4 %)(4 %)(4 %)1 %2 %2 %2 % - Impact from the exit of a COVID-19 testing application(1)— %2 %— %1 %— %— %— %— %Change in organic net sales13 %15 %9 %13 %6 %18 %13 %12 %(1) Represents the acceleration of previously deferred revenue of $17.9 million as a result of a customer’s decision to discontinue further investment in commercializing its COVID-19 testing application. See Note 15 in the Notes to Consolidated Financial Statements for further detail.2. Reconciliations of Reported-to-Adjusted Net Income and Diluted EPS(In millions, except per share amounts)For the Years Ended December 31,20222021Reported net income attributable to IDEX$586.9 $449.4 + Restructuring expenses and asset impairments4.5 9.3 + Tax impact on restructuring expenses and asset impairments(0.9)(2.2) + Fair value inventory step-up charges8.5 11.6 + Tax impact on fair value inventory step-up charges(2.2)(2.7) - Net impact from the exit of a COVID-19 testing application(1)(1.1)— + Tax impact on the exit of a COVID-19 testing application0.3 — - Gain on sale of business(34.8)— + Tax impact on gain on sale of business5.5 — - Gains on sales of assets(2.7)— + Tax impact on gains on sales of assets0.6 — + Loss on early debt redemption— 8.6 + Tax impact on loss on early debt redemption— (1.8) + Termination of the U.S. pension plan, net of curtailment— 8.6 + Tax impact on termination of the U.S. pension plan, net of curtailment— (1.9) + Corporate transaction indemnity— 3.5 + Tax impact on corporate transaction indemnity— (0.8) + Acquisition-related intangible asset amortization69.0 56.4 + Tax impact on acquisition-related intangible asset amortization(15.5)(12.9)Adjusted net income attributable to IDEX$618.1 $525.1 Reported diluted EPS attributable to IDEX$7.71 $5.88 + Restructuring expenses and asset impairments0.06 0.12 + Tax impact on restructuring expenses and asset impairments(0.01)(0.03) + Fair value inventory step-up charges0.11 0.15 + Tax impact on fair value inventory step-up charges(0.03)(0.04) - Net impact from the exit of a COVID-19 testing application(1)(0.01)— + Tax impact on the exit of a COVID-19 testing application— — - Gain on sale of business(0.46)— + Tax impact on gain on sale of business0.07 — - Gains on sales of assets(0.03)— + Tax impact on gains on sales of assets0.01 — + Loss on early debt redemption— 0.11 + Tax impact on loss on early debt redemption— (0.02) + Termination of the U.S. pension plan, net of curtailment— 0.11 + Tax impact on termination of the U.S. pension plan, net of curtailment— (0.02) + Corporate transaction indemnity— 0.05 + Tax impact on corporate transaction indemnity— (0.01) + Acquisition-related intangible asset amortization0.91 0.74 + Tax impact on acquisition-related intangible asset amortization(0.21)(0.17)Adjusted diluted EPS attributable to IDEX$8.12 $6.87 Diluted weighted average shares outstanding76.0 76.4 (1) Represents the net impact of the acceleration of previously deferred revenue of $17.9 million and an impairment charge of $16.8 million as a result of a customer’s decision to discontinue further investment in commercializing its COVID-19 testing application. See Note 15 in the Notes to Consolidated Financial Statements for further detail.3. Reconciliations of Net Income to Adjusted EBITDA and Net Sales to Adjusted Net Sales(Dollars in millions)For the Year Ended December 31, 2022FMTHSTFSDPCorporateIDEXReported net income$—$—$—$—$586.7+ Provision for income taxes————162.7+ Interest expense————40.7- Other income (expense) - net————3.9- Gain on sale of business————34.8Operating income (loss)334.0334.9166.6(84.1)751.4+ Other income (expense) - net1.81.92.4(2.2)3.9+ Depreciation16.125.78.40.550.7+ Amortization20.841.66.6—69.0+ Fair value inventory step-up charges0.48.1——8.5+ Restructuring expenses and asset impairments2.30.71.40.14.5 - Net impact from the exit of a COVID-19 testing application(1)—(1.1)——(1.1)- Gains on sales of assets(1.2)—(1.5)—(2.7)Adjusted EBITDA$374.2$411.8$183.9$(85.7)$884.2Net sales (eliminations)$1,167.3$1,339.2$679.2$(3.8)$3,181.9 - Impact from the exit of a COVID-19 testing application (1)(17.9)(17.9)Adjusted net sales (eliminations)$1,321.3$3,164.0Net income margin18.4 %Adjusted EBITDA margin32.1 %31.2 %27.1 %n/m27.9 %(1) Represents the net impact of the acceleration of previously deferred revenue of $17.9 million and an impairment charge of $16.8 million as a result of a customer’s decision to discontinue further investment in commercializing its COVID-19 testing application. See Note 15 in the Notes to Consolidated Financial Statements for further detail.For the Year Ended December 31, 2021FMTHSTFSDPCorporateIDEXReported net income$—$—$—$—$449.3+ Provision for income taxes————130.5+ Interest expense————41.0- Other income (expense) - net————(16.2)Operating income (loss)259.3288.9169.3(80.5)637.0+ Other income (expense) - net(6.1)(0.5)(1.2)(8.4)(16.2)+ Depreciation15.921.68.60.546.6+ Amortization14.635.16.7—56.4+ Fair value inventory step-up charges2.59.1——11.6+ Restructuring expenses and asset impairments4.51.70.52.69.3+ Corporate transaction indemnity———3.53.5+ Loss on early debt redemption———8.68.6+ Termination of the U.S. pension plan, net of curtailment6.3—1.80.58.6Adjusted EBITDA$297.0$355.9$185.7$(73.2)$765.4Net sales (eliminations)$998.7$1,121.8$647.9$(3.6)$2,764.8Net income margin16.3 %Adjusted EBITDA margin29.7 %31.7 %28.7 %n/m27.7 %For the Year Ended December 31, 2020FMTHSTFSDPCorporateIDEXReported net income$—$—$—$—$377.8+ Provision for income taxes————92.5+ Interest expense————44.8- Other income (expense) - net————(5.6)Operating income (loss)235.0206.4144.2(64.9)520.7+ Other income (expense) - net0.9—(0.4)(6.1)(5.6)+ Depreciation14.817.88.50.641.7+ Amortization11.124.06.7—41.8+ Fair value inventory step-up charges4.1———4.1+ Restructuring expenses and asset impairments5.62.72.51.011.8+ Loss on early debt redemption———8.48.4Adjusted EBITDA$271.5$250.9$161.5$(61.0)$622.9Net sales (eliminations)$896.3$896.0$562.9$(3.6)$2,351.6Net income margin16.1 %Adjusted EBITDA margin30.3 %28.0 %28.7 %n/m26.5 %34Table of ContentsItem 7A. Quantitative and Qualitative Disclosures About Market Risk.The Company is subject to market risk associated with changes in foreign currency exchange rates and interest rates as well as inflationary factors. The Company may, from time to time, enter into foreign currency forward contracts and interest rate swaps on its debt when it believes there is a financial advantage in doing so. A treasury risk management policy, adopted by the Board of Directors, describes the procedures and controls over derivative financial and commodity instruments, including foreign currency forward contracts and interest rate swaps. Under the policy, the Company does not use financial or commodity derivative instruments for trading purposes and the use of these instruments is subject to strict approvals by senior officers. Typically, the use of derivative instruments is limited to foreign currency forward contracts and interest rate swaps on the Company’s outstanding long-term debt. As of December 31, 2022, the Company did not have any derivative instruments outstanding.Foreign Currency Exchange RatesThe Company’s foreign currency exchange rate risk is limited principally to the Euro, Swiss Franc, British Pound, Canadian Dollar, Indian Rupee, Chinese Renminbi, Swedish Krona and Brazilian Real. The Company manages its foreign exchange risk principally through invoicing customers in the same currency as the source of products. The foreign currency transaction (gains) losses for the periods ended December 31, 2022, 2021 and 2020 were $(0.8) million, $1.1 million and $3.0 million, respectively, and are reported within Other (Income) Expense - Net on the Consolidated Statements of Income. See Note 1 in Part II, Item 8, “Financial Statements and Supplementary Data,” for further discussion.Interest Rate FluctuationsThe Company has interest rate exposure due to $277.7 million of the $1,477.8 million debt outstanding at December 31, 2022 being floating rate debt. The Company’s Revolving Facility and Term Facility both bear interest at either an alternate base rate or adjusted Term SOFR (or appropriate alternative currency reference rates) plus, in each case, an applicable margin based on the lower of the Company’s senior, unsecured, long-term debt rating or the Company’s applicable leverage ratio. At December 31, 2022, there was $77.7 million outstanding under the Revolving Facility with an interest rate of 3.32% and $200.0 million outstanding under the Term Facility with an interest rate of 5.83%.Inflation RiskWe source a wide variety of materials and components from a network of global suppliers. While materials are typically available from numerous suppliers, they are subject to price fluctuations, which could have a negative impact on our results. We seek to minimize the effects of inflation and changing prices through price increases to maintain reasonable gross margins.35Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Consolidated Financial Data” and the Consolidated Financial Statements and related Notes included elsewhere in this Report. A discussion of our financial performance for the year ended December 31, 2022 as compared to the year ended December 31, 2021 appears below under the captions “Results of Operations” and “Liquidity and Capital Resources.” A discussion of our financial performance for the year ended December 31, 2021 compared to the year ended December 31, 2020 can be found under the same captions in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 8, 2022, which is available free of charge on the SEC’s website at www.sec.gov and our Investor Relations website at investor.incyte.com/financial-information/annual-reports. These website addresses are intended to be inactive, textual references only. None of the materials on, or accessible through, these websites are part of this report or are incorporated by reference herein. OverviewIncyte is a biopharmaceutical company focused on the discovery, development and commercialization of proprietary therapeutics. Our global headquarters is located in Wilmington, Delaware, where we conduct global clinical development and commercial operations. We also conduct clinical development and commercial operations from our European headquarters in Morges, Switzerland and our other offices across Europe, our Japanese office in Tokyo and our Canadian headquarters in Montreal.Our portfolio focuses on areas of high unmet medical need and includes compounds in various stages, ranging from preclinical to late stage development, and commercialized products JAKAFI® (ruxolitinib), ICLUSIG® (ponatinib), PEMAZYRE® (pemigatinib) and OPZELURA™ (ruxolitinib) cream, as well as MINJUVI® (tafasitamab) and MONJUVI® (tafasitamab-cxix), which are co-commercialized. Our revenues depend on continued sales of our products, and we depend substantially on product revenues from JAKAFI. We must develop and commercialize new products to achieve revenue growth and to offset revenue losses from when products lose their exclusivity or when competing products are launched. For additional information, including information on the expirations of patents for various products, see Part I, Item 1 of this report, “Business—Patents and Other Intellectual Property” and “Business—Competition.” We devote substantial resources to research and development activities and to acquire rights to new product candidates and technologies, but successful product development in the biopharmaceutical industry is highly uncertain.Our product revenues also face challenges from economic conditions and drug pricing initiatives driven by governments and private payors. See Part I, Item 1A of this report, “Risk Factors” for a further discussion of certain factors that could impact our future product revenues.65Table of ContentsEffects of the COVID-19 Pandemic on Our BusinessThe impact of the COVID-19 pandemic on our operational and financial performance going forward depends on numerous factors, all of which are difficult to predict. These include the duration, spread and intensity of the pandemic; the protective measures imposed (or reimposed) by governmental authorities or by us to protect our employees; and the effects of the pandemic and such protective measures on our suppliers, collaborators and services providers and on the healthcare organizations serving patients. As a result, it is not currently possible to ascertain the potential long term impact of the COVID-19 pandemic on our business. To date, however, we have not experienced a material effect on the results of our commercial operations, or our manufacturing supply chain. New patient starts for treatment decreased as a result of shelter in place and other protective measures in the early stages of the pandemic, and if decreases in new patient starts occur in future periods, our revenues in future periods could be adversely affected. We continue to anticipate that short-term effects may continue to emerge across different aspects of our global clinical trial programs. For example, while we expect ongoing monitoring of already-enrolled patients to continue, difficulties in monitoring may result as a consequence of any new shelter in place orders and other protective measures implemented by governmental authorities or clinical trial sites. In addition, new patient recruitment in certain clinical trials has been and may in the future be impacted, in particular with respect to our earlier stage clinical trials. We also expect the conduct of clinical trials may continue to vary by disease state and by severity of disease, as well as by geography, as some regions are more adversely impacted. Overall, we caution that the duration and severity of the continuing COVID-19 pandemic remains uncertain, and we may not yet be able to assess its consequences accurately or fully at this time.Regulatory AchievementsIn May 2022, under our collaboration agreement with Novartis International Pharmaceutical Ltd., the European Commission (EC) approved JAKAVI (ruxolitinib) for the treatment of patients aged 12 years and older with acute and chronic GVHD and who have inadequate response to corticosteroids or other systemic therapies. JAKAVI is the first Janus kinase (JAK)1/2 inhibitor available for patients with GVHD in Europe.In May 2022, under our collaboration agreement with Eli Lilly and Company, the U.S. Food and Drug Administration (FDA) approved OLUMIANT for the treatment of COVID-19 in hospitalized adults requiring supplemental oxygen, non-invasive or invasive mechanical ventilation, or extracorporeal membrane oxygenation with a recommended dose of 4-mg once daily for 14 days or until hospital discharge, whichever comes first. OLUMIANT is the first and only JAK inhibitor FDA-approved for the treatment of COVID-19 in certain hospitalized adults requiring various degrees of oxygen support.In June 2022, under our collaboration agreement with Novartis, the EC approved TABRECTA (capmatinib) as a monotherapy for the treatment of adults with advanced non-small cell lung cancer NSCLC) harboring alterations leading to mesenchymalepithelial-transition factor gene (MET) exon 14 (METex14) kipping who require systemic therapy following prior treatment with immunotherapy and/or platinum-based chemotherapy.In June 2022, under our collaboration agreement with Lilly, the FDA approved OLUMIANT as the first and only systemic treatment for adults with severe alopecia areata (AA). In June 2022, the EC approved OLUMIANT as the first and only centrally-authorized treatment for adults with severe AA in Europe. In June 2022, the Japan Ministry of Health, Labor and Welfare approved OLUMIANT as a treatment for adults with alopecia areata.In July 2022, the FDA approved OPZELURA (ruxolitinib) cream for the topical treatment of nonsegmental vitiligo in adult and pediatric patients 12 years of age and older. OPZELURA is the first and only FDA-approved treatment for repigmentation in patients with vitiligo, and the only topical formulation of a JAK inhibitor approved in the United States.In August 2022, the FDA approved PEMAZYRE for the treatment of adults with relapsed or refractory myeloid/ lymphoid neoplasms (MLNs) with FGFR1 rearrangement. PEMAZYRE is the first and only targeted treatment for MLNs with FGFR1 rearrangement. MLNs with FGFR1 rearrangement are extremely rare and aggressive blood cancers that may impact less than 1 in 100,000 people in the United States.66Table of ContentsIn December 2022, the FDA approved a supplemental new drug application (sNDA) for revisions to JAKAFI labelling to update the Pediatric Use section of the Prescribing Information to describe the available experience of ruxolitinib in pediatric patients based on data from a study in children with de novo high-risk CRLF2-rearranged and/or JAK pathway-mutant acute lymphoblastic leukemia.License Agreements, Business Relationships and AcquisitionsWe establish business relationships, including collaborative arrangements with other companies and medical research institutions to assist in the clinical development and/or commercialization of certain of our drugs and drug candidates and to provide support for our research programs. We also establish business relationships with other companies and medical research institutions to acquire products or rights to products and technologies that are complementary to our business. Summarized below are the significant achievements under our existing collaboration and license agreements and additional agreements we entered into during the year ended December 31, 2022. InnoventIn March 2022, we recognized a $5.0 million milestone under our collaboration and licensing agreement with Innovent Biologics, Inc., for approval for PEMAZYRE in China for the treatment of adults with locally advanced or metastatic cholangiocarcinoma, which was recorded in milestone and contract revenues.LillyIn June 2022, we recognized $70.0 million in regulatory milestones for Eli Lilly and Company gaining approval of OLUMIANT in the United States, Europe and Japan for the treatment of alopecia areata.MaruhoIn April 2022, we entered into a Strategic Alliance Agreement with Maruho Co., Ltd for the development, manufacturing and exclusive commercialization of ruxolitinib cream, a novel cream formulation of Incyte’s selective JAK2 inhibitor ruxolitinib, for treatment of autoimmune and inflammatory dermatology indications in Japan. Under the terms of the agreement, we recognized an upfront payment and are eligible to receive additional potential development, regulatory and commercial milestones and royalties on net sales of the licensed product in Japan. Maruho will receive the rights to develop, manufacture and exclusively commercialize ruxolitinib cream, and other potential future topical formulations of ruxolitinib, in autoimmune and inflammatory dermatologic diseases, including vitiligo and atopic dermatitis, in Japan.NovartisIn April 2022, we recognized a $15.0 million regulatory milestone for the positive opinion issued by the Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) that recommended granting marketing authorization for capmatinib (TABRECTA) as a monotherapy for the treatment of adults with advanced non-small cell lung cancer. Additionally, in May 2022, we recognized a $45.0 million regulatory milestone as a result of the European Commission’s approval of JAKAVI (ruxolitinib) as the first post-steroid treatment for acute and chronic GVHD.Villaris In November 2022, we acquired Villaris Therapeutics, Inc., an asset-centric biopharmaceutical company focused on the development of novel antibody therapeutics for vitiligo. Its lead asset, auremolimab (VM6), is an anti-IL-15Rβ monoclonal antibody (mAb). Under the terms of the agreement, we paid an upfront payment of $70 million, and former Villaris stockholders will be eligible for up to $310.0 million upon achievement of certain development and regulatory milestones, as well as up to an additional $1.05 billion in commercial milestones on net sales of the product.67Table of ContentsCMS Aesthetics LimitedIn December 2022, we entered into a Collaboration and License Agreement with CMS Aesthetics Limited, a subsidiary of China Medical System Holdings Limited, for the development and commercialization of ruxolitinib cream, a novel cream formulation of Incyte’s selective JAK inhibitor ruxolitinib, for the treatment of autoimmune and inflammatory dermatologic diseases in Greater China and Southeast Asia. Under the terms of the agreement, CMS paid us an upfront payment of $30.0 million upon our transfer of the functional intellectual property related to ruxolitinib cream to CMS, and we are eligible to receive additional potential development, regulatory and commercial milestones and royalties on net sales of the licensed product in CMS’ territory. CMS received an exclusive license to develop and commercialize and a non-exclusive license to manufacture ruxolitinib cream, and potentially other future topical formulations of ruxolitinib, in autoimmune and inflammatory dermatologic diseases, including vitiligo and atopic dermatitis, for patients in mainland China, Hong Kong, Macau, Taiwan and Southeast Asia.Critical Accounting Policies and Significant Estimates The preparation of financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates under different assumptions or conditions. We believe the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of the consolidated financial statements. See Note 1 of Notes to the Consolidated Financial Statements for a complete list of our significant accounting policies.Revenue Recognition. We recognize revenue only when we have satisfied a performance obligation through transferring control of the promised good or service to a customer in an amount that reflects the consideration we expect to receive in exchange for those goods or services. We apply the following five-step model in order to determine this amount: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations, including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation, which for the Company is at a point in time. We also assess collectability based primarily on the customer’s payment history and on the creditworthiness of the customer.Product RevenuesOur product revenues consist of sales of JAKAFI, OPZELURA, PEMAZYRE, ICLUSIG, and MINJUVI. Product revenues are recognized once we satisfy the performance obligation at a point in time under the revenue recognition criteria as described above. We recognize revenues for product received by our customers net of allowances for customer credits, including estimated rebates, chargebacks, discounts, returns, distribution service fees, patient assistance programs, and government rebates, such as Medicare Part D coverage gap reimbursements in the United States. These sales allowances and accruals are recorded based on estimates which are described in detail below. Estimates are assessed as of the end of each reporting period and are updated to reflect current information. We believe that our sales allowances and accruals are reasonable and appropriate based on current facts and circumstances. As of December 31, 2022, a 5% change in our sales allowance and accruals would have had an approximate $50.1 million impact on our income before taxes. Customer Credits: Our customers are offered various forms of consideration, including allowances, service fees and prompt payment discounts. We expect our customers will earn prompt payment discounts and, therefore, we deduct the full amount of these discounts from total product sales when revenues are recognized. Service fees are also deducted from total product sales as they are earned.68Table of ContentsRebates and Discounts: We accrue rebates for mandated discounts under the Medicaid Drug Rebate Program in the United States and mandated discounts in Europe in markets where government-sponsored healthcare systems are the primary payers for healthcare. These accruals are based on statutory discount rates and expected utilization as well as historical data we have accumulated since product launch. In the fourth quarter of 2021 and fiscal year 2022 for non-covered patients of OPZELURA, we offered a full buy-down program as we were in the process of obtaining commercial insurance coverage for OPZELURA. During 2022, we contracted with the three largest group purchasing organizations to obtain coverage for OPZELURA. All full buy-down programs for OPZELURA ended effective January 31, 2023. Our estimates for expected utilization of commercial insurance rebates are based on data received from our customers. Rebates are generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarters’ unpaid rebates. If actual future rebates vary from estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment.Chargebacks: Chargebacks are discounts that occur when certain indirect contracted customers purchase directly from our wholesalers at a discounted price. The wholesalers, in turn, charges back to us the difference between the price initially paid by the wholesalers and the discounted price paid by the contracted customers. In addition to actual chargebacks received, we maintain an accrual for chargebacks based on the estimated contractual discounts on the inventory levels on hand in our distribution channel. If actual future chargebacks vary from these estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment.Medicare Part D Coverage Gap: Medicare Part D prescription drug benefit mandates manufacturers to fund 70% of the Medicare Part D insurance coverage gap for prescription drugs sold to eligible patients. Our estimates for the expected Medicare Part D coverage gap are based on historical invoices received and in part from data received from our customers. Funding of the coverage gap is generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarters. If actual future funding varies from estimates, we may need to adjust prior period accruals, which would affect revenue in the period of adjustment. Additionally, beginning in January 2020, the amount of spending required by eligible patients in the Medicare Part D insurance coverage gap increased 30% due to the expiration of a provision in the Patient Protection and Affordable Care Act, which now results in a change in the True Out of Pocket (TrOOP) calculation methodology. The methodological change has resulted in an increase in required spending by patients and, in turn, an increase in manufacturers’ contributions on behalf of patients in the Medicare Part D insurance coverage gap.Co-payment Assistance: Patients who have commercial insurance and meet certain eligibility requirements may receive co-payment assistance. We accrue a liability for co-payment assistance based on actual program participation and estimates of program redemption using data provided by third-party administrators. During the fourth quarter of 2021 and fiscal year 2022, we also offered a full buy-down program to non-covered patients of OPZELURA as we were obtaining commercial insurance coverage for OPZELURA. All full buy-down programs for OPZELURA ended effective January 31, 2023.Product Royalty RevenuesRoyalty revenues on commercial sales for JAKAVI and TABRECTA by Novartis are estimated based on information provided by Novartis. Royalty revenues on commercial sales for OLUMIANT by Lilly are estimated based on information provided by Lilly. Royalty revenues on commercial sales for PEMAZYRE by Innovent are estimated based on information provided by Innovent. We recognize royalty revenues in the period the sales occur. We exercise judgment in determining whether the information provided is sufficiently reliable for us to base our royalty revenue recognition thereon. If actual royalties vary from estimates, we may need to adjust the prior period, which would affect royalty revenue and receivable in the period of adjustment. Historically, adjustments to these estimates to reflect actual royalty revenues have not been material to our financial results and have been less than 1% of royalty revenues.69Table of ContentsMilestone and Contract RevenuesAt the inception of a contract, we determine the transaction price, in addition to any upfront payment, by estimating the amount of variable consideration, including milestone payments, at the outset of the contract utilizing the most likely amount method. Our contractual milestones typically relate to the achievement of pre-specified development, regulatory and commercialization events outside of our control, such as regulatory approval of a compound, first patient dosing or achievement of sales-based thresholds. We include milestones in the transaction price only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the milestone is subsequently resolved. Given the high level of uncertainty of achievement, variable consideration associated with milestones are fully constrained until confirmation of the satisfaction or completion of the milestone by the third-party. We review our estimate of the transaction price each period, and make revisions to such estimates as necessary.Stock Compensation. Share-based payment transactions with employees, which include stock options, restricted stock units (RSUs) and performance shares (PSUs), are recognized as compensation expense over the requisite service period based on their estimated fair values at the date of grant as well as expected forfeiture rates based on actual experience. The stock compensation process requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility over the option term and expected option lives, as well as expected forfeiture rates and the probability of PSUs vesting. For the years ending December 31, 2022 and 2021, our Black-Scholes assumptions included a weighted-average stock price volatility of 36% in 2022 and 39% in 2021, average expected option life of approximately five years and an estimated annualized forfeiture rate of 5%. The average risk-free interest rate assumption used in the Black-Scholes valuations increased from 0.62% in 2021 to 2.14% in 2022.The fair value of stock options, which are subject to graded vesting, are recognized as compensation expense over the requisite service period using the accelerated attribution method. The fair value of RSUs that are subject to cliff vesting are recognized as compensation expense over the requisite service period using the straight-line attribution method, and the fair value of RSUs that are subject to graded vesting are recognized as compensation expense over the requisite service period using the accelerated attribution method. The fair value of PSUs are recognized as compensation expense beginning at the time in which the performance conditions are deemed probable of achievement. We assess the probability of achievement of performance conditions, including projected product revenues and clinical development milestones, as of the end of each reporting period. Once a performance condition is considered probable, we record compensation expense based on the portion of the service period elapsed to date with respect to that award, with a cumulative catch-up, net of estimated forfeitures, and recognize any remaining compensation expense, if any, over the remaining requisite service period using the straight-line attribution method for PSUs that are subject to cliff vesting and using the accelerated attribution method for PSUs that are subject to graded vesting. Compensation expense for PSUs with market performance conditions is calculated using a Monte Carlo simulation model as of the date of grant and recorded over the requisite service period.Income Taxes. We account for income taxes using an asset and liability approach to financial accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect for years in which the basis differences are expected to reverse. We periodically assess the likelihood of the realization of deferred tax assets, and reduce the carrying amount of these deferred tax assets to an amount that is considered to be more-likely-than-not to be realizable. Our assessment considers recent cumulative earnings experience, projections of future taxable income (losses) and ongoing prudent and feasible tax planning strategies. When performing our assessment on projections of future taxable income (losses), we consider factors such as the likelihood of regulatory approval and commercial success of products currently under development, among other factors. Significant judgment is required in making this assessment and, to the extent that a reversal of any portion of our valuation allowance against our deferred tax assets is deemed appropriate, a tax benefit will be recognized against our income tax provision in the period of such reversal.We recognize the tax benefit from an uncertain tax position only if it is more-likely-than-not that the position will be sustained upon examination by the taxing authorities, including resolutions of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit that is recorded for these positions is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. We adjust the level of the liability to reflect any subsequent changes in the relevant facts surrounding the uncertain positions. Any interest and penalties on uncertain tax positions are included within the tax provision. 70Table of ContentsWe record estimates and prepare and file tax returns in various jurisdictions across the United States, Canada, Europe, and Asia based upon our interpretation of local tax laws and regulations. While we exercise significant judgment when applying complex tax laws and regulations in these various taxing jurisdictions, many of our tax returns are open to audit, and may be subject to future tax, interest, and penalty assessments. We believe our estimates for the valuation allowances against certain deferred tax assets and the amount of benefits associated with uncertain tax positions recognized in our financial statements are appropriate based upon our assessment of the factors mentioned above. As a result of releasing the valuation allowance on the majority of our U.S. deferred tax assets in 2021, we expect that our reported income tax expense (current plus deferred) for future periods will be higher than that recorded for prior periods.Acquisition-related contingent consideration. Acquisition-related contingent consideration, which consists of our future royalty obligations to ARIAD/Takeda, was recorded on the acquisition date at the estimated fair value of the obligation, in accordance with the acquisition method of accounting using an income approach based on projected future net revenues of ICLUSIG in the European Union and other countries. The fair value of the acquisition-related contingent consideration is remeasured each reporting period, with changes in fair value recorded in the consolidated statements of operations. The assumptions used to determine the fair value of the acquisition-related contingent consideration include projected future net revenues of ICLUSIG and a discount rate, which require significant judgement and are analyzed on a quarterly basis. As the fair value measurement is based on significant inputs that are unobservable in the market, this represents a Level 3 measurement.The valuation inputs utilized to estimate the fair value of the contingent consideration as of December 31, 2022 and 2021 included a discount rate of 10% and updated projections of future net revenues of ICLUSIG in the European Union and other countries for the approved third line treatment.While we use the best available information to prepare our projections of future net revenues of ICLUSIG and discount rate assumptions, actual ICLUSIG revenues and/or market conditions could differ significantly. Changes to one or multiple inputs could have a material impact on the amount of acquisition-related contingent consideration expense recorded during the reporting period. Results of OperationsYears Ended December 31, 2022 and 2021We recorded net income for the years ended December 31, 2022 and 2021 of $340.7 million and $948.6 million, respectively. On a per share basis, basic net income was $1.53 and diluted net income was $1.52 for the year ended December 31, 2022. On a per share basis, basic net income was $4.30 and diluted net income was $4.27 for the year ended December 31, 2021. For the year ended December 31, 2021, we recorded a benefit from income taxes of $569.0 million when we released the valuation allowance on the majority of our U.S. deferred tax assets. This benefit increased net income by $2.58 per basic and $2.56 per diluted share for the year ended December 31, 2021.71Table of ContentsRevenuesFor the Year Ended,December 31, 20222021(in millions)JAKAFI revenues, net$2,409.2 $2,134.5 ICLUSIG revenues, net105.8 109.4 PEMAZYRE revenues, net83.5 68.5 MINJUVI revenues, net19.7 4.9 OPZELURA revenues, net128.7 4.7 Total product revenues, net2,746.9 2,322.0 JAKAVI product royalty revenues331.6 338.0 OLUMIANT product royalty revenues134.5 220.9 TABRECTA product royalty revenues15.4 10.4 PEMAZYRE product royalty revenues1.2 — Total product royalty revenues482.7 569.3 Milestone and contract revenues165.0 95.0 Total revenues$3,394.6 $2,986.3 The increase in JAKAFI product revenues from 2021 to 2022 was comprised of a volume increase of $156.5 million and a price increase of $118.2 million. The increase in OPZELURA product revenues in 2022 was driven by the full year sales volume impact of the launch of OPZELURA following the September 2021 FDA approval for the treatment of atopic dermatitis and, subsequently, for the treatment of vitiligo in July 2022. Our product revenues may fluctuate from period to period due to our customers’ purchasing patterns over the course of a year, including as a result of increased inventory building by customers in advance of expected or announced price increases. Product revenues are recorded net of estimated product returns, pricing discounts including rebates offered pursuant to mandatory federal and state government programs and chargebacks, prompt pay discounts and distribution fees and co-pay assistance. Our revenue recognition policies require estimates of the aforementioned sales allowances each period.The following table provides a summary of activity with respect to our sales allowances and accruals (in thousands):Year Ended December 31, 2022Discounts and DistributionFeesGovernmentRebates andChargebacksCo-PayAssistanceand OtherDiscountsProductReturnsTotalBalance at January 1, 2022$14,678 $99,304 $24,074 $4,740 $142,796 Allowances for current period sales119,977 621,051 258,041 5,587 1,004,656 Allowances for prior period sales(94)(2,626)(5)— (2,725)Credits/payments for current period sales(97,085)(509,430)(248,300)— (854,815)Credits/payments for prior period sales(12,160)(59,834)(8,230)(3,961)(84,185)Balance at December 31, 2022$25,316 $148,465 $25,580 $6,366 $205,727 72Table of ContentsGovernment rebates and chargebacks are the most significant component of our sales allowances. Increases in certain government reimbursement rates are limited to a measure of inflation, and when the price of a drug increases faster than this measure of inflation it will result in a penalty adjustment factor that causes a larger sales allowance to those government related entities. We expect government rebates and chargebacks as a percentage of our gross product sales will continue to increase in connection with any future product price increases greater than the rate of inflation, and any such increase in these government rebates and chargebacks will have a negative impact on our reported product revenues, net. We adjust our estimates for government rebates and chargebacks based on new information regarding actual rebates as it becomes available. Claims by third-party payors for rebates and chargebacks are frequently submitted after the period in which the related sales occurred, which may result in adjustments to prior period accrual balances in the period in which the new information becomes available. Our company-sponsored patient savings program in which we provide financial assistance to enable commercially-insured patients to afford their insurance premium and co-pays may fluctuate as the commercial insurance landscape evolves and may impact net revenues, particularly for drugs like OPZELURA. We also adjust our allowance for product returns based on new information regarding actual returns as it becomes available.We expect our sales allowances to fluctuate from quarter to quarter as a result of the Medicare Part D Coverage Gap, the volume of purchases eligible for government mandated discounts and rebates as well as changes in discount percentages which are impacted by potential future price increases, rate of inflation, and other factors.Product royalty revenues on commercial sales of JAKAVI and TABRECTA by Novartis are based on net sales of licensed products in licensed territories as provided by Novartis. The decrease in JAKAVI product royalty revenues for the year ended December 31, 2022 as compared to the corresponding period in 2021 reflects unfavorable changes in foreign currency exchange rates. Product royalty revenues on commercial sales of OLUMIANT by Lilly are based on net sales of licensed products in licensed territories as provided by Lilly. The decrease in OLUMIANT product royalty revenues for the year ended December 31, 2022 as compared to the corresponding period in 2021 reflects unfavorable changes in foreign currency exchange rates and a decrease in net product sales of OLUMIANT for use as a treatment for COVID-19. Product royalty revenues on commercial sales of PEMAZYRE by Innovent are based on net sales of licensed products in licensed territories as provided by Innovent. Our milestone and contract revenues were $165.0 million and $95.0 million for the years ended December 31, 2022 and 2021, respectively. During the year ended December 31, 2022, our milestone and contract revenues were derived from total regulatory milestones achieved of $135.0 million, in addition to a $30.0 million upfront payment received upon our transfer of functional intellectual property to one of our collaboration partners. During the year ended December 31, 2021, our milestone and contract revenues were derived from the achievement of a $50.0 million sales milestone, a $10.0 million regulatory milestone, and $35.0 million upfront payment received upon our transfer of functional intellectual property to one of our collaboration partners.Cost of Product RevenuesFor the Year Ended December 31,20222021(in millions)Product costs$57.1 $21.0 Salary and benefits related9.5 7.2 Stock compensation2.7 1.7 Royalty expense116.2 99.6 Amortization of definite-lived intangible assets21.5 21.5 Total cost of product revenues$207.0 $151.0 Cost of product revenues includes all product related costs, employee personnel costs, including stock compensation, for those employees dedicated to the production of our commercial products, royalties owed under our collaborative agreements and amortization of our licensed intellectual property rights for ICLUSIG using the straight-line method over the estimated useful life of 12.5 years. Cost of product revenues increased from 2021 to 2022 due primarily to product related costs for our commercial products, including OPZELURA.73Table of ContentsOperating ExpensesResearch and development expenses For the Year Ended December 31,20222021(in millions)Salary and benefits related$345.6 $306.0 Stock compensation112.5 114.3 Clinical research and outside services978.9 902.3 Occupancy and all other costs148.9 135.6 Total research and development expenses$1,585.9 $1,458.2 We account for research and development costs by natural expense line and not costs by project. Salary and benefits related expense increased from 2021 to 2022 due primarily to increased development headcount to sustain our development pipeline. Stock compensation expense may fluctuate from period to period based on the number of awards granted, stock price volatility and expected award lives, as well as expected award forfeiture rates which are used to value equity-based compensation. The increase in clinical research and outside services expense from 2021 to 2022 was primarily due to continued investment in our late stage development assets. Research and development expenses also include upfront and milestone expenses related to our collaborative agreements and the acquisition of Villaris, which were $126.0 million and $149.0 million for the years ended December 31, 2022 and 2021, respectively. Research and development expenses for the years ended December 31, 2022 and 2021 were net of $52.2 million and $29.6 million, respectively, of costs reimbursed by our collaborative partners.In addition to one-time expenses resulting from upfront fees in connection with the entry into any new or amended collaboration agreements and payment of milestones under those agreements, research and development expenses may fluctuate from period to period depending upon the stage of certain projects and the level of pre-clinical and clinical trial related activities. Many factors can affect the cost and timing of our clinical trials, including requests by regulatory agencies for more information, inconclusive results requiring additional clinical trials, slow patient enrollment, adverse side effects among patients, insufficient supplies for our clinical trials, timing of drug supply, including API, and real or perceived lack of effectiveness or safety of our investigational drugs in our clinical trials. In addition, the development of all of our products will be subject to extensive governmental regulation. These factors make it difficult for us to predict the timing and costs of the further development and approval of our products. Selling, general and administrative expenses For the Year Ended December 31,20222021(in millions)Salary and benefits related$269.1 $222.4 Stock compensation73.2 67.0 Other contract services and outside costs659.8 450.2 Total selling, general and administrative expenses$1,002.1 $739.6 Salary and benefits related expense increased from 2021 to 2022 due primarily to increased headcount. This increased headcount was due primarily to the establishment of our dermatology commercial organization. Stock compensation expense may fluctuate from period to period based on the number of awards granted, stock price volatility and expected award lives, as well as expected award forfeiture rates which are used to value equity-based compensation. The increase in other contract services and outside costs was primarily due to expenses related to our dermatology commercial organization and activities to support the launch of OPZELURA for the treatments of atopic dermatitis and vitiligo.74Table of ContentsLoss on change in fair value of acquisition-related contingent considerationAcquisition-related contingent consideration, which consists of our future royalty obligations to ARIAD/Takeda, was recorded on the acquisition date, June 1, 2016, at the estimated fair value of the obligation, in accordance with the acquisition method of accounting. The fair value of the acquisition-related contingent consideration is remeasured quarterly. The change in fair value of the acquisition-related contingent consideration for the years ended December 31, 2022 and 2021 was expense of $12.1 million and $14.7 million, respectively, which is recorded in loss on change in fair value of acquisition-related contingent consideration on the consolidated statements of operations. The losses on change in fair value of the contingent consideration during the years ended December 31, 2022 and 2021, were due primarily to the impact of updated projections of future net revenues of ICLUSIG in the European Union and the passage of time.(Profit) and loss sharing under collaboration agreementsUnder the collaboration and license agreement with MorphoSys, which was executed in March 2020, we and MorphoSys are both responsible for the commercialization efforts of tafasitamab in the United States and will share equally the profits and losses from the co-commercialization efforts. For the year ended December 31, 2022 and 2021, our 50% share of the costs for tafasitamab was $8.0 million and $37.0 million, respectively, as recorded in (profit) and loss sharing under collaboration agreements on the consolidated statement of operations. Other income (expense), netOther income (expense), net. Other income (expense), net, for the years ended December 31, 2022 and 2021 was $39.9 million and $10.6 million, respectively. The increase in other income (expense), net primarily relates to an increase in interest income.Unrealized gain (loss) on long term investments. Unrealized gains and losses on long term investments will fluctuate from period to period, based on the change in fair value of the securities we hold in our publicly held collaboration partners. The following table provides a summary of those unrealized gains and (losses): For the Years Ended,December 31,20222021(in millions)Agenus$(9.9)$4.6 Calithera(0.9)(7.3)Merus(58.0)48.1 MorphoSys(21.2)(68.7)Syndax5.1 6.3 Syros(2.7)(7.1)Total unrealized loss on long term investments$(87.6)$(24.1)Provision (benefit) for income taxes. The provision (benefit) for income taxes for the years ended December 31, 2022 and 2021 was a provision of $188.5 million and a benefit of $378.1 million, respectively. The increase in tax expense of $566.6 million from 2021 to 2022 was primarily driven by the change in valuation allowance for U.S. deferred tax assets. For the year ended December 31, 2022, we recorded net tax expense of $28.4 million for the increase in the valuation allowance for deferred tax assets, primarily as a result of legislative changes from the Tax Cut and Jobs Act of 2017 that went into effect in 2022 requiring capitalization of research and development expenditures. For the year ended December 31, 2021, we recorded a benefit from income taxes of $569.0 million when we released the valuation allowance on the majority of our U.S. deferred tax assets. Further information on the impacts of the valuation allowance and significant judgments related to changes can be found in Note 13 of Notes to the Consolidated Financial Statements.75Table of ContentsLiquidity and Capital Resources20222021(in millions)December 31:Cash, cash equivalents, and marketable securities$3,239.0 $2,348.2 Working capital$2,935.8 $2,264.4 Year ended December 31:Cash provided by (used in):Operating activities$969.9 $749.5 Investing activities$(78.5)$(207.7)Financing activities$(0.8)$6.2 Capital expenditures (included in investing activities above)$(77.8)$(181.0)Sources and Uses of Cash.Due to historical net losses, we had an accumulated deficit of $0.4 billion as of December 31, 2022. We have funded our research and development operations through cash received from customers, sales of equity securities, the issuance of convertible notes, and collaborative arrangements. At December 31, 2022, we had available cash, cash equivalents and marketable securities of $3.2 billion. Our cash and marketable securities balances are held in a variety of interest-bearing instruments, including money market accounts and U.S. government debt securities. Available cash is invested in accordance with our investment policy’s primary objectives of liquidity, safety of principal and diversity of investments.Cash provided by (used in) operating activities. The increase in cash provided by operating activities from 2021 to 2022 was due primarily to changes in working capital.Cash used in investing activities. Our investing activities, other than purchases, sales and maturities of marketable securities, have consisted predominantly of capital expenditures and purchases of long term investments. During 2022, net cash used in investing activities was $78.5 million, which represents purchases of marketable securities of $79.9 million, capital expenditures of $77.8 million, offset in part by the sale and maturity of marketable securities of $79.2 million. During 2021, net cash used in investing activities was $207.7 million, which represents purchases of marketable securities of $235.2 million, capital expenditures of $181.0 million and purchase of long term equity investments of $33.5 million, offset in part by the sale and maturity of marketable securities of $231.5 million and the sale of long term investment of $10.5 million.Cash (used in) provided by financing activities. During 2022, net cash used in financing activities was $0.8 million, and in 2021, net cash provided by financing activities was $6.2 million, respectively, consisting primarily of proceeds from the issuance of common stock under our stock plans net of tax withholdings, offset in part by cash paid to ARIAD/Takeda for contingent consideration. Our capital expenditures for construction activities and our non-operating contractual operating and finance lease obligations are discussed in Note 8 of Notes to the Consolidated Financial Statements. In addition, in October 2019, we entered into an agreement with Wilmington Friends School Inc., to purchase property for $50.0 million to expand our global headquarters. Under that agreement, closing of the purchase is subject to certain standard closing conditions, including an initial diligence period and a subsequent approval period. In August 2021, we entered into a $500.0 million, three-year senior unsecured revolving credit facility. We may increase the maximum revolving commitments or add one or more incremental term loan facilities, subject to obtaining commitments from any participating lenders and certain other conditions, in an amount not to exceed $250.0 million plus a contingent additional amount that is dependent on our pro forma consolidated leverage ratio. As of December 31, 2022, we had no outstanding borrowings and were in compliance with all covenants under this facility. Our U.S. income tax payments will increase significantly due to the mandatory capitalization and amortization of research and development expenses for tax years beginning after December 31, 2021, as required under the Tax Cuts and Jobs Act of 2017, which eliminated the immediate expensing of such expenses.76Table of ContentsWe believe that our cash flow from operations, together with our cash, cash equivalents and marketable securities and funds available under our revolving credit facility, will be adequate to satisfy our capital needs for the foreseeable future. Our cash requirements depend on numerous factors, including our expenditures in connection with our drug discovery and development programs and commercialization operations; expenditures in connection with litigation or other legal proceedings; costs for future facility requirements; and expenditures for future strategic equity investments or potential acquisitions. We have entered into and may in the future seek to license additional rights relating to technologies or drug development candidates in connection with our drug discovery and development programs. Under these licenses, we may be required to pay upfront fees, milestone payments, and royalties on sales of future products. These contingent future payments are discussed in detail in Note 7 of Notes to the Consolidated Financial Statements.To the extent we seek to augment our existing cash resources and cash flow from operations to satisfy our cash requirements for future acquisitions or other strategic purposes, we expect that additional funding can be obtained through equity or debt financings or from other sources. The sale of equity or convertible debt securities in the future may be dilutive to our stockholders, and may provide for rights, preferences or privileges senior to those of our holders of common stock. Debt financing arrangements may require us to pledge certain assets or enter into covenants that could restrict our operations or our ability to incur further indebtedness.Item 7A. Quantitative and Qualitative Disclosures About Market RiskOur investments in marketable securities, which are composed primarily of U.S. government securities, are subject to default, changes in credit rating and changes in market value. These investments are also subject to interest rate risk and will decrease in value if market interest rates increase. As of December 31, 2022, marketable securities were $287.5 million. Due to the nature of these investments, if market interest rates were to increase immediately and uniformly by 10% from levels as of December 31, 2022, the decline in fair value would not be material.77Table of Contents
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+Item 7. Management’s Discussion and Analysis and Results of Operations in our Form 10-K for the fiscal year ended December 31, 2021 filed with the Securities and Exchange Commission on February 24, 2022.Factors Affecting Operating ResultsOur Pods are intended to be used continuously for up to three days and then be replaced with a new disposable Pod. We recently achieved a milestone of 360,000 estimated global customers using Omnipod, including over 100,000 U.S. customers using the Omnipod 5. As we grow our customer base, we expect to generate an increasing portion of our revenues through recurring sales of our disposable Pods, which provides recurring revenue. Our recurring revenue business model, alongside the Omnipod System’s unique patented design enables us to provide pump therapy at a low or no up-front investment in regions where reimbursement allows for it. Our pay-as-you-go pricing model also reduces the risk to third-party payors.During 2022, we issued two voluntary MDCs, one in October for our Omnipod DASH PDM related to its battery and the other in November for our Omnipod 5 Controller related to the charging port and cable. In addition to the estimated liability we recorded in 2022, we have a performance obligation to replace Omnipod DASH PDMs and Omnipod 5 Controllers sold subsequent to the MDC issuances, which is expected to negatively impact gross margins and net income in 2023, most notably in the first half of the year. We have also experienced and expect to continue to experience challenges stemming from the global supply chain disruption that began during the coronavirus pandemic (“COVID-19”); however, to date we have been able to successfully mitigate this disruption and ensure uninterrupted supply to our customers by increasing our inventory levels and taking other measures. While our mitigation efforts and inflation have and are expected to continue to negatively impact gross margins and net income in 2023, we intend to continue to work to improve productivity to help offset these costs.Comparison of the Years Ended December 31, 2022 and December 31, 2021 RevenueYears Ended December 31,(In millions)20222021% ChangeCurrency ImpactConstant Currency(1)U.S. Omnipod$884.8 $651.5 35.8 %— %35.8 %International Omnipod363.0 359.9 0.9 %(11.2)%12.1 %Total Omnipod1,247.8 1,011.4 23.4 %(3.6)%27.0 %Drug Delivery57.5 87.4 (34.2)%— %(34.2)%Total$1,305.3 $1,098.8 18.8 %(3.4)%22.2 %(1) Constant currency revenue growth is a non-GAAP financial measure which should be considered supplemental to, and not a substitute for, our reported financial results prepared in accordance with GAAP. See “Management’s Use of Non-GAAP Measures.”Total revenue for 2022 increased $206.5 million, or 18.8%, to $1,305.3 million, compared with $1,098.8 million in 2021. Constant currency revenue growth of 22.2% was primarily driven by higher volume and, to a lesser extent, favorable sales channel mix. U.S. OmnipodU.S. Omnipod revenue for 2022 increased $233.3 million, or 35.8%, to $884.8 million, compared with $651.5 million in 2021. This increase was primarily due to higher Omnipod 5 and Omnipod DASH volumes driven by growing our customer base and, to a lesser extent, growth through the pharmacy channel, where Pods have a higher average selling price due in part to the fact that we offer the PDM/Controller for no charge. Existing customer conversions to Omnipod 5 also contributed to the revenue increase as some users fill both their starter kit and their first month of refills simultaneously.U.S. Omnipod revenue for 2022 includes $249.9 million of related party revenue, compared with $58.2 million in 2021. The $191.7 million increase primarily resulted from a shift in certain revenues from one distributor to another as we worked to extend our reach through the pharmacy channel. Additional information regarding our related party transactions is provided in Note 5 to our consolidated financial statements. In 2023, we expect strong Omnipod revenue growth driven by continued volume growth of Omnipod 5 in the pharmacy channel, continued adoption of Omnipod DASH, and the benefits of our recurring revenue model.33Table of ContentsInternational OmnipodInternational Omnipod revenue for 2022 increased $3.1 million, or 0.9%, to $363.0 million, compared with $359.9 million in 2021. Excluding the 11.2% unfavorable impact of currency exchange, the remaining 12.1% increase was primarily due to higher volumes as we continue to expand awareness and access to Omnipod DASH, partially offset by increased competition from AID systems. In 2023, we expect higher International Omnipod revenue due to continued volume growth driven by the ongoing adoption of Omnipod DASH, partially offset by competition from AID systems and an unfavorable impact of currency exchange.Drug DeliveryDrug Delivery revenue for 2022 decreased $29.9 million, or 34.2%, to $57.5 million, compared with $87.4 million in 2021. This decrease was primarily driven by a decline in production volume due to lower demand from our partner. In 2023, we expect Drug Delivery revenue to decline due to a lower demand forecast from our partner.Operating ExpensesYears Ended December 31,20222021(In millions)AmountPercent of RevenueAmountPercent of RevenueCost of revenue$499.7 38.3 %$346.7 31.6 %Research and development expenses$180.2 13.8 %$160.1 14.6 %Selling, general and administrative expenses$587.8 45.0 %$466.0 42.4 %Cost of RevenueCost of revenue for 2022 increased $153.0 million, or 44.1%, to $499.7 million, compared with $346.7 million in 2021. Gross margin was 61.7% in 2022, compared with 68.4% in 2021. The 6.7 point decrease in gross margin was primarily driven by a $57.9 million net charge, or 4.5 points, associated with the voluntary MDCs we issued in 2022. The decrease was also driven by higher expected production costs in the U.S. as manufacturing continues to ramp and become a larger portion of our total production and higher costs associated with Omnipod 5 production. These decreases were partially offset by higher average selling price due to growth in the pharmacy channel, where Pods have a higher average selling price due in part to the fact that we offer the PDM/Controller for no charge.We expect gross margin for 2023 to be in the range of 65% to 66%. We anticipate gross margin to increase due to significant costs associated with the MDCs in 2022, most of which we do not expect to recur in 2023 and higher volume in the pharmacy channel and favorable geographical sales mix. We believe these increases will be partially offset by continued higher production costs as we further scale U.S. manufacturing, unfavorable product line mix due to higher costs associated with Omnipod 5 production, and higher costs as we contend with inflation.Research and DevelopmentResearch and development expenses for 2022 increased $20.1 million, or 12.6%, to $180.2 million, compared with $160.1 million in 2021. This increase was primarily due to year-over-year headcount additions to support our continued investment in development of Omnipod products, partially offset by lower outside services used for clinical activities. We expect research and development spending in 2023 to increase compared with 2022 as we continue to invest in advancing our innovation and clinical pipeline and contend with inflation.Selling, General and AdministrativeSelling, general and administrative expenses for 2022 increased $121.8 million, or 26.1%, to $587.8 million, compared with $466.0 million in 2021. This increase was primarily attributable to year-over-year headcount additions, mainly to support information technology and commercial operations and $25.2 million of legal charges related to the settlement of a patent infringement lawsuit, associated legal fees, and the settlement of a contract dispute. To a lesser extent, these increases were due to an increase in investments to expand market acceptance and access to Omnipod, higher travel and entertainment expenses due to increased activity as COVID-19 restrictions have lifted, an increase in software license fees driven by investments in new systems to support our growing business and headcount additions, and higher amortization of cloud computing implementation costs. Additionally, selling, general and administrative expenses include $3.4 million of costs associated with the retirement and advisory services of our former chief executive officer. These increases were partially offset by a decrease in direct-to-consumer advertising resulting from the timing of spend. We expect selling, general and administrative expenses to increase in 2023 compared with 2022 due to investments in our operating structure to facilitate operational efficiencies and continued growth, including customer support and a new enterprise 34Table of Contentsresource planning system. Additionally, we plan to make investments to support the Omnipod System, including market acceptance and access, and the phased launch of Omnipod 5 in our international markets.Non-Operating ItemsInterest Expense, NetInterest expense, net for 2022 decreased $34.5 million, or 56.4%, to $26.7 million, compared with $61.2 million in 2021. This decrease was primarily driven by the adoption of Accounting Standards Update 2020-06, Accounting for Convertible Debt Instruments and Contracts in an Entity's Own Equity (“ASU 2020-06”), which eliminated most of the non-cash interest expense associated with our convertible notes. Refer to Recently Adopted Accounting Standard in Note 2 to our consolidated financial statements for additional information.Loss on Extinguishment of DebtDuring 2021, we incurred a $42.4 million loss on extinguishment of debt related to the repurchase and conversion of all of our outstanding 1.375% Notes. Refer to Note 15 to our consolidated financial statements for additional information.Other Expense, NetOther expense, net for 2022 decreased $0.8 million to $1.1 million, compared with $1.9 million in 2021. The decrease was primarily driven by an increase in unrealized foreign currency gains, which was partially offset by realized foreign currency losses.Income Tax ExpenseIncome tax expense was $5.2 million on pre-tax income of $9.8 million for 2022 and $3.7 million on pre-tax income of $20.5 million for 2021. Our effective tax rate was 53.4% and 18.2% for 2022 and 2021, respectively. The increase in our effective tax rate was primarily driven by a decrease in pre-tax income in the U.S. where we have net operating loss carryforwards to reduce taxable profits and a full valuation allowance against deferred tax assets. Refer to Note 22 to our consolidated financial statements for additional information on our income tax expense.Adjusted EBITDAThe table below presents reconciliations of Adjusted EBITDA, a non-GAAP financial measure, to net income, the most directly comparable financial measure prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”):Years Ended December 31,(in millions)20222021Net income$4.6 $16.8 Interest expense, net26.7 61.2 Income tax expense5.2 3.7 Depreciation and amortization63.2 57.4 Stock-based compensation expense38.6 34.4 Voluntary MDCs(1)57.9 — Legal costs(2)25.2 — CEO transition costs(3)3.4 — Loss on extinguishment of debt(4)— 42.4 Adjusted EBITDA$224.8 $215.9 (1) Represents net charge recorded for the estimated costs associated with the voluntary MDCs. Refer to Note 13 to our consolidated financial statements for additional information.(2) Includes a $20.0 million charge to settle patent infringement litigation with Roche, associated legal fees, and a $3.6 million charge to settle a contract dispute. Refer to Note 17 to our consolidated financial statements for additional information.(3) Represents costs associated with the retirement and advisory services of our former chief executive officer, including $2.3 million of accelerated stock-based compensation expense.(4) Relates to the repurchase and conversion of all of our outstanding 1.375% Notes. Refer to Note 15 to our consolidated financial statements for additional information.35Table of ContentsNon-GAAP Financial MeasuresManagement uses the following non-GAAP financial measures:Constant currency revenue growth represents the change in revenue between current and prior year periods using the exchange rate in effect during the applicable prior year period. We present constant currency revenue growth because we believe it provides meaningful information regarding our results on a consistent and comparable basis. Management uses this non-GAAP financial measure, in addition to financial measures in accordance with GAAP, to evaluate our operating results. It is also one of the performance metrics that determines management incentive compensation.Adjusted EBITDA represents net income (loss) plus net interest expense, income tax expense (benefit), depreciation and amortization, stock-based compensation expense and other significant transactions or events, such as legal settlements, medical device corrections, and loss on extinguishment of debt, that affect the period-to-period comparability of our operating performances, as applicable. We present Adjusted EBITDA because management uses it as a supplemental measure in assessing our operating performance, and we believe that it is helpful to investors, and other interested parties as a measure of our comparative operating performance from period to period. Adjusted EBITDA is a commonly used measure in determining business value and we use it internally to report results. These non-GAAP financial measures should be considered supplemental to, and not a substitute for, our reported financial results prepared in accordance with GAAP. In addition, the above definitions may differ from similarly titled measures used by others. Non-GAAP financial measures exclude the effect of items that increase or decrease our reported results of operations; accordingly, we strongly encourage investors to review our consolidated financial statements in their entirety.Liquidity and Capital ResourcesCapitalizationThe following table contains several key measures to gauge our financial condition and liquidity at the end of each year:As of December 31,(in millions)20222021Cash and cash equivalents$674.7 $791.6 Current portion of long-term debt$27.5 $25.1 Long-term debt, net$1,374.3 $1,248.8 Total debt, net$1,401.8 $1,273.9 Total stockholders’ equity$476.4 $556.3 Debt-to-total capital ratio75 %70 %Net debt-to-total capital ratio39 %26 %The increase in debt and the decrease in stockholders’ equity was primarily due to the adoption of ASU 2020-06. Refer to Recently Adopted Accounting Standard in Note 2 to our consolidated financial statements for additional information.Convertible DebtTo finance our operations and global expansion, we have periodically issued convertible senior notes, which are convertible into our common stock. As of December 31, 2022, the following notes were outstanding:Issuance DateCouponPrincipal Outstanding (in millions)Due DateConversion Rate(1)Conversion Price per Share of Common StockSeptember 20190.375%$800.0 September 20264.4105$226.73(1) Per $1,000 face value of notes.In connection with the issuance of the 0.375% Convertible Senior Notes (“0.375% Notes”), we purchased capped call options (“Capped Calls”) on our common stock. By entering into the Capped Calls, we expect to reduce the potential dilution to our common stock (or, in the event the conversion is settled in cash, to provide a source of cash to settle a portion of our cash payment obligation) in the event that at the time of conversion our stock price exceeds the conversion price under the 0.375% Notes. The Capped Calls have an initial strike price of $335.90 per share and cover 3.5 million shares of our common stock. Credit AgreementWe have a $100 million three-year senior secured revolving credit facility (“Revolving Credit Facility”), which expires in 2024. At December 31, 2022, no amount was outstanding under the Revolving Credit Facility. The Revolving Credit Facility contains a covenant to maintain a specified leverage ratio under certain conditions when there are amounts outstanding under the facility. 36Table of ContentsIt also contains other customary covenants, none of which are considered restrictive to our operations. Additionally, we have a seven year term loan, which matures in 2028, that contains covenants restricting or limiting our ability to incur additional indebtedness, make asset dispositions, create or permit liens, sell, transfer or exchange assets, guarantee certain indebtedness, and make acquisitions and other investments. Additional information regarding our debt is provided in Note 15 to the consolidated financial statements. We believe that our current liquidity will be sufficient to meet our projected operating, investing, and debt service requirements for at least the next twelve months.Summary of Cash FlowsYears Ended December 31,(in millions)20222021Cash provided by (used in):Operating activities$119.0 $(68.1)Investing activities(191.1)(82.7)Financing activities(40.3)40.7 Effect of exchange rate changes on cash(4.3)(5.5)Net decrease in cash, cash equivalents, and restricted cash$(116.7)$(115.6)Operating ActivitiesNet cash provided by operating activities of $119.0 million in 2022 was primarily attributable to net income, as adjusted for depreciation and amortization and stock-based compensation expense, partially offset by a $2.5 million working capital cash outflow. The working capital outflow was driven by a $36.8 million increase in prepaid expenses and other assets, a $51.8 million increase in accounts receivable, and a $49.1 million increase in inventories, partially offset by a $137.6 million increase in accrued expenses and other liabilities. The increase in prepaid expenses and other assets was primarily driven by an increase in cloud computing implementation costs. The increase in accounts receivable was primarily due to an increase in sales in the U.S. pharmacy channel, which has longer payment terms, partially offset by a decrease in unbilled accounts receivable related to lower production volumes of our Drug Delivery product. The increase in inventories was primarily driven by a planned inventory build to satisfy demand. Finally, the increase in accrued expenses and other liabilities was primarily driven by the voluntary MDCs issued for our Omnipod DASH PDMs and Omnipod 5 Controllers, an increase in rebates due to growth in the pharmacy channel and an increase in compensation costs due to higher incentive compensation achievement and head count additions.Net cash used in operating activities of $68.1 million in 2021 was primarily attributable to net income, as adjusted for depreciation and amortization, loss on extinguishment of debt, non-cash interest, and stock-based compensation expense, partially offset by a $263.6 million working capital cash outflow. The working capital outflow was driven by a $154.4 million increase in inventories, a $71.3 million increase in accounts receivable and a $46.7 million increase in prepaid expenses and other assets, partially offset by a $24.4 million increase in accrued expenses and other liabilities. The increase in inventories was primarily driven by a planned inventory build to satisfy demand and the addition of our third highly automated manufacturing line. The increase in accounts receivable was primarily due to an increase in sales in the U,S. pharmacy channel, which has longer payment terms. The increase in prepaid expenses and other assets was primarily driven by an increase in cloud computing implementation costs. Finally, the increase in accrued expenses and other liabilities was primarily driven by an increase in rebates due to growth in the pharmacy channel and higher compensation costs due to an increase in both incentive compensation achievement and head count.Investing ActivitiesWe had $191.1 million of net cash used in investing activities in 2022, compared with $82.7 million in 2021.Capital Spending—Capital expenditures were $122.9 million and $111.9 million in 2022 and 2021, respectively, and primarily related to the purchase of equipment to increase our manufacturing capacity. We expect capital expenditures for 2023 to decrease compared with 2022 given our significant investments to build capacity in 2022, including acceleration of some of our spending on machinery and equipment for our new Malaysia manufacturing facility that is under construction. We expect to fund our capital expenditures using existing cash.Investments in Developed Software—Investments in developed software were $12.9 million and $10.8 million in 2022 and 2021, respectively, and primarily related to investments in projects to support our cloud-based capabilities.37Table of ContentsAcquisitions and Investments—In 2022, we paid $26.0 million to acquire substantially all the assets related to the manufacture and production of shape-memory alloy wire assemblies that are used in the production of Omnipods from Dynalloy, Inc. and $21.5 million to acquire developed technology and patents from AGC. In addition we paid $7.8 million for strategic investments in two private companies. Sales of Marketable Securities—The $40.0 million decrease in cash receipts from maturities of marketable securities in 2021 was driven by the prior year shift of a portion of our investment portfolio to investments that are classified as cash equivalents.Financing ActivitiesWe had $40.3 million of net cash used in financing activities in 2022, compared with $40.7 million of net cash provided by financing activities in 2021.Debt Issuance and Repayment—During 2022, we made $24.5 million in aggregate principal payments on our equipment financings, mortgage, and term loan, compared with $22.3 million in 2021. The $2.2 million increase is due to entering the term loan and an additional equipment financing in the second and third quarters of 2021, respectively. During 2021, we received net proceeds of $489.5 million from the issuance of the term loan and used $460.9 million of cash to partially fund the repurchase of a portion of our 1.375% Notes. We also received net proceeds of $43.1 million from the equipment financing transaction entered into in 2021.Prepayments of Finance Lease Obligation—During 2022, we made $15.3 million in upfront payments upon entering into an agreement to acquire real estate in Malaysia. Refer to Note 14 to the consolidated financial statements for additional information regarding this lease.Option Exercises and Employee Stock Purchase Plan Proceeds—Total proceeds from option exercises and issuance of employee stock purchase plan shares were $16.3 million and $23.5 million in 2022 and 2021, respectively. The $7.2 million decrease was primarily driven by option exercises in the prior year by our former chief executive officer who retired in 2018.Payment of Taxes for Restricted Stock Net Settlements—Payments for taxes related to net restricted and performance stock unit settlements were $16.8 million and $28.2 million in 2022 and 2021, respectively. The $11.4 million decrease was primarily driven by vesting of performance stock units in the prior year by our former chief executive officer who retired in 2018.Commitments and Contingencies Contractual Obligations—A summary of our contractual obligations and commitments for debt, operating lease obligations and other obligations at December 31, 2022 is presented in the following table:(in millions)Short TermLong TermTotalDebt obligations$26.9 $1,397.6 $1,424.5 Interest payments(1)(2)45.9 174.6 220.5 Purchase obligations(3) 218.0 42.9 260.9 Lease obligations(1) 6.1 42.3 48.4 Total contractual obligations$296.9 $1,657.4 $1,954.3 (1)Interest on debt and lease obligations are projected for future periods using the interest rates in effect as of December 31, 2022. Certain of these projected interest payments may differ in the future based on changes in market interest rates. Additional information regarding our leases is provided in Note 14 to the consolidated financial statements.(2)Excludes the impact of the interest rate swaps discussed in Note 16 to our consolidated financial statements.(3)Purchase obligations include commitments for the purchase of Omnipod System components, commitments related to establishing additional manufacturing capabilities, and other commitments for purchases of goods or services in the normal course of business. These commitments are derived from purchase orders, supplier contracts and open orders based on projected demand information.Off-Balance Sheet ArrangementsAs of December 31, 2022, we had various letters of credit totaling $18.6 million. During 2022, the Company entered into a $20 million uncommitted letter of credit facility. In conjunction with the execution of an agreement to acquire real estate in Malaysia, including land and building, a letter of credit of $17.2 million was issued under this facility to backstop a bank guarantee for the same amount. The bank guarantee serves as security for the building while under construction. Additional information regarding our letters of credit is provided in Note 17 to the consolidated financial statements.38Table of ContentsCritical Accounting Policies and EstimatesThe preparation of our consolidated financial statements in conformity with U.S. GAAP requires management to use judgment in making estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. The following accounting policies are based on, among other things, judgments and assumptions made by management that include inherent risks and uncertainties. Management’s estimates are based on the relevant information available at the end of each period.Revenue RecognitionWe recognize revenue when a customer obtains control of the promised products in an amount that reflects the net consideration to which we expect to be entitled. We sell products both through distributors, who resell the products to consumers, and directly to consumers. Transaction price is typically based on contracted rates less any estimates of claim denials and historical reimbursement experience, guidelines and payor mix, and less estimated variable consideration adjustments, including rebates. Recognizing revenue requires us to exercise judgment and use estimates that can have a significant impact on the amount and timing of revenue we report. We exercise significant judgment when we determine variable consideration adjustments. The amount of variable consideration that is included in the transaction price is included in revenue only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. We estimate reductions to our revenues for rebates paid to distributors in the United States and Canada and pharmacy benefit managers (“PBM”) in the United States. Rebates are based on contractual arrangements, which may vary. Our estimates are based on products sold, historical experience, trends, specific known market events and, as available, channel inventory data. Rebates charged against gross sales amounted to $247.1 million, $143.3 million and $82.5 million in 2022, 2021 and 2020, respectively. Provisions for rebates, sales discounts, and returns are accounted for as a reduction of sales when revenue is recognized and are included within accounts receivable trade or accrued expenses and other current liabilities on our consolidated balance sheets, based upon the recipient of the rebate. If the actual amounts of consideration that we receive differ from our estimates, we adjust our estimates, which affects reported revenue in the period that such variances become known. Our Drug Delivery product line includes sales of a modified version of the Omnipod to pharmaceutical and biotechnology companies who use our technology as a delivery method for their drugs. Revenue from the Drug Delivery product was $57.5 million for 2022. Revenue for this product line is recognized as the product is produced. Accounting for Drug Delivery revenue requires us to select a method to measure progress towards the satisfaction of the performance obligation. This election of the most meaningful measure of progress by which to recognize Drug Delivery revenue requires the application of judgment. We elected the input method and selected a blend of cost and time to produce as the measure of progress. Accordingly, revenue is recognized over time using a blend of costs incurred to date relative to total estimated costs at completion and time incurred to date relative to total production time to measure progress toward the satisfaction of our performance obligations. We believe that both incurred cost and elapsed time reflect the value generated, which best depicts the transfer of control to the customer. Contract costs include third-party costs as well as an allocation of manufacturing overhead. Changes from quarter to quarter in quantity and stage of production of in-process inventory could have a significant quarterly impact on revenue.Product WarrantyWe provide a four-year warranty on our PDMs and Controllers sold in the United States and Europe and a five-year warranty on PDMs sold in Canada. In addition, we may replace Pods that do not function in accordance with product specifications. We estimate our warranty obligation at the time the product is shipped based on historical experience and the estimated cost to service the claims, which include the current product cost, reclaim costs, shipping and handling costs and direct and incremental distribution and customer service support costs. Since we continue to introduce new products and versions, the anticipated performance of the product over the warranty period is also considered in estimating warranty reserves. Changes to the actual replacement rates, which are evaluated quarterly, could have a material impact on our estimated warranty reserve.In 2022, we issued voluntary MDCs for the Omnipod DASH PDM and the Omnipod 5 Controller and accrued an associated warranty reserve of $68.9 million, which was subsequently reduced by $11.0 million primarily due to significantly fewer customers requesting a replacement Omnipod DASH PDM prior to our updated PDM being available. The remaining $54.6 million warranty reserve at December 31, 2022 includes an estimate regarding the number of:•customers expected to request a replacement Omnipod 5 Controller;•PDMs/Controllers that will be distributed by third parties and the cost of distribution assistance outside the U.S.;•additional customer support personnel, their cost and the length of time they will be needed; and•old PDMs expected to be returned for disposal and the cost of reclaimChanges in these assumptions could have a material impact on our estimated warranty reserve related to the MDCs.39Table of ContentsIntangible AssetsCertain of our intangible assets have been acquired through business combinations or asset purchases that include multiple components, both of which have required us to perform valuations. Our valuations involve assumptions, including, revenue and/or revenue growth rates associated with acquired assets, customer attrition rates, discount rate rates, royalty rates, tax rates, expected product development plans, product lifecycles, and obsolescence. In 2022, we entered into an Asset Purchase Agreement pursuant to which we made a one-time payment of $25.0 million for the acquisition of technology and patents and the release of future obligations to AGC, including any future royalty obligations. This amount, together with transaction costs, was allocated between the assets acquired and the settlement component based on estimated relative fair value. The valuation of these intangible assets included assumptions based on future revenues, royalty rates, and obsolescence curves related to our Omnipod 5 product. In addition, since certain of the intangible assets were classified as defensive assets, the valuation included an assumption related to the probability that a claim made by Insulet would be successful. As a result of the relative fair value allocation, values of $12.0 million and $9.5 million were assigned to acquired technology and patents, respectively, and the settlement component was estimated to have a value of $3.6 million. Changes in these assumptions could impact the values assigned to the intangible assets acquired and, accordingly have a material impact on the amount attributed to the settlement component in our results of operations.Inventory Reserves We reduce the carrying value of inventories for items that are potentially excess, obsolete, or slow-moving based on changes in customer demand, technology developments, or other economic factors in order to state inventories at net realizable value. Factors influencing these adjustments include inventories on hand compared to estimated future usage and sales. During 2022, we charged $8.4 million to the consolidated statement of operations for excess and obsolete inventory, including $4.8 million related to the phase-out of Classic Omnipod. The determination of this charge involved assumptions regarding the number of PDMs expected to be utilized to satisfy warranty claims during the phase-out period and the length of time we will continue to offer Classic Omnipod outside the United States. Forward-Looking StatementsThis Annual Report on Form 10-K contains forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “targets,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. These statements are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, results of operations, and financial condition. Forward-looking statements involve risks, uncertainties, and assumptions. Actual results may differ materially from those expressed in these forward-looking statements. You should not put undue reliance on any forward-looking statements.The risk factors discussed in “Risk Factors” could cause our results to differ materially from those expressed in forward-looking statements. In addition, there may be other risks and uncertainties that we are unable to predict at this time or that we currently do not expect to have a material adverse effect on our business. We expressly disclaim any obligation to update these forward-looking statements other than as required by law.Item 7A. Quantitative and Qualitative Disclosures about Market RiskInterest Rate RiskOur exposure to changes in interest rates is associated with borrowings under our Revolving Credit Facility and our Term Loan, both of which are variable-rate debt. At December 31, 2022, no amounts were outstanding under our Revolving Credit Facility. In May 2021, we entered into two interest rate swap agreements to effectively convert $480.0 million of our term loan borrowings from a variable rate to a fixed rate. These interest rate swaps are intended to mitigate the exposure to fluctuations in interest rates and qualify for hedge accounting treatment as cash flow hedges. A 100 basis point increase or decrease in interest rates as of December 31, 2022 would decrease or increase our annual earnings, respectively, by approximately $0.1 million.Market Price Sensitive InstrumentsAs of December 31, 2022, we had outstanding debt related to our convertible senior notes recorded on our consolidated balance sheet of $788.8 million, net of unamortized discount and issuance costs totaling $11.2 million. Changes in the fair value of our outstanding debt, which could be impacted by changes in interest rates, are not recorded in these consolidated financial statements as the debt is accounted for at cost less unamortized discount and issuance costs. The fair value of the convertible senior notes, which was $1,038.7 million as of December 31, 2022, is also impacted by changes in our stock price.In order to reduce potential equity dilution, in connection with the issuance of the $800.0 million aggregate principal amount of 0.375% Notes, we entered into Capped Calls. We expect the Capped Calls to reduce the potential dilution to our common stock 40Table of Contents(or, in the event the conversion is settled in cash, to provide a source of cash to settle a portion of our cash payment obligation) in the event that at the time of conversion our stock price exceeds the conversion price under the 0.375% Notes. The Capped Calls have an initial strike price of $335.90 per share and cover 3.5 million shares of common stock.Foreign Currency Exchange RiskForeign currency risk arises from our investments in subsidiaries owned and operated in non-U.S. countries. Such risk is also a result of transactions with customers in countries outside the United States. Approximately 28% of our revenue was denominated in foreign currencies for the year ended December 31, 2022. As our business in regions outside of the United States continues to increase, we will be increasingly exposed to foreign currency exchange risk related to our foreign operations. The cost of revenue related to revenue generated outside of the United States is primarily denominated in U.S. dollars; however, operating costs related to these revenues are largely denominated in the same respective currencies, thereby partially limiting our transaction risk exposure. Fluctuations in the rate of exchange between the United States dollar and foreign currencies, primarily the Euro, British Pound and Canadian Dollar, could adversely affect our financial results, including our revenues, revenue growth rates, gross margins, income and losses as well as assets and liabilities. We have intercompany receivables and payables from our foreign subsidiaries that are denominated in foreign currencies, principally the Euro, the British pound and the Canadian dollar. Fluctuations from the beginning to the end of a reporting period result in the revaluation of our foreign currency-denominated intercompany receivables and payables, generating currency translation gains or losses. Net realized and unrealized gains (losses) from foreign currency transactions are included in other (expense) income, net in the consolidated statement of operations and amounted to a loss of $1.3 million for the year ended December 31, 2022.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsYou should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should read the “Risk Factors” section of this Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.46OverviewIQVIA is a leading global provider of advanced analytics, technology solutions and clinical research services to the life sciences industry. IQVIA creates intelligent connections across all aspects of healthcare through its analytics, transformative technology, big data resources and extensive domain expertise. IQVIA Connected Intelligence™ delivers powerful insights with speed and agility — enabling customers to accelerate the clinical development and commercialization of innovative medical treatments that improve healthcare outcomes for patients. With approximately 86,000 employees, we conduct operations in more than 100 countries.We are managed through three reportable segments: Technology & Analytics Solutions, Research & Development Solutions and Contract Sales & Medical Solutions. Technology & Analytics Solutions provides mission critical information, technology solutions and real world insights and services to our life science clients. Research & Development Solutions, which primarily serves biopharmaceutical clients, provides outsourced clinical research and clinical trial services. Contract Sales & Medical Solutions provides health care provider (including contract sales) and patient engagement services to both biopharmaceutical clients and the broader healthcare market.For a description of our service offerings within our segments, refer to Part I, Item 1, “Business”.Throughout 2022 we experienced broad, robust demand for all our offerings as demonstrated by our results for the year ended December 31, 2022, and our remaining performance obligations of approximately $29.2 billion as of December 31, 2022. We produced these results in the face of significant unforeseen challenges presented by the global macro environment including wage inflation and attrition, general inflation, staff shortages affecting investigator sites, along with the slow recovery of patient visits. As a response to these challenges, we have decided to accelerate targeted productivity initiatives so we can mitigate the impact in 2023. Overall, the life sciences industry that we serve is a long-cycle business and is well placed to weather uncertainties.The COVID-19 pandemic continued to impact operations in 2022. While we expanded our decentralized clinical trials capabilities and other more remote and technology-based offerings throughout 2022, due to the progression of the world’s overall response to the pandemic and specifically work related to clinical development of COVID-19 vaccines, we experienced a decline in revenues in 2022 from COVID-19 related work. If current trends for the pandemic continue, we expect to see a continued decline in COVID-19 related work in 2023 compared to 2022. As of December 31, 2022 COVID-19 related work did not represent a material amount of our remaining performance obligations. The Company continues to maintain strong liquidity. As of December 31, 2022, cash and cash equivalents were $1,216 million and the Company had $425 million drawn under its $1.5 billion revolving credit facility. As of December 31, 2022, the Company was in compliance with the financial covenants under its debt agreements in all material respects and does not have material uncertainty about ongoing ability to meet the covenants of our credit arrangements.Industry OutlookFor information about the industry outlook and markets that we operate in, refer to Part I, Item I, “Our Market Opportunity”.Business CombinationsWe have completed and will continue to consider strategic business combinations to enhance our capabilities and offerings in certain areas, including various individually immaterial acquisitions during the years ended December 31, 2022 and 2021. These transactions were accounted for as business combinations and the acquired results of operations are included in our consolidated financial information since the acquisition date. See Note 14 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information with respect to these business combinations.Sources of RevenuesTotal revenues are comprised of revenues from the provision of our services. We do not have any material product revenues.47Costs and ExpensesOur costs and expenses are comprised primarily of our cost of revenues including reimbursed expenses and selling, general and administrative expenses. Cost of revenues includes compensation and benefits for billable employees and personnel involved in production, trial monitoring, data management and delivery, and the costs of acquiring and processing data for our information offerings; costs of staff directly involved with delivering technology-related services offerings and engagements, related accommodations and the costs of data purchased specifically for technology services engagements; and other expenses directly related to service contracts such as courier fees, laboratory supplies, professional services and travel expenses. Reimbursed expenses, which are included in cost of revenues, are comprised principally of payments to investigators who oversee clinical trials and travel expenses for our clinical monitors and sales representatives. Selling, general and administrative expenses include costs related to sales, marketing and administrative functions (including human resources, legal, finance, quality assurance, compliance and general management) for compensation and benefits, travel, professional services, training and expenses for information technology and facilities. We also incur costs and expenses associated with depreciation and amortization.Foreign Currency TranslationIn 2022, approximately 30% of our revenues were denominated in currencies other than the United States dollar, which represents approximately 60 currencies. Because a large portion of our revenues and expenses are denominated in foreign currencies and our financial statements are reported in United States dollars, changes in foreign currency exchange rates can significantly affect our results of operations. The revenues and expenses of our foreign operations are generally denominated in local currencies and translated into United States dollars for financial reporting purposes. Accordingly, exchange rate fluctuations will affect the translation of foreign results into United States dollars for purposes of reporting our consolidated results. As a result, we believe that reporting results of operations that exclude the effects of foreign currency rate fluctuations on certain financial results can facilitate analysis of period to period comparisons. This constant currency information assumes the same foreign currency exchange rates that were in effect for the comparable prior-year period were used in translation of the current period results. As such, the differences noted below between reported results of operations and constant currency information is wholly attributable to the effects of foreign currency rate fluctuations.Consolidated Results of OperationsFor information regarding our results of operations for our Technology & Analytics Solutions, Research & Development Solutions and Contract Sales & Medical Solutions segments, refer to “Segment Results of Operations” later in this section.For a discussion of our results of operations comparison for 2021 and 2020, refer to our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 filed on February 16, 2022. RevenuesYear Ended December 31,Change2022 vs. 20212021 vs. 2020(dollars in millions)202220212020$%$%Revenues$14,410 $13,874 $11,359 $536 3.9 %$2,515 22.1 %2022 compared to 2021In 2022, our revenues increased $536 million, or 3.9%, as compared to 2021. This increase was comprised of constant currency revenue growth of approximately $1,084 million, or 7.8%, reflecting a $483 million increase in Technology & Analytics Solutions, a $580 million increase in Research & Development Solutions, and a $21 million increase in Contract Sales & Medical Solutions.48Cost of Revenues, exclusive of Depreciation and AmortizationYear Ended December 31,(dollars in millions)202220212020Cost of revenues, exclusive of depreciation and amortization$9,382 $9,233 $7,500 % of revenues65.1 %66.5 %66.0 %2022 compared to 2021When compared to 2021, cost of revenues, exclusive of depreciation and amortization increased $149 million in 2022, or 1.6%. This increase included a constant currency increase of approximately $674 million, or 7.3%, comprised of a $228 million increase in Technology & Analytics Solutions, a $408 million increase in Research & Development Solutions, and a $38 million increase in Contract Sales & Medical Solutions.As a percent of revenues, cost of revenues, exclusive of depreciation and amortization in 2022 decreased compared to 2021.Selling, General and Administrative ExpensesYear Ended December 31,(dollars in millions)202220212020Selling, general and administrative expenses$2,071 $1,964 $1,789 % of revenues14.4 %14.2 %15.7 %2022 compared to 2021The $107 million increase in selling, general and administrative expenses in 2022 as compared to 2021 included a constant currency increase of approximately $211 million, or 10.7%, comprised of a $107 million increase in Technology & Analytics Solutions, a $81 million increase in Research & Development Solutions, a $8 million increase in Contract Sales & Medical Solutions, and a $15 million increase in general corporate and unallocated expenses. Depreciation and AmortizationYear Ended December 31,(dollars in millions)202220212020Depreciation and amortization$1,130 $1,264 $1,287 % of revenues7.8 %9.1 %11.3 %The $134 million decrease in depreciation and amortization in 2022 as compared to 2021 was primarily due to certain intangible assets from the merger between Quintiles and IMS Health becoming fully amortized in 2021, offset by higher intangible asset balances as a result of acquisitions occurring in 2021 and 2022, increased amortization due to higher capitalized software balances and accelerated amortization related to the abandonment of certain internally developed software assets.Restructuring CostsYear Ended December 31,(in millions)202220212020Restructuring costs$28 $20 $52 The restructuring costs incurred were due to ongoing efforts to streamline our global operations and reduce overcapacity to adapt to changing market conditions and integrate acquisitions. The remaining actions under these plans are expected to occur throughout 2023 and are expected to consist of consolidating functional activities, eliminating redundant positions, and aligning resources with customer requirements.49Interest Income and Interest ExpenseYear Ended December 31,(in millions)202220212020Interest income$(13)$(6)$(6)Interest expense$416 $375 $416 Interest income included interest received primarily from bank balances and investments. The increase is primarily a result of higher deposit rates.Interest expense during 2022 was higher than 2021 due primarily to higher base rate interest costs across the floating rate debt portfolio as well as from an increase in our net debt. Loss on Extinguishment of DebtYear Ended December 31,(in millions)202220212020Loss on extinguishment of debt$— $26 $13 During 2021, we recognized a loss on extinguishment of debt of $26 million for fees and expenses incurred related to the refinancing of our 3.250% Senior Notes due 2025 and Prior Credit Agreement as discussed further in Note 10 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.Other expense (income), netYear Ended December 31,(in millions)202220212020Other expense (income), net$33 $(130)$(65)Other expense (income), net for 2022 increased compared to 2021 primarily due to foreign currency losses and losses on investments.Income Tax ExpenseYear Ended December 31,(dollars in millions)202220212020Income tax expense $260 $163 $72 Effective income tax rate19.1 %14.5 %19.3 %In 2022, we recorded a benefit of $6 million related to a 2021 U.S. Federal tax return position associated with Foreign Derived Intangible Income (“FDII”) and Global Intangible Low-Taxed Income (“GILTI”) tax credits. In addition, our effective tax rate was impacted by changes in the geographical mix of earnings amongst foreign tax jurisdictions as well as state and local tax rates.In 2021, we recorded a benefit of $29 million related to a 2020 U.S. Federal tax return position associated with FDII and GILTI tax credits. Also in 2021, we recorded a $9 million tax expense as a result of the U.S. Treasury Department issuing final regulations on foreign tax credits. Equity in (Losses) Earnings of Unconsolidated AffiliatesYear Ended December 31,(in millions)202220212020Equity in (losses) earnings of unconsolidated affiliates$(12)$6 $7 Equity in (losses) earnings of unconsolidated affiliates decreased in 2022 compared to 2021 due to the losses in the operations of our unconsolidated affiliates.50Net Income Attributable to Non-controlling InterestsYear Ended December 31,(in millions)202220212020Net income attributable to non-controlling interests$— $(5)$(29)Net income attributable to non-controlling interests included Quest Diagnostics Incorporated's ("Quest") interest in Q2 Solutions. On April 1, 2021 the Company acquired the 40% non-controlling interest in Q2 Solutions from Quest which resulted in a decrease in the net income attributable to non-controlling interests in 2022 compared to 2021. See Note 13 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details regarding this transaction. Segment Results of OperationsRevenues and profit by segment are as follows:Segment RevenuesSegment Profit(in millions)202220212020202220212020Technology & Analytics Solutions$5,746 $5,534 $4,858 $1,550 $1,458 $1,216 Research & Development Solutions7,921 7,556 5,760 1,695 1,476 1,048 Contract Sales & Medical Solutions743 784 741 42 75 57 Total14,410 13,874 11,359 3,287 3,009 2,321 General corporate and unallocated(330)(332)(251)Depreciation and amortization(1,130)(1,264)(1,287)Restructuring costs(28)(20)(52)Consolidated$14,410 $13,874 $11,359 $1,799 $1,393 $731 Certain costs are not allocated to our segments and are reported as general corporate and unallocated expenses. These costs primarily consist of stock-based compensation and expenses related to integration activities and acquisitions. We also do not allocate depreciation and amortization or impairment charges to our segments. Technology & Analytics SolutionsYear Ended December 31,Change(dollars in millions)2022202120202022 vs. 20212021 vs. 2020Revenues$5,746 $5,534 $4,858 $212 3.8%$676 13.9%Cost of revenues, exclusive of depreciation and amortization3,348 3,2782,900702.137813.0Selling, general and administrative expenses848 798742506.3567.5Segment profit$1,550 $1,458 $1,216 $92 6.3%$242 19.9%Revenues2022 compared to 2021Technology & Analytics Solutions’ revenues were $5,746 million in 2022, an increase of $212 million, or 3.8%, over 2021. This increase was comprised of constant currency revenue growth of approximately $483 million, or 8.7%, reflecting revenue growth across all regions. The constant currency revenue growth was primarily driven by an increase in real world services, and to a lesser extent by increases in consulting and analytical services and information and technology services.51Cost of Revenues, exclusive of Depreciation and Amortization2022 compared to 2021Technology & Analytics Solutions’ cost of revenues, exclusive of depreciation and amortization, was $3,348 million in 2022, an increase of $70 million over 2021. This increase was comprised of constant currency increase of approximately $228 million, or 7.0%, reflecting an increase in compensation and related expenses to support revenue growth.Selling, General and Administrative Expenses2022 compared to 2021Technology & Analytics Solutions’ selling, general and administrative expenses increased $50 million in 2022 as compared to 2021. This increase was comprised of a constant currency increase of approximately $107 million, or 13.4%, reflecting an increase in compensation and related expenses.Research & Development SolutionsYear Ended December 31,Change(dollars in millions)2022202120202022 vs. 20212021 vs. 2020Revenues$7,921 $7,556 $5,760 $365 4.8%$1,796 31.2%Cost of revenues, exclusive of depreciation and amortization5,395 5,3033,974921.71,32933.4Selling, general and administrative expenses831 777738546.9395.3Segment profit$1,695 $1,476 $1,048 $219 14.8%$428 40.8%BacklogResearch & Development Solutions' contracted backlog increased from $24.8 billion as of December 31, 2021 to $27.2 billion as of December 31, 2022 and we expect approximately $7.3 billion of this backlog to convert to revenues in the next 12 months. Contracted backlog was $22.6 billion as of December 31, 2020. Backlog represents, at a particular point in time, future revenues from work not yet completed or performed under signed contracts. Once work begins on a project, revenues are recognized over the duration of the project. We believe that backlog is an indicator of future revenues but the timing of revenues will be affected by a number of factors, including the variable size and duration of projects, many of which are performed over several years, cancellations, and changes to the scope of work during the course of projects. Projects that have been delayed remain in backlog, but the timing of the revenues generated may differ from the timing originally expected. Additionally, projects may be terminated or delayed by the customer or delayed by regulatory authorities. In the event that a client cancels a contract, we typically would be entitled to receive payment for all services performed up to the cancellation date and subsequent client-authorized services related to winding down the canceled project. For more details regarding risks related to our backlog, see Part I, Item IA, “Risk Factors—Risks Related to our Business—The relationship of backlog to revenues varies over time.”Revenues2022 compared to 2021Research & Development Solutions’ revenues were $7,921 million in 2022, an increase of $365 million, or 4.8%, over 2021. This increase was comprised of constant currency revenue growth of approximately $580 million, or 7.7%, reflecting revenue growth in the Europe and Africa and Asia-Pacific regions, partially offset by a decrease in COVID-19 related work in the Americas region. The constant currency revenue growth was primarily the result of volume-related increases in clinical services and to a lesser extent from volume-related increases in lab testing.52Cost of Revenues, exclusive of Depreciation and Amortization2022 compared to 2021Research & Development Solutions’ cost of revenues, exclusive of depreciation and amortization, increased $92 million, or 1.7%, in 2022 as compared to 2021. This increase included a constant currency increase of approximately $408 million, or 7.7%, reflecting an increase in compensation and related expenses as a result of volume-related increases in clinical services and lab testing.Selling, General and Administrative Expenses2022 compared to 2021Research & Development Solutions’ selling, general and administrative expenses increased $54 million, or 6.9%, in 2022 as compared to 2021, which included a constant currency increase of approximately $81 million, or 10.4%, reflecting an increase in compensation and related expenses.Contract Sales & Medical SolutionsYear Ended December 31,Change(dollars in millions)2022202120202022 vs. 20212021 vs. 2020Revenues$743 $784 $741 $(41)(5.2)%$43 5.8%Cost of revenues, exclusive of depreciation and amortization639 652 626 (13)(2.0)26 4.2Selling, general and administrative expenses62 57 58 5 8.8(1)(1.7)Segment profit$42 $75 $57 $(33)(44.0)%$18 31.6%Revenues2022 compared to 2021Contract Sales & Medical Solutions’ revenues were $743 million in 2022, a decrease of $41 million, or 5.2%, over 2021. This decrease included constant currency revenue growth of approximately $21 million, or 2.7%, reflecting revenue growth primarily in the Europe and Africa region. The constant currency revenue growth was largely due to a volume-related increase in services performed.Cost of Revenues, exclusive of Depreciation and Amortization2022 compared to 2021Contract Sales & Medical Solutions’ cost of revenues, exclusive of depreciation and amortization, decreased $13 million, or 2.0%, in 2022 as compared to 2021. This decrease included a constant currency increase of approximately $38 million, or 5.8%, reflecting an increase in compensation and related expenses and reimbursed expenses.Selling, General and Administrative Expenses2022 compared to 2021Contract Sales & Medical Solutions’ selling, general and administrative expenses increased $5 million, or 8.8%, in 2022 as compared to 2021. This increase included a constant currency increase of approximately $8 million, or 14.0%, reflecting an increase in compensation and related expenses and IT-related expenses.53Liquidity and Capital ResourcesOverviewWe assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Our principal source of liquidity is operating cash flows. In addition to operating cash flows, other significant factors that affect our overall management of liquidity include: capital expenditures, acquisitions, investments, debt service requirements, equity repurchases, adequacy of our revolving credit and receivables financing facilities, and access to the capital markets. We manage our worldwide cash requirements by monitoring the funds available among our subsidiaries and determining the extent to which those funds can be accessed on a cost-effective basis. The repatriation of cash balances from certain of our subsidiaries could have adverse tax consequences; however, those balances are generally available without legal restrictions to fund ordinary business operations. We have and expect to transfer cash from those subsidiaries to the United States and to other international subsidiaries when it is cost effective to do so.We had a cash balance of $1,216 million as of December 31, 2022 ($349 million of which was in the United States), a decrease from $1,366 million as of December 31, 2021.Based on our current operating plan, we believe that our available cash and cash equivalents, future cash flows from operations and our ability to access funds under our revolving credit and receivables financing facilities will enable us to fund our operating requirements, capital expenditures, contractual obligations, and meet debt obligations for at least the next 12 months. We regularly evaluate our debt arrangements, as well as market conditions, and from time to time we may explore opportunities to modify our existing debt arrangements or pursue additional financing arrangements that could result in the issuance of new debt securities by us or our affiliates. We may use our existing cash, cash generated from operations or dispositions of assets or businesses and/or proceeds from any new financing arrangements or issuances of debt or equity securities to repay or reduce some of our outstanding obligations, to repurchase shares from our stockholders or for other purposes. As part of our ongoing business strategy, we also continually evaluate new acquisition, expansion and investment possibilities or other strategic growth opportunities, as well as potential dispositions of assets or businesses, as appropriate, including dispositions that may cause us to recognize a loss on certain assets. Should we elect to pursue any such transaction, we may seek to obtain debt or equity financing to facilitate those activities. Our ability to enter into any such potential transactions and our use of cash or proceeds is limited to varying degrees by the terms and restrictions contained in our existing debt arrangements. We cannot provide assurances that we will be able to complete any such financing arrangements or other transactions on favorable terms or at all.Equity Repurchase ProgramOn February 10, 2022 the Board increased the stock repurchase authorization under the Company's equity repurchase program (the “Repurchase Program”) with respect to the repurchase of the Company's common stock by an additional $2.0 billion, which increased the total amount that has been authorized under the Repurchase Program to $9.725 billion since the program's inception in October 2013. The Repurchase Program does not obligate the Company to repurchase any particular amount of common stock, and it may be modified, extended, suspended or discontinued at any time.As of December 31, 2022, the Company had remaining authorization to repurchase up to approximately $1.36 billion of its common stock under the Repurchase Program. In addition, from time to time, the Company has repurchased and may continue to repurchase common stock through private or other transactions outside of the Repurchase Program.Additional information regarding the Repurchase Program is presented in Part II, Item 5 “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” and Note 13 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.DebtAs of December 31, 2022, we had $12.8 billion of total indebtedness, excluding $1.1 billion of additional available borrowings under our revolving credit facility. See Note 10 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional details regarding our credit arrangements.54Our long-term debt arrangements contain customary restrictive covenants and, as of December 31, 2022, we believe we were in compliance with our restrictive covenants in all material respects.Senior Secured Credit FacilitiesOn June 16, 2022, the Company entered into Amendment No. 1 to the Company’s Fifth Amended and Restated Credit Agreement (as amended, the “Fifth Amended and Restated Credit Agreement”) to borrow $1,250 million in Additional Term A Loans. The proceeds from the Additional Term A Loans were used to repay approximately $950 million of outstanding revolving credit loans under the Company's senior secured credit facilities and for general corporate purposes. On October 13, 2022, the Company elected to prepay $510 million, the entire outstanding balance, of its U.S. Dollar Term B Loan due 2024.As of December 31, 2022, the Fifth Amended and Restated Credit Agreement provided financing through several senior secured credit facilities (collectively, the “senior secured credit facilities”) of up to approximately $7,637 million, which consisted of $6,562 million principal amounts of debt outstanding and $1,070 million of available borrowing capacity on the revolving credit facility and standby letters of credit, with a total capacity of $1,500 million. The revolving credit facility is comprised of a $675 million senior secured revolving facility available in U.S. dollars, a $600 million senior secured revolving facility available in U.S. dollars, Euros, Swiss Francs and other foreign currencies, and a $225 million senior secured revolving facility available in U.S. dollars and Yen. The term A loans and revolving credit facility under the Fifth Amended and Restated Credit Agreement mature in August 2026, the Additional Term A Loans mature June 2027, while the term B loans under the Fifth Amended and Restated Credit Agreement mature in 2024 and 2025. We are required to make scheduled quarterly payments on the term A loans and the Additional Term A Loans equal to 1.25% of the original principal amount, with the remaining balance paid at maturity. In addition, beginning with fiscal year ending December 31, 2017, we were required to apply 50% of excess cash flow (as defined in the Fifth Amended and Restated Credit Agreement), subject to a reduction to 25% or 0% depending upon our senior secured first lien net leverage ratio, for prepayment of the term loans, with any such prepayment to be applied toward principal payments due in subsequent quarters. We are also required to pay an annual commitment fee that ranges from 0.20% to 0.35% in respect of any unused commitments under the revolving credit facility. The senior secured credit facilities are collateralized by substantially all of our assets and the assets of our material domestic subsidiaries including 100% of the equity interests of substantially all of our material domestic subsidiaries and 66% of the equity interests of substantially all of our first-tier material foreign subsidiaries and their domestic subsidiaries.For information regarding the senior secured credit facilities, see Note 10 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.Receivables Financing FacilityFor information regarding the receivables financing facility, see Note 10 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. As of December 31, 2022, no additional amounts of revolving loan commitments were available under the receivables financing facility.Years ended December 31, 2022, 2021 and 2020Cash Flow from Operating ActivitiesYear Ended December 31,(in millions)202220212020Net cash provided by operating activities$2,260 $2,942 $1,959 552022 compared to 2021Cash provided by operating activities decreased $682 million in 2022 as compared to 2021. The decrease is primarily due to a decrease in cash from unearned income ($560 million) and accounts receivable and unbilled services ($283 million) and an increase in cash used for income tax and other payables ($126 million), offset by a decrease in cash for accounts payable and accrued expenses ($183 million), an increase in cash-related net income ($82 million) and less cash used for prepaid expenses and other assets ($22 million).Cash Flow from Investing ActivitiesYear Ended December 31,(in millions)202220212020Net cash used in investing activities$(2,006)$(2,103)$(796)2022 compared to 2021Cash used in investing activities decreased $97 million in 2022 as compared to 2021. The decrease was primarily driven by less cash used for the acquisition of businesses, net of cash acquired ($143 million), a decrease in purchase of marketable securities ($5 million) and an increase in cash from other sources ($3 million), offset by an increase in acquisitions of property, equipment, and software ($34 million), an increase in investments in unconsolidated affiliates ($15 million) and a decrease in net proceeds from the sale of equity securities ($5 million). Cash Flow from Financing ActivitiesYear Ended December 31,(in millions)202220212020Net cash used in financing activities$(329)$(1,235)$(217)2022 compared to 2021Cash used in financing activities decreased $906 million in 2022 as compared to 2021, primarily due to a decrease in debt payments ($1,457 million), the absence of cash payments for the Company's acquisition of Quest's non-controlling interest in Q2 Solutions ($758 million), a decrease in cash used in repayments of revolving credit facilities, net of proceeds ($115 million), a decrease in cash payments on contingent consideration and deferred purchase price accruals ($16 million), offset by an increase in cash used to repurchase common stock ($762 million), a decrease in cash provided by proceeds from debt issuances, net of payment of debt issuance costs ($666 million) and an increase in cash payments related to employee stock option plans ($12 million). ContingenciesWe are exposed to certain known contingencies that are material to our investors. The facts and circumstances surrounding these contingencies and a discussion of their effect on us are included in Note 12 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. These contingencies may have a material effect on our liquidity, capital resources or results of operations. In addition, even where our accruals are adequate, the incurrence of any of these liabilities may have a material effect on our liquidity and the amount of cash available to us for other purposes.We believe that we have made appropriate arrangements in respect of the future effect on us of these known contingencies. We also believe that the amount of cash available to us from our operations, together with cash from financing, will be sufficient for us to pay any known contingencies as they become due without materially affecting our ability to conduct our operations and invest in the growth of our business.56Off-Balance Sheet ArrangementsWe do not have any material off-balance sheet arrangements.Contractual Obligations and CommitmentsBelow is a summary of our future payment commitments by year under contractual obligations as of December 31, 2022:(in millions)20232024-20252026-2027ThereafterTotalLong-term debt, including interest (1)$723 $5,514 $6,026 $2,596 $14,859 Operating leases123 173 66 38 400 Finance leases11 25 26 295 357 Data acquisition609 518 204 6 1,337 Purchase obligations (2)79 24 9 11 123 Commitments to unconsolidated affiliates (3)— — — — — Benefit obligations (4)32 28 31 81 172 Uncertain income tax positions (5)22 20 15 — 57 Total$1,599 $6,302 $6,377 $3,027 $17,305 (1) Interest payments on our debt are based on the interest rates in effect as of December 31, 2022.(2) Purchase obligations are defined as agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including fixed or minimum quantities to be purchased, fixed, minimum or variable pricing provisions and the approximate timing of the transactions.(3) We are currently committed to invest $249 million in private equity funds. As of December 31, 2022, we have funded approximately $119 million of these commitments and we have approximately $130 million remaining to be funded which has not been included in the above table as we are unable to predict when these commitments will be paid.(4) Amounts represent expected future benefit payments for our pension and postretirement benefit plans, as well as expected contributions for 2023 for our funded pension benefit plans. We made cash contributions totaling approximately $35 million to our defined benefit plans in 2022, and we estimate that we will make contributions totaling approximately $32 million to our defined benefit plans in 2023. Due to the potential impact of future plan investment performance, changes in interest rates, changes in other economic and demographic assumptions and changes in legislation in foreign jurisdictions, we are not able to reasonably estimate the timing and amount of contributions that may be required to fund our defined benefit plans for periods beyond 2023.(5) As of December 31, 2022, our liability related to uncertain income tax positions was approximately $136 million, $79 million of which has not been included in the above table as we are unable to predict when these liabilities will be paid due to the uncertainties in the timing of the settlement of the income tax positions.Application of Critical Accounting Policies and EstimatesNote 1 to the audited consolidated financial statements provided elsewhere in this Annual Report on Form 10-K describes the significant accounting policies used in the preparation of the consolidated financial statements. The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the period. Our estimates are based on historical experience and various other assumptions we believe are reasonable under the circumstances. We evaluate our estimates on an ongoing basis and make changes to the estimates and related disclosures as experience develops or new information becomes known. Actual results may differ from those estimates.We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.57Revenue RecognitionThe majority of the Company’s contracts within the Research & Development Solutions segment are service contracts for clinical research that represent a single performance obligation. The Company provides a significant integration service resulting in a combined output, which is clinical trial data that meets the relevant regulatory standards and can be used by the customer to progress to the next phase of a clinical trial or solicit approval of a treatment by the applicable regulatory body. The performance obligation is satisfied over time as the output is captured in data and documentation that is available for the customer to consume over the course of the arrangement and furthers progress of the clinical trial. The Company recognizes revenues over time using a cost-based input method since there is no single output measure that would fairly depict the transfer of control over the life of the performance obligation. Progress on the performance obligation is measured by the proportion of actual costs incurred to the total costs expected to complete the contract. Costs included in the measure of progress include direct labor and third-party costs (such as payments to investigators and other reimbursed expenses for the Company’s clinical monitors). This cost-based method of revenue recognition requires the Company to make estimates of costs to complete its projects on an ongoing basis. Significant judgment is required to evaluate assumptions related to these estimates. The effect of revisions to estimates related to the transaction price or costs to complete a project are recorded in the period in which the estimate is revised. Most contracts may be terminated upon 30 to 90 days' notice by the customer; however, in the event of termination, most contracts require payment for services rendered through the date of termination, as well as for subsequent services rendered to close out the contract. A hypothetical increase of one percent in the estimated costs to complete these service contracts as of December 31, 2022 could have resulted in approximately a one percent reduction in total revenues for the year ended December 31, 2022, whereas, a hypothetical decrease of one percent could have resulted in a one percent increase in total revenues.Income TaxesThe provision for income taxes includes federal, state, local and foreign taxes. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences of temporary differences between the financial statement carrying amounts and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which the temporary differences are expected to be recovered or settled. We record U.S. deferred taxes based on the Federal corporate income tax rate of 21%, We account for tax related to GILTI as a period cost when incurred. Recognition of deferred income tax assets is based on management’s belief that it is more likely than not that the income tax benefit associated with certain temporary differences, income tax operating loss, capital loss carryforwards, and income tax credits, will be realized. We recorded a valuation allowance to reduce our deferred income tax assets for those deferred income tax items for which it was more likely than not that realization would not occur. We determined the amount of the valuation allowance based, in part, on our assessment of future taxable income and in light of our ongoing income tax strategies. If our estimate of future taxable income or tax strategies changes at any time in the future, we would record an adjustment to our valuation allowance. Recording such an adjustment could have a material effect on our financial condition or results of operations.Income tax expense is based on the distribution of profit before income tax among the various taxing jurisdictions in which we operate, adjusted as required by the income tax laws of each taxing jurisdiction. Changes in the distribution of profits and losses among taxing jurisdictions may have a significant impact on our effective income tax rate. We do not consider the undistributed earnings of our foreign subsidiaries to be indefinitely reinvested outside of the United States.Business Combinations and GoodwillWe use the acquisition method to account for business combinations, and accordingly, the identifiable assets acquired, the liabilities assumed and any non-controlling interests in the acquiree are recorded at their estimated fair values on the date of the acquisition. We use significant judgments, estimates and assumptions in determining the estimated fair value of assets acquired, liabilities assumed and non-controlling interests including expected future cash flows and discount rates that reflect the risk associated with the expected future cash flows and estimated useful lives.We have recorded and allocated to our reporting units the excess of the purchase price over the fair value of the net assets acquired, known as goodwill. The recoverability of goodwill is evaluated annually for impairment, or if and when events or circumstances indicate a possible impairment. We perform our annual goodwill impairment evaluation as of July 31. The impairment analysis requires significant judgments, estimates and assumptions, including those related to macroeconomic conditions, industry and market considerations, cost factors, financial performance, fair value history and other company specific events. For the years ended December 31, 2022, 2021 and 2020, the Company determined that there was no impairment of goodwill.58We review the carrying values of other identifiable intangible assets if the facts and circumstances indicate a possible impairment. Any future impairment could have a material adverse effect on our financial condition or results of operations.Stock-based CompensationWe measure compensation cost for stock-based payment awards (stock options and stock appreciation rights) granted to employees and non-employee directors at fair value using the Black-Scholes-Merton option-pricing model. Stock-based compensation expense includes stock-based awards granted to employees and non-employee directors and has been reported in selling, general and administrative expenses in our consolidated statements of income based upon the classification of the individuals who were granted stock-based awards.The Black-Scholes-Merton option-pricing model requires the use of subjective assumptions, including share price volatility, the expected life of the award, risk-free interest rate and the fair value of the underlying common shares on the date of grant. In developing our assumptions, we take into account the following:•We calculate expected volatility based on an analysis of the historical volatility of the Company's stock since the Merger in October 2016 and reported data for selected reasonably similar publicly traded companies for which the historical information is available. We plan to continue to use an analysis that incorporates the selected reasonably similar publicly traded companies volatility information and the historical volatility of our common shares to measure expected volatility for future award grants;•We determine the risk-free interest rate by reference to implied yields available from United States Treasury securities with a remaining term equal to the expected life assumed at the date of grant;•We estimate the dividend yield to be zero as we do not currently anticipate paying any future dividends;•We estimate the average expected life of the award based on our historical experience; and•We estimate forfeitures based on our historical analysis of actual forfeitures.The Company accounts for its stock-based compensation for performance awards related to compound annual earnings per share (“EPS”) growth over a three year period based on the closing market price of the Company’s common stock on the date of grant, and for performance awards related to relative total shareholder return (“TSR”) based on a Monte Carlo simulation model. The Company records the expense amount of the EPS awards based on its estimates of the likelihood that the various performance targets will be achieved. The estimates are assessed on a quarterly basis. For the TSR awards the Company records the expense amount evenly over the service period.Pensions and Other Postretirement BenefitsWe provide retirement benefits to certain employees, including defined benefit pension plans and postretirement medical plans. The determination of benefit obligations and expense is based on actuarial models. In order to measure benefit costs and obligations using these models, critical assumptions are made with regard to the discount rate, expected return on plan assets, cash balance crediting rate, lump sum conversion rate and the assumed rate of compensation increases. In addition, retiree medical care cost trend rates are a key assumption used exclusively in determining costs for our postretirement health care and life insurance benefit plans.Recently Issued Accounting StandardsInformation relating to recently issued accounting standards is included in Note 1 to our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.59Item 7A. Quantitative and Qualitative Disclosures About Market RiskMarket risk is the potential loss arising from adverse changes in market rates and prices. In the ordinary course of business, we are exposed to various market risks and we regularly evaluate our exposure to such changes. Our overall risk management strategy seeks to balance the magnitude of the exposure and the cost and availability of appropriate financial instruments. The following analyses present the sensitivity of our financial instruments to hypothetical changes that are reasonably possible over a one-year period.Foreign Currency Exchange RatesWe transact business in more than 100 countries and approximately 60 currencies and are subject to risks associated with fluctuating foreign currency exchange rates. Our objective is to reduce earnings and cash flow volatility associated with foreign currency exchange rate movements. Accordingly, we enter into foreign currency forward contracts to hedge certain forecasted foreign currency cash flows related to service contracts. It is our policy to enter into foreign currency transactions only to the extent necessary to meet our objectives as stated above. We do not enter into foreign currency transactions for investment or speculative purposes. The principal currency hedged in 2022 was the British Pound.The contractual value of our foreign exchange derivative instruments, all of which were foreign exchange forward contracts, was approximately $122 million as of December 31, 2022. The fair value of these contracts is subject to change as a result of potential changes in foreign exchange rates. We assess our market risk based on changes in foreign exchange rates utilizing a sensitivity analysis. The sensitivity analysis measures the potential gain or loss in fair values based on a hypothetical 10% change in foreign currency exchange rates. The potential gain in fair value for foreign exchange forward contracts based on a hypothetical 10% decrease in the value of the United States dollar was $12 million as of December 31, 2022. However, the change in the fair value of the foreign exchange forward contracts would likely be offset by a change in the value of the future service contract revenues being hedged caused by the currency exchange rate fluctuation. The estimated fair values of the foreign exchange forward contracts were determined based on quoted market prices.Exchange rate fluctuations affect the United States dollar value of foreign currency revenues and expenses and may have a significant effect on our results. Excluding the impacts from any outstanding or future hedging transactions, a hypothetical 10% change in average exchange rates used to translate all foreign currencies to the United States dollar would have impacted income before income taxes for 2022 by approximately $276 million. The actual impact of exchange rate movements in the future could differ materially from this hypothetical analysis, based on the mix of foreign currencies and the timing and magnitude of individual exchange rate movements.Additionally, commencing in 2016, we designated a portion of our foreign currency denominated debt as a hedge of our net investment in foreign subsidiaries to reduce the volatility in stockholders’ equity caused by changes in the Euro exchange rate with respect to the United States dollar. As of December 31, 2022, these borrowings (net of original issue discount) were €5,211 million ($5,580 million). A hypothetical 10% decrease in the value of the United States dollar would lead to a potential loss in fair value of $558 million. However, this change in fair value would be offset by the change in value of the hedged portion of our net investment in foreign subsidiaries caused by the currency exchange rate fluctuation.Interest RatesBecause we have variable rate debt, fluctuations in interest rates affect our business. We attempt to minimize interest rate risk and lower our overall borrowing costs through the utilization of derivative financial instruments, primarily interest rate swaps. We do not enter into interest rate swaps for investment or speculative purposes. We have entered into interest rate swaps with financial institutions that have reset dates and critical terms that match the underlying debt. Accordingly, any change in market value associated with the interest rate swaps is offset by the opposite market impact on the related debt. As of December 31, 2022, we had approximately $7.1 billion of variable rate indebtedness and interest rate swaps with a notional value of $1.8 billion. On January 3, 2023, the Company entered into three interest rate swaps with a combined notional value of $1 billion. Because we do not attempt to hedge all of our variable rate debt, we may incur higher interest costs for the portion of our variable rate debt that is not hedged. Excluding debt covered by hedges, including the swaps entered into on January 3, 2023, each quarter-point increase or decrease in the interest rate on our variable rate debt would result in our interest expense changing by approximately $14 million per year.60Marketable SecuritiesAs of December 31, 2022, we held investments in marketable equity securities. These investments are classified as either trading securities or available-for-sale securities and are recorded at fair value. These securities are subject to price risk. As of December 31, 2022, the fair value of these investments was $122 million based on the quoted market value of the securities. The potential loss in fair value resulting from a hypothetical decrease of 10% in quoted market values was approximately $12 million as of December 31, 2022.61
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion contains management’s discussion and analysis of our financial condition and results of operations and should be read together with our audited consolidated financial statements and related notes to our consolidated financial statements included elsewhere in this Form 10-K. This discussion contains forward-looking statements and involves numerous risks and uncertainties. Our actual results may differ materially from those anticipated in any forward-looking statements as a result of many factors, including those set forth under the “Special Note Regarding Forward-Looking Statements,” “Item 1A. Risk Factors” and elsewhere in this Form 10-K.Executive OverviewOur CompanyIngersoll Rand is a global market leader with a broad range of innovative and mission-critical air, fluid, energy and medical technologies, providing services and solutions to increase industrial productivity and efficiency. We manufacture one of the broadest and most complete ranges of compressor, pump, vacuum and blower products in our markets, which, when combined with our global geographic footprint and application expertise, allows us to provide differentiated product and service offerings to our customers. Our products are sold under a collection of premier, market-leading brands, including Ingersoll Rand, Gardner Denver, Nash, CompAir, Thomas, Milton Roy, Seepex, Elmo Rietschle, ARO, Robuschi, Emco Wheaton and Runtech Systems, which we believe are globally recognized in their respective end-markets and known for product quality, reliability, efficiency and superior customer service.23Table of ContentsThese attributes, along with over 160 years of engineering heritage, generate strong brand loyalty for our products and foster long-standing customer relationships, which we believe have resulted in leading market positions within each of our operating segments. We have sales in all major geographic markets and our diverse customer base utilizes our products across a wide array of end-markets that have favorable near- and long-term growth prospects, including industrial manufacturing, energy, transportation, medical and laboratory sciences, food and beverage packaging and chemical processing.Our products and services are critical to the processes and systems in which they are utilized, which are often complex and function in harsh conditions where the cost of failure or downtime is high. However, our products and services typically represent only a small portion of the costs of the overall systems or functions that they support. As a result, our customers place a high value on our application expertise, product reliability and the responsiveness of our service. To support our customers and market presence, we maintain significant global scale with 66 key manufacturing facilities, approximately 38 complementary service and repair centers across six continents and approximately 17,000 employees worldwide as of December 31, 2022.The process-critical nature of our product applications, coupled with the standard wear and tear replacement cycles associated with the usage of our products, generates opportunities to support customers with our broad portfolio of aftermarket parts, consumables and services. Customers place a high value on minimizing any time their operations are offline. As a result, the availability of replacement parts, consumables and our repair and support services are key components of our value proposition. Our large installed base of products provides a recurring revenue stream through our aftermarket parts, consumables and services offerings. As a result, our aftermarket revenue is significant, representing 35.2% of total Company revenue in 2022.Components of Our Revenue and ExpensesRevenuesWe generate revenue from sales of original equipment and associated aftermarket parts, consumables and services. We sell our products and deliver services both directly to end-users and through independent distribution channels, depending on the product line and geography. Revenue derived from short duration contracts is recognized at a single point in time when control is transferred to the customer, generally at shipment or when delivery has occurred or as services are performed. Certain contracts involve significant design engineering unique to customer specifications, and depending upon the contractual terms, revenue is recognized either over the duration of the contract or at contract completion when equipment is delivered to the customer. ExpensesCost of SalesCost of sales includes the costs we incur, including purchased materials, labor and overhead related to manufactured products and aftermarket parts sold during a period. Depreciation related to manufacturing equipment and facilities is included in cost of sales. Purchased materials represent the majority of costs of sales, with steel, aluminum, copper and partially finished castings representing our most significant material inputs. Stock-based compensation expense for employees associated with the manufacture of products or delivery of services to customers is included in cost of sales. We have instituted a global sourcing strategy to take advantage of coordinated purchasing opportunities of key materials across our manufacturing plant locations.Cost of sales for services includes the direct costs we incur, including direct labor, parts and other overhead costs including depreciation of equipment and facilities, to deliver repair, maintenance and other field services to our customers.Selling and Administrative ExpensesSelling and administrative expenses consist of (i) salaries and other employee-related expenses for our selling and administrative functions and other activities not associated with the manufacture of products or delivery of services to customers; (ii) facility operating expenses for selling and administrative activities, including office rent, maintenance, depreciation and insurance; (iii) marketing and direct costs of selling products and services to customers including internal and external sales commissions; (iv) research and development expenditures; (v) professional and consultant fees; (vi) employee related stock-based compensation for our selling and administrative functions and (vii) other miscellaneous expenses. Certain corporate expenses, including those related to our shared service centers in the United States and Europe, that directly benefit our businesses are allocated to our business segments. Certain corporate administrative expenses, including corporate executive compensation, treasury, certain information technology, internal audit and tax compliance, are not allocated to the business segments.Amortization of Intangible AssetsAmortization of intangible assets includes the periodic amortization of intangible assets — including customer relationships, tradenames, developed technology, backlog and internal-use software.24Table of ContentsImpairment of Other Intangible AssetsImpairment of other intangible assets represents the recognition of non-cash charges to reduce the carrying value of intangible assets other than goodwill to their fair value.Other Operating Expense, NetOther operating expense, net includes foreign currency transaction gains and losses, net, restructuring charges, acquisition and other transaction related expenses and non-cash charges, losses and gains on asset disposals and other miscellaneous operating expenses.Provision (Benefit) for Income TaxesThe provision or benefit for income taxes includes U.S. federal, state and local income taxes and all non-U.S. income taxes. We are subject to income tax in approximately 47 jurisdictions outside of the United States. Because we conduct operations on a global basis, our effective tax rate depends, and will continue to depend, on the geographic distribution of our pre-tax earnings among several different taxing jurisdictions. Our effective tax rate can also vary based on changes in the tax rates of the different jurisdictions, the availability of tax credits and non-deductible items.Items Affecting our Reported ResultsThe COVID-19 Pandemic and Related Supply Chain DisruptionsWe continue to assess and actively manage the impact of the COVID-19 pandemic on our global operations and also the operations of our suppliers and customers. In order to position ourselves to fulfill demand, we continue to monitor the supply chain closely and take proactive steps to ensure continuity of supply. We are adhering to all state and country mandates and guidelines wherever we operate. We have taken certain actions to reduce costs and preserve cash given the uncertain environment. The substantial majority of our production sites have remained fully operational this year. Certain facilities, including several manufacturing sites in China, have recently experienced interruptions in production due to outbreaks of COVID-19 infections and subsequent government restrictions. These interruptions have contributed to component shortages and other supply chain constraints that may limit our ability to fulfill customer orders within desired lead times, both directly in the Asia Pacific region and indirectly in other regions. The degree to which the pandemic will continue to impact our operations, and the operations of our customers and suppliers remains uncertain. See “The COVID-19 pandemic could have a material and adverse effect on our business, results of operations and financial condition in the future” in Part II Item 1A. “Risk Factors” included elsewhere in this Form 10-K.General Economic Conditions and Capital Spending in the Industries We ServeOur financial results closely follow changes in the industries and end-markets we serve. Demand for most of our products depends on the level of new capital investment and planned and unplanned maintenance expenditures by our customers. The level of capital expenditures depends, in turn, on the general economic conditions as well as access to capital at reasonable cost. In particular, demand for our Industrial Technologies and Services products generally correlates with the rate of total industrial capacity utilization and the rate of change of industrial production. Capacity utilization rates above 80% have historically indicated a strong demand environment for industrial equipment. In our Industrial Technologies and Services segment, overall economic growth and industrial production, as well as secular trends, impact demand for our products. In certain businesses of our Precision and Science Technologies segment, we expect demand for our products to be driven by favorable trends, including the growth in healthcare spend and expansion of healthcare systems due to an aging population requiring medical care and increased investment in health solutions and safety infrastructures in emerging economies. Over longer time periods, we believe that demand for all of our products also tends to follow economic growth patterns indicated by the rates of change in the GDP around the world, as augmented by secular trends in each segment. Our ability to grow and our financial performance will also be affected by our ability to address a variety of challenges and opportunities that are a consequence of our global operations, including efficiently utilizing our global sales, manufacturing and distribution capabilities and engineering innovative new product applications for end-users in a variety of geographic markets.Foreign Currency FluctuationsA significant portion of our revenues, approximately 56% for the year ended December 31, 2022, was denominated in currencies other than the U.S. dollar. Because much of our manufacturing facilities and labor force costs are outside of the United States, a significant portion of our costs are also denominated in currencies other than the U.S. dollar. Changes in foreign exchange rates can therefore impact our results of operations and are quantified when significant to our discussion.25Table of ContentsFactors Affecting the Comparability of our Results of OperationsCertain factors affecting the comparability of our current and historical results of operations are summarized below.AcquisitionsPart of our strategy for growth is to acquire complementary businesses that provide access to new technologies or geographies or expand our offerings. While acquisitions, as discussed further in Note 4, are not individually significant or significant in the aggregate, they may be relevant when comparing our results from period to period.See Note 4 “Acquisitions” to our audited consolidated financial statements included elsewhere in this Form 10-K for further discussion of these acquisitions.Restructuring and Other Business Transformation InitiativesWe continue to implement business transformation initiatives. A key element of those business transformation initiatives was restructuring programs within our Industrial Technologies and Services and Precision and Science Technologies segments, as well as at the Corporate level. Restructuring charges, program related facility reorganization, relocation and other costs, and related capital expenditures were impacted most significantly.Subsequent to the acquisition of Ingersoll Rand Industrial, we announced a restructuring program (“2020 Plan”) to drive efficiencies and synergies, reduce the number of facilities and optimize operating margin within the merged Company. For the years ended December 31, 2022 and 2021, $29.3 million and $13.4 million, respectively, were charged to expense related to this restructuring program. Through December 31, 2022, we recognized expense related to the 2020 Plan of $98.8 million, $15.6 million and $11.3 million for Industrial Technologies and Services, Precision and Science Technologies and Corporate, respectively.Stock-Based Compensation ExpenseFor the years ended December 31, 2022 and 2021, we incurred stock-based compensation expense of approximately $78.9 million and $87.2 million, respectively. The decrease from 2021 was primarily due to the $150 million equity grant to nearly 16,000 employees worldwide announced in the third quarter of 2020 becoming fully vested in the third quarter of 2022. See Note 18 “Stock-Based Compensation” to our audited consolidated financial statements included elsewhere in this Form 10-K for further discussion around our stock-based compensation expense.How We Assess the Performance of Our BusinessWe manage operations through the two business segments described above. In addition to our consolidated GAAP financial measures, we review various non-GAAP financial measures, including Adjusted EBITDA, Adjusted Net Income and Free Cash Flow.We believe Adjusted EBITDA and Adjusted Net Income are helpful supplemental measures to assist us and investors in evaluating our operating results as they exclude certain items whose fluctuation from period to period do not necessarily correspond to changes in the operations of our business. Adjusted EBITDA represents net income (loss) before interest, taxes, depreciation, amortization and certain non-cash, non-recurring and other adjustment items. We believe that the adjustments applied in presenting Adjusted EBITDA are appropriate to provide additional information to investors about certain material non-cash items and about non-recurring items that we do not expect to continue at the same level in the future. Adjusted Net Income is defined as net income (loss) including interest, depreciation and amortization of non-acquisition related intangible assets and excluding other items used to calculate Adjusted EBITDA and further adjusted for the tax effect of these exclusions.We use Free Cash Flow to review the liquidity of our operations. We measure Free Cash Flow as cash flows from operating activities less capital expenditures. We believe Free Cash Flow is a useful supplemental financial measure for us and investors in assessing our ability to pursue business opportunities and investments and to service our debt. Free Cash Flow is not a measure of our liquidity under GAAP and should not be considered as an alternative to cash flows from operating activities.Management and our board of directors regularly use these measures as tools in evaluating our operating and financial performance and in establishing discretionary annual compensation. Such measures are provided in addition to, and should not be considered to be a substitute for, or superior to, the comparable measures under GAAP. In addition, we believe that Adjusted EBITDA, Adjusted Net Income and Free Cash Flow are frequently used by investors and other interested parties in the evaluation of issuers, many of which also present Adjusted EBITDA, Adjusted Net Income and Free Cash Flow when reporting their results in an effort to facilitate an understanding of their operating and financial results and liquidity.26Table of ContentsAdjusted EBITDA, Adjusted Net Income and Free Cash Flow should not be considered as alternatives to net income (loss) or any other performance measure derived in accordance with GAAP, or as alternatives to cash flow from operating activities as a measure of our liquidity. Adjusted EBITDA, Adjusted Net Income and Free Cash Flow have limitations as analytical tools, and you should not consider such measures either in isolation or as substitutes for analyzing our results as reported under GAAP.Included in our discussion of our consolidated and segment results below are changes in revenues and Adjusted EBITDA on a Constant Currency basis. Constant Currency information compares results between periods as if exchange rates had remained constant period over period. We define Constant Currency revenues and Adjusted EBITDA as total revenues and Adjusted EBITDA excluding the impact of foreign exchange rate movements and use it to determine the Constant Currency revenue and Adjusted EBITDA growth on a year-over-year basis. Constant Currency revenues and Adjusted EBITDA are calculated by translating current period revenues and Adjusted EBITDA using corresponding prior period exchange rates. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a Constant Currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP.For further information regarding these measures, see “Non-GAAP Financial Measures” below.Results of Continuing OperationsConsolidated results should be read in conjunction with segment results and the Segment Information notes to our audited consolidated financial statements included elsewhere in this Form 10-K, which provide more detailed discussions concerning certain components of our consolidated statements of operations. All intercompany accounts and transactions have been eliminated within the consolidated results.This section discusses our results of continuing operations for the year ended December 31, 2022 as compared to the year ended December 31, 2021. For a discussion and analysis of the year ended December 31, 2021, compared to the same in 2020, please refer to the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC on February 25, 2022.27Table of ContentsConsolidated Results of Operations for the Years Ended December 31, 2022 and 2021Year Ended December 31,20222021Consolidated Statements of OperationsRevenues$5,916.3 $5,152.4 Cost of sales3,590.7 3,163.9 Gross Profit2,325.6 1,988.5 Selling and administrative expenses1,095.8 1,028.0 Amortization of intangible assets347.6 332.9 Other operating expense, net64.9 61.9 Operating Income817.3 565.7 Interest expense103.2 87.7 Loss on extinguishment of debt1.1 9.0 Other income, net(29.2)(44.0)Income Before Income Taxes742.2 513.0 Provision (benefit) for income taxes149.6 (21.8)Income (loss) on equity method investments0.7 (11.4)Income from Continuing Operations593.3 523.4 Income from discontinued operations, net of tax15.2 41.6 Net Income608.5 565.0 Less: Net income attributable to noncontrolling interests3.8 2.5 Net Income Attributable to Ingersoll Rand Inc.$604.7 $562.5 Percentage of RevenuesGross profit39.3 %38.6 %Selling and administrative expenses18.5 %20.0 %Operating income13.8 %11.0 %Income from continuing operations10.0 %10.2 %Adjusted EBITDA(1)24.3 %23.1 %Other Financial DataAdjusted EBITDA(1)$1,434.8 $1,191.9 Adjusted net income(1)971.7 881.4 Cash flows - operating activities865.4 627.8 Cash flows - investing activities(337.3)(1,029.4)Cash flows - financing activities(954.0)(1,157.0)Free cash flow(1)770.8 563.7 (1)See “Non-GAAP Financial Measures” below for a reconciliation to the most directly comparable GAAP measure.RevenuesRevenues for 2022 were $5,916.3 million, an increase of $763.9 million, or 14.8%, compared to $5,152.4 million in 2021. The increase in revenues was primarily due to higher pricing of $420.7 million, higher organic volumes of $409.4 million, and acquisitions of $225.5 million, partially offset by unfavorable impact of foreign currencies of $291.7 million. The percentage of consolidated revenues derived from aftermarket parts and services was 35.2% in 2022 compared to 36.2% in 2021.Gross ProfitGross profit in 2022 was $2,325.6 million, an increase of $337.1 million, or 17.0%, compared to $1,988.5 million in 2021, and as a percentage of revenues was 39.3% in 2022 and 38.6% in 2021. The increase in gross profit is primarily due to higher pricing, higher organic volumes and acquisitions discussed above. The increase in gross profit as a percentage of revenues is primarily due to the benefits of pricing changes in excess of inflation in material and labor costs.28Table of ContentsSelling and Administrative ExpensesSelling and administrative expenses were $1,095.8 million in 2022, an increase of $67.8 million, or 6.6%, compared to $1,028.0 million in 2021. The increase in selling and administrative expenses was mainly from businesses acquired in the second half of 2021, partially offset by lower incentive compensation expense. Selling and administrative expenses as a percentage of revenues decreased to 18.5% in 2022 from 20.0% in 2021.Amortization of Intangible AssetsAmortization of intangible assets was $347.6 million in 2022, an increase of $14.7 million compared to $332.9 million in 2021. The increase was primarily the result of recognizing a full year of amortization of assets acquired in the second half of 2021, partially offset by the impact of foreign currency translation.Other Operating Expense, NetOther operating expense, net was $64.9 million in 2022, an increase of $3.0 million compared to $61.9 million in 2021. The increase was primarily due to higher restructuring charges of $15.9 million and lower foreign currency transaction gains, net of $6.1 million, partially offset by lower acquisition related expenses of $16.6 million.Interest ExpenseInterest expense was $103.2 million in 2022, an increase of $15.5 million, compared to $87.7 million in 2021. The increase was primarily due to an increase in the weighted-average interest rate, partially offset by the prepayment of the Dollar Term Loan Series A on September 30, 2021, the prepayment of the Euro Term Loan on June 30, 2022, and the interest rate derivative contracts discussed in Note 19 “Hedging Activities, Derivative Instruments and Credit Risk” to our consolidated financial statements included elsewhere in this Form 10-K. The weighted-average interest rate was approximately 3.2% in 2022 and 2.0% in 2021.Loss on Extinguishment of DebtLoss on extinguishment of debt was $1.1 million in 2022, which was related to the payoff of the Euro Term Loan. Loss on extinguishment of debt was $9.0 million in 2021, which was related to the payoff of the Dollar Term Loan Series A. See Note 11 “Debt” to our audited consolidated financial statements included elsewhere in this Form 10-K for further details.Other Income, NetOther income, net, was $29.2 million in 2022, a decrease of $14.8 million compared to $44.0 million in 2021. The decrease in other income, net was primarily due to a lower gain from settling post-acquisition contingencies in the 2022 period compared to the 2021 period, partially offset by an increase in interest income from holdings of cash and cash equivalents.Provision (Benefit) for Income TaxesThe provision for income taxes was $149.6 million resulting in a 20.2% effective tax rate in 2022 compared to a benefit for income taxes of $21.8 million resulting in a 4.2% effective tax provision rate in 2021. The increase in the tax provision and the change in the effective tax rate is primarily due to an increase in the pre-tax book income in jurisdictions with higher effective tax rates combined with lower earnings in jurisdictions with lower tax rates. In addition, the 2021 provision and rate were reduced by the release of unrecognized tax reserves as a result of the lapse of the limitation on statutes, a benefit associated with the final settlement on the merger transaction, and the utilization of excess foreign tax credits as a result of restructuring benefits recognized in 2021. All of these items were one-time impacts to the 2021 tax provision and effective tax rate.Net IncomeNet income was $608.5 million in 2022, an increase of $43.5 million compared to $565.0 million in 2021. The increase in net income was primarily due to higher gross profit on increased revenues, partially offset by higher provision for income taxes and, to a lesser extent, selling and administrative expenses.Adjusted EBITDAAdjusted EBITDA increased $242.9 million to $1,434.8 million in 2022 compared to $1,191.9 million in 2021. Adjusted EBITDA as a percentage of revenues increased 120 basis points to 24.3% in 2022 from 23.1% in 2021. The increase in Adjusted EBITDA was primarily due to improved pricing of $420.7 million and higher organic sales volume of $162.4 million, partially offset by unfavorable cost inflation and product mix of $244.6 million and the unfavorable impact of foreign currencies of $72.0 29Table of Contentsmillion. The increase in Adjusted EBITDA as a percentage of revenues is primarily attributable to higher pricing and volume, partially offset by unfavorable cost inflation and product mix.Adjusted Net IncomeAdjusted Net Income increased $90.3 million to $971.7 million in 2022 compared to $881.4 million in 2021. The increase was primarily due to higher Adjusted EBITDA, partially offset by higher income tax provision, as adjusted and interest expense.Non-GAAP Financial MeasuresSet forth below are reconciliations of Net Income to Adjusted EBITDA and Adjusted Net Income and Cash flows from operating activities to Free Cash Flow. For additional information regarding Adjusted EBITDA and Adjusted Net Income, see “How We Assess the Performance of Our Business” above.Year Ended December 31,20222021Net Income$608.5 $565.0 Less: Income from discontinued operations0.5 121.0 Less: Income tax benefit (provision) from discontinued operations14.7 (79.4)Income from continuing operations, net of tax593.3 523.4 Plus:Interest expense103.2 87.7 Provision (benefit) for income taxes149.6 (21.8)Depreciation expense(a)81.8 85.1 Amortization expense(b)347.6 332.9 Restructuring and related business transformation costs(c)32.3 18.8 Acquisition related expenses and non-cash charges(d)40.7 65.2 Stock-based compensation(e)85.6 95.9 Foreign currency transaction gains, net(5.9)(12.0)Loss (income) on equity method investments(0.7)11.4 Loss on extinguishment of debt1.1 9.0 Adjustments to LIFO inventories36.1 33.2 Gain on settlement of post-acquisition contingencies(6.2)(30.1)Other adjustments(f)(23.7)(6.8)Adjusted EBITDA$1,434.8 $1,191.9 Minus:Interest expense$103.2 $87.7 Income tax provision, as adjusted(g)267.3 120.7 Depreciation expense81.8 85.1 Amortization of non-acquisition related intangible assets18.8 17.0 Interest income on cash and cash equivalents(8.0)— Adjusted Net Income$971.7 $881.4 Free Cash Flow from Continuing Operations:Cash flows from operating activities from continuing operations$865.4 $627.8 Minus:Capital expenditures94.6 64.1 Free Cash Flow from Continuing Operations$770.8 $563.7 (a)Depreciation expense excludes $3.4 million and $4.1 million of depreciation of rental equipment for the years ended December 31, 2022 and 2021, respectively.30Table of Contents(b)Represents $328.8 million and $315.9 million of amortization of intangible assets arising from acquisitions (customer relationships, technology, tradenames and backlog) and $18.8 million and $17.0 million of amortization of non-acquisition related intangible assets, in each case for the years ended December 31, 2022 and 2021, respectively.(c)Restructuring and related business transformation costs consisted of the following.Year Ended December 31,20222021Restructuring charges$29.3 $13.4 Facility reorganization, relocation and other costs3.0 3.1 Other, net— 2.3 Total restructuring and related business transformation costs$32.3 $18.8 (d)Represents costs associated with successful and abandoned acquisitions, including third-party expenses, post-closure integration costs (including certain incentive and non-incentive cash compensation costs), and non-cash charges and credits arising from fair value purchase accounting adjustments.(e)Represents stock-based compensation expense recognized for the year ended December 31, 2022 of $78.9 million and associated employer taxes of $6.7 million. Represents stock-based compensation expense recognized for the year ended December 31, 2021 of $87.2 million and associated employer taxes of $8.7 million.(f)Includes (i) effects of the amortization of prior service costs and amortization of losses in pension and other postemployment (“OPEB”) expense, (ii) interest income on cash and cash equivalents and (iii) other miscellaneous adjustments.(g)Represents our income tax provision adjusted for the tax effect of pre-tax items excluded from Adjusted Net Income and the removal of applicable discrete tax items. The tax effect of pre-tax items excluded from Adjusted Net Income is computed using the statutory tax rate related to the jurisdiction that was impacted by the adjustment after taking into account the impact of permanent differences and valuation allowances. Discrete tax items include changes in tax laws or rates, changes in uncertain tax positions relating to prior years and changes in valuation allowances.The income tax provision, as adjusted for each of the periods presented below consists of the following.Year Ended December 31,20222021Provision (benefit) for income taxes$149.6 $(21.8)Tax impact of pre-tax income adjustments107.3 97.6 Discrete tax items10.4 44.9 Income tax provision, as adjusted$267.3 $120.7 Segment ResultsWe report our business into two segments: Industrial Technologies and Services and Precision and Science Technologies. Our Corporate operations (as described below) are not discussed separately as any results that had a significant impact on operating results are included in the consolidated results discussion above.We evaluate the performance of our segments based on Segment Revenues and Segment Adjusted EBITDA. Segment Adjusted EBITDA is indicative of operational performance and ongoing profitability. Our management closely monitors Segment Adjusted EBITDA to evaluate past performance and identify actions required to improve profitability.The segment measurements provided to, and evaluated by, the Chief Operating Decision Maker (“CODM”) are described in Note 23 “Segment Information” to our audited consolidated financial statements included elsewhere in this Form 10-K.Included in our discussion of our segment results below are changes in Segment Revenues and Segment Adjusted EBITDA on a Constant Currency basis. Constant Currency information compares results between periods as if exchange rates had remained constant period over period. We define Constant Currency as changes in Segment Revenues and Segment Adjusted EBITDA excluding the impact of foreign exchange rate movements. We use these measures to determine the Constant Currency Segment Revenues and Segment Adjusted EBITDA growth on a year-on-year basis. Constant Currency Segment Revenues and Segment Adjusted EBITDA are calculated by translating current period Segment Revenues and Segment Adjusted EBITDA using prior period exchange rates. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with GAAP.Segment Results for Years Ended December 31, 2022 and 2021The following tables display Segment Order, Segment Revenues, Segment Adjusted EBITDA and Segment Adjusted EBITDA Margin (Segment Adjusted EBITDA as a percentage of Segment Revenues) for each of our Segments and illustrates, on a 31Table of Contentspercentage basis, the impact of foreign currency fluctuations on Segment Orders, Segment Revenues and Segment Adjusted EBITDA growth.Industrial Technologies and Services Segment ResultsYears Ended December 31,Percent Change202220212022 vs. 2021Segment Orders$5,120.1 $4,678.8 9.4 %Segment Revenues$4,705.1 $4,161.0 13.1 %Segment Adjusted EBITDA$1,214.0 $1,033.7 17.4 %Segment Adjusted EBITDA Margin25.8 %24.8 %100 bps2022 vs. 2021Segment Orders for 2022 were $5,120.1 million, an increase of $441.3 million, or 9.4%, compared to $4,678.8 million in 2021. The increase in Segment Orders was primarily due to organic growth of $633.3 million or 13.5% and acquisitions of $49.4 million or 1.1%, partially offset by unfavorable impact of foreign currencies of $241.4 million or 5.2%.Segment Revenues for 2022 were $4,705.1 million, an increase of $544.1 million, or 13.1%, compared to $4,161.0 million in 2021. The increase in Segment Revenues was primarily due to higher organic sales volumes of $375.5 million or 9.0%, improved pricing of $352.3 million or 8.5%, and acquisitions of $44.4 million or 1.1%, partially offset by unfavorable impact of foreign currencies of $228.1 million or 5.5%. The percentage of Segment Revenues derived from aftermarket parts and service was 39.4% in 2022 compared to 40.7% in 2021.Segment Adjusted EBITDA in 2022 was $1,214.0 million, an increase of $180.3 million, or 17.4%, from $1,033.7 million in 2021. Segment Adjusted EBITDA Margin increased 100 bps to 25.8% from 24.8% in 2021. The increase in Segment Adjusted EBITDA was primarily due to improved pricing of $352.3 million or 34.1%, higher organic sales volumes of $147.2 million or 14.2%, and acquisitions of $8.4 million or 0.8%, partially offset by unfavorable cost inflation and product mix of $205.1 million or 19.8%, unfavorable impact of foreign currencies of $57.9 million or 5.6%, and higher selling and administrative expenses of $64.5 million or 6.2%.Precision and Science Technologies Segment ResultsYears Ended December 31,Percent Change202220212022 vs. 2021Segment Orders$1,247.5 $1,085.7 14.9 %Segment Revenues$1,211.2 $991.4 22.2 %Segment Adjusted EBITDA$347.5 $291.4 19.3 %Segment Adjusted EBITDA Margin28.7 %29.4 %(70) bps2022 vs. 2021Segment Orders for 2022 were $1,247.5 million, an increase of $161.8 million, or 14.9%, compared to $1,085.7 in 2021. The increase in Segment Orders was primarily due to acquisitions of $203.5 million or 18.7% and organic growth of $23.5 million or 2.2%, partially offset by unfavorable impact of foreign currencies of $65.2 million or 6.0%.Segment Revenues for 2022 were $1,211.2 million, an increase of $219.8 million, or 22.2%, compared to $991.4 million in 2021. The increase in Segment Revenues was primarily due to acquisitions of $181.1 million or 18.3%, improved pricing of $68.4 million or 6.9%, and higher volume of $33.9 million or 3.4%, partially offset by unfavorable impact of foreign currencies of $63.6 million or 6.4%. The percentage of Segment Revenues derived from aftermarket parts and service was 19.1% in 2022 compared to 17.1% in 2021.Segment Adjusted EBITDA in 2022 was $347.5 million, an increase of $56.1 million, or 19.3%, from $291.4 million in 2021. Segment Adjusted EBITDA Margin decreased 70 bps to 28.7% from 29.4% in 2021. The increase in Segment Adjusted EBITDA was due primarily to improved pricing of $68.4 million or 23.5%, acquisitions of $38.7 million or 13.3%, and higher organic sales volumes of $15.2 million or 5.2%, partially offset by unfavorable cost inflation and product mix of $38.2 million or 13.1%, unfavorable impact of foreign currencies of $18.3 million or 6.3%, and higher selling and administrative expenses of $11.7 million or 4.0%.32Table of ContentsResults of Discontinued OperationsResults of Discontinued Operations - SVTThe following table presents selected Consolidated Results of Operations of our business for the years ended December 31, 2022 and 2021.Years Ended December 31,20222021Revenues$6.6 $430.9 Cost of sales6.5 321.3 Gross profit0.1 109.6 Selling and administrative expenses0.1 35.7 Amortization of intangible assets— 10.4 Gain on sale(2.8)(298.3)Other operating expense, net0.7 18.1 Income Before Income Taxes2.1 343.7 Provision (benefit) for income taxes(13.2)87.1 Income from Discontinued Operations, Net of Tax$15.3 $256.6 The change in income from discontinued operations for the year ended December 31, 2022 compared to 2021 is primarily due to the substantial completion of the sale of SVT on June 1, 2021.Results of Discontinued Operations - HPSThe following table presents selected Consolidated Results of Operations of our business for the years ended December 31, 2022 and 2021.Years Ended December 31,20222021Revenues$— $71.9 Cost of sales— 60.2 Gross profit— 11.7 Selling and administrative expenses— 5.3 Amortization of intangible assets— 2.4 Loss on sale— 207.7 Other operating expense, net1.6 19.0 Loss Before Income Taxes(1.6)(222.7)Benefit for income taxes(1.5)(7.7)Loss from Discontinued Operations, Net of Tax$(0.1)$(215.0)The change in results from discontinued operations for the year ended December 31, 2022 compared to 2021 is primarily due to the substantial completion of the sale of HPS on April 1, 2021. The remaining activities mainly represent expenses incurred to finalize separation and fulfill transition services.33Table of ContentsUnaudited Quarterly Results of Operations(in millions, except per share amounts)Year Ended December 31, 2022Year Ended December 31, 2021Q1Q2Q3Q4Q1Q2Q3Q4Revenues$1,337.0 $1,439.9 $1,515.7 $1,623.7 $1,129.5 $1,279.1 $1,325.0 $1,418.8 Gross profit$526.1 $569.8 $575.3 $654.4 $452.1 $512.7 $514.3 $509.4 Operating income$157.0 $197.4 $190.0 $272.9 $121.3 $140.1 $163.9 $140.4 Income from continuing operations, net of tax$105.9 $137.8 $145.5 $204.1 $90.1 $138.3 $131.0 $164.0 Income (loss) from discontinued operations, net of tax$(1.4)$1.5 $0.5 $14.6 $(180.2)$96.3 $(4.2)$129.7 Net income (loss)$104.5 $139.3 $146.0 $218.7 $(90.1)$234.6 $126.8 $293.7 Net income (loss) attributable to Ingersoll Rand Inc.$103.7 $138.5 $145.1 $217.4 $(90.4)$233.9 $126.0 $293.0 Weighted average shares, basic407.6 404.5 404.0 405.0 419.2 419.9 412.3 407.8 Weighted average shares, diluted413.1 409.4 408.5 409.3 425.9 426.8 418.5 413.4 Basic earnings per share of common stock from continuing operations$0.26 $0.34 $0.36 $0.50 $0.21 $0.33 $0.32 $0.40 Basic earnings (loss) per share of common stock from discontinued operations$— $— $— $0.04 $(0.43)$0.23 $(0.01)$0.32 Basic earnings (loss) per share of common stock$0.25 $0.34 $0.36 $0.54 $(0.22)$0.56 $0.31 $0.72 Diluted earnings per share of common stock from continuing operations$0.25 $0.33 $0.35 $0.50 $0.21 $0.32 $0.31 $0.40 Diluted earnings (loss) per share of common stock from discontinued operations$— $— $— $0.04 $(0.42)$0.23 $(0.01)$0.31 Diluted earnings (loss) per share of common stock$0.25 $0.34 $0.36 $0.53 $(0.21)$0.55 $0.30 $0.71 Adjusted EBITDA(1)$303.6 $334.9 $376.1 $420.2 $244.0 $292.1 $313.7 $342.1 34Table of Contents(1)Set forth below are the reconciliations of Net Income to Adjusted EBITDAYear Ended December 31, 2022Year Ended December 31, 2021Q1Q2Q3Q4Q1Q2Q3Q4Net Income (Loss)$104.5 $139.3 $146.0 $218.7 $(90.1)$234.6 $126.8 $293.7 Less: Income (loss) from discontinued operations(1.8)2.0 0.6 (0.3)(177.8)258.5 (7.6)47.9 Less: Income tax benefit (provision) from discontinued operations0.4 (0.5)(0.1)14.9 (2.4)(162.2)3.4 81.8 Income from continuing operations, net of tax105.9 137.8 145.5 204.1 90.1 138.3 131.0 164.0 Plus:Interest expense19.0 23.2 26.6 34.4 23.1 22.7 22.5 19.4 Provision (benefit) for income taxes32.4 41.9 30.3 45.0 10.6 12.5 2.7 (47.6)Depreciation expense21.3 20.1 20.4 20.0 20.3 21.0 21.2 22.6 Amortization expense86.2 83.6 93.8 84.0 84.2 80.3 80.3 88.1 Restructuring and related business transformation costs(a)14.2 9.5 7.2 1.4 2.7 6.7 3.1 6.3 Acquisition related expenses and non-cash charges(b)9.5 5.4 12.1 13.7 10.5 14.3 14.4 26.0 Stock-based compensation(c)19.8 22.4 27.1 16.3 21.6 21.5 29.8 23.0 Loss (income) on equity method investments4.3 0.8 (2.6)(3.2)— 0.7 2.2 8.5 Loss on extinguishment of debt— 1.1 — — — — 9.0 — Foreign currency transaction losses (gains), net(3.8)(1.8)(6.7)6.4 (18.1)3.4 1.1 1.6 Adjustments to LIFO inventories— — 33.0 3.1 — — — 33.2 Gain on settlement of post-acquisition contingencies(d)— — (6.2)— — (30.1)— — Other adjustments(e)(5.2)(9.1)(4.4)(5.0)(1.0)0.8 (3.6)(3.0)Adjusted EBITDA$303.6 $334.9 $376.1 $420.2 $244.0 $292.1 $313.7 $342.1 (a)Restructuring and related business transformation costs consist of (i) restructuring charges, (ii) severance, sign-on, relocation and executive search costs, (iii) facility reorganization, relocation and other costs, (iv) information technology infrastructure transformation, (v) gains and losses on asset disposals, (vi) consultant and other advisor fees and (vii) other miscellaneous costs.(b)Represents costs associated with successful and abandoned acquisitions, including third-party expenses, post-closure integration costs (including certain incentive and non-incentive cash compensation costs) and non-cash charges and credits arising from fair value purchase accounting adjustments.(c)Represents stock-based compensation expense recognized and associated employer taxes.(d)Represents a gain on settlement of post-acquisition contingencies outside of the measurement period related to adjustments to the transaction price for retirement plan funding and net working capital.(e)Includes (i) effects of amortization of prior service costs and amortization of losses in pension and other postemployment (“OPEB”) expense, (ii) interest income on cash and cash equivalents and (iii) other miscellaneous adjustments.35Table of ContentsLiquidity and Capital ResourcesOur investment resources include cash on hand, cash generated from operations and borrowings under our Revolving Credit Facility. We also have the ability to seek additional secured and unsecured borrowings, subject to Credit Agreement restrictions.For a description of our material indebtedness, see Note 11 “Debt” to our audited consolidated financial statements included elsewhere in this Form 10-K.As of December 31, 2022, we had no outstanding borrowings, no outstanding letters of credit under the New Revolving Credit Facility and unused availability of $1,100.0 million.As of December 31, 2022, we were in compliance with all of our debt covenants and no event of default had occurred or was ongoing.LiquidityOur liquidity needs primarily arise from working capital needs for normal operating costs, servicing debt, funding acquisitions and capital expenditures.Year Ended December 31,20222021Cash and cash equivalents$1,613.0 $2,109.6 Short-term borrowings and current maturities of long-term debt$36.5 $38.8 Long-term debt2,716.1 3,401.8 Total debt$2,752.6 $3,440.6 We can increase the borrowing availability under the Senior Secured Credit Facilities by up to $1,600.0 million in the form of additional commitments under the Revolving Credit Facility and/or incremental term loans plus an additional amount so long as we do not exceed a specified senior secured leverage ratio. We can incur additional secured indebtedness under the Senior Secured Credit Facilities if certain specified conditions are met under the credit agreement governing the Senior Secured Credit Facilities. Our liquidity requirements are significant primarily due to debt service requirements. See Note 11 “Debt” to our audited consolidated financial statements included elsewhere in this Form 10-K for further details.Our principal sources of liquidity have been existing cash and cash equivalents, cash generated from operations and borrowings under the Senior Secured Credit Facilities. Our principal uses of cash will be to provide working capital, meet debt service requirements, fund capital expenditures and finance strategic plans, including possible acquisitions. We may also seek to finance capital expenditures under capital leases or other debt arrangements that provide liquidity or favorable borrowing terms. We continue to consider acquisition opportunities, but the size and timing of any future acquisitions and the related potential capital requirements cannot be predicted. In the event that suitable businesses are available for acquisition upon acceptable terms, we may obtain all or a portion of the necessary financing through the incurrence of additional long-term borrowings. We may from time to time, seek to repay loans that we have borrowed, including the borrowings under the Senior Secured Credit Facilities. Based on our current level of operations and available cash, we believe our cash flow from operations, together with availability under the Revolving Credit Facility, will provide sufficient liquidity to fund our current obligations, projected working capital requirements, debt service requirements and capital spending requirements for the foreseeable future. Our ability to do so depends on, among other factors, prevailing economic conditions, many of which are beyond our control. In addition, upon the occurrence of certain events, such as a change in control, we could be required to repay or refinance our indebtedness. We may not be able to refinance any of our indebtedness, including the Senior Secured Credit Facilities, on commercially reasonable terms or at all. Any future acquisitions, joint ventures, or other similar transactions may require additional capital and there can be no assurance that any such capital will be available to us on acceptable terms or at all.We may from time to time repurchase shares of our common stock in the open market at prevailing market prices (including through a Rule 10b5-1 plan), in privately negotiated transactions, a combination thereof or through other transactions. The actual timing, number, manner and value of any shares repurchased will depend on several factors, including the market price of our stock, general market and economic conditions, our liquidity requirements, applicable legal requirements and other business considerations.A substantial portion of our cash is in jurisdictions outside the United States. We do not assert ASC 740-30 (formerly APB 23) indefinite reinvestment of our historical non-U.S. earnings or future non-U.S. earnings. The Company records a deferred foreign tax liability to cover all estimated withholding, state income tax and foreign income tax associated with repatriating all non-U.S. Table of Contentsearnings back to the United States. Our deferred income tax liability as of December 31, 2022 is $32.4 million which consists mainly of withholding taxes.Working CapitalFor the Years Ended December 31,20222021Net Working CapitalCurrent assets$3,967.3 $4,114.9 Less: Current liabilities1,674.0 1,467.7 Net working capital$2,293.3 $2,647.2 Operating Working CapitalAccounts receivable$1,122.0 $948.6 Plus: Inventories (excluding LIFO)1,085.9 878.6 Plus: Contract assets70.6 60.8 Less: Accounts payable778.7 670.5 Less: Contract liabilities305.6 242.1 Operating working capital$1,194.2 $975.4 Net working capital decreased $353.9 million to $2,293.3 million as of December 31, 2022 from $2,647.2 million as of December 31, 2021. Operating working capital increased $218.8 million to $1,194.2 million as of December 31, 2022 from $975.4 million as of December 31, 2021. Operating working capital as of December 31, 2022 was 20.2% of 2022 revenues as compared to 18.9% as of December 31, 2021 as a percentage of 2021 revenues. The increase in operating working capital was primarily due to higher inventories and higher accounts receivable, partially offset by higher accounts payable and higher contract liabilities. The increase in inventory was primarily attributable to additions to inventory to fulfill increased demand for certain products and to acquisitions completed in 2022. The increase in accounts receivable was primarily due to the increase in revenue in the fourth quarter of 2022 compared to the fourth quarter of 2021 and to acquisitions completed in 2022. The increase in accounts payable was primarily due to the timing of vendor cash disbursements. The increase in contract liabilities was primarily due to the higher volume of engineered to order contracts.Cash FlowsThe following table reflects the major categories of cash flows for the years ended December 31, 2022 and 2021, respectively.20222021Cash flows provided by (used in) continuing operations:Cash flows provided by operating activities$865.4 $627.8 Cash flows used in investing activities(337.3)(1,029.4)Cash flows used in financing activities(954.0)(1,157.0)Net cash provided by (used in) discontinued operations(0.7)1,931.4 Free cash flow (1)770.8 563.7 (1)See “Non-GAAP Financial Measures” for a reconciliation to the most directly comparable GAAP measure.Operating activitiesCash provided by operating activities increased $237.6 million to $865.4 million in 2022 from $627.8 million in 2021, primarily due to a decrease in cash paid for income taxes of $246.4 million and higher income from continuing operations partially offset by cash used in operating working capital.Operating working capital used cash of $237.2 million in 2022 compared to using cash of $3.0 million in 2021. Changes in account receivables used cash of $195.2 million in 2022 compared to using cash of $62.5 million in 2021. Changes in contract assets used cash of $9.8 million in 2022 compared to using cash of $0.4 million in 2021. Changes in inventory used cash of $225.6 million in 2022 compared to using cash of $134.4 million in 2021. Changes in accounts payable generated cash of $120.4 million in 2022 compared to generating cash of $118.2 million in 2021. Changes in contract liabilities generated cash of $73.0 million in 2022 compared to generating cash of $76.1 million in 2021.37Table of ContentsInvesting activitiesCash flows used in investing activities included capital expenditures of $94.6 million (1.6% of consolidated revenues) and $64.1 million (1.2% of consolidated revenues) in 2022 and 2021, respectively. We expect capital expenditures will be approximately 2% of consolidated revenues in 2023. Net cash paid in acquisitions was $246.8 million and $974.8 million in 2022 and 2021, respectively. Net proceeds from the disposal of property, plant and equipment were $9.5 million in 2021.Financing activitiesCash used in financing activities of $954.0 million in 2022 is primarily due to repayments of long-term debt of $655.6 million, purchases of treasury stock of $261.1 million, and cash dividends on common stock of $32.4 million, partially offset by proceeds from stock option exercises of $19.3 million.Cash used in financing activities of $1,157.0 million in 2021 is primarily due to purchases of treasury stock of $736.8 million, repayments of long-term debt of $435.7 million, and cash dividends on common stock of $8.2 million, partially offset by proceeds from stock option exercises of $23.7 million.Discontinued OperationsCash provided by (used in) discontinued operations decreased $1,932.1 million to $(0.7) million in 2022 from $1,931.4 million in 2021, primarily due to the sales being substantially completed in the second quarter of 2021. Cash used in discontinued operations in 2022 related primarily to separation related expenses.Free cash flowFree cash flow increased $207.1 million to $770.8 million in 2022 from $563.7 million in 2021 primarily due to the increase in cash provided by operating activities discussed above.Purchase ObligationsPurchase obligations consist primarily of agreements to purchase inventory or services made in the normal course of business to meet operational requirements. As of December 31, 2022, the Company had purchase obligations of $444.3 million, with $388.3 million payable in the next 12 months. The purchase obligation amounts do not represent the entire anticipated purchases in the future, but represent only those items for which we are contractually obligated as of December 31, 2022. For this reason, these amounts will not provide a complete and reliable indicator of our expected future cash outflows.ContingenciesWe are a party to various legal proceedings, lawsuits and administrative actions, which are of an ordinary or routine nature for a company of our size and in our sector. We believe that such proceedings, lawsuits and administrative actions will not materially adversely affect our operations, financial condition, liquidity or competitive position. We have accrued liabilities and other liabilities on our consolidated balance sheet, including a total litigation reserve of $137.9 million as of December 31, 2022 with respect to potential liability arising from our asbestos-related litigation. Other than our asbestos-related litigation reserves, liabilities on our consolidated balance sheet related to legal proceedings, lawsuits and administrative actions are not significant. A more detailed discussion of certain of these proceedings, lawsuits and administrative actions is set forth in “Item 3. Legal Proceedings.”Critical Accounting EstimatesAccounting estimates discussed in this section are those that we consider to be the most critical to an understanding of our consolidated financial statements because they involve significant judgments and uncertainties. These estimates reflect our best judgment about current, and for some estimates, future economic and market conditions and their effect based on information available as of the date of these consolidated financial statements. If these conditions change from those expected, it is reasonably possible that the judgments and estimates described below could change, which may result in future impairments of goodwill, intangibles and long-lived assets, increases in reserves for contingencies, establishment of valuation allowances on deferred tax assets and increase in tax liabilities, among other effects. Also see Note 1 “Summary of Significant Accounting Policies” to our audited consolidated financial statements included elsewhere in this Form 10-K, which discusses the significant accounting policies that we have selected from acceptable alternatives.38Table of ContentsBusiness CombinationsWe apply the acquisition method of accounting with respect to the identifiable assets and liabilities of a business combination and record the assets acquired and liabilities assumed at their estimated fair values as of the acquisition date. The excess of the cost of the acquired business and the fair value of the assets acquired and liabilities assumed is recognized as goodwill. Estimates of fair value represent management’s best estimate of assumptions and about future events and uncertainties, including significant judgments related to future cash flows, discount rates, competitive trends, margin and revenue growth assumptions including royalty rates, customer attrition rates and others. Inputs used are generally obtained from historical data supplemented by current and anticipated market conditions and growth rates.Significant judgment is required in estimating the fair value of identifiable intangible assets and in assigning their respective useful lives. The fair value estimates are based on historical information and on future expectations and assumptions deemed reasonable by management, but which are inherently uncertain. See Note 4 “Acquisitions” to our consolidated financial statements included elsewhere in this Form 10-K for further information regarding the fair value determination of each of the classes of identifiable intangible assets. Determining the useful life of an intangible asset also requires judgment. Certain intangibles are expected to have indefinite lives while certain other identifiable intangible assets have determinable lives. The useful lives of identifiable intangibles with determinable useful lives are based on a variety of factors, including but not limited to, the competitive environment, product cycles, order life cycles, historical customer attrition rates, market share, operating plans and the macroeconomic environment. The costs of determinable-lived intangible assets are amortized to expense over the estimated useful life.Impairment of Goodwill and Other Identified Intangible AssetsWe test goodwill for impairment annually in the fourth quarter of each year using data as of October 1 of that year and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The impairment test consists of comparing the fair value of the reporting unit to the carrying value of the reporting unit. An impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; provided, the loss recognized cannot exceed the total amount of goodwill allocated to the reporting unit. If applicable, we consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss. We determined fair values for all of the reporting units using a combination of the income and market multiples approaches which are weighted 75% and 25%, respectively.Under the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We use our internal forecasts to estimate future cash flows and include an estimate of long-term future growth rates based on our most recent views of the long-term outlook for each business. Actual results may differ from those assumed in our forecasts. We derive our discount rates using a capital asset pricing model and analyzing published rates for industries relevant to our reporting units to estimate the cost of equity financing. We use discount rates that are commensurate with the risks and uncertainty inherent in the respective businesses and in our internally developed forecasts. Discount rates used in our 2022 reporting unit valuations ranged from 9.5% to 10.5%. Additionally, we assumed 3.5% terminal growth rates for all reporting units, except a single reporting unit in which we determined it most appropriate to assume a 2.5% terminal growth rate due to it being closely aligned to the GDP percentage growth rate.Under the market multiples approach, fair value is determined based on multiples derived from the stock prices of publicly traded guideline companies to develop a business enterprise value (“BEV”) for our reporting units. The application of the market multiples method entails the development of book value multiples based on the market value of the guideline companies. The multiples are developed by first calculating the market value of equity of the guideline companies and then adjusting these multiples for cash and debt to arrive at a BEV multiple. Identifying appropriate guideline companies and computing appropriate market multiples is subjective. We considered various public companies that had reasonably similar qualitative factors as our reporting units while also considering quantitative factors such as revenue growth, profitability and total assets.The excess of the estimated fair value over the carrying value for all reporting units was a minimum of 32%, and therefore, no impairments were recorded.We test intangible assets with indefinite lives for impairment annually utilizing a discounted cash flow valuation referred to as the relief from royalty method. We estimated forecasted revenues for a period of five years with discount rates ranging from 10.0% to 11.0%, terminal growth rates of 2.5% to 3.5%, and royalty rates ranging from 0.5% to 4.0%. There were no impairments identified or recognized during the year ended December 31, 2022.We review identified intangible assets with defined useful lives and subject to amortization for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Determining whether an impairment 39Table of Contentsloss occurred requires comparing the carrying amount to the sum of undiscounted cash flows expected to be generated by the asset.Also see Note 9 “Goodwill and Other Intangible Assets” to our audited consolidated financial statements included elsewhere in this Form 10-K.Income TaxesOur annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions, including evaluating uncertainties. We review our tax positions quarterly and adjust the balances as new information becomes available.The Tax Cuts and Jobs Act (“Tax Act”), enacted on December 22, 2017, created a new requirement that certain income (i.e., Global intangible low taxed income (“GILTI”)) earned by controlled foreign corporations (“CFC”) must be included currently in the gross income of the CFCs’ U.S. shareholder. GILTI is the excess of the shareholder’s “net CFC tested income” over the net deemed tangible income return, which is currently defined as the excess of (1) 10% of the aggregate of the U.S. shareholder’s pro rata share of the qualified business asset investment of each CFC with respect to which it is a U.S. shareholder over (2) the amount of certain interest expense taken into account in the determination of net CFC-tested income.Under U.S. GAAP, the Company is allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the “period cost method”) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the “deferred method”). The Company has determined that it will follow the period cost method (option 1 above). The Company recorded a tax expense of $2.5 million in 2022 for the GILTI provisions of the Tax Act.Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carryforwards. We evaluate the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These sources of income rely heavily on estimates. To the extent we do not consider it more likely than not that a deferred tax asset will be recovered, a valuation allowance is established. Amounts recorded for deferred tax assets related to tax attribute carryforwards, net of valuation allowances, were $58.9 million and $38.0 million as of December 31, 2022 and 2021, respectively, with the increase due to the creation of attributes in the current year.Loss ContingenciesLoss contingencies are uncertain and unresolved matters that arise in the ordinary course of business and result from events or actions by others that have the potential to result in a future loss. Such contingencies include, but are not limited to, asbestos and silica related litigation, environmental obligations and losses resulting from other events and developments.When a loss is considered probable and reasonably estimable, we record a liability in the amount of our best estimate for the ultimate loss. When there appears to be a range of possible costs with equal likelihood, liabilities are based on the low-end of such range. However, the likelihood of a loss with respect to a particular contingency is often difficult to predict and determining a meaningful estimate of the loss or a range of loss may not be practicable based on the information available and the potential effect of future events and decisions by third parties that will determine the ultimate resolution of the contingency. In particular, as it relates to estimating asbestos and silica contingencies, there are a number of key variables and assumptions including the number and type of new claims to be filed each year, the resolution or outcome of these claims, the average cost of resolution of each new claim, the amount of insurance available, allocation methodologies, the contractual terms with each insurer with whom we have reached settlements, the resolution of coverage issues with other excess insurance carriers with whom we have not yet achieved settlements and the solvency risk with respect to our insurance carriers. Moreover, it is not uncommon for such matters to be resolved over many years, during which time relevant developments and new information must be continuously evaluated to determine both the likelihood of potential loss and whether it is possible to reasonably estimate a range of possible loss. When a loss is probable but a reasonable estimate cannot be made, disclosure is provided.Disclosure also is provided when it is reasonably possible that a loss will be incurred or when it is reasonably possible that the amount of a loss will exceed the recorded provision. We regularly review all contingencies to determine whether the likelihood of loss has changed and to assess whether a reasonable estimate of the loss or range of loss can be made. As discussed above, development of a meaningful estimate of loss or a range of potential loss is complex when the outcome is directly dependent on 40Table of Contentsnegotiations with or decisions by third parties, such as regulatory agencies, the court system and other interested parties. Such factors bear directly on whether it is possible to reasonably estimate a range of potential loss and boundaries of high and low.Recent Accounting PronouncementsSee Note 2 “New Accounting Standards” to our audited consolidated financial statements included elsewhere in this Form 10-K for a discussion of recent accounting standards.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKInterest Rate RiskWe are exposed to interest rate risk as a result of our variable-rate borrowings. We manage our exposure to interest rate risk by maintaining a mixture of fixed and variable debt, and use pay-fixed interest rate swaps and interest rate caps as cash flow hedges of our variable rate debt in order to adjust the relative fixed and variable portions.As of December 31, 2022, we had variable rate debt outstanding of $2,749.8 million, substantially all of which was incurred under our Senior Secured Credit Facility, under which an aggregate of $2,749.8 million was outstanding under the $1,900.0 million Dollar Term Loan B and $927.6 million Dollar Term Loan. Based on prevailing rates at December 31, 2022, the weighted average interest rate was approximately 5.9%.The Dollar Term Loan B and Dollar Term Loan bear interest primarily based on SOFR plus a spread and are subject to a 0% SOFR base rate floor. Thus, the interest rate on the Dollar Term Loan B and Dollar Term Loan will fluctuate when SOFR, exceeds that percentage. As of December 31, 2022, SOFR was higher than the 0% floor.We use interest rate swaps and interest rate caps to offset or mitigate our exposure to interest rate movements. These outstanding interest rate swap and interest rate cap contracts qualify and are designated as cash flow hedges of forecasted SOFR-based interest payments. As of December 31, 2022, we were a fixed rate payer on two fixed-floating interest rate swap contracts that effectively fixed the SOFR-based index used to determine the interest rates charged on our SOFR-based variable rate borrowings and we have three interest rate cap contracts that effectively limit the SOFR-based index used to determine the interest rates charged on a total of $1,000.0 million of the Company’s SOFR-based variable rate borrowings to 4.0%. See Note 19 “Hedging Activities, Derivative Instruments and Credit Risk” to our audited consolidated financial statements included elsewhere in this Form 10-K.The following table presents the impact of hypothetical changes in market interest rates across the yield curve by 100 basis points, including the effect of our interest rate swaps and caps for the years ended December 31, 2022 and 2021 on our interest expense.20222021Increase (decrease) in market interest rates100 basis points$12.3 $30.1 (100) basis points(1)(21.4)(2.5)(1)A decrease in interest rates would not have impacted our interest expense in 2022 or 2021 on EURO debt which was lower than the 0% base rate floor under the Senior Secured Credit Facility for the entire fiscal year 2022 and 2021, but would have impacted interest expense in 2022 and 2021 on SOFR or LIBOR debt, for the respective period, which was higher than the 0% based rate floors under the Senior Secured Credit Facility for the year ended December 31, 2022 and 2021.Foreign Currency RiskWe are exposed to foreign currency risks that arise from our global business operations. Changes in foreign currency exchange rates affect the translation of local currency balances of foreign subsidiaries, transaction gains and losses associated with intercompany loans with foreign subsidiaries and transactions denominated in currencies other than a subsidiary’s functional currency. In 2022 and 2021, the relative strengthening of the U.S. dollar against foreign currencies had a unfavorable impact on our revenues and results of operations. While future changes in foreign currency exchange rates are difficult to predict, our revenues and earnings may be adversely affected if the U.S. dollar strengthens against foreign currencies.We seek to minimize our exposure to foreign currency risks through a combination of normal operating activities, including by conducting our international business operations primarily in their functional currencies to match expenses with revenues and the use of foreign currency forward exchange contracts and net investment hedges. In addition, to mitigate the risk arising from entering into transactions in currencies other than our functional currencies, we typically settle intercompany trading balances at least quarterly.41Table of ContentsThe table below presents the percentage of revenues and gross profit by functional currency for the years ended December 31, 2022 and 2021.U.S. DollarEuroChinese RenminbiBritish PoundOtherYear Ended December 31, 2022Revenues44 %25 %15 %4 %12 %Gross profit44 %26 %17 %3 %10 %Year Ended December 31, 2021Revenues41 %27 %16 %4 %12 %Gross profit42 %28 %17 %3 %10 %We utilize foreign currency denominated debt obligations supplemented from time to time with cross currency interest rate swaps designated as net investment hedges to selectively hedge portions of our investment in non-U.S. subsidiaries. The currency effects of the designated debt obligations and cross currency interest rate swaps are reflected in accumulated other comprehensive income within our stockholders’ equity, where they partially offset the currency translation effects of our investments in non-U.S. subsidiaries, which in turn partially offset gains and losses recorded on our net investments globally. These currency translation effects and offsetting impacts of our derivatives for the years ended December 31, 2022 and 2021 are summarized in Note 14 “Accumulated Other Comprehensive Income (Loss)” to our audited consolidated financial statements included elsewhere in this Form 10-K.We also enter into foreign currency forward contracts to manage the risk arising from transaction gains and losses associated with intercompany loans with foreign subsidiaries. Our foreign currency forward contracts are typically short-term and are rolled forward as necessary upon settlement. As of December 31, 2022, we were party to three foreign currency forward contracts, all of which are carried on our balance sheet at fair value. See Note 19 “Hedging Activities, Derivative Instruments and Credit Risk” to our audited consolidated financial statements included elsewhere in this Form 10-K.The table below presents, for the year ended December 31, 2022, the hypothetical effect of a 10% appreciation in the average exchange rate of the U.S. dollar relative to the principal foreign currencies in which our revenues and gross profit are denominated.Year Ended December 31, 2022EuroChinese RenminbiBritish PoundRevenues$148.7 $90.3 $24.3 Gross profit60.1 39.9 7.9 42Table of Contents
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the audited consolidated financial statements and the related notes in Part II, Item 8, of this Annual Report on Form 10-K. In addition to historical information, the following discussion also contains forward-looking statements that include risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under the heading “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K. Business Overview We are an automated global electronic broker. We custody and service accounts for hedge and mutual funds, ETFs, registered investment advisers, proprietary trading groups, introducing brokers and individual investors. We specialize in routing orders and executing and processing trades in stocks, options, futures, forex, bonds, mutual funds, ETFs and precious metals on more than 150 electronic exchanges and market centers in 33 countries and 26 currencies seamlessly around the world. In addition, our customers can use our trading platform to trade certain cryptocurrencies through a third-party cryptocurrency service provider that executes, clears and custodies the cryptocurrencies. As an electronic broker, we execute, clear and settle trades globally for both institutional and individual customers. Capitalizing on our proprietary technology, our systems provide our customers with the capability to monitor multiple markets around the world simultaneously and to execute trades electronically in these markets at a low cost, in multiple products and currencies from a single trading account. The ever-growing complexity of multiple market centers across diverse geographies provides us with ongoing opportunities to build and continuously adapt our order routing software to secure excellent execution prices.Since our inception in 1977, we have focused on developing proprietary software to automate broker-dealer functions. The proliferation of electronic exchanges and market centers since the early 1990s has allowed us to integrate our software with an increasing number of trading venues, creating one automatically functioning, computerized platform that requires minimal human intervention. Our customer base is diverse with respect to geography and type. Currently, approximately 79% of our customers reside outside the U.S. in over 200 countries and territories, and over 50% of new customers come from outside the U.S. Approximately 59% of our customers’ equity is in institutional accounts such as hedge funds, financial advisors, proprietary trading desks and introducing brokers. Specialized products and services that we have developed successfully attract these accounts. For example, we offer prime brokerage services, including financing and securities lending, to hedge funds; our model portfolio technology and automated share allocation and rebalancing tools are particularly attractive to financial advisors; and our trading platform, global access and low pricing attract introducing brokers. Business Environment Equities markets around the world were predominantly down in 2022, with major equity market indices in the U.S., Europe and Asia falling by double digits. This declining market backdrop occurred in the face of inflation, rising interest rates worldwide, fears of recession and unpredictable geopolitical uncertainty. Individual investors, who had helped drive equities markets higher in the prior year, were less engaged with them as economic conditions weakened in 2022. The following is a summary of the key economic drivers that affect our business and how they compared to the prior year: Global trading volumes. According to industry data, in 2022 average daily volume in U.S. exchange-listed equity-based options increased by 5%, U.S. futures by 19% and U.S. listed cash equities volume by 4%, over the prior year. Various market cross-currents led to mixed results across our major product types: customer options, futures and foreign exchange volumes were up 3%, 33% and 18%, respectively, while stock volumes declined 58% compared to 2021. Volumes rose in financial futures, particularly foreign exchange and equity index futures, as higher inflation, a stronger U.S. dollar and investors looking to benefit from rising volatility drove this increase during the period. While stock trading volumes remain significantly higher than pre-pandemic levels, in 2022 they were below the unusually high levels of stock trading seen in 2021, a period dominated by trading in “meme” stocks and low-priced stocks generally. Note that while U.S. options, futures and cash equities volumes are readily comparable measures, they reflect most but not all of the global volumes that generate our commission revenue. See “Trading Volumes and Customer Statistics” below in this Item 7 for additional details regarding our trade volumes, contract and share volumes, and customer statistics. 34 Table of Contents Volatility. U.S. market volatility, as measured by the average Chicago Board Options Exchange Volatility Index (“VIX®”), rose 32%, from an average of 19.7 in 2021 to 26.0 in 2022. Volatility increased as numerous cross-currents, from inflationary pressures, changing central interest rate policies, unpredictable world economies and geopolitical uncertainty, impacted markets worldwide. In general, higher volatility improves our performance because it often correlates positively with customer trading activity across product types. In 2022, higher options and futures volumes in a period of elevated volatility demonstrated the continuing benefit of more participants in the financial markets and their increasing comfort with these exchange-listed derivative products, which can be used to manage risk amid heightened and ongoing geopolitical and interest rate uncertainty. Interest Rates. In 2022, interest rates rose in a steady series of increases from the zero to 0.25% range that had been targeted for two years prior to March 2022. Over the course of 2022, the U.S. Federal Reserve increased the federal funds rate seven times, ending 2022 with a target range of 4.25% to 4.50%. By year end, the U.S. Treasury yield curve became inverted, with long-term rates markedly lower than short-term rates. In nearly every country, interest rates also rose in 2022 as central banks sought to control inflationary pressures. Higher U.S. benchmark rates have boosted the interest we earn on our segregated cash, the majority of which is invested in U.S. government securities and related instruments. The environment of uncertainty over future U.S. Federal Reserve rate policy has led us to maintain a short duration investment profile, so that additional rate increases present more opportunities for interest-sensitive assets. Further, our margin balances are tied to benchmark rates, so rising rates have also improved the interest we earn on margin lending to our customers. We continue to offer among the lowest rates in the industry on margin lending, and we believe our low rates are an important feature that attracts customers to our platform. Increasing rates also increase our interest expense. For example, in U.S. dollars we pay interest to customers when the federal funds effective rate is above 0.50%, which it has been since May 2022. Central banks in many other countries have also increased their interest rates in recent months. We believe the attractive rates we pay on customer cash are another important feature that draws customers to our platform. Net interest income on customer cash and margin loan balances increased significantly compared to the prior year as the average federal funds effective rate increased to 1.68% in 2022 from 0.08% in 2021. During an extended period prior to 2022, the interest we paid on customer cash balances and earned on customer margin loans and investment of customer segregated funds resulted in spreads that were compressed at low benchmark rates. Benchmark interest rates over 50 basis points eliminate this spread compression and lead to higher net interest income. Higher interest rates contributed to a 45% rise in net interest income over the prior year. Combined with increases in average interest-earning assets, particularly in segregated cash balances, these higher rates led to a widening of our net interest margin from 1.17% in 2021 to 1.53% in 2022. Currency fluctuations. As a global electronic broker trading on exchanges around the world in multiple currencies, we are exposed to foreign currency risk. We actively manage this exposure by keeping our equity in proportion to a defined basket of 10 currencies we call the “GLOBAL” to diversify our risk and to align our hedging strategy with the currencies that we use in our business. Because we report our financial results in U.S. dollars, the change in the value of the GLOBAL versus the U.S. dollar affects our earnings. In 2022, the value of the GLOBAL, as measured in U.S. dollars, decreased 1.85% compared to its value at December 31, 2021, which had a negative impact on our comprehensive earnings for the current year. A discussion of our approach for managing foreign currency exposure is contained in Part I, Item 7A of this Quarterly Report on Form 10-Q entitled “Quantitative and Qualitative Disclosures about Market Risk.” Financial Overview We report non-GAAP financial measures, which exclude certain items that may not be indicative of our core operating results and business outlook and are useful in evaluating the operating performance of our business. See the “Non-GAAP Financial Measures” section below in this Item 7 for additional details. Diluted earnings per share were $3.75 for the year ended December 31, 2022 (“current year”), compared to $3.24 for the year ended December 31, 2021 (“prior year”). Adjusted diluted earnings per share were $4.05 for the current year, compared to $3.37 for the prior year. The calculation of diluted earnings per share is detailed in Note 4 – “Equity and Earnings Per Share” to the audited consolidated financial statements, in Part II, Item 8 of this Annual Report on Form 10-K. For the current year, our net revenues were $3,067 million and income before income taxes was $1,998 million, compared to net revenues of $2,714 million and income before income taxes of $1,787 million in the prior year. Adjusted net revenues were $3,213 million and adjusted income before income taxes was $2,144 million, compared to adjusted net revenues of $2,780 million and adjusted income before income taxes of $1,853 million in the prior year. 35 Table of Contents The financial highlights for the current year were: Net interest income increased 45% from the prior year to $1,668 million, driven by higher benchmark interest rates and customer credit balances, despite a decline in margin lending balances. Commission revenue decreased 2% from the prior year to $1,322 million on lower customer stock trading volumes, partially offset by higher futures and options volumes. Other income decreased $105 million from the prior year. This decrease was mainly comprised of (1) $63 million related to our currency diversification strategy and (2) $39 million related to our U.S. government securities portfolio; partially offset by (3) a $16 million gain related to our strategic investment in Up Fintech Holding Limited (“Tiger Brokers”). Pretax profit margin was 65%, down from 66% in the prior year. Adjusted pretax profit margin was 67% for both years. In connection with our currency diversification strategy as of December 31, 2022, approximately 24% of our equity was denominated in currencies other than the U.S. dollar. In the current year, our currency diversification strategy decreased our comprehensive earnings by $211 million (compared to a decrease of $134 million in the prior year), as the U.S. dollar value of the GLOBAL decreased by approximately 1.85%, compared to its value as of December 31, 2021. The effects of our currency diversification strategy are reported as (1) a component of other income (loss of $100 million) in the consolidated statements of comprehensive income and (2) other comprehensive income (“OCI”) (loss of $111 million) in the consolidated statements of financial condition and the consolidated statements of comprehensive income. The full effect of the GLOBAL is captured in comprehensive income. ‎ 36 Table of Contents Certain Trends and Uncertainties We believe that our current operations may be favorably or unfavorably impacted by the following trends that may affect our financial condition and results of operations: Retail participation in the equity markets has fluctuated in the past due to investor sentiment, market conditions and a variety of other factors. Retail transaction volumes may not be sustainable and are not predictable. Consolidation among market centers may adversely affect the value of our IB SmartRoutingSM software. Price competition among broker-dealers may continue to intensify. Benchmark interest rates have fluctuated over the past years due to economic conditions. Changes in interest rates may not be predictable. Fiscal and/or monetary policy may change and impact the financial services business and securities markets. New legislation or modifications to existing regulations and rules could occur in the future. Scrutiny of payment for order flow and order routing practices by regulatory and legislative authorities has increased. The COVID-19 pandemic precipitated unprecedented market conditions with equally unprecedented social and community challenges. The impact of the COVID-19 or another public health emergency going forward will depend on numerous evolving factors that cannot be accurately predicted, including the duration and spread of the pandemic, governmental regulations in response to the pandemic, and the effectiveness of vaccinations and other medical advancements. We continue to be exposed to the risks and uncertainties of doing business in international markets, particularly in the heavily regulated brokerage industry. Such risks and uncertainties include political, economic and financial instability, and foreign policy changes. For example, tensions between the U.S. and China have escalated recently, and changes in Chinese governmental oversight of Hong Kong and in the Chinese and Hong Kong capital markets could result in adverse effects on our business and loss of assets we hold in the region. Additionally, although our direct and indirect exposures to Russia and Ukraine are not material, the war in Ukraine and related sanctions have created substantial uncertainty in the global economy and financial markets. We continue to monitor the war and assess any potential impact to our business, including effects relating to currency control restrictions imposed by the Central Bank of Russia and restrictions by the Moscow Stock Exchange regarding the sale of assets by non-Russian residents. Our remaining market making activities will continue to be impacted by market structure changes, market conditions, the level of automation of competitors, and the relationship between actual and implied volatility in the equities markets. See “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K for a discussion of other risks that may affect our financial condition and results of operations.‎ 37 Table of Contents Trading Volumes and Customer StatisticsThe tables below present historical trading volumes and customer statistics for our business. Trading volumes are the primary driver in our business. Information on our net interest income can be found elsewhere in this report. TRADE VOLUMES: (in thousands, except %) Cleared Non-Cleared Avg. Trades Customer % Customer % Principal % Total % per U.S.Period Trades Change Trades Change Trades Change Trades Change Trading Day2018 328,099 21,880 18,663 368,642 1,478 2019 302,289 (8%) 26,346 20% 17,136 (8%) 345,771 (6%) 1,380 2020 620,405 105% 56,834 116% 27,039 58% 704,278 104% 2,795 2021 871,319 40% 78,276 38% 32,621 21% 982,216 39% 3,905 2022 735,619 (16%) 70,049 -11% 32,863 1% 838,531 (15%) 3,347 CONTRACT AND SHARE VOLUMES:(in thousands, except %) TOTAL Options % Futures (1) % Stocks %Period (contracts) Change (contracts) Change (shares) Change2018 408,406 151,762 210,257,186 2019 390,739 (4%) 128,770 (15%) 176,752,967 (16%)2020 624,035 60% 167,078 30% 338,513,068 92%2021 887,849 42% 154,866 (7%) 771,273,709 128%2022 908,415 2% 207,138 34% 330,035,586 (57%) ALL CUSTOMERS Options % Futures (1) % Stocks %Period (contracts) Change (contracts) Change (shares) Change2018 358,852 148,485 198,909,375 2019 349,287 (3%) 126,363 (15%) 167,826,490 (16%)2020 584,195 67% 164,555 30% 331,263,604 97%2021 852,169 46% 152,787 (7%) 766,211,726 131%2022 873,914 3% 203,933 33% 325,368,714 (58%) CLEARED CUSTOMERS Options % Futures (1) % Stocks %Period (contracts) Change (contracts) Change (shares) Change2018 313,795 146,806 194,012,882 2019 302,068 (4%) 125,225 (15%) 163,030,500 (16%)2020 518,965 72% 163,101 30% 320,376,365 97%2021 773,284 49% 151,715 (7%) 752,720,070 135%2022 781,373 1% 202,145 33% 314,462,672 (58%)___________________________ (1)Futures contract volume includes options on futures.‎ 38 Table of Contents PRINCIPAL TRANSACTIONS Options % Futures (1) % Stocks %Period (contracts) Change (contracts) Change (shares) Change2018 49,554 3,277 11,347,811 2019 41,452 (16%) 2,407 (27%) 8,926,477 (21%)2020 39,840 (4%) 2,523 5% 7,249,464 (19%)2021 35,680 (10%) 2,079 (18%) 5,061,983 (30%)2022 34,501 (3%) 3,205 54% 4,666,872 (8%)___________________________ (1)Futures contract volume includes options on futures. CUSTOMER STATISTICS: Year over Year 2022 2021 % ChangeTotal Accounts (in thousands) 2,091 1,676 25%Customer Equity (in billions) (1) $ 306.7 $ 373.8 (18%) Cleared DARTs (in thousands) (2) 1,887 2,300 (18%)Total Customer DARTs (in thousands) (2) 2,124 2,570 (17%) Cleared Customers Commission per Cleared Commissionable Order (3) $ 2.83 $ 2.37 19%Cleared Avg. DARTs per Account (Annualized) 206 339 (39%)___________________________ (1)Excludes non-customers. (2)Daily average revenue trades ("DARTs") are based on customer orders. (3)Commissionable order – a customer order that generates commissions. 39 Table of Contents Results of Operations The table below presents our consolidated results of operations for the periods indicated. The period-to-period comparisons below of financial results are not necessarily indicative of future results. Year-Ended December 31, 2022 2021 2020 (in millions, except share and per share amounts)Revenues Commissions $ 1,322 $ 1,350 $ 1,112 Other fees and services 184 218 175 Other income (loss) (107) (2) 59 Total non-interest income 1,399 1,566 1,346 Interest income 2,686 1,372 1,133 Interest expense (1,018) (224) (261)Total net interest income 1,668 1,148 872 Total net revenues 3,067 2,714 2,218 Non-interest expenses Execution, clearing and distribution fees 324 236 293 Employee compensation and benefits 454 399 325 Occupancy, depreciation and amortization 90 80 69 Communications 33 33 26 General and administrative 165 176 236 Customer bad debt 3 3 13 Total non-interest expenses 1,069 927 962 Income before income taxes 1,998 1,787 1,256 Income tax expense 156 151 77 Net income 1,842 1,636 1,179 Less net income attributable to noncontrolling interests 1,462 1,328 984 Net income available for common stockholders $ 380 $ 308 $ 195 Earnings per share Basic $3.78 $3.27 $2.44Diluted $3.75 $3.24 $2.42 Weighted average common shares outstanding Basic 100,460,016 94,167,572 79,939,289 Diluted 101,299,609 95,009,880 80,638,908 Comprehensive income Net income available for common stockholders $ 380 $308 $195Other comprehensive income Cumulative translation adjustment, before income taxes (26) (22) 26Income taxes related to items of other comprehensive income - - -Other comprehensive income (loss), net of tax (26) (22) 26Comprehensive income available for common stockholders $ 354 $286 $221 Comprehensive income attributable to noncontrolling interests Net income attributable to noncontrolling interests $ 1,462 $ 1,328 $984Other comprehensive income - cumulative translation adjustment (85) (75) 98Comprehensive income attributable to noncontrolling interests $ 1,377 $1,253 $1,082 40Table of Contents The table below presents our consolidated results of operations as a percent of our total net revenues for the periods indicated. Year Ended December 31, 2022 2021 2020 Revenues Commissions 43% 50% 50%Other fees and services 6% 8% 8%Other income (loss) (3%) 0% 3%Total non-interest income 46% 58% 61% Interest income 88% 51% 51%Interest expense (33%) (8%) (12%)Total net interest income 54% 42% 39%Total net revenues 100% 100% 100% Non-interest expenses Execution, clearing and distribution fees 11% 9% 13%Employee compensation and benefits 15% 15% 15%Occupancy, depreciation and amortization 3% 3% 3%Communications 1% 1% 1%General and administrative 5% 6% 11%Customer bad debt 0% 0% 1%Total non-interest expenses 35% 34% 43%Income before income taxes 65% 66% 57%Income tax expense 5% 6% 3%Net income 60% 60% 53%Less net income attributable to noncontrolling interests 48% 49% 44%Net income available for common stockholders 12% 11% 9% Year Ended December 31, 2022 (“current year”) compared to the Year Ended December 31, 2021 (“prior year”) Net Revenues Total net revenues, for the current year, increased $353 million, or 13%, compared to the prior year, to $3,067 million. The increase in net revenues was due to higher net interest income, partially offset by lower other income, other fees and services, and commissions. Commissions We earn commissions primarily from our cleared customers for whom we act as an executing and clearing broker and also from our non-cleared customers for whom we act as an execution-only broker. Our commission structure allows customers to choose between (1) an all-inclusive fixed, or “bundled”, rate; (2) a tiered, or “unbundled”, rate that offers lower commissions for high volume customers where we pass through regulatory and exchange fees; and (3) our IBKR LiteSM offering, which provides commission-free trades on U.S. exchange-listed stocks and ETFs. Instead of commission revenue, IBKR LiteSM trades generate payments from market makers and others to whom we route these orders, which are reported in commissions. Our commissions are geographically diversified. In 2022, 2021, and 2020 we generated 37%, 39% and 29%, respectively, of commissions from operations conducted by our subsidiaries outside the U.S. Commissions for the current year decreased $28 million, or 2%, compared to the prior year, to $1,322 million, driven by lower customer trading volumes in stocks, partially offset by higher volumes in futures and options. Total customer futures and options contract volumes increased 33% and 3%, respectively, while stock share volume decreased 58% from unusually high trading volume, primarily in “meme” stocks and low-priced stocks generally, in the prior year. Total DARTs for cleared and execution-only customers, for the current year, decreased 17% to 2.1 million, compared to 2.6 million for the prior year. DARTs for cleared customers, i.e., customers for whom we execute trades, as well as clear and carry positions, for the current year, decreased 18% to 1.9 million, compared to 2.3 million for the prior year. Average commission per commissionable order for cleared customers, for the current year, increased 19% to $2.83, compared to $2.37 for the prior year, as our customers’ trading volume mix resulted in higher per order commissions in options, stocks and forex. 41Table of Contents Other Fees and Services We earn fee income on services provided to customers, which includes market data fees, risk exposure fees, payments for order flow from exchange-mandated programs, minimum activity fees, and other fees and services charged to customers. Other fees and services, for the current year decreased $34 million, or 16%, compared to the prior year, to $184 million, driven by a $15 million decrease in minimum activity fees, which were discontinued for most account types effective July 1, 2021, a $15 million decrease in IPO-related fee income, and a $5 million decrease in exposure fees as customers reduced risk; partially offset by a $4 million increase in FDIC sweep fees due to higher benchmark interest rates. Other Income (Loss) Other income consists of foreign exchange gains (losses) from our currency diversification strategy, gains (losses) from principal transactions, gains (losses) from our equity method investments, and other revenue not directly attributable to our core business offerings. A discussion of our approach to managing foreign currency exposure is contained in Part II, Item 7A of this Annual Report on Form 10-K entitled “Quantitative and Qualitative Disclosures about Market Risk.” Other income, for the current year, decreased $105 million, compared to the prior year, to a loss of $107 million. This decrease was mainly comprised of $63 million related to our currency diversification strategy, a $39 million mark-to-market loss on our U.S. government securities portfolio in the current year, and $7 million related to trading activities; partially offset by a $16 million smaller loss related to our strategic investment in Up Fintech Holding Limited (“Tiger Brokers”). Interest Income and Interest Expense We earn interest on margin lending to customers secured by marketable securities these customers hold with us; from our investments in U.S. and foreign government securities; from borrowing and lending securities; on deposits (in positive interest rate currencies) with banks; and on certain customers’ cash balances in negative rate currencies. We pay interest on customer cash balances (in sufficiently positive interest rate currencies); for borrowing and lending securities; on deposits (in negative interest rate currencies) with banks; and on our borrowings. Net interest income (interest income less interest expense), for the current year, increased $520 million, or 45%, compared to the prior year, to $1,668 million. The increase in net interest income was driven by higher benchmark interest rates and customer credit balances, despite a decline in margin lending balances. Net interest income on customer balances, for the current year, increased $503 million, compared to the prior year, driven by an increase in the average federal funds effective rate to 1.68% from 0.08% in the prior year and a $10.9 billion increase in average customer credit balances; despite a $2.3 billion decrease in average margin lending balances. See the “Business Environment” section above in this Item 7 for a further discussion about the change in interest rates in the current year. We earn income on securities loaned and borrowed to support customer long and short stock holdings in margin accounts. In addition, our Stock Yield Enhancement Program provides an opportunity for customers with fully-paid stock to allow us to lend it out. We pay customers a rebate on the cash collateral generally equal to 50% of the income we earn from lending the shares. We place cash and/or U.S. Treasury securities, as collateral securing the loans in the customer’s account, in segregated accounts, or at an affiliate acting as collateral agent for the benefit of our customer. In the current year, average securities borrowed balances increased 8%, to $4.0 billion, and average securities loaned balances decreased 7%, to $10.1 billion, compared to the prior year. Net interest earned from securities lending is affected by the level of demand for securities positions held by our customers that investors are looking to sell short. During the current year, net interest earned from securities lending transactions decreased $155 million, or 27%, compared to the prior year. Securities lending opportunities maintained a strong pace during the current year, despite fewer opportunities than the prior year. However, the rise in benchmark interest rates rise has shifted the interest reported as generated by lending securities to interest income on segregated cash (see further explanation below). It should be noted that securities lending transactions entered into to support customer activity may produce interest income (expense) that is offset by interest expense (income) related to customer balances. The Company measures return on interest-earning assets using net interest margin (“NIM”). NIM is computed by dividing the annualized net interest income by the average interest-earning assets for the period. Interest-earning assets consist of cash and securities segregated for regulatory purposes (including U.S. government securities and securities purchased under agreements to resell), customer margin loans, securities borrowed, other interest-earning assets (solely firm assets) and customer cash balances swept into FDIC-insured banks as part of our Insured Bank Deposit Sweep Program. Interest-bearing liabilities consist of customer credit balances, securities loaned, and other interest-bearing liabilities. 42Table of Contents Yields are generally a reflection of benchmark interest rates in each currency in which the Company and its customers hold cash balances. Because a meaningful portion of customer cash and margin loans are denominated in currencies other than the U.S. dollar, changes in U.S. benchmark interest rates do not impact the total amount of segregated cash and securities, customer margin loans and customer credit balances. Furthermore, because interest, when benchmark rates are at sufficiently high levels, is paid only on eligible cash credit balances (i.e., balances over $10 thousand or equivalent, in securities accounts with over $100 thousand in equity, and in smaller accounts at reduced rates), changes in benchmark interest rates are not passed through to the total amount of customer credit balances. Finally, the Company’s policies with respect to currencies with negative interest rates impact the overall yields on segregated cash and customer credit balances as effective interest rates in those currencies fluctuate. Securities lending generates (1) net interest earned on lending a security, which is based on supply and demand for that security, and (2) interest earned on the cash collateral deposited for the loan of that security, which is based on benchmark interest rates. Because cash collateral from securities lending is held in specially designated bank accounts for the benefit of customers, in accordance with the U.S. customer protection rules, interest on this collateral is reported as net interest on segregated cash. Generally, as benchmark interest rates rise, an increasing portion of the interest earned on securities lending transactions is classified as net interest income on “Segregated cash and securities, net” instead of net interest income on “Securities borrowed and loaned, net”. The table below presents net interest income information corresponding to interest-earning assets and interest-bearing liabilities for the periods indicated. Year-Ended December 31, 2022 2021 2020 (in millions)Average interest-earning assets Segregated cash and securities $ 51,644 $ 40,328 $ 41,898 Customer margin loans 43,402 45,681 28,960 Securities borrowed 3,961 3,677 4,235 Other interest-earning assets 9,000 7,029 5,593 FDIC sweeps 1 2,229 2,663 2,882 $ 110,235 $ 99,376 $ 83,568 Average interest-bearing liabilities Customer credit balances $ 90,172 $ 79,297 $ 67,540 Securities loaned 10,095 10,871 5,702 Other interest-bearing liabilities 4 109 215 $ 100,271 $ 90,277 $ 73,457 Net Interest income Segregated cash and securities, net $742 $(9) $166Customer margin loans 2 1,083 535 380Securities borrowed and loaned, net 413 568 343Customer credit balances, net 2 (763) 33 (46)Other net interest income 1,3 207 36 55 Net interest income 3 $ 1,682 $ 1,163 $ 898 Net interest margin ("NIM") 1.53% 1.17% 1.07% Annualized Yields Segregated cash and securities 1.44% -0.02% 0.40%Customer margin loans 2.50% 1.17% 1.31%Customer credit balances 0.85% -0.04% 0.07%___________________________ (1)Represents the average amount of customer cash swept into FDIC-insured banks as part of our Insured Bank Deposit Sweep Program. This item is not recorded in the Company's consolidated statements of financial condition. Income derived from program deposits is reported in other net interest income in the table above.‎‎ 43Table of Contents (2)Interest income and interest expense on customer margin loans and customer credit balances, respectively, are calculated on daily cash balances within each customer’s account on a net basis, which may result in an offset of balances across multiple account segments (e.g., between securities and commodities segments).‎(3)Includes income from financial instruments that has the same characteristics as interest, but is reported in other fees and services and other income in the Company’s consolidated statements of comprehensive income. For the years ended December 31, 2022, 2021, and 2020, $10 million, $15 million and $21 million were reported in other fees and services, respectively. For the years ended December 31, 2022, 2021, and 2020, $4 million, $0 million and $5 million were reported in other income, respectively. Non-Interest Expenses Non-interest expenses, for the current year, increased $142 million, or 15%, compared to the prior year, to $1,069 million, mainly due to an $88 million increase in execution, clearing and distribution fees; a $55 million increase in employee compensation and benefits; and a $10 million increase in occupancy, depreciation and amortization; partially offset by a $11 million decrease in general and administrative expenses. As a percentage of total net revenues, non-interest expenses were 35% for the current year and 34% for the prior year. Execution, Clearing and Distribution Fees Execution, clearing and distribution fees include the costs of executing and clearing trades, net of liquidity rebates received from various exchanges and market centers, as well as regulatory fees and market data fees. Execution fees are paid primarily to electronic exchanges and market centers on which we trade. Clearing fees are paid to clearing houses and clearing agents. Market data fees are paid to third parties to receive streaming price quotes and related information. Execution, clearing and distribution fees, for the current year, increased $88 million, or 37%, compared to the prior year, to $324 million, primarily driven by an $86 million increase in exchange fees on higher customer trading volumes in futures, which carry higher fees, and lower liquidity rebates; and a $12 million increase in regulatory fees due to higher SEC and FINRA fee rates; partially offset by a $6 million decrease in market data fees and a $3 million decrease in clearing and depository fees on lower options fee rates. As a percentage of total net revenues, execution, clearing and distribution fees were 11% for the current year and 9% for the prior year. Employee Compensation and Benefits Employee compensation and benefits include salaries, bonuses and other incentive compensation plans, group insurance, contributions to benefit programs and other related employee costs. Employee compensation and benefits expenses, for the current year, increased $55 million, or 14%, compared to the prior year, to $454 million, associated with a 16% increase in the average number of employees to 2,721 for the current year, compared to 2,336 for the prior year. We continued to add staff worldwide in software development and compliance. As we continue to grow, our focus on automation has allowed us to maintain a relatively small staff. As a percentage of total net revenues, employee compensation and benefits expenses were 15% for both the current year and the prior year. Employee compensation and benefits expenses as a percentage of adjusted net revenues were 14% for both the current year and the prior year. Occupancy, Depreciation and Amortization Occupancy expenses consist primarily of rental payments on office and data center leases and related occupancy costs, such as utilities. Depreciation and amortization expenses result from the depreciation of fixed assets, such as computing and communications hardware, as well as amortization of leasehold improvements and capitalized in-house software development. Occupancy, depreciation and amortization expenses, for the current year, increased $10 million, or 13%, compared to the prior year, to $90 million, mainly due to higher costs related to the expansion of our physical space for both offices and data centers. As a percentage of total net revenues, occupancy, depreciation and amortization expenses were 3% for both the current year and the prior year.‎ 44Table of Contents Communications Communications expenses consist primarily of the cost of voice and data telecommunications lines supporting our business, including connectivity to exchanges and market centers around the world. Communications expenses, for the current year, were unchanged, at $33 million. As a percentage of total net revenues, communications expenses were 1% for both the current year and the prior year. General and Administrative General and administrative expenses consist primarily of advertising; professional services expenses, such as legal and audit work; legal and regulatory matters; and other operating expenses. General and administrative expenses, for the current year, decreased $11 million, or 6%, compared to the prior year, to $165 million, primarily due to the non-recurrence of $19 million in costs for Brexit-related regulatory onboarding to bring our new brokerage operations on line in Europe incurred in the prior year and a $3 million decrease in legal and consulting expenses; partially offset by a $3 million increase in advertising expenses and a $5 million increase in software and network related expenses. As a percentage of total net revenues, general and administrative expenses were 5% for the current year and 6% for the prior year. Customer Bad Debt Customer bad debt expense consists primarily of losses incurred by customers in excess of their assets with us, net of amounts recovered by us. Customer bad debt expense, for the current year, was unchanged at $3 million. Income Tax Expense We pay U.S. federal, state and local income taxes on our taxable income, which is proportional to the percentage we own of IBG LLC. Also, our operating subsidiaries are subject to income tax in the respective jurisdictions in which they operate. Income tax expense, for the current year, increased $5 million, or 3%, compared to the prior year, to $156 million, primarily due to (1) higher income before income taxes at our operating subsidiaries outside the U.S.; (2) higher income before income taxes subject to U.S. income tax at IBG, Inc., additionally increased by IBG, Inc.’s higher average ownership percentage of IBG LLC, which rose from 22.6% to 24.0%; and (3) $6 million higher expense related to the remeasurement of deferred tax assets related to the step-up in basis arising from the acquisition of interests in IBG LLC, due to changes in the Company’s effective tax rates; partially offset by (4) the non-recurrence of an $8 million tax settlement in the prior year; and (5) the non-recurrence of $6 million in expenses related to the repositioning of European operations in the aftermath of Brexit in the prior year. ‎ 45Table of Contents The table below presents information about our income tax expense for the periods indicated. Year-Ended December 31, 2022 2021 2020 (in millions, except %) Consolidated Consolidated income before income taxes$ 1,998 $ 1,787 $ 1,256 IBG, Inc. stand-alone income before income taxes 2 - (4) Operating subsidiaries income before income taxes$ 1,996 $ 1,787 $ 1,260 Operating subsidiaries Income before income taxes$ 1,996 $ 1,787 $ 1,260 Income tax expense 69 76 38 Net income available to members$ 1,927 $ 1,711 $ 1,222 IBG, Inc. Average ownership percentage in IBG LLC 24.0% 22.6% 19.2% Net income available to IBG, Inc. from operating subsidiaries$ 463 $ 383 $ 237 IBG, Inc. stand-alone income before income taxes 4 - (3) Income before income taxes 467 383 234 Income tax expense 87 75 39 Net income available to common stockholders$ 380 $ 308 $ 195 Consolidated income tax expense Income tax expense attributable to operating subsidiaries$ 69 $ 76 $ 38 Income tax expense attributable IBG, Inc. 87 75 39 Consolidated income tax expense$ 156 $ 151 $ 77 Operating Results Income before income taxes, for the current year, increased $211 million, or 12%, compared to the prior year, to $1,998 million. Pretax profit margin was 65% for the current year and 66% for the prior year. Comparing our operating results for the current year to the prior year using non-GAAP financial measures, adjusted net revenues were $3,213 million, up 16%; adjusted income before income taxes was $2,144 million, up 16%; and adjusted pre-tax profit margin was 67% for both the current year and the prior year. See the “Non-GAAP Financial Measures” section below in this Item 7 for additional details. Noncontrolling Interest We are the sole managing member of IBG LLC and, as such, operate and control all of the business and affairs of IBG LLC and its subsidiaries and consolidate IBG LLC’s financial results into our financial statements. As of December 31, 2022, we held approximately 24.5% ownership interest in IBG LLC. Holdings holds approximately 75.5% ownership interest in IBG LLC. We reflect Holdings’ ownership as a noncontrolling interest in our consolidated statements of financial condition, consolidated statements of comprehensive income, consolidated statements of changes in equity and consolidated statements of cash flows. Our share of IBG LLC’s net income, excluding Holdings’ noncontrolling interest, for the current year was approximately 24.0%, compared to approximately 22.6% for the prior year. Year Ended December 31, 2021 compared to the Year Ended December 31, 2020 For a discussion of changes for the year ended December 31, 2021 compared to the Year Ended December 31, 2020 refer to the Annual Report on Form 10-K filed with the SEC on February 25, 2022. ‎ 46Table of Contents Non-GAAP Financial Measures We use certain non-GAAP financial measures as additional measures to enhance the understanding of our financial results. These non-GAAP financial measures include adjusted net revenues, adjusted income before income taxes, adjusted net income available for common stockholders, and adjusted diluted earnings per share (“EPS”). We believe that these non-GAAP financial measures are important measures of our financial performance because they exclude certain items that may not be indicative of our core operating results and business outlook. We believe these non-GAAP financial measures are useful to investors and analysts in evaluating the operating performance of the business. We define adjusted net revenues as net revenues adjusted to remove the effect of our currency diversification strategy, our net mark-to-market gains (losses) on investments, and the remeasurement of our Tax Receivable Agreement (“TRA”) liability. We define adjusted income before income taxes as income before income taxes adjusted to remove the effect of our currency diversification strategy, our net mark-to-market gains (losses) on investments, the remeasurement of our TRA liability, customer compensation expenses, and unusual bad debt expense. We define adjusted net income available to common stockholders as net income available for common stockholders adjusted to remove the after-tax effects attributable to IBG, Inc. of our currency diversification strategy, our net mark-to-market gains (losses) on investments, the remeasurement of our TRA liability, customer compensation expenses, unusual bad debt expense, and the remeasurement of certain deferred tax assets. We define adjusted diluted EPS as adjusted net income available for common stockholders divided by the diluted weighted average number of shares outstanding for the period. Mark-to-market on investments represents the net mark-to-market gains (losses) on investments in equity securities that do not qualify for equity method accounting which are measured at fair value, on our U.S. government and municipal securities portfolios, which are typically held to maturity, and on certain other investments, including equity securities taken over by the Company from customers related to unusual losses on margin loans. Remeasurement of our TRA liability represents the change in the amount payable to IBG Holdings LLC under the TRA, primarily due to changes in the Company’s effective tax rates, which is related to the remeasurement of the deferred tax assets described below. For further information refer to Note 4 – Equity and Earnings per Share under Part II, Item 8 – Financial Statements and Supplementary Data of this Annual Report on Form 10-K. Customer compensation expenses were incurred to compensate certain affected customers in connection with their losses on West Texas Intermediate Crude Oil contracts on April 20, 2020, as described below. Unusual bad debt expense includes material losses on margin loans resulting from unusual events that occur in the marketplace. For the year-ended December 31, 2020, unusual bad debt expense reflects losses incurred by futures customers in excess of the equity in their accounts related to the West Texas Intermediate Crude Oil event described below. Remeasurement of certain deferred tax assets represents the change in the unamortized balance of deferred tax assets related to the step-up in basis arising from the acquisition of interests in IBG LLC, primarily due to changes in the Company’s effective tax rates. For further information refer to Note 4 – Equity and Earnings per Share under Part II, Item 8 – Financial Statements and Supplementary Data of this Annual Report on Form 10-K. We also report compensation and benefits expenses as a percent of adjusted net revenues, as we believe this measure is useful to investors and analysts in evaluating the growth of our work force in relation to the growth of our core revenues. These non-GAAP financial measures should be considered in addition to, rather than as a substitute for, measures of financial performance prepared in accordance with GAAP1.‎___________________________1 Refers to generally accepted accounting principles in the United States.‎ 47Table of Contents West Texas Intermediate Crude Oil Event On April 20, 2020 the energy markets exhibited extraordinary price activity in the New York Mercantile Exchange ("NYMEX") West Texas Intermediate Crude Oil futures contract. The price of the May 2020 physically-settled futures contract dropped to an unprecedented negative price. This price was the basis for determining the settlement price for cash-settled futures contracts traded on the CME Globex and also for a separate, expiring cash-settled futures contract listed on the Intercontinental Exchange Europe ("ICE Europe"). Several of the Company’s customers held long positions in these CME and ICE Europe contracts, and as a result they incurred losses, including losses in excess of the equity in their accounts. The Company fulfilled the required variation margin settlements with the respective clearinghouses on behalf of its customers. The Company subsequently compensated certain affected customers in connection with their losses resulting from the contracts settling at a price below zero. As a result, the Company recognized an aggregate loss of approximately $104 million in the prior year, of which $103 million is included in general and administrative expenses and $1 million in customer bad debt expense in the consolidated statements of comprehensive income. The tables below present a reconciliation of consolidated GAAP to non-GAAP financial measures for the periods indicated. Year-Ended December 31, 2022 2021 2020 (in millions) Adjusted net revenues Net revenues - GAAP $3,067 $2,714 $2,218Non-GAAP adjustments Currency diversification strategy, net 100 37 19Mark-to-market on investments 52 30 (36)Remeasurement of TRA liability (6) (1) 3Total non-GAAP adjustments 146 66 (14)Adjusted net revenues $3,213 $2,780 $2,204 Year-Ended December 31, 2022 2021 2020 (in millions) Adjusted income before income taxes Income before income taxes - GAAP $1,998 $1,787 $1,256Non-GAAP adjustments Currency diversification strategy, net 100 37 19Mark-to-market on investments 52 30 (36)Remeasurement of TRA liability (6) (1) 3Customer compensation expense - - 103Bad debt expense - - 1Total non-GAAP adjustments 146 66 90Adjusted income before income taxes $2,144 $1,853 $1,346 Adjusted pre-tax profit margin 67% 67% 61% 48Table of Contents Year-Ended December 31, 2022 2021 2020 (in millions) Adjusted net income available for common stockholders Net income available for common stockholders - GAAP $380 $308 $195Non-GAAP adjustments Currency diversification strategy, net 24 8 4Mark-to-market on investments 13 7 (7)Remeasurement of TRA liability (6) (1) 3Customer compensation expense - - 20Bad debt expense - - -Income tax effect of above adjustments1 (7) (3) (3)Remeasurement of deferred income taxes 7 1 (11)Total non-GAAP adjustments 30 12 6Adjusted net income available for common stockholders $410 $320 $201 Note: Amounts may not add due to rounding. Year-Ended December 31, 2022 2021 2020 (in dollars, except share amounts) Adjusted diluted EPS Diluted EPS - GAAP $3.75 $3.24 $2.42Non-GAAP adjustments Currency diversification strategy, net 0.24 0.09 0.05Mark-to-market on investments 0.12 0.07 (0.08)Remeasurement of TRA liability (0.06) (0.01) 0.04Customer compensation expense - - 0.24Bad debt expense - - 0.00Income tax effect of above adjustments1 (0.07) (0.03) (0.04)Remeasurement of deferred income taxes 0.07 0.01 (0.14)Total non-GAAP adjustments 0.30 0.13 0.08Adjusted diluted EPS $4.05 $3.37 $2.49 Diluted weighted average common shares outstanding 101,299,609 95,009,880 80,638,908 Note: Amounts may not add due to rounding._________________________1 The income tax effect is estimated using the statutory income tax rates applicable to the Company.‎ 49Table of Contents Liquidity and Capital Resources We maintain a highly liquid balance sheet. The majority of our assets consist of investments of customer funds, collateralized receivables arising from customer-related and proprietary securities transactions, and exchange-listed marketable securities, which are marked-to-market daily. Collateralized receivables consist primarily of customer margin loans, securities borrowed, and securities purchased under agreements to resell. As of December 31, 2022, total assets were $115.1 billion of which approximately $114.2 billion, or 99.2%, were considered liquid. Decisions on the allocation of capital are based upon, among other things, prudent risk management guidelines, potential liquidity and cash flow needs for current and future business activities, regulatory capital requirements, and projected profitability. Our Treasury department, Market Risk Committee, Enterprise Risk Management department and other management control groups assist in evaluating, monitoring and controlling the impact that our business activities have on our financial condition, liquidity and capital structure. The objective of these policies is to support our business strategies while ensuring ongoing and sufficient liquidity. Our significant capital comprises an aggregate across our many regulated subsidiaries, and in addition to supporting our current and future expansion plans we believe this financial strength provides our customers with a source of confidence. Daily monitoring of liquidity needs and available collateral levels is undertaken to help ensure that an appropriate liquidity cushion, in the form of cash and unpledged collateral, is maintained at all times. We actively manage our excess liquidity and maintain significant borrowing capabilities through the securities lending markets and in the form of credit facilities with banks. As a general practice, we maintain sufficient levels of cash on hand to provide us with a buffer should we need immediately available funds for any reason. In addition, pursuant to our liquidity risk management plan we perform periodic liquidity stress tests, which are designed to identify and reserve liquid assets that would be available under market or idiosyncratic stress events. Based on our current level of operations, we believe our cash flows from operations, available cash and available borrowings will be adequate to meet our future liquidity needs for more than the next twelve months. As of December 31, 2022, liability balances in connection with payables to customers were higher than the average monthly balance during the current year and our securities loaned and short-term borrowings were lower than their respective average monthly balances during the current year. Cash and cash equivalents held by our non-U.S. operating subsidiaries as of December 31, 2022 were $1,394 million ($1,058 million as of December 31, 2021). These funds are primarily intended to finance each individual operating subsidiary’s local operations, and thus would not be available to fund U.S. domestic operations unless repatriated through payment of dividends to IBG LLC. As of December 31, 2022, we had no intention to repatriate any amounts from non-U.S. operating subsidiaries. With the enactment of the U.S. Tax Cuts and Jobs Act on December 22, 2017, we recognized a liability for the one-time transition tax on deemed repatriation of earnings of some of our foreign subsidiaries for the year ended December 31, 2017. As a result, in the event dividends were to be paid to the Company in the future by a non-U.S. operating subsidiaries, the Company would not be required to accrue and pay income taxes on such dividends, except for foreign taxes in the form of dividend withholding tax, if any, imposed on the recipient of the distribution or dividend distribution tax imposed on the payor of the distribution. Historically, our consolidated equity has consisted primarily of accumulated retained earnings, which to date have been sufficient to fund our operations and growth. Our consolidated equity increased 14% to $11.6 billion as of December 31, 2022, from $10.2 billion as of December 31, 2021. This increase is attributable to total comprehensive income, partially offset by distributions and dividends paid during 2022. Cash Flows The table below presents our cash flows from operating activities, investing activities and financing activities for the periods indicated. Year-Ended December 31, 2022 2021 2020 (in millions)Net cash provided by operating activities $ 3,968 $ 5,896 $ 8,068Net cash used in investing activities (67) (188) (50)Net cash used in financing activities (470) (523) (229)Effect of exchange rate changes on cash, cash equivalents, and restricted cash (111) (97) 124Increase in cash, cash equivalents and restricted cash $ 3,320 $ 5,088 $ 7,913 Our cash flows from operating activities are largely a reflection of the changes in customer credit and margin loan balances. Our cash flows from investing activities are primarily related to other investments, capitalized internal software development, purchases and sales of memberships, trading rights and shares at exchanges where we trade, and strategic investments where such investments may 50Table of Contents enable us to offer better execution alternatives to our current and prospective customers, allow us to influence exchanges to provide competing products at better prices using sophisticated technology, or enable us to acquire either technology or customers faster than we could develop them on our own. Our cash flows from financing activities are comprised of short-term borrowings, capital transactions and payments made to Holdings under the Tax Receivable Agreement. Short-term borrowings from banks and through our senior notes program are part of our daily cash management in support of operating activities. Capital transactions consist primarily of quarterly dividends paid to common stockholders and related distributions paid to Holdings. Year Ended December 31, 2022: Our cash, cash equivalents and restricted cash (i.e., cash and cash equivalents that are subject to withdrawal or usage restrictions) increased by $3,320 million to $28.6 billion for the year ended December 31, 2022. We raised $3,968 million in net cash from operating activities. We used net cash of $537 million in our investing and financing activities, primarily for distributions to noncontrolling interests, short-term borrowings, dividends paid to our common stockholders and payments made under the Tax Receivable Agreement. Investing activities mainly consisted of purchases of other investments and property, equipment and intangible assets. Year Ended December 31, 2021: For a discussion of changes in cash flows for the year ended December 31, 2021 refer to our Annual Report on Form 10-K filed with the SEC on February 25, 2022. Year Ended December 31, 2020: For a discussion of changes in cash flows for the year ended December 31, 2020 refer to our Annual Report on Form 10-K filed with the SEC on February 26, 2021. Senior Notes In 2020, IBG LLC initiated a program to offer senior notes in private placements to certain qualified customers of IB LLC. IBG LLC intends to use the proceeds for general financing purposes when interest spread opportunities arise. The senior notes are offered at an issue price of $1 thousand per note at an interest rate calculated by adding the benchmark rate to a rate (spread) that IBG LLC announces from time to time. The benchmark rate is the effective federal funds rate as reported by the Federal Reserve Bank of New York on the morning of the date of the offering. The senior notes mature no later than the thirtieth day following the issuance date, and IBG LLC, at its option, may redeem the senior notes at any time, at a redemption price equal to 100% of the principal amount of the senior notes to be redeemed, plus accrued and unpaid interest. During the year ended December 31, 2022, the Company did not issue any senior notes. Regulatory Capital Requirements As of December 31, 2022, all operating subsidiaries were in compliance with their respective regulatory capital requirements. For additional information regarding our regulatory capital requirements see Note 16 – “Regulatory Requirements” to the audited consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K. Capital Expenditures Our capital expenditures are comprised of compensation costs of our software engineering staff for development of software for internal use and expenditures for computer, networking and communications hardware, and leasehold improvements. These expenditure items are reported as property, equipment, and intangible assets. Capital expenditures for property, equipment, and intangible assets were approximately $69 million, $77 million and $50 million for the three years ended December 31, 2022, 2021, and 2020, respectively. In the future, we plan to meet capital expenditure needs with cash from operations and cash on hand, as we continue our focus on technology infrastructure initiatives to further enhance our competitive position. In response to changing economic conditions, we believe we have the flexibility to modify our capital expenditures by adjusting them (either upward or downward) to match our actual performance. If we pursue any additional strategic acquisitions, we may incur additional capital expenditures.‎ 51Table of Contents Contractual Obligations Summary Our contractual obligations principally include obligations associated with our outstanding indebtedness and interest payments as of December 31, 2022. Payments Due by Year Total 2023-2024 2025-2026 Thereafter (in millions)Payable to Holdings under Tax Receivable Agreement (1) $214 $50 $26 $138Operating leases 159 56 40 63Transition Tax liability (2) 44 26 18 -Total contractual cash obligations $417 $132 $84 $201___________________________ (1)As of December 31, 2022, contractual amounts owed under the Tax Receivable Agreement of $214 million have been recorded in payable to affiliate in the consolidated financial statements, representing management’s best estimate of the amounts currently expected to be owed under the Tax Receivable Agreement. Through December 31, 2022, approximately $243 million of cumulative cash payments have been made. (2)The Tax Act implemented a modified territorial tax system that includes a one-time transition tax on deemed repatriated earnings of foreign subsidiaries to be paid over an eight-year period starting in 2018. We believe this tax will not have a material impact on our liquidity. Seasonality Our businesses are subject to seasonal fluctuations, reflecting varying numbers of market participants at times during the year, varying numbers of trading days from quarter-to-quarter, and declines in trading activity due to holidays. Typical seasonal trends may be superseded by market or world events, which can have a significant impact on prices and trading volume. Inflation Although we cannot accurately anticipate the effects of inflation on our operations, we believe that, for the three most recent years, inflation has not had a material impact on our results of operations, though it may be a contributing factor to general uncertainty in the markets in the foreseeable future. Statements about future inflation are subject to the risk that actual inflation and its effects may differ, possibly materially, due to, among other things, changes in economic growth, impact of supply chain disruptions, unemployment and consumer demand. Investments in U.S. Government Securities We invest in U.S. government securities to satisfy U.S. regulatory requirements. As a broker-dealer, unlike banks, we are required to mark these investments to market even though we intend to hold them to maturity. Sudden increases (decreases) in interest rates will cause mark-to-market losses (gains) on these securities, which are recovered (eliminated) if we hold them to maturity, as currently intended. The impact of changes in interest rates is further described in Part II, Item 7A of this Annual Report on Form 10-K entitled “Quantitative and Qualitative Disclosures about Market Risk.” Strategic Investments and Acquisitions We regularly evaluate potential strategic investments and acquisitions. We hold strategic investments in certain electronic trading exchanges, including BOX Options Exchange, LLC. We also hold strategic investments in certain businesses, including Tiger Brokers, an online stock brokerage established for Chinese retail and institutional customers, in which we have a beneficial ownership interest of 7.6%. We intend to continue making acquisitions on an opportunistic basis, generally only when the acquisition candidate will, in our opinion, enable us to offer better execution alternatives to our current and prospective customers, allow us to influence exchanges to provide competing products at better prices using sophisticated technology, or enable us to acquire either technology or customers faster than we could develop them on our own. As of December 31, 2022, there were no other definitive agreements with respect to any material acquisition. 52Table of Contents Certain Information Concerning Off-Balance-Sheet Arrangements We may be exposed to a risk of loss not reflected in our consolidated financial statements for futures products, which represent our obligations to settle at contracted prices, and which may require us to repurchase or sell in the market at prevailing prices. Accordingly, these transactions result in off-balance sheet risk, as our cost to liquidate such futures contracts may exceed the amounts reported in our consolidated statements of financial condition. Critical Accounting Policies and Estimates Our consolidated financial statements have been prepared in accordance with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements and accompanying notes. These estimates and assumptions are based on judgment and the best available information at the time. Therefore, actual results could differ materially from those estimates. We believe that the critical policies listed below represent the most significant estimates used in the preparation of our consolidated financial statements. See Note 2 – “Significant Accounting Policies” to the audited consolidated financial statements for a summary of our significant accounting policies in Part II, Item 8 of this Annual Report on Form 10-K. Contingencies Our policy is to estimate and accrue for potential losses that may arise out of litigation and regulatory proceedings, to the extent that such losses are probable and can be estimated. Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total liability accrued with respect to litigation and regulatory proceedings is determined on a case by case basis and represents an estimate of probable losses based on, among other factors, the progress of each case, our experience with and industry experience with similar cases and the opinions and views of internal and external legal counsel. Given the inherent difficulty of predicting the outcome of litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, or where cases or proceedings are in the early stages, we cannot estimate losses or ranges of losses for cases or proceedings where there is only a reasonable possibility that a loss may be incurred. Income Taxes Our income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits are based on enacted tax laws and reflect management’s best assessment of estimated future taxes to be paid. We are subject to income taxes in both the U.S. and numerous foreign jurisdictions. Determining income tax expense requires significant judgment and estimates. Deferred income tax assets and liabilities arise from temporary differences between the tax and financial statement recognition of the underlying assets and liabilities. In evaluating our ability to recover our deferred tax assets within the jurisdictions from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. In projecting future taxable income, historical results are adjusted for changes in accounting policies and incorporate assumptions including the amount of future state, federal and foreign pre-tax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax-planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. In evaluating the objective evidence that historical results provide, three years of cumulative operating income (loss) are considered. Deferred income taxes have not been provided for U.S. tax liabilities or for additional foreign taxes on the unremitted earnings of foreign subsidiaries that have been indefinitely reinvested. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. We record tax liabilities in accordance with Financial Accounting Standards Board (“FASB”) ASC Topic 740 and adjust these liabilities when management’s judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in payments that are different from the current estimates of these tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information becomes available. We recognize that a tax benefit from an uncertain tax position may be recognized only when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. A tax position that meets this standard is measured at the largest amount of benefit that will more likely than not be realized on settlement. 53Table of Contents Accounting Pronouncements Issued but Not Yet Adopted For additional information regarding FASB Accounting Standards Updates (“ASU”s) that have been issued but not yet adopted and that may impact the Company, refer to Note 2 – “Significant Accounting Policies” to the audited consolidated financial statements in Part II, Item 8 of this annual Report on form 10-K. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to various market risks. Our exposures to market risks arise from assumptions built into our pricing models, equity price risk, foreign currency exchange rate fluctuations related to our international operations, changes in interest rates and risks relating to the extension of margin credit to our customers. Market risk refers to the risk that a change in the level of one or more market prices, rates, indices, implied volatilities (the price volatility of the underlying instrument imputed from option prices), correlations or other market factors, such as market liquidity, will result in losses for a position or portfolio. Generally, we incur trading-related market risk as a result of our remaining market making activities, where the substantial majority of our Value-at-Risk (“VaR”) for market risk exposures is generated. In addition, we incur non-trading-related market risk primarily from investment activities and from foreign currency exposure held in the equity of our foreign subsidiaries, i.e., our non-U.S. brokerage subsidiaries and information technology subsidiaries, and held to meet target balances in our currency diversification strategy. We use various risk management tools in managing our market risk, which are embedded in our real-time market making systems. We employ certain hedging and risk management techniques to protect us from a severe market dislocation. Our risk management policies are developed and implemented by our Steering Committee, which is chaired by our Chief Executive Officer and comprised of senior executives of our various operating subsidiaries. The strategy of our remaining market making activities is to calculate quotes a few seconds ahead of the market and execute small trades at a tiny but favorable differential as a result. This strategy is made possible by our proprietary pricing model, which evaluates and monitors the risks inherent in our portfolio, assimilates external market data and reevaluates the outstanding quotes in our portfolio many times per second. Our model automatically rebalances our positions throughout each trading day to manage risk exposures on our options and futures positions and the underlying securities and will price the increased risk that a position would add to the overall portfolio into the bid and offer prices we post. Under risk management policies implemented and monitored primarily through our computer systems, reports to management, including risk profiles, profit and loss analysis and trading performance, are prepared on a real-time basis as well as daily and periodical bases. Although our remaining market making activities are completely automated, the trading process and our risk are monitored by a team of individuals who, in real-time, observe various risk parameters of our consolidated positions. Our assets and liabilities are marked-to-market daily for financial reporting purposes and re-valued continuously throughout the trading day for risk management and asset/liability management purposes. We use a covariant VaR methodology to measure, monitor and review the market risk of our market making portfolios, with the exception of fixed income products, and our currency exposures. The risk of fixed income products, which comprise primarily U.S. government securities, is measured using a stress test. Pricing Model Exposure As described above, our proprietary pricing model, which continuously evaluates and monitors the risks inherent in our portfolio, assimilates external market data and reevaluates the outstanding quotes in our entire portfolio many times per second. Certain aspects of the model rely on historical prices of securities. If the behavior of price movements of individual securities diverges substantially from what their historical behavior would predict, we might incur trading losses. We attempt to limit such risks by diversifying our portfolio across many different options, futures and underlying securities and avoiding concentrations of positions based on the same underlying security. Historically, our losses from these events have been immaterial in comparison to our annual trading profits. Foreign Currency Exposure As a result of our international activities and accumulated earnings in our foreign subsidiaries, our income and equity are exposed to fluctuations in foreign exchange rates. For example, some of our European and Asian operations are conducted by our Swiss subsidiary, IBKRFS. IBKRFS is regulated by the Swiss Financial Market Supervisory Authority as a securities dealer and its financial statements are presented in Swiss francs. Accordingly, IBKRFS is exposed to certain foreign exchange risks as described below: IBKRFS buys and sells securities denominated in various currencies and carries bank balances and borrows and lends such currencies in its regular course of business. At the end of each accounting period, IBKRFS’ assets and liabilities are revalued into Swiss francs for presentation in its financial statements. The resulting foreign currency gains or losses are reported in IBKRFS’ income statement and, as translated into U.S. dollars for U.S. GAAP purposes, in our consolidated statements of comprehensive income as a component of other income.‎ 54Table of Contents IBKRFS’ financial statements are presented in Swiss francs (i.e., its functional currency) as noted above. At the end of each accounting period, IBKRFS’ equity is translated at the then prevailing exchange rate into U.S. dollars and the resulting translation gain or loss is reported as OCI in our consolidated statements of financial condition and consolidated statements of comprehensive income. OCI is also produced by our other non-U.S. subsidiaries. Historically, we have taken the approach of not hedging the above exposures, based on the notion that the cost of constantly hedging over the years would amount to more than the random impact of rate changes on our non-U.S. dollar balances. For instance, an increase in the value of the Swiss franc would be unfavorable to the earnings of IBKRFS but would be counterbalanced to some extent by the fact that the translation gain or loss into U.S. dollars is likely to move in the opposite direction. Our risk management systems incorporate cash forex to hedge our currency exposure at little or no cost. Currency spot positions entered into as part of our currency diversification strategy are held by the parent holding company, IBG LLC. In connection with the development of our currency diversification strategy, we determined to base our equity in GLOBALs, a basket of currencies. Because we conduct business in many countries and many currencies and because we consider ourselves a global enterprise based in a diversified basket of currencies rather than a U.S. dollar based company, we actively manage our global currency exposure by maintaining our equity in GLOBALs. The U.S. dollar value of the GLOBAL decreased 1.85% as of December 31, 2022 compared to December 31, 2021. As of December 31, 2022, approximately 24% of our equity was denominated in currencies other than the U.S. dollar. The table below presents a comparison of the U.S. dollar equivalent of the GLOBAL for the periods indicated. As of 12/31/2021 As of 12/31/2022 GLOBAL in % ofNet Equity GLOBAL in % ofNet EquityCHANGE inCurrency CompositionFX RateUSD Equiv. Comp.(in USD millions)FX RateUSD Equiv. Comp.(in USD millions)% of Comp.USD 0.72 1.0000 0.720 74.4% $ 7,605 1.0000 0.720 75.8% $ 8,803 1.4%EUR 0.09 1.1372 0.102 10.6% 1,081 1.0704 0.096 10.1% 1,178 -0.4%JPY 3.91 0.0087 0.034 3.5% 359 0.0076 0.030 3.1% 365 -0.4%GBP 0.02 1.3527 0.027 2.8% 286 1.2099 0.024 2.5% 296 -0.2%CHF 0.02 1.0963 0.022 2.3% 232 1.0816 0.022 2.3% 265 0.0%CNH 0.13 0.1572 0.020 2.1% 216 0.1445 0.019 2.0% 230 -0.1%INR 1.10 0.0134 0.015 1.5% 156 0.0121 0.013 1.4% 163 -0.1%CAD 0.02 0.7912 0.012 1.2% 125 0.7385 0.011 1.2% 135 -0.1%AUD 0.02 0.7266 0.011 1.1% 115 0.6816 0.010 1.1% 125 0.0%HKD 0.04 0.1283 0.004 0.5% 47 0.1281 0.004 0.5% 55 0.0% 0.968 100.0% $ 10,222 0.950 100.0% $ 11,615 0.0% The effects of our currency diversification strategy appear in two places in the consolidated financial statements: (1) as a component of other income in the consolidated statements of comprehensive income and (2) as OCI in the consolidated statements of financial condition and the consolidated statements of comprehensive income. The full effect of the GLOBAL is captured in the consolidated statements of comprehensive income. Reported results on a comprehensive basis reflect the U.S. GAAP convention that requires the reporting of currency translation results contained in OCI as part of reportable earnings. Interest Rate Risk We had no variable-rate debt outstanding as of December 31, 2022. We pay our customers interest based on benchmark overnight interest rates in various currencies, when interest rates are above a benchmark rate plus a small spread, on cash balances above $10 thousand (or equivalent) in securities accounts holding more than $100 thousand and at lower, tiered rates for accounts holding less than $100 thousand (or equivalent) net asset value. In currencies with negative rates, we pass through the cost of holding certain cash balances to our customers; therefore, we charge our customers interest on these cash balances. In a normal rate environment, we typically invest a portion of these funds in U.S. government securities with maturities of up to two years. If interest rates were to increase rapidly and substantially, our net interest income would not increase proportionally with the interest rates for the portion of the funds invested at fixed yields. In addition, the mark-to-market changes in the value of these fixed rate securities will be reflected in other income, instead of net interest income. Our margin balances are priced to a benchmark rate plus a spread, with a minimum charge of 0.75% in U.S. dollars and most foreign currencies. At negative or near-zero benchmark rates, our interest sensitivity to rate increases is limited to the extent that a higher benchmark rate 55Table of Contents plus a spread may still be below the minimum charge. Based on customer balances and investments outstanding as of December 31, 2022, and assuming reinvestment of maturing instruments in instruments of short-term duration, an unexpected increase of 0.25% over current U.S. dollar interest rate levels would increase our net interest income by approximately $49 million on an annualized basis, assuming the full effect of reinvestment at higher rates. A 0.25% increase in all the relevant non-U.S. dollar benchmark rates would increase our net interest income by $25 million on an annualized basis. Our interest rate sensitivity estimate contains separate assumptions for U.S. dollar rates from other currencies’ rates and it isolates the effects of a rate increase on reinvestments. We do not approximate mark-to-market impact from interest rate changes; if U.S. government securities whose prices were to fall under these scenarios were held to maturity, as intended, then the reduction in other income would be temporary, as the securities would mature at par value. We also face the potential for reduced net interest income from customer deposits and margin loans if benchmark rates were to fall. Based on customer balances and investments outstanding as of December 31, 2022, and assuming reinvestment of maturing instruments in instruments of short-term duration, an unexpected decrease in U.S. dollar interest rates of 0.25% would decrease our net interest income by approximately $49 million on an annualized basis, assuming the full effect of reinvestment at lower rates. A 0.25% decrease in all the relevant non-U.S. dollar benchmark rates would decrease our net interest income by $25 million on an annualized basis. We also face interest rate risk due to positions carried for our remaining market making activities to the extent that long or short stock positions may have been established for future or forward dates on options or futures contracts and the value of such positions is impacted by interest rates. The amount of such risk cannot be quantified, however, the current low level of market making positions does not indicate a material potential exposure. Dividend Risk We face dividend risk in our remaining market making activities as we derive revenues and incur expenses in the form of dividend income and expense, respectively, from our inventory of equity securities, and must make payments in lieu of dividends on short positions in equity securities within our portfolio. Projected future dividends are an important component of pricing equity options and other derivatives, and incorrect projections may lead to trading losses. The amount of such risk cannot be quantified, however, the current low level of market making positions does not indicate a material potential exposure. Margin Loans We extend margin loans to our customers, which are subject to various regulatory requirements. Margin loans are collateralized by cash and securities in the customers’ accounts. The risks associated with margin credit increase during periods of fast market movements or in cases where collateral is concentrated and market movements occur. During such times, customers who utilize margin loans and who have collateralized their obligations with securities may find that the securities have a rapidly depreciating value and may not be sufficient to cover their obligations in the event of a liquidation. We are also exposed to credit risk when our customers execute transactions, such as short sales of options and equities that can expose them to risk beyond their invested capital. We expect this kind of exposure to increase with the growth of our overall business. Because we indemnify and hold harmless our clearing houses and counterparties from certain liabilities or claims, the use of margin loans and short sales may expose us to significant off-balance-sheet risk if collateral requirements are not sufficient to fully cover losses that customers may incur and those customers fail to satisfy their obligations. As of December 31, 2022, we had $38.8 billion in margin loans extended to our customers. The amount of risk to which we are exposed from the margin loans we extend to our customers and from short sale transactions by our customers is unlimited and not quantifiable as the risk is dependent upon analysis of a potentially significant and undeterminable rise or fall in stock prices. Our account level margin requirements meet or exceed those required by Regulation T of the Board of Governors of the Federal Reserve and FINRA portfolio margin rules, as applicable. As a matter of practice, we enforce real-time margin compliance monitoring and liquidate customers’ positions if their equity falls below required margin requirements. We have a comprehensive policy implemented in accordance with regulatory standards to assess and monitor the suitability of investors to engage in various trading activities. To mitigate our risk, we also continuously monitor customer accounts to detect excessive concentration, large orders or positions, patterns of day trading and other activities that indicate increased risk to us. Our credit exposure is to a great extent mitigated by our real-time margining system, which automatically evaluates each account throughout the trading day and closes out positions automatically for accounts that are found to be under-margined. While this methodology is effective in most situations, it may not be effective in situations where no liquid market exists for the relevant securities or commodities or where, for any reason, automatic liquidation for certain accounts has been disabled. Our Risk Management Committee continually monitors and evaluates our risk management policies, including the implementation of policies and procedures to enhance the detection and prevention of potential events to mitigate margin loan losses.‎ 56Table of Contents Value-at-Risk We estimate VaR using a historical approach, which uses the historical daily price returns of underlying assets as well as estimates of the end of day implied volatility for options. Our one-day VaR is defined as the unrealized loss in portfolio value that, based on historically observed market risk factors, would have been exceeded with a frequency of one percent, based on a calculation with a confidence interval of 99%. Our VaR model generally takes into account exposures to equity and commodity price risk and foreign exchange rates. We use VaR as one of a range of risk management tools. Among their benefits, VaR models permit the estimation of a portfolio’s aggregate market risk exposure, incorporating a range of varied market risks and portfolio assets. One key element of the VaR model is that it reflects risk reduction due to portfolio diversification or hedging activities. However, VaR has various strengths and limitations, which include, but are not limited to: use of historical changes in market risk factors, which may not be accurate predictors of future market conditions, and may not fully incorporate the risk of extreme market events that are outsized relative to observed historical market behavior or reflect the historical distribution of results beyond the confidence interval; and reporting of losses in a single day, which does not reflect the risk of positions that cannot be liquidated or hedged in one day. A small proportion of market risk generated by trading positions is not included in VaR. The modeling of the risk characteristics of some positions relies on approximations that, under certain circumstances, could produce significantly different results from those produced using more precise measures. VaR is most appropriate as a risk measure for trading positions in liquid financial markets and will understate the risk associated with severe events, such as periods of extreme illiquidity. The VaR calculation simulates the performance of the portfolio based on several years of daily price changes of the underlying assets and determines the VaR as the calculated loss that occurs at the 99th percentile. Since the reported VaR statistics are estimates based on historical data, VaR should not be viewed as predictive of our future revenues or financial performance or of our ability to monitor and manage risk. There can be no assurance that our actual losses on a particular day will not exceed the indicated VaR or that such losses will not occur more than one time in 100 trading days. VaR does not predict the magnitude of losses which, should they occur, may be significantly greater than the VaR amount. Stress Test We estimate the market risk of our fixed income portfolio using a risk analysis model provided by a leading external vendor. For corporate bonds, this stress test is configured to calculate the change in value of each fixed income security in the portfolio over one day in five scenarios each of which represents a parallel shift of the U.S. Treasury yield curve. The scenarios are shifts of +/−100 and +/−200 basis points. For U.S. government securities, the stress test is configured to calculate the change in value of each fixed income security in the portfolio over one day in three scenarios each of which represents a parallel shift of the U.S. Treasury yield curve. The scenarios are shifts of +/−50 basis points.‎ 57Table of Contents VaR and Stress Test Measures At December 31, At December 31, Average HighMarket Risk Category 2022 2021 2022 2022 (in millions)Trading (1) Equities and Currencies (2) $8 $8 $7 $8Trading Total $8 $8 $7 $8 Non-Trading (1) Equities and Currencies $26 $18 $20 $26Fixed Income, Other (3), (4) 9 14 12 16Non-Trading Total $35 $32 $32 $42 ___________________________ (1)The product categories displayed in the table as “Trading” reflect activities undertaken in the Company's market making activities.‎‎The “Non-trading” category reflects investment activities and foreign currency exposures of the Company's non-market making subsidiaries (i.e., its brokerage subsidiaries and information technology subsidiaries). This category also includes corporate activities in foreign exchange designed to achieve the Company's currency diversification strategy. The average and high VaR amounts for equities and currencies are based on end of day calculations performed in 2022. The fixed income stress amounts are based on the four quarter ending calculations performed in 2022.‎(2)Equities and currencies held for market making purposes are combined because these products are part of an integrated, hedged market making portfolio, on which the risk is measured using VaR. (3)The Non-Trading – Fixed Income, Other category contains primarily U.S. government securities held in segregated safekeeping accounts for the exclusive benefit of our brokerage customers, on which the risk is measured using a stress test analysis. (4)As a result of the active rising interest rate environment, in 2022, we changed our methodology for risk computed under a stress test. Prior period amounts have been updated to conform to the current period presentation. 58Table of Contents
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2021 Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission on February 3, 2022. Overview We are a provider of market infrastructure, data services and technology solutions to a broad range of customers including financial institutions, corporations and government entities. These products, which span major asset classes including futures, equities, fixed income and U.S. residential mortgages, provide our customers with access to mission critical tools that are designed to increase asset class transparency and workflow efficiency. The majority of our identifiable assets are located in the U.S. and U.K. We report our results in the following three segments:•Exchanges: We operate regulated marketplaces for the listing, trading and clearing of a broad array of derivatives contracts and financial securities.•Fixed Income and Data Services: We provide fixed income pricing, reference data, indices, analytics and execution services as well as global CDS clearing and multi-asset class data delivery solutions.•Mortgage Technology: We provide a technology platform that offers customers comprehensive, digital workflow tools that aim to address the inefficiencies that exist in the U.S. residential mortgage market, from application through closing and the secondary market.Recent Developments Pending Acquisition of Black Knight, Inc.On May 4, 2022, we announced that we had entered into a definitive agreement to acquire Black Knight, Inc., or Black Knight, a software, data and analytics company that serves the housing finance continuum, including real estate data, mortgage lending and servicing, as well as the secondary markets. Pursuant to that certain Agreement and Plan of Merger, dated as of May 4, 2022, among ICE, Sand Merger Sub Corporation, a wholly owned subsidiary of ICE, or Sub, and Black Knight, which we refer to as the “merger agreement,” Sub will merge with and into Black Knight, which we refer to as the “merger,” with Black Knight surviving as a wholly owned subsidiary of ICE. As of May 4, 2022, the transaction was valued at approximately $13.1 billion, or $85 per share of Black Knight common stock, with cash comprising 80% of the value of the aggregate transaction consideration and shares of our common stock comprising 20% of the value of the 44aggregate transaction consideration at that time. The aggregate cash component of the transaction consideration is fixed at $10.5 billion, and the value of the aggregate stock component of the transaction consideration will fluctuate with the market price of our common stock and will be determined based on the average of the volume weighted averages of the trading prices of our common stock on each of the ten consecutive trading days ending three trading days prior to the closing of the merger. This transaction builds on our position as a provider of electronic workflow solutions for the rapidly evolving U.S. residential mortgage industry.Black Knight provides a comprehensive and integrated ecosystem of software, data and analytics solutions serving the real estate and housing finance markets. We believe the Black Knight ecosystem adds value for clients of all sizes across the mortgage and real estate lifecycles by helping organizations lower costs, increase efficiencies, grow their businesses, and reduce risk.On August 19, 2022, our preliminary proxy statement/prospectus on Form S-4 was declared effective by the SEC, and on September 21, 2022, Black Knight stockholders approved the transaction. The transaction is expected to close in the first half of 2023 following the receipt of regulatory approvals and the satisfaction of customary closing conditions.Global Market Conditions Our results of operations are affected by global economic conditions, including macroeconomic conditions and geopolitical events or conflicts. During 2022, macroeconomic conditions, including rising interest rates, recent spikes in inflation rates and market volatility, along with geopolitical concerns, including the war in Ukraine and the sanctions and other measures that have been and continue to be imposed in response to the war, created uncertainty and volatility in the global economy and resulted in a dynamic operating environment. Our business has been impacted positively and negatively by these global economic conditions. For instance, due to market volatility and rising interest rates, we have seen increased trading across a number of our products, such as interest rate and equity futures, credit default swaps and bonds. Conversely, increases in mortgage interest rates in 2022 have resulted in reduced consumer and investor demand for mortgages and adversely impacted the transaction-based revenues in our Mortgage Technology segment.We have suspended all services in Russia except for limited offerings to non-sanctioned entities. From an operational perspective, our businesses, including our exchanges, clearing houses, listings venues, data services businesses and mortgage platforms, have not suffered a material negative impact as a result of these events in Ukraine and the surrounding region. We expect the macro environment to remain dynamic in the near-term, and we continue to monitor macroeconomic conditions, including interest rates and inflation rates, as well as the uncertainty surrounding the extent and duration of the ongoing conflict between Russia and Ukraine, and the impact that any of the foregoing may have on the global economy and on our business.Tax Policy ChangesIn July and August 2022, the CHIPS and Science Act, or CHIPS, and the Inflation Reduction Act of 2022, or IRA, were signed into law. The IRA introduced a 15% corporate alternative minimum tax, or CAMT, on adjusted financial statement income for corporations with profits in excess of $1 billion, effective for tax years after December 31, 2022. While further guidance on the implementation of the CAMT is expected, we do not expect it will have a material impact to our 2023 effective tax rate. We also do not expect that CHIPS will have a material impact. The IRA also includes a stock buyback excise tax of 1% on share repurchases, which will apply to net stock buybacks after December 31, 2022. We do not expect this to have a material impact once share repurchases are resumed.The Organization for Economic Cooperation and Development, or OECD/G20, has proposed the introduction of a global minimum tax rate at 15%. Consultations are ongoing and while we expect increased tax compliance requirements, we do not expect a material impact to our effective tax rate given our current tax profile.45Consolidated Financial HighlightsThe following summarizes our results and significant changes in our consolidated financial performance for the periods presented (dollars in millions, except per share amounts): 46Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeRevenues, less transaction-based expenses $7,292 $7,146 2 %$7,146 $6,036 18 % Recurring revenues(1)$3,721 $3,509 6 %$3,509 $2,923 20 % Transaction revenues, net(1)$3,571 $3,637 (2)%$3,637 $3,113 17 %Operating expenses $3,654 $3,697 (1)%$3,697 $3,003 23 %Adjusted operating expenses(2)$2,953 $2,977 (1)%$2,977 $2,495 19 %Operating income $3,638 $3,449 5 %$3,449 $3,033 14 %Adjusted operating income(2)$4,339 $4,169 4 %$4,169 $3,541 18 %Operating margin 50 %48 %2 pts48 %50 %(2 pts)Adjusted operating margin(2)59 %58 %1 pt58 %59 %(1 pt)Other income/(expense), net $(1,830)$2,249 n/a$2,249 $(267)n/aIncome tax expense$310 $1,629 (81)%$1,629 $658 148 %Effective tax rate 17 %29 %(12 pts)29 %24 %5 ptsNet income attributable to ICE$1,446 $4,058 (64)%$4,058 $2,089 94 %Adjusted net income attributable to ICE(2)$2,974 $2,863 4 %$2,863 $2,449 17 %Diluted earnings per share attributable to ICE common stockholders$2.58 $7.18 (64)%$7.18 $3.77 90 %Adjusted diluted earnings per share attributable to ICE common stockholders(2)$5.30 $5.06 5 %$5.06 $4.41 15 %Cash flows from operating activities$3,554 $3,123 14 %$3,123 $2,881 8 %*Percentage changes in the table above deemed "n/a" are not meaningful.(1) We define recurring revenues as the portion of our revenues that are generally predictable, stable, and can be expected to occur at regular intervals in the future with a relatively high degree of certainty and visibility. We define transaction revenues as those associated with a more specific point-in-time service, such as trade execution.(2) The adjusted figures exclude items that are not reflective of our ongoing core operations and business performance. Adjusted net income attributable to ICE and adjusted diluted earnings per share attributable to ICE common stockholders are presented net of taxes. These adjusted figures are not calculated in accordance with U.S. Generally Accepted Accounting Principles, or GAAP. See “- Non-GAAP Financial Measures” below.•Revenues, less transaction-based expenses, increased $146 million in 2022 from 2021. The increase in revenues includes $115 million in unfavorable foreign exchange effects arising from the stronger U.S. dollar in 2022 from 2021.•Revenues, less transaction-based expenses, increased $1.1 billion in 2021 from 2020. The increase in revenues includes $44 million in favorable foreign exchange effects arising from the weaker U.S. dollar in 2021 from 2020. •Operating expenses decreased $43 million in 2022 from 2021. The decrease in operating expenses includes $38 million in favorable foreign exchange effects arising from the stronger U.S. dollar in 2022 from 2021.•Operating expenses increased $694 million in 2021 from 2020. The increase in operating expenses includes $22 million in unfavorable foreign exchange effects arising from the weaker U.S. dollar in 2021 from 2020.•Other income/(expense), net, in 2022 primarily includes our share of estimated equity method investment losses and an impairment charge on our investment in Bakkt to its fair value, of $1.4 billion, a net gain on the sale of our Euroclear plc, or Euroclear, stake of $41 million, interest income of $108 million and interest expense of $616 million.•Other income/(expense), net, in 2021 primarily includes our gain on the Bakkt transaction of $1.4 billion, our gain on the sale of our Coinbase Global, Inc., or Coinbase, investment of $1.2 billion, equity earnings in OCC of $51 million, estimated equity losses in our investment in Bakkt during the post-merger period of $92 million, dividend income from Euroclear plc, or Euroclear, of $60 million, a fair value adjustment gain on our Euroclear investment of $34 million and interest expense of $423 million.•The effective tax rate in 2022 was lower than the effective tax rate in 2021 primarily due to the deferred income tax benefit from the impairment to our equity method investment in Bakkt in the current year, and the deferred income tax expense from the U.K. tax law changes in the prior year.47•The effective tax rate in 2021 was higher than the effective tax rate in 2020 primarily due to the deferred income tax impacts resulting from the U.K. tax law changes. In 2021, the U.K. enacted a corporate income tax rate increase from 19% to 25% effective April 1, 2023. In 2020, the UK enacted a corporate income tax rate increase from 17% to 19% effective April 1, 2020.Business Environment and Market TrendsOur business environment has been characterized by:•globalization of marketplaces, customers and competitors;•growing customer demand for workflow efficiency and automation; •commodity, interest rate, inflation rate and financial markets volatility and uncertainty;•growing demand for data to inform customers' risk management and investment decisions;•evolving, increasing and disparate regulation across multiple jurisdictions;•price volatility increasing customers' demand for risk management services;•increasing focus on capital and cost efficiencies;•customers' preference to manage risk in markets demonstrating the greatest depth of liquidity and product diversity;•the evolution of existing products and new product innovation to serve emerging customer needs and changing industry agreements;•rising demand for speed, data, data capacity and connectivity by market participants, necessitating increased investment in technology; and•consolidation and increasing competition among global markets for trading, clearing and listings.Recent changes with regard to global financial reform have emphasized the importance of transparent markets, centralized clearing and access to data, all of which are important aspects of our product offering. However, some of the proposed rules have yet to be implemented and some rules that have already been partially implemented are being reconsidered. In addition, some of the global regulations have not been fully harmonized and several non-U.S. regulations are inconsistent with U.S. rules. As the evolution continues, legislative and regulatory actions may change the way we conduct our business and may create uncertainty for market participants, which could affect trading volumes or demand for market data. As a result, it is difficult to predict all of the effects that the legislation and its implementing regulations will have on us. As discussed more fully in Item 1 “- Business - Regulation” included in this Annual Report, Brexit, MiFID II and other regulations have resulted in operational, regulatory and/or business risk.We have diversified our business so that we are not dependent on volatility or transaction activity in any one asset class. In addition, we have increased our portion of recurring revenues from 34% in 2014 to 51% in 2022. These recurring revenues include data services, listings and various mortgage technology solutions.Many of the data products we sell and services we provide are required for our clients’ business operations regardless of market volatility or shifts in business profitability levels. We anticipate that there will continue to be growth in the financial information services sector driven by a number of global trends, including the following: •increasing global regulatory demands; •greater use of fair value accounting standards and reliance on independent valuations; •greater emphasis on risk management; •market fragmentation driven by regulatory changes; •the move to passive investing and indexation; •ongoing growth in the size and diversity of financial markets; •increased automation of fixed income, mortgage and other less automated markets; •the development of new data products; •the demand for greater data capacity and connectivity; •new entrants; and •increasing demand for outsourced services by financial institutions.We continue to focus on our strategy to grow each of our revenue streams, and prudently manage expenses, in order to mitigate these uncertainties and to build on our growth opportunities by leveraging our proprietary data, clearing, markets and technology solutions.48Segment ResultsOur business is conducted through three reportable business segments: Exchanges, Fixed Income and Data Services and Mortgage Technology. Segments are discussed more in detail in "Item 1- Business". While revenues are recorded specifically in the segment in which they are earned or to which they relate, a significant portion of our operating expenses are not solely related to a specific segment because the expenses serve functions that are necessary for the operation of more than one segment. We directly allocate expenses when reasonably possible to do so. Otherwise, we use a pro-rata revenue approach as the allocation method for the expenses that do not relate solely to one segment and serve functions that are necessary for the operation of all segments. Our segments do not engage in intersegment transactions.For details on trends in recent prior-year periods, refer to our 2021 and 2020 Annual Reports on Form 10-K.Exchanges SegmentThe following presents selected statements of income data for our Exchanges segment (dollars in millions):49(1) The adjusted figures in the charts above are calculated by excluding items that are not reflective of our cash operations and core business performance. As a result, these adjusted figures are not calculated in accordance with U.S. GAAP. See “- Non-GAAP Financial Measures” below.Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeRevenues:Energy futures and options$1,162 $1,236 (6)%$1,236 $1,120 10 %Agricultural and metals futures and options235 228 3 228 245 (7)Financial futures and options475 394 21 394 357 10 Futures and options1,872 1,858 1 1,858 1,722 8 Cash equities and equity options2,722 2,377 15 2,377 2,585 (8)OTC and other 429 326 31 326 296 10 Transaction and clearing, net 5,023 4,561 10 4,561 4,603 (1)Data and connectivity services877 838 5 838 790 6 Listings515 479 7 479 446 7 Revenues6,415 5,878 9 5,878 5,839 1 Transaction-based expenses(1) 2,344 2,022 16 2,022 2,208 (8)Revenues, less transaction-based expenses4,071 3,856 6 3,856 3,631 6 Other operating expenses968 1,028 (6)1,028 965 6 Depreciation and amortization 240 244 (2)244 261 (7)Acquisition-related transaction and integration costs1 61 (99)61 16 287 Operating expenses1,209 1,333 (9)1,333 1,242 7 Operating income$2,862 $2,523 13 %$2,523 $2,389 6 %Recurring revenues$1,392 $1,317 6 %$1,317 $1,236 7 %Transaction revenues, net$2,679 $2,539 6 %$2,539 $2,395 6 %(1)Transaction-based expenses are largely attributable to our cash equities and options business.Exchanges RevenuesOur Exchanges segment includes transaction and clearing revenues from our futures and NYSE exchanges, related data and connectivity services, and our listings business. Transaction and clearing revenues consist of fees collected from derivatives, cash equities and equity options trading and derivatives clearing, and are reported on a net basis, except for the NYSE transaction-based expenses discussed below. Rates per-contract, or RPC, are driven by the number of contracts or securities traded and the fees charged per contract, net of certain rebates. Our per-contract transaction and clearing revenues will depend upon many factors, including, but not limited to, market conditions, transaction and clearing volume, product mix, pricing, applicable revenue sharing and market making agreements, and new product introductions.50Transaction and clearing revenues are generally assessed on a per-contract basis and revenues and profitability fluctuate with changes in contract volume and product mix. We consider data and connectivity services revenues and listings revenues to be recurring revenues. Our data and connectivity services revenues are recurring subscription fees related to the various data and connectivity services that we provide which are directly attributable to our exchange venues. Our listings revenues are also recurring subscription fees that we earn for the provision of NYSE listings services for public companies and ETFs, and related corporate actions for listed companies.In 2022 and 2021, 18% and 17%, respectively, of our Exchanges segment revenues, less transaction-based expenses, were billed in pounds sterling or euros. Due to the fluctuations of the pound sterling and euro compared to the U.S. dollar, our Exchanges segment revenues, less transaction-based expenses, were lower by $87 million in 2022 from 2021.Our exchange transaction and clearing revenues are presented net of rebates. We recorded rebates of $869 million and $1.0 billion in 2022 and 2021, respectively. We offer rebates in certain of our markets primarily to support market liquidity and trading volume by providing qualified participants in those markets a discount to the applicable commission rate. Such rebates are calculated based on volumes traded. The decrease in rebates is primarily due to lower volumes as compared to the prior year and the migration of Sterling futures rebates into the Sterling Overnight Index Average, or SONIA, and a change in the pricing and structure of SONIA products.•Energy Futures and Options: Total energy volume decreased 4% and revenues decreased 6% in 2022 from 2021.–Total oil futures and options volume decreased 12% in 2022 from 2021 driven, in part, by lower Gasoil volumes which are impacted by the uncertainty around Russian sanctions and the conflict in Ukraine.–Our global natural gas futures and options volume increased 16% in 2022 from 2021 as 2022 benefited from elevated price volatility related to geopolitical events, including the conflict in Ukraine.–Our environmentals and other futures and options volume decreased 12% in 2022 from 2021 with growth in U.S. environmental volumes offset by lower EU environmental volumes.•Agricultural and Metals Futures and Options: Total volume in our agricultural and metals futures and options markets increased 5% and revenues increased 3% in 2022 from 2021. The overall increase in agricultural volumes was due to 2022 benefiting from elevated price volatility and price inflation driving an increased need to manage risk across our commodity markets.–Sugar futures and options volumes increased 5% in 2022 from 2021. –Other agricultural and metal futures and options volumes increased 4% in 2022 from 2021. •Financial Futures and Options: Total volume increased 2% and revenues increased 21% in our financial futures and options markets in 2022 from 2021. Adjusting for the transition of the LIBOR-based Sterling contract to the alternative rate-based SONIA contract, which is half the notional size of the Sterling contract, total volume in our financial futures and options markets increased 19% in 2022. 2022 benefited from elevated volatility across global markets driven by geopolitical events, central bank activity and inflationary concerns.–Interest rate futures and options volume decreased 1% and revenue increased 23%, respectively, in 2022 from 2021. Adjusting for the transition of the LIBOR-based Sterling contract to the alternative rate-based SONIA contract, which is half the notional size of the Sterling contract, interest rate volumes increased 20% in 2022 from 2021 driven by interest rate volatility and increased speculation of central bank activity due to inflation concerns. Interest rate futures and options revenues were $292 million and $237 million in 2022 and 2021, respectively.–Other financial futures and options volume, which includes our MSCI®, FTSE® and NYSE FANG+ equity index products, increased 15% and revenue increased 16% in 2022 from 2021. 2022 benefited from elevated volatility across global equity markets driven by geopolitical events, central bank activity and inflationary concerns. Other financial futures and options revenues were $183 million and $157 million in 2022 and 2021, respectively.•Cash Equities and Equity Options: Cash equities volume increased 4% in 2022 from 2021 due to higher market volumes driven by elevated volatility related to inflationary, recessionary and geopolitical concerns. Cash equities revenues, net of transaction-based expenses, were $275 million and $246 million in 2022 and 2021, respectively. Equity options volume increased 6% in 2022 from 2021 driven by increased participation and higher market share. 51Equity options revenues, net of transaction-based expenses, were $103 million and $109 million in 2022 and 2021, respectively.•OTC and Other: OTC and other transactions include revenues from our OTC energy business and other trade confirmation services, as well as interest income on certain clearing margin deposits, regulatory penalties and fines, fees for use of our facilities, regulatory fees charged to member organizations of our U.S. securities exchanges, designated market maker service fees, exchange membership fees and agricultural grading and certification fees. Our OTC and other revenues increased 31% in 2022 from 2021 primarily due to an increase in interest income on clearing margin deposits. Following the October 2021 Bakkt transaction, Bakkt revenues are no longer included within our OTC and other revenues.•Data and Connectivity Services: Our data and connectivity services revenues increased 5% in 2022 from 2021. The increase in revenue was driven by the strong retention rate of existing customers, the addition of new customers and increased purchases by existing customers.•Listings Revenues: Through NYSE, NYSE American and NYSE Arca, we generate listings revenue related to the provision of listings services for public companies and ETFs, and related corporate actions for listed companies. Listings revenues increased 7% in 2022 from 2021, driven by the full impact of strong equity capital markets activity in 2021.Listings revenues in our securities markets arise from fees applicable to companies listed on our cash equities exchanges– original listing fees and annual listing fees. Original listing fees consist of two components: initial listing fees and fees related to corporate actions. Initial listing fees, subject to a minimum and maximum amount, are based on the number of shares that a company initially lists. All listings fees are billed upfront and the identified performance obligations are satisfied over time. Revenue related to the investor relations performance obligation is recognized ratably over the period these services are provided, with the remaining revenue recognized ratably over time as customers continue to list on our exchanges.In addition, we earn corporate actions-related listing fees in connection with actions involving the issuance of new shares, such as stock splits, rights issues and sales of additional securities, as well as mergers and acquisitions. Listings fees related to other corporate actions are considered contract modifications of our listing contracts and are recognized ratably over time as customers continue to list on our exchanges.In 2022, NYSE listed over $345 billion in total market value from IPOs, including three of the top five operating company IPOs defined by offering proceeds raised, follow-on offerings and over 30 transfers from competing exchanges, an increase of 56% from $221 billion raised in 2021.Selected Operating DataManagement considers volume metrics when making financial and operating decisions, and believes volumes are useful for management and investors in understanding the performance of our exchanges business. The following charts and tables present trading activity in our futures and options markets by commodity type based on the total number of contracts traded, as well as futures and options rate per contract (in millions, except for percentages and rate per contract amounts):52Volume and Rate per ContractYear Ended December 31,Year Ended December 31,20222021Change20212020ChangeNumber of contracts traded (in millions):Energy futures and options 753 782 (4)%782 773 1 % Agricultural and metals futures and options 102 98 5 %98 108 (10)%Financial futures and options 646 634 2 %634 619 2 %Total 1,501 1,514 (1)%1,514 1,500 1 %Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeAverage Daily Volume of contracts traded (in thousands):Energy futures and options 3,000 3,103 (3)%3,103 3,054 2 % Agricultural and metals futures and options 407 388 5 %388 428 (9)%Financial futures and options 2,524 2,475 2 %2,475 2,409 3 %Total 5,931 5,966 (1)%5,966 5,891 1 %Year Ended December 31,Year Ended December 31,Rate per contract:20222021Change20212020ChangeEnergy futures and options$1.54 $1.58 (2)%$1.58 $1.45 9 %Agricultural and metals futures and options$2.30 $2.34 (2)%$2.34 $2.27 3 %Financial futures and options$0.73 $0.61 19 %$0.61 $0.57 7 %Open interest is the aggregate number of contracts (long or short) that clearing members hold either for their own account or on behalf of their clients. Open interest refers to the total number of contracts that are currently “open,” – in other words, contracts that have been entered into but not yet liquidated by either an offsetting trade, exercise, expiration or assignment. Open interest is also a measure of the future activity remaining to be closed out in terms of the number of contracts that members and their clients continue to hold in the particular contract and by the number of contracts held for each contract month listed by the exchange. The following charts and table present our year-end open interest for our futures and options contracts (in thousands, except for percentages): 53As of December 31,As of December 31,20222021Change20212020ChangeOpen interest — in thousands of contracts:Energy futures and options 42,524 40,317 5 %40,317 40,073 1 %Agricultural and metals futures and options 3,881 3,763 3 %3,763 3,608 4 %Financial futures and options 20,342 23,942 (15)%23,942 27,535 (13)%Total 66,747 68,022 (2)%68,022 71,216 (4)%The following charts and tables present selected cash and equity options trading data. All trading volume below is presented as average net daily trading volume, or ADV, and is single counted:54Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeNYSE cash equities (shares in millions):Total cash handled volume2,409 2,317 4 %2,317 2,466 (6)%Total cash market share matched19.9 %19.9 %— 19.9 %22.1 %(2.3) ptsNYSE equity options (contracts in thousands):NYSE equity options volume7,621 7,162 6 %7,162 5,101 40 %Total equity options volume38,244 37,170 3 %37,170 27,685 34 % NYSE share of total equity options19.9 %19.3 %0.6 pts19.3 %18.4 %0.8 ptsRevenue capture or rate per contract:Cash equities rate per contract (per 100 shares)$0.045$0.0428 %$0.042$0.044(5)%Equity options rate per contract$0.05$0.06(9)%$0.06$0.08(23)%Handled volume represents the total number of shares of equity securities, ETFs and crossing session activity internally matched on our exchanges or routed to and executed on an external market center. Matched volume represents the total number of shares of equity securities, ETFs and crossing session activity executed on our exchanges.Transaction-Based Expenses Our equities and equity options markets pay fees to the SEC pursuant to Section 31 of the Exchange Act. Section 31 fees are recorded on a gross basis as a component of transaction and clearing fee revenue. These Section 31 fees are assessed to recover the government’s costs of supervising and regulating the securities markets and professionals and are subject to change. We, in turn, collect corresponding activity assessment fees from member organizations clearing or settling trades on the equities and options exchanges, and recognize these amounts in our transaction and clearing revenues when invoiced. The activity assessment fees are designed to equal the Section 31 fees. As a result, activity assessment fees and the corresponding Section 31 fees do not have an impact on our net income, although the timing of payment by us will vary from collections. Section 31 fees were $499 million and $248 million in 2022 and 2021, respectively. The increase in Section 31 fees was primarily due to an increase in rates. The fees we collect are included in cash at the time of receipt and we remit the amounts to the SEC semi-annually as required. The total amount is included in accrued liabilities and was $223 million as of December 31, 2022.We make liquidity payments to cash and options trading customers, as well as routing charges made to other exchanges which are included in transaction-based expenses. We incur routing charges when we do not have the best bid or offer in the market for a security that a customer is trying to buy or sell on one of our securities exchanges. In that case, we route the customer’s order to the external market center that displays the best bid or offer. The external market center charges us a fee per share (denominated in tenths of a cent per share) for routing to its system. We record routing charges on a gross basis as a component of transaction and clearing fee revenue. Cash liquidity payments, routing and clearing fees were $1.8 billion in both 2022 and 2021.Operating Expenses, Operating Income and Operating MarginThe following chart summarizes our Exchanges segment's operating expenses, operating income and operating margin (dollars in millions). See “- Consolidated Operating Expenses” below for a discussion of the significant changes in our operating expenses.Exchanges Segment:Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeOperating expenses $1,209 $1,333 (9)%$1,333 $1,242 7 %Adjusted operating expenses(1)$1,142 $1,201 (5)%$1,201 $1,145 5 %Operating income $2,862 $2,523 13 %$2,523 $2,389 6 %Adjusted operating income(1)$2,929 $2,655 10 %$2,655 $2,486 7 %Operating margin 70 %65 %5 pts65 %66 %(1 pt)Adjusted operating margin(1)72 %69 %3 pts69 %68 %1 pt(1) The adjusted figures exclude items that are not reflective of our ongoing core operations and business performance. These adjusted numbers are not calculated in accordance with GAAP. See “- Non-GAAP Financial Measures” below. 55Fixed Income and Data Services SegmentThe following charts and table present our selected statements of income data for our Fixed Income and Data Services segment (dollars in millions): (1) The adjusted figures in the charts above are calculated by excluding items that are not reflective of our cash operations and core business performance. As a result, these adjusted numbers are not calculated in accordance with U.S. GAAP. See “- Non-GAAP Financial Measures” below.56Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeRevenues:Fixed income execution$101 $52 96 %$52 $70 (25)%CDS clearing305 192 59 192 208 (8)Fixed income data and analytics1,098 1,082 1 1,082 1,018 6 Fixed income and credit1,504 1,326 13 1,326 1,296 2 Other data and network services588 557 6 557 514 8 Revenues2,092 1,883 11 1,883 1,810 4 Other operating expenses1,023 1,012 1 1,012 967 5 Acquisition-related transaction and integration costs1 1 (20)1 — 195 Depreciation and amortization349 341 2 341 351 (3)Operating expenses1,373 1,354 1 1,354 1,318 3 Operating income$719 $529 36 %$529 $492 7 %Recurring revenues$1,686 $1,639 3 %$1,639 $1,532 7 %Transaction revenues$406 $244 66 %$244 $278 (12)%In the table above, we consider fixed income data and analytics revenues and other data and network services revenues to be recurring revenues. In 2022 and 2021, 11% and 14%, respectively, of our Fixed Income and Data Services segment revenues were billed in pounds sterling or euros. As the pound sterling or euro exchange rate changes, the U.S. equivalent of revenues denominated in foreign currencies changes accordingly. Due to the fluctuations of the pound sterling and euro compared to the U.S. dollar during 2022, our Fixed Income and Data Services revenues were lower by $28 million in 2022 than in 2021.Fixed Income and Data Services RevenuesOur Fixed Income and Data Services revenues increased 11% in 2022 from 2021 primarily due to strength in our fixed income execution and CDS clearing businesses due to elevated volatility across global markets driven by geopolitical events, central bank activity and inflationary concerns.•Fixed Income Execution: Fixed income execution includes revenues from ICE Bonds. Execution fees are reported net of rebates, which were nominal in 2022 and 2021. Our fixed income execution revenues increased 96% in 2022 from 2021 due to elevated volatility across global markets driven by geopolitical events, central bank activity and inflationary concerns.•CDS Clearing: CDS clearing revenues increased 59% in 2022 from 2021. The notional value of CDS cleared was $23.8 trillion and $17.0 trillion in 2022 and 2021, respectively. The increases in the notional value of CDS cleared were primarily driven by heightened volatility related to geopolitical events and inflationary concerns.•Fixed Income Data and Analytics: Our fixed income data and analytics revenues increased 1% in 2022 from 2021. The increase in revenues was due to strength in our index business during the first half of 2022 and continued growth in our pricing and reference data business driven by the strong retention rate of existing customers, the addition of new customers, and increased purchases by existing customers. This was partially offset by unfavorable foreign exchange effects arising from fluctuations of the U.S. dollar as compared to 2021.•Other Data and Network Services: Our other data and network services revenues increased 6% in 2022 from 2021. The increase in revenues was driven primarily by growth in our ICE Global Network offering, coupled with increased demand and strong retention in our consolidated feeds business, and strength in our derivatives analytics and desktop revenues.Annual Subscription Value, or ASV, represents, at a point in time, the data services revenues, which includes Fixed Income Data and Analytics as well as other data and network services, subscribed for the succeeding 12 months. ASV does not include new sales, contract terminations or price changes that may occur during that 12-month period. However, while it is an indicative forward-looking metric, it does not provide a precise growth forecast of the next 12 months of data 57services revenues. Management considers ASV metrics when making financial and operating decisions, and believes ASV is useful for management and investors in understanding our data services business performance.As of December 31, 2022, ASV was $1.682 billion, which increased 2.2% compared to the ASV as of December 31, 2021. ASV represents nearly 100% of total data services revenues for this segment. This does not adjust for year-over-year foreign exchange fluctuations.Operating Expenses, Operating Income and Operating MarginThe following chart summarizes our Fixed Income and Data Services segment's operating expenses, operating income and operating margin (dollars in millions). See “- Consolidated Operating Expenses” below for a discussion of the significant changes in our operating expenses.Fixed Income and Data Services Segment:Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeOperating expenses $1,373 $1,354 1 %$1,354 $1,318 3 %Adjusted operating expenses(1)$1,193 $1,174 2 %$1,174 $1,119 5 %Operating income $719 $529 36 %$529 $492 7 %Adjusted operating income(1)$899 $709 27 %$709 $691 3 %Operating margin 34 %28 %6 pts28 %27 %1 ptAdjusted operating margin(1)43 %38 %5 pts38 %38 %—(1) The adjusted figures exclude items that are not reflective of our ongoing core operations and business performance. These adjusted figures are not calculated in accordance with GAAP. See “- Non-GAAP Financial Measures” below.58Mortgage Technology SegmentThe following charts and table present our selected statements of income data for our Mortgage Technology segment (dollars in millions): *Other revenues were $19 million and data and analytics revenues were $22 million in 2020.(1) The adjusted figures in the charts above are calculated by excluding items that are not reflective of our cash operations and core business performance. As a result, these adjusted figures are not calculated in accordance with U.S. GAAP. See “- Non-GAAP Financial Measures” below.59Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeRevenues:Origination technology758 971 (22)%971 316 208 %Closing solutions229 310 (26)310 238 30 Data and analytics90 73 24 73 22 226 Other52 53 (3)53 19 185 Revenues1,129 1,407 (20)1,407 595 137 Other operating expenses539 546 (1)546 215 154 Acquisition-related transaction and integration costs91 40 130 40 89 (56)Depreciation and amortization442 424 4 424 139 205 Operating expenses1,072 1,010 6 1,010 443 128 Operating income$57 $397 (86)%$397 $152 162 %Recurring revenues$643 $553 16 %$553 $155 256 %Transaction revenues$486 $854 (43)%$854 $440 94 %In the table above, we consider subscription fee and certain other revenues to be recurring revenues. Each revenue classification above contains a mix of recurring and transaction revenues, based on the various service offerings described in more detail below.Mortgage Technology RevenuesOur mortgage technology revenues are derived from our comprehensive U.S. residential mortgage platform. Our mortgage technology business is intended to enable greater workflow efficiency for customers focused on originating U.S. residential mortgage loans. Mortgage technology revenues decreased $278 million or 20% in 2022 from 2021 primarily due to lower mortgage origination volumes driven by rising interest rates.•Origination technology: Our origination technology revenues decreased 22% in 2022 from 2021 due to lower transaction-based revenues as mortgage origination volumes declined during 2022. Our origination technology acts as a system of record for the mortgage transaction, automating the gathering, reviewing, and verifying of mortgage-related information and enabling automated enforcement of rules and business practices designed to help ensure that each completed loan transaction is of high quality and adheres to secondary market standards. These revenues are based on recurring Software as a Service, or SaaS, subscription fees, with an additive transaction-based or success-based pricing fee as lenders exceed the number of loans closed that are included with their monthly base subscription.In addition, the ICE Mortgage Technology network provides originators connectivity to the mortgage supply chain and facilitates the secure exchange of information between our customers and a broad ecosystem of third-party service providers, as well as lenders and investors that are critical to consummating the millions of loan transactions that occur on our origination network each year. Revenue from the ICE Mortgage Technology network is largely transaction-based.•Closing solutions: Our closing solutions revenues decreased 26% in 2022 from 2021 due to lower mortgage origination volumes. Our closing solutions connect key participants, such as lenders, title and settlement agents and individual county recorders, to digitize the closing and recording process. Closing solutions also include revenues from our MERSCORP Holdings, Inc., or MERS database, which provides a system of record for recording and tracking changes and servicing rights and beneficial ownership interests in loans secured by U.S. residential real estate. Revenues from closing solutions are largely transaction-based and are based on the volume of loans closed.•Data and Analytics: Our Data and Analytics revenues increased 24% in 2022 from 2021 due to the addition of new customers in our Automation, Intelligence, Quality, or AIQ, and data businesses. Revenues include those related to ICE Mortgage Technology’s AIQ offering, which applies machine learning to the entire loan origination process, offering customers greater efficiency by streamlining data collection and validation through our automated document recognition and data extraction capabilities. AIQ revenues can be both recurring and transaction-based in nature. In addition, our data offerings include real-time industry and peer benchmarking tools, which provide originators a granular view into the real-time trends of the U.S. residential mortgage market. We also provide a Data as a Service, or DaaS, offering through private data clouds for lenders to access their own data and origination information. Revenues related to our data products are largely subscription-based and recurring in nature.60•Other: Other revenues decreased 3% in 2022 from 2021 due to lower professional services and non-mortgage consumer engagement revenue. Other revenues include professional services fees, as well as revenues from ancillary products. Other revenues can be both recurring and transaction-based in nature.Operating Expenses, Operating Income and Operating Margin The following chart summarizes our Mortgage Technology segment's operating expenses, operating income and operating margin (dollars in millions). See “- Consolidated Operating Expenses” below for a discussion of the significant changes in our operating expenses.Mortgage Technology Segment:Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeOperating expenses $1,072 $1,010 6 %$1,010 $443 128 %Adjusted operating expenses(1)$618 $602 3 %$602 $231 160 %Operating income $57 $397 (86)%$397 $152 162 %Adjusted operating income(1)$511 $805 (37)%$805 $364 122 %Operating margin 5 %28 %(23 pts)28 %25 %3 ptsAdjusted operating margin(1)45 %57 %(12 pts)57 %61 %(4 pts)(1) The adjusted figures exclude items that are not reflective of our ongoing core operations and business performance. These adjusted numbers are not calculated in accordance with GAAP. See “- Non-GAAP Financial Measures” 61Consolidated Operating Expenses The following presents our consolidated operating expenses (dollars in millions):Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeCompensation and benefits $1,407 $1,462 (4)%$1,462 $1,188 23 %Professional services 131 159(17)159 14410 Acquisition-related transaction and integration costs 93 102(9)102 105(3)Technology and communication 683 6662 666 54921 Rent and occupancy 83 84(1)84 813 Selling, general and administrative 226 2155 215 18516 Depreciation and amortization 1,031 1,0092 1,009 75134 Total operating expenses $3,654 $3,697 (1)%$3,697 $3,003 23 %62The majority of our operating expenses do not vary directly with changes in our volume and revenues, except for certain technology and communication expenses, including data acquisition costs, licensing and other fee-related arrangements and a portion of our compensation expense that is tied directly to our data sales or overall financial performance.We expect our operating expenses to increase in absolute terms in future periods in connection with the growth of our business, and to vary from year-to-year based on the type and level of our acquisitions, integration of acquisitions, and other investments.In 2022 and 2021, 9% and 10%, respectively, of our operating expenses were incurred in pounds sterling or euros. Due to fluctuations in the U.S. dollar compared to the pound sterling and euro, our consolidated operating expenses were $38 million lower in 2022 than in 2021. See Item 7(A) “- Quantitative and Qualitative Disclosures About Market Risk - Foreign Currency Exchange Rate Risk” below for additional information.Compensation and Benefits Expenses Compensation and benefits expense is our most significant operating expense and includes non-capitalized employee wages, bonuses, non-cash or stock compensation, certain severance costs, benefits and employer taxes. The bonus component of our compensation and benefits expense is based on both our financial performance and individual employee performance. The performance-based restricted stock compensation expense is also based on our financial performance. Therefore, our compensation and benefits expense will vary year-to-year based on our financial performance and fluctuations in our number of employees. The below chart summarizes the significant drivers of our compensation and benefits expense results for the periods presented (dollars in millions, except employee headcount).Year Ended December 31,20222021ChangeEmployee headcount 8,911 8,858 1 %Stock-based compensation expenses$149 $155 (4)%Employee headcount increased in 2022 from 2021 primarily due to recent acquisitions and a shift to move certain costs in-house, primarily in India.Compensation and benefits expense decreased $55 million in 2022 from 2021 primarily due to $54 million in expenses related to Bakkt prior to deconsolidation in 2021. Compensation expense includes higher costs from increased headcount, annual merit increases and other related costs, offset by lower bonus expense in 2022 due to lower target performance as compared to the above-target performance in 2021. Stock-based compensation expenses decreased in 2022 due to the deconsolidation of Bakkt and lower target performance in 2022 as compared to the above-target performance in 2021.Professional Services Expenses Professional services expense includes fees for consulting services received on strategic and technology initiatives, temporary labor, as well as regulatory, legal and accounting fees, and may fluctuate as a result of changes in our use of these services in our business. Professional services expenses decreased $28 million in 2022 from 2021 primarily due to lower regulatory and litigation expenses, lower consulting expenses related to bringing certain mortgage technology-related costs in-house, and $13 million in expenses recorded at Bakkt in 2021 prior to deconsolidation.Acquisition-Related Transaction and Integration CostsIn 2022, we incurred $93 million in acquisition-related transaction costs primarily due legal and consulting expenses related to our pending acquisition of Black Knight and our integration of Ellie Mae.We expect to continue to explore and pursue various potential acquisitions and other strategic opportunities to strengthen our competitive position and support our growth. As a result, we may incur acquisition-related transaction costs in future periods.63Technology and Communication Expenses Technology support services consist of costs for running our wholly-owned data centers, hosting costs paid to third-party data centers, and maintenance of our computer hardware and software required to support our technology and cybersecurity. These costs are driven by system capacity, functionality and redundancy requirements. Communication expenses consist of costs for network connections for our electronic platforms and telecommunications costs.Technology and communications expense also includes fees paid for access to external market data, licensing and other fee agreement expenses. Technology and communications expenses may be impacted by growth in electronic contract volume, our capacity requirements, changes in the number of telecommunications hubs and connections with customers to access our electronic platforms directly. Technology and communications expenses increased by $17 million in 2022 from 2021, primarily due to increased hardware and software support costs, increased hosting costs and increased data services costs, partially offset by $11 million in expenses in 2021 related to Bakkt prior to deconsolidation.Rent and Occupancy ExpensesRent and occupancy expense relates to leased and owned property and includes rent, maintenance, real estate taxes, utilities and other related costs. We have significant operations located in the U.S., U.K., and India, with smaller offices located throughout the world.Rent and occupancy expenses included decreased rent expense in 2022 from 2021 due to office closures, and expenses in 2021 related to Bakkt prior to deconsolidation. These costs were partially offset by higher costs related to utilities, repairs and maintenance as more employees returned to the office. See Item 2 “- Properties” above for additional information regarding our leased and owned property.Selling, General and Administrative Expenses Selling, general and administrative expenses include marketing, advertising, public relations, insurance, bank service charges, dues and subscriptions, travel and entertainment, non-income taxes and other general and administrative costs.Selling, general and administrative expenses increased in 2022 from 2021, primarily due to increased marketing expenses related to additional branding efforts and increased travel and entertainment expenses compared to suppressed travel demand in 2021 as a result of COVID-19. These were partially offset by $19 million in expenses related to Bakkt in 2021 prior to deconsolidation.Depreciation and Amortization Expenses Depreciation and amortization expense results from depreciation of long-lived assets such as buildings, leasehold improvements, aircraft, hardware and networking equipment, software, furniture, fixtures and equipment over their estimated useful lives. This expense includes amortization of intangible assets obtained in our acquisitions of businesses, as well as on various licensing agreements, over their estimated useful lives. Intangible assets subject to amortization consist primarily of customer relationships, trading products with finite lives and technology. This expense also includes amortization of internally-developed and purchased software over its estimated useful life.We recorded amortization expenses on intangible assets acquired as part of our acquisitions, as well as on other intangible assets, of $610 million and $622 million in 2022 and 2021, respectively.We recorded depreciation expenses on our fixed assets of $421 million and $387 million in 2022 and 2021, respectively. The increase in 2022 over 2021 was primarily due to an increase in internally developed software assets at ICE Mortgage Technology.64Consolidated Non-Operating Income/(Expense) Income and expenses incurred through activities outside of our core operations are considered non-operating. The following tables present our non-operating income/(expenses) (dollars in millions): Year Ended December 31,Year Ended December 31,20222021Change20212020ChangeOther income/(expense):Interest income$108 $1 n/a$1 $10 (93)%Interest expense (616)(423)46 (423)(357)19 Other income/(expense), net (1,322)2,671 n/a2,671 80 n/aTotal other income/(expense), net $(1,830)$2,249 n/a$2,249 $(267)n/aNet income attributable to non-controlling interest $(52)$(11)383 %$(11)$(19)(44)%Interest IncomeInterest income increased in 2022 from 2021 primarily due to an increase in short-term interest rates combined with larger investment balances. Interest income in 2022 includes $76 million in interest income recognized in connection with the short-term investments related to the $5.0 billion of SMR Notes (as defined in "Liquidity and Capital Resources— Debt") for the Black Knight acquisition and the remainder primarily relates to interest on the restricted cash balances held within our regulated entities.Interest ExpenseInterest expense increased in 2022 from 2021 primarily due to $135 million in interest expense in 2022 related to the Black Knight acquisition-related-debt, $30 million in costs associated with our May 2022 debt refinancing as well as higher bond coupons associated with the re-financing of our existing debt. See “— Debt” below.Other income/(expense), netOur equity method investments include OCC and Bakkt, among others. We recognized ($1.3 billion) and ($42 million) during 2022 and 2021, respectively, of our share of estimated equity method investment losses, net, and impairment charges, which are included in other income/(expense). In 2022, after recording our share of Bakkt's equity method losses, which included Bakkt's impairment charge, we recorded an impairment charge on our investment in Bakkt to its fair value as other expense. This was based on what we consider to be an other-than-temporary decline in fair value as a result of several factors, including consideration of the impairment charge recorded by Bakkt (see Notes 3 and 4 to our consolidated financial statements). The estimated losses and impairment during 2022 and 2021 are primarily related to our investment in Bakkt. These are partially offset by the estimated profits related to our investment in OCC. Both 2022 and 2021 include adjustments to reflect the difference between reported prior period actual results from our original estimates.During 2021, Bakkt completed its merger with VIH, as a result of which we retained an approximate 68% economic interest in Bakkt, and we recorded a gain of $1.4 billion as other income upon our deconsolidation of Bakkt. Following the merger, we show our economic interest share of estimated Bakkt profits/(losses) as equity earnings, which are also included in other income (expense), net. We recorded other expense of ($92 million) related to our Bakkt investment for the post-merger period during 2021.During 2021, Coinbase completed an IPO and we sold our investment in Coinbase for $1.2 billion, and recorded a gain of $1.2 billion as other income.During 2022, we recorded a $9 million accrual for legal settlements as other expense. During 2021, we recorded a gain of $7 million related to the settlement of an acquisition-related indemnification claim from a prior acquisition as other income. In addition, we accrued approximately $16 million related to a legal settlement.We completed the sale of our Euroclear stake on May 20, 2022. The carrying value of our investment was $700 million at the time of the sale. We recorded a net gain of $41 million on the sale, which is included in other income during 2022. We did not receive a Euroclear dividend during the 2022 prior to the sale of our investment.65We incurred foreign currency transaction losses of $9 million and $13 million in 2022 and 2021, respectively. This was primarily attributable to the fluctuations of the pound sterling and euro relative to the U.S. dollar. Foreign currency transaction gains and losses are recorded in other income/(expense), net, when the settlement of foreign currency assets, liabilities and payables occur in non-functional currencies and there is an increase or decrease in the period-end foreign currency exchange rates between periods. See Item 7A “- Quantitative and Qualitative Disclosures About Market Risk -Foreign Currency Exchange Rate Risk” included elsewhere in this Annual Report for more information on these items.In connection with Accounting Standards Update, or ASU, 2017-07, Compensation Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, or ASU 2017-07, we are recognizing the other components of net benefit cost of our defined benefit plans in the income statement as non-operating income on a full retrospective basis. The combined net periodic expense of these plans was $2 million and $3 million in 2022 and 2021, respectively.Non-controlling InterestFor consolidated subsidiaries in which our ownership is less than 100%, and for which we have control over the assets, liabilities and management of the entity, the outside stockholders’ interests are shown as non-controlling interests. As of December 31, 2022, our non-controlling interests include those related to the non-ICE limited partners' interest in our CDS clearing subsidiaries and non-controlling interest in ICE Futures Abu Dhabi. During 2021 we received a contribution from a group of minority investors for a non-controlling interest in ICE Futures Abu Dhabi. Prior to completion of the Bakkt transaction on October 15, 2021, our non-controlling interest also included the redeemable non-controlling interest of the non-ICE partners in Bakkt. On October 15, 2021, Bakkt completed its merger with VIH and as of December 31, 2021, we no longer held redeemable non-controlling interest related to Bakkt. Refer to Note 3 to our consolidated financial statements contained elsewhere in this Annual Report.Consolidated Income Tax Provision Consolidated income tax expense was $310 million and $1.6 billion in 2022 and 2021, respectively. The change in consolidated income tax expense between years is primarily due to the tax impact of changes in our pre-tax income and the changes in our effective tax rate. The consolidated income tax expense for 2021 was elevated due to the tax expense associated with the gains resulting from our Coinbase and Bakkt transactions. Our effective tax rate was 17% and 29% in 2022 and 2021, respectively. The effective tax rate for 2022 is lower than the effective tax rate for 2021 primarily due to the deferred income tax benefit from the impairment to our equity method investment in Bakkt in 2022 and deferred income tax expenses from the U.K. tax law changes in 2021. In 2021, the U.K. enacted a corporate income tax rate increase from 19% to 25% effective April 1, 2023.See Note 13 to our consolidated financial statements and related notes, which are included in this Annual Report, for additional information on these tax items.66Liquidity and Capital Resources Below are charts that reflect our outstanding debt and capital allocation. The acquisition and integration costs in the chart below include cash paid for acquisitions, net of cash received for divestitures, cash paid for equity and equity method investments, cash paid for non-controlling interest and redeemable non-controlling interest, and acquisition-related transaction and integration costs, in each year.We have financed our operations, growth and cash needs primarily through income from operations and borrowings under our various debt facilities. Our principal capital requirements have been to fund capital expenditures, working capital, strategic acquisitions and investments, stock repurchases, dividends and the development of our technology platforms. We believe that our cash on hand and cash flows from operations will be sufficient to repay our outstanding debt, but we 67may also need to incur additional debt or issue additional equity securities in the future. See “- Future Capital Requirements” below.See “- Cash Flow” below for a discussion of our capital expenditures and capitalized software development costs.Consolidated cash and cash equivalents were $1.8 billion and $607 million as of December 31, 2022 and 2021, respectively. We had $6.6 billion and $1.4 billion in short-term and long-term restricted cash and cash equivalents as of December 31, 2022 and 2021, respectively, the increase of which is related to the restricted $5.0 billion of SMR Notes intended to be used to finance the Black Knight acquisition. We had $142.0 billion and $145.9 billion of cash and cash equivalent margin deposits and guaranty funds as of December 31, 2022 and 2021, respectively.As of December 31, 2022, the amount of unrestricted cash held by our non-U.S. subsidiaries was $502 million. Due to U.S. tax reform, the majority of our foreign earnings since January 1, 2018 have been subject to immediate U.S. income taxation, and the existing non-U.S. unrestricted cash balance can be distributed to the U.S. in the future with no material additional income tax consequences.Our cash and cash equivalents and financial investments are managed as a global treasury portfolio of non-speculative financial instruments that are readily convertible into cash, such as overnight deposits, term deposits, money market funds, mutual funds for treasury investments, short duration fixed income investments and other money market instruments, thus ensuring high liquidity of financial assets. We may invest a portion of our cash in excess of short-term operating needs in investment-grade marketable debt securities, including government or government-sponsored agencies and corporate debt securities. As of December 31, 2022, we held $1 million of unrestricted cash that was set aside for legal, regulatory and surveillance operations at NYSE.Cash Flow The following table presents the major components of net changes in cash and cash equivalents, and restricted cash and cash equivalents (in millions):Year Ended December 31,202220212020Net cash provided by (used in):Operating activities$3,554 $3,123 $2,881 Investing activities677 (786)(10,361)Financing activities(1,841)62,026 26,000 Effect of exchange rate changes (23)(6)8 Net increase in cash and cash equivalents, restricted cash and cash equivalents, and cash and cash equivalent margin deposits and guaranty funds$2,367 $64,357 $18,528 Operating ActivitiesNet cash provided by operating activities primarily consists of net income adjusted for certain items, including depreciation and amortization, deferred taxes, stock-based compensation and the effects of changes in working capital. The $431 million increase in net cash provided by operating activities in 2022 from 2021 was driven by a $220 million increase in net income, adjusted for certain noncash operating activities. In 2022, these adjustments also include the gain on the sale of our Euroclear investment and the net losses and impairment of our unconsolidated investees. During 2021, these adjustments also included the gains on the sale of our Coinbase investment and our deconsolidation of Bakkt. Net income increased in 2022 from 2021 due to higher revenues of $146 million, driven by our Exchanges and Fixed Income and Data Services segments, as well as lower expenses, primarily due to the deconsolidation of Bakkt.The remaining $211 million increase is due to changes in our working capital and the timing of various payments and receipts. These changes include higher Section 31 fees payable of $316 million due to the rate changes determined by the SEC, offset primarily by timing of various payments and receipts, including higher interest receivable/payable on the cash and collateral held at our clearinghouses.Investing Activities Consolidated net cash provided by investing activities in 2022 primarily relates to $7.5 billion of proceeds from the sale of invested margin deposits and $741 million in proceeds from the sale of our Euroclear investment, partially offset by $6.9 billion purchases of invested margin deposits, $225 million of capitalized expenditures, $257 million of software development costs, $73 million for purchases of equity and equity method investments and $59 million cash paid for acquisitions, net of cash acquired.68Consolidated net cash used in investing activities in 2021 relates to $5.1 billion purchases of invested margin deposits, $179 million of capitalized expenditures, $273 million of capitalized software development costs, $117 million for the purchase of an equity method investment and $66 million cash paid for acquisitions, net of cash acquired, partially offset by $3.7 billion of proceeds from the sale of invested margin deposits and $1.2 billion in proceeds from the sale of our Coinbase investment.The capital expenditures primarily relate to hardware and software purchases to continue the development and expansion of our electronic platforms, data services and clearing houses and leasehold improvements. The software development expenditures primarily relate to the development and expansion of our electronic trading platforms, data services, mortgage services and clearing houses.Financing Activities Consolidated net cash used in financing activities in 2022 primarily relates to a $4.5 billion change in our cash and cash equivalent margin deposits and guaranty fund balances, $2.7 billion in repayments of debt, $1.0 billion in net repayments under our Commercial Paper Program, $632 million in repurchases of common stock, $853 million in dividend payments to our stockholders and $73 million in cash payments related to treasury shares received for restricted stock tax payments and stock options exercises, partially offset by $7.9 billion in net proceeds from our debt offerings. Consolidated net cash provided by financing activities in 2021 primarily relates to an increase in our cash and cash equivalent margin deposits and guaranty fund balances of $65.7 billion, partially offset by $1.2 billion in repayments of debt, $1.4 billion in net repayments under our Commercial Paper Program, $250 million in repurchases of common stock, $747 million in dividend payments to stockholders and $70 million in cash payments related to treasury shares received for restricted stock tax payments and stock options exercises.DebtAs of December 31, 2022, we had $18.1 billion in outstanding debt, all of which relates to our senior notes. We also have $4 million outstanding under credit lines at our ICE India subsidiaries. As of December 31, 2022, our senior notes of $18.1 billion had a weighted average maturity of 16 years and a weighted average cost of 3.6% per annum. We did not have any commercial paper notes outstanding as of December 31, 2022.As of December 31, 2021, we had $13.9 billion in outstanding debt, consisting of $12.9 billion of senior notes, $1.0 billion under our U.S. dollar commercial paper program, or the Commercial Paper Program, and $10 million under credit lines at our ICE India subsidiaries. As of December 31, 2021, our senior notes of $12.9 billion had a weighted average maturity of 15 years and a weighted average cost of 2.9% per annum. The commercial paper notes had original maturities ranging from three to 73 days as of December 31, 2021, with a weighted average interest rate of 0.33% per annum, and a weighted average remaining maturity of 26 days.In September 2021, we used the proceeds from commercial paper issuances and cash on hand to fund the redemption of $1.25 billion aggregate principal amount of senior floating rate notes due in June 2023, or the Floating Rate Notes. We delivered a notice of redemption of the Floating Rate Notes to Wells Fargo Bank, National Association, as trustee, under the indenture governing the Floating Rate Notes, which was delivered to the holders of the Floating Rate Notes on September 17, 2021, and they were subsequently redeemed on September 27, 2021. In connection with this redemption, we recorded $4 million in accelerated unamortized deferred loan costs, which are included in interest expense in our consolidated statements of income for 2021.We have a $3.9 billion senior unsecured revolving credit facility, or the Credit Facility, pursuant to a credit agreement with Wells Fargo Bank, N.A., as primary administrative agent, issuing lender and swing-line lender, Bank of America, N.A., as syndication agent, backup administrative agent and swing-line lender, and the lenders party thereto. On October 15, 2021, we agreed with the lenders to extend the maturity date of the Credit Facility to October 15, 2026, among other items. On May 25, 2022, we agreed with the lenders to extend the maturity date of the Credit Facility from October 15, 2026, to May 25, 2027, among other items. As of December 31, 2022, of the $3.9 billion that is currently available for borrowing under the Credit Facility, $171 million was required to support certain broker-dealer and other subsidiary commitments. We did not have any notes outstanding under our Commercial Paper Program, as of December 31, 2022. Therefore, there was not a required amount to backstop the Commercial Paper Program. Amounts required to backstop notes outstanding under the Commercial Paper Program will fluctuate as we increase or decrease our commercial paper borrowings. The remaining $3.7 billion is available for working capital and general corporate purposes, including, but not limited to, acting as a backstop to future increases in the amounts outstanding under the Commercial Paper Program.On May 23, 2022, we issued $8.0 billion in aggregate principal amount of new senior notes, comprised of the following:•$1.25 billion in aggregate principal amount of 3.65% senior notes due in 2025, or the 2025 Notes;69•$1.5 billion in aggregate principal amount of 4.00% senior notes due in 2027, or the 2027 Notes;•$1.25 billion in aggregate principal amount of 4.35% senior notes due in 2029, or the 2029 Notes;•$1.5 billion in aggregate principal amount of 4.60% senior notes due in 2033, or the 2033 Notes;•$1.5 billion in aggregate principal amount of 4.95% senior notes due in 2052, or the 2052 Notes; and•$1.0 billion in aggregate principal amount of 5.20% senior notes due in 2062, or the 2062 Notes, collectively, the Notes.We intend to use the net proceeds of $4.9 billion from the offering of the 2025 Notes, the 2027 Notes, the 2029 Notes and the 2062 Notes, or collectively, the SMR Notes, together with the issuance of commercial paper and/or borrowings under the Credit Facility, cash on hand or other immediately available funds and borrowings under the Term Loan, discussed below, to finance the cash portion of the purchase price for Black Knight. The SMR Notes are subject to a special mandatory redemption feature pursuant to which we will be required to redeem all of the outstanding SMR Notes at a redemption price equal to 101% of the aggregate principal amount of the SMR Notes, plus accrued and unpaid interest, in the event that the Black Knight acquisition is not consummated on or prior to May 4, 2023 subject to two automatic extensions of three months each, to August 4, 2023 and to November 4, 2023, respectively, if clearance under the HSR Act (or a restraint under U.S. antitrust laws) remains outstanding and all other conditions to closing are satisfied (or in the case of conditions that by their terms are to be satisfied at the closing, are capable of being satisfied if the closing were to occur on such date) at each extension date, or if the Black Knight merger agreement is terminated at any time prior to such date. ICE would then need to secure new financing to close the transaction. There can be no assurance that the new financing could be secured and if it is secured, the terms of the new financing may be more expensive to ICE when compared to the existing financing terms for the $5.0 billion of outstanding notes. The $4.9 billion of net proceeds from the SMR Notes are separately invested and recorded as short-term restricted cash and cash equivalents in our consolidated balance sheet as of December 31, 2022.We used the $3.0 billion of net proceeds from the offering of the 2033 Notes and the 2052 Notes to redeem $2.7 billion aggregate principal amount of four series of senior notes that would have matured in 2022 and 2023. The balance of the net proceeds was used for general corporate purposes, which included paying down a portion of the amounts outstanding under our Commercial Paper Program. We recorded $30 million in costs associated with the extinguishment and re-financing of our existing debt in connection with our May 2022 debt refinancing. These costs are included in interest expense in our consolidated statements of income for 2022. For additional information regarding this transaction, refer to Note 3 to our consolidated unaudited financial statements, included in this Annual Report.On May 4, 2022, we entered into a 364-day senior unsecured bridge facility in an aggregate principal amount not to exceed $14.0 billion, or the Bridge Facility. The commitments that the Company obtained for the Bridge Facility were permanently reduced from $14.0 billion and there were no amounts outstanding as of December 31, 2022 as a result of (i) the amendment and extension of the Credit Facility, (ii) the issuance by the Company of certain senior unsecured notes on May 23, 2022, (iii) Euroclear divestment proceeds, (iv) the generation of cash internally by the Company, and (v) the effectiveness of our term loan facility.On May 25, 2022, we entered into a $2.4 billion two-year senior unsecured delayed draw term loan facility, or the Term Loan. Draws under the Term Loan bear interest on the principal amount outstanding at either (a) Term SOFR plus an applicable margin plus a credit spread adjustment of 10 basis points or (b) a "base rate" plus an applicable margin. The applicable margin ranges from 0.625% to 1.125% for Term SOFR loans and from 0.000% to 0.125% for base rate loans, in each case, based on a ratings-based pricing grid. The proceeds from borrowings under the Term Loan will be used to fund a portion of the purchase price for the Black Knight acquisition. We have the option to prepay outstanding amounts under the Term Loan in whole or in part at any time. No amounts were outstanding under the Term Loan as of December 31, 2022.Our Commercial Paper Program enables us to borrow efficiently at reasonable short-term interest rates and provides us with the flexibility to de-lever using our strong annual cash flows from operating activities whenever our leverage becomes elevated as a result of investment or acquisition activities. We had net repayments of $1.0 billion under our Commercial Paper Program during 2022, and did not have any notes outstanding under our Commercial Paper Program as of December 31, 2022.Upon maturity of our commercial paper and to the extent old issuances are not repaid by cash on hand, we are exposed to the rollover risk of not being able to issue new commercial paper. To mitigate this risk, we maintain the Credit Facility for an aggregate amount which meets or exceeds the amount issued under our Commercial Paper Program at any time. If we were not able to issue new commercial paper, we have the option of drawing on the backstop revolving facility. However, electing to do so would result in higher interest expense.70For additional details of our debt instruments, refer to Note 10 to our consolidated financial statements, included in this Annual Report.Capital ReturnIn December 2021, our Board approved an aggregate of $3.15 billion for future repurchases of our common stock with no fixed expiration date that became effective January 1, 2022. The $3.15 billion replaced the previous amount approved by the Board. The approval of our Board for stock repurchases does not obligate us to acquire any particular amount of our common stock. In addition, our Board may increase or decrease the amount available for repurchases from time to time.During 2022, we repurchased 5.0 million shares of our outstanding common stock at a cost of $632 million, including 4.6 million shares at a cost of $582 million under our Rule 10b5-1 trading plan and 0.4 million shares at a cost of $50 million on the open market. During 2021, we repurchased 1.8 million shares of our outstanding common stock at a cost of $250 million on the open market. Open market repurchases are only made during an open trading period and all shares repurchased are held in treasury stock.We discontinued stock repurchases and terminated our Rule 10b5-1 trading plan in August 2020 in connection with our Ellie Mae acquisition and in November 2021, we resumed repurchases. In December 2021, we entered into a new Rule 10b5-1 trading plan that became effective in February 2022. In connection with our pending acquisition of Black Knight, on May 4, 2022, we terminated our Rule 10b5-1 trading plan and suspended share repurchases. The remaining balance of Board approved funds for future repurchases as of December 31, 2022 was $2.5 billion.From time to time, we enter into Rule 10b5-1 trading plans, as authorized by our Board, to govern some or all of the repurchases of our shares of common stock. We may discontinue stock repurchases at any time and may amend or terminate a Rule 10b5-1 trading plan at any time, subject to applicable rules. We expect funding for any stock repurchases to come from our operating cash flow or borrowings under our Commercial Paper Program or our debt facilities. The timing and extent of future repurchases that are not made pursuant to a Rule 10b5-1 trading plan will be at our discretion and will depend upon many conditions. In making a determination regarding any stock repurchases, management considers multiple factors, including overall stock market conditions, our common stock price performance, the remaining amount authorized for repurchases by our Board, the potential impact of a stock repurchase program on our corporate debt ratings, our expected free cash flow and working capital needs, our current and future planned strategic growth initiatives, and other potential uses of our cash and capital resources.During 2022, we paid cash dividends of $1.52 per share of our common stock in the aggregate, including quarterly dividends of $0.38 per share, for an aggregate payout of $853 million, which includes the payment of dividend equivalents on unvested employee restricted stock units. Refer to Note 12 to our consolidated financial statements included in this Annual Report, for details on the amounts of our quarterly dividend payouts for the last three years. Future Capital Requirements Our future capital requirements will depend on many factors, including the rate of growth across our segments, strategic plans and acquisitions, available sources for financing activities, required and discretionary technology and clearing initiatives, regulatory requirements, the timing and introduction of new products and enhancements to existing products, the geographic mix of our business and potential stock repurchases. We currently expect to incur capital expenditures (including operational and real estate capital expenditures) and to incur software development costs that are eligible for capitalization ranging in the aggregate between $450 million and $500 million in 2023, which we believe will support the enhancement of our technology, business integration and the continued growth of our businesses.As of December 31, 2022, we had $2.5 billion authorized for future repurchases of our common stock. Refer to Note 12 to our consolidated financial statements included in this Annual Report for additional details on our stock repurchase program.Our Board has adopted a quarterly dividend policy providing that dividends will be approved quarterly by the Board or the Audit Committee taking into account factors such as our evolving business model, prevailing business conditions, our current and future planned strategic growth initiatives and our financial results and capital requirements, without a predetermined net income payout ratio. On February 2, 2023, we announced a $0.42 per share dividend for the first quarter of 2023 payable on March 31, 2023 to stockholders of record as of March 17, 2023.Other than the facilities for the ICE Clearing Houses, our Credit Facility and our Commercial Paper Program are currently the only significant agreements or arrangements that we have for liquidity and capital resources with third parties. See 71Notes 10 and 14 to our consolidated financial statements for further discussion. In the event of any strategic acquisitions, mergers or investments, or if we are required to raise capital for any reason or desire to return capital to our stockholders, we may incur additional debt, issue additional equity to raise necessary funds, repurchase additional shares of our common stock or pay a dividend. However, we cannot provide assurance that such financing or transactions will be available or successful, or that the terms of such financing or transactions will be favorable to us. See “-Risk Factors" and Note 10 to our consolidated financial statements, included in this Annual Report.Non-GAAP Measures We use certain financial measures internally to evaluate our performance and make financial and operational decisions that are presented in a manner that adjusts from their equivalent GAAP measures or that supplement the information provided by our GAAP measures. We use these adjusted results because we believe they more clearly highlight trends in our business that may not otherwise be apparent when relying solely on GAAP financial measures, since these measures eliminate from our results specific financial items that have less bearing on our core operating performance. We use these measures in communicating certain aspects of our results and performance, including in this Annual Report, and believe that these measures, when viewed in conjunction with our GAAP results and the accompanying reconciliation, can provide investors with greater transparency and a greater understanding of factors affecting our financial condition and results of operations than GAAP measures alone. In addition, we believe the presentation of these measures is useful to investors for making period-to-period comparisons of results because the adjustments to GAAP are not reflective of our core business performance. These financial measures are not presented in accordance with, or as an alternative to, GAAP financial measures and may be different from non-GAAP measures used by other companies. We encourage investors to review the GAAP financial measures included in this Annual Report, including our consolidated financial statements, to aid in their analysis and understanding of our performance and in making comparisons.The table below outlines our adjusted operating expenses, adjusted operating income, adjusted operating margin, adjusted net income attributable to ICE common stockholders and adjusted diluted earnings per share, which are non-GAAP measures that are calculated by making adjustments for items we view as not reflective of our cash operations and core business performance. These measures, including the adjustments and their related income tax effect and other tax adjustments (in millions, except for percentages and per share amounts), are as follows:72Exchanges SegmentFixed Income and Data Services SegmentMortgage Technology SegmentConsolidatedYear Ended December 31,Year Ended December 31,Year Ended December 31,Year Ended December 31,Operating income adjustments:202220212020202220212020202220212020202220212020Total revenues, less transaction-based expenses$4,071 $3,856 $3,631 $2,092 $1,883 $1,810 $1,129 $1,407 $595 $7,292 $7,146 $6,036 Operating expenses1,209 1,333 1,242 1,373 1,354 1,318 1,072 1,010 443 3,654 3,697 3,003 Less: Amortization of acquisition-related intangibles67 73 74 180 180 191 363 369 123 610 622 388 Less: Transaction and integration costs and acquisition-related success fees — 59 12 — — — 91 39 89 91 98 101 Less: Impairment of developed software— — 11 — — — — — — — — 11 Less: Accrual relating to a regulatory settlement— — — — — 8 — — — — — 8 Adjusted operating expenses$1,142 $1,201 $1,145 $1,193 $1,174 $1,119 $618 $602 $231 $2,953 $2,977 $2,495 Operating income$2,862 $2,523 $2,389 $719 $529 $492 $57 $397 $152 $3,638 $3,449 $3,033 Adjusted operating income$2,929 $2,655 $2,486 $899 $709 $691 $511 $805 $364 $4,339 $4,169 $3,541 Operating margin70 %65 %66 %34 %28 %27 %5 %28 %25 %50 %48 %50 %Adjusted operating margin72 %69 %68 %43 %38 %38 %45 %57 %61 %59 %58 %59 %Non-operating income adjustments:Net income attributable to ICE common stockholders$1,446 $4,058 $2,089 Add: Amortization of acquisition-related intangibles610 622 388 Add: Transaction and integration costs and acquisition-related success fees 91 98 101 Less: Gain on sale and fair value adjustment of equity investments and dividends received, net(41)(1,321)(55)Less: Gain on deconsolidation of Bakkt— (1,419)— Add/(Less): Net losses/(income) from and impairment of unconsolidated investees1,340 42 (71)Add: Net interest expense on pre-acquisition-related debt and debt extinguishment89 4 19 Add: Other9 9 51 Add/(Less): Net income tax effect for the above items and deferred tax adjustments (579)587 (109)Add: Deferred tax adjustments on acquisition-related intangibles9 183 36 Adjusted net income attributable to ICE common stockholders$2,974 $2,863 $2,449 Diluted earnings per share attributable to ICE common stockholders$2.58 $7.18 $3.77 Adjusted diluted earnings per share attributable to ICE common stockholders$5.30 $5.06 $4.41 Diluted weighted average common shares outstanding561 565 555 Amortization of acquisition-related intangibles are included in non-GAAP adjustments as excluding these non-cash expenses provides greater clarity regarding our financial strength and stability of cash operating results. Transaction and integration costs are included as part of our core business expenses, except for those that are directly related to the announcement, closing, financing or termination of a transaction. However, we adjust for the acquisition-related transaction and integration costs relating to acquisitions such as Ellie Mae given the magnitude of the $11.4 billion purchase price of the acquisition. We also adjust for the acquisition-related transaction costs related to the merger of Bakkt and VIH, and for our pending acquisition of Black Knight, due to the significance of these transactions.We adjust for gains and losses on investment transactions and changes in the fair value of our investments. Our investments are not considered to be a part of our core business operations and the impacts of changes in our investments are often non-cash in nature. The following non-GAAP adjustments are reported in the table above related to investments:•During 2022, we excluded the $41 million gain on the sale of our Euroclear investment; •During 2021 and 2020, we excluded $34 million and $35 million, respectively, of fair value gains on our Euroclear equity investment and during 2021, we excluded Euroclear dividends received of $60 million;•In 2021, we excluded the $1.4 billion gain on the deconsolidation of Bakkt and the $1.2 billion gain on the sale of our Coinbase equity investment; and•In 2020, we excluded the $20 million gain on the sale of our BIDS equity investment.73Similarly, and as included in the table above, we adjust for our share of net income/(losses) and impairment charges related to our equity method investments, which primarily include OCC and Bakkt. Our share of 2021 net losses from unconsolidated investees includes the period from the Bakkt merger on October 15, 2021 through December 31, 2021. During 2022, after recording our share of Bakkt's equity method losses, which included Bakkt's impairment charge, we recorded an impairment in our investment in Bakkt to its fair value as other expense. In 2022, the total Bakkt net losses and impairment was $1.4 billion and our share of OCC net income was $15 million. In 2021, our share of Bakkt losses was $92 million and our share of OCC income was $51 million. We believe these adjustments provide greater clarity of our performance given that equity method investments are non-cash and not a part of our core operations.We adjust for certain items related to our debt. Certain debt activities, such as the early termination of notes, pre-acquisition interest and expense and accelerated amortization of debt costs are not considered to be a part of our core business operations and the impacts of changes in our investments are often non-cash in nature. The following non-GAAP adjustments are reported in the table above related to our debt:•In 2022, we adjusted for costs of $30 million associated with the May and June 2022 extinguishment of four series of senior notes that would have matured in 2022 and 2023 using proceeds from our May 2022 issuance of new senior notes. •In 2022, we excluded $135 million of interest expense on pre-acquisition-related debt from our May 2022 debt refinancing related to the pending Black Knight acquisition. This adjustment was net of $76 million of interest income earnings on investments from the pre-acquisition debt proceeds.•In 2021, we adjusted for the acceleration of unamortized costs of $4 million related to the September 2021 early redemption of our Floating Rate Notes.•In 2020, we adjusted for the extinguishment payment of $14 million related to the June 2020 early redemption of the December 2020 Senior Notes which included both a make-whole redemption payment and duplicative interest, and adjusted for pre-acquisition interest expense of $5 million on the August 2020 debt issued to fund a portion of the purchase price of our Ellie Mae acquisition.Other adjustments not considered to be a part of our core business operations include:•Accruals related to legal and regulatory settlements, including settlements related to an acquisition-related indemnification claim;•A 2020 impairment of software developed at Bakkt when it was our subsidiary, since it related to the build-out of a fundamental software design rather than a recurring upgrade; and•A 2020 promissory note impairment charge on work performed by the original plan processor on the CAT as non-GAAP adjustments. See additional discussion on the CAT in Item 1(A) "-Risk Factors" in this Annual Report.Non-GAAP tax adjustments include the tax impacts of the pre-tax non-GAAP adjustments and deferred tax adjustments on acquisition-related intangibles. Deferred tax adjustments on acquisition-related intangibles include the impact of U.K. and U.S. state tax law changes and apportionment updates, as well as other foreign tax law changes which resulted in deferred tax expense of $9 million, $183 million and $36 million in 2022, 2021 and 2020, respectively, related to the following:•Deferred tax adjustments in 2022 related primarily to U.S. state apportionment changes. •Deferred tax adjustments in 2021 related primarily to the U.K. tax law changes enacted in June 2021, which increased the U.K. corporate income tax rate from 19% to 25% effective April 1, 2023. •The deferred tax adjustments in 2020 were due to the tax law changes enacted in July 2020, which increased the U.K. corporate income tax rate from 17% to 19% effective April 1, 2020, as well as impacts of U.S. state apportionment charges.For additional information on these items, refer to our consolidated financial statements included in this Annual Report and “- Recent Developments,” “- Consolidated Operating Expenses”, “- Consolidated Non-Operating Income (Expenses)” and “-Consolidated Income Tax Provision” above.Off-Balance Sheet Arrangements As described in Note 14 to our consolidated financial statements, which are included elsewhere in this Annual Report, certain clearing house collateral is reported off-balance sheet. We do not have any relationships with unconsolidated entities or financial partnerships, often referred to as structured finance or special purpose entities.74Contractual Obligations and Commercial Commitments We intend to fund our contractual obligations and commercial commitments from existing cash and cash flow from operations. As of December 31, 2022, our primary cash requirements include the following contractual and other obligations.As of December 31, 2022, we had $18.1 billion in outstanding debt, including $4 million of short-term debt. Our outstanding debt consists of $18.1 billion of fixed rate senior notes and $4 million under credit lines at our ICE India subsidiaries.Our operating leases primarily relate to our leased office space and data center facilities, and as of December 31, 2022, we had fixed lease payment obligations of $342 million, with $73 million payable within one-year.We have other purchase obligations to purchase various goods and services that we believe are enforceable and legally binding.In addition, we have $147.4 billion in cash and cash equivalent margin deposits and guaranty funds, invested deposits, delivery contracts payable and unsettled variation margin. Clearing members of our clearing houses are required to deposit original margin and variation margin and to make deposits to a guaranty fund. The cash and cash equivalent deposits made to these margin accounts and to the guaranty fund are recorded in the consolidated balance sheets as current assets with corresponding current liabilities to the clearing members that deposited them. ICE NGX administers the physical delivery of energy trading contracts. It has an equal and offsetting claim to and from its respective participants on opposite sides of the physically-settled contract, each of which is reflected as a delivery contract receivable with an offsetting delivery contract payable. See Note 14 to our consolidated financial statements included in this Annual Report for additional information on our clearing houses and the margin deposits, guaranty funds, invested deposits, delivery contracts payable and unsettled variation margin.We also have unrecognized tax benefits, or UTBs. As of December 31, 2022, our cumulative UTBs were $247 million, and accrued interest and penalties related to UTBs were $61 million. We are under examination by various tax authorities. We are unable to make a reasonable estimate of the periods of cash settlement because it is not possible to reasonably predict the amount of tax, interest and penalties, if any, that might be assessed by a tax authority or the timing of an assessment or payment. It is also not possible to reasonably predict whether or not the applicable statutes of limitations might expire without us being examined by any particular tax authority. See Note 13 to our consolidated financial statements for additional information on our UTBs. As of December 31, 2022, we, through NYSE, have net obligations of $102 million related to our pension and other benefit programs. The date of payment under these net obligations cannot be determined. See Note 17 to our consolidated financial statements for additional information on our pension and other benefit programs. In addition, the future funding of the implementation and operation of the CAT is ultimately expected to be provided by both the SROs and broker-dealers. To date, however, funding has been provided solely by the SROs, and future funding is expected to be repaid if industry member fees are approved by the SEC and subsequently collected by industry members.New and Recently Adopted Accounting Pronouncements Refer to Note 2 to our consolidated financial statements included in this Annual Report for information on the new and recently adopted accounting pronouncements that are applicable to us.Critical Accounting Policies We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact of, and any associated risks related to, these policies on our business operations is discussed throughout “- Management’s Discussion and Analysis of Financial Condition and Results of Operations.” For a detailed discussion on the application of these and other accounting policies, see Note 2 to our consolidated financial statements included in this Annual Report. Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of financial statements in conformity with these accounting principles requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, and the disclosure of contingent assets and liabilities, at the date of our financial statements and the reported amounts of revenues and expenses during the reporting period. 75We base our estimates and judgments on our historical experience and other factors that we believe to be reasonable under the circumstances when we make these estimates and judgments and re-evaluate them on a periodic basis. Based on these factors, we make estimates and judgments about, among other things, the carrying values of assets and liabilities that are not readily apparent from market prices or other independent sources and about the recognition and characterization of our revenues and expenses. The values and results based on these estimates and judgments could differ significantly under different assumptions or conditions and could change materially in the future. We believe that the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements and could materially increase or decrease our reported results, assets and liabilities. Goodwill and Other Identifiable Intangible Assets Assets acquired and liabilities assumed in connection with our acquisitions are recorded at their estimated fair values. Goodwill represents the excess of the purchase price of an acquired company over the fair value of its identifiable net assets, including identified intangible assets. We recognize specifically identifiable intangibles, such as customer relationships, trademarks, technology, trading products, data, exchange registrations, backlog, trade names and licenses when a specific right or contract is acquired. Our determination of the fair value of the intangible assets and whether or not these assets may be impaired following their acquisition requires us to apply significant judgments and make significant estimates and assumptions regarding future cash flows. If we change our strategy or if market conditions shift, our judgments and estimates may change, which may result in adjustments to recorded asset balances. Intangible assets with finite useful lives are amortized over their estimated useful lives whereas goodwill and intangible assets with indefinite useful lives are not. In performing the allocation of the acquisitions' purchase price to assets and liabilities, we consider, among other factors, the intended use of the acquired assets, analysis of past financial performance and estimates of future performance of the acquired business. At the acquisition date, a preliminary allocation of the purchase price is recorded based upon a preliminary valuation performed with the assistance of a third-party valuation specialist. We continue to review and assess our estimates, assumptions and valuation methodologies during the measurement period provided by GAAP, which ends as soon as we receive the information about facts and circumstances that existed as of the acquisition date or we learn that more information is not obtainable, which usually does not exceed one year from the date of acquisition. Accordingly, these estimates and assumptions are subject to change, which could have a material impact on our consolidated financial statements. Estimation uncertainty may exist due to the sensitivity of the respective fair value to underlying assumptions about the future performance of an acquired business in our discounted cash flow models. Significant assumptions typically include revenue growth rates and expense synergies that form the basis of the forecasted results and the discount rate.Our goodwill and other indefinite-lived intangible assets are evaluated for impairment annually in our fiscal fourth quarter or more frequently if conditions exist that indicate that the value may be impaired. We test our goodwill for impairment at the reporting unit level, and we have identified four reporting units. Our reporting units identified for our goodwill testing are the NYSE, Other Exchanges, Fixed Income and Data Services, and Mortgage Technology reporting units. These impairment evaluations are performed by comparing the carrying value of the goodwill or other indefinite-lived intangibles to its estimated fair value. In accordance with ASU 2017-04, Simplifying the Test for Goodwill Impairment, or ASU-2017, for both goodwill and indefinite-lived intangible impairment testing, we have the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit or indefinite-lived intangible asset is less than its carrying amount. If the fair value of the goodwill or indefinite-lived intangible asset is less than its carrying value, an impairment loss is recognized in earnings in an amount equal to the difference. Alternatively, we may choose to bypass the qualitative option and perform quantitative testing to determine if the fair value is less than the carrying value. For our goodwill impairment testing, we have elected to bypass the qualitative assessment and apply the quantitative approach. For our testing of indefinite-lived intangible assets, we apply qualitative and quantitative approaches.Application of the impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. We have historically determined the fair value of our reporting units based on various valuation techniques, including discounted cash flow analysis and a multiple of earnings approach. In assessing whether goodwill and other intangible assets are impaired, we must make estimates and assumptions regarding future cash flows, long-term growth rates of our business, operating margins, discount rates, weighted average cost of capital and other factors to determine the fair value of our assets. These estimates and assumptions require management’s judgment, and changes to these estimates and assumptions, as a result of changing economic and competitive conditions, could materially affect the 76determination of fair value and/or impairment. We did not record any impairments in 2022, 2021 or 2020 as a result of our goodwill or indefinite-lived impairment testing.We are also required to evaluate other finite-lived intangible assets for impairment by first determining whether events or changes in circumstances indicate that the carrying value of these assets to be held and used may not be recoverable. If impairment indicators are present, then an estimate of undiscounted future cash flows produced by these long-lived assets is compared to the carrying value of those assets to determine if the asset is recoverable. If an asset is not recoverable, the loss is measured as the difference between fair value and carrying value of the impaired asset. Fair value of these assets is based on various valuation techniques, including discounted cash flow analysis, which are assessed and conducted in accordance with our internal impairment analysis policies.Income Taxes We are subject to income taxes in the U.S., U.K. and other foreign jurisdictions where we operate. The determination of our provision for income taxes and related accruals, deferred tax assets and liabilities requires the use of significant judgment, estimates, and the interpretation and application of complex tax laws. We recognize a current tax liability or tax asset for the estimated taxes payable or refundable on tax returns for the current year. We recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of our assets and liabilities. We establish valuation allowances if we believe that it is more likely than not that some or all of our deferred tax assets will not be realized. Deferred tax assets and liabilities are measured using current enacted tax rates in effect for the years in which those temporary differences and carryforwards are expected to reverse.The Financial Accounting Standards Board, or FASB, Staff has provided additional guidance to address the accounting for the effects of the provisions related to the taxation of Global Intangible Low-Taxed Income noting that companies should make an accounting policy election to recognize deferred taxes for temporary basis differences expected to reverse in future years or to include the tax expense in the year it is incurred. We have made a policy election to recognize such taxes as current period expenses when incurred.We do not recognize a tax benefit unless we conclude that it is more likely than not that the benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, we recognize a tax benefit measured at the largest amount of the tax benefit that, in our judgment, is greater than 50 percent likely to be realized. We recognize accrued interest and penalties related to uncertain income tax positions as income tax expense in the consolidated statements of income.We operate within multiple domestic and foreign taxing jurisdictions and are subject to audit in these jurisdictions by domestic and foreign tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions taken and the allocation of income among various tax jurisdictions. We record accruals for the estimated outcomes of these audits, and the accruals may change in the future due to new developments in each matter. At any point in time, many tax years are subject to or in the process of being audited by various taxing authorities. To the extent our estimates of settlements change or the final tax outcome of these matters is different from the amounts recorded, such differences will impact the income tax provision in the period in which such determinations are made. Our income tax expense includes changes in our estimated liability for exposures associated with our various tax filing positions. Determining the income tax expense for these potential assessments requires management to make assumptions that are subject to factors such as proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations, and resolution of tax audits. We believe the judgments and estimates discussed above are reasonable. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material. ITEM 7 (A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a result of our operating and financing activities, we are exposed to market risks such as interest rate risk, foreign currency exchange rate risk and credit risk. We have implemented policies and procedures designed to measure, manage, monitor and report risk exposures, which are regularly reviewed by the appropriate management and supervisory bodies. 77Interest Rate Risk We have exposure to market risk for changes in interest rates relating to our cash and cash equivalents, short-term and long-term restricted cash and cash equivalents, short-term and long-term investments and indebtedness. As of December 31, 2022 and 2021, our cash and cash equivalents and short-term and long-term restricted cash and cash equivalents were $8.4 billion and $2.0 billion, respectively, of which $346 million and $276 million, respectively, were denominated in pounds sterling, euros or Canadian dollars, and the remaining amounts are denominated in U.S. dollars. We do not use our investment portfolio for trading or other speculative purposes. A hypothetical 50% decrease in short-term interest rates would decrease our annual pre-tax earnings by $21 million as of December 31, 2022, assuming no change in the amount or composition of our cash and cash equivalents and short-term and long-term restricted cash and cash equivalents. As of December 31, 2022, we had $18.1 billion in outstanding debt, consisting of $18.1 billion related to our senior notes and $4 million under lines of credit at our India subsidiaries. See Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations – Debt," and Note 10 to our consolidated financial statements included in this Annual Report. The interest rates on our Commercial Paper Program are currently evaluated based upon current maturities and market conditions. As of December 31, 2022, we did not have any notes outstanding under our Commercial Paper Program. The weighted average interest rate on our Commercial Paper Program was 0.33% as of December 31, 2021. The effective interest rate of commercial paper issuances will continue to fluctuate based on the movement in short-term interest rates along with shifts in supply and demand within the commercial paper market.Foreign Currency Exchange Rate Risk As an international business, we are subject to foreign currency exchange rate risk. We may experience gains or losses from foreign currency transactions in the future given that a significant part of our assets and liabilities are recorded in pounds sterling, Canadian dollars or euros, and a significant portion of our revenues and expenses are recorded in pounds sterling or euros. Certain assets, liabilities, revenues and expenses of foreign subsidiaries are denominated in the local functional currency of such subsidiaries. Our exposure to foreign denominated earnings in 2022 and 2021 is presented by primary foreign currency in the following table (dollars in millions, except exchange rates): Year Ended December 31, 2022Year Ended December 31, 2021 Pound Sterling EuroPound Sterling EuroAverage exchange rate to the U.S. dollar in the current year$1.2376 $1.0540 $1.3762 $1.1835 Average exchange rate to the U.S. dollar in the prior year$1.3762 $1.1835 $1.2832 $1.1412 Average exchange rate increase/(decrease)(10)%(11)%7 %4 %Foreign denominated percentage of: Revenues, less transaction-based expenses7 %6 %7 %6 %Operating expenses7 %2 %8 %2 %Operating income7 %11 %6 %11 %Impact of the currency fluctuations (1) on: Revenues, less transaction-based expenses$(59)$(56)$31 $13 Operating expenses$(30)$(8)$19 $3 Operating income$(29) $(48)$12 $10 (1) Represents the impact of currency fluctuation for the year compared to the same period in the prior year.We have a significant part of our assets, liabilities, revenues and expenses recorded in pounds sterling or euros. In both 2022 and 2021, 13% of our consolidated revenues, less transaction-based expenses, were denominated in pounds sterling or euros, and in 2022 and 2021, 9% and 10%, respectively, of our consolidated operating expenses were denominated in pounds sterling or euros. As the pound sterling or euro exchange rate changes, the U.S. equivalent of revenues and expenses denominated in foreign currencies changes accordingly.Foreign currency transaction risk related to the settlement of foreign currency denominated assets, liabilities and payables occurs through our operations, which are received in or paid in pounds sterling, Canadian dollars, or euros, due to the increase or decrease in the foreign currency exchange rates between periods. We incurred foreign currency transaction losses of $9 million and $13 million in 2022 and 2021, respectively, inclusive of the impact of foreign currency hedging transactions. The foreign currency transaction losses were primarily attributable to the fluctuations of the pound sterling 78and euro relative to the U.S. dollar. A 10% adverse change in the underlying foreign currency exchange rates as of December 31, 2022, assuming no change in the composition of the foreign currency denominated assets, liabilities and payables and assuming no hedging activity, would result in a foreign currency loss of $14 million.We entered into foreign currency hedging transactions during 2022 and 2021 as economic hedges to help mitigate a portion of our foreign exchange risk exposure and may enter into additional hedging transactions in the future to help mitigate our foreign exchange risk exposure. Although we may enter into additional hedging transactions in the future, these hedging arrangements may not be effective, particularly in the event of imprecise forecasts of the levels of our non-U.S. denominated assets and liabilities. We have foreign currency translation risk equal to our net investment in our foreign subsidiaries. The financial statements of these subsidiaries are translated into U.S. dollars using a current rate of exchange, with gains or losses included in the cumulative translation adjustment account, a component of equity. Our exposure to the net investment in foreign currencies is presented by primary foreign currencies in the table below (in millions): As of December 31, 2022 Position in pounds sterlingPosition in Canadian dollarsPosition in eurosAssets£720 $4,298 €171 of which goodwill represents561 394 92 Liabilities101 3,852 52 Net currency position£619 $446 €119 Net currency position, in $USD$748 $329 $127 Negative impact on consolidated equity of a 10% decrease in foreign currency exchange rates$75 $33 $13 Foreign currency translation adjustments are included as a component of accumulated other comprehensive income/(loss) within our balance sheet. See the table below for the portion of equity attributable to foreign currency translation adjustments as well as the activity by year included within our statement of other comprehensive income. The impact of the foreign currency exchange rate differences in the table below were primarily driven by fluctuations of the pound sterling as compared to the U.S. dollar which were 1.2093, 1.3524 and 1.3665 as of December 31, 2022, 2021, and 2020, respectively.Changes in Accumulated Other Comprehensive Income/ (Loss) from Foreign Currency Translation Adjustments (in millions)Balance, as of January 1, 2020$(177)Net current period other comprehensive income/(loss)43 Balance, as of December 31, 2020(134)Net current period other comprehensive income/(loss)(16)Balance, as of December 31, 2021(150)Net current period other comprehensive income/(loss)(128)Balance, as of December 31, 2022$(278) The future impact on our business relating to the U.K. leaving the EU and the corresponding regulatory changes are uncertain at this time, including future impacts on currency exchange rates.Credit Risk We are exposed to credit risk in our operations in the event of a counterparty default. We limit our exposure to credit risk by rigorously selecting the counterparties with which we make our investments, monitoring them on an ongoing basis and executing agreements to protect our interests. Clearing House Cash Deposit RisksThe ICE Clearing Houses hold material amounts of clearing member margin deposits which are held or invested primarily to provide security of capital while minimizing credit, market and liquidity risks. Refer to Note 14 to our consolidated financial statements for more information on the ICE Clearing Houses' cash and cash equivalent margin deposits and 79guaranty funds, invested deposits, delivery contracts receivable and unsettled variation margin which were $147.4 billion as of December 31, 2022. While we seek to achieve a reasonable rate of return which may generate interest income for our clearing members, we are primarily concerned with preservation of capital and managing the risks associated with these deposits. As the ICE Clearing Houses may pass on interest revenues (minus costs) to the clearing members, this could include negative or reduced yield due to market conditions. The following is a summary of the risks associated with these deposits and how these risks are mitigated:•Credit Risk: When a clearing house has the ability to hold cash collateral at a central bank, the clearing house utilizes its access to the central bank system to minimize credit risk exposures. Credit risk is managed by using exposure limits depending on the credit profile of the counterparty as well as the nature and maturity of transactions. Our investment objective is to invest in securities that preserve principal while maximizing yields, without significantly increasing risk. We seek to substantially mitigate the credit risk associated with investments by placing them with governments, well-capitalized financial institutions and other creditworthy counterparties.An ongoing review is performed to evaluate changes in the financial status of counterparties. In addition to the intrinsic creditworthiness of counterparties, our policies require diversification of counterparties (banks, financial institutions, bond issuers and funds) so as to avoid a concentration of risk.•Liquidity Risk: Liquidity risk is the risk a clearing house may not be able to meet its payment obligations in the right currency, in the right place and at the right time. To mitigate this risk, the clearing houses monitor liquidity requirements closely and maintain funds and assets in a manner which minimizes the risk of loss or delay in the access by the clearing house to such funds and assets. For example, holding funds with a central bank where possible or making only short term investments such as overnight reverse repurchase agreements serves to reduce liquidity risks.•Interest Rate Risk: Interest rate risk is the risk that interest rates rise and cause the value of securities we hold or invest in to decline. If we were required to sell securities prior to maturity, and interest rates had risen, the sale might be made at a loss relative to the carrying value. Our clearing houses seek to manage this risk by making short term investments. For example, where possible and in accordance with regulatory requirements, the clearing houses invest cash pursuant to overnight reverse repurchase agreements or term reverse repurchase agreements with short dated maturities. In addition, the clearing house investment guidelines allow for direct purchases of high quality sovereign debt (for example, U.S. Treasury securities) and supranational debt instruments (Euro cash deposits only) with short dated maturities. •Security Issuer Risk: Security issuer risk is the risk that an issuer of a security defaults on the payment when the security matures or debt is serviced. This risk is mitigated by limiting allowable investments under the reverse repurchase agreements to high quality sovereign or government agency debt and limiting any direct investments to high quality sovereign debt instruments. •Investment Counterparty Risk: Investment counterparty risk is the risk that a reverse repurchase agreement counterparty might become insolvent and, thus, fail to meet its obligations to our clearing houses. We mitigate this risk by only engaging in transactions with high credit quality counterparties and by limiting the acceptable collateral to securities of high quality issuers. When engaging in reverse repurchase agreements, our clearing houses take delivery of the securities underlying the reverse repurchase arrangement in custody accounts under clearing house control. Additionally, the securities purchased subject to reverse repurchase have a market value greater than the reverse repurchase amount. Thus, in the event that a reverse repurchase counterparty defaults on its obligation to repurchase the underlying reverse repurchase securities, our clearing house will have possession of a security with a value potentially greater than the counterparty’s obligation.The ICE Clearing Houses may use third-party investment advisors who make investments subject to the guidelines provided by each clearing house. Clearing house property is held in custody accounts under clearing house control with credit worthy custodians. The ICE Clearing Houses employ (or may employ) multiple investment advisors and custodians to ensure that in the event a single advisor or custodian is unable to fulfill its role, additional advisors or custodians are available as alternatives.•Cross-Currency Margin Deposit Risk: Each of the ICE Clearing Houses may permit posting of cross-currency collateral to satisfy margin requirements (for example, accepting margin deposits denominated in U.S. dollars to secure a Euro margin obligation). The ICE Clearing Houses mitigate the risk of a currency value exposure by applying a “haircut” to the currency posted as margin at a level viewed as sufficient to provide financial protection during periods of currency volatility. Cross-currency balances are marked-to-market on a daily basis. Should the currency posted to satisfy margin requirements decline in value, the clearing member is required to increase its margin deposit on a same-day basis.80Impact of InflationWe have not been materially adversely affected by inflation as technological advances and competition have generally caused prices for the hardware and software that we use for our electronic platforms to remain constant. In the event of continued inflation, we believe that we will be able to pass on any price increases to our participants, as the prices that we charge are not governed by long-term contracts.81
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The discussion and analysis disclosed herein apply to material changes in the Consolidated Financial Statements for 2022 and 2021. For the comparison of 2021 and 2020, see the Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of the company’s 2021 Annual Report on Form 10-K, filed with the SEC on February 18, 2022. The following discussion and analysis of the results of operations and financial condition of Invesco should be read in conjunction with the “Forward-looking Statements” disclosure set forth in Part I and the “Risk Factors” set forth in Item 1A of Part I of this Annual Report on Form 10‑K, each of which describe our risks, uncertainties and other important factors in more detail.Executive OverviewThe following executive overview summarizes the significant trends affecting our results of operations and financial condition for the periods presented. This overview and the remainder of this management's discussion and analysis supplements and should be read in conjunction with the Consolidated Financial Statements of Invesco and the notes thereto contained elsewhere in this Annual Report on Form 10-K.Global capital markets in 2022 were challenging for the asset management industry and for Invesco, as investors reacted to uncertainty associated with rising interest rates and high inflation in most major economies as well as geopolitical tensions. The table below summarizes the year ended December 31 returns based on price appreciation/(depreciation) of several major market indices for 2022 and 2021:Year ended December 31,Equity IndexIndex expressed in currency20222021S&P 500U.S. Dollar(19.4)%26.9%FTSE 100British Pound0.9%14.3%FTSE 100U.S. Dollar(9.8)%13.3%S&P/TSX 60 IndexCanadian Dollar(9.2)%24.4%S&P/TSX 60 IndexU.S. Dollar(15.1)%25.5%MSCI Emerging MarketsU.S. Dollar(22.4)%(4.6)%Bond IndexBarclays U.S. Aggregate BondU.S. Dollar(13.0)%(1.5)%The company’s financial results are impacted by the fluctuations in exchange rates against the U.S. Dollar, as discussed in the “Results of Operations” section below.Invesco benefits from our long-term efforts to ensure a diversified base of AUM. One of Invesco's core strengths, and a key differentiator for the company within the industry, is our broad diversification across client domiciles, asset classes and distribution channels. Our geographic diversification recognizes growth opportunities in different parts of the world. This broad diversification mitigates the impact on Invesco of different market cycles and enables the company to take advantage of growth opportunities in various markets and channels.Despite the volatile markets, our diversified product lineup maintained net long-term inflows in certain key capabilities, notably ETFs, Fixed Income, Greater China, and the Institutional Channel. We remain highly focused on our capital priorities, investing in our key capabilities, and efficiently allocating our resources. Consistent with our commitment to improve our leverage profile, we continue to manage our debt to lower levels. We redeemed $600 million of senior notes in May 2022, ended the year with no balance on our credit facility and our cash and cash equivalents balance increased to over $1.2 billion. Our debt of $1.5 billion is the lowest level in ten years. The progress we have made in our efforts to build financial flexibility has Invesco well-positioned to navigate volatile market conditions and deliver long-term growth. We remain committed to returning capital to shareholders longer term through a combination of modestly increasing dividends and share repurchases.We are nearing completion of our strategic evaluation of the business that we began in 2020 and expect to be complete by the end of first quarter of 2023. Our strategic evaluation was primarily focusing on four key areas of our expense base: our organizational model, our real estate footprint, management of third-party spend and technology and operations efficiency. 27Table of Contents Through this evaluation, we invested and will continue to invest in key areas of growth aligned with our strategic plan, including ETFs, Fixed Income, China, Solutions, Alternatives and Global Equities, which has had a positive impact on the company’s results. We achieved $213 million in annualized savings in 2022, surpassing our original goal of $200 million of savings. We remain focused on identifying areas of expense improvement that will deliver positive operating leverage when markets recover and organic growth resumes.On February 8, 2023 we announced that Martin L. Flanagan will retire as President and CEO of the company and as a member of the Board of Directors effective June 30, 2023. Andrew R. Schlossberg will succeed Mr. Flanagan as President and CEO and as a member of the Board of Directors effective June 30, 2023. Mr. Schlossberg is currently Senior Managing Director and Head of Americas and has served in multiple leadership roles across the company’s businesses and locations since joining the company in 2001. Upon his retirement, Mr. Flanagan will serve as Chairman Emeritus for the company and will provide advice, guidance and support to Mr. Schlossberg through December 31, 2024.Presentation of Management's Discussion and Analysis of Financial Condition and Results of Operations - Impact of Consolidated Investment ProductsThe company provides investment management services to, and has transactions with, various retail mutual funds and similar entities, private equity, real estate, fund-of-funds, CLOs and other investment entities sponsored by the company for the investment of client assets in the normal course of business. The company serves as the investment manager, making day-to-day investment decisions concerning the assets of the products. The company is required to consolidate certain of these managed funds from time-to-time, as discussed more fully in Item 8, Financial Statements and Supplementary Data, Note 1, "Accounting Policies -- Basis of Accounting and Consolidation." Investment products that are consolidated are referred to in this Report as CIP. The company's economic risk with respect to each investment in CIP is limited to its equity ownership and any uncollected management and performance fees. The majority of the company's CIP balances are CLO-related. The collateral assets of the CLOs are held solely to satisfy the obligations of the CLOs. The company has no right to the benefits from, nor does it bear the risks associated with, the collateral assets held by the CLOs, beyond the company's direct investments in, and management and performance fees generated from, the CLOs. If the company were to liquidate, the collateral assets would not be available to the general creditors of the company, and as a result, the company does not consider them to be company assets. Likewise, the investors in the CLOs have no recourse to the general credit of the company for the notes issued by the CLOs. The company therefore does not consider this debt to be a company liability.Due to the significant impact that CIP has on the presentation of the company’s Consolidated Financial Statements, the company has elected to deconsolidate these products in its non-GAAP disclosures (among other adjustments). See "Schedule of Non-GAAP Information" for additional information regarding these adjustments. The following discussion therefore combines the results presented under U.S. Generally Accepted Accounting Principles (U.S. GAAP) with the company’s non-GAAP presentation. To assess the impact of CIP on the company's Results of Operations and Balance Sheet Discussion, refer to Part II, Item 8, Financial Statements, Note 19, "Consolidated Investment Products."28Table of Contents Summary Operating InformationWherever a non-GAAP measure is referenced, a disclosure will follow in the narrative or in the note referring the reader to the Schedule of Non-GAAP Information, where additional details regarding the use of the non-GAAP measure by the company are disclosed, along with reconciliations of the most directly comparable U.S. GAAP measures to the non-GAAP measures. To further enhance the readability of the Results of Operations section, separate tables for each of the revenue, expense and other income and expenses (non-operating income/expense) sections of the income statement introduce the narrative that follows, providing a section-by-section review of the company’s income statements for the periods presented. Summary operating information for 2022, 2021 and 2020 is presented in the table below.$ in millions, other than per common share amounts, operating margins and AUMYear ended December 31,U.S. GAAP Financial Measures Summary202220212020Operating revenues6,048.9 6,894.5 6,145.6 Operating income1,317.7 1,788.2 920.4 Operating margin21.8 %25.9 %15.0 %Net income attributable to Invesco Ltd.683.9 1,393.0 524.8 Diluted earnings per share (EPS)1.49 2.99 1.13 Non-GAAP Financial Measures Summary(1)Net revenues 4,645.0 5,261.1 4,501.0 Adjusted operating income 1,614.8 2,182.6 1,664.5 Adjusted operating margin 34.8 %41.5 %37.0 %Adjusted net income attributable to Invesco Ltd.773.2 1,439.6 892.9 Adjusted diluted earnings per share (EPS )1.68 3.09 1.93 Assets Under Management Ending AUM (billions)1,409.2 1,610.9 1,349.9 Average AUM (billions)1,452.5 1,499.9 1,194.9 _________(1)Net revenues, Adjusted Operating Income (and by calculation, adjusted operating margin), and Adjusted Net Income (and by calculation, adjusted diluted EPS) are non-GAAP financial measures, based on methodologies other than U.S. GAAP. See “Schedule of Non-GAAP Information” for a reconciliation of the most directly comparable U.S. GAAP measures to the non-GAAP measures.29Table of Contents Investment Capabilities Performance OverviewInvesco's first strategic objective is to achieve strong investment performance over the long-term for our clients. The table below presents the one-, three-, five-, and ten-year performance of our actively managed investment products measured by the percentage of AUM in the top half of benchmark and in the top half of peer group.(1)Benchmark ComparisonPeer Group Comparison% of AUM In Top Half of Benchmark% of AUM In Top Half of Peer Group1yr3yr5yr10yr1yr3yr5yr10yrEquities (2)U.S. Core (4%)43 %42 %31 %16 %22 %27 %27 %— %U.S. Growth (5%)— %46 %46 %46 %— %30 %31 %31 %U.S. Value (7%)91 %91 %91 %87 %86 %60 %47 %42 %Sector (1%)— %10 %1 %52 %10 %34 %25 %53 %UK (1%)56 %38 %45 %44 %93 %30 %43 %38 %Canadian (<1%)100 %100 %66 %58 %87 %100 %42 %— %Asian (4%)44 %65 %85 %91 %77 %25 %74 %84 %Continental European (2%)78 %80 %21 %93 %92 %78 %37 %92 %Global (5%)22 %22 %4 %83 %15 %7 %— %22 %Global Ex U.S. and Emerging Markets (8%)16 %32 %95 %99 %14 %12 %14 %11 %Fixed Income (2)Money Market (29%)83 %95 %97 %100 %86 %86 %85 %98 %U.S. Fixed Income (11%)23 %78 %80 %97 %35 %64 %76 %92 %Global Fixed Income (6%)48 %87 %94 %90 %62 %66 %75 %93 %Stable Value (6%)100 %100 %100 %100 %17 %97 %97 %100 %Other (2)Alternatives (6%)24 %39 %31 %33 %45 %45 %41 %41 %Balanced (7%)80 %93 %63 %62 %81 %79 %80 %94 %____________ (1) Excludes passive products, closed-end funds, private equity limited partnerships, non-discretionary funds, UITs, fund of funds with component funds managed by Invesco, stable value building block funds and CDOs. Certain funds and products were excluded from the analysis because of limited benchmark or peer group data. Had these been available, results may have been different. These results are preliminary and subject to revision.AUM measured in the one, three, five and ten year quartile rankings represents 47%, 47%, 46% and 42% of total Invesco AUM, respectively, and AUM measured versus benchmark on a one, three, five and ten year basis represents 61%, 58%, 57% and 51% of total Invesco AUM as of December 31, 2022. Peer group rankings are sourced from a widely-used third-party ranking agency in each fund’s market (e.g., Morningstar, IA, Lipper, eVestment, Mercer, Galaxy, SITCA, Value Research) and asset-weighted in USD. Rankings are as of prior quarter-end for most institutional products and prior month-end for Australian retail funds due to their late release by third parties. Rankings are calculated against all funds in each peer group. Rankings for the primary share class of the most representative fund in each composite are applied to all products within each composite. Performance assumes the reinvestment of dividends. Past performance is not indicative of future results and may not reflect an investor’s experience.(2) Numbers in parenthesis reflect AUM for each investment product (see Note 1 above for exclusions) as a percentage of the total AUM for the 5 year peer group ($651.3 billion). Assets Under ManagementThe following presentation and discussion of AUM includes Passive and Active AUM. Passive AUM include index-based ETFs, UITs, non-management fee earning AUM and other passive mandates. Active AUM are Total AUM less Passive AUM.Non-management fee earning AUM includes non-management fee earning ETFs, UITs and product leverage. The net flows in non-management fee earning AUM can be relatively short-term in nature and, due to the relatively low revenue yield, these can have a significant impact on overall net revenue yield.30Table of Contents The AUM tables and the discussion below refer to certain AUM as long-term. Long-term inflows and the underlying reasons for the movements in this line item include investments from new clients, existing clients adding new accounts/funds or contributions/subscriptions into existing accounts/funds. Long-term outflows reflect client redemptions from accounts/funds and include the return of invested capital on the maturity. We present net flows into money market funds separately because shareholders of those funds typically use them as short-term funding vehicles and because their flows are particularly sensitive to short-term interest rate movements.Changes in AUM were as follows:202220212020$ in billionsTotal AUMActivePassiveTotal AUMActivePassiveTotal AUMActivePassiveJanuary 11,610.9 1,082.5 528.4 1,349.9 979.3 370.6 1,226.2 929.2 297.0 Long-term inflows330.3 197.9 132.4 426.8 260.2 166.6 310.9 204.3 106.6 Long-term outflows(330.8)(226.2)(104.6)(345.4)(242.0)(103.4)(326.6)(236.1)(90.5)Net long-term flows(0.5)(28.3)27.8 81.4 18.2 63.2 (15.7)(31.8)16.1 Net flows in non-management fee earning AUM(3.2)— (3.2)20.6 (0.1)20.7 (5.1)— (5.1)Net flows in money market funds56.4 56.4 — 39.7 39.7 — 14.3 14.3 — Total net flows52.7 28.1 24.6 141.7 57.8 83.9 (6.5)(17.5)11.0 Reinvested distributions15.2 15.2 — 31.6 31.6— 16.9 16.9 — Market gains and losses(243.5)(125.6)(117.9)94.0 18.375.7 103.0 40.8 62.2 Foreign currency translation(26.1)(24.0)(2.1)(6.3)(4.5)(1.8)10.3 9.9 0.4 December 311,409.2 976.2 433.0 1,610.9 1,082.5 528.4 1,349.9 979.3 370.6 Average AUMAverage long-term AUM1,104.8 820.8 284.0 1,177.1 919.1 258.0 952.0 784.6 167.4 Average AUM1,452.5 988.2 464.3 1,499.9 1,050.2 449.7 1,194.9 893.0 301.9 Average QQQ AUM169.1 — 169.1 176.0 — 176.0 115.2 — 115.2 202220212020Revenue yield (bps) (1)U.S. GAAP gross revenue yield44.548.753.7Net revenue yield ex performance fees ex QQQ (2)35.5 39.1 40.7 Active net revenue yield ex performance fees40.744.045.2Passive net revenue yield ex QQQ (2)18.1 20.1 19.2 ____________(1) U.S. GAAP gross revenue yield is not considered a meaningful effective fee rate measure. Gross revenue yield on AUM is equal to U.S. GAAP annualized total operating revenues divided by average AUM, excluding IGW AUM. It is appropriate to exclude the average AUM of IGW as the revenues resulting from these AUM are not presented in U.S. GAAP operating revenues. The average AUM for Invesco Great Wall was $93.5 billion in 2022 (2021: $84.0 billion, 2020: $50.0 billion). Additionally, the U.S. GAAP gross revenue yield is not a good measure because the numerator of the U.S. GAAP gross revenue yield excludes the management fees earned from CIP; however, the denominator of the measure includes the AUM of these investment products. Net revenue yield metrics include the net revenues and average AUM of IGW and CIP. See “Schedule of Non-GAAP Information” for a reconciliation of operating revenues to net revenues.(2) Performance fees are earned when certain performance metrics are achieved and QQQ ETFs do not earn net revenues. Therefore, net revenue yield is calculated excluding performance fees and QQQ AUM. Passive net revenue yield is calculated excluding QQQ AUM.FlowsThere are numerous drivers of AUM inflows and outflows, including individual investor decisions to change investment preferences, fiduciaries and other gatekeepers making broad asset allocation decisions on behalf of their clients and reallocation of investments within portfolios. We are not a party to these asset allocation decisions, as the company does not generally have access to the underlying investor's decision-making process, including their risk appetite or liquidity needs. 31Table of Contents Average AUM during the year ended December 31, 2022 were $1,452.5 billion, as compared to $1,499.9 billion for the year ended December 31, 2021.Market ReturnsMarket gains and losses include the net change in AUM resulting from changes in market values of the underlying securities from period to period. The table in the “Executive Overview” section of this Management's Discussion and Analysis of Financial Condition and Results of Operations summarizes returns based on price appreciation/(depreciation) of several major market indices for the years ended December 31, 2022 and December 31, 2021.Foreign Exchange RatesDuring the year ended December 31, 2022, we experienced a decrease in AUM of $26.1 billion due to changes in foreign exchange rates (December 31, 2021: AUM decreased by $6.3 billion).32Table of Contents Changes in our AUM by channel, asset class, and client domicile, and average AUM by asset class, are presented below:Total AUM by Channel (1)$ in billionsTotalRetailInstitutionalDecember 31, 20211,610.9 1,106.5 504.4 Long-term inflows330.3 243.9 86.4 Long-term outflows(330.8)(257.5)(73.3)Net long-term flows(0.5)(13.6)13.1 Net flows in non-management fee earning AUM(3.2)0.9 (4.1)Net flows in money market funds56.4 1.8 54.6 Total net flows52.7 (10.9)63.6 Reinvested distributions15.2 14.8 0.4 Market gains and losses(243.5)(227.3)(16.2)Foreign currency translation(26.1)(10.8)(15.3)December 31, 20221,409.2 872.3 536.9 December 31, 20201,349.9 947.1 402.8 Long-term inflows426.8 301.2 125.6 Long-term outflows(345.4)(265.7)(79.7)Net long-term flows81.4 35.5 45.9 Net flows in non-management fee earning AUM 20.6 20.2 0.4 Net flows in money market funds39.7 3.3 36.4 Total net flows141.7 59.0 82.7 Reinvested distributions31.6 31.1 0.5 Market gains and losses94.0 69.0 25.0 Foreign currency translation(6.3)0.3 (6.6)December 31, 20211,610.9 1,106.5 504.4 December 31, 20191,226.2 878.2 348.0 Long-term inflows310.9 221.6 89.3 Long-term outflows(326.6)(267.6)(59.0)Net long-term flows(15.7)(46.0)30.3 Net flows in non-management fee earning AUM (5.1)7.2 (12.3)Net flows in money market funds14.3 2.0 12.3 Total net flows(6.5)(36.8)30.3 Reinvested distributions16.9 16.3 0.6 Market gains and losses103.0 85.4 17.6 Foreign currency translation10.3 4.0 6.3 December 31, 20201,349.9 947.1 402.8 ____________See accompanying notes immediately following these AUM tables.33Table of Contents Active AUM by Channel (1)$ in billionsTotalRetailInstitutionalDecember 31, 20211,082.5 631.7 450.8 Long-term inflows197.9 117.0 80.9 Long-term outflows(226.2)(157.5)(68.7)Net long-term flows(28.3)(40.5)12.2 Net flows in money market funds56.4 1.8 54.6 Total net flows28.1 (38.7)66.8 Reinvested distributions15.2 14.8 0.4 Market gains and losses(125.6)(115.6)(10.0)Foreign currency translation(24.0)(10.1)(13.9)December 31, 2022976.2 482.1 494.1 December 31, 2020979.3 601.1 378.2 Long-term inflows260.2 163.5 96.7 Long-term outflows(242.0)(167.9)(74.1)Net long-term flows18.2 (4.4)22.6 Net flows in non-management fee earning AUM (0.1)(0.1)— Net flows in money market funds39.7 3.3 36.4 Total net flows57.8 (1.2)59.0 Reinvested distributions31.6 31.1 0.5 Market gains and losses18.3 (0.1)18.4 Foreign currency translation(4.5)0.8 (5.3)December 31, 20211,082.5 631.7 450.8 December 31, 2019929.2 602.4 326.8 Long-term inflows204.3 128.0 76.3 Long-term outflows(236.1)(178.6)(57.5)Net long-term flows(31.8)(50.6)18.8 Net flows in non-management fee earning AUM — (0.1)0.1 Net flows in money market funds14.3 2.0 12.3 Total net flows(17.5)(48.7)31.2 Reinvested distributions16.9 16.3 0.6 Market gains and losses40.8 27.5 13.3 Foreign currency translation9.9 3.6 6.3 December 31, 2020979.3 601.1 378.2 ____________See accompanying notes immediately following these AUM tables.34Table of Contents Passive AUM by Channel (1)$ in billionsTotalRetailInstitutionalDecember 31, 2021528.4 474.8 53.6 Long-term inflows132.4 126.9 5.5 Long-term outflows(104.6)(100.0)(4.6)Net long-term flows27.8 26.9 0.9 Net flows in non-management fee earning AUM (3.2)0.9 (4.1)Total net flows24.6 27.8 (3.2)Market gains and losses(117.9)(111.7)(6.2)Foreign currency translation(2.1)(0.7)(1.4)December 31, 2022433.0 390.2 42.8 December 31, 2020370.6 346.0 24.6 Long-term inflows166.6 137.7 28.9 Long-term outflows(103.4)(97.8)(5.6)Net long-term flows63.2 39.9 23.3 Net flows in non-management fee earning AUM 20.7 20.3 0.4 Total net flows83.9 60.2 23.7 Market gains and losses75.7 69.1 6.6 Foreign currency translation(1.8)(0.5)(1.3)December 31, 2021528.4 474.8 53.6 December 31, 2019297.0 275.8 21.2 Long-term inflows106.6 93.6 13.0 Long-term outflows(90.5)(89.0)(1.5)Net long-term flows16.1 4.6 11.5 Net flows in non-management fee earning AUM (5.1)7.3 (12.4)Total net flows11.0 11.9 (0.9)Market gains and losses62.2 57.9 4.3 Foreign currency translation0.4 0.4 — December 31, 2020370.6 346.0 24.6 ____________See accompanying notes immediately following these AUM tables.35Table of Contents Total AUM by Asset Class (2)$ in billionsTotalEquityFixed Income BalancedMoney MarketAlternativesDecember 31, 20211,610.9 841.6 334.8 88.6 148.8 197.1 Long-term inflows330.3 143.7 119.3 15.2 — 52.1 Long-term outflows(330.8)(152.5)(102.4)(20.9)— (55.0)Net long-term flows(0.5)(8.8)16.9 (5.7)— (2.9)Net flows in non-management fee earning AUM(3.2)1.0 (4.2)— — — Net flows in money market funds56.4 — — — 56.4 — Total net flows52.7 (7.8)12.7 (5.7)56.4 (2.9)Reinvested distributions15.2 11.1 1.6 1.2 — 1.3 Market gains and losses(243.5)(198.8)(27.3)(13.2)1.1 (5.3)Foreign currency translation(26.1)(9.1)(8.1)(3.8)(2.8)(2.3)December 31, 20221,409.2 637.0 313.7 67.1 203.5 187.9 Average AUM1,452.5 697.1 315.1 73.3 167.6 199.4 % of total average AUM100.0 %48.0 %21.7 %5.1 %11.5 %13.7 %December 31, 20201,349.9 689.6 296.4 78.9 108.5 176.5 Long-term inflows426.8 205.0 118.1 48.5 — 55.2 Long-term outflows(345.4)(182.1)(76.8)(40.8)— (45.7)Net long-term flows81.4 22.9 41.3 7.7 — 9.5 Net flows in non-management fee earning AUM20.6 20.6 — — — — Net flows in money market funds39.7 — — — 39.7 — Total net flows141.7 43.5 41.3 7.7 39.7 9.5 Reinvested distributions31.6 25.4 1.9 2.7 — 1.6 Market gains and losses94.0 85.9 (2.0)(1.1)— 11.2 Foreign currency translation(6.3)(2.8)(2.8)0.4 0.6 (1.7)December 31, 20211,610.9 841.6 334.8 88.6 148.8 197.1 Average AUM1,499.9 778.3 316.1 86.5 131.1 187.9 % of total average AUM100.0 %51.9 %21.1 %5.8 %8.7 %12.5 %December 31, 20191,226.2 598.8 283.5 67.3 91.4 185.2 Long-term inflows310.9 134.6 102.9 30.5 — 42.9 Long-term outflows(326.6)(167.4)(76.8)(29.7)— (52.7)Net long-term flows(15.7)(32.8)26.1 0.8 — (9.8)Net flows in non-management fee earning AUM(5.1)17.2 (22.3)— — — Net flows in money market funds14.3 — — — 14.3 — Total net flows(6.5)(15.6)3.8 0.8 14.3 (9.8)Reinvested distributions16.9 11.5 2.3 1.8 — 1.3 Market gains and losses103.0 92.2 4.7 7.1 1.2 (2.2)Foreign currency translation10.3 2.7 2.1 1.9 1.6 2.0 December 31, 20201,349.9 689.6 296.4 78.9 108.5 176.5 Average AUM1,194.9 573.1 275.3 65.1 108.4 173.0 % of total average AUM100.0 %48.0 %23.0 %5.4 %9.1 %14.5 %____________See accompanying notes immediately following these AUM tables.36Table of Contents Active AUM by Asset Class (2)$ in billionsTotalEquityFixed IncomeBalancedMoney MarketAlternativesDecember 31, 20211,082.5 389.6 293.1 87.4 148.8 163.6 Long-term inflows197.9 54.2 98.1 15.2 — 30.4 Long-term outflows(226.2)(83.3)(89.7)(20.8)— (32.4)Net long-term flows(28.3)(29.1)8.4 (5.6)— (2.0)Net flows in money market funds56.4 — — — 56.4 — Total net flows28.1 (29.1)8.4 (5.6)56.4 (2.0)Reinvested distributions15.2 11.1 1.6 1.2 — 1.3 Market gains and losses(125.6)(86.4)(22.4)(12.9)1.1 (5.0)Foreign currency translation(24.0)(7.7)(7.7)(3.8)(2.8)(2.0)December 31, 2022976.2 277.5 273.0 66.3 203.5 155.9 Average AUM988.2 309.6 275.2 72.3 167.5 163.6 % of total average AUM100.0 %31.3 %27.8 %7.3 %17.0 %16.6 %December 31, 2020979.3 383.2 259.4 77.9 108.5 150.3 Long-term inflows260.2 70.9 103.5 48.3 — 37.5 Long-term outflows(242.0)(98.9)(67.9)(40.8)— (34.4)Net long-term flows18.2 (28.0)35.6 7.5 — 3.1 Net flows in non-management fee earning AUM (0.1)(0.1)(0.1)0.1 — — Net flows in money market funds39.7 — — — 39.7 — Total net flows57.8 (28.1)35.5 7.6 39.7 3.1 Reinvested distributions31.6 25.4 1.9 2.7 — 1.6 Market gains and losses18.3 10.8 (1.3)(1.2)— 10.0 Foreign currency translation(4.5)(1.7)(2.4)0.4 0.6 (1.4)December 31, 20211,082.5 389.6 293.1 87.4 148.8 163.6 Average AUM1,050.2 401.5 275.0 85.4 131.1 157.2 % of total average AUM100.0 %38.2 %26.2 %8.1 %12.5 %15.0 %December 31, 2019929.2 381.7 224.6 66.4 91.4 165.1 Long-term inflows204.3 61.2 90.3 30.4 — 22.4 Long-term outflows(236.1)(104.4)(65.3)(29.7)— (36.7)Net long-term flows(31.8)(43.2)25.0 0.7 — (14.3)Net flows in money market funds14.3 — — — 14.3 — Total net flows(17.5)(43.2)25.0 0.7 14.3 (14.3)Reinvested distributions16.9 11.5 2.3 1.8 — 1.3 Market gains and losses40.8 30.8 5.5 7.1 1.2 (3.8)Foreign currency translation9.9 2.4 2.0 1.9 1.6 2.0 December 31, 2020979.3 383.2 259.4 77.9 108.5 150.3 Average AUM892.9 335.7 234.5 64.1 108.4 150.2 % of total average AUM100.0 %37.6 %26.3 %7.2 %12.1 %16.8 %____________See accompanying notes immediately following these AUM tables.37Table of Contents Passive AUM by Asset Class (2)$ in billionsTotalEquityFixed IncomeBalancedMoney MarketAlternativesDecember 31, 2021528.4 452.0 41.7 1.2 — 33.5 Long-term inflows132.4 89.5 21.2 — — 21.7 Long-term outflows(104.6)(69.2)(12.7)(0.1)— (22.6)Net long-term flows27.8 20.3 8.5 (0.1)— (0.9)Net flows in non-management fee earning AUM(3.2)1.0 (4.2)— — — Total net flows24.6 21.3 4.3 (0.1)— (0.9)Market gains and losses(117.9)(112.4)(4.9)(0.3)— (0.3)Foreign currency translation(2.1)(1.4)(0.4)— — (0.3)December 31, 2022433.0 359.5 40.7 0.8 — 32.0 Average AUM464.3 387.6 39.9 0.9 — 35.9 % of total average AUM100.0 %83.5 %8.6 %0.2 %— %7.7 %December 31, 2020370.6 306.4 37.0 1.0 — 26.2 Long-term inflows166.6 134.1 14.6 0.2 — 17.7 Long-term outflows(103.4)(83.2)(8.9)— — (11.3)Net long-term flows63.2 50.9 5.7 0.2 — 6.4 Net flows in non-management fee earning AUM 20.7 20.7 0.1 (0.1)— — Total net flows83.9 71.6 5.8 0.1 — 6.4 Market gains and losses75.7 75.1 (0.7)0.1 — 1.2 Foreign currency translation(1.8)(1.1)(0.4)— — (0.3)December 31, 2021528.4 452.0 41.7 1.2 — 33.5 Average AUM449.7 376.8 41.1 1.1 — 30.7 % of total average AUM100.0 %83.8 %9.2 %0.2 %— %6.8 %December 31, 2019297.0 217.1 58.9 0.9 — 20.1 Long-term inflows106.6 73.4 12.6 0.1 — 20.5 Long-term outflows(90.5)(63.0)(11.5)— — (16.0)Net long-term flows16.1 10.4 1.1 0.1 — 4.5 Net flows in non-management fee earning AUM(5.1)17.2 (22.3)— — — Total net flows11.0 27.6 (21.2)0.1 — 4.5 Market gains and losses62.2 61.4 (0.8)— — 1.6 Foreign currency translation0.4 0.3 0.1 — — — December 31, 2020370.6 306.4 37.0 1.0 — 26.2 Average AUM301.9 237.5 40.8 0.8 — 22.9 % of total average AUM100.0 %78.6 %13.5 %0.3 %— %7.6 %____________See accompanying notes immediately following these AUM tables.38Table of Contents Total AUM by Client Domicile (3)$ in billionsTotalAmericasAPACEMEA(4)December 31, 20211,610.9 1,132.5 247.3 231.1 Long-term inflows330.3 184.0 76.6 69.7 Long-term outflows(330.8)(193.8)(62.5)(74.5)Net long-term flows(0.5)(9.8)14.1 (4.8)Net flows in non-management fee earning AUM (3.2)(3.6)1.1 (0.7)Net flows in money market funds56.4 58.3 (0.3)(1.6)Total net flows52.7 44.9 14.9 (7.1)Reinvested distributions15.2 14.9 — 0.3 Market gains and losses(243.5)(191.3)(22.6)(29.6)Foreign currency translation(26.1)(1.6)(16.1)(8.4)December 31, 20221,409.2 999.4 223.5 186.3 December 31, 20201,349.9 959.9 171.3 218.7 Long-term inflows426.8 213.2 139.0 74.6 Long-term outflows(345.4)(197.7)(71.8)(75.9)Net long-term flows81.4 15.5 67.2 (1.3)Net flows in non-management fee earning AUM 20.6 15.9 2.4 2.3 Net flows in money market funds39.7 35.7 4.1 (0.1)Total net flows141.7 67.1 73.7 0.9 Reinvested distributions31.6 31.2 0.1 0.3 Market gains and losses94.0 74.4 5.9 13.7 Foreign currency translation(6.3)(0.1)(3.7)(2.5)December 31, 20211,610.9 1,132.5 247.3 231.1 December 31, 20191,226.2 879.5 128.6 218.1 Long-term inflows310.9 176.2 64.1 70.6 Long-term outflows(326.6)(206.7)(44.8)(75.1)Net long-term flows(15.7)(30.5)19.3 (4.5)Net flows in non-management fee earning AUM (5.1)3.6 0.7 (9.4)Net flows in money market funds14.3 10.9 3.1 0.3 Total net flows(6.5)(16.0)23.1 (13.6)Reinvested distributions16.9 16.6 0.1 0.2 Market gains and losses103.0 79.3 13.7 10.0 Foreign currency translation10.3 0.5 5.8 4.0 December 31, 20201,349.9 959.9 171.3 218.7 ____________See accompanying notes immediately following these AUM tables.39Table of Contents Active AUM by Client Domicile (3)$ in billionsTotalAmericasAPACEMEA(4)December 31, 20211,082.5 724.5 208.8 149.2 Long-term inflows197.9 104.0 69.3 24.6 Long-term outflows(226.2)(133.4)(56.1)(36.7)Net long-term flows(28.3)(29.4)13.2 (12.1)Net flows in non-management fee earning AUM— — 0.1 (0.1)Net flows in money market funds56.4 58.3 (0.3)(1.6)Total net flows28.1 28.9 13.0 (13.8)Reinvested distributions15.2 14.9 — 0.3 Market gains and losses(125.6)(96.0)(16.3)(13.3)Foreign currency translation(24.0)(1.5)(14.5)(8.0)December 31, 2022976.2 670.8 191.0 114.4 December 31, 2020979.3 656.9 163.4 159.0 Long-term inflows260.2 113.6 110.5 36.1 Long-term outflows(242.0)(125.4)(67.4)(49.2)Net long-term flows18.2 (11.8)43.1 (13.1)Net flows in non-management fee earning AUM (0.1)(0.2)0.1 — Net flows in money market funds39.7 35.7 4.1 (0.1)Total net flows57.8 23.7 47.3 (13.2)Reinvested distributions31.6 31.2 0.1 0.3 Market gains and losses18.3 12.8 0.3 5.2 Foreign currency translation(4.5)(0.1)(2.3)(2.1)December 31, 20211,082.5 724.5 208.8 149.2 December 31, 2019929.2 639.5 123.7 166.0 Long-term inflows204.3 108.6 61.3 34.4 Long-term outflows(236.1)(147.2)(42.6)(46.3)Net long-term flows(31.8)(38.6)18.7 (11.9)Net flows in money market funds14.3 10.9 3.1 0.3 Total net flows(17.5)(27.7)21.8 (11.6)Reinvested distributions16.9 16.6 0.1 0.2 Market gains and losses40.8 27.9 12.0 0.9 Foreign currency translation9.9 0.6 5.8 3.5 December 31, 2020979.3 656.9 163.4 159.0 ____________See accompanying notes immediately following these AUM tables.40Table of Contents Passive AUM by Client Domicile (3)$ in billionsTotalAmericasAPACEMEA(4)December 31, 2021528.4 408.0 38.5 81.9 Long-term inflows132.4 80.0 7.3 45.1 Long-term outflows(104.6)(60.4)(6.4)(37.8)Net long-term flows27.8 19.6 0.9 7.3 Net flows in non-management fee earning AUM(3.2)(3.6)1.0 (0.6)Total net flows24.6 16.0 1.9 6.7 Market gains and losses(117.9)(95.3)(6.3)(16.3)Foreign currency translation(2.1)(0.1)(1.6)(0.4)December 31, 2022433.0 328.6 32.5 71.9 December 31, 2020370.6 303.0 7.9 59.7 Long-term inflows166.6 99.6 28.5 38.5 Long-term outflows(103.4)(72.3)(4.4)(26.7)Net long-term flows63.2 27.3 24.1 11.8 Net flows in non-management fee earning AUM 20.7 16.1 2.3 2.3 Total net flows83.9 43.4 26.4 14.1 Market gains and losses75.7 61.6 5.6 8.5 Foreign currency translation(1.8)— (1.4)(0.4)December 31, 2021528.4 408.0 38.5 81.9 December 31, 2019297.0 240.0 4.9 52.1 Long-term inflows106.6 67.6 2.8 36.2 Long-term outflows(90.5)(59.5)(2.2)(28.8)Net long-term flows16.1 8.1 0.6 7.4 Net flows in non-management fee earning AUM (5.1)3.6 0.7 (9.4)Total net flows11.0 11.7 1.3 (2.0)Market gains and losses62.2 51.4 1.7 9.1 Foreign currency translation0.4 (0.1)— 0.5 December 31, 2020370.6 303.0 7.9 59.7 ____________(1) Channel refers to the internal distribution channel from which the AUM originated. Retail AUM represent AUM distributed by the company's retail sales team. Institutional AUM represent AUM distributed by our institutional sales team. This aggregation is viewed as a proxy for presenting AUM in the retail and institutional markets in which the company operates.(2) Asset classes are descriptive groupings of AUM by common type of underlying investments.(3) Client domicile disclosure groups AUM by the domicile of the underlying clients.(4) EMEA includes U.K. net long-term outflows of $6.1 billion for the year ended December 31, 2022. Ending AUM of U.K. as of December 31, 2022 was $44.4 billion.Results of Operations for the Year Ended December 31, 2022 compared to December 31, 2021The discussion below includes the use of non-GAAP financial measures. See “Schedule of Non-GAAP Information” for additional details and reconciliations of the most directly comparable U.S. GAAP measures to the non-GAAP measures.41Table of Contents Operating Revenues and Net RevenuesThe main categories of revenues, and the dollar and percentage change between the periods, are as follows:VarianceYears ended December 31,2022 vs 20212021 vs 2020$ in millions202220212020$ Change% Change$ Change% ChangeInvestment management fees4,358.4 4,995.9 4,451.0 (637.5)(12.8)%544.9 12.2 %Service and distribution fees1,405.5 1,596.4 1,419.0 (190.9)(12.0)%177.4 12.5 %Performance fees68.2 56.1 65.6 12.1 21.6 %(9.5)(14.5)%Other216.8 246.1 210.0 (29.3)(11.9)%36.1 17.2 %Total operating revenues6,048.9 6,894.5 6,145.6 (845.6)(12.3)%748.9 12.2 %Revenue Adjustments: Investment management fees(764.7)(844.1)(779.8)79.4 (9.4)%(64.3)8.2 % Service and distribution fees(961.1)(1,087.5)(986.1)126.4 (11.6)%(101.4)10.3 % Other(160.4)(217.7)(181.7)57.3 (26.3)%(36.0)19.8 %Total Revenue Adjustments (1)(1,886.2)(2,149.3)(1,947.6)263.1 (12.2)%(201.7)10.4 %Invesco Great Wall432.7 473.5 263.2 (40.8)(8.6)%210.3 79.9 %CIP49.6 42.4 39.8 7.2 17.0 %2.6 6.5 %Net revenues (2)4,645.0 5,261.1 4,501.0 (616.1)(11.7)%760.1 16.9 %_________(1) Total revenue adjustments include pass through investment management, service and distribution, and other revenues and equal the same amount as the third-party distribution, service and advisory expenses.(2) See “Schedule of Non-GAAP Information” for additional important disclosures regarding the use of net revenues.The impact of foreign exchange rate movements decreased operating revenues by $153.1 million during the year ended December 31, 2022, as compared to the year ended December 31, 2021 ($87.6 million increase in 2021).Our revenues are directly influenced by the level and composition of our AUM. Therefore, movements in global capital market levels, net business inflows (or outflows), changes in the mix of investment products between asset classes and geographies may materially affect our revenues from period to period. See the company’s disclosures regarding the changes in AUM during the year ended December 31, 2022 and December 31, 2021 in the “Assets Under Management” section above for additional information.Passive AUM generally earn a lower effective fee rate than active asset classes, and therefore, changes in the mix of AUM have an impact on revenues and net revenue yield. In addition, as a significant proportion of our AUM are based outside of the U.S., changes in foreign exchange rates can result in a change to the mix of U.S. Dollar denominated AUM for AUM denominated in other currencies. As fee rates differ across geographic locations, changes to exchange rates have an impact on revenues and net revenue yields.Average AUM were $1,452.5 billion in the year ended December 31, 2022, as compared to $1,499.9 billion in the year ended December 31, 2021. In addition to the impact of lower AUM, investors continued to shift AUM toward lower yield passive products, such as ETFs, during 2022. As a result, net revenue yield ex performance fees ex QQQ declined from 39.1 basis points (bps) for the year ended December 31, 2021 to 35.5 bps for the year ended December 31, 2022.Investment Management FeesInvestment management fees were $4,358.4 million for year ended December 31, 2022 as compared to $4,995.9 million for year ended December 31, 2021. The impact of foreign exchange rate movements decreased investment management fees by $127.5 million during the year ended December 31, 2022, as compared to the year ended December 31, 2021. After allowing for foreign exchange movements, investment management fees decreased by $510.0 million as a result of decline in average AUM and lower revenue yields when compared to the 2021 period.42Table of Contents Service and Distribution FeesFor the year ended December 31, 2022, service and distribution fees were $1,405.5 million, as compared to $1,596.4 million for the year ended December 31, 2021. The impact of foreign exchange rate movements decreased service and distribution fees by $20.9 million in the year ended December 31, 2022, as compared to the year ended December 31, 2021. After allowing for foreign exchange movements, service and distribution fees decreased by $170.0 million. The total decrease is driven primarily by lower distribution fees of $92.2 million, transfer agency fees of $41.3 million and administrative fees of $37.1 million. The decrease is primarily driven by lower AUM to which these fees apply.Performance FeesFor the year ended December 31, 2022, performance fees were $68.2 million, as compared to $56.1 million for the year ended December 31, 2021. Performance fees in 2022 were primarily generated from real estate, institutional, bank loans and private equity products. Performance fees in 2021 were primarily generated from real estate, institutional products and various institutional mandates in Japan.Other RevenuesIn the year ended December 31, 2022, other revenues were $216.8 million, as compared to $246.1 million for the year ended December 31, 2021. The impact of foreign exchange rate movements decreased other revenues by $2.1 million during the year ended December 31, 2022, as compared to the year ended December 31, 2021. The decrease in other revenues was primarily driven by lower front end fees of $53.7 million which were partially offset by higher real estate transaction fees and other revenues of $13.1 million and $13.3 million, respectively.Invesco Great WallThe company’s most significant joint venture is our 49% investment in IGW. Management reflects 100% of IGW's results in its net revenues and adjusted operating expenses because it is important to evaluate the contribution that IGW is making to the business. The company’s non-GAAP operating results reflect the economics of these holdings on a basis consistent with the underlying AUM and flows. Adjusted net income is reduced by the amount of earnings attributable to the 51% noncontrolling interests. See “Schedule of Non-GAAP Information” for additional disclosures regarding the use of net revenues.Net revenues from IGW were $432.7 million and average AUM was $93.5 billion for the year ended December 31, 2022 (net revenues were $473.5 million and average AUM was $84.0 billion, for the year ended December 31, 2021). The impact of foreign exchange rate movements decreased net revenues from IGW by $16.7 million for the year ended December 31, 2022, as compared to the year ended December 31, 2021. After allowing for foreign exchange movements, net revenues from IGW were $449.4 million. The decrease in revenue was primarily due to a change in the mix of AUM and lower performance fees. Management, performance and other fees earned from CIPManagement believes that the consolidation of investment products may impact a reader's analysis of our underlying results of operations and could result in investor confusion or the production of information about the company by analysts or external credit rating agencies that is not reflective of the underlying results of operations and financial condition of the company. Accordingly, management believes that it is appropriate to adjust operating revenues for the impact of CIP in calculating net revenues. As management and performance fees earned by Invesco from the consolidated products are eliminated upon consolidation of the investment products, management believes that it is appropriate to add these operating revenues back in the calculation of net revenues. See “Schedule of Non-GAAP Information” for additional disclosures regarding the use of net revenues.Management and performance fees earned from CIP were $49.6 million in the year ended December 31, 2022, as compared to $42.4 million for the year ended December 31, 2021. The increase is due to higher management fees earned from newly launched retail funds.43Table of Contents Operating ExpensesThe main categories of operating expenses, and the dollar and percentage changes between periods, are as follows: VarianceYears ended December 31,2022 vs 20212021 vs 2020$ in millions202220212020$ Change% Change$ Change% ChangeThird-party distribution, service and advisory1,886.2 2,149.3 1,947.6 (263.1)(12.2)%201.7 10.4 %Employee compensation1,725.1 1,911.3 1,807.9 (186.2)(9.7)%103.4 5.7 %Marketing114.9 98.6 83.3 16.3 16.5 %15.3 18.4 %Property, office and technology539.8 526.0 512.3 13.8 2.6 %13.7 2.7 %General and administrative380.2 424.1 480.8 (43.9)(10.4)%(56.7)(11.8)%Transaction, integration and restructuring21.2 (65.9)330.8 87.1 N/A(396.7)N/AAmortization of intangibles (1)63.8 62.9 62.5 0.9 1.4 %0.4 0.6 %Total operating expenses4,731.2 5,106.3 5,225.2 (375.1)(7.3)%(118.9)(2.3)%The table below sets forth these expense categories as a percentage of total operating expenses and operating revenues, which we believe provides useful information as to the relative significance of each type of expense.$ in millions2022% of Total Operating Expenses% of Operating Revenues2021% of Total Operating Expenses% of Operating Revenues2020% of Total Operating Expenses% of Operating RevenuesThird-party distribution, service and advisory1,886.2 39.9 %31.2 %2,149.3 42.1 %31.2 %1,947.6 37.3 %31.7 %Employee compensation1,725.1 36.5 %28.5 %1,911.3 37.4 %27.7 %1,807.9 34.6 %29.4 %Marketing114.9 2.4 %1.9 %98.6 1.9 %1.4 %83.3 1.6 %1.4 %Property, office and technology539.8 11.5 %8.8 %526.0 10.4 %7.7 %512.3 9.8 %8.3 %General and administrative380.2 8.0 %6.3 %424.1 8.3 %6.2 %480.8 9.2 %7.8 %Transaction, integration and restructuring21.2 0.4 %0.4 %(65.9)(1.3)%(1.0)%330.8 6.3 %5.4 %Amortization of intangibles (1)63.8 1.3 %1.1 %62.9 1.2 %0.9 %62.5 1.2 %1.0 %Total operating expenses4,731.2 100.0 %78.2 %5,106.3 100 %74.1 %5,225.2 100.0 %85.0 %_________(1) In prior periods, amortization of intangible assets was included in the transaction, integration and restructuring line item. From the beginning of 2021, amortization of intangible assets was presented on a separate line item. There was no impact on operating expenses, operating income or net income.Operating expenses decreased $375.1 million in 2022 compared to 2021. The impact of foreign exchange rate movements decreased operating expenses by $146.2 million during the year ended December 31, 2022, as compared to the year ended December 31, 2021.44Table of Contents Third-Party Distribution, Service and Advisory Third-party distribution, service and advisory expenses include periodic “renewal” commissions paid to brokers and independent financial advisors for the continuing oversight of their clients' assets over the time they are invested and are payments for the servicing of client accounts. Renewal commissions are calculated based upon a percentage of the AUM value and apply to much of the company's non-U.S. retail operations. The revenues from the company’s U.S. retail operations include 12b-1 distribution fees, which are largely passed through to brokers who sell the funds as third-party distribution expenses along with additional marketing support distribution costs. Both the revenues and the costs are dependent on the underlying AUM of the brokers' clients. Third-party distribution expenses also include the amortization of upfront commissions paid to broker-dealers for sales of fund shares with a contingent deferred sales charge (a charge levied to the investor for client redemption of AUM within a certain contracted period of time). The upfront distribution commissions are amortized over the redemption period. Also included in third-party distribution, service and advisory expenses are sub-transfer agency fees that are paid to third parties for processing client common share purchases and redemptions, call center support and client reporting. These costs are reimbursed by the related funds.Third-party distribution service and advisory expenses were $1,886.2 million for the year ended December 31, 2022, as compared to $2,149.3 million for the year ended December 31, 2021. The impact of foreign exchange rate movements decreased third-party costs by $44.7 million during the year ended December 31, 2022, as compared to the year ended December 31, 2021. After allowing for foreign exchange rate changes, the decrease in costs was $218.4 million. The decrease was primarily due to decreases of $113.6 million in service fees, $59.5 million in renewal commissions, $40.8 million in transaction fees, and $16.1 million in front end commissions, partially offset by $11.6 million of higher administrative and other third-party management fees. The decrease is primarily driven by lower average AUM, partially offset by changes in AUM mix as discussed above. See "Schedule of Non-GAAP Information" for additional disclosures.Employee CompensationEmployee compensation includes salary, cash bonuses and long-term incentive plans designed to attract and retain the highest caliber employees. Employee staff benefit plan costs and payroll taxes are also included in employee compensation. Employee compensation was $1,725.1 million in the year ended December 31, 2022, as compared to $1,911.3 million for the year ended December 31, 2021. The impact of foreign exchange rate movements decreased employee compensation by $58.6 million during the year ended December 31, 2022, as compared to the year ended December 31, 2021. After allowing for foreign exchange rate changes, the decrease in employee compensation was $127.6 million. This decrease was due to decreases of $79.9 million in variable compensation as a result of lower revenues in 2022 compared to 2021 and $95.7 million related to mark-to-market losses on deferred compensation liabilities. These decreases were partially offset by an increase of $41.9 million in salaries, staff costs and benefits as well as a $5.6 million increase in deferred compensation expenses. Headcount at December 31, 2022 was 8,611 (December 31, 2021; 8,513).MarketingMarketing expenses include the cost of direct advertising of our products through trade publications, television and other media, and public relations costs, such as the marketing of the company's products through conferences or other sponsorships, and the cost of marketing-related employee travel.Marketing expenses were $114.9 million in the year ended December 31, 2022, as compared to $98.6 million for the year ended December 31, 2021. The impact of foreign exchange rate movements decreased marketing expenses by $5.0 million. After allowing for foreign exchange rate movements, marketing expenses increased $21.3 million during the year ended December 31, 2022, as compared to the year ended December 31, 2021. The increase was related to increased client events and marketing travel and entertainment costs as travel activity returned to more normalized levels with the easing of COVID-19 related travel restrictions.Property, Office and TechnologyProperty, office and technology expenses include rent and utilities for our various leased facilities, depreciation of company-owned property, capitalized software and computer equipment costs, minor non-capitalized computer equipment and software purchases and related maintenance payments, and costs related to externally provided operations, technology, middle office and back office management services.45Table of Contents Property, office and technology expenses were $539.8 million in the year ended December 31, 2022, as compared to $526.0 million for the year ended December 31, 2021. The impact of foreign exchange rate movements decreased property, office and technology expenses by $16.6 million during the year ended December 31, 2022, as compared to the year ended December 31, 2021. After allowing for foreign exchange rate movements, property, office and technology expenses increased $30.4 million. The increase was primarily driven by increased technology costs including software maintenance costs of $24.7 million related to investments in foundational technology projects that will enable future scale in our operating platform. Property expense also increased by $4.2 million due to higher property and office costs as a result of overlapping rent associated with the move of our new Atlanta headquarters which we expect to complete in mid-2023 and higher outsourced administration costs of $6.6 million, which were partially offset by lower depreciation and other expense of $5.2 million. General and Administrative General and administrative expenses include professional services costs, such as information service subscriptions, irrecoverable indirect taxes, non-marketing related employee travel expenditures, consulting fees, audit, tax and legal fees, professional insurance costs and recruitment and training costs.General and administrative expenses were $380.2 million in the year ended December 31, 2022, as compared to $424.1 million for the year ended December 31, 2021. The impact of foreign exchange rate movements decreased general and administrative expenses by $21.3 million during the year ended December 31, 2022, as compared to the year ended December 31, 2021. After allowing for foreign exchange rate movements, the decrease was $22.6 million. The decrease is due to $70 million of recoveries received during the year relating to losses incurred in prior periods, a $16.6 million decrease in the impact of CIP on general and administrative expenses, and $11.5 million in charitable contributions to the Invesco foundation and other charitable causes in the prior year. The decrease was partially offset by increases of $24.0 million in professional services costs relating to our investment in foundational technology projects, $29.3 million in fund-related client and administrative expenses, $11.5 million in travel and entertainment expenses, and $10.8 million in market data services costs.Transaction, Integration and RestructuringTransaction, integration and restructuring expenses include costs related to the acquisition and integration of a business and costs incurred by the company to restructure business operations to improve overall efficiency and longer-term profit, including legal, regulatory, advisory, valuation, professional services and consulting fees as well as costs for travel, severance, temporary staff and contract terminations. Transaction, integration and restructuring charges were $21.2 million during the year ended December 31, 2022 (year ended December 31, 2021: $65.9 million benefit). Transaction and integration expense (excluding restructuring) was a benefit to expense of $43.6 million in the year ended December 31, 2022, as compared to a benefit to expense of $186.5 million in the year ended December 31, 2021. The benefit in 2022 was primarily due to $55.0 million of recoveries related to the previously disclosed OppenheimerFunds acquisition-related matter. The benefit in 2021 was primarily due to a $131.1 million reduction to the OppenheimerFunds acquisition-related liability and $100.0 million of recoveries received related to the matter (See Item 8, Financial Statements and Supplementary Data, - Note 18, "Commitments and Contingencies," for additional details). Restructuring costs were $64.8 million for the year ended December 31, 2022 (year ended December 31, 2021: $120.6 million). Restructuring costs related to the strategic evaluation were $41.0 million for the year ended December 31, 2022 (year ended December 31, 2021: $100.5 million) and are primarily composed of compensation and property, office and technology costs (see Item 8, Financial Statements and Supplementary Data, - Note 13, "Restructuring," for additional details). The remaining restructuring costs are primarily composed of professional service costs related to other initiatives.Operating Income, Adjusted Operating Income, Operating Margin and Adjusted Operating MarginOperating income was $1,317.7 million in the year ended December 31, 2022, as compared to $1,788.2 million for the year ended December 31, 2021. Operating margin (operating income divided by operating revenues), decreased to 21.8% for the year ended December 31, 2022 from 25.9% in the year ended December 31, 2021. Adjusted operating income decreased to $1,614.8 million for the year ended December 31, 2022 from $2,182.6 million in the year ended December 31, 2021. Adjusted operating margin decreased to 34.8% for the year ended December 31, 2022 from 41.5% in the year ended December 31, 2021. See “Schedule of Non-GAAP Information” for a reconciliation of operating revenues to net revenues, a reconciliation of operating income to adjusted operating income and additional important disclosures regarding net revenues, adjusted operating income and adjusted operating margin.46Table of Contents Other Income and ExpensesThe main categories of other income and expenses, and the dollar and percentage changes between periods are as follows: VarianceYears ended December 31,2022 vs 20212021 vs 2020$ in millions202220212020$ Change% Change$ Change% ChangeEquity in earnings of unconsolidated affiliates106.1 152.3 72.7 (46.2)(30.3)%79.6 109.5 %Interest and dividend income24.4 25.2 20.5 (0.8)(3.2)%4.7 22.9 %Interest expense(85.2)(94.7)(129.3)9.5 (10.0)%34.6 (26.8)%Other gains and losses, net(139.5)120.5 44.9 (260.0)N/A75.6 168.4 %Other income/(expense) of CIP, net24.2 509.0 139.9 (484.8)(95.2)%369.1 263.8 %Total other income and expenses(70.0)712.3 148.7 (782.3)N/A563.6 379.0 %Equity in earnings of unconsolidated affiliatesEquity in earnings of unconsolidated affiliates decreased to $106.1 million for the year ended December 31, 2022, as compared to the year ended December 31, 2021. The decrease is primarily driven by decreases in private equity investments and our joint venture investment in IGW due to lower revenue as discussed above, which were partially offset by an increase in the earnings of the real estate investments.Interest expense Interest expense was $85.2 million in the year ended December 31, 2022, as compared to $94.7 million for the year ended December 31, 2021. The decrease is primarily driven by the early redemption of $600 million of our senior notes in May 2022.Other gains and losses, net Other gains and losses was a net loss of $139.5 million for the year ended December 31, 2022, compared to a net gain of $120.5 million for the year ended December 31, 2021. The net loss in 2022 included $17.9 million of losses related to the mark-to-market on seed money investments and $132.5 million of losses on investments and instruments held for our deferred compensation plans which were partially offset by $9.7 million of gains on pension and other investments. Other income/(expense) of CIPOther income/(expense) of CIP includes interest and dividend income, interest expense, and realized and unrealized gains and losses on the underlying investments and debt owned by CIP. For the year ended December 31, 2022, interest and dividend income of CIP increased by $94.6 million to $374.3 million (year ended December 31, 2021: $279.7 million). Interest expense of CIP increased by $62.5 million to $223.2 million for the year ended December 31, 2022 (year ended December 31, 2021: $160.7 million). The increase in interest income and interest expense was primarily due to higher net interest income earned by the CLOs in 2022. For the year ended December 31, 2022, other gains and losses of CIP were a net loss of $126.9 million, as compared to a net gain of $390.0 million for the year ended December 31, 2021. The net loss during 2022 was attributable to market-driven losses on investments held by consolidated funds.Net impact of CIP and related noncontrolling interests in consolidated entitiesThe consolidation of investment products did not have an impact on net income attributable to Invesco for the years ended December 31, 2022 and 2021. The adjustment to net income for the net income/(loss) attributable to noncontrolling interests in consolidated entities represent the CIP profit or loss attributable to third-party investors. The impact of any realized or unrealized gains or losses attributable to the interests of third-parties which is reflected in other income/(expense) of CIP, is offset by this adjustment to arrive at net income attributable to Invesco. Also, the net income or loss of CIP are taxed at the investor level, not at the product level; therefore, a tax provision is not reflected in the net impact of CIP.Additionally, CIP represent less than 1% of the company's AUM. Therefore, the net gains or losses of CIP are not indicative of the performance of the company's aggregate AUM.47Table of Contents Income Tax Expense Our effective tax rate increased to 25.8% for the year ended December 31, 2022 from 21.2% for the year ended December 31, 2021 primarily due to the decline in income attributable to CIP and the change in the mix of income across tax jurisdictions. For additional income tax information, refer to Note 15, "Taxation," in
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations are incorporated herein by reference: Page(s)Discussion of dividends in the section captioned “Capital — Dividends”68 Discussion of our common shares, shareholder information, and repurchase activities in the section captioned “Capital — Common Shares outstanding”68 The following graph compares the price performance of our Common Shares (based on an initial investment of $100 on December 31, 2017, and assuming reinvestment of dividends) with that of the S&P 500 Index and a group of other banks that constitute our peer group. The peer group consists of the banks that make up the S&P 500 Regional Bank Index and the banks that make up the Standard & Poor’s 500 Diversified Bank Index. We are included in the S&P 500 Index and the peer group. Share price performance is not necessarily indicative of future price performance.From time to time, KeyCorp or its principal subsidiary, KeyBank, may seek to retire, repurchase, or exchange outstanding debt of KeyCorp or KeyBank, and capital securities or preferred stock of KeyCorp, through cash purchase, privately negotiated transactions, or otherwise. Such transactions, if any, depend on prevailing market conditions, our liquidity and capital requirements, contractual restrictions, and other factors. The amounts involved may be material.As part of our previous 2021 capital plan, which was effective through the third quarter of 2022, the Board had authorized the repurchase of up to $1.5 billion of our Common Shares. In September 2022, the Board approved the extension of the previous authorization through the third quarter of 2023.The following table summarizes our repurchases of our Common Shares for the three months ended December 31, 2022.Calendar monthTotal number of sharesrepurchased(a)Average price paid per shareTotal number of shares purchased as part of publicly announced plans or programs(a)Dollar value of shares that may yet be purchased as part of publicly announced plans or programsOctober 1 - 31— $— — $745,991,117 November 1 - 30— — — 745,991,117 December 1 - 312,401 17.89 2,401 745,948,169 Total2,401 $17.89 2,401 (a)Includes Common Shares deemed surrendered by employees in connection with our stock compensation and benefit plans to satisfy tax obligations.45Table of contentsITEM 6. [RESERVED]ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page NumberIntroduction47Long-term financial targets48Corporate strategy49Strategic developments49Results of Operations50Earnings overview50Net interest income50Provision for credit losses53Noninterest income53Noninterest expense55Income taxes57Business Segment Results57Consumer Bank57Commercial Bank58Financial Condition60Loans and loans held for sale60Securities66Deposits and other sources of funds69Capital69Off-Balance Sheet Arrangements and Aggregate Contractual Obligations71Off-balance sheet arrangements71Guarantees72Risk Management72Overview72Market risk management74Liquidity risk management80Credit risk management83Operational and compliance risk management87GAAP to Non-GAAP Reconciliations89Critical Accounting Policies and Estimates90Allowance for loan and lease losses90Valuation methodologies91Derivatives and hedging93Contingent liabilities, guarantees and income taxes93Accounting and reporting developments9446Table of contentsIntroductionThis section reviews the financial condition and results of operations of KeyCorp and its subsidiaries for 2022 and 2021. Some tables may include additional periods to comply with disclosure requirements or to illustrate trends in greater depth. When you read this discussion, you should also refer to the consolidated financial statements and related notes in this report. The page locations of specific sections and notes that we refer to are presented in the Table of Contents. To review our financial condition and results of operations for 2020 and a comparison between the 2020 and 2021 results, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations of our 2021 Form 10-K filed with the SEC on February 22, 2022, which discussion is incorporated herein by reference.47Table of contentsLong-term financial targets(a)See the section entitled “GAAP to non-GAAP Reconciliations,” which presents the computations of certain financial measures related to “cash efficiency.” The section includes tables that reconcile the GAAP performance measures to the corresponding non-GAAP measures, which provides a basis for period-to-period comparisons.(a)See the section entitled “GAAP to non-GAAP Reconciliations,” which presents the computations of certain financial measures related to “tangible common equity.” The section includes tables that reconcile the GAAP performance measures to the corresponding non-GAAP measures, which provides a basis for period-to-period comparisons.Positive Operating LeverageGenerate positive operating leverage and a cash efficiency ratio in the range of 54.0% to 56.0%.Positive operating leverage was delivered for the 2022 fiscal year, marking the ninth time in the past ten years this was achieved. We expect to again generate positive operating leverage in 2023.Moderate Risk ProfileMaintain a moderate risk profile by targeting a net loan charge-offs to average loans ratio in the range of .40% to .60% through a credit cycle.Our net charge-offs to average loans ratio remains at a historically low level. We believe our strong risk management practices will allow us to continue supporting our clients, while maintaining our moderate risk profile, and will position Key to perform well through all business cycles. Financial ReturnA return on average tangible common equity in the range of 16.0% to 19.0%. Our full-year dividend for 2022 was $.79, reflecting a Board approved increase in the fourth quarter. We remain committed to delivering value to all shareholders.48Table of contentsCorporate strategyWe remain committed to enhancing long-term shareholder value by continuing to execute our relationship-based business model, growing our franchise, and being disciplined in our capital management. We intend to pursue this commitment by growing profitably; acquiring and expanding targeted client relationships; effectively managing risk and rewards; maintaining financial strength; and engaging, retaining, and inspiring our diverse and high-performing workforce. These strategic priorities for enhancing long-term shareholder value are described in more detail below.•Grow profitably — We intend to continue to focus on generating positive operating leverage by growing revenue and creating a more efficient operating environment. We expect our relationship business model to keep generating organic growth as it helps us expand engagement with existing clients and attract new customers. We plan to leverage our continuous improvement culture to maintain an efficient cost structure that is aligned, sustainable, and consistent with the current operating environment and that supports our relationship business model. •Acquire and expand targeted client relationships — We seek to be client-centric in our actions and have taken purposeful steps to enhance our ability to acquire and expand targeted relationships. We seek to provide solutions to serve our clients' needs. We focus on markets and clients where we can be the most relevant. In aligning our businesses and investments against these targeted client segments, we are able to make a meaningful impact for our clients.•Effectively manage risk and rewards — Our risk management activities are focused on ensuring we properly identify, measure, and manage risks across the entire company to maintain safety and soundness and maximize profitability.•Maintain financial strength — With the foundation of a strong balance sheet, we intend to remain focused on sustaining strong reserves, liquidity, and capital. We plan to work closely with our Board and regulators to manage capital to support our clients’ needs and drive long-term shareholder value. Our capital remains a competitive advantage for us.•Engage a high-performing, talented, and diverse workforce — Every day our employees provide our clients with great ideas, extraordinary service, and smart solutions. We intend to continue to engage our high-performing, talented, and diverse workforce to create an environment where they can make a difference, own their careers, be respected, and feel a sense of pride.Strategic developmentsWe took the following actions during 2022 in support of our corporate strategy:•We continued the momentum of loan growth across both our consumer and commercial businesses as we continue to add clients and deepen our existing relationships. •In the third quarter, we implemented new client-friendly fee terms, eliminating NSF fees and introducing Key Coverage Zone TM for overdraft fees.•We continued to expand targeted client relationships in healthcare, growing relationships with nurses and significant healthcare providers, including healthcare systems and facilities.•Our strong capital position allows us to continue to execute against each of our capital priorities of organic growth, dividends, and share repurchases. During the fourth quarter, the Board of Directors announced an increase in the quarterly dividend to $.205 per common share resulting in a full-year dividend of $.79.•We continued to grow profitably during 2022. Positive operating leverage was achieved for the year, and we expect to deliver positive operating leverage in 2023.•During 2022 we completed the acquisition of GradFin, one of the nation's leading Public Service Loan Forgiveness counseling providers. The acquisition furthers Key's commitment to accelerate growth through targeted investments in digital, niche businesses. •Overall, credit quality remains strong as our new loan originations in both our commercial and consumer book continue to meet our criteria for high quality loans as we continue to effectively manage risk and rewards. Our continuous focus on maintaining our risk discipline has and will continue to position us to perform well through all business cycles.•Maintaining financial strength while driving long-term shareholder value was again a focus during 2022. At December 31, 2022, our Common Equity Tier 1 and Tier 1 risk-based capital ratios stood at 9.10% and 10.60%, respectively. •We remained committed to our strategy to engage a high-performing, talented, and diverse workforce. We have been recognized by multiple organizations for our dedication to creating an environment where employees 49Table of contentsare treated with respect and empowered to bring their authentic selves to work. Some of these awards and recognitions included the Human Rights Campaign naming us one of the 2022 Best Places to Work for LGBT Equality, Bloomberg listing us on the Gender-Equality Index, G.I. Jobs and Military Spouse Magazine recognizing us as a Military Friendly® and Military Friendly® Spouse Employer, and receiving the Leading Disability Employer Seal from the National Organization on Disability. We were also named to DiversityInc’s 2022 Top 50 Companies for Diversity. Results of OperationsEarnings OverviewThe following chart provides a reconciliation of net income from continuing operations attributable to Key common shareholders for the year ended December 31, 2021, to the year ended December 31, 2022 (dollars in millions): (a) Includes Preferred dividends.Net interest incomeOne of our principal sources of revenue is net interest income. Net interest income is the difference between interest income received on earning assets (such as loans and securities) and loan-related fee income, and interest expense paid on deposits and borrowings. There are several factors that affect net interest income, including:•the volume, pricing, mix, and maturity of earning assets and interest-bearing liabilities;•the volume and value of net free funds, such as noninterest-bearing deposits and equity capital;•the use of derivative instruments to manage interest rate risk;•interest rate fluctuations and competitive conditions within the marketplace;•asset quality; and•fair value accounting of acquired earning assets and interest-bearing liabilities.To make it easier to compare both the results among several periods and the yields on various types of earning assets (some taxable, some not), we present net interest income in this discussion on a “TE basis” (i.e., as if all income were taxable and at the same rate). For example, $100 of tax-exempt income would be presented as $126, an amount that, if taxed at the statutory federal income tax rate of 21%, would yield $100.50Table of contentsNet interest income (TE) for 2022 was $4.6 billion, and the net interest margin was 2.64%. Compared to 2021, net interest income (TE) increased $456 million and the net interest margin increased by 14 basis points. Net interest income (TE) benefited from higher earning asset balances, higher interest rates, and a favorable balance sheet mix. Net interest income (TE) and the net interest margin were negatively impacted by the sale of the indirect auto loan portfolio in the third quarter of 2021, higher interest-bearing deposit costs, and lower loan fees from PPP.Average loans totaled $111.3 billion for 2022, compared to $100.3 billion in 2021. Commercial loans increased $6.5 billion, reflecting core commercial and industrial loan growth and an increase in commercial mortgage real estate loans, which mitigated the impact of a $4.7 billion decline in PPP balances. Consumer loans increased $4.6 billion driven by Key’s consumer mortgage business and student loan originations from Laurel Road, partly offset by the sale of the indirect auto loan portfolio in the third quarter of 2021.Average deposits totaled $146.9 billion for 2022, an increase of $1.8 billion compared to 2021. The increase reflects growth from consumer and commercial relationships, partially offset by a decline in time deposits and non-operating commercial deposit balances.Figure 1 shows the various components of our balance sheet that affect interest income and expense and their respective yields or rates over the past five years. This figure also presents a reconciliation of TE net interest income to net interest income reported in accordance with GAAP for each of those years. The net interest margin, which is an indicator of the profitability of our earning assets less the cost of funding, is calculated by dividing taxable-equivalent net interest income by average earning assets.51Table of contentsFigure 1. Consolidated Average Balance Sheets, Net Interest Income, and Yields/Rates from Continuing Operations(h) Year ended December 31,202220212020Dollars in millionsAverageBalanceInterest (a)Yield/Rate (a)AverageBalanceInterest (a)Yield/Rate (a)AverageBalanceInterest (a)Yield/Rate (a)ASSETSLoans (b), (c)Commercial and industrial (d)$54,970 $2,148 3.91 %$50,931 $1,795 3.52 %$55,145 $1,977 3.59 %Real estate — commercial mortgage15,572 633 4.07 13,118 472 3.60 13,279 521 3.92 Real estate — construction2,229 99 4.44 2,113 77 3.61 1,843 74 3.99 Commercial lease financing3,869 98 2.54 4,019 114 2.84 4,497 139 3.09 Total commercial loans76,640 2,978 3.89 70,181 2,458 3.50 74,764 2,711 3.63 Real estate — residential mortgage19,036 559 2.94 12,252 348 2.84 8,094 284 3.50 Home equity loans8,115 347 4.28 8,967 336 3.74 9,772 392 4.01 Consumer direct loans6,490 277 4.27 5,105 233 4.56 4,213 221 5.26 Credit cards959 107 11.23 925 94 10.11 1,001 107 10.65 Consumer indirect loans62 — — 2,839 90 3.19 4,845 180 3.72 Total consumer loans34,662 1,290 3.72 30,088 1,101 3.66 27,925 1,184 4.24 Total loans111,302 4,268 3.84 100,269 3,559 3.55 102,689 3,895 3.79 Loans held for sale1,278 56 4.41 1,700 50 2.96 1,972 69 3.49 Securities available for sale (b), (e)42,325 752 1.62 35,765 546 1.53 23,742 484 2.10 Held-to-maturity securities (b)7,676 213 2.77 7,035 185 2.63 8,938 222 2.49 Trading account assets850 31 3.61 820 19 2.35 814 20 2.47 Short-term investments4,264 97 2.28 17,529 28 .16 9,096 18 .20 Other investments (e)952 22 2.26 621 7 1.14 635 6 .87 Total earning assets168,647 5,439 3.15 163,739 4,394 2.69 147,886 4,714 3.20 Allowance for loan and lease losses(1,101)(1,340)(1,481)Accrued income and other assets18,340 16,520 15,650 Discontinued assets492 632 775 Total assets$186,378 $179,551 $162,830 LIABILITIESNOW and money market deposit accounts$85,673 $234 .27 %$84,736 $41 .05 %$75,733 $206 .27 %Savings deposits7,798 1 .01 6,893 1 .02 5,252 2 .04 Certificates of deposit ($100,000 or more)(f)1,455 8 .56 2,135 16 .72 4,520 83 1.83 Other time deposits2,892 36 1.25 2,540 9 .37 4,041 56 1.38 Total interest-bearing deposits97,818 279 .29 96,304 67 .07 89,546 347 .39 Federal funds purchased and securities sold under repurchase agreements2,107 41 1.93 239 — .02 670 6 .88 Bank notes and other short-term borrowings2,963 90 3.02 770 8 1.08 1,452 12 .85 Long-term debt (f), (g)14,915 475 3.19 12,391 221 1.79 12,578 286 2.36 Total interest-bearing liabilities117,803 885 .75 109,704 296 .27 104,246 651 .63 Noninterest-bearing deposits49,044 48,731 37,740 Accrued expense and other liabilities4,309 2,819 2,433 Discontinued liabilities (g)492 632 775 Total liabilities171,648 161,886 145,194 EQUITYKey shareholders’ equity14,730 17,665 17,636 Noncontrolling interests— — — Total equity14,730 17,665 17,636 Total liabilities and equity$186,378 $179,551 $162,830 Interest rate spread (TE)2.40 %2.42 %2.57 %Net interest income (TE) and net interest margin (TE)$4,554 2.64 %$4,098 2.50 %$4,063 2.77 %Less: TE adjustment (b)27 27 29 Net interest income, GAAP basis$4,527 $4,071 $4,034 (a)Results are from continuing operations. Interest excludes the interest associated with the liabilities referred to in (g) below, calculated using a matched funds transfer pricing methodology.(b)Interest income on tax-exempt securities and loans has been adjusted to a TE basis using the statutory federal income tax rate in effect that calendar year.(c)For purposes of these computations, nonaccrual loans are included in average loan balances.(d)Commercial and industrial average loan balances include $157 million, $134 million, and $130 million of assets from commercial credit cards for the years ended December 31, 2022, December 31, 2021, and December 31, 2020, respectively.(e)Yield is calculated on the basis of amortized cost.(f)Rate calculation excludes basis adjustments related to fair value hedges.(g)A portion of long-term debt and the related interest expense is allocated to discontinued liabilities as a result of applying our matched funds transfer pricing methodology to discontinued operations.(h)Average balances presented are based on daily average balances over the respective stated period.52Table of contentsFigure 2 shows how the changes in yields or rates and average balances from the prior year affected net interest income. The section entitled “Financial Condition” contains additional discussion about changes in earning assets and funding sources.Figure 2. Components of Net Interest Income Changes from Continuing Operations 2022 vs. 2021Dollars in millionsAverageVolumeYield/ RateNet Change(a)INTEREST INCOMELoans$428 $281 $709 Loans held for sale(14)20 6 Securities available for sale109 97 206 Held-to-maturity securities17 11 28 Trading account assets1 11 12 Short-term investments(36)105 69 Other investments5 10 15 Total interest income (TE)509 536 1,045 INTEREST EXPENSENOW and money market deposit accounts— 193 193 Savings deposits— — — Certificates of deposit ($100,000 or more)(4)(4)(8)Other time deposits1 26 27 Total interest-bearing deposits(2)214 212 Federal funds purchased and securities sold under repurchase agreements— 41 41 Bank notes and other short-term borrowings49 33 82 Long-term debt52 202 254 Total interest expense99 490 589 Net interest income (TE)$410 $46 $456 (a)The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each.Provision for credit lossesOur provision for credit losses was a net charge of $502 million for 2022, compared to a $418 million net benefit for 2021. The increase in our provision for credit losses was a result of reserve increases largely driven by changes in the economic outlook and loan growth, offset somewhat by lower net charge-offs. In 2021, our provision for credit losses was a net benefit due to reserve releases as the economic stress and uncertainty in the U.S. and globally caused by COVID-19 eased, along with significantly lower net loan charge-offs and improved asset quality. In 2023 we expect net charge-offs to average loans to be in the range of 25 to 30 bps. 53Table of contentsNoninterest incomeNoninterest income for 2022 was $2.7 billion, compared to $3.2 billion during 2021. Noninterest income represented 37% of total revenue for 2022 and 44% of total revenue for 2021. In 2023, we expect noninterest income to be down 1% to 3% compared to 2022.The following discussion explains the composition of certain elements of our noninterest income and the factors that caused those elements to change.Figure 3. Noninterest Income (a)Other noninterest income includes operating lease income and other leasing gains, corporate services income, corporate-owned life insurance income, consumer mortgage income, commercial mortgage servicing fees, and other income. See the "Consolidated Statements of Income" in Part II,
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” together with our audited consolidated financial statements and the related notes thereto for a discussion of material information relevant to an assessment of our financial condition and results of operations, including, to the extent material, the effects that compliance with governmental regulations may have upon our capital expenditures and earnings. 6 Table of Contents Human Capital Resources The Company believes that our associates are one of our strongest resources and that a variety of perspectives and experiences found in a diverse workforce spark innovation and enrich company culture. The Company is committed to diversity, equity and inclusion best practices in all phases of the associate life cycle, including recruitment, training and development and promotion. By cultivating high levels of associate satisfaction and improving the diversity of our team, management’s goal is to ensure the Company will remain a significant driving force in commercial real estate well into the future. The Company has been and will continue to be an equal opportunity employer committed to hiring, developing, and supporting a diverse, equitable, and inclusive workplace. To ensure full implementation of this equal employment policy, we take steps to ensure that persons are recruited, hired, assigned and promoted without regard to race, creed, national origin, ancestry, citizenship status, religion, age, color, sex, gender (including pregnancy, childbirth and related medical conditions), gender identity and expression, sexual orientation, marital status, disability, genetic information, protected veteran status, or any other characteristic protected by local, state, or federal laws, rules, or regulations. All of our employees must adhere to a Code of Business Conduct and Ethics that sets standards for appropriate behavior and includes required, regular internal training on preventing, identifying, reporting and stopping any type of discrimination and/or retaliation. To attract and retain high performing individuals, we are committed to partnering with our associates to provide opportunities for their professional development and promote their health and well-being. We offer a broad range of benefits, and we believe our compensation package and benefits are competitive with others in our industry. Our benefits programs include a robust offering of medical, dental, vision, life, disability and a number of exciting ancillary benefits, all of which require very low associate contributions or are offered at no cost to associates. The Company also provides a Safe Harbor 401(k) program with both pretax and Roth offering including a robust, fully vested matching contribution. The Company has been recognized as a Great Place to Work® for five consecutive years as well as a One of the 2022 Best Workplaces in Real Estate™, both of which are based on anonymous third-party surveys and feedback collected from our associates. Additionally, the Company was designated a Best Place to Work for LGBTQ+ Equality and has achieved a perfect score on the Human Rights Campaign Foundation’s 2022 Corporate Equality Index, a nationally recognized benchmarking survey and report measuring corporate policies and practices related to LGBTQ+ workplace equality. The Company operates under a hybrid work model, which balances associates’ need for valuable face-to-face interactions with individual preferences for ideal work conditions. By continuing to focus on communication, collaboration, and innovation, and by encouraging associates to protect their personal time and be deliberate in where and how they choose to work, management is confident that the model results in a happier, engaged, and more efficient workforce. The Company’s executive and management team promotes a true “open door” environment in which all feedback and suggestions are welcome. Whether it be through regular all employee calls, department meetings, frequent training sessions, Coffee Connections with the executive team, use of our BRAVO recognition program, awarding of iPads for Ideas, or participation in our LABS (Leaders Advancing Business Strategy) program, associates are encouraged to be inquisitive and share ideas. Those ideas have resulted in a number of programs and benefit enhancements. The Company promotes physical health, including access to a national gym membership program for associates and their family members as well as host to regular wellness and nutrition seminars and health screenings. The Company also feels it is important that our associates are engaged and active in the community. Across our numerous offices, associates host volunteer and social activities. Whether we’re participating in walks, runs, food or toy drives, the Company promotes and supports associate volunteerism with two volunteer days off per year and a company matching program in support of each associates charitable endeavors. The Company also encourages associates to directly drive strategy around the Company’s environmental, social and governance initiatives through participation in five associate-driven KIMunity Councils focused in the areas of diversity, equity and inclusion, giving, wellness, sustainability, and tenant engagement. The Company recognizes the importance of advanced education. Each year, the Company funds $100,000 in college scholarships to benefit the children of our associates. In addition, the Company recently announced, in partnership with ICSC, it is providing $100,000 in scholarships to students wishing to pursue careers in real estate, of which no less than 50% will be awarded to students of under-represented groups. Both programs are managed by independent third parties who consider an equal balance of academics and financial need as determining factors. The Company's executive offices are located at 500 North Broadway, Suite 201, Jericho, NY 11753, a mixed-use property that is wholly owned by the Company, and its telephone number is (516) 869-9000 or 1-800-764-7114. Nearly all corporate functions, including legal, data processing, finance and accounting are administered by the Company from its executive offices in Jericho, New York and supported by the Company’s regional offices. As of December 31, 2022, a total of 639 persons were employed by the Company, of which 31% were located in our corporate office with the remainder located in 28 offices throughout the United States. The average tenure of our employees was 9.0 years. 7 Table of Contents Cybersecurity The Company’s Audit Committee receives quarterly briefings from the Company’s Chief Information Officer regarding the emerging cybersecurity threat and risk landscape as well as the Company’s security program and related readiness, resiliency, and response efforts. The Company has a Cyber Risk Committee (“Cyber Committee”) which reviews and reports on technology-based security issues. The Cyber Committee is comprised of senior management from various business units within the Company and meets quarterly to review the status of the Company’s overall security program as well as controls and procedures and to stay up-to-date of relevant legislative, regulatory and technical developments. The Company utilizes a variety of administrative, technical and physical safeguards that take into account the nature of our IT environment, information assets and cyber risks posed by both internal and external threats. The Company has incorporated cybersecurity coverage in its insurance policies. The Company’s goal is to keep its data and systems, as well as its employees safe from cybersecurity threats. The Company conducts employee security awareness training and internal phishing exercises. When security issues arise, the Company conducts a prompt investigation and initiates response protocols and other measures to protect the Company and its valued employees and key stakeholders. Environmental, Social and Governance (“ESG”) Programs The Company strives to build a thriving and viable business, one that succeeds by delivering long-term value for its stakeholders. We believe that the Company’s ESG programs are aligned with its core business strategy of creating destinations for everyday living that inspire a sense of community and deliver value to its many stakeholders. 8 Table of Contents The Company has identified the following five pillars that outline the Company’s current strategic priorities within our ESG program. The Company has defined 16 ESG goals that expand upon the Company’s commitment with clear targets in each pillar: The Company has aligned its annual reporting with standards from the Global Reporting Initiative (“GRI”), Sustainability Accounting Standards Board (“SASB”) and Task Force on Climate-related Financial Disclosures (“TCFD”). The Company also discloses aggregate-level EEO-1 workforce diversity data that can be found on the Company’s website, which data and website contents are not incorporated by reference hereto. Additional ESG information of relevance to stakeholders can be found on the Company’s website, the contents of which are not incorporated by reference and do not form a part of this Form 10-K. The Company’s Board of Directors sets the Company’s overall ESG program objectives and oversees enterprise risk management. The Nominating and Corporate Governance Committee of the Board of Directors is responsible for overseeing the Company's efforts with regard to the Company's ESG matters. The Company recognizes that climate change is one of the most significant stakeholder issues of our times, threatening the viability of economic and environmental systems globally. The scientific community has studied climate change and a consensus exists that warming is occurring outside the boundaries of historical planetary trends due in significant part, to human activity. As a real estate portfolio owner, the Company monitors physical and transition risks as well as opportunities posed to its business by climate change and quantifies and discloses the climate impacts of its activities. The Company’s science-based GHG emissions reduction goals are aligned with the Paris Climate Accord and while there can be no guarantees, we believe they could put the Company on pace to achieve Scope 1 and Scope 2 net zero GHG emissions by 2050. 9 Table of Contents Climate risks and opportunities are generally evaluated at both the corporate and individual asset level. The following table summarizes relevant climate risks identified as a part of the Company’s ongoing risk assessment process. The Company may be subject to other climate risks not included below. Climate Risk Description Physical Windstorms Increased frequency and intensity of windstorms, such as hurricanes, could lead to property damage, loss of property value and interruptions to business operations Sea Level Rise Rising sea levels could lead to storm surge and other potential impacts for low-lying coastal properties leading to damage, loss of property value and interruptions to business operations Flooding Change in rainfall conditions leading to increased frequency and severity of flooding could lead to property damage, loss of property value and interruptions to business operations Wildfires Change in fire potential could lead to permanent loss of property, stress on human health (air quality) and stress on ecosystem services Heat and Water Stress Increases in temperature could lead to droughts and decreased available water supply could lead to higher utility usage, supply interruptions and reputational issues in local communities Transition Regulation Regulations at the federal, state and local levels could impose additional operating and capital costs associated with utilities, energy efficiency, building materials and building design Reputation Increased interest among retail tenants in building efficiency, sustainable design criteria and "green leases", which incorporate provisions intended to promote sustainability at the property, could result in decreased demand for outdated space The Company’s approach in mitigating these risks include but are not limited to (i) carrying additional insurance coverage relating to flooding and windstorms, (ii) maintaining a geographically diversified portfolio, which limits exposure to event driven risks and (iii) creating a form “green lease” for its tenants which incorporates varied criteria that align landlord and tenant sustainability priorities as well as establishing green construction criteria. In 2020, the Company issued $500.0 million in 2.70% notes due 2030 in its inaugural green bond offering. The net proceeds from this offering are allocated to finance or refinance, in whole or in part, recently completed, existing or future eligible green projects, with projects are to be aligned with the four core components of the Green Bond Principles, 2018 as administered by the International Capital Market Association. Additionally, the Company’s $2.0 billion Credit Facility (as defined below) is a green credit facility which incorporates rate adjustments associated with attainment (or nonattainment) of Scope 1 and 2 greenhouse gas emissions reductions. Information About Our Executive Officers The following table sets forth information with respect to the executive officers of the Company as of December 31, 2022: Name Age Position Joined Kimco Milton Cooper 93 Executive Chairman of the Board of Directors Co-Founder Conor C. Flynn 42 Chief Executive Officer 2003 Ross Cooper 40 President and Chief Investment Officer 2006 Glenn G. Cohen 58 Executive Vice President, Chief Financial Officer and Treasurer 1995 David Jamieson 42 Executive Vice President, Chief Operating Officer 2007 Available Information The Company’s website is located at http://www.kimcorealty.com. The information contained on our website does not constitute part of this Form 10-K. On the Company’s website you can obtain, free of charge, a copy of this Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable, after we file such material electronically with, or furnish it to, the SEC. The public may read and obtain a copy of any materials we file electronically with the SEC at http://www.sec.gov. 10 Table of Contents Item 1A. Risk Factors We are subject to certain business and legal risks including, but not limited to, the following: Risks Related to Our Business and Operations Adverse global market and economic conditions may impede our ability to generate sufficient income and maintain our properties. Our properties consist primarily of open-air shopping centers, including mixed-use assets, and other retail properties. Our performance, therefore, is generally linked to economic conditions in the market for retail space. The economic performance and value of our properties is subject to all of the risks associated with owning and operating real estate, including but not limited to: ● changes in the national, regional and local economic climate; ● local conditions, including an oversupply of, or a reduction in demand for, space in properties like those that we own or operate; ● trends toward smaller store sizes as retailers reduce inventory and develop new prototypes; ● increasing use by customers of e-commerce and online store sites; ● the attractiveness of our properties to tenants; ● market disruptions due to global pandemics; ● the ability of tenants to pay rent, particularly anchor tenants with leases in multiple locations; ● tenants who may declare bankruptcy and/or close stores; ● competition from other available properties to attract and retain tenants; ● changes in market rental rates; ● the need to periodically pay for costs to repair, renovate and re-let space; ● ongoing consolidation in the retail sector; ● the excess amount of retail space in a number of markets; ● changes in operating costs, including costs for maintenance, insurance and real estate taxes; ● the expenses of owning and operating properties, which are not necessarily reduced when circumstances such as market factors and competition cause a reduction in income from the properties; ● changes in laws and governmental regulations, including those governing usage, zoning, the environment and taxes; ● acts of terrorism and war and acts of God, including physical and weather-related damage to our properties; ● the continued service and availability of key personnel; and ● the risk of functional obsolescence of properties over time. Competition may limit our ability to purchase new properties or generate sufficient income from tenants and may decrease the occupancy and rental rates for our properties. Numerous commercial developers and real estate companies compete with us in seeking tenants for our existing properties and properties for acquisition. Open-air shopping centers, including mixed-use assets, or other retail shopping centers with more convenient locations or better rents may attract tenants or cause them to seek more favorable lease terms at or prior to renewal. Retailers at our properties may face increasing competition from other retailers, e-commerce, outlet malls, discount shopping clubs, telemarketing or home shopping networks, all of which could (i) reduce rents payable to us; (ii) reduce our ability to attract and retain tenants at our properties; or (iii) lead to increased vacancy rates at our properties. We may fail to anticipate the effects of changes in consumer buying practices, particularly of growing online sales and the resulting retailing practices and space needs of our tenants or a general downturn in our tenants’ businesses, which may cause tenants to close stores or default in payment of rent. We face competition in the acquisition or development of real property from others engaged in real estate investment that could increase our costs associated with purchasing and maintaining assets. Some of these competitors may have greater financial resources than we do. This could result in competition for the acquisition of properties for tenants who lease or consider leasing space in our existing and subsequently acquired properties and for other investment or development opportunities. Our performance depends on our ability to collect rent from tenants, including anchor tenants, our tenants’ financial condition and our tenants maintaining leases for our properties. At any time, our tenants may experience a downturn in their business that may significantly weaken their financial condition. As a result, our tenants may delay a number of lease commencements, decline to extend or renew leases upon expiration, fail to make rental payments when due, close stores or declare bankruptcy. Any of these actions could result in the termination of tenants’ leases and the loss of rental income attributable to these tenants’ leases. In the event of a default by a tenant, we may experience delays and costs in enforcing our rights as landlord under the terms of the leases. 11 Table of Contents In addition, multiple lease terminations by tenants, including anchor tenants, or a failure by multiple tenants to occupy their premises in a shopping center could result in lease terminations or significant reductions in rent by other tenants in the same shopping centers under the terms of some leases. In that event, we may be unable to re-lease the vacated space at attractive rents or at all, and our rental payments from our continuing tenants could significantly decrease. The occurrence of any of the situations described above, particularly involving a substantial tenant with leases in multiple locations, could have a material adverse effect on our financial condition, results of operations and cash flows. A tenant that files for bankruptcy protection may not continue to pay us rent. A bankruptcy filing by, or relating to, one of our tenants or a lease guarantor would bar all efforts by us to collect pre-bankruptcy debts from the tenant or the lease guarantor, or their property, unless the bankruptcy court permits us to do so. A tenant bankruptcy could delay our efforts to collect past due balances under the relevant leases and could ultimately preclude collection of these sums. If a lease is rejected by a tenant in bankruptcy, we would have only a general unsecured claim for damages. As a result, it is likely that we would recover substantially less than the full value of any unsecured claims we hold, if at all. E-commerce and other changes in consumer buying practices present challenges for many of our tenants and may require us to modify our properties, diversify our tenant composition and adapt our leasing practices to remain competitive. Many of our tenants face increasing competition from e-commerce and other sources that could cause them to reduce their size, limit the number of locations and/or suffer a general downturn in their businesses and ability to pay rent. We may also fail to anticipate the effects of changes in consumer buying practices, particularly of growing online sales and the resulting change in retailing practices and space needs of our tenants, which could have an adverse effect on our results of operations and cash flows. We are focused on anchoring and diversifying our properties with tenants that are more resistant to competition from e-commerce (e.g., groceries, essential retailers, restaurants and service providers), but there can be no assurance that we will be successful in modifying our properties, diversifying our tenant composition and/or adapting our leasing practices. Our expenses may remain constant or increase, even if income from our Combined Shopping Center Portfolio decreases, which could adversely affect our financial condition, results of operations and cash flows. Costs associated with our business, such as common area expenses, utilities, insurance, real estate taxes, mortgage payments, and corporate expenses are relatively inflexible and generally do not decrease in the event that a property is not fully occupied, rental rates decrease, a tenant fails to pay rent or other circumstances cause our revenues to decrease. In addition, inflation could result in higher operating costs. If we are unable to lower our operating costs when revenues decline and/or are unable to pass along cost increases to our tenants, our financial condition, results of operations and cash flows could be adversely impacted. We may be unable to sell our real estate property investments when appropriate or on terms favorable to us. Real estate property investments are illiquid and generally cannot be disposed of quickly. The capitalization rates at which properties may be sold could be higher than historic rates, thereby reducing our potential proceeds from sale. In addition, the Code includes certain restrictions on a REIT’s ability to dispose of properties that are not applicable to other types of real estate companies. Therefore, we may not be able to vary our portfolio in response to economic or other conditions promptly or on terms favorable to us within a time frame that we would need. All of these factors reduce our ability to respond to changes in the performance of our investments and could adversely affect our business, financial condition and results of operations. Certain properties we own have a low tax basis, which may result in a taxable gain on sale. We may utilize like-kind exchanges qualifying under Section 1031 of the Code (“1031 Exchanges”) to mitigate taxable income; however, there can be no assurance that we will identify properties that meet our investment objectives for acquisitions. In the event that we do not utilize 1031 Exchanges, we may be required to distribute the gain proceeds to shareholders or pay income tax, which may reduce our cash flow available to fund our commitments. We may acquire or develop properties or acquire other real estate related companies, and this may create risks. We may acquire or develop properties or acquire other real estate related companies when we believe that an acquisition or development is consistent with our business strategies. We may not succeed in consummating desired acquisitions or in completing developments on time or within budget. When we do pursue a project or acquisition, we may not succeed in leasing newly developed or acquired properties at rents sufficient to cover the costs of acquisition or development and operations. Difficulties in integrating acquisitions may prove costly or time-consuming and could divert management’s attention from other activities. Acquisitions or developments in new markets or industries where we do not have the same level of market knowledge may result in poorer than anticipated performance. We may also abandon acquisition or development opportunities that management has begun pursuing and consequently fail to recover expenses already incurred and will have devoted management’s time to a matter not consummated. Furthermore, our acquisitions of new properties or companies will expose us to the liabilities of those properties or companies, some of which we may not be aware of at the time of the acquisition. In addition, development of our existing properties presents similar risks. 12 Table of Contents Newly acquired or re-developed properties may have characteristics or deficiencies currently unknown to us that affect their value or revenue potential. It is also possible that the operating performance of these properties may decline under our management. As we acquire additional properties, we will be subject to risks associated with managing new properties, including lease-up and tenant retention. In addition, our ability to manage our growth effectively will require us to successfully integrate our new acquisitions into our existing management structure. We may not succeed with this integration or effectively manage additional properties, particularly in secondary markets. Also, newly acquired properties may not perform as expected. We face risks associated with the development of mixed-use commercial properties. We operate, are currently developing, and may in the future develop, properties either alone or through joint ventures with other persons that are known as “mixed-use” developments. This means that in addition to the development of retail space, the project may also include space for residential, office, hotel or other commercial purposes. We have less experience in developing and managing non-retail real estate than we do with retail real estate. As a result, if a development project includes a non-retail use, we may seek to develop that component ourselves, sell the rights to that component to a third-party developer with experience developing properties for such use or partner with such a developer. If we do not sell the rights or partner with such a developer, or if we choose to develop the other component ourselves, we would be exposed not only to those risks typically associated with the development of commercial real estate generally, but also to specific risks associated with the development and ownership of non-retail real estate. In addition, even if we sell the rights to develop the other component or elect to participate in the development through a joint venture, we may be exposed to the risks associated with the failure of the other party to complete the development as expected. These include the risk that the other party would default on its obligations necessitating that we complete the other component ourselves, including providing any necessary financing. In the case of residential properties, these risks include competition for prospective residents from other operators whose properties may be perceived to offer a better location or better amenities or whose rent may be perceived as a better value given the quality, location and amenities that the resident seeks. We will also compete against condominiums and single-family homes that are for sale or rent. In the case of office properties, the risks also include changes in space utilization by tenants due to technology, economic conditions and business culture, declines in financial condition of these tenants and competition for credit worthy office tenants. In the case of hotel properties, the risks also include increases in inflation and utilities that may not be offset by increases in room rates. We are also dependent on business and commercial travelers and tourism. Because we have less experience with residential, office and hotel properties than with retail properties, we expect to retain third parties to manage our residential and other non-retail components as deemed warranted. If we decide to not sell or participate in a joint venture and instead hire a third-party manager, we would be dependent on them and their key personnel who provide services to us, and we may not find a suitable replacement if the management agreement is terminated, or if key personnel leave or otherwise become unavailable to us. Construction projects are subject to risks that materially increase the costs of completion. In the event that we decide to redevelop existing properties, we will be subject to risks and uncertainties associated with construction and development. These risks include, but are not limited to, risks related to obtaining all necessary zoning, land-use, building occupancy and other governmental permits and authorizations, risks related to the environmental concerns of government entities or community groups, risks related to changes in economic and market conditions between development commencement and stabilization, risks related to construction labor disruptions, adverse weather, acts of God or shortages of materials and labor which could cause construction delays and risks related to increases in the cost of labor and materials which could cause construction costs to be greater than projected and adversely impact the amount of our development fees or our financial condition, results of operations and cash flows. Supply chain disruptions and unexpected construction expenses and delays could impact our ability to timely deliver spaces to tenants and/or our ability to achieve the expected value of a construction project or lease, thereby adversely affecting our profitability. The construction and building industry, similar to many other industries, are experiencing worldwide supply chain disruptions due to a multitude of factors that are beyond our control. Materials, parts and labor have also increased in cost over the past year or more, sometimes significantly and over a short period of time. We may incur costs for a property renovation or tenant buildout that exceeds our original estimates due to increased costs for materials or labor or other costs that are unexpected. We also may be unable to complete renovation of a property or tenant space on schedule due to supply chain disruptions or labor shortages, which could result in increased debt service expense or construction costs. Additionally, some tenants may have the right to terminate their leases if a renovation project is not completed on time. The time frame required to recoup our renovation and construction costs and to realize a return on such costs can often be significant and materially adversely affect our profitability. The Americans with Disabilities Act of 1990 could require us to take remedial steps with respect to existing or newly acquired properties. Our existing properties, as well as properties we may acquire, as commercial facilities, are required to comply with Title III of the Americans with Disabilities Act of 1990 (the “ADA”). Investigation of a property may reveal non-compliance with the ADA. The requirements of the ADA, or of other federal, state or local laws or regulations, also may change in the future and restrict further renovations of our properties with respect to access for disabled persons. Future compliance with the ADA may require expensive changes to the properties. 13 Table of Contents We do not have exclusive control over our joint venture and preferred equity investments, such that we are unable to ensure that our objectives will be pursued. We have invested in some properties as a co-venturer or a partner, instead of owning directly. In these investments, we do not have exclusive control over the development, financing, leasing, management and other aspects of these investments. As a result, the co-venturer or partner might have interests or goals that are inconsistent with ours, take action contrary to our interests or otherwise impede our objectives. These investments involve risks and uncertainties. The co-venturer or partner may fail to provide capital or fulfill its obligations, which may result in certain liabilities to us for guarantees and other commitments. Conflicts arising between us and our partners may be difficult to manage and/or resolve and it could be difficult to manage or otherwise monitor the existing business arrangements. The co-venturer or partner also might become insolvent or bankrupt, which may result in significant losses to us. In addition, joint venture arrangements may decrease our ability to manage risk and implicate additional risks, such as: ● our joint venture partner having potentially inferior financial capacity, diverging business goals and strategies and the need for their continued cooperation; ● our inability to take actions with respect to the joint venture activities that we believe are favorable to us if our joint venture partner does not agree; ● our inability to control the legal entity that has title to the real estate associated with the joint venture; ● our lenders may not be easily able to sell our joint venture assets and investments or may view them less favorably as collateral, which could negatively affect our liquidity and capital resources; ● our joint venture partners can take actions that we may not be able to anticipate or prevent, which could result in negative impacts on our debt and equity; and ● our joint venture partners’ business decisions or other actions or omissions may result in harm to our reputation or adversely affect the value of our investments. Our joint venture and preferred equity investments generally own real estate properties for which the economic performance and value is subject to all the risks associated with owning and operating real estate as described above. We may not be able to recover our investments in marketable securities, mortgage receivables or other investments, which may result in significant losses to us. Our investments in marketable securities are subject to specific risks relating to the particular issuer of the securities, including the financial condition and business outlook of the issuer, which may result in significant losses to us. Marketable securities are generally unsecured and may also be subordinated to other obligations of the issuer. As a result, investments in marketable securities are subject to risks of: ● limited liquidity in the secondary trading market; ● substantial market price volatility, resulting from changes in prevailing interest rates; ● subordination to the prior claims of banks and other senior lenders to the issuer; ● the possibility that earnings of the issuer may be insufficient to meet its debt service and distribution obligations; and ● the declining creditworthiness and potential for insolvency of the issuer during periods of rising interest rates and economic downturn. These risks may adversely affect the value of outstanding marketable securities and the ability of the issuers to make distribution payments. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Footnote 9 of the Notes to the Consolidated Financial Statements included in this Form 10-K for additional discussion regarding the shares held by the Company of Albertsons Companies, Inc. (“ACI”). Our investments in mortgage receivables are subject to specific risks relating to the borrower and the underlying property. In the event of a default by a borrower, it may be necessary for us to foreclose our mortgage or engage in costly negotiations. Delays in liquidating defaulted mortgage loans and repossessing and selling the underlying properties could reduce our investment returns. Furthermore, in the event of default, the actual value of the property collateralizing the mortgage may decrease. A decline in real estate values will adversely affect the value of our loans and the value of the properties collateralizing our loans. Our mortgage receivables may be or become subordinated to mechanics' or materialmen's liens or property tax liens. In these instances, we may need to protect a particular investment by making payments to maintain the current status of a prior lien or discharge it entirely. Where that occurs, the total amount we recover may be less than our total investment, resulting in a loss. In the event of a major loan default or several loan defaults resulting in losses, our investments in mortgage receivables would be materially and adversely affected. 14 Table of Contents The economic performance and value of our other investments, which we do not control and are in retail operations, are subject to risks associated with owning and operating retail businesses, including: ● changes in the national, regional and local economic climate; ● the adverse financial condition of some large retailing companies; ● increasing use by customers of e-commerce and online store sites; and ● ongoing consolidation in the retail sector. A decline in the value of our other investments may require us to recognize an other-than-temporary impairment (“OTTI”) against such assets. When the fair value of an investment is determined to be less than its amortized cost at the balance sheet date, we assess whether the decline is temporary or other-than-temporary. If we intend to sell an impaired asset, or it is more likely than not that we will be required to sell the impaired asset before any anticipated recovery, then we must recognize an OTTI through charges to earnings equal to the entire difference between the asset’s amortized cost and its fair value at the balance sheet date. When an OTTI is recognized through earnings, a new cost basis is established for the asset, and the new cost basis may not be adjusted through earnings for subsequent recoveries in fair value. Our real estate assets may be subject to impairment charges. We periodically assess whether there are any indicators that the value of our real estate assets and other investments may be impaired. A property’s value is considered to be impaired only if the estimated aggregate future undiscounted property cash flows are less than the carrying value of the property. In our estimate of cash flows, we consider factors such as trends and prospects and the effects of demand and competition on expected future operating income. If we are evaluating the potential sale of an asset or redevelopment alternatives, the undiscounted future cash flows consider the most likely course of action as of the balance sheet date based on current plans, intended holding periods and available market information. We are required to make subjective assessments as to whether there are impairments in the value of our real estate assets and other investments. Impairment charges have an immediate direct impact on our earnings. There can be no assurance that we will not take additional charges in the future related to the impairment of our assets. Any future impairment could have a material adverse effect on our results of operations in the period in which the charge is taken. We intend to continue to sell our lesser quality assets and may not be able to recover our investments, which may result in significant losses to us. There can be no assurance that we will be able to recover the current carrying amount of all of our lesser quality properties and investments and those of our unconsolidated joint ventures in the future. Our failure to do so would require us to recognize impairment charges for the period in which we reached that conclusion, which could materially and adversely affect our financial condition, results of operations and cash flows. We have completed our efforts to exit Mexico, Chile, Brazil, Peru and Canada, however, we cannot predict the impact of laws and regulations affecting these international operations, including the United States Foreign Corrupt Practices Act, or the potential that we may face regulatory sanctions. Our international operations have included properties in Mexico, Chile, Brazil, Peru and Canada and are subject to a variety of United States and foreign laws and regulations, including the United States Foreign Corrupt Practices Act and foreign tax laws and regulations. Although we have completed our efforts to exit our investments in Mexico, South America and Canada, we cannot assure you that our past practices will continue to be found to be in compliance with such laws or regulations. In addition, we cannot predict the manner in which such laws or regulations might be administered or interpreted, or when, or the potential that we may face regulatory sanctions or tax audits as a result of our international operations. We have experienced cybersecurity attacks and could in the future be subject to significant disruption, data loss or other security incidents or breaches. Our information technology (“IT”) networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations and, in some cases, may be critical to the operations of certain of our tenants. While we maintain some of our own critical IT networks and related systems, we also depend on third parties to provide important software, technologies, tools and a broad array of services and operational functions, including payroll, human resources, electronic communications and finance functions. In the ordinary course of our business, we and our third-party service providers collect, process, transmit and store sensitive information and data, including intellectual property, our proprietary business information and that of our customers, suppliers and business partners, as well as personally identifiable information. We, and our third-party service providers like all businesses, are subject to cyberattacks and security incidents, which threaten the confidentiality, integrity, and availability of our systems and information resources. Those attacks and incidents may be due to intentional or unintentional acts by employees, customers, contractors or third parties, who seek to gain unauthorized access to our or our service providers’ systems to disrupt operations, corrupt data, or steal confidential or personal information through malware, computer viruses, ransomware, software or hardware vulnerabilities, social engineering (e.g., phishing attachments to e-mails) or other vectors. The risk of a cybersecurity attack, breach or operational disruption, particularly through a cyber incident, including by computer hackers, foreign governments or cyber terrorists, has generally increased. Although we make efforts to maintain the security and integrity of IT networks and related systems on which we rely, and we have implemented various measures to manage the risk of a cyberattack, security breach or security related disruption, there can be no assurance that our efforts and measures or those of our third-party services providers will be effective or that attempted security breaches or disruptions would not be successful or damaging. 15 Table of Contents Attack methodologies change frequently or are not recognized until launched, and we may be unable to investigate or remediate incidents because attackers increasingly use techniques and tools designed to circumvent controls, to avoid detection, and to remove or obfuscate forensic evidence. We have in the past experienced adverse events that have not resulted, and are not expected to result, in a material impact on the Company’s business operations or financial results. For example, in February 2023, the Company experienced a criminal ransomware attack affecting data contained on legacy servers of Weingarten Realty Investors (“WRI”). The Company acquired WRI in August 2021. The affected servers and exfiltrated data were on the WRI network. The WRI network is separate and is not connected to the Company’s network. The Company promptly initiated an investigation and its response protocols, including deploying containment measures such as taking affected systems offline, implementing enhanced monitoring technology and data recovery processes. The Company also notified federal law enforcement, engaged the services of cybersecurity and forensics professionals, and restored affected systems. The WRI network data is historical and stored for archival purposes. A cyber incident could: ● disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our tenants; ● result in misstated financial reports, violations of loan covenants and/or missed reporting deadlines; ● result in our inability to properly monitor our compliance with the rules and regulations regarding our qualification as a REIT; ● result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of proprietary, confidential, sensitive or otherwise valuable information of ours or others, which others could use to compete against us or for disruptive, destructive or otherwise harmful purposes and outcomes; ● result in our inability to maintain the building systems relied upon by our tenants for the efficient use of their leased space; ● require significant management attention and resources to remediate systems, fulfill compliance requirements and/or to remedy any damages that result; ● subject us to regulatory enforcement, including investigative costs and fines or penalties, as the White House, SEC and other regulators have increased their focus on companies’ cybersecurity vulnerabilities and risks; ● subject us to litigation claims for negligence, breach of contract or other agreements or other causes of action, potentially resulting in remedies such as damages, credits, penalties or termination of leases or other agreements; or ● damage our reputation among our tenants, investors and associates. The occurrence or perception of a cyberattack or security incident could result in operational interruption, damage to our relationship with our tenants, and confidential data exposure. In addition, federal and state governments and agencies have enacted, and continue to develop, broad data protection legislation, regulations, and guidance that require companies to increasingly implement, monitor and enforce reasonable cybersecurity measures. These governmental entities and agencies are aggressively investigating and enforcing such legislation, regulations and guidance across industry sectors and companies. We may be required to expend significant capital and other resources to address an attack or incident, including those as a result of the February 2023 incident involving the WRI legacy servers, and our insurance may not cover some or all of our losses resulting from an attack or incident. These losses may include payments for investigations, forensic analyses, legal advice, public relations advice, system repair or replacement, or other services, in addition to any remedies or relief that may result from legal proceedings. The incurrence of these losses, costs or business interruptions may adversely affect our reputation as well as our financial condition, results of operations and cash flows. We may be subject to liability under environmental laws, ordinances and regulations. Under various federal, state, and local laws, ordinances and regulations, we may be considered an owner or operator of real property and may be responsible for paying for the disposal or treatment of hazardous or toxic substances released on or in our property, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property). This liability may be imposed whether or not we knew about, or were responsible for, the presence of hazardous or toxic substances. The Company has environmental insurance coverage on certain of its properties, however this coverage may not be sufficient to cover any or all expenses associated with the aforementioned risks. 16 Table of Contents Natural disasters, severe weather conditions and the effects of climate change could have an adverse impact on our financial condition, results of operations and cash flows. Our operations are located in areas that are subject to natural disasters and severe weather conditions such as hurricanes, tornados, earthquakes, snowstorms, floods and fires, and the frequency of these natural disasters and severe weather conditions may increase due to climate change. The occurrence of natural disasters, severe weather conditions and the effects of climate change, including extreme temperatures and ambient temperature increases, can delay new development or redevelopment projects, decrease the attractiveness of locations, increase investment costs to repair or replace damaged properties (or make repair or replacement impossible), increase operation costs, including the cost of energy at our properties, increase costs for future property insurance, negatively impact the tenant demand for lease space and cause substantial damages or losses to our properties which could exceed any applicable insurance coverage. The incurrence of any of these losses, costs or business interruptions may adversely affect our financial condition, results of operations and cash flows. We anticipate the potential effects of climate change will increasingly impact the decisions and analysis we make with respect to our properties, since climate change considerations can impact the relative desirability of locations and the cost of operating and insuring real estate properties. In addition, changes in government legislation and regulation on climate change could result in increased capital expenditures to improve the energy efficiency of our existing properties and could also require us to spend more on our development or redevelopment projects without a corresponding increase in revenues, which may adversely affect our financial condition, results of operations and cash flows. Transition impacts of climate change may subject us to increased regulations, reporting requirements (such as the SEC’s proposed climate change disclosure rule), standards, or expectations regarding the environmental impacts of our or our tenants’ business. Failure to disclose accurate information in a timely manner may also adversely affect our reputation, business, or financial performance. Pandemics or other health crises may adversely affect our tenants’ financial condition and the profitability of our properties. Our business and the businesses of our tenants could be materially and adversely affected by the risks, or the public perception of the risks, related to a pandemic or other health crisis, such as the outbreak of novel coronavirus (COVID-19). Such events could result in the complete or partial closure of one or more of our tenants’ manufacturing facilities or distribution centers, temporary or long-term disruption in our tenants’ supply chains from local and international suppliers, and /or delays in the delivery of our tenants’ inventory. The profitability of our properties depends, in part, on the willingness of customers to visit our tenants’ businesses. The risk, or public perception of the risk, of a pandemic or media coverage of infectious diseases could cause employees or customers to avoid our properties, which could adversely affect foot traffic to our tenants’ businesses and our tenants’ ability to adequately staff their businesses. Such events could adversely impact tenants’ sales and/or cause the temporary closure of our tenants’ businesses, which could severely disrupt their operations and have a material adverse effect on our business, financial condition and results of operations. Financial disruption or a prolonged economic downturn could materially and adversely affect the Company’s business. Worldwide financial markets have recently experienced periods of extraordinary disruption and volatility, resulting in heightened credit risk, reduced valuation of investments and decreased economic activity. Moreover, many companies have experienced reduced liquidity and uncertainty as to their ability to raise capital during such periods of market disruption and volatility. In the event that these conditions recur or result in a prolonged economic downturn, our results of operations, financial position or liquidity could be materially and adversely affected. These market conditions may affect the Company's ability to access debt and equity capital markets. In addition, as a result of recent financial events, we may face increased regulation. Corporate responsibility, specifically related to ESG factors and commitments, imposes additional costs and expose us to new risks. Sustainability evaluations is becoming more broadly accepted or expected by investors and shareholders. Certain organizations that provide corporate governance and other corporate risk information to investors and shareholders have developed scores and ratings to evaluate companies and investment funds based upon ESG or “sustainability” metrics. Many investment funds focus on positive ESG business practices and sustainability scores when making investments and may consider a company’s sustainability score as a reputational or other factor in making an investment decision. In addition, investors, particularly institutional investors, use these scores to benchmark companies against their peers and if a company is perceived as lagging, these investors may engage with companies to require improved ESG disclosure or performance. We may face reputational damage or additional costs in the event our corporate responsibility procedures or standards do not meet the standards set by various constituencies. In addition, the criteria by which companies are rated may change, which could cause us to receive lower scores than previous years. A low sustainability score could result in a negative perception of the Company, or exclusion of our common stock from consideration by certain investors who may elect to invest with our competition instead. In addition, as part of our corporate responsibility, we have adopted certain ESG goals, including greenhouse gas emissions reduction targets and other sustainability initiatives. If we cannot not meet these goals fully or on time, we may face reputational damage. Moreover, while we may create and publish voluntary disclosures regarding ESG matters from time to time, many of the statements in those voluntary disclosures are based on hypothetical expectations and assumptions that may or may not be representative of current or actual risks or events or forecasts of expected risks or events, including the costs associated therewith. Such expectations and assumptions are necessarily uncertain and may be prone to error or subject to misinterpretation given the long timelines involved and the lack of an established single approach to identifying, measuring and reporting on many ESG matters. Such disclosures may also be at least partially reliant on third-party information that we have not independently verified or cannot be independently verified. In addition, we expect there will likely be increasing levels of regulation, disclosure-related and otherwise, with respect to ESG matters, and increased regulation will likely lead to increased compliance costs as well as scrutiny that could heighten all of the risks identified in this risk factor. Such ESG matters may also impact our suppliers or customers, which may adversely impact our business, financial condition, or results of operations. 17 Table of Contents Our success depends largely on the continued service and availability of key personnel. We depend on the deep industry knowledge and efforts of key personnel, including our executive officers, to manage our day-to-day operations and strategic business direction. Our ability to attract, retain and motivate key personnel may significantly impact our future performance, and if any of our executive officers or other key personnel depart the Company, for any reason, we may not be able to easily replace such individual. The loss of the services of our executive officers and other key personnel could have a material adverse effect on our financial condition, results of operations and cash flows. Retail operating conditions may adversely affect our results of operations. A retail property’s revenues and value may be adversely affected by a number of factors, many of which apply to real estate investment generally, but which also include trends in the retail industry and perceptions by retailers or shoppers of the safety, convenience and attractiveness of the retail property. Our retail properties are public locations, and any incidents of crime or violence, including acts of terrorism, could result in a reduction of business traffic to tenant stores in our properties. Any such incidents may also expose us to civil liability or harm our reputation. In addition, to the extent that the investing public has a negative perception of the retail sector, the value of our retail properties may be negatively impacted. Our Umbrella Partnership Real Estate Investment Trust (“UPREIT”) structure may result in potential conflicts of interest with members of Kimco OP whose interests may not be aligned with those of our stockholders. Our directors and officers have duties to our corporation and our stockholders under Maryland law in connection with their management of the corporation. At the same time, we, as managing member of Kimco OP, our operating company, have fiduciary duties under Delaware law to our operating company and to its members in connection with the management of our operating company. If we admit outside members to our operating company, our duties as managing member of our operating company and to its members may come into conflict with the duties of our directors and officers to the corporation and our stockholders. While the operating agreement contains provisions limiting the fiduciary duties of the managing member to the operating company and its members, the provisions of Delaware law that allow for such limitations have not been fully tested in a court of law. Risks Related to Our Debt and Equity Securities We may be unable to obtain financing through the debt and equity markets, which would have a material adverse effect on our growth strategy, our financial condition and our results of operations. We cannot assure you that we will be able to access the credit and/or equity markets to obtain additional debt or equity financing or that we will be able to obtain financing on terms favorable to us. The inability to obtain financing on a timely basis could have negative effects on our business, such as: ● we could have great difficulty acquiring or developing properties, which would materially adversely affect our investment strategy; ● our liquidity could be adversely affected; ● we may be unable to repay or refinance our indebtedness; ● we may need to make higher interest and principal payments or sell some of our assets on terms unfavorable to us to fund our indebtedness; or ● we may need to issue additional capital stock, which could further dilute the ownership of our existing stakeholders. Adverse changes in our credit ratings could impair our ability to obtain additional debt and equity financing on terms favorable to us, if at all, and could significantly reduce the market price of our publicly traded securities. We are subject to financial covenants that may restrict our operating and acquisition activities. Our Credit Facility and the indentures under which our senior unsecured debt is issued contain certain financial and operating covenants, including, among other things, certain coverage ratios and limitations on our ability to incur debt, make dividend payments, sell all or substantially all of our assets and engage in mergers and consolidations and certain acquisitions. These covenants may restrict our ability to pursue certain business initiatives or certain acquisition transactions that might otherwise be advantageous. In addition, failure to meet any of the financial covenants could cause an event of default under our Credit Facility and the indentures and/or accelerate some or all of our indebtedness, which would have a material adverse effect on us. We have a substantial amount of indebtedness and may need to incur more in the future. We have substantial indebtedness. The level of indebtedness could have adverse consequences on our business, such as: ● requiring the Company to use a substantial portion of our cash flow from operations to service our indebtedness, which would reduce the available cash flow to fund working capital, capital expenditures, development projects, and other general corporate purposes and reduce cash for distributions; ● limiting our ability to obtain additional financing to fund our working capital needs, acquisitions, capital expenditures, or other debt service requirements or for other purposes; ● increasing our costs of incurring additional debt; ● subjecting us to floating interest rates; ● limiting our ability to compete with other companies that are not as highly leveraged, as we may be less capable of responding to adverse economic and industry conditions; 18 Table of Contents ● restricting the Company from making strategic acquisitions, developing properties, or exploiting business opportunities; ● restricting the way in which we conduct our business because of financial and operating covenants in the agreements governing our existing and future indebtedness; ● exposing the Company to potential events of default (if not cured or waived) under covenants contained in our debt instruments that could have a material adverse effect on our business, financial condition, and operating results; ● increasing our vulnerability to a downturn in general economic conditions; and ● limiting our ability to react to changing market conditions in its industry. The impact of any of these potential adverse consequences could have a material adverse effect on our results of operations, financial condition, and liquidity. Changes in market conditions could adversely affect the market price of our publicly traded securities. The market price of our publicly traded securities depends on various market conditions, which may change from time-to-time. Among the market conditions that may affect the market price of our publicly traded securities are the following: ● the extent of institutional investor interest in us; ● the reputation of REITs generally and the reputation of REITs with portfolios similar to ours; ● the attractiveness of the securities of REITs in comparison to securities issued by other entities, including securities issued by other real estate companies; ● our financial condition and performance; ● the market’s perception of our growth potential, potential future cash dividends and risk profile; ● an increase in market interest rates, which may lead prospective investors to demand a higher distribution rate in relation to the price paid for our shares; and ● general economic and financial market conditions. We may change the dividend policy for our common stock in the future. The decision to declare and pay dividends on our common stock in the future, as well as the timing, amount and composition of any such future dividends, will be at the sole discretion of our Board of Directors and will depend on our earnings, operating cash flows, liquidity, financial condition, capital requirements, contractual prohibitions or other limitations under our indebtedness including preferred stock, the annual distribution requirements under the REIT provisions of the Code, state law and such other factors as our Board of Directors deems relevant or are requirements under the Code or state or federal laws. Any negative change in our dividend policy could have a material adverse effect on the market price of our common stock. Our charter and bylaws and Maryland law contain provisions that may delay, defer or prevent a change of control transaction, even if such a change in control may be in our best interest, and as a result may depress the market price of our securities. Our charter contains certain ownership limits. Our charter contains various provisions that are intended to preserve our qualification as a REIT and, subject to certain exceptions, authorize our directors to take such actions as are necessary or appropriate to preserve our qualification as a REIT. For example, our charter prohibits the actual, beneficial or constructive ownership by any person of more than 9.8% in value or number of shares, whichever is more restrictive, of the outstanding shares of our common stock, and more than 9.8% in value of the aggregate outstanding shares of all classes and series of our stock. Our Board of Directors, in its sole and absolute discretion, may exempt a person, prospectively or retroactively, from these ownership limits if certain conditions are satisfied. The restrictions on ownership and transfer of our stock may: ● discourage a tender offer or other transactions or a change in management or of control that might involve a premium price for our common stock or that our stockholders otherwise believe to be in their best interests; or ● result in the transfer of shares acquired in excess of the restrictions to a trust for the benefit of a charitable beneficiary and, as a result, the forfeiture by the acquirer of the benefits of owning the additional shares. Risks Related to Our Status as a REIT and Related U.S. Federal Income Tax Matters Loss of our tax status as a REIT or changes in U.S. federal income tax laws, regulations, administrative interpretations or court decisions relating to REITs could have significant adverse consequences to us and the value of our securities. We have elected to be taxed as a REIT for U.S. federal income tax purposes under the Code. We believe that we are organized and operate in a manner that has allowed us to qualify and will allow us to remain qualified as a REIT under the Code. However, there can be no assurance that we have qualified or will continue to qualify as a REIT for U.S. federal income tax purposes. 19 Table of Contents Qualification as a REIT involves the application of highly technical and complex Code provisions, for which there are only limited judicial and administrative interpretations. The determination of various factual matters and circumstances not entirely within our control may affect our ability to qualify as a REIT. The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the U.S. Internal Revenue Service (the “IRS”) and U.S. Department of the Treasury. We cannot predict how changes in the tax laws might affect our investors or us. New legislation, regulations, administrative interpretations or court decisions could significantly and negatively change the tax laws with respect to qualification as a REIT, the U.S. federal income tax consequences of such qualification or the desirability of an investment in a REIT relative to other investments. In order to qualify as a REIT, we must satisfy a number of requirements, including requirements regarding the ownership of our stock, the composition of our assets and the sources of our gross income. Also, we must make distributions to stockholders aggregating annually at least 90% of our REIT taxable income, excluding net capital gains. Furthermore, we own a direct or indirect interest in certain subsidiary REITs which have elected to be taxed as REITs for U.S. federal income tax purposes under the Code. Provided that each subsidiary REIT qualifies as a REIT, our interest in such subsidiary REIT will be treated as a qualifying real estate asset for purposes of the REIT asset tests. To qualify as a REIT, the subsidiary REIT must independently satisfy all of the REIT qualification requirements. The failure of a subsidiary REIT to qualify as a REIT could have an adverse effect on our ability to comply with the REIT income and asset tests, and thus our ability to qualify as a REIT. If we were to lose our REIT status, we would face serious tax consequences that would substantially reduce the funds available to pay distributions to stockholders for each of the years involved because: ● we would not be allowed a deduction for dividends to stockholders in computing our taxable income, and we would be subject to the regular U.S. federal corporate income tax; ● we could possibly be subject to a federal alternative minimum tax or increased state and local taxes; ● unless we were entitled to relief under statutory provisions, we could not elect to be taxed as a REIT for four taxable years following the year during which we were disqualified; and ● we would not be required to make distributions to stockholders. Our failure to qualify as a REIT or new legislation or changes in U.S. federal income tax laws including with respect to qualification as a REIT or the tax consequences of such qualification, could also impair our ability to expand our business or raise capital and have a materially adverse effect on the value of our securities. To maintain our REIT status, we may be forced to borrow funds during unfavorable market conditions, and the unavailability of such capital on favorable terms at the desired times, or at all, may cause us to curtail our investment activities and/or to dispose of assets at inopportune times, which could adversely affect our financial condition, results of operations, cash flows and per share trading price of our common stock. To qualify as a REIT, we generally must distribute to our stockholders at least 90% of our REIT taxable income each year, excluding net capital gains, and we will be subject to regular U.S. federal corporate income taxes on the amount we distribute that is less than 100% of our net taxable income each year, including capital gains. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years. While we have historically satisfied these distribution requirements by making cash distributions to our stockholders, a REIT is permitted to satisfy these requirements by making distributions of cash or other property, including, in limited circumstances, its own stock. Assuming we continue to satisfy these distribution requirements with cash, we may need to borrow funds to meet the REIT distribution requirements and avoid the payment of income and excise taxes even if the then prevailing market conditions are not favorable for these borrowings. These borrowing needs could result from differences in timing between the actual receipt of cash and inclusion of income for U.S. federal income tax purposes, or the effect of non-deductible capital expenditures, the creation of cash reserves or required debt or amortization payments. These sources, however, may not be available on favorable terms or at all. Our access to third-party sources of capital depends on a number of factors, including the market's perception of our growth potential, our current debt levels, the market price of our common stock, and our current and potential future earnings. We cannot assure you that we will have access to such capital on favorable terms at the desired times, or at all, which may cause us to curtail our investment activities and/or to dispose of assets at inopportune times, and could adversely affect our financial condition, results of operations, cash flows and per share trading price of our common stock. The tax imposed on REITs engaging in “prohibited transactions” may limit our ability to engage in transactions which would be treated as sales for U.S. federal income tax purposes. A REIT's net income from prohibited transactions is subject to a 100% penalty tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, held primarily for sale to customers in the ordinary course of business. Although we do not intend to hold any properties that would be characterized as held for sale to customers in the ordinary course of our business, unless a sale or disposition qualifies under certain statutory safe harbors, or is held through a taxable REIT subsidiary, such characterization is a factual determination and no guarantee can be given that the IRS would agree with our characterization of our properties or that we will always be able to make use of the available safe harbors. 20 Table of Contents Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends. The maximum tax rate applicable to “qualified dividend income” payable to U.S. stockholders that are individuals, trusts and estates is 20%. Dividends payable by REITs, however, generally are not eligible for these reduced rates. U.S. stockholders that are individuals, trusts and estates generally may deduct up to 20% of the ordinary dividends (i.e., dividends not designated as capital gain dividends or qualified dividend income) received from a REIT for taxable years beginning before January 1, 2026. Although this deduction reduces the effective tax rate applicable to certain dividends paid by REITs (generally to 29.6% assuming the shareholder is subject to the 37% maximum rate), such tax rate is still higher than the tax rate applicable to corporate dividends that constitute qualified dividend income. Accordingly, investors who are individuals, trusts and estates may perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends treated as qualified dividend income, which could materially and adversely affect the value of the shares of REITs, including the per share trading price of our common stock. Item 1B. Unresolved Staff Comments None. Item 2. Properties Real Estate Portfolio. As of December 31, 2022, the Company had interests in 532 shopping center properties aggregating 90.8 million square feet of GLA located in 28 states. In addition, the Company had 23 other property interests, primarily through the Company’s preferred equity investments and other investments, totaling 5.7 million square feet of GLA. Open-air shopping centers comprise the primary focus of the Company's current portfolio. As of December 31, 2022, the Company’s Combined Shopping Center Portfolio, including noncontrolling interests, was 95.7% leased. The Company's open-air shopping center properties, which are generally owned and operated through subsidiaries or joint ventures, had an average size of 170,754 square feet as of December 31, 2022. The Company generally retains its shopping centers for long-term investment and consequently pursues a program of regular physical maintenance together with redevelopment, major renovations and refurbishing to preserve and increase the value of its properties. This includes renovating existing facades, installing uniform signage, resurfacing parking lots and enhancing parking lot lighting. During 2022, the Company expended $113.9 million in connection with property redevelopments and $79.8 million related to improvements. 21 Table of Contents The Company's management believes its experience in the real estate industry and its relationships with numerous national and regional tenants gives it an advantage in an industry where ownership is fragmented among a large number of property owners. The Company's open-air shopping centers are usually "anchored" by a grocery store, home improvement centers, off-price retailer, discounter or service-oriented tenant. As one of the original participants in the growth of the shopping center industry and the nation's largest owner and operator of shopping centers, the Company has established close relationships with a large number of major national and regional retailers. Some of the major national and regional companies that are tenants in the Company's shopping center properties include TJX Companies, The Home Depot, Albertsons Companies, Ross Stores, Amazon/Whole Foods Market, PetSmart, Ahold Delhaize, Kroger, Burlington Stores and Walmart. The Company reduces its operating and leasing risks through diversification achieved by the geographic distribution of its properties and a large tenant base. As of December 31, 2022, no single open-air shopping center accounted for more than 1.3% of the Company's annualized base rental revenues, including the proportionate share of base rental revenues from properties in which the Company has less than a 100% economic interest, or more than 1.4% of the Company’s total shopping center GLA. At December 31, 2022, the Company’s five largest tenants were TJX Companies, The Home Depot, Ross Stores, Albertsons Companies and Amazon/Whole Foods Market, which represented 3.7%, 2.1%, 1.9%, 1.9% and 1.8%, respectively, of the Company’s annualized base rental revenues, including the proportionate share of base rental revenues from properties in which the Company has less than a 100% economic interest. A substantial portion of the Company's income consists of rent received under long-term leases. Most of the leases provide for the payment of fixed-base rentals monthly in advance and for the payment by tenants of an allocable share of the real estate taxes, insurance, utilities and common area maintenance expenses incurred in operating the shopping centers (certain of the leases provide for the payment of a fixed-rate reimbursement of these such expenses). Although many of the leases require the Company to make roof and structural repairs as needed, a number of tenant leases place that responsibility on the tenant, and the Company's standard small store lease provides for reimbursements by the tenant as part of common area maintenance. Additionally, many of the leases provide for reimbursements by the tenant of capital expenditures. Minimum base rental revenues and operating expense reimbursements accounted for 97% and other revenues, including percentage rents, accounted for 3% of the Company's total revenues from rental properties for the year ended December 31, 2022. The Company's management believes that the base rent per leased square foot for many of the Company's existing leases is generally lower than the prevailing market-rate base rents in the geographic regions where the Company operates, reflecting the potential for future growth. Additionally, a majority of the Company’s leases have provisions requiring contractual rent increases. The Company’s leases may also include escalation clauses, which provide for increases based upon changes in the consumer price index or similar inflation indices. As of December 31, 2022, the Company’s consolidated operating portfolio, comprised of 428 shopping center properties aggregating 70.6 million square feet of GLA, was 95.5% leased. The consolidated operating portfolio consists entirely of properties located in the U.S., inclusive of Puerto Rico. For the period of January 1, 2022 to December 31, 2022, the Company increased the average base rent per leased square foot, which includes the impact of tenant concessions, in its consolidated portfolio of open-air shopping centers from $19.05 to $19.60, an increase of $0.55. This increase primarily consists of (i) a $0.28 increase relating to rent step-ups within the portfolio and new leases signed, net of leases vacated, (ii) a $0.17 increase relating to acquisitions and (iii) a $0.10 increase relating to dispositions. The Company has a total of 8,292 leases in the consolidated operating portfolio. The following table sets forth the aggregate lease expirations for each of the next ten years, assuming no renewal options are exercised. For purposes of the table, the Total Annual Base Rent Expiring represents annualized rental revenue, excluding the impact of straight-line rent, for each lease that expires during the respective year. Amounts in thousands, except for number of leases data: Year Ending December 31, Number of Leases Expiring Square Feet Expiring Total Annual Base Rent Expiring % of Gross Annual Rent (1) 167 469 $ 11,527 0.9 % 2023 867 4,771 $ 89,735 7.2 % 2024 1,185 7,648 $ 146,985 11.8 % 2025 1,149 8,134 $ 152,931 12.3 % 2026 1,071 9,563 $ 158,673 12.7 % 2027 1,138 9,726 $ 175,091 14.0 % 2028 790 7,860 $ 141,934 11.4 % 2029 432 3,915 $ 73,695 5.9 % 2030 321 2,612 $ 58,702 4.7 % 2031 338 2,385 $ 54,674 4.4 % 2032 402 2,901 $ 56,550 4.5 % (1) Leases currently under a month-to-month lease or in process of renewal. 22 Table of Contents During 2022, the Company executed 1,696 leases totaling 10.7 million square feet in the Company’s consolidated operating portfolio comprised of 525 new leases and 1,171 renewals and options. The leasing costs associated with these new leases are estimated to aggregate $107.4 million or $39.40 per square foot. These costs include $84.3 million of tenant improvements and $23.1 million of external leasing commissions. The average rent per square foot for (i) new leases was $21.76 and (ii) renewals and options was $18.20. The Company will seek to obtain rents that are higher than amounts within its expiring leases, however, there are many variables and uncertainties which can significantly affect the leasing market at any time; as such, the Company cannot guarantee that future leases will continue to be signed for rents that are equal to or higher than current amounts. Ground-Leased Properties. The Company has interests in 40 consolidated shopping center properties that are subject to long-term ground leases where a third party owns and has leased the underlying land to the Company to construct and/or operate a shopping center. The Company pays rent for the use of the land and generally is responsible for all costs and expenses associated with the building and improvements. At the end of these long-term leases, unless extended, the land together with all improvements reverts to the landowner. More specific information with respect to each of the Company's property interests is set forth in Exhibit 99.1, which is incorporated herein by reference. Item 3. Legal Proceedings The Company is not presently involved in any litigation nor, to its knowledge, is any litigation threatened against the Company or its subsidiaries that, in management's opinion, would result in any material effect on the Company's ownership, management or operation of its properties taken as a whole, or which is not covered by the Company's insurance. Item 4. Mine Safety Disclosures Not applicable. 23 Table of Contents PART II Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information: The Company’s common stock is traded on the NYSE under the trading symbol "KIM". Holders: The number of holders of record of the Company's common stock, par value $0.01 per share, was 2,767 as of January 31, 2023. Dividends: Since the IPO, the Company has paid regular quarterly cash dividends to its stockholders. While the Company intends to continue paying regular quarterly cash dividends, future dividend declarations will be paid at the discretion of the Board of Directors and will depend on the actual cash flows of the Company, its financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Code and such other factors as the Board of Directors deems relevant. The Company’s Board of Directors will continue to evaluate the Company’s dividend policy on a quarterly basis as they monitor sources of capital and evaluate operating fundamentals. The Company is required by the Code to distribute at least 90% of its REIT taxable income determined without regard to the dividends paid deduction and excluding any net capital gain. In addition, the Company will be subject to federal income tax at regular corporate rates to the extent that it distributes less than 100% of its net taxable income, including any net capital gains. The actual cash flow available to pay dividends will be affected by a number of factors, including the revenues received from operating properties, the operating expenses of the Company, the interest expense on its borrowings, the ability of lessees to meet their obligations to the Company, the ability to refinance near-term debt maturities and any unanticipated capital expenditures. The following table reflects the income tax status of distributions per share paid to holders of shares of our common stock: Year Ended December 31, 2022 2021 Dividend paid per share $ 0.84 $ 0.68 Ordinary income 81 % 77 % Capital gains 16 % 3 % Return of capital 3 % 20 % In addition to common stock offerings, the Company has capitalized on the growth in its business through the issuance of unsecured fixed rate medium-term notes, underwritten bonds, unsecured bank debt, mortgage debt and perpetual preferred stock. Borrowings under the Company's unsecured revolving credit facility have also been an interim source of funds to both finance the purchase of properties and other investments and meet any short-term working capital requirements. The various instruments governing the Company's issuance of its unsecured public debt, bank debt, mortgage debt and preferred stock impose certain restrictions on the Company regarding dividends, voting, liquidation and other preferential rights available to the holders of such instruments. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Footnotes 13, 14 and 19 of the Notes to Consolidated Financial Statements included in this Form 10-K. The Company does not believe that the preferential rights available to the holders of its Class L Preferred Stock and Class M Preferred Stock, the financial covenants contained in its public bond indentures, as amended, or the credit agreement for its Credit Facility will have an adverse impact on the Company's ability to pay dividends in the normal course to its common stockholders or to distribute amounts necessary to maintain its qualification as a REIT. The Company maintains a dividend reinvestment and direct stock purchase plan (the "Plan") pursuant to which common and preferred stockholders and other interested investors may elect to automatically reinvest their dividends to purchase shares of the Company’s common stock or, through optional cash payments, purchase shares of the Company’s common stock. The Company may, from time-to-time, either (i) purchase shares of its common stock in the open market or (ii) issue new shares of its common stock for the purpose of fulfilling its obligations under the Plan. Recent Sales of Unregistered Securities: None. Issuer Purchases of Equity Securities: The Company’s Board of Directors had authorized the repurchase of up to 900,000 depositary shares of Class L preferred stock and 1,058,000 depositary shares of Class M preferred stock through December 31, 2022, which represented up to an aggregate of 1,958 shares of the Company’s preferred stock, par value $1.00 per share. During the year ended December 31, 2022, the Company repurchased 54,508 depositary shares of Class L preferred stock and 90,760 depositary shares of Class M preferred stock for a purchase price of $1.3 million and $2.1 million, respectively. During February 2018, the Company’s Board of Directors authorized a share repurchase program, which is scheduled to expire February 29, 2024. Under this program, the Company may repurchase shares of its common stock, par value $0.01 per share, with an aggregate gross purchase price of up to $300.0 million. The Company did not repurchase any shares under the share repurchase program during the year ended December 31, 2022. As of December 31, 2022, the Company had $224.9 million available under this common share repurchase program. 24 Table of Contents During the year ended December 31, 2022, the Company repurchased 567,450 shares of the Company’s common stock for an aggregate purchase price of $13.7 million (weighted average price of $24.11 per share) in connection with common shares surrendered or deemed surrendered to the Company to satisfy statutory minimum tax withholding obligations in connection with equity-based compensation plans. The following table presents information regarding the shares of common stock repurchased by the Company during the three months ended December 31, 2022. Period Total Number of Shares Purchased Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in millions) October 1, 2022 – October 31, 2022 1,791 $ 18.63 - $ 224.9 November 1, 2022 – November 30, 2022 - - - $ 224.9 December 1, 2022 – December 31, 2022 4,472 21.49 - $ 224.9 Total 6,263 $ 20.67 - Total Stockholder Return Performance: The following performance chart compares, over the five years ended December 31, 2022, the cumulative total stockholder return on the Company’s common stock with the cumulative total return of the S&P 500 Index and the cumulative total return of the NAREIT Equity REITs Index (the “NAREIT Equity REITs”) prepared and published by the National Association of Real Estate Investment Trusts (“NAREIT”). The NAREIT Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. equity REITs. Constituents of the index include all tax-qualified REITs with more than 50% of total assets in qualifying real estate assets other than mortgages secured by real property. Stockholder return performance, presented annually for the five years ended December 31, 2022, is not necessarily indicative of future results. All stockholder return performance assumes the reinvestment of dividends. The information in this paragraph and the following performance chart are deemed to be furnished, not filed. Comparison of 5 year cumulative total return data points Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 Dec-22 Kimco Realty Corporation $ 100 $ 87 $ 130 $ 99 $ 167 $ 149 S&P 500 $ 100 $ 96 $ 126 $ 149 $ 192 $ 157 NAREIT Equity REITs $ 100 $ 95 $ 120 $ 111 $ 158 $ 120 Item 6. Reserved 25 Table of Contents Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in this Form 10-K. Historical results and percentage relationships set forth in the Consolidated Statements of Income contained in the Consolidated Financial Statements, including trends, should not be taken as indicative of future operations. The Consolidated Financial Statements of the Company include the accounts of the Company, its wholly owned subsidiaries and all entities in which the Company has a controlling interest, including where the Company has been determined to be a primary beneficiary of a variable interest entity in accordance with the consolidation guidance of the FASB Accounting Standards Codification. The Company applies these provisions to each of its joint venture investments to determine whether the cost, equity or consolidation method of accounting is appropriate. The Company evaluates performance on a property specific or transactional basis and does not distinguish its principal business or group its operations on a geographical basis for purposes of measuring performance. Accordingly, the Company believes it has a single reportable segment for disclosure purposes in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Critical Accounting Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying Consolidated Financial Statements and related notes. In preparing these financial statements, management has made its best estimates and assumptions that affect the reported amounts of assets and liabilities. These estimates are based on, but not limited to, historical results, industry standards and current economic conditions, giving due consideration to materiality. The Company’s significant accounting policies are more fully described in Footnote 1 to the Consolidated Financial Statements. The Company is required to make subjective assessments, of which, the most significant assumptions and estimates relate to the recoverability of trade accounts receivable, depreciable lives, valuation of real estate and intangible assets and liabilities, and valuation of joint venture investments and other investments. The Company’s reported net earnings are directly affected by management’s estimate of impairments. Application of these assumptions requires the exercise of judgment as to future uncertainties, and, as a result, actual results could materially differ from these estimates. Trade Accounts Receivable The Company reviews its trade accounts receivable, related to base rents, straight-line rent, expense reimbursements and other revenues for collectability. The Company evaluates the probability of the collection of the lessee’s total accounts receivable, including the corresponding straight-line rent receivable balance on a lease-by-lease basis. Determining the probability of collection of substantially all lease payments during a lease term requires significant judgment. The Company’s analysis of its accounts receivable included (i) customer credit worthiness, (ii) assessment of risk associated with the tenant, and (iii) current economic trends. In addition, tenants in bankruptcy are analyzed and considerations are made in connection with the expected recovery of pre-petition and post-petition bankruptcy claims. The Company includes provision for doubtful accounts in Revenues from rental properties, net. If a lessee’s accounts receivable balance is considered uncollectible, the Company will write-off the receivable balances associated with the lease and will only recognize lease income on a cash basis. In addition to the lease-specific collectability assessment, the analysis also recognizes a general reserve, as a reduction to Revenues from rental properties, for its portfolio of operating lease receivables which are not expected to be fully collectible based on the Company’s historical and current collection experience and the potential for settlement of arrears. Although the Company estimates uncollectible receivables and provides for them through charges against Revenues from rental properties, actual results may differ from those estimates. For example, in the event that the Company’s collectability determinations are not accurate, and we are required to write off additional receivables equaling 1% of the outstanding accounts receivable balance at December 31, 2022, the Company’s rental income and net income would decrease by $3.0 million for the year ended December 31, 2022. If the Company subsequently determines that it is probable it will collect the remaining lessee’s lease payments under the lease term, any outstanding lease receivables (including straight-line rent receivables) are reinstated with a corresponding increase to rental income. Real Estate Valuation of Real Estate, and Intangible Assets and Liabilities The Company’s investments in real estate properties are stated at cost, less accumulated depreciation and amortization. Expenditures for maintenance and repairs are charged to operations as incurred. Significant renovations and replacements, which improve and extend the life of the asset, are capitalized. Transaction costs related to acquisitions that qualify as asset acquisitions are capitalized as part of the cost basis of the acquired assets, while transaction costs for acquisitions that are deemed to be business combinations are expensed as incurred. Also, upon acquisition of real estate operating properties in either an asset acquisition or business combination, the Company estimates the fair value of acquired tangible assets (consisting of land, building, building improvements and tenant improvements) and identified intangible assets and liabilities (consisting of above and below-market leases, in-place leases, and tenant relationships, where applicable), assumed debt and redeemable units issued at the date of acquisition, based on evaluation of information and estimates available at that date. Fair value is determined based on a market approach, which contemplates the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 26 Table of Contents Depreciation and amortization are provided on the straight-line method over the estimated useful lives of the assets, as follows: Buildings and building improvements (in years) 5 to 50 Fixtures, leasehold and tenant improvements (including certain identified intangible assets) Terms of leases or useful lives, whichever is shorter The Company is required to make subjective assessments as to the useful lives of its properties for purposes of determining the amount of depreciation to reflect on an annual basis with respect to those properties. These assessments have a direct impact on the Company’s net earnings. During 2022, the Company acquired properties for a total purchase price of $524.9 million. $8.4 million, or less than 1.6% of the total purchase price, was allocated to above-market leases and $24.1 million, or 4.6% was allocated to below-market leases. If the amounts allocated in 2022 to above-market and below-market leases were each reduced by 1% of the total purchase price, the net annual market lease amortization through rental income would decrease by $0.9 million (using the weighted average life of above-market and below-market leases at each respective acquired property). On a continuous basis, management assesses whether there are any indicators, including property operating performance, changes in anticipated holding period, general market conditions and delays of development, that the value of the real estate properties (including any related amortizable intangible assets or liabilities) may be impaired. A property value is considered impaired only if management’s estimate of current and projected operating cash flows, net of anticipated construction and leasing costs (undiscounted and unleveraged), of the property over its anticipated hold period is less than the net carrying value of the property. Such cash flow projections consider factors such as expected future costs of materials and labor, operating income, trends and prospects, as well as the effects of demand, competition and other factors. To the extent impairment has occurred, the carrying value of the property would be adjusted to reflect the estimated fair value of the property. The Company’s estimated fair values are primarily based upon estimated sales prices from signed contracts or letters of intent from third parties, discounted cash flow models or third-party appraisals. Estimated fair values that are based on discounted cash flow models include all estimated cash inflows and outflows over a specified holding period. Capitalization rates and discount rates utilized in these models are based upon unobservable rates that the Company believes to be within a reasonable range of current market rates. See Footnote 3, 4 and 6 of the Notes to Consolidated Financial Statements for further discussion. Valuation of Joint Venture Investments and Other Investments On a continuous basis, management assesses whether there are any indicators, including property operating performance and general market conditions, that the value of the Company’s investments in unconsolidated joint ventures may be impaired. An investment’s value is impaired only if management’s estimate of the fair value of the investment is less than the carrying value of the investment and such difference is deemed to be other-than-temporary. To the extent impairment has occurred, the loss will be measured as the excess of the carrying amount of the investment over the estimated fair value of the investment. Estimated fair values which are based on discounted cash flow models include all estimated cash inflows and outflows over a specified holding period, capitalization rates and discount rates utilized in these models are based upon unobservable rates that the Company believes to be within a reasonable range of current market rates. See Footnote 1 of the Notes to Consolidated Financial Statements for further discussion of the Company’s accounting policies and estimates. Executive Overview Kimco Realty Corporation is North America’s largest publicly traded owner and operator of open-air, grocery-anchored shopping centers, and a growing portfolio of mixed-use assets. The executive officers are engaged in the day-to-day management and operation of real estate exclusively with the Company, with nearly all operating functions, including leasing, asset management, maintenance, construction, legal, finance and accounting, administered by the Company. Weingarten Merger On August 3, 2021, Weingarten merged with and into the Company, with the Company continuing as the surviving public company, pursuant to the Merger Agreement between the Company and Weingarten which was entered into on April 15, 2021. The total purchase price of the Merger was $4.1 billion, which consists primarily of 179.9 million shares of the Company’s common stock issued in exchange for Weingarten common shares, plus $281.1 million of cash consideration. The Merger brought together two industry-leading retail real estate platforms with highly complementary portfolios and created the preeminent open-air shopping center and mixed-use real estate owner in the country. As a result of the Merger, the Company acquired 149 properties, including 30 held through joint venture programs. The increased scale in targeted growth markets, coupled with a broader pipeline of redevelopment opportunities, has positioned the combined company to create significant value for its shareholders. See Footnote 2 of the Notes to the Consolidated Financial Statements for additional discussion regarding the Merger. Corporate UPREIT Reorganization In January of 2023, the Company completed the Reorganization into an UPREIT structure as described in the Explanatory Note at the beginning of this Annual Report. Prior to the Reorganization, the Company’s business was conducted through the Predecessor. This Annual Report pertains to the business and results of operations of the Predecessor for its fiscal year ended December 31, 2022. As a result of the Reorganization, the Company became the successor issuer to the Predecessor under the Exchange Act. The Company and Kimco OP have elected to co-file this Annual Report of the Predecessor to ensure continuity of information to investors. For additional information about the Reorganization, please see the Company’s Current Reports on Form 8-K filed with the SEC on January 3, 2023 and January 4, 2023. 27 Table of Contents Financial Highlights The following highlights the Company’s significant transactions, events and results that occurred during the year ended December 31, 2022: Financial and Portfolio Information: ● Net income available to the Company’s common shareholders was $100.8 million, or $0.16 per diluted share, for the year ended December 31, 2022 as compared to $818.6 million, or $1.60 per diluted share, for the year ended December 31, 2021. ● FFO available to the Company's common shareholders was $976.4 million, or $1.58 per diluted share, for the year ended December 31, 2022, as compared to $706.8 million, or $1.38 per diluted share, for the corresponding period in 2021 (see additional disclosure on FFO beginning on page 40). ● Same property net operating income (“Same property NOI”) was $1.3 billion for the year ended December 31, 2022, as compared to $1.2 billion for the corresponding period in 2021, an increase of 4.4% (see additional disclosure on Same property NOI beginning on page 40). ● Executed 1,696 new leases, renewals and options totaling approximately 10.7 million square feet in the consolidated operating portfolio during the year ended December 31, 2022. ● Consolidated operating portfolio occupancy at December 31, 2022 was 95.5% as compared to 94.2% at December 31, 2021. Acquisitions, Dispositions and Other Activity (see Footnotes 4, 5 and 9 of the Notes to Consolidated Financial Statements included in this Form 10-K): ● Acquired 10 operating properties and eight parcels, in separate transactions, for $524.9 million ● Disposed of nine operating properties and 13 parcels, in separate transactions, for an aggregate sales price of $191.1 million, which resulted in aggregate gains of $15.2 million, before noncontrolling interests and taxes. ● Monetized 11.5 million of shares of ACI held by the Company, generating net proceeds of $301.1 million and a book gain of $15.2 million. For tax purposes, the Company recognized a long-term capital gain of $251.5 million. The Company has elected to retain the proceeds from this stock sale for general corporate purposes and pay corporate income tax of $57.2 million on the taxable gain. The Company held 28.3 million shares of ACI as of December 31, 2022. Capital Activity (for additional details see Liquidity and Capital Resources below): ● Issued $650.0 million of 4.60% notes maturing February 2033 and $600.0 million of 3.20% notes maturing in April 2032. ● Repaid $1.4 billion of notes bearing interest rates from 3.13% to 3.50% with maturity dates ranging from October 2022 to June 2023. ● Assumed $79.4 million of mortgage debt (including fair market value adjustment of $9.4 million) encumbering six operating properties acquired in 2022 and obtained a $19.0 million mortgage relating to a consolidated joint venture operating property. ● Repaid $158.4 million of mortgage debt that encumbered 11 operating properties. ● As of December 31, 2022, had $2.1 billion in immediate liquidity, including $149.8 million in cash. 28 Table of Contents As a result of the above debt activity, the Company’s consolidated debt maturity profile, including extension options as of December 31, 2022, is as follows: ● As of December 31, 2022, the weighted average interest rate was 3.49% and the weighted average maturity profile was 9.5 years related to the Company’s consolidated debt. The Company faces external factors which may influence its future results from operations. There remains significant uncertainty in the current macro-economic environment, driven by inflationary pressures, as well as ongoing supply chain issues. These factors have impacted, and are expected to continue to impact, consumer discretionary spending and many of our tenants. The convenience and availability of e-commerce has continued to impact the retail sector, which could affect our ability to increase or maintain rental rates and our ability to renew expiring leases and/or lease available space. To better position itself, the Company’s strategy has been to attract local area customers to its properties by providing a diverse and robust tenant base across a variety of retailers, including grocery stores, off-price retailers, discounters and service-oriented tenants, which offer buy online and pick up in store, off-price merchandise and day-to-day necessities rather than high-priced luxury items. The Company’s portfolio is focused on first ring suburbs around major metropolitan-area U.S. markets, predominantly on the east and west coasts and in the sun belt region, which are supported by strong demographics, significant projected population growth, and where the Company perceives significant barriers to entry. The Company owns a predominantly grocery-anchored portfolio clustered in the nation’s top markets. The Company believes it can continue to increase its occupancy levels, rental rates and overall rental growth. In addition, the Company, on a selective basis, has developed or redeveloped projects which include residential and mixed-use components. As part of the Company’s investment strategy, each property is evaluated for its highest and best use, which may include residential and mixed-use components. In addition, the Company may consider other opportunistic investments related to retailer controlled real estate, such as, repositioning underperforming retail locations, retail real estate financing and bankruptcy transaction support. The Company may continue to dispose of certain properties. If the estimated fair value for any of these assets is less than their net carrying values, the Company would be required to take impairment charges and such amounts could be material. For a further discussion of these and other factors that could impact our future results, performance or transactions, see Item 1A. Risk Factors. 29 Table of Contents Results of Operations Comparison of the years ended December 31, 2022 and 2021 Results from operations for the year ended December 31, 2021 include the combined operations for five months as a result of the Company’s Merger with Weingarten which occurred on August 3, 2021. The following table presents the comparative results from the Company’s Consolidated Statements of Income for the year ended December 31, 2022, as compared to the corresponding period in 2021 (in thousands, except per share data): Year Ended December 31, 2022 2021 Change Revenues Revenues from rental properties, net $ 1,710,848 $ 1,349,702 $ 361,146 Management and other fee income 16,836 14,883 1,953 Operating expenses Rent (1) (15,811 ) (13,773 ) (2,038 ) Real estate taxes (224,729 ) (181,256 ) (43,473 ) Operating and maintenance (2) (290,367 ) (222,882 ) (67,485 ) General and administrative (3) (119,534 ) (104,121 ) (15,413 ) Impairment charges (21,958 ) (3,597 ) (18,361 ) Merger charges - (50,191 ) 50,191 Depreciation and amortization (505,000 ) (395,320 ) (109,680 ) Gain on sale of properties 15,179 30,841 (15,662 ) Other income/(expense) Other income, net 28,829 19,810 9,019 (Loss)/gain on marketable securities, net (315,508 ) 505,163 (820,671 ) Interest expense (226,823 ) (204,133 ) (22,690 ) Early extinguishment of debt charges (7,658 ) - (7,658 ) Provision for income taxes, net (56,654 ) (3,380 ) (53,274 ) Equity in income of joint ventures, net 109,481 84,778 24,703 Equity in income of other investments, net 17,403 23,172 (5,769 ) Net loss/(income) attributable to noncontrolling interests 11,442 (5,637 ) 17,079 Preferred dividends (25,218 ) (25,416 ) 198 Net income available to the Company's common shareholders $ 100,758 $ 818,643 $ (717,885 ) Net income available to the Company's common shareholders: Diluted per share $ 0.16 $ 1.60 $ (1.44 ) (1) Rent expense relates to ground lease payments for which the Company is the lessee. (2) Operating and maintenance expense consists of property related costs including repairs and maintenance costs, roof repair, landscaping, parking lot repair, snow removal, utilities, property insurance costs, security and various other property related expenses. (3) General and administrative expense includes employee-related expenses (including salaries, bonuses, equity awards, benefits, severance costs and payroll taxes), professional fees, office rent, travel and entertainment costs and other company-specific expenses. Net income available to the Company’s common shareholders was $100.8 million for the year ended December 31, 2022, as compared to $818.6 million for the comparable period in 2021. On a diluted per share basis, net income available to the Company’s common shareholders for the year ended December 31, 2022, was $0.16 as compared to $1.60 for the comparable period in 2021. For additional disclosure, see Footnote 28 of the Notes to Consolidated Financial Statements included in this Form 10-K. The following describes the changes of certain line items included on the Company’s Consolidated Statements of Income, that the Company believes changed significantly and affected Net income available to the Company’s common shareholders during the year ended December 31, 2022, as compared to the corresponding period in 2021: Revenue from rental properties, net – The increase in Revenues from rental properties, net of $361.1 million is primarily from (i) an increase in revenues of $332.6 million due to properties acquired during 2022 and 2021, including the results of the Merger, and (ii) an increase in revenues from tenants of $53.7 million primarily due to an increase in leasing activity and net growth in the current portfolio, partially offset by (iii) a net decrease of $19.6 million due to changes in credit losses from tenants, (iv) a decrease in revenues of $3.1 million due to dispositions in 2022 and 2021 and (v) a decrease in lease termination fee income of $2.5 million. Real estate taxes – The increase in Real estate taxes of $43.5 million is primarily due to properties acquired during 2022 and 2021, including the impact of the Merger. 30 Table of Contents Operating and maintenance – The increase in Operating and maintenance expense of $67.5 million is primarily due to (i) properties acquired during 2022 and 2021, including the impact of the Merger, and (ii) increases in repairs and maintenance, utilities and other operating costs throughout the Company’s operating properties. General and administrative – The increase in General and administrative expense of $15.4 million is primarily due to (i) an increase in employee-related expenses of $10.5 million resulting from additional employees hired in connection with the Merger and (ii) an increase in professional fees and corporate expenses of $6.6 million, including costs related to the Company’s UPREIT Reorganization, partially offset by (iii) a decrease of $1.7 million primarily due to the fluctuations in value of various directors’ deferred stock. Impairment charges – During the years ended December 31, 2022 and 2021, the Company recognized impairment charges of $22.0 million and $3.6 million, respectively, primarily related to adjustments to property carrying values for which the Company’s estimated fair values were primarily based upon signed contracts or letters of intent from third-party offers. These adjustments to property carrying values were recognized in connection with the Company’s efforts to market certain properties and management’s assessment as to the likelihood and timing of such potential transactions. Certain of the calculations to determine fair values utilized unobservable inputs and, as such, were classified as Level 3 of the FASB’s fair value hierarchy. For additional disclosure, see Footnotes 6 and 18 of the Notes to Consolidated Financial Statements included in this Form 10-K. Merger charges – During the year ended December 31, 2021, the Company incurred costs of $50.2 million associated with the Merger. These charges are primarily comprised of severance costs and professional and legal fees. Depreciation and amortization – The increase in Depreciation and amortization of $109.7 million is primarily due to (i) an increase of $166.7 million resulting from properties acquired during 2022 and 2021, including the impact of the Merger, and (ii) an increase of $1.4 million due to depreciation commencing on certain redevelopment projects that were placed into service during 2022 and 2021, partially offset by (iii) a net decrease of $58.4 million primarily from fully depreciated assets and write-offs due to tenant vacates and dispositions during 2022 and 2021. Gain on sale of properties – During 2022, the Company disposed of nine operating properties and 13 parcels, in separate transactions, for an aggregate sales price of $191.1 million, which resulted in aggregate gains of $15.2 million. During 2021, the Company disposed of 13 operating properties and 10 parcels (including the deconsolidation of six operating properties), in separate transactions, for an aggregate sales price of $612.4 million, which resulted in aggregate gains of $30.8 million. Other income, net – The increase in Other income, net of $9.0 million is primarily due to (i) a net increase in mortgage and other financing income of $9.4 million, including profit participation of $4.0 million relating to the repayment of a loan, and (ii) an increase in dividend, interest and other income of $3.2 million, partially offset by (iii) a decrease in net periodic benefit income of $3.6 million relating to the Company’s defined benefit plan. (Loss)/gain on marketable securities, net – The change in (Loss)/gain on marketable securities, net of $820.7 million is primarily the result of mark-to-market fluctuations of the shares of ACI common stock held by the Company. Interest expense – The increase in Interest expense of $22.7 million is primarily due to (i) increased levels of borrowings resulting from the assumption of senior unsecured notes and mortgages in connection with the Merger and public debt offerings, partially offset by (ii) the repayment of senior unsecured notes and mortgages during 2022 and 2021 and (iii) an increase in fair market value amortization, primarily related to the assumption of debt in connection with the Merger and acceleration due to the repayment of senior unsecured notes in 2022. 31 Table of Contents Early extinguishment of debt charges – The increase in Early extinguishment of debt charges of $7.7 million is primarily due to the Company’s repayment of its $500.0 million 3.40% senior unsecured notes, which were scheduled to mature in November 2022. As a result, the Company incurred a prepayment charge of $6.5 million and $0.7 million from the write-off of deferred financing costs during 2022. Provision for income taxes, net – The increase in Provision for income taxes, net of $53.3 million is primarily due to the sale of 11.5 million of the shares of ACI held by the Company, which generated a taxable long-term capital gain. The Company elected to retain the proceeds from the sale and as a result incurred federal corporate and state income tax aggregating $57.2 million on such gain. Equity in income of joint ventures, net – The increase in Equity in income of joint ventures, net of $24.7 million is primarily due to (i) an increase in net gains of $21.9 million resulting from the sale of properties within various joint venture investments during 2022, as compared to 2021, and (ii) an increase in equity in income of $4.5 million from ownership interests acquired in unconsolidated joint ventures in connection with the Merger, partially offset by (iii) an increase in impairment charges of $1.7 million recognized during 2022, as compared to 2021. Equity in income of other investments, net – The decrease in Equity in income of other investments, net of $5.8 million is primarily due to the sale of properties within the Company’s Preferred Equity Program during 2022 and 2021. Net loss/(income) attributable to noncontrolling interests – The change in Net loss/(income) attributable to noncontrolling interests of $17.1 million is primarily due to (i) impairment charges relating to properties within consolidated joint ventures recognized during 2022, partially offset by (ii) an increase in net income attributable to noncontrolling interests primarily related to consolidated joint ventures acquired in the Merger. Comparison of the years ended December 31, 2021 and 2020 Information pertaining to fiscal year 2020 was included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which was filed with the SEC on March 1, 2022. Liquidity and Capital Resources The Company’s capital resources include accessing the public debt and equity capital markets, unsecured term loans, mortgages and construction loan financing, marketable securities (including 28.3 million shares of ACI common stock held by the Company, which had a value of $587.7 million at December 31, 2022 and are subject to certain contractual lock-up provisions that expire in May 2023) and immediate access to an unsecured revolving credit facility (the “Credit Facility”) with bank commitments of $2.0 billion which can be increased to $2.75 billion through an accordion feature. The Company’s cash flow activities are summarized as follows (in thousands): Year Ended December 31, 2022 2021 Cash, cash equivalents and restricted cash, beginning of year $ 334,663 $ 293,188 Net cash flow provided by operating activities 861,114 618,875 Net cash flow used for investing activities (63,217 ) (476,259 ) Net cash flow used for financing activities (982,731 ) (101,141 ) Net change in cash, cash equivalents and restricted cash (184,834 ) 41,475 Cash, cash equivalents and restricted cash, end of year $ 149,829 $ 334,663 Operating Activities The Company anticipates that cash on hand, net cash flow provided by operating activities, borrowings under its Credit Facility and the issuance of equity, public debt, as well as other debt and equity alternatives, and the sale of marketable equity securities, will provide the necessary capital required by the Company. The Company will continue to evaluate its capital requirements for both its short-term and long-term liquidity needs, which could be affected by various risks and uncertainties, including, but not limited to, the effects of the current inflationary environment, rising interest rates, and other risks detailed in Part I, Item 1A. Risk Factors 32 Table of Contents Net cash flows provided by operating activities for the year ended December 31, 2022, was $861.1. million, as compared to $618.9 million for the comparable period in 2021. The increase of $242.2 million is primarily attributable to: ● additional operating cash flow generated by operating properties acquired during 2022 and 2021, including those acquired from the Merger; ● new leasing, expansion and re-tenanting of core portfolio properties; ● changes in accounts payable and accrued expenses due to timing of receipts and payments; and ● nonrecurring costs incurred in connection with the Merger during 2021, partially offset by ● changes in operating assets and liabilities due to timing of receipts and payments; ● a decrease in distributions from the Company’s joint ventures programs due to the sale of properties within the ventures; and ● the disposition of operating properties in 2022 and 2021. Investing Activities Net cash flows used for investing activities was $63.2 million for 2022, as compared to $476.3 million for 2021. Investing activities during 2022 consisted primarily of: Cash inflows: ● $302.5 million in proceeds from the sale of marketable securities, primarily due to the sale of 11.5 million shares of ACI; ● $184.3 million in proceeds from the sale of nine consolidated properties and 13 parcels; ● $68.4 million in reimbursements of investments in and advances to real estate joint ventures and other investments primarily due to the sale of properties within the investments; ● $60.3 million in collection of mortgage and other financing receivables; and ● $4.0 million for principal payments from securities held to maturity. Cash outflows: ● $300.8 million for the acquisition of 10 consolidated operating properties and eight parcels; ● $193.7 million for improvements to operating real estate primarily related to the Company’s active redevelopment pipeline; ● $104.7 million for investments in and advances to real estate joint ventures, primarily related to partner buyouts and a redevelopment project within the Company’s joint venture portfolio, and investments in other investments, primarily related to funding commitments for certain investments; ● $75.1 million for investment in mortgage and other financing receivables; ● $4.5 million for investment in cost method investments; and ● $4.0 million for investment in marketable securities. Investing activities during 2021 consisted primarily of: Cash inflows: ● $302.8 million in proceeds from the sale of 13 consolidated properties and 10 parcels (including the deconsolidation of 6 operating properties); ● $111.9 million in reimbursements of investments in and advances to real estate joint ventures and other investments primarily due to the sale of properties within the investments; and ● $13.8 million in collection of mortgage and other financing receivables. Cash outflows: ● $356.0 million for the acquisition of 11 consolidated operating properties and one parcel; ● $264.0 million net cash consideration paid in conjunction with the Merger; ● $163.7 million for improvements to operating real estate primarily related to the Company’s active redevelopment pipeline; ● $67.1 million for investments in and advances to other investments, primarily related to a preferred equity investment located in San Antonio, TX; ● $41.9 million for investment in other financing receivables; and ● $12.6 million for investments in and advances to real estate joint ventures, primarily related to a redevelopment project within the Company’s joint venture portfolio. 33 Table of Contents Acquisitions of Operating Real Estate and Other Related Net Assets During the years ended December 31, 2022 and 2021, the Company expended $300.8 million and $619.9 million, respectively, towards the acquisition of operating real estate properties, including the Merger in 2021. The Company anticipates spending approximately $125.0 million to $250.0 million towards the acquisition of operating properties during 2023. The Company intends to fund these acquisitions with cash on hand, net cash flow provided by operating activities, proceeds from property dispositions, proceeds from the sale of marketable securities and/or availability under its Credit Facility. Improvements to Operating Real Estate During the years ended December 31, 2022 and 2021, the Company expended $193.7 million and $163.7 million, respectively, towards improvements to operating real estate. These amounts consist of the following (in thousands): Year Ended December 31, 2022 2021 Redevelopment and renovations $ 113,928 $ 100,784 Tenant improvements and tenant allowances 79,782 62,915 Total improvements $ 193,710 $ 163,699 The Company has an ongoing program to redevelop and re-tenant its properties to maintain or enhance its competitive position in the marketplace. The Company is actively pursuing redevelopment opportunities within its operating portfolio which it believes will increase the overall value by bringing in new tenants and improving the assets’ value. The Company anticipates its capital commitment toward these redevelopment projects and re-tenanting efforts for 2023 will be approximately $175.0 million to $225.0 million. The funding of these capital requirements will be provided by cash on hand, proceeds from property dispositions, proceeds from the sale of marketable securities, net cash flow provided by operating activities and/or availability under the Company’s Credit Facility. Financing Activities Net cash flows used for financing activities was $982.7 million for 2022, as compared to $101.1 million for 2021. Financing activities during 2022 primarily consisted of the following: Cash inflows: ● $1.25 billion in proceeds from issuance of the Company’s $600.0 million 3.20% senior unsecured notes due 2032 and $650.0 million 4.60% senior unsecured notes due 2033; ● $19.0 million in proceeds from a mortgage loan financing; ● $15.5 million in proceeds from the issuance of common stock; and ● $5.3 million from changes in tenants’ security deposits. Cash outflows: ● $1.4 billion for repayment of four separate senior unsecured notes, which had maturity dates ranging from November 2022 to June 2023; ● $544.7 million of dividends paid; ● $167.7 million in principal payment on debt, including normal amortization of rental property debt; ● $67.5 million in redemption/distribution of noncontrolling interests; ● $20.3 million in financing origination costs, in connection with the issuance of senior unsecured notes; ● $13.7 million in shares repurchased for employee tax withholding on equity awards; ● $7.0 million for payment of early extinguishment of debt charges; and ● $3.4 million for repurchase of preferred stock. Financing activities during 2021 primarily consisted of the following: Cash inflows: ● $500.0 million in proceeds from issuance of 2.25% senior unsecured notes due in 2031; and ● $83.0 million in proceeds from issuance of common stock, primarily related to the Company’s at-the-market continuous offering program and the exercise of employee stock options. Cash outflows: ● $382.1 million of dividends paid; ● $239.9 million in principal payment on debt, including normal amortization of rental property debt; ● $34.6 million in redemption/distribution of noncontrolling interests; ● $20.8 million in shares repurchased for employee tax withholding on equity awards; and ● $8.2 million in financing origination costs, primarily in connection with the Company’s issuance of $500.0 million of senior unsecured notes. 34 Table of Contents The Company continually evaluates its debt maturities, and, based on management’s current assessment, believes it has viable financing and refinancing alternatives that will not materially adversely impact its expected financial results. As of December 31, 2022, the Company had consolidated floating rate debt totaling $18.4 million, excluding deferred financing costs of $0.1 million. The Company continues to pursue borrowing opportunities with large commercial U.S. and global banks, select life insurance companies and certain regional and local banks. Debt maturities for 2023 consist of: $12.0 million of consolidated debt, $38.1 million of unconsolidated joint venture debt and $32.3 million of debt included in the Company's preferred equity program, assuming the utilization of extension options where available. The 2023 consolidated debt maturities are anticipated to be repaid with operating cash flows or debt refinancing, as deemed appropriate. The 2023 debt maturities on properties in the Company’s unconsolidated joint ventures are anticipated to be repaid through operating cash flows, debt refinancing, unsecured credit facilities, proceeds from sales within the respective entities, and partner capital contributions, as deemed appropriate. The Company intends to maintain strong debt service coverage and fixed charge coverage ratios as part of its commitment to maintain or improve its unsecured debt ratings. The Company may, from time to time, seek to obtain funds through additional common and preferred equity offerings, unsecured debt financings and/or mortgage/construction loan financings and other capital alternatives. Since the completion of the Company’s IPO in 1991, the Company has utilized the public debt and equity markets as its principal source of capital for its expansion needs. Since the IPO, the Company has completed additional offerings of its public unsecured debt and equity, raising in the aggregate over $17.4 billion. Proceeds from public capital market activities have been used for the purposes of, among other things, repaying indebtedness, acquiring interests in open-air, grocery anchored shopping centers and mixed-use assets, expanding and improving properties in the portfolio and other investments. During January 2023, the Company filed a shelf registration statement on Form S-3, which is effective for a term of three years, for future unlimited offerings, from time to time, of debt securities, preferred stock, depositary shares, common stock and common stock warrants. The Company, pursuant to this shelf registration statement may, from time to time, offer for sale its senior unsecured debt securities for any general corporate purposes, including (i) funding specific liquidity requirements in its business, including property acquisitions, development and redevelopment costs and (ii) managing the Company’s debt maturities. During January 2023, the Company filed a registration statement on Form S-8 for its 2020 Equity Participation Plan (the “2020 Plan”), which was previously approved by the Company’s stockholders and is a successor to the Restated Kimco Realty Corporation 2010 Equity Participation Plan that expired in March 2020. The 2020 Plan provides for a maximum of 10,000,000 shares of the Company’s common stock to be reserved for the issuance of stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards, dividend equivalents, stock payments and deferred stock awards. At December 31, 2022, the Company had 6.9 million shares of common stock available for issuance under the 2020 Plan. (see Footnote 23 of the Notes to Consolidated Financial Statements included in this Form 10-K). Preferred Stock – The Company’s Board of Director’s authorized the repurchase of up to 900,000 depositary shares of Class L preferred stock and 1,058,000 depositary shares of Class M preferred stock representing up to 1,958 shares the Company’s preferred stock, par value $1.00 per share through December 31, 2022. During the year ended December 31, 2022, the Company repurchased the following preferred stock: Class of Preferred Stock Depositary Shares Repurchased Purchase Price (in millions) Class L 54,508 $ 1.3 Class M 90,760 $ 2.1 Common Stock – During August 2021, the Company established an at-the-market continuous offering program (the “ATM program”) pursuant to which the Company may offer and sell from time-to-time shares of its common stock, par value $0.01 per share, with an aggregate gross sales price of up to $500.0 million through a consortium of banks acting as sales agents. Sales of the shares of common stock may be made, as needed, from time to time in “at the market” offerings as defined in Rule 415 of the Securities Act of 1933, including by means of ordinary brokers’ transactions on the New York Stock Exchange or otherwise (i) at market prices prevailing at the time of sale, (ii) at prices related to prevailing market prices or (iii) as otherwise agreed to with the applicable sales agent. In addition, the Company may from time to time enter into separate forward sale agreements with one or more banks. During 2022, the Company issued 450,000 shares and received net proceeds after commissions of $11.3 million. During 2021, the Company issued 3.5 million shares and received net proceeds after commissions of $76.9 million. As of December 31, 2022, the Company had $411.0 million available under this ATM program. 35 Table of Contents The Company has a share repurchase program, which is scheduled to expire on February 29, 2024. Under this program, the Company may repurchase shares of its common stock, par value $0.01 per share, with an aggregate gross purchase price of up to $300.0 million. The Company did not repurchase any shares under the share repurchase program during 2022 and 2021. As of December 31, 2022, the Company had $224.9 million available under this common share repurchase program. Senior Notes – During the year ended December 31, 2022, the Company issued the following senior unsecured notes (dollars in millions): Date Issued Amount Issued Interest Rate Maturity Date Aug-22 $ 650.0 4.600% Feb-33 Feb-22 $ 600.0 3.200% Apr-32 During the year ended December 31, 2022, the Company fully repaid the following senior unsecured notes (dollars in millions): Date Paid Amount Repaid Interest Rate Maturity Date Sep-22 (1) $ 299.7 3.500% Apr-23 Sep-22 (1) (2) $ 350.0 3.125% Jun-23 Sep-22 (1) (2) $ 299.4 3.375% Oct-22 Mar-22 (3) $ 500.0 3.400% Nov-22 (1) There were no prepayment charges associated with this early repayment. (2) Includes partial repayments during May and June 2022. (3) The Company incurred a prepayment charge of $6.5 million and $0.7 million in write-off of deferred financing costs resulting from this early repayment, which are included in Early extinguishment of debt charges on the Company’s Consolidated Statements of Income. The Company’s supplemental indenture governing its senior notes contains the following covenants, all of which the Company is compliant with: Covenant Must Be As of December 31, 2022 Consolidated Indebtedness to Total Assets <60% 37% Consolidated Secured Indebtedness to Total Assets <40% 2% Consolidated Income Available for Debt Service to Maximum Annual Service Charge >1.50x 3.9x Unencumbered Total Asset Value to Consolidated Unsecured Indebtedness >1.50x 2.5x For a full description of the various indenture covenants refer to the Indenture dated September 1, 1993; the First Supplemental Indenture dated August 4, 1994; the Second Supplemental Indenture dated April 7, 1995; the Third Supplemental Indenture dated June 2, 2006; the Fourth Supplemental Indenture dated April 26, 2007; the Fifth Supplemental Indenture dated as of September 24, 2009; the Sixth Supplemental Indenture dated as of May 23, 2013; Seventh Supplemental Indenture dated as of April 24, 2014; and the Eighth Supplemental Indenture dated as of January 3, 2023 each as filed with the SEC. See the Index to Exhibits included in this Form 10-K for specific filing information. In addition, for a full description of the various indenture covenants for senior unsecured notes assumed during the Merger, refer to the Indenture dated May 1, 1995 included as an exhibit to Weingarten’s Registration Statement on Form S-3, filed with the Securities and Exchange Commission on May 1, 1995; First Supplemental Indenture, dated as of August 2, 2006, included as an exhibit to Weingarten’s Current Report on Form 8-K dated August 2, 2006, Second Supplemental Indenture, dated as of October 9, 2012 filed with Weingarten’s Current Report on Form 8-K dated October 9, 2012. See the Exhibits Index in this Form 10-K for specific filing information. In connection with the Reorganization, Kimco OP became the issuer of the senior notes and the Parent Company has provided a full and unconditional guarantee of Kimco OP’s obligations under each series of senior notes previously issued and outstanding. Credit Facility – The Company had a $2.0 billion Credit Facility with a group of banks which was scheduled to expire in March 2024, with two additional six-month options to extend the maturity date, at the Company’s discretion, to March 2025. The Credit Facility was a green credit facility tied to sustainability metric targets, as described in the agreement. In July 2022, the Company amended the Credit Facility to (i) replace LIBOR borrowings with Secured Overnight Financing Rate (“SOFR”) borrowings, (ii) supplement the sustainability grid with an additional one basis point reduction of applicable margin if certain criteria as defined in the Credit Facility are met, (iii) add a leverage metric test which, if met, reduces the applicable margin by five basis points and (iv) obtain pre-approval of a possible organizational conversion to an UPREIT structure. The Company achieved such sustainability metric targets, which effectively reduced the rate on the Credit Facility by two basis points. The Credit Facility, which accrued interest at a rate of Adjusted Term SOFR, as defined in the terms of the Credit Facility, plus 75.5 basis points (5.21% as of December 31, 2022), and can be increased to $2.75 billion through an accordion feature. Pursuant to the terms of the Credit Facility, the Company, among other things, was subject to covenants requiring the maintenance of (i) maximum indebtedness ratios and (ii) minimum interest and fixed charge coverage ratios. As of December 31, 2022, the Credit Facility had no outstanding balance and appropriations for letters of credit of $1.2 million. 36 Table of Contents In February 2023, the Company closed on a new $2.0 billion unsecured revolving credit facility (the “New Credit Facility”) with a group of banks, which is scheduled to expire in March 2027 with two additional six-month options to extend the maturity date, at the Company’s discretion, to March 2028. The New Credit Facility can be increased to $2.75 billion through an accordion feature. The New Credit Facility is a green credit facility tied to sustainability metric targets, as described in the agreement. The New Credit Facility replaces the Company’s Credit Facility discussed above, that was scheduled to mature in March 2024. The New Credit Facility accrues interest at a rate of Adjusted Term SOFR, as defined in the terms of the New Credit Facility, plus 77.5 basis points and fluctuates in accordance with the Company's credit ratings, which can be further adjusted upward or downward by four basis points based on the sustainability metric targets, as defined in the agreement. The Company achieved certain sustainability metric targets, which effectively reduced the rate on the New Credit Facility by two basis points. Pursuant to the terms of the New Credit Facility, the Company continues to be subject to the same covenants under the Credit Facility. Pursuant to the terms of the Credit Facility, the Company, among other things, is subject to maintenance of various covenants. The Company is currently in compliance with these covenants. The financial covenants for the Credit Facility are as follows: Covenant Must Be As of December 31, 2022 Total Indebtedness to Gross Asset Value (“GAV”) <60% 38% Total Priority Indebtedness to GAV <35% 2% Unencumbered Asset Net Operating Income to Total Unsecured Interest Expense >1.75x 4.6x Fixed Charge Total Adjusted EBITDA to Total Debt Service >1.50x 4.1x For a full description of the Credit Facility’s covenants, refer to Amendment No. 2, dated July 12, 2022, to the Amended and Restated Credit Agreement, dated February 27, 2020, filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2022, file with the SEC on July 29, 2022. See the Index to Exhibits included in this Form 10-K for specific filing information. Mortgages Payable – During 2022, the Company (i) assumed $79.4 million of mortgage debt (including fair market value adjustment of $9.4 million) encumbering six operating properties acquired in 2022, (ii) obtained a $19.0 million mortgage relating to a consolidated joint venture operating property and (iii) repaid $158.4 million of mortgage debt (including fair market value adjustment of $0.5 million) that encumbered 11 operating properties. In addition to the public equity and debt markets as capital sources, the Company may, from time to time, obtain mortgage financing on selected properties to partially fund the capital needs of its real estate re-development and re-tenanting projects. As of December 31, 2022, the Company had over 485 unencumbered property interests in its portfolio. Albertsons Companies, Inc. – In October 2022, the Company sold 11.5 million shares of ACI held by the Company, generating net proceeds of $301.1 million. For tax purposes, the Company recognized a long-term capital gain of $251.5 million. The Company elected to retain the proceeds from this stock sale for general corporate purposes and pay corporate income tax of $57.2 million on the taxable gain. This undistributed long-term capital gain is allocated to, and reportable by, each shareholder, and each shareholder is also entitled to claim a federal income tax credit for its allocable share of the federal income tax paid by the Company for 2022. The allocable share of the long-term capital gain and the federal tax credit will be reported to direct holders of Kimco common shares, on Form 2439, and to others in year-end reporting documents issued by brokerage firms if Kimco shares are held in a brokerage account. As of December 31, 2022, the Company holds 28.3 million shares of ACI, which had a value of $587.7 million, which are subject to certain contractual lock-up provisions that expire in May 2023. On October 13, 2022, The Kroger Co. (“Kroger”) and ACI entered into a definitive merger agreement (“ACI Merger”), with Kroger continuing as the surviving public company. The ACI Merger is subject to numerous regulatory approvals and customary closing conditions. Separate from the ACI Merger, on October 13, 2022, ACI declared a special cash dividend of $6.85 per share to ACI shareholders of record as of the close of business on October 24, 2022 and was scheduled to be paid on November 7, 2022. On November 3, 2022, the Superior Court of King County in the State of Washington issued an order temporarily restraining the payment of the special dividend in the case State of Washington v. Albertsons Companies, Inc. et al., until a hearing on a motion for a preliminary injunction could be held. On December 9, 2022, the Superior Court denied the motion for a preliminary injunction but extended the temporary restraining order for the Attorney General for the State of Washington to appeal to the Supreme Court of the State of Washington. Due to the contingency resulting from this unresolved litigation at December 31, 2022, the Company did not recognize its share of the special dividend for the year ended December 31, 2022. On January 17, 2023, the Supreme Court of the State of Washington denied a motion by the Attorney General of the State of Washington to hear an appeal from the Superior Court’s denial to enjoin ACI from paying the special dividend. As a result of the decision by the Supreme Court of the State of Washington, the temporary restraining order preventing payment of the special dividend was lifted. On January 20, 2023, ACI distributed the special dividend to holders of record as of October 24, 2022. The Company received its share of the special dividend payment of $194.1 million during January 2023, and will recognize this income during the three months ending March 31, 2023. 37 Table of Contents Dividends – In connection with its intention to continue to qualify as a REIT for U.S. federal income tax purposes, the Company expects to continue paying regular dividends to its stockholders. These dividends will be paid from operating cash flows. The Company’s Board of Directors will continue to evaluate the Company’s dividend policy on a quarterly basis as it monitors sources of capital and evaluates the impact of the economy and capital markets availability on operating fundamentals. Since cash used to pay dividends reduces amounts available for capital investment, the Company generally intends to maintain a dividend payout ratio which reserves such amounts as it considers necessary for the expansion and renovation of shopping centers in its portfolio, debt reduction, the acquisition of interests in new properties and other investments as suitable opportunities arise and such other factors as the Board of Directors considers appropriate. Cash dividends paid were $544.7 million, $382.1 million and $379.9 million in 2022, 2021 and 2020, respectively. Although the Company receives substantially all of its rental payments on a monthly basis, it generally intends to continue paying dividends quarterly. Amounts accumulated in advance of each quarterly distribution will be invested by the Company in short-term money market or other suitable instruments. The Company’s objective is to establish a dividend level that maintains compliance with the Company’s REIT taxable income distribution requirements. On October 25, 2022, the Company’s Board of Directors declared a quarterly dividend with respect to the Company’s classes of cumulative redeemable preferred shares (Classes L and M) which were paid on January 17, 2023, to shareholders of record on December 30, 2022. In addition, the Company’s Board of Directors declared a quarterly cash dividend of $0.23 per common share, which was paid on December 23, 2022, to shareholders of record on December 9, 2022. On February 8, 2023, the Company’s Board of Directors declared quarterly dividends with respect to the Company’s classes of cumulative redeemable preferred shares (Classes L and M), which are scheduled to be paid on April 17, 2023, to shareholders of record on April 3, 2023. Additionally, on February 8, 2023, the Company’s Board of Directors declared a quarterly cash dividend of $0.23 per common share payable on March 23, 2023 to shareholders of record on March 9, 2023. Contractual Obligations and Other Commitments Contractual Obligations The Company has debt obligations relating to its Credit Facility (no outstanding balance as of December 31, 2022), unsecured senior notes and mortgages with maturities ranging from four months to 27 years. As of December 31, 2022, the Company’s consolidated total debt had a weighted average term to maturity of 9.5 years. In addition, the Company has non-cancelable leases pertaining to its shopping center portfolio. As of December 31, 2022, the Company had 40 consolidated shopping center properties that are subject to long-term ground leases where a third party owns and has leased the underlying land or a portion of the underlying land to the Company to construct and/or operate a shopping center. Amounts due in 2023 in connection with these leases aggregate $12.4 million. The following table summarizes the Company’s consolidated debt maturities (excluding extension options, unamortized debt issuance costs of $68.1 million and fair market value of debt adjustments aggregating $43.7 million) and obligations under non-cancelable operating leases as of December 31, 2022: Payments due by period (in millions) 2023 2024 2025 2026 2027 Thereafter Total Long-Term Debt: Principal (1) $ 23.4 $ 667.7 $ 813.5 $ 780.4 $ 472.7 $ 4,424.6 $ 7,182.3 Interest (2) $ 250.3 $ 229.6 $ 204.1 $ 191.0 $ 161.4 $ 1,553.5 $ 2,589.9 Non-cancelable Leases: Operating leases (3) $ 12.4 $ 11.6 $ 11.1 $ 10.4 $ 10.1 $ 188.9 $ 244.5 Financing leases $ 23.0 $ - $ - $ - $ - $ - $ 23.0 (1) Maturities utilized do not reflect extension options, which range from two to five years. (2) For loans which have interest at floating rates, future interest expense was calculated using the rate as of December 31, 2022. (3) For leases which have inflationary increases, future ground and office rent expense was calculated using the rent based upon initial lease payment. The Company has $12.0 million of consolidated secured debt scheduled to mature in 2023. The Company anticipates satisfying the remaining future maturities with operating cash flows or debt refinancing. Commitments The Company has issued letters of credit in connection with the completion and repayment guarantees, primarily on certain of the Company’s redevelopment projects and guaranty of payment related to the Company’s insurance program. At December 31, 2022, these letters of credit aggregated $43.3 million. 38 Table of Contents The Company has investments with funding commitments of $30.4 million, of which $16.5 million has been funded as of December 31, 2022. In connection with the construction of its development/redevelopment projects and related infrastructure, certain public agencies require posting of performance and surety bonds to guarantee that the Company’s obligations are satisfied. These bonds expire upon the completion of the improvements and infrastructure. As of December 31, 2022, the Company had $18.4 million in performance and surety bonds outstanding. The Company provides a guaranty for the payment of any debt service shortfalls on Series A bonds issued by the Sheridan Redevelopment Agency which are tax increment revenue bonds issued in connection with a property owned by the Company in Sheridan, Colorado. These tax increment revenue bonds have a balance of $45.5 million outstanding at December 31, 2022. The bonds are to be repaid with incremental sales and property taxes and a public improvement fee ("PIF") to be assessed on current and future retail sales and, to the extent necessary, any amounts we may have to provide under a guaranty. The revenue generated from incremental sales, property taxes and PIF have satisfied the debt service requirements to date. The incremental taxes and PIF are to remain intact until the earlier of the payment of the bond liability in full or 2040. Off-Balance Sheet Arrangements Unconsolidated Real Estate Joint Ventures The Company has investments in various unconsolidated real estate joint ventures with varying structures. These joint ventures primarily operate shopping center properties. The properties owned by the joint ventures are primarily financed with individual non-recourse mortgage loans, however, the Company, on a selective basis, has obtained unsecured financing for certain joint ventures. As of December 31, 2022, the Company did not guarantee any joint venture unsecured debt. Non-recourse mortgage debt is generally defined as debt whereby the lenders’ sole recourse with respect to borrower defaults is limited to the value of the property collateralized by the mortgage. The lender generally does not have recourse against any other assets owned by the borrower or any of the constituent members of the borrower, except for certain specified exceptions listed in the particular loan documents (see Footnote 7 of the Notes to Consolidated Financial Statements included in this Form 10-K). Debt balances within the Company’s unconsolidated joint venture investments for which the Company held noncontrolling ownership interests at December 31, 2022, aggregated $1.4 billion. As of December 31, 2022, these loans had scheduled maturities ranging from three months to 8.5 years and bore interest at rates ranging from 2.95% to LIBOR plus 200 basis points (6.39% as of December 31, 2022). Approximately $38.1 million of the aggregate outstanding loan balance matures in 2023. These maturing loans are anticipated to be repaid with operating cash flows, debt refinancing, unsecured credit facilities, proceeds from sales of properties within the ventures, and partner capital contributions, as deemed appropriate (see Footnote 7 of the Notes to Consolidated Financial Statements included in this Form 10-K). Other Investments The Company has provided capital to owners and developers of real estate properties and loans through its Preferred Equity Program. As of December 31, 2022, the Company’s net investment under the Preferred Equity Program was $69.4 million relating to 12 properties As of December 31, 2022, these preferred equity investment properties had non-recourse mortgage loans aggregating $232.8 million. These loans have scheduled maturities ranging from less than one year to 1.5 years and bear interest at rates ranging from 4.19% to SOFR plus 265 basis points (6.78% as of December 31, 2022). Due to the Company’s preferred position in these investments, the Company’s share of each investment is subject to fluctuation and is dependent upon property cash flows. The Company’s maximum exposure to losses associated with its preferred equity investments is limited to its invested capital. Effects of Inflation Many of the Company's long-term leases contain provisions designed to mitigate the adverse impact of inflation. Such provisions include clauses enabling the Company to receive payment of additional rent calculated as a percentage of tenants' gross sales above pre-determined thresholds, which generally increase as prices rise, and/or as a result of escalation clauses, which generally increase rental rates during the terms of the leases. Such escalation clauses often include increases based upon changes in the consumer price index or similar inflation indices. In addition, many of the Company's leases are for terms of less than 10 years, which permits the Company to seek to increase rents to market rates upon renewal. To assist in partially mitigating the Company's exposure to increases in costs and operating expenses, including common area maintenance costs, real estate taxes and insurance, resulting from inflation the Company’s leases include provisions that either (i) require the tenant to pay an allocable share of these operating expenses or (ii) contain fixed contractual amounts, which include escalation clauses, to reimburse these operating expenses. 39 Table of Contents Funds From Operations FFO is a supplemental non-GAAP financial measure utilized to evaluate the operating performance of real estate companies. NAREIT defines FFO as net income/(loss) available to the Company’s common shareholders computed in accordance with GAAP, excluding (i) depreciation and amortization related to real estate, (ii) gains or losses from sales of certain real estate assets, (iii) gains and losses from change in control, (iv) impairment write-downs of certain real estate assets and investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity and (v) after adjustments for unconsolidated partnerships and joint ventures calculated to reflect FFO on the same basis. The Company also made an election, per the NAREIT Funds From Operations White Paper-2018 Restatement, to exclude from its calculation of FFO (i) gains and losses on the sale of assets and impairments of assets incidental to its main business and (ii) mark-to-market changes in the value of its equity securities. As such, the Company does not include gains/impairments on land parcels, mark-to-market gains/losses from marketable securities, allowance for credit losses on mortgage receivables or gains/impairments on other investments in NAREIT defined FFO. The Company presents FFO available to the Company’s common shareholders as it considers it an important supplemental measure of our operating performance and believes it is frequently used by securities analysts, investors and other interested parties in the evaluation of REITs, many of which present FFO available to the Company’s common shareholders when reporting results. Comparison of our presentation of FFO available to the Company’s common shareholders to similarly titled measures for other REITs may not necessarily be meaningful due to possible differences in the application of the NAREIT definition used by such REITs. FFO is a supplemental non-GAAP financial measure of real estate companies’ operating performances, which does not represent cash generated from operating activities in accordance with GAAP and, therefore, should not be considered an alternative for net income or cash flows from operations as a measure of liquidity. The Company’s reconciliation of Net (loss)/income available to the Company’s common shareholders to FFO available to the Company’s common shareholders is reflected in the table below (in thousands, except per share data). Three Months Ended December 31, Year Ended December 31, 2022 2021 2022 2021 Net (loss)/income available to the Company’s common shareholders $ (56,086 ) $ 75,327 $ 100,758 $ 818,643 Gain on sale of properties (4,221 ) - (15,179 ) (30,841 ) Gain on sale of joint venture properties (643 ) (11,596 ) (38,825 ) (16,879 ) Depreciation and amortization - real estate related 123,663 132,797 501,274 392,095 Depreciation and amortization - real estate joint ventures 16,158 15,949 66,326 51,555 Impairment charges (including real estate joint ventures) 1,585 3,932 27,254 7,145 Profit participation from other investments, net (4,584 ) (9,824 ) (15,593 ) (8,595 ) Loss/(gain) on marketable securities, net 100,314 37,347 315,508 (505,163 ) Provision/(benefit) for income taxes (1) 58,608 (25 ) 58,373 2,152 Noncontrolling interests (1) 63 (3,835 ) (23,540 ) (3,285 ) FFO available to the Company’s common shareholders (3) $ 234,857 $ 240,072 $ 976,356 $ 706,827 Weighted average shares outstanding for FFO calculations: Basic 615,856 614,150 615,528 506,248 Units 2,559 3,878 2,492 2,627 Dilutive effect of equity awards 2,114 2,410 2,283 2,422 Diluted (2) 620,529 620,438 620,303 511,297 FFO per common share – basic $ 0.38 $ 0.39 $ 1.59 $ 1.40 FFO per common share – diluted (2) $ 0.38 $ 0.39 $ 1.58 $ 1.38 (1) Related to gains, impairment, depreciation on properties, and gains/(losses) on sales of marketable securities, where applicable. (2) Reflects the potential impact if certain units were converted to common stock at the beginning of the period, which would have a dilutive effect on FFO available to the Company’s common shareholders. FFO available to the Company’s common shareholders would be increased by $584 and $856 for the three months ended December 31, 2022 and 2021, respectively, and $2,041 and $1,053 for the years ended December 31, 2022 and 2021, respectively. The effect of other certain convertible units would have an anti-dilutive effect upon the calculation of FFO available to the Company’s common shareholders per share. Accordingly, the impact of such conversion has not been included in the determination of diluted earnings per share calculations. (3) Includes Merger charges of $50.2 million recognized during the year ended December 31, 2021, in connection with the Merger. In addition, the three months and year ended December 31, 2021, includes a pension valuation adjustment of $3.0 million of income included in Other income, net on the Company’s Consolidated Statements of Income. Includes Early extinguishment of debt charges of $7.7 million recognized during the year ended December 31, 2022. Same Property Net Operating Income Same property NOI is a supplemental non-GAAP financial measure of real estate companies’ operating performance and should not be considered an alternative to net income in accordance with GAAP or cash flows from operations as a measure of liquidity. The Company considers Same property NOI as an important operating performance measure because it is frequently used by securities analysts and investors to measure only the net operating income of properties that have been owned by the Company for the entire current and prior year reporting periods. It excludes properties under redevelopment, development and pending stabilization; properties are deemed stabilized at the earlier of (i) reaching 90% leased or (ii) one year following a project’s inclusion in operating real estate. Same property NOI assists in eliminating disparities in net income due to the development, acquisition or disposition of properties during the particular period presented, and thus provides a more consistent performance measure for the comparison of the Company's properties. 40 Table of Contents For the three months and years ended December 31, 2022 and 2021, the Company included Same property NOI from the Weingarten properties acquired through the Merger. The amount included in the table below, for "Weingarten Same property NOI", for the year ended December 31, 2021, represents the Same property NOI from Weingarten properties prior to the Merger, which is not included in the Company's Net (loss)/income available to the Company’s common shareholders. Same property NOI is calculated using revenues from rental properties (excluding straight-line rent adjustments, lease termination fees, TIFs and amortization of above/below-market rents) less charges for credit losses, operating and maintenance expense, real estate taxes and rent expense plus the Company’s proportionate share of Same property NOI from unconsolidated real estate joint ventures, calculated on the same basis. The Company’s method of calculating Same property NOI available to the Company’s common shareholders may differ from methods used by other REITs and, accordingly, may not be comparable to such other REITs. The following is a reconciliation of Net (loss)/income available to the Company’s common shareholders to Same property NOI (in thousands): Three Months Ended December 31, Year Ended December 31, 2022 2021 2022 2021 Net (loss)/income available to the Company’s common shareholders $ (56,086 ) $ 75,327 $ 100,758 $ 818,643 Adjustments: Management and other fee income (3,955 ) (4,249 ) (16,836 ) (14,883 ) General and administrative 31,928 28,985 119,534 104,121 Impairment charges 200 2,643 21,958 3,597 Merger charges - - - 50,191 Depreciation and amortization 124,676 133,633 505,000 395,320 Gain on sale of properties (4,221 ) - (15,179 ) (30,841 ) Interest and other expense, net 50,969 49,503 205,652 184,323 Loss/(gain) on marketable securities, net 100,314 37,347 315,508 (505,163 ) Provision for income taxes, net 57,750 483 56,654 3,380 Equity in income of other investments, net (1,912 ) (12,807 ) (17,403 ) (23,172 ) Net income/(loss) attributable to noncontrolling interests 2,710 268 (11,442 ) 5,637 Preferred dividends 6,307 6,354 25,218 25,416 Weingarten same property NOI (1) - - - 252,651 Non same property net operating income (14,942 ) (15,661 ) (80,504 ) (113,794 ) Non-operational expense from joint ventures, net 23,934 9,987 55,514 55,213 Same property NOI $ 317,672 $ 311,813 $ 1,264,432 $ 1,210,639 (1) Amount for the year ended December 31, 2021, represents the Same property NOI from Weingarten properties, not included in the Company's Net income available to the Company's common shareholders pre-Merger. Same property NOI increased by $5.9 million, or 1.9%, for the three months ended December 31, 2022, as compared to the corresponding period in 2021. This increase is primarily the result of (i) an increase of $15.4 million primarily related to an increase in rental revenue driven by strong leasing activity and a decrease in tenant rent abatements and vacancies as a result of the diminishing effects of the COVID-19 pandemic, partially offset by (ii) a change in credit loss from tenants of $9.5 million. Same property NOI increased by $53.8 million, or 4.4%, for the year ended December 31, 2022, as compared to the corresponding period in 2021. This increase is primarily the result of (i) an increase of $81.0 million primarily related to an increase in rental revenue driven by strong leasing activity and a decrease in tenant rent abatements and vacancies as a result of the diminishing effects of the COVID-19 pandemic, partially offset by (ii) a change in credit loss from tenants of $27.2 million. New Accounting Pronouncements See Footnote 1 of the Notes to Consolidated Financial Statements included in this Form 10-K. 41 Table of Contents Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Company’s primary market risk exposure is interest rate risk. The Company periodically evaluates its exposure to short-term interest rates and will, from time-to-time, enter into interest rate protection agreements which mitigate, but do not eliminate, the effect of changes in interest rates on its floating-rate debt. The Company has not entered, and does not plan to enter, into any derivative financial instruments for trading or speculative purposes. The following table presents the Company’s aggregate fixed rate and variable rate debt obligations outstanding, including fair market value adjustments and unamortized deferred financing costs, as of December 31, 2022, with corresponding weighted-average interest rates sorted by maturity date. The table does not include extension options where available (amounts in millions). 2023 2024 2025 2026 2027 Thereafter Total Fair Value Secured Debt Fixed Rate $ 12.0 $ 14.9 $ 53.0 $ - $ 34.3 $ 244.4 $ 358.6 $ 293.8 Average Interest Rate 3.23 % 4.87 % 3.50 % - 4.01 % 4.23 % 4.10 % Variable Rate $ - $ - $ 18.3 $ - $ - $ - $ 18.3 $ 17.9 Average Interest Rate - - 5.43 % - - - 5.43 % Unsecured Debt Fixed Rate $ - $ 654.3 $ 752.9 $ 785.4 $ 436.8 $ 4,151.6 $ 6,781.0 $ 5,837.4 Average Interest Rate - 3.37 % 3.48 % 3.06 % 4.03 % 3.47 % 3.45 % Based on the Company’s variable-rate debt balances, interest expense would have increased by $0.2 million for the year ended December 31, 2022, if short-term interest rates were 1.0% higher.
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+Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 7A. “Quantitative and Qualitative Disclosures About Market Risk—Energy Commodity Market Risk.” When considering forward-looking statements, you should keep in mind the factors described in this section and the other sections referenced above. We disclaim any obligation, other than as required by applicable law, to publicly update or revise any of our forward-looking statements to reflect future events or developments.3PART IItems 1 and 2. Business and Properties.We are one of the largest energy infrastructure companies in North America. We own an interest in or operate approximately 83,000 miles of pipelines, 140 terminals, 700 Bcf of working natural gas storage capacity and have RNG generation capacity of approximately 2.2 Bcf per year of gross production. Our pipelines transport natural gas, renewable fuels, refined petroleum products, crude oil, condensate, CO2 and other products, and our terminals store and handle various commodities including gasoline, diesel fuel, renewable fuel feedstocks, chemicals, ethanol, metals and petroleum coke.General Development of BusinessRecent DevelopmentsThe following is a listing of significant developments and updates related to our major projects and financing transactions. “Capital Scope” is estimated for our share of the described project which may include portions not yet completed.Asset or projectDescriptionActivityApprox. Capital Scope (KMI Share)Placed in service, acquisitions or divestituresELCSold a 25.5% interest in ELC to an undisclosed financial buyer and now own a 25.5% interest.Completed in September 2022.n/aMas RangerAcquired three landfill assets with the purchase of Mas Ranger, LLC and its subsidiaries from Mas CanAm, LLC. Assets include an RNG facility in Arlington, Texas and Medium British Thermal Units facilities in Shreveport, Louisiana and Victoria, Texas. Acquired in July 2022.$358 millionNorth American Natural ResourcesAcquired seven landfill assets with the purchase of North American Natural Resources, Inc. and, its sister companies, North American Biofuels, LLC and North American-Central, LLC (NANR). Assets include GTE facilities in Michigan and Kentucky. A final investment decision was made to convert Autumn Hills, one of the seven landfill assets acquired, to an RNG facility and construction began in January 2023.Acquired in August 2022.$132 millionOther AnnouncementsNatural Gas PipelinesTGP and SNG Evangeline PassTwo-phase 2 Bcf/d project to serve Venture Global’s proposed Plaquemines LNG facility (Plaquemines). First phase, TGP will provide approximately 0.9 Bcf/d natural gas transportation capacity to Plaquemines. Second phase, TGP and SNG will jointly provide volumes up to the remaining 1.1 Bcf/d to Plaquemines. Expected in-service date for first phase is fourth quarter of 2024 and third quarter of 2025 for the second phase, pending receipt of all required permits.$678 millionEagleford transport projectExpansion project includes constructing 69 miles of 42-inch pipeline, multiple receipt and delivery meters and upgrades to Kinder Morgan Freer compressor station to transport up to 1.88 Bcf/d of lean Eagleford production to Gulf Coast markets.Expected in-service date is fourth quarter 2023.$283 millionTGP East 300 UpgradeExpansion project involves upgrading compression facilities upstream on TGP’s system in order to provide 115,000 Dth/d of capacity to Con Edison’s distribution system in Westchester County, New York. Supported by a long-term contract with Con Edison.Expected in-service date is November 2023, pending receipt of all required permits. $263 millionPHP expansionJoint venture project that will expand PHP’s capacity by approximately 550,000 Dth/d, increasing natural gas deliveries from the Permian to U.S. Gulf Coast markets. Supported by long-term contracts.Expected in-service date is November 2023.$149 million4Asset or projectDescriptionActivityApprox. Capital Scope (KMI Share)Greenholly pipeline - North Holly expansionJoint venture project (our ownership interest of 37.58%) to construct 38 miles of 36-inch pipeline from partner receipt points to KinderHawk wholly owned North Holly gathering system and includes joint venture pipeline receipt interconnects off KinderHawk’s Greenwood system, upgrades to KinderHawk’s North Holly system and 400 gallons per minute treating capacity addition to KinderHawk’s North Holly plant. Supported by long-term contracts.Expected in-service date is second quarter 2023.$121 million3Rivers Offload Phase IIConstruct 19 miles of 16-inch pipeline and associated compression allowing delivery of 50,000 Dth/d of incremental gathered production for third-party processing.Expected in-service date is third quarter 2023.$96 millionCO2 - Energy Transition VenturesRNG facilitiesConstruction of three additional landfill-based RNG facilities for Kinetrex in order to provide approximately 3.5 Bcf of RNG a year. Supported by a long-term contract.Expected to be in service throughout 2023.$150 millionFinancingsDuring 2022, EPNG issued $300 million and KMI issued $1,500 million of new senior notes to repay maturing debt and for general corporate purposes. On January 17, 2023, we repaid $1,250 million of maturing senior notes using cash on hand and short-term borrowings. On January 31, 2023, we issued $1,500 million of new senior notes to repay short-term borrowings, maturing debt and for general corporate purposes. On January 18, 2023, our board of directors approved an increase in our share repurchase authorization of our share buy-back program from $2 billion to $3 billion. Subsequently, we have approximately $2.1 billion of capacity remaining under this program. During 2022, we repurchased approximately 21.7 million shares of Class P common stock for $368 million at an average price of $16.94 per share. Narrative Description of BusinessBusiness StrategyOur business strategy is to:•focus on stable, fee-based energy transportation and storage assets that are central to the energy infrastructure and energy transition of growing markets within North America or served by U.S. exports; •increase utilization of our existing assets while controlling costs, operating safely, and employing environmentally sound operating practices;•exercise discipline in capital allocation and in evaluating expansion projects and acquisition opportunities;•leverage economies of scale from asset expansions and acquisitions that fit within our strategy; and•maintain a strong financial profile and enhance and return value to our stockholders.It is our intention to carry out the above business strategy, modified as necessary to reflect changing economic conditions and other circumstances. However, as discussed under Item 1A. “Risk Factors” below and at the beginning of this report in “Information Regarding Forward-Looking Statements,” there are factors that could affect our ability to carry out our strategy or affect its level of success even if carried out.We regularly consider and enter into discussions regarding potential acquisitions and divestitures, and we are currently contemplating potential transactions. Any such transaction would be subject to negotiation of mutually agreeable terms and conditions, and, as applicable, receipt of fairness opinions, and approval of our board of directors. While there are currently no unannounced purchase or sale agreements for the acquisition or sale of any material business or assets, such transactions can be effected quickly, may occur at any time and may be significant in size relative to our existing assets or operations.5Business SegmentsFor financial information on our reportable business segments, see Note 16 “Reportable Segments” to our consolidated financial statements.Natural Gas PipelinesOur Natural Gas Pipelines business segment includes interstate and intrastate pipelines, underground storage facilities, our LNG liquefaction and terminal facilities and NGL fractionation facilities, and includes both FERC regulated and non-FERC regulated assets.Our primary businesses in this segment consist of natural gas transportation, storage, sales, gathering, processing and treating, and various LNG services. Within this segment are: (i) approximately 45,000 miles of wholly owned natural gas pipelines and (ii) our equity interests in entities that have approximately 27,000 miles of natural gas pipelines, along with associated storage and supply lines for these transportation networks, which are strategically located throughout the North American natural gas pipeline grid. Our transportation network provides access to the major natural gas supply areas and consumers in the western U.S., Rocky Mountain, Midwest, Texas, Louisiana, Southeastern and Northeast regions. Our LNG terminal facilities also serve natural gas market areas in the southeast. The following tables summarize our significant Natural Gas Pipelines business segment assets as of December 31, 2022. The design capacity represents transmission, gathering, regasification or liquefaction capacity, depending on the nature of the asset.AssetOwnership Interest Miles of Pipeline Design (Bcf/d) [(MBbl/d)] CapacityStorage (Bcf) [Processing (Bcf/d)] CapacityEast RegionTGP(a)100 %11,755 12.23 76 NGPL37.5 %9,105 7.84 288 KMLP100 %140 3.89 — Stagecoach100 %185 3.22 41 SNG(a)50 %6,925 4.47 66 6AssetOwnership Interest Miles of Pipeline Design (Bcf/d) [(MBbl/d)] CapacityStorage (Bcf) [Processing (Bcf/d)] CapacityFlorida Gas Transmission (Citrus)50 %5,380 4.31 — MEP50 %515 1.81 — Elba Express100 %190 1.10 — FEP50 %185 2.00 — Gulf LNG Holdings50 %5 1.50 7 SLNG100 %— 1.76 12 ELC25.5 %— 0.35 — West RegionEPNG/Mojave100 %10,720 6.39 44 CIG(b)100 %4,300 6.00 38 WIC100 %850 3.61 — Ruby(c)50 %685 1.53 — CPGPL100 %415 1.20 — TransColorado100 %310 0.80 — Sierrita35 %60 0.52 — Young Gas Storage47.5 %15 — 6 Keystone Gas Storage100 %15 — 6 Midstream KM Texas and Tejas pipelines(d)100 %5,9158.30 136[0.52]Mier-Monterrey pipeline(d)100 %900.65 — KM North Texas pipeline(d)100 %800.33 — Gulf Coast Express pipeline34 %5302.00 — PHP26.67 %4352.10 — OklahomaOklahoma system100 %3,2250.73 [0.09]Cedar Cove70 %1200.03 — South TexasSouth Texas system100 %1,1551.93 [1.02]Webb/Duval gas gathering system91 %1450.15 — Camino Real 100 %750.15 — EagleHawk25 %5501.20 — KM Altamont100 %1,5350.13 [0.1]Red Cedar49 %8650.33 — Rocky MountainFort Union50 %315 1.25 — Bighorn51 %265 0.60 — KinderHawk100 %535 2.35 — North Texas100 %530 0.14 — KM Treating100 %— — — Hiland - Williston - gas 100 %2,190 0.62 [0.33]Liberty pipeline50 %85 [140]— South Texas NGL pipelines(e)100 %340 [115]— Utopia pipeline50 %265 [50]— Cypress pipeline50 %105 [56]— EagleHawk - Condensate(f)25 %410 [220]— (a)Includes proportionate share of storage capacity from our Bear Creek Storage joint venture.7(b)Includes leased pipeline miles and proportionate share of design and storage capacity from our WYCO joint venture.(c)As of December 31, 2022, we operated Ruby and owned an effective 50% interest. Ruby is not included on the map above. On January 13, 2023, a bankruptcy court confirmed a plan of reorganization satisfactory to all interested parties regarding Ruby which involved the sale of Ruby, and subsequently we no longer hold an interest in Ruby. For further information regarding Ruby’s bankruptcy filing, see Note 4 “Gains and Losses on Divestitures, Impairments and Other Write-downs—Ruby Chapter 11 Bankruptcy Filing.” (d)Collectively referred to as Texas intrastate natural gas pipeline operations.(e)Includes proportionate share of design capacity from our Liberty pipeline joint venture.(f)Asset also has storage capacity of 60 MBbl.Segment ContractsRevenues from our interstate natural gas pipelines, related storage facilities and LNG terminals are primarily received under long-term fixed contracts. To the extent practicable and economically feasible in light of our strategic plans and other factors, we generally attempt to mitigate risk of reduced volumes and prices by negotiating contracts with longer terms, with higher per-unit pricing and for a greater percentage of our available capacity. These long-term contracts are typically structured with a fixed fee reserving the right to transport or store natural gas and specify that we receive the majority of our fee for making the capacity available, whether or not the customer actually chooses to utilize that capacity. Similarly, our Texas Intrastate natural gas pipeline operations currently derive approximately 77% of its sales and transport margins from long-term transport and sales contracts. As contracts expire, we have additional exposure to the longer term trends in supply and demand for natural gas. As of December 31, 2022, the remaining weighted average contract life of our natural gas transportation contracts held by assets we own or have equity interests in (including intrastate pipelines’ sales portfolio) was approximately six years. Our LNG regasification and liquefaction and associated storage contracts are subscribed under long-term agreements with a weighted average remaining contract life of approximately 12 years.Our Midstream assets provide natural gas gathering and processing services. These assets are mostly fee-based, and the revenues and earnings we realize from gathering natural gas, processing natural gas in order to remove NGL from the natural gas stream, and fractionating NGL into its base components, are affected by the volumes of natural gas made available to our systems. Such volumes are impacted by producer rig count and drilling activity. In addition to fee-based arrangements, some of which may include minimum volume commitments, we also provide some services based on percent-of-proceeds, percent-of-index and keep-whole contracts. Our service contracts may rely solely on a single type of arrangement, but more often they combine elements of two or more of the above, which helps us and our counterparties manage the extent to which each shares in the potential risks and benefits of changing commodity prices.Segment CompetitionThe market for natural gas infrastructure is highly competitive, and new pipelines, storage facilities, treating facilities, and facilities for related services are currently being built to serve demand for natural gas in the domestic and export markets served by the pipelines in our Natural Gas Pipelines business segment. We compete with interstate and intrastate pipelines for connections to new markets and supplies and for transportation, processing, storage and treating services. We believe the principal elements of competition in our various markets are location, rates, terms of service, flexibility, availability of alternative forms of energy and reliability of service. From time to time, projects are proposed that compete with our existing assets. Whether or when any such projects would be built, or the extent of their impact on our operations or profitability is typically not known.Shippers on our natural gas pipelines compete with other forms of energy available to their natural gas customers and end users, including oil, coal, nuclear and renewables such as hydro, wind and solar power, along with other evolving forms of renewable energy. Several factors influence the demand for natural gas, including price changes, the availability of supply, other forms of energy, the level of business activity, conservation, legislation and governmental regulations, the ability to convert to alternative fuels and weather.8Products Pipelines Our Products Pipelines business segment consists of our refined petroleum products, crude oil and condensate pipelines, and associated terminals, our Southeast terminals, our condensate processing facility and our transmix processing facilities. The following summarizes the significant Products Pipelines business segment assets that we own and operate as of December 31, 2022:AssetOwnership InterestMiles of PipelineNumber of Terminals (a) or locationsTerminal Capacity(MMBbl)Crude & CondensateKM Crude & Condensate pipeline100 %266 5 2.6 Camino Real Gathering100 %68 1 0.1 Hiland - Williston Basin - oil(b)100 %1,617 7 0.8 Double H pipeline(b)100 %512 — — Double Eagle pipeline50 %204 2 0.6 KM Condensate Processing Facility (Splitter)100 %— 1 2.1 Southeast Refined ProductsProducts (SE) pipeline51 %3,186 — — Central Florida pipeline100 %206 2 2.6 Southeast Terminals100 %— 25 9.3 Transmix Operations100 %— 5 0.7 West Coast Refined ProductsPacific (SFPP)99.5 %2,804 13 15.9 Calnev100 %566 2 2.1 West Coast Terminals100 %44 8 10.1 (a)The terminals provide services including short-term product storage, truck loading, vapor handling, additive injection, dye injection and ethanol blending.(b)Collectively referred to as Bakken Crude assets.9Segment ContractsThe profitability of our refined petroleum products pipeline transportation business generally is driven by the volume of refined petroleum products that we transport and the prices we receive for our services. We also have 49 liquids terminals in this business segment that store fuels and offer blending services for ethanol and biodiesel. The transportation and storage volume levels are primarily driven by the demand for the refined petroleum products being shipped or stored. Demand for refined petroleum products tends to track in large measure demographic and economic growth, and, with the exception of periods of time with very high product prices or recessionary conditions, demand tends to be relatively stable. Because of that, we seek to own refined petroleum products pipelines and terminals located in, or that transport to, stable or growing markets and population centers. The prices for shipping are generally based on regulated tariffs that are adjusted annually based on changes in the U.S. Producer Price Index and a FERC index rate.Our crude, condensate and refined petroleum products transportation services are primarily provided pursuant to (i) either FERC or state tariffs (which do not require contractual commitments) or (ii) long-term contracts that normally contain minimum volume commitments. Where we have long-term contracts, our settlement volumes are generally not sensitive to changing market conditions in the shorter term; however, the revenues and earnings we realize from our pipelines and terminals are affected by the volumes of crude oil, refined petroleum products and condensate available to our pipeline systems, which are impacted by the levels of oil and gas drilling activity and product demand in the respective regions that we serve. Our petroleum condensate processing facility splits condensate into its various components, such as light and heavy naphtha, under a long-term fee-based agreement with a major integrated oil company. Our crude oil marketing activities generate revenues from the sale and delivery of crude oil and condensate purchased either directly from producers or from others on the open market. In general, sales prices referenced in underlying purchase and sales contracts are market-based and include pricing differentials for factors such as delivery location or crude oil quality. Segment CompetitionOur Products Pipelines’ pipeline and terminal operations compete against proprietary pipelines and terminals owned and operated by major oil companies, other independent products pipelines and terminals, trucking and marine transportation firms (for short-haul movements of products). Our transmix operations compete with refineries owned by major oil companies and independent transmix facilities.10TerminalsOur Terminals business segment includes the operations of our refined petroleum product, chemical, renewable fuel and other liquid terminal facilities (other than those included in the Products Pipelines business segment) and all of our petroleum coke, metal and ores facilities. Our terminals are located primarily near large U.S. urban centers. We believe the location of our facilities and our ability to provide flexibility to customers help attract new and retain existing customers at our terminals and provide expansion opportunities. We often classify our terminal operations based on the handling of either liquids or dry-bulk material products. In addition, our Terminals’ marine operations include Jones Act-qualified product tankers that provide marine transportation of crude oil, condensate, refined petroleum products and renewable fuel between U.S. ports.The following summarizes our Terminals business segment assets, as of December 31, 2022:NumberCapacity(MMBbl)Liquids terminals4777.8Bulk terminals28— Jones Act-qualified tankers165.3Segment ContractsThe factors impacting our Terminals business segment generally differ between liquid and bulk terminals. Our liquids terminals business generally has long-term contracts that require the customer to pay regardless of whether they use the capacity. Thus, similar to our natural gas pipelines business, our liquids terminals business is less sensitive to short-term changes in supply and demand. Therefore, the extent to which changes in these variables affect our terminals business in the near term is a function of the remaining length of the underlying service contracts (which on a weighted average basis is approximately three years), the extent to which revenues under the contracts are a function of the amount of product stored or transported, and the extent to which such contracts expire during any given period of time.As with our refined petroleum products pipelines transportation business, the revenues from our bulk terminals business are generally driven by the volumes we handle and/or store, as well as the prices we receive for our services, which in turn are driven by the demand for the products being shipped or stored. While we handle and store a large variety of products in our bulk terminals, the primary products are petroleum coke, metals and ores. In addition, the majority of our contracts for this 11business contain minimum volume guarantees and/or service exclusivity arrangements under which customers are required to utilize our terminals for all or a specified percentage of their handling and storage needs. The profitability of our minimum volume contracts is generally unaffected by short-term variation in economic conditions; however, to the extent we expect volumes above the minimum and/or have contracts which are volume-based, we can be sensitive to changing market conditions. To the extent practicable and economically feasible in light of our strategic plans and other factors, we generally attempt to mitigate the risk of reduced volumes and pricing by negotiating contracts with longer terms, with higher per-unit pricing and for a greater percentage of our available capacity. In addition, weather-related events, including hurricanes, may impact our facilities and access to them and, thus, the profitability of certain terminals for limited periods of time or, in relatively rare cases of severe damage to facilities, for longer periods.Our Jones Act-qualified tankers provide marine transportation of crude oil, condensate, refined products and renewable fuel in the U.S. and are primarily operating pursuant to fixed price term charters with major integrated oil companies, major refiners and the U.S. Military Sealift Command.Segment CompetitionWe are one of the largest independent operators of liquids terminals in the U.S., based on barrels of liquids terminaling capacity. Our liquids terminals compete with other publicly or privately held independent liquids terminals and terminals owned by oil, chemical, pipeline and refining companies. Our bulk terminals compete with numerous independent terminal operators, terminals owned by producers and distributors of bulk commodities, stevedoring companies and other industrial companies opting not to outsource terminaling services. In some locations, competitors are smaller, independent operators with lower cost structures. Our Jones Act-qualified product tankers compete with other Jones Act-qualified vessel fleets.12CO2 Our CO2 business segment produces, transports and markets CO2 for use in enhanced oil recovery projects as a flooding medium for recovering crude oil from mature oil fields. We also own and operate oil and gas producing fields, and RNG, LNG and landfill GTE facilities. Our CO2 pipelines and related assets allow us to market a complete package of CO2 supply and transportation services to our customers. Source and Transportation ActivitiesCO2 Resource InterestsOur ownership of CO2 resources as of December 31, 2022 includes:OwnershipInterestCompressionCapacity (Bcf/d)McElmo Dome unit45 %1.5 Doe Canyon Deep unit87 %0.2 Bravo Dome unit(a)11 %0.3 (a)We do not operate this unit.13CO2 and Crude Oil PipelinesIndustry demand for transportation on our CO2 pipelines is expected to remain stable for the foreseeable future.Our ownership of CO2 and crude oil pipelines as of December 31, 2022 includes:AssetOwnership InterestMiles of PipelineTransport Capacity (Bcf/d)[(MBbl/d)]CO2 pipelinesCortez pipeline53 %5691.5Central Basin pipeline100 %3370.7Bravo pipeline(a)13 %2180.4Canyon Reef Carriers pipeline98 %1630.3Centerline CO2 pipeline100 %1130.3Eastern Shelf CO2 pipeline100 %980.1Pecos pipeline95 %250.1Crude oil pipelineWink pipeline100 %434[145](a)We do not operate Bravo pipeline.Oil, Gas and RNG Producing ActivitiesOil and Gas Producing InterestsOur ownership interests in oil and gas producing fields as of December 31, 2022 include the following:Working InterestKMI Gross Developed AcresSACROC97 %50,316 Yates50 %9,576 Goldsmith Landreth San Andres99 %6,166 Katz Strawn99 %7,194 Reinecke70 %3,793 Sharon Ridge(a)14 %2,619 Tall Cotton100 %641MidCross(a)13 %320(a)We do not operate these fields.Our oil and gas producing activities are not significant to KMI as a whole; therefore, we do not include the supplemental information on oil and gas producing activities under Accounting Standards Codification Topic 932, Extractive Activities – Oil and Gas. Gas Plant InterestsOwned and operated gas plants as of December 31, 2022 include:AssetOwnership InterestSourceSnyder gas plant(a)22 %The SACROC unit and neighboring CO2 projects, specifically the Sharon Ridge and Cogdell unitsDiamond M gas plant51 %Snyder gas plantNorth Snyder gas plant100 %Snyder gas plant(a)This is a working interest; in addition we have a 28% net profits interest.14RNG, LNG and GTE FacilitiesOwned and operated RNG, LNG and GTE facilities as of December 31, 2022 include:AssetOwnership InterestStorage [Production] Generation Capacity(a)ProductLNG Indy100 %2 BcfLNGIndy High BTU50 %[0.8 Bcf]RNGSoutheast Berrien100 %4.8 mW/hGTEAutumn Hills100 %4.0 mW/hGTECentral100 %4.0 mW/hGTEVenice Park100 %6.4 mW/hGTEPeoples100 %4.8 mW/hGTEMorehead100 %1.6 mW/hGTEBlue Ridge100 %1.6 mW/hGTEArlington RNG100 %7.3 mcf/dRNGShreveport RNG(b)— %3.8 mcf/dMedium BTUVictoria RNG100 %1.4 mcf/dMedium BTU(a)GTE generation capacity is measured in megawatts per hour (mW/h). RNG and Medium British Thermal Units (BTU) gas capacities are measured in thousands of cubic feet per day (mcf/d).(b)We operate Shreveport for a fee and receive royalties on RNG sales. Segment ContractsThe CO2 source and transportation business primarily has third-party contracts with minimum volume requirements, which as of December 31, 2022 had a remaining average contract life of approximately eight years. CO2 sales contracts vary from customer to customer and have evolved over time as supply and demand conditions have changed. Our current sales contracts have generally provided for a delivered price tied to the price of crude oil, but with a floor price. Beginning in 2022, due to the floor price associated with a significant sales contract no longer being a component of the pricing formula, only a small percentage of our sales contracts will be based on a fixed fee or floor price. Our success in this portion of the CO2 business segment can be impacted by the demand for CO2. In the CO2 business segment’s oil and gas producing activities, we monitor the amount of capital we expend in relation to the amount of production that we expect to add. The revenues we receive from our crude oil and NGL sales are affected by the prices we realize from the sale of these products. Over the long-term, we tend to receive prices that are dictated by the demand and overall market price for these products. In the shorter term, however, market prices are likely not indicative of the revenues we will receive due to our risk management, or hedging, program, in which the prices to be realized for certain of our future sales quantities are fixed or bracketed through the use of financial derivative contracts, particularly for crude oil. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Segment Earnings Results” for more information on crude oil sales prices.Segment CompetitionOur primary competitors for the sale of CO2 include suppliers that have an ownership interest in McElmo Dome, Bravo Dome and Sheep Mountain CO2 resources. Our ownership interests in the Central Basin, Cortez and Bravo pipelines are in direct competition with other CO2 pipelines. We compete with other interest owners in the McElmo Dome unit and the Bravo Dome unit for transportation of CO2 to the Denver City, Texas market area.Major Customers Our revenue is derived from a wide customer base. For each of the years ended December 31, 2022, 2021 and 2020, no revenues from transactions with a single external customer accounted for 10% or more of our total consolidated revenues. We do not believe that a loss of revenues from any single customer would have a material adverse effect on our business, financial position, results of operations or cash flows.15Industry RegulationOur business operations are subject to extensive federal, state and local laws and regulations. Please read Item 1A. “Risk Factors—Risks Related to Regulation” for discussions of the risks we face related to regulation. For information related to pending regulatory proceedings, see Note 18 “Litigation and Environmental” to our consolidated financial statements.Interstate Natural Gas Transportation and Storage RegulationWe operate our interstate natural gas pipeline and storage facilities subject to the jurisdiction of the FERC and the provisions of the Natural Gas Act of 1938 (NGA), the Natural Gas Policy Act of 1978 (NGPA), and the Energy Policy Act of 2005 (the Energy Policy Act). These laws give the FERC authority over the construction and operation of such facilities, including their modification, extension, enlargement and abandonment. Pursuant to the NGA, the FERC also has authority over the rates charged and terms and conditions of services offered by interstate natural gas pipeline and storage companies. The FERC’s regulatory authority extends to establishing minimum and maximum rates for services and allows operators to discount or negotiate rates on a non-discriminatory basis. The rates, terms and conditions of service are set forth in posted tariffs approved by the FERC for each of our interstate natural gas pipeline and storage companies. Posted tariff rates are deemed just and reasonable and cannot be changed without FERC authorization following an evidentiary hearing or settlement. The FERC can initiate proceedings, on its own initiative or in response to a shipper complaint, that could result in a rate change or confirm existing rates. Negotiated rates provide certainty to the pipeline and the shipper of agreed-upon rates during the term of the transportation agreement, regardless of changes to the posted tariff rates. Negotiated rate agreements must be filed with the FERC or included in summary form in the pipeline’s tariff. FERC regulations also include a comprehensive framework for market transparency and nondiscrimination, as well as the FERC’s prohibition against market manipulation. Under the Energy Policy Act and related regulations, it is unlawful for any entity, directly or indirectly in connection with the purchase or sale of natural gas subject to the jurisdiction of the FERC, or the purchase or sale of transportation services subject to the jurisdiction of the FERC, to engage in fraudulent conduct. FERC Standards of Conduct regulate, among other things, the manner in which interstate natural gas pipelines may interact with their marketing affiliates. The FERC’s market oversight and transparency regulations require annual reports of purchases or sales of natural gas meeting certain thresholds and criteria and certain public postings of information on scheduled volumes. The FERC has authority to impose civil penalties of more than $1.3 million per day per violation. Should we fail to comply with all applicable statutes, rules, regulations, and orders administered by the FERC, we could be subject to substantial civil penalties and fines.In addition to having jurisdiction over interstate natural gas pipelines and storage companies, the FERC also has jurisdiction over the interstate transportation and storage services that are provided by intrastate pipelines and storage companies under Section 311 of the NGPA. We have numerous intrastate pipelines and storage companies that provide interstate services pursuant to Section 311 of the NGPA. Under Section 311, along with the FERC’s implementing regulations, an intrastate pipeline may transport gas “on behalf of” an interstate pipeline company or any local distribution company served by an interstate pipeline, without becoming subject to the FERC’s broader regulatory authority under the NGA. These services must be provided on an open and nondiscriminatory basis, and the rates charged for these services may not exceed a “fair and equitable” level as determined by the FERC in periodic rate proceedings. Interstate Common Carrier Refined Petroleum Products and Oil Pipeline Rate RegulationSome of our U.S. refined petroleum products and crude oil gathering and transmission pipelines are interstate common carrier pipelines, subject to regulation by the FERC under the Interstate Commerce Act, or ICA. The ICA requires that we maintain our tariffs on file with the FERC. Those tariffs set forth the rates we charge for providing gathering or transportation services on our interstate common liquids carrier pipelines as well as the rules and regulations governing these services. The ICA requires, among other things, that rates on interstate common liquids carrier pipelines be “just and reasonable” and nondiscriminatory. The ICA permits interested persons to challenge newly proposed or changed rates and authorizes the FERC to suspend the effectiveness of such rates for a period of up to seven months and to investigate such rates. If, upon completion of an investigation, the FERC finds that the new or changed rate is unlawful, it is authorized to require the carrier to refund to shippers the difference between the revenues collected during the pendency of the investigation and the revenues that would have been collected based on the rate the FERC finds to be just and reasonable. The FERC also may investigate, upon complaint or on its own motion, rates that are already in effect and may order a carrier to change its rates prospectively. Upon an appropriate showing, a shipper may obtain reparations for damages sustained during the two years prior to the filing of a complaint.16Petroleum products and crude oil pipelines may change their rates within prescribed ceiling levels that are tied to an inflation index. Shippers may protest rate increases made within the ceiling levels, but such protests must show that the portion of the rate increase resulting from application of the index is substantially in excess of the pipeline’s increase in costs from the previous year. Generally, a petroleum products or crude oil pipeline will utilize the FERC’s indexing methodology to adjust its rates, as indexing serves as the default rate-adjustment mechanism. Cost-of-service based rates, market-based rates and settlement rates are alternatives to the default indexing mechanism and may be used in certain specified circumstances to change rates.CPUC Rate RegulationThe intrastate common carrier operations of our refined products pipelines in California are subject to regulation by the CPUC under a “depreciated book plant” methodology, which is based on an original cost measure of investment. Intrastate tariffs filed by us with the CPUC have been established on the basis of revenues, expenses and investments allocated as applicable to the California intrastate portion of the refined products operations’ business. Tariff rates with respect to intrastate pipeline service in California are subject to challenge by protest by interested parties or by independent action of the CPUC.Railroad Commission of Texas (RCT) Rate RegulationThe intrastate operations of our crude oil and liquids pipelines and natural gas pipelines and storage facilities in Texas are subject to regulation with respect to such intrastate transportation by the RCT. The RCT has the authority to regulate our rates, though it generally has not investigated the rates or practices of our intrastate pipelines in the absence of shipper complaints.Mexico - Energy Regulatory CommissionThe Mier-Monterrey Pipeline has a natural gas transportation permit granted by the Energy Regulatory Commission of Mexico (the Commission) that defines the conditions for the pipeline to carry out activity and provide natural gas transportation service. This permit expires in 2026, subject to an additional 15-year renewal term.This permit establishes certain restrictive conditions, including without limitation: (i) compliance with the general conditions for the provision of natural gas transportation service; (ii) compliance with certain safety measures, contingency plans, maintenance plans and the official standards of Mexico regarding safety; (iii) compliance with the technical and economic specifications of the natural gas transportation system authorized by the Commission; (iv) compliance with certain technical studies established by the Commission; and (v) compliance with a minimum contributed capital not entitled to withdrawal of at least the equivalent of 10% of the investment proposed in the project.Mexico - National Agency for Industrial and Operational Safety and Environmental Protection (ASEA)ASEA regulates environmental compliance and industrial and operational safety. The Mier-Monterrey Pipeline must satisfy and maintain ASEA’s requirements, including compliance with certain safety measures, contingency plans, maintenance plans and the official standards of Mexico regarding safety, including a Safety Administration Program. The main environmental authorization for the operation of the pipeline is the Environmental Impact Authorization. The Mier-Monterrey Pipeline authorization expires at the end of March 2023, and is currently in the process of being renewed.Pipeline Safety RegulationWe are also subject to pipeline safety regulations issued by PHMSA as well as any states that are certified by PHMSA to regulate pipeline safety for intrastate pipes in their respective states. These regulations apply to pipelines and pipeline facilities, including associated underground natural gas storage, terminals, and liquefied natural gas facilities. PHMSA regulations in particular, require us to develop and maintain pipeline integrity management programs to evaluate our pipelines and take additional measures to protect pipeline segments located in what are referred to as High Consequence Areas (HCAs) for both gas and liquid pipelines and Moderate Consequence Areas (MCAs) for gas pipelines, where a leak or rupture could potentially do the most harm.In the past several years, PHMSA has passed several new rules that impose additional pipeline safety requirements including without limitation: (i) expanding certain integrity management program requirements outside of HCAs (with some exceptions) for both gas and hazardous liquid pipelines; (ii) requiring reconfirmation of the maximum allowable operating pressure (MAOP) by 2035 on certain gas pipelines; (iii) installation of remote control or automatic shut-off valves (or alternative equivalent technology) on certain newly constructed or replaced gas pipelines; (iv) increasing requirements for 17corrosion control; and (v) providing additional prescriptive requirements that increase conservatism and specificity on the evaluation of discovered anomalies and their associated repair criteria.OSHAWe are also subject to the requirements of federal and state agencies, including, where appropriate, the Occupational Safety and Health Administration (OSHA), that address, among other things, employee health and safety.State and Local RegulationCertain of our activities are subject to various state and local laws and regulations, as well as orders of regulatory bodies, governing a wide variety of matters, including marketing, production, pricing, pollution, pipeline safety, protection of the environment, and human health and safety.Marine OperationsThe operation of tankers and marine equipment create maritime obligations involving property, personnel and cargo under General Maritime Law. These obligations create a variety of risks including, among other things, the risk of collision, which may result in claims for personal injury, cargo, contract, pollution, third-party claims and property damages to vessels and facilities.We are subject to the Jones Act and other federal laws that restrict maritime transportation (between U.S. departure and destination points) to vessels built and registered in the U.S. and owned and crewed by U.S. citizens. As a result, we monitor the foreign ownership of our common stock and under certain circumstances consistent with our certificate of incorporation, we have the right to redeem shares of our common stock owned by non-U.S. citizens. If we do not comply with such requirements, we would be prohibited from operating our vessels in U.S. coastwise trade, and under certain circumstances we would be deemed to have undertaken an unapproved foreign transfer, resulting in severe penalties, including permanent loss of U.S. coastwise trading rights for our vessels, fines or forfeiture of the vessels. Furthermore, from time to time, legislation has been introduced unsuccessfully in the U.S. Congress to amend the Jones Act to ease or remove the requirement that vessels operating between U.S. ports be built and registered in the U.S. and owned and crewed by U.S. citizens. If the Jones Act were amended in such fashion, we could face competition from foreign-flagged vessels.In addition, the U.S. Coast Guard and the American Bureau of Shipping maintain the most stringent regime of vessel inspection in the world, which tends to result in higher regulatory compliance costs for U.S.-flag operators than for owners of vessels registered under foreign flags of convenience. The Jones Act and General Maritime Law also provide damage remedies for crew members injured in the service of the vessel arising from employer negligence or vessel unseaworthiness.The Merchant Marine Act of 1936 is a federal law that provides the U.S. Secretary of Transportation, upon proclamation by the U.S. President of a national emergency or a threat to the national security, the authority to requisition or purchase any vessel or other watercraft owned by U.S. citizens (including us, provided that we are considered a U.S. citizen for this purpose). If one of our vessels were purchased or requisitioned by the U.S. government under this law, we would be entitled to be paid the fair market value of the vessel in the case of a purchase or, in the case of a requisition, the fair market value of charter hire. However, we would not be entitled to compensation for any consequential damages suffered as a result of such purchase or requisition.Derivatives RegulationWe use energy commodity derivative contracts as part of our strategy to hedge our exposure to energy commodity market risk and other external risks in the ordinary course of business. The derivative contracts that we use include exchange-traded and OTC commodity financial instruments such as futures and options contracts, fixed price swaps and basis swaps. The Dodd-Frank Act requires the U.S. Commodity Futures Trading Commission (CFTC) and the SEC to promulgate rules and regulations establishing federal oversight and regulation of the OTC derivatives market and entities that participate in that market. In October 2020, the CFTC finalized one of the last remaining new rules pursuant to the Dodd-Frank Act that institutes broad new aggregate position limits for OTC swaps and futures and options traded on regulated exchanges. As finalized, these rules include exemptions for hedging positions.18Environmental MattersOur business operations are subject to extensive federal, state and local laws and regulations relating to environmental protection and human health and safety. For example, if a leak, release or spill of liquid petroleum products, chemicals or other hazardous substances occurs at or from our pipelines, storage or other facilities, we may experience significant operational disruptions, and we may have to pay a significant amount to clean up the leak, release or spill, pay government penalties, address natural resource damages, compensate for human exposure or property damage, install costly pollution control equipment or a combination of these and other measures. Furthermore, new projects may require permits, approvals and environmental analyses under federal and state laws, including the Clean Water Act, the Clean Air Act, the National Environmental Policy Act and the Endangered Species Act, as well as Executive Orders focused on environmental justice considerations. The resulting costs and liabilities could be material to us, and increasing compliance costs under federal and state environmental laws for both new and existing facilities could require us to make significant capital expenditures. In general, the cost of environmental control at facilities is increasing and limiting the return on capital projects and the number of capital projects that are viable. Please read Item 1A. “Risk Factors—Risks Related to Regulation.”In accordance with GAAP, we record liabilities for environmental matters when it is probable that obligations have been incurred and the amounts can be reasonably estimated. For information related to pending environmental matters, including our accruals of environmental reserves, see Note 18 “Litigation and Environmental” to our consolidated financial statements.Hazardous and Non-Hazardous WasteWe generate both hazardous and non-hazardous wastes that are subject to the requirements of the Federal Resource Conservation and Recovery Act (RCRA) and comparable state statutes. RCRA establishes standards for the generation, treatment, storage, transport, and disposal of solid wastes, including hazardous wastes. SuperfundThe CERCLA or the Superfund law, and analogous state laws, impose joint and several liability, without regard to fault or the legality of the original conduct, on certain classes of potentially responsible persons for releases of hazardous substances into the environment. These persons include the owner or operator of a site and companies that disposed or arranged for the disposal of the hazardous substances found at the site. CERCLA authorizes the EPA and, in some cases, third parties to take actions in response to threats to public health or the environment and to seek to recover from the responsible classes of persons the costs they incur, including remediation costs. Additionally, CERCLA allows for the recovery of compensation for natural resource damages, if any. Although petroleum is excluded from CERCLA’s definition of a hazardous substance, in the course of our ordinary operations, we have and will generate materials that may fall within the definition of “hazardous substance.” By operation of law, if we are determined to be a potentially responsible person, we may be responsible under CERCLA for all or part of the costs required to evaluate and remediate sites at which such materials are present, in addition to compensation for natural resource damages, if any.Clean Air ActOur operations are subject to the Clean Air Act, its implementing regulations, and analogous state statutes and regulations. The EPA regulations under the Clean Air Act contain requirements for the monitoring, reporting, and control of greenhouse gas (GHG) emissions from stationary sources. For further information, see “—Climate Change” below.Clean Water ActOur operations can result in the discharge of pollutants. The Federal Water Pollution Control Act of 1972, as amended, also known as the Clean Water Act, and analogous state laws impose restrictions and controls regarding the discharge of fills and pollutants into waters of the U.S. The discharge of fills and pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by applicable federal or state authorities. The Oil Pollution Act was enacted in 1990 and amends provisions of the Clean Water Act pertaining to prevention of and response to oil spills. Spill prevention, control and countermeasure requirements of the Clean Water Act and some state laws require containment and similar structures to help prevent contamination of navigable waters in the event of an overflow or release of oil.EPA Revisions to Ozone National Ambient Air Quality Standard (NAAQS)As required by the Clean Air Act, the EPA establishes National Ambient Air Quality Standards (NAAQS) for how much pollution is permissible, and the states then have to adopt rules so their air quality meets the NAAQS. In October 2015, the 19EPA published a rule lowering the ground level ozone NAAQS from 75 parts per billion (ppb) to a more stringent 70 ppb standard. This change triggered a process under which the EPA designated the areas of the country in or out of compliance with the 2015 standards. In December 2020, EPA completed a review of the ozone NAAQS and published a rule retaining the 2015 standards. State rules implementing the NAAQS, including those existing or proposed in Colorado and New Mexico, require the installation of more stringent air pollution controls on newly-installed equipment and possibly require the retrofitting of existing KMI facilities with air pollution controls. These rules will have financial impacts to our Natural Gas Business Unit. Future state rules could have financial impacts on multiple business units.Climate ChangeDue to concern over climate change, numerous proposals to monitor and limit emissions of GHGs have been made and are likely to continue to be made at the federal, state and local levels of government. Methane, a primary component of natural gas, and CO2, which is naturally occurring and also a byproduct of burning natural gas, are examples of GHGs. Various laws and regulations exist or are under development to regulate the emission of such GHGs, including the EPA programs to report GHG emissions and state actions to develop statewide or regional programs. The U.S. Congress has in the past considered legislation to reduce emissions of GHGs. Beginning in 2009, EPA published several findings and rulemakings under the Clean Air Act requiring the permitting and reporting of certain GHGs, including CO2 and methane. Certain of our facilities are subject to these requirements. Operational or physical changes to existing facilities could require those facilities to comply with these requirements. In addition, proposed regulatory changes, if enacted, would require almost all existing oil and natural gas facilities to reduce GHG emissions.At the state level, more than one-third of the states, either individually or through multi-state regional initiatives, already have begun implementing legal measures to reduce emissions of GHGs, such as through establishment of GHG reduction targets or regional GHG “cap and trade” programs. It is possible that sources such as our gas-fueled compressors and processing plants could become subject to these state GHG reduction regulations. Various states are also proposing or have implemented stricter regulations for reporting, monitoring or reducing GHGs that go beyond the requirements of the EPA. Compliance with state rules could require additional expenditures, above and beyond those spent to comply with the November 2021 proposed EPA GHG rules for new and existing sources.Because our operations, including the compressor stations and processing plants, emit various types of GHGs, primarily methane and CO2, such new legislation or regulation could increase the costs related to operating and maintaining our facilities. Depending on the particular law, regulation or program, we or our subsidiaries could be required to incur capital expenditures for installing new monitoring equipment or emission controls on the facilities, acquire and surrender allowances for the GHG emissions, pay taxes related to the GHG emissions and administer and manage a more comprehensive GHG emissions program. We are not able at this time to estimate such increased costs; however, as is the case with similarly situated companies in our industry, they could be significant to us. While we may be able to include some or all of such increased costs in the rates charged by our or our subsidiaries’ pipelines, recovery of costs is uncertain in all cases and may depend on events beyond our control, including the outcome of future rate proceedings before the FERC or other regulatory bodies, and the provisions of any final legislation or other regulations. Any of the foregoing could have an adverse effect on our business, financial position, results of operations and prospects.Because the combustion of natural gas produces lower GHG emissions per unit of energy than competing fossil fuels, cap-and-trade legislation or EPA regulatory initiatives to reduce GHGs could stimulate demand for natural gas by increasing the relative cost of competing fuels such as coal and oil. In addition, we anticipate that GHG regulations will increase demand for carbon sequestration technologies, such as the techniques we have successfully demonstrated in our enhanced oil recovery operations within our CO2 business segment. However, these potential positive effects on our markets may be offset if these same regulations also cause the cost of natural gas to increase relative to competing non-fossil fuels. Although we currently cannot predict the magnitude and direction of these impacts, GHG regulations could have material adverse effects on our business, financial position, results of operations or cash flows.Department of Homeland SecurityThe Department of Homeland Security, referred to in this report as the DHS, has regulatory authority over security at certain high-risk chemical facilities. The DHS has promulgated the Chemical Facility Anti-Terrorism Standards and required all high-risk chemical and industrial facilities, including oil and gas facilities, to comply with the regulatory requirements of these standards. This process includes completing security vulnerability assessments, developing site security plans, and implementing protective measures necessary to meet DHS-defined, risk-based performance standards. The DHS has not provided final notice to all facilities that it determines to be high risk and subject to the rule; therefore, neither the extent to 20which our facilities may be subject to coverage by the rules nor the associated costs to comply can currently be determined, but it is possible that such costs could be substantial.CybersecurityIn response to ongoing cybersecurity threats affecting the pipeline industry, the DHS’s Transportation Safety Administration, or TSA, has issued a series of security directives setting forth specific elements that all pipeline owners and operators must include in their cybersecurity planning and their reporting of any incidents. These security directives require, among other things, that pipeline owners comply with mandatory reporting measures; designate a cybersecurity coordinator; provide vulnerability assessments; ensure compliance with certain cybersecurity requirements; establish and implement a TSA-approved Cybersecurity Implementation Plan; develop and maintain a Cybersecurity Incident Response Plan; and establish a Cybersecurity Assessment Program, and submit an annual plan that describes how owners will assess the effectiveness of cybersecurity measures. In addition, PHMSA requires reporting of any event that involves a release from or the shutdown of a pipeline, including because of a cyber-attack. The SEC has issued guidance outlining its position on cybersecurity disclosure requirements that apply under federal securities laws, but new binding rules imposing affirmative reporting requirements were proposed in March 2022 and are expected to be finalized in 2023. Also under development is the Cyber Incident Reporting for Critical Infrastructure Act of 2022 (CIRCIA), a law concerning the reporting of cyber incidents and ransomware payments that was signed into law in early 2022 and is expected to take effect in early 2024.Human CapitalIn managing our human capital resources, we use a strategic approach to building a diverse, inclusive, and respectful workplace. Our human resources department provides expertise and tools to attract, develop, and retain diverse talent and support our employees’ career and development goals. Our leadership teams have plans in place to enhance diversity and equality of opportunity in hiring, development, and promotions. We value our employees’ opinions and encourage them to engage with management and ask questions on topics such as our goals, challenges and employee concerns.We employed 10,525 full-time personnel at December 31, 2022, including approximately 888 full-time hourly personnel at certain terminals and pipelines covered by collective bargaining agreements that expire between 2023 and 2027. We consider relations with our employees to be good.We value the safety of our workforce and integrate a culture of safety, emergency preparedness and environmental responsibility through our operations management system (OMS). Our OMS conforms to common industry standards and establishes a framework that helps us (i) provide employees and contractors with a safe work environment; (ii) comply with laws, rules, regulations, policies, and procedures; and (iii) identify opportunities to improve. Although our ultimate target is zero incidents, we also have three non-zero employee safety performance targets as follows:Non-zero employee safety performance target2022 Company-wide TRIR (excluding COVID-19 cases)Outperform the annual industry average total recordable incident rate (TRIR)1.9 (0.8)Outperform our own three-year TRIR averageImprove our company-wide employee TRIR from 1.0 in the baseline year 2019 to 0.7 by 2024We seek to constantly improve our contractor TRIR performance through initiatives to address recent incident trends and new best practices.Our board of directors’ nominating and governance committee is responsible for planning for succession in the senior management ranks of the Company, including the office of chief executive officer. The chief executive officer shall report to the committee, generally at the time of the regularly scheduled third quarter board of directors meeting in each year, regarding the processes in place to identify talent within and outside the Company to succeed to senior management positions and the information developed during the current calendar year pursuant to those processes. As part of our annual succession planning process, we identify minority and female candidates to include in the plan for senior positions. Management reviews its succession plan, including a discussion on development opportunities for potential successors, with the nominating and governance committee of our board of directors annually.21We consider employee diversity an asset and support equal opportunity employment. We take affirmative steps to employ and advance in employment all persons without regard to their race/ethnicity; sex; sexual orientation; gender, including gender identity and expression; veteran status; disability; or other protected categories, and base employment decisions solely on valid job requirements. We are committed to a harassment free workplace, supported with online and face-to-face workplace harassment and discrimination prevention training for our employees. Employees and supervisors review our harassment and discrimination prevention policy every two years as part of our policy renewal training.Our employees are an integral part of our success, and we value their career development. We encourage and support professional development and learning for our employees by offering workforce training, tuition reimbursement, leadership and other development programs. These programs help improve recruitment, development, and retention. We support our employees’ ongoing career goals and development through several programs. These programs help maximize our employees’ potential and give them the skills they need to further enhance their careers.Our compensation program is linked to long- and short-term strategic financial and operational objectives, including environmental, safety, and compliance targets. Compensation includes competitive base salaries in the markets in which we operate and competitive benefits, including retirement plans, opportunities for annual bonuses, and, for eligible employees, long-term incentives and an employee stock purchase plan.Properties and Rights-of-WayWe believe we generally have satisfactory title to the properties we own and use in our businesses, subject to liens for current taxes, liens incident to minor encumbrances, and easements and restrictions, which do not materially detract from the value of such property, the interests in those properties or the use of such properties in our businesses. Our terminals, storage facilities, treating and processing plants, regulator and compressor stations, oil and gas wells, offices and related facilities are located on real property owned or leased by us. In some cases, the real property we lease is on federal, state or local government land.We generally do not own the land on which our pipelines are constructed. Instead, we obtain and maintain rights to construct and operate the pipelines on other people’s land generally under agreements that are perpetual or provide for renewal rights. Substantially all of our pipelines are constructed on rights-of-way granted by the apparent record owners of such property. In many instances, lands over which rights-of-way have been obtained are subject to prior liens that have not been subordinated to the right-of-way grants. In some cases, not all of the apparent record owners have joined in the right-of-way grants, but in substantially all such cases, signatures of the owners of a majority of the interests have been obtained. Permits have been obtained from public authorities to cross over or under, or to lay facilities in or along, water courses, county roads, municipal streets and state highways, and in some instances, such permits are revocable at the election of the grantor, or, the pipeline may be required to move its facilities at its own expense. Permits also have been obtained from railroad companies to run along or cross over or under lands or rights-of-way, many of which are also revocable at the grantor’s election. Some such permits require annual or other periodic payments. In a few minor cases, property for pipeline purposes was purchased by the Company.Financial Information about Geographic AreasFor geographic information concerning our assets and operations, see Note 16 “Reportable Segments” to our consolidated financial statements. Available InformationWe make available free of charge on or through our internet website, at www.kindermorgan.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. The information contained on or connected to our internet website is not incorporated by reference into this Form 10-K and should not be considered part of this or any other report that we file with or furnish to the SEC.22Item 1A. Risk Factors. You should carefully consider the risks described below, in addition to the other information contained in this document. Realization of any of the following risks could have a material adverse effect on our business, financial condition, cash flows and results of operations.Risks Related to Operating our BusinessOur businesses are dependent on the supply of and demand for the products we handle.Our pipelines, terminals and other assets and facilities, including the availability of expansion opportunities, depend in part on continued production of natural gas, crude oil and other products in the geographic areas that they serve. Without additions to crude oil and gas reserves, production will decline over time as reserves are depleted, and production costs may rise. Producers in areas served by us may not be successful in exploring for and developing additional reserves or their costs of doing so may become uneconomic. Commodity prices and tax incentives may not remain at levels that encourage producers to explore for and develop additional reserves, produce existing marginal reserves or renew transportation contracts as they expire. Our business also depends in part on the levels of demand for natural gas, crude oil, NGL, refined petroleum products, CO2, steel, chemicals and other products in the geographic areas to which our pipelines, terminals, shipping vessels and other facilities deliver or provide service, and the ability and willingness of our shippers and other customers to supply such demand. Decreases in the supply of or demand for natural gas, crude oil and other products could adversely impact the utilization of our assets.Economic disruptions, such as those which occurred during the COVID-19 pandemic, or conditions in the business environment generally, such as declining or sustained low commodity prices, supply disruptions, or higher development or production costs, could result in a slowing of supply to our pipelines, terminals and other assets. Also, sustained lower demand for hydrocarbons, or changes in the regulatory environment or applicable governmental policies, including in relation to climate change or other environmental concerns, may have a negative impact on the supply of crude oil and other products. In recent years, a number of initiatives and regulatory changes relating to reducing GHG emissions have been undertaken by federal, state and municipal governments and crude oil and gas industry participants. In addition, public concern about the potential risks posed by climate change has resulted in increased demand for energy efficiency and a transition to energy provided from renewable energy sources rather than fossil fuels, fuel-efficient alternatives such as hybrid and electric vehicles, and pursuit of other technologies to reduce GHG emissions, such as carbon capture and sequestration. We have seen and may see further intensification of these trends if and to the extent that the Biden presidential administration succeeds in further enacting its energy and environmental policies. Each of the foregoing could negatively impact our business directly, as well as our shippers and other customers, which in turn could negatively impact our prospects for new contracts for transportation, terminaling or other midstream services, or renewals of existing contracts or the ability of our customers and shippers to honor their contractual commitments. Furthermore, such unfavorable conditions may compound the adverse effects of larger disruptions such as COVID-19. See “—Financial distress experienced by our customers or other counterparties could have an adverse impact on us in the event they are unable to pay us for the products or services we provide or otherwise fulfill their obligations to us.” below.We cannot predict the impact of future economic conditions, fuel conservation measures, alternative fuel requirements, governmental regulation or technological advances in fuel economy and energy generation devices, all of which could reduce the production of and/or demand for the products we handle. We face competition from other pipelines and terminals, as well as other forms of transportation and storage.Competition is a factor affecting our existing businesses and our ability to secure new project opportunities. Any current or future pipeline system or other form of transportation (such as barge, rail or truck) that delivers the products we handle into the areas that our pipelines serve could offer transportation services that are more desirable to shippers than those we provide because of price, location, facilities or other factors. Likewise, competing terminals or other storage options may become more attractive to our customers. To the extent that competitors offer the markets we serve more desirable transportation or storage options, or customers opt to construct their own facilities for services previously provided by us, this could result in unused capacity on our pipelines and in our terminals. We also could experience competition for the supply of the products we handle from both existing and proposed pipeline systems; for example, several pipelines access many of the same areas of supply as our pipeline systems and transport to destinations not served by us. If capacity on our assets remains unused, our ability to re-contract for expiring capacity at favorable rates or otherwise retain existing customers could be impaired. In addition, to the 23extent that companies pursuing development of carbon capture and sequestration technology are successful, they could compete with us for customers who purchase CO2 for use in enhanced oil recovery operations.The volatility of crude oil, NGL and natural gas prices could adversely affect our business.The revenues, cash flows, profitability and future growth of some of our businesses (and the carrying values of certain of their respective assets, which include related goodwill) depend to a large degree on prevailing crude oil, NGL and natural gas prices.Prices for crude oil, NGL and natural gas are subject to large fluctuations in response to relatively minor changes in the supply of and demand for crude oil, NGL and natural gas, uncertainties within the market and a variety of other factors beyond our control. These factors include, among other things (i) weather conditions and events such as hurricanes in the U.S.; (ii) domestic and global economic conditions; (iii) the activities of the OPEC and other countries that are significant producers of crude oil (OPEC+); (iv) governmental regulation; (v) armed conflict or political instability in crude oil and natural gas producing countries; (vi) the foreign supply of and demand for crude oil and natural gas; (vii) the price of foreign imports; (viii) the proximity and availability of storage and transportation infrastructure and processing and treating facilities; and (ix) the availability and prices of alternative fuel sources. We use hedging arrangements to partially mitigate our exposure to commodity prices, but these arrangements also are subject to inherent risks. Please read “—Our use of hedging arrangements does not eliminate our exposure to commodity price risks and could result in financial losses or volatility in our income.” In addition, wide fluctuations in commodity prices can impact the accuracy of assumptions used in our budgeting process. If commodity prices fall substantially or remain low for a sustained period and we are not sufficiently protected through hedging arrangements, we may be unable to realize a profit from these businesses and would operate at a loss.Sharp declines in the prices of crude oil, NGL or natural gas, or a prolonged unfavorable price environment, may result in a commensurate reduction in our revenues, income and cash flows from our businesses that produce, process, or purchase and sell crude oil, NGL, or natural gas, and could have a material adverse effect on the carrying value (which includes assigned goodwill) of our CO2 business segment’s proved reserves, certain assets in certain midstream businesses within our Natural Gas Pipelines business segment, and certain assets within our Products Pipelines business segment. For example, following the commodity price declines we experienced due to COVID-19 during the first half of 2020, we recorded a combined $1.950 billion of non-cash impairments associated with our Natural Gas Pipelines Non-Regulated and CO2 reporting units, primarily for impairments of goodwill and assets owned in these businesses. See Note 4 “Gains and Losses on Divestitures, Impairments and Other Write-downs” and Note 8 “Goodwill” to our consolidated financial statements for more information. For more information about our energy and commodity market risk, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.”Commodity transportation and storage activities involve numerous risks that may result in accidents or otherwise adversely affect our operations.There are a variety of hazards and operating risks inherent to the transportation and storage of the products we handle, such as leaks; releases; the breakdown, underperformance or failure of equipment, facilities, information systems or processes; damage to our pipelines caused by third-party construction; the compromise of information and control systems; spills at terminals and hubs; spills associated with loading and unloading harmful substances at rail facilities; adverse sea conditions (including storms and rising sea levels) and releases or spills from our shipping vessels or vessels loaded at our marine terminals; operator error; labor disputes/work stoppages; disputes with interconnected facilities and carriers; operational disruptions or apportionment on third-party systems or refineries on which our assets depend; and catastrophic events or natural disasters such as fires, floods, explosions, earthquakes, acts of terrorists and saboteurs, cyber security breaches, and other similar events, many of which are beyond our control. Additional risks to our vessels include capsizing, grounding and navigation errors.The occurrence of any of these risks could result in serious injury and loss of human life, significant damage to property and natural resources, environmental pollution, significant reputational damage, impairment or suspension of operations, fines or other regulatory penalties, costs associated with responding to an investigation or enforcement action brought by a governmental agency, and revocation of regulatory approvals or imposition of new requirements, any of which also could result in substantial financial losses, including lost revenue and cash flow to the extent that an incident causes an interruption of service. For pipeline and storage assets located near populated areas, including residential areas, commercial business centers, industrial sites and other public gathering areas, the level of damage resulting from these risks may be greater. In addition, the consequences of any operational incident (including as a result of adverse sea conditions) at one of our marine terminals may be 24even more significant as a result of the complexities involved in addressing leaks and releases occurring in the ocean or along coastlines and/or the repair of marine terminals.Our operating results may be adversely affected by unfavorable economic and market conditions.Unfavorable conditions such as a general slowdown of the global or U.S. economy, uncertainty and volatility in the financial markets, or inflation and rising interest rates, could materially adversely affect our operating results. For example, COVID-19 resulted in a global economic downturn in 2020. The slowdown resulting from the pandemic affected numerous industries, including the crude oil and gas industry, the steel industry and specific segments and markets in which we operate, resulting in reduced demand and increased price competition for our products and services. While global economic activity largely rebounded in 2021, we could experience similar or compounded adverse impacts as a result of other global events affecting economic conditions. Also, economic conditions in the wake of the pandemic have included inflationary pressure, which has resulted in higher operating expenses and project costs for us, as well as higher interest rates.In addition, uncertain or changing economic conditions within one or more geographic regions may affect our operating results within the affected regions. Sustained unfavorable commodity prices, volatility in commodity prices or changes in markets for a given commodity might also have a negative impact on many of our customers, which could impair their ability to meet their obligations to us. See “—Financial distress experienced by our customers or other counterparties could have an adverse impact on us in the event they are unable to pay us for the products or services we provide or otherwise fulfill their obligations to us.” In addition, decreases in the prices of crude oil, NGL and natural gas are likely to have a negative impact on our operating results and cash flow. See “—The volatility of crude oil, NGL and natural gas prices could adversely affect our business.”If economic and market conditions (including volatility in commodity markets) globally, in the U.S. or in other key markets become more volatile or deteriorate, we may experience material impacts on our business, financial condition and results of operations.Financial distress experienced by our customers or other counterparties could have an adverse impact on us in the event they are unable to pay us for the products or services we provide or otherwise fulfill their obligations to us.We are exposed to the risk of loss in the event of nonperformance by our customers or other counterparties, such as hedging counterparties, joint venture partners and suppliers. Many of our counterparties finance their activities through cash flow from operations or debt or equity financing, and some of them may be highly leveraged and may not be able to access additional capital to sustain their operations in the future. Our counterparties are subject to their own operating, market, financial and regulatory risks, and some have experienced, are experiencing, or may experience in the future, severe financial problems that have had or may have a significant impact on their creditworthiness. Further, the security we are able to obtain from such customers may be limited, including by FERC regulation. While certain of our customers are subsidiaries of an entity that has an investment grade credit rating, in many cases the parent entity has not guaranteed the obligations of the subsidiary and, therefore, the parent’s credit ratings may have no bearing on such customers’ ability to pay us for the services we provide or otherwise fulfill their obligations to us. See Note 2 “Summary of Significant Accounting Policies—Allowance for Credit Losses” in our consolidated financial statements.Furthermore, financially distressed customers might be forced to reduce or curtail their future use of our products and services, which also could have a material adverse effect on our results of operations, financial condition, and cash flows.We cannot provide any assurance that such customers and key counterparties will not become financially distressed or that such financially distressed customers or counterparties will not default on their obligations to us or file for bankruptcy protection. If one or more customers or counterparties files for bankruptcy protection, we likely would be unable to collect all, or even a significant portion of, amounts they owe to us. Similarly, our contracts with such customers may be renegotiated at lower rates or terminated altogether. Significant customer and other counterparty defaults and bankruptcy filings could have a material adverse effect on our business, financial position, results of operations or cash flows.We are subject to reputational risks and risks relating to public opinion.Our business, operations or financial condition generally may be negatively impacted as a result of negative public opinion towards our industry sector, the products we handle, or us specifically. Public opinion may be influenced by negative portrayals of the industry in which we operate as well as opposition to development projects. In addition, market events specific to us could result in the deterioration of our reputation with key stakeholders.25Reputational risk cannot be managed in isolation from other forms of risk. Credit, market, operational, insurance, regulatory and legal risks, among others, must all be managed effectively to safeguard our reputation. Our reputation and public opinion could also be impacted by the actions and activities of other companies operating in the energy industry, particularly other energy infrastructure providers, over which we have no control. In particular, our reputation could be impacted by negative publicity related to pipeline incidents or unpopular expansion projects and due to opposition to development of hydrocarbons and energy infrastructure, particularly projects involving resources that are considered to increase GHG emissions and contribute to climate change. Negative impacts from a compromised reputation or changes in public opinion (including with respect to the production, transportation and use of hydrocarbons generally) could include increased regulatory oversight, difficulty obtaining rights-of-way and delays in obtaining, or challenges to, regulatory approvals with respect to growth projects, blockades, project cancellations, difficulty securing financing, revenue loss, reduction in customer base, and decreased value of our securities and our business. Moreover, governmental agencies have responded to environmental justice concerns by imposing greater scrutiny in permitting approvals and enforcement actions that could exacerbate such negative impacts.Our use of hedging arrangements does not eliminate our exposure to commodity price risks and could result in financial losses or volatility in our income.We engage in hedging arrangements to reduce our direct exposure to fluctuations in the prices of crude oil, natural gas and NGL, including differentials between regional markets. These hedging arrangements expose us to risk of financial loss in some circumstances, including when production is less than expected, when the counterparty to the hedging contract defaults on its contract obligations, or when there is a change in the expected differential between the underlying price in the hedging agreement and the actual price received. In addition, these hedging arrangements may limit the benefit we would otherwise receive from increases in prices for crude oil, natural gas and NGL. Furthermore, our hedging arrangements cannot hedge against any decrease in the volumes of products we handle. See “—Our businesses are dependent on the supply of and demand for the products we handle.”The markets for instruments we use to hedge our commodity price exposure generally reflect then-prevailing conditions in the underlying commodity markets. As our existing hedges expire, we will seek to replace them. To the extent then-existing underlying market conditions are unfavorable, new hedging arrangements available to us will reflect such unfavorable conditions, limiting our ability to hedge our exposure to unfavorable commodity prices.When we engage in hedging transactions (for example, to mitigate our exposure to fluctuations in commodity prices or currency exchange rates or to balance our exposure to fixed and variable interest rates) that are effective economically, these transactions may not be considered effective for accounting purposes. Accordingly, our consolidated financial statements may reflect some volatility due to these hedges, even when there is no underlying economic impact at the dates of those consolidated financial statements. In addition, it may not be possible for us to engage in hedging transactions that completely eliminate our exposure to commodity prices; therefore, our consolidated financial statements may reflect a gain or loss arising from an exposure to commodity prices for which we are unable to enter into a completely effective hedge. For more information about our hedging activities, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” and Note 14 “Risk Management” to our consolidated financial statements.A breach of information security or the failure of one or more key information technology (IT) or operational (OT) systems, or those of third parties, may adversely affect our business, results of operations or business reputation.Our business is dependent upon our operational systems to process a large amount of data and complex transactions. Some of the operational systems we use are owned or operated by independent third-party vendors. The various uses of these systems, networks and services include, but are not limited to, controlling our pipelines and terminals with industrial control systems, collecting and storing information and data, processing transactions, and handling other processes necessary to manage our business.In accordance with government mandates, we have implemented and maintain a cybersecurity program—both internal and incorporating industry expertise—designed to protect our IT, OT and data systems from attacks, however, we can provide no assurance that our cybersecurity program will be completely effective. We have experienced increases in the number of attempts by external parties to access our networks or our company data without authorization. While we have taken additional steps to secure our networks and systems to specifically respond to new and elevated risks associated with recent increases in remote work, we may nevertheless be more vulnerable to a successful cyber-attack or information security incident when significant numbers of our employees are working remotely. The risk of a disruption or breach of our operational systems, or the compromise of the data processed in connection with our operations, has increased as attempted attacks, including acts of terrorism or cyber sabotage, have advanced in sophistication and number around the world.26If any of our systems are damaged, fail to function properly or otherwise become unavailable, we may incur substantial costs to repair or replace them. We may also experience loss or corruption of critical data and interruptions or delays in our ability to perform critical functions, which could adversely affect our business and results of operations. A significant failure, compromise, breach or interruption in our systems, which may result from problems such as ransomware, malware, computer viruses, hacking attempts or third-party error or malfeasance, could result in a disruption of our operations, customer dissatisfaction, damage to our reputation and a loss of customers or revenues. Efforts by us and our vendors to develop, implement and maintain security measures, including malware and anti-virus software and controls, may not be successful in preventing these events, and any network and information systems-related events could require us to expend significant remedial resources. In the future, we may be required to expend significant additional resources to continue to enhance our information security measures, to comply with regulations, to develop and implement government-mandated plans, and/or to investigate and remediate information security vulnerabilities.Attacks, including acts of terrorism or cyber sabotage, or the threat of such attacks, may adversely affect our business or reputation.The U.S. government has issued public warnings indicating that pipelines and other infrastructure assets might be specific targets of terrorist organizations or “cyber sabotage” events. For example, in May 2021, a ransomware attack on a major U.S. refined products pipeline forced the operator to temporarily shut down the pipeline, resulting in disruption of fuel supplies along the East Coast. Potential targets include our pipeline systems, terminals, processing plants, databases or operating systems. The occurrence of an attack could cause a substantial decrease in revenues and cash flows, increased costs to respond or other financial loss, significant reporting requirements, damage to our reputation, increased regulation or litigation or inaccurate information reported from our operations. In the event of such an incident, we may need to retain cybersecurity experts to assist us in stopping, diagnosing, and recovering from the attack. There is no assurance that adequate cyber sabotage and terrorism insurance will be available at rates we believe are reasonable in the near future. The potential for an attack may subject our operations to increased risks and costs, and, depending on their ultimate magnitude, have a material adverse effect on our business, results of operations, financial condition and/or business reputation.Hurricanes, earthquakes, flooding and other natural disasters, as well as subsidence and coastal erosion and climate-related physical risks, could have an adverse effect on our business, financial condition and results of operations.Some of our pipelines, terminals and other assets are located in, and our shipping vessels operate in, areas that are susceptible to hurricanes, earthquakes, flooding and other natural disasters or could be impacted by subsidence and coastal erosion. These natural disasters could potentially damage or destroy our assets and disrupt the supply of the products we transport. Many climate models indicate that global warming is likely to result in rising sea levels, increased frequency and severity of weather events such as winter storms, hurricanes and tropical storms, extreme precipitation and flooding. These climate-related changes could result in damage to our physical assets, especially operations located in low-lying areas near coasts and river banks, and facilities situated in hurricane-prone and rain-susceptible regions. Natural disasters can similarly affect the facilities of our customers. The timing, severity and location of these climate change impacts are not known with certainty, and these impacts are expected to manifest themselves over varying time horizons.In addition, we may experience increased insurance premiums and deductibles, or a decrease in available coverage, for our assets in areas subject to severe weather. In either case, losses could exceed our insurance coverage and our business, financial condition and results of operations could be adversely affected, perhaps materially. See “—Risks Related to Regulation—Climate-related risks and related regulation could result in significantly increased operating and capital costs for us and could reduce demand for our products and services.”Our insurance policies do not cover all losses, costs or liabilities that we may experience, and insurance companies that currently insure companies in the energy industry may cease to do so or substantially increase premiums.Our insurance program may not cover all operational risks and costs and may not provide sufficient coverage in the event of a claim. We do not maintain insurance coverage against all potential losses and could suffer losses for uninsurable or uninsured risks or in amounts in excess of existing insurance coverage. Losses in excess of our insurance coverage could have a material adverse effect on our business, financial condition and results of operations.Changes in the insurance markets subsequent to certain hurricanes and other natural disasters have made it more difficult and more expensive to obtain certain types of coverage. The occurrence of an event that is not fully covered by insurance, or failure by one or more of our insurers to honor its coverage commitments for an insured event, could have a material adverse effect on our business, financial condition and results of operations. Insurance companies may reduce the insurance capacity 27they are willing to offer or may demand significantly higher premiums or deductibles to cover our assets. If significant changes in the number or financial solvency of insurance underwriters for the energy industry occur, we may be unable to obtain and maintain adequate insurance at a reasonable cost. There is no assurance that our insurers will renew their insurance coverage on acceptable terms, if at all, or that we will be able to arrange for adequate alternative coverage in the event of non-renewal. The unavailability of full insurance coverage to cover events in which we suffer significant losses could have a material adverse effect on our business, financial condition and results of operations.Expanding our existing assets and constructing new assets is part of our growth strategy. Our ability to begin and complete expansion and new-build projects may be inhibited by difficulties in obtaining permits and rights-of-way, public opposition, increases in costs of construction materials, cost overruns, inclement weather and other delays. Should we pursue projects through joint ventures with others, we will share control of and any benefits from those projects.We regularly undertake construction projects to expand our existing assets and to construct new assets. New growth projects generally will be subject to, among other things, the receipt of regulatory approvals, feasibility and cost analyses, funding availability and industry, market and demand conditions, and environmental justice considerations. A variety of factors outside of our control, such as difficulties in obtaining rights-of-way and permits or other regulatory approvals, have caused, and may continue to cause, delays in or cancellations of our construction projects. Regulatory authorities may modify their permitting policies in ways that disadvantage our construction projects, such as the FERC’s ongoing evaluation of its process for reviewing and approving applications for construction of natural gas infrastructure, including consideration of changes to its Certificate Policy Statement and its issuance of a Draft GHG Policy Statement. Federal regulators may also expand existing regulatory requirements, such as PHMSA’s recent expansion of gas gathering pipeline regulation and PHMSA’s consideration of regulating the transportation of gaseous CO2. Such factors can be exacerbated by public opposition to our projects. See “—We are subject to reputational risks and risks relating to public opinion.” Inclement weather, natural disasters and delays in performance by third-party contractors have also resulted in, and may continue to result in, increased costs or delays in construction. In addition, we may experience increasing costs for construction materials. Significant increases in costs of construction materials, cost overruns or delays, or our inability to obtain a required permit or right-of-way, could have a material adverse effect on our return on investment, results of operations and cash flows, and could result in project cancellations or limit our ability to pursue other growth opportunities.If we pursue joint ventures with third parties, those parties may share approval rights over major decisions, and may act in their own interests. Their views may differ from our own or our views of the interests of the venture which could result in operational delays or impasses, which in turn could affect the financial expectations of and our expected benefits from the venture.Substantially all of the land on which our pipelines are located is owned by third parties. If we are unable to procure and maintain access to land owned by third parties, our revenue and operating costs, and our ability to complete construction projects, could be adversely affected.We must obtain and maintain the rights to construct and operate pipelines on other owners’ land, including private landowners, railroads, public utilities and others. While our interstate natural gas pipelines in the U.S. have federal eminent domain authority, the availability of eminent domain authority for our other pipelines varies from state to state depending upon the type of pipeline—petroleum liquids, natural gas, CO2, or crude oil—and the laws of the particular state. In any case, we must compensate landowners for the use of their property, and in eminent domain actions, such compensation may be determined by a court. If we are unable to obtain rights-of-way on acceptable terms, our ability to complete construction projects on time, on budget, or at all, could be adversely affected. In addition, we are subject to the possibility of increased costs under our rights-of-way or rental agreements with landowners, primarily through renewals of expiring agreements and rental increases. If we were to lose these rights, our operations could be disrupted or we could be required to relocate the affected pipelines, which could cause a substantial decrease in our revenues and cash flows and a substantial increase in our costs.The acquisition of additional businesses and assets is part of our growth strategy. We may experience difficulties completing acquisitions or integrating new businesses and properties, and we may be unable to achieve the benefits we expect from any future acquisitions.Part of our business strategy includes acquiring additional businesses and assets. We cannot provide any assurance that we will be able to find complementary acquisition targets or complete such acquisitions, or achieve the desired results from any acquisitions we do complete. Any acquired businesses or assets will be subject to many of the same risks as our existing businesses and may not achieve the levels of performance that we anticipate.28We may not realize anticipated operating advantages and cost savings. Integration of acquired businesses or assets involves a number of risks, including (i) the loss of key customers of the acquired business; (ii) demands on management related to the increase in our size; (iii) the diversion of management’s attention from the management of daily operations; (iv) difficulties in implementing or unanticipated costs of accounting, budgeting, reporting, internal controls and other systems; and (v) difficulties in the retention and assimilation of necessary employees.Difficulties in integration may be magnified if we make multiple acquisitions over a relatively short period of time. Because of difficulties in combining and expanding operations, we may not be able to achieve the cost savings and other size-related benefits that we hoped to achieve after these acquisitions, which would harm our financial condition and results of operations.The future success of our oil and gas development and production operations depends in part upon our ability to develop additional oil and gas reserves that are economically recoverable, which involves risks that may result in a total loss of investment.The rate of production from oil and natural gas properties declines as reserves are depleted. Without successful development activities, the reserves, revenues and cash flows of the oil and gas producing assets within our CO2 business segment will decline. We may not be able to develop or acquire additional reserves at an acceptable cost or have necessary financing for these activities in the future. Additionally, if we do not realize production volumes greater than, or equal to, our hedged volumes, we may suffer financial losses not offset by physical transactions.Developing and operating oil and gas properties involves a high degree of business and financial risk that even a combination of experience, knowledge and careful evaluation may not be able to overcome. Acquisition and development decisions generally are based on subjective judgments and assumptions that, while they may be reasonable, are by their nature speculative. It is impossible to predict with certainty the production potential of a particular property or well. Furthermore, the successful completion of a well does not ensure a profitable return on the investment. A variety of geological, operational and market-related factors may substantially delay or prevent completion of any well or otherwise prevent a property or well from being profitable. Our business requires the retention and recruitment of a skilled executive team and workforce, and difficulties recruiting and retaining executives and other key personnel could impair our ability to develop and implement our business strategy.Our success depends in part on the performance of and our ability to attract, retain and effectively manage the succession of a skilled executive team. We depend on our executive officers to develop and execute our business strategy. If we are not successful in retaining our executive officers, or replacing them, our business, financial condition or results of operations could be adversely affected. We do not maintain key personnel insurance.In addition, our business requires the retention and recruitment of a skilled workforce, including engineers, technical personnel and other professionals. We and our affiliates compete with other companies in the energy industry for this skilled workforce. In addition, many of our current employees are retirement eligible and have significant institutional knowledge that must be transferred to other employees. If we are unable to (i) retain current employees; (ii) successfully complete the knowledge transfer; and/or (iii) recruit new employees of comparable knowledge and experience, our business could be negatively impacted. In addition, we could experience increased costs to retain and recruit these professionals.Risks Related to Financing Our BusinessOur substantial debt could adversely affect our financial health and make us more vulnerable to adverse economic conditions.As of December 31, 2022, we had approximately $31.7 billion of consolidated debt (excluding debt fair value adjustments). Additionally, we and substantially all of our wholly owned U.S. subsidiaries are parties to a cross guarantee agreement under which each party to the agreement unconditionally guarantees the indebtedness of each other party, which means that we are liable for the debt of each of such subsidiaries. This level of consolidated debt and the cross guarantee agreement could have important consequences, such as (i) limiting our ability to obtain additional financing to fund our working capital, capital expenditures, debt service requirements or potential growth, or for other purposes; (ii) increasing the cost of our future borrowings; (iii) limiting our ability to use operating cash flow in other areas of our business or to pay dividends because we must dedicate a substantial portion of these funds to make payments on our debt; (iv) placing us at a competitive disadvantage compared to competitors with less debt; and (v) increasing our vulnerability to adverse economic and industry conditions.29Our ability to service our consolidated debt, and our ability to meet our consolidated leverage targets, will depend upon, among other things, our future financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, many of which are beyond our control. If our consolidated cash flow is not sufficient to service our consolidated debt, and any future indebtedness that we incur, we will be forced to take actions such as reducing dividends, reducing or delaying our business activities, acquisitions, investments or capital expenditures, selling assets or seeking additional equity capital. We may also take such actions to reduce our indebtedness if we determine that our earnings (or consolidated EBITDA, as calculated in accordance with our revolving credit facility) may not be sufficient to meet our consolidated leverage targets or to comply with consolidated leverage ratios required under certain of our debt agreements. We may not be able to effect any of these actions on satisfactory terms or at all. For more information about our debt, see Note 9 “Debt” to our consolidated financial statements.Our business, financial condition and operating results may be affected adversely by adverse changes in the availability, terms and cost of capital or a reduction in the availability of credit.We may need to rely on external financing sources, including commercial borrowings and issuances of debt and equity securities, to fund acquisitions, capital projects or refinancing debt maturities. Adverse changes to the availability, terms and cost of capital, interest rates or our credit ratings (which would have a corresponding impact on the credit ratings of our subsidiaries that are party to the cross guarantee agreement) could cause our cost of doing business to increase by limiting our access to capital, including our ability to refinance maturities of existing indebtedness on similar terms, which could in turn reduce our cash flows, and could limit our ability to pursue acquisition or expansion opportunities. Our credit ratings may be impacted by our leverage, liquidity, credit profile and potential transactions. Although the ratings from credit agencies are not recommendations to buy, sell or hold our securities, our credit ratings will generally affect the market value of our and our subsidiaries’ debt securities and the terms available to us for future issuances of debt securities.Also, disruptions and volatility in the global financial markets may lead to an increase in interest rates or a contraction in credit availability, impacting our ability to finance our operations and strategy on favorable terms. A significant reduction in the availability of credit could materially and adversely affect our business, financial condition and results of operations.Our and our customers’ access to capital could be affected by evolving financial institutions’ policies concerning businesses linked to fossil fuels.Our and our customers’ access to capital could be affected by financial institutions’ evolving policies concerning businesses linked to fossil fuels. Concerns about the potential effects of climate change have caused some to direct their attention towards sources of funding for fossil-fuel energy companies, which has resulted in certain financial institutions, funds and other sources of capital restricting or eliminating their investment in such companies. Ultimately, this could make it more difficult for our customers to secure funding for exploration and production activities or for us to secure funding for growth projects, and consequently could both indirectly affect demand for our services and directly affect our ability to fund construction or other capital projects.Our large amount of variable rate debt makes us vulnerable to increases in interest rates.As of December 31, 2022, approximately $6.3 billion of our approximately $31.7 billion of consolidated debt (excluding debt fair value adjustments) was subject to variable interest rates, either as short-term or long-term variable-rate debt obligations, or as long-term fixed-rate debt effectively converted to variable rates through the use of interest rate swaps. Variable-to-fixed interest rate swap agreements covering an additional $1.25 billion of our consolidated debt will expire at the end of 2023. In response to increasing inflation, the U.S. Federal Reserve raised interest rates in March 2022 for the first time in over three years, raised rates several more times since and has signaled it expects to make additional rate increases. As interest rates increase, the amount of cash required to service variable-rate debt also increases, as do our costs to refinance maturities of existing indebtedness, and our earnings and cash flows could be adversely affected. For more information about our interest rate risk, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk—Interest Rate Risk.”Our debt instruments may limit our financial flexibility and increase our financing costs.The instruments governing our debt contain restrictive covenants that may prevent us from engaging in certain transactions that may be beneficial to us. Some of the agreements governing our debt generally require us to comply with various affirmative and negative covenants, including the maintenance of certain financial ratios and restrictions on (i) incurring 30additional debt; (ii) entering into mergers, consolidations and sales of assets; (iii) granting liens; and (iv) entering into sale-leaseback transactions. The instruments governing any future debt may contain similar or more limiting restrictions. Our ability to respond to changes in business and economic conditions and to obtain additional financing, if needed, may be restricted.Risks Related to RegulationThe FERC or state public utility commissions, such as the CPUC, may establish pipeline tariff rates that have a negative impact on us. In addition, the FERC, state public utility commissions or our customers could initiate proceedings or file complaints challenging the tariff rates charged by our pipelines, which could have an adverse impact on us.The profitability of our regulated pipelines is influenced by fluctuations in costs and our ability to recover any increases in our costs in the rates charged to our shippers. To the extent that our costs increase in an amount greater than what we are permitted by the FERC or state public utility commissions to recover in our rates, or to the extent that there is a lag before we can file for and obtain rate increases, such events can have a negative impact on our operating results.Our existing rates may also be challenged by complaint or protest. Regulators and shippers on our pipelines have rights to challenge, and have challenged, the rates we charge under certain circumstances prescribed by applicable regulations. Some shippers on our pipelines have filed complaints with the regulators seeking prospective reductions in the tariff rates and, in the case of a protest to a rate filing, seeking substantial refunds for alleged overcharges during the years in question. Further, the FERC has initiated and may continue to initiate investigations to determine whether our interstate natural gas pipeline rates are just and reasonable. Please read Note 18 “Litigation and Environmental” to our consolidated financial statements for a description of material pending challenges to the rates we charge on our pipelines. We are unable to predict the extent to which these proceedings will result in lower transportation rates on our pipelines, and in the case of a protest, refunds for alleged overcharges. Any successful challenge to our rates could materially adversely affect our future earnings, cash flows and financial condition.New laws, policies, regulations, rulemaking and oversight, as well as changes to those currently in effect, could adversely impact our earnings, cash flows and operations.Our assets and operations are subject to extensive regulation and oversight by federal, state and local regulatory authorities. Legislative changes, as well as regulatory actions taken by these authorities, have the potential to adversely affect our profitability. Additional regulatory burdens and uncertainties will be created if and to the extent that more stringent energy and environmental and pipeline safety policies are enacted. Overall, we have seen an increase in the efforts of regulatory authorities to issue new regulations and guidance and to interpret existing laws and regulations in ways that promote the use of renewable energy sources and further protection of the environment, call upon companies to increase monitoring and emissions reduction efforts, and increase investigations and enforcement actions for potential violations of environmental laws. For example, in November 2021, the EPA proposed a rule containing standards of performance for GHG emissions, in the form of methane limitations, and volatile organic compound emissions for crude oil and natural gas sources, including the production, processing, transmission and storage segments. In November 2022, the EPA announced a supplemental proposal expanding on the November 2021 proposed rule aimed at achieving more comprehensive emissions reductions from oil and natural gas sources. In April 2022, the EPA proposed a rule calling for significant reductions in nitrogen oxide emissions in 26 states, including on new and existing natural gas fired reciprocating engines used at compressor stations. These types of proposals, if finalized, would affect our assets and operations indirectly, such as by increasing the costs associated with the production of natural gas and liquids that we transport, or directly, such as by increasing significantly our capital and operating costs associated with impacted equipment. These and other initiatives of regulatory authorities may affect our assets and operations directly or indirectly, such as by preventing or delaying the exploration for and production of natural gas and liquids that we transport or expanding regulation of existing infrastructure or new sources that are not currently regulated.Regulation affects almost every part of our business. In addition to environmental and pipeline safety matters, we are subject to regulations extending to such matters as (i) federal, state and local taxation; (ii) rates (which include reservation, commodity, surcharges, fuel and gas lost and unaccounted for), operating terms and conditions of service; (iii) the types of services we may offer to our customers; (iv) the contracts for service entered into with our customers; (v) the certification and construction of new facilities; (vi) the integrity, safety and security (including against cyber-attacks) of facilities and operations; (vii) the acquisition of other businesses; (viii) the acquisition, extension, disposition or abandonment of services or facilities; (ix) reporting and information posting requirements; (x) the maintenance of accounts and records; and (xi) relationships with affiliated companies involved in various aspects of the natural gas and energy businesses.31Should we fail to comply with any applicable statutes, rules, regulations, and orders of such regulatory authorities, we could be subject to substantial penalties and fines and potential loss of government contracts. New laws or regulations, or different interpretations of existing laws or regulations, including unexpected policy changes, applicable to our income, operations, assets or another aspect of our business could have a material adverse impact on our earnings, cash flow, financial condition and results of operations. For more information, see Items 1 and 2. “Business and Properties—Narrative Description of Business—Industry Regulation.” Environmental, health and safety laws and regulations could expose us to significant costs and liabilities.Our operations are subject to extensive federal, state and local laws, regulations and potential liabilities arising under or relating to the protection or preservation of the environment, natural resources and human health and safety. Such laws and regulations affect many aspects of our past, present and future operations, and generally require us to obtain and comply with various environmental registrations, licenses, permits, inspections and other approvals. It is possible that costs associated with complying with the aforementioned laws will increase as a result of the emphasis regulatory authorities are placing on protection of the environment and environmental justice considerations. Liability under such laws and regulations may be incurred without regard to fault under CERCLA, the Resource Conservation and Recovery Act, the Federal Clean Water Act, the Oil Pollution Act, or analogous state laws, as a result of the presence or release of hydrocarbons and other hazardous substances into or through the environment, and these laws may require response actions and remediation and may impose liability for natural resource and other damages. Private parties, including the owners of properties through which our pipelines pass, also may have the right to pursue legal actions to enforce compliance as well as to seek damages for non-compliance with such laws and regulations or for personal injury or property damage. Our insurance may not cover all environmental risks and costs and/or may not provide sufficient coverage in the event an environmental claim is made against us.Failure to comply with these laws and regulations, including required permits and other approvals, also may expose us to civil, criminal and administrative fines, penalties and/or interruptions in our operations that could harm our business, financial position, results of operations and prospects. For example, if a leak, release or spill of liquid petroleum products, chemicals or other hazardous substances occurs at or from our pipelines, shipping vessels or storage or other facilities, we may experience significant operational disruptions, and we may have to pay a significant amount to clean up or otherwise respond to the leak, release or spill, pay government penalties, address natural resource damage, compensate for human exposure or property damage, install costly pollution control equipment or undertake a combination of these and other measures.We own and/or operate numerous properties and equipment that have been used for many years in connection with our business activities and contain hydrocarbons or other hazardous substances. While we believe we have utilized operating, handling and disposal practices that were consistent with industry practices at the time, hydrocarbons or other hazardous substances may have been released at or from properties and equipment owned, operated or used by us or our predecessors, or at or from properties where our or our predecessors’ wastes have been taken for disposal. In addition, many of these properties have been owned and/or operated by third parties whose management, handling and disposal of hydrocarbons or other hazardous substances were not under our control. These properties and any hazardous substances released and wastes disposed at or from them may be subject to U.S. laws such as CERCLA, which impose joint and several liability without regard to fault or the legality of the original conduct. Under such laws, we could be required to remove previously disposed wastes, remediate property contamination or both, including contamination caused by prior owners or operators. Furthermore, it is possible that some wastes that are currently classified as non-hazardous, which could include wastes currently generated during our pipeline or liquids or bulk terminal operations or wastes from oil and gas facilities that are currently exempt as being exploration and production waste, may in the future be designated as hazardous wastes. Hazardous wastes are subject to more rigorous and costly handling and disposal requirements than non-hazardous wastes. Such changes in the regulations may result in additional capital expenditures or operating expenses for us.Environmental and health and safety laws and regulations are subject to change. The long-term trend in environmental regulation has been to place more restrictions and limitations on activities that may be perceived to affect the environment, wildlife, natural resources and human health, including without limitation, the exploration, development, storage and transportation of oil and gas. For example, the Federal Clean Air Act and other similar federal and state laws are subject to periodic review and amendment, which could result in more stringent emission control requirements obligating us to make significant capital expenditures at our facilities. Several state and federal agencies have also increased their daily and maximum penalty amounts in recent years. There can be no assurance as to the amount or timing of future expenditures for environmental compliance or remediation, and actual future expenditures may be different from the amounts we currently anticipate. New or revised regulations that result in increased compliance costs or additional operating restrictions, particularly if those costs are not fully recoverable from our customers, as well as increased penalty amounts for inadvertent non-compliance, 32such as a pipeline leak, could have a material adverse effect on our business, financial position, results of operations and prospects. For more information, see Items 1 and 2. “Business and Properties—Narrative Description of Business—Environmental Matters.”Increased regulatory requirements relating to the safety and integrity of our pipelines may require us to incur significant capital and operating expense outlays to comply.We are subject to extensive laws and regulations related to pipeline safety and integrity at the federal and state levels. There are, for example, regulations issued by PHMSA for pipeline operators in the areas of design, operations, integrity testing, repairs, qualification and training, emergency response, control room management, and public awareness. We expect the costs of compliance with these regulations, including integrity management rules, will be substantial. The majority of compliance costs relate to pipeline integrity testing and repairs and reconfirmation of the maximum allowable operating pressure on our gas pipelines. Technological advances in in-line inspection tools, identification of additional threats to a pipeline’s integrity and changes to the amount of pipeline determined to be located in HCAs or MCAs can have a significant impact on integrity testing and repair costs. We plan to continue our integrity testing programs to assess and maintain the integrity of our existing and future pipelines as required by PHMSA rules. Repairs or upgrades deemed necessary to address results of integrity assessments and other testing and/or ensure the continued safe and reliable operation of our pipelines and pipeline facilities could cause us to incur significant and unanticipated capital and operating expenditures. Such expenditures will vary depending on the number of repairs determined to be necessary as a result of integrity assessments and other testing. We expect to increase expenditures in the future to comply with PHMSA regulations.Further, additional laws and regulations that may be enacted in the future or a new interpretation of existing laws and regulations could significantly increase the amount of these expenditures. Pipeline safety regulations or changes to such regulations may require additional leak detection, reporting, the replacement of some of our pipeline segments, addition of monitoring equipment and more frequent monitoring, inspection or testing of our pipeline facilities. Repair, remediation, and preventative or mitigating actions may require significant capital and operating expenditures. Pipeline safety regulation has increased over time, including recent final gas and hazardous liquid regulations that we must timely implement, and existing obligations may increase with new proposed rules that are currently under consideration. Congress is set to reauthorize the Pipeline Safety Act in 2023, which could further expand PHMSA’s current rulemaking agenda and/or statutory authority in certain areas. For example, PHMSA is working on a number of proposed rulemakings projected for publication in 2023, including those related to (i) pipeline leak detection and repair; (ii) updating regulations for LNG facilities; (iii) inspection and maintenance requirements for idled pipelines; and (iv) revising existing requirements for transportation of CO2 in the liquid phase as well as establishing regulation of the transportation of gaseous CO2 (projected in 2024). There can be no assurance as to the amount or timing of future expenditures for pipeline safety and integrity regulation, and actual future expenditures may be different from the amounts we currently anticipate. Revised or additional regulations that result in increased compliance costs or additional operating restrictions, particularly if those costs are not deemed by regulators to be fully recoverable from our customers, could have a material adverse effect on our business, financial position, results of operations and prospects.Climate-related risks and related regulation could result in significantly increased operating and capital costs for us and could reduce demand for our products and services.Various laws and regulations exist or are under development that seek to regulate the emission of GHGs such as methane and CO2, including the EPA programs to control GHG emissions, PHMSA’s existing and anticipated leak detection and repair requirements, and state actions to develop statewide or regional programs. Existing EPA regulations require us to report GHG emissions in the U.S. from sources such as our larger natural gas compressor stations, fractionated NGL, and production of naturally occurring CO2 (for example, from our McElmo Dome CO2 field), even when such production is not emitted to the atmosphere. Proposed approaches to further address GHG emissions include establishing GHG “cap and trade” programs, a fee on methane emissions from petroleum and natural gas systems, increased efficiency standards, participation in international climate agreements, issuance of executive orders by the U.S. presidential administration and incentives or mandates for pollution reduction, use of renewable energy sources, or use of alternative fuels with lower carbon content. For more information about climate change regulation, see Items 1 and 2. “Business and Properties—Narrative Description of Business—Environmental Matters—Climate Change.”Adoption of any such laws or regulations could increase our costs to operate and maintain our facilities, expand existing facilities or construct new facilities. We could be required to install new emission controls on our facilities, acquire allowances for our GHG emissions, pay taxes related to our GHG emissions and administer and manage a GHG emissions program, and such increased costs could be significant. Recovery of such increased costs from our customers is uncertain in all cases and may depend on events beyond our control, including the outcome of future rate proceedings before the FERC. Such laws or regulations could also lead to reduced demand for hydrocarbon products that are deemed to contribute to GHGs, or restrictions 33on their use, which in turn could adversely affect demand for our products and services. See also “—Business Risks—We are subject to reputational risks and risks relating to public opinion.” and “—Business Risks—Hurricanes, earthquakes, flooding and other natural disasters, as well as subsidence and coastal erosion and climate-related physical risks, could have an adverse effect on our business, financial condition and results of operations.”In March 2022, the SEC proposed new climate-related disclosure rules, which if adopted as proposed, would require significant new climate-related disclosure in SEC filings, including certain climate-related metrics and GHG emissions data, and third-party attestation requirements. At this time, we cannot predict the costs of compliance with or any potential adverse impacts resulting from, the new rules if adopted as proposed. Any of the foregoing could have adverse effects on our business, financial position, results of operations or cash flows.Increased regulation of exploration and production activities, including activity on public lands, could result in reductions or delays in drilling and completing new oil and natural gas wells, as well as reductions in production from existing wells, which could adversely impact the volumes of natural gas transported on our natural gas pipelines and our own oil and gas development and production activities.We gather, process or transport crude oil, natural gas or NGL from several areas, including lands that are federally managed. Policy and regulatory initiatives or legislation by Congress may decrease access to federally managed lands or increase the regulatory burdens associated with using these lands to produce crude oil or natural gas, or both. Recently, the federal government has deprioritized onshore leasing and its review of applications for permits to drill. Third-party interests groups and members of the oil and gas industry have initiated litigation challenging decisions to approve or prohibit oil and gas activities on federally managed lands.In addition, oil and gas development and production activities are subject to increasing regulation at the federal, state and local levels. For example, there have been initiatives at the federal and state levels to regulate or otherwise restrict the use of certain hydraulic fracturing activities, and many states are promulgating stricter requirements related not only to well development but also to compressor stations and other facilities in the oil and gas industry. These activities are subject to laws and regulations regarding the acquisition of permits before drilling, restrictions on drilling activities and location, emissions into the environment, water discharges, transportation of hazardous materials, and storage and disposition of wastes. In addition, legislation has been enacted that requires well and facility sites to be abandoned and reclaimed to the satisfaction of state authorities. Adoption of legislation or regulations restricting these activities in our areas of operations could impose operational delays, increased operating costs and additional regulatory burdens on exploration and production operators, which could reduce their production of crude oil, natural gas or NGL and, in turn, adversely affect our revenues, cash flows and results of operations by decreasing the volumes of these commodities that we handle. These laws and regulations may also adversely affect our own oil and gas development and production activities.The Jones Act includes restrictions on ownership by non-U.S. citizens of our U.S. point to point maritime shipping vessels, and failure to comply with the Jones Act, or changes to or a repeal of the Jones Act, could limit our ability to operate our vessels in the U.S. coastwise trade, result in the forfeiture of our vessels or otherwise adversely impact our earnings, cash flows and operations.We are subject to the Jones Act, which generally restricts U.S. point-to-point maritime shipping to vessels operating under the U.S. flag, built in the U.S., owned and operated by U.S.-organized companies that are controlled and at least 75% owned by U.S. citizens and crewed by predominately U.S. citizens. Our business would be adversely affected if we fail to comply with the Jones Act provisions on coastwise trade. If we do not comply with any of these requirements, we would be prohibited from operating our vessels in the U.S. coastwise trade and, under certain circumstances, we could be deemed to have undertaken an unapproved transfer to non-U.S. citizens that could result in severe penalties, including permanent loss of U.S. coastwise trading rights for our vessels, fines or forfeiture of vessels. Our business could be adversely affected if the Jones Act were to be modified or repealed so as to permit foreign competition that is not subject to the same U.S. government imposed burdens.Proposed changes to U.S. federal, state, and local tax laws, if enacted, could have a material adverse effect on our business and profitability.New federal, state, or local tax legislation or administrative guidance may be enacted or issued in the future, and such legislation or guidance could materially impact our current or future tax planning and effective tax rates. It is unclear (i) whether these or similar changes will occur, (ii) if such changes occur, when such changes will become effective, and (iii) 34whether such changes will have a material adverse effect on our business, profitability, financial position, results of operations, or cash flows.Risks Related to Ownership of Our Capital StockThe guidance we provide for our anticipated dividends is based on estimates. Circumstances may arise that lead to conflicts between using funds to pay anticipated dividends or to invest in our business.We disclose in this report and elsewhere the expected cash dividends on our common stock. These reflect our current judgment, but as with any estimate, they may be affected by inaccurate assumptions and other risks and uncertainties, many of which are beyond our control. See “Information Regarding Forward-Looking Statements” at the beginning of this report. If our board of directors elects to pay dividends at the anticipated level and that action would leave us with insufficient cash to take timely advantage of growth opportunities (including through acquisitions), to meet any large unanticipated liquidity requirements, to fund our operations, to maintain our leverage metrics or otherwise to properly address our business prospects, our business could be harmed.Conversely, a decision to address such needs might lead to the payment of dividends below the anticipated levels. As events present themselves or become reasonably foreseeable, our board of directors, which determines our business strategy and our dividends, may decide to address those matters by reducing our anticipated dividends. Alternatively, because nothing in our governing documents or credit agreements prohibits us from borrowing to pay dividends, we could choose to incur debt to enable us to pay our anticipated dividends. This would add to our substantial debt discussed above under “—Risks Related to Financing Our Business—Our substantial debt could adversely affect our financial health and make us more vulnerable to adverse economic conditions.”Our certificate of incorporation restricts the ownership of our common stock by non-U.S. citizens within the meaning of the Jones Act. These restrictions may affect the liquidity of our common stock and may result in non-U.S. citizens being required to sell their shares at a loss.The Jones Act requires, among other things, that at least 75% of our common stock be owned at all times by U.S. citizens, as defined under the Jones Act, in order for us to own and operate vessels in the U.S. coastwise trade. As a safeguard to help us maintain our status as a U.S. citizen, our certificate of incorporation provides that, if the number of shares of our common stock owned by non-U.S. citizens exceeds 22%, we have the ability to redeem shares owned by non-U.S. citizens to reduce the percentage of shares owned by non-U.S. citizens to 22%. These redemption provisions may adversely impact the marketability of our common stock, particularly in markets outside of the U.S. Further, those stockholders would not have control over the timing of such redemption and may be subject to redemption at a time when the market price or timing of the redemption is disadvantageous. In addition, the redemption provisions might have the effect of impeding or discouraging a merger, tender offer or proxy contest by a non-U.S. citizen, even if it were favorable to the interests of some or all of our stockholders.Item 1B. Unresolved Staff Comments.None.Item 3. Legal Proceedings.See Note 18 “Litigation and Environmental” to our consolidated financial statements.Item 4. Mine Safety Disclosures.Except for one terminal facility that is in temporary idle status with the Mine Safety and Health Administration, we do not own or operate mines for which reporting requirements apply under the mine safety disclosure requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). We have not received any specified health and safety violations, orders or citations, related assessments or legal actions, mining-related fatalities, or similar events requiring disclosure pursuant to the mine safety disclosure requirements of Dodd-Frank for the year ended December 31, 2022.35PART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.As of February 7, 2023, we had 9,941 holders of our Class P common stock, which does not include beneficial owners whose shares are held by a nominee, such as a broker or bank.For information on our equity compensation plans, see Note 10 “Share-based Compensation and Employee Benefits—Share-based Compensation” to our consolidated financial statements.Our Purchases of Our Class P Stock(During the quarter ended December 31, 2022)Settlement PeriodTotal number of securities purchased(a)Average price paid per security(b)Total number of securities purchased as part of publicly announced plans(a)Maximum number (or approximate dollar value) of securities that may yet be purchased under the plans or programs(a)October 1 to October 31, 20222,056,189 $16.75 2,056,189 $1,057,284,126 November 1 to November 30, 2022— — — 1,057,284,126 December 1 to December 31, 2022— — — 1,057,284,126 Total2,056,189 $16.75 2,056,189 $1,057,284,126 (a)On July 19, 2017, our board of directors approved a $2 billion common share buy-back program. On January 18, 2023, our board of directors approved an increase in our share repurchase authorization to $3 billion from $2 billion, increasing the maximum dollar value of securities that may yet be purchased under the plan as of January 18, 2023 to $2.1 billion. After repurchase, the shares are canceled and no longer outstanding.(b)Amount includes any commission or other costs to repurchase shares.Item 6. [Reserved] Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.The following discussion and analysis should be read in conjunction with our consolidated financial statements and the notes thereto. We prepared our consolidated financial statements in accordance with GAAP. Additional sections in this report which should be helpful to the reading of our discussion and analysis include the following: (i) a description of our business strategy found in Items 1 and 2. “Business and Properties—Narrative Description of Business—Business Strategy;” (ii) a description of developments during 2022, found in Items 1 and 2. “Business and Properties—General Development of Business—Recent Developments;” (iii) a description of terms for services and commodities we provide, found in Items 1 and 2.“Business and Properties—Narrative Description of Business—Business Segments;” (iv) a description of risk factors affecting us and our business, found in Item 1A. “Risk Factors;” and (v) a discussion of forward-looking statements, found in “Information Regarding Forward-Looking Statements” at the beginning of this report.A comparative discussion of our 2021 to 2020 operating results can be found in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC on February 7, 2022.36GeneralSignificant Acquisitions and DispositionsFollowing are significant acquisitions and dispositions during the reporting periods. See Note 3, “Acquisitions and Divestitures” to our consolidated financial statements for further information on these transactions.EventDescriptionBusiness SegmentSale of interest in ELC(September 2022)We sold a 25.5% interest in our joint venture ELC. We now own a 25.5% interest in ELC and continue to operate, have a controlling financial interest in and consolidate ELC.Natural Gas Pipelines business segment(East Region)North American Natural Resources acquisition(August 2022)We acquired seven landfill assets with the purchase of North American Natural Resources, Inc. and, its sister companies, North American Biofuels, LLC and North American-Central, LLC (NANR) consisting of GTE facilities in Michigan and Kentucky.CO2 business segment(Energy Transition Ventures group)Mas Ranger acquisition(July 2022)We acquired three landfill assets with the purchase of Mas Ranger, LLC and its subsidiaries from Mas CanAm, LLC, comprising an RNG facility in Arlington, Texas and medium Btu facilities in Shreveport, Louisiana and Victoria, Texas.CO2 business segment(Energy Transition Ventures group)February 2021 Winter StormOur earnings for 2021 reflect impacts of the February 2021 winter storm that affected Texas, which are largely nonrecurring. See “—Segment Earnings Results” below.2023 Dividends and Discretionary Capital We expect to declare dividends of $1.13 per share for 2023, a 2% increase from the 2022 declared dividends of $1.11 per share. We also expect to invest $2.1 billion in expansion projects and contributions to joint ventures, or discretionary capital expenditures during 2023.The expectations for 2023 discussed above involve risks, uncertainties and assumptions, and are not guarantees of performance. Many of the factors that will determine these expectations are beyond our ability to control or predict, and because of these uncertainties, it is advisable not to put undue reliance on any forward-looking statement. Please read our Item 1A. “Risk Factors” and “Information Regarding Forward-Looking Statements” at the beginning of this report for more information. Furthermore, we plan to provide updates to these 2022 expectations when we believe previously disclosed expectations no longer have a reasonable basis.Critical Accounting EstimatesCritical accounting estimates and assumptions involve material levels of subjectivity and complex judgement to account for highly uncertain matters or matters with a high susceptibility to change, and could result in a material impact to our financial statements. Examples of certain areas that require more judgment relative to others when preparing our consolidated financial statements and related disclosures include our use of estimates in determining (i) revenue recognition; (ii) income taxes; (iii) the economic useful lives of our assets and related depletion rates; (iv) the fair values used in (a) assignment of the purchase price for a business acquisition, (b) calculations of possible asset and equity investment impairment charges, (c) calculation for the annual goodwill impairment test (or interim tests if triggered), and (d) recording derivative contract assets and liabilities; (v) reserves for environmental claims, legal fees, transportation rate cases and other litigation liabilities; (vi) provisions for credit losses; and (vii) exposures under contractual indemnifications. We routinely evaluate these estimates, utilizing historical experience, consultation with experts and other methods we consider reasonable in the particular circumstances. Nevertheless, actual results may differ significantly from our estimates, and any effects on our business, financial position or results of operations resulting from revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known.37For a summary of our significant accounting policies, see Note 2 “Summary of Significant Accounting Policies” to our consolidated financial statements and the following discussion for further information regarding critical estimates and assumptions used in the preparation of our financial statements. For discussion on our hedging activities and relatedsensitivities to our estimates, see Note 14 “Risk Management” to our consolidated financial statements and Item 7A.“Quantitative and Qualitative Disclosures About Market Risk,” respectively.ImpairmentsIn addition to our annual testing of impairment for goodwill, we evaluate impairment of our long-lived assets when a triggering event occurs. Management applies judgment in determining whether there is an impairment indicator. Fair value calculated for the purpose of testing our long-lived assets, including intangible assets, goodwill and equity method investments, for impairment involves the use of significant estimates and assumptions regarding the timing and amounts of future cash inflows and outflows, discount rates, market prices and asset lives, among other items. The estimates and assumptions can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts. An estimate of the sensitivity to changes in underlying assumptions of a fair value calculation is not practicable, given the numerous assumptions that can materially affect our estimates.For more information on our impairments and significant estimates and assumptions used in our impairment evaluations, see Note 4 “Gains and Losses on Divestitures, Impairments and Other Write-downs.”Environmental MattersWith respect to our environmental exposure, we utilize both internal staff and external experts to assist us in identifying environmental issues and in estimating the costs and timing of remediation efforts. Our accrual of environmental liabilities often coincides either with our completion of a feasibility study or our commitment to a formal plan of action, but generally, we recognize and/or adjust our probable environmental liabilities, if necessary or appropriate, following quarterly reviews of potential environmental issues and claims that could impact our assets or operations. In recording and adjusting environmental liabilities, we consider the effect of environmental compliance, pending legal actions against us, and potential third-party liability claims. For more information on environmental matters, see Part I, Items 1 and 2. “Business and Properties—Narrative Description of Business—Environmental Matters.” For more information on our environmental disclosures, see Note 18 “Litigation and Environmental” to our consolidated financial statements.Legal and Regulatory MattersMany of our operations are regulated by various U.S. regulatory bodies, and we are subject to legal and regulatory matters as a result of our business operations and transactions. We utilize both internal and external counsel in evaluating our potential exposure to adverse outcomes from orders, judgments or settlements. Any such liability recorded is revised as better information becomes available. Accordingly, to the extent that actual outcomes differ from our estimates, or additional facts and circumstances cause us to revise our estimates, our earnings will be affected. For more information on regulatory matters, see Part I, Items 1 and 2. “Business and Properties—Narrative Description of Business—Industry Regulation.” For more information on legal proceedings, see Note 18 “Litigation and Environmental” to our consolidated financial statements. Employee Benefit PlansOur pension and OPEB obligations and net benefit costs are primarily based on actuarial calculations. A significant assumption we utilize is the discount rate used in calculating our benefit obligations. The selection of assumptions used in the actuarial calculations of our pension and OPEB plans is further discussed in Note 10 “Share-based Compensation and Employee Benefits” to our consolidated financial statements.Actual results may differ from the assumptions included in these calculations, and as a result, our estimates associated with our pension and OPEB can be, and have been revised in subsequent periods. The income statement impact of the changes in the assumptions on our related benefit obligations are deferred and amortized into income over either the period of expected future service of active participants, or over the expected future lives of inactive plan participants. 38The following sensitivity analysis shows the estimated impact of a 1% change in the primary assumptions used in our actuarial calculations associated with our pension and OPEB plans for the year ended December 31, 2022: Pension BenefitsOPEBNet benefit cost (income)Change in funded status(a)Net benefit cost (income)Change in funded status(a)(In millions)One percent increase in:Discount rates$(13)$145 $— $13 Expected return on plan assets(22)— (4)— Rate of compensation increase3 (9)— — One percent decrease in:Discount rates15 (169)— (15)Expected return on plan assets22 — 4 — Rate of compensation increase(3)8 — — (a)Includes amounts deferred as either accumulated other comprehensive income (loss) or as a regulatory asset or liability for certain of our regulated operations.Income TaxesWe make significant judgments and estimates in determining our provision for income taxes, including our assessment of our income tax positions given the uncertainties involved in the interpretation and application of complex tax laws and regulations in various taxing jurisdictions. Numerous and complex judgments and assumptions are inherent in the estimation of future taxable income when determining a valuation allowance, including factors such as future operating conditions and the apportionment of income by state. For more information, see Note 5 “Income Taxes” to our consolidated financial statements.Results of OperationsOverviewAs described in further detail below, our management evaluates our performance primarily using the GAAP financial measures of Segment EBDA (as presented in Note 16, “Reportable Segments”) and Net income attributable to Kinder Morgan, Inc., along with the non-GAAP financial measures of Adjusted Earnings and DCF, both in the aggregate and per share for each, Adjusted Segment EBDA, Adjusted EBITDA and Net Debt.GAAP Financial MeasuresThe Consolidated Earnings Results for the years ended December 31, 2022 and 2021 present Segment EBDA and Net income attributable to Kinder Morgan, Inc., which are prepared and presented in accordance with GAAP. Segment EBDA is a useful measure of our operating performance because it measures the operating results of our segments before DD&A and certain expenses that are generally not controllable by our business segment operating managers, such as general and administrative expenses and corporate charges, interest expense, net, and income taxes. Our general and administrative expenses and corporate charges include such items as unallocated employee benefits, insurance, rentals, unallocated litigation and environmental expenses, and shared corporate services including accounting, information technology, human resources and legal services.Non-GAAP Financial MeasuresOur non-GAAP financial measures described below should not be considered alternatives to GAAP Net income attributable to Kinder Morgan, Inc. or other GAAP measures and have important limitations as analytical tools. Our computations of these non-GAAP financial measures may differ from similarly titled measures used by others. You should not consider these non-GAAP financial measures in isolation or as substitutes for an analysis of our results as reported under GAAP. Management compensates for the limitations of these non-GAAP financial measures by reviewing our comparable GAAP measures, understanding the differences between the measures and taking this information into account in its analysis and its decision making processes.39Certain ItemsCertain Items, as adjustments used to calculate our non-GAAP financial measures, are items that are required by GAAP to be reflected in Net income attributable to Kinder Morgan, Inc., but typically either (i) do not have a cash impact (for example, unsettled commodity hedges and asset impairments), or (ii) by their nature are separately identifiable from our normal business operations and in our view are likely to occur only sporadically (for example, certain legal settlements, enactment of new tax legislation and casualty losses). We also include adjustments related to joint ventures (see “Amounts from Joint Ventures” below and the tables included in “—Consolidated Earnings Results (GAAP)—Certain Items Affecting Consolidated Earnings Results,” “—Non-GAAP Financial Measures—Reconciliation of Net Income Attributable to Kinder Morgan, Inc. (GAAP) to Adjusted EBITDA” and “—Non-GAAP Financial Measures—Supplemental Information” below). In addition, Certain Items are described in more detail in the footnotes to tables included in “—Segment Earnings Results” and “—DD&A, General and Administrative and Corporate Charges, Interest, net and Noncontrolling Interests” below.Adjusted EarningsAdjusted Earnings is calculated by adjusting Net income attributable to Kinder Morgan, Inc. for Certain Items. Adjusted Earnings is used by us and certain external users of our financial statements to assess the earnings of our business excluding Certain Items as another reflection of our ability to generate earnings. We believe the GAAP measure most directly comparable to Adjusted Earnings is Net income attributable to Kinder Morgan, Inc. Adjusted Earnings per share uses Adjusted Earnings and applies the same two-class method used in arriving at basic earnings per share. See “—Non-GAAP Financial Measures—Reconciliation of Net Income Attributable to Kinder Morgan, Inc. (GAAP) to Adjusted Earnings to DCF” below.DCFDCF is calculated by adjusting Net income attributable to Kinder Morgan, Inc. for Certain Items (Adjusted Earnings), and further by DD&A and amortization of excess cost of equity investments, income tax expense, cash taxes, sustaining capital expenditures and other items. We also include amounts from joint ventures for income taxes, DD&A and sustaining capital expenditures (see “Amounts from Joint Ventures” below). DCF is a significant performance measure useful to management and external users of our financial statements in evaluating our performance and in measuring and estimating the ability of our assets to generate cash earnings after servicing our debt, paying cash taxes and expending sustaining capital, that could be used for discretionary purposes such as dividends, stock repurchases, retirement of debt, or expansion capital expenditures. DCF should not be used as an alternative to net cash provided by operating activities computed under GAAP. We believe the GAAP measure most directly comparable to DCF is Net income attributable to Kinder Morgan, Inc. DCF per share is DCF divided by average outstanding shares, including restricted stock awards that participate in dividends. See “—Non-GAAP Financial Measures—Reconciliation of Net Income Attributable to Kinder Morgan, Inc. (GAAP) to Adjusted Earnings to DCF” and “—Non-GAAP Financial Measures—Adjusted Segment EBDA to Adjusted EBITDA to DCF” below.Adjusted Segment EBDAAdjusted Segment EBDA is calculated by adjusting Segment EBDA for Certain Items attributable to the segment. Adjusted Segment EBDA is used by management in its analysis of segment performance and management of our business. We believe Adjusted Segment EBDA is a useful performance metric because it provides management and external users of our financial statements additional insight into the ability of our segments to generate cash earnings on an ongoing basis. We believe it is useful to investors because it is a measure that management uses to allocate resources to our segments and assess each segment’s performance. We believe the GAAP measure most directly comparable to Adjusted Segment EBDA is Segment EBDA. See “—Consolidated Earnings Results (GAAP)—Certain Items Affecting Consolidated Earnings Results” for a reconciliation of Segment EBDA to Adjusted Segment EBDA by business segment. Adjusted EBITDAAdjusted EBITDA is calculated by adjusting EBITDA for Certain Items. We also include amounts from joint ventures for income taxes and DD&A (see “Amounts from Joint Ventures” below). Adjusted EBITDA is used by management and external users, in conjunction with our Net Debt (as described further below), to evaluate our leverage. Therefore, we believe Adjusted EBITDA is useful to investors. We believe the GAAP measure most directly comparable to Adjusted EBITDA is Net income attributable to Kinder Morgan, Inc. See “—Adjusted Segment EBDA to Adjusted EBITDA to DCF” and “—Non-GAAP Financial Measures—Reconciliation of Net Income Attributable to Kinder Morgan, Inc. (GAAP) to Adjusted EBITDA” below.40Amounts from Joint VenturesCertain Items, DCF and Adjusted EBITDA reflect amounts from unconsolidated joint ventures and consolidated joint ventures utilizing the same recognition and measurement methods used to record “Earnings from equity investments” and “Noncontrolling interests,” respectively. The calculations of DCF and Adjusted EBITDA related to our unconsolidated and consolidated joint ventures include the same items (DD&A and income tax expense, and for DCF only, also cash taxes and sustaining capital expenditures) with respect to the joint ventures as those included in the calculations of DCF and Adjusted EBITDA for our wholly-owned consolidated subsidiaries. (See “—Non-GAAP Financial Measures—Supplemental Information” below.) Although these amounts related to our unconsolidated joint ventures are included in the calculations of DCF and Adjusted EBITDA, such inclusion should not be understood to imply that we have control over the operations and resulting revenues, expenses or cash flows of such unconsolidated joint ventures. Net DebtNet Debt is calculated, based on amounts as of December 31, 2022, by subtracting the following amounts from our total debt balance of $31,788 million: (i) cash and cash equivalents of $745 million; and (ii) debt fair value adjustments of $115 million; and excluding the foreign exchange impact on Euro-denominated bonds of $(8) million for which we have entered into currency swaps to convert that debt to U.S. dollars. Net Debt is a non-GAAP financial measure that management believes is useful to investors and other users of our financial information in evaluating our leverage. We believe the most comparable measure to Net Debt is total debt. 41Consolidated Earnings Results (GAAP)The following tables summarize the key components of our consolidated earnings results.Year Ended December 31,20222021Earningsincrease/(decrease)(In millions, except percentages)Segment EBDA(a) Natural Gas Pipelines$4,801 $3,815 $986 26 %Products Pipelines1,107 1,064 43 4 %Terminals975 908 67 7 %CO2819 760 59 8 %Total segment EBDA7,702 6,547 1,155 18 %DD&A(2,186)(2,135)(51)(2)%Amortization of excess cost of equity investments(75)(78)3 4 %General and administrative and corporate charges(593)(623)30 5 %Interest, net(1,513)(1,492)(21)(1)%Income before income taxes3,335 2,219 1,116 50 %Income tax expense(710)(369)(341)(92)%Net income2,625 1,850 775 42 %Net income attributable to noncontrolling interests(77)(66)(11)(17)%Net income attributable to Kinder Morgan, Inc.$2,548 $1,784 $764 43 %(a)Includes revenues, earnings from equity investments, operating expenses, (gain) loss on divestitures and impairments, net, other income, net and other, net. Operating expenses include costs of sales, operations and maintenance expenses, and taxes, other than income taxes. Year Ended December 31, 2022 vs. 2021Net income attributable to Kinder Morgan, Inc. increased $764 million in 2022 compared to 2021. The increase was primarily due to the $1,600 million non-cash impairment loss and associated income tax benefit in 2021 related to South Texas gathering and processing assets within our Natural Gas Pipeline segment and higher earnings across all of our business segments partially offset by the benefit in the 2021 period of $1,092 million for largely nonrecurring pre-tax earnings related to the February 2021 winter storm, mostly impacting the earnings from our Natural Gas Pipelines and CO2 business segments.42Certain Items Affecting Consolidated Earnings ResultsYear Ended December 31,20222021GAAPCertain ItemsAdjustedGAAPCertain ItemsAdjustedAdjusted amountsincrease/(decrease) to earnings(In millions)Segment EBDANatural Gas Pipelines$4,801 $141 $4,942 $3,815 $1,648 $5,463 $(521)Products Pipelines1,107 — 1,107 1,064 53 1,117 (10)Terminals975 — 975 908 42 950 25 CO2819 (11)808 760 (6)754 54 Total Segment EBDA(a)7,702 130 7,832 6,547 1,737 8,284 (452)DD&A and amortization of excess cost of equity investments(2,261)— (2,261)(2,213)— (2,213)(48)General and administrative and corporate charges(a)(593)6 (587)(623)— (623)36 Interest, net(a)(1,513)(11)(1,524)(1,492)(26)(1,518)(6)Income before income taxes3,335 125 3,460 2,219 1,711 3,930 (470)Income tax expense(b)(710)(37)(747)(369)(491)(860)113 Net income2,625 88 2,713 1,850 1,220 3,070 (357)Net income attributable to noncontrolling interests(a)(77)— (77)(66)— (66)(11)Net income attributable to Kinder Morgan, Inc.$2,548 $88 $2,636 $1,784 $1,220 $3,004 $(368)(a)For a more detailed discussion of these Certain Items, see the footnotes to the tables within “—Segment Earnings Results” and “—DD&A, General and Administrative and Corporate Charges, Interest, net and Noncontrolling Interests” below.(b)The combined net effect of the income tax Certain Items represents the income tax provision on Certain Items plus discrete income tax items.Net income attributable to Kinder Morgan, Inc. adjusted for Certain Items (Adjusted Earnings) decreased by $368 million from the prior year. The decrease was primarily due to lower Adjusted Segment EBDA contributions of $668 million from our Natural Gas Pipelines business segment’s Midstream region (see “—Segment Earnings Results—Natural Gas Pipelines” further below) which was impacted by the February 2021 winter storm (and therefore largely nonrecurring) partially offset by lower income tax expense related to the reduction in earnings.43Non-GAAP Financial MeasuresReconciliation of Net Income Attributable to Kinder Morgan, Inc. (GAAP) to Adjusted Earnings to DCFYear Ended December 31,20222021(In millions)Net income attributable to Kinder Morgan Inc. (GAAP)$2,548 $1,784 Total Certain Items88 1,220 Adjusted Earnings(a)2,636 3,004 DD&A and amortization of excess cost of equity investments for DCF(b)2,534 2,481 Income tax expense for DCF(a)(b)822 943 Cash taxes(b)(83)(69)Sustaining capital expenditures(b)(901)(864)Other items(c)(38)(35)DCF$4,970 $5,460 Adjusted Segment EBDA to Adjusted EBITDA to DCFYear Ended December 31,20222021(In millions, except per share amounts)Natural Gas Pipelines$4,942 $5,463 Products Pipelines1,107 1,117 Terminals975 950 CO2808 754 Adjusted Segment EBDA(a)7,832 8,284 General and administrative and corporate charges(a)(587)(623)Joint venture DD&A and income tax expense(a)(b)348 351 Net income attributable to noncontrolling interests(a)(77)(66)Adjusted EBITDA7,516 7,946 Interest, net(a)(1,524)(1,518)Cash taxes(b)(83)(69)Sustaining capital expenditures(b)(901)(864)Other items(c)(38)(35)DCF$4,970 $5,460 Adjusted Earnings per share$1.16 $1.32 Weighted average shares outstanding for dividends(d)2,271 2,278 DCF per share$2.19 $2.40 Declared dividends per share$1.11 $1.08 (a)Amounts are adjusted for Certain Items. See tables included in “—Reconciliation of Net Income Attributable to Kinder Morgan, Inc. (GAAP) to Adjusted EBITDA” and “—Supplemental Information” below.(b)Includes or represents DD&A, income tax expense, cash taxes and/or sustaining capital expenditures (as applicable for each item) from joint ventures. See tables included in “—Supplemental Information” below.(c)Includes pension contributions, non-cash pension expense and non-cash compensation associated with our restricted stock program.(d)Includes restricted stock awards that participate in dividends. 44Reconciliation of Net Income Attributable to Kinder Morgan, Inc. (GAAP) to Adjusted EBITDAYear Ended December 31,20222021(In millions)Net income attributable to Kinder Morgan, Inc. (GAAP)$2,548 $1,784 Certain Items:Fair value amortization(15)(19)Legal, environmental and other reserves51 160 Change in fair value of derivative contracts(a)57 19 Loss on impairments, divestitures and other write-downs, net(b)— 1,535 Income tax Certain Items(37)(491)Other32 16 Total Certain Items(c)88 1,220 DD&A and amortization of excess cost of equity investments2,261 2,213 Income tax expense(d)747 860 Joint venture DD&A and income tax expense(d)(e)348 351 Interest, net(d)1,524 1,518 Adjusted EBITDA$7,516 $7,946 (a)Gains or losses are reflected in our DCF when realized.(b)2021 amount primarily includes a pre-tax non-cash impairment loss of $1,600 million related to our South Texas gathering and processing assets within our Natural Gas Pipelines business segment reported within “(Gain) loss on divestitures and impairments, net” and a pre-tax gain of $206 million associated with the sale of a partial interest in our equity investment in NGPL Holdings LLC, offset partially by a write-down of $117 million on a long-term subordinated note receivable from an equity investee, Ruby, reported within “Other, net” and “Earnings from equity investments,” respectively, on the accompanying consolidated statement of income. (c)2022 and 2021 amounts include $1 million and $124 million, respectively, reported within “Earnings from equity investments” on our accompanying consolidated statements of income.(d)Amounts are adjusted for Certain Items. See tables included in “—Supplemental Information” and “—DD&A, General and Administrative and Corporate Charges, Interest, net and Noncontrolling Interests” below.(e)Represents joint venture DD&A and income tax expense. See table included in “—Supplemental Information” below.45Supplemental InformationYear Ended December 31,20222021(In millions)DD&A (GAAP)$2,186 $2,135 Amortization of excess cost of equity investments (GAAP)75 78 DD&A and amortization of excess cost of equity investments2,261 2,213 Joint venture DD&A273 268 DD&A and amortization of excess cost of equity investments for DCF$2,534 $2,481 Income tax expense (GAAP)$710 $369 Certain Items37 491 Income tax expense(a)747 860 Unconsolidated joint venture income tax expense(a)(b)75 83 Income tax expense for DCF(a)$822 $943 Additional joint venture informationUnconsolidated joint venture DD&A$323 $312 Less: Consolidated joint venture partners’ DD&A50 44 Joint venture DD&A273 268 Unconsolidated joint venture income tax expense(a)(b)75 83 Joint venture DD&A and income tax expense(a)$348 $351 Unconsolidated joint venture cash taxes(b)$(70)$(60)Unconsolidated joint venture sustaining capital expenditures$(148)$(116)Less: Consolidated joint venture partners’ sustaining capital expenditures(8)(9)Joint venture sustaining capital expenditures$(140)$(107)(a)Amounts are adjusted for Certain Items.(b)Amounts are associated with our Citrus, NGPL and Products (SE) Pipe Line equity investments.46Segment Earnings ResultsNatural Gas Pipelines Year Ended December 31, 20222021 (In millions, except operating statistics)Revenues$12,686 $11,709 Operating expenses(8,562)(7,000)Gain (loss) on divestitures and impairments, net10 (1,599)Other income3 2 Earnings from equity investments683 487 Other, net(19)216 Segment EBDA4,801 3,815 Certain Items(a)141 1,648 Adjusted Segment EBDA$4,942 $5,463 Change from prior periodIncrease/(Decrease)Segment EBDA$986 Adjusted Segment EBDA$(521)Volumetric data(b)Transport volumes (BBtu/d)39,064 38,577 Sales volumes (BBtu/d)2,482 2,473 Gathering volumes (BBtu/d)3,046 2,749 NGLs (MBbl/d)30 29 (a)For more detail of these Certain Items, see the discussion of changes in Segment EBDA below.(b)Joint venture throughput is reported at our ownership share. Volumes for acquired pipelines are included and volumes for assets sold are excluded for all periods presented, however, EBDA contributions from acquisitions are included only for the periods subsequent to their acquisition.Below are the changes in Segment EBDA between 2022 and 2021:Year Ended December 31, 2022 versus Year Ended December 31, 2021Segment EBDA 20222021increase/(decrease) (In millions)Midstream$1,441 $442 $999 East2,502 2,510 (8)West858 863 (5)Total Natural Gas Pipelines$4,801 $3,815 $986 The changes in Segment EBDA for our Natural Gas Pipelines business segment in the comparable years of 2022 and 2021 are explained by the following discussion:•A $999 million (226%) increase in Midstream was affected by the following items for 2022 and 2021: (i) a pre-tax non-cash asset impairment loss of $1,600 million in the 2021 period related to our South Texas gathering and processing assets; (ii) an increase in expense in the 2021 period related to a certain litigation matter; and (iii) an increase in revenues 47and costs of sales period over period related to the impacts of non-cash mark-to-market derivative contracts used to hedge forecasted commodity sales and purchases, all of which we treated as Certain Items.In addition, Midstream’s Segment EBDA was unfavorably impacted by lower realized gas sales margins of $781 million on our Texas intrastate natural gas pipeline operations and $77 million on our South Texas assets largely driven by higher commodity prices related to the February 2021 winter storm partially offset by (i) higher volumes on our KinderHawk assets; (ii) higher commodity sales margins driven by higher prices on our Altamont asset; and (iii) higher earnings on our Oklahoma assets from lower costs of sales due to higher commodity prices in 2021 on certain purchase contracts as a result of the February 2021 winter storm. Overall, Midstream’s revenue changes are partially offset by corresponding changes in costs of sales.• An $8 million (—%) decrease in the East Region was affected by a pre-tax gain in the 2021 period associated with the sale of a partial interest in our equity investment in NGPL Holdings which we treated as a Certain Item.In addition, East Region’s Segment EBDA was favorably impacted by (i) our July 2021 acquisition of the Stagecoach assets; (ii) higher equity earnings from MEP driven by new customer contracts in 2022; (iii) increased earnings from KMLP reflecting a new LNG customer contract; and (iv) higher equity earnings from SNG as a result of increased demand for services; partially offset by decreased earnings on TGP driven by higher operating expenses due in part to higher pipeline integrity costs partially offset by higher park and loan revenues. •A $5 million (1%) decrease in the West Region was primarily impacted by lower earnings from CIG driven by lower revenues resulting from a rate case settlement and from EPNG driven by increased operating expenses and decreased revenues due to lower commodity and park and loan volumes which resulted from a partial pipeline outage, partially offset by an increase in gas sales margin.In addition, the West Region’s Segment EBDA was affected by the following items for 2022 and 2021: (i) a write-down on a long-term subordinated note receivable from our equity investee, Ruby, in 2021; (ii) an increase in operating expenses in the 2022 period related to litigation reserves and other costs associated with the EPNG pipeline rupture; and (iii) an increase in expense in the 2022 period resulting from a payment associated with the bankruptcy settlement involving our equity investee, Ruby, all of which we treated as Certain Items.Below are the changes in Adjusted Segment EBDA between 2022 and 2021:Year Ended December 31, 2022 versus Year Ended December 31, 202120222021 Segment EBDA(GAAP)Certain ItemsAdjusted Segment EBDASegment EBDA(GAAP)Certain ItemsAdjusted Segment EBDAAdjusted Segment EBDA increase/(decrease) (In millions)Midstream$1,441 $62 $1,503 $442 $1,729 $2,171 $(668)East2,502 1 2,503 2,510 (199)2,311 192 West858 78 936 863 118 981 (45)Total Natural Gas Pipelines$4,801 $141 $4,942 $3,815 $1,648 $5,463 $(521)48Products Pipelines Year Ended December 31, 20222021 (In millions, except operating statistics)Revenues$3,418 $2,245 Operating expenses(2,391)(1,239)Gain on divestitures and impairments, net12 — Earnings from equity investments68 57 Other, net— 1 Segment EBDA1,107 1,064 Certain Items(a)— 53 Adjusted Segment EBDA$1,107 $1,117 Change from prior periodIncrease/(Decrease)Segment EBDA$43 Adjusted Segment EBDA$(10)Volumetric data(b)Gasoline(c)978 987 Diesel fuel367 390 Jet fuel264 223 Total refined product volumes1,609 1,600 Crude and condensate471 498 Total delivery volumes (MBbl/d)2,080 2,098 (a)For more detail of these Certain Items, see the discussion of changes in Segment EBDA below.(b)Joint venture throughput is reported at our ownership share.(c)Volumes include ethanol pipeline volumes.Below are the changes in Segment EBDA between 2022 and 2021:Year Ended December 31, 2022 versus Year Ended December 31, 2021Segment EBDA 20222021increase/(decrease) (In millions)West Coast Refined Products$511 $448 $63 Southeast Refined Products265 258 7 Crude and Condensate331 358 (27)Total Products Pipelines$1,107 $1,064 $43 The changes in Segment EBDA for our Products Pipelines business segment in the comparable years of 2022 and 2021 are explained by the following discussion:•A $63 million (14%) increase in West Coast Refined Products was affected by increased expenses in the 2021 period related to litigation and environmental reserve adjustments which we treated as Certain Items.In addition, West Coast Refined Products Segment EBDA was further impacted by a gain on sale of land at Calnev and increased earnings driven by higher revenues on our West Coast terminals from higher volumes and rates, partially offset 49by lower earnings on our Pacific operations resulting from higher integrity management expenses partially offset by higher revenues driven by increased transportation rates.•A $7 million (3%) increase in Southeast Refined Products was primarily due to an increase in equity earnings from Products (SE) Pipe Line primarily due to higher revenues as a result of increased volumes partially offset by higher pipeline integrity costs. Overall, revenues from our Transmix processing operations were largely offset by corresponding costs of sales. •A $27 million (8%) decrease in Crude and Condensate was primarily due to lower earnings from our Bakken Crude assets due to lower volumes on our Double H pipeline and from our Kinder Morgan Crude & Condensate pipeline driven primarily by lower deficiency revenues, partially offset by higher earnings from our KM Condensate Processing facility reflecting increased revenues due to higher volumes and rate escalations. Our Crude and Condensate business also had higher revenues of $974 million with a corresponding increase in cost of sales, resulting from increased marketing activities.Below are the changes in Adjusted Segment EBDA between 2022 and 2021:Year Ended December 31, 2022 versus Year Ended December 31, 202120222021 Segment EBDA(GAAP)Certain ItemsAdjusted Segment EBDASegment EBDA(GAAP)Certain ItemsAdjusted Segment EBDAAdjusted Segment EBDA increase/(decrease) (In millions)West Coast Refined Products$511 $— $511 $448 $53 $501 $10 Southeast Refined Products265 — 265 258 — 258 7 Crude and Condensate331 — 331 358 — 358 (27)Total Products Pipelines$1,107 $— $1,107 $1,064 $53 $1,117 $(10)50Terminals Year Ended December 31, 20222021 (In millions, except operating statistics)Revenues$1,792 $1,715 Operating expenses(853)(793)Gain (loss) on divestitures and impairments, net9 (36)Other income5 4 Earnings from equity investments14 15 Other, net8 3 Segment EBDA975 908 Certain Items(a)— 42 Adjusted Segment EBDA$975 $950 Change from prior periodIncrease/(Decrease)Segment EBDA$67 Adjusted Segment EBDA$25 Volumetric data(b)Liquids leasable capacity (MMBbl)77.8 77.8 Liquids utilization %(c)93.3 %94.8 %Bulk transload tonnage (MMtons)53.2 51.3 (a)For more detail of these Certain Items, see the discussion of changes in Segment EBDA below.(b)Volumes for facilities divested, idled, and/or held for sale are excluded for all periods presented.(c)The ratio of our tankage capacity in service to liquids leasable capacity.For purposes of the following tables and related discussions, the results of operations of our terminals held for sale or divested, including any associated gain or loss on sale, are reclassified for all periods presented from the historical region and included within the All others group. 51Below are the changes in Segment EBDA between 2022 and 2021:Year Ended December 31, 2022 versus Year Ended December 31, 2021Segment EBDA 20222021increase/(decrease) (In millions)Mid Atlantic$101 $63 $38 Lower River74 51 23 Gulf Central134 122 12 Gulf Liquids285 300 (15)Northeast92 107 (15)Marine operations146 151 (5)All others (including intrasegment eliminations)143 114 29 Total Terminals$975 $908 $67 The changes in Segment EBDA for our Terminals business segment in the comparable years of 2022 and 2021 are explained by the following discussion:•A $38 million (60%) increase in the Mid Atlantic terminals was primarily due to higher handling rates and coal volumes at our Pier IX facility.•A $23 million (45%) increase in the Lower River terminals was primarily due to higher deficiency revenues from a coal customer and the non-recurring impact associated with 2021’s Hurricane Ida, including lower revenues and higher operating expenses recognized in the 2021 period. The non-recurring impact on 2021 operating expenses associated with Hurricane Ida was treated by us as a Certain Item.•A $12 million (10%) increase in the Gulf Central terminals was primarily due to higher volumes for petroleum coke handling activities, owing largely to refinery outages in the 2021 period associated with the February 2021 winter storm and lower property tax expense at Battleground Oil Specialty Terminal Company LLC.•A $15 million (5%) decrease in the Gulf Liquids region was primarily due to re-contracting at lower rates and higher property tax expense partially offset by contractual rate escalations. •A $15 million (14%) decrease in the Northeast terminals was primarily driven by decreased revenues associated with lower utilization and lower rates on re-contracted tank positions at our Carteret and Perth Amboy facilities.•A $5 million (3%) decrease in Marine operations was primarily due to lower average charter rates partially offset by higher fleet utilization.•In addition, other Terminals Segment EBDA was further affected in the 2021 period by pre-tax non-cash impairment losses related to the planned divestiture of our Wilmington terminal and the sale of our interest in Kinder Morgan Resources LLC, both of which we treated as Certain Items.52Below are the changes in Adjusted Segment EBDA between 2022 and 2021: Year Ended December 31, 2022 versus Year Ended December 31, 202120222021 Segment EBDA(GAAP)Certain ItemsAdjusted Segment EBDASegment EBDA(GAAP)Certain ItemsAdjusted Segment EBDAAdjusted Segment EBDA increase/(decrease) (In millions)Mid Atlantic$101 $— $101 $63 $— $63 $38 Lower River74 — 74 51 8 59 15 Gulf Central134 — 134 122 — 122 12 Gulf Liquids285 — 285 300 — 300 (15)Northeast92 — 92 107 — 107 (15)Marine operations146 — 146 151 — 151 (5)All others (including intrasegment eliminations)143 — 143 114 34 148 (5)Total Terminals$975 $— $975 $908 $42 $950 $25 53CO2 Year Ended December 31, 20222021 (In millions, except operating statistics)Revenues$1,334 $1,009 Operating expenses(554)(289)Gain on divestitures and impairments, net1 8 Earnings from equity investments38 32 Segment EBDA819 760 Certain Items(a)(11)(6)Adjusted Segment EBDA $808 $754 Change from prior periodIncrease/(Decrease)Segment EBDA$59 Adjusted Segment EBDA$54 Volumetric dataSACROC oil production19.92 19.88 Yates oil production6.52 6.57 Other2.75 3.25 Total oil production, net (MBbl/d)(b)29.19 29.70 NGL sales volumes, net (MBbl/d)(b)9.40 9.38 CO2 sales volumes, net (Bcf/d)0.36 0.38 Realized weighted average oil price ($ per Bbl)(c)$66.78 $52.71 Realized weighted average NGL price ($ per Bbl)$39.59 $25.39 (a)For more detail of these Certain Items, see the discussion of changes in Segment EBDA below.(b)Net of royalties and outside working interests.(c)Had we not used energy derivative contracts to transfer commodity price risk, our crude oil sales prices would have averaged $96.36 per barrel and $68.47 per barrel in 2022 and 2021, respectively.Below are the changes in Segment EBDA between 2022 and 2021:Year Ended December 31, 2022 versus Year Ended December 31, 2021Segment EBDA 20222021increase/(decrease) (In millions)Oil and Gas Producing activities$553 $507 $46 Source and Transportation activities247 245 2 Subtotal800 752 48 Energy Transition Ventures19 8 11 Total CO2$819 $760 $59 The changes in Segment EBDA for our CO2 business segment in the comparable years of 2022 and 2021 are explained by the following discussion:•A $46 million (9%) increase in Oil and Gas Producing activities primarily due to higher realized crude oil and NGL prices which increased revenues by $203 million, a 2021 settlement of $38 million for a terminated affiliate purchase contract with Source and Transportation activities partially offset by higher operating expenses of $186 million mainly 54driven by the benefit realized in the 2021 period from returning power to the grid by curtailing oil production during the February 2021 winter storm.In addition, Oil and Gas Producing activities Segment EBDA was favorably affected in 2022 and 2021 by changes in revenues related to non-cash mark-to-market derivative hedge contracts which we treated as Certain Items.•A $2 million (1%) increase in Source and Transportation activities primarily due to increased revenues of $51 million related to higher CO2 sales prices partially offset by a 2021 settlement of $38 million for a terminated affiliate sales contract with Oil and Gas Producing activities and decreased revenues related to lower CO2 sales volumes.In addition, Source and Transportation activities was unfavorably impacted by a gain on sale of an asset in 2021 which we treated as a Certain Item.Below are the changes in Adjusted Segment EBDA between 2022 and 2021:Year Ended December 31, 2022 versus Year Ended December 31, 202120222021 Segment EBDA(GAAP)Certain ItemsAdjusted Segment EBDASegment EBDA(GAAP)Certain ItemsAdjusted Segment EBDAAdjusted Segment EBDA increase/(decrease) (In millions)Oil and Gas Producing activities$553 $(11)$542 $507 $4 $511 $31 Source and Transportation activities247 — 247 245 (10)235 12 Subtotal800 (11)789 752 (6)746 43 Energy Transition Ventures19 — 19 8 — 8 11 Total CO2$819 $(11)$808 $760 $(6)$754 $54 We believe that our existing hedge contracts in place within our CO2 business segment substantially mitigate commodity price sensitivities in the near-term and to lesser extent over the following few years from price exposure. Below is a summary of our CO2 business segment hedges outstanding as of December 31, 2022.2023202420252026Crude Oil(a)Price ($ per Bbl)$64.19 $61.66 $61.76 $65.72 Volume (MBbl/d)22.30 14.14 9.72 4.10 NGLsPrice ($ per Bbl)$59.13 Volume (MBbl/d)3.08 Midland-to-Cushing Basis SpreadPrice ($ per Bbl)$0.97 Volume (MBbl/d)17.96 (a)Includes West Texas Intermediate hedges.55DD&A, General and Administrative and Corporate Charges, Interest, net and Noncontrolling Interests Year Ended December 31, 20222021Earnings increase/(decrease) (In millions)DD&A (GAAP)$(2,186)$(2,135)$(51)General and administrative (GAAP)$(637)$(655)$18 Corporate benefit44 32 12 Certain Items(a)6 — 6 General and administrative and corporate charges(b)$(587)$(623)$36 Interest, net (GAAP)$(1,513)$(1,492)$(21)Certain Items(a)(11)(26)15 Interest, net(b)$(1,524)$(1,518)$(6)Net income attributable to noncontrolling interests (GAAP)$(77)$(66)$(11)Certain Items(a)— — — Net income attributable to noncontrolling interests(b)$(77)$(66)$(11)(a)For more detailed discussions of these Certain Items, see the discussions of changes in DD&A, General and Administrative and Corporate Charges, Interest, net and Noncontrolling Interests below.(b)Amounts are adjusted for Certain Items.We had a favorable change of $18 million in general and administrative expenses and a favorable change of $12 million in our corporate benefit in 2022 when compared to 2021. The combined changes were primarily due to higher capitalized costs of $24 million, reflecting higher capital spending, and lower benefit-related and pension costs of $18 million partially offset by $9 million of higher labor, travel and legal costs. In addition, the combined changes included the unfavorable impact of an increase in costs of $6 million associated with the Ruby bankruptcy which we treated as a Certain Item.In the table above, we report our interest expense as “net,” meaning that we have subtracted interest income and capitalized interest from our total interest expense to arrive at one interest amount. Our consolidated interest expense, net increased $21 million in 2022 when compared to 2021 primarily due to higher realized LIBOR/SOFR rates associated with interest rate swaps partially offset by lower average long-term debt balances at slightly lower weighted average rates.The increase in interest expense was further impacted by (i) non-cash differences between the change in fair value of interest rate swaps not designated as accounting hedges and the change in fair value of hedged debt, primarily related to our floating-to-fixed LIBOR/SOFR interest rate swaps, and (ii) non-cash debt fair value adjustments associated with acquisitions, both of which were treated by us as Certain ItemsWe use interest rate swap agreements to convert a portion of the underlying cash flows related to our long-term fixed rate debt securities (senior notes) into variable rate debt in order to achieve our desired mix of fixed and variable rate debt. As of December 31, 2022 and 2021, approximately 20% and 21%, respectively, of the principal amount of our debt balances were subject to variable interest rates—either as short-term or long-term variable rate debt obligations or as fixed-rate debt converted to variable rates through the use of interest rate swaps. The percentage at December 31, 2022 includes $1,250 million of variable-to-fixed interest rate derivative contracts which expire in December 2023. The percentage at December 31, 2021 excludes $4,860 million of variable-to-fixed interest rate derivative contracts which became effective January 4, 2022 and hedged our exposure through 2022. For more information on our interest rate swaps, see Note 14 “Risk Management—Interest Rate Risk Management” to our consolidated financial statements.Net income attributable to noncontrolling interests represents the allocation of our consolidated net income attributable to all outstanding ownership interests in our consolidated subsidiaries that are not owned by us. 56Income Taxes Year Ended December 31, 20222021Increase (In millions)Income tax expense$710 $369 $341 The increase in income tax expense is due primarily to (i) higher pretax book income in 2022; (ii) the release of a valuation allowance related to our investment in NGPL in 2021; (iii) the Enhanced Oil Recovery Credit in 2021; and (iv) lower dividend-received deductions in 2022.On August 16, 2022, the Inflation Reduction Act of 2022 (IRA) was enacted into law. The IRA contains significant U.S. federal income tax law changes, including the addition of a corporate alternative minimum tax imposed at a rate of fifteen percent (15%) on our global adjusted financial statement income effective as of January 1, 2023. Based on current guidance, we do not expect the IRA to have a material adverse impact on our business, results of operations or financial position. Liquidity and Capital Resources GeneralAs of December 31, 2022, we had $745 million of “Cash and cash equivalents,” a decrease of $395 million from December 31, 2021. Additionally, as of December 31, 2022, we had borrowing capacity of approximately $3.9 billion under our credit facilities (discussed below in “—Short-term Liquidity”). As discussed further below, we believe our cash flows from operating activities, cash position and remaining borrowing capacity on our credit facilities are more than adequate to allow us to manage our day-to-day cash requirements and anticipated obligations.We have consistently generated substantial cash flow from operations, providing a source of funds of $4,967 million and $5,708 million in 2022 and 2021, respectively. The year-to-year decrease is discussed below in “—Cash Flows—Operating Activities.” We primarily rely on cash provided from operations to fund our operations as well as our debt service, sustaining capital expenditures, dividend payments, and our growth capital expenditures; however, we may access the debt capital markets from time to time to refinance our maturing long-term debt and finance incremental investments, if any.Our board of directors declared a quarterly dividend of $0.2775 per share for the fourth quarter of 2022, consistent with previous quarters in 2022. The total of the dividends declared for 2022 of $1.11 represents a 3% increase over total dividends declared for 2021.On February 23, 2022, EPNG issued in a private offering $300 million aggregate principal amount of 3.50% senior notes due 2032 and received net proceeds of $298 million after discount and issuance costs.On August 3, 2022, we issued in a registered offering two series of senior notes consisting of $750 million aggregate principal amount of 4.80% senior notes due 2033 and $750 million aggregate principal amount of 5.45% senior notes due 2052 and received combined net proceeds of $1,484 million. We used a portion of the proceeds to repay short-term borrowings and for general corporate purposes.During the first quarter of 2022, upon maturity, we repaid EPNG’s 8.625% senior notes, our 4.15% corporate senior notes, and the 1.50% series of our Euro denominated debt. During the second quarter 2022, we repaid $1 billion of our 3.95% senior notes using short-term borrowings. The short-term borrowings were repaid in the third quarter 2022 with proceeds from the August 2022 senior note issuances.On January 17, 2023, we repaid $1 billion of our 3.15% and $250 million of our floating rate senior notes using cash on hand and short-term borrowings. On January 31, 2023, we issued in a registered offering $1.5 billion aggregate principal amount of 5.20% senior notes due 2033 for net proceeds of $1,485 million, which were used to repay short-term borrowings, maturing debt and for general corporate purposes.57Short-term LiquidityAs of December 31, 2022, our principal sources of short-term liquidity are (i) cash from operations; and (ii) our combined $4.0 billion of credit facilities with an available capacity of approximately $3.9 billion and an associated $3.5 billion commercial paper program. The loan commitments under our credit facilities can be used for working capital and other general corporate purposes and as a backup to our commercial paper program. Commercial paper borrowings reduce borrowings allowed under our credit facilities and letters of credit reduce borrowings allowed under our $3.5 billion credit facility. On December 15, 2022, we amended our credit facilities to provide for, among other things, the replacement of LIBOR-based provisions with term SOFR provisions, updated related benchmark replacement provisions and the extension of the maturity date on our $3.5 billion credit facility from August 2026 to August 2027. We provide for liquidity by maintaining a sizable amount of excess borrowing capacity under our credit facilities and, as previously discussed, have consistently generated strong cash flows from operations. As of December 31, 2022, our $3,385 million of short-term debt consisted primarily of senior notes that mature in the next twelve months. We intend to fund our debt as it becomes due, primarily through credit facility borrowings, commercial paper borrowings, cash flows from operations, and/or issuing new long-term debt. Our short-term debt balance as of December 31, 2021 was $2,646 million. We had working capital (defined as current assets less current liabilities) deficits of $3,127 million and $1,992 million as of December 31, 2022 and 2021, respectively. From time to time, our current liabilities may include short-term borrowings used to finance our expansion capital expenditures, which we may periodically replace with long-term financing and/or pay down using retained cash from operations. The overall $1,135 million unfavorable change from year-end 2021 was primarily due to (i) a $739 million increase in current debt, primarily related to senior notes that mature in the next twelve months; (ii) a $395 million decrease in cash and cash equivalents, which was used to repay a portion of senior notes that matured in the first quarter of 2022; and (iii) unfavorable net short-term fair value adjustments of $276 million on derivative contract assets and liabilities in 2022, offset partially by (i) a $156 million decrease in accrued contingencies; (ii) a $72 million increase in inventories, primarily products inventories; (iii) a $44 million net favorable change in our accounts receivables and payables, and (iv) a $42 million increase in restricted deposits. Generally, our working capital balance varies due to factors such as the timing of scheduled debt payments, timing differences in the collection and payment of receivables and payables, the change in fair value of our derivative contracts, and changes in our cash and cash equivalent balances as a result of excess cash from operations after payments for investing and financing activities (discussed below in “—Long-term Financing” and “—Capital Expenditures”).We employ a centralized cash management program for our U.S.-based bank accounts that concentrates the cash assets of our wholly owned subsidiaries in joint accounts for the purpose of providing financial flexibility and lowering the cost of borrowing. These programs provide that funds in excess of the daily needs of our wholly owned subsidiaries are concentrated, consolidated or otherwise made available for use by other entities within the consolidated group. We place no material restrictions on the ability to move cash between entities, payment of intercompany balances or the ability to upstream dividends to KMI other than restrictions that may be contained in agreements governing the indebtedness of those entities. Credit Ratings and Capital Market LiquidityWe believe that our capital structure will continue to allow us to achieve our business objectives. We expect that our short-term liquidity needs will be met primarily through retained cash from operations or short-term borrowings. Generally, we anticipate re-financing maturing long-term debt obligations in the debt capital markets and are therefore subject to certain market conditions which could result in higher costs or negatively affect our and/or our subsidiaries’ credit ratings. A decrease in our credit ratings could negatively impact our borrowing costs and could limit our access to capital.As of December 31, 2022, our short-term corporate debt ratings were A-2, Prime-2 and F2 at Standard and Poor’s, Moody’s Investor Services and Fitch Ratings, Inc., respectively. The following table represents KMI’s and KMP’s senior unsecured debt ratings as of December 31, 2022.Rating agencySenior debt ratingOutlookStandard and Poor’sBBB StableMoody’s Investor ServicesBaa2StableFitch Ratings, Inc.BBBStable58Long-term FinancingOur equity consists of Class P common stock with a par value of $0.01 per share. We do not expect to need to access the equity capital markets to fund our discretionary capital investments for the foreseeable future. See also “—Dividends and Stock Buy-back Program” below for additional discussion related to our dividends and stock buy-back program.From time to time, we issue long-term debt securities, often referred to as senior notes. All of our senior notes issued to date, other than those issued by certain of our subsidiaries, generally have very similar terms, except for interest rates, maturity dates and prepayment premiums. All of our fixed rate senior notes provide that the notes may be redeemed at any time at a price equal to 100% of the principal amount of the notes plus accrued interest to the redemption date, and, in most cases, plus a make-whole premium. In addition, from time to time, our subsidiaries issue long-term debt securities. Furthermore, we and almost all of our direct and indirect wholly owned domestic subsidiaries are parties to a cross guaranty wherein each party guarantees each other party’s debt. See “—Summarized Combined Financial Information for Guarantee of Securities of Subsidiaries. As of December 31, 2022 and 2021, the aggregate principal amount outstanding of our various long-term debt obligations (excluding current maturities) was $28,288 million and $29,772 million, respectively.We achieve our variable rate exposure primarily by issuing long-term fixed rate debt and then swapping a portion of the fixed rate interest payments for variable rate interest payments and through the issuance of commercial paper or credit facility borrowings.For additional information about our outstanding senior notes and debt-related transactions in 2022, see Note 9 “Debt” to our consolidated financial statements. For information about our interest rate risk, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk—Interest Rate Risk.”Counterparty CreditworthinessSome of our customers or other counterparties may experience severe financial problems that may have a significant impact on their creditworthiness. These financial problems may arise from current global economic conditions, continued volatility of commodity prices or otherwise. In such situations, we utilize, to the extent allowable under applicable contracts, tariffs and regulations, prepayments and other security requirements, such as letters of credit, to enhance our credit position relating to amounts owed from these counterparties. While we believe we have taken reasonable measures to protect against counterparty credit risk, we cannot provide assurance that one or more of our customers or other counterparties will not become financially distressed and will not default on their obligations to us. The balance of our allowance for credit losses as of both December 31, 2022 and 2021, was $1 million, reflected in “Other current assets” on our consolidated balance sheets. Capital ExpendituresWe account for our capital expenditures in accordance with GAAP. Additionally, we distinguish between capital expenditures as follows:Type of ExpenditurePhysical Determination of ExpenditureSustaining capital expenditures•Maintain throughput or capacityExpansion capital expenditures (discretionary capital expenditures)(a)•Increase throughput or capacity (i.e., production capacity) from that which existed immediately prior to the making or acquisition of additions or improvements(a)Not included in calculating DCF (see “—Results of Operations—Non-GAAP Financial Measures—Reconciliation of Net Income Attributable to Kinder Morgan, Inc. (GAAP) to Adjusted Earnings to DCF”).Budgeting of maintenance capital expenditures, which we refer to as sustaining capital expenditures, is done annually on a bottom-up basis. For each of our assets, we budget for and make those sustaining capital expenditures that are necessary to maintain safe and efficient operations, meet customer needs and comply with our operating policies and applicable law. We may budget for and make additional sustaining capital expenditures that we expect to produce economic benefits such as increasing efficiency and/or lowering future expenses. Budgeting and approval of expansion capital expenditures are generally made periodically throughout the year on a project-by-project basis in response to specific investment opportunities identified by our business segments from which we generally expect to receive sufficient returns to justify the expenditures. Generally, the determination of whether a capital expenditure is classified as sustaining or as expansion capital expenditures is made on a project level. The classification of our capital expenditures as expansion capital expenditures or as sustaining capital expenditures is made consistent with our accounting policies and is generally a straightforward process, but in certain 59circumstances can be a matter of management judgment and discretion. The classification has an impact on DCF because capital expenditures that are classified as expansion capital expenditures are not deducted from DCF, while those classified as sustaining capital expenditures are. Our capital expenditures for the year ended December 31, 2022, and the amount we expect to spend for 2023 to sustain our assets and grow our business are as follows:2022Expected 2023(In millions)Sustaining capital expenditures(a)(b)$901 $1,002 Discretionary capital investments(b)(c)(d)1,709 2,138 (a)2022 and Expected 2023 amounts include $140 million and $145 million, respectively, for sustaining capital expenditures from unconsolidated joint ventures, reduced by consolidated joint venture partners’ sustaining capital expenditures. See table included in “Non-GAAP Financial Measures—Supplemental Information.” (b)2022 combined sustaining and discretionary amounts include $96 million due to increases in accrued capital expenditures and contractor retainage and net changes in other.(c)2022 amount includes $264 million of our contributions to certain unconsolidated joint ventures for capital investments and $489 million for our acquisitions of Mas Ranger and NANR.(d)Amounts include our actual or estimated contributions to certain unconsolidated joint ventures, net of actual or estimated contributions from certain partners in non-wholly owned consolidated subsidiaries for capital investments.Off Balance Sheet Arrangements We have invested in entities that are not consolidated in our financial statements. For information on our obligations with respect to these investments, as well as our obligations with respect to related letters of credit, see Note 13 “Commitments and Contingent Liabilities” to our consolidated financial statements. Additional information regarding the nature and business purpose of our investments is included in Note 7 “Investments” to our consolidated financial statements.60Contractual Obligations and Commercial Commitments The table below provides a summary of our material cash requirements. Payments due by period TotalLess than 1year1-3 years3-5 yearsMore than 5 years (In millions)Contractual obligations: Debt borrowings-principal payments(a)$31,673 $3,385 $3,491 $1,992 $22,805 Interest payments(b) 21,234 1,616 2,900 2,689 14,029 Lease obligations(c)375 58 90 61 166 Pension and OPEB plans(d) 469 50 31 32 356 Transportation, volume and storage agreements(e)661 157 267 131 106 Other obligations(f) 341 90 105 38 108 Total$54,753 $5,356 $6,884 $4,943 $37,570 Other commercial commitments: Standby letters of credit(g)$153 $81 $72 Capital expenditures(h)$527 $527 (a)See Note 9 “Debt” to our consolidated financial statements.(b)Interest payment obligations exclude adjustments for interest rate swap agreements and assume no change in variable interest rates from those in effect at December 31, 2022. (c)Represents commitments pursuant to the terms of operating lease agreements as of December 31, 2022.(d)Represents the amount by which the benefit obligations exceeded the fair value of plan assets at year-end for pension and OPEB plans whose accumulated postretirement benefit obligations exceeded the fair value of plan assets. The payments by period include expected contributions in 2023 and estimated benefit payments for underfunded plans in the other years. (e)Primarily represents transportation agreements of $298 million, storage agreements for capacity of $159 million and NGL volume agreements of $155 million.(f)Primarily includes (i) rights-of-way obligations; and (ii) environmental liabilities related to sites that we own or have a contractual or legal obligation with a regulatory agency or property owner upon which we will perform remediation activities. These environmental liabilities are included within “Other current liabilities” and “Other long-term liabilities and deferred credits” in our consolidated balance sheet as of December 31, 2022.(g)The $153 million in letters of credit outstanding as of December 31, 2022 consisted of the following (i) $54 million under six letters of credit for insurance purposes; (ii) a $46 million letter of credit supporting our International Marine Terminals Partnership Plaquemines Bond; (iii) a $24 million letter of credit supporting our Kinder Morgan Operating LLC “B” tax-exempt bonds; and (iv) a combined $30 million in twenty-nine letters of credit supporting environmental and other obligations of us and our subsidiaries.(h)Represents commitments for the purchase of plant, property and equipment as of December 31, 2022.61Cash Flows The following table summarizes our net cash flows provided by (used in) operating, investing and financing activities between 2022 and 2021.Year Ended December 31,20222021Changes(In millions)Net Cash Provided by (Used in) Operating activities $4,967 $5,708 $(741)Investing activities(2,175)(2,305)130 Financing activities(3,145)(3,465)320 Net Decrease in Cash, Cash Equivalents and Restricted Deposits$(353)$(62)$(291)Operating Activities$741 million less cash provided by operating activities in the comparable years of 2022 and 2021 is explained by the following discussion.•a $502 million decrease in cash after adjusting the $775 million increase in net income by $1,277 million for the combined effects of the period-to-period net changes in non-cash items. This overall cash decrease primarily resulted from the benefit recognized in 2021 for largely nonrecurring earnings related to the February 2021 winter storm (see discussion above in “—Results of Operations”); and•a $239 million decrease in cash associated with net changes in working capital items and other non-current assets and liabilities. The decrease was primarily driven by unfavorable changes due to the timing of trade payments in accounts payable and payments from reserves in 2022 compared with 2021 associated with litigation matters. Investing Activities$130 million less cash used in investing activities in the comparable years of 2022 and 2021 is explained by the following discussion.•a $1,060 million decrease in expenditures for the acquisition of assets and investments, net of cash acquired, primarily driven by a combined $487 million of net cash used for our acquisitions of Mas Ranger, LLC and NANR in 2022, compared with a combined $1,538 million of net cash used for the acquisitions of Stagecoach and Kinetrex in 2021; See Note 3 “Acquisitions and Divestitures” to our consolidated financial statements for further information regarding these two acquisitions; partially offset by,•a $400 million decrease in proceeds from sales of property, plant and equipment, investments, and other assets, net of removal costs primarily due to $412 million received from the sale of a partial interest in our equity investment in NGPL Holdings in 2021;•a $340 million increase in capital expenditures reflecting an overall increase of expansion capital projects for most of our business segments in 2022 over the comparative 2021 period; and•a $191 million increase in cash used for contributions to equity investees driven primarily by higher contributions in 2022 compared with 2021 to SNG associated with a debt payment.Financing Activities$320 million less cash used in financing activities in the comparable years of 2022 and 2021 is explained by the following discussion.•$557 million of net proceeds received from the sale of a 25.5% ownership interest in ELC in 2022; and•a $197 million net decrease in cash used related to debt activity as a result of lower net debt payments in 2022 compared to 2021; partially offset by,•$368 million of cash used in 2022 for share repurchases under our share buy-back program.62Dividends and Stock Buy-back ProgramThe table below reflects the declaration of dividends of $1.11 per share for 2022:Three months endedTotal quarterly dividend per share for the periodDate of declarationDate of recordDate of dividendMarch 31, 2022$0.2775April 20, 2022May 2, 2022May 16, 2022June 30, 20220.2775July 20, 2022August 1, 2022August 15, 2022September 30, 20220.2775October 19, 2022October 31, 2022November 15, 2022December 31, 20220.2775January 18, 2023January 31, 2023February 15, 2023We expect to continue to return additional value to our shareholders in 2023 through our previously announced dividend increase. We plan to increase our dividend by 2% to $1.13 per common share in 2023. On January 18, 2023, our board of directors approved an increase to our stock buy-back program from $2 billion to $3 billion. Since December 2017, in total, we have repurchased approximately 54 million shares of our Class P common stock under the program at an average price of approximately $17.40 per share for approximately $943 million, leaving a remaining capacity of $2.1 billion. For information on our equity buy-back program, see Note 11 “Stockholders’ Equity” to our consolidated financial statements.The actual amount of dividends to be paid on our capital stock will depend on many factors, including our financial condition and results of operations, liquidity requirements, business prospects, capital requirements, legal, regulatory and contractual constraints, tax laws, Delaware laws and other factors. See Item 1A. “Risk Factors—The guidance we provide for our anticipated dividends is based on estimates. Circumstances may arise that lead to conflicts between using funds to pay anticipated dividends or to invest in our business.” All of these matters will be taken into consideration by our board of directors when declaring dividends.Our dividends are not cumulative. Consequently, if dividends on our stock are not paid at the intended levels, our stockholders are not entitled to receive those payments in the future. Our dividends generally will be paid on or about the 15th day of each February, May, August and November. 63Summarized Combined Financial Information for Guarantee of Securities of SubsidiariesKMI and certain subsidiaries (Subsidiary Issuers) are issuers of certain debt securities. KMI and substantially all of KMI’s wholly owned domestic subsidiaries (Subsidiary Guarantors), are parties to a cross guarantee agreement whereby each party to the agreement unconditionally guarantees, jointly and severally, the payment of specified indebtedness of each other party to the agreement. Accordingly, with the exception of certain subsidiaries identified as subsidiary non-guarantors (Subsidiary Non-Guarantors), the parent issuer, Subsidiary Issuers and Subsidiary Guarantors (the “Obligated Group”) are all guarantors of each series of our guaranteed debt (Guaranteed Notes). As a result of the cross guarantee agreement, a holder of any of the Guaranteed Notes issued by KMI or Subsidiary Issuers are in the same position with respect to the net assets, and income of KMI and the Subsidiary Issuers and Guarantors. The only amounts that are not available to the holders of each of the Guaranteed Notes to satisfy the repayment of such securities are the net assets, and income of the Subsidiary Non-Guarantors.In lieu of providing separate financial statements for the Obligated Group, we have presented the accompanying supplemental summarized combined income statement and balance sheet information for the Obligated Group based on Rule 13-01 of the SEC’s Regulation S-X. Also, see Exhibit 10.14 to this Report “Cross Guarantee Agreement, dated as of November 26, 2014, among KMI and certain of its subsidiaries, with schedules updated as of December 31, 2022.”All significant intercompany items among the Obligated Group have been eliminated in the supplemental summarized combined financial information. The Obligated Group’s investment balances in Subsidiary Non-Guarantors have been excluded from the supplemental summarized combined financial information. Significant intercompany balances and activity for the Obligated Group with other related parties, including Subsidiary Non-Guarantors (referred to as “affiliates”), are presented separately in the accompanying supplemental summarized combined financial information.Excluding fair value adjustments, as of December 31, 2022 and 2021, the Obligated Group had $30,886 million and $31,608 million, respectively, of Guaranteed Notes outstanding. Summarized combined balance sheet and income statement information for the Obligated Group follows:December 31,Summarized Combined Balance Sheet Information20222021(In millions)Current assets$3,514 $3,556 Current assets - affiliates618 1,233 Noncurrent assets61,523 61,754 Noncurrent assets - affiliates516 508 Total Assets$66,171 $67,051 Current liabilities$6,612 $5,413 Current liabilities - affiliates707 1,332 Noncurrent liabilities30,668 32,310 Noncurrent liabilities - affiliates1,096 1,047 Total Liabilities39,083 40,102 Kinder Morgan, Inc.’s stockholders’ equity27,088 26,949 Total Liabilities and Stockholders’ Equity$66,171 $67,051 Summarized Combined Income Statement InformationYear Ended December 31, 2022(In millions)Revenues$17,778 Operating income3,611 Net income2,175 64Recent Accounting PronouncementsPlease refer to Note 19 “Recent Accounting Pronouncements” to our consolidated financial statements for information concerning recent accounting pronouncements.Item 7A. Quantitative and Qualitative Disclosures About Market Risk.Generally, our market risk sensitive instruments and positions have been determined to be “other than trading.” Our exposure to market risk as discussed below includes forward-looking statements and represents an estimate of possible changes in fair value or future earnings that would occur assuming hypothetical future movements in energy commodity prices or interest rates. Our views on market risk are not necessarily indicative of actual results that may occur and do not represent the maximum possible gains and losses that may occur, since actual gains and losses will differ from those estimated based on actual fluctuations in energy commodity prices or interest rates and the timing of transactions.Energy Commodity Market RiskWe enter into certain energy commodity derivative contracts in order to reduce and minimize the risks encountered in the ordinary course of business associated with unfavorable changes in the market price of crude oil, natural gas and NGL. The derivative contracts that we use include exchange-traded and OTC commodity financial instruments, including, but not limited to, futures and options contracts, fixed price swaps and basis swaps. We may categorize such use of energy commodity derivative contracts as cash flow hedges because the derivative contract is used to hedge the anticipated future cash flow of a transaction that is expected to occur but whose value is uncertain.Our hedging strategy involves entering into a financial position intended to offset our physical position, or anticipated position, in order to minimize the risk of financial loss from an adverse price change. For example, as sellers of crude oil, natural gas and NGL, we often enter into fixed price swaps and/or futures contracts to guarantee or lock-in the sale price of our crude oil or the margin from the sale and purchase of our natural gas at the time of market delivery, thereby in whole or in part offsetting any change in prices, either positive or negative. Using derivative contracts for this purpose helps provide increased certainty with regard to operating cash flows which helps us to undertake further capital improvement projects, attain budget results and meet dividend targets.Our policies require that derivative contracts are only entered into with carefully selected major financial institutions or similar counterparties based upon their credit ratings and other factors, and we maintain strict dollar and term limits that correspond to our counterparties’ credit ratings. While it is our policy to enter into derivative transactions principally with investment grade counterparties and actively monitor their credit ratings, it is nevertheless possible that losses will result from counterparty credit risk in the future.We measure the risk of price changes in the derivative instrument portfolios utilizing a sensitivity analysis model. The sensitivity analysis applied to each portfolio measures the potential income or loss (i.e., the change in fair value of the derivative instrument portfolio) based upon a hypothetical 10% movement in the underlying quoted market prices. In addition to these variables, the fair value of each portfolio is influenced by fluctuations in the notional amounts of the instruments and the discount rates used to determine the present values. Because we enter into derivative contracts largely for the purpose of mitigating the risks that accompany certain of our business activities, both in the sensitivity analysis model and in reality, the change in the market value of the derivative contracts’ portfolio is offset largely by changes in the value of the underlying physical transactions. A hypothetical 10% movement in the underlying commodity prices would have the following effect on the associated derivative contracts’ estimated fair value:As of December 31,Commodity derivative20222021(In millions)Crude oil$157 $135 Natural gas49 36 NGL5 8 Total$211 $179 Our sensitivity analysis represents an estimate of the reasonably possible gains and losses that would be recognized on the crude oil, natural gas and NGL portfolios of derivative contracts assuming hypothetical movements in future market rates and is 65not necessarily indicative of actual results that may occur. It does not represent the maximum possible loss or any expected loss that may occur, since actual future gains and losses will differ from those estimated. Actual gains and losses may differ from estimates due to actual fluctuations in market rates, operating exposures and the timing thereof, as well as changes in our portfolio of derivatives during the year.Interest Rate RiskIn order to maintain a cost effective capital structure, it is our policy to borrow funds using a mix of fixed rate debt and variable rate debt. Fixed-to-variable interest rate swap agreements are entered into for the purpose of converting a portion of the underlying cash flows related to long-term fixed rate debt securities into variable rate debt in order to achieve our desired mix of fixed and variable rate debt. Variable-to-fixed interest rate swap agreements are entered into primarily for the purpose of managing our exposure to changes in interest rates on our debt balances that are subject to variable interest rates and adjusting, on a short-term basis, our mix of fixed rate debt and variable rate debt based on changes in market conditions. The market risk inherent in our debt instruments and positions is the potential change arising from increases or decreases in interest rates as discussed below.For fixed rate debt, changes in interest rates generally affect the fair value of the debt instrument, but not our earnings or cash flows. Conversely, for variable rate debt, changes in interest rates generally do not impact the fair value of the debt instrument, but may affect our future earnings and cash flows. Generally, there is not an obligation to prepay fixed rate debt prior to maturity and, as a result, changes in fair value should not have a significant impact on the fixed rate debt. We are generally subject to interest rate risk upon refinancing maturing debt. Below are our debt balances, including debt fair value adjustments, and sensitivity to interest rates: December 31, 2022December 31, 2021 CarryingvalueEstimatedfair value(a)CarryingvalueEstimatedfair value(a)(In millions)Fixed rate debt(b)$31,474 $29,756 $33,006 $37,459 Variable rate debt$314 $314 $314 $316 Notional principal amount of variable-to-fixed interest rate swap agreements(c)(1,500)(490)Notional principal amount of fixed-to-variable interest rate swap agreements7,500 7,100 Debt balances subject to variable interest rates(d)$6,314 $6,924 (a)Fair values were determined using Level 2 inputs.(b)A hypothetical 10% change in the average interest rates applicable to such debt as of December 31, 2022 and 2021, would result in changes of approximately $1,882 million and $1,614 million, respectively, in the estimated fair values of these instruments.(c)December 31, 2022 amount includes $1.25 billion of variable-to-fixed interest rate swap agreements that expire in December 2023. December 31, 2021 amount excludes $4.9 billion of variable-to-fixed interest rate swap agreements that became effective January 4, 2022 and expired December 31, 2022.(d)A hypothetical 10% change in the weighted average interest rate on all of our borrowings (approximately 48 and 47 basis points, respectively, in 2022 and 2021) when applied to our outstanding balance of variable rate debt as of December 31, 2022 and 2021, including adjustments for the notional swap amounts described in the table above, would result in changes of approximately $30 million and $32 million.As presented in the table above, we monitor the mix of fixed rate and variable rate debt obligations in light of changing market conditions and from time to time, may alter that mix by, for example, refinancing outstanding balances of variable rate debt with fixed rate debt (or vice versa) or by entering into interest rate swap agreements or other interest rate hedging agreements. As of December 31, 2022, including debt converted to variable rates through the use of interest rate swaps but excluding our debt fair value adjustments, approximately 20% of our debt balances were subject to variable interest rates.For more information on our interest rate risk management and on our interest rate swap agreements, see Note 14 “Risk Management” to our consolidated financial statements.66Foreign Currency RiskAs of December 31, 2022, we had a notional principal amount of $543 million of cross-currency swap agreements that effectively convert all of our fixed-rate Euro denominated debt, including annual interest payments and the payment of principal at maturity, to U.S. dollar denominated debt at fixed rates. These swaps eliminate the foreign currency risk associated with our foreign currency denominated debt.67
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+ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion and analysis should be read in conjunction with the consolidated financial statements of KKR & Co. Inc., together with its consolidated subsidiaries, and the related notes included elsewhere in this report. In addition, this discussion and analysis contains forward-looking statements and involves numerous risks and uncertainties, including those described under "Cautionary Note Regarding Forward-looking Statements" and "Risk Factors." Actual results may differ materially from those contained in any forward-looking statements.Business EnvironmentEconomic and Market ConditionsOur asset management and insurance businesses are materially affected by the economic conditions of, and financial markets in, the United States, the EU, China, Japan, and other countries. Global and regional economic conditions can each have substantial impact on our business, financial condition and results of operations in various ways, including the valuations of our investments, our ability to exit these investments profitably, our ability to raise capital from investors, and our ability to make new investments. Economic ConditionsDuring the year ended December 31, 2022, the global economy continued to recover from the impact of the COVID-19 pandemic; however, many countries and regions, including the United States, showed signs of slowing economic activity, potentially indicating the early stages of a recession. Economic activity began to be adversely impacted by the effects of monetary and fiscal policy tightening as years of fiscal stimulus from governments and accommodative monetary policy from global central banks began to wane as central banks took measures to combat significant inflationary pressures at multi-decade highs in many major economies around the world. Inflation presented a headwind for many country and regional economies in which we operate. The Federal Reserve Board has continued to raise interest rates and has indicated that it is prepared to take decisive action to manage inflation, including raising interest rates further and shrinking the size of its balance sheet. As a result of these and other actions by central banks, overall macro conditions began to transition by the fourth quarter of 2022 with less focus on inflation’s impact on repricing capital markets and moving towards a period where high rates and inflation began to put significant pressure on corporate profits and consumer balance sheets. By year-end 2022, inflation began to show signs of peaking on a year-over-year basis in the U.S. and in certain other regions, but remained elevated in absolute terms.Higher interest rates in conjunction with slower growth or weaker currencies in some emerging market economies have caused, and may further cause, the default risk of these countries to increase, and this could impact the operations or value of our investments that operate in these regions. Areas that have central bank quantitative easing or tightening campaigns affecting their interest rates relative to the United States could potentially experience further currency volatility relative to the U.S. dollar. Relatedly, foreign exchange rates are often affected by countries’ monetary and fiscal responses to inflationary trends. Foreign exchange rates have a substantial impact on the valuations of our investments that are denominated in currencies other than the U.S. dollar. Currency volatility can also affect our businesses and investments that deal in cross-border trade. Labor disputes, shortages of material and skilled labor, work stoppages and increasing labor costs can also adversely impact us and the assets we manage. Despite various economic headwinds, several key economic indicators in the U.S., including employment have demonstrated resilience in 2022.During 2022, the growth in economic activity and demand for goods and services, alongside supply chain complications, contributed to these significant inflationary pressures. Various supply bottlenecks ranging from dynamic zero-COVID policy to shifting Russia-Ukraine supply chains to U.S. domestic semiconductor industry output shortages as a result of restrictions on trade with Chinese semiconductor companies contributed to inflationary pressure throughout much of 2022. In the United States and many other countries, laws designed to protect national security or to restrict foreign direct investment continued to proliferate in 2022, which adversely affected the business and investment environments in various ways. These and related concerns, such as rising interest rates and geopolitical uncertainty in countries such as China, Russia, Belarus and the Ukraine, contributed to substantial market volatility, equity and credit market declines and increased pressures on labor supply. In the Eurozone, disruptions to European energy markets and Russia’s ongoing invasion of Ukraine adversely affected the business environment. The Russia-Ukraine conflict, including the sanctions imposed in response to Russia's invasion of Ukraine, have exacerbated and may further exacerbate these issues and trends globally, including by increasing oil and gas prices and price volatility. Protectionist policies, such as restrictions on exports of food, have also increased globally as a result of Russia's invasion of Ukraine. As of December 31, 2022, we have no investments in any portfolio companies whose executive 132Table of Contentsheadquarters are located in Russia, Ukraine or Belarus, and we believe that the direct exposure of our investment portfolio to Russia, Ukraine and Belarus is insignificant. In addition, the Chinese economy experienced headwinds related to the ongoing slowdown in China’s property sector and the effects of the government’s zero-COVID policies. In Japan, the economic recovery from COVID-19 continued, despite higher energy costs and significant volatility in currency markets.Several relevant key economic indicators in the U.S. and in other countries and areas in which our business operates include: •Inflation. The U.S. core consumer price index rose 5.7% on a year-over-year basis as of December 31, 2022, up from 5.5% on a year-over-year basis as of December 31, 2021. Core inflation in China was 0.7% on a year-over-year basis as of December 31, 2022, down from 1.2% on a year-over-year basis as of December 31, 2021. In Japan, core inflation rose to 1.6% on a year-over-year basis as of December 31, 2022, up from -1.3% on a year-over-year basis as of December 31, 2021. Euro Area core inflation was 5.2% as of December 31, 2022, up from 2.6% as of December 31, 2021.•Interest Rates. The effective federal funds rate set by the Federal Reserve Board was 4.33% as of December 31, 2022, up from 0.1% as of December 31, 2021. The Federal Reserve raised interest rates by 75 basis points in November, and 50 basis points in December, leading to increased market volatility. The short-term benchmark interest rate set by the Bank of Japan was -0.1% as of December 31, 2022, unchanged from December 31, 2021. The short-term benchmark interest rate set by the European Central Bank was 2.5% as of December 31, 2022, up from 0.0% as of December 31, 2021.•GDP. In the United States, real GDP is estimated to have expanded by 2.1% for the year ended December 31, 2022, compared to an expansion of 5.9% for the year ended December 31, 2021. Real GDP in China is estimated to have increased by 3.0% for the year ended December 31, 2022, compared to growth of 8.4% reported for the year ended December 31, 2021. In Japan, real GDP growth for the year ended December 31, 2022, is estimated to have been 1.3%, down from 2.3% for the year ended December 31, 2021. Euro Area real GDP growth was 3.2% as of December 31, 2022, up from 5.3% as of December 31, 2021.•Unemployment. The U.S. unemployment rate was 3.5% as of December 31, 2022, down from 3.9% as of December 31, 2021. The unemployment rate in China was 5.5% as of December 31, 2022, up from 5.1% as of December 31, 2021. The unemployment rate in Japan was 2.5% as of December 31, 2022, down from 2.7% as of December 31, 2021. In addition, Euro Area unemployment was 6.5% as of December 31, 2022, up from 7.0% as of December 31, 2021.Market ConditionsEquity, credit, commodity and foreign exchange markets in the United States and in other countries and areas in which we have made investments each can have a material effect on our financial condition and results of operations. In our asset management segment, many of our investments are in equities, so a change in global equity prices or in market volatility directly impacts the value of our investments and our profitability as well as our ability to realize investment gains and the receptiveness of fund investors to our investment products. Volatility across global equity and credit markets, alongside shifting liquidity conditions in new issue activity across equity and non-investment grade credit markets, have adversely impacted (and may continue to adversely impact) our financial results and the volume of capital markets activity, the level of transaction fees that our Capital Markets business line is able to earn, the valuation of our portfolio companies, the investment income that we recognize and our ability to deploy our, and our funds', capital. For our investments that are publicly listed and thus have readily observable market prices, global equity market price declines had (and may continue to have) a direct impact on valuation. For many other of our investments, these markets had an indirect materially adverse impact on many of our investment valuations as we typically utilize market multiples as a critical input to ascertain fair value of our investments that do not have readily observable market prices. In addition, many of our investments are in non-investment grade credit instruments and investment grade credit instruments. Many of our funds invest or have the flexibility to invest a significant portion of their assets in the equity, debt, loans or other securities of issuers that are based outside of the United States. A substantial amount of these investments consist of private equity investments made by our private equity funds. For example, as of December 31, 2022, approximately 50% of the capital invested in those funds was attributable to non-U.S. investments. In our insurance business, a change in equity prices also impacts Global Atlantic’s equity-sensitive annuity and life insurance products, including with respect to hedging costs related to and fee-income earned on those products. Our funds, our portfolio companies and Global Atlantic also rely on credit financing and the ability to refinance existing debt. Consequently, any decrease in the value of credit instruments that we have 133Table of Contentsinvested in or any increase in the cost of credit financing reduces our returns and decreases our net income. Tightening liquidity conditions in equity and credit capital markets affect the availability and cost of capital for us and our portfolio companies, and the increased cost of credit or degradation in debt financing terms may impact our ability to identify and execute investments on attractive terms. In our insurance segment, periods of rising or higher interest rates as we are currently experiencing may result in differing impacts on Global Atlantic’s business. Periods of rising or higher interest rates can benefit Global Atlantic’s results of operations and financial condition, as we generally expect the yield on new investment purchases and income from any floating rate investments held in Global Atlantic’s investment portfolio to increase as interest rates rise. Higher interest rates also generally tend to increase the demand for certain of Global Atlantic’s products, as the benefits and solutions Global Atlantic can offer to clients may become more attractive, potentially resulting in higher new business volumes. Rising rates are also expected to result in decreases to certain policy liabilities as a result of new accounting guidance which we adopted effective January 1, 2023 (with a transition date of January 1, 2021) for insurance companies that issue or reinsure long-duration contracts such as life insurance and annuities. For a further discussion of this guidance, see Note 2 "Summary of Significant Accounting Policies—Future application of accounting standards" in our financial statements.Higher interest rates can also have a negative impact on Global Atlantic. For example, higher policyholder surrenders may occur in response to rising interest rates as more attractive products become available to policyholders in a higher rate environment. The majority of our investments at Global Atlantic are in investment grade credit instruments. Sales of those investments at a loss, for example to raise cash to meet policyholder obligations upon surrender earlier than expected maturity or as we rotate out of investments acquired with new reinsurance transactions to our desired asset mix during a period of rising or higher rates compared to when the investment was acquired, is expected to decrease our net income in that period and such decrease could be significant. We also expect that in a higher rate environment we will generally have a higher cost of insurance on new business, including higher hedging costs, as the benefits to policyholders on new business will be generally higher. If Global Atlantic fails to adequately cash flow match liabilities sold with higher benefits and interest rates fall while Global Atlantic holds that liability, Global Atlantic may not generate its expected earnings on those liabilities. In addition, rising interest rates will decrease the fair value of Global Atlantic’s credit investments and the value of embedded derivatives associated with funds withheld reinsurance transactions. Global Atlantic expects that substantially all of its unrealized losses will not be realized as it intends to hold these investments until recovery of the losses, which may be at maturity, as part of its asset liability cash-flow matching strategy. However, if the market, industry and company-specific factors relating to these investments deteriorate meaningfully, Global Atlantic may be required to recognize an impairment to goodwill and may realize losses as a result of credit defaults or impairments on investments, either of which could have a material adverse effect on our results of operations and financial condition.In addition, commodity prices are generally expected to rise in inflationary environments. Our Real Assets business line portfolio contains energy real asset investments, and certain of our other Private Equity, Real Assets and Credit and Liquid Strategies business line strategies have investments in or related to the energy sector. The value of these investments is heavily influenced by the price of natural gas and oil. As noted above, the actions taken by Russia in the Ukraine starting in February 2022 have caused volatility in the commodities markets. To the extent energy real asset investments are directly held by our balance sheet, price movements can have an amplified impact on our financial results, as we directly bear the full extent of such gains or losses, subject to hedging.Although the recent bankruptcies and financial distress among crypto asset market participants and the resulting price volatility of crypto assets have caused widespread disruption in those markets, as of December 31, 2022, these events have had no material impact on our business, financial condition or results of operations. Neither we through our balance sheet, nor the limited partner funds we manage, have material direct exposure to crypto asset market participants that we are aware of that have: commenced insolvency, receivership, reorganization or bankruptcy proceedings; experienced excessive redemptions or suspended redemptions or withdrawals of crypto assets; the crypto assets of their customers unaccounted for; or experienced material corporate compliance failures. While, to date, our business has only minimal crypto exposure, the level of exposure may shift over time, and we cannot predict the broader impact, including to us, of the recent bankruptcies and financial distress among crypto asset market participants and coverage of new regulatory developments related to crypto assets and crypto asset markets.Several relevant key market indicators in the U.S. and in other countries and areas which constitute our business environment include: •Equity Markets. For the year ended December 31, 2022, global equity markets were negative, with the S&P 500 down 18.1% and the MSCI World Index down 17.7% on a total return basis including dividends. Equity market volatility as evidenced by the Chicago Board Options Exchange Market Volatility Index (VIX), a measure of volatility, ended at 21.7 as of December 31, 2022, increasing from 17.2 as of December 31, 2021.134Table of Contents•Credit Markets. During the year ended December 31, 2022, U.S. investment grade corporate bond spreads (BofA Merrill Lynch US Corporate Index) widened by 40 basis points and U.S. high-yield corporate bond spreads (BofAML HY Master II Index) widened by 171 basis points. The non-investment grade credit indices were down during the year ended December 31, 2022, with the S&P/LSTA Leveraged Loan Index down 0.6% and the BAML US High Yield Index down 11.2%. During the year ended December 31, 2022, 10-year government bond yields rose 236 basis points in the United States, rose 6 basis points in China, rose 35 basis points in Japan, rose 270 basis points in the UK and rose 275 basis points in Germany.•Commodity Markets. During the year ended December 31, 2022, the 3-year forward price of WTI crude oil increased approximately 11.3%, and the 3-year forward price of natural gas increased from approximately $3.43 per MMBtu to $4.99 per MMBtu as of December 31, 2021 and December 31, 2022. The Japan spot LNG import price decreased to approximately $28.46 per MMBtu as of December 31, 2022 from approximately $31.26 per MMBtu as of December 31, 2021.•Foreign Exchange Rates. For the year ended December 31, 2022, the euro fell 5.8%, the British pound 10.7%, the Japanese yen 12.2%, and the Chinese renminbi fell 7.9%, respectively, relative to the U.S. dollar. Other Trends, Uncertainties and Risks Related to Our BusinessPlease refer to the "Risk Factors" section of this report for important additional detail regarding the known trends or uncertainties and competitive conditions that have had or that are reasonably likely to have a material favorable or unfavorable impact on our businesses, including the impact of economic and market conditions on valuations of investments. These known trends, uncertainties and competitive conditions should be read in conjunction with this Business Environment section and the entire Risk Factor section.Basis of Accounting and Key Financial Measures under GAAPWe manage our business using certain financial measures and key operating metrics since we believe these metrics measure the productivity of our investment activities. We prepare our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). See Note 2 “ Summary of Significant Accounting Policies” in our financial statements and “Critical Accounting Policies and Estimates” contained in this section below. Our key Segment and non-GAAP financial measures and operating metrics are discussed below. Key Segment and Non-GAAP Performance Measures The following key segment and non-GAAP performance measures are used by management in making operational and resource deployment decisions as well as assessing the performance of KKR's business. They include certain financial measures that are calculated and presented using methodologies other than in accordance with GAAP. These performance measures as described below are presented prior to giving effect to the allocation of income (loss) between KKR & Co. Inc. and holders of exchangeable securities and as such represent the entire KKR business in total. In addition, these performance measures are presented without giving effect to the consolidation of the investment funds and collateralized financing entities ("CFEs") that KKR manages.We believe that providing these segment and non-GAAP performance measures on a supplemental basis to our GAAP results is helpful to stockholders in assessing the overall performance of KKR's business. These non-GAAP measures should not be considered as a substitute for financial measures calculated in accordance with GAAP. Reconciliations of these non-GAAP measures to the most directly comparable financial measures calculated and presented in accordance with GAAP, where applicable are included under "—Analysis of Non-GAAP Performance Measures—Reconciliations to GAAP Measures."After-tax Distributable EarningsAfter-tax distributable earnings is a non-GAAP performance measure of KKR’s earnings, which is derived from KKR’s reported segment results. After-tax distributable earnings is used to assess the performance of KKR’s business operations and measures the earnings potentially available for distribution to its equity holders or reinvestment into its business. After-tax distributable earnings is equal to Distributable Operating Earnings less Interest Expense, Net Income Attributable to Noncontrolling Interests and Income Taxes Paid. Series C Mandatory Convertible Preferred Stock dividends have been excluded from After-tax Distributable Earnings, because the definition of Adjusted Shares used to calculate After-tax Distributable Earnings per Adjusted Share assumes that all shares of Series C Mandatory Convertible Preferred Stock have been converted to shares of common stock of KKR & Co. Inc. Income Taxes Paid represents the amount of income taxes that 135Table of Contentswould be paid assuming that all pre-tax distributable earnings were allocated to KKR & Co. Inc. and taxed at the same effective rate, which assumes that all securities exchangeable into shares of common stock of KKR & Co. Inc. were exchanged. Income Taxes Paid includes the benefit of tax deductions arising from equity-based compensation, which reduces income taxes paid or payable during the period. Equity based compensation expense is excluded from After-tax Distributable Earnings, because (i) KKR believes that the cost of equity awards granted to employees does not contribute to the earnings potentially available for distributions to its equity holders or reinvestment into its business and (ii) excluding this expense makes KKR’s reporting metric more comparable to the corresponding metric presented by other publicly traded companies in KKR’s industry, which KKR believes enhances an investor’s ability to compare KKR’s performance to these other companies. If tax deductions from equity-based compensation were to be excluded from Income Taxes Paid, KKR’s After-tax Distributable Earnings would be lower and KKR’s effective tax rate would appear to be higher, even though a lower amount of income taxes would have actually been paid or payable during the period. KKR separately discloses the amount of tax deduction from equity-based compensation for the period reported and the effect of its inclusion in After-tax Distributable Earnings for the period. KKR makes these adjustments when calculating After-tax Distributable Earnings in order to more accurately reflect the net realized earnings that are expected to be or become available for distribution to KKR’s equity holders or reinvestment into KKR’s business. However, After-tax Distributable Earnings does not represent and is not used to calculate actual dividends under KKR’s dividend policy, which is a fixed amount per period, and After-tax Distributable Earnings should not be viewed as a measure of KKR’s liquidity.Book ValueBook Value is a non-GAAP performance measure of the net assets of KKR and is used by management primarily in assessing the unrealized value of KKR’s net assets presented on a basis that (i) deconsolidates KKR’s investment funds and CFEs that KKR manages, (ii) includes the net assets that are attributable to certain securities exchangeable into shares of common stock of KKR & Co. Inc., and (iii) includes KKR’s ownership of the net assets of Global Atlantic. We believe this measure is useful to stockholders as it provides additional insight into the net assets of KKR excluding those net assets that are allocated to investors in KKR’s investment funds and other noncontrolling interest holders. KKR's book value includes the net impact of KKR's tax assets and liabilities as calculated under GAAP. Series C Mandatory Convertible Preferred Stock has been included in book value, because the definition of adjusted shares used to calculate book value per adjusted share assumes that all shares of Series C Mandatory Convertible Preferred Stock have been converted to shares of common stock of KKR & Co. Inc. To calculate Global Atlantic book value and to make it more comparable with the corresponding metric presented by other publicly traded companies in Global Atlantic’s industry, Global Atlantic book value excludes (i) accumulated other comprehensive income and (ii) accumulated change in fair value of reinsurance balances and related assets, net of deferred acquisition costs and income tax.Distributable Operating EarningsDistributable operating earnings is a non-GAAP performance measure that KKR believes is useful to stockholders as it provides a supplemental measure of our operating performance without taking into account items that KKR does not believe arise from or relate directly to KKR's operations. Distributable Operating Earnings excludes: (i) equity-based compensation charges, (ii) amortization of acquired intangibles, (iii) strategic corporate transaction-related charges and (iv) non-recurring items, if any. Strategic corporate transaction-related items arise from corporate actions and consist primarily of (i) impairments, (ii) non-monetary gains or losses on divestitures, (iii) transaction costs from strategic acquisitions, and (iv) depreciation on real estate that KKR owns and occupies. Inter-segment transactions are not eliminated from segment results when management considers those transactions in assessing the results of the respective segments. These transactions include (i) management fees earned by KKR as the investment adviser for Global Atlantic insurance companies and (ii) interest income and expense based on lending arrangements where one or more KKR subsidiaries borrow from a Global Atlantic insurance subsidiary. Inter-segment transactions are recorded by each segment based on the definitive documents that contain arms' length terms and comply with applicable regulatory requirements. Distributable Operating Earnings represents operating earnings of KKR’s Asset Management and Insurance segments, which are comprised of the following:•Asset Management Segment Operating Earnings is the segment profitability measure used to make operating decisions and to assess the performance of the Asset Management segment and is comprised of: (i) Fee Related Earnings, (ii) Realized Performance Income, (iii) Realized Performance Income Compensation, (iv) Realized Investment Income, and (v) Realized Investment Income Compensation. Asset Management Segment Operating Earnings excludes the impact of: (i) unrealized carried interest, (ii) net unrealized gains (losses) on investments, and (iii) related unrealized carried interest compensation. Management fees earned by KKR as the adviser, manager or sponsor for its investment funds, vehicles and accounts, including Global Atlantic insurance companies, are included in Asset Management Segment Operating Earnings.136Table of Contents•Insurance Segment Operating Earnings is the segment profitability measure used to make operating decisions and to assess the performance of the Insurance segment and is comprised of: (i) Net Investment Income, (ii) Net Cost of Insurance, (iii) General, Administrative, and Other Expenses, (iv) Income Taxes, and (v) Net Income Attributable to Noncontrolling Interests. The non-operating adjustments made to derive Insurance Segment Operating Earnings exclude the impact of: (i) realized (gains) losses related to asset/liability matching investments strategies, (ii) unrealized investment (gains) losses, (iii) changes in the fair value of derivatives, embedded derivatives, and fair value liabilities for fixed-indexed annuities, indexed universal life contracts and variable annuities, and (iv) the associated income tax effects of all exclusions from Insurance Segment Operating Earnings except for equity-based compensation expense. Insurance Segment Operating Earnings includes (i) realized gains and losses not related to asset/liability matching investments strategies and (ii) the investment management fee expenses that are earned by KKR as the investment adviser of the Global Atlantic insurance companies.Fee Related EarningsFee related earnings is a performance measure used to assess the Asset Management segment’s generation of profits from revenues that are measured and received on a recurring basis and are not dependent on future realization events. KKR believes this measure is useful to stockholders as it provides additional insight into the profitability of KKR’s fee generating asset management and capital markets businesses and other recurring revenue streams. FRE equals (i) Management Fees, including fees paid by the Insurance segment to the Asset Management segment and fees paid by certain insurance co-investment vehicles, (ii) Transaction and Monitoring Fees, Net and (iii) Fee Related Performance Revenues, less (x) Fee Related Compensation, and (y) Other Operating Expenses.•Fee Related Performance Revenues refers to the realized portion of Incentive Fees from certain AUM that has an indefinite term and for which there is no immediate requirement to return invested capital to investors upon the realization of investments. Fee-related performance revenues consists of performance fees (i) to be received from our investment funds, vehicles and accounts on a recurring basis, and (ii) that are not dependent on a realization event involving investments held by the investment fund, vehicle or account.•Fee Related Compensation refers to the compensation expense, excluding equity-based compensation, paid from (i) Management Fees, (ii) Transaction and Monitoring Fees, Net, and (iii) Fee Related Performance Revenues.•Other Operating Expenses represents the sum of (i) occupancy and related charges and (ii) other operating expenses.Total Asset Management Segment Revenues Total Asset Management Segment Revenues is a performance measure that represents the realized revenues of the Asset Management segment (which excludes unrealized carried interest and unrealized net gains (losses) on investments) and is the sum of (i) Management Fees, (ii) Transaction and Monitoring Fees, Net, (iii) Fee Related Performance Revenues, (iv) Realized Performance Income, and (v) Realized Investment Income. KKR believes that this performance measure is useful to stockholders as it provides additional insight into the realized revenues generated by KKR's asset management segment.Other Terms and Capital MetricsAdjusted SharesAdjusted shares represents shares of common stock of KKR & Co. Inc. outstanding under GAAP adjusted to include (i) the number of shares of common stock of KKR & Co. Inc. assumed to be issuable upon conversion of the Series C Mandatory Convertible Preferred Stock and (ii) certain securities exchangeable into shares of common stock of KKR & Co. Inc. Weighted average adjusted shares is used in the calculation of After-tax Distributable Earnings per Adjusted Share, and Adjusted Shares is used in the calculation of Book Value per Adjusted Share.Assets Under ManagementAssets under management represent the assets managed, advised or sponsored by KKR from which KKR is entitled to receive management fees or performance income (currently or upon a future event), general partner capital, and assets managed, advised or sponsored by our strategic BDC partnership and the hedge fund and other managers in which KKR holds an ownership interest. We believe this measure is useful to stockholders as it provides additional insight into the capital raising activities of KKR and its hedge fund and other managers and the overall activity in their investment funds and other managed or sponsored capital. KKR calculates the amount of AUM as of any date as the sum of: (i) the fair value of the investments of KKR's investment funds and certain co-investment vehicles; (ii) uncalled capital commitments from these funds, including 137Table of Contentsuncalled capital commitments from which KKR is currently not earning management fees or performance income; (iii) the asset value of the Global Atlantic insurance companies; (iv) the par value of outstanding CLOs; (v) KKR's pro rata portion of the AUM of hedge fund and other managers in which KKR holds an ownership interest; (vi) all of the AUM of KKR's strategic BDC partnership; (vii) the acquisition cost of invested assets of certain non-U.S. real estate investment trusts; and (viii) the value of other assets managed or sponsored by KKR. The pro rata portion of the AUM of hedge fund and other managers is calculated based on KKR’s percentage ownership interest in such entities multiplied by such entity’s respective AUM. KKR's definition of AUM (i) is not based on any definition of AUM that may be set forth in the governing documents of the investment funds, vehicles, accounts or other entities whose capital is included in this definition, (ii) includes assets for which KKR does not act as an investment adviser, and (iii) is not calculated pursuant to any regulatory definitions.Capital InvestedCapital invested is the aggregate amount of capital invested by (i) KKR’s investment funds and Global Atlantic insurance companies, (ii) KKR's Principal Activities business line as a co-investment, if any, alongside KKR’s investment funds, and (iii) KKR's Principal Activities business line in connection with a syndication transaction conducted by KKR's Capital Markets business line, if any. Capital invested is used as a measure of investment activity at KKR during a given period. We believe this measure is useful to stockholders as it provides a measure of capital deployment across KKR’s business lines. Capital invested includes investments made using investment financing arrangements like credit facilities, as applicable. Capital invested excludes (i) investments in certain leveraged credit strategies, (ii) capital invested by KKR’s Principal Activities business line that is not a co-investment alongside KKR’s investment funds, and (iii) capital invested by KKR’s Principal Activities business line that is not invested in connection with a syndication transaction by KKR’s Capital Markets business line. Capital syndicated by KKR's Capital Markets business line to third parties other than KKR’s investment funds or Principal Activities business line is not included in capital invested.Fee Paying AUMFee paying AUM represents only the AUM from which KKR is entitled to receive management fees. We believe this measure is useful to stockholders as it provides additional insight into the capital base upon which KKR earns management fees. FPAUM is the sum of all of the individual fee bases that are used to calculate KKR's and its hedge fund and BDC partnership management fees and differs from AUM in the following respects: (i) assets and commitments from which KKR is not entitled to receive a management fee are excluded (e.g., assets and commitments with respect to which it is entitled to receive only performance income or is otherwise not currently entitled to receive a management fee) and (ii) certain assets, primarily in its private equity funds, are reflected based on capital commitments and invested capital as opposed to fair value because fees are not impacted by changes in the fair value of underlying investments.Uncalled CommitmentsUncalled commitments is the aggregate amount of unfunded capital commitments that KKR’s investment funds and carry-paying co-investment vehicles have received from partners to contribute capital to fund future investments. The amount of uncalled commitments is not reduced by capital invested using borrowings under an investment fund’s subscription facility until capital is called from our fund investors. We believe this measure is useful to stockholders as it provides additional insight into the amount of capital that is available to KKR’s investment funds and carry paying co-investment vehicles to make future investments. Uncalled commitments are not reduced for investments completed using fund-level investment financing arrangements or investments we have committed to make but remain unfunded at the reporting date.138Table of ContentsConsolidated Results of Operations (GAAP Basis) The following is a discussion of our consolidated results of operations on a GAAP basis for the years ended December 31, 2022 and 2021. You should read this discussion in conjunction with the financial statements and related notes included elsewhere in this report. See "—Business Environment" for more information about factors that may affect our business, financial performance, operating results and valuations. Years Ended December 31, 2022December 31, 2021Change ($ in thousands)Revenues Asset ManagementFees and Other$2,821,627 $2,850,154 $(28,527)Capital Allocation-Based Income (Loss)(2,500,509)6,842,414 (9,342,923)321,118 9,692,568 (9,371,450)InsuranceNet Premiums1,182,461 2,226,078 (1,043,617)Policy Fees1,278,736 1,147,913 130,823 Net Investment Income4,118,246 2,845,623 1,272,623 Net Investment-Related Gains (Losses)(1,318,490)203,753 (1,522,243)Other Income139,124 120,213 18,911 5,400,077 6,543,580 (1,143,503)Total Revenues5,721,195 16,236,148 (10,514,953)ExpensesAsset ManagementCompensation and Benefits1,144,666 4,428,743 (3,284,077)Occupancy and Related Charges77,271 69,084 8,187 General, Administrative and Other993,548 959,077 34,471 2,215,485 5,456,904 (3,241,419)InsuranceNet Policy Benefits and Claims3,184,427 5,055,709 (1,871,282)Amortization of Policy Acquisition Costs10,990 (65,949)76,939 Interest Expense87,182 61,661 25,521 Insurance Expenses565,304 358,878 206,426 General, Administrative and Other718,422 555,321 163,101 4,566,325 5,965,620 (1,399,295)Total Expenses6,781,810 11,422,524 (4,640,714)Investment Income (Loss) - Asset ManagementNet Gains (Losses) from Investment Activities(1,665,537)7,720,923 (9,386,460)Dividend Income1,322,447 698,800 623,647 Interest Income1,895,282 1,485,470 409,812 Interest Expense(1,550,777)(1,070,368)(480,409)Total Investment Income (Loss)1,415 8,834,825 (8,833,410)Income (Loss) Before Taxes(1,059,200)13,648,449 (14,707,649)Income Tax Expense (Benefit)(35,672)1,353,270 (1,388,942)139Table of ContentsYears EndedDecember 31, 2022December 31, 2021Change($ in thousands)Net Income (Loss)(1,023,528)12,295,179 (13,318,707)Net Income (Loss) Attributable to Redeemable Noncontrolling Interests2,792 4,060 (1,268)Net Income (Loss) Attributable to Noncontrolling Interests(185,190)7,624,643 (7,809,833)Net Income (Loss) Attributable to KKR & Co. Inc.(841,130)4,666,476 (5,507,606)Series A Preferred Stock Dividends— 23,656 (23,656)Series B Preferred Stock Dividends— 12,991 (12,991)Series C Mandatory Convertible Preferred Stock Dividends69,000 69,000 — Net Income (Loss) Attributable to KKR & Co. Inc. Common Stockholders$(910,130)$4,560,829 $(5,470,959)140Table of ContentsConsolidated Results of Operations (GAAP Basis) - Asset ManagementRevenues For the years ended December 31, 2022 and 2021, revenues consisted of the following: Years Ended December 31, 2022December 31, 2021Change($ in thousands)Management Fees$1,682,466 $1,301,975 $380,491 Fee Credits(532,355)(464,594)(67,761)Transaction Fees1,316,637 1,552,621 (235,984)Monitoring Fees131,750 134,472 (2,722)Incentive Fees33,537 55,701 (22,164)Expense Reimbursements102,927 178,572 (75,645)Consulting Fees86,665 91,407 (4,742)Total Fees and Other2,821,627 2,850,154 (28,527)Carried Interest(2,068,662)5,388,354 (7,457,016)General Partner Capital Interest(431,847)1,454,060 (1,885,907)Total Capital Allocation-Based Income (Loss)(2,500,509)6,842,414 (9,342,923)Total Revenues - Asset Management$321,118 $9,692,568 $(9,371,450)Fees and OtherTotal Fees and Other for the year ended December 31, 2022 decreased compared to the year ended December 31, 2021 primarily as a result of a lower level of transaction fees, which was partially offset by an increase in management fees.For a more detailed discussion of the factors that affected our transaction fees during the period, see "—Analysis of Asset Management Segment Operating Earnings."The increase in management fees was primarily attributable to management fees earned from North America Fund XIII, Global Infrastructure Investors IV and European Fund VI. This increase was partially offset by a decrease in management fees earned from European Fund V and Americas Fund XII as a result of entering their post-investment periods and, consequently, we now earn fees based on capital invested rather than capital committed and at a lower fee rate.Management fees due from consolidated investment funds and other vehicles are eliminated upon consolidation under GAAP. However, because these amounts are funded by, and earned from, noncontrolling interests, upon consolidation under GAAP, KKR's allocated share of the net income from the consolidated investment funds and other vehicles is increased by the amount of fees that are eliminated. Accordingly, net income (loss) attributable to KKR would be unchanged if such investment funds and other vehicles were not consolidated. For a more detailed discussion on the factors that affect our management fees during the period, see "—Analysis of Asset Management Segment Operating Earnings." Fee credits increased compared to the prior period as a result of a higher level of transaction fees from infrastructure transaction fee-generating investments in our Real Asset business line. Fee credits owed to consolidated investment funds are eliminated upon consolidation under GAAP. However, because these amounts are owed to noncontrolling interests, upon consolidation under GAAP, KKR's allocated share of the net income from the consolidated investment funds is decreased by the amount of fee credits that are eliminated. Accordingly, net income (loss) attributable to KKR would be unchanged if such investment funds and other vehicles were not consolidated. Transaction and monitoring fees earned from KKR portfolio companies are not eliminated upon consolidation because those fees are earned from companies which are not consolidated. Furthermore, transaction fees earned in our capital markets business are not shared with fund investors. Accordingly, certain transaction fees are reflected in our revenues without a corresponding fee credit.141Table of ContentsCapital Allocation-Based Income (Loss)Capital Allocation-Based Income (Loss) for the year ended December 31, 2022 was negative primarily due to the net depreciation of the underlying investments in many of our carry-earning investment funds, most notably Americas Fund XII, Asian Fund II, and Asian Fund III. Capital Allocation-Based Income (Loss) for the year ended December 31, 2021 was positive primarily due to the net appreciation of the underlying investments at our carry earning investment funds, most notably Americas Fund XII, Asian Fund III, and North America Fund XI.KKR calculates the carried interest that would be due to KKR for each investment fund, pursuant to the fund agreements, as if the fair value of the underlying investments were realized as of the reporting date, irrespective of whether such amounts have been realized. Since the fair value of the underlying investments varies between reporting periods, it is necessary to make adjustments to the amounts recorded as carried interest to reflect either (a) positive performance, resulting in an increase in the carried interest allocated to the general partner or (b) negative performance that would cause the amount due to KKR to be less than the amount previously recognized, resulting in a negative adjustment to carried interest allocated to the general partner. In each case, it is necessary to calculate the carried interest on cumulative results compared to the carried interest recorded to date and to make the required positive or negative adjustments.Investment Income (Loss) - Asset ManagementNet Gains (Losses) from Investment Activities for the year ended December 31, 2022The net losses from investment activities for the year ended December 31, 2022 were comprised of net realized gains of $1,298.5 million and net unrealized losses of $(2,964.0) million.Investment gains and losses relating to our general partner capital interest in our unconsolidated funds are not reflected in our discussion and analysis of Net Gains (Losses) from Investment Activities. Our economics associated with these gains and losses are reflected in Capital Allocation-Based Income (Loss) as described above. Realized Gains and Losses from Investment ActivitiesFor the year ended December 31, 2022, net realized gains related primarily to (i) the sale of our investment in Fiserv, Inc. (NASDAQ: FISV), which was a significant contributor to gains from investment activities in 2022 but has now been completely sold and will no longer contribute to gains from investment activities, (ii) realizations on certain foreign exchange forward contracts, and (iii) the sale of real estate investments held in certain consolidated opportunistic real estate equity funds. Partially offsetting these realized gains were realized losses primarily relating to (i) various investments held in our consolidated alternative credit funds, (ii) a realized loss on Magneti Marelli CK Holdings (industrials sector) held in certain consolidated funds and (iii) realized losses from the sales of revolving credit facilities. Unrealized Gains and Losses from Investment ActivitiesFor the year ended December 31, 2022, net unrealized losses were driven primarily by mark-to-market losses from (i) investments held in our consolidated CLOs and in certain consolidated alternative credit funds, (ii) OutSystems Holdings S.A. (technology sector) held in certain consolidated funds and (iii) the reversal of previously recognized unrealized gains relating to the realization activity described above. These unrealized losses were partially offset by mark-to-market gains related to (i) investments held in certain consolidated energy funds, (ii) USI, Inc. (financial services sector), and (iii) ERM Worldwide Group Limited (services sector).The extent and the factors that affect each investment strategy vary depending on the nature of the asset class and the valuation methodology employed. For the year ended December 31, 2022 net unrealized losses were primarily generated in the following asset classes:•Private equity (excluding core private equity), which was primarily impacted by (i) the negative returns of global equity markets and the related reduction of market multiples used in the market comparables methodology for the valuation of Level III investments, and (ii) the negative impact of higher interest rates and a higher market risk premium in 2022 on discount rates used in the discounted cash flow methodology for the valuation of Level III investments; •Credit, which were primarily impacted by the widening of the credit spreads observed in the credit markets in 2022; and 142Table of Contents•Real estate, which, notwithstanding the positive operating performance of certain properties, was negatively impacted by the reversal of previously recognized unrealized gains relating to the realization activity described above and the capitalization rates widening in the fourth quarter of 2022.Partially offsetting the losses in the asset classes above, there were the unrealized gains generated in the following asset classes: •Infrastructure and energy, which benefited from (i) higher oil and gas prices and (ii) the positive operating performance of certain infrastructure assets; and •Core private equity, which benefited from the positive operating performance of its portfolio companies. For a discussion of other factors that affected KKR's realized investment income, see "—Analysis of Asset Management Segment Operating Results".Net Gains (Losses) from Investment Activities for the year ended December 31, 2021The net gains from investment activities for the year ended December 31, 2021 were comprised of net realized gains of $2,382.2 million and net unrealized gains of $5,338.7 million.Realized Gains and Losses from Investment ActivitiesFor the year ended December 31, 2021, net realized gains related primarily to the sales of investments held by KKR and certain consolidated funds, the most significant of which were in FanDuel Inc. (technology sector), Mr. Cooper Group Inc. (NASDAQ: COOP), and Darktrace Limited (LSE: DARK). Partially offsetting these realized gains were realized losses, the most significant of which were realized losses from various investments held in our consolidated credit funds and realized losses on certain hedging instruments.Unrealized Gains and Losses from Investment ActivitiesFor the year ended December 31, 2021, net unrealized gains related primarily to mark-to-market gains from investments held by KKR and certain consolidated funds, the most significant of which were PetVet Care Centers, LLC (health care sector), Heartland Dental LLC (health care sector) and OutSystems Holdings S.A. Partially offsetting these unrealized gains were unrealized losses, the most significant of which were (i) the reversal of previously recognized unrealized gains relating to the realization activity described above and (ii) an unrealized loss on BridgeBio Pharma, Inc. (NASDAQ: BBIO).For a discussion of other factors that affected KKR's realized investment income, see "—Analysis of Asset Management Segment Operating Results". For additional information about net gains (losses) from investment activities, see Note 5 "Net Gains (Losses) from Investment Activities - Asset Management" in our financial statements.Dividend IncomeDuring the year ended December 31, 2022, the most significant dividends received included (i) $441.2 million from investments held in our consolidated core plus and opportunistic real estate equity funds and (ii) $86.6 million from our investment in Exact Group B.V. (technology sector) held in our consolidated core vehicles. During the year ended December 31, 2021, the most significant dividends received included (i) $215.5 million from our consolidated real estate funds, (ii) $138.7 million from our investment in Viridor Limited (Infrastructure: energy and energy transition sector), and (iii) $70.9 million from our investment in Arnott's Biscuits Limited (consumer products sector).Significant dividends from portfolio companies and consolidated funds are generally not recurring quarterly dividends, and while they may occur in the future, their size and frequency are variable. For a discussion of other factors that affected KKR's dividend income, see "—Analysis of Asset Management Segment Operating Results." Interest IncomeThe increase in interest income during the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily due to the (i) impact of closing additional CLOs that were consolidated during 2022 and higher interest rates on assets held in consolidated CLOs and (ii) a higher level of interest income from investments held in certain of our consolidated alternative credit funds, primarily related to an increase in the amount of capital deployed and higher interest rates. Partially offsetting these increases was the deconsolidation of KREF in the fourth quarter of 2021. For a discussion of other factors that affected KKR's interest income, see "—Analysis of Asset Management Segment Operating Results."143Table of ContentsInterest ExpenseThe increase in interest expense during the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily due to (i) an increase in the amount of borrowings outstanding from consolidated funds and other vehicles, (ii) the impact of closing additional CLOs that were consolidated during 2022 and higher interest rates on debt obligations held in consolidated CLOs, and (iii) the impact of issuances of our notes after December 31, 2021. Partially offsetting these increases was the deconsolidation of KREF in the fourth quarter of 2021. For a discussion of other factors that affected KKR's interest expense, see "—Analysis of Non-GAAP Performance Measures."Expenses - Asset ManagementCompensation and Benefits Expenses The decrease in compensation and benefits expense during the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily due to the reversal of previously recognized accrued carried interest, partially offset by (i) higher equity-based compensation charges and (ii) a higher level of discretionary cash compensation resulting from a higher level of segment fee related revenue and realized performance income in the current period.General, Administrative and OtherThe increase in general, administrative and other expenses during the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily due to a higher level of (i) expenses at our consolidated funds and investment vehicles, (ii) strategic corporate transaction-related charges, (iii) professional fees, information technology and other administrative costs in connection with the growth of the firm, and (iv) travel related expenses as a result of a return of travel activity to pre-COVID-19 pandemic levels.In periods of significant fundraising and to the extent that we use third parties to assist in our capital raising efforts, our General, Administrative and Other are expected to increase accordingly. Similarly, our General, Administrative and Other expenses are expected to increase as a result of increased levels of professional and other fees incurred as part of due diligence related to strategic acquisitions and new product development.Consolidated Results of Operations (GAAP Basis) - InsuranceFor the year ended December 31, 2021, the results of Global Atlantic's insurance operations included in our consolidated results of operations are from the acquisition date, February 1, 2021, through December 31, 2021. Assumption reviewThe assumptions on which reserves, deferred revenue and expenses are based are intended to represent an estimation of the benefits that are expected to be payable to, and fees or premiums that are expected to be collectible from, policyholders in future periods. Global Atlantic reviews the adequacy of its reserves, deferred revenue and expenses and the assumptions underlying those items at least annually, usually in the third quarter. As Global Atlantic analyzes its assumptions, to the extent Global Atlantic chooses to update one or more of those assumptions, there may be an “unlocking” impact. Generally, favorable unlocking means the change in assumptions required a reduction in reserves, or in deferred revenue liabilities or an increase in deferred expenses, and unfavorable unlocking means the change in assumptions required an increase in reserves or in deferred revenue liabilities, or a reduction in deferred expenses.144Table of ContentsThe following table reflects the impact on net income by financial statement line item and to insurance segment adjusted operating earnings from Global Atlantic’s assumption review:Years EndedDecember 31, 2022December 31, 2021Change($ in thousands)Impacts of assumption review, by statement of income line item:Policy fees$(14)$182 $(196)Policy benefits and claims(23,079)20,904 (43,983)Amortization of policy acquisition costs7,686 (2,119)9,805 Income tax impact3,236 (3,983)7,219 Total assumption review impact on net income$(12,171)$14,984 $(27,155)Assumption review impact on adjustments to derive insurance segment adjusted operating earnings(157)(97)(60)Noncontrolling interests' share of assumption review impact4,749 (5,734)10,483 Total assumption review impact on insurance segment adjusted operating earnings$(7,579)$9,153 $(16,732)For the year ended December 31, 2022, the net unfavorable unlocking impact on net income and insurance segment adjusted operating earnings was primarily due to an increase in expected future surrender experience of annuity policies, partially as a result of higher interest rates, and a decrease in expected future surrender experience of life insurance policies. For the year ended December 31, 2021, the net favorable unlocking impact on net income and insurance segment adjusted operating earnings was primarily due to lower expected future mortality rates.RevenuesFor the years ended December 31, 2022 and 2021, revenues consisted of the following: Years Ended December 31, 2022December 31, 2021Change($ in thousands)Net Premiums$1,182,461 $2,226,078 $(1,043,617)Policy Fees1,278,736 1,147,913 130,823 Net Investment Income4,118,246 2,845,623 1,272,623 Net Investment-Related Gains(1,318,490)203,753 (1,522,243)Other Income139,124 120,213 18,911 Total Insurance Revenues$5,400,077 $6,543,580 $(1,143,503)Net PremiumsNet premiums decreased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to lower initial premiums related to fewer reinsurance transactions with life contingencies assumed during the year ended December 31, 2022 as compared to the year ended December 31, 2021. The decrease was partially offset by lower retrocessions to third party reinsurers during the year ended December 31, 2022 as compared to the year ended December 31, 2021. The initial premiums on assumed reinsurance were offset by a comparable increase in policy reserves reported within net policy benefits and claims (as discussed below).Policy feesPolicy fees increased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition on February 1, 2021.145Table of ContentsNet investment incomeNet investment income increased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to (i) higher yields on floating-rate investments due to higher market interest rates, (ii) rotation into higher yielding assets, (iii) increased average assets under management due to growth in assets in our institutional market channel as a result of new reinsurance transactions and individual market channel sales, and (iv) one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition having occurred on February 1, 2021.Net investment-related lossesThe components of net investment-related losses were as follows: Years Ended December 31, 2022December 31, 2021Change($ in thousands)Funds withheld payable embedded derivatives$3,448,710 $49,491 $3,399,219 Equity futures contracts167,924 (263,637)431,561 Foreign currency forwards18,929 2,484 16,445 Credit risk contracts(108)(400)292 Equity index options(895,602)549,987 (1,445,589)Interest rate contracts(333,937)(146,920)(187,017)Funds withheld receivable embedded derivatives(29,390)31,740 (61,130)Other(29,779)— (29,779)Net gains on derivative instruments2,346,747 222,745 2,124,002 Net other investment losses(3,665,237)(18,992)(3,646,245)Net investment-related losses$(1,318,490)$203,753 $(1,522,243)Net gains on derivative instrumentsThe increase in the fair value of embedded derivatives on funds withheld at interest payable for the year ended December 31, 2022 was primarily driven by the change in fair value of the underlying investments in the funds withheld at interest payable portfolio, which is primarily comprised of fixed maturity securities (designated as trading for accounting purposes), mortgage and other loan receivables, and other investments. The underlying investments in the funds withheld at interest payable portfolio declined in value in the current period primarily due to an increase in market interest rates and wider credit spreads.The increase in the fair value of equity futures was driven primarily by the performance of equity markets. Global Atlantic purchases equity futures primarily to hedge the market risk in our variable annuity products which are accounted for in net policy benefits and claims. The majority of Global Atlantic's equity futures are based on the S&P 500 Index, which decreased during the year ended December 31, 2022, as compared to an increase during the year ended December 31, 2021, resulting in, respectively, a gain and a loss on equity futures contracts in the respective periods.The decrease in the fair value of equity index options was primarily driven by the performance of the indexes upon which call options are based. Global Atlantic purchases equity index options to hedge the market risk of embedded derivatives in indexed universal life and fixed-indexed annuity products (the change in which is accounted for in net policy benefits and claims). The majority of Global Atlantic's equity index call options are based on the S&P 500 Index, which decreased during the year ended December 31, 2022, as compared to the increase during the year ended December 31, 2021.The decrease in the fair value of interest rate contracts was driven by an increase in market interest rates during both the year ended December 31, 2022 and the prior financial reporting period, resulting in a loss on interest rate contracts.The decrease in the fair value of embedded derivatives on funds withheld at interest receivable was primarily due to widening of credit spreads during the year ended December 31, 2022, as compared to the tightening of credit spreads in the year ended December 31, 2021.146Table of ContentsNet other investment lossesThe components of net other investment losses were as follows: Years Ended December 31, 2022December 31, 2021Change($ in thousands)Realized gains on investments not supporting asset-liability matching strategies$87,198 $527,788 $(440,590)Realized losses on available-for-sale fixed maturity debt securities(559,987)(201,411)(358,576)Credit loss allowances(456,176)(249,338)(206,838)Unrealized losses on fixed maturity securities classified as trading(2,603,874)(118,714)(2,485,160)Unrealized gains on investments classified as trading or fair-value option60,237 39,758 20,479 Unrealized (losses) gains on real estate investments recognized at fair value under investment company accounting(42,870)35,418 (78,288)Realized gains (losses) on funds withheld at interest, payable portfolio38,074 (30,015)68,089 Realized gains (losses) on funds withheld at interest, receivable portfolio(3,176)12,418 (15,594)Other(184,663)(34,896)(149,767)Net investment-related gains$(3,665,237)$(18,992)$(3,646,245)The increase in net other investment losses for the year ended December 31, 2022 were primarily due to (i) an increase in unrealized losses on fixed maturity securities classified as trading was primarily due to an increase in interest rates and widening credit spreads in the current period, (ii) a decrease in realized gains on investments not supporting asset-liability matching strategies primarily due to the non-recurrence of a gain from the disposition of Origis USA, LLC (Infrastructure: energy and energy transition sector) in the prior financial reporting period, (iii) the increase in realized losses on available-for-sale fixed maturity debt securities primarily due to portfolio rotation in a higher interest rate environment, (iv) an increase in credit loss allowances on mortgage and other loan receivables in the current period primarily due to an increase in credit risk of our loan portfolio, offset in part by the recognition of an initial credit loan loss allowance upon the adoption of the current expected credit loss accounting standard concurrent with the GA Acquisition in the prior financial reporting period, and (v) realized losses on renewable energy investments in the current period.Offsetting these losses were realized gains on funds withheld at interest payable portfolio.Other incomeOther income increased for the year ended December 31, 2022 as compared to the prior financial reporting period primarily due to one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition having occurred on February 1, 2021.ExpensesNet policy benefits and claimsNet policy benefits and claims decreased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to (i) lower initial reserves assumed related to fewer new reinsurance transactions with life contingencies in the year ended December 31, 2022 as compared to the year ended December 31, 2021, and (ii) a decrease in the value of embedded derivatives in Global Atlantic's indexed universal life and fixed indexed annuity products, as a result of lower equity market returns (as discussed above under "Revenues—Net gains on derivatives instruments," Global Atlantic purchases equity index options in order to hedge this risk, the fair value changes of which are accounted for in gains on derivative instruments, and generally offsetting the change in embedded derivative fair value reported in net policy benefits and claims). This decrease was offset by (i) one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition having occurred on February 1, 2021, (ii) an increase in net flows from both individual and institutional market channel sales, (iii) an increase in variable annuity reserves primarily due to lower equity market returns, (iv) higher funding costs on new business, and (v) unfavorable unlocking related to the assumption review described above under “—Consolidated Results of Operations (GAAP Basis)—Insurance (Unaudited)—Assumption Review.”147Table of ContentsAmortization of policy acquisition costsAmortization of policy acquisition costs increased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to (i) a decrease in the net benefit (that is, a reduction to expense) from the amortization of the net negative insurance intangibles recognized as part of purchase accounting of the GA Acquisition, as the underlying business runs off, and (ii) growth in our individual market channel. Offsetting these increases in expense was (i) a decrease of amortization due to realized investment losses in the current period, and (ii) favorable unlocking related to the assumption review described above under “—Consolidated Results of Operations (GAAP Basis)—Insurance (Unaudited)—Assumption Review.”Interest expenseInterest expense increased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to (i) a net increase in debt outstanding, including a draw on Global Atlantic's revolving credit facility in the quarter ended March 31, 2022, (ii) an increase in interest expense on floating rate debt (Global Atlantic's revolving facility and fixed-to-floating swaps on Global Atlantic's fixed rate debt) due to higher market rates, and (iii) the impact of one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition having occurred on February 1, 2021.Insurance expensesInsurance expenses increased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to (i) one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition having occurred on February 1, 2021, (ii) increased commission expense related to increased sales in our individual market and increased reinsurance transactions, and (iii) increased reinsurance ceding expense allowances paid for policy administration services as a result of an increase in reinsurance transactions.General, administrative and otherGeneral, administrative and other expenses increased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to (i) one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition having occurred on February 1, 2021, (ii) increased employee compensation and benefits related expenses, (iii) increased professional service fees, and (iv) increased third-party administrator ("TPA") policy servicing fees, all due to growth of the business.Other Consolidated Results of Operations (GAAP Basis)Income Tax Expense (Benefit)For the year ended December 31, 2022, income tax was a benefit of $35.7 million compared to an income tax expense of $1,353.3 million in the prior period. The tax benefit in the current period was generated primarily from deferred tax benefits recorded in connection with pre-tax unrealized losses driven by net capital allocation-based losses and investment losses offset by income tax expense relating to Global Atlantic’s insurance operations. For a discussion of factors that impacted KKR's tax provision, see Note 19 "Income Taxes" to the financial statements included elsewhere in this report. The amount of U.S. federal and state corporate income taxes we pay in future periods may be materially increased if adverse tax laws become enacted. See “—Business Environment— Economic and Market Conditions” in this report.Net Income (Loss) Attributable to Noncontrolling InterestsNet Income (Loss) attributable to noncontrolling interests for the year ended December 31, 2022 relates primarily to net income (loss) attributable to (i) exchangeable securities representing ownership interests in KKR Group Partnership, (ii) third-party limited partner interests in consolidated investment funds, and (iii) interests that co-investors and rollover investors hold in Global Atlantic. The net loss attributable to noncontrolling interests for the year ended December 31, 2022 was primarily due to (i) net losses from investment activities at our consolidated investment funds and (ii) a net loss attributable to exchangeable securities in the current period.Net Income (Loss) Attributable to KKR & Co. Inc. The net loss attributable to KKR & Co. Inc. for the year ended December 31, 2022 was primarily due to (i) net capital allocation-based losses and (ii) net losses from investment activities, partially offset by (i) a higher level of management fees and (ii) a reversal of previously recognized accrued carried interest compensation, as described above.148Table of ContentsConsolidated Results of Operations (GAAP Basis)The following is a discussion of our consolidated results of operations for the years ended December 31, 2021 and 2020. You should read this discussion in conjunction with the financial statements and related notes included elsewhere in this report. See also "—Business Environment" for more information about factors that may affect our business, financial performance, operating results and valuations. Years Ended December 31, 2021December 31, 2020Change ($ in thousands)Revenues Asset ManagementFees and Other$2,850,154 $2,006,791 $843,363 Capital Allocation-Based Income (Loss)6,842,414 2,224,100 4,618,314 9,692,568 4,230,891 5,461,677 InsuranceNet Premiums2,226,078 — 2,226,078 Policy Fees1,147,913 — 1,147,913 Net Investment Income2,845,623 — 2,845,623 Net Investment-Related Gains (Losses)203,753 — 203,753 Other Income120,213 — 120,213 6,543,580 — 6,543,580 Total Revenues16,236,148 4,230,891 12,005,257 ExpensesAsset ManagementCompensation and Benefits4,428,743 2,152,490 2,276,253 Occupancy and Related Charges69,084 72,100 (3,016)General, Administrative and Other959,077 708,542 250,535 5,456,904 2,933,132 2,523,772 InsuranceNet Policy Benefits and Claims5,055,709 — 5,055,709 Amortization of Policy Acquisition Costs(65,949)— (65,949)Interest Expense61,661 — 61,661 Insurance Expenses358,878 — 358,878 General, Administrative and Other555,321 — 555,321 5,965,620 — 5,965,620 Total Expenses11,422,524 2,933,132 8,489,392 Investment Income (Loss) - Asset ManagementNet Gains (Losses) from Investment Activities7,720,923 3,642,804 4,078,119 Dividend Income698,800 352,563 346,237 Interest Income1,485,470 1,403,440 82,030 Interest Expense(1,070,368)(969,871)(100,497)Total Investment Income (Loss)8,834,825 4,428,936 4,405,889 Income (Loss) Before Taxes13,648,449 5,726,695 7,921,754 Income Tax Expense (Benefit)1,353,270 609,097 744,173 149Table of ContentsYears EndedDecember 31, 2021December 31, 2020Change($ in thousands)Net Income (Loss)12,295,179 5,117,598 7,177,581 Net Income (Loss) Attributable to Redeemable Noncontrolling Interests4,060 — 4,060 Net Income (Loss) Attributable to Noncontrolling Interests7,624,643 3,115,089 4,509,554 Net Income (Loss) Attributable to KKR & Co. Inc.4,666,476 2,002,509 2,663,967 Series A Preferred Stock Dividends23,656 23,288 368 Series B Preferred Stock Dividends12,991 10,076 2,915 Series C Mandatory Convertible Preferred Stock Dividends69,000 23,191 45,809 Net Income (Loss) Attributable to KKR & Co. Inc. Common Stockholders$4,560,829 $1,945,954 $2,614,875 150Table of ContentsConsolidated Results of Operations (GAAP Basis) - Asset ManagementRevenues For the years ended December 31, 2021 and 2020, revenues consisted of the following: Years Ended December 31, 2021December 31, 2020Change($ in thousands)Management Fees$1,301,975 $965,664 $336,311 Fee Credits(464,594)(299,415)(165,179)Transaction Fees1,552,621 950,205 602,416 Monitoring Fees134,472 127,907 6,565 Incentive Fees55,701 10,404 45,297 Expense Reimbursements178,572 149,522 29,050 Oil and Gas Revenue— 21,054 (21,054)Consulting Fees91,407 81,450 9,957 Total Fees and Other2,850,154 2,006,791 843,363 Carried Interest5,388,354 1,719,527 3,668,827 General Partner Capital Interest1,454,060 504,573 949,487 Total Capital Allocation-Based Income (Loss)6,842,414 2,224,100 4,618,314 Total Revenues - Asset Management$9,692,568 $4,230,891 $5,461,677 Fees and Other Total Fees and Other for the year ended December 31, 2021 increased compared to the year ended December 31, 2020 primarily as a result of the increase in transaction fees and management fees.For a more detailed discussion of the factors that affected our transaction fees during the period, see "—Analysis of Asset Management Segment Operating Results." The increase in management fees was primarily attributable to management fees earned from (i) North America Fund XIII, Global Infrastructure Investors IV, and Health Care Strategic Growth Fund II, all of which entered their investment periods in 2021 and (ii) Asian Fund IV, which entered its investment period in the third quarter of 2020. These increases were partially offset by a decrease in management fees earned from Asian Fund III, Americas Fund XII, and Global Infrastructure Investors III as a result of entering their post-investment periods in the third quarter of 2020, second quarter of 2021 and second quarter of 2021, respectively, with all three investment funds now earning fees based on capital invested rather than capital committed and at a lower fee rate for Asian Fund III and Americas Fund XII.Management fees due from consolidated investment funds and other vehicles are eliminated upon consolidation under GAAP. However, because these amounts are funded by, and earned from, noncontrolling interests, upon consolidation under GAAP, KKR's allocated share of the net income from the consolidated investment funds and other vehicles is increased by the amount of fees that are eliminated. Accordingly, net income (loss) attributable to KKR would be unchanged if such investment funds and other vehicles were not consolidated. For a more detailed discussion on the factors that affect our management fees during the period, see "—Analysis of Asset Management Segment Operating Results."Fee credits increased compared to the prior period as a result of a higher level of transaction fees in our Private Equity, Real Assets, and Credit and Liquid Strategies business lines. Fee credits owed to consolidated investment funds are eliminated upon consolidation under GAAP. However, because these amounts are owed to noncontrolling interests, upon consolidation under GAAP, KKR's allocated share of the net income from the consolidated investment funds is decreased by the amount of fee credits that are eliminated. Accordingly, net income (loss) attributable to KKR would be unchanged if such investment funds and other vehicles were not consolidated. Transaction and monitoring fees earned from KKR portfolio companies are not eliminated upon consolidation because those fees are earned from companies which are not consolidated. Furthermore, 151Table of Contentstransaction fees earned in our Capital Markets business line are not shared with fund investors. Accordingly, certain transaction fees are reflected in revenues without a corresponding fee credit.Capital Allocation-Based Income (Loss)The increase in carried interest and general partner capital interest during the year ended December 31, 2021 compared to the prior period was due primarily to a higher level of net appreciation in the value of our investment portfolio as compared to the year ended December 31, 2020. Capital Allocation-Based Income (Loss) for the year ended December 31, 2021 was positive primarily due to the net appreciation of the underlying investments at our carry-earning investment funds, most notably Americas Fund XII, Asian Fund III and North America Fund XI. Capital Allocation-Based Income (Loss) for the year ended December 31, 2020 was positive due to the net appreciation of the underlying investments at our carry-earning investment funds, most notably Americas Fund XII, Asian Fund III and North America Fund XI. KKR generally calculates the carried interest that would be due to KKR for each investment fund, pursuant to the fund agreements, as if the fair value of the underlying investments were realized as of the reporting date, irrespective of whether such amounts have been realized. Since the fair value of the underlying investments varies between reporting periods, it is necessary to make adjustments to the amounts recorded as carried interest to reflect either (a) positive performance resulting in an increase in the carried interest allocated to the general partner or (b) negative performance that would cause the amount due to KKR to be less than the amount previously recognized, resulting in a negative adjustment to carried interest allocated to the general partner. In each case, it is necessary to calculate the carried interest on cumulative results compared to the carried interest recorded to date and to make the required positive or negative adjustments.Investment Income (Loss) - Asset ManagementNet Gains (Losses) from Investment Activities for the year ended December 31, 2021The net gains from investment activities for the year ended December 31, 2021 were comprised of net realized gains of $2,382.2 million and net unrealized gains of $5,338.7 million.Investment gains and losses relating to our general partner capital interest in our unconsolidated funds are not reflected in our discussion and analysis of Net Gains (Losses) from Investment Activities. Our economics associated with these gains and losses are reflected in Capital Allocation-Based Income (Loss) as described above. For a discussion and analysis of the investment gains or losses relating to the investments in our unconsolidated funds, see "—Analysis of Asset Management Segment Operating Results."Realized Gains and Losses from Investment ActivitiesFor the year ended December 31, 2021, net realized gains related primarily to the sales of our investments held by KKR and certain consolidated funds, the most significant of which were in FanDuel Inc., Mr. Cooper Group Inc., and Darktrace Limited. Partially offsetting these realized gains were realized losses, the most significant of which were realized losses from certain investments held in our consolidated credit funds and realized losses on certain hedging instruments.Unrealized Gains and Losses from Investment ActivitiesFor the year ended December 31, 2021, net unrealized gains related primarily to mark-to-market gains from our investments held by KKR and certain consolidated funds, the most significant of which were PetVet Care Centers, LLC, Heartland Dental LLC, and OutSystems Holdings S.A. Partially offsetting these unrealized gains were unrealized losses, the most significant of which are (i) the reversal of previously recognized unrealized gains relating to the realization activity described above and (ii) an unrealized loss on BridgeBio Pharma, Inc.For a discussion of other factors that affected KKR's realized investment income, see "—Analysis of Asset Management Segment Operating Results" and Note 5 "Net Gains (Losses) from Investment Activities - Asset Management" in our financial statements.Net Gains (Losses) from Investment Activities for the year ended December 31, 2020The net gains from investment activities for the year ended December 31, 2020 were comprised of net realized gains of $162.9 million and net unrealized gains of $3,479.9 million.152Table of ContentsRealized Gains and Losses from Investment ActivitiesFor the year ended December 31, 2020, net realized gains related primarily to (i) the sale of our investment in The Hut Group Limited (LSE: THG), (ii) partial sales of our investment in Fiserv, Inc., and (iii) the sale of our investment in Ivalua SAS (technology sector). Partially offsetting these realized gains were realized losses primarily relating to (i) an $88.3 million impairment charge taken on one of our investments that is accounted for under the equity method of accounting, (ii) a realized loss on the partial sale of our investment in LCI Helicopters Limited (financial services sector) and (iii) the realization of losses on certain investments held through consolidated CLOs and alternative credit funds.Unrealized Gains and Losses from Investment ActivitiesFor the year ended December 31, 2020, net unrealized gains were driven primarily by (i) mark-to-market gains in our growth equity and core investments held by KKR and certain consolidated entities, the most significant of which were BridgeBio Pharma, Inc., FanDuel Inc., and PetVet Care Centers, LLC. Partially offsetting these unrealized gains were unrealized losses relating to (i) the reversal of previously recognized unrealized gains relating to the realization activity described above, (ii) mark-to-market losses on our investment in Fiserv, Inc., which is held both in our funds and as a coinvestment by KKR, and (iii) mark-to-market losses on certain investments held through consolidated alternative credit and real estate funds.For a discussion of other factors that affected KKR's realized investment income, see "—Analysis of Asset Management Segment Operating Results" and Note 5 "Net Gains (Losses) from Investment Activities - Asset Management" in our financial statements.Dividend IncomeDuring the year ended December 31, 2021, the most significant dividends received included (i) $215.5 million from our consolidated real estate funds, (ii) $138.7 million from our investment in Viridor Limited, and (iii) $70.9 million from our investment in Arnott's Biscuits Limited. During the year ended December 31, 2020, the most significant dividends received included $152.4 million from our consolidated real estate funds, $62.5 million from our investment in Fiserv, Inc. part of which is held as a co-investment by KKR, and $48.9 million from our investment in Epicor Software Corporation (technology sector). Significant dividends from portfolio companies and consolidated funds are generally not recurring quarterly dividends, and while they may occur in the future, their size and frequency are variable. For a discussion of other factors that affected KKR's dividend income, see "—Analysis of Asset Management Segment Operating Results."Interest IncomeThe increase in interest income during the year ended December 31, 2021 compared to the year ended December 31, 2020 was primarily due to (i) a higher level of interest income from certain of our consolidated credit funds, primarily related to an increase in the amount of capital deployed, and (ii) the impact of closing additional CLOs that are consolidated subsequent to December 31, 2020. Partially offsetting these increases was a lower level of reported interest income from investments at KREF as a result of the deconsolidation of KREF in the fourth quarter of 2021. For a discussion of other factors that affected KKR's interest income, see "—Analysis of Asset Management Segment Operating Results."Interest ExpenseThe increase in interest expense during the year ended December 31, 2021 compared to the year ended December 31, 2020 was primarily due to (i) the impact of issuances of our senior notes, (ii) an increase in the amount of borrowings outstanding from the financing arrangements of consolidated investment funds and other vehicles, and (iii) the impact of closing additional CLOs that were consolidated subsequent to December 31, 2020. Partially offsetting these increases was a lower level of reported interest expense on debt obligations at KREF as a result of the deconsolidation of KREF in the fourth quarter of 2021. For a discussion of other factors that affected KKR's interest expense, see "—Analysis of Non-GAAP Performance Measures."153Table of ContentsExpenses - Asset ManagementCompensation and Benefits Expenses The increase in compensation and benefits expenses during the year ended December 31, 2021 compared to the prior period was primarily due to (i) a higher level of accrued carried interest compensation resulting from a higher level of carried interest from the appreciation in the value of our investment portfolio in the current period, (ii) a higher level of accrued discretionary compensation and benefits resulting from a higher level of fee revenue, realized performance income and realized investment income in the current period, and (iii) a higher level of equity-based compensation.General, Administrative and OtherThe increase in general, administrative and other expenses during the year ended December 31, 2021 compared to the prior period was primarily due to (i) a higher level of expenses at our consolidated CLOs, investment funds and other vehicles, (ii) a higher level of broken-deal expenses, (iii) a higher level of expenses reimbursable by our investment funds, and (iv) placement fees incurred related to capital raising activities.The level of broken-deal expenses can vary significantly period to period based upon a number of factors, the most significant of which are the number of potential investments being pursued for our investment funds, the size and complexity of investments being pursued and the number of investment funds currently in their investment period. Also, in periods of significant fundraising and to the extent that we use third parties to assist in our capital raising efforts, our General, Administrative and Other may increase accordingly. Similarly, our General, Administrative and Other may increase as a result of professional and other fees incurred as part of due diligence related to strategic acquisitions and new product development.Consolidated Results of Operations (GAAP Basis) - InsuranceFor the year-ended December 31, 2021, the results of Global Atlantic's insurance operations included in our consolidated results of operations are from the acquisition date, February 1, 2021, through December 31, 2021.Assumption reviewThe assumptions on which reserves, deferred revenue and expenses are based are intended to represent an estimation of the benefits that are expected to be payable to, and fees or premiums that are expected to be collectible from, policyholders in future periods. Global Atlantic reviews the adequacy of its reserves, deferred revenue and expenses and the assumptions underlying those items at least annually, usually in the third quarter. As Global Atlantic analyzes its assumptions, to the extent Global Atlantic chooses to update one or more of those assumptions, there may be an “unlocking” impact. Generally, favorable unlocking means the change in assumptions required a reduction in reserves, or in deferred revenue liabilities or an increase in deferred expenses, and unfavorable unlocking means the change in assumptions required an increase in reserves or in deferred revenue liabilities, or a reduction in deferred expenses.The following table reflects the impact on net income by financial statement line item and to insurance segment adjusted operating earnings from Global Atlantic’s assumption review:Year EndedDecember 31, 2021($ in thousands)Impacts of assumption review, by statement of income line item:Policy fees$182 Policy benefits and claims20,904 Amortization of policy acquisition costs(2,119)Income tax impact(3,983)Total assumption review impact on net income$14,984 Assumption review impact on adjustments to derive insurance segment adjusted operating earnings(97)Noncontrolling interests' share of assumption review impact(5,734)Total assumption review impact on insurance segment adjusted operating earnings$9,153 For the year ended December 31, 2021, the net favorable unlocking impact on net income and insurance segment adjusted operating earnings was primarily due to favorable mortality experience.154Table of ContentsRevenuesFor the year ended December 31, 2021, revenues consisted of the following: Year Ended December 31, 2021($ in thousands)Net Premiums$2,226,078 Policy Fees1,147,913 Net Investment Income2,845,623 Net Investment-Related Gains203,753 Other Income120,213 Total Insurance Revenues$6,543,580 Net PremiumsNet premiums were primarily driven by initial premiums related to new reinsurance transactions with life contingencies assumed during the year ended December 31, 2021. These initial premiums were wholly offset by a comparable increase in policy reserves reported within policy benefits and claims (as discussed below).Policy feesPolicy fees were primarily driven by cost of insurance, administrative, and rider fees during the year ended December 31, 2021.Net investment incomeNet investment income was primarily driven by insurance segment investments and the effective book yield (as determined, in part, by the allocated fair value of the investment portfolio as determined as of the GA Acquisition on February 1, 2021). Average insurance segment investments were primarily driven by net inflows of assets from the individual markets and institutional channels. In addition to the impact of higher asset balances, net investment income was also positively impacted by income from bond call and loan prepayment activity.Net investment-related gains (losses)The components of net investment-related gains (losses) were as follows: Year Ended December 31, 2021($ in thousands)Equity index options$549,987 Funds withheld payable embedded derivatives49,491 Funds withheld receivable embedded derivatives31,740 Equity future contracts(263,637)Interest rate contracts(146,920)Foreign currency forwards2,484 Credit risk contracts(400)Net gains on derivative instruments222,745 Net other investment losses(18,992)Net investment-related gains$203,753 Net gains on derivative instrumentsThe increase in the fair value of equity index options were primarily driven by the performance of the indexes upon which call options are based. Global Atlantic purchases equity index options to hedge the market risk of embedded derivatives in indexed universal life and fixed-indexed annuity products (the change for which is accounted for in policy benefits and claims). The majority of Global Atlantic's equity index call options are based on the S&P 500 Index, which increased during the year ended December 31, 2021.155Table of ContentsThe decrease in the fair value of equity futures and interest rate contracts were driven primarily by the performance of equity markets and interest rates. Global Atlantic purchases equity futures primarily to hedge the market risk in our variable annuity products which are accounted for in policy benefits and claims. The majority of Global Atlantic's equity futures are based on the S&P 500 Index, which increased during the year ended December 31, 2021, resulting in a loss on equity futures contracts. Market interest rates increased during the year ended December 31, 2021, resulting in a loss on interest rate contracts. The increase in the fair value of embedded derivatives on funds withheld at interest payable and receivable were primarily driven by the change in fair value of the underlying investments in the respective funds withheld at interest payable and receivable portfolios.Net other investment lossesThe components of net other investment losses were as follows: Year Ended December 31, 2021($ in thousands)Realized gains (losses) on investments not supporting asset-liability matching strategies$527,788 Realized gains (losses) on available-for-sale fixed maturity debt securities(201,411)Credit loss allowances(249,338)Unrealized gains (losses) on fixed maturity securities classified as trading(118,714)Unrealized gains (losses) on investments classified as trading or accounted under a fair-value option39,758 Unrealized gains (losses) on real estate investments recognized at fair value under investment company accounting35,418 Realized gains (losses) on funds withheld at interest payable portfolio(30,015)Realized gains (losses) on funds withheld at interest receivable portfolio12,418 Other(34,896)Net other investment losses$(18,992)Net other investment losses for the year ended December 31, 2021 were primarily due to (i) the recognition of a credit loan loss allowances as a result of the application of the current expected credit loss accounting standard adopted concurrent with the GA Acquisition, (ii) losses on the sale of available-for-sale ("AFS") securities as a result of portfolio rotation strategies, and (iii) net unrealized losses on trading fixed maturity securities underlying a portion of the funds withheld payable at interest portfolio due to an increase in market interest rates. These losses were almost wholly offset by realized gains (losses) on investments not supporting asset-liability matching strategies, including in particular a gain from the disposition of Origis USA, LLC.Other incomeOther income is mainly driven by expense allowances on ceded reinsurance, administration, management fees and distribution fees.ExpensesPolicy benefits and claimsPolicy benefits and claims were primarily driven by (i) initial reserves related to new reinsurance transactions with life contingencies during the year ended December 31, 2021, (ii) an increase in the value of embedded derivatives in Global Atlantic's indexed universal life and fixed indexed annuity products, as a result of higher equity market returns (as discussed above under "Revenues—Net gains on derivative instruments," Global Atlantic purchases equity index options in order to hedge this risk, the fair value changes of which are accounted for in gains on derivative instruments, and generally offsetting the change in embedded derivative fair value reported in policy benefits and claims), and (iii) an increase in net flows in the institutional and individual channels, all offset by a decrease in variable annuity reserves primarily due to higher equity market returns and market interest rates.156Table of ContentsAmortization of policy acquisition costsAmortization of policy acquisition costs during the year ended December 31, 2021 was primarily driven by the amortization of insurance intangibles recognized as part of purchase accounting of the Global Atlantic acquisition. Amortization is negative (that is, a reduction to expense) as a result of the net negative value-of-business-acquired insurance intangible recognized as part of the aforementioned purchase accounting.Interest expenseInterest expense for the year ended December 31, 2021 reflects a net increase in debt outstanding due to the issuance of new senior and subordinated notes which was partially offset by the pay-down of other debt, and the favorable impact to interest expense as a result of the lower average coupon due on new debt added at lower interest rates.Insurance expensesInsurance expenses were primarily driven by (i) commission expense related to sales, and (ii) reinsurance ceding expense allowances paid for policy administration services during the year ended December 31, 2021.General, administrative and otherGeneral, administrative and other expenses were driven primarily by (i) employee compensation and benefits related expenses, (ii) TPA policy servicing fees, (iii) technology hardware and software related charges, and (iv) professional fees during the year ended December 31, 2021.Other Consolidated Results of Operations (GAAP Basis)Income Tax Expense (Benefit)For the year ended December 31, 2021, income tax expense was $1,353.3 million compared to $609.1 million in the prior period. The increase in the income tax expense was primarily due to (i) a higher level of fees, capital allocation-based income and investment income as described above earned from asset management operations and (ii) the inclusion of income taxes relating to Global Atlantic's insurance operations. Our effective tax rate under GAAP for the year ended December 31, 2021 was 9.9%. For a discussion of factors that impacted KKR's tax provision, see Note 19 "Income Taxes" in our financial statements. The amount of U.S. federal and state corporate income taxes we pay in future periods may be materially increased if adverse tax laws become enacted. See also “—Business Environment—Economic and Market Conditions” in this report.Net Income (Loss) Attributable to Noncontrolling InterestsNet Income (Loss) attributable to noncontrolling interests for the year ended December 31, 2021 relates primarily to net income (loss) attributable to (i) interests of KKR Holdings and other exchangeable securities representing ownership interests in KKR Group Partnership, (ii) third-party limited partner interests in consolidated investment funds and (iii) interests that co-investors and rollover investors hold in Global Atlantic. Net income (loss) attributable to noncontrolling interests for the year ended December 31, 2021 increased compared to the prior period primarily due to a higher level of net income generated during the year ended December 31, 2021, allocable to the holders of the noncontrolling interests.Net Income (Loss) Attributable to KKR & Co. Inc. Net Income (loss) attributable to KKR & Co. Inc. for the year ended December 31, 2021 increased compared to the prior period primarily due to (i) a higher level of net gains from investment activities, capital allocation-based income, and fees earned from asset management operations during the year ended December 31, 2021 as described above and (ii) the acquisition of Global Atlantic, which was completed in February 2021. These increases were partially offset by accrued carried interest compensation and income tax expense, each as described above.157Table of ContentsCondensed Consolidated Statements of Financial Condition (GAAP Basis)The following table provides our condensed consolidated statements of financial condition on a GAAP basis as of December 31, 2022 and December 31, 2021.(Amounts in thousands, except per share amounts)As ofAs ofDecember 31, 2022December 31, 2021AssetsAsset ManagementCash and Cash Equivalents$6,705,325 $6,699,668 Investments92,375,463 88,775,514 Other Assets7,114,360 4,244,894 106,195,148 99,720,076 InsuranceCash and Cash Equivalents6,118,231 3,391,934 Investments124,199,176 123,763,675 Other Assets40,564,636 37,409,755 170,882,043 164,565,364 Total Assets$277,077,191$264,285,440Liabilities and EquityAsset ManagementDebt Obligations$40,598,613 $36,669,755 Other Liabilities6,937,832 8,359,619 47,536,445 45,029,374 InsuranceDebt Obligations2,128,166 1,908,006 Other Liabilities173,753,695 159,208,840 175,881,861 161,116,846 Total Liabilities$223,418,306 $206,146,220 Redeemable Noncontrolling Interests152,065 82,491 Stockholders' EquityStockholders' Equity - Series C Mandatory Convertible Preferred Stock1,115,792 1,115,792 Stockholders' Equity - Common Stock16,613,028 16,466,372 Noncontrolling Interests35,778,000 40,474,565 Total Equity53,506,820 58,056,729 Total Liabilities and Equity$277,077,191 $264,285,440 KKR & Co. Inc. Stockholders' Equity - Common StockPer Outstanding Share of Common Stock$19.29 $27.64 KKR & Co. Inc. Stockholders’ Equity - Common Stock per Outstanding Share of Common Stock was $19.29 as of December 31, 2022, down from $27.64 as of December 31, 2021. The decrease was primarily due to the (i) unrealized losses on available-for-sale-securities from Global Atlantic that are recorded in other comprehensive income, (ii) dividends to common stockholders, and (iii) a net loss attributable to KKR & Co. Inc. common stockholders during the year ended December 31, 2022.158Table of ContentsConsolidated Statements of Cash Flows (GAAP Basis) The following is a discussion of our consolidated cash flows for the years ended December 31, 2022 and 2021. You should read this discussion in conjunction with the financial statements and related notes included elsewhere in this report. The consolidated statements of cash flows include the cash flows of our consolidated entities, which include certain consolidated investment funds, CLOs and certain variable interest entities formed by Global Atlantic notwithstanding the fact that we may hold only a minority economic interest in those investment funds and CFEs. The assets of our consolidated investment funds and CFEs, on a gross basis, can be substantially larger than the assets of our business and, accordingly, could have a substantial effect on the cash flows reflected in our consolidated statements of cash flows. The primary cash flow activities of our consolidated funds and CFEs involve: (i) capital contributions from fund investors; (ii) using the capital of fund investors to make investments; (iii) financing certain investments with indebtedness; (iv) generating cash flows through the realization of investments; and (v) distributing cash flows from the realization of investments to fund investors. Because our consolidated funds are treated as investment companies for accounting purposes, certain of these cash flow amounts are included in our cash flows from operations.Net Cash Provided (Used) by Operating ActivitiesOur net cash provided (used) by operating activities was $(5.3) billion and $(7.2) billion during the years ended December 31, 2022 and 2021, respectively. These amounts primarily included: (i) investments purchased (asset management), net of proceeds from investments (asset management) of $(10.4) billion and $(10.6) billion during the years ended December 31, 2022 and 2021, respectively, (ii) net realized gains (losses) on asset management investments of $1.3 billion and $2.4 billion during the years ended December 31, 2022 and 2021, respectively, (iii) change in unrealized gains (losses) on investments (asset management) of $(3.0) billion and $5.3 billion during the years ended December 31, 2022 and 2021, respectively, (iv) capital allocation-based income (loss) of $(2.5) billion and $6.8 billion during the years ended December 31, 2022 and 2021, respectively, and (v) net realized gains (losses) on insurance operations of $(1.0) billion and $(0.9) billion during the years ended December 31, 2022 and 2021, respectively. Investment funds are investment companies under GAAP and reflect their investments and other financial instruments at fair value.Net Cash Provided (Used) by Investing ActivitiesOur net cash provided (used) by investing activities was $(13.6) billion and $(9.6) billion during the years ended December 31, 2022 and 2021, respectively. Our investing activities included: (i) investments purchased (insurance), net of proceeds from investments (insurance), of $(11.8) billion and $(9.1) billion during the years ended December 31, 2022 and 2021, respectively, (ii) acquisitions, net of cash acquired, of $(1.7) billion and $(473.8) million during the years ended December 31, 2022 and 2021, respectively, and (iii) the purchase of fixed assets of $(85.1) million and $(102.0) million during the years ended December 31, 2022 and 2021, respectively.Net Cash Provided (Used) by Financing ActivitiesOur net cash provided (used) by financing activities was $22.1 billion and $20.4 billion during the years ended December 31, 2022 and 2021, respectively. Our financing activities primarily included: (i) contributions by, net of distributions to, our noncontrolling and redeemable noncontrolling interests of $6.6 billion and $6.4 billion during the years ended December 31, 2022 and 2021, respectively, (ii) proceeds received, net of repayment of debt obligations, of $6.5 billion and $8.9 billion during the years ended December 31, 2022 and 2021, respectively, (iii) additions to, net of withdrawals from, contractholder deposit funds of $9.3 billion and $5.9 billion during years ended December 31, 2022 and 2021, respectively, (iv) common stock dividends of $(444.3) million and $(331.4) million during the years ended December 31, 2022 and 2021, respectively, (v) net delivery of common stock of $(65.7) million and $(166.8) million during the years ended December 31, 2022 and 2021, respectively, (vi) repurchases of common stock of $(346.7) million and $(269.7) million during the years ended December 31, 2022 and 2021, respectively, (vii) Series A and B Preferred Stock dividends of $(19.2) million during the year ended December 31, 2021, (viii) Series C Mandatory Convertible Preferred Stock dividends of $(69.0) million during each of the years ended December 31, 2022 and 2021, and (ix) private placement share issuance of $38.5 million during year ended December 31, 2021.159Table of ContentsAnalysis of Segment Operating ResultsThe following is a discussion of the results of our business on a segment basis for the years ended December 31, 2022, 2021, and 2020. You should read this discussion in conjunction with the information included under "—Key Segment and Non-GAAP Performance Measures" and the financial statements and related notes included elsewhere in this report. See "—Business Environment" for more information about factors that may impact our business, financial performance, operating results and valuations.For the year ended December 31, 2021, the results of our insurance segment are from February 1, 2021 (closing date of the GA Acquisition) through December 31, 2021.Analysis of Asset Management Segment Operating ResultsThe following tables set forth information regarding KKR's asset management segment operating results and certain key capital metrics as of and for the years ended December 31, 2022 and 2021.Years EndedDecember 31, 2022December 31, 2021Change($ in thousands)Management Fees$2,656,487 $2,071,440 $585,047 Transaction and Monitoring Fees, Net775,933 1,004,241 (228,308)Fee Related Performance Revenues90,665 45,852 44,813 Fee Related Compensation(769,735)(702,387)(67,348)Other Operating Expenses(585,999)(449,155)(136,844)Fee Related Earnings2,167,351 1,969,991 197,360 Realized Performance Income2,176,658 2,141,596 35,062 Realized Performance Income Compensation(1,333,526)(1,239,177)(94,349)Realized Investment Income1,134,419 1,613,244 (478,825)Realized Investment Income Compensation(159,003)(241,994)82,991 Asset Management Segment Operating Earnings$3,985,899 $4,243,660 $(257,761)Management FeesThe following table presents management fees by business line:Years EndedDecember 31, 2022December 31, 2021Change($ in thousands)Management FeesPrivate Equity$1,188,463 $967,038 $221,425 Real Assets679,890 437,102 242,788 Credit and Liquid Strategies788,134 667,300 120,834 Total Management Fees$2,656,487 $2,071,440 $585,047 The increase in Private Equity business line management fees was primarily attributable to a higher level of management fees earned from North America Fund XIII and European Fund VI. The increase was partially offset by a decrease in management fees earned from European Fund V and Americas Fund XII as a result of entering their post-investment periods and, consequently, we now earn fees based on capital invested rather than capital committed and at a lower fee rate. During the fourth quarter of 2022, approximately $11 million of management fees were earned on new capital raised that is retroactive to the start of the fund's investment period.160Table of ContentsThe increase in Real Assets business line management fees was primarily due to (i) a higher level of management fees earned from Global Infrastructure Investors IV, (ii) an increase in management fees earned from Global Atlantic and (iii) management fees earned on assets managed by KJRM, which we acquired in 2022. These increases were partially offset by a decrease in management fees earned from (i) Real Estate Partners Americas II as a result of a decline in capital invested from investment realizations (of which this investment fund's fee base is invested capital) and (ii) Global Infrastructure Investors III as a result of entering its post-investment period and, consequently, we now earn fees based on capital invested rather than capital committed.The increase in Credit and Liquid Strategies business line management fees was primarily attributable to (i) an increase in management fees earned from Global Atlantic and (ii) a higher level of management fees earned from FS KKR Capital Corp. ("FSK"), our business development company.Transaction and Monitoring Fees, NetThe following table presents transaction and monitoring fees, net by business line:Years EndedDecember 31, 2022December 31, 2021Change($ in thousands)Transaction and Monitoring Fees, NetPrivate Equity$120,410 $122,478 $(2,068)Real Assets33,202 20,687 12,515 Credit and Liquid Strategies22,018 14,181 7,837 Capital Markets600,303 846,895 (246,592)Total Transaction and Monitoring Fees, Net$775,933 $1,004,241 $(228,308)Our Capital Markets business line earns transaction fees, which are not shared with fund investors. The decrease in capital markets transaction fees was primarily due to a decrease in the number of capital markets transactions for the year ended December 31, 2022, compared to the year ended December 31, 2021. Overall, we completed 240 capital markets transactions for the year ended December 31, 2022, of which 29 represented equity offerings and 211 represented debt offerings, as compared to 358 transactions for the year ended December 31, 2021, of which 60 represented equity offerings and 298 represented debt offerings. We earned fees in connection with underwriting, syndication and other capital markets services. While each of the capital markets transactions that we undertake in this business line is separately negotiated, our fee rates are generally higher with respect to underwriting or syndicating equity offerings than with respect to debt offerings, and the amount of fees that we earn for similar transactions generally correlates with overall transaction sizes. Our capital markets fees are generated in connection with activity involving our private equity, real assets and credit funds as well as from third-party companies. For the year ended December 31, 2022, approximately 14% of our transaction fees in our Capital Markets business line were earned from unaffiliated third parties as compared to approximately 23% for the year ended December 31, 2021. Our transaction fees are comprised of fees earned from North America, Europe, and the Asia-Pacific region. For the year ended December 31, 2022, approximately 46% of our transaction fees were generated outside of North America as compared to approximately 38% for the year ended December 31, 2021. Our Capital Markets business line is dependent on the overall capital markets environment, which is influenced by equity prices, credit spreads, and volatility. Our Capital Markets business line does not generate monitoring fees.Our Private Equity, Real Assets and Credit and Liquid Strategies business lines separately earn transaction and monitoring fees from portfolio companies, and under the terms of the management agreements with certain of our investment funds, we are generally required to share all or a portion of such fees with our fund investors. Additionally, transaction fees are generally not earned with respect to energy and real estate investments. The decrease in our Private Equity business line transaction and monitoring fees, net, was primarily attributable to a lower average transaction fee earned in 2022. During the year ended December 31, 2022, there were 77 transaction fee-generating investments that paid an average fee of $5.3 million compared to 76 transaction fee-generating investments that paid an average fee of $5.5 million during the year ended December 31, 2021. For the year ended December 31, 2022, approximately 46% of Private Equity transaction fees were paid by companies in North America, 31% were paid from companies in the Asia-Pacific region, and 23% were paid from companies in Europe. Transaction fees vary by investment based upon a number of factors, the most significant of which are transaction size, the amount of the fees as set forth in the transaction agreements, the complexity of the transaction, and KKR's role in the transaction.161Table of ContentsFee Related Performance RevenuesThe following table presents fee related performance revenues by business line:Years EndedDecember 31, 2022December 31, 2021Change($ in thousands)Fee Related Performance RevenuesPrivate Equity$— $— $— Real Assets51,183 9,068 42,115 Credit and Liquid Strategies39,482 36,784 2,698 Total Fee Related Performance Revenues$90,665 $45,852 $44,813 Fee related performance revenues represent performance fees that are (i) expected to be received from our investment funds, vehicles and accounts on a recurring basis, and (ii) not dependent on a realization event involving investments held by the investment fund, vehicle or account. These performance fees are primarily earned from FSK (our business development company), KKR Property Partners Americas ("KPPA") (our open-ended core plus real estate fund), KREST (our registered closed-end real estate equity fund), KREF (our real estate credit investment trust), and KJRM (our Japanese real estate investment trust asset manager). Fee related performance revenues were higher for the year ended December 31, 2022 compared to the prior period primarily due to performance revenues earned from KPPA and KJRM in the current period.Fee Related CompensationThe increase in fee related compensation for the year ended December 31, 2022 compared to the prior period was primarily due to a higher level of compensation recorded in connection with the higher level of revenues included within fee related earnings.Other Operating ExpensesThe increase in other operating expenses for the year ended December 31, 2022 compared to the prior period was primarily due to (i) a higher level of professional fees, information technology and other administrative costs in connection with the growth of the firm and (ii) an increase in travel related expenses as a result of a return of travel activity to pre-COVID-19 pandemic levels.Fee Related EarningsThe increase in fee related earnings for the year ended December 31, 2022 compared to the prior period is primarily due to a higher level of management fees from our Private Equity, Real Assets, and Credit and Liquid Strategies business lines and a higher level of fee related performance revenues, partially offset by a lower level of transaction and monitoring fees, net, and a higher level of fee related compensation and other operating expenses, as described above.Realized Performance IncomeThe following table presents realized performance income by business line:Years EndedDecember 31, 2022December 31, 2021Change($ in thousands)Realized Performance IncomePrivate Equity$1,903,580 $1,678,753 $224,827 Real Assets113,465 97,312 16,153 Credit and Liquid Strategies159,613 365,531 (205,918)Total Realized Performance Income$2,176,658 $2,141,596 $35,062 162Table of ContentsYears EndedDecember 31, 2022December 31, 2021Change($ in thousands)Private EquityNorth America Fund XI$932,428 $433,708 $498,720 Core Investment Vehicles262,219 80,937 181,282 2006 Fund231,689 219,737 11,952 Americas Fund XII197,023 207,559 (10,536)Asian Fund III104,601 387,863 (283,262)European Fund IV86,233 186,476 (100,243)Co-Investment Vehicles and Other55,868 90,305 (34,437)Next Generation Technology Growth Fund— 32,544 (32,544)European Fund III— 353 (353)Total Realized Carried Interest (1)1,870,061 1,639,482 230,579 Incentive Fees33,519 39,271 (5,752)Total Realized Performance Income$1,903,580 $1,678,753 $224,827 Years EndedDecember 31, 2022December 31, 2021Change($ in thousands)Real AssetsReal Estate Partners Americas II$95,772 $— $95,772 Global Infrastructure Investors II17,693 72,862 (55,169)Real Estate Partners Europe— 18,200 (18,200)Co-Investment Vehicles and Other— 3,283 (3,283)Global Infrastructure Investors— 2,967 (2,967)Total Realized Carried Interest (1)113,465 97,312 16,153 Incentive Fees— — — Total Realized Performance Income$113,465 $97,312 $16,153 Years EndedDecember 31, 2022December 31, 2021Change($ in thousands)Credit and Liquid StrategiesAlternative Credit and Other Funds$10,334 $15,336 $(5,002)Total Realized Carried Interest (1)10,334 15,336 (5,002)Incentive Fees149,279 350,195 (200,916)Total Realized Performance Income$159,613 $365,531 $(205,918)(1)The above tables exclude any funds for which there was no realized carried interest during both of the periods presented.Realized performance income includes (i) realized carried interest from our carry-earning funds and (ii) incentive fees not included in Fee Related Performance Revenues.Realized carried interest in our Private Equity business line for the year ended December 31, 2022 consisted primarily of realized proceeds from the sales of our investments in Internet Brands, Inc. (technology sector) and CHI Overhead Doors, Inc. (manufacturing sector) held by North America Fund XI, Fiserv, Inc. held by 2006 Fund, and performance income from our core investment vehicles.163Table of ContentsRealized carried interest in our Private Equity business line for the year ended December 31, 2021 consisted primarily of realized proceeds from the sales of our investments in Kokusai Electric Corporation (manufacturing sector), The Bountiful Company (consumer products sector), Ingersoll Rand Inc. (NYSE: IR), Academy Sports & Outdoors Inc. (NASDAQ: ASO), and Endeavor Group Holdings, Inc. (NASDAQ: EDR).Realized carried interest in our Real Assets business line for the year ended December 31, 2022 consisted primarily of realized proceeds from dividends received and sales of various investments held by Real Estate Partners Americas II.Realized carried interest in our Real Assets business line for the year ended December 31, 2021 consisted primarily of realized proceeds from (i) the sale of our infrastructure investments, Calisen PLC (LSE: CLSN LN) and Telxius Telecom S.A.U. (Infrastructure: telecommunications infrastructure sector) and (ii) dividends received from and sales of various investments held by Real Estate Partners Europe.Incentive fees consist of performance fees earned from (i) our hedge fund partnerships, (ii) investment management agreements with KKR sponsored investment vehicles, and (iii) investment management agreements to provide KKR’s investment strategies to funds managed by a UK investment fund manager.Incentive fees in our Private Equity business line decreased for the year ended December 31, 2022 compared to the prior period as a result of a lower level of incentive fees being earned from assets we manage under a sub-advisory agreement with a UK investment fund manager in 2022. Incentive fees in our Credit and Liquid Strategies business line decreased for the year ended December 31, 2022 compared to the prior period primarily as a result of a lower level of performance fees earned from our hedge fund partnership, Marshall Wace.Realized Performance Income CompensationThe increase in realized performance income compensation for the year ended December 31, 2022 compared to the prior period is primarily due to a higher level of compensation recorded in connection with the higher level of realized performance income.Realized Investment IncomeThe following table presents realized investment income from our Principal Activities business line:Years EndedDecember 31, 2022December 31, 2021Change($ in thousands)Realized Investment IncomeNet Realized Gains (Losses)$530,284 $1,199,414 $(669,130)Interest Income and Dividends604,135 413,830 190,305 Total Realized Investment Income$1,134,419 $1,613,244 $(478,825)The decrease in realized investment income is primarily due to a lower level of net realized gains, partially offset by a higher level of interest income and dividends. The amount of realized investment income depends on the transaction activity of our funds and our subsidiaries, which can vary from period to period.For the year ended December 31, 2022, net realized gains were comprised of realized gains primarily from the sale of our investments in Fiserv, Inc., Internet Brands, Inc., Viridor Limited, and CHI Overhead Doors, Inc. Partially offsetting these realized gains were realized losses, the most significant of which were (i) a realized loss on our alternative credit investment, Hilding Anders International AB (consumer products sector), (ii) a realized loss on Magneti Marelli CK Holdings, and (iii) realized losses from the sales of various revolving credit facilities.For the year ended December 31, 2021, net realized gains were comprised of realized gains primarily from the sale of our investments in FanDuel Inc., Mr. Cooper Group Inc., Fiserv, Inc., The Bountiful Company, and BridgeBio Pharma Inc. Partially offsetting these realized gains were realized losses, the most significant of which were realized losses on certain hedging instruments.164Table of ContentsFor the year ended December 31, 2022, interest income and dividends were comprised of (i) $362.6 million of dividend income primarily from levered multi-asset investment vehicles, our investments in Exact Holdings B.V., Internet Brands, Inc. and Pembina Gas Infrastructure Inc. (midstream sector), and our real estate investments, including our investment in KPPA and KREF, and (ii) $241.5 million of interest income primarily from our investments in CLOs.For the year ended December 31, 2021, interest income and dividends were comprised of (i) $261.3 million of dividend income primarily from our real estate investments, including our investment in KREF, as well as our investments in Viridor Limited, Kokusai Electric Corporation, and Arnott's Biscuits Limited and (ii) $152.5 million of interest income primarily from our investments in CLOs and, to a lesser extent, our other credit investments. See "—Analysis of Non-GAAP Performance Measures—Non-GAAP Balance Sheet Measures."We expect realized performance income and realized investment income to be greater than $250 million in the first quarter of 2023 relating to realized carried interest and realized investment income from completed, or signed and expected to be completed sales, partial sales or secondary sales subsequent to December 31, 2022 with respect to certain private equity portfolio companies and other investments. Some of these transactions are not complete, and are subject to the satisfaction of closing conditions, including, but not limited, to regulatory approvals; there can be no assurance if or when any of these transactions will be completed. For the year ended December 31, 2022, total fees attributable to KKR Capstone were $86.7 million and total expenses attributable to KKR Capstone were $81.7 million. For KKR Capstone-related adjustments in reconciling asset management segment revenues to GAAP revenues see "—Analysis of Non-GAAP Performance Measures—Reconciliations to GAAP Measures". Realized Investment Income CompensationThe decrease in realized investment income compensation for the year ended December 31, 2022 compared to the prior period is primarily due to a lower level of compensation recorded in connection with the lower level of realized investment income.Other Operating and Capital MetricsThe following table presents certain key operating and capital metrics as of December 31, 2022 and December 31, 2021:As ofDecember 31, 2022December 31, 2021Change($ in millions)Assets Under Management$503,897 $470,555 $33,342 Fee Paying Assets Under Management$411,923 $357,389 $54,534 Uncalled Commitments$107,679 $111,822 $(4,143)The following table presents one of our key capital metrics for the year ended December 31, 2022 and 2021:Years EndedDecember 31, 2022December 31, 2021Change($ in millions)Capital Invested$71,411 $73,318 $(1,907)165Table of ContentsAssets Under ManagementPrivate EquityThe following table reflects the changes in the AUM of our Private Equity business line from December 31, 2021 to December 31, 2022: ($ in millions)December 31, 2021$173,745 New Capital Raised18,087 Distributions and Other(16,171)Change in Value(10,514)December 31, 2022$165,147 AUM of our Private Equity business line was $165.1 billion at December 31, 2022, a decrease of $8.6 billion, compared to $173.7 billion at December 31, 2021.The decrease was primarily attributable to (i) distributions to fund investors primarily as a result of realized proceeds, most notably from North America Fund XI, 2006 Fund, and Americas Fund XII, (ii) the liquidation of KKR Acquisition Holdings I, our special purpose acquisition company, and (iii) a decrease in investment value from Americas Fund XII, Asian Fund III, and Asian Fund II. Partially offsetting these decreases was new capital raised from European Fund VI, a new strategic investor partnership investing across multi-strategies, and Next Generation Technology Growth Fund III.For the year ended December 31, 2022, the value of our traditional private equity investment portfolio decreased by 14%. This was comprised of a 57% decrease in share prices of various publicly held investments and a 1% decrease in value of our privately held investments. For the year ended December 31, 2022, the value of our growth equity investment portfolio decreased 11% and our core private equity investment portfolio increased 7%. The most significant decreases in share prices of our publicly held investments were decreases in AppLovin Corporation (NASDAQ: APP), Max Healthcare Institute Limited (NSE: MAXHEALTH), and GoTo Gojek Tokopedia PT Tbk (IDX: GOTO). These decreases were partially offset by increases in share prices of other publicly held investments, the most significant of which were Hensoldt AG (FRA: HAG) and KnowBe4, Inc. (NASDAQ: KNBE). The prices of publicly held companies may experience volatile changes following the reporting period. See "—Business Environment" for more information about the factors, such as volatility, that may impact our business, financial performance, operating results and valuations.The most significant decreases in the value of our privately held investments were decreases in Kokusai Electric Corporation, OneStream Software, LLC (technology sector), and Unzer GmbH (financial services sector). These decreases in value on our privately held investments were partially offset by increases in the value of certain other privately held investments, the most significant of which were CHI Overhead Doors, Inc., ERM Worldwide Group Limited, and Internet Brands, Inc. The decreased valuations of individual companies in our privately held investments, in the aggregate, generally related to (i) an unfavorable business outlook and (ii) a decrease in the value of market comparables, both influenced by the economic outlook and overall market environment. The increased valuations of individual companies in our privately held investments, in the aggregate, generally related to (i) individual company performance, (ii) with respect to CHI Overhead Doors, Inc., an increase in valuation reflecting an agreement to exit the investment, which was executed in the period, and (iii) with respect to Internet Brands, Inc. an increase in valuation driven by a partial sale transaction, which was executed in the period. See "—Business Environment" for more information about the factors, that may impact our business, financial performance, operating results and valuations166Table of ContentsReal AssetsThe following table reflects the changes in the AUM of our Real Assets business line from December 31, 2021 to December 31, 2022: ($ in millions)December 31, 2021$83,303 New Capital Raised29,244 Acquisitions and Other(1)13,779 Distributions and Other(6,369)Change in Value(1,365)December 31, 2022$118,592 (1)Reflects the AUM of KJRM at closing of $12,730 million and represents an adjustment reflecting a change in the fee base of Global Atlantic's management fees from market value to book value.AUM of our Real Assets business line was $118.6 billion at December 31, 2022, an increase of $35.3 billion, compared to $83.3 billion at December 31, 2021.The increase was primarily attributable to (i) assets managed by KJRM, which we acquired in 2022, and (ii) new capital raised from Global Atlantic, Asia Pacific Infrastructure Investors II and our open-ended core infrastructure fund, Diversified Core Infrastructure Fund. Partially offsetting these increases were payments to Global Atlantic policyholders and distributions to fund investors as a result of realized proceeds, most notably from Global Infrastructure Investors III and Real Estate Partners Americas II. The decrease in investment value was due to the impact of the (i) decline in the value of the Japanese yen associated with assets managed by KJRM and the decline in value of our real estate credit portfolio partially offset by the increase in value across our energy, infrastructure and opportunistic real estate equity investment portfolios.For the year ended December 31, 2022, the value of our energy investment portfolio increased by 18%, the value of our infrastructure investment portfolio increased 5%, and the value of our opportunistic real estate equity investment portfolio increased by 3%. The most significant increases in the value of our privately held investments related to various assets held in our energy portfolio, Sempra Global, L.P. (Infrastructure: energy and energy transition sector), and Viridor Limited. These increases in value were partially offset by decreases in value relating primarily to Colonial Enterprises, Inc. (midstream sector) and various assets held in our opportunistic real estate equity investment portfolio. The increased valuations of individual companies or assets in our privately held investments, in the aggregate, generally related to individual company or asset performance. The decreased valuations of individual companies or assets in our privately held investments, in the aggregate, generally related to (i) a decrease in the value of market comparables and (ii) an unfavorable business outlook, both influenced by economic outlook and market environment. See "—Business Environment" for more information about the factors that may impact our business, financial performance, operating results and valuations.The most significant decrease in share prices of our publicly held investments was a decrease in First Gen Corporation (PM: FGEN). The prices of publicly held companies may experience volatile changes following the reporting period. See "—Business Environment" for more information about factors, such as volatility, that may impact our business, financial performance, operating results and valuations. 167Table of ContentsCredit and Liquid StrategiesThe following table reflects the changes in the AUM of our Credit and Liquid Strategies business line from December 31, 2021 to December 31, 2022: ($ in millions)December 31, 2021$213,507 New Capital Raised33,883 Acquisitions and Other(1)7,997 Distributions and Other(15,854)Redemptions(6,030)Change in Value(13,345)December 31, 2022$220,158 (1)Represents an adjustment reflecting a change in the fee base of Global Atlantic's management fees from market value to book value.AUM of our Credit and Liquid Strategies business line totaled $220.2 billion at December 31, 2022, an increase of $6.7 billion compared to AUM of $213.5 billion at December 31, 2021.The increase was primarily attributable to (i) new capital raised from Global Atlantic and various alternative and leveraged credit investment vehicles and (ii) the change in fee base for Global Atlantic's management fees from fair market value to book value. Partially offsetting these increases were (i) payments to Global Atlantic policyholders, (ii) redemptions at our hedge fund partnership, Marshall Wace, (iii) distributions to fund investors at certain alternative credit funds and (iv) a decline in investment value on the assets managed across our leveraged credit portfolio.See also "—Business Environment" for more information about the factors that may impact our business, financial performance, operating results and valuations.Fee Paying Assets Under ManagementPrivate EquityThe following table reflects the changes in the FPAUM of our Private Equity business line from December 31, 2021 to December 31, 2022: ($ in millions)December 31, 2021$87,890 New Capital Raised20,735 Distributions and Other(3,887)Net Changes in Fee Base of Certain Funds (1,573)Change in Value(904)December 31, 2022$102,261 FPAUM of our Private Equity business line was $102.3 billion at December 31, 2022, an increase of $14.4 billion, compared to $87.9 billion at December 31, 2021.The increase was primarily attributable to new capital raised from European Fund VI, Next Generation Technology Growth Fund III, and Global Impact Fund II. Partially offsetting this increase were decreases from (i) distributions to fund investors, primarily as a result of realized proceeds, most notably from North America Fund XI and Asian Fund III, and (ii) a change in fee base for European Fund V as a result of entering its post-investment period, during which we earn fees on invested capital rather than committed capital. 168Table of ContentsUncalled capital commitments from private equity and multi-strategy investment funds from which KKR is currently not earning management fees amounted to approximately $18.6 billion at December 31, 2022, which includes capital commitments reserved for follow-on investments for funds that have completed their investment periods. This capital will generally begin to earn management fees upon deployment of the capital or upon the commencement of the fund's investment period. The average annual management fee rate associated with this capital is approximately 1.0%. The date on which we begin to earn fees (as specified above) is not guaranteed to occur and may not occur for an extended period of time. If and when such management fees are earned, a portion of existing FPAUM may cease paying fees or pay lower fees, thus offsetting a portion of any new management fees earned.Real AssetsThe following table reflects the changes in the FPAUM of our Real Assets business line from December 31, 2021 to December 31, 2022: ($ in millions)December 31, 2021$66,965 New Capital Raised32,315 Acquisitions and Other(1)13,779 Distributions and Other(4,685)Net Changes in Fee Base of Certain Funds (1,125)Change in Value(3,717)December 31, 2022$103,532 (1)Reflects the FPAUM of KJRM at closing of $12,730 million and represents an adjustment reflecting a change in the fee base of Global Atlantic's management fees from market value to book value.FPAUM of our Real Assets business line was $103.5 billion at December 31, 2022, an increase of $36.5 billion, compared to $67.0 billion at December 31, 2021.The increase was primarily attributable to (i) assets managed by KJRM, which we acquired in 2022, and (ii) new capital raised from Global Atlantic, Asia Pacific Infrastructure Investors II, and Diversified Core Infrastructure Fund. Partially offsetting these increases were (i) payments to Global Atlantic policyholders, (ii) a change in fee base for Asia Pacific Infrastructure Investors as a result of entering its post-investment period, during which we earn fees on invested capital rather than committed capital, and (iii) distributions to fund investors as a result of realized proceeds, most notably from Global Infrastructure Investors III.Uncalled capital commitments from real assets investment funds from which KKR is currently not earning management fees amounted to approximately $10.3 billion at December 31, 2022, which includes capital commitments reserved for follow-on investments for funds that have completed their investment periods. This capital will generally begin to earn management fees upon deployment of the capital or upon the commencement of the fund's investment period. The average annual management fee rate associated with this capital is approximately 1.2%. The date on which we begin to earn fees (as specified above) is not guaranteed to occur and may not occur for an extended period of time. If and when such management fees are earned, a portion of existing FPAUM may cease paying fees or pay lower fees, thus offsetting a portion of any new management fees earned.169Table of ContentsCredit and Liquid StrategiesThe following table reflects the changes in the FPAUM of our Credit and Liquid Strategies business line from December 31, 2021 to December 31, 2022: ($ in millions)December 31, 2021$202,534 New Capital Raised29,430 Acquisitions and Other(1)7,997 Distributions and Other(15,097)Redemptions(6,030)Change in Value(12,704)December 31, 2022$206,130 (1)Represents an adjustment reflecting a change in the fee base of Global Atlantic's management fees from market value to book value. FPAUM of our Credit and Liquid Strategies business line was $206.1 billion at December 31, 2022, an increase of $3.6 billion compared to $202.5 billion at December 31, 2021. The increase was primarily attributable to (i) new capital raised from Global Atlantic and various alternative and leveraged credit investment vehicles and (ii) the change in fee base for Global Atlantic's management fees from fair market value to book value. Partially offsetting these increases were (i) payments to Global Atlantic policyholders, (ii) redemptions at our hedge fund partnership, Marshall Wace, (iii) distributions to fund investors at certain alternative credit funds and (iv) a decline in investment value on the assets managed across our leveraged credit portfolio.Uncalled capital commitments from investment funds in our Credit and Liquid Strategies business line from which KKR is currently not earning management fees amounted to approximately $10.3 billion at December 31, 2022. This capital will generally begin to earn management fees upon deployment of the capital or upon the commencement of the fund's investment period. The average annual management fee rate associated with this capital is approximately 0.7%. The date on which we begin to earn fees (as specified above) is not guaranteed to occur and may not occur for an extended period of time. If and when such management fees are earned, which will occur over an extended period of time, a portion of existing FPAUM may cease paying fees or pay lower fees, thus offsetting a portion of any new management fees earned.See "—Business Environment" for more information about the factors that may impact our business, financial performance, operating results and valuations.Uncalled CommitmentsPrivate EquityAs of December 31, 2022, our Private Equity business line had $65.9 billion of remaining uncalled capital commitments that could be called for investments in new transactions as compared to $66.3 billion as of December 31, 2021. The decrease was primarily attributable to capital called from fund investors to make investments during the period, which was partially offset by new capital commitments from fund investors.Real AssetsAs of December 31, 2022, our Real Assets business line had $27.5 billion of remaining uncalled capital commitments that could be called for investments in new transactions as compared to $35.2 billion as of December 31, 2021. The decrease was primarily attributable to capital called from fund investors to make investments during the period, which was partially offset by new capital commitments from fund investors.Credit and Liquid StrategiesAs of December 31, 2022, our Credit and Liquid Strategies business line had $14.3 billion of remaining uncalled capital commitments that could be called for investments in new transactions as compared to $10.3 billion as of December 31, 2021. The increase was primarily attributable to new commitments from fund investors, which was partially offset by capital called from fund investors to make investments during the period.170Table of ContentsCapital InvestedPrivate EquityFor the year ended December 31, 2022, $18.8 billion of capital was invested by our Private Equity business line, as compared to $17.6 billion for the year ended December 31, 2021. The increase was driven primarily by a $2.4 billion increase in capital invested in our traditional private equity strategy, partially offset by a $1.5 billion decrease in capital invested in our core private equity strategy. During the year ended December 31, 2022, 56% of capital deployed in private equity was in transactions in North America, 26% was in the Asia-Pacific region, and 18% was in Europe. The number of large private equity investments made in any quarterly or year-to-date period is volatile and, consequently, a significant amount of capital invested in one period or a few periods may not be indicative of a similar level of capital deployment in future periods.Real AssetsFor the year ended December 31, 2022, $27.8 billion of capital was invested by our Real Assets business line, as compared to $21.4 billion for the year ended December 31, 2021. The increase was driven primarily by a $4.1 billion increase in capital invested in our infrastructure strategy and a $1.6 billion increase in capital invested in our real estate strategy. During the year ended December 31, 2022, 69% of capital deployed in real assets was in transactions in North America, 23% was in Europe, and 8% was in the Asia-Pacific region. The number of large Real Asset investments made in any quarterly or year-to-date period is volatile and, consequently, a significant amount of capital invested in one period or a few periods may not be indicative of a similar level of capital deployment in future periods.Credit and Liquid StrategiesFor the year ended December 31, 2022, $24.7 billion of capital was invested by our Credit and Liquid Strategies business line, as compared to $34.4 billion for the year ended December 31, 2021. The decrease was primarily due to a lower level of capital deployed across our direct lending and SIG strategies. During the year ended December 31, 2022, 87% of capital deployed was in transactions in North America, 9% was in Europe, and 4% was in the Asia-Pacific region.Analysis of Insurance Segment Operating ResultsAs discussed above, our insurance segment consists solely of the operations of Global Atlantic, which was acquired on February 1, 2021. For the year ended December 31, 2021, the results of our insurance segment is from the acquisition date, February 1, 2021, through December 31, 2021.The following tables set forth information regarding KKR's insurance segment operating results and certain key operating metrics as of and for the years ended December 31, 2022 and 2021:Years EndedDecember 31, 2022December 31, 2021Change($ in thousands)Net Investment Income$4,112,244 $3,329,570 $782,674 Net Cost of Insurance(2,415,996)(1,566,681)(849,315)General, Administrative and Other(637,718)(500,410)(137,308)Pre-tax Insurance Operating Earnings1,058,530 1,262,479 (203,949)Income Taxes(171,744)(199,095)27,351 Net Income Attributable to Noncontrolling Interests(341,582)(410,833)69,251 Insurance Segment Operating Earnings$545,204 $652,551 $(107,347)Insurance segment operating earningsInsurance segment operating earnings decreased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to (i) higher net cost of insurance, primarily due to the growth in both our individual market and institutional market channels and higher funding cost on new business, and (ii) a corresponding increase in general and administrative expenses. The decrease was offset in part by (i) higher net investment income resulting from an increase in average assets under management due to growth of the business, and higher average yields, (ii) one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition having occurred on February 1, 2021, and (iii) a decrease in income tax expense. 171Table of ContentsNet investment incomeNet investment income increased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to (i) one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition having occurred on February 1, 2021, (ii) growth in portfolio yields due to higher market interest rates on floating rate investments, (iii) rotation into higher yielding assets, and (iv) increased average assets under management due to growth in assets in our institutional market channel as a result of new reinsurance transactions and individual market channel sales from new business growth. Offsetting these increases to net investment income was a decrease in variable investment income, primarily due to the non-recurrence of net realized gains from the sale of investments not related to asset/liability matching strategies, including in particular the disposition of Origis USA, LLC, reported in the prior financial reporting period.Net cost of insuranceNet cost of insurance increased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to (i) one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition having occurred on February 1, 2021, (ii) growth in reserves in the institutional market as a result of new reinsurance transactions and in the individual market as a result of new business volumes, and (iii) higher funding costs on new business originated, and (iv) the impact of assumption review (as described in “—Consolidated Results of Operations (GAAP Basis)—Insurance (Unaudited)—Assumption Review” above).General, administrative and other expensesGeneral and administrative expenses increased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to (i) one less month of activity reported in the prior financial reporting period as a result of the GA Acquisition having occurred on February 1, 2021, (ii) increased employee compensation and benefits-related expenses, (iii) increased professional service fees, and (iv) increased TPA policy servicing fees, all due to growth of the business.Income taxesInsurance segment income tax expense reflects the effective tax rate for the insurance segment on an operating basis, including the benefit of investment tax credits for the prior year period.Net Income attributable to noncontrolling interestsNet income attributable to noncontrolling interests decreased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 in proportion to the decrease in insurance segment operating earnings for the comparable period. Net income attributable to noncontrolling interests represents the proportionate interest in the insurance segment operating earnings attributable to other investors in Global Atlantic.172Table of ContentsAnalysis of Non-GAAP Performance MeasuresThe following is a discussion of our Non-GAAP performance measures for the years ended December 31, 2022 and 2021:Year EndedDecember 31, 2022December 31, 2021Change($ in thousands)Asset Management Segment Operating Earnings$3,985,899 $4,243,660 $(257,761)Insurance Segment Operating Earnings545,204 652,551 (107,347)Distributable Operating Earnings4,531,103 4,896,211 (365,108)Interest Expense(315,189)(250,183)(65,006)Preferred Dividends— (19,201)19,201 Net Income Attributable to Noncontrolling Interests(23,200)(23,664)464 Income Taxes Paid(738,841)(687,572)(51,269)After-tax Distributable Earnings$3,453,873 $3,915,591 $(461,718)For the year ended December 31, 2021, the results of our insurance segment above are from February 1, 2021 (closing date of the GA Acquisition) through December 31, 2021.Distributable Operating Earnings The decrease in distributable operating earnings for the year ended December 31, 2022 compared to the prior period is primarily due to a lower level of asset management segment operating earnings and insurance segment operating earnings. For a discussion of the asset management and insurance segment operating earnings, see "—Analysis of Asset Management Segment Operating Results" and "—Analysis of Insurance Segment Operating Results."Interest ExpenseThe increase in interest expense for the year ended December 31, 2022 compared to the prior period is due primarily to debt issuances by KKR's financing subsidiaries. Preferred Dividends The decrease in preferred dividends for the year ended December 31, 2022 compared to the prior period was attributable to the redemption of all of our Series A and B preferred stock.Income Taxes PaidThe increase in income taxes paid for the year ended December 31, 2022 compared to the prior period was primarily due to a lower tax benefit from equity-based compensation and an increase in U.S. state and local taxes.After-tax Distributable EarningsThe decrease in after-tax distributable earnings for the year ended December 31, 2022 compared to the prior period was primarily due to a lower level of distributable operating earnings and an increase in interest expense and income taxes paid, partially offset by a decrease in preferred dividends, as discussed above.For the years ended December 31, 2022 and 2021, the amount of the tax benefit from equity-based compensation included in income taxes paid was $65.4 million and $123.1 million, respectively. The inclusion of the tax benefit from equity-based compensation in After-tax Distributable Earnings had the effect of increasing this measure by 2% and 3%, respectively, for the years ended December 31, 2022 and 2021.173Table of ContentsAnalysis of Asset Management Segment Operating ResultsThe following tables set forth information regarding KKR's asset management segment operating results for the years ended December 31, 2021 and 2020:Year EndedDecember 31, 2021December 31, 2020Change($ in thousands)Management Fees$2,071,440 $1,441,578 $629,862 Transaction and Monitoring Fees, Net1,004,241 632,433 371,808 Fee Related Performance Revenues45,852 39,555 6,297 Fee Related Compensation(702,387)(486,481)(215,906)Other Operating Expenses(449,155)(346,558)(102,597)Fee Related Earnings1,969,991 1,280,527 689,464 Realized Performance Income2,141,596 1,165,699 975,897 Realized Performance Income Compensation(1,239,177)(697,071)(542,106)Realized Investment Income1,613,244 644,659 968,585 Realized Investment Income Compensation(241,994)(106,830)(135,164)Asset Management Segment Operating Earnings$4,243,660 $2,286,984 $1,956,676 Management FeesThe following table presents management fees by business line:Year EndedDecember 31, 2021December 31, 2020Change($ in thousands)Management FeesPrivate Equity$967,038 $714,070 $252,968 Real Assets437,102 262,537 174,565 Credit and Liquid Strategies667,300 464,971 202,329 Total Management Fees$2,071,440 $1,441,578 $629,862 The increase in Private Equity business line management fees was primarily attributable to management fees earned from North America Fund XIII, Asian Fund IV, and Health Care Strategic Growth Fund II. The increase was partially offset by a decrease in management fees earned from Americas Fund XII and Asian Fund III as a result of entering their post-investment periods and, consequently, we now earn fees based on capital invested rather than capital committed and at a lower fee rate.The increase in Real Assets business line management fees was primarily due to (i) management fees earned from Global Infrastructure Investors IV and Real Estate Partners Americas III, and (ii) an increase in management fees earned from Global Atlantic. These increases were partially offset by a decrease in management fees earned from Global Infrastructure Investors III as a result of entering its post-investment period and, consequently, we now earn fees based on capital invested rather than capital committed.The increase in Credit and Liquid Strategies business line management fees was primarily attributable to (i) management fees earned from Global Atlantic during the period February 1, 2021 through December 31, 2021, (ii) the issuance of new CLOs subsequent to December 31, 2020, (iii) higher overall FPAUM at our hedge fund partnerships from investment appreciation and, to a lesser extent, net capital inflows, and (iv) net capital inflows in certain leveraged credit strategy accounts.174Table of ContentsTransaction and Monitoring Fees, NetThe following table presents transaction and monitoring fees, net by business line:Year EndedDecember 31, 2021December 31, 2020Change($ in thousands)Transaction and Monitoring Fees, NetPrivate Equity$122,478 $135,235 $(12,757)Real Assets20,687 13,172 7,515 Credit and Liquid Strategies14,181 3,543 10,638 Capital Markets846,895 480,483 366,412 Total Transaction and Monitoring Fees, Net$1,004,241 $632,433 $371,808 Our Capital Markets business line earns transaction fees, which are not shared with fund investors. The increase in transaction fees was primarily due to an increase in the number of capital markets transactions for the year ended December 31, 2021, compared to the year ended December 31, 2020. Overall, we completed 358 capital markets transactions for the year ended December 31, 2021, of which 60 represented equity offerings and 298 represented debt offerings, as compared to 193 transactions for the year ended December 31, 2020, of which 36 represented equity offerings and 157 represented debt offerings. We earned fees in connection with underwriting, syndication and other capital markets services. While each of the capital markets transactions that we undertake in this business line is separately negotiated, our fee rates are generally higher with respect to underwriting or syndicating equity offerings than with respect to debt offerings, and the amount of fees that we earn for similar transactions generally correlates with overall transaction sizes. Our capital markets fees are generated in connection with our Private Equity, Real Assets, and Credit and Liquid Strategies business lines as well as from third-party companies. For the year ended December 31, 2021, approximately 23% of our transaction fees in our Capital Markets business line were earned from unaffiliated third parties as compared to approximately 18% for the year ended December 31, 2020. Our transaction fees are comprised of fees earned from North America, Europe, and the Asia-Pacific region. For the year ended December 31, 2021, approximately 38% of our transaction fees were generated outside of North America as compared to approximately 58% for the year ended December 31, 2020. Our Capital Markets business line is dependent on the overall capital markets environment, which is influenced by equity prices, credit spreads, and volatility. Our Capital Markets business line does not generate monitoring fees.Our Private Equity, Real Assets, and Credit and Liquid Strategies business lines separately earn transaction and monitoring fees from portfolio companies, and under the terms of the management agreements with certain of our investment funds, we are required to share all or a portion of such fees with our fund investors. Additionally, transaction fees are generally not earned with respect to energy and real estate investments.The decrease in Private Equity business line transaction and monitoring fees, net was primarily attributable to the write-off of outstanding monitoring fee receivables for two portfolio companies, partially offset by an increase in net transaction fees. During the year ended December 31, 2021, there were 76 transaction fee-generating investments that paid an average fee of $5.5 million compared to 54 transaction fee-generating investments that paid an average fee of $6.5 million during the year ended December 31, 2020. For the year ended December 31, 2021, approximately 52% of these transaction fees were paid by companies in North America, 25% were paid from companies in Europe, and 23% of these transaction fees were paid from companies in the Asia-Pacific region. Transaction fees vary by investment based upon a number of factors, the most significant of which are transaction size, amount of the fees as set forth in the governing agreements, the complexity of the transaction, and KKR's role in the transaction.175Table of ContentsFee Related Performance RevenuesThe following table presents fee related performance revenues by business line:Year EndedDecember 31, 2021December 31, 2020Change($ in thousands)Fee Related Performance RevenuesPrivate Equity$— $— $— Real Assets9,068 4,797 4,271 Credit and Liquid Strategies36,784 34,758 2,026 Total Fee Related Performance Revenues$45,852 $39,555 $6,297 Fee related performance revenues represent performance fees that are (i) to be received from our investment funds, vehicles, and accounts on a recurring basis and (ii) not dependent on a realization event involving investments held by the investment fund, vehicle or account. Fee related performance revenues were higher for the year ended December 31, 2021 compared to the prior period primarily due to a higher level of performance revenues earned from KREF and FSK.Fee Related CompensationThe increase in fee related compensation for the year ended December 31, 2021 compared to the prior period is primarily due to a higher level of compensation recorded in connection with the higher level of revenues included within fee related earnings.Other Operating ExpensesThe increase in other operating expenses for the year ended December 31, 2021 compared to the prior period is primarily due to a higher level of (i) professional fees and other administrative costs in connection with the overall growth of the firm and (ii) placement fees related to capital raising activities.Fee Related EarningsThe increase in fee related earnings for the year ended December 31, 2021 compared to the prior period is primarily due to a higher level of management fees in our Private Equity, Real Assets and Credit and Liquid Strategies business lines and transaction fees from our Capital Markets business line, partially offset by a higher level of fee related compensation and other operating expenses, as described above.Realized Performance IncomeThe following table presents realized performance income by business line:Year EndedDecember 31, 2021December 31, 2020Change($ in thousands)Realized Performance IncomePrivate Equity$1,678,753 $807,275 $871,478 Real Assets97,312 208,590 (111,278)Credit and Liquid Strategies365,531 149,834 215,697 Total Realized Performance Income$2,141,596 $1,165,699 $975,897 176Table of ContentsYear EndedDecember 31, 2021December 31, 2020Change($ in thousands)Private EquityNorth America Fund XI$433,708 $203,606 $230,102 Asian Fund III387,863 46,347 341,516 2006 Fund219,737 181,899 37,838 Americas Fund XII207,559 — 207,559 European Fund IV186,476 139,948 46,528 Co-Investment Vehicles and Other90,305 93,648 (3,343)Core Investment Vehicles80,937 57,484 23,453 Next Generation Technology Growth Fund32,544 13,964 18,580 European Fund III353 — 353 Asian Fund II— 60,647 (60,647)Asian Fund— 431 (431)Total Realized Carried Interest (1)1,639,482 797,974 841,508 Incentive Fees39,271 9,301 29,970 Total Realized Performance Income$1,678,753 $807,275 $871,478 Year EndedDecember 31, 2021December 31, 2020Change($ in thousands)Real AssetsGlobal Infrastructure Investors II$72,862 $148,882 $(76,020)Real Estate Partners Europe18,200 — 18,200 Co-Investment Vehicles and Other3,283 2 3,281 Global Infrastructure Investors2,967 54,729 (51,762)Real Estate Partners Americas— 4,977 (4,977)Total Realized Carried Interest (1)97,312 208,590 (111,278)Incentive Fees— — — Total Realized Performance Income$97,312 $208,590 $(111,278)Year EndedDecember 31, 2021December 31, 2020Change($ in thousands)Credit and Liquid StrategiesAlternative Credit and Other Funds$15,336 $25,740 $(10,404)Mezzanine Partners— 9,900 (9,900)Total Realized Carried Interest (1)15,336 35,640 (20,304)Incentive Fees350,195 114,194 236,001 Total Realized Performance Income$365,531 $149,834 $215,697 (1)The above tables exclude any funds for which there was no realized carried interest during both of the periods presented.Realized performance income includes (i) realized carried interest from our carry earning funds and (ii) incentive fees not included in Fee Related Performance Revenues.177Table of ContentsRealized carried interest in our Private Equity business line for the year ended December 31, 2021 consisted primarily of realized proceeds from the sales of our investments in The Bountiful Company, Ingersoll Rand Inc., Academy Sports & Outdoors Inc., Kokusai Electric Corporation, and Endeavor Group Holdings, Inc.Realized carried interest in our Private Equity business line for the year ended December 31, 2020 consisted primarily of realized proceeds from the sales of our investments in Privilege Underwriters, Inc. (financial services sector), Fiserv, Inc., LGC Science Group Limited (health care sector), and Epicor Software Corporation.Realized carried interest in our Real Assets business line for the year ended December 31, 2021 consisted primarily of realized proceeds from (i) the sale of our infrastructure investments, Calisen PLC and Telxius Telecom S.A.U. and (ii) dividends received from and sales of various investments in our European real estate strategy.Realized carried interest in our Real Assets business line for the year ended December 31, 2020 consisted primarily of realized proceeds from the sales of our investments in Deutsche Glasfaser (Infrastructure: telecommunications infrastructure sector), ELL Group (Infrastructure: asset leasing sector), and X-Elio Energy, S.L. (power and utilities sector).Realized carried interest in our Credit and Liquid Strategies Markets business line decreased for the year ended December 31, 2021 compared to the prior period as a result of a lower level of realization activity at certain alternative credit investment funds, from which we are eligible to take cash carry.Incentive fees consist of performance fees earned from (i) our hedge fund partnerships, (ii) investment management agreements with KKR sponsored investment vehicles, and (iii) investment management agreements to provide KKR’s investment strategies to funds managed by a third party asset management firm. Incentive fees in our Private Equity business line increased for the year ended December 31, 2021 compared to the prior period primarily attributable to a higher level of investment appreciation at funds managed by a UK investment manager.Incentive fees in our Credit and Liquid Strategies business line increased for the year ended December 31, 2021 compared to the prior period primarily due to a higher level of incentive fees earned from our hedge fund partnership, Marshall Wace.Realized Performance Income CompensationThe increase in realized performance income compensation for the year ended December 31, 2021 compared to the prior period was primarily due to a higher level of compensation recorded in connection with the higher level of realized performance income.Realized Investment IncomeThe following table presents realized investment income from our Principal Activities business line for the years ended December 31, 2021 and 2020:Year EndedDecember 31, 2021December 31, 2020Change($ in thousands)Realized Investment IncomeNet Realized Gains (Losses)$1,199,414 $284,521 $914,893 Interest Income and Dividends413,830 360,138 53,692 Total Realized Investment Income$1,613,244 $644,659 $968,585 The increase in realized investment income was primarily due to a higher level of net realized gains and, to a lesser extent, a higher level of interest income and dividends. The amount of realized investment income depends on the transaction activity of our funds and our subsidiaries, which can vary from period to period.For the year ended December 31, 2021, net realized gains were comprised of realized gains primarily from the sale of our investments in FanDuel Inc., Mr. Cooper Group Inc., Fiserv, Inc., The Bountiful Company, and BridgeBio Pharma Inc. Partially offsetting these realized gains were realized losses, the most significant of which were realized losses on certain hedging instruments.178Table of ContentsFor the year ended December 31, 2020, net realized gains were comprised of realized gains primarily from the sale of our investments in The Hut Group Limited, Deutsche Glasfaser, Ivalua SAS, Fiserv, Inc., and BridgeBio Pharma, Inc. Partially offsetting these realized gains were realized losses, the most significant of which were realized losses on our investment in LCI Helicopters Limited, Yorktown Center (real estate), and various alternative credit strategy investments.For the year ended December 31, 2021, interest income and dividends were comprised of (i) $261.3 million of dividend income primarily from our real estate investments, including our investment in KREF, as well as our investments in Viridor Limited, Kokusai Electric Corporation, and Arnott's Biscuits Limited and (ii) $152.5 million of interest income primarily from our investments in CLOs and, to a lesser extent, our other credit investments.For the year ended December 31, 2020, interest income and dividends were comprised of (i) $225.4 million of dividend income from our investments in Fiserv, Inc., Epicor Software Corporation, and our real assets investments, including our investment in KREF and (ii) $134.7 million of interest income from our investments in CLOs, other credit investments and, to a lesser extent, our cash balances. See "—Analysis of Non-GAAP Performance Measures—Non-GAAP Balance Sheet Measures."For the year ended December 31, 2021, total fees attributable to KKR Capstone were $91.4 million and total expenses attributable to KKR Capstone were $94.6 million. For KKR Capstone-related adjustments in reconciling Asset Management segment revenues to GAAP revenues see "—Analysis of Non-GAAP Performance Measures—Reconciliations to GAAP Measures".Realized Investment Income CompensationThe increase in realized investment income compensation for the year ended December 31, 2021 compared to the prior period is primarily due to a higher level of compensation recorded in connection with the higher level of realized investment income.Other Operating and Capital MetricsThe following table presents certain key operating and capital metrics as of December 31, 2021 and December 31, 2020:As ofDecember 31, 2021December 31, 2020Change($ in millions)Assets Under Management$470,555 $251,679 $218,876 Fee Paying Assets Under Management$357,389 $186,217 $171,172 Uncalled Commitments$111,822 $66,960 $44,862 The following table presents one of our key capital metrics for the year ended December 31, 2021 and 2020:Year EndedDecember 31, 2021December 31, 2020Change($ in millions)Capital Invested$73,318 $29,517 $43,801 Assets Under ManagementPrivate EquityThe following table reflects the changes in the AUM of our Private Equity business line from December 31, 2020 to December 31, 2021: ($ in millions)December 31, 2020$113,477 New Capital Raised44,478 Distributions and Other(17,524)Change in Value33,314 December 31, 2021$173,745 179Table of ContentsAUM of our Private Equity business line was $173.7 billion at December 31, 2021, an increase of $60.2 billion, compared to $113.5 billion at December 31, 2020.The increase was primarily attributable to (i) new capital raised from North America Fund XIII, our core investment strategy and European Fund VI and (ii) an increase in investment value from Americas Fund XII, Asian Fund III, and our core investment strategy. Partially offsetting these increases were distributions to fund investors, primarily as a result of realized proceeds, most notably from Americas Fund XII, North America Fund XI, and Asian Fund III.For the year ended December 31, 2021, the value of our traditional private equity investment portfolio increased by 46%. This was comprised of a 71% increase in share prices of various publicly held investments and a 37% increase in value of our privately held investments. For the year ended December 31, 2021, the value of our growth equity and core equity investment portfolios increased 45% and 42%, respectively.The most significant increases in the value of our publicly held investments across our Private Equity business line were increases in AppLovin Corporation, Max Healthcare Institute Limited, and J.B. Chemicals and Pharmaceuticals Limited (NSE: JBCP). These increases were partially offset by decreases in share prices of certain other publicly held investments, the most significant of which were BridgeBio Pharma, Inc., PHC Holdings Corporation (TYO: 6523), and Fiserv, Inc. The prices of publicly held or publicly indexed companies may experience volatile changes following the reporting period. See "—Business Environment" for more information about factors, such as volatility, that may impact our business, financial performance, operating results and valuations. The most significant increases in the value of our privately held investments across our Private Equity business line were increases in Internet Brands, Inc., Kokusai Electric Corporation, and PetVet Care Centers, LLC. These increases in value on our privately held investments were partially offset by decreases in value of certain other privately held investments, the most significant of which were Magneti Marelli CK Holdings, Envision Healthcare Corporation (health care sector), and Upfield (consumer products). The increased valuations of individual companies in our privately held investments, in the aggregate, generally related to (i) individual company performance, (ii) an increase in the value of market comparables, and (iii) with respect to Kokusai Electric Corporation, an increase in valuation reflecting an agreement to sell a minority stake in the company. The decreased valuations of individual companies in our privately held investments, in the aggregate, generally related to (i) an unfavorable business outlook and (ii) a decrease in the value of market comparables, both influenced by the impact of COVID-19 on the economic outlook and overall market environment. See "—Business Environment" for more information about factors, that may impact our business, financial performance, operating results and valuations. Real AssetsThe following table reflects the changes in the AUM of our Real Assets business line from December 31, 2020 to December 31, 2021: ($ in millions)December 31, 2020$35,212 New Capital Raised39,380 Acquisitions and Other(1)12,012 Distributions and Other(6,364)Change in Value3,063 December 31, 2021$83,303 (1)Reflects the AUM of Global Atlantic at February 1, 2021.AUM of our Real Assets business line was $83.3 billion at December 31, 2021, an increase of $48.1 billion, compared to $35.2 billion at December 31, 2020.The increase was primarily attributable to (i) new capital raised from Global Infrastructure Investors IV, Global Atlantic and Diversified Core Infrastructure Fund and (ii) assets we now manage under our investment agreements with Global Atlantic's insurance companies. Partially offsetting these increases were payments to Global Atlantic policyholders and distributions to fund investors as a result of realized proceeds, most notably from Global Infrastructure Investors II and Real Estate Partners Americas II.180Table of ContentsFor the year ended December 31, 2021, the value of our opportunistic real estate equity investment portfolio increased by 27%, and the value of our infrastructure investment portfolio increased 12%, and the value of our energy investment portfolio decreased by 15%.The most significant increases in the value of our privately held investments were KRE AIP LLC (real estate), Telxius Telecom, S.A.U, Hivory SAS (Infrastructure: telecommunications infrastructure sector), and Viridor Limited. These increases in value were partially offset by decreases in the value of certain other privately held investments, the most significant of which were Colonial Enterprises, Inc. and River Plaza (real estate). The increased valuations of individual companies or assets in our privately held investments, in the aggregate, generally related to individual company performance. The decreased valuations of individual companies or assets in our privately held investments, in the aggregate, generally related to (i) a decrease in the value of market comparables and (ii) an unfavorable business outlook, both influenced by economic outlook and market environment. See "—Business Environment" for more information about factors, that may impact our business, financial performance, operating results and valuations. The most significant decrease in share prices of our publicly held investments was a decrease in Crescent Energy. See "—Business Environment" for more information about factors, such as volatility, that may impact our business, financial performance, operating results and valuations. Credit and Liquid StrategiesThe following table reflects the changes in the AUM of our Credit and Liquid Strategies business line from December 31, 2020 to December 31, 2021: ($ in millions)December 31, 2020$102,990 New Capital Raised36,706 Acquisitions and Other(1)85,491 Distributions and Other(11,271)Redemptions(8,196)Change in Value7,788 December 31, 2021$213,507 (1)Reflects the AUM of Global Atlantic at February 1, 2021.AUM of our Credit and Liquid Strategies business line totaled $213.5 billion at December 31, 2021, an increase of $110.5 billion compared to AUM of $103.0 billion at December 31, 2020.The increase was primarily attributable to (i) assets we now manage under our investment management agreements with Global Atlantic's insurance companies, (ii) new capital raised from Global Atlantic since February 1, 2021, CLO issuances, and our hedge fund partnerships, and (iii) to a lesser extent, an increase in investment value across our leveraged and alternative credit portfolios and at our hedge fund partnerships. Partially offsetting these increases were (i) payments made to Global Atlantic to satisfy its obligations to policyholders, (ii) redemptions at our hedge fund partnerships and leveraged credit separately managed accounts and (iii) distributions to fund investors as a result of realized proceeds at certain leveraged and alternative credit funds.See also "—Business Environment" for more information about the factors that may impact our business, financial performance, operating results and valuations.181Table of ContentsFee Paying Assets Under ManagementPrivate EquityThe following table reflects the changes in the FPAUM of our Private Equity business line from December 31, 2020 to December 31, 2021: ($ in millions)December 31, 2020$68,506 New Capital Raised29,649 Distributions and Other(7,428)Net Changes in Fee Base of Certain Funds (2,569)Change in Value(268)December 31, 2021$87,890 FPAUM of our Private Equity business line was $87.9 billion at December 31, 2021, an increase of $19.4 billion, compared to $68.5 billion at December 31, 2020.The increase was primarily attributable to new capital raised from North America Fund XIII, Health Care Strategic Growth Fund II, and our core investment strategy. Partially offsetting this increase were (i) distributions to fund investors, primarily as a result of realized proceeds, most notably from 2006 Fund, North America Fund XI, and Americas Fund XII and (ii) a change in fee base for Americas Fund XII and Health Care Growth Fund as a result of these funds entering its post-investment period, during which we earn fees on invested capital rather than committed capital. Uncalled capital commitments from private equity and multi-strategy investment funds from which KKR is currently not earning management fees amounted to approximately $19.6 billion at December 31, 2021, which includes capital commitments reserved for follow-on investments for funds that have completed their investment periods. This capital will generally begin to earn management fees upon deployment of the capital or upon the commencement of the fund's investment period. The average annual management fee rate associated with this capital is approximately 1.0%. The date on which we begin to earn fees (as specified above) is not guaranteed to occur and may not occur for an extended period of time. If and when such management fees are earned, a portion of existing FPAUM may cease paying fees or pay lower fees, thus offsetting a portion of any new management fees earned.Real AssetsThe following table reflects the changes in the FPAUM of our Real Assets business line from December 31, 2020 to December 31, 2021: ($ in millions)December 31, 2020$25,690 New Capital Raised35,615 Acquisitions and Other(1)12,012 Distributions and Other(4,264)Net Changes in Fee Base of Certain Funds (2,829)Change in Value741 December 31, 2021$66,965 (1)Reflects the FPAUM of Global Atlantic at February 1, 2021.FPAUM of our Real Assets business line was $67.0 billion at December 31, 2021, an increase of $41.3 billion, compared to $25.7 billion at December 31, 2020.The increase was primarily attributable to (i) new capital raised by Global Infrastructure Investors IV, Global Atlantic, Real Estate Partners Americas III and Diversified Core Infrastructure Fund and (ii) assets we now manage under our investment agreements with Global Atlantic's insurance companies. Partially offsetting these increases were (i) payments to Global Atlantic policyholders and distributions to fund investors as a result of realized proceeds, most notably from Global Infrastructure Investors II and Real Estate Partners Americas II and (ii) a change in fee base for Global Infrastructure Investors III as a result of entering its post-investment period, during which we earn fees on invested capital rather than committed capital.182Table of ContentsUncalled capital commitments from real assets investment funds from which KKR is currently not earning management fees amounted to approximately $11.7 billion at December 31, 2021, which includes capital commitments reserved for follow-on investments for funds that have completed their investment periods. This capital will generally begin to earn management fees upon deployment of the capital or upon the commencement of the fund's investment period. The average annual management fee rate associated with this capital is approximately 1.1%. The date on which we begin to earn fees (as specified above) is not guaranteed to occur and may not occur for an extended period of time. If and when such management fees are earned, a portion of existing FPAUM may cease paying fees or pay lower fees, thus offsetting a portion of any new management fees earned.Credit and Liquid StrategiesThe following table reflects the changes in the FPAUM of our Credit and Liquid Strategies business line from December 31, 2020 to December 31, 2021: ($ in millions)December 31, 2020$92,021 New Capital Raised38,644 Acquisitions and Other(1)85,491 Distributions and Other(12,989)Redemptions(6,590)Change in Value5,957 December 31, 2021$202,534 (1)Reflects the FPAUM of Global Atlantic at February 1, 2021.FPAUM of our Credit and Liquid Strategies business line was $202.5 billion at December 31, 2021, an increase of $110.5 billion compared to $92.0 billion at December 31, 2020. The increase was primarily attributable to (i) assets we now manage under our investment management agreements with Global Atlantic's insurance companies, (ii) new capital raised from Global Atlantic, CLO issuances, and our alternative credit funds and (iii) to a lesser extent, an increase in investment value at our hedge fund partnerships and from leveraged credit investments we manage under our investment management agreements with Global Atlantic's insurance companies. Partially offsetting these increases were (i) payments made to Global Atlantic policyholders, (ii) redemptions at our hedge fund partnerships and leveraged credit separately managed accounts and (iii) distributions to fund investors as a result of realized proceeds at certain leveraged and alternative credit funds.Uncalled capital commitments from investment funds in our Credit and Liquid Strategies business line from which KKR is currently not earning management fees amounted to approximately $6.7 billion at December 31, 2021. This capital will generally begin to earn management fees upon deployment of the capital or upon the commencement of the fund's investment period. The average annual management fee rate associated with this capital is approximately 0.9%. The date on which we begin to earn fees (as specified above) is not guaranteed to occur and may not occur for an extended period of time. If and when such management fees are earned, which will occur over an extended period of time, a portion of existing FPAUM may cease paying fees or pay lower fees, thus offsetting a portion of any new management fees earned.See "—Business Environment" for more information about the factors that may impact our business, financial performance, operating results and valuations.Uncalled CommitmentsPrivate EquityAs of December 31, 2021, our Private Equity business line had $66.3 billion of remaining uncalled capital commitments that could be called for investments in new transactions as compared to $38.8 billion as of December 31, 2020. The increase was primarily attributable to new capital commitments from fund investors, which were partially offset by capital called from fund investors to make investments during the period. 183Table of ContentsReal AssetsAs of December 31, 2021, our Real Assets business line had $35.2 billion of remaining uncalled capital commitments that could be called for investments in new transactions as compared to $17.9 billion as of December 31, 2020. The increase was primarily attributable to new capital commitments from fund investors, which were partially offset by capital called from fund investors to make investments during the period.Credit and Liquid StrategiesAs of December 31, 2021 and 2020, our Credit and Liquid Strategies business line had $10.3 billion of remaining uncalled capital commitments that could be called for investments in new transactions. Uncalled commitments remained flat against the comparable period as new capital commitments from fund investors were offset by capital called from fund investors to make investments during the period.Capital InvestedPrivate EquityFor the year ended December 31, 2021, $17.6 billion of capital was invested by our Private Equity business line, as compared to $14.5 billion for the year ended December 31, 2020. The increase was driven primarily by a $1.5 billion increase in capital invested in our core investment strategy. During the year ended December 31, 2021, 60% of capital deployed in private equity was in transactions in North America, 21% was in Europe, and 19% was in the Asia-Pacific region. The number of large private equity investments made in any quarterly or year-to-date period is volatile and, consequently, a significant amount of capital invested in one period or a few periods may not be indicative of a similar level of capital deployment in future periods.Real AssetsFor the year ended December 31, 2021, $21.4 billion of capital was invested by our Real Assets business line, as compared to $4.7 billion for the year ended December 31, 2020. The increase was driven primarily by a $9.6 billion increase in capital invested in our real estate strategy and a $6.8 billion increase in capital invested in our infrastructure strategy. During the year ended December 31, 2021, 71% of capital deployed in real assets was in transactions in North America, 23% was in Europe, and 6% was in the Asia-Pacific region. The number of large Real Asset investments made in any quarterly or year-to-date period is volatile and, consequently, a significant amount of capital invested in one period or a few periods may not be indicative of a similar level of capital deployment in future periods.Credit and Liquid StrategiesFor the year ended December 31, 2021, $34.4 billion of capital was invested by our Credit and Liquid Strategies business line, as compared to $10.3 billion for the year ended December 31, 2020. The increase was primarily due to (i) capital deployed under our investment management agreements with Global Atlantic's insurance companies and (ii) a higher level of capital deployed across our direct lending and SIG strategies. During the year ended December 31, 2021, 90% of capital deployed was in transactions in North America, 9% was in Europe and 1% was in the Asia-Pacific region.184Table of ContentsAnalysis of Insurance Segment Operating ResultsAs discussed above, our Insurance segment consists solely of the operations of Global Atlantic, which was acquired on February 1, 2021. Accordingly, prior financial reporting periods have been excluded for Insurance segment results. For the year ended December 31, 2021, the results of our Insurance segment is from the acquisition date, February 1, 2021, through December 31, 2021.The following tables set forth information regarding KKR's insurance segment operating results and certain key operating metrics as of and for the year ended December 31, 2021:Year EndedDecember 31, 2021($ in thousands)Net Investment Income$3,329,570 Net Cost of Insurance(1,566,681)General, Administrative and Other(500,410)Pre-tax Insurance Operating Earnings1,262,479 Income Taxes(199,095)Net Income Attributable to Noncontrolling Interests(410,833)Insurance Segment Operating Earnings$652,551 Insurance segment operating earningsInsurance segment operating earnings were primarily driven by net investment income and stable net cost of insurance.Net investment incomeNet investment income was primarily driven by (i) insurance segment investments and the effective book yield (as determined, in part, by the allocated fair value of the investment portfolio as of the closing date of the GA Acquisition), and (ii) variable investment income from net realized gains from the sale of investments not related to asset/liability matching strategies, including in particular the disposition of Origis USA, LLC. Average insurance segment investments were primarily driven by net inflows of assets from the individual markets and institutional channels. In addition to the impact of higher asset balances, net investment income was also impacted by income from bond call and loan prepayment activity.Net cost of insuranceNet cost of insurance was driven primarily by stable liability performance across in-force and new business, including favorable adjustments to reserves and policy acquisition costs resulting from higher reserves and insurance intangibles established as part of the purchase accounting for the GA Acquisition and the impact of assumption review (as described in “—Consolidated Results of Operations (GAAP Basis) – Insurance (Unaudited)” above).General, administrative and other expensesGeneral and administrative expenses were driven by (i) employee compensation and benefits related expenses, (ii) policy servicing fees, (iii) technology-related charges and (iv) consulting and professional fees.Income taxesInsurance segment income tax expense reflects the effective tax rate for the insurance segment on an operating basis, including the benefit of investment tax credits.Net Income attributable to noncontrolling interestsIncome attributable to noncontrolling interests represents the portion of the insurance segment adjusted operating earnings attributable to rollover and co-investors in Global Atlantic.185Table of ContentsAnalysis of Non-GAAP Performance MeasuresThe following is a discussion of our Non-GAAP performance measures for the years ended December 31, 2021 and 2020:Year EndedDecember 31, 2021December 31, 2020Change($ in thousands)Asset Management Segment Operating Earnings$4,243,660 $2,286,984 $1,956,676 Insurance Segment Operating Earnings652,551 — 652,551 Distributable Operating Earnings4,896,211 2,286,984 2,609,227 Interest Expense(250,183)(211,037)(39,146)Preferred Dividends(19,201)(33,364)14,163 Net Income Attributable to Noncontrolling Interests(23,664)(7,842)(15,822)Income Taxes Paid(687,572)(265,950)(421,622)After-tax Distributable Earnings$3,915,591 $1,768,791 $2,146,800 As discussed in the Analysis of Segment Operating Results, following the acquisition of Global Atlantic, we re-evaluated our operating structure and the manner by which we manage and assess the performance of our businesses and allocate our resources. In the first quarter of 2021, we changed the presentation of our non-GAAP performance measures principally to reflect how we evaluate our business following the Global Atlantic acquisition. We also believe that this revised presentation improves the comparability of our non-GAAP financial information with that provided by other publicly traded companies in the alternative asset management industry.Distributable Operating Earnings The increase in distributable operating earnings for the year ended December 31, 2021 compared to the prior period was primarily due to a higher level of Asset Management segment operating earnings and the addition of our Insurance segment operating earnings in connection with the Global Atlantic acquisition. For a discussion of the Asset Management and Insurance segment operating earnings, see "—Analysis of Asset Management Segment Operating Results and Analysis of Insurance Segment Operating Results."Interest ExpenseFor the year ended December 31, 2021 and 2020, interest expense relates primarily to the interest expense from our senior notes outstanding for KKR and KFN.The increase in interest expense for the year ended December 31, 2021 compared to the prior period was primarily attributable to new note issuances.Preferred DividendsThe decrease in preferred dividends for the year ended December 31, 2021 compared to the prior period was attributable to the redemption of all of our Series A and B preferred stock outstanding during the year ended December 31, 2021.Income Taxes PaidThe increase in income taxes paid for the year ended December 31, 2021 compared to the prior period was primarily due to a higher level of distributable operating earnings.After-tax Distributable Earnings The increase in after-tax distributable earnings for the year ended December 31, 2021 compared to the prior period was primarily due to a higher level of distributable operating earnings, partially offset by an increase in income taxes paid and interest expense, as discussed above.186Table of ContentsFor the years ended December 31, 2021 and 2020, the amount of the tax benefit from equity-based compensation included in income taxes paid was $123.1 million and $59.1 million, respectively. The inclusion of the tax benefit from equity-based compensation in After-tax Distributable Earnings had the effect of increasing this measure by 3% for each of the years ended December 31, 2021 and 2020.Non-GAAP Balance Sheet MeasuresBook ValueThe following table presents our calculation of book value as of December 31, 2022 and December 31, 2021:As of December 31, 2022December 31, 2021 ($ in thousands)(+)Cash and Short-term Investments$3,256,515 $4,869,203 (+)Investments17,628,327 17,763,542 (+)Net Unrealized Carried Interest (1)2,509,589 4,967,401 (+)Other Assets, Net (2)6,979,235 4,706,108 (+)Global Atlantic Book Value 3,929,710 3,372,498 (-)Debt Obligations - KKR (excluding KFN and Global Atlantic)6,957,932 5,836,267 (-)Debt Obligations - KFN948,517 948,517 (-)Tax Liabilities, Net1,648,600 2,697,317 (-)Other Liabilities911,612 774,711 (-)Noncontrolling Interests32,843 33,058 Book Value$23,803,872 $25,388,882 Book Value Per Adjusted Share$26.73 $28.77 Adjusted Shares890,628,190 882,589,036 (1)The following table provides net unrealized carried interest by business line:As ofDecember 31, 2022December 31, 2021($ in thousands)Private Equity Business Line$2,199,869 $4,697,134 Real Assets Business Line212,974 159,709 Credit and Liquid Strategies Business Line96,746 110,558 Total$2,509,589 $4,967,401 (2)Other Assets, Net include our (i) ownership interest in FS/KKR Advisor, (ii) minority ownership interests in hedge fund partnerships, and (iii) the net assets of KJRM.Book value decreased 6% from December 31, 2021. The decrease was primarily attributable to (i) a reduction in net unrealized carried interest due to the reversal of previously recognized carried interest from our carried interest eligible investment funds, most notably Americas Fund XII, Asian Fund II, and Asian Fund III, (ii) a reduction in the value of our asset management segment investments of 5%, (iii) repurchases of our common stock, and (iv) payment of dividends during the period. Partially offsetting these decreases was the positive impact of our after-tax distributable earnings recognized and a decrease in the amount of deferred tax liabilities during the period. For a further discussion, see "—Consolidated Results of Operations (GAAP Basis) - Asset Management—Investment Income (Loss) - Asset Management—Unrealized Gains and Losses from Investment Activities." For a discussion of the changes in our investment portfolio, see "—Analysis of Asset Management Segment Operating Results—Assets Under Management." For a discussion of factors that impacted KKR's after-tax distributable earnings, see "—Analysis of Non-GAAP Performance Measures—After-tax Distributable Earnings" and for more information about the factors that may impact our business, financial performance, operating results and valuations, see "—Business Environment."187Table of ContentsThe following table presents the holdings of our investments in the asset management segment by asset class as of December 31, 2022. To the extent investments are realized at values below their cost in future periods, after-tax distributable earnings would be adversely affected by the amount of such loss, if any, during the period in which the realization event occurs.As of December 31, 2022($ in thousands)Investments (1)CostFair ValueFair Value as a Percentage ofTotal InvestmentsTraditional Private Equity$1,730,298 $3,078,987 17.5 %Core Private Equity2,701,596 5,707,478 32.4 %Growth Equity328,514 822,250 4.7 %Private Equity Total4,760,408 9,608,715 54.6 %Energy862,651 929,269 5.3 %Real Estate1,887,520 2,032,209 11.5 %Infrastructure1,066,157 1,232,412 7.0 %Real Assets Total3,816,328 4,193,890 23.8 %Leveraged Credit1,267,501 1,016,274 5.8 %Alternative Credit855,941 891,474 5.1 %Credit Total2,123,442 1,907,748 10.9 %Other2,279,705 1,917,974 10.7 %Total Investments$12,979,883 $17,628,327 100.0 %(1)Investments is a term used solely for purposes of financial presentation of a portion of KKR's balance sheet and includes majority ownership of subsidiaries that operate KKR's asset management and insurance businesses, including the general partner interests of KKR's investment funds. Investments presented are principally the assets measured at fair value that are held by KKR's asset management segment, which, among other things, does not include the underlying investments held by Global Atlantic and Marshall Wace.188Table of ContentsAs of December 31, 2022($ in thousands)Top 20 Investments: (1)CostFair ValueUSI, Inc.$531,425 $1,300,370 PetVet Care Centers, LLC243,211 1,143,092 Heartland Dental, LLC320,656 801,640 Exact Group B.V.213,362 560,630 Arnott's Biscuits Limited250,841 470,916 1-800 Contacts Inc.300,178 405,153 Internet Brands, Inc.340,312 372,628 Barracuda Networks, Inc.343,320 343,320 ERM Worldwide Group Limited228,710 343,035 Teaching Strategies, LLC307,162 307,162 Crescent Energy Company (NYSE: CRGY)533,543 304,117 Resolution Life Group Holdings, L.P.262,191 263,477 Roompot B.V.193,578 255,950 Shriram General Insurance Co.245,470 251,414 Atlantic Aviation FBO Inc.170,274 186,672 Viridor Limited132,023 169,709 The Bay Clubs Company, LLC160,127 160,127 PortAventura155,803 154,784 Pembina Gas Infrastructure Inc.92,632 148,421 FiberCop S.p.A.127,742 133,698 Total Top 20 Investments$5,152,560 $8,076,315 (1)This list of investments identifies the twenty largest companies or assets based on their fair values as of December 31, 2022. It does not deduct fund or vehicle level debt, if any, incurred in connection with funding the investment. This list excludes (i) investments expected to be syndicated, (ii) investments expected to be transferred in connection with a new fundraising, (iii) investments in funds and other entities that are owned by one or more third parties and established for the purpose of making investments and (iv) the portion of any investment that may be held through collateralized loan obligations or levered multi-asset investment vehicles, if any. For additional information about the asset classes of the investments held on KKR's balance sheet see "—Our Business—Principal Activities" for the "Holdings by Asset Class" pie chart. The fair value figures include the co-investment and the limited partner and/or general partner interests held by KKR in the underlying investment, if applicable.With respect to KKR's book value relating to its insurance business, KKR includes Global Atlantic's book value, which consists of KKR's pro rata equity interest in Global Atlantic on a GAAP basis, excluding (i) accumulated other comprehensive income and (ii) accumulated change in fair value of reinsurance embedded derivative balances and related assets, net of deferred acquisition costs and income tax. KKR believes this presentation of Global Atlantic's book value is comparable with the corresponding metric presented by other publicly traded companies in Global Atlantic's industry. As of December 31, 2022, KKR's pro rata interest in Global Atlantic's book value was $3.9 billion. For more information about the composition and credit quality of Global Atlantic's investments on a consolidated basis, please see "—Global Atlantic's Investment Portfolio" below.Global Atlantic's Investment PortfolioAs of December 31, 2022, 95% and 85% of Global Atlantic's available-for-sale ("AFS") fixed maturity securities were considered investment grade under ratings from the Securities Valuation Office of the NAIC and NRSROs, respectively. As of December 31, 2021, 97% and 87% of Global Atlantic's AFS fixed maturity securities were considered investment grade under ratings from NAIC and NRSROs, respectively. Securities where a rating by an NRSRO was not available are considered investment grade if they have an NAIC designation of “1” or “2.” The three largest asset categories in Global Atlantic's AFS fixed-maturity security portfolio as of December 31, 2022 were Corporate, RMBS and CMBS securities, comprising 29%, 5% and 5% of Global Atlantic's investment portfolio, respectively. Within these categories, 94%, 95% and 95% of Global Atlantic's Corporate, RMBS and CMBS securities, respectively, were investment grade according to NAIC ratings and 94%, 45% and 53% of its Corporate, RMBS and CMBS securities, respectively, were investment grade according to NRSRO ratings as of December 31, 2022. The three largest asset categories in Global Atlantic's AFS fixed-maturity security portfolio as of December 31, 2021 were Corporate, RMBS and CMBS securities, comprising 34%, 6% and 5% of Global Atlantic's investment portfolio, respectively. Within these categories, 95%, 96% and 99% of Global Atlantic's Corporate, RMBS and CMBS 189Table of Contentssecurities, respectively, were investment grade according to NAIC ratings and 95%, 38% and 62% of its Corporate, RMBS and CMBS securities, respectively, were investment grade according to NRSRO ratings as of December 31, 2021. NRSRO and NAIC ratings have different methodologies. Global Atlantic believes the NAIC ratings methodology, which considers the likelihood of recovery of amortized cost as opposed to the recovery of all contractual payments including the principal at par, as the more appropriate way to view the ratings quality of its AFS fixed maturity portfolio since a large portion of its holdings were purchased at a significant discount to par value. The portion of Global Atlantic's investment portfolio consisting of floating rate assets was 29% and 20% as of December 31, 2022 and 2021, respectively.Within the funds withheld receivable at interest portfolio, 97% and 96% of the fixed maturity securities were investment grade by NAIC designation as of December 31, 2022 and 2021, respectively.Trading fixed maturity securities back funds withheld payable at interest where the investment performance is ceded to reinsurers under the terms of the respective reinsurance agreements.Credit quality of AFS fixed maturity securitiesThe Securities Valuation Office of the NAIC evaluates the AFS fixed maturity security investments of insurers for regulatory reporting and capital assessment purposes and assigns securities to one of six credit quality categories called “NAIC designations.” Using an internally developed rating is permitted by the NAIC if no rating is available. These designations are generally similar to the credit quality designations of NRSROs for marketable fixed maturity securities, except for certain structured securities as described below. NAIC designations of “1,” highest quality, and “2,” high quality, include fixed maturity securities generally considered investment grade by NRSROs. NAIC designations “3” through “6” include fixed maturity securities generally considered below investment grade by NRSROs.Consistent with the NAIC Process and Procedures Manual, an NRSRO rating was assigned based on the following criteria: (i) the equivalent S&P rating where the security is rated by one NRSRO; (ii) the equivalent S&P rating of the lowest NRSRO when the security is rated by two NRSROs; and (iii) the equivalent S&P rating of the second lowest NRSRO if the security is rated by three or more NRSROs. If the lowest two NRSROs’ ratings are equal, then such rating will be the assigned rating. NRSROs’ ratings available for the periods presented were S&P, Fitch, Moody’s, DBRS, Inc. and Kroll Bond Rating Agency, Inc. If no rating is available from a rating agency, then an internally developed rating is used.Substantially all of the AFS fixed maturity securities portfolio, 95% and 97% as of December 31, 2022 and December 31, 2021, respectively, were invested in investment grade assets with a NAIC rating of 1 or 2.The portion of the AFS fixed maturity securities portfolio that was considered below investment grade by NAIC designation was 5% and 3% as of December 31, 2022 and 2021, respectively. Pursuant to Global Atlantic's investment guidelines, Global Atlantic actively monitors the percentage of its portfolio that is held in investments rated NAIC 3 or lower and must obtain an additional approval from Global Atlantic's management investment committee before making a significant investment in an asset rated NAIC 3 or lower.Corporate fixed maturity securitiesGlobal Atlantic maintains a diversified portfolio of corporate fixed maturity securities across industries and issuers. As of December 31, 2022 and 2021, 59% and 60%, respectively, of the AFS fixed maturity securities portfolio was invested in corporate fixed maturity securities. As of December 31, 2022 and 2021, approximately, 5% and 3%, respectively, of the portfolio is denominated in foreign currency. As of December 31, 2022 and 2021, 94% and 95% of the total fair value of corporate fixed maturity securities is rated NAIC investment grade and 94% and 95% is rated NRSROs investment grade, respectively.Residential mortgage-backed securitiesAs of December 31, 2022 and 2021, 10% and 11% of the AFS fixed maturity securities portfolio was invested in RMBS, respectively. RMBS are securities constructed from pools of residential mortgages and backed by payments from those pools. Excluding limitations on access to lending and other extraordinary economic conditions, Global Atlantic would expect prepayments of principal on the underlying loans to accelerate with decreases in market interest rates and diminish with increases in market interest rates.190Table of ContentsThe NAIC designations for RMBS, including prime, sub-prime, alt-A, and adjustable rate mortgages with variable payment options ("Option ARM"), are based upon a comparison of the bond’s amortized cost to the NAIC’s loss expectation for each security. Accordingly, an investment in the same security at a lower cost may result in a higher quality NAIC designation in recognition of the lower likelihood the investment would result in a realized loss. Prime residential mortgage lending includes loans to the most creditworthy borrowers with high quality credit profiles. Alt-A is a classification of mortgage loans where the risk profile of the borrower is between prime and sub-prime. Sub-prime mortgage lending is the origination of residential mortgage loans to borrowers with weak credit profiles.As of December 31, 2022 and December 31, 2021, 90% and 93%, respectively, of RMBS securities that are below investment grade as rated by the NRSRO, carry an NAIC 1 ("highest quality") designation.As of December 31, 2022, Alt-A, Option ARM, Re-Performing and Sub-prime represent 31%, 28%, 14% and 12% of the total RMBS portfolio ($6.4 billion), respectively. As of December 31, 2021, Alt-A, Option ARM, Re-Performing and Sub-prime represent 33%, 30%, 14% and 12% of the total RMBS portfolio ($7.7 billion), respectively.Unrealized gains and losses for AFS fixed maturity securitiesGlobal Atlantic's investments in AFS fixed maturity securities are reported at fair value with changes in fair value recorded in other comprehensive income as unrealized gains or losses, net of taxes and offsets. Unrealized gains and losses can be created by changes in interest rates or by changes in credit spreads.As of December 31, 2022 and 2021, Global Atlantic had gross unrealized losses on below investment grade AFS fixed maturity securities of $917.6 million and $80.3 million based on NRSRO rating and $224.9 million and $13.5 million based on NAIC ratings, respectively. Unrealized losses were not recognized in net income on these debt securities because there were no specific securities that, as of each such date, Global Atlantic intended to sell or believed it was more likely than not that it would be required to sell before recovery of their cost or amortized cost basis.Mortgage and other loan receivables - Credit quality indicatorsMortgage and other loan receivables consist of commercial and residential mortgage loans, and other loan receivables. As of December 31, 2022 and 2021, 28% and 23%, respectively, of Global Atlantic's total investments consisted of mortgage and other loan receivables. Global Atlantic invests in U.S. mortgage loans, comprised of first lien and mezzanine real estate loans, residential mortgage loans, consumer loans, and other loan receivables. Global Atlantic's commercial mortgage loans may also be rated based on NAIC designations, with designations “CM1” and “CM2” considered to be investment grade. As of December 31, 2022 and 2021, 88% and 96% of the commercial mortgage loan portfolio was rated investment grade based on NAIC designation, respectively. 100% of the commercial mortgage loan portfolio is in current status. As of December 31, 2022, 96% of the residential mortgage loan portfolio is in current status, and approximately $192.3 million is over 90 days past due (representing 2% of the total residential mortgage portfolio).The loan-to-value ratio is expressed as a percentage of the current amount of the loan relative to the value of the underlying collateral. Approximately 84% of the commercial mortgage loans has a loan-to-value ratio of 70% or less and 3% has loan-to-value ratio over 90%.Changing economic conditions affect Global Atlantic’s valuation of commercial mortgage loans. Changing vacancies and rents are incorporated into the discounted cash flow analysis that Global Atlantic performs for monitored loans and may contribute to the establishment of (or increase or decrease in) a commercial mortgage loan valuation allowance for losses. In addition, Global Atlantic continuously monitors its commercial mortgage loan portfolio to identify risk. Areas of emphasis are properties that have exposure to specific geographic events or have deteriorating credit.The weighted average loan-to-value ratio for residential mortgage loans was 64% and 68% as of December 31, 2022 and 2021, respectively.Global Atlantic's residential mortgage loan portfolio is comprised mainly of re-performing loans that were purchased at a discount after they were modified and returned to performing status, as well as prime jumbo loans and mortgage loans backed by single family rental properties. Global Atlantic has also extended financing to counterparties in the form of repurchase agreements secured by mortgage loans, including performing and non-performing mortgage loans. 191Table of ContentsGlobal Atlantic’s consumer loan portfolio is primarily comprised of home improvement loans, solar panel loans, student loans and auto loans.Reconciliations to GAAP MeasuresThe following tables reconcile the most directly comparable financial measures calculated and presented in accordance with GAAP to KKR's non-GAAP financial measures for the years ended December 31, 2022, 2021, and 2020:Revenues Year Ended December 31, 2022December 31, 2021December 31, 2020 ($ in thousands)Total GAAP Revenues$5,721,195 $16,236,148 $4,230,891 Impact of Consolidation and Other841,711 808,174 461,244 Asset Management Adjustments:Capital Allocation-Based Income (Loss) (GAAP)2,500,509 (6,842,414)(2,224,100)Realized Carried Interest1,993,860 1,752,130 1,042,204 Realized Investment Income1,134,419 1,613,244 644,659 Capstone Fees(86,665)(91,407)(81,452)Expense Reimbursements(102,927)(178,572)(149,522)Insurance Adjustments:Net Premiums(1,182,461)(2,226,078)— Policy Fees(1,278,736)(1,147,913)— Other Income(139,124)(120,213)— Investment Gains and Losses472,053 544,357 — Derivative Gains and Losses1,072,572 (141,513)— Total Segment Revenues (1)$10,946,406 $10,205,943 $3,923,924 (1)Total Segment Revenues is comprised of (i) Management Fees, (ii) Transaction and Monitoring Fees, Net, (iii) Fee Related Performance Revenues, (iv) Realized Performance Income, (v) Realized Investment Income, and (vi) Net Investment Income.192Table of ContentsNet Income (Loss) Attributable to KKR & Co. Inc. Common StockholdersYear Ended December 31, 2022December 31, 2021December 31, 2020 ($ in thousands)Net Income (Loss) Attributable to KKR & Co. Inc. Common Stockholders (GAAP)$(910,130)$4,560,829 $1,945,954 Preferred Stock Dividends 69,000 105,647 56,555 Net Income (Loss) Attributable to Noncontrolling Interests(182,398)7,628,703 3,115,089 Income Tax Expense (Benefit)(35,672)1,353,270 609,097 Income (Loss) Before Tax (GAAP)$(1,059,200)$13,648,449 $5,726,695 Impact of Consolidation and Other (107,754)(5,189,459)(1,704,739)Equity-based Compensation - KKR Holdings(1)119,834 161,283 80,739 Preferred Stock Dividends— (19,201)(33,364)Income Taxes Paid(738,841)(687,572)(265,950)Asset Management Adjustments:Net Unrealized (Gains) Losses 2,002,082 (2,590,280)(1,697,740)Unrealized Carried Interest4,231,359 (4,043,135)(1,070,803)Unrealized Carried Interest Compensation (Carry Pool)(1,753,396)1,751,912 467,485 Strategic Corporate Transaction-Related Charges (2)94,629 25,153 20,073 Equity-based Compensation210,756 183,100 236,199 Equity-based Compensation - Performance based238,929 78,230 10,196 Insurance Adjustments:(3)Net (Gains) Losses from Investments and Derivatives(3)192,743 658,975 — Strategic Corporate Transaction-Related Charges(3)24,746 25,711 — Equity-based and Other Compensation(3) 152,083 95,344 — Amortization of Acquired Intangibles(3) 17,647 16,176 — Income Taxes(3)(171,744)(199,095)— After-tax Distributable Earnings$3,453,873 $3,915,591 $1,768,791 Interest Expense315,189 250,183 211,037 Preferred Stock Dividends— 19,201 33,364 Net Income Attributable to Noncontrolling Interests23,200 23,664 7,842 Income Taxes Paid738,841 687,572 265,950 Distributable Operating Earnings$4,531,103 $4,896,211 $2,286,984 Insurance Segment Operating Earnings (545,204)(652,551)— Realized Performance Income(2,176,658)(2,141,596)(1,165,699)Realized Performance Income Compensation1,333,526 1,239,177 697,071 Realized Investment Income(1,134,419)(1,613,244)(644,659)Realized Investment Income Compensation159,003 241,994 106,830 Fee Related Earnings$2,167,351 $1,969,991 $1,280,527 Insurance Segment Operating Earnings545,204 652,551 — Realized Performance Income2,176,658 2,141,596 1,165,699 Realized Performance Income Compensation(1,333,526)(1,239,177)(697,071)Realized Investment Income1,134,419 1,613,244 644,659 Realized Investment Income Compensation(159,003)(241,994)(106,830)Depreciation and Amortization33,809 25,940 18,626 Adjusted EBITDA$4,564,912 $4,922,151 $2,305,610 (1)Represents equity-based compensation expense in connection with the allocation of KKR Holdings Units, which were not dilutive to common stockholders of KKR & Co. Inc.(2)For the year ended December 31, 2022, strategic corporate transaction-related charges include a $40.7 million realized loss from foreign exchange derivatives that were entered in connection with the acquisition of KJRM and that were settled upon closing.(3)Amounts include the portion allocable to noncontrolling interests (~37%).193Table of ContentsKKR & Co. Inc. Stockholders' Equity - Common StockAs ofDecember 31, 2022December 31, 2021($ in thousands)KKR & Co. Inc. Stockholders' Equity - Series I and II Preferred Stock, Common Stock$16,613,028 $16,466,372 Series C Mandatory Convertible Preferred Stock1,115,792 1,115,792 Impact of Consolidation and Other399,318 (1,048,569)KKR Holdings and Exchangeable Securities126,519 8,595,510 Accumulated Other Comprehensive Income (AOCI) and Other (Insurance)5,549,215 259,777 Book Value$23,803,872 $25,388,882 The following table provides a reconciliation of KKR's GAAP Shares of Common Stock Outstanding to Adjusted Shares: As of December 31, 2022December 31, 2021GAAP Shares of Common Stock Outstanding 861,110,478 595,663,618 Adjustments:KKR Holdings Units— 258,726,163 Exchangeable Securities (1)2,695,142 1,376,655 Common Stock - Series C Mandatory Convertible Preferred Stock (2)26,822,570 26,822,600 Adjusted Shares (3)890,628,190 882,589,036 Unvested Equity Awards and Exchangeable Securities (4)35,457,274 39,000,561 (1)Consists of vested restricted holdings units granted under our 2019 Equity Incentive Plan, which are exchangeable for shares of KKR & Co. Inc. common stock on a one-for-one basis.(2)Assumes that all shares of Series C Mandatory Convertible Preferred Stock have been converted into shares of KKR & Co. Inc. common stock on December 31, 2022 and December 31, 2021.(3)Amounts exclude unvested equity awards granted under our Equity Incentive Plans.(4)Represents equity awards granted under our Equity Incentive Plans. Excludes market condition awards that did not meet their market-price based vesting conditions as of December 31, 2022 and December 31, 2021.LiquidityWe manage our liquidity and capital requirements by (i) focusing on our cash flows before the consolidation of our funds and CFEs and the effect of changes in short term assets and liabilities, which we anticipate will be settled for cash within one year, and (ii) seeking to maintain access to sufficient liquidity through various sources. The overall liquidity framework and cash management approach of our insurance business are also based on seeking to build an investment portfolio that is cash flow matched, providing cash inflows from insurance assets that meet our insurance companies' expected cash outflows to pay their liabilities. Our primary cash flow activities typically involve: (i) generating cash flow from operations; (ii) generating income from investment activities, by investing in investments that generate yield (namely interest and dividends), as well as through the sale of investments and other assets; (iii) funding capital commitments that we have made to, and advancing capital to, our funds and CLOs; (iv) developing and funding new investment strategies, investment products, and other growth initiatives, including acquisitions of other investments, assets, and businesses; (v) underwriting and funding commitments in our capital markets business; (vi) distributing cash flow to our stockholders and holders of our preferred stock; and (vii) paying borrowings, interest payments, and repayments under credit agreements, our senior and subordinated notes, and other borrowing arrangements. See "—Liquidity—Liquidity Needs—Dividends." See "—Business Environment" for more information on factors that may impact our business, financial performance, operating results and valuations.194Table of ContentsSources of Liquidity Our primary sources of liquidity consist of amounts received from: (i) our operating activities, including the fees earned from our funds, portfolio companies, and capital markets transactions; (ii) realizations on carried interest from our investment funds; (iii) interest and dividends from investments that generate yield, including our investments in CLOs; (iv) in our insurance business, cash inflows in respect of new premiums, policyholder deposits, reinsurance transactions and funding agreements, including through memberships in Federal Home Loan Banks; (v) realizations on and sales of investments and other assets, including the transfers of investments or other assets for fund formations (including CLOs and other investment vehicles); and (vi) borrowings, including advances under our revolving credit facilities, debt offerings, repurchase agreements, and other borrowing arrangements. In addition, we may generate cash proceeds from issuances of our or our subsidiaries' equity securities.Many of our investment funds like our private equity and real assets funds provide for carried interest. With respect to our carry-paying investment funds, carried interest is eligible to be distributed to the general partner of the fund only after all of the following are met: (i) a realization event has occurred (e.g., sale of a portfolio company, dividend, etc.); (ii) the vehicle has achieved positive overall investment returns since its inception, in excess of performance hurdles where applicable, and is accruing carried interest; and (iii) with respect to investments with a fair value below cost, cost has been returned to fund investors in an amount sufficient to reduce remaining cost to the investments' fair value. Even after all of the preceding conditions are met, the general partner of the fund may, in its sole discretion, decide to defer the distribution of carried interest to it to a later date. In addition, these funds generally include what is called a “clawback” provision, which provides that the general partner must return any carried interest that is paid in excess of what the general partner is entitled to receive at the end of the term of the fund, as discussed further below.As of December 31, 2022, certain of our investment funds had met the first and second criteria, as described above, but did not meet the third criteria. In these cases, carried interest accrues on the consolidated statement of operations, but will not be distributed in cash to us as the general partner of an investment fund upon a realization event. For a fund that has a fair value above cost, overall, and is otherwise accruing carried interest, but has one or more investments where fair value is below cost, the shortfall between cost and fair value for such investments is referred to as a "netting hole." When netting holes are present, realized gains on individual investments that would otherwise allow the general partner to receive carried interest distributions are instead used to return invested capital to our funds' limited partners in an amount equal to the netting hole. Once netting holes have been filled with either (a) return of capital equal to the netting hole for those investments where fair value is below cost or (b) increases in the fair value of those investments where fair value is below cost, then realized carried interest will be distributed to the general partner upon a realization event. A fund that is in a position to pay cash carry refers to a fund for which carried interest is expected to be paid to the general partner upon the next material realization event, which includes funds with no netting holes as well as funds with a netting hole that is sufficiently small in size such that the next material realization event would be expected to result in the payment of carried interest. Strategic investor partnerships with fund investors may require netting across the various funds in which they invest, which may reduce the carried interest we otherwise would have earned if such fund investors were to have invested in our funds without the existence of the strategic investor partnership. As of December 31, 2022, there was no netting hole in excess of $50 million at any of our investment funds that had a fair value above cost, overall, and is otherwise accruing carried interest. In accordance with the criteria set forth above, other funds currently have and may in the future develop netting holes, and netting holes for those and other funds may otherwise increase or decrease in the future. There are also investment funds that are not accruing carried interest and do not have a netting hole although they may be in a clawback position. If the investment fund has distributed carried interest, but subsequently does not have sufficient value to provide for the distribution of carried interest at the end of the life of the investment fund, the general partner is typically required to return previously distributed carried interest to the fund investors. Although our current and former employees who received distributions of carried interest subject to clawback are required to return them to KKR, it is KKR’s obligation to return carried interest subject to clawback to the fund investors. As of December 31, 2022, approximately $520 million of carried interest was subject to this clawback obligation, assuming that all applicable carry-paying funds and their alternative investment vehicles were liquidated at their December 31, 2022 fair values. As of December 31, 2022, Asia Fund II is the only investment fund with a clawback obligation in excess of $50 million. See Note 25 "Commitments and Contingencies—Contingent Repayment Guarantees" in our financial statements included elsewhere in this report for further information.We have access to funding under various credit facilities, other borrowing arrangements and other sources of liquidity that we have entered into with major financial institutions or which we receive from the capital markets. 195Table of ContentsFor a discussion of our debt obligations, including our debt securities, revolving credit agreements and loans, see Note 17 "Debt Obligations" in our financial statements.Liquidity NeedsWe expect that our (including Global Atlantic's) primary liquidity needs will consist of cash required to meet various obligations, including, without limitation, to:•continue to support and grow our Asset Management business lines, including seeding new investment strategies, supporting capital commitments made by our vehicles to existing and future funds, co-investments and any net capital requirements of our capital markets companies and otherwise supporting the investment vehicles that we sponsor;•continue to support and grow our insurance business;•grow and expand our businesses generally, including by acquiring or launching new, complementary or adjacent businesses;•warehouse investments in portfolio companies or other investments for the benefit of one or more of our funds, accounts or CLOs or other investment vehicles pending the contribution of committed capital by the fund investors in such vehicles, and advancing capital to them for operational or other needs;•service debt obligations including the payment of obligations at maturity, on interest payment dates or upon redemption, as well as any contingent liabilities, including from litigation, that may give rise to future cash payments, including funding requirements to levered investment vehicles or structured transactions;•fund cash operating expenses and contingencies, including for litigation matters and guarantees;•pay corporate income taxes and other taxes;•pay policyholders and amounts in our insurance business related to investment, reinvestment, reinsurance or funding agreement activity;•pay amounts that may become due under our tax receivable agreement;•pay cash dividends in accordance with our dividend policy for our common stock or the terms of our preferred stock, if any;•underwrite commitments, advance loan proceeds and fund syndication commitments within our capital markets business;•post or return collateral in respect of derivative contracts;•acquire other assets for our Principal Activities business line, including other businesses, investments and assets, some of which may be required to satisfy regulatory requirements for our capital markets business or risk retention requirements for CLOs (to the extent they may apply); •address capital needs of regulated subsidiaries as well as non-regulated subsidiaries; and•repurchase shares of our common stock or retire equity awards pursuant to the share repurchase program or repurchase or redeem other securities issued by us.For a discussion of KKR's share repurchase program, see Note 23 "Equity" in our financial statements.Capital CommitmentsThe agreements governing our active investment funds generally require the general partners of the funds to make minimum capital commitments to such funds, which generally range from 2% to 8% of a fund's total capital commitments at final closing, but may be greater for certain funds (i) where we are pursuing newer strategies, (ii) where third party investor demand is limited, and (iii) where a larger commitment is consistent with the asset allocation strategy for our Principal Activities business line, including core investments and exposure to the Asia-Pacific region.196Table of ContentsThe following table presents our uncalled commitments to our active investment funds and other vehicles as of December 31, 2022: UncalledCommitmentsPrivate Equity($ in millions)Core Investment Vehicles$3,883 European Fund VI750 Asian Fund IV367 North America Fund XIII359 Next Generation Technology Growth Fund III196 Global Impact Fund II145 Health Care Strategic Growth Fund II127 Other Private Equity Vehicles1,543 Total Private Equity Commitments7,370 Real AssetsAsia Pacific Infrastructure Investors II357 Global Infrastructure Investors IV272 Asia Real Estate Partners162 Real Estate Partners Americas III91 Diversified Core Infrastructure Fund87 Real Estate Partners Europe II81 Real Estate Credit Opportunity Partners II17 Other Real Assets Vehicles782 Total Real Assets Commitments1,849 Credit and Liquid StrategiesAsset-Based Finance Partners97 Asia Credit97 Dislocation Opportunities Fund84 Lending Partners III12 Lending Partners Europe II11 Other Credit and Liquid Strategies Vehicles916 Total Credit and Liquid Strategies Commitments1,217 Total Uncalled Commitments$10,436 Other CommitmentsIn addition to the uncalled commitments to our investment funds as shown above, KKR has entered into contractual commitments primarily with respect to underwriting transactions, debt financing, revolving credit facilities, and equity syndications in our Capital Markets business line. As of December 31, 2022, these commitments amounted to $0.7 billion.Whether these amounts are actually funded, in whole or in part, depends on the contractual terms of such commitments, including the satisfaction or waiver of any conditions to closing or funding. Our capital markets business has arrangements with third parties, which reduce our risk under certain circumstances when underwriting certain debt transactions, and thus our unfunded commitments as of December 31, 2022 have been reduced to reflect the amount to be funded by such third parties. In the case of purchases of investments or assets in our Principal Activities business line, the amount to be funded includes amounts that are intended to be syndicated to third parties, and the actual amounts to be funded may be less. For more information about our Capital Markets business line's risks, see "Risks Related to Our Business—Our capital markets activities expose us to material risks." 197Table of ContentsFrom time to time, we fund various underwriting, syndication and fronting commitments in our capital markets business in connection with the arranging or underwriting of loans, securities or other financial instruments, for which we may draw all or substantially all of our availability for borrowings under our available credit facilities. We generally expect these borrowings by our Capital Markets business line to be repaid promptly as these commitments are syndicated to third parties or otherwise fulfilled or terminated, although we may in some instances elect to retain a portion of the commitments for our own investment. For more information about our Capital Markets business line's risks, see "Risks Related to Our Business—Our capital markets activities expose us to material risks" in this report.Tax Receivable AgreementOn May 30, 2022, KKR terminated the tax receivable agreement with KKR Holdings other than with respect to exchanges of KKR Holdings Units completed prior to such date. As of December 31, 2022, an undiscounted payable of $420.6 million has been recorded in due to affiliates in the financial statements representing management's best estimate of the amounts currently expected to be owed for certain exchanges of KKR Holdings Units that took place prior to the termination of the tax receivable agreement. As of December 31, 2022, approximately $60.4 million of cumulative cash payments have been made under the tax receivable agreement since inception.DividendsA dividend of $0.155 per share of our common stock has been declared and will be paid on March 7, 2023 to holders of record of our common stock as of the close of business on February 17, 2023.A dividend of $0.75 per share of Series C Mandatory Convertible Preferred Stock has been declared and set aside for payment on March 15, 2023 to holders of record of Series C Mandatory Convertible Preferred Stock as of the close of business on March 1, 2023. When KKR & Co. Inc. receives distributions from KKR Group Partnership, holders of exchangeable securities receive their pro rata share of such distributions from KKR Group Partnership. The declaration and payment of dividends to our common stockholders will be at the sole discretion of our Board of Directors, and our dividend policy may be changed at any time. We announced on February 7, 2023 that our current dividend policy will be to pay dividends to holders of our common stock in an annual aggregate amount of $0.66 per share (or a quarterly dividend of $0.165 per share) beginning with the dividend to be announced with the results for the first quarter of 2023. The declaration of dividends is subject to the discretion of our Board of Directors based on a number of factors, including KKR’s future financial performance and other considerations that the Board of Directors deems relevant, and compliance with the terms of KKR & Co. Inc.'s certificate of incorporation and applicable law. For U.S. federal income tax purposes, any dividends we pay (including dividends on our preferred stock) generally will be treated as qualified dividend income for U.S. individual stockholders to the extent paid out of our current or accumulated earnings and profits, as determined for U.S. federal income tax purposes. There can be no assurance that future dividends will be made as intended or at all or that any particular dividend policy for our common stock will be maintained. Furthermore, the declaration and payment of distributions by KKR Group Partnership and our other subsidiaries may also be subject to legal, contractual and regulatory restrictions, including restrictions contained in our debt agreements and the terms of the preferred units of KKR Group Partnership.Contractual Obligations, Commitments and ContingenciesIn the ordinary course of business, we (including Global Atlantic) and our consolidated funds and CFEs enter into contractual arrangements that may require future cash payments. Contractual arrangements include (1) commitments to fund the purchase of investments or other assets (including obligations to fund capital commitments as the general partner of our investment funds) or to fund collateral for derivative transactions or otherwise, (2) obligations arising under our senior notes, subordinated notes, and other indebtedness, (3) commitments by our capital markets business to underwrite transactions or to lend capital, (4) obligations arising under insurance policies written, (5) other contractual obligations, including servicing agreements with third-party administrators for insurance policy administration, and (6) commitments to fund the business, operations or investments of our subsidiaries. In addition, we may incur contingent liabilities for claims that may be made against us in the future. For more information about these contingent liabilities, please see Note 25 "Commitments and Contingencies" in our financial statements.198Table of ContentsThe following table sets forth information relating to anticipated future cash payments as of December 31, 2022 excluding consolidated funds and CFEs with a reconciliation of such amounts to anticipated future cash payments by us (including Global Atlantic) and our consolidated funds and CFEs. Payments due by PeriodTypes of Contractual Obligations<1 Year1-3 Years3-5 Years>5 YearsTotal ($ in millions)Asset ManagementUncalled commitments to investment funds (1)$10,436.0 $— $— $— $10,436.0 Debt payment obligations (2)189.5 37.9 275.9 7,368.6 7,871.9 Interest obligations on debt payment obligations (3)334.0 567.4 565.1 4,084.2 5,550.7 Underwriting commitments (4)6.1 — — — 6.1 Lending commitments (5)507.1 — — — 507.1 Purchase commitments (6)141.1 — — — 141.1 Lease obligations45.6 94.5 68.3 192.6 401.0 Insurance (7)Policy liabilities (8)13,623.9 29,730.8 24,036.3 102,686.6 170,077.6 Debt payment obligations (9)— — 400.0 1,900.0 2,300.0 Interest obligations on debt payment obligations (10)103.0 206.0 205.0 1,517.0 2,031.0 Purchase and lease commitments (11)60.9 97.6 63.0 347.8 569.3 Total Contractual Obligations of KKR$25,447.2 $30,734.2 $25,613.6 $118,096.8 $199,891.8 (+) Uncalled commitments of consolidated funds (12)19,423.9 — — — 19,423.9 (+) Debt payment obligations of consolidated funds, CFEs and Other (13)2,266.7 900.5 980.8 29,470.8 33,618.8 (+) Corporate real estate borrowings (14)490.0 — — — 490.0 (+) Interest obligations of consolidated funds, CFEs and Other (15)1,660.1 2,896.4 2,797.6 6,034.7 13,388.8 Total Consolidated Contractual Obligations$49,287.9 $34,531.1 $29,392.0 $153,602.3 $266,813.3 (1)These uncalled commitments represent amounts committed by us to fund a portion of the purchase price paid for each investment made by our investment funds which are actively investing. Because capital contributions are due on demand, the above commitments have been presented as falling due within one year. However, given the size of such commitments and the pace at which our investment funds make investments, we expect that the capital commitments presented above will be called over a period of several years. See "—Liquidity Needs" and Note 17 "Debt Obligations" in our financial statements.(2)Amounts include senior notes and subordinated notes issued by KKR and its subsidiaries. KFN's debt obligations are non-recourse to KKR beyond the assets of KFN.(3)These interest obligations on debt represent estimated interest to be paid over the term of the related debt obligation, which has been calculated assuming the debt outstanding at December 31, 2022 is not repaid until its maturity. Future interest rates are assumed to be those in effect as of December 31, 2022, including both variable and fixed rates, as applicable, provided for by the relevant debt agreements. The amounts presented above include accrued interest on outstanding indebtedness.(4)Represents various commitments in our capital markets business in connection with the underwriting of loans, securities and other financial instruments. These commitments are shown net of amounts syndicated.(5)Represents obligations in our capital markets business to lend under various revolving credit facilities.(6)Represents commitments of KKR's asset management business line including KFN to fund the purchase of various investments.(7)Global Atlantic has other obligations related to collateral payable held for derivative instruments ($466.4 million) and outstanding commitments to make investments in commercial mortgage loans, other lending facilities and other investments ($3.3 billion) which have not been included in the above table as the exact timing of these payments cannot be estimated. Global Atlantic's debt obligations are non-recourse to KKR beyond the assets of Global Atlantic.(8)Policy liabilities for insurance obligations consist of amounts required to meet future obligations for future policy benefits and policy account balances. Amounts presented in the table represent estimated cash payments under such contracts, including significant assumptions related to the receipt of future premiums, mortality, lapse, renewal, withdrawal, and annuitization comparable with actual experience. These assumptions also include market growth and policy crediting consistent with assumptions used in amortizing DAC. All estimated cash payments are not discounted to present value. Accordingly, the total of cash flows presented for all years of $170.1 billion significantly exceeds total policy liabilities of $141.2 billion recorded on the statements of financial condition as of December 31, 2022. Estimated cash payments are also presented gross of reinsurance. Due to the significance of the assumptions used, the amounts presented could differ materially from actual results.(9)The payments due by period for debt obligations reflects the contractual maturities of principal. (10)Reflects estimated future interest payments. Future interest on variable rate debt (which includes borrowing under our revolving credit facility and the subordinated debentures) was computed using prevailing rates as of December 31, 2022 and, as such, does not consider the impact of future rate movements. Future interest on fixed rate debt was computed using the stated rate on the obligations.199Table of Contents(11)Reflects operational servicing agreements with third-party administrators for policy administration.(12)Represents uncalled commitments of our consolidated funds excluding KKR's portion of uncalled commitments as the general partner of the respective funds. Because capital contributions are due on demand, the above commitments have been presented as falling due within one year. However, given the size of such commitments and the pace at which our investment funds make investments, we expect that the capital commitments presented above will be called over a period of several years. See "—Liquidity Needs" and Note 17 "Debt Obligations" in our financial statements.(13)Amounts include (i) financing arrangements entered into by our consolidated funds with the objective of providing liquidity to the funds of $9.0 billion, (ii) debt securities issued by our consolidated CLOs of $22.3 billion and (iii) borrowings collateralized by fund investments, fund co-investments and other assets held by levered investment vehicles of $2.3 billion. Debt securities issued by consolidated CLO entities are supported solely by the investments held at the CLO vehicles and are not collateralized by assets of any other KKR entity. Borrowings by levered investment vehicles are supported solely by the investments held at the investment vehicles and are not collateralized by assets of any other KKR entity. Obligations under financing arrangements entered into by our consolidated funds are generally limited to our pro rata equity interest in such funds. Our management companies bear no obligations to repay any financing arrangements at our consolidated funds.(14)Represents a debt obligation in connection with the ownership of KKR office space. (15)The interest obligations on debt of our CFEs and other borrowings represent estimated interest to be paid over the term of the related debt obligation, which has been calculated assuming the debt outstanding at December 31, 2022 is not repaid until its maturity. Future interest rates are assumed to be those in effect as of December 31, 2022, including both variable and fixed rates, as applicable, provided for by the relevant debt agreements. The amounts presented above include accrued interest on outstanding indebtedness.The commitment table above excludes contractual amounts owed under the tax receivable agreement because the ultimate amount and timing of the amounts due are not presently known. See "—Liquidity Needs—Tax Receivable Agreement" in this report and "Risk Factors—We will be required to pay our principals for most of the benefits relating to our use of tax attributes we receive from certain prior exchanges of our common stock for KKR Group Partnership Units" in this report. Off Balance Sheet ArrangementsWe do not have any off-balance sheet financings or liabilities other than contractual commitments and other legal contingencies incurred in the normal course of our business.Critical Accounting Policies and Estimates The preparation of our financial statements in accordance with GAAP requires our management to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and reported amounts of fees, capital allocation-based income (loss), expenses, investment income, and income taxes. Our management bases these estimates and judgments on available information, historical experience and other assumptions that we believe are reasonable under the circumstances. However, these estimates, judgments and assumptions are often subjective and may be impacted negatively based on changing circumstances or changes in our analyses. If actual amounts are ultimately different from those estimated, judged or assumed, revisions are included in the financial statements in the period in which the actual amounts become known. We believe our critical accounting policies could potentially produce materially different results if we were to change underlying estimates, judgments or assumptions. For a further discussion about our critical accounting policies, see Note 2 "Summary of Significant Accounting Policies" in our financial statements included in this report.Basis of AccountingWe consolidate the financial results of KKR Group Partnership and its consolidated entities, which include the accounts of our investment advisers, broker-dealers, Global Atlantic’s insurance companies, the general partners of certain unconsolidated investment funds, general partners of consolidated investment funds and their respective consolidated investment funds and certain other entities including CFEs.When an entity is consolidated, we reflect the accounts of the consolidated entity, including its assets, liabilities, revenues, expenses, investment income, cash flows and other amounts, on a gross basis. While the consolidation of an investment fund or entity does not have an effect on the amounts of Net Income Attributable to KKR or KKR's stockholders' equity that KKR reports, the consolidation does significantly impact the financial statement presentation under GAAP. This is due to the fact that the accounts of the consolidated entities are reflected on a gross basis while the allocable share of those amounts that are attributable to third parties are reflected as single line items. The single line items in which the accounts attributable to third parties are recorded are presented as noncontrolling interests on the consolidated statements of financial condition and net income (loss) attributable to noncontrolling interests on the consolidated statements of operations.200Table of ContentsThe presentation in the financial statements reflect the significant industry diversification of KKR by its acquisition of Global Atlantic. Global Atlantic operates an insurance business, and KKR operates an asset management business, each of which possess distinct characteristics. As a result, KKR developed a two-tiered presentation approach for the financial statements in this Management's Discussion and Analysis. KKR believes that these separate presentations provide a more informative view of the consolidated financial position and results of operations than traditional aggregated presentations. KKR believes that reporting Global Atlantic’s insurance operations separately is appropriate given, among other factors, the relative significance of Global Atlantic’s policy liabilities, which are not obligations of KKR (other than the insurance companies that issued them). If a traditional aggregated presentation were to be used, KKR would expect to eliminate or combine several identical or similar captions, which would condense the presentations but would reduce transparency. KKR also believes that using a traditional aggregated presentation would result in no new line items compared to the two-tier presentation included in the financial statements in this report. We acquired Global Atlantic on February 1, 2021; accordingly, the results of Global Atlantic's insurance operations included in our consolidated results of operations for the year ended December 31, 2021 are from February 1, 2021 (the closing date of the GA Acquisition) through December 31, 2021.ConsolidationKKR consolidates all entities that it controls either through a majority voting interest or as the primary beneficiary of variable interest entities (“VIEs”). The following discussion is intended to provide supplemental information about how the application of consolidation principles impact our financial results, and management’s process for implementing those principles including areas of significant judgment. For a detailed description of our accounting policy on consolidation, see Note 2 "Summary of Significant Accounting Policies" in our financial statements included in this report. As part of its consolidation procedures, KKR evaluates: (1) whether it holds a variable interest in an entity, (2) whether the entity is a VIE, and (3) whether the KKR’s involvement would make it the primary beneficiary. The determination that KKR holds a controlling financial interest in an investment vehicle significantly changes the presentation of our consolidated financial statements. The assessment of whether we consolidate an investment vehicle we manage requires the application of significant judgment. These judgments are applied both at the time we become involved with an investment vehicle and on an ongoing basis and include, but are not limited to: •Determining whether our management fees, carried interests or incentive fees represent variable interests - We make judgments as to whether the fees we earn are commensurate with the level of effort required for those fees and at market rates. In making this judgment, we consider, among other things, the extent of third party investment in the entity and the terms of any other interests we hold in the VIE. •Determining whether a legal entity qualifies as a VIE - For those entities where KKR holds a variable interest, management determines whether each of these entities qualifies as a VIE and, if so, whether or not KKR is the primary beneficiary. The assessment of whether the entity is a VIE is generally performed qualitatively, which requires judgment. These judgments include: (a) determining whether the equity investment at risk is sufficient to permit the entity to finance its activities without additional subordinated financial support, (b) evaluating whether the equity holders, as a group, can make decisions that have a significant effect on the economic performance of the entity, (c) determining whether two or more parties’ equity interests should be aggregated, and (d) determining whether the equity investors have proportionate voting rights to their obligations to absorb losses or rights to receive returns from an entity. Entities that do not qualify as VIEs are generally assessed for consolidation as voting interest entities. Under the voting interest entity model, the Company consolidates those entities it controls through a majority voting interest. •Concluding whether KKR has an obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE - As there is no explicit threshold in GAAP to define “potentially significant,” we must apply judgment and evaluate both quantitative and qualitative factors to conclude whether this threshold is met.Changes to these judgments could result in a change in the consolidation conclusion for a legal entity.Fair Value MeasurementsFair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. 201Table of ContentsGAAP establishes a hierarchical disclosure framework which prioritizes and ranks the level of market price observability used in measuring financial instruments at fair value. Investments and other financial instruments measured and reported at fair value are classified and disclosed based on the observability of inputs used in the determination of fair values, as follows:Level IPricing inputs are unadjusted, quoted prices in active markets for identical assets or liabilities as of the measurement date. Level IIPricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the measurement date, and fair value is determined through the use of models or other valuation methodologies.Level IIIPricing inputs are unobservable for the financial instruments and include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value require significant management judgment or estimation. The valuation of our Level III investments at December 31, 2022 represents management's best estimate of the amounts that we would anticipate realizing on the sale of these investments in an orderly transaction at such date.In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Level III Valuation MethodologiesOur investments and financial instruments are impacted by various economic conditions and events outside of our control that are difficult to quantify or predict, which may have a significant impact on the valuation of our investments and, therefore, on the carried interest and investment income we realize. Additionally, a change in interest rates could have a significant impact on valuations. Across the total Level III private equity investment portfolio (including core private equity investments), and including investments in both consolidated and unconsolidated investment funds, approximately 55% of the fair value is derived from investments that are valued based exactly 50% on market comparables and 50% on a discounted cash flow analysis. Less than 5% of the fair value of this Level III private equity investment portfolio is derived from investments that are valued either based 100% on market comparables or 100% on a discounted cash flow analysis. As of December 31, 2022, the overall weights ascribed to the market comparables methodology, the discounted cash flow methodology, and a methodology based on pending sales for this portfolio of Level III private equity investments were 38%, 55%, and 7%, respectively.There is inherent uncertainty involved in the valuation of Level III investments, and there is no assurance that, upon liquidation, KKR will realize the values reflected in our valuations. Our valuations may differ significantly from the values that would have been used had an active market for the investments existed, and it is reasonably possible that the difference could be material. See "—Business Environment" for more information on factors that may impact our business, financial performance, operating results and valuations. Key unobservable inputs that have a significant impact on our Level III valuations as described above are included in Note 10 "Fair Value Measurements" in our financial statements.Level III Valuation ProcessThe valuation process involved for Level III measurements is completed on a quarterly basis and is designed to subject the valuation of Level III investments to an appropriate level of consistency, oversight, and review.For private equity and real asset investments classified as Level III, investment professionals prepare preliminary valuations based on their evaluation of financial and operating data, company specific developments, market valuations of comparable companies and other factors. KKR begins its procedures to determine the fair values of its Level III assets approximately one month prior to the end of a reporting period, and KKR follows additional procedures to ensure that its determinations of fair value for its Level III assets are appropriate as of the relevant reporting date. These preliminary valuations are reviewed by an independent valuation firm engaged by KKR to perform certain procedures in order to assess the reasonableness of KKR's valuations annually for all Level III private equity and real asset investments and quarterly for 202Table of Contentsinvestments other than certain investments, which have values less than preset value thresholds and which in the aggregate comprise less than 1% of the total value of KKR's Level III private equity and real asset investments. The valuations of certain real asset investments are determined solely by independent valuation firms without the preparation of preliminary valuations by our investment professionals, and instead such independent valuation firms rely on valuation information available to it as a broker or valuation firm. For credit investments, an independent valuation firm is generally engaged by KKR to assist with the valuations of most investments classified as Level III. The valuation firm either provides a value, provides a valuation range from which KKR's investment professionals select a point in the range to determine the valuation, or performs certain procedures in order to assess the reasonableness of KKR's valuations. After reflecting any input from the independent valuation firm, the valuation proposals are submitted for review and approval by KKR's valuation committees. As of December 31, 2022, less than 3% of the total value of our Level III credit investments were not valued with the engagement of an independent valuation firm.For Level III investments in Asset Management, KKR has a global valuation committee that is responsible for coordinating and implementing the firm's valuation process to ensure consistency in the application of valuation principles across portfolio investments and between periods. The global valuation committee is assisted by the asset class-specific valuation committees that exist for private equity (including core equity investments and certain impact investments), growth equity (including certain impact investments), real estate, energy, infrastructure and credit. The asset class-specific valuation committees are responsible for the review and approval of all preliminary Level III valuations in their respective asset classes on a quarterly basis. The members of these valuation committees are comprised of investment professionals, including the heads of each respective strategy, and professionals from business operations functions such as legal, compliance and finance, who are not primarily responsible for the management of the investments. All Level III valuations for investments in Asset Management are also subject to approval by the global valuation committee, which is comprised of senior employees including investment professionals and professionals from business operations functions, and includes KKR's Co-Chief Executive Officers and its Chief Financial Officer, Chief Legal Officer, General Counsel, and Chief Compliance Officer. When valuations are approved by the global valuation committee after reflecting any input from it, the valuations of Level III investments, as well as the valuations of Level I and Level II investments, are presented to the Audit Committee of the Board of Directors of KKR & Co. Inc. and are then reported to the Board of Directors.Level III investments held by Global Atlantic are valued on the basis of pricing services, broker-dealers or internal models. Global Atlantic performs a quantitative and qualitative analysis and review of the information and prices received from independent pricing services as well as broker-dealers to verify that it represents a reasonable estimate of fair value. As of December 31, 2022, approximately 87% of these investments were priced via external sources, while approximately 13% were valued on the basis of internal models. For all the internally developed models, Global Atlantic seeks to verify the reasonableness of fair values by analyzing the inputs and other assumptions used. These preliminary valuations are reviewed, based on certain thresholds, by an independent valuation firm engaged by Global Atlantic to perform certain procedures in order to assess the reasonableness of Global Atlantic's valuations. When valuations are approved by Global Atlantic's management, the valuations of its Level III investments, as well as the valuations of Level I and Level II investments, are presented to the Audit Committee of the Board of Directors of KKR & Co. Inc. and are then reported to the Board of Directors.As of December 31, 2022, upon completion by, where applicable, independent valuation firms of certain limited procedures requested to be performed by them on certain Level III investments, the independent valuation firms concluded that the fair values, as determined by KKR (including Global Atlantic), of those investments reviewed by them were reasonable. The limited procedures did not involve an audit, review, compilation or any other form of examination or attestation under generally accepted auditing standards and were not conducted on all Level III investments. We are responsible for determining the fair value of investments in good faith, and the limited procedures performed by an independent valuation firm are supplementary to the inquiries and procedures that we are required to undertake to determine the fair value of the commensurate investments. As described above, Level II and Level III investments were valued using internal models with significant unobservable inputs, and our determinations of the fair values of these investments may differ materially from the values that would have resulted if readily observable inputs had existed. Additional external factors may cause those values, and the values of investments for which readily observable inputs exist, to increase or decrease over time, which may create volatility in our earnings and the amounts of assets and stockholders' equity that we report from time to time.Changes in the fair value of investments impacts the amount of carried interest that is recognized as well as the amount of investment income that is recognized for investments held directly in Asset Management and through our consolidated funds as described below. We estimate that an immediate 10% decrease in the fair value of investments held directly and through consolidated investment funds generally would result in a commensurate change in the amount of net gains (losses) from investment activities for investments held directly and through investment funds and a more significant impact to the amount of 203Table of Contentscarried interest recognized, regardless of whether the investment was valued using observable market prices or management estimates with significant unobservable pricing inputs. With respect to consolidated investment funds, the impact that the consequential decrease in investment income would have on net income attributable to KKR would generally be significantly less than the amount described above, given that a majority of the change in fair value of our consolidated funds would be attributable to noncontrolling interests and therefore we are only impacted to the extent of our carried interest and our balance sheet investments. With respect to Insurance, a decrease in investment income for certain assets where investment gains and losses are recognized through the statement of operations would impact KKR only to the extent of our economic ownership interest in Global Atlantic.As of December 31, 2022, there were no investments which represented greater than 5% of total investments on a GAAP basis. On a non-GAAP basis, as of December 31, 2022, investments which represented greater than 5% of total non-GAAP investments consisted of USI, Inc. and PetVet Care Centers, LLC and valued at $1,300 million and $1,143 million, respectively. Our investment income on a GAAP basis and our book value can be impacted by volatility in the public markets related to our holdings of publicly traded securities, including our sizable holdings of Crescent Energy. See "—Business Environment" for a discussion of factors that may impact the valuations of our investments, financial results, operating results and valuations, and "—Non-GAAP Balance Sheet Measures" for additional information regarding our largest holdings on a non-GAAP basis.Business CombinationsKKR accounts for business combinations using the acquisition method of accounting, under which the purchase price of the acquisition is allocated to the assets acquired and liabilities assumed using the fair values determined by management as of the acquisition date. Management’s determination of fair value of assets acquired and liabilities assumed at the acquisition date is based on the best information available in the circumstances and may incorporate management’s own assumptions and involve a significant degree of judgment. We use our best estimates and assumptions to accurately assign fair value to the tangible and identifiable intangible assets acquired and liabilities assumed at the acquisition date as well as the useful lives of those acquired intangible assets. Examples of critical estimates in valuing certain of the intangible assets we have acquired include, but are not limited to, future expected cash inflows and outflows, future fundraising assumptions, expected useful life, discount rates and income tax rates. Our estimates for future cash flows are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates we are using to manage the underlying assets acquired. We estimate the useful lives of the intangible assets based on the expected period over which we anticipate generating economic benefit from the asset. We base our estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. Unanticipated events and circumstances may occur that could affect the accuracy or validity of such assumptions, estimates or actual result.Income TaxesSignificant judgment is required in estimating the provision for (benefit from) income taxes, current and deferred tax balances (including valuation allowance), accrued interest or penalties and uncertain tax positions. In evaluating these judgments, we consider, among other items, projections of taxable income (including the character of such income), beginning with historic results and incorporating assumptions of the amount of future pretax operating income. These assumptions about future taxable income require significant judgment and are consistent with the plans and estimates that KKR uses to manage its business. As of December 31, 2022, a portion of the deferred tax assets are not considered to be more likely than not to be realized. For that portion of the deferred tax assets for Global Atlantic, a valuation allowance has been recorded. Revisions in estimates and/or actual costs of a tax assessment may ultimately be materially different from the recorded accruals and unrecognized tax benefits, if any. Please see Note 19 "Income Taxes" in our financial statements in this report for further details. Critical Accounting Policies and Estimates - Asset ManagementRevenuesFees and OtherFees and other consist primarily of (i) management and incentive fees from providing investment management services to unconsolidated funds, CLOs, other vehicles, and separately managed accounts; (ii) transaction fees earned in connection with successful investment transactions and from capital markets activities; (iii) monitoring fees from providing services to portfolio companies; (iv) expense reimbursements from certain investment funds and portfolio companies; and (v) consulting fees. These 204Table of Contentsfees are based on the contractual terms of the governing agreements and are recognized when earned, which coincides with the period during which the related services are performed and in the case of transaction fees, upon closing of the transaction. Monitoring fees may provide for a termination payment following an initial public offering or change of control. These termination payments are recognized in the period when the related transaction closes.Transaction fee calculations and management fee calculations based on committed capital or invested capital typically do not require discretion and therefore do not require the use of significant estimates or judgments. Management fee calculations based on net asset value depend on the fair value of the underlying investments within the investment vehicles. Estimates and assumptions are made when determining the fair value of the underlying investments within the funds and could vary depending on the valuation methodology that is used as well as economic conditions.Capital Allocation-Based Income (Loss)Capital allocation-based income (loss) is earned from those arrangements whereby KKR serves as general partner and includes income or loss from KKR's capital interest as well as "carried interest" which entitles KKR to a disproportionate allocation of investment income or loss from an investment fund's limited partners. Carried interest is recognized upon appreciation of the funds’ investment values above certain return hurdles set forth in their partnership agreement. KKR recognizes revenues attributable to capital allocation-based income based upon the amount that would be due pursuant to the fund partnership agreement at each period end as if the funds were terminated at that date. Accordingly, the amount recognized reflects KKR’s share of the gains and losses of the associated funds’ underlying investments measured at their then-current fair values relative to the fair values as of the end of the prior period. Because of the inherent uncertainty in measuring the fair value of investments in the absence of observable market prices as previously discussed, these estimated values may differ significantly from the values that would have been used had a ready market for the investments existed, and it is reasonably possible that the difference could be material. ExpensesCompensation and BenefitsCompensation and Benefits expense includes (i) base cash compensation consisting of salaries and wages, (ii) benefits, (iii) carry pool allocations, (iv) equity-based compensation and (v) discretionary cash bonuses.To supplement base cash compensation, benefits, carry pool allocations, and equity-based compensation, we typically pay discretionary cash bonuses, which are included in Compensation and Benefits expense in the consolidated statements of operations, based principally on the level of (i) management fees and other fee revenues (including incentive fees), (ii) realized carried interest and (iii) realized investment income earned during the year. The amounts paid as discretionary cash bonuses, if any, are at our sole discretion and vary from individual to individual and from period to period, including having no cash bonus. We accrue discretionary cash bonuses when payment becomes probable and reasonably estimable which is generally in the period when we make the decision to pay discretionary cash bonuses and is based upon a number of factors, including the recognition of fee revenues, realized carried interest, realized investment income and other factors determined during the year.Beginning in 2021, we expect to pay our employees by assigning a percentage range to each component of asset management segment revenues. Based on the current components and blend of our asset management segment revenues on an annual basis, we expect to use approximately: (i) 20‐25% of fee related revenues, (ii) 60‐70% of realized carried interest and incentive fees not included in fee related performance revenues or earned from our hedge fund partnerships, and (iii) 10‐20% of realized investment income and hedge fund partnership incentive fees to pay our asset management employees. Because these ranges are applied to applicable asset management segment revenue components independently, and on an annual basis, the amount paid as a percentage of total asset management segment revenue will vary and will, for example, likely be higher in a period with relatively higher realized carried interest and lower in a period with relatively lower realized carried interest. We decide whether to pay a discretionary cash bonus and determine the percentage of applicable revenue components to pay compensation only upon the occurrence of the realization event. There is no contractual or other binding obligation that requires us to pay a discretionary cash bonus to the asset management employees, except in limited circumstances.Assuming that we had accrued compensation of (i) 65% of the unrealized carried interest earned by the funds that allocate 40% and 43% to the carry pool and (ii) 15% of the unrealized net gains in our Principal Activities business line (in each case at the mid-point of the ranges above), KKR & Co. Inc. Stockholders’ Equity – Common Stock as of December 31, 2022 would have been reduced by approximately $1.46 per share, compared to our reported $19.29 per share on such date, and our book value as of December 31, 2022 would have been reduced by approximately $1.42 per adjusted share, compared to our reported book value of $26.73 per adjusted share on such date.205Table of ContentsCarry Pool AllocationWith respect to our funds that provide for carried interest, we allocate a portion of the realized and unrealized carried interest that we earn to a carry pool established at KKR Associates Holdings L.P., which is not a KKR subsidiary, from which our asset management employees and certain other carry pool participants are eligible to receive a carried interest allocation. The allocation is determined based upon a fixed arrangement between KKR Associates Holdings and us, and we do not exercise discretion on whether to make an allocation to the carry pool upon a realization event. These amounts are accounted for as compensatory profit sharing arrangements in Accrued Expenses and Other Liabilities within the accompanying consolidated statements of financial condition in conjunction with the related carried interest income and are recorded as compensation expense. Upon a reversal of carried interest income, the related carry pool allocation, if any, is also reversed. Accordingly, such compensation expense is subject to both positive and negative adjustments.In February 2021, with the approval of a majority of our independent directors, KKR amended the percentage of carried interest that is allocable to the carry pool to 65% for (i) current investment funds for which no or de minimis amounts of carried interest was accrued as of December 31, 2020 and (ii) all future funds. For all other funds, the percentage of carried interest remains 40% or 43%, as applicable. The percentage of carried interest allocable to the carry pool may be increased above 65% only with the approval of a majority of our independent directors. To account for the difference in the carry pool allocation percentages, we expect to use a portion of realized carried interest from the older funds equal to the difference between 65% and 40% or 43%, as applicable, to supplement the carry pool and to pay amounts as discretionary cash bonus compensation as described above to our asset management employees. The amounts paid as discretionary cash bonuses, if any, are at our discretion and vary from individual to individual and from period to period, including having no cash bonus at all for certain employees. See "—Revenues—Capital Allocation-Based Income (Loss)" and "—Compensation and Benefits" above.On the Sunset Date (which will not be later than December 31, 2026), KKR will acquire control of KKR Associates Holdings and will commence making decisions regarding the allocation of carry proceeds pursuant to the limited partnership agreement of KKR Associates Holdings. Until the Sunset Date, our Co-Founders will continue to make decisions regarding the allocation of carry proceeds to themselves and others, pursuant to the limited partnership agreement of KKR Associates Holdings, provided that any allocation of carry proceeds to the Co-Founders will be on a percentage basis consistent with past practice. For additional information about the Sunset Date and the Reorganization Agreement, please see "Certain Relationships and Related Transactions, and Director Independence" in this report.Equity-based CompensationIn addition to the cash-based compensation and carry pool allocations as described above, employees receive equity awards under our Equity Incentive Plans, most of which are subject to service-based vesting typically over a three to five-year period from the date of grant, and some of which are also subject to the achievement of market-based conditions. Certain of these awards are subject to post-vesting transfer restrictions and minimum retained ownership requirements.Compensation expense relating to the issuance of equity-based awards is measured at fair value on the grant date. In determining the aggregate fair value of any award grants, we make judgments as to the grant-date fair value, particularly for certain restricted units with a vesting condition based upon market conditions, whose grant date fair values are based on a probability distributed Monte-Carlo simulation. See Note 20 "Equity Based Compensation,” in our financial statements included in this report for further discussion and activity of these awards.Investment Income (Loss) -Net Gains (Losses) from Investment ActivitiesNet gains (losses) from investment activities consist of realized and unrealized gains and losses arising from our investment activities as well as income earned from certain equity method investments. Fluctuations in net gains (losses) from investment activities between reporting periods is driven primarily by changes in the fair value of our investment portfolio as well as the realization of investments. The fair value of, as well as the ability to recognize gains from, our investments is significantly impacted by the global financial markets, which, in turn, affects the net gains (losses) from investment activities recognized in any given period. Upon the disposition of an investment, previously recognized unrealized gains and losses are reversed and an offsetting realized gain or loss is recognized in the current period. Since our investments are carried at fair value, fluctuations between periods could be significant due to changes to the inputs to our valuation process over time. For a further discussion of our fair value measurements and fair value of investments, see the above "—Critical Accounting Policies and Estimates—Fair Value Measurements."206Table of ContentsCritical Accounting Policies and Estimates – InsurancePolicy liabilitiesPolicy liabilities (collectively, "reserves,") are the portion of past premiums or assessments received that are set aside to meet future policy and contract obligations as they become due. Interest accrues on the reserves and on future premiums, which may also be available to pay for future obligations. Global Atlantic establishes reserves to pay future policy benefits, claims, and certain expenses for its life policies and annuity contracts.Global Atlantic's reserves are estimated based on models that include many actuarial assumptions and projections. These assumptions and projections, which are inherently uncertain, involve significant judgment, including assumptions as to the levels and/or timing of premiums, benefits, claims, expenses, interest credits, investment results (including equity market returns), credit spreads, mortality, longevity, and persistency.The assumptions on which reserves are based are intended to represent an estimation of experience for the period that policy benefits are payable. Global Atlantic reviews the adequacy of its reserves and the assumptions underlying those reserves at least annually. Global Atlantic cannot, however, determine with precision the amount or the timing of actual benefit payments. If actual experience is better than or equal to the assumptions, then reserves would be adequate to provide for future benefits and expenses. If experience is worse than the assumptions, additional reserves may be required to meet future policy and contract obligations. This would result in a charge to our net income during the period in which excess benefits are paid or an increase in reserves occurs.For a majority of Global Atlantic's in-force policies, including its universal life policies and most annuity contracts, the base policy reserve is equal to the account value. For these products, the account value represents its obligation to repay to the policyholder the amounts held on deposit. However, there are several significant blocks of business where policy reserves, in addition to the account value, are explicitly calculated, including variable annuities, fixed-indexed annuities, universal life products with secondary guarantees, indexed universal life and preneed policies.Guaranteed minimum death benefits ("GMDB")Some of Global Atlantic's variable annuity and fixed-indexed annuity contracts contain a GMDB feature that provides a guarantee that the benefit received at death will be no less than a prescribed minimum amount, even if the account balance is reduced to zero. This amount is based on either the net deposits paid into the contract, the net deposits accumulated at a specified rate, the highest historical account value on a contract anniversary, or sometimes a combination of these values. If the GMDB is higher than the current account value at the time of death, Global Atlantic incurs a cost equal to the difference.Guaranteed minimum withdrawal benefits ("GMWB")Global Atlantic issues fixed-indexed annuity and variable annuity contracts with a guaranteed minimum withdrawal feature. GMWB are an optional benefit where the contract owner is entitled to withdraw a maximum amount of their benefit base each year.Once exercised, living benefit features provide annuity policyholders with a minimum guaranteed stream of income for life. A policyholder’s annual income benefit is generally based on an annual withdrawal percentage multiplied by the benefit base. The benefit base is defined in the policy and is generally the initial premium, reduced by any partial withdrawals and increased by a defined percentage, formula or index credits. Any living benefit payments are first deducted from the account value. Global Atlantic is responsible for paying any excess guaranteed living benefits still owed after the account value has reached zero.The ultimate cost of these benefits will depend on the level of market returns and the level of contractual guarantees, as well as policyholder behavior, including surrenders, withdrawals, and benefit utilization. For fixed-indexed annuity products, costs also include certain non-guaranteed terms that impact the ultimate cost, such as caps on crediting rates that Global Atlantic can, in its discretion, reset annually.207Table of ContentsGMDB and GMWB sensitivitiesAs of December 31, 2022, the GMDB and GMWB liability balance totaled $1.3 billion. As of December 31, 2022, the liability balances for GMDB were $36.0 million for fixed-indexed annuities and $33.8 million for variable annuities. As of December 31, 2022, the liability balances for GMWB were $1.2 billion for fixed-indexed annuities. The increase (decrease) to the GMDB and GMWB liability balance as a result of hypothetical changes in projected assessments, equity market prices, and annual equity growth is summarized in the table below. This sensitivity considers the direct effect of such changes only and not changes in any other assumptions used in or items considered in the measurement of such balances.December 31, 2022($ in thousands)Balance$1,252,206 Hypothetical change:'+10% future assessments(1)(27,887)'-10% future assessments(1)31,696 +10% equity market prices(18,298)-10% equity market prices9,730 1% lower annual equity growth4,918 ________________Note: Hypothetical changes to the liability balance do not reflect the impact of related hedges.(1)The assessments used to accrue liabilities are generally based on investment yields, realized gains and losses, rider charges, surrender charges, and asset-based fees, such as mortality and expense fees.Embedded derivativesGlobal Atlantic's fixed-indexed annuity, variable annuity and indexed universal life products contain equity-indexed features, which are considered embedded derivatives and are required to be measured at fair value.The embedded derivative is calculated as the present value of future projected benefits in excess of the projected guaranteed benefits, using an option budget as the indexed account value growth rate. In addition, the fair value of the embedded derivative is reduced to reflect the risk of non-performance on Global Atlantic's obligations (i.e., own credit risk).Changes in interest rates, future index credits, Global Atlantic's own credit risk, projected withdrawal and surrender activity, and mortality on fixed-indexed annuity and indexed universal life contracts can have a significant impact on the value of the embedded derivative.Valuation of embedded derivatives – Fixed-indexed annuitiesFixed-indexed annuity contracts allow the policyholder to elect a fixed interest rate of return or a market indexed strategy where interest credited is based on the performance of an index, such as the S&P 500 Index, or other indexes. The market indexed strategy is an embedded derivative, similar to a call option. The fair value of the embedded derivative is computed as the present value of benefits attributable to the excess of the projected policy contract values over the projected minimum guaranteed contract values. The projections of policy contract values are based on assumptions for future policy growth, which include assumptions for expected index credits, future equity option costs, volatility, interest rates, and policyholder behavior. The projections of minimum guaranteed contract values include the same assumptions for policyholder behavior as are used to project policy contract values. The embedded derivative cash flows are discounted using a risk-free interest rate adjusted by a non-performance risk spread tied to Global Atlantic's own credit rating. 208Table of ContentsValuation of embedded derivatives – Indexed universal lifeIndexed universal life products allow a policyholder’s account value to grow based on the performance of certain equity indexes, which result in an embedded derivative similar to a call option. The embedded derivative related to the index is bifurcated from the host contract and measured at fair value. The valuation of the embedded derivative is the present value of future projected benefits in excess of the projected guaranteed benefits, using the option budget as the indexed account value growth rate and the guaranteed interest rate as the guaranteed account value growth rate. Present values are based on discount rate curves determined at the valuation or issue date as well as assumed lapse and mortality rates. The discount rate equals the forecast treasury rate plus a non-performance risk spread tied to Global Atlantic’s own credit rating. Changes in discount rates and other assumptions such as spreads and/or option budgets can have a substantial impact on the embedded derivative.Valuation of embedded derivatives – Variable annuitiesVariable annuity contracts offered and assumed by Global Atlantic provide the contractholder with GMDB and/or GMWB. The liabilities for these benefits are included in policy liabilities in the consolidated statement of financial condition. The change in the liabilities for these benefits is included in policy benefits and claims in the consolidated statements of operation. Global Atlantic has issued variable annuity contracts with GMDB features. Global Atlantic elected the fair value option to measure the liability for certain of these variable annuity contracts, valued at $394.6 million as of December 31, 2022. Fair value is calculated as the present value of the estimated death benefits less the present value of the GMDB fees, using 1,000 risk neutral scenarios. Global Atlantic discounts the cash flows using U.S. Treasury rates plus an adjustment for its own credit risk.Global Atlantic also issues variable annuity contracts with a GMWB. The GMWB feature represents an embedded derivative. The embedded derivative is required to be bifurcated and measured at fair value. This liability is calculated as the present value of the excess GMWB claims less the present value of GMWB fees, using 1,000 risk neutral scenarios. Global Atlantic discounts the cash flows using U.S. Treasury rates plus an adjustment for its own company credit risk.As of December 31, 2022, the embedded derivative liability balance totaled $1.9 billion for fixed-indexed annuities, $337.9 million for indexed universal life and $2.3 million for variable annuities. As of December 31, 2022, variable annuities accounted for using the fair value option was $394.6 million. The increase (decrease) to the embedded derivatives on fixed-indexed annuity, indexed universal life, and variable annuity products and the increase (decrease) in the reserves for variable annuities accounted for using the fair value option as a result of hypothetical changes in interest rates, non-performance risk premium, and equity market prices is summarized in the table below. This sensitivity considers the direct effect of such changes only and not changes in any other assumptions used in or items considered in the measurement of such balances.As of December 31, 2022FIAIULVAVA (FVO)($ in thousands)Balance$1,853,031 $337,860 $2,335 $394,638 Hypothetical change:+50 bps interest rates(44,023)(5,524)(38,491)(20,995)-50 bps interest rates46,270 4,122 47,277 22,609 '+50bps non-performance risk premium(44,023)(5,524)(15,142)(13,534)'-50bps non-performance risk premium46,270 4,122 18,599 14,575 +10% equity market prices338,258 61,879 (25,892)(9,826)-10% equity market prices(166,396)(50,597)28,771 9,826 ________________Note: Hypothetical changes to the liability balances do not reflect the impact of related hedges.Valuation of embedded derivatives in modified coinsurance or funds withheldGlobal Atlantic's reinsurance agreements include modified coinsurance and coinsurance with funds withheld arrangements that include terms that require payment by the ceding company of a principal amount plus a return that is based on a proportion of the ceding company’s return on a designated portfolio of assets. Because the return on the funds withheld receivable or payable is not clearly and closely related to the host insurance contract, these contracts are deemed to contain embedded 209Table of Contentsderivatives, which are measured at fair value. Global Atlantic is exposed to both the interest rate and credit risk of the assets. Changes in discount rates and other assumptions can have a significant impact on this embedded derivative. The fair value of the embedded derivatives is included in the funds withheld receivable at interest and funds withheld payable at interest line items on the consolidated statement of financial condition. The change in the fair value of the embedded derivatives is recorded in net investment-related gains (losses) in the consolidated statement of operations.As of December 31, 2022, the embedded derivative balance for modified coinsurance or funds withheld arrangements was a $3,500 million net asset ($12.8 million in funds withheld receivables at interest, and $(3,487.8) million in funds withheld payable at interest). The increase (decrease) to the balance as a result of hypothetical changes in credit spreads and interest rates is summarized in the table below. This sensitivity considers the direct effect of such changes only and not changes in any other factors that impact the embedded derivative balance for modified coinsurance or funds withheld arrangements.As of December 31, 2022Embedded derivative on funds withheld receivable at interestEmbedded derivative on funds withheld payable at interest($ in thousands)Balance$12,785 $(3,487,766)Hypothetical change:+50 bps credit spreads(41,714)(781,981)-50 bps credit spreads41,714 849,203 +50 bps interest rates(12,880)(739,840)-50 bps interest rates18,078 807,062 ________________Note: Hypothetical changes to the funds withheld receivable and payable embedded derivative balances do not reflect the impact of related hedges or trading assets which back the funds withheld at interest.Recently Issued Accounting PronouncementsFor a full discussion of recently issued accounting pronouncements, see Note 2 "Summary of Significant Accounting Policies" in our financial statements.210Table of ContentsITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to market risks primarily relates to movements in the fair value of investments, including the effect that those movements have on our management fees, carried interest, and net gains from investment activities. The fair value of investments may fluctuate in response to changes in the values of investments, foreign currency exchange rates, and interest rates. Additionally, interest rate movements can adversely impact the amount of interest income we receive on credit instruments bearing variable rates and could also impact the amount of interest that we pay on debt obligations bearing variable rates. Following our acquisition of Global Atlantic, we expect to be affected by market risks arising from Global Atlantic’s business. Global Atlantic has material exposure to market volatility in interest rates, credit spreads, and equity prices through its insurance liabilities, many of which are structured to have exposure to market level changes, its investment portfolio and its hedge program. The quantitative information provided in this section was prepared using estimates and assumptions that management believes are appropriate. The actual impact of a hypothetical adverse movement in these risks could be materially different from the amounts shown below. Management of Market Risk Asset ManagementWhen we commit capital from our Principal Activities business line to investments or transactions, a balance sheet committee of senior employees, including our Co-Executive Chairmen, one of our Co-Chief Executive Officers, and the Chief Financial Officer, must approve the investment or transaction before it may be made. The committee has delegated authority to other senior employees to approve certain investments or transactions, subject to maximum commitment sizes or other limitations determined by the committee. In addition, this committee supervises activities governing KKR's capital structure, liquidity, and the composition of our balance sheet.Certain securities transactions by our capital markets business are subject to risk tolerance limits, regulatory capital requirements, and the review and approval of one or more committees in compliance with rules applicable to broker-dealers pursuant to the Exchange Act. When our capital is committed to capital markets transactions after diligence is conducted, such transactions are subject to the review and approval of a capital markets underwriting committee. These transactions are also subject to risk tolerance limits. The risk tolerance limits establish the level of investment we may make in a single company or type of transaction, for example, and are designed to avoid undue concentration and risk exposure. Regulatory capital requirements also place limits on the size of securities underwritings the capital markets business can conduct based on quantitative measure of assets, liabilities, and certain off-balance-sheet items. Aggregate balance sheet risk and capital deployed for transactions are monitored on an ongoing basis by the balance sheet committee referenced above.With respect to the funds and other investment vehicles through which we make investments for our fund investors, KKR manages risk by subjecting transactions to the review and approval of an applicable investment committee or portfolio manager; a portfolio management committee (or other designated senior employees) then regularly monitors these investments. Before making an investment, investment professionals identify risks in due diligence, evaluating, among other things, business, financial, legal and regulatory issues, financial data, and other information relevant to a particular investment. An investment team presents the investment and its identified risks to an investment committee or a portfolio manager, which must approve each investment before it may be made. If an investment is made, a portfolio management committee (or other designated senior employees) is responsible for working with our investment professionals to monitor the investment on an ongoing basis.InsuranceThe board of directors of TGAFG, which is the holding company for Global Atlantic, has established a risk committee that has primary oversight of market risk at Global Atlantic. This risk committee has adopted Global Atlantic’s risk appetite principles that form the foundation of Global Atlantic’s enterprise risk management program. The risk appetite principles include: (1) protect policyholders by seeking to maintain adequate capital and liquidity resources to honor its obligations to policyholders under situations reflecting stress scenarios calibrated to the worst modern economic cycles; (2) deliver value by remaining in a position of strength during periods of adverse market conditions, and (3) protect the franchise by identifying and cost-effectively managing risks that could adversely and materially impact franchise value. The Global Atlantic enterprise risk management program formalizes the review of financial and non-financial risks and establishes risk management controls. Global Atlantic monitors risks on an aggregate, legal entity and product basis, monitoring different factors, including financial and insurance, investment, hedge management, operational, and legal, compliance and regulatory risks to confirm that its risks remain within established risk limits and tolerances.For a discussion of Global Atlantic's hedge program, see "—Insurance Segment Market Risks—Hedge Program."211Table of ContentsManagement of General Business RiskAsset ManagementKKR has a risk and operations committee comprised of senior employees from across our Asset Management business and operations, and it includes our Chief Operating Officer, Chief Financial Officer, Chief Legal Officer, General Counsel, and Chief Compliance Officer. The risk and operations committee focuses on KKR's operations and enterprise risk management. This committee is aided by various other committees focused on the oversight of risks to our business, including a global conflicts and compliance committee. This committee focuses on the most significant operating and business risks, which includes, among others, regulatory, cyber, operational, geopolitical, and reputational risks. KKR has a global conflicts and compliance committee comprised of senior employees from across our Asset Management business and operations, and it includes, among others, our Chief Financial Officer, Chief Legal Officer, General Counsel and Chief Compliance Officer. The global conflicts and compliance committee focuses on new or potential conflicts of interest that may arise in KKR's business, including, but not limited to, conflicts relating to specific transactions as well as potential conflicts involving the overall activities of KKR and its various businesses. This committee also reviews and monitors certain compliance matters.KKR's technology and information security committee is responsible for reviewing and monitoring global technology risks including information security, business disruption and fraud related risks.In addition, KKR has other committees comprised of senior employees across our Asset Management business and operations that consider potential risks to our business.InsuranceThe TGAFG board of directors is responsible for oversight and the overall governance of Global Atlantic's business and operations. The TGAFG board includes among its members one of our Co-Chief Executive Officers. To assist with its oversight of Global Atlantic, the TGAFG board of directors has established an audit, risk, investment, operations & technology, nominating & governance, compensation and special transaction review committee.Asset Management Segment Market RisksThe following is a discussion of the significant market risk exposures for KKR's Asset Management business.Changes in Fair ValueThe majority of our investments as of December 31, 2022, are reported at fair value. Net changes in the fair value of investments impact the net gains (losses) from investment activities in our consolidated statements of operations. Based on investments held as of December 31, 2022, we estimate that an immediate 10% decrease in the fair value of investments generally would result in a commensurate change in the amount of net gains (losses) from investment activities (except that carried interest would likely be more significantly impacted), regardless of whether the investment was valued using observable market prices or management estimates with significant unobservable pricing inputs. The impact that the consequential decrease in investment income would have on net income attributable to KKR & Co. Inc. would generally be significantly less than the amount described above, given that a significant portion of the change in fair value would be attributable to noncontrolling interests and therefore we are only impacted to the extent of our carried interest and our balance sheet investments and to a lesser extent our management fees. Because of this, the quantitative information that follows represents the impact that a reduction to each of the income streams shown below would have on net income attributable to KKR & Co. Inc. before income taxes. The actual impact to individual line items within the consolidated statements of operations would differ from the amounts shown below as a result of (i) the elimination of management fees and carried interest as a result of the consolidation of certain investment funds and CFEs and (ii) the gross-up of net gains (losses) from investment activities, in each case as a result of the consolidation of certain investment funds and CFEs.212Table of ContentsBased on the fair value of investments as of December 31, 2022, we estimate that an immediate, hypothetical 10% decline in the fair value of investments would result in declines in net income attributable to KKR & Co. Inc. before income taxes in 2023 from reductions in the following items, if not offset by other factors:Management FeesCarried Interest, Net of Carry Pool AllocationNet Gains/(Losses) From Investment Activities Including General Partner Capital Interest($ in thousands)Hypothetical 10% Decline in Fair Value of Investments (1)$43,743 (2)$714,236 (3)$1,757,368 (3)(1)An immediate, hypothetical 10% decline in the fair value of investments would also impact our ability to earn incentive fees. Since the majority of our incentive fees are not subject to clawback, a 10% decline in fair value would generally result in the recognition of no incentive fees on a prospective basis and result in lower net income relative to prior years where such incentive fees may have been earned.(2)Represents an annualized reduction in management fees.(3)Decrease would impact our statement of operations in a single quarter. With respect to carried interest, for purposes of this analysis the impact of preferred returns are ignored.Management FeesOur management fees in our Private Equity and Real Assets business lines are generally calculated based on the amount of capital committed or invested by a fund, as described under "Business—Our Business—Private Equity" and "Business—Our Business—Real Assets." Accordingly, movements in the fair value of investments do not significantly affect the amount of fees we may charge in Private Equity and Real Assets funds. Management fees in our infrastructure funds are calculated based on the NAV of the fund and, in some cases, we additionally earn management fees on the fund's remaining commitment. In the case of our Credit and Liquid Strategies business line, management fees are often calculated based on the average NAV of the fund for that particular period, although certain funds in our Credit and Liquid Strategies business line have management fees based on the amount of capital invested. In the case of our CLO vehicles, management fees are calculated based on the collateral of the vehicle. The collateral is based on the par value of the investments and cash on hand.To the extent that management fees are calculated based on the NAV of the fund's investments, the amount of fees that we may charge will increase or decrease in direct proportion to the effect of changes in the fair value of the fund's investments. The proportion of our management fees that are based on NAV depends on the number and type of funds in existence. For the year ended December 31, 2022, the fund management fees that were recognized based on the NAV of the applicable funds was approximately 17%.Publicly Traded Securities Our investment funds and KKR's balance sheet hold certain investments in portfolio companies whose securities are publicly traded. The market prices of securities may be volatile and are likely to fluctuate due to a number of factors beyond our control. These factors include actual or anticipated fluctuations in the quarterly and annual results of such companies or of other companies in the industries in which they operate, market perceptions concerning the availability of additional securities for sale, general economic, social or political developments, industry conditions, changes in government regulation, shortfalls in operating results from levels forecasted by securities analysts, the general state of the securities markets and other material events, such as significant management changes, re-financings, acquisitions, and dispositions. In addition, although a substantial portion of our investments are comprised of investments in portfolio companies whose securities are not publicly traded, the value of these privately held investments may also fluctuate as our Level III investments are valued in part using a market comparables analysis. Consequently, due to similar factors beyond our control as described above for portfolio companies whose securities are publicly traded, the value of these Level III investments may fluctuate with market prices. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Business Environment."213Table of ContentsExchange Rate Risk Our investment funds, CLO vehicles, and KKR's balance sheet hold investments denominated in currencies other than the U.S. dollar. Those investments expose us and our fund investors to the risk that the value of the investments will be affected by changes in exchange rates between the currency in which the investments are denominated and the currency in which the investments are made. Additionally, a portion of our management fees are denominated in non-U.S. dollar currencies. Our policy is to reduce these risks by employing hedging techniques, including using foreign currency options and foreign exchange forward contracts to reduce exposure to future changes in exchange rates when a meaningful amount of capital has been invested in currencies other than the currencies in which the investments are denominated. Our primary exposure to exchange rate risk relates to movements in the value of exchange rates between the U.S. dollar and other currencies in which our investments are denominated (including euros, British pounds, Japanese yen, among others), net of the impact of foreign exchange hedging strategies. The quantitative information that follows represents the impact that a reduction to each of the income streams shown below would have on net income attributable to KKR & Co. Inc. before income taxes. The actual impact to individual line items within the statements of operations would differ from the amounts shown below as a result of (i) the elimination of carried interest as a result of the consolidation of certain investment funds and (ii) the gross-up of net gains (losses) from investment activities, in each case as a result of the consolidation of certain investment funds and CLO vehicles. We estimate that an immediate, hypothetical 10% decline in the exchange rates between the U.S. dollar and all of the major foreign currencies in which our investments were denominated as of December 31, 2022 (i.e., an increase in the value of the U.S. dollar against these foreign currencies) would result in declines in net income attributable to KKR & Co. Inc. before income taxes in 2023 from reductions in the following items, net of the impact of foreign exchange hedging strategies, if not offset by other factors:Carried Interest, Net of Carry Pool AllocationNet Gains/(Losses) From Investment Activities Including General Partner Capital Interest($ in thousands)Hypothetical 10% Decline in Foreign Currencies Against the U.S. Dollar (1)$110,914 (2)$231,732 (2)(1)An immediate, hypothetical 10% decline in exchange rates between the U.S. dollar and all of the major foreign currencies in which our investments were denominated would not be expected to materially impact our management fees or incentive fees. The majority of our funds in which we are entitled to earn incentive fees are denominated in U.S. dollars. Additionally, our management fees that are denominated in non-U.S. dollar currencies are generally hedged.(2)Decrease would impact our statement of operations in a single quarter. With respect to carried interest, for purposes of this analysis the impact of preferred returns are ignored.Interest Rate Risk Valuation of Investments Changes in credit markets and in particular, interest rates, can impact investment valuations, particularly our Level III investments, and may have offsetting results depending on the valuation methodology used. For example, we typically use a discounted cash flow analysis as one of the methodologies to ascertain the fair value of our investments that do not have readily observable market prices. If applicable interest rates rise, then the assumed cost of capital for those portfolio companies would be expected to increase under the discounted cash flow analysis, and this effect would negatively impact their valuations if not offset by other factors. Conversely, a fall in interest rates can positively impact valuations of certain portfolio companies if not offset by other factors. These impacts could be substantial depending upon the magnitude of the change in interest rates. In certain cases, the valuations obtained from the discounted cash flow analysis and the other primary methodology we use, the market multiples approach, may yield different and offsetting results. For example, the positive impact of falling interest rates on discounted cash flow valuations may offset the negative impact of the market multiples valuation approach and may result in less of a decline in value than for those investments that had a readily observable market price. Finally, low interest rates related to monetary stimulus and economic stagnation may also negatively impact expected returns on all investments, as the demand for relatively higher return assets increases and supply decreases. 214Table of ContentsInterest Income We and certain consolidated funds, including CLOs, hold credit investments that generate interest income based on variable interest rates. We are exposed to interest rate risk relating to investments that generate yield since a meaningful portion of credit investments held by us and our consolidated funds, including CLOs, earn income based on variable interest rates. The impact on net income attributable to KKR & Co. Inc. resulting from a decrease of a hypothetical 100 basis points in variable interest rates used in the recognition of interest income would not be expected to be material since a substantial portion of this decrease would be attributable to noncontrolling interests and CLO third party noteholders. Interest Expense We and certain consolidated funds, including CLOs, have debt obligations that include revolving credit agreements, certain investment financing arrangements and debt securities issued by CLO vehicles that accrue interest at variable rates. Changes in these rates would affect the amount of interest payments that our consolidated funds, including CLOs, would have to make. With respect to consolidated funds and CLOs, the impact on net income attributable to KKR & Co. Inc. resulting from an increase of a hypothetical 100 basis points in variable interest rates used in the recognition of interest expense would not be expected to be material since a substantial portion of this increase would be attributable to noncontrolling interests and third party CLO noteholders. With respect to debt obligations held by KKR and not in the consolidated funds or CLOs, as of December 31, 2022, KKR had debt obligations outstanding with an aggregate principal amount of approximately $258.5 million that accrues interest at a variable rate. Our policy is to reduce these risks by employing hedging techniques, including using interest rate swaps. The impact on net income attributable to KKR & Co. Inc. resulting from an increase of a hypothetical 100 basis points in variable interest rates used in the recognition of interest expense, net of the impact of interest rate hedging strategies, would not be expected to be material.Credit Risk We are party to agreements providing for various financial services and transactions that contain an element of risk in the event that the counterparties are unable to meet the terms of such agreements. In these agreements, we depend on these counterparties to make payment or otherwise perform. We generally endeavor to reduce our risk of exposure by limiting the counterparties with which we enter into financial transactions to reputable financial institutions. In addition, availability of financing from financial institutions may be uncertain due to market events, and we may not be able to access these financing markets. 215Table of ContentsInsurance Segment Market RisksThe following is a discussion of the significant market risk exposures for Global Atlantic.Hedge ProgramTo manage market risk, Global Atlantic established a hedge program that seeks to mitigate economic impacts primarily from interest rate and equity price movements, while taking into consideration accounting and capital impacts. For Global Atlantic's fixed-indexed annuity and indexed universal life policies, Global Atlantic generally seeks to use static hedges to offset the exposure primarily created by changes in embedded derivative balances. For Global Atlantic's variable annuity policies, Global Atlantic generally seeks to dynamically hedge its exposure to changes in the value of the guarantee Global Atlantic provides to policyholders. In the context of specific reinsurance or other transactions in Global Atlantic's institutional channel or strategic acquisitions, Global Atlantic may also enters into hedges which are designed to limit short-term market risks to the economic value of the target assets. From time to time, Global Atlantic also enters into hedges designed to limit the volatility associated with changes in the value of its general account assets or changes to net investment income as a result of interest rate or credit spread movements, while also taking into consideration economic impacts. While not the primary focus of its hedging strategy, Global Atlantic also enters into currency swaps and forwards to manage foreign exchange rate risks with respect to certain investments denominated in foreign currencies. Global Atlantic also enters into inflation swaps to manage inflation risk associated with inflation-indexed preneed policies. Where Global Atlantic has derivative instruments that are designated and qualify as accounting hedges, these derivative instruments receive hedge accounting.Global Atlantic's hedge program is not designed to, and may not be effective in, offsetting all impacts to net income, assets under management, statutory capital or economic values. Movements in market variables other than interest rates and equity market prices that are not explicitly hedged can also cause net income volatility. See "Risk Factors—Risks Related to Global Atlantic—Business Risks Related to Global Atlantic—Global Atlantic's use of derivative financial instruments within its risk management strategy may not be effective or sufficient." and "Risk Factors—Risks Related to Global Atlantic—Business Risks Related to Global Atlantic—Global Atlantic may experience volatility in its net income under GAAP due to its funds withheld coinsurance transactions" in this report.SensitivitiesGlobal Atlantic evaluates the sensitivity of net income to specific changes in interest rates, credit spreads and equity prices projected using internal models. All of the estimated sensitivities assume that all other factors remain constant and reflect the impact of related hedges assuming no hedge rebalancing in Global Atlantic's dynamic program, as explained further below.Global Atlantic's internal models project impacts as of a specific date, and are measured relative to a starting level reflecting its assets and liabilities at that date and the actuarial factors, investment activity, and assumed investment returns associated with insurance liabilities. The models measure the impact of changing one factor at a time and assume that all other factors remain unchanged. Actual results can differ significantly from these estimates for a variety of reasons, including the interaction among these factors when more than one changes, discretionary actions by management in response to such changes, differences between the return of the underlying fund and the return on the index being hedged, actual experience differing from the assumptions, changes in business mix, effective tax rates and other market factors, and limitations inherent in the use of models. For these reasons, the sensitivities should only be viewed as directional estimates of the impacts on Global Atlantic's net income and shareholders’ equity, excluding accumulated other comprehensive income ("AOCI"), and actual changes in response to such scenarios may differ materially from estimates provided.For the dynamic portion of the hedge program, Global Atlantic primarily uses interest rate and equity futures to hedge liabilities which have option-like embedded derivatives. As such, Global Atlantic's program requires frequent rebalancing as markets move to ensure that the hedges are being re-sized to the new liability exposure. In addition, certain of the underlying variable annuity separate account funds are managed volatility funds, so Global Atlantic's market exposures may change substantially after sharp market moves. The point-in-time estimates provided in this section assume no hedge rebalancing and, as such, the impact on Global Atlantic's consolidated net income may be different from what is shown below.Interest rate riskGlobal Atlantic is exposed to interest rate risk as a result of changes in the level and volatility of interest rates. Changes in the level and volatility of interest rates primarily impacts the fair value reported in our consolidated financial statements of the following:216Table of Contents•embedded derivatives associated with modified coinsurance and coinsurance with funds withheld payables or receivables; •embedded derivatives associated with variable annuities, fixed-indexed annuities and indexed universal life products; •policy liabilities accounted under the fair value option, and•financial instruments held in Global Atlantic's investment portfolio and used in its hedge program.Changes in fair value of the foregoing are generally recorded as gains or losses in the consolidated statement of operations, or in the statement of comprehensive income for unrealized gains and losses on available for sale securities. For specific derivatives designated as cash flow hedges of forecasted bond purchases and receiving hedge accounting treatment, gains or losses are recorded in accumulated other comprehensive income and reclassified to net investment income following the qualifying purchases of available-for-sale securities, as an adjustment to the yield earned over the life of the purchased securities, using the effective interest method.Due to the dynamic lapse sensitivities within Global Atlantic's models, market volatility in interest rates also impacts the reserves and deferred acquisition costs of certain fixed annuity products, changes in which are recorded in the consolidated statement of operations.In periods following interest rate moves, Global Atlantic will also recognize a change in the income earned on certain of its floating-rate assets and the cost of funding on certain of Global Atlantic's liabilities recorded in the consolidated statement of operations.Effect of interest rate sensitivityIn the table below, Global Atlantic estimates the impact of a 50 basis point increase/(decrease) in interest rates, from a parallel shift in the yield curve, from levels as of December 31, 2022 to its net income and shareholders’ equity, excluding AOCI. These sensitivities include the impact of related hedges and adjustments to DAC attributable to interest rate changes. December 31, 2022Hypothetical change(1)+50 Basis points-50 Basis points($ in thousands)Total estimated net income and shareholders’ equity excluding AOCI sensitivity (point in time)$214,931 $(225,368)Total estimated net income and shareholders’ equity excluding AOCI sensitivity (over 12 months)(2)54,215 (54,215)(1)The point in time and over 12 months total estimated impacts reflect the impact of hedges within Global Atlantic's liability hedging program, as well as hedges designed to limit surplus volatility resulting from interest rate movements.(2)Excludes point in time impact. Estimated sensitivity to a hypothetical change over 12 months does not take into account any management actions that may be taken to mitigate actual impacts.The estimated point in time impact is driven by a net decrease/(increase) in the value of the embedded derivatives associated with Global Atlantic's modified coinsurance and coinsurance with funds withheld payables and receivables and the embedded derivatives associated with its variable annuity, fixed-indexed annuity and indexed universal life products, and largely offset by a loss/(gain) in financial instruments used in its hedging program, investments classified as trading, and loans designated under the fair value option, based on balances in place at quarter end. These estimated changes include the impact of related amortization of deferred revenue and expenses and related income tax impacts. In addition, the point in time impact includes a decrease/(increase) in the value of the reserve and (decrease)/increase in the deferred acquisition cost balance of certain fixed annuity blocks of business due to the dynamic lapse sensitivities within Global Atlantic's models.The impact over 12 months is driven by an increase/(decrease) in the income earned on Global Atlantic's floating rate assets, and partially offset by an increase/(decrease) in the cost of its floating-rate liabilities.217Table of ContentsIn the table below we estimate the impact of a 50 basis point increase/(decrease) in interest rates, for a parallel shift in the yield curve, from levels as of December 31, 2022 to Global Atlantic's AOCI.December 31, 2022Hypothetical change+50 Basis points-50 Basis points($ in thousands)Total estimated AOCI sensitivity (point in time)$(1,276,273)$1,351,119 The estimated point in time impact is driven by a net (decrease)/increase in the value of Global Atlantic's available-for-sale fixed maturity securities which are carried at fair value with unrealized gains and losses, net of certain offsets, reported in AOCI. The estimated changes include the impact of related amortization of deferred revenue and expenses and related income tax impacts.Credit spread riskGlobal Atlantic is exposed to credit spread risk as a result of changes in the spread between the yields on its funds withheld payables and receivables at interest and yields on comparable U.S. Treasury securities. Global Atlantic's reinsurance agreements include modified coinsurance and funds withheld coinsurance arrangements. Such arrangements are deemed to contain embedded derivatives, which are measured at fair value, and are therefore impacted by the mark-to-market value of the related assets. Changes in the credit spreads associated with the assets impact the mark-to-market value of the assets. There is additional credit spread risk exposure inherent in Global Atlantic's own credit spread used in valuing embedded derivative liabilities, which serves to mitigate net credit exposure. Global Atlantic may choose to enter into hedge positions to manage credit spread risk. As of December 31, 2022, Global Atlantic had a $929 thousand credit derivative position.Effect of credit spread sensitivityIn the table below, Global Atlantic estimates the impact of a 50 basis points increase/(decrease) in credit spreads from levels as of December 31, 2022 to its net income and shareholders’ equity, excluding AOCI. These estimated changes include the impact of related amortization of deferred revenues and expenses and related income tax impacts and include impacts on our own credit spread used in valuing embedded derivative liabilities.December 31, 2022Hypothetical change+50 Basis points-50 Basis points($ in thousands)Total estimated net income and shareholders’ equity excluding AOCI sensitivity (point in time)$236,276 $(250,355)Equity price riskGlobal Atlantic is exposed to equity price risk as a result of changes in the level and volatility of equity prices.Changes in the level and volatility of equity prices primarily impacts the fair value reported in the consolidated financial statements of the following:•embedded derivatives and policy liabilities associated with Global Atlantic's variable annuities, fixed-indexed annuities and indexed universal life products; •financial instruments held in Global Atlantic's investment portfolio and used in its hedge program; and•certain of Global Atlantic's alternative assets.Changes in fair value of the foregoing are recorded as gains or losses in our consolidated statements of operations.In addition, certain of the fees Global Atlantic earns, and benefits Global Atlantic pays in its variable annuity and variable universal life blocks are calculated on the account values, which are exposed to equity price risk. These changes impact our net income over the periods following equity price moves.218Table of ContentsEffect of equity price sensitivityIn the table below, Global Atlantic estimates the impact of a 10% increase/(decrease) in equity prices from levels as of December 31, 2022 to its net income and shareholders’ equity, excluding AOCI. These sensitivities include the impact of related hedges but exclude the potential impact of alternative assets, because the fair value of these investments do not necessarily move directly in line with movements in public equity markets.December 31, 2022Hypothetical change(1)+10% Equity Prices-10% Equity Prices($ in thousands)Total estimated net income and shareholders’ equity excluding AOCI sensitivity (point in time)$(24,425)$40,929 Total estimated net income and shareholders’ equity excluding AOCI sensitivity (over 12 months)(2)4,442 (4,834)(1)From time to time, Global Atlantic may choose to enter into additional hedges to mitigate economic exposure to equity markets.(2)Excludes point in time impact. Estimated sensitivity to a hypothetical change over 12 months does not take into account any management actions that may be taken to mitigate actual impacts. The estimated point-in-time impact is driven by an increase/(decrease) in the value of the embedded derivatives associated with Global Atlantic's fixed-indexed annuity and indexed universal life products, and largely offset by a decrease / (increase) in Global Atlantic's variable annuity embedded derivatives and policy benefits, and gains or losses on financial instruments used in Global Atlantic's hedging program. These estimated changes include the impact of related amortization of deferred revenue and expenses and related income tax impacts.For a discussion of current market conditions, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Business Environment." 219Table of Contents
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+ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations This section of this Annual Report on Form 10-K generally discusses the years ended December 31, 2022 and 2021 and year-over-year comparisons between the years ended December 31, 2022 and 2021. Discussions of the periods prior to the year ended December 31, 2021 that are not included in this Annual Report on Form 10-K are found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021 and the discussion therein for the year ended December 31, 2021 compared to the year ended December 31, 2020 is incorporated by reference into this Annual Report. This Annual Report on Form 10-K contains the names of some of our owned or licensed trademarks, trade names and service marks, which we refer to as our brands. All of the product names included in this Annual Report on Form 10-K are either our registered trademarks or those of our licensors.OVERVIEWKDP is a leading beverage company in North America, with a diverse portfolio of flavored CSDs, NCBs, including water (enhanced and flavored), RTD tea and coffee, juice, juice drinks, mixers and specialty coffee, and is a leading producer of innovative single serve brewers. With a wide range of hot and cold beverages that meet virtually any consumer need, KDP key brands include Keurig, Dr Pepper, Canada Dry, Snapple, Mott's, Clamato, Core, Green Mountain Coffee Roasters and The Original Donut Shop. KDP has some of the most recognized beverage brands in North America, with significant consumer awareness levels and long histories that evoke strong emotional connections with consumers. KDP offers more than 125 owned, licensed and partner brands, including the top ten best-selling coffee brands and Dr Pepper as a leading flavored CSD in the U.S. according to IRi, available nearly everywhere people shop and consume beverages. KDP operates as an integrated brand owner, manufacturer and distributor. We believe our integrated business model strengthens our route-to-market and provides opportunities for net sales and profit growth through the alignment of the economic interests of our brand ownership and our manufacturing and distribution businesses through both our DSD system and our WD system. KDP markets and sells its products to retailers, including supermarkets, mass merchandisers, club stores, pure-play e-commerce retailers, and office superstores; to restaurants, hotel chains, office product and coffee distributors, and partner brand owners; and directly to consumers through its website. Our integrated business model enables us to be more flexible and responsive to the changing needs of our large retail customers and allows us to more fully leverage our scale and reduce costs by creating greater geographic manufacturing and distribution coverage.SEGMENTSAs of December 31, 2022, our reportable segments were as follows:•The Coffee Systems segment reflects sales in the U.S. and Canada of the manufacture and distribution of finished goods relating to our single-serve brewers, K-Cup pods and other coffee products.•The Packaged Beverages segment reflects sales in the U.S. and Canada from the manufacture and distribution of finished beverages and other products, including sales of our own brands and third-party brands, through both the DSD and WD systems.•The Beverage Concentrates segment reflects sales primarily in the U.S. and Canada of our branded concentrates to third-party bottlers and our syrup to fountain foodservice customers. Most of the brands in this segment are carbonated soft drink brands.•The Latin America Beverages segment reflects sales primarily in Mexico and the Caribbean from the manufacture and distribution of concentrates, syrup and finished beverages.25Table of ContentsVOLUMEIn evaluating our performance, we consider different volume measures depending on whether we sell beverage concentrates, finished beverages, pods or brewers.Coffee Systems K-Cup Pod and Appliance Sales VolumeIn our Coffee Systems segments, we measure our sales volume as the number of appliances and the number of individual K-Cup pods sold to our customers.Packaged Beverages and Latin America Beverages Sales VolumeIn our Packaged Beverages and Latin America Beverages segments, we measure volume as case sales to customers. A case sale represents a unit of measurement equal to 288 fluid ounces of packaged beverage sold by us. Case sales include both our owned brands and certain brands licensed to and/or distributed by us.Beverage Concentrates Sales VolumeIn our Beverage Concentrates segment, we measure our sales volume as concentrate case sales for concentrates sold by us to our bottlers and distributors. A concentrate case is the amount of concentrate needed to make one case of 288 fluid ounces of finished beverage, the equivalent of 24 twelve ounce servings. It does not include any other component of the finished beverage other than concentrate. USE OF NON-GAAP FINANCIAL MEASURESNon-GAAP financial measures are provided in addition to U.S. GAAP measures, including adjusted income from operations, adjusted net income and adjusted diluted earnings per share. See Non-GAAP Financial Measures for more information, including reconciliations to the corresponding U.S. GAAP measures.26Table of ContentsEXECUTIVE SUMMARY Financial Overview As Reported, in millions (except Diluted EPS)As Adjusted, in millions (except Diluted EPS) On October 6, 2022, we announced a strategic partnership with Red Bull, the iconic global energy brand, to sell and distribute Red Bull Energy Drink products in Mexico, which began in the fourth quarter of 2022.On November 9, 2022, we invested $51 million, inclusive of incremental third-party costs, in exchange for equity interests in Athletic Brewing, a leading non-alcoholic craft beer maker in the U.S. On December 8, 2022, we announced a strategic partnership with Nutrabolt, a global active health and wellness company, to sell and distribute C4 Energy RTD beverages in the vast majority of our company-owned DSD territories. We invested $871 million, inclusive of incremental third-party costs, in exchange for an approximately 30% ownership interest in the company and expect to begin distributing C4 Energy RTD beverages in early 2023.As a result of our quarterly triggering events assessment and our annual impairment assessment, we recorded non-cash impairment charges of $472 million on indefinite-lived brands during the year ended December 31, 2022, led by Bai and Schweppes. Refer to Note 3 of the Notes to our Consolidated Financial Statements for further information.27Table of ContentsUncertainties and Trends Affecting Our BusinessWe believe the North American beverage market is influenced by certain key trends and uncertainties. Refer to Item 1A, Risk Factors, as well as the Uncertainties and Trends Affecting Liquidity section below, for more information about risks and uncertainties facing us. Some of these items, such as the ongoing COVID-19 pandemic and the invasion of Ukraine by Russia, and the resulting impacts on the global economy, including supply chain constraints and labor shortages, have led to inflation in input costs, logistics, manufacturing and labor costs, which has further led to fluctuation in interest rates. During the year ended December 31, 2022, we have experienced supply chain disruptions and a significant inflationary impact compared to the prior year. These impacts have created headwinds for our industry that we expect to continue into 2023. As a result of these inflationary pressures, we have increased the pricing on a number of our products across our portfolio. Consequently, we may incur a reduction of volume or net sales, which, combined with the inflationary pressures, could impact our margins and operating results.Refer to Note 5 of the Notes to our Consolidated Financial Statements and Item 7A, Quantitative and Qualitative Disclosures About Market Risk for management's discussion of how we manage our exposure to commodity risk. Impact of COVID-19 on our Financial StatementsThe following table sets forth our reconciliation of significant COVID-19-related expenses. Employee compensation expense and employee protection costs, which impact our SG&A expenses and cost of sales, are included as the COVID-19 item affecting comparability and are excluded in our Adjusted financial measures. In addition, reported amounts under U.S. GAAP also include additional costs, not included as the COVID-19 item affecting comparability, as presented in tables below.Items Affecting Comparability(1)(in millions)Employee Compensation Expense(2)Employee Protection Costs(3)Allowances for Expected Credit Losses(4)TotalFor the year ended December 31, 2022Coffee Systems$1 $5 $— $6 Packaged Beverages4 3 — 7 Beverage Concentrates— — — — Latin America Beverages— 1 — 1 Total$5 $9 $— $14 For the year ended December 31, 2021Coffee Systems$4 $16 $(2)$18 Packaged Beverages8 7 (8)7 Beverage Concentrates— — (3)(3)Latin America Beverages— 2 — 2 Total$12 $25 $(13)$24 (1)Employee compensation expense and employee protection costs are both included as the COVID-19 items affecting comparability in the reconciliation of our Adjusted Non-GAAP financial measures.(2)Amounts primarily included incremental benefits provided to frontline workers such as extended sick leave, in order to maintain essential operations during the COVID-19 pandemic.(3)Includes costs associated with personal protective equipment, temperature scans, cleaning and other sanitization services. Impacts both cost of sales and SG&A expenses.(4)Reflects reversal of allowances initially recorded in 2020 specifically related to the COVID-19 pandemic, driven by improving economic conditions during 2021.28Table of ContentsRESULTS OF OPERATIONSWe eliminate from our financial results all intercompany transactions between entities included in our consolidated financial statements and the intercompany transactions with our equity method investees.References in the financial tables to percentage changes that are not meaningful are denoted by "NM".Consolidated OperationsThe following table sets forth our consolidated results of operations for the years ended December 31, 2022 and 2021: For the Year Ended December 31,DollarPercentage(in millions, except per share amounts)20222021ChangeChangeNet sales$14,057 $12,683 $1,374 10.8 %Cost of sales6,734 5,706 1,028 18.0 Gross profit7,323 6,977 346 5.0 Selling, general and administrative expenses4,645 4,153 492 11.8 Impairment of intangible assets477 — 477 NMGain on litigation settlement(299)— (299)NMOther operating income, net(105)(70)(35)NMIncome from operations2,605 2,894 (289)(10.0)Interest expense693 500 193 38.6 Loss on early extinguishment of debt217 105 112 NMGain on sale of equity method investment(50)(524)474 NMImpairment of investments and note receivable12 17 (5)NMOther expense (income), net14 (2)16 NMIncome before provision for income taxes1,719 2,798 (1,079)(38.6)Provision for income taxes284 653 (369)(56.5)Net income including non-controlling interest1,435 2,145 (710)(33.1)Less: Net loss attributable to non-controlling interest(1)(1)— NMNet income attributable to KDP$1,436 $2,146 $(710)(33.1)%Earnings per common share: Basic$1.01 $1.52 $(0.51)(33.6)%Diluted1.01 1.50 (0.49)(32.7)%Gross margin52.1 %55.0 %(290) bpsOperating margin18.5 %22.8 %(430) bpsEffective tax rate16.5 %23.3 %(680) bpsSales Volume. The following table sets forth changes in sales volume for the year ended December 31, 2022 compared to the prior year:K-Cup pod volume1.4 %Brewer volume(5.2)%CSD sales volume1.5 %NCB sales volume1.3 %29Table of ContentsNet Sales. Net sales increased $1,374 million, or 10.8%, to $14,057 million for the year ended December 31, 2022 compared to $12,683 million in the prior year. This performance reflected favorable net price realization across all segments totaling 10.6% and volume/mix growth of 0.5%. These benefits were slightly offset by unfavorable FX translation of 0.3%.Gross Profit. Gross profit increased $346 million, or 5.0%, to $7,323 million for the year ended December 31, 2022 compared to $6,977 million in the prior year. This performance primarily reflected the strong growth in net sales and the benefit of productivity, partially offset by broad-based inflation and an unfavorable change in unrealized commodity mark-to-market impacts of $152 million. Gross margin decreased 290 bps versus the year ago period to 52.1%.Selling, General and Administrative Expenses. SG&A expenses increased $492 million, or 11.8%, to $4,645 million for the year ended December 31, 2022 compared to $4,153 million in the prior year. The increase reflected higher logistics costs, driven by both inflation and volume/mix impacts, increases in labor and other operating expenses, and an unfavorable comparison of unrealized mark-to-market losses of $55 million on commodity contracts.Impairment of Intangible Assets. Impairment of intangible assets reflected non-cash impairment charges of $477 million primarily driven by Bai and Schweppes. Refer to Note 3 of the Notes to our Consolidated Financial Statements for further information.Gain on litigation settlement. Gain on litigation settlement reflects the portion of the settlement payment from BodyArmor which was allocated to the gain on the full settlement of the existing claims against BodyArmor in the first quarter of 2022. Refer to Note 12 of the Notes to our Consolidated Financial Statements for further information. Other Operating Income, Net. Other operating income, net increased $35 million for the year ended December 31, 2022 compared to the prior year, primarily driven by the portion of the settlement payment from BodyArmor which was allocated to the recovery of legal fees incurred during the litigation process and a business interruption insurance recovery.Income from Operations. Income from operations decreased $289 million, or 10.0%, to $2,605 million for the year ended December 31, 2022 compared to $2,894 million in the prior year, primarily driven by the non-cash impairment charges of $477 million, which was partially offset by the gain on the litigation settlement. Other factors include higher SG&A expenses, partially offset by increased gross profit. Operating margin decreased 430 bps versus the year ago period to 18.5%.Interest Expense. Interest expense increased $193 million, or 38.6%, to $693 million for the year ended December 31, 2022 compared to $500 million for the prior year. This change was primarily driven by the unfavorable comparison of unrealized mark-to-market losses of $255 million on interest rate contracts, which was partially offset by reduced interest expense on our senior unsecured notes as a result of our strategic refinancing initiatives.Loss on Early Extinguishment of Debt. Loss on early extinguishment of debt reflected an unfavorable change of $112 million, with a loss of $217 million during the year ended December 31, 2022 related to our 2022 Strategic Refinancing and our early retirement of our 2038 Notes, the 2021 364-Day Credit Agreement and the KDP Revolver, as compared to a loss of $105 million in the prior year associated with our 2021 strategic refinancing.Gain on sale of equity method investment. For the years ended December 31, 2022 and 2021 we recorded $50 million and $524 million, respectively, for the sale of our equity method investment in BodyArmor. The amount recorded in 2022 represents the portion of the settlement payment from BodyArmor that was allocated to the satisfaction of the holdback amount owed to us. Refer to Note 12 of the Notes to our Consolidated Financial Statements for further information. Impairment of Investments and Note Receivable. Impairment on investments and note receivable reflected non-cash impairment charges of $12 million and $17 million for the years ended December 31, 2022 and 2021, respectively, associated with the wind-down of Bedford. Refer to Note 12 of the Notes to our Consolidated Financial Statements for further information. Effective Tax Rate. The effective tax rate decreased 680 bps to 16.5% for the year ended December 31, 2022, compared to 23.3% in the prior year, primarily driven by the revaluation of state deferred tax liabilities due to legislative changes and the favorable mix of our incremental income in low tax jurisdictions in the year.Net Income Attributable to KDP. Net income attributable to KDP decreased $710 million, or 33.1%, to $1,436 million for the year ended December 31, 2022 as compared to $2,146 million in the prior year, primarily driven by the unfavorable change in gain on sale of our equity method investment in BodyArmor, lower income from operations, increased interest expense, and the unfavorable change in loss on early extinguishment of debt, partially offset by the decrease in our effective tax rate.Diluted EPS. Diluted EPS decreased 32.7% to $1.01 per diluted share as compared to $1.50 in the prior year.30Table of ContentsResults of Operations by SegmentThe following tables set forth net sales and income from operations for our segments for the years ended December 31, 2022 and 2021, as well as the other amounts necessary to reconcile our total segment results to our consolidated results presented in accordance with U.S. GAAP:(in millions)For the Year Ended December 31,Segment Results — Net sales20222021Coffee Systems$4,982 $4,716 Packaged Beverages6,607 5,882 Beverage Concentrates1,725 1,486 Latin America Beverages743 599 Net sales$14,057 $12,683 For the Year Ended December 31,(in millions)20222021Segment Results — Income from Operations Coffee Systems$1,316 $1,446 Packaged Beverages1,014 1,023 Beverage Concentrates1,061 1,047 Latin America Beverages158 133 Unallocated corporate costs(944)(755)Income from operations$2,605 $2,894 COFFEE SYSTEMSThe following table provides selected information for our Coffee Systems segment for the years ended December 31, 2022 and 2021:For the Year Ended December 31,DollarPercentage(in millions)20222021ChangeChangeNet sales$4,982 $4,716 $266 5.6 %Income from operations1,316 1,446 (130)(9.0)%Operating margin26.4 %30.7 %(430) bpsSales Volume. Inclusive of the impact of the 53rd week, K-Cup pod volume increased 1.4% for the year ended December 31, 2022, which reflected the segment’s coffee recovery program to increase pod manufacturing output and rebuild finished goods inventories to satisfy consumer demand and restore customer service levels. Brewer volume decreased 5.2% in the year ended December 31, 2022, driven by the unfavorable comparison to brewer shipment growth of 10.0% in the prior year as appliance household penetration growth rates returned to expected long-term trends.Net Sales. Net sales increased 5.6% to $4,982 million for the year ended December 31, 2022 compared to $4,716 million in the prior year, driven by favorable net price realization of 7.0%, partially offset by volume/mix declines of 0.8% and unfavorable FX translation of 0.6%.Income from Operations. Income from operations decreased $130 million, or 9.0%, to $1,316 million for the year ended December 31, 2022, compared to $1,446 million in the prior year, as a result of broad-based inflation, particularly in green coffee and packaging and increases in other operating expenses. These decreases were partially offset by the benefits of net sales growth, productivity, favorable asset sale-leaseback activity of $44 million in the Coffee Systems segment associated with our strategic asset investment program and a business interruption insurance recovery. Operating margin declined 430 bps versus the prior year to 26.4%, primarily due to the aforementioned inflationary headwinds.31Table of ContentsPACKAGED BEVERAGESThe following table provides selected information for our Packaged Beverages segment for the years ended December 31, 2022 and 2021:For the Year Ended December 31,DollarPercentage(in millions)20222021ChangeChangeNet sales$6,607 $5,882 $725 12.3 %Income from operations1,014 1,023 (9)(0.9)%Operating margin15.3 %17.4 %(210) bpsSales Volume. Sales volume for the year ended December 31, 2022 decreased 0.5% compared to the prior year. Reductions in contract manufacturing more than offset growth in our branded portfolio, with strength in Motts, Core, Polar, Hawaiian Punch, and our CSD portfolio, partially offset by declines in Bai.Net Sales. Net sales increased 12.3% to $6,607 million in the year ended December 31, 2022, compared to $5,882 million in the prior year, driven by favorable net price realization of 12.1% and volume/mix growth of 0.3%, slightly offset by unfavorable FX translation of 0.1%.Income from Operations. Income from operations decreased $9 million, or 0.9%, to $1,014 million for the year ended December 31, 2022 compared to $1,023 million for the prior year, primarily driven by the $316 million non-cash impairment charges in the segment, predominantly related to Bai, which were partially offset by the gain on the settlement of litigation with BodyArmor of $271 million. Other offsetting factors included the benefits of net sales growth, productivity, and reduced restructuring and integration expense, partially offset by broad-based inflation, higher costs to serve the ongoing strong consumer demand, and the unfavorable year-over-year comparison in the Packaged Beverages segment of asset sale-leaseback activity associated with our strategic asset investment program. Operating margin declined 210 bps versus the prior year to 15.3%.BEVERAGE CONCENTRATESThe following table provides selected information for our Beverage Concentrates segment for the years ended December 31, 2022 and 2021:For the Year Ended December 31,DollarPercentage(in millions)20222021ChangeChangeNet sales$1,725 $1,486 $239 16.1 %Income from operations1,061 1,047 14 1.3 %Operating margin61.5 %70.5 %(900) bpsSales Volume. Sales volume for the year ended December 31, 2022 increased 1.6% compared to the prior year, primarily driven by Dr Pepper and Canada Dry, partially offset by Schweppes and Crush.Net Sales. Net sales increased 16.1% to $1,725 million in the year ended December 31, 2022, compared to $1,486 million in the prior year, reflecting higher net price realization of 14.7% and volume/mix growth of 1.7%, slightly offset by unfavorable FX translation effects of 0.3%. Income from Operations. Income from operations increased $14 million, or 1.3%, to $1,061 million for the year ended December 31, 2022 compared to $1,047 million in the prior year. This performance reflected the impact of strong net sales growth, partially offset by the non-cash impairment charges in the segment of $161 million, led by Schweppes, broad-based inflation and costs associated with the start-up and operation of our new manufacturing facility. Operating margin decreased 900 bps versus the prior year to 61.5%.32Table of ContentsLATIN AMERICA BEVERAGESThe following table provides selected information for our Latin America Beverages segment for the years ended December 31, 2022 and 2021:For the Year Ended December 31,DollarPercentage(in millions)20222021ChangeChangeNet sales$743 $599 $144 24.0 %Income from operations158 133 25 18.8 %Operating margin21.3 %22.2 %(90) bpsSales Volume. Sales volume for the year ended December 31, 2022 increased 7.2% versus the prior year, driven by strong in-market execution across the segment’s portfolio, with particular strength in Peñafiel and Squirt.Net Sales. Net sales grew 24.0% to $743 million for the year ended December 31, 2022, compared to $599 million in the prior year, reflecting favorable net price realization of 13.9%, volume/mix growth of 9.1%, and favorable FX translation of 1.0%.Income from Operations. Income from operations increased $25 million, or 18.8%, to $158 million for the year ended December 31, 2022 compared to $133 million in the prior year, driven by the benefits of net sales growth and productivity, partially offset by the impacts of broad-based inflation, logistics and operating costs associated with incremental volumes, and increased marketing expense. Operating margin decreased 90 bps versus the prior year to 21.3%.LIQUIDITY AND CAPITAL RESOURCESOverviewWe believe our financial condition and liquidity remain strong. We continue to manage all aspects of our business, including, but not limited to, monitoring the financial health of our customers, suppliers and other third-party relationships, implementing cost management strategies through our productivity initiatives, and developing new opportunities for growth such as innovation and agreements with partners to distribute brands that are accretive to our portfolio.The following summarizes our cash activity for the years ended December 31, 2022, 2021 and 2020:Cash, cash equivalents, restricted cash and restricted cash equivalents decreased $33 million from December 31, 2021 to December 31, 2022 primarily as a result of our investment in Nutrabolt, offset by proceeds from the cash settlement with BodyArmor.Cash generated by our foreign operations is generally repatriated to the U.S. periodically as working capital funding requirements where allowed. We do not expect restrictions or taxes on repatriation of cash held outside the U.S. to have a material effect on our overall business, liquidity, financial condition or results of operations for the foreseeable future . 33Table of ContentsAdditionally, in April 2022, we chose to undertake our 2022 Strategic Refinancing, issuing approximately $3 billion of senior unsecured notes and using the net proceeds to voluntarily prepay and retire several tranches of existing senior unsecured notes with higher interest rates, which reduced our overall interest payments and our annual cash requirements. As part of this transaction, we additionally unwound approximately $1.5 billion of notional amount of our outstanding designated forward starting swaps and received cash proceeds of approximately $125 million. Refer to Note 4 of the Notes to our Consolidated Financial Statements for further information about the 2022 strategic refinancing initiative.Principal Sources of Capital ResourcesOur principal sources of liquidity are our existing cash and cash equivalents, cash generated from our operations and borrowing capacity currently available under our 2022 Revolving Credit Agreement. Additionally, we have an uncommitted commercial paper program where we can issue unsecured commercial paper notes on a private placement basis. Based on our current and anticipated level of operations, we believe that our operating cash flows will be sufficient to meet our anticipated obligations for the next twelve months. To the extent that our operating cash flows are not sufficient to meet our liquidity needs, we may utilize cash on hand or amounts available under our financing arrangements, if necessary.Sources of Liquidity - OperationsNet cash provided by operating activities decreased $37 million for the year ended December 31, 2022, as compared to the year ended December 31, 2021, driven by the decrease in net income adjusted for non-cash items and the impact of the change in working capital.Cash Conversion CycleOur cash conversion cycle is defined as DIO and DSO less DPO. The calculation of each component of the cash conversion cycle is provided below:ComponentCalculation (on a trailing twelve month basis)DIO(Average inventory divided by cost of sales) * Number of days in the periodDSO(Accounts receivable divided by net sales) * Number of days in the periodDPO(Accounts payable * Number of days in the period) divided by cost of sales and SG&A expensesThe following table summarizes our cash conversion cycle. December 31,20222021DIO68 58 DSO39 33 DPO167 160 Cash conversion cycle(60)(69)Our cash conversion cycle increased 9 days to approximately (60) days as of December 31, 2022 as compared to (69) days as of December 31, 2021. The increases in DSO and DPO were primarily driven by rising inflation during the year, and the increase in DIO reflects our efforts to restore inventory to meet customer service levels.Accounts Payable ProgramAs part of our ongoing efforts to improve our cash flow and related liquidity, we work with our suppliers to optimize our terms and conditions, which include the extension of payment terms. Excluding our suppliers who require cash at date of purchase or sale, our current payment terms with our suppliers generally range from 10 to 360 days. We also enter into agreements with third party administrators to allow participating suppliers to track payment obligations from us, and if voluntarily elected by the supplier, sell payment obligations from us to financial institutions. Suppliers can sell one or more of our payment obligations at their sole discretion and our rights and obligations to our suppliers are not impacted. We have no economic interest in a supplier’s decision to enter into these agreements and no direct financial relationship with the financial institutions. Our obligations to our suppliers, including amounts due and scheduled payment terms, are not impacted. We have been informed by the third party administrators that as of December 31, 2022 and December 31, 2021, $3,839 million and $3,194 million, respectively, of our outstanding payment obligations were voluntarily elected by the supplier and sold to financial institutions. The amounts settled through the program and paid to the financial institutions were $3,935 million, $3,331 million and $2,770 million for the years ended December 31, 2022, 2021 and 2020, respectively.34Table of ContentsImpact of the CARES ActBeginning in the second quarter of 2020, we deferred payments of employer-related payroll taxes as allowed under the CARES Act. Payment of at least 50% of the deferred amount was due on January 3, 2022, with the remainder due by January 3, 2023. We deferred a total of $59 million in such payments since the CARES Act was implemented, and we timely paid approximately $30 million as of January 3, 2022 and the remainder as of January 3, 2023.Sources of Liquidity - FinancingIn February 2022, we terminated our 2021 364-Day Credit Agreement and our KDP Revolver and replaced them with the 2022 Revolving Credit Agreement, which provides for a $4 billion revolving credit facility.In April 2022, we undertook our 2022 Strategic Refinancing and issued a $3 billion aggregate face value of Notes, consisting of the 2029 Notes, the 2032 Notes, and the 2052 Notes. The proceeds from the issuance were used to voluntarily prepay and retire the remaining 2023 Merger Notes and to tender portions of the 2025 Merger Notes, the 2028 Merger Notes, the 2038 Merger Notes, and the 2048 Merger Notes.We have a commercial paper program, under which we may issue unsecured commercial paper notes on a private placement basis up to a maximum aggregate amount outstanding at any time of $2,400 million. As of December 31, 2022, we had borrowings of $399 million outstanding.We also have an active shelf registration statement, filed with the SEC on August 19, 2022, which allows us to issue an indeterminate number or amount of common stock, preferred stock, debt securities and warrants from time to time in one or more offerings at the direction of our Board of Directors.Refer to Note 4 of the Notes to our Consolidated Financial Statements for management's discussion of our financing arrangements.Sources of Liquidity - Asset Sale-Leaseback TransactionsWe have leveraged our strategic asset investment program to create value from certain assets to enable reinvestment in KDP. These transactions are accounted for as sale-leaseback transactions. We received $168 million, $102 million, and $200 million of net cash proceeds from our strategic asset investment program during the years ended December 31, 2022, 2021 and 2020, respectively, which are included in Proceeds from sales of property, plant and equipment in the Consolidated Statements of Cash Flows.Debt RatingsAs of December 31, 2022, our credit ratings were as follows:Rating AgencyLong-Term Debt RatingCommercial Paper RatingOutlookDate of Last ChangeMoody'sBaa2P-2StableFebruary 26, 2021S&PBBBA-2StableApril 19, 2022These debt and commercial paper ratings impact the interest we pay on our financing arrangements. A downgrade of one or both of our debt and commercial paper ratings could increase our interest expense and decrease the cash available to fund anticipated obligations. As of December 31, 2022, we were in compliance with all debt covenants and we have no reason to believe that we will be unable to satisfy these covenants. 35Table of ContentsLIBOR ConsiderationsIn 2017, the U.K. Financial Conduct Authority announced that LIBOR will no longer be published after 2021. In the U.S., the Alternative Reference Rates Committee selected the SOFR as the preferred alternative reference rate to LIBOR. Certain LIBOR tenors will continue to be published through June 30, 2023.We have a number of financing arrangements which incorporate LIBOR as a benchmark rate and which extend past 2022. The agreements related to such financing arrangements use LIBOR tenors which will continue to be published through June 30, 2023. Additionally, these agreements contain provisions for alternative reference rates. We do not expect a significant change to our cost of debt as a result of the transition from LIBOR to an alternative reference rate.Principal Uses of Capital ResourcesOver the past several years, our principal uses of our capital resources were deleveraging, providing shareholder return to our investors through regular quarterly dividends, and investing in KDP to capture market share and drive growth through innovation and routes to market.Now that we have met our post-merger goals, we plan to further reduce our leverage ratio. We also plan to invest in inorganic value creation through M&A, including portfolio expansion, distribution scale, geographic expansion, and new capabilities. In addition to M&A, we have repurchased shares of our outstanding common stock, as described below. Deleveraging and Other Debt RepaymentsDuring the year ended December 31, 2022, we made net debt repayments of $115 million, primarily driven by the redemption and retirement of the remainder of our 2023 Merger Notes and 2038 Notes, as well as the tender of portions of the 2025 Merger Notes, the 2028 Merger Notes, the 2038 Merger Notes, and the 2048 Merger Notes. Regular Quarterly DividendsFor the year ended December 31, 2022, we have declared total dividends of $0.775 per share, versus $0.7125 per share for the year ended December 31, 2021.Repurchases of Common StockOur Board authorized a four-year share repurchase program of up to $4 billion of our outstanding common stock potentially enabling us to return value to shareholders. We repurchased and retired $379 million of common stock during the year ended December 31, 2022. Capital ExpendituresWe are investing in state-of-the-art manufacturing and warehousing facilities, including expansive investments in facilities in Newbridge, Ireland; Spartanburg, South Carolina; and Allentown, Pennsylvania, in 2022 and 2021, in order to optimize our supply chain network.Purchases of property, plant and equipment were $353 million, $423 million and $461 million for the years ended December 31, 2022, 2021 and 2020, respectively. Capital expenditures, which includes both purchases of property, plant and equipment and amounts included in accounts payable and accrued expenses, for the years ended December 31, 2022, 2021 and 2020 primarily related to the manufacturing and warehousing facilities discussed above. Capital expenditures included in accounts payable and accrued expenses were $213 million, $189 million and $280 million for the years ended December 31, 2022, 2021 and 2020, respectively, which primarily related to these investments.Investments in Unconsolidated AffiliatesFrom time to time, we expect to invest in beverage startup companies or in brand ownership companies to grow our presence in certain product categories, or enter into various licensing and distribution agreements to expand our product portfolio. Our investments in beverage startup companies generally involve acquiring a minority interest in equity securities of a company, in certain cases with a protected path to ownership at our future option. During the year ended December 31, 2022, we invested $972 million in exchange for equity interests in Nutrabolt, Tractor and Athletic Brewing.Purchases of Intangible AssetsWe have invested in the expansion of our DSD network through transactions with strategic independent bottlers to ensure competitive distribution scale for our brands. From time to time, we additionally acquire brand ownership companies to expand our portfolio. These transactions are generally accounted for as an asset acquisition, as the majority of the transaction price represents the acquisition of an intangible asset. Purchases of intangible assets were $45 million, $32 million and $56 million for the years ended December 31, 2022, 2021 and 2020, respectively. 36Table of ContentsRESIDUAL VALUE GUARANTEESWe have a number of leasing arrangements and one licensing arrangement with special purpose entities associated with the same sponsor. Each one of these arrangements contain a residual value guarantee. As of December 31, 2022, we have not recorded any liabilities as it is not probable that we will have to make any payments required under the residual value guarantee. Refer to Note 19 of the Notes to our Consolidated Financial Statements for further information.UNCERTAINTIES AND TRENDS AFFECTING LIQUIDITY AND CAPITAL RESOURCESDisruptions in financial and credit markets, including those caused by inflation due to global economic uncertainty and the associated rise in interest rates, may impact our ability to manage normal commercial relationships with our customers, suppliers and creditors. These disruptions could have a negative impact on the ability of our customers to timely pay their obligations to us, thus reducing our cash flow, or the ability of our vendors to timely supply materials.Customer and consumer demand for our products may also be impacted by the risk factors discussed under "Risk Factors" in Part 1, Item 1A of our Annual Report, as well as subsequent filings with the SEC, that could have a material effect on production, delivery and consumption of our products, which could result in a reduction in our sales volume. We believe that the following events, trends and uncertainties may also impact liquidity: •Our ability to either repay existing debt maturities through cash flow from operations or refinance through future issuances of senior unsecured notes;•Our ability to access and/or renew our committed financing arrangements;•A significant downgrade in our credit ratings could limit i) our ability to issue debt at terms that are favorable to us, or ii) a financial institution's willingness to participate in our accounts payable program and reduce the attractiveness of the accounts payable program to participating suppliers who may sell payment obligations from us to financial institutions, which could impact our accounts payable program; •Our continued payment of regular quarterly dividends;•Future opportunistic repurchases of our common stock or special dividends to drive total shareholder return;•Our continued capital expenditures;•Future equity investments;•Seasonality of our operating cash flows, which could impact short-term liquidity; •Our ability to issue unsecured uncommitted commercial paper notes on a private placement basis up to a maximum aggregate amount outstanding at any time of $2,400 million;•Future mergers or acquisitions, which may include brand ownership companies, regional bottling companies, distributors and/or distribution rights to further extend our geographic coverage; and•Fluctuations in our tax obligations.37Table of ContentsCRITICAL ACCOUNTING ESTIMATES The process of preparing our consolidated financial statements in conformity with U.S. GAAP requires the use of estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. Critical accounting estimates are both fundamental to the portrayal of a company’s financial condition and results and require difficult, subjective or complex estimates and assessments. These estimates and judgments are based on historical experience, future expectations and other factors and assumptions we believe to be reasonable under the circumstances. The most significant estimates and judgments are reviewed on an ongoing basis and revised when necessary. We have not made any material changes in the accounting methodology we use to assess or measure our critical accounting estimates. We have identified the items described below as our critical accounting estimates. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use in our critical accounting estimates. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to gains or losses that could be material to our consolidated financial statements. See Note 2 of the Notes to our Consolidated Financial Statements for a discussion of these and other accounting policies.Goodwill and Other Indefinite Lived Intangible AssetsWe conduct tests for impairment of our goodwill and our other indefinite lived intangible assets annually, as of October 1, or more frequently if events or circumstances indicate the carrying amount may not be recoverable. We use present value and other valuation techniques to make this assessment. If the carrying amount of goodwill or an intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. For purposes of impairment testing, we assign goodwill to the reporting unit that benefits from the synergies arising from each business combination, and we also assign indefinite lived intangible assets to our reporting units. Effective January 1, 2021, we modified our internal reporting and operating segments to reflect changes in the executive leadership team to further enhance speed-to-market and decision effectiveness. Although this did not change our reportable segments, our reporting units and operating segments were redefined. For 2022 and 2021, we defined our six reporting units as follows: Reportable SegmentsReporting UnitsPackaged BeveragesDSDWDCoffee SystemsCoffee SystemsBeverage ConcentratesBranded ConcentratesFountain FoodserviceLatin America BeveragesLatin America BeveragesFor both goodwill and other indefinite lived intangible assets, we have the option to first assess qualitative factors to determine whether the fair value of either the reporting unit or indefinite lived intangible asset is "more likely than not" less than its carrying value, also known as a Step 0 analysis. If a quantitative analysis is required, the following would be required:•The impairment test for indefinite lived intangible assets encompasses calculating a fair value of an indefinite lived intangible asset and comparing the fair value to its carrying value. If the carrying value exceeds the estimated fair value, impairment is recorded.•The impairment tests for goodwill include comparing fair value of the respective reporting unit with its carrying value, including goodwill and considering any indefinite lived intangible asset impairment charges.As of October 1, 2022, we performed a quantitative analysis for goodwill and certain indefinite lived brand assets, whereby we used an income approach, or in some cases a combination of income and market based approaches, to determine the fair value of our assets, as well as an overall consideration of market capitalization and enterprise value. We performed a qualitative Step 0 analysis for other indefinite lived intangible assets, including certain brands, trade names, contractual arrangements, and distribution rights. These types of analyses contain uncertainties because they require management to make assumptions and to apply judgment to estimate industry and economic factors and the profitability of future business strategies. These assumptions could be negatively impacted by various risks discussed in Item 1A, Risk Factors, in this Annual Report on Form 10-K.Critical assumptions for quantitative analyses include revenue growth and profit performance over the next five year period, as well as an appropriate discount rate and long-term growth rate, as applicable. Discount rates are based on a weighted average cost of equity and cost of debt, adjusted with various risk premiums. Long-term growth rates are based on the long-term inflation forecast, industry growth and the long-term economic growth potential. 38Table of ContentsThe following table provides the range of rates used in the analysis as of October 1, 2022:RateMinimumMaximumDiscount rates7.3 %10.3 %Long-term growth rates— %3.8 %The following table shows the non-cash impairment charges that were recorded for the years presented:Year Ended December 31, (in millions)202220212020Non cash-impairment charges for indefinite lived brand assets$472 $— $67 Sensitivity Analysis - Discount RateFor goodwill, holding all other assumptions in the analysis constant, including the revenue and profit performance assumption, the effect of a 0.50% increase in the discount rate used to determine the fair value of the reporting units as of October 1, 2022, would not change our conclusion.For the indefinite-lived intangible assets quantitatively assessed, holding all other assumptions in the analysis constant, including the revenue and profit performance assumption, the effect of a 0.50% increase in the discount rate used to determine the fair value of those brands as of October 1, 2022, would impact the amount of headroom over the carrying value of those brands as follows (in millions):Selected Discount RateDiscount Rate Increase of 0.50%Headroom PercentageCarrying ValueFair ValueCarrying ValueFair ValueBrands0%(1)$2,136 $2,136 $2,710 $2,537 Less than 25%2,186 2,547 1,612 1,799 26 - 50%— — 2,351 3,446 In excess of 50%14,848 28,942 12,497 22,797 (1)Carrying value reflects the results of the annual impairment analysis recognized during the year ended December 31, 2022. Sensitivity Analysis - Long-Term Growth RateFor goodwill, holding all other assumptions in the analysis constant, including the discrete period revenue and profit performance assumptions as well as the discount rates, the effect of a 0.50% decrease in the long-term growth rate used to determine the fair value of the reporting units as of October 1, 2022, would not change our conclusion.For the indefinite-lived intangible assets quantitatively assessed, holding all other assumptions in the analysis constant, including the discrete period revenue and profit performance assumptions as well as the discount rates, the effect of a 0.50% decrease in the long-term revenue growth rate used to determine the fair value of those brands as of October 1, 2022, would impact the amount of headroom over the carrying value of those brands as follows (in millions):Selected Long-Term Growth RateLong-Term Growth Rate Decrease of 0.50%Headroom PercentageCarrying ValueFair ValueCarrying ValueFair ValueBrands0%(1)$2,136 $2,136 $2,396 $2,271 Less than 25%2,186 2,547 1,926 2,153 26 - 50%— — 2,351 3,515 In excess of 50%14,848 28,942 12,497 23,257 (1)Carrying value reflects the results of the annual impairment analysis recognized during the year ended December 31, 2022.Refer to Note 3 of the Notes to our Consolidated Financial Statements for additional information about our impairment assessments.39Table of ContentsRevenue RecognitionWe recognize revenue when performance obligations under the terms of a contract with the customer are satisfied. Accruals for customer incentives, sales returns and marketing programs are established for the expected payout based on contractual terms, volume-based metrics and/or historical trends.Our customer incentives, sales returns and marketing accrual methodology contains uncertainties because it requires management to make assumptions and to apply judgment regarding our contractual terms in order to estimate our customer participation and volume performance levels which impact the expense recognition. Our estimates are based primarily on a combination of known or historical transaction experiences. Differences between estimated expenses and actual costs are normally insignificant and are recognized to earnings in the period differences are determined.Additionally, judgment is required to ensure the classification of the spend is correctly recorded as either a reduction from gross sales or advertising and marketing expense, which is a component of our SG&A expenses.A 10% change in the accrual for our customer incentives, sales returns and marketing programs would have affected our income from operations by $50 million for the year ended December 31, 2022.Income TaxesWe establish income tax liabilities to remove some or all of the income tax benefit of any of our income tax positions based upon one of the following: •the tax position is not “more likely than not” to be sustained, •the tax position is “more likely than not” to be sustained, but for a lesser amount, or•the tax position is “more likely than not” to be sustained, but not in the financial period in which the tax position was originally taken.Our liability for uncertain tax positions contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various tax positions.Our income tax returns, like those of most companies, are periodically audited by domestic and foreign tax authorities. These audits include questions regarding our tax positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. As these audits progress, events may occur that cause us to change our liability for uncertain tax positions. To the extent we prevail in matters for which a liability for uncertain tax positions has been established, or are required to pay amounts in excess of our established liability, our effective tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement generally would require use of our cash and may result in an increase in our effective tax rate in the period of resolution. A favorable tax settlement may be recognized as a reduction in our effective tax rate in the period of resolution.We also assess the likelihood of realizing our deferred tax assets. Valuation allowances reduce deferred tax assets to the amount more likely than not to be realized. We base our judgment of the recoverability of our deferred tax assets primarily on historical earnings, our estimate of current and expected future earnings and prudent and feasible tax planning strategies.If results differ from our assumptions, a valuation allowance against deferred tax assets may be increased or decreased which would impact our effective tax rate.Business CombinationsWe record acquisitions using the purchase method of accounting. All of the assets acquired and liabilities assumed are recorded at fair value as of the acquisition date. The excess of the purchase price over the estimated fair values of the net tangible and intangible assets acquired is recorded as goodwill. The application of the purchase method of accounting for business combinations requires management to make significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed, in order to properly allocate purchase price consideration between assets that are depreciated and amortized from goodwill. The fair value assigned to tangible and intangible assets acquired and liabilities assumed are based on management’s estimates and assumptions, as well as other information compiled by management, including valuations that utilize customary valuation procedures and techniques. Significant assumptions and estimates include, but are not limited to, the cash flows that an asset is expected to generate in the future, the appropriate weighted-average cost of capital, and the cost savings expected to be derived from acquiring an asset, if applicable.If the actual results differ from the estimates and judgments used in these estimates, the amounts recorded in the consolidated financial statements may be exposed to potential impairment of the intangible assets and goodwill, as discussed in the Goodwill and Other Indefinite Lived Intangible Assets critical accounting estimate section above. 40Table of ContentsEFFECT OF RECENT ACCOUNTING PRONOUNCEMENTSRefer to Note 2 of the Notes to our Consolidated Financial Statements for a discussion of recently issued accounting standards and recently adopted provisions of U.S. GAAP.SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATIONThe Notes are fully and unconditionally guaranteed by certain of our direct and indirect subsidiaries (the "Guarantors"), as defined in the indentures governing the Notes. The Guarantors are 100% owned either directly or indirectly by us and jointly and severally guarantee, subject to the release provisions described below, our obligations under the Notes. None of our subsidiaries organized outside of the U.S., immaterial subsidiaries used for charitable purposes, any of the subsidiaries held by Maple Parent Holdings Corp. prior to the DPS Merger or any of the subsidiaries acquired after the DPS Merger (collectively, the "Non-Guarantors") guarantee the Notes. The subsidiary guarantees with respect to the Notes are subject to release upon the occurrence of certain events, including the sale of all or substantially all of a subsidiary's assets, the release of the subsidiary's guarantee of our other indebtedness, our exercise of the legal defeasance option with respect to the Notes and the discharge of our obligations under the applicable indenture. The following schedules present the summarized financial information for the Parent and the Guarantors on a combined basis after intercompany eliminations; the Parent and the Guarantors' amounts due from; amounts due to, and transactions with Non-Guarantors are disclosed separately. The consolidating schedules are provided in accordance with the reporting requirements of Rule 13-01 under SEC Regulation S-X for the issuer and guarantor subsidiaries. The summarized financial information for the Parent and Guarantors were as follows:(in millions)For the Year Ended December 31, 2022Net sales$8,242 Income from operations1,008 Net income attributable to KDP1,436 December 31,(in millions)20222021Current assets$1,712 $1,594 Non-current assets45,721 43,972 Total assets(1)$47,433 $45,566 Current liabilities$4,797 $3,470 Non-current liabilities17,463 17,125 Total liabilities(2)$22,260 $20,595 (1)Includes $3 million and $209 million of intercompany receivables due to the Parent and Guarantors from the Non-Guarantors as of December 31, 2022 and December 31, 2021, respectively. (2)Includes $1,186 million and $40 million of intercompany payables due to the Non-Guarantors from the Parent and Guarantors as of December 31, 2022 and December 31, 2021, respectively.41Table of ContentsNON-GAAP FINANCIAL MEASURESTo supplement the consolidated financial statements presented in accordance with U.S. GAAP, we have presented for certain constant currency adjusted or adjusted financial measures for the years ended December 31, 2022 and 2021, which are considered non-GAAP financial measures. The non-GAAP financial measures provided should be viewed in addition to, and not as an alternative for, results prepared in accordance with U.S. GAAP. The non-GAAP financial measures presented may differ from similarly titled non-GAAP financial measures presented by other companies, and other companies may not define these non-GAAP financial measures in the same way. The non-GAAP financial measures are not substitutes for their comparable U.S. GAAP financial measures, such as income from operations, net income, diluted EPS or other measures prescribed by U.S. GAAP, and there are limitations to using non-GAAP financial measures. We use these non-GAAP financial measures, in addition to U.S. GAAP financial measures, to evaluate our operating and financial performance and to compare such performance to that of prior periods and to the performance of our competitors. Additionally, we use these non-GAAP financial measures in making operational and financial decisions and in our budgeting and planning process. We believe that providing these non-GAAP financial measures to investors helps investors evaluate our operating performance, profitability and business trends in a way that is consistent with how management evaluates such performance and consistent with guidance previously provided by us. The non-GAAP measures are defined as follows:Adjusted: Defined as certain financial statement captions and metrics adjusted for certain items affecting comparability.Items affecting comparability: Defined as certain items that are excluded for comparison to prior year periods, adjusted for the tax impact as applicable. Tax impact is determined based upon an approximate rate for each item. For each period, management adjusts for (i) the unrealized mark-to-market impact of derivative instruments not designated as hedges in accordance with U.S. GAAP that do not have an offsetting risk reflected within the financial results, as well as the unrealized mark-to-market impact of our Vita Coco investment; (ii) the amortization associated with definite-lived intangible assets; (iii) the amortization of the deferred financing costs associated with the DPS Merger; (iv) the amortization of the fair value adjustment of the senior unsecured notes obtained as a result of the DPS Merger; (v) stock compensation expense and the associated windfall tax benefit attributable to the matching awards made to employees who made an initial investment in KDP; (vi) non-cash changes in deferred tax liabilities related to goodwill and other intangible assets as a result of tax rate or apportionment changes; and (vii) other certain items that are excluded for comparison purposes to prior year periods. For the year ended December 31, 2022, the other certain items excluded for comparison purposes include (i) restructuring and integration expenses related to significant business combinations; (ii) productivity expenses; (iii) costs related to significant non-routine legal matters, specifically the antitrust litigation; (iv) the loss on early extinguishment of debt related to the redemption of debt; (v) incremental costs to our operations related to risks associated with the COVID-19 pandemic, which were incurred to either maintain the health and safety of our front-line employees or temporarily increase compensation to such employees to ensure essential operations continue during the pandemic; (vi) the gain on the sale of our investment in BodyArmor as a result of the settlement of the associated holdback liability; (vii) the gain on the settlement of our prior litigation with BodyArmor, excluding recoveries of previously incurred litigation expenses which were included in our adjusted results; (viii) losses recognized with respect to our equity method investment in Bedford as a result of funding our share of their wind-down costs; (ix) transaction costs for significant business combinations (completed or abandoned); (x) foundational projects, which are transformative and non-recurring in nature; and (xi) impairments recognized on certain intangible brand assets.For the year ended December 31, 2021, the other certain items excluded for comparison purposes include (i) restructuring and integration expenses related to significant business combinations; (ii) productivity expenses; (iii) costs related to significant non-routine legal matters; (iv) the loss on early extinguishment of debt related to the redemption of debt; (v) incremental costs to our operations related to risks associated with the COVID-19 pandemic; (vi) gains from insurance recoveries related to the February 2019 organized malware attack on our business operation networks in the Coffee Systems segment; (vii) the gain on the sale of our investment in BodyArmor; (viii) impairment recognized on our equity method investment with Bedford as a result of funding our share of their wind-down costs; and (ix) transaction costs for significant business combinations (completed or abandoned).Constant currency adjusted: Defined as certain financial statement captions and metrics adjusted for certain items affecting comparability, calculated on a constant currency basis by converting our current period local currency financial results using the prior period foreign currency exchange rates.For the years ended December 31, 2022 and 2021, the supplemental financial data set forth below includes reconciliations of adjusted and constant currency adjusted financial measures to the applicable financial measure presented in the consolidated financial statements for the same period.42Table of ContentsKEURIG DR PEPPER INC.RECONCILIATION OF CERTAIN REPORTED ITEMS TO CERTAIN NON-GAAP ADJUSTED ITEMS(Unaudited, in millions, except per share and percentages)Cost of salesGross profitGross marginSelling, general and administrative expensesImpairment of intangible assetsGain on litigation settlementOther operating income, netIncome from operationsOperating marginFor the Year Ended December 31, 2022Reported$6,734 $7,323 52.1 %$4,645 $477 $(299)$(105)$2,605 18.5 %Items Affecting Comparability:Mark to market(120)120 (30)— — — 150 Amortization of intangibles— — (138)— — — 138 Stock compensation— — (5)— — — 5 Restructuring and integration costs— — (170)— — (2)172 Productivity(116)116 (114)— — — 230 Impairment of intangible assets— — — (477)— — 477 Non-routine legal matters— — (13)— — — 13 COVID-19(9)9 (5)— — — 14 Gain on litigation— — — — 271 — (271)Transaction costs— — (1)— — — 1 Foundational projects— — (4)— — — 4 Adjusted$6,489 $7,568 53.8 %$4,165 $— $(28)$(107)$3,538 25.2 %Impact of foreign currency— %— %Constant currency adjusted53.8 %25.2 %For the Year Ended December 31, 2021Reported$5,706 $6,977 55.0 %$4,153 $— $— $(70)$2,894 22.8 %Items Affecting Comparability:Mark to market32 (32)25 — — — (57)Amortization of intangibles— — (134)— — — 134 Stock compensation— — (18)— — — 18 Restructuring and integration costs— — (202)— — — 202 Productivity(72)72 (91)— — — 163 Non-routine legal matters— — (30)— — — 30 COVID-19(26)26 (11)— — — 37 Transaction costs— — (2)— — — 2 Malware incident— — 2 — — — (2)Adjusted$5,640 $7,043 55.5 %$3,692 $— $— $(70)$3,421 27.0 %Refer to page 46 for reconciliations of reported net sales to constant currency net sales and adjusted income from operations to constant currency adjusted income from operations.43Table of ContentsKEURIG DR PEPPER INC.RECONCILIATION OF CERTAIN REPORTED ITEMS TO CERTAIN NON-GAAP ADJUSTED ITEMS(Unaudited, in millions, except per share and percentages)Interest expenseLoss on early extinguishment of debtGain on sale of equity method investmentImpairment of investments and note receivableOther expense (income), netIncome before provision for income taxesProvision for income taxesEffective tax rateNet income attributable to KDPDiluted earnings per shareFor the Year Ended December 31, 2022Reported$693 $217 $(50)$12 $14 $1,719 $284 16.5 %$1,436 $1.01 Items Affecting Comparability:Mark to market(249)— — — 4 395 93 302 0.21 Amortization of intangibles— — — — — 138 35 103 0.07 Amortization of deferred financing costs(2)— — — — 2 — 2 — Amortization of fair value debt adjustment(19)— — — — 19 4 15 0.01 Stock compensation— — — — — 5 (1)6 — Restructuring and integration costs— — — — — 172 41 131 0.09 Productivity— — — — — 230 56 174 0.12 Impairment of intangible assets— — — — — 477 126 351 0.25 Impairment of investment— — — (12)— 12 3 9 0.01 Loss on early extinguishment of debt— (217)— — — 217 51 166 0.12 Non-routine legal matters— — — — — 13 3 10 0.01 COVID-19— — — — — 14 4 10 0.01 Gain on litigation— — — — — (271)(68)(203)(0.14)Gain on sale of equity-method investment— — 50 — — (50)(12)(38)(0.03)Transaction costs— — — — — 1 — 1 — Foundational projects— — — — — 4 1 3 — Change in deferred tax liabilities related to goodwill and other intangible assets— — — — — — 80 (80)(0.06)Adjusted$423 $— $— $— $18 $3,097 $700 22.6 %$2,398 $1.68 Impact of foreign currency— %Constant currency adjusted22.6 %Diluted earnings per common share may not foot due to rounding.44Table of ContentsKEURIG DR PEPPER INC.RECONCILIATION OF CERTAIN REPORTED ITEMS TO CERTAIN NON-GAAP ADJUSTED ITEMS(Unaudited, in millions, except per share and percentages)Interest expenseLoss on early extinguishment of debtGain on sale of equity method investmentImpairment of investments and note receivableOther expense (income), netIncome before provision for income taxesProvision for income taxesEffective tax rateNet income attributable to KDPDiluted earnings per shareFor the Year Ended December 31, 2021Reported$500 $105 $(524)$17 $(2)$2,798 $653 23.3 %$2,146 $1.50 Items Affecting Comparability:Mark to market6 — — — (6)(57)(13)(44)(0.03)Amortization of intangibles— — — — — 134 31 103 0.07 Amortization of deferred financing costs(7)— — — — 7 2 5 — Amortization of fair value of debt adjustment(19)— — — — 19 5 14 0.01 Stock compensation— — — — — 18 15 3 — Restructuring and integration costs— — — — — 202 47 155 0.11 Productivity— — — — — 163 40 123 0.09 Impairment of investment— — — (17)— 17 (45)62 0.04 Loss on early extinguishment of debt— (105)— — — 105 24 81 0.06 Non-routine legal matters— — — — — 30 7 23 0.01 COVID-19— — — — — 37 9 28 0.02 Gain on sale of equity-method investment— — 524 — — (524)(124)(400)(0.28)Transaction costs— — — — — 2 — 2 — Malware incident— — — — — (2)— (2)— Change in deferred tax liabilities related to goodwill and other intangible assets— — — — — — 19 (19)(0.01)Adjusted$480 $— $— $— $(8)$2,949 $670 22.7 %$2,280 $1.60 Change - adjusted(11.9)%5.2 %5.0 %Impact of foreign currency— %0.2 %— %Change - constant currency adjusted(11.9)%5.4 %5.0 %Diluted earnings per common share may not foot due to rounding.45Table of ContentsKEURIG DR PEPPER INC.RECONCILIATION OF CERTAIN REPORTED SEGMENT MEASURES TO CERTAIN NON-GAAP ADJUSTED AND CURRENCY NEUTRAL ADJUSTED SEGMENT MEASURES(Unaudited)(in millions)ReportedItems Affecting ComparabilityAdjustedFor the year ended December 31, 2022Income from operationsCoffee Systems$1,316 $198 $1,514 Packaged Beverages1,014 119 1,133 Beverage Concentrates1,061 173 1,234 Latin America Beverages158 4 162 Unallocated corporate costs(944)439 (505)Total income from operations$2,605 $933 $3,538 For the year ended December 31, 2021Income from operationsCoffee Systems$1,446 $197 $1,643 Packaged Beverages1,023 99 1,122 Beverage Concentrates1,047 11 1,058 Latin America Beverages133 2 135 Unallocated corporate costs(755)218 (537)Total income from operations$2,894 $527 $3,421 ReportedImpact of Foreign CurrencyConstant CurrencyFor the year ended December 31, 2022Net salesCoffee Systems5.6 %0.6 %6.2 %Packaged Beverages12.3 0.1 12.4 %Beverage Concentrates16.1 0.3 16.4 %Latin America Beverages24.0 (1.0)23.0 %Total net sales10.8 0.3 11.1 %AdjustedImpact of Foreign CurrencyConstant Currency AdjustedFor the year ended December 31, 2022Income from operationsCoffee Systems(7.9)%0.4 %(7.5)%Packaged Beverages1.0 0.2 1.2 %Beverage Concentrates16.6 0.3 16.9 %Latin America Beverages20.0 (1.5)18.5 %Total income from operations3.4 0.3 3.7 %ReportedItems Affecting ComparabilityAdjustedImpact of Foreign CurrencyConstant Currency AdjustedFor the year ended December 31, 2022Operating marginCoffee Systems26.4 %4.0 %30.4 %(0.1)%30.3 %Packaged Beverages15.3 1.8 %17.1 0.1 %17.2 Beverage Concentrates61.5 10.0 %71.5 — %71.5 Latin America Beverages21.3 0.5 %21.8 (0.1)%21.7 Total operating margin18.5 6.7 %25.2 — %25.2 46Table of ContentsCONSTANT CURRENCY ADJUSTED RESULTS OF OPERATIONSYear Ended December 31, 2022 Compared to Year Ended December 31, 2021 The following discussion of our results for the year ended December 31, 2022 is presented on a constant currency adjusted basis. These adjusted financial results are calculated on a constant currency basis by converting our current-period local currency financial results using the prior-period FX rates.Consolidated OperationsConstant Currency Net Sales. Constant currency net sales increased 11.1% in the year ended December 31, 2022 compared to the prior year, driven by favorable net price realization of 10.6% and volume/mix growth of 0.5%.Constant Currency Adjusted Income from Operations. Constant currency adjusted income from operations increased 3.7% compared to the prior year, primarily driven by the strong growth in net sales and the benefit of productivity. These benefits were partially offset by the impact of broad-based inflation and increases in other operating costs. Constant Currency Adjusted Interest Expense. Constant currency adjusted interest expense decreased 11.9% compared to the prior year, driven by reduced interest expense on our senior unsecured notes as a result of our strategic refinancing initiatives.Constant Currency Adjusted Effective Tax Rate. The constant currency adjusted effective tax rate was 22.6% for the year ended December 31, 2022 compared to 22.7% for the prior year, primarily driven by our incremental income in low tax jurisdictions in the current year, mostly offset by the unfavorable comparison to the tax benefit received in the prior year from the release of our valuation allowance against our U.S. foreign tax credit carryforwards.Constant Currency Adjusted Net Income Attributable to KDP. Constant currency adjusted net income attributable to KDP increased 5.4% compared to the prior year, primarily driven by income from operations growth and lower interest expense.Constant Currency Adjusted Diluted EPS. Constant currency adjusted diluted EPS increased approximately 5.0% over the prior year.Results of Operations by SegmentCOFFEE SYSTEMSConstant Currency Net Sales. Constant currency net sales increased 6.2%, driven by higher net price realization of 7.0%, partially offset by unfavorable volume/mix of 0.8%.Constant Currency Adjusted Income from Operations. Constant currency adjusted income from operations for the year ended December 31, 2022 decreased 7.5% compared to the prior year period, as a result of broad-based inflation, particularly in green coffee and increases in other operating expenses. These decreases were partially offset by the benefits of net sales growth, productivity, favorable asset sale-leaseback activity in the Coffee Systems segment associated with our strategic asset investment program and a business interruption insurance recovery.PACKAGED BEVERAGESConstant Currency Net Sales. Constant currency net sales increased 12.4%, reflecting favorable net price realization of 12.1% and volume/mix growth of 0.3%.Constant Currency Adjusted Income from Operations. Constant currency adjusted income from operations for the year ended December 31, 2022 increased 1.2% compared to the prior year period, driven by the benefits of net sales growth and increased productivity. These benefits were partially offset by broad-based inflation, higher costs to serve the ongoing strong consumer demand, and the unfavorable year-over-year comparison in the Packaged Beverages segment of asset sale-leaseback activity associated with our strategic asset investment program.BEVERAGE CONCENTRATESConstant Currency Net Sales. Constant currency net sales increased 16.4%, reflecting higher net price realization of 14.7% and volume/mix growth of 1.7%.Constant Currency Adjusted Income from Operations. Constant currency adjusted income from operations for the year ended December 31, 2022 increased 16.9% compared to the prior year period. This performance reflected the impact of net sales growth, partially offset by costs associated with the operation of our new manufacturing facility in Newbridge, Ireland.47Table of ContentsLATIN AMERICA BEVERAGESConstant Currency Net Sales. Constant currency net sales increased 23.0%, driven by favorable net price realization of 13.9% and volume/mix growth of 9.1%.Constant Currency Adjusted Income from Operations. Constant currency adjusted income from operations for the year ended December 31, 2022 increased 18.5% compared to the prior year period, driven by the benefits of net sales growth and productivity, partially offset by the impacts of broad-based inflation, logistics and operating costs associated with incremental volumes, and increased marketing expense. ITEM 7A. Quantitative and Qualitative Disclosures About Market RiskWe are exposed to market risks arising from changes in market rates and prices, including movements in foreign currency exchange rates, interest rates and commodity prices. We regularly enter into derivatives or other financial instruments to hedge or mitigate commercial risks. We do not enter into derivative instruments for speculation, investing or trading. Refer to Note 5 of the Notes to our Consolidated Financial Statements for further information about our derivative instruments.FOREIGN EXCHANGE RISKThe majority of our net sales, expenses and capital purchases are transacted in U.S. dollars. However, we have exposure with respect to foreign exchange rate fluctuations. Our primary exposure to foreign exchange rates is the Canadian dollar, the Mexican peso and the Euro against the U.S. dollar. Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses in earnings as incurred.We use derivative instruments such as foreign exchange forward contracts to manage a portion of our exposure to changes in foreign exchange rates. As of December 31, 2022, we had derivative contracts outstanding with notional values of $1,001 million maturing at various dates through October 2024. The fair value of foreign currency derivatives that qualify for hedge accounting resulted in a net unrealized gain of $19 million as of December 31, 2022, and the impact of a 10% change (up or down) in exchange rates is estimated to increase or decrease the fair value by approximately $50 million. The fair value of foreign currency derivatives that do not qualify for hedge accounting resulted in a net unrealized gain of $16 million as of December 31, 2022, and the impact of a 10% change (up or down) in exchange rates is estimated to increase or decrease the fair value by approximately $50 million. Any increase or decrease in the value of the foreign currency derivatives would have an approximately offsetting change in the underlying hedged risk.INTEREST RATE RISKWe centrally manage our debt portfolio through the use of interest rate contracts and monitor our mix of fixed-rate and variable-rate debt. As of December 31, 2022, the carrying value of our fixed-rate debt, excluding lease obligations, was $11,568 million and our variable-rate debt was $399 million, comprised entirely of commercial paper. Additionally, as of December 31, 2022, the total notional value of receive-fixed, pay-variable interest rate swaps was $1,900 million. Our variable-rate derivative instruments are generally based on SOFR and a credit spread.We estimate that the potential impact to our interest rate expense associated with variable rate debt and derivative instruments resulting from a hypothetical interest rate change of 1%, based on variable-rate debt and derivative instrument levels as of December 31, 2022, would be an increase or decrease of approximately $23 million. Our estimate of the annual impact to interest expense reflects our assumption that SOFR will not fall below 0%.COMMODITY RISKWe are subject to market risks with respect to commodities because our ability to recover increased costs through higher pricing may be limited by the competitive environment in which we operate. Our principal commodities risks relate to our purchases of coffee beans, PET, aluminum, diesel fuel, corn (for high fructose corn syrup), apple juice concentrate, sucrose and natural gas (for use in processing and packaging).We utilize commodities derivative instruments and supplier pricing agreements to hedge the risk of movements in commodity prices for limited time periods for certain commodities. As of December 31, 2022, we had derivative contracts outstanding with a notional value of $754 million maturing at various dates through April 2024. The fair market value of these contracts as of December 31, 2022 was a net liability of $45 million.As of December 31, 2022, the impact of a 10% change (up or down) in market prices for these commodities where the risk of movements has not been hedged is estimated to have a $42 million impact to our income from operations for the year ended December 31, 2023.48Table of Contents
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+Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in millions)GeneralDuring the year ended December 31, 2022, the Company's revenues were $14.9 billion, a decrease of 7.7% from $16.1 billion in 2021. The decrease was due to lower organic revenue of 7.5% and foreign currency translation of 1.0%, partially offset by acquisitions net of divestitures of 0.8%. The 7.5% decrease in organic revenue was due to a 10.0% decrease in COVID-19 Testing, partially offset by a 2.5% increase in the Company's organic Base Business. The Company defines organic growth as the increase in revenue excluding the year over year impact of acquisitions, divestitures, and currency. Acquisition and divestiture impact is considered for a twelve-month period following the close of each transaction. Base Business includes the Company's business operations except for COVID-19 Testing.Strategic Review of Company Structure and Capital Allocation StrategyIn March 2021, the Company announced the undertaking of a comprehensive review by its board of directors (the Board) and management team of the Company's structure and capital allocation strategy. In December 2021, the Company announced the Board's conclusion, as well as actions that the management team and the Board would take to enhance shareholder returns. These actions have included: •initiating a dividend in the second quarter of 2022, as well as subsequent dividends paid in the third and fourth quarters of 2022, with total dividend payments for 2022 in the amount of $195.2 million;•authorizing a $2.50 billion share repurchase program. As part of this program, $1.0 billion was repurchased under an accelerated share repurchase plan in 2021, and a total of $1.1 billion of stock was repurchased in 2022, representing approximately 4.7 million shares;•implementing a new LaunchPad business process improvement initiative, targeting savings of $350.0 million through 2025;54•providing a longer-term outlook in connection with the announcement of the Company's 2021 year-end results in addition to the Company's annual guidance;•providing additional business insights through enhanced disclosures beginning with the Company's results for the first quarter of 2022; and•continuing a commitment to profitable growth through investments in science, innovation, and new technologies; andOn July 28, 2022, the Company announced that it would pursue a planned spin-off of its Clinical Development and Commercialization Services (CDCS) business, as further discussed below.Management and the Board are committed to continuing to evaluate all avenues for enhancing shareholder value.The updated capital allocation plan is designed to enable the Company to continue investment in key growth areas. This plan is expected to fuel growth through innovation by using the Company's unique data and insights to bring scientific advancements—both those developed internally and those developed by outside companies and scientists—to market at scale. It reflects the Board's confidence in the Company's strong balance sheet and cash flow generation profile, as well as the Board's commitment to deploying capital to enhance value for shareholders, patients, providers, and pharmaceutical customers worldwide.Spin-Off of the Company's CDCS BusinessOn July 28, 2022, the Company announced that the Board authorized the Company to pursue a spin-off of the Company’s wholly owned CDCS business to its shareholders through a tax-free transaction. The planned spin-off will result in two independent companies, each poised for strong, sustainable growth. On January 9, 2023, Thomas (Tom) Pike joined the Company as president and chief executive officer of its DD Clinical Development business unit, and when the planned spin-off is complete, Mr. Pike will become the chief executive officer and chairman of the board of directors of the independent, publicly listed company. On February 9, 2023, the Company announced that the name of the CDCS business will become Fortrea in connection with the planned spin-off. The Company is targeting completion of the planned spin-off in mid-2023. The planned spin-off will be subject to the satisfaction of certain customary conditions, including, among others, the receipt of final approval by the Company's Board, the receipt of appropriate assurances regarding the tax-free nature of the separation and effectiveness of any required filings with the U.S. Securities and Exchange Commission (SEC). There can be no assurances regarding the ultimate timing of the transaction or that the spin-off will be completed.When the transaction is complete, the resulting companies will be Labcorp, comprising the Company’s routine and esoteric labs, central labs and early development research labs, and Fortrea, a global contract research organization (CRO) providing Phase I-IV clinical trial management, market access and technology solutions to pharmaceutical and biotechnology organizations.The planned spin-off is expected to provide each company with:•strengthened strategic flexibility and operational focus to pursue specific market opportunities and better meet customer needs;•focused capital structures and capital allocation strategies to drive innovation and growth; •a more targeted investment opportunity for different investor bases; and •the ability to align its particular incentive compensation with its financial performance.Following the planned spin-off, the Company believes that Labcorp will be positioned to:•invest in R&D and innovation to develop and launch diagnostic advancements globally in key clinical areas including oncology, Alzheimer's, and autoimmune and liver disease through organic and inorganic opportunities; •bring together its global health and patient data and provide insights to enable customers to innovate; •utilize its worldwide laboratory network to serve a broad, growing and global customer base including pharmaceutical and biotechnology companies, physicians, health systems, consumers, and other start-ups and laboratories that require lab services or diagnostic testing; and•launch innovative tests globally, providing patients, physicians, health systems and pharmaceutical companies with access to its advanced science, technology and diagnostic capabilities.Following the planned spin-off, the Company believes that Fortrea will be positioned to:•capitalize on growth opportunities across Phases I-IV clinical trials and extend its leadership in oncology, cell and gene therapy, rare disease, and other emerging therapeutic areas;•increase agility with large pharmaceutical and biotechnology clients to better serve customers and advance life-saving therapies;•access to unique data sets and insights through an arrangement with the Company for a defined period of time which will enable Fortrea to provide enhanced trial execution and a differentiated value proposition; 55•invest in capabilities, technologies, diverse talent and innovation to enhance trial execution and better serve all of its customers; and•implement a capital structure that is tailored to support its growth strategy and enhance stakeholder value.The planned spin-off is intended to qualify as a tax-free transaction for U.S. federal income tax purposes. See “Risk Factors - Risks Related to the Planned Spin-off of the Company’s Clinical Development and Commercialization Services Business.”Unless otherwise indicated, the disclosure in this Annual Report assumes that Clinical Development and Commercialization Services business will be with the Company for the full year.COVID-19 OutlookWhile the Company anticipates that COVID-19 will continue impacting its business in 2023 and potentially beyond, the Company expects a continued decline in demand for COVID-19 Testing, with the potential for increases in demand at different times and across different geographies. As a result, COVID-19 Testing demand in 2023 is not predicted to match 2022 levels.Results of OperationsThe following tables present the financial measures that management considers to be the most significant indicators of the Company's performance. For discussion of 2021 results and comparison with 2020 results refer to “Management's Discussion and Analysis of Financial Conditions and Results of Operations” in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2021.Years ended December 31, 2022 and 2021Revenues Years Ended December 31,20222021ChangeDx$9,203.5 $10,363.6 (11.2)%DD5,710.2 5,845.5 (2.3)%Intercompany eliminations(36.9)(88.2)58.2 %Total$14,876.8 $16,120.9 (7.7)%The 7.7% decrease in revenues for the year ended December 31, 2022, as compared to the corresponding period in 2021 was due to lower organic revenue of 7.5% and unfavorable foreign currency translation of 1.0%, partially offset by acquisitions net of divestitures of 0.8%. The 7.5% decrease in organic revenue was due to a 10.0% decrease in COVID-19 Testing, partially offset by a 2.5% increase in the Company's organic Base Business.Dx revenues for the year ended December 31, 2022, were $9,203.5, a decrease of 11.2% compared to revenues of $10,363.6 in the corresponding period in 2021. The decrease was primarily due to lower organic revenue of 12.1% and unfavorable foreign currency translation of 0.1%, partially offset by acquisitions of 1.1%. The 12.1% decrease in organic revenue was due to a 15.6% decrease in COVID-19 Testing, partially offset by a 3.4% contribution from organic Base Business.Total volume, measured by requisitions, decreased by 7.5% as organic volume decreased by 8.4% and acquisition volume contributed growth of 0.8%. Organic volume was impacted by a 10.4% decrease in COVID-19 Testing, partially offset by a 2.0% increase in Base Business. Price/mix decreased by 3.7% due to lower COVID-19 Testing of 5.2% and unfavorable foreign currency translation of 0.1%, partially offset by higher Base Business of 1.4% and acquisitions of 0.2%.DD revenues for the year ended December 31, 2022, were $5,710.2, a decrease of 2.3% over revenues of $5,845.5 in the corresponding period in 2021. The decrease in revenues was primarily due to unfavorable foreign currency translation of 2.6% and lower COVID-19 Testing of 0.6%, partially offset by organic base business growth of 0.5%, and acquisitions net of divestitures of 0.3%.Cost of RevenuesYears Ended December 31, 20222021ChangeCost of revenues$10,491.7$10,496.6— %Cost of revenues as a % of revenues70.5 %65.1 % Cost of revenues were flat in 2022 as compared with 2021 and increased as a percentage of revenues to 70.5% in 2022 as compared to 65.1% in 2021. This increase in cost of revenues as a percentage of revenues was primarily due to a reduction in 56Indexhigher margin COVID-19 Testing, higher personnel expenses, and other inflationary costs, partially offset by organic Base Business growth and LaunchPad savings.Selling, General and Administrative Expenses Years Ended December 31, 20222021ChangeSelling, general and administrative expenses$1,996.6$1,952.12.3 %SG&A as a % of revenues13.4 %12.1 % Selling, general and administrative expenses as a percentage of revenues increased to 13.4% in 2022 compared to 12.1% in 2021. The increase in selling, general and administrative expenses as a percentage of revenues is primarily due to a decrease in higher margin COVID-19 Testing and higher personnel costs, partially offset by LaunchPad savings.Goodwill and Other Asset Impairments Years Ended December 31, 20222021ChangeGoodwill and other asset impairments$271.5 $— 100.0%The 2022 impairment charges were primarily comprised of $260.0 of goodwill impairment for the early development reporting unit, which is part of the DD segment, and the impairment of a technology intangible asset. There were no goodwill and other asset impairments for the year ended December 31, 2021.Amortization of Intangibles and Other Assets Years Ended December 31, 20222021ChangeAmortization of intangibles and other assets$259.3 $369.6 (29.8)%The decrease in amortization of intangibles and other assets for the year ended December 31, 2022 is primarily due to $88.4 in amortization acceleration of certain intangible assets related to trade names as a result of the Company's rebranding initiative recognized during 2021, partially offset by the impact of acquisitions.Restructuring and Other Charges Years Ended December 31, 20222021ChangeRestructuring and other charges$83.8 $43.1 94.5 % During 2022, the Company recorded net restructuring charges of $83.8. The charges were comprised of $39.3 in severance and other personnel costs, $45.7 in facility-related costs primarily associated with general integration activities. The charges were offset by the reversal of previously established liability of $0.3 in unused severance and $0.9 in unused facility-related costs.During 2021, the Company recorded net restructuring charges of $43.1. The charges were comprised of $16.3 in severance and other personnel costs and $28.0 in facility closures, lease terminations, and general integration activities. The charges were offset by the reversal of previously established liability of $0.4 and $0.8 in unused severance costs and facility-related costs, respectively.Interest ExpenseYears Ended December 31, 20222021ChangeInterest expense$180.3 $212.1 (15.0)%The decrease in interest expense for 2022 as compared with the corresponding period in 2021 is primarily due to the costs of redeeming the outstanding 3.20% senior notes due February 1, 2022 and the 3.75% notes due August 23, 2022 and issuing the new senior notes in 2021 and lower outstanding debt partially offset by a higher average cost of debt in 2022.57IndexEquity Method Income, Net Years Ended December 31, 20222021ChangeEquity method income, net$5.4 $26.5 (79.7)%Equity method income, net represents the Company's ownership share in joint venture partnerships along with equity investments in other companies in the health care industry. The decrease in income for 2022 as compared with the corresponding period in 2021 was primarily due to the decreased profitability of the Company's joint ventures in 2022.Other, Net Years Ended December 31, 20222021ChangeOther, net$(25.3)$42.5 159.8 %The change in Other, net for the year ended December 31, 2022, as compared to the year ended December 31, 2021, was primarily due to investment losses of $19.6 compared to $61.8 of investment gains in the corresponding period of 2021. In addition, foreign currency transaction losses of $5.0 and $4.4 were recognized for the years ended December 31, 2022 and 2021, respectively.Income Tax ExpenseYears Ended December 31, 20222021Income tax expense$302.0 $747.1 Income tax expense as a % of income before tax19.1 %23.9 %The current year effective tax rate was favorably impacted by the Company's research and development tax credits, changes in effective state income tax rates, and deferred tax adjustments. During the third quarter, the Company completed a detailed domestic research and development tax credit analysis for the 2019, 2020, and 2021 tax years that resulted in an incremental income tax benefit. The prior year effective tax rate was favorably impacted by stock-based compensation arrangements that was offset by the deferred revaluation related to the U.K. rate change.Operating Results by SegmentDuring the fourth quarter of 2022, the Company modified the segment performance measure to exclude the amortization of intangibles and other assets, restructuring and other charges, goodwill and other asset impairments, and certain corporate charges for items such as transaction costs, COVID-19 costs, and other special items. These changes align with how the CODM now evaluates segment performance and allocates resources. Prior periods have been conformed for comparability. Years Ended December 31, 20222021ChangeDx segment operating income$2,025.5 $3,205.6 (36.8)%Dx segment operating margin22.0 %30.9 %(8.9)%DD segment operating income801.1 887.1 (9.7)%DD segment operating margin14.0 %15.2 %(1.1)%Segment operating income2,826.6 4,092.7 (30.9)%General corporate and unallocated expenses(438.1)(420.5)4.2 %Amortization of intangibles and other assets(259.3)(369.6)(29.8)%Restructuring and other charges(83.8)(43.1)94.4 %Goodwill and other asset impairments(271.5)— 100.0 %Total operating income$1,773.9 $3,259.5 (45.6)%Dx operating income was $2,025.5 for the year ended December 31, 2022, a decrease of 36.8% over operating income of $3,205.6 in the corresponding period of 2021, and Dx operating margin decreased 890 basis points in operating margin year-over-year. The decrease in operating income and margin were primarily due to a reduction in COVID-19 Testing, higher personnel expense, the mix impact from Ascension, partially offset by organic Base Business growth.58IndexDD operating income was $801.1 for the year ended December 31, 2022, a decrease of 9.7% from operating income of $887.1 in the corresponding period of 2021. The decrease was primarily due to a reduction in COVID-19 Testing, a reduction in COVID-19 related work, the interruption of some clinical trial activity due to the Ukraine/Russia crisis, and other inflationary costs. These impacts were partially offset by Base Business growth and LaunchPad savings.General corporate expenses are comprised primarily of administrative services such as executive management, human resources, legal, finance, corporate affairs, and information technology. Corporate expenses were $438.1 for the year ended December 31, 2022, an increase of 4.2% over corporate expenses of $420.5 in the corresponding period of 2021, primarily due to higher personnel costs, bonus allocation, research and development costs, and other costs.Liquidity, Capital Resources and Financial PositionThe Company's strong cash-generating capability and financial condition typically have provided ready access to capital markets. The Company's principal source of liquidity is operating cash flow, supplemented by proceeds from debt offerings. The Company's senior unsecured revolving credit facility is further discussed in Note 10 Debt to the Company's Consolidated Financial Statements. In summary the Company's cash flows were as follows: For the Year Ended December 31, 20222021Net cash provided by operating activities$1,955.9 $3,109.6 Net cash used for investing activities(1,652.2)(884.6)Net cash used for financing activities(1,322.2)(2,065.8)Effect of exchange rate on changes in cash and cash equivalents(24.2)(7.3)Net change in cash and cash equivalents$(1,042.7)$151.9 Cash and Cash EquivalentsCash and cash equivalents at December 31, 2022 and 2021 totaled $430.0 and $1,472.7, respectively. Cash and cash equivalents consist of highly liquid instruments, such as time deposits and other money market investments, which have original maturities of three months or less. Cash Flows from Operating ActivitiesDuring the year ended December 31, 2022, the Company's operations provided $1,955.9 of cash as compared to $3,109.6 in 2021. The $1,153.7 decrease in cash provided from operations in 2022 as compared with the corresponding 2021 period was primarily due to lower cash earnings as COVID-19 revenues decreased significantly.Cash Flows from Investing ActivitiesNet cash used by investing activities for the year ended December 31, 2022 was $1,652.2 as compared to net cash used by investing activities of $884.6 for the year ended December 31, 2021. The $767.6 increase in net cash used by investing activities for the year ended December 31, 2022, was primarily due to a year over year increase of $667.1 in cash paid for acquisitions. The Company had proceeds of $87.3 from the sale of assets and disposition of businesses during 2021 in comparison to $1.4 during 2022. Capital expenditures were $481.9 and $460.4 for the years ended December 31, 2022 and 2021, respectively. Capital expenditures in 2022 were 3.2% of revenues, primarily in connection with projects to support growth in the Company's core businesses. The Company intends to continue to pursue acquisitions to drive growth, to make important investments in its business, including in information technology, and to improve efficiency and enable the execution of the Company's mission. Such expenditures are expected to be funded by cash flow from operations or, as needed, through borrowings under debt facilities, including the Company's revolving credit facility or any successor facility. The Company expects capital expenditures in 2023 to be approximately 3.5% of revenues, primarily in connection with projects to support growth in the Company's core businesses, facility updates, projects related to LaunchPad, and further acquisition integration initiatives.Cash Flows from Financing ActivitiesNet cash used in financing activities for the year ended December 31, 2022 was $1,322.2 compared to cash used in financing activities of $2,065.8 for the year ended December 31, 2021. This movement in cash within financing activities for 2022, as compared to 2021, was primarily a result of $1,100.0 in share repurchases in 2022 compared to $1,668.5 in 2021 and the commencement of quarterly dividend payments in the second quarter of 2022.On May 26, 2021, the Company issued new senior notes representing $1,000.0 in debt securities and consisting of $500.0 aggregate principal amount of 1.55% senior notes due 2026 and $500.0 aggregate principal amount of 2.70% senior notes due 2031. Interest on these notes is payable semi-annually in arrears on June 1 and December 1 of each year, commencing on 59IndexDecember 1, 2021. Net proceeds from the offering of these notes were $989.4 after deducting underwriting discounts and other expenses of the offering. The net proceeds were used to redeem, prior to maturity, the Company's outstanding 3.20% senior notes due February 1, 2022 and 3.75% senior notes due August 23, 2022.During the second quarter of 2021, the Company entered into fixed-to-variable interest rate swap agreements for its 2.70% senior notes due 2031 with an aggregate notional amount of $500.0 and variable interest rates based on three-month LIBOR plus 1.0706%. These instruments are designated as hedges against changes in the fair value of a portion of the Company's long-term debt. The aggregate fair value of $79.7 at December 31, 2022, was included as a component of other long-term liabilities and deducted from the reported value of the senior notes. On April 30, 2021, the Company amended and restated its revolving credit facility. It consists of a five-year revolving facility in the principal amount of up to $1,000.0, with the option of increasing the facility by up to an additional $500.0, subject to the agreement of one or more new or existing lenders to provide such additional amounts and certain other customary conditions. The Company is required to pay a facility fee on the aggregate commitments under the revolving credit facility, at a per annum rate ranging from 0.100% to 0.225%, depending on the Company’s debt ratings. Borrowings under the revolving credit facility will accrue interest at a per annum rate equal to, at the Company’s election, either (x) a LIBOR rate plus a margin ranging from 0.775% to 1.275% or (y) a base rate plus a margin ranging from 0% to 0.275%, in each case, depending on the Company’s debt ratings.The Company continues to evaluate its outstanding debt portfolio to take advantage of market conditions that would allow the Company to reduce its interest rate or financing risk and provide a lower long-term borrowing cost.Under the Company's revolving credit facility, the Company is subject to negative covenants limiting subsidiary indebtedness and certain other covenants typical for investment grade-rated borrowers and the Company is required to maintain certain leverage ratios. The Company was in compliance with all covenants under the revolving credit facility at December 31, 2022, and expects that it will remain in compliance with its existing debt covenants for the next twelve months.During 2022, the Company repurchased 5.6 shares of its common stock at an average price of $233.48 for a total cost of $1,100.0. This included 0.9 shares which were repurchased in 2022 but were part of the $1,000.0 ASR Program paid for in 2021. At the end of 2022, the Company had outstanding authorization from the Board to purchase $531.5 of Company common stock. The repurchase authorization has no expiration date. On February 7, 2023, the board of directors adopted a new share repurchase plan authorizing up to $1,000.0 of the Company's shares in addition to the remaining amount outstanding under the previous plan. The repurchase authorization has no expiration date.For the year ended December 31, 2022, the Company paid $195.2 in common stock dividends. On January 12, 2023, the Company announced a cash dividend of $0.72 per share of common stock for the first quarter, or approximately $64.8 in the aggregate. The dividend will be payable on March 13, 2023, to stockholders of record of all issued and outstanding shares of common stock as of the close of business on February 23, 2023. The declaration and payment of any future dividends will be at the discretion of the Company's board of directors.Credit RatingsThe Company’s investment grade debt ratings from Moody’s and Standard & Poor's (S&P) contribute to its ability to access capital markets.Off-Balance Sheet ArrangementsThe Company does not have transactions or relationships with “special purpose” entities, and the Company does not have any off-balance sheet financing other than normal operating leases and letters of credit.Other Commercial CommitmentsAs of December 31, 2022, the Company provided letters of credit aggregating approximately $84.5, primarily in connection with certain insurance programs which are renewed annually. The contractual value of the noncontrolling interest put in the Company's Ontario subsidiary totaled $15.0 and $16.3 at December 31, 2022, and 2021, respectively, and has been classified as mezzanine equity in the Company's consolidated balance sheet.Based on current and projected levels of cash flows from operations, coupled with availability under its revolving credit facility, the Company believes it has sufficient liquidity to meet both its anticipated short-term and long-term cash needs for the next 12 months and the reasonably foreseeable future; however, the Company continually reassesses its liquidity position in light of market conditions and other relevant factors.60IndexCritical Accounting EstimatesThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. While the Company believes these estimates are reasonable and consistent, they are by their very nature estimates of amounts that will depend on future events. Accordingly, actual results could differ from these estimates. The Company’s Audit Committee periodically reviews the Company’s significant accounting policies. The Company’s critical accounting policies arise in conjunction with the following:•Revenue recognition; •Business combinations;•Income taxes;•Goodwill and indefinite-lived assets; and•Legal contingencies.Revenue RecognitionDxWithin the Dx segment, a revenue transaction is initiated when Dx receives a requisition order to perform a diagnostic test. The information provided on the requisition form is used to determine the party that will be billed for the testing performed and the expected reimbursement. Dx recognizes revenue and satisfies its performance obligation for services rendered when the testing process is complete and the associated results are reported. Revenues are distributed among four payer portfolios - clients, patients, Medicare and Medicaid and third party. Dx considers negotiated discounts and anticipated adjustments, including historical collection experience for the payer portfolio, when revenues are recorded. The following are descriptions of the Dx payer portfolios:ClientsClient payers represent the portion of Dx’s revenue related to physicians, hospitals, health systems, accountable care organizations (ACOs), employers and other entities where payment is received exclusively from the entity ordering the testing service. Generally, client revenues are recorded on a fee-for-service basis at Dx’s client list price, less any negotiated discount. A portion of client billing is for laboratory management services, collection kits and other non-testing services or products. In these cases, revenue is recognized when services are rendered or delivered. PatientsThis portfolio includes revenue from uninsured patients and member cost-share for insured patients (e.g., coinsurance, deductibles and non-covered services). Uninsured patients are billed based upon Dx’s patient fee schedules, net of any discounts negotiated with physicians on behalf of their patients. Dx bills insured patients as directed by their health plan and after consideration of the fees and terms associated with an established health plan contract. Medicare and MedicaidThis portfolio relates to fee-for-service revenue from traditional Medicare and Medicaid programs. Net revenue from these programs is based on the fee schedule established by the related government authority. In addition to contractual discounts, other adjustments including anticipated payer denials are considered when determining net revenue. Any remaining adjustments to revenue are recorded at the time of final collection and settlement. These adjustments are not material to Dx’s results of operations in any period presented.Third PartyThird party includes revenue related to MCOs. The majority of Dx's third-party revenue is reimbursed on a fee-for-service basis. These payers are billed at Dx's established list price and revenue is recorded net of contractual discounts. The majority of Dx’s MCO revenues are recorded based upon contractually negotiated fee schedules with revenues for non-contracted MCOs recorded based on historical reimbursement experience. Third-party reimbursement is also received through capitation agreements with MCOs and independent physician associations (IPAs). Under capitated agreements, revenue is recognized based on a negotiated per-member, per-month payment for an agreed upon menu of tests, or based upon the proportionate share earned by Dx from a capitation pool. When the agreed upon reimbursement is based solely on an established rate per member, revenue is not impacted by the volume of testing performed. Under a capitation pool arrangement, the aggregate value of an established rate per member is distributed based on 61Indexthe volume and complexity of the procedures performed by laboratories participating in the agreement. Dx recognizes revenue monthly, based upon the established capitation rate or anticipated distribution from a capitated pool. Dx has a formal process to estimate implicit price concessions for uncollectable accounts. The majority of Dx's collection risk is related to accounts receivable from both insured and uninsured patients who are unwilling or unable to pay. Anticipated write-offs are recorded as adjustments to revenue at an amount considered necessary to record the segment's revenue at its net realizable value. In addition to contractual discounts, other adjustments including anticipated payer denials and other external factors that could affect the collectability of its receivables are considered when determining revenue and the net receivable amount. Any remaining adjustments to revenue are recorded at the time of final collection and settlement. These adjustments are not material to Dx's results of operations in any period presented.DDA majority of DD’s revenues are earned under contracts that are long term in nature, ranging in duration from a few months to many years. The majority of DD's contracts contain a single performance obligation, as DD provides a significant service of integrating all promises in the contract and the promises are highly interdependent and interrelated with one another. For contracts that include multiple performance obligations, DD allocates the contract value to the goods and services based on a customer price list, if available. If a price list is not available, DD will estimate the transaction price using either market prices or an “expected cost plus margin” approach. The total contract value is estimated at the beginning of the contract, and is equal to the amount expected to be billed to the customer. Other payments and billing adjustments may also factor into the calculation of total contract value, such as the reimbursement of out-of-pocket costs and volume-based rebates. These contracts generally take the form of fixed-price or fee-for-service arrangements subject to pricing adjustments based on changes in scope.Fixed-price contracts are typically recognized as revenue over time based on a proportional-performance basis, using either input or output methods that are specific to the service provided. In an output method, revenue is determined by dividing the actual units of output achieved by the total units of output required under the contract and multiplying that percentage by the total contract value. When using an input method, revenue is recognized by dividing the actual costs incurred by the total estimated cost expected to complete the contract, and multiplying that percentage by the total contract value. Contract costs principally include direct labor and reimbursable out-of-pocket costs. The estimate of total costs expected to complete the contract requires significant judgment and estimates are based on various assumptions of events that often span several years. These estimates are reviewed periodically and any adjustments are recognized on a cumulative catch-up basis in the period they become known.Fee-for-service contracts are typically priced based on transaction volume or time and materials. For volume based contracts the contract value is entirely variable and revenue is recognized as the specific product or service is completed. For services billed based on time and materials, revenue is recognized using the right to invoice practical expedient.Contracts are often modified to account for changes in contract specifications and requirements. Generally, when contract modifications create new performance obligations, the modification is considered to be a separate contract and revenue is recognized prospectively. When contract modifications change existing performance obligations, the impact on the existing transaction price and measure of progress for the performance obligation to which it relates is generally recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative catch-up basis. Most contracts are terminable with or without cause by the customer, either immediately or upon notice. These contracts often require payment to DD of expenses to wind-down the study or project, fees earned to date and, in some cases, a termination fee or a payment to DD of some portion of the fees or profits that could have been earned by DD under the contract if it had not been terminated early. Termination fees are included in revenues when services are performed and realization is assured.Business CombinationsThe Company accounts for business combination transactions under the acquisition method of accounting and reported the results of operations of the acquired entities from its respective date of acquisition. Assets acquired were recorded at their estimated fair values as of the acquisition date. Estimated fair values were based on various valuation methodologies, including an income approach using primarily discounted cash flow techniques for the customer relationships intangible assets. The aforementioned income methods utilize management's estimates of future operating results and cash flows discounted using a weighted-average cost of capital that reflects market participant assumptions. The excess of the fair value of the consideration conveyed over the fair value of the assets acquired was recorded as goodwill. The goodwill reflects management's expectations of the ability to gain access to and penetrate the acquired entities' historical patient base and the benefits of being able to leverage operational efficiencies with favorable growth opportunities based on positive demographic trends in the market.62IndexIncome TaxesThe Company accounts for income taxes utilizing the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company does not recognize a tax benefit, unless the Company concludes that it is more likely than not that the benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, the Company recognizes a tax benefit measured at the largest amount of the tax benefit that the Company believes is greater than 50% likely to be realized. The Company records interest and penalties in income tax expense.Goodwill and Indefinite-Lived AssetsThe Company assesses goodwill and indefinite-lived intangibles for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The annual impairment test for goodwill includes an option to perform a qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying value. Reporting units are businesses with discrete financial information that is available and reviewed by management. If the Company determines that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then the Company performs the quantitative goodwill impairment test. The Company may also choose to bypass the qualitative assessment for any reporting unit in its goodwill assessment and proceed directly to performing the quantitative assessment. The Company recognizes an impairment charge for the amount by which the reporting unit's carrying amount exceeds its fair value. In the qualitative assessment, the Company considers relevant events and circumstances for each reporting unit, including (i) current year results, (ii) financial performance versus management’s annual and five-year strategic plans, (iii) changes in the reporting unit carrying value since prior year, (iv) industry and market conditions in which the reporting unit operates, (v) macroeconomic conditions, including discount rate changes, and (vi) changes in products or services offered by the reporting unit. If applicable, performance in recent years is compared to forecasts included in prior quantitative valuations. Based on the results of the qualitative assessment, if the Company concludes that it is not more likely than not that the fair value of the reporting unit is less than its carrying values of the reporting unit, then no quantitative assessment is performed.The quantitative assessment includes the estimation of the fair value of each reporting unit as compared to the carrying value of the reporting unit. The Company estimates the fair value of a reporting unit using both income-based and market-based valuation methods. The income-based approach is based on the reporting unit's forecasted future cash flows that are discounted to the present value using the reporting unit's weighted average cost of capital. For the market-based approach, the Company utilizes a number of factors such as publicly available information regarding the market capitalization of the Company as well as operating results, business plans, market multiples, and present value techniques. Based upon the range of estimated values developed from the income and market-based methods, the Company determines the estimated fair value for the reporting unit. If the estimated fair value of the reporting unit exceeds the carrying value, the goodwill is not impaired and no further review is required. The income-based fair value methodology requires management's assumptions and judgments regarding economic conditions in the markets in which the Company operates and conditions in the capital markets, many of which are outside of management's control. At the reporting unit level, fair value estimation requires management's assumptions and judgments regarding the effects of overall economic conditions on the specific reporting unit, along with assessment of the reporting unit's strategies and forecasts of future cash flows. Forecasts of individual reporting unit cash flows involve management's estimates and assumptions regarding:•Annual cash flows, on a debt-free basis, arising from future revenues and profitability, changes in working capital, capital spending and income taxes for at least a five-year forecast period.•A terminal growth rate for years beyond the forecast period. The terminal growth rate is selected based on consideration of growth rates used in the forecast period, historical performance of the reporting unit and economic conditions.•A discount rate that reflects the risks inherent in realizing the forecasted cash flows. A discount rate considers the risk-free rate of return on long-term treasury securities, the risk premium associated with investing in equity securities of comparable companies, the beta obtained from the comparable companies and the cost of debt for investment grade issuers. In addition, the discount rate may consider any company-specific risk in achieving the prospective financial information.63IndexUnder the market-based fair value methodology, judgment is required in evaluating market multiples and recent transactions. Management believes that the assumptions used for its impairment tests are representative of those that would be used by market participants performing similar valuations of the reporting units.Management performed its annual goodwill and intangible asset impairment testing as of the beginning of the fourth quarter of 2022. The Company elected to perform the qualitative assessment for goodwill and intangible assets for the domestic Dx reporting units and a quantitative assessment for all of the DD reporting units and the Canadian reporting unit which includes indefinite-lived assets consisting of acquired Canadian licenses. Based upon the results of the qualitative and quantitative assessments, the Company concluded that the fair values of each of its reporting units, as of October 1, 2022, were greater than the carrying values. For the early development reporting unit, which is part of the DD segment, the fair value of the business exceeded the book value by approximately 10%.In December 2022, a significant supplier of our early development reporting unit was no longer able to provide critical testing supplies resulting in an expectation of lower near term revenue and profitability and potential higher future costs. Based on this information, management prepared a new forecast and updated its impairment testing valuations as of December 31, 2022. Based on the quantitative impairment assessment performed in the same manner as the Company's annual quantitative assessment, the Company concluded that the fair value was less than carrying value for the early development reporting unit and recorded a goodwill impairment of $260.0 in the DD segment.Although the Company believes that the current assumptions and estimates used in its goodwill analysis are reasonable, supportable, and appropriate, continued efforts to maintain or improve the performance of these businesses could be impacted by unfavorable or unforeseen changes which could impact the existing assumptions used in the impairment analysis. Various factors could reasonably be expected to unfavorably impact existing assumptions: primarily delays in new customer bookings and the related delay in revenue from new customers, increases in customer termination activity or increases in operating costs. Accordingly, there can be no assurance that the estimates and assumptions made for the purposes of the goodwill impairment analysis will prove to be accurate predictions of future performance. It is possible that the Company's conclusions regarding impairment or recoverability of goodwill or intangible assets in any reporting unit could change in future periods. There can be no assurance that the estimates and assumptions used in the Company's goodwill and intangible asset impairment testing performed as of the beginning of the fourth quarter of 2022 or at the end of the year will prove to be accurate predictions of the future, if, for example, (i) the businesses do not perform as projected, (ii) overall economic conditions in 2022 or future years vary from current assumptions (including changes in discount rates), (iii) business conditions or strategies for a specific reporting unit change from current assumptions, including loss of major customers, (iv) investors require higher rates of return on equity investments in the marketplace or (v) enterprise values of comparable publicly traded companies, or actual sales transactions of comparable companies, were to decline, resulting in lower multiples of revenues and EBITDA. Legal ContingenciesThe Company is involved from time to time in various claims and legal actions, including arbitrations, class actions, and other litigation (including those described in more detail below), arising in the ordinary course of business. These matters include, but are not limited to, intellectual property disputes, commercial and contract disputes, professional liability claims, employee-related matters, transaction related disputes, securities and corporate law matters, and inquiries, including subpoenas and other civil investigative demands, from governmental agencies, Medicare or Medicaid payers and MCOs reviewing billing practices or requesting comment on allegations of billing irregularities that are brought to their attention through billing audits or third parties. The Company also is named from time to time in suits brought under the qui tam provisions of the False Claims Act and comparable state laws. These suits typically allege that the Company has made false statements and/or certifications in connection with claims for payment from U.S. federal or state healthcare programs. The suits may remain under seal (hence, unknown to the Company) for some time while the government decides whether to intervene on behalf of the qui tam plaintiff. Such claims are an inevitable part of doing business in the healthcare field today.The Company believes that it is in compliance in all material respects with all statutes, regulations, and other requirements applicable to its commercial laboratory operations and drug development support services. The healthcare diagnostics and drug development industries are, however, subject to extensive regulation, and the courts have not interpreted many of the applicable statutes and regulations. Therefore, the applicable statutes and regulations could be interpreted or applied by a prosecutorial, regulatory, or judicial authority in a manner that would adversely affect the Company. Potential sanctions for violation of these statutes and regulations include significant civil and criminal penalties, fines, the loss of various licenses, certificates and authorizations, additional liabilities from third-party claims, and/or exclusion from participation in government programs.The Company records an aggregate legal reserve, which is determined using calculations based on historical loss rates and assessment of trends experienced in settlements and defense costs. In accordance with FASB Accounting Standards 64IndexCodification Topic 450 “Contingencies,” the Company establishes reserves for judicial, regulatory, and arbitration matters outside the aggregate legal reserve if and when those matters present loss contingencies that are both probable and estimable and would exceed the aggregate legal reserve. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. If a loss is reasonably possible but not known or probable, and may be reasonably estimated, the estimated loss or range of loss is disclosed. For more information about legal contingencies, see Note 14 Commitments and Contingencies to the Consolidated Financial Statements.Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK (in millions)Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange rates, interest rates and other relevant market rate or price changes. In the ordinary course of business, the Company is exposed to various market risks, including changes in foreign currency exchange and interest rates, and the Company regularly evaluates the exposure to such changes. The Company addresses its exposure to market risks, principally the market risks associated with changes in foreign currency exchange rates and interest rates, through a controlled program of risk management that includes, from time to time, the use of derivative financial instruments such as foreign currency forward contracts, cross currency swaps and interest rate swap agreements. The Company does not hold or issue derivative financial instruments for trading purposes. Foreign Currency Exchange RatesApproximately 14.7% and 15.3% of the Company's revenues for the year ended December 31, 2022 and 2021, respectively, were denominated in currencies other than the U.S. dollar (USD). The Company's financial statements are reported in USD and, accordingly, fluctuations in exchange rates will affect the translation of revenues and expenses denominated in foreign currencies into USD for purposes of reporting the Company's consolidated financial results. In both 2022 and 2021, the most significant currency exchange rate exposures were to the Canadian dollar, Swiss franc, euro and British pound. Excluding the impacts from any outstanding or future hedging transactions, a hypothetical change of 10% in average exchange rates used to translate all foreign currencies to USD would have impacted income before income taxes for 2022 by approximately $26.9. Gross accumulated currency translation adjustments recorded as a separate component of shareholders’ equity were $(336.4) and $(104.6) at December 31, 2022, and 2021, respectively. The Company does not have significant operations in countries in which the economy is considered to be highly inflationary.The Company earns revenue from service contracts over a period of several months and, in some cases, over a period of several years. Accordingly, exchange rate fluctuations during this period may affect the Company's profitability with respect to such contracts. The Company is also subject to foreign currency transaction risk for fluctuations in exchange rates during the period of time between the consummation and cash settlement of transactions. The Company limits its foreign currency transaction risk through exchange rate fluctuation provisions stated in some of its contracts with customers, or it may hedge transaction risk with foreign currency forward contracts. At December 31, 2022, the Company had 27 open foreign exchange forward contracts with various amounts maturing monthly through January 2023 with a notional value totaling approximately $629.5. At December 31, 2021, the Company had 28 open foreign exchange forward contracts with various amounts maturing monthly through January 2022 with a notional value totaling approximately $600.7.The Company is party to USD to Swiss Franc cross-currency swap agreements with a notional amount of $600.0, maturing in 2024 and 2025, as a hedge against the impact of foreign exchange movements on its net investment in its Swiss Franc functional currency subsidiary.Interest RatesSome of the Company's debt is subject to interest at variable rates. As a result, fluctuations in interest rates affect the Company's financial results. The Company attempts to manage interest rate risk and overall borrowing costs through an appropriate mix of fixed and variable rate debt including the utilization of derivative financial instruments, primarily interest rate swaps. Borrowings under the Company's term loan credit facilities and revolving credit facility are subject to variable interest rates, unless fixed through interest rate swaps or other agreements.In May, 2021, to hedge against changes in the fair value portion of the Company's long-term debt, the Company entered into fixed-to-variable interest rate swap agreements for the 2.70% senior notes due 2031 with an aggregate notional value of $500.0 and variable interest rates based on three-month LIBOR plus 1.0706%.
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+ITEM 7. — MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion should be read in conjunction with, and is qualified in its entirety by, the audited consolidated financial statements and the notes thereto, and other financial information included in this Form 10-K. Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" are forward-looking statements. See "Special Note Regarding Forward-Looking Statements."OverviewWe view each of our Integrated Resorts as an operating segment. Our operating segments in Macao consist of The Venetian Macao; The Londoner Macao; The Parisian Macao; The Plaza Macao and Four Seasons Macao; and the Sands Macao. Our operating segment in Singapore is Marina Bay Sands.On February 23, 2022, we closed on the sale of our Las Vegas real property and operations, including The Venetian Resort Las Vegas and the Sands Expo and Convention Center (the “Las Vegas Operations”), for $6.25 billion (the “Las Vegas Sale”). At closing, we received approximately $5.05 billion in cash proceeds, before transaction costs and working capital adjustments of $77 million, a $1.20 billion seller financing loan and recognized a gain on disposal of $3.60 billion, before income tax expense of $750 million, during the year ended December 31, 2022.During 2022, we achieved milestones in advancing several of our strategic objectives. We were awarded a new 10-year gaming concession for the operation of casino games of chance in Macao under the Concession entered into with the Macao government. We completed our key development project in Macao with the conversion of Sands Cotai Central into The Londoner Macao, in which the Londoner Arena and the expansion of the Shoppes at Londoner were completed during the first half of 2022. We began renovations at Marina Bay Sands, to provide world-class suites in Tower 1 and Tower 2, and welcomed the return of Marina Bay Sands to normal operating conditions in the second half of 2022 with the removal of various COVID-19 restrictions. We also continued to strengthen our balance sheet with the completion of the sale of the Las Vegas Operations. COVID-19 Pandemic Update While visitation to Macao remains substantially below pre-COVID-19 pandemic levels, the Macao government's policy regarding the management of COVID-19 and general travel restrictions has adjusted in line with changes in policy in mainland China in late December 2022 and early January 2023. Currently, visitors from mainland China, Hong Kong and Taiwan may enter Macao, subject to them holding the appropriate travel documents, without having to present any proof of COVID-19 testing. Arrivals from foreign countries must provide proof of a negative COVID-19 nucleic acid test ("NAT") or antigen test completed within 48 hours prior to arrival. Our operations in Macao will continue to be impacted and subject to changes in the government policies of Macao, mainland China, Hong Kong and other jurisdictions in Asia addressing travel and public health measures associated with COVID-19.Throughout the year ended December 31, 2022, various outbreaks occurred in the region, particularly in Hong Kong in late January and early February, the Guangdong province in March, Macao in mid-June and Zhuhai in early October, all of which resulted in various travel, border and/or operational restrictions. Specifically, on July 9, 2022, the Macao government ordered casinos and all non-essential businesses to close from July 11 to July 18 in an attempt to control the outbreak in Macao, which was extended through July 22, 2022. On July 20, 2022, the Macao government announced a consolidation period, which started on July 23, 2022 and ended on July 30, 2022, whereby certain business activities were allowed to resume limited operations; however, casino operations resumed, but with a maximum capacity of 50% of casino staff working at any point. Throughout August, these preventative measures were gradually reduced, as well as various restrictions on movement between Macao and Zhuhai were progressively lifted by both the Macao and mainland China governments.Various travel restrictions, such as border closures, mandatory quarantines and proof of negative COVID-19 testing on arrival in Macao, among others, were in effect at various times during the year ended December 31, 2022, resulting in fluctuations in guest travel and visitation.44Table of ContentsThe Hong Kong / Macao Express bus service and the ferry services between the Taipa Ferry Terminal and Hong Kong International Airport recommenced on December 24, 2022 and December 30, 2022, respectively. Our ferry operations between Macao and Hong Kong were suspended throughout 2022 and resumed operation on a limited basis on January 8, 2023.Our Macao gaming operations remained open during most of the year ended December 31, 2022. While guest visitation has begun to recover with the gradual relaxation of travel and quarantine restrictions, the timing and manner in which our casinos, restaurants and shopping malls will operate at full capacity will progressively be assessed against business volumes.At our Macao properties, all social distancing requirements, including those requiring reduced seating at table games and a decreased number of active slot machines on the casino floor compared to pre-COVID-19 levels, have ceased in early January 2023.As with prior periods, in support of the Macao government’s initiatives to fight the COVID-19 Pandemic, at various times throughout the year ended December 31, 2022, we provided both towers of the Sheraton Grand Macao hotel and also The Parisian Macao hotel to the Macao government to house individuals for quarantine and medical observation purposes. Our operations in Macao have been significantly impacted by the reduced visitation to Macao. The Macao government announced total visitation from mainland China to Macao decreased approximately 27.5% and 81.7%, during the year ended December 31, 2022, as compared to the same period in 2021 and 2019 (pre-pandemic), respectively. The Macao government also announced gross gaming revenue decreased approximately 51.4% and 85.6%, during the year ended December 31, 2022, as compared to the same period in 2021 and 2019, respectively. In Singapore, the Vaccinated Travel Framework (“VTF”) was launched on April 1, 2022, to facilitate the resumption of travel for all travelers, including short-term visitors. Under the VTF, all fully vaccinated travelers are permitted to enter Singapore, without entry approvals, and starting April 26, 2022, these travelers are no longer required to take a COVID-19 test before departing for Singapore. Non-fully vaccinated travelers need only take a pre-departure test within two days before departure for Singapore and test negative before departing for Singapore. Operations at Marina Bay Sands will continue to be impacted and subject to changes in the government policies of Singapore and other jurisdictions in Asia, if any, addressing travel and public health measures associated with COVID-19.Visitation to Marina Bay Sands continues to be impacted by the effects of the COVID-19 Pandemic; however, visitation has increased since restrictions have been lifted. The STB announced total visitation to Singapore increased from approximately 330,000 in 2021 to 6.3 million in 2022, while visitation decreased 67.0% when compared to the same period in 2019.While our properties were open and some operating at reduced levels due to lower visitation and required safety measures in place as described above during the year ended December 31, 2022, the current economic and regulatory environment on a global basis and in each of our jurisdictions continue to evolve. We cannot predict the manner in which governments will react as the global and regional impact of the COVID-19 Pandemic changes over time, which could significantly alter our current operations.We have a strong balance sheet and sufficient liquidity in place, including total unrestricted cash and cash equivalents of $6.31 billion and access to $1.50 billion, $541 million and $439 million of available borrowing capacity from our LVSC Revolving Facility, 2018 SCL Revolving Facility and the 2012 Singapore Revolving Facility, respectively, as of December 31, 2022. We believe we are able to support continuing operations, complete the major construction projects that are underway and respond to the current COVID-19 Pandemic challenges. We have taken various mitigating measures to manage through the current environment, including a cost and capital expenditure reduction program to minimize cash outflow for nonessential items.Macao ConcessionUntil December 31, 2022, gaming in Macao was administered by the government through concession agreements awarded to three different concessionaires and three subconcessionaires, of which VML was one. On June 23, 2022, an extension was approved and authorized by the Macao government and executed between VML and Galaxy Casino, S.A., pursuant to which the subconcession was extended from June 26, 2022 to December 31, 45Table of Contents2022 (the “Subconcession Amendment”). VML paid the Macao government 47 million patacas (approximately $6 million at exchange rates in effect at the time of the transaction) and provided a bank guarantee on September 20, 2022, of 2.31 billion patacas (approximately $289 million at exchange rates as defined in the bank guarantee contract) to secure the fulfillment of VML's payment obligations towards its employees if VML were unsuccessful in tendering for a new concession contract after its subconcession expired. On November 26, 2022, the Macao government awarded six concessions to six of the bidders on a temporary basis, of which VML was one, subject to fulfillment of certain conditions, namely providing a bank guarantee of 1.0 billion patacas (approximately $125 million at exchange rates in effect on December 31, 2022) to secure the fulfillment of VML’s legal, contractual and other obligations, including labor obligations. VML complied with all of these conditions by December 9, 2022. On December 16, 2022, the Macao government awarded six concessions on a definitive basis, of which VML was one, and VML entered into the Concession with the Macao government, effective as of January 1, 2023, and for the duration of ten years. On December 19, 2022, VML requested the release of all the bank guarantees it provided to the Macao government under its subconcession, and in January 2023 such bank guarantees were released, including the 2.31 billion patacas bank guarantee.On December 30, 2022, in accordance with the requirements of the Gaming Law and their obligations under letters of undertakings (the "Undertakings"), each of VML, Venetian Cotai Limited ("VCL"), Venetian Orient Limited ("VOL") and Cotai Strip Lot 2 Apart Hotel (Macau) Limited (“CSL2,” a subsidiary of SCL) entered into deeds of reversion, pursuant to which each of VML, VCL, VOL and CSL2 confirmed and agreed to revert to the Macao government relevant gaming equipment and gaming areas (as identified in the Undertakings) without compensation and free of any liens or charges upon the expiry of the term of the subconcession extension period. On the same day, VML entered into a handover record (the "Handover Record"), pursuant to which the right to operate the same gaming equipment and gaming areas was granted to VML for the duration of the Concession, in return for annual payments of 750 patacas per square meter for the first three years and 2,500 patacas per square meter for the following seven years (approximately $93 and $311, respectively, at exchange rates in effect on December 31, 2022). The annual payment of 750 patacas per square meter will be adjusted with the Macao average price index of the corresponding preceding year for years two and three and the annual payment of 2,500 patacas per square meter will be adjusted with the Macao average price index of the corresponding preceding year for years five through ten. Inflation Reduction Act The Inflation Reduction Act of 2022 (“IRA”) was signed into law on August 16, 2022. The IRA contains numerous provisions including a 15% corporate alternative minimum tax (“CAMT”) for certain large corporations that have at least an average of $1 billion adjusted financial statement income over a consecutive three-year period effective in tax years beginning after December 31, 2022. Applicable corporations would be allowed to claim a credit for the corporate minimum tax paid against regular tax in future years. The IRA also includes a 1% excise tax on corporate stock repurchases beginning January 1, 2023. The CAMT could impact our future cash flows and results of operations. The Internal Revenue Service has been granted broad authority to issue regulations or other guidance that could clarify how these taxes will be applied. We will continue to evaluate the impact of the IRA as additional information becomes available. Intercompany Loan Agreement with SCLOn July 11, 2022, we entered into an intercompany term loan agreement with SCL, a related party, in the amount of $1.0 billion, which is repayable on July 11, 2028. In the first two years from July 11, 2022, SCL will have the option to elect to pay cash interest at 5% per annum or payment-in-kind interest at 6% per annum by adding the amount of such interest to the then-outstanding principal amount of the loan, following which only cash interest at 5% per annum will be payable. This loan is unsecured, subordinated to all third party unsecured indebtedness and other obligations of SCL and its subsidiaries and is eliminated in consolidation.Key Operating Revenue MeasurementsOperating revenues at The Venetian Macao, The Londoner Macao, The Parisian Macao, The Plaza Macao and Four Seasons Macao, Marina Bay Sands and our Las Vegas Operating Properties, prior to its sale on February 23, 2022, are dependent upon the volume of customers who stay at the hotel, which affects the price charged for hotel 46Table of Contentsrooms and our gaming volume. Operating revenues at Sands Macao are principally driven by casino customers who visit the property on a daily basis.Management utilizes the following volume and pricing measures in order to evaluate past performance and assist in forecasting future revenues. The various volume measurements indicate our ability to attract customers to our Integrated Resorts. In casino operations, win and hold percentages indicate the amount of revenue to be expected based on volume. In hotel operations, average daily rate and revenue per available room indicate the demand for rooms and our ability to capture that demand. In mall operations, base rent per square foot indicates our ability to attract and maintain profitable tenants for our leasable space.The following are the key measurements we use to evaluate operating revenues:Casino revenue measurements for Macao and Singapore: Macao and Singapore table games are segregated into two groups: Rolling Chip play (composed of VIP players) and Non-Rolling Chip play (mostly non-VIP players). The volume measurement for Rolling Chip play is non-negotiable gaming chips wagered and lost. The volume measurement for Non-Rolling Chip play is table games drop ("drop"), which is net markers issued (credit instruments), cash deposited in the table drop boxes and gaming chips purchased and exchanged at the cage. Rolling Chip and Non-Rolling Chip volume measurements are not comparable as they are two distinct measures of volume. The amounts wagered and lost for Rolling Chip play are substantially higher than the amounts dropped for Non-Rolling Chip play. Slot handle, also a volume measurement, is the gross amount wagered for the period cited.We view Rolling Chip win as a percentage of Rolling Chip volume, Non-Rolling Chip win as a percentage of drop and slot hold (amount won by the casino) as a percentage of slot handle. Win or hold percentage represents the percentage of Rolling Chip volume, Non-Rolling Chip drop or slot handle that is won by the casino and recorded as casino revenue. Our win and hold percentages are calculated before discounts, commissions, deferring revenue associated with our loyalty programs and allocating casino revenues related to goods and services provided to patrons on a complimentary basis. Our Rolling Chip win percentage is expected to be 3.15% to 3.45% in Macao and Singapore. Actual win percentage may vary from our expected win percentage and historical win and hold percentages. Generally, slot machine play is conducted on a cash basis. In Macao and Singapore, 9.8% and 15.8%, respectively, of our table games play was conducted on a credit basis for the year ended December 31, 2022.Casino revenue measurements for the U.S.: The volume measurements in the U.S. were slot handle, as previously described, and table games drop, which was the total amount of cash and net markers issued (credit instruments) deposited in the table drop box. We viewed table games win as a percentage of drop and slot hold as a percentage of slot handle. Our win and hold percentages were calculated before discounts, commissions, deferring revenue associated with our loyalty programs and allocating casino revenues related to goods and services provided to patrons on a complimentary basis. Similar to Macao and Singapore, slot machine play was generally conducted on a cash basis.Hotel revenue measurements: Performance indicators used are occupancy rate (a volume indicator), which is the average percentage of available hotel rooms occupied during a period, and average daily room rate ("ADR," a price indicator), which is the average price of occupied rooms per day. Available rooms exclude those rooms unavailable for occupancy during the period due to renovation, development or other requirements (such as government mandated closure, lodging for team members and usage by the Macao and Singapore governments for quarantine measures). The calculations of the occupancy rate and ADR include the impact of rooms provided on a complimentary basis. Revenue per available room ("RevPAR") represents a summary of hotel ADR and occupancy. Because not all available rooms are occupied, ADR is normally higher than RevPAR. Reserved rooms where the guests do not show up for their stay and lose their deposit, or where guests check out early, may be re-sold to walk-in guests.Mall revenue measurements: Occupancy, base rent per square foot and tenant sales per square foot are used as performance indicators. Occupancy represents gross leasable occupied area ("GLOA") divided by gross leasable area ("GLA") at the end of the reporting period. GLOA is the sum of: (1) tenant occupied space under lease and (2) tenants no longer occupying space, but paying rent. GLA does not include space currently under development or not on the market for lease. Base rent per square foot is the weighted average base or minimum rent charge, excluding rent concessions, in effect at the end of the reporting period for all tenants that would qualify to be included in occupancy. Tenant sales per square foot is the sum of reported comparable sales for the trailing 47Table of Contents12 months divided by the comparable square footage for the same period. Only tenants that have been open for a minimum of 12 months are included in the tenant sales per square foot calculation.Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021Summary Financial ResultsThe reopening of borders and elimination of most pandemic-related restrictions in Singapore positively impacted the financial results of Marina Bay Sands. In contrast, tighter border and travel restrictions had an adverse impact at our Macao operations. See "COVID-19 Pandemic Update" for further information. Net revenues for the year ended December 31, 2022 were $4.11 billion, compared to $4.23 billion for the year ended December 31, 2021. Operating loss was $792 million for the year ended December 31, 2022, compared to $689 million for the year ended December 31, 2021. Net loss from continuing operations was $1.54 billion for the year ended December 31, 2022, compared to $1.47 billion for the year ended December 31, 2021. Operating RevenuesOur net revenues consisted of the following: Year Ended December 31, 20222021Percent Change (Dollars in millions)Casino$2,627 $2,892 (9.2)%Rooms469 415 13.0 %Food and beverage301 199 51.3 %Mall580 649 (10.6)%Convention, retail and other133 79 68.4 %Total net revenues$4,110 $4,234 (2.9)%Consolidated net revenues were $4.11 billion for the year ended December 31, 2022, a decrease of $124 million compared to $4.23 billion for the year ended December 31, 2021, driven by a decrease of $1.27 billion at our Macao operations due to decreased visitation as tighter border restrictions were introduced throughout 2022 as a result of increased COVID-19 cases in Macao and the surrounding region. The decrease was partially offset by an increase of $1.15 billion at Marina Bay Sands, primarily due to increased visitation from the reopening of borders and elimination of most pandemic-related restrictions in April 2022. Net casino revenues decreased $265 million compared to the year ended December 31, 2021. The decrease was driven by a $1.04 billion decrease at our Macao operations due to lower visitation across our properties resulting in decreased table games and slot volumes. Casino revenues at Marina Bay Sands increased by $775 million due to increased table games and slot volumes, driven by the reopening of borders and elimination of most pandemic-related restrictions, partially offset by a lower Rolling Chip win percentage. The following table summarizes the results of our casino activity:Year Ended December 31,20222021Change(Dollars in millions)Macao Operations:The Venetian MacaoTotal casino revenues$438 $944 (53.6)%Non-Rolling Chip drop$1,751 $3,234 (45.9)%Non-Rolling Chip win percentage25.7 %27.4 %(1.7)ptsRolling Chip volume$1,295 $4,412 (70.6)%Rolling Chip win percentage3.77 %3.99 %(0.22)ptsSlot handle$1,132 $1,841 (38.5)%Slot hold percentage3.9 %3.9 %— pts48Table of ContentsYear Ended December 31,20222021Change(Dollars in millions)The Londoner MacaoTotal casino revenues$194 $396 (51.0)%Non-Rolling Chip drop$896 $1,755 (48.9)%Non-Rolling Chip win percentage21.7 %21.6 %0.1 ptsRolling Chip volume$936 $3,674 (74.5)%Rolling Chip win percentage5.03 %3.23 %1.80 ptsSlot handle$671 $962 (30.2)%Slot hold percentage3.4 %3.8 %(0.4)ptsThe Parisian MacaoTotal casino revenues$116 $244 (52.5)%Non-Rolling Chip drop$454 $1,146 (60.4)%Non-Rolling Chip win percentage24.9 %22.3 %2.6 ptsRolling Chip volume$283 $502 (43.6)%Rolling Chip win percentage7.66 %3.73 %3.93 ptsSlot handle$305 $787 (61.2)%Slot hold percentage3.8 %3.3 %0.5 ptsThe Plaza Macao and Four Seasons MacaoTotal casino revenues$146 $298 (51.0)%Non-Rolling Chip drop$551 $1,140 (51.7)%Non-Rolling Chip win percentage23.8 %23.5 %0.3 ptsRolling Chip volume$1,452 $2,659 (45.4)%Rolling Chip win percentage4.48 %4.64 %(0.16)ptsSlot handle$21 $42 (50.0)%Slot hold percentage9.4 %5.7 %3.7 ptsSands MacaoTotal casino revenues$53 $105 (49.5)%Non-Rolling Chip drop$237 $433 (45.3)%Non-Rolling Chip win percentage17.9 %17.1 %0.8 ptsRolling Chip volume$192 $1,073 (82.1)%Rolling Chip win percentage4.16 %4.39 %(0.23)ptsSlot handle$409 $606 (32.5)%Slot hold percentage3.2 %3.1 %0.1 pts49Table of ContentsYear Ended December 31,20222021Change(Dollars in millions)Singapore Operations:Marina Bay SandsTotal casino revenues$1,680 $905 85.6 %Non-Rolling Chip drop$4,640 $2,679 73.2 %Non-Rolling Chip win percentage18.6 %15.0 %3.6 ptsRolling Chip volume$21,223 $3,901 444.0 %Rolling Chip win percentage2.92 %5.79 %(2.87)ptsSlot handle$16,547 $12,084 36.9 %Slot hold percentage4.3 %4.2 %0.1 ptsU.S. Operations:Las Vegas Operating Properties(1)Total net casino revenues$61 $443 (86.2)%Table games drop$257 $1,630 (84.2)%Table games win percentage13.6 %16.4 %(2.8)ptsSlot handle$599 $3,830 (84.4)%Slot hold percentage8.2 %8.5 %(0.3)pts__________________________(1) The Las Vegas Operating Properties are classified as a discontinued operation. We completed the sale on February 23, 2022. Financial results are for the period through February 22, 2022. In our experience, average win percentages remain fairly consistent when measured over extended periods of time with a significant volume of wagers, but can vary considerably within shorter time periods as a result of the statistical variances associated with games of chance in which large amounts are wagered.50Table of ContentsRoom revenues increased $54 million compared to the year ended December 31, 2021. The increase was primarily due to increased occupancy rates and ADR at Marina Bay Sands driven by increased visitation, partially offset by decreased occupancy rates and ADR driven by reduced visitation at our Macao properties. The following table summarizes the results of our room activity:Year Ended December 31,20222021Change(Room revenues in millions)Macao Operations:The Venetian MacaoTotal room revenues$55 $77 (28.6)%Occupancy rate41.7 %49.7 %(8.0)ptsAverage daily room rate (ADR)$143 $155 (7.7)%Revenue per available room (RevPAR)$60 $77 (22.1)%The Londoner MacaoTotal room revenues$61 $90 (32.2)%Occupancy rate26.9 %40.3 %(13.4)ptsAverage daily room rate (ADR)$155 $160 (3.1)%Revenue per available room (RevPAR)$42 $64 (34.4)%The Parisian MacaoTotal room revenues$33 $54 (38.9)%Occupancy rate37.9 %52.1 %(14.2)ptsAverage daily room rate (ADR)$110 $118 (6.8)%Revenue per available room (RevPAR)$42 $61 (31.1)%The Plaza Macao and Four Seasons MacaoTotal room revenues$29 $45 (35.6)%Occupancy rate27.5 %44.3 %(16.8)ptsAverage daily room rate (ADR)$440 $438 0.5 %Revenue per available room (RevPAR)$121 $194 (37.6)%Sands MacaoTotal room revenues$6 $10 (40.0)%Occupancy rate51.1 %68.2 %(17.1)ptsAverage daily room rate (ADR)$141 $138 2.2 %Revenue per available room (RevPAR)$72 $94 (23.4)%Singapore Operations:Marina Bay Sands(1)Total room revenues$285 $139 105.0 %Occupancy rate93.1 %70.1 %23.0 ptsAverage daily room rate (ADR)$422 $236 78.8 %Revenue per available room (RevPAR)$393 $165 138.2 %U.S. Operations:Las Vegas Operating Properties(2)Total room revenues$78 $454 (82.8)%Occupancy rate84.6 %82.4 %2.2 ptsAverage daily room rate (ADR)$247 $221 11.8 %Revenue per available room (RevPAR)$209 $182 14.8 %_________________________(1)During the year ended December 31, 2022, approximately 500 rooms were under construction for renovation purposes.(2)The Las Vegas Operating Properties are classified as a discontinued operation. We completed the sale on February 23, 2022. Financial results are for the period through February 22, 2022. 51Table of ContentsFood and beverage revenues increased $102 million compared to the year ended December 31, 2021. The increase was due to a $128 million increase driven by increased business volume at food and beverage outlets and banquets at Marina Bay Sands, partially offset by a decrease of $26 million at our Macao operations.Mall revenues decreased $69 million compared to the year ended December 31, 2021. A $119 million decrease in mall revenues in Macao, driven by decreases in base rent and turnover rent, and an increase in rent concessions granted to our mall tenants, was partially offset by a $50 million increase in mall revenues at Marina Bay Sands, driven by a decrease in rent concessions granted to our mall tenants and an increase in turnover rent. For further information related to the financial performance of our malls, see "Additional Information Regarding our Retail Mall Operations." The following table summarizes the results of our malls on the Cotai Strip in Macao and in Singapore: Year Ended December 31, 20222021Change (Mall revenues in millions)Macao Operations:Shoppes at VenetianTotal mall revenues$154 $194 (20.6)%Mall gross leasable area (in square feet)813,832 814,784 (0.1)%Occupancy81.0 %79.7 %1.3 ptsBase rent per square foot$274 $292 (6.2)%Tenant sales per square foot(1)$932 $1,348 (30.9)%Shoppes at LondonerTotal mall revenues$47 $55 (14.5)%Mall gross leasable area (in square feet)610,238 532,175 14.7 %Occupancy54.7 %54.4 %0.3 ptsBase rent per square foot$134 $152 (11.8)%Tenant sales per square foot(1)$1,139 $1,462 (22.1)%Shoppes at ParisianTotal mall revenues$25 $39 (35.9)%Mall gross leasable area (in square feet)296,322 296,322 — %Occupancy67.6 %74.5 %(6.9)ptsBase rent per square foot$107 $133 (19.5)%Tenant sales per square foot(1)$338 $648 (47.8)%Shoppes at Four SeasonsTotal mall revenues$127 $184 (31.0)%Mall gross leasable area (in square feet)248,674 244,208 1.8 %Occupancy93.6 %94.3 %(0.7)ptsBase rent per square foot$538 $549 (2.0)%Tenant sales per square foot(1)$3,806 $6,300 (39.6)%Singapore Operations:The Shoppes at Marina Bay SandsTotal mall revenues$226 $176 28.4 %Mall gross leasable area (in square feet)622,007 622,362 (0.1)%Occupancy99.5 %98.2 %1.3 ptsBase rent per square foot$284 $277 2.5 %Tenant sales per square foot(1)$2,596 $1,614 60.8 %_________________________Note: This table excludes the results of retail outlets at Sands Macao. As a result of the COVID-19 Pandemic, tenants were provided rent concessions during the year ended December 31, 2022 and 2021. Base rent per square foot presented above excludes the impact of these rent concessions.52Table of Contents(1)Tenant sales per square foot is the sum of reported comparable sales for the trailing 12 months divided by the comparable square footage for the same period.Convention, retail, and other revenues increased $54 million compared to the year ended December 31, 2021. The increase was due to increases of $47 million and $7 million at Marina Bay Sands and our Macao operations, respectively, driven primarily by increases in convention revenue at Marina Bay Sands, and quarantine room revenue at the Sheraton Grand Macao hotel and The Parisian Macao. Operating ExpensesOur operating expenses consisted of the following:Year Ended December 31,20222021Percent Change(Dollars in millions)Casino$1,792 $2,068 (13.3)%Rooms173 164 5.5 %Food and beverage319 244 30.7 %Mall73 65 12.3 %Convention, retail and other103 85 21.2 %Provision for credit losses15 3 400.0 %General and administrative936 831 12.6 %Corporate235 211 11.4 %Pre-opening13 19 (31.6)%Development143 109 31.2 %Depreciation and amortization1,036 1,041 (0.5)%Amortization of leasehold interests in land55 56 (1.8)%Loss on disposal or impairment of assets9 27 (66.7)%Total operating expenses$4,902 $4,923 (0.4)%Operating expenses were $4.90 billion for the year ended December 31, 2022, a decrease of $21 million compared to $4.92 billion for the year ended December 31, 2021. The decrease was primarily driven by a $276 million decrease in casino expenses, partially offset by increases of $105 million in general and administrative expenses, $75 million in food and beverage expenses, $34 million in in development expenses and $24 million in corporate expenses. Casino expenses decreased $276 million compared to the year ended December 31, 2021. The decrease was primarily attributable to a decrease of $290 million in gaming taxes. The $1.04 billion decrease in casino revenue at our Macao operating properties is subject to a 39% tax rate, whereas the $775 million increase in casino revenue at Marina Bay Sands is subject to a lower tax rate.Food and beverage expenses increased $75 million compared to the year ended December 31, 2021. The increase was due to an $86 million increase at Marina Bay Sands, driven by increased business volume at food outlets and banquets and consistent with increased revenues, partially offset by an $11 million decrease at our Macao operations. Convention, retail and other expenses increased $18 million compared to the year ended December 31, 2021, primarily driven by an increase of $16 million, consistent with increased revenues at Marina Bay Sands.The provision for credit losses was $15 million for the year ended December 31, 2022, compared to $3 million for the year ended December 31, 2021. The $12 million increase was primarily driven by an $11 million increase at Marina Bay Sands due to an increase in new credit issued and patrons who were unable to return to the property. The amount of this provision can vary over short periods of time because of factors specific to the patrons who owe us money from gaming activities. We believe the amount of our provision for credit losses in the future will depend upon the state of the economy, our credit standards, our risk assessments and the judgment of our employees responsible for granting credit.53Table of ContentsGeneral and administrative expenses increased $105 million compared to the year ended December 31, 2021, primarily driven by increases at Marina Bay Sands. The increases were primarily driven by increases in property operation costs, marketing and payroll to support the increased visitation and property tax and insurance costs.Corporate expenses increased $24 million compared to the year ended December 31, 2021. The increase was primarily driven by increases in bonuses and stock-based compensation. Pre-opening expenses represent personnel and other costs incurred prior to the opening of new ventures, which are expensed as incurred. The majority of pre-opening expenses for the year ended December 31, 2022, related to Marina Bay Sands. Pre-opening expenses for the year ended December 31, 2021, related to The Londoner Macao.Development expenses were $143 million for the year ended December 31, 2022, compared to $109 million for the year ended December 31, 2021. During the year ended December 31, 2022, the costs were associated with our evaluation and pursuit of new business opportunities, primarily in Florida and Texas, and our digital gaming related efforts. Development costs are expensed as incurred. Loss on disposal or impairment of assets was $9 million for the year ended December 31, 2022, compared to $27 million for the year ended December 31, 2021. The losses incurred for the year ended December 31, 2022, were primarily due to $4 million in asset disposals related to aircraft parts and $3 million in asset disposal and demolition costs, primarily at The Londoner Macao, The Venetian Macao, Sands Macao and our corporate offices. The losses for the year ended December 31, 2021, were primarily due to asset disposals and demolition costs related to The Londoner Macao. Segment Adjusted Property EBITDAThe following table summarizes information related to our segments (see "Item 8 — Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 20 — Segment Information" for discussion of our operating segments):Year Ended December 31,20222021Percent Change(Dollars in millions)Macao:The Venetian Macao$(25)$297 (108.4)%The Londoner Macao(189)(84)125.0 %The Parisian Macao(103)(17)505.9 %The Plaza Macao and Four Seasons Macao81 219 (63.0)%Sands Macao(81)(69)17.4 %Ferry Operations and Other(7)(8)(12.5)%(324)338 (195.9)%Marina Bay Sands1,056 448 135.7 %Consolidated adjusted property EBITDA(1)$732 $786 (6.9)%Las Vegas Operating Properties(2)$63 $290 (78.3)%_________________________(1)Consolidated adjusted property EBITDA, which is a non-GAAP financial measure, is used by management as the primary measure of the operating performance of our segments. Consolidated adjusted property EBITDA is net income/loss before stock-based compensation expense, corporate expense, pre-opening expense, development expense, depreciation and amortization, amortization of leasehold interests in land, gain or loss on disposal or impairment of assets, interest, other income or expense, gain or loss on modification or early retirement of debt and income taxes. Consolidated adjusted property EBITDA is a supplemental non-GAAP financial measure used by management, as well as industry analysts, to evaluate operations and operating performance. In particular, management utilizes consolidated adjusted property EBITDA to compare the operating profitability of our operations with those of our competitors, as well as a basis for determining certain 54Table of Contentsincentive compensation. Integrated Resort companies have historically reported adjusted property EBITDA as a supplemental performance measure to GAAP financial measures. In order to view the operations of their properties on a more stand-alone basis, Integrated Resort companies, including Las Vegas Sands Corp., have historically excluded certain expenses that do not relate to the management of specific properties, such as pre-opening expense, development expense and corporate expense, from their adjusted property EBITDA calculations. Consolidated adjusted property EBITDA should not be interpreted as an alternative to income from operations (as an indicator of operating performance) or to cash flows from operations (as a measure of liquidity), in each case, as determined in accordance with GAAP. We have significant uses of cash flow, including capital expenditures, dividend payments, interest payments, debt principal repayments and income taxes, which are not reflected in consolidated adjusted property EBITDA. Not all companies calculate adjusted property EBITDA in the same manner. As a result, our presentation of consolidated adjusted property EBITDA may not be directly comparable to similarly titled measures presented by other companies. Year Ended December 31, 20222021 (In millions)Consolidated adjusted property EBITDA$732 $786 Other Operating Costs and ExpensesStock-based compensation(a)(33)(12)Corporate(235)(211)Pre-opening(13)(19)Development(143)(109)Depreciation and amortization(1,036)(1,041)Amortization of leasehold interests in land(55)(56)Loss on disposal or impairment of assets(9)(27)Operating loss(792)(689)Other Non-Operating Costs and ExpensesInterest income116 4 Interest expense, net of amounts capitalized(702)(621)Other expense(9)(31)Loss on modification or early retirement of debt— (137)Income tax (expense) benefit(154)5 Net loss from continuing operations$(1,541)$(1,469)(a)During the years ended December 31, 2022 and 2021, the Company recorded stock-based compensation expense of $70 million and $27 million, respectively, of which $37 million and $15 million, respectively, was included in corporate expense in the accompanying consolidated statements of operations.(2)The Las Vegas Operating Properties are classified as a discontinued operation. We completed the sale on February 23, 2022. Financial results are for the period through February 22, 2022. Adjusted property EBITDA at our Macao operations decreased $662 million compared to the year ended December 31, 2021. The decrease was primarily due to decreased casino, mall and room revenues, driven by decreased visitation at our properties as tighter border and travel restrictions were in place in 2022 as a result of increased COVID-19 cases in Macao and the surrounding areas. Adjusted property EBITDA at Marina Bay Sands increased $608 million compared to the year ended December 31, 2021. The increase was primarily due to increased casino, room, food and beverage and mall operations driven by increased visitation and loosened pandemic-related restrictions implemented in April 2022. Discontinued OperationAdjusted property EBITDA at our Las Vegas Operating Properties decreased $227 million compared to the year ended December 31, 2021. The decrease was primarily due to the current year activity representing only 53 days of operations as we completed the sale of the Las Vegas Operating properties on February 23, 2022, partially 55Table of Contentsoffset by increased casino and room operations as Las Vegas Operating Properties operated under pre-pandemic guidelines.Interest ExpenseThe following table summarizes information related to interest expense:Year Ended December 31,20222021(Dollars in millions)Interest cost$706 $636 Less — capitalized interest(4)(15)Interest expense, net$702 $621 Cash paid for interest$618 $606 Weighted average total debt balance$15,298 $14,592 Weighted average interest rate4.6 %4.4 %Interest cost increased $70 million compared to the year ended December 31, 2021, resulting primarily from increases in our weighted average interest rate and weighted average total debt balance. The weighted average debt balance increased due to draws of $1.20 billion on the SCL revolver during the year ended December 31, 2022. Additionally, the weighted average interest rate increased primarily due to increased interest rates on the SCL revolver and the MBS credit facility in line with increases in market rates and increased interest rates on the SCL senior notes in connection with the credit rating downgrades in February and June 2022 (see "Item 8 — Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 12 — Long-Term Debt").Other Factors Affecting EarningsInterest income was $116 million for the year ended December 31, 2022, compared to $4 million for the year ended December 31, 2021. This increase was primarily from the $90 million in interest income on money market funds and bank deposits driven by an increase in cash due to the sale of the Las Vegas Operating Properties and higher interest rates. We also had $21 million in interest income from the seller financing loan in connection with the sale of the Las Vegas Operating Properties in 2022. Other expense was $9 million for the year ended December 31, 2022, compared to $31 million during the year ended December 31, 2021. The change was due to the fluctuation in the exchange rate between the U.S. dollar and pataca in connection with our U.S. dollar denominated debt held by SCL.Our income tax expense was $154 million on a loss from continuing operations before income taxes of $1.39 billion for the year ended December 31, 2022, resulting in an 11.1% effective income tax rate. This compares to a (0.3)% effective income tax rate for the year ended December 31, 2021. The income tax expense for the year ended December 31, 2022, reflects a 17% statutory tax rate on our Singapore operations, a 21% corporate income tax rate on our U.S. operations, and a zero percent tax rate on our Macao gaming operations due to our income tax exemption in Macao. Our U.S. operations recorded a valuation allowance on certain U.S. foreign tax credits, which we no longer expect to utilize. Our U.S. tax expense was partially offset by a tax benefit associated with the pre-tax book losses incurred for the year ended December 31, 2022. We have had the benefit of a corporate tax exemption in Macao, which exempts us from paying the 12% corporate income tax on profits generated by the operation of casino games, but does not apply to our non-gaming activities. We continued to benefit from this tax exemption through December 31, 2022. Additionally, we entered into a shareholder dividend tax agreement with the Macao government in April 2019, effective through June 26, 2022, providing an annual payment as a substitution for a 12% tax otherwise due from VML shareholders on dividend distributions paid from VML gaming profits. In December 2022, we requested a corporate tax exemption on profits generated by the operation of casino games in Macao for the new gaming concession period effective from January 1, 2023 through December 31, 2032, or for a period of corporate tax exemption that the Chief Executive of Macao may deem more appropriate. We are evaluating the timing of an application for a new shareholder dividend tax agreement.56Table of ContentsThe net loss attributable to our noncontrolling interests from continuing operations was $475 million for the year ended December 31, 2022, compared to $315 million for the year ended December 31, 2021. These amounts were related to the noncontrolling interest of SCL.Additional Information Regarding our Retail Mall OperationsThe following tables summarize the results of our mall operations on the Cotai Strip and at Marina Bay Sands for the years ended December 31, 2022 and 2021:Shoppes at VenetianShoppes at Four SeasonsShoppes at LondonerShoppes at ParisianThe Shoppes at Marina Bay Sands(In millions)For the year ended December 31, 2022Mall revenues:Minimum rents(1)$168 $119 $30 $22 $145 Overage rents6 8 11 2 51 Rent concessions(2)(47)(10)(6)(7)— Total overage rents and rent concessions(41)(2)5 (5)51 CAM, levies and direct recoveries27 10 12 8 30 Total mall revenues154 127 47 25 226 Mall operating expenses:Common area maintenance11 5 7 4 20 Marketing and other direct operating expenses7 6 4 3 5 Mall operating expenses18 11 11 7 25 Property taxes(3)1 — — — 4 Mall-related expenses(4)$19 $11 $11 $7 $29 For the year ended December 31, 2021Mall revenues:Minimum rents(1)$181 $121 $29 $29 $144 Overage rents15 54 15 6 25 Rent concessions(2)(31)(1)(3)(6)(24)Other(5)— — — — 6 Total overage rents and rent concessions(16)53 12 — 7 CAM, levies and direct recoveries29 10 14 10 25 Total mall revenues194 184 55 39 176 Mall operating expenses:Common area maintenance12 5 7 4 16 Marketing and other direct operating expenses6 4 3 2 6 Mall operating expenses18 9 10 6 22 Property taxes(3)1 — — — 2 Provision for (recovery of) credit losses(1)— — 3 — Mall-related expenses(4)$18 $9 $10 $9 $24 ____________________Note: This table excludes the results of our mall operations at Sands Macao.(1) Minimum rents include base rents and straight-line adjustments of base rents.(2) Rent concessions were provided to tenants as a result of the COVID-19 Pandemic and the related impact on mall operations.57Table of Contents(3) Commercial property that generates rental income is exempt from property tax for the first six years for newly constructed buildings in Cotai. If the property also qualifies for Tourism Utility Status, the property tax exemption can be extended to twelve years with effect from the opening of the property. To date, The Venetian Macao, The Plaza Macao and Four Seasons Macao, The Londoner Macao and The Parisian Macao have obtained an extended exemption. The exemption for The Venetian Macao and The Plaza Macao and Four Seasons Macao expired in August 2019 and August 2020, respectively, and the exemption for The Londoner Macao and The Parisian Macao will be expiring in December 2027 and September 2028, respectively.(4) Mall-related expenses consist of CAM, marketing fees and other direct operating expenses, property taxes and provision for credit losses, but excludes depreciation and amortization and general and administrative costs.(5) The amount for Marina Bay Sands of $6 million related to a grant provided by the Singapore government to lessors to support small and medium enterprises impacted by the COVID-19 Pandemic in connection with their rent obligations.It is common in the mall operating industry for companies to disclose mall net operating income ("NOI") as a useful supplemental measure of a mall's operating performance. Because NOI excludes general and administrative expenses, interest expense, impairment losses, depreciation and amortization, gains and losses from property dispositions, allocations to noncontrolling interests and provision for income taxes, it provides a performance measure that, when compared year over year, reflects the revenues and expenses directly associated with owning and operating commercial real estate properties and the impact on operations from trends in occupancy rates, rental rates and operating costs.In the table above, we believe taking total mall revenues less mall-related expenses provides an operating performance measure for our malls. Other mall operating companies may use different methodologies for deriving mall-related expenses. As such, this calculation may not be comparable to the NOI of other mall operating companies.Year Ended December 31, 2021 Compared to the Year Ended December 31, 2020A discussion of changes in our results of operations between 2021 and 2020 has been omitted from this Form 10-K and can be found in "Item 7 — Management's Discussion and Analysis of Financial Condition and Results of Operations — Year Ended December 31, 2021 Compared to the Year Ended December 31, 2020" of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2021.58Table of ContentsLiquidity and Capital ResourcesCash Flows — SummaryOur cash flows consisted of the following:Year Ended December 31,20222021(In millions)Net cash used in operating activities from continuing operations$(944)$(243)Cash flows from investing activities from continuing operations:Capital expenditures(651)(828)Proceeds from disposal of property and equipment9 7 Acquisition of intangible assets and other(129)(11)Proceeds from seller loan50 — Net cash used in investing activities from continuing operations(721)(832)Cash flows from financing activities from continuing operations:Proceeds from exercise of stock options— 19 Tax withholding on vesting of equity awards(1)— Proceeds from long-term debt1,200 2,702 Repayments of long-term debt(66)(1,867)Payments of financing costs(11)(38)Make-whole premium on early extinguishment of debt— (131)Transaction with discontinued operations5,032 178 Net cash generated from financing activities from continuing operations6,154 863 Net cash generated from (used in) discontinued operations$— $16 A discussion of changes in cash flows between 2021 and 2020 has been omitted from this Form 10-K and can be found in "Item 7 — Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources" of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2021.Cash Flows — Operating ActivitiesTable games play at our properties is conducted on a cash and credit basis, while slot machine play is primarily conducted on a cash basis. Our rooms, food and beverage and other non-gaming revenues are conducted primarily on a cash basis and to a lesser extent as a trade receivable. Operating cash flows are generally affected by changes in operating income, accounts receivable, gaming related liabilities and interest payments. For the year ended December 31, 2022, cash used in operations was $944 million, an increase of $701 million compared to $243 million for the year ended December 31, 2021. The increase in cash used for operations was primarily due to cash tax payments inclusive of, and primarily due to, the gain on sale of the Las Vegas Operations totaling $612 million, and our Macao operations generating increased operating losses and working capital requirements due to the decrease in visitation resulting from COVID-19 travel restrictions across key China markets in 2022 and Macao experiencing COVID-19 cases at various times throughout 2022. This cash usage was partially offset by operating cash flows provided by Marina Bay Sands due to the acceleration of visitation and elimination of restrictions in Singapore over the course of 2022.Cash Flows — Investing ActivitiesCapital expenditures for the year ended December 31, 2022, totaled $651 million. Included in this amount was $348 million at Marina Bay Sands in Singapore and $243 million for construction and development activities in Macao, which consisted of $175 million for The Londoner Macao, $52 million for The Venetian Macao, $9 million for The Plaza Macao and Four Seasons Macao, $4 million for Sands Macao and $3 million for The Parisian Macao. Additionally, this amount included $60 million for corporate and other.59Table of ContentsCapital expenditures for the year ended December 31, 2021, totaled $828 million, including $653 million in Macao, which consisted of $551 million for The Londoner Macao, $71 million for The Venetian Macao and $19 million for The Plaza Macao and Four Seasons Macao primarily for The Grand Suites at Four Seasons, $7 million from Sands Macao, $4 million for The Parisian Macao and $1 million for Ferry and Other; $148 million at Marina Bay Sands in Singapore; and $27 million for corporate and other.Cash Flows — Financing ActivitiesNet cash flows generated from financing activities were $6.15 billion for the year ended December 31, 2022, which was primarily attributable to the net proceeds from the sale of the Las Vegas Operating Properties of $4.89 billion and $1.20 billion from the drawdown of our SCL revolving facility. These items were partially offset by $66 million in repayments on long-term debt and $11 million in deferred offering costs relating to obtaining LVSC Revolving Facility lender consents to consummate the Las Vegas Sale and the covenant waiver obtained on the 2018 SCL Credit Facility.Net cash flows generated from financing activities were $863 million for the year ended December 31, 2021, which was primarily attributable to net proceeds of $756 million, received from the drawdown of our SCL revolving facility, and transactions with discontinued operations. These items were partially offset by a $131 million make-whole premium for the early redemption of the SCL senior note due 2023 and $38 million in financing costs related to the issuance of the new unsecured notes at SCL and the covenant waivers obtained on the LVSC Revolving Facility, 2018 SCL Credit Facility and 2012 Singapore Credit Facility. As of December 31, 2022, we had $2.48 billion available for borrowing under our U.S., Macao and Singapore revolving facilities, net of letters of credit. Additionally, we had $2.74 billion available for borrowing under the 2012 Singapore Delayed Draw Term Facility to finance construction costs incurred in connection with the MBS Expansion Project.Cash Flows — Discontinued OperationsCash flows from discontinued operations for the twelve months ended December 31, 2022, were primarily attributable to $4.89 billion in net proceeds from the Las Vegas Sale, which were transferred to continuing operations.Capital Financing OverviewWe fund our development projects primarily through borrowings from our debt instruments (see "Item 8 — Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 12 — Long-Term Debt") and operating cash flows.On February 23, 2022, we closed the sale of our Las Vegas Operations. At closing, we received approximately $5.05 billion in cash proceeds, before transaction costs and income taxes. The net proceeds of approximately $4.36 billion, after working capital adjustments, transaction costs and the payment of income taxes throughout 2022, will be used for incremental liquidity and general corporate purposes, which may include capital expenditures and development activities. In connection with the closing of the sale, we may be required to make certain payments (“Support Payments”) to OpCo. The Support Payments are payable on a monthly basis following the closing through the year ending December 31, 2023, based upon the performance of the Las Vegas Operations relative to certain agreed upon target metrics and subject to quarterly and annual adjustments. Our remaining payment obligations are subject to a cap equal to $250 million for the period beginning January 1, 2023 and ending December 31, 2023. No Support Payments were made for the period post-close through December 31, 2022. On January 31, 2023, the Company received notice from OpCo that the Contingent Lease Support Agreement had terminated pursuant to its terms and that neither party would have any further liability or obligation thereunder. Our U.S., SCL and Singapore credit facilities, as amended, contain various financial covenants, which include maintaining a maximum leverage ratio or net debt, as defined, to trailing twelve-month adjusted earnings before interest, income taxes, depreciation and amortization, as defined. In September 2021, LVSC extended the amendment, pursuant to which lenders, among other things, removed LVSC’s requirement to maintain a maximum leverage ratio as of the last day of the fiscal quarter, through and including December 31, 2022. In November 2022, SCL extended the waiver and amendment request letter, pursuant to which lenders, among other things, waived SCL’s requirement to ensure the leverage ratio does not exceed 4.0x and the interest coverage ratio is greater than 60Table of Contents2.50x, through July 31, 2023. In September 2021, MBS extended the amendment letter, pursuant to which MBS will not have to comply with the leverage or interest coverage covenants as of the last day of the fiscal quarter, through and including December 31, 2022. Our compliance with our financial covenants for periods beyond December 31, 2022 could be affected by certain factors beyond our control, such as the impact of the COVID-19 Pandemic, including travel, quarantine and border restrictions occurring in the future. We will pursue additional waivers to meet the required financial covenant ratios, which include a maximum leverage ratio of 4.0x, 4.0x and 4.5x under our U.S., Macao and Singapore credit facilities, respectively, for periods beyond December 31, 2022 for LVSC and MBS and July 31, 2023 for SCL, if deemed necessary. We believe we will be successful in obtaining the additional waivers, although no assurance can be provided that such waivers will be granted, which could negatively impact our ability to be in compliance with our debt covenants for periods beyond December 31, 2022 for LVSC and MBS and July 31, 2023 for SCL. The 2018 SCL Credit Facility expires on July 31, 2023; however, we believe we will be successful in extending the maturity date of the facility prior to its expiration. If we are unable to extend the maturity date or refinance the 2018 SCL Credit Facility, we would be required to seek alternative forms of capital to repay the outstanding balance and our available liquidity may be reduced. On January 30, 2023, LVSC entered into the Fourth Amendment with lenders to the LVSC Revolving Credit Agreement. Pursuant to the Fourth Amendment, the existing LVSC Revolving Credit Agreement was amended to (a) determine consolidated adjusted EBITDA on a year-to-date annualized basis during the period commencing on the effective date and ending on and including December 31, 2023, as follows: (i) for the fiscal quarter ending March 31, 2023, consolidated adjusted EBITDA for such fiscal quarter multiplied by four, (ii) for the fiscal quarter ending June 30, 2023, consolidated adjusted EBITDA for such fiscal quarter and the immediately preceding fiscal quarter multiplied by two, and (iii) for the fiscal quarter ending September 30, 2023, consolidated adjusted EBITDA for such fiscal quarter and the two immediately preceding fiscal quarters, multiplied by four-thirds; (b) extend the period during which LVSC is required to maintain a specified amount of minimum liquidity as of the last day of each month to December 31, 2023; and (c) extend the period during which LVSC is unable to declare or pay any dividend or other distribution, unless liquidity is greater than $1.0 billion on a pro forma basis after giving effect to such dividend or distribution, to December 31, 2023.Any defaults under our debt agreements would allow the lenders, in each case, to exercise their rights and remedies as defined under their respective agreements. If the lenders were to exercise their rights to accelerate the due dates of the indebtedness outstanding, there can be no assurance we would be able to repay or refinance any amounts that may become due and payable under such agreements, which could force us to restructure or alter our operations or debt obligations.We held unrestricted cash and cash equivalents of $6.31 billion and restricted cash of $125 million as of December 31, 2022, of which approximately $2.57 billion of the unrestricted amount is held by non-U.S. subsidiaries. Of the $2.57 billion, approximately $2.06 billion is available to be repatriated, either in the form of dividends or via intercompany loans or advances, to the U.S., subject to levels of earnings, cash flow generated from gaming operations and various other factors, including dividend requirements to third-party public stockholders in the case of funds being repatriated from SCL, compliance with certain local statutes, laws and regulations currently applicable to our subsidiaries and restrictions in connection with their contractual arrangements. We do not expect withholding taxes or other foreign income taxes to apply should these earnings be distributed in the form of dividends or otherwise.We believe the cash on hand and cash flow generated from operations, as well as the $2.48 billion available for borrowing under our U.S., Macao and Singapore credit facilities, net of outstanding letters of credit, and SGD 3.69 billion (approximately $2.74 billion at exchange rates in effect on December 31, 2022) under the 2012 Singapore Delayed Draw Term Facility, as of December 31, 2022 (only available for draws after the construction cost estimate and construction schedule for the MBS Expansion Project have been delivered to the lenders), will be sufficient to maintain compliance with the financial covenants of our credit facilities and fund our working capital needs, committed and planned capital expenditures, development opportunities and debt obligations. In the normal course of our activities, we will continue to evaluate global capital markets to consider future opportunities for enhancements of our capital structure. During the year ended December 31, 2022, SCL drew down $114 million and HKD 8.50 billion (approximately $1.09 billion at exchange rates in effect on December 31, 2022) under the SCL revolving facility for general corporate purposes.61Table of ContentsWe have suspended our quarterly dividend program beginning in April 2020, and SCL suspended its dividend payments after paying its interim dividend for 2019 on February 21, 2020. We believe we have a strong balance sheet and sufficient liquidity in place, including access to available borrowing capacity under our credit facilities. We also believe we are well positioned to support our continuing operations, complete the major construction projects underway, meet our commitments under the Macao Concession and respond to the current COVID-19 Pandemic challenges. We have taken various mitigating measures to manage through the current environment, including a cost and capital expenditure reduction program to minimize cash outflow for non-essential items.Share Repurchase ProgramIn June 2018, our Board of Directors authorized the repurchase of $2.50 billion of our outstanding common stock, which was to expire in November 2020. In October 2020, our Board of Directors authorized the extension of the expiration date of the remaining repurchase amount of $916 million to November 2022 and in October 2022, our Board of Directors authorized the further extension of the expiration date of the remaining repurchase amount of $916 million to November 2024. During the year ended December 31, 2022, no shares of our common stock were repurchased under this program. All share repurchases of our common stock have been recorded as treasury stock. Repurchases of our common stock are made at our discretion in accordance with applicable federal securities laws in the open market or otherwise. The timing and actual number of shares to be repurchased in the future will depend on a variety of factors, including our financial position, earnings, cash flows, legal requirements, other investment opportunities and market conditions.Aggregate Indebtedness and Other Contractual ObligationsOur total long-term indebtedness and other contractual obligations are summarized below as of December 31, 2022:Payments Due by Period(1)20232024 - 20252026 - 2027ThereafterTotal(In millions)Long-Term Debt Obligations(2)LVSC Senior Notes$— $2,250 $1,000 $750 $4,000 SCL Senior Notes— 1,800 1,500 3,850 7,150 2018 SCL Credit Facility — Revolving1,958 — — — 1,958 2012 Singapore Credit Facility62 1,165 1,676 — 2,903 Singapore Delayed Draw Term Facility— 15 31 — 46 Other Debt(3)11 14 1 — 26 Fixed Interest Payments480 898 521 379 2,278 Variable Interest Payments(4)206 235 35 — 476 Macao Concession Related(5)Macao Annual Premium(6)41 82 82 203 408 Handover Record(7)13 25 85 212 335 Contractual ObligationsOperating Leases, Including Imputed Interest(8)14 19 14 304 351 Mall Deposits(9)65 58 13 13 149 Other(10)95 96 39 134 364 Total$2,945 $6,657 $4,997 $5,845 $20,444 _______________________(1)As of December 31, 2022, we had a $100 million liability related to uncertain tax positions. We do not expect this liability to result in a payment of cash within the next 12 months. We are unable to reasonably 62Table of Contentsestimate the timing of the liability in individual years beyond 12 months due to uncertainties in the timing of the effective settlement of tax positions; therefore, such amounts are not included in the table.(2)See "Item 8 — Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 12 — Long-Term Debt" for further details on these financing transactions and "Item 8 — Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 16 — Leases" for further details on finance leases.(3)Other debt consists of finance leases, including imputed interest, and other financed purchased obligations, including the related interest.(4)Based on the 1-month rate as of December 31, 2022, Secured Overnight Financing Rate ("SOFR") of 4.30%, Hong Kong Inter-Bank Offer Rate (“HIBOR”) of 4.35% and Singapore Swap Offer Rate ("SOR") of 2.53%, plus the applicable interest rate spread in accordance with the respective debt agreements.(5)In addition to the amounts listed in the table above, under the Macao Concession, we have committed to spend 30.24 billion patacas (approximately $3.77 billion at exchange rates in effect on December 31, 2022) through 2032 on both capital and operating projects, including 27.80 billion patacas (approximately $3.46 billion at exchange rates in effect on December 31, 2022) in non-gaming projects. We will be required to increase our investment in non-gaming projects by up to 20% in the following year subject to a trigger, namely if Macao’s annual market gross gaming revenue achieves or exceeds 180 billion patacas (approximately $22.42 billion at exchange rates in effect on December 31, 2022). The 20% increase is subject to a deduction of 4% per year if the revenue trigger occurs on or after 2028 (the sixth year of the term of the Concession). This potential additional investment is estimated to be approximately $700 million. As the exact timing of this spend has not been finalized, these amounts have not been included in the table above.We are also required to pay a 35% gross gaming revenue special gaming tax and a 5% gross gaming revenue contribution in Macao, which amounts we pay are variable in nature. Under the Concession, however, we are obligated to pay a special annual gaming premium if the average of the gross gaming revenues of our gaming tables and our electrical or mechanical gaming machines, including slot machines, is lower than a certain minimum amount determined by the Macao government; such special premium being the difference between the gaming tax based on the actual gross gaming revenues and that of the specified minimum amount. Based on the maximum number of gaming tables and gaming machines we are currently authorized to operate, if the monthly special gaming taxes paid during the year aggregates to less than 4.50 billion patacas (approximately $561 million at exchange rates in effect on December 31, 2022), we would be required to pay the difference as the special annual gaming premium.(6)We are required to pay an annual premium with a fixed portion and a variable portion, which is based on the number and type of gaming tables and gaming machines we operate. Based on the gaming tables and gaming machines (which is at the maximum number of tables and machines currently allowed by the Macao government) in operation as of January 1, 2023, the annual premium payable to the Macao government is approximately $41 million for the years ending December 31, 2023 through December 31, 2027, respectively, and $203 million in aggregate thereafter through the termination of the Concession in December 2032. (7)Under the Handover Record, we are required to make annual payments of 750 patacas per square meter for the first three years and 2,500 patacas per square meter for the following seven years (approximately $93 and $311, respectively, at exchange rates in effect on December 31, 2022). The annual payment of 750 patacas per square meter will be adjusted with the Macao average price index of the corresponding preceding year for years two and three and the annual payment of 2,500 patacas per square meter will be adjusted with the Macao average price index of the corresponding preceding year for years five through ten. (8)We are party to certain operating leases for real estate, which primarily include $319 million related to long-term land leases in Macao with an anticipated lease term of 50 years and $16 million related to a long-term land lease in Las Vegas with a 40-year lease term. See "Item 8 — Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 16 — Leases" for further details on operating leases.63Table of Contents(9)Mall deposits consist of refundable security deposits received from mall tenants.(10)Primarily consists of all other non-cancellable contractual obligations and primarily relates to certain hotel management and service agreements, as described below. The amounts exclude open purchase orders with our suppliers that have not yet been received as these agreements generally allow us the option to cancel, reschedule and adjust terms based on our business needs prior to the delivery of goods or performance of services. Some of our hotel properties operate pursuant to management agreements with various experienced third-party hotel operators (management companies), whereby the management company controls the day-to-day operations of each of these hotels, and we are granted limited approval rights with respect to certain of the management company’s actions. The non-cancelable period of our management agreements ranges from 14 to 40 years with various extension provisions and some with early termination options. Each management company receives a base management fee, generally a percentage of revenue as defined. There are also monthly fees for certain support services and some also include incentive fees based on attaining certain financial thresholds.Off-Balance Sheet ArrangementsWe have not entered into any transactions with special purpose entities, nor have we engaged in any derivative transactions other than foreign currency swaps. Refer to "Item 8 — Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 11 — Derivative Instruments" for outstanding foreign currency swaps as of December 31, 2022.Restrictions on DistributionsWe are a parent company with limited business operations. Our main asset is the stock and ownership interests of our subsidiaries. Certain of our debt instruments contain restrictions that, among other things, limit the ability of certain subsidiaries to incur additional indebtedness, issue disqualified stock or equity interests, pay dividends or make other distributions, repurchase equity interests or certain indebtedness, create certain liens, enter into certain transactions with affiliates, enter into certain mergers or consolidations or sell certain of our assets without prior approval of the lenders or noteholders. Under the Concession, although not a restriction, we have to provide a five-day prior notification to the Macao government for any major financial decisions exceeding 10% of the share capital of VML.Special Note Regarding Forward-Looking StatementsThis report contains forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include the discussions of our business strategies and expectations concerning future operations, margins, profitability, liquidity and capital resources. In addition, in certain portions included in this report, the words: “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends” and similar expressions, as they relate to our Company or management, are intended to identify forward-looking statements. Although we believe these forward-looking statements are reasonable, we cannot assure you any forward-looking statements will prove to be correct. These forward-looking statements involve known and unknown risks, uncertainties and other factors beyond our control, which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. These factors include, among others, the risks associated with:•the uncertainty of the extent, duration and effects of the COVID-19 Pandemic and the response of governments and other third parties, including government-mandated property closures, increased operational regulatory requirements or travel restrictions, on our business, results of operations, cash flows, liquidity and development prospects;•our ability to maintain our Concession in Macao and gaming license in Singapore;•our ability to invest in future growth opportunities; •the ability to execute our previously announced capital expenditure programs in Singapore, and produce future returns;64Table of Contents•general economic and business conditions internationally, which may impact levels of disposable income, consumer spending, group meeting business, pricing of hotel rooms and retail and mall tenant sales;•disruptions or reductions in travel and our operations due to natural or man-made disasters, pandemics, epidemics or outbreaks of infectious or contagious diseases, political instability, civil unrest, terrorist activity or war;•the uncertainty of consumer behavior related to discretionary spending and vacationing at our Integrated Resorts in Macao and Singapore;•the extensive regulations to which we are subject and the costs of compliance or failure to comply with such regulations;•new developments and construction projects and ventures, including development at our existing properties (for example, development at our Cotai Strip properties and the MBS Expansion Project);•regulatory policies in China or other countries in which our patrons reside, or where we have operations, including visa restrictions limiting the number of visits or the length of stay for visitors from China to Macao, restrictions on foreign currency exchange or importation of currency, and the judicial enforcement of gaming debts;•the possibility that the laws and regulations of mainland China become applicable to our operations in Macao and Hong Kong;•the possibility that economic, political and legal developments in Macao adversely affect our Macao operations, or that there is a change in the manner in which regulatory oversight is conducted in Macao;•our leverage, debt service and debt covenant compliance, including the pledge of certain of our assets (other than our equity interests in our subsidiaries) as security for our indebtedness and ability to refinance our debt obligations as they come due or to obtain sufficient funding for our planned, or any future, development projects;•fluctuations in currency exchange rates and interest rates, and the possibility of increased expense as a result;•increased competition for labor and materials due to planned construction projects in Macao and Singapore and quota limits on the hiring of foreign workers;•our ability to compete for limited management and labor resources in Macao and Singapore, and policies of those governments may also affect our ability to employ imported managers or labor from other countries;•our dependence upon properties primarily in Macao and Singapore for all of our cash flow and the ability of our subsidiaries to make distribution payments to us;•the passage of new legislation and receipt of governmental approvals for our operations in Macao and Singapore and other jurisdictions where we are planning to operate;•the ability of our insurance coverage to cover all possible losses that our properties could suffer and the potential for our insurance costs to increase in the future;•our ability to collect gaming receivables from our credit players;•the collectability of our outstanding loan receivable;•our dependence on chance and theoretical win rates;•fraud and cheating;•our ability to establish and protect our intellectual property rights;•reputational risk related to the license of certain of our trademarks;•the possibility that our securities may be prohibited from being traded in the U.S. securities market under the Holding Foreign Companies Accountable Act;65Table of Contents•conflicts of interest that arise because certain of our directors and officers are also directors and officers of SCL;•government regulation of the casino industry (as well as new laws and regulations and changes to existing laws and regulations), including gaming license regulation, the requirement for certain beneficial owners of our securities to be found suitable by gaming authorities, the legalization of gaming in other jurisdictions and regulation of gaming on the internet;•increased competition in Macao, including recent and upcoming increases in hotel rooms, meeting and convention space, retail space, potential additional gaming licenses and online gaming;•the popularity of Macao and Singapore as convention and trade show destinations;•new taxes, changes to existing tax rates or proposed changes in tax legislation;•the continued services of our key officers;•any potential conflict between the interests of our Principal Stockholders and us;•labor actions and other labor problems;•our failure to maintain the integrity of our information and information systems or comply with applicable privacy and data security requirements and regulations could harm our reputation and adversely affect our business;•the completion of infrastructure projects in Macao;•limitations on the transfers of cash to and from our subsidiaries, limitations of the pataca exchange markets and restrictions on the export of the renminbi;•the outcome of any ongoing and future litigation; and•potential negative impacts from environmental, social and governance and sustainability matters.All future written and verbal forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. New risks and uncertainties arise from time to time, and it is impossible for us to predict these events or how they may affect us. Readers are cautioned not to place undue reliance on these forward-looking statements. We assume no obligation to update any forward-looking statements after the date of this report as a result of new information, future events or developments, except as required by federal securities laws.Investors and others should note we announce material financial information using our investor relations website (https://investor.sands.com), our company website, SEC filings, investor events, news and earnings releases, public conference calls and webcasts. We use these channels to communicate with our investors and the public about our company, our products and services, and other issues.In addition, we post certain information regarding SCL, a subsidiary of Las Vegas Sands Corp. with ordinary shares listed on The Stock Exchange of Hong Kong Limited, from time to time on our company website and our investor relations website. It is possible the information we post regarding SCL could be deemed to be material information.Critical Accounting Policies and EstimatesThe preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires our management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. These estimates and judgments are based on historical information, information currently available to us and on various other assumptions management believes to be reasonable under the circumstances. Actual results could vary from those estimates and we may change our estimates and assumptions in future evaluations. Changes in these estimates and assumptions may have a material effect on our results of operations and financial condition. We believe the critical accounting policies discussed below affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.66Table of ContentsProvision for Expected Credit LossesWe maintain a provision for expected credit losses on casino, hotel and mall receivables and regularly evaluate the balances. We apply standard reserve percentages to aged account balances, which are grouped based on shared credit risk characteristics and days past due. The reserve percentages are based on estimated loss rates supported by historical observed default rates over the expected life of the receivable and are adjusted for forward-looking information. We also specifically analyze the collectability of each account with a balance over a specified dollar amount, based upon the age of the account, the customer's financial condition, collection history and any other known information and adjust the aforementioned reserve with the results from the individual reserve analysis. We also monitor regional and global economic conditions and forecasts, which include the impact of the COVID-19 Pandemic, in our evaluation of the adequacy of the recorded reserves.During the year ended December 31, 2022, there continued to be a delay in payments on casino receivables due to the inability of patrons to travel to our properties or to accomplish financial transactions due to the travel restrictions caused by the COVID-19 Pandemic. The collection of casino receivables has also been impacted by liquidity issues faced by certain patrons also stemming from the COVID-19 Pandemic. We have increased the provision for credit losses where appropriate to account for the expected credit losses due to the COVID-19 Pandemic. We continue to closely monitor any delays in payments due to the COVID-19 Pandemic and will increase the provision accordingly depending on the facts and circumstances. Although we believe the provision on our casino receivables is adequate as of December 31, 2022, it is possible our provisions could increase if we experience further delays on payments from patrons.Account balances are written off against the provision when we believe it is probable the receivable will not be recovered. Credit or marker play was 9.8% and 15.8% of table games play at our Macao properties and Marina Bay Sands, respectively, during the year ended December 31, 2022. Our provision for casino credit losses was 61.6% and 72.5% of gross casino receivables as of December 31, 2022 and 2021, respectively. The credit extended to gaming promoters can be offset by the commissions payable to said gaming promoters, which is considered in the establishment of the provision for credit losses. Our provision for credit losses from our hotel and other receivables is not material.Litigation AccrualWe are subject to various claims and legal actions. We estimate the accruals for these claims and legal actions based on all relevant facts and circumstances currently available and include such accruals in other accrued liabilities in the consolidated balance sheets when it is determined such contingencies are both probable and reasonably estimable.Property and EquipmentAs of December 31, 2022, we had net property and equipment of $11.45 billion, representing 52.0% of our total assets. We depreciate property and equipment on a straight-line basis over their estimated useful lives. The estimated useful lives are based on the nature of the assets as well as current operating strategy and legal considerations, such as contractual life. Future events, such as property expansions, property developments, new competition or new regulations, could result in a change in the manner in which we use certain assets requiring a change in the estimated useful lives of such assets. The estimated useful lives of assets are periodically reviewed and adjusted as necessary on a prospective basis.For assets to be held and used (including projects under development), fixed assets are reviewed for impairment whenever indicators of impairment exist. If an indicator of impairment exists, we first group our assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities (the "asset group"). Secondly, we estimate the undiscounted future cash flows directly associated with and expected to arise from the completion, use and eventual disposition of such asset group. We estimate the undiscounted cash flows over the remaining useful life of the primary asset within the asset group. If the undiscounted cash flows exceed the carrying value, no impairment is indicated. If the undiscounted cash flows do not exceed the carrying value, then an impairment is measured based on fair value compared to carrying value, with fair value typically based on a discounted cash flow model. If an asset is still under development, future cash flows include remaining construction costs.67Table of ContentsTo estimate the undiscounted cash flows of our asset groups, we consider all potential cash flows scenarios, which are probability weighted based on management's estimates given current conditions. Determining the recoverability of our asset groups is judgmental in nature and requires the use of significant estimates and assumptions, including estimated cash flows, probability weighting of potential scenarios, costs to complete construction for assets under development, growth rates and future market conditions, among others. Future changes to our estimates and assumptions based upon changes in macro-economic factors, regulatory environments, operating results or management's intentions may result in future changes to the recoverability of our asset groups.For assets to be held for sale, the fixed assets (the "disposal group") are measured at the lower of their carrying amount or fair value less costs to sell. Losses are recognized for any initial or subsequent write-down to fair value less costs to sell, while gains are recognized for any subsequent increase in fair value less costs to sell, but not in excess of the cumulative loss previously recognized. Any gains or losses not previously recognized that result from the sale of the disposal group shall be recognized at the date of sale. Fixed assets are not depreciated while classified as held for sale.Income TaxesWe are subject to income taxes in the U.S. (including federal and state) and numerous foreign jurisdictions in which we operate. We record income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and attributable to operating loss and tax credit carryforwards.Our foreign and U.S. tax rate differential reflects the fact that U.S. tax rates are higher than the statutory tax rates in Singapore and Macao of 17% and 12%, respectively. In August 2018, we received an exemption from Macao's corporate income tax on profits generated by the operation of casino games of chance for the period of January 1, 2019 through June 26, 2022. In September 2022, we received an additional extension of this exemption for the period June 27, 2022 through December 31, 2022. Additionally, we entered into an agreement with the Macao government in April 2019, effective through June 26, 2022, providing for payments as a substitution for a 12% tax otherwise due from VML shareholders on dividend distributions paid from VML gaming profits, namely a payment of 38 million patacas (approximately $5 million at exchange rates in effect on December 31, 2022) for each of the years 2021 and 2020, each payment to be made on or before January 31 of the following year, and a payment of 18 million patacas (approximately $2 million at exchange rates in effect on December 31, 2022) for the period between January 1, 2022 through June 26, 2022, to be paid on or before July 26, 2022. In December 2022, we requested a corporate tax exemption on profits generated by the operation of casino games in Macao for the new Concession period effective from January 1, 2023 through December 31, 2032, or for a period of corporate tax exemption that the Chief Executive of Macao may deem more appropriate. We are evaluating the timing of an application for a new shareholder dividend tax agreement. There is no certainty either of these tax arrangements will be granted.Accounting standards regarding income taxes require a reduction of the carrying amounts of deferred tax assets by a valuation allowance, if based on the available evidence, it is "more-likely-than-not" such assets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed at each reporting period based on a "more-likely-than-not" realization threshold. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the duration of statutory carryforward periods, our experience with operating loss and tax credit carryforwards not expiring and tax planning strategies.We recorded a valuation allowance on the net deferred tax assets of certain foreign jurisdictions of $475 million and $416 million as of December 31, 2022 and 2021, respectively, and a valuation allowance on certain net deferred tax assets of our U.S. operations of $3.61 billion and $4.62 billion as of December 31, 2022 and 2021, respectively. Management will reassess the realization of deferred tax assets each reporting period and consider the scheduled reversal of deferred tax liabilities, sources of taxable income and tax planning strategies. To the extent the financial results of these operations improve and it becomes "more-likely-than-not" the deferred tax assets are realizable, we will be able to reduce the valuation allowance in the period such determination is made, as appropriate. 68Table of ContentsSignificant judgment is required in evaluating our tax positions and determining our provision for income taxes. During the ordinary course of business, there are many transactions for which the ultimate tax determination is uncertain. Accounting standards regarding uncertainty in income taxes provides a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is "more-likely-than-not" the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely, based solely on the technical merits, of being sustained on examinations. We recorded unrecognized tax benefits of $136 million as of December 31, 2022 and 2021. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and for which actual outcomes may be different.Our major tax jurisdictions are the U.S., Macao, and Singapore. We could be subject to examination for tax years beginning in 2018 in Macao and Singapore and tax years 2010 through 2015 and 2019 through 2021 in the U.S.Recent Accounting PronouncementsSee related disclosure at "Item 8 — Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 2 — Summary of Significant Accounting Policies — Recent Accounting Pronouncements."ITEM 7A. — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKMarket risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates and commodity prices. Our primary exposures to market risk are interest rate risk associated with our long-term debt and foreign currency exchange rate risk associated with our operations outside the United States, which we may manage through the use of futures, options, caps, forward contracts and similar instruments. We do not hold or issue financial instruments for trading purposes and do not enter into derivative transactions that would be considered speculative positions.As of December 31, 2022, the estimated fair value of our long-term debt was approximately $15.14 billion, compared to its contractual value of $16.06 billion. The estimated fair value of our long-term debt is based on recent trades, if available, and indicative pricing from market information (level 2 inputs). A hypothetical 100 basis point change in market rates would cause the fair value of our long-term debt to change by $370 million. A hypothetical 100 basis point change in SOFR, HIBOR and SOR would cause our annual interest cost on our long-term debt to change by approximately $41 million. Foreign currency transaction losses for the year ended December 31, 2022, were $10 million primarily due to U.S. dollar denominated debt issued by SCL and by Singapore dollar denominated intercompany debt reported in U.S. dollars. We may be vulnerable to changes in the U.S. dollar/SGD and U.S. dollar/pataca exchange rates. Based on balances as of December 31, 2022, a hypothetical 10% weakening of the U.S. dollar/SGD exchange rate would cause a foreign currency transaction loss of approximately $42 million and a hypothetical 1% weakening of the U.S. dollar/pataca exchange rate would cause a foreign currency transaction loss of approximately $57 million (net of the impact from the foreign currency swap agreements). The pataca is pegged to the Hong Kong dollar and the Hong Kong dollar is pegged to the U.S. dollar (within a narrow range). We maintain a significant amount of our operating funds in the same currencies in which we have obligations thereby reducing our exposure to currency fluctuations.69Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and accompanying notes included elsewhere in this Report. It also should be read in conjunction with the disclosure under “Special Note Regarding Forward-Looking Statements” in Part I of this Form 10-K.Outlook We had strong 2022 results, particularly in view of the difficult home sale market in the second half of the year. Market conditions continued to deteriorate in the fourth quarter as the now well-documented interest rate driven sales slowdown and pricing correction intersected with the still stressed supply chain, high labor and material costs and elongated cycle times (i.e., the time it takes to build a home). Sales and sales prices are down across both the new and existing home markets. We believe that production of single family and multifamily dwellings nationally will be down between a quarter to a third in 2023. In addition, the supply of existing homes for sale has come down as homeowners hold on to extremely low mortgage rates. This, combined with the housing production shortfall over the past decade, leaves the industry in the middle of what we believe should be a fairly short duration market correction and, unlike previous market corrections, there currently is no inventory overhang to resolve. Against this backdrop, we have developed a strategy that we believe should enable us to maintain sales pace and increase market share despite the difficult market: •We have adjusted prices in various communities to levels that are intended to enable us to maintain reasonable volume. The result is that margin, as opposed to volume, becomes the shock absorber. •We are working with our trade partners to right size our cost structure to current market conditions. Although our trade partners are still completing homes that were started in the first half of 2022, the amount of new work they are receiving is down substantially. We are offering a steady flow of starts in exchange for price reductions. •We are being extremely selective on new land acquisitions and new communities. We have re-reviewed and re-underwritten land purchases in our pipeline and are not going forward with land purchases that do not meet our standards under current market conditions.•We will continue to improve our cost of doing business by focusing on and reducing SG&A expenses. Over the past several years, we have seen quarter over quarter improvement in our SG&A expenses as a percentage of home sale revenues achieving record lows. However, as average sales prices come down, the percentages will not hold without additional cost cuts. Further, we know that in more difficult times there will be upward pressure on some of our sales and marketing costs in order to drive new sales.•We will maintain tight control of our inventory under construction. We will pace home starts to meet expected sales volume. Nonetheless, inventory dollars related to inventory under construction has grown through the year because of expanded cycle times due to the supply chain disruption. We expect to bring down our cycle time during the next few quarters. This will free up a significant amount of cash that currently is tied up in the increased inventory dollars related to homes under construction. We will continue to focus on our cash flow and bottom line to protect and enhance our already strong balance sheet.While we continue to have many strong markets, in our more challenging areas we have had to adjust base sales prices, offer mortgage buy down programs and increase sales incentives to maintain or regain sales momentum. Our cancellation rate increased significantly during our third quarter and into the beginning of our fourth quarter. However, our cancellation rate peaked in October and declined significantly in November.Our construction playbook has three primary areas of focus: lowering construction costs, reducing cycle time, and achieving even flow production. We expect what has been a steady increase in construction costs over the last few years due to supply shortages will reverse over the course of fiscal 2023, as many homebuilders reduce or totally curtail new starts. Similarly, we expect cycle times, which increased significantly due to shortages of materials and labor, to start to return to normal as the number of homes being built falls as a result of market conditions. During the fourth quarter of 2022, the average cycle time was the same as in the third quarter despite the continuing effect of supply chain disruptions and two hurricanes that delayed production in Florida and parts of the Carolinas. Even flow production is a core focus for us and is a pillar for being the builder of choice for the trades as it maximizes efficiencies for them. By maintaining our starts pace at a time when many homebuilders are reducing or stopping construction starts, we have been able to obtain cost reductions from our trade partners and increase our market share in many markets. We continue to strategically acquire land, primarily through options. Our continued focus on our land-light strategy resulted in ending fiscal 2022 with a percentage of homesites controlled rather than owned of 63%, up from 59% last year. Our 22Table of Contentsyears’ supply of owned home sites decreased to 2.5 years as compared to 3.0 years at the end of the prior year. From a leverage perspective, we continue to benefit from our paydown of senior notes and strong generation of earnings which brought our homebuilding debt to total capital down to 14.4% at year-end, our lowest ever, and an improvement from 18.3% at the end of the prior year. While we did repurchase some stock in the fourth quarter, given the current market conditions and as a matter of careful capital allocation, we decided to go slow. We expect to continue to look at repurchasing stock in the future as opportunities present themselves.Regarding the planned spin-off of our multifamily and single-family rental investment and property management companies, current market conditions are not favorable so we are going to postpone the spin-off for the time being and wait for the right timing.Given the uncertainty about market conditions, it is difficult to provide the targeted guidance about our expected future performance that we provided in the past. Instead, we are providing broad ranges to give some boundaries for various components of our expected results during the first quarter of 2023. We expect our new orders for the first quarter of 2023 to be in the range of 12,000 to 13,500 homes, and we anticipate our first quarter deliveries to be in the range of 12,000 to 13,500 homes. We expect gross margins will be about 21.0%, though this number will adjust somewhat based on the number of deliveries. We expect our SG&A expenses as a percentage of home sale revenues will be about 8%, but that percentage will adjust based on deliveries and homebuilding revenue. We expect our first quarter ending community count to be about the same as the community count at the end of 2022, as we walked away from deals that would have produced new active communities. Our first quarter average sales price should be in the range of $440,000 to $450,000 as we continue to price to market. We believe our fiscal 2023 deliveries will be between 60,000 to 65,000 homes.We ended the year with the highest revenues, the highest profit, the highest cash flow, and the highest liquidity in Lennar's history. We have a plan of execution as we move into the uncertainties of 2023 with a focus on maintaining volume, maximizing margin through cost reductions, managing inventories, driving cash flow, managing land spend, and further enhancing our balance sheet in spite of challenging market conditions.Results of OperationsOverviewOur net earnings attributable to Lennar were $4.6 billion, or $15.72 per diluted share ($15.74 per basic share) in 2022 and $4.4 billion, or $14.27 per diluted share ($14.28 per basic share) in 2021.23Table of ContentsFinancial information relating to our operations was as follows:Year ended November 30, 2022(In thousands)HomebuildingFinancial ServicesMultifamilyLennar OtherCorporateTotalRevenues:Sales of homes$31,778,885 — — — — 31,778,885 Sales of land143,041 — — — — 143,041 Other revenues29,409 809,680 865,603 44,392 — 1,749,084 Total revenues31,951,335 809,680 865,603 44,392 — 33,671,010 Costs and expenses:Costs of homes sold23,025,467 — — — — 23,025,467 Costs of land sold171,589 — — — — 171,589 Selling, general and administrative1,964,243 — — — — 1,964,243 Other costs and expenses— 426,378 848,931 32,258 — 1,307,567 Total costs and expenses25,161,299 426,378 848,931 32,258 — 26,468,866 Equity in earnings (loss) from unconsolidated entities, Multifamily other gain and Lennar Other other income (expense), net, and other gain (loss)(17,235)— 52,821 (91,689)— (56,103)Homebuilding other income, net4,516 — — — — 4,516 Lennar Other unrealized loss from technology investments— — — (655,094)— (655,094)Operating earnings (loss)6,777,317 383,302 69,493 (734,649)— 6,495,463 Corporate general and administrative expenses— — — — 414,498 414,498 Charitable foundation contribution— — — — 66,399 66,399 Earnings (loss) before income taxes$6,777,317 383,302 69,493 (734,649)(480,897)6,014,566 Year ended November 30, 2021(In thousands)HomebuildingFinancial ServicesMultifamilyLennar OtherCorporateTotalRevenues:Sales of homes$25,348,105 — — — — 25,348,105 Sales of land167,913 — — — — 167,913 Other revenues29,224 898,745 665,232 21,457 — 1,614,658 Total revenues25,545,242 898,745 665,232 21,457 — 27,130,676 Costs and expenses:Costs of homes sold18,562,213 — — — — 18,562,213 Costs of land sold143,631 — — — — 143,631 Selling, general and administrative1,796,697 — — — — 1,796,697 Other costs and expenses— 407,731 652,810 30,955 — 1,091,496 Total costs and expenses20,502,541 407,731 652,810 30,955 — 21,594,037 Equity in earnings (loss) from unconsolidated entities, Multifamily other gain and Lennar Other other income (expense), net, and other gain (loss) (1)(14,205)— 9,031 231,731 — 226,557 Homebuilding other income, net3,266 — — — — 3,266 Lennar Other unrealized gain from technology investments— — — 510,802 — 510,802 Operating earnings5,031,762 491,014 21,453 733,035 — 6,277,264 Corporate general and administrative expenses— — — — 398,381 398,381 Charitable foundation contribution— — — — 59,825 59,825 Earnings before income taxes$5,031,762 491,014 21,453 733,035 (458,206)5,819,058 (1)During the year ended November 30, 2021, the Company realized a gain of $158.1 million on the sale of its residential solar business24Table of Contents2022 versus 2021Revenues from home sales increased 25% in the year ended November 30, 2022 to $31.8 billion from $25.3 billion in the year ended November 30, 2021. Revenues were higher primarily due to an 11% increase in the number of home deliveries and a 13% increase in the average sales price. New home deliveries increased to 66,399 homes in the year ended November 30, 2022 from 59,825 homes in the year ended November 30, 2021. The average sales price of homes delivered was $480,000 in the year ended November 30, 2022, compared to $424,000 in the year ended November 30, 2021.Gross margins on home sales were $8.8 billion, or 27.5% (27.7% pre-impairment), in the year ended November 30, 2022, compared to $6.8 billion, or 26.8%, in the year ended November 30, 2021. Gross margins in the year ended November 30, 2022 include $33.6 million of homebuilding impairments in nine communities and $18.1 million of impairments to our homes in backlog taken during the year. During the year ended November 30, 2022, an increase in costs per square foot primarily due to higher materials and labor costs, was mostly offset by an increase in revenues per square foot. Overall, gross margins improved year over year as land costs remained relatively flat while interest expense decreased as a result of our focus on reducing debt. Gross loss on land sales was $28.5 million in the year ended November 30, 2022, which includes $47.9 million of deposit write-offs as we walked away from 42,000 controlled homesites. This compared to gross margin on land sales of $24.3 million in the year ended November 30, 2021.Selling, general and administrative expenses were $2.0 billion in the year ended November 30, 2022, compared to $1.8 billion in the year ended November 30, 2021. As a percentage of revenues from home sales, selling, general and administrative expenses improved to 6.2% in the year ended November 30, 2022, from 7.1% in the year ended November 30, 2021, due to a decrease in broker commissions, an increase in leverage, and benefits of our technology efforts.Operating earnings for our Financial Services segment were $381.9 million in the year ended November 30, 2022.The operating earnings included a $35.5 million one-time charge due to an increase in a litigation accrual in the third quarter related to a court judgment. We have appealed this judgment since we believe there were clear errors of law made by the trial court. Excluding this one-time charge, operating earnings were $417.4 million, compared to operating earnings of $490.4 million in the year ended November 30, 2021. The decrease in operating earnings was primarily due to lower mortgage net margins driven by a more competitive mortgage market, partially offset by an increase in rate lock volume. Mortgage results were partially offset by our title earnings, which increased primarily due to higher revenues per transaction and lower costs due to benefits of our technology efforts.Operating earnings for the Multifamily segment were $66.8 million in the year ended November 30, 2022, compared to $21.5 million in the year ended November 30, 2021. Operating loss for the Lennar Other segment was $735.6 million in the year ended November 30, 2022, compared to operating earnings of $733.0 million in the year ended November 30, 2021. Lennar Other operating loss for the year ended November 30, 2022 was primarily due to negative mark-to-market adjustments on our publicly traded technology investments. The operating earnings for the year ended November 30, 2021 were primarily due to positive mark-to-market adjustments on our publicly traded technology investments and the gain on the sale of the our solar business.For both the years ended November 30, 2022 and 2021, we had a tax provision of $1.4 billion, which resulted in an overall effective income tax rate of 22.8% and 23.5%, respectively. Our overall effective income tax rate was lower in 2022 primarily due to the resolution of an uncertain state tax position and the retroactive reinstatement of the energy efficient home credits for 2022, resulting from the passage of the Inflation Reduction Act by Congress. Homebuilding Segments At November 30, 2022, our Homebuilding operating segments and Homebuilding Other consisted of homebuilding divisions located in:East: Alabama, Florida, New Jersey, Pennsylvania and South CarolinaCentral: Georgia, Illinois, Indiana, Maryland, Minnesota, North Carolina, Tennessee and VirginiaTexas: TexasWest: Arizona, California, Colorado, Idaho, Nevada, Oregon, Utah and WashingtonOther: Urban divisions and other homebuilding related investments primarily in California, including FivePoint25Table of ContentsThe following tables set forth selected financial and operational information related to our homebuilding operations for the years indicated:Selected Financial and Operational DataYear Ended November 30, 2022Gross MarginsOperating Earnings (Loss)(Dollars in thousands)Sales of Homes RevenuesCosts of Sales of HomesGross Margin %Net Margins on Sales of Homes (1)Gross Loss on Sales of Land (2)Other RevenuesEquity in Earnings (Loss) from Unconsolidated EntitiesOther Income (Expense), netOperating Earnings (Loss)East$9,201,412 6,341,272 31.1 %$2,222,835 (10,701)3,991 1,300 22,831 2,240,256 Central5,830,587 4,532,474 22.3 %889,359 (171)1,496 691 (2,144)889,231 Texas4,212,223 2,992,532 29.0 %941,899 (9,387)1,250 — (4,525)929,237 West12,513,277 9,114,818 27.2 %2,775,430 (4,398)3,916 4,412 (5,763)2,773,597 Other (3)21,386 44,371 (107.5)%(40,348)(3,891)18,756 (23,638)(5,883)(55,004)Totals$31,778,885 23,025,467 27.5 %$6,789,175 (28,548)29,409 (17,235)4,516 6,777,317 Year Ended November 30, 2021Gross MarginsOperating Earnings (Loss)(Dollars in thousands)Sales of Homes RevenuesCosts of Sales of HomesGross Margin %Net Margins on Sales of Homes (1)Gross Margins on Sales of LandOther RevenuesEquity in Earnings (Loss) from Unconsolidated EntitiesOther Income (Expense), netOperating Earnings (Loss)East$6,814,578 4,858,456 28.7 %$1,432,242 10,835 7,161 308 4,886 1,455,432 Central4,807,194 3,731,567 22.4 %713,229 4,271 1,977 1,088 (146)720,419 Texas3,204,609 2,238,204 30.2 %725,065 6,347 1,630 498 (3,075)730,465 West10,503,305 7,694,870 26.7 %2,179,980 1,394 4,778 5,388 906 2,192,446 Other (3)18,419 39,116 (112.4)%(61,321)1,435 13,678 (21,487)695 (67,000)$25,348,105 18,562,213 26.8 %$4,989,195 24,282 29,224 (14,205)3,266 5,031,762 (1)Net margins on sales of homes include selling, general and administrative expenses.(2)Gross loss on sales of land includes $47.9 million of deposit write-offs as we walked away from 42,000 controlled homesites.(3)Negative gross and net margins were due to period costs in Urban divisions that impact costs of homes sold without sufficient sales of homes revenues to offset those costs.Summary of Homebuilding DataDeliveries:For the Years Ended November 30,HomesDollar Value (In thousands)Average Sales Price202220212022202120222021East21,214 18,879 $9,268,940 6,846,153 $437,000 363,000 Central13,152 12,138 5,830,587 4,807,195 443,000 396,000 Texas12,993 10,939 4,212,223 3,204,609 324,000 293,000 West19,015 17,850 12,513,277 10,503,304 658,000 588,000 Other25 19 21,386 18,419 855,000 969,000 Total66,399 59,825 $31,846,413 25,379,680 $480,000 424,000 Of the total homes delivered listed above, 174 homes with a dollar value of $67.5 million and an average sales price of $388,000 represent home deliveries from unconsolidated entities for the year ended November 30, 2022, compared to 95 home deliveries with a dollar value of $31.6 million and an average sales price of $332,000 for the year ended November 30, 2021.26Table of ContentsSales Incentives (1):Average Sales Incentives PerHome DeliveredSales Incentivesas a % of RevenuesYears Ended November 30,2022202120222021East$12,600 10,500 2.8 %2.8 %Central11,900 8,500 2.6 %2.1 %Texas23,000 10,000 6.6 %3.3 %West22,200 6,900 3.3 %1.2 %Other90,000 116,500 9.5 %10.7 %Total$17,300 9,000 3.5 %2.1 %(1) Sales incentives relate to home deliveries during the period, excluding deliveries by unconsolidated entities.New Orders (2):At November 30,For the Years Ended November 30,Active CommunitiesHomesDollar Value (In thousands)Average Sales Price20222021202220212022202120222021East316 345 21,649 20,566 $9,516,178 7,908,164 $440,000 385,000 Central313 302 12,020 12,871 5,351,534 5,366,197 445,000 417,000 Texas235 241 11,424 12,382 3,596,037 3,833,294 315,000 310,000 West341 372 15,990 18,703 10,604,593 11,725,035 663,000 627,000 Other3 3 22 21 18,608 20,513 846,000 977,000 Total1,208 1,263 61,105 64,543 $29,086,950 28,853,203 $476,000 447,000 Of the total new orders listed above, 261 homes with a dollar value of $116.7 million and an average sales price of $447,000 represent new orders from unconsolidated entities for the year ended November 30, 2022, compared to 136 new orders with a dollar value of $48.8 million and an average sales price of $359,000 for the year ended November 30, 2021.(2)New orders represent the number of new sales contracts executed with homebuyers, net of cancellations, during the years ended November 30, 2022 and 2021.We experienced cancellation rates in our Homebuilding segments and Homebuilding other as follows:Years Ended November 30,20222021East11 %8 %Central12 %7 %Texas27 %18 %West21 %10 %Other49 %— %Total17 %10 %Backlog:At November 30,HomesDollar Value (In thousands)Average Sales Price202220212022202120222021East8,706 7,932 $3,820,714 3,448,719 $439,000 435,000 Central4,025 5,104 1,855,430 2,321,174 461,000 455,000 Texas2,697 4,266 837,083 1,453,270 310,000 341,000 West3,440 6,465 2,226,477 4,135,162 647,000 640,000 Other1 4 1,164 3,942 1,164,000 986,000 Total18,869 23,771 $8,740,868 11,362,266 $463,000 478,000 Of the total homes in backlog listed above, 166 homes with a backlog dollar value of $77.8 million and an average sales price of $469,000 represent the backlog from unconsolidated entities at November 30, 2022, compared to 79 homes with a backlog dollar value of $28.6 million and an average sales price of $363,000 at November 30, 2021. During the year ended November 30, 2022, we acquired 339 homes and 53 homes in backlog in the East and Central Homebuilding segments, respectively.27Table of ContentsBacklog represents the number of homes under sales contracts. Homes are sold using sales contracts, which are generally accompanied by sales deposits. In some instances, purchasers are permitted to cancel sales if they fail to qualify for financing or under certain other circumstances. We do not recognize revenue on homes under sales contracts until the sales are closed and title passes to the new homeowners.Homebuilding East: Revenues from home sales increased in 2022 compared to 2021, primarily due to an increase in the number of home deliveries and the average sales price in all the states of the segment. The increase in the number of home deliveries was primarily due to higher demand as the number of deliveries per active community increased. The increase in the average sales price of homes delivered was primarily due to price appreciation year over year. For the year ended November 30, 2022, an increase in revenues per square foot was partially offset by an increase in costs per square foot primarily due to higher materials and labor costs. Overall, gross margins improved year over year as land costs remained relatively flat while interest expense decreased as a result of our focus on reducing debt.Homebuilding Central: Revenues from home sales increased in 2022 compared to 2021, primarily due to an increase in the number of home deliveries in all the states of the segment except for Georgia and Virginia and an increase in the average sales price in all the states of the segment. The increase in the number of home deliveries was primarily due to an increase in the number of deliveries per active community. The decrease in the number of home deliveries in Georgia and Virginia was primarily due to a decrease in the number of deliveries per active community due to the timing of opening and closing of communities as a result of supply chain disruptions. For the year ended November 30, 2022, an increase in revenues per square foot was partially offset by an increase in costs per square foot primarily due to higher materials and labor costs. Overall, gross margins remained flat year over year as land costs remained relatively flat while interest expense decreased as a result of our focus on reducing debt.Homebuilding Texas: Revenues from home sales increased in 2022 compared to 2021, primarily due to an increase in the number of home deliveries and the average sales price. The increase in the number of home deliveries was primarily due to higher demand as the number of deliveries per active community increased. The increase in the average sales price of homes delivered was primarily due to price appreciation year over year. For the year ended November 30, 2022, gross margins decreased year over year as an increase in costs per square foot was partially offset by an increase in revenues per square foot.Homebuilding West: Revenues from home sales increased in 2022 compared to 2021, primarily due to an increase in the number of home deliveries in all states of the segment except for Arizona, Nevada and Utah and an increase in the average sales price in all the states of the segment. The increase in the number of home deliveries was primarily due to an increase in the number of deliveries per active community. The decrease in the number of home deliveries in Arizona, California, Nevada and Utah was primarily due to a decrease in the number of deliveries per active community due to the timing of opening and closing of communities as a result of supply chain disruptions. The increase in the average sales price of homes delivered was primarily due to price appreciation year over year. For the year ended November 30, 2022, an increase in revenues per square foot was partially offset by an increase in costs per square foot primarily due to higher materials and labor costs. Overall, gross margins increased year over year as land costs remained relatively flat while interest expense decreased as a result of our focus on reducing debt.Financial Services SegmentOur Financial Services reportable segment primarily provides mortgage financing, title and closing services primarily for buyers of our homes, as well as property and casualty insurance. The segment also originates and sells into securitizations commercial mortgage loans through its LMF Commercial business. Our Financial Services segment sells substantially all of the residential loans it originates within a short period in the secondary mortgage market, the majority of which are sold on a servicing released, non-recourse basis. After the loans are sold, we retain potential liability for possible claims by purchasers that we breached certain limited industry-standard representations and warranties in the loan sale agreements.The following table sets forth selected financial and operational information related to the residential mortgage and title activities of our Financial Services:Years Ended November 30,(Dollars in thousands)20222021Dollar value of mortgages originated$14,432,200 13,247,100 Number of mortgages originated37,700 38,100 Mortgage capture rate of Lennar homebuyers72%75%Number of title and closing service transactions68,800 67,500 At November 30, 2022 and 2021, the carrying value of Financial Services' commercial mortgage-backed securities ("CMBS") was $143.3 million and $157.8 million, respectively. Details of these securities and related debt are within Note 2 of the Notes to Consolidated Financial Statements.28Table of ContentsLMF Commercial LMF Commercial originates and sells into securitizations first mortgage loans, which are secured by income producing commercial properties. LMF Commercial originated commercial loans as follows:November 30,(Dollars in thousands)20222021Originations$740,345 770,107 Sold$715,933 931,023 Securitizations6 6 Multifamily SegmentWe have been actively involved, primarily through unconsolidated entities, in the development, construction and property management of multifamily rental properties. Our Multifamily segment focuses on developing a geographically diversified portfolio of institutional quality multifamily rental properties in select U.S. markets.Originally, our Multifamily segment focused on building multifamily properties and selling them shortly after they were completed. However, more recently we have focused on creating and participating in funds that build multifamily properties with the intention of retaining them after they are completed.The following tables provide information related to our investment in the Multifamily segment:Balance SheetNovember 30,(In thousands)20222021Multifamily investments in unconsolidated entities$648,126 654,029 Lennar's net investment in Multifamily935,961 976,676 Statement of OperationsYears Ended November 30,(Dollars in thousands)20222021Number of operating properties/investments sold through joint ventures2 1 Lennar's share of gains on the sale of operating properties/investments$43,308 14,784 The Multifamily segment manages and has investments in Multifamily Venture Fund I (the "LMV I") and Multifamily Venture Fund II LP (the "LMV II"), which are long-term multifamily development investment vehicles involved in the development, construction and ownership of class-A multifamily rental properties. Details of each as of and during the year ended November 30, 2022 are included below: November 30, 2022(In thousands)LMV ILMV IILennar's carrying value of investments$217,099 293,831 Equity commitments2,204,016 1,257,700 Equity commitments called2,152,324 1,206,664 Lennar's equity commitments504,016 381,000 Lennar's equity commitments called499,919 365,807 Lennar's remaining commitments4,097 15,193 Distributions to Lennar25,576 12,555 Our Multifamily segment had equity investments in unconsolidated entities. The breakout of the Multifamily segment's equity investments in unconsolidated entities and the development activities by stage were as follows:(Dollars in thousands)November 30, 2022Under construction/owned25 Partially completed and leasing9 Completed and operating49 Total unconsolidated joint ventures83 Total development costs$10,043,000 29Table of ContentsAs of November 30, 2022, our Multifamily segment also had a pipeline of potential future projects, which were under contract or had letters of intent, totaling approximately $8.7 billion in anticipated development costs across a number of states that will be developed primarily by unconsolidated entities.Lennar Other SegmentOur Lennar Other segment includes fund investments we retained subsequent to our sale of the Rialto investment and asset management platform as well as strategic investments in technology companies that are looking to improve the homebuilding and financial services industries to better serve homebuyers and homeowners and increase efficiencies. As of November 30, 2022 and 2021, our balance sheet had $788.5 million and $1.5 billion, respectively, of assets in the Lennar Other segment, which included investments in unconsolidated entities of $316.5 million and $346.3 million, respectively. We have investments in Blend Labs, Inc. ("Blend Labs"), Hippo Holdings, Inc. ("Hippo"), Opendoor, Inc. ("Opendoor"), SmartRent, Inc. ("SmartRent"), Sonder Holdings, Inc. ("Sonder") and Sunnova Energy International, Inc. ("Sunnova"), which are held at market and will therefore change depending on the fair value of our share holdings in those entities on the last day of each quarter. All the investments are accounted for as investments in equity securities which are held at fair value and the changes in fair values are recognized through earnings. The following is a detail of Lennar Other unrealized gains (losses) from our technology investments: Years Ended November 30,(In thousands)20222021Blend Labs (BLND) mark-to-market$(25,630)(6,744)Hippo (HIPO) mark-to-market(222,447)207,634 Opendoor (OPEN) mark-to-market(265,276)239,312 SmartRent (SMRT) mark-to-market(78,177)79,483 Sonder (SOND) mark-to-market(2,339)— Sunnova (NOVA) mark-to-market(61,225)(8,883)Lennar Other unrealized gains (losses) from technology investments$(655,094)510,802 At November 30, 2022 and 2021, Lennar Other owned commercial mortgage-backed securities ("CMBS") with carrying values of $35.5 million and $41.7 million, respectively. These securities were purchased at discount rates ranging from 33% to 55% with coupon rates ranging from 3.0% to 3.4%, stated and assumed final distribution dates between September 2025 and March 2026, and stated maturity dates between September 2058 and March 2059. We review changes in estimated cash flows periodically to determine if an other-than-temporary impairment has occurred on our CMBS. Based on management’s assessment, no impairment charges were recorded during the years ended November 30, 2022 and 2021. We classify these securities as held-for-sale at November 30, 2022 and 2021. Financial Condition and Capital ResourcesAt November 30, 2022, we had cash and cash equivalents and restricted cash related to our homebuilding, financial services, multifamily and other operations of $4.8 billion, compared to $3.0 billion at November 30, 2021.We finance all of our activities including homebuilding, financial services, multifamily, other and general operating needs primarily with cash generated from our operations, debt issuances and investor funds as well as cash borrowed under our warehouse lines of credit and our unsecured revolving credit facility (the "Credit Facility"). At November 30, 2022, we had $4.6 billion of Homebuilding cash and cash equivalents and no outstanding borrowings under our $2.6 billion revolving credit facility, thereby providing $7.2 billion of available capacity.Operating Cash Flow ActivitiesDuring 2022 and 2021, cash provided by operating activities totaled $3.3 billion and $2.5 billion, respectively. During 2022, cash provided by operating activities was positively impacted by our net earnings, excluding Lennar Other unrealized mark-to-market losses on our publicly traded technology investments and other realized loss totaling $672 million and an increase in accounts payable and other liabilities of $701 million. This was partially offset by a $2.4 billion increase in inventories due to strategic land purchases, land development and construction costs and an increase in receivables of $422 million. During 2021, cash provided by operating activities was positively impacted by our net earnings, net of Lennar Other unrealized/realized gains of $681 million primarily due to mark-to-market gains on strategic investments that went public during the year ended November 30, 2021 (Opendoor, Hippo and SmartRent) and the sale of our solar business to Sunnova. In addition, there was an increase in accounts payable and other liabilities of $881 million, partially offset by a $2.0 billion increase in inventories due to strategic land purchases, land development and construction costs and an increase in receivables of $290 million.30Table of ContentsInvesting Cash Flow ActivitiesDuring 2022 and 2021, cash used in investing activities totaled $128 million and $105 million, respectively. During 2022, our cash used in investing activities was primarily due to cash contributions of $447 million to unconsolidated entities, which primarily included (1) $307 million to Homebuilding unconsolidated entities (2) $111 million to Lennar Other unconsolidated entities and (3) $30 million to Multifamily unconsolidated entities. In addition, we had $94 million of purchases of investment securities related to strategic technology investments in the Lennar Other segment. This was partially offset by distributions of capital from unconsolidated entities of $398 million, which primarily included (1) $79 million from Homebuilding unconsolidated entities, (2) $252 million from Multifamily unconsolidated entities, and (3) $67 million from our Lennar Other unconsolidated entities.During 2021, our cash used in investing activities was primarily due to cash contributions of $408 million to unconsolidated entities, which primarily included (1) $251 million to Homebuilding unconsolidated entities (2) $72 million to Multifamily unconsolidated entities, and (3) $83 million to strategic technology investments included in the Lennar Other segment. In addition, we had $128 million of purchases of investment securities related to strategic technology investments in the Lennar Other segment. This was partially offset by distributions of capital from unconsolidated entities of $362 million, which primarily included (1) $177 million from Homebuilding unconsolidated entities (2) $128 million from Multifamily unconsolidated entities, and (3) $57 million from our Lennar Other segment, which included our unconsolidated Rialto real estate funds and distributions from strategic investments.Financing Cash Flow ActivitiesDuring 2022 and 2021, our cash used in financing activities totaled $1.3 billion and $2.4 billion, respectively. During 2022, our cash used in financing activities was primarily due to (1) early redemption of $575 million aggregate principal amount of our 4.75% senior notes due November 2022, (2) $48 million principal payments on notes payable and other borrowings, (3) repurchase of our common stock for $1.0 billion, which included $968 million of repurchases of our stock under our repurchase program and $72 million of repurchases related to our equity compensation plan, and (4) $438 million of dividend payments. These were partially offset by (1) $485 million of net proceeds from liabilities related to consolidated inventory not owned due to land sales to land banks, net of takedowns, (2) $409 million of net borrowings under our Financial Services warehouse facilities, and (3) receipts related to noncontrolling interests of $42 million.During 2021, our cash used in financing activities was primarily impacted by (1) redemption of $600 million aggregate principal amount of our 4.125% senior notes due January 2022 at par, (2) early retirement, at a premium, of $250 million aggregate principal amount of our 5.375% senior notes due October 2022, (3) retirement of $300 million aggregate principal amount of our 6.25% senior notes due December 2021, (4) $195 million principal payments on notes payable and other borrowings, (5) repurchase of our common stock for $1.4 billion, which included $1.4 billion of repurchases of our stock under our repurchase program and $65 million of repurchases related to our equity compensation plan, and (6) $310 million of dividend payments. These were partially offset by (1) $344 million of reductions in liabilities related to consolidated inventory not owned due to land sales to land banks, (2) $262 million of net borrowings under our Financial Services warehouse facilities, and (3) receipts related to noncontrolling interests of $70 million.Debt to total capital ratios are financial measures commonly used in the homebuilding industry and are presented to assist in understanding the leverage of our Homebuilding operations. Homebuilding debt to total capital and net Homebuilding debt to total capital were calculated as follows:November 30,(Dollars in thousands)20222021Homebuilding debt$4,047,294 4,652,338 Stockholders’ equity24,100,500 20,816,425 Total capital$28,147,794 25,468,763 Homebuilding debt to total capital14.4%18.3%Homebuilding debt$4,047,294 4,652,338 Less: Homebuilding cash and cash equivalents4,616,124 2,735,213 Net Homebuilding debt$(568,830)1,917,125 Net Homebuilding debt to total capital (1)(2.4)%8.4%(1)Net homebuilding debt to total capital is a non-GAAP financial measure defined as net homebuilding debt (homebuilding debt less homebuilding cash and cash equivalents) divided by total capital (net homebuilding debt plus stockholders' equity). Our management believes the ratio of net homebuilding debt to total capital is a relevant and a useful financial measure to investors in understanding the leverage employed in our homebuilding operations. However, because net homebuilding debt to total capital is not calculated in accordance with GAAP, this financial measure should not be considered in isolation or as an alternative to financial measures prescribed by GAAP. Rather, this non-GAAP financial measure should be used to supplement our GAAP results.31Table of ContentsAt November 30, 2022, Homebuilding debt to total capital was lower compared to November 30, 2021 primarily as a result of an increase in stockholders' equity due to net earnings and a decrease in homebuilding debt due todebt paydowns, partially offset by share repurchases.We are continually exploring various types of transactions to manage our leverage and liquidity positions, take advantage of market opportunities and increase our revenues and earnings. These transactions may include the issuance of additional indebtedness, the repurchase of our outstanding indebtedness, the repurchase of our common stock, the acquisition of homebuilders and other companies, the purchase or sale of assets or lines of business, the issuance of common stock or securities convertible into shares of common stock, and/or the pursuit of other financing alternatives. In connection with some of our non-homebuilding businesses, we are also considering other types of transactions such as sales, restructurings, joint ventures, spin-offs or initial public offerings as we continue to move back towards being a pure play homebuilding company. We have announced an intention to spin off, subject to market conditions, our multifamily and single family rental asset management businesses and some of our investment assets.Our Homebuilding senior notes and other debts payable are summarized within Note 4 of the Notes to Consolidated Financial Statements.In May 2022, we amended the credit agreement governing our unsecured revolving credit facility (the “Credit Facility") which increased the commitment from $2.5 billion to $2.6 billion and extended the maturity to May 2027, except for $350 million which matures in April 2024. The Credit Facility has a $425 million accordion feature, subject to additional commitments, thus the maximum borrowings are $3.0 billion. The proceeds available under the Credit Facility, which are subject to specified conditions for borrowing, may be used for working capital and general corporate purposes. The credit agreement also provides that up to $500 million in commitments may be used for letters of credit. As of both November 30, 2022 and 2021, we had no outstanding borrowings under the Credit Facility. In addition to the Credit Facility, we have other letter of credit facilities with different financial institutions.We often post letters of credit instead of making cash deposits for option contracts and for similar purposes. We often are required to post surety bonds to guarantee completion of projects, particularly when municipal authorities are involved. Our outstanding letters of credit and surety bonds are described below:November 30,(In thousands)20222021Performance letters of credit$1,259,033 924,584 Financial letters of credit503,659 425,843 Surety bonds4,136,715 3,553,047 Anticipated future costs primarily for site improvements related to performance surety bonds2,273,694 1,690,861 Our Homebuilding average debt outstanding and the average rates of interest were as follows:November 30,(Dollars in thousands)20222021Homebuilding average debt outstanding $4,705,892 5,711,100 Average interest rate4.7%4.9%Interest incurred$230,839 275,091 Under the Credit Facility agreement (the "Credit Agreement"), we are required to maintain a minimum consolidated tangible net worth, a maximum leverage ratio and either a liquidity or an interest coverage ratio. These ratios are calculated per the Credit Facility agreement, which involves adjustments to GAAP financial measures. As of the end of each fiscal quarter, we are required to maintain minimum consolidated tangible net worth of approximately $10.6 billion plus 50% of the cumulative consolidated net income for each completed fiscal quarter subsequent to February 28, 2022, if positive, plus 50% of the net cash proceeds from any equity offerings from and after February 28, 2022, minus the amount paid after February 28, 2022 to repurchase common stock (subject to a limit on deductions in any four fiscal quarter period of 12.5% of consolidated tangible net worth) and minus, in the case of a spin-off transaction, the consolidated net worth of assets that are spun off (subject to a limit of $1.0 billion). As of the end of each fiscal quarter, we are required to maintain a leverage ratio that shall not exceed 65% and may be reduced by 2.5% per quarter if our interest coverage ratio is less than 2.25:1.00 for two consecutive fiscal calendar quarters. The leverage ratio will have a floor of 60%. If our interest coverage ratio subsequently exceeds 2.25:1.00 for two consecutive fiscal calendar quarters, the leverage ratio we will be required to maintain will be increased by 2.5% per quarter to a maximum of 65%. As of the end of each fiscal quarter, we are also required to maintain either (1) liquidity in an amount equal to or greater than 1.00x consolidated interest incurred for the last twelve months then ended or (2) an interest coverage ratio equal to or greater than 1.50:1.00 for the last twelve months then ended. We believe that we were in compliance with our debt covenants at November 30, 2022.32Table of ContentsThe following summarizes our required debt covenants and our actual levels or ratios with respect to those covenants as calculated per the Credit Agreement as of November 30, 2022:(Dollars in thousands)Covenant LevelLevel Achieved as of November 30, 2022Minimum net worth test$12,196,941 17,779,830 Maximum leverage ratio65.0%(0.2)%Liquidity test (1)1.00 32.08 (1)We are only required to maintain either (1) liquidity in an amount equal to or greater than 1.00x consolidated interest incurred for the last twelve months then ended or (2) an interest coverage ratio of equal to or greater than 1.50:1.00 for the last twelve months then ended. Although we are in compliance with our debt covenants for both calculations, we have only disclosed our liquidity test.At November 30, 2022, the Financial Services segment had warehouse facilities, all of which were 364-day repurchase facilities and were used to fund residential mortgages or commercial mortgages for LMF Commercial as follows:(In thousands)Maximum Aggregate CommitmentResidential facilities maturing:December 2022 (1)$800,000 May 2023500,000 August 20231,000,000 Total - Residential facilities$2,300,000 LMF Commercial facilities maturing:December 2022 (1)$400,000 July 202350,000 November 2023100,000 Total - LMF Commercial facilities$550,000 Total$2,850,000 (1)Subsequent to November 30, 2022, the maturity date was extended to December 2023.The Financial Services segment uses the residential warehouse facilities to finance its residential lending activities until the mortgage loans are sold to investors and the proceeds are collected. The facilities are non-recourse to us and are expected to be renewed or replaced with other facilities when they mature. The LMF Commercial facilities finance LMF Commercial loan originations and securitization activities and were secured by up to 80% interests in the originated commercial loans financed.Borrowings and collateral under the facilities and their prior year predecessors were as follows:November 30,(In thousands)20222021Borrowings under the residential facilities$1,877,411 1,482,258Collateral under the residential facilities1,950,155 1,539,641Borrowings under the LMF Commercial facilities124,399 96,294If the facilities are not renewed or replaced, the borrowings under the lines of credit will be repaid by selling the mortgage loans held-for-sale to investors and by collecting receivables on loans sold but not yet paid for. Without the facilities, the Financial Services segment would have to use cash from operations and other funding sources to finance its lending activities.Changes in Capital StructureIn October 2021, the Board of Directors authorized an increase to our stock repurchase program to enable us to repurchase up to the lesser of an additional $1.0 billion in value, excluding commission, or 25 million in shares, of our outstanding Class A or Class B common stock. As a result of prior authorizations being almost exhausted, in March 2022, our Board of Directors approved an additional authorization for us to repurchase up to the lesser of $2.0 billion in value, or 30 million in shares, of our outstanding Class A or Class B common stock. The repurchase authorization has no expiration date. 33Table of ContentsThe following table provides information about our repurchases of Class A and Class B common stock: Years EndedNovember 30, 2022November 30, 2021(Dollars in thousands, except price per share)Class AClass BClass AClass BShares repurchased9,628,203 1,339,797 13,910,000 100,000 Total purchase price$868,788 $98,613 $1,357,081 $8,197 Average price per share$90.23 $73.60 $97.56 $81.97 During the year ended November 30, 2022, treasury stock decreased due to our retirement of 46.7 million and 2.8 million treasury shares of Class A and Class B common stock, respectively, as authorized by our Board of Directors. The retirement of Class A and Class B common stock in treasury resulted in a reclass between treasury shares and additional paid-in capital within stockholders' equity. During the year ended November 30, 2022, this decrease in treasury shares was partially offset by our repurchase of 9.6 million and 1.3 million shares of Class A and Class B common stock, respectively, through our stock repurchase program. During the year ended November 30, 2021, treasury stock increased by 14.7 million shares of Class A common stock and 0.1 million shares of Class B common stock primarily due to 14.0 million shares of common stock repurchased during the year through our stock repurchase program. During the years ended November 30, 2022 and 2021, our Class A and Class B common stockholders received an aggregate per share annual dividend of $1.50 and $1.00, respectively. On January 12, 2023, our Board of Directors declared a quarterly cash dividend of $0.375 per share on both our Class A and Class B common stock. The dividend is payable on February 10, 2023 to holders of record at the close of business on January 27, 2023.Based on our current financial condition and credit relationships, we believe that our operations and borrowing resources will provide for our current and long-term capital requirements at our anticipated levels of activity.Supplemental Financial InformationCurrently, certain of our 100% owned subsidiaries, which are primarily our homebuilding subsidiaries, are guaranteeing all our senior notes. The guarantees are full and unconditional.The indentures governing our senior notes require that, if any of our 100% owned subsidiaries, other than our finance company subsidiaries and foreign subsidiaries, directly or indirectly guarantee at least $75 million principal amount of debt of Lennar Corporation (other than senior notes), those subsidiaries must also guarantee Lennar Corporation’s obligations with regard to its senior notes. Included in the following tables as part of “Obligors” together with Lennar Corporation are subsidiary entities that are not finance company subsidiaries or foreign subsidiaries and were guaranteeing the senior notes because at November 30, 2022 they were guaranteeing Lennar Corporation's letter of credit facilities and its Credit Facility, disclosed in Note 4 of the Notes to Consolidated Financial Statements. The guarantees are full, unconditional and joint and several and the guarantor subsidiaries are 100% directly or indirectly owned by Lennar Corporation. A subsidiary's guarantee of Lennar senior notes will be suspended at any time when it is not directly or indirectly guaranteeing at least $75 million principal amount of debt of Lennar Corporation (other than senior notes), and a subsidiary will be released from its guarantee and any other obligations it may have regarding the senior notes if all or substantially all its assets, or all of its capital stock, are sold or otherwise disposed. If the proposed spin-off of our multifamily and single family rental asset management businesses takes place, the subsidiaries involved in those businesses will no longer guarantee our senior notes.Supplemental information for the Obligors, which excludes non-guarantor subsidiaries and intercompany transactions, at November 30, 2022 is included in the following tables. Intercompany balances and transactions within the Obligors have been eliminated and amounts attributable to the Obligor’s investment in consolidated subsidiaries that have not issued or guaranteed the senior notes have been excluded. Amounts due from and transactions with non-guarantor subsidiaries and related parties are separately disclosed:(In thousands)November 30, 2022November 30, 2021Due from non-guarantor subsidiaries$17,959,091 4,187,044 Equity method investments1,090,831 937,920 Total assets40,929,435 30,750,296 Total liabilities10,455,359 9,631,796 34Table of ContentsYear Ended(In thousands)November 30, 2022Total revenues$31,078,352 Operating earnings6,578,451 Earnings before income taxes6,106,521 Net earnings attributable to Lennar4,708,943 Off-Balance Sheet ArrangementsHomebuilding - Investments in Unconsolidated EntitiesAt November 30, 2022, we had equity investments in 48 active Homebuilding and land unconsolidated entities (of which 4 had recourse debt, 15 had non-recourse debt and 29 had no debt), compared to 41 active Homebuilding and land unconsolidated entities at November 30, 2021. Historically, we have invested in unconsolidated entities that acquired and developed land (1) for our homebuilding operations or for sale to third parties or (2) for the construction of homes for sale to third-party homebuyers. Through these entities, we have primarily sought to reduce and share our risk by limiting the amount of our capital invested in land, while obtaining access to potential future homesites and allowing us to participate in strategic ventures. The use of these entities also, in some instances, has enabled us to acquire land to which we could not otherwise obtain access, or could not obtain access on as favorable terms, without the participation of a strategic partner. Participants in these joint ventures have been land owners/developers, other homebuilders and financial or strategic partners. Joint ventures with land owners/developers have given us access to homesites owned or controlled by our partners. Joint ventures with other homebuilders have provided us with the ability to bid jointly with our partners for large land parcels. Joint ventures with financial partners have allowed us to combine our homebuilding expertise with access to our partners’ capital. Joint ventures with strategic partners have allowed us to combine our homebuilding expertise with the specific expertise (e.g. commercial or infill experience) of our partner. Each joint venture is governed by an executive committee consisting of members from the partners. Details regarding these investments, balances and debt are included in Note 3 of the Notes to Consolidated Financial Statements.We regularly monitor the results of our Homebuilding unconsolidated joint ventures and any trends that may affect their future liquidity or results of operations. We also monitor the performance of Homebuilding joint ventures in which we have investments on a regular basis to assess compliance with debt covenants. For those joint ventures not in compliance with the debt covenants, we evaluate and assess possible impairment of our investment. We believe all of the joint ventures were in compliance with their debt covenants at November 30, 2022.The following table summarizes the principal maturities of our Homebuilding unconsolidated entities ("JVs") debt as per current debt arrangements as of November 30, 2022. It does not represent estimates of future cash payments that will be made to reduce debt balances. Many JV loans have extension options in the loan agreements that would allow the loans to be extended into future years.Principal Maturities of Homebuilding Unconsolidated JVs Debt by Period(In thousands)Total JV Debt202320242025ThereafterOtherDebt without recourse to Lennar$1,381,438 167,051 391,940 715,283 107,164 — Land seller and other debt without recourse to Lennar11,113 — — — 11,113 — Maximum recourse debt exposure to Lennar9,138 — — — 9,138 — Debt issuance costs(18,387)— — — — (18,387)Total$1,383,302 167,051 391,940 715,283 127,415 (18,387)Multifamily - Investments in Unconsolidated EntitiesAt November 30, 2022, Multifamily had equity investments in 23 active unconsolidated entities that are engaged in multifamily residential developments (of which 15 had non-recourse debt and 8 had no debt), compared to 14 active unconsolidated entities at November 30, 2021. We invest in unconsolidated entities that acquire and develop land to construct multifamily rental properties. Through these entities, we are focusing on developing a geographically diversified portfolio of institutional quality multifamily rental properties in select U.S. markets. Participants in these joint ventures have been financial partners. Joint ventures with financial partners have allowed us to combine our development and construction expertise with access to our partners’ capital. Each joint venture is governed by an operating agreement that provides significant substantive 35Table of Contentsparticipating voting rights on major decisions to our partners.The Multifamily segment manages and has investments in LMV I and LMV II, which are long-term multifamily development investment vehicles involved in the development, construction and ownership of class-A multifamily rental properties. Details of each as of and during the year ended November 30, 2022 are included in Note 3 of the Notes to Consolidated Financial Statements.We regularly monitor the results of our Multifamily unconsolidated joint ventures and any trends that may affect their future liquidity or results of operations. We also monitor the performance of Multifamily joint ventures in which we have investments on a regular basis to assess compliance with debt covenants. For those joint ventures not in compliance with the debt covenants, we evaluate and assess possible impairment of our investment. We believe all of the joint ventures were in compliance with their debt covenants at November 30, 2022.The following table summarizes the principal maturities of our Multifamily unconsolidated entities debt as per current debt arrangements as of November 30, 2022. It does not represent estimates of future cash payments that will be made to reduce debt balances.Principal Maturities of Multifamily Unconsolidated JVs Debt by Period(In thousands)Total JV Debt202320242025ThereafterOtherDebt without recourse to Lennar$4,345,145 1,286,563 1,022,248 1,052,564 983,770 — Debt issuance costs(26,371)— — — — (26,371)Total$4,318,774 1,286,563 1,022,248 1,052,564 983,770 (26,371)Lennar Other - Investments in Unconsolidated EntitiesAs part of the sale of the Rialto investment and asset management platform, we retained the right to receive a portion of payments with regard to carried interests if funds meet specified performance thresholds. We periodically receive advance distributions related to the carried interests in order to cover income tax obligations resulting from allocations of taxable income to the carried interests. These distributions are not subject to clawbacks but will reduce future carried interest payments to which we become entitled and have been recorded as revenues.As of November 30, 2022 and 2021, we had strategic technology investments in unconsolidated entities of $131.5 million and $145.6 million, respectively, accounted for under the equity method of accounting.Option ContractsWe often obtain access to land through option contracts, which generally enable us to control portions of properties owned by third parties (including land funds) and unconsolidated entities until we have determined whether to exercise the options. Since fiscal year 2020, we have been increasing the percentage of our total homesites that we control through options rather than own. As part of our focus on strategic relationships to further enhance our land lighter strategy, at the end of fiscal year 2020 we entered into an arrangement with various land bank investor groups. Under the arrangement, in most instances when we want to acquire a property for use in our for-sale single family home business, we will offer the investor group the opportunity to acquire the property and give us an option to purchase all or a portion of it back in the future, if it is mutually beneficial to both parties. To the extent the investor group does not elect to purchase properties we identify, we can utilize our other investor relationships to have other investor groups purchase the land or we can purchase it directly. The arrangement with the investor group, together with existing and other strategic partnerships we are discussing, are significant steps in our strategy to migrate to a higher percentage of our homesites which we control but do not own, which we expect will result in greater cash flow and higher returns on assets and equity.36Table of ContentsThe table below indicates the number of homesites owned and homesites to which we had access through option contracts with third parties ("optioned") or unconsolidated JVs (i.e., controlled homesites) at November 30, 2022 and 2021:Controlled HomesitesNovember 30, 2022OptionedJVsTotalOwnedHomesitesTotalHomesitesYears of Supply Owned (1)East92,710 — 92,710 49,507 142,217 Central41,725 — 41,725 34,242 75,967 Texas79,775 — 79,775 38,620 118,395 West61,441 — 61,441 41,320 102,761 Other— 5,758 5,758 2,018 7,776 Total homesites275,651 5,758 281,409 165,707 447,116 2.5 % of total homesites63 %37 %Controlled HomesitesNovember 30, 2021OptionedJVsTotalOwnedHomesitesTotalHomesitesYears of Supply Owned (1)East87,083 — 87,083 51,041 138,124 Central30,682 — 30,682 41,872 72,554 Texas75,027 — 75,027 37,946 112,973 West58,631 — 58,631 49,059 107,690 Other— 6,086 6,086 2,043 8,129 Total homesites251,423 6,086 257,509 181,961 439,470 3.0 % of total homesites59 %41 %(1)Based on trailing twelve months of home deliveries.Excluding homes in inventory, our percentage of total homesites controlled as of November 30, 2022 and 2021 was 69% and 64%, respectively. Excluding homes in inventory, our years of supply owned as of November 30, 2022 and 2021 was 1.9 years and 2.4 years, respectively. Details on option contracts and related consolidated inventory not owned and exposure are included in Note 1 and Note 8 of the Notes to Consolidated Financial Statements.Contractual Obligations and Commercial CommitmentsThe following table summarizes certain of our contractual obligations at November 30, 2022:Payments Due by Period(In thousands)TotalLess than1 year1 to 3years3 to 5yearsMore than5 yearsHomebuilding - Senior notes and other debts payable (1)$4,038,871 223,130 2,103,491 1,669,835 42,415 Financial Services - Notes and other debts payable2,135,093 2,001,810 — — 133,283 Interest commitments under interest bearing debt (2)599,130 200,754 254,614 136,724 7,038 Operating lease obligations178,677 34,167 52,721 34,832 56,957 Other contractual obligations (3)96,577 36,582 38,816 2,304 18,875 Total contractual obligations$7,048,348 2,496,443 2,449,642 1,843,695 258,568 (1)The amounts presented in the table above exclude debt issuance costs and any discounts/premiums and purchase accounting adjustments.(2)Interest commitments on variable interest-bearing debt are determined based on the interest rate as of November 30, 2022.(3)Amounts include $4.1 million and $15.2 million remaining equity investment commitments to LMV I and LMV II, respectively, for future expenditures related to the construction and development of the projects and $77.3 million remaining equity investment commitment to the Upward America Venture. We are subject to the usual obligations associated with entering into contracts (including option contracts) for the purchase, development and sale of real estate in the routine conduct of our business. Option contracts for the purchase of land generally reduces our financial risk and costs of capital associated with land holdings. At November 30, 2022, we had access to 281,409 homesites through option contracts with third parties and unconsolidated entities in which we have investments. At November 30, 2022, we had $2.0 billion of non-refundable option deposits and pre-acquisition costs related to certain of these homesites and had posted $163.9 million of letters of credit in lieu of cash deposits under certain land and option contracts.37Table of ContentsAt November 30, 2022, we had letters of credit outstanding in the amount of $1.8 billion (which included the $163.9 million of letters of credit discussed above). Details on our letters of credit outstanding and outstanding surety bonds are included in Note 4 of the Notes to Consolidated Financial Statements.Our Financial Services segment had a pipeline of loan applications in process of $3.8 billion at November 30, 2022. Loans in process for which interest rates were committed to the borrowers totaled approximately $2.2 billion as of November 30, 2022. A significant portion of these commitments had a remaining period of 60 days or less. Since a portion of these commitments is expected to expire without being exercised by the borrowers or borrowers may not meet certain criteria at the time of closing, the total commitments do not necessarily represent future cash requirements.Our Financial Services segment uses mandatory mortgage-backed securities ("MBS") forward commitments, option contracts, futures contracts and investor commitments to hedge our mortgage-related interest rate exposure. These instruments involve, to varying degrees, elements of credit and interest rate risk. Credit risk associated with MBS forward commitments, option contracts, futures contracts and loan sales transactions is managed by limiting our counterparties to investment banks, federally regulated bank affiliates and other investors meeting our credit standards. Our risk, in the event of default by the purchaser, is the difference between the contract price and fair value of the MBS forward commitments and the option contracts. At November 30, 2022, we had open commitments amounting to $3.5 billion to sell MBS with varying settlement dates through February 2023 and open future contracts in the amount of $9.5 million with the settlement dates through March 2023.The following sections discuss market and financing risk, seasonality and interest rates and changing prices that may have an impact on our business:Market and Financing RiskWe finance our contributions to JVs, land acquisition and development activities, construction activities, financial services activities, Multifamily activities and general operating needs primarily with cash generated from operations and debt, as well as borrowings under our Credit Facility and warehouse repurchase facilities. We also purchase land under option agreements, which enables us to control homesites until we have determined whether to exercise the options. We try to manage the financial risks of adverse market conditions associated with land holdings by what we believe to be prudent underwriting of land purchases in areas we view as desirable growth markets, careful management of the land development process and limitation of risks by using partners to share the costs of purchasing and developing land as well as obtaining access to land through option contracts. Although we believe our land underwriting standards are conservative, we were required to take impairment charges with regards to several properties in 2022 due to the reduced demand for new homes in the second half of 2022. SeasonalityWe historically have experienced, and expect to continue to experience, variability in quarterly results. Our homebuilding business is seasonal in nature and generally reflects higher levels of new home order activity in our second and third fiscal quarters and increased deliveries in the second half of our fiscal year. However, a variety of factors can alter seasonal patterns. For example, in 2020, the shutdown of large portions of our national economy in March and April due to the COVID-19 pandemic temporarily reduced our home sales, and therefore altered our normal seasonal pattern.Interest Rates and Changing PricesInflation can have a long-term impact on us because increasing costs of land, materials and labor result in a need to increase the sales prices of homes. In addition, inflation is often accompanied by higher interest rates, which can have a negative impact on housing demand and increase the costs of financing land development activities and housing construction. Rising interest rates as well as increased material and labor costs, may reduce gross margins. An increase in materials and labor costs would be particularly a problem during a period of declining home prices. Conversely, deflation can impact the value of real estate and make it difficult for us to recover our land costs. Therefore, either inflation or deflation could adversely impact our future results of operations.New Accounting Pronouncements See Note 1 of the notes to our consolidated financial statements for a comprehensive list of new accounting pronouncements.Critical Accounting Policies and EstimatesOur accounting policies are more fully described in Note 1 of the notes to our consolidated financial statements included in Item 8 of this document. As discussed in Note 1, the preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and accompanying 38Table of Contentsnotes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and such differences may be material to our consolidated financial statements. Listed below are those policies and estimates that we believe are critical and require the use of significant judgment in their application.GoodwillWe recorded a significant amount of goodwill in connection with the 2018 acquisition of CalAtlantic. We record goodwill associated with acquisitions of businesses when the purchase price of the business exceeds the fair value of the net tangible and identifiable assets acquired. In accordance with ASC Topic 350, Intangibles-Goodwill and Other ("ASC 350"), we evaluate goodwill for potential impairment on at least an annual basis. We have the option to perform a qualitative or quantitative assessment to determine whether the fair value of a reporting unit exceeds its carrying value. Qualitative factors may include, but are not limited to, economic conditions, industry and market considerations, cost factors, overall financial performance of the reporting units and other entity and reporting unit specific events. We believe that the accounting estimate for goodwill is a critical accounting estimate because of the judgment required in assessing the fair value of each of our reporting units. We estimate fair value through various valuation methods, including the use of discounted expected future cash flows of each reporting unit. The expected future cash flows for each segment are significantly impacted by current market conditions. If these market conditions and resulting expected future cash flows for each reporting unit decline significantly, the actual results for each segment could differ from our estimate, which would cause goodwill to be impaired. Our accounting for goodwill represents our best estimate of future events.Homebuilding Revenue RecognitionHomebuilding revenues and related profits from sales of homes are recognized at the time of the closing of a sale, when title to and possession of the property are transferred to the homebuyer. In order to promote sales of the homes, we may offer sales incentives to homebuyers. The types of incentives vary on a community-by-community basis and home-by-home basis. They include primarily price discounts on individual homes and financing incentives, all of which are reflected as a reduction of home sales revenues. Our performance obligation, to deliver the agreed-upon home, is generally satisfied in less than one year from the original contract date. Cash proceeds from home closings held in escrow for our benefit, typically for approximately three days, are included in Homebuilding cash and cash equivalents in the Consolidated Balance Sheets and disclosed in the notes to consolidated balance sheets. Contract liabilities include customer deposit liabilities related to sold but undelivered homes that are included in other liabilities in the Consolidated Balance Sheets. We periodically elect to sell parcels of land to third parties. Cash consideration from land sales is typically due on the closing date, which is generally when performance obligations are satisfied, and revenue is recognized as title to and possession of the property are transferred to the buyer.Multifamily Revenue RecognitionOur Multifamily segment provides management services with respect to the development, construction and property management of rental projects in joint ventures in which we have investments. As a result, our Multifamily segment earns and receives fees, which are generally based upon a stated percentage of development and construction costs and a percentage of gross rental collections. These fees are recorded over the period in which the services are performed using an input method, which properly depicts the level of effort required to complete the management services. In addition, our Multifamily segment provides general contractor services for the construction of some of its rental projects and recognizes the revenue over the period in which the services are performed using an input method, which properly depicts the level of effort required to complete the construction services. These customer contracts require us to provide management and general contractor services which represents a performance obligation that we satisfy over time. Management fees and general contractor services in the Multifamily segment are included in Multifamily revenue. When the Multifamily segment acts as general contractor, it treats the entire construction cost as revenue and treats payments to subcontractors as expenses.InventoriesInventories are stated at cost unless the inventory within a community is determined to be impaired, in which case the impaired inventory is written down to fair value. Inventory costs include land, land development and home construction costs, real estate taxes, deposits on land purchase contracts and interest related to development and construction. We review our inventory for indicators of impairment by evaluating each community during each reporting period. If the undiscounted cash flows expected to be generated by a community are less than its carrying amount, an impairment charge is recorded to write down the carrying amount of such community to its estimated fair value.In conducting our review for indicators of impairment on a community level, we evaluate, among other things, the margins on homes that have been delivered, margins on homes under sales contracts in backlog, projected margins with regard to future home sales over the life of the community, projected margins with regard to future land sales, and the estimated fair value of the land itself.39Table of ContentsWe estimate the fair value of our communities using a discounted cash flow model. The projected cash flows for each community are significantly impacted by estimates related to market supply and demand, product type by community, homesite sizes, sales pace, sales prices, sales incentives, construction costs, sales and marketing expenses, the local economy, competitive conditions, labor costs, costs of materials and other factors for that particular community. Every division evaluates the historical performance of each of its communities as well as current trends in the market and economy impacting the community and its surrounding areas. These trends are analyzed for each of the estimates listed above. Since the estimates and assumptions included in our cash flow models are based upon historical results and projected trends, they do not anticipate unexpected changes in market conditions or strategies that may lead to us incurring additional impairment charges in the future.Using all the available information, we calculate our best estimate of projected cash flows for each community. While many of the estimates are calculated based on historical and projected trends, all estimates are subjective and change from market to market and community to community as market and economic conditions change. The determination of fair value also requires discounting the estimated cash flows at a rate we believe a market participant would determine to be commensurate with the inherent risks associated with the assets and related estimated cash flow streams. The discount rate used in determining each asset’s fair value depends on the community’s projected life and development stage.We estimate the fair value of inventory evaluated for impairment based on market conditions and assumptions made by management at the time the inventory is evaluated, which may differ materially from actual results if market conditions or our assumptions change. We believe that the accounting related to inventory valuation and impairment is a critical accounting policy because: (1) assumptions inherent in the valuation of our inventory are highly subjective and susceptible to change and (2) the impact of recognizing impairments on our inventory could be material to our consolidated financial statements. Product WarrantyAlthough we subcontract virtually all aspects of construction to others and our contracts call for the subcontractors to repair or replace any deficient items related to their trades, we are primarily responsible to homebuyers to correct any deficiencies. Additionally, in some instances, we may be held responsible for the actions of or losses incurred by subcontractors. Warranty and similar reserves for homes are established at an amount estimated to be adequate to cover potential costs for materials and labor with regard to warranty-type claims expected to be incurred subsequent to the delivery of a home. Reserves are determined based upon historical data and trends with respect to similar product types and geographical areas. We believe the accounting estimate related to the reserve for warranty costs is a critical accounting estimate because the estimate requires a large degree of judgment. While we believe that the reserve for warranty costs is adequate, there can be no assurances that historical data and trends will accurately predict our actual warranty costs. Additionally, there can be no assurances that future economic or financial developments might not lead to a significant change in the reserve.Investments in Unconsolidated EntitiesWe strategically invest in unconsolidated entities that acquire and develop land (1) for our homebuilding operations or for sale to third parties, (2) for construction of homes for sale to third-party homebuyers or (3) for the construction and sale of multifamily rental properties. Our Homebuilding partners generally are unrelated homebuilders, land owners/developers and financial or other strategic partners. Additionally, in recent years, we have invested in technology companies that are looking to improve the homebuilding and financial services industry in order to better serve homebuyers and homeowners and increase efficiencies. Our Multifamily partners are all financial partners.Most of the unconsolidated entities through which we acquire and develop land are accounted for by the equity method of accounting because we are not the primary beneficiary or a de-facto agent, and we have a significant, but less than controlling, interest in the entities. We record our investments in these entities in our consolidated balance sheets as Investments in Unconsolidated Entities and our pro-rata share of the entities’ earnings or losses in our consolidated statements of operations as Equity in Earnings (Loss) from Unconsolidated Entities within each of the respective segments. For most unconsolidated entities, we generally have the right to share in earnings and distributions on a pro-rata basis based upon ownership percentages. However, certain Homebuilding unconsolidated entities and all of our Multifamily unconsolidated entities provide for a different allocation of profit and cash distributions if and when cumulative results of the joint venture exceed specified targets (such as a specified internal rate of return). Advances to these entities are included in the investment balance.Management looks at specific criteria and uses its judgment when determining if we are the primary beneficiary of, or have a controlling interest in, an unconsolidated entity. Factors considered in determining whether we have significant influence, or we have control include risk and reward sharing, experience and financial condition of the other partners, voting rights, involvement in day-to-day capital and operating decisions and continuing involvement. The accounting policy relating to the use of the equity method of accounting is a critical accounting policy due to the judgment required in determining whether the entity is a VIE or a voting interest entity and then whether we are the primary beneficiary or have control or significant 40Table of Contentsinfluence. We believe that the equity method of accounting is appropriate for our investments in unconsolidated entities where we are not the primary beneficiary and we do not have a controlling interest, but rather share control with our partners.We evaluate the long-lived assets in unconsolidated entities for indicators of impairment during each reporting period. A series of operating losses of an investee or other factors may indicate that a decrease in the fair value of our investment in the unconsolidated entity below its carrying amount has occurred which is other-than-temporary. The amount of impairment recognized is the excess of the investment’s carrying amount over its estimated fair value.The evaluation of our investment in unconsolidated entities for other-than-temporary impairment includes certain critical assumptions: (1) projected future distributions from the unconsolidated entities, (2) discount rates applied to the future distributions and (3) various other factors. Our assumptions on the projected future distributions from unconsolidated entities are dependent on market conditions. We believe our assumptions on discount rates are critical accounting policies because the selection of the discount rates affects the estimated fair value of our investments in unconsolidated entities. A higher discount rate reduces the estimated fair value of our investments in unconsolidated entities, while a lower discount rate increases the estimated fair value of our investments in unconsolidated entities. Because of changes in economic conditions, actual results could differ materially from management’s assumptions and may require material valuation adjustments to our investments in unconsolidated entities to be recorded in the future.Consolidation of Variable Interest EntitiesGAAP requires the assessment of whether an entity is a VIE and, if so, if we are the primary beneficiary at the inception of the entity or at a reconsideration event. Additionally, GAAP requires the consolidation of VIEs in which we have a controlling financial interest. A controlling financial interest will have both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.Our variable interest in VIEs may be in the form of (1) equity ownership, (2) contracts to purchase assets, (3) management services and development agreements between us and a VIE, (4) loans provided by us to a VIE or other partner and/or (5) guarantees provided by members to banks and other third parties. We examine specific criteria and use our judgment when determining if we are the primary beneficiary of a VIE. Factors considered in determining whether we are the primary beneficiary include risk and reward sharing, experience and financial condition of other partner(s), voting rights, involvement in day-to-day capital and operating decisions, representation on a VIE’s executive committee, existence of unilateral kick-out rights or voting rights, level of economic disproportionality between us and the other partner(s) and contracts to purchase assets from VIEs.Generally, all major decision making in our joint ventures is shared among all partners. In particular, business plans and budgets are generally required to be unanimously approved by all partners. Usually, management and other fees earned by us are nominal and believed to be at market and there is no significant economic disproportionality between us and other partners. Generally, we purchase less than a majority of the JV’s assets and the purchase prices under our option contracts are believed to be at market.Generally, our unconsolidated entities become VIEs and consolidate if the other partner(s) lack the intent and financial wherewithal to remain in the entity. As a result, we continue to fund operations and debt paydowns through partner loans or substituted capital contributions. The accounting policy relating to variable interest entities is a critical accounting policy because the determination of whether an entity is a VIE and, if so, whether we are primary beneficiary may require us to exercise significant judgment.Item 7A. Quantitative and Qualitative Disclosures About Market Risk.We are exposed to a number of market risks in the ordinary course of business. Our primary market risk exposure relates to fluctuations in interest rates on our investments, loans held-for-sale, loans held-for-investment and outstanding variable rate debt. For fixed rate debt, such as our senior notes, changes in interest rates generally affect the fair value of the debt instrument, but not our earnings or cash flows. For variable rate debt such as our unsecured revolving credit facility and Financial Services’ and LMF Commercial’s warehouse repurchase facilities, changes in interest rates generally do not affect the fair value of the outstanding borrowings on the debt facilities but do affect our earnings and cash flows. In our Financial Services operations, we utilize mortgage backed securities forward commitments, option contracts and investor commitments to protect the value of rate-locked commitments and loans held-for-sale from fluctuations in mortgage-related interest rates.41Table of ContentsTo mitigate interest risk associated with LMF Commercial's loans held-for-sale, we use derivative financial instruments to hedge our exposure to risk from the time a borrower locks a loan until the time the loan is securitized. We hedge our interest rate exposure through entering into interest rate swap futures. We also manage a portion of our credit exposure by buying protection within the CMBX and CDX markets.We do not enter into or hold derivatives for trading or speculative purposes.The table below provides information at November 30, 2022 about our significant instruments that are sensitive to changes in interest rates. For loans held-for-investment, net and investments held-to-maturity, senior notes and other debts payable and notes and other debts payable, the table presents principal cash flows and related weighted average effective interest rates by expected maturity dates and estimated fair values at November 30, 2022. Weighted average variable interest rates are based on the variable interest rates at November 30, 2022. See Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and Notes 1 and 7 of the Notes to Consolidated Financial Statements in Item 8 for a further discussion of these items and our strategy of mitigating our interest rate risk.Information Regarding Interest Rate SensitivityPrincipal (Notional) Amount byExpected Maturity and Average Interest RateNovember 30, 2022Years Ending November 30,Fair Value atNovember 30,(Dollars in millions)20232024202520262027ThereafterTotal2022ASSETSFinancial Services:Loans held-for-investment, net:Fixed rate$1.0 1.0 1.0 1.1 1.1 32.7 37.9 37.9 Average interest rate3.6 %3.6 %3.6 %3.6 %3.6 %3.6 %3.6 %— Variable rate$7.3 — — — — 0.5 7.8 7.8 Average interest rate8.6 %— — — — 2.8 %8.3 %— LIABILITIESHomebuilding:Senior notes and other debts payable:Fixed rate$223.1 1,537.4 566.1 404.5 1,265.3 42.4 4,038.8 3,993.2 Average interest rate3.9 %5.0 %4.7 %5.2 %4.8 %6.2 %4.9 %— Financial Services:Notes and other debts payable:Fixed rate$— — — — — 133.3 133.3 134.0 Average interest rate— — — — — 3.4 %3.4 %— Variable rate$2,001.8 — — — — — 2,001.8 2,001.8 Average interest rate5.8 %— — — — — 5.8 %— Multifamily:Notes and other debts payable:Fixed rate$13.5 — — — — — 13.5 13.5 Average interest rate0.0 %— — — — — 0.0 %— Variable rate$— 3.2 — — — — 3.2 3.2 Average interest rate— 3.6 %— — — — 3.6 %— 42Table of Contents
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+ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand our results of operations and financial condition. The MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and notes thereto included in Item 8 - Financial Statements and Supplementary Data.The MD&A generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results or Operations” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021 filed with the SEC on January 25, 2022.Business OverviewWe are a global security and aerospace company principally engaged in the research, design, development, manufacture, integration and sustainment of advanced technology systems, products and services. We also provide a broad range of management, engineering, technical, scientific, logistics, system integration and cybersecurity services. Our main areas of focus are in defense, space, intelligence, homeland security and information technology, including cybersecurity. We serve both U.S. and international customers with products and services that have defense, civil and commercial applications, with our principal customers being agencies of the U.S. Government. In 2022, 73% of our $66.0 billion in net sales were from the U.S. Government, either as a prime contractor or as a subcontractor (including 64% from the Department of Defense (DoD)), 26% were from international customers (including foreign military sales (FMS) contracted through the U.S. Government) and 1% were from U.S. commercial and other customers. We operate in four business segments: Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS) and Space. We organize our business segments based on the nature of the products and services offered. We operate in a complex and evolving global security environment. Our strategy consists of the design and development of platforms and systems that meet the future requirements of 21st Century Security. Our vision for 21st Century Security is to accelerate the adoption of advanced networking and leading-edge technologies into our national defense enterprise, while enhancing the performance and value of our platforms and products for our customers. The aim of 21st Century Security is to integrate new and existing systems across all domains with advanced, open-architecture networking and operational technologies to make forces more agile, adaptive and unpredictable. 21st Century Security is an overarching vision that will guide our investment and strategy and we are also focused on four elements for potential growth in the near to mid-term: current programs of record, classified programs, hypersonics and new awards. We have multiple programs of record from each business segment that are entering growth stages, including the F-35 sustainment activity (Aeronautics), increased PAC-3 production rates (Missiles and Fire Control), CH-53K heavy lift helicopter (Rotary and Mission Systems), and the modernization and enhancements to the Trident II D5 Fleet Ballistic Missile (Space). We are engaged in significant classified development programs and pending successful achievement of the objectives within those programs, we expect to begin the transition from development to production over the next few years. We are currently performing on multiple hypersonic programs and following the successful completion of ongoing testing and evaluation activity, multiple programs are expected to enter early production phases between 2023 and 2026. Finally, we are always in pursuit of new program awards to develop future platforms that enable us to continue to place security capability into the market and expand our global reach.Key to enabling success of our strategy is developing differentiating technologies, forging strategic partnerships, including with commercial companies, executing on our multi-year business transformation initiative to enhance our digital infrastructure and increase efficiencies and collaboration throughout our business and maintaining fiscal discipline. Underpinning our ability to execute our strategy is our talent and culture. We invest substantially in our people to ensure that our workforce has the technical skills necessary to succeed, and we expect to continue to invest internally in innovative technologies that address rapidly evolving mission requirements for our customers. We also will continue to evaluate our portfolio and will make strategic acquisitions or divestitures, as appropriate, while deepening our connection to commercial industry through cooperative partnerships, joint ventures, and equity investments. COVID-19COVID-19 continued to cause business impacts in 2022. The emergence of the Omicron variant in late 2021 and resulting increase in COVID-19 cases in early 2022 adversely impacted our operations and our supply chain. Our performance was affected during 2022 by supply chain disruptions and delays, as well as labor challenges associated with employee absences, travel restrictions, site access, quarantine restrictions, remote work, and adjusted work schedules. The recovery from 30Table of Contents that disruption has been slower than originally anticipated, in particular within our supply chain, and some of those supply chain impacts are expected to continue into 2023. Attendance for employees required to be onsite fluctuated during 2022 based on COVID-19 developments. We are actively engaging with our customers and are continuing to take measures to protect the health and safety of our employees. In our on-going effort to mitigate supply chain risks, we accelerated payments of $1.5 billion to our suppliers as of December 31, 2022, that are due according to contractual terms in future periods, while consistently prioritizing small businesses, which make up over half of our active supply base, as well as at-risk businesses. Additionally, we have deployed resources at supplier sites to improve oversight and performance. We will continue to monitor supply chain risks, especially at small and at-risk related suppliers, and may continue to utilize accelerated payments in 2023 on an as needed basis.The impact of COVID-19 on our operations and financial performance in future periods, including our ability to execute our programs in the expected timeframe, remains uncertain and will depend on a number of factors, including the impact of potential new COVID-19 variants or subvariants, the effectiveness and adoption of COVID-19 vaccines and therapeutics, and supplier impacts and related government actions to prevent and manage disease spread,. The long-term impacts of COVID-19 on government budgets and other funding priorities, including international priorities, that impact demand for our products and services also are difficult to predict, but could negatively affect our future results and performance.InflationHeightened levels of inflation and the potential worsening of macro-economic conditions present risks for Lockheed Martin, our suppliers and the stability of the broader defense industrial base. During 2022, we have experienced impacts to our labor rates and suppliers have signaled inflation related cost pressures, which will flow through to our costs and pricing. Although inflation did not significantly impact our financial results in 2022, if inflation remains at current levels for an extended period, or increases, and we are unable to successfully mitigate the impact, our costs are likely to increase, resulting in pressure on our profits, margins and cash flows, particularly for existing fixed-price contracts. For new contract proposals, we are factoring into our pricing heightened levels of inflation based on accepted DoD escalation indices and other assumptions, and in some cases seeking the inclusion of economic price adjustment (EPA) clauses, which would permit, subject to the particular contractual terms, cost adjustments in fixed-price contracts for unexpected inflation. In addition, inflation and the increases in the cost of borrowing from rising interest rates could constrain the overall purchasing power of our customers for our products and services, in particular in the near term to the extent inflation assumptions are less than current inflationary pressures. Rising interest rates will also increase our borrowing costs on new debt and could affect the fair value of our investments. While rising interest rates reduce the measure of our gross pension obligations, they can also lead to decline in pension plan assets with offsetting impacts on our net pension liability. We remain committed to our ongoing efforts to increase the efficiency of our operations and improve the cost competitiveness and affordability of our products and services, which may, in part, offset cost increases from inflation.Conflict in UkraineRussia’s invasion of Ukraine has significantly elevated global geopolitical tensions and security concerns. As a result, we have received increased interest for some of our products and services as countries seek to improve their security posture, particularly in Europe. In addition, security assistance provided by the U.S. government to Ukraine has created U.S. government demand to replenish U.S. stockpiles, resulting in additional and potential future orders for our products. We are beginning to see this interest result in initiation of new contract discussions, however, given the long-cycle nature of our business and current industry capacity, we do not expect a significant increase in near term sales from new contracts in response to the conflict. We are evaluating capacity at our operations and the supply chain to anticipate potential demand and enable us to deliver critical capabilities. In addition, the U.S. Government and other nations have implemented broad economic sanctions and export controls targeting Russia, which combined with the conflict have the potential to indirectly disrupt our supply chain and access to certain resources. We have not, however, experienced significant adverse impacts to date and we will continue to monitor for any impacts and seek to mitigate disruption that may arise. The conflict also has increased the threat of malicious cyber activity from nation states and other actors. We have taken steps designed to enhance our defensive posture against tactics and techniques associated with this increased threat. Portfolio Shaping ActivitiesWe continuously strive to strengthen our portfolio of products and services to meet the current and future needs of our customers. We accomplish this in part by our independent research and development activities and through acquisition, divestiture and internal realignment activities.We selectively pursue the acquisition of businesses, investments and ventures at attractive valuations that will expand or complement our current portfolio and allow access to new customers or technologies. We also may explore the divestiture of 31Table of Contents businesses, investments or ventures that no longer meet our needs or strategy or that could perform better outside of our organization or with a different owner. In pursuing our business strategy, we routinely conduct discussions, evaluate targets and enter into agreements regarding possible acquisitions, divestitures, joint ventures and equity investments.Renationalization of the Atomic Weapons Establishment ProgramOn June 30, 2021, the UK Ministry of Defence terminated the contract to operate the UK’s nuclear deterrent program and assumed control of the entity that manages the program (referred to as the renationalization of the Atomic Weapons Establishment (AWE program)). Accordingly, the AWE program’s ongoing operations, including the entity that manages the program, are no longer included in our financial results as of that date. Therefore, during 2021, AWE only generated sales of $885 million and operating profit of $18 million, which are included in Space’s financial results for the year ended December 31, 2021. During the year ended December 31, 2020, AWE generated sales of $1.4 billion and operating profit of $35 million, which are included in Space’s financial results for 2020.U.S. Government FundingOn March 28, 2022 the Administration submitted to Congress the President’s Fiscal Year (FY) 2023 budget request, which proposed $813.4 billion in total national defense spending, of which $773 billion was for the base budget of the Department of Defense (DoD).On December 29, 2022, the President signed the FY 2023 Omnibus Appropriations Act into law, which provides $858 billion in total national defense funding, of which $816.7 billion is for the DoD base budget. This reflects a $44.6 billion increase over the FY 2023 request for national defense spending, and a $43.7 billion increase for the DoD.The FY 2023 Omnibus Appropriations Act also provided separate and additional funding of $47 billion for Ukraine, the fourth supplemental since March of 2022, bringing the total amount of supplemental funding authority provided to $113 billion.The President’s FY 2024 budget request is anticipated to be submitted to Congress in March 2023, initiating the FY 2024 defense authorization and appropriations legislative process. In addition to the FY 2024 budget process, Congress will have to contend with the legal limit on U.S. debt, commonly known as the debt ceiling. The current statutory limit of $31.4 trillion was reached in January, requiring the Treasury Department to take accounting measures to continue normally financing U.S. government obligations while avoiding exceeding the debt ceiling. It is expected, however, the U.S. government will exhaust these measures by June 2023. If the debt ceiling is not raised, the U.S. government may not be able to fulfill its funding obligations and there could be significant disruption to all discretionary programs and wider financial and economic repercussions. The federal budget and debt ceiling are expected to continue to be the subject of considerable congressional debate. Although we believe DoD, intelligence, and homeland security programs will continue to receive consensus support for increased funding and would likely receive priority if this scenario came to fruition, the effect on individual programs or Lockheed Martin cannot be predicted at this time.International BusinessA key component of our strategic plan is to grow our international sales. To accomplish this growth, we continue to focus on strengthening our relationships internationally through partnerships and joint technology efforts. Our international business is conducted either by foreign military sales (FMS) contracted through the U.S. Government or by direct commercial sales (DCS) to international customers. In 2022, approximately 74% of our sales to international customers were FMS and about 26% were DCS. Additionally, in 2022, substantially all of our sales from international customers were in our Aeronautics, MFC and RMS business segments. Space’s sales from international customers were not material in 2022. See Item 1A - Risk Factors for a discussion of risks related to international sales.In 2022, international customers accounted for 33% of Aeronautics’ net sales. There continues to be strong international interest in the F-35 program, which includes commitments from the U.S. Government and seven international partner countries and nine FMS customers, as well as expressions of interest from other countries. The U.S. Government and the partner countries continue to work together on the design, testing, production, and sustainment of the F-35 program. Other areas of international expansion at our Aeronautics business segment include the F-16 and C-130J programs, which continue to draw interest from international customers for new aircraft.In 2022, international customers accounted for 31% of MFC’s net sales. Our MFC business segment continues to generate significant international interest, most notably in the air and missile defense product line, which produces the Patriot Advanced Capability-3 (PAC-3) and Terminal High Altitude Area Defense (THAAD) systems. Fourteen nations have chosen PAC-3 Cost Reduction Initiative (CRI) and PAC-3 Missile Segment Enhancement (MSE) to provide missile defense capabilities. 32Table of Contents Additionally, we continue to see international demand for our tactical and strike missile products, where we received orders for precision fires systems from Germany and Taiwan and for Long Range Anti-Ship Missiles (LRASM) from Australia.In 2022, international customers accounted for 28% of RMS’ net sales. Our RMS business segment continues to experience international interest in the Aegis Ballistic Missile Defense System (Aegis) for which we perform activities in the development, production, modernization, ship integration, test and lifetime support for ships of international customers such as Japan, Spain, Republic of Korea, and Australia. We have ongoing combat systems programs associated with different classes of surface combatant ships for customers in Canada, Chile, and New Zealand. Our Multi-Mission Surface Combatant (MMSC) program will provide surface combatant ships for international customers, such as the Kingdom of Saudi Arabia, designed to operate in shallow waters and the open ocean. In our training and logistics solutions portfolio, we have active programs and pursuits in the United Kingdom, the Kingdom of Saudi Arabia, Canada, Singapore, Australia, Germany and France. We have active development, production, and sustainment support of the S-70 Black Hawk and MH-60 Seahawk helicopters to international customers, including India, Philippines, Australia, Republic of Korea, Thailand, the Kingdom of Saudi Arabia, and Greece. Additionally, in December 2021, the Israeli Ministry of Defense signed a Letter of Offer and Acceptance (LOA) to procure 12 CH-53K King Stallion heavy lift helicopters, of which the first four were awarded in 2022. Commercial aircraft are sold to international customers to support search and rescue missions as well as VIP and offshore oil and gas transportation. Status of the F-35 ProgramThe F-35 program primarily consists of production contracts, sustainment activities, and new development efforts. Production of the aircraft is expected to continue for many years given the U.S. Government’s current inventory objective of 2,456 aircraft for the U.S. Air Force, U.S. Marine Corps, and U.S. Navy; commitments from our seven international partner countries and nine Foreign Military Sales (FMS) customers; as well as interest from other countries. We saw strong international demand for the F-35 in 2022. During the first quarter of 2022, Finland became the seventh FMS customer to join the program. During the second quarter of 2022, the Government of Canada selected Lockheed Martin and the F-35 as the preferred bidder to move into the Finalization Phase of the competitive process to replace its fighter fleet. As a result of the Finalization Phase, the Government of Canada recently announced in January 2023 their commitment to purchase 88 F-35 aircraft. During the third quarter of 2022, the Swiss government signed a Letter of Offer and Acceptance for the procurement of 36 F-35 aircraft and became the eighth FMS customer to join the program. During the fourth quarter of 2022, the German government signed a Letter of Offer and Acceptance for the procurement of 35 F-35 aircraft and became the ninth FMS customer to join the program.During the fourth quarter of 2022, we finalized the F-35 Low Rate Initial Production (LRIP) Lots 15-17 production contract with the U.S. Government for up to 398 aircraft. The agreement includes 145 aircraft for Lot 15, 127 for Lot 16 and up to 126 for a Lot 17 contract option. In 2022 we delivered 141 aircraft and had a backlog of 345 production aircraft, including orders from our international partner countries and FMS customers. Since program inception we have delivered 894 production F-35 aircraft to U.S. and international customers, including 648 F-35A variants, 178 F-35B variants, and 68 F-35C variants, demonstrating the F-35 program’s continued progress and longevity.COVID-19 and other impacts experienced by the F-35 enterprise have continued to impact our near-term production plans. At the end of 2022, there was an issue with the Government Furnished Equipment (GFE) engine that resulted in a pause in flight operations and 2022 aircraft deliveries were impacted. The delivery pause continues as flight operations remain on hold and concurrently, GFE engine deliveries have been suspended. We will have greater clarity if changes to our 2023 aircraft delivery expectation are required once the pause in flight operations and the GFE engine delivery suspension have been resolved. As of January 2023, we plan on producing 147-153 aircraft in 2023 and 2024, and 2023 deliveries will be determined pending the resumption of engine deliveries and other factors. We anticipate annual deliveries of 156 aircraft in 2025 and for the foreseeable future.Given the size and complexity of the F-35 program, we anticipate that there will be continual reviews related to aircraft performance, program, and delivery schedule, cost, and requirements as part of the DoD, Congressional, and international countries’ oversight, and budgeting processes. Current program challenges include our and our suppliers’ performance (including COVID-19 performance-related challenges), software development, execution of future flight tests and findings resulting from testing and operating the aircraft, the level of cost associated with life cycle operations, sustainment and potential contractual obligations, inflation-related cost pressures, and the ability to improve affordability.BacklogAt December 31, 2022, our backlog was $150.0 billion compared with $135.4 billion at December 31, 2021. Backlog is converted into sales in future periods as work is performed or deliveries are made. We expect to recognize approximately 37% 33Table of Contents of our backlog over the next 12 months and approximately 61% over the next 24 months as revenue, with the remainder recognized thereafter.Our backlog includes both funded (firm orders for our products and services for which funding has been both authorized and appropriated by the customer) and unfunded (firm orders for which funding has not been appropriated) amounts. We do not include unexercised options or potential orders under indefinite-delivery, indefinite-quantity (IDIQ) agreements in our backlog. If any of our contracts with firm orders were to be terminated, our backlog would be reduced by the expected value of the unfilled orders of such contracts. Funded backlog was $95.5 billion at December 31, 2022, as compared to $88.5 billion at December 31, 2021. For backlog related to each of our business segments, see below.Consolidated Results of Operations Our operating cycle is primarily long term and involves many types of contracts for the design, development and manufacture of products and related activities with varying delivery schedules. Consequently, the results of operations of a particular year, or year-to-year comparisons of sales and profits, may not be indicative of future operating results. The following discussions of comparative results among years should be reviewed in this context. All per share amounts cited in these discussions are presented on a “per diluted share” basis, unless otherwise noted. Our consolidated results of operations were as follows (in millions, except per share data):202220212020Net sales$65,984 $67,044 $65,398 Cost of sales(57,697)(57,983)(56,744)Gross profit8,287 9,061 8,654 Other income (expense), net61 62 (10)Operating profit8,348 9,123 8,644 Interest expense(623)(569)(591)Non-service FAS pension (expense) income(971)(1,292)219 Other non-operating (expense) income, net(74)288 (37)Earnings from continuing operations before income taxes6,680 7,550 8,235 Income tax expense(948)(1,235)(1,347)Net earnings from continuing operations5,732 6,315 6,888 Net loss from discontinued operations— — (55)Net earnings$5,732 $6,315 $6,833 Diluted earnings (loss) per common shareContinuing operations$21.66 $22.76 $24.50 Discontinued operations— — (0.20)Total diluted earnings per common share$21.66 $22.76 $24.30 Certain amounts reported in other income (expense), net, including our share of earnings or losses from equity method investees, are included in the operating profit of our business segments. Accordingly, such amounts are included in the discussion of our business segment results of operations.34Table of Contents Net SalesWe generate sales from the delivery of products and services to our customers. Our consolidated net sales were as follows (in millions):202220212020Products$55,466 $56,435 $54,928 % of total net sales84.1 %84.2 %84.0 %Services10,518 10,609 10,470 % of total net sales15.9 %15.8 %16.0 %Total net sales$65,984 $67,044 $65,398 Substantially all of our contracts are accounted for using the percentage-of-completion cost-to-cost method. Under the percentage-of-completion cost-to-cost method, we record net sales on contracts over time based upon our progress towards completion on a particular contract, as well as our estimate of the profit to be earned at completion. The following discussion of material changes in our consolidated net sales should be read in tandem with the subsequent discussion of changes in our consolidated cost of sales and our business segment results of operations because changes in our sales are typically accompanied by a corresponding change in our cost of sales due to the nature of the percentage-of-completion cost-to-cost method. Overall, our sales were negatively affected in 2022 because of supply chain impacts.Product SalesProduct sales decreased $1.0 billion, or 2%, in 2022 as compared to 2021. The decrease is primarily attributable to lower product sales of approximately $670 million at RMS mostly due to lower production volume on Black Hawk and lower net sales for training and logistics solutions (TLS) programs due to the delivery of an international pilot training system in the first quarter of 2021; about $315 million at Space primarily due to the renationalization of AWE on June 30, 2021, partially offset by higher development volume (Next Generation Interceptor (NGI)); and approximately $220 million at MFC primarily due to lower volume on Terminal High Altitude Area Defense (THAAD) and air dominance weapon systems. These decreases were partially offset by higher product sales of about $240 million at Aeronautics mostly due to higher volume on classified contracts that were partially offset by lower volume on F-35 contracts.Service SalesService sales decreased $91 million, or 1%, in 2022 as compared to 2021. The decrease in service sales was primarily due to lower sales of approximately $155 million at MFC primarily due to lower volume on the Special Operations Forces Global Logistics Support Services (SOF GLSS) program.Cost of Sales Cost of sales, for both products and services, consist of materials, labor, subcontracting costs and an allocation of indirect costs (overhead and general and administrative), as well as the costs to fulfill our industrial cooperation agreements, sometimes referred to as offset agreements, required under certain contracts with international customers. For each of our contracts, we monitor the nature and amount of costs at the contract level, which form the basis for estimating our total costs to complete the contract. Our consolidated cost of sales were as follows (in millions):202220212020Cost of sales – products$(49,577)$(50,273)$(48,996)% of product sales89.4 %89.1 %89.2 %Cost of sales – services(9,280)(9,463)(9,371)% of service sales88.2 %89.2 %89.5 %Severance and other charges(100)(36)(27)Other unallocated, net1,260 1,789 1,650 Total cost of sales$(57,697)$(57,983)$(56,744)The following discussion of material changes in our consolidated cost of sales for products and services should be read in tandem with the preceding discussion of changes in our consolidated net sales and our business segment results of operations. Except for potential impacts to our programs resulting from COVID-19, supply chain disruptions and inflation, we have not 35Table of Contents identified any additional developing trends in cost of sales for products and services that would have a material impact on our future operations.Product CostsProduct costs decreased approximately $696 million, or 1%, in 2022 as compared to 2021. The decrease was primarily attributable to lower product costs of approximately $525 million at RMS mostly due to lower production volume on Black Hawk and the delivery of an international pilot training system in the first quarter of 2021; about $195 million at MFC primarily due to lower volume on air dominance weapon systems and THAAD; and approximately $165 million at Space primarily due to the renationalization of AWE, partially offset by higher development volume (NGI). These decreases were partially offset by higher product costs of about $185 million at Aeronautics mostly due to higher volume on classified contracts that were partially offset by lower volume on F-35 contracts.Service CostsService costs decreased approximately $183 million, or 2%, in 2022 compared to 2021. The decrease was primarily attributable to lower service costs of approximately $160 million at MFC primarily due to lower volume on the SOF GLSS program.Severance and other chargesDuring the fourth quarter of 2022, we recorded charges totaling $100 million ($79 million, or $0.31 per share, after-tax) that relate to actions at our RMS business segment, which include severance costs for reduction of positions and asset impairment charges. After a strategic review of RMS, these actions will improve the efficiency of our operations, better align the organization and cost structure with changing economic conditions, and changes in program lifecycles. During 2021, we recorded severance and restructuring charges of $36 million ($28 million, or $0.10 per share, after-tax) associated with plans to close and consolidate certain facilities and reduce the total workforce within our RMS business segment.Other Unallocated, NetOther unallocated, net primarily includes the FAS/CAS pension operating adjustment (which represents the difference between CAS pension cost recorded in our business segments’ results of operations and the service cost component of Financial Accounting Standards (FAS) pension expense), stock-based compensation expense, changes in the fair value of investments and liabilities for deferred compensation plans and other corporate costs. These items are not allocated to the business segments and, therefore, are not allocated to cost of sales for products or services. Other unallocated, net reduced cost of sales by $1.3 billion in 2022, compared to $1.8 billion in 2021. Other unallocated, net during 2022 was lower primarily due to a decrease in our FAS/CAS pension operating adjustment due to lower CAS cost from the American Rescue Plan Act of 2021 (ARPA) legislation, declines in the fair value of investments and liabilities for deferred compensation plans, and fluctuations in costs associated with various corporate items, none of which were individually significant. See “Business Segment Results of Operations” and “Critical Accounting Policies - Postretirement Benefit Plans” discussion below for more information on our pension cost.Other Income (Expense), NetOther income (expense), net primarily includes earnings generated by equity method investees. Other income, net in 2022 was $61 million, compared to $62 million in 2021.Interest ExpenseInterest expense in 2022 was $623 million, compared to $569 million in 2021. The increase in interest expense in 2022 resulted primarily from the issuance of notes in October of 2022 to fund share repurchases. See “Capital Structure, Resources and Other” included within “Liquidity and Cash Flows” discussion below and “Note 10 – Debt” included in our Notes to Consolidated Financial Statements for a discussion of our debt.Non-Service FAS Pension (Expense) IncomeNon-service FAS pension expense was $1.0 billion in 2022, compared to $1.3 billion in 2021. Non-service FAS pension expense in 2022 includes a noncash, non-operating pension settlement charge of $1.5 billion ($1.2 billion, or $4.33 per share, after-tax), related to the transfer of $4.3 billion of our gross defined benefit pension obligations and related plan assets to an insurance company in the second quarter of 2022. Non-service FAS pension expense in 2021 includes a noncash, non-operating pension settlement charge of $1.7 billion ($1.3 billion, or $4.72 per share, after-tax), related to the transfer of $4.9 billion of our 36Table of Contents gross defined benefit pension obligations and related plan assets to an insurance company in the third quarter of 2021. See “Note 11 – Postretirement Benefit Plans” included in our Notes to Consolidated Financial Statements for additional information.Other Non-operating (Expense) Income, NetOther non-operating (expense) income, net primarily includes gains or losses related to changes in the fair value of mark-to-market investments. See “Note 1 – Organization and Significant Accounting Policies” included in our Notes to Consolidated Financial Statements for additional information. Other non-operating expense, net in 2022 was $74 million, compared to other non-operating income, net of $288 million in 2021. The decrease in 2022 was primarily due to decreases in the fair value of certain mark-to-market investments.Income Tax ExpenseOur effective income tax rate was 14.2% for 2022 and 16.4% for 2021. The rate for 2022 was lower than the rate for 2021 primarily due to increased research and development tax credits. The rates for both 2022 and 2021 benefited from tax deductions for foreign derived intangible income, dividends paid to the company's defined contribution plans with an employee stock ownership plan feature, and employee equity awards.Changes in U.S. (federal or state) or foreign tax laws and regulations, or their interpretation and application (including those with retroactive effect), such as the amortization for research or experimental expenditures, could significantly impact our provision for income taxes, the amount of taxes payable, our deferred tax asset and liability balances, and stockholders’ equity. In addition to future changes in tax laws, the amount of net deferred tax assets will change periodically based on several factors, including the measurement of our postretirement benefit plan obligations, actual cash contributions to our postretirement benefit plans and the change in the amount or reevaluation of uncertain tax positions.Beginning in 2022, the Tax Cuts and Jobs Act of 2017 eliminated the option to deduct research and development expenditures immediately in the year incurred and requires taxpayers to amortize such expenditures over five years for tax purposes. This provision resulted in a cash tax liability for the 2022 tax year of approximately $660 million. Our net deferred tax assets increased in 2022 by approximately $660 million as a result as well. This provision is expected to increase our 2023 cash tax liability by approximately $575 million. The actual impact on 2023 cash tax liability will depend on the amount of research and development expenses paid or incurred in 2023 among other factors. While the largest impact of this provision will be to 2022 cash tax liability, the impact will continue over the five-year amortization period, but will decrease over the period and be immaterial in year six.As of December 31, 2021, our liabilities associated with uncertain tax positions were not material. As of December 31, 2022, our liabilities associated with uncertain tax positions increased to $1.6 billion with a corresponding increase to net deferred tax assets primarily as a result of the provision described above from the Tax Cuts and Jobs Act of 2017. See “Note 9 – Income Taxes” included in our Notes to Consolidated Financial Statements for additional information.We are regularly under audit or examination by tax authorities, including foreign tax authorities (including in, amongst others, Australia, Canada, India, Italy, Japan, Poland, and the United Kingdom). The final determination of tax audits and any related litigation could similarly result in unanticipated increases in our tax expense and affect profitability and cash flows.On August 16, 2022, the President signed into law the Inflation Reduction Act of 2022 which contained provisions effective January 1, 2023, including a 15% corporate minimum tax and a 1% excise tax on stock buybacks, both of which we expect to be immaterial to our financial results, financial position and cash flows.Net EarningsWe reported net earnings of $5.7 billion ($21.66 per share) in 2022 and $6.3 billion ($22.76 per share) in 2021. Both net earnings and earnings per share in 2022 were affected by the factors mentioned above. Earnings per share also benefited from a net decrease of approximately 12.8 million weighted average common shares outstanding in 2022, compared to 2021. The reduction in weighted average common shares was a result of share repurchases, partially offset by share issuance under our stock-based awards and certain defined contribution plans.37Table of Contents Business Segment Results of OperationsWe operate in four business segments: Aeronautics, MFC, RMS and Space. We organize our business segments based on the nature of products and services offered.Net sales and operating profit of our business segments exclude intersegment sales, cost of sales, and profit as these activities are eliminated in consolidation and not included in management’s evaluation of performance of each segment. Business segment operating profit includes our share of earnings or losses from equity method investees as the operating activities of the equity method investees are closely aligned with the operations of our business segments. United Launch Alliance (ULA), results of which are included in our Space business segment, is our largest equity method investee.Business segment operating profit also excludes the FAS/CAS pension operating adjustment described below, a portion of corporate costs not considered allowable or allocable to contracts with the U.S. Government under the applicable U.S. Government cost accounting standards (CAS) or federal acquisition regulations (FAR), and other items not considered part of management’s evaluation of segment operating performance such as a portion of management and administration costs, legal fees and settlements, environmental costs, changes in the fair value of certain mark-to-market investments, stock-based compensation expense, changes in the fair value of investments and liabilities for deferred compensation plans, retiree benefits, significant severance actions, significant asset impairments, gains or losses from divestitures, and other miscellaneous corporate activities. Excluded items are included in the reconciling item “Unallocated items” between operating profit from our business segments and our consolidated operating profit. See “Note 1 – Organization and Significant Accounting Policies” for a discussion related to certain factors that may impact the comparability of net sales and operating profit of our business segments.38Table of Contents Summary operating results for each of our business segments were as follows (in millions): 202220212020Net salesAeronautics$26,987 $26,748 $26,266 Missiles and Fire Control11,317 11,693 11,257 Rotary and Mission Systems16,148 16,789 15,995 Space11,532 11,814 11,880 Total net sales$65,984 $67,044 $65,398 Operating profitAeronautics$2,866 $2,799 $2,843 Missiles and Fire Control1,635 1,648 1,545 Rotary and Mission Systems1,673 1,798 1,615 Space1,045 1,134 1,149 Total business segment operating profit7,219 7,379 7,152 Unallocated items FAS/CAS pension operating adjustment 1,709 1,960 1,876 Severance and other charges (a)(100)(36)(27)Other, net (b)(480)(180)(357)Total unallocated, net1,129 1,744 1,492 Total consolidated operating profit$8,348 $9,123 $8,644 (a)See “Consolidated Results of Operations – Severance and Other Charges” discussion above for information on charges related to certain severance and other actions across our organization.(b)Other, net in 2020 includes a noncash impairment charge of $128 million recognized on our investment in the international equity method investee, Advanced Military Maintenance, Repair and Overhaul Center (AMMROC). (See “Note 1 – Organization and Significant Accounting Policies” included in our Notes to Consolidated Financial Statements for more information).Our business segments’ results of operations include pension expense only as calculated under U.S. Government Cost Accounting Standards (CAS), which we refer to as CAS pension cost. We recover CAS pension and other postretirement benefit plan cost through the pricing of our products and services on U.S. Government contracts and, therefore, recognize CAS pension cost in each of our business segment’s net sales and cost of sales. Our consolidated financial statements must present pension and other postretirement benefit plan (expense) income calculated in accordance with Financial Accounting Standards (FAS) requirements under U.S. GAAP. The operating portion of the total FAS/CAS pension adjustment represents the difference between the service cost component of FAS pension (expense) income and total CAS pension cost. The non-service FAS pension (expense) income components are included in non-service FAS pension (expense) income in our consolidated statements of earnings. As a result, to the extent that CAS pension cost exceeds the service cost component of FAS pension (expense) income, we have a favorable FAS/CAS pension operating adjustment.39Table of Contents The total FAS/CAS pension adjustments, including the service and non-service cost components of FAS pension (expense) income for our qualified defined benefit pension plans, were as follows (in millions):202220212020Total FAS (expense) income and CAS costFAS pension (expense) income$(1,058)$(1,398)$118 Less: CAS pension cost1,796 2,066 1,977 Total FAS/CAS pension adjustment$738 $668 $2,095 Service and non-service cost reconciliationFAS pension service cost$(87)$(106)$(101)Less: CAS pension cost1,796 2,066 1,977 Total FAS/CAS pension operating adjustment1,709 1,960 1,876 Non-service FAS pension (expense) income(971)(1,292)219 Total FAS/CAS pension adjustment$738 $668 $2,095 The total FAS/CAS pension adjustment in 2022 reflects a noncash, non-operating pension settlement charge of $1.5 billion ($1.2 billion, or $4.33 per share, after-tax) recognized in connection with the transfer of $4.3 billion of our gross defined benefit pension obligations and related plan assets to an insurance company in the second quarter of 2022. The total FAS/CAS pension adjustment in 2021 reflects a noncash, non-operating pension settlement charge of $1.7 billion ($1.3 billion, or $4.72 per share, after-tax) recognized in connection with the transfer of $4.9 billion of our gross defined benefit pension obligations and related plan assets to an insurance company in the third quarter of 2021. See “Note 11 – Postretirement Benefit Plans” included in our Notes to Consolidated Financial Statements.The following segment discussions also include information relating to backlog for each segment. Backlog was approximately $150.0 billion and $135.4 billion at December 31, 2022 and 2021. These amounts included both funded backlog (firm orders for which funding has been both authorized and appropriated by the customer) and unfunded backlog (firm orders for which funding has not yet been appropriated). Backlog does not include unexercised options or task orders to be issued under indefinite-delivery, indefinite-quantity contracts. Funded backlog was approximately $95.5 billion at December 31, 2022, as compared to $88.5 billion at December 31, 2021. If any of our contracts with firm orders were to be terminated, our backlog would be reduced by the expected value of the unfilled orders of such contracts.Management evaluates performance on our contracts by focusing on net sales and operating profit and not by type or amount of operating expense. Consequently, our discussion of business segment performance focuses on net sales and operating profit, consistent with our approach for managing the business. This approach is consistent throughout the life cycle of our contracts, as management assesses the bidding of each contract by focusing on net sales and operating profit and monitors performance on our contracts in a similar manner through their completion.We regularly provide customers with reports of our costs as the contract progresses. The cost information in the reports is accumulated in a manner specified by the requirements of each contract. For example, cost data provided to a customer for a product would typically align to the subcomponents of that product (such as a wing-box on an aircraft) and for services would align to the type of work being performed (such as aircraft sustainment). Our contracts generally allow for the recovery of costs in the pricing of our products and services. Most of our contracts are bid and negotiated with our customers under circumstances in which we are required to disclose our estimated total costs to provide the product or service. This approach for negotiating contracts with our U.S. Government customers generally allows for recovery of our actual costs plus a reasonable profit margin. We also may enter into long-term supply contracts for certain materials or components to coincide with the production schedule of certain products and to ensure their availability at known unit prices.Many of our contracts span several years and include highly complex technical requirements. At the outset of a contract, we identify and monitor risks to the achievement of the technical, schedule and cost aspects of the contract and assess the effects of those risks on our estimates of total costs to complete the contract. The estimates consider the technical requirements (e.g., a newly-developed product versus a mature product), the schedule and associated tasks (e.g., the number and type of milestone events) and costs (e.g., material, labor, subcontractor, overhead and the estimated costs to fulfill our industrial cooperation agreements, sometimes referred to as offset agreements, required under certain contracts with international customers). The initial profit booking rate of each contract considers risks surrounding the ability to achieve the technical requirements, schedule and costs in the initial estimated total costs to complete the contract and variable considerations. Profit booking rates may increase during the performance of the contract if we successfully retire risks related to the technical, 40Table of Contents schedule and cost aspects of the contract, which decreases the estimated total costs to complete the contract. Conversely, our profit booking rates may decrease if the estimated total costs to complete the contract increase. All of the estimates are subject to change during the performance of the contract and may affect the profit booking rate. For further discussion on fixed-price contracts, see “Note 1 – Organization and Significant Accounting Policies” included in our Notes to Consolidated Financial Statements.We have a number of programs that are designated as classified by the U.S. Government which cannot be specifically described. The operating results of these classified programs are included in our consolidated and business segment results and are subjected to the same oversight and internal controls as our other programs.Our net sales are primarily derived from long-term contracts for products and services provided to the U.S. Government as well as FMS contracted through the U.S. Government. We recognize revenue as performance obligations are satisfied and the customer obtains control of the products and services. For performance obligations to deliver products with continuous transfer of control to the customer, revenue is recognized based on the extent of progress towards completion of the performance obligation, generally using the percentage-of-completion cost-to-cost measure of progress for our contracts because it best depicts the transfer of control to the customer as we incur costs on our contracts. For performance obligations in which control does not continuously transfer to the customer, we recognize revenue at the point in time in which each performance obligation is fully satisfied.Changes in net sales and operating profit generally are expressed in terms of volume. Changes in volume refer to increases or decreases in sales or operating profit resulting from varying production activity levels, deliveries or service levels on individual contracts. Volume changes in segment operating profit are typically based on the current profit booking rate for a particular contract.In addition, comparability of our segment sales, operating profit and operating margin may be impacted favorably or unfavorably by changes in profit booking rates on our contracts for which we recognize revenue over time using the percentage-of-completion cost-to-cost method to measure progress towards completion. Increases in the profit booking rates, typically referred to as favorable profit adjustments, usually relate to revisions in the estimated total costs to fulfill the performance obligations that reflect improved conditions on a particular contract. Conversely, conditions on a particular contract may deteriorate, resulting in an increase in the estimated total costs to fulfill the performance obligations and a reduction in the profit booking rate and are typically referred to as unfavorable profit adjustments. Increases or decreases in profit booking rates are recognized in the current period they are determined and reflect the inception-to-date effect of such changes. Segment operating profit and margin may also be impacted favorably or unfavorably by other items, which may or may not impact sales. Favorable items may include the positive resolution of contractual matters, cost recoveries on severance and restructuring, insurance recoveries and gains on sales of assets. Unfavorable items may include the adverse resolution of contractual matters; COVID-19 impacts or supply chain disruptions; restructuring charges (except for significant severance actions, which are excluded from segment operating results); reserves for disputes; certain asset impairments; and losses on sales of certain assets.Our consolidated net profit booking rate adjustments increased segment operating profit by approximately $1.8 billion in 2022 and $2.0 billion in 2021. The consolidated net profit booking rate adjustments in 2022 compared to 2021 decreased primarily due to decreases in profit booking rate adjustments at Space, RMS and MFC offset by an increase in Aeronautics. The consolidated net adjustments for 2022 and 2021 are inclusive of approximately $780 million and $900 million in unfavorable items, which include reserves for a classified program at Aeronautics, various programs at RMS and a ground solutions program at Space.We periodically experience performance issues and record losses for certain programs. For further discussion on programs at Aeronautics and RMS, see “Note 1 – Organization and Significant Accounting Policies” included in our Notes to Consolidated Financial Statements for more information.41Table of Contents We have contracted with the Canadian Government for the Canadian Maritime Helicopter Program at our RMS business segment that provide for design, development, and production of CH-148 aircraft (the Original Equipment contract), which is a military variant of the S-92 helicopter, and for logistical support to the fleet (the In Service Support contract) over an extended time period. The program has experienced performance issues, including delays in the final aircraft deliveries from the original contract requirement, and to date the Royal Canadian Air Force’s flight hours have been less than originally anticipated, which has impacted program revenues and the recovery of our costs under this program. Future sales and recovery of existing and future costs under the program are highly dependent upon achieving a certain number of flight hours, which could be adversely impacted by aircraft availability and performance, and the availability of Canadian government resources. We are currently in discussions with the Canadian Government to potentially restructure certain contractual terms and conditions that may be beneficial to both parties. Future performance issues or changes in our estimates due to revised contract scope or customer requirements may affect our ability to recover our costs and may result in a loss that could be material to our operating results.We also have a number of contracts with Türkish industry for the Türkish Utility Helicopter Program (TUHP), which anticipates co-production with Türkish industry for production of T70 helicopters for use in Türkiye, as well as the related provision of Türkish goods and services under buy-back or offset obligations, to include the future sales of helicopters built in Türkiye for sale globally. The U.S. Government has imposed certain sanctions on Türkish entities and persons that has affected our ability to perform under contracts supporting the Türkish Utility Helicopter Program. As a result of the sanctions, we have provided force majeure notices under the affected contracts and these contracts may be restructured or terminated, either in whole or in part, which could result in a further reduction in sales, the imposition of penalties or assessment of damages, and increased unrecoverable costs, which could have an adverse effect on our financial results.Aeronautics Our Aeronautics business segment is engaged in the research, design, development, manufacture, integration, sustainment, support and upgrade of advanced military aircraft, including combat and air mobility aircraft, unmanned air vehicles and related technologies. Aeronautics’ major programs include the F-35 Lightning II, C‑130 Hercules, F-16 Fighting Falcon and F-22 Raptor. Aeronautics’ operating results included the following (in millions): 202220212020Net sales$26,987 $26,748 $26,266 Operating profit2,866 2,799 2,843 Operating margin10.6 %10.5 %10.8 %Backlog at year-end$56,630 $49,118 $56,551 Aeronautics’ net sales in 2022 increased $239 million, or 1%, compared to 2021. Net sales increased by approximately $375 million on classified contracts primarily due to higher volume; about $80 million for the F-22 program due to higher net favorable profit adjustments; and approximately $55 million for the F-16 program due to higher volume on production contracts that was partially offset by lower volume on sustainment contracts and unfavorable profit adjustments on a production contract and modernization contracts. These increases were partially offset by a decrease of about $310 million for the F-35 program due to lower volume and favorable profit adjustments on sustainment and production contracts that were partially offset by higher volume on development contracts.Aeronautics’ operating profit in 2022 increased $67 million, or 2%, compared to 2021. Operating profit increased approximately $145 million on classified contracts primarily due to lower unfavorable profit adjustments on a classified program ($45 million in 2022 compared to $225 million in 2021) that were partially offset by lower favorable profit adjustments; and about $100 million for the F-22 program due to higher net favorable profit adjustments. These increases were partially offset by lower operating profit of approximately $110 million for the F-16 program due to unfavorable profit adjustments in 2022 on a production contract and modernization contracts; and about $80 million for the F-35 program due to lower net favorable profit adjustments on production and sustainment contracts and volume on sustainment contracts. Net favorable profit booking rate adjustments were $30 million higher in 2022 compared to 2021.BacklogBacklog increased in 2022 compared to 2021 primarily due to the delay of F-35 Lot 15 award from 2021 to 2022 and the award of the F-35 Lot 16 contract in December 2022.42Table of Contents Missiles and Fire ControlOur MFC business segment provides air and missile defense systems; tactical missiles and air-to-ground precision strike weapon systems; logistics; fire control systems; mission operations support, readiness, engineering support and integration services; manned and unmanned ground vehicles; and energy management solutions. MFC’s major programs include PAC‑3, THAAD, Multiple Launch Rocket System (MLRS), Hellfire, Joint Air-to-Surface Standoff Missile (JASSM), Apache fire control system, Sniper Advanced Targeting Pod (SNIPER®), Infrared Search and Track (IRST21®) and Special Operations Forces Global Logistics Support Services (SOF GLSS). MFC’s operating results included the following (in millions):202220212020Net sales$11,317 $11,693 $11,257 Operating profit1,635 1,648 1,545 Operating margin14.4 %14.1 %13.7 %Backlog at year-end$28,735 $27,021 $29,183 MFC’s net sales in 2022 decreased $376 million, or 3%, compared to 2021. The decrease was primarily attributable to lower net sales of approximately $280 million for sensors and global sustainment programs due to lower volume on SOF GLSS as a result of changes in mission requirements and lower volume on SNIPER®; and about $60 million for integrated air and missile defense programs due to lower volume (THAAD) and lower net favorable profit adjustments (PAC-3) that were partially offset by higher volume (PAC-3). Net sales for tactical and strike missile programs were comparable as higher volume (PrSM) was offset by lower volume (air dominance weapon systems).MFC’s operating profit in 2022 decreased $13 million, or 1%, compared to 2021. The decrease was primarily attributable to lower operating profit of approximately $85 million for integrated air and missile defense programs due to lower net favorable profit adjustments for the PAC-3 program and an unfavorable profit adjustment of about $40 million on an air and missile defense development program. This decrease was partially offset by an increase of about $50 million for tactical and strike missile programs due to contract mix and higher net favorable profit adjustments (an international tactical and strike missile program and HIMARS) that were partially offset by an unfavorable profit adjustment of about $25 million on an air-to-ground missile program. There also were unfavorable profit adjustments of approximately $25 million on an energy program in 2021 that did not recur in 2022. Operating profit for sensors and global sustainment programs was comparable as both contract mix and the net effect of favorable profit adjustments on an international program in 2022 were offset by the closeout activities related to the Warrior program in 2021 that did not recur in 2022. Net favorable profit booking rate adjustments were $45 million lower in 2022 compared to 2021.BacklogBacklog increased in 2022 compared to 2021 primarily due to higher orders on precision fires (GMLRS) and THAAD programs.Rotary and Mission Systems RMS designs, manufactures, services and supports various military and commercial helicopters, surface ships, sea and land-based missile defense systems, radar systems, sea and air-based mission and combat systems, command and control mission solutions, cyber solutions, and simulation and training solutions. RMS’ major programs include Aegis Combat System, Littoral Combat Ship (LCS), Multi-Mission Surface Combatant (MMSC), Black Hawk and Seahawk helicopters, CH-53K King Stallion heavy lift helicopter, Combat Rescue Helicopter (CRH), VH-92A helicopter, and the C2BMC program. On December 5, 2022, the U.S. Army selected Sikorsky’s competitor in the Future Long Range Assault Aircraft Competition, a component of its Future Vertical Lift initiative to replace a portion of its assault and utility helicopter fleet. On December 28, 2022, Sikorsky, on behalf of Team DEFIANT, filed a protest challenging the U.S. Army’s decision, and a ruling is expected on or before April 7, 2023 based on the 100-day deadline. Sikorsky remains one of two competitors for the other component of the Future Vertical Lift initiative, the Future Attack Reconnaissance Aircraft competition.43Table of Contents RMS’ operating results included the following (in millions):202220212020Net sales$16,148 $16,789 $15,995 Operating profit1,673 1,798 1,615 Operating margin10.4 %10.7 %10.1 %Backlog at year-end$34,949 $33,700 $36,249 RMS’ net sales in 2022 decreased $641 million, or 4%, compared to 2021. The decrease was primarily attributable to lower net sales of approximately $280 million for TLS programs primarily due to the delivery of an international pilot training system in the first quarter of 2021 that did not recur in 2022; about $205 million for various C6ISR programs due to lower volume; and approximately $170 million for Sikorsky helicopter programs due to lower production volume (Black Hawk) that was partially offset by higher production volume (CH-53K).RMS’ operating profit in 2022 decreased $125 million, or 7%, compared to 2021. The decrease was primarily attributable to approximately $70 million for Sikorsky helicopter programs due to lower production volume and net favorable profit adjustments (Black Hawk) that were partially offset by higher net favorable profit adjustments (CRH); about $50 million for various C6ISR programs due to lower net favorable profit adjustments; and approximately $15 million for integrated warfare systems and sensors (IWSS) programs due to lower net favorable profit adjustments (TPQ-53 and Aegis) that were partially offset by $30 million of unfavorable profit adjustments on a ground-based radar program in 2021 that did not recur in 2022. These decreases were partially offset by an increase of approximately $35 million for TLS programs due to higher net favorable profit adjustments that were partially offset by lower volume due to the delivery of an international pilot training system in the first quarter of 2021 that did not recur in 2022. Net favorable profit booking rate adjustments were $65 million lower in 2022 compared to 2021.BacklogBacklog increased in 2022 compared to 2021 primarily due to higher orders on Sikorsky programs.Space Our Space business segment is engaged in the research and design, development, engineering and production of satellites, space transportation systems, and strategic, advanced strike and defensive systems. Space provides network-enabled situational awareness and integrates complex space and ground global systems to help our customers gather, analyze, and securely distribute critical intelligence data. Space is also responsible for various classified systems and services in support of vital national security systems. Space’s major programs include the Trident II D5 Fleet Ballistic Missile (FBM), Orion Multi-Purpose Crew Vehicle (Orion), Space Based Infrared System (SBIRS) and Next Generation Overhead Persistent Infrared (Next Gen OPIR) system, Global Positioning System (GPS) III, hypersonics programs and Next Generation Interceptor (NGI). Operating profit for our Space business segment includes our share of earnings for our investment in ULA, which provides expendable launch services to the U.S. Government and commercial customers. Space’s operating results included the following (in millions):202220212020Net sales$11,532 $11,814 $11,880 Operating profit1,045 1,134 1,149 Operating margin9.1 %9.6 %9.7 %Backlog at year-end$29,684 $25,516 $25,148 Space’s net sales in 2022 decreased $282 million, or 2%, compared to 2021. The decrease was primarily attributable to lower net sales of approximately $885 million due to the renationalization of the AWE program on June 30, 2021, which was no longer included in our financial results beginning in the third quarter of 2021; and about $125 million for commercial civil space programs due to lower volume (Orion). These decreases were partially offset by higher net sales of about $495 million for strategic and missile defense programs due to higher development volume (NGI); and about $245 million for national security space programs due to higher development volume (classified programs).Space’s operating profit in 2022 decreased $89 million, or 8%, compared to 2021. The decrease was primarily attributable to approximately $85 million for national security space programs primarily due to lower net favorable profit adjustments (classified programs and SBIRS) that were partially offset by lower net unfavorable profit adjustments of $25 million on a 44Table of Contents ground solutions program; and about $40 million for commercial civil space programs due to lower net favorable profit adjustments (Human Lander System (HLS)) and lower volume (Orion). These decreases were partially offset by higher equity earnings of approximately $35 million from the company's investment in ULA due to higher launch volume and launch mix; and about $20 million for strategic and missile defense programs due to higher net favorable profit adjustments (primarily NGI). Operating profit for the AWE program was comparable as its operating profit in 2021 was mostly offset by accelerated amortization expense for intangible assets as a result of the renationalization. Net favorable profit booking rate adjustments were $150 million lower in 2022 compared to 2021.Equity earningsTotal equity earnings (primarily ULA) represented approximately $100 million and $65 million, or 10% and 6%, of Space’s operating profit during 2022 and 2021. BacklogBacklog increased in 2022 compared to 2021 primarily due to the exercise of the Orion Production Contract option for Artemis VI-VIII in commercial civil space and contract awards in national security space (Southern Positioning Augmentation Network (SouthPan) and classified).Liquidity and Cash FlowsAs of December 31, 2022, we had cash and cash equivalents of $2.5 billion. Our principal source of liquidity is our cash from operations. However, we also have access to credit markets, if needed, for liquidity or general corporate purposes, including share repurchases. This access includes our $3.0 billion revolving credit facility or the ability to issue commercial paper, and letters of credit to support customer advance payments and for other trade finance purposes such as guaranteeing our performance on particular contracts. We believe our cash and cash equivalents, our expected cash flow generated from operations and our access to credit markets will be sufficient to meet our cash requirements and cash deployment plans over the next twelve months and beyond based on our current business plans.Cash received from customers, either from the payment of invoices for work performed or for advances from non-U.S. government customers in excess of costs incurred, is our primary source of cash from operations. We generally do not begin work on contracts until funding is appropriated by the customer. However, from time to time, we fund customer programs ourselves pending government appropriations. If we incur costs in excess of funds obligated on the contract or in advance of a contract award, this negatively affects our cash flows and we may be at risk for reimbursement of the excess costs.Billing timetables and payment terms on our contracts vary based on a number of factors, including the contract type. We generally bill and collect cash more frequently under cost-reimbursable contracts, which represented approximately 38% of the sales we recorded in 2022, as we are authorized to bill as the costs are incurred. A number of our fixed-price contracts may provide for performance-based payments, which allow us to bill and collect cash as we perform on the contract. The amount of performance-based payments and the related milestones are encompassed in the negotiation of each contract. The timing of such payments may differ from the timing of the costs incurred related to our contract performance, thereby affecting our cash flows.The U.S. Government has indicated that it would consider progress payments as the baseline for negotiating payment terms on fixed-price contracts, rather than performance-based payments. In contrast to negotiated performance-based payment terms, progress payment provisions correspond to a percentage of the amount of costs incurred during the performance of the contract and are invoiced regularly as costs are incurred. Our cash flows may be affected if the U.S. Government changes its payment policies or decides to withhold payments on our billings. While the impact of policy changes or withholding payments may delay the receipt of cash, the cumulative amount of cash collected during the life of the contract should not vary.To date, the effects of COVID-19 have resulted in some negative impacts on our cash flows, partially due to supplier disruptions and delays. The U.S. Government has taken certain actions and enacted legislation to mitigate the impacts of COVID-19 on public health, the economy, state and local governments, individuals, and businesses. Since the pandemic began, Lockheed Martin has remained committed to accelerating payments to the supply chain with a focus on small and at risk businesses. As of December 31, 2022, we have accelerated $1.5 billion of payments to our suppliers that are due by their terms in future periods. We will continue to monitor supply chain risks, especially at small and at-risk related suppliers, and may continue to utilize accelerated payments in 2023 on an as needed basis. In addition, we have a balanced cash deployment strategy to invest in our business and key technologies to provide our customers with enhanced capabilities, enhance stockholder value, and position ourselves to take advantage of new business 45Table of Contents opportunities when they arise. Consistent with that strategy, we have continued to invest in our business and technologies through capital expenditures, independent research and development, and selective business acquisitions and investments. We have returned cash to stockholders through dividends and share repurchases. On October 17, 2022, the Board of Directors authorized an additional $14.0 billion to the program. During the fourth quarter of 2022, we entered into an accelerated share repurchase (ASR) agreement to repurchase $4.0 billion of our common stock and issued $4.0 billion of senior unsecured notes. As of December 31, 2022, the total remaining authorization for future common share repurchases under our program was $10.0 billion, which is expected to be utilized over a three-year period. We expect to fund the repurchases through a combination of cash from operations and the issuance of additional debt. The stock repurchase program does not have an expiration date and may be amended or terminated by the Board of Directors at any time. The amount of shares ultimately purchased and the timing of purchases are at the discretion of management and subject to compliance with applicable law and regulation.We continue to actively manage our debt levels, including maturities and interest rates, as evidenced by the debt transaction in the second quarter of 2022, the proceeds of which were used to refinance certain upcoming debt maturities between 2023 and 2026. We also actively manage our pension obligations and expect to continue to opportunistically manage our pension liabilities through the purchase of group annuity contracts for portions of our outstanding defined benefit pension obligations using assets from the pension trust as we did in the second quarter of 2022. See “Note 11 – Postretirement Benefit Plans” included in our Notes to Consolidated Financial Statements for additional information. Future pension risk transfer transactions could also be significant and result in us making additional contributions to the pension trust.The following table provides a summary of our cash flow information followed by a discussion of the key elements (in millions): 202220212020Cash and cash equivalents at beginning of year$3,604 $3,160 $1,514 Operating activitiesNet earnings5,732 6,315 6,833 Noncash adjustments2,455 3,109 1,726 Changes in working capital(733)9 101 Other, net348 (212)(477)Net cash provided by operating activities7,802 9,221 8,183 Net cash used for investing activities(1,789)(1,161)(2,010)Net cash used for financing activities(7,070)(7,616)(4,527)Net change in cash and cash equivalents(1,057)444 1,646 Cash and cash equivalents at end of year$2,547 $3,604 $3,160 Operating ActivitiesNet cash provided by operating activities decreased $1.4 billion in 2022 compared to 2021. The decrease was primarily attributable to lower cash at Aeronautics, MFC and RMS. The decrease at Aeronautics was primarily due to timing of production and billing cycles impacting contract assets (primarily F-35). The decrease at MFC was primarily due to timing of accounts receivables collections. The decrease at RMS was primarily due to liquidation of inventories (primarily TLS and Sikorsky helicopter programs) in 2021 that did not recur in 2022. As of December 31, 2022, we accelerated $1.5 billion of payments to suppliers that were due in the first quarter of 2023, compared to $2.2 billion of payments to suppliers as of December 31, 2021 that were due in the first quarter of 2022. Our federal and foreign income tax payments, net of refunds, were $1.6 billion in 2022, compared to $1.4 billion in 2021.Non-GAAP Financial Measure - Free Cash FlowFree cash flow is a non-GAAP financial measure that we define as cash from operations less capital expenditures. Our capital expenditures are comprised of equipment and facilities infrastructure and information technology (inclusive of costs for the development or purchase of internal-use software that are capitalized). We use free cash flow to evaluate our business performance and overall liquidity, as well as a performance goal in our annual and long-term incentive plans. We believe free cash flow is a useful measure for investors because it represents the amount of cash generated from operations after reinvesting in the business and that may be available to return to stockholders and creditors (through dividends, stock repurchases and debt repayments) or available to fund acquisitions and other investments. The entire amount of free cash flow is not necessarily available for discretionary expenditures, however, because it does not account for certain mandatory expenditures, such as the 46Table of Contents repayment of maturing debt and pension contributions. While management believes that free cash flow as a non-GAAP financial measure may be useful in evaluating our financial performance, it should be considered supplemental to, and not a substitute for, financial information prepared in accordance with GAAP and may not be comparable to similarly titled measures used by other companies.The following table reconciles net cash provided by operating activities to free cash flow (in millions):202220212020Cash from operations$7,802 $9,221 $8,183 Capital expenditures(1,670)(1,522)(1,766)Free cash flow$6,132 $7,699 $6,417 Investing ActivitiesCash flows related to investing activities primarily include capital expenditures and payments for acquisitions and divestitures of businesses and investments. The majority of our capital expenditures are for equipment and facilities infrastructure that generally are incurred to support new and existing programs across all of our business segments. We also incur capital expenditures for information technology to support programs and general enterprise information technology infrastructure, inclusive of costs for the development or purchase of internal-use software.Net cash used for investing activities increased $628 million in 2022 compared to 2021. The increase in cash used for investing activities is due to an increase in capital expenditures and the receipt of $307 million in 2021 from the sale of our ownership interest in the Advanced Military Maintenance, Repair and Overhaul Center (AMMROC) joint venture. Capital expenditures totaled $1.7 billion and $1.5 billion in 2022 and 2021.Financing ActivitiesNet cash used for financing activities decreased $546 million in 2022 compared to 2021, primarily due to repayment of $500 million of long-term notes in 2021. We paid dividends totaling $3.0 billion ($11.40 per share) in 2022 and $2.9 billion ($10.60 per share) in 2021. We paid quarterly dividends of $2.80 per share during each of the first three quarters of 2022 and $3.00 per share during the fourth quarter of 2022. We paid quarterly dividends of $2.60 per share during each of the first three quarters of 2021 and $2.80 per share during the fourth quarter of 2021.During 2022, we paid $7.9 billion to repurchase 18.3 million shares of our common stock. See “Note 12 – Stockholders’ Equity” included in our Notes to Consolidated Financial Statements for additional information. During 2021, we paid $4.1 billion to repurchase 11.7 million shares of our common stock.In October 2022, we received net proceeds of $3.9 billion from issuance of senior unsecured notes and used the net proceeds from the offering to enter into an ASR agreement to repurchase $4.0 billion of our common stock. See “Note 10 – Debt” included in our Notes to Consolidated Financial Statements for additional information.In May 2022, we received net proceeds of $2.3 billion from issuance of senior unsecured notes and used the net proceeds from the offering to redeem all of the outstanding $500 million Notes due 2023, $750 million Notes due 2025 and used the remaining balance of the net proceeds to redeem $1.0 billion of our outstanding $2.0 billion Notes due 2026.In September 2021, we repaid $500 million of long-term notes with a fixed interest rate of 3.35% according to their scheduled maturities.Capital Structure, Resources and OtherAt December 31, 2022, we held cash and cash equivalents of $2.5 billion that were generally available to fund ordinary business operations without significant legal, regulatory, or other restrictions.Our outstanding debt, net of unamortized discounts and issuance costs, was $15.5 billion as of December 31, 2022 and is in the form of publicly-issued notes that bear interest at fixed rates. As of December 31, 2022, we were in compliance with all covenants contained in our debt and credit agreements. See “Note 10 – Debt” included in our Notes to Consolidated Financial Statements for more information on our long-term debt and revolving credit facilities.47Table of Contents We actively seek to finance our business in a manner that preserves financial flexibility while minimizing borrowing costs to the extent practicable. We review changes in financial market and economic conditions to manage the types, amounts and maturities of our indebtedness. We may at times refinance existing indebtedness, vary our mix of variable-rate and fixed-rate debt or seek alternative financing sources for our cash and operational needs.Long-Term DebtOn October 24, 2022, we issued a total of $4.0 billion of senior unsecured notes, consisting of $500 million aggregate principal amount of 4.95% Notes due 2025 (the “2025 Notes”), $750 million aggregate principal amount of 5.10% Notes due 2027 (the “2027 Notes”), $1.0 billion aggregate principal amount of 5.25% Notes due 2033 (the “2033 Notes”), $1.0 billion aggregate principal amount of 5.70% Notes due 2054 (the “2054 Notes”) and $750 million aggregate principal amount of 5.90% Notes due 2063 (the “2063 Notes” and, together with the 2025 Notes, the 2027 Notes, the 2033 Notes and the 2054 Notes, the “October 2022 Notes”). We will pay interest on the 2025 Notes semi-annually in arrears on April 15 and October 15 of each year, beginning on April 15, 2023. We will pay interest on the 2033 Notes semi-annually in arrears on January 15 and July 15 of each year, beginning on January 15, 2023. We will pay interest on each of 2027 Notes, 2054 Notes and 2063 Notes semi-annually in arrears on May 15 and November 15 of each year, beginning on May 15, 2023. We may, at our option, redeem the October 2022 Notes of any series, in whole or in part, at any time at the redemption prices equal to the greater of 100% of the principal amount of the Notes to be redeemed or an applicable “make-whole” amount, plus accrued and unpaid interest to the date of redemption. On May 5, 2022, we issued a total of $2.3 billion of senior unsecured notes, consisting of $800 million aggregate principal amount of 3.90% Notes due June 15, 2032 (the “2032 Notes”), $850 million aggregate principal amount of 4.15% Notes due June 15, 2053 (the “2053 Notes”) and $650 million aggregate principal amount of 4.30% Notes due June 15, 2062 (the “2062 Notes” and, together with the 2032 Notes and 2053 Notes, the “May 2022 Notes”) in a registered public offering. Net proceeds received from the offering were, after deducting pricing discounts and debt issuance costs, which are being amortized and recorded as interest expense over the term of the May 2022 Notes. We will pay interest on the May 2022 Notes semi-annually in arrears on June 15 and December 15 of each year with the first payment made on June 15, 2022. We may, at our option, redeem the May 2022 Notes of any series, in whole or in part, at any time and from time to time, at a redemption price equal to the greater of 100% of the principal amount of the May 2022 Notes to be redeemed or an applicable make-whole amount, plus accrued and unpaid interest to the date of redemption.On May 11, 2022, we used the net proceeds from the May 2022 Notes to redeem all of the outstanding $500 million in aggregate principal amount of our 3.10% Notes due 2023, $750 million in aggregate principal amount of our 2.90% Notes due 2025, and $1.0 billion of our outstanding $2.0 billion in aggregate principal amount of our 3.55% Notes due 2026 at their redemption price. We paid make-whole premiums of $13.9 million in connection with the early extinguishments of debt. We incurred losses of $34 million ($26 million, or $0.10 per share, after tax) on these transactions related to early extinguishments of debt, additional interest expense and other related charges, which was recorded in other non-operating (expense) income, net in our consolidated statements of earnings.48Table of Contents Contractual Commitments At December 31, 2022, we had contractual commitments to repay debt, make payments under operating leases, settle obligations related to agreements to purchase goods and services and settle tax and other liabilities. Financing lease obligations were not material. Payments due under these obligations and commitments are as follows (in millions):TotalDue Within 1 YearTotal debt$16,842 $118 Interest payments15,028 768 Other liabilities 3,520 222 Operating lease obligations1,342 327 Purchase obligations:Operating activities59,101 27,925 Capital expenditures671 472 Total contractual cash obligations$96,504 $29,832 The table above includes debt presented gross of any unamortized discounts and issuance costs, but excludes the net unfunded obligation and estimated minimum funding requirements related to our qualified defined benefit pension plans. For additional information about obligations and our future minimum contribution requirements for these plans, see “Note 11 – Postretirement Benefit Plans” included in our Notes to Consolidated Financial Statements. Amounts related to other liabilities represent the contractual obligations for certain long-term liabilities recorded as of December 31, 2022. Such amounts mainly include expected payments under non-qualified pension plans, environmental liabilities and deferred compensation plans. Purchase obligations related to operating activities include agreements and contracts that give the supplier recourse to us for cancellation or nonperformance under the contract or contain terms that would subject us to liquidated damages. Such agreements and contracts may, for example, be related to direct materials, obligations to subcontractors and outsourcing arrangements. Total purchase obligations for operating activities in the preceding table include approximately $53.7 billion related to contractual commitments entered into as a result of contracts we have with our U.S. Government customers. The U.S. Government generally would be required to pay us for any costs we incur relative to these commitments if they were to terminate the related contracts “for convenience” under the FAR, subject to available funding. This also would be true in cases where we perform subcontract work for a prime contractor under a U.S. Government contract. The termination for convenience language also may be included in contracts with foreign, state and local governments. We also have contracts with customers that do not include termination for convenience provisions, including contracts with commercial customers. The majority of our capital expenditures for 2022 and those planned for 2023 are for equipment, facilities infrastructure and information technology. The amounts above in the table represent the portion of expected capital expenditures to be incurred in 2023 and beyond that have been obligated under contracts as of December 31, 2022 and not necessarily total capital expenditures for future periods. Expenditures for equipment and facilities infrastructure are generally incurred to support new and existing programs across all of our business segments. For example, we have projects underway at Aeronautics to support classified development programs and at RMS to support our Sikorsky helicopter programs; and we have projects underway to modernize certain of our facilities. We also incur capital expenditures for information technology to support programs and general enterprise information technology infrastructure, inclusive of costs for the development or purchase of internal-use software.We also may enter into industrial cooperation agreements, sometimes referred to as offset agreements, as a condition to obtaining orders for our products and services from certain customers in foreign countries. These agreements are designed to enhance the social and economic environment of the foreign country by requiring the contractor to promote investment in the country. Offset agreements may be satisfied through activities that do not require us to use cash, including transferring technology, providing manufacturing and other consulting support to in-country projects and the purchase by third parties (e.g., our vendors) of supplies from in-country vendors. These agreements also may be satisfied through our use of cash for such activities as purchasing supplies from in-country vendors, providing financial support for in-country projects, establishment of joint ventures with local companies and building or leasing facilities for in-country operations. We typically do not commit to offset agreements until orders for our products or services are definitive. The amounts ultimately applied against our offset agreements are based on negotiations with the customer and typically require cash outlays that represent only a fraction of the original amount in the offset agreement. Satisfaction of our offset obligations are included in the estimates of our total costs to complete the contract and may impact our sales, profitability and cash flows. Our ability to recover investments on our consolidated balance sheet that we make to satisfy offset obligations is generally dependent upon the successful operation of 49Table of Contents ventures that we do not control and may involve products and services that are dissimilar to our business activities. At December 31, 2022, the notional value of remaining obligations under our outstanding offset agreements totaled approximately $16.1 billion, which primarily relate to our Aeronautics, MFC and RMS business segments, most of which extend through 2044. To the extent we have entered into purchase or other obligations at December 31, 2022 that also satisfy offset agreements, those amounts are included in the contractual commitments table above. Offset programs usually extend over several years and may provide for penalties, estimated at approximately $1.8 billion at December 31, 2022, in the event we fail to perform in accordance with offset requirements. While historically we have not been required to pay material penalties, resolution of offset requirements are often the result of negotiations and subjective judgments.We have entered into standby letters of credit and surety bonds issued on our behalf by financial institutions, and we have directly issued guarantees to third parties primarily relating to advances received from customers and the guarantee of future performance on certain contracts. Letters of credit and surety bonds generally are available for draw down in the event we do not perform. In some cases, we may guarantee the contractual performance of third parties such as joint venture partners. At December 31, 2022, we had the following outstanding letters of credit, surety bonds and third-party guarantees (in millions): Total CommitmentLess Than1 Year Standby letters of credit (a)$2,504 $966 Surety bonds342 342 Third-party Guarantees904 230 Total commitments$3,750 $1,538 (a)Approximately $704 million of standby letters of credit in the “Less Than 1 Year” category are expected to renew for additional periods until completion of the contractual obligation.At December 31, 2022, third-party guarantees totaled $904 million, of which approximately 71% related to guarantees of contractual performance of joint ventures to which we currently are or previously were a party. These amounts represent our estimate of the maximum amounts we would expect to incur upon the contractual non-performance of the joint venture, joint venture partners or divested businesses. Generally, we also have cross-indemnities in place that may enable us to recover amounts that may be paid on behalf of a joint venture partner.In determining our exposures, we evaluate the reputation, performance on contractual obligations, technical capabilities and credit quality of our current and former joint venture partners and the transferee under novation agreements, all of which include a guarantee as required by the FAR. At December 31, 2022 and 2021, there were no material amounts recorded in our financial statements related to third-party guarantees or novation agreements.Critical Accounting PoliciesContract Accounting / Sales RecognitionThe majority of our net sales are generated from long-term contracts with the U.S. Government and international customers (including FMS contracted through the U.S. Government) for the research, design, development, manufacture, integration and sustainment of advanced technology systems, products and services. We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. For certain contracts that meet the foregoing requirements, primarily international direct commercial sale contracts, we are required to obtain certain regulatory approvals. In these cases, we recognize revenue when it is probable that we will receive regulatory approvals based upon all known facts and circumstances. We provide our products and services under fixed-price and cost-reimbursable contracts.Under fixed-price contracts, we agree to perform the specified work for a pre-determined price. To the extent our actual costs vary from the estimates upon which the price was negotiated, we will generate more or less profit or could incur a loss. Some fixed-price contracts have a performance-based component under which we may earn incentive payments or incur financial penalties based on our performance.Cost-reimbursable contracts provide for the payment of allowable costs incurred during performance of the contract plus a fee up to a ceiling based on the amount that has been funded. Typically, we enter into three types of cost-reimbursable contracts: cost-plus-award-fee, cost-plus-incentive-fee, and cost-plus-fixed-fee. Cost-plus-award-fee contracts provide for an award fee that varies within specified limits based on the customer’s assessment of our performance against a predetermined set of criteria, such as targets based on cost, quality, technical and schedule criteria. Cost-plus-incentive-fee contracts provide for reimbursement of costs plus a fee, which is adjusted by a formula based on the relationship of total allowable costs to total target costs (i.e., incentive based on cost) or reimbursement of costs plus an incentive to exceed stated performance targets (i.e., 50Table of Contents incentive based on performance). Cost-plus-fixed-fee contracts provide a fixed fee that is negotiated at the inception of the contract and does not vary with actual costs.We assess each contract at its inception to determine whether it should be combined with other contracts. When making this determination, we consider factors such as whether two or more contracts were negotiated and executed at or near the same time or were negotiated with an overall profit objective. If combined, we treat the combined contracts as a single contract for revenue recognition purposes.We evaluate the products or services promised in each contract at inception to determine whether the contract should be accounted for as having one or more performance obligations. The products and services in our contracts are typically not distinct from one another due to their complex relationships and the significant contract management functions required to perform under the contract. Accordingly, our contracts are typically accounted for as one performance obligation. In limited cases, our contracts have more than one distinct performance obligation, which occurs when we perform activities that are not highly complex or interrelated or involve different product lifecycles. Significant judgment is required in determining performance obligations, and these decisions could change the amount of revenue and profit recorded in a given period. We classify net sales as products or services on our consolidated statements of earnings based on the predominant attributes of the performance obligations.We determine the transaction price for each contract based on the consideration we expect to receive for the products or services being provided under the contract. For contracts where a portion of the price may vary (e.g. awards, incentive fees and claims), we estimate variable consideration at the most likely amount, which is included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur. We analyze the risk of a significant revenue reversal and if necessary constrain the amount of variable consideration recognized in order to mitigate this risk.At the inception of a contract we estimate the transaction price based on our current rights and do not contemplate future modifications (including unexercised options) or follow-on contracts until they become legally enforceable. Contracts are often subsequently modified to include changes in specifications, requirements or price, which may create new or change existing enforceable rights and obligations. Depending on the nature of the modification, we consider whether to account for the modification as an adjustment to the existing contract or as a separate contract. Generally, modifications to our contracts are not distinct from the existing contract due to the significant integration and interrelated tasks provided in the context of the contract. Therefore, such modifications are accounted for as if they were part of the existing contract and recognized as a cumulative adjustment to revenue. For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation based on the estimated standalone selling price of the product or service underlying each performance obligation. The standalone selling price represents the amount we would sell the product or service to a customer on a standalone basis (i.e., not bundled with any other products or services). Our contracts with the U.S. Government, including FMS contracts, are subject to FAR and the price is typically based on estimated or actual costs plus a reasonable profit margin. As a result of these regulations, the standalone selling price of products or services in our contracts with the U.S. Government and FMS contracts are typically equal to the selling price stated in the contract.For non-U.S. Government contracts with multiple performance obligations, we evaluate whether the stated selling prices for the products or services represent their standalone selling prices. We primarily sell customized solutions unique to a customer’s specifications. When it is necessary to allocate the transaction price to multiple performance obligations, we typically use the expected cost plus a reasonable profit margin to estimate the standalone selling price of each product or service. We occasionally sell standard products or services with observable standalone sales transactions. In these situations, the observable standalone sales transactions are used to determine the standalone selling price.We recognize revenue as performance obligations are satisfied and the customer obtains control of the products and services. In determining when performance obligations are satisfied, we consider factors such as contract terms, payment terms and whether there is an alternative future use of the product or service. Substantially all of our revenue is recognized over time as we perform under the contract because control of the work in process transfers continuously to the customer. For most contracts with the U.S. Government and FMS contracts, this continuous transfer of control of the work in process to the customer is supported by clauses in the contract that give the customer ownership of work in process and allow the customer to unilaterally terminate the contract for convenience and pay us for costs incurred plus a reasonable profit. For most non-U.S. Government contracts, primarily international direct commercial contracts, continuous transfer of control to our customer is supported because we deliver products that do not have an alternative use to us and if our customer were to terminate the contract for reasons other than our non-performance we would have the right to recover damages which would include, among other potential damages, the right to payment for our work performed to date plus a reasonable profit.51Table of Contents For performance obligations to deliver products with continuous transfer of control to the customer, revenue is recognized based on the extent of progress towards completion of the performance obligation, generally using the percentage-of-completion cost-to-cost measure of progress for our contracts because it best depicts the transfer of control to the customer as we incur costs on our contracts. Under the percentage-of-completion cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs to complete the performance obligation(s). For performance obligations to provide services to the customer, revenue is recognized over time based on costs incurred or the right to invoice method (in situations where the value transferred matches our billing rights) as our customer receives and consumes the benefits.For performance obligations in which control does not continuously transfer to the customer, we recognize revenue at the point in time in which each performance obligation is fully satisfied. This coincides with the point in time the customer obtains control of the product or service, which typically occurs upon customer acceptance or receipt of the product or service, given that we maintain control of the product or service until that point.Significant estimates and assumptions are made in estimating contract sales, costs, and profit. We estimate profit as the difference between estimated revenues and total estimated costs to complete the contract. At the outset of a long-term contract, we identify and monitor risks to the achievement of the technical, schedule and cost aspects of the contract, as well as our ability to earn variable consideration, and assess the effects of those risks on our estimates of sales and total costs to complete the contract. The estimates consider the technical requirements (e.g., a newly-developed product versus a mature product), the schedule and associated tasks (e.g., the number and type of milestone events) and costs (e.g., material, labor, subcontractor, overhead, general and administrative and the estimated costs to fulfill our industrial cooperation agreements, sometimes referred to as offset or localization agreements, required under certain contracts with international customers). The initial profit booking rate of each contract considers risks surrounding the ability to achieve the technical requirements, schedule and costs in the initial estimated total costs to complete the contract. Profit booking rates may increase during the performance of the contract if we successfully retire risks related to technical, schedule and cost aspects of the contract, which decreases the estimated total costs to complete the contract or may increase the variable consideration we expect to receive on the contract. Conversely, our profit booking rates may decrease if the estimated total costs to complete the contract increase or our estimates of variable consideration we expect to receive decrease. All of the estimates are subject to change during the performance of the contract and may affect the profit booking rate. When estimates of total costs to be incurred on a contract exceed total estimates of the transaction price, a provision for the entire loss is determined at the contract level and is recorded in the period in which the loss is evident, which we refer to as a reach-forward loss.Comparability of our segment sales, operating profit and operating margin may be impacted favorably or unfavorably by changes in profit booking rates on our contracts for which we recognize revenue over time using the percentage-of-completion cost-to-cost method to measure progress towards completion. Increases in the profit booking rates, typically referred to as favorable profit adjustments, usually relate to revisions in the estimated total costs to fulfill the performance obligations that reflect improved conditions on a particular contract. Conversely, conditions on a particular contract may deteriorate, resulting in an increase in the estimated total costs to fulfill the performance obligations and a reduction in the profit booking rate and are typically referred to as unfavorable profit adjustments. Increases or decreases in profit booking rates are recognized in the current period they are determined and reflect the inception-to-date effect of such changes. Segment operating profit and margin may also be impacted favorably or unfavorably by other items, which may or may not impact sales. Favorable items may include the positive resolution of contractual matters, cost recoveries on severance and restructuring, insurance recoveries and gains on sales of assets. Unfavorable items may include the adverse resolution of contractual matters; COVID-19 impacts or supply chain disruptions; restructuring charges (except for significant severance actions, which are excluded from segment operating results); reserves for disputes; certain asset impairments; and losses on sales of certain assets.Other Contract Accounting ConsiderationsThe majority of our sales are driven by pricing based on costs incurred to produce products or perform services under contracts with the U.S. Government. Cost-based pricing is determined under the FAR. The FAR provides guidance on the types of costs that are allowable in establishing prices for goods and services under U.S. Government contracts. For example, costs such as those related to charitable contributions, interest expense and certain advertising and public relations activities are unallowable and, therefore, not recoverable through sales. In addition, we may enter into advance agreements with the U.S. Government that address the subjects of allowability and allocability of costs to contracts for specific matters. For example, most of the environmental costs we incur for environmental remediation related to sites operated in prior years are allocated to our current operations as general and administrative costs under FAR provisions and supporting advance agreements reached with the U.S. Government.52Table of Contents We closely monitor compliance with and the consistent application of our critical accounting policies related to contract accounting. Costs incurred and allocated to contracts are reviewed for compliance with U.S. Government regulations by our personnel and are subject to audit by the Defense Contract Audit Agency.Postretirement Benefit PlansOverviewMany of our employees and retirees participate in qualified and nonqualified defined benefit pension plans, retiree medical and life insurance plans and other postemployment plans (collectively, postretirement benefit plans - see “Note 11 – Postretirement Benefit Plans” included in our Notes to Consolidated Financial Statements). The majority of our accrued benefit obligations relate to our qualified defined benefit pension and retiree medical and life insurance plans. We recognize on a plan-by-plan basis the net funded status of these postretirement benefit plans under GAAP as either an asset or a liability on our consolidated balance sheets. The GAAP funded status represents the difference between the fair value of each plan’s assets and the benefit obligation of the plan. The GAAP benefit obligation represents the present value of the estimated future benefits we currently expect to pay to plan participants based on past service. The qualified defined benefit pension plans for salaried employees are fully frozen effective January 1, 2020 and our salaried employees participate in an enhanced defined contribution retirement savings plan.Similar to recent years, we continue to take actions to mitigate the effect of our defined benefit pension plans on our financial results by reducing the volatility of our pension obligations, including entering into pension risk transfer transactions involving the purchase of group annuity contracts (GACs) for portions of our outstanding defined benefit pension obligations using assets from the pension trust. During the second quarter of 2022, we purchased GACs to transfer $4.3 billion of gross defined benefit pension obligations and related plan assets to an insurance company for approximately 13,600 U.S. retirees and beneficiaries. The GACs were purchased using assets from Lockheed Martin’s master retirement trust and no additional funding contribution was required. In connection with this transaction, we recognized a noncash, non-operating pension settlement charge of $1.5 billion ($1.2 billion, or $4.33 per share, after-tax) for the affected defined benefit pension plans in the quarter ended June 26, 2022, which represents the accelerated recognition of actuarial losses that were included in the accumulated other comprehensive loss account within stockholders’ equity. Similarly, in the third quarter of 2021, we purchased GACs to transfer $4.9 billion of gross defined benefit pension obligations and related plan assets to an insurance company for approximately 18,000 U.S. retirees and beneficiaries. In connection with this transaction, we recognized a noncash pension settlement charge of $1.7 billion ($1.3 billion, or $4.72 per share, after tax) during the third quarter of 2021. Inclusive of the transactions described above, since December 2018, Lockheed Martin, through its master retirement trust, has purchased total contracts for approximately $15.9 billion related to our outstanding defined benefit pension obligations eliminating pension plan volatility for approximately 109,000 retirees and beneficiaries and annually required Pension Benefit Guarantee Corporation (PBGC) premiums of approximately $79 million per year.We expect to continue to look for opportunities to manage our pension liabilities through additional pension risk transfer transactions in future years. Future transactions could result in a noncash settlement charge to earnings, which could be material to a reporting period.Notwithstanding these actions, the impact of our postretirement benefit plans on our earnings may be volatile in that the amount of expense we record and the funded status for our postretirement benefit plans may materially change from year to year because the calculations are sensitive to changes in several key economic assumptions, including interest rates, actual rates of return on plan assets and other actuarial assumptions including participant longevity, as well as the timing of cash funding.Actuarial AssumptionsThe benefit obligations and assets of our postretirement benefit plans are measured at the end of each year, or more frequently, upon the occurrence of certain events such as a significant plan amendment (including in connection with a pension risk transfer transaction), settlement, or curtailment. The amounts we record are measured using actuarial valuations, which are dependent upon key assumptions such as discount rates, the expected long-term rate of return on plan assets and participant longevity. The assumptions we make affect both the calculation of the benefit obligations as of the measurement date and the calculation of FAS expense in subsequent periods. When reassessing these assumptions, we consider past and current market conditions and make judgments about future market trends. We also consider factors such as the timing and amounts of expected contributions to the plans and benefit payments to plan participants.We continue to use a single weighted average discount rate approach when calculating our consolidated benefit obligations related to our defined benefit pension plans resulting in 5.250% at December 31, 2022, compared to 2.875% at December 31, 53Table of Contents 2021. We utilized a single weighted average discount rate of 5.25% when calculating our benefit obligations related to our retiree medical and life insurance plans at December 31, 2022, compared to 2.75% at December 31, 2021. We evaluate several data points in order to arrive at an appropriate single weighted average discount rate, including results from cash flow models, quoted rates from long-term bond indices and changes in long-term bond rates over the past year. As part of our evaluation, we calculate the approximate average yields on corporate bonds rated AA or better selected to match our projected postretirement benefit plan cash flows. The increase in the discount rate from December 31, 2021 to December 31, 2022 resulted in a decrease in the projected benefit obligations of our qualified defined benefit pension plans of approximately $10.2 billion at December 31, 2022.We utilized an expected long-term rate of return on plan assets of 6.50% at both December 31, 2022 and December 31, 2021. The long-term rate of return assumption represents the expected long-term rate of return on the funds invested or to be invested, to provide for the benefits included in the benefit obligations. This assumption is based on several factors including historical market index returns, the anticipated long-term allocation of plan assets, the historical return data for the trust funds, plan expenses and the potential to outperform market index returns. The difference between the long-term rate of return on plan assets assumption we select and the actual return on plan assets in any given year affects both the funded status of our benefit plans and the calculation of FAS pension expense in subsequent periods. Although the actual return in any specific year likely will differ from the assumption, the average expected return over a long-term future horizon should be approximately equal to the assumption. Any variance each year should not, by itself, suggest that the assumption should be changed. Patterns of variances are reviewed over time, and then combined with expectations for the future. As a result, changes in this assumption are less frequent than changes in the discount rate. The actual investment return for our qualified defined benefit plans during 2022 of $(5.9) billion, based on an actual rate of approximately (18)%, reduced plan assets more than the $1.9 billion expected return based on our long-term rate of return assumption.Our stockholders’ equity has been reduced cumulatively by $7.9 billion from the annual year-end measurements of the funded status of postretirement benefit plans. The cumulative noncash, after-tax reduction primarily represents net actuarial losses resulting from changes in discount rates, investment experience, and updated longevity. A market-related value of our plan assets, determined using actual asset gains or losses over the prior three-year period, is used to calculate the amount of deferred asset gains or losses to be amortized. These cumulative actuarial losses will be amortized to expense using the corridor method, where gains and losses are recognized to the extent they exceed 10% of the greater of plan assets or benefit obligations, over an average period of approximately twenty years as of December 31, 2022. During 2022, $1.2 billion of these amounts, along with amortization of net prior service credit, were recognized as a component of postretirement benefit plans expense inclusive of the noncash pension settlement charge of $1.2 billion. The discount rate and long-term rate of return on plan assets assumptions we select at the end of each year are based on our best estimates and judgment. A change of plus or minus 25 basis points in the 5.25% discount rate assumption at December 31, 2022, with all other assumptions held constant, would have decreased or increased the amount of the qualified pension benefit obligation we recorded at the end of 2022 by approximately $800 million, which would result in an after-tax increase or decrease in stockholders’ equity at the end of the year of approximately $600 million. If the 5.25% discount rate at December 31, 2022 that was used to compute the expected 2023 FAS pension income for our qualified defined benefit pension plans had been 25 basis points higher or lower, with all other assumptions held constant, the amount of FAS pension income projected for 2023 would change approximately $5 million. If the 6.50% expected long-term rate of return on plan assets assumption at December 31, 2022 that was used to compute the expected 2023 FAS pension income for our qualified defined benefit pension plans had been 25 basis points higher or lower, with all other assumptions held constant, the amount of FAS pension income projected for 2023 would be higher or lower by approximately $65 million. Each year, differences between the actual and expected long-term rate of return on plan assets impacts the measurement of the following year’s FAS pension income. Every 100 basis points increase (decrease) in return during 2022 between our actual rate of return of approximately (18)% and our expected long-term rate of return increased (decreased) 2023 expected FAS pension income by approximately $10 million.Funding ConsiderationsWe made no contributions in 2022 and 2021 to our qualified defined benefit pension plans. Funding of our qualified defined benefit pension plans is determined in a manner consistent with CAS and in accordance with the Employee Retirement Income Security Act of 1974 (ERISA), as amended, along with consideration of CAS and Internal Revenue Code rules. Our goal has been to fund the pension plans to a level of at least 80%, as determined in accordance with ERISA. The ERISA funded status of our qualified defined benefit pension plans was approximately 82% and 92% as of December 31, 2022 and 2021; which is calculated on a different basis than under GAAP and reflects the impact of the American Rescue Plan Act of 2021.Contributions to our defined benefit pension plans are recovered over time through the pricing of our products and services on U.S. Government contracts, including FMS, and are recognized in our cost of sales and net sales. CAS govern the extent to 54Table of Contents which our pension costs are allocable to and recoverable under contracts with the U.S. Government, including FMS. Pension cost recoveries under CAS occur in different periods from when pension contributions are made in accordance with ERISA.We recovered $1.8 billion in 2022 and $2.1 billion in 2021 as CAS pension costs. Amounts contributed in excess of the CAS pension costs recovered under U.S. Government contracts are considered to be prepayment credits under the CAS rules. Our prepayment credits were approximately $4.3 billion and $7.0 billion at December 31, 2022 and 2021. The prepayment credit balance will increase or decrease based on our actual investment return on plan assets.Environmental MattersWe are a party to various agreements, proceedings and potential proceedings for environmental remediation issues, including matters at various sites where we have been designated a potentially responsible party (PRP). At December 31, 2022 and 2021, the total amount of liabilities recorded on our consolidated balance sheet for environmental matters was $696 million and $742 million. We have recorded assets totaling $618 million and $645 million at December 31, 2022 and 2021 for the portion of environmental costs that are probable of future recovery in pricing of our products and services for agencies of the U.S. Government, as discussed below. The amount that is expected to be allocated to our non-U.S. Government contracts or that is determined to not be recoverable under U.S. Government contracts is expensed through cost of sales. We project costs and recovery of costs over approximately 20 years.We enter into agreements (e.g., administrative consent orders, consent decrees) that document the extent and timing of some of our environmental remediation obligations. We also are involved in environmental remediation activities at sites where formal agreements either do not exist or do not quantify the extent and timing of our obligations. Environmental remediation activities usually span many years, which makes estimating the costs more judgmental due to, for example, changing remediation technologies. To determine the costs related to clean up sites, we have to assess the extent of contamination, effects on natural resources, the appropriate technology to be used to accomplish the remediation, and evolving environmental standards.We perform quarterly reviews of environmental remediation sites and record liabilities and receivables in the period it becomes probable that the liabilities have been incurred and the amounts can be reasonably estimated (see the discussion under “Environmental Matters” in “Note 1 – Organization and Significant Accounting Policies” and “Note 14 – Legal Proceedings, Commitments and Contingencies” included in our Notes to Consolidated Financial Statements). We consider the above factors in our quarterly estimates of the timing and amount of any future costs that may be required for environmental remediation activities, which result in the calculation of a range of estimates for each particular environmental remediation site. We do not discount the recorded liabilities, as the amount and timing of future cash payments are not fixed or cannot be reliably determined. Given the required level of judgment and estimation, it is likely that materially different amounts could be recorded if different assumptions were used or if circumstances were to change (e.g., a change in environmental standards or a change in our estimate of the extent of contamination).Under agreements reached with the U.S. Government, most of the amounts we spend for environmental remediation are allocated to our operations as general and administrative costs. Under existing U.S. Government regulations, these and other environmental expenditures relating to our U.S. Government business, after deducting any recoveries received from insurance or other PRPs, are allowable in establishing prices of our products and services. As a result, most of the expenditures we incur are included in our net sales and cost of sales according to U.S. Government agreement or regulation, regardless of the contract form (e.g. cost-reimbursable, fixed-price). We continually evaluate the recoverability of our assets for the portion of environmental costs that are probable of future recovery by assessing, among other factors, U.S. Government regulations, our U.S. Government business base and contract mix, our history of receiving reimbursement of such costs, and efforts by some U.S. Government representatives to limit such reimbursement.As disclosed above, we may record changes in the amount of environmental remediation liabilities as a result of our quarterly reviews of the status of our environmental remediation sites, which would result in a change to the corresponding amount that is probable of future recovery and a charge to earnings. For example, if we were to determine that the liabilities should be increased by $100 million, the corresponding amount that is probable of future recovery would be increased by approximately $89 million, with the remainder recorded as a charge to earnings. This allocation is determined annually, based upon our existing and projected business activities with the U.S. Government.We cannot reasonably determine the extent of our financial exposure at all environmental remediation sites with which we are involved. There are a number of former operating facilities we are monitoring or investigating for potential future environmental remediation. In some cases, although a loss may be probable, it is not possible at this time to reasonably estimate the amount of any obligation for remediation activities because of uncertainties (e.g., assessing the extent of the contamination). During any particular quarter, such uncertainties may be resolved, allowing us to estimate and recognize the initial liability to 55Table of Contents remediate a particular former operating site. The amount of the liability could be material. Upon recognition of the liability, a portion will be recognized as a receivable with the remainder charged to earnings, which may have a material effect in any particular interim reporting period.If we are ultimately found to have liability at those sites where we have been designated a PRP, we expect that the actual costs of environmental remediation will be shared with other liable PRPs. Generally, PRPs that are ultimately determined to be responsible parties are strictly liable for site remediation and usually agree among themselves to share, on an allocated basis, the costs and expenses for environmental investigation and remediation. Under existing environmental laws, responsible parties are jointly and severally liable and, therefore, we are potentially liable for the full cost of funding such remediation. In the unlikely event that we were required to fund the entire cost of such remediation, the statutory framework provides that we may pursue rights of cost recovery or contribution from the other PRPs. The amounts we record do not reflect the fact that we may recover some of the environmental costs we have incurred through insurance or from other PRPs, which we are required to pursue by agreement and U.S. Government regulation.Goodwill and Intangible AssetsThe assets and liabilities of acquired businesses are recorded under the acquisition method of accounting at their estimated fair values at the date of acquisition. Goodwill represents costs in excess of fair values assigned to the underlying identifiable net assets of acquired businesses. Intangible assets from acquired businesses are recognized at fair value on the acquisition date and consist of customer programs, trademarks, customer relationships, technology and other intangible assets. Customer programs include values assigned to major programs of acquired businesses and represent the aggregate value associated with the customer relationships, contracts, technology and trademarks underlying the associated program. Intangible assets are amortized over a period of expected cash flows used to measure fair value, which typically ranges from five to 20 years.Our goodwill balance was $10.8 billion at both December 31, 2022 and 2021. We perform an impairment test of our goodwill at least annually in the fourth quarter or more frequently whenever events or changes in circumstances indicate the carrying value of goodwill may be impaired. Such events or changes in circumstances may include a significant deterioration in overall economic conditions, changes in the business climate of our industry, a decline in our market capitalization, operating performance indicators, competition, reorganizations of our business, U.S. Government budget restrictions or the disposal of all or a portion of a reporting unit. Our goodwill has been allocated to and is tested for impairment at a level referred to as the reporting unit, which is our business segment level or a level below the business segment. The level at which we test goodwill for impairment requires us to determine whether the operations below the business segment constitute a self-sustaining business for which discrete financial information is available and segment management regularly reviews the operating results.We may use both qualitative and quantitative approaches when testing goodwill for impairment. For selected reporting units where we use the qualitative approach, we perform a qualitative evaluation of events and circumstances impacting the reporting unit to determine the likelihood of goodwill impairment. Based on that qualitative evaluation, if we determine it is more likely than not that the fair value of a reporting unit exceeds its carrying amount, no further evaluation is necessary. Otherwise, we perform a quantitative impairment test. We perform quantitative tests for most reporting units at least once every three years. However, for certain reporting units we may perform a quantitative impairment test every year.To perform the quantitative impairment test, we compare the fair value of a reporting unit to its carrying value, including goodwill. If the fair value of a reporting unit exceeds its carrying value, goodwill of the reporting unit is not impaired. If the carrying value of the reporting unit, including goodwill, exceeds its fair value, a goodwill impairment loss is recognized in an amount equal to that excess. We generally estimate the fair value of each reporting unit using a combination of a discounted cash flow (DCF) analysis and market-based valuation methodologies such as comparable public company trading values and values observed in recent business acquisitions. Determining fair value requires the exercise of significant judgments, including the amount and timing of expected future cash flows, long-term growth rates, discount rates and relevant comparable public company earnings multiples and relevant transaction multiples. The cash flows employed in the DCF analysis are based on our best estimate of future sales, earnings and cash flows after considering factors such as general market conditions, U.S. Government budgets, existing firm orders, expected future orders, contracts with suppliers, labor agreements, changes in working capital, long term business plans and recent operating performance. The discount rates utilized in the DCF analysis are based on the respective reporting unit’s weighted average cost of capital, which takes into account the relative weights of each component of capital structure (equity and debt) and represents the expected cost of new capital, adjusted as appropriate to consider the risk inherent in future cash flows of the respective reporting unit. The carrying value of each reporting unit includes the assets and liabilities employed in its operations, goodwill and allocations of amounts held at the business segment and corporate levels.In the fourth quarter of 2022, we performed our annual goodwill impairment test for each of our reporting units. The results of that test indicated that for each of our reporting units no impairment existed, including Sikorsky. Based on this, the fair value 56Table of Contents of our Sikorsky reporting unit exceeded its carrying value, which included goodwill of $2.7 billion, by a margin of approximately 40%. The fair value of both our Sikorsky reporting unit and the indefinite-lived trademark intangible asset can be significantly impacted by its performance, the amount and timing of expected future cash flows, contract terminations, changes in expected future orders, general market pressures, including U.S. Government budgetary constraints, discount rates, long term growth rates, and changes in U.S. (federal or state) or foreign tax laws and regulations, or their interpretation and application, including those with retroactive effect, along with other significant judgments. Based on our assessment of these circumstances, we have determined that goodwill at our Sikorsky reporting unit and the indefinite-lived trademark intangible asset at our Sikorsky reporting unit are at risk for impairment should there be a significant deterioration of projected cash flows of the reporting unit. We do not currently anticipate any material impairments on our assets as a result of COVID-19 or inflation.Impairment assessments inherently involve management judgments regarding a number of assumptions such as those described above. Due to the many variables inherent in the estimation of a reporting unit’s fair value and the relative size of our recorded goodwill, differences in assumptions could have a material effect on the estimated fair value of one or more of our reporting units and could result in a goodwill impairment charge in a future period.Acquired intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment testing or more frequently if events or change in circumstance indicate that it is more likely than not that the asset is impaired. This testing compares carrying value to fair value and, when appropriate, the carrying value of these assets is reduced to fair value. In the fourth quarter of 2022, we performed our annual impairment test, and the results of that test indicated no impairment existed. Intangibles are amortized to expense over their applicable useful lives, ranging from five to 20 years, based on the nature of the asset and the underlying pattern of economic benefit as reflected by future net cash inflows. We perform an impairment test of finite-lived intangibles whenever events or changes in circumstances indicate their carrying value may be impaired. If events or changes in circumstances indicate the carrying value of a finite-lived intangible may be impaired, the sum of the undiscounted future cash flows expected to result from the use of the asset group would be compared to the asset group’s carrying value. If the asset group’s carrying amount exceed the sum of the undiscounted future cash flows, we would determine the fair value of the asset group and record an impairment loss in net earnings.57Table of Contents ITEM 7A. Quantitative and Qualitative Disclosures About Market RiskWe maintain active relationships with a broad and diverse group of U.S. and international financial institutions. We believe that they provide us with sufficient access to the general and trade credit we require to conduct our business. We closely monitor the financial market environment and actively manage counterparty exposure to minimize the potential impact from adverse developments with any single credit provider while ensuring availability of, and access to, sufficient credit resources. Our main exposure to market risk relates to interest rates, foreign currency exchange rates and market prices on certain equity securities. Our financial instruments that are subject to interest rate risk principally include fixed-rate long-term debt and commercial paper, if issued. The estimated fair value of our outstanding debt was $16.0 billion at December 31, 2022 and the outstanding principal amount was $16.8 billion, excluding unamortized discounts and issuance costs of $1.3 billion. A 10% change in the level of interest rates would not have a material impact on the fair value of our outstanding debt at December 31, 2022.We use derivative instruments principally to reduce our exposure to market risks from changes in foreign currency exchange rates and interest rates. We do not enter into or hold derivative instruments for speculative trading purposes. We transact business globally and are subject to risks associated with changing foreign currency exchange rates. We enter into foreign currency hedges such as forward and option contracts that change in value as foreign currency exchange rates change. Our most significant foreign currency exposures relate to the British pound sterling, the euro, the Canadian dollar, the Australian dollar, the Norwegian kroner and the Polish zloty. These contracts hedge forecasted foreign currency transactions in order to minimize fluctuations in our earnings and cash flows associated with changes in foreign currency exchange rates. We designate foreign currency hedges as cash flow hedges. We also are exposed to the impact of interest rate changes primarily through our borrowing activities. For fixed rate borrowings, we may use variable interest rate swaps, effectively converting fixed rate borrowings to variable rate borrowings in order to hedge changes in the fair value of the debt. These swaps are designated as fair value hedges. For variable rate borrowings, we may use fixed interest rate swaps, effectively converting variable rate borrowings to fixed rate borrowings in order to minimize the impact of interest rate changes on earnings. These swaps are designated as cash flow hedges. We also may enter into derivative instruments that are not designated as hedges and do not qualify for hedge accounting, which are intended to minimize certain economic exposures.The classification of gains and losses resulting from changes in the fair values of derivatives is dependent on our intended use of the derivative and its resulting designation. Adjustments to reflect changes in fair values of derivatives attributable to highly effective hedges are either reflected in earnings and largely offset by corresponding adjustments to the hedged items or reflected net of income taxes in accumulated other comprehensive loss until the hedged transaction is recognized in earnings. Changes in the fair value of the derivatives that are not highly effective, if any, are immediately recognized in earnings. The aggregate notional amount of our outstanding interest rate swaps at December 31, 2022 and 2021 was $1.3 billion and $500 million. The increase in 2022 was designated on the additional debt we issued during the fourth quarter. The aggregate notional amount of our outstanding foreign currency hedges at December 31, 2022 and 2021 was $7.3 billion and $4.0 billion. The increase in 2022 is due to the timing of foreign denominated international contract awards. At December 31, 2022 and 2021, the net fair value of our derivative instruments was not material (see “Note 15 – Fair Value Measurements” included in our Notes to Consolidated Financial Statements). A 10% unfavorable exchange rate movement of our foreign currency contracts would not have a material impact on the aggregate net fair value of such contracts or our consolidated financial statements. Additionally, as we enter into foreign currency contracts to hedge foreign currency exposure on underlying transactions we believe that any movement on our foreign currency contracts would be offset by movement on the underlying transactions and, therefore, when taken together do not create material risk.We evaluate the credit quality of potential counterparties to derivative transactions and only enter into agreements with those deemed to have acceptable credit risk at the time the agreements are executed. Our foreign currency exchange hedge portfolio is diversified across many banks. We regularly monitor changes to counterparty credit quality as well as our concentration of credit exposure to individual counterparties. We do not hold or issue derivative financial instruments for trading or speculative purposes. We maintain a separate trust that includes investments to fund certain of our non-qualified deferred compensation plans. As of December 31, 2022, investments in the trust totaled $1.6 billion and are reflected at fair value on our consolidated balance sheet in other noncurrent assets. The trust holds investments in marketable equity securities and fixed-income securities that are exposed to price changes and changes in interest rates. A portion of the liabilities associated with the deferred compensation plans supported by the trust is also impacted by changes in the market price of our common stock and certain market indices. Changes in the value of the liabilities have the effect of partially offsetting the impact of changes in the value of the trust. Both the change in the fair value of the trust and the change in the value of the liabilities are recognized on our consolidated statements of earnings in other unallocated, net and were not material for the year ended December 31, 2022.58Table of Contents We are exposed to equity market risk through certain marketable securities. The fair value of these marketable securities was $24 million as of December 31, 2022. A 10% decrease in the market price of our marketable equity securities as of December 31, 2022 would not have a material impact on the carrying amounts of these securities or our consolidated financial statements. Many of the same factors that could result in an adverse movement of equity market prices affect our non-marketable equity investments, although we cannot always quantify the impacts directly. Financial markets are volatile, which could negatively affect the valuations and prospects of the companies we invest in, their ability to raise additional capital, and the likelihood of our ability to realize value in our investments through liquidity events such as initial public offerings, mergers, and private sales.59Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Report, “Note 3—Summary of Significant Accounting Policies” of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.Leidos Holdings, Inc. Annual Report - 27Table of ContentsPART ICybersecurity breaches and other information security incidents could negatively impact our business and financial results, impair our ability to effectively provide our services to our clients and cause harm to our reputation or competitive position.As a government contractor and a provider of information technology services operating in multiple regulated industries and geographies, we and our service providers, suppliers and subcontractors collect, store, transmit and otherwise process personal, confidential, proprietary and sensitive information, including protected health information, personnel information, personal information, classified information, controlled unclassified information, intellectual property and financial information, concerning our business, employees and customers. Therefore, we are continuously exposed to unauthorized attempts to compromise access, release or otherwise compromise such information through cyber-attacks and other information security threats, including, among other things, physical break-ins, theft, denial-of-service attacks, worms, computer viruses, software bugs, malicious or destructive code, social engineering, phishing attacks and impersonating authorized users, credential stuffing, account takeovers, insider threats, malfeasance or improper access by employees or service providers, human error, fraud, use of artificial intelligence, “bots” or other automation software, or other similar disruptions. We are also exposed to hackers that have requested “ransom” in exchange for not disclosing information or for restoring access to information or systems. These techniques may be perpetrated by internal bad actors, such as employees or contractors, or by third parties (including traditional computer hackers, persons involved with well-funded organized crime or state-sponsored actors). Any electronic or physical break-in or other security breach or compromise of our information technology systems and networks or facilities, or those of our service providers, suppliers, joint ventures or subcontractors, may jeopardize the security of information, including personal, confidential, proprietary or sensitive information, stored or transmitted through these systems and networks or stored in those facilities. This could lead to disruptions in mission-critical systems, unauthorized access to or release of personal, confidential, proprietary, sensitive or otherwise protected information and corruption of data or systems. We could also be potentially subject to operational downtimes and delays and other detrimental impacts on our operations or ability to provide products and services to our customers. We are also increasingly subject to customer-driven cybersecurity certification requirements, which are expected to be necessary to win future contracts. Such security incidents also could result in liability or trigger other obligations under such contracts or increase the difficulty of winning future contracts. Many statutory requirements, both in the U.S. and abroad, also include obligations for companies to provide notice of information security incidents involving certain types of information (including obligations to notify affected individuals and regulators in the event of cybersecurity breaches involving certain personal information), which could result from breaches of our service providers, our suppliers or subcontractors.Although we have implemented policies, procedures and controls designed to protect against, detect and mitigate these threats and attacks, we and our service providers, suppliers, joint ventures and subcontractors have faced and continue to face advanced and persistent attacks on our information systems. We cannot guarantee that future incidents will not occur, and if an incident does occur, our incident response planning may not prove fully adequate. We may also not be able to mitigate its impacts successfully. Techniques used by others to gain unauthorized access to personal, confidential, proprietary or sensitive information or disrupt systems and networks for economic or strategic gain are constantly evolving, increasingly sophisticated, and increasingly difficult to detect and successfully defend against. Recently, the U.S. government has raised concerns about a potential increase in cyber-attacks generally as a result of the military conflict between Russia and Ukraine and the related sanctions imposed by the United States and other countries.While we generally perform cybersecurity diligence on our key service providers, we do not control our service providers and our ability to monitor their cybersecurity is limited, so we cannot ensure the cybersecurity measures they take will be sufficient to protect any information we share with them. Due to applicable laws and regulations or contractual obligations, we may be held responsible for cybersecurity breaches or other information security incidents attributed to our service providers as they relate to the information we share with them.Leidos Holdings, Inc. Annual Report - 28Table of ContentsPART IWe seek to detect and investigate all information security incidents and to prevent their occurrence, prolongation or recurrence. We continue to invest in and improve our threat protection, detection and mitigation policies, procedures and controls. In addition, we work with other companies in the industry and government participants on increased awareness and enhanced protections against information security and malicious insider threats. However, because of the evolving nature and sophistication of these security threats, which can be difficult to detect, there can be no assurance that our policies, procedures and controls, or those of our service providers, suppliers or subcontractors, have protected against, detected, mitigated or will detect, prevent or mitigate, any of these threats and we cannot predict the full impact of any such past or future incident. We may be currently unaware of certain vulnerabilities or lack the capability to detect them, which may allow them to persist in our information technology environment over long periods and, even if discovered, it could take considerable time for us to obtain full and reliable information about the extent, amount and type of information compromised, and our remediation efforts may not be completely successful. As cybersecurity threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate or remediate any information security vulnerabilities, cybersecurity breaches or other information security incidents.We also may experience similar security threats to the information technology systems that we develop, install or maintain under customer contracts. Although we work cooperatively with our customers and other business partners, including our service providers, suppliers and subcontractors, to seek to minimize the potential for and impact of cyber-attacks and other security threats, we must rely on the safeguards put in place by those entities. See also the risk factor “Internal system or service failures, or failures in the systems or services of third parties on which we rely, could disrupt our business and impair our ability to effectively provide our services and products to our customers, which could damage our reputation and adversely affect our revenues and profitability.”The occurrence of any unauthorized access to, attacks on cybersecurity breaches of other information security threats to our or our service providers', suppliers' or subcontractors' information technology infrastructure, systems or networks or data, or our failure to make adequate or timely disclosure to the public, regulators, or law enforcement agencies following any such event, could disrupt our infrastructure, systems, or networks or those of our customers, impair our ability to provide services to our customers and may jeopardize the security of data collected, stored, transmitted or otherwise processed through our information technology infrastructure, systems and networks. As a result, we could be exposed to claims, fines, penalties, loss of revenues, product development delays, compromise, corruption or loss of confidential, proprietary or sensitive information (including personal information or technical business information), contract terminations and damages, remediation costs and other costs and expenses, regulatory investigations or sanctions, indemnity obligations and other potential liabilities. Any of the foregoing could adversely affect our reputation, ability to win work on sensitive contracts or loss of current and future contracts (including sensitive U.S. government contracts), business operations and financial results. We have insurance against some cyber-risks and attacks; however, our insurer may deny coverage as to any future claim, our insurance coverage may not be sufficient to offset the impact of a material loss event, and such insurance may increase in cost or cease to be available on commercial terms in the future.Leidos Holdings, Inc. Annual Report - 29Table of ContentsPART IInternal system or service failures, or failures in the systems or services of third parties on which we rely, could disrupt our business and impair our ability to effectively provide our services and products to our customers, which could damage our reputation and adversely affect our revenues and profitability.Any system or service disruptions, including those caused by ongoing projects to improve our information technology systems and networks and the delivery of services, whether through our shared services organization or outsourced services, if not anticipated and appropriately mitigated, could materially and adversely affect our business including, among other things, an adverse effect on our ability to perform on contracts, bill our customers for work performed on our contracts, collect the amounts that have been billed and produce accurate financial statements in a timely manner. We, and the service providers, suppliers and subcontractors on which we rely, are also subject to systems failures, including network, software or hardware failures, whether caused by us, third-party service providers, cybersecurity threats, malicious insiders, natural disasters, power shortages, terrorist attacks, pandemics or other events, which could cause loss of data and interruptions or delays in our business, cause us to incur remediation costs, subject us to claims and damage our reputation. In addition, the failure or disruption of our communications, or those of our service providers, suppliers or subcontractors, could cause us to interrupt or suspend our operations or otherwise adversely affect our business. Our property and business interruption insurance may be inadequate to compensate us for all losses that may occur as a result of any system or operational failure or disruption.Our business is subject to disruption caused by physical or transition risks that could adversely affect our operations, profitability and overall financial position.We have significant operations, including infrastructure, information technology systems, research facilities and centers of excellence, located in regions that may be exposed to physical risks, such as hurricanes, earthquakes, other damaging storms, water levels, wildfires and other natural disasters, including places such as Alabama, Florida, California and Texas. Our subcontractors and suppliers are also subject to physical risks that could affect their ability to deliver or perform under a contract, including as a result of disruptions to their workforce and critical industrial infrastructure needed for normal business operations. Although we maintain crisis management and disaster response plans, such events could make it difficult or impossible for us to deliver our services to our customers, could decrease demand for our services, could make existing customers unable or unwilling to fulfill their contractual requirements to us, including their payment obligations, and could cause us to incur substantial expense, including expenses or liabilities arising from potential litigation. If insurance or other risk transfer mechanisms are unavailable or insufficient to recover all costs or if we experience a significant disruption to our business due to a natural disaster, it could adversely affect our financial position, results of operations and cash flows.There is also an increasing concern over the risks of climate change and related environmental sustainability matters. In addition to physical risks, climate change risk includes longer-term shifts in climate patterns, such as extreme heat, sea level rise, and more frequent and prolonged drought. Such events could disrupt our operations or those of our customers or third parties on which we rely, including through direct damage to assets and indirect impacts from supply chain disruption and market volatility. We could also incur significant costs to improve the climate resiliency of our infrastructure and supply chain and otherwise prepare for, respond to, and mitigate the effects of climate change. Additionally, transitioning to a low-carbon economy may entail extensive policy, legal, technology and market initiatives. Such changes could result in laws, regulations or policies that significantly increase our direct and indirect operational and compliance burdens, which could adversely affect our financial condition and results of operations. We monitor developments in climate change-related laws, regulations and policies for their potential effect on us, however, we currently are not able to accurately predict the materiality of any potential costs associated with such developments. In addition, our reputation and client relationships may be damaged as a result of our practices related to climate change, including our involvement, or our clients’ involvement, in certain industries or projects associated with causing or exacerbating climate change, as well as any decisions we make to continue to conduct or change our activities in response to considerations relating to climate change.Leidos Holdings, Inc. Annual Report - 30Table of ContentsPART ICustomer systems failures could damage our reputation and adversely affect our revenues and profitability.Many of the systems and networks that we develop, install and maintain for our customers involve managing and protecting personal information and information relating to national security and other sensitive government functions. While we have programs designed to comply with relevant data privacy and security laws and restrictions, if a system or network that we develop, install or maintain were to fail or experience a security breach or service interruption, whether caused by us, third-party service providers, cybersecurity threats or other events, we may experience loss of revenue, remediation costs or face claims for damages or contract termination. Any such event could cause serious harm to our reputation and prevent us from having access to or being eligible for further work on such systems and networks. Our errors and omissions liability insurance may be inadequate to compensate us for all of the damages that we may incur and, as a result, our future results could be adversely affected.Our success depends, in part, on our ability to work with complex and rapidly changing technologies to meet the needs of our customers.We design and develop technologically advanced and innovative products and services applied by our customers in various environments. The needs of our customers change and evolve regularly and in particular by complex and rapidly evolving technologies. Our success depends upon our ability to identify emerging technological trends, develop technologically advanced, innovative and cost-effective products and services and market these products and services to our customers. Our success also depends on our continued access to suppliers of important technologies and components. Many of our contracts contain performance obligations that require innovative design capabilities, are technologically complex, or depend on factors not wholly within our control. Problems and delays in development or delivery as a result of issues with respect to design, technology, licensing and patent rights, labor, learning curve assumptions or materials and components could prevent us from achieving such contractual requirements. Failure to meet these obligations could adversely affect our profitability and future prospects. In addition, our offerings cannot be tested and proven in all situations and are otherwise subject to unforeseen problems that could negatively affect revenue and profitability, such as problems with quality and workmanship, country of origin, delivery of subcontractor components or services, unplanned degradation of product performance, and unauthorized use or modifications of our products and services. Among the factors that may affect revenue and profits could be unforeseen costs and expenses not covered by insurance or indemnification from the customer, diversion of management focus in responding to unforeseen problems, loss of follow-on work, and, in the case of certain contracts, repayment to the government customer of contract costs and fee payments we previously received.We have classified contracts with the U.S. government, which may limit investor insight into portions of our business.We derive a portion of our revenues from programs with the U.S. government and its agencies that are subject to security restrictions (e.g., contracts involving classified information and classified programs), which preclude the dissemination of information and technology that is classified for national security purposes under applicable law and regulation. In general, access to classified information, technology, facilities or programs requires appropriate personnel security clearances, is subject to additional contract oversight and potential liability and may also require appropriate facility clearances and other specialized infrastructure. In the event of a security incident involving classified information, technology, facilities, programs or personnel holding clearances, we may be subject to legal, financial, operational and reputational harm. We are limited in our ability to provide information about these classified programs, their risks or any disputes or claims relating to such programs. As a result, investors have less insight into our classified business or our business overall. However, historically the business risks associated with our work on classified programs have not differed materially from those of our other government contracts.Leidos Holdings, Inc. Annual Report - 31Table of ContentsPART IWe have made and continue to make acquisitions, investments, joint ventures and divestitures that involve numerous risks and uncertainties.We selectively pursue strategic acquisitions, investments and joint ventures. We also may enter into relationships with other businesses to expand our products or our ability to provide services. These transactions require a significant investment of time and resources and may disrupt our business and distract our management from other responsibilities. Even if successful, these transactions could result in unfavorable public perception or reduce earnings for a number of reasons, including the amortization of intangible assets, impairment charges, adverse tax consequences, acquired operations that are not yet profitable or the payment of additional consideration under earn-out arrangements if an acquisition performs better than expected. Acquisitions, investments and joint ventures pose many other risks that could adversely affect our reputation, operations or financial results, including that:•we may not be able to identify, compete effectively for or complete suitable acquisitions and investments at prices we consider attractive;•we may not be able to accurately estimate the financial effect of acquisitions and investments on our business or realize anticipated synergies, business growth or profitability and may be unable to recover investments in any such acquisitions and investments; •we may not be able to manage the integration process for acquisitions successfully, and the integration process may divert management time and focus from operating our business, including as a result of incompatible accounting, information management or other control systems; •acquired technologies, capabilities, products and service offerings, particularly those that are still in development when acquired, may not perform as expected, may have defects or may not be integrated into our business as expected; •we may have trouble retaining key employees and customers of an acquired business; •we may need to implement or improve controls, procedures and policies at a business that prior to the acquisition may have lacked sufficiently effective controls, procedures and policies, including those relating to financial reporting, revenue recognition or other financial or control deficiencies; •we may assume legal or regulatory risks, particularly with respect to smaller businesses that have immature business processes and compliance programs, or may be required to comply with additional laws and regulations, or to engage in remediation efforts to cause the acquired company to comply with applicable laws and regulations, or result in liabilities resulting from the acquired company’s failure to comply with applicable laws or regulations;•we may face litigation or material liabilities that were not identified or were underestimated as part of our due diligence or for which we are unable to receive a purchase price adjustment or reimbursement through indemnification, including intellectual property claims and disputes or claims from terminated employees, customers, former stockholders or other third parties, or there may be other unanticipated write-offs or charges; •we may be required to spend a significant amount of cash or to incur debt, resulting in limitations on other potential uses for cash, increased fixed payment obligations or covenants or other restrictions on us, or issue shares of our common stock or convertible debt, resulting in dilution of ownership; •we may not be able to influence the operations of our joint ventures effectively, or we may be exposed to certain liabilities if our joint venture partners do not fulfill their obligations; and•if our acquisitions, investments or joint ventures fail, perform poorly, or their value is otherwise impaired for any reason, including contractions in credit markets and global economic conditions, our business and financial results could be adversely affected.In addition, we periodically divest businesses, including businesses that are no longer a part of our ongoing strategic plan. These divestitures similarly require a significant investment of time and resources, may disrupt our business, distract management from other responsibilities and may result in losses on disposal or continued financial involvement in the divested business, including through indemnification, guarantee or other financial arrangements, for a period of time following the transaction, which would adversely affect our financial results.Leidos Holdings, Inc. Annual Report - 32Table of ContentsPART IGoodwill and other intangible assets represent significant assets on our balance sheet and any impairment of these assets could negatively impact our results of operations. As of December 30, 2022, goodwill and intangible assets, net was 59% of our total assets. The amount of our goodwill may substantially increase in the future as a result of any acquisitions that we make. Intangible assets and goodwill are tested for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable and at least annually in the case of intangible assets with indefinite lives. The impairment test is based on several factors requiring judgment. Examples of events or changes in circumstances indicating that the carrying value of intangible assets may not be recoverable could include a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, adverse contract acquisition performance, loss of key personnel, or a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed. Adverse changes in fiscal and economic conditions, such as those related to federal budget cuts and the nation’s debt ceiling, deteriorating market conditions for companies in our industry and unfavorable changes in discount rates could result in an impairment of goodwill and other intangibles. Any future impairment of goodwill or other intangible assets would have a negative impact on our results of operations in the period in which they are recognized. For additional information on our accounting policies related to impairment of goodwill, see our discussion under “Critical Accounting Estimates” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K, "Note 3—Summary of Significant Accounting Policies” and “Note 8—Goodwill and Intangible Assets” of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.We depend on our teaming arrangements and relationships with other contractors and subcontractors. If we are not able to maintain these relationships, or if these parties fail to satisfy their obligations to us or the customer, our revenues, profitability and growth prospects could be adversely affected.We rely on our teaming relationships with other prime contractors and subcontractors, who are also often our competitors in other contexts, to submit bids for large procurements or other opportunities where we believe the combination of services and products provided by us and other companies will help us to win and perform the contract. Our future revenues and growth prospects could be adversely affected if other contractors eliminate or reduce their contract relationships with us or if the U.S. government terminates or reduces these other contractors’ programs, does not award them new contracts or refuses to pay under a contract. Companies that do not have access to U.S. government contracts may perform services as our subcontractor, and that exposure could enhance such companies’ prospect of securing a future position as a prime U.S. government contractor, which could increase competition for future contracts and impair our ability to perform on contracts. We may have disputes with our subcontractors arising from, among other things, the quality and timeliness of work performed by the subcontractor, customer concerns about the subcontractor, our failure to extend existing task orders or issue new task orders under a subcontract, our hiring of a subcontractor’s personnel or the subcontractor’s failure to comply with applicable law. If any of our subcontractors fail to timely meet their contractual obligations or have regulatory compliance or other problems, our ability to fulfill our obligations as a prime contractor or higher tier subcontractor may be jeopardized. Significant losses could arise in future periods and subcontractor performance deficiencies could result in our termination for default. A termination for default could eliminate a revenue source, expose us to liability and have an adverse effect on our ability to compete for future contracts and task orders, especially if the customer is an agency of the U.S. government.Leidos Holdings, Inc. Annual Report - 33Table of ContentsPART IOur services and operations, which sometimes involve using, handling, or disposing of hazardous substances, are subject to numerous environmental, health and safety laws and regulations, pursuant to which we could face potentially significant liabilities, costs or obligations.Our services are subject to numerous environmental, health and safety laws and regulations. Some of our services and operations involve using, handling, or disposing of hazardous substances. These activities and our operations generally subject us to complex and stringent foreign, federal, state, and local environmental, health and safety laws and regulations, which have tended to become more stringent over time. Among other things, these laws and regulations require us to incur costs to comply and could impose liability on us for handling or disposing of hazardous substances. For example, we provide infrastructure and site services necessary to accomplish critical waste management and the continued environmental cleanup of the Hanford Site in southeastern Washington. In addition, some of our work sites put our employees and others in close proximity with mechanized equipment, moving vehicles, chemical and manufacturing processes, and highly regulated materials. On some work sites, we may be responsible for safety and have an obligation to implement effective safety procedures. If we fail to implement these procedures, or if the procedures we implement are ineffective, we may suffer the loss of or injury to our employees, as well as expose ourselves to possible litigation.Failure to comply with these environmental, health and safety laws and regulations could result in civil, criminal, regulatory, administrative, or contractual sanctions, including fines, penalties or suspension or debarment from contracting with the U.S. government. In addition, our failure to maintain adequate safety standards and equipment could result in reduced profitability and loss of work or clients. Our current and previous ownership and operation of real property also subject us to environmental laws and regulations, some of which hold current or previous owners or operators of businesses and real property jointly and severally liable for hazardous substance releases, even if they did not know of and were not responsible for the releases. Past business practices at companies that we have acquired may also expose us to future unknown environmental liabilities. Liabilities related to environmental contamination or human exposure to hazardous substances, or violations of these laws or regulations, could result in substantial costs to us, including cleanup costs, fines and civil or criminal sanctions, third-party claims for property damage or personal injury. Our continuing work in the areas governed by these laws and regulations exposes us to the risk of substantial liability and may adversely affect our financial condition and operating results.We could incur significant liabilities and suffer negative publicity if our inspection or detection systems fail to detect bombs, explosives, weapons, contraband or other threats.We design, develop, manufacture, sell, service, and maintain various inspection systems and related integration and automation systems designed to assist in detecting bombs, explosives, weapons, contraband or other threats. In some instances, we also train operators of such systems. Such systems utilize detection technology and software algorithms to interpret data produced by the system and signal to the operator when a dangerous object or substance may be present. Such algorithms are probabilistic in nature and are generally designed to meet requirements established by regulatory agencies. Many of these systems require that an operator interpret an image of suspicious items within a bag, parcel, container, vehicle or other vessel. Others signal to the operator that further investigation is required, and the training, reliability and competence of the customer's operator are crucial to the detection of suspicious items. Nevertheless, if such a system were to fail to signal to an operator when an explosive or other contraband was, in fact, present, resulting in significant damage, we could become the subject of significant product liability claims. There are many factors, some of which are beyond our control, which could result in the failure of our products to help detect the presence of bombs, explosives, weapons, contraband or other threats. Some of these factors could include inherent limitations in our systems and misuse or malfunction of our systems. The failure of our systems to help detect the presence of any of these dangerous materials could lead to injury, death and extensive property damage and may lead to product liability, professional liability or other claims against us. Further, if our security and inspection systems fail to, or are perceived to have failed to, help detect a threat, we could experience negative publicity and reputational harm, which could reduce demand for our inspection or detection systems, and adversely affect our business.Leidos Holdings, Inc. Annual Report - 34Table of ContentsPART IOur insurance, customer indemnifications or other liability protections may be insufficient to protect us from product and other liability claims or losses.We maintain insurance coverage with third-party insurers as part of our overall risk management strategy and because some of our contracts require us to maintain specific insurance coverage limits. Not every risk or liability is or can be protected by insurance, and, for those risks we insure, the limits of coverage that are reasonably obtainable may not be sufficient to cover all actual losses or liabilities incurred. We are limited in the amount of insurance we can obtain to cover certain risks, such as cybersecurity risks and natural hazards, including earthquakes, fires, extreme weather conditions, some of which can be worsened by climate change and pandemics. If any of our third-party insurers fail, becomes insolvent, cancel our coverage or otherwise are unable to provide us with adequate insurance coverage, then our overall risk exposure and our operational expenses would increase, and the management of our business operations would be disrupted. Our insurance may be insufficient to protect us from significant product and other liability claims or losses. Moreover, there is a risk that commercially available liability insurance will not continue to be available to us at a reasonable cost, if at all. In some circumstances we are entitled to certain legal protections or indemnifications from our customers through contractual provisions, laws, regulations or otherwise. However, these protections are not always available, can be difficult to obtain, are typically subject to certain terms or limitations, including the availability of funds, and may not be sufficient to cover all losses or liabilities incurred. If liability claims or losses exceed our current or available insurance coverage, customer indemnifications or other legal protections, our business, financial position, operating results and prospects may be harmed. Any significant claim may have an adverse effect on our industry and market reputation, leading to a substantial decrease in demand for our products and services and reduced revenues, making it more difficult for us to compete effectively, and could affect the cost and availability of insurance coverage at adequate levels in the future.We face risks associated with our international business.During fiscal 2022, revenue attributable to our services provided outside of the United States to non-U.S. customers was approximately 8% of our total revenue. Our international business operations may be subject to additional and different risks than our U.S. business. These risks and challenges include:•failure to comply with U.S. government and foreign laws and regulations applicable to international business, including, without limitation, those related to employment, data privacy and cybersecurity, taxes, technology transfer, information security, environment, data transfer, import and export controls (including the International Traffic in Arms Regulations (“ITAR”) administered by the U.S. Department of State and the anti-boycott provisions of the Export Administration Regulations (“EAR”) administered by the U.S. Department of Commerce’s Bureau of Industry and Security), sanctions, and other administrative, legislative or regulatory actions that could materially interfere with our ability to offer our products or services in certain countries or have an adverse impact on our business with the U.S. government, and expose us to risks and costs of noncompliance with such laws and regulations, in addition to administrative, civil or criminal penalties; •increased financial and legal risks arising, for example, from foreign exchange rate variability, imposition of tariffs or additional taxes, inflation, restrictive trade policies, longer payment cycles, delays or failures to collect amounts due to us and differing legal systems, and which may adversely affect the performance of our services, sale of our products or repatriation of our profits;•political or economic instability, international security concerns and geopolitical conflict in countries where we provide services and products in support of the U.S. government and other customers in countries, which increases the risk of an incident resulting in injury or loss of life, damage or destruction of property, inability to meet our contractual obligations or retaliatory measures taken in respect thereof; and•the ongoing conflict between Russia and Ukraine, which has resulted in the imposition by the U.S. and other nations of restrictive actions against Russia, Belarus and certain banks, companies and individuals.Leidos Holdings, Inc. Annual Report - 35Table of ContentsPART IWe are also subject to the U.S. Foreign Corrupt Practices Act (“FCPA”), the U.K. Bribery Act of 2010 (the “UK Bribery Act”) and other anti-corruption and anti-bribery laws and regulations in jurisdictions where we do business. These laws and regulations generally prohibit improper payments or offers of improper payments to government officials, political parties, or commercial partners to obtain or retain business or secure an improper business advantage. We have operations, deal with and make sales to governmental or quasi-governmental entities in non-U.S. countries, including those known to experience corruption, and further expansion of our non-U.S. sales efforts may involve additional regions. In many countries, particularly countries with developing economies, it may be common for businesses to engage in practices prohibited by the FCPA or other applicable laws and regulations. Our activities in these countries pose a heightened risk of unauthorized payments or offers of payments by one of our employees or third-party business partners, representatives, and agents that could violate various laws, including the FCPA. The FCPA, U.K. Bribery Act and other applicable anti-bribery and anti-corruption laws also may hold us liable for acts of corruption and bribery committed by our third-party business partners, representatives, and agents. We and our third-party business partners, representatives, and agents may have direct or indirect interactions with officials and employees of government agencies or state-owned or affiliated entities, and we may be held liable for the corrupt or other illegal activities of our employees or such third parties even if we do not explicitly authorize such activities. The FCPA or other applicable laws and regulations also require that we keep accurate books and records and maintain internal controls and compliance procedures designed to prevent any such actions. While we have implemented policies and procedures to address compliance with such laws, we cannot assure you that our employees or other third parties working on our behalf have not engaged or will not engage in conduct in violation of our policies or applicable law for which we might ultimately be held responsible. Violations of any of these laws or regulations, including the FCPA and the U.K. Bribery Act, may result in whistleblower complaints, negative media coverage, investigations, imposition of significant legal fees, loss of export privileges, as well as severe criminal or civil sanctions, including suspension or debarment from U.S. government contracting. We may also be subject to other liabilities and adverse effects on our reputation, which could negatively affect our business, results of operations, financial condition, and growth prospects. In addition, responding to any enforcement action may result in a significant diversion of management’s attention and resources and significant defense costs and other professional fees. Although our international operations have historically generated a small proportion of our revenues, we are seeking to grow our international business. Our exposure for violating these laws will increase as our non-U.S. presence expands and as we increase sales and operations in foreign jurisdictions. For additional information regarding government investigations and reviews that we are subject to, see "Government Investigations and Reviews" in “Note 21—Commitments and Contingencies” of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.We have only a limited ability to protect or exploit intellectual property rights, which are important to our success. Our failure to adequately obtain, maintain, protect, defend and enforce our proprietary information and intellectual property rights could adversely affect our competitive position.We rely on a combination of confidentiality, intellectual property and other contractual arrangements, including licenses and copyright, trademark and trade secret law to protect much of our proprietary information and intellectual property in cases where we do not believe patent protection is appropriate or obtainable. Despite our efforts to protect our intellectual property and other proprietary rights, third parties may attempt to obtain, copy, use or disclose our intellectual property or other proprietary information or technology without our authorization. In addition to protection under the law and contractual arrangements with our corporate and joint venture partners, employees, consultants, advisors, service providers, suppliers, subcontractors and customers, we generally attempt to limit access to and distribution of our proprietary information. Although our employees and contractors are subject to confidentiality obligations and use restrictions, this protection may be inadequate to deter or prevent them from infringing, misappropriating or otherwise violating our confidential information, technology or other intellectual property or proprietary rights, and can be difficult to enforce. In addition, trade secrets are generally difficult to protect and some courts inside and outside the United States may be less willing or unwilling to protect trade secrets.Leidos Holdings, Inc. Annual Report - 36Table of ContentsPART IWe may be unable to detect unauthorized use of our intellectual property or otherwise take appropriate steps to enforce our rights. Our intellectual property rights may be challenged by others, invalidated, narrowed in scope or held unenforceable through administrative process or litigation in the United States or in foreign jurisdictions. We may be required to expend significant resources and efforts to monitor and protect our intellectual property and other proprietary rights, and we may conclude that, in at least some instances, the benefits of protecting our intellectual property or other proprietary rights may be outweighed by the expense or distraction to our management. We may initiate claims or litigation against third parties for infringement, misappropriation or other violations of our intellectual property or other proprietary rights or to establish the validity of our intellectual property or other proprietary rights, but outcomes in any such litigation can be difficult to predict, and could be time-consuming, result in significant expense to us and divert the efforts of our technical and management personnel. Additionally, because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure during this type of litigation. If we are unable to detect or prevent third parties from infringing, misappropriating or otherwise violating our rights in our patents, copyrights, trademarks, trade secrets or other proprietary rights or information, our competitive position could be adversely affected. Also, in connection with our performance of services for the U.S. government, the U.S. government has certain rights to inventions, data, software codes and related material and intellectual property that we develop under government-funded contracts and subcontracts, which means that the U.S. government may disclose or license our information and intellectual property to third parties, including, in some instances, our competitors. Any exercise by the U.S. government of such rights could adversely affect our competitive position, business, financial condition, results of operations and prospects. We also may be limited in our ability to disclose or license such information and intellectual property to third parties and the U.S. government may also decline to make intellectual property of others available to us under acceptable terms.Third parties may also, from time to time, claim that we have infringed the intellectual property rights of others, resulting in claims against our customers or us, or we may face allegations that we or our service providers, suppliers, subcontractors, or customers have violated the intellectual property rights of others. Even if we believe that intellectual property-related claims are without merit, litigation may be necessary to determine the scope and validity of intellectual property or proprietary rights of others or to protect or enforce our intellectual property rights. If, with respect to any claim against us for violation of third-party intellectual property rights, we are unable to prevail in the litigation, retain or obtain sufficient rights, develop non-infringing solutions or otherwise alter our business practices on a timely or cost-efficient basis, our business and competitive position may be adversely affected. Such claims also could subject us to injunctions and significant liability for damages, potentially including treble damages if we are found to have willfully infringed a third party's intellectual property rights. In addition, our contracts generally indemnify our customers for third-party claims for intellectual property infringement by the services and products we provide. Besides the expense and time to defend such claims and the cost of any large indemnity payments, any dispute with a customer with respect to such obligations also could have adverse effects on our relationship with that customer and other existing and new customers, require us to pay substantial royalty or licensing fees, and divert management’s attention, any of which could harm our business, financial condition and results of operations.Changes in tax laws and regulations or exposure to additional tax liabilities could adversely affect our financial resultsWe are subject to income taxes in the U.S. and numerous foreign jurisdictions. Changes in U.S. (federal or state) or foreign tax laws and regulations, or their interpretation and application, including those with retroactive effect, could result in increases in our tax expense and adversely affect our financial results. For example, beginning in 2022, the Tax Cuts and Jobs Act of 2017 eliminated the option to deduct research and development expenditures immediately in the year incurred and requires taxpayers to amortize such expenditures over five years, which likely will materially decrease our cash from operations unless Congress defers, modifies or repeals this provision with retroactive effect. See “Liquidity and Capital Resources” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained within this Annual Report on Form 10-K for additional information on the impact of this change.Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We are regularly under audit by tax authorities. Although we believe that our tax estimates and tax positions are reasonable, they could be materially affected by many factors including the final outcome of tax audits and related litigation, the introduction of new tax accounting standards, legislation, regulations and related interpretations, our global mix of earnings, the realizability of deferred tax assets and changes in uncertain tax positions. An increase or decrease in our effective tax rate, or an ultimate determination that we owe more taxes than the amounts previously accrued, could have a material adverse impact on our financial condition and results of operations.Leidos Holdings, Inc. Annual Report - 37Table of ContentsPART IRisks Relating to Our StockWe cannot assure you that we will continue to pay or increase dividends on our common stock or to repurchase shares of our common stock.The timing, declaration, amount and payment of any future dividends fall within the discretion of our Board and depend on many factors, including our available cash, estimated cash needs, cash deployment alternatives, earnings, financial condition, operating results and capital requirements, as well as limitations in our contractual agreements, applicable law, regulatory constraints, industry practice and other business considerations that our Board considers relevant. Decreases in asset values or increases in liabilities, including liabilities associated with employee benefit plans and assets and liabilities associated with taxes, can reduce cash, net earnings and stockholders' equity. In addition, the timing and amount of share repurchases under Board-approved share repurchase plans is within the discretion of management and will depend on many factors, including our ability to generate sufficient cash flows from operations in the future or to borrow money from available financing sources, results of operations, capital requirements, general business conditions and applicable law. Our payment of dividends and share repurchases could vary from historical practices or our stated expectations. A change in our dividend or share repurchase programs could have an adverse effect on the market price of our common stock.Provisions in our charter documents and under Delaware law could delay or prevent transactions that many stockholders may favor.Some provisions of our certificate of incorporation and bylaws may have the effect of delaying, discouraging or preventing a merger or acquisition that our stockholders may consider favorable, including transactions in which stockholders might receive a premium for their shares. These restrictions, which may also make it more difficult for our stockholders to elect directors not endorsed by our current directors and management, include mergers and certain other business combinations between a related person and us requiring approval by the holders of a majority of the voting power of such securities that are not owned by the related person unless approved by a majority of continuing directors or certain other exceptions; our stockholders may not act by written consent; our Board may issue, without stockholder approval, shares of undesignated preferred stock, the terms of which may be determined by the Board; and we are also subject to certain restrictions on business combinations under Section 203 of the Delaware General Corporation Law ("DGCL"), which imposes additional requirements for business combinations, and may prevent our stockholders from receiving the benefit from any premium to the market price of our common stock offered by a bidder in a takeover context.Leidos Holdings, Inc. Annual Report - 38Table of ContentsPART IItem 1B. Unresolved Staff CommentsNone.Item 2. PropertiesAs of December 30, 2022, we conducted our operations in 416 locations in 42 states, the District of Columbia and various foreign countries. We occupy approximately 8.6 million square feet of floor space. Of this amount, we own approximately 1.1 million square feet, and the remaining balance is leased. Our major locations are in the Washington, D.C., metropolitan area, where we occupy a combination of leased and owned floor space of approximately 2.2 million square feet. We also have employees working at customer sites throughout the United States and in other countries. As of December 30, 2022, we owned the following properties:LocationNumber ofbuildingsSquarefootageAcreageHuntsville, Alabama7 801,000 90.7 Columbia, Maryland1 95,000 7.3 Orlando, Florida1 85,000 8.5 Oak Ridge, Tennessee1 83,000 8.4 Decatur, Alabama1 50,000 5.0 The nature of our business is such that there is no practicable way to relate occupied space to our reportable segments.Item 3. Legal ProceedingsWe have provided information about legal proceedings in which we are involved in "Note 21—Commitments and Contingencies" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.In addition, we are routinely subject to investigations and reviews relating to compliance with various laws and regulations. Additional information regarding such investigations and reviews is set forth in "Note 21—Commitments and Contingencies” of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.Item 4. Mine Safety DisclosuresNot applicable.Executive Officers of the RegistrantThe following is a list of the names and ages (as of February 14, 2023) of our executive officers, indicating all positions and offices held by each such person and each such person’s business experience during at least the past five years. All such persons have been elected to serve until their successors are elected and qualified or until their earlier resignation or removal.Name of officerAgePosition(s) with the company and prior business experienceRoger A. Krone66Mr. Krone is Chairman and Chief Executive Officer of Leidos. He joined Leidos as CEO in July 2014. Mr. Krone has held leadership roles at The Boeing Company, McDonnell Douglas Corp. and General Dynamics. He is a member of the Georgia Tech Foundation Board of Trustees, WETA Public Television and Radio in Washington board, National Air and Space Museum board, Lear Corporation board, the National Academy of Engineering, the Business Roundtable and the Executive Committee of the Aerospace Industries Association.Christopher R. Cage51Mr. Cage has served as Executive Vice President and Chief Financial Officer since July 2021. He has served in several capacities throughout his 24-year tenure with Leidos, including Senior Vice President, Chief Accounting Officer and Corporate Controller, Senior Vice President for Financial Planning and Analysis and Chief Financial Officer for the Health Group.Leidos Holdings, Inc. Annual Report - 39Table of ContentsPART IName of officerAgePosition(s) with the company and prior business experienceCarly E. Kimball47Ms. Kimball has served as Senior Vice President, Chief Accounting Officer and Corporate Controller since July 2021. Previously, she served as the Company’s Assistant Corporate Controller. Ms. Kimball brings over 20 years of experience leading large teams and has extensive proficiency in accounting, auditing, financial reporting, acquisitions and integrations, as well as business operations. Prior to joining Leidos, she served as Chief Financial Officer of CACI Products Company Inc. and senior manager in Ernst & Young’s Aerospace and Defense audit practice.Gerard A. Fasano57Mr. Fasano has served as President for our Defense Group since October 2018, and before that, as Chief of Business Development and Strategy Officer. Mr. Fasano led the separation from Lockheed Martin and the integration of the Information Systems & Global Solutions Business into Leidos. Prior to joining Leidos, Mr. Fasano served Lockheed Martin Corporation for over 30 years. Jerald S. Howe, Jr.67Mr. Howe has served as Executive Vice President and General Counsel since July 2017. Prior to joining Leidos, Mr. Howe was a partner at Fried, Frank, Harris, Shriver & Jacobson LLP, where he served in the firm’s litigation, government contracts, mergers and acquisitions and aerospace and defense practices. Prior to joining Fried Frank, Mr. Howe held general counsel positions at TASC, a leading aerospace and defense company, and at Veridian Corporation, a publicly traded company that provided advanced technology services and solutions to the intelligence community, military and homeland defense agencies.Steve Cook55Mr. Cook has served as President of the Dynetics Group since April 2022. He previously served as Deputy Group President and Operations Manager of the Leidos Innovations Center from February 2020 to March 2022. He joined Dynetics in 2009 as the director of space technologies before leading the Dynetics Space Division and then later overseeing Dynetics’ corporate development efforts. Prior to joining Dynetics, Mr. Cook enjoyed a long and successful career at NASA, serving in such roles as the deputy manager of NASA’s Marshall Space Transportation Programs and Projects Office as well as the manager of the Ares Projects Office at the Marshall Space Flight Center in Huntsville.James R. Moos53Mr. Moos has served as President for our Civil Group since February 2020. He previously served as Senior Vice President and Acting Group President for the Civil Group since October 2019, and before that, as Deputy President and Chief Operations Officer for the Civil Group. Prior to that, Mr. Moos has served Leidos for over 20 years in several capacities, including Senior Vice President and General Manager of Leidos' former Engineering Solutions Group.Elizabeth A. Porter52Ms. Porter has served as President for our Health Group since August 2020 and, before that, as Acting Group President for the Health Group since March 2020. She previously served as Senior Vice President and Operation Manager for Leidos’ Federal Energy and Environment business. Prior to that role, Ms. Porter served as the Department of Defense Information Networks & Mission Partner Program Director. Prior to joining Leidos, Ms. Porter served Lockheed Martin Corporation for over 20 years in several capacities, most recently as Director of Energy Initiatives, Corporate Engineering & Technology.Roy Stevens54Mr. Stevens has served as President for our Intelligence Group since July 2021, and before that, as Chief of Business Development and Strategy. Prior to joining Leidos, Mr. Stevens served Lockheed Martin Corporation in a variety of executive level positions for over 20 years, most recently as Vice President of Global Solutions under the Information Systems & Global Solutions business, and has also been integral to the merger and acquisition of several companies during his career. He serves on the Board of Directors for Cornerstones.Leidos Holdings, Inc. Annual Report - 40Table of ContentsPART IName of officerAgePosition(s) with the company and prior business experienceDebbie Opiekun60Ms. Opiekun has served as Chief Business Development Officer since August 2021, and before that, as Senior Vice President and Operations Manager of Leidos’ Military and Veterans Health Solutions business. She previously served as Leidos Deputy Health Group President and Senior Vice President Capture Operations and Excellence. Prior to joining Leidos, Ms. Opiekun served Lockheed Martin Corporation in a variety of positions for over 30 years, most recently as Director Capture Operations and Excellence. Thomas C. Sanglier62Mr. Sanglier has served as Senior Vice President and Chief Audit Executive since July 2022. Prior to joining Leidos, Mr. Sanglier served as Senior Director, Internal Audit with Raytheon Technologies from November 2016 to June 2022 and as a Partner with Ernst & Young’s Advisory practice serving private and public organizations in the technology, manufacturing and professional services industries during June 2008 to December 2010. He currently serves as Chair of the North American Board and a member of the Global Board of the Institute of Internal Auditors ("IIA"). He has been involved as a volunteer leader with the IIA since becoming a member in 2011. Mr. Sanglier has also served as a member of The IIA’s Audit Committee, Guidance Development Committee, North American Publications Advisory Committee and multiple task forces.Maureen Waterston58Ms. Waterston has served as Chief Human Resources Officer for Leidos since March 2022. Ms. Waterston brings over 25 years of experience overseeing talent, recruitment, and development; employee and labor relations; compensation and benefits; and diversity and inclusion across a global workforce. Prior to joining Leidos, Ms. Waterston served as Chief Human Resources Officer for Pratt & Whitney from November 2015 to March 2022, Chief Human Resources Officer for United Technologies Building & Industrial Systems and Global Chief Human Resources Officer for Otis Elevator Company.James F. Carlini57Mr. Carlini has served as Chief Technology Officer of Leidos since June 2019. Prior to joining Leidos, Mr. Carlini founded and operated a national security consultancy from May 2006 to October 2018. Previously, Mr. Carlini served at Northrop Grumman Electronic Systems as Vice President of Advanced Development Programs between July 2002 to May 2006. He also served at the Defense Advanced Research Projects Agency (DARPA) for six years, with his last position being Director of the Special Projects Office. Mr. Carlini is a former member of the United States Army Science Board and the United States Air Force Scientific Advisory Board. He is currently a member of the Department of Defense’s Defense Science Board.M. Victoria Schmanske 60Ms. Schmanske has served as the Executive Vice President of Leidos Corporate Operations since July 2021, and before that, as President for the Intelligence Group. Ms. Schmanske has also served as the Leidos Chief Administrative Officer and Deputy President and Chief Operations Officer for the Health Group. Prior to joining Leidos, Ms. Schmanske served Lockheed Martin Corporation for over 30 years, most recently as Vice President for Operations IS&GS. She serves on multiple outside boards to include Intelligence and National Security Alliance, U.S. Geospatial Intelligence Foundation and The Women’s Center.Leidos Holdings, Inc. Annual Report - 41Table of ContentsPART IIItem 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesOur common stock is listed on the New York Stock Exchange ("NYSE") under the ticker symbol "LDOS." Holders of Common StockAs of February 7, 2023, there were approximately 19,798 holders of record of Leidos common stock. The number of stockholders of record of our common stock is not representative of the number of beneficial owners due to the fact that many shares are held by depositories, brokers or nominees. Dividend PolicyDuring fiscal 2022 and 2021, we declared and paid quarterly dividends totaling $1.44 and $1.40 per share, respectively, of Leidos common stock. We currently intend to continue paying dividends on a quarterly basis, although the declaration of any future dividends will be determined by our Board of Directors and will depend on many factors, including available cash, estimated cash needs, earnings, financial condition, operating results and capital requirements, as well as limitations in our contractual agreements, applicable law, regulatory constraints, industry practice and other business considerations that the Board of Directors considers relevant. Our ability to declare and pay future dividends on Leidos stock may be restricted by the provisions of Delaware law and covenants in our then-existing indebtedness arrangements.Stock Performance GraphThe following graph compares the total cumulative five-year return on Leidos common stock through December 30, 2022 to two indices: (i) the Standard & Poor's 500 Composite index and (ii) the Standard & Poor's 500 IT Services Industry index. The graph assumes an initial investment of $100 on December 29, 2017, and that dividends, if any, have been reinvested. The comparisons in the graph are required by the SEC, based upon historical data and are not intended to forecast or be indicative of possible future performance of Leidos common stock.Comparison of Cumulative Total ReturnLeidos Holdings, Inc. Annual Report - 42Table of ContentsPART IICompany/Market/Peer Group12/29/201712/28/20181/3/20201/1/202112/31/202112/30/2022Leidos Inc.$100.00 $82.79 $159.84 $171.33 $147.03 $176.50 S&P 500 Composite Index$100.00 $94.80 $125.91 $148.85 $191.58 $156.88 S&P 500 IT Services Index$100.00 $103.70 $147.74 $180.40 $189.20 $154.13 Purchases of Equity SecuritiesIn February 2022, our Board of Directors authorized a share repurchase program of up to 20 million shares of our outstanding common stock. The shares may be repurchased from time to time in one or more open market repurchases or privately negotiated transactions, including accelerated share repurchase transactions. The actual timing, number and value of shares repurchased under the program will depend on a number of factors, including the market price of Leidos common stock, general market and economic conditions, applicable legal requirements, compliance with the terms of our outstanding indebtedness and other considerations. There is no assurance as to the number of shares that will be repurchased, and the repurchase program may be suspended or discontinued at any time at our Board of Directors' discretion. This share repurchase authorization replaces the previous share repurchase authorization announced in February 2018. As of December 30, 2022, the maximum number of shares that may yet be repurchased under the program was 15,203,974.For the three months ended December 30, 2022, there were no repurchases of our common stock.Item 6. [Reserved]Leidos Holdings, Inc. Annual Report - 43Table of ContentsPART IIItem 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis of Leidos Holdings, Inc.'s ("Leidos") financial condition, results of operations and quantitative and qualitative disclosures about business environment and trends and market risk should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties, including those described under the heading “Forward-Looking Statements.” You should also review the disclosure under Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.Unless indicated otherwise, references in this report to “we,” “us” and “our” refer collectively to Leidos and its consolidated subsidiaries. In this section, we discuss our financial condition, changes in financial condition and results of our operations for the year ended December 30, 2022, compared to the year ended December 31, 2021. For a discussion and analysis comparing our results for the year ended December 31, 2021, to the year ended January 1, 2021, see our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 15, 2022, under Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” OverviewWe are a FORTUNE 500® technology, engineering, and science company that provides services and solutions in the defense, intelligence, civil and health markets, both domestically and internationally. We bring domain-specific capabilities and innovations to customers in each of these markets by leveraging five technical core capabilities: digital modernization, cyber operations, mission software systems, integrated systems and mission operations. Our customers include the U.S. Department of Defense ("DoD"), the U.S. Intelligence Community, the U.S. Department of Homeland Security, the Federal Aviation Administration, the Department of Veterans Affairs and many other U.S. civilian, state and local government agencies, foreign government agencies and commercial businesses. Approximately 8% of our revenues and tangible long-lived assets are generated by or owned by entities located outside of the United States. We operate in three reportable segments: Defense Solutions, Civil and Health. Additionally, we separately present the unallocable costs associated with corporate functions as Corporate. Effective July 3, 2021, certain contracts were reassigned from the Defense Solutions reportable segment to the Civil reportable segment. Impact on the first half of fiscal 2021 segment results were determined to be immaterial and have not been recast to reflect this change.For additional information regarding our reportable segments, see “Business” in Part I and "Note 20—Business Segments" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.Our significant initiatives include the following:•achieving annual revenue growth through internal collaboration and better leveraging of key differentiators across our company and the deployment of resources and investments into higher growth markets;•increasing headcount and internal direct labor content on our contract portfolio;•continued improvement in our back-office infrastructure and related business processes for greater effectiveness and efficiency across all business functions; and•disciplined deployment of our cash resources and use of our capital structure to enhance shareholder value while retaining an appropriate amount of financial leverage.Sales Trend. For fiscal 2022, revenues increased $0.7 billion, or 5%, compared to fiscal 2021, primarily due to a net increase in volumes on certain programs, program wins and a net increase in revenues related to our business acquisitions. We also received $28 million in recoveries related to stop work orders on certain programs as a result of COVID-19. The increase was partially offset by the completion of certain contracts and unfavorable exchange rate movements.Leidos Holdings, Inc. Annual Report - 44Table of ContentsPART IIOperating Expenses and Income Trend. For fiscal 2022, operating expenses increased by $0.7 billion, or 6%, compared to fiscal 2021. Operating margin for fiscal 2022 was 7.6% compared to 8.4% for fiscal 2021. Operating income was $1,088 million, a $64 million decrease compared to fiscal 2021. The decrease in operating income was primarily attributable to the completion of certain contracts, increase in legal fees and settlement costs and impairment charges of $37 million related to our ongoing facility rationalization efforts. The decrease in operating income was partially offset by program wins and $28 million in recoveries related to stop work orders on certain programs as a result of COVID-19.From a macroeconomic perspective, our industry is under general competitive pressures associated with spending from our largest customer, the U.S. government, and requires a high level of cost management focus to allow us to remain competitive. Although the U.S. Presidential Administration has not indicated a desire to reduce spending in the defense and homeland security sectors, the likelihood, extent and duration of current spending levels in these areas remains unclear. We continue to review our cost structure against our anticipated sales and undertake cost management actions and efficiency initiatives where necessary.COVID-19 For fiscal 2022, the COVID-19 pandemic did not have a material impact to revenues and operating income, other than the receipt of $28 million in recoveries, within our Health segment related to stop work orders on certain programs. The volume of global passenger air travel remains below pre-pandemic levels, which continues to impact the operations of our Security Enterprise Solutions reporting unit. The full extent of the impact of the COVID-19 pandemic on our operational and financial performance, including our ability to execute on programs in the expected timeframe, will depend on future developments, including the duration and spread of the pandemic and the distribution of vaccines, all of which are uncertain and cannot be predicted.Business Environment and TrendsU.S. Government MarketsIn fiscal 2022, we generated approximately 86% of our total revenues from contracts with the U.S. government, either as a prime contractor or a subcontractor to other contractors engaged in work for the U.S. government. Revenues under contracts with the DoD and U.S. Intelligence Community, including subcontracts under which the DoD or the U.S. Intelligence Community is the ultimate purchaser, represented approximately 44% of our total revenues for fiscal 2022. Accordingly, our business performance is affected by the overall level of U.S. government spending, especially national security, homeland security and intelligence spending, and the alignment of our service and product offerings and capabilities with current and future budget priorities of the U.S. government. President Biden signed the $1.7 trillion GFY 2023 omnibus spending bill into law on December 29, 2022. The omnibus spending bill funds the federal government through September 30, 2023. The bill includes $772.5 billion in non-defense spending and $858.4 billion in defense spending. The bill also includes $85 billion in emergency spending not included in the discretionary amount. The new 118th Congress will begin to work on the GFY 2024 appropriations bills in the spring of 2023.Trends in the U.S. government contracting process, including a shift towards multiple-awards contracts, in which certain contractors are preapproved using IDIQ and U.S. General Services Administration ("GSA") contract vehicles, have increased competition for U.S. government contracts, reduced backlogs by shortening periods of performance on contracts and increased pricing pressure. We expect that a majority of the business that we seek in the foreseeable future will be awarded through a competitive bidding process. For more information on these risks and uncertainties, see “Risk Factors” in Part I of this Annual Report on Form 10-K.International MarketsSales to customers in international markets represented approximately 8% of total revenues for fiscal 2022. Our international customers include foreign governments and their agencies. Our international business increases our exposure to international markets and the associated international regulatory, foreign currency exchange rate and geopolitical risks.Changes in international trade policies, including higher tariffs on imported goods and materials, may increase our procurement costs of certain IT hardware used both on our contracts and for internal use. However, we expect to recover certain portions of these higher tariffs through our cost-plus contracts. While we evaluate the impact of higher tariffs, currently, we do not expect tariffs to have a significant impact to our business.Leidos Holdings, Inc. Annual Report - 45Table of ContentsPART IIKey Performance MeasuresThe primary financial performance measures we use to manage our business and monitor results of operations are revenue, operating income, cash flows from operations and diluted earnings per share. Bookings and backlog are also useful measures for management and investors to evaluate our performance and potential future revenues. In addition, we consider business performance by contract type to be useful to management and investors when evaluating our operating income and margin performance.Results of OperationsOur results of operations for the periods presented were as follows: Year Ended2022 to 2021 December 30,2022December 31,2021Dollar changePercentchange (dollars in millions)Revenues$14,396 $13,737 $659 5 %Cost of revenues12,312 11,723 589 5 %Selling, general and administrative expenses950 860 90 10 %Credit losses (recoveries), net1 (9)10 (111)%Acquisition, integration and restructuring costs17 27 (10)(37)%Asset impairment charges40 4 36 NMEquity earnings of non-consolidated subsidiaries(12)(20)8 (40)%Operating income1,088 1,152 (64)(6)%Non-operating expense, net(202)(185)(17)9 %Income before income taxes886 967 (81)(8)%Income tax expense(193)(208)15 (7)%Net income693 759 (66)(9)%Less: net income attributable to non-controlling interest8 6 2 33 %Net income attributable to Leidos common stockholders$685 $753 $(68)(9)%Operating income margin7.6 %8.4 %NM - Not meaningfulSegment and Corporate ResultsYear Ended2022 to 2021Defense SolutionsDecember 30,2022December 31,2021Dollar changePercentchange (dollars in millions)Revenues$8,244 $8,032 $212 3 %Operating income541 569 (28)(5)%Operating income margin6.6 %7.1 %The increase in revenues for fiscal 2022 as compared to fiscal 2021 was primarily attributable to program wins, a net increase in volumes on certain programs and a $63 million net increase in revenues related to our acquisitions made in the second and third quarters from the prior year and the Cobham Special Mission acquisition made in the current year. The increase was partially offset by the completion of certain contracts, contracts that were reassigned from Defense Solutions reportable segment to the Civil reportable segment during the third quarter of fiscal 2021 and $95 million related to unfavorable exchange rate movements. The decrease in operating income for fiscal 2022 as compared to fiscal 2021 was primarily attributable to the completion of certain contracts, net write-downs on certain contracts, increased amortization expense of $8 million and $6 million related to unfavorable exchange rate movements. Fiscal 2022 also included impairment charges of $12 million related to our ongoing facility rationalization efforts (see "Note 10—Leases"). The decrease was partially offset by program wins and a net increase in volumes on certain programs.Leidos Holdings, Inc. Annual Report - 46Table of ContentsPART IIYear Ended2022 to 2021CivilDecember 30,2022December 31,2021Dollar changePercent change(dollars in millions)Revenues$3,464 $3,157 $307 10 %Operating income234 248 (14)(6)%Operating income margin6.8 %7.9 %The increase in revenues for fiscal 2022 as compared to fiscal 2021 was primarily attributable to program wins, a net increase in program volumes and contracts that were reassigned from Defense Solutions reportable segment to the Civil reportable segment during the third quarter of fiscal 2021. The increase was partially offset by the completion of certain contracts and $12 million of unfavorable exchange rate movements.The decrease in operating income for fiscal 2022 as compared to fiscal 2021 was primarily attributable to a $19 million increase in legal fees and settlement costs resulting from an adverse arbitration ruling related to the 2016 acquisition of the Information Systems & Global Solutions business (“IS&GS Business”) from Lockheed Martin and impairment charges of $14 million related to our ongoing facility rationalization efforts (see "Note 10—Leases"). The decreases were partially offset by a net increase in program volumes. Operating income for fiscal 2021 included a $26 million benefit from a legal reserve adjustment related to the Mission Support Alliance joint venture (see "Note 1—Nature of Operations and Basis of Presentation"). Year Ended2022 to 2021HealthDecember 30,2022December 31,2021Dollar changePercentchange (dollars in millions)Revenues$2,688 $2,548 $140 5 %Operating income421 442 (21)(5)%Operating income margin15.7 %17.3 %The increase in revenues for fiscal 2022 as compared to fiscal 2021 was primarily attributable to a net increase in program volumes, program wins and $28 million in recoveries related to stop work orders on certain programs as a result of COVID-19. The increase was partially offset by the completion of certain contracts.The decrease in operating income for fiscal 2022 as compared to fiscal 2021 was primarily attributable to a net decrease in volumes on higher margin programs and the completion of certain contracts. The decrease was partially offset by $28 million in recoveries related to stop work orders on certain programs as a result of COVID-19 and program wins. Year Ended2022 to 2021CorporateDecember 30,2022December 31,2021Dollar changePercentchange (dollars in millions)Operating loss$(108)$(107)$(1)1 %The increase in operating loss for fiscal 2022 as compared to fiscal 2021 was primarily attributable to an increase in legal costs partially offset by lower acquisition and integration costs.Equity earnings of non-consolidated subsidiariesWe have certain non-controlling ownership interests in equity method investments. For fiscal 2022 and fiscal 2021 we recorded earnings of $12 million and $20 million, respectively, from our equity method investments.Leidos Holdings, Inc. Annual Report - 47Table of ContentsPART IINon-Operating Expense, NetNon-operating expense, net increased $17 million for fiscal 2022 as compared to fiscal 2021, primarily due to higher interest expense driven by increased interest rates.Provision for Income Taxes Our effective tax rate was 21.8%, and 21.5% in fiscal 2022 and 2021, respectively. The effective tax rate for fiscal 2022 and 2021 were both favorably impacted primarily by federal research tax credits and excess tax benefits related to employee stock-based payment transactions.Beginning in 2022, the Tax Cuts and Jobs Act of 2017 ("TCJA") eliminated the option to currently deduct certain research and development costs for tax purposes and requires taxpayers to capitalize and amortize research costs over five years. Based upon our interpretation of the law as enacted, we recorded the estimated fiscal 2022 impact, resulting in increases of $130 million to both our income taxes payable and net deferred tax assets, and our fiscal 2022 unrecognized tax benefits increased by $91 million with a corresponding increase to net deferred tax assets. We expect this TCJA provision to have a similar impact to income taxes payable, unrecognized tax benefits and net deferred tax assets during fiscal 2023. The actual impact will depend on the amount of research and development costs the Company will incur, whether Congress modifies or repeals this provision and whether new guidance and interpretive rules are issued by the U.S. Treasury, among other factors.Bookings and BacklogWe had net bookings of $15.4 billion and $15.5 billion during fiscal 2022 and 2021, respectively. Net bookings represent the estimated amount of revenue to be earned in the future from funded and unfunded contract awards that were received during the year, net of any adjustments to previously awarded backlog amounts. We calculate net bookings as the year’s ending backlog, plus the year’s revenues, less the prior year’s ending backlog and any impacts from foreign currency or acquisitions and divestitures.Backlog represents the estimated amount of future revenues to be recognized under negotiated contracts. We segregate our backlog into two categories as follows:•Funded Backlog. Funded backlog for contracts with the U.S. government represents the value on contracts for which funding is appropriated less revenues previously recognized on these contracts. Funded backlog for contracts with non-U.S. government entities and commercial customers represents the estimated value on contracts, which may cover multiple future years, under which we are obligated to perform, less revenues previously recognized on the contracts.•Negotiated Unfunded Backlog. Negotiated unfunded backlog represents estimated amounts of revenue to be earned in the future from contracts for which funding has not been appropriated and unexercised priced contract options. Negotiated unfunded backlog does not include unexercised option periods and future potential task orders expected to be awarded under IDIQ, GSA Schedule or other master agreement contract vehicles, with the exception of certain IDIQ contracts where task orders are not competitively awarded and separately priced but instead are used as a funding mechanism, and where there is a basis for estimating future revenues and funding on future anticipated task orders.The estimated value of our total backlog for the periods presented was as follows:Year endedDecember 30, 2022December 31, 2021SegmentFundedUnfundedTotalFundedUnfundedTotal(in millions)Defense Solutions$4,442 $14,155 $18,597 $4,393 $15,274 $19,667 Civil1,876 8,790 10,666 1,628 7,903 9,531 Health2,064 4,455 6,519 1,428 3,829 5,257 Total$8,382 $27,400 $35,782 $7,449 $27,006 $34,455 Leidos Holdings, Inc. Annual Report - 48Table of ContentsPART IITotal backlog at December 30, 2022, and December 31, 2021, included $610 million and $800 million, respectively, of backlog acquired during the year through business combinations in our Defense Solutions reportable segment.The increase in backlog as of December 30, 2022, as compared to December 31, 2021, included an unfavorable impact of $233 million due to the movements in the British pound and Australian dollar when compared to the U.S. dollar.Bookings and backlog fluctuate from period to period depending on our success rate in winning contracts and the timing of contract awards, renewals, modifications and cancellations, as well as foreign currency movements. Contract awards may be negatively impacted by ongoing industry-wide delays in procurement decisions and budget cuts by the U.S. government as discussed in “Business Environment and Trends” in this Annual Report on Form 10-K.We expect to recognize a substantial portion of our funded backlog as revenues within the next 12 months. However, the U.S. government may cancel any contract at any time through a termination for the convenience of the U.S. government. In addition, certain contracts with commercial or non-U.S. government customers may include provisions that allow the customer to cancel at any time. Most of our contracts have cancellation terms that would permit us to recover all or a portion of our incurred costs and fees for work performed.Contract TypesOur earnings and profitability may vary materially depending on changes in the proportionate amount of revenues derived from each type of contract. For a discussion of the types of contracts under which we generate revenues, see “Business—Contract Types” in Part I of this Annual Report on Form 10-K. Revenues by contract type as a percentage of our total revenues for the periods presented were as follows: Year Ended December 30,2022December 31,2021January 1,2021Cost-reimbursement and fixed-price-incentive-fee50 %50 %51 %Firm-fixed-price38 %37 %36 %Time-and-materials and fixed-price-level-of-effort 12 %13 %13 %Total100 %100 %100 %Liquidity and Capital ResourcesOverview of LiquidityAs of December 30, 2022, we had $516 million in cash and cash equivalents. Additionally, we have an unsecured revolving credit facility which can provide up to $750 million in additional borrowing, if required. During fiscal 2022 and 2021, there were no borrowings outstanding under the credit facilities. At December 30, 2022 and December 31, 2021, we had outstanding debt of $4.9 billion and $5.1 billion, respectively. On May 6, 2022, we entered into a Term Loan Agreement which provided for a senior unsecured term loan facility in an aggregate principal amount of $380 million. We have a commercial paper program in which we may issue short-term unsecured commercial paper notes not toexceed $750 million and have maturities of up to 397 days from the date of issuance (see "Note 13—Debt"). As of December 30, 2022, we did not have any commercial paper notes outstanding.We made principal payments on our debt of $545 million, $106 million and $731 million during fiscal 2022, 2021 and 2020, respectively. This activity included required principal payments on our term loans of $476 million, $96 million and $72 million during fiscal 2022, 2021 and 2020, respectively. During fiscal 2020, we made $4,925 million of principal repayments for outstanding debt and retired the $450 million senior notes. The notes outstanding as of December 30, 2022, contain financial covenants and customary restrictive covenants. We were in compliance with all covenants as of December 30, 2022.Leidos Holdings, Inc. Annual Report - 49Table of ContentsPART IIInterest on our Credit Facilities is calculated based on the London Interbank Offered Rate (“LIBOR”). On July 27, 2017, the U.K.’s Financial Conduct Authority announced that LIBOR would be discontinued or become unavailable as a reference rate by the end of 2021 and LIBOR will be fully discontinued or become unavailable as a benchmark rate by June 2023. In December 2022, the FASB issued guidance which provides relief for entities with such LIBOR denominated credit instruments so that entities may continue to account for contract modifications as a continuation of the existing contract and the continuation of the hedge accounting arrangement through December 31, 2024. Although our Credit Facilities include mechanics to facilitate the adoption by us and our lenders of an alternative benchmark rate for use in place of LIBOR, no assurance can be made that such alternative benchmark rate will perform in a manner similar to LIBOR or result in interest rates that are at least as favorable to us as those that would have resulted had LIBOR remained in effect, which could result in an increase in our interest expense and other debt service obligations. In addition, the overall credit market may be disrupted as a result of the replacement of LIBOR or in the anticipation thereof, which could have an adverse impact on our ability to refinance, reprice, or amend our existing indebtedness or incur additional indebtedness on favorable terms.We paid dividends of $199 million, $199 million and $196 million for fiscal 2022, 2021 and 2020, respectively.During fiscal 2022, we sold $209 million of accounts receivable under accounts receivable purchase agreements and received proceeds of $209 million (see "Note 6—Receivables"). There were no sales of accounts receivable in the second half of fiscal 2022.We may from time to time seek to retire or purchase our outstanding debt through cash purchases in the open market, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.Stock repurchases of Leidos common stock may be made on the open market or in privately negotiated transactions with third parties including through accelerated share repurchase ("ASR") agreements. Whether repurchases are made and the timing and actual number of shares repurchased depends on a variety of factors including price, corporate capital requirements, other market conditions and regulatory requirements. The repurchase program may be accelerated, suspended, delayed or discontinued at any time.During fiscal 2021 and 2020, we made open market repurchases of our common stock for an aggregate purchase price of $237 million and $67 million, respectively. There were no open market share repurchases in fiscal 2022.In fiscal 2022, we entered into an ASR with a financial institution to repurchase shares of our outstanding common stock. We paid $500 million to the financial institution and received 4.8 million shares (see "Note 16—Earnings Per Share" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K). All shares delivered were immediately retired.During fiscal 2022, we made a $25 million payment in connection with the adverse arbitration ruling related to the 2016 acquisition of the IS&GS Business from Lockheed Martin. Beginning in 2022, a provision in the TCJA which eliminated the option to currently deduct research and development costs for tax purposes and requires taxpayers to capitalize and amortize the costs over five years became effective. We anticipate our tax cash payments to increase by $300 million in 2023 primarily to cover both the 2022 and 2023 tax obligations related to this provision. The actual impact will depend on the amount of research and development costs the Company will incur during fiscal 2023 and whether new guidance and interpretive rules are issued by the U.S. Treasury, among other factors. We will continue to assess our liquidity needs as the tax legislation and pandemic evolve.For the next 12 months, we anticipate that we will be able to meet our liquidity needs, including servicing our debt, through cash generated from operations, available cash balances, sales of accounts receivable and, if needed, borrowings from our revolving credit facility and commercial paper program. Leidos Holdings, Inc. Annual Report - 50Table of ContentsPART IISummary of Cash FlowsThe following table summarizes cash flow information for the periods presented: Year Ended December 30,2022December 31,2021 (in millions)Net cash provided by operating activities$986 $1,031 Net cash used in investing activities(313)(730)Net cash used in financing activities(865)(113)Net (decrease) increase in cash, cash equivalents and restricted cash$(192)$188 Net cash provided by operating activities decreased $45 million for fiscal 2022 as compared to fiscal 2021. The decrease was primarily due to a $25 million payment in connection with the adverse arbitration ruling related to the 2016 acquisition of the IS&GS Business from Lockheed Martin and $23 million of payments for other legal and tax settlements occurred during the current year, partially offset by favorable working capital changes.Net cash used in investing activities decreased $417 million for fiscal 2022 as compared to fiscal 2021. The decrease was primarily due to $430 million of less cash paid related to our business acquisitions in current year as compared to prior year and $15 million of proceeds received from the sale of Aviation & Missile Solutions LLC in the current year. The decrease was partially offset by $25 million of higher capital expenditures in the current year.Net cash used in financing activities increased $752 million for fiscal 2022 as compared to fiscal 2021. The increase was primarily due to $439 million increase in principal payments of our debt, an increase of $272 million in stock repurchases primarily attributable to the accelerated share repurchase agreement and a $45 million decrease in net capital contributions received from our non-controlling interest.Off-Balance Sheet ArrangementsWe have outstanding performance guarantees and cross-indemnity agreements in connection with certain aspects of our business. We have letters of credit outstanding principally related to performance guarantees on contracts and surety bonds outstanding principally related to performance and subcontractor payment bonds. We also have future lease commitments for the use of certain aircraft as described in "Note 21—Commitments and Contingencies" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K. These arrangements have not had, and management does not believe it is likely that they will in the future have, a material effect on our liquidity, capital resources, operations or financial condition.Contractual ObligationsOur future contractual obligations are related to debt, finance and operating leases, long-term liabilities under deferred compensation arrangements, purchase obligations for long-term purchases and service agreements and other liabilities. For more information, see "Note 10—Leases", "Note 13—Debt", “Note 19—Retirement Plans” and "Note 21—Commitments and Contingencies" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.We have interest payments related to our outstanding debt and finance leases. As of December 30, 2022, future scheduled interest payments on our outstanding debt and finance leases were $195 million, expected to be paid in fiscal 2023 and $946 million expected to be paid thereafter.As of December 30, 2022, future payments on our deferred compensation arrangements and purchase obligations for long-term purchases and service agreements were $36 million, expected to be paid in fiscal 2023, and $120 million expected to be paid thereafter. Our future payments do not include $92 million of income tax liabilities as a result of uncertain tax positions arising from certain provisions of the TCJA becoming effective in 2022, and the timing of such payments, if any, cannot be reasonably estimated. For additional information, see "Note 18—Income Taxes" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K. Leidos Holdings, Inc. Annual Report - 51Table of ContentsPART IIGuarantors and Issuers of Guaranteed SecuritiesLeidos Holdings, Inc. (“Guarantor”) has fully and unconditionally guaranteed the debt securities of its subsidiary, Leidos, Inc. (“Issuer”), that were issued pursuant to transactions that were registered under the Securities Act of 1933, as amended (collectively, the “Registered Notes”). The following is a list of the Registered Notes guaranteed by Leidos Holdings, Inc. Senior unsecured Registered Notes:$500 million 2.950% notes, due May 2023$500 million 3.625% notes, due May 2025$750 million 4.375% notes, due May 2030$1,000 million 2.300% notes, due February 2031Leidos Holdings, Inc. has also fully and unconditionally guaranteed debt securities of Leidos, Inc. that were issued pursuant to transactions that were not registered under the Securities Act of 1933, as amended. The following is a list of unregistered debt securities guaranteed by Leidos Holdings, Inc.Senior unsecured unregistered debt securities issued by Leidos, Inc.:$250 million 7.125% notes, due July 2032$300 million 5.500% notes, due July 2033Additionally, Leidos, Inc. has fully and unconditionally guaranteed debt securities of Leidos Holding, Inc. that were issued pursuant to transactions that were not registered under the Securities Act of 1933, as amended. The following is a list of unregistered debt securities guaranteed by Leidos, Inc.Senior unsecured unregistered debt securities issued by Leidos Holdings, Inc.:$300 million 5.950% notes, due December 2040The following summarized financial information includes the assets, liabilities and results of operations for the Guarantor and Issuer of the Registered Notes described above. Intercompany balances and transactions between the Issuer and Guarantor have been eliminated from the financial information below. Investments in the consolidated subsidiaries of the Issuer and Guarantor that do not guarantee the senior unsecured notes have been excluded from the financial information. Intercompany payables represent amounts due to non-guarantor subsidiaries of the Issuer.Balance Sheet Information for the Guarantor and Issuer of Registered Notes December 30,2022(in millions)Total current assets$2,115 Goodwill5,810 Other long-term assets1,188 Total assets$9,113 Total current liabilities$2,922 Long-term debt, net of current portion3,925 Intercompany payables1,695 Other long-term liabilities699 Total liabilities$9,241 Leidos Holdings, Inc. Annual Report - 52Table of ContentsPART IIStatement of Income Information for the Guarantor and Issuer of Registered NotesDecember 30,2022(in millions)Revenues, net$9,808 Operating income698 Net income 250 Commitments and ContingenciesWe are subject to a number of reviews, investigations, claims, lawsuits, other uncertainties and future obligations related to our business. For a discussion of these items, see "Note 10—Leases" and "Note 21—Commitments and Contingencies" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.Critical Accounting EstimatesOur discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Management evaluates these estimates and assumptions on an ongoing basis. Our estimates and assumptions have been prepared by management on the basis of the most current and best available information. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions and conditions.We have identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our results of operations or financial condition.•Revenue Recognition•Goodwill and Intangible AssetsRevenue RecognitionWe perform work under various types of contracts, which include firm-fixed-price ("FFP"), time-and-materials ("T&M"), fixed-price-level-of-effort ("FP-LOE"), cost-plus-fixed-fee ("CPFF"), cost-plus-award-fee, cost-plus-incentive-fee and fixed-price-incentive-fee contracts. Some of these contracts require us to use estimates of the revenue and cost associated with the design, manufacture and delivery of our products and services for the purposes of recognizing revenue.We also evaluate whether two or more contracts should be combined and accounted for as a single contract, including the task orders issued under an IDIQ award. In addition, we assess contract modifications to determine whether changes to existing contracts should be accounted for as part of the original contract or as a separate contract. Some of our cost-plus and fixed-price contracts contain award fees, incentive fees or other provisions that may either increase or decrease the transaction price. These variable amounts generally are awarded upon achievement of certain performance metrics, program milestones or cost targets and can be based upon customer discretion. We estimate variable consideration at the most probable amount that we expect to be entitled to, based on the assessment of the contractual variable fee criteria, complexity of work and related risks, extent of customer discretion, amount of variable consideration received historically and the potential of significant reversal of revenue.Leidos Holdings, Inc. Annual Report - 53Table of ContentsPART IIOn FFP contracts requiring system integration and cost-plus contracts with variable consideration, revenue is recognized over time generally using a method that measures the extent of progress towards completion of a performance obligation, principally using a cost-input method (referred to as the cost-to-cost method). Under the cost-to-cost method, revenue is recognized based on the proportion of total costs incurred to estimated total costs-at-completion ("EAC"). A performance obligation's EAC includes all direct costs such as materials, labor, subcontract costs, overhead and a ratable portion of general and administrative costs. In addition, an EAC of a performance obligation includes future losses estimated to be incurred on onerous contracts, as and when known. For the impacts of changes in estimates on our contracts, (see "Note 3—Summary of Significant Accounting Policies").Goodwill and Intangible Assets Goodwill represents the excess of the fair value of consideration transferred, plus the fair value of any non-controlling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. We recognize purchased intangible assets in connection with our business acquisitions at fair value on the acquisition date. Goodwill is not amortized, but instead is tested annually, at the beginning of the fourth quarter, for impairment at the reporting unit level and may be tested more frequently if events or circumstances indicate that the carrying value may not be recoverable. Intangible assets with indefinite lives are not amortized but are assessed for impairment at the beginning of the fourth quarter and whenever events or changes in circumstances indicate that the carrying value may not be recoverable.Goodwill and intangible assets, net, collectively represent 59% and 60% of our total assets as of December 30, 2022 and December 31, 2021, respectively.We may perform qualitative or quantitative analysis to test for impairment. Qualitative factors may include macroeconomic, industry and market considerations, overall financial performance, industry, legal and other relevant events and factors affecting the reporting unit.For quantitative analysis, we use discounted cash flow models and market multiple analyses in order to estimate reporting unit fair values. Discounted cash flow analyses rely on significant judgement and assumptions about expected future cash flows, weighted-average cost of capital, discount rates, expected long-term growth rates and operating margins. These assumptions are based on estimates of future sales and earnings after considering such factors as general market conditions, customer budgets, existing firm and future orders, changes in working capital, long term business plans and recent operating performance. Market multiple analyses incorporate significant judgments and assumptions related to the selection of guideline public companies, our forecast earnings before interest, taxes, depreciation and amortization (“EBITDA”), forecast EBITDA of guideline public companies and control premium estimates. We performed our annual test for impairment as of October 1, 2022, which resulted in no impairments being identified. However, through this analysis we determined that our Security Enterprise Solutions reporting unit within the Civil reportable segment, which holds goodwill in the amount of $899 million as of December 30, 2022, was at risk of future impairment. The estimated fair value of the Security Enterprise Solutions reporting unit exceeded the carrying value by approximately 13%. Operations of the reporting unit rely heavily on the sales and servicing of security and detection products, which have been negatively impacted by COVID-19. The forecasts utilized to estimate the fair value of the Security Enterprise Solutions reporting unit assume continued global operations in all of our existing markets and a gradual improvement in the global aviation security product and related service sales, reaching pre-COVID-19 levels by fiscal 2025. The fair value of the reporting unit is also negatively impacted by rising interest rate factored into cost of capital. In the event that there are significant unfavorable changes to the forecasted cash flows of the reporting unit (including if the impact of COVID-19 on passenger travel levels is more prolonged or severe than what is incorporated into our forecast), terminal growth rates or the cost of capital used in the fair value estimates, we may be required to record a material impairment of goodwill or intangible assets at a future date.Recently Adopted and Issued Accounting PronouncementsFor a discussion of these items, see "Note 2—Accounting Standards" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.Leidos Holdings, Inc. Annual Report - 54Table of ContentsPART IIItem 7A. Quantitative and Qualitative Disclosures About Market RiskWe are exposed to certain market risks in the normal course of business. Our current market risk exposures are primarily related to interest rates and foreign currency fluctuations. The following information about our market sensitive financial instruments contains forward-looking statements.Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to long-term debt obligations and derivatives. Our policy authorizes, with Board of Directors' approval, the limited use of derivative instruments to hedge specific interest rate risks. Debt and derivativesAt December 30, 2022 and December 31, 2021, we had $4.9 billion and $5.1 billion, respectively, of debt, which included $1.5 billion and $1.7 billion, respectively, related to our senior unsecured term loans that have a variable stated interest rate that is determined based on either the London Interbank Offered Rate ("LIBOR") or the Stated Overnight Financing Date ("SOFR") rate plus a margin. As a result, we may experience fluctuations in interest expense.As of December 30, 2022, we hold $500 million of unsecured notes due May 2023. We anticipate refinancing this obligation during fiscal 2023, at which time we will be subject to current market rates which may vary significantly from the existing rates on our debt.We have interest rate swap agreements to hedge the cash flows of a portion of our variable rate senior unsecured term loan ("Variable Rate Loan"). Under the terms of the interest rate swap agreements, we receive variable interest payments based on the one-month LIBOR rate and pay interest at a fixed rate. As of December 30, 2022, the notional value of the interest rate swap agreements was $1.0 billion. The interest rate swap agreements effectively converted a portion of our variable rate borrowing to a fixed rate borrowing. The fair value of our interest rate swap agreements with respect to our Variable Rate Loan was an asset of $20 million, as of December 30, 2022, and a liability of $53 million, as of December 31, 2021.The counterparties to these agreements are financial institutions. We do not hold or issue derivative financial instruments for trading or speculative purposes. We cannot predict future market fluctuations in interest rates and their impact on our interest rate swaps. The net hypothetical 10% movement in the one-month LIBOR or SOFR rate would not have a significant impact on our annual interest expense. For additional information related to our interest rate swap agreements and debt, see "Note 12—Derivative Instruments" and "Note 13—Debt," respectively, of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.Cash and Cash EquivalentsAs of December 30, 2022 and December 31, 2021, our cash and cash equivalents included investments in several large institutional money market accounts. For fiscal 2022 and fiscal 2021, a hypothetical 10% interest rate movement would not have a significant impact on the value of our holdings or on interest income.Foreign Currency RiskAlthough the majority of our transactions are denominated in U.S. dollars, some of our transactions are denominated in foreign currencies. Our foreign currency exchange rate risk relates to receipts from customers, payments to suppliers and certain intercompany transactions denominated in currencies other than our (or one of our subsidiaries') functional currency. Our foreign operations represented 8% of total revenues for fiscal 2022, 2021 and 2020.Leidos Holdings, Inc. Annual Report - 55Table of ContentsPART II
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+Item 7.—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations and Commitments—Firm Commitments for further discussion.We depend on the cash flows of our subsidiaries in order to satisfy our obligations. We rely on distributions and loans from our subsidiaries to meet our payment requirements under our obligations. If our subsidiaries are unable to pay dividends or otherwise make payments to us, we may not be able to make debt service payments on our obligations. We conduct substantially all of our operations through our subsidiaries. Our operating cash flows and consequently our ability to service our debt is therefore principally dependent upon our subsidiaries’ earnings and their distributions of those earnings to us and may also be dependent upon loans or other payments of funds to us by those subsidiaries. Our subsidiaries are separate legal entities and may have no obligation, contingent or otherwise, to pay any amount due pursuant to our obligations or to make any funds available for that purpose. Our foreign subsidiaries generate a portion of our operating cash flows. Although we do not intend to repatriate these funds from our foreign subsidiaries in order to satisfy payment requirements in the United States, we would be required to accrue and pay United States state income taxes as well as any applicable foreign withholding or transaction taxes on future repatriations. These taxes could be substantial and could have a material adverse effect on our financial condition and results of operations. In addition, the ability of our subsidiaries to provide funds to us may be subject to restrictions under our senior secured credit facility and may be subject to the terms of such subsidiaries’ future indebtedness, as well as the availability of sufficient surplus funds under applicable law.Conversion of our convertible notes may dilute the ownership interest of existing stockholders and may affect our per share results and the trading price of our common stock.The issuance of shares of our common stock upon conversion of our convertible notes may dilute the ownership interests of existing stockholders. Issuances of stock on conversion may also affect our per share results of operations. Any sales in the public market of our common stock issuable upon such conversion could adversely affect prevailing market prices of our common stock.ITEM 1B. UNRESOLVED STAFF COMMENTS None. 27ITEM 2. PROPERTIESAs of December 31, 2022, we own, operate or lease 172 entertainment venues throughout North America and 99 entertainment venues internationally. We have a lease ending June 30, 2030 for our corporate headquarters in Beverly Hills, California, used primarily by our executive group and certain of our domestic operations management staff. We also lease office space and other facilities in 44 countries that support our Concerts, Ticketing and Sponsorship & Advertising segment operations. We believe our venues and facilities are generally well-maintained and in good operating condition and have adequate capacity to meet our current business needs.Our leases are for varying terms ranging from monthly to multi-year. These leases can typically be for terms of three to 10 years for our office leases and five to 25 years for our venue leases, and many include renewal options. There is no significant concentration of venues under any one lease or subject to negotiation with any one landlord. We believe that an important part of our management activity is to negotiate suitable lease renewals and extensions.ITEM 3. LEGAL PROCEEDINGSInformation regarding our legal proceedings can be found in Part II—Financial Information—
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations; and Notes 2 and 17 to the Consolidated Financial Statements.We have made, and intend to continue to make, the expenditures necessary for compliance with applicable laws and regulations relating to environmental, health and safety matters. We incurred capital expenditures of $194 million in 2022 for health, safety and environmental compliance purposes and improvement programs, and estimate such expenditures to be approximately $325 million in 2023 and $300 million in 2024.While capital expenditures or operating costs for environmental compliance, including compliance with potential legislation and potential regulation related to climate change, cannot be predicted with certainty, we do not believe they will have a material effect on our competitive position in the near term.While there can be no assurance that physical impacts to our facilities and supply chain due to climate change will not occur in the future, we do not believe these impacts are material in the near term.SustainabilityLyondellBasell has established sustainability goals focusing on three key areas: ending plastic waste, addressing climate change and advancing a thriving society. One of our sustainability goals is to produce and market at least two million metric tons of recycled and renewable-based polymers annually by 2030, which represents approximately 20% of our 2022 global sales of polyethylene and polypropylene. Since 2019, we have produced and marketed products with more than 175,000 metric tons of recycled and renewable content.In December 2022 we announced more ambitious climate reduction goals, increasing our 2030 GHG emissions reduction target for scope 1 and scope 2 emissions from 30% to 42%, relative to a 2020 baseline. In addition, we established a 2030 scope 3 GHG emissions reduction target of 30%, relative to a 2020 baseline, to align with science-based guidance.As we progress in our efforts to achieve our goal to produce and market two million metric tons of recycled and renewable-based products, the corresponding increases in recycling rates will positively impact scope 3 emissions. We expect the emissions reductions we will get from accomplishing this goal to be incremental to the plans we currently have to reduce our scope 3 emissions by 30% by 2030. We estimate approximately 1 million metric tons of scope 3 reductions coming from achieving our circularity ambition.13Table of ContentsAs announced in April 2022, we are planning to close our Houston refinery by the end of December 2023. This is expected to reduce scope 1 and scope 2 GHG emissions by more than 3 million metric tons annually and scope 3 emissions by approximately 40 million metric tons annually.Certain GHG emissions reduction initiatives planned for implementation by 2030 are expected to begin in the near-term as we plan to leverage existing asset turnaround schedules for our largest sites. In 2024, our Wesseling site in Germany is planning implementation of process heat recovery projects, electrification of a large process turbine and optimization of steam demand, including phasing out the use of coal, reducing scope 1 emissions by 150 thousand metric tons annually when compared to the average for 2019 and 2020. In 2025, at our Channelview site in Texas we plan to optimize heated equipment through advanced digitization, efficiency improvements and fuel management.Our previously announced goal to achieve net zero scope 1 and 2 GHG emissions from global operations by 2050 remains unchanged. Our ambition to achieve net zero by 2050 will need to be enabled by the development and deployment of new technology, including those related to cracker electrification, the use of hydrogen, carbon capture and storage and carbon utilization, across our manufacturing footprint.We also aim to secure at least 50% of our global electricity from renewable sources by 2030. As of February 2023, we have executed eight power purchase agreements, achieving over half of our 2030 target. These agreements will generate over 2.6 million megawatt hours of renewable electricity annually and reduce our scope 2 emissions by nearly 1 million metric tons of carbon emissions. To achieve our targets, we expect capital spending in the future will include investments to support lowering emissions in our operations. We also anticipate incurring costs for environmental compliance, including compliance with potential legislation and potential regulation related to climate change. We expect capital spending to support these ambitions will represent approximately 15% of total capital expenditures over the next two years. While many of the GHG emissions reduction projects are still in the early stages of development, we will evaluate, pursue and prioritize our GHG emission investments based on a rate of return for the project.Human CapitalOur success as a company is tied to the passion, knowledge and talent of our global team. To achieve our vision of being the best operated and most valued company in the industry, we must attract top performers and equip them with the tools needed to continuously grow and leverage their potential. Our Code of Conduct sets out our expectations on topics such as respecting fellow employees, anti-corruption, conflicts of interest, trade compliance, anti-trust and competition law, insider trading, sanctions, misconduct and political donations. It is available in seventeen languages on our company website. New employees are trained on the Code of Conduct and all employees receive annual refresher training. We also have a human rights policy that establishes our standards for workforce health and safety; prevention of discrimination, harassment and retaliation; diversity and inclusion; workplace security; working conditions and fair wages; freedom of association; freely chosen employment; and child labor protections.Safety, Employee Health and Well-Being—We are committed to providing a safe workplace, free from recognized hazards, and we comply with all applicable health and safety laws and recognized standards. GoalZERO is our commitment to operating safely and with a goal of zero incidents, zero injuries and zero accidents. We cultivate a GoalZERO mindset with clear standards, regular communication, training, and targeted campaigns and events, including our annual Global Safety Day.Workplace Flexibility—We continued to support workplace flexibility in 2022 as a result of feedback we received from employees. Based in part on data from employee surveys, we enhanced our workplace flexibility initiative in early 2023 by offering up to three remote days per work week. These changes have helped to attract and retain employees. We will continue to study the effectiveness of this policy and will make changes, where necessary, to support business needs.14Table of ContentsGlobal Talent Development and Engagement—To prepare our key individuals for advancement to larger roles, we tripled participation in our executive mentoring and peer learning programs. In addition, we launched a new program in partnership with external consultants to help diverse employees advance their leadership skills. Approximately 83% of our openings in leadership roles were filled by internal talent. Demographics—As of December 31, 2022 we had approximately 19,300 employees. Our employee demographics, excluding temporary employees, consisted of the following:U.S. Underrepresented population (“URP”) is based on reporting for the U.S. Equal Employment Opportunity Commission (“EEOC”), and includes employees who self-identify as Hispanic or Latino, Black or African American, Asian or Pacific Islander, Indian, Alaskan Native, Native Hawaiian or two or more races. Employees who self-identify as White or Caucasian are considered U.S. Non-Underrepresented.Diversity, Equity, Inclusion—DEI remained a key focus in 2022. Our efforts reflect a holistic, multi-year strategy to improve representation, ensure fairness, and increase visibility and accountability to leadership. Diversity (Representation)—The percentage of diverse employees on our Executive Committee, which reports directly to our CEO, increased from 18% in 2021 to 33% in 2022, and as of February 2023, has increased to 40%. Of the ten members on our Executive Committee, four are women, and together, our CEO and Executive Committee represent six different nationalities. This increase brings us closer to our long-term goals of achieving gender parity in global senior leadership. We are also committed to increasing the number of underrepresented senior leaders in the U.S. to reflect the general population ratio by 2032. To meet these targets, we have set short-term goals to increase the number of female senior leaders globally and the number of underrepresented senior leaders in the U.S. by 50% by 2027, relative to a 2022 baseline. These ambitious goals demonstrate our commitment to having a diverse group of company leaders.To achieve these goals, we focused on enhancing our hiring, promotion and retention practices. With respect to hiring, we expanded our existing senior-level hiring practices to a larger group of positions. These practices include broader recruiting efforts, diverse interview panels and candidate slates, standardized interview questions and hiring-manager training. With respect to promotions, we launched a new program to help diverse employees advance their leadership skills. We also continued to develop and improve our internal talent programs. Through these efforts, we promoted 16% more women in 2022 than in 2021. Indeed, increased promotions of women were the main reason the number of women in senior leadership globally increased by 1% to 22% in 2022. 15Table of ContentsWhile we are making significant efforts, our progress towards our goals in 2022 was negatively impacted by increased attrition of both women and URP leaders. Despite increased hiring and promotions of URP employees, the number of URP senior leaders in the U.S. decreased by 1% from 2021 to 18% in 2022. We continue to analyze retention issues to understand attrition drivers and to enhance our employee engagement efforts. Other factors impacting our results were the challenging external talent market and the addition of new senior leadership roles due to the Company’s growth initiatives. We recognize that building talent pipelines and transforming culture takes time, and we remain committed to frequently assessing outcomes and developing programs that will advance these goals.Equity (Fairness)—For the second consecutive year, we completed a pay equity review and performance analysis. Our pay equity review compared pay for like jobs and specifically focused on base pay for gender (globally) and ethnicity (U.S. only). Consistent with 2021 findings, the review reflected that pay is generally administered fairly with a small number of exceptions that should be remediated by the second quarter of 2023. We also confirmed that performance appraisals are generally administered fairly. Both of these annual review processes are now embedded in our HR processes.The Company also implemented several practices to advance pay equity, including:•Ensuring that job offers are based on the role, market competitiveness, and a candidate's level of proficiency and experience and not based on a candidate’s historical compensation;•Modifying promotion practices to ensure pay fairness is applied consistently for internal candidates compared to external hires; •Helping line managers conduct an internal equity review for their employees and, when necessary, making compensation adjustments; and •Establishing a consistent framework for recognizing and retaining employees.Finally, we conducted stakeholder workshops to strengthen our approach to pay equity and provide increased transparency to employees about pay practices.Inclusion (Belonging)—We advanced our inclusion efforts by increasing the number of global employee networks from four to six, building a global diverse network of employees championing inclusion. Executive leaders serve as active sponsors for each network, and about 15% of our global workforce has joined at least one of our employee networks. We have network members present at 92% of our global sites, with 47% of members residing outside of the U.S. and 28% joining as allies of underrepresented groups. Network programming is strongly tied to career development and business and community impact, including engagement in strategy development activities with executives in 2022.16Table of ContentsINFORMATION ABOUT OUR EXECUTIVE OFFICERSOur executive officers as of February 23, 2023 were as follows:Name and AgeSignificant ExperiencePeter Vanacker, 56Chief Executive Officer since May 2022. President, Chief Executive Officer and Chair of the Executive Committee of Neste Corporation, a renewable products company From September 2018 to May 2022.Chief Executive Officer and Managing Director of the CABB Group, a global supplier of fine and specialty chemicals from April 2015 to August 2018. Tracey Campbell, 56Executive Vice President, Sustainability and Corporate Affairs since October 2022.Vice President, Public Affairs from November 2020 to September 2022. Director, Polyolefins Asia Pacific from July 2018 to October 2020. Director, North America Feedstock Supply from April 2015 to June 2018. Trisha Conley, 50Executive Vice President, People and Culture since February 2023.Senior Vice President, People Development of Renewable Energy Group, a renewable energy company, from August 2020 to January 2023. Vice President of Human Resources, Fuels North America and Head of Country (United States) for Downstream Human Resources at BP, a global energy provider, from July 2015 to July 2020.Kim Foley, 56Executive Vice President, Intermediates and Derivatives and Refining since October 2022. Senior Vice President, HSE, Global Engineering and Turnarounds from August 2020 to September 2022.Vice President, Health, Safety and Environment from October 2019 to July 2020.Site Manager at Channelview from May 2017 to October 2019.Dale Friedrichs, 59Executive Vice President, Operational Excellence and HSE since October 2022. Interim Executive Vice President, People and Culture from October 2022 to February 2023.Senior Vice President, Human Resources and Global Projects from August 2020 to September 2022.Vice President, Human Resources from October 2019 to July 2020.Vice President, Health, Safety, Environment and Security from February 2017 to October 2019.17Table of ContentsName and AgeSignificant ExperienceJames Guilfoyle, 52Senior Vice President, O&P, Europe, Africa, Middle East and India since October 2022. Executive Vice President, Advanced Polymer Solutions & Global Supply Chain from July 2018 to September 2022. Senior Vice President, Global Intermediates & Derivatives and Global Supply Chain from February 2017 to July 2018.Jeffrey Kaplan, 54Executive Vice President and General Counsel since October 2022. Executive Vice President, Legal & Public Affairs and Chief Legal Officer from March 2015 to September 2022.Kenneth (“Ken”) Lane, 54Executive Vice President, Olefins & Polyolefins since October 2022.Executive Vice President, Global Olefins and Polyolefins from July 2019 to September 2022. Interim Chief Executive Officer from January 2022 to May 2022. President, Monomers Division at BASF, a German chemical company, from January 2019 to July 2019.President, Global Catalysts at BASF from June 2013 to December 2018.Michael C. McMurray, 58Executive Vice President and Chief Financial Officer since November 2019.Senior Vice President and Chief Financial Officer at Owens Corning, a global manufacturer of insulation, roofing and fiberglass composites, from August 2012 to November 2019. Torkel Rhenman, 59Executive Vice President, Advanced Polymer Solutions since October 2022. Executive Vice President, Intermediates & Derivatives, and Refining from August 2020 to September 2022.Executive Vice President, Intermediates & Derivatives from July 2019 to July 2020. Chief Executive Officer and Director of Lhoist Group, a privately held minerals and mining company, from 2012 to 2017. 18Table of ContentsName and AgeSignificant ExperienceJames Seward, 55Executive Vice President and Chief Innovation Officer since October 2022. Senior Vice President, Research & Development, Technology and Sustainability from August 2020 to September 2022.Senior Vice President, Technology Business, Sustainability, and Olefins & Polyolefins, Europe, Asia and International Joint Venture Management from September 2018 to July 2020.Vice President, Joint Ventures and International Marketing from May 2014 to August 2018.Yvonne van der Laan, 51Executive Vice President, Circular and Low Carbon Solutions since October 2022.Senior Director, Global Circularity from May 2022 to September 2022. Director, Olefins & Optimizations, Europe from September 2019 to April 2022.Vice President, Industry & Bulk Cargo for the Port of Rotterdam, the largest seaport in Europe, from February 2016 to September 2019.19Table of ContentsDescription of PropertiesOur principal manufacturing facilities as of December 31, 2022 are set forth below and are identified by the principal segment or segments using the facility. All of the facilities are wholly owned, except as otherwise noted. LocationSegmentAmericasBayport (Pasadena), TexasI&DBayport (Pasadena), Texas(1)I&DBayport (Pasadena), TexasO&P-AmericasChannelview, TexasO&P-AmericasChannelview, Texas(1)(2)I&DChocolate Bayou, TexasO&P-AmericasClinton, IowaO&P-AmericasCorpus Christi, TexasO&P-AmericasEdison, New JerseyO&P-AmericasHouston, TexasRefiningLa Porte, Texas(3)O&P-AmericasLa Porte, Texas(3)I&DLake Charles, LouisianaO&P-AmericasLake Charles, LouisianaO&P-AmericasMatagorda, TexasO&P-AmericasMorris, IllinoisO&P-AmericasVictoria, Texas†O&P-AmericasEuropeBerre l’Etang, FranceO&P-EAIBotlek, Rotterdam, The Netherlands†I&DBrindisi, ItalyO&P-EAICarrington, UK†O&P-EAIFerrara, ItalyO&P-EAITechnologyFos-sur-Mer, France†I&DFrankfurt, Germany†O&P-EAITechnologyKnapsack, Germany†O&P-EAIAPSKerpen, GermanyAPSLudwigshafen, Germany†TechnologyMaasvlakte, The Netherlands(4)†I&DMoerdijk, The Netherlands†APSMünchsmünster, GermanyO&P-EAITarragona, Spain(5)†O&P-EAIAPSWesseling, GermanyO&P-EAIAsia-PacificPanjin, China(6)†O&P-EAI† The facility is located on leased land.20Table of Contents(1)The Bayport PO/TBA plants and the Channelview PO/SM I plant are held by the U.S. PO joint venture between Covestro and Lyondell Chemical Company. These plants are located on land leased by the U.S. PO joint venture.(2)Equistar Chemicals, LP operates a polybutadiene unit, which is owned by an unrelated party and is located within the Channelview facility on property leased from Equistar Chemicals, LP.(3)The La Porte facilities are on contiguous property.(4)The Maasvlakte plant is owned by the European PO joint venture and is located on land leased by the European PO joint venture.(5)The Tarragona PP facility is located on leased land; the compounds facility is located on co-owned land.(6)The Panjin facility is owned by the Bora LyondellBasell Petrochemical Co., Ltd. joint venture and is located on land leased by the joint venture. Other Locations and PropertiesWe maintain executive offices in London, the United Kingdom; Rotterdam, The Netherlands; Houston, Texas and Hong Kong, China. We maintain research facilities in Lansing, Michigan; Channelview, Texas; Cincinnati, Ohio; Ferrara, Italy and Frankfurt, Germany. Our Asia-Pacific headquarters are in Hong Kong. We also have technical support centers in Bayreuth, Germany; Mumbai, India; and Tarragona, Spain. We have various sales facilities worldwide.Website Access to SEC ReportsOur Internet website address is http://www.LyondellBasell.com. Information contained on our Internet website is not part of this report on Form 10-K.Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available on our website, free of charge, as soon as reasonably practicable after such reports are filed with, or furnished to, the U.S. Securities and Exchange Commission (“SEC”). Alternatively, these reports may be accessed at the SEC’s website at http://www.sec.gov.Item 1A. Risk Factors.You should carefully consider the following risk factors in addition to the other information included in this Annual Report on Form 10-K. Each of these risk factors could adversely affect our business, operating results and financial condition, as well as adversely affect the value of an investment in our common stock.Risks Related to our Business and IndustryThe cyclicality and volatility of the industries in which we participate may cause significant fluctuations in our operating results.Our business operations are subject to the cyclical and volatile nature of the supply-demand balance in the chemical and refining industries. Our future operating results are expected to continue to be affected by this cyclicality and volatility. The chemical and refining industries historically have experienced alternating periods of capacity shortages, causing prices and profit margins to increase, followed by periods of excess capacity, resulting in oversupply, declining capacity utilization rates and declining prices and profit margins.In addition to changes in the supply and demand for products, changes in energy prices and other worldwide economic conditions can cause volatility. These factors result in significant fluctuations in profits and cash flow from period to period and over business cycles.21Table of ContentsNew capacity additions around the world may lead to periods of oversupply and lower profitability. The timing and extent of any changes to currently prevailing market conditions are uncertain and supply and demand may be unbalanced at any time. As a consequence, we are unable to accurately predict the extent or duration of future industry cycles or their effect on our business, financial condition or results of operations.A sustained decrease in the price of crude oil may adversely impact the results of our operations, primarily in North America.Energy costs generally follow price trends of crude oil and natural gas. These price trends may be highly volatile and cyclical. In the past, raw material and energy costs have experienced significant fluctuations that adversely affected our business segments’ results of operations. For example, we have benefited from the favorable ratio of U.S. crude oil prices to natural gas prices in the past. If the price of crude oil remains lower relative to U.S. natural gas prices or if the demand for natural gas and NGLs increases, this may have a negative impact on our results of operations.Costs and limitations on supply of raw materials and energy may result in increased operating expenses.The costs of raw materials and energy represent a substantial portion of our operating expenses. Due to the significant competition we face and the commodity nature of many of our products we are not always able to pass on raw material and energy cost increases to our customers. When we do have the ability to pass on the cost increases, we are not always able to do so quickly enough to avoid adverse impacts on our results of operations. For example during 2022, increases in costs for energy and raw materials, and the related decline in demand for our products, resulted in the reduction of operating rates or delayed restart of operations at several of our sites in Europe.Cost increases for raw materials, energy, or broad-based price inflation also increase working capital needs, which could reduce our liquidity and cash flow. Even if we are able to increase our sales prices to reflect these increases, demand for products may decrease as consumers and customers reduce their consumption or use substitute products, which may have an adverse impact on our results of operations. In addition, producers in natural gas cost-advantaged regions, such as the Middle East and North America, benefit from the lower prices of natural gas and NGLs. Competition from producers in these regions may cause us to reduce exports from Europe and elsewhere. Any such reductions may increase competition for product sales within Europe and other markets, which can result in lower margins in those regions.For some of our raw materials and utilities there are a limited number of suppliers and, in some cases, the supplies are specific to the particular geographic region in which a facility is located. It is also common in the chemical and refining industries for a facility to have a sole, dedicated source for its utilities, such as steam, electricity and gas. Having a sole or limited number of suppliers may limit our negotiating power, particularly in the case of rising raw material costs. Any new supply agreements we enter into may not have terms as favorable as those contained in our current supply agreements.Additionally, there is concern over the reliability of water sources, including around the U.S. Gulf Coast where several of our facilities are located. The decreased availability or less favorable pricing for water as a result of population growth, drought or regulation could negatively impact our operations, including by impacting our ability to produce or transport our products.If our raw material or utility supplies were disrupted, our businesses would likely incur increased costs to procure alternative supplies or incur excessive downtime, which would have a negative impact on plant operations. Disruptions of supplies may occur as a result of transportation issues resulting from natural disasters, water levels, and interruptions in marine water routes, among other causes, that can affect the operations of vessels, barges, rails, trucks and pipeline traffic. These risks are particularly prevalent in the U.S. Gulf Coast area. Additionally, increasing exports of NGLs and crude oil from the U.S. or greater restrictions on hydraulic fracturing could restrict the availability of our raw materials, thereby increasing our costs.With increased volatility in raw material costs, our suppliers could impose more onerous terms on us, resulting in shorter payment cycles and increasing our working capital requirements.22Table of ContentsOur ability to source raw materials may be adversely affected by political instability, civil disturbances or other governmental actions.We obtain a portion of our principal raw materials from sources in the Middle East and Central and South America that may be less politically stable than other areas in which we conduct business. Political instability, civil disturbances and actions by governments in these areas are more likely to substantially increase the price and decrease the supply of raw materials necessary for our operations, which could have a material adverse effect on our results of operations.Incidents of civil unrest, including terrorist attacks and demonstrations that have been marked by violence, have occurred in a number of countries in the Middle East and South America. Some political regimes in these countries are threatened or have changed as a result of such unrest. Political instability and civil unrest could continue to spread in the region and involve other areas. Such unrest, if it continues to spread or grow in intensity, could lead to civil wars, regional conflicts or regime changes resulting in governments that are hostile to countries in which we conduct substantial business, such as in the U.S., Europe or their respective trading partners.Our business is capital intensive and we rely on cash generated from operations and external financing to fund our growth and ongoing capital needs. Limitations on access to external financing could adversely affect our operating results.We require significant capital to operate our current business and fund our growth strategy. Moreover, interest payments, dividends, capital requirements of our joint ventures, the expansion of our current business or other business opportunities may require significant amounts of capital. If we need external financing, our access to credit markets and pricing of our capital is dependent upon maintaining sufficient credit ratings from credit rating agencies and the state of the capital markets generally. There can be no assurances that we would be able to incur indebtedness on terms we deem acceptable, and it is possible that the cost of any financings could increase significantly, thereby increasing our expenses and decreasing our net income. If we are unable to generate sufficient cash flow or raise adequate external financing, including as a result of significant disruptions in the global credit markets, we could be forced to restrict our operations and growth opportunities, which could adversely affect our operating results.We may use our $3,250 million revolving credit facility, which backs our commercial paper program, to meet our cash needs, to the extent available. As of December 31, 2022, we had no borrowings or letters of credit outstanding under the facility and $200 million, net of discount, outstanding under our commercial paper program, leaving an unused and available credit capacity of $3,050 million. We may also meet our cash needs by selling receivables under our $900 million U.S. Receivables Facility. As of December 31, 2022, we had availability of $794 million under this facility. In the event of a default under our credit facilities or any of our senior notes, we could be required to immediately repay all outstanding borrowings and make cash deposits as collateral for all obligations the facility supports, which we may not be able to do. Any default under any of our credit arrangements could cause a default under many of our other credit agreements and debt instruments. Without waivers from lenders party to those agreements, any such default could have a material adverse effect on our ability to continue to operate.Risks Related to our OperationsOur operations are subject to risks inherent in chemical and refining businesses, and we could be subject to liabilities for which we are not fully insured or that are not otherwise mitigated.We maintain property, business interruption, product, general liability, casualty and other types of insurance that we believe are appropriate for our business and operations as well as in line with industry practices. However, we are not fully insured against all potential hazards incident to our business, including losses resulting from natural disasters or climate-related exposures, wars or terrorist acts. Changes in insurance market conditions have caused, and may in the future cause, premiums and deductibles for certain insurance policies to increase substantially and, in some instances, for certain insurance to become unavailable or available only for reduced amounts of coverage. If we were to incur a significant liability for which we were not fully insured, we might not be able to finance the 23Table of Contentsamount of the uninsured liability on terms acceptable to us or at all, and might be obligated to divert a significant portion of our cash flow from normal business operations.Our business, including our results of operations and reputation, could be adversely affected by safety or product liability issues.Failure to appropriately manage occupational safety, process safety, product safety, human health, product liability and environmental risks inherent in the chemical and refining businesses and associated with our products, product life cycles and production processes could result in unexpected incidents including releases, fires, or explosions resulting in personal injury, loss of life, environmental damage, loss of revenue, legal liability, and/or operational disruption. Public perception of the risks associated with our products and production processes could impact product acceptance and influence the regulatory environment in which we operate. While we have management systems, procedures and controls to manage these risks, issues could be created by events outside of our control, including natural disasters, severe weather events and acts of sabotage.Further, because a part of our business involves licensing polyolefin process technology, our licensees are exposed to similar risks involved in the manufacture and marketing of polyolefins. Hazardous incidents involving our licensees, if they do result or are perceived to result from use of our technologies, may harm our reputation, threaten our relationships with other licensees and/or lead to customer attrition and financial losses. Our policy of covering these risks through contractual limitations of liability and indemnities and through insurance may not always be effective. As a result, our financial condition and results of operation would be adversely affected, and other companies with competing technologies may have the opportunity to secure a competitive advantage.Interruptions of operations at our facilities may result in increased liabilities or lower operating results.We own and operate large-scale facilities. Our operating results are dependent on the continued operation of our various production facilities and the ability to complete construction and maintenance projects on schedule. Interruptions at our facilities may materially reduce the productivity and profitability of a particular manufacturing facility, or our business as a whole, during and after the period of such operational difficulties. In recent years, we have had to shut down plants on the U.S. Gulf Coast, including the temporary shutdown of a portion of our Houston refinery, as a result of various hurricanes and cold weather events striking Texas and Louisiana. In addition, because the Houston refinery is our only refining operation, an outage at the refinery could have a particularly negative impact on our operating results as we do not have the ability to increase refining production elsewhere.Our operations are subject to hazards inherent in chemical manufacturing and refining and the related storage and transportation of raw materials, products and wastes. These potential hazards include:•pipeline leaks and ruptures;•explosions;•fires;•severe weather and natural disasters;•mechanical failure;•unscheduled downtimes;•supplier disruptions;•labor shortages or other labor difficulties;•transportation interruptions;•remediation complications;•increased restrictions on, or the unavailability of, water for use at our manufacturing sites or for the transport of our products or raw materials;24Table of Contents•chemical and oil spills;•discharges or releases of toxic or hazardous substances or gases;•shipment of incorrect or off-specification product to customers;•storage tank leaks;•other environmental risks; and•cyber-attack or other terrorist acts.Some of these hazards may cause severe damage to or destruction of property and equipment, personal injury, loss of life, environmental damage, legal liability resulting from government action or litigation, loss of revenue, suspension of operations or the shutdown of affected facilities.Large capital projects can take many years to complete, and market conditions could deteriorate significantly between the project approval date and the project startup date, negatively impacting project returns. If we are unable to complete capital projects at their expected costs and in a timely manner, or if the market conditions assumed in our project economics deteriorate, our business, financial condition, results of operations and cash flows could be materially and adversely affected.Delays or cost increases related to capital spending programs involving engineering, procurement and construction of facilities could materially adversely affect our ability to achieve forecasted internal rates of return and operating results. For example, higher costs arising from delaying construction of our world-scale PO/TBA plant in Houston due to COVID-19, more extensive civil construction, and unexpected tariffs on materials increased our costs and impacted our projected rate of return on the project. Delays in making required changes or upgrades to our facilities could subject us to fines or penalties as well as affect our ability to contract with our customers and supply certain products we produce. Such delays or cost increases may arise as a result of unpredictable factors, many of which are beyond our control, including:•denial of or delay in receiving requisite regulatory approvals and/or permits; •unplanned increases in the cost of construction materials or labor;•disruptions in transportation of components or construction materials;•adverse weather conditions, natural disasters or other events (such as equipment malfunctions, explosions, fires or spills) affecting our facilities, or those of vendors or suppliers;•shortages of sufficiently skilled labor, or labor disagreements resulting in unplanned work stoppages; and•nonperformance by, or disputes with, vendors, suppliers, contractors or subcontractors.Any one or more of these factors could have a significant impact on our ongoing capital projects. If we were unable to make up the delays associated with such factors or to recover the related costs, or if market conditions change, it could materially and adversely affect our business, financial condition, results of operations and cash flows.Shared control or lack of control of joint ventures may delay decisions or actions regarding our joint ventures.A portion of our operations are conducted through joint ventures, where control may be exercised by or shared with unaffiliated third parties. We cannot control the actions or ownership of our joint venture partners, including any nonperformance, default or bankruptcy of joint venture partners. The joint ventures that we do not control may also lack financial reporting systems to provide adequate and timely information for our reporting purposes.25Table of ContentsOur joint venture partners may have different interests or goals than we do and may take actions contrary to our requests, policies or objectives. Differences in views among the joint venture participants also may result in delayed decisions or in failures to agree on major matters, potentially adversely affecting the business and operations of the joint ventures and in turn our business and operations. We may develop a dispute with any of our partners over decisions affecting the venture that may result in litigation, arbitration or some other form of dispute resolution. If a joint venture participant acts contrary to our interest, it could harm our brand, business, results of operations and financial condition.We may be required to record material charges against our earnings due to any number of events that could cause impairments to our assets.We may be required to reduce production or idle facilities for extended periods of time or exit certain businesses as a result of the cyclical nature of our industry. Specifically, oversupplies of or lack of demand for particular products or high raw material prices may cause us to reduce production. We may choose to reduce production at certain facilities because we have off-take arrangements at other facilities, which make any reductions or idling unavailable at those facilities. Any decision to permanently close facilities or exit a business would likely result in impairment and other charges to earnings. For example, in April 2022, the Finance Committee of the Board of Directors of the Company approved a plan to exit the refining business, resulting in the recognition of $187 million of expense. See Notes 7, 12 and 20 to the Consolidated Financial Statements for additional information regarding the planned exit.Temporary outages at our facilities can last for several quarters and sometimes longer. These outages could cause us to incur significant costs, including the expenses of maintaining and restarting these facilities. In addition, we have significant obligations under take-or-pay agreements. Even though we may reduce production at facilities, we may be required to continue to purchase or pay for utilities or raw materials under these arrangements.Acquisitions or dispositions of assets or businesses could disrupt our business and harm our financial condition and stock price.We continually evaluate the performance and strategic fit of all of our businesses and evaluate whether our businesses would benefit from acquisitions to enhance growth or dispositions that would align our footprint with our overall business strategy. These transactions pose risks and challenges that could negatively impact our business and financial statements.Acquisitions involve numerous risks, including meeting our standards for compliance, problems combining the purchased operations, technologies or products, unanticipated costs and liabilities, diversion of management’s attention from our core businesses, and potential loss of key employees. There can be no assurance that we will be able to integrate successfully any businesses, products, technologies, or personnel that we might acquire. The integration of businesses that we may acquire is likely to be a complex, time-consuming, and expensive process and we may not realize the anticipated revenues, synergies, or other benefits associated with our acquisitions if we do not manage and operate the acquired business up to our expectations. If we are unable to efficiently operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls, and human resources practices, our business, financial condition, and results of operations may be adversely affected.Dispositions of assets or businesses involve risks, including difficulties in the separation of operations, services, products and personnel, the diversion of management's attention from other business concerns, the disruption of our business, the potential loss of key employees and the retention of uncertain environmental or other contingent liabilities related to the divested business. In addition, they may result in significant asset impairment charges, including those related to goodwill and other intangible assets, which could have a material adverse effect on our financial condition and results of operations. For example, in April 2022 we agreed to the sale of our Australian polypropylene business that resulted in a $69 million non-cash impairment charge, which impacted earnings. In the event we are unable to successfully divest a business or product line, we may be forced to wind down such business or product line, which could materially and adversely affect our results of operations and financial condition.26Table of ContentsWe cannot assure you that we will be successful in managing these or any other significant risks that we encounter in acquiring or divesting a business or product line, and any transaction we undertake could materially and adversely affect our business, financial condition, results of operations and cash flows, and may also result in a diversion of management attention, operational difficulties and losses.Risks related to the Global Economy and Multinational OperationsEconomic disruptions and downturns in general, and particularly continued global economic uncertainty or economic turmoil in emerging markets, could have a material adverse effect on our business, prospects, operating results, financial condition and cash flows.Our results of operations can be materially affected by adverse conditions in the financial markets and depressed economic conditions generally. Economic downturns in the businesses and geographic areas in which we sell our products could substantially reduce demand for our products and result in decreased sales volumes and increased credit risk. Recessionary environments adversely affect our business because demand for our products is reduced, particularly from our customers in industrial markets generally and the automotive and housing industries specifically, and may result in higher costs of capital. A significant portion of our revenues and earnings are derived from our business in Europe. In addition, most of our European transactions and assets, including cash reserves and receivables, are denominated in euros.We also derive significant revenues from our business in emerging markets, particularly the emerging markets in Asia and South America. Any broad-based downturn in these emerging markets, or in a key market such as China, could require us to reduce export volumes into these markets and could also require us to divert product sales to less profitable markets. Any of these conditions could ultimately harm our overall business, prospects, operating results, financial condition and cash flows.We sell products in highly competitive global markets and face significant price pressures.We sell our products in highly competitive global markets. Due to the commodity nature of many of our products, competition in these markets is based primarily on price and, to a lesser extent, on product performance, product quality, product deliverability, reliability of supply and customer service. Often, we are not able to protect our market position for these products by product differentiation and may not be able to pass on cost increases to our customers due to the significant competition in our business.In addition, we face increased competition from companies that may have greater financial resources and different cost structures or strategic goals than us. These include large integrated oil companies (some of which also have chemical businesses), government-owned businesses, and companies that receive subsidies or other government incentives to produce certain products in a specified geographic region. Continuing competition from these companies, especially in our olefin and refining businesses, could limit our ability to increase product sales prices in response to raw material and other cost increases, or could cause us to reduce product sales prices to compete effectively, which would reduce our profitability. Competitors with different cost structures or strategic goals than we have may be able to invest significant capital into their businesses, including expenditures for research and development. In addition, specialty products we produce may become commoditized over time. Increased competition could result in lower prices or lower sales volumes, which would have a negative impact on our results of operations.27Table of ContentsWe operate internationally and are subject to exchange rate fluctuations, exchange controls, political risks and other risks relating to international operations.We operate internationally and are subject to the risks of doing business on a global level. These risks include fluctuations in currency exchange rates, economic instability and disruptions, restrictions on the transfer of funds and the imposition of trade restrictions or duties and tariffs, and complex regulations concerning privacy and data security. Additional risks from our multinational business include transportation delays and interruptions, war, terrorist activities, epidemics, pandemics, political instability, import and export controls, sanctions, changes in governmental policies, labor unrest and current and changing regulatory environments.We generate revenues from export sales and operations that may be denominated in currencies other than the relevant functional currency. Exchange rates between these currencies and functional currencies in recent years have fluctuated significantly and may do so in the future. It is possible that fluctuations in exchange rates will result in reduced operating results. Additionally, we operate with the objective of having our worldwide cash available in the locations where it is needed, including the United Kingdom for our parent company’s significant cash obligations as a result of dividend payments. It is possible that we may not always be able to provide cash to other jurisdictions when needed or that such transfers of cash could be subject to additional taxes, including withholding taxes.Our operating results could be negatively affected by the laws, rules and regulations, as well as political environments, in the jurisdictions in which we operate. There could be reduced demand for our products, decreases in the prices at which we can sell our products and disruptions of production or other operations. Trade protection measures such as quotas, duties, tariffs, safeguard measures or anti-dumping duties imposed in the countries in which we operate could negatively impact our business. Additionally, there may be substantial capital and other costs to comply with regulations and/or increased security costs or insurance premiums, any of which could reduce our operating results.We obtain a portion of our principal raw materials from international sources that are subject to these same risks. Our compliance with applicable customs, currency exchange control regulations, transfer pricing regulations or any other laws or regulations to which we may be subject could be challenged. Furthermore, these laws may be modified, the result of which may be to prevent or limit subsidiaries from transferring cash to us.Furthermore, we are subject to certain existing, and may be subject to possible future, laws that limit or may limit our activities while some of our competitors may not be subject to such laws, which may adversely affect our competitiveness.Changes in tax laws and regulations could affect our tax rate and our results of operations. The Company operates in multiple jurisdictions with complex legal and tax regulatory environments and is subject to taxes in the U.S. and non-U.S. jurisdictions. Significant changes to tax laws and regulations in these jurisdictions or their interpretation could have a material impact on our effective income tax rate. Our future effective income tax rates could also fluctuate based on, among other factors, changes in pre-tax income in countries with varying statutory tax rates, changes in valuation allowances, changes in foreign exchange gains/losses, the amount of exempt income, and changes in unrecognized tax benefits associated with uncertain tax positions. Our tax returns are periodically audited or subjected to review by tax authorities, and any adverse result of these examinations could also have an impact on our effective income tax rate and our results of operations. We regularly evaluate the likelihood of an adverse result of an examination, however, there is no assurance as to the ultimate outcome and impact.28Table of ContentsRisks Related to Health, Safety, and the Environment We cannot predict with certainty the extent of future costs under environmental, health and safety and other laws and regulations, and cannot guarantee they will not be material. We may face liability arising out of the normal course of business, including alleged personal injury or property damage due to exposure to chemicals or other hazardous substances at our current or former facilities, or exposure to products or chemicals that we manufacture, handle or own. In addition, because our products are components of a variety of other end-use products, we, along with other members of the chemical industry, are subject to potential claims related to those end-use products. Any substantial increase in the success of these types of claims could negatively affect our operating results. We are subject to extensive national, regional, state and local environmental laws, regulations, directives, rules and ordinances concerning pollution, protection of the environment, hazardous materials, health and safety, the security of our facilities, and the safety of our products. We generally expect that these requirements are likely to become more stringent over time. Changes to such laws could result in restrictions on our operations, denial of permits, loss of business opportunities, increased operating costs or additional capital expenditures. We could incur significant costs or operational restrictions due to violations of or liabilities under such laws and regulations in the form of fines, penalties, and injunctive relief. Any substantial liability under such laws could have a material adverse effect on our financial condition, results of operations and cash flows. Additionally, we are required to have permits for our businesses and are subject to licensing regulations. These permits and licenses are subject to renewal, modification and in some circumstances, revocation. Further, the permits and licenses are often difficult, time consuming and costly to obtain and could contain conditions that limit our operations.We may incur substantial costs to comply with climate change legislation and related regulatory initiatives. There has been a broad range of proposed or promulgated international, national and state laws focusing on greenhouse gas (“GHG”) emission reduction and global climate change. These proposed or promulgated laws apply or could apply in countries where we have interests or may have interests in the future. Laws and regulations in this field continue to evolve and, while they are likely to be increasingly widespread and stringent, at this stage it is not possible to accurately estimate either a timetable for implementation or our future compliance costs relating to implementation. Under the 2015 Paris Agreement, parties to the United Nations Framework Convention on Climate Change agreed to undertake ambitious efforts to reduce GHG emissions and strengthen adaptation to the effects of climate change.Jurisdictions in which we operate, including, in particular, the European Union (EU), are preparing national legislation and protection plans to implement their emission reduction commitments under the Paris Agreement. In June 2021, the European Climate Law set legally binding targets of net zero GHG emissions by 2050, and a 55% reduction in GHG emissions by 2030. In December 2022, the EU announced forthcoming regulations to support the 2030 climate target, including a revision of the EU Emissions Trading System (ETS), and the introduction of a Carbon Border Adjustment Mechanism. Our operations in Europe participate in the ETS and we meet our obligations through a combination of free and purchased emission allowances. We anticipate the forthcoming regulations will result in an accelerated reduction of our free allowances and higher market prices for purchased allowances. These and other future regulations could result in increased costs, additional capital expenditures, and/or restrictions on operations.In the U.S., addressing climate change is a stated priority of President Biden, and in February 2021, the U.S. recommitted to the Paris Agreement after having withdrawn in August 2017. The U.S. Environmental Protection Agency as well as several state governments have promulgated regulations directed at GHG emissions reductions from certain types of facilities. Additional regulations could be forthcoming at the U.S. federal or state level that could result in increased operating costs for compliance, required acquisition or trading of emission allowances, or compliance costs associated with additional regulatory frameworks for a range of potential carbon reduction projects, including carbon capture, use, and sequestration projects. Additionally, demand for the products we produce may be reduced.29Table of ContentsNon-Governmental Organizations have been active in filing lawsuits against governments and private parties in various jurisdictions around the world seeking enforcement of existing laws and new requirements to reduce GHG emissions. In one case decided in the Netherlands in May 2021, plaintiffs obtained a ruling ordering Royal Dutch Shell to reduce its Scope 1, 2 and 3 carbon emissions by 45% by 2030. These types of laws, regulations, and litigation results could increase the cost of purchased energy and increase costs of compliance in various locations. Compliance with climate regulations may result in increased permitting necessary for the operation of our business or for any of our growth plans. Difficulties in obtaining such permits could have an adverse effect on our future growth. In addition, any future potential climate regulations, legislation, or litigation results could impose additional operating restrictions or delays in implementing growth projects or other capital investments, require us to incur increased costs, and could have a material adverse effect on our business and results of operations. Legislation and regulatory initiatives could lead to a decrease in demand for our products. New or revised governmental regulations and independent studies relating to the effect of our products on health, safety and the environment may affect demand for our products and the cost of producing our products. Initiatives by governments and private interest groups will potentially result in increased toxicological testing and risk assessments of a wide variety of chemicals, including chemicals used or produced by us. New or revised legislation or regulations could result in additional use restrictions and/or bans of certain chemicals. For example, in the EU, the European Commission as part of its Green Deal published the Chemicals Strategy for Sustainability Towards a Toxic-Free Environment (“CSS”). The CSS sets forth far-reaching plans for introducing significant changes to the EU regulatory frameworks for chemicals including the Regulation on Registration, Evaluation, Authorization and Restriction of Chemicals (“REACH”), and the Classification, Labelling and Packaging Regulation (“CLP”) that could result in increased compliance costs, additional restrictions, and/or bans of chemicals used or produced by us. In the U.S., changes to the U.S. Environmental Protection Agency’s risk evaluation process under the Toxic Substances Control Act (“TSCA”) could also result in additional restrictions and/or bans of chemicals used or produced by us.Assessments under TSCA, REACH or similar programs or regulations in other state or national jurisdictions may result in heightened concerns about the chemicals we use or produce and may result in additional requirements or bans being placed on the production, handling, labeling or use of those chemicals. Such concerns and additional requirements could also increase the cost incurred by our customers to use our chemical products and otherwise limit the use of these products, which could lead to a decrease in demand for these products. Such a decrease in demand could have an adverse impact on our business and results of operations. The physical impacts of climate change can negatively impact our facilities and operations. Potential physical impacts of climate change include increased frequency and severity of hurricanes and floods as well as freezing conditions, tornadoes, and global sea level rise. Although we have preparedness plans in place designed to minimize impacts and enhance safety, should an event occur, it could have the potential to disrupt our supply chain and operations. A number of our facilities are located on the U.S. Gulf Coast, which has been impacted by hurricanes that have required us to temporarily shut down operations at those sites. Our sites rely on rivers for transportation that may experience restrictions in times of drought or other unseasonal weather variation. In addition, scarcity of water and drought conditions due to climate change could reduce the availability of fresh water needed to produce our products which could increase our costs of operations.30Table of ContentsIncreased regulation or deselection of plastic could lead to a decrease in demand growth for some of our products. There is a growing concern with the accumulation of plastic, including microplastics, and plastic waste in the environment. Additionally, plastics have recently faced increased public backlash and scrutiny, as well as governmental investigations and enforcement, and private litigation. Policy measures to address this concern are being discussed or implemented by governments at all levels. For example, on March 2, 2022, the United Nations Environment Assembly adopted a resolution to develop a new international legally binding instrument on plastic pollution with the ambition to complete the negotiations by the end of 2024. The European Union has been undertaking a series of actions under its Circular Economy Action Plan, including adoption of the Single Use Plastics Directive in 2019, which introduced policy measures for single use plastics including bans, product design requirements, extended producer responsibility obligations, and labeling requirements, and adoption of a proposed Packaging and Packaging Waste Regulation in 2022. In addition, a host of single-use plastic bans and taxes have been passed by countries around the world and states and municipalities throughout the U.S. Consumer deselection, increased regulation of, or prohibition on, the manufacturing or use of plastic or plastic products could limit the use of these products or increase the costs incurred by our customers to use such products, and could lead to a decrease in demand for PE, PP, and other products we make. Such a decrease in demand could adversely affect our business, operating results, and financial condition.Failure to effectively and timely achieve our GHG emissions reduction goals could damage our reputation and have an adverse effect on the demand for our products.In December 2022, we announced that we were increasing our GHG emissions reduction targets for 2030, while maintaining our previously announced goal to achieve net zero scope 1 and 2 GHG emissions by 2050. Our ability to achieve these goals depends on many factors, including the availability of technology, our ability to secure permits and emissions credits, evolving regulatory requirements, competitor actions, customer preferences, and our ability to reduce emissions from our operations through modernization and innovation, reduce the emissions intensity of the electricity we buy, and invest in renewables and low carbon energy. We may also not timely adapt to changes or methods in carbon pricing that could increase our costs and reduce our competitiveness. The cost associated with our GHG emissions reduction goals could be significant. Failure to achieve our emissions targets could result in reputational harm, enforcement or litigation, changing investor sentiment regarding investment in LyondellBasell or a negative impact on access to and cost of capital.Failure to achieve our circularity goals could have an adverse effect on the demand for our products.In September 2020, we announced a circularity goal of marketing at least two million metric tons of recycled and renewable-based polymers annually by 2030. Many of our customers also have goals to increase the recycled and renewable content in their own products and packaging. Our ability to achieve this goal depends on many factors, including the availability of collection and sortation infrastructure, evolving regulations on chemical recycling and recycled content, our ability to grow our circular and low carbon solutions business established in 2022, make investments in new technologies, expand the global footprint of our recycling facilities and joint ventures, secure access to feedstock, and manufacture recycled and low carbon products at commercial scale.General Risk FactorsThe COVID-19 pandemic could materially adversely affect our financial condition and results of operations.In early 2020, responses to the COVID-19 pandemic caused significant economic disruption and adversely impacted the global economy, leading to reduced consumer spending and volatility in the global financial and commodities markets. The return to pre-pandemic economic activity continues to depend on the severity and transmission rate of the virus, the continued effectiveness of vaccines and treatments, and policy decisions made by governments in reaction to evolving local conditions. Any further global supply chain or economic disruption as a result of COVID-19 could have a material negative impact on our business, results of operations, access to sources of liquidity and financial condition. 31Table of ContentsIncreased IT and cybersecurity threats and more sophisticated and targeted computer crime could pose a risk to our systems, networks, data, products, facilities and services.Increased global information cybersecurity threats and more sophisticated, targeted computer crime pose a risk to the confidentiality, availability and integrity of our data, operations and infrastructure. While we attempt to mitigate these risks by employing a number of measures, including security measures, employee training, comprehensive monitoring of our networks and systems, and maintenance of backup and protective systems, our employees, systems, networks, products, facilities and services remain potentially vulnerable to ransomware, sophisticated espionage or cyber-assault. Depending on their nature and scope, such threats could potentially lead to the compromise of confidential information, improper use of our systems and networks, manipulation and destruction of data, defective products, production downtimes and operational disruptions, which in turn could adversely affect our reputation, competitiveness and results of operations.Many of our businesses depend on our intellectual property. Our future success will depend in part on our ability to develop new technologies and protect our intellectual property rights, and our inability to do so could reduce our ability to maintain our competitiveness and margins.We have a significant worldwide patent portfolio of issued and pending patents and our future results could be impacted by our ability to successfully develop and protect new processes and technologies. Our patents and patent applications, together with proprietary technical know-how, are significant to our competitive position, particularly with regard to PO, intermediate chemicals, polyolefins, licensing and catalysts. We rely on the patent, copyright and trade secret laws of the countries in which we operate to protect our investment in research and development, manufacturing and marketing. We operate plants, sell catalysts and products, participate in joint ventures, and license our process technology in many foreign jurisdictions, including those having heightened risks for intellectual property. In some of these instances, we must disclose at least a portion of our technology to third parties or regulatory bodies. In these cases, we rely primarily on contracts and trade secret laws to protect the associated trade secrets. However, we may be unable to prevent third parties from using our intellectual property without authorization. Proceedings to protect these rights could be costly, and we may not prevail.The failure of our patents or confidentiality agreements to protect our processes, apparatuses, technology, trade secrets or proprietary know-how could result in significantly lower revenues, reduced profit margins and cash flows and/or loss of market share. We also may be subject to claims that our technology, patents or other intellectual property infringes on a third party’s intellectual property rights. Unfavorable resolution of these claims could result in restrictions on our ability to deliver the related service or in a settlement that could be material to us.Adverse results of legal proceedings could materially adversely affect us.We are subject to and may in the future be subject to a variety of legal proceedings and claims that arise out of the ordinary conduct of our business. Results of legal proceedings cannot be predicted with certainty. Irrespective of its merits, litigation may be both lengthy and disruptive to our operations and may cause significant expenditure and diversion of management attention. We may be faced with significant monetary damages or injunctive relief against us that could have an adverse impact on our business and results of operations should we fail to prevail in certain matters.If we lose key employees or are unable to attract and retain the employees we need, our business and operating results could be adversely affected.Our success depends on our ability to attract and retain key personnel, and we rely heavily on our management team. The inability to recruit and retain key personnel or the unexpected loss of key personnel may adversely affect our operations. In addition, because of the reliance on our management team, our future success depends in part on our ability to identify and develop talent to succeed senior management. The retention of key personnel and appropriate senior management succession planning will continue to be critically important to the successful implementation of our strategies.32Table of ContentsThere is substantial and continuous competition for diverse, talented engineering, manufacturing, and operations employees. We may not be successful in attracting and retaining such personnel, and we may experience increased compensation and training costs that may not be offset by either improved productivity or higher sales. We have from time to time experienced, and we may continue to experience, difficulty in hiring and retaining employees with appropriate qualifications, and may not be able to fill positions in desired geographic areas or at all.Significant changes in pension fund investment performance or assumptions relating to pension costs may adversely affect the valuation of pension obligations, the funded status of pension plans, and our pension cost.Our pension cost is materially affected by the discount rates used to measure pension obligations, the level of plan assets available to fund those obligations at the measurement date and the expected long-term rates of return on plan assets. Significant changes in investment performance or a change in the portfolio mix of invested assets may result in corresponding increases and decreases in the value of plan assets, particularly equity securities, or in a change of the expected rate of return on plan assets. Any changes in key actuarial assumptions, such as the discount rate or mortality rate, would impact the valuation of pension obligations, affecting the reported funded status of our pension plans as well as the net periodic pension cost in the following fiscal years.Many of our current pension plans have projected benefit obligations that exceed the fair value of the plan assets. As of December 31, 2022, the aggregate deficit was $662 million. Any declines in the fair values of the pension plans’ assets could require additional payments by us in order to maintain specified funding levels. Our pension plans are subject to legislative and regulatory requirements of applicable jurisdictions, which could include, under certain circumstances, local governmental authority to terminate the plan.See Note 14 to the Consolidated Financial Statements for additional information regarding pensions and other post-retirement benefits.Item 1B. Unresolved Staff Comments.None.Item 3. Legal Proceedings.Environmental Matters From time to time, we and our joint ventures receive notices or inquiries from government entities regarding alleged violations of environmental laws and regulations pertaining to, among other things, the disposal, emission and storage of chemical and petroleum substances, including hazardous wastes. U.S. Securities and Exchange Commission rules require disclosure of certain environmental matters when a governmental authority is a party to the proceedings and the proceedings involve potential monetary sanctions that we reasonably believe could exceed $300,000. The matters below are disclosed solely pursuant to that requirement and we do not believe that any of these proceedings will have a material impact on the Company’s Consolidated Financial Statements.In connection with an enforcement initiative of EPA regarding flare emissions at petrochemical plants, we have settled with EPA and the U.S. Department of Justice in order to resolve claims initiated in July 2014, related to alleged improper operation and maintenance of flares at four of our U.S. facilities. The consent decree related to the settlement was entered by the U.S. District Court for the Southern District of Texas in January 2022. Under the terms of the settlement, we paid a penalty of $3.4 million in January 2022 and will conduct fence line monitoring and make investments in equipment at the facilities. The consent decree was amended in September 2022 to include flares at an additional facility, including a penalty of $324,000 that we paid in October 2022. In March 2018, the Cologne, Germany local court issued a regulatory fine notice of €1.8 million arising from a pipeline leak near our Wesseling, Germany facility. We expect the Cologne prosecutor to issue a corresponding payment request, which will resolve the matter.33Table of ContentsIn February 2020, the State of Texas filed suit against Houston Refining, LP, a subsidiary of LyondellBasell, in Travis County District Court seeking civil penalties and injunctive relief for violations of the Texas Clean Air Act related to several emission events. In July 2020, Harris County, Texas petitioned to intervene in the lawsuit and the State added additional claims to its petition relating to self-reported deviations of Houston Refining’s air operating permit. We are currently engaged in settlement negotiations to resolve the matter.On July 27, 2021, approximately 160,000 pounds of liquid process material containing primarily acetic acid was released from a reactor at the La Porte acetic acid unit. In October 2021, the Texas Commission on Environmental Quality (“TCEQ”) issued a Notice of Enforcement for the incident. In November 2021, the State of Texas filed a petition on behalf of the TCEQ seeking injunctive relief and civil penalties for unauthorized air pollution and regulatory nuisance related to the incident. We are currently engaged in settlement discussions with the State to resolve this matter.In April 2022, the State of Texas filed suit against Equistar Chemicals, LP, in Travis County District Court seeking civil penalties and injunctive relief for alleged violations of the Texas Clean Air Act related to multiple emissions events at Equistar’s Bayport Plant. Litigation and Other MattersInformation regarding our litigation and other legal proceedings can be found in Note 17 to the Consolidated Financial Statements.Item 4. Mine Safety Disclosures.Not applicable.34Table of ContentsPART II Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.Market and Dividend InformationOur shares were listed on the New York Stock Exchange (“NYSE”) on October 14, 2010 under the symbol “LYB.” The payment of dividends or distributions in the future will be subject to the requirements of Dutch law and the discretion of our Board of Directors. The declaration of any future cash dividends and, if declared, the amount of any such dividends, will depend upon general business conditions, our financial condition, our earnings and cash flow, our capital requirements, financial covenants and other contractual restrictions on the payment of dividends or distributions.We intend to continue to declare and pay quarterly dividends, with the goal of increasing the dividend over time, after giving consideration to our cash balances and expected results from operations. However, there can be no assurance that any dividends or distributions will be declared or paid in the future.HoldersAs of February 21, 2023, there were approximately 5,200 record holders of our shares, including Cede & Co. as nominee of the Depository Trust Company. Equity Compensation PlanSee Part III, Item 11. Executive Compensation for information relating to the Company’s equity compensation plans.United Kingdom Tax ConsiderationsAs a result of its United Kingdom tax residency, dividend distributions by LyondellBasell Industries N.V. to its shareholders are not subject to withholding tax, as the United Kingdom currently does not levy a withholding tax on dividend distributions.Performance GraphThe performance graph and the information contained in this section is not “soliciting material,” is being furnished, not filed, with the SEC and is not to be incorporated by reference into any of our filings under the Securities Act or the Exchange Act whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing.The graph below shows the relative investment performance of LyondellBasell Industries N.V. shares, the S&P 500 Index and the S&P 500 Chemicals Index since December 31, 2017. The graph assumes that $100 was invested on December 31, 2017 and any dividends paid were reinvested at the date of payment. The graph is presented pursuant to SEC rules and is not meant to be an indication of our future performance. 35Table of Contents12/31/201712/31/201812/31/201912/31/202012/31/202112/31/2022LyondellBasell Industries N.V.$100.00$78.31$93.50$95.97$100.84$99.85S&P 500 Index$100.00$95.62$125.72$148.85$191.58$156.88S&P 500 Chemicals Index$100.00$88.39$107.85$127.31$160.30$142.24Issuer Purchases of Equity SecuritiesOn May 27, 2022, our shareholders approved a share repurchase authorization of up to 34,026,947 of our ordinary shares, through November 27, 2023, which superseded any prior repurchase authorizations. The maximum number of shares that may yet be purchased is not necessarily an indication of the number of shares that will ultimately be purchased.Item 6. Reserved36Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.GENERALThis discussion should be read in conjunction with the information contained in our Consolidated Financial Statements, and the accompanying notes elsewhere in this report. Unless otherwise indicated, the “Company,” “we,” “us,” “our” or similar words are used to refer to LyondellBasell Industries N.V. together with its consolidated subsidiaries (“LyondellBasell N.V.”).The discussion summarizing the significant factors affecting the results of operations and financial condition for the year ended December 31, 2020 and for the year ended December 31, 2021 compared to 2020 have been excluded from this Form 10-K and can be found in Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the Securities and Exchange Commission on February 24, 2022, of which Item 7 is incorporated herein by reference.OVERVIEWIn 2022, our balanced business portfolio, consistent cash generation and strong balance sheet enabled us to successfully navigate through challenging market conditions while continuing to provide significant returns for our shareholders. During the year, petrochemical markets were pressured by high and volatile energy and feedstock costs as well as reduced global demand for our products. Our O&P-Americas and O&P-EAI segments encountered headwinds from reduced demand in Europe and Asia as well as global capacity additions. Our I&D segment benefited from improved oxyfuels margins which were partially offset by lower margins for other products due to lower demand. Margins in our Refining segment benefited from increased global mobility and favorable markets.During 2022 we generated $6.1 billion in cash from operating activities. We remain committed to a disciplined approach to capital allocation. In 2022, approximately $1.9 billion was reinvested in the business and $3.7 billion was returned to shareholders through quarterly dividends, a special dividend and share repurchases.In 2022, we launched a comprehensive review of our strategy. Initial strategic actions included the decision to exit the refining business and the sale of the Australian polypropylene business. We also formed a circular and low carbon solutions business within our O&P-Americas and O&P-EAI segments. This business was created to accelerate progress in capturing value from serving the rapidly growing customer demand for recycled and renewable solutions. 37Table of ContentsResults of operations for the periods discussed are presented in the table below. Year Ended December 31,Millions of dollars20222021Sales and other operating revenues$50,451 $46,173 Cost of sales43,847 37,397 Impairments69 624 Selling, general and administrative expenses1,310 1,255 Research and development expenses124 124 Operating income5,101 6,773 Interest expense(287)(519)Interest income29 9 Other (expense) income, net(72)62 Income from equity investments5 461 Income from continuing operations before income taxes4,776 6,786 Provision for income taxes882 1,163 Income from continuing operations3,894 5,623 Loss from discontinued operations, net of tax(5)(6)Net income3,889 5,617 Other comprehensive income (loss), net of tax –Financial derivatives208 72 Unrealized losses on available-for-sale debt securities— (1)Defined benefit pension and other postretirement benefit plans346 224 Foreign currency translations(123)(155)Total other comprehensive income, net of tax431 140 Comprehensive income$4,320 $5,757 RESULTS OF OPERATIONSRevenues—Revenues increased $4,278 million, or 9%, in 2022 compared to 2021. Average sales prices in 2022 were higher for many of our products as sales prices generally correlate with crude oil prices, which increased relative to 2021. These higher prices led to a 13% increase in revenue. Unfavorable foreign exchange impacts resulted in a 4% decrease in revenue. Cost of Sales—Cost of sales increased $6,450 million, or 17%, in 2022 compared to 2021. This increase primarily related to higher feedstock and energy costs. Fluctuations in our cost of sales are generally driven by changes in feedstock and energy costs. Feedstock and energy related costs generally represent approximately 70% to 80% of cost of sales, other variable costs account for approximately 10% of cost of sales on an annual basis and fixed operating costs, consisting primarily of expenses associated with employee compensation, depreciation and amortization, and maintenance, range from approximately 10% to 20% in each annual period.Impairments—During 2022 we recognized a non-cash impairment charge of $69 million related to the sale of our Australian polypropylene manufacturing facility. During 2021 we recognized a non-cash impairment charge of $624 million related to our Houston refinery. See Notes 7 and 20 to the Consolidated Financial Statements for additional information regarding impairment charges.38Table of ContentsOperating Income—Operating income decreased by $1,672 million or 25% in 2022 compared to 2021. In 2022, Operating income decreased for our O&P-Americas, O&P-EAI, Technology and APS segments by $2,470 million, $1,214 million, $140 million and $85 million, respectively. These decreases were partially offset by increases in Operating income for our Refining and I&D segments of $1,585 million and $637 million, respectively. Results for each of our business segments are discussed further in the Segment Analysis section below.Interest Expense—Interest expense decreased $232 million or 45% in 2022 compared to 2021 primarily driven by debt extinguishment costs of $130 million recognized in 2021 related to the redemption of certain guaranteed notes, including a cash tender offer, coupled with a decrease in the weighted average outstanding debt balance in 2022 compared to 2021. See Note 11 to the Consolidated Financial Statements for additional information.Income from Equity Investments—Income from equity method investments decreased $456 million, or 99%, in 2022 compared to 2021, primarily due to lower polyolefin spreads for our joint ventures in our O&P—EAI segment, particularly those in Asia and Saudi Arabia.Income Taxes—Our effective income tax rates of 18.5% in 2022 and 17.1% in 2021 resulted in tax provisions of $882 million and $1,163 million, respectively. In 2021, we benefited from return to accrual adjustments primarily associated with a step-up of certain Italian assets to fair market value and benefits from the Coronavirus Aid, Relief, and Economic Security Act, also known as “CARES Act” of 1.8% and 0.9%, respectively. These increases were coupled with a decrease in exempt income in 2022 resulting in a 2% increase in the effective tax rate, partially offset by changes in pretax income in countries with varying statutory tax rates and fluctuations in uncertain tax positions of 2.1% and 1.8%, respectively. For additional information, see Note 16 to our Consolidated Financial Statements.Comprehensive Income—Comprehensive income decreased by $1,437 million in 2022 compared to 2021, primarily due to a decrease in net income. The activities from the remaining components of Comprehensive income are discussed below.Financial derivatives designated as cash flow hedges, primarily our forward-starting interest rate swaps, led to an increase in Comprehensive income of $136 million in 2022 compared to 2021, due to periodic changes in the benchmark interest rates.Defined benefit pension and other postretirement benefit plans led to an increase in Comprehensive income of $122 million in 2022 compared to 2021, primarily resulting from changes in actuarial assumptions and pension settlements. In 2022, a decrease in foreign currency translation losses led to an increase in Comprehensive income of $32 million compared to 2021, primarily due to continued strengthening of the U.S. dollar relative to the euro and the pre-tax gain from the effective portion of our net investment hedges in 2022.See Notes 13, 14 and 18 to our Consolidated Financial Statements for further discussions.39Table of ContentsSegment AnalysisWe use earnings from continuing operations before interest, income taxes, and depreciation and amortization (“EBITDA”) as our measure of profitability for segment reporting purposes. This measure of segment operating results is used by our chief operating decision maker to assess the performance of, and allocate resources to, our operating segments. Intersegment eliminations and items that are not directly related or allocated to business operations, such a s foreign exchange gains (losses) and components of pension and other post-retirement benefit costs other than service cost, are included in “Other.” For additional information related to our operating segments, as well as a reconciliation of EBITDA to its nearest generally accepted accounting principles (“GAAP”) measure, Income from continuing operations before income taxes, see Note 20 to our Consolidated Financial Statements.Our continuing operations are managed through six reportable segments: O&P-Americas, O&P-EAI, I&D, APS, Refining and Technology. The following tables reflect selected financial information for our reportable segments.Year Ended December 31,Millions of dollars20222021Sales and other operating revenues:O&P-Americas$13,935 $15,002 O&P-EAI12,823 13,490 I&D12,950 10,180 APS5,231 5,145 Refining11,893 8,002 Technology693 843 Other, including segment eliminations(7,074)(6,489)Total$50,451 $46,173 Operating income (loss):O&P-Americas$2,082 $4,552 O&P-EAI14 1,228 I&D1,604 967 APS201 286 Refining889 (696)Technology331 471 Other, including segment eliminations(20)(35)Total$5,101 $6,773 Depreciation and amortization:O&P-Americas$582 $578 O&P-EAI166 197 I&D332 379 APS109 117 Refining39 79 Technology39 43 Total$1,267 $1,393 Income (loss) from equity investments:O&P-Americas$98 $115 O&P-EAI(68)313 I&D(25)34 APS— (1)Total$5 $461 40Table of Contents Year Ended December 31,Millions of dollars20222021Other (expense) income, net:O&P-Americas$(28)$28 O&P-EAI— 11 I&D(39)(2)APS2 7 Refining(7)(7)Technology(4)— Other, including intersegment eliminations4 25 Total$(72)$62 EBITDA:O&P-Americas$2,734 $5,273 O&P-EAI112 1,749 I&D1,872 1,378 APS312 409 Refining921 (624)Technology366 514 Other, including intersegment eliminations(16)(10)Total$6,301 $8,689 Olefins and Polyolefins-Americas SegmentOverview—EBITDA decreased in 2022 relative to 2021 primarily driven by lower olefins margins.In calculating the impact of margin and volume on EBITDA, consistent with industry practice, management offsets revenues and volumes related to ethylene co-products against the cost to produce ethylene. Volume and price impacts of ethylene co-products are reported in margin.Ethylene Raw Materials—Ethylene and its co-products are produced from two major raw material groups:•NGLs, principally ethane and propane, the prices of which are generally affected by natural gas prices; and•crude oil-based liquids (“liquids” or “heavy liquids”), including naphtha, condensates and gas oils, the prices of which are generally related to crude oil prices.We have flexibility to vary the raw material mix and process conditions in our U.S. olefins plants in order to maximize profitability as market prices fluctuate for both feedstocks and products. Although prices of crude-based liquids and natural gas liquids are generally related to crude oil and natural gas prices, during specific periods the relationships among these materials and benchmarks may vary significantly. In 2022 and 2021, approximately 70% and 60%, respectively, of the raw materials used in our North American crackers was ethane.41Table of ContentsThe following table sets forth selected financial information for the O&P-Americas segment including Income from equity investments, which is a component of EBITDA. Year Ended December 31,Millions of dollars20222021Sales and other operating revenues$13,935 $15,002 Income from equity investments98 115 EBITDA2,734 5,273 Revenues—Revenues decreased by $1,067 million, or 7%, in 2022 compared to 2021. Lower average sales prices for all businesses resulted in the 7% decrease in revenue primarily driven by reduced demand and increased market supply. EBITDA—EBITDA decreased by $2,539 million, or 48%, in 2022 compared to 2021. Lower olefins results led to a 33% decrease in EBITDA primarily due to margin compression driven by lower ethylene prices coupled with higher feedstock and energy costs. Lower polyethylene and polypropylene results led to a 9% and 5% decrease in EBITDA, respectively, primarily driven by lower demand, an increase in industry capacity and higher energy costs.Olefins and Polyolefins-Europe, Asia, International SegmentOverview—EBITDA decreased in 2022 compared to 2021 mainly as a result of lower volumes and margins across all businesses, lower income from equity investments and unfavorable impacts of foreign exchange.In calculating the impact of margin and volume on EBITDA, consistent with industry practice, management offsets revenues and volumes related to ethylene co-products against the cost to produce ethylene. Volume and price impacts of ethylene co-products are reported in margin.Ethylene Raw Materials—In Europe, naphtha is the primary raw material for our ethylene production and represents approximately 70% of the raw materials used in 2022 and 2021.The following table sets forth selected financial information for the O&P-EAI segment including Income from equity investments, which is a component of EBITDA. Year Ended December 31,Millions of dollars20222021Sales and other operating revenues$12,823 $13,490 (Loss) income from equity investments(68)313 EBITDA112 1,749 Revenues—Revenues decreased by $667 million, or 5%, in 2022 compared to 2021. Unfavorable foreign exchange impacts resulted in a revenue decrease of 8%. Lower volumes resulted in a revenue decrease of 8% primarily due to lower demand along with planned and unplanned maintenance. During 2022, we had planned and unplanned maintenance resulting in ethylene cracker operating rates of approximately 67% of capacity compared to 89% of capacity during 2021. Higher average sales prices resulted in a 11% increase in revenue as sales prices generally correlate with crude oil prices, which on average, increased compared to 2021.42Table of ContentsEBITDA—EBITDA decreased by $1,637 million, or 94%, in 2022 compared to 2021. Lower polyolefin results led to a 39% decrease in EBITDA. Approximately 60% of the change was driven by decreased margins resulting from higher energy costs and lower spreads with the remainder due to a decrease in volumes driven by lower demand. Lower olefins results led to a 20% decrease in EBITDA, approximately half of the change was driven by lower volumes due to unplanned maintenance and reduced operating rates to manage working capital. The other half of the change was due to lower margins resulting from higher feedstock and energy costs which outpaced increased ethylene prices. Lower income from our equity investments led to a decrease in EBITDA of 22% mainly attributable to lower polyolefin spreads across all joint ventures, particularly those located in Asia and Saudi Arabia. Unfavorable foreign exchange impacts resulted in a 10% decrease in EBITDA.In the second quarter of 2022, we recognized a $69 million non-cash impairment charge in conjunction with the sale of our polypropylene manufacturing facility located in Australia, resulting in a 4% decrease in EBITDA for 2022 compared to 2021. Intermediates and Derivatives SegmentOverview—EBITDA increased in 2022 compared to 2021, primarily driven by increased oxyfuels and related products margin, partially offset by decreases in margin for propylene oxide and derivatives and intermediate chemicals.The following table sets forth selected financial information for the I&D segment including Income from equity investments, which is a component of EBITDA. Year Ended December 31,Millions of dollars20222021Sales and other operating revenues$12,950 $10,180 (Loss) income from equity investments(25)34 EBITDA1,872 1,378 Revenues—Revenues increased by $2,770 million, or 27%, in 2022 compared to 2021. Higher average sales prices resulted in a 25% increase in revenue as sales prices generally correlate with crude oil prices, which, on average, increased compared to the same period in 2021, coupled with lower industry supply. Sales volumes improved resulting in a 6% increase in revenue as 2021 was impacted by unusually cold temperatures and associated electrical power outages that led to shutdowns of our manufacturing facilities in Texas. Unfavorable foreign exchange impacts resulted in a revenue decrease of 4%.EBITDA—EBITDA increased $494 million, or 36%, in 2022 compared to 2021. Oxyfuels and related products increased EBITDA by 53% primarily driven by margin improvement as a result of higher gasoline prices. Propylene oxide and derivatives and intermediate chemicals results declined each resulting in a 5% reduction in EBITDA driven by reduced margins from higher energy and feedstock costs. Unfavorable foreign exchange impacts resulted in a 4% decrease in EBITDA. Lower income from our equity investments led to a decrease in EBITDA of 4% mainly attributable to lower margins in Asia. During 2022 and 2021, we recognized LIFO inventory charges of $26 million and $93 million, respectively, which resulted in a 5% increase in EBITDA.Advanced Polymer Solutions SegmentOverview—EBITDA decreased in 2022 compared to 2021, primarily due to a decline in compounding and solutions results partially offset by improved advanced polymers results. In the first quarter of 2023, our Catalloy and polybutene-1 products, previously reflected in our APS segment, will be transferred to and reflected in our O&P-Americas and O&P-EAI segments. Our reporting structure will be revised in the first quarter of 2023 to reflect this change.43Table of ContentsThe following table sets forth selected financial information for the APS segment:Year Ended December 31,Millions of dollars20222021Sales and other operating revenues$5,231 $5,145 Loss from equity investments— (1)EBITDA312 409 Revenues—Revenues increased in 2022 by $86 million, or 2%, compared to 2021. Higher average sales prices resulted in a 13% increase in revenue as sales prices generally correlate with prices for crude oil and its derivatives, which, on average, increased compared to 2021. Foreign exchange impacts resulted in a revenue decrease of 8%. Sales volumes declined resulting in a 3% decrease in revenue stemming from lower demand.EBITDA—EBITDA decreased in 2022 by $97 million, or 24%, compared to 2021. Compounding and solutions results led to a 29% reduction in EBITDA. Approximately 55% of the change was driven by higher raw material and energy costs with the remainder due to lower volumes as demand declined. Advanced polymers results increased by 4% driven by margin improvements for Catalloy due to higher sales prices. Unfavorable foreign exchange impacts resulted in a EBITDA decrease of 9%. During 2022 and 2021, we recognized $28 million and $55 million, respectively, of LIFO inventory charges which resulted in a 7% increase in EBITDA.Refining SegmentOverview—EBITDA increased in 2022 relative to 2021 primarily due to higher margins.The following table sets forth selected financial information and heavy crude oil processing rates for the Refining segment and the U.S. refining market margins for the applicable periods. “Brent” is a light sweet crude oil and is one of the main benchmark prices for purchases of oil worldwide. “Maya” is a heavy sour crude oil grade produced in Mexico that is a relevant benchmark for heavy sour crude oils in the U.S. Gulf Coast market. References to industry benchmarks for refining market margins are to industry prices reported by Platts, a division of S&P Global. Year Ended December 31,Millions of dollars20222021Sales and other operating revenues$11,893 $8,002 EBITDA921 (624)Thousands of barrels per dayHeavy crude oil processing rates238 231 Market margins, dollars per barrel Brent - 2-1-1$33.62 $14.39 Brent - Maya differential11.71 6.48 Total Maya 2-1-1$45.33 $20.87 Revenues—Revenues increased by $3,891 million, or 49%, in 2022 compared to 2021. Higher product prices led to a revenue increase of 45% as the average Brent crude oil price increased approximately $28.11 per barrel. Sales volumes increased resulting in a 4% increase in revenue due to improved demand as refined products markets recovered from the impacts of the COVID-19 pandemic.44Table of ContentsEBITDA—EBITDA increased by $1,545 million or 248%, in 2022 compared to 2021. Margin improvements drove a 173% increase in EBITDA primarily due to an increase in the Maya 2-1-1 market margin driven by higher demand for transportation fuels. Additionally, during 2022 we incurred costs related to our planned exit from the refining business, which resulted in a 25% decrease in EBITDA compared to 2021. See Notes 7, 12 and 20 to the Consolidated Financial Statements for additional information regarding the planned exit. The remaining change is due to non-cash impairment charges of $624 million recorded in 2021 with no similar charge incurred in 2022. For additional information see Notes 7 and 20 to our Consolidated Financial Statements.Technology SegmentOverview—The Technology segment recognizes revenues related to the sale of polyolefin catalysts and the licensing of chemical and polyolefin process technologies. These revenues are offset in part by the costs incurred in the production of catalysts, licensing and services activities and research and development (“R&D”) activities. In 2022 and 2021, our Technology segment incurred approximately 55% of all R&D costs. EBITDA decreased in 2022 compared to 2021 driven by lower licensing revenues and the unfavorable impacts of foreign exchange.The following table sets forth selected financial information for the Technology segment. Year Ended December 31,Millions of dollars20222021Sales and other operating revenues$693 $843 EBITDA366 514 Revenues—Revenues decreased by $150 million, or 18%, in 2022 compared to 2021. Lower licensing revenues resulting from fewer contracts reaching significant milestones drove an 11% decrease in revenue. Unfavorable foreign exchange impacts resulted in a 10% decrease in revenue. Changes in average catalyst sales price resulted in a 2% increase in revenue. Higher catalyst volumes resulted in a 1% increase in revenue primarily driven by increased demand.EBITDA—EBITDA in 2022 decreased by $148 million, or 29%, compared to 2021. Lower licensing revenues resulting from fewer contracts reaching significant milestones drove a 16% decrease in EBITDA. Unfavorable foreign exchange impacts resulted in an EBITDA decrease of 11%.45Table of ContentsFINANCIAL CONDITIONOperating, investing and financing activities of continuing operations, which are discussed below, are presented in the following table: Year Ended December 31,Millions of dollars20222021Cash provided by (used in):Operating activities$6,119 $7,695 Investing activities(1,977)(1,502)Financing activities(3,407)(6,385)Operating Activities—Cash provided by operating activities of $6,119 million in 2022 primarily reflected earnings adjusted for non-cash items and cash used by the main components of working capital–Accounts receivable, Inventories and Accounts payable.In 2022, the main components of working capital provided $450 million of cash driven by a decrease in Accounts receivable, partially offset by a decrease in Accounts payable. The decrease in Accounts receivable was primarily due to lower revenues across most businesses primarily driven by lower average sales prices. The decrease in Accounts payable was driven by lower production volumes as a result of lower operating rates. Cash provided by operating activities of $7,695 million in 2021 primarily reflected earnings adjusted for non-cash items and cash provided by the main components of working capital.In 2021, the main components of working capital used $960 million of cash driven by an increase in Inventories and Accounts receivable, partially offset by an increase in Accounts payable. The increase in Inventories was primarily due to an increase in raw material costs coupled with an increase in inventory to levels required to support improved demand and in anticipation of turnarounds in 2022. The increase in Accounts receivable was driven by higher revenues across most businesses primarily driven by higher average sales prices. The increase in Accounts payable was primarily driven by increased raw material and energy costs.Other operating activities in 2021 includes an $870 million tax refund received in the fourth quarter of 2021 and the effects of changes in income tax accruals primarily driven by increased pretax income. For additional information see Note 16 to our Consolidated Financial Statements.Investing Activities—Capital expenditures in 2022 totaled $1,890 million compared to $1,959 million in 2021. Approximately 50% and 60% of our capital expenditures in 2022 and 2021, respectively, was for profit-generating growth projects, primarily our PO/TBA plant, with the remaining expenditures supporting sustaining maintenance. See Note 20 to the Consolidated Financial Statements for additional information regarding capital spending by segment.We invest cash in investment-grade and other high-quality instruments that provide adequate flexibility to redeploy funds as needed to meet our cash flow requirements while maximizing yield.In 2022 and 2021, we received proceeds of $8 million and $335 million, respectively, from the liquidation of our investment in equity securities. Additionally, in 2021 we received proceeds of $346 million, upon the maturities of certain of our available-for-sale debt securities.In 2021, we made an equity contribution of $104 million to form Ningbo ZRCC LyondellBasell New Material Company Limited, a 50/50 joint venture with Sinopec. For additional information related to our Equity investments, see Note 8 to the Consolidated Financial Statements.46Table of ContentsIn 2022, foreign currency contracts with an aggregate notional value of €500 million expired. Upon settlement of these foreign currency contracts, we paid €500 million ($501 million at the expiry spot rate) to our counterparties and received $614 million from our counterparties.In 2021, foreign currency contracts with an aggregate notional value of €300 million expired. Upon settlement of these foreign currency contracts, we paid €300 million ($355 million at the expiry spot rate) to our counterparties and received $358 million from our counterparties.Financing Activities—We made dividend payments totaling $3,246 million, which included a combination of a special dividend of $5.20 per share and an increased quarterly dividend, and $1,486 million in 2022 and 2021, respectively. Additionally, in 2022 and 2021, we made payments of $420 million and $463 million to repurchase outstanding ordinary shares, respectively. For additional information related to our share repurchases and dividend payments, see Note 18 to the Consolidated Financial Statements.In 2022 and 2021, we made net repayments of $4 million and $296 million, respectively, through the issuance and repurchase of commercial paper instruments under our commercial paper program.In 2022, we received a return of collateral of $238 million related to the positions held with our counterparties for certain forward-starting interest rate swaps.In 2021, we prioritized debt reduction resulting in a $4 billion decrease in our outstanding long-term debt. For a detailed discussion of financing activities for 2021, see Note 11 to the Consolidated Financial Statements.In November 2021, foreign currency contracts previously designated as cash flow hedges with an aggregate notional value of $855 million expired. Upon settlement of these foreign currency contracts we paid €790 million ($904 million at the expiry spot rate) to our counterparties and received $855 million from our counterparties.For additional information related to our swaps and currency contracts, see Note 13 to the Consolidated Financial Statements.Liquidity and Capital ResourcesOverviewWe plan to fund our working capital, capital expenditures, debt service, dividends and other cash requirements with our current available liquidity and cash from operations, which could be affected by general economic, financial, competitive, legislative, regulatory, business and other factors, many of which are beyond our control. Debt repayment, and the purchase of shares under our share repurchase authorization, may be funded from cash and cash equivalents, cash from our short-term investments, cash from operating activities, proceeds from the issuance of debt, or a combination thereof. We intend to continue to declare and pay quarterly dividends, with the goal of increasing the dividend over time, after giving consideration to our cash balances and expected results from operations. Our focus on funding our dividends while remaining committed to a strong investment grade balance sheet continues to be the foundation of our capital allocation strategy.Cash and Liquid InvestmentsAs of December 31, 2022, we had Cash and cash equivalents totaling $2,151 million, which includes $1,044 million in jurisdictions outside of the U.S., primarily held within the United Kingdom. There are currently no legal or economic restrictions that would materially impede our transfers of cash.47Table of ContentsCredit ArrangementsAt December 31, 2022, we had total debt, including current maturities, of $11,321 million, and $227 million of outstanding letters of credit, bank guarantees and surety bonds issued under uncommitted credit facilities.We had total unused availability under our credit facilities of $3,844 million at December 31, 2022, which included the following:•$3,050 million under our $3,250 million Senior Revolving Credit Facility, which backs our $2,500 million commercial paper program. Availability under this facility is net of outstanding borrowings, outstanding letters of credit provided under the facility and notes issued under our commercial paper program. At December 31, 2022, we had $200 million of outstanding commercial paper, net of discount, and no borrowings or letters of credit outstanding under this facility; and•$794 million under our $900 million U.S. Receivables Facility. Availability under this facility is subject to a borrowing base of eligible receivables, which is reduced by outstanding borrowings and letters of credit, if any. At December 31, 2022 we had no borrowings or letters of credit outstanding under this facility. At any time and from time to time, we may repay or redeem our outstanding debt, including purchases of our outstanding bonds in the open market, through privately negotiated transactions or a combination thereof, in each case using cash and cash equivalents, cash from our short-term investments, cash from operating activities, proceeds from the issuance of debt or proceeds from asset divestitures. Any repayment or redemption of our debt will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. In connection with such repurchases or redemptions, we may incur cash and non-cash charges, which could be material in the period in which they are incurred.In accordance with our current interest rate risk management strategy and subject to management’s evaluation of market conditions and the availability of favorable interest rates among other factors, we may from time to time enter into interest rate swap agreements to economically convert a portion of our fixed rate debt to variable rate debt or convert a portion of our variable rate debt to fixed rate debt.Share RepurchasesIn May 2022, our shareholders approved a proposal to authorize us to repurchase up to 34.0 million ordinary shares, through November 27, 2023, which superseded any prior repurchase authorizations. Our share repurchase authorization does not have a stated dollar amount, and purchases may be made through open market purchases, private market transactions or other structured transactions. Repurchased shares could be retired or used for general corporate purposes, including for various employee benefit and compensation plans. The maximum number of shares that may yet be purchased is not necessarily an indication of the number of shares that will ultimately be purchased. In 2022, we purchased 4.4 million shares under our share repurchase authorization for $406 million.As of February 21, 2023, we had approximately 31.7 million shares remaining under the current authorization. The timing and amounts of additional shares repurchased, if any, will be determined based on our evaluation of market conditions and other factors, including any additional authorizations approved by our shareholders. For additional information related to our share repurchase authorizations, see Note 18 to the Consolidated Financial Statements.Capital Budget In 2023, we are planning to invest approximately $1.6 billion in capital expenditures. Approximately 70% of the 2023 budget is planned for sustaining maintenance, with the remaining budget supporting profit-generating growth projects. 48Table of ContentsCash Requirements from Contractual and Other ObligationsAs part of our ongoing operations, we enter into contractual arrangements that may require us to make future cash payments under certain circumstances. Our cash requirements related to contractual and other obligations primarily consist of purchase obligations, principal and interest payments on outstanding debt, lease payments, pension and other post-retirement benefits and income taxes. For more information regarding our debt arrangements, lease obligations, pension and other post-retirement benefits and income taxes, see Notes 11, 12, 14 and 16 to the Consolidated Financial Statements, respectively.We are party to obligations to purchase raw materials, utilities and industrial gases which are designed to ensure sources of supply and are not expected to be in excess of normal requirements. These purchase arrangements include provisions which state minimum purchase quantities; however, in the event we do not take the contractual minimum volumes, we are obligated to compensate the vendor only for any resulting economic losses they suffer. No material fees were paid to vendors for such losses in 2022. Assuming that contractual minimum volumes are purchased at contract prices as of December 31, 2022, these commitments represent approximately 20% of our annual Cost of sales with a weighted average remaining term of 7 years.We also have purchase obligations under take-or-pay agreements which require us to either buy and take delivery of a minimum quantity of goods or to pay for any shortfall. These arrangements primarily relate to product off-take agreements with joint ventures located in Poland. No material shortfall was paid for quantities not taken under these contracts in 2022. When valued using a contract price as of December 31, 2022, these commitments represent approximately 5% of our annual Cost of sales with a weighted average remaining term of 14 years.CURRENT BUSINESS OUTLOOKIn January 2023, demand from consumer packaging, oxyfuels and refining markets remained stable. Moderating energy and feedstock costs are providing some offsets to tepid global demand. Nonetheless, challenging market conditions are expected to persist through the first half of 2023. We are aligning production with global demand trends and expect first quarter average utilization rates for assets operated by us to be 80% for each of our O&P-Americas, O&P-EAI and I&D segments. Start-up activities for the new PO/TBA capacity remain on track for the end of the first quarter 2023, with approximately half of the assets nameplate capacity expected to be produced and sold during the first year of operations. We expect typical spring and summer seasonal demand improvements and are prepared to leverage any increased economic activity in China as the year progresses.During 2022, we introduced our value enhancement program that is anticipated to generate approximately $575 million in recurring annual Net income improvement by the end of 2025, which, after adding back income taxes and depreciation and amortization of $140 million and $35 million, respectively, results in $750 million of EBITDA. By the end of 2023, we anticipate that our value enhancement program will achieve annual recurring Net income of approximately $115 million, which, after adding back income taxes and depreciation and amortization of approximately $25 million and $10 million, respectively, results in $150 million of EBITDA. We estimate costs of $150 million in 2023 to achieve this milestone.RELATED PARTY TRANSACTIONSWe have related party transactions with our joint venture partners. We believe that such transactions are effected on terms substantially no more or less favorable than those that would have been agreed upon by unrelated parties on an arm’s length basis. See Note 4 to the Consolidated Financial Statements for additional related party disclosures.49Table of ContentsCRITICAL ACCOUNTING POLICIES AND ESTIMATESManagement applies those accounting policies that it believes best reflect the underlying business and economic events, consistent with accounting principles generally accepted in the U.S., see Note 2 to the Consolidated Financial Statements. Inherent in such policies are certain key assumptions and estimates made by management and updated periodically based on its latest assessment of the current and projected business and general economic environment.Management believes the following accounting policies and estimates, and the judgments and uncertainties affecting them, are critical in understanding our reported operating results and financial condition.Inventories—We account for our raw materials, work-in-progress and finished goods inventories using the last-in, first-out (“LIFO”) method of accounting.The cost of raw materials, which represents a substantial portion of our operating expenses, and energy costs generally follow price trends for crude oil and/or natural gas. Crude oil and natural gas prices are subject to many factors, including changes in economic conditions.Since our inventory consists of manufactured products derived from crude oil, natural gas, natural gas liquids and correlated materials, as well as the associated feedstocks and intermediate chemicals, our inventory market values are generally influenced by changes in the benchmark of crude oil and heavy liquid values and prices for manufactured finished goods. The degree of influence of a particular benchmark may vary from period to period, as the composition of the dollar value LIFO pools change. An actual valuation of inventory under the LIFO method is performed at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on our estimates of expected inventory levels and costs at the end of the year. The impact of the measurement of each LIFO pool at the lower of cost or market value (“LCM”) is a function of the current market prices and the composition, or product mix, of inventory within the pool at the balance sheet date. Due to the compositions of our LIFO pools, changes in market prices from period-to-period do not necessarily correlate with LCM charges. Additionally, an LCM condition may arise due to a volumetric or price decline in a particular material that had previously provided a positive impact within a pool. In the measurement of an LCM adjustment, the numeric input value for determining the crude oil market price includes pricing that is weighted by volume of inventories held at a point in time, including WTI, Brent and Maya crude oils.As indicated above, fluctuation in the prices of crude oil, natural gas and correlated products from period to period may result in the recognition of charges to adjust the value of inventory to the lower of cost or market in periods of falling prices and the reversal of those charges in subsequent interim periods as market prices recover. Accordingly, our cost of sales and results of operations may be affected by such fluctuations.No LCM inventory valuation charges were recorded in 2022 or 2021, and we do not believe any of our inventory balance at year-end is at risk for impairment. Given the inherent volatility in the prices of our finished goods and raw materials, sustained price declines could result in LCM inventory valuation charges. Long-Lived Assets Impairment Assessment—The need to test for impairment can be based on several indicators, including a significant reduction in prices of or demand for products produced, a weakened outlook for profitability, a significant reduction in margins, an expectation that a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life, other changes to contracts or changes in the regulatory environment. If the sum of the undiscounted estimated pre-tax cash flows for an asset group is less than the asset group’s carrying value, fair value is calculated for the asset group using an income approach or a market approach when appropriate, and the carrying value is written down to the calculated fair value. For purposes of impairment evaluation, long-lived assets including finite-lived intangible assets must be grouped at the lowest level for which independent cash flows can be identified.50Table of ContentsSignificant judgment is involved in developing estimates of future cash flows since the results are based on forecasted financial information prepared using significant assumptions which may include, among other things, projected changes in supply and demand fundamentals (including industry-wide capacity, our planned utilization rate and end-user demand), new technological developments, capital expenditures, new competitors with significant raw material or other cost advantages, changes associated with world economies, the cyclical nature of the chemical and refining industries, uncertainties associated with governmental actions and other economic conditions. Such estimates are consistent with those used in our financial planning and business performance reviews. When an income approach is used to estimate fair value of our long-lived assets, the cash flows are discounted using a rate that is based on a variety of factors, including market and economic conditions, operational risk, regulatory risk and political risk. This discount rate is also compared to recent observable market transactions, if possible.Houston Refinery Impairment—During the fourth quarter of 2021, we identified impairment triggers relating to our Houston refinery’s asset group which resulted in non-cash impairment charges of $624 million. Refer to Note 7 to our Consolidated Financial Statements.In 2021, the estimate of the Houston refinery’s undiscounted pre-tax cash flows was based on significant assumptions including management’s best estimates of the expected future cash flows, the estimated useful lives of the asset group, and the residual value of the refinery. These estimates required considerable judgment and are sensitive to changes in underlying assumptions such as future commodity prices, margins on refined products, operating rates and capital expenditures including repairs and maintenance. As a result, there can be no assurance that the estimates and assumptions made for purposes of our impairment determination will prove to be an accurate prediction of the future. The Houston refinery’s estimated fair value was calculated using a market approach which utilized unobservable inputs, which generally consist of market information provided by unrelated third parties. Should our estimates and assumptions significantly change in future periods, it is possible that we may determine future impairment charges. An estimate of the sensitivity to net income resulting from impairment calculations is not practicable, given the numerous assumptions, including pricing, volumes, discount rates, and market information provided by unrelated third parties that can materially affect our estimates. That is, unfavorable adjustments to some of the above listed assumptions may be offset by favorable adjustments in other assumptions.Equity Method Investments Impairment—Investments in nonconsolidated entities accounted for under the equity method are assessed for impairment when there are indicators of a loss in value, such as a lack of sustained earnings capacity or a current fair value less than the investment’s carrying amount. When it is determined such a loss in value is other than temporary, an impairment charge is recognized for the difference between the investment’s carrying value and its estimated fair value. When determining whether a decline in value is other than temporary, management considers factors such as the duration and extent of the decline, the investee’s financial condition and near-term prospects, and our ability and intention to retain our investment for a period that will be sufficient to allow for any anticipated recovery in the value of the investment. Management’s estimate of fair value of an investment is based on the income approach and/or market approach. For the income approach, the fair value is typically based on the present value of expected future cash flows using discount rates believed to be consistent with those used by principal market participants. For the market approach, since quoted market prices are usually not available, we utilize market multiples of revenue and earnings derived from comparable publicly-traded industrial gases companies.In response to challenging market conditions in China, during 2022 we assessed our equity method investment in Bora LyondellBasell Petrochemical Co. Ltd. (“BLYB”) for impairment and concluded that our $345 million investment in BLYB is not impaired. However, certain circumstances beyond our control could change in the near-term resulting in the need to recognize a non-cash impairment in subsequent periods.51Table of ContentsGoodwill—As of December 31, 2022, we had goodwill of $1,827 million. Of this amount, $1,357 million is related to the acquisition of A. Schulman Inc. in 2018, which is included in our APS segment. The remaining goodwill at December 31, 2022 primarily represents the tax effect of the differences between the tax and book basis of our assets and liabilities resulting from the revaluation of those assets and liabilities to fair value in connection with the Company’s emergence from bankruptcy and fresh-start accounting in 2010. Additional information on the amount of goodwill allocated to our reporting units appears in Notes 7 and 20 to the Consolidated Financial Statements.We evaluate the recoverability of the carrying value of goodwill annually or more frequently if events or changes in circumstances indicate that the carrying amount of the goodwill of a reporting unit may not be fully recoverable. We have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. Qualitative factors assessed for each of the reporting units include, but are not limited to, changes in long-term commodity prices, discount rates, competitive environments, planned capacity, cost factors such as raw material prices, and financial performance of the reporting units. If the qualitative assessment indicates that it is more likely than not that the carrying value of a reporting unit exceeds its estimated fair value, a quantitative test is required.We also have the option to proceed directly to the quantitative impairment test. Under the quantitative impairment test, the fair value of each reporting unit, calculated using a discounted cash flow model, is compared to its carrying value, including goodwill. The discounted cash flow model inherently utilizes a significant number of estimates and assumptions, including operating margins, tax rates, discount rates, capital expenditures and working capital changes. If the carrying value of the reporting unit including goodwill exceeds its fair value, an impairment charge equal to the excess would be recognized, up to a maximum amount of goodwill allocated to that reporting unit.For 2022 and 2021, management performed a qualitative impairment assessment of our reporting units, which indicated that it was more likely than not that the fair value of our reporting units was greater than their carrying value including goodwill. Accordingly, a quantitative goodwill impairment test was not required, and no goodwill impairment was recognized in 2022 or 2021. See Note 20 to the Consolidated Financial Statements regarding subsequent events impacting our reporting units.Long-Term Employee Benefit Costs—Our costs for long-term employee benefits, particularly pension and other post-retirement medical and life insurance benefits, are incurred over long periods of time, and involve many uncertainties over those periods. The net periodic benefit cost attributable to current periods is based on several assumptions about such future uncertainties and is sensitive to changes in those assumptions. It is management’s responsibility, often with the assistance of independent experts, to select assumptions that in its judgment represent its best estimates of the future effects of those uncertainties and to review those assumptions periodically to reflect changes in economic or other factors.The current benefit service costs, as well as the existing liabilities, for pensions and other post-retirement benefits are measured on a discounted present value basis. The discount rate is a current rate, related to the rate at which the liabilities could be settled. Our assumed discount rate is based on yield information for high-quality corporate bonds with durations comparable to the expected cash settlement of our obligations. For the purpose of measuring the benefit obligations at December 31, 2022, we used a weighted average discount rate of 5.50% for the U.S. plans, which reflects the different terms of the related benefit obligations. The weighted average discount rate used to measure obligations for non-U.S. plans at December 31, 2022, was 3.99%, reflecting market interest rates. The discount rates in effect at December 31, 2022 will be used to measure net periodic benefit cost during 2023.The benefit obligation and the net periodic benefit cost of other post-retirement medical benefits are also measured based on assumed rates of future increase in the per capita cost of covered health care benefits. As of December 31, 2022, the assumed rate of increase for our U.S. plans was 6.5%, decreasing to 4.5% in 2031 and thereafter.52Table of ContentsThe net periodic benefit cost of pension benefits included in expense is affected by the expected long-term rate of return on plan assets assumption. Investment returns that are recognized currently in net income represent the expected long-term rate of return on plan assets applied to a market-related value of plan assets, which is defined as the market value of assets. The expected rate of return on plan assets is a longer-term rate and is expected to change less frequently than the current assumed discount rate, reflecting long-term market expectations, rather than current fluctuations in market conditions.The weighted average expected long-term rate of return on assets in our U.S. plans of 7.25% is based on the average level of earnings that our independent pension investment advisor advised could be expected to be earned over time. The weighted average expected long-term rate of return on assets in our non-U.S. plans of 1.85% is based on expectations and asset allocations that vary by region. The asset allocations are summarized in Note 14 to the Consolidated Financial Statements. The actual rate of return on plan assets may differ from the expected rate due to the volatility normally experienced in capital markets. Management’s goal is to manage the investments over the long term to achieve optimal returns with an acceptable level of risk and volatility.Net periodic pension cost recognized each year includes the expected asset earnings, rather than the actual earnings or loss. Along with other gains and losses, this unrecognized amount, to the extent it cumulatively exceeds 10% of the greater of the projected benefit obligation or the market related value of the plan assets for the respective plan, is recognized as additional net periodic benefit cost over the average remaining service period of the participants in each plan.The following table reflects the sensitivity of the benefit obligations and the net periodic benefit costs of our pension plans to changes in the actuarial assumptions: Effects onBenefit Obligationsin 2022Effects on NetPeriodic PensionCosts in 2023Millions of dollarsU.S.Non-U.S.U.S.Non-U.S.Projected benefit obligations at December 31, 2022$1,140 $1,276 $— $— Projected net periodic pension costs in 2023— — 57 47 Discount rate increases by 100 basis points(94)(163)(7)(7)Discount rate decreases by 100 basis points111 192 8 10 The sensitivity of our post-retirement benefit plans obligations and net periodic benefit costs to changes in actuarial assumptions are reflected in the following table: Effects onBenefit Obligationsin 2022Effects on NetPeriodic BenefitCosts in 2023Millions of dollarsU.S.Non-U.S.U.S.Non-U.S.Projected benefit obligations at December 31, 2022$153 $41 $— $— Projected net periodic benefit costs in 2023— — (2)2 Discount rate increases by 100 basis points(11)(8)— (1)Discount rate decreases by 100 basis points12 8 1 1 Additional information on the key assumptions underlying these benefit costs appears in Note 14 to the Consolidated Financial Statements.53Table of ContentsAccruals for Taxes Based on Income—The determination of our provision for income taxes and the calculation of our tax benefits and liabilities is subject to management’s estimates and judgments due to the complexity of the tax laws and regulations in the tax jurisdictions in which we operate. Uncertainties exist with respect to interpretation of these complex laws and regulations.Deferred tax assets and liabilities are determined based on temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, and are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. We recognize future tax benefits to the extent that the realization of these benefits is more likely than not. Our current provision for income taxes is impacted by the recognition and release of valuation allowances related to net deferred tax assets in certain jurisdictions. Further changes to these valuation allowances may impact our future provision for income taxes, which will include no tax benefit with respect to losses incurred and no tax expense with respect to income generated in these countries until the respective valuation allowance is eliminated.We recognize the financial statement benefits with respect to an uncertain income tax position that we have taken or may take on an income tax return when we believe it is more likely than not that the position will be sustained with the tax authorities.ACCOUNTING AND REPORTING CHANGESFor a discussion of the potential impact of new accounting pronouncements on our Consolidated Financial Statements, see Note 2 to the Consolidated Financial Statements.54Table of ContentsItem 7A. Quantitative and Qualitative Disclosures About Market Risk.See Note 13 to the Consolidated Financial Statements for further discussion of our management of commodity price risk, foreign exchange risk and interest rate risk.Commodity Price Risk—Prices for our products and raw materials are subject to changes in supply and demand. Natural gas, crude oil, utilities, and refined products, along with feedstocks for ethylene and propylene production, constitute the main commodity exposures. Pricing terms in our raw material contracts are generally indexed to market prices. Changes in market prices for raw materials generally correlate with market prices for our products. In certain sales contracts, we may negotiate pricing terms to better align with changes in raw material costs. We also selectively enter commodity swap, option and futures contracts to manage commodity price risk. The impact of a 10% change in commodity prices at December 31, 2022 and 2021 would not materially impact the fair values of our commodity derivative contracts.Foreign Exchange Risk—We manufacture and market our products in many countries throughout the world and, as a result, are exposed to changes in foreign currency exchange rates. Our reporting currency is the U.S. dollar. Many of our operating entities use the euro as their functional currency. Translation adjustments are deferred in Accumulated other comprehensive income.We enter foreign currency derivatives that are designated as net investment hedges to reduce the volatility in Shareholders’ equity resulting from translation adjustments associated with our net investments in foreign operations. We also enter foreign currency contracts that are designated as cash flow hedges to manage the variability in cash flows associated with intercompany debt balances. The table below illustrates the impact on Other comprehensive loss of a 10% fluctuation in the foreign currency rate associated with the hedges at December 31:Notional Amount10% Variance onForeign Currency RateImpact on OtherComprehensive LossMillions of euro/dollars2022202120222021Net investment hedges:Cross currency basis swaps€617 €617 euro/U.S. dollar rate$67 $71 Cross currency swaps€750 €750 euro/U.S. dollar rate$75 $92 Forward exchange contracts€1,350 €1,250 euro/U.S. dollar rate$138 $142 Cash flow hedges:Cross currency swaps€1,052 €1,051 euro/U.S. dollar rate$113 $134 Some of our consolidated entities enter transactions that are not denominated in their functional currency. This results in exposure to foreign currency risk for financial instruments, including, but not limited to, third-party and intercompany receivables and payables and intercompany loans.Our policy is to maintain a balanced position in foreign currencies to minimize exchange gains and losses arising from changes in exchange rates. We maintain risk management control practices to monitor the foreign currency risk attributable to our inter-company and third party outstanding foreign currency balances. These practices involve the centralization of our exposure to underlying currencies that are not subject to central bank and/or country specific restrictions. By centralizing most of our foreign currency exposure into one subsidiary, we are able to take advantage of natural offsets thereby reducing the overall impact of changes in foreign currency rates on our earnings.55Table of ContentsTo minimize the effects of our net currency exchange exposures, we enter into forward exchange contracts and cross-currency swaps. We also engage in short-term forward exchange contracts to manage our net exposure to foreign currencies as economic hedges. Changes in the fair value of these foreign currency contracts are reported in the Consolidated Statements of Income and offset the currency exchange results recognized on foreign currency balances.Other (expense) income, net, in the Consolidated Statements of Income reflects net foreign currency losses of $14 million and $2 million in 2022 and 2021, respectively. As of December 31, 2022, our foreign currency contracts that are accounted for as economic hedges mature between January 2023 and September 2023, inclusively, and had an aggregate notional amount of $396 million. A 10% fluctuation compared to the U.S. dollar would have resulted in an additional impact to earnings of approximately $17 million and $4 million in 2022 and 2021, respectively.Interest Rate Risk—We are exposed to interest rate risk with respect to our fixed-rate and variable-rate debt. Fluctuations in interest rates impact the fair value of fixed-rate debt and expose us to the risk that we may need to refinance debt at higher rates. Fluctuations in interest rates impact interest expense from our variable-rate debt. To minimize earnings at risk as part of our interest rate risk management strategy, we target to maintain floating-rate debt, through the use of interest rate swaps and issuance of variable-rate debt, equal to our cash and cash equivalents, as those assets earn interest based on floating-rates.Pre-issuance interest rate—To mitigate the risk that benchmark interest rates may increase in connection with future financing activities, we adopted a pre-issuance interest rate strategy, under which we entered forward-starting interest rate swaps that are designated as cash flow hedges. We estimate that a 10% change in market interest rates as of December 31, 2022 and 2021, would change the fair value of these forward-starting interest rate swaps by approximately $23 million and $48 million, respectively.Fixed-rate debt—We enter into interest rate swaps that effectively convert our fixed-rate debt to variable-rate debt. These interest rate swaps are designated as fair value hedges. At December 31, 2022 and 2021, the total notional amount of these interest rate swaps was $2,164 million and $1,163 million, respectively.At December 31, 2022, after giving consideration to the fixed-rate debt that we have effectively converted to variable-rate debt, approximately 81% of our debt portfolio, on a gross basis, incurred interest at a fixed-rate and the remaining 19% of the portfolio incurred interest at a variable-rate. We estimate that a 10% change in market interest rates as of December 31, 2022, would change the fair value of these interest rate swaps by approximately $35 million; while an equivalent change in market interest rates as of December 31, 2021, would not materially impact the fair value of these interest rate swaps.Variable-rate debt—At December 31, 2022, our variable-rate debt consisted of $200 million outstanding under our Commercial Paper Program. We also have available borrowing capacity under our $3,250 million Senior Revolving Credit Facility and our $900 million U.S. Receivables Facility. At December 31, 2022, there were no outstanding borrowings under these facilities. Based on our average variable-rate debt outstanding per year, we estimate that a 10% change in market interest rates as of December 31, 2022 and 2021 would not materially impact the fair value of these facilities.56Table of Contents
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 35 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 68 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 70 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 113 ITEM 9A. CONTROLS AND PROCEDURES 113 ITEM 9B. OTHER INFORMATION 114 ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS 114 PART III 115 ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 115 ITEM 11. EXECUTIVE COMPENSATION 115 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 115 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 115 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 115 PART IV 116 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 116 ITEM 16. FORM 10-K SUMMARY 122 SIGNATURES 123 Part I ♦ Item 1 – Business PART I ITEM 1 – BUSINESS General Martin Marietta Materials, Inc. (the Company or Martin Marietta) is a natural resource-based building materials company. The Company supplies aggregates (crushed stone, sand and gravel) through its network of approximately 350 quarries, mines and distribution yards in 28 states, Canada and The Bahamas. In 2022, aggregates product gross profit accounted for 69% of the Company’s consolidated total products and services gross profit. Martin Marietta also provides cement and downstream products, namely, ready mixed concrete, asphalt and paving services, in markets that are naturally vertically integrated and where the Company has a leading aggregates position. The Company’s heavy-side building materials are used in infrastructure, nonresidential and residential construction projects. Aggregates are also used in agricultural, utility and environmental applications and as railroad ballast. The aggregates, cement, ready mixed concrete and asphalt and paving operations are reported collectively as the “Building Materials business”. The Company also operates a Magnesia Specialties business with production facilities in Michigan and Ohio. The Magnesia Specialties business produces magnesia-based chemical products that are used in industrial, agricultural and environmental applications. It also produces dolomitic lime sold primarily to customers for steel production and soil stabilization. Magnesia Specialties’ products are shipped to customers domestically and worldwide. On April 30, 2021, the Company acquired Tiller Corporation (Tiller), a leading aggregates and hot mix asphalt supplier in the Minneapolis/St. Paul area, a large and fast-growing midwestern metropolitan area. The Tiller acquisition complemented the Company’s existing product offerings in the surrounding areas. Additionally, Tiller sells asphalt solely as a materials provider and does not offer paving or other associated services. Tiller is reported in the Company’s East Group. On July 30, 2021, the Company acquired assets of Southern Crushed Concrete (SCC). SCC was a leading producer of recycled concrete in the Houston area, one of the country’s largest aggregates markets. Recycled concrete is principally used as a base aggregates product in infrastructure, commercial and residential construction applications. SCC is reported in the Company’s West Group. On October 1, 2021, the Company acquired the Lehigh Hanson West Region business (Lehigh West Region) for $2.26 billion in cash. The acquisition included a portfolio of 17 active aggregates quarries, two cement plants with related distribution terminals, and targeted downstream operations in California, Arizona, Nevada and Oregon. These operations provided a new upstream, materials-led growth platform across several of the nation’s largest megaregions in California and Arizona, solidifying the Company’s position as a leading coast-to-coast aggregates producer. The acquired cement plants, distribution terminals and California ready mixed concrete operations are classified as assets held for sale and discontinued operations as of and for the years ended December 31, 2022 and 2021. The Lehigh West Region business is reported in the Company’s West Group. On April 1, 2022, the Company divested its Colorado and Central Texas ready mixed concrete operations to Smyrna Ready Mix Concrete LLC. This transaction optimized the Company’s aggregates-led portfolio and improved its ability to generate more attractive margins over the long term by reducing both business cyclicality and exposure to raw material cost inflation. The transaction resulted in a pretax gain of $151.9 million, inclusive of expenses incurred due to the divestiture. The divested operations and the gain on divestiture are all reported in the West Group in the Company's consolidated financial statements included in
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsIndex to Management’s Discussion and Analysis of Financial Condition and Results of OperationsPageForward-Looking Statements and Other Financial Information52Executive Summary52Consolidated Company Outlook54Industry Trends55Summary of Critical Accounting Estimates62Acquisitions and Dispositions70Results of Operations71Investments88Derivatives104Policyholder Liabilities106Liquidity and Capital Resources113Adopted Accounting Pronouncements 129Future Adoption of Accounting Pronouncements 129Non-GAAP and Other Financial Disclosures130Risk Management133Subsequent Events13551Table of ContentsForward-Looking Statements and Other Financial InformationFor purposes of this discussion, “MetLife,” the “Company,” “we,” “our” and “us” refer to MetLife, Inc., a Delaware corporation incorporated in 1999, its subsidiaries and affiliates. This discussion should be read in conjunction with “Note Regarding Forward-Looking Statements,” “Risk Factors,” “Quantitative and Qualitative Disclosures About Market Risk” and the Company’s consolidated financial statements included elsewhere herein.This Management’s Discussion and Analysis of Financial Condition and Results of Operations may contain or incorporate by reference information that includes or is based upon forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. See “Note Regarding Forward-Looking Statements” for cautionary language regarding forward-looking statements.This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes references to our performance measures, adjusted earnings and adjusted earnings available to common shareholders, that are not based on GAAP. See “— Non-GAAP and Other Financial Disclosures” for definitions and a discussion of these and other financial measures, and “— Results of Operations” and “— Investments” for reconciliations of historical non-GAAP financial measures to the most directly comparable GAAP measures.For information relating to the Company’s financial condition and results of operations as of and for the year ended December 31, 2020, as well as for the year ended December 31, 2021 compared with the year ended December 31, 2020, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in MetLife, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2021.Executive SummaryOverviewMetLife is one of the world’s leading financial services companies, providing insurance, annuities, employee benefits and asset management. MetLife is organized into five segments: U.S.; Asia; Latin America; EMEA; and MetLife Holdings. In addition, the Company reports certain of its results of operations in Corporate & Other. See “Business — Segments and Corporate & Other” and Note 2 of the Notes to the Consolidated Financial Statements for further information on the Company’s segments and Corporate & Other.Current Year HighlightsDuring 2022, adjusted premiums, fees and other revenues, net of foreign currency fluctuations, increased compared to 2021 driven by growth in our U.S. segment, primarily in our RIS business. Equity market returns had a less favorable impact on our private equity funds and hedge funds compared to 2021 and resulted in lower investment yields, however, positive net flows drove an increase in our investment portfolio. An unfavorable change in net investment gains (losses) primarily reflects 2022 losses versus 2021 gains on sales of fixed maturity securities and the 2021 gain on the sale of Metropolitan Property and Casualty Insurance Company and certain of its wholly-owned subsidiaries (collectively, “MetLife P&C”), partially offset by the 2021 losses on the sale of certain subsidiaries. Higher long-term interest rates drove an unfavorable change in net derivative gains (losses). Underwriting experience was favorable and reflected an overall decline in COVID-19 related claims. Our actuarial assumption review resulted in a gain in 2022 versus a charge in 2021. In addition, 2022 results include the favorable impact from a reinsurance recapture and the unfavorable impact from model refinements.52Table of ContentsThe following represents segment level results and percentage contributions to total segment level adjusted earnings available to common shareholders for the year ended December 31, 2022:(1) Excludes Corporate & Other adjusted loss available to common shareholders of $844 million.(2) Consistent with GAAP guidance for segment reporting, adjusted earnings is our GAAP measure of segment performance. For additional information, see Note 2 of the Notes to the Consolidated Financial Statements. 53Table of ContentsYear Ended December 31, 2022 Compared with the Year Ended December 31, 2021Consolidated Results - HighlightsNet income (loss) available to MetLife, Inc.’s common shareholders down $4.0 billion:•Unfavorable change in net investment gains (losses) of $2.8 billion ($2.2 billion, net of income tax)•Unfavorable change in net derivative gains (losses) of $144 million ($114 million, net of income tax)(2)•Favorable change from actuarial assumption reviews of $356 million ($269 million, net of income tax)(3)•Adjusted earnings available to common shareholders down $2.4 billion(1) See “— Results of Operations — Consolidated Results” and “— Non-GAAP and Other Financial Disclosures” for reconciliations and definitions of non-GAAP financial measures.(2) Includes amounts relating to investment hedge adjustments, which are also included in adjusted earnings available to common shareholders. See “— Investments — Current Environment — Investment Portfolio Results” for additional information.(3) Includes amounts recognized in net derivative gains (losses) and adjusted earnings available to common shareholders. See “— Results of Operations — Consolidated Results — Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021 — Actuarial Assumption Review and Certain Other Insurance Adjustments” for additional information.Consolidated Results - Adjusted Earnings HighlightsAdjusted earnings available to common shareholders was down $2.4 billion primarily due to (i) lower investment yields as a result of the unfavorable impact of lower equity market returns on our private equity funds and hedge funds, (ii) higher interest credited expense and (iii) higher expenses, partially offset by (i) higher net investment income due to a larger average invested asset base, and (ii) favorable underwriting, primarily driven by an overall decline in COVID-19 related claims. Our results for 2022 also included the favorable impacts from a reinsurance recapture in our U.S. segment, a reinsurance settlement in our MetLife Holdings segment and our actuarial assumption review, as well as the unfavorable impact from model refinements in our MetLife Holdings segment. Our results for 2021 included the favorable impacts of tax adjustments related to an IRS audit settlement and the non-cash transfer of assets from a wholly-owned U.K. investment subsidiary to its U.S. parent, as well as the release of a legal reserve, all in Corporate & Other, and the unfavorable impact of our actuarial assumption review.For a more in-depth discussion of our consolidated results, see “— Results of Operations — Consolidated Results,” “— Results of Operations — Consolidated Results — Adjusted Earnings” and “— Results of Operations — Segment Results and Corporate & Other.”Consolidated Company Outlook Our outlook reflects the impacts of the adoption of targeted improvements to the accounting for long-duration contracts (“LDTI”). We assume COVID-19 to be endemic consistent with the recent trends that we have been experiencing. We expect continued uncertainty to persist around inflation and a potential recession.54Table of ContentsWe expect interest rates to remain elevated relative to December 31, 2022. We believe that our investment portfolio is highly diversified and positioned to perform well in a variety of economic scenarios. See “— Industry Trends — Impact of Market Interest Rates” for discussion of the mitigating actions the Company has taken to reduce interest rate sensitivity, as market interest rates are a key driver of our results. As of December 31, 2022, we had $5.4 billion of cash and liquid assets at the holding companies which is above the high end of our $3.0 billion to $4.0 billion holding company cash target. In 2023, we expect to maintain this holding company cash target.Our continued capital stress testing and longstanding commitment to liquidity position us to withstand a variety of economic conditions. We do not expect any material liquidity deficiencies, and we expect to remain able to comply with the financial covenants of our credit agreements. See “— Liquidity and Capital Resources.” We will continue reviewing accounting estimates, asset valuations and various financial scenarios for capital and liquidity implications. See “— Investments — Current Environment” and “Risk Factors” for additional information.Assuming (i) interest rates following the observable forward yield curves as of December 31, 2022, including a 10-year U.S. Treasury rate of 3.88% at December 31, 2022, and 3.84% at December 31, 2023, (ii) S&P 500 equity index annual return of 5% over the near-term, and (iii) private equity annual returns of 12% over the near-term consistent with historical long-term averages; we expect to maintain the two-year average annual ratio of free cash flow to adjusted earnings, excluding total notable items, at 65% to 75%.Further, based on the aforementioned assumptions, the growing impact of our mix of business and higher new business returns over the last several years, as well as the impact of LDTI, we are increasing our target for adjusted return on equity, excluding accumulated other comprehensive income (“AOCI”) other than foreign currency translation adjustments (“FCTA”) to 13% to 15% over the near-term. Lastly, we expect to exceed our goals to generate approximately $20.0 billion of free cash flow and make available an additional $1.0 billion to invest in growth and innovation, over the time period of 2020 through 2024.Our full year direct expense ratio target, excluding total notable items related to direct expenses and pension risk transfers, is 12.6% over the near-term. This increase from the previous target of 12.3% reflects a reduction in adjusted premiums, fees and other revenues, excluding pension risk transfers, due to the impact of the adoption of LDTI. Since this change in accounting will be applied retrospectively to January 1, 2021, our previously reported direct expense ratios will likewise be re-calibrated to put 2021 and 2022 on the same basis as 2023 and beyond. Our outlook relies on the accuracy of our assumptions about future economic and business conditions, which can be affected by known and unknown risks, uncertainties and other factors. We continually review our assumptions, implement mitigation plans, and take precautions. We may revise our outlook as we obtain more information regarding economic conditions, regulatory changes, and other events, and the impact of these events on our business operations, investment portfolio, derivatives, financial results and financial condition.Industry TrendsWe continue to be impacted by the changing global financial and economic environment that has been affecting the industry.Financial and Economic EnvironmentOur business and results of operations are materially affected by conditions in the global financial markets and the economy generally due to our market presence in numerous countries, our large investment portfolio and the sensitivity of our insurance liabilities and derivatives to changing market factors. We are closely monitoring political and economic conditions that might contribute to global market volatility and impact our business operations, investment portfolio and derivatives, such as global inflation, supply chain disruptions, the Russia-Ukraine conflict and the COVID-19 pandemic. We are also monitoring the imposition of tariffs, sanctions or other barriers to international trade, changes to international trade agreements, and their potential impacts on our business, results of operations and financial condition. See “— Impact of Market Interest Rates — Effects of Inflation,” and “— Investments — Current Environment.”55Table of ContentsGovernments and central banks around the world are using fiscal and monetary policies to address uncertain economic conditions. In the U.S., the Federal Reserve Board and the Federal Open Market Committee took various actions in 2022 to promote economic stability and combat inflation, including raising interest rates, although a heightened level of concern about an economic downturn in the U.S. remains. The European Central Bank and Bank of England have been taking similar actions. In contrast, the Bank of Japan (“BoJ”) has mostly kept its monetary policy settings on hold, reflecting a more cautious view on growth. The Japanese yen weakened to its lowest level against the U.S. dollar since the 1990s as monetary policy divergence has widened between the BoJ and the Federal Reserve Board.Impact of Market Interest Rates Market interest rates are a key driver of our results. Increases and decreases in such rates, as well as extended periods of stagnation, may impact our business and investments in various ways.Effects of InflationManagement believes that while inflation has not had a material effect on the Company’s consolidated results of operations, except insofar as inflation may affect interest rates, both rising interest rates and inflation will have a neutral to modest impact on our business. See “— Impact of a Rising Interest Rate Environment” and “— Interest Rate Scenarios.”An increase in inflation could affect our business in several ways. In our group life and disability businesses, premiums increase as compensation levels of our customers’ employees increase. However, during inflationary periods with rising interest rates, the value of fixed income investments falls which could increase realized and unrealized losses, resulting in additional deferred tax assets that may not be realizable. Inflation also increases expenses for labor and other costs, potentially putting pressure on profitability if such costs cannot be passed through in our product prices. Prolonged and elevated inflation could adversely affect the financial markets and the economy generally, and dispelling it may require governments to pursue a restrictive fiscal and monetary policy, which could constrain overall economic activity, inhibit revenue growth and reduce the number of attractive investment opportunities.Impact of a Sustained Low Interest Rate EnvironmentSustained periods of low U.S. interest rates may cause us to:•Reduce the difference between interest credited to policyholders and interest earned on supporting assets (“gross margin”); •Reinvest investment proceeds in lower yielding assets and experience higher frequency prepayment or redemption of assets in our portfolio;•Increase our reserves related to policy liabilities and potentially impair intangible assets;•Reduce interest expense, change pension and other post-retirement benefit calculations, and change derivative cash flows and market values;•Change our product offerings, design features, crediting rates and sales mix; and•Experience changing policyholder behavior, including surrender or withdrawal activity.For additional discussion on gross margin and interest rate assumptions, as well as the potential impact of low interest rates, see “— Results of Operations — Consolidated Results — Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021 — Actuarial Assumption Review and Certain Other Insurance Adjustments;” “Risk Factors — Economic Environment and Capital Markets Risks — We May Face Difficult Economic Conditions — Interest Rate Risks;” “Risk Factors — Business Risks — We May Be Required to Impair VOBA, VODA or VOCRA;” “Risk Factors — Business Risks — We May Be Required to Recognize an Impairment of Our Goodwill or Other Long-Lived Assets or to Establish a Valuation Allowance Against Our Deferred Income Tax Assets;” and “Risk Factors — Business Risks — We May Face Volatility, Higher Risk Management Costs, and Increased Counterparty Risk Due to Guarantees Within Certain of Our Products.” Impact of a Rising Interest Rate EnvironmentPeriods of rising U.S. interest rates may cause us to:•Reinvest investment proceeds in higher yielding assets and experience lower frequency prepayment or redemption of assets in our portfolio;•Decrease the value of our reserves related to policy liabilities;56Table of Contents•Increase interest expense, change pension and other post-retirement benefit calculations, and change derivative cash flows and market values; and•Change our product offerings, design features, crediting rates and sales mix.For additional discussion on the potential impact of rising interest rates, see “Risk Factors — Investment Risks — We May Change Our Securities and Investments Valuation, or Take Allowances and Impairments on Our Investments, or Change Our Methodologies, Estimations, and Assumptions.”Management ActionsTo manage the impact of a changing U.S. interest rate environment, we maintain diversification across products, distribution channels, and geographies while proactively evaluating interest rate and product strategies. In addition, we apply disciplined asset/liability management (“ALM”) strategies, including the use of derivatives. Our ability to take such actions may be limited by competition, regulatory approval requirements, or minimum crediting rate guarantees and may not match the timing or magnitude of interest rate changes.In addition to proactive management strategies, businesses within our Latin America, EMEA, and Asia (exclusive of our Japan business) segments help manage impacts to our consolidated results given their limited U.S. interest rate sensitivity. For additional discussion on interest rate risk management and our ability to change interest crediting rates or dividend scales, see “Risk Factors — Economic Environment and Capital Markets Risks — We May Face Difficult Economic Conditions — Interest Rate Risks;” “— Policyholder Liabilities;” “— Risk Management;” and “Quantitative and Qualitative Disclosures About Market Risk — Management of Market Risk Exposures.”Interest Rate ScenariosTo illustrate our sensitivity to U.S. interest rates, we compared the outcome of two hypothetical interest rate environments (the “Declining Interest Rate Scenario” and “Rising Interest Rate Scenario”) relative to our baseline economic assumptions (the “Base Scenario”) through 2025. The Declining Interest Rate Scenario assumes U.S. interest rates for all maturities decline immediately on January 1, 2023 by 50 basis points compared to the Base Scenario through 2025. The Rising Interest Rate Scenario assumes U.S. interest rates rise immediately on January 1, 2023 by 50 basis points through 2025. Other than changing U.S. interest rates through 2025, all other economic assumptions are equivalent in the Base Scenario, Declining Interest Rate Scenario and Rising Interest Rate Scenario.The following table compares the most relevant interest rate assumptions for the dates indicated:Years Ended December 31,202320242025Base ScenarioDeclining Interest Rate ScenarioRising Interest Rate ScenarioBase ScenarioDeclining Interest Rate ScenarioRising Interest Rate ScenarioBase ScenarioDeclining Interest Rate ScenarioRising Interest Rate ScenarioThree-month LIBOR4.74%4.24%5.24%3.52%3.02%4.02%3.41%2.91%3.91%10-year U.S. Treasury3.84%3.34%4.34%3.86%3.36%4.36%3.93%3.43%4.43%30-year U.S. Treasury3.91%3.41%4.41%3.89%3.39%4.39%3.88%3.38%4.38%Hypothetical Impact to Net Derivative Gains (Losses) and Adjusted EarningsWe estimate a net favorable impact to net derivative gains (losses) from non-VA program derivatives through 2025 for the hypothetical Declining Interest Rate Scenario. We hold significant positions in long-duration receive-fixed U.S. interest rate swaps, which are most sensitive to the 10-year and 30-year swap rates, to hedge reinvestment risk. We estimate a net unfavorable impact to net derivative gains (losses) from the non-VA program derivatives through 2025 for the hypothetical Rising Interest Rate Scenario. For purposes of the two hypothetical interest rate scenarios, we have excluded all VA program derivatives. For information regarding our VA and non-VA program derivatives, see “— Results of Operations — Consolidated Results.”57Table of ContentsWe estimate a net unfavorable impact to consolidated adjusted earnings through 2025 for the hypothetical Declining Interest Rate Scenario. The negative impact of reinvesting cash flows in lower yielding assets is partially offset by lowering interest crediting rates and dividend scales on products, and additional derivative income. We estimate a net favorable impact to consolidated adjusted earnings through 2025 for the hypothetical Rising Interest Rate Scenario. The positive impact of reinvesting cash flows in higher yielding assets is partially offset by increased interest crediting rates and dividend scales on products and lower derivative income. The following table summarizes the hypothetical impact on net derivative gains (losses) and adjusted earnings for certain of our segments, as well as Corporate & Other, for the Declining Interest Rate Scenario:Years Ended December 31,202320242025(In millions - post-tax)Net Derivative Gains (Losses):Non-VA Program Derivatives$443 $(6)$(23)Adjusted Earnings:U.S. $(49)$(53)$(65)Group Benefits(4)(6)(16)RIS(45)(47)(49)Asia (Japan only)(3)(18)(37)MetLife Holdings(17)(31)(42)Corporate & Other 17 4 (25)Total Adjusted Earnings Impact$(52)$(98)$(169)The following table summarizes the hypothetical impact on net derivative gains (losses) and adjusted earnings for certain of our segments, as well as Corporate & Other, for the Rising Interest Rate Scenario:Years Ended December 31,202320242025(In millions - post-tax)Net Derivative Gains (Losses):Non-VA Program Derivatives$(347)$— $13 Adjusted Earnings:U.S. $55 $56 $71 Group Benefits8 7 17 RIS47 49 54 Asia (Japan only)2 18 38 MetLife Holdings33 42 47 Corporate & Other (2)3 25 Total Adjusted Earnings Impact$88 $119 $181 58Table of ContentsSegments and Corporate & OtherThe primary drivers impacting certain of our segments, as well as Corporate & Other, in the hypothetical interest rate scenarios are summarized below. Our Latin America, EMEA, and Asia (exclusive of our Japan business) segments are excluded given their limited U.S. interest rate sensitivity. For additional information regarding account values subject to minimum crediting rate guarantees, the maturity profile of fixed maturity securities available-for-sale (“AFS”), and the yield on invested assets, see “— Investments,” “— Policyholder Liabilities — Policyholder Account Balances,” and Note 8 of the Notes to the Consolidated Financial Statements.U.S.Group BenefitsDeclining Interest Rate Scenario. Our group life insurance products are primarily renewable term policies. This provides repricing flexibility to mitigate the negative impact of reinvesting in lower yielding assets. Our retained asset accounts experience gross margin compression due to minimum crediting rate guarantees. Additionally, we experience gross margin compression from our disability policy claim reserves for which crediting rates cannot be reduced. We use interest rate derivatives to mitigate gross margin compression for both products. Gross margin compression is limited for our group disability products, which are generally renewable term policies allowing for crediting rate adjustments at renewal based on the retrospective experience rating and the prevailing interest rate assumptions. Rising Interest Rate Scenario. We reinvest our cash flows from our group insurance products in higher yielding assets, mitigating the impact of (i) higher interest crediting rates on, primarily, our retained asset accounts, and (ii) lower income from our derivative positions used to mitigate low interest rate margin compression. Retirement and Income SolutionsThis business contains both short- and long-duration products consisting of capital market products, pension risk transfers, structured settlements, and other benefit funding products. The two hypothetical interest rate scenarios do not assume any additional ALM actions we may take to preserve margins.Declining Interest Rate Scenario. A significant portion of short-duration products are managed on a floating rate basis, which mitigates gross margin compression. Our long-duration products have very predictable cash flows and we use both interest rate derivatives and asset/liability duration matching to mitigate gross margin compression. These mitigating strategies partially offset the negative impact of reinvesting in lower yielding assets. Based on our investment portfolios and expected cash flows, only a small portion of invested assets are subject to reinvestment risk through 2025.Rising Interest Rate Scenario. Our long-duration products which have very predictable cash flows benefit from reinvesting in higher yielding assets, which is partially offset by the negative impact of lower income from derivative positions designed to protect against a low interest rate environment. A significant portion of our short-duration products are managed on a floating rate basis. The negative impact of higher crediting rates on these short-duration products is partially offset by higher income from derivative positions designed to protect against a rising interest rate environment. AsiaDeclining Interest Rate Scenario. Our Japan business offers traditional life insurance and accident & health products, many of which are U.S. dollar denominated. We experience gross margin compression to the extent our investment portfolios are U.S. interest rate sensitive and we are unable to offset the impact by lowering interest crediting rates. Additionally, we manage interest rate risk on our life products through a combination of product design features and ALM strategies.Our Japan business also offers U.S. dollar denominated annuities which are predominantly single premium products with crediting rates set upon issuance. This allows for tightly managing product ALM, cash flows and net spreads, which mitigates interest rate risk.59Table of ContentsRising Interest Rate Scenario. For U.S. dollar denominated products, higher reinvestment rates on cash flows from these products more than offset the negative impacts of (i) higher interest crediting rates on such products, and (ii) lower income from derivative positions designed to protect against a low interest rate environment. MetLife HoldingsDeclining Interest Rate Scenario. Our interest rate sensitive life products include traditional and universal life products. Since most of our traditional life insurance is participating, we can mitigate gross margin compression by adjusting the applicable dividend scale. For our universal life products, we manage interest rate risk through a combination of product design features and ALM strategies, including the use of interest rate derivatives. Although we are able to mitigate gross margin compression by lowering interest crediting rates on certain in-force universal life policies, these actions may be partially offset by increased liabilities for policies with secondary guarantees.Our annuity products experience gross margin compression primarily from deferred annuities with minimum crediting rate guarantees. Most of these contracts are at their minimum crediting rate, and therefore we use interest rate derivatives to partially mitigate gross margin compression.Our long-term care business experiences gross margin compression as we cannot reduce interest crediting rates for established claim reserves. Long-term care policies are guaranteed renewable, and rates may be adjusted on a class basis with regulatory approval to reflect emerging experience. We review the discount rate assumptions and other assumptions associated with our long-term care claim reserves no less frequently than annually and, with respect to interest rates, set the discount rate based on the prevailing interest rate environment. Our retained asset accounts experience gross margin compression due to minimum crediting rate guarantees. Most of these accounts are at their minimum crediting rates and therefore we use interest rate derivatives to mitigate gross margin compression.Based on our investment portfolios and cash flow estimates, approximately 5% of our invested assets each year are subject to reinvestment risk through 2025. Rising Interest Rate Scenario. Higher reinvestment rates on cash flows, over time, more than offset the negative impacts of (i) higher interest crediting rates, and (ii) lower income from derivative positions designed to protect against a low interest rate environment. Corporate & OtherCorporate & Other contains the surplus investment portfolios used to fund capital and liquidity needs, certain reinsurance agreements, collateral financing arrangements, and our outstanding debt and preferred securities. For purposes of the two hypothetical interest rate scenarios, the impact on pension and postretirement plan expenses is included within Corporate & Other and not allocated across segments. Declining Interest Rate Scenario. The negative impact of reinvesting in lower yielding assets, over time, more than offsets the positive impact of lower interest expense on debt, preferred stock dividends and lower pension expense. Although low interest rates result in pension and other postretirement benefit liabilities increasing, the impact is more than offset by the corresponding returns on fixed income investments and results in lower expenses. Rising Interest Rate Scenario. The positive impact of reinvesting in higher yielding assets, over time, more than offsets the negative impact of higher interest expense on debt, preferred stock dividends and higher pension expense. Although higher interest rates result in pension and other postretirement benefit liabilities decreasing, the impact is more than offset by the corresponding returns on fixed income investments and results in higher expenses. 60Table of ContentsCompetitive PressuresThe life insurance industry remains highly competitive. See “Business — Competition.” Product development is focused on differentiation leading to more intense competition with respect to product features and services. Certain of the industry’s products can be quite homogeneous and subject to intense price competition. Cost reduction efforts are a priority for industry players, with benefits resulting in price adjustments to favor customers and reinvestment capacity. Larger companies have the ability to invest in brand equity, product development, technology optimization, risk management, and innovation, which are among the fundamentals for sustained profitable growth in the life insurance industry. Insurers are focused on their core businesses, specifically in markets where they can achieve scale. Insurers are increasingly seeking alternative sources of revenue; there is a focus on monetization of assets, fee-based services, and opportunities to offer comprehensive solutions, which include providing value-added services along with traditional products. Financial strength and flexibility and technology modernization are prerequisites for sustainable growth in the life insurance industry. Larger market participants tend to have the capacity to invest in analytics, distribution, and information technology and have the ability to leverage the capabilities of new digital entrants. There is a shift in distribution from proprietary to third party models in mature markets, due to the lower cost structure. Evolving customer expectations are having a significant impact on the competitive environment as insurers strive to offer the superior customer service demanded by an increasingly sophisticated industry client base. Rising demands from stakeholders to address ESG issues have resulted in insurers expanding their sustainability efforts. Legislative and other changes affecting the regulatory environment can also affect the competitive environment within the life insurance industry and within the broader financial services industry. See “Business — Regulation.” In addition to financial strength, technological efficiency and organizational agility, we believe that the ability to adapt to changes in the competitive environment as a result of global market volatility, changing interest rates, uncertain economic conditions and the COVID-19 pandemic is a significant differentiator to success in the life insurance industry and the broader financial services industry, and we are well positioned to compete in this environment.Regulatory DevelopmentsIn the U.S., our life insurance companies are regulated primarily at the state level, with some products and services also subject to federal regulation. As life insurers introduce new and often more complex products, regulators refine capital requirements and introduce new reserving standards for the life insurance industry. Laws and regulations recently adopted or currently under review can potentially impact the statutory reserve and capital requirements of the industry. Regulators have also undertaken market and sales practices reviews of several markets or products, including equity-indexed annuities, variable annuities and group products and New York maintains a moratorium on new reserve financing transactions. See “Business — Regulation,” “Risk Factors — Economic Environment and Capital Markets Risks — Our Statutory Life Insurance Reserve Financings Costs May Increase, and We May Find Limited Market Capacity for New Financings,” “Risk Factors — Regulatory and Legal Risks — Changes in Laws or Regulation, or in Supervisory and Enforcement Policies, May Reduce Our Profitability, Limit Our Growth, or Otherwise Adversely Affect Us” and “— Liquidity and Capital Resources — The Company — Capital — Affiliated Captive Reinsurance Transactions.”61Table of ContentsSummary of Critical Accounting Estimates The preparation of financial statements in conformity with GAAP requires management to adopt accounting policies and make estimates and assumptions that affect amounts reported on the Consolidated Financial Statements. For a discussion of our significant accounting policies, see Note 1 of the Notes to the Consolidated Financial Statements. The most critical estimates include those used in determining:(i)liabilities for future policy benefits and the accounting for reinsurance;(ii)capitalization and amortization of deferred policy acquisition costs (“DAC”) and the establishment and amortization of VOBA;(iii)estimated fair values of investments in the absence of quoted market values;(iv)investment allowance for credit loss (“ACL”) and impairments;(v)estimated fair values of freestanding derivatives and the recognition and estimated fair value of embedded derivatives requiring bifurcation; (vi)measurement of goodwill and related impairment;(vii)measurement of employee benefit plan liabilities;(viii)measurement of income taxes and the valuation of deferred tax assets; and(ix)liabilities for litigation and regulatory matters.In addition, the application of acquisition accounting requires the use of estimation techniques in determining the estimated fair values of assets acquired and liabilities assumed — the most significant of which relate to the aforementioned critical accounting estimates. In applying these policies and estimates, management makes subjective and complex judgments that frequently require assumptions about matters that are inherently uncertain. Many of these policies, estimates and related judgments are common in the insurance and financial services industries; others are specific to our business and operations. Actual results could differ from these estimates.Liability for Future Policy BenefitsGenerally, future policy benefits are payable over an extended period of time and related liabilities are calculated as the present value of future expected benefits to be paid, reduced by the present value of future expected premiums. Such liabilities are established based on methods and underlying assumptions in accordance with GAAP and applicable actuarial standards. Principal assumptions used in the establishment of liabilities for future policy benefits are mortality, morbidity, policy lapse, renewal, retirement, disability incidence, disability terminations, investment returns, inflation, expenses and other contingent events as appropriate to the respective product type and geographical area. These assumptions are established at the time the policy is issued and are intended to estimate the experience for the period the policy benefits are payable. Utilizing these assumptions, liabilities are established on a block of business basis. If experience is less favorable than assumed, additional liabilities may be established, resulting in a charge to policyholder benefits and claims.Future policy benefit liabilities for disabled lives are estimated at the time of claim incurral, using the present value of benefits method and experience assumptions as to claim terminations, expenses and interest.Liabilities for unpaid claims are estimated based upon our historical experience and other actuarial assumptions that consider the effects of current developments, anticipated trends and risk management programs.Future policy benefit liabilities for minimum death and income benefit guarantees relating to certain annuity contracts are based on estimates of the expected value of benefits in excess of the projected account balance, recognizing the excess ratably over the accumulation period based on total expected assessments. Liabilities for ULSG and paid-up guarantees are determined by estimating the expected value of death benefits payable when the account balance is projected to be zero and recognizing those benefits ratably over the accumulation period based on total expected assessments. The assumptions used in estimating the secondary and paid-up guarantee liabilities are consistent with those used for amortizing DAC, and are thus subject to the same variability and risk. The assumptions of investment performance and volatility for variable products are consistent with historical experience of the appropriate underlying equity index, such as the S&P 500 Index.We regularly review our estimates of liabilities for future policy benefits and compare them with our actual experience. Differences between actual experience and the assumptions used in pricing these policies and guarantees, as well as in the establishment of the related liabilities, result in variances in profit and could result in losses.62Table of ContentsTraditional long-duration and limited-payment contracts comprise approximately 70% of MetLife’s liabilities for future policyholder benefits. For such contracts, original assumptions developed at the time of issue are locked-in and used in all future liability calculations provided the resulting liabilities are adequate to provide for future benefits and expenses (i.e., there is no premium deficiency). Therefore, liabilities for these products would not be impacted by changes in assumptions unless such change would result in an adverse impact that would trigger an establishment of a premium deficiency reserve. Favorable experience for traditional long-duration and limited-payment contracts would have no impact on liabilities given that the current assumption is required to remain locked-in, however the positive experience would be reflected in net income over the life of the policies in force.We have assessed the sensitivities of reported amounts related to our traditional long-duration and limited-payment contracts to demonstrate the impact of the Declining Interest Rate Scenario and the Rising Interest Rate Scenario. These sensitivities show the resulting change in net derivative gains (losses) and adjusted earnings versus the Base Scenario. These results are included in “— Industry Trends — Impact of Market Interest Rates — Interest Rate Scenarios.” Our traditional life and other participating blocks comprise approximately 25% of our future policyholder benefit liabilities. For these contracts, MetLife’s risk of adverse experience may be mitigated through adjustments to the dividend scales.For all insurance assets and liabilities, MetLife holds capital and surplus to mitigate potential adverse experience development. The Company’s approaches for managing liquidity and capital are described in “— Liquidity and Capital Resources.”See Note 4 of the Notes to the Consolidated Financial Statements for additional information on our liability for future policy benefits.ReinsuranceAccounting for reinsurance requires extensive use of assumptions and estimates, particularly related to the future performance of the underlying business and the potential impact of counterparty credit risks. We periodically review actual and anticipated experience compared to the aforementioned assumptions used to establish assets and liabilities relating to ceded and assumed reinsurance and evaluate the financial strength of counterparties to our reinsurance agreements using criteria similar to that evaluated in our security impairment process. See “— Investment Allowance for Credit Loss and Impairments.” Additionally, for each of our reinsurance agreements, we determine whether the agreement provides indemnification against loss or liability relating to insurance risk, in accordance with applicable accounting standards. We review all contractual features, including those that may limit the amount of insurance risk to which the reinsurer is subject or features that delay the timely reimbursement of claims. If we determine that a reinsurance agreement does not expose the reinsurer to a reasonable possibility of a significant loss from insurance risk, we record the agreement using the deposit method of accounting.See Note 6 of the Notes to the Consolidated Financial Statements for additional information on our reinsurance programs.Deferred Policy Acquisition Costs and Value of Business AcquiredWe incur significant costs in connection with acquiring new and renewal insurance business. Costs that relate directly to the successful acquisition or renewal of insurance contracts are capitalized as DAC. In addition to commissions, certain direct-response advertising expenses and other direct costs, deferrable costs include the portion of an employee’s total compensation and benefits related to time spent selling, underwriting or processing the issuance of new and renewal insurance business only with respect to actual policies acquired or renewed. We utilize various techniques to estimate the portion of an employee’s time spent on qualifying acquisition activities that result in actual sales, including surveys, interviews, representative time studies and other methods. These estimates include assumptions that are reviewed and updated on a periodic basis to reflect significant changes in processes or distribution methods.VOBA represents the excess of book value over the estimated fair value of acquired insurance, annuity, and investment-type contracts in force at the acquisition date. For certain acquired blocks of business, the estimated fair value of the in-force contract obligations exceeded the book value of assumed in-force insurance policy liabilities, resulting in negative VOBA, which is presented separately from VOBA as an additional insurance liability included in other policy-related balances. The estimated fair value of the acquired obligations is based on projections, by each block of business, of future policy and contract charges, premiums, mortality and morbidity, separate account performance, surrenders, expenses, investment returns, nonperformance risk adjustment and other factors. Actual experience on the purchased business may vary from these projections. The recovery of DAC and VOBA is dependent upon the future profitability of the related business.63Table of ContentsSeparate account rates of return on variable universal life contracts and variable deferred annuity contracts affect in-force account balances on such contracts each reporting period, which can result in significant fluctuations in amortization of DAC and VOBA. Our practice to determine the impact of gross profits resulting from returns on separate accounts assumes that long-term appreciation in equity markets is not changed by short-term market fluctuations but is only changed when sustained interim deviations are expected. We monitor these events and only change the assumption when our long-term expectation changes. The effect of an increase (decrease) by 100 basis points in the assumed future rate of return is reasonably likely to result in a decrease (increase) in the DAC and VOBA amortization with an offset to our unearned revenue liability which nets to approximately $30 million. We use a mean reversion approach to separate account returns where the mean reversion period is five years with a long-term separate account return after the five-year reversion period is over. The current long-term rate of return assumption for the U.S. business variable universal life contracts and variable deferred annuity contracts is 5.75%.We periodically review long-term assumptions underlying the projections of estimated gross margins and profits. These assumptions primarily relate to investment returns, policyholder dividend scales, interest crediting rates, mortality, persistency, and expenses to administer business. Assumptions used in the calculation of estimated gross margins and profits which may have significantly changed are updated annually. If the update of assumptions causes expected future gross margins and profits to increase, DAC and VOBA amortization will decrease, resulting in a current period increase to earnings. The opposite result occurs when the assumption update causes expected future gross margins and profits to decrease.Our most significant assumption updates resulting in a change to expected future gross margins and profits and the amortization of DAC and VOBA are due to revisions to expected future investment returns, expenses, in-force or persistency assumptions and policyholder dividends on participating traditional life contracts, variable and universal life contracts and annuity contracts. We expect these assumptions to be the ones most reasonably likely to cause significant changes in the future. Changes in these assumptions can be offsetting and we are unable to predict their movement or offsetting impact over time. At December 31, 2022 and 2021, DAC and VOBA for the Company was $23.0 billion and $16.1 billion, respectively. The following illustrates the effect on DAC and VOBA of changing each of the respective assumptions, as well as updating estimated gross margins or profits with actual gross margins or profits during the years ended December 31, 2022 and 2021. Increases (decreases) in DAC and VOBA balances, as presented below, resulted in a corresponding decrease (increase) in amortization. Years Ended December 31, 20222021 (In millions)General account investment return$281 $(197)Separate account investment return(64)32 Net investment/Net derivative gains (losses) and GMIB115 (93)In-force/Persistency(183)77 Policyholder dividends, expense and other146 (22)Total$295 $(203)Items contributing to the changes to DAC and VOBA amortization in 2022 consisted of the following:•Net decrease in amortization of $281 million associated with the general account long-term investment rates of return, primarily driven by the following:•A decrease in amortization of approximately $60 million associated with realized losses in Japan largely caused by the increasing interest rate environment in 2022.•Net decrease in amortization of approximately $220 million mainly driven by the Japan actuarial assumption review relating to the general account long-term investment rates of return.•Net decrease in amortization of $115 million associated with net investment/net derivative gains (losses) and GMIBs, primarily driven by the following:64Table of Contents•A decrease in amortization of approximately $10 million associated with gains from GMIB hedges and the decreases in GMIB obligations.•Net decrease in amortization of approximately $105 million resulting from other investment activities.•Net increase in amortization of $183 million associated with in-force/persistency primarily due to higher lapses in Japan.•Net decrease in amortization of $146 million associated with policyholder dividends, expense and other, was primarily driven by following:•A decrease of approximately $50 million of DAC amortization resulting from the actuarial assumption review relating to the closed block.•Decrease in amortization of approximately $90 million mostly due to unfavorable closed block mortality.Items contributing to the changes to DAC and VOBA amortization in 2021 consisted of the following:•Net increase in amortization of $197 million mostly due to the actuarial assumption review relating to the general account long-term investment rates of return.•Net increase in amortization of $93 million associated with net investment/net derivative gains (losses) and GMIB, primarily driven by the following:•A decrease in amortization of approximately $10 million associated with gains from GMIB hedges and the decreases in GMIB obligations.•Net increase in amortization of approximately $100 million from other investment activities.Our DAC and VOBA balance is also impacted by unrealized investment gains (losses) and the amount of amortization which would have been recognized if such gains and losses had been realized. The decrease in unrealized investment gains (losses) increased the DAC and VOBA balance by $7.2 billion and $822 million in 2022 and 2021, respectively. See Notes 5 and 16 of the Notes to the Consolidated Financial Statements for information regarding the DAC and VOBA offset to unrealized investment gains (losses).Estimated Fair Value of InvestmentsIn determining the estimated fair value of our investments, fair values are based on unadjusted quoted prices for identical investments in active markets that are readily and regularly obtainable. When such unadjusted quoted prices are not available, estimated fair values are based on quoted prices in markets that are not active, quoted prices for similar but not identical investments, or other observable inputs. If these inputs are not available, or observable inputs are not determinable, unobservable inputs and/or adjustments to observable inputs requiring significant management judgment, including assumptions or estimates, are used to determine the estimated fair value of investments. Unobservable inputs are based on management’s assumptions about the inputs market participants would use in pricing such investments. The methodologies, assumptions and inputs utilized are described in Note 10 of the Notes to the Consolidated Financial Statements. For the vast majority of our investments, sensitivity analysis regarding unobservable inputs is not necessary or appropriate, as they are valued using quoted prices, as described above. Quantitative information about the significant unobservable inputs used in fair value measurement and the sensitivity of the estimated fair value to changes in those inputs for the more significant asset and liability classes measured at estimated fair value on a recurring basis is presented in Note 10 of the Notes to the Consolidated Financial Statements.Financial markets are susceptible to severe events evidenced by rapid depreciation in asset values accompanied by a reduction in asset liquidity. Our ability to sell investments, or the price ultimately realized for investments, depends upon the demand and liquidity in the market and increases the use of judgment in determining the estimated fair value of certain investments.Investment Allowance for Credit Loss and ImpairmentsThe significant estimates and inherent uncertainties related to our evaluation of credit loss and impairments on our investment portfolio are summarized below. See “Quantitative and Qualitative Disclosures About Market Risk” for information regarding the sensitivity of our fixed maturity securities and mortgage loan portfolios to changes in interest rates and foreign currency exchange rates. 65Table of ContentsFixed Maturity SecuritiesThe assessment of whether a credit loss has occurred is based on our case-by-case evaluation of whether the net amount expected to be collected is less than the amortized cost basis. We consider a wide range of factors about the security issuer and use our best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. We evaluate credit loss by considering information that changes from time to time about past events, current and forecasted economic conditions, and we measure credit loss by estimating recovery value using a discounted cash flow analysis. We estimate recovery value based on our best estimate of future cash flows, which is inherently subjective, and methodologies can vary depending on the facts and circumstances specific to each security. We record an ACL for the amount of the credit loss instead of recording a reduction of the amortized cost as an impairment. The evaluation processes, measurement methodologies, significant inputs and significant judgments and assumptions used to determine the amount of credit loss are described in Notes 1 and 8 of the Notes to the Consolidated Financial Statements. The determination of the amount of ACL is subjective as it includes our estimates and assumptions and assessment of known and inherent risks. We revise these evaluations as conditions change and new information becomes available. The valuation of our fixed maturity securities portfolio is sensitive to changes in interest rates and the estimated fair value of the portion of our fixed maturities securities portfolio that is foreign denominated, is sensitive to changes in foreign currency exchange rates.Mortgage LoansThe ACL is established both for pools of loans with similar risk characteristics and for loans with dissimilar risk characteristics, collateral dependent loans and reasonably expected troubled debt restructurings, individually on a loan specific basis. We record an allowance for expected lifetime credit loss in an amount that represents the portion of the amortized cost basis of mortgage loans that we do not expect to collect, resulting in mortgage loans being presented at the net amount expected to be collected. To determine the mortgage loan ACL, we apply significant judgement to estimate expected lifetime credit loss over the contractual term of our mortgage loans adjusted for expected prepayments and any extensions; and we consider past events and current and forecasted economic conditions which are subject to inherent uncertainty and which necessarily change from time to time. The ACL methodologies, significant inputs and significant judgements and assumptions used to determine the amount of credit loss are described in Notes 1 and 8 of the Notes to the Consolidated Financial Statements. The determination of the amount of ACL is subjective as it includes our estimates and assumptions and assessment of known and inherent risks. We revise these estimates as conditions change and new information becomes available. The estimated fair value of our mortgage loan portfolio is sensitive to changes in interest rates and the estimated fair value of the portion of our mortgage loan portfolio that is foreign denominated, is sensitive to changes in foreign currency exchange rates. Real Estate, Leases and Other Asset ClassesThe determination of the amount of ACL on leases and impairments on real estate and the remaining asset classes is highly subjective and is based upon our quarterly evaluation and assessment of known and inherent risks associated with the respective asset class. The evaluation processes, measurement methodologies, significant inputs and significant judgments and assumptions used to determine the amount of ACL and impairments are described in Notes 1 and 8 of the Notes to the Consolidated Financial Statements. Such evaluations and assessments are revised as conditions change and new information becomes available.DerivativesThe determination of the estimated fair value of freestanding derivatives, when quoted market values are not available, is based on market standard valuation methodologies and inputs that management believes are consistent with what other market participants would use when pricing the instruments. Derivative valuations can be affected by changes in interest rates, foreign currency exchange rates, financial indices, credit spreads, default risk, nonperformance risk, volatility, liquidity and changes in estimates and assumptions used in the pricing models. See Note 10 of the Notes to the Consolidated Financial Statements for additional details on significant inputs into the OTC derivative pricing models and credit risk adjustment.66Table of ContentsWe issue variable annuity products with guaranteed minimum benefits, some of which are embedded derivatives measured at estimated fair value separately from the host variable annuity product, with changes in estimated fair value reported in net derivative gains (losses). The estimated fair values of these embedded derivatives are determined based on the present value of projected future benefits minus the present value of projected future fees. The projections of future benefits and future fees require capital market and actuarial assumptions, including expectations concerning policyholder behavior. A risk neutral valuation methodology is used under which the cash flows from the guarantees are projected under multiple capital market scenarios using observable risk-free rates. The valuation of these embedded derivatives also includes an adjustment for our nonperformance risk and risk margins for non-capital market inputs. The nonperformance risk adjustment, which is captured as a spread over the risk-free rate in determining the discount rate to discount the cash flows of the liability, is determined by taking into consideration publicly available information relating to spreads in the secondary market for MetLife, Inc.’s debt, including related credit default swaps. These observable spreads are then adjusted, as necessary, to reflect the priority of these liabilities and the claims paying ability of the issuing insurance subsidiaries compared to MetLife, Inc. Risk margins are established to capture the non-capital market risks of the instrument which represent the additional compensation a market participant would require to assume the risks related to the uncertainties in certain actuarial assumptions. The establishment of risk margins requires the use of significant management judgment, including assumptions of the amount and cost of capital needed to cover the guarantees.The table below illustrates the impact that a range of reasonably likely variances in credit spreads would have on our consolidated balance sheet, excluding the effect of income tax, related to the embedded derivative valuation on certain variable annuity products measured at estimated fair value. In determining the ranges, we have considered current market conditions, as well as the market level of spreads that can reasonably be anticipated over the near term. The ranges do not reflect extreme market conditions, as we do not consider those to be reasonably likely events in the near future.The impact of the range of reasonably likely variances in credit spreads increased as compared to prior periods. However, these estimated effects do not take into account potential changes in other variables, such as equity price levels and market volatility, which can also contribute significantly to changes in carrying values. Therefore, the table does not necessarily reflect the ultimate impact on the consolidated financial statements under the credit spread variance scenarios presented below. Changes in Balance Sheet Carrying Value At December 31, 2022 Policyholder Account BalancesDAC and VOBA (In millions)100% increase in our credit spread$429 $(8)As reported$561 $43 50% decrease in our credit spread $596 $54 Variable annuities with guaranteed minimum benefits may be more costly than expected in volatile or declining equity markets. Market conditions including, but not limited to, changes in interest rates, equity indices, market volatility and foreign currency exchange rates, changes in our nonperformance risk, variations in actuarial assumptions regarding policyholder behavior, mortality and risk margins related to non-capital market inputs, may result in significant fluctuations in the estimated fair value of the guarantees that could materially affect net income. If interpretations change, there is a risk that features previously not bifurcated may require bifurcation and reporting at estimated fair value on the consolidated financial statements and respective changes in estimated fair value could materially affect net income.Additionally, we ceded the risk associated with certain of the variable annuities with guaranteed minimum benefits described in the preceding paragraphs. The value of the embedded derivatives on the ceded risk is determined using a methodology consistent with that described previously for the guarantees directly written by us with the exception of the input for nonperformance risk that reflects the credit of the reinsurer. Because certain of the direct guarantees do not meet the definition of an embedded derivative and, thus, are not accounted for at fair value, significant fluctuations in net income may occur since the change in fair value of the embedded derivative on the ceded risk is being recorded in net income without a corresponding and offsetting change in fair value of the direct guarantee.See Note 9 of the Notes to the Consolidated Financial Statements for additional information on our derivatives and hedging programs. See also “Quantitative and Qualitative Disclosures About Market Risk” for information regarding the sensitivity of our derivatives to changes in interest rates, foreign currency exchange rates, and equity market prices.67Table of ContentsGoodwill Goodwill is tested for impairment at least annually or more frequently if events or circumstances, such as adverse changes in the business climate, indicate that there may be justification for conducting an interim test.For purposes of goodwill impairment testing, if the carrying value of a reporting unit exceeds its estimated fair value, an impairment charge would be recognized for the amount by which the carrying value exceeds the reporting unit’s fair value; however, the loss recognized would not exceed the total amount of goodwill allocated to that reporting unit. Additionally, the Company will consider income tax effects from any tax-deductible goodwill on the carrying value of the reporting unit when measuring the goodwill impairment loss, if applicable. The key inputs, judgments and assumptions necessary in determining estimated fair value of the reporting units include projected adjusted earnings, current book value, the level of economic capital required to support the mix of business, long-term growth rates, comparative market multiples, the account value of in-force business, projections of new and renewed business, as well as margins on such business, interest rate levels, credit spreads, equity market levels, and the discount rate that we believe is appropriate for the respective reporting unit. We apply significant judgment when determining the estimated fair value of our reporting units and when assessing the relationship of market capitalization to the aggregate estimated fair value of our reporting units. The valuation methodologies utilized are subject to key judgments and assumptions that are sensitive to change. Estimates of fair value are inherently uncertain and represent only management’s reasonable expectation regarding future developments. These estimates and the judgments and assumptions upon which the estimates are based may differ from actual future results. The estimated fair value of the reporting units tested can be impacted by unexpected changes in the legislative, regulatory and macroeconomic environment. Declines in the estimated fair value of our reporting units could result in goodwill impairments in future periods which could materially adversely affect our results of operations or financial position.In the third quarter of 2022, the Company performed its annual goodwill impairment tests on all of its reporting units, using both qualitative and quantitative assessments. The quantitative assessment utilized the market multiple, embedded value and discounted cash flow valuation approaches based on best available data as of June 30, 2022. The Company concluded that the estimated fair values of all its reporting units were substantially in excess of their carrying values and, therefore, goodwill was not impaired.See Note 12 of the Notes to the Consolidated Financial Statements for additional information on our goodwill.Employee Benefit PlansCertain subsidiaries of MetLife, Inc. sponsor defined benefit pension plans and other postretirement benefit plans covering eligible employees. See Note 18 of the Notes to the Consolidated Financial Statements for information on amendments to our U.S. benefit plans. The calculation of the obligations and expenses associated with these plans requires an extensive use of assumptions such as the discount rate, expected rate of return on plan assets, rate of future compensation increases and healthcare cost trend rates, as well as assumptions regarding participant demographics such as rate and age of retirement, withdrawal rates and mortality. In consultation with external actuarial firms, we determine these assumptions based upon a variety of factors such as historical experience of the plan and its assets, currently available market and industry data, and expected benefit payout streams.We determine the expected rate of return on plan assets based upon an approach that considers inflation, real return, term premium, credit spreads, equity risk premium and capital appreciation, as well as expenses, expected asset manager performance, asset weights and the effect of rebalancing. Given the amount of plan assets as of December 31, 2021, the beginning of the measurement year, if we had assumed an expected rate of return for both our pension and other postretirement benefit plans that was 100 basis points higher or 100 basis points lower than the rates we assumed, the change in our net periodic benefit costs in 2022 would have been as follows:Year Ended December 31, 2022Increase/(Decrease) in Net Periodic Pension CostIncrease/(Decrease) in Net Other PostretirementBenefit Cost(In millions)Increase in expected rate of return by 100 bps$(106)$(14)Decrease in expected rate of return by 100 bps$106 $14 68Table of ContentsThis table considers only changes in our assumed long-term rate of return given the level and mix of invested assets at the beginning of the year, without consideration of possible changes in any of the other assumptions described above that could ultimately accompany any changes in our assumed long-term rate of return.We determine the discount rates used to value the Company’s pension and postretirement obligations, based upon rates commensurate with current yields on high quality corporate bonds. Given our pension and postretirement obligations as of December 31, 2021, the beginning of the measurement year, if we had assumed a discount rate for both our pension and postretirement benefit plans that was 100 basis points higher or 100 basis points lower than the rates we assumed, the change in our net periodic benefit costs would have been as follows: Year Ended December 31, 2022Increase/(Decrease) in Net Periodic Pension CostIncrease/(Decrease) in Net Other PostretirementBenefit Cost(In millions)Increase in discount rate by 100 bps$(56)$(1)Decrease in discount rate by 100 bps$75 $4 Given our pension and postretirement obligations as of December 31, 2022, the end of the measurement year, if we had assumed a discount rate for both our pension and postretirement benefit plans that was 100 basis points higher or 100 basis points lower than the rates we assumed, the change in our benefit obligations would have been as follows:Year Ended December 31, 2022Increase/(Decrease) in Pension Benefit ObligationIncrease/(Decrease) in Other PostretirementBenefit Obligation(In millions)Increase in discount rate by 100 bps$(818)$(74)Decrease in discount rate by 100 bps$964 $88 These tables consider only changes in our assumed discount rates without consideration of possible changes in any of the other assumptions described above that could ultimately accompany any changes in our assumed discount rate. The assumptions used may differ materially from actual results due to, among other factors, changing market and economic conditions and changes in participant demographics. These differences may have a significant impact on the Company’s consolidated financial statements and liquidity.See Note 18 of the Notes to the Consolidated Financial Statements for additional discussion of assumptions used in measuring liabilities relating to our employee benefit plans.Income Taxes and Valuation of Deferred Tax AssetsOur accounting for income taxes represents our best estimate of various events and transactions. Tax laws are often complex and may be subject to differing interpretations by the taxpayer and the relevant governmental taxing authorities. In establishing a provision for income tax expense, we must make judgments and interpretations about the application of inherently complex tax laws. We must also make estimates about when in the future certain items will affect taxable income in the various tax jurisdictions in which we conduct business.The Company considers all available factors, both positive and negative, to determine whether, based on the weight of these factors, a partial or full valuation allowance for categories of deferred tax assets is required. The weight given to these factors is commensurate with the extent to which it can be objectively verified. Examples of factors considered in determining deferred tax asset realizability include past earnings history, projections of taxable income and tax planning strategies. Changes in tax laws and/or statutory tax rates in countries in which we operate could have an impact on our valuation of net deferred tax assets. If there were a 1% increase in the global effective income tax rate, the change would have resulted in an approximate $112 million increase in the net deferred income tax asset balance at December 31, 2022. See Notes 1 and 19 of the Notes to the Consolidated Financial Statements for additional information on our income taxes.69Table of ContentsLitigation ContingenciesWe are a defendant in a large number of litigation matters and are involved in a number of regulatory investigations. Given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material effect on the Company’s consolidated net income or cash flows in particular quarterly or annual periods. Liabilities are established when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Liabilities related to certain lawsuits, including our asbestos-related liability, are especially difficult to estimate due to the limitation of reliable data and uncertainty regarding numerous variables that can affect liability estimates. On a quarterly and annual basis, we review relevant information with respect to liabilities for litigation, regulatory investigations and litigation-related contingencies to be reflected in our consolidated financial statements. It is possible that an adverse outcome in certain of our litigation and regulatory investigations, including asbestos-related cases, or the use of different assumptions in the determination of amounts recorded could have a material effect upon our consolidated net income or cash flows in particular quarterly or annual periods.See Note 21 of the Notes to the Consolidated Financial Statements for additional information regarding our assessment of litigation contingencies.Acquisitions and DispositionsAcquisitionsPending Acquisition of Raven Capital ManagementIn February 2023, the Company entered into a definitive agreement to acquire Raven Capital Management, a privately-owned alternative investment company. This transaction is subject to customary closing conditions.Acquisition of Affirmative Investment ManagementIn December 2022, the Company completed the acquisition of Affirmative Investment Management, a specialist global environmental, social and corporate governance impact fixed income investment manager. Ownership Increase of PNB MetLifeIn February 2022, the Company acquired approximately 15.0% ownership in PNB MetLife India Insurance Company Limited (“PNB MetLife”). As a result, the Company’s ownership in PNB MetLife, an operating joint venture accounted for under the equity method, increased to approximately 47.0%. This transaction supports the Company’s continued growth in India and will enable us to deliver more value for our customers, partners and shareholders.DispositionsDisposition of MetLife Poland and GreeceFor information regarding the Company's dispositions of its wholly-owned subsidiaries in Poland and Greece in April 2022 and January 2022, respectively, which were reported as held-for-sale, see Notes 1 and 3 of the Notes to the Consolidated Financial Statements.Disposition of MetLife SegurosFor information regarding the Company's September 2021 disposition of its wholly-owned Argentinian subsidiary, MetLife Seguros S.A. (“MetLife Seguros”), see Note 3 of the Notes to the Consolidated Financial Statements.Disposition of MetLife P&CFor information regarding the Company's April 2021 disposition of MetLife P&C, which was reported as held-for-sale, see Notes 1 and 3 of the Notes to the Consolidated Financial Statements.Disposition of MetLife RussiaFor information regarding the Company's January 2021 disposition of its wholly-owned Russian subsidiary, the Joint-stock Company MetLife Insurance Company (“MetLife Russia”), see Note 3 of the Notes to the Consolidated Financial Statements.70Table of ContentsResults of OperationsConsolidated Results Years Ended December 31, 20222021 (In millions)RevenuesPremiums$49,397 $42,009 Universal life and investment-type product policy fees5,585 5,756 Net investment income15,916 21,395 Other revenues2,634 2,619 Net investment gains (losses)(1,262)1,529 Net derivative gains (losses)(2,372)(2,228)Total revenues69,898 71,080 ExpensesPolicyholder benefits and claims and policyholder dividends51,313 44,830 Interest credited to policyholder account balances3,692 5,538 Capitalization of DAC(2,558)(2,718)Amortization of DAC and VOBA1,931 2,555 Amortization of negative VOBA(41)(34)Interest expense on debt938 920 Other expenses11,764 11,863 Total expenses67,039 62,954 Income (loss) before provision for income tax2,859 8,126 Provision for income tax expense (benefit)301 1,551 Net income (loss)2,558 6,575 Less: Net income (loss) attributable to noncontrolling interests19 21 Net income (loss) attributable to MetLife, Inc.2,539 6,554 Less: Preferred stock dividends185 195 Preferred stock redemption premium— 6 Net income (loss) available to MetLife, Inc.’s common shareholders$2,354 $6,353 Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021During 2022, net income (loss) decreased $4.0 billion from 2021, primarily driven by unfavorable changes in adjusted earnings and net investment gains (losses).Management of Investment Portfolio and Hedging Market Risks with Derivatives. See “— Investments — Overview” for a discussion of the management of our investment portfolio. We purchase investments to support our insurance liabilities and not to generate net investment gains and losses. However, net investment gains and losses are incurred and can change significantly from period to period due to changes in external influences, including changes in market factors such as interest rates, foreign currency exchange rates, credit spreads and equity markets; counterparty specific factors such as financial performance, credit rating and collateral valuation; and internal factors such as portfolio rebalancing. Changes in these factors from period to period can significantly impact the levels of provision for credit loss and impairments on our investment portfolio, as well as realized gains and losses on investments sold.71Table of ContentsWe also use derivatives as an integral part of our management of the investment portfolio and insurance liabilities to hedge certain risks, including changes in interest rates, foreign currency exchange rates, credit spreads and equity market levels. We use freestanding interest rate, equity, credit and currency derivatives to hedge certain invested assets and insurance liabilities. A portion of these hedges are designated and qualify as accounting hedges, which reduce volatility in earnings. For those hedges not designated as accounting hedges, changes in market factors lead to the recognition of fair value changes in net derivative gains (losses) generally without an offsetting gain or loss recognized in earnings for the item being hedged, which creates volatility in earnings. We actively evaluate market risk hedging needs and strategies to ensure our free cash flow and capital objectives are met under a range of market conditions. Certain variable annuity products with guaranteed minimum benefits contain embedded derivatives that are measured at estimated fair value separately from the host variable annuity contract, with changes in estimated fair value recorded in net derivative gains (losses). We use freestanding derivatives to hedge the market risks inherent in these variable annuity guarantees. The valuation of these embedded derivatives includes a nonperformance risk adjustment, which is unhedged, and can be a significant driver of net derivative gains (losses) and volatility in earnings, but does not have an economic impact on us.We continuously review and refine our hedging strategy in light of changing economic and market conditions, evolving NAIC and NYDFS statutory requirements, and accounting rule changes. As a part of our current hedging strategy, we maintain portfolio level derivatives in our macro hedge program. These macro hedge program derivatives, which are included in the non-VA program derivatives section of the table below, mitigate the potential deterioration in our capital positions from significant adverse economic conditions. Net Derivative Gains (Losses). The variable annuity embedded derivatives and associated freestanding derivative hedges are collectively referred to as “VA program derivatives.” All other derivatives that are economic hedges of certain invested assets and insurance liabilities are referred to as “non-VA program derivatives.” The table below presents the impact on net derivative gains (losses) from non-VA program derivatives and VA program derivatives: Years Ended December 31, 20222021 (In millions)Non-VA program derivativesInterest rate$(2,618)$(1,075)Foreign currency exchange rate408 (429)Credit55 85 Equity113 (771)Non-VA embedded derivatives127 37 Total non-VA program derivatives(1,915)(2,153)VA program derivativesMarket risks in embedded derivatives512 1,006 Nonperformance risk adjustment on embedded derivatives18 (17)Other risks in embedded derivatives(485)(279)Total embedded derivatives45 710 Freestanding derivatives hedging embedded derivatives(502)(785)Total VA program derivatives(457)(75)Net derivative gains (losses)$(2,372)$(2,228)72Table of ContentsThe favorable change in net derivative gains (losses) on non-VA program derivatives was $238 million ($188 million, net of income tax). This was primarily due to key equity indexes decreasing in 2022 versus increasing in 2021, favorably impacting equity options and total rate of return swaps acquired primarily as part of our macro hedge program. In addition, the U.S. dollar strengthened less significantly against the Chilean peso in 2022 compared to 2021. This favorably impacted the estimated fair value of pay U.S. dollar foreign currency swaps. These favorable changes were largely offset by long-term rates increasing more significantly in 2022 compared to 2021. This unfavorably impacted the estimated fair value of receive fixed interest rate swaps. Because certain of these hedging strategies are not designated or do not qualify as accounting hedges, the changes in the estimated fair value of these freestanding derivatives are recognized in net derivative gains (losses) without an offsetting gain or loss recognized in earnings for the items being hedged.The unfavorable change in net derivative gains (losses) on VA program derivatives was $382 million ($302 million, net of income tax). This was due to (i) an unfavorable change of $211 million ($167 million, net of income tax), in market risks in embedded derivatives, net of freestanding derivatives hedging market risks in embedded derivatives, and (ii) an unfavorable change of $206 million ($163 million, net of income tax) in other risks in embedded derivatives; partially offset by a favorable change of $35 million ($28 million, net of income tax) in the nonperformance risk adjustment on embedded derivatives. The aforementioned $211 million ($167 million, net of income tax) unfavorable change reflects a $494 million ($390 million, net of income tax) unfavorable change in market risks in embedded derivatives, partially offset by a $283 million ($223 million, net of income tax) favorable change in freestanding derivatives hedging market risks in embedded derivatives.The primary changes in market factors affecting the valuation of VA program derivatives are summarized as follows:•Long-term interest rates increased more significantly in 2022 compared to 2021, contributing to an unfavorable change in our freestanding derivatives and a favorable change in our embedded derivatives. For example, the 30-year U.S. swap rate increased 176 basis points in 2022 and increased 33 basis points in 2021.•Key equity index levels decreased in 2022 versus increased in 2021, contributing to an unfavorable change in our embedded derivatives and a favorable change in our freestanding derivatives. For example, the S&P 500 Index decreased 19% in 2022 and increased 27% in 2021.The aforementioned $206 million ($163 million, net of income tax) unfavorable change in other risks in embedded derivatives reflects actuarial assumption updates and a combination of factors, such as fees deducted from accounts, changes in the benefit base, premiums, lapses, withdrawals and deaths, in addition to changes to cross-effect, basis mismatch, risk margin and fund allocation.The aforementioned $35 million ($28 million, net of income tax) favorable change in the nonperformance risk adjustment on embedded derivatives resulted from a favorable change of $55 million ($44 million, net of income tax) related to model changes and changes in capital market inputs, such as long-term interest rates and key equity index levels, on variable annuity guarantees, partially offset by an unfavorable change of $20 million ($16 million, net of income tax) related to changes in our own credit spread. When equity index levels decrease in isolation, the variable annuity guarantees become more valuable to policyholders, which results in an increase in the undiscounted embedded derivative liability. Discounting this unfavorable change by the risk adjusted rate results in a smaller loss than by discounting at the risk-free rate, thus creating a gain from including an adjustment for nonperformance risk.When the risk-free interest rate decreases in isolation, discounting the embedded derivative liability produces a higher valuation of the liability than if the risk-free interest rate had remained constant. Discounting this unfavorable change by the risk adjusted rate results in a smaller loss than by discounting at the risk-free interest rate, thus creating a gain from including an adjustment for nonperformance risk.When our own credit spread increases in isolation, discounting the embedded derivative liability produces a lower valuation of the liability than if our own credit spread had remained constant. As a result, a gain is created from including an adjustment for nonperformance risk. For each of these primary market drivers, the opposite effect occurs when the driver moves in the opposite direction.73Table of ContentsNet Investment Gains (Losses). The unfavorable change in net investment gains (losses) of $2.8 billion ($2.2 billion, net of income tax) primarily reflects (i) losses in 2022 on sales of fixed maturity securities, (ii) the 2021 gain on the disposition of MetLife P&C, (iii) lower gains in 2022 on sales of real estate investments, and (iv) mark-to-market losses in 2022 compared to market-to-market gains in 2021 on equity securities, which are measured at fair value through net income (loss). These unfavorable changes were partially offset by 2021 losses on the sales of certain subsidiaries, as well as net foreign currency transaction gains in 2022.Divested Businesses. Income (loss) before provision for income tax related to divested businesses, excluding net investment gains (losses) and net derivative gains (losses), decreased $93 million ($74 million, net of income tax) to a loss of $31 million ($21 million, net of income tax) in 2022 from income of $62 million ($53 million, net of income tax) in 2021. Included in this decrease was a decline in total revenues of $1.0 billion, before income tax, and a decrease in total expenses of $939 million, before income tax. Divested businesses primarily included activity related to the disposition of MetLife P&C in 2021.Taxes. Our 2022 effective tax rate on income (loss) before provision for income tax was 11%. Our effective tax rate differed from the U.S. statutory rate of 21% primarily due to tax benefits from tax credits, foreign earnings taxed at different rates than the U.S. statutory rate, an IRS audit settlement, the corporate tax deduction for stock compensation and non-taxable investment income. Our 2021 effective tax rate on income (loss) before provision for income tax was 19%. Our effective tax rate differed from the U.S. statutory rate of 21% primarily due to tax benefits from tax credits, non-taxable investment income, an IRS audit settlement, the non-cash transfer of assets from a wholly-owned U.K. investment subsidiary to its U.S. parent and the corporate tax deduction for stock compensation, partially offset by tax charges from foreign earnings taxed at different rates than the U.S. statutory rate and the dispositions of MetLife P&C, MetLife Seguros and MetLife Poland and Greece.Actuarial Assumption Review and Certain Other Insurance Adjustments. Results for 2022 include a $75 million ($53 million, net of income tax) gain associated with our annual review of actuarial assumptions related to reserves and DAC, of which a $344 million ($273 million, net of income tax) loss was recognized in net derivative gains (losses). Of the $75 million gain, a $315 million ($242 million, net of income tax) gain was related to DAC, and a loss of $240 million ($189 million, net of income tax) was associated with reserves. The portion of the $75 million gain that is included in adjusted earnings is $48 million ($33 million, net of income tax). The $344 million ($273 million, net of income tax) loss recognized in net derivative gains (losses) associated with our annual review of actuarial assumptions is included within the other risks in embedded derivatives line in the table above. As a result of our annual review of actuarial assumptions, changes were made to economic, biometric, policyholder behavior, and operational assumptions. The most significant impacts were in the MetLife Holdings and Asia segments. In the MetLife Holdings segment, significant impacts included economic assumption updates related to the projection of closed block results and updates to behavioral assumptions for variable annuities. In the Asia segment, the most significant impact was driven by economic assumption updates for interest sensitive whole life and fixed annuities. The breakdown of total current period results is summarized as follows: •Economic assumption updates resulted in favorable impacts to reserves and DAC, for a net gain of $308 million ($234 million, net of income tax). •Changes in biometric assumptions resulted in unfavorable impacts to reserves and favorable impacts to DAC, for a net charge of $5 million ($4 million, net of income tax). •Changes in policyholder behavior assumptions resulted in unfavorable impacts to reserves and favorable impacts to DAC, for a net charge of $245 million ($192 million, net of income tax). •Changes in operational assumptions resulted in favorable impacts to reserves and unfavorable impacts to DAC, for a net gain of $17 million ($15 million, net of income tax). Results for 2021 include a $281 million ($216 million, net of income tax) charge associated with our annual review of actuarial assumptions related to reserves and DAC, of which a $2 million ($1 million, net of income tax) loss was recognized in net derivative gains (losses). Of the $281 million charge, $129 million ($96 million, net of income tax) was related to DAC and $152 million ($120 million, net of income tax) was associated with reserves. The portion of the $281 million charge that is included in adjusted earnings is $187 million ($140 million, net of income tax).Certain other insurance adjustments recorded in 2022 include a $115 million ($91 million, net of income tax) favorable reinsurance recapture in our U.S. segment and a $114 million ($90 million, net of income tax) charge related to model refinements in our MetLife Holdings segment. These adjustments are included in adjusted earnings.74Table of ContentsAdjusted Earnings. As more fully described in “— Non-GAAP and Other Financial Disclosures,” we use adjusted earnings, which does not equate to net income (loss), as determined in accordance with GAAP, to analyze our performance, evaluate segment performance, and allocate resources. We believe that the presentation of adjusted earnings and other financial measures based on adjusted earnings, as we measure it for management purposes, enhances the understanding of our performance by highlighting the results of operations and the underlying profitability drivers of the business. Adjusted earnings and other financial measures based on adjusted earnings allow analysis of our performance relative to our business plan and facilitate comparisons to industry results. Adjusted earnings should not be viewed as a substitute for net income (loss). Adjusted earnings available to common shareholders and adjusted earnings available to common shareholders on a constant currency basis should not be viewed as substitutes for net income (loss) available to MetLife, Inc.’s common shareholders. Adjusted earnings available to common shareholders decreased $2.4 billion, net of income tax, to $5.5 billion, net of income tax, for 2022 from $8.0 billion, net of income tax, for 2021.75Table of ContentsReconciliation of net income (loss) to adjusted earnings available to common shareholders and premiums, fees and other revenues to adjusted premiums, fees and other revenuesYear Ended December 31, 2022U.S.AsiaLatin AmericaEMEAMetLife HoldingsCorporate & OtherTotal(In millions)Net income (loss) available to MetLife, Inc.'s common shareholders$2,698 $(750)$613 $115 $276 $(598)$2,354 Add: Preferred stock dividends— — — — — 185 185 Add: Net income (loss) attributable to noncontrolling interests— — 8 5 — 6 19 Add: Preferred stock redemption premium— — — — — — — Net income (loss)2,698 (750)621 120 276 (407)2,558 Less: adjustments from net income (loss) to adjusted earnings available to common shareholders:Revenues:Net investment gains (losses)(451)(1,124)52 (99)4 356 (1,262)Net derivative gains (losses)429 (2,060)434 (22)(1,213)60 (2,372)Premiums— — — 41 — — 41 Universal life and investment-type product policy fees— (41)— 19 75 — 53 Net investment income(360)(338)(275)(1,024)(281)5 (2,273)Other revenues— — — 8 — 155 163 Expenses:Policyholder benefits and claims and policyholder dividends6 162 (453)(100)438 — 53 Interest credited to policyholder account balances— 246 43 1,030 — — 1,319 Capitalization of DAC— — — 11 — — 11 Amortization of DAC and VOBA— 63 — (7)50 — 106 Amortization of negative VOBA— — — — — — — Interest expense on debt— — — — — — — Other expenses— — 9 (31)— (241)(263)Goodwill impairment— — — — — — — Provision for income tax (expense) benefit78 964 50 48 195 (83)1,252 Adjusted earnings$2,996 $1,378 $761 $246 $1,008 (659)5,730 Less: Preferred stock dividends185 185 Adjusted earnings available to common shareholders$(844)$5,545 Premiums, fees and other revenues$38,462 $7,457 $4,440 $2,367 $4,353 $537 $57,616 Less: adjustments to premiums, fees and other revenues— (41)— 68 75 155 257 Adjusted premiums, fees and other revenues$38,462 $7,498 $4,440 $2,299 $4,278 $382 $57,359 76Table of ContentsYear Ended December 31, 2021 U.S.AsiaLatin AmericaEMEAMetLife HoldingsCorporate & OtherTotal(In millions)Net income (loss) available to MetLife, Inc.'s common shareholders$3,509 $1,597 $(258)$58 $905 $542 $6,353 Add: Preferred stock dividends— — — — — 195 195 Add: Net income (loss) attributable to noncontrolling interests— 2 6 3 — 10 21 Add: Preferred stock redemption premium— — — — — 6 6 Net income (loss)3,509 1,599 (252)61 905 753 6,575 Less: adjustments from net income (loss) to adjusted earnings available to common shareholders:Revenues:Net investment gains (losses)410 (6)(134)(190)86 1,363 1,529 Net derivative gains (losses)226 (818)(416)(20)(1,167)(33)(2,228)Premiums865 — — 117 — — 982 Universal life and investment-type product policy fees— 73 — 42 80 — 195 Net investment income(310)58 (64)717 (293)7 115 Other revenues11 — 1 11 — 220 243 Expenses:Policyholder benefits and claims and policyholder dividends(610)(81)(8)(141)(338)(1)(1,179)Interest credited to policyholder account balances2 (211)(42)(695)— — (946)Capitalization of DAC89 — — 30 — — 119 Amortization of DAC and VOBA(98)(35)— (26)(60)— (219)Amortization of negative VOBA— — — — — — — Interest expense on debt— — — — — (1)(1)Other expenses(222)3 3 (81)— (267)(564)Goodwill impairment— — — — — — — Provision for income tax (expense) benefit(75)318 117 (4)355 (331)380 Adjusted earnings$3,221 $2,298 $291 $301 $2,242 (204)8,149 Less: Preferred stock dividends195 195 Adjusted earnings available to common shareholders$(399)$7,954 Adjusted earnings available to common shareholders on a constant currency basis (1)$3,221 $2,218 $253 $245 $2,242 $(399)$7,780 Premiums, fees and other revenues$29,912 $8,381 $3,760 $2,883 $4,771 $677 $50,384 Less: adjustments to premiums, fees and other revenues876 73 1 170 80 220 1,420 Adjusted premiums, fees and other revenues$29,036 $8,308 $3,759 $2,713 $4,691 $457 $48,964 Adjusted premiums, fees and other revenues on a constant currency basis (1)$29,036 $7,263 $3,643 $2,429 $4,691 $457 $47,519 __________________(1)Amounts for U.S., MetLife Holdings and Corporate & Other are shown on a reported basis, as constant currency impact is not significant.Consolidated Results — Adjusted EarningsBusiness Overview. Adjusted premiums, fees and other revenues for 2022 increased $8.4 billion, or 17%, compared to 2021. Adjusted premiums, fees and other revenues, net of foreign currency fluctuations, increased $9.8 billion, or 21%, compared to 2021 primarily due to higher premiums in our RIS business and growth in our Group Benefits business, both in our U.S. segment. Strong sales and solid persistency in our Latin America segment also contributed to the improvement in adjusted premiums, fees and other revenues. In our Asia segment, increases in adjusted premiums, fees and other revenues in Japan, Australia and Korea were partially offset by the impact of our actuarial assumption review in both years. A decrease in adjusted premiums, fees and other revenues in our EMEA segment was primarily due to the dispositions of MetLife Poland and Greece. In our MetLife Holdings segment, for 2023, we anticipate an average decline in adjusted premiums, fees and other revenues of approximately 12% to 14% from expected business run-off. For 2024 and beyond, we expect this decline to be approximately 6% to 8% per year.77Table of Contents Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021Unless otherwise stated, all amounts discussed below are net of income tax.Overview. The primary drivers of the decrease in adjusted earnings were (i) lower investment yields due to the unfavorable impact of lower equity market returns on our private equity funds and hedge funds, (ii) higher interest credited expense and (iii) higher expenses, partially offset by (i) higher net investment income due to a larger average invested asset base, and (ii) favorable underwriting, primarily driven by an overall decline in COVID-19 related claims. Our results for 2022 also included the favorable impacts from a reinsurance recapture in our U.S. segment, a reinsurance settlement in our MetLife Holdings segment and our actuarial assumption review, as well as the unfavorable impact from model refinements in our MetLife Holdings segment. Our results for 2021 included the favorable impacts of tax adjustments related to an IRS audit settlement and the non-cash transfer of assets from a wholly-owned U.K. investment subsidiary to its U.S. parent, as well as the release of a legal reserve, all in Corporate & Other, and the unfavorable impact of our actuarial assumption review.Foreign Currency. Changes in foreign currency exchange rates had a $174 million negative impact on adjusted earnings for 2022 compared to 2021. Unless otherwise stated, all amounts discussed below are net of foreign currency fluctuations. Foreign currency fluctuations can result in significant variances in the financial statement line items.Business Growth. We benefited from positive net flows from most of our businesses, which increased our average invested asset base and resulted in higher net investment income. However, consistent with the growth in average invested assets, interest credited expenses on certain insurance-related liabilities increased. Higher premiums, fees and other revenues, net of corresponding changes in policyholder benefits, improved adjusted earnings, primarily from growth in our Asia, Latin America and EMEA segments, partially offset by a decline in our MetLife Holdings segment. Higher commissions were offset by higher DAC capitalization. The combined impact of the items affecting our business growth, partially offset by higher DAC amortization, resulted in a $254 million increase in adjusted earnings.Market Factors. Market factors, including interest rate levels, variability in equity market returns, and foreign currency fluctuations, continued to impact our results; however, certain impacts were mitigated by derivatives used to hedge these risks. Excluding the impact of changes in foreign currency exchange rates on net investment income in our non-U.S. segments and changes in inflation rates on our inflation-indexed investments, investment yields decreased. The decrease in investment yields was primarily driven by the unfavorable impact of lower equity market returns on our private equity funds and hedge funds, as well as lower prepayment fees. These decreases were partially offset by higher yields on our fixed income securities and mortgage loans, as well as higher income on derivatives. The changes in market factors discussed above resulted in a $3.4 billion decrease in adjusted earnings. Underwriting, Actuarial Assumption Review and Other Insurance Adjustments. Favorable underwriting resulted in a $1.1 billion increase in adjusted earnings and reflected overall lower impacts from the COVID-19 pandemic. This was primarily driven by favorable mortality in our U.S. and Latin America segments, partially offset by unfavorable claims experience in our Asia segment. The favorable change from our actuarial assumption reviews resulted in a net increase of $173 million in adjusted earnings. Refinements to certain insurance and other liabilities in both years resulted in a $132 million increase in adjusted earnings, which includes the favorable impacts from a reinsurance recapture in our U.S. segment and a reinsurance settlement in our MetLife Holdings segment, mostly offset by model refinements in our MetLife Holdings segment, all in 2022.Expenses. Adjusted earnings decreased $253 million primarily due to an increase in corporate-related expenses, as well as the release of a legal reserve in 2021.Taxes. Our 2022 effective tax rate on adjusted earnings was 21%, which is equal to the U.S. statutory rate and reflects tax charges from foreign earnings taxed at different rates than the U.S. statutory rate, offset by tax benefits from tax credits, an IRS audit settlement, the corporate tax deduction for stock compensation and non-taxable investment income. Our 2021 effective tax rate on adjusted earnings was 19%. Our effective tax rate differed from the U.S. statutory rate of 21% primarily due to tax benefits from tax credits, non-taxable investment income, an IRS audit settlement, the non-cash transfer of assets from a wholly-owned U.K. investment subsidiary to its U.S. parent and the corporate tax deduction for stock compensation, partially offset by tax charges from foreign earnings taxed at different rates than the U.S. statutory rate.78Table of ContentsSegment Results and Corporate & OtherU.S.Business Overview. Adjusted premiums, fees and other revenues for 2022 increased $9.4 billion, or 32%, compared to 2021. This was primarily due to higher premiums in our RIS business, as well as growth in our Group Benefits business. The increase in premiums in RIS was mainly driven by a large pension risk transfer transaction in 2022. Changes in RIS premiums are mostly offset by a corresponding change in policyholder benefits. The increase in our Group Benefits business was primarily due to growth from our voluntary products, group disability and dental businesses. Years Ended December 31, 20222021 (In millions)Adjusted revenuesPremiums$35,548 $26,358 Universal life and investment-type product policy fees1,158 1,140 Net investment income7,340 8,048 Other revenues1,756 1,538 Total adjusted revenues45,802 37,084 Adjusted expensesPolicyholder benefits and claims and policyholder dividends36,273 27,957 Interest credited to policyholder account balances1,789 1,422 Capitalization of DAC(77)(65)Amortization of DAC and VOBA59 60 Interest expense on debt9 7 Other expenses3,962 3,632 Total adjusted expenses42,015 33,013 Provision for income tax expense (benefit)791 850 Adjusted earnings$2,996 $3,221 Adjusted premiums, fees and other revenues$38,462 $29,036 Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021 Unless otherwise stated, all amounts discussed below are net of income tax.Business Growth. The impact of positive flows from pension risk transfer transactions and funding agreement issuances resulted in higher average invested assets, improving net investment income. However, this was partially offset by a corresponding increase in interest credited expenses on long duration insurance and investment-type products. Higher direct expenses, including certain employee-related costs, coupled with an increase in variable expenses, exceeded the corresponding increase in premiums, fees and other revenues. The combined impact of the items affecting our business growth increased adjusted earnings by $133 million.Market Factors. Market factors, including interest rate levels, variability in equity market returns and foreign currency fluctuations, continued to impact our results; however, certain impacts were mitigated by derivatives used to hedge these risks. Investment yields decreased primarily driven by the unfavorable impact of lower equity market returns on our private equity funds and hedge funds, partially offset by higher yields on fixed income securities and mortgage loans, and higher income on derivatives. The impact of interest rate fluctuations resulted in an increase in our average interest credited rates on long duration insurance and investment-type products, which drove an increase in interest credited expenses. The changes in market factors discussed above resulted in a $1.3 billion decrease in adjusted earnings.79Table of ContentsUnderwriting and Other Insurance Adjustments. Favorable mortality in our Group Benefits business resulted in an increase in adjusted earnings of $830 million. This was driven by decreases in both incidence and severity of COVID-19 and non-COVID-19 claims. Less favorable mortality in our RIS business resulted in a decrease in adjusted earnings of $64 million, primarily driven by our structured settlement and pension risk transfer businesses. Favorable claims experience in our Group Benefits business, primarily within our accident & health, vision and dental businesses, partially offset by unfavorable experience in our individual and group disability businesses resulted in a $74 million increase to adjusted earnings. Refinements to certain insurance and other liabilities in both years resulted in a $150 million increase in adjusted earnings, which includes the favorable impact from a reinsurance recapture in the current year.AsiaBusiness Overview. Adjusted premiums, fees and other revenues for 2022 decreased $810 million, or 10%, compared to 2021. Adjusted premiums, fees and other revenues, net of foreign currency fluctuations, increased $235 million, or 3%, compared to 2021, mainly due to increases in Japan, Australia and Korea, partially offset by the impact of our actuarial assumption review in both years. In Japan, higher fees from foreign currency-denominated life and fixed annuity products were partially offset by a decrease in premiums from yen-denominated life products. The increases in Australia and Korea were primarily due to business growth. Years Ended December 31, 20222021 (In millions)Adjusted revenuesPremiums$5,568 $6,421 Universal life and investment-type product policy fees1,840 1,814 Net investment income3,909 5,052 Other revenues90 73 Total adjusted revenues11,407 13,360 Adjusted expensesPolicyholder benefits and claims and policyholder dividends4,752 5,008 Interest credited to policyholder account balances2,003 1,995 Capitalization of DAC(1,524)(1,607)Amortization of DAC and VOBA1,105 1,369 Amortization of negative VOBA(36)(27)Other expenses3,153 3,388 Total adjusted expenses9,453 10,126 Provision for income tax expense (benefit)576 936 Adjusted earnings$1,378 $2,298 Adjusted earnings on a constant currency basis$1,378 $2,218 Adjusted premiums, fees and other revenues$7,498 $8,308 Adjusted premiums, fees and other revenues on a constant currency basis$7,498 $7,263 Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021Unless otherwise stated, all amounts discussed below are net of income tax.Foreign Currency. Changes in foreign currency exchange rates decreased adjusted earnings by $80 million for 2022 compared to 2021, primarily due to the weakening of the Japanese yen, Korean won and Australian dollar against the U.S. dollar. Unless otherwise stated, all amounts discussed below are net of foreign currency fluctuations. Foreign currency fluctuations can result in significant variances in the financial statement line items.80Table of ContentsBusiness Growth. Increased premiums, fees and other revenues were partially offset by higher policyholder benefits and commissions, net of DAC capitalization, which contributed to Asia’s business growth. Positive net flows in Japan and Korea resulted in higher average invested assets, which improved net investment income. The increase in net investment income was largely offset by a corresponding increase in interest credited expenses on certain insurance liabilities. The combined impact of the items affecting our business growth, partially offset by higher DAC amortization, improved adjusted earnings by $99 million.Market Factors. Market factors, including interest rate levels and variability in equity market returns, continued to impact our results; however, certain impacts were mitigated by derivatives used to hedge these risks. Investment yields decreased, driven by the unfavorable impact of lower equity market returns on our private equity and hedge funds, and lower income on derivatives. These unfavorable impacts were partially offset by higher yields on fixed income securities supporting products sold in Japan denominated in U.S. dollars and Japanese yen. In addition, a decrease in interest credited expenses on certain insurance liabilities improved adjusted earnings. The changes in market factors discussed above decreased adjusted earnings by $804 million.Underwriting, Actuarial Assumption Review and Other Insurance Adjustments. Unfavorable underwriting, mainly driven by COVID-19-related claims in Japan, decreased adjusted earnings by $202 million. The favorable change from our actuarial assumption reviews resulted in a net increase of $102 million in adjusted earnings. Refinements to certain insurance liabilities and other liabilities in both years resulted in an $18 million increase in adjusted earnings.Expenses and Taxes. Higher expenses, primarily driven by higher employee-related and other operating expenses, as well as an increase in corporate overhead costs, decreased adjusted earnings by $60 million. Our 2022 results also included a benefit of $8 million resulting from a change in the tax rate in Korea.81Table of ContentsLatin AmericaBusiness Overview. Adjusted premiums, fees and other revenues for 2022 increased $681 million, or 18%, compared to 2021. Adjusted premiums, fees and other revenues, net of foreign currency fluctuations, increased $797 million, or 22%, compared to 2021, mainly driven by strong sales and solid persistency across the region. Years Ended December 31,20222021 (In millions)Adjusted revenuesPremiums$3,226 $2,609 Universal life and investment-type product policy fees1,175 1,109 Net investment income1,593 1,271 Other revenues39 41 Total adjusted revenues6,033 5,030 Adjusted expensesPolicyholder benefits and claims and policyholder dividends3,301 3,143 Interest credited to policyholder account balances335 249 Capitalization of DAC(499)(414)Amortization of DAC and VOBA339 285 Interest expense on debt12 5 Other expenses1,553 1,401 Total adjusted expenses5,041 4,669 Provision for income tax expense (benefit)231 70 Adjusted earnings$761 $291 Adjusted earnings on a constant currency basis$761 $253 Adjusted premiums, fees and other revenues$4,440 $3,759 Adjusted premiums, fees and other revenues on a constant currency basis$4,440 $3,643 Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021Unless otherwise stated, all amounts discussed below are net of income tax.Foreign Currency. Changes in foreign currency exchange rates decreased adjusted earnings by $38 million for 2022 compared to 2021, mainly due to the weakening of foreign currencies against the U.S. dollar, primarily the Chilean peso. Unless otherwise stated, all amounts discussed below are net of foreign currency fluctuations. Foreign currency fluctuations can result in significant variances in the financial statement line items.Business Growth. Latin America experienced premium and fee growth across the region, primarily in Chile and Mexico. The increase in premiums and fees was partially offset by related changes in policyholder benefits. An increase in average invested assets, primarily in Chile and Mexico, generated higher net investment income. The increase in net investment income was partially offset by a corresponding increase in interest credited expenses on certain insurance liabilities. Business growth in the region drove an increase in commissions and other variable expenses, which was partially offset by higher DAC capitalization. The combined impact of the items affecting business growth, partially offset by higher DAC amortization, increased adjusted earnings by $71 million.82Table of ContentsMarket Factors. Market factors, including interest rate levels and variability in equity market returns, continued to impact our results; however, certain impacts were mitigated by derivatives used to hedge these risks. Investment yields increased, driven by higher yields on fixed maturity securities in Chile and Mexico, higher earnings from a joint venture investment in Chile, the favorable impact of an increase in bond index returns on our Chilean encaje within fair value option securities (“FVO Securities”), and higher income on derivatives. These increases were partially offset by lower equity market returns on private equity funds. An increase in interest credited expenses on certain insurance liabilities also decreased adjusted earnings. The changes in market factors discussed above, as well as the net impact of inflation, resulted in a $22 million increase in adjusted earnings.Underwriting, Actuarial Assumption Review and Other Insurance Adjustments. Favorable underwriting drove a $395 million increase in adjusted earnings. This increase includes a decline in COVID-19-related claims, primarily in Mexico and Brazil, as well as a reduction to the incurred but not reported reserve that was established in the prior year. The favorable change from our actuarial assumption reviews resulted in a net increase of $9 million in adjusted earnings. Refinements to certain insurance liabilities and other liabilities in both periods resulted in a $20 million increase in adjusted earnings.Expenses and Taxes. Adjusted earnings decreased $46 million due to higher employee-related costs and the region’s continued investment in technology, partially offset by the impact of continued expense discipline. Tax-related adjustments in both years resulted in a $37 million increase in adjusted earnings, primarily driven by a recurring tax item related to inflation in Chile, as well as a 2022 adjustment related to the filing of the Company’s 2021 U.S. income tax return.83Table of ContentsEMEABusiness Overview. Adjusted premiums, fees and other revenues for 2022 decreased $414 million, or 15%, compared to 2021. Adjusted premiums, fees and other revenues, net of foreign currency fluctuations, decreased $130 million, or 5%, compared to 2021 primarily due to (i) the disposition of MetLife Poland and Greece, (ii) a prior year favorable refinement to an unearned premium reserve in Italy, and (iii) decreases in our corporate solutions and variable life businesses in the Gulf, as well as our pension business in Romania, partially offset by growth in our (i) accident & health business across the region, (ii) corporate solutions business in Egypt, and (iii) credit life business in Turkey and Romania. Years Ended December 31, 20222021 (In millions)Adjusted revenuesPremiums$1,964 $2,271 Universal life and investment-type product policy fees300 395 Net investment income160 215 Other revenues35 47 Total adjusted revenues2,459 2,928 Adjusted expensesPolicyholder benefits and claims and policyholder dividends990 1,241 Interest credited to policyholder account balances71 86 Capitalization of DAC(411)(469)Amortization of DAC and VOBA333 356 Amortization of negative VOBA(5)(7)Interest expense on debt— — Other expenses1,171 1,324 Total adjusted expenses2,149 2,531 Provision for income tax expense (benefit)64 96 Adjusted earnings$246 $301 Adjusted earnings on a constant currency basis$246 $245 Adjusted premiums, fees and other revenues$2,299 $2,713 Adjusted premiums, fees and other revenues on a constant currency basis$2,299 $2,429 Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021Unless otherwise stated, all amounts discussed below are net of income tax.Foreign Currency. Changes in foreign currency exchange rates decreased adjusted earnings by $56 million for 2022 as compared to 2021, primarily driven by the strengthening of the U.S. dollar against the Turkish lira, euro and British pound. Unless otherwise stated, all amounts discussed below are net of foreign currency fluctuations. Foreign currency fluctuations can result in significant variances in the financial statement line items.Business Growth. Growth in our (i) accident & health business across the region, (ii) credit life business in Turkey, (iii) corporate solutions business in Egypt, (iv) ordinary life business in Europe, and (v) other minor increases across the region, partially offset by decreases in our variable life and corporate solutions businesses in the Gulf, as well as our pension business in Romania, resulted in a $6 million increase in adjusted earnings.Market Factors. Market factors, including interest rate levels and variability in equity market returns, resulted in a slight decrease in adjusted earnings. 84Table of ContentsUnderwriting, Actuarial Assumption Review and Other Insurance Adjustments. Adjusted earnings increased $53 million as a result of favorable underwriting experience, primarily due to the impact of the COVID-19 pandemic, which resulted in lower utilization in 2022 and higher claims in 2021. Favorable underwriting experience in our (i) corporate solutions business in Egypt, the U.K. and the Gulf, (ii) variable life business in Lebanon and Czech Republic, and (iii) credit life business in Turkey and Romania were partially offset by unfavorable underwriting experience in our ordinary life business in France. The favorable change from our actuarial assumption reviews resulted in a net increase of $10 million in adjusted earnings. Refinements to certain insurance-related assets and liabilities in both years resulted in a $43 million decrease in adjusted earnings.Expenses and Taxes. Higher expenses resulted in a $24 million decrease in adjusted earnings due to various operating expenses across the region. Taxes increased adjusted earnings by $12 million primarily due to changes in business mix among tax jurisdictions and tax-related adjustments in both years.Other. In addition to the items discussed above, adjusted earnings decreased by $11 million due to the disposition of MetLife Poland and Greece.MetLife HoldingsBusiness Overview. Our MetLife Holdings segment consists of operations relating to products and businesses, previously included in our former retail business, that we no longer actively market in the U.S. For 2023, we anticipate an average decline in adjusted premiums, fees and other revenues of approximately 12% to 14% from expected business run-off. For 2024 and beyond, we expect this decline to be approximately 6% to 8% per year. A significant portion of our adjusted earnings is driven by separate account balances. Most directly, these balances determine asset-based fee income but they also impact DAC amortization and asset-based commissions. Separate account balances are driven by movements in the market, surrenders, deposits, withdrawals, benefit payments, transfers and policy charges. Although we have discontinued selling our long-term care product, we continue to collect premiums and administer the existing block of business, which contributed to asset growth in the segment, and we expect the related reserves to grow as this block matures. Our future policyholder benefit liability for our long-term care business was $14.3 billion and $14.4 billion as of December 31, 2022 and 2021, respectively. Years Ended December 31, 20222021 (In millions)Adjusted revenuesPremiums$3,066 $3,333 Universal life and investment-type product policy fees1,057 1,101 Net investment income4,971 6,450 Other revenues155 257 Total adjusted revenues9,249 11,141 Adjusted expensesPolicyholder benefits and claims and policyholder dividends6,056 6,268 Interest credited to policyholder account balances813 840 Capitalization of DAC(28)(33)Amortization of DAC and VOBA192 257 Interest expense on debt8 5 Other expenses953 992 Total adjusted expenses7,994 8,329 Provision for income tax expense (benefit)247 570 Adjusted earnings$1,008 $2,242 Adjusted premiums, fees and other revenues$4,278 $4,691 85Table of ContentsYear Ended December 31, 2022 Compared with the Year Ended December 31, 2021Unless otherwise stated, all amounts discussed below are net of income tax.Business Growth. A decrease in average invested assets resulted in lower net investment income, decreasing adjusted earnings. In our deferred annuity business, negative net flows resulted in lower asset-based fee income. In addition, premiums declined due to business run-off and the impact of dividend scale reductions in both periods. The combined impact of the items affecting our business growth, partially offset by lower DAC amortization, resulted in a $145 million decrease in adjusted earnings.Market Factors. Market factors, including interest rate levels, variability in equity market returns, and foreign currency fluctuations, continued to impact our results; however, certain impacts were mitigated by derivatives used to hedge these risks. Investment yields decreased driven by the unfavorable impact of lower equity market returns on our private equity and hedge funds, lower prepayment fees and lower yields on our mortgage loans and fixed income securities. The changes in market factors discussed above resulted in a $1.2 billion decrease in adjusted earnings.Underwriting, Actuarial Assumption Review and Other Insurance Adjustments. Less favorable underwriting, mainly in our long-term care business, reflecting a smaller impact from the COVID-19 pandemic in 2022, partially offset by favorable underwriting in our life business, resulted in a $30 million decrease in adjusted earnings. The favorable change from our actuarial assumption reviews resulted in a net increase of $52 million in adjusted earnings. Refinements to certain insurance-related liabilities, which include the unfavorable impact from model refinements, partially offset by a reinsurance settlement, all in 2022, resulted in a $13 million decrease in adjusted earnings. Dividend scale reductions, as well as run-off in the MLIC closed block, contributed to lower dividend expense, net of DAC amortization, and resulted in a $80 million increase in adjusted earnings. Expenses. Adjusted earnings increased by $20 million mainly due to lower corporate-related expenses.Corporate & Other Years Ended December 31, 20222021 (In millions)Adjusted revenuesPremiums$(16)$35 Universal life and investment-type product policy fees2 2 Net investment income216 244 Other revenues396 420 Total adjusted revenues598 701 Adjusted expensesPolicyholder benefits and claims and policyholder dividends(6)34 Capitalization of DAC(8)(11)Amortization of DAC and VOBA9 9 Interest expense on debt909 902 Other expenses709 562 Total adjusted expenses1,613 1,496 Provision for income tax expense (benefit)(356)(591)Adjusted earnings(659)(204)Less: Preferred stock dividends185 195 Adjusted earnings available to common shareholders$(844)$(399)Adjusted premiums, fees and other revenues$382 $457 86Table of ContentsThe table below presents adjusted earnings available to common shareholders by source: Years Ended December 31,20222021(In millions)Business activities$138 $143 Net investment income219 248 Interest expense on debt(943)(944)Corporate initiatives and projects(64)(128)Other(365)(114)Provision for income tax (expense) benefit and other tax-related items356 591 Preferred stock dividends(185)(195)Adjusted earnings available to common shareholders$(844)$(399)Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021Unless otherwise stated, all amounts discussed below are net of income tax.Net Investment Income. Net investment income decreased $23 million, primarily due to the unfavorable impact of lower equity market returns, predominantly on our private equity funds and FVO Securities, as well as lower investment income from our mortgage loans. These decreases were partially offset by higher yields on our fixed income securities. Corporate Initiatives and Projects & Other. Adjusted earnings decreased $147 million, primarily as a result of an increase in corporate-related expenses, the release of a legal reserve in the prior year and higher interest expense on tax positions due to audit settlements in both years, partially offset by lower employee-related costs.Provision for Income Tax (Expense) Benefit and Other Tax-Related Items. An unfavorable change in Corporate & Other’s taxes was primarily due to (i) lower utilization of tax preferenced items, which include non-taxable investment income and tax credits, (ii) IRS audit settlements in both years, and (iii) the non-cash transfer of assets from a wholly-owned U.K. investment subsidiary to its U.S. parent in 2021, partially offset by lower taxes on stock compensation.Preferred Stock Dividends. Adjusted earnings available to common shareholders increased $10 million primarily as a result of the redemption and cancellation of the 5.25% Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series C (the “Series C preferred stock”), in June 2021.87Table of ContentsInvestmentsOverviewWe manage our investment portfolio using disciplined ALM principles, focusing on cash flow and duration to support our current and future liabilities. Our intent is to match the timing and amount of liability cash outflows with invested assets that have cash inflows of comparable timing and amount, while optimizing risk-adjusted investment income and risk-adjusted total return. Our investment portfolio is heavily weighted toward fixed income investments, with the vast majority of our portfolio invested in fixed maturity securities AFS and mortgage loans. These securities and loans have varying maturities and other characteristics which cause them to be generally well suited for matching the cash flow and duration of insurance liabilities.Current Environment As a global insurance company, we continue to be impacted by the changing global financial and economic environment, the fiscal and monetary policy of governments and central banks around the world and other governmental measures. Global inflation, supply chain disruptions, the Russia-Ukraine conflict, and the COVID-19 pandemic continue to impact the global economy and financial markets and has caused volatility in the global equity, credit and real estate markets. See “— Industry Trends — Financial and Economic Environment” for further information regarding conditions in the global financial markets and the economy generally which may affect us. These factors may persist for some time and may continue to impact pricing levels of risk-bearing investments, as well as our business operations, investment portfolio and derivatives. Rising market interest rates have impacted our investment portfolio and derivatives. See “— Results of Operations — Consolidated Results” and “— Results of Operations — Consolidated Results — Adjusted Earnings” for impacts on our derivatives and analysis of the period over period changes in investment portfolio results and “Investments — Fixed Maturity Securities AFS — Evaluation of Fixed Maturity Securities AFS for Credit Loss — Evaluation of Fixed Maturity Securities AFS in an Unrealized Loss Position” in Note 8 of the Notes to the Consolidated Financial Statements for impacts on the net unrealized gain (loss) on our fixed maturity securities AFS.Selected Country InvestmentsWe have a market presence in numerous countries and, therefore, our investment portfolio, which supports our insurance operations and related policyholder liabilities, as well as our global portfolio diversification objectives, is exposed to risks posed by local political and economic conditions. The countries included in the following table have been the most affected by these risks. The table below presents a summary of selected country fixed maturity securities AFS, at estimated fair value, on a “country of risk basis” (e.g. where the issuer primarily conducts business). Selected Country Fixed Maturity Securities AFS at December 31, 2022CountrySovereign (1)FinancialServicesNon-FinancialServicesTotal (2) (Dollars in millions)Italy $16 $60 $582 $658 Peru109 20 175 304 Ukraine (3)57 — 2 59 Turkey36 — 10 46 Russian Federation (3)41 — — 41 Total$259 $80 $769 $1,108 Investment grade %46.1 %95.5 %73.1 %68.4 %__________________(1)Sovereign includes government and agency.(2)The par value, amortized cost net of ACL and estimated fair value, net of purchased and written credit default swaps, of these securities were $1.3 billion, $1.2 billion and $1.0 billion, respectively, at December 31, 2022. The notional value and estimated fair value of the net purchased and written credit default swaps were $71 million and $0, respectively, at December 31, 2022.88Table of Contents(3)As of December 31, 2022, the amortized cost, ACL and amortized cost, net of ACL of our Russian Federation sovereign securities were $120 million, $79 million and $41 million, respectively; and the amortized cost, ACL and amortized cost, net of ACL of our Russian Federation corporate securities were $2 million, $2 million and less than $1 million, respectively. As of December 31, 2022, the amortized cost, ACL and amortized cost, net of ACL of our Ukraine sovereign securities were $88 million, $31 million and $57 million, respectively; and the amortized cost, ACL and amortized cost, net of ACL of our Ukraine corporate securities were $3 million, $1 million and $2 million, respectively.We manage direct and indirect investment exposure in the selected countries through fundamental analysis and we continually monitor and adjust our level of investment exposure. Investment Portfolio ResultsThe reconciliation of net investment income under GAAP to adjusted net investment income is presented below. Years Ended December 31, 20222021 (In millions)Net investment income — GAAP$15,916 $21,395 Investment hedge adjustments976 895 Unit-linked investment income1,298 (952)Other(1)(58)Adjusted net investment income (1)$18,189 $21,280 __________________(1)See “Financial Measures and Segment Accounting Policies” in Note 2 of the Notes to the Consolidated Financial Statements for a discussion of the adjustments made to net investment income under GAAP in calculating adjusted net investment income.The following yield table presentation is consistent with how we measure our investment performance for management purposes, and we believe it enhances understanding of our investment portfolio results. Years Ended December 31, 20222021Asset ClassYield% (1)AmountYield% (1)Amount (Dollars in millions)Fixed maturity securities AFS (2), (3)3.76 %$11,098 3.74 %$11,146 Mortgage loans (3)4.34 3,536 4.19 3,430 Real estate and real estate joint ventures6.40 798 4.81 579 Policy loans5.15 459 5.11 474 Equity securities3.96 36 4.45 36 Other limited partnership interests (4)5.92 860 40.71 4,935 Cash and short-term investments2.31 282 0.80 87 Other invested assets— 1,670 — 1,197 Investment income4.32 %$18,739 5.05 %$21,884 Investment fees and expenses(0.12)(539)(0.12)(537)Net investment income including divested businesses (5)4.20 %$18,200 4.93 %$21,347 Less: net investment income from divested businesses (5)11 67 Adjusted net investment income$18,189 $21,280 __________________89Table of Contents(1)We calculate yields using adjusted net investment income as a percent of average quarterly asset carrying values. Adjusted net investment income excludes realized gains (losses) from sales and disposals and includes the impact of changes in foreign currency exchange rates. Average quarterly asset carrying values exclude unrealized gains (losses), collateral received in connection with our securities lending program, annuities funding structured settlement claims freestanding derivative assets, collateral received from derivative counterparties and contractholder-directed equity securities. In addition, average quarterly asset carrying values include invested assets reclassified to held-for-sale, while ending carrying values exclude invested assets reclassified to held-for-sale. A yield is not presented for other invested assets, as it is not considered a meaningful measure of performance for this asset class.(2)Investment income (loss) from fixed maturity securities AFS includes amounts from FVO Securities of ($127) million and $167 million for the years ended December 31, 2022 and 2021, respectively.(3)Investment income from fixed maturity securities AFS and mortgage loans includes prepayment fees.(4)See “— Results of Operations — Consolidated Results — Adjusted Earnings” for discussion of results for the year ended December 31, 2022 compared to the year ended December 31, 2021.(5)See “Financial Measures and Segment Accounting Policies” in Note 2 of the Notes to the Consolidated Financial Statements for discussion of divested businesses.See “— Results of Operations — Consolidated Results — Adjusted Earnings” for an analysis of the period over period changes in investment portfolio results. Fixed Maturity Securities AFS and Equity SecuritiesThe following table presents public and private fixed maturity securities AFS and equity securities held at:December 31,20222021Securities by TypeEstimated FairValue% ofTotalEstimated FairValue% ofTotal(Dollars in millions)Fixed maturity securities AFSPublicly-traded$211,579 76.4 %$267,040 78.5 %Privately-placed65,201 23.6 73,234 21.5 Total fixed maturity securities AFS$276,780 100.0 %$340,274 100.0 %Percentage of cash and invested assets61.0 %66.1 %Equity securitiesPublicly-traded$1,423 84.5 %$1,118 88.1 %Privately-held261 15.5 151 11.9 Total equity securities$1,684 100.0 %$1,269 100.0 %Percentage of cash and invested assets0.4 %0.2 %See Note 8 of the Notes to the Consolidated Financial Statements for information about fixed maturity securities AFS by sector, contractual maturities, continuous gross unrealized losses and equity securities by security type and the related cost, net unrealized gains (losses) and estimated fair value of these securities; as well as realized gains (losses) on sales and disposals and unrealized net gains (losses) recognized in earnings.Included within fixed maturity securities AFS are structured securities, including residential mortgage-backed securities (“RMBS”), asset-backed securities and collateralized loan obligations (collectively “ABS & CLO”) and commercial mortgage-backed securities (“CMBS”) (collectively, “Structured Products”). See “— Structured Products” for further information.90Table of ContentsValuation of Securities. We are responsible for the determination of the estimated fair value of our investments. We determine the estimated fair value of publicly-traded securities after considering one of three primary sources of information: quoted market prices in active markets, independent pricing services, or independent broker quotations. We determine the estimated fair value of privately-placed securities after considering one of three primary sources of information: market standard internal matrix pricing, market standard internal discounted cash flow techniques, or independent pricing services (after we determine the independent pricing services’ use of available observable market data). For publicly-traded securities, the number of quotations obtained varies by instrument and depends on the liquidity of the particular instrument. Generally, we obtain prices from multiple pricing services to cover all asset classes and obtain multiple prices for certain securities, but ultimately utilize the price with the highest placement in the fair value hierarchy. Independent pricing services that value these instruments use market standard valuation methodologies based on data about market transactions and inputs from multiple pricing sources that are market observable or can be derived principally from or corroborated by observable market data. See Note 10 of the Notes to the Consolidated Financial Statements for a discussion of the types of market standard valuation methodologies utilized and key assumptions and observable inputs used in applying these standard valuation methodologies. When a price is not available in the active market or through an independent pricing service, management values the security primarily using market standard internal matrix pricing or discounted cash flow techniques, and non-binding quotations from independent brokers who are knowledgeable about these securities. Independent non-binding broker quotations utilize inputs that may be difficult to corroborate with observable market data. As shown in the following section, less than 1% of our fixed maturity securities AFS were valued using non-binding quotations from independent brokers at December 31, 2022.Senior management, independent of the trading and investing functions, is responsible for the oversight of control systems and valuation policies for securities, mortgage loans, real estate and derivatives. On a quarterly basis, new transaction types and markets are reviewed and approved to ensure that observable market prices and market-based parameters are used for valuation, wherever possible, and for determining that valuation adjustments, when applied, are based upon established policies and are applied consistently over time. Senior management oversees the selection of independent third-party pricing providers and the controls and procedures to evaluate third-party pricing. We review our valuation methodologies on an ongoing basis and revise those methodologies when necessary based on changing market conditions. Assurance is gained on the overall reasonableness and consistent application of input assumptions, valuation methodologies and compliance with fair value accounting guidance through controls designed to ensure valuations represent an exit price. Several controls are utilized, including certain monthly controls, which include, but are not limited to, analysis of portfolio returns to corresponding benchmark returns, comparing a sample of executed prices of securities sold to the fair value estimates, comparing fair value estimates to management’s knowledge of the current market, reviewing the bid/ask spreads to assess activity, comparing prices from multiple independent pricing services and ongoing due diligence to confirm that independent pricing services use market-based parameters. The process includes a determination of the observability of inputs used in estimated fair values received from independent pricing services or brokers by assessing whether these inputs can be corroborated by observable market data. We ensure that prices received from independent brokers, also referred to herein as “consensus pricing,” are representative of estimated fair value by considering such pricing relative to our knowledge of the current market dynamics and current pricing for similar investments. While independent non-binding broker quotations are utilized, they are not used for a significant portion of the portfolio.On a quarterly basis, we also apply a formal process to challenge any prices received from independent pricing services that are not considered representative of estimated fair value. If prices received from independent pricing services are not considered reflective of market activity or representative of estimated fair value, independent non-binding broker quotations are obtained, or an internally developed valuation is prepared. Internally developed valuations of current estimated fair value, compared with pricing received from the independent pricing services, did not produce material differences in the estimated fair values for the majority of the portfolio; accordingly, overrides were not material. This is, in part, because internal estimates are generally based on available market evidence and estimates used by other market participants. In the absence of such market-based evidence, management’s best estimate is used.We have reviewed the significance and observability of inputs used in the valuation methodologies to determine the appropriate fair value hierarchy level for each of our securities. Based on the results of this review and investment class analysis, each instrument is categorized as Level 1, 2 or 3 based on the lowest level significant input to its valuation. See Note 10 of the Notes to the Consolidated Financial Statements for valuation approaches and key inputs by major category of assets or liabilities that are classified within Level 2 and Level 3 of the fair value hierarchy.91Table of ContentsFair Value of Fixed Maturity Securities AFS and Equity SecuritiesFixed maturity securities AFS and equity securities measured at estimated fair value on a recurring basis and their corresponding fair value pricing sources were as follows: December 31, 2022LevelFixed MaturitySecurities AFSEquitySecurities (Dollars in millions)Level 1Quoted prices in active markets for identical assets$15,959 5.8 %$1,293 76.8 %Level 2Independent pricing sources232,048 83.8 129 7.6 Internal matrix pricing or discounted cash flow techniques— — 3 0.2 Significant other observable inputs$232,048 83.8 %$132 7.8 %Level 3Independent pricing sources21,762 7.9 45 2.7 Internal matrix pricing or discounted cash flow techniques6,639 2.4 214 12.7 Independent broker quotations372 0.1 — — Significant unobservable inputs$28,773 10.4 %$259 15.4 %Total at estimated fair value$276,780 100.0 %$1,684 100.0 %See Note 10 of the Notes to the Consolidated Financial Statements for the fixed maturity securities AFS and equity securities fair value hierarchy; a rollforward of the fair value measurements for securities measured at estimated fair value on a recurring basis using significant unobservable (Level 3) inputs; transfers into and/or out of Level 3; and further information about the valuation approaches and inputs by level by major classes of invested assets that affect the amounts reported above.The majority of the Level 3 fixed maturity securities AFS and equity securities were concentrated in three sectors at December 31, 2022: U.S. corporate securities, foreign corporate securities and ABS & CLO. During the year ended December 31, 2022, Level 3 fixed maturity securities AFS decreased by $2.6 billion, or 8%. The decrease was driven by a decrease in estimated fair value recognized in other comprehensive income (loss), partially offset by transfers into Level 3 in excess of transfers out of Level 3, partially offset by purchases in excess of sales.Fixed Maturity Securities AFS Credit Quality — Ratings The Securities Valuation Office of the NAIC evaluates the fixed maturity securities of insurers for regulatory reporting and capital assessment purposes. The NAIC assigns securities to one of six credit quality categories defined as “NAIC designations.” In general, securities with NAIC designations of 1 and 2 are considered investment grade and securities with NAIC designations of 3 through 6 are considered below investment grade. If no NAIC designation is available, then, as permitted by the NAIC, an internally developed designation is used.NAIC designations for non-agency RMBS and CMBS are based on a modeling methodology that estimates security level expected losses under a variety of economic scenarios. The modeling methodology for non-agency RMBS and CMBS issued prior to January 1, 2013 incorporates the amortized cost of the security (including any purchase discounts and prior impairments) and the likelihood of recovery of the amortized cost; while for non-agency RMBS and CMBS issued after January 1, 2013, the modeling methodology does not incorporate the amortized cost of the security. The NAIC’s objective with the modeling methodology is to increase accuracy in estimating expected losses and recovery value, and to use this credit quality assessment to determine an appropriate RBC charge for non-agency RMBS and CMBS. We utilize these NAIC designations for our non-agency RMBS and CMBS in our disclosures below. The NAIC evaluates non-agency RMBS and CMBS held by insurers on an annual basis. When we acquire non-agency RMBS and CMBS that have not been previously evaluated by the NAIC, an internally developed designation is used until a NAIC designation becomes available.92Table of ContentsIn addition to the six NAIC designations, the NAIC maintains 20 “NAIC designation categories” which is an additional, more granular credit quality categorization. These NAIC designation categories correspond more closely to the NRSRO’s alpha-numeric credit quality ratings. The NAIC maintains unique RBC factors for each of the 20 NAIC designation categories. The NAIC’s goal is to better align RBC charges on securities with the instruments’ actual credit risk.Rating agency ratings are based on availability of applicable ratings from rating agencies on the NAIC credit rating provider list, including Moody’s Investors Service (“Moody’s”), S&P, Fitch Ratings (“Fitch”), DBRS Morningstar, A.M. Best Company (“A.M. Best”), Kroll Bond Rating Agency and Egan Jones Ratings Company. If no rating is available from a rating agency, then an internally developed rating is used.NAIC designations are generally similar to the credit quality ratings of the NRSROs, except for (i) non-agency RMBS and CMBS as described above, and (ii) securities rated Ca or C by NRSROs, included within Caa and lower in our disclosures below, that are designated NAIC 6; accordingly, NAIC designations may not correspond to NRSRO ratings. The following table presents total fixed maturity securities AFS by NRSRO rating, except for non-agency RMBS and CMBS, which are presented using NAIC designations for modeled securities. In addition, in the following table, the applicable NAIC designation from the NAIC published comparison of NRSRO ratings to NAIC designations is provided. December 31, 20222021NRSRORatingNAIC DesignationAmortizedCost net of ACLUnrealizedGains (Losses)EstimatedFairValue% of TotalAmortizedCost net of ACLUnrealizedGains (Losses) (1)EstimatedFairValue% ofTotal (Dollars in millions)Aaa/Aa/A1$209,951 $(19,930)$190,021 68.7 %$217,886 $21,508 $239,394 70.4 %Baa281,280 (8,086)73,194 26.5 77,739 7,470 85,209 25.0 Subtotal investment grade291,231 (28,016)263,215 95.2 295,625 28,978 324,603 95.4 Ba311,223 (712)10,511 3.8 11,439 534 11,973 3.5 B42,786 (215)2,571 0.9 3,152 (2)3,150 0.9 Caa and lower5517 (116)401 0.1 563 (37)526 0.2 In or near default685 (3)82 — 14 8 22 — Subtotal below investment grade14,611 (1,046)13,565 4.8 15,168 503 15,671 4.6 Total fixed maturity securities AFS$305,842 $(29,062)$276,780 100.0 %$310,793 $29,481 $340,274 100.0 %__________________(1)Excludes gross unrealized gains (losses) related to assets held-for-sale. See Note 3 of the Notes to the Consolidated Financial Statements for information on the Company’s business dispositions.93Table of ContentsThe following tables present total fixed maturity securities AFS, at estimated fair value, by sector and by NRSRO rating, except for non-agency RMBS and CMBS, which are presented using NAIC designations for modeled securities. In addition, in the following table, the applicable NAIC designation from the NAIC published comparison of the NRSRO ratings to NAIC designations is provided. Fixed Maturity Securities AFS — by Sector & Credit Quality RatingNRSRO RatingAaa/Aa/ABaaBaBCaa and LowerIn or Near DefaultTotalEstimatedFair ValueNAIC Designation123456 (Dollars in millions)December 31, 2022U.S. corporate$40,293 $33,569 $4,281 $1,659 $209 $19 $80,030 Foreign corporate18,229 30,657 3,121 513 51 1 52,572 Foreign government38,658 5,143 2,582 256 65 43 46,747 U.S. government and agency31,786 443 — — — — 32,229 RMBS25,510 504 59 69 13 10 26,165 ABS & CLO13,848 2,495 370 74 26 9 16,822 Municipals11,932 196 24 — — — 12,152 CMBS9,765 187 74 — 37 — 10,063 Total fixed maturity securities AFS$190,021 $73,194 $10,511 $2,571 $401 $82 $276,780 Percentage of total68.7 %26.5 %3.8 %0.9 %0.1 %— %100.0 %December 31, 2021U.S. corporate$47,377 $39,094$4,523 $1,796 $244 $— $93,034 Foreign corporate23,228 35,8933,731 577 210 1 63,640 Foreign government52,316 5,7393,032 506 14 2 61,609 U.S. government and agency46,065 534— — — — 46,599 RMBS29,529 634150 67 5 19 30,404 ABS & CLO15,920 2,221316 85 27 — 18,569 Municipals13,737 45718 — — — 14,212 CMBS 11,222 637203 119 26 — 12,207 Total fixed maturity securities AFS$239,394 $85,209 $11,973 $3,150 $526 $22 $340,274 Percentage of total70.4 %25.0 %3.5 %0.9 %0.2 %— %100.0 %94Table of ContentsU.S. and Foreign Corporate Fixed Maturity Securities AFSWe maintain a broadly diversified portfolio of corporate fixed maturity securities AFS across many industries and issuers. This portfolio did not have any exposure to any single issuer in excess of 1% of total investments at either December 31, 2022 or 2021. The top 10 holdings comprised 1% and 2% of total investments at December 31, 2022 and 2021, respectively. The table below presents our U.S. and foreign corporate securities portfolios by industry at: December 31, 20222021IndustryEstimated Fair Value% ofTotalEstimated Fair Value% of Total (Dollars in millions)Finance$30,786 23.2 %$35,676 22.8 %Consumer (1)27,834 21.0 33,043 21.1 Utility23,215 17.5 28,961 18.5 Industrial (2)14,276 10.8 16,128 10.3 Transportation11,342 8.5 13,118 8.4 Communications10,046 7.6 12,346 7.9 Energy7,711 5.8 9,184 5.8 Technology4,396 3.3 5,401 3.4 Other2,996 2.3 2,817 1.8 Total$132,602 100 %$156,674 100 %__________________(1)Includes consumer cyclical and consumer non-cyclical.(2)Includes basic industry, capital goods and other industrial.Structured ProductsOur investments in Structured Products are collateralized by residential mortgages, commercial mortgages, bank loans and other assets. Our investment selection criteria and monitoring includes review of credit ratings, characteristics of the assets underlying the securities, borrower characteristics and the level of credit enhancement. We held $53.0 billion and $61.2 billion of Structured Products, at estimated fair value, at December 31, 2022 and 2021, respectively, as presented in the RMBS, ABS & CLO and CMBS sections below.RMBS Our RMBS portfolio is broadly diversified by security type and risk profile.On a security type basis, RMBS includes collateralized mortgage obligations and pass-through mortgage-backed securities. Collateralized mortgage obligations are structured by dividing the cash flows of mortgage loans into separate pools or tranches of risk that create multiple classes of bonds with varying maturities and priority of payments. Pass-through mortgage-backed securities are secured by a mortgage loan or collection of mortgage loans. The monthly mortgage loan payments from homeowners pass from the originating bank through an intermediary, such as a government agency or investment bank, which collects the payments and, for a fee, remits or passes these payments through to the holders of the pass-through securities.On a risk profile basis, RMBS includes Agency and Non-Agency securities. Agency RMBS were guaranteed or otherwise supported by Federal National Mortgage Association, Federal Home Loan Mortgage Corporation or Government National Mortgage Association. Non-Agency securities include prime, prime investor, non-qualified residential mortgage (“NQM”), alternative (“Alt-A”), reperforming and sub-prime mortgage-backed securities. Prime (owner-occupied) and prime investor (non owner-occupied) loans were originated to the most creditworthy borrowers with high quality credit profiles. NQM and Alt-A are classifications of mortgage loans where the risk profile of the borrower is between prime and sub-prime. Sub-prime mortgage lending is the origination of residential mortgage loans to borrowers with weak credit profiles, while reperforming loans were previously delinquent that returned to performing status.The following table presents our RMBS portfolio by security type, risk profile and ratings profile at:95Table of Contents December 31, 20222021 EstimatedFairValue% ofTotalNet Unrealized Gains (Losses) EstimatedFairValue% ofTotalNet Unrealized Gains (Losses) (1) (Dollars in millions)Security typeCollateralized mortgage obligations$15,275 58.4 %$(1,917)$17,646 58.0 %$1,092 Pass-through mortgage-backed securities10,890 41.6 (1,414)12,758 42.0 160 Total RMBS$26,165 100.0 %$(3,331)$30,404 100.0 %$1,252 Risk profileAgency$16,291 62.3 %$(2,183)$19,487 64.1 %$671 Non-AgencyPrime and prime investor3,958 15.1 (687)3,161 10.4 13 NQM and Alt-A1,964 7.5 (126)2,351 7.7 217 Reperforming and sub-prime2,892 11.1 (230)4,288 14.1 352 Other (2)1,060 4.0 (105)1,117 3.7 (1)Subtotal Non-Agency9,874 37.7 %(1,148)10,917 35.9 %581 Total RMBS$26,165 100.0 %$(3,331)$30,404 100.0 %$1,252 Ratings profileRated Aaa and Aa$21,927 83.8 %$24,190 79.6 %Designated NAIC 1$25,514 97.5 %$29,529 97.1 %__________________(1)Excludes gross unrealized gains (losses) related to assets held-for-sale. See Note 3 of the Notes to the Consolidated Financial Statements for information on the Company’s business dispositions.(2)Other Non-Agency RMBS are broadly diversified across several subsectors and issuers, including securities collateralized by the following mortgage loan types: single family rental, early buyout securitization and small business commercial.The majority of our RMBS holdings were rated Aaa and were designated NAIC 1 at December 31, 2022 and 2021. We manage our exposure to reperforming and sub-prime RMBS holdings by focusing primarily on senior tranche securities, stress testing the portfolio with severe loss assumptions and closely monitoring the performance of the portfolio. Our reperforming RMBS are generally newer vintage securities and higher quality at purchase (e.g., NAIC 1 and NAIC 2). Our sub-prime RMBS portfolio consists predominantly of securities that were purchased at significant discounts to par value and discounts to the expected principal recovery value of these securities and are investment grade under NAIC designations (e.g., NAIC 1 and NAIC 2).96Table of ContentsABS & CLOOur non-mortgage loan-backed structured securities are comprised of two broad categories of securitizations: ABS & CLO. These portfolios are broadly diversified by collateral type and issuer. The following table presents our ABS & CLO portfolios by collateral type and ratings profile at: December 31, 20222021EstimatedFairValue% ofTotalNet UnrealizedGains (Losses) EstimatedFairValue% ofTotalNet UnrealizedGains (Losses) (1) (Dollars in millions)ABSCollateral typeVehicle and equipment loans$1,404 8.4 %$(61)$1,864 10.0 %$10 Consumer loans1,212 7.2 (118)1,672 9.0 48 Credit card 1,181 7.0 (17)899 4.8 9 Digital infrastructure1,014 6.0 (112)834 4.5 7 Franchise931 5.5 (113)763 4.1 17 Student loans814 4.9 (91)1,143 6.2 16 Other (2)2,896 17.2 (335)2,953 15.9 22 Total ABS 9,452 56.2 %(847)10,128 54.5 %129 CLO (3)7,370 43.8 %(322)8,441 45.5 %(3) Total ABS & CLO$16,822 100 %$(1,169)$18,569 100.0 %$126 ABS ratings profileRated Aaa and Aa$4,285 45.3 %$5,289 52.2 %Designated NAIC 1$7,211 76.3 %$8,105 80.0 %CLO ratings profileRated Aaa and Aa$5,454 74.0 %$6,749 80.0 %Designated NAIC 1$6,634 90.0 %$7,815 92.6 %ABS & CLO ratings profileRated Aaa and Aa$9,739 57.9 %$12,038 64.8 %Designated NAIC 1$13,845 82.3 %$15,920 85.7 %_________________(1)Excludes gross unrealized gains (losses) related to assets held-for-sale. See Note 3 of the Notes to the Consolidated Financial Statements for information on the Company’s business dispositions.(2)Other ABS are broadly diversified across several subsectors and issuers, including securities with the following collateral types: foreign residential loans, transportation equipment and renewable energy.(3)Includes primarily securities collateralized by broadly syndicated bank loans.97Table of ContentsCMBS Our CMBS portfolio is comprised primarily of conduit and single asset and single borrower securities. Conduit securities are collateralized by many commercial mortgage loans and are broadly diversified by property type, borrower and geography. The following tables present our CMBS portfolio by collateral type and ratings profile at:December 31,20222021Estimated Fair Value % of TotalNet Unrealized Gains (Losses)Estimated Fair Value% of TotalNet Unrealized Gains (Losses) (1)(Dollars in millions)Collateral typeConduit $6,781 67.4 %$(740)$8,282 67.8 %$341 Single asset and single borrower1,971 19.6 (184)2,269 18.6 32 Agency 607 5.9 (99)610 5.0 50 Commercial real estate collateralized loan obligations 418 4.2 (14)653 5.4 2 Other286 2.9 (4)393 3.2 2 Total CMBS $10,063 100.0 %$(1,041)$12,207 100 %$427 Ratings profile Rated Aaa and Aa$8,138 80.9 %$9,614 78.8 %Designated NAIC 1$9,765 97.0 %$11,222 91.9 %__________________(1)Excludes gross unrealized gains (losses) related to assets held-for-sale. See Note 3 of the Notes to the Consolidated Financial Statements for information on the Company’s business dispositions.Evaluation of Fixed Maturity Securities AFS for Credit Loss, Rollforward of Allowance for Credit Loss and Credit Loss on Fixed Maturity Securities AFS Recognized in EarningsSee Note 8 of the Notes to the Consolidated Financial Statements for information about the evaluation of fixed maturity securities AFS for credit loss, rollforward of the ACL, net credit loss provision (release) and impairment (losses), as well as realized gross gains (losses) on sales and disposals of fixed maturity securities AFS at December 31, 2022 and 2021 and for the years ended December 31, 2022, 2021 and 2020.Contractholder-Directed Equity Securities and Fair Value Option SecuritiesThe estimated fair value of these investments, which are primarily comprised of contractholder-directed investments supporting unit-linked variable annuity type liabilities (“Unit-linked investments”), was $9.7 billion and $12.1 billion, or 2.1% and 2.4% of cash and invested assets, at December 31, 2022 and 2021, respectively. See Notes 1, 8 and 10 of the Notes to the Consolidated Financial Statements for a description of this portfolio, investments by asset type, and the related cost or amortized cost, net unrealized gains (losses) and estimated fair value of these securities, the fair value hierarchy, rollforward of the fair value measurements for these investments measured at estimated fair value on a recurring basis using significant unobservable (Level 3) inputs and net realized and net unrealized gains (losses) recognized in net investment income at December 31, 2022 and 2021 and for the years ended December 31, 2022, 2021 and 2020.Securities Lending Transactions, Repurchase Agreements and Third-Party Custodian Administered ProgramsWe participate in securities lending transactions, repurchase agreements and third-party custodian administered programs with unaffiliated financial institutions in the normal course of business for the purpose of enhancing the total return on our investment portfolio. Securities lending transactions and repurchase agreements: We account for these arrangements as secured borrowings and record a liability in the amount of the cash received. We obtain collateral, usually cash, from the borrower, which must be returned to the borrower when the securities are returned to us. Through these arrangements, we were liable for cash collateral under our control of $15.2 billion and $24.4 billion at December 31, 2022 and 2021, respectively, including a portion that may require the immediate return of cash collateral we hold. See Notes 1 and 8 of the Notes to the Consolidated Financial Statements for further information about the secured borrowings accounting and the classification of revenues and expenses.98Table of ContentsThird-party custodian administered programs: The estimated fair value of securities we own which are loaned in connection with these programs was $324 million and $273 million at December 31, 2022 and 2021, respectively. The estimated fair value of the related non-cash collateral on deposit with third-party custodians on our behalf, which is not reflected in our consolidated financial statements and cannot be sold or re-pledged, was $331 million and $282 million at December 31, 2022 and 2021, respectively.Mortgage LoansOur mortgage loans are principally collateralized by commercial, agricultural and residential properties. Mortgage loans carried at amortized cost and the related ACL are summarized as follows at: December 31, 20222021Portfolio SegmentAmortized Cost% ofTotalACL ACL as % ofAmortized CostAmortized Cost% ofTotalACL ACL as % ofAmortized Cost (Dollars in millions)Commercial$52,502 62.3 %$218 0.4 %$50,553 63.3 %$340 0.7 %Agricultural19,306 22.9 119 0.6 %18,111 22.7 88 0.5 %Residential12,482 14.8 190 1.5 %11,196 14.0 206 1.8 %Total$84,290 100.0 %$527 0.6 %$79,860 100.0 %$634 0.8 %The carrying value of all mortgage loans, net of ACL, was 18.5% and 15.4% of cash and invested assets at December 31, 2022 and 2021, respectively.We diversify our mortgage loan portfolio by both geographic region and property type to reduce the risk of concentration. Of our commercial and agricultural mortgage loans carried at amortized cost, 85% are collateralized by properties located in the U.S., with the remaining 15% collateralized by properties located primarily in Mexico, U.K and Australia at December 31, 2022. The carrying values of our commercial and agricultural mortgage loans carried at amortized cost located in California, New York and Texas were 16%, 9% and 7%, respectively, of total commercial and agricultural mortgage loans carried at amortized cost at December 31, 2022. Additionally, we manage risk when originating commercial and agricultural mortgage loans by generally lending up to 75% of the estimated fair value of the underlying real estate collateral.We manage our residential mortgage loans carried at amortized cost in a similar manner to reduce risk of concentration, with 91% collateralized by properties located in the U.S., and the remaining 9% collateralized by properties located primarily in Chile, at December 31, 2022. The carrying values of our residential mortgage loans carried at amortized cost located in California, Florida, and New York were 32%, 10%, and 8%, respectively, of total residential mortgage loans carried at amortized cost at December 31, 2022.99Table of ContentsCommercial Mortgage Loans by Geographic Region and Property Type. Commercial mortgage loans are the largest mortgage loan portfolio segment. The tables below present the diversification across geographic regions and property types of commercial mortgage loans carried at amortized cost at: December 31, 20222021 Amount% ofTotalAmount% ofTotal (Dollars in millions)RegionPacific$9,628 18.3 %$9,676 19.1 %Non-U.S.9,299 17.7 9,969 19.7 Middle Atlantic7,574 14.4 7,537 14.9 South Atlantic6,617 12.6 6,800 13.5 West South Central3,721 7.1 3,492 6.9 New England2,764 5.3 2,748 5.4 Mountain2,284 4.4 1,993 4.0 East North Central1,594 3.0 2,129 4.2 East South Central620 1.2 759 1.5 West North Central597 1.1 663 1.3 Multi-Region and Other7,804 14.9 4,787 9.5 Total amortized cost$52,502 100.0 %$50,553 100.0 %Less: ACL218 340 Carrying value, net of ACL$52,284 $50,213 Property TypeOffice$21,009 40.0 %$22,388 44.3 %Apartment10,575 20.2 9,121 18.0 Retail8,046 15.3 8,548 16.9 Industrial5,607 10.7 5,096 10.1 Hotel3,172 6.0 3,201 6.3 Other4,093 7.8 2,199 4.4 Total amortized cost$52,502 100.0 %$50,553 100.0 %Less: ACL218 340 Carrying value, net of ACL$52,284 $50,213 Our commercial mortgage loan portfolio is well positioned with exposures concentrated in high quality underlying properties located in primary markets typically with institutional investors who are better positioned to manage their assets during periods of market volatility. Our portfolio is comprised primarily of lower risk loans with higher debt-service coverage ratios (“DSCR”) and lower loan-to-value (“LTV”) ratios. See “— Mortgage Loan Credit Quality — Monitoring Process” for further information and Note 8 of the Notes to the Consolidated Financial Statements for a distribution of our commercial mortgage loans by DSCR and LTV ratios.Mortgage Loan Credit Quality — Monitoring Process. We monitor our mortgage loan investments on an ongoing basis, including a review of loans by credit quality indicator and loans that are current, past due, restructured and under foreclosure. See Note 8 of the Notes to the Consolidated Financial Statements for further information regarding mortgage loans by credit quality indicator, past due and nonaccrual mortgage loans.100Table of ContentsWe review our commercial mortgage loans on an ongoing basis. These reviews may include an analysis of the property financial statements and rent roll, lease rollover analysis, property inspections, market analysis, estimated valuations of the underlying collateral, LTV ratios, DSCR and tenant creditworthiness. The monitoring process focuses on higher risk loans, which include those that are classified as restructured, delinquent or in foreclosure, as well as loans with higher LTV ratios and lower DSCR. The monitoring process for agricultural mortgage loans is generally similar, with a focus on higher risk loans, such as loans with higher LTV ratios. Agricultural mortgage loans are reviewed on an ongoing basis which include, but are not limited to, property inspections, market analysis, estimated valuations of the underlying collateral, LTV ratios and borrower creditworthiness, including reviews on a geographic and property-type basis. We review our residential mortgage loans on an ongoing basis, with a focus on higher risk loans, such as nonperforming loans. See Note 8 of the Notes to the Consolidated Financial Statements for information on our evaluation of residential mortgage loans and related ACL methodology.LTV ratios and DSCR are common measures in the assessment of the quality of commercial mortgage loans. LTV ratios are a common measure in the assessment of the quality of agricultural mortgage loans. LTV ratios compare the amount of the loan to the estimated fair value of the underlying collateral. An LTV ratio greater than 100% indicates that the loan amount is greater than the collateral value. An LTV ratio of less than 100% indicates an excess of collateral value over the loan amount. Generally, the higher the LTV ratio, the higher the risk of experiencing a credit loss. The DSCR compares a property’s net operating income to amounts needed to service the principal and interest due under the loan. Generally, the lower the DSCR, the higher the risk of experiencing a credit loss. For our commercial mortgage loans, our average LTV ratio was 57% and 56% at December 31, 2022 and 2021, respectively, and our average DSCR was 2.6x and 2.5x at December 31, 2022 and 2021, respectively. The DSCR and the values utilized in calculating the ratio are updated routinely. In addition, the LTV ratio is routinely updated for all but the lowest risk loans as part of our ongoing review of our commercial mortgage loan portfolio. For our agricultural mortgage loans, our average LTV ratio was 47% and 49% at December 31, 2022 and 2021, respectively. The values utilized in calculating our agricultural mortgage loan LTV ratio are developed in connection with the ongoing review of our agricultural loan portfolio and are routinely updated.Mortgage Loan Allowance for Credit Loss. Our ACL is established for both pools of loans with similar risk characteristics and for mortgage loans with dissimilar risk characteristics, collateral dependent loans and reasonably expected troubled debt restructurings, individually on a loan specific basis. We record an allowance for expected lifetime credit loss in earnings within net investment gains (losses) in an amount that represents the portion of the amortized cost basis of mortgage loans that the Company does not expect to collect, resulting in mortgage loans being presented at the net amount expected to be collected. In determining our ACL, management (i) pools mortgage loans that share similar risk characteristics, (ii) considers expected lifetime credit loss over the contractual term of our mortgage loans, as adjusted for expected prepayments and any extensions, and (iii) considers past events and current and forecasted economic conditions. Actual credit loss realized could be different from the amount of the ACL recorded. These evaluations and assessments are revised as conditions change and new information becomes available, which can cause the ACL to increase or decrease over time as such evaluations are revised. Negative credit migration, including an actual or expected increase in the level of problem loans, will result in an increase in the ACL. Positive credit migration, including an actual or expected decrease in the level of problem loans, will result in a decrease in the ACL. See Notes 1 and 8 of the Notes to the Consolidated Financial Statements for information on how the ACL is established and monitored, and activity in and balances of the ACL.Real Estate and Real Estate Joint VenturesOur real estate investments are comprised of wholly-owned properties, and interests in both real estate joint ventures and real estate funds which invest in a wide variety of properties and property types, including single and multi-property projects, and broadly diversified across multiple property types and geographies. The carrying value of our real estate investments was $13.1 billion and $12.2 billion, or 2.9% and 2.4% of cash and invested assets, at December 31, 2022 and 2021, respectively.Our real estate investments are typically stabilized properties that we intend to hold for the longer-term for portfolio diversification and long-term appreciation. Our real estate investment portfolio had significantly appreciated to a $6.7 billion and $6.8 billion unrealized gain position at December 31, 2022 and 2021, respectively. We continuously monitor and assess our real estate investments for impairment when facts and circumstances indicate that the real estate may be impaired. There were no impairments (losses) recognized on our real estate investments for either the year ended December 31, 2022 or 2021.101Table of ContentsWe diversify our real estate investments by property type, form of equity interest (wholly-owned, joint venture and funds) and geographic region to reduce risk of concentration. See Note 8 of the Notes to the Consolidated Financial Statements for a summary of our real estate investments, by income type, as well as income earned.Property type diversification: Our real estate investments are categorized by property type as follows at: December 31, 20222021Property TypeCarryingValue% ofTotalCarryingValue% ofTotal (Dollars in millions)Office$3,964 30.2 %$4,209 34.5 %Retail1,329 10.1 1,105 9.0 Apartment1,225 9.3 1,343 11.0 Land 901 6.9 1,008 8.3 Hotel 796 6.1 677 5.5 Industrial 356 2.7 421 3.4 Agriculture5 — 18 0.2 Other 6 — 10 0.1 Wholly-owned and real estate joint ventures$8,582 65.3 %$8,791 72.0 %Diversified property types and multi-property1,042 7.9 937 7.6 Real estate funds3,513 26.8 2,488 20.4 Total real estate and real estate joint ventures$13,137 100.0 %$12,216 100.0 %Geographical diversification: Wholly-owned and real estate joint ventures totaled $8.6 billion at December 31, 2022, 66% of which were located in the U.S. and 34% of such properties were located outside the U.S., at December 31, 2022, at carrying value. The portion of these properties located in Japan, Washington, D.C. and Georgia were 31%, 8% and 8%, respectively, at December 31, 2022, at carrying value.Other Limited Partnership InterestsOther limited partnership interests are comprised of investments in private funds, including private equity funds and hedge funds. At December 31, 2022 and 2021, the carrying value of other limited partnership interests was $14.4 billion and $14.6 billion, which included $414 million and $663 million of hedge funds, respectively. Other limited partnership interests were 3.2% and 2.8% of cash and invested assets at December 31, 2022 and 2021, respectively. Cash distributions on these investments are generated from investment gains, operating income from the underlying investments of the funds and liquidation of the underlying investments of the funds.We use the equity method of accounting for most of our private equity funds. We generally recognize our share of a private equity fund’s earnings in net investment income on a three-month lag when the information is reported to us. Accordingly, changes in equity market levels, which can impact the underlying results of these private equity funds, are recognized in earnings within our net investment income on a three-month lag.102Table of ContentsOther Invested AssetsThe following table presents the carrying value of our other invested assets by type at: December 31, 20222021Asset TypeCarrying Value% of TotalCarrying Value% of Total(Dollars in millions)Freestanding derivatives with positive estimated fair values$11,411 56.9 %$10,466 56.1 %Tax credit and renewable energy partnerships1,318 6.6 1,564 8.4 Annuities funding structured settlement claims1,238 6.2 1,251 6.7 Direct financing leases1,195 6.0 1,143 6.1 Operating joint ventures1,099 5.5 901 4.8 Leveraged leases731 3.6 787 4.2 FHLBNY common stock 729 3.6 769 4.1 Funds withheld359 1.8 525 2.8 Other1,958 9.8 1,249 6.8 Total$20,038 100 %$18,655 100 %Percentage of cash and invested assets4.4 %3.6 %See Notes 1, 8 and 9 of the Notes to the Consolidated Financial Statements for information regarding freestanding derivatives with positive estimated fair values, tax credit and renewable energy partnerships, annuities funding structured settlement claims, direct financing and leveraged leases, operating joint ventures, FHLBNY common stock, and funds withheld, as well as gains (losses) on disposals of leveraged leases and renewable energy partnerships.Investment CommitmentsWe enter into the following commitments in the normal course of business for the purpose of enhancing the total return on our investment portfolio: mortgage loan commitments and commitments to fund partnerships, bank credit facilities, bridge loans and private corporate bond investments. See Note 21 of the Notes to the Consolidated Financial Statements for the amount of our unfunded investment commitments at December 31, 2022 and 2021. See “Net Investment Income” and “Net Investment Gains (Losses)” in Note 8 of the Notes to the Consolidated Financial Statements for information on the investment income, investment expense, gains and losses from such investments and the liability for credit loss for unfunded mortgage loan commitments. See also “— Fixed Maturity Securities AFS and Equity Securities,” “— Mortgage Loans,” “— Real Estate and Real Estate Joint Ventures” and “— Other Limited Partnership Interests.” 103Table of ContentsDerivatives OverviewWe are exposed to various risks relating to our ongoing business operations, including interest rate, foreign currency exchange rate, credit and equity market. We use a variety of strategies to manage these risks, including the use of derivatives, such as market standard purchased and written credit default swap contracts. See Note 9 of the Notes to the Consolidated Financial Statements for: •A comprehensive description of the nature of our derivatives, including the strategies for which derivatives are used in managing various risks.•Information about the primary underlying risk exposure, gross notional amount, and estimated fair value of our derivatives by type of hedge designation, excluding embedded derivatives held at December 31, 2022 and 2021.•The statement of operations effects of derivatives in net investments in foreign operations, cash flow, fair value, or nonqualifying hedge relationships for the years ended December 31, 2022, 2021 and 2020.We enter into market standard purchased and written credit default swap contracts. Payout under such contracts is triggered by certain credit events experienced by the referenced entities. For credit default swaps covering North American corporate issuers, credit events typically include bankruptcy and failure to pay on borrowed money. For European corporate issuers, credit events typically also include involuntary restructuring. With respect to credit default contracts on sovereign debt, credit events typically include failure to pay debt obligations, repudiation, moratorium, or involuntary restructuring. In each case, payout on a credit default swap is triggered only after the relevant third party, Credit Derivatives Determinations Committee, determines that a credit event has occurred.We use purchased credit default swaps to mitigate credit risk in our investment portfolio. Generally, we purchase credit protection by entering into credit default swaps referencing the issuers of specific assets we own. In certain cases, basis risk exists between these credit default swaps and the specific assets we own. For example, we may purchase credit protection on a macro basis to reduce exposure to specific industries or other portfolio concentrations. In such instances, the referenced entities and obligations under the credit default swaps may not be identical to the individual obligors or securities in our investment portfolio. In addition, our purchased credit default swaps may have shorter tenors than the underlying investments they are hedging, which gives us more flexibility in managing our credit exposures. We believe that our purchased credit default swaps serve as effective economic hedges of our credit exposure.See “Quantitative and Qualitative Disclosures About Market Risk — Management of Market Risk Exposures — Hedging Activities” for more information about our use of derivatives by major hedge program.Fair Value HierarchySee Note 10 of the Notes to the Consolidated Financial Statements for derivatives measured at estimated fair value on a recurring basis and their corresponding fair value hierarchy.The valuation of Level 3 derivatives involves the use of significant unobservable inputs and generally requires a higher degree of management judgment or estimation than the valuations of Level 1 and Level 2 derivatives. Although Level 3 inputs are unobservable, management believes they are consistent with what other market participants would use when pricing such instruments and are considered appropriate given the circumstances. The use of different inputs or methodologies could have a material effect on the estimated fair value of Level 3 derivatives and could materially affect net income.Derivatives categorized as Level 3 at December 31, 2022 include: interest rate forwards with maturities which extend beyond the observable portion of the yield curve; foreign currency swaps and forwards with certain unobservable inputs, including the unobservable portion of the yield curve; and credit default swaps priced using unobservable credit spreads, or that are priced through independent broker quotations. At December 31, 2022, 1% of the estimated fair value of our derivatives was priced through independent broker quotations.See Note 10 of the Notes to the Consolidated Financial Statements for a rollforward of the fair value measurements for derivatives measured at estimated fair value on a recurring basis using significant unobservable (Level 3) inputs.See “— Summary of Critical Accounting Estimates — Derivatives” for further information on the estimates and assumptions that affect derivatives.104Table of ContentsCredit RiskSee Note 9 of the Notes to the Consolidated Financial Statements for information about how we manage credit risk related to derivatives and for the estimated fair value of our net derivative assets and net derivative liabilities after the application of master netting agreements and collateral.Our policy is not to offset the fair value amounts recognized for derivatives executed with the same counterparty under the same master netting agreement. This policy applies to the recognition of derivatives on the consolidated balance sheets and does not affect our legal right of offset.Credit DerivativesThe following table presents the gross notional amount and estimated fair value of credit default swaps at:December 31,20222021Credit Default SwapsGrossNotionalAmountEstimated Fair ValueGrossNotionalAmountEstimated Fair Value(In millions)Purchased$2,925 $(61)$3,042 $(100)Written11,512 105 8,626 165 Total$14,437 $44 $11,668 $65 The following table presents the gross gains, gross losses and net gains (losses) recognized in net derivative gains (losses) for credit default swaps as follows:Years Ended December 31,20222021Credit Default SwapsGrossGains GrossLosses NetGains(Losses)GrossGains GrossLosses NetGains(Losses)(In millions)Purchased (1)$78 $(3)$75 $18 $(9)$9 Written (1)62 (154)(92)52 (11)41 Total$140 $(157)$(17)$70 $(20)$50 __________________(1)Gains (losses) do not include earned income (expense) on credit default swaps.The unfavorable change in net gains (losses) on written credit default swaps was $133 million for the year ended December 31, 2022 as compared to the year ended December 31, 2021 due to certain credit spreads on certain credit default swaps used as replications widening in the current period and narrowing in the prior period. The favorable change in net gains(losses) on purchased credit default swaps of $66 million for the year ended December 31, 2022 as compared to the year ended December 31, 2021 due to certain credit spreads on certain credit default swaps widening in the current period as compared to narrowing in the prior period.The maximum amount at risk related to our written credit default swaps is equal to the corresponding gross notional amount. In a replication transaction, we pair an asset on our balance sheet with a written credit default swap to synthetically replicate a corporate bond, a core asset holding of life insurance companies. Replications are entered into in accordance with the guidelines approved by state insurance regulators and the NAIC and are an important tool in managing the overall corporate credit risk within the Company. In order to match our long-dated insurance liabilities, we seek to buy long-dated corporate bonds. In some instances, these may not be readily available in the market, or they may be issued by corporations to which we already have significant corporate credit exposure. For example, by purchasing Treasury bonds (or other high quality assets) and associating them with written credit default swaps on the desired corporate credit name, we can replicate the desired bond exposures and meet our ALM needs. In addition, given the shorter tenor of the credit default swaps (generally five-year tenors) versus a long-dated corporate bond, we have more flexibility in managing our credit exposures.105Table of ContentsCollateral for DerivativesWe enter into derivatives to manage various risks relating to our ongoing business operations. We receive non-cash collateral from counterparties for derivatives, which can be sold or re-pledged subject to certain constraints, and which is not reflected on our consolidated balance sheets. The amounts of this non-cash collateral were $1.7 billion and $1.1 billion at estimated fair value, at December 31, 2022 and 2021, respectively. See “— Liquidity and Capital Resources — The Company — Liquidity and Capital Uses — Pledged Collateral” and Note 9 of the Notes to the Consolidated Financial Statements for information regarding the earned income on and the gross notional amount, estimated fair value of assets and liabilities and primary underlying risk exposure of our derivatives. Embedded DerivativesSee Notes 9 and 10 of the Notes to the Consolidated Financial Statements for information about embedded derivatives.See “— Summary of Critical Accounting Estimates — Derivatives” for further information on the estimates and assumptions that affect embedded derivatives.Policyholder Liabilities We establish, and carry as liabilities, actuarially determined amounts that are calculated to meet policy obligations or to provide for future annuity payments. Amounts for actuarial liabilities are computed and reported on the consolidated financial statements in conformity with GAAP. For more details on Policyholder Liabilities, see “ — Summary of Critical Accounting Estimates.”We periodically review our estimates of actuarial liabilities for future benefits and compare them with our actual experience. We revise estimates, to the extent permitted or required under GAAP, if we determine that future expected experience differs from assumptions used in the development of actuarial liabilities. We charge or credit changes in our liabilities to expenses in the period the liabilities are established or re-estimated. If the liabilities originally established for future benefit payments prove inadequate, we must increase them. Such an increase could adversely affect our earnings and have a material adverse effect on our business, results of operations and financial condition. See “Business — Regulation — Insurance Regulation — Policy and Contract Reserve Adequacy Analysis” and “Risk Factors — Business Risks” for further information regarding required analyses of the adequacy of statutory reserves of our insurance operations.The following discussions on future policy benefits and policyholder account balances should be read in conjunction with “— Industry Trends — Impact of Market Interest Rates,” “— Variable Annuity Guarantees” and “— Liquidity and Capital Resources — The Company — Liquidity and Capital Sources — Global Funding Sources — Policyholder Account Balances.” See also Notes 1 and 4 of the Notes to the Consolidated Financial Statements for additional information.Future Policy BenefitsWe establish liabilities for amounts payable under insurance policies. A discussion of future policy benefits by segment (as well as Corporate & Other) follows.U.S.Amounts payable under insurance policies for this segment are comprised of group insurance and annuities. For group insurance, future policyholder benefits are comprised mainly of liabilities for disabled lives under disability waiver of premium policy provisions, liabilities for survivor income benefit insurance, active life policies and premium stabilization and other contingency liabilities held under life insurance contracts. For group annuity contracts, future policyholder benefits are primarily related to payout annuities, including pension risk transfers, structured settlement annuities and institutional income annuities. There is no interest rate crediting flexibility on these liabilities.AsiaFuture policy benefits for this segment are held primarily for traditional life, endowment, annuity and accident & health contracts. They are also held for total return pass-through provisions included in certain universal life and savings products. They include certain liabilities for variable annuity and variable life guarantees of minimum death benefits, and longevity guarantees. Factors impacting these liabilities include sustained periods of lower than expected yields, lower than expected asset reinvestment rates, market volatility, actual lapses resulting in lower than expected income, and actual mortality or morbidity resulting in higher than expected benefit payments.106Table of ContentsLatin AmericaFuture policy benefit liabilities for this segment are held primarily for immediate annuities, traditional life contracts and total return pass-through provisions included in certain universal life and savings products. There is no interest rate crediting flexibility on the immediate annuity and traditional life liabilities. Other factors impacting these liabilities are actual mortality resulting in higher than expected benefit payments and actual lapses resulting in lower than expected income. EMEAFuture policy benefits for this segment include unearned premium reserves for group life and medical and credit insurance contracts. Future policy benefits are also held for traditional life, endowment and annuity contracts with significant mortality risk and accident & health contracts. Factors impacting these liabilities include lower than expected asset reinvestment rates, market volatility, actual lapses resulting in lower than expected income, and actual mortality or morbidity resulting in higher than expected benefit payments.MetLife Holdings Future policy benefits for the life insurance business are comprised mainly of liabilities for traditional life insurance contracts. For the annuities business, future policy benefits are comprised mainly of liabilities for life-contingent income annuities and liabilities for the variable annuity guaranteed minimum benefits that are accounted for as insurance. For the long-term care business, future policyholder benefits are comprised mainly of liabilities for disabled lives under disability waiver of premium policy provisions, and active life policies. In addition, for our other products, future policyholder benefits related to the reinsurance of our former Japan joint venture are comprised of liabilities for the variable annuity guaranteed minimum benefits that are accounted for as insurance.Corporate & OtherFuture policy benefits primarily include liabilities for other reinsurance business. Policyholder Account Balances Policyholder account balances are generally equal to the account value, which includes accrued interest credited, but excludes the impact of any applicable charge that may be incurred upon surrender. A discussion of policyholder account balances by segment follows.U.S.Policyholder account balances in this segment are comprised of funding agreements, retained asset accounts, universal life policies, the fixed account of variable life insurance policies and specialized life insurance products for benefit programs. Group BenefitsPolicyholder account balances in this business are held for retained asset accounts, universal life policies, the fixed account of variable life insurance policies and specialized life insurance products for benefit programs. Policyholder account balances are credited interest at a rate we determine, which is influenced by current market rates. Most of these policyholder account balances have minimum credited rate guarantees.The table below presents the breakdown of account value subject to minimum guaranteed crediting rates for Group Benefits: December 31, 2022Guaranteed Minimum Crediting RateAccountValue Account Value at Guarantee (In millions)Greater than 0% but less than 2%$5,571 $5,393 Equal to or greater than 2% but less than 4%$1,496 $1,453 Equal to or greater than 4%$817 $786 107Table of ContentsRetirement and Income SolutionsPolicyholder account balances in this business are held largely for investment-type products, mainly funding agreements, as well as postretirement benefits and corporate-owned life insurance to fund non-qualified benefit programs for executives. Interest crediting rates vary by type of contract and can be fixed or variable. Variable interest crediting rates are generally tied to an external index, most commonly (1-month or 3-month) LIBOR or Secured Overnight Financing Rate. We guarantee payment of interest and return of principal at the contractual maturity date. The table below presents the breakdown of account value subject to minimum guaranteed crediting rates for RIS: December 31, 2022Guaranteed Minimum Crediting RateAccountValue Account Value at Guarantee (In millions)Greater than 0% but less than 2%$1,295 $— Equal to or greater than 2% but less than 4%$771 $232 Equal to or greater than 4%$4,627 $4,439 AsiaPolicyholder account balances in this segment are held largely for fixed income retirement and savings plans, fixed deferred annuities, interest sensitive whole life products, universal life and, to a lesser degree, liability amounts for Unit-linked investments that do not meet the GAAP definition of separate accounts. Also included are certain liabilities for retirement and savings products sold in certain countries in Asia that generally are sold with minimum credited rate guarantees. Liabilities for guarantees on certain variable annuities in Asia are accounted for as embedded derivatives and recorded at estimated fair value and are also included within policyholder account balances. Most of these policyholder account balances have minimum credited rate guarantees. Liabilities for Unit-linked investments are impacted by changes in the fair value of the associated underlying investments, as the return on assets is generally passed directly to the policyholder.The table below presents the breakdown of account value subject to minimum guaranteed crediting rates for Asia: December 31, 2022Guaranteed Minimum Crediting Rate AccountValue Account Value at Guarantee (In millions)AnnuitiesGreater than 0% but less than 2%$32,646 $1,679 Equal to or greater than 2% but less than 4%$900 $394 Equal to or greater than 4%$1 $1 Life & OtherGreater than 0% but less than 2%$12,122 $11,383 Equal to or greater than 2% but less than 4%$34,725 $21,184 Equal to or greater than 4%$265 $265 Latin AmericaPolicyholder account balances in this segment are held largely for investment-type products, universal life products, deferred annuities and Unit-linked investments that do not meet the GAAP definition of separate accounts. Liabilities for Unit-linked investments are impacted by changes in the fair value of the associated investments, as the return on assets is generally passed directly to the policyholder. Many of the other liabilities have minimum credited rate guarantees.108Table of ContentsEMEAPolicyholder account balances in this segment are held mostly for universal life, deferred annuities, pension products, and Unit-linked investments that do not meet the GAAP definition of separate accounts. They are also held for endowment products without significant mortality risk. Most of these policyholder account balances have minimum credited rate guarantees. Liabilities for Unit-linked investments are impacted by changes in the fair value of the associated investments, as the return on assets is generally passed directly to the policyholder.MetLife Holdings Life policyholder account balances in this segment are held for retained asset accounts, universal life policies, the fixed account of variable life insurance policies, and funding agreements. For annuities, policyholder account balances are held for fixed deferred annuities, the fixed account portion of variable annuities, non-life contingent income annuities, and embedded derivatives related to variable annuity guarantees. Interest is credited to the policyholder’s account at interest rates we determine which are influenced by current market rates, subject to specified minimums. Most of these policyholder account balances have minimum credited rate guarantees. Additionally, for our other products, policyholder account balances are held for variable annuity guarantees assumed from a former operating joint venture in Japan that are accounted for as embedded derivatives.The table below presents the breakdown of account value subject to minimum guaranteed crediting rates for the MetLife Holdings segment: December 31, 2022Guaranteed Minimum Crediting Rate AccountValue AccountValue atGuarantee (In millions)Greater than 0% but less than 2%$1,028 $1,001 Equal to or greater than 2% but less than 4%$16,507 $14,418 Equal to or greater than 4%$7,111 $6,512 Variable Annuity GuaranteesWe issue, directly and through assumed business, certain variable annuity products with guaranteed minimum benefits that provide the policyholder a minimum return based on their initial deposit (i.e., the benefit base) less withdrawals. In some cases, the benefit base may be increased by additional deposits, bonus amounts, accruals or optional market value resets. See Notes 1 and 4 of the Notes to the Consolidated Financial Statements for additional information.Certain guarantees, including portions thereof, have insurance liabilities established that are included in future policy benefits. Guarantees accounted for in this manner include GMDBs, the life-contingent portion of GMWBs, elective GMIB annuitizations, and the life contingent portion of GMIBs that require annuitization when the account balance goes to zero. These liabilities are accrued over the life of the contract in proportion to actual and future expected policy assessments based on the level of guaranteed minimum benefits generated using multiple scenarios of separate account returns. The scenarios are based on best estimate assumptions consistent with those used to amortize DAC. When current estimates of future benefits exceed those previously projected or when current estimates of future assessments are lower than those previously projected, liabilities will increase, resulting in a current period charge to net income. The opposite result occurs when the current estimates of future benefits are lower than those previously projected or when current estimates of future assessments exceed those previously projected. At the end of each reporting period, we update the actual amount of business remaining in-force, which impacts expected future assessments and the projection of estimated future benefits resulting in a current period charge or increase to earnings.109Table of ContentsCertain guarantees, including portions thereof, accounted for as embedded derivatives, are recorded at estimated fair value and included in policyholder account balances. Guarantees accounted for as embedded derivatives include GMABs, the non-life contingent portion of GMWBs and certain non-life contingent portions of GMIBs. The estimated fair values of guarantees accounted for as embedded derivatives are determined based on the present value of projected future benefits minus the present value of projected future fees. The projections of future benefits and future fees require capital market and actuarial assumptions including expectations concerning policyholder behavior. A risk-neutral valuation methodology is used to project the cash flows from the guarantees under multiple capital market scenarios to determine an economic liability. The reported estimated fair value is then determined by taking the present value of these risk-free generated cash flows using a discount rate that incorporates a spread over the risk-free rate to reflect our nonperformance risk and adding a risk margin. For more information on the determination of estimated fair value, see Note 10 of the Notes to the Consolidated Financial Statements.The table below presents the carrying value for guarantees at: Future PolicyBenefitsPolicyholderAccount Balances December 31,December 31, 2022202120222021 (In millions)AsiaGMDB$5 $4 $— $— GMAB— — 11 14 GMWB29 32 56 107 EMEAGMDB2 3 — — GMAB— — 4 6 GMWB12 19 (49)(58)MetLife HoldingsGMDB737 561 — — GMIB828 1,029 407 180 GMAB— — (1)— GMWB207 174 133 173 Total $1,820 $1,822 $561 $422 The carrying amounts for guarantees included in policyholder account balances above include nonperformance risk adjustments of $138 million and $120 million at December 31, 2022 and 2021, respectively. These nonperformance risk adjustments represent the impact of including a credit spread when discounting the underlying risk-neutral cash flows to determine the estimated fair values. The nonperformance risk adjustment does not have an economic impact on us as it cannot be monetized given the nature of these policyholder liabilities. The change in valuation arising from the nonperformance risk adjustment is not hedged.The carrying values of these guarantees can change significantly during periods of sizable and sustained shifts in equity market performance, equity volatility, interest rates or foreign currency exchange rates. Carrying values are also impacted by our assumptions around mortality, separate account returns and policyholder behavior, including lapse rates.As discussed below, we use a combination of product design, hedging strategies, reinsurance, and other risk management actions to mitigate the risks related to these benefits. Within each type of guarantee, there is a range of product offerings reflecting the changing nature of these products over time. Changes in product features and terms are in part driven by customer demand but, more importantly, reflect our risk management practices of continuously evaluating the guaranteed benefits and their associated asset-liability matching. We continue to diversify the concentration of income benefits in our portfolio by focusing on withdrawal benefits, variable annuities without living benefits and index-linked annuities. 110Table of ContentsThe sections below provide further detail by total account value for certain of our most popular guarantees. Total account values include amounts not reported on the consolidated balance sheets from assumed business, Unit-linked investments that do not qualify for presentation as separate account assets, and amounts included in our general account. The total account values and the net amounts at risk include direct and assumed business, but exclude offsets from hedging or ceded reinsurance, if any.GMDBsWe offer a range of GMDBs to our contractholders. The table below presents GMDBs, by benefit type, at December 31, 2022:Total Account Value (1)Asia & EMEAMetLife Holdings (In millions)Return of premium or five to seven year step-up$5,469 $34,655 Annual step-up— 2,299 Roll-up and step-up combination— 3,853 Total$5,469 $40,807 __________________(1)Total account value excludes $517 million for contracts with no GMDBs. The Company’s annuity contracts with guarantees may offer more than one type of guarantee in each contract. Therefore, the amounts listed for GMDBs and for living benefit guarantees are not mutually exclusive.Based on total account value, less than 17% of our GMDBs included enhanced death benefits such as the annual step-up or roll-up and step-up combination products at December 31, 2022.Living Benefit Guarantees The table below presents our living benefit guarantees based on total account values at December 31, 2022: Total Account Value (1)Asia & EMEAMetLife Holdings (In millions)GMIB$— $14,516 GMWB - non-life contingent (2)677 1,417 GMWB - life-contingent2,112 6,085 GMAB1,064 98 Total$3,853 $22,116 __________________(1)Total account value excludes $20.8 billion for contracts with no living benefit guarantees. The Company’s annuity contracts with guarantees may offer more than one type of guarantee in each contract. Therefore, the amounts listed for GMDBs and for living benefit guarantee amounts are not mutually exclusive.(2)The Asia and EMEA segments include the non-life contingent portion of the GMWB total account value of $677 million with a guarantee at annuitization.In terms of total account value, GMIBs are our most significant living benefit guarantee. Our primary risk management strategy for our GMIB products is our derivatives hedging program as discussed below. Additionally, we have engaged in certain reinsurance agreements covering some of our GMIB business. As part of our overall risk management approach for living benefit guarantees, we continually monitor the reinsurance markets for the right opportunity to purchase additional coverage for our GMIB business. We stopped selling GMIBs in February 2016.111Table of ContentsThe table below presents our GMIB associated total account values, by their guaranteed payout basis, at December 31, 2022: Total Account Value (In millions)7-year setback, 2.5% interest rate$4,444 7-year setback, 1.5% interest rate911 10-year setback, 1.5% interest rate2,943 10-year mortality projection, 10-year setback, 1.0% interest rate5,277 10-year mortality projection, 10-year setback, 0.5% interest rate941 $14,516 The annuitization interest rates on GMIBs have been decreased from 2.5% to 0.5% over time, partially in response to the low interest rate environment, in effect at the time the GMIBs were sold, accompanied by an increase in the setback period from seven years to 10 years and the introduction of a 10-year mortality projection.Additionally, 33% of the $14.5 billion of GMIB total account value has been invested in managed volatility funds as of December 31, 2022. These funds seek to manage volatility by adjusting the fund holdings within certain guidelines based on capital market movements. Such activity reduces the overall risk of the underlying funds while maintaining their growth opportunities. These risk mitigation techniques reduce or eliminate the need for us to manage the funds’ volatility through hedging or reinsurance.Our GMIB products typically have a waiting period of 10 years to be eligible for annuitization. As of December 31, 2022, only 49% of our contracts with GMIBs were eligible for annuitization. The remaining contracts are not eligible for annuitization for an average of three years.Once eligible for annuitization, contractholders would be expected to annuitize only if their contracts were in-the-money. We calculate in-the-moneyness with respect to GMIBs consistent with net amount at risk as discussed in Note 4 of the Notes to the Consolidated Financial Statements, by comparing the contractholders’ income benefits based on total account values and current annuity rates versus the guaranteed income benefits. The net amount at risk was $433 million at December 31, 2022, of which $371 million was related to GMIBs. For those contracts with GMIB, the table below presents details of contracts that are in-the-money and out-of-the-money at December 31, 2022:In-the-MoneynessTotal Account Value% of Total (In millions) In-the-money30% or greater$351 3 %20% to less than 30%193 1 %10% to less than 20% 359 3 %0% to less than 10%735 5 %1,638 Out-of-the-money-10% to 0%1,647 11 %-20% to less than -10%3,378 23 %Greater than -20%7,853 54 %12,878 Total GMIBs$14,516 112Table of ContentsDerivatives Hedging Variable Annuity GuaranteesOur risk mitigating hedging strategy uses various OTC and exchange traded derivatives. The table below presents the gross notional amount, estimated fair value and primary underlying risk exposure of the derivatives hedging our variable annuity guarantees: December 31, 20222021Primary Underlying Risk Exposure Gross NotionalEstimated Fair ValueGross NotionalEstimated Fair ValueInstrument TypeAmountAssetsLiabilitiesAmountAssetsLiabilities (In millions)Interest rateInterest rate swaps$7,938 $34 $763 $8,663 $52 $75 Interest rate futures1,110 2 1 1,087 3 — Interest rate options50 5 — 100 1 — Foreign currency exchange rateForeign currency forwards887 26 2 1,149 4 13 Equity marketEquity futures2,508 7 3 3,641 11 5 Equity index options3,621 213 265 4,161 513 362 Equity variance swaps163 4 1 699 17 13 Equity total return swaps2,537 9 112 2,763 11 44 Total$18,814 $300 $1,147 $22,263 $612 $512 The change in estimated fair values of our derivatives is recorded in policyholder benefits and claims if such derivatives are hedging guarantees included in future policy benefits, and in net derivative gains (losses) if such derivatives are hedging guarantees included in policyholder account balances.Our hedging strategy involves the significant use of static longer-term derivative instruments to avoid the need to execute transactions during periods of market disruption or higher volatility. We continually monitor the capital markets for opportunities to adjust our liability coverage, as appropriate. Futures are also used to dynamically adjust the daily coverage levels as markets and liability exposures fluctuate.We remain liable for the guaranteed benefits in the event that reinsurers or derivative counterparties are unable or unwilling to pay. Certain of our reinsurance agreements and all derivative positions are collateralized and derivatives positions are subject to master netting agreements, both of which significantly reduce the exposure to counterparty risk. In addition, we are subject to the risk that hedging and other risk management actions prove ineffective or that unanticipated policyholder behavior or mortality, combined with adverse market events, produces economic losses beyond the scope of the risk management techniques employed.Liquidity and Capital ResourcesOverviewOur business and results of operations are materially affected by conditions in the global financial markets and the economy generally due to our market presence in numerous countries, large investment portfolio and the sensitivity of our insurance liabilities and derivatives to changing market factors. Changing conditions in the global financial markets and the economy may affect our financing costs and market interest for our debt or equity securities. For further information regarding market factors that could affect our ability to meet liquidity and capital needs, see “— Industry Trends” and “— Investments — Current Environment.”Liquidity ManagementBased upon the strength of our franchise, diversification of our businesses, strong financial fundamentals and the substantial funding sources available to us as described herein, we continue to believe we have access to ample liquidity to meet business requirements under current market conditions and reasonably possible stress scenarios. We continuously monitor and adjust our liquidity and capital plans for MetLife, Inc. and its subsidiaries in light of market conditions, as well as changing needs and opportunities.113Table of ContentsShort-term LiquidityWe maintain a substantial short-term liquidity position, which was $16.4 billion and $12.4 billion at December 31, 2022 and 2021, respectively. Short-term liquidity includes cash and cash equivalents and short-term investments, excluding assets that are pledged or otherwise committed, including amounts received in connection with securities lending, repurchase agreements, derivatives, and secured borrowings, as well as amounts held in the closed block. Liquid AssetsAn integral part of our liquidity management includes managing our level of liquid assets, which was $180.4 billion and $223.0 billion at December 31, 2022 and 2021, respectively. Liquid assets include cash and cash equivalents, short-term investments and publicly-traded securities, excluding assets that are pledged or otherwise committed. Assets pledged or otherwise committed include amounts received in connection with securities lending, repurchase agreements, derivatives, regulatory deposits, the collateral financing arrangement, funding agreements and secured borrowings, as well as amounts held in the closed block.Capital ManagementWe have established several senior management committees as part of our capital management process. These committees, including the Capital Management Committee and the Enterprise Risk Committee (“ERC”), regularly review actual and projected capital levels (under a variety of scenarios including stress scenarios) and our annual capital plan in accordance with our capital policy. The Capital Management Committee is comprised of members of senior management, including MetLife, Inc.’s Chief Financial Officer (“CFO”), Treasurer, and Chief Risk Officer (“CRO”). The ERC is also comprised of members of senior management, including MetLife, Inc.’s CFO, CRO and Chief Investment Officer.Our Board of Directors and senior management are directly involved in the development and maintenance of our capital policy. The capital policy sets forth, among other things, minimum and target capital levels and the governance of the capital management process. All capital actions, including proposed changes to the annual capital plan, capital targets or capital policy, are reviewed by the Finance and Risk Committee of the Board of Directors prior to obtaining full Board of Directors approval. The Board of Directors approves the capital policy and the annual capital plan and authorizes capital actions, as required.See “Risk Factors — Capital Risks — We May Not be Able to Pay Dividends or Repurchase Our Stock Due to Legal and Regulatory Restrictions or Cash Buffer Needs” for information regarding restrictions on payment of dividends and stock repurchases. See also Note 16 of the Notes to the Consolidated Financial Statements for information regarding MetLife, Inc.’s common stock repurchase authorizations.114Table of ContentsThe CompanyLiquidityLiquidity refers to the ability to generate adequate amounts of cash to meet our needs. We determine our liquidity needs based on a rolling 12-month forecast by portfolio of invested assets which we monitor daily. We adjust the asset mix and asset maturities based on this rolling 12-month forecast. To support this forecast, we conduct cash flow and stress testing, which include various scenarios of the potential risk of early contractholder and policyholder withdrawal. We include provisions limiting withdrawal rights on many of our products, including general account pension products sold to employee benefit plan sponsors. Certain of these provisions prevent the customer from making withdrawals prior to the maturity date of the product. In the event of significant cash requirements beyond anticipated liquidity needs, we have various alternatives available depending on market conditions and the amount and timing of the liquidity need. These available alternatives include cash flows from operations, sales of liquid assets, global funding sources including commercial paper and various credit and committed facilities.Under certain stressful market and economic conditions, our access to liquidity may deteriorate, or the cost to access liquidity may increase. A downgrade in our credit or financial strength ratings could also negatively affect our liquidity. See “— Rating Agencies.” If we require significant amounts of cash on short notice in excess of anticipated cash requirements or if we are required to post or return cash collateral in connection with derivatives or our securities lending program, we may have difficulty selling investments in a timely manner, be forced to sell them for less than we otherwise would have been able to realize, or both. In addition, in the event of such forced sale, for securities in an unrealized loss position, realized losses would be incurred on securities sold and impairments would be incurred, if there is a need to sell securities prior to recovery, which may negatively impact our financial condition. See “Risk Factors — Investment Risks — We May Have Difficulty Selling Holdings in Our Investment Portfolio or in Our Securities Lending Program in a Timely Manner to Realize Their Full Value.”All general account assets within a particular legal entity — other than those which may have been pledged to a specific purpose — are generally available to fund obligations of the general account of that legal entity.CapitalWe manage our capital position to maintain our financial strength and credit ratings. See “— Rating Agencies” for information regarding such ratings. Our capital position is supported by our ability to generate strong cash flows within our operating companies and borrow funds at competitive rates, as well as by our demonstrated ability to raise additional capital to meet operating and growth needs despite adverse market and economic conditions.Statutory Capital and DividendsOur U.S. insurance subsidiaries have statutory surplus well above levels to meet current regulatory requirements.RBC requirements are used as minimum capital requirements by the NAIC and the state insurance departments to identify companies that merit regulatory action. RBC is based on a formula calculated by applying factors to various asset, premium, claim, expense and statutory reserve items. The formula takes into account the risk characteristics of the insurer, including asset risk, insurance risk, interest rate risk, market risk and business risk and is calculated on an annual basis. The formula is used as an early warning regulatory tool to identify possible inadequately capitalized insurers for purposes of initiating regulatory action, and not as a means to rank insurers generally. These rules apply to most of our U.S. insurance subsidiaries. State insurance laws provide insurance regulators the authority to require various actions by, or take various actions against, insurers whose total adjusted capital does not meet or exceed certain RBC levels. As of the date of the most recent annual statutory financial statements filed with insurance regulators, the total adjusted capital of each of these subsidiaries subject to these requirements was in excess of each of those RBC levels.As a Delaware corporation, American Life is subject to Delaware law; however, because it does not conduct insurance business in Delaware or any other U.S. state, it is exempt from RBC requirements under Delaware law. American Life’s operations are also regulated by applicable authorities of the jurisdictions in which it operates and is subject to capital and solvency requirements in those jurisdictions.115Table of ContentsThe amount of dividends that our insurance subsidiaries can pay to MetLife, Inc. or to other parent entities is constrained by the amount of surplus we hold to maintain our ratings, which provides an additional margin for risk protection and investment in our businesses. We proactively take actions to maintain capital consistent with these ratings objectives, which may include adjusting dividend amounts and deploying financial resources from internal or external sources of capital. Certain of these activities may require regulatory approval. Furthermore, the payment of dividends and other distributions to MetLife, Inc. and other parent entities by their respective insurance subsidiaries is governed by insurance laws and regulations. See “Business — Regulation — Insurance Regulation,” “— MetLife, Inc. — Liquidity and Capital Sources — Dividends from Subsidiaries” and Note 16 of the Notes to the Consolidated Financial Statements.Affiliated Captive Reinsurance TransactionsMLIC cedes specific policy classes, including term and universal life insurance, participating whole life insurance, group life insurance and other business to various wholly-owned captive reinsurers. The reinsurance activities among these affiliated companies are eliminated within our consolidated results of operations. The statutory reserves of such affiliated captive reinsurers are supported by a combination of funds withheld assets, investment assets and letters of credit issued by unaffiliated financial institutions. MetLife, Inc. has entered into various support agreements in connection with the activities of these captive reinsurers. See Note 5 of the Notes to the MetLife, Inc. (Parent Company Only) Condensed Financial Information included in Schedule II of the Financial Statement Schedules for further details on certain of these support arrangements. MLIC has entered into reinsurance agreements with affiliated captive reinsurers for risk and capital management purposes, as well as to manage statutory reserve requirements related to universal life and term life insurance policies and other business. The NYDFS continues to have a moratorium on new reserve financing transactions involving captive insurers. We are not aware of any states other than New York implementing such a moratorium. While such a moratorium would not impact our existing reinsurance agreements with captive reinsurers, a moratorium placed on the use of captives for new reserve financing transactions could impact our ability to write certain products and/or impact our RBC ratios and ability to deploy excess capital in the future. This could result in our need to increase prices, modify product features or limit the availability of those products to our customers. While this affects insurers across the industry, it could adversely impact our competitive position and our results of operations in the future. We continue to evaluate product modifications, pricing structure and alternative means of managing risks, capital and statutory reserves and we expect the discontinued use of captive reinsurance on new reserve financing transactions would not have a material impact on our future consolidated financial results. See Note 6 of the Notes to the Consolidated Financial Statements for further information on our reinsurance activities.Rating AgenciesRating agencies assign insurer financial strength ratings to MetLife, Inc.’s U.S. life insurance subsidiaries and credit ratings to MetLife, Inc. and certain of its subsidiaries. Financial strength ratings represent the opinion of rating agencies regarding the ability of an insurance company to pay obligations under insurance policies and contracts in accordance with their terms and are not evaluations directed toward the protection of investors in MetLife, Inc.’s securities. Insurer financial strength ratings are not statements of fact nor are they recommendations to purchase, hold or sell any security, contract or policy. Each rating should be evaluated independently of any other rating.Rating agencies use an “outlook statement” of “positive,” “stable,” ‘‘negative’’ or “developing” to indicate a medium- or long-term trend in credit fundamentals which, if continued, may lead to a rating change. A rating may have a “stable” outlook to indicate that the rating is not expected to change; however, a “stable” rating does not preclude a rating agency from changing a rating at any time, without notice. Certain rating agencies assign rating modifiers such as “CreditWatch” or “under review” to indicate their opinion regarding the potential direction of a rating. These ratings modifiers are generally assigned in connection with certain events such as potential mergers, acquisitions, dispositions or material changes in a company’s results, in order for the rating agency to perform its analysis to fully determine the rating implications of the event.116Table of ContentsOur insurer financial strength ratings at the date of this filing are indicated in the following table. Outlook is stable unless otherwise indicated. Additional information about financial strength ratings can be found on the websites of the respective rating agencies.A.M. BestFitchMoody’sS&PRatings Structure“A++ (Superior)”to “S (Suspended)”“AAA(ExceptionallyStrong)” to “C(Distressed)”“Aaa (HighestQuality)” to “C(Lowest Rated)”“AAA (ExtremelyStrong)” to “SD(SelectiveDefault)” or “D(Default)”American Life Insurance Company NRNRA1AA-5th of 214th of 21Metropolitan Life Insurance Company A+AA-Aa3AA-2nd of 164th of 194th of 214th of 21MetLife Insurance K.K. (MetLife Japan)NRNRNRAA-4th of 21Metropolitan Tower Life Insurance Company A+AA-Aa3AA-2nd of 164th of 194th of 214th of 21__________________NR = Not ratedCredit ratings indicate the rating agency’s opinion regarding a debt issuer’s ability to meet the terms of debt obligations in a timely manner. They are important factors in our overall funding profile and ability to access certain types of liquidity. The level and composition of regulatory capital at the subsidiary level and our equity capital are among the many factors considered in determining our insurer financial strength ratings and credit ratings. Each agency has its own capital adequacy evaluation methodology, and assessments are generally based on a combination of factors. In addition to heightening the level of scrutiny that they apply to insurance companies, rating agencies have increased and may continue to increase the frequency and scope of their credit reviews, may request additional information from the companies that they rate and may change the capital and other requirements employed in the rating agency models for maintenance of certain ratings levels.A downgrade in the credit ratings or insurer financial strength ratings of MetLife, Inc. or its subsidiaries would likely impact us in the following ways, including:•impact our ability to generate cash flows from the sale of funding agreements and other capital market products offered by our RIS business;•impact the cost and availability of financing for MetLife, Inc. and its subsidiaries; and•result in additional collateral requirements or other required payments under certain agreements, which are eligible to be satisfied in cash or by posting investments held by the subsidiaries subject to the agreements. See “— Liquidity and Capital Uses — Pledged Collateral.”See also “Risk Factors — Economic Environment and Capital Markets Risks — We May Lose Business Due to a Downgrade or a Potential Downgrade in Our Financial Strength or Credit Ratings.”117Table of ContentsSummary of the Company’s Primary Sources and Uses of Liquidity and CapitalOur primary sources and uses of liquidity and capital are summarized as follows:Years Ended December 31,20222021(In millions)Sources:Operating activities, net$13,204 $12,596 Net change in policyholder account balances5,150 3,827 Net change in payables for collateral under securities loaned and other transactions— 1,883 Long-term debt issued1,013 29 Financing element on certain derivative instruments and other derivative related transactions, net— 270 Other, net— 22 Total sources19,367 18,627 Uses:Investing activities, net2,620 11,187 Net change in payables for collateral under securities loaned and other transactions10,730 — Cash paid for other transactions with tenors greater than three months— 100 Long-term debt repaid85 582 Collateral financing arrangement repaid50 79 Financing element on certain derivative instruments and other derivative related transactions, net61 — Treasury stock acquired in connection with share repurchases3,326 4,303 Redemption of preferred stock— 494 Preferred stock redemption premium— 6 Dividends on preferred stock185 195 Dividends on common stock1,598 1,647 Other, net236 — Effect of change in foreign currency exchange rates on cash and cash equivalents397 478 Total uses19,288 19,071 Net increase (decrease) in cash and cash equivalents$79 $(444)Cash Flows from OperationsThe principal cash inflows from our insurance activities come from insurance premiums, net investment income, annuity considerations and deposit funds. The principal cash outflows are the result of various life insurance, annuity and pension products, operating expenses and income tax, as well as interest expense.Cash Flows from InvestmentsThe principal cash inflows from our investment activities come from repayments of principal, proceeds from maturities and sales of investments and settlements of freestanding derivatives. The principal cash outflows relate to purchases of investments, issuances of policy loans and settlements of freestanding derivatives. In addition, cash inflows and outflows relate to sales and purchases of businesses. We typically have a net cash outflow from investing activities because cash inflows from insurance operations are reinvested in accordance with our ALM discipline to fund insurance liabilities. We closely monitor and manage these risks through our comprehensive investment risk management process.Cash Flows from FinancingThe principal cash inflows from our financing activities come from issuances of debt and other securities, deposits of funds associated with policyholder account balances and lending of securities. The principal cash outflows come from repayments of debt and the collateral financing arrangement, payments of dividends on and repurchases or redemptions of MetLife, Inc.’s securities, withdrawals associated with policyholder account balances and the return of securities on loan.118Table of ContentsLiquidity and Capital SourcesIn addition to the general description of liquidity and capital sources in “— Summary of the Company’s Primary Sources and Uses of Liquidity and Capital,” the Company’s primary sources of liquidity and capital are set forth below.Global Funding SourcesLiquidity is provided by a variety of global funding sources, including funding agreements, credit and committed facilities and commercial paper. Capital is provided by a variety of global funding sources, including short-term and long-term debt, the collateral financing arrangement, junior subordinated debt securities, preferred securities, equity securities and equity-linked securities. MetLife, Inc. maintains a shelf registration statement with the SEC that permits the issuance of public debt, equity and hybrid securities. As a “Well-Known Seasoned Issuer” under SEC rules, MetLife, Inc.’s shelf registration statement provides for automatic effectiveness upon filing and has no stated issuance capacity. The diversity of our global funding sources enhances our funding flexibility, limits dependence on any one market or source of funds and generally lowers the cost of funds. Our primary global funding sources include:Preferred StockSee Note 16 of the Notes to the Consolidated Financial Statements.Common StockSee Note 16 of the Notes to the Consolidated Financial Statements.Commercial Paper, Reported in Short-term DebtMetLife, Inc. and MetLife Funding each have a commercial paper program that is supported by our Credit Facility (see “— Credit and Committed Facilities”). MetLife Funding raises cash from its commercial paper program and uses the proceeds to extend loans through MetLife Credit Corp., another subsidiary of MLIC, to affiliates in order to enhance the financial flexibility and liquidity of these companies.Policyholder Account BalancesSee Notes 1 and 4 of the Notes to the Consolidated Financial Statements for a description of the components of policyholder account balances. See “— Liquidity and Capital Uses — Insurance Liabilities” regarding the source and uncertainties associated with the estimation of the contractual obligations related to future policy benefits and policyholder account balances.The sum of the estimated cash flows of $258.3 billion ($30.5 billion of which are estimated to occur in one year or less) exceeds the liability amount of $203.1 billion included on the consolidated balance sheet principally due to (i) the time value of money, which accounts for a substantial portion of the difference; (ii) differences in assumptions, between the date the liabilities were initially established and the current date; and (iii) liabilities related to accounting conventions, or which are not contractually due, which are excluded.The estimated cash flows represent cash payments undiscounted as to interest and including assumptions related to the receipt of future premiums and deposits; withdrawals, including unscheduled or partial withdrawals; policy lapses; surrender charges; annuitization; mortality; future interest credited; policy loans and other contingent events as appropriate for the respective product type. Such estimated cash payments are also presented net of estimated future premiums on policies currently in-force and gross of any reinsurance recoverable. For obligations denominated in foreign currencies, cash payments have been estimated using current spot foreign currency rates.FHLBNY Funding Agreements, Reported in Policyholder Account BalancesCertain of our U.S. insurance subsidiaries are members of FHLBNY. For the years ended December 31, 2022 and 2021, we issued $29.9 billion and $34.0 billion, respectively, and repaid $30.8 billion and $34.5 billion, respectively, of funding agreements with FHLBNY. At December 31, 2022 and 2021, total obligations outstanding under these funding agreements were $14.9 billion and $15.8 billion, respectively. See Note 4 of the Notes to the Consolidated Financial Statements.119Table of ContentsSpecial Purpose Entity Funding Agreements, Reported in Policyholder Account BalancesWe issue fixed and floating rate funding agreements which are denominated in either U.S. dollars or foreign currencies, to certain unconsolidated special purpose entities that have issued either debt securities or commercial paper for which payment of interest and principal is secured by such funding agreements. For the years ended December 31, 2022 and 2021, we issued $48.5 billion and $40.8 billion, respectively, and repaid $47.4 billion and $41.2 billion, respectively, under such funding agreements. At December 31, 2022 and 2021, total obligations outstanding under these funding agreements were $40.7 billion and $39.5 billion, respectively. See Note 4 of the Notes to the Consolidated Financial Statements.Federal Agricultural Mortgage Corporation Funding Agreements, Reported in Policyholder Account BalancesWe have issued funding agreements to a subsidiary of Farmer Mac which are secured by a pledge of certain eligible agricultural mortgage loans. For the years ended December 31, 2022 and 2021, we issued $625 million and $425 million, respectively, and repaid $625 million and $750 million, respectively, under such funding agreements. At both December 31, 2022 and 2021, total obligations outstanding under these funding agreements were $2.1 billion. See Note 4 of the Notes to the Consolidated Financial Statements.Debt IssuancesSee Notes 13 and 22 of the Notes to the Consolidated Financial Statements for information on senior notes issued by MetLife, Inc.Credit and Committed FacilitiesSee Note 13 of the Notes to the Consolidated Financial Statements for information on credit and committed facilities.We have no reason to believe that our lending counterparties will be unable to fulfill their respective contractual obligations under these facilities. As commitments under our credit and committed facilities may expire unused, these amounts do not necessarily reflect our actual future cash funding requirements.Outstanding Debt Under Global Funding SourcesThe following table summarizes our outstanding debt at: December 31, 20222021 (In millions)Short-term debt (1)$175 $341 Long-term debt (2)$14,647 $13,933 Collateral financing arrangement$716 $766 Junior subordinated debt securities$3,158 $3,156 __________________(1)Includes $76 million and $241 million of short-term debt that is non-recourse to MetLife, Inc. and MLIC, subject to customary exceptions, at December 31, 2022 and 2021, respectively. Certain subsidiaries have pledged assets to secure this debt.(2)Includes $447 million and $482 million of long-term debt that is non-recourse to MetLife, Inc. and MLIC, subject to customary exceptions, at December 31, 2022 and 2021, respectively. Certain investment subsidiaries have pledged assets to secure this debt.Debt and Facility CovenantsCertain of our debt instruments and committed facilities, as well as our Credit Facility, contain various administrative, reporting, legal and financial covenants. We believe we were in compliance with all applicable financial covenants at December 31, 2022.DispositionsSee “— Acquisitions and Dispositions” and Note 3 of the Notes to the Consolidated Financial Statements for information on the Company’s business dispositions.120Table of ContentsLiquidity and Capital UsesIn addition to the general description of liquidity and capital uses in “— Summary of the Company’s Primary Sources and Uses of Liquidity and Capital” the Company’s primary uses of liquidity and capital are set forth below.Preferred Stock RedemptionSee Note 16 of the Notes to the Consolidated Financial Statements for information on the redemption of Series C preferred stock.Common Stock RepurchasesSee Note 16 of the Notes to the Consolidated Financial Statements for information relating to authorizations by the Board of Directors to repurchase MetLife, Inc. common stock, amounts of common stock repurchased pursuant to such authorizations for the years ended December 31, 2022 and 2021, and the amount remaining under such authorizations at December 31, 2022. Common stock repurchases are subject to the discretion of our Board of Directors and will depend upon our capital position, liquidity, financial strength and credit ratings, general market conditions, the market price of MetLife, Inc.’s common stock compared to management’s assessment of the stock’s underlying value, applicable regulatory approvals, and other legal and accounting factors. Restrictions on the payment of dividends that may arise under so-called “Dividend Stopper” provisions would also restrict MetLife, Inc.’s ability to repurchase common stock. See “— Dividends” for information on these restrictions. See also “Risk Factors — Capital Risks — We May Not be Able to Pay Dividends or Repurchase Our Stock Due to Legal and Regulatory Restrictions or Cash Buffer Needs.”DividendsFor the years ended December 31, 2022 and 2021, MetLife, Inc. paid dividends on its preferred stock of $185 million and $195 million, respectively. For both the years ended December 31, 2022 and 2021, MetLife, Inc. paid dividends on its common stock of $1.6 billion. The declaration and payment of common stock dividends are subject to the discretion of our Board of Directors, and will depend on MetLife, Inc.’s financial condition, results of operations, cash requirements, future prospects, regulatory restrictions on the payment of dividends by MetLife, Inc.’s insurance subsidiaries and other factors deemed relevant by the Board. See Note 16 of the Notes to the Consolidated Financial Statements for additional information, including the calculation and timing of these dividend payments.“Dividend Stopper” Provisions in MetLife’s Preferred Stock and Junior Subordinated DebenturesMetLife, Inc.’s preferred stock and junior subordinated debentures contain “dividend stopper” provisions under which MetLife, Inc. may not pay dividends on instruments junior to those instruments if payments have not been made on those instruments. Moreover, MetLife, Inc.’s Series A preferred stock and its junior subordinated debentures contain provisions that would limit the payment of dividends or interest on those instruments if MetLife, Inc. fails to meet certain tests (“Trigger Events”), to an amount not greater than the net proceeds from sales of common stock and other specified instruments during a period preceding the dividend declaration date or the interest payment date, as applicable. If such proceeds were under the circumstances insufficient to make such payments on those instruments, the dividend stopper provisions affecting common stock (and preferred stock, as applicable) would come into effect.A “Trigger Event” would occur if:•the RBC ratio of MetLife’s largest U.S. insurance subsidiaries in the aggregate (as defined in the applicable instrument) were to be less than 175% of the company action level based on the subsidiaries’ prior year annual financial statements filed (generally around March 1) with state insurance commissioners; or•at the end of a quarter (“Final Quarter End Test Date”), consolidated GAAP net income for the four-quarter period ending two quarters before such quarter-end (the “Preliminary Quarter End Test Date”) is zero or a negative amount and the consolidated GAAP stockholders’ equity, minus AOCI, (the “adjusted stockholders’ equity amount”), as of the Final Quarter End Test Date and the Preliminary Quarter End Test Date, declined by 10% or more from its level 10 quarters before the Final Quarter End Test Date (the “Benchmark Quarter End Test Date”). 121Table of ContentsOnce a Trigger Event occurs for a Final Quarter End Test Date, the suspension of payments of dividends and interest (in the absence of sufficient net proceeds from the issuance of certain securities during specified periods) would continue until there is no Trigger Event at a subsequent Final Quarter End Test Date, and, if the test in the second paragraph above caused the Trigger Event, the adjusted stockholders’ equity amount is no longer 10% or more below its level at the Benchmark Quarter End Test Date that is associated with the Trigger Event. In the case of successive Trigger Events, the suspension would continue until MetLife satisfies these conditions for each of the Trigger Events.The junior subordinated debentures further provide that MetLife, Inc. may, at its option and provided that certain conditions are met, elect to defer payment of interest. See Note 15 of the Notes to the Consolidated Financial Statements. Any such elective deferral would trigger the dividend stopper provisions.Further, MetLife, Inc. is a party to certain replacement capital covenants which limit its ability to eliminate these restrictions through the repayment, redemption or purchase of the junior subordinated debentures by requiring MetLife, Inc., with some limitations, to receive cash proceeds during a specified period from the sale of specified replacement securities prior to any repayment, redemption or purchase. See Note 15 of the Notes to the Consolidated Financial Statements for a description of such covenants.Debt RepaymentsFor the years ended December 31, 2022 and 2021, following regulatory approval, MetLife Reinsurance Company of Charleston, a wholly-owned subsidiary of MetLife, Inc., repurchased and canceled $50 million and $79 million, respectively, in aggregate principal amount of its surplus notes, which were reported in collateral financing arrangement on the consolidated balance sheets. See Notes 13 and 14 of the Notes to the Consolidated Financial Statements for further information on long-term and short-term debt and the collateral financing arrangement, respectively.Debt Repurchases, Redemptions and ExchangesWe may from time to time seek to retire or purchase our outstanding debt through cash purchases, redemptions and/or exchanges for other securities, in open market purchases, privately negotiated transactions or otherwise. Any such repurchases, redemptions, or exchanges will be dependent upon several factors, including our liquidity requirements, contractual restrictions, general market conditions, and applicable regulatory, legal and accounting factors. Whether or not to repurchase or redeem any debt and the size and timing of any such repurchases or redemptions will be determined at our discretion.See Notes 13 and 22 of the Notes to the Consolidated Financial Statements for information on the redemption and cancellation of senior notes. Support AgreementsMetLife, Inc. and several of its subsidiaries (each, an “Obligor”) are parties to various capital support commitments and guarantees with subsidiaries. Under these arrangements, each Obligor has agreed to cause the applicable entity to meet specified capital and surplus levels or has guaranteed certain contractual obligations. We anticipate that in the event these arrangements place demands upon us, there will be sufficient liquidity and capital to enable us to meet such demands. See Note 5 of the Notes to the MetLife, Inc. (Parent Company Only) Condensed Financial Information included in Schedule II of the Financial Statement Schedules. See also “Guarantees” in Note 21 of the Notes to the Consolidated Financial Statements.Insurance LiabilitiesInsurance liabilities include future policy benefits, other policy-related balances, policyholder dividends payable and the policyholder dividend obligation, which are all reported on the consolidated balance sheet and are more fully described in Notes 1 and 4 of the Notes to the Consolidated Financial Statements. The sum of the estimated cash flows of $360.8 billion ($21.2 billion of which are estimated to occur in one year or less) exceeds the liability amounts of $224.3 billion included on the consolidated balance sheet principally due to (i) the time value of money, which accounts for a substantial portion of the difference; (ii) differences in assumptions, most significantly mortality, between the date the liabilities were initially established and the current date; and (iii) liabilities related to accounting conventions, or which are not contractually due, which are excluded.122Table of ContentsThe estimated cash flows reflect future estimated cash payments and (i) are based on mortality, morbidity, lapse and other assumptions comparable with our experience and expectations of future payment patterns; and (ii) consider future premium receipts on current policies in-force. Estimated cash payments are undiscounted as to interest, net of estimated future premiums on in-force policies and gross of any reinsurance recoverable. Payment of amounts related to policyholder dividends left on deposit are projected based on assumptions of policyholder withdrawal activity.Actual cash payments may differ significantly from the liabilities as presented on the consolidated balance sheet and the estimated cash payments due to differences between actual experience and the assumptions used in the establishment of these liabilities and the estimation of these cash payments.For the majority of our insurance operations, estimated contractual obligations for future policy benefits and policyholder account balances are derived from the annual asset adequacy analysis used to develop actuarial opinions of statutory reserve adequacy for state regulatory purposes. These cash flows are materially representative of the cash flows under GAAP. See “— Liquidity and Capital Sources — Global Funding Sources — Policyholder Account Balances.”Liabilities arising from our insurance activities primarily relate to benefit payments under various life insurance, annuity and group pension products, as well as payments for policy surrenders, withdrawals and loans. For annuity or deposit type products, surrender or lapse behavior differs somewhat by segment. In the MetLife Holdings segment, which includes individual annuities, lapses and surrenders tend to occur in the normal course of business. For the years ended December 31, 2022 and 2021, general account surrenders and withdrawals from annuity products were $1.5 billion and $1.4 billion, respectively. In the RIS business within the U.S. segment, which includes pension risk transfers, bank-owned life insurance and other fixed annuity contracts, as well as funding agreements and other capital market products, most of the products offered have fixed maturities or fairly predictable surrenders or withdrawals. With regard to the RIS business products that provide customers with limited rights to accelerate payments, at December 31, 2022, there were funding agreements totaling $127 million that could be put back to the Company.Pledged CollateralWe pledge collateral to, and have collateral pledged to us by, counterparties in connection with our derivatives. At December 31, 2022 and 2021, we had received pledged cash collateral from counterparties of $5.7 billion and $7.5 billion, respectively. At December 31, 2022 and 2021, we had pledged cash collateral to counterparties of $423 million and $142 million, respectively. See Note 9 of the Notes to the Consolidated Financial Statements for additional information about collateral pledged to us, collateral we pledge and derivatives subject to credit contingent provisions. We pledge collateral and have had collateral pledged to us, and may be required from time to time to pledge additional collateral or be entitled to have additional collateral pledged to us, in connection with the collateral financing arrangement related to the reinsurance of closed block liabilities. See Note 14 of the Notes to the Consolidated Financial Statements.We pledge collateral from time to time in connection with funding agreements and advance agreements. See Note 4 of the Notes to the Consolidated Financial Statements.Securities Lending Transactions, Repurchase Agreements and Third-Party Custodian Administered ProgramsSee “— Investments — Securities Lending Transactions, Repurchase Agreements and Third-Party Custodian Administered Programs.” LitigationWe establish liabilities for litigation and regulatory loss contingencies when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. For material matters where a loss is believed to be reasonably possible but not probable, no accrual is made but we disclose the nature of the contingency and an aggregate estimate of the reasonably possible range of loss in excess of amounts accrued, when such an estimate can be made. It is not possible to predict the ultimate outcome of all pending investigations and legal proceedings. In some of the matters referred to herein, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Given the large and/or indeterminate amounts sought in certain of these matters and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on our consolidated net income or cash flows in particular quarterly or annual periods. See Note 21 of the Notes to the Consolidated Financial Statements.123Table of ContentsAcquisitionsSee “— Acquisitions and Dispositions” and Note 3 of the Notes to the Consolidated Financial Statements for information on the Company’s business acquisitions.MetLife, Inc.Liquidity and Capital ManagementLiquidity and capital are managed to preserve stable, reliable and cost-effective sources of cash to meet all current and future financial obligations and are provided by a variety of sources, including a portfolio of liquid assets, a diversified mix of short- and long-term funding sources from the wholesale financial markets and the ability to borrow through credit and committed facilities. Liquidity is monitored through the use of internal liquidity risk metrics, including the composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, access to the financial markets for capital and debt transactions and exposure to contingent draws on MetLife, Inc.’s liquidity. MetLife, Inc. is an active participant in the global financial markets through which it obtains a significant amount of funding. These markets, which serve as cost-effective sources of funds, are critical components of MetLife, Inc.’s liquidity and capital management. Decisions to access these markets are based upon relative costs, prospective views of balance sheet growth and a targeted liquidity profile and capital structure. A disruption in the financial markets could limit MetLife, Inc.’s access to liquidity.MetLife, Inc.’s ability to maintain regular access to competitively priced wholesale funds is fostered by its current credit ratings from the major credit rating agencies. We view our capital ratios, credit quality, stable and diverse earnings streams, diversity of liquidity sources and our liquidity monitoring procedures as critical to retaining such credit ratings. See “— The Company — Rating Agencies.”LiquidityFor a summary of MetLife, Inc.’s liquidity, see “— The Company — Liquidity.”CapitalFor a summary of MetLife, Inc.’s capital, see “— The Company — Capital.” See also “— The Company — Liquidity and Capital Uses — Common Stock Repurchases” for information regarding MetLife, Inc.’s common stock repurchases.Liquid AssetsAt both December 31, 2022 and 2021, MetLife holding companies had $5.4 billion in liquid assets. Of these amounts, $4.5 billion and $4.2 billion were held by MetLife, Inc. and $909 million and $1.2 billion were held by other MetLife holding companies at December 31, 2022 and 2021, respectively. Liquid assets include cash and cash equivalents, short-term investments and publicly-traded securities, excluding assets that are pledged or otherwise committed. Assets pledged or otherwise committed include amounts received in connection with derivatives and a collateral financing arrangement.Liquid assets held in non-U.S. holding companies are generated in part through dividends from non-U.S. insurance operations. Such dividends are subject to local insurance regulatory requirements, as discussed in “— Liquidity and Capital Sources — Dividends from Subsidiaries.”See “— Executive Summary — Consolidated Company Outlook,” for the targeted level of liquid assets at the holding companies.124Table of ContentsMetLife, Inc. and Other MetLife Holding Companies Sources and Uses of Liquid Assets and Sources and Uses of Liquid Assets included in Free Cash FlowMetLife, Inc.’s sources and uses of liquid assets, as well as sources and uses of liquid assets included in free cash flow are summarized as follows. Year Ended December 31, 2022Year Ended December 31, 2021Sources and Uses of Liquid AssetsSources and Uses of Liquid Assets Included in Free Cash FlowSources and Uses of Liquid AssetsSources and Uses of Liquid Assets Included in Free Cash Flow(In millions)MetLife, Inc. (Parent Company Only)Sources:Dividends and returns of capital from subsidiaries (1)$5,176 $5,176 $4,837 $4,837 Long-term debt issued (2)1,000 1,000 — — Other, net (3), (4)92 44 3,865 (156)Total sources6,268 6,220 8,702 4,681 Uses:Capital contributions to subsidiaries5 5 88 88 Long-term debt repaid — unaffiliated— — 500 — Interest paid on debt and financing arrangements — unaffiliated764 764 795 795 Dividends on common stock1,598 — 1,647 — Treasury stock acquired in connection with share repurchases3,326 — 4,303 — Dividends on preferred stock185 185 195 195 Issuances of and (repayments on) loans to subsidiaries and related interest, net (5) 94 94 92 92 Redemption of preferred stock and preferred stock redemption premium— — 500 — Total uses5,972 1,048 8,120 1,170 Net increase (decrease) in liquid assets, MetLife, Inc. (Parent Company Only)296 582 Liquid assets, beginning of year4,177 3,595 Liquid assets, end of year$4,473 $4,177 Free Cash Flow, MetLife, Inc. (Parent Company Only) 5,172 3,511 Net cash provided by operating activities, MetLife, Inc. (Parent Company Only) $4,428 $3,757 Other MetLife Holding CompaniesSources:Dividends and returns of capital from subsidiaries$1,410 $1,410 $2,077 $2,077 Total sources1,410 1,410 2,077 2,077 Uses:Capital contributions to subsidiaries87 87 24 24 Repayments on and (issuance of) loans to subsidiaries and affiliates and related interest, net5 5 9 9 Dividends and returns of capital to MetLife, Inc.1,434 1,434 1,300 1,300 Other, net 212 390 379 420 Total uses1,738 1,916 1,712 1,753 Net increase (decrease) in liquid assets, Other MetLife Holding Companies(328)365 Liquid assets, beginning of year1,238 873 Liquid assets, end of year$910 $1,238 Free Cash Flow, Other MetLife Holding Companies (506)324 Net increase (decrease) in liquid assets, All Holding Companies$(32)$947 Free Cash Flow, All Holding Companies (6)$4,666 $3,835 __________________(1)Dividends and returns of capital to MetLife, Inc. included $3.8 billion and $3.5 billion from operating subsidiaries and $1.4 billion and $1.3 billion from other MetLife holding companies for the years ended December 31, 2022 and 2021, respectively.125Table of Contents(2)Included in free cash flow is the portion of long-term debt issued that represents incremental debt to be at or below target leverage ratios.(3)Other, net includes $129 million and ($18) million of net receipts (payments) by MetLife, Inc. to and from subsidiaries under a tax sharing agreement and tax payments to tax agencies for the years ended December 31, 2022 and 2021, respectively.(4)Also, included in other, net is $0 and $3.9 billion from sales of businesses for the years ended December 31, 2022 and 2021, respectively. (5)See MetLife, Inc. (Parent Company Only) Condensed Statements of Cash Flows included in Schedule II of the Financial Statement Schedules for information regarding the source of liquid assets from receipts on loans to subsidiaries (excluding interest) and the use of liquid assets related to the issuances of loans to subsidiaries (excluding interest).(6)See “— Non-GAAP and Other Financial Disclosures” for the reconciliation of net cash provided by operating activities of MetLife, Inc. to free cash flow of all holding companies.Sources and Uses of Liquid Assets of MetLife, Inc.The primary sources of MetLife, Inc.’s liquid assets are dividends and returns of capital from subsidiaries, issuances of long-term debt, issuances of common and preferred stock, and net receipts from subsidiaries under a tax sharing agreement. MetLife, Inc.’s insurance subsidiaries are subject to regulatory restrictions on the payment of dividends imposed by the regulators of their respective domiciles. See “— Liquidity and Capital Sources — Dividends from Subsidiaries.”The primary uses of MetLife, Inc.’s liquid assets are principal and interest payments on long-term debt, dividends on and repurchases of common and preferred stock, capital contributions to subsidiaries, funding of business acquisitions, income taxes and operating expenses. MetLife, Inc. is party to various capital support commitments and guarantees with certain of its subsidiaries. See “— Liquidity and Capital Uses — Support Agreements.”In addition, MetLife, Inc. issues loans to subsidiaries or subsidiaries issue loans to MetLife, Inc. Accordingly, changes in MetLife, Inc. liquid assets include issuances of loans to subsidiaries, proceeds of loans from subsidiaries and the related repayment of principal and payment of interest on such loans. See “— Liquidity and Capital Sources — Affiliated Long-term Debt” and “— Liquidity and Capital Uses — Affiliated Capital and Debt Transactions.”Sources and Uses of Liquid Assets of Other MetLife Holding CompaniesThe primary sources of liquid assets of other MetLife holding companies are dividends, returns of capital and remittances from their subsidiaries and branches, principally non-U.S. insurance companies; capital contributions received; receipts of principal and interest on loans to subsidiaries and affiliates and borrowings from subsidiaries and affiliates. MetLife, Inc.’s non-U.S. operations are subject to regulatory restrictions on the payment of dividends imposed by local regulators. See “— Liquidity and Capital Sources — Dividends from Subsidiaries.” The primary uses of liquid assets of other MetLife holding companies are capital contributions paid to their subsidiaries and branches, principally non-U.S. insurance companies; loans to subsidiaries and affiliates; principal and interest paid on loans from subsidiaries and affiliates; dividends and returns of capital to MetLife, Inc. and the following items, which are reported within other, net: business acquisitions; and operating expenses. Liquidity and Capital SourcesIn addition to the description of liquidity and capital sources in “— The Company — Summary of the Company’s Primary Sources and Uses of Liquidity and Capital” and “— The Company — Liquidity and Capital Sources,” MetLife, Inc.’s primary sources of liquidity and capital are set forth below.126Table of ContentsDividends from SubsidiariesMetLife, Inc. relies, in part, on dividends from its subsidiaries to meet its cash requirements. MetLife, Inc.’s insurance subsidiaries are subject to regulatory restrictions on the payment of dividends imposed by the regulators of their respective domiciles. See Note 16 of the Notes to the Consolidated Financial Statements. The dividend limitation for U.S. insurance subsidiaries is generally based on the surplus to policyholders at the end of the immediately preceding calendar year and statutory net gain from operations for the immediately preceding calendar year. Statutory accounting practices, as prescribed by insurance regulators of various states in which we conduct business, differ in certain respects from accounting principles used in financial statements prepared in conformity with GAAP. The significant differences relate to the treatment of DAC, certain deferred income tax, required investment liabilities, statutory reserve calculation assumptions, goodwill and surplus notes.The table below sets forth the dividends permitted to be paid by MetLife, Inc.’s primary U.S. insurance subsidiaries without insurance regulatory approval and the actual dividends paid: 202320222021CompanyPermitted Without Approval (1)Paid (2)Permitted Without Approval (1)Paid (2)Permitted Without Approval (1) (In millions)Metropolitan Life Insurance Company$2,471 $3,539 $3,539 $3,393 $3,393 American Life Insurance Company$499 $1,289 $554 $1,135 $800 Metropolitan Property and Casualty Insurance Company N/AN/AN/A$35 (3)$222 Metropolitan Tower Life Insurance Company$189 $— $163 $— $82 __________________(1)Reflects dividend amounts that may be paid during the relevant year without prior regulatory approval. However, because dividend tests may be based on dividends previously paid over rolling 12-month periods, if paid before a specified date during such year, some or all of such dividends may require regulatory approval. (2)Reflects all amounts paid, including those where regulatory approval was obtained as required.(3)Consists of the stock of a subsidiary paid to MetLife, Inc. See Note 3 of the Notes to the Consolidated Financial Statements for information on the Company’s business dispositions.In addition to the amounts presented in the table above, for the years ended December 31, 2022 and 2021, MetLife, Inc. also received from certain other subsidiaries cash dividends of $340 million and $302 million, respectively, as well as cash returns of capital of $8 million and $13 million, respectively.The dividend capacity of our non-U.S. operations is subject to similar restrictions established by the local regulators. The non-U.S. regulatory regimes also commonly limit dividend payments to the parent company to a portion of the subsidiary’s prior year statutory income, as determined by the local accounting principles. The regulators of our non-U.S. operations, including the FSA, may also limit or not permit profit repatriations or other transfers of funds to the U.S. if such transfers are deemed to be detrimental to the solvency or financial strength of the non-U.S. operations, or for other reasons. Most of our non-U.S. subsidiaries are second tier subsidiaries which are owned by various non-U.S. holding companies. The capital and rating considerations applicable to our first tier subsidiaries may also impact the dividend flow into MetLife, Inc.We proactively manage target and excess capital levels and dividend flows and forecast local capital positions as part of the financial planning cycle. The dividend capacity of certain U.S. and non-U.S. subsidiaries is also subject to business targets in excess of the minimum capital necessary to maintain the desired rating or level of financial strength in the relevant market. See “Risk Factors — Capital Risks — Our Subsidiaries May be Unable to Pay Dividends, a Major Component of Holding Company Free Cash Flow” and Note 16 of the Notes to the Consolidated Financial Statements.Affiliated Long-term Debt See “Senior Notes — Affiliated” in Note 4 of the Notes to the MetLife, Inc. (Parent Company Only) Condensed Financial Information included in Schedule II of the Financial Statement Schedules for information on affiliated long-term debt.Collateral Financing Arrangement and Junior Subordinated Debt SecuritiesFor information on MetLife, Inc.’s collateral financing arrangement and junior subordinated debt securities, see Notes 14 and 15 of the Notes to the Consolidated Financial Statements, respectively. 127Table of ContentsCredit and Committed FacilitiesSee Note 13 of the Notes to the Consolidated Financial Statements for further information regarding the Company’s Credit Facility and certain committed facilities.Long-term Debt OutstandingThe following table summarizes the outstanding long-term debt of MetLife, Inc. at: December 31, 20222021 (In millions)Long-term debt — unaffiliated$13,588 $12,814 Long-term debt — affiliated (1), (2)$1,676 $1,884 Junior subordinated debt securities$2,465 $2,463 __________________(1)In December 2021, ¥54.6 billion 3.1350% senior unsecured notes issued to various subsidiaries matured and were refinanced with the following senior unsecured notes issued to various subsidiaries: (i) ¥12.2 billion 1.588% due December 2026, (ii) ¥19.1 billion 1.7185% due December 2028 and (iii) ¥23.3 billion 1.850% due December 2031.(2)In July 2021, ¥53.7 billion 2.9725% senior unsecured notes issued to various subsidiaries matured and were refinanced with the following senior unsecured notes issued to various subsidiaries: (i) ¥13.7 billion 1.610% due July 2026, (ii) ¥14.3 billion 1.755% due July 2028 and (iii) ¥25.7 billion 1.852% due July 2031.Debt and Facility CovenantsCertain of MetLife, Inc.’s debt instruments and committed facilities, as well as its Credit Facility, contain various administrative, reporting, legal and financial covenants. MetLife, Inc. believes it was in compliance with all applicable financial covenants at December 31, 2022.DispositionsSee Note 3 of the Notes to the Consolidated Financial Statements for information on MetLife, Inc.’s business dispositions.Liquidity and Capital UsesThe primary uses of liquidity of MetLife, Inc. include debt service, cash dividends on common and preferred stock, capital contributions to subsidiaries, common stock, preferred stock and debt repurchases and/or redemptions, payment of general operating expenses and acquisitions. Based on our analysis and comparison of our current and future cash inflows from the dividends we receive from subsidiaries that are permitted to be paid without prior insurance regulatory approval, our investment portfolio and other cash flows and anticipated access to the capital markets, we believe there will be sufficient liquidity and capital to enable MetLife, Inc. to make payments on debt, pay cash dividends on its common and preferred stock, contribute capital to its subsidiaries, repurchase its common stock and certain of its other securities, pay all general operating expenses and meet its cash needs under current market conditions and reasonably possible stress scenarios.In addition to the description of liquidity and capital uses in “— The Company — Liquidity and Capital Uses,” MetLife, Inc.’s primary uses of liquidity and capital are set forth below.Affiliated Capital and Debt TransactionsFor the years ended December 31, 2022 and 2021, excluding acquisitions, MetLife, Inc. invested a net amount of $14 million and $111 million, respectively, in various subsidiaries.MetLife, Inc. lends funds, as necessary, through credit agreements or otherwise to its subsidiaries and affiliates, some of which are regulated, to meet their capital requirements or to provide liquidity. MetLife, Inc. had loans to subsidiaries outstanding of $95 million and $35 million at December 31, 2022 and 2021, respectively.Debt RepaymentsFor information on MetLife, Inc.’s debt repayments, see “— The Company — Liquidity and Capital Uses — Debt Repayments.” MetLife, Inc. intends to repay, redeem or refinance, in whole or in part, all the debt that is due in 2023. 128Table of ContentsMaturities of Senior NotesThe following table summarizes MetLife, Inc.’s outstanding senior notes by year of maturity, excluding any premium or discount and unamortized issuance costs, at December 31, 2022:Year of MaturityPrincipalInterest Rate (In millions) Unaffiliated:2023$1,000 4.37%2024$1,000 3.60%2024$421 5.38%2025$500 3.00%2025$500 3.60%2026$191 0.50%2029 - 2052$10,059 Ranging from 0.77% to 6.50%Affiliated:2023$283 1.60%2025$250 6.56%2026$121 1.64%2026$104 1.61%2026$93 1.59%2028 - 2031$825 Ranging from 1.72% to 1.85%See Note 22 of the Notes to the Consolidated Financial Statements for information on the redemption and cancellation of senior notes subsequent to December 31, 2022. Support AgreementsMetLife, Inc. is party to various capital support commitments and guarantees with certain of its subsidiaries. See Note 5 of the Notes to the MetLife, Inc. (Parent Company Only) Condensed Financial Information included in Schedule II of the Financial Statement Schedules.AcquisitionsSee Note 3 of the Notes to the Consolidated Financial Statements for information regarding the acquisition of Versant Health.Adopted Accounting PronouncementsSee Note 1 of the Notes to the Consolidated Financial Statements.Future Adoption of Accounting PronouncementsSee Note 1 of the Notes to the Consolidated Financial Statements.129Table of ContentsNon-GAAP and Other Financial DisclosuresIn this report, the Company presents certain measures of its performance on a consolidated and segment basis that are not calculated in accordance with GAAP. We believe that these non-GAAP financial measures enhance the understanding for the Company and our investors of our performance by highlighting the results of operations and the underlying profitability drivers of our business. Segment-specific financial measures are calculated using only the portion of consolidated results attributable to that specific segment.The following non-GAAP financial measures should not be viewed as substitutes for the most directly comparable financial measures calculated in accordance with GAAP:Non-GAAP financial measures:Comparable GAAP financial measures:(i)adjusted premiums, fees and other revenues (i)premiums, fees and other revenues (ii)adjusted earnings(ii)net income (loss) (iii)adjusted earnings available to commonshareholders(iii)net income (loss) available to MetLife, Inc.’s common shareholders(iv)free cash flow of all holding companies(iv)MetLife, Inc. (parent company only) net cash providedby (used in) operating activities(v) adjusted net investment income(v) net investment incomeAny of these financial measures shown on a constant currency basis reflect the impact of changes in foreign currency exchange rates and are calculated using the average foreign currency exchange rates for the most recent period and applied to the comparable prior period (“constant currency basis”). Reconciliations of these non-GAAP financial measures to the most directly comparable historical GAAP financial measures are included in “— Results of Operations” and “— Investments.” Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are not accessible on a forward-looking basis because we believe it is not possible without unreasonable effort to provide other than a range of net investment gains and losses and net derivative gains and losses, which can fluctuate significantly within or outside the range and from period to period and may have a material impact on net income. Our definitions of non-GAAP and other financial measures discussed in this report may differ from those used by other companies.Adjusted earnings and related measures:•adjusted earnings; •adjusted earnings available to common shareholders; and•adjusted earnings available to common shareholders on a constant currency basis. These measures are used by management to evaluate performance and allocate resources. Consistent with GAAP guidance for segment reporting, adjusted earnings and components of, or other financial measures based on, adjusted earnings are also our GAAP measures of segment performance. Adjusted earnings and other financial measures based on adjusted earnings are also the measures by which senior management’s and many other employees’ performance is evaluated for the purposes of determining their compensation under applicable compensation plans. Adjusted earnings and other financial measures based on adjusted earnings allow analysis of our performance relative to our business plan and facilitate comparisons to industry results. Adjusted earnings is defined as adjusted revenues less adjusted expenses, net of income tax. Adjusted loss is defined as negative adjusted earnings. Adjusted earnings available to common shareholders is defined as adjusted earnings less preferred stock dividends. For information relating to adjusted revenues and adjusted expenses, see “Financial Measures and Segment Accounting Policies” in Note 2 of the Notes to the Consolidated Financial Statements.In addition, adjusted earnings available to common shareholders excludes the impact of preferred stock redemption premium, which is reported as a reduction to net income (loss) available to MetLife, Inc.’s common shareholders.130Table of ContentsReturn on equity, allocated equity and related measures:•Total MetLife, Inc.’s common stockholders’ equity, excluding AOCI other than FCTA, is defined as total MetLife, Inc.’s common stockholders’ equity, excluding the net unrealized investment gains (losses) and defined benefit plans adjustment components of AOCI, net of income tax.•Return on MetLife, Inc.’s common stockholders’ equity: net income (loss) available to MetLife, Inc.’s common shareholders divided by MetLife, Inc.’s average common stockholders’ equity.•Adjusted return on MetLife, Inc.’s common stockholders’ equity is defined as adjusted earnings available to common shareholders divided by MetLife, Inc.’s average common stockholders’ equity.•Adjusted return on MetLife, Inc.’s common stockholders’ equity, excluding AOCI other than FCTA, is defined as adjusted earnings available to common shareholders divided by MetLife, Inc.’s average common stockholders’ equity, excluding AOCI other than FCTA.•Allocated equity is the portion of MetLife, Inc.’s common stockholders’ equity that management allocates to each of its segments and sub-segments based on local capital requirements and economic capital. See “— Risk Management— Economic Capital.” Allocated equity excludes the impact of AOCI other than FCTA. The above measures represent a level of equity consistent with the view that, in the ordinary course of business, we do not plan to sell most investments for the sole purpose of realizing gains or losses. Expense ratio and direct expense ratio:•Expense ratio: other expenses, net of capitalization of DAC, divided by premiums, fees and other revenues.•Direct expense ratio: adjusted direct expenses divided by adjusted premiums, fees and other revenues. Direct expenses are comprised of employee-related costs, third party staffing costs, and general and administrative expenses.•Direct expense ratio, excluding total notable items related to direct expenses and pension risk transfers: adjusted direct expenses excluding total notable items related to direct expenses, divided by adjusted premiums, fees and other revenues, excluding pension risk transfers.The following additional information is relevant to an understanding of our performance results and outlook:•We sometimes refer to sales activity for various products. These sales statistics do not correspond to revenues under GAAP, but are used as relevant measures of business activity. Further, sales statistics for our Latin America, Asia and EMEA segments are on a constant currency basis.•Near-term represents one to three years.•We refer to observable forward yield curves as of a particular date in connection with making our estimates for future results. The observable forward yield curves at a given time are based on implied future interest rates along a range of interest rate durations. This includes the 10-year U.S. Treasury rate which we use as a benchmark rate to describe longer-term interest rates used in our estimates for future results.•Asymmetrical and non-economic accounting refers to: (i) the portion of net derivative gains (losses) on embedded derivatives attributable to the inclusion of our credit spreads in the liability valuations, (ii) hedging activity that generates net derivative gains (losses) and creates fluctuations in net income because hedge accounting cannot be achieved and the item being hedged does not a have an offsetting gain or loss recognized in earnings, (iii) inflation-indexed benefit adjustments associated with contracts backed by inflation-indexed investments and amounts associated with periodic crediting rate adjustments based on the total return of a contractually referenced pool of assets and other pass through adjustments, and (iv) impact of changes in foreign currency exchange rates on the re-measurement of foreign denominated unhedged funding agreements and financing transactions to the U.S. dollar and the re-measurement of certain liabilities from non-functional currencies to functional currencies. We believe that excluding the impact of asymmetrical and non-economic accounting from total GAAP results enhances investor understanding of our performance by disclosing how these accounting practices affect reported GAAP results.• Notable items reflect the unexpected impact of events that affect the Company’s results, but that were unknown and that the Company could not anticipate when it devised its business plan. Notable items also include certain items regardless of the extent anticipated in the business plan, to help investors have a better understanding of MetLife’s results and to evaluate and forecast those results. Notable items represent a positive (negative) impact to adjusted earnings available to common shareholders.131Table of Contents•The Company uses a measure of free cash flow to facilitate an understanding of its ability to generate cash for reinvestment into its businesses or use in non-mandatory capital actions. The Company defines free cash flow as the sum of cash available at MetLife’s holding companies from dividends from operating subsidiaries, expenses and other net flows of the holding companies (including capital contributions to subsidiaries), and net contributions from debt to be at or below target leverage ratios. This measure of free cash flow is prior to capital actions, such as common stock dividends and repurchases, debt reduction and mergers and acquisitions. Free cash flow should not be viewed as a substitute for net cash provided by (used in) operating activities calculated in accordance with GAAP. The free cash flow ratio is typically expressed as a percentage of annual adjusted earnings available to common shareholders. A reconciliation of net cash provided by operating activities of MetLife, Inc. (parent company only) to free cash flow of all holding companies for the years ended December 31, 2022 and 2021 is provided below.Reconciliation of Net Cash Provided by Operating Activities of MetLife, Inc. to Free Cash Flow of All Holding CompaniesYears Ended December 31,20222021 (In millions, except ratios)MetLife, Inc. (parent company only) net cash provided by operating activities $4,428 $3,757 Adjustments from net cash provided by operating activities to free cash flow:Add: Incremental debt to be at or below target leverage ratios1,000 — Add: Capital contributions to subsidiaries(5)(88)Add: Returns of capital from subsidiaries8 7 Add: Repayments on and (issuances of) loans to subsidiaries, net(60)(35)Add: Investment portfolio and derivatives changes and other, net(199)(130)MetLife, Inc. (parent company only) free cash flow5,172 3,511 Other MetLife, Inc. holding companies:Add: Dividends and returns of capital from subsidiaries1,410 2,077 Add: Capital contributions to subsidiaries(87)(24)Add: Repayments on and (issuances of) loans to subsidiaries, net(5)(9)Add: Other expenses(656)(613)Add: Dividends and returns of capital to MetLife, Inc.(1,434)(1,300)Add: Investment portfolio and derivative changes and other, net266 193 Total other MetLife, Inc. holding companies free cash flow(506)324 Free cash flow of all holding companies$4,666 $3,835 Ratio of net cash provided by operating activities to consolidated net income (loss) available to MetLife, Inc.’s common shareholders:MetLife, Inc. (parent company only) net cash provided by operating activities $4,428 $3,757 Consolidated net income (loss) available to MetLife, Inc.’s common shareholders$2,354 $6,353 Ratio of net cash provided by operating activities (parent company only) to consolidated net income (loss) available to MetLife, Inc.'s common shareholders (1)188 %59 %Ratio of free cash flow to adjusted earnings available to common shareholders:Free cash flow of all holding companies (2)$4,666 $3,835 Consolidated adjusted earnings available to common shareholders (2)$5,545 $7,954 Ratio of free cash flow of all holding companies to consolidated adjusted earnings available to common shareholders (2)84 %48 %__________________(1)Including the free cash flow of other MetLife, Inc. holding companies of ($506) million and $324 million for the years ended December 31, 2022 and 2021, respectively, in the numerator of the ratio, this ratio, as adjusted, would be 167% and 64%, respectively. (2)i) Consolidated adjusted earnings available to common shareholders for the year ended December 31, 2022, was positively impacted by notable items related to the actuarial assumption review and other insurance adjustments of $111 million, net of income tax. Excluding these notable items from the denominator of the ratio, the adjusted free cash flow ratio for 2022, would be 86%.132Table of Contentsii) Consolidated adjusted earnings available to common shareholders for the year ended December 31, 2021, was positively impacted by notable items related to tax adjustments of $140 million, net of income tax, and litigation reserves and settlement costs of $66 million, net of income tax, offset by the actuarial assumption review and other insurance adjustments of $140 million, net of income tax. Excluding these notable items from the denominator of the ratio, the adjusted free cash flow ratio for 2021, would be 49%.Risk ManagementWe have an integrated process for managing risk, that is supported by a Risk Appetite Statement approved by the Board of Directors. Risk management is overseen and conducted through multiple Board and senior management risk committees (financial and non-financial). The risk committees are established at the enterprise, regional and local levels, as needed, to oversee capital and risk positions, approve ALM strategies and limits, and establish certain corporate risk standards and policies. The risk committees are comprised of senior leaders from the lines of business and corporate functions which ensures comprehensive coverage and sharing of risk reporting. The ERC is responsible for reviewing all material risks impacting the enterprise and deciding on actions, if necessary, in the event risks exceed desired tolerances, taking into consideration industry best practices and the current environment to resolve or mitigate those risks.Three Lines of DefenseMetLife operates under the “Three Lines of Defense” model. Under this model, the lines of business and corporate functions are the first and primary line of defense in identifying, measuring, monitoring, managing, and reporting risks. Global Risk Management forms the second line of defense providing strategic advisory services and effective challenge and oversight to the business and corporate functions in the first line of defense. Internal Audit serves as the third line of defense, providing independent assurance and testing over the risk and control environment and related processes and controls.Global Risk ManagementIndependent from the lines of business, the centralized Global Risk Management department, led by the CRO, coordinates across all risk committees to ensure that all material risks are properly identified, measured, monitored, managed and reported across the Company. The CRO reports to the CEO and is primarily responsible for maintaining and communicating the Company’s enterprise risk policies and for monitoring and analyzing all material risks.Global Risk Management considers and monitors a full range of risks relating to the Company’s solvency, liquidity, earnings, business operations and reputation. Global Risk Management’s primary responsibilities consist of:•implementing an enterprise risk framework, which outlines our enterprise approach for managing financial and non-financial risk;•developing policies and procedures for identifying, measuring, monitoring, managing and reporting those risks identified in the enterprise risk framework;•coordinating Own Risk Solvency Assessment for Board, senior management and regulator use;•establishing appropriate corporate risk tolerance levels;•measuring capital on an economic basis; •mitigating compliance risk and establishing controls; •integrating climate risk into MetLife’s risk management framework and developing impact assessment capabilities; and •reporting to (i) the Finance and Risk Committee of the Board of Directors; (ii) the Compensation Committee of the Board of Directors; and (iii) the financial and non-financial senior management committees on various aspects of risk.133Table of ContentsKey Risk TypesMetLife has defined each material risk to which it is exposed and has established individual frameworks to monitor, manage and report on the respective risk.•Market Risk: is the risk of loss due to potential changes in the value of assets and liabilities arising from fluctuations in financial market, real estate, and other economic factors. Market risk is comprised of interest rate risk, equity risk, foreign currency exchange rate risk, spread risk and inflation risk. •Credit Risk: is the risk of loss or credit rating downgrade arising from an obligor or counterparty with a direct or contingent financial obligation to MetLife that is either unable or unwilling to meet its obligation in full and on a timely basis. These risks arise from public fixed income assets, private loans including real estate, derivative transactions, bank deposits, reinsurance treaties and other similar contracts. •Insurance Risk: is the risk of loss or adverse change in insurance liabilities from changes in the level, trend, and volatility of insurance and policyholder behavior experience varying from best estimate assumptions. These variances can be driven by catastrophic events such as pandemics or can be the result of misestimating base assumptions. Insurance risks to MetLife generally arise from mortality, morbidity, longevity, and policyholder behavior.•Non-Financial Risk: is the risk of failed or inadequate internal processes, human errors, system errors or external events that may result in financial loss, non-financial damage, and/or non-compliance with applicable laws and regulations. Non-Financial risk captures operational and compliance risks, including risks such as business interruption, customer protection, financial crime, privacy, fraud and theft, and information security risk. •Liquidity Risk: refers to the risk that MetLife is unable to raise cash necessary to meet current obligations.Economic CapitalEconomic capital is an internally developed risk capital model, the purpose of which is to measure the risk in the business and to provide a basis upon which capital can be deployed. The economic capital model accounts for the unique and specific nature of the risks inherent in our business. Our economic capital model, coupled with considerations of local capital requirements, aligns segment allocated equity with emerging standards and consistent risk principles. The model applies statistics-based risk evaluation principles to the material risks to which the company is exposed. These consistent risk principles include calibrating required economic capital shock factors to a specific confidence level and time horizon while applying an industry standard method for the inclusion of diversification benefits among risk types. MetLife’s management is responsible for the ongoing production and enhancement of the economic capital model and reviews its approach periodically to ensure that it remains consistent with emerging industry practice standards. For further information, see “Financial Measures and Segment Accounting Policies” in Note 2 of the Notes to the Consolidated Financial Statements.Asset/Liability ManagementWe actively manage our assets using an approach that is liability driven and balances quality, diversification, asset/liability matching, liquidity, concentration and investment return. The goals of the investment process are to optimize, net of income tax, risk-adjusted investment income and risk-adjusted total return while ensuring that the assets and liabilities are reasonably aligned on a cash flow and duration basis. The ALM process is the shared responsibility of the ALM, Global Risk Management, and Investments departments, with the engagement of senior members of the business segments and Finance, and is governed by the ALM Committees. The ALM Committees’ duties include reviewing and approving investment guidelines and limits, approving significant portfolio and ALM strategies and providing oversight of the ALM process. The directives of the ALM Committees are carried out and monitored through ALM Working Groups which are set up to manage risk by geography, product or portfolio type. The ALM Steering Committee oversees the activities of the underlying ALM Committees and Working Groups. The ALM Steering Committee reports to the ERC.We establish portfolio guidelines that define ranges and limits related to asset allocation, interest rate risk, liquidity, concentration and other risks for each major business segment, legal entity or insurance product group. These guidelines support implementation of investment strategies used to adequately fund our liabilities within acceptable levels of risk. We also establish hedging programs and associated investment portfolios for different blocks of business. The ALM Working Groups monitor these strategies and programs through regular review of portfolio metrics, such as effective duration, yield curve sensitivity, convexity, value at risk, market sensitivities (to interest rates, equity market levels, equity volatility, foreign currency exchange rates and inflation), stress scenario payoffs, liquidity, asset sector concentration and credit quality.134Table of ContentsWe manage credit risk through in-house fundamental credit analysis of the underlying obligors, issuers, transaction structures and real estate properties. We also manage credit, market valuation and liquidity risk through industry and issuer diversification and asset allocation limits. These risk limits, approved annually by the Investment Risk Committee, promote diversification by asset sector, avoid concentrations in any single issuer and limit overall aggregate credit and equity risk exposure, as measured by our economic capital framework. For real estate assets, we manage credit and market risk through asset allocation limits and by diversifying by geography, property and product type. Information Security Risk ManagementWe manage information security risk through MetLife’s Information Security Program (the “Program”), which is overseen by our enterprise Chief Information Security Officer (“CISO”), with collaboration across lines of businesses and corporate functions. The CISO is a senior-level executive responsible for establishing and executing the company’s information security strategy; the CISO regularly reports about information security risk to the ERC, the Audit Committee and the Board. The primary goal of the Program is to protect information and technology assets through physical, technical, and administrative safeguards. This includes monitoring, reporting, managing and remediating cyber threats. The Program aims to prevent data exfiltration, manipulation, and destruction, as well as system and transactional disruption. The Program’s threat-centric and risk-based approach for securing the MetLife environment is based on the cybersecurity framework developed by the U.S. Government’s National Institute of Standards and Technology. Subsequent EventsSee “— Acquisitions and Dispositions” and Note 22 of the Notes to the Consolidated Financial Statements.135Table of ContentsItem 7A. Quantitative and Qualitative Disclosures About Market RiskThe following discussion on market risk should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Management.”Market Risk ExposuresWe regularly analyze our exposure to interest rate, foreign currency exchange rate and equity market price risk. As a result of that analysis, we have determined that the estimated fair values of certain assets and liabilities are materially exposed to changes in interest rates, foreign currency exchange rates and equity markets. We have exposure to market risk through our insurance operations and investment activities. For purposes of this disclosure, “market risk” is defined as the risk of loss due to potential changes in the value of assets and liabilities arising from fluctuation in the financial market and other economic factors.Interest RatesOur exposure to interest rate changes results most significantly from our holdings of fixed maturity securities AFS, mortgage loans and derivatives, as well as our interest rate sensitive liabilities. The fixed maturity securities AFS include U.S. and foreign government bonds, securities issued by government agencies, corporate bonds, mortgage-backed securities and ABS & CLO, all of which are mainly exposed to changes in medium- and long-term interest rates. The interest rate sensitive liabilities for purposes of this disclosure include debt, policyholder account balances related to certain investment type contracts, and embedded derivatives on variable annuities with guaranteed minimum benefits which have the same type of interest rate exposure (medium- and long-term interest rates) as fixed maturity securities AFS. The interest rate sensitive liabilities for purposes of this disclosure exclude a significant portion of the liabilities relating to insurance contracts. See “Risk Factors — Economic Environment and Capital Markets Risks — We May Face Difficult Economic Conditions.”Foreign Currency Exchange RatesOur exposure to fluctuations in foreign currency exchange rates against the U.S. dollar results from our holdings in non-U.S. dollar denominated fixed maturity and equity securities, mortgage loans, and certain liabilities, as well as through our investments in foreign subsidiaries. The foreign currency exchange rate liabilities for purposes of this disclosure exclude a significant portion of the liabilities relating to insurance contracts. The principal currencies that create foreign currency exchange rate risk in our investment portfolios and liabilities are the Japanese yen, the Euro and the British pound. Selectively, we use U.S. dollar assets to support certain long-duration foreign currency liabilities. Through our investments in foreign subsidiaries and joint ventures, we are primarily exposed to the Japanese yen, the Euro, the Australian dollar, the British pound, the Mexican peso, the Chilean peso and the Korean won. In addition to hedging with foreign currency swaps, forwards and options, local surplus in some countries may be held entirely or in part in U.S. dollar assets, which further minimize exposure to foreign currency exchange rate fluctuation risk. We have matched much of our foreign currency liabilities in our foreign subsidiaries with their respective foreign currency assets, thereby reducing our risk to foreign currency exchange rate fluctuation. See “Risk Factors — Economic Environment and Capital Markets Risks — We May Face Difficult Economic Conditions.”Equity MarketAlong with investments in equity securities, we have exposure to equity market risk through certain liabilities that involve long-term guarantees on equity performance such as embedded derivatives on variable annuities with guaranteed minimum benefits and certain policyholder account balances. Equity exposures associated with real estate and limited partnership interests are excluded from this discussion as they are not considered financial instruments under GAAP.Management of Market Risk ExposuresWe use a variety of strategies to manage interest rate, foreign currency exchange rate and equity market risk, including the use of derivatives.136Table of ContentsInterest Rate Risk ManagementTo manage interest rate risk, we analyze interest rate risk using various models, including multi-scenario cash flow projection models that forecast cash flows of the liabilities and their supporting investments, including derivatives. These projections involve evaluating the potential gain or loss on most of our in-force business under various increasing and decreasing interest rate environments. The NYDFS regulations require that we perform some of these analyses annually as part of our review of the sufficiency of our regulatory reserves. For several of our legal entities, we maintain segmented operating and surplus asset portfolios for the purpose of ALM and the allocation of investment income to product lines. In the U.S., for each segment, invested assets greater than or equal to the GAAP liabilities net of certain non-invested assets allocated to the segment are maintained, with any excess allocated to Corporate & Other. The business segments may reflect differences in legal entity, statutory line of business and any product market characteristic which may drive a distinct investment strategy with respect to duration, liquidity or credit quality of the invested assets. Certain smaller entities make use of unsegmented general accounts for which the investment strategy reflects the aggregate characteristics of liabilities in those entities. We measure relative sensitivities of the value of our assets and liabilities to changes in key assumptions utilizing internal models. These models reflect specific product characteristics and include assumptions based on current and anticipated experience regarding lapse, mortality, morbidity and interest crediting rates. In addition, these models include asset cash flow projections reflecting interest payments, sinking fund payments, principal payments, bond calls, mortgage loan prepayments and defaults.We employ product design, pricing and ALM strategies to reduce the potential effects of interest rate movements. Product design and pricing strategies include the use of surrender charges or restrictions on withdrawals in some products and the ability to reset crediting rates for certain products. ALM strategies include the use of derivatives. We also use reinsurance to mitigate interest rate risk.We also use common industry metrics, such as duration and convexity, to measure the relative sensitivity of assets and liability values to changes in interest rates. In computing the duration of liabilities, we consider policyholder guarantees and how we intend to set indeterminate policy elements such as interest credits or dividends. Each asset portfolio or portfolio group has a duration target based on the liability duration and the investment objectives of that portfolio. Where a liability cash flow may exceed the maturity of available assets, we may support such liabilities with equity investments, derivatives or interest rate curve mismatch strategies.Foreign Currency Exchange Rate Risk ManagementMetLife has a well-established policy to manage foreign currency exchange rate exposures within its risk tolerance. In general, investments backing specific liabilities are currency matched. This is achieved through direct investments in matching currency or through the use of foreign currency exchange rate derivatives. Enterprise foreign currency exchange rate risk limits are established by the ERC. Management of each of our segments, with oversight from our FX Working Group and the ALM committee for the respective segment, is responsible for managing any foreign currency exchange rate exposure.We use foreign currency swaps, forwards and options to mitigate the liability exposure, risk of loss and financial statement volatility associated with our investments in foreign subsidiaries, foreign currency denominated fixed income investments and the sale of certain insurance products.Equity Market Risk ManagementWe manage equity market risk on an integrated basis with other risks through our ALM strategies, including the dynamic hedging with derivatives of certain variable annuity guarantee benefits, as well as reinsurance, in order to limit losses, minimize exposure to large risks, and provide additional capacity for future growth. We also manage equity market risk exposure in our investment portfolio through the use of derivatives. These derivatives include exchange-traded equity futures, equity index options contracts, TRRs and equity variance swaps.137Table of ContentsHedging ActivitiesWe use derivative contracts primarily to hedge a wide range of risks including interest rate risk, foreign currency exchange rate risk, and equity market risk. Derivative hedges are designed to reduce risk on an economic basis while considering their impact on financial results under different accounting regimes, including GAAP and local statutory accounting. Our derivative hedge programs vary depending on the type of risk being hedged. Some hedge programs are asset or liability specific while others are portfolio hedges that reduce risk related to a group of liabilities or assets. Our use of derivatives by major hedge programs is as follows:•Risks Related to Guarantee Benefits — We use a wide range of derivative contracts to mitigate the risk associated with living guarantee benefits. These derivatives include equity and interest rate futures, interest rate swaps, currency futures/forwards, equity indexed options, TRRs, interest rate option contracts and equity variance swaps.•Minimum Interest Rate Guarantees — For certain liability contracts, we provide the contractholder a guaranteed minimum interest rate. These contracts include certain fixed annuities and other insurance liabilities. We purchase interest rate caps and floors to reduce risk associated with these liability guarantees.•Reinvestment Risk in Long-Duration Liability Contracts — Derivatives are used to hedge interest rate risk related to certain long-duration liability contracts. Hedges include interest rate swaps, swaptions and Treasury bond forwards.•Foreign Currency Exchange Rate Risk — We use foreign currency swaps, futures, forwards and options to hedge foreign currency exchange rate risk. These hedges are generally used to swap foreign currency denominated bonds, investments in foreign subsidiaries or equity market exposures to U.S. dollars. Our foreign subsidiaries also use these hedges to swap non-local currency assets to local currency, to match liabilities.•General ALM Hedging Strategies — In the ordinary course of managing our asset/liability risks, we use interest rate futures, interest rate swaps, interest rate caps, interest rate floors, and inflation swaps. These hedges are designed to reduce interest rate risk or inflation risk related to the existing assets or liabilities or related to expected future cash flows.•Macro Hedge Program — We use equity options, equity TRRs, interest rate swaptions, interest rate swaps and Treasury locks to mitigate the potential loss of legal entity statutory capital under stress scenarios.Risk Measurement: Sensitivity AnalysisWe measure market risk related to our market sensitive assets and liabilities based on changes in interest rates, foreign currency exchange rates and equity market prices utilizing a sensitivity analysis. For purposes of this disclosure, a significant portion of the liabilities relating to insurance contracts is excluded, as discussed further below. This analysis estimates the potential changes in estimated fair value based on a hypothetical 100 basis point change (increase or decrease) in interest rates, as well as a 10% change (increase or decrease) in foreign currency exchange rates and equity market prices. We believe these changes in market rates and prices are reasonably possible in the near term. In performing the analysis summarized below, we used market rates at December 31, 2022. The sensitivity analysis separately calculates each of our market risk exposures (interest rate, foreign currency exchange rate and equity market) relating to our assets and liabilities. We modeled the impact of changes (increases and decreases) in market rates and prices on the estimated fair values of our market sensitive assets and liabilities and present the results with the most adverse level of market risk impact to the Company for each of these market risk exposures as follows:•the net present values of our interest rate sensitive exposures resulting from a 100 basis point change (increase or decrease) in interest rates;•estimated fair values of our foreign currency exchange rate sensitive exposures due to a 10% change (appreciation or depreciation) in the value of the U.S. dollar compared to all other currencies; and•the estimated fair value of our equity market sensitive exposures due to a 10% change (increase or decrease) in equity market prices.138Table of ContentsThe sensitivity analysis is an estimate and should not be viewed as predictive of our future financial performance. We cannot ensure that our actual losses in any particular period will not exceed the amounts indicated in the table below. Limitations related to this sensitivity analysis include:•interest sensitive and foreign currency exchange rate sensitive liabilities do not include $223.9 billion, at carrying value, of insurance contracts. Management believes that the changes in the economic value of those contracts under changing interest rates and changing foreign currency exchange rates would offset a significant portion of the fair value changes of interest sensitive and foreign currency exchange rate sensitive assets;•the market risk information is limited by the assumptions and parameters established in creating the related sensitivity analysis, including the impact of prepayment rates on mortgage loans;•sensitivities do not include the impact on asset or liability valuation of changes in market liquidity or changes in market credit spreads;•foreign currency exchange rate risk is not isolated for certain embedded derivatives within host asset and liability contracts, as the risk on these instruments is reflected as equity;•for the derivatives that qualify as hedges, and for certain other assets such as mortgage loans, the impact on reported earnings may be materially different from the change in market values;•the analysis excludes liabilities pursuant to insurance contracts, as well as real estate holdings, private equity and hedge fund holdings; and•the model assumes that the composition of assets and liabilities remains unchanged throughout the period.Accordingly, we use such models as tools and not as substitutes for the experience and judgment of our management. Based on our analysis of the impact of a 100 basis point change (increase or decrease) in interest rates, as well as a 10% change (increase or decrease) in foreign currency exchange rates and equity market prices, we have determined that such a change could have a material adverse effect on the estimated fair value of certain assets and liabilities from interest rate, foreign currency exchange rate and equity market exposures.The table below illustrates the potential loss in estimated fair value for each market risk exposure based on market sensitive assets and liabilities at: December 31, 2022 (In millions)Interest rate risk $22,327 Foreign currency exchange rate risk$5,929 Equity market risk $97 The risk sensitivities derived used a 100 basis point increase to interest rates, a 10% strengthening of the U.S. dollar against foreign currencies, and a 10% increase in equity prices. The potential losses in estimated fair value presented are for non-trading securities.139Table of ContentsThe table below provides additional detail regarding the potential loss in estimated fair value of our interest sensitive financial instruments due to a 100 basis point increase in interest rates at:December 31, 2022NotionalAmount EstimatedFairValue (1) Assuming a100 bpsIncreasein Interest Rates(In millions)AssetsFixed maturity securities AFS$276,780 $(20,707)Equity securities$1,684 (80)FVO Securities$1,435 (26)Mortgage loans$78,694 (2,708)Policy loans$9,682 (268)Short-term investments$4,935 (11)Other invested assets$2,078 (156)Cash and cash equivalents$20,195 (6)Accrued investment income$3,446 — Premiums, reinsurance and other receivables$2,963 (37)Other assets$265 (14)Embedded derivatives within asset host contracts (2)$29 (8)Total assets$(24,021)Liabilities (3)Policyholder account balances$115,408 $3,339 Payables for collateral under securities loaned and other transactions$20,937 — Short-term debt$175 — Long-term debt$14,241 1,031 Collateral financing arrangement$591 — Junior subordinated debt securities$3,502 294 Other liabilities$3,170 151 Embedded derivatives within liability host contracts (2)$578 317 Total liabilities$5,132 Derivative InstrumentsInterest rate swaps$39,911 $938 $(2,182)Interest rate floors$25,270 $125 (66)Interest rate caps$48,290 $950 302 Interest rate futures$1,453 $1 31 Interest rate options$44,391 $385 (218)Interest rate forwards$7,828 $(1,385)(950)Synthetic GICs$46,316 $— — Foreign currency swaps$56,025 $3,008 (307)Foreign currency forwards$18,211 $(234)12 Currency futures$333 $8 — Currency options$3,000 $236 (8)Credit default swaps$14,437 $44 2 Equity futures$2,988 $4 (4)Equity index options$16,701 $442 (45)Equity variance swaps$163 $3 — Equity total return swaps$2,799 $(89)(5)Total derivative instruments$(3,438)Net Change$(22,327)__________________(1)Separate account assets and liabilities and Unit-linked investments and associated policyholder account balances, which are interest rate sensitive, are not included herein as any interest rate risk is borne by the contractholder, notwithstanding any general account guarantees which are included within embedded derivatives (see footnote (2) below) or included within future policy benefits and other policy-related balances (see footnote (3) below).(2)Embedded derivatives are recognized on the consolidated balance sheet in the same caption as the host contract.(3)Excludes $223.9 billion of liabilities, at carrying value, pursuant to insurance contracts reported within future policy benefits and other policy-related balances. These liabilities would economically offset a significant portion of the net change in fair value of our financial instruments resulting from a 100 basis point increase in interest rates.140Table of ContentsSensitivity to interest rates decreased $9.0 billion to $22.0 billion at December 31, 2022 from $31.0 billion at December 31, 2021.The table below provides additional detail regarding the potential loss in estimated fair value of our portfolio due to a 10% appreciation in the U.S. dollar compared to all other currencies at:December 31, 2022NotionalAmountEstimatedFairValue (1)Assuming a10% Appreciation in the U.S. Dollar(In millions)AssetsFixed maturity securities AFS$276,780 $(7,836)Equity securities$1,684 (42)FVO Securities$1,435 (59)Mortgage loans$78,694 (815)Policy loans$9,682 (123)Short-term investments$4,935 (234)Other invested assets$2,078 (50)Cash and cash equivalents$20,195 (424)Accrued investment income$3,446 (64)Premiums, reinsurance and other receivables$2,963 (59)Other assets$265 (18)Embedded derivatives within asset host contracts (2)$29 (5)Total assets$(9,729)Liabilities (3)Policyholder account balances$115,408 $2,757 Payables for collateral under securities loaned and other transactions$20,937 188 Long-term debt$14,241 148 Other liabilities$3,170 14 Embedded derivatives within liability host contracts (2)$578 7 Total liabilities$3,114 Derivative InstrumentsInterest rate swaps$39,911 $938 $41 Interest rate floors$25,270 $125 — Interest rate caps$48,290 $950 — Interest rate futures$1,453 $1 — Interest rate options$44,391 $385 (1)Interest rate forwards$7,828 $(1,385)80 Synthetic GICs$46,316 $— — Foreign currency swaps$56,025 $3,008 1,360 Foreign currency forwards$18,211 $(234)(931)Currency futures$333 $8 (35)Currency options$3,000 $236 162 Credit default swaps$14,437 $44 — Equity futures$2,988 $4 — Equity index options$16,701 $442 9 Equity variance swaps$163 $3 — Equity total return swaps$2,799 $(89)1 Total derivative instruments$686 Net Change$(5,929)__________________(1)Does not necessarily represent those financial instruments solely subject to foreign currency exchange rate risk. Separate account assets and liabilities and Unit-linked investments and associated policyholder account balances, which are foreign currency exchange rate sensitive, are not included herein as any foreign currency exchange rate risk is borne by the contractholder, notwithstanding any general account guarantees which are included within embedded derivatives (see footnote (2) below) or included within future policy benefits and other policy-related balances (see footnote (3) below).141Table of Contents(2)Embedded derivatives are recognized on the consolidated balance sheet in the same caption as the host contract.(3)Excludes $223.9 billion of liabilities, at carrying value, pursuant to insurance contracts reported within future policy benefits and other policy-related balances. These liabilities would economically offset a significant portion of the net change in fair value of our financial instruments resulting from a 10% appreciation in the U.S. dollar compared to all other currencies.Sensitivity to foreign currency exchange rates decreased $1.2 billion to $6.0 billion at December 31, 2022 from $7.2 billion at December 31, 2021.The table below provides additional detail regarding the potential loss in estimated fair value of our portfolio due to a 10% increase in equity prices at: December 31, 2022 NotionalAmountEstimatedFairValue (1)Assuming a10% Increasein EquityPrices (In millions)AssetsEquity securities$1,684 $67 FVO Securities$1,435 72 Other invested assets$2,078 30 Embedded derivatives within asset host contracts (2)$29 (3)Total assets$166 Liabilities (3)Policyholder account balances$115,408 $— Embedded derivatives within liability host contracts (2)$578 191 Total liabilities$191 Derivative InstrumentsInterest rate swaps$39,911 $938 $— Interest rate floors$25,270 $125 — Interest rate caps$48,290 $950 — Interest rate futures$1,453 $1 — Interest rate options$44,391 $385 — Interest rate forwards$7,828 $(1,385)— Synthetic GICs$46,316 $— — Foreign currency swaps$56,025 $3,008 — Foreign currency forwards$18,211 $(234)— Currency futures$333 $8 — Currency options$3,000 $236 — Credit default swaps$14,437 $44 — Equity futures$2,988 $4 (207)Equity index options$16,701 $442 (39)Equity variance swaps$163 $3 — Equity total return swaps$2,799 $(89)(208)Total derivative instruments$(454)Net Change$(97)__________________(1)Does not necessarily represent those financial instruments solely subject to equity price risk. Additionally, separate account assets and liabilities and Unit-linked investments and associated policyholder account balances, which are equity market sensitive, are not included herein as any equity market risk is borne by the contractholder, notwithstanding any general account guarantees which are included within embedded derivatives (see footnote (2) below) or included within future policy benefits and other policy-related balances (see footnote (3) below).(2)Embedded derivatives are recognized on the consolidated balance sheet in the same caption as the host contract.(3)Excludes $223.9 billion of liabilities, at carrying value, pursuant to insurance contracts reported within future policy benefits and other policy-related balances.142Table of ContentsSensitivity to equity market prices decreased $26 million to $97 million at December 31, 2022 from $123 million at December 31, 2021.143Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion analyzes the financial condition and results of operations of both MAA and the Operating Partnership, of which MAA is the sole general partner and in which MAA owned a 97.3% interest as of December 31, 2022. MAA conducts all of its business through the Operating Partnership and its various subsidiaries. This discussion should be read in conjunction with the consolidated financial statements and notes thereto included in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results, performance or achievements may differ materially from those expressed or implied by such forward-looking statements as a result of many factors, including, but not limited to, those under the heading “Risk Factors” in this Annual Report on Form 10-K. MAA, an S&P 500 company, is a multifamily-focused, self-administered and self-managed real estate investment trust, or REIT. We own, operate, acquire and selectively develop apartment communities primarily located in the Southeast, Southwest and Mid-Atlantic regions of the United States. As of December 31, 2022, we owned and operated 290 apartment communities (which does not include development properties under construction) through the Operating Partnership and its subsidiaries, and had an ownership interest in one apartment community through an unconsolidated real estate joint venture. In addition, as of December 31, 2022, we had six development communities under construction, and 34 of our apartment communities included retail components. Our apartment communities, including development communities under construction, were located across 16 states and the District of Columbia as of December 31, 2022. We report in two segments, Same Store and Non-Same Store and Other. Our Same Store segment represents those apartment communities that have been owned and stabilized for at least 12 months as of the first day of the calendar year. Our Non-Same Store and Other segment includes recently acquired communities, communities being developed or in lease-up, communities identified for disposition, communities that have incurred a significant casualty loss and stabilized communities that do not meet the requirements to be Same Store communities. Also included in our Non-Same Store and Other segment are non-multifamily activities and storm related expenses related to hurricanes. Additional information regarding the composition of our segments is included in Note 13 to the consolidated financial statements included in this Annual Report on Form 10-K. Overview For the year ended December 31, 2022, net income available for MAA common shareholders was $633.7 million as compared to $530.1 million for the year ended December 31, 2021. Results for the year ended December 31, 2022 included $215.6 million of gain related to the sale of real estate assets and $29.9 million in net casualty gain primarily due to winter storm Uri, partially offset by $35.8 million of non-cash loss, net of tax, from investments and $21.1 million of non-cash loss related to the fair value adjustment of the embedded derivative in the MAA Series I preferred shares. Results for the year ended December 31, 2021 included $221.2 million of gain related to the sale of real estate assets and $40.9 million of non-cash gain, net of tax, from investments. Revenues for the year ended December 31, 2022 increased 13.6% as compared to the year ended December 31, 2021, driven by a 13.5% increase in our Same Store segment. Property operating expenses, excluding depreciation and amortization, for the year ended December 31, 2022 increased by 7.8% as compared to the year ended December 31, 2021, driven by a 7.6% increase in our Same Store segment. The primary drivers of these changes are discussed in the “Results of Operations” section. Trends During the year ended December 31, 2022, revenue growth for our Same Store segment continued to be primarily driven by growth in average effective rent per unit. The average effective rent per unit for our Same Store segment continued to increase from the prior year, up 14.6% for the year ended December 31, 2022 as compared to the year ended December 31, 2021. Average effective rent per unit represents the average of gross rent amounts, after the effect of leasing concessions, for occupied apartment units plus prevalent market rates asked for unoccupied apartment units, divided by the total number of units. Leasing concessions represent discounts to the current market rate. We believe average effective rent per unit is a helpful measurement in evaluating average pricing; however, it does not represent actual rental revenue collected per unit. For the year ended December 31, 2022, average physical occupancy for our Same Store segment was 95.7%, as compared to 96.1% for the year ended December 31, 2021. Average physical occupancy is a measurement of the total number of our apartment units that are occupied by residents, and it represents the average of the daily physical occupancy for the period. An important part of our portfolio strategy is to maintain diversity of markets, submarkets, product types and price points in the Southeast, Southwest and Mid-Atlantic regions of the U.S. This diversity tends to mitigate exposure to economic issues in any one geographic market or area. We believe that a well-balanced portfolio, including both urban and suburban locations, with a broad range of monthly rent price points, will perform well in economic up cycles as well as better weather economic down cycles. Through our investment in 39 defined markets, we are diversified across markets, urban and suburban submarkets, and a variety of product types and monthly rent price points. Though demand for apartments moderated during the second half of 2022, we were able to maintain strong rent growth. We believe demand for apartments is primarily driven by general economic conditions in our markets and is particularly correlated to job 27 growth, population growth, household formation and in-migration. While our rent growth and rent collection trends during the year ended December 31, 2022 were strong, we continue to monitor pressures surrounding inflation trends, general economic conditions and housing supply. A worsening of the current environment could contribute to uncertain rent collections going forward and suppress demand for apartments and could drive lower rent growth on new leases and renewals than what we achieved during the year ended December 31, 2022. Current elevated supply levels could further affect rent growth for our portfolio, though we expect the demand side to continue to be more impactful over the long term. Supply chain and inflationary pressures have driven higher operating expenses during the year ended December 31, 2022, particularly in personnel, repairs and maintenance and real estate taxes, and this trend may continue going forward. Access to the financial markets remains available for high credit rated borrowers. However, a prolonged disruption of the markets or a decline in credit and financing conditions could negatively affect our ability to access capital necessary to fund our operations or refinance maturing debt in the future. Additionally, rising interest rates could negatively impact our borrowing costs for any variable rate borrowings or refinancing activity. Results of Operations For the year ended December 31, 2022, we achieved net income available for MAA common shareholders of $633.7 million, a 19.6% increase as compared to the year ended December 31, 2021, and total revenue growth of $241.8 million, representing a 13.6% increase in property revenues as compared to the year ended December 31, 2021. The following discussion describes the primary drivers of the increase in net income available for MAA common shareholders for the year ended December 31, 2022 as compared to the year ended December 31, 2021. A discussion of the results of operations for the year ended December 31, 2021 as compared to the year ended December 31, 2020 is found in Item 7 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 17, 2022, which is available free of charge on the SEC’s website at https://www.sec.gov and on our website at https://www.maac.com, on the “For Investors” page under “Filings and Financials—Annual Reports.” Property Revenues The following table reflects our property revenues by segment for the year ended December 31, 2022 (dollars in thousands): December 31, 2022 December 31, 2021 Increase % Change Same Store $ 1,924,709 $ 1,695,234 $ 229,475 13.5 % Non-Same Store and Other 95,157 82,848 12,309 14.9 % Total $ 2,019,866 $ 1,778,082 $ 241,784 13.6 % The increase in rental revenues for our Same Store segment for the year ended December 31, 2022 as compared to the year ended December 31, 2021 was the primary driver of total property revenue growth. The Same Store segment generated a 13.5% increase in revenues for the year ended December 31, 2022, primarily the result of average effective rent per unit growth of 14.6% as compared to the year ended December 31, 2021, partially offset by lower average physical occupancy. The increase in property revenues from the Non-Same Store and Other segment for the year ended December 31, 2022 as compared to the year ended December 31, 2021 was primarily the result of increased revenues from recently completed development communities and acquired communities, partially offset by decreased revenues from recently disposed communities. Property Operating Expenses Property operating expenses include costs for property personnel, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping and other operating expenses. The following table reflects our property operating expenses by segment for the year ended December 31, 2022 (dollars in thousands): December 31, 2022 December 31, 2021 Increase % Change Same Store $ 682,014 $ 633,662 $ 48,352 7.6 % Non-Same Store and Other 41,680 37,503 4,177 11.1 % Total $ 723,694 $ 671,165 $ 52,529 7.8 % The increase in property operating expenses for our Same Store segment for the year ended December 31, 2022 as compared to the year ended December 31, 2021 was primarily driven by increases in real estate tax expense of $15.0 million, personnel expense of $9.6 million, building repairs and maintenance of $9.2 million, utilities expense of $6.9 million, office operations expense of $4.3 million, and insurance expense of $3.1 million. The increase in property operating expenses from the Non-Same Store and Other segment for the year ended December 31, 2022 as compared to the year ended December 31, 2021 was primarily the result of $1.8 million of storm-related expenses related to hurricanes and increased property operating expenses from recently completed development communities and acquired communities, partially offset by decreased property operating expenses from recently disposed communities. 28 Depreciation and Amortization Depreciation and amortization expense for the year ended December 31, 2022 was $543.0 million, an increase of $9.6 million as compared to the year ended December 31, 2021. The increase was primarily driven by the recognition of depreciation expense associated with our recently completed development communities and capital spend activities made in the normal course of business during the year ended December 31, 2022, partially offset from decreased depreciation expense from recently disposed communities. Other Income and Expenses Property management expenses for the year ended December 31, 2022 were $65.5 million, an increase of $9.7 million as compared to the year ended December 31, 2021. General and administrative expenses for the year ended December 31, 2022 were $58.8 million, an increase of $5.9 million as compared to the year ended December 31, 2021. Interest expense for the year ended December 31, 2022 was $154.7 million, a decrease of $2.1 million as compared to the year ended December 31, 2021. The decrease was primarily due to a decrease in our average outstanding debt balance during the year ended December 31, 2022 as compared to the year ended December 31, 2021. For the year ended December 31, 2022, we disposed of four apartment communities, resulting in a gain on sale of depreciable real estate assets of $214.8 million. For the year ended December 31, 2021, we disposed of seven apartment communities, resulting in a gain on sale of depreciable real estate assets of $220.4 million. During the year ended December 31, 2022, we disposed of two land parcels resulting in a gain on sale of non-depreciable real estate assets of $0.8 million. During the year ended December 31, 2021, we disposed of five land parcels resulting in a gain on sale of non-depreciable real estate assets of $0.8 million. Other non-operating expense (income) for the year ended December 31, 2022 was $42.7 million of expense, as compared to $33.9 million of income for the year ended December 31, 2021. The expense for the year ended December 31, 2022 was driven by $45.4 million of non-cash loss from investments, $21.1 million of non-cash loss related to the fair value adjustment of the embedded derivative in the MAA Series I preferred shares, partially offset by $29.9 million in net casualty gain primarily due to winter storm Uri. The income for the year ended December 31, 2021 was driven by $51.7 million of non-cash gain from investments, partially offset by $13.4 million in debt extinguishment costs and $4.6 million of non-cash loss related to the fair value adjustment of the embedded derivative. Funds from Operations and Core Funds from Operations Funds from operations, or FFO, a non-GAAP financial measure, represents net income available for MAA common shareholders (computed in accordance with the U.S. generally accepted accounting principles, or GAAP) excluding gains or losses on disposition of operating properties and asset impairment, plus depreciation and amortization of real estate assets, net income attributable to noncontrolling interests and adjustments for joint ventures. Because net income attributable to noncontrolling interests is added back, FFO, when used in this Annual Report on Form 10-K, represents FFO attributable to the Company. FFO should not be considered as an alternative to net income available for MAA common shareholders or any other GAAP measurement, as an indicator of operating performance or as an alternative to cash flow from operating, investing and financing activities as a measure of liquidity. Management believes that FFO is helpful to investors in understanding our operating performance, primarily because its calculation excludes depreciation and amortization expense on real estate assets and gain on sale of depreciable real estate assets. We believe that GAAP historical cost depreciation of real estate assets is generally not correlated with changes in the value of those assets, whose value does not diminish predictably over time, as historical cost depreciation implies. While our calculation of FFO is in accordance with the National Association of Real Estate Investment Trusts’, or NAREIT’s, definition, it may differ from the methodology for calculating FFO utilized by other REITs and, accordingly, may not be comparable to such other REITs. Core FFO represents FFO as adjusted for items that are not considered part of our core business operations, such as adjustments related to the fair value of the embedded derivative in the MAA Series I preferred shares; gain or loss on sale of non-depreciable assets; gain or loss on investments, net of tax; casualty related (recoveries) charges, net; gain or loss on debt extinguishment; legal costs and settlements, net; COVID-19 related costs and mark-to-market debt adjustments. While our definition of Core FFO may be similar to others in the industry, our methodology for calculating Core FFO may differ from that utilized by other REITs and, accordingly, may not be comparable to such other REITs. Core FFO should not be considered as an alternative to net income available for MAA common shareholders, or any other GAAP measurement, as an indicator of operating performance or as an alternative to cash flow from operating, investing and financing activities as a measure of liquidity. We believe that Core FFO is helpful in understanding our core operating performance between periods in that it removes certain items that by their nature are not comparable over periods and therefore tend to obscure actual operating performance from rental activities. 29 The following table presents a reconciliation of net income available for MAA common shareholders to FFO and Core FFO for the years ended December 31, 2022 and 2021, as we believe net income available for MAA common shareholders is the most directly comparable GAAP measure (dollars in thousands): Year ended December 31, 2022 2021 Net income available for MAA common shareholders $ 633,748 $ 530,103 Depreciation and amortization of real estate assets 535,835 526,220 Gain on sale of depreciable real estate assets (214,762 ) (220,428 ) Depreciation and amortization of real estate assets of real estate joint venture 621 616 Net income attributable to noncontrolling interests 17,340 16,911 FFO attributable to the Company 972,782 853,422 Loss on embedded derivative in preferred shares (1) 21,107 4,560 Gain on sale of non-depreciable real estate assets (809 ) (811 ) Loss (gain) on investments, net of tax (1)(2) 35,822 (40,875 ) Casualty related (recoveries) charges, net (3) (29,930 ) 1,524 Loss on debt extinguishment (1) 47 13,391 Legal costs and settlements, net (1) 8,535 (2,167 ) COVID-19 related costs (1) 575 1,301 Mark-to-market debt adjustment (4) 77 270 Core FFO $ 1,008,206 $ 830,615 (1)Included in “Other non-operating expense (income)” in the Consolidated Statements of Operations. (2)For the years ended December 31, 2022 and 2021, loss (gain) on investments are presented net of tax benefit of $9.5 million and net of tax expense of $10.8 million, respectively. (3)During the year ended December 31, 2022, MAA incurred $5.8 million in casualty losses related to winter storm Elliot (primarily building repairs, landscaping and asset write-offs). During the year ended December 31, 2021, MAA incurred $26.0 million in casualty losses related to winter storm Uri. The majority of the storm costs are expected to be or have been reimbursed through insurance coverage. An insurance recovery was recognized in Other non-operating expense (income) in the amount of the recognized losses that MAA expects to recover. Additional costs related to the storms that are not expected to be recovered through insurance coverage, along with other unrelated casualty losses and recoveries, including the receipt of insurance proceeds that exceeded the recognized casualty losses from winter storm Uri, are reflected in Casualty related (recoveries) charges, net. For the year ended December 31, 2022, MAA recognized $29.0 million from the receipt of insurance proceeds that exceeded its casualty losses related to winter storm Uri. The adjustments are primarily included in “Other non-operating expense (income)” in the Consolidated Statements of Operations. (4)Included in “Interest expense” in the Consolidated Statements of Operations. Core FFO for the year ended December 31, 2022 was $1.0 billion, an increase of $177.6 million as compared to the year ended December 31, 2021, primarily as a result of an increase in property revenues of $241.8 million, partially offset by increases in property operating expenses, excluding depreciation and amortization, of $52.5 million, property management expenses of $9.7 million and general and administrative expenses of $5.9 million. Liquidity and Capital Resources Overview Our cash flows from operating, investing and financing activities, as well as general economic and market conditions, are the principal factors affecting our liquidity and capital resources. We expect that our primary uses of cash will be to fund our ongoing operating needs, to fund our ongoing capital spending requirements, which relate primarily to our development, redevelopment and property repositioning activities, to repay maturing borrowings, to fund the future acquisition of assets and to pay shareholder dividends. We expect to meet our cash requirements through net cash flows from operating activities, existing unrestricted cash and cash equivalents, borrowings under our commercial paper program and our revolving credit facility, the future issuance of debt and equity and the future disposition of assets. We historically have had positive net cash flows from operating activities. We believe that future net cash flows generated from operating activities, existing unrestricted cash and cash equivalents, borrowing capacity under our current commercial paper program and revolving credit facility, and our ability to issue debt and equity will provide sufficient liquidity to fund the cash requirements for our business over the next 12 months and the foreseeable future. As of December 31, 2022, we had $1.3 billion of combined unrestricted cash and cash equivalents and available capacity under our revolving credit facility. 30 Cash Flows from Operating Activities Net cash provided by operating activities was $1.1 billion for the year ended December 31, 2022 as compared to $895.0 million for the year ended December 31, 2021. The increase in operating cash flows was primarily driven by our operating performance, partially offset by the timing of cash payments. Cash Flows from Investing Activities Net cash used in investing activities was $405.2 million for the year ended December 31, 2022 as compared to $253.6 million for the year ended December 31, 2021. The primary drivers of the change were as follows (dollars in thousands): Primary drivers of cash (outflow) inflowduring the year ended December 31, (Decrease) Increase 2022 2021 in Net Cash Purchases of real estate and other assets $ (271,428 ) $ (46,028 ) $ (225,400 ) Capital improvements and other (296,176 ) (279,635 ) (16,541 ) Development costs (172,124 ) (231,642 ) 59,518 Contributions to affiliates (13,849 ) (4,669 ) (9,180 ) Proceeds from real estate asset dispositions 320,491 293,071 27,420 Proceeds from insurance recoveries 27,312 14,820 12,492 The increase in cash outflows for purchases of real estate and other assets was driven by the nature of the real estate assets acquired during the year ended December 31, 2022 as compared to the year ended December 31, 2021. During the year ended December 31, 2022, we acquired two apartment communities and closed on the pre-purchase of a multifamily development community. During the year ended December 31, 2021, we closed on the pre-purchase of two multifamily development communities. The increase in cash outflows for capital improvements and other was primarily driven by increased capital spend relating to our property redevelopment and repositioning activities and recurring capital replacements, partially offset by decreased reconstruction-related capital expenditures relating to winter storm Uri during the year ended December 31, 2022 as compared to the year ended December 31, 2021. The decrease in cash outflows for development costs was driven by decreased development spend during the year ended December 31, 2022 as compared to the year ended December 31, 2021. The increase in cash outflows for contributions to affiliates was driven by investments in the technology-focused limited partnerships during the year ended December 31, 2022, while less limited partnership contributions were made during the year ended December 31, 2021. The increase in cash inflows from proceeds from real estate asset dispositions was driven by the nature and quality of the real estate assets sold during the year ended December 31, 2022 as compared to the year ended December 31, 2021. During the year ended December 31, 2022, we sold four apartment communities as compared to seven apartment communities during the year ended December 31, 2021. The increase in cash inflows from proceeds from insurance recoveries was driven by increased insurance reimbursements received for casualty claims related to winter storm Uri during the year ended December 31, 2022 as compared to the year ended December 31, 2021. Cash Flows from Financing Activities Net cash used in financing activities was $722.8 million for the year ended December 31, 2022 as compared to $546.4 million for the year ended December 31, 2021. The primary drivers of the change were as follows (dollars in thousands): Primary drivers of cash inflow (outflow) during the year ended December 31, Increase (Decrease) 2022 2021 in Net Cash Net change in commercial paper $ 20,000 $ (172,000 ) $ 192,000 Proceeds from notes payable — 594,423 (594,423 ) Principal payments on notes payable (126,401 ) (467,153 ) 340,752 Dividends paid on common shares (539,605 ) (470,401 ) (69,204 ) Acquisition of noncontrolling interests (43,070 ) — (43,070 ) The increase in cash inflows related to the net change in commercial paper resulted from the increase in net borrowings of $20.0 million on our commercial paper program during the year ended December 31, 2022 as compared to the decrease in net borrowings of $172.0 million on our commercial paper program during the year ended December 31, 2021. The decrease in cash inflows related to proceeds from notes payable primarily resulted from no issuance of unsecured senior notes during the year ended December 31, 2022 as compared to the issuance of $600.0 million of unsecured senior notes during the year ended December 31, 2021. The decrease in cash outflows from principal payments on notes payable primarily resulted from the retirement of $125.0 million of unsecured senior notes during the year ended December 31, 2022 as compared to the retirement of $222.0 million of senior unsecured private placement notes, $125.0 million of unsecured senior notes and $118.6 million of property mortgages during the year ended December 31, 2021. The increase in cash outflows from dividends paid on common shares primarily resulted from the increase in the dividend rate to $4.675 per share during the year ended December 31, 2022 as compared to the dividend rate of $4.10 per share 31 during the year ended December 31, 2021. The increase in cash outflows from the acquisition of noncontrolling interests resulted from the acquisition of the noncontrolling interest of a consolidated real estate entity for $43.1 million during the year ended December 31, 2022. Debt The following schedule reflects our outstanding debt as of December 31, 2022 (dollars in thousands): Principal Balance Average Years to Rate Maturity Effective Rate Unsecured debt Fixed rate senior notes $ 4,050,000 6.4 3.4 % Variable rate commercial paper 20,000 0.1 4.7 % Debt issuance costs, discounts, premiums and fair market value adjustments (19,090 ) Total unsecured debt $ 4,050,910 6.3 3.4 % Secured debt Fixed rate property mortgages $ 367,154 25.8 4.4 % Debt issuance costs (3,161 ) Total secured debt $ 363,993 25.8 4.4 % Total debt $ 4,414,903 7.9 3.4 % The following schedule presents the contractual maturity dates of our outstanding debt, net of debt issuance costs, discounts, premiums and fair market value adjustments as of December 31, 2022 (dollars in thousands): Commercial Paper & Revolving Credit Facility ⁽¹⁾ ⁽²⁾ Senior Notes Property Mortgages Total 2023 $ 20,000 $ 349,509 $ — $ 369,509 2024 — 398,842 — 398,842 2025 — 397,773 3,978 401,751 2026 — 297,202 — 297,202 2027 — 596,548 — 596,548 2028 — 396,695 — 396,695 2029 — 559,082 — 559,082 2030 — 297,542 — 297,542 2031 — 444,985 — 444,985 2032 — — — — Thereafter — 292,732 360,015 652,747 Total $ 20,000 $ 4,030,910 $ 363,993 $ 4,414,903 (1)There was $20.0 million outstanding under MAALP’s commercial paper program as of December 31, 2022. Under the terms of the program, MAALP may issue up to a maximum aggregate amount outstanding at any time of $625.0 million. For the year ended December 31, 2022, average daily borrowings outstanding under the commercial paper program were $34.9 million. (2)There were no borrowings outstanding under MAALP’s $1.25 billion unsecured revolving credit facility as of December 31, 2022. The following schedule reflects the interest rate maturities of our outstanding fixed rate debt, net of debt issuance costs, discounts, premiums and fair market value adjustments as of December 31, 2022 (dollars in thousands): Fixed Rate Debt Effective Rate 2023 $ 349,509 4.2 % 2024 398,842 4.0 % 2025 401,751 4.2 % 2026 297,202 1.2 % 2027 596,548 3.7 % 2028 396,695 4.2 % 2029 559,082 3.7 % 2030 297,542 3.1 % 2031 444,985 1.8 % 2032 — — Thereafter 652,747 3.8 % Total $ 4,394,903 3.4 % 32 Unsecured Revolving Credit Facility & Commercial Paper In July 2022, MAALP amended its unsecured revolving credit facility, increasing its borrowing capacity to $1.25 billion with an option to expand to $2.0 billion. The revolving credit facility bears interest at an adjusted Secured Overnight Financing Rate plus a spread of 0.70% to 1.40% based on an investment grade pricing grid. The revolving credit facility has a maturity date in October 2026 with an option to extend for two additional six-month periods. As of December 31, 2022, there was no outstanding balance under the revolving credit facility, while $4.3 million of capacity was used to support outstanding letters of credit. MAALP has established an unsecured commercial paper program, whereby it can issue unsecured commercial paper notes with varying maturities not to exceed 397 days. In September 2022, MAALP amended its commercial paper program to increase the maximum aggregate principal amount of notes that may be outstanding from time to time under the program from $500.0 million to $625.0 million. As of December 31, 2022, there were $20.0 million of borrowings outstanding under the commercial paper program. Unsecured Senior Notes As of December 31, 2022, MAALP had $4.1 billion of publicly issued unsecured senior notes outstanding. In September 2022, MAALP retired the remaining $125.0 million portion of its publicly issued unsecured senior notes due in December 2022. Secured Property Mortgages MAALP maintains secured property mortgages with various life insurance companies. As of December 31, 2022, MAALP had $367.2 million of secured property mortgages outstanding. For more information regarding our debt capital resources, see Note 5 to the consolidated financial statements included in this Annual Report on Form 10-K. Equity As of December 31, 2022, MAA owned 115,480,336 OP Units, comprising a 97.3% limited partnership interest in MAALP, while the remaining 3,164,933 outstanding OP Units were held by limited partners of MAALP other than MAA. Holders of OP Units (other than MAA) may require us to redeem their OP Units from time to time, in which case we may, at our option, pay the redemption price either in cash (in an amount per OP Unit equal, in general, to the average closing price of MAA’s common stock on the NYSE over a specified period prior to the redemption date) or by delivering one share of MAA’s common stock (subject to adjustment under specified circumstances) for each OP Unit so redeemed. MAA has registered under the Securities Act the 3,164,933 shares of its common stock that, as of December 31, 2022, were issuable upon redemption of OP Units, in order for those shares to be sold freely in the public markets. In August 2021, MAA entered into two 18-month forward sale agreements with respect to a total of 1.1 million shares of its common stock at an initial forward sale price of $190.56 per share, which is net of issuance costs. Under the forward sale agreements, the forward sale price is subject to adjustment on a daily basis based on a floating interest rate factor equal to a specified daily rate less a spread and will be decreased based on amounts related to dividends on MAA’s common stock during the term of the forward sale agreements. No shares had been settled under the forward sale agreements as of December 31, 2022. In January 2023, MAA settled its two forward sale agreements with respect to a total of 1.1 million shares at a forward price per share of $185.23, which is inclusive of adjustments made to reflect the then-current federal funds rate, the amount of dividends paid to holders of MAA common stock and commissions paid to sales agents, for net proceeds of $203.7 million. We intend to use these proceeds to fund our development and redevelopment activities, among other potential uses. In November 2021, the Company entered into an equity distribution agreement to establish a new ATM program, replacing MAA’s previous ATM program and allowing MAA to sell shares of its common stock from time to time to or through its sales agents into the existing market at current market prices, and to enter into separate forward sales agreements to or through its forward purchasers. Under its current ATM program, MAA has the authority to issue up to an aggregate of 4.0 million shares of its common stock, at such times to be determined by MAA. MAA has no obligation to issue shares through the ATM program. During the years ended December 31, 2022 and 2021, MAA did not sell any shares of common stock under its ATM program. As of December 31, 2022, there were 4.0 million shares remaining under the current ATM program. For more information regarding our equity capital resources, see Note 8 and Note 9 to the consolidated financial statements included in this Annual Report on Form 10-K. 33 Material Cash Requirements The following table summarizes material cash requirements as of December 31, 2022 related to contractual obligations, which consist of principal and interest on our debt obligations and right-of-use lease liabilities (dollars in thousands): 2023 2024 2025 2026 2027 Thereafter Total Debt obligations (1) $ 371,481 $ 401,566 $ 400,815 $ 300,000 $ 600,000 $ 2,363,292 $ 4,437,154 Fixed rate interest 149,027 127,021 118,070 103,099 88,161 579,987 1,165,365 Right-of-use lease liabilities (2) 2,885 2,862 2,872 2,920 2,969 57,024 71,532 Total $ 523,393 $ 531,449 $ 521,757 $ 406,019 $ 691,130 $ 3,000,303 $ 5,674,051 (1)Represents principal payments gross of debt issuance costs, discounts, premiums and fair market value adjustments of debt assumed. (2)Primarily comprised of a ground lease underlying one apartment community we own and the lease of our corporate headquarters. As of December 31, 2022, we also had obligations, which are not reflected in the table above, to make additional capital contributions to five technology-focused limited partnerships in which we hold equity interests. The capital contributions may be called by the general partners at any time after giving appropriate notice. As of December 31, 2022, we had committed to make additional capital contributions totaling up to $45.2 million if and when called by the general partners of the limited partnerships. We have other material cash requirements that do not represent contractual obligations, but we expect to incur in the ordinary course of our business. As of December 31, 2022, we had six development communities under construction totaling 2,310 apartment units once complete. Total expected costs for the six development projects are $728.7 million, of which $291.7 million had been incurred through December 31, 2022. In addition, our property redevelopment and repositioning activities are ongoing, and we incur expenditures relating to recurring capital replacements, which typically include scheduled carpet replacement, new roofs, HVAC units, plumbing, concrete, masonry and other paving, pools and various exterior building improvements. For the year ending December 31, 2023, we expect that our total capital expenditures relating to our development activities, our property redevelopment and repositioning activities and recurring capital replacements will be in line with our total capital expenditures for the year ended December 31, 2022. We expect to have additional development projects in the future. During the year ended December 31, 2022, we acquired two multifamily apartment communities for approximately $213 million, acquired four land parcels for future development for approximately $49 million, purchased the noncontrolling interest of a consolidated real estate entity for approximately $43 million and funded the pre-purchase of a multifamily community for approximately $10 million. These activities were primarily funded from the proceeds we received from the sale of four multifamily apartment communities in 2022. We typically declare cash dividends on MAA’s common stock on a quarterly basis, subject to approval by MAA’s Board of Directors. We expect to pay quarterly dividends at an annual rate of $5.60 per share of MAA common stock during the year ending December 31, 2023. The timing and amount of future dividends will depend on actual cash flows from operations, our financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code of 1986 and other factors as MAA’s Board of Directors deems relevant. MAA’s Board of Directors may modify our dividend policy from time to time. Inflation Our resident leases at our apartment communities allow for adjustments in the rental rate at the time of renewal, which may enable us to seek rent increases. The majority of our leases are for one year or less. The short-term nature of these leases generally serves to reduce our risk to adverse effects of inflation on our revenue. During the year ended December 31, 2022, we experienced inflationary pressures that drove higher operating expenses, primarily in personnel, repairs and maintenance and real estate taxes. 34 Critical Accounting Estimates A critical accounting estimate is one that is both important to our financial condition and results of operations and that involves some degree of uncertainty. The preceding discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements and the notes thereto, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires management to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable under the circumstances; however, actual results may differ from these estimates and assumptions. We believe that the estimates and assumptions summarized below are most important to the portrayal of our financial condition and results of operations because they involve a significant level of estimation uncertainty and they have had, or are reasonably likely to have, a material impact on our financial condition or results of operations. Acquisition of real estate assets We account for our acquisitions of investments in real estate as asset acquisitions in accordance with Accounting Standards Codification Topic 805, Business Combinations, which requires the cost of the real estate acquired to be allocated to the individual acquired tangible assets, consisting of land, buildings and improvements and other, and identified intangible assets, consisting of the value of in-place leases and other contracts, on a relative fair value basis. In calculating the asset value of acquired tangible and intangible assets, management may use significant subjective inputs, including forecasted net operating income, or NOI, and market specific capitalization and discount rates. Management analyzes historical stabilized NOI to determine its estimate for forecasted NOI. Management estimates the market capitalization rate by analyzing the market capitalization rates for sold properties with comparable ages in similarly sized markets. Management allocates the purchase price of the asset acquisition based on the relative fair value of the individual components as a proportion of the total assets acquired. Impairment of long-lived assets We account for long-lived assets in accordance with the provisions of accounting standards for the impairment or disposal of long-lived assets. Management periodically evaluates long-lived assets, including investments in real estate, for indicators that would suggest that the carrying amount of the assets may not be recoverable. The judgments regarding the existence of such indicators are based on factors such as operating performance, market conditions and legal factors. Long-lived assets, such as real estate assets, equipment, right-of-use lease assets and purchased intangibles subject to amortization, are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities, or an asset group. Management generally considers the individual assets of an apartment community to collectively represent an asset group. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated future undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. Management calculates the fair value of an asset by dividing estimated future annual cash flows by a market capitalization rate. No material impairment losses were recognized during the years ended December 31, 2022 and 2021. Our impairment assessments may contain uncertainties because they require management to make assumptions and to apply judgment to estimate future undiscounted cash flows and the fair value of the assets. Key assumptions used in estimating future cash flows and the fair value of an asset include projecting an apartment community’s NOI, estimating asset useful lives, disposition dates and recurring capital expenditures, as well as selecting an appropriate market capitalization rate. Management considers its apartment communities’ historical stabilized NOI performance, local market economics and the business environment impacting our apartment communities as the basis in projecting forecasted NOI, which management believes is representative of future cash flows. Management estimates the market capitalization rate by analyzing the market capitalization rates for sold properties with comparable ages in similarly sized markets. These estimates are subjective and our ability to realize future cash flows and asset fair values is affected by factors such as ongoing maintenance and improvement of the assets, changes in economic conditions and changes in operating performance. 35 Valuation of embedded derivative The redemption feature embedded in the MAA Series I preferred stock is reported as a derivative asset and is adjusted to its fair value at each reporting date, with a corresponding non-cash adjustment to the income statement. The derivative asset related to the redemption feature is valued using widely accepted valuation techniques, including a discounted cash flow analysis in which the perpetual value of the preferred shares is compared to the value of the preferred shares assuming the call option is exercised, with the value of the bifurcated call option as the difference between the two values. The analysis reflects the contractual terms of the redeemable preferred shares, which are redeemable at our option beginning on October 1, 2026 and at the redemption price of $50 per share. We use various significant inputs in the analysis, including trading data available on the preferred shares, estimated coupon yields on preferred stock instruments from REITs with similar credit ratings as MAA and treasury rates to determine the fair value of the bifurcated call option. As a result of the adjustments recorded to reflect the change in fair value of the derivative asset, the fair value of the embedded derivative asset decreased to $13.4 million as of December 31, 2022 as compared to $34.5 million as of December 31, 2021, a decrease in value of the asset of $21.1 million. Arriving at the valuation of the embedded derivative requires a significant amount of subjective judgment by management, and the valuation of the embedded derivative is highly sensitive to changes in certain inputs in the analysis. For example, changes in the inputs of the trading data available on the preferred shares, estimated coupon yields on preferred stock instruments from REITs with similar credit ratings as MAA and treasury rates could cause the valuation of the embedded derivative to materially change from the recorded balance as of December 31, 2022. For instance, holding all other assumptions constant, a $1 decrease in the trading price of the preferred shares as of December 31, 2022 would result in a decrease in fair value of the embedded derivative asset of approximately $3 million. Significant Accounting Policies For more information regarding our significant accounting policies, including the accounting polices related to the critical accounting estimates discussed above as well as a brief description of recent accounting pronouncements that could have a material impact on our financial statements, see Note 1 to the consolidated financial statements included in this Annual Report on Form 10-K. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. Our primary market risk exposure is to changes in interest rates on our borrowings. As of December 31, 2022, 19.2% of our total market capitalization consisted of debt borrowings. Our interest rate risk objective is to limit the impact of interest rate fluctuations on earnings and cash flows and to lower our overall borrowing costs. To achieve this objective, we manage our exposure to fluctuations in market interest rates for borrowings through the use of fixed rate debt instruments and from time to time interest rate swaps to effectively fix the interest rate on anticipated future debt transactions. We use our best efforts to have our debt instruments mature across multiple years, which we believe limits our exposure to interest rate changes in any one year. We do not enter into derivative instruments for trading or other speculative purposes. As of December 31, 2022, 99.5% of our outstanding debt was subject to fixed rates. We regularly review interest rate exposure on outstanding borrowings in an effort to minimize the risk of interest rate fluctuations.
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the consolidated financial statements and related notes which appear under Item 8 in this Annual Report on Form 10-K. This discussion and analysis contain, in addition to historical information, forward-looking statements that include risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under “Part I, Item 1A. Risk Factors” and elsewhere in this Annual Report on Form 10-K. Discussions of 2020 results and year-to-year comparisons between 2021 and 2020 that are omitted in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 25, 2022. Overview We are a fabless company with a global footprint that provides high-performance, semiconductor-based power electronic solutions. Incorporated in 1997, our three core strengths include deep system-level knowledge, strong semiconductor expertise, and innovative proprietary technologies in the areas of semiconductor processes, system integration, and packaging. These combined advantages enable us to deliver reliable, compact, and monolithic solutions found in storage and computing, enterprise data, automotive, industrial, communications and consumer applications. Our mission is to reduce energy and material consumption to improve all aspects of quality of life. We believe that we differentiate ourselves by offering solutions that are more highly integrated, smaller in size, more energy-efficient, more accurate with respect to performance specifications and, consequently, more cost-effective than many competing solutions. We plan to continue to introduce new products within our existing product families, as well as in new innovative product categories. We operate in the cyclical semiconductor industry. We are not immune from industry downturns, but we have targeted product and market areas that we believe have the ability to offer above average industry performance over the long term. Historically, our revenue has generally been higher in the second half of the year than in the first half although various factors, such as market conditions and the timing of key product introductions, could impact this trend. We work with third parties to manufacture and assemble our ICs. This has enabled us to limit our capital expenditures and fixed costs, while focusing our engineering and design resources on our core strengths. Following the introduction of a product, our sales cycle generally takes a number of quarters after we receive an initial customer order for a new product to ramp up. Typical supply chain lead times for orders are generally 16 to 26 weeks. These factors, combined with the fact that our customers can cancel or reschedule orders without significant penalty to the customer, make the forecasting of our orders and revenue difficult. We derive most of our revenue from sales through distribution arrangements and direct sales to customers in Asia, where our products are incorporated into end-user products. Our revenue from direct or indirect sales to customers in Asia was 86%, 90% and 91% for the years ended December 31, 2022, 2021 and 2020, respectively. We derive a majority of our revenue from the sales of our DC to DC converter products which serve the storage and computing, enterprise data, automotive, industrial, communications and consumer markets. We believe our ability to achieve revenue growth will depend, in part, on our ability to develop new products, enter new market segments, gain market share, manage litigation risk, diversify our customer base and continue to secure manufacturing capacity. Impact of COVID-19 on Our Business The COVID-19 pandemic has had, and continues to have, a significant impact around the world. Our primary focus is to continue to execute our business plan and mitigate the effect of the COVID-19 pandemic on our financial position and operations, while actively taking all necessary precautions to ensure the safety of our employees, our suppliers and our customers. The pandemic did not have a material adverse impact on our overall operating results or business operations for the year ended December 31, 2022. In 2022, China has continued to experience outbreaks, specifically in Shanghai and Chengdu where we have business operations and where many of our customers and suppliers are located. Local governments have implemented, and may continue to implement, strict measures including quarantines, shutdowns and other business restrictions, which have resulted in logistics challenges throughout China. Although these strict measures and the disruptions, as a result thereof, did not have a material adverse impact on our operations in 2022, we will continue to monitor and evaluate future developments. However, we cannot reasonably estimate the potential effect of these measures on the global economy, the semiconductor industry and our business. We have worked, and are continuing to actively work, with our stakeholders, including customers, suppliers and employees, to address the impact of the pandemic. We will continue to monitor the situation, to assess further possible implications to our business, supply chain and customers, and to take actions in an effort to mitigate adverse consequences to the extent feasible. A prolonged economic slowdown as a result of the pandemic, or otherwise, could materially and adversely impact our business, results of operations and financial condition for 2023 and beyond. 31 Table of Contents Russia-Ukraine Conflict As the Russia-Ukraine conflict continues to evolve, we are closely monitoring the impact of future developments on our business, supply chain, employees, customers and other business partners. Our total revenue in Russia has historically not been material and we have stopped shipping to customers in Russia. All accounts receivable balances from our customers in Russia have been paid. Macroeconomic Conditions and Recent Regulations During 2022, the semiconductor industry faced a number of macro-economic challenges including the impact of supply chain capacity constraints, wide swings in customer demand, rising inflation, increased interest rates, and fluctuations in currency rates. We remain cautious in light of changing macroeconomic conditions and will continue to monitor potential impact on our operations. The implications of macroeconomic events on our business, results of operations and overall financial position remain uncertain. There also have been recent changes to export control laws, trade regulations and other trade requirements. As of December 31, 2022 and through the date we filed this Annual Report, there have been a number of additional trade restrictions introduced. To date, those restrictions have had an immaterial impact on our revenue and operations. We will continue to monitor any changes to export control laws, trade regulations and other trade requirements and are committed to complying with all applicable trade laws, regulations and other requirements. Cybersecurity Risk Management We are committed to protecting our IT assets, including computers, systems, corporate networks and sensitive data, from unauthorized access or attack. We have established an internal global IT policy handbook as well as IT security management control procedures designed to: ● Create information security awareness and define responsibilities among our employees and business partners; ● Implement controls to identify IT risks and monitor the use of our systems and information resources; ● Establish key policies and processes to adequately and timely respond to security threats; ● Maintain disaster recovery and business continuity plans; and ● Ensure compliance with applicable laws and regulations regarding the management of information security. We require all new employees to attend an IT security training orientation. In addition, on a regular basis, our IT team updates training materials related to our policies and procedures and shares news and articles related to cybersecurity awareness, both of which are stored on our intranet and available to all employees. We also currently maintain an insurance policy that provides certain coverage for losses we incur due to data breaches and other cybersecurity incidents. Our IT Steering Committee, which consists of our senior management and IT team, meets on a regular basis to review initiatives and projects to improve IT security, as well as resources and budgets for our cybersecurity compliance and education efforts. In 2021, we completed the ISO 27001 certification, a globally recognized information security standard. Our Audit Committee of the Board of Directors, which consists of three independent members, is responsible for the oversight of our cybersecurity risk program. At least quarterly, the Audit Committee reviews reports and updates from our Chief Financial Officer and IT senior management about major risk exposures, their potential impact on our business operations, and management’s strategies to assess, monitor and mitigate those risks. The Audit Committee also provides updates of their oversight and findings to the Board of Directors. We believe we have adequate resources and sufficient policies, procedures and oversight in place to identify and manage our IT security risks to our business operations. To date, we do not believe we have experienced any material information security breaches and have not incurred significant operating expenses related to information security breaches. 32 Table of Contents Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis, including those related to revenue recognition, stock-based compensation, inventories, income taxes and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and judgments used in the preparation of our financial statements are, by their nature, uncertain and unpredictable, and depend upon, among other things, many factors outside of our control, including demand for our products, economic conditions and other current and future events, such as macroeconomic factors, including the impact of the COVID-19 pandemic, the global economic downturn and the Russia-Ukraine conflict. Actual results could differ from these estimates and assumptions, and any such differences may be material to our consolidated financial statements. See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for a summary of significant accounting policies and the effect on our financial statements. As of the date of issuance of these consolidated financial statements, we are not aware of any specific event or circumstance that would require our management to update the significant estimates and assumptions used in the preparation of the consolidated financial statements. As new events continue to evolve and additional information becomes available, any changes to these estimates and assumptions will be recognized in the consolidated financial statements as soon as they become known. We believe the following critical accounting policies reflect our more significant judgments used in the preparation of our consolidated financial statements. Revenue Recognition We account for price adjustments and stock rotation rights as variable consideration that reduces the transaction price, and recognize that reduction in the same period the associated revenue is recognized. Four U.S.-based distributors have price adjustment rights when they sell our products to their end customers at a price that is lower than the distribution price invoiced by us. When we receive claims from the distributors that products have been sold to the end customers at the lower price, we issue the distributors credit memos for the price adjustments. We estimate the price adjustments using the expected value method based on an analysis of historical claims, at both the distributor and product level, as well as an assessment of any known trends of product sales mix. Certain distributors have limited stock rotation rights that permit the return of a small percentage of the previous six months’ purchases in accordance with the contract terms. We estimate the stock rotation returns using the expected value method based on an analysis of historical returns, and the current level of inventory in the distribution channel. Overall, our estimates of adjustments to contract price due to variable consideration have been materially consistent with actual results; however, these estimates are subject to management’s judgment and actual provisions could be different from our estimates and current provisions, resulting in future adjustments to our revenue and operating results. Inventory Valuation Inventories are stated at the lower of standard cost (which approximates actual cost determined on a first-in first-out basis) and estimated net realizable value. We write down excess and obsolete inventories based on their age and forecasted demand, which includes estimates taking into consideration our revenue forecast, outlook on market and economic conditions, technology changes, new product introductions and changes in strategic direction. If actual demand or market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Conversely, if actual demand or market conditions are more favorable, inventories may be sold that were previously written down. Accounting for Income Taxes Our calculation of current and deferred tax assets and liabilities is based on certain estimates and judgments and involves dealing with uncertainties in the application of complex tax laws. Our estimates of current and deferred tax assets and liabilities may change based, in part, on added certainty, finality or uncertainty to an anticipated outcome, changes in accounting or tax laws in the U.S. or foreign jurisdictions where we operate, or changes in other facts or circumstances. In addition, we recognize liabilities for potential U.S. and foreign income tax for uncertain income tax positions taken on our tax returns if it has less than a 50% likelihood of being sustained. If we determine that payment of these amounts is unnecessary or if the recorded tax liability is less than our current assessment, we may be required to recognize an income tax benefit or additional income tax expense in our financial statements in the period such determination is made. As of December 31, 2022 and 2021, we had a valuation allowance of $20.3 million and $19.5 million, respectively, attributable to management’s determination that it is more likely than not that certain deferred tax assets will not be fully realized. In the event we determine that it is more likely than not that we would be able to realize the deferred tax assets in the future in excess of our net recorded amount, an adjustment to the valuation allowance for the deferred tax assets would increase income in the period such determination was made. Likewise, should it be determined that additional amounts of the net deferred tax assets will not be realized in the future, an adjustment to increase the deferred tax assets valuation allowance will be charged to income in the period such determination is made. 33 Table of Contents Contingencies We record a contingent liability related to pending legal and regulatory proceedings when it is probable that a loss has been incurred and the amount is reasonably estimable. Based on the facts and circumstances in each matter, the determination of such liability requires significant judgment. In determining the amount of a contingent loss, we take into account advice received from experts for each specific matter regarding the status of legal proceedings, settlement negotiations, prior case history and other factors. Should the judgments and estimates made by management need to be adjusted as additional information becomes available, we may need to record additional contingent losses that could materially and adversely impact our results of operations. Alternatively, if the judgments and estimates made by management are adjusted, for example, if a particular contingent loss does not occur, the contingent loss recorded would be reversed which could result in a favorable impact on our results of operations. Stock-Based Compensation For equity awards with performance conditions, as well as awards containing both market and performance conditions, we recognize compensation expense when it becomes probable that the performance goals will be achieved. Management performs the probability assessment on a quarterly basis by reviewing external factors, such as macroeconomic conditions and the analog industry revenue forecasts, and internal factors, such as our business and operational objectives and revenue forecasts. Changes in the probability assessment of achievement of the performance conditions are accounted for in the period of change by recording a cumulative catch-up adjustment as if the new estimate had been applied since the service inception date. If the projected achievement was revised upward or if the actual results were higher than the projected achievement, additional compensation expense would be recorded for the awards due to the cumulative catch-up adjustment, which would have an adverse impact on our results of operations. Conversely, if the projected achievement was revised downward or if the actual results were lower than the projected achievement, previously accrued compensation expense would be reversed for the awards, which would have a favorable impact on our results of operations. As a result, our stock-based compensation expense is subject to volatility and may fluctuate significantly each quarter due to changes in our probability assessment of achievement of the performance conditions or actual results being different from projections made by management. Recent Accounting Pronouncements See Note 1 of the Notes to Consolidated Financial Statements regarding accounting pronouncements not yet adopted as of December 31, 2022. Results of Operations The following table summarizes our results of operations: Year Ended December 31, 2022 2021 2020 (in thousands, except percentages) Revenue $ 1,794,148 100.0 % $ 1,207,798 100.0 % $ 844,452 100.0 % Cost of revenue 745,596 41.6 522,339 43.2 378,498 44.8 Gross profit 1,048,552 58.4 685,459 56.8 465,954 55.2 Operating expenses: Research and development 240,171 13.4 190,627 15.8 137,598 16.3 Selling, general and administrative 273,595 15.2 226,190 18.7 161,670 19.1 Litigation expense, net 8,001 0.4 6,225 0.6 7,804 1.0 Total operating expenses 521,767 29.0 423,042 35.1 307,072 36.4 Operating income 526,785 29.4 262,417 21.7 158,882 18.8 Other income (expense), net (1,848 ) (0.1 ) 9,802 0.8 10,460 1.3 Income before income taxes 524,937 29.3 272,219 22.5 169,342 20.1 Income tax expense 87,265 4.9 30,196 2.5 4,967 0.6 Net income $ 437,672 24.4 % $ 242,023 20.0 % $ 164,375 19.5 % 34 Table of Contents Revenue The following table summarizes our revenue by end market: Year Ended December 31, Change From From % of % of % of 2021 to 2020 to End Market 2022 Revenue 2021 Revenue 2020 Revenue 2022 2021 (in thousands, except percentages) Storage and Computing $ 452,594 25.3 % $ 255,933 21.2 % $ 180,293 21.4 % 76.8 % 42.0 % Enterprise Data 251,415 14.0 116,345 9.6 72,884 8.6 116.1 % 59.6 % Automotive 300,016 16.7 204,335 16.9 108,966 12.9 46.8 % 87.5 % Industrial 219,179 12.2 184,784 15.3 119,603 14.2 18.6 % 54.5 % Communications 251,452 14.0 164,091 13.6 142,326 16.8 53.2 % 15.3 % Consumer 319,492 17.8 282,310 23.4 220,380 26.1 13.2 % 28.1 % Total $ 1,794,148 100.0 % $ 1,207,798 100.0 % $ 844,452 100.0 % 48.5 % 43.0 % Revenue for the year ended December 31, 2022 was $1,794.1 million, an increase of $586.3 million, or 48.5%, from $1,207.8 million for the year ended December 31, 2021. The increase in revenue was primarily due to increases in the average selling prices resulting primarily from the sale of higher value products and increases in shipment volume. For the year ended December 31, 2022, revenue from the storage and computing market increased $196.7 million, or 76.8%, from the same period in 2021. This increase was primarily driven by strong sales growth for storage applications and enterprise notebooks. Revenue from the enterprise data market increased $135.1 million, or 116.1%, from the same period in 2021. This increase was primarily due to higher sales of our power management solutions for cloud-based CPU and GPU server applications. Revenue from the automotive market increased $95.7 million, or 46.8%, from the same period in 2021. This increase was primarily due to increased sales of our highly integrated applications supporting automated driver assistance systems, digital cockpits and connectivity. Revenue from the industrial market increased $34.4 million, or 18.6%, from the same period in 2021. This increase was primarily due to higher sales in applications for smart meters and industrial automation. Revenue from the communications market increased $87.4 million, or 53.2%, from the same period in 2021. The increase was primarily due to higher sales of products for both 5G and satellite communications infrastructure applications. Revenue from the consumer market increased $37.2 million, or 13.2%, from the same period in 2021. This increase was primarily driven by increased sales for home appliances, gaming consoles and smart TVs. Cost of Revenue and Gross Margin Cost of revenue primarily consists of costs incurred to manufacture, assemble and test our products, as well as warranty costs, inventory-related and other overhead costs, and stock-based compensation expenses. Year Ended December 31, Change From 2021 to From 2020 to 2022 2021 2020 2022 2021 (in thousands, except percentages) Cost of revenue $ 745,596 $ 522,339 $ 378,498 42.7 % 38.0 % As a percentage of revenue 41.6 % 43.2 % 44.8 % Gross profit $ 1,048,552 $ 685,459 $ 465,954 53.0 % 47.1 % Gross margin 58.4 % 56.8 % 55.2 % Cost of revenue was $745.6 million, or 41.6% of revenue, for the year ended December 31, 2022, and $522.3 million, or 43.2% of revenue, for the year ended December 31, 2021. The $223.3 million increase in cost of revenue was primarily due to increased shipment volume, product mix, increases in manufacturing overhead costs and increased input cost. Gross margin was 58.4% for the year ended December 31, 2022, compared with 56.8% for the year ended December 31, 2021. The increase in gross margin was mainly driven by lower warranty expenses as a percentage of revenue and a favorable product mix. Research and Development (“R&D”) R&D expenses primarily consist of salary and benefit expenses, bonuses, stock-based compensation and deferred compensation for design and product engineers, expenses related to new product development and supplies, and facility costs. Year Ended December 31, Change From 2021 to From 2020 to 2022 2021 2020 2022 2021 (in thousands, except percentages) R&D expenses $ 240,171 $ 190,627 $ 137,598 26.0 % 38.5 % As a percentage of revenue 13.4 % 15.8 % 16.3 % R&D expenses were $240.2 million, or 13.4% of revenue, for the year ended December 31, 2022, and $190.6 million, or 15.8% of revenue, for the year ended December 31, 2021. The $49.6 million increase in R&D expenses was primarily due to an increase of $40.1 million in cash compensation expenses, which include salary, benefits and bonuses, and an increase of $9.3 million in stock-based compensation expenses, which were mainly associated with performance-based equity awards. The increase was partially offset by a $4.7 million benefit related to changes in the value of deferred compensation plan liabilities. Our R&D headcount was 1,328 employees as of December 31, 2022, compared with 1,087 employees as of December 31, 2021. 35 Table of Contents Selling, General and Administrative (“SG&A”) SG&A expenses primarily include salary and benefit expenses, bonuses, stock-based compensation and deferred compensation for sales, marketing and administrative personnel, sales commissions, travel expenses, facilities costs, and professional service fees. Year Ended December 31, Change From 2021 to From 2020 to 2022 2021 2020 2022 2021 (in thousands, except percentages) SG&A expenses $ 273,595 $ 226,190 $ 161,670 21.0 % 39.9 % As a percentage of revenue 15.2 % 18.7 % 19.1 % SG&A expenses were $273.6 million, or 15.2% of revenue, for the year ended December 31, 2022, and $226.2 million, or 18.7% of revenue, for the year ended December 31, 2021. The $47.4 million increase in SG&A expenses was primarily due to an increase of $27.0 million in stock-based compensation expenses, which were mainly associated with performance-based equity awards, and $20.7 million in cash compensation expenses, which include salary, benefits and bonuses. The increase was partially offset by a $7.2 million benefit related to changes in the value of deferred compensation plan liabilities. Our SG&A headcount was 780 employees as of December 31, 2022, compared with 688 employees as of December 31, 2021. Litigation Expense, Net Litigation expense was $8.0 million for the year ended December 31, 2022, compared with litigation expense, net, of $6.2 million for the year ended December 31, 2021. The expense for both periods was attributable to litigation activity related to ongoing patent infringement and other matters. Other Income (Expense), Net Other expense, net, was $1.8 million for the year ended December 31, 2022, compared with other income, net, of $9.8 million for the year ended December 31, 2021. The increase in other expense was primarily due to an increase of $11.2 million in expense related to changes in the value of deferred compensation plan investments and an increase of $4.4 million in charitable contributions, which was partially offset by an increase of $3.0 million in net interest income. Income Tax Expense The income tax expense for the year ended December 31, 2022 was $87.3 million, or 16.6% of pre-tax income. The effective tax rate was lower than the federal statutory rate primarily due to foreign income from our subsidiaries in Bermuda and China being taxed at lower statutory tax rates, and excess tax benefits from stock-based compensation. The decrease in the effective tax rate relative to the federal statutory rate was partially offset by the inclusion of the global intangible low-taxed income (“GILTI”) tax. The income tax expense for the year ended December 31, 2021 was $30.2 million, or 11.1% of pre-tax income. The effective tax rate was lower than the federal statutory rate primarily due to foreign income from our subsidiaries in Bermuda and China being taxed at lower statutory tax rates. The decrease in the effective tax rate relative to the federal statutory rate was partially offset by the inclusion of the GILTI tax. The increase in the effective tax rate for the year ended December 31, 2022 compared to the prior period was primarily due to an increase in GILTI inclusion due to the capitalization of research and experimental expenditures under Section 174 of the Internal Revenue Code (the “IRC”) and lower excess tax benefits from stock-based compensation. The increase was partially offset by higher foreign income from our subsidiaries in Bermuda and China taxed at lower statutory tax rates. In August 2022, the CHIPS Act and the Inflation Reduction Act of 2022 (the “IRA”) were enacted and signed into law, which did not have a material impact on our income tax provisions, results of operations or financial condition for the year ending December 31, 2022. We will continue to monitor any new developments related to the CHIPS Act and the IRA and evaluate their impact on our financial statements. See Note 11 of the Notes to Consolidated Financial Statements for further discussion. 36 Table of Contents Liquidity and Capital Resources December 31, 2022 2021 (in thousands, except percentages) Cash and cash equivalents $ 288,607 $ 189,265 Short-term investments 449,266 535,817 Total cash, cash equivalents and short-term investments $ 737,873 $ 725,082 Percentage of total assets 35.8 % 45.7 % Total current assets $ 1,410,619 $ 1,124,852 Total current liabilities (263,400 ) (226,944 ) Working capital $ 1,147,219 $ 897,908 As of December 31, 2022, we had cash and cash equivalents of $288.6 million and short-term investments of $449.3 million, compared with cash and cash equivalents of $189.3 million and short-term investments of $535.8 million as of December 31, 2021. As of December 31, 2022, $253.8 million of cash and cash equivalents and $270.4 million of short-term investments were held by our international subsidiaries. We have and may continue to repatriate cash from our Bermuda subsidiary to fund our expenditures in future periods. We anticipate that earnings from other foreign subsidiaries will continue to be indefinitely reinvested. Summary of Cash Flows The following table summarizes our cash flow activities: Year Ended December 31, 2022 2021 2020 (in thousands) Net cash provided by operating activities $ 246,674 $ 320,010 $ 267,803 Net cash used in investing activities (12,510 ) (378,886 ) (39,177 ) Net cash used in financing activities (128,785 ) (90,206 ) (71,557 ) Effect of change in exchange rates (6,039 ) 3,400 4,926 Net increase (decrease) in cash, cash equivalents and restricted cash $ 99,340 $ (145,682 ) $ 161,995 For the year ended December 31, 2022, the $73.3 million decrease in cash provided by operating activities compared to the prior period was primarily due to changes in operating assets and liabilities, in particular, inventories and prepaid wafer purchases, partially offset by an increase of $195.6 million in net income and an increase of $37.5 million in stock-based compensation expenses. For the year ended December 31, 2022, the $366.4 million decrease in cash used in investing activities compared to the prior period was primarily due to a $331.2 million decrease in purchases of short-term investments and a $35.6 million decrease in capital expenditures. For the year ended December 31, 2022, the $38.6 million increase in cash used in financing activities compared to the prior period was primarily due to a $28.6 million increase in dividend and dividend equivalent payments and a $12.0 million decrease in proceeds from common stock issued under the employee equity incentive plan. 37 Table of Contents In the future, in order to strengthen our financial position, respond to adverse developments, changes in our circumstance or unforeseen events or conditions, or fund our growth, we may need to raise additional funds by any one or a combination of the following: issuing equity securities, issuing debt or convertible debt securities, incurring indebtedness secured by our assets, or selling certain product lines and/or portions of our business. There can be no guarantee that we will be able to raise additional funds on terms acceptable to us, or at all. From time to time, we have engaged in discussions with third parties concerning capital investments and potential acquisitions of product lines, technologies, businesses and companies, and we continue to consider potential investments and acquisition candidates. Any such transactions could involve the issuance of a significant number of new equity securities, assumptions of debt, and/or payment of cash consideration. We may also be required to raise additional funds to complete any such investments or acquisitions, through either the issuance of equity and/or debt securities or incurring indebtedness secured by our assets. If we raise additional funds or acquire businesses or technologies through the issuance of equity securities or convertible debt securities, our existing stockholders may experience significant dilution. Cash Requirements Although consequences of economic uncertainty and macroeconomic conditions and other factors could adversely affect our liquidity and capital resources in the future, and cash requirements may fluctuate based on the timing and extent of many factors such as those discussed above, we believe that our balances of cash, cash equivalents and short-term investments of $737.9 million as of December 31, 2022, along with cash generated by ongoing operations, will be sufficient to satisfy our liquidity requirements for the next 12 months and beyond. Our material cash requirements include the following contractual and other obligations: Purchase Obligations Purchase obligations represent our obligations with our suppliers and other parties that require the purchases of goods or services, which primarily consist of wafer and other inventory purchases, assembly and other manufacturing services, construction of manufacturing and R&D facilities, purchases of production and other equipment, and license arrangements. In May 2022, we entered into a long-term supply agreement in order to secure manufacturing production capacity for silicon wafers over a four-year period. As of December 31, 2022, the Company had made prepayments under this agreement of $170.0 million. As of December 31, 2022, total estimated future unconditional purchase commitments to all suppliers and other parties were $1.1 billion, of which $455.4 million was short-term. Transition Tax Liability The transition tax liability represents the one-time, mandatory deemed repatriation tax imposed on previously deferred foreign earnings under the U.S. Tax Cuts and Jobs Act enacted in December 2017 (“2017 Tax Act”). As permitted by the 2017 Tax Act, we have elected to pay the tax liability in installments on an interest-free basis through 2025. As of December 31, 2022, the remaining liability totaled $14.8 million, of which $3.7 million was short-term. Operating Leases Operating lease obligations represent the undiscounted remaining lease payments primarily for our leased facilities and equipment. As of December 31, 2022, these obligations totaled $3.8 million, of which $2.1 million was short-term. Dividends We currently have a dividend program approved by our Board of Directors, pursuant to which we intend to pay quarterly cash dividends on our common stock. Based on our historical practice, stockholders of record as of the last business day of the quarter are entitled to receive the quarterly cash dividends when and if declared by the Board of Directors, which are payable to the stockholders in the following month. As of December 31, 2022, accrued dividends totaled $35.3 million. The declaration of any future cash dividends is at the discretion of our Board of Directors and will depend on, among other things, our financial condition, results of operations, capital requirements, business conditions and other factors that our Board of Directors may deem relevant, as well as a determination that cash dividends are in the best interests of our stockholders. In February 2023, our Board of Directors approved an increase in the quarterly cash dividend from $0.75 per share to $1.00 per share, which amount will be paid on April 14, 2023 to all stockholders of record as of the close of business on March 31, 2023. Other Long-Term Obligations Other long-term obligations primarily include payments for deferred compensation plan liabilities and accrued dividend equivalents. As of December 31, 2022, these obligations totaled $71.7 million. 38 Table of Contents Item 7A. Quantitative and Qualitative Disclosures about Market Risk Interest Rate Risk Our cash equivalents and short-term investments are subject to market risk, primarily interest rate and credit risk. Our investments are managed by outside professional managers within investment guidelines set by management and approved by the Audit Committee of the Board of Directors. Such guidelines include security type, credit quality and maturity and are intended to limit market risk by restricting our investments to high quality debt instruments with relatively short-term maturities. Based on our investment positions as of December 31, 2022, the impact of changes in interest rates on our interest income was immaterial. Investments in debt securities are classified as available-for-sale, which are reported at fair value with the unrealized gains or losses being included in accumulated other comprehensive income (loss) on the Consolidated Balance Sheets. When the fair value of an investment is below its amortized cost basis, unrealized losses due to changes in interest rates (i.e., non-credit loss factors) are not recognized in our results of operations unless we have the intent to sell the securities or it is more likely than not that we will be required to sell the securities before recovery of the entire amortized cost basis. Based on our investment positions as of December 31, 2022, a hypothetical 100 basis point increase in interest rates would result in a $3.2 million decline in the fair value of our investments. Any losses resulting from such interest rate changes would only be realized if we sold the investments prior to maturity. We do not use derivative financial instruments in our investment portfolio. Foreign Currency Exchange Risk Our sales outside the United States are primarily transacted in U.S. dollars through our subsidiary in Bermuda. Accordingly, our sales are not generally impacted by foreign currency rate changes. The functional currency of our offshore operations is generally the local currency, primarily including the Renminbi, the New Taiwan Dollar and the Euro. We incur foreign currency exchange gains or losses related to certain transactions, including intercompany transactions between the U.S. and our foreign subsidiaries, that are denominated in a currency other than the functional currency. Gains or losses from the remeasurement and settlement of the balances are reported in other income (expense), net, on the Consolidated Statements of Operations. Fluctuations in foreign currency exchange rates have not had a material impact on our results of operations for the periods presented. 39 Table of Contents
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+Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview” and Note 1, “Introduction and Basis of Presentation—Significant Accounting Policies—Revenue Recognition,” of the Notes to the Consolidated Financial Statements included herein for information on how we generate revenue and our revenue recognition policy.SegmentsFor the year ended December 31, 2022, we had the following five operating segments: Index, Analytics, ESG and Climate, Real Assets and The Burgiss Group, LLC (“Burgiss”), which are presented as the following four reportable segments: Index, Analytics, ESG and Climate, and All Other – Private Assets. For reporting purposes, the Real Assets and Burgiss operating segments are combined and presented as All Other – Private Assets, as they did not meet the thresholds for separate presentation. During the year ended December 31, 2022, the Company renamed the Real Estate operating segment to Real Assets. The Burgiss operating segment represents the Company’s equity method investment in Burgiss. Financial results related to MSCI’s acquisition of RCA have 4Table of Contentsbeen included prospectively as a component of the Real Assets operating segment and presented as a component of the All Other – Private Assets reportable segment, commencing as of September 13, 2021 (the date we completed the acquisition).IndexClients use our indexes in many areas of the investment process, including for developing indexed financial products (e.g., ETFs, mutual funds, annuities, futures, options, structured products, over-the-counter derivatives), performance benchmarking, portfolio construction and rebalancing, and asset allocation. We currently calculate more than 278,0002 end-of-day indexes daily and more than 16,000 indexes in real time. Clients access our index data directly from MSCI or from third-party vendors worldwide.Our index product offerings include:•MSCI Global Equity Indexes. MSCI Global Equity Indexes are designed to measure returns across a wide variety of equity markets, size segments, sectors and industries. As of December 31, 2022, we calculated indexes that covered more than 80 developed, emerging, frontier and standalone equity markets, as well as various regional indexes built from the component indexes.•ESG and Climate Indexes. ESG and Climate Indexes are constructed from an underlying index by applying data from our ESG and Climate segment to additional screening or other criteria.•Factor Indexes. Factor Indexes seek to reflect the performance characteristics of a range of investment styles and strategies, such as momentum or value. These indexes include stocks that demonstrate high exposure to the target factor. In addition to single factor indexes, we offer multiple-factor indexes for investors with diversified multi-factor strategies.•Thematic Indexes. Thematic Indexes are designed to measure the performance of companies associated with shifts in macroeconomic, geopolitical and technological trends. These indexes can target areas of interest under megatrend categories such as the environment, healthcare and lifestyle. Examples of our Thematic Indexes include digital economy, efficient energy, genomic innovation and smart cities.•Custom Indexes. Custom Indexes are calculated by applying additional criteria supplied by a client – such as stock exclusion lists, currency hedging rules, tax rates or special weighting – to an MSCI index. Investors with unique index requirements can build an index to meet their specific needs and better update index design over time to support their evolving investment strategies.•Fixed Income Indexes. Fixed Income Indexes include both investment grade and high-yield securities across a number of currencies that reflect the performance of credit markets generally, or specific investment strategies, including climate-focused or factor strategies.•Real Estate Indexes. Real Estate Indexes provide transparency and insight to private real estate investment strategies.In 2022, we launched a number of new indexes, including the following:•MSCI Global Quarterly Property Index. The MSCI Global Quarterly Property Index tracks the property-level performance of quarterly-valued assets across the world’s major real estate markets. This index aims to help investors as they monitor and manage international real estate portfolios, particularly in the context of macroeconomic and geopolitical developments.•MSCI ACWI IMI Virology Index. Part of MSCI’s previously announced strategic collaboration with Royalty Pharma plc, the MSCI ACWI IMI Virology Index aims to measure the performance of a set of companies associated with biotech innovation and the treatment of infectious diseases.•MSCI Climate Action Indexes. The MSCI Climate Action Indexes are a suite of equity indexes that are designed to support investors with a strategy focused on companies that are leaders in their sectors with respect to climate transition activities, including in emissions reduction commitments, climate risk management and revenue from greener businesses.•Bloomberg MSCI China ESG Index Suite. This index suite includes nine ESG indexes and is the first Bloomberg MSCI index suite that tracks the performance of the RMB-denominated bond and USD-denominated Chinese bond markets, while incorporating ESG and socially responsible investment considerations.Our Index segment also includes revenues from licenses of GICS and GICS Direct, the global industry classification standard jointly developed and maintained by MSCI and S&P Dow Jones Indices, a division of S&P Global Inc. This classification system was developed in response to investors’ need for a comprehensive and consistent framework for classifying companies into industries. 2 The number of indexes includes different return versions (e.g., price, net and gross returns) but does not include different currency versions.5Table of ContentsGICS is widely accepted as an industry analysis framework for investment research, portfolio management and asset allocation. GICS Direct is a dataset comprised of active companies and securities classified by sector, industry group, industry and sub-industry in accordance with the proprietary GICS methodology. The MSCI Sector Indexes are comprised of GICS sector, industry group, and industry indexes across countries and regions in Developed, Emerging and select Frontier markets. For the year ended December 31, 2022, 58.0% of our revenues were attributable to our Index segment. A majority of those revenues were attributable to annual, recurring subscriptions. A portion of our revenues comes from clients who use our indexes as the basis for indexed investment products. Such fees are primarily based on a client’s assets under management (“AUM”) or trading volumes and are referred to herein as asset-based fees. Since market movement and investment trends impact our asset-based fees, our revenues from asset-based fees are subject to volatility. For the year ended December 31, 2022, asset-based fees accounted for 40.5% of the total revenues for our Index segment.AnalyticsOur Analytics segment offers risk management, performance attribution and portfolio management content, applications and services that provide clients with an integrated view of risk and return and tools for analyzing market, credit, liquidity, counterparty and climate risk across all major asset classes, spanning short-, medium- and long-term time horizons. Our offerings also support clients’ various regulatory reporting needs. Our Analytics tools and capabilities include the following: models to support factor-based analytics (e.g., Barra equity models and fixed income and multi-asset class (“MAC”) models), pricing models and single security analytics, time series-based analytics, stress testing, performance attribution, portfolio optimization and liquidity risk analytics, as well as underlying inputs such as interest rate and credit curves. We continue to develop new and improved tools and capabilities in response to the evolving needs of our clients. In addition, our analytics capabilities are helping to fuel growth in key areas across our business, such as our factor indexes and many of our climate risk and reporting offerings.Our clients access our Analytics tools and content through our proprietary applications and application programming interfaces (“APIs”), third-party applications or directly through their own platforms. Our Analytics solutions provide clients with tools to construct and manage portfolios, including integrated market data from multiple third parties as well as content from MSCI’s other segments, which significantly reduces the operational burden on clients to independently source this information and populate it in our Analytics products. Our key Analytics products include:•RiskMetrics RiskManager. RiskMetrics RiskManager provides risk analytics across a broad range of publicly traded instruments and private assets. Clients use RiskManager for daily analysis, including: Value-at-Risk (“VaR”) simulation; measuring and monitoring market and liquidity risk at position, fund and firm levels; sensitivity analysis and stress testing; interactive what-if analysis; counterparty credit exposure; and regulatory risk reporting.•BarraOne. Powered by our MAC Barra factor model, BarraOne provides clients with MAC risk and performance analytics. BarraOne allows clients to build equity, fixed income, and MAC portfolios with specific risk, ESG and climate exposures.•Barra Portfolio Manager. Barra Portfolio Manager is an integrated risk, performance and portfolio-construction interactive platform with a flexible user interface that enables our clients to design investment strategies and build portfolios, and to share analytics and reports across their organizations. It is used by equity fund managers and their teams to gain additional portfolio insight and manage their investment processes more systematically. •RiskMetrics WealthBench and RiskMetrics CreditManager. RiskMetrics WealthBench is a web-based platform used by private banks, financial advisers, brokerages and trust companies to help wealth managers assess portfolio risk, construct asset allocation policies and create comprehensive client proposals. RiskMetrics CreditManager is a portfolio credit risk management system used primarily by banks to quantify portfolio credit risk by capturing market exposure, rating changes and default risk. •Climate Lab Enterprise. Powered by MSCI’s climate data integrated with MSCI’s enterprise analytics infrastructure, Climate Lab Enterprise enables our clients to measure, manage and monitor net-zero commitments and climate exposure and risks. Climate Lab Enterprise is able to aggregate climate data across multiple portfolios and asset classes, providing clients the ability to understand alignment with their climate goals from the enterprise level down through portfolios to individual positions and issuers.•Risk Insights. Our Risk Insights offering calculates, stores and delivers a broad range of risk measures to help investors identify trends and respond to rapid changes in markets. Risk Insights automates many tasks to allow investors to more quickly and effectively understand the overall level of risk in their portfolios, how that risk has changed, and what factors may have caused the changes.6Table of ContentsOur Analytics segment also provides various managed services to help clients operate more efficiently, including consolidation of client portfolio data from various sources, review and reconciliation of input data and results, and customized reporting, including ESG and climate reporting. In addition, our RiskMetrics HedgePlatform service allows clients such as funds of funds, pension funds and endowments who invest in hedge funds to measure, evaluate and monitor the risk of their hedge fund investments across multiple hedge fund strategies.For the year ended December 31, 2022, 25.6% of our revenues were attributable to our Analytics segment.ESG and ClimateThe ESG and Climate segment3 offers products and services that help institutional investors understand how ESG and climate considerations can impact the long-term risk and return of their portfolio and individual security-level investments. We provide data, ratings, research and tools to help investors navigate increasing regulation, meet new client demands and better integrate ESG and climate elements into their investment processes.In recent years, ESG and climate related issues have become key business priorities across industries. At MSCI, we believe our ESG and Climate solutions support ESG integration by strengthening transparency around ESG and climate metrics and helping to analyze and quantify ESG and climate risks. Investors commonly use our ESG and Climate solutions, including MSCI ESG Ratings, to help assess ESG-related financial risks in their investment processes and to help inform their investment decisions. Our ESG and Climate solutions are also used by some clients to help them identify investments that may generate a social or environmental impact or that may otherwise align with an investor’s ethical values.Our ESG and Climate research team analyzes over 10,0004 entities worldwide, and we will continue to expand and deepen our coverage to help investors and others in their asset allocation, portfolio construction and risk management processes. Clients include global asset managers, leading asset owners, consultants, advisers, corporates and academics.Our ESG and Climate offerings include:•MSCI ESG Ratings. Our ESG ratings aim to measure a company’s resilience to long-term ESG risks. Companies are scored on an industry-relative scale across the most relevant key ESG issues based on a company’s business model. MSCI ESG Ratings include ratings of equity issuers and fixed income securities. The MSCI ESG Industry Materiality Map is a public tool that explores the key ESG issues by GICS sub-industry or sector and their contribution to companies’ overall ESG ratings. In assigning an MSCI ESG Rating, we collect the most relevant, publicly available data and assess the most significant ESG risks a company faces. Investors use MSCI ESG Ratings for a variety of purposes, including to assist with fundamental or quantitative analysis, portfolio construction and risk management, engagement and thought leadership, benchmarking and custom index design. •MSCI ESG Business Involvement Screening Research. MSCI ESG Business Involvement Screening Research is a screening service that enables institutional investors to manage ESG standards and restrictions reliably and efficiently. Asset managers, investment advisers and asset owners can access screening research through the online MSCI ESG Manager platform or a data feed to support alignment with their investment guidelines, implement client mandates or manage potential ESG portfolio risks.•MSCI Climate Solutions. With MSCI Climate Solutions, investors and issuers utilize our climate data and tools to support their investment decision making. These activities can include measuring and reporting on climate risk exposure, implementing low-carbon or fossil-fuel-free strategies, factoring climate change research into risk management processes and engaging companies and external stakeholders. For example, in 2022, we launched Total Portfolio Footprinting, which helps financial institutions better understand the extent and impact of greenhouse gas emissions at companies they are financing and provides information needed to focus on sustainable business practices.MSCI ESG ratings and certain other ESG and climate data provided to our clients are also made available to, and used in, our other operating segments, such as in the construction of our MSCI ESG and Climate equity and fixed income indexes. These Index products are designed to help institutional investors more effectively benchmark ESG investment performance, issue indexed investment products, as well as manage, measure and report on ESG mandates. For a description of regulation applicable to MSCI ESG Research LLC, see “—Government Regulation” below. 3 Products and services in our ESG and Climate segment are provided by MSCI ESG Research LLC, a wholly owned subsidiary of MSCI Inc. that is registered with the U.S. Securities and Exchange Commission (SEC) as an Investment Adviser under the Investment Advisers Act of 1940. MSCI ESG Ratings are used as an input in the construction and calculation of MSCI ESG indexes, which are not subject to our SEC registration. MSCI indexes are products of MSCI Inc., and MSCI Limited is the benchmark administrator.4 Does not include subsidiary-level companies.7Table of ContentsFor the year ended December 31, 2022, 10.2% of our revenues were attributable to our ESG and Climate segment.All Other – Private AssetsFor reporting purposes, our Real Assets and Burgiss operating segments are combined and presented as All Other – Private Assets. Our Real Assets offerings include transaction data, benchmarks, return-analytics, climate assessments and market insights for tangible assets such as real estate and infrastructure. In 2021, we completed our acquisition of RCA to meaningfully accelerate our Real Assets strategy. RCA’s rich transaction and pricing data enhances our offering to clients and allows us to integrate this information in other MSCI products including indexes, climate risk models and other MSCI solutions. Our Real Assets performance and risk analytics range from enterprise-wide to property-specific analytics. We also provide business intelligence products to real estate owners, managers, developers and brokers worldwide. Some of the risk analytics generated as part of our Real Assets offerings are also used in the products offered by our other operating segments.Our Real Assets offerings include:•Real Capital Analytics. RCA aggregates timely transaction data and provides valuable information on market pricing, capital flows and investment trends in more than 170 countries. Our clients use this unique data to formulate strategies, source new opportunities and execute deals.•MSCI Real Estate Enterprise Analytics. Our Real Estate Enterprise Analytics application offers an interactive, integrated view to private real estate investors and managers, providing them with the ability to evaluate and analyze the drivers of portfolio performance across an organization’s investments, as well as review exposures and concentrations across markets, asset types and increasingly diverse portfolios.•MSCI Global Intel. Our Global Intel offering is an extensive private real estate database that is used by institutional investors, asset managers, banks, custodians and investment consultants to drive allocation decisions, research and strategy developments, and portfolio and risk management. This tool comprises a consolidated set of global, regional, national, city and submarket indexes with segmentation by property type. •Datscha. Datscha provides web-based services for the analysis of commercial real estate and offers extensive information on real estate, rental levels, property holdings, transactions, ownership, occupiers, footfall, lease data and the ability to simulate market values.•MSCI Real Estate Climate Value-at-Risk (“RE Climate VaR”). Our RE Climate VaR solution provides forward-looking and return-based valuation assessments to measure climate-related risks for real estate assets in an investment portfolio. By calculating transition risk from changing legislation, regulation and sustainability strategies as well as physical risk from extreme weather impacts, RE Climate VaR offers a framework for investors to improve portfolio performance, risk management, regulatory reporting and progress towards broader sustainability goals.•INCANS. Our INCANS solution enables investors to proactively measure and manage income risk. This offering uses intuitive dashboards, bond-equivalent rating scores and a proprietary global tenant grading system to enable investors to better understand the likelihood of current and future tenant default. For the year ended December 31, 2022, 6.3% of our revenues were attributable to our Real Assets offerings.Research and Product DevelopmentWe apply an integrated team approach to developing content across our operating segments. Our product management, research and product development, data operations and technology, and application development departments are at the center of this process. Our content is developed by a research and product development team comprised of mathematicians, economists, statisticians, financial engineers and industry experts. Content created in one segment can often be used for the creation of products in another segment. For example, the MAC models created in our Analytics segment offer a view of risk across market and asset classes, including private real estate, by incorporating content generated in the Real Assets operating segment. In addition, MSCI ESG indexes and our Climate Lab Enterprise analytics product are constructed using data from our ESG and Climate operating segment. Through our relationships with the world’s largest investment institutions, we monitor investment trends and their drivers globally and support instrument valuation, risk modeling, portfolio construction, portfolio attribution, asset allocation and VaR simulation. An important way we monitor global investment trends and their implications for our business is through direct public consultations and client advisory panels and through the forum provided by our Advisory Council. Our Advisory Council typically 8Table of Contentsmeets three times during the year to discuss current and emerging investment industry trends and is comprised of senior investment professionals from around the world and senior members of our research and product development team.TechnologyTechnology plays a pivotal role in our operations and our ability to innovate and launch products and services. Current areas of focus include:•Improving the client experience by enhancing the way clients access, interact with and use our data, applications and other tools, including by developing and launching our new open-architecture ISaaS services, many of which are available via modern, web-based platforms, such as our new MSCI ONE offering, or integrate with our clients’ existing ecosystems via APIs. •Enhancing data processing by utilizing data science and machine learning in our data collection processes to more efficiently build scale and facilitate faster product enhancements and releases while also maintaining the highest quality standards.•Enhancing information security by further strengthening our technology infrastructure and software security processes. We implement changes and upgrades to technology regularly and maintain processes to minimize risk on an ongoing basis, and we seek to improve employee awareness of cyber and information security issues through training.•Modernizing our workplace to better support a remote and hybrid workforce that can collaborate and productively work from anywhere. •Migrating products, data and services onto a cloud platform to accelerate the delivery of new capabilities that will help investors more swiftly and efficiently manage data and understand the drivers of risk and performance, drive automation across our corporate processes and minimize data center risks.CompetitionIndex. Many industry participants compete with us by offering one or more indexes in similar categories. Such indexes vary widely in scope, including by geographic region, business sector and weighting methodology, and may be used by clients in a variety of ways in many different markets around the world. Among our Index competitors are S&P Dow Jones Indices LLC (a joint venture of S&P Global Inc. and CME Group Inc.); FTSE Russell, a subsidiary of the London Stock Exchange Group plc; and Solactive AG.Competition also exists from industry participants, including asset managers and investment banks, that create their own indexes, often in cooperation with index providers, which may, among other things, provide some form of calculation agent service. Some asset managers also manage funds, including ETFs, based on their proprietary indexes, and some investment banks launch structured products or create over-the-counter derivatives based on their proprietary indexes. This is often referred to as self-indexing.Analytics. Our Analytics offerings compete with those from a range of competitors, including Qontigo (formerly Axioma Inc.), BlackRock Solutions, Bloomberg Finance L.P. (“Bloomberg”), and FactSet Research Systems Inc. Additionally, some of the larger broker-dealers have developed proprietary analytics tools for their clients. Similarly, some of the large global investment organizations, such as custodians, have developed internal risk management and performance analytics tools that they offer to their clients.ESG and Climate. Our ESG and Climate offerings compete with a growing number of companies that issue ESG data, ratings or research. For example, our ESG and Climate offerings compete with those from a range of competitors, including Sustainalytics Holding B.V. (a part of Morningstar, Inc.), Institutional Shareholder Services Inc. (majority owned by Deutsche Börse AG), Trucost (an S&P Global Inc. business), Refinitiv (a London Stock Exchange Group business), Bloomberg and Moody’s Corporation.All Other – Private Assets. We also have a variety of competitors for our offerings that provide data, market intelligence, indexes, and performance and risk attribution services relating to real estate and other private assets. Intellectual Property, Other Proprietary Rights and Sources of DataWe consider many aspects of our offerings, processes and services to be proprietary. We have registered “MSCI” and other marks as trademarks or service marks in the United States and in certain other countries. We will continue to evaluate the registration of additional trademarks and service marks as appropriate. From time to time, we have also filed patent applications to protect our proprietary rights. Additionally, many of our offerings, processes and services require the use of intellectual property that we license for use from third parties. It may be necessary in the future to seek or renew licenses relating to various aspects of our offerings and 9Table of Contentsservices. Our ownership and protection of intellectual property and other proprietary rights and our ability to obtain the rights to use third-party intellectual property are important to our business and contribute in part to our overall success. In addition to our intellectual property, we rely on third-party data to create and deliver our products and services. For example, we require certain stock exchange data to construct equity indexes. Termination of or disputes regarding our rights to receive or use such data could limit the information available for us to use or distribute in connection with our products and services.Corporate ResponsibilityAs a leader in providing ESG and climate solutions to investors, we also aim to demonstrate leading corporate responsibility practices and policies that are meaningful to our various stakeholders, including our clients, employees, shareholders and local communities. The Governance and Corporate Responsibility Committee of our Board of Directors provides oversight of our corporate responsibility strategy and activities and receives regular updates and reports from MSCI management, including our Chief Responsibility and Diversity Officer.We are committed to continuing to develop and enhance our climate-focused strategies and to regularly reporting on our efforts. As part of our corporate responsibility efforts, we have published reports aligned with a number of international frameworks, including the Task Force on Climate-related Financial Disclosures (TCFD), the Sustainability Accounting Standard Board (SASB), CDP and the United Nations Department of Economic and Social Affairs’ Sustainable Development Goals (UN SDG) as well as our carbon emissions metrics.Additional information on our corporate responsibility progress, including our net-zero commitment and climate transition plan, can be found on our website at https://www.msci.com/who-we-are/corporate-responsibility. Information contained on our website is not deemed part of or incorporated by reference into this Annual Report on Form 10-K or any other report filed with the SEC.Human Capital ManagementMSCI is committed to creating a performance culture with a high degree of employee engagement. Our talent and leadership development programs are designed to ensure we have the right people with the necessary skills to deliver on MSCI’s strategy, including a workplace that values and promotes diversity, equity and inclusion (“DE&I”).The Compensation, Talent and Culture Committee of our Board of Directors has oversight over talent management matters, including efforts relating to succession/progression planning, career progression and retention strategies, and learning and leadership development programs. In addition, this Committee oversees our efforts relating to our corporate culture, such as our DE&I strategy and our employee engagement. Our Chief Human Resources Officer, our Chief Responsibility and Diversity Officer and our Head of Talent report to our Board regularly on DE&I initiatives, our work towards enhancing corporate culture and our talent management strategies. We also engage with our shareholders around these aspects of our human capital management strategies. The Board periodically reviews our executive talent, including our current leadership bench and succession/progression planning efforts relating to our entire executive team. Our Chief Executive Officer and our President and Chief Operating Officer also meet regularly with the heads of our functions to review talent plans, with an aim of identifying top talent with the most immediate or near-term potential to progress to the senior-most roles at MSCI.MSCI is a global company with a highly diverse footprint. As of December 31, 2022, we employed 4,759 people, of which 49.7% of MSCI employees were located in the Asia Pacific region, 22.6% in Europe, Middle East and Africa, 18.7% in the U.S. and Canada, and 9.0% in Mexico and Brazil. For the one-year period ended December 31, 2022, voluntary turnover was 13.8% and involuntary turnover was 3.2%. Diversity, Equity and InclusionDiversity, equity and inclusion are core values of MSCI. We strive to empower our people to maximize their potential in an environment where all individuals are respected and encouraged to bring their authentic selves to work. MSCI’s culture embraces diverse experiences and perspectives, which we believe foster creativity and innovation. As a leading provider of tools and solutions to the global investment community, it is critical that DE&I principles are central to how we manage our business and global workforce. We firmly believe that a diverse team is a stronger team and that cultivating diverse, highly engaged talent is an important part of our success. As of December 31, 2022, of those who self-identified, women represented 35.9% of our global employees, and people of color (defined as those who identify as Asian, Black or African American, Hispanic or Latino, American Indian or Alaska Native, 10Table of ContentsNative Hawaiian or Other Pacific Islander or two or more races) represented 47.3% of our U.S. employees and 42.1% of our U.S. employees in management roles5. The U.S. represents 17.8% of our global workforce. Our most recent EEO-1 consolidated reports can be found on our website at https://www.msci.com/who-we-are/diversity-equity-and-inclusion. Information contained on our website is not deemed part of or incorporated by reference into this Annual Report on Form 10-K or any other report filed with the SEC.Our Chief Responsibility and Diversity Officer is responsible for operating across MSCI to align our DE&I goals with business outcomes. We have operationalized our DE&I strategy and alignment through our Executive DE&I Council (“EDC”) and our Inclusion and Belonging Council (“IBC”). The EDC consists of senior leaders and subject matter experts who develop and execute our DE&I efforts across three strategic pillars relating to talent, senior leader engagement and accountability, and stakeholder engagement. The IBC proactively works with local leaders to adapt MSCI’s global DE&I strategy to local circumstances and requirements. The roughly 30 members on the IBC represent most geographies, functions and levels, including members of our employee resource groups (the Women’s Leadership Forum, Women in Tech, Pride & Allies, the Black Leadership Network, Asian Support Network, All Abilities Network and Hola! MSCI).Our DE&I efforts aim to create a strong sense of belonging and inclusion, foster employee engagement, nurture a pipeline of diverse talent and position MSCI as a leading organization that recognizes diversity, equity and inclusion as strategic priorities. Additional information on our DE&I efforts and programs can be found on our website at https://www.msci.com/who-we-are/diversity-equity-and-inclusion. Information contained on our website is not deemed part of or incorporated by reference into this Annual Report on Form 10-K or any other report filed with the SEC.Compensation, Benefits and Well-beingWe offer a broad range of highly competitive compensation and benefits programs to our employees and their families, including same-sex domestic partners. These programs include health and welfare benefits, including an employee assistance program; enhanced maternity and paternity leave policies, including a global minimum standard applicable to all offices worldwide; contributions to defined contribution and defined benefit pensions plans globally and health savings accounts in the U.S.; life insurance; a global wellness initiative that can help employees improve their health and well-being; presentations on well-being topics, including retirement planning, parenting, meditation, stress management and nutrition; ergonomic equipment and desk assessments; and wellness rooms in all MSCI office locations.Compensation at MSCI supports a culture of high performance and accountability. Our goal is to provide competitive compensation in the markets where we compete for talent. We believe in linking all employee compensation to Company, Product/Function and individual performance by making 100% of our employees eligible for annual cash bonuses. We strongly differentiate cash bonus payouts based on actual results against goals and for managers, how effectively they demonstrate behaviors consistent with our values and culture.Senior employees and select other employees are eligible to participate in the MSCI Long-Term Incentive Program with awards of MSCI common stock that vest over a multi-year period. The goal of the Long-Term Incentive Program is to: (i) align the interests of eligible employees with those of our shareholders, (ii) enhance our “owner-operator” philosophy, (iii) recognize and reward potential long-term contributions, and (iv) retain key leaders and top performers.In 2020, MSCI announced our hybrid-work initiative called the Future of Work at MSCI, and we formally began implementing this initiative in January 2022. For most of our employees, the Future of Work introduced a hybrid work environment allowing employees to work at times at the office and other times remotely, depending on the requirements of a specific role and the needs of our clients. The Future of Work at MSCI unites our inclusive culture with modern and flexible ways of working to give employees the accountability, responsibility and empowerment to perform at their very best, while keeping our clients at the center of all we do. As we continue to adapt and iterate how we work, employee feedback will remain central to this initiative.Cultivating Talent and Employee EngagementMSCI is committed to investing in employee learning and development. Throughout the year, we offer tools and workshops to help employees better understand how their work aligns with MSCI’s overall strategy, seek and receive real-time and transparent feedback and coaching, successfully deliver on their goals, and more effectively plan and develop their careers. MSCI also offers on demand learning tools covering a wide range of topics with numerous options for employees to pursue self-paced career development opportunities.5 Management roles are employees in Managing Director, Executive Director or Vice President roles.11Table of ContentsMSCI conducts an employee engagement survey at least annually that measures whether our approaches to performance, growth and career development are driving employee engagement. Managers receive anonymous feedback and are accountable for improving and enhancing the work environment to drive higher engagement. In our December 2022 employee engagement survey, we achieved a 78% response rate, and the percentage of respondents characterized as fully engaged was 74%, the highest since we implemented the engagement survey.Additional information on our training programs and engagement metrics can be found on our website at https://www.msci.com/who-we-are/corporate-responsibility/social-practices. Information contained on our website is not deemed part of or incorporated by reference into this Annual Report on Form 10-K or any other report filed with the SEC.Health and SafetyWe are committed to providing a safe workplace, and the well-being of our employees is one of our highest priorities. We strive to meet or exceed all applicable laws, regulations and accepted practices relating to workplace safety. We have extensive safety policies, standards and procedures that all employees are required to follow. In particular, the COVID-19 pandemic has underscored for us the importance of keeping our employees safe and healthy. In response to the pandemic, we have taken numerous steps to support our employees, including transitioning to a hybrid work environment for most employees, enhancing our sick leave policies, engaging with external health and ergonomics consultants and increasing the use of technology to allow our employees to remain fully engaged, productive and well. We continue to closely monitor and manage the situation regarding the COVID-19 pandemic and follow local requirements where our offices are located globally.Government RegulationThe Company is subject to reporting, disclosure and recordkeeping obligations pursuant to SEC requirements applicable to U.S. public companies.The United Kingdom’s Financial Conduct Authority (“UK FCA”) authorized MSCI Limited (a subsidiary of MSCI Inc.) to be the benchmark administrator for applicable MSCI indexes. Information about index regulation is periodically updated on our website at https://www.msci.com/index-regulation. Information contained on our website is not deemed part of or incorporated by reference into this Annual Report on Form 10-K or any other report filed with the SEC.MSCI ESG Research LLC is a registered investment adviser and must comply with the requirements of the Investment Advisers Act of 1940 (the “Advisers Act”) and related SEC regulations. Such requirements relate to, among other things, disclosure obligations, recordkeeping and reporting requirements, marketing restrictions and general anti-fraud prohibitions. It is possible that in addition to MSCI ESG Research LLC, other entities in our corporate family may be required to register as an investment adviser under the Advisers Act or comply with similar laws or requirements in states or foreign jurisdictions. A subsidiary of the Company is registered with the State Council Information Office of the Ministry of Commerce and the State Administration for Industry and Commerce in China as a foreign institution supplying financial information services in China. This license is currently administered by the Cyberspace Administration of China.Information About Our Executive OfficersNameAgePositionHenry A. Fernandez64Chairman and Chief Executive OfficerC.D. Baer Pettit58Director, President and Chief Operating OfficerAndrew C. Wiechmann43Chief Financial OfficerRobert J. Gutowski55General CounselScott A. Crum66Chief Human Resources OfficerThere are no family relationships between any of our executive officers and any director or other executive officer of the Company. Henry A. FernandezMr. Fernandez has served as Chairman since October 2007 and as Chief Executive Officer and a director since 1998. He served as head of the MSCI business from 1996 to 1998 and as President from 1998 to October 2017. MSCI was previously a business 12Table of Contentsunit within Morgan Stanley prior to its IPO in 2007. Before leading MSCI, he was a Managing Director at Morgan Stanley, where he worked from 1983 to 1991 and from 1994 to 2007, in emerging markets business strategy, equity derivatives sales and trading, mergers and acquisitions, and corporate and mortgage finance. Mr. Fernandez also serves on boards of directors/trustees at Royalty Pharma plc, Stanford University, King Abdullah University of Science and Technology and its affiliate, KIMC, the Hoover Institution, Memorial Sloan-Kettering Cancer Center, the Foreign Policy Association, and Catholic Charities of the Archdiocese of New York. Mr. Fernandez previously served on the boards of trustees at Georgetown University, the Trinity School, The Browning School and MexDer (Mexican Derivatives Exchange) and was the Chair of the Advisory Council at the Stanford University Graduate School of Business. He holds a Bachelor of Arts in economics from Georgetown University, an M.B.A. from the Stanford University Graduate School of Business and pursued doctoral studies in economics at Princeton University.C.D. Baer PettitMr. Pettit has served as the Company’s President since October 2017, the Company’s Chief Operating Officer since January 2020 and a Director on the Company’s Board since January 2023. As President and Chief Operating Officer, Mr. Pettit oversees the Company's business functions, including client coverage, marketing, product management, research and product development, technology and operations. He previously served as Chief Operating Officer from 2015 to 2017, Head of the Product Group from February 2015 to September 2015, Head of Index Products from 2011 to 2015, Head of Marketing from 2005 to 2012 and Head of Client Coverage from 2001 to 2012. Prior to joining MSCI, Mr. Pettit worked for Bloomberg L.P. from 1992 to 1999. Mr. Pettit holds a Master of Arts degree in history from Cambridge University and a Master of Science degree from the School of Foreign Service at Georgetown University.Andrew C. WiechmannMr. Wiechmann has served as the Company’s Chief Financial Officer since September 2020. Mr. Wiechmann previously served as Treasurer from November 2021 to June 2022, Chief Strategy Officer from May 2019 to September 2020, Interim Chief Financial Officer from March 2019 to May 2019, Head of Strategy and Corporate Development from July 2012 to March 2019, Head of Investor Relations from December 2017 to March 2019 and Head of Financial Planning & Analysis from July 2015 to December 2017. Prior to joining MSCI in 2012, Mr. Wiechmann was an investment banker at Morgan Stanley where he executed M&A and capital markets transactions for financial technology and specialty finance companies, including advising MSCI on its IPO and various acquisitions. Mr. Wiechmann holds Bachelor of Arts degrees in Physics and Economics from Hamilton College.Robert J. GutowskiMr. Gutowski has served as the Company’s General Counsel since January 2020. Mr. Gutowski previously served as the Company’s Deputy General Counsel and the Head of Compliance from 2010 to 2019 and the Head of Internal Audit from 2012 to 2019. He joined MSCI in 2002. Prior to joining MSCI, he was an attorney in private practice at Rogers & Wells LLP and Clifford Chance LLP. He received his B.A. from Georgetown University and his J.D. from the State University of New York at Buffalo Law School.Scott A. CrumMr. Crum has served as the Company’s Chief Human Resources Officer since April 2014. Prior to joining MSCI, Mr. Crum served as global head of human resources for four publicly traded companies. Mr. Crum worked for Avon Products, Inc. as Senior Vice President of Human Resources and Chief People Officer from 2012 to 2013. From 2010 to 2012, Mr. Crum served as Senior Vice President and Chief People Officer of Motorola Mobility Holdings, Inc., one of two publicly traded companies formally created when Motorola Inc. split in January 2011 until it was acquired by Google. Prior to that, he served as the Senior Vice President and Director of Human Resources of ITT Corporation from 2002 to 2010 and Senior Vice President of Administration and Employee Resources at General Instruments Corp. from 1997 to 2000. Mr. Crum holds a Bachelor of Business Administration with a concentration in industrial relations from Southern Methodist University.Available InformationOur corporate headquarters is located at 7 World Trade Center, 250 Greenwich Street, 49th Floor, New York, New York, 10007, and our telephone number is (212) 804-3900. We maintain a website on the internet at www.msci.com. The contents of our website are not a part of or incorporated by reference in this Annual Report on Form 10-K.We file annual, quarterly and current reports, proxy statements and other information with the SEC. The SEC maintains a website that contains reports, proxy and information statements and other information that we file electronically with the SEC at www.sec.gov. We also make available free of charge, on or through our website, these reports, proxy statements and other information 13Table of Contentsas soon as reasonably practicable following the time they are electronically filed with or furnished to the SEC. To access these, click on the “SEC Filings” link under the “Financial Information” tab found on our Investor Relations homepage (http://ir.msci.com).We also use our Investor Relations homepage, Corporate Responsibility homepage and corporate Twitter account (@MSCI_Inc) as channels of distribution of Company information. The information we post through these channels may be deemed material.Accordingly, investors should monitor these channels, in addition to following our press releases, SEC filings and public conference calls and webcasts. In addition, you may automatically receive email alerts and other information about us when you enroll your email address by visiting the “Email Alerts” on our Investor Relations homepage at https://ir.msci.com/email-alerts. The contents of our website, including our Investor Relations homepage and Corporate Responsibility homepage, and our social media channels are not, however, a part of or incorporated by reference in this Annual Report on Form 10-K.Item 1A. Risk FactorsYou should carefully consider the following risks and all of the other information set forth in this Annual Report on Form 10-K. If any of the following risks actually occurs, our business, financial condition or results of operations could be materially and adversely affected. You should read the section titled “Forward-Looking Statements” on page 1 for a description of the types of statements that are considered forward-looking statements, as well as the significance of such statements in the context of this Annual Report on Form 10-K. This information should be read in conjunction with "Management’s Discussion and Analysis of Financial Condition and Result of Operations" and the consolidated financial statements and related notes. These factors could cause our future results to differ materially from our historical results and from expectations reflected in forward-looking statements. Summary of Risk FactorsOur business is subject to numerous risks and uncertainties, discussed in more detail in the following section. These risks include, among others, the following key risks:•Our dependence on third parties to supply data, applications and services for our products and services and on certain vendors to distribute our products;•Undetected errors, defects, malfunctions or similar problems in our products leading to increased costs or liability;•Our exposure to potential reputational and credibility concerns;•The impact of the COVID-19 pandemic or other widespread health crises;•The possibility that our clients seek to negotiate lower asset-based fees or cease using our indexes as the basis for indexed investment products;•Cancellations or reductions by any of our largest clients or reduced demand for our products or services;•The impact of failures, disruptions, instability or vulnerabilities in our information technology systems or applications;•Our inability to ensure and protect the confidentiality of data;•Our exposure to security breaches including cyber-attacks or failures of our security plans, systems or procedures;•Unanticipated failures, interruptions or delays in the performance or delivery of our products as a result of the adoption of new technologies;•Security vulnerabilities resulting from our use of open source code;•The impact of changes in economic conditions and the global capital markets, including resulting from geopolitical events, adverse equity market conditions, volatility in the financial markets and evolving investment trends;•The effects on us from competition and financial and budgetary pressures affecting our clients;•Our need to successfully develop new and enhanced products and services in order to remain competitive;•The impact of our global operations and any future expansion on management and our exposure to additional issues from our increased global footprint;•Failure to comply with laws, rules or regulations; changes to current laws, rules or regulations; or the introduction of new laws, rules or regulations relevant to our business;•Our inability to protect our intellectual property rights;14Table of Contents•The impact of foreign currency exchange rate fluctuation;•The impact of our indebtedness on our financial flexibility;•The impact of changes in our credit ratings; and•Our exposure to tax liabilities in various jurisdictions.Operational RisksWe are dependent on third parties to supply data, applications and services for our products and services and are dependent on certain vendors to distribute our products. A refusal or failure by a key vendor to distribute our products; any loss of key outside suppliers of data, applications or services; a reduction in the accuracy or quality of such data, applications or services; or any failure by us to comply with our suppliers’ or distributors’ licensing requirements could impair our ability to provide our clients with our products and services, which could have a material adverse effect on our business, financial condition or results of operations.We rely on third-party suppliers of data, applications and services, including data from stock exchanges and other suppliers (collectively, “Vendor Products”), and depend on the accuracy and quality of Vendor Products and the ability and willingness of such suppliers to deliver, support, enhance and develop new Vendor Products on a timely and cost-effective basis, and respond to emerging industry needs and other changes in order to produce, deliver and develop our products and services. Additionally, we depend on clients to supply certain data in order to provide our services to them. Any failure to supply, errors or reduction in the amount, accuracy or quality of such data supplied from clients impairs our ability to provide them with our products and services.If Vendor Products include errors, design defects, are delayed, become incompatible with future versions of our products, are unavailable on acceptable terms or are not available at all, we may not be able to deliver our products and services. In addition, in the ordinary course suppliers of Vendor Products are subject to various forms of cyber-attacks or other failures or security breaches. Breaches of our suppliers’ systems and networks may cause material interruptions or malfunctions in our or such suppliers’ websites, applications or data processing, or may compromise the confidentiality and integrity of affected information.Some of our agreements with third-party suppliers allow them to cancel on short notice and from time to time we receive notices from third-party suppliers threatening to terminate the provision of their products or services to us, and some data suppliers have terminated the provision of their data to us. Termination of the provision of Vendor Products by one or more of our significant suppliers or exclusion from, or restricted use of, or litigation in connection with Vendor Products could decrease the data and materials available for us to use and deliver to our clients. In addition, some of our competitors could enter into exclusive contracts with our data suppliers, including with certain stock exchanges. If our competitors enter into such exclusive contracts, we may be precluded from receiving certain data or other materials from these suppliers or restricted in our use of such data or other materials, which would give our competitors a competitive advantage. Such exclusive contracts could hinder our ability to create our products and services or to provide our clients with the data or other products or services they prefer, which could lead to a decrease in our client base.Despite our efforts to comply with the licensing requirements of Vendor Products, there can be no assurance that third parties will not challenge our use, which could result in increased acquisition or licensing costs, loss of rights or costly legal actions. Our business could be materially adversely affected if we are unable to timely or effectively replace the data or functionality provided by Vendor Products that become unavailable or fail to operate effectively for any reason. Our operating costs could increase if additional license fees are imposed or current license fees increase or the efforts to incorporate enhancements to Vendor Products are substantial and we are unable to negotiate acceptable licensing arrangements with these suppliers or find alternative sources of equivalent products or services. If any of these risks materialize, they could have a material adverse effect on our business, financial condition or results of operations.We also rely on certain third-party vendors to distribute our data to clients. While some of our vendors generate revenue in connection with distributing our data, others do not derive a direct financial benefit. Should any of our key vendors refuse to distribute our data for any reason or require that we pay them new or additional fees in connection with the distribution of our data, we would need to find alternative ways to distribute our data or lose revenue or profitability for certain products, which may have a material adverse effect on our business, financial condition or results of operations.If our products contain undetected errors or fail to perform properly due to defects, malfunctions or similar problems, we may, among other things, become subject to increased costs or liability based on the use of our products or services to support our 15Table of Contentsclients’ investment processes, which could have a material adverse effect on our business, financial condition or results of operations.Our products and services support the investment processes of our clients, which relate to, in the aggregate, trillions of dollars in assets. Products or services we develop or license have contained, and in the future may contain, undetected errors or defects despite testing or other quality assurance practices. Use of our products or services as part of the investment process creates the risk that our clients, the parties whose assets are managed by our clients, investors in investment products linked to our indexes, the companies that we rate or assess in our ESG solutions or the shareholders of those companies, may pursue claims against us based on even a small error in our data, calculations, methodologies or analysis or a malfunction or failure in our systems, products or services.Errors or defects can exist at any point in a product’s lifecycle, but are frequently found after introduction of new products or services or enhancements to existing products. We continually introduce new methodologies and products, and new versions of and updates to our existing products or services. Despite internal testing and in some cases testing or use by clients, our products or services have contained, and in the future may contain, errors in our data, calculations, methodologies or analysis, including serious defects or malfunctions. This risk may grow with the increase in the number, type and complexity of our products, such as complex client-designed indexes that may require unique and more manual implementation and maintenance. If we detect any errors before we release or deliver a product or service or publish a methodology or analysis, we might have to suspend or delay the product or service release or delivery for an extended period of time while we address the problem. We may not discover errors that affect our products or services or enhancements until after they are deployed, and we may need to provide enhancements or corrections to address such errors, and in certain cases it may be impracticable to do so. If undetected errors exist in our products or services, or if our products or services fail to perform properly due to defects, malfunctions or similar problems, it could result in harm to our brand or reputation, significantly increased costs, lost sales and revenues, delays in commercial release, third-party claims, contractual disputes, negative publicity, delays in or loss of market acceptance of our products or services, license terminations or renegotiations or unexpected expenses and diversion of resources to remedy or mitigate such errors, defects or malfunctions. The realization of any of these events could materially adversely affect our business, financial condition or results of operations. While we have provisions in our client contracts that are designed to limit our liability from claims brought by our clients or third parties relating to our products or services, these provisions could be invalidated or fail to adequately or effectively limit our liability. In addition, clients also increasingly require us to provide contractual assurances regarding our IT and operational risk management and security practices or policies, and many of our clients in the financial services sector are subject to regulations and requirements to adopt risk management processes to oversee their third-party relationships. Contractual disputes could result in the provision of credits, adverse monetary judgments and other penalties and damages. Any such claims brought against us, even if the outcome were to be ultimately favorable to us, would require attention of our management, personnel, financial and other resources and could have a negative impact on our reputation or pose a significant disruption to our normal business operations. In addition, the duration or outcome of such claims and lawsuits is difficult to predict, which could further exacerbate the adverse effect they may have on our business, financial condition or results of operations.MSCI is exposed to potential reputational and credibility concerns.To the extent that any of MSCI’s operating segments or product lines or MSCI as a whole suffers a reputational or other loss in credibility, it could have a material adverse impact on MSCI’s business, financial condition or results of operations. Real or perceived factors that may have already affected credibility, or which could potentially have an impact in this regard, include: the appearance of a conflict of interest; the editorial independence of our index composition and ESG rating and assessment processes and decisions; the influence, attempted influence or appearance of influence of third parties, including governments, politicians and large investors or asset owners, on our editorial decisions; the performance of companies relative to their ESG ratings, index inclusion, risk characteristics or other MSCI content or analytics; the timing and nature of changes to our indexes or ESG ratings and assessments; disagreement with our methodologies or models, including for calculating indexes, value-at-risk and other risk measures, ESG ratings and assessments, data, information and analysis; the accuracy and completeness of our data; views expressed by the media, politicians, other government officials or representatives, regulators or other third parties regarding our company or our industry or our role in the investment process, including allegations or suggestions that we encourage investment in certain companies, countries or regions or in support of certain causes or trends; and the impact of political tensions relating to countries, industries, companies or issues relevant to our products and services, such as the inclusion of certain Chinese companies in our indexes or the focus on sustainable or ESG investing and climate considerations in our products. In some cases, our ESG and Climate offerings, such as our country and company ESG ratings or our Net-Zero Tracker, may insert MSCI into a public spotlight or a public debate regarding the environment, climate change, social concerns or corporate responsibility. In addition, our position as a leading source of ESG research, ratings, data and assessments may at times become contentious, politicized or controversial and lead to disputes with companies or investors or other interested stakeholders and create negative media or regulatory attention. 16Table of ContentsIn addition, there has been increased regulatory and political focus on ESG-related practices of asset managers. Certain of our clients make use of our ESG data and tools as well as our ESG indexes to benchmark ESG investment performance and to construct and manage ETFs and other indexed financial products. These institutional investors are increasingly the subject of additional disclosure requirements, as well as media and political scrutiny, that are focused on preventing asset managers from “greenwashing” (i.e., holding out an investment product as having “green” or “sustainable” characteristics when this is not, in fact, the case). Use of our products by these investors could draw MSCI into debates about and criticisms of greenwashing.Factors affecting our reputation and credibility also include our own sustainability and corporate responsibility policies or practices, including as a result of failure to meet publicly disclosed ESG and climate-related targets or goals, or misalignment with evolving market standards or the methodologies and standards used in our own products and ESG ratings.Errors and other actions by MSCI competitors could also damage the reputation of the industries that we operate in and, therefore, harm the reputation of the Company or certain of our products. In addition, we believe that MSCI’s corporate culture and reputation positively contribute to our ability to attract and retain talent, and that reputational damage could negatively affect our hiring, employee engagement and retention. Damage to our reputation, brand or credibility could have a material adverse effect on MSCI’s business, financial condition or results of operations.The COVID-19 pandemic, or other widespread health crises, could have a material adverse effect on our business, financial condition or results of operations. The COVID-19 pandemic has caused significant economic disruption, including volatility in the global equity markets and continues to persist throughout the world, including in locations where we operate. To date, the COVID-19 pandemic has negatively impacted the global economy, created significant financial market volatility, disrupted global supply chains and resulted in a significant number of infections and deaths worldwide. The COVID-19 pandemic has also created significant uncertainties. These uncertainties include, but are not limited to, the adverse effects of the pandemic on the economy and financial markets, our employees, our clients and our third-party service providers. Certain long-term effects of the efforts of governments and monetary authorities to ameliorate the impacts of the pandemic have also become evident, including both price and wage inflation as well as increased competition for workers. While to date the COVID-19 pandemic has not had a material negative impact on our business, financial condition or results of operations, we cannot assure you that we will be successful in our attempts to mitigate any negative effects of this global pandemic or any other widespread health crisis on our business. We closely monitor the impact of the COVID-19 pandemic and continually assess its potential effects on our business and take appropriate actions in accordance with the recommendations and requirements of relevant authorities. The extent to which the COVID-19 pandemic may impact our operational and financial performance remains uncertain and will depend on many factors outside of our control, including the timing, extent, trajectory and duration of the pandemic; the emergence, spread and severity of new variants of COVID-19; the development, availability, distribution and effectiveness of vaccines and treatments; the imposition of protective public safety measures, including vaccine and testing mandates; and the impact of the pandemic on the global economy, including financial markets. If we are not able to respond to and manage the impact of such events effectively, or if we are not able to cope with the effects of new widespread health crises, our business, financial condition or results of operations may be negatively impacted. Client RisksOur clients that pay us a variable license fee (e.g., based on the assets under management or total expense ratio or trading volumes of an indexed investment product) may seek to negotiate a lower fee structure or may lower the total expense ratio of such products or may cease using our indexes, which could limit the growth of or decrease our revenues from asset-based or other variable fees.A portion of our revenues are from asset-based fees or fees based on trading volumes and some of these revenue streams are concentrated in some of our largest clients, including BlackRock, and in our largest market, the U.S. Our clients, including our largest clients, may seek for a variety of reasons to negotiate to pay us lower asset-based fee percentages, which are sometimes calculated as a percentage of the relevant product’s total expense ratio (“TER”). Additionally, competition is intense among our clients that offer or manage indexed investment products, including ETFs, and low fees are one of the competitive differentiators. Where an investment product’s TER determines our fees, a reduction in the TER may negatively impact our revenues. Additionally, our clients, including our largest clients, may seek to renegotiate existing asset-based fee models with the objective of achieving lower fees, either on a rate basis or in aggregate, which may have a negative impact on our operating revenues.Moreover, clients that have licensed our indexes to serve as the basis of indexed investment products are generally not required to continue to use our indexes and could elect at any time to cease offering the investment product or switch to using a non-MSCI index. Clients that license our indexes to serve as the basis for listed futures and options contracts might also discontinue such 17Table of Contentscontracts. Additionally, we have a differentiated licensing strategy for our indexes and from time to time experience faster growth from lower fee products, resulting in a lower average asset-based fee percentage from indexed investment products. While we aim to maximize the price and volume trade-off over the long-term, there can be no assurance that we will be able to do so. Results for any given quarter could be materially adversely affected by stronger growth in assets in indexed investment products with lower-than-average fees not sufficiently offset by growth in assets in indexed investment products with higher-than-average fees. Our asset-based fees could dramatically decrease, which could have a material adverse effect on our business, financial condition or results of operations. Finally, to the extent that multiple investment products are based on the same index, (i) assets under management in one product could shift to products that pay MSCI lower fee levels, (ii) the products could compete for the same assets such that none of the products becomes large enough to be successful or sustained, or (iii) the failure or discontinuance of one product (e.g., derivatives used for hedging) could have a detrimental effect on the use of the other products (e.g., ETFs).Cancellations or reductions by any of our largest clients could have a material adverse effect on our business, financial condition or results of operations.A material portion of our revenues is concentrated in some of our largest clients. For the fiscal year ended December 31, 2022, our largest client organization by revenue, BlackRock, accounted for 10.3% of our consolidated operating revenues. For the fiscal year ended December 31, 2021, BlackRock accounted for 12.7% of our consolidated operating revenues. Our revenue growth depends on our ability to obtain new clients, quickly onboard our clients and deploy our products and services to them, sell additional services to existing clients and achieve and sustain a high level of renewal rates with respect to our existing licenses. Failure to achieve one or more of these objectives could have a material adverse effect on our business, financial condition or results of operations. A client’s activity with us may decrease for a variety of reasons, including the client’s level of satisfaction with our products and services, the effectiveness of our support services, the pricing of our products and services, the pricing and quality of competing products or services or the effects of changes in economic conditions and the global capital markets. If one or more of our largest clients cancels or reduces its licenses and we are unsuccessful in replacing those licenses, our business, financial condition or results of operations could be materially adversely affected.Our clients may become more self-sufficient, which may reduce demand for our products or services and materially adversely affect our business, financial condition or results of operations.Our clients may internally develop certain functionality contained in the products or services they currently license from us. For example, a number of our clients have obtained regulatory clearance to create indexes for use as the basis of ETFs that they manage and others have invested in direct indexing strategies, allowing investors to purchase individual stocks making up an index rather than investing in a fund or ETF. Similarly, some of our clients who currently license our risk or ESG and climate data to analyze their portfolio risk may develop their own tools to collect data and assess risk or embed ESG and climate considerations into their investment processes, making our products or services unnecessary for them. A growing number of asset managers and investment banks, in partnership with index providers that offer calculation agent services, or acting together with an industry group or association, have created or may create their own range of proprietary indexes, which they use to manage funds or as the basis of ETFs, structured products or over-the-counter derivatives. To the extent that our clients become more self-sufficient, demand for our products or services may be reduced, which could have a material adverse effect on our business, financial condition or results of operations.Technology RisksAny failures, disruptions, instability or vulnerabilities in our information technology architecture, platforms, vendors and service providers, production and delivery systems, software, code, internal network, the Internet or other systems or applications may disrupt our operations, cause our products to be unavailable or fail and impose delays or additional costs in deploying our products, or impose conditions or restrictions on our ability to commercialize our products or keep them confidential and result in reputational and other harm and have a material adverse effect on our business, financial condition or results of operations.We depend heavily on the capacity, reliability and security of our information technology systems and platforms and their components, including our data centers, cloud providers and other vendors and service providers, production and delivery systems as well the Internet, to create and deliver our products and service our clients. Our employees also depend on these systems, platforms and providers for internal use. Heavy use of our electronic delivery systems and other factors such as loss of service from third parties, operational failures, human error, terrorist or other attacks, climate or weather related events (e.g., hurricanes, floods or other natural disasters), another outbreak of pandemic or contagious disease, power loss, telecommunications failures, technical breakdowns, Internet failures or malicious attacks exploiting security vulnerabilities could impair our systems’ operations or interrupt their availability for extended periods of time or impact the availability of personnel. Our ability to effectively use the Internet, including 18Table of Contentsour remote work force’s ability to access the Internet, may also be impaired due to infrastructure failures, service outages at third-party Internet providers, malicious attacks exploiting security vulnerabilities or increased government regulation. Disruptions, failures or slowdowns that could occur with respect to our operations, including to our information technology systems and platforms, our electronic delivery systems or the Internet, could damage our brand and reputation, result in litigation and negatively affect our ability to distribute our products effectively and to service our clients, including delivering managed services or delivering real-time index data. To the extent we grow through acquisitions, newly acquired businesses may not have invested in technological infrastructure and disaster recovery to the same extent as we have. As their systems are integrated into ours, a vulnerability could be introduced, which could impact our platforms across the Company. There is no assurance that we will be able to successfully defend against such disruptions or that our disaster recovery or business continuity plans, or those of our third-party service providers (including cloud providers), will be effective in mitigating the risks and associated costs, which could be exacerbated by our shift to an increasingly remote working environment, and which could have a material impact on our business, financial condition or results of operations.Any failure to ensure and protect the confidentiality of data could have a material adverse effect on our business, financial condition or results of operations.Many of our products, as well as our internal systems and processes, involve the collection, retrieval, processing, storage and transmission, through a variety of channels, of proprietary, third party and client confidential information. We also handle personal information of our employees in connection with their employment. We rely on a complex system of internal processes and IT controls along with policies, procedures and training to protect this information, including sensitive client data such as material non-public information and client portfolio data that may be provided to us or hosted on our systems, against unauthorized access or disclosure. In addition, we believe that when we change the composition of our indexes, in some cases the changes can have an indirect effect on the prices of constituent securities and on certain indexed investment products as a result of trading activity related to tracking our indexes. As the usage and types of uses of our ESG ratings increase, the ratings and changes to the ratings in some cases could also potentially have an impact on the companies that we rate, the price of their securities and the price of other securities that reference their securities. If our internal processes, confidentiality policies, conflict of interest policies or information barrier procedures fail or are insufficient, including as a result of human error or manual processes, system error, other inadvertent release or other failure, or if an employee purposely circumvents or violates our internal controls, policies or procedures, then unauthorized access to, or disclosure or misappropriation of, data, including material non-public or other confidential information (e.g., certain index composition data or ESG rating data), our brand and reputation may suffer and we may become subject to litigation, regulatory actions, sanctions or other penalties, leading to a loss of client confidence, which could have a material adverse effect on our business, financial condition or results of operations.Successful cyber-attacks or other security breaches and the failure of security plans, systems and procedures could have a material adverse effect on our business, financial condition or results of operations. Our operations rely on the secure processing, storage and transmission of confidential, sensitive, proprietary and other types of data and information that is managed internally and with third-party vendors. We and our vendors are subject to security risks, including cyber-attacks and other security breaches, such as phishing scams, hacking, tampering, intrusions, viruses, ransomware, malware and denial-of-service attacks. In some cases, these risks are heightened when employees are working remotely. Our and our vendors’ use of mobile and cloud technologies may also increase our risk for such threats. We may be exposed to more targeted and more sophisticated cyber and other security attacks aimed at accessing certain information on our systems because of our role or prominence in the global marketplace, including client portfolio data, the composition of our indexes and MSCI ESG Research ratings of corporate issuers. Any such threats may cause material interruptions or malfunctions in our or our vendors’ products or services, networks, systems, websites, applications, data or data processing, or may otherwise compromise the availability, confidentiality or integrity of data or information in our possession. While we have not experienced cyber or other security incidents that are individually, or in the aggregate, material to the Company, we have experienced cyber-attacks of varying degrees in the past, including denial-of-service attacks. There can be no assurance that there will not be material adverse effects relating to these types of incidents in the future, in particular as these incidents have generally become increasingly frequent, sophisticated, difficult to detect and difficult to successfully defend against. Our security measures or those of our third-party providers, including any cloud-based technologies, may prove insufficient depending upon the attack or threat posed. Cyber-attacks, security breaches or third-party reports of perceived security vulnerability to our systems, even if no breach has occurred, could damage our brand and reputation, result in litigation, regulatory actions, sanctions or other penalties, lead to loss of client confidence, which would harm our ability to retain clients and gain new ones, and lead to 19Table of Contentsfinancial losses. Any of the foregoing could lead to unexpected or higher than estimated costs. We may also incur additional costs as a result of increasing and refining our internal processes and IT controls and policies and procedures related to security, processing integrity and confidentiality or privacy.Migration of our applications, systems, processes and infrastructure to new technologies, cloud providers, data centers, processes, platforms or applications could result in unanticipated failures, interruptions or delays in the performance and delivery of our products, services and client support. Such incidents could have a material adverse effect on our business, financial condition or results of operations.In the past, we have experienced unanticipated interruption and delay in the performance and delivery of certain products, including after we migrated applications and infrastructure to new data centers, database storage facilities or other network infrastructure located across multiple facilities globally. While we have taken steps to mitigate such interruptions and delays, we cannot provide assurance that they will not occur again in the future as part of migration efforts to new technologies, applications or processes (e.g., cloud migration), even after extensive testing of new systems, processes, applications and hardware, or if we experience significant growth of our customer base or increases in the number of products or services or in the speed at which we are required to provide products and services. Such disruptions may result in cancellations and reduced demand for our products and services, resulting in decreased revenues, or in cost increases relating to our use of power and data storage. After adopting new technologies, applications and processes, such as cloud computing, virtualization and agile software development, we may experience unanticipated interruption and delay in the performance and delivery of certain of our products, services and client support. We may also incur increased operating expenses to recover data, repair, replace or remediate systems, equipment or facilities, and to protect ourselves from such disruptions. Accordingly, any significant failures, disruptions or instability affecting our information technology platform, cloud providers, data centers, production and delivery systems, applications, processes or the Internet could negatively affect our ability to distribute our products effectively and to service our clients, damage our brand and reputation and result in litigation, which may have a material adverse effect on our business, financial condition or results of operations.Our use of open source code could introduce security vulnerabilities, impose unanticipated delays or costs in deploying our products or services, or impose conditions or restrictions on our ability to commercialize our products or services or keep them confidential.We rely on open source code to develop software and to incorporate it in our products and internal systems. The use of open source code may entail greater risks than the use of third-party commercial software, as open source licensors generally do not provide warranties or other contractual protections regarding infringement claims, the quality of the code or the security of the code. Some open source licenses provide that if we combine our proprietary code with open source code and distribute it in a certain manner, we could be required to release the source code of our proprietary applications to the public. This would allow our competitors to create similar products with less development effort and time and ultimately put us at a competitive disadvantage. Additionally, the terms of many open source code licenses are ambiguous and have not been interpreted by U.S. courts. Therefore, we could be required to seek licenses from third parties on terms that are not commercially feasible, to make generally available portions of our proprietary code, to re-engineer our products or systems, to discontinue the licensing of our products if re-engineering could not be accomplished on a timely or cost-effective basis, or to take other remedial action that could divert resources away from our development efforts. Any of these requirements could materially adversely affect our business, financial condition or results of operations.Strategy and Growth RisksOur business may be affected by changes in economic conditions and the global capital markets, including resulting from geopolitical events, adverse equity market conditions, volatility in the financial markets and evolving investment trends. Such changes could decrease the use of our products and services which could have a material adverse effect on our business, financial condition or results of operations.Our business is impacted by economic conditions, volatility in the global capital markets and evolving investment trends (including conditions, volatility and trends that result from geopolitical events, such as Russia’s invasion of Ukraine and the related global escalation of geopolitical tensions). Our clients use our products for a variety of purposes, including benchmarking, performance attribution, portfolio construction and risk management, and to support investment strategies including ESG, climate, factor, thematic, private asset and MAC investing. Volatile capital markets, geopolitical instability or unrest and other economic and market conditions and trends, including a recession or other significant financial-market event or crisis, may impact whether, how, where and when investors choose to invest, for example between developed or emerging markets, U.S. or non-U.S. markets, as well as whether to adopt different investment strategies.A portion of our revenues comes from clients who use our indexes as the basis for indexed investment products. These fees are primarily based on a client’s assets under management or trading volumes, and if the level of assets under management or trading 20Table of Contentsvolumes declines, we expect our fee-based revenue to show a corresponding decline. The value of an investment product’s assets may increase or decrease in response to changes in market performance and cash inflows and outflows, which could impact our revenues. Additionally, an increasing portion of our revenues comes from products and services that relate to certain investment trends, such as ESG and climate, factor, thematic, private asset and MAC investing. A decline in the equity markets or movement away from such investment trends, including as a result of changing economic conditions or political or regulatory concerns or scrutiny, could decrease demand for our related products and services, which could have a material adverse effect on our business, financial condition or results of operations.Competition and financial and budgetary pressures affecting clients in our industry may cause price reductions or loss of market share, which may materially adversely affect our business, financial condition or results of operations.Competition exists across all markets for our products and services. Our competitors range in size from large companies with substantial resources to small, single-product businesses that are highly specialized. Our larger competitors may have access to more resources and may be able to achieve greater economies of scale, and our specialized competitors may be more effective in devoting technical, marketing and financial resources to compete with us with respect to a particular product or service. Some competitors may offer price incentives or different pricing structures that are more attractive to clients. The competitive landscape may also experience consolidation in the form of mergers and acquisitions, joint ventures or strategic partnerships, which result in a narrower pool of competitors that are better capitalized or that are able to gain a competitive advantage through synergies.Barriers to entry may be low or declining in many of the markets for our products and services, including for single-purpose product companies, which could lead to the emergence of new competitors. For example, more broker-dealers, data suppliers, credit rating agencies or other market participants or vendors could begin developing their own content such as proprietary risk analytics, ESG and climate data or indexes. Recent developments, including increases in the availability of free or relatively inexpensive information through Internet sources or other low-cost delivery systems, advances in cloud computing, increased use of open source code, the ability of machine learning and other artificial intelligence systems to process and organize large data sets, as well as client development of proprietary applications in specific areas, have further reduced barriers to entry in some cases. We may experience pressures to reduce our fees on account of financial and budgetary pressures affecting our clients, including those resulting from weak or volatile economic or market conditions, including uncertainty regarding a global recession or significant financial-market event or crisis, the duration and long-term economic and societal consequences of the COVID-19 pandemic, the Russia-Ukraine conflict and the inflationary environment, which may lead certain clients to reduce their overall spending on our products or services, including by seeking similar products or services at a lower cost than what we are able to provide, by consolidating their spending with fewer providers, by consolidating with other clients or by self-sourcing certain of their information and analytical needs. Accordingly, competitive and market pressures may result in fewer clients or reduced sales, including as a result of client closures and consolidations, price reductions, prolonged selling and renewal cycles and increased operating costs, such as for marketing and product development, which could, individually or in the aggregate, result in a material adverse effect on our business, financial condition or results of operations. To remain competitive, we must successfully develop new and enhanced products and services and effectively manage product transitions and integrations.To remain competitive, we must continually introduce new products and services; enhance existing products and services, including through integration of products and services within MSCI and with third-party platforms; collect, organize, analyze and protect large amounts of information to generate insights; and effectively generate client demand for new and enhanced products and services. We may not be successful in developing, introducing, implementing, marketing, pricing, launching or licensing new products or enhancements on a timely or cost-effective basis or without impacting the stability and efficiency of existing products and systems. Any new products and enhancements may not adequately meet the requirements of the marketplace or industry standards or achieve market acceptance. The process of developing and enhancing our products and services is complex and may become increasingly complex and expensive in the future due to the introduction of new platforms, operating systems, technologies and client expectations. This process often requires effective collaboration across various functions and product lines, and ineffective or insufficient collaboration may harm our ability to meet our business objectives. In addition, our reputation could be harmed if we are perceived as not innovating rapidly enough to meet the changing needs of investors or their advisors. We must make long-term investments and commit significant resources before knowing whether these investments will eventually result in new or enhanced products and services that satisfy our clients’ needs and generate adequate revenues. From time to time, we also incur costs to integrate existing products and services and transition clients to enhanced products and services, which also present execution risks and challenges and could lead to price reductions or other concessions. If we are unable to effectively manage the development of new or enhanced products and services, we 21Table of Contentsmay not be able to remain competitive and our business, financial condition or results of operations could be materially adversely affected. Our global operations and any future expansions may continue to place significant strain on our management and other resources, as well as subject us to additional, and in some cases unanticipated, risks and costs in connection with political, economic, legal, operational and other issues resulting from our increased global footprint, which could materially adversely impact our businesses. Our global operations and any future expansion are expected to continue to place significant demands on our personnel, management and other resources. In our existing global operations or any future expansion, including as a result of acquisition, there can be no assurance that we will effectively attract, engage and retain qualified personnel, develop and retain effective leadership in all our locations; operate and expand our physical facilities and information technology, legal and compliance infrastructure; integrate acquired businesses; or otherwise adequately manage our global operations and any future expansion. Our global operations also expose us to political, economic, legal, operational, reputational, franchise and other risks that are inherent in operating in many countries, including risks of possible capital controls, exchange controls, customs duties, sanctions compliance, tax penalties, levies or assessments, legal uncertainty, broad regulatory discretion and other restrictive governmental actions, as well as the outbreak of hostilities or political and governmental instability in certain of the countries or regions in which we conduct operations. The majority of our employees are located in offices outside of the U.S., and a number of those employees are located in emerging market locations. The cost of establishing and maintaining these offices, including costs related to information technology infrastructure, as well as the costs of attracting, training and retaining employees in these locations may be higher, or may increase at a faster rate, than we anticipate. Additionally, public health epidemics impacting the global economy and our employees, such as the worldwide COVID-19 pandemic, may have a material adverse effect on our business, financial condition or results of operations.The laws and regulations in many countries applicable to our business are uncertain and evolving, and it may be difficult or costly for us to determine and remain compliant with the exact requirements of local laws in every market. Our inability to maintain consistent internal policies and procedures across our offices and remain in compliance with local laws in a particular market could have a significant and negative effect not only on our businesses in that market but also on our reputation generally.Demand for our products and services is still nascent in many parts of the world, particularly in emerging market locations where risk management and ESG and climate integration practices are often not fully developed. In addition, the data required to model local securities in some emerging markets might be difficult to source and local investment product nuances may be difficult or costly to model. If we do not appropriately tailor our products and services to fit the needs of the local market, we may be unable to effectively grow sales of our products and services in some locations outside of the U.S. There can be no assurances that demand for our products and services will develop in these countries.Any failure to effectively manage expansion or to effectively manage the business globally could damage our brand and reputation, result in increased costs and litigation and have a material adverse effect on our business, financial condition or results of operations.Legal and Regulatory RisksFailure to comply with laws, rules or regulations, or the introduction of new laws, rules or regulations or changes to existing laws, rules or regulations could materially adversely affect our business, financial condition or results of operations.Failure to comply with any applicable laws, rules, orders, regulations, codes or other requirements could subject us to litigation, regulatory actions, sanctions, fines or other penalties, as well as damage our brand and reputation. The financial services industry, within which we and many of our clients operate, is subject to extensive laws, rules and regulations at the federal and state levels, as well as by foreign governments, with some jurisdictions regulating indexes directly. These laws, rules and regulations are complex, evolve frequently and sometimes quickly and unexpectedly, and are subject to administrative interpretation and judicial construction in ways that are difficult to predict, and could materially adversely affect our business and our clients’ businesses. Uncertainty caused by political change globally heightens regulatory uncertainty. Additionally, we may be required to comply with multiple and potentially conflicting laws, rules or regulations in various jurisdictions, which could, individually or in the aggregate, result in materially higher compliance costs to us. It is possible that laws, rules or regulations could cause us to restrict or change the way we license and price our products and services across our offerings, including if data or information from one offering is used in another offering, or could impose additional costs on us. Changes to the laws, rules and regulations applicable to our clients could limit our clients’ ability to use our products and services or could otherwise impact our clients’ demand for our products and services. As such, to the extent that our clients become subject to certain laws, rules or regulations, we may incur higher costs in connection 22Table of Contentswith modifying our products or services. To the extent that we rely on our clients and vendors to provide data for our products and services and certain laws, rules or regulations impact our clients’ and vendors’ ability or willingness to provide that data to us or regulate the fees for which such data can be provided, our ability to continue to produce our products and services or the related costs could be negatively impacted. The regulations and regulatory developments that most significantly impact us are described below:•Brexit. The United Kingdom (“UK”) exited the European Union (“EU”) on January 31, 2020 (commonly referred to as “Brexit”) and the UK’s membership in the EU single market ended on December 31, 2020. On December 24, 2020, the UK and the EU announced that they had struck a new bilateral trade and cooperation deal governing the future relationship between the UK and the EU (the “EU-UK Trade and Cooperation Agreement”) which was formally approved by the 27 member states of the EU on December 29, 2020. In March 2021, the UK and EU agreed on a framework for voluntary regulatory cooperation and dialogue on financial services issues between them in a Memorandum of Understanding (the “MOU”), which is expected to be signed after formal steps are completed, although this has not yet occurred. There remain uncertainties related to Brexit and the new relationship between the UK and EU that will continue to be developed and defined, as well as uncertainties related to the wider trading, legal, regulatory, tax and labor environments, and the resulting impact on our business and that of our clients. For instance, under the EU Benchmarks Regulation, benchmarks provided by a third-country (i.e. non-EU) benchmark administrator may be used by EU-supervised entities in the EU if the benchmark administrator applies for recognition, endorsement or if its home jurisdiction’s regime is deemed equivalent by the European Commission. The EU Benchmarks Regulation currently provides for a transition period until December 31, 2023, allowing supervised entities to continue to utilize benchmarks provided by non-EU administrators. The European Commission has indicated that it may further extend the transition period for the use of benchmarks provided by non-EU administrators until at least January 1, 2026. One of our subsidiaries is authorized as a UK benchmark administrator regulated by the UK FCA, we have significant operations in the EU and certain members of our senior management team are based in the UK. As a result, uncertainties related to Brexit and the new relationship between the UK and EU could increase our costs of doing business, or in some cases, affect our ability to do business, which could have a material adverse effect on our business, financial condition or results of operations.•Regulation Affecting Benchmarks. Compliance efforts associated with regulations affecting benchmarks or their uses and any related technical standards and guidance could have a negative impact on our business and results of operations. In particular, compliance requirements could lead to a change in our business practices, product offerings or our ability to offer indexes in certain jurisdictions, including the EU, including without limitation, by increasing our costs of doing business, including direct costs paid to regulators, diminishing our intellectual property rights, impacting the fees we can charge for our indexes, imposing constraints on our ability to meet contractual commitments to our data providers, imposing constraints on how we offer our products or causing our data providers to refuse to provide data to us, any of which could have a material adverse effect on our index products. For example, the benchmark industry is subject to regulations in the EU, such as Regulation (EU) 2016/1011 (as amended), which is also applicable in the UK as it forms part of UK domestic law by virtue of the European Union (Withdrawal) Act 2018 (as amended), as well as increased scrutiny and potential new or increased regulation in various other jurisdictions. Additionally, the European Securities and Markets Authority (“ESMA”) issues guidance from time to time regarding interpretations of the EU Benchmarks Regulation (such as Regulation (EU) 2016/1011 (as amended) and Regulation (EU) No 600/2014). The ESMA Guidelines on ETFs and other UCITS Issues limit the types of indexes that can be used as the basis of Undertakings for Collective Investment in Transferable Securities (“UCITS”) funds and require, among other things, index constituents, together with their respective weightings, to be made easily accessible free of charge, such as via the internet, to investors and prospective investors on a delayed and periodic basis. The International Organization of Securities Commissions (“IOSCO”) recommends that benchmark administrators, on a voluntary basis, publicly disclose whether they comply with the principles for financial benchmarks published by IOSCO. Other jurisdictions have also indicated they may consider potential benchmark regulation or conduct reviews of the benchmark industry. For instance, the UK FCA has announced that it will conduct a market study into how competition is working in the markets for benchmarks and indices. The heightened attention and scrutiny on benchmarks and index providers by regulators, policymakers and the media in the EU, the U.S. and other jurisdictions around the world could result in negative publicity or comments about the role or influence of our company or the index industry generally, which could harm our reputation and credibility.Further, laws, rules, regulations and orders affecting users of our indexes can have an indirect impact on our indexes, including their construction and composition, such as sanctions that prohibit users of our indexes from investing or transacting in securities included in our indexes.•Data Privacy Legislation. Changes in laws, rules or regulations, or consumer environments relating to privacy or data collection and use may affect our ability to collect, manage, aggregate, store, transfer and use personal data. 23Table of ContentsThere could be a material adverse impact on our direct marketing due to the enactment of legislation or industry regulations, or simply a change in practices, arising from public concern over privacy issues. Restrictions or bans could be placed, or penalties could be levied, relating to the collection, management, aggregation, storage, transfer and use of information that is currently legally available, in which case our costs related to handling information could increase materially. For example, California passed the California Consumer Privacy Act (“CCPA”), which took effect on January 1, 2020, and the California Privacy Rights Act (“CPRA”), which took effect on January 1, 2023 and significantly amends and expands the CCPA. The CCPA and CPRA regulate the processing of personal data of all Californians and imposes significant penalties for non-compliance. The European General Data Protection Regulation imposes enhanced operational requirements for companies that receive or process personal data of residents of the EU and includes significant penalties for non-compliance. In Japan, the Act on the Protection of Personal Information regulates the use of personal information and personal data of “data subjects” for business purposes without regard to whether such use is within Japan. In addition, other jurisdictions, including China and India, are considering imposing or have already imposed additional restrictions on the use and transfer of personal and other types of data.•Investment Advisers Act. Except with respect to certain products provided by MSCI ESG Research LLC and certain of its designated foreign affiliates, we believe that our products and services do not constitute or provide investment advice as contemplated by the Advisers Act. See Part I, Item 1. “Business—Government Regulation” above. The Advisers Act imposes fiduciary duties, recordkeeping and reporting requirements, disclosure requirements, limitations on agency and principal transactions between an adviser and advisory clients, as well as general anti-fraud prohibitions. Future developments in our product lines or changes to current laws, rules, regulations or interpretations could cause this status to change, requiring other entities in our corporate family to register as investment advisers under the Advisers Act or comply with similar laws or requirements in states or foreign jurisdictions. In the U.S., the SEC has recently sought public comment on the role of certain third-party information providers to the asset management industry, including index providers and model providers, and whether, under particular facts and circumstances, information providers are acting as investment advisers under the Advisers Act. The specific questions in the SEC’s request for comment demonstrate that the SEC is considering whether, and to what extent, information providers, including index providers, should register as investment advisers and be subject to all aspects of the Advisers Act. The SEC’s request for comment is far-reaching and could lead to regulation pursuant to the Advisers Act or other framework. If our index business were to be deemed an investment adviser, we could be deemed a fiduciary to our clients, increasing the costs and complexity of our business. In addition, aspects of this regulatory framework may be at odds with our obligations under other benchmark regulations. The SEC has also recently proposed a rule that would prohibit SEC-registered investment advisers from outsourcing certain services or functions to service providers that do not meet minimum requirements. This proposed rule would impose on investment advisers due diligence, monitoring and record-keeping requirements of their service providers, and index providers, among others, are identified as service providers that could fall within the scope of the proposed requirements. This proposed rule could therefore impose additional requirements on our business.In some instances, in connection with the provision of data and services, we have incurred additional costs to implement processes and systems at the request of our clients to ensure that the products and services that they in turn provide to their clients using our data are compliant with the financial regulations to which our clients may be subject. For example, a U.S. Executive Order prohibiting many of our clients from transacting in the securities of certain Chinese companies resulted in our decision to remove these companies from relevant indexes in order to support our clients’ needs that our indexes meet their objective to be replicable in investment portfolios. To the extent that our clients are subject to increased regulation, we may be indirectly impacted and could incur increased costs that could have a negative impact on the profitability of certain products.Additionally, there has been increased attention on and scrutiny of index and ESG rating and data providers by politicians, regulators, policymakers and the media, which could create negative publicity that could harm our reputation or credibility as well as result in new or additional regulation that could increase our costs and have a negative impact on our business, financial condition or results of operations. For example, IOSCO has asked regulators to consider focusing more attention on the use of ESG ratings and data products. In the EU, the European Commission published a Summary Report in August 2022, following a targeted consultation on the functioning of the ESG ratings market in the EU and on the consideration of ESG factors in credit ratings, which the Commission will use to consider the need for possible policy initiatives. In addition, in December 2022, the UK government announced a consultation on the regulation of ESG ratings. Furthermore, in December 2022, the Japan Financial Services Agency published a Code of Conduct for ESG rating and data providers, and the UK FCA announced the formation of an industry-led group to develop a voluntary Code of Conduct for ESG data and ratings providers. These or similar regulatory regimes or initiatives could impose significant compliance burdens and costs on our ESG and Climate products and services. Furthermore, regulation in multiple jurisdictions may be inconsistent, which could create implementation challenges and result in inadvertent noncompliance.24Table of ContentsLegal protections for our intellectual property rights and other rights may not be sufficient or available to protect our competitive advantages. Third parties may infringe on our intellectual property rights or we may infringe upon their intellectual property rights, which, in each case, could have a material adverse effect on our business, financial condition or results of operations.We consider many aspects of our products and services to be proprietary. We rely primarily on a combination of trade secrets, patents, copyrights and trademark rights, laws regarding unfair competition and the misappropriation of intellectual property, as well as technical measures and contractual protections, such as non-disclosure obligations, to protect our products and services. Moreover, we license or acquire technology that we incorporate into our services and products, and third parties or previous owners may not have taken sufficient measures to protect intellectual property. Despite our best efforts, we cannot be certain that the steps we have taken to protect our intellectual property rights, and the rights of those from whom we license or acquire intellectual property, are adequate to prevent unauthorized use, misappropriation, distribution or theft of our intellectual property. Intellectual property laws in various jurisdictions in which we operate are subject to change or varying interpretations at any time and could further restrict our ability to protect our intellectual property rights. The enforceability of intellectual property rights and obligations under our agreements, as well as the availability of remedies in the event of a breach, may vary due to the different jurisdictions in which our clients and employees are located. Failure to protect our intellectual property adequately could harm us, our brand or reputation and affect our ability to compete effectively. There is no guarantee that any intellectual property rights that we may obtain will protect our competitive advantages, nor is there any assurance that our competitors will not infringe upon our rights. Furthermore, our competitors may independently develop and protect products and services that are the same or similar to ours. We may be unable to detect the unauthorized use or disclosure of our intellectual property or confidential information, or to take the necessary steps to enforce our rights. In addition, our products and services, or third-party products that we provide to our clients, could infringe upon the intellectual property rights of others.Pursuing intellectual property claims to preserve our intellectual property rights or responding to intellectual property claims, regardless of merit, can consume valuable time, and result in costly litigation or delays, and there is no guarantee that we will be successful. From time to time, we receive claims or notices from third parties alleging infringement or potential infringement of their intellectual property rights; and the number of these claims may grow. These intellectual property claims would likely be costly to defend and could require us to pay damages, limit our future use of certain technologies, harm our brand and reputation, significantly increase our costs and prevent us from offering some services or products. We may need to settle such claims on unfavorable terms, pay damages, stop providing or using the affected products or services, undertake workarounds or substantial reengineering of our products or services or enter into royalty or licensing agreements, which may include terms that are not commercially acceptable to us. From time to time, we receive notices calling upon us to defend partners, clients, suppliers or distributors against third-party claims under indemnification clauses in our contracts. If any of these risks materialize, they could have a material adverse effect on our business, financial condition or results of operations.There have been a number of lawsuits in multiple jurisdictions, including in the U.S. and Germany, regarding whether issuers of indexed investment products are required to obtain a license from the index owner or whether issuers may issue investment products based on publicly available index-level data without obtaining permission from (or making payment to) the index owner. The outcome of these cases depends on a number of factors, including the governing law, the amount of information about the index available without a license and the other particular facts and circumstances of the cases. In some instances, the results have been unfavorable to the index owner. If courts or regulators or other governmental bodies in relevant jurisdictions determine that a license is not required to issue investment products linked to indexes, this could have a material adverse effect on our business, financial condition or results of operations. It might also lead to changes in current industry practices such that we would no longer make our index level data publicly available, such as via our website or news media, on a timely basis.Some of our products and services help our clients to meet their regulatory requirements. Changes to regulatory requirements may obviate the need for these products or services or may cause us to invest in enhancing the products or services to help our clients meet the new regulatory requirements.Financial RisksOur revenues, expenses, assets and liabilities are subject to foreign currency exchange rate fluctuation risk.We are subject to foreign currency exchange rate fluctuation risk. Exchange rate movements can impact the U.S. dollar reported value of our revenues, expenses, assets and liabilities denominated in non-U.S. dollar currencies or where the currency of such items is different than the functional currency of the entity where these items were recorded. Additionally, the value of assets in indexed investment products can fluctuate significantly over short periods of time and such volatility may be further impacted by fluctuations in foreign currency exchange rates. 25Table of ContentsWe manage certain portions of our foreign currency exchange rate risk, in part, through the use of derivative financial instruments comprised principally of forward contracts on foreign currency which are not designated as hedging instruments for accounting purposes. Any derivative financial instruments that we are currently party to or may enter into in the future may not be successful, resulting in an adverse impact on our results of operations.To the extent that our international activities recorded in local currencies increase or decrease in the future, our exposure to fluctuations in foreign currency exchange rates may correspondingly increase or decrease and could have a material adverse effect on our business, financial condition or results of operations. Our indebtedness could materially adversely affect our cash flows and financial flexibility.For an overview of our current outstanding indebtedness, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Although we believe that our cash flows will be sufficient to service our outstanding indebtedness, we cannot provide assurance that we will generate and maintain cash flows sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. Our ability to make payments on indebtedness and to fund planned capital expenditures depends on our ability to generate and access cash in the future, which, in turn, is subject to general economic, financial, competitive, regulatory and other factors, many of which are beyond our control. If we are unable to pay our obligations as they mature, we may need to refinance all or a portion of our indebtedness on or before maturity. If we are unable to secure additional financing on terms favorable or acceptable to us or at all, we could also be forced to sell assets to make up for any shortfall in our payment obligations. If we cannot refinance or otherwise pay our obligations as they mature and fund our liquidity needs, our business, financial condition, results of operations, cash flows, liquidity, ability to obtain financing and ability to compete in our industry could be materially adversely affected. We may need or want to refinance our existing debt or incur additional debt from time to time to finance working capital, capital expenditures, investments or acquisitions, or for other purposes. If we do so, we may be subject to less favorable terms. The risks related to our level of indebtedness could also intensify, including by making it difficult for us to optimally capitalize and manage the cash flow for our business or placing us at a competitive disadvantage compared to our competitors that have less indebtedness. Furthermore, the terms of our debt agreements include restrictive covenants that limit, among other things, our and our existing and future subsidiaries’ financial flexibility. If we are unable to comply with the restrictions and covenants in our debt agreements, there could be a default that, in some cases, if continuing, could result in the accelerated payment of our debt obligations or the termination of borrowing commitments on the part of the lenders under our revolving credit facility (the “Revolving Credit Facility) or our term loan A facility (the “TLA Facility”) under the Amended and Restated Credit Agreement (the “Credit Agreement”), dated as of June 9, 2022, by and among the Company, the guarantors party thereto, JPMorgan Chase Bank, N.A., as administrative agent and the lenders from time to time party thereto, as amended, supplemented, modified or amended and restated from time to time. As of December 31, 2022, there were no amounts outstanding under our Revolving Credit Facility, and the TLA Facility was fully drawn. In 2017, the UK Financial Conduct Authority (the “FCA”), which regulates London Interbank Offered Rate (“LIBOR”), announced that the FCA will no longer persuade or compel banks to submit rates for the calculation of the LIBOR benchmark after 2021. The administrator for LIBOR announced on March 5, 2021 that it will permanently cease to publish most LIBOR settings beginning on January 1, 2022 and cease to publish the overnight, one-month, three-month, six-month and 12-month USD LIBOR settings on July 1, 2023. Accordingly, the FCA has stated that it does not intend to persuade or compel banks to submit to LIBOR after such respective dates. Until such time, however, FCA panel banks have agreed to continue to support LIBOR. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is recommending replacing USD LIBOR with the Secured Overnight Financing Rate (“SOFR”), a new index calculated by short-term repurchase agreements, backed by Treasury securities. In 2022, we amended our prior credit agreement to, among other things, replace LIBOR with SOFR. Any borrowings under the credit facilities under our Credit Agreement are primarily based on SOFR. It is unknown whether SOFR will attain market acceptance as a replacement for LIBOR and, because SOFR differs fundamentally from LIBOR, there is no assurance that SOFR will perform in the same way as LIBOR would have performed at any time, and there is no guarantee that it is a comparable substitute for LIBOR. As a result, we cannot reasonably predict the potential effect, if any, of the replacement of LIBOR with SOFR or the establishment of other alternative reference rates on our business, financial condition or results of operations. In addition, we have incurred variable rate indebtedness under the TLA Facility, and we may incur variable rate indebtedness under our Revolving Credit Facility, which subjects us to interest rate risk generally and could cause our debt service obligations to increase significantly. 26Table of ContentsA change in our credit ratings could materially adversely affect our financial condition.Our credit ratings are not recommendations to buy, sell or hold any of our common stock or outstanding debt. Our outstanding debt under our senior unsecured notes (the “Senior Notes”) currently has non-investment grade ratings. Any rating assigned to our debt is subject to ongoing evaluation by the credit rating agencies and could be lowered or withdrawn entirely at any time by any of the agencies if, in the agency’s judgment, future circumstances relating to the basis of the rating so warrant. Such future circumstances include, but are not limited to, adverse changes to our results of operations, financial condition or cash flows, or revisions to our corporate strategy pertaining to capitalization or leverage. Any such downgrade or withdrawal could adversely affect the amount of capital we can access, as well as the terms of any financing we obtain.In addition, our debt covenants contain certain obligations that are triggered by a change in our credit rating, including obligations to make repurchase offers to the noteholders of our Senior Notes if we experience one of the specified kinds of changes in control and related lowering of our credit ratings, as detailed in the indentures governing our Senior Notes.Any adverse change in our credit rating could have a negative effect on our liquidity and future growth through transactions in which we rely on the ability to receive debt capital at an advantageous cost and on favorable terms. Accordingly, actual or anticipated changes or downgrades to or withdrawal of our credit ratings, including any announcement that our ratings are under review or have been assigned a negative outlook, could result in damage to our brand and reputation and have a material adverse effect on our business, financial condition, results of operations and cash flows and on the market value of our common stock and outstanding debt.We may have exposure to tax liabilities in various jurisdictions. Future changes in tax law could materially affect our tax obligations and effective tax rate. We are subject to income taxes, as well as non-income or indirect taxes, in the U.S. and various foreign jurisdictions. Significant judgment is required in determining our global provision for income taxes and other tax liabilities. In the ordinary course of a global business, there are many intercompany transactions and calculations where the ultimate tax determination is uncertain. Changes in domestic and international tax laws could negatively impact our overall effective tax rate. Over the last several years, many jurisdictions and intergovernmental organizations have been discussing or are in the process of implementing proposals that may change aspects of the existing framework under which our tax obligations are determined in many of the jurisdictions in which we operate, including to ensure that multinational enterprises pay a global minimum tax, among other changes. Recent pronouncements and directives related to this project suggest an implementation of the proposed 15% global minimum tax in the near term. Continued negotiations on important details of this project are ongoing, and ultimate enactment and timing in the EU, United States, UK and other jurisdictions remain uncertain. Based on our current understanding of these proposals and directives, we expect that we may be within their scope and that their implementation could impact the amount of tax we have to pay.We are regularly under audit by tax authorities. We may be subject to additional tax liabilities as the jurisdictions in which we do business globally are increasingly focused on digital taxes and the treatment of remote workforces. Although we believe that our tax provisions are reasonable, there can be no assurance that the final determination of tax audits or tax disputes will not be different from what is reflected in our historical income tax provisions and accruals. To the extent we are required to pay amounts in excess of our reserves, such differences could have a material adverse effect on our Consolidated Statement of Income for a particular future period. In addition, an unfavorable tax settlement could require use of our cash and result in an increase in our effective tax rate in the period in which such resolution occurs.General RisksOur business performance might not be sufficient for us to meet the full-year financial guidance or long-term targets that we provide publicly.We provide certain full-year financial guidance and long-term targets to the public based upon our assumptions regarding our expected financial performance that may not always prove to be accurate and may vary from actual results. In addition, uncertainty regarding macroeconomic factors such as inflation could impact our ability to forecast costs, which inform our financial guidance and long-term targets. If we fail to meet the full-year financial guidance or achieve the long-term targets that we provide, or if we find it necessary to revise such guidance or targets, the market value of our common stock or other securities could be adversely affected.27Table of ContentsOur growth and profitability may not continue at the same rate as we have experienced in the past for several reasons, including if our operating costs are higher than expected, which could have a material adverse effect on our business, financial condition or results of operations.We have experienced significant revenue and earnings growth since we began operations. There can be no assurance that we will be able to maintain the levels of growth and profitability that we have experienced in the past. If we experience higher than expected operating costs, including increased compensation costs, regulatory compliance costs, occupancy costs, selling and marketing costs, investments in geographic expansion, market data costs, software license costs, communication costs, travel costs, application development costs, professional fees, costs related to information technology infrastructure, cloud usage and other IT costs, and we cannot adjust to these costs, our operating results may fluctuate significantly or our anticipated profitability may be reduced and our anticipated results of operations and financial position may be materially adversely affected. Additionally, there can be no assurance that we will be as successful in our product development, selling and marketing efforts, or capital return or allocation strategies as we have been in the past, or that such efforts will result in growth or profit margins comparable to those we have experienced in the past. We may be exposed to liabilities as a result of failure to comply with laws and regulations relating to our global operations, including anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business.We are subject to complex laws and regulations that are applicable to our global operations, such as laws and regulations governing economic and trade sanctions, tariffs, embargoes, anti-boycott restrictions and anti-corruption and other similar laws and regulations. Any determination that we have violated these laws or regulations could have a material adverse effect on our business, financial condition or results of operations.In particular, we are subject to various anti-corruption laws that prohibit improper payments or benefits or offers of payments or benefits to foreign governments and their officials and, in some cases, to employees of a business for the purpose of directing, obtaining or retaining business. We conduct business in countries and regions that are less developed than the U.S. and in some cases are generally recognized as potentially more corrupt business environments. Our activities in these countries create the risk of unauthorized payments or offers of payments by one of our employees or agents that could be in violation of various anti-corruption laws including the Foreign Corrupt Practices Act of 1977, as amended (the “FCPA”) and the UK Bribery Act 2010. We have implemented safeguards and policies to discourage these types of practices by our employees and agents. However, our existing safeguards and any future improvements may prove to be less than fully effective, and our employees or agents may engage in conduct for which we might be held responsible. If employees violate our policies or we fail to maintain adequate record-keeping and internal accounting practices to accurately record our transactions we may be subject to regulatory fines, sanctions, damages or other penalties or costs. Violations of any of these laws, including the FCPA or other anti-corruption laws, may result in severe criminal or civil sanctions and penalties, damage our brand and reputation and subject us to other liabilities which could have a material adverse effect on our business, financial condition or results of operations.If we are unable to successfully identify, execute and realize expected returns and synergies from acquisitions or strategic partnerships or investments, or if we experience integration, financing, or other risks resulting from our acquisitions or strategic partnerships or investments, our financial results may be materially adversely affected.An element of our growth strategy is growth through acquisitions, strategic partnerships and investments. Despite our best efforts to continue pursuing such transactions, there can be no assurance that we will be able to identify and execute transactions with suitable strategic partners, investment opportunities or attractive acquisition candidates at acceptable terms. In addition, we may require additional debt or equity financing for future acquisitions and doing so may be made more difficult by the terms of our existing indebtedness.Our ability to achieve the expected returns and synergies from our past and future acquisitions, strategic partnerships and investments depends, in part, upon our ability to effectively leverage or integrate the offerings, technology, sales, administrative functions and personnel of these businesses. We cannot provide assurance that we will be successful in integrating acquired businesses, that our acquired businesses will perform at the levels we anticipate or that our strategic partnerships and investments will advance the long-term growth strategy of our company. Our past and future acquisitions, strategic partnerships and investments may subject us to unanticipated risks or liabilities, including the potential to disrupt our operations. Additionally, strategic partnerships may increase our reliance on third parties, which may result in future disruptions if those partnerships are unsuccessful or discontinued or the content or level of support provided by strategic partners is diminished.28Table of ContentsIf we experience a high level of acquisition, strategic partnership or investment-related activity within a limited period of time, the probability that certain of these risks would occur would likely increase. In addition, if we are unsuccessful in completing acquisitions of other businesses or assets, executing strategic partnerships or investments, or if such opportunities for expansion do not arise, our brand or reputation could suffer, and our future growth, business, financial condition or results of operations could be materially adversely affected.Our goodwill and other intangible assets resulting from our acquisitions could be impaired as a result of future business conditions, requiring us to record substantial write-downs that would reduce our operating income.We evaluate the recoverability of recorded goodwill amounts annually or when evidence of potential impairment exists. Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. These impairment tests are based on several factors requiring management’s judgment. Changes in fair market valuations and our operating performance or business conditions, in general, could result in future impairments of goodwill or intangible assets which could materially adversely affect our results of operations. In addition, if we are not successful in achieving anticipated operating efficiencies associated with acquisitions, our goodwill and intangible assets may become impaired.If we fail to attract, develop or retain the necessary qualified personnel, including through our compensation programs, our business, financial condition or results of operations could be materially adversely affected.The development, maintenance and support of our products and services are dependent upon the knowledge, skills, experience and abilities of our employees. Accordingly, we believe the success of our business depends to a significant extent upon the continued service of our executives and other key employees. Although we do not believe that we are overly dependent upon any individual employee, our management and other employees may terminate employment at any time, and the loss of any of our key employees and our inability to replace them with suitable candidates quickly or at all, as well as any negative market perception resulting from such loss, could have a material adverse effect on our business, financial condition or results of operations. We compete for key employees not only with other companies in our industry but also with companies in other industries, such as software services, engineering services and financial services companies, and there is a limited pool of employees who have the skills and training needed to do our work. Competition for these employees is intense, and employee turnover may impact our objectives and place strain on our human resources teams. We may not be able to attract these employees or to develop and retain similar highly qualified personnel in the future. Rising compensation expenses could also adversely affect our ability to attract and retain high-quality employees. Competitors may seek to attract talent by providing more favorable working conditions or offering significantly more attractive compensation packages. If our compensation programs do not adequately engage our key employees or are not competitive, or if we fail to attract, engage and retain the necessary qualified personnel, the quality of our products and services as well as our ability to support and retain our clients and achieve business objectives may suffer.We cannot provide any guaranty that we will continue to repurchase shares of our common stock pursuant to our share repurchase program.The timing, price and volume of repurchases of shares of our common stock will be based on market conditions, relevant securities laws and other factors. The stock repurchases may be made from time to time, through one or more open market repurchases or privately negotiated transactions, including, without limitation, accelerated share repurchase transactions, trading plans or derivative transactions, or otherwise.Share repurchases under our share repurchase program constitute components of our capital return strategy, which we fund with free operating cash flow and borrowings. However, we are not required to make any share repurchases under our share repurchase program. The share repurchase program does not obligate us to repurchase any set dollar amount or number of shares and may be modified, suspended, or terminated at any time without prior notice. The reduction or elimination of our share repurchase program could adversely affect the market price of our common stock. Additionally, the existence of a share repurchase program could cause the market price of our common stock to be higher than it would be in the absence of such a program and could potentially reduce the market liquidity for our shares. As a result, any repurchase program may not ultimately result in enhanced value to our shareholders and may not prove to be the best use of our cash resources.Item 1B. Unresolved Staff CommentsNothing required to be disclosed.29Table of ContentsItem 2. PropertiesAs of December 31, 2022, our principal offices consisted of the following leased properties:LocationSquare FeetExpiration DateNew York, New York125,811(1)February 28, 2033Budapest, Hungary70,833February 28, 2029Mumbai, India63,143July 31, 2032Monterrey, Mexico56,213October 31, 2028Manila, Philippines31,544February 28, 2027London, England30,519December 25, 2026Pune, India24,434 January 19, 2026Berkeley, California19,808February 28, 2030________________(1)As of December 31, 2022, 41,759 square feet of this location have been subleased.As of December 31, 2022, we had more than 30 leased and occupied locations of which the principal offices are listed above. We believe that our properties are in good operating condition and adequately serve our current business operations. We also anticipate that suitable additional or alternative space, including those under lease options, will be available at commercially reasonable terms for future expansion.Item 3. Legal ProceedingsVarious lawsuits, claims and proceedings have been or may be instituted or asserted against the Company in the ordinary course of business. While the amounts claimed could be substantial, the ultimate liability cannot now be determined because of the considerable uncertainties that exist. Therefore, it is possible that MSCI’s business, operating results, financial condition or cash flows in a particular period could be materially affected by certain contingencies. However, based on facts currently available, management believes that the disposition of matters that are currently pending or asserted will not, individually or in the aggregate, have a material effect on MSCI’s business, operating results, financial condition or cash flows.Item 4. Mine Safety DisclosuresNot applicable.30Table of ContentsPART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesStock Price and DividendsOur common stock is traded on the New York Stock Exchange under the symbol “MSCI.” As of February 3, 2023, there were 109 shareholders of record of our common stock. Because many shares of our common stock are held by brokers and other institutions on behalf of beneficial holders, we are unable to estimate the total number of shareholders represented by these shareholders of record.Dividend PolicyThe payment amounts of future dividends will be determined by the Board of Directors in light of conditions then existing, including our earnings, financial condition and capital requirements, business conditions, corporate law requirements and other factors. See Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for additional information on our dividend policy. Stock RepurchasesOur Board of Directors has approved a stock repurchase program for the purchase of the Company’s common stock in the open market. See Note 11, “Shareholders’ Equity (Deficit),” of the Notes to Consolidated Financial Statements included herein for additional information on our stock repurchase program.The following table provides information with respect to purchases made by or on behalf of the Company of its shares of common stock during the quarter ended December 31, 2022.Issuer Purchases of Equity SecuritiesPeriodTotalNumber ofSharesPurchased (1)AveragePricePaid PerShareTotalNumberof SharesPurchasedAs Part ofPubliclyAnnouncedPlans orProgramsApproximateDollarValue of Sharesthat May Yet BePurchased Underthe Plans orPrograms (2)October 1, 2022-October 31, 2022163,117$430.06 163,064$1,304,379,000 November 1, 2022-November 30, 2022167$502.00 —$1,304,379,000 December 1, 2022-December 31, 2022—$— —$1,304,379,000 Total163,284$430.14 163,064$1,304,379,000 ________________(1)Includes (i) shares purchased by the Company on the open market under the stock repurchase program; (ii) shares withheld to satisfy tax withholding obligations on behalf of employees that occur upon vesting and delivery of outstanding shares underlying restricted stock units; and (iii) shares held in treasury under the MSCI Inc. Non-Employee Directors Deferral Plan. The value of shares withheld to satisfy tax withholding obligations was determined using the fair market value of the Company’s common stock on the date of withholding, using a valuation methodology established by the Company.(2)See Note 11, “Shareholders’ Equity (Deficit),” of the Notes to the Consolidated Financial Statements included herein for further information regarding our stock repurchase program.Recent Sales of Unregistered SecuritiesThere were no unregistered sales of equity securities in the year ended December 31, 2022.Use of Proceeds from Sale of Registered SecuritiesNone.31Table of ContentsFIVE-YEAR STOCK PERFORMANCE GRAPHThe following graph compares the cumulative total shareholders’ return on our common stock, the Standard & Poor’s 500 Stock Index, the MSCI USA Financials Index and the NYSE Composite Index since December 31, 2017 assuming an investment of $100 at the closing price on December 31, 2017. In calculating total annual shareholders’ return, reinvestment of dividends, if any, is assumed. The indexes are included for comparative purposes only. They do not necessarily reflect management’s opinion that such indexes are an appropriate measure of the relative performance of the common stock. This graph is not “soliciting material,” is not to be deemed filed with the SEC and is not to be incorporated by reference in any of our filings under the Securities Act of 1933, as amended (the “Securities Act”) or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.Total Investment ValueYears EndedDecember 31, 2017December 31, 2018December 31, 2019December 31, 2020December 31, 2021December 31, 2022MSCI Inc.$100$118$209$364$503$386S&P 500$100$96$126$149$192$157MSCI USA Financials Index(1)$100$86$115$113$153$134NYSE Composite Index(1)$100$91$114$122$148$134________________(1)To better align with comparable investment opportunities, for the year ended December 31, 2022, MSCI replaced the NYSE Composite Index with the MSCI USA Financials Index. Both indices are presented, in accordance with SEC rules, which require that if a company selects a different index from that used in the immediately preceding fiscal year, the company’s stock performance must be compared against both the newly selected index and previous index in the year of change. MSCI USA Financials Index is an index operated by MSCI.Item 6. [Reserved]32Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following Management’s Discussion and Analysis of Financial Condition and Results of Operations is a discussion and analysis of the financial condition and results of the operations of MSCI Inc. and its consolidated subsidiaries for the year ended December 31, 2022. This discussion should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The discussion summarizing the significant factors affecting the results of operations and financial condition of MSCI for the year ended December 31, 2021 can be found in Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021 (the “2021 Annual Report”), which was filed with the Securities and Exchange Commission on February 11, 2022.OverviewWe are a leading provider of critical decision support tools and solutions for the global investment community. Our mission-critical offerings help investors address the challenges of a transforming investment landscape and power better investment decisions. Leveraging our knowledge of the global investment process and our expertise in research, data and technology, we enable our clients to understand and analyze key drivers of risk and return and confidently and efficiently build more effective portfolios. We operate in four reportable segments as follows: Index, Analytics, ESG and Climate, and All Other – Private Assets. The operating segments of Real Assets and The Burgiss Group, LLC (“Burgiss”) do not individually meet the segment reporting thresholds and have been combined and presented as part of the All Other – Private Assets reportable segment. During the year ended December 31, 2022, we renamed the Real Estate operating segment to Real Assets.Our growth strategy includes: (a) extending leadership in research-enhanced content across asset classes, (b) leading the enablement of ESG and climate investment integration, (c) enhancing distribution and content-enabling technology, (d) expanding solutions that empower client customization, (e) strengthening client relationships and growing into strategic partnerships with clients and (f) executing strategic relationships and acquisitions with complementary content and technology companies. For more information about our Company’s operations, see “Item 1: Business”.Key Financial and Operating Metrics and DriversIn evaluating our financial performance, we focus on revenue and profit growth, including results accounted for under generally accepted accounting principles in the United States (“GAAP”) as well as non-GAAP measures, for the Company as a whole and by operating segment.We present revenues disaggregated by types and by segments, which represent our major product lines. We also review expenses by activity, which provides more transparency into how resources are being deployed. In addition, we utilize operating metrics including Run Rate, subscription sales and Retention Rate to manage and assess performance and to provide deeper insights into the recurring portion of our business.In the discussion that follows, we provide certain variances excluding the impact of foreign currency exchange rate fluctuations and acquisitions. Foreign currency exchange rate fluctuations reflect the difference between the current period results as reported compared to the current period results recalculated using the foreign currency exchange rates in effect for the comparable prior period. While operating revenues adjusted for the impact of foreign currency fluctuations includes asset-based fees that have been adjusted for the impact of foreign currency fluctuations, the underlying AUM, which is the primary component of asset-based fees, is not adjusted for foreign currency fluctuations. Approximately three-fifths of the AUM is invested in securities denominated in currencies other than the U.S. dollar, and accordingly, any such impact is excluded from the disclosed foreign currency-adjusted variances.RevenuesOur revenues are presented by type and by reportable segment. For each reportable segment, we present revenues disaggregated by the nature of the revenues, which are recurring subscriptions, asset-based fees and non-recurring revenues.Recurring subscription revenues represent fees earned from clients primarily under renewable contracts and are generally recognized ratably over the term of the license or service pursuant to the contract terms. The fees are recognized as we provide the product and service to the client over the license period and are generally billed in advance, prior to the license start date. 33Table of ContentsAsset-based fees represent fees earned that are variable in nature, as they are primarily calculated based on the AUM linked to our indexes. Asset-based fees also include revenues related to futures and options contracts linked to our indexes, which are based on trading volumes and fee levels.Non-recurring revenues primarily represent fees earned on products and services where we typically do not have renewal clauses within the contract. Examples of such products and services include one-time license fees, certain derivative financial products, certain implementation services and historical data sets. Based on the nature of the services provided, non-recurring revenues are generally billed either in advance or after delivery and recognized point in time or over the service period.Operating ExpensesWe group our operating expenses into the following activity categories:•Cost of revenues;•Selling and marketing;•Research and development (“R&D”);•General and administrative (“G&A”);•Amortization of intangible assets; and•Depreciation and amortization of property, equipment and leasehold improvements.Costs are assigned to these activity categories based on the nature of the expense or, when not directly attributable, an estimated allocation based on the type of effort involved. Cost of revenues, selling and marketing, R&D and G&A all include both compensation as well as non-compensation related expensesCost of RevenuesCost of revenues expenses consist of costs related to the production and servicing of our products and services and primarily includes related information technology costs, including data center, cloud service, platform and infrastructure costs; costs to acquire, produce and maintain market data information; costs of research to support and maintain existing products; costs of product management teams; costs of client service and consultant teams to support customer needs; as well as other support costs directly attributable to the cost of revenues including certain human resources, finance and legal costs. Selling and MarketingSelling and marketing expenses consist of costs associated with acquiring new clients or selling new products or product renewals to existing clients and primarily includes the costs of our sales and marketing teams, as well as costs incurred in other departments associated with acquiring new business, including product management, research, technology and sales operations.Research and DevelopmentR&D expenses consist of costs to develop new or enhance existing products and the costs to develop new or enhanced technologies and service platforms for the delivery of our products and services and primarily include the costs of development, research, product management, project management and the technology support directly associated with these activities.General and AdministrativeG&A expenses consist of costs primarily related to finance operations, human resources, office of the CEO, legal, corporate technology, corporate development, impairment charges associated with right of use assets and certain other administrative costs that are not directly attributed, but are instead allocated, to a product or service.Amortization of Intangible AssetsAmortization of intangible assets expense relates to definite-lived intangible assets arising from past acquisitions and capitalization of internally developed software projects. Intangibles arising from past acquisitions consist of customer relationships, proprietary data, trademarks and trade names and technology and software. We amortize definite-lived intangible assets over their estimated useful lives. We have no indefinite-lived intangible assets.34Table of ContentsDepreciation and Amortization of Property, Equipment and Leasehold ImprovementsDepreciation and amortization of property, equipment and leasehold improvements consists of expenses related to depreciating or amortizing the cost of computer and related equipment, leasehold improvements, software and furniture and fixtures over the estimated useful life of the assets.Other Expense (Income), NetOther expense (income), net consists primarily of interest we pay on our outstanding indebtedness, including losses on early extinguishment of debt, income and losses associated with our equity method investment, foreign currency exchange rate gains and losses, interest we collect on cash and short-term investments, as well as other non-operating income and expense items that may arise from time to time.Non-GAAP Financial MeasuresAdjusted EBITDA“Adjusted EBITDA,” a non-GAAP measure used by management to assess operating performance, is defined as net income before (1) provision for income taxes, (2) other expense (income), net, (3) depreciation and amortization of property, equipment and leasehold improvements, (4) amortization of intangible assets and, at times, (5) certain other transactions or adjustments, including, when applicable, impairment related to sublease of leased property and certain non-recurring acquisition-related integration and transaction costs.“Adjusted EBITDA expenses,” a non-GAAP measure used by management to assess operating performance, is defined as operating expenses less depreciation and amortization of property, equipment and leasehold improvements and amortization of intangible assets and, at times, certain other transactions or adjustments, including, when applicable, impairment related to sublease of leased property and certain non-recurring acquisition-related integration and transaction costs.“Adjusted EBITDA margin” is defined as adjusted EBITDA divided by operating revenues.Adjusted EBITDA, Adjusted EBITDA margin and Adjusted EBITDA expenses are believed to be meaningful measures for management to assess the operating performance of the Company because they adjust for significant one-time, unusual or non-recurring items as well as eliminate the accounting effects of certain capital spending and acquisitions that do not directly affect what management considers to be the Company’s ongoing operating performance in the period. All companies do not calculate adjusted EBITDA, adjusted EBITDA margin and adjusted EBITDA expenses in the same way. These measures can differ significantly from company to company depending on, among other things, long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate and capital investments. Accordingly, the Company’s computation of the Adjusted EBITDA, Adjusted EBITDA margin and Adjusted EBITDA expenses measures may not be comparable to similarly titled measures computed by other companies.Run RateRun Rate is a key operating metric and is important because an increase or decrease in our Run Rate ultimately impacts our future operating revenues over time. At the end of any period, we generally have subscription and investment product license agreements in place for a large portion of total revenues for the following 12 months. We measure the fees related to these agreements and refer to this as “Run Rate.” See “—Operating Metrics—Run Rate” below for additional information on the calculation of this metric.Subscription SalesSubscription sales is a key operating metric and is important to management because new subscription sales increase our Run Rate and represent future operating revenues that will be recognized over time. See “—Operating Metrics— Sales” below for additional information.Retention RateRetention Rate is a key operating metric and is important to management because subscription cancellations decrease our Run Rate and ultimately our future operating revenues over time. See “—Operating Metrics—Retention Rate” below for additional information on the calculation of this metric.35Table of ContentsCritical Accounting EstimatesOur consolidated financial statements are prepared in accordance with GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the periods presented. Significant estimates and judgments made by management include such examples as assessment of impairment of goodwill and intangible assets and income taxes. We believe the estimates and judgments upon which we rely are reasonable based upon information available to us at the time these estimates and judgments are made. To the extent there are material differences between these estimates and actual results, our consolidated financial statements will be affected. GoodwillGoodwill is recorded as a result of business combinations undertaken by the Company when the purchase price exceeds the fair value of the net tangible assets and separately identifiable intangible assets acquired. We test goodwill for impairment on an annual basis on July 1st and on an interim basis when certain events and circumstances exist. The test for impairment is performed at the reporting unit level. When testing goodwill for impairment, we first assess qualitative factors to determine whether it is necessary to perform the quantitative goodwill impairment test; however, on a periodic basis, we may elect to bypass the qualitative assessment and proceed directly to the quantitative test. When performing the quantitative test for impairment, we use the income approach to estimate the fair value of each reporting unit. Under the income approach, we estimate the fair value of each reporting unit based on the present value of estimated future cash flows. Estimating discounted future cash flows requires significant management judgment including in estimating forecasted future cash flows and determining both discount rates and terminal growth rates. Forecasted future cash flows are estimated based on a combination of historical experience and assumptions regarding the future growth and profitability of each reporting unit. Discount rates are selected based on discount rates of similar public companies to the reporting unit being valued and terminal growth rates are selected based on consideration of growth rates used during the reporting unit’s forecast period in combination with economic conditions. These assumptions require management’s judgment and changes to these estimates or assumptions could materially affect the determination of the reporting unit’s fair value. Any impairment is measured as the difference between the carrying amount and its fair value. Based on our qualitative assessment for 2022, we determined that it was not more likely than not that the fair value of the company’s reporting units is less than their respective carrying values and no impairments were recorded.Definite Lived Intangible AssetsDefinite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of the asset or asset group may not be recoverable. These events or circumstances include adverse changes in the manner in which the asset will be used, adverse changes in legal factors related to the asset or negative changes in expected financial performance of the asset, including accumulation of costs and operating losses. Determining whether an event or changes in circumstances warrant an impairment review involves management judgment.Once it is determined that an impairment review is necessary, determination of recoverability is determined based on comparing the carrying amount of the asset group to the estimated future undiscounted cash flows. If the carrying amount exceeds the estimated future undiscounted cash flows, the asset grouping is considered to be impaired. Measurement of impairment for intangible assets is based on the amount the carrying value exceeds the fair value of the asset, which is based on estimated discounted future cash flows. Estimated undiscounted and discounted cash flows used in the determination and calculation of impairments represent management forecasts and require significant management judgment. While management believes that its forecasts are reasonable, differences between forecasts and actual experience could materially affect the valuations. There were no events or changes in circumstances that would indicate that the carrying value of the definite-lived intangible assets may not be recoverable during the years presented. With respect to our acquisition of RCA on September 13, 2021, the valuation of intangible assets, as part of the acquisition method of accounting, was subjective and based, in part, on inputs that were unobservable. The significant assumptions used to estimate the fair value of the acquired intangible assets included, forecasted cash flows which were determined based on certain assumptions that included, among others, projected future revenues, and expected market royalty rate, technology obsolescence rates and discount rates. These estimates are inherently uncertain and unpredictable, and if different estimates were used, the purchase price for the acquisition could be allocated to the acquired assets and assumed liabilities of RCA differently from the allocation that we have made.We amortize our intangible assets over the estimated period of economic benefit. If the estimated period of economic benefit is changed, the prospective amortization of the intangible asset could materially change.36Table of ContentsIncome TaxesWe are subject to income taxes in the U.S. and other foreign jurisdictions. Our tax provision is an estimate based on our understanding of laws in federal, state and foreign tax jurisdictions. These laws can be complicated and are difficult to apply to any business. The tax laws also require us to allocate our taxable income to many jurisdictions based on subjective allocation methodologies and information collection processes. Provision for income taxes is provided for using the asset and liability method, under which deferred tax assets and deferred tax liabilities are determined based on the temporary differences between the financial statement and income tax bases of assets and liabilities using currently enacted tax rates. Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that all or some portion of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, management is required to estimate future taxable income which requires judgment.We must regularly assess the likelihood of additional assessments in each of the taxing jurisdictions in which we file income tax returns and adjust unrecognized tax benefits when additional information is available or when an event occurs. This assessment requires significant judgment in assessment of tax laws, frequency of tax examinations, and the nature of intercompany transactions and tax positions.Factors Affecting the Comparability of ResultsAcquisition of RCAOn September 13, 2021, MSCI completed the acquisition of RCA for an aggregate cash purchase price of $949.0 million, subject to working capital adjustments. See Note 5, “Acquisitions,” of the Notes to the Consolidated Financial Statements included herein for additional information on the acquisition of RCA.Results of OperationsOperating RevenuesOur operating revenues are grouped by the following types: recurring subscriptions, asset-based fees and non-recurring. We also group operating revenues by major product or reportable segment as follows: Index, Analytics, ESG and Climate and All Other – Private Assets, which includes the Real Assets product line and our equity method investment in Burgiss.The following table presents operating revenues by type for the years indicated:Years Ended(in thousands)December 31,2022December 31,2021Increase/(Decrease)Recurring subscriptions$1,659,523 $1,426,040 16.4 %Asset-based fees528,127 553,991 (4.7)%Non-recurring60,948 63,513 (4.0)%Total operating revenues$2,248,598 $2,043,544 10.0 %Total operating revenues increased 10.0% for the year ended December 31, 2022 compared to the year ended December 31, 2021. Adjusting for the impact of acquisitions and foreign currency exchange rate fluctuations, total operating revenues would have increased 8.9%.Operating revenues from recurring subscriptions increased 16.4% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by strong growth in Index products, which increased $79.1 million, or 12.2%, strong growth in ESG and Climate products, which increased $60.6 million, or 37.2%, strong growth in All Other - Private Assets products, which increased $60.0 million, or 75.4%, and growth in Analytics products, which increased $33.8 million, or 6.3%. Adjusting for the impact of acquisitions and foreign currency exchange rate fluctuations, operating revenues from recurring subscriptions would have increased 14.6%.Operating revenues from asset-based fees decreased 4.7% for the year ended December 31, 2022 compared to the year ended December 31, 2021, driven by a decline in revenues from ETFs linked to MSCI equity indexes and non-ETF indexed funds linked to MSCI indexes, partially offset by an increase in revenues from exchange traded futures and options contracts linked to MSCI indexes. Operating revenues from ETFs linked to MSCI equity indexes decreased by 7.7%, primarily driven by a decrease in average basis point fees and average AUM. Operating revenues from non-ETF indexed funds linked to MSCI indexes decreased by 6.9%, primarily 37Table of Contentsdriven by a decrease in average basis point fees, partially offset by an increase in average AUM. Operating revenues from exchange traded futures and options contracts linked to MSCI indexes increased by 15.1%, driven by volume increases.The following table presents the value of AUM in ETFs linked to MSCI equity indexes and the sequential change of such assets as of the end of each of the periods indicated:Period Ended20212022(in billions)March 31,June 30,September 30,December 31,March 31,June 30,September 30, December 31,AUM in ETFs linked to MSCI equity indexes(1) (2)$1,209.6 $1,336.2 $1,336.6 $1,451.6 $1,389.3 $1,189.5 $1,081.2 $1,222.9 Sequential Change in ValueMarket Appreciation/(Depreciation)$43.2 $73.7 $(30.7)$56.5 $(89.7)$(207.3)$(105.7)$118.8 Cash Inflows62.8 52.9 31.1 58.5 27.4 7.5 (2.6)22.9 Total Change$106.0 $126.6 $0.4 $115.0 $(62.3)$(199.8)$(108.3)$141.7 The following table presents the average value of AUM in ETFs linked to MSCI equity indexes for the periods indicated:Year-to-Date Average20212022(in billions)MarchJuneSeptemberDecemberMarchJuneSeptemberDecemberAUM in ETFs linked to MSCI equity indexes(1) (2)$1,169.2 $1,230.8 $1,274.5 $1,309.6 $1,392.5 $1,338.9 $1,295.6 $1,267.2 ________________(1)The historical values of the AUM in ETFs linked to our equity indexes as of the last day of the month and the monthly average balance can be found under the link “AUM in ETFs Linked to MSCI Equity Indexes” on our Investor Relations homepage at http://ir.msci.com. This information is updated mid-month each month. Information contained on our website is not deemed part of or incorporated by reference into this Annual Report on Form 10-K or any other report filed with the SEC. The AUM in ETFs also includes AUM in Exchange Traded Notes, the value of which is less than 1.0% of the AUM amounts presented.(2)The value of AUM in ETFs linked to MSCI equity indexes is calculated by multiplying the equity ETF net asset value by the number of shares outstanding.For the year ended December 31, 2022, the average value of AUM in ETFs linked to MSCI equity indexes was down $42.4 billion, or 3.2%, compared to the year ended December 31, 2021.38Table of ContentsThe following table presents operating revenues by reportable segment and revenue type for the years indicated:Years Ended(in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Operating revenues:IndexRecurring subscriptions$729,710 $650,629 12.2 %Asset-based fees528,127 553,991 (4.7)%Non-recurring45,372 47,144 (3.8)%Index total1,303,209 1,251,764 4.1 %Analytics Recurring subscriptions567,004 533,178 6.3 %Non-recurring9,103 11,121 (18.1)%Analytics total576,107 544,299 5.8 %ESG and Climate Recurring subscriptions223,160 162,609 37.2 %Non-recurring5,151 3,583 43.8 %ESG and Climate total228,311 166,192 37.4 %All Other - Private Assets Recurring subscriptions139,649 79,624 75.4 %Non-recurring1,322 1,665 (20.6)%All Other - Private Assets total140,971 81,289 73.4 %Total operating revenues$2,248,598 $2,043,544 10.0 %Refer to the section titled “Segment Results” that follows for further discussion of segment revenues.Operating ExpensesTotal operating expenses increased 7.2% for the year ended December 31, 2022 compared to the year ended December 31, 2021. Adjusting for the impact of foreign currency exchange rate fluctuations, the increase would have been 11.2%.The following table presents operating expenses by activity category for the years indicated:Years Ended(in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Operating expenses:Cost of revenues$404,341 $358,684 12.7 %Selling and marketing264,583 243,185 8.8 %Research and development107,205 111,564 (3.9)%General and administrative146,857 147,893 (0.7)%Amortization of intangible assets91,079 80,592 13.0 %Depreciation and amortization of property, equipment and leasehold improvements26,893 28,901 (6.9)%Total operating expenses$1,040,958 $970,819 7.2 %Cost of RevenuesCost of revenues increased 12.7% for the year ended December 31, 2022 compared to the year ended December 31, 2021, reflecting increases across the All Other - Private Assets, ESG and Climate and Index reportable segments. The change was driven by increases in non-compensation costs, primarily relating to higher information technology costs and professional fees, as well as 39Table of Contentsincreases in compensation and benefit costs, reflecting higher wages and salaries and higher severance costs, partially offset by lower incentive compensation costs.Selling and MarketingSelling and marketing expenses increased 8.8% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily reflecting increases across the All Other - Private Assets, ESG and Climate and Index segments. The change was primarily driven by higher compensation and benefits costs, primarily relating to higher wages and salaries, benefits and severance costs, partially offset by lower incentive compensation. The change was also driven by higher non-compensation costs, primarily related to higher costs associated with conferences and events and travel.Research and DevelopmentR&D expenses decreased 3.9% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by increased capitalization of costs related to internally developed software projects. The decrease was partially offset by higher wages and salaries costs, driven by headcount increases, as well as higher non-compensation costs, reflecting increased information technology costs. Taking into consideration investments eligible for capitalization, R&D spending increased across the All Other - Private Assets, ESG and Climate and Index reportable segments, partially offset by decreased spending in the Analytics reportable segment.General and AdministrativeG&A expenses decreased 0.7% for the year ended December 31, 2022 compared to the year ended December 31, 2021, reflecting decreased spending in the Analytics reportable segment, partially offset by increases across the All Other - Private Assets, ESG and Climate and Index reportable segments. The change was primarily driven by the absence of impairment charges associated with right of use assets and lower transaction costs related to the acquisition of RCA. The decrease was partially offset by higher compensation and benefit costs, primarily relating to higher severance costs, wages and salaries and incentive compensation.The following table presents operating expenses using compensation and non-compensation categories, rather than using activity categories, for the years indicated:Years Ended(in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Compensation and benefits$652,364 $614,950 6.1 %Non-compensation expenses270,622 246,376 9.8 %Amortization of intangible assets91,079 80,592 13.0 %Depreciation and amortization of property, equipment and leasehold improvements26,893 28,901 (6.9)%Total operating expenses$1,040,958 $970,819 7.2 %A significant portion of the incentive compensation component of operating expenses is based on the achievement of a number of financial and operating metrics. In a scenario where operating revenue growth and profitability moderate, incentive compensation would be expected to decrease accordingly.Fixed costs constitute a significant portion of the non-compensation component of operating expenses. The discretionary non-compensation component of operating expenses could, however, be reduced in the near-term in a scenario where operating revenue growth moderates.We had 4,759 employees as of December 31, 2022 compared to 4,303 employees as of December 31, 2021, reflecting a 10.6% growth in the number of employees. Continued growth of our emerging market centers around the world is an important factor in our ability to manage and control the growth of our compensation and benefits costs. As of December 31, 2022, 65.0% of our employees were located in emerging market centers compared to 63.2% as of December 31, 2021.Compensation and benefits costs increased 6.1% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by an increase in salaries and benefits due to headcount growth and an increase in severance costs, partially offset by increased capitalization of costs related to internally developed software projects and lower incentive compensation.40Table of ContentsNon-compensation expenses increased 9.8% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by higher information technology costs, professional fees, market data costs and travel and entertainment expenses, partially offset by lower impairment charges associated with right of use assets, lower non-recurring transaction and integration costs related to the acquisition of RCA as well as decreased other non-income tax expenses as a result of favorable settlements reached in the current period.Amortization of Intangible AssetsAmortization of intangible assets expense increased 13.0% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by additional amortization recognized on acquired intangible assets from the acquisition of RCA, partially offset by the absence of intangible assets write-off costs.Depreciation and Amortization of Property, Equipment and Leasehold ImprovementsDepreciation and amortization of property, equipment and leasehold improvements decreased 6.9% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by lower amortization on software and the lack of impairment charges on leasehold improvements.Total Other Expense (Income), NetThe following table shows our other expense (income), net for the years indicated:Years Ended (in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Interest income$(11,769)$(1,497)686.2 %Interest expense171,571 159,614 7.5 %Other expense (income)3,997 56,472 (92.9)%Total other expense (income), net$163,799 $214,589 (23.7)%Total other expense (income), net decreased 23.7% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by the absence of debt extinguishment costs and higher interest income, partially offset by higher interest expense associated with higher average outstanding debt balances and by the absence in the current period of a one-time gain of $7.0 million resulting from changes in our ownership interest of Burgiss.Income TaxesThe following table shows our income tax provision and effective tax rate for the years indicated:Years Ended (in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Provision for income taxes$173,268 $132,153 31.1 %ETR16.6 %15.4 %7.8 %The effective tax rate of 16.6% for the year ended December 31, 2022 reflects the impact of certain favorable discrete items totaling $29.1 million, in relation to pretax income, primarily related to $28.4 million of excess tax benefits recognized on share-based compensation vested during the period.The effective tax rate of 15.4% for the year ended December 31, 2021 reflects the impact of certain favorable discrete items totaling $28.3 million, in relation to pretax income, primarily related to $22.7 million of excess tax benefits recognized on share-based compensation vested during the period, a $5.1 million benefit related to prior year settlements, a $2.3 million benefit related to the revaluation of deferred taxes as a result of the enactment of an increase in the UK corporate tax rate and a $2.0 million benefit related to the filing of prior year refund claims, partially offset by a $3.8 million expense related to other prior year items. In addition, the effective tax rate was impacted by the level of earnings.41Table of ContentsNet IncomeThe following table shows our net income for the years indicated:Years Ended(in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Net income$870,573 $725,983 19.9 %As a result of the factors described above, net income increased 19.9% for the year ended December 31, 2022 compared to the year ended December 31, 2021.Weighted Average Shares and Common Shares OutstandingThe following table shows our weighted average shares and common shares outstanding for the years indicated:Years Ended(in thousands)December 31, 2022December 31, 2021% ChangeWeighted average shares outstanding:Basic80,74682,508(2.1 %)Diluted81,21583,479(2.7 %)Common shares outstanding79,96082,439(3.0 %)The decrease in weighted average shares and common shares outstanding primarily reflects the impact of share repurchases made pursuant to the stock repurchase program.Adjusted EBITDAThe following table presents non-GAAP Adjusted EBITDA, Adjusted EBITDA expenses and Adjusted EBITDA margin for the years indicated:Years Ended (in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Operating revenues:$2,248,598 $2,043,544 10.0 %Adjusted EBITDA expenses918,927 846,754 8.5 %Adjusted EBITDA$1,329,671 $1,196,790 11.1 %Operating margin %53.7 %52.5 %Adjusted EBITDA margin %59.1 %58.6 %The increase in Adjusted EBITDA and Adjusted EBITDA margin reflects a higher rate of growth in operating revenues as compared to the rate of growth of Adjusted EBITDA expenses, driven by the factors previously described.42Table of ContentsReconciliation of Net Income to Adjusted EBITDA and Operating Expenses to Adjusted EBITDA ExpensesThe following table presents the reconciliation of net income to Adjusted EBITDA for the years indicated:Years Ended(in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Net income$870,573 $725,983 19.9 %Provision for income taxes173,268 132,153 31.1 %Other expense (income), net163,799 214,589 (23.7)%Operating income1,207,640 1,072,725 12.6 %Amortization of intangible assets91,079 80,592 13.0 %Depreciation and amortization of property, equipment and leasehold improvements26,893 28,901 (6.9 %)Impairment related to sublease of leased property— 7,702 (100.0 %)Acquisition-related integration and transaction costs (1)4,059 6,870 (40.9 %)Consolidated Adjusted EBITDA$1,329,671 $1,196,790 11.1 %Index Adjusted EBITDA985,407 951,312 3.6 %Analytics Adjusted EBITDA247,895 198,799 24.7 %ESG and Climate Adjusted EBITDA61,094 29,748 105.4 %All Other - Private Assets Adjusted EBITDA35,275 16,931 108.3 %Consolidated Adjusted EBITDA$1,329,671 $1,196,790 11.1 %________________(1)Incremental and non-recurring costs attributable to acquisitions directly related to the execution of the transaction and integration of the acquired business that have occurred no later than 12 months after the close of the transaction.The following table presents the reconciliation of operating expenses to Adjusted EBITDA expenses for the years indicated:Years Ended(in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Total operating expenses$1,040,958 $970,819 7.2 %Amortization of intangible assets91,079 80,592 13.0 %Depreciation and amortization of property, equipment and leasehold improvements26,893 28,901 (6.9)%Impairment related to sublease of leased property— 7,702 (100.0)%Acquisition-related integration and transaction costs (1)4,059 6,870 (40.9)%Consolidated Adjusted EBITDA expenses$918,927 $846,754 8.5 %Index Adjusted EBITDA expenses317,802 300,452 5.8 %Analytics Adjusted EBITDA expenses328,212 345,500 (5.0 %)ESG and Climate Adjusted EBITDA expenses167,217 136,444 22.6 %All Other - Private Assets Adjusted EBITDA expenses105,696 64,358 64.2 %Consolidated Adjusted EBITDA expenses$918,927 $846,754 8.5 %________________(1)Incremental and non-recurring costs attributable to acquisitions directly related to the execution of the transaction and integration of the acquired business that have occurred no later than 12 months after the close of the transaction.43Table of ContentsSegment ResultsThe results for each of our four reportable segments for the years ended December 31, 2022, and 2021 are presented below:Index SegmentThe following table presents the results for the Index segment for the years indicated:Years Ended (in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Operating revenues:Recurring subscriptions$729,710 $650,629 12.2 %Asset-based fees528,127 553,991 (4.7)%Non-recurring45,372 47,144 (3.8)%Operating revenues total1,303,209 1,251,764 4.1 %Adjusted EBITDA expenses317,802 300,452 5.8 %Adjusted EBITDA$985,407 $951,312 3.6 %Adjusted EBITDA margin %75.6 %76.0 %Index operating revenues increased 4.1% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by growth from recurring subscriptions, partially offset by a decline in asset-based fees and non-recurring revenues. Adjusting for the impact of foreign currency exchange rate fluctuations, Index operating segment revenues would have increased 4.5%.Revenues from recurring subscriptions increased 12.2% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by strong growth from both market cap-weighted and factor, ESG and climate Index products.Operating revenues from asset-based fees decreased 4.7% for the year ended December 31, 2022 compared to the year ended December 31, 2021, driven by a decline in revenues from ETFs linked to MSCI equity indexes and non-ETF indexed funds linked to MSCI indexes, partially offset by an increase in revenues from exchange traded futures and options contracts linked to MSCI indexes. Operating revenues from ETFs linked to MSCI equity indexes decreased by 7.7%, primarily driven by a decrease in average basis point fees and average AUM. Operating revenues from non-ETF indexed funds linked to MSCI indexes decreased by 6.9%, primarily driven by a decrease in average basis point fees, partially offset by an increase in average AUM. Operating revenues from exchange traded futures and options contracts linked to MSCI indexes increased by 15.1%, driven by volume increases.Index segment Adjusted EBITDA expenses increased 5.8% for the year ended December 31, 2022 compared to the year ended December 31, 2021, driven by higher non-compensation expenses across the cost of revenues, R&D and selling and marketing expense categories, primarily relating to higher information technology costs. The change was also driven by higher compensation costs across all expense activity categories, primarily reflecting higher wages and salaries and benefits costs, as a result of increased headcount, partially offset by lower incentive compensation. Adjusting for the impact of foreign currency exchange rate fluctuations, Index segment Adjusted EBITDA expenses would have increased 9.9%.44Table of ContentsAnalytics SegmentThe following table presents the results for the Analytics segment for the years indicated:Years Ended (in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Operating revenues:Recurring subscriptions$567,004 $533,178 6.3 %Non-recurring9,103 11,121 (18.1)%Operating revenues total576,107 544,299 5.8 %Adjusted EBITDA expenses328,212 345,500 (5.0)%Adjusted EBITDA$247,895 $198,799 24.7 %Adjusted EBITDA margin %43.0 %36.5 %Analytics operating revenues increased 5.8% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by growth from recurring subscriptions related to both Multi-Asset Class and Equity Analytics products. Adjusting for the impact of foreign currency exchange rate fluctuations, Analytics operating revenues would have increased 6.8%.Analytics segment Adjusted EBITDA expenses decreased 5.0% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by lower compensation expenses across all expense activity categories, as a result of lower incentive compensation and increased capitalization of expenses related to internally developed software projects. Adjusting for the impact of foreign currency exchange rate fluctuations, Analytics segment Adjusted EBITDA expenses would have decreased 1.7%.ESG and Climate SegmentThe following table presents the results for the ESG and Climate segment for the years indicated:Years Ended (in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Operating revenues:Recurring subscriptions$223,160 $162,609 37.2 %Non-recurring5,151 3,583 43.8 %Operating revenues total228,311 166,192 37.4 %Adjusted EBITDA expenses167,217 136,444 22.6 %Adjusted EBITDA$61,094 $29,748 105.4 %Adjusted EBITDA margin %26.8 %17.9 %ESG and Climate operating revenues increased 37.4% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by strong growth from recurring subscriptions related to Ratings, Climate and Screening products. Adjusting for the impact of foreign currency exchange rate fluctuations, ESG and Climate operating revenues would have increased 47.5%.ESG and Climate segment Adjusted EBITDA expenses increased 22.6% for the year ended December 31, 2022 compared to the year ended December 31, 2021, reflecting higher compensation and non-compensation expenses to support growth across all expense categories. The increase was primarily driven by increased salaries and benefits costs, as a result of increased headcount, as well as increased information technology costs and professional fees. The increase was partially offset by increased capitalization of expenses related to internally developed software projects. Adjusting for the impact of foreign currency exchange rate fluctuations, ESG and Climate segment Adjusted EBITDA expenses would have increased 28.0%.All Other – Private Assets SegmentThe following table presents the results for the All Other – Private Assets segment for the years indicated:45Table of ContentsYears Ended (in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Operating revenues:Recurring subscriptions$139,649 $79,624 75.4 %Non-recurring1,322 1,665 (20.6)%Operating revenues total140,971 81,289 73.4 %Adjusted EBITDA expenses105,696 64,358 64.2 %Adjusted EBITDA$35,275 $16,931 108.3 %Adjusted EBITDA margin %25.0 %20.8 %All Other – Private Assets operating revenues increased 73.4% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by revenues attributable to the acquisition of RCA as well as growth from recurring subscriptions related to Global Intel, Enterprise Analytics and Climate Value-at-Risk products, partially offset by unfavorable foreign currency exchange rate fluctuations. Adjusting for both the impact of the acquisition and foreign currency exchange rate fluctuations, All Other – Private Assets operating revenues would have increased 12.5%. Adjusting for the impact of the acquisition and foreign currency exchange rate fluctuations individually, All Other - Private Assets operating revenues would have increased 2.5% and 83.4%, respectively.All Other – Private Assets segment Adjusted EBITDA expenses increased 64.2% for the year ended December 31, 2022 compared to the year ended December 31, 2021, reflecting higher compensation and non-compensation across all spending categories, primarily driven by the acquisition of RCA. Adjusting for the impact of the acquisition and foreign currency exchange rate fluctuations individually, All Other - Private Assets segment Adjusted EBITDA expenses would have increased 6.7% and 73.7%, respectively.Operating MetricsRun Rate“Run Rate” estimates at a particular point in time the annualized value of the recurring revenues under our client license agreements (“Client Contracts”) for the next 12 months, assuming all Client Contracts that come up for renewal, or reach the end of the committed subscription period, are renewed and assuming then-current currency exchange rates, subject to the adjustments and exclusions described below. For any Client Contract where fees are linked to an investment product’s assets or trading volume/fees, the Run Rate calculation reflects, for ETFs, the market value on the last trading day of the period, for futures and options, the most recent quarterly volumes and/or reported exchange fees, and for other non-ETF products, the most recent client-reported assets. Run Rate does not include fees associated with “one-time” and other non-recurring transactions. In addition, we add to Run Rate the annualized fee value of recurring new sales, whether to existing or new clients, when we execute Client Contracts, even though the license start date, and associated revenue recognition, may not be effective until a later date. We remove from Run Rate the annualized fee value associated with products or services under any Client Contract with respect to which we have received a notice of termination, non-renewal or an indication the client does not intend to continue their subscription during the period and have determined that such notice evidences the client’s final decision to terminate or not renew the applicable products or services, even though such notice is not effective until a later date.Changes in our recurring revenues typically lag changes in Run Rate. The actual amount of recurring revenues we will realize over the following 12 months will differ from Run Rate for numerous reasons, including:•fluctuations in revenues associated with new recurring sales;•modifications, cancellations and non-renewals of existing Client Contracts, subject to specified notice requirements;•differences between the recurring license start date and the date the Client Contract is executed due to, for example, contracts with onboarding periods or fee waiver periods;•fluctuations in asset-based fees, which may result from changes in certain investment products’ total expense ratios, market movements, including foreign currency exchange rates, or from investment inflows into and outflows from investment products linked to our indexes;•fluctuations in fees based on trading volumes of futures and options contracts linked to our indexes;•fluctuations in the number of hedge funds for which we provide investment information and risk analysis to hedge fund investors;46Table of Contents•price changes or discounts;•revenue recognition differences under U.S. GAAP, including those related to the timing of implementation and report deliveries for certain of our products and services;•fluctuations in foreign currency exchange rates; and•the impact of acquisitions and divestitures.The following table presents Run Rates by reportable segment as of the dates indicated and the growth percentages over the years indicated:As of(in thousands)December 31, 2022December 31, 2021Increase/(Decrease)Index:Recurring subscriptions$777,633 $694,591 12.0 %Asset-based fees514,253 589,320 (12.7)%Index total1,291,886 1,283,911 0.6 %Analytics616,069 585,223 5.3 %ESG and Climate267,019 199,597 33.8 %All Other - Private Assets145,333 135,150 7.5 %Total Run Rate$2,320,307 $2,203,881 5.3 %Recurring subscriptions total$1,806,054 $1,614,561 11.9 %Asset-based fees514,253 589,320 (12.7)%Total Run Rate$2,320,307 $2,203,881 5.3 %Total Run Rate increased 5.3% for the year ended December 31, 2022 compared to the year ended December 31, 2021, driven by an 11.9% increase from recurring subscriptions, offset by a 12.7% decrease from asset-based fees. Adjusting for the impact of foreign currency exchange rate fluctuations, recurring subscriptions Run Rate would have increased 13.0%. Run Rate from Index recurring subscriptions increased 12.0% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by strong growth from market cap-weighted, factor, ESG and climate, and custom Index products and special packages. The increase reflected growth across all regions and client segments.Run Rate from Index asset-based fees decreased 12.7% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by lower AUM in ETFs linked to MSCI equity indexes and non-ETF indexed funds linked to MSCI indexes, partially offset by higher exchange traded futures and options volume. Run Rate from Analytics products increased 5.3% for the year ended December 31, 2022 compared to the year ended December 31, 2021, driven by strong growth in Equity Analytics products as well as growth in Multi-Asset Class products, and reflected growth across all regions. Adjusting for the impact of foreign currency exchange rate fluctuations, Analytics Run Rate would have increased 6.6%.Run Rate from ESG and Climate products increased 33.8% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by strong growth in Ratings, Climate and Screening products. Adjusting for the impact of foreign currency exchange rate fluctuations, ESG and Climate Run Rate would have increased 36.8%.Run Rate from All Other - Private Assets increased 7.5% for the year ended December 31, 2022 compared to the year ended December 31, 2021, primarily driven by growth in RCA, Global Intel, Climate Value-at-Risk and Enterprise Analytics products across all regions, partially offset by unfavorable foreign currency exchange rate fluctuations. Adjusting for the impact of foreign currency exchange rate fluctuations, All Other - Private Assets Run Rate would have increased 11.6%.47Table of ContentsSalesSales represents the annualized value of products and services clients commit to purchase from MSCI and will result in additional operating revenues. Non-recurring sales represent the actual value of the customer agreements entered into during the period and are not a component of Run Rate. New recurring subscription sales represent additional selling activities, such as new customer agreements, additions to existing agreements or increases in price that occurred during the period and are additions to Run Rate. Subscription cancellations reflect client activities during the period, such as discontinuing products and services and/or reductions in price, resulting in reductions to Run Rate. Net new recurring subscription sales represent the amount of new recurring subscription sales net of subscription cancellations during the period, which reflects the net impact to Run Rate during the period. Total gross sales represent the sum of new recurring subscription sales and non-recurring sales. Total net sales represent the total gross sales net of the impact from subscription cancellations. 48Table of ContentsThe following table presents our recurring subscription sales, cancellations and non-recurring sales by reportable segment for the years indicated:Years Ended (in thousands)December 31, 2022December 31, 2021Increase/(Decrease)New recurring subscription salesIndex$109,699 $99,686 10.0 %Analytics75,584 71,656 5.5 %ESG and Climate78,980 69,964 12.9 %All Other - Private Assets23,213 14,142 64.1 %New recurring subscription sales total287,476 255,448 12.5 %Subscription cancellationsIndex(27,103)(24,399)11.1 %Analytics(37,171)(34,291)8.4 %ESG and Climate(5,618)(4,811)16.8 %All Other - Private Assets(7,569)(6,737)12.3 %Subscription cancellations total(77,461)(70,238)10.3 %Net new recurring subscription salesIndex82,596 75,287 9.7 %Analytics38,413 37,365 2.8 %ESG and Climate73,362 65,153 12.6 %All Other - Private Assets15,644 7,405 111.3 %Net new recurring subscription sales total210,015 185,210 13.4 %Non-recurring salesIndex57,560 54,030 6.5 %Analytics11,143 12,407 (10.2)%ESG and Climate4,268 4,135 3.2 %All Other - Private Assets1,264 1,694 (25.4)%Non-recurring sales total74,235 72,266 2.7 %Gross salesIndex$167,259 $153,716 8.8 %Analytics86,727 84,063 3.2 %ESG and Climate83,248 74,099 12.3 %All Other - Private Assets24,477 15,836 54.6 %Total gross sales$361,711 $327,714 10.4 %Net salesIndex$140,156 $129,317 8.4 %Analytics49,556 49,772 (0.4)%ESG and Climate77,630 69,288 12.0 %All Other - Private Assets16,908 9,099 85.8 %Total net sales$284,250 $257,476 10.4 %49Table of ContentsRetention RateAnother key metric is our “Retention Rate.” The following table presents our Retention Rate by reportable segment for the periods indicated:IndexAnalyticsESG and ClimateAll Other - Private Assets (1)Total2022Three Months Ended March 31,96.6%94.4%98.7%94.1%95.9%Three Months Ended June 30,95.9%94.3%97.3%96.0%95.5%Three Months Ended September 30,96.9%95.9%97.4%94.8%96.4%Three Months Ended December 31,95.0%90.0%95.4%92.6%93.0%Year Ended December 31,(2)96.1%93.6%97.2%94.4%95.2%2021Three Months Ended March 31,96.6%95.8%97.0%95.1%96.3%Three Months Ended June 30,95.6%92.7%96.4%93.7%94.4%Three Months Ended September 30,96.0%93.4%96.1%91.0%94.5%Three Months Ended December 31,96.0%93.4%96.6%88.1%94.4%Year Ended December 31,(2)96.1%93.8%96.5%90.5%94.7%______________________________(1)Includes RCA’s Run Rate commencing as of the acquisition date of September 13, 2021. (2)Retention rate for All Other – Private Assets excluding the impact of RCA was 92.7% and 92.4% for the years ended December 31, 2022 and 2021, respectively.Retention Rate is an important metric because subscription cancellations decrease our Run Rate and ultimately our future operating revenues over time. The annual Retention Rate represents the retained subscription Run Rate (subscription Run Rate at the beginning of the fiscal year less actual cancels during the year) as a percentage of the subscription Run Rate at the beginning of the fiscal year. The Retention Rate for a non-annual period is calculated by annualizing the cancellations for which we have received a notice of termination or for which we believe there is an intention not to renew or discontinue the subscription during the non-annual period, and we believe that such notice or intention evidences the client’s final decision to terminate or not renew the applicable agreement, even though such notice is not effective until a later date. This annualized cancellation figure is then divided by the subscription Run Rate at the beginning of the fiscal year to calculate a cancellation rate. This cancellation rate is then subtracted from 100% to derive the annualized Retention Rate for the period.For example, in the fourth quarter of 2022, we recorded cancellations of $28.1 million. To derive the Retention Rate for the fourth quarter, we annualized the actual cancellations during the quarter of $28.1 million to derive $112.3 million of annualized cancellations. This $112.3 million was then divided by the $1,614.6 million subscription Run Rate at the beginning of the year to derive a cancellation rate of 7.0%. The 7.0% was then subtracted from 100.0% to derive a Retention Rate of 93.0% for the fourth quarter.Retention Rate is computed by operating segment on a product/service-by-product/service basis. In general, if a client reduces the number of products or services to which it subscribes within a segment, or switches between products or services within a segment, we treat it as a cancellation for purposes of calculating our Retention Rate except in the case of a product or service switch that management considers to be a replacement product or service. In those replacement cases, only the net change to the client subscription, if a decrease, is reported as a cancellation. In the Analytics and the ESG and Climate operating segments, substantially all product or service switches are treated as replacement products or services and netted in this manner, while in our Index and Real Assets operating segments, product or service switches that are treated as replacement products or services and receive netting treatment occur only in certain limited instances. In addition, we treat any reduction in fees resulting from a down-sell of the same product or service as a cancellation to the extent of the reduction. We do not calculate Retention Rate for that portion of our Run Rate attributable to assets in index-linked investment products or futures and options contracts, in each case, linked to our indexes.For the year ended December 31, 2022, 36.2% of our cancellations occurred in the fourth quarter. In our product lines, Retention Rate is generally higher during the first three quarters and lower in the fourth quarter, as the fourth quarter is traditionally the largest renewal period in the year.50Table of ContentsLiquidity and Capital ResourcesWe require capital to fund ongoing operations, internal growth initiatives and acquisitions. Our primary sources of liquidity are cash flows generated from our operations, existing cash and cash equivalents and credit capacity under our existing credit facility. In addition, we believe we have access to additional funding in the public and private markets. We intend to use these sources of liquidity to, among other things, service our existing and future debt obligations, fund our working capital requirements for capital expenditures, investments, acquisitions and dividend payments, and make repurchases of our common stock. In connection with our business strategy, we regularly evaluate acquisition and strategic partnership opportunities. We believe our liquidity, along with other financing alternatives, will provide the necessary capital to fund these transactions and achieve our planned growth.Senior Notes and Credit AgreementAs of December 31, 2022, we had an aggregate of $4,200.0 million in Senior Notes outstanding. In addition, under the Credit Agreement, we had as of December 31, 2022: (i) an aggregate of $347.8 million in Tranche A Term Loans outstanding under the TLA Facility and (ii) $500 million of undrawn borrowing capacity under the Revolving Credit Facility. See Note 6, “Commitments and Contingencies,” of the Notes to Consolidated Financial Statements included herein for additional information on our outstanding indebtedness and revolving credit facility.The Senior Notes and the Credit Agreement are fully and unconditionally, and jointly and severally, guaranteed by our direct or indirect wholly owned domestic subsidiaries that account for more than 5% of our and our subsidiaries’ consolidated assets, other than certain excluded subsidiaries (the “subsidiary guarantors”). Amounts due under the Credit Agreement are our and the subsidiary guarantors’ senior unsecured obligations and rank equally with the Senior Notes and any of our other unsecured, unsubordinated debt, senior to any of our subordinated debt and effectively subordinated to our secured debt to the extent of the assets securing such debt.The indentures governing our Senior Notes (the “Indentures”) among us, each of the subsidiary guarantors, and Computershare, National Association, as trustee and successor to Wells Fargo Bank, National Association, contain covenants that limit our and certain of our subsidiaries’ ability to, among other things, incur liens, enter into sale/leaseback transactions and consolidate, merge or sell all or substantially all of our assets. In addition, the Indentures restrict our non-guarantor subsidiaries’ ability to create, assume, incur or guarantee additional indebtedness without such non-guarantor subsidiaries guaranteeing the Senior Notes on a pari passu basis.The Credit Agreement contains affirmative and restrictive covenants that, among other things, limit our ability and/or the ability of our existing or future subsidiaries to:•incur liens and further negative pledges;•incur additional indebtedness or prepay, redeem or repurchase indebtedness;•make loans or hold investments;•merge, dissolve, liquidate, consolidate with or into another person;•enter into acquisition transactions;•enter into sale/leaseback transactions;•issue disqualified capital stock;•pay dividends or make other distributions in respect of our capital stock or engage in stock repurchases, redemptions and other restricted payments;•create new subsidiaries;•permit certain restrictions affecting our subsidiaries;•change the nature of our business, accounting policies or fiscal periods;•enter into any transactions with affiliates other than on an arm’s-length basis; and•amend our organizational documents or amend, modify or change the terms of certain agreements relating to our indebtedness.The Credit Agreement and the Indentures also contain customary events of default, including those relating to non-payment, breach of representations, warranties or covenants, cross-default and cross-acceleration, and bankruptcy and insolvency events, and, in the case of the Credit Agreement, invalidity or impairment of loan documentation, change of control and customary ERISA defaults in addition to the foregoing. None of the restrictions above are expected to impact our ability to effectively operate the business.51Table of ContentsThe Credit Agreement also requires us and our subsidiaries to achieve financial and operating results sufficient to maintain compliance with the following financial ratios on a consolidated basis through the termination of the Credit Agreement: (1) the maximum Consolidated Leverage Ratio (as defined in the Credit Agreement) measured quarterly on a rolling four-quarter basis not to exceed 4.25:1.00 (or 4.50:1.00 for two fiscal quarters following a material acquisition) and (2) the minimum Consolidated Interest Coverage Ratio (as defined in the Credit Agreement) measured quarterly on a rolling four-quarter basis of at least 4.00:1.00. As of December 31, 2022, our Consolidated Leverage Ratio was 3.08:1.00 and our Consolidated Interest Coverage Ratio was 8.45:1.00. Our non-guarantor subsidiaries under the Senior Notes and the Credit Agreement consist of: (i) domestic subsidiaries of the Company that account for 5% or less of consolidated assets of the Company and its subsidiaries and (ii) any foreign or domestic subsidiary of the Company that is deemed to be a controlled foreign corporation within the meaning of Section 957 of the Internal Revenue Code of 1986, as amended. Our non-guarantor subsidiaries accounted for approximately $1,363.1 million, or 60.6%, of our total revenue for the trailing 12 months ended December 31, 2022, approximately $537.4 million, or 44.5%, of our consolidated operating income for the trailing 12 months ended December 31, 2022, and approximately $1,043.0 million, or 20.9%, of our consolidated total assets (excluding intercompany assets) and $863.5 million, or 14.4%, of our consolidated total liabilities, in each case as of December 31, 2022.Share RepurchasesIn 2022, our Board of Directors approved a stock repurchase program for the purchase of shares of the Company’s common stock in the open market. See Note 11, “Shareholders’ Equity (Deficit),” of the Notes to Consolidated Financial Statements included herein for additional information on our stock repurchase program.As of trade date February 9, 2023, a total of $1,304.4 million of authorization remained available under the share repurchase program. This authorization may be modified, suspended or terminated by the Board of Directors at any time without prior notice.Cash DividendsOn September 17, 2014, our Board of Directors approved a plan to initiate a regular quarterly cash dividend to our shareholders. On October 30, 2014, we began paying regular quarterly cash dividends and have paid such dividends each quarter thereafter.On January 30, 2023, the Board of Directors declared a quarterly cash dividend of $1.38 per share for the three months ending March 31, 2023. This reflects an increase of 10.4% over the quarterly cash dividend declared for the three months ended December 31, 2022. The first quarter 2023 dividend is payable on February 28, 2023 to shareholders of record as of the close of trading on February 17, 2023.Cash FlowsThe following table presents the Company’s cash and cash equivalents as of the dates indicated:As of(in thousands)December 31, 2022December 31, 2021Cash and cash equivalents$993,564 $1,421,449 The following table presents the breakdown of the Company’s cash flows for the periods indicated:Years Ended (in thousands)December 31, 2022December 31, 2021Net cash provided by operating activities$1,095,369 $936,069 Net cash used in investing activities(79,335)(1,035,713)Net cash provided by (used in) financing activities(1,425,380)229,505 Effect of exchange rate changes(18,539)(8,933)Net increase (decrease) in cash$(427,885)$120,928 52Table of ContentsCash and Cash EquivalentsWe typically seek to maintain minimum cash balances globally of approximately $225.0 million to $275.0 million for general operating purposes. As of December 31, 2022 and 2021, $344.5 million and $542.2 million, respectively, of the cash and cash equivalents were held by foreign subsidiaries. Repatriation of some foreign cash may be subject to certain withholding taxes in local jurisdictions and other distribution restrictions. We believe the global cash and cash equivalent balances that are maintained will be available to meet our global needs whether for general corporate purposes or other needs, including acquisitions or expansion of our products.Cash Flows From Operating ActivitiesCash flows from operating activities consist of net income adjusted for certain non-cash items and changes in assets and liabilities. The year-over-year change was primarily driven by higher cash collections from customers, partially offset by higher payments for cash expenses, mainly reflecting higher cash compensation and benefits costs, information technology costs, professional fees, market data costs and travel & entertainment costs.Our primary uses of cash from operating activities are for the payment of cash compensation and benefits costs, income taxes, interest expense, information technology costs, professional fees, market data costs and office rent. Historically, the payment of cash for compensation and benefits is at its highest level in the first quarter when we pay discretionary employee compensation related to the previous fiscal year.Cash Flows From Investing ActivitiesThe year-over-year change was primarily driven by the absence of cash outflows associated with acquisitions and equity method investment, partially offset by higher capitalized software development costs.Cash Flows From Financing ActivitiesThe year-over-year change was primarily driven by the impact of lower proceeds from borrowings and higher share repurchases, partially offset by lower repayments on debt.We believe that global cash flows from operations, together with existing cash and cash equivalents and funds available under our existing revolving credit facility and our ability to access bank debt and the capital markets for additional funds, will continue to be sufficient to fund our global operating activities and cash commitments for investing and financing activities, such as material capital expenditures and share repurchases, for at least the 12 months following issuance of this Form 10-K and for the foreseeable future thereafter. In addition, we expect that foreign cash flows from operations, together with existing cash and cash equivalents, will continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities, such as material capital expenditures, for at least the 12 months following issuance of this Form 10-K and for the foreseeable future thereafter. Contractual ObligationsOur contractual obligations consist primarily of our debt obligations arising from the issuance of the Senior Notes, Tranche A Term Loans, leases for office space, leases for equipment and other operating leases and obligations to vendors arising out of market data contracts. The following table summarizes our contractual obligations for the periods indicated as of December 31, 2022:Years Ending December 31,(in thousands)Total20232024202520262027ThereafterSenior Notes(1)5,505,073 155,875 155,875 155,875 155,875 155,875 4,725,698 Tranche A Term Loans(2)431,685 30,718 32,309 40,007 44,990 283,661 — Operating leases178,234 28,063 23,890 22,673 21,142 16,708 65,758 Vendor obligations212,146 76,316 45,215 28,751 32,485 29,379 — Other obligations(3)19,392 1,465 7,968 9,959 — — — Total contractual obligations$6,346,530 $292,437 $265,257 $257,265 $254,492 $485,623 $4,791,456 ______________________________(1)Includes the impact of payments for the principal amount on the Senior Notes due 2029, the Senior Notes due 2030, the 3.875% Senior Notes due 2031, the 3.625% Senior Notes due 2031 and the Senior Notes due 2033 plus interest based on the 4.000%, 3.625%, 3.875%, 3.625% and 3.250% coupon interest rates, respectively.53Table of Contents(2)Includes the impact of payments for the principal amount as well as coupon interest payments at the interest rate in effect as of December 31, 2022 on the variable rate Tranche A Term Loans due 2027.(3)Primarily includes amounts payable related to an estimated one-time tax on deemed repatriation of historic earnings of foreign subsidiaries (the “Toll Charge”) imposed after Tax Reform was enacted. The Toll Charge, to the extent it is payable in more than one year, is included within “Other non-current liabilities” in our Consolidated Statements of Financial Condition.The obligations related to our uncertain tax positions, which are not considered material, have been excluded from the table above because of the uncertainty surrounding the timing and final amounts of any settlement.Recent Accounting Standards UpdatesSee Note 2, “Recent Accounting Standards Updates,” of the Notes to the Consolidated Financial Statements included herein for further information.Item 7A. Quantitative and Qualitative Disclosures About Market RiskForeign Currency RiskWe are subject to foreign currency exchange fluctuation risk. Exchange rate movements can impact the U.S. dollar-reported value of our revenues, expenses, assets and liabilities denominated in non-U.S. dollar currencies or where the currency of such items is different than the functional currency of the entity where these items were recorded.We generally invoice our clients in U.S. dollars; however, we invoice a portion of our clients in Euros, British pounds sterling, Japanese yen and a limited number of other non-U.S. dollar currencies. For the years ended December 31, 2022 and 2021, 15.9% and 15.1%, respectively, of our revenues were subject to foreign currency exchange rate risk and primarily included clients billed in foreign currency as well as U.S. dollar exposures on non-U.S. dollar foreign operating entities. Of the 15.9% of non-U.S. dollar exposure for the year ended December 31, 2022, 41.4% was in Euros, 30.4% was in British pounds sterling and 18.8% was in Japanese yen. Of the 15.1% of non-U.S. dollar exposure for the year ended December 31, 2021, 41.6% was in Euros, 26.5% was in British pounds sterling and 23.8% was in Japanese yen.Revenues from asset-based fees represented 23.5% and 27.1% of operating revenues for the years ended December 31, 2022 and 2021, respectively. While a substantial portion of our asset-based fees are invoiced in U.S. dollars, the fees are based on the assets in investment products, of which approximately three-fifths are invested in securities denominated in currencies other than the U.S. dollar. Accordingly, declines in such other currencies against the U.S. dollar will decrease the fees payable to us under such licenses. In addition, declines in such currencies against the U.S. dollar could impact the attractiveness of such investment products resulting in net fund outflows, which would further reduce the fees payable under such licenses.We are exposed to additional foreign currency risk in certain of our operating costs. Approximately 42.1% and 41.1% of our operating expenses for the years ended December 31, 2022 and 2021, respectively, were denominated in foreign currencies, the significant majority of which were denominated in British pounds sterling, Indian rupees, Euros, Hungarian forints, Mexican pesos and Swiss francs.We have certain monetary assets and liabilities denominated in currencies other than local functional amounts, and when these balances are remeasured into their local functional currency, either a gain or a loss results from the change of the value of the functional currency as compared to the originating currencies. We manage foreign currency exchange rate risk, in part, through the use of derivative financial instruments comprised principally of forward contracts on foreign currency which are not designated as hedging instruments for accounting purposes. The objective of the derivative instruments is to minimize the impact on the income statement of the volatility of amounts denominated in certain foreign currencies. We recognized total foreign currency exchange gains of $0.5 million for the year ended December 31, 2022 and foreign currency exchange losses of $1.9 million for the year ended December 31, 2021.54Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 7A. Quantitative and Qualitative Disclosures about Market Risk, includes forward-looking statements that are subject to risks, contingencies or uncertainties. You can identify forward-looking statements by words such as “anticipate,” “believe,” “commitment,” “could,” “design,” “estimate,” “expect,” “forecast,” “goal,” “guidance,” “intend,” “may,” “objective,” “opportunity,” “outlook,” “plan,” “policy,” “position,” “potential,” “predict,” “priority,” “project,” “prospective,” “pursue,” “seek,” “should,” “strategy,” “target,” “will,” “would” or other similar expressions that convey the uncertainty of future events or outcomes. Forward-looking statements include, among other things, statements regarding: •future financial and operating results; •ESG goals and targets, including those related to GHG emissions, diversity and inclusion and ESG reporting;•our plans to achieve our ESG goals and targets and to monitor and report progress thereon;•future levels of capital, environmental or maintenance expenditures, general and administrative and other expenses; •expected savings from the restructuring or reorganization of business components;•the success or timing of completion of ongoing or anticipated maintenance projects or transactions; •business strategies, growth opportunities and expected investments; •consumer demand for refined products, natural gas, renewables and NGLs; •the timing, amount and form of future capital return transactions at MPC or MPLX; and•the anticipated effects of actions of third parties such as competitors, activist investors, federal, foreign, state or local regulatory authorities, or plaintiffs in litigation. Our forward-looking statements are not guarantees of future performance, and you should not rely unduly on them, as they involve risks, uncertainties and assumptions that we cannot predict. Material differences between actual results and any future performance suggested in our forward-looking statements could result from a variety of factors, including the following:•general economic, political or regulatory developments, including inflation, changes in governmental policies relating to refined petroleum products, crude oil, natural gas, NGLs or renewables, or taxation;•further impairments;•the regional, national and worldwide availability and pricing of refined products, crude oil, natural gas, renewables, NGLs and other feedstocks;•disruptions in credit markets or changes to credit ratings;•the adequacy of capital resources and liquidity, including availability, timing and amounts of free cash flow necessary to execute business plans and to effect any share repurchases or to maintain or increase the dividend;•the potential effects of judicial or other proceedings on the business, financial condition, results of operations and cash flows;•volatility in or degradation of general economic, market, industry or business conditions as a result of the COVID-19 pandemic, other infectious disease outbreaks, natural hazards, extreme weather events, the military conflict between Russia and Ukraine, other conflicts, inflation, rising interest rates or otherwise;•compliance with federal and state environmental, economic, health and safety, energy and other policies and regulations or enforcement actions initiated thereunder;•adverse market conditions or other risks affecting MPLX;•refining industry overcapacity or under capacity;•changes in producer customers’ drilling plans or in volumes of throughput of crude oil, natural gas, NGLs, refined products, other hydrocarbon-based products or renewables;•non-payment or non-performance by our customers;•changes in the cost or availability of third-party vessels, pipelines, railcars and other means of transportation for crude oil, natural gas, NGLs, feedstocks, refined products and renewables;•the price, availability and acceptance of alternative fuels and alternative-fuel vehicles and laws mandating such fuels or vehicles;•political and economic conditions in nations that consume refined products, natural gas, renewables and NGLs, including the United States and Mexico, and in crude oil producing regions, including the Middle East, Russia, Africa, Canada and South America;2Table of Contents•actions taken by our competitors, including pricing adjustments, the expansion and retirement of refining capacity and the expansion and retirement of pipeline capacity, processing, fractionation and treating facilities in response to market conditions;•completion of pipeline projects within the United States;•changes in fuel and utility costs for our facilities;•accidents or other unscheduled shutdowns affecting our refineries, machinery, pipelines, processing, fractionation and treating facilities or equipment, means of transportation, or those of our suppliers or customers;•acts of war, terrorism or civil unrest that could impair our ability to produce refined products, receive feedstocks or to gather, process, fractionate or transport crude oil, natural gas, NGLs, refined products or renewables;•political pressure and influence of environmental groups and other stakeholders upon policies and decisions related to the production, gathering, refining, processing, fractionation, transportation and marketing of crude oil or other feedstocks, refined products, natural gas, NGLs or other hydrocarbon-based products or renewables;•labor and material shortages; •our ability to successfully achieve our ESG goals and targets within the expected timeframe, if at all; •the costs, disruption and diversion of management’s attention associated with campaigns commenced by activist investors; •personnel changes; and•the other factors described in Item 1A. Risk Factors.We undertake no obligation to update any forward-looking statements except to the extent required by applicable law.3Table of ContentsPART IItem 1. BusinessOVERVIEWMarathon Petroleum Corporation (“MPC”) has 135 years of history in the energy business, and is a leading, integrated, downstream energy company. We operate the nation's largest refining system with approximately 2.9 million barrels per day of crude oil refining capacity and believe we are one of the largest wholesale suppliers of gasoline and distillates to resellers in the United States. We distribute our refined products through one of the largest terminal operations in the United States and one of the largest private domestic fleets of inland petroleum product barges. In addition, our integrated midstream energy asset network links producers of natural gas and NGLs from some of the largest supply basins in the United States to domestic and international markets. Our operations consist of two reportable operating segments: Refining & Marketing and Midstream. Each of these segments is organized and managed based upon the nature of the products and services it offers.•Refining & Marketing – refines crude oil and other feedstocks, including renewable feedstocks, at our refineries in the Gulf Coast, Mid-Continent and West Coast regions of the United States, purchases refined products and ethanol for resale and distributes refined products, including renewable diesel, through transportation, storage, distribution and marketing services provided largely by our Midstream segment. We sell refined products to wholesale marketing customers domestically and internationally, to buyers on the spot market, to independent entrepreneurs who operate primarily Marathon® branded outlets and through long-term supply contracts with direct dealers who operate locations mainly under the ARCO® brand.•Midstream – transports, stores, distributes and markets crude oil and refined products principally for the Refining & Marketing segment via refining logistics assets, pipelines, terminals, towboats and barges; gathers, processes and transports natural gas; and gathers, transports, fractionates, stores and markets NGLs. The Midstream segment primarily reflects the results of MPLX LP (“MPLX”). MPLX is a diversified, large-cap master limited partnership (“MLP”) formed in 2012 that owns and operates midstream energy infrastructure and logistics assets and provides fuels distribution services. As of December 31, 2022, we owned the general partner of MPLX and approximately 65 percent of the outstanding MPLX common units.Corporate History and StructureMPC was incorporated in Delaware on November 9, 2009 in connection with an internal restructuring of Marathon Oil Corporation (“Marathon Oil”). On May 25, 2011, the Marathon Oil board of directors approved the spinoff of its Refining, Marketing & Transportation Business into an independent, publicly traded company, MPC, through the distribution of MPC common stock to the stockholders of Marathon Oil on June 30, 2011. Our common stock trades on the NYSE under the ticker symbol “MPC.” On October 1, 2018, we acquired Andeavor. Andeavor shareholders received in the aggregate approximately 239.8 million shares of MPC common stock valued at $19.8 billion and $3.5 billion in cash. Andeavor was a highly integrated marketing, logistics and refining company operating primarily in the Western and Mid-Continent United States. Our acquisition of Andeavor in 2018 substantially increased our geographic diversification and the scale of our assets, which provides increased opportunities to optimize our system.On May 14, 2021, we completed the sale of Speedway, our company-owned and operated retail transportation fuel and convenience store business, to 7-Eleven, Inc. (“7-Eleven”) for cash proceeds of $21.38 billion ($17.22 billion after cash-tax payments). This transaction resulted in a pretax gain of $11.68 billion ($8.02 billion after income taxes), after deducting the book value of the net assets and certain other adjustments.OUR OPERATIONSRefining & MarketingRefineriesWe currently own and operate refineries in the Gulf Coast, Mid-Continent and West Coast regions of the United States with an aggregate crude oil refining capacity of 2,898 mbpcd. During 2022, our refineries processed 2,761 mbpd of crude oil and 190 mbpd of other charge and blendstocks. During 2021, our refineries processed 2,621 mbpd of crude oil and 178 mbpd of other charge and blendstocks. Our refineries include crude oil atmospheric and vacuum distillation, fluid catalytic cracking, hydrocracking, catalytic reforming, coking, desulfurization and sulfur recovery units. The refineries process a wide variety of condensate and light and heavy crude oils purchased from various domestic and foreign suppliers. We produce numerous refined products, ranging from transportation fuels, such as reformulated gasolines, blend-grade gasolines intended for blending with ethanol and ULSD fuel, to heavy fuel oil 4Table of Contentsand asphalt. Additionally, we manufacture NGLs and petrochemicals and propane. See the Refined Product Marketing section for further information about the products we produce. Our refineries are integrated with each other via pipelines, terminals and barges to maximize operating efficiency. The transportation links that connect our refineries allow the movement of intermediate products between refineries to optimize operations, produce higher margin products and efficiently utilize our processing capacity. Also, shipping intermediate products between facilities during partial refinery shutdowns allows us to utilize processing capacity that is not directly affected by the shutdown work.Following is a description of each of our refineries and their capacity by region.Gulf Coast Region (1,189 mbpcd)Garyville, Louisiana Refinery (596 mbpcd) Our Garyville refinery, which is one of the largest refineries in the U.S., is located along the Mississippi River in southeastern Louisiana between New Orleans, Louisiana and Baton Rouge, Louisiana. The Garyville refinery is configured to process a wide variety of crude oils into gasoline, distillates, NGLs and petrochemicals, heavy fuel oil, asphalt and propane. The refinery has access to the export market and multiple options to sell refined products. Our Garyville refinery has earned designation as an OSHA VPP Star site.Galveston Bay, Texas City, Texas Refinery (593 mbpcd) Our Galveston Bay refinery is a combination of our former Texas City refinery and Galveston Bay refinery. The refinery is located on the Texas Gulf Coast southeast of Houston, Texas and can process a wide variety of crude oils into gasoline, distillates, NGLs and petrochemicals, heavy fuel oil and propane. The refinery has access to the export market and multiple options to sell refined products. Our cogeneration facility, which supplies the Galveston Bay refinery, currently has 1,055 megawatts of electrical production capacity and can produce 4.3 million pounds of steam per hour. Approximately 48 percent of the power generated in 2022 was used at the refinery, with the remaining electricity being sold into the electricity grid.Mid-Continent Region (1,159 mbpcd)Catlettsburg, Kentucky Refinery (291 mbpcd)Our Catlettsburg refinery is located in northeastern Kentucky on the western bank of the Big Sandy River, near the confluence with the Ohio River. The Catlettsburg refinery processes sweet and sour crude oils, including production from the nearby Utica Shale, into gasoline, distillates, asphalt, NGLs and petrochemicals, propane and heavy fuel oil. Our Catlettsburg refinery has earned designation as an OSHA VPP Star site. Robinson, Illinois Refinery (253 mbpcd) Our Robinson refinery is located in southeastern Illinois. The Robinson refinery processes sweet and sour crude oils into gasoline, distillates, NGLs and petrochemicals, propane and heavy fuel oil. The Robinson refinery has earned designation as an OSHA VPP Star site.Detroit, Michigan Refinery (140 mbpcd) Our Detroit refinery is located in southwest Detroit. It is the only petroleum refinery currently operating in Michigan. The Detroit refinery processes sweet and heavy sour crude oils into gasoline, distillates, asphalt, NGLs and petrochemicals, propane and heavy fuel oil. Our Detroit refinery has earned designation as an OSHA VPP Star site. El Paso, Texas Refinery (133 mbpcd) Our El Paso refinery is located east of downtown El Paso. The El Paso refinery processes sweet and sour crudes into gasoline, distillates, heavy fuel oil, propane, asphalt and NGLs and petrochemicals. St. Paul Park, Minnesota Refinery (105 mbpcd) Our St. Paul Park refinery is located along the Mississippi River southeast of St. Paul Park. The St. Paul Park refinery processes sweet and heavy sour crude and manufactures gasoline, distillates, asphalt, propane, heavy fuel oil and NGLs and petrochemicals.Canton, Ohio Refinery (100 mbpcd) Our Canton refinery is located south of Cleveland, Ohio. The Canton refinery processes sweet and sour crude oils, including production from the nearby Utica Shale, into gasoline, distillates, asphalt, propane, NGLs and petrochemicals and heavy fuel oil. The Canton refinery has earned designation as an OSHA VPP Star site.5Table of ContentsMandan, North Dakota Refinery (71 mbpcd) Our Mandan refinery is located outside of Bismarck, North Dakota. The Mandan refinery processes primarily sweet domestic crude oil from North Dakota and manufactures gasoline, distillates, propane, heavy fuel oil and NGLs and petrochemicals.Salt Lake City, Utah Refinery (66 mbpcd) Our Salt Lake City refinery is the largest in Utah and is located north of downtown Salt Lake City. The Salt Lake City refinery processes crude oil from Utah, Colorado, Wyoming and Canada to manufacture gasoline, distillates, heavy fuel oil, NGLs and petrochemicals and propane.West Coast Region (550 mbpcd)Los Angeles, California Refinery (363 mbpcd) Our Los Angeles refinery is located in Los Angeles County, near the Los Angeles Harbor. The Los Angeles refinery is the largest refinery on the West Coast and is a major producer of cleaner burning CARB fuels. The Los Angeles refinery processes heavy crude from California’s San Joaquin Valley and Los Angeles Basin, as well as crudes from the Alaska North Slope, South America, West Africa and other international sources, and manufactures CARB gasoline and CARB diesel fuel, as well as conventional gasoline, distillates, NGLs and petrochemicals, heavy fuel oil and propane.Anacortes, Washington Refinery (119 mbpcd) Our Anacortes refinery is located north of Seattle on Puget Sound. The Anacortes refinery processes Canadian crude, domestic crude from North Dakota and the Alaska North Slope and international crudes to manufacture gasoline, distillates, heavy fuel oil, propane and NGLs and petrochemicals.Kenai, Alaska Refinery (68 mbpcd)Our Kenai refinery is located on the Cook Inlet, southwest of Anchorage. The Kenai refinery processes mainly Alaska domestic crude, domestic crude from North Dakota, along with limited international crude and manufactures distillates, gasoline, heavy fuel oil, asphalt, propane and NGLs and petrochemicals.Planned maintenance activities, or turnarounds, requiring temporary shutdown of certain refinery operating units, are periodically performed at each refinery.Refined Product YieldsThe following table sets forth our refinery production by product group for each of the last three years.(mbpd)202220212020Gasoline(a)1,494 1,446 1,314 Distillates(a)1,079 965 905 NGLs and petrochemicals(a)178 250 244 Asphalt89 91 81 Propane70 52 51 Heavy fuel oil73 31 28 Total2,983 2,835 2,623 (a) Product yields include renewable production.Crude Oil SupplyWe obtain the crude oil we refine through negotiated term contracts and purchases or exchanges on the spot market. Our term contracts generally have market-related pricing provisions. The following table provides information on our sources of crude oil for each of the last three years. The crude oil sourced outside of North America was acquired from various foreign national oil companies, production companies and trading companies.(mbpd)202220212020United States1,895 1,890 1,650 Canada539 445 442 Middle East and other international327 286 326 Total2,761 2,621 2,418 Our refineries receive crude oil and other feedstocks and distribute our refined products through a variety of channels, including pipelines, trucks, railcars, ships and barges. 6Table of ContentsRenewable Fuels The Dickinson, North Dakota, renewable fuels facility began operations at the end of 2020 and reached full design operating capacity in the second quarter of 2021. The facility has the capacity to produce 184 million gallons per year of renewable diesel from corn oil, soybean oil, fats and greases. The produced renewable diesel generates federal RINs and LCFS credits when sold in California or similar markets. These instruments are used to help meet our Renewable Fuel Standard and LCFS compliance obligations as a petroleum fuel producer.On September 21, 2022, MPC closed on the formation of the Martinez Renewable Fuels joint venture (the “Martinez Renewable joint venture”), a partnership structured as a 50/50 joint venture with Neste Corporation (“Neste”). Converting the Martinez facility from refining petroleum to manufacturing renewable fuels signals our strong commitment to producing a substantial level of lower carbon-intensity fuels in California. The facility is expected to ramp up to producing 730 million gallons per year by the end of 2023, with pretreatment capabilities coming online in 2023. Our wholly owned subsidiary, Virent Inc. (“Virent”), operates an advanced biofuels facility in Madison, Wisconsin at which it is working to commercialize a process for converting biobased feedstocks into renewable fuels and chemicals. During 2022, Virent continued to advance its technology to commercialization with demonstration activities in both the fuels and chemicals industries, including a demonstration flight with Gulfstream in a G650 aircraft in which one engine used 100 percent sustainable aviation fuel (“SAF”) that included Virent’s synthesized aromatic kerosene as a blending component to provide a 100 percent drop-in SAF that was fully compatible with today’s jet fuel specifications. Additional demonstration projects included the introduction of bio-based polyester fabrics to applications in the airline, fashion and outdoor clothing industries.On December 14, 2021, we finalized the formation of a joint venture with Archer-Daniels-Midland Company (“ADM”) for the production of soybean oil to supply rapidly growing demand for renewable diesel fuel. The joint venture, which is named Green Bison Soy Processing, LLC, will own and operate a soybean processing complex in Spiritwood, North Dakota, with ADM owning 75 percent of the joint venture and MPC owning 25 percent. When complete in 2023, the Spiritwood facility will source and process local soybeans and supply the resulting soybean oil exclusively to MPC. The Spiritwood complex is expected to produce approximately 600 million pounds of refined soybean oil annually, enough feedstock for approximately 75 million gallons of renewable diesel per year. We hold an ownership interest in ethanol production facilities in Albion, Michigan; Logansport, Indiana; Greenville, Ohio and Denison, Iowa. These plants have a combined ethanol production capacity of approximately 475 million gallons per year and are managed by our joint venture partner, The Andersons, Inc. (“The Andersons”).Refined Product SalesOur refined products are sold to independent retailers, wholesale customers, our brand jobbers and direct dealers. In addition, we sell refined products for export to international customers. As of December 31, 2022, there were 7,209 brand jobber outlets in 38 states, the District of Columbia and Mexico where independent entrepreneurs primarily maintain Marathon-branded outlets. We also have long-term supply contracts for 1,172 direct dealer locations primarily in Southern California, largely under the ARCO® brand. We believe we are one of the largest wholesale suppliers of gasoline and distillates to resellers and consumers within our market area.The following table sets forth our refined product sales volumes by product group for each of the last three years.(mbpd)2022(a)2021(a)2020(a)Gasoline(b)1,870 1,834 1,669 Distillates(b)1,169 1,089 1,040 NGLs and petrochemicals(b)221 293 323 Asphalt89 94 86 Propane93 76 69 Heavy fuel oil66 39 35 Total3,508 3,425 3,222 (a) Refined product sales include volumes marketed directly to end-users and trading/supply volumes such as bulk sales to large unbranded resellers and other downstream companies. Marketed volumes directly to end users such as branded retail stations were 2,355 mbpd and 2,338 mbpd for the years ended December 31, 2022 and 2021, respectively. (b) Sales include renewable products.7Table of ContentsRefined Product Sales Destined for ExportWe sell gasoline, distillates and asphalt for export, primarily out of our Garyville, Galveston Bay, Anacortes and Los Angeles refineries. The following table sets forth our refined product sales destined for export by product group for the past three years.(mbpd)202220212020Gasoline105 154 110 Distillates158 162 187 Other52 55 43 Total315 371 340 Gasoline and Distillates We sell gasoline, gasoline blendstocks and distillates (including No. 1 and No. 2 fuel oils, jet fuel, kerosene, diesel and renewable diesel) to wholesale customers, branded jobbers, direct dealers and in the spot market. In addition, we sell diesel fuel and gasoline for export to international customers. The demand for gasoline and distillates is seasonal in many of our markets, with demand typically at its highest levels during the summer months.NGLs and PetrochemicalsWe are a producer and marketer of NGLs and petrochemicals. Product availability varies by refinery and includes, among others, propylene, xylene, butane, benzene, toluene and cumene. We market these products domestically to customers in the chemical, agricultural and fuel-blending industries. In addition, we produce fuel-grade coke at our Garyville, Detroit, Galveston Bay and Los Angeles refineries, which is used for power generation and in miscellaneous industrial applications, and anode-grade coke at our Los Angeles and Robinson refineries, which is used to make carbon anodes for the aluminum smelting industry.AsphaltWe have refinery-based asphalt production capacity of up to 141 mbpcd, which includes asphalt cements, polymer-modified asphalt, emulsified asphalt, industrial asphalts and roofing flux. We have a broad customer base, including asphalt-paving contractors, resellers, government entities (states, counties, cities and townships) and asphalt roofing shingle manufacturers. We sell asphalt in the domestic and export wholesale markets via rail, barge and vessel.PropaneWe produce propane at all of our refineries. Propane is primarily used for home heating and cooking, as a feedstock within the petrochemical industry, for grain drying and as a fuel for trucks and other vehicles. Our propane sales are split approximately 80 percent and 20 percent between the home heating market and industrial/petrochemical consumers, respectively.Heavy Fuel OilWe produce and market heavy residual fuel oil or related components, including slurry, at all of our refineries. Heavy residual fuel oil is primarily used in the utility and ship bunkering (fuel) industries, though there are other more specialized uses of the product.Terminals and TransportationWe transport, store and distribute crude oil, feedstocks and refined products through pipelines, terminals and marine fleets owned by MPLX and third parties in our market areas. We own a fleet of transport trucks and trailers for the movement of refined products and crude oil. In addition, we maintain a fleet of leased and owned railcars for the movement and storage of refined products.The locations and detailed information about our Refining & Marketing assets are included under Item 2. Properties and are incorporated herein by reference. Competition, Market Conditions and SeasonalityThe downstream petroleum business is highly competitive, particularly with regard to accessing crude oil and other feedstock supply and the marketing of refined products. We compete with a number of other companies to acquire crude oil for refinery processing and in the distribution and marketing of a full array of refined products.We compete in four distinct markets for the sale of refined products—wholesale, including exports, spot, branded and retail distribution. Our marketing operations compete with numerous other independent marketers, integrated oil companies and high-volume retailers. We compete with companies in the sale of refined products to wholesale marketing customers, including private-brand marketers and large commercial and industrial consumers; companies in the sale of refined products in the spot market; and refiners or marketers in the supply of refined products to refiner-branded independent entrepreneurs. In addition, we compete with producers and marketers in other industries that supply alternative forms of energy and fuels to satisfy the requirements of our industrial, commercial and retail consumers.8Table of ContentsMarket conditions in the oil and gas industry are cyclical and subject to global economic and political events and new and changing governmental regulations. Our operating results are affected by price changes in crude oil, natural gas and refined products, as well as changes in competitive conditions in the markets we serve. Price differentials between sweet and sour crude oils, ANS, WTI and MEH crude oils and other market structure impacts also affect our operating results. Demand for gasoline, diesel fuel and asphalt is higher during the spring and summer months than during the winter months in most of our markets, primarily due to seasonal increases in highway traffic and construction. As a result, the operating results for our Refining & Marketing segment for the first and fourth quarters may be lower than for those in the second and third quarters of each calendar year.Midstream The Midstream segment primarily includes the operations of MPLX, our sponsored MLP, and certain related operations retained by MPC.MPLXMPLX owns and operates a network of crude oil, natural gas and refined product pipelines and has joint ownership interests in crude oil, refined products and other pipelines. MPLX also owns and operates light products terminals, storage assets and maintains a fleet of owned and leased towboats and barges in support of fuels distribution on behalf of MPC. MPLX’s assets also include natural gas gathering systems and natural gas processing and NGL fractionation complexes. MPC-Retained Midstream Assets and Investments We own four Jones Act product tankers, have ownership interests in several crude oil and refined products pipeline systems and pipeline companies and have an indirect ownership interest in an ocean vessel joint venture through our investment in Crowley Coastal Partners LLC (“Crowley Coastal Partners”). The locations and detailed information about our Midstream assets are included under Item 2. Properties and are incorporated herein by reference. Competition, Market Conditions and SeasonalityOur Midstream operations face competition for natural gas gathering, crude oil transportation and in obtaining natural gas supplies for our processing and related services; in obtaining unprocessed NGLs for gathering, transportation and fractionation; and in marketing our products and services. Competition for natural gas supplies is based primarily on the location of gas gathering systems and gas processing plants, operating efficiency and reliability, residue gas and NGL market connectivity, the ability to obtain a satisfactory price for products recovered and the fees charged for the services supplied to the customer. Competition for oil supplies is based primarily on the price and scope of services, location of gathering/transportation and storage facilities and connectivity to the best priced markets. Competitive factors affecting our fractionation services include availability of fractionation capacity, proximity to supply and industry marketing centers, the fees charged for fractionation services and operating efficiency and reliability of service. Competition for customers to purchase our natural gas and NGLs is based primarily on price, credit and market connectivity. In addition, certain of our Midstream operations are subject to rate regulation, which affects the rates that our common carrier pipelines can charge for transportation services and the return we obtain from such pipelines.Our Midstream segment can be affected by seasonal fluctuations in the demand for natural gas and NGLs and the related fluctuations in commodity prices caused by various factors such as changes in transportation and travel patterns and variations in weather patterns from year to year. REGULATORY MATTERSOur operations are subject to numerous laws and regulations, including those relating to the protection of the environment. Such laws and regulations include, among others, the Clean Air Act (“CAA”) with respect to air emissions, the Clean Water Act (“CWA”) with respect to water discharges, the Resource Conservation and Recovery Act (“RCRA”) with respect to solid and hazardous waste treatment, storage and disposal, the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) with respect to releases and remediation of hazardous substances and the Oil Pollution Act of 1990 (“OPA-90”) with respect to oil pollution and response. In addition, many states where we operate have similar laws. New laws are being enacted and regulations are being adopted on a continuing basis, and the costs of compliance with such new laws and regulations are very difficult to estimate until finalized.For a discussion of environmental capital expenditures and costs of compliance, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Environmental Matters and Compliance Costs. For additional information regarding regulatory risks, see Item 1A. Risk Factors.9Table of ContentsRate RegulationSome of our existing pipelines are considered interstate common carrier pipelines subject to regulation by the Federal Energy Regulatory Commission (“FERC”) under the Interstate Commerce Act (the “ICA”), Energy Policy Act of 1992 (“EPAct 1992”) and the rules and regulations promulgated under those laws. The ICA and FERC regulations require that tariff rates for oil pipelines, a category that includes crude oil and petroleum product pipelines, be just and reasonable and the terms and conditions of service must not be unduly discriminatory. The ICA permits interested persons to challenge newly proposed tariff rates or terms and conditions of service, or any change to tariff rates or terms and conditions of service, and authorizes FERC to suspend the effectiveness of such proposal or change for a period of time to investigate. If, upon completion of an investigation, FERC finds that the new or changed service or rate is unlawful, it is authorized to require the carrier to refund the revenues in excess of the prior tariff collected during the pendency of the investigation. An interested person may also challenge existing terms and conditions of service or rates and FERC may order a carrier to change its terms and conditions of service or rates prospectively. Upon an appropriate showing, a shipper may also obtain reparations, from a pipeline, for damages sustained as a result of rates or terms which FERC deemed were not just and reasonable. Such reparation damages may accrue from the complaint through the final order and during the two years prior to the filing of a complaint.EPAct 1992 deemed certain interstate petroleum pipeline rates then in effect to be just and reasonable under the ICA. These rates are commonly referred to as “grandfathered rates.” Our rates for interstate transportation service in effect for the 365-day period ending on the date of the passage of EPAct 1992 were deemed just and reasonable and therefore are grandfathered. Subsequent changes to those rates are not grandfathered. New rates have since been established after EPAct 1992 for certain pipelines.FERC permits regulated oil pipelines to change their rates within prescribed ceiling levels that are tied to an inflation index. A carrier must, as a general rule, utilize the indexing methodology to change its rates. Cost-of-service ratemaking, market-based rates and settlement rates are alternatives to the indexing approach and may be used in certain specified circumstances to change rates.AirGHG EmissionsWe believe the advancement of public policy intended to address GHG emissions, climate change, and climate adaptation will continue, with the potential for further regulations that could affect our operations. Currently, legislative and regulatory measures to address GHG emissions are in various phases of review, discussion or implementation. Reductions in GHG emissions could result in increased costs to (i) operate and maintain our facilities, (ii) install new emission controls at our facilities, (iii) capture the emissions from our facilities and (iv) administer and manage any GHG emissions programs, including acquiring emission credits or allotments.In February 2021, the Interagency Working Group on the Social Cost of Greenhouse Gases published interim estimates of the social cost of carbon, methane and nitrous oxide (collectively, social cost of GHG emissions). In its proposed methane emission rules for the oil and natural gas sector, the EPA significantly increased the social cost of GHG emissions in the cost and benefit analysis for the proposed rule. A higher social cost could support more stringent GHG emission regulation in various rule makings from methane emissions to vehicle tailpipe emissions.States are becoming active in regulating GHG emissions. These measures may include state actions to develop statewide or regional programs to report emissions and impose emission reductions. These measures may also include low-carbon fuel standards, such as the California program, or a state carbon tax. These measures could result in increased costs to operate and maintain our facilities, capital expenditures to install new emission controls and costs to administer any carbon trading or tax programs implemented. For example, California has enacted a cap-and-trade program. Much of the compliance costs associated with the California program are ultimately passed on to the consumer in the form of higher fuel costs. States are increasingly announcing aspirational goals to be net-zero carbon emissions by a certain date through both legislation and executive orders. To date, these states have not provided significant details as to achievement of these goals; however, meeting these aspirations will require a reduction in fossil fuel combustion and/or a mechanism to capture GHGs from the atmosphere. As a result, we cannot currently predict the impact of these potential regulations on our liquidity, financial position, or results of operations.Other Air EmissionsIn 2021, the EPA announced it is reconsidering the National Ambient Air Quality Standards (“NAAQS”) for ozone and fine particulate matter. In January 2023, EPA published its proposal to lower the primary (health-based) fine particulate matter annual standard from its current level of 12.0 µg/m3 to within the range of 9.0 to 10.0 µg/m3. EPA has not yet announced its decision on reconsideration of the ozone NAAQS. Lowering of the NAAQS and subsequent designation as a nonattainment area could result in increased costs associated with, or result in cancellation or delay of, capital projects at our or our customers’ facilities, or could require emission reductions that could result in increased costs to us or our customers. We cannot predict the effects of the various state implementation plan requirements at this time.10Table of ContentsIn California, the Governing Board for the South Coast Air Quality Management District (“SCAQMD”) adopted Rule 1109.1 in November 2021, which establishes Best Available Retrofit Control Technology (“BARCT”) oxides of nitrogen (“NOx”) and carbon monoxide (“CO”) emission limits for combustion equipment at petroleum refineries. These new requirements will replace the Regional Clean Air Incentives Market (“RECLAIM”) cap-and-trade program which has required a staged refinery-wide reduction of NOx emissions over the last several years and will result in additional emission reductions from our Los Angeles Refinery. Compliance with Rule 1109.1 is being phased in through 2032 and will result in increased costs to operate and maintain our Los Angeles Refinery.WaterWe maintain numerous discharge permits as required under the National Pollutant Discharge Elimination System program of the CWA and have implemented systems to oversee our compliance with these permits. In addition, we are regulated under OPA-90, which, among other things, requires the owner or operator of a tank vessel or a facility to maintain an emergency plan to respond to releases of oil or hazardous substances. OPA-90 also requires the responsible company to pay resulting removal costs and damages and provides for civil penalties and criminal sanctions for violations of its provisions. We operate tank vessels and facilities from which spills of oil and hazardous substances could occur. We have implemented emergency oil response plans for all of our components and facilities covered by OPA-90 and we have established Spill Prevention, Control and Countermeasures plans for all facilities subject to such requirements. Some coastal states in which we operate have passed state laws similar to OPA-90, but with expanded liability provisions, that include provisions for cargo owner responsibility as well as ship owner and operator responsibility.On October 22, 2019, EPA and the United States Army Corps of Engineers (“Army Corps”) published a final rule to repeal the 2015 “Clean Water Rule: Definition of Waters of the United States” (“2015 Rule”), which amended portions of the Code of Federal Regulations to restore the regulatory text that existed prior to the 2015 Rule, effective December 23, 2019. The rule repealing the 2015 Rule has been challenged in multiple federal courts. On April 21, 2020, EPA and the Army Corps promulgated the Navigable Waters Protection Rule (“2020 Rule”) to define “waters of the United States.” The 2020 Rule has been vacated by a federal court. On December 7, 2021, EPA and the Army Corps issued a notice of proposed rulemaking with the stated purpose of repealing the 2020 Rule defining “waters of the United States” and adopting a rule largely based upon the definition adopted in 1986 with some revisions based upon subsequent United States Supreme Court rulings, in particular Rapanos v. United States (2006) which produced two different tests for determining “waters of the United States,” the relatively permanent waters and significant nexus tests. A broader definition could result in increased cost of compliance or increased capital costs for construction of new facilities or expansion of existing facilities. In April 2020, the U.S. District Court in Montana vacated Nationwide Permit 12 (“NWP 12”), which authorizes the placement of fill material in “waters of the United States” for utility line activities as long as certain best management practices are implemented. The decision was ultimately appealed to the United States Supreme Court, which partially reversed the district court’s decision, temporarily reinstating NWP 12 for all projects except the Keystone XL oil pipeline. The Army Corps subsequently reissued its nationwide permit authorizations on January 13, 2021, by dividing the NWP that authorizes utility line activities (NWP 12) into three separate NWPs that address the differences in how different utility line projects are constructed, the substances they convey, and the different standards and best management practices that help ensure those NWPs authorize only those activities that have no more than minimal adverse environmental effects. A challenge of the 2021 authorization is currently pending before the U.S. District Court for the District of Columbia (“D.D.C.”), after being transferred from the U.S. District Court for the District of Montana in August 2022, and the plaintiffs request the court vacate and remand the 2021 authorization. Also, a petition has been filed with the Army Corps asking it to revoke the 2021 authorization. The Biden Administration could repeal or replace the 2021 authorization in a subsequent rulemaking. The repeal, vacatur, revocation or replacement of the 2021 authorization could impact pipeline construction and maintenance activities.As part of our emergency response activities, we have used aqueous film forming foam (“AFFF”) containing per- and polyfluoroalkyl substances (“PFAS”) chemicals as a vapor and fire suppressant. At this time, AFFFs containing PFAS are the only proven foams that can prevent and control a flammable petroleum-based liquid fire involving a large storage tank or tank containment area.In May 2016, EPA issued lifetime health advisory levels (“HALs”) and health effects support documents for two PFAS substances - Perfluorooctanoic Acid (“PFOA”) and Perfluorooctane Sulfonate (“PFOS”). These HALs were updated in June 2022, when EPA also issued HALs for two additional PFAS substances. In February 2019, EPA issued a PFAS Action Plan identifying actions it is planning to take to study and regulate various PFAS chemicals. EPA identified that it would evaluate, among other actions, (1) proposing national drinking water standards for PFOA and PFOS, (2) develop cleanup recommendations for PFOA and PFOS, (3) evaluate listing PFOA and PFOS as hazardous substances under CERCLA, and (4) conduct toxicity assessments for other PFAS chemicals. EPA did not issue any further regulations for PFAS under the Trump administration. In October 2021, EPA updated the 2019 PFAS Action Plan. On December 5, 2022, EPA issued to states and EPA regional offices a memorandum providing guidance for addressing PFAS discharges in wastewater and stormwater. Also, EPA has indicated it intends to issue a notice of proposed rulemaking in 2023 that will establish national drinking water standards for PFOS and PFOA. Congress may also take further action to regulate PFAS. We cannot currently predict the impact of potential statutes or regulations on our operations.11Table of ContentsIn addition, many states are actively proposing and adopting legislation and regulations relating to the use of AFFFs containing PFAS. Additionally, many states are using EPA HALs for PFOS and PFOA and some states are adopting and proposing state-specific drinking water and cleanup standards for various PFAS, including but not limited to PFOS and PFOA. We cannot currently predict the impact of these regulations on our liquidity, financial position, or results of operations.Solid WasteWe continue to seek methods to minimize the generation of hazardous wastes in our operations. RCRA establishes standards for the management of solid and hazardous wastes. Besides affecting waste disposal practices, RCRA also addresses the environmental effects of certain past waste disposal operations, the recycling of wastes and the regulation of USTs containing regulated substances.RemediationWe own or operate, or have owned or operated, certain convenience stores and other locations where, during the normal course of operations, releases of refined products from USTs have occurred. Federal and state laws require that contamination caused by such releases at these sites be assessed and remediated to meet applicable standards. Penalties or other sanctions may be imposed for noncompliance. The enforcement of the UST regulations under RCRA has been delegated to the states, which administer their own UST programs. Our obligation to remediate such contamination varies, depending on the extent of the releases and the applicable state laws and regulations. A portion of these remediation costs may be recoverable from the appropriate state UST reimbursement funds once the applicable deductibles have been satisfied. We also have ongoing remediation projects at a number of our current and former refinery, terminal and pipeline locations.Claims under CERCLA and similar state acts have been raised with respect to the clean-up of various waste disposal and other sites. CERCLA is intended to facilitate the clean-up of hazardous substances without regard to fault. Potentially responsible parties for each site include present and former owners and operators of, transporters to and generators of the hazardous substances at the site. Liability is strict and can be joint and several. Because of various factors including the difficulty of identifying the responsible parties for any particular site, the complexity of determining the relative liability among them, the uncertainty as to the most desirable remediation techniques and the amount of damages and clean-up costs and the time period during which such costs may be incurred, we are unable to reasonably estimate our ultimate cost of compliance with CERCLA; however, we do not believe such costs will be material to our business, financial condition, results of operations or cash flows.On September 6, 2022, EPA issued a notice of proposed rulemaking that would designate PFOS and PFOA as hazardous substances under CERCLA Section 102(a). Additional PFAS regulation could include the designation of PFAS as a RCRA hazardous waste. We cannot currently predict the impact of potential statutes or regulations on our remediation costs.Vehicle and Fuel RequirementsFuel Economy and GHG Emission Standards for VehiclesThe National Highway Traffic Safety Administration (“NHTSA”) establishes corporate average fuel economy (“CAFE”) standards for passenger cars and light trucks. In addition, EPA establishes carbon dioxide (“CO2”) emission standards for passenger cars and light trucks. At the direction of President Biden in his executive order setting a goal that 50 percent of all new passenger cars and light trucks sold in 2030 be zero emission vehicles, EPA and NHTSA have promulgated separate rules setting more stringent requirements for reductions through model year 2026. NHTSA’s amended CAFE standards would increase in stringency from model year 2023 levels by eight percent annually for model years 2024-2025 and ten percent annually for model year 2026. EPA’s revised model year 2023-2026 CO2 emission standards, which were finalized in December 2021, result in average fuel economy of 40 mpg in model year 2026. The NHTSA and EPA regulations have been challenged in court. Higher CAFE and CO2 emission standards for cars and light trucks reduce demand for our transportation fuels. In addition, California may establish per its Clean Air Act waiver authority different standards that could apply in multiple states. EPA has issued a rule that reinstates California’s waiver for its Advanced Clean Car I program, which includes requirements for zero emission vehicle sales through 2025. California’s governor has also issued an executive order requiring sales of all new passenger vehicles in the state be zero-emission by 2035. The California Air Resources Board followed this executive order by finalizing its Advanced Clean Car II regulation, which bans the sale of internal combustion engine vehicles in California in 2035. Other states have issued, or may issue, zero emission vehicle mandates. Renewable Fuels Standards and Low Carbon Fuel StandardsPursuant to the Energy Policy Act of 2005 and the EISA, Congress established a Renewable Fuel Standard (“RFS”) program that requires annual volumes of renewable fuel be blended into domestic transportation fuel. The statutory volumes apply through calendar year 2022. When EPA promulgates the annual renewable fuel volume obligations, EPA may reduce the statutory amount of renewable fuel that must be blended using its waiver or reset authority. After calendar year 2022, the statute gives EPA the authority to set the annual volumes. EPA has proposed annual volumes for 2023-2025 that increase the volume of renewable fuel that must be blended year over year. The greatest increase in annual volumes arises from EPA’s proposal to approve a process in which electricity generated from renewable biomass used to fuel vehicles can generate a Renewable Identification Number (“eRIN”) under the RFS. 12Table of ContentsThere is currently no regulatory method for verifying the validity of most RINs sold on the open market. We have developed a RIN integrity program to vet the RINs that we purchase, and we incur costs to audit RIN generators. Nevertheless, if any of the RINs that we purchase and use for compliance are found to be invalid, we could incur costs and penalties for replacing the invalid RINs.In addition to the federal Renewable Fuel Standards, certain states have, or are considering, promulgation of state renewable or low carbon fuel standards. For example, California began implementing its LCFS in January 2011. In September 2015, the CARB approved the re-adoption of the LCFS, which became effective on January 1, 2016, to address procedural deficiencies in the way the original regulation was adopted. The LCFS was amended again in 2018 with the current version targeting a 20 percent reduction in fuel carbon intensity from a 2010 baseline by 2030. CARB is currently holding a series of workshops to discuss potential changes to the LCFS, including increasing the stringency of the carbon intensity targets for 2030 and beyond. We incur costs to comply with LCFS programs, and these costs may increase if the cost of LCFS credits increases.In sum, the RFS has required, and may in the future continue to require, additional capital expenditures or expenses by us to accommodate increased renewable fuels use. We may experience a decrease in demand for refined products due to an increase in combined fleet mileage or due to refined products being replaced by renewable fuels. Demand for our refined products also may decrease as a result of low carbon fuel standard programs or electric vehicle mandates.Safety MattersWe are subject to oversight pursuant to the federal Occupational Safety and Health Act, as amended (“OSH Act”), as well as comparable state statutes that regulate the protection of the health and safety of workers. We believe that we have conducted our operations in substantial compliance with regulations promulgated pursuant to the OSH Act, including general industry standards, record-keeping requirements and monitoring of occupational exposure to regulated substances.We are also subject at regulated facilities to the Occupational Safety and Health Administration’s Process Safety Management (“PSM”) and EPA’s Risk Management Program (“RMP”) requirements, which are intended to prevent or minimize the consequences of catastrophic releases of toxic, reactive, flammable or explosive chemicals. EPA has proposed revisions to its RMP regulation. The proposed revisions include a requirement that refineries with hydrofluoric acid alkylation units perform a safer technologies and alternatives analysis as part of the process hazard analysis and to document the feasibility of inherent safety measures. The application of these regulations can result in increased compliance expenditures.In general, we expect industry and regulatory safety standards to become more stringent over time, resulting in increased compliance expenditures. While these expenditures cannot be accurately estimated at this time, we do not expect such expenditures will have a material adverse effect on our results of operations.The DOT has adopted safety regulations with respect to the design, construction, operation, maintenance, inspection and management of our pipeline assets. These regulations contain requirements for the development and implementation of pipeline integrity management programs, which include the inspection and testing of pipelines and the correction of anomalies. These regulations also require that pipeline operation and maintenance personnel meet certain qualifications and that pipeline operators develop comprehensive spill response plans. Tribal LandsVarious federal agencies, including EPA and the Department of the Interior, along with certain Native American tribes, promulgate and enforce regulations pertaining to oil and gas operations on Native American tribal lands where we operate. These regulations include such matters as lease provisions, drilling and production requirements, and standards to protect environmental quality and cultural resources. In addition, each Native American tribe is a sovereign nation having the right to enforce certain laws and regulations and to grant approvals independent from federal, state and local statutes and regulations. These laws and regulations may increase our costs of doing business on Native American tribal lands and impact the viability of, or prevent or delay our ability to conduct, our operations on such lands.TRADEMARKS, PATENTS AND LICENSES Our Marathon and ARCO trademarks are material to the conduct of our refining and marketing operations. We currently hold a number of U.S. and foreign patents and have various pending patent applications. Although in the aggregate our patents and licenses are important to us, we do not regard any single patent or license or group of related patents or licenses as critical or essential to our business as a whole. In general, we depend on our technological capabilities and the application of know-how rather than patents and licenses in the conduct of our operations.HUMAN CAPITALWe believe our employees are our greatest asset of strength, and our culture reflects the quality of individuals across our workforce. Our collaborative efforts, which include fostering an inclusive environment, providing broad-based development and mentorship opportunities, recognizing and rewarding accomplishments and offering benefits that support the well-being of our employees and their families, contribute to increased engagement and fulfilling careers. Empowering our people and prioritizing 13Table of Contentsaccountability are also key components for developing MPC’s high-performing culture, which is critical to achieving our strategic vision. Employee ProfileAs of December 31, 2022, we employed approximately 17,800 people in full-time and part-time roles. Many of these employees provide services to MPLX, for which we are reimbursed in accordance with employee service agreements. Approximately 3,755 of our employees are covered by collective bargaining agreements. Safety We are committed to safe operations to protect the health and safety of our employees, contractors and communities. Our commitment to safe operations is reflected in our safety systems design, our well-maintained equipment and by learning from our incidents. Part of our effort to promote safety includes our Operational Excellence Management System, which expands on the RC14001® scope, incorporates a Plan-Do-Check-Act continual improvement cycle, and aligns with ISO 9001, incorporating quality and an increased stakeholder and process focus. Together, these components of our safety management system provide us with a comprehensive approach to managing risks and preventing incidents, illnesses and fatalities. Additionally, our annual cash bonus program metrics include several employee, process and environmental safety metrics.In 2022, MPC rolled back a majority of its COVID protocols which included the return of all employees to their respective work locations. We continue to monitor the situation and adapt our COVID protocols as appropriate.Talent ManagementExecuting our strategic vision requires that we attract and retain the best talent. Recruiting and retention success requires that we effectively nurture new employees, providing opportunities for long-term engagement and career advancement. We also appropriately reward high-performers and offer competitive benefits. Our Talent Acquisition team consists of three segments: Executive Recruiting, Experienced Recruiting and University Recruiting. The specialization within each group allows us to specifically address MPC’s broad range of current and future talent needs, as well as devote time and attention to candidates during the hiring process. We value diverse perspectives in the workforce, and accordingly we seek candidates with a variety of backgrounds and experience. Our primary source of full-time, entry-level new hires is our intern/co-op program. Through our university recruiters, we offer college students who have completed their freshman year the opportunity to participate in our hands-on programs focused in areas of finance and accounting, marketing, engineering and IT.We provide a broad range of leadership training opportunities to support the development of leaders at all levels. Our programs, which are offered across the organization are a blended approach of business and leadership content, with many featuring external faculty. We utilize various learning modalities, such as visual, audio, print, tactile, interactive, kinesthetic, experiential and leader-teaching-leader to address and engage different learning styles. We believe networking and access to our executive team are a key leadership success factor, and we incorporate these opportunities into all of our programs.Compensation and BenefitsTo ensure we are offering competitive pay packages in our recruitment and retention efforts, we annually benchmark compensation, including base salaries, bonus levels and long-term incentive targets. Our annual bonus program is a critical component of our compensation, as it provides individual rewards for MPC’s achievement against preset financial and ESG goals, encouraging a sense of employee ownership. Employees in our senior leader pay grades, as well as most other leaders, receive long-term incentive awards annually to align their compensation to the interests of MPC shareholders and MPLX unitholders.We offer comprehensive benefits that are also benchmarked annually, including medical, dental and vision insurance for our employees, their spouses or domestic partners, and their dependents. We also provide retirement programs, life insurance, education assistance, family assistance, short-term disability and paid vacation and sick time. In addition, we provide generous paid parental leave benefits for birth mothers and nonbirth parents; and parents who both work for the Company are each eligible for the benefit. Further, we have a substantial accrual cap for vacation banks and also award a significant number of college and trade school scholarships to high school senior children of our employees through the Marathon Petroleum Scholars Program. Both full-time and part-time employees are eligible for these benefits. InclusionOur company-wide Diversity, Equity and Inclusion ("DE&I") program is guided by a dedicated DE&I team led by our Vice President Talent Acquisition and Diversity, Equity & Inclusion and supported by leadership company-wide. Our program is based on our four-pillar DE&I strategy of building awareness, increasing representation, ensuring success, and measurement and accountability. To execute our strategy, our near-term action plans are focused on building a diverse workforce, creating a more inclusive culture, and contributing to our thriving communities.We have employee networks focusing on seven populations: Asian, Black, Disability, Hispanic, LGBTQ+, Veterans and Women. Our employee networks have approximately 60 chapters across the company and all networks encourage ally membership. This broad support extends also to our leaders throughout MPC, with each employee network represented by two active executive 14Table of Contentssponsors. The sponsors form several counsels that meet regularly to share updates, gain alignment, build deeper connections across networks and pursue collaboration ideas. Our employee networks not only provide opportunities for our employees to make meaningful and supportive connections, but they also serve a significant role in our DE&I strategy.EXECUTIVE OFFICERS Following is information about the executive officers and corporate officers of MPC:NameAge as of February 1, 2023Position with MPCMichael J. Hennigan63President and Chief Executive Officer Maryann T. Mannen60Executive Vice President and Chief Financial OfficerTimothy J. Aydt59Executive Vice President, RefiningSuzanne Gagle57General Counsel and Senior Vice President, Government AffairsFiona C. Laird*61Chief Human Resources Officer and Senior Vice President, CommunicationsC. Kristopher Hagedorn46Senior Vice President and ControllerDavid R. Heppner*56Senior Vice President, Strategy and Business DevelopmentRick D. Hessling*56Senior Vice President, Global FeedstocksBrian K. Partee*49Senior Vice President, Global Clean ProductsEhren D. Powell*43Senior Vice President and Chief Digital Officer James R. Wilkins*56Senior Vice President, Health, Environment, Safety and SecurityMolly R. Benson*56Vice President, Chief Securities, Governance & Compliance Officer and Corporate SecretaryKristina A. Kazarian*40Vice President, Finance and Investor RelationsKelly S. Niese*43Vice President, TreasuryGregory S. Floerke59MPLX Executive Vice President and Chief Operating OfficerShawn M. Lyon55MPLX Senior Vice President, Logistics & Storage* Corporate officer.Mr. Hennigan was appointed President and Chief Executive Officer effective March 2020, and as a member of the Board of Directors effective April 2020. He also has served as Chairman of the Board of MPLX since April 2020, as Chief Executive Officer since November 2019 and as President since June 2017. Before joining MPLX, Mr. Hennigan was President, Crude, NGL and Refined Products, of the general partner of Energy Transfer Partners L.P., an energy service provider. He was President and Chief Executive Officer of Sunoco Logistics Partners L.P., an oil and gas transportation, terminalling and storage company, from 2012 to 2017, President and Chief Operating Officer beginning in 2010, and Vice President, Business Development, beginning in 2009. Ms. Mannen was appointed Executive Vice President and Chief Financial Officer effective January 25, 2021 and as a member of MPLX’s Board of Directors effective February 1, 2021. Before joining MPC, she served as Executive Vice President and Chief Financial Officer of TechnipFMC (a successor to FMC Technologies, Inc.), a global leader in subsea, onshore/offshore, and surface projects for the energy industry, since 2017, having previously served as Executive Vice President and Chief Financial Officer of FMC Technologies, Inc. since 2014, Senior Vice President and Chief Financial Officer since 2011, and in various positions of increasing responsibility with FMC Technologies, Inc. since 1986. Mr. Aydt was appointed Executive Vice President, Refining, effective October 2022, having previously served as Executive Vice President and Chief Commercial Officer of MPLX since August 2020. Prior to his 2020 appointment, he served as Vice President, Business Development, beginning in November 2018, Vice President, Operations, and President of Marathon Pipe Line LLC beginning in January 2017, MPC’s Terminal, Transport and Rail General Manager beginning in 2013, and Project Director for the $2.2 billion Detroit Heavy Oil Upgrade Project beginning in 2008. Ms. Gagle was appointed General Counsel and Senior Vice President, Government Affairs, effective February 24, 2021. Prior to this appointment, she served as General Counsel beginning in March 2016, Assistant General Counsel, Litigation and Human Resources, beginning in 2011, Senior Group Counsel, Downstream Operations, beginning in 2010, and Group Counsel, Litigation, beginning in 2003.Ms. Laird was appointed Chief Human Resources Officer and Senior Vice President, Communications, effective February 24, 2021. Prior to this appointment, she served as Chief Human Resources Officer beginning in October 2018, having previously served as Chief Human Resources Officer at Andeavor beginning in February 2018. Before joining Andeavor, Ms. Laird was Chief Human Resources and Communications Officer for Newell Brands, a global consumer goods company, beginning in May 2016 and Executive Vice President, Human Resources, for Unilever, a global consumer goods company, beginning in 2011.15Table of ContentsMr. Hagedorn was appointed Senior Vice President and Controller effective September 2021. Prior to this appointment, he served as MPLX’s Vice President and Controller since October 2017. Before joining MPLX, he was Vice President and Controller at CONSOL Energy Inc., a Pennsylvania-based natural gas and coal producer and exporter, beginning in 2015, Assistant Controller beginning in 2014 and Director, Financial Accounting, beginning in 2012. Mr. Hagedorn was Chief Accounting Officer for CONE Midstream Partners LP, a publicly traded master limited partnership with gathering assets in the Appalachian Basin, from 2014 to 2015. Previously, he served in positions of increasing responsibility with PricewaterhouseCoopers LLP beginning in 1998.Mr. Heppner was appointed Senior Vice President, Strategy and Business Development, effective February 24, 2021. Prior to this appointment, he served as Vice President, Commercial and Business Development, beginning in October 2018, Senior Vice President of Engineering Services and Corporate Support of Speedway LLC beginning in 2014, and Director, Wholesale Marketing, beginning in 2010.Mr. Hessling was appointed Senior Vice President, Global Feedstocks, effective February 24, 2021. Prior to this appointment, he served as Senior Vice President, Crude Oil Supply and Logistics, beginning in October 2018, Manager, Crude Oil & Natural Gas Supply and Trading, beginning in 2014, and Crude Oil Logistics & Analysis Manager beginning in 2011.Mr. Partee was appointed Senior Vice President, Global Clean Products, effective February 24, 2021. Prior to this appointment, he served as Senior Vice President, Marketing, beginning in October 2018, Vice President, Business Development, beginning in February 2018, Director of Business Development beginning in January 2017, Manager of Crude Oil Logistics beginning in 2014, and Vice President, Business Development and Franchise, at Speedway beginning in 2012. Mr. Powell was appointed Senior Vice President and Chief Digital Officer effective July 20, 2020. Before joining MPC, he served as Vice President and Chief Information Officer (“CIO”) at GE Healthcare, a segment of General Electric Company (“GE”) that provides medical technologies and services, beginning in April 2018, having previously served as Senior Vice President and CIO, Services, of GE, a multinational conglomerate, since January 2017 and CIO, Power Services, with GE Power since 2014, and in various positions of increasing responsibility with GE and its subsidiaries since 2000.Mr. Wilkins was appointed Senior Vice President, Health, Environment, Safety and Security, effective February 24, 2021. Prior to this appointment, he served as Vice President, Environment, Safety and Security, beginning in October 2018, Director, Environment, Safety, Security and Product Quality, beginning in February 2016, and Director, Refining Environmental, Safety, Security and Process Safety Management, beginning in 2013.Ms. Benson was appointed Vice President, Chief Securities, Governance & Compliance Officer and Corporate Secretary effective June 2018, having previously served as Vice President, Chief Compliance Officer and Corporate Secretary since March 2016. Prior to her 2016 appointment, she served as Assistant General Counsel, Corporate and Finance, beginning in 2012, and Group Counsel, Corporate and Finance, beginning in 2011. Ms. Kazarian was appointed Vice President, Finance and Investor Relations, effective January 2023. Prior to this appointment, she served as Vice President, Investor Relations, beginning in April 2018. Before joining MPC, she was Managing Director and head of the MLP, Midstream and Refining Equity Research teams at Credit Suisse, a global investment bank and financial services company, beginning in September 2017. Previously, Ms. Kazarian was Managing Director of MLP, Midstream and Natural Gas Equity Research at Deutsche Bank, a global investment bank and financial services company, beginning in 2014, and an analyst specializing on various energy industry subsectors with Fidelity Management & Research Company, a privately held investment manager, beginning in 2005. Ms. Niese was appointed Vice President, Treasury, effective January 2023. Prior to this appointment, she served as Assistant Treasurer beginning in February 2017, Corporate Finance Manager beginning in October 2014, and Brand Coordinating Manager beginning in 2011, having previously served in various analytical roles within Crude Supply, Terminals, Transportation and Rail and Internal Audit since joining MPC in 2003.Mr. Floerke was appointed MPLX Executive Vice President and Chief Operating Officer effective August 2020. Prior to this appointment, he served as Executive Vice President, Gathering and Processing, beginning in 2018, Executive Vice President and Chief Operating Officer, MarkWest Operations, beginning in July 2017, and Executive Vice President and Chief Commercial Officer, MarkWest Assets, beginning in 2015, at the time of MPLX’s acquisition of MarkWest Energy Partners, L.P. Before joining us, Mr. Floerke was Executive Vice President and Chief Commercial Officer at MarkWest beginning in 2015, and Senior Vice President, Northeast region, at MarkWest beginning in 2013. Previously, Mr. Floerke held senior management positions at Access Midstream Partners, L.P. from 2011 until 2013.Mr. Lyon was appointed MPLX Senior Vice President, Logistics and Storage, effective September 2022, having previously served as Vice President, Operations, and President, Marathon Pipe Line LLC, since November 2018. Prior to his 2018 appointment, he was Vice President of Operations for Marathon Pipe Line LLC beginning in 2011. Previously, Mr. Lyon served in various roles of increasing responsibility with MPC since 1989, including as Manager, Marketing and Transportation Engineering beginning in 2010, and District Manager, Transport and Rail beginning in 2008. He serves as board chair for Liquid Energy Pipeline Association.16Table of ContentsAVAILABLE INFORMATIONGeneral information about MPC, including our Corporate Governance Principles, our Code of Business Conduct and our Code of Ethics for Senior Financial Officers, can be found at www.marathonpetroleum.com under the “Investors” tab by selecting “Corporate Governance.” We would post on our website any amendments to, or waivers from, either of our codes requiring disclosure under applicable rules within four business days following any such amendment or waiver. Charters for the Audit Committee, Compensation and Organization Development Committee, Corporate Governance and Nominating Committee and Sustainability and Public Policy Committee are also available at this site under the “About” tab by selecting “Board of Directors.”MPC uses its website, www.marathonpetroleum.com, as a channel for routine distribution of important information, including news releases, analyst presentations, financial information and market data. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as any amendments and exhibits to those reports, are available free of charge through our website as soon as reasonably practicable after the reports are filed or furnished with the SEC, or on the SEC’s website at www.sec.gov. These documents are also available in hard copy, free of charge, by contacting our Investor Relations office. In addition, our website allows investors and other interested persons to sign up to automatically receive email alerts when we post news releases and financial information on our website. Information contained on our website is not incorporated into this Annual Report on Form 10-K or other securities filings.Item 1A. Risk Factors You should carefully consider each of the following risks and all the other information contained in this Annual Report on Form 10-K in evaluating us and our common stock. Although the risks are organized by headings, and each risk is discussed separately, many are interrelated. Our business, financial condition, results of operations and cash flows could be materially and adversely affected by these risks, and, as a result, the trading price of our common stock could decline. We have in the past been adversely affected by certain of, and may in the future be affected by, these risks. You should not interpret the disclosure of any risk factor to imply that the risk has not already materialized.Business and Operational RisksOur financial results are affected by volatile refining margins, which are dependent on factors beyond our control.Our operating results, cash flows, future rate of growth, the carrying value of our assets and our ability to execute share repurchases and continue the payment of our base dividend are highly dependent on the margins we realize on our refined products. Historically, refining and marketing margins have been volatile, and we believe they will continue to be volatile. Our margins from the sale of gasoline and other refined products are influenced by a number of conditions, including the price of crude oil and other feedstocks. The prices of feedstocks and the prices at which we can sell our refined products fluctuate independently due to a variety of regional and global market factors that are beyond our control, including:•worldwide and domestic supplies of and demand for feedstocks and refined products; •transportation infrastructure cost and availability;•operation levels of other refineries in our markets;•the development by competitors of new refining or renewable conversion capacity;•natural gas and electricity supply costs; •political instability, threatened or actual terrorist incidents, armed conflict or other global political or economic conditions; •local weather conditions; and•the occurrence of other risks described herein. Some of these factors can vary by region and may change quickly, adding to market volatility, while others may have longer-term effects. The longer-term effects of these and other factors on refining and marketing margins are uncertain. We generally purchase our feedstocks weeks before we refine them and sell the refined products. Price level changes during the period between purchasing feedstocks and selling the refined products from these feedstocks can have a significant effect on our financial results. We also purchase refined products manufactured by others for resale to our customers. Price changes during the periods between purchasing and reselling those refined products can have a material and adverse effect on our business, financial condition, results of operations and cash flows.Lower refining and marketing margins have in the past, and may in the future, lead us to reduce the amount of refined products we produce, which may reduce our revenues, income from operations and cash flows. Significant reductions in refining and marketing margins could require us to reduce our capital expenditures, impair the carrying value of our assets (such as property, plant and equipment, inventory or goodwill), and require us to re-evaluate practices regarding our repurchase activity and dividends.17Table of ContentsLegal, technological, political and scientific developments regarding emissions, fuel efficiency and alternative fuel vehicles may decrease demand for petroleum-based transportation fuels. Developments aimed at reducing vehicle emissions, increasing vehicle efficiency or reducing the sale of new petroleum-fueled vehicles may decrease the demand and may increase the cost for our transportation fuels. At the direction of President Biden in his Executive Order setting a goal that 50 percent of all new passenger cars and light trucks sold in 2030 be zero emission vehicles, EPA and NHTSA have promulgated separate rules setting more stringent requirements for reductions through model year 2026. NHTSA’s amended CAFE standards increase in stringency from model year 2023 levels by eight percent annually for model years 2024-2025 and ten percent annually for model year 2026. EPA’s revised model year 2023-2026 CO2 emission standards, which were finalized in December 2021, result in average fuel economy of 40 mpg in model year 2026. Other jurisdictions have issued or considered issuing similar mandates, and we expect this trend will continue. Moreover, consumer acceptance and market penetration of electric, hybrid and alternative fuel vehicles continues to increase. In 2021, several automobile manufacturers jointly announced their shared goal that 40-50% of their new vehicle sales be battery electric, fuel cell or plug-in hybrid vehicles by 2030. Other automobile manufacturers have similar, or more aggressive, goals with respect to vehicle electrification. Technological breakthroughs relating to renewable fuels or other fuel alternatives such as hydrogen or ammonia, or efficiency improvements for internal combustion engines could reduce demand for petroleum-based transportation fuels.Together, these trends and developments have had and are expected to continue to have an adverse effect on sales of our petroleum-based transportation fuels, which in turn could have a material and adverse effect on our business, financial condition, results of operations and cash flows.Our operations are subject to business interruptions and casualty losses.Our operations are subject to business interruptions, such as scheduled and unscheduled refinery turnarounds, unplanned maintenance, explosions, fires, refinery or pipeline releases, product quality incidents, power outages, severe weather, labor disputes, acts of terrorism, or other natural or man-made disasters. These types of incidents adversely affect our operations and may result in serious personal injury or loss of human life, significant damage to property and equipment, impaired ability to manufacture our products, environmental pollution, and substantial losses. We have experienced certain of these incidents in the past. For assets located near populated areas, the level of damage resulting from such an incident could be greater. In addition, we operate in and adjacent to environmentally sensitive waters where tanker, pipeline, rail car and refined product transportation and storage operations are closely regulated by federal, state and local agencies and monitored by environmental interest groups. Certain of our refineries receive crude oil and other feedstocks by tanker or barge. MPLX operates a fleet of boats and barges to transport light products, heavy oils, crude oil, renewable fuels, chemicals and feedstocks to and from refineries and terminals owned by MPC. Transportation and storage of crude oil, other feedstocks and refined products over and adjacent to water involves inherent risk and subjects us to the provisions of the OPA-90 and state laws in U.S. coastal and Great Lakes states and states bordering inland waterways on which we operate, as well as international laws in the jurisdictions in which we operate. If we are unable to promptly and adequately contain any accident or discharge involving tankers, pipelines, rail cars or above ground storage tanks transporting or storing crude oil, other feedstocks or refined products, we may be subject to substantial liability. In addition, the service providers contracted to aid us in a discharge response may be unavailable due to weather conditions, governmental regulations or other local or global events. Damages resulting from an incident involving any of our assets or operations may result in our being named as a defendant in one or more lawsuits asserting potentially substantial claims or in our being assessed potentially substantial fines by governmental authorities.We are increasingly dependent on the performance of our information technology systems and those of our third-party business partners and service providers.We are increasingly dependent on our information technology systems and those of our third-party business partners and service providers for the safe and effective operation of our business. We rely on such systems to process, transmit and store electronic information, including financial records and personally identifiable information such as employee, customer and investor data, and to manage or support a variety of business processes, including our supply chain, pipeline operations, gathering and processing operations, credit card payments and authorizations at certain of our customers’ retail outlets, financial transactions, banking and numerous other processes and transactions. Our systems (and those of our third-party business partners and service providers) are subject to numerous and evolving cybersecurity threats and attacks, including ransomware and other malware, and phishing and social engineering schemes, which can compromise our ability to operate, and the confidentiality, availability, and integrity of data in our systems or those of our third-party business partners and service providers. These and other cybersecurity threats may originate with criminal attackers, state-sponsored actors or employee error or malfeasance. Because the techniques used to obtain unauthorized access, or to disable or degrade systems continuously evolve and have become increasingly complex and sophisticated, and can remain undetected for a period of time despite efforts to detect and respond in a timely manner, we (and our third-party business partners and service providers) are subject to the risk of cyberattacks.18Table of ContentsOur cybersecurity and infrastructure protection technologies, disaster recovery plans and systems, employee training and vendor risk management may not be sufficient to defend us against all unauthorized attempts to access our information or impact our systems. We and our third-party vendors and service providers have been and may in the future be subject to cybersecurity events of varying degrees. To date, the impacts of prior events have not had a material adverse effect on us.Cybersecurity events involving our information technology systems or those of our third-party business partners and service providers can result in theft, destruction, loss, misappropriation or release of confidential financial data, regulated personally identifiable information, intellectual property and other information; give rise to remediation or other expenses; result in litigation, claims and increased regulatory review or scrutiny; reduce our customers’ willingness to do business with us; disrupt our operations and the services we provide to customers; and subject us to litigation and legal liability under international, U.S. federal and state laws. Any of such results could have a material adverse effect on our reputation, business, financial condition, results of operations and cash flows.The availability and cost of renewable identification numbers could have an adverse effect on our financial condition and results of operations.Pursuant to the Energy Policy Act of 2005 and the EISA, Congress established a Renewable Fuel Standard (“RFS”) program that requires annual volumes of renewable fuel be blended into domestic transportation fuel. A RIN is assigned to each gallon of renewable fuel produced in, or imported into, the United States. As a producer of petroleum-based motor fuels, we are obligated to blend renewable fuels into the products we produce at a rate that is at least commensurate to EPA’s quota and, to the extent we do not, we must purchase RINs in the open market to satisfy our obligation under the RFS program. We are exposed to the volatility in the market price of RINs. We cannot predict the future prices of RINs. RINs prices are dependent upon a variety of factors, including EPA regulations, the availability of RINs for purchase, and levels of transportation fuels produced, which can vary significantly from quarter to quarter. There is currently no regulatory method for verifying the validity of most RINs sold on the open market. We have developed a RIN integrity program to vet the RINs that we purchase, and we incur costs to audit RIN generators. Nevertheless, if any of the RINs that we purchase and use for compliance are found to be invalid, we could incur costs and penalties for replacing the invalid RINs. See Item 1. Business – Regulatory Matters for additional information on these and other regulatory compliance matters. Competitors that produce their own supply of feedstocks, own their own retail sites, or have greater financial resources may have a competitive advantage.The refining and marketing industry is highly competitive with respect to both feedstock supply and refined petroleum products. We compete with many companies for available supplies of crude oil and other feedstocks, and we do not produce any of our crude oil feedstocks. Our competitors include multinational, integrated major oil companies that can obtain a significant portion of their feedstocks from company-owned production. Competitors that produce crude oil are at times better positioned to withstand periods of depressed refining margins or feedstock shortages. We also compete with other companies for customers for our refined petroleum products. The independent entrepreneurs who operate primarily Marathon-branded outlets and the direct dealer locations we supply compete with other convenience store chains, outlets owned or operated by integrated major oil companies or their dealers or jobbers, and other well-recognized national or regional retail outlets, often selling transportation fuels and merchandise at very competitive prices. Non-traditional transportation fuel retailers, such as supermarkets, club stores and mass merchants, may be better able to withstand volatile market conditions or levels of low or no profitability in the retail segment of the market. The loss of market share by those who operate our branded outlets and the direct dealer locations we supply could adversely affect our business, financial condition, results of operations and cash flows.The COVID-19 pandemic has had, and may continue to have, a material and adverse effect on our and our customers’ business and on general economic, financial and business conditions. The COVID-19 pandemic and existing COVID-19 mitigation measures have had adverse effects on global travel and economic activity and, consequently, demand for the petroleum products that we manufacture, sell, transport and store. While demand for the petroleum products that we manufacture, sell, transport and store witnessed a substantial recovery in 2022, significant uncertainty remains as to the extent to which further resurgences in the virus, the emergence of new variants and waning vaccine effectiveness may spur future actions by individuals, governments and the private sector to stem the spread of the virus. The extent to which the COVID-19 pandemic continues to impact global economic conditions, our business and the business of our customers, suppliers and other counterparties, will depend largely on future developments that remain uncertain and cannot be predicted, such as the length and severity of the pandemic; the social, economic and epidemiological effects of COVID-19 mitigation measures; the extent to which individuals acquire and retain immunity; emerging virus variants and how those new variants of the disease affect the human body; the stress on access to materials, supplies and contract labor; and general economic conditions. Additionally, the continuation of the pandemic could precipitate or aggravate the other risks identified in this Form 10-K, which in turn could further materially and adversely affect our business, financial condition and results of operations, including in ways not currently known or considered by us to present significant risks.19Table of ContentsWe may be negatively impacted by inflation.Increases in inflation may have an adverse effect on us. Current and future inflationary effects may be driven by, among other things, supply chain disruptions and governmental stimulus or fiscal policies. Continuing increases in inflation could impact the commodity markets generally, the overall demand for our products and services, our costs for labor, material and services and the margins we are able to realize on our products, all of which could have an adverse impact on our business, financial position, results of operations and cash flows. Inflation may also result in higher interest rates, which in turn would result in higher interest expense related to our variable rate indebtedness and any borrowings we undertake to refinance existing fixed rate indebtedness.We are subject to interruptions of supply and increased costs as a result of our reliance on third-party transportation of crude oil and refined products.We utilize the services of third parties to transport crude oil and refined products to and from our refineries. In addition to our own operational risks, we could experience interruptions of supply or increases in costs to deliver refined products to market if the ability of the pipelines, railways or vessels to transport crude oil or refined products is disrupted or limited because of weather events, accidents, labor disputes, governmental regulations or third-party actions. In particular, pipelines or railroads provide a nearly exclusive form of transportation of crude oil to, or refined products from, some of our refineries. A prolonged interruption, material reduction or cessation of service of such a pipeline or railway, whether due to private party or governmental action or other reason, or any other prolonged disruption of the ability of the trucks, pipelines, railways or vessels to transport crude oil or refined products to or from one or more of our refineries, can adversely affect us. A significant decrease in oil and natural gas production in MPLX’s areas of operation may adversely affect MPLX’s business, financial condition, results of operations and cash available for distribution to its unitholders, including MPC.A significant portion of MPLX’s operations is dependent on the continued availability of natural gas and crude oil production. The production from oil and natural gas reserves and wells owned by its producer customers will naturally decline over time, which means that MPLX’s cash flows associated with these wells will also decline over time. To maintain or increase throughput levels and the utilization rate of MPLX’s facilities, MPLX must continually obtain new oil, natural gas, NGL and refined product supplies, which depend in part on the level of successful drilling activity near its facilities, its ability to compete for volumes from successful new wells and its ability to expand its system capacity as needed.We have no control over the level of drilling activity in the areas of MPLX’s operations, the amount of reserves associated with the wells or the rate at which production from a well will decline. In addition, we have no control over producers or their production decisions, which are affected by demand, prevailing and projected energy prices, drilling costs, operational challenges, access to downstream markets, the level of reserves, geological considerations, governmental regulations and the availability and cost of capital. Reductions in exploration or production activity in MPLX’s areas of operations could lead to reduced throughput on its pipelines and utilization rates of its facilities.Decreases in energy prices can lead to decreases in drilling activity, production rates and investments by third parties in the development of new oil and natural gas reserves. The prices for oil, natural gas and NGLs depend upon factors beyond our control, including global and local demand, production levels, changes in interstate pipeline gas quality specifications, imports and exports, seasonality and weather conditions, economic and political conditions domestically and internationally and governmental regulations. Sustained periods of low prices can result in producers deciding to limit their oil and gas drilling operations, which can substantially delay the production and delivery of volumes of oil, natural gas and NGLs to MPLX’s facilities and adversely affect their revenues and cash available for distribution to us. This impact may also be exacerbated due to the extent of MPLX’s commodity-based contracts, which are more directly impacted by changes in natural gas and NGL prices than its fee-based contracts due to frac spread exposure and may result in operating losses when natural gas becomes more expensive on a Btu equivalent basis than NGL products. In addition, the purchase and resale of natural gas and NGLs in the ordinary course exposes our Midstream operations to volatility in natural gas or NGL prices due to the potential difference in the time of the purchases and sales and the potential difference in the price associated with each transaction, and direct exposure may also occur naturally as a result of production processes. Also, the significant volatility in natural gas, NGL and oil prices could adversely impact MPLX’s unit price, thereby increasing its distribution yield and cost of capital. Such impacts could adversely impact MPLX’s ability to execute its long‑term organic growth projects, satisfy obligations to its customers and make distributions to unitholders at intended levels, and may also result in non-cash impairments of long-lived assets or goodwill or other-than-temporary non-cash impairments of our equity method investments.Severe weather events, other climate conditions and earth movement and other geological hazards may adversely affect our assets and ongoing operations.Our assets are subject to acute physical risks, such as floods, hurricane-force winds, wildfires, winter storms, and earth movement in variable, steep and rugged terrain and terrain with varied or changing subsurface conditions, and chronic physical risks, such as sea-level rise or water shortages. For example, in 2021, our Galveston Bay refinery was adversely affected by Winter Storm Uri and our Garyville refinery was adversely affected by Hurricane Ida. The occurrence of these and similar events have had, and may in the future have, an adverse effect on our assets and operations. We have incurred and will continue to incur additional costs to protect our assets and operations from such physical risks and employ the evolving technologies and 20Table of Contentsprocesses available to mitigate such risks. To the extent such severe weather events or other climate conditions increase in frequency and severity, we may be required to modify operations and incur costs that could materially and adversely affect our business, financial condition, results of operations and cash flows.We are subject to risks arising from our operations outside the United States and generally to worldwide political and economic developments.We operate and sell some of our products outside the United States. Our business, financial condition, results of operations and cash flows could be negatively impacted by disruptions in any of these markets, including economic instability, restrictions on the transfer of funds, supply chain disruptions, duties and tariffs, transportation delays, difficulty in enforcing contractual provisions, import and export controls, changes in governmental policies, political and social unrest, security issues involving key personnel and changing regulatory and political environments. Future outbreaks of infectious diseases or pandemics could affect demand for refined products and economic conditions generally, as the COVID-19 pandemic has done in recent years. In addition, the deterioration of trade relationships, modification or termination of existing trade agreements, imposition of new economic sanctions against Russia or other countries and the effects of potential responsive countermeasures, or increased taxes, border adjustments or tariffs can make international business operations more costly, which can have a material adverse effect on our business, financial condition, results of operations and cash flows.We are required to comply with U.S. and international laws and regulations, including those involving anti-bribery, anti-corruption and anti-money laundering. Our training and compliance program and our internal control policies and procedures may not always protect us from violations committed by our employees or agents. Actual or alleged violations of these laws could disrupt our business and cause us to incur significant legal expenses, and could result in a material adverse effect on our reputation, business, financial condition, results of operations and cash flows.More broadly, political and economic factors in global markets could impact crude oil and other feedstock supplies and could have a material adverse effect on us in other ways. Hostilities in the Middle East, Russia or elsewhere or the occurrence or threat of future terrorist attacks could adversely affect the economies of the U.S. and other countries. Lower levels of economic activity often result in a decline in energy consumption, which may cause our revenues and margins to decline and limit our future growth prospects. These risks could lead to increased volatility in prices for refined products, NGLs and natural gas. Additionally, these risks could increase instability in the financial and insurance markets and make it more difficult or costly for us to access capital and to obtain the insurance coverage that we consider adequate. Additionally, tax policy, legislative or regulatory action and commercial restrictions could reduce our operating profitability. For example, the U.S. government could prevent or restrict exports of refined products, NGLs, natural gas or the conduct of business in or with certain foreign countries. In addition, foreign countries could restrict imports, investments or commercial transactions or revoke or refuse to grant necessary permits.Our investments in joint ventures could be adversely affected by our reliance on our joint venture partners and their financial condition, and our joint venture partners may have interests or goals that are inconsistent with ours.We conduct some of our operations through joint ventures in which we share control over certain economic and business interests with our joint venture partners. Our joint venture partners may have economic, business or legal interests or goals that are inconsistent with our goals and interests or may be unable to meet their obligations. Failure by us, or an entity in which we have an interest, to adequately manage the risks associated with any acquisitions or joint ventures could have a material adverse effect on the financial condition or results of operations of our joint ventures and adversely affect our reputation, business, financial condition, results of operations and cash flows.Terrorist attacks or other targeted operational disruptions may affect our facilities or those of our customers and suppliers. Refining, gathering and processing, pipeline and terminal infrastructure, and other energy assets, may be the subject of terrorist attacks or other targeted operational disruptions. Any attack or targeted disruption of our operations, those of our customers or, in some cases, those of other energy industry participants, could have a material and adverse effect on our business. Similarly, any similar event that severely disrupts the markets we serve could materially and adversely affect our results of operations, financial position and cash flows.Financial RisksWe have significant debt obligations; therefore, our business, financial condition, results of operations and cash flows could be harmed by a deterioration of our credit profile or downgrade of our credit ratings, a decrease in debt capacity or unsecured commercial credit available to us, or by factors adversely affecting credit markets generally.At December 31, 2022, our total debt obligations for borrowed money and finance lease obligations were $27.08 billion, including $20.11 billion of obligations of MPLX and its subsidiaries. We may incur substantial additional debt obligations in the future.Our indebtedness may impose various restrictions and covenants on us that could have material adverse consequences, including:•increasing our vulnerability to changing economic, regulatory and industry conditions; •limiting our ability to compete and our flexibility in planning for, or reacting to, changes in our business and the industry; 21Table of Contents•limiting our ability to pay dividends to our stockholders; •limiting our ability to borrow additional funds; and •requiring us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing funds available for working capital, capital expenditures, acquisitions, share repurchases, dividends and other purposes. A decrease in our debt or commercial credit capacity, including unsecured credit extended by third-party suppliers, or a deterioration in our credit profile could increase our costs of borrowing money and limit our access to the capital markets and commercial credit. Our credit rating is determined by independent credit rating agencies. We cannot provide assurance that any of our credit ratings will remain in effect for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances so warrant. Any changes in our credit capacity or credit profile could materially and adversely affect our business, financial condition, results of operations and cash flows.Significant variations in the market prices of crude oil and refined products can affect our financial performance.During 2020, there were significant variations in the market prices of products held in our inventories. Those significant variations required us to record either inventory valuation charges or benefits to reflect the valuation of our inventories at the lower of cost or market. Future inventory valuation adjustments could have a negative or positive effect on our financial performance. In addition, a sustained period of low crude oil prices may also result in significant financial constraints on certain producers from which we acquire our crude oil, which could result in long term crude oil supply constraints for our business. Such conditions could also result in an increased risk that our customers and other counterparties may be unable to fully fulfill their obligations in a timely manner, or at all. A continued period of economic slowdown or recession, or a protracted period of depressed prices for crude oil or refined petroleum products, could have significant and adverse consequences for our financial condition and the financial condition of our customers, suppliers and other counterparties, and could diminish our liquidity, trigger additional impairments and negatively affect our ability to obtain adequate crude oil volumes and to market certain of our products at favorable prices, or at all.Our working capital, cash flows and liquidity can be significantly affected by decreases in commodity prices.Payment terms for our crude oil purchases are generally longer than the terms we extend to our customers for refined product sales. As a result, the payables for our crude oil purchases are proportionally larger than the receivables for our refined product sales. Due to this net payables position, a decrease in commodity prices generally results in a use of working capital, and given the significant volume of crude oil that we purchase the impact can materially affect our working capital, cash flows and liquidity. Increases in interest rates could adversely impact our share price, our ability to issue equity or incur debt for acquisitions or other purposes and our ability to make dividends at our intended levels.Our revolving credit facility has a variable interest rate. As a result, future interest rates on our debt could be higher than current levels, causing our financing costs to increase accordingly. In addition, we may in the future refinance outstanding borrowings under our revolving credit facility with fixed-rate indebtedness. Interest rates payable on fixed-rate indebtedness typically are higher than the short-term variable interest rates that we pay on borrowings under our revolving credit facility. We also have other fixed-rate indebtedness that we may need or desire to refinance in the future at or prior to the applicable stated maturity. A rising interest rate environment could have an adverse impact on our share price and our ability to issue equity or incur debt for acquisitions or other purposes and to make dividends at our intended levels.We may incur losses and additional costs as a result of our forward-contract activities and derivative transactions. We currently use commodity derivative instruments, and we expect to continue their use in the future. If the instruments we use to hedge our exposure to various types of risk are not effective, we may incur losses. Derivative transactions involve the risk that counterparties may be unable to satisfy their obligations to us. The risk of counterparty default is heightened in a poor economic environment. In addition, we may be required to incur additional costs in connection with future regulation of derivative instruments to the extent it is applicable to us.We do not insure against all potential losses, and, therefore, our business, financial condition, results of operations and cash flows could be adversely affected by unexpected liabilities and increased costs.We maintain insurance coverage in amounts we believe to be prudent against many, but not all, potential liabilities arising from operating hazards. Uninsured liabilities arising from operating hazards such as explosions, fires, refinery or pipeline releases, cybersecurity breaches or other incidents involving our assets or operations can reduce the funds available to us for capital and investment spending and could have a material adverse effect on our business, financial condition, results of operations and cash flows. Historically, we also have maintained insurance coverage for physical damage and resulting business interruption to our major facilities, with significant self-insured retentions. In the future, we may not be able to maintain insurance of the types and amounts we desire at reasonable rates.22Table of ContentsWe have recorded goodwill and other intangible assets that could become further impaired and result in material non-cash charges to our results of operations. We accounted for the Andeavor and other acquisitions using the acquisition method of accounting, which requires that the assets and liabilities of the acquired business be recorded to our balance sheet at their respective fair values as of the acquisition date. Any excess of the purchase consideration over the fair value of the acquired net assets is recognized as goodwill.As of December 31, 2022, our balance sheet reflected $8.2 billion and $1.9 billion of goodwill and other intangible assets, respectively. We have in the past recorded significant impairments of our goodwill. To the extent the value of goodwill or intangible assets becomes further impaired, we may be required to incur additional material non-cash charges relating to such impairment. Our operating results may be significantly impacted from both the impairment and the underlying trends in the business that triggered the impairment.Large capital projects can be subject to delays, take years to complete, and market conditions could deteriorate significantly between the project approval date and the project startup date, negatively impacting project returns. We have several large capital projects underway, including the activities associated with the conversion of the Martinez refinery to a renewable diesel facility. Delays in completing capital projects or making required changes or upgrades to our facilities could subject us to fines or penalties as well as affect our ability to supply certain products we produce. Such delays or cost increases may arise as a result of unpredictable factors, many of which are beyond our control, including:•denials of, delays in receiving, or revocations of requisite regulatory approvals or permits;•unplanned increases in the cost of construction materials or labor, whether due to inflation or other factors;•disruptions in transportation of components or construction materials;•adverse weather conditions, natural disasters or other events (such as equipment malfunctions, explosions, fires or spills) affecting our facilities, or those of vendors or suppliers;•shortages of sufficiently skilled labor, or labor disagreements resulting in unplanned work stoppages;•market-related increases in a project’s debt or equity financing costs; •global supply chain disruptions;•nonperformance by, or disputes with, vendors, suppliers, contractors or subcontractors; and•delays due to citizen, state or local political or activist pressure.Moreover, our revenues may not increase immediately upon the expenditure of funds on a particular project. For instance, if we build a new pipeline, the construction will occur over an extended period of time and we may not receive any material increases in revenues until after completion of the project, if at all. Any one or more of these factors could have a significant impact on our ongoing capital projects. If we were unable to make up the delays associated with such factors or to recover the related costs, or if market conditions change, it could materially and adversely affect our capital project returns and our business, financial condition, results of operations and cash flows.Legal and Regulatory RisksWe expect to continue to incur substantial capital expenditures and operating costs to meet the requirements of evolving environmental or other laws or regulations. Future environmental laws and regulations may impact our current business plans and reduce demand for our products and services.Our business is subject to numerous environmental laws and regulations. These laws and regulations continue to increase in both number and complexity and affect our business. Laws and regulations expected to become more stringent relate to the following:•the emission or discharge of materials into the environment,•solid and hazardous waste management,•the regulatory classification of materials currently or formerly used in our business,•pollution prevention,•climate change and GHG emissions,•characteristics and composition of transportation fuels, including the quantity of renewable fuels that must be blended into transportation fuels,•public and employee safety and health, •permitting,•inherently safer technology, and•facility security.23Table of ContentsThe specific impact of laws and regulations on us and our competitors may vary depending on a number of factors, including the age and location of operating facilities, marketing areas, crude oil and feedstock sources, production processes and subsequent judicial interpretation of such laws and regulations. We have incurred and will continue to incur substantial capital, operating and maintenance, and remediation expenditures to modify operations, install pollution control equipment, perform site cleanups or curtail operations. We have incurred and may in the future incur liability for personal injury, property damage, natural resource damage or clean-up costs due to alleged contamination and/or exposure to chemicals such as benzene and MTBE. There is also increased regulatory interest in per- and polyfluoroalkyl substances (“PFAS”), which we expect will lead to increased monitoring and remediation obligations and potential liability related thereto. Such expenditures could materially and adversely affect our business, financial condition, results of operations and cash flows.Increased regulation of hydraulic fracturing and other oil and gas production activities could result in reductions or delays in U.S. production of crude oil and natural gas, which could adversely affect our results of operations and financial condition.While we do not conduct hydraulic fracturing operations, we do provide gathering, processing and fractionation services with respect to natural gas and natural gas liquids produced by our customers as a result of such operations. Our refineries are also supplied in part with crude oil produced from unconventional oil shale reservoirs. A range of federal, state and local laws and regulations currently govern or, in some cases, prohibit, hydraulic fracturing in some jurisdictions. Stricter laws, regulations and permitting processes may be enacted in the future. If federal, state and local legislation and regulatory initiatives relating to hydraulic fracturing or other oil and gas production activities are enacted or expanded, such efforts could impede oil and gas production, increase producers’ cost of compliance, and result in reduced volumes available for our midstream assets to gather, process and fractionate.The tax treatment of publicly traded partnerships or an investment in MPLX units could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.The present U.S. federal income tax treatment of publicly traded partnerships, including MPLX, or an investment in MPLX common units may be modified by administrative, legislative or judicial interpretation at any time. From time to time, the President and members of the U.S. Congress propose and consider substantive changes to the existing U.S. federal income tax laws that would affect publicly traded partnerships, including proposals that would eliminate MPLX’s ability to qualify for partnership tax treatment. We are unable to predict whether any such changes will ultimately be enacted. Any modification to the U.S. federal income tax laws and interpretations thereof may or may not be applied retroactively and could make it more difficult or impossible for MPLX to meet the exception for certain publicly traded partnerships to be treated as partnerships for U.S. federal income tax purposes or increase the amount of taxes payable by unitholders in publicly traded partnerships.Climate change and GHG emission regulation could affect our operations, energy consumption patterns and regulatory obligations, any of which could affect our results of operations and financial condition.Currently, multiple legislative and regulatory measures to address GHG (including carbon dioxide, methane and nitrous oxides) and other emissions are in various phases of consideration, promulgation or implementation. These include actions to develop international, federal, regional or statewide programs, which could require reductions in our GHG or other emissions, establish a carbon tax and decrease the demand for refined products. Requiring reductions in these emissions could result in increased costs to (i) operate and maintain our facilities, (ii) install new emission controls at our facilities and (iii) administer and manage any emissions programs, including acquiring emission credits or allotments.For example, California and Washington have enacted cap-and-trade programs. Other states are proposing, or have already promulgated, low carbon fuel standards or similar initiatives to reduce emissions from the transportation sector. If we are unable to pass the costs of compliance on to our customers, sufficient credits are unavailable for purchase, we have to pay a significantly higher price for credits, or if we are otherwise unable to meet our compliance obligation, our financial condition and results of operations could be adversely affected.Certain municipalities have also proposed or enacted restrictions on the installation of natural gas appliances and infrastructure in new residential or commercial construction, which could affect demand for the natural gas that MPLX transports and stores.Regional and state climate change and air emissions goals and regulatory programs are complex, subject to change and considerable uncertainty due to a number of factors including technological feasibility, legal challenges and potential changes in federal policy. Increasing concerns about climate change and carbon intensity have also resulted in societal concerns and a number of international and national measures to limit GHG emissions. Additional stricter measures and investor pressure can be expected in the future and any of these changes may have a material adverse impact on our business or financial condition.International climate change-related efforts, such as the 2015 United Nations Conference on Climate Change, which led to the creation of the Paris Agreement, may impact the regulatory framework of states whose policies directly influence our present and future operations. Though the United States had withdrawn from the Paris Agreement, President Biden issued an executive order recommitting the United States to the Paris Agreement on January 20, 2021. President Biden also issued an Executive Order on climate change in which he announced putting the U.S. on a path to achieve net-zero carbon emissions, economy-wide, by 2050. The Executive Order also calls for the federal government to pause oil and gas leasing on federal lands, reduce methane 24Table of Contentsemissions from the oil and gas sector as quickly as possible, and requires federal permitting decisions to consider the effects of GHG emissions and climate change. In a second Executive Order, President Biden reestablished a working group to develop the social cost of carbon and the social cost of methane. The social cost of carbon and social cost of methane can be used to weigh the costs and benefits of proposed regulations. A higher social cost of carbon could support more stringent GHG emission regulation.The scope and magnitude of the changes to U.S. climate change strategy under the Biden administration and future administrations, however, remain subject to the passage of legislation and interpretation and action of federal and state regulatory bodies; therefore, the impact to our industry and operations due to GHG regulation is unknown at this time.Energy companies are subject to increasing environmental and climate-related litigation.Governmental and other entities in various U.S. states have filed lawsuits against various energy companies, including us. The lawsuits allege damages as a result of climate change and the plaintiffs are seeking unspecified damages and abatement under various tort theories. Similar lawsuits may be filed in other jurisdictions. Additionally, private plaintiffs and government parties have undertaken efforts to shut down energy assets by challenging operating permits, the validity of easements or the compliance with easement conditions. For example, the Dakota Access Pipeline, in which MPLX has a minority interest, has been subject to, and may in the future be subject to, litigation seeking a permanent shutdown of the pipeline. There remains a high degree of uncertainty regarding the ultimate outcome of these types of proceedings, as well as their potential effect on our business, financial condition, results of operation and cash flows.We are subject to risks associated with societal and political pressures and other forms of opposition to the development, transportation and use of carbon-based fuels. Such risks could adversely impact our business and ability to realize certain growth strategies.We operate and develop our business with the expectation that regulations and societal sentiment will continue to enable the development, transportation and use of carbon-based fuels. However, policy decisions relating to the production, refining, transportation, storage and marketing of carbon-based fuels are subject to political pressures and the influence of public sentiment on GHG emissions, climate change, and climate adaptation. Additionally, societal sentiment regarding carbon-based fuels may adversely impact our reputation and ability to attract and retain employees.The approval process for storage and transportation projects has become increasingly challenging, due in part to state and local concerns related to pipelines, negative public perception regarding the oil and gas industry, and concerns regarding GHG emissions downstream of pipeline operations. Our expansion or construction projects may not be completed on schedule (or at all), or at the budgeted cost. We also may be required to incur additional costs and expenses in connection with the design and installation of our facilities due to their location and the surrounding terrain. We may be required to install additional facilities, incur additional capital and operating expenditures, or experience interruptions in or impairments of our operations to the extent that the facilities are not designed or installed correctly. Increasing attention to environmental, social and governance matters may impact our business and financial results.In recent years, increasing attention has been given to corporate activities related to ESG matters in public discourse and the investment community. A number of advocacy groups, both domestically and internationally, have campaigned for governmental and private action to promote ESG-related change at public companies, including, but not limited to, through the investment and voting practices of investment advisers, pension funds, universities and other members of the investing community. These activities include increasing attention and demands for action related to climate change and energy transition matters, such as promoting the use of substitutes to fossil fuel products and encouraging the divestment of fossil fuel equities, as well as pressuring lenders and other financial services companies to limit or curtail activities with fossil fuel companies. If this were to continue, it could have a material adverse effect on our access to capital. Members of the investment community have begun to screen companies such as ours for sustainability performance, including practices related to GHG emission reduction and energy transition strategies. If we are unable to find economically viable, as well as publicly acceptable, solutions that reduce our GHG emissions, reduce GHG intensity for new and existing projects, increase our non-fossil fuel product portfolio, and/or address other ESG-related stakeholder concerns, our business and results of operations could be materially and adversely affected.Our goals, targets and disclosures related to ESG matters expose us to numerous risks, including risks to our reputation and stock price. Companies across all industries are facing increasing scrutiny from stakeholders related to ESG matters, including practices and disclosures regarding climate-related initiatives. In 2022, MPC established a target to reduce GHG emissions and MPLX established a target to reduce methane emissions intensity. These targets reflect our current plans and aspirations and are not guarantees that we will be able to achieve them. Our efforts to accomplish and accurately report on these goals and objectives, which may be, in part, dependent on the actions of suppliers and other third parties, present numerous operational, regulatory, reputational, financial, legal, and other risks, any of which could have a material negative impact, including on our reputation and stock price.Efforts to achieve goals and targets, such as the foregoing and future internal climate-related initiatives, may increase costs, require purchase of carbon credits, or limit or impact our business plans and financial results, potentially resulting in the reduction 25Table of Contentsto the economic end-of-life of certain assets and an impairment of the associated net book value, among other material adverse impacts. Additionally, as the nature, scope and complexity of ESG reporting, calculation methodologies, voluntary reporting standards and disclosure requirements expand, including the SEC’s proposed disclosure requirements regarding, among other matters, GHG emissions, we may have to undertake additional costs to control, assess and report on ESG metrics. Our failure or perceived failure to pursue or fulfill such goals and targets or to satisfy various reporting standards within the timelines we announce, or at all, could have a negative impact on investor sentiment, ratings outcomes for evaluating our approach to ESG matters, stock price, and cost of capital and expose us to government enforcement actions and private litigation, among other material adverse impacts.Regulatory and other requirements concerning the transportation of crude oil and other commodities by rail may cause increases in transportation costs or limit the amount of crude oil that we can transport by rail.We rely on a variety of systems to transport crude oil, including rail. Rail transportation is regulated by federal, state and local authorities. New regulations or changes in existing regulations could result in increased compliance expenditures. For example, in 2015, the U.S. Department of Transportation issued new standards and regulations applicable to crude-by-rail transportation (Enhanced Tank Car Standards and Operational Controls for High-Hazard Flammable Trains). These or other regulations that require the reduction of volatile or flammable constituents in crude oil that is transported by rail, change the design or standards for rail cars used to transport the crude oil we purchase, change the routing or scheduling of trains carrying crude oil, or require any other changes that detrimentally affect the economics of delivering North American crude oil by rail could increase the time required to move crude oil from production areas to our refineries, increase the cost of rail transportation and decrease the efficiency of shipments of crude oil by rail within our operations. Any of these outcomes could have a material adverse effect on our business and results of operations.Historic or current operations could subject us to significant legal liability or restrict our ability to operate.We currently are defending litigation and anticipate we will be required to defend new litigation in the future. Our operations, including those of MPLX, and those of our predecessors could expose us to litigation and civil claims by private plaintiffs for alleged damages related to contamination of the environment or personal injuries caused by releases of hazardous substances from our facilities, products liability, consumer credit or privacy laws, product pricing or antitrust laws or any other laws or regulations that apply to our operations. While an adverse outcome in most litigation matters would not be expected to be material to us, in class-action litigation, large classes of plaintiffs may allege damages relating to extended periods of time or other alleged facts and circumstances that could increase the amount of potential damages. Attorneys general and other government officials have in the past and may in the future pursue litigation in which they seek to recover civil damages from companies on behalf of a state or its citizens for a variety of claims, including violation of consumer protection and product pricing laws or natural resources damages. If we are not able to successfully defend such litigation, it may result in liability to our company that could materially and adversely affect our business, financial condition, results of operations and cash flows. In addition to substantial liability, plaintiffs in litigation may also seek injunctive relief which, if imposed, could have a material adverse effect on our future business, financial condition, results of operations and cash flows.A portion of our workforce is unionized, and we may face labor disruptions that could materially and adversely affect our business, financial condition, results of operations and cash flows.Approximately 3,755 of our employees are covered by collective bargaining agreements. Approximately 2,545 refinery employees are covered by collective bargaining agreements with expiration dates ranging from 2023 to 2027. These agreements may be renewed at an increased cost to us. In addition, we have experienced in the past, and may experience in the future, work stoppages as a result of labor disagreements. Any prolonged work stoppages disrupting operations could have a material adverse effect on our business, financial condition, results of operations and cash flows.In addition, California requires refinery owners to pay prevailing wages to contract craft workers and restricts refiners’ ability to hire qualified employees to a limited pool of applicants. Legislation or changes in regulations could result in labor shortages, higher labor costs, and an increased risk that contract workers become joint employees, which could trigger bargaining issues, and wage and benefit consequences, especially during critical maintenance and construction periods.One of our subsidiaries acts as the general partner of a master limited partnership, which may expose us to certain legal liabilities.One of our subsidiaries acts as the general partner of MPLX, a master limited partnership. Our control of the general partner of MPLX may increase the possibility of claims of breach of fiduciary duties, including claims of conflicts of interest. Any liability resulting from such claims could have a material adverse effect on our future business, financial condition, results of operations and cash flows.If foreign investment in us or MPLX exceeds certain levels, we could be prohibited from operating vessels engaged in U.S. coastwise trade, which could adversely affect our business, financial condition, results of operations and cash flows.The Shipping Act of 1916 and Merchant Marine Act of 1920 (collectively, the “Maritime Laws”), generally require that vessels engaged in U.S. coastwise trade be owned by U.S. citizens. Among other requirements to establish citizenship, entities that own such vessels must be owned at least 75 percent by U.S. citizens. If we fail to maintain compliance with the Maritime Laws, we 26Table of Contentswould be prohibited from operating vessels in the U.S. inland waters or otherwise in U.S. coastwise trade. Such a prohibition could materially and adversely affect our business, financial condition, results of operations and cash flows.Our operations could be disrupted if we are unable to maintain or obtain real property rights required for our business.We do not own all of the land on which certain of our assets are located, particularly our midstream assets, but rather obtain the rights to construct and operate such assets on land owned by third parties and governmental agencies for a specific period of time. Therefore, we are subject to the possibility of more burdensome terms and increased costs to retain necessary land use if our leases, rights-of-way or other property rights lapse, terminate or are reduced or it is determined that we do not have valid leases, rights-of-way or other property rights. For example, a portion of the Tesoro High Plains pipeline in North Dakota remains shut down following delays in renewing a right-of-way necessary for the operation of a section of the pipeline. Any loss of or reduction in our real property rights, including loss or reduction due to legal, governmental or other actions or difficulty renewing leases, right-of-way agreements or permits on satisfactory terms or at all, could have a material adverse effect on our business, financial condition, results of operations and cash flows.Certain of our facilities are located on Native American tribal lands and are subject to various federal and tribal approvals and regulations, which can increase our costs and delay or prevent our efforts to conduct operations.Various federal agencies within the U.S. Department of the Interior, particularly the Bureau of Indian Affairs, along with each Native American tribe, regulate natural gas and oil operations on Native American tribal lands. In addition, each Native American tribe is a sovereign nation having the right to enforce laws and regulations and to grant approvals independent from federal, state and local statutes and regulations. These tribal laws and regulations include various taxes, fees, requirements to employ Native American tribal members and other conditions that apply to operators and contractors conducting operations on Native American tribal lands. Persons conducting operations on tribal lands are generally subject to the Native American tribal court system. In addition, if our relationships with any of the relevant Native American tribes were to deteriorate, we could face significant risks to our ability to continue operations on Native American tribal lands. One or more of these factors has in the past and may in the future increase our cost of doing business on Native American tribal lands and impact the viability of, or prevent or delay our ability to conduct operations on such lands. For example, we are subject to ongoing litigation regarding trespass claims relating to a portion of the Tesoro High Plains pipeline in North Dakota.The Court of Chancery of the State of Delaware will be, to the extent permitted by law, the sole and exclusive forum for substantially all disputes between us and our shareholders. Our Restated Certificate of Incorporation provides that the Court of Chancery of the State of Delaware will be the sole and exclusive forum for:•any derivative action or proceeding brought on behalf of MPC;•any action asserting a claim of breach of a fiduciary duty owed by any director or officer of MPC to MPC or its stockholders•any action asserting a claim against MPC arising pursuant to any provision of the General Corporation Law of the State of Delaware, MPC’s Restated Certificate of Incorporation, any Preferred Stock Designation or the Bylaws of MPC; or•any other action asserting a claim against MPC or any Director or officer of MPC that is governed by or subject to the internal affairs doctrine for choice of law purposes.The forum selection provision may restrict a stockholder’s ability to bring a claim against us or directors or officers of MPC in a forum that it finds favorable, which may discourage stockholders from bringing such claims at all. Alternatively, if a court were to find the forum selection provision contained in our Restated Certificate of Incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in another forum, which could materially adversely affect our business, financial condition and results of operations. However, the forum selection provision does not apply to any claims, actions or proceedings arising under the Securities Act or the Exchange Act.Provisions in our corporate governance documents could operate to delay or prevent a change in control of our company, dilute the voting power or reduce the value of our capital stock or affect its liquidity.The existence of some provisions within our restated certificate of incorporation and amended and restated bylaws could discourage, delay or prevent a change in control of us that a stockholder may consider favorable. These include provisions:•providing that our board of directors fixes the number of members of the board; •providing for the division of our board of directors into three classes with staggered terms; •providing that only our board of directors may fill board vacancies; •limiting who may call special meetings of stockholders; •prohibiting stockholder action by written consent, thereby requiring stockholder action to be taken at a meeting of the stockholders; •establishing advance notice requirements for nominations of candidates for election to our board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings; •establishing supermajority vote requirements for certain amendments to our restated certificate of incorporation; 27Table of Contents•providing that our directors may only be removed for cause; •authorizing a large number of shares of common stock that are not yet issued, which would allow our board of directors to issue shares to persons friendly to current management, thereby protecting the continuity of our management, or which could be used to dilute the stock ownership of persons seeking to obtain control of us; and •authorizing the issuance of “blank check” preferred stock, which could be issued by our board of directors to increase the number of outstanding shares and thwart a takeover attempt. Our restated certificate of incorporation also authorizes us to issue, without the approval of our stockholders, one or more classes or series of preferred stock having such designation, powers, preferences and relative, participating, optional and other special rights, including preferences over our common stock respecting dividends and distributions, as our board of directors generally may determine. The terms of one or more classes or series of preferred stock could dilute the voting power or reduce the value of our common stock. For example, we could grant holders of preferred stock the right to elect some number of our board of directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences we could assign to holders of preferred stock could affect the residual value of our common stock.Finally, to facilitate compliance with the Maritime Laws, our restated certificate of incorporation limits the aggregate percentage ownership by non-U.S. citizens of our common stock or any other class of our capital stock to 23 percent of the outstanding shares. We may prohibit transfers that would cause ownership of our common stock or any other class of our capital stock by non-U.S. citizens to exceed 23 percent. Our restated certificate of incorporation also authorizes us to effect any and all measures necessary or desirable to monitor and limit foreign ownership of our common stock or any other class of our capital stock. These limitations could have an adverse impact on the liquidity of the market for our common stock if holders are unable to transfer shares to non-U.S. citizens due to the limitations on ownership by non-U.S. citizens. Any such limitation on the liquidity of the market for our common stock could adversely impact the market price of our common stock.Strategic Transaction Risks Following the Speedway sale, our diminished diversification of revenue sources may adversely affect our results of operations and financial condition. On May 14, 2021, we completed the sale of Speedway, our company-owned and operated retail transportation fuel and convenience store business, to 7-Eleven. Following the completion of the sale, our diversification of revenue sources diminished, and our business, financial condition, results of operations and cash flows may be subject to increased volatility as a result.General Risk FactorsSignificant stockholders may attempt to effect changes at our company or acquire control over our company, which could impact the pursuit of business strategies and adversely affect our results of operations and financial condition.Our stockholders may from time to time engage in proxy solicitations, advance stockholder proposals or otherwise attempt to effect changes or acquire control over our company. Campaigns by stockholders to effect changes at publicly traded companies are sometimes led by investors seeking to increase short-term stockholder value through actions such as financial restructuring, increased debt, special dividends, stock repurchases or sales of assets or the entire company. Responding to proxy contests and other actions by activist stockholders can be costly and time-consuming and could divert the attention of our board of directors and senior management from the management of our operations and the pursuit of our business strategies. As a result, stockholder campaigns could adversely affect our results of operations and financial condition.Future acquisitions will involve the integration of new assets or businesses and may present substantial risks that could adversely affect our business, financial conditions, results of operations and cash flows.Future transactions involving the addition of new assets or businesses will present risks, which may include, among others:•inaccurate assumptions about future synergies, revenues, capital expenditures and operating costs;•an inability to successfully integrate, or a delay in the successful integration of, assets or businesses we acquire;•a decrease in our liquidity resulting from using a portion of our available cash or borrowing capacity under our revolving credit agreement to finance transactions;•a significant increase in our interest expense or financial leverage if we incur additional debt to finance transactions;•the assumption of unknown environmental and other liabilities, losses or costs for which we are not indemnified or for which our indemnity is inadequate;•the diversion of management’s attention from other business concerns; •the loss of customers or key employees from the acquired business; and•the incurrence of other significant charges, such as impairment of goodwill or other intangible assets, asset devaluation or restructuring charges.28Table of ContentsCompliance with and changes in tax laws could materially and adversely impact our financial condition, results of operations and cash flows. We are subject to extensive tax liabilities, including federal, state and local income taxes in the United States and in foreign jurisdictions, and, transactional, payroll, franchise, withholding and property taxes. New tax laws and regulations and changes in, interpretations of, and guidance regarding tax laws and regulations, including impacts of the Tax Cuts and Jobs Act of 2017, the Coronavirus Aid, Relief, Economic Security Act of 2020, and the Inflation Reduction Act of 2022, could result in increased expenditures by us for tax liabilities in the future and could materially and adversely impact our financial condition, results of operations and cash flows.In addition, we are subject to the examination of our returns by taxing authorities. We regularly assess the likelihood of adverse outcomes resulting from such examinations to determine the adequacy of our provision for income taxes. Although we believe we have made appropriate provisions for taxes in the jurisdictions in which we operate, changes in the tax laws or challenges from tax authorities under existing tax laws could adversely affect our business, financial condition and results of operations and could subject us to interest and penalties.Item 1B. Unresolved Staff CommentsNoneItem 2. Properties We believe that our properties and facilities are adequate for our operations and that our facilities are adequately maintained. See the following sections for details of our assets by segment.REFINING & MARKETINGThe table below sets forth the location and crude oil refining capacity for each of our refineries as of December 31, 2022. Refining throughput can exceed crude oil refining capacity due to the processing of other charge and blendstocks in addition to crude oil and the timing of planned turnaround and major maintenance activity.RefineryCrude Oil Refining Capacity (mbpcd)Gulf Coast RegionGaryville, Louisiana596 Galveston Bay, Texas City, Texas593 Subtotal Gulf Coast region1,189 Mid-Continent RegionCatlettsburg, Kentucky291 Robinson, Illinois253 Detroit, Michigan140 El Paso, Texas133 St. Paul Park, Minnesota105 Canton, Ohio100 Mandan, North Dakota71 Salt Lake City, Utah66 Subtotal Mid-Continent region1,159 West Coast RegionLos Angeles, California363 Anacortes, Washington119 Kenai, Alaska68 Subtotal West Coast region550 Total 2,898 The Dickinson, North Dakota, renewable fuels facility has the capacity to produce 184 million gallons per year of renewable diesel from corn oil, soybean oil, fats and greases. MPC is currently in the process of converting the Martinez refinery to a renewable diesel facility. The full capacity of the Martinez facility is expected to be approximately 730 million gallons per year. 29Table of ContentsThe following table sets forth the approximate number of locations where jobbers maintain branded outlets, marketing fuels under the Marathon, ARCO, Shell, Mobil, Tesoro and other brands, as of December 31, 2022.LocationNumber ofBranded OutletsAlabama404 Alaska54 Arizona79 Arkansas1 California114 Colorado12 District of Columbia2 Florida639 Georgia400 Idaho105 Illinois183 Indiana640 Iowa4 Kentucky515 Louisiana57 Maryland60 Massachusetts1 Mexico281 Michigan732 Minnesota299 Mississippi118 Nevada19 New Mexico38 New York62 North Carolina208 North Dakota119 Ohio811 Oregon43 Pennsylvania85 Rhode Island3 South Carolina102 South Dakota33 Tennessee407 Texas11 Utah109 Virginia192 Washington95 West Virginia109 Wisconsin58 Wyoming5 Total7,209 30Table of ContentsThe Refining & Marketing segment sells transportation fuels through long-term fuel supply contracts to direct dealer locations, primarily under the ARCO brand. The following table sets forth the number of direct dealer locations by state as of December 31, 2022.LocationNumber ofLocationsArizona69 California1,035 Nevada68 Total1,172 The following table sets forth details about our Refining & Marketing owned and operated terminals as of December 31, 2022. See the Midstream - MPLX section for information with respect to MPLX owned and operated terminals. Owned and Operated TerminalsNumber ofTerminalsTank Storage Capacity (thousand barrels)Light Products Terminals:Alaska1 231 New York1 352 Subtotal light products terminals2 583 Asphalt Terminals:Florida1 263 Indiana1 121 Kentucky4 549 Louisiana1 54 Michigan1 12 New York1 417 Ohio4 2,207 Pennsylvania1 451 Tennessee2 480 Subtotal asphalt terminals16 4,554 Total owned and operated terminals18 5,137 31Table of ContentsMIDSTREAM - MPLXThe following table sets forth certain information relating to MPLX’s crude oil and refined products pipeline systems and storage assets as of December 31, 2022.Pipeline System or Storage AssetDiameter (inches)Length(miles)CapacityTotal crude oil pipeline systems(a)(b)2" - 42"5,135 VariousTotal refined products pipeline systems(a)(b)(c)4" - 36"3,732 VariousBarge Docks (mbpd)4,834 Storage assets: (mbbls)Refining Logistics(d)93,493 Tank Farms33,190 Caverns4,209 (a) Includes approximately 16 miles of crude pipeline and 2 miles of refined product pipeline leased from third parties.(b) Includes approximately 1,173 miles of inactive crude pipeline and 203 miles of inactive refined product pipeline.(c) Includes approximately 87 miles and 17 miles of refined product pipelines in which MPLX has partial ownership of 65% and 50%, respectively.(d) Refining logistics assets primarily include tankage. During 2022, MPC formed the Martinez Renewables joint venture and is currently in the process of converting the Martinez refinery to a renewable diesel facility. MPLX owns refining logistics assets with 5,809 mbbls of storage capacity associated with the facility and has entered into terminalling and storage service agreements with the joint venture and its partners to provide logistics services for the facility.The following table sets forth information regarding the pipeline systems which MPLX has an interest in through ownership of its equity method investments as of December 31, 2022.Diameter (inches)Length(miles)Ownership PercentageCrude Systems:MarEn Bakken Company LLC(a)30"1,916 25%Minnesota Pipe Line Company LLC16"-24"975 17%Wink to Webster Holdings LLC36"522 11%Illinois Extension Pipeline Company LLC24"168 35%Andeavor Logistics Rio Pipeline LLC12"119 67%LOCAP LLC48"57 59%LOOP LLC48"48 41%Refined Product Systems:Explorer Pipeline Company12" - 28"1,826 25%Natural Gas and NGL Systems:Whistler Pipeline LLC36" - 42"498 38%BANGL LLC(a)12" - 24"109 25%(a) The investment in MarEn Bakken Company LLC includes MPLX’s 9.19 percent indirect interest in a joint venture that owns and operates the Dakota Access Pipeline and Energy Transfer Crude Oil Pipeline projects, collectively referred to as the Bakken Pipeline system or DAPL.(b) BANGL LLC also owns a 30% interest in a 323 mile NGL pipeline.32Table of ContentsThe following table sets forth details about MPLX owned and operated terminals as of December 31, 2022. Additionally, MPLX has partial ownership interest in one terminal.Owned and Operated TerminalsNumber ofTerminalsTank Storage Capacity (mbbls)Refined Products Terminals:Alabama2 443 Alaska3 1,573 California8 3,483 Florida3 2,265 Georgia4 982 Idaho3 999 Illinois2 562 Indiana7 3,812 Kentucky6 2,587 Louisiana2 5,404 Michigan8 2,440 Minnesota1 13 New Mexico3 471 North Carolina3 1,356 North Dakota1 — Ohio12 3,200 Pennsylvania1 390 South Carolina1 371 Tennessee4 1,149 Texas1 76 Utah1 21 Washington4 920 West Virginia2 1,564 Subtotal light products terminals82 34,081 Asphalt TerminalsArizona3 554 Minnesota1 — Nevada(a)1 283 New Mexico1 38 Texas1 197 Subtotal asphalt terminals7 1,072 Total owned and operated terminals89 35,153 (a) MPLX accounts for this terminal as an equity method investment.The following table sets forth details about MPLX barges and towboats as of December 31, 2022.Class of EquipmentNumberin ClassCapacity(mbbls)Inland tank barges296 7,820 Inland towboats23 N/A33Table of ContentsThe following tables set forth certain information relating to MPLX’s consolidated and operated joint venture gas processing facilities, fractionation facilities, natural gas gathering systems, NGL pipelines and natural gas pipelines as of and for the year ended December 31, 2022. Gas Processing ComplexesDesign Throughput Capacity (MMcf/d)Natural GasThroughput (MMcf/d)(a)Utilizationof DesignCapacity(a)Marcellus Operations6,320 5,515 87 %Utica Operations1,325 495 37 %Southern Appalachia Operations495 217 44 %Southwest Operations(b)2,545 1,637 69 %Bakken Operations185 146 79 %Rockies Operations1,177 438 37 %Total 12,047 8,448 71 %(a) Natural gas throughput is a weighted average for days in operation. The utilization of design capacity has been calculated using the weighted average design throughput capacity.(b) The capacity presented above includes MPLX’s proportionate share of Centrahoma Processing LLC’s processing capacity of 550 MMcf/d, as MPLX owns a non-operating 40 percent interest in this joint venture. Actual throughput of 170 MMcf/d representing MPLX’s share of processed volumes is also included and used to compute the utilization presented above.Fractionation & Condensate Stabilization FacilitiesDesignThroughputCapacity (mbpd)NGL Throughput (mbpd)(a)Utilizationof DesignCapacity(a)Marcellus Operations413 307 74 %Utica Operations23 14 61 %Southern Appalachia Operations24 11 46 %Bakken Operations33 21 64 %Rockies Operations5 4 80 %Total498 357 72 %(a) NGL throughput is a weighted average for days in operation. The utilization of design capacity has been calculated using the weighted average design throughput capacity.De-ethanization FacilitiesDesignThroughputCapacity (mbpd)NGL Throughput (mbpd)(a)Utilizationof DesignCapacity(a)Marcellus Operations309 204 72 %Utica Operations40 5 13 %Rockies Operations5 — — %Total354 209 64 %(a) NGL throughput is a weighted average for days in operation. The utilization of design capacity has been calculated using the weighted average design throughput capacity.Natural Gas Gathering SystemsDesignThroughputCapacity (MMcf/d)Natural GasThroughput (MMcf/d)(a)Utilizationof DesignCapacity(a)Marcellus Operations1,547 1,321 85 %Utica Operations3,183 2,134 67 %Southwest Operations2,980 1,629 58 %Bakken Operations189 152 80 %Rockies Operations(b)1,486 448 30 %Total9,385 5,684 62 %(a) Natural gas throughput is a weighted average for days in operation. The utilization of design capacity has been calculated using the weighted average design throughput capacity.(b) This region does not include MPLX’s operated joint venture, Rendezvous Gas Services, L.L.C. (“RGS”), which has a gathering capacity of 1,032 MMcf/d; this system supports other systems which are included in the Rockies region and that throughput is presented in the Rockies gathering throughput above. The third party volumes gathered for RGS during the year ended December 31, 2022 were 110 MMcf/d.34Table of ContentsThe following table sets forth certain information relating to MPLX’s NGL pipelines as of December 31, 2022.NGL PipelinesDiameter (inches)Length(miles)DesignThroughputCapacity (mbpd)Marcellus Operations4” - 20”442VariousUtica Operations4”- 12”119VariousSouthern Appalachia Operations6” - 8”13835Southwest Operations(a)6”5039Bakken Operations8” - 12”8480Rockies Operations8”1015(a) Includes 38 miles of inactive pipeline.MIDSTREAM - MPC-RETAINED ASSETS AND INVESTMENTSThe following table sets forth certain information related to our crude oil and refined products pipeline systems not owned by MPLX. As of December 31, 2022, we had partial ownership interests in the following pipeline companies.Pipeline CompanyDiameter (inches)Length (miles)OwnershipInterestOperatedby MPLCrude oil pipeline companies:Capline Pipeline Company LLC40”644 33%YesGray Oak Pipeline, LLC8”-30”845 25%NoLOOP(a)48”48 10%NoTotal1,489 Refined products pipeline companies:Ascension Pipeline Company LLC12”32 50%NoCentennial Pipeline LLC(b)24”-26”793 50%YesMuskegon Pipeline LLC10”-12”170 60%YesWolverine Pipe Line Company6”-18”798 6%NoTotal1,793 (a)Represents interest retained by MPC and excludes MPLX’s 40.7 percent ownership interest in LOOP. Pipeline mileage is excluded from total as it is included with MPLX assets.(b)All system pipeline miles are inactive.As of December 31, 2022, we had a partial ownership interest in the following crude oil terminal.TerminalOwnershipInterestTank Storage Capacity (million barrels)South Texas Gateway Terminal LLC25%8.6The following table sets forth details about our ocean vessels as of December 31, 2022.Class of EquipmentNumberin ClassCapacity(mbbls)Jones Act product tankers4 1,320 750 Series ATB vessels(a)3 990 (a)Represents ownership through our indirect noncontrolling 50% interest in Crowley Blue Water Partners.35Table of ContentsItem 3. Legal ProceedingsWe are the subject of, or a party to, a number of pending or threatened legal actions, contingencies and commitments involving a variety of matters, including laws and regulations relating to the environment. While it is possible that an adverse result in one or more of the lawsuits or proceedings in which we are a defendant could be material to us, based upon current information and our experience as a defendant in other matters, we believe that these lawsuits and proceedings, individually or in the aggregate, will not have a material adverse effect on our consolidated results of operations, financial position or cash flows.Item 103 of Regulation S-K promulgated by the SEC requires disclosure of certain environmental matters when a governmental authority is a party to the proceedings and such proceedings involve potential monetary sanctions, unless we reasonably believe that the matter will result in no monetary sanctions, or in monetary sanctions, exclusive of interest and costs, of less than a specified threshold. We use a threshold of $1 million for this purpose. Climate Change LitigationGovernmental and other entities in various states have filed climate-related lawsuits against a number of energy companies, including MPC. The lawsuits allege damages as a result of climate change and the plaintiffs are seeking unspecified damages and abatement under various tort theories. Similar lawsuits may be filed in other jurisdictions. The names of the courts in which the proceedings are pending and the dates instituted are as follows:PlaintiffDate InstitutedName of Court(s) where pendingCounty of San Mateo, CaliforniaJuly 17, 2017U.S. District Court (Northern District of California); U.S. Court of Appeals for the Ninth CircuitCounty of Marin, CaliforniaJuly 17, 2017U.S. District Court (Northern District of California); U.S. Court of Appeals for the Ninth CircuitCity of Imperial Beach, CaliforniaJuly 17, 2017U.S. District Court (Northern District of California); U.S. Court of Appeals for the Ninth CircuitCounty of Santa Cruz, CaliforniaDecember 20, 2017U.S. District Court (Northern District of California); U.S. Court of Appeals for the Ninth CircuitCity of Santa Cruz, CaliforniaDecember 20, 2017U.S. District Court (Northern District of California); U.S. Court of Appeals for the Ninth CircuitCity of Richmond, CaliforniaJanuary 22, 2018U.S. District Court (Northern District of California); U.S. Court of Appeals for the Ninth CircuitState of Rhode IslandJuly 2, 2018Superior Court of Providence County; U.S. Court of Appeals for the First CircuitMayor and City Council of Baltimore, MarylandJuly 20, 2018Circuit Court of Baltimore City; U.S. Court of Appeals for the Fourth CircuitPacific Coast Federation of Fishermen’s Associations, Inc.November 14, 2018U.S. District Court (Northern District of California)City and County of Honolulu, HawaiiMarch 9, 2020U.S. District Court (District of Hawaii); U.S. Court of Appeals for the Ninth Circuit; Circuit Court of the First Circuit (State of Hawaii); Hawaii Intermediate Court of AppealsCity of Charleston, South CarolinaSeptember 9, 2020U.S. District Court (District of South Carolina)State of DelawareSeptember 10, 2020U.S. District Court (District of Delaware); U.S. Court of Appeals for the Third CircuitCounty of Maui, HawaiiOctober 12, 2020U.S. District Court (District of Hawaii); U.S. Court of Appeals for the Ninth Circuit; Circuit Court of the First Circuit (State of Hawaii)City of Annapolis, MarylandFebruary 22, 2021U.S. District Court (District of Maryland); US Court of Appeals for the Fourth CircuitAnne Arundel County, MarylandApril 26, 2021U.S. District Court (District of Maryland); U.S. Court of Appeals for the Fourth CircuitDakota Access PipelineMPLX holds a 9.19 percent indirect interest in a joint venture (“Dakota Access”) that owns and operates the Dakota Access Pipeline and Energy Transfer Crude Oil Pipeline projects, collectively referred to as the Bakken Pipeline system or DAPL. In 2020, the D.D.C. ordered the Army Corps, which granted permits and an easement for the Bakken Pipeline system, to prepare an environmental impact statement (“EIS”) relating to an easement under Lake Oahe in North Dakota. The D.D.C. later vacated the easement. The Army Corps expects to release a draft EIS in 2023. In May 2021, the D.D.C. denied a renewed request for an injunction to shut down the pipeline while the EIS is being prepared. In June 2021, the D.D.C. issued an order dismissing without prejudice the tribes’ claims against the Dakota Access Pipeline. The litigation could be reopened or new litigation challenging the EIS, once completed, could be filed. The pipeline remains operational.36Table of ContentsMPLX has entered into a Contingent Equity Contribution Agreement whereby it, along with the other joint venture owners in the Bakken Pipeline system, has agreed to make equity contributions to the joint venture upon certain events occurring to allow the entities that own and operate the Bakken Pipeline system to satisfy their senior note payment obligations. The senior notes were issued to repay amounts owed by the pipeline companies to fund the cost of construction of the Bakken Pipeline system. If the pipeline were temporarily shut down, MPLX would have to contribute its 9.19 percent pro rata share of funds required to pay interest accruing on the notes and any portion of the principal that matures while the pipeline is shutdown. MPLX also expects to contribute its 9.19 percent pro rata share of any costs to remediate any deficiencies to reinstate the permit and/or return the pipeline into operation. If the vacatur of the easement permit results in a permanent shutdown of the pipeline, MPLX would have to contribute its 9.19 percent pro rata share of the cost to redeem the bonds (including the 1% redemption premium required pursuant to the indenture governing the notes) and any accrued and unpaid interest. As of December 31, 2022, our maximum potential undiscounted payments under the Contingent Equity Contribution Agreement were approximately $170 million.Tesoro High Plains PipelineIn July 2020, Tesoro High Plains Pipeline Company, LLC (“THPP”), a subsidiary of MPLX, received a Notification of Trespass Determination from the Bureau of Indian Affairs (“BIA”) relating to a portion of the Tesoro High Plains Pipeline that crosses the Fort Berthold Reservation in North Dakota. The notification demanded the immediate cessation of pipeline operations and assessed trespass damages of approximately $187 million. After subsequent appeal proceedings and in compliance with a new order issued by the BIA, in December 2020, THPP paid approximately $4 million in assessed trespass damages and ceased use of the portion of the pipeline that crosses the property at issue. In March 2021, the BIA issued an order purporting to vacate the BIA's prior orders related to THPP’s alleged trespass and direct the Regional Director of the BIA to reconsider the issue of THPP’s alleged trespass and issue a new order. In April 2021, THPP filed a lawsuit in the District of North Dakota against the United States of America, the U.S. Department of the Interior and the BIA (together, the “U.S. Government Parties”) challenging the March 2021 order purporting to vacate all previous orders related to THPP’s alleged trespass. On February 8, 2022, the U.S. Government Parties filed their answer and counterclaims to THPP’s suit claiming THPP is in continued trespass with respect to the pipeline and seek disgorgement of pipeline profits from June 1, 2013 to present, removal of the pipeline and remediation. We intend to vigorously defend ourselves against these counterclaims.Martinez RefineryWe have resolved 99 NOVs received from the Bay Area Air Quality Management District (“BAAQMD”) through settlement with the BAAQMD that includes payment of a cash penalty of approximately $1.5 million. The NOVs were issued from 2011 to 2018 and allege violations of air quality regulations and the idled Martinez refinery’s air permit. On July 18, 2016, the U.S. Department of Justice (“DOJ”) lodged a complaint on behalf of EPA and a Consent Decree in the U.S. Court for the Western District of Texas. Among other things, the Consent Decree required that the Martinez refinery meet certain annual emission limits for NOx by July 1, 2018. In 2018, TRMC informed EPA that it would need additional time to satisfy requirements of the Consent Decree. In 2019, TRMC and the United States entered into an agreement to amend the Consent Decree to resolve these issues. In light of the actions to strategically reposition the Martinez refinery to a renewable diesel facility, we are renegotiating the Consent Decree modification. Subject to final approval by the court, we expect that, contingent on TRMC completing the conversion of the Martinez refinery to renewable diesel production, the renegotiated Consent Decree modification will no longer require the installation of a Selective Catalytic Reduction system to control NOx emissions from the now-idled fluid catalytic cracking unit, but will result in an increased civil penalty.Gathering and ProcessingMPLX has been negotiating with the EPA with respect to multiple alleged violations of the National Emission Standards for Hazardous Air Pollutants by the Chapita, Coyote Wash, Island, River Bend and Wonsits Valley Compressor Stations in Utah as well as the Robinson Lake Gas Plant in North Dakota. MPLX is in the process of finalizing a settlement with the EPA pursuant to which MPLX expects to pay a cash penalty of $2 million, incorporate additional remedial measures, mitigate excess emissions associated with events and enter into a consent decree covering MPLX gas plants and compressor stations located in Utah, North Dakota and Wyoming. We expect the settlement to be finalized later in 2023.Edwardsville IncidentIn March 2022, the State of Illinois brought an action in Madison County Circuit Court in Illinois against Marathon Pipe Line LLC, an indirect wholly owned subsidiary of MPLX, asserting various violations and demanding a permanent injunction and civil penalties in connection with a March 2022 release of crude oil on the Wood River to Patoka 22" line near Edwardsville, Illinois. We are negotiating a settlement of the allegations. We cannot currently estimate the amount of any civil penalty or the timing of the resolution of this matter but do not believe any civil penalty will have a material impact on our consolidated results of operations, financial position or cash flows. Item 4. Mine Safety DisclosuresNot applicable37Table of ContentsPART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Our common stock is listed on the NYSE and traded under the symbol “MPC.” As of February 16, 2023, there were 26,034 registered holders of our common stock.Issuer Purchases of Equity SecuritiesThe following table sets forth a summary of our purchases during the quarter ended December 31, 2022, of equity securities that are registered by MPC pursuant to Section 12 of the Securities Exchange Act of 1934, as amended:Millions of DollarsPeriodTotal Number of Shares Purchased(a)Average Price Paid per Share(b)Total Number ofShares Purchased asPart of PubliclyAnnounced Plansor ProgramsMaximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs(c)(d)10/01/2022-10/31/2022991,728 $105.08 989,787 $5,004 11/01/2022-11/30/20223,742,961 122.76 3,742,909 4,545 12/01/2022-12/31/202210,773,486 112.56 10,773,486 3,332 Total15,508,175 114.54 15,506,182 (a)The amounts in this column include 1,941, 52 and 0 shares of our common stock delivered by employees to MPC, upon vesting of restricted stock, to satisfy tax withholding requirements in October, November and December, respectively.(b)Amounts in this column reflect the weighted average price paid for shares repurchased under our share repurchase authorizations and for shares tendered to us in satisfaction of employee tax withholding obligations upon the vesting of restricted stock granted under our stock plans. The weighted average price includes commissions paid to brokers during the quarter. (c)On February 2, 2022, we announced that our board of directors had approved an additional $5 billion share repurchase authorization, which was exhausted during the fourth quarter of 2022. On August 2, 2022, we announced that our board of directors had approved an additional $5 billion share repurchase authorization. On January 31, 2023, we announced that our board of directors had approved an additional $5 billion share repurchase authorization, which authorization is not reflected in this column. These share repurchase authorizations have no expiration date.(d)Includes the payment of any commissions paid to brokers during the quarter.38Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsAll statements in this section, other than statements of historical fact, are forward-looking statements that are inherently uncertain. See “Disclosures Regarding Forward-Looking Statements” and Item 1A. Risk Factors for a discussion of the factors that could cause actual results to differ materially from those projected in these statements. The following information concerning our business, results of operations and financial condition should also be read in conjunction with the information included under Item 1. Business, Item 1A. Risk Factors and
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsKey Terms:Operating and financial metrics:•Americas includes North America, Central America, South America, and the Caribbean islands.•Europe includes continental Europe, the British Isles, Iceland, Greenland, and Russia, but excludes Turkey (which is included in APAC and Other).•APAC and Other includes Asia, Australia, the Pacific islands, the Middle East, and Africa.•Direct Revenue is revenue that is received directly from end users of our services and includes both subscription and à la carte revenue.•Indirect Revenue is revenue that is not received directly from an end user of our services, substantially all of which is advertising revenue.•Payers are unique users at a brand level in a given month from whom we earned Direct Revenue. When presented as a quarter-to-date or year-to-date value, Payers represents the average of the monthly values for the respective period presented. At a consolidated level, duplicate Payers may exist when we earn revenue from the same individual at multiple brands in a given month, as we are unable to identify unique individuals across brands in the Match Group portfolio.•Revenue Per Payer (“RPP”) is the average monthly revenue earned from a Payer and is Direct Revenue for a period divided by the Payers in the period, further divided by the number of months in the period.Operating costs and expenses:•Cost of revenue - consists primarily of the amortization of in-app purchase fees, compensation expense (including stock-based compensation expense) and other employee-related costs for personnel engaged in data center and customer care functions, credit card processing fees, hosting fees, live video costs, and data center rent, energy, and bandwidth costs. In-app purchase fees are monies paid to Apple and Google in connection with the processing of in-app purchases of subscriptions and service features through the in-app payment systems provided by Apple and Google. •Selling and marketing expense - consists primarily of advertising expenditures and compensation expense (including stock-based compensation expense) and other employee-related costs for personnel engaged in selling and marketing, and sales support functions. Advertising expenditures includes online marketing, including fees paid to search engines and social media sites, offline marketing (which is primarily television advertising), and payments to partners that direct traffic to our brands. •General and administrative expense - consists primarily of compensation expense (including stock-based compensation expense) and other employee-related costs for personnel engaged in executive management, finance, legal, tax and human resources, fees for professional services (including transaction-related costs for acquisitions), and facilities costs.•Product development expense - consists primarily of compensation expense (including stock-based compensation expense) and other employee-related costs that are not capitalized for personnel engaged in the design, development, testing, and enhancement of service offerings and related technology.Long-term debt:•Credit Facility - The revolving credit facility under the credit agreement of MG Holdings II. At December 31, 2022, there was $0.4 million in outstanding letters of credit and $749.6 million of availability under the Credit Facility.•Term Loan - The term loan facility under the credit agreement of MG Holdings II. At December 31, 2022 and December 31, 2021, the Term Loan bore interest at LIBOR plus 1.75% and the then 33Table of Contentsapplicable rates were 6.49% and 1.91%, respectively. At December 31, 2022, $425 million was outstanding.•5.00% Senior Notes - MG Holdings II’s 5.00% Senior Notes due December 15, 2027, with interest payable each June 15 and December 15, which were issued on December 4, 2017. At December 31, 2022, $450 million aggregate principal amount was outstanding.•4.625% Senior Notes - MG Holdings II’s 4.625% Senior Notes due June 1, 2028, with interest payable each June 1 and December 1, which were issued on May 19, 2020. At December 31, 2022, $500 million aggregate principal amount was outstanding.•5.625% Senior Notes - MG Holdings II’s 5.625% Senior Notes due February 15, 2029, with interest payable each February 15 and August 15, which were issued on February 15, 2019. At December 31, 2022, $350 million aggregate principal amount was outstanding.•4.125% Senior Notes - MG Holdings II’s 4.125% Senior Notes due August 1, 2030, with interest payable each February 1 and August 1, which were issued on February 11, 2020. At December 31, 2022, $500 million aggregate principal amount was outstanding.•3.625% Senior Notes - MG Holdings II’s 3.625% Senior Notes due October 1, 2031, with interest payable each April 1 and October 1, which were issued on October 4, 2021. At December 31, 2022, $500 million aggregate principal amount was outstanding.•2022 Exchangeable Notes - During the third quarter of 2017, Match Group FinanceCo, Inc., a subsidiary of the Company, issued $517.5 million aggregate principal amount of 0.875% Exchangeable Senior Notes due October 1, 2022, which were exchangeable into shares of the Company's common stock. Interest was payable each April 1 and October 1. In October 2022, the then outstanding 2022 Exchangeable Notes were settled at maturity with cash on hand.•2026 Exchangeable Notes - During the second quarter of 2019, Match Group FinanceCo 2, Inc., a subsidiary of the Company, issued $575.0 million aggregate principal amount of 0.875% Exchangeable Senior Notes due June 15, 2026, which are exchangeable into shares of the Company's common stock. Interest is payable each June 15 and December 15. The outstanding balance of the 2026 Exchangeable Notes at December 31, 2022 was $575 million.•2030 Exchangeable Notes - During the second quarter of 2019, Match Group FinanceCo 3, Inc., a subsidiary of the Company, issued $575.0 million aggregate principal amount of 2.00% Exchangeable Senior Notes due January 15, 2030, which are exchangeable into shares of the Company's common stock. Interest is payable each January 15 and July 15. The outstanding balance of the 2030 Exchangeable Notes at December 31, 2022 was $575 million.Non-GAAP financial measure:•Adjusted Operating Income - is a Non-GAAP financial measure. See “Non-GAAP Financial Measures” for the definition of Adjusted Operating Income and a reconciliation of net earnings attributable to Match Group, Inc. shareholders to operating income and Adjusted Operating Income.Separation from IACOn June 30, 2020, the companies formerly known as Match Group, Inc. (referred to as “Former Match Group”) and IAC/InterActiveCorp (referred to as “Former IAC”) completed the separation of the Company from IAC through a series of transactions that resulted in two, separate public companies—(1) Match Group, which consists of the businesses of Former Match Group and certain financing subsidiaries previously owned by Former IAC, and (2) IAC, consisting of Former IAC’s businesses other than Match Group (the “Separation”). As part of the Separation, Former Match Group merged with and into MG Holdings II, an indirect wholly-owned subsidiary of Match Group, with MG Holdings II surviving the merger as an indirect wholly-owned subsidiary of Match Group. As a result of the Separation, the operations of Former IAC businesses other than Match Group are presented as discontinued operations.For additional information relating to the Separation and the related transactions and agreements, see “Part I—Item 1—Business—Separation of Match Group and IAC” and “Part I—Item 1—Business—Relationship with IAC after the Separation.”34Table of ContentsMANAGEMENT OVERVIEWMatch Group, Inc., through its portfolio companies, is a leading provider of digital technologies designed to help people make meaningful connections. Our global portfolio of brands includes Tinder®, Hinge®, Match®, Meetic®, OkCupid®, Pairs™, Plenty Of Fish®, Azar®, Hakuna®, and more, each built to increase our users’ likelihood of connecting with others. Through our trusted brands, we provide tailored services to meet the varying preferences of our users. Our services are available in over 40 languages to our users all over the world.As used herein, “Match Group,” the “Company,” “we,” “our,” “us,” and similar terms refer to Match Group, Inc. and its subsidiaries, unless the context indicates otherwise.Sources of RevenueAll of our services provide the use of certain features for free as well as a variety of additional features through a subscription or, for certain features, on a pay-per-use, or à la carte, basis. Our revenue is primarily derived directly from users in the form of recurring subscription fees and à la carte purchases.Subscription revenue is presented net of credits and credit card chargebacks. Payers who purchase subscriptions or à la carte features pay in advance, primarily by using a credit card or through mobile app stores, and, subject to certain conditions identified in our terms and conditions, all purchases are final and nonrefundable. Fees collected, or contractually due, in advance for subscriptions are deferred and recognized as revenue using the straight-line method over the term of the applicable subscription period, which primarily ranges from one to six months, and corresponding in-app purchase fees incurred on such transactions, if any, are deferred and expensed over the same period. Revenue from the purchase of à la carte features is recognized based on usage. We also earn revenue from online advertising, which is recognized every time an ad is displayed.Trends affecting our businessOver the last several years, we have seen significant changes in our business. Tinder has grown from incubation to the largest contributing brand in our portfolio and Hinge has grown meaningfully since acquisition. We have acquired brands such as Azar, Hakuna, and The League and incubated new brands such as Chispa™, BLK®, Stir, and Upward, where we have seen initial growth and we expect to see additional growth opportunities into the future. With our evolving portfolio of brands, we have seen a number of other significant trends in our business in recent years, including the following:Lower cost users. All of our brands rely on word-of-mouth, or free, user acquisition to varying degrees. Word-of-mouth acquisition is typically a function of scale (with larger communities driving greater numbers of referrals), youthfulness (with the viral effect being more pronounced in younger populations due, in part, to a significantly higher concentration of people seeking connections in any given social circle and the increased adoption of social media and similar platforms among such populations), and monetization rate (with people generally more likely to talk openly about using technologies to meet people that are less heavily monetized). Additionally, some, but not all, of our brands spend meaningfully on paid marketing. Accordingly, the average amount we spend to acquire a user differs significantly across brands based in large part on each brand’s mix of paid and free acquisition channels. As our mix has shifted toward younger users, our mix of acquisition channels has shifted toward lower cost channels, driving a decline over the past several years in the average amount we spend to acquire a new user across our portfolio. As a percentage of revenue, our costs of acquiring users have declined.Changing paid acquisition dynamics. Even as we increase our acquisition of lower cost users, paid acquisition of users remains an important driver of our business. The channels through which we market our brands are always evolving, but we are currently in a period of rapid change as TV and video consumption patterns evolve and internet consumption occurs regularly on mobile devices. As we adapt our paid marketing activities to maximize user engagement with our brands, we may increase our use of paid advertising at brands where we traditionally relied on word-of-mouth engagement to leverage these shifts in media consumption patterns and fuel international growth. Other brands in our portfolio may reduce paid marketing activities to reflect the change in audience engagement.In-App Purchase Fees. Purchases made by our customers through mobile applications, as opposed to desktop or mobile web, continue to increase. Purchases processed through the in-app payments systems provided by the Apple App Store and Google Play Store are subject to in-app purchase fees, which are generally 35Table of Contents30% of the purchase price (Google reduced its in-app purchase fees for subscriptions to 15% as of January 1, 2022). As a result, the percentage of our revenues paid to Apple and Google continues to be a significant and growing expense. For additional information, see “Item 1 Business—Dependencies on services provided by others—App Stores.”On March 31, 2022, Google began enforcing its new in-app payments policy, which requires all developers to process all in-app purchases of subscriptions and features entirely through Google’s in-app payment system. If an application developer failed to comply by June 1, 2022, Google threatened to remove that developer’s applications from the Google Play Store and not allow it to make updates to its applications. In May 2022, several of our subsidiaries filed a complaint in federal district court in California against Google alleging that Google’s dominance and anti-competitive conduct in the Android app distribution and in-app payment markets violate federal antitrust laws, particularly with respect to the requirement that we use Google’s in-app payment system exclusively. For additional information, see “Item 3 Legal Proceedings—Google Litigation.” While Google has already enforced its new payments policy in most jurisdictions, it has not done so with respect to our applications due to a stipulation reached by the parties in the ongoing Google litigation.Increase in acceptance and growth of technologies to meet people globally. Over the past decade, there has been meaningful growth in the usage of technologies to meet people in North America and Western Europe, and we see the potential for similar growth in the rest of the world in the years ahead. As more internet-connected people seeking connections utilize technologies to meet people and the stigma around using such technologies continues to erode, we believe that there is potential for accelerating growth in the use of these technologies globally. As a result, new services, entrants to the market, and business models are likely to continue to emerge, sometimes at the expense of our existing brands, through harnessing a new technology or a new or existing distribution channel, creating a new or different approach to connecting people, or some other means.Implementing new technologies that enhance our user experience. We expect new technologies to continue to drive user engagement. As new technologies develop, we evaluate if those technologies can be incorporated into our apps and will enhance the user experience. We believe that implementation of recent advances in technology, such as live video and live experiences, have enhanced our brands’ ability to attract and retain users. We expect new technologies to continue to drive user engagement and expect other technologies beyond video and live experiences to be tested in our services and incorporated into our apps in the future.Impacts of the Coronavirus. When the novel coronavirus (“COVID-19”) first hit Western Europe and the U.S. in 2020, user engagement increased significantly, but subscribers who purchase a subscription for the first time (“first-time subscribers”) declined at most of our brands as meeting in person was restricted. As 2020 progressed, propensity to pay rebounded across our portfolio, and first-time subscribers climbed amid reduced COVID-19 cases, but then faced new headwinds at the end of 2020. In 2021 and continuing into 2022, we saw a new normalization level as vaccines rolled out globally, even as several countries experienced additional waves of cases. The Omicron variant surge caused a modest impact on our business, with rolling global effects as the wave passed through various parts of the globe. Despite these past effects, the business has proven to be quite resilient over the last three years and we do not currently expect significant effects from COVID-19 in the near future.Other trends or factors affecting the comparability of our resultsAdvertising spend. Our advertising spend, which is included in our selling and marketing expense, has consistently been one of our larger operating expenses. How we deploy our advertising spend varies among brands, with the majority of our advertising spend taking place online, including search engines, social media sites, streaming services and influencers. Additionally, some brands utilize television and out-of-home marketing campaigns, such as on outdoor billboards. For established brands, we seek to optimize for total return on advertising spend by frequently analyzing and adjusting spend to focus on marketing channels and markets that generate returns above our thresholds. Our data-driven approach provides us the flexibility to scale and optimize our advertising spend. We spend advertising dollars against an expected lifetime value of a Payer that is realized over a multi-year period. While this advertising spend is intended to be profitable on that basis, it is nearly always negative during the period in which the expense is incurred. For newer brands that are gaining scale, or existing brands that are expanding into new geographies, we may make incremental advertising investments to establish the brand before optimizing monetization of the brand. In general, our more established brands spend 36Table of Contentsa higher proportion of their revenue on advertising while our newer brands spend a lower proportion and tend to rely more on word of mouth and other viral marketing. Our advertising spend may be incurred unevenly throughout the year.International markets. Our services are available across the world. Our international revenue represented 55% and 54% of our total revenue for years ended December 31, 2022 and 2021, respectively. We vary our pricing to align with local market conditions and our international businesses typically earn revenue in local currencies. As foreign currency exchange rates change, translation of the statement of operations of our international businesses into U.S. dollars affects year-over-year comparability of operating results.2022 Consolidated ResultsIn 2022, revenue grew 7%, operating income decreased 40%, and Adjusted Operating Income grew 6% year-over-year. Revenue growth was primarily due to strong growth at Tinder and Hinge, as well as the acquisition of Hyperconnect in June 2021. Operating income and Adjusted Operating Income benefited from lower selling and marketing expense and general and administrative expense as a percentage of revenue, both excluding stock-based compensation expense, partially offset by an increase in cost of revenue due to higher-in app fees, and an increase in product development expense primarily due to increase in compensation expense. Operating income was further impacted by impairments of intangible assets and increased stock-based compensation expense primarily due to new grants made during the year.37Table of ContentsResults of Operations for the years ended December 31, 2022, 2021 and 2020The following discussion should be read in conjunction with “
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+Item 7.Management's Discussion and Analysis of Financial Condition and Results of OperationsYou should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Part I, Item 1A, "Risk Factors." For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled "Limitations of Key Metrics and Other Data" in this Annual Report on Form 10-K.To supplement our consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles in the United States (GAAP), we present revenue on a constant currency basis and free cash flow, which are non-GAAP financial measures. Revenue on a constant currency basis is presented in the section entitled "—Revenue—Foreign Exchange Impact on Revenue." To calculate revenue on a constant currency basis, we translated revenue for the full year 2022 using 2021 monthly exchange rates for our settlement or billing currencies other than the U.S. dollar. For a full description of our free cash flow non-GAAP measure, see the section entitled "—Liquidity and Capital Resources—Free Cash Flow."These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. These measures may be different from non‑GAAP financial measures used by other companies, limiting their usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe these non-GAAP financial measures provide investors with useful supplemental information about the financial performance of our business, enable comparison of financial results between periods where certain items may vary independent of business performance, and allow for greater transparency with respect to key metrics used by management in operating our business.Executive Overview of Full Year 2022 Results Our mission is to give people the power to build community and bring the world closer together. In 2022, we continued to focus on our main revenue growth priorities: (i) helping marketers use our products to connect with consumers and (ii) making our ads more relevant and effective. We also continued to invest in both our family of apps and our metaverse efforts based on our company priorities. Our financial results and key community metrics for 2022 are set forth below. Our total revenue for 2022 was $116.61 billion, a decrease of 1% compared to 2021, which reflects a $5.96 billion negative impact from the appreciation of the U.S. dollar relative to other foreign currencies. Revenue on a constant currency basis was $122.57 billion for 2022, an increase of 4% compared to 2021. Our advertising revenue was impacted by a reduction in advertising demand during 2022 compared to 2021, which we believe was primarily driven by reduced marketer spending as a result of a more challenging macroeconomic environment, as well as limitations on our ad targeting and measurement tools arising from changes to iOS and the regulatory environment. Our average price per ad decreased by 16% year-over-year in 2022, partially offset by an 18% year-over-year increase in ad impressions delivered across our Family of Apps.Income from operations for 2022 was $28.94 billion, a decrease of $17.81 billion, or 38%, compared to 2021, mainly due to an increase in payroll and related expenses associated with a 20% increase in employee headcount particularly in engineering and other technical functions and higher operational expenses related to our data centers and technical infrastructure. Starting in the third quarter of 2022, we began a series of cost management initiatives including facilities consolidation, a layoff of approximately 11,000 employees, and a pivot in our data center strategy, which resulted in total restructuring charges of $4.61 billion in 2022. We expect we may incur significant additional restructuring charges as we continue to focus on cost efficiency measures through 2023. 54Table of ContentsConsolidated and Segment ResultsWe report our financial results for our two reportable segments: Family of Apps (FoA) and Reality Labs (RL). FoA includes Facebook, Instagram, Messenger, WhatsApp, and other services. RL includes our augmented and virtual reality related consumer hardware, software, and content.Family of AppsReality LabsTotalYear EndedDecember 31,Year EndedDecember 31,Year EndedDecember 31,20222021% change20222021% change20222021% change(in millions, except percentages)Revenue$114,450 $115,655 (1)%$2,159 $2,274 (5)%$116,609 $117,929 (1)%Costs and expenses$71,789 $58,709 22%$15,876 $12,467 27%$87,665 $71,176 23%Income (loss) from operations$42,661 $56,946 (25)%$(13,717)$(10,193)(35)%$28,944 $46,753 (38)%Operating margin37 %49 %(635)%(448)%25 %40 % •Net income was $23.20 billion, with diluted earnings per share of $8.59 for the year ended December 31, 2022.•Capital expenditures, including principal payments on finance leases, were $32.04 billion for the year ended December 31, 2022.•Effective tax rate was 19.5% for the year ended December 31, 2022.•Cash, cash equivalents, and marketable securities were $40.74 billion as of December 31, 2022.•Long-term debt was $9.92 billion as of December 31, 2022.•Headcount was 86,482 as of December 31, 2022, an increase of 20% year-over-year. Our reported headcount includes a substantial majority of the approximately 11,000 employees impacted by the layoff we announced in November 2022, who will no longer be reflected in our headcount by the end of the first quarter of 2023.RestructuringIn 2022, we initiated several measures to pursue greater efficiency and to realign our business and strategic priorities. This includes a facilities consolidation strategy to sublease, early terminate, or abandon several office buildings under operating leases, a layoff of approximately 11,000 of our employees across the FoA and RL segments, and a pivot towards a next generation data center design, including cancellation of multiple data center projects.A summary of our restructuring charges for the year ended December 31, 2022 by major activity type is as follows (in millions):Facilities ConsolidationSeverance and Other Personnel CostsData Center AssetsTotalCost of revenue$154 $— $1,341 $1,495 Research and development1,311 408 — 1,719 Marketing and sales404 234 — 638 General and administrative426 333 — 759 Total$2,295 $975 $1,341 $4,611 Total restructuring charges recorded under our FoA segment were $4.10 billion and RL segment were $515 million. These charges lowered our operating margin by four percentage points and diluted earnings per share (EPS) by $1.34. The impact of severance and other personnel costs recorded in the fourth quarter of 2022 was not material after offsetting with the savings from the decreases in payroll, bonus and other benefits expenses.See Note 3 — Restructuring in the notes to the consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K for additional information regarding restructuring charges.55Table of ContentsFamily of Apps Metrics•Family daily active people (DAP) was 2.96 billion on average for December 2022, an increase of 5% year-over-year.•Family monthly active people (MAP) was 3.74 billion as of December 31, 2022, an increase of 4% year-over-year.•Facebook daily active users (DAUs) were 2.00 billion on average for December 2022, an increase of 4% year-over-year.•Facebook monthly active users (MAUs) were 2.96 billion as of December 31, 2022, an increase of 2% year-over-year.•Ad impressions delivered across our Family of Apps increased by 18% year-over-year in 2022, and the average price per ad decreased by 16% year-over-year in 2022.Developments in AdvertisingSubstantially all of our revenue is currently generated from advertising on Facebook and Instagram. We rely on targeting and measurement tools that incorporate data signals from user activity on websites and services that we do not control in order to deliver relevant and effective ads to our users. Our advertising revenue has been, and we expect will continue to be, adversely affected by reduced marketer spending as a result of limitations on our ad targeting and measurement tools arising from changes to the regulatory environment and third-party mobile operating systems and browsers.In particular, legislative and regulatory developments such as the General Data Protection Regulation, ePrivacy Directive, and California Privacy Rights Act have impacted our ability to use data signals in our ad products, and we expect these and other developments such as the Digital Markets Act will have further impact in the future. As a result, we have implemented, and we will continue to implement, changes to our products and user data practices, which reduce our ability to effectively target and measure ads. In addition, mobile operating system and browser providers, such as Apple and Google, have implemented product changes and/or announced future plans to limit the ability of websites and application developers to collect and use these signals to target and measure advertising. For example, in 2021, Apple made certain changes to its products and data use policies in connection with changes to its iOS operating system that reduce our and other iOS developers' ability to target and measure advertising, which has negatively impacted, and we expect will continue to negatively impact, the size of the budgets marketers are willing to commit to us and other advertising platforms.To mitigate these developments, we are working to evolve our advertising systems to improve the performance of our ad products. We are developing privacy enhancing technologies to deliver relevant ads and measurement capabilities while reducing the amount of personal information we process, including by relying more on anonymized or aggregated third-party data. In addition, we are developing tools that enable marketers to share their data into our systems, as well as ad products that generate more valuable signals within our apps. More broadly, we also continue to innovate our advertising tools to help marketers prepare campaigns and connect with consumers, including developing growing formats such as Reels ads and our business messaging ad products. Across all of these efforts, we are making significant investments in artificial intelligence and machine learning to improve our delivery, targeting, and measurement capabilities. We are also engaging with others across our industry to explore the possibility of new open standards for the private and secure processing of data for advertising purposes. We expect that some of these efforts will be long-term initiatives, and that the regulatory and platform developments described above will continue to adversely impact our advertising revenue for the foreseeable future.Other Business and Macroeconomic ConditionsOther global and regional business, macroeconomic, and geopolitical conditions also have had, and we believe will continue to have, an impact on our user growth and engagement and advertising revenue. In particular, we believe advertising budgets have been pressured by factors such as inflation, rising interest rates, and related market uncertainty, which has led to reduced marketer spending. In addition, competitive products and services have reduced some users' engagement with our products and services. In response to competitive pressures, we have introduced new features such as Reels and are investing in our artificial intelligence-powered discovery engine to recommend relevant unconnected content across our products. While Reels is growing in usage, it is not currently monetized at the same rate as our feed or Stories products. We also have seen fluctuations and declines in the size of our active user base in one or more markets from time to time. For example, in connection with the war in Ukraine, access to Facebook and Instagram was restricted in Russia and the services were then prohibited by the Russian government, which adversely affected user growth and engagement in 2022. These trends adversely affected advertising revenue in 2022, and we expect will continue to affect our advertising revenue in the foreseeable future.56Table of ContentsThe COVID-19 pandemic has also impacted our business and results of operations, with a varied impact on user growth and engagement, as well as the demand for and pricing of our ads from period to period. While we experienced a reduction in advertising demand and a related decline in pricing during the onset of the pandemic, we believe the pandemic subsequently contributed to an acceleration in the growth of online commerce, and we experienced increasing demand for advertising as a result of this trend. More recently, we believe this growth has declined, and we saw continued softening of advertising demand in 2022 as many activities that shifted online during COVID-19 related lockdowns resumed in person. We may experience similar volatility in the demand for and pricing of our advertising services as a result of the pandemic in the future.Although we regularly evaluate a variety of sources to understand trends in our advertising revenue, we do not have perfect visibility into the factors driving advertiser spending decisions and our assessments involve complex judgments about what is driving advertising decisions across a large and diversified advertiser base across the globe. Trends impacting advertising spend are also dynamic and interrelated. As a result, it is difficult to identify with precision which advertiser spending decisions are attributable to which trends, and we are unable to quantify the exact impact that each trend had on our advertising revenue during the periods presented.Investment PhilosophyIn 2022, we continued to invest based on the following company priorities: (i) continue making progress on the major social issues facing the internet and our company, including privacy, safety, and security; (ii) build new experiences that meaningfully improve people's lives today and set the stage for even bigger improvements in the future; (iii) keep building our business by supporting the millions of businesses that rely on our services to grow and create jobs; and (iv) communicate more transparently about what we're doing and the role our services play in the world.We anticipate that investments in our data center capacity, servers, network infrastructure, and headcount will continue to drive expense growth in 2023, which will adversely affect our operating margin and profitability. The majority of our investments are directed toward developing our family of apps. In 2022, 82% of our total costs and expenses were recognized in FoA and 18% were recognized in RL. Our FoA investments include expenses relating to headcount, data centers and technical infrastructure as part of our efforts to develop our apps and our advertising services. We are also making significant investments in our metaverse efforts, including developing virtual and augmented reality devices, software for social platforms, neural interfaces, and other foundational technologies for the metaverse. Our RL investments include expenses relating to headcount and technology development across these efforts. Many of our RL investments are directed toward long-term, cutting-edge research and development for products for the metaverse that are not on the market today and may only be fully realized in the next decade. Although it is inherently difficult to predict when and how the metaverse ecosystem will develop, we expect our RL segment to continue to operate at a loss for the foreseeable future, and our ability to support our metaverse efforts is dependent on generating sufficient profits from other areas of our business. We expect this will be a complex, evolving, and long-term initiative. We are investing now because we believe this is the next chapter of the internet and will unlock monetization opportunities for businesses, developers, and creators, including around advertising, hardware, and digital goods.57Table of ContentsTrends in Our Family MetricsThe numbers for our key Family metrics, our DAP, MAP, and average revenue per person (ARPP), do not include users on our other products unless they would otherwise qualify as DAP or MAP, respectively, based on their other activities on our Family products. Trends in the number of people in our community affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active people (as defined below) access our Family products on mobile devices.•Daily Active People (DAP). We define a daily active person as a registered and logged-in user of Facebook, Instagram, Messenger, and/or WhatsApp (collectively, our "Family" of products) who visited at least one of these Family products through a mobile device application or using a web or mobile browser on a given day. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of DAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view DAP, and DAP as a percentage of MAP, as measures of engagement across our products. For additional information, see the section entitled "Limitations of Key Metrics and Other Data" in this Annual Report on Form 10-K. DAP/MAP:79%79%79%78%79%79%79%79%79%Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled "Limitations of Key Metrics and Other Data" in this Annual Report on Form 10-K. In the first quarter of 2021, we updated our Family metrics calculations to maintain calibration of our models against recent user survey data, and we estimate such update contributed an aggregate of approximately 60 million DAP to our reported worldwide DAP in March 2021. In the third quarter of 2022, we updated our Family metrics calculations to maintain calibration of our models against recent user survey data, and we estimate such update contributed an aggregate of approximately 30 million DAP to our reported worldwide DAP in September 2022.Worldwide DAP increased 5% to 2.96 billion on average during December 2022 from 2.82 billion during December 2021. 58Table of Contents•Monthly Active People (MAP). We define a monthly active person as a registered and logged-in user of one or more Family products who visited at least one of these Family products through a mobile device application or using a web or mobile browser in the last 30 days as of the date of measurement. We do not require people to use a common identifier or link their accounts to use multiple products in our Family, and therefore must seek to attribute multiple user accounts within and across products to individual people. Our calculations of MAP rely upon complex techniques, algorithms, and machine learning models that seek to estimate the underlying number of unique people using one or more of these products, including by matching user accounts within an individual product and across multiple products when we believe they are attributable to a single person, and counting such group of accounts as one person. As these techniques and models require significant judgment, are developed based on internal reviews of limited samples of user accounts, and are calibrated against user survey data, there is necessarily some margin of error in our estimates. We view MAP as a measure of the size of our global active community of people using our products. For additional information, see the section entitled "Limitations of Key Metrics and Other Data" in this Annual Report on Form 10-K.Note: We report the numbers of DAP and MAP as specific amounts, but these numbers are estimates of the numbers of unique people using our products and are subject to statistical variances and errors. While we expect the error margin for these estimates to vary from period to period, we estimate that such margin generally will be approximately 3% of our worldwide MAP. At our scale, it is very difficult to attribute multiple user accounts within and across products to individual people, and it is possible that the actual numbers of unique people using our products may vary significantly from our estimates, potentially beyond our estimated error margins. For additional information, see the section entitled "Limitations of Key Metrics and Other Data" in this Annual Report on Form 10-K. In the first quarter of 2021, we updated our Family metrics calculations to maintain calibration of our models against recent user survey data, and we estimate such update contributed an aggregate of approximately 70 million MAP to our reported worldwide MAP in March 2021. In the third quarter of 2022, we updated our Family metrics calculations to maintain calibration of our models against recent user survey data, and we estimate such update contributed an aggregate of approximately 40 million MAP to our reported worldwide MAP in September 2022.As of December 31, 2022, we had 3.74 billion MAP, an increase of 4% from 3.59 billion as of December 31, 2021. 59Table of Contents•Average Revenue Per Person (ARPP). We define ARPP as our total revenue during a given quarter, divided by the average of the number of MAP at the beginning and end of the quarter. While ARPP includes all sources of revenue, the number of MAP used in this calculation only includes users of our Family products as described in the definition of MAP above. We estimate that the share of revenue from users who are not also MAP was not material. ARPP:$8.62$7.75$8.36$8.18$9.39$7.72$7.91$7.53$8.63 Note: Non-advertising revenue includes RL revenue generated from the delivery of consumer hardware products and FoA Other revenue, which consists of net fees we receive from developers using our Payments infrastructure and revenue from various other sources.Our annual worldwide ARPP in 2022, which represents the sum of quarterly ARPP during such period, was $31.79, a decrease of 6% from 2021.60Table of ContentsTrends in Our Facebook User MetricsThe numbers for our key Facebook metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include users on Instagram, WhatsApp, or our other products, unless they would otherwise qualify as DAUs or MAUs, respectively, based on their other activities on Facebook.Trends in the number of users affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active users (as defined below) access Facebook on mobile devices. •Daily Active Users (DAUs). We define a daily active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement on Facebook. DAU/MAU:66%66%66%66%66%67%67%67%67% DAU/MAU:76%75%75%75%74%75%75%74%75%DAU/MAU:74%73%73%73%72%73%74%74%75% DAU/MAU:62%62%62%63%63%64%64%64%65%DAU/MAU:65%65%65%66%65%66%66%66%66%Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East. 61Table of ContentsWorldwide DAUs increased 4% to 2.00 billion on average during December 2022 from 1.93 billion during December 2021. Users in India, the Philippines, and Bangladesh represented the top three sources of growth in DAUs during December 2022, relative to the same period in 2021.•Monthly Active Users (MAUs). We define a monthly active user as a registered and logged-in Facebook user who visited Facebook through our website or a mobile device, or used our Messenger application (and is also a registered Facebook user), in the last 30 days as of the date of measurement. MAUs are a measure of the size of our global active user community on Facebook. As of December 31, 2022, we had 2.96 billion MAUs, an increase of 2% from December 31, 2021. Users in India, Nigeria, and Bangladesh represented the top three sources of growth in 2022, relative to the same period in 2021.62Table of ContentsTrends in Our Monetization by Facebook User GeographyWe calculate our revenue by user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or consumer hardware products are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users of Facebook and Messenger as described in the definition of MAU above. While the share of revenue from users who are not also Facebook or Messenger MAUs has grown over time, we estimate that revenue from users who are Facebook or Messenger MAUs represents the substantial majority of our total revenue. See "Average Revenue Per Person (ARPP)" above for our estimates of trends in our monetization of our Family products. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States & Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in 2022 in the United States & Canada region was more than 11 times higher than in the Asia-Pacific region.ARPU:$10.14 $9.27 $10.12 $10.00$11.57$9.54$9.82$9.41$10.86 ARPU:$53.56 $48.03 $53.01 $52.34 $60.57 $48.29$50.25$49.13$58.77ARPU:$16.87$15.49$17.23$16.50$19.68$15.35$15.64$14.23$17.29 ARPU:$4.05$3.94$4.16$4.30$4.89$4.47$4.54$4.42$4.61ARPU:$2.77$2.64$3.05$3.14$3.43$3.14$3.35$3.21$3.52 Note: Non-advertising revenue includes RL revenue generated from the delivery of consumer hardware products and FoA Other revenue, which consists of net fees we receive from developers using our Payments infrastructure and revenue from various other sources.63Table of Contents Our revenue by user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our users when they perform a revenue-generating activity. This allocation differs from our revenue disaggregated by geography disclosure in Note 2 — Revenue in our consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplemental Data" where revenue is geographically apportioned based on the addresses of our customers. Our annual worldwide ARPU in 2022, which represents the sum of quarterly ARPU during such period, was $39.63, a decrease of 3% from 2021. For 2022, ARPU decreased by 9% in Europe and 4% in United States & Canada, and increased by 4% in Asia-Pacific and 8% in Rest of World. In addition, user growth was mostly in geographies with relatively lower ARPU, such as Asia‑Pacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may decrease at a higher rate, or increase at a slower rate, relative to ARPU in any geographic region in a particular period, or potentially decrease even if ARPU increases in each geographic region.64Table of ContentsCritical Accounting Policies and EstimatesOur consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Our actual results could differ from these estimates under different assumptions or conditions.An accounting policy is deemed to be critical if the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and the impact of the estimates and assumptions on our consolidated financial statements is material. We believe that the assumptions and estimates associated with gross vs. net in revenue recognition, valuation of non-marketable equity securities, income taxes, loss contingencies, and valuation of long-lived assets including goodwill, intangible assets, and property and equipment, and their associated estimated useful lives, when applicable, have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see Note 1 — Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.Gross vs. Net in Revenue RecognitionFor revenue generated from arrangements that involve third parties, there is significant judgment in evaluating whether we are the principal, and report revenue on a gross basis, or the agent, and report revenue on a net basis. In this assessment, we consider if we obtain control of the specified goods or services before they are transferred to the customer, as well as other indicators such as the party primarily responsible for fulfillment, inventory risk, and discretion in establishing price. The assessment of whether we are considered the principal or the agent in a transaction could impact our revenue and cost of revenue recognized on the consolidated statements of income. Valuation of Non-marketable Equity SecuritiesFor our non-marketable equity securities without readily determinable fair values accounted for using the measurement alternative, determining whether a non-marketable equity security issued by the same issuer is similar to the non-marketable equity security we hold may require judgment in (a) assessment of differences in rights and obligations associated with the instruments such as voting rights, distribution rights and preferences, and conversion features, and (b) adjustments to the observable price for differences such as, but not limited to, rights and obligations, control premium, liquidity, or principal or most advantageous markets. In addition, the identification of observable transactions will depend on the timely reporting of these transactions from our investee companies, which may occur in a period subsequent to when the transactions take place. Therefore, our fair value adjustment for these observable transactions may occur in a period subsequent to when the transaction actually occurred. For non-marketable equity securities, we perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; regulatory, economic or technological environment; operational and financing cash flows; and other relevant events and factors affecting the investee. When indicators of impairment exist, we estimate the fair value of our non-marketable equity securities using the market approach and/or the income approach and recognize impairment loss in the consolidated statements of income if the estimated fair value is less than the carrying value. Estimating fair value requires judgment and use of estimates such as discount rates, forecast cash flows, holding period, and market data of comparable companies, among others.Income TaxesWe are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws. We recognize tax benefits from uncertain tax positions only if we believe that it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. These uncertain tax positions include our estimates for transfer pricing that have been developed based upon analyses of appropriate 65Table of Contentsarms-length prices. Similarly, our estimates related to uncertain tax positions concerning research and development tax credits are based on an assessment of whether our available documentation corroborating the nature of our activities supporting the tax credits will be sufficient. Although we believe that we have adequately reserved for our uncertain tax positions (including net interest and penalties), we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves in accordance with the income tax accounting guidance when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made, and could have a material impact on our financial condition and operating results.Loss ContingenciesWe are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. Additionally, we are required to comply with various legal and regulatory obligations around the world, and we regularly become subject to new laws and regulations in the jurisdictions in which we operate. The requirements for complying with these obligations may be uncertain and subject to interpretation and enforcement by regulatory and other authorities, and any failure to comply with such obligations could eventually lead to asserted legal or regulatory action. With respect to these matters, asserted and unasserted, we evaluate the associated developments on a regular basis and accrue a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be reasonably estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material.We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the merits of our defenses and the impact of negotiations, settlements, regulatory proceedings, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine the probability of loss and the estimated amount of loss, including when and if the probability and estimate has changed for asserted and unasserted matters. Certain factors, in particular, have resulted in significant changes to these estimates and judgments in prior quarters based on updated information available. For example, in certain jurisdictions where we operate, fines and penalties may be the result of new laws and preliminary interpretations regarding the basis of assessing damages, which may make it difficult to estimate what such fines and penalties would amount to if successfully asserted against us. In addition, certain government inquiries and investigations, such as matters before our lead European Union privacy regulator, the IDPC, are subject to review by other regulatory bodies before decisions are finalized, which can lead to significant changes in the outcome of an inquiry. As a result of these and other factors, we reasonably expect that our estimates and judgments with respect to our contingencies may continue to be revised in future quarters. The ultimate outcome of these matters, such as whether the likelihood of loss is remote, reasonably possible, or probable or if and when the reasonably possible range of loss is estimable, is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's estimates of losses, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected. See Note 13 — Commitments and Contingencies and Note 16 — Income Taxes of the accompanying notes to our consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" and Part I, Item 3, "Legal Proceedings" of this Annual Report on Form 10-K for additional information regarding these contingencies.Valuation of Long-lived Assets including Goodwill, Intangible Assets, and Property and Equipment and Estimated Useful Lives We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill to reporting units based on the expected benefit from the business combination. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, estimated replacement costs and future expected cash flows from acquired users, acquired technology, acquired patents, and trade 66Table of Contentsnames from a market participant perspective, useful lives, and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects our amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite-lived intangible assets, including goodwill, are not amortized. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.Goodwill is tested for impairment at the reporting unit level annually or more frequently if events or changes in circumstances would more likely than not reduce the fair value of a reporting unit below its carrying value. We have two reporting units subject to goodwill impairment testing. As of December 31, 2022, no impairment of goodwill has been identified.Long-lived assets, including property and equipment and finite-lived intangible assets are reviewed for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. The evaluation is performed at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate from the use and eventual disposition. If such review indicates that the carrying amount of property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value.The useful lives of our long-lived assets including property and equipment and finite-lived intangible assets are determined by management when those assets are initially recognized and are routinely reviewed for the remaining estimated useful lives. The current estimate of useful lives represents our best estimate based on current facts and circumstances, but may differ from the actual useful lives due to changes in future circumstances such as changes to our business operations, changes in the planned use of assets, and technological advancements. When we change the estimated useful life assumption for any asset, the remaining carrying amount of the asset is accounted for prospectively and depreciated or amortized over the revised remaining useful life. In connection with our periodic reviews of the estimated useful lives of property and equipment, we extended the estimated average useful lives of our servers and network assets category effective the second and the fourth quarters of 2022. The financial impact of the changes in estimates was a reduction in depreciation expense of $860 million and an increase in net income of $693 million, or $0.26 per diluted share for the year ended December 31, 2022. The impact from the changes in our estimates was calculated based on the servers and network assets existing as of the effective date of the change and applying the revised useful lives prospectively. See Note 1 — Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K, for additional information regarding the changes in the estimated useful lives of our servers and network assets.67Table of ContentsComponents of Results of OperationsRevenue Family of Apps (FoA)Advertising. We generate substantially all of our revenue from advertising. Our advertising revenue is generated by displaying ad products on Facebook, Instagram, Messenger, and third-party mobile applications. Marketers pay for ad products either directly or through their relationships with advertising agencies or resellers, based on the number of impressions delivered or the number of actions, such as clicks, taken by users. We recognize revenue from the display of impression-based ads in the contracted period in which the impressions are delivered. Impressions are considered delivered when an ad is displayed to a user. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. The number of ads we show is subject to methodological changes as we continue to evolve our ads business and the structure of our ads products. In particular, the number of ads we show may vary by product (for example, our video and Reels products are not currently monetized at the same rate as our feed or Stories products), and from time to time we increase or decrease the number or frequency of ads we show as part of our product and monetization strategies. We calculate average price per ad as total advertising revenue divided by the number of ads delivered, representing the average price paid per ad by a marketer regardless of their desired objective such as impression or action. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis. Other revenue. Other revenue consists of net fees we receive from developers using our Payments infrastructure and revenue from WhatsApp Business Platform and various other sources.Reality Labs (RL)RL revenue is generated from the delivery of consumer hardware products, such as Meta Quest, wearables, and related software and content.Cost of Revenue and Operating Expenses Cost of revenue. Our cost of revenue consists mostly of expenses associated with the delivery and distribution of our products. These include expenses related to the operation of our data centers and technical infrastructure, such as depreciation expense from servers, network infrastructure and buildings, as well as payroll and related expenses which include share-based compensation for employees on our operations teams, and energy and bandwidth costs. Cost of revenue also includes costs associated with partner arrangements, including traffic acquisition costs and credit card and other fees related to processing customer transactions, and content costs. Additionally, cost of revenue includes RL inventory costs, which consist of cost of products sold and estimated losses on non-cancelable contractual commitments. Research and development. Research and development expenses consist primarily of payroll and related expenses which include share-based compensation, facilities-related costs for employees on our engineering and technical teams who are responsible for developing new products as well as improving existing products, RL technology development costs, and professional services. Marketing and sales. Marketing and sales expenses consist mostly of marketing and promotional expenses as well as payroll and related expenses which include share-based compensation for our employees engaged in sales, sales support, marketing, business development, and customer service functions. Our marketing and sales expenses also include professional services such as content reviewers to support our community and product operations.General and administrative. General and administrative expenses consist primarily of payroll and related expenses which include share-based compensation for certain of our executives as well as our legal, finance, human resources, corporate communications and policy, and other administrative employees; legal-related costs, which include estimated fines, settlements, or other losses in connection with legal and related matters, as well as other legal fees; professional services, and other taxes, such as digital services taxes, other tax levies.68Table of ContentsResults of OperationsIn this section, we discuss the results of our operations for the year ended December 31, 2022 compared to the year ended December 31, 2021. For a discussion of the year ended December 31, 2021 compared to the year ended December 31, 2020, please refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2021.The following table sets forth our consolidated statements of income data (in millions):Year Ended December 31,202220212020Revenue$116,609 $117,929 $85,965 Costs and expenses: Cost of revenue25,249 22,649 16,692 Research and development35,338 24,655 18,447 Marketing and sales15,262 14,043 11,591 General and administrative11,816 9,829 6,564 Total costs and expenses87,665 71,176 53,294 Income from operations28,944 46,753 32,671 Interest and other income (expense), net(125)531 509 Income before provision for income taxes28,819 47,284 33,180 Provision for income taxes5,619 7,914 4,034 Net income$23,200 $39,370 $29,146 The following table sets forth our consolidated statements of income data (as a percentage of revenue)(1):Year Ended December 31,202220212020Revenue100 %100 %100 %Costs and expenses:Cost of revenue22 19 19 Research and development30 21 21 Marketing and sales13 12 13 General and administrative10 8 8 Total costs and expenses75 60 62 Income from operations25 40 38 Interest and other income (expense), net— — 1 Income before provision for income taxes25 40 39 Provision for income taxes5 7 5 Net income20 %33 %34 %_________________________(1)Percentages have been rounded for presentation purposes and may differ from unrounded results.69Table of ContentsRevenueThe following table sets forth our revenue by source and by segment. For comparative purposes, amounts for the year ended December 31, 2020 have been recast: Year Ended December 31, 2022202120202022 vs 2021 % change2021 vs 2020 % change(in millions, except percentages)Advertising$113,642 $114,934 $84,169 (1)%37 %Other revenue808 721 657 12 %10 %Family of Apps114,450 115,655 84,826 (1)%36 %Reality Labs2,159 2,274 1,139 (5)%100 %Total revenue$116,609 $117,929 $85,965 (1)%37 %Family of AppsFoA revenue in 2022 decreased $1.21 billion, or 1%, compared to 2021. The decrease was mostly driven by advertising revenue.AdvertisingAdvertising revenue in 2022 decreased $1.29 billion, or 1%, compared to 2021 due to a decrease in the average price per ad, partially offset by an increase in the number of ads delivered. In 2022, the average price per ad decreased by 16%, as compared with an increase of 24% in 2021. The decrease in average price per ad was driven by an increase in the number of ads delivered, especially in geographies and in products such as video and Reels that monetize at lower rates, and an unfavorable foreign exchange impact. In addition, the decrease in average price per ad was impacted by a reduction in advertising demand, which we believe was primarily driven by reduced marketer spending as a result of a more challenging macroeconomic environment and limitations on our ad targeting and measurement tools arising from changes to iOS and the regulatory environment, as well as, to a lesser extent, the other factors discussed in the section entitled "—Executive Overview of Full Year 2022 Results." In 2022, the number of ads delivered increased by 18%, as compared with a 10% increase in 2021. Ads impressions grew in all regions during 2022, mostly driven by an increase in ads delivered in Asia-Pacific and Rest of World. The increase in the ads delivered during 2022 was driven by increases in the number and frequency of ads displayed across our products and an increase in users. We anticipate that future advertising revenue will be driven by a combination of price and the number of ads delivered.Reality LabsRL revenue in 2022 decreased $115 million, or 5%, compared to 2021. The decrease in RL revenue was driven by a decrease in the volume of Meta Quest sales.Revenue Seasonality and Customer ConcentrationRevenue is traditionally seasonally strong in the fourth quarter of each year due in part to seasonal holiday demand. We believe that this seasonality in both advertising revenue and RL consumer hardware sales affects our quarterly results, which generally reflect significant growth in revenue between the third and fourth quarters and a decline between the fourth and subsequent first quarters. For instance, our total revenue increased 16%, 16%, and 31% between the third and fourth quarters of 2022, 2021, and 2020, respectively, while total revenue for the first quarters of 2022, 2021, and 2020 declined 17%, 7%, and 16% compared to the fourth quarters of 2021, 2020, and 2019, respectively.No customer represented 10% or more of total revenue during the years ended December 31, 2022, 2021, and 2020.Foreign Exchange Impact on Revenue The general strengthening of the U.S. dollar relative to certain foreign currencies in the full year 2022 compared to the same period in 2021 had an unfavorable impact on revenue. If we had translated revenue for the full year 2022 using the prior 70Table of Contentsyear's monthly exchange rates for our settlement or billing currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $122.57 billion and $119.54 billion, respectively. Using these constant rates, total revenue and advertising revenue would have been $5.96 billion and $5.90 billion higher than actual total revenue and advertising revenue, respectively, for the full year 2022. Using the same constant rates, full year 2022 total revenue and advertising revenue would have been $4.64 billion and $4.60 billion, respectively, higher than actual total revenue and advertising revenue for the full year 2021.Cost of revenueYear Ended December 31,2022202120202022 vs 2021 % change2021 vs 2020 % change(in millions, except percentages)Cost of revenue$25,249 $22,649 $16,692 11 %36 %Percentage of revenue22 %19 %19 %Cost of revenue in 2022 increased $2.60 billion, or 11%, compared to 2021. The increase was mainly due to an increase in operational expenses related to our data centers and technical infrastructure, adjusted for a decrease in the depreciation growth rate due to extensions in the useful lives of servers and network assets. In addition, we recorded $1.34 billion of abandonment charges related to data center assets. These increases were partially offset by a decrease in RL inventory cost including lower losses on purchase commitments.See Note 1 — Summary of Significant Accounting Policies and Note 3 — Restructuring in the notes to the consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K for additional information regarding changes in the estimated useful life of our servers and network assets as well as the abandonment charges related to data center assets, respectively.Research and developmentYear Ended December 31,2022202120202022 vs 2021 % change2021 vs 2020 % change(in millions, except percentages)Research and development$35,338 $24,655 $18,447 43 %34 %Percentage of revenue30 %21 %21 %Research and development expenses in 2022 increased $10.68 billion, or 43%, compared to 2021. The increase was mainly due to higher payroll and related expenses and $1.31 billion impairment charges to leases and leasehold improvements as part of our restructuring efforts. Our payroll and related expenses increased as a result of a 26% increase in employee headcount from December 31, 2021 to December 31, 2022 in engineering and other technical functions supporting our continued investment in our family of products and RL.Marketing and salesYear Ended December 31,2022202120202022 vs 2021 % change2021 vs 2020 % change(in millions, except percentages)Marketing and sales$15,262 $14,043 $11,591 9 %21 %Percentage of revenue13 %12 %13 %Marketing and sales expenses in 2022 increased $1.22 billion, or 9%, compared to 2021. The increase was mostly due to increases in payroll and related expenses and $404 million impairment charges to leases and leasehold improvements as part of our restructuring efforts. 71Table of ContentsGeneral and administrativeYear Ended December 31,2022202120202022 vs 2021 % change2021 vs 2020 % change(in millions, except percentages)General and administrative$11,816 $9,829 $6,564 20 %50 %Percentage of revenue10 %8 %8 % General and administrative expenses in 2022 increased $1.99 billion, or 20%, compared to 2021. The increase was primarily due to increases in payroll and related expenses and $426 million impairment charges to leases and leasehold improvements as part of our restructuring efforts. Our payroll and related expenses increased as a result of a 20% increase in employee headcount from December 31, 2021 to December 31, 2022 in our general and administrative functions.See Note 3 — Restructuring in the notes to the consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K for additional information regarding impairment charges to leases and leasehold improvements. Segment profitabilityThe following table sets forth income (loss) from operations by segment. For comparative purposes, amounts for the year ended December 31, 2020 have been recast:Year Ended December 31,2022202120202022 vs 2021 % change2021 vs 2020 % change(in millions, except percentages)Family of Apps$42,661 $56,946 $39,294 (25)%45 %Reality Labs(13,717)(10,193)(6,623)(35)%(54)%Total income from operations$28,944 $46,753 $32,671 (38)%43 %Family of AppsFoA income from operations in 2022 decreased $14.29 billion, or 25%, compared to 2021. The decrease was due to an increase in FoA total costs and expenses, primarily due to an increase in payroll and related expenses as a result of higher employee headcount, additional charges recorded related to our restructuring efforts and an increase in costs related to our data centers and technical infrastructure.See Note 3 — Restructuring in the notes to the consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K for additional information.Reality LabsRL loss from operations in 2022 increased $3.52 billion, or 35%, compared to 2021. The increase in loss from operations was mainly driven by increases in payroll and related expenses and research and development expenses, partially offset by a decrease in RL inventory cost including lower losses on purchase commitments.72Table of ContentsInterest and other income (expense), netYear Ended December 31,2022202120202022 vs 2021 % change2021 vs 2020 % change(in millions, except percentages)Interest income, net$276 $461 $672 (40)%(31)%Foreign currency exchange losses, net(81)(140)(129)42 %(9)%Other income (expense), net(320)210 (34)(252)%NMInterest and other income (expense), net$(125)$531 $509 (124)%4 % Interest and other income (expense), net in 2022 decreased $656 million, or 124%, compared to 2021. The decrease was mostly due to a decrease in other income (expense), net related to higher unrealized losses recognized for our equity investments and an increase in interest expense recognized on long-term debt. Provision for income taxesYear Ended December 31,2022202120202022 vs 2021 % change2021 vs 2020 % change(in millions, except percentages)Provision for income taxes$5,619 $7,914 $4,034 (29)%96 %Effective tax rate19.5 %16.7 %12.2 %Our provision for income taxes in 2022 decreased $2.29 billion, or 29%, compared to 2021, mostly due to a decrease in income from operations.Our effective tax rate in 2022 increased compared to 2021, mainly due to an increase in tax shortfalls recognized from share-based compensation and the effect of regulations issued by the U.S. Department of the Treasury in 2022 on foreign tax credits, partially offset by an increase in tax benefits from foreign-derived intangible income.Effective Tax Rate Items. Our effective tax rate in the future will depend upon the proportion between the following items and income before provision for income taxes: U.S. tax benefits from foreign-derived intangible income, tax effects from share-based compensation, research tax credit, tax effects of integrating intellectual property from acquisitions, settlement of tax contingency items, tax effects of changes in our business, and the effects of changes in tax law.The accounting for share-based compensation may increase or decrease our effective tax rate based upon the difference between our share-based compensation expense and the deductions taken on our tax return, which depend upon the stock price at the time of employee award vesting. If our stock price remains constant to the January 27, 2023 price, and absent any changes to U.S. tax law, we expect our effective tax rate for the full year 2023 to be in the low twenties. This includes the effects of the mandatory capitalization and amortization of research and development expenses incurred in 2022, as required by the 2017 Tax Cuts and Jobs Act (Tax Act). The mandatory capitalization requirement increased our 2022 cash tax liabilities materially but also decreased our effective tax rate due to increasing the foreign-derived intangible income deduction. If the mandatory capitalization requirement is deferred, our effective tax rate in 2023 could be higher when compared to current law and our cash tax liabilities could be several billion dollars lower.Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods.On August 16, 2022, Congress passed the Inflation Reduction Act of 2022. The key tax provisions applicable to us are a 15% corporate minimum tax on book income and a 1% excise tax on stock repurchases effective January 1, 2023. We do 73Table of Contentsnot expect these tax law changes to have a material impact on our consolidated financial position; however, we will continue to evaluate their impact as further information becomes available.Unrecognized Tax Benefits. As of December 31, 2022, we had net uncertain tax positions of $5.49 billion which were accrued as other liabilities. These unrecognized tax benefits were predominantly accrued for uncertainties related to transfer pricing with our foreign subsidiaries, which includes licensing of intellectual property, providing services and other transactions, as well as for uncertainties regarding the utilization of our research tax credits. The ultimate settlement of the liabilities will depend upon resolution of tax audits, litigation, or events that would otherwise change the assessment of such items. Based upon the status of litigation described below and the current status of tax audits in various jurisdictions, we do not anticipate a material change to such amounts within the next 12 months.See Note 16 — Income Taxes in the notes to consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K for additional information regarding income tax contingencies.74Table of ContentsLiquidity and Capital ResourcesOur principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents and marketable securities consist mostly of cash on deposit with banks, investments in money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Cash and cash equivalents and marketable securities were $40.74 billion as of December 31, 2022, a decrease of $7.26 billion from December 31, 2021. The majority of the decrease was due to $32.04 billion for capital expenditures, including principal payments on finance leases, $27.96 billion repurchases of our Class A common stock, $3.60 billion of taxes paid related to net share settlement of employee restricted stock unit (RSU) awards, and $1.31 billion for acquisitions of businesses and intangible assets. These decreases were partially offset by $50.48 billion of cash generated from operations and $9.92 billion of net proceeds from the issuance of fixed-rate senior notes (the "Notes") in August 2022. Cash paid for income taxes was $6.41 billion for the year ended December 31, 2022. As of December 31, 2022, our federal net operating loss carryforward was $196 million and our federal tax credit carryforward was $276 million. We anticipate the utilization of most of these net operating losses and credits within the next two years. Our board of directors has authorized a share repurchase program of our Class A common stock, which commenced in January 2017 and does not have an expiration date. In 2022, we repurchased and subsequently retired 161 million shares of our Class A common stock for an aggregate amount of $27.93 billion. As of December 31, 2022, $10.87 billion remained available and authorized for repurchases. In January 2023, an additional $40 billion of repurchases was authorized under this program.The following table presents our cash flows (in millions):Year Ended December 31,202220212020Net cash provided by operating activities$50,475 $57,683 $38,747 Net cash used in investing activities$(28,970)$(7,570)$(30,059)Net cash used in financing activities$(22,136)$(50,728)$(10,292)Cash Provided by Operating ActivitiesCash provided by operating activities during 2022 mostly consisted of net income adjusted for certain non-cash items, such as $11.99 billion of share-based compensation expense, $8.69 billion of depreciation and amortization, and $3.56 billion of impairment for leases, leasehold improvements, and abandonment charges for data center assets related to our restructuring efforts. The decrease in cash flows from operating activities during 2022 compared to 2021 was mainly due to a decrease in net income as adjusted for the aforementioned non-cash items, partially offset by changes in working capital.Cash Used in Investing ActivitiesCash used in investing activities during 2022 mostly consisted of $31.19 billion of net purchases of property and equipment as we continued to invest in servers, data centers, and network infrastructure, partially offset by $3.53 billion proceeds from net sales and maturities of marketable debt securities. The increase in cash used in investing activities during 2022 compared to 2021 was mostly due to an increase in net purchases of property and equipment, and a decrease in proceeds from net sales and maturities of marketable debt securities.We anticipate making capital expenditures of approximately $30 billion to $33 billion in 2023.Cash Used in Financing ActivitiesCash used in financing activities during 2022 mostly consisted of $27.96 billion for repurchases of our Class A common stock and $3.60 billion of taxes paid related to net share settlement of RSUs, partially offset by $9.92 billion proceeds from the issuance of the Notes. The decrease in cash used in financing activities during 2022 compared to 2021 was mostly due to a decrease in repurchases of our Class A common stock and proceeds from the issuance of the Notes.75Table of ContentsFree Cash Flow In addition to other financial measures presented in accordance with U.S. GAAP, we monitor free cash flow (FCF) as a non-GAAP measure to manage our business, make planning decisions, evaluate our performance, and allocate resources. We define FCF as net cash provided by operating activities reduced by net purchases of property and equipment and principal payments on finance leases.We believe that FCF is one of the key financial indicators of our business performance over the long term and provides useful information regarding how cash provided by operating activities compares to the property and equipment investments required to maintain and grow our business. We have chosen our definition for FCF because we believe that this methodology can provide useful supplemental information to help investors better understand underlying trends in our business. We use FCF in discussions with our senior management and board of directors.FCF has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of other GAAP financial measures, such as net cash provided by operating activities. FCF is not intended to represent our residual cash flow available for discretionary expenses. Some of the limitations of FCF are:•FCF does not reflect our future contractual commitments; and•other companies in our industry present similarly titled measures differently than we do, limiting their usefulness as comparative measures.Management compensates for the inherent limitations associated with using the FCF measure through disclosure of such limitations, presentation of our financial statements in accordance with GAAP, and reconciliation of FCF to the most directly comparable GAAP measure, net cash provided by operating activities, as presented below.The following is a reconciliation of FCF to the most comparable GAAP measure, net cash provided by operating activities (in millions):Year Ended December 31,202220212020Net cash provided by operating activities$50,475 $57,683 $38,747 Purchases of property and equipment, net(31,186)(18,567)(15,115)Principal payments on finance leases(850)(677)(604)Free Cash Flow$18,439 $38,439 $23,028 Material Cash RequirementsWe currently anticipate that our available funds and cash flow from operations and financing activities will be sufficient to meet our operational cash needs and fund our share repurchase program for at least the next 12 months and thereafter for the foreseeable future. We continuously evaluate our liquidity and capital resources, including our access to external capital, to ensure we can finance our future capital requirements.Leases and Contractual CommitmentsOur operating lease obligations mostly include, among others, offices, data centers, colocations, and land. Our finance lease obligations mostly include certain network infrastructure. Our restructuring efforts to sublease, early terminate or abandon several office buildings under operating leases did not materially change our operating lease obligations. Our contractual commitments are primarily related to our investments in network infrastructure, servers, and consumer hardware products in Reality Labs. 76Table of ContentsLong-term DebtIn August 2022, we issued an aggregate of $10.0 billion principal amount of the Notes. The Notes were issued in four series, which mature from 2027 through 2062. Short-term and long-term future interest payments obligations as of December 31, 2022 are $411 million and $7.69 billion, respectively. We intend to use the net proceeds from the offering for general corporate purposes, which may include, but are not limited to, capital expenditures, repurchases of outstanding shares of our common stock, acquisitions, or investments.TaxesAs of December 31, 2022, we had taxes payable of $1.51 billion related to a one-time transition tax payable incurred as a result of the Tax Act, of which $361 million is due within one year. As permitted by the Tax Act, we will pay the transition tax in annual interest-free installments through 2025. Our other liabilities also include $5.49 billion related to the uncertain tax positions as of December 31, 2022. Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments.ContingenciesWe are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements to the extent material. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows.See Note 9 — Leases, Note 11 — Long-term Debt, Note 13 — Commitments and Contingencies, and Note 16 — Income Taxes in the notes to the consolidated financial statements included in Part II, Item 8, and "Legal Proceedings" contained in Part I, Item 3 of this Annual Report on Form 10-K for additional information regarding leases and contractual commitments, long-term debt, taxes, and contingencies.Recently Issued Accounting Pronouncements For information on recently issued accounting pronouncements, see Note 1 — Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K.77Table of ContentsItem 7A.Quantitative and Qualitative Disclosures About Market RiskWe are exposed to market risks, including changes to foreign currency exchange rates, interest rates, and equity price risk.Foreign Currency Exchange RiskWe have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Euro. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, have negatively affected, and may continue to negatively affect, our revenue and other operating results as expressed in U.S. dollars. See Management's Discussion and Analysis of Financial Condition and Results of Operations — Foreign Exchange Impact on Revenue section included in Part II, Item 7 of this Annual Report on Form 10-K for additional information.We have experienced and will continue to experience fluctuations in our net income as a result of transaction gains or losses related to revaluing monetary asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. At this time, we have not entered into, but in the future we may enter into, derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk. It is difficult to predict the effect hedging activities would have on our results of operations. Foreign currency exchange net losses of $81 million, $140 million, and $129 million were recognized in 2022, 2021, and 2020, respectively.Interest Rate SensitivityOur exposure to changes in interest rates relates primarily to interest income and market value of our cash equivalents, marketable debt securities, and the fair value of our long-term debt.Our cash, cash equivalents, and marketable debt securities consist of cash, certificates of deposit, time deposits, money market funds, U.S. government securities, U.S. government agency securities, and investment grade corporate debt securities. Our investment policy and strategy are focused on preservation of capital and supporting our liquidity requirements. Changes in U.S. interest rates affect the interest earned on our cash, cash equivalents, and marketable securities, and the market value of those securities. A hypothetical 100 basis point increase in market interest rates would have resulted in a decrease of $558 million and $714 million in the market value of our available-for-sale debt securities and cash equivalents as of December 31, 2022 and 2021, respectively. Any realized gains or losses resulting from such interest rate changes and from the current unrealized losses would only occur if we sold the investments prior to maturity.As of December 31, 2022, we also had $10.0 billion aggregate principal amount of fixed-rate senior notes (the "Notes") outstanding. Since our Notes bear interest at fixed rates and are carried at amortized cost, fluctuations in interest rates do not have any impact on our consolidated financial statements. However, the fair value of the Notes will fluctuate with movements in market interest rates, increasing in periods of declining interest rates and declining in periods of increasing interest rates. Equity Price RiskOur equity investments are substantially all in non-marketable equity securities and are subject to equity price risks that could have a material impact on the carrying value of our holdings.Our non-marketable equity securities are investments in privately-held companies without readily determinable fair values. We elected to account for most of our non-marketable equity securities using the measurement alternative, which is cost, less any impairment, adjusted for changes in fair value resulting from observable transactions for identical or similar investments of the same issuer. We perform a qualitative assessment at each reporting date to determine whether there are triggering events for impairment. The qualitative assessment considers factors such as, but not limited to, the investee's financial condition and business outlook; industry and sector performance; economic or technological environment; and other relevant events and factors affecting the investee. Valuations of our non-marketable equity securities are complex due to the lack of readily available market data and observable transactions. Uncertainties in the global economic climate and financial markets could adversely impact the valuation of these companies we invest in and, therefore, result in a material impairment or downward adjustment in our investments. Our total non-marketable equity securities had a carrying value of $6.20 billion and $6.78 billion as of December 31, 2022 and 2021, respectively. 78Table of ContentsFor additional information, see Note 1 — Summary of Significant Accounting Policies, Note 6 — Non-marketable Equity Securities, Note 7 — Fair Value Measurements, and Note 11 — Long-term Debt in the notes to the consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" and Part II, Item 7, "Management’s Discussion and Analysis of Financial Conditions and Results of Operations — Critical Accounting Policies and Estimates" contained in this Annual Report on Form 10-K. 79Table of Contents
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+EM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is provided as a supplement to – and should be read in conjunction with – our financial statements and the accompanying notes (“Notes”) included in Part II, Item 8 of this Form 10-K. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about our business and operations. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements. See “Forward-Looking Statements” and “Part I, Item 1A – Risk Factors.”This overview provides our perspective on the individual sections of MD&A. MD&A includes the following sections:●CANarchy Acquisition – a discussion of our acquisition of CANarchy on February 17, 2022;●Russia-Ukraine Conflict – a discussion of the impact of the Russia-Ukraine conflict on our business and operations;●The COVID-19 Pandemic – a discussion of the impact of the COVID-19 pandemic on our business and operations;●Pricing Actions – a discussion of certain pricing actions implemented during 2022;●Our Business – a general description of our business, the value drivers of our business, and opportunities and risks facing our Company, stock repurchases, acquisitions and divestitures;●Results of Operations – an analysis of our consolidated results of operations for the years ended December 31, 2022 and 2021;●Sales – details of our sales measured on a quarterly basis in both dollars and cases;●Inflation – information about the impact that inflation may or may not have on our results;●Liquidity and Capital Resources – an analysis of our cash flows, sources and uses of cash and contractual obligations;●Accounting Policies and Pronouncements – a discussion of accounting policies that require critical judgments and estimates including newly issued accounting pronouncements;●Forward-Looking Statements – cautionary information about forward-looking statements and a description of certain risks and uncertainties that could cause our actual results to differ materially from the Company’s historical results or our current expectations or projections; and●Market Risks – information about market risks and risk management. (See “Forward-Looking Statements” and “Part II, Item 7A – Qualitative and Quantitative Disclosures about Market Risks”).CANarchy AcquisitionOn February 17, 2022, we completed the CANarchy Transaction. The CANarchy Transaction facilitates our entry into the alcohol beverage sector and brings the Cigar CityTM family of brands including Jai Alai® IPA and Florida ManTM IPA, the Oskar BluesTM family of brands including Dale’s Pale Ale®, Wild BasinTM Hard Seltzers, the Deep EllumTM family of brands including Dallas Blonde® and Deep EllumTM IPA, the Perrin Brewing CompanyTM family of brands including Black Ale, the Squatters® family of brands including Hop Rising® Double IPA, and the Wasatch® family of brands including Apricot Hefeweizen to our beverage portfolio. The CANarchy Transaction did not include CANarchy’s stand-alone restaurants. Our organizational structure for our existing energy beverage business remains unchanged. CANarchy is functioning independently, retaining its own organizational structure and team.​44 Table of ContentsRussia-Ukraine ConflictDuring the year ended December 31, 2022, the Russia-Ukraine conflict did not have a material impact on our financial position, results of operations and liquidity. Net sales in Russia and Ukraine combined were approximately 1.1% of our total net sales for the twelve months ended December 31, 2021. We will continue to monitor future developments relative to this conflict and its potential impacts.​The COVID – 19 PandemicThe COVID-19 pandemic has directly and indirectly impacted our business. The duration and severity of this impact will depend on future developments that are highly uncertain and cannot be accurately predicted, including new information regarding the COVID-19 pandemic, as well as the emergence of new variants, the actions taken to limit its spread and the economic impact on local, regional, national and international markets. See “Part I, Item 1A – Risk Factors.”Pricing ActionsIn 2022, we implemented measures to mitigate our increased costs through price increases and reductions in promotions (“Pricing Actions”). We implemented a price increase effective September 1, 2022 in the United States and implemented price increases at various times in certain international markets, all of which positively impacted gross profit margins in the third and fourth quarters of 2022.Distribution and Supply ChainSince the beginning of the COVID-19 pandemic and the subsequent increased demand for our energy drinks, we prioritized ensuring product availability for our customers and consumers. This strategic direction has remained in place throughout the global supply chain challenges and disruptions, despite adversely impacting our profitability. We continue to stand by our strategy to ensure product availability and solidify the continued long-term growth of our brands.During the year ended December 31, 2022, we experienced a significant increase in cost of sales, resulting in a material decrease in both gross profit and gross profit as a percentage of net sales, relative to the comparative year ended December 31, 2021. The increase in cost of sales was primarily due to (i) increased ingredient and other input costs, including secondary packaging materials and increased co-packing fees, (ii) increased logistical costs, (iii) increased aluminum can costs and (iv) geographical and product sales mix.In the third and fourth quarters of 2022 we began to see an improvement in our gross profit margins as compared to the second quarter of 2022. This improvement was primarily attributable to (i) Pricing Actions, (ii) our decreased reliance on imported cans and (iii) improved finished product inventory levels in closer proximity to our customers, resulting in a reduction of long-distance freight costs. Furthermore, we experienced significant increases in distribution expenses, primarily the result of increased warehousing expenses, as well as increases in other logistical expenses, which adversely impacted operating costs.We continue to address the controllable challenges in our supply chain.Liquidity and Capital Resources As of the date of this filing, we expect to maintain substantial liquidity as we manage through the current environment as described in the “Liquidity and Capital Resources” section below.45 Table of ContentsOur BusinessOverviewWe develop, market, sell and distribute energy drink beverages and concentrates for energy drink beverages, primarily under the following brand names:●Monster Energy®●Monster Energy Ultra®●Monster Rehab®●Monster Energy® Nitro●Java Monster®●Punch Monster®●Juice Monster®●Monster Hydro® Energy Water●Monster Hydro® Super Sport●Monster Super Fuel®●Monster Dragon Tea®●Reign Total Body Fuel®●Reign Inferno® Thermogenic Fuel●Reign Storm®●True North®●NOS®●Full Throttle®●Burn®●Mother®●Nalu®●Ultra Energy®●Play® and Power Play® (stylized)●Relentless®●BPM®●BU®●Gladiator®●Samurai®●Live+®●Predator®●Fury®​We also develop, market, sell and distribute craft beers, FMBs and hard seltzers under a number of brands, including Jai Alai® IPA, Florida ManTM IPA, Dale’s Pale Ale®, Wild BasinTM Hard Seltzers, Dallas Blonde®, Deep EllumTM IPA, Perrin Brewing CompanyTM Black Ale, Hop Rising® Double IPA, Wasatch® Apricot Hefeweizen, The Beast UnleashedTM and a host of other brands.We also develop, market, sell and distribute still and sparkling waters under the Monster® Tour WaterTM brand name.Our net sales of $6.31 billion for the year ended December 31, 2022 represented record annual net sales. Net changes in foreign currency exchange rates had an unfavorable impact on net sales of approximately $239.5 million for the year ended December 31, 2022.The vast majority of our net sales are derived from our Monster Energy® Drinks segment. Our Monster Energy® Drinks segment represented 92.4% and 94.2% of our net sales for the years ended December 31, 2022 and 2021, respectively. Our Strategic Brands segment represented 5.6% and 5.3% of our net sales for the years ended December 31, 2022 and 2021, respectively. Our Alcohol Brands segment represented 1.6% of our net sales for the year ended December 31, 2022. Our Other segment represented 0.4% and 0.5% of our net sales for the years ended December 31, 2022 and 2021, respectively. Net changes in foreign currency exchange rates had an unfavorable impact on our net sales of the Monster Energy® Drinks segment of approximately $222.3 million for the year ended December 31, 2022. Net changes in foreign currency exchange rates had an unfavorable impact on net sales in the Strategic Brands segment of approximately $17.2 million for the year ended December 31, 2022.Our growth strategy includes further developing our domestic markets, expanding our international business and growing our business into new sectors, such as the alcohol beverage sector. Net sales to customers outside the United States amounted to $2.36 billion and $2.04 billion for the years ended December 31, 2022 and 2021, respectively. Such sales were 46 Table of Contentsapproximately 37% of net sales for both the years ended December 31, 2022 and 2021. Net changes in foreign currency exchange rates had an unfavorable impact on net sales to customers outside of the United States of approximately $239.5 million for the year ended December 31, 2022. Net sales to customers outside the United States, on a foreign currency adjusted basis, increased 27.1% for the year ended December 31, 2022. On February 17, 2022, we completed the CANarchy Transaction which facilitated our entry into the alcohol beverage sector.Our non-alcohol customers are primarily full service beverage bottlers/distributors, retail grocery and specialty chains, wholesalers, club stores, mass merchandisers, convenience chains, foodservice customers, value stores, e-commerce retailers and the military. Our alcohol customers are primarily beer distributors who in turn sell to retailers within the alcohol distribution system. Percentages of our gross billings to our various customer types for the years ended December 31, 2022, 2021 and 2020 are reflected below. Such information includes sales made by us directly to the customer types concerned, which include our full service beverage bottlers/distributors in the United States. Such full service beverage bottlers/distributors in turn sell certain of our products to some of the same customer types listed below. We limit our description of our customer types to include only our sales to our full service bottlers/distributors without reference to such bottlers/distributors’ sales to their own customers. ​​​​​​​​ 2022 2021 2020U.S. full service bottlers/distributors 48%​51%​56%International full service bottlers/distributors 39%​39%​34%Club stores and e-commerce retailers 9%​8%​8%Retail grocery, direct convenience, specialty chains and wholesalers 2%​1%​1%Alcohol, direct value stores and other 2%​1%​1%​Our non-alcohol customers include Coca-Cola Canada Bottling Limited, Coca-Cola Consolidated, Inc., Coca-Cola Bottling Company United, Inc., Reyes Coca-Cola Bottling, LLC, Coca-Cola Southwest Beverages LLC, The Coca-Cola Bottling Company of Northern New England, Inc., Swire Pacific Holdings, Inc. (USA), Liberty Coca-Cola Beverages, LLC, Coca-Cola Europacific Partners (formerly Coca-Cola European Partners and Coca-Cola Amatil), Coca-Cola Hellenic, Coca-Cola FEMSA, Swire Coca-Cola (China), COFCO Coca-Cola, Coca-Cola Beverages Africa, Coca-Cola İçecek and certain other TCCC network bottlers, Asahi Soft Drinks, Co., Ltd., Wal-Mart, Inc. (including Sam’s Club), Costco Wholesale Corporation and Amazon.com, Inc. Our alcohol customers include J.J. Taylor Distributing, Ben E. Keith, Reyes Beer Division, Sheehan Family Companies, and Admiral Beverage. A decision by any large customer to decrease amounts purchased from us or to cease carrying our products could have a material adverse effect on our financial condition and consolidated results of operations.Coca-Cola Consolidated, Inc. accounted for approximately 11%, 12% and 12% of our net sales for the years ended December 31, 2022, 2021 and 2020, respectively.Reyes Coca-Cola Bottling, LLC accounted for approximately 9%, 10% and 11% of our net sales for the years ended December 31, 2022, 2021 and 2020, respectively.Coca-Cola Europacific Partners (formerly Coca-Cola European Partners) accounted for approximately 13%, 12% and 10% of our net sales for the years ended December 31, 2022, 2021 and 2020, respectively. We continue to incur expenditures in connection with the development and introduction of new products and flavors.47 Table of ContentsValue Drivers of our BusinessWe believe that the key value drivers of our business include the following:●International Growth – The introduction, development and sustained profitability of our brands internationally remains a key value driver for our corporate growth. One or more of our products are distributed in approximately 157 countries and territories worldwide.●Profitable Growth – We believe “functional” value-added beverage brands supported by marketing and innovation and targeted to a diverse consumer base, drive profitable growth. We are focused on increasing the profit margins for our Monster Energy® Drinks segment, our Strategic Brands segment and our Alcohol Brands segment, and believe that tailored branding, packaging, pricing and distribution channel strategies help achieve profitable growth. We are implementing these strategies with a view to continuing profitable growth.●Cost Management – The principal focus of cost management will continue to be on mitigating increases and/or reducing input procurement and production costs on a per-case basis, including raw material costs and co-packing fees, as well as reducing freight costs by securing additional co-packing facilities strategically localized. Another key area of focus is to decrease promotional allowances, selling and general and administrative costs, including sponsorships, sampling, promotional and marketing expenses, as a percentage of net sales.●Efficient Capital Structure – Our capital structure is designed to optimize our working capital in order to finance expansion, both domestically and internationally. We believe that with our strong capital position, our ability to raise funds, if necessary, at a relatively low effective cost of borrowings, provides a competitive advantage. The reduction of days outstanding for accounts receivable and inventory days on hand will remain an area of focus.We believe that, subject to increases in the costs of certain raw materials being contained, these value drivers, when implemented and/or achieved in the United States and internationally, will result in: (1) improving or maintaining our product gross profit margins; (2) reducing our expenses as a percentage of net operating revenues; and (3) enhancing our cost of capital. The ultimate measure of success is and will be reflected in our current and future results of operations. Net sales, gross profit, operating income, net income and net income per share represent key measurements of the above value drivers. These measurements will continue to be a key management focus in 2023 and beyond (See “Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations”). As of December 31, 2022, the Company had working capital of $3.76 billion compared to $3.72 billion as of December 31, 2021. The increase in working capital was primarily the result of the increase in accounts receivable and inventories, related to the increase in net sales for the year ended December 31, 2022. For the year ended December 31, 2022, our net cash provided by operating activities was approximately $887.7 million as compared to $1.16 billion for the year ended December 31, 2021. Principal uses of cash flows in 2022 were purchases of investments, purchases of treasury stock, the acquisition of CANarchy, development of our brands internationally and acquisitions of real property, property and equipment. These principal uses of cash flows are expected to be and remain our principal recurring use of cash and working capital funds in the future (See “Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources”).48 Table of ContentsOpportunities, Challenges and RisksLooking forward, our management has identified certain challenges and risks for the beverage industry and the Company, including our significant commercial relationship with TCCC and TCCC’s status as a significant stockholder of the Company, in each case as described above under “Part I, Item 1A – Risk Factors.” In addition, legislation has been proposed and/or adopted at the U.S., state, county and/or municipal level and proposed and/or adopted in certain foreign jurisdictions to restrict the sale of energy and alcohol drinks (including prohibiting the sale of energy and/or alcohol drinks at certain establishments or pursuant to certain governmental programs), limit caffeine and/or alcohol content, require certain product labeling disclosures and/or warnings, impose taxes, limit product sizes or impose age restrictions for the sale of energy and/or alcohol drinks. In addition, articles critical of the caffeine content in energy drinks and their perceived benefits, or alcohol drinks and their misuse or abuse, as well as articles indicating certain health risks of energy or alcohol drinks have been published. The proposal and/or adoption of such legislation and the publication of such articles, or the future proposal and/or adoption of similar legislation or publication of similar articles, may adversely affect our Company. In addition, uncertainty and/or volatility in our domestic and/or our international economic markets could negatively affect both the stability of our industry and our Company. Furthermore, our growth strategy includes expanding our international business, which exposes us to risks inherent in conducting international operations, including the risks associated with foreign currency exchange rate fluctuations. Consumer discretionary spending also represents a challenge to the successful marketing and sale of our products. Increases in consumer and regulatory awareness of the health problems arising from obesity and inactive lifestyles as well as alcohol consumption continue to represent a challenge. We recognize that obesity and alcohol abuse and misuse are complex and serious public health problems. Our commitment to consumers begins with our broad product line and a wide selection of diet, light and low calorie beverages within our product lines. We continuously strive to meet changing consumer needs through beverage innovation, choice and variety. (See “Part I, Item 1A – Risk Factors”).Our historical success is attributable, in part, to our introduction of different and innovative beverages which have been positively accepted by consumers. Our future success will depend, in part, upon our continued ability to develop and introduce different and innovative beverages that meet consumer preferences, although there can be no assurance of our ability to do so. In order to retain and expand our market share, we must continue to develop and introduce different and innovative beverages and be competitive in the areas of price, quality, method of distribution, brand image and intellectual property protection. The beverage industry is subject to changing consumer preferences that may adversely affect us if we misjudge such preferences.In addition, other key challenges and risks that could impact our Company’s future financial results include, but are not limited to:●the risks associated with the realization of benefits from our relationship with TCCC;●changes in consumer preferences and demand for our products;●economic uncertainty in the United States, Europe and other countries in which we operate;●the risks associated with foreign currency exchange rate fluctuations;●maintenance of our brand image, product quality and corporate reputation;●increasing concern over various environmental, human rights and health matters, including obesity, caffeine and/or alcohol consumption and energy and/or alcohol drinks generally, and changes in regulation and consumer preferences in response to those concerns;49 Table of Contents●profitable expansion and growth of our family of brands in the competitive market place (See “Part I, Item 1 – Business – Competition” and “Part I, Item 1 – Business – Sales and Marketing”);●costs of establishing and promoting our brands internationally;●the risks associated with entering into new sectors in the beverage industry, in particular the alcohol beverage sector, and making acquisitions to implement our growth strategy;●increases in costs of raw materials used by us;●restrictions on imports and sources of supply, duties or tariffs, changes in related government regulations and disruptions in the timely import or export of our products and/or ingredients including flavors, flavor ingredients and supplement ingredients, due to port strikes and/or port congestion, delays due to the COVID-19 pandemic, related labor issues or other importation impediments;●protection of our existing intellectual property portfolio of trademarks and copyrights and our continuous pursuit to develop and protect new and innovative trademarks and copyrights for our expanding product lines;●limitations on available quantities of aluminum cans, other packaging materials and ingredients;●limitations on co-packing availability and in particular, consolidation in the co-packing industry; ●increases in ocean and domestic freight rates;●the long-term impact of Brexit on our business in Europe and the United Kingdom; ●the imposition of additional regulation, including regulation restricting the sale of energy or alcohol drinks, limiting caffeine or alcohol content in beverages, requiring product labeling and/or warnings, imposing excise taxes and/or sales taxes, and/or limiting product size and/or age restrictions; and●the continuation or worsening of the COVID-19 pandemic.See “Part I, Item 1A – Risk Factors” for additional information about risks and uncertainties facing our Company.We believe that the following opportunities exist for us:●domestic and international growth potential of our products;●growth potential of the energy drink and alcohol beverage categories, both domestically and internationally;●growth potential of the affordable energy drink category;●planned and future new product and product line introductions with the objective of increasing sales and/or contributing to higher profitability;●the introduction of new package formats designed to generate strong revenue growth;●package, pricing and channel opportunities to increase profitable growth;●effective strategic positioning to capitalize on industry growth;●broadening distribution/expansion opportunities in both domestic and international markets;●launching and/or relaunching our products and new products into new domestic and international markets and channels;●continued focus on reducing our cost base; and●our entry into the alcohol category and development of our alcohol portfolio.50 Table of ContentsResults of OperationsThis section of the Annual Report on Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. A detailed discussion of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021.The following table sets forth key statistics for the years ended December 31, 2022, 2021 and 2020, respectively.​​​​​​​​​​​​​​​(In thousands, except per share amounts) ​ ​​ ​​ ​Percentage​Percentage​​​​​​​​​​​​Change​Change​​ 2022 2021 2020 22 vs. 21 21 vs. 20​Net sales1​$ 6,311,050​$ 5,541,352​$ 4,598,638​ 13.9% 20.5%Cost of sales​ 3,136,483​ 2,432,839​ 1,874,758​ 28.9% 29.8%Gross profit*1​ 3,174,567​ 3,108,513​ 2,723,880​ 2.1% 14.1%Gross profit as a percentage of net sales​ 50.3% 56.1% 59.2%​​​​​​​​​​​​​​​​​​​Operating expenses​ 1,589,846​ 1,311,046​ 1,090,727​ 21.3% 20.2%Operating expenses as a percentage of net sales​ 25.2% 23.7% 23.7%​​​​​​​​​​​​​​​​​​​Operating income1​ 1,584,721​ 1,797,467​ 1,633,153​ (11.8)% 10.1%Operating income as a percentage of net sales​ 25.1% 32.4% 35.5%​​​​​​​​​​​​​​​​​​​Other (expense) income, net​ (12,757)​ 3,952​ (6,996)​ (422.8)% (156.5)%​​​​​​​​​​​​​​​Income before provision for income taxes1​ 1,571,964​ 1,801,419​ 1,626,157​ (12.7)% 10.8%​​​​​​​​​​​​​​​Provision for income taxes​ 380,340​ 423,944​ 216,563​ (10.3)% 95.8%​​​​​​​​​​​​​​​Income taxes as a percentage of income before taxes​ 24.2% 23.5% 13.3%​​​​​​​​​​​​​​​​​​​Net income1​$ 1,191,624​$ 1,377,475​$ 1,409,594​ (13.5)% (2.3)%Net income as a percentage of net sales​ 18.9% 24.9% 30.7%​​​​​​​​​​​​​​​​​​​Net income per common share:​ ​​ ​​ ​​​​​​Basic​$ 2.26​$ 2.61​$ 2.66​ (13.2)% (2.1)%Diluted​$ 2.23​$ 2.57​$ 2.64​ (13.1)% (2.4)%​​​​​​​​​​​​​​​Energy Drink case sales (in thousands) (in 192‑ounce case equivalents)2​ 701,677​ 613,441​ 504,821​ 14.4% 21.5%​1Includes $40.0 million, $41.5 million and $42.1 million for the years ended December 31, 2022, 2021 and 2020, respectively, related to the recognition of deferred revenue.2Excludes case sales of the Alcohol Brands and Other segments.*Gross profit may not be comparable to that of other entities since some entities include all costs associated with their distribution process in cost of sales, whereas others exclude certain costs and instead include such costs within another line item such as operating expenses. We include out-bound freight and warehouse costs in operating expenses rather than in cost of sales.51 Table of ContentsNet SalesNet sales were $6.31 billion for the year ended December 31, 2022, an increase of approximately $769.7 million, or 13.9% higher than net sales of $5.54 billion for the year ended December 31, 2021. Net sales increased primarily due to increased worldwide sales by volume of our Monster Energy® brand energy drinks as a result of increased consumer demand, as well as due to pricing actions and reductions in promotions in certain markets. Net changes in foreign currency exchange rates had an unfavorable impact on net sales of approximately $239.5 million for the year ended December 31, 2022. Net sales on a foreign currency adjusted basis increased 18.2% for the year ended December 31, 2022.Net sales were $2.20 billion and $1.90 billion for the years ended December 31, 2022 and 2021, respectively, in EMEA, Asia Pacific, Latin America and the Caribbean.Net sales for the Monster Energy® Drinks segment were $5.83 billion for the year ended December 31, 2022, an increase of approximately $612.5 million, or 11.7% higher than net sales of $5.22 billion for the year ended December 31, 2021. Net sales for the Monster Energy® Drinks segment increased primarily due to increased worldwide sales by volume of our Monster Energy® brand energy drinks as a result of increased consumer demand. Net changes in foreign currency exchange rates had an unfavorable impact on net sales for the Monster Energy® Drinks segment of approximately $222.3 million for the year ended December 31, 2022. Net sales for the Monster Energy® Drinks segment on a foreign currency adjusted basis increased 16.0% for the year ended December 31, 2022.Net sales for the Strategic Brands segment were $353.5 million for the year ended December 31, 2022, an increase of approximately $58.7 million, or 19.9% higher than net sales of $294.8 million for the year ended December 31, 2021. Net sales for the Strategic Brands segment increased primarily due to increased worldwide sales by volume of our Predator® and NOS® brand energy drinks as a result of increased consumer demand. Net changes in foreign currency exchange rates had an unfavorable impact on net sales of approximately $17.2 million for the Strategic Brands segment for the year ended December 31, 2022. Net sales for the Strategic Brands segment on a foreign currency adjusted basis increased 25.8% for the year ended December 31, 2022.Net sales for the Alcohol Brands segment were $101.4 million for the year ended December 31, 2022 (effectively from February 17, 2022 to December 31, 2022). There were no comparative 2021 net sales for the Alcohol Brands segment as the Company completed its acquisition of CANarchy on February 17, 2022. Net sales for the Other segment were $22.9 million for the year ended December 31, 2022, a decrease of approximately $3.0 million, or 11.5% lower than net sales of $25.9 million for the year ended December 31, 2021. Case sales for our energy drink products, in 192-ounce case equivalents, were 701.7 million cases for the year ended December 31, 2022, an increase of approximately 88.2 million cases or 14.4% higher than case sales of 613.4 million cases for the year ended December 31, 2021. The overall average net sales per case for our energy drink products (excluding net sales of Alcohol Brands and Other segments) decreased to $8.82 for the year ended December 31, 2022, which was 1.9% lower than the average net sales per case of $8.99 for the year ended December 31, 2021. The decrease in the average net sales per case was primarily the result of geographical and product sales mix. Barrel sales for our craft beers and hard seltzers, in 31 US gallon equivalents, were 0.3 million barrels for the year ended December 31, 2022 (effectively from February 17, 2022 to December 31, 2022).Gross ProfitGross profit was $3.17 billion for the year ended December 31, 2022, an increase of approximately $66.1 million, or 2.1% higher than the gross profit of $3.11 billion for the year ended December 31, 2021. 52 Table of ContentsGross profit as a percentage of net sales decreased to 50.3% for the year ended December 31, 2022 from 56.1% for the year ended December 31, 2021. The decrease for the year ended December 31, 2022 was primarily the result of increased freight rates and fuel costs, including costs relating to the importation of aluminum cans, increased ingredient and other input costs, including secondary packaging materials, increased aluminum can costs attributable to higher aluminum commodity pricing, increased co-packing fees, production inefficiencies and geographical sales mix. Operating Expenses Total operating expenses were $1.59 billion for the year ended December 31, 2022, an increase of approximately $278.8 million, or 21.3% higher than total operating expenses of $1.31 billion for the year ended December 31, 2021. The comparative operating expenses for the year ended December 31, 2021 included a $16.9 million reversal of amounts previously accrued in connection with an intellectual property claim. The increase in operating expenses was primarily due to increased general and administrative expenses of $92.9 million, including travel and entertainment, professional service fees (including legal and accounting) and depreciation and amortization, increased out-bound fuel, freight and warehouse costs of $74.3 million, increased selling and marketing expenses of $59.9 million, including sponsorships and endorsements, point of sale, premiums and allocated trade development, and increased payroll expenses of $57.0 million (of which $23.1 million was related to CANarchy). In addition, CANarchy related depreciation and amortization was $8.7 million for year ended December 31, 2022. The increase in operating expenses was partially offset by a decrease in distributor termination expenses of $5.3 million for the year ended December 31, 2022.Operating expenses as a percentage of net sales for the years ended December 31, 2022 and 2021 were 25.2% and 23.7%, respectively. Operating expenses for the year ended December 31, 2019 (pre COVID-19) were $1.12 billion, or 26.6% of net sales.Operating Income Operating income was $1.58 billion for the year ended December 31, 2022, a decrease of approximately $212.7 million, or 11.8% lower than operating income of $1.80 billion for the year ended December 31, 2021. Operating income as a percentage of net sales decreased to 25.1% for the year ended December 31, 2022 from 32.4% for the year ended December 31, 2021. Operating income for the year ended December 31, 2022 decreased primarily as a result of the increase in operating expenses as well as the decrease in the gross profit as a percentage of net sales.Operating income was $316.3 million and $402.8 million for the years ended December 31, 2022 and 2021, respectively, for our operations in EMEA, Asia Pacific, Latin America and the Caribbean. Operating income for the Monster Energy® Drinks segment, exclusive of corporate and unallocated expenses, was $1.85 billion for the year ended December 31, 2022, a decrease of approximately $140.7 million, or 7.1% lower than operating income of $1.99 billion for the year ended December 31, 2021. The decrease in operating income for the Monster Energy® Drinks segment was primarily the result of an increase in operating expenses as well as a decrease in gross profit as a percentage of net sales.Operating income for the Strategic Brands segment, exclusive of corporate and unallocated expenses, was $197.7 million for the year ended December 31, 2022, an increase of approximately $24.0 million, or 13.8% higher than operating income of $173.7 million for the year ended December 31, 2021. The increase in operating income for the Strategic Brands segment was primarily the result of a $30.6 million increase in gross profit.Operating loss for the Alcohol Brands segment, exclusive of corporate and unallocated expenses, was $31.5 million for the year ended December 31, 2022 (effectively from February 17, 2022 to December 31, 2022). The operating loss for the year ended December 31, 2022 was due in part to (i) excess depreciation and amortization as well as the fair value treatment of purchased inventory, all relating to the CANarchy Transaction, (ii) increased input costs and an underutilization 53 Table of Contentsof fixed overhead and (iii) sales volume declines primarily of Wild BasinTM due in part to overall sales declines in the hard seltzer category. The inventory acquired, which was subsequently sold, was recognized through cost of goods sold at fair value (purchased cost), resulting in no recognized profits on the associated sales.Operating income for the Other segment, exclusive of corporate and unallocated expenses, was $3.0 million for the year ended December 31, 2022, a decrease of approximately $3.9 million, or 56.2% lower than operating income of $6.9 million for the year ended December 31, 2021.Other (Expense) Income, net Other (expense) income, net, was ($12.8) million for the year ended December 31, 2022, as compared to other (expense) income, net, of $4.0 million for the year ended December 31, 2021. Foreign currency transaction gains (losses) were ($37.9) million and $0.3 million for the years ended December 31, 2022 and 2021, respectively. Interest income was $29.7 million and $4.2 million for the years ended December 31, 2022 and 2021, respectively.Provision for Income Taxes Provision for income taxes was $380.3 million for the year ended December 31, 2022, a decrease of $43.6 million, or 10.3% lower than the provision for income taxes of $423.9 million for the year ended December 31, 2021. The effective combined federal, state and foreign tax rate was 24.2% and 23.5% for the years ended December 31, 2022 and 2021, respectively. The increase in the effective tax rate was primarily attributable to the decrease in income in certain foreign jurisdictions with lower tax rates compared to the United States.Net IncomeNet income was $1.19 billion for the year ended December 31, 2022, a decrease of $185.9 million, or 13.5% lower than net income of $1.38 billion for the year ended December 31, 2021. The decrease in net income for the year ended December 31, 2022 was primarily due to the decrease in the gross profit percentage of net sales as well as the increase in operating expenses.Key Business MetricsWe use certain key metrics and financial measures not prepared in accordance with United States Generally Accepted Accounting Principles (“GAAP”) to evaluate and manage our business. For a further discussion of how we use key metrics and certain non-GAAP financial measures, see “Non-GAAP Financial Measures and Other Key Metrics” below.Non-GAAP Financial Measures and Other Key MetricsGross Billings**Gross billings were $7.26 billion for the year ended December 31, 2022, an increase of approximately $837.0 million, or 13.0% higher than gross billings of $6.42 billion for the year ended December 31, 2021. Net changes in foreign currency exchange rates had an unfavorable impact on gross billings of approximately $285.9 million for the year ended December 31, 2022. Gross billings for the Monster Energy® Drinks segment were $6.74 billion for the year ended December 31, 2022, an increase of approximately $678.4 million, or 11.2% higher than gross billings of $6.06 billion for the year ended December 31, 2021. Gross billings for the Monster Energy® Drinks segment increased primarily due to increased worldwide sales by volume of our Monster Energy® brand energy drinks as a result of increased consumer demand, as well as due to price increases in certain markets. Net changes in foreign currency exchange rates had an unfavorable impact on 54 Table of Contentsgross billings for the Monster Energy® Drinks segment of approximately $268.7 million for the year ended December 31, 2022. Gross billings for the Strategic Brands segment were $398.7 million for the year ended December 31, 2022, an increase of $58.6 million, or 17.2% higher than gross billings of $340.2 million for the year ended December 31, 2021. Net changes in foreign currency exchange rates had an unfavorable impact on gross billings in the Strategic Brands segment of approximately $17.2 million for the year ended December 31, 2022.Gross billings for the Alcohol Brands segment were $103.0 million for the year ended December 31, 2022 (effectively from February 17, 2022 to December 31, 2022). There were no comparative 2021 gross billings for the Alcohol Brands segment as the Company completed its acquisition of CANarchy on February 17, 2022.Gross billings for the Other segment were $22.9 million for the year ended December 31, 2022, a decrease of $3.0 million, or 11.5% lower than gross billings of $25.9 million for the year ended December 31, 2021. Promotional allowances, commissions and other expenses, as described in the footnote below, were $990.6 million for the year ended December 31, 2022, an increase of $65.8 million, or 7.1% higher than promotional allowances, commissions and other expenses of $924.7 million for the year ended December 31, 2021. Promotional allowances as a percentage of gross billings were 13.6% and 14.4% for the years ended December 31, 2022 and 2021, respectively.**Gross billings represent amounts invoiced to customers net of cash discounts, returns and excise taxes. Gross billings are used internally by management as an indicator of and to monitor operating performance, including sales performance of particular products, salesperson performance, product growth or declines and is useful to investors in evaluating overall Company performance. The use of gross billings allows evaluation of sales performance before the effect of any promotional items, which can mask certain performance issues. We therefore believe that the presentation of gross billings provides a useful measure of our operating performance. The use of gross billings is not a measure that is recognized under GAAP and should not be considered as an alternative to net sales, which is determined in accordance with GAAP, and should not be used alone as an indicator of operating performance in place of net sales. Additionally, gross billings may not be comparable to similarly titled measures used by other companies, as gross billings has been defined by our internal reporting practices. In addition, gross billings may not be realized in the form of cash receipts as promotional payments and allowances may be deducted from payments received from certain customers.55 Table of ContentsThe following table reconciles the non-GAAP financial measure of gross billings with the most directly comparable GAAP financial measure of net sales: ​​​​​​​​​​​​​​​​ ​ ​ ​ Percentage Percentage​In thousands​​​​​​​​​ Change​Change​​ 2022 2021 2020 22 vs. 21​21 vs. 20​Gross Billings​$ 7,261,639​$ 6,424,632​$ 5,328,683 13.0% 20.6%Deferred Revenue​​ 39,969​​ 41,462​​ 42,110​ (3.6)% (1.5)%Less: Promotional allowances, commissions and other expenses***​ (990,558)​ (924,742)​ (772,155) 7.1% 19.8%Net Sales​$ 6,311,050​$ 5,541,352​$ 4,598,638 13.9% 20.5%​***Although the expenditures described in this line item are determined in accordance with GAAP and meet GAAP requirements, the presentation thereof does not conform to GAAP presentation requirements. Additionally, our definition of promotional and other allowances may not be comparable to similar items presented by other companies. Promotional and other allowances for our energy drink products primarily include consideration given to our non-alcohol bottlers/distributors or retail customers including, but not limited to the following: (i) discounts granted off list prices to support price promotions to end-consumers by retailers; (ii) reimbursements given to our bottlers/distributors for agreed portions of their promotional spend with retailers, including slotting, shelf space allowances and other fees for both new and existing products; (iii) our agreed share of fees given to bottlers/distributors and/or directly to retailers for advertising, in-store marketing and promotional activities; (iv) our agreed share of slotting, shelf space allowances and other fees given directly to retailers, club stores and/or wholesalers; (v) incentives given to our bottlers/distributors and/or retailers for achieving or exceeding certain predetermined sales goals; (vi) discounted or free products; (vii) contractual fees given to our bottlers/distributors related to sales made by us direct to certain customers that fall within the bottlers’/distributors’ sales territories; and (viii) certain commissions paid based on sales to our bottlers/distributors. The presentation of promotional and other allowances facilitates an evaluation of their impact on the determination of net sales and the spending levels incurred or correlated with such sales. Promotional and other allowances for our energy drink products constitute a material portion of our marketing activities. Our promotional allowance programs for our energy drink products with our numerous bottlers/distributors and/or retailers are executed through separate agreements in the ordinary course of business. These agreements generally provide for one or more of the arrangements described above and are of varying durations, ranging from one week to one year. The primary drivers of our promotional and other allowance activities for our energy drink products for the years ended December 31, 2022 and 2021 were (i) to increase sales volume and trial, (ii) to address market conditions, and (iii) to secure shelf and display space at retail. Promotional and other allowances for our Alcohol Brands segment primarily include price promotions where permitted.SalesThe table set forth below discloses selected quarterly data regarding sales for the past three years. Data from any one or more quarters is not necessarily indicative of annual results or continuing trends.Sales of our energy drinks are expressed in unit case volume. A “unit case” means a unit of measurement equal to 192 U.S. fluid ounces of finished beverage (24 eight-ounce servings). Unit case volume means the number of unit cases (or unit case equivalents) of finished products or concentrates, as if converted into finished products, sold by us.Our quarterly results of operations reflect seasonal trends that are primarily the result of increased demand in the warmer months of the year. Beverage sales tend to be lower during the first and fourth quarters of each calendar year. However, our experience with our energy drink products suggests they are less seasonal than the seasonality expected from traditional beverages. In addition, our continued growth internationally may further reduce the impact of seasonality on our business. Quarterly fluctuations may also be affected by other factors including the introduction of new products, the opening of new markets where temperature fluctuations are more pronounced, the addition of new bottlers/distributors, changes in the sales mix of our products and changes in and/or increased advertising and promotional expenses. The 56 Table of ContentsCOVID-19 pandemic, including new variants, may also have an impact on consumer behavior and change the seasonal fluctuation of our business. (See “Part I, Item 1 – Business – Seasonality”).​​​​​​​​​​​ 2022 2021 2020Net Sales (in Thousands)​​​​​​​​​Quarter 1​$ 1,518,574​$ 1,243,816​$ 1,062,097Quarter 2​ 1,655,260​ 1,461,934​ 1,093,896Quarter 3​ 1,624,286​ 1,410,557​ 1,246,362Quarter 4​ 1,512,930​ 1,425,045​ 1,196,283Total​$ 6,311,050​$ 5,541,352​$ 4,598,638​​​​​​​​​​Less: Alcohol Brands and Other segment net sales (in Thousands)​​​​​​​​​Quarter 1​$ (21,134)​$ (5,727)​$ (5,105)Quarter 2​ (38,428)​ (7,905)​ (6,644)Quarter 3​ (33,265)​ (6,316)​ (8,618)Quarter 4​ (31,522)​ (5,969)​ (6,671)Total​$ (124,349)​$ (25,917)​$ (27,038)​​​​​​​​​​Adjusted Net Sales (in Thousands)¹​​​​​​​​​Quarter 1​$ 1,497,440​$ 1,238,089​$ 1,056,992Quarter 2​ 1,616,832​ 1,454,029​ 1,087,252Quarter 3​ 1,591,021​ 1,404,241​ 1,237,744Quarter 4​ 1,481,408​ 1,419,076​ 1,189,612Total​$ 6,186,701​$ 5,515,435​$ 4,571,600​​​​​​​​​​Energy Drink Case Volume / Sales (in Thousands)​​​​​​​​​Quarter 1​ 168,793​ 138,566​ 115,598Quarter 2​ 184,197​ 161,450​ 116,960Quarter 3​ 182,460​ 159,975​ 139,922Quarter 4​ 166,227​ 153,450​ 132,341Total​ 701,677​ 613,441​ 504,821​​​​​​​​​​Energy Drink Adjusted Average Net Sales Per Case​​​​​​​​​Quarter 1​$ 8.87​$ 8.94​$ 9.14Quarter 2​ 8.78​ 9.01​ 9.30Quarter 3​ 8.72​ 8.78​ 8.85Quarter 4​ 8.91​ 9.25​ 8.99Total​$ 8.82​$ 8.99​$ 9.06​1Excludes Alcohol Brands and Other segment net sales.57 Table of ContentsThe following represents energy drink case sales by segment for the years ended December 31:​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​(In thousands, except average net sales per case) 2022 2021 2020Net sales​$ 6,311,050​$ 5,541,352​$ 4,598,638Less: Alcohol Brands segment sales​​ (101,405)​​ —​​ —Less: Other segment sales​ (22,944)​ (25,917)​ (27,038)Adjusted net sales1​$ 6,186,701​$ 5,515,435​$ 4,571,600​​​​​​​​​​Case sales by segment:1​ ​ ​ Monster Energy® Drinks​ 581,937​ 520,577​ 428,596Strategic Brands​ 119,740​ 92,864​ 76,225Total case sales​ 701,677​ 613,441​ 504,821Average net sales per case - Energy Drinks​$ 8.82​$ 8.99​$ 9.06​1Excludes Alcohol Brands segment (effectively from February 17, 2022 to December 31, 2022) and Other segment net sales.Net changes in foreign currency exchange rates had an unfavorable impact on both net sales and the overall average net sales per case for the year ended December 31, 2022.Unit Sales of our alcohol products are expressed in barrel equivalents (“Barrel”). A Barrel is a unit of measurement equal to 31 U.S. gallons. Barrel sales were 0.3 million for the year ended December 31, 2022 (effectively from February 17, 2022 to December 31, 2022).InflationInflation had a negative impact on our results of operations, leading to increased cost of sales and operating expenses for the years ended December 31, 2022 and 2021. To mitigate the impact of inflation, we implemented a price increase effective September 1, 2022 in the United States and continue to implement price increases in certain international markets where feasible. Liquidity and Capital ResourcesCash and cash equivalents, short-term and long-term investments – As of December 31, 2022, we had $1.31 billion in cash and cash equivalents, $1.36 billion in short-term investments and $61.4 million in long-term investments. We maintain our investments for cash management purposes and not for purposes of speculation. Our risk management policies emphasize credit quality (primarily based on short-term ratings by nationally recognized statistical rating organizations) in selecting and maintaining our investments. We regularly assess market risk of our investments and believe our current policies and investment practices adequately limit those risks. However, certain of these investments are subject to general credit, liquidity, market and interest rate risks. These market risks associated with our investment portfolio may have an adverse effect on our future results of operations, liquidity and financial condition.Of our $1.31 billion of cash and cash equivalents held at December 31, 2022, $668.9 million was held by our foreign subsidiaries. No short-term or long-term investments were held by our foreign subsidiaries at December 31, 2022. We believe that cash available from operations, including our cash resources and access to credit, will be sufficient for our working capital needs, including purchase commitments for raw materials and inventory, increases in accounts receivable, payments of tax liabilities, expansion and development needs, purchases of capital assets, purchases of equipment, purchases of real property and purchases of shares of our common stock, through at least the next 12 months. Based on our current plans, capital expenditures (exclusive of common stock repurchases) are likely to be less than $300.0 million through December 31, 2023. However, future business opportunities may cause a change in this estimate.58 Table of ContentsPurchases of inventories, increases in accounts receivable and other assets, acquisition of property and equipment (including real property, personal property and coolers), leasehold improvements, advances for or the purchase of equipment for our bottlers, acquisition and maintenance of trademarks, payments of accounts payable, income taxes payable and purchases of our common stock are expected to remain our principal recurring use of cash.The following summarizes our cash flows for the years ended December 31, 2022, 2021 and 2020 (in thousands):​​​​​​​​​​​Net cash provided by (used in): ​​ ​​ ​​​ 2022 2021 2020Operating activities​$ 887,699​$ 1,155,741​$ 1,364,163Investing activities​$ (161,367)​$ (992,022)​$ (472,487)Financing activities​$ (706,938)​$ 34,821​$ (526,068)​Cash flows provided by operating activities. Cash provided by operating activities was $887.7 million for the year ended December 31, 2022, as compared with cash provided by operating activities of $1.16 billion for the year ended December 31, 2021. For the year ended December 31, 2022, cash provided by operating activities was primarily attributable to net income earned of $1.19 billion and adjustments for certain non-cash expenses, consisting of $64.1 million of stock-based compensation, $61.2 million of depreciation and amortization, $7.3 million of non-cash lease expense and $2.2 million loss on impairment of intangibles. For the year ended December 31, 2022, cash provided by operating activities also increased due to a $49.8 million increase in accounts payable, a $48.2 million decrease in deferred income taxes, a $50.8 million increase in accrued promotional allowances and a $3.7 million increase in accrued compensation. For the year ended December 31, 2022, cash used in operating activities was primarily attributable to a $347.7 million increase in inventories, a $129.0 million increase in accounts receivable, a $38.3 million increase in prepaid expenses and other assets, a $30.4 million decrease in accrued liabilities, a $19.9 million decrease in deferred revenue, a $16.9 million decrease in income taxes payable, a $4.5 million decrease in other liabilities and $4.4 million decrease in prepaid income taxes.For the year ended December 31, 2021, cash provided by operating activities was primarily attributable to net income earned of $1.38 billion and adjustments for certain non-cash expenses, consisting of $50.2 million of depreciation and amortization, and $70.5 million of stock-based compensation. For the year ended December 31, 2021, cash provided by operating activities also increased due to a $114.3 million increase in accounts payable, a $71.6 million increase in accrued liabilities, a $31.5 million increase in accrued promotional allowances, a $16.4 million increase in deferred income taxes, an $8.0 million increase in accrued compensation and a $7.2 million increase in income taxes payable. For the year ended December 31, 2021, cash used in operating activities was primarily attributable to a $277.8 million increase in inventories, a $254.2 million increase in accounts receivable, a $29.3 million increase in prepaid expenses and other assets, a $22.7 million decrease in deferred revenue and a $10.9 million increase in prepaid income taxes.Cash flows used in investing activities. Net cash used in investing activities was $161.4 million for the year ended December 31, 2022, as compared to cash used in investing activities of $992.0 million for the year ended December 31, 2021. For both the years ended December 31, 2022 and 2021, cash provided by investing activities was primarily attributable to sales of available-for-sale investments. For both the years ended December 31, 2022 and 2021, cash used in investing activities was primarily attributable to purchases of available-for-sale investments. For the year ended December 31, 2022, cash used in investing activities included $329.5 million (net of cash acquired), related to the CANarchy Transaction. To a lesser extent, for both the years ended December 31, 2022 and 2021, cash used in investing activities also included the acquisition of real property, fixed assets consisting of vans and promotional vehicles, coolers and other equipment to support our marketing and promotional activities, production equipment, furniture and fixtures, office and computer equipment, computer software, equipment used for sales and administrative activities, certain leasehold improvements, improvements to real property as well as the acquisition, defense and maintenance of trademarks. We expect 59 Table of Contentsto continue to use a portion of our cash in excess of our requirements for operations for purchasing short-term and long-term investments, leasehold improvements, the acquisition of capital equipment (specifically, vans, trucks and promotional vehicles, coolers, other promotional equipment, merchandise displays, warehousing racks as well as items of production equipment required to produce certain of our existing and/or new products and to develop our brand in international markets) and for other corporate purposes. From time to time, we may also use cash to purchase additional real property related to our beverage business and/or acquire compatible businesses.Cash flows (used in) provided by financing activities. Cash used in financing activities was $706.9 million for the year ended December 31, 2022 as compared to cash provided by financing activities of $34.8 million for the year ended December 31, 2021. The cash flows used in financing activities for the year ended December 31, 2022 was primarily the result of the repurchases of our common stock. The cash flows provided by financing activities for both the years ended December 31, 2022, and 2021 was primarily attributable to the issuance of our common stock related to stock-based compensation. The following represents a summary of the Company’s contractual commitments and related scheduled maturities as of December 31, 2022:​​​​​​​​​​​​​​​​​​Payments due by period (in thousands)​ ​​ Less than 1‑3 3‑5 More thanObligations​Total​1 year years years 5 yearsContractual Obligations1​$ 314,251​$ 239,350​$ 65,315​$ 9,586​$ —Finance Leases​ 811​ 769​ 40​ 2​ —Operating Leases​ 42,011​ 8,854​ 12,566​ 8,242​ 12,349Purchase Commitments2​ 328,015​ 316,680​ 11,156​ 179​ —​​$ 685,088​$ 565,653​$ 89,077​$ 18,009​$ 12,349​1Contractual obligations include our obligations related to sponsorships and other commitments.2Purchase commitments include obligations made by us and our subsidiaries to various suppliers for raw materials used in the production of our products. These obligations vary in terms, but are generally satisfied within one year.In addition, approximately $3.0 million of unrecognized tax benefits have been recorded as liabilities as of December 31, 2022. It is expected that the amount of unrecognized tax benefits will not significantly change within the next 12 months. As of December 31, 2022, we had $0.4 million of accrued interest and penalties related to unrecognized tax benefits.Accounting Policies and PronouncementsCritical Accounting Policies and EstimatesOur consolidated financial statements are prepared in accordance with GAAP. GAAP requires us to make estimates and assumptions that affect the reported amounts in our consolidated financial statements. Critical accounting estimates are those that management believes are the most important to the portrayal of our financial condition and results and require the most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and that have had, or are reasonably likely to have, a material impact on our financial condition or results of operations. Judgments and uncertainties may result in materially different amounts being reported under different conditions or using different assumptions. See “Part II, Item 8 – Financial Statements and Supplementary Data – Note 1 – Organization and Summary of Significant Accounting Policies” for a summary of our significant accounting policies.60 Table of ContentsThe following summarizes our most significant critical accounting estimates:Goodwill – The Company records goodwill when the consideration paid for an acquisition exceeds the fair value of net tangible and intangible assets acquired, including related tax effects. Goodwill is not amortized; instead, goodwill is tested for impairment on an annual basis, or more frequently if the Company believes indicators of impairment exist. The Company first assesses qualitative factors to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying value. If the Company reasonably determines that it is more-likely-than-not that the fair value is less than the carrying value, the Company performs its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. Application of the goodwill impairment test requires significant judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated through the use of a discounted cash flow methodology. This analysis requires significant assumptions, including discount rate, projected future revenues, projected future operating margins and terminal growth rates. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit. The Company will recognize an impairment for the amount by which the carrying amount exceeds a reporting unit’s fair value. For the years ended December 31, 2022, 2021 and 2020, there were no goodwill impairments recorded and there are no accumulated impairment balances.Other Intangibles – In accordance with FASB ASC 350, intangible assets with indefinite lives are not amortized but instead are measured for impairment at least annually, or when events indicate that an impairment exists. Recoverability of indefinite-lived intangible assets is determined on a relief from royalty methodology, which is based on the implied royalty paid, at an appropriate discount rate, to license the use of an asset rather than owning the asset. The present value of the after-tax cost savings (i.e. royalty relief) indicates the estimated fair value of the asset. Any excess of the carrying value over the estimated fair value is recognized as an impairment loss equal to that excess. This analysis requires significant assumptions, including discount rate, projected future revenues and terminal growth rates. A significant change in any or a combination of the assumptions used to estimate fair value of our indefinite-lived intangible assets could have a negative impact on the estimated fair values. The Company amortizes its trademarks with finite useful lives over their respective useful lives. For the year ended December 31, 2022, an impairment charge of $2.2 million was recorded to intangibles. For the year ended December 31, 2021 no impairment charges were recorded to intangibles. For the year ended December 31, 2020, an impairment charge of $8.7 million was recorded to intangibles.Revenue Recognition – Promotional and other allowances (variable consideration) recorded as a reduction to net sales for our energy drink products primarily include consideration given to the Company’s non-alcohol bottlers/distributors or retail customers including, but not limited to the following:●discounts granted off list prices to support price promotions to end-consumers by retailers; ●reimbursements given to the Company’s bottlers/distributors for agreed portions of their promotional spend with retailers, including slotting, shelf space allowances and other fees for both new and existing products; ●the Company’s agreed share of fees given to bottlers/distributors and/or directly to retailers for advertising, in-store marketing and promotional activities; ●the Company’s agreed share of slotting, shelf space allowances and other fees given directly to retailers; ●incentives given to the Company’s bottlers/distributors and/or retailers for achieving or exceeding certain predetermined sales goals; ●discounted or free products; ●contractual fees given to the Company’s bottlers/distributors related to sales made directly by the Company to certain customers that fall within the bottlers’/distributors’ sales territories; and 61 Table of Contents●commissions paid to TCCC based on our sales to certain wholly-owned subsidiaries of TCCC and/or to certain companies accounted for under the equity method by TCCC.The Company’s promotional allowance programs for its energy drink products with its bottlers/distributors and/or retailers are executed through separate agreements in the ordinary course of business. These agreements generally provide for one or more of the arrangements described above and are of varying durations, ranging from one week to one year. The Company’s promotional and other allowances for its energy drink products are calculated based on various programs with bottlers/distributors and retail customers, and accruals are established during the year for its anticipated liabilities. These accruals are based on agreed upon terms as well as the Company’s historical experience with similar programs and require management’s judgment with respect to estimating consumer participation and/or distributor and retail customer performance levels. Differences between such estimated expenses and actual expenses for promotional and other allowance costs have historically been insignificant and are recognized in earnings in the period such differences are determined.Promotional and other allowances for the Alcohol Brands segment primarily include price promotions where permitted. Recent Accounting PronouncementsSee “Part II, Item 8 – Financial Statements and Supplementary Data – Note 1 – Organization and Summary of Significant Accounting Policies – Recent Accounting Pronouncements” for a full description of recent accounting pronouncements including the respective expected dates of adoption and expected effects on the Company’s consolidated financial position, results of operations or liquidity.Forward-Looking StatementsCertain statements made in this report may constitute forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended) (the “Exchange Act”) regarding the expectations of management with respect to revenues, profitability, adequacy of funds from operations and our existing credit facility, among other things. All statements containing a projection of revenues, income (loss), earnings (loss) per share, capital expenditures, dividends, capital structure or other financial items, a statement of management’s plans and objectives for future operations, or a statement of future economic performance contained in management’s discussion and analysis of financial condition and results of operations, including statements related to new products, volume growth and statements encompassing general optimism about future operating results and non-historical information, are forward-looking statements within the meaning of the Exchange Act. Without limiting the foregoing, the words “believes,” “thinks,” “anticipates,” “plans,” “expects,” “estimates” and similar expressions are intended to identify forward-looking statements.Management cautions that these statements are qualified by their terms and/or important factors, many of which are outside our control and involve a number of risks, uncertainties and other factors, that could cause actual results and events to differ materially from the statements made including, but not limited to, the following:●Our ability to absorb, mitigate or pass on cost increases to our bottlers/distributors and/or customers;●The impact of rising costs, interest rates, and inflation on the discretionary income of our consumers, particularly the rising cost of energy;●Uncertainties associated with an economic slowdown or recession that could negatively impact the financial condition of our customers and could result in a reduced demand for our products;●The impact of the military conflict in Ukraine, including supply chain disruptions, volatility in commodity prices, increased economic uncertainty and escalating geopolitical tensions; 62 Table of Contents●Fluctuations in growth and/or growth rates and/or decline in sales of the domestic and international energy drink categories generally, including in the convenience and gas channel (which is our largest channel) and the impact on demand for our products resulting from deteriorating economic conditions and/or financial uncertainties;●The impact of temporary or permanent facility closures, production slowdowns and disruptions in operations experienced by our suppliers, bottlers/distributors,/or co-packers, and/or breweries, including any material disruptions on the production and distribution of our products;●The consolidation of co-packers leading us to increasingly rely on fewer co-packing groups, certain of which account for a large percentage of our co-packing capacity for our Monster Energy® drinks;●The impact of logistical issues and delays, including shortages of shipping containers and port of entry congestion;●We have extensive commercial arrangements with TCCC and, as a result, our future performance is substantially dependent on the success of our relationship with TCCC;●The impact of TCCC’s bottlers/distributors distributing Coca-Cola brand energy drinks and possible reductions in the number of our SKUs carried by such bottlers/distributors and/or such bottlers/distributors imposing limitations on distributing new product SKUs;●The effect of TCCC being one of our significant stockholders and the potential divergence of TCCC’s interests from those of our other stockholders;●Our ability to maintain relationships with TCCC system bottlers/distributors and manage their ongoing commitment to focus on our non-alcohol products;●Disruption in distribution channels and/or decline in sales due to the termination and/or insolvency of existing and/or new domestic and/or international bottlers/distributors;●Lack of anticipated demand for our products in domestic and/or international markets;●Fluctuations in the inventory levels of our bottlers/distributors, planned or otherwise, and the resultant impact on our revenues;●Unfavorable regulations, including taxation, age restrictions imposed on the sale, purchase, or consumption of our products, marketing restrictions, product registration requirements, tariffs, trade restrictions, container size limitations and/or ingredient restrictions;●The effect of inquiries from, and/or actions by, state attorneys general, the Federal Trade Commission (the “FTC”), the Food and Drug Administration (the “FDA”), the Bureau of Alcohol, Tobacco, Firearms and Explosives (the “ATF”), municipalities, city attorneys, other government agencies, quasi-government agencies, government officials (including members of U.S. Congress) and/or analogous central and local agencies and other authorities in the foreign countries in which our products are manufactured and/or distributed, into the advertising, marketing, promotion, ingredients, sale and/or consumption of our products, including voluntary and/or required changes to our business practices;●Our ability to comply with laws, regulations and evolving industry standards regarding consumer privacy and data use and security, including, but not limited to, with respect to the General Data Protection Regulation and the California Consumer Privacy Act of 2018;●Our ability to achieve profitability and/or repatriate cash from certain of our operations outside the United States;●Our ability to manage legal and regulatory requirements in foreign jurisdictions, potential difficulties in staffing and managing foreign operations and potentially higher incidence of fraud or corruption and credit risk of foreign customers and/or bottlers/distributors;●Changes in U.S. tax laws as a result of any legislation proposed by the U.S. Presidential Administration or U.S. Congress, which may include efforts to change or repeal the 2017 Tax Cuts and Jobs Act and the federal corporate income tax rate reduction;●Our ability to produce our products in international markets in which they are sold, thereby reducing freight costs and/or product damages;●Our ability to effectively manage our inventories and/or our accounts receivables;●Our foreign currency exchange rate risk with respect to our sales, expenses, profits, assets and liabilities denominated in currencies other than the U.S. dollar, which will continue to increase as foreign sales increase;●The long-term impact of the United Kingdom’s departure from the European Union (or “Brexit”);●Changes in accounting standards may affect our reported profitability;63 Table of Contents●Implications of the Organization for Economic Cooperation and Development’s base erosion and profit shifting project;●Any proceedings which may be brought against us by the Securities and Exchange Commission (the “SEC”), the FDA, the FTC, the ATF or other governmental agencies or bodies;●The outcome and/or possibility of future shareholder derivative actions or shareholder securities litigation that may be filed against us and/or against certain of our officers and directors, and the possibility of other private shareholder litigation;●The outcome of product liability or consumer fraud litigation and/or class action litigation (or its analog in foreign jurisdictions) regarding the safety of our products and/or the ingredients in and/or claims made in connection with our products and/or alleging false advertising, marketing and/or promotion, and the possibility of future product liability and/or class action lawsuits;●Exposure to significant liabilities due to litigation, legal or regulatory proceedings, including litigation directed at the energy and alcohol beverage industries generally or at the Company in particular;●Intellectual property injunctions;●Unfavorable resolution of tax matters;●Uncertainty and volatility in the domestic and global economies, including risk of counterparty default or failure;●Our ability to address any significant deficiencies or material weakness in our internal controls over financial reporting;●Our ability to continue to generate sufficient cash flows to support our expansion plans and general operating activities;●Decreased demand for our products resulting from changes in consumer preferences, including, but not limited to: changes in demand for different packages, sizes and configurations; changes due to perceived health concerns such as obesity, ingredients in our products or packaging, and alcohol abuse; changes due to product safety concerns; and/or changes due to decreased consumer discretionary spending power;●Adverse publicity surrounding obesity, alcohol consumption, and other health concerns related to our products, product safety and quality, water usage, environmental impact and sustainability, human rights, our culture, workforce and labor and workplace laws;●Our ability to meet or comply with sustainability-related expectations, standards, and regulations, including forthcoming rules set forth by the SEC and European Commission; ●Changes in demand that are weather or season related and/or for other reasons, including changes in product category and/or package consumption and changes in cost and availability of certain key ingredients including aluminum cans, as well as disruptions to the supply chain, as a result of climate change and poor or extreme weather conditions; ●The impact of unstable political conditions, civil unrest, large scale terrorist acts, the outbreak or escalation of armed hostilities, major natural disasters and extreme weather conditions, widespread outbreaks of infectious diseases (such as the COVID-19 pandemic), or unforeseen economic and political changes and local or international catastrophic events;●The human and economic consequences of the COVID-19 pandemic, including new variants, as well as the measures taken or that may be taken in the future by governments, and consequently, businesses (including the Company and its suppliers, bottlers/ distributors, co-packers and other service providers) and the public at large to limit the COVID-19 pandemic;●The impact of changes to our sponsorship and endorsement activities, our sampling activities, and/or our innovation activities as a result of COVID-19 or other pandemics on our future sales and market share;●The impact of countries being in lockdown due to the COVID-19 pandemic at various times; ●The impact on our business of competitive products and pricing pressures and our ability to gain or maintain our share of sales in the marketplace as a result of actions by competitors, including unsubstantiated and/or misleading claims, false advertising claims and tortious interference, as well as competitors selling misbranded products;●The impact on our business of trademark and trade dress infringement proceedings brought against us relating to our brands, which could result in an injunction barring us from selling certain of our products and/or require changes to be made to our current trade dress;●Our ability to implement and/or maintain price increases, including through reductions in promotional allowances;●An inability to achieve volume growth through product and packaging initiatives;64 Table of Contents●Our ability to sustain the current level of sales and/or achieve growth for our Monster Energy® brand energy drinks and/or our other products, including our Strategic Brands and Alcohol Brands;●Our ability to implement our growth strategy, including expanding our business in existing and new sectors, such as the alcohol beverage sector;●Our ability to successfully integrate CANarchy and other acquired businesses or assets;●The inherent operational risks presented by the alcohol beverage industry that may not be adequately covered by insurance or lead to litigation relating to alcohol marketing, advertising, or distribution practices, alcohol abuse problems and other health consequences arising from excessive consumption of or other misuse of alcohol, including death; ●The impact of criticism of our products and/or the energy drink and/or alcohol beverage markets generally and/or legislation enacted (whether as a result of such criticism or otherwise) that restricts the marketing or sale of energy drinks and/or alcohol beverages (including prohibiting the sale of energy and/or alcohol drinks at certain establishments or pursuant to certain governmental programs), limits caffeine or alcohol content in beverages, requires certain product labeling disclosures and/or warnings, imposes excise and/or sales taxes, limits product sizes and/or imposes age restrictions for the sale of energy and/or alcohol drinks;●Our ability to comply with and/or resulting lower consumer demand and/or lower profit margins for energy drinks and/or alcohol beverages due to proposed and/or future U.S. federal, state and local laws and regulations and/or proposed or existing laws and regulations in certain foreign jurisdictions and/or any changes therein, including changes in taxation requirements (including tax rate changes, new tax laws, new and/or increased excise, sales and/or other taxes on our products and revised tax law interpretations) and environmental laws, as well as the Federal Food, Drug, and Cosmetic Act and regulations or rules made thereunder or in connection therewith by the FDA, as well as changes in any other food, drug or similar laws in the United States and internationally, especially those changes that may restrict the sale of energy and/or alcohol drinks (including prohibiting the sale of energy and/or alcohol drinks at certain establishments or pursuant to certain governmental programs), limit caffeine or alcohol content in beverages, require certain product labeling disclosures and/or warnings, impose excise taxes, impose sugar taxes, limit product sizes, or impose age restrictions for the sale of energy and/or alcohol drinks, as well as laws and regulations or rules made or enforced by the ATF and Explosives and/or the FTC or their foreign counterparts;●Disruptions in the timely import or export of our products and/or ingredients including flavors, flavor ingredients and supplement ingredients due to port congestion, strikes and related labor issues or otherwise;●Our ability to satisfy all criteria set forth in any model energy and/or alcohol drink guidelines, including, without limitation, those adopted by the American Beverage Association, of which we are a member, and/or any international beverage associations and the impact of our failure to satisfy such guidelines may have on our business;●The effect of unfavorable or adverse public relations, press, articles, comments and/or media attention;●Changes in the cost, quality and availability of containers, packaging materials, aluminum cans or kegs, the Midwest and other premiums, raw materials, including flavors and flavor ingredients, and other ingredients and juice concentrates, and our ability to obtain and/or maintain favorable supply arrangements and relationships and procure timely and/or sufficient production of all or any of our products to meet customer demand;●Any shortages that may be experienced in the procurement of containers and/or other raw materials including, without limitation, water, flavors, flavor ingredients, supplement ingredients, aluminum cans generally, PET containers used for our Monster Hydro® energy drinks, 24-ounce aluminum cap cans and 550ml BRE aluminum cans with resealable ends;●Limitations in procuring sufficient quantities of aluminum cans; ●In order to secure sufficient quantities of aluminum cans and sufficient co-packing availability in the future, we may be required to commit to minimum purchase volumes and/or minimum co-packing volumes. In the event that we over-estimate future demand for our products and therefore may not purchase such minimum quantities in full, or utilize such minimum co-packing volumes in full, we may incur claims and/or costs or losses in respect of such shortfalls;●The impact on our cost of sales of corporate activity among the limited number of suppliers from whom we purchase certain raw materials;65 Table of Contents●Our ability to pass on to our customers all or a portion of any increases in the costs of raw materials, ingredients, commodities and/or other cost inputs affecting our business;●Our ability to achieve both internal domestic and international forecasts, which may be based on projected volumes and sales of many product types and/or new products, certain of which are more profitable than others; there can be no assurance that we will achieve projected levels of sales as well as forecasted product and/or geographic mixes;●Our ability to penetrate new domestic and/or international markets and/or gain approval or mitigate the delay in securing approval for the sale of our products in various countries;●The effectiveness of sales and/or marketing efforts by us and/or by the bottlers/distributors of our products, most of whom distribute products that may be regarded as competitive with our products;●Unilateral decisions by bottlers/distributors, buying groups, convenience chains, grocery chains, mass merchandisers, specialty chain stores, e-commerce retailers, e-commerce websites, club stores and other customers to discontinue carrying all or any of our products that they are carrying at any time, restrict the range of our products they carry, impose restrictions or limitations on the sale of our products and/or the sizes of containers of our products and/or devote less resources to the sale of our products;●The impact of certain activities by competitors and others to persuade regulators and/or retailers and/or customers in certain countries to reduce the permitted or maximum container sizes for our products from those currently being sold and marketed by us;●The impact of possible trading disputes between our bottler/distributors and their customers and/or one or more buying groups which may result in the delisting of certain of the Company products, temporarily or otherwise;●The effects of retailer consolidation on our business and our ability to successfully adapt to the rapidly changing retail landscape, including, but not limited to, substantial competition in the alcohol beverage market from new entrants, consolidations by competitors and retailers, and other competitive activities;●Our ability to adapt to the changing retail landscape with the rapid growth in e-commerce retailers;●The effects of bottler/distributor consolidation on our business;●The costs and/or effectiveness, now or in the future, of our advertising, marketing and promotional strategies;●The success of our sports marketing, social media and other general marketing endeavors both domestically and internationally;●Possible product recalls and/or reformulations of certain of our products and/or market withdrawals of certain of our products due to defective and/or non-compliant formulas or production in one or more jurisdictions;●The failure of our bottlers and/or co-packers to manufacture our products on a timely basis or at all;●Our ability to make suitable arrangements and/or procure sufficient capacity for the co-packing of any of our products both domestically and internationally, the timely replacement of discontinued co-packing arrangements and/or limitations on co-packing availability, including for retort production;●Our ability to make suitable arrangements for the timely procurement of non-defective raw materials;●Our inability to protect and/or the loss of our intellectual property rights and/or our inability to use our trademarks, trade names or designs and/or trade dress in certain countries;●Volatility of stock prices which may restrict stock sales, stock purchases or other opportunities as well as negatively impact the motivation of equity award grantees;●Provisions in our organizational documents and/or control by insiders which may prevent changes in control even if such changes would be beneficial to other stockholders;●Any disruption in and/or lack of effectiveness of our information technology systems, including a breach of cyber security, that disrupts our business or negatively impacts customer relationships, as well as cybersecurity incidents involving data shared with third parties; and●Recruitment and retention of senior management, other key employees and our employee base in general.The foregoing list of important factors and other risks detailed from time to time in our reports filed with the SEC is not exhaustive. See “Part I, Item 1A – Risk Factors” for a more complete discussion of these risks and uncertainties and for other risks and uncertainties. Those factors and the other risk factors described therein are not necessarily all of the important factors that could cause actual results or developments to differ materially from those expressed in any of our 66 Table of Contentsforward-looking statements. Other unknown or unpredictable factors also could harm our results. Consequently, our actual results could be materially different from the results described or anticipated by our forward-looking statements due to the inherent uncertainty of estimates, forecasts and projections and may be better or worse than anticipated. Given these uncertainties, you should not rely on forward-looking statements. Forward-looking statements represent our estimates and assumptions only as of the date that they were made. We expressly disclaim any duty to provide updates to forward-looking statements, and the estimates and assumptions associated with them, after the date of this report, in order to reflect changes in circumstances or expectations or the occurrence of unanticipated events except to the extent required by applicable securities laws.ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKIn the normal course of business our financial position is routinely subject to a variety of risks. The principal market risks (i.e., the risk of loss arising from adverse changes in market rates and prices) to which we are exposed are fluctuations in commodity and other input prices affecting the costs of our raw materials (including, but not limited to, increases in the costs of aluminum cans, as well as sugar, sucralose and other sweeteners, glucose, sucrose, juice concentrates, milk, cream, coffee, tea, hops, malt and yeast, all of which are used in some or many of our products), fluctuations in energy and fuel prices, as well as limitations in the availability of aluminum cans and certain other raw materials and packaging materials. We generally do not use hedging agreements or alternative instruments to manage the risks associated with securing sufficient ingredients or raw materials. We are also subject to market risks with respect to the cost of commodities and other inputs because our ability to recover increased costs through higher pricing is limited by the competitive environment in which we operate. We do not use derivative financial instruments to protect ourselves from fluctuations in interest rates and generally do not hedge against fluctuations in commodity prices. Our net sales to customers outside of the United States were approximately 37% of consolidated net sales for both the years ended December 31, 2022 and 2021. Our growth strategy includes expanding our international business. As a result, we are subject to risks from changes in foreign currency exchange rates. During the year ended December 31, 2022, we entered into forward currency exchange contracts with financial institutions to create an economic hedge to specifically manage a portion of the foreign exchange risk exposure associated with certain consolidated subsidiaries’ non-functional currency denominated assets and liabilities. All foreign currency exchange contracts entered into by us as of December 31, 2022 have terms of three months or less. We do not enter into forward currency exchange contracts for speculation or trading purposes.We have not designated our foreign currency exchange contracts as hedge transactions under FASB ASC 815. Therefore, gains and losses on our foreign currency exchange contracts are recognized in other (expense) income, net, in the consolidated statements of income, and are largely offset by the changes in the fair value of the underlying economically hedged item. We do not consider the potential loss resulting from a hypothetical 10% adverse change in quoted foreign currency exchange rates as of December 31, 2022 to be significant.As of December 31, 2022, we had $1.31 billion in cash and cash equivalents, $1.36 billion in short-term investments and $61.4 million in long-term investments Certain of these investments are subject to general credit, liquidity, market and interest rate risks.ITE
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsOVERVIEWThe following discussion should be read along with the financial statements included in this Form 10-K, as well as Part II, “Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations” of our Form 10-K for the year ended December 31, 2021 (“2021 Annual Report on Form 10-K”).Global Security EnvironmentThe U.S. and its allies continue to face a global security environment of heightened tensions and instability, threats from state and non-state actors, including in particular major global powers, as well as terrorist organizations, increasing nuclear tensions, diverse regional security concerns and political instability. The market for defense products, services and solutions globally is driven by these complex and evolving security challenges, considered in the broader context of political and socioeconomic circumstances and priorities. Our operations and financial performance, as well as demand for our products and services, are impacted by global events, including violence and unrest. The same is true for our suppliers and other business partners.The conflict in Ukraine has increased global tensions and instability, highlighted threats and increased global demand, as well as further disrupted global supply chains and added costs. We have experienced a modest increase in demand for certain of our goods and services directly and indirectly related to the conflict in the Ukraine. We also have experienced a slight disruption to some of our programs and supply chain, including unanticipated cost growth, as a result of the conflict in Ukraine and economic sanctions. However, we do not have sizable business dealings in Russia or Ukraine, and do not anticipate significant adverse impacts from the ongoing conflict.More broadly, the conflict in Ukraine and threats elsewhere have heightened tensions and highlighted security requirements globally, especially in Europe and the Pacific region, as well as the U.S. We have started to see, and expect to continue to see, increased demand for defense products and services from allies and partner nations, particularly in those areas. We are actively exploring both opportunities and risks.For further information on the global security environment, including the risks related thereto, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Liquidity and Capital Resources,” “Quantitative and Qualitative Disclosures About Market Risks” and “Risk Factors.”Global Health and Economic EnvironmentCOVID-19Since at least March 2020, when it was first characterized as a global pandemic, COVID-19 has dramatically impacted and continues to impact the global health and economic environments, including millions of confirmed cases and deaths, business slowdowns or shutdowns, labor shortfalls, supply chain challenges, regulatory challenges, inflationary pressures and market volatility. We discussed in some detail in our Annual Reports on Form 10-K for the fiscal years ended December 31, 2020 and 2021, and subsequent SEC filings, the pandemic, its impacts and risks, and actions taken up to the time of each filing. In this Form 10-K, we provide a further update.In 2022, the pandemic continued to have significant adverse impacts on the global health and macroeconomic environments, particularly with the spread of new variants and other viruses and illnesses, ongoing disruption of the labor force and supply chains, continued inflation, and market volatility and uncertainties. We expect such adverse impacts to continue. However, with extraordinary efforts by our employees, our governments and customers, our partners and our company, direct COVID-19-related impacts on our business generally declined in 2022. While we cannot predict the future course of the pandemic or its consequences, we are not currently assuming significant additional direct COVID-19 related impacts on our business.The company continues to work to monitor and address the pandemic, including its impact on our company, our employees, our customers, our suppliers and our communities. Our goals have been, and continue to be, to keep our employees safe, to lessen the potential adverse impacts, both health and economic, and to continue to position the company for long-term success. Like the communities in which we operate, our actions have varied, and will continue to vary, depending on the spread of COVID-19 and other illnesses, applicable government requirements, and the needs of our stakeholders.Global Economic EnvironmentIn part as a result of the COVID-19 pandemic, the global economic environment has experienced, and continues to experience, extraordinary challenges, including high rates of inflation and inflationary pressures; widespread delays and disruptions in supply chains; workforce challenges, including labor shortages (especially in critical skill areas); and market volatility. These macroeconomic factors have contributed, and we expect will continue to contribute, to increased costs, delays and other performance challenges, as well as increased competing demands for limited -30-NORTHROP GRUMMAN CORPORATION resources to address such increased costs and other challenges, for our company, our suppliers and partners, and our customers. For example, as discussed in greater detail in Note 12 to the consolidated financial statements, our latest estimated cost to complete the low-rate initial production (LRIP) phase of the B-21 program reflects updated estimates for adverse impacts from these macroeconomic factors, as well as potential opportunities to address them.We continue to work hard to mitigate some of the challenges caused by the current macroeconomic environment on our business, including by taking steps to support our suppliers and small businesses and enhancing our workforce through extensive hiring, development and retention efforts. However, the broader macroeconomic environment, including inflationary pressures and supply chain challenges, continued adversely to affect the company’s results for the year ended December 31, 2022. We cannot clearly predict how long these macroeconomic challenges will continue, or how they will change over time, or what additional resources will be available, but we expect to see this challenging macroeconomic environment continue adversely to impact the global economy, our customers, our industry and our company in 2023.In addition, increased interest rates, raising the cost of borrowing for governments, could further impact government spending priorities (in the U.S. and allied countries, in particular), including their demand for defense products. Economic tensions and changes in international trade policies, including higher tariffs on imported goods and materials and renegotiation of free trade agreements, could also further impact the global market for defense products, services and solutions.U.S. Political, Budget and Regulatory EnvironmentOn March 15, 2022, the President signed into law the Consolidated Appropriations Act for FY 2022, which provided full-year funding for federal agencies, including $782 billion for national defense. This represented an approximately $42 billion or 6 percent increase above the budget for FY 2021, approximately $30 billion more than the Administration had initially requested. The Pentagon’s portion of the overall national defense budget for FY 2022 was $743 billion. On March 28, 2022, the President proposed his budget for FY 2023, which included $813 billion for national defense programs, approximately $31 billion or 4 percent higher than what was appropriated in FY 2022. The Pentagon’s portion of the overall requested national defense budget was $773 billion.On December 23, 2022, the President signed the National Defense Authorization Act (NDAA) for FY 2023, which supports approximately $858 billion in FY 2023 funding for national defense, $817 billion of which is for the DoD. In addition, the FY 2023 NDAA grants DoD discretionary authority under limited circumstances to provide extraordinary relief to contractors to address certain inflationary impacts. Although discussions have occurred, DoD has not yet issued written guidance for how it intends to exercise this authority.On December 29, 2022, the President signed an Omnibus appropriations act for FY 2023 that provided $858 billion for national defense programs, approximately $45 billion more than the Administration initially requested for FY 2023 and approximately $76 billion or 10 percent higher than what was appropriated in FY 2022. The Pentagon’s portion of the overall national defense budget for FY 2023 is $817 billion. It includes up to $1 billion for extraordinary relief in FY 2023.In addition to the U.S. national security spending detailed above, the U.S. has pledged over $100 billion in security assistance to address the ongoing conflict in Ukraine across FY 2022 and FY 2023, including approximately $50 billion in DoD spending. Assistance includes transfers of weapons systems from U.S. inventories, orders for production of additional weapons systems, both to backfill U.S. stockpiles and for Ukraine directly, and assistance from U.S. capabilities.It is difficult to predict the specific course of future defense budgets. Current and future requirements related to the conflict in Ukraine, threats in the Pacific regions and other security priorities, as well as global inflation, the national debt, the costs of the pandemic and other domestic priorities, among other things, in the U.S. and globally, will continue to impact our customers’ budgets and priorities, and our industry. Current tensions within Congress and the wider U.S. political environment may also impact defense budgets and government spending more broadly. We believe the current global security environment highlights the significant national security threats to our nation and our allies, and the need for strong deterrence and a robust defense capability. We believe that our capabilities, particularly in space, C4ISR, missile defense, battle management, advanced weapons, survivable aircraft and mission systems should help our customers in the U.S. and globally defend against current and future threats and, as a result, continue to allow for long-term profitable business growth.The Bipartisan Budget Act of 2019 suspended the debt ceiling through July 31, 2021. In October 2021, the statutory debt limit was increased by $480 billion and, in December 2021, it was further increased by $2.5 trillion, which is -31-NORTHROP GRUMMAN CORPORATION currently expected to allow the Treasury Department to finance the government into 2023. In January 2023, the debt ceiling was reached and the Treasury Department began taking “extraordinary measures” to finance the government and avoid a breach of the debt ceiling. We expect statutory action will be needed in 2023 to increase or suspend the debt ceiling. During the third quarter of 2022, the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act of 2022, which includes an advanced manufacturing investment tax credit, among other provisions, and the Inflation Reduction Act of 2022, which includes implementation of a new alternative minimum tax and a one percent excise tax on share repurchases, among other provisions, were signed into law. We expect the excise tax on share repurchases to impact us beginning in 2023; however, we do not expect this tax or any other provision of this legislation to have a material impact on our results of operations or cash flows. More broadly, we have seen, and expect to continue to see, an accelerated pace of new rulemakings, new and expanded uses of existing authorities, changing legal rulings and landscapes, and aggressive enforcement actions. These changes and the accelerated pace of change, not only impose additional obligations and risk, but also create further uncertainty regarding our operating environment. The political environment, federal budget, debt ceiling and regulatory environment are expected to continue to be the subject of considerable debate, especially in light of the ongoing conflict in Ukraine, the inflationary environment and political tensions. The results of those debates could have material impacts on defense spending broadly and the company’s programs in particular. We anticipate that the broader macroeconomic environment, with ongoing inflationary pressures, labor challenges, and supply chain disruption, among other considerations, will continue to play a significant role in the outcome of these debates and, in turn, on our industry and company.For further information on the risks we face from the current political and economic environment, see “Risk Factors.”Disposition of IT and Mission Support Services BusinessEffective January 30, 2021 (the “Divestiture date”), we completed the sale of our IT and mission support services business (the “IT services divestiture”) for $3.4 billion in cash and recorded a pre-tax gain of $2.0 billion. The IT and mission support services business was comprised of the majority of the former IS&S division of Defense Systems (excluding the Vinnell Arabia business); select cyber, intelligence and missions support programs, which were part of the former CIMS division of Mission Systems; and the former Space Technical Services business unit of Space Systems. Operating results include sales and operating income for the IT and mission support services business prior to the Divestiture date; therefore, no sales and operating income were recognized for this business during the year ended December 31, 2022.The company recorded pre-tax profit of the IT and mission support services business of $20 million and $247 million for the years ended December 31, 2021 and 2020, respectively.Operating Performance Assessment and ReportingWe manage and assess our business based on our performance on contracts and programs (typically larger contracts or two or more closely-related contracts). We recognize sales from our portfolio of long-term contracts as control is transferred to the customer, primarily over time on a cost-to-cost basis (cost incurred relative to costs estimated at completion). As a result, sales tend to fluctuate in concert with costs incurred across our large portfolio of contracts. Due to the applicable FAR and CAS requirements that govern our U.S. government business, most types of costs are allocable to U.S. government contracts. As such, we do not focus on individual cost groupings (such as manufacturing, engineering and design labor, subcontractor, material, overhead and general and administrative (G&A) costs), as much as we do on total contract cost, which is the key driver of our sales and operating income.In evaluating our operating performance, we primarily focus on changes in sales and operating margin rates. Where applicable, significant fluctuations in operating performance attributable to individual contracts or programs, or changes in a specific cost element across multiple contracts, are described in our analysis. Based on this approach and the nature of our operations, the discussion of results of operations below first focuses on our four segments before distinguishing between products and services. Changes in sales are generally described in terms of volume, while changes in operating margin rates are generally described in terms of performance and/or contract mix. For purposes of this discussion, volume generally refers to increases or decreases in sales or cost from production/service activity levels and performance generally refers to non-volume-related changes in profitability, which are typically described in terms of changes in net EAC adjustments. Contract mix generally refers to changes in the ratio of contract type and/or life cycle (e.g., cost-type, fixed-price, development, production, and/or sustainment).-32-NORTHROP GRUMMAN CORPORATION CONSOLIDATED OPERATING RESULTSFor purposes of the operating results discussion below, we assess our performance using certain financial measures that are not calculated in accordance with accounting principles generally accepted in the United States of America (“GAAP” or “FAS”). Organic sales is defined as total sales excluding sales attributable to the company's IT services divestiture. This measure may be useful to investors and other users of our financial statements as a supplemental measure in evaluating the company’s underlying sales growth as well as in providing an understanding of our ongoing business and future sales trends by presenting the company’s sales before the impact of divestiture activity. Transaction-adjusted net earnings and transaction-adjusted earnings per share (transaction-adjusted EPS) exclude impacts related to the IT services divestiture, including the gain on sale of the business, associated federal and state income tax expenses, transaction costs, and the make-whole premium for early debt redemption. They also exclude the impact of mark-to-market pension and OPB (“MTM”) benefit/(expense) and related tax impacts, which are generally only recognized during the fourth quarter. These non-GAAP measures may be useful to investors and other users of our financial statements as supplemental measures in evaluating the company’s underlying financial performance by presenting the company’s operating results before the non-operational impact of divestiture activity and pension and OPB actuarial gains and losses. These measures are also consistent with how management views the underlying performance of the business as the impact of the IT services divestiture and MTM accounting are not considered in management’s assessment of the company’s operating performance or in its determination of incentive compensation awards. We reconcile these non-GAAP financial measures to their most directly comparable GAAP financial measures below. These non-GAAP measures may not be defined and calculated by other companies in the same manner and should not be considered in isolation or as an alternative to operating results presented in accordance with GAAP.Selected financial highlights are presented in the table below: Year Ended December 31% Change in$ in millions, except per share amounts20222021202020222021Sales$36,602 $35,667 $36,799 3 %(3)%Operating costs and expenses33,001 31,996 32,734 3 %(2)%Operating costs and expenses as a % of sales90.2 %89.7 %89.0 %Gain on sale of business— 1,980 — NMNMOperating income3,601 5,651 4,065 (36)%39 %Operating margin rate9.8 %15.8 %11.0 %Mark-to-market pension and OPB benefit (expense) 1,232 2,355 (1,034)(48)%(328)%Federal and foreign income tax expense940 1,933 539 (51)%259 %Effective income tax rate16.1 %21.6 %14.5 %Net earnings4,896 7,005 3,189 (30)%120 %Diluted earnings per share$31.47 $43.54 $19.03 (28)%129 %-33-NORTHROP GRUMMAN CORPORATION SalesThe tables below reconcile sales to organic sales:Year Ended December 3120222021$ in millionsSalesIT services salesOrganicsalesSalesIT services salesOrganicsalesOrganic sales % changeAeronautics Systems$10,531 $— $10,531 $11,259 $— $11,259 (6)%Defense Systems5,579 — 5,579 5,776 (106)5,670 (2)%Mission Systems10,396 — 10,396 10,134 (42)10,092 3 %Space Systems12,275 — 12,275 10,608 (16)10,592 16 %Intersegment eliminations(2,179)— (2,179)(2,110)2 (2,108)Total$36,602 $— $36,602 $35,667 $(162)$35,505 3 %Year Ended December 3120212020$ in millionsSalesIT services salesOrganicsalesSalesIT services salesOrganicsalesOrganic sales % changeAeronautics Systems$11,259 $— $11,259 $12,169 $— $12,169 (7)%Defense Systems5,776 (106)5,670 7,543 (1,637)5,906 (4)%Mission Systems10,134 (42)10,092 10,080 (527)9,553 6 %Space Systems10,608 (16)10,592 8,744 (182)8,562 24 %Intersegment eliminations(2,110)2 (2,108)(1,737)17 (1,720)Total$35,667 $(162)$35,505 $36,799 $(2,329)$34,470 3 %2022 sales increased $935 million and 2022 organic sales increased $1.1 billion, or 3 percent, due to higher sales at Space Systems and Mission Systems, partially offset by lower sales at Aeronautics Systems and Defense Systems. 2022 sales reflect strong demand, the timing of material receipts and improving trends in labor availability during the second half of the year. See “Segment Operating Results” below for further information by segment and “Product and Service Analysis” for product and service detail. See Note 16 to the consolidated financial statements for information regarding the company’s sales by customer type, contract type and geographic region for each of our segments. Operating Income and Margin Rate2022 operating income decreased $2.1 billion, or 36 percent, primarily due to a $2.0 billion pre-tax gain on sale and $192 million of unallocated corporate expenses recognized in the prior year associated with the IT services divestiture. Operating income also decreased due to a $330 million reduction in the FAS/CAS operating adjustment, which more than offset higher segment operating income and lower non-divestiture-related unallocated corporate expense. 2022 operating margin rate declined to 9.8 percent from 15.8 percent reflecting the items above.2022 G&A costs as a percentage of sales increased to 10.6 percent from 10.1 percent, primarily due to an increase in investments for future business opportunities.For further information regarding product and service operating costs and expenses, see “Product and Service Analysis” below.-34-NORTHROP GRUMMAN CORPORATION Mark-to-Market Pension and OPB Benefit/ExpenseThe primary components of pre-tax MTM benefit (expense) are presented in the table below: Year Ended December 31$ in millions202220212020Actuarial gains (losses) on projected benefit obligation$9,662 $1,163 $(3,570)Actuarial (losses) gains on plan assets (8,430)1,192 2,536 MTM benefit (expense)$1,232 $2,355 $(1,034)2022 MTM benefit (expense) of $1.2 billion was primarily driven by a 256 basis point increase in the discount rate from year end 2021, partially offset by losses of 15.4 percent on plan assets compared to our 7.5 percent asset return assumption.Federal and Foreign Income TaxesThe 2022 effective tax rate (ETR) decreased to 16.1 percent from 21.6 percent primarily due to an $86 million benefit resulting from the resolution of the IRS examination of certain legacy OATK tax returns, as well as additional federal income taxes in the prior year resulting from the IT services divestiture. The company’s 2022 MTM benefit increased the 2022 ETR by 1.2 percentage points; however, the 2021 MTM benefit did not significantly impact the 2021 ETR. See Note 7 to the consolidated financial statements for additional information.Net EarningsThe table below reconciles net earnings to transaction-adjusted net earnings: Year Ended December 31% Change in$ in millions20222021202020222021Net earnings$4,896 $7,005 $3,189 (30)%120 %MTM (benefit) expense (1,232)(2,355)1,034 (48)%(328)%MTM-related deferred state tax expense (benefit)(1)65 124 (54)(48)%(330)%Federal tax expense (benefit) of items above(2)245 469 (206)(48)%(328)%MTM adjustment, net of tax(922)(1,762)774 (48)%(328)%Gain on sale of business— (1,980)— NMNMState tax impact(3)— 160 — NMNMTransaction costs— 32 — NMNMMake-whole premium— 54 — NMNMFederal tax impact of items above(4)— 614 — NMNMTransaction adjustment, net of tax— (1,120)— NMNMTransaction-adjusted net earnings$3,974 $4,123 $3,963 (4)%4 %(1)The deferred state tax impact in each period was calculated using the company’s blended state tax rate of 5.25 percent and is included in Unallocated corporate expense within operating income. (2)The federal tax impact in each period was calculated by subtracting the deferred state tax impact from MTM benefit (expense) and applying the 21 percent federal statutory rate. (3)The state tax impact includes $62 million of incremental tax expense related to $1.2 billion of nondeductible goodwill in the divested business.(4)The federal tax impact was calculated by applying the 21 percent federal statutory rate to the adjustment items and also includes $250 million of incremental tax expense related to $1.2 billion of nondeductible goodwill in the divested business.2022 net earnings decreased $2.1 billion, or 30 percent, principally due to a $1.1 billion decrease associated with the IT services divestiture, net of tax, and an $840 million decrease in our MTM benefit (expense), net of tax. Transaction-adjusted net earnings decreased $149 million, or 4 percent, primarily due to a $330 million reduction in the FAS/CAS operating adjustment and $97 million of lower returns on marketable securities, partially offset by lower income tax and interest expense and higher segment operating income.-35-NORTHROP GRUMMAN CORPORATION Diluted Earnings Per ShareThe table below reconciles diluted earnings per share to transaction-adjusted EPS: Year Ended December 31% Change in20222021202020222021Diluted earnings per share$31.47 $43.54 $19.03 (28)%129 %MTM (benefit) expense per share(7.92)(14.64)6.17 (46)%(337)%MTM-related deferred state tax expense (benefit) per share(1)0.42 0.77 (0.32)(45)%(341)%Federal tax expense (benefit) of items above per share(2)1.57 2.92 (1.23)(46)%(337)%MTM adjustment per share, net of tax(5.93)(10.95)4.62 (46)%(337)%Gain on sale of business per share— (12.31)— NMNMState tax impact(3) per share— 0.99 — NMNMTransaction costs per share— 0.20 — NMNMMake-whole premium per share— 0.34 — NMNMFederal tax impact of items above(4) per share— 3.82 — NMNMTransaction adjustment per share, net of tax— (6.96)— NMNMTransaction-adjusted EPS$25.54 $25.63 $23.65 — %8 %(1)The deferred state tax impact in each period was calculated using the company’s blended state tax rate of 5.25 percent and is included in Unallocated corporate expense within operating income. (2)The federal tax impact in each period was calculated by subtracting the deferred state tax impact from MTM benefit (expense) and applying the 21 percent federal statutory rate. (3)The state tax impact includes $62 million of incremental tax expense related to $1.2 billion of nondeductible goodwill in the divested business.(4)The federal tax impact was calculated by applying the 21 percent federal statutory rate to the adjustment items and also includes $250 million of incremental tax expense related to $1.2 billion of nondeductible goodwill in the divested business.2022 diluted earnings per share decreased $12.07, or 28 percent, principally due to a $6.96 decrease associated with the IT services divestiture, net of tax, and a $5.02 decrease in our 2022 MTM benefit, net of tax. Transaction-adjusted EPS was comparable with the prior year and reflects a 4 percent reduction in transaction-adjusted net earnings and a 3 percent decrease in weighted-average diluted shares outstanding.SEGMENT OPERATING RESULTSBasis of PresentationThe company is aligned in four operating sectors, which also comprise our reportable segments: Aeronautics Systems, Defense Systems, Mission Systems and Space Systems. For a more complete description of each segment’s products and services, see “Business.”We present our sectors in the following business areas, which are reported in a manner reflecting core capabilities:Aeronautics SystemsDefense SystemsMission SystemsSpace SystemsAutonomous SystemsBattle Management & Missile SystemsAirborne Multifunction SensorsLaunch & Strategic MissilesManned AircraftMission ReadinessMaritime/Land Systems & SensorsSpaceNavigation, Targeting & SurvivabilityNetworked Information SolutionsThis section discusses segment sales, operating income and operating margin rate. A reconciliation of segment operating income to total operating income is provided below. -36-NORTHROP GRUMMAN CORPORATION Segment Operating Income and Margin RateSegment operating income, as reconciled in the table below, and segment operating margin rate (segment operating income divided by sales) are non-GAAP measures that reflect the combined operating income of our four segments less the operating income associated with intersegment sales. Segment operating income includes pension expense allocated to our sectors under FAR and CAS and excludes FAS pension service expense and unallocated corporate items (certain corporate-level expenses, which are not considered allowable or allocable under applicable FAR and CAS requirements, and costs not considered part of management’s evaluation of segment operating performance). These non-GAAP measures may be useful to investors and other users of our financial statements as supplemental measures in evaluating the financial performance and operational trends of our sectors. These measures may not be defined and calculated by other companies in the same manner and should not be considered in isolation or as alternatives to operating results presented in accordance with GAAP. Year Ended December 31% Change in$ in millions20222021202020222021Operating income$3,601 $5,651 $4,065 (36)%39 %Operating margin rate9.8 %15.8 %11.0 %Reconciliation to segment operating income:CAS pension expense(167)(544)(827)(69)%(34)%FAS pension service expense367 414 409 (11)%1 %FAS/CAS operating adjustment200 (130)(418)(254)%(69)%Gain on sale of business— (1,980)— NMNMIT services divestiture – unallowable state taxes and transaction costs— 192 — NMNMIntangible asset amortization and PP&E step-up depreciation242 254 322 (5)%(21)%MTM-related deferred state tax expense (benefit)(1)65 124 (54)(48)%(330)%Other unallocated corporate expense145 106 273 37 %(61)%Unallocated corporate expense (income)452 (1,304)541 (135)%(341)%Segment operating income$4,253 $4,217 $4,188 1 %1 %Segment operating margin rate11.6 %11.8 %11.4 %(1)Represents the deferred state tax benefit associated with MTM benefit (expense), which is recorded in Unallocated corporate expense consistent with other changes in deferred state taxes.Segment Operating Income and Margin Rate2022 segment operating income increased $36 million, or 1 percent, due to higher operating income at Mission Systems, Space Systems and Aeronautics Systems, partially offset by lower operating income at Defense Systems due, in part, to the impact of the IT services divestiture. 2021 segment operating income included $20 million from the IT services business, as well as a benefit of approximately $100 million due to the impact of lower overhead rates on the company’s fixed price contracts. Segment operating margin rate decreased to 11.6 percent from 11.8 percent principally due to lower net EAC adjustments due, in part, to macroeconomic impacts, including inflationary pressures and supply chain challenges. FAS/CAS Operating AdjustmentThe decrease in our 2022 FAS/CAS operating adjustment is due to lower CAS pension expense resulting from favorable plan asset returns in 2021 and changes in certain CAS actuarial assumptions as of December 31, 2021.Unallocated Corporate Expense (Income)The change in 2022 unallocated corporate expense (income) is primarily due to the prior year $2.0 billion pre-tax gain on sale and $192 million of unallowable state taxes and transaction costs associated with the IT services divestiture. -37-NORTHROP GRUMMAN CORPORATION Net Estimate-At-Completion (EAC) Adjustments - We record changes in estimated contract earnings at completion (net EAC adjustments) using the cumulative catch-up method of accounting. Net EAC adjustments can have a significant effect on reported sales and operating income and the aggregate amounts are presented in the table below:Year Ended December 31$ in millions202220212020Favorable EAC adjustments$1,337 $1,242 $1,082 Unfavorable EAC adjustments(977)(715)(616)Net EAC adjustments$360 $ 527 $ 466 Net EAC adjustments by segment are presented in the table below:Year Ended December 31$ in millions202220212020Aeronautics Systems$174 $25 $77 Defense Systems111 113 148 Mission Systems138 263 216 Space Systems(38)134 33 Eliminations(25)(8)(8)Net EAC adjustments$360 $527 $466 For purposes of the discussion in the remainder of this Segment Operating Results section, references to operating income and operating margin rate reflect segment operating income and segment operating margin rate, respectively.AERONAUTICS SYSTEMS Year Ended December 31% Change in$ in millions20222021202020222021Sales$10,531 $11,259 $12,169 (6)%(7)%Operating income1,116 1,093 1,206 2 %(9)%Operating margin rate10.6 %9.7 %9.9 %Sales2022 sales decreased $728 million, or 6 percent, due to lower volume in both Manned Aircraft and Autonomous Systems, including restricted programs, a $180 million decrease on the Global Hawk program, a $159 million decrease on the E-2 program and a $119 million decrease on the JSTARS program as it nears completion. Operating Income2022 operating income increased $23 million, or 2 percent, due to a higher operating margin rate, partially offset by lower sales. 2022 operating margin rate increased to 10.6 percent from 9.7 percent primarily due to higher net favorable EAC adjustments and a $38 million gain on a property sale. Higher net favorable EAC adjustments reflect $133 million of positive adjustments on the engineering, manufacturing and development phase of the B-21 program, partially offset by lower net EAC adjustments associated with other restricted work, as well as $135 million of unfavorable EAC adjustments on F-35 in the prior year. The prior year operating margin rate also reflects a $21 million benefit associated with favorable overhead rate performance.-38-NORTHROP GRUMMAN CORPORATION DEFENSE SYSTEMS Year Ended December 31% Change in$ in millions20222021202020222021Sales$5,579 $5,776 $7,543 (3)%(23)%Operating income664 696 846 (5)%(18)%Operating margin rate11.9 %12.0 %11.2 %Sales2022 sales decreased $197 million, or 3 percent, due, in part, to a $106 million reduction in sales related to the IT services divestiture. 2022 organic sales decreased $91 million, or 2 percent, principally due to a $154 million decrease from lower scope on an international training program, completion of a Joint Services support program and wind-down of the UKAWACS and JSTARS programs, partially offset by a $144 million increase from ramp-up on the Integrated Air and Missile Defense Battle Command System (IBCS) program, as well as higher volume on the Special Ammunition and Weapon Systems (SAWS) and NATO Alliance Ground Surveillance In-Service Support (NATO AGS ISS) programs.Operating Income2022 operating income decreased $32 million, or 5 percent, due, in part, to a $14 million reduction in operating income related to the IT services divestiture, as well as lower sales. Operating margin rate was comparable with the prior year. MISSION SYSTEMS Year Ended December 31% Change in$ in millions20222021202020222021Sales$10,396 $10,134 $10,080 3 %1 %Operating income1,618 1,579 1,459 2 %8 %Operating margin rate15.6 %15.6 %14.5 %Sales2022 sales increased $262 million, or 3 percent, and includes a $42 million reduction in sales related to the IT services divestiture. 2022 organic sales increased $304 million, or 3 percent, primarily due to higher restricted sales in the Networked Information Solutions business area, $107 million of higher volume on airborne radar programs and a $107 million increase on the Surface Electronic Warfare Improvement Program (SEWIP). These increases were partially offset by a $231 million decrease on Navigation, Targeting and Survivability programs and a $118 million decrease on the Joint Counter Radio-Controlled Improvised Explosive Device Electronic Warfare (JCREW) program. Operating Income2022 operating income increased $39 million, or 2 percent, due to higher sales. Operating margin rate was comparable with the prior year and reflects a $33 million benefit recognized in connection with a contract-related legal matter, partially offset by the previously described overhead rate benefit to fixed price contracts in the prior year.-39-NORTHROP GRUMMAN CORPORATION SPACE SYSTEMS Year Ended December 31% Change in$ in millions20222021202020222021Sales$12,275 $10,608 $8,744 16 %21 %Operating income1,158 1,121 893 3 %26 %Operating margin rate9.4 %10.6 %10.2 %Sales2022 sales and organic sales increased $1.7 billion, or 16 percent, due to higher sales in both business areas. Launch & Strategic Missiles sales increased primarily due to ramp-up on development programs, including a $454 million increase on the Ground Based Strategic Deterrent (GBSD) program and a $449 million increase on the Next Generation Interceptor (NGI) program, as well as higher volume on the GEM63 program in support of Amazon’s Project Kuiper. Sales in the Space business area were driven by a $320 million increase due to ramp-up on the Space Development Agency (SDA) Tranche 1 Transport and Tracking Layer programs awarded earlier this year, higher volume on restricted programs and a $134 million increase in sales on the Commercial Resupply Services (CRS) program, partially offset by a $149 million decrease in sales for the James Webb Space Telescope after its successful launch in December 2021. Operating Income2022 operating income increased $37 million, or 3 percent, due to higher sales, partially offset by a lower operating margin rate. Operating margin rate decreased to 9.4 percent from 10.6 percent primarily due to lower net EAC adjustments and a $45 million write-down of commercial inventory, partially offset by a $96 million gain recognized in connection with a land exchange transaction. -40-NORTHROP GRUMMAN CORPORATION PRODUCT AND SERVICE ANALYSISThe following table presents product and service sales and operating costs and expenses by segment: Year Ended December 31$ in millions202220212020Segment Information:SalesOperating Costs and ExpensesSalesOperating Costs and ExpensesSalesOperating Costs and ExpensesAeronautics SystemsProduct$ 7,981 $ 7,161 $ 9,408 $ 8,534 $ 10,437 $ 9,435 Service2,311 2,042 1,662 1,462 1,610 1,417 Intersegment eliminations239 212 189 170 122 111 Total Aeronautics Systems10,531 9,415 11,259 10,166 12,169 10,963 Defense SystemsProduct2,717 2,385 2,564 2,243 3,024 2,740 Service2,056 1,819 2,423 2,137 3,791 3,305 Intersegment eliminations806 711 789 700 728 652 Total Defense Systems5,579 4,915 5,776 5,080 7,543 6,697 Mission SystemsProduct7,376 6,291 7,064 6,017 6,744 5,757 Service2,005 1,639 2,077 1,695 2,557 2,201 Intersegment eliminations1,015 848 993 843 779 663 Total Mission Systems10,396 8,778 10,134 8,555 10,080 8,621 Space SystemsProduct10,448 9,455 8,832 7,898 6,810 6,084 Service1,708 1,557 1,637 1,464 1,826 1,672 Intersegment eliminations119 105 139 125 108 95 Total Space Systems12,275 11,117 10,608 9,487 8,744 7,851 Segment TotalsTotal Product$28,522 $25,292 $27,868 $24,692 $27,015 $24,016 Total Service8,080 7,057 7,799 6,758 9,784 8,595 Total Segment(1)$36,602 $32,349 $35,667 $31,450 $36,799 $32,611 (1)A reconciliation of segment operating income to total operating income is included in “Segment Operating Results.”Product Sales and Costs2022 product sales increased $654 million, or 2 percent, primarily due to an increase in product sales at Space Systems, partially offset by a decrease in product sales at Aeronautics Systems. The increase at Space Systems was driven by ramp-up on development programs including GBSD and NGI, as well as higher volume on the SDA Tranche 1 Transport Layer and Tranche 1 Tracking Layer programs. The decrease at Aeronautics Systems was principally due to lower volume on restricted programs, as well as the Global Hawk and E-2 programs. 2022 product costs increased $600 million, or 2 percent, consistent with the higher product sales described above.Service Sales and Costs2022 service sales increased $281 million, or 4 percent, primarily due to an increase in service sales at Aeronautics Systems, principally on restricted programs, partially offset by a decrease in service sales at Defense Systems. The decrease at Defense Systems was driven by lower scope on an international training program, the impact of the IT services divestiture, completion of a Joint Services support program and wind-down of the UKAWACS program. Sales from the divested IT services business, which were largely included in service sales, were $162 million in the prior year. 2022 service costs increased $299 million, or 4 percent, consistent with the higher service sales described above.-41-NORTHROP GRUMMAN CORPORATION BACKLOGBacklog represents the future sales we expect to recognize on firm orders received by the company and is equivalent to the company’s remaining performance obligations at the end of each period. It comprises both funded backlog (firm orders for which funding is authorized and appropriated) and unfunded backlog. Unexercised contract options and indefinite delivery indefinite quantity (IDIQ) contracts are not included in backlog until the time the option or IDIQ task order is exercised or awarded. Backlog is converted into sales as costs are incurred or deliveries are made.Backlog consisted of the following at December 31, 2022 and 2021: 20222021$ in millionsFundedUnfundedTotalBacklogTotalBacklog% Change in 2022Aeronautics Systems$8,458 $10,939 $19,397 $18,277 6 %Defense Systems5,881 1,634 7,515 6,349 18 %Mission Systems9,835 4,040 13,875 14,306 (3)%Space Systems8,317 29,639 37,956 37,114 2 %Total backlog$32,491 $46,252 $78,743 $76,046 4 %2022 net awards totaled $39.3 billion. Significant 2022 new awards include $10.6 billion for restricted programs (principally at Aeronautics Systems, Mission Systems and Space Systems), $5.3 billion for F-35, $2.1 billion for GEM63 solid rocket boosters, largely related to Amazon's Project Kuiper, $1.5 billion for the SDA Tranche 1 Transport and Tracking Layer programs, $1.3 billion for Commercial Resupply Services (CRS) missions and $1.3 billion for Ground-based Midcourse Defense (GMD).LIQUIDITY AND CAPITAL RESOURCESWe are focused on the efficient conversion of operating income into cash to provide for the company’s material cash requirements, including working capital needs, satisfaction of contractual commitments, funding of our pension and OPB plans, investment in our business through capital expenditures, and shareholder return through dividend payments and share repurchases. As of December 31, 2022, we had cash and cash equivalents of $2.6 billion; $316 million was held outside of the U.S. by foreign subsidiaries. We expect cash and cash equivalents and cash generated from operating activities, supplemented by borrowings under credit facilities, commercial paper and/or in the capital markets through our shelf registration with the SEC, if needed, to be sufficient to provide liquidity to the company in the short-term and long-term. The company has a five-year senior unsecured credit facility in an aggregate principal amount of $2.5 billion, and in April 2022, we renewed our one-year $500 million uncommitted credit facility. At December 31, 2022, there were no borrowings outstanding under these credit facilities.The company’s principal contractual commitments include purchase obligations, repayments of long-term debt and related interest, and payments under operating leases. At December 31, 2022, we had $19.0 billion of purchase obligations, approximately half of which is short-term. Purchase obligations are largely comprised of open purchase order commitments to suppliers and subcontractors under U.S. government contracts. In most circumstances, our risk associated with the purchase obligations on our U.S. government contracts is limited to the termination liability provisions within those contracts. As such, we do not believe they represent a material liquidity risk to the company. At December 31, 2022, we had capital expenditure commitments of $1.5 billion, which we expect to satisfy with cash on hand. We also had provisions for uncertain tax positions of $1.7 billion, some or all of which could result in future cash payments to various taxing authorities. At this time, we are unable to estimate the timing and amount of any future cash outflows related to these uncertain tax positions. Refer to the respective notes to the consolidated financial statements for further information about our share repurchase programs (Note 3), commercial paper, credit facilities and long-term debt (Note 10), standby letters of credit and guarantees (Note 12), future minimum contributions for the company’s pension and OPB plans (Note 13), and lease payment obligations (Note 15). COVID-19 and the CARES ActThe Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) established a program with provisions to allow U.S. companies to defer the employer’s portion of social security taxes between March 27, 2020 and December 31, 2020 and pay such taxes in two installments in 2021 and 2022. Our first installment of deferred social security taxes of $200 million was paid in the fourth quarter of 2021 and the second installment of $200 million was -42-NORTHROP GRUMMAN CORPORATION paid in the fourth quarter of 2022. Under Section 3610, the CARES Act also authorized the government to reimburse qualifying contractors for certain costs of providing paid leave to employees as a result of COVID-19. The company has sought and may continue to seek recovery for certain COVID-19-related costs under Section 3610 of the CARES Act and through our contract provisions, though it is unclear what funds will be available and how much we will be able to recover. In addition, the DoD has taken steps to increase the rate for certain progress payments from 80 percent to 90 percent for costs incurred and work performed on relevant contracts; it is unclear how long the 90 percent progress payment rate will remain in place and whether the DoD will take any further steps.Internal Revenue Code (IRC) Section 174Beginning in 2022, the Tax Cuts and Jobs Act of 2017 (“TCJA”) eliminated the option to deduct research and development expenditures in the current year and requires taxpayers to amortize them over five years pursuant to IRC Section 174. Our 2022 cash from operations were reduced by approximately $900 million for federal tax payments we made related to Section 174. In the future, Congress may consider legislation that would defer the amortization requirement to later years, possibly with retroactive effect. In the meantime, we expect to continue to make additional federal tax payments based on the current Section 174 tax law. The impact of Section 174 on our cash from operations depends on the amount of research and development expenditures incurred by the company and whether the IRS issues guidance on the provision which differs from our current interpretation, among other things. Cash Flow MeasuresIn addition to our cash position, we consider various cash flow measures in capital deployment decision-making, including cash provided by operating activities and adjusted free cash flow, a non-GAAP measure described in more detail below.Operating Cash FlowThe table below summarizes key components of cash flow provided by operating activities: Year Ended December 31$ in millions202220212020Net earnings$4,896 $7,005 $3,189 Gain on sale of business— (1,980)— Non-cash items(1)(1,305)(1,510)1,799 Pension and OPB contributions(136)(141)(887)Changes in trade working capital(600)181 227 Other, net46 12 (23)Net cash provided by operating activities$2,901 $3,567 $4,305 (1)Includes depreciation and amortization, non-cash lease expense, MTM benefit (expense), stock based compensation expense, deferred income taxes and net periodic pension and OPB income.2022 cash provided by operating activities decreased $666 million principally due to lower CAS pension recoveries and changes in trade working capital, including approximately $900 million of federal tax payments related to the Section 174 tax legislation described above. The prior year included $785 million of tax payments related to the IT services divestiture.Adjusted Free Cash FlowAdjusted free cash flow, as reconciled in the table below, is a non-GAAP measure defined as net cash provided by or used in operating activities, less capital expenditures, plus proceeds from the sale of equipment to a customer (not otherwise included in net cash provided by or used in operating activities) and the after-tax impact of discretionary pension contributions. Adjusted free cash flow includes proceeds from the sale of equipment to a customer as such proceeds were generated in a customer sales transaction. It also includes the after-tax impact of discretionary pension contributions for consistency and comparability of financial performance. This measure may not be defined and calculated by other companies in the same manner. We use adjusted free cash flow as a key factor in our planning for, and consideration of, acquisitions, the payment of dividends and stock repurchases. This non-GAAP measure may be useful to investors and other users of our financial statements as a supplemental measure of our cash performance, but should not be considered in isolation, as a measure of residual cash flow available for discretionary purposes, or as an alternative to operating cash flows presented in accordance with GAAP.-43-NORTHROP GRUMMAN CORPORATION The table below reconciles net cash provided by operating activities to adjusted free cash flow:Year Ended December 31% Change in$ in millions20222021202020222021Net cash provided by operating activities$2,901 $3,567 $4,305 (19)%(17)%Capital expenditures(1,435)(1,415)(1,420)1 %— %Proceeds from sale of equipment to a customer155 84 205 85 %(59)%After-tax discretionary pension contributions— — 593 NM(100)%Adjusted free cash flow$1,621 $2,236 $3,683 (28)%(39)%2022 adjusted free cash flow decreased $615 million principally due to lower net cash provided by operating activities, partially offset by an increase in proceeds from the sale of equipment to a customer. Investing Cash Flow2022 net cash used in investing activities was $1.2 billion compared to net cash provided by investing activities of $2.1 billion in the prior year, principally due to $3.4 billion in cash received from the sale of our IT services business during the first quarter of 2021. Financing Cash Flow2022 net cash used in financing activities decreased $4.4 billion principally due to a $2.2 billion decrease in debt repayments and a $2.2 billion reduction in share repurchases.CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTSOur consolidated financial statements are prepared in conformity with GAAP, which requires us to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements. We employ judgment in making our estimates in consideration of historical experience, currently available information and various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from our estimates and assumptions, and any such differences could be material to our consolidated financial statements. We believe the following accounting policies are critical to the understanding of our consolidated financial statements and require the use of significant management judgment in their application. For a summary of our significant accounting policies, see Note 1 to the consolidated financial statements.Revenue RecognitionDue to the long-term nature of our contracts, we generally recognize revenue over time using the cost-to-cost method, which requires us to make reasonably dependable estimates regarding the revenue and cost associated with the design, manufacture and delivery of our products and services. Contract sales may include estimates of variable consideration, including cost or performance incentives (such as award and incentive fees), contract claims and requests for equitable adjustment (REAs). Variable consideration is included in total estimated sales to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. We estimate variable consideration as the most likely amount to which we expect to be entitled. Our cost estimation process is based on the professional knowledge of our engineering, program management and financial professionals, and draws on their significant experience and judgment. We prepare EACs for our contracts and calculate an estimated contract profit based on total estimated contract sales and cost. Since our contracts typically span a period of several years, estimation of revenue, cost, and progress toward completion requires the use of judgment. Factors considered in these estimates include our historical performance, the availability, productivity and cost of labor, the nature and complexity of work to be performed, the effect of change orders, availability and cost of materials, components and subcontracts, the effect of any delays in performance and the level of indirect cost allocations. We also consider the impact of macroeconomic factors on our estimates, in particular on contract EACs that span several years. For example, during 2022, we included in our EACs management’s best estimate of the impact inflation has had and may continue to have on our contracts. We also included our current best estimate of the impact on our EACs of disruptions we have experienced and continue to experience in the supply chain. The volatility of the recent macroeconomic environment has added complexity to our estimation process and may result in our year end 2022 contract EACs having more variability in the future than they might otherwise have had if the estimates had been prepared in a more stable macroeconomic environment.-44-NORTHROP GRUMMAN CORPORATION We generally review and reassess our sales, cost and profit estimates for each significant contract at least annually or more frequently as determined by the occurrence of events, changes in circumstances and evaluations of contract performance to reflect the latest reliable information available. The company performs on a broad portfolio of long-term contracts, including the development of complex and customized military platforms and systems, as well as advanced electronic equipment and software, that often include technology at the forefront of science. Cost estimates on fixed-price development contracts and early-stage/low-rate production contracts are inherently more uncertain as to future events than on mature, full-rate production contracts. As a result, there is typically more variability in those estimates and greater financial risk associated with unanticipated cost growth on fixed-price development contracts and early-stage/low-rate production contracts. Changes in estimates occur for a variety of reasons, including changes in contract scope, the resolution of risk at lower or higher cost than anticipated, unanticipated performance and other risks affecting contract costs, performance issues with subcontractors or suppliers, changes in indirect cost allocations, such as overhead and G&A costs, and changes in estimated award and incentive fees. Identified risks typically include technical, schedule and/or performance risk based on our evaluation of the contract effort. Similarly, the changes in estimates may include changes in, or resolution of, identified opportunities for operating margin improvement.For the impacts of changes in estimates on our consolidated statements of earnings and comprehensive income, see “Segment Operating Results” and Note 1 to the consolidated financial statements.Retirement BenefitsOverview – The determination of projected benefit obligations, the fair value of plan assets, and pension and OPB expense for our retirement benefit plans requires the use of estimates and actuarial assumptions. We perform an annual review of our actuarial assumptions in consultation with our actuaries. As we determine changes in the assumptions are warranted, or as a result of plan amendments, future pension and OPB expense and our projected benefit obligation could increase or decrease. The principal estimates and assumptions that have a significant effect on our consolidated financial position and annual results of operations are the discount rate, cash balance crediting rate, expected long-term rate of return on plan assets, estimated fair market value of plan assets, and the mortality rate of those covered by our pension and OPB plans. The effects of actual results differing from our assumptions and the effects of changing assumptions (i.e., actuarial gains or losses) are recognized immediately through earnings upon annual remeasurement in the fourth quarter, or on an interim basis as triggering events warrant remeasurement. Discount Rate – The discount rate represents the interest rate used to determine the present value of future cash flows currently expected to be required to settle our pension and OPB obligations. The discount rate is generally based on the yield of high-quality corporate fixed-income investments. At the end of each year, we determine the discount rate using a theoretical bond portfolio model of bonds rated AA or better to match the notional cash outflows related to projected benefit payments for each of our significant benefit plans. Taking into consideration the factors noted above, our weighted-average composite pension discount rate was 5.54 percent at December 31, 2022 and 2.98 percent at December 31, 2021.The effects of a hypothetical change in the discount rate may be nonlinear and asymmetrical for future years as the discount rate changes. Holding all other assumptions constant, an increase or decrease of 25 basis points in the December 31, 2022 discount rate assumption would have the following estimated effects on 2022 pension and OPB obligations, which would be reflected in the 2022 MTM expense (benefit), and 2023 expected pension and OPB expense:$ in millions25 Basis Point Decrease in Rate25 Basis Point Increase in Rate2022 pension and OPB obligation and MTM expense (benefit)$817 $(781)2023 pension and OPB (benefit) expense(20)18 -45-NORTHROP GRUMMAN CORPORATION Cash Balance Crediting Rate – A portion of the company’s pension obligation and resulting pension expense is based on a cash balance formula, where participants’ hypothetical account balances are accumulated over time with pay-based credits and interest. Interest is credited monthly using the current 30-Year Treasury bond rate. The interest crediting rate is part of the cash balance formula and independent of actual pension investment earnings. The cash balance crediting rate used for FAS purposes tends to move in concert with the discount rate but has an offsetting effect on pension benefit obligations and the related MTM expense (benefit). The minimum cash balance crediting rate allowed under the plan is 2.25 percent. The cash balance crediting rate assumption has been set to its current level of 3.96 percent as of December 31, 2022, declining to 3.88 percent by 2028. Holding all other assumptions constant, an increase or decrease of 25 basis points in the December 31, 2022 cash balance crediting rate assumption would have the following estimated effects on the 2022 pension benefit obligation, which would be reflected in the 2022 MTM expense (benefit), and 2023 expected pension expense:$ in millions25 Basis Point Decrease in Rate25 Basis Point Increase in Rate2022 pension obligation and MTM expense (benefit)$(96)$100 2023 pension (benefit) expense(9)9 Expected Long-Term Rate of Return on Plan Assets – The expected long-term rate of return on plan assets (EROA) assumption reflects the average rate of net earnings we expect on current and future benefit plan investments. EROA is a long-term assumption, which we review annually and adjust to reflect changes in our long-term view of expected market returns and/or significant changes in our plan asset investment policy. Due to the inherent uncertainty of this assumption, we consider multiple data points at the measurement date including the plan’s target asset allocation, historical asset returns and third party projection models of expected long-term returns for each of the plans’ strategic asset classes. In addition to the data points themselves, we consider trends in the data points, including changes from the prior measurement date. The EROA assumptions we use for pension benefits are consistent with those used for OPB plans; however, we reduce the EROA for OPB plans to allow for the impact of tax on investment earnings, as certain Voluntary Employee Beneficiary Association trusts are taxable.During 2022, the Investment Committee of the company’s benefit plans reviewed the plans’ major asset class allocations and approved an update to increase the target fixed-income asset allocation from 30% to 40%. The current asset allocation is now approximately 35% fixed-income, 30% public equities, 30% alternatives and 5% cash. At this time, the Investment Committee is not planning any significant changes to that mix. For further information on plan asset investments, see Note 13 to the consolidated financial statements.While historical market returns are not necessarily predictive of future market returns, given our long history of plan performance supported by the stability in our investment mix, investment managers, and active asset management, we believe our actual historical performance is a reasonable metric to consider when developing our EROA. Our average annual rate of return from 1976 to 2022 was approximately 10.7 percent and our 20-year and 30-year rolling average rates of return were approximately 8.6 percent and 8.8 percent, respectively, each determined on an arithmetic basis and net of expenses. Our 2022 losses on plan assets, net of expenses, were approximately 15.4 percent.Consistent with our past practice, we obtained long-term capital market forecasting models from several third parties and, using our target asset allocation, developed an expected rate of return on plan assets from each model. We considered not only the specific returns projected by those third party models, but also changes in the models year-to-year when developing our EROA. Despite the change in our target asset allocation described above, these models show a year-over-year increase in the expected rate of return on plan assets largely due to recent increases in interest rates, which more than offset the downward pressure on our EROA caused by the change in asset mix.For determining 2022 FAS expense, we assumed an expected long-term rate of return on pension plan assets of 7.5 percent and an expected long-term rate of return on OPB plan assets of 7.19 percent. For 2023 FAS expense, we have assumed an expected long-term rate of return on pension plan assets of 7.5 percent and 7.23 percent on OPB plans. Holding all other assumptions constant, an increase or decrease of 25 basis points in our December 31, 2022 EROA assumption would have the following estimated effects on 2023 expected pension and OPB expense:$ in millions25 Basis Point Decrease25 Basis Point Increase2023 pension and OPB expense (benefit)$73 $(73)-46-NORTHROP GRUMMAN CORPORATION In addition, holding all other assumptions constant, an increase or decrease of 100 basis points in actual versus expected return on plan assets would have the following estimated effects on our 2023 MTM expense (benefit):$ in millions100 Basis Point Decrease100 Basis Point Increase 2023 MTM expense (benefit)$292 $(292)Estimated Fair Market Value of Plan Assets – For certain plan assets where the fair market value is not readily determinable, such as real estate, private equity, hedge funds and opportunistic investments, we develop estimates of fair value using the best information available. Estimated fair values on these plan assets are based on redemption values and net asset values (NAV), as well as valuation methodologies that include third party appraisals, comparable transactions, discounted cash flow valuation models and public market data.Mortality Rate – Mortality assumptions are used to estimate life expectancies of plan participants. In October 2014, the Society of Actuaries Retirement Plans Experience Committee (RPEC) issued updated mortality tables and a mortality improvement scale, which reflected longer life expectancies than previously projected. In October 2019, the RPEC issued an updated mortality base table (the Private Retirement Plans Mortality table for 2012 (Pri-2012)), which we adopted after reviewing our own historical mortality experience. In October 2021, the RPEC released a new projection scale (MP-2021) that included additional underlying data for 2019, which included an increase in life expectancies relative to the prior year.The RPEC did not release a MP-2022 projection scale citing complexities in incorporating the substantial number of “excess deaths” in 2020 into their existing model and uncertainties about future expectations primarily related to COVID-19. As such, after considering the information released by the RPEC in October 2021 as well as the company’s recent mortality experience in light of the COVID-19 pandemic, we adopted the full MP-2021 projection scale while continuing to use the Pri-2012 White Collar table. While the amounts and structure of the PRI-2012 base mortality table with the MP-2021 projection scale continues to reflect a reasonable estimate of mortality, we supplemented the table with 50% of the Gradual Wear-Off illustration as outlined in the RPEC’s 2022 Mortality Improvement Update paper to reflect the future impacts of COVID-19. Accordingly, we updated the mortality assumptions used in calculating our pension and OPB obligations recognized at December 31, 2022, and the amounts estimated for our 2023 pension and OPB expense.For further information regarding our pension and OPB plans, see “Risk Factors” and Notes 1 and 13 to the consolidated financial statements.Litigation, Commitments and ContingenciesWe are subject to a range of claims, disputes, enforcement actions, investigations, lawsuits, overhead cost claims, environmental matters, income tax matters and administrative proceedings that arise in the ordinary course of business. Estimating liabilities and costs associated with these matters requires judgment based upon the professional knowledge and experience of management. We determine whether to record a reserve and, if so, what amount based on consideration of the facts and circumstances of each matter as then known to us. Determinations regarding whether to record a reserve and, if so, of what amount, reflect management’s assessment regarding what is likely to occur; they do not necessarily reflect what management believes should occur. The ultimate resolution of any such exposure to us may vary materially from earlier estimates as further facts and circumstances develop or become known to us.Environmental Matters – We are subject to environmental laws and regulations in the jurisdictions in which we do or have done business. Factors that could result in changes to the assessment of probability, range of reasonably estimated costs and environmental accruals include: modification of planned remedial actions; changes in the estimated time required to conduct remedial actions; discovery of more or less extensive (or different) contamination than anticipated; information regarding the potential causes and effects of contamination; results of efforts to involve other responsible parties; financial capabilities of other responsible parties; changes in laws and regulations, their interpretation or application; contractual obligations affecting remediation or responsibilities; and improvements in remediation technology. As we expect to be able to recover a portion of environmental remediation liabilities through overhead charges on government contracts, such amounts are deferred in prepaid expenses and other current assets (current portion) and other non-current assets until charged to contracts. We use judgment to evaluate the recoverability of our environmental remediation costs, assessing, among other things, U.S. government regulations, our U.S. government contract mix and past practices. Portions of the company’s environmental liabilities we do not expect to be recoverable have been expensed. -47-NORTHROP GRUMMAN CORPORATION Income Tax Matters – The evaluation of tax positions taken in a filed tax return, or planned to be taken in a future tax return or claim, requires the use of judgment. We establish reserves for uncertain tax positions when, despite the belief that our tax positions are supportable, there remains uncertainty in a tax position taken in our filed tax returns or planned to be taken in a future tax return or claim. The company follows a recognition and measurement approach, considering the facts, circumstances, and information available at the reporting date. We exercise judgment in determining the level of evidence necessary and appropriate to support our assessment using all available information. The technical merits of a given tax position are derived from sources of authority in the tax law and their applicability to the facts and circumstances of the position. In measuring the tax position, the company considers the amounts and probabilities of the outcomes that could be realized upon settlement. When it is more likely than not that a tax position will be sustained, we record the largest amount of tax benefit with a greater than 50 percent likelihood of being realized upon ultimate settlement with a taxing authority. To the extent we prevail in matters for which reserves have been established or are required to pay amounts in excess of reserves, there could be a significant impact on our consolidated financial position and annual results of operations.For further information on litigation, commitments and contingencies, see “Risk Factors” and Note 1, Note 7, Note 11 and Note 12 to the consolidated financial statements.Goodwill and Long-Lived AssetsOverview – We allocate the purchase price of acquired businesses to the underlying tangible and intangible assets acquired and liabilities assumed based upon their respective fair values, with the excess recorded as goodwill. Such fair value assessments require judgments and estimates that can be affected by contract performance and other factors over time, which may cause final amounts to differ materially from original estimates. Adjustments to the fair value of purchased assets and liabilities after the initial measurement period are recognized in net earnings.We recognize purchased intangible assets in connection with our business acquisitions at fair value on the acquisition date. The most significant purchased intangible assets recognized from our acquisitions are generally customer-related intangible assets, including customer contracts and commercial customer relationships. We determine the fair value of those customer-related intangible assets based on estimates and judgments, including the amount and timing of expected future cash flows, long-term growth rates and discount rates. In some cases, we use discounted cash flow analyses, which are based on estimates of future sales, earnings and cash flows after considering such factors as general market conditions, customer budgets, existing firm and future orders, changes in working capital, long term business plans and recent operating performance. We record property, plant and equipment (PP&E) for capital assets used in operating our business. Depreciation expense associated with our PP&E is generally an allowable and allocable cost in accordance with applicable FAR and CAS requirements. However, depreciation expense associated with PP&E used in our commercial businesses, as well as the additional depreciation expense related to the step-up in fair value of PP&E acquired through business combinations, is not allocable to government contracts and is therefore subject to greater recoverability risk than the PP&E for which depreciation expense is recovered through our U.S. government contracts.Impairment Testing – We test for impairment of goodwill annually at each of our reporting units, which comprise our operating segments. The results of our annual goodwill impairment tests as of December 31, 2022 and 2021, respectively, indicated that the estimated fair value of each reporting unit significantly exceeded its respective carrying value. There were no impairment charges recorded in the years ended December 31, 2022, 2021 and 2020.In addition to performing an annual goodwill impairment test, we may perform an interim impairment test if events occur or circumstances change that suggest goodwill in any of our reporting units may be impaired. Such indicators may include, but are not limited to, the loss of significant business, significant reductions in federal government appropriations or other significant adverse changes in industry or market conditions. During 2022, we determined there were no impairment indicators requiring us to perform an interim goodwill impairment test.When testing goodwill for impairment, we compare the fair values of each of our reporting units to their respective carrying values. To determine the fair value of our reporting units, we primarily use the income approach based on the cash flows we expect the reporting units to generate in the future, consistent with our operating plans. This income valuation method requires management to project sales, operating expenses, working capital, capital spending and cash flows for the reporting units over a multi-year period, as well as to determine the weighted-average cost of capital (WACC) used as a discount rate and terminal value assumptions. The WACC takes into account the relative weights of each component of our consolidated capital structure (equity and debt) and represents the expected cost of new capital adjusted as appropriate to consider lower risk profiles associated with longer-term contracts and barriers to market entry. The terminal value assumptions are applied to the final year of the discounted cash flow model. We use industry multiples (including relevant control premiums) of operating earnings to -48-NORTHROP GRUMMAN CORPORATION corroborate the fair values of our reporting units determined under the market valuation method of the income approach.We test for impairment of our long-lived assets, including PP&E and purchased intangible assets, when events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Our assessment is based on our projection of the undiscounted future operating cash flows of the related asset group. If such projections indicate that future undiscounted cash flows are not sufficient to recover the carrying amount, we recognize a non-cash impairment charge to reduce the carrying amount to fair value. There were no impairment charges recorded in the years ended December 31, 2022, 2021 and 2020.Impairment assessment inherently involves management judgments as to assumptions about expected future cash flows and the impact of market conditions on those assumptions. Due to the many variables inherent in the estimation of a business’ fair value and the relative size of our recorded goodwill and other purchased intangible assets, differences in assumptions may have a material effect on the results of our impairment analysis.-49-NORTHROP GRUMMAN CORPORATION Item 7A. Quantitative and Qualitative Disclosures About Market RiskEQUITY RISKWe are exposed to market risk with respect to our portfolio of marketable securities with a fair value of $332 million at December 31, 2022. These securities are exposed to market volatilities, changes in price and interest rates.INTEREST RATE RISKWe are exposed to interest rate risk on variable-rate short-term credit facilities for which there were no borrowings outstanding at December 31, 2022. At December 31, 2022, we have $12.9 billion of long-term debt, primarily consisting of fixed-rate debt, with a fair value of approximately $12.1 billion. The terms of our fixed-rate debt obligations do not generally allow investors to demand payment of these obligations prior to maturity. Therefore, we do not have significant exposure to interest rate risk for our fixed-rate debt; however, we do have exposure to fair value risk if we repurchase or exchange long-term debt prior to maturity. Additionally, if we were to refinance our long-term debt, it may be refinanced at higher interest rates.FOREIGN CURRENCY RISKIn certain circumstances, we are exposed to foreign currency risk. We enter into foreign currency forward contracts to manage a portion of the exchange rate risk related to receipts from customers and payments to suppliers denominated in foreign currencies. We do not hold or issue derivative financial instruments for trading purposes. At December 31, 2022, foreign currency forward contracts with a notional amount of $221 million were outstanding. At December 31, 2022, a 10 percent unfavorable foreign exchange rate movement would not have a material impact on our consolidated financial position, annual results of operations and/or cash flows. INFLATION RISKThe global macroeconomic environment has experienced, and continues to experience, extraordinary challenges, including the highest rates of inflation in 40 years. These macroeconomic factors have contributed, and we expect will continue to contribute, to increased costs, among other concerns. We cannot predict how long these inflationary pressures will continue, or how they may change over time, but we expect to see continued impacts on the global economy, our customers, our industry and our company.Historically, we generally have been able to anticipate such increases in costs when pricing our contracts, and our bids for longer-term firm fixed-price contracts have typically included assumptions regarding cost escalations in amounts that have been sufficient to cover most cost increases over the period of performance, including as offset by operational efficiencies. However, the company, its subcontractors and other suppliers, have experienced, and continue to experience, increased pressures from recent heightened levels of inflation and the challenges of the current macroeconomic environment, which we have not been able to fully mitigate. If inflationary pressures continue to persist, they may continue to have an adverse impact on our consolidated financial position, results of operations and/or cash flows.-50-
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. (dollars in thousands, except per share data)Results of OperationsThis section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.OverviewBusiness Environment and Current OutlookDuring the second quarter of 2022, we began to experience a significant decline in the demand for new homes as home affordability was negatively impacted by rising mortgage interest rates and higher home prices. In addition to affordability concerns, current market conditions including a high rate of inflation, anticipated further interest rate increases and the possibility of a recession have contributed to lower consumer confidence levels. We also faced higher costs for certain materials and labor as strong demand in prior quarters has resulted in increased construction activity and demand for building materials and contractor labor. These factors have led to supply chain disruptions and longer construction cycle times. We continue to work closely with our suppliers and trade partners to manage these disruptions and reduce construction cycle times.We expect that demand for new homes will continue to be negatively impacted by higher mortgage interest rates and lower consumer confidence driven by affordability issues, high inflation, anticipated further interest rate increases and the possibility of a recession. We also expect to continue to face cost pressures related to building materials, labor and land costs, as well as pricing pressures, which will impact profit margins based on our ability to manage these costs while balancing sales pace and declining home prices. Although we are unable to predict the extent to which this will impact our operational and financial performance, we believe that we are well positioned to take advantage of opportunities that may arise from future economic and homebuilding market volatility due to the strength of our balance sheet and our disciplined lot acquisition strategy.BusinessOur primary business is the construction and sale of single-family detached homes, townhomes and condominium buildings, all of which are primarily constructed on a pre-sold basis. To fully serve customers of our homebuilding operations, we also operate a mortgage banking and title services business. We primarily conduct our operations in mature markets. Additionally, we generally grow our business through market share gains in our existing markets and by expanding into markets contiguous to our current active markets. Our four homebuilding reportable segments consist of the following regions: Mid Atlantic: Maryland, Virginia, West Virginia, Delaware and Washington, D.C.North East: New Jersey and Eastern PennsylvaniaMid East: New York, Ohio, Western Pennsylvania, Indiana and IllinoisSouth East: North Carolina, South Carolina, Georgia, Florida and TennesseeOur lot acquisition strategy is predicated upon avoiding the financial risks associated with direct land ownership and development. We generally do not engage in land development (see discussion below of our land development activities). Instead, we typically acquire finished lots from various third party land developers pursuant to LPAs. These LPAs require deposits, typically ranging up to 10% of the aggregate purchase price of the finished lots, in the form of cash or letters of credit that may be forfeited if we fail to perform under the LPA. This strategy has allowed us to maximize inventory turnover, which we believe enables us to minimize market risk and to operate with less capital, thereby enhancing rates of return on equity and total capital.In addition to constructing homes primarily on a pre-sold basis and utilizing what we believe is a conservative lot acquisition strategy, we focus on obtaining and maintaining a leading market position in each market we serve. This strategy allows us to gain valuable efficiencies and competitive advantages in our markets, which we believe contributes to minimizing the adverse effects of regional economic cycles and provides growth opportunities within these markets. Our continued success is contingent upon our ability to control an adequate supply of finished lots on which to build. In limited specific strategic circumstances, we deviate from our historical lot acquisition strategy and engage in joint venture arrangements with land developers or directly acquire raw ground already zoned for its intended use for development. Once we acquire control of raw ground, we determine whether to sell the raw parcel to a developer and enter into an LPA with the developer to purchase the finished lots or to hire a developer to develop the land on our behalf. While joint venture arrangements and direct land development activity are not our preferred method of acquiring finished building lots, we may enter into additional transactions in the future on a limited basis where there exists a compelling strategic or prudent financial reason to do so. We expect, however, to continue to acquire substantially all of our finished lot inventory using LPAs with forfeitable deposits.12Table of ContentsAs of December 31, 2022, we controlled approximately 131,900 lots as discussed below.Lot Purchase Agreements ("LPAs")We controlled approximately 125,100 lots under LPAs with third parties through deposits in cash and letters of credit totaling approximately $543,100 and $6,900, respectively. Included in the number of controlled lots are approximately 11,200 lots for which we have recorded a contract land deposit impairment reserve of approximately $57,100 as of December 31, 2022.Joint Venture Limited Liability Corporations (“JVs”)We had an aggregate investment totaling approximately $27,200 in five JVs, expected to produce approximately 5,300 lots. Of the lots to be produced by the JVs, approximately 4,900 lots were controlled by us and approximately 400 lots were either under contract with unrelated parties or currently not under contract.Land Under DevelopmentWe owned land with a carrying value of approximately $27,100 that we intend to develop into approximately 1,900 finished lots. We had additional funding commitments of approximately $2,100 under a joint development agreement related to one project, a portion of which we expect will be offset by development credits of approximately $900.See Notes 3, 4 and 5 to the consolidated financial statements included herein for additional information regarding LPAs, JVs and land under development, respectively.Raw Land Purchase AgreementsIn addition to the lots we currently control as discussed above, we have certain properties under contract with land owners that are expected to yield approximately 19,300 lots. Some of these properties may require rezoning or other approvals to achieve the expected yield. These properties are controlled with cash deposits totaling approximately $10,100 as of December 31, 2022, of which approximately $2,500 is refundable if we do not perform under the contract. We generally expect to assign the raw land contracts to a land developer and simultaneously enter into an LPA with the assignee if the project is determined to be feasible.Key Financial ResultsOur consolidated revenues for the year ended December 31, 2022 totaled $10,526,434, an increase of 18% from $8,951,025 in 2021. Our net income for 2022 was $1,725,575, or $491.82 per diluted share, increases of 40% and 53% compared to 2021 net income and diluted earnings per share, respectively. Our homebuilding gross profit margin percentage was 25.8% in 2022 compared to 22.3% in 2021. Settlements for the year ended December 31, 2022 totaled 22,732 units, an increase of 6% from 2021. New orders, net of cancellations (“New Orders”) during 2022 were 19,164, a decrease of 16% from 2021 while our average New Order sales price increased 6% to $462.8 in 2022. Our backlog of homes sold but not yet settled with the customer as of December 31, 2022 decreased on a unit basis by 28% to 9,162 units and decreased on a dollar basis by 25% to $4,325,876 when compared to December 31, 2021. Income before tax from our mortgage banking segment totaled $122,150 in 2022, a decrease of 29% when compared to $171,604 in 2021 due primarily to a decrease in secondary marketing gains on sales of loans.Homebuilding OperationsThe following table summarizes the results of our consolidated homebuilding operations and certain operating activity for each of the last three years: Year Ended December 31, 202220212020Financial data:Revenues$10,326,770 $8,701,693 $7,328,889 Gross profit margin$2,664,499 $1,938,578 $1,391,488 Gross profit margin percentage25.8 %22.3 %19.0 %Selling, general and administrative expenses$532,353 $474,808 $431,008 Operating data:New orders (units)19,164 22,721 23,082 Average new order price$462.8 $436.1 $380.1 Settlements (units)22,732 21,540 19,766 Average settlement price$454.3 $403.9 $370.8 Backlog (units)9,162 12,730 11,549 Average backlog price$472.2 $454.2 $396.2 New order cancellation rate14.2 %9.2 %14.9 %13Table of ContentsConsolidated HomebuildingHomebuilding revenues increased 19% in 2022 compared to 2021, as a result of a 6% increase in the number of units settled and a 12% increase in the average settlement price year over year. The increase in the number of units settled was primarily attributable to a 10% higher backlog unit balance entering 2022 compared to the same period in 2021, offset partially by an 11% decrease in New Orders in the first six months of 2022 compared to the same period in 2021. The increase in the average settlement price was primarily attributable to a 15% higher average sales price of units in backlog entering 2022 compared to the same period of 2021, coupled with a 10% increase in the average sales price of New Orders during the first six months of 2022 compared to backlog entering 2021. The gross profit margin percentage in 2022 increased to 25.8% from 22.3% in 2021. Gross profit margins were favorably impacted by the aforementioned increase in the average settlement price attributable to improved pricing power in prior quarters and improved leveraging of certain operating costs attributable to the increase in settlement activity year over year. These favorable factors were partially offset by higher material and labor costs year over year. The number of New Orders decreased 16% while the average sales price of New Orders increased 6% in 2022 when compared to 2021. New Orders were negatively impacted in each of our reportable segments by the significant increase in mortgage interest rates during 2022, resulting in a decline in affordability and in turn, led to lower absorption rates and to an increase in the cancellation rate year over year. Additionally, New Orders were also adversely impacted by a 2% decrease in the average number of active communities year over year. The increase in the average sales price of New Orders was attributable to significant price appreciation resulting from strong demand through the first quarter of 2022. Selling, general and administrative ("SG&A") expenses in 2022 increased by $57,545 compared to 2021, but as a percentage of revenue decreased to 5.2% in 2022 from 5.5% in 2021 due to improved leveraging of SG&A costs. The increase in SG&A expense year over year was attributable primarily to an increase of approximately $24,800 in equity-based compensation due to a four year block grant of Options and RSUs in the second quarter of 2022, as well as, to an increase of approximately $9,900 in selling and marketing costs and an increase of approximately $6,500 in personnel costs attributable to higher average headcount year over year. Our backlog represents homes sold but not yet settled with our customers. As of December 31, 2022, our backlog decreased on a unit basis by 28% to 9,162 units and on a dollar basis by 25% to $4,325,876 when compared to 12,730 units and $5,782,035, respectively, as of December 31, 2021. The decrease in both backlog units and dollars was primarily attributable to a 21% decrease in New Orders during the six-month period ending December 31, 2022 compared to the same period in 2021. Our backlog may be impacted by customer cancellations for various reasons that are beyond our control, such as failure to obtain mortgage financing, inability to sell an existing home, job loss, or a variety of other reasons. In any period, a portion of the cancellations that we experience are related to new sales that occurred during the same period, and a portion are related to sales that occurred in prior periods and therefore appeared in the beginning backlog for the current period. Calculated as the total of all cancellations during the period as a percentage of gross sales during the period, our cancellation rate was approximately 14%, 9% and 15% in 2022, 2021, and 2020, respectively. During the four quarters of each of 2022, 2021 and 2020, approximately 4% in 2022, 3% in 2021 and 6% in 2020, of a reporting quarter’s opening backlog cancelled during the quarter. We can provide no assurance that our historical cancellation rates are indicative of the actual cancellation rate that may occur in future years. Other than those units that are cancelled, and subject to potential construction delays due to continued supply chain disruptions, we expect to settle substantially all of our December 31, 2022 backlog during 2023. See “Risk Factors” in Item 1A of this Form 10-K.The backlog turnover rate is impacted by various factors, including, but not limited to, changes in New Order activity, internal production capacity, external subcontractor capacity, building material availability and other external factors over which we do not exercise control.Reportable Homebuilding SegmentsHomebuilding segment profit includes all revenues and income generated from the sale of homes, less the cost of homes sold, SG&A expenses, and a corporate capital allocation charge determined by corporate management. The corporate capital allocation charge eliminates in consolidation and is based on the segment’s average net assets employed. The corporate capital allocation charged to the operating segment allows the Chief Operating Decision Maker to determine whether the operating segment is providing the desired rate of return after covering our cost of capital. We record impairment charges on contract land deposits when we determine that it is probable that recovery of the deposit is impaired. For segment reporting purposes, impairments on contract land deposits are generally charged to the operating segment upon the termination of an LPA with the developer, or the restructuring of an LPA resulting in the forfeiture of the deposit. We evaluate our entire net contract land deposit portfolio for impairment each quarter. For presentation purposes below, the contract land deposit reserve at December 31, 2022 and 2021 has been allocated to the reportable segments for the respective years to show contract land deposits on a net basis. The net contract land deposit balances below also include approximately $6,900 and $10,100 at December 31, 2022 and 2021, respectively, of letters of credit issued as deposits in lieu of cash. The following tables summarize certain homebuilding operating activity by reportable segment for each of the last three years:14Table of ContentsSelected Segment Financial Data: Year Ended December 31, 202220212020Revenues:Mid Atlantic$4,766,329 $4,049,871 $3,668,542 North East892,543 767,828 538,772 Mid East2,147,262 1,891,729 1,524,667 South East2,520,636 1,992,265 1,596,908 Year Ended December 31, 202220212020Gross profit margin:Mid Atlantic$1,280,596 $987,926 $690,058 North East226,666 163,990 102,621 Mid East476,659 391,405 282,443 South East751,734 469,520 327,483 Year Ended December 31, 202220212020Gross profit margin percentage:Mid Atlantic26.9 %24.4 %18.8 %North East25.4 %21.4 %19.0 %Mid East22.2 %20.7 %18.5 %South East29.8 %23.6 %20.5 % Year Ended December 31, 202220212020Segment profit:Mid Atlantic$994,027 $734,941 $437,849 North East157,333 105,432 50,677 Mid East343,236 271,756 168,605 South East577,030 329,982 205,029 Segment Operating Activity: Year Ended December 31, 202220212020 UnitsAveragePriceUnitsAveragePriceUnitsAveragePriceNew orders, net of cancellations: Mid Atlantic7,816 $526.6 8,749 $522.4 9,230 $453.8 North East1,679 $528.3 1,685 $497.4 1,738 $416.6 Mid East4,344 $400.5 5,567 $369.3 5,780 $330.9 South East5,325 $399.4 6,720 $363.6 6,334 $307.7 Total19,164 $462.8 22,721 $436.1 23,082 $380.1 15Table of Contents Year Ended December 31, 202220212020 UnitsAveragePriceUnitsAveragePriceUnitsAveragePriceSettlements: Mid Atlantic9,042 $527.1 8,310 $487.3 8,363 $438.6 North East1,763 $506.3 1,666 $460.9 1,375 $391.8 Mid East5,518 $389.1 5,414 $349.4 4,719 $323.1 South East6,409 $393.3 6,150 $323.9 5,309 $300.8 Total22,732 $454.3 21,540 $403.9 19,766 $370.8 Year Ended December 31, 202220212020 UnitsAveragePriceUnitsAveragePriceUnitsAveragePriceBacklog: Mid Atlantic3,692 $536.3 4,918 $534.8 4,479 $470.9 North East885 $553.9 969 $511.5 950 $447.8 Mid East1,853 $403.2 3,027 $381.3 2,874 $344.5 South East2,732 $405.7 3,816 $393.7 3,246 $323.7 Total9,162 $472.2 12,730 $454.2 11,549 $396.2 Operating Data: Year Ended December 31, 202220212020New order cancellation rate:Mid Atlantic14.4 %9.0 %14.9 %North East12.2 %8.6 %13.1 %Mid East16.4 %10.2 %14.5 %South East12.6 %8.8 %15.8 % Year Ended December 31, 202220212020Average active communities:Mid Atlantic160 155 177 North East36 34 40 Mid East126 129 138 South East93 106 112 Total415 424 467 Homebuilding Inventory: As of December 31, 20222021Sold inventory: Mid Atlantic$727,501 $867,892 North East156,798 154,053 Mid East278,034 342,011 South East413,576 439,892 Total (1)$1,575,909 $1,803,848 16Table of Contents As of December 31, 20222021Unsold lots and housing units inventory:Mid Atlantic$111,816 $87,412 North East23,013 14,656 Mid East17,044 12,892 South East31,791 14,193 Total (1)$183,664 $129,153 (1)Total segment inventory differs from consolidated inventory due to certain consolidation adjustments necessary to convert the reportable segments’ results, which are predominantly maintained on a cash basis, to a full accrual basis for external financial statement presentation purposes. These consolidation adjustments are not allocated to our operating segments.Lots Controlled and Land Deposits:As of December 31,20222021Total lots controlled:Mid Atlantic48,200 47,900 North East11,300 11,900 Mid East21,800 23,700 South East50,600 41,400 Total131,900 124,900 As of December 31,20222021Contract land deposits, net:Mid Atlantic$212,273 $257,244 North East54,558 51,257 Mid East44,813 52,537 South East191,332 146,246 Total$502,976 $507,284 Year Ended December 31,202220212020Contract land deposit impairments (recoveries), net:Mid Atlantic$3 $16 $114 North East75 — 60 Mid East369 10 293 South East— — 1,045 Total$447 $26 $1,512 Mid AtlanticThe Mid Atlantic segment had an approximate $259,100, or 35%, increase in segment profit in 2022 compared to 2021, driven by improved gross profit margins and an increase in segment revenues of approximately $716,500, or 18%, year over year. Segment revenues increased due primarily to a 9% increase in the number of units settled and an 8% increase in the average settlement price year over year. The increases in settlements and the average settlement price were primarily attributable to a 10% higher backlog unit balance and a 14% higher average sales price of units in backlog entering 2022 compared to backlog entering 2021. The Mid Atlantic segment’s gross profit margin percentage increased to 26.9% in 2022 from 24.4% in 2021. Gross profit margins were favorably impacted by the aforementioned 8% increase in the average settlement price attributable to improved pricing power in prior quarters, offset partially by higher material and labor costs year over year. 17Table of ContentsSegment New Orders decreased 11% while the average sales price of New Orders increased 1% in 2022 compared to 2021. As previously discussed in the "Consolidated Homebuilding" section above, New Orders were negatively impacted by the significant increase in mortgage interest rates. The increase in the average sales price of New Orders was attributable to significant price appreciation resulting from strong demand through the first quarter of 2022. North EastThe North East segment had an approximate $51,900, or 49%, increase in segment profit in 2022 compared to 2021, driven by an increase in segment revenues of approximately $124,700, or 16%, year over year and improved gross profit margins. The increase in segment revenues was attributable to a 6% increase in the number of units settled and a 10% increase in the average settlement price year over year. The increase in the number of units settled was attributable to a 2% higher backlog unit balance entering 2022 compared to the backlog unit balance entering 2021, coupled with an 8% increase in New Orders in the segment during the first six months of 2022 compared to the same period in 2021. The increase in the average settlement price was primarily attributable to a 14% higher average sales price of units in backlog entering 2022 compared to backlog entering 2021. The segment’s gross profit margin percentage increased to 25.4% in 2022 from 21.4% in 2021. Gross profit margins were favorably impacted by the aforementioned 10% increase in the average settlement price, offset partially by higher material and labor costs year over year. Segment New Orders were flat while the average sales price of New Orders increased 6% in 2022 compared to 2021. New Orders were flat despite a 7% increase in the average number of active communities year over year due primarily to the impact of the significant increase in mortgage interest rates in 2022 as previously discussed in the "Consolidated Homebuilding" section above. The increase in the average sales price of New Orders was attributable to significant price appreciation resulting from strong demand through the first quarter of 2022. Mid EastThe Mid East segment had an approximate $71,500, or 26%, increase in segment profit in 2022 compared to 2021. The increase in segment profit was driven by an increase of segment revenues of approximately $255,500, or 14%, year over year and improved gross profit margins. Segment revenues increased due to increases in the number of units settled and the average settlement price of 2% and 11%, respectively, year over year. The increase in the number of units settled was largely attributable to a 5% higher backlog unit balance entering 2022 compared to the backlog unit balance entering 2021. The increase in the average settlement price was primarily attributable to an 11% higher average sales price of units in backlog entering 2022 compared to the same period in 2021, coupled with a 12% increase in the average sales price of New Orders in the first six months of 2022 compared to the same period in 2021. The segment’s gross profit margin percentage increased to 22.2% in 2022 from 20.7% in 2021. Gross profit margins were favorably impacted by the aforementioned 11% increase in the average settlement price, offset partially by higher material and labor costs year over year. Segment New Orders decreased 22% while the average sales price of New Orders increased 8% in 2022 compared to 2021. As previously discussed in the "Consolidated Homebuilding" section above, New Orders in 2022 were negatively impacted by the significant increase in mortgage interest rates. In addition, New Orders were also negatively impacted by a 2% decrease in the average number of active communities in 2022 compared to 2021. The increase in the average sales price of New Orders was attributable to significant price appreciation resulting from strong demand through the first quarter of 2022. South EastThe South East segment had an approximate $247,000, or 75%, increase in segment profit in 2022 compared to 2021. The increase in segment profit was primarily driven by an increase in segment revenues of approximately $528,400, or 27%, year over year and improved gross profit margins. The increase in revenues was attributable to a 4% increase in the number of units settled and a 21% increase in the average settlement price year over year. The increase in the number of units settled was primarily attributable to an 18% higher backlog unit balance entering 2022 compared to the same period in 2021, offset partially by an 18% decrease in New Orders in the first six months of 2022 compared to the same period in 2021. The increase in the average settlement price was primarily attributable to a 22% higher average sales price of units in backlog entering 2022 compared to the same period in 2021, coupled with a 21% increase in the average sales price of New Orders in the first six months of 2022 compared to the same period in 2021. The segment’s gross profit margin percentage increased to 29.8% in 2022 from 23.6% in 2021. Gross profit margins were favorably impacted by the aforementioned 21% increase in the average settlement price, offset partially by higher material and labor costs year over year.Segment New Orders decreased 21% while the average sales price of New Orders increased 10% in 2022 compared to 2021. The decrease in New Orders was primarily attributable to a 12% decrease in the average number of active communities, coupled with the impact of the significant increase in mortgage interest rates in 2022 as previously discussed in the "Consolidated Homebuilding" section above. The increase in the average sales price of New Orders was attributable to significant price appreciation resulting from strong demand through the first quarter of 2022. 18Table of ContentsHomebuilding Segment Reconciliations to Consolidated Homebuilding OperationsIn addition to the corporate capital allocation and contract land deposit impairments discussed above, the other reconciling items between homebuilding segment profit and homebuilding consolidated profit before tax include unallocated corporate overhead (which includes all management incentive compensation), equity-based compensation expense, consolidation adjustments and external corporate interest expense. Our overhead functions, such as accounting, treasury and human resources, are centrally performed and the costs are not allocated to our operating segments. Consolidation adjustments consist of such items to convert the reportable segments’ results, which are predominantly maintained on a cash basis, to a full accrual basis for external financial statement presentation purposes, and are not allocated to our operating segments. External corporate interest expense is primarily comprised of interest charges on our 3.00% Senior Notes due 2030, and is not charged to the operating segments because the charges are included in the corporate capital allocation discussed above. Year Ended December 31, 202220212020Homebuilding consolidated gross profit:Mid Atlantic$1,280,596 $987,926 $690,058 North East226,666 163,990 102,621 Mid East476,659 391,405 282,443 South East751,734 469,520 327,483 Consolidation adjustments and other(71,156)(74,263)(11,117)Homebuilding consolidated gross profit$2,664,499 $1,938,578 $1,391,488 Year Ended December 31, 202220212020Homebuilding consolidated profit before taxes:Mid Atlantic$994,027 $734,941 $437,849 North East157,333 105,432 50,677 Mid East343,236 271,756 168,605 South East577,030 329,982 205,029 Reconciling items:Contract land deposit impairment reserve (1)(27,300)22,163 (24,633)Equity-based compensation expense (2)(78,931)(53,587)(47,548)Corporate capital allocation (3)302,904 252,787 239,233 Unallocated corporate overhead(129,998)(139,611)(114,921)Consolidation adjustments and other (4)(1,719)(56,511)54,561 Corporate interest income32,457 2,840 8,464 Corporate interest expense(37,995)(51,393)(39,356)Reconciling items sub-total59,418 (23,312)75,800 Homebuilding consolidated profit before taxes$2,131,044 $1,418,799 $937,960 (1)This item represents changes to the contract land deposit impairment reserve, which are not allocated to the reportable segments. See further discussion of contract land deposit impairment charges in Note 3 in the accompanying consolidated financial statements.(2)The increase in equity-based compensation expense in 2022 was primarily attributable to a four year block grant of Options and RSUs in May 2022. See further discussion of equity-based compensation in Note 12 in the accompanying consolidated financial statements. (3)This item represents the elimination of the corporate capital allocation charge included in the respective homebuilding reportable segments. The corporate capital allocation charge is based on the segment’s monthly average asset balance and is as follows for the years presented:19Table of Contents Year Ended December 31, 202220212020Corporate capital allocation charge:Mid Atlantic$143,251 $124,316 $124,426 North East30,623 25,431 22,850 Mid East51,376 43,686 40,256 South East77,654 59,354 51,701 Total corporate capital allocation charge$302,904 $252,787 $239,233 (4) The consolidation adjustments and other in each period are primarily driven by changes in units under construction as well as significant fluctuations in lumber prices year over year. Our reportable segments' results include the intercompany profits of our production facilities for home packages delivered to our homebuilding divisions. Costs related to homes not yet settled are reversed through the consolidation adjustment and recorded in inventory. These costs are subsequently recorded through the consolidation adjustment when the respective homes are settled. The consolidation adjustment in 2021 was negatively impacted by a higher number of units under construction as of the end of the year compared to the prior year end, resulting in an increase in the reversal of intercompany profits year over year through the consolidation adjustment. In 2022, the consolidation adjustment was favorably impacted by a reduction in the number of units under construction year over year, resulting in a decrease in intercompany profits deferred year over year. This favorable impact was offset by the recognition of previously deferred home package costs that included higher priced lumber. Mortgage Banking SegmentWe conduct our mortgage banking activity through NVRM, a wholly owned subsidiary. NVRM focuses almost exclusively on serving the homebuilding segment customer base. The following table summarizes the results of our mortgage banking operations and certain statistical data for each of the last three years: Year Ended December 31, 202220212020Loan closing volume: Total principal$6,313,416 $6,073,934 $5,317,811 Loan volume mix: Adjustable rate mortgages8 %3 %2 %Fixed-rate mortgages92 %97 %98 %Operating profit: Segment profit$125,756 $176,251 $143,319 Equity-based compensation expense(3,606)(4,647)(3,246)Mortgage banking income$122,150 $171,604 $140,073 Capture rate:83 %89 %90 %Mortgage banking fees: Net gain on sale of loans$152,668 $205,582 $168,720 Title services46,793 42,958 38,554 Servicing fees203 792 760 $199,664 $249,332 $208,034 Loan closing volume in 2022 increased by approximately $239,500, or 4%, from 2021. The increase was primarily attributable to a 9% increase in the average loan balance for loans closed, driven by a 12% increase in the homebuilding segment’s average home settlement price in 2022 as compared to 2021. The increase was partially offset by a 4% decrease in the number of loans closed, which was primarily attributable to the 6% decrease in capture rate in 2022 compared to 2021, due to a more competitive mortgage environment in 2022.20Table of ContentsSegment profit in 2022 decreased by approximately $50,500, or 29%, from 2021. This decrease was primarily attributable to a decrease of approximately $49,700, or 20%, in mortgage banking fees, primarily due to a decrease in gains on sales of loans due to a more competitive mortgage environment. Mortgage Banking – OtherWe sell all of the loans we originate into the secondary mortgage market. Insofar as we underwrite our originated loans to the standards and specifications of the ultimate investor, we have no further financial obligations from the issuance of loans, except in certain limited instances where repurchases or early payment default occur. Those underwriting standards are typically equal to or more stringent than the underwriting standards required by FNMA, GNMA, FHLMC, VA and FHA. Because we sell all of our loans and do not service them, there is often a substantial delay between the time that a loan goes into default and the time that the investor requests us to reimburse them for losses incurred because of the default. We believe that all of the loans that we originate are underwritten to the standards and specifications of the ultimate investor to whom we sell our originated loans. We employ a quality control department to ensure that our underwriting controls are effective, and further assess the underwriting function as part of our assessment of internal controls over financial reporting.We maintain a reserve for losses on mortgage loans originated that reflects our judgment of the present loss exposure from the loans that we have originated and sold. At December 31, 2022 and 2021, we had repurchase reserves of approximately $21,800 and $21,400, respectively. NVRM is dependent on our homebuilding operation’s customers for business. If new orders and selling prices of the homebuilding segment decline, NVRM’s operations will also be adversely affected. In addition, NVRM’s operating results may be adversely affected in future periods due to tightening and volatility of the credit markets, changes in investor funding times, increased regulation of mortgage lending practices and increased competition in the mortgage market.SeasonalityWe generally have higher New Order activity in the first half of the year and higher home settlements, revenues and net income in the second half of the year. However, our typical seasonal New Order and settlement trends may be affected by significant changes in market conditions. Effective Tax RateOur consolidated effective tax rates in 2022 and 2021 were 23.42% and 22.24%, respectively. The effective tax rates in each year were favorably impacted by the recognition of an income tax benefit related to excess tax benefits from stock option exercises totaling $50.3 million and $48.4 million for 2022 and 2021, respectively. We expect continued tax rate volatility in future years attributable to the recognition of excess tax benefits from equity plan activity and distributions from the deferred compensation plans.Recent Accounting Pronouncements Pending AdoptionSee Note 1 to the accompanying consolidated financial statements for discussion of recently issued accounting pronouncements applicable to us.Liquidity and Capital ResourcesWe fund our operations primarily from our current cash holdings and cash flows generated by operating activities. In addition, we have available a short-term unsecured working capital revolving credit facility and revolving mortgage repurchase facility, as further described below. As of December 31, 2022, we had a strong liquidity position with approximately $2,500,000 in cash and cash equivalents, approximately $289,000 in unused committed capacity under our revolving credit facility and $150,000 in unused committed capacity under our revolving mortgage repurchase facility.Material Cash RequirementsWe believe that our current cash holdings, cash generated from operations, and cash available under our short-term unsecured credit agreement and revolving mortgage repurchase facility, as well as the public debt and equity markets, will be sufficient to satisfy both our short term and long term cash requirements for working capital to support our daily operations and meet commitments under our contractual obligations with third parties. Our material contractual obligations primarily consist of the following: (i) Payments due to service our debt and interest on that debt. In June 2022, we used cash holdings to redeem $600,000 in outstanding 3.95% Senior Notes that were set to mature in September 2022. The Senior Notes were redeemed at par, plus accrued interest. Our current outstanding Senior Notes total $900,000 and mature in May 2030. Future interest payments on our remaining outstanding Senior Notes total approximately $199,050, with approximately $27,000 due within the next twelve months.21Table of Contents (ii) Payment obligations totaling approximately $348,000 under existing LPAs for deposits to be paid to land developers, assuming that contractual development milestones are met by the developers and we exercise our option to acquire finished lots under those LPAs. We expect to make the majority of these payments within the next three years. (iii) Obligations under operating and finance leases related primarily to office space and our production facilities. See Note 13 of this Form 10-K for additional discussion of our leases.In addition to funding growth in our homebuilding and mortgage banking operations, we historically have used a substantial portion of our excess liquidity to repurchase outstanding shares of our common stock in open market and privately negotiated transactions. This ongoing repurchase program assists us in accomplishing our primary objective, creating increases in shareholder value. See “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in Item 5 of this Form 10-K for disclosure of amounts repurchased during the fourth quarter of 2022. For the year ended December 31, 2022, we repurchased 323,652 shares of our common stock at an aggregate purchase price of $1,500,358. As of December 31, 2022, we had approximately $507,700 available under Board approved repurchase authorizations. Capital ResourcesSenior NotesDuring the second quarter of 2022, we redeemed the outstanding $600,000 principal amount of 3.95% Senior Notes due September 15, 2022, at par, plus accrued interest.As of December 31, 2022, we had a total of $900,000 in outstanding Senior Notes which mature in May 2030. The Senior Notes are senior unsecured obligations and rank equally in right of payment with any of our existing and future unsecured senior indebtedness, will rank senior in right of payment to any of our future indebtedness that is by its terms expressly subordinated to the Senior Notes and will be effectively subordinated to any of our existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness. The indenture governing the Senior Notes does not contain any financial covenants; however, it does contain, among other items, and subject to certain exceptions, covenants that restrict our ability to create, incur, assume or guarantee secured debt, enter into sale and leaseback transactions and conditions related to mergers and/or the sale of assets. We were in compliance with all covenants under the Senior Notes at December 31, 2022. Credit AgreementWe have an unsecured revolving credit agreement (the "Credit Agreement") with a group of lenders which may be used for working capital and general corporate purposes. The Credit Agreement provides for aggregate revolving loan commitments of $300,000 (the "Facility"). Under the Credit Agreement, we may request increases of up to $300,000 to the Facility in the form of revolving loan commitments or term loans to the extent that new or existing lenders agree to provide additional revolving loan or term loan commitments. In addition, the Credit Agreement provides for a $100,000 sublimit for the issuance of letters of credit of which there was approximately $11,000 outstanding at December 31, 2022. The Credit Agreement termination date is February 12, 2026. There were no borrowings outstanding under the Credit Agreement as of December 31, 2022.Repurchase AgreementOur mortgage banking subsidiary, NVRM, has an unsecured revolving mortgage repurchase agreement (the "Repurchase Agreement") which is non-recourse to NVR. The purpose of the Repurchase Agreement is to finance the origination of mortgage loans by NVRM. The Repurchase Agreement provides borrowing capacity up to $150,000, subject to certain sublimits. The Repurchase Agreement expires on July 19, 2023. At December 31, 2022, there was no debt outstanding under the Repurchase Agreement and there were no borrowing base limitations.See Note 9 of this Form 10-K for additional disclosures regarding our Senior Notes, Credit Agreement and Repurchase Agreement.Cash FlowsFor the year ended December 31, 2022, cash, restricted cash and cash equivalents decreased by $62,466. Net cash provided by operating activities was $1,870,101, due primarily to cash provided by earnings in 2022 and by a decrease in inventory of $159,091 attributable to a decrease in units under construction at December 31, 2022 compared to December 31, 2021. Additionally, cash was provided by net proceeds of $156,756 from mortgage loan activity. Cash was primarily used as a result of a decrease in customer deposits of $103,659 attributable to the decrease in our ending backlog year over year. Net cash used in investing activities in 2022 was $27,431. Cash was used primarily for purchases of property, plant and equipment of $18,428 and investments in unconsolidated joint ventures totaling $9,735. Net cash used by financing activities in 2022 was $1,905,136. Cash was used primarily to repurchase 323,652 shares of our common stock at an aggregate purchase price of $1,500,358 under our ongoing common stock repurchase program, discussed above. In addition, cash was used to redeem the outstanding $600,000 principal amount of 3.95% Senior Notes due September 15, 2022. Cash was provided from stock option exercise proceeds totaling $196,717. 22Table of ContentsFor the year ended December 31, 2021, cash, restricted cash and cash equivalents decreased by $172,798. Net cash provided by operating activities was $1,242,393, due primarily to cash provided by earnings in 2021 and net proceeds of $344,750 from mortgage loan activity. Additionally, cash was provided by an increase in customer deposits of $176,705 attributable to the increase in our ending backlog year over year. Cash was primarily used to fund the increase in inventory of $238,284, attributable to an increase in units under construction at December 31, 2021 compared to December 31, 2020. Net cash used in investing activities in 2021 was $18,179. Cash was used primarily for purchases of property, plant and equipment. Net cash used by financing activities in 2021 was $1,397,012. Cash was used primarily to repurchase shares of our common stock under our ongoing common stock repurchase program as discussed above. Cash was provided from stock option exercise proceeds totaling $142,370.At December 31, 2022 and 2021, the homebuilding segment had restricted cash of $48,455 and $60,730, respectively. Restricted cash in each year was attributable to customer deposits for certain home sales.Critical Accounting Policies and EstimatesGeneralThe preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. We continually evaluate the estimates we use to prepare the consolidated financial statements and update those estimates as necessary. In general, our estimates are based on historical experience, on information from third party professionals, and other various assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ materially from those estimates made by management.Homebuilding InventoryThe carrying value of inventory is stated at the lower of cost or market value. Cost of lots and completed and uncompleted housing units represent the accumulated actual cost of the units. Field construction supervisors’ salaries and related direct overhead expenses are included in inventory costs. Interest costs are not capitalized into inventory, with the exception of land under development and joint venture investments, as applicable. Upon settlement, the cost of the unit is expensed on a specific identification basis. Cost of building materials is determined on a first-in, first-out basis.Sold inventory is evaluated for impairment based on the contractual sales price compared to the total estimated cost to construct. Unsold inventory is evaluated for impairment by analyzing recent comparable sales prices within the applicable community compared to the costs incurred to date plus the expected costs to complete. Any calculated impairments are recorded immediately in cost of sales.Contract Land Deposits We purchase finished lots under LPAs that require deposits that may be forfeited if we fail to perform under the contract. The deposits are in the form of cash or letters of credit in varying amounts and represent a percentage of the aggregate purchase price of the finished lots.We maintain an allowance for losses on contract land deposits that reflects our judgment of the present loss exposure in the existing contract land deposit portfolio at the end of the reporting period. To analyze contract land deposit impairments, we conduct a loss contingency analysis each quarter. In addition to considering market and economic conditions, we assess contract land deposit impairments on a community-by-community basis pursuant to the purchase contract terms, analyzing quantitative and qualitative information including, as applicable, current sales absorption levels, recent sales’ profit margin, the dollar differential between the contractual purchase price and the current market price for lots, a developer’s performance, a developer’s financial ability or willingness to reduce lot prices to current market prices, if necessary, and the contract’s default status by either us or the developer along with an analysis of the expected outcome of any such default.Our analysis is focused on whether we can sell houses at an acceptable profit margin and sales pace in a particular community in the current market with which we are faced. Because we do not own the finished lots on which we had placed a contract land deposit, if the above analysis leads to a determination that we cannot sell homes at an acceptable profit margin and sales pace at the current contractual lot price, we then determine whether we will elect to default under the contract, forfeit our deposit and terminate the contract, or whether we will attempt to restructure the LPA, which may require us to forfeit the deposit to obtain contract concessions from a developer. We also assess whether an impairment is present due to collectability issues resulting from a developer’s non-performance because of financial or other conditions.Although we consider the allowance for losses on contract land deposits reflected on the December 31, 2022 consolidated balance sheet to be adequate (see Note 1 to the accompanying consolidated financial statements included herein), there can be no 23Table of Contentsassurance that this allowance will prove to be adequate over time to cover losses due to unanticipated adverse changes in the economy or other events adversely affecting specific markets or the homebuilding industry.Warranty/Product Liability ReservesWe establish warranty and product liability reserves to provide for estimated future expenses as a result of construction and product defects, product recalls and litigation incidental to our homebuilding business. Liability estimates are determined based on our judgment considering such factors as historical experience, the likely current cost of corrective action, manufacturers’ and subcontractors’ participation in sharing the cost of corrective action, consultations with third party experts such as engineers, and discussions with our General Counsel and outside counsel retained to handle specific product liability cases. Although we consider the warranty and product liability accrual reflected on the December 31, 2022 consolidated balance sheet to be adequate (see Note 14 to the accompanying consolidated financial statements included herein), there can be no assurance that this accrual will prove to be adequate over time to cover losses due to increased costs for material and labor, the inability or refusal of manufacturers or subcontractors to financially participate in corrective action, unanticipated adverse legal settlements, or other unanticipated changes to the assumptions used to estimate the warranty and product liability accrual.Equity-Based Compensation We recognize equity-based compensation expense within our income statement for all share-based payment arrangements, which include non-qualified stock options to purchase shares of NVR common stock ("Options") and restricted share units ("RSUs"). Compensation expense is based on the grant-date fair value of the Options and RSUs granted, and is recognized on a straight-line basis over the requisite service period for the entire award (from the date of grant through the period of the last separately vesting portion of the grant). Options and RSUs which are subject to a performance condition are treated as a separate award from the “service-only” Options and RSUs, and compensation expense is recognized when it becomes probable that the stated performance target will be achieved. We calculate the fair value of our Options, which are non-publicly traded, using the Black-Scholes option-pricing model. The grant date fair value of the RSUs is the closing price of our common stock on the day immediately preceding the date of grant. The reversal of compensation expense previously recognized for grants forfeited is recorded in the period in which the forfeiture occurs.As noted above, we calculate the fair value of our Options using the Black-Scholes option-pricing model. While the Black-Scholes model is a widely accepted method to calculate the fair value of options, its results are dependent on input variables, two of which, expected term and expected volatility, are significantly dependent on management’s judgment. We have concluded that our historical exercise experience is the best estimate of future exercise patterns to determine an Option’s expected term. To estimate expected volatility, we analyze the historical volatility of our common stock over a period equal to the Option’s expected term. Changes in management’s judgment of the expected term and the expected volatility could have a material effect on the grant-date fair value calculated and expensed within the income statement.In addition, when recognizing equity-based compensation cost related to “performance condition” Option and RSU grants, we are required to make a determination as to whether the performance conditions will be met prior to the completion of the actual performance period. The performance metric is based on our return on capital performance during a specified three year period based on the date of Option grant. While we currently believe that this performance condition will be satisfied at the target level and are recognizing compensation expense related to such Options and RSUs accordingly, our future expected activity levels could cause us to make a different determination, resulting in a change to the compensation expense to be recognized related to performance condition Option and RSU grants that would otherwise have been recognized to date. Although we believe that the compensation costs recognized in 2022 are representative of the cumulative ratable amortization of the grant-date fair value of unvested Options and RSUs outstanding, changes to the estimated input values such as expected term and expected volatility and changes to the determination of whether performance condition grants will vest, could produce widely different expense valuations and recognition.Mortgage Repurchase ReserveWe originate several different loan products to our customers to finance the purchase of their home. We sell all of the loans we originate into the secondary mortgage market, typically on a servicing released basis and within 30 days from closing. All of the loans that we originate are underwritten to the standards and specifications of the ultimate investor. Those underwriting standards are typically equal to or more stringent than the underwriting standards required by FNMA, GNMA, FHLMC, VA and FHA. Insofar as we underwrite our originated loans to those standards, we bear no increased concentration of credit risk from the issuance of loans, except in certain limited instances where repurchases or early payment default occur. We employ a quality control department to ensure that our underwriting controls are effectively operating, and further assess the underwriting function as part of our assessment of internal controls over financial reporting. We maintain a reserve for losses on mortgage loans originated that reflects our judgment of the present loss exposure in the loans that we have originated and sold. The reserve is calculated based on an analysis of historical experience and exposure. Although we consider the mortgage repurchase reserve reflected on the December 31, 2022 consolidated balance sheet to be adequate (see Note 16 to the accompanying consolidated financial statements included herein), there can be no 24Table of Contentsassurance that this reserve will prove to be adequate over time to cover losses due to unanticipated changes to the assumptions used to estimate the mortgage repurchase reserve.Impact of Inflation, Changing Prices and Economic ConditionsSee “Risk Factors” included in Item 1A of this Form 10-K for a description of the impact of inflation, changing prices and economic conditions on our business and our financial results. See also the discussion of the current business environment in the Overview section above.Item 7A. Quantitative and Qualitative Disclosure About Market Risk. (dollars in thousands)Market risk is the risk of loss arising from adverse changes in market prices and interest rates. Our market risk arises from interest rate risk inherent in our financial instruments and debt obligations. Interest rate risk results from the possibility that changes in interest rates will cause unfavorable changes in net income or in the value of interest rate-sensitive assets, liabilities and commitments. Lower interest rates tend to increase demand for mortgage loans for home purchasers, while higher interest rates make it more difficult for potential borrowers to purchase residential properties and to qualify for mortgage loans. We have no market rate sensitive instruments held for speculative or trading purposes.We are exposed to interest rate risk as it relates to our fixed rate debt, primarily our Senior Notes and our variable rate credit facility and loan repurchase facility. Changes to interest rates generally affect the fair value of fixed-rate debt instruments, but not earnings or cash flows. For variable rate debt, interest rate changes generally will not affect the fair value of the variable debt instruments but will affect earnings and cash flow. At December 31, 2022, there was no debt outstanding under our credit facility or loan repurchase facility. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 9 to the accompanying consolidated financial statements included herein for further discussion of these debt instruments. Our mortgage banking segment is exposed to interest rate risk as it relates to its lending activities, including originating mortgage loans and providing rate lock commitments to borrowers. To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, we enter into optional or mandatory delivery forward sales contracts to sell whole loans and mortgage-backed securities to investors. The forward sales contracts lock-in a range of interest rates and prices for the sale of loans similar to the specific rate lock commitments. We do not engage in speculative or trading derivative activities. All of the mortgage banking segment’s loan portfolio is held for sale and subject to forward sale commitments. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 15 to the accompanying consolidated financial statements included herein for further discussion of these items. The following table represents the contractual balances of our on-balance sheet financial instruments at the expected maturity dates, as well as the fair values of those on-balance sheet financial instruments at December 31, 2022. The expected maturity categories take into consideration the actual and anticipated amortization of principal and do not take into consideration the reinvestment of cash or the refinancing of existing indebtedness. Because we sell all of the mortgage loans we originate into the secondary markets, we have made the assumption that the portfolio of mortgage loans held for sale will mature in the first year.25Table of ContentsMaturities (000's)20232024202520262027ThereafterTotalFairValueMortgage banking segmentInterest rate sensitive assets:Mortgage loans held for sale$319,481 — — — — — $319,481 $316,806 Average interest rate5.6 %— — — — — 5.6 %Other:Forward trades of mortgage-backed securities (a)$(16,060)— — — — — $(16,060)$(16,060)Forward loan commitments (a)$11,300 — — — — — $11,300 $11,300 Homebuilding segmentInterest rate sensitive assets:Interest-bearing deposits$2,453,692 — — — — — $2,453,692 $2,453,692 Average interest rate4.4 %— — — — — 4.4 %Interest rate sensitive liabilities:Fixed rate obligations $— — — — $900,000 $900,000 $788,166 Average interest rate— %— — — 3.0 %3.0 % (a)Represents the fair value recorded pursuant to ASC 815, Derivatives and Hedging. 26Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.Unless otherwise required, all references herein to “we”, “our”, “us”, “NXP” and the “Company” are to NXP Semiconductors N.V. and its consolidated subsidiaries. This Annual Report includes market data and certain other statistical information and estimates that are based on reports and other publications from industry analysts, market research firms, and other independent sources, as well as management’s own good faith estimates and analyses. NXP believes these third-party reports to be reputable, but has not independently verified the underlying data sources, methodologies or assumptions. The reports and other publications referenced are generally available to the public and were not commissioned by NXP. Information that is based on estimates, forecasts, projections, market research or similar methodologies is inherently subject to uncertainties and actual events or circumstances may differ materially from events and circumstances reflected in this information.2Part IItem 1. Business Company Overview NXP Semiconductors N.V. is a global semiconductor company and a long-standing supplier in the industry, with over 60 years of innovation and operating history. For the year ended December 31, 2022, we generated revenue of $13,205 million, compared to $11,063 million for the year ended December 31, 2021. We provide leading solutions that leverage our combined portfolio of intellectual property, deep application knowledge, process technology and manufacturing expertise in the domains of cryptography-security, high-speed interface, radio frequency (RF), mixed-signal analog-digital (mixed A/D), power management, digital signal processing and embedded system design. Our product solutions are used in a wide range of end market applications including: automotive, industrial & Internet of Things (IoT), mobile, and communication infrastructure. We engage with leading global original equipment manufacturers (OEMs) and sell products in all major geographic regions. Our legal name is NXP Semiconductors N.V. and our commercial name is “NXP” or “NXP Semiconductors”. We were incorporated in the Netherlands in 2006 as a Dutch public company with limited liability (naamloze vennootschap).Our corporate seat is in Eindhoven, the Netherlands. Our principal executive office is at High Tech Campus 60, 5656 AG Eindhoven, the Netherlands, and our telephone number is +31 40 2729999. Our registered agent in the United States is NXP USA, Inc., 6501 William Cannon Dr. West, Austin, Texas 78735, United States of America, phone number +1 512 9338214. Semiconductor Market OverviewSemiconductors perform a broad variety of functions within electronic products and systems, including processing data, sensing, storing information and converting or controlling electronic signals. Semiconductors vary significantly depending upon the specific function or application of the end product in which the semiconductor is used and the customer who is deploying it. Semiconductors also vary on a number of technical characteristics including the degree of integration, level of customization, programmability and the process technology utilized to manufacture the semiconductor. Advances in semiconductor technology have increased the functionality and performance of semiconductors, improving their features and power consumption characteristics while reducing their size and cost. These advances have resulted in growth of semiconductors and electronic content across a diverse array of products. The semiconductor market totaled $574.1 billion in 2022.Reporting SegmentNXP has one reportable segment representing the entity as a whole, which reflects the way in which our chief operating decision maker executes operating decisions, allocates resources, and manages the growth and profitability of the Company. End Market Exposure Our product groups are focused on four primary end markets that we believe are characterized by long-term, attractive growth opportunities and where we believe we enjoy sustained, competitive differentiation through our technology leadership. The four end markets are Automotive, Industrial & IoT, Mobile, and Communication Infrastructure & Other. 3AutomotiveIndustrial & IoTMobileComm Infra & OtherCore ApplicationsADASElectrificationVehicle NetworksSecure Car AccesseCockpitBody Comfort & ConveniencePowertrainSmart HomeEdge Nodes Factory and Building AutomationHome EntertainmentPower and EnergySmart AppliancesMedicalSmart RetailSmartphonesWearablesMobile AccessoriesWireless Basestations Network & SecurityBanking Cards Government ID documentsTransit CardsRFID TaggingKey Growth DriversRadar systemsDomain and zonalprocessorsElectrification systemsSecure connected Edge solutionsSmart home and industrial automationConnectivity and crossover processorsUWB mobile access solutionsRF Power Systemsi.AutomotiveGrowth in automotive semiconductor sales relies on global vehicle sales and production trends and the increase in semiconductor content per vehicle, which is being driven by the proliferation of electronic features throughout the vehicle. Despite the decline in vehicles sales and production in 2020 due to the outbreak of the COVID-19 and the moderate growth in 2021 and 2022 due to the global supply crisis, the increase in semiconductor content per vehicle continued. We believe three mega-trends will drive the semiconductor content increase in the future: Autonomous driving, electrification and the service oriented car. Each of the megatrends involve new functions and each new function requires new technologies. The path to full autonomy is driving the increase of driver assistance systems in the car already today. In the same way, strict emissions regulations as well as consumer willingness for energy efficient cars are accelerating the penetration of electrification, which has been even more intensified during the pandemic, with OEMs prioritizing investments in this area. Last but not least, many consumers want their cars to be service oriented, hyper-connected, configurable and upgradeable, in the same way as they are used to with their smartphones. Semiconductor content per vehicle continues to increase due to government regulation of safety and emissions, standardization of higher-end options across a greater number of vehicle classes as well as consumer demand for greater fuel efficiency, advanced safety, multimedia applications and connectivity. Automotive safety features are evolving from passive safety systems to active safety systems with Advanced Driving Assisted Systems (ADAS) such as radar and vision systems. Semiconductor content is also increasing in engine management and fuel economy applications, like Battery Management Systems (BMS). Comfort and convenience systems and user interface applications, as well as infotainment features such as digital audio broadcasting are also areas with high semiconductor content increases. In addition, the use of networking in automotive applications continues to increase as various subsystems communicate within the automobile and with external devices and networks. Furthermore, we believe networking will play a key role in the electrical/electronic architecture transformation towards domain and zonal architectures. Smart car access, automotive Ultra-Wideband (UWB) and Near-Field Communication (NFC) are gaining ground in automotive as well, enabling the connection of vehicles and car keys to portable devices and the infrastructure. Data integrity and security hardware features for safeguarding memory, communication and system data are also increasing in importance. Due to the high degree of regulatory scrutiny and safety requirements, the automotive semiconductor market is characterized by stringent qualification processes, zero defect quality processes, functionally safe design architecture, high reliability, extensive design-in timeframes and long product life cycles, which results in significant barriers to entry. ii.Industrial & IoT The world is becoming smarter, more connected and more data driven, and the Industrial & IoT market sits at the center of this global digital transformation. The Industrial & IoT market is highly fragmented with a diverse collection of products and applications such as factory automation, smart home, smart appliances, home entertainment, smart retail, power and energy and medical electronics. 4Growth in the Industrial market is driven by the replacement of traditional mechanical equipment by smart, energy-saving and connected electronic equipment using various sensors, processors, connectivity, analog and security chipsets that align well with NXP’s ability to provide a complete range of processing, connectivity and secure solutions. Reducing carbon emissions (global net zero emission commitments) will likely also be a key growth driver with large transformations expected of our energy systems. Factories and homes will need to rely much more on renewable energy (e.g., solar, wind) and increase efficient use of energy. The way we generate and store energies will likely be more distributed. The energy ecosystem needs to develop and ensure smart, efficient and reliable power delivery.In IoT, growth is driven by the increasing use of high-performance edge and media devices (e.g., home entertainment, connected home assistants, home control and security) and low power IoT nodes (e.g. smart home, hearables, health trackers) where NXP scalable solutions across the entire embedded processing spectrum are ideally suited. Working and learning from home during the COVID-19 pandemic has been a major demand driver for smart home devices, computing peripherals, home entertainment and gaming consoles within our Industrial & IoT business.The increase in productivity with real-time insights and efficient processes for factory automation, the enhancement in consumer convenience, security and comfort for smart homes, the reduction of resource consumption and better energy efficiency for smart factories and cities, the increase in performance of rich media content in smart consumer devices and the need for better health prevention and monitoring solutions (wearables, smart patches and smart drug delivery devices) to help ensure the future health of millions of people are some of the key use-cases driving growth in Industrial & IoT. Finally, with the growing number of connected devices, latency, privacy and bandwidth have become critical limiting factors and Edge computing solves this by bringing the intelligence closer to the source. Security and tamper-detection capabilities are also becoming essential features of these Industrial & IoT solutions. iii.Mobile Mobile includes applications such as smartphones, feature phones, tablets, wearables and mobile accessories. NXP has a strong focus on mobile wallet, Ultra-Wideband (UWB) and specialty custom analog solutions. The demand for faster speeds, improved battery life, fast charging, mobile wallets, highly secure localization and sensing technology, mobile transit and authentication is driving increased semiconductor content for NXP. The growth in this market is mainly driven by the increasing attach rate of these features across devices, vendors and regions, from flagship smartphones down to feature phones, from developed countries to emerging regions. UWB, thanks to its unique precision, robustness, and reliability, is emerging as a secure, fine-ranging technology capable of enabling a wide range of innovative location-based user experiences. The technology is gaining momentum thanks to wider chipset availability, adoption across various devices by multiple brands, and the formation of a strong UWB ecosystem across the whole supply chain and NXP is well positioned in this market. iv.Communication Infrastructure & Other The Communication Infrastructure & Other end market is a combination of three different application markets, namely 5G networks, digital network communications and secure edge identification solutions. The transition to 5G and the cloudification of the network present a significant opportunity for NXP. More base stations are needed and massive MIMO radio technology - which provides better throughput and better spectrum efficiency - is greatly expanding the number of antennas and power amplifiers needed. Small cells are also deployed to improve coverage and capacity of wireless networks. In power amplification, as more bandwidth and higher frequencies are needed, we observe an increasing adoption of GaN technology because of its higher power output and efficiency.Workplaces are evolving from offices to homes, and consumers and enterprises need to adapt to changing working conditions, leading to increasing demand for better digital communication capabilities and digital content. This creates strong growth in the network communications market. Meanwhile, billions of connected devices exchange more and more data, leading to strong demand for device edge and cloud processing solutions. 5Finally, in secure edge identification solutions, NXP has extensive experience providing customers with solutions for applications demanding the highest security and reliability (ePassports, eID credentials, transportation & payment cards and RFID solutions). Further digitalization of governmental services, the trend towards secure contactless payment and the need to improve tracking, traceability and authentication of products are driving demand across these applications. Products We offer customers a broad portfolio of semiconductor products, including microcontrollers, application processors, communication processors, connectivity chipsets, analog and interface devices, RF power amplifiers, security controllers and sensors. A key element of our strategy is to offer highly integrated and secure solutions that are increasingly sought by our customers to simplify their development efforts and shorten their time to market. We believe we have the broadest ARM processor portfolio in the industry, from microcontrollers to crossover processors and from application processors to communication processors. i.Microcontrollers We have been a provider of MCU solutions for more than 40 years. MCUs integrate all of the major components of a computing system onto a single semiconductor device. Typically, this includes a programmable processor core, memory, interface circuitry and other components. MCUs provide the digital logic, or intelligence, for electronic applications, controlling electronic equipment or analyzing sensor inputs. We are a trusted, long-term supplier of MCUs to many of our customers, especially in the automotive, smartcards, industrial and consumer markets. Our MCU product portfolio ranges from 8-bit products to higher performance 16-bit and 32-bit products with on-board flash memory. Our portfolio is highly scalable, and is coupled with our extensive software and design tools. This enables our customers to design-in and deploy our MCU families, leveraging a consistent software development environment. Due to the scalability of our portfolio we are able to help future-proof our customer’s products as their systems evolve, becoming more complex or requiring greater processing capabilities over time. For automotive applications, our microcontrollers deliver the required reliability, security and functional safety to address current and future automotive challenges. In an increasingly connected and networked society, where security is playing a more important role, our MCU families are equipped with varying security features (such as remote authentication, system/data integrity, secure communication and anomaly detection) to address different type of security risks. Our new i.MX RT crossover processors are built using applications processors chassis, delivering a high level of integration, high speed peripherals, enhanced security, and engines for enhanced user experience (for example, 2D/3D graphics), but powered by a low-power MCU core running a real-time operating system like Amazon Free RTOS or Zephyr RTOS. The i.MX RT series offers the high performing Arm Cortex-M core, real-time functionality, and MCU usability at an affordable price. Our S32x Automotive Processing Platform offers scalability across products and multiple application domains with S32K MCU’s based on Arm Cortex-M cores with Automotive Safety Integrity Level (ASIL-D) capabilities. ii.Application Processors Application processors consist of a computing core with embedded memory and special-purpose hardware and software for secure multimedia applications such as graphics and video. Our products focus on consumer devices, industrial applications and automotive applications, like driver information systems, ADAS and vehicle networking that require processing and multimedia capabilities. We provide highly integrated ARM-based i.MX application processors with integrated audio, video and graphics capability that are optimized for low-power and high-performance applications. Our i.MX family of processors are designed in conjunction with a broad suite of additional products including power management solutions, audio codecs, touch sensors and accelerometers to provide full systems solutions across a wide range of operating systems and applications. Our i.MX 8 and 9 families are the latest generations of our general purpose application processors. Our i.MX 8 family is a feature and performance scalable multi-core platform that includes single, dual and quad-core families based on the Arm Cortex architecture for advanced graphics, imaging, machine vision, audio, voice, video, and safety-critical applications. Together, these products provide a family of applications processors featuring software, power and pin compatibility across single, dual and quad core implementations. Software support includes Linux and Android implementations. Our i.MX 9 series of application processors integrates hardware neural processing units across the entire series for acceleration of machine learning applications at the edge. In Automotive, our 6S32x Automotive Processing Platform offers scalability across products and multiple application domains based on Arm Cortex-A, Cortex-R, and Cortex-M cores with Automotive Safety Integrity Level (ASIL-D) capabilities with software compatibility from the MCU’s to SoC’s. iii.Communication Processors Communication processors combine a computing core, caches and other memories, with high-speed networking and input/output interfaces, such as Ethernet and PCI Express. Our portfolio includes 64-bit Arm-based Layerscape processors with up to 16 CPUs and Ethernet ports running at up to 100Gbps. Software support includes Linux and commercial real-time operating systems. Within enterprise and data-center communications infrastructure, our processors are used in switches, routers, SD-WAN access devices, Wi-Fi access points, and network security systems. Within service-provider communications infrastructure, our processors are used in cellular base stations, fixed wireless access Customer Premises Equipment (CPE), residential gateways, broadband aggregation systems, and core networking equipment. Although designed for use in communications infrastructure, these processors are also used in industrial and cloud server offload-applications. We also offer Layerscape Access processors, which implement baseband functions, principally for wireless systems such as 5G fixed wireless access and small cells. iv.Wireless Connectivity We offer a broad portfolio of connectivity solutions, including Near Field Communications (NFC), Ultra-wideband (UWB), Bluetooth low-energy (BLE), Zigbee, Thread as well as Wi-Fi and Wi-Fi/Bluetooth integrated SoCs. These products are integrated into a wide variety of end devices, such as mobile phones, wearables, enterprise access points, home gateways, voice assistants, multimedia devices, gaming consoles, printers, automotive infotainment and smart industrial devices. v.Analog and Interface Products We have a very broad portfolio of Analog and Interface products that are used in many markets, particularly automotive, industrial/IoT and mobile. In automotive we are the market leader in most of the applications, with integrated 77Ghz Radar solution for ADAS, battery management products for Electrification, audio processing solutions and amplifiers for car entertainment, Controller Area Network (CAN), Local Interconnect Network (LIN), FlexRay and Ethernet solutions for in-vehicle networking and two-way secure products for secure car access. In Industrial/IoT and mobile, we are a major supplier in interface, power and high-performance analog products. Our product portfolios includes I2C/I³C, General Purpose Input/Output (GPIO), LED controllers, real-time clocks, signal and load switches, signal integrity products, wired charging solutions, fast charging solutions, DC-DC, AC-DC converters and high-performance RF amplifiers. We have also successfully engaged with leading OEMs to drive custom and semi-custom products which in turn allow us to refine and accelerate our innovation and product roadmaps. vi.Radio Frequency Devices NXP is the market leader in High-Performance Radio Frequency (HPRF) power amplifiers. We have an extensive portfolio of LDMOS, GaN and GaAs RF transistors. NXP’s solutions range from sub-6GHz to 40GHz and from milliwatts to kilowatts. For base stations, NXP offers a full range of solutions addressing 5G RF power amplification needs from MIMO to massive MIMO based active antenna systems for cellular and millimeter Wave (mmWave) spectrum bands. We are engaged with the majority of the largest customers in mobile base stations and in several other application areas. In low and medium Power Amplification, NXPs low noise amplifier (LNA) portfolio offers solutions to meet future design needs in a wide range of applications. Two technologies serve the LNA portfolio, each with distinct advantages for their applications. Wireless infrastructure applications and many general wireless applications are served with III-V technology LNAs. Advanced SiGe technology is utilized in LNAs designed for wireless communication, cellular, consumer, automotive and industrial applications. vii.Security Controllers NXP is the market leader in security controller ICs. Our security controller ICs are embedded in smart cards (ePassports, electronic ID credentials, payment cards and transportation cards), as well as in consumer electronic and smart devices, for example in smartphones, tablets and wearables. These security controller ICs 7are suited for applications demanding the highest security and reliability. Nearly all of our security products consist of multi-functional solutions comprised of passive RF connectivity devices facilitating information transfer from the user document to reader infrastructure; secure, tamper-proof microcontroller devices in which information is securely encrypted (“secure element”); and secure real-time operating system software products to facilitate the encryption-decryption of data, and the interaction with the reader infrastructure systems. Our solutions are developed to provide extreme levels of security of user information, undergoing stringent and continued global governmental and banking certification processes, and to deliver a high level of device performance enabling significant throughput and productivity to our customers. viii.Sensors Sensors serve as a primary interface in embedded systems for advanced human interface and contextual awareness that mimic the human “5 senses” interaction with the external environment. We provide several categories of semiconductor-based environmental and inertial sensors for the Automotive market, including pressure, inertial, magnetic and gyroscopic sensors that provide orientation detection, gesture recognition, tilt to scroll functionality and position detection. Manufacturing We manufacture integrated circuits and discrete semiconductors through a combination of wholly owned manufacturing facilities, a manufacturing facility operated jointly with another semiconductor company and third-party foundries and assembly and test subcontractors. We manage our manufacturing assets together through one centralized organization to ensure we realize scale benefits in asset utilization, purchasing volumes and overhead leverage across businesses. The manufacturing of a semiconductor involves several phases of production, which can be broadly divided into “front-end” and “back-end” processes. Front-end processes take place at highly complex wafer manufacturing facilities (called fabrication plants or “wafer fabs”), and involve the imprinting of substrate silicon wafers with the precise circuitry required for semiconductors to function. The front-end production cycle requires high levels of precision and involves as many as 300 process steps. Back-end processes involve the assembly, test and packaging of semiconductors in a form suitable for distribution. In contrast to the highly complex front-end process, back-end processing is generally less complicated, and as a result we tend to determine the location of our back-end facilities based more on cost factors than on technical considerations. We primarily focus our internal and joint venture wafer manufacturing operations on running proprietary specialty process technologies that enable us to differentiate our products on key performance features, and we generally outsource wafer manufacturing in process technologies that are available at third-party wafer foundries when it is economical to do so. In addition, we increasingly focus our in-house manufacturing on our competitive 8-inch wafer facilities, which predominantly run manufacturing processes in the 140 nanometer, 180 nanometer and 250 nanometer process nodes. This focus increases our return on invested capital and reduces capital expenditures. Our front-end manufacturing facilities use a broad range of production processes and proprietary design methods, including complementary metal oxide semiconductor (CMOS), bipolar, bipolar CMOS (BiCMOS) and double-diffused metal on silicon oxide semiconductor (DMOS) technologies. Our wafer fabs produce semiconductors with line widths ranging from 90 nanometers to 3 microns for integrated circuits and 0.5 microns to greater than 4 microns for discretes. This broad technology portfolio enables us to meet increasing demand from customers for system solutions, which require a variety of technologies. Our back-end manufacturing facilities test and package many different types of products using a wide variety of processes. To optimize flexibility, we use shared technology platforms for our back-end assembly operations. Most of our assembly and test activities are maintained in-house. 8The following table shows selected key information with respect to our major front-end and back-end facilities:SiteOwnershipWafer sized usedLine widths used (vm)Technology/Products(Microns)Front-endSingapore (SSMC)¹⁾61.2 %8”0.14-0.25CMOS, eNVM, Power, BCDMOS, RFNijmegen, the Netherlands100 %8”0.14-1.00CMOS, BCDMOS, RF, Power MOSFETAustin (Oak Hill), United States100 %8”0.25-1.50CMOS, Sensors, RF, Power MOSFETChandler, United States100 %8”0.18-0.50CMOS, eNVM, BCDMOSChandler RF, United States100 %6”0.25-0.40GaNAustin (Ed Bluestein), United States100 %8”0.09-0.18CMOS, eNVM, BCDMOS, RadarBack-endKaohsiung, Taiwan100 %— — NFC, Automotive Car-access, In-Vehicle Networking, Micro-controllers, ADAS (Radar), Analog, Mixed-Signal and PowerBangkok, Thailand100 %— — Automotive In-Vehicle Networking and Sensors, Analog, RFID, Banking and e-Passport modules, Power ManagementKuala Lumpur, Malaysia100 %— — Micro-processors, ADAS/Radar, Micro-controllers, Advanced Audio Processor, Sensors, Power Management, Analog and Mixed Signal, RF devicesTianjin, China100 %— — Micro-processors, Micro-controllers, Power Management, Battery Management, Analog and Mixed Signal1) Joint venture with TSMC; we are entitled to 60% of the joint venture’s annual capacity. We use a large number of raw materials in our front- and back-end manufacturing processes, including silicon wafers, chemicals, gases, lead frames, substrates, molding compounds and various types of precious and other metals. Our most important raw materials are the raw, or substrate, silicon wafers we use to make our semiconductors. We purchase these wafers, which must meet exacting specifications, from a limited number of suppliers in the geographic region in which our fabrication facilities are located. At our wholly owned fabrication plants, we use raw wafers ranging from 6 inches to 8 inches in size. Our SSMC wafer fab facility, which produces 8 inch wafers, is jointly owned by TSMC and ourselves. Emerging fabrication technologies employ larger wafer sizes and, accordingly, we expect that our production requirements will in the future shift towards larger substrate wafers. We typically source our other raw materials in a similar fashion as our wafers, although our portfolio of suppliers is more diverse. Some of our suppliers provide us with materials on a just-in-time basis, which permits us to reduce our procurement costs and the negative cash flow consequences of maintaining inventories, but exposes us to potential supply chain interruptions. We purchase most of our raw materials on the basis of fixed price contracts. Over the past two years, semiconductor supply chains have been constrained. As a result, there has been a tendency towards longer term supply contracts with suppliers in exchange for capacity. From an operational perspective, all of our manufacturing facilities continue to operate around the world in accordance with guidance issued by local and national government authorities.9Sales, Marketing and Customers We market our products and solutions worldwide to a variety of OEMs, contract manufacturers and distributors. We generate demand for our products by delivering product solutions to our customers, and supporting their system design-in activities by providing application architecture expertise and local field application engineering support. Our sales and marketing teams are organized into five regions, which are EMEA (Europe, the Middle East and Africa), the Americas, Japan, South Korea, and China and Asia Pacific. These sales regions are responsible for managing customer relationships and creating demand for our solutions through the full ecosystem development. In addition, our sales and marketing teams in the regions partner with our distributors and our large number of mass market customers. Our sales and marketing strategy focuses on key defined verticals in Automotive, Mobile, Industrial & IoT and Communication Infrastructure, deepening our relationship with our top OEMs and electronic manufacturing service customers, expanding our reach to our mass market customers, startups and our distribution partners and becoming their preferred supplier, which we believe assists us in reducing sales volatility in challenging markets. We have long-standing customer relationships with most of our customers. Our 10 largest OEM end customers, some of whom are supplied by distributors, in alphabetical order, are Apple, Aptiv, Bosch, Continental, Denso, Harman Auto, Hyundai, Samsung, Visteon, and Vitesco. We also have a strong position with our distribution partners, including our three largest, Arrow, Avnet and WT Micro. Our revenue is primarily the sum of our direct sales to OEMs plus our distributors’ resale of NXP products. Avnet accounted for 20% of our revenue in 2022 and 18% in 2021. No other distributor accounted for greater than 10% of our revenue. No OEM for which we had direct sales to accounted for more than 10% of our revenue in 2022 or 2021. Research and Development We believe that our future success depends on our ability to both improve our existing products and to develop new products for both existing and new markets. We direct our research and development efforts largely to the development of new semiconductor solutions where we see significant opportunities for growth. We target applications that require stringent overall system and subsystem performance. As new and challenging applications proliferate, we believe that many of these applications will benefit from our solutions. We have assembled a global team of highly skilled semiconductor and embedded software design engineers with expertise in RF, analog, power management, interface, security and digital processing. To outpace market growth we invest in research and development to extend or create leading market positions, with an emphasis on fast growing sizable market segments, such as ADAS, in-vehicle networks and power management, as well as Edge computing to support the successful deployment in the IoT with our cross-over processing technology, but also in emerging markets, such as massive MIMO in RF Power and mmWave for 5G. In addition, we invest a few percent of our total research and development expenditures in research activities that develop fundamental new technologies or product categories that could contribute significantly to our company's growth in the future. We annually perform a fundamental review of our business portfolio and our related new product and technology development opportunities in order to decide on changes in the allocation of our research and development resources. For products targeting established markets, we evaluate our research and development expenditures based on clear business need and risk assessments. For break-through technologies and new market opportunities, we look at the strategic fit and synergies with the rest of our portfolio and the size of the potential addressable market. Overall, we allocate our research and development to maintain a healthy mix of emerging growth and mature businesses. Intellectual Property The creation and use of intellectual property is a key aspect of our strategy to differentiate ourselves in the marketplace. We seek to protect our proprietary technologies by obtaining patents, trademarks, domain names, 10retaining trade secrets and defending, enforcing and utilizing our intellectual property rights, where appropriate. We believe this strategy allows us to preserve the advantages of our products and technologies, and helps us to improve the return on our investment in research and development. We have a broad portfolio of approximately 9,500 patent families (each patent family includes all patents and patent applications originating from the same invention). To protect confidential technical information and software, we rely on copyright and trade secret law and enter into confidentiality agreements as applicable. In situations where we believe that a third party has infringed on our intellectual property, we enforce our rights through all available legal means to the extent that we determine the benefits of such actions to outweigh the costs and risks involved. We own a number of trademarks that are used in the conduct of our business. Where we consider it desirable, we develop names for our new products and secure trademark protection. Our trademarks allow us to further distinguish our company and our products and are important in our relationships with customers, suppliers, partners and end-users. While our patents, trademarks, trade secrets and other intellectual property rights constitute valuable assets, we do not view any individual right or asset as material to our operations as a whole. We believe it is the combination of our proprietary technology, patents, know-how and other intellectual property rights and assets that creates an advantage for our business. In addition to obtaining our own patents and other intellectual property rights, we have entered into licensing agreements and other arrangements authorizing us to use intellectual property rights, confidential technical information, software and other technology owned by third parties. We also engage, in certain instances, in licensing and selling of certain of our technology, patents and other intellectual property rights. Competition We compete with many different semiconductor companies on a global basis, including with both integrated device manufacturers (“IDMs”) as well as fabless companies. Nearly all our competitors invest extensively in research and development, manufacturing, sales and marketing capabilities across a broad spectrum of product lines. Many of our competitors are focused on single applications or market segments. Most of our competitors compete with us with respect to some, but not all, of our product lines. Our primary key public competitors in alphabetical order include, but are not limited to, Analog Devices Inc., Infineon Technologies AG, Intel Corp., Marvell Technology, Mediatek Inc., Microchip Technology Inc., NVIDIA Corp., Qualcomm Incorporated, Renesas Electronics Corp., STMicroelectronics NV and Texas Instruments Incorporated. The basis on which we compete varies across end markets and geographic regions. This includes competing on the basis of our ability to develop new products and the underlying intellectual property in a timely manner to meet customer requirements in terms of product features, quality, performance, warranty, availability and cost. In addition, we are asked to deliver full system capabilities which include multiple NXP devices and enabling software. This requires in-depth knowledge of specific applications in target markets in order to develop robust system solutions and qualified customer support resources. SeasonalityHistorically, our net revenue does not display consistent or predictable seasonal patterns.Government Regulation, including Environmental RegulationThe information set forth under the “Environmental remediation” caption of Note 15 of our notes to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report is incorporated herein by reference. For additional discussion of certain risks associated with government and environmental regulation, see Part I, Item 1A. Risk Factors.Information about our Executive Officers 11The names, ages and positions as of March 1, 2023, of our executive officers, including our chief executive officer, Mr. Sievers, are as follows:NameAgePositionKurt Sievers53Executive director, president and chief executive officerBill Betz45Executive vice president and chief financial officerChristopher Jensen53Executive vice president and chief human resources officerRon Martino57Executive vice president salesAndrew Micallef58Executive vice president global operationsJennifer Wuamett57Executive vice president, general counsel, corporate secretary and chief sustainability officerHuman CapitalAt NXP, our diverse and talented employees, referred to as team members, drive the innovation that sets our company apart and fuels our success in the market. Our purpose is bringing together bright minds to create breakthrough technologies that make the connected world better, safer, and more secure. This purpose is reinforced by our values of innovation, expertise, collaboration, ownership and growth built on a foundation of trust and respect. Across the globe, we have policies and programs to attract and maintain the best talent possible. We focus on driving team member engagement; building thought leadership; embracing diversity, equity and inclusion; providing competitive and fair compensation and benefits; enabling talent development and growth opportunities; investing in future talent; focusing on team member retention; and giving back to our communities. NXP’s workforce includes direct labor (DL) and indirect labor (IDL). DL are those team members directly involved in manufacturing our products, while IDL consists of individual contributors, managers and executives in other functions such as research and development (R&D) and selling, as well as general and administrative (SG&A). At December 31, 2022, we had approximately 34,500 employees, which includes approximately 1,500 employees in our joint venture. Our NXP global workforce spans three regions encompassing 30+ countries and includes more than 11,000 team members dedicated to research and development of our products and solutions (representing 34% of our NXP workforce and 56% of our IDL workforce).Corporate Values and Team Member EngagementNXP's values are our fundamental beliefs and guiding principles. They speak to how we operate, engage, develop and value our team members, and push the boundaries of creativity and innovation. We hold ourselves accountable to our values by ensuring they are reflected in all of our talent programs, including hiring, learning and development, performance evaluation, recognition, rewards, and promotions.12 To assess and improve engagement, NXP regularly conducts our global Winning Culture Survey, which is administered by a third party to ensure confidentiality. We invite team members to share their feedback on a variety of factors, including engagement, strategy, culture, leadership, continuous improvement, collaboration, execution, ownership, work environment, support and diversity, equality and inclusion. Insights from our survey equip us to improve the team member experience as well as our policies and processes. We prioritize team member retention and closely monitor voluntary attrition as an indicator of engagement. This attrition is also compared to industry norms to ensure we are effectively retaining our employees throughout the world. During calendar 2022, our voluntary attrition rate was 7.5% for IDL, 18.1% for our DL population and 11.7% of the total population, a slight reduction in total year over year. We managed several initiatives centered around retention for strategic roles and top-performing talent. We also have broad-based programs targeting all team members ensuring that we are retaining our talent over the longer term. Diversity, Equality and InclusionAt NXP, the foundation of our values is trust and respect to ensure our inclusive culture. We recognize the importance of diversity, equality, and inclusion and respect the unique talents, experiences, backgrounds, cultures and ideas of our team members. Our diversity, equality and inclusion approach is centered around •Ensuring leadership commitment and accountability; •Building and sustaining a qualified and diverse talent pipeline and equitable processes; and •Fostering an inclusive culture and a sense of belonging to attract and retain the best talent.NXP continues to contribute resources focused on driving cultural awareness across the Company, which is spearheaded by NXP’s Vice President and Head of Diversity, Equality and Inclusion. The Human Resources and Compensation Committee of our Board provides oversight of our policies, programs and initiatives focusing on human capital management, including workforce diversity, equality and inclusion. NXP Employee Resource Groups (ERGs) enable our culture and inclusive work environment, as we work to ensure diversity of thought throughout our company and bring unique perspectives and skills to help those in our communities. Today, we have nine primary ERGs, with representation in Asia, Europe, Mexico and the United States. Membership and participation in ERGs is open to all team members, and global engagement is encouraged. To track the progress of our growing ERGs, we measure membership, programming and team member engagement for each group.To support our diversity, equality and inclusion approach and demonstrate our commitment to transparency and accountability, we have established the aspirational 2025 diversity, equality and inclusion goals listed below to improve global gender representation and minority race and ethnicity representation in the United States. We continue to focus on hiring, developing, and retaining team members across all global sites to meet our 2025 representation goals. In a competitive hiring market, our overall employee population grew by 11% in 2022. Of this increased population, compared to 2021 there was a 1% increase with women in the global indirect labor workforce, 2% increase with women in R&D positions, 3% increase with women of executive positions and the percent of women in the global workforce remained the same in 2022 compared to 2021. While we present gender representation data by men and women, we acknowledge this is not fully encompassing of all gender identities.132025 Diversity, Equality, & Inclusion Goals40% Women in Overall Global Workforce30% Women in Global Indirect Labor Workforce20% Women in Executive Positions*25% Women in R&D Positions50% Minority Representation in the United States*2022 Diversity, Equality, & Inclusion Performance37%25%16%19%51%* Executive positions are defined as individuals at the level of Vice President and above. Minority representation includes team members who self-identify as Asian, Hispanic or Latino, Black or African American, American Indian or Alaska Native, Pacific Islander or two or more races. We also include within minority representation team members who have not self-identified an ethnicity.Talent Development and Investing in the FutureNXP is committed to a 70/20/10 continuous learning model, including mechanisms for learning through on-the-job experiences (70%), learning through others (20%), and learning through education (10%). Using a blend of internally designed and externally sourced courses and learning resources, we offer our team members around the globe a variety of training programs that provide real-time learning opportunities in support of key business processes, requirements and initiatives. We also provide a library of on-demand skills development and microlearning resources to all our team members. We work to create developmental opportunities for our team members through stretch assignments, project roles, cross-functional interactions, cross-geography engagements, and both temporary and longer-term job rotations – all of which are used to stimulate core skill and leadership competency development, to provide on-the-job learning experience, and to fuel career growth. We also believe that our commitment to our internship programs and university partnerships are a key contributor to developing the new generation of talent, including engineers in our industry and company, and provide a pipeline of recent college graduates into our talent pool. Through our partnerships with universities across the world, we fund and support advanced research programs and projects that demonstrate our commitment to investing in the future of not only technology, but also students' knowledge and skills. Compensation and BenefitsWe provide total rewards packages that include market competitive base salary, as well as opportunities to earn short-term cash incentives and equity-based incentives. In addition, in an effort to meet the specific needs of our team members and their families, we offer locally competitive benefits programs, which vary by country/region, and include an Employee Stock Purchase Plan, retirement programs, healthcare and insurance benefits, allowances, paid time off, family leave, our flexible work arrangement program, and other team member assistance programs. NXP’s compensation programs are designed to attract the best talent and drive performance across all areas of our diverse workforce. NXP is committed to managing all reward-based compensation programs, including merit increases, incentive program payouts and long-term incentive awards, to deliver on our pay-for-performance philosophy. Rewarding performance is a critical foundation for our overall compensation program.We believe that pay decisions should be made on three factors: external (i.e. market conditions), internal equity, and employee performance/contributions. We have developed a proactive process to evaluate each reward-based compensation program in real time and provide leaders with feedback to create more visibility into fair and equitable compensation while decisions are being made. NXP also utilizes third-party data to formulate compensation and benefits programs that are fair, equitable and competitive. We then empower leaders to recognize both individual and team accomplishments through a variety of compensation programs.14Since 2022, we have linked a portion of our executive and employee compensation to our ESG Goals. For more information, see our 2023 Proxy Statement and the ESG Goals section in the Corporate Sustainability Report1. Employee Health and SafetyWe are committed to the safety of our employees, and we continuously assess safety risks globally to ensure workplace risks are mitigated. We are certified to the ISO 45001 Occupational Health and Safety Management System, and have developed robust safety programs and initiatives to safeguard our workforce. In 2022, as a follow-up to a previous survey, we conducted a global survey on employee safety, inquiring about opportunities for improvement and asking employees about their comfort level when raising safety concerns. The follow-up survey had a participation rate of approximately 80% and the responses to all questions were more favorable than those provided on the previous survey. In particular, 94% of our employees felt that safety concerns are a high priority for NXP and 98% of employees felt that safety starts with them. We used the results from the follow-up survey to identify improvement opportunities, and have started working at our sites and locations to address these opportunities.For the past three years, the ongoing COVID-19 pandemic has made it all the more important to maintain employee health and safety, and we have effectively managed our health-and-safety programs over this period. During the height of the pandemic, we hosted several successful vaccination drives in a number of countries where our employees live and work. As community conditions improved, we developed a global program for flexible work arrangements, offering eligible employees the option to perform a combination of onsite and remote work. We believe this approach – emphasizing onsite safety, vaccination availability, and the option to work remotely – addresses the safety needs of our workforce while ensuring the robust continuity of our operations.Employee RepresentationA number of our team members are members of a labor union and in various countries, local law requires us to inform and consult with employee representatives on matters relating to labor conditions. We have not experienced any material strikes or labor disputes in the past and consider our employee relations to be good.We also have employee-lead worker’s councils in various countries that provide input and oversight to many of the decisions made on behalf of employees.Climate and EnvironmentAs part of our commitment to reducing emissions and conserving the earth’s natural resources, we have made the environment a key pillar in our Sustainability Policy and corporate strategy. We set company-wide environmental targets to optimize our use of resources, minimize waste and continuously improve. We periodically set and reset targets, and publish mid- and long-term targets on carbon footprint reduction and renewable energy consumption, as well as water and waste recycling.See Part I, Item 1A. Risk Factors for a discussion of potential global environmental risks that may adversely affect our business operations, such as climate change or natural disasters.Our commitment to enabling a smarter, more sustainable world goes beyond our operations, and includes developing innovative product solutions that support the sustainability goals and objectives of our stakeholders. We monitor developments of global legislation by tracking current discussions, timelines, and the likelihood of new implementations. During the design and development of our new product solutions, we emphasize these potential requirements to coincide with new product introductions. By minimizing the environmental impact of our products in the early stages of the design process, we enable sustainable, green technology for NXP and our customers.Additional information about our environmental strategy, targets, and metrics is included in our Corporate Sustainability Report, and can be found on our website2.1 The contents of our Corporate Sustainability Report are referenced for general information only and are not incorporated by reference in this Form 10-K. Except as specifically noted elsewhere in this Form 10-K, the contents of our 2023 Proxy Statement are referenced here for general information only and are not incorporated by reference in this Form 10-K.2 The contents of our website, our Corporate Sustainability Report, and our Sustainability Policy are referenced for general information only and are not incorporated by reference in this Form 10-K.15Available InformationOur main corporate website address is www.nxp.com. Copies of our filings with the United States Securities and Exchange Commission (SEC), including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our website within the "Investors Relations" section as soon as reasonably practicable after having been electronically filed or furnished to the SEC. All SEC filings are also available at the SEC's website at www.sec.gov. The information contained on these websites as referenced is not incorporated by reference into this filing. Further, the Company’s references to website URLs are intended to be inactive textual references only.Item 1A. Risk FactorsRisks related to the semiconductor industry and the markets in which we participateThe semiconductor industry is highly cyclical. Historically, the relationship between supply and demand in the semiconductor industry has caused a high degree of cyclicality in the semiconductor market. Semiconductor supply is partly driven by manufacturing capacity, which in the past has demonstrated alternating periods of substantial capacity additions and periods in which no or limited capacity was added. As a general matter, semiconductor companies are more likely to add capacity in periods when current or expected future demand is strong and margins are, or are expected to be, high. Investments in new capacity can result in overcapacity, which can lead to a reduction in prices and margins. In response, companies typically limit further capacity additions, eventually causing the market to be relatively undersupplied. In addition, demand for semiconductors varies, which can exacerbate the effect of supply fluctuations. As a result of this cyclicality, the semiconductor industry has in the past experienced significant downturns, such as in 1997/1998, 2001/2002 and in 2008/2009, often in connection with, or in anticipation of, maturing life cycles of semiconductor companies’ products and declines in general economic conditions. These downturns have been characterized by diminishing demand for end-user products, high inventory levels, under-utilization of manufacturing capacity and accelerated erosion of average selling prices. The foregoing risks have historically had, and may continue to have, a material adverse effect on our business, financial condition and results of operations. Significantly increased volatility and instability and unfavorable economic conditions may adversely affect our business. It is difficult for us, our customers and suppliers to forecast demand trends. We may be unable to accurately predict the extent or duration of cycles or their effect on our financial condition or result of operations and can give no assurance as to the timing, extent or duration of the current or future business cycles generally, or specific to the markets in which we participate. In the first half of 2020, demand in the automotive market steeply declined as a result of manufacturing shutdowns by automotive OEMs due to the coronavirus pandemic, resulting in an unforeseen negative impact to our results of operations. Beginning in the third quarter of 2020, demand rebounded across all end markets more quickly than anticipated and accelerated through the third quarter of 2022, resulting in our inability to fully satisfy customer demand. Beginning in the third quarter of 2022, we have seen a slowdown, primarily in our more consumer exposed end markets of IoT and Mobile versus the prior year with a significant degree of uncertainty for the near-term demand trends. In 2008 and 2009, Europe, the United States and international markets experienced increased volatility and instability related to the global financial crisis. In the event of a future decline in global economic conditions, our business, financial condition and results of operations could be materially adversely affected, and the resulting economic decline might disproportionately affect the markets in which we participate, further exacerbating a decline in our results of operations. The semiconductor industry is highly competitive. If we fail to introduce new technologies and products in a timely manner, this could adversely affect our business. The semiconductor industry is highly competitive and characterized by constant and rapid technological change, short product lifecycles, significant price erosion and evolving standards. Accordingly, the success of our business depends to a significant extent on our ability to develop new technologies and products that are 16ultimately successful in the market. The costs related to the research and development necessary to develop new technologies and products are significant and subject to increase due to current and expected inflation and any reduction of our research and development budget could harm our competitiveness. Meeting evolving industry requirements and introducing new products to the market in a timely manner and at prices that are acceptable to our customers are significant factors in determining our competitiveness and success. Commitments to develop new products must be made well in advance of any resulting sales, and technologies and standards may change during development, potentially rendering our products outdated or noncompetitive before their introduction. If we are unable to successfully develop new products, our revenue may decline substantially. Moreover, some of our competitors are well-established entities, are larger than us and have greater resources than we do. If these competitors increase the resources they devote to developing and marketing their products, we may not be able to compete effectively. Any consolidation among our competitors could enhance their product offerings and financial resources, further strengthening their competitive position. In addition, some of our competitors operate in narrow business areas relative to us, allowing them to concentrate their research and development efforts directly on products and services for those areas, which may give them a competitive advantage. As a result of these competitive pressures, we may face declining sales volumes or lower prevailing prices for our products, and we may not be able to reduce our total costs in line with this declining revenue. If any of these risks materialize, they could have a material adverse effect on our business, financial condition and results of operations. The demand for our products depends to a significant degree on the demand for our customers’ end products. The vast majority of our revenue is derived from sales to manufacturers in the automotive, industrial & IoT, mobile, and communication infrastructure. Demand in these markets fluctuates significantly, driven by consumer spending, consumer preferences, the development of new technologies and prevailing economic conditions. In addition, the specific products in which our semiconductors are incorporated may not be successful, or may experience price erosion or other competitive factors that affect the price manufacturers are willing to pay us. Such customers have in the past, and may in the future, vary order levels significantly from period to period, request postponements to scheduled delivery dates, modify their orders or reduce lead times. This is particularly common during periods of low demand. This can make managing our business difficult, as it limits the predictability of future revenue. It can also affect the accuracy of our financial forecasts. Furthermore, developing industry trends, such as customers’ use of outsourcing and revised supply chain models, including the direct purchase of semiconductor products by end product manufacturers instead of component manufacturers, may affect our revenue, costs, customer relations and working capital requirements. If customers do not purchase products made specifically for them, we may not be able to resell such products to other customers or may not be able to require the customers who have ordered these products to pay a cancellation fee. The foregoing risks could have a material adverse effect on our business, financial condition and results of operations. The semiconductor industry is historically characterized by continued price erosion, especially after a product has been on the market. One of the results of the rapid innovation in the semiconductor industry is that pricing pressure, especially on products containing older technology, can be intense. Product life cycles are relatively short, and as a result, products tend to be replaced by more technologically advanced substitutes on a regular basis. In turn, historically demand for older technology falls, causing the price at which such products can be sold to drop, in some cases precipitously. If this trend continues, in order to continue profitably supplying these products, we must reduce our production and procurement costs in line with the lower revenue we can expect to generate per unit. Usually, this must be accomplished through improvements in process technology, production efficiencies and efficient procurement pricing. If we cannot advance our process technologies or improve our efficiencies to a degree sufficient to maintain required margins, we will no longer be able to make a profit from the sale of these products. Moreover, we may not be able to cease production of such products, either due to contractual obligations or for customer relationship reasons, and as a result may be required to bear a loss on such products. We cannot guarantee that competition in our core product markets will not lead to price erosion, lower revenue or lower margins in the future. Should reductions in our manufacturing costs fail to keep pace with reductions in market prices for the products we sell, this could have a material adverse effect on our business, financial condition and results of operations. 17Risks related to our business operationsIn many of the market segments in which we compete, we depend on winning selection processes, and failure to be selected could adversely affect our business in those market segments. One of our business strategies is to participate in and win competitive bid selection processes to develop products for use in our customers’ equipment and products. These selection processes can be lengthy and require us to incur significant design and development expenditures, with no guarantee of winning a contract or generating revenue. Failure to win new design projects and delays in developing new products with anticipated technological advances or in commencing volume shipments of these products may have an adverse effect on our business. This risk is particularly pronounced in markets where there are only a few potential customers and in the automotive market, where, due to the longer design cycles involved, failure to win a design-in could prevent access to a customer for several years. Our failure to win a sufficient number of these bids could result in reduced revenue and hurt our competitive position in future selection processes because we may not be perceived as being a technology or industry leader, each of which could have a material adverse effect on our business, financial condition and results of operations.Our global business operations expose us to international business risks that could adversely affect our business.If any of the following international business risks were to materialize or become worse, they could have a material adverse effect on our business, financial condition and results of operations:•negative economic developments in economies around the world and the instability of governments and international trade arrangements, such as the increase of barriers to international trade including the imposition of tariffs on imports by the United States and China, the withdrawal of the United Kingdom from the European Union, enhanced export controls on certain products and sanctions on certain industry sectors and parties and the sovereign debt crisis in certain European countries; •social and political instability in a number of countries around the world, including continued hostilities and civil unrest in the Middle East and the armed conflict in Ukraine. The instability may have a negative effect on our business, financial condition and operations via our customers and global supply chain and volatility in energy prices and the financial markets; •potential terrorist attacks; •epidemics and pandemics, such as the coronavirus outbreak, which may adversely affect our workforce, as well as our suppliers and customers; •geopolitical tension and disputes and resulting adverse changes in government policies, especially those affecting global trade and investment. Sustained geopolitical tensions could lead to long-term changes in global trade and technology supply chains and decoupling of global trade networks;•volatility in foreign currency exchange rates, in particular with respect to the U.S. dollar, and transfer restrictions, in particular in mainland China; and•threats that our operations or property could be subject to nationalization and expropriation.In addition, Russia’s recent invasion of Ukraine has led to sanctions, export controls and other penalties being levied by the United States, European Union and other countries against Russia, Belarus, the Crimea Region of Ukraine, the so-called Donetsk People’s Republic, and the so-called Luhansk People’s Republic. Additional potential sanctions and penalties have also been proposed and/or threatened. Russian military and economic actions and resulting sanctions could adversely affect the global economy and financial markets. Further escalation of the conflict between Ukraine and Russia could adversely impact the global supply chain, disrupt our operations, or negatively impact the demand for our products in our primary end markets. Any such disruption could result in an adverse impact to our financial results. Goodwill and other identifiable intangible assets represent a significant portion of our total assets, and we may never realize the full value of our intangible assets. Goodwill and other identifiable intangible assets are recorded at fair value on the date of an acquisition. We review our goodwill and other intangible assets balance for impairment upon any indication of a potential impairment, and in the case of goodwill, at a minimum of once a year. Impairment may result from, among other things, a sustained decrease in share price, deterioration in performance, adverse market conditions, adverse changes in applicable laws or regulations, including changes that restrict the activities of or affect the products 18and services we sell, challenges to the validity of certain registered intellectual property, reduced sales of certain products incorporating intellectual property and a variety of other factors. The amount of any quantified impairment must be expensed immediately as a charge to results of operations. Depending on future circumstances, it is possible that we may never realize the full value of our intangible assets. Any future determination of impairment of goodwill or other identifiable intangible assets could have a material adverse effect on our financial position, results of operations and stockholders’ equity. In difficult market conditions, our high fixed costs combined with low revenue may negatively affect our results of operations. The semiconductor industry is characterized by high fixed costs and, notwithstanding our utilization of third-party manufacturing capacity, our production requirements are in part met by our own manufacturing facilities. In less favorable industry environments, like we faced in the first half of 2020, we are generally faced with a decline in the utilization rates of our manufacturing facilities due to decreases in demand for our products. During such periods, our fabrication plants could operate at lower loading level, while the fixed costs associated with the full capacity continue to be incurred, resulting in lower gross profit. We may from time to time restructure parts of our organization. Any such restructuring may impact customer satisfaction and the costs of implementation may be difficult to predict. We have previously executed restructuring initiatives and continue to assess, restructure and make changes to parts of the processes in our organization. If the global economy remains volatile, our revenues could decline and we may be forced to take cost savings steps that could result in additional charges and materially affect our business. The costs of implementing any restructurings, changes or cost savings steps may differ from our estimates and any negative impacts on our revenues or otherwise of such restructurings, changes or steps, such as situations in which customer satisfaction is negatively impacted, may be larger than originally estimated. If we fail to extend or renegotiate our collective bargaining agreements and social plans with our labor unions as they expire from time to time, if regular or statutory consultation processes with employee representatives such as works councils fail or are delayed, or if our unionized employees were to engage in a strike or other work stoppage, our business and operating results could be materially harmed. We are a party to collective bargaining agreements and social plans with our labor unions. We are also required to consult with our employee representatives, such as works councils, on items such as restructurings, acquisitions and divestitures. Although we believe that our relations with our employees, employee representatives and unions are satisfactory, no assurance can be given that we will be able to successfully extend or renegotiate these agreements as they expire from time to time or to conclude the consultation processes in a timely and favorable way. The impact of future negotiations and consultation processes with employee representatives could have a material impact on our financial results. Also, if we fail to extend or renegotiate our labor agreements and social plans, if significant disputes with our unions arise, or if our unionized workers engage in a strike or other work stoppage, we could incur higher ongoing labor costs or experience a significant disruption of operations, which could have a material adverse effect on our business. Our working capital needs are difficult to predict. Our working capital needs are difficult to predict and may fluctuate. The comparatively long period between the time at which we commence development of a product and the time at which it may be delivered to a customer leads to high inventory and work-in-progress levels. The volatility of our customers’ own businesses and the time required to manufacture products also make it difficult to manage inventory levels and require us to stockpile products across many different specifications. Our business may be adversely affected by costs relating to product defects, and we could be faced with product liability and warranty claims. We make highly complex electronic components and, accordingly, there is a risk that defects may occur in any of our products. Such defects can give rise to significant costs, including expenses relating to recalling products, replacing defective items, writing down defective inventory and loss of potential sales. In addition, the occurrence of such defects may give rise to product liability and warranty claims, including liability for damages caused by such defects. If we release defective products into the market, our reputation could suffer and we may 19lose sales opportunities and incur liability for damages. Moreover, since the cost of replacing defective semiconductor devices is often much higher than the value of the devices themselves, we may at times face damage claims from customers in excess of the amounts they pay us for our products, including consequential damages. We also face exposure to potential liability resulting from the fact that our customers typically integrate the semiconductors we sell into numerous consumer products, which are then sold into the marketplace. We are exposed to product liability claims if our semiconductors or the consumer products based on them malfunction and result in personal injury or death. We may be named in product liability claims even if there is no evidence that our products caused the damage in question, and such claims could result in significant costs and expenses relating to attorneys’ fees and damages. In addition, our customers may recall their products if they prove to be defective or make compensatory payments in accordance with industry or business practice or in order to maintain good customer relationships. If such a recall or payment is caused by a defect in one of our products, our customers may seek to recover all or a portion of their losses from us. If any of these risks materialize, our reputation would be harmed and there could be a material adverse effect on our business, financial condition and results of operations. We face risks related to security vulnerabilities in our products. We and third parties regularly identify security vulnerabilities with respect to our products and services. The same holds for the operating systems and workloads that run on them and the components that interact with them. Components and Intellectual Property (IP) we purchase or license from third parties for use in our products, as well as industry-standard specifications we implement in our products, are also regularly subject to security vulnerabilities. As we have become a more data-centric company, our processors and other products are being used in additional and new and critical application areas that create new or increased cybersecurity, privacy or safety risks. This includes applications that gather and process large amounts of data, such as the cloud or Internet of Things, and critical infrastructure and automotive applications. We, our customers, and the users of our products do not always promptly learn of or have the ability to fully assess the magnitude or effects of a vulnerability, including the extent, if any, to which a vulnerability has been exploited. Additionally, new information can subsequently develop that may impact our assessment of a security vulnerability, including additional information learned as we develop and deploy mitigations or updates, become aware of additional variants and evaluate the competitiveness of existing and new products.Security vulnerabilities and any limitations of, or adverse effects resulting from, mitigation techniques can adversely affect our results of operations, financial condition, sales, branding, customer relationships, share price, prospects, and reputation in a number of ways, any of which may be material. Adverse publicity about security vulnerabilities or mitigations could damage our reputation with customers or users and reduce demand for our products and services. These effects may be greater to the extent that competing products are not susceptible to the same vulnerabilities or if vulnerabilities can be more effectively mitigated in competing products. Moreover, third parties can release information regarding potential vulnerabilities of our products before mitigations are available. This, in turn, could lead to attempted or successful exploits, adversely affect our ability to introduce mitigations, or otherwise harm our business and reputation.Our business has suffered, and could in the future suffer, from manufacturing problems. We manufacture, in our own factories as well as with third parties, our products using processes that are highly complex, require advanced and costly equipment and must continuously be modified to improve yields and performance. Difficulties in the production process can reduce yields or interrupt production, and, as a result of such problems, we may on occasion not be able to deliver products or do so in a timely or cost-effective or competitive manner. Such difficulties may include rationing, or other forced disruption of utility supplies such as electricity, gas or water by governments or regulators which could lead to disruptions of our operation resulting in high costs and global supply chain disruptions. As the complexity of both our products and our fabrication processes has become more advanced, manufacturing tolerances have been reduced and requirements for precision have become more demanding. As is common in the semiconductor industry, we have in the past experienced manufacturing difficulties that have given rise to delays in delivery and quality control problems. There can be no assurance that any such occurrence in the future would not materially harm our results of operations. Further, we may suffer disruptions in our manufacturing operations, either due to production difficulties such as those described above or as a result of external factors beyond our control, such as the disruption to our Austin, Texas manufacturing facilities caused by the February 2021 winter storm. We may, in the future, experience manufacturing difficulties or permanent or temporary loss of manufacturing capacity due 20to the preceding or other risks. Any such event could have a material adverse effect on our business, financial condition and results of operations. We rely on the timely supply of equipment and materials and could suffer if suppliers fail to meet their delivery obligations or raise prices. Certain equipment and materials needed in our manufacturing operations are only available from a limited number of suppliers. Our manufacturing operations depend on deliveries of equipment and materials in a timely manner and, in some cases, on a just-in-time basis. From time to time, suppliers may extend lead times, limit the amounts supplied to us or increase prices due to capacity constraints or other factors. Supply disruptions may also occur due to shortages in critical materials, such as silicon wafers or specialized chemicals. Because the equipment that we purchase is complex, it is frequently difficult or impossible for us to substitute one piece of equipment for another or replace one type of material with another. A failure by our suppliers to deliver our requirements could result in disruptions to our manufacturing operations. Our business, financial condition and results of operations could be harmed if we are unable to obtain adequate supplies of quality equipment or materials in a timely manner or if there are significant increases in the costs of equipment or materials due to current or expected inflation or other reasons and we are not able to increase the price of our products. Failure of our third party suppliers to perform could adversely affect our results of operations. We currently use outside suppliers for a portion of our manufacturing capacity. Outsourcing our production presents a number of risks. If our outside suppliers are unable to satisfy our demand, or experience manufacturing difficulties, delays or reduced yields, our results of operations and ability to satisfy customer demand could suffer. For example, as part of the industry-wide shortage of semiconductors during 2022 we could not obtain sufficient silicon wafers from our foundry partners to meet the demand for our products, causing us to not fully supply the demand for our products, and negatively affecting our results of operations. In addition, purchasing rather than manufacturing these products may adversely affect our gross profit margin if the purchase costs of these products are higher than our own manufacturing costs would have been or if we are not able to increase the price of our products to reflect the higher input costs. Prices for foundry products also vary depending on capacity utilization rates at our suppliers, quantities demanded, product technology and geometry. Furthermore, these outsourcing costs can vary materially from quarter to quarter and, in cases of industry shortages like we experienced in 2022, they can increase significantly, which may negatively affect our gross profit if we are not able to increase the price of our products. In addition, we have entered into long term supply agreements with certain key manufacturing partners. The failure of these suppliers to perform under these agreements or an unexpected reduction in demand for these products could result in a material adverse effect on our business, financial condition and results of operations.Disruptions in our relationships with any one of our key customers could adversely affect our business. A substantial portion of our revenue is derived from our top customers, including our distributors. We cannot guarantee that we will be able to generate similar levels of revenue from our largest customers in the future. If one or more of these customers substantially reduce their purchases from us, this could have a material adverse effect on our business, financial condition and results of operations. We receive subsidies and grants in certain countries, and a reduction in the amount of governmental funding available to us or demands for repayment could increase our costs and affect our results of operations. As is the case with other large semiconductor companies, we receive subsidies and grants from governments in some countries. These programs are subject to periodic review by the relevant governments, and if any of these programs are curtailed or discontinued, this could have a material adverse effect on our business, financial condition and results of operations. As the availability of government funding is outside our control, we cannot guarantee that we will continue to benefit from government support or that sufficient alternative funding will be available if we lose such support. Moreover, if we terminate any activities or operations, including strategic alliances or joint ventures, we may face adverse actions from the local governmental agencies providing such subsidies to us. In particular, such government agencies could seek to recover such subsidies from us and they could cancel or reduce other subsidies we receive from them. This could have a material adverse effect on our business, financial condition and results of operations. 21Certain natural disasters, such as flooding, large earthquakes, volcanic eruptions or nuclear or other disasters, may negatively impact our business. Climate change may cause a rising number of natural disasters that could negatively affect our operations. Environmental and other disasters, such as flooding, large earthquakes, volcanic eruptions or nuclear or other disasters, or a combination thereof may negatively impact our business. If flooding, a large earthquake, volcanic eruption or, extreme weather event or other natural disaster were to directly damage, destroy or disrupt our manufacturing facilities, it could disrupt our operations, delay new production and shipments of existing inventory or result in costly repairs, replacements or other costs, all of which would negatively impact our business. Even if our manufacturing facilities are not directly damaged, a large natural disaster may result in disruptions in distribution channels, supply chains, movement of goods and significant increases in the prices of raw materials used for our manufacturing process. For instance, the nuclear incident following the tsunami in Japan in 2011 impacted the supply chains of our customers and suppliers. Furthermore, any disaster affecting our customers (or their respective customers) may significantly negatively impact the demand for our products and our revenues. In addition, climate change could cause certain natural disasters, such as drought, wildfires, storms, flooding or rising sea levels, to occur more frequently or with greater intensity. Such natural disasters pose physical risks to our manufacturing, IT facilities or our suppliers’ facilities, or could disrupt the availability of water and utilities necessary for the operation of our manufacturing facilities or our suppliers’ facilities resulting in increased operating costs and business disruption, such as the disruption to our Austin, Texas manufacturing facilities caused by the February 2021 winter storm and weather-related disruption of water and utilities to these facilities. In addition, semiconductor manufacturing is a water-intensive process. Many of our manufacturing sites and those of our suppliers are located in semi–arid regions that may become increasingly vulnerable to prolonged droughts associated with evolving changes to the climate, which may lead to water scarcity. If we and our suppliers are not able to implement adequate water recycling and conservation measures or if the water scarcity in a particular region becomes acute and restricts the availability of water necessary for the operation of our manufacturing facilities or our suppliers’ facilities, our business may be significantly negatively impacted. The impact of any such natural disasters depends on the specific geographic circumstances but could be significant, as some of our factories are located in areas with known earthquake fault zones, flood or storm risks, including but not limited to Singapore, Taiwan, Malaysia or Thailand. There is increasing concern that climate change is occurring that may cause a rising number of natural disasters with potentially dramatic effects on human activity. We cannot predict the economic impact, if any, of natural disasters or climate change.Risks related to regulatory or legal challengesAs our business is global, we need to comply with laws and regulations in countries across the world. We operate globally, with manufacturing, assembly and testing facilities in several continents, and we market our products globally. As a result, we are subject to environmental, data privacy, labor and health and safety laws and regulations in each jurisdiction in which we operate. We are also required to obtain environmental permits and other authorizations or licenses from governmental authorities for certain of our operations. In the jurisdictions where we operate, we need to comply with differing standards and varying practices of regulatory, tax, judicial and administrative bodies. No assurance can be given that we have been or will be at all times in complete compliance with the laws and regulations to which we are subject or that we have obtained or will obtain the permits and other authorizations or licenses that we need. If we violate or fail to comply with laws, regulations, permits and other authorizations or licenses, we could be fined or otherwise sanctioned by regulators. Furthermore, if one or more of our customers are sanctioned by regulators for non-compliance with laws and regulations, we could experience a decrease in demand for our products. For example, import and export regulations, such as the U.S. Export Administration Regulations administered by the U.S. Department of Commerce, are complex, change frequently, have generally become more stringent over time and have intensified in recent years. In October 2022, the U.S. imposed restrictions on the export of US-regulated products and technology to certain mainland Chinese technology companies. Our results of operations could be negatively impacted if we are required to suspend activities with certain customers or suppliers due to the current and future changes in regulations. In 2020, due to regulations imposed by the U.S. government, we ceased shipments of our products to Huawei pending approval of export licenses. Furthermore, global privacy legislation, enforcement, and policy activity, such as the EU General Data Privacy Regulation, are rapidly expanding and creating a complex regulatory 22compliance environment. Costs to comply with and implement these privacy-related and data protection measures could be significant. Even our inadvertent failure to comply with applicable privacy-related or data protection laws and regulations could result in proceedings against us by governmental entities or others. In addition, governments are increasingly imposing restrictions on foreign investment in semiconductor businesses and technology, such as the Dutch foreign investment control regime, that may limit our ability to execute strategic acquisitions, investments and alliances, any of which could have a material adverse effect on our business.Legal proceedings covering a range of matters are pending in various jurisdictions. Due to the uncertainty inherent in litigation, it is difficult to predict the final outcome. An adverse outcome might affect our results of operations. We and certain of our businesses are involved as plaintiffs or defendants in legal proceedings in various matters. For example, we are involved in legal proceedings claiming personal injuries to the children of former employees as a result of employees’ alleged exposure to chemicals used in semiconductor manufacturing clean room environments operated by us or our former parent companies, Philips and Motorola. Furthermore, because we continue to utilize these clean rooms, we may become subject to future claims alleging personal injury that may lead to additional liability. A judgment against us or material defense cost could harm our business, financial condition and results of operations. Our manufacturing operations are subject to environmental laws and regulations and initiatives to address climate change. We are subject to many environmental, health and safety laws and regulations in each jurisdiction in which we operate, which govern, among other things, emissions of pollutants into the air, wastewater discharges, the use and handling of hazardous substances, waste disposal, the investigation and remediation of soil and ground water contamination and the health and safety of our employees. We are also required to obtain environmental permits from governmental authorities for certain of our operations. We cannot assure you that we have been or will be at all times in complete compliance with such laws, regulations and permits. If we violate or fail to comply with these laws, regulations or permits, we could be fined or otherwise sanctioned by regulators.As with other companies engaged in similar activities or that own or operate real property, we face inherent risks of environmental liability at our current and historical manufacturing facilities. Certain environmental laws impose strict, and in certain circumstances, joint and several liability on current or previous owners or operators of real property for the cost of investigation, removal or remediation of hazardous substances as well as liability for related damages to natural resources. Certain of these laws also assess liability on persons who arrange for hazardous substances to be sent to disposal or treatment facilities when such facilities are found to be contaminated. While we do not expect that any contamination currently known to us will have a material adverse effect on our business, we cannot assure you that this is the case or that we will not discover new facts or conditions or that environmental laws or the enforcement of such laws will not change such that our liabilities would be increased significantly. In addition, we could also be held liable for consequences arising out of human exposure to hazardous substances or other environmental damage. In summary, we cannot assure you that our costs of complying with current and future environmental and health and safety laws, or our liabilities arising from past or future releases of, or exposures to, regulated materials, will not have a material adverse effect on our business, financial conditions and results of operations. Public and private initiatives to address climate change may result in an increase in the cost of production due to increase in the prices of energy, introduction of energy or carbon tax or the purchase of carbon offsets. A variety of regulatory developments have been introduced that focus on restricting or managing the emission of carbon dioxide, methane and other greenhouse gases. Enterprises may need to purchase at higher costs new equipment or raw materials with lower carbon footprints. Environmental laws and regulations could also require us to acquire pollution abatement or remediation equipment, modify product designs, or incur expenses. New materials that we are evaluating for use in our operations may become subject to regulation. These developments and further legislation that is likely to be enacted could affect our operations negatively. Changes in environmental regulations could increase our production and operational costs, which could adversely affect our results of operations and financial condition. Risks related to cybersecurity and IT systems23Interruptions in our information technology systems could adversely affect our business. We rely on the efficient and uninterrupted operation of complex information technology applications, systems and networks to operate our business. The reliability and security of our information technology infrastructure and software, and our ability to expand and continually update technologies in response to our changing needs is critical to our business. Any significant interruption in our business applications, systems or networks, including but not limited to new system implementations, computer viruses, cyberattacks, security breaches, facility issues or energy blackouts could have a material adverse impact on our business, financial condition and results of operations. Our computer systems and networks are subject to attempted security breaches and other cybersecurity incidents, which, if successful, could adversely impact our business. We have, from time to time, experienced cyber-attacks attempting to obtain access to and misuse our computer systems and networks. Such incidents could result in the misappropriation of our proprietary information and technology, the compromise of personal and confidential information of our employees, customers or suppliers or interrupt our business. There can be no assurance that a breach or incident will not have a material impact on our operations and financial results in the future. In the current environment, there are numerous and evolving risks to cybersecurity and privacy, including criminal hackers, state-sponsored intrusions, industrial espionage, employee malfeasance, and human or technological error. Computer hackers and others routinely attempt to breach the security of technology products, services, and systems, and those of customers, suppliers, and some of those attempts may be successful. Such breaches could result in, for example, unauthorized access to, disclosure, misuse, loss, or destruction of our, our customer, or other third party data or systems, theft of sensitive or confidential data including personal information (including personal data about our employees, customers or other third parties) and intellectual property, system disruptions, and denial of service. In the event of such breaches, we, our customers or other third parties could be exposed to potential liability, litigation, and regulatory action, as well as the loss of existing or potential customers, damage to our reputation, and other financial loss. In addition, the cost and operational consequences of responding to breaches and implementing remediation measures could be significant. We have identified instances of employee misappropriation or theft of certain proprietary technology by individuals who are no longer employed by NXP. In some cases, such misappropriation may result in the violation of applicable export control regulations, which we report to relevant authorities as appropriate. As of the date of this filing we do not believe that any such misappropriation or theft known to us has resulted in a material adverse effect on our business or any material damage to us. However, there can be no assurance that these or other similar incidents will not have a material impact on our operations and financial results in the future. Accordingly, as these threats become increasingly sophisticated and continue to develop and grow, we are actively adapting our security measures and we continue to increase the amount we allocate to implement, maintain and/or update security systems to protect our infrastructure, intellectual property and data. As a global enterprise, we could also be impacted by existing and proposed laws and regulations, as well as government policies and practices related to cybersecurity, privacy and data protection. Additionally cyber-attacks or other catastrophic events resulting in disruptions to or failures in power, information technology, communication systems or other critical infrastructure could result in interruptions or delays to us, our customers, or other third party operations or services, financial loss, potential liability, and damage our reputation and affect our relationships with our customers and suppliers. Risks related to intellectual propertyWe rely to a significant extent on proprietary intellectual property. We may not be able to protect this intellectual property against improper use by our competitors or others. Our success and future revenue growth depends, in part, on our ability to protect our proprietary technology, our products, our proprietary designs and fabrication processes, and other intellectual property against misappropriation by others. We primarily rely on patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods, to protect our intellectual property. We may have difficulty obtaining patents and other intellectual property rights to protect our proprietary products, technology and intellectual property, and the patents and other intellectual property rights we receive may be insufficient to provide us with meaningful protection or commercial advantage. We may not obtain patent protection or secure other intellectual property rights in all the countries in which we operate, and under the laws of such countries, 24patents and other intellectual property rights may be or become unavailable or limited in scope. Even if new patents are issued, the claims allowed may not be sufficiently broad to effectively protect our proprietary technology, processes and other intellectual property. In addition, any of our existing patents, and any future patents issued to us may be challenged, invalidated or circumvented. The protection offered by intellectual property rights may be inadequate or weakened for reasons or circumstances that are out of our control. Further, our proprietary technology, designs and processes and other intellectual property may be vulnerable to disclosure or misappropriation by employees, contractors and other persons. It is possible that competitors or other unauthorized third parties may obtain, copy, use or disclose our proprietary technologies, our products, designs, processes and other intellectual property despite our efforts to protect our intellectual property. While we hold a significant number of patents, there can be no assurances that additional patents will be issued or that any rights granted under our patents will provide meaningful protection against misappropriation of our intellectual property. Our competitors may also be able to develop similar technology independently or design around our patents. We may not have or pursue patents or pending applications in all the countries in which we operate corresponding to all of our primary patents and applications. Even if patents are granted, effective enforcement in some countries may not be available. In particular, intellectual property rights are difficult to enforce in countries where the application and enforcement of the laws governing such rights may not have reached the same level as compared to other jurisdictions where we operate. Consequently, operating in some countries may subject us to an increased risk that unauthorized parties may attempt to copy or otherwise use our intellectual property or the intellectual property of our suppliers or other parties with whom we engage. There is no assurance that we will be able to protect our intellectual property rights or have adequate legal recourse in the event that we seek legal or judicial enforcement of our intellectual property rights under the laws of such countries. Any inability on our part to adequately protect our intellectual property may have a material adverse effect on our business, financial condition and results of operations. We may become party to intellectual property claims or litigation that could cause us to incur substantial costs, pay substantial damages or prohibit us from selling our products. We have from time to time received, and may in the future receive, communications alleging possible infringement of patents and other intellectual property rights of others. Further, we may become involved in costly litigation brought against us regarding patents, copyrights, trademarks, trade secrets or other intellectual property rights. If any such claims are asserted against us, we may seek to obtain a license under the third party’s intellectual property rights. We cannot assure you that we will be able to obtain any or all of the necessary licenses on satisfactory terms, if at all. In the event that we cannot obtain or take the view that we don’t need a license, these parties may file lawsuits against us seeking damages (and potentially treble damages in the United States) or an injunction against the sale of our products that incorporate allegedly infringed intellectual property or against the operation of our business as presently conducted. Such lawsuits, if successful, could result in an increase in the costs of selling certain of our products, our having to partially or completely redesign our products or stop the sale of some of our products and could cause damage to our reputation. Any litigation could require significant financial and management resources regardless of the merits or outcome, and we cannot assure you that we would prevail in any litigation or that our intellectual property rights can be successfully asserted in the future or will not be invalidated, circumvented or challenged. The award of damages, including material royalty payments, or the entry of an injunction against the manufacture and sale of some or all of our products, could affect our ability to compete or have a material adverse effect on our business, financial condition and results of operations. Risks related to human capital managementLoss of our key management and other personnel, or an inability to attract such management and other personnel, could affect our business. We depend on our key management to run our business and on our senior engineers to develop new products and technologies. Our success will depend on the continued service of these individuals. The loss of any of our key personnel, whether due to departures, death, ill health or otherwise, could have a material adverse effect on our business. The market for qualified employees, including skilled engineers and other individuals with the required technical expertise to succeed in our business, is highly competitive and the loss of qualified employees or an inability to attract, retain and motivate the additional highly skilled employees required for the operation and expansion of our business could hinder our ability to successfully conduct research activities or develop marketable products. The foregoing risks could have a material adverse effect on our business. 25Risks related to our corporate structure United States civil liabilities may not be enforceable against us. We are incorporated under the laws of the Netherlands and substantial portions of our assets are located outside of the United States. In addition, certain members of our board and officers reside outside the United States. As a result, it may be difficult for investors to effect service of process within the United States upon us or such other persons residing outside the United States, or to enforce outside the United States judgments obtained against such persons in U.S. courts in any action. In addition, it may be difficult for investors to enforce, in original actions brought in courts in jurisdictions located outside the United States, rights predicated upon the U.S. laws. In the absence of an applicable treaty for the mutual recognition and enforcement of judgments (other than arbitration awards) in civil and commercial matters to which the United States and the Netherlands are a party, a judgment obtained against the Company in the courts of the United States, whether or not predicated solely upon the U.S. federal securities laws, including a judgment predicated upon the civil liability provisions of the U.S. securities law or securities laws of any State or territory within the United States, will not be directly enforceable in the Netherlands. In order to obtain a judgment which is enforceable in the Netherlands, the claim must be relitigated before a competent court of the Netherlands; the relevant Netherlands court has discretion to attach such weight to a judgment of the courts of the United States as it deems appropriate; based on case law, the courts of the Netherlands may be expected to recognize and grant permission for enforcement of a judgment of a court of competent jurisdiction in the United States without re-examination or relitigation of the substantive matters adjudicated thereby, provided that (i) the relevant court in the United States had jurisdiction in the matter in accordance with standards which are generally accepted internationally; (ii) the proceedings before that court complied with principles of proper procedure; (iii) recognition and/or enforcement of that judgment does not conflict with the public policy of the Netherlands; and (iv) recognition and/or enforcement of that judgment is not irreconcilable with a decision of a Dutch court rendered between the same parties or with an earlier decision of a foreign court rendered between the same parties in a dispute that is about the same subject matter and that is based on the same cause, provided that earlier decision can be recognized in the Netherlands. Based on the foregoing, there can be no assurance that U.S. investors will be able to enforce against us or members of our board of directors or officers who are residents of the Netherlands or countries other than the United States any judgments obtained in U.S. courts in civil and commercial matters. In addition, there is doubt as to whether a Dutch court would impose civil liability on us, the members of our board of directors, our officers or certain experts named herein in an original action predicated solely upon the U.S. laws brought in a court of competent jurisdiction in the Netherlands against us or such members, officers or experts, respectively. We are a Dutch public company with limited liability. The rights of our stockholders may be different from the rights of stockholders governed by the laws of U.S. jurisdictions. We are a Dutch public company with limited liability (naamloze vennootschap). Our corporate affairs are governed by our articles of association and by the laws governing companies incorporated in the Netherlands. The rights of stockholders and the responsibilities of members of our board of directors may be different from the rights and obligations of stockholders in companies governed by the laws of U.S. jurisdictions. In the performance of its duties, our board of directors is required by Dutch law to consider the interests of our company, its stockholders, its employees and other stakeholders, in all cases with due observation of the principles of reasonableness and fairness. It is possible that some of these parties will have interests that are different from, or in addition to, your interests as a stockholder. See Part III, Item 10. Directors, Executive Officers and Corporate Governance. Risks related to our indebtedness Our debt obligations expose us to risks that could adversely affect our financial condition, which could adversely affect our results of operations. 26As of December 31, 2022, we had outstanding indebtedness with an aggregate principal amount of $11,250 million. Our substantial indebtedness could have a material adverse effect on our business by: •increasing our vulnerability to adverse economic, industry or competitive developments; •requiring a substantial portion of cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities; •exposing us to the risk of increased interest rates in the event we have borrowings under our $2,500 million revolving credit facility agreement (the “RCF Agreement”) because loans under the RCF Agreement bear interest at a variable rate; •making it more difficult for us to satisfy our obligations with respect to our indebtedness and any failure to comply with the obligations of any our debt instruments, including restrictive covenants and borrowing conditions, could result in an event default under the indentures governing our notes and agreements governing other indebtedness; •restricting us from making strategic acquisitions or causing us to make non-strategic divestitures; •limiting our ability to obtain additional financial for working capital, capital expenditures, restructurings, product development, research and development, debt service requirements, investments, acquisitions and general corporate or other purposes; and •limiting our flexibility in planning for, or reacting to, changes in our business or market conditions and placing us at a competitive disadvantage compared to our competitors who are less highly leveraged and who therefore, may be able to take advantage of opportunities that our leverage prevents us from exploiting. Despite our level of indebtedness, we may still incur significantly more debt, which could further exacerbate the risks described above and affect our ability to service and repay our debt. If we do not comply with the covenants in our debt agreements or fail to generate sufficient cash to service and repay our debt, it could adversely affect our operating results and our financial condition. The RCF Agreement and the indentures governing our unsecured notes or any other debt arrangements that we may have require us to comply with various covenants. If there were an event of default under any of our debt instruments that was not cured or waived, the holders of the defaulted debt could terminate commitments to lend and cause all amounts outstanding with respect to the debt to be due and payable immediately, which in turn could result in cross defaults under our other debt instruments. Our assets and cash flow may not be sufficient to fully repay borrowings under all of our outstanding debt instruments if some or all of these instruments are accelerated upon an event of default. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments and capital expenditures, or to sell assets, seek additional capital, restructure or refinance our indebtedness or reduce or delay capital expenditures, strategic acquisitions, investments and alliances, any of which could have a material adverse effect on our business. We cannot guarantee that we will be able to obtain enough capital to service our debt and fund our planned capital expenditures and business plan. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of existing or future debt instruments may restrict us from adopting some of these alternatives. In addition, any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. The rating of our debt by major rating agencies may further improve or deteriorate, which could affect our additional borrowing capacity and financing costs. The major debt rating agencies routinely evaluate our debt. These ratings are based on current information furnished to the ratings agencies by us and information obtained by the ratings agencies from other sources. An explanation of the significance of such rating may be obtained from such rating agency. There can be no assurance that such credit ratings will remain in effect for any given period of time or that such ratings will not be lowered, suspended or withdrawn entirely by the rating agencies, if, in each rating agency’s judgment, 27circumstances so warrant. Actual or anticipated changes or downgrades in our credit ratings, including any announcement that our ratings are under further review for a downgrade, could affect our market value and/or increase our corporate borrowing costs. General risk factorsThe coronavirus (COVID-19) pandemic and measures taken in response have adversely impacted the Company's financial condition and results of operations. The COVID-19 pandemic, or a similar global health crisis, may continue to impact us in the future.The COVID-19 outbreak has significantly increased economic and demand uncertainty. We experienced a significant decline in revenue in the first half of 2020 related to the COVID-19 outbreak and then a swift rebound in demand beginning in the third quarter of 2020 and accelerating through the fourth quarter of 2021. The situation remains uncertain and the continued spread of COVID-19 or variants of COVID-19 may result in economic slowdown or disruptions to our supply chain in one or more geographic areas in which we operate, including the possibility that it could lead to a global recession. Specifically, in the last quarter of 2022 we experienced an unexpected decrease in demand in mainland China due to the increased COVID-19 infection rate. Risks related to a slowdown or recession are described in our risk factor titled “Significantly increased volatility and instability and unfavorable economic conditions may adversely affect our business” above.The spread of COVID-19 caused us to modify our business practices (including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences), and we may reinstitute these and additional measures as may be required by government authorities or that we determine are in the best interests of our employees, customers, partners, and suppliers.The degree to which COVID-19, or a similar global health crisis, adversely impacts our future results will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. To the extent the COVID-19 pandemic, or a similar global health crisis, adversely affects our business, results of operations, financial condition and cash flows, it may also heighten many of the other risks described in Part I, Item 1A Risk Factors. We previously identified a material weakness in our internal control related to ineffective information technology general controls and if we fail to maintain an effective system of internal control in the future, this could result in loss of investor confidence and adversely impact our stock price. Internal controls related to the operation of technology systems are critical to maintaining adequate internal control over financial reporting. We reported in our Annual Report on Form 10-K as of December 31, 2021, a material weakness in our internal control over financial reporting associated with ineffective information technology general controls (ITGCs) in the areas of user access, change-management and IT operations over certain information technology (IT) systems that support the Company’s financial reporting processes.During 2022, we completed the remediation measures related to the material weakness and concluded that our internal control over financial reporting was effective as of December 31, 2022. Completion of remediation does not provide assurance that our remediation or other controls will continue to operate properly. If we are unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately, and to prepare financial statements within required time periods could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our financial statements and adversely impact our stock price.The price of our common stock historically has been volatile. The price of our common stock may fluctuate significantly. The stock market in recent years has experienced significant price and volume fluctuations that have often been unrelated to the operating performance of companies. The market price for our common stock has varied between a high of $234.90 on January 4, 2022 and a low of $132.08 on October 13, 2022 in the twelve-month period ending on December 31, 2022. The market price of our common stock is likely to continue to be volatile and subject to significant price and volume fluctuations for many reasons, including in response to the risks 28described in this section, changes in our dividend or share repurchase policies, variations between our actual financial results or guidance and expectations of securities analysts or investors or for reasons unrelated to our operations, such as reports by industry analysts, investor perceptions or negative announcements by our customers, competitors, peer companies or suppliers regarding their own performance, or announcements by our competitors of significant contracts, strategic partnerships, joint ventures, joint marketing relationships or capital commitments, the passage of legislation or other regulatory developments affecting us or our industry, as well as industry conditions and general financial, economic and political instability. In the past, following periods of market volatility, shareholders have instituted securities class action litigation. If we were involved in securities litigation, it could have a substantial cost and divert resources and the attention of executive management from our business regardless of the outcome of such litigation.We may have fluctuations in the amount and frequency of our stock repurchases. The amount, timing, and execution of our stock repurchases may fluctuate based on our priorities for the use of cash for other purposes—such as investing in our business, including operational spending, capital spending, and acquisitions, and returning cash to our stockholders as dividend payments—and because of changes in cash flows, tax laws, and the market price of our common stock. There can be no assurance that we will continue to declare cash dividends. Our board of directors has adopted a dividend policy pursuant to which we currently pay a cash dividend on our ordinary shares on a quarterly basis. The declaration and payment of any dividend is subject to the approval of our board and our dividend may be discontinued or reduced at any time. There can be no assurance that we will declare cash dividends in the future in any particular amounts, or at all. Future dividends, if any, and their timing and amount, may be affected by, among other factors: management’s views on potential future capital requirements for strategic transactions, including acquisitions; earnings levels; contractual restrictions; cash position and overall financial condition; and changes to our business model. The payment of cash dividends is restricted by applicable law, contractual restrictions and our corporate structure. The impact of a negative performance of financial markets and demographic trends on our defined benefit pension liabilities and costs cannot be predicted. We sponsor defined benefit pension plans in a number of countries and a significant number of our employees are covered by our defined benefit pension plans. As of December 31, 2022, we had recognized a net accrued benefit liability of $335 million, representing the unfunded benefit obligations of our defined pension plans. The funding status and the liabilities and costs of maintaining these defined benefit pension plans may be impacted by financial market developments. For example, the accounting for such plans requires determining discount rates, expected rates of compensation and expected returns on plan assets, and any changes in these variables can have a significant impact on the projected benefit obligations and net periodic pension costs. Negative performance of the financial markets could also have a material impact on funding requirements and net periodic pension costs. Our defined benefit pension plans may also be subject to demographic trends. Accordingly, our costs to meet pension liabilities going forward may be significantly higher than they are today, which could have a material adverse impact on our financial condition. Future changes to Dutch, U.S. and other foreign tax laws could adversely affect us. The European Commission, U.S. Congress and Treasury Department, the Organization for Economic Co-operation and Development (OECD), and other government agencies in jurisdictions where we and our affiliates do business have had an extended focus on issues related to the taxation of multinational corporations, particularly payments made between affiliates from a jurisdiction with high tax rates to a jurisdiction with lower tax rates. As a result, the tax laws in the European Union, U.S. and other countries in which we and our affiliates do business could change on a prospective or retroactive basis, and any such changes could adversely affect us and our affiliates. Recent examples include the OECD’s initiatives to revise profit allocation and nexus rules to allocate more taxing rights to countries where companies have their markets and to establish a minimum tax rate on a global basis. As part of the OECD framework to implement a minimum tax rate, the EU has adopted a directive on ensuring a global minimum level of taxation for multinational companies, also known as Pillar 2, to become 29effective in 2024. It is anticipated that other countries will also introduce Pillar 2 legislation. These initiatives include recommendations and proposals that, if enacted in countries in which we and our affiliates do business, could adversely affect us and our affiliates. We are exposed to a number of different tax uncertainties, which could have an impact on our results. We are required to pay taxes in multiple jurisdictions. We determine the taxes we are required to pay based on our interpretation of the applicable tax laws and regulations in the jurisdictions in which we operate. We may be subject to unfavorable changes in the respective tax laws and regulations to which we are subject. Tax controls, audits, change in controls and changes in tax laws or regulations or the interpretation given to them may expose us to negative tax consequences, including interest payments and potentially penalties. We have issued transfer-pricing directives in the areas of goods, services and financing, which are in accordance with OECD guidelines. As transfer pricing has a cross border effect, the focus of local tax authorities on implemented transfer pricing procedures in a country may have an impact on results in another country. Transfer pricing uncertainties can also result from disputes with local tax authorities about transfer pricing of internal deliveries of goods and services or related to financing, acquisitions and divestments, the use of tax credits and permanent establishments, and tax losses carried forward. These uncertainties may have a significant impact on local tax results. We also have various tax assets resulting from acquisitions. Tax assets can also result from the generation of tax losses in certain legal entities. Tax authorities may challenge these tax assets. In addition, the value of the tax assets resulting from tax losses carried forward depends on having sufficient taxable profits in the future.Item 1B. Unresolved Staff CommentsNot applicable.Item 2. PropertiesThe Company's headquarters are located in Eindhoven, the Netherlands. As of March 1, 2023, the Company operates owned manufacturing facilities primarily in the United States, Netherlands, Malaysia, China, Thailand and Taiwan, as well as in Singapore (SSMC) together with our joint venture partner TSMC. The Company also owns or leases other properties in multiple countries for use as administrative, sales or research and development facilities. The Company believes its existing facilities and equipment are in good operating condition and adequate to meet our need for the near future.Item 3. Legal ProceedingsThe information set forth under the “Litigation” and “Environmental Remediation” captions of Note 15 to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report is incorporated herein by reference. For additional discussion of certain risks associated with legal proceedings, see Part I, Item 1A. Risk Factors.Item 4. Mine Safety DisclosuresNot applicable.30Part IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesThe Company's common stock is traded on the Nasdaq stock market under the symbol NXPI. On February 22, 2023 there were 15 shareholders of record and 730,850 beneficial shareholders of our common stock.Dividends Per Common ShareThe following table presents the quarterly dividends on our common stock for the periods indicated:20222021First Quarter0.845 0.5625 Second Quarter0.845 0.5625 Third Quarter0.845 0.5625 Fourth Quarter0.845 0.5625 On January 30, 2023, the board of directors of NXP approved a 20 percent increase in the quarterly cash dividend to $1.014 per ordinary share to be paid in cash on April 5, 2023 to shareholders of record as of March 15, 2023. We currently expect to continue to pay dividends in the future.Issuer Purchases of Equity SecuritiesOur Board has approved the purchase of shares from participants in NXP's equity programs to satisfy participants' tax withholding obligations and this authorization will remain in effect until terminated by the Board. In March 2021, the Board approved the repurchase of shares up to a maximum of $2 billion (the "2021 Share Repurchase Program"), and in August 2021, the Board increased the 2021 Share Repurchase Program authorization by $2 billion, for a total of $4 billion approved for the repurchase of shares under the 2021 Share Repurchase Program. In January 2022, the Board approved the repurchase of shares up to a maximum of $2 billion (the "2022 Share Repurchase Program"). At December 31, 2022, there was approximately $437 million remaining for the repurchase of shares under the 2021 Share Repurchase Program and $2 billion remaining under the 2022 Share Repurchase Program.The following table provides a summary of share repurchase activity during the three months ended December 31, 2022:PeriodTotal Number of Shares PurchasedAverage Price Paid per ShareNumber of Shares Purchased as Part of Publicly Announced Plans or ProgramsMaximum Number of Shares That May Yet Be Purchased Under the Plans or Program (1)Number of Shares Purchased as Trade for Tax (2)October 3, 2022 – November 6, 20222,620,196$147.712,065,20016,600,635554,996November 7, 2022 – December 4, 2022318,794$161.66209,50014,454,957109,294December 5, 2022 – December 31, 2022221,381$163.56220,80015,418,236581Total3,160,3712,495,500664,871(1) Represents the number of shares that may be purchased under the remaining dollar repurchase authorizations noted above, calculated based on the share closing price at the end of the respective monthly period.(2) Reflects shares surrendered by participants to satisfy tax withholding obligations in connection with the Company's equity programs.31Company PerformanceThe following graph shows a comparison, since December 31, 2017 of cumulative total return for NXP, the Standard & Poor's 500 Index, and the Philadelphia Stock Exchange Semiconductor Index. The graph assumes $100 (not in millions) invested on December 31, 2017 in our common stock and each of the indices. Item 6. [Reserved]Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsManagement’s discussion and analysis of financial condition and results of operations (MD&A) should be read in conjunction with the financial statements and the related notes that appear elsewhere in this document. This section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 as filed with the SEC on February 24, 2022.Our MD&A is provided in addition to the accompanying consolidated financial statements and notes to assist readers in understanding our results of operations, financial condition and cash flows. MD&A is organized as follows:•Overview - Overall analysis of financial and other highlights to provide context for the MD&A•Results of Operations - An analysis of our financial results•Financial Condition, Liquidity and Capital Resources - An analysis of changes in our balance sheets and cash flows and a discussion of our financial condition and potential sources of liquidity•Critical Accounting Estimates - Accounting estimates that management believes are the most important to understanding the assumptions and judgments incorporated in our financial results and forecasts•Use of Certain Non-GAAP Financial Measures - A discussion of the non-GAAP measures used32NXP has one reportable segment representing the entity as a whole. Our segment represents groups of similar products that are combined on the basis of similar design and development requirements, product characteristics, manufacturing processes and distribution channels, and how management allocates resources and measures results. See Note 1 to the consolidated financial statements for more information regarding our segment.Overview($ in millions, unless otherwise stated)Three Months EndedYears EndedDecember 31, 2022December 31, 2021Increase/(decrease)December 31, 2022December 31, 2021Increase/(decrease)Revenue3,312 3,039 273 13,205 11,063 2,142 Gross profit1,891 1,707 184 7,517 6,067 1,450 Operating income (loss)980 807 173 3,797 2,583 1,214 Cash flow from operating activities1,076 785 291 3,895 3,077 818 Total debt11,165 10,572 593 11,165 10,572 593 Net debt7,320 7,742 (422)7,320 7,742 (422)Diluted weighted average number of shares outstanding261,448 268,545 (7,097)264,053 275,646 (11,593)Diluted net income per share2.76 2.24 0.52 10.55 6.79 3.76 Dividends per common share0.8450 0.5625 0.283 3.38 2.25 1.13 Revenue for 2022 was $13,205 million as compared to the $11,063 million reported in 2021, an increase of $2,142 million or an increase of 19.4% year-on-year. The increase is attributed to inflationary effects of increased input costs from suppliers which were passed along to end customers in the form of higher average selling prices and strong customer demand.Our gross profit percentage for 2022 increased to 56.9% from 54.8%, primarily due to the significant higher revenue during 2022, which led to improved utilization and efficiencies, partly offset by higher personnel-related costs and higher supplier costs. Revenue for the fourth quarter, which ended December 31, 2022, was $3,312 million as compared to $3,039 million for the fourth quarter ended December 31, 2021, an increase of $273 million or an increase of 9.0%. The growth compared with the previous year period results from higher average selling prices across all of our end markets and strong demand within NXP’s Automotive end market, while the Industrial IoT, Communication Infrastructure & Other and the Mobile end markets experienced slower demand signals versus the year ago period. When aggregating all end markets together, and reviewing sales channel performance, business transacted through direct OEM and EMS customers was $1,397 million, an increase of 8.1% versus the year ago period. NXP's third party distribution partners was $1,876 million, an increase of 9.8%. From a geographic perspective, revenue increased across all regions.The gross profit percentage for the fourth quarter of 2022 increased to 57.1% from 56.2%, primarily due to the higher revenue in the fourth quarter of 2022 which led to improved utilization and efficiencies, partly offset by higher personnel-related costs and higher supplier costs.We continue to generate strong operating cash flows, with $3,895 million in cash flows from operations for 2022. We returned $2,244 million to our shareholders during the year in dividends and repurchases of common stock. Our cash position at the end of 2022 was $3,845 million. Results of OperationsThe following table presents the composition of operating income for the years ended December 31, 2022 and December 31, 2021.33($ in millions, unless otherwise stated)20222021Revenue13,205 11,063 % nominal growth19.4 28.5 Gross profit7,517 6,067 Research and development(2,148)(1,936)Selling, general and administrative (SG&A)(1,066)(956)Amortization of acquisition-related intangible assets(509)(592)Other income3 0 Operating income3,797 2,583 Revenue Revenue for the year-ended December 31, 2022 was $13,205 million compared to $11,063 million for the year-ended December 31, 2021, an increase of $2,142 million or 19.4% year-on-year, with growth in all of the Company’s end markets. Revenue by end market was as follows: ($ in millions, unless otherwise stated)20222021Increase/(decrease)%Automotive6,879 5,493 1,386 25.2 %Industrial & IoT2,713 2,410 303 12.6 %Mobile1,607 1,412 195 13.8 %Communication Infrastructure & Other2,006 1,748 258 14.8 %Revenue13,205 11,063 2,142 19.4 %Revenue by sales channel was as follows: ($ in millions, unless otherwise stated)20222021Increase/(decrease)%Distributors7,261 6,325 936 14.8 %OEM/EMS5,775 4,587 1,188 25.9 %Other169 151 18 11.9 %Revenue13,205 11,063 2,142 19.4 %34Revenue by geographic region, which is based on the customer’s shipped-to location, was as follows: ($ in millions, unless otherwise stated)20222021Increase/(decrease)%China 1)4,700 4,180 520 12.4 %APAC, excluding China4,165 3,471 694 20.0 %EMEA (Europe, the Middle East and Africa)2,582 2,036 546 26.8 %Americas1,758 1,376 382 27.8 %Revenue13,205 11,063 2,142 19.4 %1) China includes Mainland China and Hong KongnAutomotivenMobilenDistributorsnOthernIndustrial & IoTnComm Infra & OthernOEM/EMSThe year-on-year increase in revenue is driven by a combination of higher average selling prices across all of our end markets and ongoing customer demand. Of the 19.4% year-on-year revenue increase, approximately 14% is attributable to higher average selling prices and 5% is attributable to product mix and increased sales volume.From an end market perspective, within the automotive end market the year-on-year growth was attributable to advanced analog, automotive processing and radar in support of the secular shift of electrification, advanced driver safety and assistance, and driver connectivity systems. The growth within the Industrial & IoT market reflects the increase in revenue in the company’s ARM-based processing solutions, industrial analog products, and IoT connectivity solutions. Growth within the Mobile end market was due to ongoing adoption of our secure embedded transaction solutions along with the company’s growth in our advanced analog high-speed interfaces. The growth within the Communication Infrastructure & Other end market was attributable to the network edge equipment, RFID tagging solutions, the transit and access solutions, and cellular base stations. Offsetting these positive growth trends were declines in demand for company’s smart antennae products used in the Android mobile handset market, as well as declines in demand for the company’s embedded power products, and wireless access point solutions.When aggregating all end markets together, and reviewing sales channel performance, business transacted through direct OEM and EMS customers was $5,775 million, an increase of 25.9% versus the year ago period. NXP's third party distribution partners was $7,261 million, an increase of 14.8%. From a geographic perspective, revenue increased across all regions.Revenue in the Automotive end market was $6,879 million, an increase of $1,386 million or 25.2% versus the year ago period. Within Automotive, customers are focused on the key functional pillars of safety, electrification and improved driver comfort to accelerate competitive differentiation. These broad functional areas are fundamentally enabled by the secular adoption of new and increased levels of semiconductor content, which is layered on top of a strong base of existing electronic content in modern automobiles. The increase in Automotive revenue can be attributed to growth in advanced analog, automotive processing and radar in support 35of the secular shift of electrification, advanced driver safety and assistance, and driver connectivity systems. From a channel perspective, the Company experienced growth from direct OEM and EMS customers and NXP's distribution partners across all geographic regions. Revenue in the Industrial & IoT end market was $2,713 million, an increase of $303 million or 12.6% versus the year ago period. The Industrial & IoT market is driven by the secular trend of multi-market OEMs seeking to enable secure, connected, high performance processing solutions at the edge of the network, whether it is in factory automation, smart building/smart home or the exploding plethora of connected IoT devices. The innovation in this market is being driven by thousands of relatively smaller customers, which NXP effectively services through its extended global distribution channel. The increase in revenue was due to growth in the company’s ARM-based processing solutions, industrial analog products, and IoT connectivity solutions. The Industrial IoT end market experienced slower demand since second half of 2022 versus the year ago period as a result of lower demand for consumer centric IoT products. From a channel perspective, the Company experienced growth from its distribution channel partners in the Asia Pacific, Europe, Americas and China regions. Revenue in the Mobile end market was $1,607 million, an increase of $195 million or 13.8% versus the year ago period. The increase in revenue was due to strong adoption of secure mobile wallet solutions, and demand for our advanced analog high-speed interfaces, partly offset by declines in embedded power solutions. Within the Mobile end market, we experienced softening demand from Android-based mobile customers, offset by strength experienced from other premium mobile customers. Our mobile customers are primarily serviced through our global distribution channels. From a channel perspective, NXP’s distribution partners in China and Asia Pacific facilitated the year-on-year growth, servicing the concentrated mobile manufacturing centers in Asia. Revenue in the Communication Infrastructure & Other end market was $2,006 million, an increase of $258 million or 14.8% versus the year ago period. The Communication Infrastructure & Other end market is an amalgamation of three separate product portfolios, which service multiple end markets, including cellular base stations, the network edge equipment, and the secure access, transit and government sponsored identification market. The increase in revenue was due to a combination of strength from network edge equipment, RF Power products levered to the secular build-out of 5G base stations, and the ongoing demand for RFID tagging solutions and transit and access solutions. Offsetting these positive growth trends were declines in demand for the company’s smart antennae products used in the Android mobile handset market, as well as declines in demand for wireless access point solutions. From a channel perspective, NXP’s distribution partners in China, Asia Pacific, the Americas, and Europe regions were responsible for the year-on-year growth. Additionally, OEM and EMS revenues increased in the China and Europe geographic regions. Gross ProfitGross profit for the year-ended December 31, 2022 was $7,517 million, or 56.9% of revenue, compared to $6,067 million, or 54.8% of revenue, for the year-ended December 31, 2021. The increase of $1,450 million was primarily driven by higher selling prices as well as improved factory loading as a result of increased manufacturing volumes to meet increased demand, which were mostly offset by higher input costs and a less favorable product mix. As a result, the gross margin percentage increased to 56.9% from 54.8%. 36Operating ExpensesOperating expenses for the year-ended December 31, 2022 totaled $3,723 million, or 28.2% of revenue, compared to $3,484 million, or 31.5% of revenue, for the year-ended December 31, 2021. The following table below presents the composition of operating expenses by line item in the statement of operations. ($ in millions, unless otherwise stated)2022% ofrevenue2021% ofrevenue% changeResearch and development2,148 16.3 %1,936 17.5 %11.0 %Selling, general and administrative1,066 8.1 %956 8.6 %11.5 %Amortization of acquisition-related intangible assets509 3.9 %592 5.4 %(14.0)%Operating expenses3,723 28.2 %3,484 31.5 %6.9 %nR&DnSG&AnAmortization acquisition-relatedThe increase in operating expenses was a result of the following items: Research and development (R&D) costs primarily consist of engineer salaries and wages (including share based compensation and other variable compensation), engineering related costs (including outside services, fixed-asset, IP and other licenses related costs), shared service center costs and other pre-production related expenses. 37•R&D costs for the year-ended December 31, 2022 increased by $212 million, or 11.0%, when compared to last year driven by: + higher personnel-related costs;+ higher professional services;+ higher share-based compensation expenses; and- lower variable compensation costs. Selling, general and administrative (SG&A) costs primarily consist of personnel salaries and wages (including share based compensation and other variable compensation), communication and IT related costs, fixed-asset related costs and sales and marketing costs (including travel expenses). •SG&A costs for the year-ended December 31, 2022 increased by $110 million, or 11.5%, when compared to last year mainly due to: + higher professional services;+ higher legal expense;+ higher travel expenses; and- lower variable compensation costs.•Amortization of acquisition-related intangible assets decreased by $83 million, or 14.0%, when compared to last year driven by: - certain intangibles became fully amortized during 2021; and- an impairment charge in 2021 as a result of the discontinuation of an IPR&D project. Other Income (Expense) Other income (expense) includes results from manufacturing service arrangements (“MSA”) and transitional service arrangements (“TSA”) that are put into place when we divest a business or activity, as well as other activity. These arrangements are expected to decrease as the divested business or activity becomes more established. Other income (expense) reflects an income of $3 million for 2022, compared to nil in 2021.Financial Income (Expense) ($ in millions)For the years ended December 31,20222021Interest income61 4 Interest expense(427)(369)Total interest expense, net(366)(365)Foreign exchange rate results(17)5 Extinguishment of debt(18)(22)Miscellaneous financing income (expense) and other, net(33)(21)Total other financial income (expense)(68)(38)Total(434)(403)Financial income (expense) was an expense of $434 million in 2022, compared to an expense of $403 million in 2021. The change in financial income (expense) is primarily attributable to an increase in interest expense of $58 million as a result of (re-)financing activities, foreign exchange results, which resulted in a loss of $17 million in 2022 versus a profit of $5 million in 2021 and a change in miscellaneous financial income/expense of $12 million, mainly driven by $5 million interest expense on corporate income tax in 2022, vs. nil in 2021. This was partially offset by higher interest income of $57 million as a result of higher interest rates, and lower debt extinguishment costs in 2022 versus 2021 of $4 million. 38Benefit (Provision) for Income TaxesWe recorded an income tax expense of $529 million for the year-ended December 31, 2022, which reflects an effective tax rate of 15.7% compared to a expense of $272 million (12.5%) for the year-ended December 31, 2021.20222021$%$%Statutory income tax in the Netherlands868 25.8 545 25.0 Rate differential local statutory rates versus statutory rate of the Netherlands(80)(2.4)(42)(1.9)Net change in valuation allowance— — (20)(0.9)Non-deductible expenses/losses56 1.7 53 2.5 Netherlands tax incentives(113)(3.4)(69)(3.2)Foreign tax incentives(266)(7.9)(163)(7.5)Changes in estimates of prior years’ income taxes(2)(0.1)(21)(1.0)Sale of non-deductible goodwill— — — — Withholding taxes8 0.3 (8)(0.4)Other differences58 1.7 (3)(0.1)Effective tax rate529 15.7 272 12.5 The effective tax rate reflects the impact of tax incentives, a portion of our earnings being taxed in foreign jurisdictions at rates different than the Netherlands statutory tax rate, changes in estimates of prior years' income taxes, change in valuation allowance and non-deductible expenses, sale of non-deductible goodwill and withholding taxes. The impact of these items results in offsetting factors that attribute to the change in the effective tax rate between the two periods, with the significant drivers outlined below: •The Company benefits from certain tax incentives, which reduce the effective tax rate. The dollar amount of the incentive in any given year is commensurate with the taxable income in that same period. For 2022, the foreign tax and Netherlands tax incentives were higher than 2021 by $147 million, mainly due to the fact that NXP benefited from higher qualifying income and also taking into account the effect of specific U.S. tax law that became effective as from 2022.•The movement in the valuation allowance was mostly due to new Dutch corporate income tax law applicable as from 2019. A portion of the interest expenses is non-deductible in the year it is recorded but can be carried forward without expiration. The release of the valuation allowance in 2021 is due to higher qualifying income compared to 2020 and 2019. •The movement in the withholding taxes in 2022 as compared to 2021 is mainly due to considering more undistributed earnings as indefinitely reinvested in 2021, resulting in a 2021 tax benefit of $17 million.•The other differences tax expense in 2022 is mainly relating to lower excess tax benefits, unfavorable FX-effects and higher taxes due on Global Intangible Low-Taxed Income (GILTI) inclusions in U.S. compared to the same period in 2021. GILTI is recognized as a current period expense when incurred.Results Relating to Equity-accounted Investees Results relating to equity-accounted investees amounted to a loss of $1 million in 2022, whereas in 2021, results relating to equity-accounted investees amounted to a loss of $2 million. Non-controlling Interests Non-controlling interests are related to the third-party share in the results of consolidated companies, predominantly SSMC. Their share of non-controlling interests amounted to a profit of $46 million for the year-ended December 31, 2022, compared to a profit of $35 million for the year-ended December 31, 2021. 39Financial Condition, Liquidity and Capital Resources We derive our liquidity and capital resources primarily from our cash flows from operations. We continue to generate strong positive operating cash flows, and we currently use cash to fund operations, meet working capital requirements, for capital expenditures and for potential common stock repurchases, dividends and strategic investments. Based on past performance and current expectations, we believe that our current available sources of funds (including cash and cash equivalents, RCF Agreement, plus anticipated cash generated from operations) will be adequate to finance our operations, working capital requirements, capital expenditures and potential dividends for at least the next year.Cash As of December 31, 2022, our cash balance was $3,845 million, an increase of $1,015 million compared to December 31, 2021 ($2,830 million), of which $227 million (2021, $208 million) was held by SSMC, our consolidated joint venture company with TSMC. Under the terms of our joint venture agreement with TSMC, a portion of this cash can be distributed by way of a dividend to us, but 38.8% of the dividend will be paid to our joint venture partner. During 2022 and 2021, no dividend was declared. Taking into account the available undrawn amount of the RCF Agreement of $2,500 million, we had access to $6,345 million of liquidity as of December 31, 2022. Capital returnThe common stock repurchase activity was as follows: ($ in millions, unless otherwise stated)20222021Shares repurchased8,330,021 20,628,901 Cost of shares repurchased1,429 4,015 Average price per share$171.59$194.63Under Dutch corporate law and our articles of association, NXP may acquire its own shares if the general meeting of shareholders has granted the board of directors the authority to effect such acquisitions. It is our standard practice to request our annual general meeting of shareholders (the “AGM”) every year to renew this authorization for a period of 18 months from the AGM. For repurchases of shares in 2021 and 2022, the board of directors made use of the authorizations renewed by the AGM on June 17, 2019, May 27, 2020, May 26, 2021 and June 1, 2022, respectively. Our board of directors has approved the purchase of shares from participants in NXP's equity programs to satisfy participants' tax withholding obligations ("trade for tax") and this authorization will remain in effect until terminated by the board of directors. In November 2019, the board of directors approved the repurchase of shares up to a maximum of $2 billion (the "2019 Share Repurchase Program"). In March 2021, the board of directors approved the additional repurchase of shares up to a maximum of $2 billion (the "2021 Share Repurchase Program"), and in August 2021, the board of directors increased the 2021 Share Repurchase Program authorization by $2 billion, for a total of $4 billion approved for the repurchase of shares under the 2021 Share Repurchase Program. In January 2022, the board of directors approved the additional repurchase of shares up to a maximum of $2 billion (the "2022 Share Repurchase Program"). During the fiscal year-ended December 31, 2021, NXP repurchased 20.6 million shares for a total of approximately $4 billion under the trade for tax and 2019 and 2021 Share Repurchase Programs, and during the fiscal year-ended December 31, 2022, NXP repurchased 8.3 million shares, for a total of approximately $1.4 billion under the trade for tax and 2021 Share Repurchase Program. Under Dutch tax law, the repurchase of a company’s shares by an entity domiciled in the Netherlands results in a taxable event (unless exemptions apply). The tax on the repurchased shares is attributed to the shareholders, with NXP making the payment on the shareholders’ behalf. As such, the tax on the repurchased shares is accounted for within stockholders’ equity. Subject to Dutch corporate law and our articles of association, the board of directors of NXP may cancel shares acquired if authorized by the general meeting of shareholders. As with repurchases of our shares, it is our standard practice to request our annual general meeting of shareholders (the “AGM”) every year to renew this authorization for a period of 18 months from the AGM. For cancellations of shares in 2020 and 2021, the board of directors made use of the authorizations renewed on May 27, 2020 and May 26, 2021, respectively.40As approved by the board of directors, on December 15, 2020, NXP cancelled 26 million shares and on November 30, 2021, NXP cancelled 15 million shares. As a result, the number of issued NXP shares as per November 30, 2021 is 274,519,638.Under our Quarterly Dividend Program, interim dividends of $0.5625 per ordinary share were paid on April 5, July 6, October 6, 2021; and January 6, 2022, and dividends of $0.845 per ordinary share were paid on April 6, July 6, October 6, 2022; and January 6, 2023. 20222021Dividends declared (per share)3.38 2.25 Dividends declared (in millions)885 606 DebtOur total debt, inclusive of aggregate principal, unamortized discounts, premiums, debt issuance costs and fair value adjustments, amounted to $11,165 million as of December 31, 2022, an increase of $593 million compared to December 31, 2021 ($10,572 million). On May 16, 2022, NXP issued $500 million of 4.4% Senior Unsecured Notes due 2027 and $1 billion of 5% Senior Unsecured Notes due 2033. On May 27, 2022, $900 million of 4.625% Senior Notes due 2023 were redeemed in full. As of December 31, 2022, the Company had outstanding fixed-rate notes with varying maturities for an aggregate principal amount of $11,250 million (collectively the “Notes”), with $0 payable within 12 months. Future interest payments associated with the Notes total $3,585 million, with $435 million payable within 12 months.41Additional capital requirementsWe believe our current cash and cash equivalents position, our expected cash flow generated from operations and our expected financing activities will satisfy our working and other capital requirements for at least the next 12 months based on our current business plans. Recent and expected working and other capital requirements, in addition to the above matters, also include the items described below:•The Company maintains purchase commitments with certain suppliers, primarily for raw materials, semi-finished goods and manufacturing services and for some non-production items. Purchase commitments for inventory materials are generally restricted to a forecasted time-horizon as mutually agreed upon between the parties. This forecasted time-horizon can vary for different suppliers. As of December 31, 2022, the Company had purchase commitments of $3,672 million, of which $1,187 million is expected to be paid in the next 12 months. We expect operating cash outflows to remain elevated as we make payments under these purchase agreements.•Amounts related to future lease payments for operating lease obligations at December 31, 2022 totaled $295 million, with $63 million expected to be paid within the next 12 months.•The Company enters into certain technology license arrangements which are used in conjunction with research and development activities for product development. Payments for these technology licenses are made over varying time periods. Outstanding unpaid balances for technology licenses total $260 million as of December 31, 2022, of which $121 million is expected to be paid in the next 12 months.•Cash outflows for capital expenditures were $1,063 million in 2022, compared to $767 million in 2021. We expect to maintain similar levels of capital expenditures as a percentage of revenue in 2023, to support current and future manufacturing and production capacity needs.•Our research and development expenditures were $2,148 million in 2022 and $1,936 million in 2021, and we expect to maintain similar levels of investment in research and development as a percentage of revenue in 2023.From time to time, we engage in discussions with third parties regarding potential acquisitions of, or investments in, businesses, technologies and product lines. Any such transaction could require significant use of our cash and cash equivalents, or require us to arrange for new debt and equity financing to fund the transaction. Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions. In the future, we may not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay principal, premium, if any, and interest on our indebtedness. Our business may not generate sufficient cash flow from operations, or we may not have enough capacity under the RCF Agreement, or from other sources in an amount sufficient to enable us to repay our indebtedness, including the RCF Agreement, the unsecured notes or to fund our other liquidity needs, including working capital and capital expenditure requirements. In any such case, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our indebtedness. See Part I, Item 1A. Risk Factors.2022 Financing ActivitiesRevolving Credit FacilityOn August 26, 2022, NXP B.V., together with NXP Funding LLC, amended and restated its revolving credit agreement entered into on June 11, 2019. The amended and restated revolving credit agreement provides for $2.5 billion of senior unsecured revolving credit commitments and is scheduled to mature on August 26, 2027.Exchange OffersOn April 14, 2022, we initiated a registered exchange offering of our outstanding Senior Unsecured Notes for new issues of substantially identical registered debt securities (the “Exchange Offers”). The Exchange Offers 42expired on May 16, 2022, at which time substantially all of the Notes were exchanged for registered senior unsecured notes. Debt Issuance and redemptionOn May 16, 2022, NXP B.V., together with NXP Funding LLC and NXP USA, Inc., issued $500 million of 4.4% senior unsecured notes due June 1, 2027 and $1 billion of 5.0% senior unsecured notes due January 15, 2033. On May 27, 2022 we redeemed the $900 million aggregate principal amount of outstanding dollar-denominated 4.625% Senior Unsecured Notes due 2023 in accordance with the terms of the indenture.2021 Financing Activities2032, 2042 and 2051 Senior Unsecured NotesOn November 30, 2021, NXP B.V., together with NXP USA Inc. and NXP Funding LLC, issued $1 billion of 2.65% Senior Unsecured Notes due 2032, $500 million of 3.125% Senior Unsecured Notes due 2042 and $500 million of 3.25% Senior Unsecured Notes due 2051. The Company used a portion of the net proceeds of the offering of these notes to redeem the $1 billion aggregate principal amount of outstanding 3.875% Senior Notes due 2022. The remaining net proceeds will be used for general corporate purposes, which may include capital expenditures or equity buyback transactions.2031 and 2041 Senior Unsecured NotesOn May 11, 2021, NXP B.V., together with NXP USA Inc. and NXP Funding LLC, issued $1 billion of 2.5% Senior Unsecured Notes due 2031 and $1 billion of 3.25% Senior Unsecured Notes due 2041. The net proceeds of the 2.5% Senior Notes due 2031 ("2031 Notes") are being used to finance certain eligible green projects. Pending the allocation of an amount equal to the net proceeds of the 2031 Notes to finance these eligible green projects, the remaining net proceeds of the 2031 Notes, together with the net proceeds of the 3.25% Senior Notes due 2041, are temporarily being held as cash and other short-term securities or are being used for general corporate purposes, including capital expenditures, short-term debt repayment or equity buyback transactions.Debt Position Short-term Debt As of December 31, 2022 and 2021, we had no short-term debt outstanding. Long-term Debt As of December 31, 2022 and 2021, we had outstanding debt of:43($ in millions)December 31, 2021Accrual/releaseOriginalIssuance/DebtDiscount andDebtIssuance CostDebtExchanges/Repurchase/NewBorrowingsDecember 31, 2022U.S. dollar-denominated 4.625% senior unsecured notes due June 2023 (1)898 2 (900)— U.S. dollar-denominated 4.875% senior unsecured notes due March 2024 (2)997 1 — 998 U.S. dollar-denominated 2.7% senior unsecured notes due May 2025 (3)498 — — 498 U.S. dollar-denominated 5.35% senior unsecured notes due March 2026 (2)498 — — 498 U.S. dollar-denominated 3.875% senior unsecured notes due June 2026 (4)747 1 — 748 U.S. dollar-denominated 3.15% senior unsecured notes due May 2027 (3)497 1 — 498 U.S. dollar-denominated 4.4% senior unsecured notes due June 2027 (7)— — 496 496 U.S. dollar-denominated 5.55% senior unsecured notes due December 2028 (2)497 — — 497 U.S. dollar-denominated 4.3% senior unsecured notes due June 2029 (4)993 — — 993 U.S. dollar-denominated 3.4% senior unsecured notes due May 2030 (3)993 1 — 994 U.S. dollar-denominated 2.5% senior unsecured notes due May 2031 (5)992 1 — 993 U.S. dollar-denominated 2.65% senior unsecured notes due Feb 2032 (6)992 — — 992 U.S. dollar-denominated 5% senior unsecured notes due Jan 2033 (7)— 1 988 989 U.S. dollar-denominated 3.25% senior unsecured notes due May 2041 (5)987 1 — 988 U.S. dollar-denominated 3.125% senior unsecured notes due Feb 2042 (6)492 — — 492 U.S. dollar-denominated 3.25% senior unsecured notes due Nov 2051 (6)491 — — 491 10,572 9 584 11,165 RCF Agreement (8)— — — — Total long-term debt10,572 9 584 11,165 (1) On May 23, 2016, we issued $900 million aggregate principal amount of 4.625% Senior Unsecured Notes due 2023. On May 27, 2022, the Notes were redeemed in full. (2) On December 6, 2018, we issued $1,000 million aggregate principal amount of 4.875% Senior Unsecured Notes due 2024, $500 million aggregate principal amount of 5.35% Senior Unsecured Notes due 2026 and $500 million aggregate principal amount of 5.55% Senior Unsecured Notes due 2028. (3) On May 1, 2020, we issued $500 million aggregate principal amount of 2.7% Senior Unsecured Notes due 2025, $500 million aggregate principal amount of 3.15% Senior Unsecured Notes due 2027 and $1 billion aggregate principal amount of 3.4% Senior Unsecured Notes due 2030.(4) On June 18, 2019, we issued $750 million of 3.875% Senior Unsecured Notes due 2026 and $1 billion of 4.3% Senior Unsecured Notes due 2029.(5) On May 11, 2021, we issued $1,000 million aggregate principal amount of 2.5% Senior Unsecured Notes due 2031 and $1,000 million aggregated principal amount of 3.25% Senior Unsecured Notes due 2041.44(6) On November 30, 2021, we issued $1,000 million aggregate principal amount of 2.65% Senior Unsecured Notes due 2032, $500 million aggregate principal amount of 3.125% Senior Unsecured Notes due 2042 and $500 million aggregated principal amount of 3.25% Senior Unsecured Notes due 2051.(7) On May 16, 2022, we issued $500 million aggregate principal amount of 4.4% Senior Unsecured Notes due 2027 and $1,000 million aggregate principal amount of 5% Senior Unsecured Notes due 2033. (8) On August 26, 2022, we entered into a $2.5 billion unsecured revolving credit facility agreement. We may from time to time continue to seek to retire or purchase our outstanding debt through cash purchases and/or exchanges, in open market purchases, privately negotiated transactions or otherwise. See the discussion in Part II, Item 7. Financial Condition, Liquidity and Capital Resources above. Cash flowsOur cash and cash equivalents in 2022 increased by $1,027 million (excluding the effect of changes in exchange rates on our cash position of $(12) million) as follows:($ in millions)Year ended December 31,20222021Net cash provided by (used for) operating activities3,895 3,077 Net cash (used for) provided by investing activities(1,249)(934)Net cash provided by (used for) financing activities(1,619)(1,585)Increase (decrease) in cash and cash equivalents1,027 558 •Cash Flow from Operating ActivitiesFor the year-ended December 31, 2022 our operating activities provided $3,895 million in cash. This was primarily the result of net income of $2,833 million, adjustments to reconcile the net income of $1,410 million and changes in operating assets and liabilities of $(372) million. Adjustments to net income include offsetting non-cash items, such as depreciation and amortization of $1,250 million, share-based compensation of $364 million, amortization of the discount on debt and debt issuance costs of $9 million, a loss on extinguishment of debt of $18 million, a loss on equity securities of $4 million, results relating to equity-accounted investees of $1 million and changes in deferred taxes of $(236) million.The change in operating assets and liabilities was attributable to the following:The $106 million increase in receivables and other current assets was driven by the accumulation of insignificant increases in numerous asset accounts within the "other" classification, with the most significant increase relating to $30 million in other receivables. In addition there was an increase of $37 million in trade accounts receivable, net, which was driven by higher average selling prices and timing of cash collections at the end of the year.The $593 million increase in inventories was primarily related to increased production levels in order to align inventory on hand with expected demand. The $633 million increase in accounts payable and other liabilities was primarily related to the following increases: $365 million in trade accounts payable as a result of purchases to meet the increase in growth in our business and timing related to payments; $211 million in income tax payables primarily driven by tax law changes in the U.S. that went into effect at the beginning of 2022; $47 million in interest payable due to new bond issuances; $48 million of other net movements including the non-cash adjustment for capital expenditures and licensing intangibles. Partially offsetting these cash flow increases was $38 million related to employee bonus accruals.45The $306 million increase in other non-current assets was primarily related to prepayments to secure long-term production supply with multiple vendors.For the year-ended December 31, 2021 our operating activities provided $3,077 million in cash. This was primarily the result of net income of $1,906 million, adjustments to reconcile the net income of $1,628 million and changes in operating assets and liabilities of $(437) million. Adjustments to net income include offsetting non-cash items, such as depreciation and amortization of $1,262 million, share-based compensation of $353 million, amortization of the discount on debt and debt issuance costs of $8 million, a gain on sale of assets of $1 million, a loss on extinguishment of debt of $22 million, a loss on equity securities of $2 million, results relating to equity-accounted investees of $2 million and changes in deferred taxes of $(20) million.•Cash Flow from Investing ActivitiesNet cash used for investing activities amounted to $1,249 million for the year-ended December 31, 2022 and principally consisted of the cash outflows for capital expenditures of $1,063 million, $159 million for the purchase of identified intangible assets, $5 million for the purchase of equipment leased to others, $27 million for purchases of interests in businesses (net of cash acquired) and $20 million for the purchase of investments, partly offset by $10 million from proceeds from return of equity investments and $13 million from proceeds from sale of investments.Net cash used for investing activities amounted to $934 million for the year-ended December 31, 2021 and principally consisted of the cash outflows for capital expenditures of $767 million, $132 million for the purchase of identified intangible assets, $33 million for the purchase of equipment leased to others, $23 million purchases of interests in businesses (net of cash acquired), and $8 million purchase of investments, partly offset by proceeds of $10 million from insurance recoveries received for equipment damage, $10 million from proceeds from return of equity investments and $8 million from proceeds from sale of investments.•Cash Flow from Financing Activities Net cash used for financing activities was $1,619 million for the year-ended December 31, 2022 compared to $1,585 million for the year-ended December 31, 2021. The cash flows related to financing transactions in 2022 and 2021 are primarily related to the financing activities described above under the captions 2022 Financing Activities and 2021 Financing Activities. In addition to the financing activities described above, net cash used for financing activities by year included: ($ in millions)Year ended December 31,20222021Dividends paid to common stockholders(815)(562)Cash proceeds from exercise of stock options59 62 Purchase of treasury shares(1,426)(4,015)Other, net(2)(2)Information Regarding Guarantors of NXP (unaudited)Summarized Combined Financial Information for Guarantee of Securities of SubsidiariesThe following debt instruments are guaranteed, fully and unconditionally, jointly and severally, by NXP Semiconductors N.V. and issued or guaranteed by NXP USA, Inc., NXP B.V. and NXP LLC, (together, the “Subsidiary Obligors” and together with NXP Semiconductors N.V., the “Obligor Group”): 4.875% Senior Notes due 2024, 2.700% Senior Notes due 2025, 5.350% Senior Notes due 2026, 3.875% Senior Notes due 2026, 3.150% Senior Notes due 2027, 4.400% Senior Notes due 2027, 5.550% Senior Notes due 2028, 4.300% Senior Notes due 2029, 3.400% Senior Notes due 2030, 2.500% Senior Notes due 2031, 2.650% Senior Notes due 2032, 5.000% Senior Notes due 2033, 3.250% Senior Notes due 2041, 3.125% Senior Notes due 2042 and the 3.250% Senior Notes due 2051 (together the “ Notes”). Other than the Subsidiary Obligors, none of the 46Company’s subsidiaries (together the “Non-Guarantor Subsidiaries”) guarantee the Notes. The Company consolidates the Subsidiary Obligors in its consolidated financial statements and each of the Subsidiary Obligors are wholly owned subsidiaries of the Company.All of the existing guarantees by the Company rank equally in right of payment with all of the existing and future senior indebtedness of the Obligor Group. There are no significant restrictions on the ability of the Obligor Group to obtain funds from respective subsidiaries by dividend or loan. The following tables present summarized financial information of the Obligor Group on a combined basis, with intercompany balances and transactions between entities of the Obligor Group eliminated and investments and equity in the earnings of the Non-Guarantor Subsidiaries excluded. The Obligor Group’s amounts due from, amounts due to, and intercompany transactions with Non-Guarantor Subsidiaries have been disclosed below the table, when material.Summarized Statements of Income($ in millions)December 31, 2022Revenue7,674 Gross Profit3,883 Operating income1,406 Net income542 Summarized Balance SheetsAs of($ in millions)December 31, 2022Current assets3,740 Non-current assets11,572 Total assets15,312 Current liabilities1,067 Non-current liabilities11,528 Total liabilities12,595 Obligor's Group equity2,717 Total liabilities and Obligor's Group equity15,312 NXP Semiconductors N.V. is the head of a fiscal unity for the corporate income tax and VAT that contains the most significant Dutch wholly-owned group companies. The Company is therefore jointly and severally liable for the tax liabilities of the tax entity as a whole, and as such the income tax expense of the Dutch fiscal unity has been included in the Net income of the Obligor Group.The financial information of the Obligor Group includes sales executed through a Non-Guarantor Subsidiary single-billing entity as a sales agent on behalf of an entity in the Obligor Group. The Obligor Group has sales to non-guarantors (2022: $813 million). The Obligor Group has amounts due from equity financing (2022: $5,210) and due to debt financing (2022: $2,629) with non-guarantor subsidiaries.Recent Legislation47US CHIPS ActOn August 9, 2022, the CHIPS and Science Act of 2022, H.R. 4346 (the “CHIPS Act”) was signed into law. The CHIPS Act provides for a 25% refundable tax credit on certain investments in domestic semiconductor manufacturing. The credit is provided for qualifying property, which is placed in service after December 31, 2022. The CHIPS Act also provides for certain other financial incentives to further investments in domestic semiconductor manufacturing. The Company is evaluating the provisions of the new law and its potential impact to the Company.Inflation Reduction ActOn August 16, 2022, the Inflation Reduction Act of 2022, H.R. 5376 (the “IRA”), was signed into law. The IRA introduces a 15% Corporate Alternative Minimum Tax (“CAMT”) for corporations whose average annual adjusted financial statement income for any consecutive three-tax-year period preceding the applicable tax year exceeds $1 billion and a 1% excise tax on certain stock repurchases The CAMT and the excise tax are effective in taxable years beginning after December 31, 2022. The Company is evaluating the provisions of the new law and its potential impact to the Company.EU Chips ActThe EU Commission proposed its “EU Chips Act” in February 2022. The announced budget is €43 billion, with approximately €30 billion for potential manufacturing projects coming from EU member states national funds. The remaining €13 billion are foreseen for RD&I programs and initiatives like the new “Chips Joint Undertaking”. The EU Chips Act is still in the legislative process and is expected to become effective in late 2023. As a reaction to the U.S. Inflation Reduction Act, the EU Commission has stated that it would come up with a legislative package itself by the summer of 2023. The Company continues to monitor the progress of this potential legislation and will evaluate the provisions and its potential impact to the Company at such a time when enacted.EU IPCEI on Microelectronics and Communication Technologies (“IPCEI”) program During 2021 several European member states formally pre-notified the European Commission of the new Important Project of Common European Interest on Microelectronics and Communication Technologies (“IPCEI”) to support transnational cooperation projects on microelectronics. By joining forces, member states and industry intend to enhance the resilience of Europe’s supply chain in semiconductors. The IPCEI program requires the approval of the European Commission under state aid law: companies and EU member states must prove in a dedicated notification process that the IPCEI follows an overriding European interest and that projects would not be realized under market forces alone. The Company is currently involved in different notification processes in multiple member states, and expects to receive allocation of the related funding budgets that typically run over five years during 2023. Critical Accounting Estimates The preparation of financial statements and related disclosures in accordance with U.S. GAAP requires our management to make judgments, assumptions and estimates that affect the amounts reported in our Consolidated Financial Statements and the accompanying notes. Our management bases its estimates and judgments on historical experience, current economic and industry conditions and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.The methods, estimates, and judgments that we use in applying our accounting policies have a significant impact on the results that we report in our Consolidated Financial Statements. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates regarding matters that are inherently uncertain. Our most critical accounting estimates include:•the valuation of inventory, which impacts gross margin;•the assessment of recoverability of goodwill, identified intangible assets and tangible fixed assets, which impacts gross margin or operating expenses when we record asset impairments or accelerate their depreciation or amortization;48•revenue recognition, which impacts our results of operations;•the recognition of current and deferred income taxes (including the measurement of uncertain tax positions), which impacts our provision for income taxes;•the assumptions used in the determination of postretirement benefit obligations, which impacts operating expenses;•the assumptions used in the determination of share based compensation, which impacts gross margin and operating expenses; and•the recognition and measurement of loss contingencies, which impacts gross margin or operating expenses when we recognize a loss contingency or revise the estimates for a loss contingency.In the following section, we discuss these policies further, as well as the estimates and judgments involved.InventoriesInventories are valued at the lower of cost or net realizable value. We regularly review our inventories and write down our inventories for estimated losses due to obsolescence. This allowance is determined for groups of products based on sales of our products in the recent past and/or expected future demand. Future demand is affected by market conditions, technological obsolescence, new products and strategic plans, each of which is subject to change with little or no forewarning. In estimating obsolescence, we utilize information that includes projecting future demand.The need for strategic inventory levels to ensure competitive delivery performance to our customers are balanced against the risk of inventory obsolescence due to rapidly changing technology and customer requirements.The change in our reserves for inventories was primarily due to the normal review and accrual of obsolete or excess inventory. If actual future demand or market conditions are less favorable than those projected by our management, additional inventory write-downs may be required.GoodwillGoodwill is required to be assessed for impairment at least once annually, or more frequently if indicators of potential impairment exist, which includes evaluating qualitative and quantitative factors to assess the likelihood of an impairment of a reporting unit’s goodwill. Such events or changes in circumstances can be significant changes in business climate, operating performance or competition, or upon the disposition of a significant portion of a reporting unit. A significant amount of judgment is involved in determining if an indicator of impairment has occurred between annual test dates. We perform impairment tests using a fair value approach when necessary. Determining the fair value of a reporting unit involves the use of significant estimates and assumptions, including projected future cash flows, discount rates based on weighted average cost of capital and future economic and market conditions. We base our fair-value estimates on assumptions we believe to be reasonable. Actual cash flow amounts for future periods may differ from estimates used in impairment testing.We perform our annual impairment test for goodwill in the fourth quarter of each fiscal year. We did not recognize any impairment charges for goodwill in the years presented, as our annual impairment testing indicated that the fair value exceeded the recorded value for the respective reporting unit.Impairment or disposal of identified long-lived assetsWe perform reviews of long-lived assets including property, plant and equipment, and intangible assets subject to amortization, whenever facts and circumstances indicate that the useful life is shorter than what we had originally estimated or that the carrying amount of assets may not be recoverable. If such facts and circumstances exist, we assess the recoverability of the long-lived assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. In the event such cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated fair values based on the expected discounted future cash flows attributable to the assets or based on appraisals. Impairment losses, if any, are based 49on the excess of the carrying amount over the fair value of those assets. Long-lived assets to be disposed of by sale are reported at the lower of their carrying amounts or their estimated fair values less costs to sell and are not depreciated.The assumptions and estimates used to determine future values and remaining useful lives of our intangible and other long-lived assets are complex and subjective. They can be affected by various factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our forecasts for specific product lines. In 2021, we recognized impairment charges of $36 million as a result of the discontinuation of an IPR&D project. In 2020, we recognized impairment charges of $36 million, relative to IPR&D that was acquired from Freescale. Revenue recognition The Company recognizes revenue under the core principle to depict the transfer of control to customers in an amount reflecting the consideration the Company expects to be entitled. In order to achieve that core principle, the Company applies the following five step approach: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when a performance obligation is satisfied. The vast majority of the Company’s revenue is derived from the sale of semiconductor products to distributors, Original Equipment Manufacturers (“OEMs”) and similar customers. In determining the transaction price, the Company evaluates whether the price is subject to refund or adjustment to determine the consideration to which the Company expects to be entitled. Variable consideration is estimated and includes the impact of discounts, price protection, product returns and distributor incentive programs. The estimate of variable consideration is dependent on a variety of factors, including contractual terms, analysis of historical data, current economic conditions, industry demand and both the current and forecasted pricing environments. The estimate of variable consideration is not constrained because the Company has extensive experience with these contracts. Revenue is recognized when control of the product is transferred to the customer (i.e., when the Company’s performance obligation is satisfied), which typically occurs at shipment. In determining whether control has transferred, the Company considers if there is a present right to payment and legal title, and whether risks and rewards of ownership having transferred to the customer. For sales to distributors, revenue is recognized upon transfer of control to the distributor. For some distributors, contractual arrangements are in place which allow these distributors to return products if certain conditions are met. These conditions generally relate to the time period during which a return is allowed and reflect customary conditions in the particular geographic market. Other return conditions relate to circumstances arising at the end of a product life cycle, when certain distributors are permitted to return products purchased during a pre-defined period after the Company has announced a product’s pending discontinuance. These return rights are a form of variable consideration and are estimated using the most likely method based on historical return rates in order to reduce revenues recognized. However, long notice periods associated with these announcements prevent significant amounts of product from being returned. For sales where return rights exist, the Company has determined, based on historical data, that only a very small percentage of the sales of this type to distributors is actually returned. Repurchase agreements with OEMs or distributors are not entered into by the Company. Sales to most distributors are made under programs common in the semiconductor industry whereby distributors receive certain price adjustments to meet individual competitive opportunities. These programs may include credits granted to distributors, or allow distributors to return or scrap a limited amount of product in accordance with contractual terms agreed upon with the distributor, or receive price protection credits when our standard published prices are lowered from the price the distributor paid for product still in its inventory. In determining the transaction price, the Company considers the price adjustments from these programs to be variable consideration that reduce the amount of revenue recognized. The Company’s policy is to estimate such price adjustments using the most likely method based on rolling historical experience rates, as well as a prospective view of products and pricing in the distribution channel for distributors who participate in our 50volume rebate incentive program. We continually monitor the actual claimed allowances against our estimates, and we adjust our estimates as appropriate to reflect trends in pricing environments and inventory levels. The estimates are also adjusted when recent historical data does not represent anticipated future activity. Historically, actual price adjustments for these programs relative to those estimated have not materially differed. Income taxesIncome taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts. Measurement of deferred tax assets and liabilities is based upon the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax liabilities for withholding taxes on dividends from subsidiaries are recognized in situations where the Company does not consider the earnings indefinitely reinvested and to the extent that these withholding taxes are not expected to be refundable.Deferred tax assets, including assets arising from loss carryforwards, are recognized, net of a valuation allowance, if based upon the available evidence it is more likely than not that the asset will be realized. The income tax benefit from an uncertain tax position is recognized only if it is more likely than not that the tax position will be sustained upon examination by the relevant taxing authorities. The income tax benefit recognized is measured based on the largest benefit that is greater than 50% likely to be realized upon resolution of the uncertainty. Unrecognized tax benefits are presented as a reduction to the deferred tax asset for related temporary differences, tax credits or net operating loss carryforwards, unless these would not be available, in which case the uncertain tax benefits are presented together with the related interest and penalties as a liability, under accrued liabilities and other non-current liabilities based on the timing of the expected payment. Related penalties are recorded as income tax expense, whereas related interest is reported as financial expense in the statement of operations.Postretirement benefitsThe Company’s employees participate in pension and other postretirement benefit plans in many countries. The costs of pension and other postretirement benefits and related assets and liabilities with respect to the Company’s employees participating in defined-benefit plans are based upon actuarial valuations.The projected defined-benefit obligation is calculated annually by qualified actuaries using the projected unit credit method. For the Company’s major plans, the discount rate is derived from market yields on high quality corporate bonds. Plans in countries without a deep corporate bond market use a discount rate based on the local government bond rates.In calculating obligation and expense, the Company is required to select actuarial assumptions. These assumptions include discount rate, expected long-term rate of return on plan assets and rates of increase in compensation costs determined based on current market conditions, historical information and consultation with and input from our actuaries. Changes in the key assumptions can have a significant impact to the projected benefit obligations, funding requirements and periodic pension cost incurred.The Company determines the fair value of plan assets based on quoted prices or comparable prices for non-quoted assets. For a defined-benefit pension plan, the benefit obligation is the projected benefit obligation; for any other postretirement defined benefit plan it is the accumulated postretirement benefit obligation.Share-based compensation We recognize compensation expense for all share-based awards based on the grant-date estimated fair values, net of an estimated forfeiture rate. We use the Black-Scholes option pricing model to determine the estimated fair value for certain awards. Share-based compensation cost for restricted share units (“RSUs”) with time-based vesting is measured based on the closing fair market value of our common stock on the date of the grant, reduced by the present value of the estimated expected future dividends, and then multiplied by the 51number of RSUs granted. Share-based compensation cost for performance-based share units (“PSUs”) granted with performance or market conditions is measured using a Monte Carlo simulation model on the date of grant. Our valuation models and generally accepted valuation techniques require us to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the volatility of our stock price, expected dividend yield, employee turnover rates and employee stock option exercise behaviors. When establishing the expected life assumption, we used the ‘simplified’ method prescribed in ASC Topic 718 for companies that do not have adequate historical data. The risk-free interest rate is measured as the prevailing yield for a U.S. Treasury security with a maturity similar to the expected life assumption. We also estimate a forfeiture rate at the time of grant and revise this rate in subsequent periods if actual forfeitures or vesting differ from the original estimates. We evaluate the assumptions used to value our awards on a quarterly basis. If factors change and we employ different assumptions, share-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellation of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned share-based compensation expense. Litigation and claimsWe are regularly involved as plaintiffs or defendants in claims and litigation related to our past and current business operations. The claims can cover a broad range of topics, including intellectual property, reflecting the Company’s identity as a global manufacturing and technology business. The Company vigorously defends itself against improper claims, including those asserted in litigation. Due to the unpredictable nature of litigation, there can be no assurance that the Company’s accruals will be sufficient to cover the extent of its potential exposure to losses but, historically, legal actions have not had a material adverse effect on the Company’s business, results of operations or financial condition.The estimated aggregate range of reasonably possible losses is based on currently available information in relation to the claims that have arisen and on the Company’s best estimate of such losses for those cases for which such estimate can be made. For certain claims, the Company believes that an estimate cannot currently be made. The estimated aggregate range requires significant judgment, given the varying stages of the proceedings (including the fact that many of them are currently in preliminary stages), the existence of multiple defendants (including the Company) in such claims whose share of liability has yet to be determined, the numerous yet-unresolved issues in many of the claims, and the attendant uncertainty of the various potential outcomes of such claims. Accordingly, the Company’s estimate will change from time to time, and actual losses may be more than the current estimate.Use of Certain Non-GAAP Financial MeasuresIn addition to disclosing financial results in accordance with U.S. GAAP, this document contains references to net debt. Net debt is a non-GAAP financial measure and represents total debt (short-term and long-term) after deduction of cash and cash equivalents. We believe this measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to calculating our net leverage.The following is a reconciliation of net debt to the most directly comparable GAAP measure, total debt, as adjusted for our cash and cash equivalents our net debt was calculated as follows:($ in millions)20222021Long-term debt11,165 10,572 Short-term debt— — Total debt11,165 10,572 Less: cash and cash equivalents(3,845)(2,830)Net debt7,320 7,742 52We understand that, although net debt is used by investors and securities analysts in their evaluation of companies, this concept has limitations as an analytical tool and it should not be used as an alternative to any other measure in accordance with U.S. GAAP.Item 7A. Quantitative and Qualitative Disclosures About Market RiskWe are exposed to changes in interest rates and foreign currency exchange rates because we finance certain operations through fixed and variable rate debt instruments and denominate our transactions in a variety of foreign currencies. Changes in these rates may have an impact on future cash flow and earnings. We manage these risks through normal operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. We do not enter into financial instruments for trading or speculative purposes. By using derivative instruments, we are subject to credit and market risk. The fair market value of the derivative instruments is determined by using valuation models whose inputs are derived using market observable inputs, including interest rate yield curves, as well as foreign exchange and commodity spot and forward rates, and reflects the asset or liability position as of the end of each reporting period. When the fair value of a derivative contract is positive, the counterparty owes us, thus creating a receivable risk for us. We are exposed to counterparty credit risk in the event of non-performance by counterparties to our derivative agreements. We minimize counterparty credit (or repayment) risk by entering into transactions with major financial institutions of investment grade credit rating. Our exposure to market risk is not hedged in a manner that completely eliminates the effects of changing market conditions on earnings or cash flow. Interest Rate RiskOur RCF Agreement has a $2,500 million borrowing capacity with a floating rate interest. As there are currently no borrowings under this facility, a hypothetical increase in interest rates would not have caused any change to our interest expense on our floating rate debt. Additional information regarding our notes is provided in Note 2 - Significant Accounting Policies, and Note 13 - Debt, of our notes to the Consolidated Financial Statements included in
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”NCLH’s principal executive offices are located in Miami, Florida where we lease approximately 386,224 square feet of facilities. We lease a number of domestic and international offices throughout Europe, Asia, South America and Australia to administer our brand operations globally. Norwegian owns a private island in the Bahamas, Great Stirrup Cay, which we utilize as a port-of-call on some of our itineraries. We operate a private cruise destination in Belize, Harvest Caye.We believe that our facilities are adequate for our current needs, and that we are capable of obtaining additional facilities as necessary.​Item 3. Legal ProceedingsOur threshold for disclosing material environmental legal proceedings involving a governmental authority where potential monetary sanctions are involved is $1 million.​See “Item 8—Financial Statements and Supplementary Data—Notes to Consolidated Financial Statements—Note 13 Commitments and Contingencies” in Part II of this annual report for information about material legal proceedings.​​Item 4. Mine Safety DisclosuresNone.​48 Table of ContentsPART II​Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesMarket InformationNCLH’s ordinary shares are listed on the NYSE under the symbol “NCLH.”HoldersAs of February 16, 2023, there were 274 record holders of NCLH’s ordinary shares. Since certain of NCLH’s ordinary shares are held by brokers and other institutions on behalf of shareholders, the foregoing number is not representative of the number of beneficial owners.DividendsNCLH does not currently pay dividends to its shareholders. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend upon our results of operations, financial condition, restrictions imposed by applicable law and our financing agreements and other factors that our Board of Directors deems relevant.​49 Table of ContentsStock Performance GraphThis performance graph shall not be deemed “soliciting material” or to be “filed” with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of NCLH under the Securities Act of 1933, as amended, or the Exchange Act.The following graph shows a comparison of the cumulative total return for our ordinary shares, the Standard & Poor’s 500 Composite Stock Index and the Dow Jones United States Travel and Leisure index. The Stock Performance Graph assumes that $100 was invested at the closing price of our ordinary shares on the NYSE and in each index on the last trading day of fiscal 2017. Past performance is not necessarily an indicator of future results. The stock prices used were as of the close of business on the respective dates.Item 6. [Reserved]​50 Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsFinancial PresentationThe following discussion and analysis contains forward-looking statements within the meaning of the federal securities laws, and should be read in conjunction with the disclosures we make concerning risks and other factors that may affect our business and operating results. You should read this information in conjunction with the consolidated financial statements and the notes thereto included in this annual report. See also “Cautionary Statement Concerning Forward-Looking Statements” immediately prior to Part I, Item 1 in this annual report.We categorize revenue from our cruise and cruise-related activities as either “passenger ticket” revenue or “onboard and other” revenue. Passenger ticket revenue and onboard and other revenue vary according to product offering, the size of the ship in operation, the length of cruises operated and the markets in which the ship operates. Our revenue is seasonal based on demand for cruises, which has historically been strongest during the Northern Hemisphere’s summer months; however, our cruise voyages were completely suspended from March 2020 until July 2021 due to the COVID-19 pandemic and our resumption of cruise voyages was phased in gradually, with full operation of our fleet resumed in May 2022 as described under “—Update Regarding COVID-19 Pandemic” below. Passenger ticket revenue primarily consists of revenue for accommodations, meals in certain restaurants on the ship, certain onboard entertainment, port fees and taxes and includes revenue for service charges and air and land transportation to and from the ship to the extent guests purchase these items from us. Onboard and other revenue primarily consists of revenue from casino, beverage sales, shore excursions, specialty dining, retail sales, spa services and Wi-Fi services. Our onboard revenue is derived from onboard activities we perform directly or that are performed by independent concessionaires, from which we receive a share of their revenue.Our cruise operating expense is classified as follows:●Commissions, transportation and other primarily consists of direct costs associated with passenger ticket revenue. These costs include travel advisor commissions, air and land transportation expenses, related credit card fees, certain port fees and taxes and the costs associated with shore excursions and hotel accommodations included as part of the overall cruise purchase price.●Onboard and other primarily consists of direct costs incurred in connection with onboard and other revenue, including casino, beverage sales and shore excursions.●Payroll and related consists of the cost of wages and benefits for shipboard employees and costs of certain inventory items, including food, for a third party that provides crew and other hotel services for certain ships. The cost of crew repatriation, including charters, housing, testing and other costs related to COVID-19 are also included.●Fuel includes fuel costs, the impact of certain fuel hedges and fuel delivery costs.●Food consists of food costs for passengers and crew on certain ships.●Other consists of repairs and maintenance (including Dry-dock costs), ship insurance and other ship expenses.Critical Accounting PoliciesOur consolidated financial statements have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our consolidated financial statements and the reported amounts of revenue and expenses during the periods presented. We rely on historical experience and on various other assumptions that we believe to be reasonable under the circumstances to make these estimates and judgments. Actual results could differ materially from these estimates. We believe that the following 51 Table of Contentscritical accounting policies reflect the significant estimates and assumptions used in the preparation of our consolidated financial statements. These critical accounting policies, which are presented in detail in our notes to our audited consolidated financial statements, relate to liquidity, ship accounting and asset impairment.LiquidityWe make several critical accounting estimates with respect to our liquidity. Significant events affecting travel typically have an impact on demand for cruise vacations, with the full extent of the impact determined by the length of time the event influences travel decisions. The level of occupancy on our ships will depend on a number of factors including, but not limited to, the conditions discussed below under “Macroeconomic Trends and Uncertainties”, further resurgences of COVID-19 or the emergence of other public health crises and any related governmental regulations and new health and safety protocols, port availability, travel restrictions, bans and advisories, and our ability to staff our ships. In addition, as a result of conditions associated with the COVID-19 pandemic and other global events, such as Russia’s ongoing invasion of Ukraine and actions taken by the United States and other governments in response to the invasion, the global economy, including the financial and credit markets, has experienced significant volatility and disruptions, including increases in inflation rates, fuel prices, and interest rates. These conditions have resulted, and may continue to result, in increased expenses and also have impacted travel and consumer discretionary spending. We believe the ongoing effects of the foregoing factors and events on our operations and global bookings have had, and will continue to have, a significant impact on our financial results and liquidity.​The estimation of our future cash flow projections includes numerous assumptions that are subject to various risks and uncertainties. Our principal assumptions for future cash flow projections include:​●Expected gradual return to historical occupancy levels;●Expected increase in revenue per passenger cruise day through a combination of both passenger ticket and onboard revenue as compared to 2019;●Forecasted cash collections in accordance with the terms of our credit card processing agreements (see Note 13 - “Commitments and Contingencies”); and●Expected sustained higher fuel prices and the impact of inflation.Our projected liquidity requirements also reflect our principal assumptions surrounding ongoing operating costs, as well as liquidity requirements for financing costs and necessary capital expenditures. We cannot make assurances that our assumptions used to estimate our liquidity requirements will not change materially due to the dynamic nature of the current economic landscape. Accordingly, the full effect of the COVID-19 pandemic and other global events impacting macroeconomic conditions and travel and consumer discretionary spending, including Russia’s ongoing invasion of Ukraine, on our financial performance and financial condition cannot be quantified at this time. We have made reasonable estimates and judgments of the impact of these events within our financial statements; however, there may be material changes to those estimates in future periods. We have taken actions to improve our liquidity, including completing various capital market and financing transactions and making capital expenditure and operating expense reductions, and we expect to continue to pursue further opportunities to improve our liquidity.Ship AccountingShips represent our most significant assets, and we record them at cost less accumulated depreciation. Depreciation of ships is computed on a straight-line basis over the weighted average useful lives of primarily 30 years after a 15% reduction for the estimated residual value of the ship. Our residual value is established based on our long-term estimates of the expected remaining future benefit at the end of the ships’ weighted average useful lives. In the third quarter of 2022, the Company took delivery of Norwegian’s first Prima Class Ship. Based on the design, structure and technological advancements made to this new class of ship and the analysis of its major components, which is generally performed upon the introduction of a new class of ship, we have assigned the Prima Class Ships a weighted-average 52 Table of Contentsuseful life of 35 years with a residual value of 10%. Ship improvement costs that we believe add value to our ships are capitalized to the ship and depreciated over the shorter of the improvements’ estimated useful lives or the remaining useful life of the ship. When we record the retirement of a ship component included within the ship’s cost basis, we estimate the net book value of the component being retired and remove it from the ship’s cost basis. Repairs and maintenance activities are charged to expense as incurred. We account for Dry-dock costs under the direct expense method which requires us to expense all Dry-dock costs as incurred.We determine the weighted average useful lives of our ships based primarily on our estimates of the costs and useful lives of the ships’ major component systems on the date of acquisition, such as cabins, main diesels, main electric, superstructure and hull, and their related proportional weighting to the ship as a whole. The useful lives of components of new ships and ship improvements are estimated based on the economic lives of the new components. In addition, to determine the useful lives of the major components of new ships and ship improvements, we consider the impact of the historical useful lives of similar assets, manufacturer recommended lives, planned maintenance programs and anticipated changes in technological conditions. Given the large and complex nature of our ships, our accounting estimates related to ships and determinations of ship improvement costs to be capitalized require judgment and are uncertain. Should certain factors or circumstances cause us to revise our estimate of ship service lives or projected residual values, depreciation expense could be materially lower or higher. In 2020, one ship had significant improvements that extended the remaining weighted average useful life of the vessel. Accordingly, we updated our estimate of both its useful life and residual value based on the new weighted average useful life of its current components. The impact of the change in estimate was accounted on a prospective basis and was not material.If circumstances cause us to change our assumptions in making determinations as to whether ship improvements should be capitalized, the amounts we expense each year as repairs and maintenance costs could increase, partially offset by a decrease in depreciation expense. If we reduced our estimated weighted average ship service life by one year, depreciation expense for the year ended December 31, 2022 would have increased by $18.8 million. In addition, if our ships were estimated to have no residual value, depreciation expense for the same period would have increased by $82.8 million. We believe our estimates for ship accounting are reasonable and our methods are consistently applied. We believe that depreciation expense is based on a rational and systematic method to allocate our ships’ costs to the periods that benefit from the ships’ usage.Asset ImpairmentWe review our long-lived assets, principally ships, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Assets are grouped and evaluated at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other groups of assets. For ship impairment analyses, the lowest level for which identifiable cash flows are largely independent of other assets and liabilities is each individual ship. We consider historical performance and future estimated results in our evaluation of potential impairment and then compare the carrying amount of the asset to the estimated future cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds the estimated expected undiscounted future cash flows, we measure the amount of the impairment by comparing the carrying amount of the asset to its estimated fair value. We estimate fair value based on the best information available utilizing estimates, judgments and projections as necessary. Our estimate of fair value is generally measured by discounting expected future cash flows at discount rates commensurate with the associated risk.We evaluate goodwill and trade names for impairment on December 31 or more frequently when an event occurs or circumstances change that indicates the carrying value of a reporting unit may not be recoverable. For our evaluation of goodwill, we use a qualitative assessment which allows us to first assess qualitative factors to determine whether it is more likely than not (i.e., more than 50%) that the estimated fair value of a reporting unit is less than its carrying value. For trade names we also provide a qualitative assessment to determine if there is any indication of impairment.53 Table of ContentsIn order to make this evaluation, we consider whether any of the following factors or conditions exist:●Changes in general macroeconomic conditions, such as a deterioration in general economic conditions; limitations on accessing capital; fluctuations in foreign exchange rates; or other developments in equity and credit markets;●Changes in industry and market conditions such as a deterioration in the environment in which an entity operates; an increased competitive environment; a decline in market-dependent multiples or metrics (in both absolute terms and relative to peers); a change in the market for an entity’s products or services; or a regulatory or political development;●Changes in cost factors that have a negative effect on earnings and cash flows;●Decline in overall financial performance (for both actual and expected performance);●Entity and reporting unit specific negative events such as changes in management, key personnel, strategy, or customers; litigation; or a change in the composition or carrying amount of net assets; and●Decline in share price (in both absolute terms and relative to peers).We believe our estimates and judgments with respect to our long-lived assets, principally ships, goodwill, tradenames and other indefinite-lived intangible assets are reasonable. Nonetheless, if there was a material change in assumptions used in the determination of such fair values or if there is a material change in the conditions or circumstances that influence such assets, we could be required to record an impairment charge. If a material change occurred or the result of the qualitative assessment indicated it is more likely than not that the estimated fair value of the asset is less than its carrying value, we would conduct a quantitative assessment comparing the fair value to its carrying value. We have concluded that our business has three reporting units. Each brand, Oceania Cruises, Regent Seven Seas and Norwegian, constitutes a business for which discrete financial information is available and management regularly reviews the operating results and, therefore, each brand is considered an operating segment. For our annual impairment evaluation, we performed a qualitative assessment for the Regent Seven Seas reporting unit and of each brand’s trade names. As part of our analysis, we performed an assessment of current factors compared to key assumptions impacting the quantitative tests performed in 2020. As of December 31, 2022, there was $98.1 million of goodwill remaining for the Regent Seven Seas reporting unit. Trade names were $500.5 million as of December 31, 2022. As of December 31, 2022, our annual impairment reviews support the carrying values of these assets. ​Non-GAAP Financial MeasuresWe use certain non-GAAP financial measures, such as Adjusted Gross Margin, Net Cruise Cost, Adjusted Net Cruise Cost Excluding Fuel, Adjusted EBITDA, Adjusted Net Loss and Adjusted EPS, to enable us to analyze our performance. See “Terms Used in this Annual Report” for the definitions of these and other non-GAAP financial measures. We utilize Adjusted Gross Margin to manage our business on a day-to-day basis because it reflects revenue earned net of certain direct variable costs. We also utilize Net Cruise Cost and Adjusted Net Cruise Cost Excluding Fuel to manage our business on a day-to-day basis. In measuring our ability to control costs in a manner that positively impacts our results of operations, we believe changes in Adjusted Gross Margin, Net Cruise Cost and Adjusted Net Cruise Cost Excluding Fuel to be the most relevant indicators of our performance. As our business includes the sourcing of passengers and deployment of vessels outside of the U.S., a portion of our revenue and expenses are denominated in foreign currencies, particularly British pound, Canadian dollar, euro and Australian dollar which are subject to fluctuations in currency exchange rates versus our reporting currency, the U.S. dollar. In order to monitor results excluding these fluctuations, we calculate certain non-GAAP measures on a Constant 54 Table of ContentsCurrency basis, whereby current period revenue and expenses denominated in foreign currencies are converted to U.S. dollars using currency exchange rates of the comparable period. We believe that presenting these non-GAAP measures on both a reported and Constant Currency basis is useful in providing a more comprehensive view of trends in our business.We believe that Adjusted EBITDA is appropriate as a supplemental financial measure as it is used by management to assess operating performance. We also believe that Adjusted EBITDA is a useful measure in determining our performance as it reflects certain operating drivers of our business, such as sales growth, operating costs, marketing, general and administrative expense and other operating income and expense. Adjusted EBITDA is not a defined term under GAAP nor is it intended to be a measure of liquidity or cash flows from operations or a measure comparable to net income, as it does not take into account certain requirements such as capital expenditures and related depreciation, principal and interest payments and tax payments and it includes other supplemental adjustments.In addition, Adjusted Net Loss and Adjusted EPS are non-GAAP financial measures that exclude certain amounts and are used to supplement GAAP net loss and EPS. We use Adjusted Net Loss and Adjusted EPS as key performance measures of our earnings performance. We believe that both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting and analyzing future periods. These non-GAAP financial measures also facilitate management’s internal comparison to our historical performance. In addition, management uses Adjusted EPS as a performance measure for our incentive compensation during normal operations. The amounts excluded in the presentation of these non-GAAP financial measures may vary from period to period; accordingly, our presentation of Adjusted Net Loss and Adjusted EPS may not be indicative of future adjustments or results. For example, for the year ended December 31, 2022, we incurred $12.1 million related to restructuring costs or charges. We included this as an adjustment in the reconciliation of Adjusted Net Loss since the expenses are not representative of our day-to-day operations; however, this adjustment did not occur and is not included in the comparative period presented within this Form 10-K.You are encouraged to evaluate each adjustment used in calculating our non-GAAP financial measures and the reasons we consider our non-GAAP financial measures appropriate for supplemental analysis. In evaluating our non-GAAP financial measures, you should be aware that in the future we may incur expenses similar to the adjustments in our presentation. Our non-GAAP financial measures have limitations as analytical tools, and you should not consider these measures in isolation or as a substitute for analysis of our results as reported under GAAP. Our presentation of our non-GAAP financial measures should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Our non-GAAP financial measures may not be comparable to other companies. Please see a historical reconciliation of these measures to the most comparable GAAP measure presented in our consolidated financial statements below in the “Results of Operations” section.Update Regarding COVID-19 Pandemic ​Safe Resumption of Operations​Due to the impact of COVID-19, travel restrictions and limited access to ports around the world, in March 2020, we implemented a voluntary suspension of all cruise voyages across our three brands. In the third quarter of 2021, we began a phased relaunch of certain cruise voyages with ships initially operating at reduced occupancy levels. In early May 2022, we completed the phased relaunch of our entire fleet with all ships now in operation with guests on board. Occupancy levels have sequentially increased in recent quarters, most recently averaging 87% in the fourth quarter 2022, with the Company expecting to return to historical Occupancy levels for the second quarter of 2023.​During 2022, we benefitted from significant improvements in the public health environment which allowed for the removal of most COVID-19 related health and safety protocols by year-end, unless required by local jurisdictions. For example, in July 2022, the CDC announced that its voluntary COVID-19 Program for Cruise Ships Operating in U.S. Waters was no longer in effect. We will continue to modify and evolve our health and safety protocols as needed along with the broader public health and regulatory environments. We continue to prioritize the health and safety of our guests, crew and communities we visit and follow applicable travel guidelines and local protocols as required by the ports and destinations we visit.55 Table of Contents​The relaxation of protocols, continued easing of travel restrictions and reopening of most ports around the globe to cruise ships has improved travel experiences, expanded the addressable cruise market, allowed us to expand the variety of our itineraries and provided additional catalysts on the road to recovery.​Modified Policies​We have launched cancellation policies for certain sailings booked during certain time periods to permit certain guests to cancel cruises which were not part of a temporary suspension of voyages up to 15 days prior to embarkation for cruises embarking prior to December 31, 2022 or in the event of a positive COVID-19 test and receive a refund in the form of a credit to be applied toward a future cruise. Standard payment schedules and cancellation penalties apply for all sailings after December 31, 2022. The future cruise credits that have been issued as face value reimbursement for cancelled bookings due to COVID-19 are generally valid for any sailing through June 30, 2023, and we may further extend the length of time these future cruise credits may be redeemed. The use of such credits may prevent us from garnering certain future cash collections as staterooms booked by guests with such credits will not be available for sale, resulting in less cash collected from bookings to new guests. We may incur incremental commission expense for the use of these future cruise credits.​Financing Transactions In 2022 and 2023, we continued to take actions to bolster our financial condition as part of our long-term post-pandemic financial recovery strategy. In February 2022, we received additional financing through various debt financings, collectively totaling $2.1 billion in gross proceeds, which was used to redeem all of the outstanding 2024 Senior Secured Notes and 2026 Senior Secured Notes and to make scheduled principal payments on debt maturing in 2022, including, in each case, to pay any accrued and unpaid interest thereon, as well as related premiums, fees and expenses. In December 2022, we amended the Senior Secured Credit Facility to extend approximately $1.4 billion of maturities by one year to January 2025. The amendment also updated certain financial covenants and increased our ability to incur additional debt. Each of our export-credit backed facilities were also amended to conform the financial covenants with the Senior Secured Credit Facility. In February 2023, a commitment of $82.5 million in aggregate principal amount of the Revolving Loan Facility that was not previously extended was obtained to assign the commitment to a new lender under the same terms as the extending lenders.In February 2023, NCLC issued $600 million aggregate principal amount of 8.375% senior secured notes due 2028. The proceeds from the notes were used to repay the loans outstanding under our Term Loan A Facility that otherwise would have become due in January 2024, including to pay any accrued and unpaid interest thereon, as well as related premiums, fees and expenses. In July 2022, we amended our $1 billion commitment, which provided additional liquidity to the Company through March 31, 2023. In February 2023, the commitment was further extended through February 2024, with an option for NCLC to further extend the commitments through February 2025 at its election. Simultaneously, the amount of the commitment was reduced to $650 million, which may be drawn in up to two draws, and in connection with the execution of the amended commitment letter, NCLC issued $250 million aggregate principal amount of senior secured notes due 2028. NCLC will use the net proceeds for general corporate purposes. In February 2023, NCLC entered into a Backstop Agreement with MS, pursuant to which MS has agreed to provide backstop committed financing to refinance and/or repay in whole or in part up to $300 million of amounts outstanding under the Senior Secured Credit Facility.Refer to Note 8 – “Long-Term Debt” for further details about the above transactions.​​​56 Table of ContentsUpdate on Bookings ​The Company entered the year with a record cumulative booked position of approximately 62% for full year 2023, in line with previously outlined expectations and within the Company’s optimal 60% to 65% range, and at higher prices than 2019 at a similar point in time. Booking volumes have accelerated in recent months buoyed by strong WAVE season demand. The Company’s brands achieved several booking records in recent months including at Norwegian Cruise Line which reached an all-time record booking month in November, boosted by Black Friday and Cyber Monday, which was subsequently exceeded in January 2023. As a result, full year 2023 cumulative booked position is ahead of 2019 levels inclusive of the Company’s approximately 19% increase in capacity, at continued higher pricing. Net booking volumes continue to be at the pace needed to reach historical Occupancy levels for the second quarter of 2023 and beyond; however, our full fleet may not achieve historical Occupancy levels on our expected schedule and as a result, current booking data may not be informative. In addition, because of our cancellation policies, bookings may not be representative of actual cruise revenues.​There are uncertainties about when our full fleet will be back at historical occupancy levels and, accordingly, we cannot estimate the impact on our business, financial condition or near- or longer-term financial or operational results with certainty; however, we will report a net loss for the first quarter of 2023.Macroeconomic Trends and UncertaintiesAs a result of conditions associated with global events, including the downstream effects of the COVID-19 pandemic and Russia’s ongoing invasion of Ukraine and actions taken by the United States and other governments in response to the invasion, the global economy, including the financial and credit markets, has experienced significant volatility and disruptions, including increases in inflation rates, fuel prices, and interest rates. Our costs have been, and are expected to continue to be, adversely impacted by these increases. We have used, and may continue to use, derivative instruments to attempt to mitigate the risk of adverse changes in fuel prices and interest expense. In an attempt to mitigate risks related to inflation, our supply chain department has negotiated contracts with varying terms, with a goal of providing us with the ability to take advantage of cost declines when they occur, and diversified our sourcing options. These strategies may not fully offset the impact of current macroeconomic conditions. Furthermore, we are exposed to fluctuations in the euro exchange rate for certain portions of ship construction contracts that have not been hedged. See “Item 1A—Risk Factors” for additional information.Climate ChangeWe believe the increasing focus on climate change and evolving regulatory requirements will materially impact our future capital expenditures and results of operations. We expect to incur significant expenses related to these regulatory requirements, which may include expenses related to greenhouse gas emissions reduction initiatives and the purchase of emissions allowances, among other things. If requirements become more stringent, we may be required to change certain operating procedures, for example slowing the speed of our ships, which could adversely impact our operations. We are evaluating the effects of global climate change related requirements, which are still evolving, including our ability to mitigate certain future expenses through initiatives to reduce greenhouse gas emissions; consequently, the full impact to the Company is not yet known. Additionally, our ships, port facilities, corporate offices and island destinations have in the past and may again be adversely affected by an increase in the frequency and intensity of adverse weather conditions caused by climate change. For example, certain ports have become temporarily unavailable to us due to hurricane damage and other destinations have either considered or implemented restrictions on cruise operations due to environmental concerns. See Item 1A, “Risk Factors” for additional information. Executive OverviewTotal revenue increased 647.5% to $4.8 billion for the year ended December 31, 2022 compared to $0.6 billion for the year ended December 31, 2021. Capacity Days increased by 420.2%.For the year ended December 31, 2022, we had net loss and diluted EPS of $(2.3) billion and $(5.41), respectively. For the year ended December 31, 2021, we had net loss and diluted EPS of $(4.5) billion and $(12.33), respectively. 57 Table of ContentsOperating loss decreased 39.2% to $(1.6) billion for the year ended December 31, 2022 from $(2.6) billion for the year ended December 31, 2021.We had Adjusted Net Loss and Adjusted EPS of $(1.9) billion and $(4.64), respectively, for the year ended December 31, 2022, including $0.3 billion of adjustments primarily consisting of losses on the extinguishment and modification of debt and share-based compensation, compared to Adjusted Net Loss and Adjusted EPS of $(2.9) billion and $(8.07), respectively, for the year ended December 31, 2021. A 60.9% improvement in Adjusted EBITDA was incurred for the same period. We refer you to our “Results of Operations” below for a calculation of Adjusted Net Loss, Adjusted EPS and Adjusted EBITDA.Results of OperationsThe discussion below compares the results of operations for the year ended December 31, 2022 to the year ended December 31, 2021. You should read this discussion in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this annual report. For a comparison of the Company’s results of operations for the fiscal years ended December 31, 2021 to the year ended December 31, 2020, see “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the U.S. Securities and Exchange Commission on March 1, 2022. ​We reported total revenue, total cruise operating expense, operating loss and net loss as follows (in thousands, except per share data):​​​​​​​​​​Year Ended December 31, ​ 2022 2021Total revenue​$ 4,843,760​$ 647,986Total cruise operating expense​$ 4,267,086​$ 1,608,037Operating loss​$ (1,551,757)​$ (2,552,348)Net loss​$ (2,269,909)​$ (4,506,587)EPS:​ ​ Basic​$ (5.41)​$ (12.33)Diluted​$ (5.41)​$ (12.33)​58 Table of ContentsThe following table sets forth operating data as a percentage of total revenue:​​​​​​​​​Year Ended December 31, ​ 2022 2021 Revenue​​​​​Passenger ticket 67.2% 60.6%Onboard and other 32.8% 39.4%Total revenue 100.0% 100.0%Cruise operating expense Commissions, transportation and other 21.4% 22.2%Onboard and other 7.4% 8.3%Payroll and related 22.5% 82.9%Fuel 14.2% 46.6%Food 5.4% 9.7%Other 17.2% 78.4%Total cruise operating expense 88.1% 248.1%Other operating expense Marketing, general and administrative 28.5% 137.6%Depreciation and amortization 15.5% 108.2%Total other operating expense 44.0% 245.8%Operating loss (32.1)% (393.9)%Non-operating income (expense) Interest expense, net (16.5)% (319.9)%Other income (expense), net 1.6% 19.1%Total non-operating income (expense) (14.9)% (300.8)%Net loss before income taxes (47.0)% (694.7)%Income tax benefit (expense) 0.1% (0.8)%Net loss (46.9)% (695.5)%​The following table sets forth selected statistical information: ​​​​​​​Year Ended December 31, ​2022 2021 Passengers carried 1,663,275 232,448 Passenger Cruise Days 12,791,773 1,778,899 Capacity Days (1) 17,566,069 3,376,703 Occupancy Percentage 72.8% 52.7% (1)Excludes certain capacity on Pride of America which was temporarily unavailable.​​59 Table of ContentsAdjusted Gross Margin was calculated as follows (in thousands):​​​​​​​​​​​​Year Ended December 31, ​ ​​ 2022 ​​​​​​ Constant​​​​​​2022 Currency​2021Total revenue​$ 4,843,760​$ 4,891,222​$ 647,986Less:​ ​ ​ Total cruise operating expense​​ 4,267,086​​ 4,306,953​​ 1,608,037Ship depreciation​​ 700,988​​ 700,988​​ 650,138Gross Margin​​ (124,314)​​ (116,719)​​ (1,610,189)Ship depreciation​​ 700,988​​ 700,988​​ 650,138Payroll and related​​ 1,088,639​​ 1,089,184​​ 537,439Fuel​​ 686,825​​ 687,022​​ 301,852Food​ 263,807​ 267,500​ 62,999Other​ 835,254​ 857,657​ 508,186Adjusted Gross Margin​$ 3,451,199​$ 3,485,632​$ 450,425​Gross Cruise Cost, Net Cruise Cost, Net Cruise Cost Excluding Fuel and Adjusted Net Cruise Cost Excluding Fuel were calculated as follows (in thousands):​​​​​​​​​​​​​Year Ended December 31, ​​​​ 2022 ​​​ ​​ Constant ​​​​2022 Currency 2021Total cruise operating expense​$ 4,267,086​$ 4,306,953​$ 1,608,037Marketing, general and administrative expense​ 1,379,105​ 1,389,087​ 891,452Gross Cruise Cost​ 5,646,191​ 5,696,040​ 2,499,489Less:​ ​ ​ Commissions, transportation and other expense​ 1,034,629​ 1,047,658​ 143,524Onboard and other expense​ 357,932​ 357,932​ 54,037Net Cruise Cost​ 4,253,630​ 4,290,450​ 2,301,928Less: Fuel expense​ 686,825​ 687,022​ 301,852Net Cruise Cost Excluding Fuel​ 3,566,805​ 3,603,428​ 2,000,076Less Non-GAAP Adjustments:​ ​ ​ Non-cash deferred compensation (1)​ 2,797​ 2,797​ 3,619Non-cash share-based compensation (2)​ 113,563​ 113,563​ 124,077Restructuring costs (3)​​ 12,140​​ 12,140​​ —Adjusted Net Cruise Cost Excluding Fuel​$ 3,438,305​$ 3,474,928​$ 1,872,380(1)Non-cash deferred compensation expenses related to the crew pension plan and other crew expenses, which are included in payroll and related expense.(2)Non-cash share-based compensation expenses related to equity awards, which are included in marketing, general and administrative expense and payroll and related expense.(3)Restructuring costs related to the workforce reduction are included in marketing, general and administrative expense.​60 Table of ContentsAdjusted Net Loss and Adjusted EPS were calculated as follows (in thousands, except share and per share data):​​​​​​​​​​Year Ended December 31, ​ 2022 2021Net loss​$ (2,269,909)​$ (4,506,587)Non-GAAP Adjustments:​ ​ Non-cash deferred compensation (1)​ 4,048​ 4,012Non-cash share-based compensation (2)​ 113,563​ 124,077Restructuring costs (3)​ 12,140​ —Extinguishment and modification of debt (4)​ 193,374​ 1,428,813Adjusted Net Loss​$ (1,946,784)​$ (2,949,685)Diluted weighted-average shares outstanding - Net loss and Adjusted Net Loss​ 419,773,195​ 365,449,967Diluted loss per share​$ (5.41)​$ (12.33)Adjusted EPS​$ (4.64)​$ (8.07)(1)Non-cash deferred compensation expenses related to the crew pension plan and other crew expenses are included in payroll and related expense and other income (expense), net.(2)Non-cash share-based compensation expenses related to equity awards are included in marketing, general and administrative expense and payroll and related expense. (3) Restructuring costs related to the workforce reduction are included in marketing, general and administrative expense.(4)Losses on extinguishments and modifications of debt are primarily included in interest expense, net.​EBITDA and Adjusted EBITDA were calculated as follows (in thousands):​​​​​​​​​Year Ended December 31, ​ 2022 2021Net loss​$ (2,269,909)​$ (4,506,587)Interest expense, net​ 801,512​ 2,072,925Income tax (benefit) expense​ (6,794)​ 5,267Depreciation and amortization expense​ 749,326​ 700,845EBITDA​ (725,865)​ (1,727,550)Other (income) expense, net (1)​ (76,566)​ (123,953)Other Non-GAAP Adjustments:​ ​ Non-cash deferred compensation (2)​ 2,797​ 3,619Non-cash share-based compensation (3)​ 113,563​ 124,077Restructuring costs (4)​​ 12,140​​ —Adjusted EBITDA​$ (673,931)​$ (1,723,807)(1)Primarily consists of gains and losses, net of foreign currency remeasurements and derivatives not designated as hedges. (2)Non-cash deferred compensation expenses related to the crew pension plan and other crew expenses are included in payroll and related expense.(3)Non-cash share-based compensation expenses related to equity awards are included in marketing, general and administrative expense and payroll and related expense.(4)Restructuring costs related to the workforce reduction are included in marketing, general and administrative expense.​Year Ended December 31, 2022 (“2022”) Compared to Year Ended December 31, 2021 (“2021”)RevenueTotal revenue increased 647.5% to $4.8 billion in 2022 compared to $0.6 billion in 2021. In 2022, revenue primarily increased as we returned to service with 12.8 million Passenger Cruise Days compared to 1.8 million in 2021. 61 Table of ContentsExpenseTotal cruise operating expense increased 165.4% in 2022 compared to 2021. In 2022, the year started with 16 ships operating with guests onboard and ended with the entire 29-ship fleet in service compared to 2021, during which only 16 ships were returned to service in the second half of the year. In 2022, our cruise operating expenses increased as more ships resumed voyages, resulting in higher payroll, fuel, and direct variable costs of fully operating ships. Costs for certain items such as food, fuel and logistics also increased related to inflation. Gross Cruise Cost increased 125.9% in 2022 compared to 2021, primarily related to the change in costs described above plus an increase in marketing, general and administrative expenses primarily related to increased marketing costs as we returned to service. Total other operating expense increased 33.7% in 2022 compared to 2021 primarily due to the increase in marketing, general and administrative expenses. Interest expense, net was $0.8 billion in 2022 compared to $2.1 billion in 2021. The decrease in 2022 primarily reflects lower losses from extinguishment of debt and debt modification costs, which were $1.4 billion in 2021. Excluding these losses, interest expense increased primarily as a result of higher debt balances and higher rates partially offset by lower interest expense in connection with refinancings.Other income (expense), net was income of $76.6 million in 2022 compared to $124.0 million in 2021. Other income in 2022 and 2021 was primarily due to gains on fuel swaps not designated as hedges and foreign currency remeasurements.Liquidity and Capital ResourcesGeneralAs of December 31, 2022, our liquidity consisted of cash and cash equivalents of $0.9 billion and a $1 billion undrawn commitment, less related fees, available through March 31, 2023. Our primary ongoing liquidity requirements are to finance working capital, capital expenditures and debt service. As of December 31, 2022, we had a working capital deficit of $3.2 billion. This deficit included $2.5 billion of advance ticket sales, which represents the total revenue we collected in advance of sailing dates and accordingly are substantially more like deferred revenue balances rather than actual current cash liabilities. Our business model, along with our liquidity and undrawn export-credit backed facilities, allows us to operate with a working capital deficit and still meet our operating, investing and financing needs.In February 2022, we received additional financing through various debt financings, collectively totaling $2.1 billion in gross proceeds, which was used to redeem all of the outstanding 2024 Senior Secured Notes and 2026 Senior Secured Notes and to make scheduled principal payments on debt maturing in 2022, including, in each case, to pay any accrued and unpaid interest thereon, as well as related premiums, fees and expenses. In December 2022, we amended our Senior Secured Credit Facility to extend approximately $1.4 billion of maturities by one year to January 2025, subject to, if a one-time minimum liquidity threshold is not satisfied on September 16, 2024, a springing maturity date of September 16, 2024. The amendment also updated certain financial covenants and increased our ability to incur additional debt. Each of our export-credit backed facilities were also amended to conform the financial covenants with the Senior Secured Credit Facility. In February 2023, a commitment of $82.5 million in aggregate principal amount of the Revolving Loan Facility that was not previously extended was obtained to assign the commitment to a new lender under the same terms as the extending lenders.In February 2023, NCLC issued $600 million aggregate principal amount of 8.375% senior secured notes due 2028. The proceeds from the notes were used to repay the loans outstanding under our Term Loan A Facility that otherwise would have become due in January 2024, including to pay any accrued and unpaid interest thereon, as well as related premiums, fees and expenses. In July 2022, we amended our $1 billion commitment, which provided additional liquidity to the Company through March 31, 2023. In February 2023, the commitment was further extended through February 2024, with an option for NCLC to further extend the commitments through February 2025 at its election. Simultaneously, the amount of the commitment was reduced to $650 million, which may be drawn in up to two draws, and in connection with the execution 62 Table of Contentsof the amended commitment letter, NCLC issued $250 million aggregate principal amount of senior secured notes due 2028. NCLC will use the net proceeds for general corporate purposes. In February 2023, NCLC entered into a Backstop Agreement with MS, pursuant to which MS has agreed to provide backstop committed financing to refinance and/or repay in whole or in part up to $300 million of amounts outstanding under the Senior Secured Credit Facility at any time between October 4, 2023 and January 2, 2024.Refer to Note 8 – “Long-Term Debt” for further details about the above financing transactions.The estimation of our future cash flow projections includes numerous assumptions that are subject to various risks and uncertainties. Refer to Note 2 – “Summary of Significant Accounting Policies” for further information on liquidity and management’s plan. Refer to Item 1A, “Risk Factors” for further details regarding uncertainty related to Russia’s ongoing invasion of Ukraine and other risks and uncertainties that may cause our results to differ from our expectations.There can be no assurance that the accuracy of the assumptions used to estimate our liquidity requirements will be correct, and our ability to be predictive is uncertain due to the dynamic nature of the current operating environment, including the impacts of the COVID-19 global pandemic, Russia’s ongoing invasion of Ukraine and current macroeconomic conditions such as inflation, rising fuel prices and rising interest rates. Based on the liquidity estimates and our current resources, we have concluded we have sufficient liquidity to satisfy our obligations for at least the next 12 months. Nonetheless, we anticipate that we will need additional equity and/or debt financing to fund our operations in the future if a substantial portion of our fleet suspends cruise voyages or operates at reduced occupancy levels for a prolonged period. There is no assurance that cash flows from operations and additional financings will be available in the future to fund our future obligations. Beyond 12 months, we will pursue refinancings and other balance sheet optimization transactions from time to time in order to reduce interest expense or extend debt maturities. We expect to collaborate with financing institutions regarding these refinancing and optimization transactions as opportunities arise in the short-term to amend long-term arrangements.We have received amendments to certain financial and other debt covenants, including the modification of our free liquidity requirements. At December 31, 2022, taking into account such amendments, we were in compliance with all of our debt covenants. If we do not continue to remain in compliance with our covenants, we would have to seek additional amendments to or waivers of the covenants. However, no assurances can be made that such amendments or waivers would be approved by our lenders. Generally, if an event of default under any debt agreement occurs, then pursuant to cross default and/or cross acceleration clauses, substantially all of our outstanding debt and derivative contract payables could become due, and all debt and derivative contracts could be terminated, which would have a material adverse impact to our operations and liquidity.Since March 2020, Moody’s has downgraded our long-term issuer rating to B2, our senior secured rating to B1 and our senior unsecured rating to Caa1. In September 2022, Moody’s reaffirmed our current ratings. Since April 2020, S&P Global has downgraded our issuer credit rating to B, lowered our issue-level rating on our $875 million Revolving Loan Facility and $1.5 billion Term Loan A Facility to BB-, our issue-level rating on our other senior secured notes to B+ and our senior unsecured rating to B-. If our credit ratings were to be further downgraded, or general market conditions were to ascribe higher risk to our rating levels, our industry, or us, our access to capital and the cost of any debt or equity financing will be further negatively impacted. We also have capacity to incur additional indebtedness under our debt agreements and may issue additional ordinary shares from time to time, subject to our authorized number of ordinary shares. However, there is no guarantee that debt or equity financings will be available in the future to fund our obligations, or that they will be available on terms consistent with our expectations.​As of December 31, 2022, we had advance ticket sales of $2.7 billion, including the long-term portion, which included approximately $144.0 million of future cruise credits. We also have agreements with our credit card processors that, as of December 31, 2022, governed approximately $2.4 billion in advance ticket sales that had been received by the Company relating to future voyages. These agreements allow the credit card processors to require under certain circumstances, including the existence of a material adverse change, excessive chargebacks and other triggering events, that the Company maintain a reserve which would be satisfied by posting collateral. Although the agreements vary, these requirements may generally be satisfied either through a percentage of customer payments withheld or providing cash 63 Table of Contentsfunds directly to the card processor. Any cash reserve or collateral requested could be increased or decreased. As of December 31, 2022, we had cash collateral reserves of approximately $622.0 million with credit card processors, of which approximately $118.4 million is recognized in accounts receivable, net and approximately $503.6 million in other long-term assets. We may be required to pledge additional collateral and/or post additional cash reserves or take other actions that may reduce our liquidity.Sources and Uses of CashIn this section, references to 2022 refer to the year ended December 31, 2022, references to 2021 refer to the year ended December 31, 2021.Net cash provided by operating activities was $210.0 million in 2022 compared to net cash used in operating activities of $2.5 billion in 2021. The net cash used in operating activities included net losses due to the suspension of global cruise voyages from March 2020 through July 2021, the subsequent resumption of cruise voyages through May 2022 and the timing differences in cash receipts and payments relating to operating assets and liabilities. The net cash provided by operating activities in 2022 included net losses of $(2.3) billion, an increase in advance ticket sales of $928.9 million and loss on extinguishment of $188.8 million. The net cash used in operating activities in 2021 included net losses of $(4.5) billion and a decrease of $1.2 billion in cash from accounts receivable, which includes our collateral reserves with credit card processors, offset by an increase in advance ticket sales of $521.9 million and loss on extinguishment of $1.4 billion. Net cash used in investing activities was $1.8 billion in 2022, primarily related to the delivery of Norwegian Prima. Net cash used in investing activities was $1.0 billion in 2021, primarily related to newbuild payments and ship improvement projects and net purchases and maturities of short-term investments. Net cash provided by financing activities was $1.0 billion in 2022, primarily due to newbuild loans and the proceeds of $2.1 billion from our various note offerings partially offset by debt repayments and related redemption premiums associated with extinguishment of certain senior secured notes. Net cash provided by financing activities was $1.7 billion in 2021, primarily due to $2.6 billion in proceeds from the issuance of debt and $2.7 billion in proceeds from issuance of NCLH’s ordinary shares offset by $2.1 billion of debt principal repayments and $1.4 billion of early redemption premiums.For the Company’s cash flow activities for the fiscal year ended December 31, 2020, see “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the U.S. Securities and Exchange Commission on March 1, 2022.Future Capital CommitmentsFuture capital commitments consist of contracted commitments, including ship construction contracts. Anticipated expenditures related to ship construction contracts are $2.4 billion, $0.5 billion and $1.8 billion for the years ending December 31, 2023, 2024 and 2025, respectively. We have export-credit backed financing in place for the anticipated expenditures related to ship construction contracts of $1.9 billion, $0.1 billion and $1.1 billion for the years ending December 31, 2023, 2024 and 2025, respectively. Anticipated non-newbuild capital expenditures are $0.4 billion for the year ended December 31, 2023. Future expected capital expenditures will significantly increase our depreciation and amortization expense.For the Norwegian brand, we have five Prima Class Ships on order, each ranging from approximately 143,500 to 169,000 Gross Tons with 3,100 or more Berths, with currently scheduled delivery dates from 2023 through 2028. For the Regent brand, we have one Explorer Class Ship on order to be delivered in 2023, which will be approximately 55,000 Gross Tons and 750 Berths. For the Oceania Cruises brand, we have orders for two Allura Class Ships to be delivered in 2023 and 2025. Each of the Allura Class Ships will be approximately 67,000 Gross Tons and 1,200 Berths.64 Table of ContentsAs of December 31, 2022, the combined contract prices of the eight ships on order for delivery was approximately €6.7 billion, or $7.2 billion based on the euro/U.S. dollar exchange rate as of December 31, 2022. Contract amendments for certain of our ships that are or will become effective subsequent to December 31, 2022 will increase the contract cost by €1.2 billion, of which $0.5 billion is included in the anticipated expenditures related to ship construction contracts discussed above. We have obtained or expect to obtain fixed rate export-credit backed financing which is expected to fund approximately 80% of the contract price of each ship, subject to certain conditions. We do not anticipate any contractual breaches or cancellations to occur. However, if any such events were to occur, it could result in, among other things, the forfeiture of prior deposits or payments made by us and potential claims and impairment losses which may materially impact our business, financial condition and results of operations.Capitalized interest for the year ended December 31, 2022 and 2021 was $58.4 million and $43.6 million, respectively, primarily associated with the construction of our newbuild ships.Material Cash RequirementsAs of December 31, 2022, our material cash requirements for debt and ship construction were as follows (in thousands):​​​​​​​​​​​​​​​​​​​​​​​​2023 2024 2025 2026 2027 Thereafter TotalLong-term debt (1)​$ 1,649,354​$ 3,060,269​$ 2,818,257​$ 2,338,101​$ 3,284,454​$ 2,990,190​$ 16,140,625Ship construction contracts (2)​ 2,198,897​​ 275,232​​ 1,617,782​​ 1,827,114​​ 842,581​​ —​ 6,761,606Total​$ 3,848,251​$ 3,335,501​$ 4,436,039​$ 4,165,215​$ 4,127,035​$ 2,990,190​$ 22,902,231(1)Includes principal as well as estimated interest payments with LIBOR/SOFR held constant as of December 31, 2022. Includes exchangeable notes which can be settled in shares. Excludes the impact of any future possible refinancings and undrawn export-credit backed facilities. Subsequent to December 31, 2022, we completed various capital market and financing transactions, including issuing two series of notes totaling an aggregate principal amount of $850 million of senior secured notes due in 2028, of which approximately $600 million was used to repay the loans outstanding under our Term Loan A Facility that otherwise would have become due in January 2024. Additionally, a commitment of $82.5 million in aggregate principal amount of the Revolving Loan Facility was obtained, which will extend the maturity date of the assigned commitments by one year to January 2025. See Note 8 – “Long-Term Debt” for further information.(2)Ship construction contracts are for our newbuild ships based on the euro/U.S. dollar exchange rate as of December 31, 2022. As of December 31, 2022, we have committed undrawn export-credit backed facilities of $5.6 billion which funds approximately 80% of our ship construction contracts. After giving effect to an amendment to our newbuild agreements for the last two Prima Class Ships subsequent to December 31, 2022, our material cash requirements for ship construction contracts are as follows (in thousands):​​​​​​​​​​​​​​​​​​​​​​​​ 2023 2024 2025 2026 2027 Thereafter TotalShip construction contracts​$ 2,204,378​$ 213,353​$ 1,573,183​$ 1,071,080​$ 1,021,461​$ 952,200​$ 7,035,655​Excludes the impact of expected future ship construction contract amendments noted above. ​For other operational commitments for lease and port obligations we refer you to Note 5 – “Leases” and Note 13 – “Commitments and Contingencies,” respectively, for further information.Funding SourcesCertain of our debt agreements contain covenants that, among other things, require us to maintain a minimum level of liquidity, as well as limit our net funded debt-to-capital ratio and maintain certain other ratios. Approximately $13.7 billion of our assets are pledged as collateral for certain of our debt. We have received amendments to certain financial 65 Table of Contentsand other debt covenants, including the modification of our free liquidity requirements. After taking into account such amendments, we believe we were in compliance with these covenants as of December 31, 2022.In addition, our existing debt agreements restrict, and any of our future debt arrangements may restrict, among other things, the ability of our subsidiaries, including NCLC, to make distributions and/or pay dividends to NCLH and NCLH’s ability to pay cash dividends to its shareholders. NCLH is a holding company and depends upon its subsidiaries for their ability to pay distributions to it to finance any dividend or pay any other obligations of NCLH. However, we do not believe that these restrictions have had or are expected to have an impact on our ability to meet any cash obligations.​We believe our cash on hand, the impact of the undrawn commitment less related fees, the backstop financing available from October 4, 2023 through January 2, 2024, the expected return of a portion of the cash collateral from our credit card processors, expected future operating cash inflows and our ability to issue debt securities or additional equity securities, will be sufficient to fund operations, debt payment requirements, capital expenditures and maintain compliance with covenants under our debt agreements over the next 12-month period. Refer to “—Liquidity and Capital Resources—General” for further information regarding the debt covenant waivers and liquidity requirements. ​OtherCertain service providers may require collateral in the normal course of our business. The amount of collateral may change based on certain terms and conditions. As a routine part of our business, depending on market conditions, exchange rates, pricing and our strategy for growth, we regularly consider opportunities to enter into contracts for the building of additional ships. We may also consider the sale of ships, potential acquisitions and strategic alliances. If any of these transactions were to occur, they may be financed through the incurrence of additional permitted indebtedness, through cash flows from operations, or through the issuance of debt, equity or equity-related securities. We refer you to “—Liquidity and Capital Resources—General” for information regarding collateral provided to our credit card processors.Item 7A. Quantitative and Qualitative Disclosures about Market RiskGeneralWe are exposed to market risk attributable to changes in interest rates, foreign currency exchange rates and fuel prices. We attempt to minimize these risks through a combination of our normal operating and financing activities and through the use of derivatives. The financial impacts of these derivative instruments are primarily offset by corresponding changes in the underlying exposures being hedged. We achieve this by closely matching the notional, term and conditions of the derivatives with the underlying risk being hedged. We do not hold or issue derivatives for trading or other speculative purposes. Derivative positions are monitored using techniques including market valuations and sensitivity analyses.Interest Rate RiskAs of December 31, 2022, 75% of our debt was fixed and 25% was variable. As of December 31, 2021, 72% of our debt was fixed and 28% was variable, which includes the effects of an interest rate swap that matured during the year ended December 31, 2022. The notional amount of our outstanding debt associated with the interest rate swap was $0.2 billion as of December 31, 2021. The change in our fixed rate percentage from December 31, 2021 to December 31, 2022 was primarily due to the addition of fixed rate debt. Based on our December 31, 2022 outstanding variable rate debt balance, a one percentage point increase in annual LIBOR interest rates would increase our annual interest expense by approximately $34.1 million excluding the effects of capitalization of interest.66 Table of ContentsForeign Currency Exchange Rate RiskAs of December 31, 2022, we had foreign currency derivatives to hedge the exposure to volatility in foreign currency exchange rates related to our ship construction contracts denominated in euros. These derivatives hedge the foreign currency exchange rate risk on a portion of the payments on our ship construction contracts. The payments not hedged aggregate €4.5 billion, or $4.8 billion based on the euro/U.S. dollar exchange rate as of December 31, 2022. As of December 31, 2021, the payments not hedged aggregated €5.0 billion, or $5.7 billion, based on the euro/U.S. dollar exchange rate as of December 31, 2021. The change from December 31, 2021 to December 31, 2022 was due to the addition of foreign currency forwards and the delivery of Norwegian Prima. We estimate that a 10% change in the euro as of December 31, 2022 would result in a $0.5 billion change in the U.S. dollar value of the foreign currency denominated remaining payments.Fuel Price RiskOur exposure to market risk for changes in fuel prices relates to the forecasted purchases of fuel on our ships. Fuel expense, as a percentage of our total cruise operating expense, was 16.1% for the year ended December 31, 2022 and 18.8% for the year ended December 31, 2021. We use fuel derivative agreements to mitigate the financial impact of fluctuations in fuel prices and as of December 31, 2022, we had hedged approximately 50% of our 2023 projected metric tons of fuel purchases. As of December 31, 2021, we had hedged approximately 24% of our 2023 projected metric tons of fuel purchases. Additional fuel swaps were executed between December 31, 2021 to December 31, 2022 to lower our fuel price risk.We estimate that a 10% increase in our weighted-average fuel price would increase our anticipated 2023 fuel expense by $67.7 million. This increase would be partially offset by an increase in the fair value of our fuel swap agreements of $38.2 million. Fair value of our derivative contracts is derived using valuation models that utilize the income valuation approach. These valuation models take into account the contract terms such as maturity, as well as other inputs such as fuel types, fuel curves, creditworthiness of the counterparty and the Company, as well as other data points.​
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations​In Management’s Discussion and Analysis, we provide a historical and prospective narrative of our general financial condition, results of operations, liquidity and certain other factors that may affect our future results, including●an overview of the key drivers and other influences on the automotive aftermarket industry;●our results of operations for the years ended December 31, 2022 and 2021;●our liquidity and capital resources;●our critical accounting estimates; and●recent accounting pronouncements that may affect our Company.​The review of Management’s Discussion and Analysis should be made in conjunction with our consolidated financial statements, related notes and other financial information, forward-looking statements and other risk factors included elsewhere in this annual report. ​OVERVIEW​We are a specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States and Mexico. We are one of the largest U.S. automotive aftermarket specialty retailers, selling our products to both DIY customers and professional service providers – our “dual market strategy.” Our stores carry an extensive product line consisting of new and remanufactured automotive hard parts, maintenance items, accessories, a complete line of auto body paint and related materials, automotive tools and professional service provider service equipment. ​Our extensive product line includes an assortment of products that are differentiated by quality and price for most of the product lines we offer. For many of our product offerings, this quality differentiation reflects “good,” “better,” and “best” alternatives. Our sales and total gross profit dollars are, generally, highest for the “best” quality category of products. Consumers’ willingness to select products at a higher point on the value spectrum is a driver of enhanced sales and profitability in our industry. We have ongoing initiatives focused on marketing and training to educate customers on the advantages of ongoing vehicle maintenance, as well as “purchasing up” on the value spectrum.​Our stores also offer enhanced services and programs to our customers, including used oil, oil filter and battery recycling; battery, wiper and bulb replacement; battery diagnostic testing; electrical and module testing; check engine light code extraction; loaner tool program; drum and rotor resurfacing; custom hydraulic hoses; professional paint shop mixing and related materials; and machine shops. As of December 31, 2022, we operated 5,929 stores in 47 U.S. states and 42 stores in Mexico.​We are influenced by a number of general macroeconomic factors that impact both our industry and consumers, including, but not limited to, inflation, including rising consumer staples, fuel and energy costs, unemployment trends, interest rates and other economic factors. Future changes, such as continued broad-based inflation and rapid increases in fuel costs that exceed wage growth, may negatively impact our consumers’ level of disposable income, and we cannot predict the degree these changes, or other future changes, may have on our business or industry.​We believe the key drivers of demand over the long-term for the products sold within the automotive aftermarket include the number of U.S. miles driven, number of U.S. registered vehicles, annual rate of light vehicle sales and average vehicle age.​Number of Miles Driven The number of total miles driven in the U.S. influences the demand for repair and maintenance products sold within the automotive aftermarket. In total, vehicles in the U.S. are driven approximately three trillion miles per year, resulting in ongoing wear and tear and a corresponding continued demand for the repair and maintenance products necessary to keep these vehicles in operation. According to the U.S. Department of Transportation, the number of total miles driven in the U.S. decreased 13.2% in 2020, as a result of responses to the coronavirus pandemic, including work from home arrangements and reduced travel. In 2021, miles driven improved and increased 11.2%, and year-to-date through November of 2022, miles driven continued to improve, increasing 1.2%. Total miles driven can be impacted by macroeconomic factors, including rapid increases in fuel cost, but we are unable to predict the degree of impact these factors may have on miles driven in the future.​Size and Age of the Vehicle FleetThe total number of vehicles on the road and the average age of the vehicle population heavily influence the demand for products sold within the automotive aftermarket industry. As reported by the Auto Care Association, the total number of registered vehicles increased 12.1% from 2011 to 2021, bringing the number of light vehicles on the road to 279 million by the end of 2021. In 2022, the rate of new 26 ​vehicle sales was pressured due to supply chain constraints experienced by manufacturers, and the seasonally adjusted annual rate of light vehicle sales in the U.S. (“SAAR”) was below the historical average at approximately 13.3 million vehicles for the year ended December 31, 2022. From 2011 to 2021, vehicle scrappage rates have remained relatively stable, ranging from 4.1% to 5.7% annually. As a result, over the past decade, the average age of the U.S. vehicle population has increased, growing 11.0%, from 10.9 years in 2011 to 12.1 years in 2021. While the annual changes to the vehicle population resulting from new vehicle sales and the fluctuation in vehicle scrappage rates in any given year represent a small percentage of the total light vehicle population and have a muted impact on the total number and average age of vehicles on the road over the short term, we believe our business benefits from the current environment of new vehicle scarcity and higher than typical used vehicle prices, as consumers are more willing to continue to invest in their current vehicle.​We believe the increase in average vehicle age over the long term can be attributed to better engineered and manufactured vehicles, which can be reliably driven at higher mileages due to better quality power trains, interiors and exteriors, and the consumer’s willingness to invest in maintaining these higher-mileage, better built vehicles. As the average age of vehicles on the road increases, a larger percentage of miles are being driven by vehicles that are outside of a manufacturer warranty. These out-of-warranty, older vehicles generate strong demand for automotive aftermarket products as they go through more routine maintenance cycles, have more frequent mechanical failures and generally require more maintenance than newer vehicles. We believe consumers will continue to invest in these reliable, higher-quality, higher-mileage vehicles and these investments, along with an increasing total light vehicle fleet, will support continued demand for automotive aftermarket products.​Inflationary cost pressures impact our business; however, historically we have been successful, in many cases, in reducing the effects of merchandise cost increases, principally by taking advantage of supplier incentive programs, economies of scale resulting from increased volume of purchases and selective forward buying. To the extent our acquisition costs increase due to base commodity price increases or other input cost increases affecting the entire industry, we have typically been able to pass along these cost increases through higher selling prices for the affected products. As a result, we do not believe inflation has had a material adverse effect on our operations.​We remain confident in our ability to gain market share in our existing markets and grow our business in new markets by focusing on our dual market strategy and the core O’Reilly values of hard work and excellent customer service. ​​ ​27 ​RESULTS OF OPERATIONS​The table below compares the Company’s selected financial data over a ten-year period:​​​​​​​​​​​​​​​​​​​​​​Year ended December 31, 2022202120202019201820172016201520142013(In thousands, except per share, Team Members, stores and ratio data) ​​​​​​​​​​​​​​​​​​​​​​SELECT INCOME STATEMENT RELATED DATA: ​​​​​​​​​​​​​​​​​​​​​​Percentage increase in comparable store sales (a)(b) 6.4% 13.3% 10.9% 4.0% 3.8% 1.4% 4.8% 7.5% 6.0% 4.6% Sales ($) 14,409,860 13,327,563 11,604,493 10,149,985 9,536,428 8,977,726 8,593,096 7,966,674 7,216,081 6,649,237Gross profit 7,381,706 7,019,949 6,085,692 5,394,691 5,039,966 4,720,683 4,509,011 4,162,643 3,708,901 3,369,001Operating income 2,954,491 2,917,168 2,419,336 1,920,726 1,815,184 1,725,400 1,699,206 1,514,021 1,270,374 1,103,485Net income ($) (c)(d) 2,172,650 2,164,685 1,752,302 1,391,042 1,324,487 1,133,804 1,037,691 931,216 778,182 670,292Earnings per share – basic ($) 33.75 31.39 23.74 18.07 16.27 12.82 10.87 9.32 7.46 6.14Earnings per share – assuming dilution ($) (c)(d) 33.44 31.10 23.53 17.88 16.10 12.67 10.73 9.17 7.34 6.03​​​​​​​​​​​​​​​​​​​​​​SELECT BALANCE SHEET AND CASH FLOW RELATED DATA:​​​​​​​​​​​​​​​​​​​​​Total assets ($) (e) 12,627,979 11,718,707 11,596,642 10,717,160 7,980,789 7,571,885 7,204,189 6,676,684 6,532,083 6,057,895Total debt ($) (e)​ 4,371,653 3,826,978 4,123,217 3,890,527 3,417,122 2,978,390 1,887,019 1,390,018 1,388,422 1,386,895Shareholders’ equity ($) (c) (1,060,752) (66,423) 140,258 397,340 353,667 653,046 1,627,136 1,961,314 2,018,418 1,966,321Inventory turnover (f) 1.7 1.7 1.5 1.4 1.4 1.4 1.5 1.5 1.4 1.4Accounts payable to inventory (g) 134.9% 127.4% 114.5% 104.4% 105.7% 106.0% 105.7% 99.1% 94.6% 86.6% Cash provided by operating activities ($) (h) 3,148,250 3,207,310 2,836,603 1,708,479 1,727,555 1,403,687 1,510,713 1,345,488 1,190,430 908,026Capital expenditures ($) 563,342 442,853 465,579 628,057 504,268 465,940 476,344 414,020 429,987 395,881Free cash flow ($) (h)(i) 2,371,123 2,548,922 2,189,995 1,020,649 1,188,584 889,059 978,375 868,390 760,443 512,145​​​​​​​​​​​​​​​​​​​​​​SELECT OPERATING DATA: ​​​​​​​​​​​​​​​​​​​​​​Number of Team Members at year end 87,377 82,852 77,654 82,484 78,882 75,552 74,580 71,621 67,569 61,909Total number of stores at year end (j)(k) 5,971 5,784 5,616 5,460 5,219 5,019 4,829 4,571 4,366 4,166Number of U.S. stores at year end (j)​ 5,929 5,759 5,594 5,439 5,219 5,019 4,829 4,571 4,366 4,166Number of Mexico stores at year end (k)​ 42 25 22 21 — — — — — —Store square footage at year end (a)(l)​ 44,604 43,185 41,668 40,227 38,455 36,685 35,123 33,148 31,591 30,077Sales per weighted-average store ($) (a)(m) 2,415 2,298 2,057 1,881 1,842 1,807 1,826 1,769 1,678 1,614Sales per weighted-average square foot ($) (a)(l)(n) 322 307 277 255 251 248 251 244 232 224​(a)Represents O’Reilly’s U.S. operations only.(b)Comparable store sales are calculated based on the change in sales of U.S. stores open at least one year and excludes sales of specialty machinery, sales to independent parts stores, sales to Team Members, and sales from Leap Day during the years ended December 31, 2020 and 2016. Online sales, resulting from ship-to-home orders and pick-up-in-store orders for U.S. stores open at least one year are included in the comparable store sales calculation.(c)During the year ended December 31, 2017, the Company adopted a new accounting standard that requires excess tax benefits related to share-based compensation payments to be recorded through the income statement. In compliance with the standard, the Company did not restate prior period amounts to conform to current period presentation. The Company recorded a cumulative effect adjustment to opening retained earnings, due to the adoption of the new accounting standard. See Note 1 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements of the annual report on Form 10-K for the year ended December 31, 2017, for more information.(d)Following the enactment of the U.S. Tax Cuts and Jobs Act in December of 2017, the Company revalued its deferred income tax liabilities, which resulted in a one-time benefit to the Company’s Consolidated Statement of Income for the years ended December 31, 2018 and 2017. See Note 13 “Income Taxes” to the Consolidated Financial Statements of the annual report on Form 10-K for the year ended December 31, 2018, for more information.(e)Certain prior period amounts have been reclassified to conform to current period presentation, due to the Company’s adoption of new accounting standards during the fourth quarter ended December 31, 2015. See Note 1 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements of the annual report on Form 10-K for the year ended December 31, 2015, for more information.(f)Inventory turnover is calculated as cost of goods sold for the last 12 months divided by average inventory. Average inventory is calculated as the average of inventory for the trailing four quarters used in determining the denominator.(g)Accounts payable to inventory is calculated as accounts payable divided by inventory.28 ​ (h)Certain prior period amounts have been reclassified to conform to current period presentation, due to the Company’s adoption of a new accounting standard during the first quarter ended March 31, 2017. See Note 1 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements of the annual report on Form 10-K for the year ended December 31, 2017, for more information.(i)Free cash flow is calculated as net cash provided by operating activities less capital expenditures, excess tax benefit from share-based compensation payments and investment in tax credit equity investments for the period.(j)In 2016 and 2018, the Company acquired materially all assets of Bond Auto Parts (“Bond”) and Bennett Auto Supply, Inc. (“Bennett”), respectively. After the close of business on December 31, 2018, the Company acquired substantially all of the non-real estate assets of Bennett, including 33 stores that were not included in the 2018 store count and were not operated by the Company in 2018, but beginning January 1, 2019, the operations of the acquired Bennett locations were included in the Company’s store count, and during the year ended December 31, 2019, the Company merged 13 of these acquired Bennett stores into existing O’Reilly locations and rebranded the remaining 20 Bennett stores as O’Reilly stores. Financial results for these acquired companies have been included in the Company’s consolidated financial statements from the dates of the acquisitions forward.(k)In 2019, the Company acquired Mayoreo de Autopartes y Aceites, S.A. de C.V. (“Mayasa”), which added 21 stores to the O’Reilly store count. Financial results for this acquired company have been included in the Company’s consolidated financial statements beginning from the date of the acquisition.(l)Square footage includes normal selling, office, stockroom and receiving space.(m)Sales per weighted-average store are weighted to consider the approximate dates of store openings, acquisitions or closures.(n)Sales per weighted-average square foot are weighted to consider the approximate dates of domestic store openings, acquisitions, expansions or closures. ​The following table includes income statement data as a percentage of sales, which is calculated independently and may not compute to presented totals due to rounding differences, for the years ended December 31, 2022 and 2021:​​​​​​​​​For the Year Ended ​​December 31, ​ 2022​2021Sales 100.0% ​ 100.0% Cost of goods sold, including warehouse and distribution expenses 48.8​​ 47.3 Gross profit 51.2​​ 52.7 Selling, general and administrative expenses 30.7​​ 30.8 Operating income 20.5 ​ 21.9 Interest expense (1.1)​​ (1.1) Interest income —​​ 0.1 Income before income taxes 19.4​​ 20.9​Provision for income taxes 4.3​​ 4.6 Net income (1) 15.1% ​ 16.2% (1) Each percentage of sales amount is calculated independently and may not compute to presented totals.​2022 Compared to 2021​Sales:Sales for the year ended December 31, 2022, increased $1.08 billion, or 8%, to $14.41 billion from $13.33 billion for the same period in 2021. Comparable store sales for stores open at least one year increased 6.4% and 13.3% for the years ended December 31, 2022 and 2021, respectively. Comparable store sales are calculated based on changes in sales for U.S. stores open at least one year and exclude sales of specialty machinery, sales to independent parts stores and sales to Team Members. Online sales, resulting from ship-to-home orders and pickup in-store orders for U.S. stores open at least one year are included in the comparable store sales calculation.​29 ​The following table presents the components of the increase in sales for the year ended December 31, 2022 (in millions):​​​​​ Increase in Sales for the Year Ended ​​December 31, 2022,​​Compared to the Same Period in 2021Store sales: ​ Comparable store sales​$ 835Non-comparable store sales:​ ​Sales for U.S. stores opened throughout 2021, excluding stores open at least one year that are included in comparable store sales, and Mexico store sales​ 95Sales for U.S. stores opened throughout 2022​ 137Sales for stores that have closed, including temporarily closed stores​ (6)Non-store sales:​ ​Includes sales of machinery, sales to independent parts stores and sales to Team Members​ 21Total increase in sales​$ 1,082​We believe the increased sales are the result of store growth, the high levels of customer service provided by our well-trained and technically proficient Team Members, superior inventory availability, including same day and over-night access to inventory from our regional distribution centers and hub store network, enhanced services and programs offered in our stores, a broader selection of product offerings in most stores with a dynamic catalog system to identify and source parts, a targeted promotional and advertising effort through a variety of media and localized promotional events, continued improvement in the merchandising and store layouts of our stores, the Omnichannel experience, compensation programs for all store Team Members that provide incentives for performance and our continued focus on serving both DIY and professional service provider customers. In addition, the strength of our distribution network and our strong supplier relationships allowed us to maintain better in-stock inventory positions than the broader market and contributed to our sales growth. ​Our comparable store sales increase for the year ended December 31, 2022, was driven by increases in average ticket values for both professional service provider and DIY customers and positive transaction counts from professional service provider customers, partially offset by negative transaction counts from DIY customers. Average ticket values benefited from increases in average selling prices, on a same-SKU basis, as compared to 2021, driven by increases in acquisition costs of inventory, which were passed on in selling prices. Average ticket values also continue to be positively impacted by the increasing complexity and cost of replacement parts necessary to maintain the current population of better-engineered and more technically advanced vehicles. These better-engineered, more technically advanced vehicles require less frequent repairs, as the component parts are more durable and last for longer periods of time. The resulting decrease in repair frequency creates pressure on customer transaction counts; however, when repairs are needed, the cost of replacement parts is, on average, greater, which is a benefit to average ticket values. The decrease in DIY customer transaction counts was driven by a challenging comparison to the strong transaction counts in 2021, which were aided by government stimulus, and broad-based inflationary pressures on the consumer.​We opened 187 and 168 net, new stores during the years ended December 31, 2022 and 2021, respectively. We anticipate new store growth will be 180 to 190 net, new store openings in 2023.​Gross profit:Gross profit for the year ended December 31, 2022, increased 5% to $7.38 billion (or 51.2% of sales) from $7.02 billion (or 52.7% of sales) for the same period in 2021. The increase in gross profit dollars for the year ended December 31, 2022, was primarily the result of new store sales and the increase in comparable store sales at existing stores. The decrease in gross profit as a percentage of sales for the year ended December 31, 2022, was due to the impact from the rollout of our professional pricing initiative, which was a strategic investment aimed at ensuring we are more competitively priced on the professional side of our business; a greater percentage of our total sales mix generated from professional service provider customers, which carry a lower gross margin than DIY sales; and a greater benefit in the prior year from selling through inventory purchased prior to recent acquisition cost increases and corresponding selling price increases. We determine inventory cost using the last-in, first-out (“LIFO”) method but had, over time, seen our LIFO reserve balance exhausted, which resulted in a LIFO inventory value above replacement cost prior to September 30, 2021. As our policy is to not write-up inventory in excess of replacement cost, we had been effectively valuing our inventory at replacement cost, which resulted in a benefit when selling prices increased as we sold through this lower cost inventory. In the third quarter of 2021, our LIFO reserve reverted back to a more typical credit balance, due to the significant inflationary acquisition cost increases. During the three months ended March 31, 2022, we realized the final benefit from selling through inventory valued at the older, lower replacement cost, at a lesser amount than the full year benefit received in 2021. ​30 ​Selling, general and administrative expenses:Selling, general and administrative expenses (“SG&A”) for the year ended December 31, 2022, increased 8% to $4.43 billion (or 30.7% of sales) from $4.10 billion (or 30.8% of sales) for the same period in 2021. The increase in total SG&A dollars for the year ended December 31, 2022, was the result of additional Team Members, facilities and vehicles to support our increased sales and store count, inflationary pressures on wages, benefits and fuel costs, as compared to the same period one year ago, and a non-cash charge associated with our transition to an enhanced paid time-off program for our Team Members. The decrease in SG&A as a percentage of sales for the year ended December 31, 2022, was principally due to leverage of fixed store operating costs on strong comparable store sales, partially offset by inflationary pressures on wages, benefits and fuel costs, as compared to the same period one year ago, and the charge associated with our transition to an enhanced paid time-off program.​Operating income:As a result of the impacts discussed above, operating income for the year ended December 31, 2022, increased 1% to $2.95 billion (or 20.5% of sales) from $2.92 billion (or 21.9% of sales) for the same period in 2021.​Other income and expense:Total other expense for the year ended December 31, 2022, increased 15% to $156 million (or 1.1% of sales), from $135 million (or 1.0% of sales) for the same period in 2021. The increase in total other expense for the year ended December 31, 2022, was the result of increased interest expense on higher average outstanding borrowings, as well as a decrease in the value of our trading securities, as compared to an increase in the same period in 2021. ​Income taxes:Our provision for income taxes for the year ended December 31, 2022, increased 1% to $626 million (22.4% effective tax rate) from $617 million (22.2% effective tax rate) for the same period in 2021. The increase in our provision for income taxes for the year ended December 31, 2022, was the result of higher taxable income and lower excess tax benefits from share-based compensation. The increase in our effective tax rate for the year ended December 31, 2022, was the result of the lower excess tax benefits from share-based compensation. ​Net income:As a result of the impacts discussed above, net income for the year ended December 31, 2022, increased to $2.17 billion (or 15.1% of sales), from $2.16 billion (or 16.2% of sales) for the same period in 2021.​Earnings per share:Our diluted earnings per common share for the year ended December 31, 2022, increased 8% to $33.44 on 65 million shares from $31.10 on 70 million shares for the same period in 2021. ​2021 Compared to 2020​A discussion of the changes in our results of operations for the year ended December 31, 2021, as compared to the year ended December 31, 2020, has been omitted from this Form 10-K but may be found in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the annual report on Form 10-K for the year ended December 31, 2021, filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2022, which is available free of charge on the SEC’s website at www.sec.gov by searching with our ticker symbol “ORLY” or at our internet address, www.OReillyAuto.com, by clicking “Investor Relations” located at the bottom of the page. ​LIQUIDITY AND CAPITAL RESOURCES​Our long-term business strategy requires capital to invest open new stores, fund strategic acquisitions, expand distribution infrastructure, operate and maintain our existing stores, develop enhanced information technology systems and tools and may include the opportunistic repurchase of shares of our common stock through our Board-approved share repurchase program. Our material cash requirements necessary to maintain the current operations of our long-term business strategy include, but are not limited to, inventory purchases, human capital obligations, including payroll and benefits, contractual obligations, including debt and interest obligations, capital expenditures, payment of income taxes and other operational priorities. We expect to fund our short- and long-term cash and capital requirements with our primary sources of liquidity, which include funds generated from the normal course of our business operations, borrowings under our unsecured revolving credit facility and senior note offerings. However, there can be no assurance that we will continue to generate cash flows or maintain liquidity at or above recent levels, as we are unable to predict decreased demand for our 31 ​products or changes in customer buying patterns. Additionally, these factors could also impact our ability to meet the debt covenants of our credit agreement and, therefore, negatively impact the funds available under our unsecured revolving credit facility. ​Our material contractual cash obligations as of December 31, 2022, included commitments for short and long-term debt arrangements and interest payments related to long-term debt, future minimum payments under non-cancelable lease arrangements, self-insurance reserves, projected obligations related to future payments under the Company’s nonqualified deferred compensation plan, purchase obligations for construction contract commitments, uncertain tax positions and associated estimated interest and penalties, payments for certain deferred income taxes and commitments for the purchase of inventory. We expect to fund these various commitments and obligations primarily with operating cash flows expected to be generated in the normal course of business or through borrowings under our unsecured revolving credit facility. See Note 5 “Leases,” Note 12 “Share-Based Compensation and Benefit Plans,” Note 13 “Commitments” and Note 15 “Income Taxes” to the Consolidated Financial Statements for further information on our leasing arrangements, share-based compensation payments, construction commitments and uncertain tax positions, respectively, which are not reflected in the table below. ​The following table identifies the estimated payments for each of the next five years, and in the aggregate thereafter, of the Company’s debt instruments and related interest payments and self-insurance reserves as of December 31, 2022 (in thousands):​​​​​​​​​December 31, 2022​​Long-Term Debt Principal​Self-Insurance​ and Interest Payments (1) Reserves (2)2023​$ 463,275​$ 138,9262024​ 157,500​ 40,3472025​ 157,500​ 27,8032026​ 647,650​ 16,7362027​​ 887,950​ 8,192Thereafter​​ 3,153,025​ 13,558Contractual cash obligations​$ 5,466,900​$ 245,562(1)See Note 7 “Financing” to the Consolidated Financial Statements for further information on our debt instruments and related interest payments.(2)See Note 13 “Commitments” and Note 1 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements for further information on our self-insurance reserves.​Due to the absence of scheduled maturities, the nature of the account or the commitment’s cancellation terms, the timing of payments for certain deferred income taxes, uncertain tax positions and commitments related to future payments under the Company’s nonqualified compensation plan cannot be determined and are therefore excluded from the above table, except for amounts estimated to be payable in 2023, which are included in “Current liabilities” on our Consolidated Balance Sheets.​Off-balance sheet arrangements are transactions, agreements, or other contractual arrangements with an unconsolidated entity, for which we have an obligation to the entity that is not recorded in our consolidated financial statements. We have entered into an agreement to make capital contributions to certain tax credit equity investments for the purpose of receiving renewable energy tax credits. We are required to make capital contributions totaling $3.4 million upon achievement of project milestones by the solar or wind energy farms, the timing of which is variable and outside of the Company’s control. See Note 7 “Financing” to the Consolidated Financial Statements for further information on our stand-by letters of credit. ​We do not have any off-balance sheet financing that has, or is reasonably likely to have, a material, current or future effect on our financial condition, cash flows, results of operations, liquidity, capital expenditures or capital resources. ​32 ​The following table identifies cash provided by/(used in) our operating, investing and financing activities for the years ended December 31, 2022, 2021 and 2020 (in thousands):​​​​​​​​​​​​For the Year Ended ​​December 31, Liquidity: 2022 2021 2020Total cash provided by/(used in): ​ ​ ​ Operating activities​$ 3,148,250​$ 3,207,310​$ 2,836,603Investing activities​ (739,985)​ (615,620)​ (614,895)Financing activities​ (2,662,536)​ (2,694,858)​ (1,796,577)Effect of exchange rate changes on cash​​ 741​​ (359)​​ 103Net (decrease) increase in cash and cash equivalents​$ (253,530)​$ (103,527)​$ 425,234​​​​​​​​​​Capital expenditures​$ 563,342​$ 442,853​$ 465,579Free cash flow (1)​​ 2,371,123​​ 2,548,922​ 2,189,995(1)Calculated as net cash provided by operating activities, less capital expenditures, excess tax benefit from share-based compensation payments and investment in tax credit equity investments for the period. See page 35 for the reconciliation of the calculation of free cash flow. ​Cash and cash equivalents balances held outside of the U.S. were $11.1 million and $7.5 million as of December 31, 2022 and 2021, respectively, which was generally utilized to support the liquidity needs of foreign operations in Mexico.​Operating activities:The decrease in net cash provided by operating activities in 2022 compared to 2021 was primarily due to a larger decrease in accrued benefits and withholdings. The larger decrease in accrued benefits and withholdings was primarily due to higher accrued incentive compensation payments in 2022 versus 2021. ​Investing activities:The increase in net cash used in investing activities in 2022 compared to 2021 was primarily the result of an increase in capital expenditures. The increase in capital expenditures was primarily due to an increase in store and distribution enhancement and expansion projects in 2022 versus 2021. ​We opened 187 and 168 net, new stores in 2022 and 2021, respectively. We plan to open 180 to 190 net, new stores in 2023. The costs associated with the expected openings of owned store locations in 2023, including the cost of land acquisition, building construction, fixtures, vehicles, net inventory investment and computer equipment, are estimated to average approximately $2.8 million to $3.0 million per store; however, such costs may be significantly reduced where we lease, rather than purchase, the store site.​Financing activities:The decrease in net cash used in financing activities in 2022 compared to 2021 was primarily attributable to net proceeds from the issuance of long-term debt in 2022, partially offset by an increase in repurchases of our common stock in 2022.​2021 Compared to 2020:A discussion of the changes in our operating activities, liquidity activities and financing activities for the year ended December 31, 2021, as compared to the year ended December 31, 2020, has been omitted from this Form 10-K but may be found in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the annual report on Form 10-K for the year ended December 31, 2021, filed with the Securities and Exchange Commission (the “SEC”) on February 28, 2022, which is available free of charge on the SEC’s website at www.sec.gov by searching with our ticker symbol “ORLY” or at our internet address, www.OReillyAuto.com, by clicking “Investor Relations” located at the bottom of the page.​Debt instruments:See Note 7 “Financing” to the Consolidated Financial Statements for information concerning the Company’s credit agreement, unsecured revolving credit facility, outstanding letters of credit and unsecured senior notes. ​Debt covenants:The indentures governing our senior notes contain covenants that limit our ability and the ability of certain of our subsidiaries to, among other things, create certain liens on assets to secure certain debt and enter into certain sale and leaseback transactions, and limit our ability to merge or consolidate with another company or transfer all or substantially all of our property, in each case as set forth in the 33 ​indentures. These covenants are, however, subject to a number of important limitations and exceptions. As of December 31, 2022, we were in compliance with the covenants applicable to our senior notes.​The Credit Agreement contains certain covenants, including limitations on indebtedness, a minimum consolidated fixed charge coverage ratio of 2.50:1.00 and a maximum consolidated leverage ratio of 3.50:1.00. The consolidated fixed charge coverage ratio includes a calculation of earnings before interest, taxes, depreciation, amortization, rent and non-cash share-based compensation expense to fixed charges. Fixed charges include interest expense, capitalized interest and rent expense. The consolidated leverage ratio includes a calculation of adjusted debt to earnings before interest, taxes, depreciation, amortization, rent and non-cash share-based compensation expense. Adjusted debt includes outstanding debt, outstanding stand-by letters of credit and similar instruments and five-times rent expense and excludes any premium or discount recorded in conjunction with the issuance of long-term debt. In the event that we should default on any covenant contained within the Credit Agreement, certain actions may be taken, including, but not limited to, possible termination of commitments, immediate payment of outstanding principal amounts plus accrued interest and other amounts payable under the Credit Agreement and litigation from our lenders.​We had a consolidated fixed charge coverage ratio of 6.71 times and 6.97 times as of December 31, 2022 and 2021, respectively, and a consolidated leverage ratio of 1.73 times and 1.59 times as of December 31, 2022 and 2021, respectively, remaining in compliance with all covenants related to the borrowing arrangements. ​34 ​The table below outlines the calculations of the consolidated fixed charge coverage ratio and consolidated leverage ratio covenants, as defined in the Credit Agreement governing the Revolving Credit Facility, for the years ended December 31, 2022 and 2021 (dollars in thousands):​​​​​​​​​​​For the Year Ended​​​December 31, ​​ 2022 2021GAAP net income​$ 2,172,650​$ 2,164,685Add:Interest expense​ 157,720​ 144,768​Rent expense (1)​ 393,032​ 372,022​Provision for income taxes​ 626,005​ 617,229​Depreciation expense​ 352,224​ 320,352​Amortization expense​ 5,709​ 7,865​Non-cash share-based compensation​ 26,458​ 24,656Non-GAAP EBITDAR​$ 3,733,798​$ 3,651,577​​​​​​​​Interest expense​$ 157,720​$ 144,768​Capitalized interest​ 5,488​ 7,001​Rent expense (1)​ 393,032​ 372,022Total fixed charges​$ 556,240​$ 523,791​​​​​​​​Consolidated fixed charge coverage ratio​ 6.71​ 6.97​​​​​​​​GAAP debt​$ 4,371,653​$ 3,826,978Add:Stand-by letters of credit​ 101,741​ 83,985​Discount on senior notes​ 6,285​ 4,360​Debt issuance costs​ 22,062​ 18,662​Five-times rent expense​ 1,965,160​ 1,860,110Non-GAAP adjusted debt​$ 6,466,901​$ 5,794,095​​​​​​​​Consolidated leverage ratio​ 1.73​ 1.59​(1)The table below outlines the calculation of Rent expense and reconciles Rent expense to Total lease cost, per Accounting Standard Codification 842 (“ASC 842”), the most directly comparable GAAP financial measure, for the years ended December 31, 2022 and 2021 (in thousands):​​​​​Total lease cost, per ASC 842, for the year ended December 31, 2022 $ 467,758Less:Variable non-contract operating lease components, related to property taxes and insurance, for the year ended December 31, 2022​ 74,726Rent expense for the year ended December 31, 2022​$ 393,032​​​​​Total lease cost, per ASC 842, for the year ended December 31, 2021​$ 443,484Less:Variable non-contract operating lease components, related to property taxes and insurance, for the year ended December 31, 2021​​ 71,462Rent expense for the year ended December 31, 2021​$ 372,022​The table below outlines the calculation of Free cash flow and reconciles Free cash flow to Net cash provided by operating activities, the most directly comparable GAAP financial measure, for the years ended December 31, 2022, 2021 and 2020 (in thousands):​​​​​​​​​​​​​​For the Year Ended ​​​December 31, ​​ 2022 2021 2020Cash provided by operating activities ​$ 3,148,250​$ 3,207,310​$ 2,836,603Less:Capital expenditures​ 563,342​ 442,853​ 465,579​Excess tax benefit from share-based compensation payments​ 25,503​ 35,202​ 16,918​Investment in tax credit equity investments​ 188,282​ 180,333​ 164,111Free cash flow​$ 2,371,123​$ 2,548,922​$ 2,189,995​Free cash flow, the consolidated fixed charge coverage ratio and the consolidated leverage ratio discussed and presented in the tables above are not derived in accordance with United States generally accepted accounting principles (“GAAP”). We do not, nor do we suggest investors should, consider such non-GAAP financial measures in isolation from, or as a substitute for, GAAP financial 35 ​information. We believe that the presentation of our free cash flow, consolidated fixed charge coverage ratio and consolidated leverage ratio provides meaningful supplemental information to both management and investors and reflects the required covenants under the Credit Agreement. We include these items in judging our performance and believe this non-GAAP information is useful to investors as well. Material limitations of these non-GAAP measures are that such measures do not reflect actual GAAP amounts. We compensate for such limitations by presenting, in the tables above, a reconciliation to the most directly comparable GAAP measures.​Share repurchase program:See Note 9 “Share Repurchase Program” to the Consolidated Financial Statements for information on our share repurchase program. ​CRITICAL ACCOUNTING ESTIMATES​The preparation of our financial statements in accordance with GAAP requires the application of certain estimates and judgments by management. Management bases its assumptions, estimates and adjustments on historical experience, current trends and other factors believed to be relevant at the time the consolidated financial statements are prepared. Management believes that the following policies are critical due to the inherent uncertainty of these matters and the complex and subjective judgments required in establishing these estimates. Management continues to review these critical accounting estimates and assumptions to ensure that the consolidated financial statements are presented fairly in accordance with GAAP. However, actual results could differ from our assumptions and estimates and such differences could be material.​Self-Insurance Reserves:We use a combination of insurance and self-insurance mechanisms to provide for potential liabilities from workers’ compensation, general liability, vehicle liability, property loss and Team Member health care benefits. With the exception of certain Team Member health care benefit liabilities, employment related claims and litigation, certain commercial litigation and certain regulatory matters, we obtain third-party insurance coverage to limit our exposure for any individual workers’ compensation, general liability, vehicle liability or property loss claim. ​When estimating our self-insurance liabilities, we consider a number of factors, including historical claims experience and trend-lines, projected medical and legal inflation, growth patterns and exposure forecasts. The assumptions made by management as they relate to each of these factors represent our judgment as to the most probable cumulative impact of each factor to our future obligations. Certain of the self-insurance liabilities are determined at an estimate of their net present value, using the U.S. treasury risk-free rate. Our calculation of self-insurance liabilities requires management to apply a significant amount of subjective judgment to estimate the ultimate cost to resolve reported claims and claims incurred but not yet reported as of the balance sheet date. The application of alternative assumptions could result in a different estimate of these liabilities. Management believes the assumptions developed and used to determine the estimate for our self-insurance reserve are reasonable. Actual claim activity or development may vary from our assumptions and estimates, which may result in material losses or gains. ​As we obtain additional information that affects the assumptions and estimates we used to recognize liabilities for claims incurred in prior accounting periods, we adjust our self-insurance liabilities to reflect the revised estimates based on this additional information. These liabilities are recorded at our estimate of their net present value. These liabilities do not have scheduled maturities, but we can estimate the timing of future payments based upon historical patterns. We could apply alternative assumptions regarding the timing of payments that could result in materially different estimates of the net present value of the liabilities. ​Our self-insurance reserve estimate included on our Consolidated Balance Sheets increased $11 million from 2021 to 2022, which is primarily due to our growing operations, inflation, increases in healthcare costs, the number of vehicles and the number of hours worked, as well as our historical claims experience. If the underlying assumptions in management’s estimate changed self-insurance reserves 10% from our estimated reserves at December 31, 2022, the financial impact would have been approximately $23 million or 0.8% of pretax income for the year ended December 31, 2022. See Note 1 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements for further information on our self-insurance reserves.​Valuation of Long-Lived Assets:We evaluate the carrying value of finite and indefinite long-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of these assets might exceed their current fair values. As a component of the finite long-lived assets evaluation, we review performance at the store level to identify any stores with current period operating losses that should be considered for impairment. A potential impairment has occurred if the projected future undiscounted cash flows realized from the best possible use of the asset are less than the carrying value of the asset. The estimate of cash flows includes management’s assumptions of cash inflows and outflows directly resulting from the use of that asset in operations. If the carrying amount of an asset exceeds its estimated future 36 ​cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the assets. ​As a component of the indefinite long-lived assets evaluation, we perform a qualitative assessment to determine if events or circumstances that could affect the inputs used to determine the fair value of the intangible asset have occurred, as well as if they continue to support an indefinite useful life. Areas evaluated include changes in cost factors such as raw materials or labor, financial performance including declining revenues or cash flows, the legal, regulatory and political environment, and other industry and market considerations, including the competitive environment and changes in product demand. If events or market conditions exist that would more likely than not indicate that impairment may be necessary, a detailed quantitative assessment would be performed. ​Based on our qualitative assessment, we do not believe there has been a change of events or circumstances that would indicate that a calculation of fair value of indefinite long-lived assets is required as of December 31, 2022. Our impairment analyses contain estimates due to the inherently judgmental nature of forecasting long-term estimated cash flows and determining the ultimate useful lives and fair values of the assets. Actual results could differ from these estimates, which could materially impact our impairment assessment. See Note 6 “Goodwill and Other Intangibles” to the Consolidated Financial Statements for further information on our finite and indefinite long-lived assets. ​RECENT ACCOUNTING PRONOUNCEMENTS​See Note 1 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements for information about recent accounting pronouncements. ​​37 ​Item 7A. Quantitative and Qualitative Disclosures about Market Risk​Interest rate risk:We are subject to interest rate risk to the extent we borrow against our unsecured revolving credit facility (the “Revolving Credit Facility”) with variable interest rates based on either an Alternative Base Rate or Adjusted LIBO Rate, as defined in the credit agreement governing the Revolving Credit Facility. As of December 31, 2022, we had no outstanding borrowings under our Revolving Credit Facility.​We had outstanding fixed rate debt of $4.4 billion and $3.9 billion as of December 31, 2022 and 2021, respectively. The fair value of our fixed rate debt was estimated at $4.1 billion as of December 31, 2022 and 2021, respectively, which was determined by reference to quoted market prices.​Cash equivalents risk:We invest certain of our excess cash balances in short-term, highly-liquid instruments with maturities of 90 days or less. We do not expect any material losses from our invested cash balances and we believe that our interest rate exposure is minimal. As of December 31, 2022, our cash and cash equivalents totaled $108.6 million.​Foreign currency risk:Foreign currency exposures arising from transactions include firm commitments and anticipated transactions denominated in a currency other than our entities’ functional currencies. To minimize our risk, we generally enter into transactions denominated in the respective functional currencies. Our foreign currency exposure arises from Mexican peso-denominated revenues and profits and their translation into U.S. dollars.​We view our investments in Mexican subsidiaries as long-term. The net asset exposure in the Mexican subsidiaries translated into U.S. dollars using the year-end exchange rates was $228.0 million at December 31, 2022. The year ended December 31, 2022, exchange rates of the Mexican peso, relative to the U.S. dollar, strengthened by approximately 5.2% from December 31, 2021. The potential loss in value of our net assets in the Mexican subsidiaries resulting from a 10% change in quoted foreign currency exchange rates at December 31, 2022, would be approximately $20.7 million. Any changes in our net assets in the Mexican subsidiaries relating to foreign currency exchange rates would be reflected in the financial statement through the foreign currency translation component of accumulated other comprehensive income, unless the Mexican subsidiaries are sold or otherwise disposed. A 10% change in average exchange rates would not have had a material impact on our results of operations. ​​38 ​
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion should be read together with the Consolidated Financial Statements and the Notes to Consolidated Financial Statements, which are included in this Form 10-K in Item 8 and the information set forth in Risk Factors under Part 1, Item 1A. The following sections include a discussion of results for fiscal 2022 compared to fiscal 2021 as well as certain 2020 results. The comparative results for fiscal 2021 with fiscal 2020 generally have not been included in this Form 10-K, but may be found in “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.INDEXPAGECurrent Business Outlook and Strategy25Oil and Gas Segment27Chemical Segment37Midstream and Marketing Segment38Segment Results of Operations and Items Affecting Comparability40Income Taxes45Consolidated Results of Operations46Liquidity and Capital Resources47Lawsuits, Claims, Commitments and Contingencies49Environmental Liabilities and Expenditures50Global Investments50Critical Accounting Policies and Estimates51Safe Harbor Discussion Regarding Outlook and Other Forward-Looking Data5524OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISCURRENT BUSINESS OUTLOOK AND STRATEGYGENERALOccidental’s operations, financial condition, cash flows and levels of expenditures are highly dependent on oil prices and, to a lesser extent, NGL and natural gas prices, the Midland-to-Gulf-Coast oil spreads, chemical product prices and inflationary pressures in the macro-economic environment. In 2022, as compared to 2021, the average annual price per barrel of WTI crude increased to $94.23 from $67.91 and the average annual Brent price per barrel increased to $98.83 from $70.78. The return of oil demand to its pre-pandemic levels, the ongoing global impact of the Russia-Ukraine war and the limited increase in supply in 2022 have resulted in an increase in benchmark oil prices year-over-year. Occidental does not operate or own assets in either Russia or Ukraine. It is expected that the price of oil will be volatile for the foreseeable future given the current geopolitical risks, the ongoing global impact of the Russia-Ukraine war, and uncertainty around the global economy, oil demand in China as it emerges from its zero-COVID policy, production levels in OPEC and non-OPEC oil producing countries and further releases from or additions to the US Strategic Petroleum Reserve.Occidental works to manage inflation impacts by capitalizing on operational efficiencies, locking in pricing on longer term contracts and working closely with vendors to secure the supply of critical materials. As of December 31, 2022, substantially all of Occidental's outstanding debt is fixed rate.STRATEGYOccidental is focused on delivering a unique shareholder value proposition with its portfolio of oil and gas, chemicals and midstream and marketing assets and its ongoing development of carbon management and storage solutions and GHG emissions reduction efforts. Occidental conducts its operations with a priority on HSE, sustainability and social responsibility. Occidental aims to maximize shareholder returns through a combination of:■Returning capital to shareholders, while redeeming a portion of preferred equity to continue improving Occidental’s financial position;■Enhancing its existing asset base with new investments in its core cash-generative oil and gas and chemical businesses as well as emerging low-carbon businesses with a focus on its net-zero pathway;■Advancing technologies and business solutions to help drive a sustainable low-carbon future; and■Further reducing long-term financial leverage.OPERATIONAL EXCELLENCE AND CAPITAL EFFICIENCY Occidental's operational priorities for 2022 were to maximize operational efficiencies by investing $4.5 billion in high return assets to generate long-term sustainable free cash flow that will provide cash flow stability throughout the commodity cycle. Occidental set new operational records and efficiency benchmarks in the Permian, Rockies, Gulf of Mexico, Oman and UAE. OxyChem generated record earnings, beating its previous record set in 2021. With the increase in commodity prices and Occidental’s focus on its operational efficiencies, Occidental’s higher cash flow allowed it to reduce its leverage and advance its shareholder return framework. DEBT AND INTEREST RATE SWAPS Strong cash flow in 2022 allowed Occidental to continue its deleveraging efforts. In 2022, Occidental reduced its debt principal by more than $10.5 billion, leaving less than $18.0 billion outstanding as of December 31, 2022, and meeting its near-term debt reduction goal. As of December 31, 2022, Occidental had debt maturities of approximately $22 million in 2023, $1.1 billion in 2024 and $1.2 billion in 2025. The current maturity of $22 million was paid in January 2023, leaving no debt maturing in 2023. Occidental’s $673 million Zero Coupons can be put to Occidental in October of each year, in whole or in part, for the then accreted value of the outstanding Zero Coupons. The Zero Coupons can next be put to Occidental in October 2023, which, if put in whole, would require a payment of approximately $344 million at such date. Occidental currently has the intent and ability to meet this obligation, including, if necessary, using amounts available under the RCF should the put right be exercised. In the year ended December 31, 2022, Occidental settled all outstanding interest rate swaps with $255 million in cash and the application of $144 million collateral, leaving none outstanding as of December 31, 2022. DEBT RATINGS As of the date of this filing, Occidental’s long-term debt was rated BB+ by Fitch Ratings, Ba1 by Moody’s Investors Service and BB+ by Standard and Poor’s. Occidental believes the deleveraging performed to date may lead to future ratings upgrades, but cannot determine the timing of any potential ratings change. Any downgrade in credit ratings could impact Occidental's ability to access capital markets and increase its cost of capital. Occidental’s non-investment grade debt rating may require Occidental or its subsidiaries to provide financial assurance in the form of cash, letters of credit, surety bonds or other acceptable support under certain contractual arrangements. OXY 2022 FORM 10-K25MANAGEMENT’S DISCUSSION AND ANALYSISSHAREHOLDER RETURN FRAMEWORKCapital is returned to shareholders through Occidental’s dividend and share repurchases. Occidental’s current dividend is $0.18 per share per quarter, or $0.72 on an annualized basis. During the fourth quarter of 2022, Occidental completed its $3.0 billion share repurchase program. In February 2023, the Board authorized a new share repurchase program of up to $3.0 billion of Occidental’s shares of common stock. Occidental anticipates that a higher percentage of excess free cash flow is expected to be allocated to shareholder returns in 2023 with the intention to begin redeeming the preferred stock. Occidental’s preferred stock includes a mandatory redemption provision that obligates Occidental to redeem the preferred at 110% of the par value on a dollar-for-dollar basis for every dollar distributed to common shareholders above $4.00 per share, on a trailing 12-month basis.SUSTAINABILITY AND ENVIRONMENTAL STEWARDSHIP STRATEGYIn 2020, Occidental was the first U.S. oil and gas company to announce goals to achieve net-zero GHG emissions for its total emissions inventory including use of sold products. These goals include achieving net-zero GHG emissions (i) from its operations and energy use before 2040, with an ambition to do so before 2035, and (ii) from its total carbon inventory, including the use of its sold products, with an ambition to do so before 2050. In 2020, Occidental also set various interim targets, including 2025 carbon and methane intensity targets, and Occidental was the first U.S. oil and gas company to endorse the World Bank’s initiative for zero routine flaring by 2030. In 2022, the Board of Directors adopted Occidental’s updated HSE and Sustainability Principles, based on engagement with shareholders, employees and other stakeholders. The Principles reinforce the alignment among Occidental’s core values, goals and strategies, underpin our operational management system, and help to guide our workforce across our businesses.Occidental seeks to meet its sustainability and environmental goals through its development and commercialization of technologies that lower both GHG emissions from industrial processes and existing atmospheric concentrations of CO2. Occidental believes that carbon removal technologies, including DAC and CCUS, can, with incentives necessary for their development and deployment, provide essential CO2 reductions to assist the world’s transition to a less carbon-intensive economy. During 2022, Occidental undertook the following actions, among others, toward advancing its low-carbon strategy:■Achieved zero routine flaring of gas across its U.S. oil and gas operations, 8 years ahead of the World Bank’s 2030 target; ■Reduced estimated methane emissions by 33% from the 2020 baseline;■Began construction activities for DAC 1 in the Permian;■Acquired interests in approximately 265,000 net acres of pore space access along the U.S. Gulf Coast; and■Invested approximately $530 million in low-carbon businesses, technologies, and net-zero pathway advancements, including the aforementioned pore space.The future costs associated with emissions reduction, carbon removal and CCUS to meet its long-term net-zero GHG goals may be substantial and execution of its plans and net-zero pathway depends on securing third-party capital investments. Occidental is pursuing multiple pathways to fund these projects including project financing, long-term carbon removal or CCUS agreements, and identifying business opportunities with stakeholders in carbon-intensive industriesKEY PERFORMANCE INDICATORSOccidental seeks to meet its strategic goals by continually measuring its success against key performance indicators that drive total stockholder return. In addition to efficient capital allocation and deployment discussed below in the section titled Oil and Gas Segment - Business Strategy, Occidental believes its most significant performance indicators are: OPERATIONAL■Total spend per barrel - In 2023, Occidental will continue to focus on controlling total costs from a per-barrel perspective. Total spend per barrel is the sum of capital spending, general and administrative expenses, other operating and non-operating expenses and oil and gas lease operating costs divided by global oil, NGL and natural gas sales volumes.■Daily production - Occidental seeks to maximize field operability and minimize production down-time. FINANCIAL■CROCE - CROCE is calculated as (i) the cash flows from operating activities, before changes in working capital, plus distributions from WES classified as investing cash flows, divided by (ii) the average of the opening and closing balances of total equity plus total debt.■Maintain and improve financial leverage to a level consistent with investment grade credit metrics. SUSTAINABILITY AND ENVIRONMENTAL■Specific interim emissions reduction and emissions intensity targets to advance our goal of net-zero operational and energy use emissions before 2040, with an ambition to achieve before 2035.■Milestones in specific carbon removal and CCUS projects that advance our net-zero total emissions inventory, including use of sold products, with an ambition to achieve before 2050.■Facilitate deployment of carbon removal, CCUS and other solutions to advance total carbon impact past 2050.26 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISOIL AND GAS SEGMENTBUSINESS STRATEGYOccidental’s oil and gas segment focuses on long-term value creation and leadership in sustainability, health, safety and the environment. In each core operating area, Occidental’s operations benefit from scale, technical expertise, decades of high-margin inventory, environmental and safety leadership and commercial and governmental collaboration. These attributes allow Occidental to bring additional production quickly to market, extend the life of older fields at lower costs and provide low-cost returns-driven growth opportunities with advanced technology. Occidental is one of the largest U.S. producers of liquids, which includes oil and NGL, allowing Occidental to maximize cash margins on a per barrel basis. The advantages that Occidental’s portfolio provides, coupled with its advanced subsurface characterization ability and the proven ability to execute, position Occidental for full-cycle success in the years ahead. The oil and gas segment maximizes efficiencies to deliver lower breakeven costs and generate excess free cash flow. The oil and gas segment strives to achieve low development and operating costs to maximize full-cycle value of the assets.The oil and gas business implements Occidental’s strategy primarily by:■Operating and developing areas where reserves are known to exist and optimizing capital intensity in core areas, primarily in the Permian Basin, DJ Basin, Gulf of Mexico, UAE, Oman and Algeria;■Maintaining a disciplined and prudent approach to capital expenditures with a focus on high-return, short and mid-cycle, cash-flow-generating opportunities and an emphasis on creating value and further enhancing Occidental’s existing positions;■Focusing Occidental’s subsurface characterization and technical activities on unconventional opportunities, primarily in the Permian Basin and Rockies;■Using secondary and tertiary recovery techniques in mature fields; and■Focusing on cost-reduction efficiencies and innovative technologies to reduce carbon emissions.In 2022, oil and gas capital expenditures were approximately $3.8 billion and primarily focused on Occidental’s assets in the Permian Basin, DJ Basin, Gulf of Mexico and Oman. In 2023, Occidental plans to spend $4.3 billion to $4.7 billion to develop its oil and gas assets.OIL AND GAS PRICE ENVIRONMENTOil and gas prices are the major variables that drive the industry’s financial performance. The following table presents the average daily WTI and Brent prices for oil and NYMEX natural gas prices for 2022 and 2021:20222021% ChangeWTI Oil ($/Bbl)$94.23 $67.91 39 %Brent Oil ($/Bbl)$98.83 $70.78 40 %NYMEX Natural Gas ($/Mcf)$6.35 $3.61 76 %The following table presents Occidental’s average realized prices for continuing operations as a percentage of WTI, Brent and NYMEX for 2022 and 2021:20222021Worldwide oil as a percentage of average WTI100 %97 %Worldwide oil as a percentage of average Brent95 %93 %Worldwide NGL as a percentage of average WTI38 %44 %Worldwide NGL as a percentage of average Brent36 %42 %Domestic natural gas as a percentage of NYMEX86 %91 %Prices and differentials can vary significantly, even on a short-term basis, making it difficult to predict realized prices with a reliable degree of certainty. OXY 2022 FORM 10-K27MANAGEMENT’S DISCUSSION AND ANALYSISDOMESTIC INTERESTSBUSINESS REVIEWOccidental conducts its domestic operations through land leases, subsurface mineral rights it owns, or a combination of both. Occidental’s domestic oil and gas leases have a primary term ranging from one to 10 years, which is extended through the end of production once it commences. Occidental has leasehold and mineral interests in 9.5 million net acres, of which approximately 52% is leased, 47% is owned subsurface mineral rights and 1% is owned land with mineral rights. Approximately $3.6 billion to $4.0 billion of Occidental’s worldwide capital budget is expected to be allocated to its domestic operations in 2023.DOMESTIC ASSETS (a)1. Powder River Basin2. DJ Basin3. Permian Basin4. Gulf of Mexico(a)Map represents geographic outlines of the respective basins.The Permian Basin The Permian Basin extends throughout West Texas and Southeast New Mexico and is one of the largest and most active oil basins in the United States, accounting for more than 43% of total United States oil production in 2022. Overall in 2022, Occidental’s production in the Permian Basin was approximately 513 Mboe/d. Occidental manages its Permian Basin operations through two businesses: Permian Resources, which includes unconventional opportunities, and Permian EOR, which utilizes secondary and tertiary recovery techniques. Occidental had a leading position in the Permian Basin, producing approximately 8% of the total oil in the basin in 2022. By exploiting the natural synergies between Permian Resources and Permian EOR, Occidental is able to deliver unique short- and long-term advantages, efficiencies and expertise across its Permian Basin operations. The Permian Resources unconventional business is focused on developing and producing unconventional reservoir targets using horizontal drilling technology. The development programs are designed to create long-term value from primary development by maximizing the recovery of oil, utilizing sustainable practices and providing strong financial returns. Occidental’s unconventional oil and gas operations in Permian Resources include approximately 1.4 million net acres. In 2022, our activities were focused in the core development areas with emphasis on maintaining the industry leading capital intensity through optimized surface infrastructure and customized well designs. Overall, in 2022, Permian Resources produced from approximately 3,300 gross wells and added 387 MMboe to Occidental’s proved reserves through development and extensions of proved areas. The Permian Basin’s concentration of large conventional reservoirs, strong CO2 flooding performance and the expansive CO2 transportation and processing infrastructure has resulted in decades of high-value enhanced oil production. With 34 active CO2 floods and over 50 years of experience, Occidental is the industry leader in Permian Basin CO2 flooding, which can increase ultimate oil recovery by 10% to 25%. Technology improvements, such as the recent trend toward vertical 28 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISexpansion of the CO2 flooded interval into residual oil zone targets, continue to yield more recovery from existing projects, and Permian EOR produced from approximately 13,000 gross wells in 2022.Significant opportunities also remain to gain additional recovery by expanding Occidental’s existing CO2 projects into new portions of reservoirs that have only been waterflooded. Permian EOR has a large inventory of future CO2 projects, which could be developed over the next 20 years or accelerated, depending on market conditions. In 2022, Occidental spent approximately $2.3 billion of capital in the Permian Basin, of which approximately 93% was spent on Permian Resources assets.Rockies and Other DomesticIn 2022, Occidental produced approximately 277 Mboe/d net in the Rockies and Other Domestic locations. Production in the DJ Basin is derived from 2,000 operated vertical wells and 2,400 operated horizontal wells primarily focused in the Niobrara and Codell formations. The DJ Basin, including the North DJ Basin, comprises approximately 800,000 total net acres and provides competitive economics, low breakeven costs and free cash flow generation through Occidental’s contiguous acreage position and royalty uplift.In the DJ Basin, horizontal drilling results in the field continue to be strong, with improved operational efficiencies in drilling and completions. In 2022, Occidental drilled 68 operated horizontal wells and completed 54 operated horizontal wells. Occidental is focusing on obtaining the necessary state, local and federal permits required to construct facilities and drill and complete wells in the DJ Basin. In January 2021, the COGCC adopted new regulations that impose siting requirements, or “setbacks,” on certain oil and gas drilling locations based on the distance of a proposed well pad to occupied structures. Under these new regulations and through thoughtful surface location planning, Occidental obtained COGCC approval for five Oil and Gas Development Plans, inclusive of 12 well pad and facility locations and approximately 150 wells. In addition to the approximately 150 wells approved through the Oil and Gas Development Plan process, during the third quarter of 2022, Occidental became the first oil and gas operator in Colorado to obtain COGCC approval for the first Comprehensive Area Plan under the new COGCC rules. This comprehensive plan will support nine well pads and approximately 140 new wells and will provide for substantial future development in a geographically remote area on Colorado’s eastern plains. Oil and Gas Development Plans associated with the Comprehensive Area Plan will be submitted in 2023.As of December 31, 2022, Occidental is permitted, or had permit applications submitted to applicable regulatory agencies, for nearly all planned 2023 drilling and completions activity in the DJ Basin. In 2023, Occidental plans to submit state and local permits with the goal of building operational inventory and maintaining its social license to operate in Colorado. Occidental has a dedicated stakeholder relations team that conducts regulatory and community outreach with respect to its permit applications and operations in Colorado with a focus on building trust and fostering open communication with those that live and work near our operations.Occidental has gained efficiencies in the permitting process and will continue to look for additional opportunities to do so. As discussed above, Occidental does not anticipate significant near-term changes to our development program in the DJ Basin based on these regulations. However, if Occidental is unable to obtain new drilling permits to develop a significant portion of the company’s undeveloped acreage in the DJ Basin, the company’s DJ Basin assets may be subject to testing for impairment, and if deemed to be impaired, such impairment could be material to our financial statements.Occidental has interest in over 300,000 net acres in the Powder River Basin, mainly located in Converse County and Campbell County, Wyoming. The field contains the Turner, Niobrara, Mowry and Parkman formations that hold both liquids and natural gas. In 2022, Occidental drilled 19 operated horizontal wells and completed 14 horizontal wells in the Powder River Basin. The company plans to run one continuous operated drilling rig in 2023 with targeted completion activity throughout the year.Occidental holds approximately 4.6 million net acres in other domestic locations, which consist of legacy acreage and fee minerals outside of Occidental’s core operated areas including parts of Arkansas, Colorado, Louisiana, Texas, West Virginia and Wyoming.OFFSHORE DOMESTIC ASSETSGulf of MexicoOccidental is the fourth-largest oil and gas producer in the deep-water Gulf of Mexico, operating 10 strategically located deep-water floating platforms, the highest number among all the deep water operators, and producing from 18 active fields while owning a working interest across 252 blocks, including approximately 1.0 million net acres. Occidental’s position is one of the largest portfolios in the Gulf of Mexico. Occidental further operates two marine shore-bases in Galveston, Texas, and Port Fourchon, Louisiana, as well as two helicopter bases in Louisiana that all provide back up and redundancy to each other to support the Gulf operations. A central logistics base with an integrated training center is located in Broussard, Louisiana, and the Gulf of Mexico operations and development are managed and supported with engineering and technical staff from The Woodlands, Texas, office tower. In 2022, Occidental increased net production to 147 Mboe/d from approximately 88 gross wells, investing over $450 million in capital, including exploration capital, primarily directed towards drilling activity in its new Horn Mountain West subsea development, Lucius and Holstein facilities, drilling five wells using one floating drill ship, one platform rig and several service rigs. Occidental successfully and safely initiated first production from its new Horn Mountain West field and tied back to the Horn Mountain facility, increasing production at the platform by over 34 Mboe/d from three subsea oil wells, OXY 2022 FORM 10-K29MANAGEMENT’S DISCUSSION AND ANALYSISon budget and three months ahead of schedule. In the fourth quarter of 2022, the new Caesar-Tonga Subsea Expansion project was also started several months ahead of schedule, debottlenecking the prolific giant Caesar-Tonga field and thus enabling future field expansion projects. Major subsea-pumping projects supporting the Marco Polo/K2 field and the Marlin/King field were progressed as well as extensive 4D seismic shoots in the Holstein field and elsewhere, setting up a runway of future development opportunities.Operational excellence and efficiency continued as the prime objective in 2022 and gathered further momentum, reducing overall base production decline rates through the implementation of several successful well stimulations and artificial lift projects. Platform operating efficiencies were significantly improved and machinery uptimes were increased all through subordinated focus and condition monitoring initiatives as well as multiple upgrade projects. Continued optimum sequencing of annual platform turn-arounds provided further operational efficiencies, avoiding around two hundred days per year of shut-ins.During 2022, all necessary regulatory permits for new wells and existing operations were obtained timely without any operational delays. Occidental was further awarded 30 new leases from BOEM’s Lease Sale 257 and was the second most successful bidder. Occidental’s Gulf of Mexico assets continued to be among the lowest carbon emissions operations in the industry with zero routine flaring and zero cold venting.The following table shows key areas of ongoing development in the Gulf of Mexico, along with the corresponding working interest in those areas.Working InterestHorn Mountain100 %Holstein100 %Marlin100 %Lucius67 %K2 Complex42 %Caesar Tonga34 %Constellation33 %In 2023, Occidental expects to continue development and expansion of its existing assets across the Gulf of Mexico, to safely deliver high-margin production while continuing to add to its drill well inventory on existing leases through expansion and infrastructure led exploration opportunities around existing infrastructure. Occidental plans to conduct development and exploration activities in 2023 using one to two floating drill ships, one platform rig and several other well service vessels and continue to optimize its extensive portfolio of lease working interests.30 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISINTERNATIONAL INTERESTSBUSINESS REVIEWOccidental conducts its ongoing international operations in two sub-regions: the Middle East and North Africa. Its activities include oil, NGL and natural gas production through direct working-interests, PSAs and PSCs. Under the PSCs, Occidental records a share of production and reserves to recover certain development and production costs and an additional share for profit. These contracts do not transfer any right of ownership to Occidental and reserves reported from these arrangements are based on Occidental’s economic interest as defined in the contracts. Occidental’s share of production and reserves from these contracts decreases when product prices rise and increases when prices decline. Overall, Occidental’s net economic benefit from these contracts is greater when product prices are higher. Approximately $0.5 billion of Occidental’s worldwide capital budget is expected to be allocated to its international operations in 2023.MIDDLE EAST / NORTH AFRICA ASSETS1.Algeria2.Oman3.Qatar4.UAEAlgeriaOccidental’s interest in Algeria involves development and production rights in 18 fields within Blocks 404a and 208, which are located in the Berkine Basin in Algeria’s Sahara Desert and are governed by an agreement amongst Occidental, Sonatrach and other partners. Occidental is responsible for 24.5% of the development and production costs. The El Merk central processing facility in Block 208 processes produced oil, NGL and natural gas, while the Hassi Berkine South and Ourhoud central processing facilities in Block 404a process produced oil. The rights to produce from the Block 404a fields expire between May 2023 and 2036, and the rights to produce from the Block 208 fields expire in 2032.In 2022, net production in Algeria was 45 Mbbl/d, two gross development wells were drilled and annual net capital expenditures were $25 million. In July 2022, Occidental signed a new PSC with Sonatrach and other partners which, upon approval by the Algerian government, will be for a new 25-year term for all of the fields under the current hydrocarbon agreement. With respect to the new PSC, Occidental is responsible for 35% of the development and production costs, and government approval is expected in the first half of 2023.OmanIn Oman, Occidental is the operator of Block 9, Block 27, Block 53 (Mukhaizna Field), Block 62 and Block 65 and has additional interests in Blocks 30, 51 and 72, which are under the Exploration phase. The working interest and contract expiration year for each of the respective blocks are shown in the table below. Occidental holds 6.0 million gross acres and has 10,000 potential well inventory locations. In 2022, Occidental’s share of production was 65 Mboe/d. OXY 2022 FORM 10-K31MANAGEMENT’S DISCUSSION AND ANALYSISWorking InterestBlock Expiration (Year)Block 950 %2030Block 2765 %2035Block 5347 %2035Block 62100 %2028Block 6551 %2037Blocks 30, 51 and 72100 %Exploration PhaseOccidental has produced over 754 million gross barrels from Block 9 since the beginning of its operation through successful exploration, continuous drilling improvements and EOR projects. The Mukhaizna Field in Block 53 is a major pattern steam flood project for EOR that utilizes some of the largest mechanical vapor compressors ever built. Since assuming operations in the Mukhaizna Field in 2005, Occidental has drilled close to 3,580 new wells and has produced over 575 million gross barrels. In 2022, Occidental declared commerciality for Block 65 and invested capital of $362 million across all of the Oman blocks to drill 92 wells and execute facilities projects to support development and EOR activities.In 2023, Occidental will continue to enhance production by adding extended and dual laterals, stimulating wells with the OXY JETTINGTM wellbore stimulation system, and expanding thermal conformance. Occidental will also continue to execute projects in Oman targeting emissions reductions. QatarIn Qatar, Occidental partners in the Dolphin Energy Project, an investment that is comprised of two separate economic interests. Occidental has a 24.5% interest in the upstream operations (Dolphin) to develop and produce NGL, natural gas and condensate from Qatar’s North Field through mid-2032. Occidental also has a 24.5% interest in DEL, which operates a pipeline and is discussed further in the midstream and marketing segment section in this Form 10-K under Pipeline. In 2022, Occidental’s net share of production from Dolphin was 37 Mboe/d.UAEIn 2011, Occidental acquired a 40% participating interest in the Shah gas field (Al Hosn Gas), joining with the Abu Dhabi National Oil Company, which expires in 2041. In 2022, Occidental’s net share of production from Al Hosn Gas was 227 million cubic feet per day (MMcf/d) of natural gas and 35 Mbbl/d of NGL and condensate. Al Hosn Gas includes gas processing facilities which are discussed further in the midstream and marketing segment section in this Form 10-K under Gas Processing, Gathering and CO2. In 2019 and 2020, Occidental acquired 9-year exploration concessions and, subject to a declaration of commerciality, 35-year production concessions for Onshore Block 3 and Block 5, which cover an area approximately 1.5 million acres and 1.0 million acres, respectively, and are adjacent to Al Hosn Gas. In 2022 and 2021, Occidental announced multi-zone oil and gas discoveries in Onshore Block 3. In 2023, Occidental plans to complete an expansion project that commenced in 2022 to increase the production capacity of the Al Hosn Gas processing facilities from 1.28 Bcf/d to 1.45 Bcf/d and continue further exploration and appraisal activities in Onshore Block 3 and Block 5. 32 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISPROVED RESERVESProved oil, NGL and natural gas reserves were estimated using the unweighted arithmetic average of the first-day-of-the-month price for each month within the year, unless prices were defined by contractual arrangements. Oil, NGL and natural gas prices used for this purpose were based on posted benchmark prices and adjusted for price differentials including gravity, quality and transportation costs. The following table shows the 2022, 2021 and 2020 calculated first-day-of-the-month average prices for both WTI and Brent oil prices, as well as the Henry Hub gas prices measured in MMbtu:202220212020WTI Oil ($/Bbl)$93.67 $66.56 $39.57 Brent Oil ($/Bbl)$97.77 $69.24 $43.41 Henry Hub Natural Gas ($/MMbtu)$6.36 $3.60 $1.98 Mt. Belvieu NGL ($/Bbl)$47.81 $44.22 $18.74 Occidental had proved reserves from continuing operations at year-end 2022 of 3,817 MMboe, compared to the year-end 2021 amount of 3,512 MMboe. Proved developed reserves represented approximately 71% and 75% of Occidental’s total proved reserves at year-end 2022 and 2021, respectively. The following table shows the breakout of Occidental’s proved reserves from continuing operations by commodity as a percentage of total proved reserves:20222021Oil50 %50 %NGL22 %22 %Natural gas28 %28 %Occidental does not have any reserves from non-traditional sources. For further information regarding Occidental’s proved reserves, see the Supplemental Oil and Gas Information section in Item 8 of this Form 10-K.CHANGES IN PROVED RESERVESChanges in Occidental’s 2022 reserves were as follows:MMboe2022Revisions of previous estimates474 Improved recovery89 Extensions and discoveries176 Purchases10 Sales(21)Production(423)Total 305 Occidental’s ability to add reserves, other than through purchases, depends on the success of infill development, extension, discovery and improved recovery projects, each of which depends on reservoir characteristics, technology improvements and oil and natural gas prices, as well as capital and operating costs. Many of these factors are outside management’s control and may negatively or positively affect Occidental’s reserves.Revisions of Previous EstimatesRevisions can include upward or downward changes to previous proved reserve estimates for existing fields due to the evaluation or interpretation of geologic, production decline or operating performance data. In addition, product price changes affect proved reserves recorded by Occidental. For example, lower prices may decrease the economically recoverable reserves, particularly for domestic properties, because the reduced margin limits the expected life of the operations. Offsetting this effect, lower prices increase Occidental’s share of proved reserves under PSCs because more oil is required to recover costs. Conversely, when prices rise, Occidental’s share of proved reserves decreases for PSCs and economically recoverable reserves may increase for other operations. Reserve estimation rules require that estimated ultimate recoveries be much more likely to increase or remain constant than to decrease, as changes are made due to increased availability of technical data. OXY 2022 FORM 10-K33MANAGEMENT’S DISCUSSION AND ANALYSISIn 2022, Occidental’s revisions of previous estimates of proved reserves were positive 474 MMboe. These revisions were primarily due to 335 MMboe of positive revisions related to additions associated with infill development projects, mainly in the Permian Basin (232 MMboe) and the DJ Basin (94 MMboe). An additional 136 MMboe of positive revisions were related price revisions. The positive price revisions were primarily associated with the Permian Basin (147 MMboe), the Gulf of Mexico (8 MMboe) and the DJ Basin (4 MMboe), which were partially offset by negative price revisions of 29 MMboe on international PSCs.Further positive revisions of 93 MMboe were associated with updates based on reservoir performance and 5 MMBoe were associated with management changes in development plans. The positive revisions were offset by negative revisions associated with various other cost and interest related revisions (95 MMboe).Improved RecoveryIn 2022, Occidental added proved reserves of 89 MMboe related to improved recovery, primarily in the Permian EOR, which accounted for 87% of the improved recovery reserve additions. These properties comprise conventional projects, which are characterized by the deployment of EOR development methods, largely employing application of CO2 flood, waterflood or steam flood. These types of conventional EOR development methods can be applied through existing wells, though additional drilling is frequently required to fully optimize the development configuration. Waterflooding is the technique of injecting water into the formation to displace the oil to the offsetting oil production wells. The use of either CO2 or steam flooding depends on the geology of the formation, the evaluation of engineering data, availability and cost of either CO2 or steam and other economic factors. Both techniques work similarly to lower viscosity causing the oil to move more easily to the producing wells. The remaining improved recovery additions were due to secondary and tertiary projects for certain international assets.Extensions and DiscoveriesOccidental also added proved reserves from extensions and discoveries, which are dependent on successful exploration and exploitation programs. In 2022, extensions and discoveries added 176 MMboe primarily related to the recognition of proved reserves in the Permian Basin (155 MMboe) and Powder River Basin (7 MMboe).Purchases of Proved ReservesIn 2022, Occidental purchased proved reserves of 10 MMboe primarily consisting of proved reserves in the Permian Basin.Sales of Proved ReservesIn 2022, Occidental sold 21 MMboe in proved reserves related to the divestitures of certain non-strategic assets in the Permian Basin.Proved Undeveloped ReservesOccidental had PUD reserves at year-end 2022 of 1,119 MMboe, compared to the year-end 2021 amount of 865 MMboe.Changes in PUD reserves were as follows:MMboe2022Revisions of previous estimates270 Improved recovery49 Extensions and discoveries107 Purchases1 Sales(10)Transfer to proved developed reserves(163)Total254 Revisions of previous estimates were a positive 270 MMboe. Approximately 263 MMboe of the positive revisions were related to additions associated with infill development projects in the Permian Basin (170 MMboe) and the DJ Basin (93 MMboe). Additionally, the revisions included positive price revisions of 24 MMboe. The positive price revisions were primarily associated with the Permian Basin. The remaining positive revisions were associated with various updates based on reservoir performance. The positive revisions were offset by negative revisions associated with various other cost and interest related revisions (21 MMboe).Extensions and discoveries added 107 MMboe primarily related to the recognition of proved reserves in the Permian Basin (100 MMboe). Total improved recovery additions of 49 MMboe were primarily the result of conventional projects in the Permian EOR (44 MMboe) and secondary and tertiary projects in international assets (5 MMboe). The 2022 additions to 34 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISPUD reserves were partially offset by transfers to proved developed reserves of 163 MMboe. The transfers were primarily associated with the Permian Basin (89 MMboe), the DJ Basin (40 MMboe) and Gulf of Mexico (21 MMboe). In 2022, Occidental incurred approximately $1.2 billion to convert PUD reserves to proved developed reserves, and in 2022 Occidental converted approximately 19% of its PUD reserves to proved developed, when adjusted for revisions and sales. As of December 31, 2022, Occidental had 1,119 MMboe of PUD reserves of which 73% were associated with domestic onshore, 4% with Gulf of Mexico and 23% with international assets. Occidental’s most active development areas are located in the Permian Basin, which represented 54% of the PUD reserves as of December 31, 2022. Occidental’s total planned 2023 capital expenditures are between $5.4 billion and $6.2 billion. Overall, Occidental plans to spend approximately $4.6 billion over the next five years to develop its PUD reserves in the Permian Basin.PUD reserves are supported by a five-year detailed field-level development plan, which includes the timing, location and capital commitment of the wells to be drilled. Only PUD reserves which are reasonably certain to be drilled within five years of booking and are supported by a final investment decision to drill them are included in the development plan. A portion of the PUD reserves are expected to be developed beyond the five years and are tied to approved long-term development projects.As of December 31, 2022, Occidental had 241 MMboe of pre-2018 PUD reserves that remained undeveloped. These PUD reserves relate to approved long-term development plans, 175 MMboe of which are primarily associated with international development projects with physical limitations in existing gas processing capacity and 66 MMboe of which are related to approved long-term development plans for Permian EOR projects, also with physical limitations in existing gas processing capacity. Occidental remains committed to these projects and continues to actively progress the development of these volumes. In addition to the above, Occidental has 57 MMboe of PUD reserves that are scheduled to be developed more than five years from their initial date of booking. These PUD reserves are related to approved long-term development plans, 41 MMboe of which are associated with international development projects and 16 MMboe with the Gulf of Mexico projects. RESERVES EVALUATION AND REVIEW PROCESSOccidental’s estimates of proved reserves and associated future net cash flows as of December 31, 2022, were made by Occidental’s technical personnel and are the responsibility of management. The estimation of proved reserves is based on the requirement of reasonable certainty of economic producibility and funding commitments by Occidental to develop the reserves. This process involves reservoir engineers, geoscientists, planning engineers and financial analysts. As part of the proved reserves estimation process, all reserve volumes are estimated by a forecast of production rates, operating costs and capital expenditures. Price differentials between benchmark prices (the unweighted arithmetic average of the first-day-of-the-month price for each month within the year) and realized prices and specifics of each operating agreement are then used to estimate the net reserves. Production rate forecasts are derived by a number of methods, including estimates from decline curve analysis, type well profile analysis, computer simulation of the reservoir performance, volumetric analysis and material balance calculations that take into account the volumes of substances replacing the volumes produced and associated reservoir pressure changes supported by various technologies including seismic analysis. These reliable field-tested technologies have demonstrated reasonably certain results with consistency and repeatability in the formation being evaluated or in an analogous formation. Operating and capital costs are forecast using the current cost environment applied to expectations of future operating and development activities.Net proved developed reserves are those volumes that are expected to be recovered through existing wells with existing equipment and operating methods for which the incremental cost of any additional required investment is relatively minor.Net PUD reserves are those volumes that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. PUD reserves are supported by a five-year, detailed, field-level development plan, which includes the timing, location and capital commitment of the wells to be drilled. The development plan is reviewed and approved annually by senior management and technical personnel. Annually, a detailed review is performed by Occidental’s Corporate Reserves Group and its technical personnel on a lease-by-lease basis to assess whether PUD reserves are being converted on a timely basis within five years from the initial disclosure date. Any leases not showing timely transfers from PUD reserves to proved developed reserves are reviewed by senior management to determine if the remaining reserves will be developed in a timely manner and have sufficient capital committed in the development plan. Only PUD reserves that are reasonably certain to be drilled within five years of booking and are supported by a final investment decision to drill them are included in the development plan. A portion of the PUD reserves associated with international operations are expected to be developed beyond the five years and are tied to approved long-term development plans.The current Senior Vice President, Reserves for Oxy Oil and Gas is responsible for overseeing the preparation of reserve estimates, in compliance with SEC rules and regulations, including the internal audit and review of Occidental’s oil and gas reserves data. He has over 40 years of experience in the upstream sector of the exploration and production business and has held various assignments in North America, Asia and Europe. He is a three-time past Chair of the Society of Petroleum Engineers Oil and Gas Reserves Committee. He is an AAPG Certified Petroleum Geologist and currently serves on the AAPG Committee on Resource Evaluation. He is a member of the Society of Petroleum Evaluation Engineers, the Colorado School of Mines Potential Gas Committee and the United Nations Economic Commission for Europe Expert OXY 2022 FORM 10-K35MANAGEMENT’S DISCUSSION AND ANALYSISGroup on Resource Management. He has Bachelor of Science and Master of Science degrees in geology from Emory University in Atlanta.Occidental has a Reserves Committee, consisting of senior corporate officers, to review and approve Occidental’s oil and gas reserves. The Reserves Committee reports to the Audit Committee of Occidental’s Board of Directors during the year. Since 2003, Occidental has retained Ryder Scott, independent petroleum engineering consultants, to review its annual oil and gas reserve estimation processes. For additional reserves information, see Supplemental Oil and Gas Information under Item 8 of this Form 10-K.In 2022, Ryder Scott conducted a process review of the methods and analytical procedures utilized by Occidental’s engineering and geological staff for estimating the proved reserves volumes, preparing the economic evaluations and determining the reserves classifications as of December 31, 2022, in accordance with SEC regulatory standards. Ryder Scott reviewed the specific application of such methods and procedures for selected oil and gas properties considered to be a valid representation of Occidental’s 2022 year-end total proved reserves portfolio. In 2022, Ryder Scott reviewed approximately 42% of Occidental’s proved oil and gas reserves. Since being engaged in 2003, Ryder Scott has reviewed the specific application of Occidental’s reserve estimation methods and procedures for approximately 92% of Occidental’s existing proved oil and gas reserves.Management retained Ryder Scott to provide objective third-party input on its methods and procedures and to gather industry information applicable to Occidental’s reserve estimation and reporting process. Ryder Scott has not been engaged to render an opinion as to the reasonableness of reserves quantities reported by Occidental. Occidental has filed Ryder Scott’s independent report as an exhibit to this Form 10-K.Based on its reviews, including the data, technical processes and interpretations presented by Occidental, Ryder Scott has concluded that the overall procedures and methodologies Occidental utilized in estimating the proved reserves volumes, preparing the economic evaluations and determining the reserves classifications for the reviewed properties are appropriate for the purpose thereof and comply with current SEC regulations.INDUSTRY OUTLOOKThe oil and gas exploration and production industry is highly competitive, is subject to significant volatility due to various market conditions and operations are highly dependent on oil prices and, to a lesser extent, NGL and natural gas prices. Oil prices increased significantly in 2022. During 2022, as compared to 2021, the average annual $/Bbl of WTI crude increased to $94.23 from $67.91 and the average annual Brent price per barrel increased to $98.83 from $70.78.Oil prices will continue to be affected by: (i) global supply and demand, which are generally a function of global economic conditions, inventory levels, production or supply chain disruptions, technological advances, regional market conditions and the actions of OPEC, other significant producers and governments; (ii) transportation capacity, infrastructure constraints, and costs in producing areas; (iii) currency exchange rates and inflation rates; and (iv) the effect of changes in these variables on market perceptions. The ongoing global impact of the Russia-Ukraine war and whether the oil industry will be able to sustain a continued supply response have resulted in an increase in benchmark oil prices year-over-year. Occidental does not operate or own assets in either Russia or Ukraine. It is expected that the price of oil will be volatile for the foreseeable future given the current geopolitical risks, the ongoing global impact of the Russia-Ukraine war, the evolving macro-economic environment and supply activity (as a result of COVID-19) from OPEC and non-OPEC oil producing countries and the Biden Administration’s releases from the US Strategic Petroleum Reserve.NGL prices are related to the supply and demand for the components of products making up these liquids. Some of them more typically correlate to the price of oil while others are affected by natural gas prices as well as the demand for certain chemical products for which they are used as feedstock. In addition, infrastructure constraints magnify the pricing volatility from region to region.Domestic natural gas prices and local differentials are strongly affected by local supply and demand fundamentals, as well as government regulations, global LNG demand and availability of transportation capacity from producing areas.We expect that oil prices in the near term will continue to be influenced by the duration and severity of the COVID-19 pandemic and its resulting impact on oil and gas supply and demand. These and other factors make it difficult to predict the future direction of oil, NGL and domestic gas prices reliably. For purposes of the current capital plan, Occidental will continue to focus on allocating capital to high return assets with the flexibility to adjust based on fluctuations in commodity prices. International gas prices are generally fixed under long-term contracts. Occidental continues to adjust capital expenditures in line with current economic conditions, such as supply chain constraints, rising interest rates, global logistics and high inflation, which has continued to disrupt global supply and demand balances, with the goal of keeping returns well above its cost of capital. The timing, process and ultimate cost to transition to a less carbon-intensive economy remains largely unknown; various industry forecasts indicate a growing demand for hydrocarbons for the remainder of the current decade. Occidental believes its operational flexibility to achieve low development and operating costs to maximize full-cycle value of its assets and its knowledge and experience in CO2 separation, transportation, use, recycling and storage position its oil and gas segment to support Occidental’s transition to net zero as well as create opportunities in a low-carbon future. 36 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSIS CHEMICAL SEGMENTBUSINESS STRATEGYOxyChem concentrates on the chlorovinyls chain, beginning with the co-production of caustic soda and chlorine. Caustic soda and chlorine are marketed to external customers. In addition, chlorine, together with ethylene, is converted through a series of intermediate products into PVC. OxyChem seeks to be a low-cost producer in order to generate cash flow in excess of its normal capital expenditure requirements and achieve above-cost-of-capital returns. OxyChem’s focus on chlorovinyls allows it to maximize the benefits of integration and take advantage of economies of scale. Capital is employed to sustain production capacity and to focus on projects and developments designed to improve the competitiveness of segment assets. Acquisitions and plant development opportunities may be pursued when they are expected to enhance the existing core chlor-alkali and PVC businesses or take advantage of other specific opportunities. The conversion of the Battleground chlor-alkali plant to membrane technology is expected to commence in 2023 with completion expected in 2026. In 2022, capital expenditures for OxyChem totaled $322 million.BUSINESS ENVIRONMENTAlthough the United States economic growth lagged significantly behind that of 2021, demand for domestically produced products remained high, including liquid caustic soda and PVC. Lockdowns in China, along with Russia’s invasion of Ukraine increased the demand for U.S. produced products in 2022, as ethylene and energy costs remained advantaged over global pricing. Caustic soda prices were significantly higher in 2022 and PVC pricing trended downward during the second half of 2022, as supply chain constraints, rising interest rates, global logistics and high inflation continued to disrupt global supply and demand balances.BUSINESS REVIEWBASIC CHEMICALS Despite the slower U.S. economic growth in 2022, chlor-alkali operating rates increased compared to 2021 as the U.S. maintained its competitive advantage in energy and feedstock costs. Pricing and margins for most products were higher in 2022 due to strong demand in most market segments, and weather events and other supply disruptions restricted supply.VINYLSPVC demand softened in 2022 from record highs in 2021 resulting in a 7% decrease in domestic PVC demand. Export demand strengthened in 2022 by 46% compared to 2021. Year over year operating rates were flat in 2022 due to a softening PVC market during the second half of 2022 that was offset by the weather-related events experienced in early 2021. Higher interest rates, lower housing starts, and inflation contributed to the lower domestic PVC demand and US producers shifted available volumes to the export markets. PVC exports represented 27% of total North American production in 2022 compared to 19% in 2021.INDUSTRY OUTLOOKIndustry performance will depend on the health of the global economy. Response to inflation will continue to control the housing and construction sectors during 2023. Automotive markets are expected to improve as semiconductor supply normalizes and demand responds. Product margins will depend on market supply and demand balances, feedstock and energy prices, supply chain interruptions, labor constraints and rising inflation rates. Further recovery in the petroleum industry should strengthen the demand and margins for some of Occidental’s products that are consumed by industry participants. U.S. commodity export markets could be impacted by the relative strength of the U.S. dollar.BASIC CHEMICALSDemand for basic chemicals is expected to decline from the robust levels of 2022. Demand in most market segments is expected to follow the trend of the general economy throughout 2023. Demand for chlorine and derivatives should gradually improve across the year as international growth returns and the domestic housing, general construction and automotive markets begin to stabilize. Demand for alkali products, particularly caustic soda, may decline moderately with lower demand in the pulp and paper, industrial and alumina markets. Chlor-alkali operating rates should remain relatively flat overall in comparison with 2022 due to continued globally advantaged energy and raw material pricing as compared to global feedstock costs.VINYLSDomestic PVC demand is expected to remain neutral to lower in 2023. Residential construction spending is expected to be lower in 2023, while new domestic infrastructure projects and recovering global demand is expected to offset the domestic decline. New domestic PVC capacity came online in 2022 but is not expected to have a material impact on PVC production rates. OXY 2022 FORM 10-K37MANAGEMENT’S DISCUSSION AND ANALYSISMIDSTREAM AND MARKETING SEGMENTBUSINESS STRATEGYThe midstream and marketing segment strives to maximize value by optimizing the use of its gathering, processing, transportation, storage and terminal commitments and by providing the oil and gas segment access to domestic and international markets. To generate returns, the segment evaluates opportunities across the value chain and uses its assets to provide services to Occidental’s subsidiaries, as well as third parties. The midstream and marketing segment operates or contracts for services on gathering systems, gas plants, co-generation facilities and storage facilities and invests in entities that conduct similar activities.This segment also seeks to minimize the costs of gas and power used in Occidental’s various businesses. Capital is employed to sustain or expand assets to improve the competitiveness of Occidental’s businesses. In 2022, capital expenditures related to the midstream and marketing segment totaled $268 million.Also included in the midstream and marketing segment is OLCV. OLCV seeks to leverage Occidental’s carbon management expertise through the development of CCUS projects, and invests in emerging low-carbon technologies that are expected to reduce our carbon footprint and enable others to do the same.BUSINESS ENVIRONMENTMidstream and marketing segment earnings are affected by the performance of its various businesses, including its marketing, gathering and transportation, gas processing and power-generation assets. The marketing business aggregates, markets and stores Occidental and third-party volumes. Marketing performance is affected primarily by commodity price changes and margins in oil and gas transportation and storage programs. The marketing business results can experience significant volatility depending on commodity prices and the Midland-to-Gulf-Coast oil spreads. The Midland-to-Gulf-Coast oil spreads have decreased from an average of $0.48 per barrel in 2021 to $0.36 per barrel for the year ended December 31, 2022. A $0.25 change in the Midland-to-Gulf-Coast oil spreads impacts total year operating cash flows by approximately $65 million. Gas gathering, processing and transportation results are affected by fluctuations in commodity prices and the volumes that are processed and transported through the segment’s plants, as well as the margins obtained on related services from investments in which Occidental has an equity interest.BUSINESS REVIEWMARKETINGThe marketing group markets substantially all of Occidental’s oil, NGL and natural gas production and optimizes its transportation and storage capacity. Occidental’s third-party marketing activities focus on purchasing oil, NGL and natural gas for resale from parties whose oil and gas supply is located near its transportation and storage capacity. These purchases allow Occidental to aggregate volumes to better utilize and optimize its assets. In 2022, compared to the prior year, marketing results were impacted by the timing of crude oil sales, partially offset by higher gas marketing margin from transportation capacity optimization.DELIVERY AND TRANSPORTATION COMMITMENTSOccidental has made long-term commitments to certain refineries and other buyers to deliver oil, NGL and natural gas. The total amount contracted to be delivered is approximately 80 MMbbl of oil through 2025, 567 MMbbl of NGL through 2029 and 845 Bcf of gas through 2029. The price for these deliveries is set at the time of delivery of the product.Occidental has crude pipeline take-or-pay capacity of approximately 850 Mbbl/d to the Gulf Coast, leased crude storage capacity of approximately 10 MMbbl and capacity at the crude terminal of approximately 525 Mbbl/d. Certain of Occidental’s crude pipeline take-or-pay agreements expire in 2025 and take-or-pay commitments will reduce by two thirds by 2027.PIPELINEOccidental’s pipeline business mainly consists of its 24.5% ownership interest in DEL. DEL owns and operates a 230-mile-long, 48-inch-diameter natural gas pipeline, known as the Dolphin Pipeline, which transports dry natural gas from Qatar to the UAE and Oman. The Dolphin Pipeline has capacity to transport up to 3.2 Bcf/d and currently transports approximately 2.0 Bcf/d and up to 2.2 Bcf/d in the summer months.GAS PROCESSING, GATHERING AND CO2Occidental processes its own and third-party domestic wet gas to extract NGL and other gas byproducts, including CO2 and delivers dry gas to pipelines. Margins primarily result from the difference between inlet costs of wet gas and market prices for NGL.As of December 31, 2022, Occidental owned all of the 2.3% non-voting general partner interest and 49.5% of the limited partner units in WES. On a combined basis, with its 2% non-voting limited partner interest in WES Operating, Occidental's total effective economic interest in WES and its subsidiaries was 51.7%. See Note 1 - Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K for more information regarding 38 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISOccidental’s equity method investment in WES. WES owns gathering systems, plants and pipelines and earns revenue from fee-based and service-based contracts with Occidental and third parties.Occidental’s 40% participating interest in Al Hosn Gas also includes sour gas processing facilities that are designed to process 1.33 Bcf/d of natural gas and separate it into salable gas, condensate, NGL and sulfur. In 2022, the project produced 568 MMcf/d of natural gas, 88 Mbbl/d of NGL and condensate, and 10,700 tons/d of sulfur, of which Occidental’s net share was 227 MMcf/d of natural gas, 35 Mbbl/d of NGL and condensate and 4,280 tons/d of sulfur.In 2022, compared to the prior year, gas processing, gathering and CO2 results increased primarily due to higher sulfur and NGL prices.POWER GENERATION FACILITIESEarnings from power and steam generation facilities are derived from sales to affiliates and third parties.LOW-CARBON VENTURESOLCV was formed to execute on Occidental’s vision to reduce global emissions and provide a more sustainable future through the development of low-carbon energy and products. OLCV capitalizes on Occidental’s extensive experience in utilizing CO2 in its development of CCUS projects and providing services to third parties to facilitate the implementation of their CCUS projects. Moreover, OLCV is fostering emerging technologies, including DAC and low-carbon power sources, and other business models with the potential to position Occidental as a leader in the production of low-carbon energy and products.Occidental has developed standards and protocols recognized by the EPA for monitoring, reporting and verifying the amount, safety and permanence of CO2 stored through secure geologic sequestration. Occidental holds the nation’s first two EPA-approved monitoring, reporting and verification plans for geologic sequestration through EOR production and obtained a third monitoring, reporting and verification plan in 2021. In 2022, OLCV acquired approximately three hundred thousand acres of pore space. In 2022, Occidental also commenced EPA Class 6 permitting with the intention of developing five sequestration hubs. OLCV commenced construction on the world’s largest DAC facility in 2022, which is expected to be online in 2025. OLCV is also currently conducting front-end engineering design work and feasibility studies on a number of projects to capture and sequester CO2, either from the atmosphere or from industrial point sources. In 2023, OLCV plans to invest between $100 million and $500 million, dependent upon potential partner participation, to pursue various projects.The profitability of sequestration projects is dependent upon the costs of developing, building and operating sequestration infrastructure, demand for sequestration services from emitters and the availability of certain tax attributes and credits generated from the capture and storage of CO2.In August 2022, Congress passed the Inflation Reduction Act that contains, among other provisions, certain tax incentives related to climate change and clean energy. These incentives may attract more third-party investment of OLCV’s projects which may help accelerate certain projects. The ultimate impact of the Inflation Reduction Act on Occidental’s emerging low-carbon businesses and net-zero pathway will depend on a number of factors, interpretations and assumptions as well as additional regulatory guidance.INDUSTRY OUTLOOKMidstream and marketing segment results can experience volatility depending on commodity price changes, demand impacting export sales and the Midland-to-Gulf-Coast oil spreads. Gas gathering, processing and transportation results are affected by fluctuations in commodity prices and the volumes that are processed and transported through the segment’s plants, as well as the margins obtained on related services from investments in which Occidental has an equity interest.Throughout 2022, the U.S. experienced economy-wide cost increases, which could increase the cost of sequestration projects. Occidental saw increased interest from third parties in providing sequestration services during the year. Additionally, grants, credits and other tax-advantaged low-carbon attributes continue to be actively discussed at both state and federal levels. These trends are expected to continue, which Occidental believes will enhance the economics of sequestration projects. OXY 2022 FORM 10-K39MANAGEMENT’S DISCUSSION AND ANALYSISSEGMENT RESULTS OF OPERATIONS AND ITEMS AFFECTING COMPARABILITYSEGMENT RESULTS OF OPERATIONSSegment earnings exclude income taxes, interest income, interest expense, environmental remediation expenses, unallocated corporate expenses and discontinued operations, but include gains and losses from divestitures of segment assets and income from the segments’ equity investments. Seasonality is not a primary driver of changes in Occidental’s consolidated quarterly earnings during the year.The following table sets forth the sales and earnings of each operating segment and corporate items for the years ended December 31:millions, except per share amounts202220212020NET SALES (a)Oil and gas$27,165 $18,941 $13,066 Chemical6,757 5,246 3,733 Midstream and marketing4,136 2,863 1,768 Eliminations (1,424)(1,094)(758)Total$36,634 $25,956 $17,809 SEGMENT RESULTS AND EARNINGSDomestic$10,439 $2,900 $(8,758)International2,580 1,497 (742)Exploration(216)(252)(132)Oil and gas 12,803 4,145 (9,632)Chemical 2,508 1,544 664 Midstream and marketing273 257 (4,175)Total$15,584 $5,946 $(13,143)Unallocated corporate itemsInterest expense, net(1,030)(1,614)(1,424)Income tax benefit (expense)(813)(915)2,172 Other(437)(627)(1,138)Income (loss) from continuing operations$13,304 $2,790 $(13,533)Discontinued operations, net — (468)(1,298)Net income (loss)13,304 2,322 (14,831)Less: Preferred stock dividends(800)(800)(844)Net income (loss) attributable to common stockholders$12,504 $1,522 $(15,675)Net income (loss) attributable to common stockholders—basic$13.41 $1.62 $(17.06)Net income (loss) attributable to common stockholders—diluted$12.40 $1.58 $(17.06)(a)Intersegment sales eliminate upon consolidation and are generally made at prices approximating those that the selling entity would be able to obtain in third-party transactions.40 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISITEMS AFFECTING COMPARABILITYOIL AND GAS SEGMENTResults of Operationsmillions202220212020Segment Sales$27,165 $18,941 $13,066 Segment Results (a)Domestic$10,439 $2,900 $(8,758)International2,580 1,497 (742)Exploration(216)(252)(132)Total$12,803 $4,145 $(9,632)Items affecting comparabilityAsset sale gains (losses), net - domestic (b)$148 $27 $(1,275)Asset sale gains (losses), net - international (c)$55 $43 $(353)Asset impairments and related items - domestic (d)$— $(282)$(5,904)Asset impairments and related items - international (e)$— $— $(1,195)Oil, natural gas and CO2 mark-to-market gains (losses)$— $(280)$1,090 Rig terminations and other - domestic$— $— $(59)Rig terminations and other - international$— $— $(13)(a)Results included significant items affecting comparability discussed in the footnotes below.(b)The 2022 amount included $148 million of gains, primarily related to the sale of certain non-strategic assets in the Permian Basin. The 2021 amount included $27 million in post-closing consideration earned from 2020 asset sales as a result of certain production and pricing targets being met. The 2020 amount included a $440 million loss on the sale of Occidental’s mineral and fee surface acres in Wyoming, Colorado and Utah and losses of $820 million related to the sale of non-core, largely non-operated acreage in the Permian Basin. (c)The 2022 amount included $55 million related to post-closing consideration earned from 2020 asset sales as a result of certain production and pricing targets being met as well as the closing of the sale of certain assets that were negotiated with the 2020 Colombia divestiture. The 2021 amount primarily included $55 million in post-closing consideration earned from 2020 asset sales as a result of certain production and pricing targets being met. The 2020 amount included a loss on the sale of Occidental’s Colombia assets of $353 million.(d)The 2021 amount included $282 million of asset impairments primarily related to undeveloped leases that either expired or were set to expire in the near term where Occidental had no plans to pursue exploration activities. The 2020 amount included pre-tax impairments of $4.5 billion primarily related to domestic onshore unproved acreage as well as $1.3 billion primarily related to other domestic onshore assets and the Gulf of Mexico. (e)The 2020 amount included $1.2 billion of impairment and related charges associated with Occidental’s proved properties in Algeria and Oman. OXY 2022 FORM 10-K41MANAGEMENT’S DISCUSSION AND ANALYSISAverage Realized PricesThe following table sets forth the average realized prices for oil, NGL and natural gas from ongoing operations for each of the three years in the period ended December 31, 2022, and includes a year-over-year change calculation:2022Year over Year Change2021Year over Year Change2020Average Realized Prices Oil ($/Bbl) United States$94.12 42 %$66.39 82 %$36.39 International$95.46 47 %$65.08 57 %$41.50 Total worldwide$94.36 43 %$66.14 77 %$37.34 NGL ($/Bbl)United States$35.69 17 %$30.62 156 %$11.98 International$34.09 30 %$26.13 61 %$16.22 Total worldwide$35.48 18 %$30.01 139 %$12.58 Natural Gas ($/Mcf)United States$5.48 66 %$3.30 180 %$1.18 International$1.89 12 %$1.69 1 %$1.67 Total worldwide $4.51 57 %$2.87 119 %$1.31 Domestic oil and gas results, excluding significant items affecting comparability, increased in 2022 compared to 2021 primarily due to higher realized oil, NGL and natural gas prices and lower DD&A rates, partially offset by higher lease operating costs. International oil and gas results, excluding significant items affecting comparability, increased in 2022 compared to 2021 primarily due to higher oil prices.Realized Price and Sales Volume VarianceThe following table presents an analysis of the impacts of changes in average realized prices and sales volumes with regard to Occidental's domestic and international oil and gas revenue: Increase (Decrease) Related tomillionsYear Ended December 31, 2021(a)Price RealizationsNet Sales VolumesYear Ended December 31, 2022(a)United States RevenueOil$12,072 $5,118 $231 $17,421 NGL2,203 332 96 2,631 Natural gas1,524 969 (71)2,422 Total$15,799 $6,419 $256 $22,474 International RevenueOil (b)$2,844 $902 $189 $3,935 NGL325 85 11 421 Natural gas291 23 (3)311 Total$3,460 $1,010 $197 $4,667 (a) Excludes "other" oil and gas revenue. See Note 2 - Revenue in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K for additional information regarding other revenue.(b) Includes the impact of international production sharing contracts.42 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISProductionThe following table sets forth the production volumes of oil, NGL and natural gas per day from ongoing operations for each of the three years in the period ended December 31, 2022, and includes a year-over-year change calculation: Production per Day, Ongoing Operations (Mboe/d)2022Year over Year Change2021Year over Year Change2020United States Permian513 5 %487 (15)%575 Rockies & Other Domestic277 (8)%302 (9)%332 Gulf of Mexico147 2 %144 11 %130 Total937 0 %933 (10)%1,037 InternationalAlgeria & Other International47 7 %44 (2)%45 Al Hosn Gas73 (4)%76 (3)%78 Dolphin37 (8)%40 (9)%44 Oman65 (12)%74 (13)%85 Total222 (5)%234 (7)%252 Total Production from Ongoing Operations1,159 (1)%1,167 (9)%1,289 Operations exited (a)— (100)%16 (72)%58 Total Production (Mboe/d) (b)1,159 (2)%1,183 (12)%1,347 (a)Operations exited include the Ghana assets (sold in October 2021) and the Colombia onshore assets (sold in December 2020).(b)Natural gas volumes have been converted to Boe based on energy content of six Mcf of gas to one barrel of oil. Boe equivalent does not necessarily result in price equivalency. Please refer to the Supplemental Oil and Gas Information (unaudited) section of this Form 10-K for additional information on oil and gas production and sales.Average daily production volumes from ongoing operations remained materially consistent in 2022 as compared to 2021. Production increased in the Permian Basin due to increased development activity, which was partially offset by a decrease in production, especially natural gas, in the DJ Basin reflecting reduced capital investment and the impact of rising commodity prices that reduce Occidental's share of production under international production sharing contracts.Lease Operating ExpenseThe following table sets forth the average lease operating expense per Boe from ongoing operations for each of the three years in the period ended December 31, 2022:202220212020Average lease operating expense per Boe$9.52 $7.58 $6.38 Average lease operating expense per Boe increased in 2022 compared to 2021 primarily as a result of inflationary pressures which led to higher workover, support and maintenance costs in the Permian Basin, Rockies and Other and Gulf of Mexico, as well as higher purchase injectant costs in the Permian Basin. OXY 2022 FORM 10-K43MANAGEMENT’S DISCUSSION AND ANALYSISCHEMICAL SEGMENTmillions202220212020Segment Sales$6,757 $5,246 $3,733 Segment Results$2,508 $1,544 $664 Chemical segment results increased in 2022 compared to 2021 due to improved demand and stronger realized prices across most product lines, including caustic soda, partially offset by higher raw material costs, primarily energy costs.MIDSTREAM AND MARKETING SEGMENTmillions202220212020Segment Sales$4,136 $2,863 $1,768 Segment Results (a)$273 $257 $(4,175)Items affecting comparabilityAsset sales gains (losses) and others, net (b)$98 $124 $(46)Derivative gains (losses), net$(259)$(252)$97 Goodwill impairments and other charges (c)$— $(21)$(4,194)(a)Results included significant items affecting comparability discussed in the footnotes below.(b)The 2022 amount included $62 million relating to a gain on the sale of 10 million limited partner units in WES and a $36 million gain on the sale of a joint venture. The 2021 amount included a $102 million gain from the sale of 11.5 million limited partner units in WES. The 2020 amount represented a loss on the exchange of WES common units to retire a $260 million note. (c)The 2020 amount included a $2.7 billion other-than-temporary impairment of the equity investment in WES and $1.4 billion of impairments related to the write-off of goodwill and a loss from an equity investment related to WES’ write-off of its goodwill. Midstream and marketing segment results, excluding items affecting comparability, increased in 2022 compared to 2021, primarily due to higher equity income from WES, improved gas marketing margin from transportation capacity optimization and improved sulfur prices at Al Hosn Gas, partially offset by the timing impact of crude oil sales in the marketing business.CORPORATESignificant corporate items include the following:millions202220212020Items Affecting ComparabilityAnadarko acquisition-related costs$(89)$(153)$(339)Interest rate swap gains (losses), net (a)$317 $122 $(428)Maxus environmental reserve adjustment$(22)$— $— Early debt extinguishment$149 $(118)$— Acquisition-related pension & termination benefits$— $— $114 Warrants gains, net (a)$— $— $5 (a)See Note 8 - Derivatives in the Notes to the Consolidated Financial Statements in Part II Item 8 of this Form 10-K for more information. 44 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISINCOME TAXES Total deferred tax assets, after valuation allowance, were $2.2 billion and $3.5 billion as of December 31, 2022 and 2021, respectively. Occidental expects to realize the recorded deferred tax assets, net of any allowances, through future operating income and reversal of temporary differences. The total deferred tax liabilities were $7.7 billion and $10.5 billion as of December 31, 2022 and 2021, respectively. The decrease in net deferred tax liability in 2022 compared to 2021 was primarily driven by the legal entity reorganization that Occidental undertook in the first quarter of 2022. See more discussion below.WORLDWIDE EFFECTIVE TAX RATEThe following table sets forth the calculation of the worldwide effective tax rate for income from continuing operations:millions202220212020SEGMENT RESULTS Oil and gas$12,803 $4,145$(9,632)Chemical2,508 1,544664 Midstream and marketing273 257(4,175)Unallocated corporate items(1,467)(2,241)(2,562)Income (loss) from continuing operations before taxes$14,117 $3,705$(15,705)Income tax benefit (expense) Federal and state248 (247)2,607 Foreign(1,061)(668)(435)Total income tax benefit (expense)(813)(915)2,172 Income (loss) from continuing operations$13,304 $2,790$(13,533)Worldwide effective tax rate6%25 %14%In 2022, Occidental’s worldwide effective tax rate was 6%, which was impacted by a tax benefit associated with Occidental's legal entity reorganization, as further described below.In 2021, Occidental’s worldwide effective tax rate was 25%, which was higher than the U.S. statutory rate of 21% due to higher tax rates in the foreign jurisdictions in which Occidental operates, partially offset by the tax impact of business credits, state tax revaluations and other domestic tax benefits.In 2020, Occidental’s worldwide effective tax rate was 14%, which was largely a result of the impairment of the WES goodwill and certain international assets for which Occidental received no tax benefit and higher-taxed international operations which generally caused Occidental’s tax rate to vary significantly from the U.S. corporate tax rate.LEGAL ENTITY REORGANIZATIONTo align Occidental’s legal entity structure with the nature of its business activities after completing the Anadarko Acquisition and subsequent large scale post-acquisition divestiture program, management undertook a legal entity reorganization that was completed in the first quarter of 2022.As a result of this legal entity reorganization, management made an adjustment to the tax basis in a portion of its operating assets, thus reducing Occidental’s deferred tax liabilities. Accordingly, in 2022, Occidental recorded a tax benefit of $2.7 billion in connection with this reorganization. The timing of any reduction in Occidental’s future cash taxes as a result of this legal entity reorganization will be dependent on a number of factors, including prevailing commodity prices, capital activity level and production mix. The legal entity reorganization transaction is currently under IRS review as part of the Company’s 2022 federal tax audit.INFLATION REDUCTION ACT In August 2022, Congress passed the Inflation Reduction Act that contains, among other provisions, a corporate book minimum tax on financial statement income, an excise tax on stock buybacks, a methane emissions fee and certain tax incentives related to climate change and clean energy. Occidental is currently evaluating the provisions of this act. The ultimate impact of the act is yet to be determined and will depend on additional regulatory guidance and interpretations. OXY 2022 FORM 10-K45MANAGEMENT’S DISCUSSION AND ANALYSISCONSOLIDATED RESULTS OF OPERATIONSREVENUE AND OTHER INCOME ITEMSmillions202220212020Net sales$36,634 $25,956 $17,809 Interest, dividends and other income$153 $166 $118 Gains (losses) on sale of assets, net$308 $192 $(1,666)NET SALESPrice and volume changes generally represent the majority of the change in the oil and gas and chemical segments sales. Midstream and marketing sales generally represent the margins earned by the marketing business at it strives to optimize the use of its transportation, storage and terminal commitments to provide access to domestic and international markets and, to a lesser extent, NGL and sulfur revenues from the gas processing business. The increase in net sales in 2022 compared to 2021 was primarily due to higher realized commodity prices in the oil and gas segment. Chemical sales increased primarily due to higher prices and volumes across all product lines. The increase in midstream and marketing sales was due to higher crude oil prices impacting the marketing businesses.EXPENSE ITEMSmillions202220212020Oil and gas operating expense$4,028 $3,160 $3,065 Transportation and gathering expense$1,475 $1,419 $1,600 Chemical and midstream cost of sales$3,273 $2,772 $2,408 Purchased commodities$3,287 $2,308 $1,395 Selling, general and administrative$945 $863 $864 Other operating and non-operating expense$1,271 $1,065 $884 Taxes other than on income$1,548 $1,005 $622 Depreciation, depletion and amortization$6,926 $8,447 $8,097 Asset impairments and other charges$— $304 $11,083 Anadarko Acquisition-related costs$89 $153 $339 Exploration expense$216 $252 $132 Interest and debt expense, net$1,030 $1,614 $1,424 OIL AND GAS OPERATING EXPENSEOil and gas operating expense increased in 2022 from the prior year, primarily as a result of higher workovers, supports and maintenance costs in the Permian Basin, Rockies and Other and Gulf of Mexico, as well as higher purchase injectant costs in the Permian Basin. CHEMICAL AND MIDSTREAM COST OF SALESChemical and midstream cost of sales increased in 2022 from the prior year, primarily due to higher raw material costs in the chemical segment, primarily energy costs, and increased power generation costs in the midstream and marketing segment.PURCHASED COMMODITIESPurchased commodities increased in 2022 from the prior year, largely as a result of higher prices on third-party crude purchases related to the midstream and marketing segment.OTHER OPERATING AND NON-OPERATING EXPENSEOther operating and non-operating expense increased in 2022 from the prior year, primarily due to increases in employee related costs and environmental remediation expenses.DEPRECIATION, DEPLETION AND AMORTIZATIONDD&A expense decreased in 2022 from the prior year, primarily as a result of lower per Boe DD&A rates due to higher proved reserves as a result of positive program adds during 2021.46 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISASSET IMPAIRMENTS AND OTHER CHARGESThere were no asset impairments in 2022. In 2021, asset impairments and other charges of $304 million were mainly comprised of the impairment of undeveloped leases that either expired or were set to expire in the near term where Occidental had no plans to pursue exploration activities.TAXES OTHER THAN ON INCOMETaxes other than on income in 2022 increased from the prior year, primarily due to higher production taxes, which are directly tied to revenues, and higher ad valorem taxes.INTEREST AND DEBT EXPENSE, NETInterest and debt expense decreased in 2022 from the prior year, due to lower outstanding debt as a result of debt repayments.OTHER ITEMSIncome (expense) millions202220212020Gains (losses) on interest rate swaps and warrants$317 $122 $(423)Income from equity investments$793 $631 $370 Income tax benefit (expense)$(813)$(915)$2,172 Loss from discontinued operations, net$— $(468)$(1,298)LOSS FROM DISCONTINUED OPERATIONS, NETThere were no discontinued operations in 2022. In 2021, discontinued operations, net primarily included a $437 million after-tax loss contingency associated with Occidental’s former operations in Ecuador, see Note - 13 Lawsuits, Claims, Commitments and Contingencies in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K for more information. In addition, discontinued operations, net was associated with operations in Ghana which were sold in October 2021.LIQUIDITY AND CAPITAL RESOURCESCASH ON HANDAs of December 31, 2022, Occidental had approximately $1.0 billion in cash and cash equivalents. A substantial majority of this cash is held and available for use in the United States.SOURCES AND USES OF CASHOccidental currently expects its operational cash flows and cash on hand to be sufficient to meet its current debt maturities and other obligations for the next 12 months from the date of this filing. Should commodity prices return to their 2020 lows, Occidental’s $4.0 billion RCF, receivables securitization facility and access to capital markets are available to meet its ongoing capital needs, purchase obligations, near-term debt maturities and other liabilities and financial obligations, if required.Occidental’s planned 2023 capital expenditures are between $5.4 billion and $6.2 billion, of which only a small percentage is allocated to non-cancellable commitments. As of December 31, 2022, Occidental had $22 million in current maturities of long-term debt which were paid in January 2023, and an additional $1.1 billion in long-term obligations due in 2024.As of December 31, 2022, Occidental had $433 million in non-cancelable lease payments due in 2023, and an additional $335 million in non-cancelable lease payments due in 2024. Dividends paid to common and preferred shareholders were $1.2 billion for the year ended December 31, 2022.Occidental is party to various purchase agreements that are not accounted for as leases or otherwise accrued as liabilities as of December 31, 2022. These agreements consist primarily of obligations to secure terminal, pipeline and processing capacity, purchase services used in the normal course of business including transporting and disposing of produced water, purchase goods used in the production of finished goods including certain chemical raw materials and power and agreements relating to equipment maintenance and service. The amounts that will be paid for such outstanding off-balance sheet purchase obligations as of December 31, 2022 are $3.0 billion in 2023, $4.2 billion in 2024 and 2025, $2.5 billion in 2026 and 2027 and $2.2 billion in 2028 and thereafter.SHARE REPURCHASE PROGRAMUnder the $3.0 billion share repurchase program announced and completed in 2022, Occidental purchased approximately 47.7 million shares. In February 2023, the Board authorized a new share repurchase program of up to $3.0 billion of Occidental’s shares of common stock. OXY 2022 FORM 10-K47MANAGEMENT’S DISCUSSION AND ANALYSISCONTRACTUAL OBLIGATIONSThe following table summarizes and cross-references Occidental’s contractual obligations and indicates on- and off-balance sheet obligations as of December 31, 2022. Commitments related to held for sale assets are excluded.millions Payments Due by YearTotal20232024 and 20252026 and 20272028 and thereafterOn-Balance Sheet Current portion of long-term debt (Note 6) (a)$22 $22 $— $— $— Long-term debt (Note 6) (a)17,936 — 2,264 2,351 13,321 Expected interest payments on long-term debt11,400 1,060 2,042 1,754 6,544 Leases (Note 7) (b)1,818 433 538 320 527 Asset retirement obligations (Note 1)3,805 169 1,124 961 1,551 Other long-term liabilities (c)2,594 11 851 253 1,479 Off-Balance SheetPurchase obligations (d)11,963 2,983 4,246 2,510 2,224 Total$49,538 $4,678 $11,065 $8,149 $25,646 (a)Excluded unamortized debt discount and interest.(b)Occidental is the lessee under various agreements for real estate, equipment, plants and facilities. (c)Included long-term obligations and current portions of long-term obligations under postretirement benefits, accrued transportation commitments, ad valorem taxes and other accrued liabilities.(d)Amounts included payments which will become due under long-term agreements to purchase goods and services used in the normal course of business to secure terminal, pipeline and processing capacity, CO2, electrical power, steam and certain chemical raw materials including but not limited to capital commitments. Amounts excluded certain product purchase obligations related to marketing activities for which there are no minimum purchase requirements or the amounts are not fixed or determinable. Long-term purchase contracts were discounted at a 5.03% discount rate. DEBT ACTIVITYFor the twelve months ended December 31, 2022, Occidental repaid debt with a face value of more than $10.5 billion, reducing the face value of Occidental’s debt to less than $18.0 billion. The net book value of the full year repayments was $9.8 billion, which resulted in a gain of $149 million.See Note 6 - Long-Term Debt in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K for more information related to Occidental’s debt issuance and repayments.GUARANTEESOccidental has entered into various guarantees, indemnities and commitments provided by Occidental to third parties, mainly to provide assurance that Occidental or its consolidated subsidiaries or affiliates will meet their various obligations.As of the date of this filing, Occidental has provided required financial assurance through a combination of cash, letters of credit and surety bonds. Occidental has not issued any letters of credit under the RCF or other committed facilities. For additional information, see Risk Factors in Part I, Item 1A of this Form 10-K.CASH FLOW ANALYSISCASH PROVIDED BY OPERATING ACTIVITIESmillions202220212020Operating cash flow from continuing operations$16,810 $10,253 $3,842 Operating cash flow from discontinued operations, net of taxes— 181 113 Net cash provided by operating activities$16,810 $10,434 $3,955 Cash provided by operating activities increased in 2022 compared to 2021, primarily due to higher commodity prices, as average WTI and Brent prices increased by 39% and 40%, respectively and NYMEX natural gas prices increased by 76%. The chemical segment also generated substantial operating cash flows largely due to higher prices for most chemical products, especially caustic soda, compared to 2021.48 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISCASH USED BY INVESTING ACTIVITIESmillions202220212020Capital expenditures Oil and gas$(3,844)$(2,409)$(2,208)Chemical(322)(308)(255)Midstream and marketing(268)(106)(50)Corporate(63)(47)(22)Total$(4,497)$(2,870)$(2,535)Changes in capital accrual147 97 (519)Purchase of businesses, assets and equity investments, net(990)(431)(114)Proceeds from sale of assets and equity investments, net584 1,624 2,281 Other investing activities, net(116)406 109 Investing cash flows from continuing operations$(4,872)$(1,174)$(778)Investing cash flows from discontinued operations— (79)(41)Net cash used by investing activities$(4,872)$(1,253)$(819)Cash flows used by investing activities increased by $3.6 billion in 2022 compared to 2021. In 2022, Occidental increased capital spending as a result of increased activity in the Permian. Occidental acquired additional primarily producing assets in the Permian Basin for approximately $400 million and additional interests in emerging low-carbon businesses and net-zero pathway for approximately $350 million. Occidental sold certain strategic assets in the Permian Basin for approximately $190 million. See Note 5 - Acquisitions, Divestitures and Other Transactions in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K for a listing of assets and equity investments acquired and sold in 2022, 2021 and 2020. In addition in 2022, Occidental sold 10 million limited partner units of WES for proceeds of approximately $250 million. CASH USED BY FINANCING ACTIVITIESmillions202220212020Financing cash flows from continuing operations$(13,715)$(8,564)$(4,508)Financing cash flows from discontinued operations— (8)(8)Net cash used by financing activities$(13,715)$(8,572)$(4,516)Cash used by financing activities increased by $5.1 billion compared to 2021 primarily due to the 2022 debt tenders and repayments and treasury share repurchase activity. See Note 6 - Long-Term Debt in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K for more information related to Occidental’s debt repayments and see Item 5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities in Part II of this Form 10-K and Note 14 - Stockholders' Equity in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K for additional information related to Occidental’s share repurchases. In addition, cash used by financing activities reflected cash dividend payments of $1.2 billion on preferred and common stock and $111 million, related to net interest rate swap settlements and collateral activity.LAWSUITS, CLAIMS, COMMITMENTS AND CONTINGENCIESLEGAL MATTERSFor information on Occidental’s Lawsuits, Claims, Commitments and Contingencies, see the information in Note 13 - Lawsuits, Claims, Commitments and Contingencies in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K. OXY 2022 FORM 10-K49MANAGEMENT’S DISCUSSION AND ANALYSISENVIRONMENTAL LIABILITIES AND EXPENDITURESENVIRONMENTAL COSTSEnvironmental costs relate to the prevention, monitoring, control, treatment or abatement of waste, emissions or releases to air, water or land from operations of Occidental’s subsidiaries. These activities are generally integrated with ongoing operations or development projects, so the costs in this table include estimates. The environmental costs in the table do not include litigation-related costs, including fines, penalties or settlements, or Occidental’s investments in low-carbon ventures. Occidental’s environmental costs are presented below for each segment for each of the years ended December 31:millions202220212020Operating Expenses Oil and gas$304 $267 $176 Chemical115 88 73 Midstream and marketing6 6 4 Total$425 $361 $253 Capital ExpendituresOil and gas$110 $87 $74 Chemical53 66 40 Midstream and marketing5 1 1 Total$168 $154 $115 Remediation ExpensesCorporate$65 $28 $36 Operating expenses are incurred on a continual basis. Capital expenditures relate to longer-lived improvements in properties currently operated by Occidental. Remediation expenses relate to existing conditions from past operations of Occidental or its subsidiaries.For additional information on Occidental’s Environmental Liabilities and Expenditures, see the information in Note 12 - Environmental Liabilities and Expenditures in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K.GLOBAL INVESTMENTSA portion of Occidental’s assets are located outside North America. The following table shows the geographic distribution of Occidental’s assets as of December 31, 2022, at both the segment and consolidated level related to Occidental’s ongoing operations:millionsOil and gasChemicalMidstream and marketingCorporate and otherTotal ConsolidatedNorth AmericaUnited States$49,786 $4,323 $8,701 $1,917 $64,727 Canada— 111 104 — 215 Middle East3,602 — 3,133 — 6,735 North Africa and Other670 124 138 — 932 Consolidated$54,058 $4,558 $12,076 $1,917 $72,609 For the year ended December 31, 2022, net sales outside North America totaled $5.5 billion, or approximately 15% of total net sales.50 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISCRITICAL ACCOUNTING POLICIES AND ESTIMATESThe process of preparing financial statements in accordance with United States GAAP requires Occidental’s management to make informed estimates and judgments regarding certain items and transactions. Changes in facts and circumstances or discovery of new information may result in revised estimates and judgments and actual results may differ from these estimates upon settlement but generally not by material amounts. The selection and development of these policies and estimates have been discussed with the Audit Committee of the Board of Directors. Occidental considers the following to be its most critical accounting policies and estimates that involve management’s judgment.OIL AND GAS PROPERTIESThe carrying value of Occidental’s PP&E represents the cost incurred to acquire or develop the asset, including any AROs and capitalized interest, net of DD&A and any impairment charges. For assets acquired in a business combination, PP&E cost is based on fair values at the acquisition date. AROs and interest costs incurred in connection with qualifying capital expenditures are capitalized and amortized over the useful lives of the related assets.Occidental uses the successful efforts method to account for its oil and gas properties. Under this method, Occidental capitalizes costs of acquiring properties, costs of drilling successful exploration wells and development costs. The costs of exploratory wells are initially capitalized pending a determination of whether proved reserves have been found. If proved reserves have been found, the costs of exploratory wells remain capitalized. For exploratory wells that find reserves that cannot be classified as proved when drilling is completed, costs continue to be capitalized as suspended exploratory drilling costs if there have been sufficient reserves found to justify completion as a producing well and sufficient progress is being made in assessing the economic and operating viability of the project. At the end of each quarter, management reviews the status of all suspended exploratory drilling costs in light of ongoing exploration activities and in particular, whether Occidental is making sufficient progress in its ongoing exploration and appraisal efforts or, in the case of discoveries requiring government sanctioning, analyzing whether development negotiations are underway and proceeding as planned. If management determines that future appraisal drilling or development activities are unlikely to occur, associated suspended exploratory well costs are expensed.Occidental expenses annual lease rentals, the costs of injectants used in production and geological and geophysical costs as incurred for exploration activities.Occidental determines depreciation and depletion of oil and gas producing properties by the unit-of-production method. It amortizes leasehold acquisition costs over total proved reserves and capitalized development and successful exploration costs over proved developed reserves.Proved oil and gas reserves are those quantities of oil and gas which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible—from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations—prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Several factors could change Occidental’s proved oil and gas reserves. For example, Occidental receives a share of production from PSCs to recover its costs and generally an additional share for profit. Occidental’s share of production and reserves from these contracts decreases when product prices rise and increases when prices decline. Generally, Occidental’s net economic benefit from these contracts is greater at higher product prices. In other cases, particularly with long-lived properties, lower product prices may lead to a situation where production of a portion of proved reserves becomes uneconomical. For such properties, higher product prices typically result in additional reserves becoming economical. Estimation of future production and development costs is also subject to change partially due to factors beyond Occidental’s control, such as energy costs and inflation or deflation of oil field service costs. These factors, in turn, could lead to changes in the quantity of proved reserves. Additional factors that could result in a change of proved reserves include production decline rates and operating performance differing from those estimated when the proved reserves were initially recorded. Changes in the political and regulatory climate could lead to decreases in proved reserves as development horizons may be extended into the future. Occidental performs impairment tests with respect to its proved properties whenever events or circumstances indicate that the carrying value of property may not be recoverable. If there is an indication the carrying amount of the asset may not be recovered due to significant and prolonged declines in current and forward prices, significant changes in reserve estimates, changes in management’s plans or other significant events, management will evaluate the property for impairment. Under the successful efforts method, if the sum of the undiscounted cash flows is less than the carrying value of the proved property, the carrying value is reduced to estimated fair value and reported as an impairment charge in the period. Individual proved properties are grouped for impairment purposes at the lowest level for which there are identifiable cash flows unless observable and comparable transactions are available. The fair value of impaired assets is typically determined based on the present value of expected future cash flows using discount rates believed to be consistent with those used by market participants. The impairment test incorporates a number of assumptions involving expectations of future cash flows which can change significantly over time. These assumptions include estimates of future production, product prices, contractual prices, estimates of risk-adjusted oil and gas proved and unproved reserves and estimates of OXY 2022 FORM 10-K51MANAGEMENT’S DISCUSSION AND ANALYSISfuture operating and development costs. It is reasonably possible that prolonged declines in commodity prices, reduced capital spending in response to lower prices or increases in operating costs could result in impairments.For impairment testing, unless prices are contractually fixed, Occidental uses observable forward strip prices for oil and natural gas prices when projecting future cash flows. Future operating and development costs are estimated using the current cost environment applied to expectations of future operating and development activities to develop and produce oil and gas reserves. Market prices for oil, NGL and natural gas have been volatile and may continue to be volatile in the future. Changes in global supply and demand, transportation capacity, currency exchange rates, applicable laws and regulations and the effect of changes in these variables on market perceptions could impact current forecasts. Future fluctuations in commodity prices could result in estimates of future cash flows to vary significantly. Net capitalized costs attributable to unproved properties were $12.6 billion as of December 31, 2022, and $14.8 billion as of December 31, 2021. The unproved amounts are not subject to DD&A until they are classified as proved properties. Individually insignificant unproved properties are combined and amortized on a group basis based on factors such as lease terms, success rates and other factors to provide for full amortization upon lease expiration or abandonment. Significant unproved properties, primarily as a result of the Anadarko Acquisition, are assessed individually for impairment and when events or circumstances indicate that the carrying value of property may not be recovered a valuation allowance is provided if an impairment is indicated. Occidental periodically reviews significant unproved properties for impairments; numerous factors are considered, including but not limited to, availability of funds for future exploration and development activities, current exploration and development plans, favorable or unfavorable exploration activity on the property or the adjacent property, geologists’ evaluation of the property, the current and projected political and regulatory climate, contractual conditions and the remaining lease term for the properties. If an impairment is indicated, Occidental will first determine whether a comparable transaction for similar properties or implied acreage valuation derived from domestic onshore market participants is available and will adjust the carrying amount of the unproved property to its fair value using the market approach. In situations where the market approach is not observable and unproved reserves are available, undiscounted future net cash flows used in the impairment analysis are determined based on managements’ risk adjusted estimates of unproved reserves, future commodity prices and future costs to produce the reserves. If undiscounted future net cash flows are less than the carrying value of the property, the future net cash flows are discounted and compared to the carrying value for determining the amount of the impairment loss to record. Occidental utilizes the same assumptions and methodology discussed above for cash flows associated with proved properties. PROVED RESERVESOccidental estimates its proved oil and gas reserves according to the definition of proved reserves provided by the SEC’s Rule 4-10 (a) of Regulation S-X and Financial Accounting Standards Board. Proved oil and gas reserves are those quantities of oil and gas which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible—from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations—prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. Prices include consideration of price changes provided only by contractual arrangements and do not include adjustments based on expected future conditions. For reserves information, see the Supplemental Information on Oil and Gas Exploration and Production Activities under Item 8 of this Form 10-K.Engineering estimates of the quantities of proved reserves are inherently imprecise and represent only approximate amounts because of the judgments involved in developing such information. Occidental’s estimates of proved reserves are made using available geological and reservoir data as well as production performance data. The reliability of these estimates at any point in time depends on both the quality and quantity of the technical and economic data and the efficiency of extracting and processing the hydrocarbons. These estimates are reviewed annually by internal reservoir engineers and revised, either upward or downward, as warranted by additional data. Revisions are necessary due to changes in, among other things, development plans, reservoir performance, prices, economic conditions and governmental restrictions as well as changes in the expected recovery associated with infill drilling. Decreases in prices, for example, may cause a reduction in some proved reserves due to reaching economic limits at an earlier projected date. A material adverse change in the estimated volume of proved reserves could have a negative impact on DD&A and could result in property impairments.The most significant ongoing financial statement effect from a change in Occidental’s oil and gas reserves or impairment of its proved properties would be to the DD&A rate. For example, a 5% increase or decrease in the amount of oil and gas reserves would change the DD&A rate by approximately $0.60/Bbl, which would increase or decrease pre-tax income by approximately $270 million annually at current production rates. FAIR VALUESOccidental estimates fair-value of long-lived assets for impairment testing, assets and liabilities acquired in a business combination or exchanged in non-monetary transactions, pension plan assets and initial measurements of AROs.Accounting for the acquisition of a business requires the allocation of the purchase price to the various assets and liabilities of the acquired business and recording deferred taxes for any differences between the allocated values and tax basis of assets and liabilities. Any excess of the purchase price over the amounts assigned to assets and liabilities is 52 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISrecorded as goodwill. The purchase price allocation is accomplished by recording each asset and liability at its estimated fair value, which may be determined using different methods of fair value measurements, largely based on the availability and quality of market information. Occidental primarily applies the market approach for recurring fair value measurements, maximizes its use of observable inputs and minimizes its use of unobservable inputs. FINANCIAL ASSETS AND LIABILITIESOccidental utilizes published prices or counterparty statements for valuing the majority of its financial assets and liabilities measured and reported at fair value. In addition to using market data, Occidental makes assumptions in valuing its assets and liabilities, including assumptions about the risks inherent in the inputs to the valuation technique. For financial assets and liabilities carried at fair value, Occidental measures fair value using the following methods:■Occidental values exchange-cleared commodity derivatives using closing prices provided by the exchange as of the balance sheet date. These derivatives are classified as using quoted prices in active markets for the assets or liabilities (Level 1).■OTC bilateral financial commodity contracts, international exchange contracts, options and physical commodity forward purchase and sale contracts are generally classified as using observable inputs other than quoted prices for the assets or liabilities (Level 2) and are generally valued using quotations provided by brokers or industry-standard models that consider various inputs, including quoted forward prices for commodities, time value, volatility factors, credit risk and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these inputs are observable in the marketplace throughout the full term of the instrument and can be derived from observable data or are supported by observable prices at which transactions are executed in the marketplace.■Occidental values commodity derivatives based on a market approach that considers various assumptions, including quoted forward commodity prices and market yield curves. The assumptions used include inputs that are generally unobservable in the marketplace or are observable but have been adjusted based upon various assumptions and the fair value is designated as using unobservable inputs (Level 3) within the valuation hierarchy.■Occidental values debt using market-observable information for debt instruments that are traded on secondary markets. For debt instruments that are not traded, the fair value is determined by interpolating the value based on debt with similar terms and credit risk.NON-FINANCIAL ASSETSOccidental uses market-observable prices for assets when comparable transactions can be identified that are similar to the asset being valued. When Occidental is required to measure fair value and there is not a market-observable price for the asset or for a similar asset then the cost or income approach is used depending on the quality of information available to support management’s assumptions. The cost approach is based on management’s best estimate of the current asset replacement cost. The income approach is based on management’s best assumptions regarding expectations of future net cash flows and the expected cash flows are discounted using a commensurate risk-adjusted discount rate. Such evaluations involve significant judgment. The results are based on expected future events or conditions such as sales prices, estimates of future oil and gas production or throughput, development and operating costs and the timing thereof, economic and regulatory climates and other factors, most of which are often outside of management’s control. However, assumptions used reflect a market participant’s view of long-term prices, costs and other factors and are consistent with assumptions used in Occidental’s business plans and investment decisions.ENVIRONMENTAL LIABILITIES AND EXPENDITURESCertain subsidiaries of Occidental incur environmental liabilities and expenditures that relate to current operations and are expensed or capitalized by such subsidiaries as appropriate. Certain subsidiaries also incur environmental liabilities and expenditures with respect to remediation of existing conditions from alleged past practices at Third-Party, Currently Operated, and Closed or Non-operated Sites. Those environmental liabilities and related charges and expenses for estimated remediation costs from past operations are recorded when environmental remediation efforts are probable and the costs can be reasonably estimated. Occidental discloses such remediation liabilities on a consolidated basis. In determining the environmental remediation liability and the range of reasonably possible additional losses, Occidental refers to currently available information, including relevant past experience, remedial objectives, available technologies, applicable laws and regulations and cost-sharing arrangements. These environmental remediation liabilities are based on management’s estimate of the most likely cost to be incurred, using the most cost-effective technology reasonably expected to achieve the remedial objective. Occidental periodically reviews these environmental remediation liabilities and adjusts them as new information becomes available. Occidental’s subsidiaries generally record reimbursements or recoveries of environmental remediation costs in income when received, or when receipt of recovery is highly probable.Many factors could affect future remediation costs incurred by Occidental’s subsidiaries and result in adjustments to environmental remediation liabilities and the range of reasonably possible additional losses. The most significant are: (1) cost estimates for remedial activities may vary from the initial estimate; (2) the length of time, type or amount of remediation necessary to achieve the remedial objective may change due to factors such as site conditions, the ability to identify and OXY 2022 FORM 10-K53MANAGEMENT’S DISCUSSION AND ANALYSIScontrol contaminant sources or the discovery of additional contamination; (3) a regulatory agency may ultimately reject or modify proposed remedial plans; (4) improved or alternative remediation technologies may change remediation costs; (5) laws and regulations may change remediation requirements or affect cost sharing or allocation of liability; and (6) changes in allocation or cost-sharing arrangements may occur.Certain sites involve multiple parties with various cost-sharing arrangements, which generally fall into the following three categories: (1) environmental proceedings that result in a negotiated or prescribed allocation of remediation costs among the affected Occidental’s subsidiary and other alleged potentially responsible parties; (2) oil and gas ventures in which each participant pays its proportionate share of remediation costs reflecting its working interest; or (3) contractual arrangements, typically relating to purchases and sales of properties, in which the parties to the transaction agree to methods of allocating remediation costs. In these circumstances, the affected subsidiary evaluates the financial viability of other parties with whom it is alleged to be jointly liable, the degree of their commitment to participate and the consequences to such subsidiary of their failure to participate when estimating its ultimate share of liability. Occidental subsidiaries record environmental remediation liabilities at their expected net cost of remedial activities. Based on these factors, except as otherwise disclosed in Note 12 - Environmental Liabilities and Expenditures in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K, Occidental’s subsidiaries believe that they will not be required to assume a share of liability of such other potentially responsible parties in an amount materially above amounts reserved.In addition to the costs of investigations and clean-up measures, which often take in excess of 10 years at CERCLA NPL sites, Occidental subsidiaries’ environmental remediation liabilities include estimates of the costs to operate and maintain remedial systems. If remedial systems are modified over time in response to significant changes in site-specific data, laws, regulations, technologies or engineering estimates, Occidental’s subsidiaries review and adjust their environmental remediation liabilities accordingly.If Occidental or its subsidiaries were to adjust the balance of their environmental remediation liabilities based on the factors described above, the amount of the increase or decrease would be recognized in earnings. For example, if the balance were reduced by 10%, Occidental would record a pre-tax increase to income of $105 million. If the balance were increased by 10%, Occidental would record an additional remediation expense of $105 million.INCOME TAXESOccidental and its subsidiaries file various U.S. federal, state and foreign income tax returns. The impact of changes in tax regulations are reflected when enacted. In general, deferred federal, state and foreign income taxes are provided on temporary differences between the financial statement carrying amounts of assets and liabilities and their respective tax basis. Occidental routinely assesses the realizability of its deferred tax assets. If Occidental concludes that it is more likely than not that some of the deferred tax assets will not be realized, the tax asset is reduced by a valuation allowance. Occidental recognizes a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, based on the technical merits of the position. The tax benefit recorded is equal to the largest amount that is greater than 50% likely to be realized through final settlement with a taxing authority. Interest and penalties related to unrecognized tax benefits are recognized in income tax expense (benefit). See Note 10 - Income Taxes in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K.LOSS CONTINGENCIESOccidental or certain of its subsidiaries are involved, in the normal course of business, in lawsuits, claims and other legal proceedings and audits. Occidental or its affected subsidiaries, as appropriate, accrues reserves for these matters when it is probable that a liability has been incurred and the liability can be reasonably estimated. In addition, Occidental discloses, in aggregate on a consolidated basis, exposure to loss in excess of the amount recorded on the balance sheet for these matters if it is reasonably possible that an additional material loss may be incurred. Occidental reviews such loss contingencies on an ongoing basis.Loss contingencies are based on judgments made by management with respect to the likely outcome of these matters and are adjusted as appropriate. Management’s judgments could change based on new information, changes in, or interpretations of, laws or regulations, changes in management’s plans or intentions, opinions regarding the outcome of legal proceedings or other factors. See Note 13 - Lawsuits, Claims, Commitments and Contingencies in the Notes to Consolidated Financial Statements in Part II Item 8 of this Form 10-K for additional information.54 OXY 2022 FORM 10-KMANAGEMENT’S DISCUSSION AND ANALYSISSAFE HARBOR DISCUSSION REGARDING OUTLOOK AND OTHER FORWARD-LOOKING DATAPortions of this report contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws, and they include, but are not limited to: any projections of earnings, revenue or other financial items or future financial position or sources of financing; any statements of the plans, strategies and objectives of management for future operations, business strategy or financial position; any statements regarding future economic conditions or performance; any statements of belief; and any statements of assumptions underlying any of the foregoing. Words such as “estimate,” “project,” “predict,” “will,” “would,” “should,” “could,” “may,” “might,” “anticipate,” “plan,” “intend,” “believe,” “expect,” “aim,” “goal,” “target,” “objective,” "commit," "advance," “likely” or similar expressions that convey the prospective nature of events or outcomes are generally indicative of forward-looking statements. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this report. Unless legally required, Occidental does not undertake any obligation to update, modify or withdraw any forward-looking statements as a result of new information, future events or otherwise.Although Occidental believes that the expectations reflected in any of its forward-looking statements are reasonable, actual results may differ from anticipated results, sometimes materially. In addition, historical, current and forward-looking sustainability-related statements may be based on standards for measuring progress that are still developing, internal controls and processes that continue to evolve and assumptions that are subject to change in the future. Factors that could cause results to differ from those projected or assumed in any forward-looking statement include, but are not limited to: general economic conditions, including slowdowns and recessions, domestically or internationally; Occidental’s indebtedness and other payment obligations, including the need to generate sufficient cash flows to fund operations; Occidental’s ability to successfully monetize select assets and repay or refinance debt and the impact of changes in Occidental’s credit ratings; the scope and duration of the global or regional health pandemics or epidemics, including the COVID-19 pandemic and ongoing actions taken by governmental authorities and other third parties in response to the pandemic; assumptions about energy markets; global and local commodity and commodity-futures pricing fluctuations and volatility; supply and demand considerations for, and the prices of, Occidental’s products and services; actions by OPEC and non-OPEC oil producing countries; results from operations and competitive conditions; future impairments of Occidental's proved and unproved oil and gas properties or equity investments, or write-downs of productive assets, causing charges to earnings; unexpected changes in costs; inflation, its impact on markets and economic activity and related monetary policy actions by governments in response to inflation; availability of capital resources, levels of capital expenditures and contractual obligations; the regulatory approval environment, including Occidental's ability to timely obtain or maintain permits or other governmental approvals, including those necessary for drilling and/or development projects; Occidental's ability to successfully complete, or any material delay of, field developments, expansion projects, capital expenditures, efficiency projects, acquisitions or dispositions; risks associated with acquisitions, mergers and joint ventures, such as difficulties integrating businesses, uncertainty associated with financial projections, projected synergies, restructuring, increased costs and adverse tax consequences; uncertainties and liabilities associated with acquired and divested properties and businesses; uncertainties about the estimated quantities of oil, NGL and natural gas reserves; lower-than-expected production from development projects or acquisitions; Occidental’s ability to realize the anticipated benefits from prior or future streamlining actions to reduce fixed costs, simplify or improve processes and improve Occidental’s competitiveness; exploration, drilling and other operational risks; disruptions to, capacity constraints in, or other limitations on the pipeline systems that deliver Occidental’s oil and natural gas and other processing and transportation considerations; volatility in the securities, capital or credit markets; governmental actions, war (including the Russia-Ukraine war) and political conditions and events; environmental risks and liability under federal, regional, state, provincial, tribal, local and international environmental laws, and regulations, and litigation (including the potential liability for remedial actions or assessments under existing or future laws, regulations and litigation); legislative or regulatory changes, including changes relating to hydraulic fracturing or other oil and natural gas operations, retroactive royalty or production tax regimes, deep-water and onshore drilling and permitting regulations and environmental regulations (including regulations related to climate change); Occidental's ability to recognize intended benefits from its business strategies and initiatives, such as Occidental's low carbon ventures businesses or announced greenhouse gas emissions reduction targets or net-zero goals; potential liability resulting from pending or future litigation; disruption or interruption of production or manufacturing or facility damage due to accidents, chemical releases, labor unrest, weather, power outages, natural disasters, cyber-attacks, terrorist acts or insurgent activity; the creditworthiness and performance of Occidental's counterparties, including financial institutions, operating partners and other parties; failure of risk management; Occidental’s ability to retain and hire key personnel; supply, transportation, and labor constraints; reorganization or restructuring of Occidental’s operations; changes in state, federal or international tax rates; and actions by third parties that are beyond Occidental's control.Additional information concerning these and other factors that may cause Occidental’s results of operations and financial position to differ from expectations can be found in Item 1A, “Risk Factors” and elsewhere in this Form 10-K, as well as in Occidental’s other filings with the SEC, including Occidental’s Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. OXY 2022 FORM 10-K55QUANTITATIVE AND QUALITATIVE DISCLOSURESITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKCOMMODITY PRICE RISKGENERALOccidental’s results are sensitive to fluctuations in oil, NGL and natural gas prices. Price changes at current global prices and levels of production affect Occidental’s budgeted 2023 pre-tax annual income by approximately $200 million for a $1 per barrel change in oil prices and approximately $30 million for a $1 per barrel change in NGL prices. If domestic natural gas prices varied by $0.10 per Mcf, it would have an estimated annual effect on Occidental’s budgeted 2023 pre-tax income of approximately $30 million. These price-change sensitivities include the impact of PSC and similar contract volume changes on income. If production levels change in the future, the sensitivity of Occidental’s results to prices also will change. Marketing results are sensitive to price changes of oil, natural gas and, to a lesser degree, other commodities. A $0.25 change in the Midland-to-Gulf-Coast oil spreads impacts budgeted 2023 operating cash flows by approximately $65 million.Occidental’s results are also sensitive to fluctuations in chemical prices. A variation in chlorine and caustic soda prices of $10 per ton would have a pre-tax annual effect on income of approximately $10 million and $30 million, respectively. A variation in PVC prices of $0.01 per lb. would have a pre-tax annual effect on income of approximately $30 million. Historically, over time, product price changes have tracked raw material and feedstock product price changes, somewhat mitigating the effect of price changes on margins.RISK MANAGEMENTOccidental conducts its risk management activities for marketing and trading under the controls and governance of its risk control policies. The controls under these policies are implemented and enforced by a risk management group which monitors risk by providing an independent and separate evaluation and check. Members of the risk management group report to the Corporate Vice President and Treasurer. Controls for these activities include limits on value at risk, limits on credit, limits on total notional trade value, segregation of duties, delegation of authority, daily price verifications, reporting to senior management on various risk measures and a number of other policy and procedural controls.FAIR VALUE OF MARKETING DERIVATIVE CONTRACTSOccidental carries derivative contracts it enters into in connection with its marketing activities at fair value. Fair values for these contracts are derived from Level 1 and Level 2 sources. The fair values in future maturity periods are insignificant. The following table shows the fair value of Occidental’s derivatives (excluding collateral), segregated by maturity periods and by methodology of fair value estimation:Maturity Periods Source of Fair Value Assets (Liabilities)millions20232024 and 20252026 and 20272028 and thereafterTotalPrices actively quoted$(18)$— $— $— $(18)Prices provided by other external sources31 1 — — 32 Total$13 $1 $— $— $14 QUANTITATIVE INFORMATIONOccidental uses value at risk to estimate the potential effects of changes in fair values of commodity contracts used in trading activities. This measure determines the maximum potential negative one day change in fair value with a 95% level of confidence. Additionally, Occidental uses complementary trading limits including position and tenor limits and maintains liquid positions as a result of which market risk typically can be neutralized or mitigated on short notice. As a result of these controls, Occidental believes that the market risk of its trading activities is not reasonably likely to have a material adverse effect on its performance.56 OXY 2022 FORM 10-KQUANTITATIVE AND QUALITATIVE DISCLOSURESINTEREST RATE RISK GENERALAs of December 31, 2022, Occidental had fixed rate debt with a fair value of $17.5 billion outstanding. A 25-basis point change in Treasury rates would change the fair value of the fixed rate debt approximately $295 million.The table below provides information about Occidental’s long-term debt obligations. Debt amounts represent principal payments by maturity date. millions except percentagesU.S. DollarFixed-Rate DebtU.S. DollarVariable-Rate DebtTotal (a)2023$22 $— $22 20241,056 — 1,056 20251,208 — 1,208 20261,448 — 1,448 2027903 — 903 Thereafter13,253 68 13,321 Total$17,890 $68 $17,958 Weighted-average interest rate5.92%5.32%5.91%Fair Value$17,508 $68 $17,576 (a)Excluded net unamortized debt premiums of $1.3 billion and debt issuance costs of $73 million. FOREIGN CURRENCY RISK Occidental’s international operations have limited currency risk. Occidental manages its exposure primarily by balancing monetary assets and liabilities and limiting cash positions in foreign currencies to levels necessary for operating purposes. A vast majority of international oil sales are denominated in United States dollars. Additionally, all of Occidental’s consolidated international oil and gas subsidiaries have the United States dollar as the functional currency. The effect of exchange rates on transactions in foreign currencies is included in periodic income. CREDIT RISK The majority of Occidental’s counterparty credit risk is related to the physical delivery of energy commodities to its customers and any inability of these customers to meet their settlement commitments. Occidental manages credit risk by selecting counterparties that it believes to be financially strong, by entering into netting arrangements with counterparties and by requiring collateral or other credit risk mitigants, as appropriate. Occidental actively evaluates the creditworthiness of its counterparties, assigns appropriate credit limits and monitors credit exposures against those assigned limits. Occidental also enters into futures contracts through regulated exchanges with select clearinghouses and brokers, which are subject to minimal credit risk, if any.As of December 31, 2022, the substantial majority of the credit exposures were with investment grade counterparties. Occidental believes its exposure to credit-related losses as of December 31, 2022, was not material and losses associated with credit risk have been insignificant for all years presented. OXY 2022 FORM 10-K57FINANCIAL STATEMENTSINDEX
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Management’s Discussion and Analysis of Financial Condition and Results of Operations generally discusses our 2022 and 2021 results and year-to-year comparisons between 2022 and 2021. Discussions of our 2020 results and year-to-year comparisons between 2021 and 2020 that are not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, which was filed with the Securities and Exchange Commission on February 23, 2022. Overview We are one of the largest North American less-than-truckload (“LTL”) motor carriers. We provide regional, inter-regional and national LTL services through a single integrated, union-free organization. Our service offerings, which include expedited transportation, are provided through an expansive network of service centers located throughout the continental United States. Through strategic alliances, we also provide LTL services throughout North America. In addition to our core LTL services, we offer a range of value-added services including container drayage, truckload brokerage and supply chain consulting. More than 98% of our revenue has historically been derived from transporting LTL shipments for our customers, whose demand for our services is generally tied to industrial production and the overall health of the U.S. domestic economy. In analyzing the components of our revenue, we monitor changes and trends in our LTL volumes and LTL revenue per hundredweight. While LTL revenue per hundredweight is a yield measurement, it is also a commonly-used indicator for general pricing trends in the LTL industry. This yield metric is not a true measure of price, however, as it can be influenced by many other factors, such as changes in fuel surcharges, weight per shipment and length of haul. As a result, changes in revenue per hundredweight do not necessarily indicate actual changes in underlying base rates. LTL revenue per hundredweight and the key factors that can impact this metric are described in more detail below: •LTL Revenue Per Hundredweight - Our LTL transportation services are generally priced based on weight, commodity, and distance. This measurement reflects the application of our pricing policies to the services we provide, which are influenced by competitive market conditions and our growth objectives. Generally, freight is rated by a class system, which is established by the National Motor Freight Traffic Association, Inc. Light, bulky freight typically has a higher class and is priced at higher revenue per hundredweight than dense, heavy freight. Fuel surcharges, accessorial charges, revenue adjustments and revenue for undelivered freight are included in this measurement. Revenue for undelivered freight is deferred for financial statement purposes in accordance with our revenue recognition policy; however, we believe including it in our revenue per hundredweight metrics results in a more accurate representation of the underlying changes in our yields by matching total billed revenue with the corresponding weight of those shipments. •LTL Weight Per Shipment - Fluctuations in weight per shipment can indicate changes in the mix of freight we receive from our customers, as well as changes in the number of units included in a shipment. Generally, increases in weight per shipment indicate higher demand for our customers’ products and overall increased economic activity. Changes in weight per shipment can also be influenced by shifts between LTL and other modes of transportation, such as truckload and intermodal, in response to capacity, service and pricing issues. Fluctuations in weight per shipment generally have an inverse effect on our revenue per hundredweight, as a decrease in weight per shipment will typically cause an increase in revenue per hundredweight. •Average Length of Haul - We consider lengths of haul less than 500 miles to be regional traffic, lengths of haul between 500 miles and 1,000 miles to be inter-regional traffic, and lengths of haul in excess of 1,000 miles to be national traffic. This metric is used to analyze our tonnage and pricing trends for shipments with similar characteristics, and also allows for comparison with other transportation providers serving specific markets. By analyzing this metric, we can determine the success and growth potential of our service products in these markets. Changes in length of haul generally have a direct effect on our revenue per hundredweight, as an increase in length of haul will typically cause an increase in revenue per hundredweight. •LTL Revenue Per Shipment - This measurement is primarily determined by the three metrics listed above and is used in conjunction with the number of LTL shipments we receive to evaluate LTL revenue. 21 Our primary revenue focus is to increase density, which is shipment and tonnage growth within our existing infrastructure. Increases in density allow us to maximize our asset utilization and labor productivity, which we measure over many different functional areas of our operations including linehaul load factor, pickup and delivery stops per hour, P&D shipments per hour, platform pounds handled per hour and platform shipments per hour. In addition to our focus on density and operating efficiencies, it is critical for us to obtain an appropriate yield, which is measured as revenue per hundredweight, on the shipments we handle to offset our cost inflation and support our ongoing investments in capacity and technology. We regularly monitor the components of our pricing, including base freight rates, accessorial charges and fuel surcharges. The fuel surcharge is generally designed to offset fluctuations in the cost of our petroleum-based products and is indexed to diesel fuel prices published by the U.S. Department of Energy, which reset each week. We believe our yield management process focused on individual account profitability, and ongoing improvements in operating efficiencies, are both key components of our ability to produce profitable growth. Our primary cost elements are direct wages and benefits associated with the movement of freight, operating supplies and expenses, which include diesel fuel, and depreciation of our equipment fleet and service center facilities. We gauge our overall success in managing costs by monitoring our operating ratio, a measure of profitability calculated by dividing total operating expenses by revenue, which also allows for industry-wide comparisons with our competition. We regularly upgrade our technological capabilities to improve our customer service and lower our operating costs. Our technology provides our customers with visibility of their shipments throughout our network, increases the productivity of our workforce, and provides key metrics that we use to monitor and enhance our processes. Results of Operations The following table sets forth, for the years indicated, expenses and other items as a percentage of revenue from operations: 2022 2021 Revenue from operations 100.0 % 100.0 % Operating expenses: Salaries, wages and benefits 43.4 47.0 Operating supplies and expenses 13.6 10.8 General supplies and expenses 2.6 2.6 Operating taxes and licenses 2.3 2.5 Insurance and claims 0.9 1.0 Communication and utilities 0.6 0.7 Depreciation and amortization 4.5 4.9 Purchased transportation 2.5 3.5 Miscellaneous expenses, net 0.2 0.5 Total operating expenses 70.6 73.5 Operating income 29.4 26.5 Interest (income) expense, net (0.1 ) 0.0 Other expense, net 0.1 0.1 Income before income taxes 29.4 26.4 Provision for income taxes 7.4 6.7 Net income 22.0 % 19.7 % 22 Key financial and operating metrics for 2022 and 2021 are presented below: 2022 2021 Change % Change Work days 253 252 1 0.4 Revenue (in thousands) $ 6,260,077 $ 5,256,328 $ 1,003,749 19.1 Operating ratio 70.6 % 73.5 % Net income (in thousands) $ 1,377,159 $ 1,034,375 $ 342,784 33.1 Diluted earnings per share $ 12.18 $ 8.89 $ 3.29 37.0 LTL tons (in thousands) 10,211 10,119 92 0.9 LTL tonnage per day 40,359 40,153 206 0.5 LTL shipments (in thousands) 12,989 12,880 109 0.8 LTL shipments per day 51,341 51,111 230 0.5 LTL weight per shipment (lbs.) 1,572 1,571 1 0.1 LTL revenue per hundredweight $ 30.24 $ 25.59 $ 4.65 18.2 LTL revenue per shipment $ 475.45 $ 402.01 $ 73.44 18.3 LTL revenue per intercity mile $ 8.28 $ 7.32 $ 0.96 13.1 LTL intercity miles (in thousands) 746,028 707,611 38,417 5.4 Average length of haul (miles) 934 935 (1 ) (0.1 ) Our financial results for 2022 included double-digit growth in our revenue, net income and earnings per diluted share. The 19.1% increase in revenue to $6.3 billion was due primarily to the increase in LTL revenue per hundredweight as LTL tons increased 0.9%. The increase in revenue and our disciplined control of our operating costs contributed to a 290 basis-point improvement in our operating ratio to 70.6% for 2022 as compared to 73.5% for 2021. As a result, net income and earnings per diluted share increased by 33.1% and 37.0%, respectively, in 2022 as compared to 2021. Revenue Revenue increased $1.0 billion, or 19.1%, in 2022 compared to 2021, due to an increase in LTL revenue per hundredweight and a slight increase in LTL tonnage. Our LTL revenue per hundredweight increased 18.2% in 2022 compared to 2021. This increase reflects the impact of higher fuel surcharges associated with the significant increase in diesel fuel prices as well as the ongoing commitment to our long-term yield management strategy. Excluding fuel surcharges, LTL revenue per hundredweight increased 8.5% in 2022 as compared to 2021. We believe our focus on obtaining an appropriate yield is necessary to offset rising operating costs and also allows us to invest in opportunities that can improve the quality of our service and provide capacity for future growth. January 2023 Update Revenue per day increased 4.2% in January 2023 compared to the same month last year. LTL tons per day decreased 7.8%, due to a 5.9% decrease in LTL shipments per day and a 2.0% decrease in LTL weight per shipment. LTL revenue per hundredweight increased 13.1% as compared to the same month last year. LTL revenue per hundredweight, excluding fuel surcharges, increased 8.6% as compared to the same month last year. Operating Costs and Other Expenses Salaries, wages, and benefits increased $248.9 million, or 10.1%, in 2022 as compared to 2021, due to a $188.5 million increase in the costs attributable to salaries and wages and a $60.4 million increase in employee benefit costs. The increase in salaries and wages was due primarily to increases in the average number of active full-time employees during the year. Our average number of active full-time employees increased 2,291, or 10.4%, during 2022 as compared to 2021 as we hired additional employees primarily during the first half of the year to balance our workforce with our customers' shipment trends and reduce our reliance on third-party purchased transportation. Salaries and wages also increased as a result of annual wage increases provided to our employees at the beginning of both September 2021 and 2022, as well as higher performance-based bonus compensation. Our productive labor costs, which include wages for drivers, platform employees, and fleet technicians, improved as a percent of revenue to 22.9% in 2022 compared to 25.1% in 2021. The improvements in our productive labor costs, as a percentage of revenue, reflect the leveraging effect of increases in our yield as well as our ongoing commitment to operating efficiently. Our productive labor costs as a percentage of revenue were also impacted by declines in our P&D shipments per hour and linehaul laden load average as we trained our new employees. Our other salaries and wages as a percent of revenue also decreased to 9.0% in 2022 as compared to 9.3% in 2021. 23 The increase in the costs attributable to employee benefits of $60.4 million, or 9.1%, includes the impact of the increase in the number of full-time employees eligible for our benefits and increases in certain higher retirement benefits costs directly linked to our net income. In addition, our benefit costs were positively impacted by a reduction in accrued benefits expense attributable to the termination of an employment agreement during the third quarter of 2022. Our employee benefit costs as a percent of salaries and wages decreased to 36.2% in 2022 from 36.6% in 2021. Operating supplies and expenses increased $285.3 million, or 50.3%, in 2022 as compared to 2021, due primarily to an increase in our costs for diesel fuel used in our vehicles, as well as other petroleum-based products. Our diesel fuel costs, excluding fuel taxes, represent the largest component of operating supplies and expenses, and can vary based on both the average price per gallon and consumption. Our average cost per gallon of diesel fuel increased 68.2% in 2022 as compared to 2021. In addition, our gallons consumed increased 4.1% in 2022 as compared to 2021 year due to an increase in miles driven. We do not use diesel fuel hedging instruments; therefore, our costs are subject to market price fluctuations. Our other operating supplies and expenses as a percent of revenue increased in 2022 as compared to the same periods of 2021, due to increases in equipment repair and maintenance costs. Depreciation and amortization increased $16.2 million, or 6.2%, in 2022 as compared to 2021. The increases in depreciation and amortization costs were due primarily to the assets acquired as part of our 2021 and 2022 capital expenditure programs. We believe depreciation costs will increase in future periods based on our 2023 capital expenditure plan. While our investments in real estate, equipment, and technology can increase our costs in the short-term, we believe these investments are necessary to support our continued long-term growth and strategic initiatives. Purchased transportation expense decreased $27.7 million, or 14.9%, in 2022 as compared to 2021. We utilize purchased transportation services from third-party transportation providers in our domestic linehaul network to supplement our equipment and our workforce when needed to support our growth initiatives and to maximize the efficient movement of LTL freight within our service center network. Our significant investments in workforce and equipment enabled us to reduce our use of purchased transportation beginning in the second quarter of 2022. Our effective tax rate in 2022 was 25.2% as compared to 25.5% in 2021. Our effective tax rate generally exceeds the federal statutory rate due to the impact of state taxes and, to a lesser extent, certain other non-deductible items. Liquidity and Capital Resources A summary of our cash flows is presented below: (In thousands) 2022 2021 Cash and cash equivalents at beginning of year $ 462,564 $ 401,430 Cash flows provided by (used in): Operating activities 1,691,582 1,212,606 Investing activities (547,472 ) (455,288 ) Financing activities (1,420,362 ) (696,184 ) (Decrease) increase in cash and cash equivalents (276,252 ) 61,134 Cash and cash equivalents at end of year $ 186,312 $ 462,564 The increase in our cash flows provided by operating activities during 2022 as compared to 2021 was primarily due to an increase in our income before income taxes of $452.9 million and fluctuations in certain working capital accounts. The increase in our cash flows used in investing activities during 2022 as compared to 2021 was primarily due to increases in property and equipment purchases under our capital expenditure plan, which was partially offset by the timing of purchases and maturities of short-term investments. Changes in our capital expenditure plans are more fully described below under “Capital Expenditures”. The increase in our cash flows used in financing activities during 2022 as compared to 2021 was due primarily to higher repurchases of our common stock, as well as an increase in dividend payments to our shareholders. Our return of capital to shareholders is more fully described below under “Stock Repurchase Program” and “Dividends to Shareholders”. We have five primary sources of available liquidity: cash flows from operations, our existing cash and cash equivalents, short-term investments, available borrowings under our second amended and restated credit agreement with Wells Fargo Bank, National Association serving as administrative agent for the lenders, which we entered into on November 21, 2019 (the “Credit Agreement”), 24 and our Note Purchase and Private Shelf Agreement with PGIM, Inc. (“Prudential”) and certain affiliates and managed accounts of Prudential, which we entered into on May 4, 2020 (the “Note Agreement”). Our Credit Agreement and Note Agreement are described in more detail below under “Financing Arrangements.” We believe we also have sufficient access to debt and equity markets to provide other sources of liquidity, if needed. Capital Expenditures The table below sets forth our net capital expenditures for property and equipment, including those obtained through noncash transactions, for the years ended December 31, 2022 and 2021: Year Ended December 31, (In thousands) 2022 2021 Land and structures $ 299,529 $ 252,155 Tractors 148,719 130,772 Trailers 216,697 140,595 Technology 33,783 17,139 Other equipment and assets 68,920 25,450 Less: Proceeds from sales (22,096 ) (19,548 ) Total $ 745,552 $ 546,563 Our capital expenditures vary based upon the projected increase in the number and size of our service center facilities necessary to support our plan for long-term growth, our planned tractor and trailer replacement cycle, and forecasted tonnage and shipment growth. Expenditures for land and structures can be dependent upon the availability of land in the geographic areas where we are looking to expand. We historically spend 10% to 15% of our revenue on capital expenditures each year. We expect to continue to maintain a high level of capital expenditures in order to support our long-term plan for market share growth. We currently estimate capital expenditures will be approximately $800 million for the year ending December 31, 2023. Approximately $300 million is allocated for the purchase of service center facilities, construction of new service center facilities or expansion of existing service center facilities, subject to the availability of suitable real estate and the timing of construction projects; approximately $400 million is allocated for the purchase of tractors and trailers; and approximately $100 million is allocated for investments in technology and other assets. We expect to fund these capital expenditures primarily through cash flows from operations, our existing cash and cash equivalents, short-term investments and, if needed, borrowings available under our Credit Agreement or Note Agreement. We believe our current sources of liquidity will be sufficient to satisfy our expected capital expenditures for the next twelve months and in the longer term. Stock Repurchase Program On May 1, 2020, we announced that our Board of Directors had approved a two-year stock repurchase program authorizing us to repurchase up to an aggregate of $700.0 million of our outstanding common stock (the “2020 Repurchase Program”). The 2020 Repurchase Program became effective upon the termination of our $350.0 million repurchase program on May 29, 2020. On July 28, 2021, we announced that our Board of Directors had approved a new stock repurchase program authorizing us to repurchase up to an aggregate of $2.0 billion of our outstanding common stock (the “2021 Repurchase Program”). The 2021 Repurchase Program, which does not have an expiration date, began after the completion of the 2020 Repurchase Program in January 2022. Under our repurchase programs, we may repurchase shares from time to time in open market purchases or through privately negotiated transactions. Shares of our common stock repurchased under our repurchase programs are canceled at the time of repurchase and are classified as authorized but unissued shares of our common stock. As of December 31, 2022, we had $679.1 million remaining authorized under the 2021 Repurchase Program. Dividends to Shareholders Our Board of Directors declared a cash dividend of $0.30 per share for each quarter of 2022 and declared a cash dividend of $0.20 per share for each quarter of 2021. On February 1, 2023, we announced that our Board of Directors had declared a cash dividend of $0.40 per share of our common stock. The dividend is payable on March 15, 2023 to shareholders of record at the close of business on March 1, 2023. Although we intend to pay a quarterly cash dividend on our common stock for the foreseeable future, the declaration and amount of any future dividend is subject to approval by our Board of Directors, and is restricted by applicable state law limitations on distributions to 25 shareholders as well as certain covenants under our Credit Agreement and Note Agreement. We anticipate that any future quarterly cash dividends will be funded through cash flows from operations, our existing cash and cash equivalents, short-term investments, and, if needed, borrowings under our Credit Agreement or Note Agreement. Financing Agreements Note Agreement The Note Agreement, which is uncommitted and subject to Prudential’s sole discretion, provides for the issuance of senior promissory notes with an aggregate principal amount of up to $350.0 million through May 4, 2023. Pursuant to the Note Agreement, we issued $100.0 million aggregate principal amount of senior promissory notes (the “Series B Notes”) on May 4, 2020. Borrowing availability under the Note Agreement is reduced by the outstanding amount of the existing Series B Notes, and all other senior promissory notes issued pursuant to the Note Agreement. The Series B Notes bear an annual interest rate of 3.10% and mature on May 4, 2027, unless prepaid. Principal payments are required annually beginning on May 4, 2023 in equal installments of $20.0 million through May 4, 2027. The Series B Notes are senior unsecured obligations and rank pari passu with borrowings under our Credit Agreement or other senior promissory notes issued pursuant to the Note Agreement. Credit Agreement The Credit Agreement provides for a five-year, $250.0 million senior unsecured revolving line of credit and a $150.0 million accordion feature, which if fully exercised and approved, would expand the total borrowing capacity up to an aggregate of $400.0 million. Of the $250.0 million line of credit commitments under the Credit Agreement, up to $100.0 million may be used for letters of credit. At our option, borrowings under the Credit Agreement bear interest at either: (i) LIBOR (including applicable successor provisions) plus an applicable margin (based on our ratio of net debt-to-total capitalization) that ranges from 1.000% to 1.375%; or (ii) a Base Rate, as defined in the Credit Agreement, plus an applicable margin (based on our ratio of net debt-to-total capitalization) that ranges from 0.000% to 0.375%. Letter of credit fees equal to the applicable margin for LIBOR loans are charged quarterly in arrears on the daily average aggregate stated amount of all letters of credit outstanding during the quarter. Commitment fees ranging from 0.100% to 0.175% (based upon the ratio of net debt-to-total capitalization) are charged quarterly in arrears on the aggregate unutilized portion of the Credit Agreement. For periods covered under the Credit Agreement, the applicable margin on LIBOR loans and letter of credit fees were 1.000% and commitment fees were 0.100%. The amounts outstanding and available borrowing capacity under the Credit Agreement are presented below: December 31, (In thousands) 2022 2021 Facility limit $ 250,000 $ 250,000 Line of credit borrowings — — Outstanding letters of credit (38,653 ) (39,169 ) Available borrowing capacity $ 211,347 $ 210,831 General Debt Provisions The Credit Agreement and Note Agreement contain customary covenants, including financial covenants that require us to observe a maximum ratio of debt to total capital and a minimum fixed charge coverage ratio. The Credit Agreement and Note Agreement also include a provision limiting our ability to make restricted payments, including dividends and payments for share repurchases, unless, among other conditions, no defaults or events of default are ongoing (or would be caused by such restricted payment). We were in compliance with all covenants in our outstanding debt instruments for the period ended December 31, 2022. We do not anticipate financial performance that would cause us to violate any such covenants in the future, and we believe the combination of our existing Credit Agreement and Note Agreement along with our additional borrowing capacity will be sufficient to meet foreseeable seasonal and long-term capital needs. 26 The interest rate is fixed on the Note Agreement. Therefore, short-term exposure to fluctuations in interest rates is limited to our Credit Agreement. We do not currently use interest rate derivative instruments to manage exposure to interest rate changes. Contractual Obligations The following table summarizes our significant contractual obligations as of December 31, 2022: Payments due by period Contractual Obligations (1) Less than More than (In thousands) Total 1 year 1-3 years 3-5 years 5 years Series B Notes $ 107,254 $ 22,691 $ 43,522 $ 41,041 $ — Operating lease obligations (2) 120,300 21,243 29,234 25,262 44,561 Purchase obligations and Other 186,680 160,776 22,151 3,753 Total $ 414,234 $ 204,710 $ 94,907 $ 70,056 $ 44,561 (1)Contractual obligations include principal and interest on our Series B Notes; leases consisting primarily of real estate and automotive leases; and purchase obligations relating to non-cancellable purchase orders for (i) equipment scheduled for delivery in 2023, and (ii) information technology agreements. (2)Lease payments include lease extensions that are reasonably certain to be exercised. Critical Accounting Policies In preparing our financial statements, we apply the following critical accounting policies that we believe affect our judgments and estimates of amounts recorded in certain assets, liabilities, revenue and expenses. These critical accounting policies, which are those that have, or are reasonably likely to have, a material impact on our financial condition or results of operations, are further described in Note 1 of the Notes to the Financial Statements included in Item 8 of this report. Revenue Recognition Our revenue is generated from providing transportation and related services to customers in accordance with the bill of lading (“BOL”) contract, our general tariff provisions and contractual agreements. Generally, our performance obligations begin when we receive a BOL from a customer and are satisfied when we complete the delivery of a shipment and related services. We recognize revenue for our performance obligations under our customer contracts over time, as our customers receive the benefits of our services in accordance with Accounting Standards Update (“ASU”) 2014-09. With respect to services not completed at the end of a reporting period, we use a percentage of completion method to allocate the appropriate revenue to each separate reporting period. Under this method, we develop a factor for each uncompleted shipment by dividing the actual number of days in transit at the end of a reporting period by that shipment’s standard delivery time schedule. This factor is applied to the total revenue for that shipment and revenue is allocated between reporting periods accordingly. A hypothetical change of 10% in our percentage of completion estimate would not have a material effect on our recorded revenue. Property and Equipment Property and equipment are recorded at cost and depreciated on a straight-line basis over their estimated economic lives. We use historical experience, certain assumptions and estimates in determining the economic life of each asset. When indicators of impairment exist, we review property and equipment for impairment due to changes in operational and market conditions, and we adjust the carrying value and economic life of any impaired asset as appropriate. Estimated economic lives for structures are 7 to 30 years, revenue equipment is 4 to 15 years, other equipment is 2 to 20 years, and leasehold improvements are the lesser of the economic life of the leasehold improvement or the remaining life of the lease. The use of different assumptions, estimates or significant changes in the resale market for our equipment could result in material changes in the carrying value and related depreciation of our assets. Depreciation expense in 2022 totaled $275.6 million. A hypothetical change of 1% in the estimated useful lives of all depreciable assets would not have a material impact on our financial results. 27 Claims and Insurance Accruals Claims and insurance accruals reflect the estimated cost of various claims, including those related to bodily injury/property damage (“BIPD”) and workers’ compensation. All related costs associated with BIPD claims are charged to insurance and claims expense, and all related costs associated with workers’ compensation claims are charged to employee benefits expense. Insurers providing excess coverage above a company’s self-insured retention or deductible levels typically adjust their premiums to cover insured losses and for other market factors. As a result, we periodically evaluate our self-insured retention and deductible levels to determine the most cost-efficient balance between our exposure and excess coverage. In establishing accruals for claims and expenses, we evaluate and monitor each claim individually, and we use factors such as historical claims development experience, known trends and third-party actuarial estimates to determine the appropriate reserves for potential liabilities. We believe the assumptions and methods used to estimate these liabilities are reasonable; however, any changes in the severity or number of reported claims, significant changes in medical costs and regulatory changes affecting the administration of our plans could significantly impact the determination of appropriate reserves in future periods. Our accrued liability for insurance, BIPD claims, and workers’ compensation claims totaled $129.6 million and $126.4 million at December 31, 2022 and 2021, respectively. Claims and insurance accruals are discussed further in Note 1 of the Notes to the Financial Statements included in Item 8 of this report. Inflation Most of our expenses are affected by inflation, which typically results in increased operating costs. In response to fluctuations in the cost of petroleum products, particularly diesel fuel, we generally include a fuel surcharge in our tariffs and contractual agreements. The fuel surcharge is designed to offset the cost of diesel fuel above a base price and fluctuates as diesel fuel prices change from the base, which is generally indexed to the DOE’s published fuel prices that reset each week. Volatility in the price of diesel fuel has impacted our business, as described in this report. However, we do not believe inflation has had a material adverse effect on our results of operations for any of the past three years. Related Party Transactions Family Relationships In August 2022, we entered into an agreement with David S. Congdon, Executive Chairman of our Board of Directors, to terminate the employment agreement between the Company and Mr. Congdon. Following termination of the employment agreement, Mr. Congdon remained an executive officer of the Company and continued to serve as Executive Chairman of our Board of Directors. John R. Congdon, Jr., a member of our Board of Directors, is the cousin of David S. Congdon. We regularly disclose the amount of compensation that we pay to these individuals, as well as the compensation paid to any of their family members employed by us that from time to time may require disclosure, in the proxy statement for our Annual Meeting of Shareholders. Audit Committee Approval The Audit Committee of our Board of Directors reviews and approves all related person transactions in accordance with our Related Person Transactions Policy. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk represents the risk of loss that may impact our financial position, results of operations and cash flows due to adverse changes in financial market prices and rates. We are exposed to interest rate risk directly related to loans, if any, under our Credit Agreement, which have variable interest rates. A 100 basis point increase in the average interest rate on this agreement would have no material effect on our operating results. We have established policies and procedures to manage exposure to market risks and use major institutions that we believe are creditworthy to minimize credit risk. We are also exposed to interest rate risk on our short-term investments. We maintain an investment portfolio principally composed of certificates of deposit and commercial paper. These investments totaled $49.4 million and $254.4 million at December 31, 2022 and 2021, respectively. These fixed rate securities are subject to interest rate risk, as sharp increases in market interest rates 28 could have an adverse impact on their fair value. Although the fair values of these instruments can fluctuate, we believe that the short-term, highly liquid nature of these debt securities, and our ability to hold these instruments to maturity, reduces our risk for potential material losses. A hypothetical 100 basis point change in market interest rates would have had an immaterial impact on the fair value of these investments at December 31, 2022 and 2021. We are exposed to market risk for investments relating to certain assets held within the Company-owned life insurance contracts on certain current and former employees. The cash surrender value in life insurance contracts included on our Balance Sheets at December 31, 2022 and 2021 was $63.5 million and $75.2 million, respectively. The portion of underlying investments with exposure to market fluctuations was $45.9 million and $59.9 million at December 31, 2022 and 2021, respectively. To provide a meaningful assessment of the market risk for investments relating to Company-owned life insurance contracts, we performed a sensitivity analysis using a 10% change in market value in those investments. A 10% change in market value would have caused a $4.6 million and a $6.0 million impact on our pre-tax income in 2022 and 2021, respectively. We are also exposed to commodity price risk related to diesel fuel prices, and we manage our exposure to that risk primarily through the application of fuel surcharges to our customers. For further discussion related to these risks, see Notes 1, 2 and 9 of the Notes to the Financial Statements included in Item 8, “Financial Statements and Supplementary Data” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” 29
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+Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates - Allowance for Doubtful Accounts” for additional information.We sell our products primarily to the following types of customers:•swimming pool remodelers and builders;•specialty retailers that sell swimming pool supplies, including independently owned and operated Pinch A Penny franchise stores;•swimming pool repair and service businesses;•irrigation construction and landscape maintenance contractors; and•commercial pool operators and pool contractors who build, remodel or service large commercial installations such as hotels, universities and community recreational facilities.We conduct our operations through 420 sales centers in North America, Europe and Australia. Our primary markets, with the highest concentration of swimming pools, are California, Texas, Florida and Arizona, collectively representing approximately 53% of our 2022 net sales. In 2022, we generated approximately 96% of our sales in North America (including Canada and Mexico), 4% in Europe and less than 1% in Australia. While we continue to expand both domestically and internationally, we 4expect this geographic mix to be similar over the next few years. References to product line and product category data throughout this Form 10-K generally reflect data related to the North American swimming pool market, as it is more readily available for analysis and represents the largest component of our operations.Our goal is to be a trusted resource for both industry professionals and consumers in the outdoor living industry. We use local sales and marketing personnel to promote the growth of our business and develop and strengthen our customers’ businesses. Our sales and marketing personnel focus on developing customer training programs and promotional activities, creating and enhancing sales management tools and providing product and market expertise. Our local sales personnel work from our sales centers. They are a trusted resource for our customers and are charged with understanding and meeting our customers’ specific needs. Our sales center personnel help educate our customers on a variety of topics including innovative products and solutions that can elevate their businesses.We offer our customers more than 200,000 manufacturer and Pool Corporation-branded products. We believe that our selection of pool equipment, supplies, chemicals, replacement parts, irrigation and related products and other pool construction and recreational products is the most comprehensive in the industry. We sell the following types of products: •maintenance products, such as chemicals, supplies and pool accessories;•repair and replacement parts for pool equipment, such as cleaners, filters, heaters, pumps and lights;•building materials, such as concrete, plumbing and electrical components, both functional and decorative pool surfaces, decking materials, tile, hardscapes and natural stone, used for pool installations and remodeling; •pool equipment and components for new pool construction and the remodeling and replacement of existing pools;•irrigation and related products, including irrigation system components and professional turf care equipment and supplies; •commercial pool products, including American Society of Material Engineers heaters, safety equipment, commercial decking equipment and commercial pumps and filters; •fiberglass pools and hot tubs and packaged pool kits including walls, liners, braces and coping for in-ground and above-ground pools; and •other pool construction and recreational products, which consist of a number of product categories and include discretionary recreational and related outdoor living products, such as grills and components for outdoor kitchens.We currently have over 600 product lines and approximately 50 product categories. Based on our 2022 product classifications, sales for our pool and hot tub chemicals product category represented approximately 13% of total net sales for 2022, 9% of total net sales in 2021 and 10% of total net sales in 2020. The increase in pool and hot tub chemicals as a percentage of our total net sales from 2021 to 2022 was driven by inflation, improved supply over last year, strong demand for non-discretionary maintenance products, and our December 2021 acquisition of Porpoise Pool & Patio, Inc., who operates a chemical packaging plant. No other product categories accounted for 10% or more of total net sales in any of the last three fiscal years.We continue to identify new related product categories, and we typically introduce new categories each year in select markets. We then evaluate the performance in these markets and focus on those product categories that we believe exhibit the best long-term growth potential. We expect to realize continued sales growth for these types of product offerings by expanding the number of locations that offer these products, increasing the number of products offered at certain locations and continuing a modest broadening of these product offerings on a company-wide basis. New product technology provides opportunities not only for improved energy-efficiency but also new enticements for leisure activities. Major equipment manufacturers have developed and will continue to develop more retrofit kits that allow homeowners to interact with their pools or hot tubs through their smartphones. Robotic cleaners offer consumers a more efficient option for maintaining their swimming pools. Regulation passed by the U.S. Department of Energy, which became effective in July 2021, mandated all new pumps sold for swimming pools must meet certain compliance regulations. We see each of these developments as significant growth opportunities. We offer a growing selection of energy-efficient and environmentally preferred products, which supports sustainability and helps pool owners save energy, water, time and money. Our environmentally-friendly technology products include variable speed pumps, LED pool and hot tub lights and high-efficiency heat pumps. Our Horizon sales centers offer organic fertilizers, organic pesticides, and irrigation and drainage products that reduce water usage and soil erosion, allowing our customers and homeowners to have less of an impact on freshwater reserves. Over the last several years, we have increased our product offerings and service abilities related to commercial swimming pools. We consider the commercial market to be a key growth opportunity as we focus more attention on providing products to customers who operate and service large commercial installations such as hotels, condominiums, apartment complexes, universities and community recreational facilities. We continue to leverage our existing networks and relationships to grow this 5market. Sales to commercial customers declined in 2020 due to COVID-19 related closures and the decline in both business and leisure travel. In 2021, commercial sales accelerated as business and leisure travel increased and public facilities reopened. This growth was sustained throughout 2022.In 2022, the sale of maintenance and minor repair products (non-discretionary) accounted for approximately 60% of our sales and gross profits, while approximately 40% of our sales and gross profits were derived from the remodel, renovation, upgrade, construction and installation (equipment, materials, plumbing, electrical, etc.) of swimming pools (partially discretionary). These components may vary from year to year. Over the last several years, we have experienced product and customer mix changes, including a shift in consumer spending to some higher value, lower margin products such as variable speed pumps and high efficiency heaters. We expect continued demand for these products, but believe our efforts in various pricing and sourcing initiatives, including growth in our higher margin private label and exclusive products (PLEX) and our expansion of building materials product offerings, have helped offset these gross margin declines. Operating StrategyWe distribute swimming pool supplies, equipment and related leisure products domestically through our SCP and Superior networks and internationally through our SCP network. We adopted the strategy of operating two distinct distribution networks within the U.S. swimming pool market primarily to offer our customers a choice of distinctive product selections, locations and service personnel. We distribute irrigation, landscape maintenance and related products through our Horizon network. Swimming pool tile, decking materials and interior pool surfacing products are distributed through our NPT network, as well as through SCP and Superior networks. Our NPT network primarily serves the swimming pool market but does provide some overlap with the irrigation and landscape industries as we offer our market-leading brand of pool tile, composite pool finish products and hardscapes. As more consumers create and enhance outdoor living areas and continue to invest in their outdoor environment, we believe we can focus our resources to address such demand by leveraging our existing pool and irrigation and landscape customer base. We feel the development of our NPT network is a natural extension of our distribution model. In addition to our 19 standalone NPT sales centers, we currently have over 100 SCP and Superior sales centers that feature consumer showrooms where landscape and swimming pool contractors, as well as homeowners, can view and select pool components including pool tile, decking materials and interior pool finishes in various styles and grades, and serve as stocking locations for our NPT branded products. We also offer virtual tools for homeowners to select and design their pool and outdoor environments, working with their chosen contractors to install these products. Our NPT® Backyard mobile app and www.nptpool.com® allow our customers to virtually design, customize and view a pool in their own backyard within seconds. We believe our showrooms, local stocking of products and virtual support provide us with a competitive advantage in these categories. Given the more discretionary nature of these products, this business is more sensitive to external market factors compared to our business overall. In December 2021, we acquired Sun Wholesale Supply, Inc., which distributes swimming pool supplies, equipment and related leisure products, primarily servicing independently owned and operated Pinch A Penny, Inc. franchise locations. Going forward, we expect to expand Pinch A Penny franchise operations through additional locations of Pinch A Penny franchised stores. Sun Wholesale Supply, Inc. also owns and operates a specialty chemical packaging operation providing pool chemical products to the Pinch A Penny franchised store network and a portion of the chemical products sold through our SCP and Superior sales centers. We evaluate our sales centers based on their performance relative to predetermined standards that include both financial and operational measures. Our corporate support groups provide our field operations with various services, such as developing and coordinating customer and vendor related programs, services from our real estate support function to find appropriate locations for our sales centers, human resources support, information systems support, support from our logistics and fleet teams, accounting and financial analysis support and expert resources to help them achieve their goals. We believe our incentive programs and feedback tools, along with the competitive nature of our sales center network, stimulate and enhance employee performance.DistributionOur sales centers are located within population centers near customer concentrations, typically in industrial, commercial or mixed-use zones. Customers may pick up products at any sales center location, or we may deliver products to their premises or job sites via our trucks or third-party carriers. For additional information on our sales centers, see Item 2, “Properties,” of this Form 10-K.6Our sales centers maintain well-stocked inventories to meet our customers’ immediate needs. We utilize warehouse management technology to optimize receiving, inventory control, picking, packing and shipping functions. For additional information regarding our inventory management, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates - Inventory Obsolescence,” of this Form 10-K. We also operate four centralized shipping locations (CSLs) in the United States that redistribute products we purchase in bulk quantities to our sales centers or, in some cases, directly to customers. Our CSLs are regional locations that carry a wide range of traditional swimming pool, irrigation and landscape products and related construction products. Purchasing and SuppliersWe enjoy good relationships with our suppliers, who generally offer competitive pricing, return policies and promotional allowances. It is customary in our industry for certain manufacturers to manage their shipments by offering seasonal terms to qualifying purchasers such as Pool Corporation, which are referred to as early buy purchases. These early buy purchases typically allow us to place orders in the fall at a modest discount, take delivery of product during the off-season months and pay for these purchases in the spring or early summer. Due to vendor backlogs resulting in product availability constraints, these early buy opportunities were generally not available in 2021 or 2020, but were re-established in 2022.Our preferred vendor program encourages our distribution networks to stock and sell products from a smaller number of vendors offering the best overall terms and service to optimize profitability and shareholder return. We also work closely with our vendors to develop programs and services to better meet the needs of our customers and to concentrate our inventory investments. These practices, together with a more comprehensive service offering, have positively impacted our selling margins and our returns on inventory investments. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates - Vendor Programs,” for additional information.We regularly evaluate supplier relationships and consider alternate sourcing to ensure competitive cost, service and quality standards. Our largest suppliers include Pentair plc, Hayward Pool Products, Inc. and Zodiac Pool Systems, Inc., which accounted for approximately 18%, 11% and 9%, respectively, of the cost of products we sold in 2022.CompetitionWe are the largest wholesale distributor of swimming pool and related backyard products (based on industry knowledge and available data) and one of the only national wholesale distributors focused on the swimming pool industry in the United States. We are also one of the leading distributors of irrigation and landscape products in the United States. We face intense competition from many regional and local distributors in our markets and from three national wholesale distributors of irrigation and landscape supplies. We also face competition, both directly and indirectly, from mass market retailers (both store-based and internet) and large pool supply retailers who primarily buy directly from manufacturers. Some geographic markets we serve, particularly the four largest and higher pool density markets of California, Texas, Florida and Arizona, have a greater concentration of competition than others. Barriers to entry in our industry are relatively low. We believe that the principal competitive factors in swimming pool and irrigation and landscape supply distribution are:•the breadth and availability of products offered;•the quality and level of customer service, including ease of ordering and speed of product delivery;•the breadth and depth of sales and marketing programs;•consistency and stability of business relationships with customers and suppliers;•competitive product pricing; and•geographic proximity to the customer.Environmental, Social and Governance (ESG)EnvironmentalWe are committed to sustainable business practices, which includes offering eco-friendly products to our customers, closely monitoring our sourcing activities, and being good stewards within the communities we serve. Currently, we are taking steps to reduce our carbon footprint and to improve product choices that allow pool and homeowners to reduce their environmental impact. Further, we are installing more energy-efficient systems throughout our sales center network. We are continually striving to ensure success in our business while protecting resources for future generations. Our sustainability goals include the 7reduction of greenhouse gases and other harmful air emissions, water conservation, energy conservation and carbon footprint minimization. We continuously endeavor to improve the ways in which we handle, distribute, transport and dispose of all products, particularly the chemicals and fertilizers that we sell. Social - Human Capital Management We employed approximately 6,000 people at December 31, 2022. Given the seasonal nature of our business, our peak employment period is the summer season and, depending on expected sales levels, we add 100 to 200 employees to our work force to meet seasonal demand. Approximately 90% of our employees are located in the U.S. We believe that we have good relations with our employees. None of our employees are currently covered under any collective bargaining agreements.Our goal is to be an Employer of Choice through focusing on the engagement, development, retention, and health and well‑being of our employees. We believe that our success is a direct result of the contributions and commitment of our employees. We provide competitive pay and benefits, training and continuing education, and professional development and promotional opportunities to engage and reward our team. We have established a set of standard operating procedures to optimize our human capital management function, including hiring and human resource policies, training practices and operational instructions. We focus on the following factors in implementing and developing our human capital strategy:•employee health, safety and wellness;•diversity, equity and inclusion; •employee growth and development; and•employee compensation and benefits.Employee Health, Safety and WellnessOur commitment to the health, safety and wellness of our employees ranks at the top of our core fundamental values. Our ultimate goal is to send every employee home each night in the same condition in which they came to work that morning. We aim to achieve zero serious injuries through continued investment in, and focus on, our core safety programs and injury-reduction initiatives. This effort begins immediately with new employees and is reinforced each day through a focus on training, safety awareness, risk identification and other essential safety protocols. We closely monitor overall workers’ compensation and auto claims, OSHA recordable incidents, Department of Transportation compliance and other internally established safety prevention elements in an effort to make every workday safe.Diversity, Equity and Inclusion (DEI)We are committed to fostering a diverse, equitable and inclusive workplace that represents the communities in which we work and live. We believe that diversity drives innovation and delivers the best solutions to complex problems, and our culture is one where differences are welcomed, valued and respected. We are committed to expanding the diversity of our workforce through the hiring, retention and advancement of underrepresented populations. To achieve this, our approach to DEI is as follows: •Diversity: Recruit, develop and retain a diverse workforce and provide developmental opportunities for career advancement for all employees; •Equity: Review current policies, practices and procedures to remove possible impediments to equal employment opportunity for prospective candidates and employees; and•Inclusion: Communicate that we, as an Employer of Choice, are committed to DEI with action-oriented programs that produce results and employee engagement.Our DEI efforts are focused on expanding content in core employee development programs and improving our ability to recruit and hire first-class diverse talent. To create connection and community, we've established a Women’s Interactive Network (WIN) and diversity mentoring program to cultivate the growth and development of our female and diverse employees. In addition to our recent initiatives, we continue to support our existing employees with training and development, which includes content aimed at creating and sustaining a more inclusive environment. Employee Growth and Development We strive to be an Employer of Choice by investing in our employees. Our goal is to attract, develop and retain a talented team of diverse people inspired by our mission to provide exceptional value to our customers and suppliers and create exceptional 8return to our shareholders, while providing exceptional opportunities for our employees. Our success depends on our employees understanding how their work contributes to the company’s overall strategy. When our employees succeed, the company succeeds. To help our employees achieve success in their roles, we emphasize continuous training and career development opportunities. These include annual performance assessments, promotion and advancement opportunities, safety and security protocols, updates on new products and service offerings and deployment of technologies. We also provide managerial training to emerging leaders, mid-level managers and departmental leaders. This coursework covers topics such as talent review, development of underperforming employees, handling employee misconduct and coaching and success workshops. Our employees are also involved in a multitude of volunteer efforts that positively impact our communities through support of charitable organizations. Recently, we have donated over $2 million through our partnerships with YMCAs across the country to provide free water safety lessons and lifeguard training in underserved communities. Our donations have funded more than 20,000 safety around water swimming lessons and lifeguard training scholarships from coast to coast. Our local employees and partners donated their time and energy to make these events a success.We also provide an entry level program to prepare Manager Trainees (MITs) for sales and operations management opportunities. Our MITs are hosted at either our state-of-the-art EDGEucation Center or in a virtual classroom. They gain valuable experience during their training program through field-based interaction with customers and operating management. Our program includes lectures by subject matter experts, hands-on projects and role play to provide MITs with practical industry knowledge, leadership skills and the tools necessary to succeed within our organization.Employee Compensation and BenefitsWe strive to provide market-competitive compensation, benefits and services to our employees. Our performance-based compensation philosophy rewards each employee’s individual contributions regardless of gender, race or ethnicity. Our total compensation package includes cash compensation (base salary and incentive or bonus payments), company contributions toward additional benefits (such as health and disability plans), retirement plans with a company match and paid time off. We also offer the opportunity to become a shareholder through equity grants for management and our employee stock purchase plan. Our employees can take advantage of a range of benefits, including healthcare and wellness programs, tuition reimbursement for eligible employees and multi-year scholarships to their dependents, and financial wellness programs to help provide education and tools to assist in improving, maintaining and capitalizing on our employees’ financial future. We closely monitor employee turnover and conduct exit interviews to gain relevant information and adapt our engagement and retention strategy as appropriate.GovernanceOur employees, managers and officers conduct our business under the direction of our CEO and the oversight of our Board of Directors (our Board) to enhance our long-term value for our stockholders. The core responsibility of our Board is to exercise its fiduciary duty to act in the best interests of our company and our stockholders. In exercising this obligation, our Board and committees perform a number of specific functions, including risk assessment, review and oversight. While management is responsible for the day-to-day management of risk, our Board is responsible for oversight of our risk management programs, ensuring that an appropriate culture of risk management exists within the company, and assisting management in addressing specific risks, such as strategic risks, financial risks, cybersecurity risks, regulatory risks and operational risks.Seasonality and WeatherOur business is seasonal. In general, sales and operating income are highest during the second and third quarters, which represent the peak months of swimming pool use, pool and irrigation installation and remodeling and repair activities. Sales are lower during the first and fourth quarters. In 2022, we generated approximately 59% of our net sales and 67% of our operating income in the second and third quarters of the year.We typically experience a build-up of product inventories and accounts payable during the winter months in anticipation of the peak selling season. Excluding borrowings to finance acquisitions, dividend payments and share repurchases, our peak borrowing usually occurs during the late spring and summer, primarily because extended terms offered by certain of our suppliers are typically payable during the second quarter of each year, while our peak accounts receivable collections typically occur in June, July and August.9We expect that our quarterly results of operations will continue to fluctuate depending on the timing and amount of revenue contributed by new and acquired sales centers. Based on our peak summer selling season, we generally open new sales centers and close or consolidate sales centers, when warranted, either in the first quarter before the peak selling season begins or in the fourth quarter after the peak selling season ends.Weather is one of the principal external factors affecting our business. The table below presents some of the possible effects resulting from various weather conditions.WeatherPossible EffectsHot and dry•Increased purchases of chemicals and supplies for existing swimming pools •Increased purchases of above-ground pools and irrigation and lawn care productsUnseasonably cool weather or extraordinary amounts•Fewer pool and irrigation and landscapingof raininstallations•Decreased purchases of chemicals and supplies•Decreased purchases of impulse items such as above-ground pools and accessoriesUnseasonably early warming trends in spring/late cooling•A longer pool and landscape season, thus positivelytrends in fallimpacting our sales(primarily in the northern half of the U.S. and Canada) Unseasonably late warming trends in spring/early cooling•A shorter pool and landscape season, thus negativelytrends in fallimpacting our sales(primarily in the northern half of the U.S. and Canada) For discussion regarding the effects seasonality and weather had on our results of operations in 2022 and 2021, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Seasonality and Quarterly Fluctuations,” of this Form 10-K.Government RegulationsOur business is subject to regulation under local fire codes and international, federal, state and local environmental and health and safety requirements, including regulation by the Environmental Protection Agency, the Consumer Product Safety Commission, the Department of Transportation, the Occupational Safety and Health Administration, the National Fire Protection Agency and the International Maritime Organization. Most of these requirements govern the packaging, labeling, handling, transportation, storage and sale of chemicals and fertilizers. We store certain types of chemicals and/or fertilizers at each of our sales centers and the storage of these items is strictly regulated by local fire codes. In addition, we sell algaecides and pest control products that are regulated as pesticides under the Federal Insecticide, Fungicide and Rodenticide Act and various state pesticide laws. These laws primarily relate to labeling, annual registration and licensing.Intellectual PropertyWe maintain both domestic and foreign registered trademarks and patents, primarily for our Pool Corporation and affiliate branded products that are important to our current and future business operations. We also own rights to numerous internet domain names.10Geographic AreasThe table below presents net sales by geographic region, with international sales translated into U.S. dollars at prevailing exchange rates, for the past three fiscal years (in thousands): Year Ended December 31, 202220212020United States$5,674,909 $4,749,459 $3,579,990 International504,818 546,125 356,633 $6,179,727 $5,295,584 $3,936,623 The table below presents net property and equipment by geographic region, with international property and equipment balances translated into U.S. dollars at prevailing exchange rates, for the past three fiscal year ends (in thousands): December 31, 202220212020United States$185,117 $171,408 $100,857 International8,592 7,600 7,384 $193,709 $179,008 $108,241 Website Access and Available InformationOur website is www.poolcorp.com. Our website and other websites mentioned in this Form 10-K are for information only and the contents of such websites are not incorporated in, or otherwise to be regarded as part of, this Form 10-K. Our periodic reports, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge on our website at www.poolcorp.com as soon as reasonably practicable after we electronically file such reports with, or furnish them to, the Securities and Exchange Commission (SEC).We regularly evaluate the possibility of acquiring additional companies, and at any given time may be engaged in discussions or negotiations regarding these transactions. We generally do not announce our acquisitions until they are completed, unless it is required by regulatory or other rules to announce when a definitive agreement is reached.Investors should also be aware that while we may answer questions raised by securities analysts, it is against our policy to disclose any material non-public information or other confidential information. Accordingly, investors should not assume that we agree with any statement or report issued by an analyst with respect to our past or projected performance. To the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility. Unless otherwise indicated, information contained in this report and other documents filed by us under the federal securities laws concerning our views and expectations regarding the industries in which we operate are based on estimates made by us using data from industry sources and making assumptions based on our industry knowledge and experience. We have not independently verified data from industry or other third-party sources and cannot guarantee its accuracy or completeness.11Item 1A. Risk FactorsCautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995This report contains forward-looking information that involves risks and uncertainties. Our forward-looking statements express our current expectations or forecasts of possible future results or events, including projections of earnings and other financial performance measures, statements of management’s expectations regarding our strategic, operational and capital allocation plans and objectives, management's views on industry, economic, competitive, technological and regulatory conditions and other forecasts of trends and other matters. Forward-looking statements speak only as of the date of this filing, and we undertake no obligation to publicly update or revise such statements to reflect new circumstances or unanticipated events as they occur. You can identify these statements by the fact that they do not relate strictly to historic or current facts and often use words such as “anticipate,” “estimate,” “expect,” “intend,” “believe,” “will likely result,” “outlook,” “project,” “may,” “can,” “plan,” “target,” “potential,” “should” and other words and expressions of similar meaning. No assurance can be given that the expected results in any forward-looking statement will be achieved, and actual results may differ materially due to one or more factors. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act.Risk FactorsCertain factors that may affect our business and could cause actual results to differ materially from those expressed in any forward-looking statement are described below. Investors should carefully consider the risks described below in addition to the other information set forth in this Annual Report on Form 10-K. The risks discussed below are not the only risks we face. Other risks or uncertainties not presently known to us, or that we currently believe are immaterial, may materially affect our business if they occur. Moreover, new risks emerge from time to time. Further, our business may also be affected by additional factors that generally apply to all companies operating in the U.S. and globally, which we have not included below. Risks Relating to Macroeconomic ConditionsThe demand for our products may be adversely affected by unfavorable economic conditions and changes in consumer discretionary spending.Consumer discretionary spending significantly affects our sales and is impacted by factors outside of our control, including general economic conditions, the residential housing market, unemployment rates, wage levels, interest rate fluctuations, inflation, disposable income levels, consumer confidence and access to credit. In economic downturns or recessions, the demand for swimming pool, irrigation, landscape and related outdoor living products may decline, often corresponding with declines in discretionary consumer spending, the growth rate of pool eligible households and swimming pool construction. Maintenance and repair products and certain replacement and refurbishment products are required to maintain existing swimming pools, and each currently accounts for approximately 60% and 21% to 23% of net sales related to our swimming pool business. However, the growth in this portion of our business depends on the expansion of the installed pool base, which could also be adversely affected by decreases in construction activities, similar to the trends between late 2006 and early 2010. A weak economy may also cause consumers to defer discretionary replacement and refurbishment activity. Even in generally favorable economic conditions, severe and/or prolonged downturns in the housing market could have a material adverse impact on our financial performance. Such downturns expose us to certain additional risks, including but not limited to the risk of customer closures or bankruptcies, which could shrink our potential customer base and inhibit our ability to collect on those customers’ receivables.We believe that homeowners’ access to consumer credit at attractive interest rates is a critical factor enabling the purchase of new pools, irrigation systems and outdoor living products. Between late 2006 and early 2010, the unfavorable economic conditions and downturn in the housing market resulted in significant tightening of credit markets, which limited the ability of consumers to access financing for new swimming pools and irrigation systems. Any similar tightening of consumer credit or increase in interest rates could prevent consumers from obtaining financing for pool, irrigation and related outdoor projects, which could negatively impact our sales of construction-related products.Discretionary spending is often adversely affected during times of economic, social or political uncertainty. The potential for natural or man-made disasters or extreme weather, geopolitical events and security issues, labor or trade disputes and similar events could create these types of uncertainties and negatively impact our business in ways that we cannot presently predict.12Changes in our customer base could also impact us. Our business could be adversely impacted if (i) consolidation of our customers leads to changes in purchasing habits, (ii) more people choose to live in urban settings or (iii) more homeowners bypass our customers by directly procuring their own supplies or undertaking their own improvement projects.During 2022, interest rates and inflation rose, economic activity slowed and consumer credit tightened, which led to a slowdown in new pool permits (signaling a decline in new construction projects). Many experts are predicting a further downturn in 2023 for the United States economy and much of the global economy. Although the severity and duration of any such downturn is difficult to predict, we expect the heightened demand for our products during the pandemic to moderate as consumers apply less disposable income to pools and other home improvements.The COVID-19 pandemic, other major public health crises in the future, and associated responses could adversely impact our business and results of operations.The COVID-19 pandemic and its aftermath significantly impacted economic activity and markets throughout the world. Even as efforts to contain the pandemic, including vaccinations, have fostered progress and eased restrictions, new variants of the virus have caused additional outbreaks and uncertainties. Our increased growth rates in the latter half of 2020 through the first half of 2022 were driven by home-centric trends influenced by the COVID-19 pandemic, during which many consumers spent more time at their homes due to travel restrictions and remote work arrangements. We believe the easing of the pandemic in 2022 led to more travel and other out-of-home activities. Impacts from the COVID-19 pandemic, coupled with heightened demand, adversely impacted our supply chain in the latter half of 2021 through the beginning of 2022, making it difficult to source and receive products needed to keep our customers adequately supplied. Notwithstanding recent improvements, there are continuing uncertainties regarding how long COVID-19 and its variant strains will continue to impact the global economy and our supply chain and the effect of the pandemic on our operational and financial performance will depend on future developments, including its impact on our customers and trade partners, all of which remain uncertain. Accordingly, COVID-19, or any other future major public health crisis, may have negative impacts on our business in the future, and any future adverse impacts on our business may be worse than we anticipate. Risks Relating to Our Business and IndustryWe are susceptible to adverse weather conditions, which could intensify as a result of climate change.Given the nature of our business, weather is one of the principal external factors affecting our business and the effect of seasonality has a significant impact on our results. In 2022, we generated approximately 59% of our net sales and 67% of our operating income in the second and third quarters of the year. These quarters represent the peak months of swimming pool use, pool and irrigation installation and remodeling and repair activities. Unfavorable weather during these quarters in our largest geographic regions can significantly affect our results. Unseasonably late warming trends in the spring or early cooling trends in the fall can shorten the length of the pool season. Also, unseasonably cool weather or extraordinary rainfall during the peak season can have an adverse impact on demand due to decreased swimming pool use, installation and maintenance, as well as decreased irrigation installations. While warmer weather conditions favorably impact our sales, global warming trends and other significant climate changes can create more variability in the short term or lead to other unfavorable weather conditions that could adversely impact our sales or operations. Drought conditions or water management initiatives may lead to government-imposed water use restrictions. Such restrictions could result in decreased pool and irrigation system installations which could negatively impact our sales. Certain extreme weather events, such as hurricanes, tornadoes, earthquakes, tropical storms, floods, drought and wildfires, may adversely impact us in several ways, including interfering with our ability to deliver our products and services, interfering with our receipt of supplies from our vendors, reducing demand for our products and services, and damaging our facilities. We have experienced short-term impacts on our sales due to closures from weather events in recent years, including Hurricane Ian in Florida in 2022. Although these events have not had any material lasting impacts on our business or resulted in any material permanent operational challenges, similar events could adversely affect our business in the future. The areas in which we operate, including California, Florida, Texas and other coastal areas, have experienced recent natural disasters or present increased risks of adverse weather or natural disasters. The physical effects of climate change may increase the frequency or severity of natural disasters and other extreme weather events in the future, which would increase our exposure to these risks.For additional discussion regarding seasonality and weather, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Seasonality and Quarterly Fluctuations,” of this Form 10-K.13Our distribution business is highly dependent on our ability to maintain favorable relationships with suppliers.As a distribution company, maintaining favorable relationships with our suppliers is critical to our success. We believe that we add considerable value to the swimming pool and irrigation supply chains by purchasing products from a large number of manufacturers and distributing the products to a highly fragmented customer base on conditions that are more favorable than these customers could obtain on their own. We believe that we currently enjoy good relationships with our suppliers, who generally offer us competitive pricing, return policies and promotional allowances. However, any failure to maintain favorable relationships with our suppliers could have an adverse effect on our business.Our largest suppliers are Pentair plc, Hayward Pool Products, Inc. and Zodiac Pool Systems, Inc., which accounted for approximately 18%, 11% and 9%, respectively, of the costs of products we sold in 2022. A decision by our largest suppliers, acting individually or in concert, to sell their products directly to retailers or other end users of their products, bypassing distribution companies like ours, would have an adverse effect on our business. Additionally, if our suppliers experience difficulties or disruptions in their operations, if there is any material interruption in our supply chain (such as the interruptions caused by the COVID-19 pandemic and exacerbated by the invasion of Ukraine) or if we lose a single significant supplier due to financial failure or a decision to sell exclusively to retailers or end-use consumers, we may experience increased supply costs or delays in establishing replacement supply sources that meet our quality and control standards, which may affect our profitability. We depend on a global network of suppliers to source our products, including our own branded products and products we have exclusive distribution rights to. Failure to achieve and maintain a high level of product and service quality and safety could damage our reputation, expose us to litigation and negatively impact our financial performance.We rely on manufacturers and other suppliers to provide us with the products we distribute. To succeed, we must continue to maintain effective business relationships with qualified suppliers who can timely and efficiently supply us with high quality products. As we increase the number of Pool Corporation and affiliate branded products we distribute, our exposure to potential liability claims may increase. Product and service quality issues could negatively impact customer confidence in our brands and our business. If our product and service offerings do not meet applicable safety standards or our customers’ expectations regarding safety or quality, we could experience lost sales and increased costs and be exposed to legal, financial and reputational risks, as well as governmental enforcement actions. Actual, potential or perceived product safety concerns, including health-related concerns, could damage our reputation with current or prospective customers, vendors and employees. Product quality or safety issues could also expose us to litigation, as well as government enforcement actions, and result in costly product recalls and other liabilities. Similar concerns impacting our competitors could damage the reputation of our industry and indirectly have an unfavorable impact on our operations. We face intense competition both from within our industry and from other leisure product alternatives.Within our industry, we directly compete against various regional and local distributors for the business of pool owners and other end-use customers. We indirectly compete against mass market retailers and large pool or irrigation supply retailers as they purchase the great majority of their needs directly from manufacturers. We compete to a lesser extent with internet retailers, as they purchase the majority of their needs from distributors. Outside of our industry, we compete indirectly with alternative suppliers of big-ticket consumer discretionary products, such as boat and motor home distributors, and with other companies who rely on discretionary homeowner expenditures, such as home remodelers. New competitors may emerge as there are low barriers to entry in our industry, which has led to highly competitive markets consisting of various-sized entities, ranging from small or local operators to large regional businesses. If our customers are attracted by the alternatives afforded by any of our competitors, they may be less inclined to purchase products or services from us, impacting our results of operations. Given the density and demand for pool products, some geographic markets that we serve also tend to have a higher concentration of competitors than others, particularly California, Texas, Florida and Arizona. These states encompass our four largest markets and represented approximately 53% of our net sales in 2022. The entry of significant new competitors into these markets could negatively impact our sales. More aggressive competition by store- and internet-based mass merchants and large pool or irrigation supply retailers could adversely affect our sales. Mass market retailers today carry a limited range of, and devote a limited amount of shelf space to, merchandise and products targeted to our industry. Historically, mass market retailers have generally expanded by adding new stores and product breadth, but their product offering of pool and irrigation related products has remained relatively constant. Should store‑ and internet-based mass market retailers increase their focus on the pool or irrigation industries, or increase the breadth of their pool and 14irrigation and related product offerings, they may become a more significant competitor for our direct customers and end-use consumers, which could have an adverse impact on our business. Additionally, because the internet facilitates competitive entry, price transparency and comparison shopping, increased internet sales by us or our competitors could increase the level of competition we face or reduce our margin. Further, we may face additional competitive pressures if large pool or irrigation supply retailers look to expand their customer base to compete more directly within the distribution channel.We depend on our ability to attract, develop and retain highly qualified personnel.We consider our employees to be the foundation for our growth and success. As such, our future success depends in large part on our ability to attract, retain and motivate qualified personnel. This includes succession planning related to our executive officers and key management personnel. Hiring and retaining such qualified individuals may be adversely impacted by global and domestic economic uncertainty, and increased competition for such qualified individuals. If we are unable to attract and retain key personnel, our operating results could be adversely affected. Given the seasonal nature of our business, we may hire additional employees during the summer months, including seasonal and part-time employees, who generally are not employed during the off-season. If we are unable to attract and hire additional personnel during the peak season, our operating results could be negatively impacted. Additionally, competition for qualified employees could require us to pay higher wages to attract and retain a sufficient number of employees. The pandemic and other events over the past few years have increased employees’ expectations regarding compensation, workplace flexibility and work-home balance. These developments have made it more difficult for us to attract and retain top talent. We do not expect these developments to have a material adverse impact on us, but we can provide no assurances to this effect.Past growth may not be indicative of future growth.Historically, we have experienced substantial sales growth through organic market share gains, new sales center openings, expanded product offerings and acquisitions that have increased our size, scope and geographic distribution. Our various business strategies and initiatives, including our growth initiatives, are subject to business, economic and competitive uncertainties and contingencies, many of which are beyond our control. While we contemplate continued growth through internal expansion and acquisitions, no assurance can be made as to our ability to:•penetrate new markets;•generate sufficient cash flows to support expansion plans and general operating activities;•obtain financing;•identify appropriate acquisition candidates and successfully integrate acquired businesses;•identify appropriate locations for new sales centers and successfully integrate them into our network;•maintain favorable supplier arrangements and relationships; and•identify and divest assets which do not continue to create value consistent with our objectives.If we do not manage these potential difficulties successfully, our operating results could be adversely affected.Our results in 2020 through the first half of 2022 were positively impacted by home-centric trends resulting from the COVID-19 pandemic. Recent trends, including a lower number of permits issued for new pools, suggest that new construction activities are moderating. While we expect home-centric trends to continue, we do not expect to realize the same growth that we recognized at the height of the pandemic. These trends may not continue, or may reverse, which could adversely impact our results of operations. In addition, in recent years our customers have had difficulty employing a sufficient number of qualified individuals to keep up with the demand for pool installation, maintenance and refurbishment. If this trend continues or accelerates, our results of operations could be negatively impacted.We are subject to inventory management risks. Insufficient inventory may result in lost sales opportunities or delayed revenue, while excess inventory may negatively impact our gross margin.We balance the need to maintain inventory levels that are sufficient to ensure competitive lead times and mitigate potential supply chain constraints against the risk of inventory obsolescence due to changing customer or consumer requirements and fluctuating commodity prices. In order to successfully manage our inventories, we must estimate demand from our customers and purchase products that substantially correspond to consumer demand. If we overestimate demand and purchase too much of a particular product, we face a risk that the price of that product will fall, leaving us with inventory that we cannot sell at normal profit margins. In addition, we may have to write down such inventory if we are unable to sell it for its recorded value. 15If we underestimate demand and purchase insufficient quantities of products, inventory shortages could result in delayed revenue or loss of sales opportunities altogether as potential customers turn to competitors’ products that are readily available. If we maintain insufficient inventory levels and prices rise for these products, we could be forced to purchase products at higher prices and forego profitability in order to meet customer demand. While always present, these challenges have been heightened over the past couple years, as the pandemic altered consumer spending trends and caused us to increase our investments in inventory. Our business, financial condition and results of operations could be negatively impacted if either or both of these situations occur frequently or in large volumes.Risks Relating to Technology, Cybersecurity and Data Privacy We rely on information technology systems to support our business operations. A significant disturbance, breach or cybersecurity attack of our technological infrastructure could adversely affect our financial condition and results of operations. Information technology supports several aspects of our business, including among others, product sourcing, pricing, customer service, transaction processing, inventory management, financial reporting, collections and cost management. Our ability to operate effectively on a day-to-day basis, communicate with our customers and accurately report our results depends on a reliable technological infrastructure, which is inherently susceptible to internal and external threats. We are vulnerable to interruption by fire, natural disaster, power loss, telecommunication failures, internet failures, security breaches and other catastrophic events. Exposure to various types of cyber-attacks such as malware, computer viruses, worms, ransomware or other malicious acts, as well as human error, could also potentially disrupt our operations, result in a significant interruption in the delivery of our goods and services or result in the loss of sensitive data. We are making, and expect to continue to make, investments in technology to maintain and update our computer systems and to expand our ability to engage in e-commerce with our customers. We may not implement these changes as quickly or successfully as our customers expect. In addition, implementing significant system changes increases the risk of computer system disruption. The potential problems and interruptions associated with implementing technology initiatives or conversions (including those contemplated under our multi-year systems upgrade project), as well as providing training and support for those initiatives, could disrupt or reduce our operational efficiency. Advances in computer and software capabilities, encryption technology and other discoveries increase the complexity of our technological environment, including how each interact with our various software platforms. Such advances could delay or hinder our ability to process transactions or could compromise the integrity of our data, resulting in a material adverse impact on our financial condition and results of operations. We also may experience occasional system interruptions and delays that make our information systems unavailable or slow to respond, including the interaction of our information systems with those of third parties or the failure of software of services provided by third parties that we do not control. A lack of sophistication or reliability of our information systems could adversely impact our operations and customer service and could require major repairs or replacements, resulting in significant costs and foregone revenue. Like other companies our size, we devote significant resources to protect our systems and data from cyber-attacks. Despite our substantial efforts to defend against these attacks, we have faced various attempted cyber-attacks that did not result in a material adverse effect on our operations, operating results or financial condition. The risk of breaches is likely to continue to increase due to several factors, including the increasing sophistication of cyber-attacks, the wider accessibility of cyber-attack tools and increased reliance on e-commerce, open source software, cloud computer services and work-from-home staffing. Known and newly discovered software and hardware vulnerabilities are constantly evolving, which increases the difficulty of detecting and successfully defending against them. Consequently, we may not be able to implement security barriers or other preventative measures that repel all future cyber-attacks or detect such attacks in a timely manner to minimize the potential business disruption and unfavorable financial impacts.Although we maintain insurance coverage that may, subject to policy terms and conditions (including self-insured deductibles, coverage restrictions and monetary coverage caps), cover certain aspects of our cyber risks, such insurance coverage may be unavailable or insufficient to cover our losses.Failure to maintain the security of confidential information could damage our reputation and expose us to litigation. Additionally, changes in data privacy laws and our ability to comply with them could have a material adverse effect on us.We collect and store data that is sensitive to us and our employees, customers and vendors. The failure to maintain security over and prevent unauthorized access to our data, our customers’ personal information, including credit card information, or data belonging to our suppliers, could put us at a competitive disadvantage. Such a breach could result in damage to our reputation and subject us to potential litigation, liability, fines and penalties and require us to incur significant expense to 16address and remediate or otherwise resolve these issues, resulting in a possible material adverse impact on our financial condition and results of operations.A variety of state, national, foreign and international laws and regulations apply to the collection, use, retention, protection, security, disclosure, transfer and other processing of personal and other data. The European Union and other international regulators, as well as state governments, have recently enacted or enhanced data privacy regulations, such as the California Consumer Privacy Rights Act, and other governments are considering establishing similar or stronger protections. These regulations impose certain obligations for handling specified personal information in our systems and for apprising individuals of the information we have collected about them. Many of these laws are complex and change frequently and often conflict with the laws in other jurisdictions. Despite our best efforts to comply, any noncompliance could result in incurring potential substantial penalties and reputational damage. Risks Relating to Legal, Regulatory and Compliance MattersThe nature of our business subjects us to compliance with employment, environmental, health, transportation, safety and other governmental regulations. Our costs of doing business could increase as a result of changes in, expanded enforcement of, or adoption of new federal, state or local laws and regulations. We are subject to regulation under federal, state, local and international employment, environmental, health, transportation and safety requirements, which govern such things as packaging, labeling, handling, transportation, storage and sale of chemicals and fertilizers. These laws and regulations, and related interpretations and enforcement activity, may change as a result of a variety of factors, including political, economic or social events. Changes in, expanded enforcement of, or adoption of new federal, state or local laws and regulations governing minimum wage or living wage requirements, the classification of exempt and non-exempt employees or other wage, labor or workplace regulations could increase our costs of doing business and adversely impact our results of operations.We sell algaecides and pest control products that are regulated as pesticides under the Federal Insecticide, Fungicide and Rodenticide Act and various state pesticide laws. These laws primarily relate to labeling, annual registration and licensing. Management has processes in place to facilitate and support our compliance with these requirements. However, failure to comply with these laws and regulations may result in investigations, the assessment of administrative, civil and criminal fines, damages, seizures, disgorgements, penalties or the imposition of injunctive relief. Moreover, compliance with such laws and regulations in the future could prove to be costly. Although we presently do not expect to incur any capital or other expenditures relating to regulatory matters in amounts that may be material to us, we may be required to make such expenditures in the future. These laws and regulations have changed substantially and rapidly over the last 25 years and we anticipate that there will be continuing changes. The clear trend in environmental, health, transportation and safety regulations is to place more restrictions and limitations on activities that impact the environment, such as the use and handling of chemicals and the discharge of greenhouse gases. Increasingly, strict restrictions and limitations have resulted in higher operating costs for us and it is possible that the costs of compliance with such laws and regulations will continue to increase. Our attempts to anticipate future regulatory requirements that might be imposed and our plans to remain in compliance with changing regulations and to minimize the costs of such compliance may not be as effective as we anticipate. Governmental actions designed to address climate change or the failure to meet environmental social and governance (“ESG”) expectations or standards or achieve our ESG goals could adversely affect our business.Concern over climate change has led to and may in the future lead to new or increased legal and regulatory requirements designed to reduce or mitigate the effects of climate change or increase disclosure related to climate change, which could increase our operating or capital expenses and compliance burdens. In particular, advocates of change are continuing to explore ways to reduce greenhouse gas emissions. These changes over time could affect the availability and cost of certain consumer products, commodities and energy, which in turn may impact our ability to procure certain products or services required for the operation of our business at the quantities and levels we require. The regulation of greenhouse gas emissions could result in additional taxes or other costs to us or require us to modify our facilities or vehicle fleet. Changes in customers’ attitudes toward the environmental impact of pools’ energy consumption or pool chemical products could reduce demand for our products.We have set certain targets aimed at reducing our impact on the environment and climate change. These initiatives reflect our current plans and aspirations, and it is possible that we may not be able to achieve such targets or our desired impact, which may cause us to suffer from legal claims, reputational damage or a loss of demand for our products. Actions we take to achieve 17our strategy or targets could result in increased costs to our operations. Investors or other stakeholders could react negatively to our targets or other positions we take on ESG matters, which could negatively impact our relationships with such stakeholders.We store chemicals, fertilizers and other combustible materials that involve fire, safety and casualty risks.We store chemicals and fertilizers, including certain combustibles and oxidizing compounds, at our sales centers. A fire, explosion or flood affecting one of our facilities could give rise to fire, safety and casualty losses and related liability claims. We maintain what we believe is prudent insurance protection. However, we cannot guarantee that our insurance coverage will be adequate to cover future claims that may arise or that we will be able to maintain adequate insurance in the future at rates we consider reasonable. Successful claims for which we are not fully insured may adversely affect our working capital and profitability. In addition, changes in the insurance industry have generally led to higher insurance costs and decreased availability of coverage.We conduct business internationally, which exposes us to additional risks.Our ability to successfully conduct operations in, and source products and materials from, international markets is affected by many of the same risks we face in our U.S. operations, as well as unique costs and difficulties of managing international operations. Our international operations, including Canada and Mexico, which accounted for 8% of our total net sales in 2022, expose us to certain additional risks, including:•difficulty in staffing international subsidiary operations;•different political, economic and regulatory conditions;•local laws and customs;•currency fluctuations (including the current strength of the U.S. dollar compared to foreign currencies), exchange controls and repatriation restrictions;•adverse tax consequences; and•adverse consequences for violating anti-corruption, anti-competition, economic sanctions, immigration and other laws governing international commerce.For foreign-sourced products, we may be subject to certain trade restrictions that would prevent us from obtaining products. There is also a greater risk that we may not be able to access products in a timely and efficient manner. Fluctuations in other factors relating to international trade, such as tariffs, transportation costs and inflation are additional risks for our international operations. We do not have operations in Russia or Ukraine. However, the contributory effects of the war in Ukraine and prolonged geopolitical conflict globally may continue to result in increased inflation, increased labor costs, escalating energy and commodity prices and increasing costs of materials and services (together with shortages or inconsistent availability of materials and services), which could negatively affect our business (particularly our European operations), results of operations and financial condition.Changes in import policy or trade relations, interruptions in our supply chain or increased commodity or supply chain costs could adversely affect our results of operations.Like other companies globally, we faced supply chain disruptions across our business in 2021 and the early part of 2022, which led to increased costs, delays and in some cases lost opportunities. As a result of these supply chain disruptions, our procurement and operational business functions increased planning and strategic purchasing and sourced products internationally where needed. Because we source certain products from outside the United States, major changes in tax policy, import or export regulations or trade relations, such as the disallowance of tax deductions for imported products or the imposition of additional tariffs or duties on imported products, could adversely affect our business, results of operations, effective income tax rate, liquidity and net income.We may have exposure to higher duty and tariff costs on certain of our imported products. We recorded $13.0 million within Cost of sales in the fourth quarter of 2022 related to duties and tariffs for certain imported chemicals. This amount primarily relates to 2022 purchases from China, where we determined, prior to submission of final liquidation amounts of our import duties and tariffs, that the initial code we used to classify the product may only apply to bulk purchases. To protect against potential penalties and receive clarification on the issue, we voluntarily filed a disclosure with U.S. Customs and Border Protection in December 2022. Changes in laws, court rulings, or differences in interpretation on product classification could lead to increased duty and tariff rates on these or other imported products.18Excess tax benefits or deficiencies recognized from our accounting for share-based awards impact our reported earnings.In 2017, we adopted Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting. Our projections of financial statement impacts related to ASU 2016-09 are subject to several assumptions which can vary significantly, including our estimated share price and the period that our employees will exercise vested stock options. Excess tax benefits or deficiencies recognized under ASU 2016-09 vary from quarter to quarter and past results may not be indicative of future results. Risks Relating to Our IndebtednessIncreases in interest rates would increase the cost of servicing our debt and could reduce our profitability. Our unsecured syndicated senior credit facility, term facility and receivable facility bear interest at variable rates. We have entered into interest rate swap contracts and a forward-starting interest rate swap contract to reduce our exposure to fluctuations in variable interest rates on current and future interest payments that we owe on a portion of our variable rate borrowings. Increases in interest rates for any amount of our variable rate debt not covered by our interest rate swaps could increase the cost of servicing our debt and could materially reduce our profitability and cash flows. For additional information regarding our interest rate risk, see Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” of this Form 10-K.We may be adversely affected by the transition away from LIBOR and the use of SOFR or other alternative reference rates.Borrowings under our unsecured syndicated senior credit facility, term facility and interest rate swap contracts are indexed to the London Inter-bank Offering Rate (“LIBOR”). On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intended to phase out LIBOR by the end of 2021. For U.S. dollar LIBOR, the cessation date has been deferred to June 30, 2023 for the most commonly used tenors (overnight and one, three and six months). The Federal Reserve System, in conjunction with the Alternative Reference Rates Committee, has recommended the replacement of LIBOR with a new index, calculated by short-term repurchase agreements collateralized by U.S. Treasury securities, called the Secured Overnight Financing Rate (“SOFR”). Using SOFR as the basis on which interest on our variable-rate debt and/or under our interest rate swaps is calculated may result in interest rates and/or payments that do not directly correlate over time with the interest rates and/or payments that would have been made on our obligations if LIBOR was available in its current form. The potential effect of the replacement of LIBOR on our cost of capital cannot yet be determined.General RisksChanges in tax laws and accounting standards related to tax matters have caused, and may in the future cause, fluctuations in our effective tax rate.Taxation and tax policy changes, tax rate changes, new tax laws, revised tax law interpretations and changes in accounting standards and guidance related to tax matters may cause fluctuations in or adversely affect our effective tax rate. Our effective tax rate may also be impacted by changes in the geographic mix of our earnings.We cannot assure you we will continue paying dividends at the current rates, or at all.We cannot assure you we will continue periodic dividends on our capital stock at the current rates, or at all. Any quarterly dividends on our common stock will be paid from funds legally available for such purpose when, and if, declared by our Board of Directors. Decisions on whether, when and in which amounts to continue making any future dividend distributions will remain at all times entirely at the discretion of our Board of Directors, which reserves the right to change or terminate our dividend practices at any time and for any reason without prior notice. Holders of our common stock should be aware they have no contractual or other legal right to receive dividends.Similarly, holders of our common stock should be aware that repurchases of our common stock under any repurchase plan then in effect are completely discretionary and may be suspended or discontinued at any time for any reason regardless of our financial position.19Lapses in our disclosure controls and procedures or internal control over financial reporting could materially and adversely affect us.We maintain disclosure controls and procedures designed to provide reasonable assurances regarding the accuracy and completeness of our SEC reports and internal control over financial reporting designed to provide reasonable assurance regarding the reliability and compliance with U.S. generally accepted accounting principles (“GAAP”) of our financial statements. We cannot assure you these measures will be effective.Item 1B. Unresolved Staff CommentsNone.20Item 2. PropertiesWe lease the Pool Corporation corporate offices, which consist of approximately 60,000 square feet of office space in Covington, Louisiana, from an entity in which we have a 50% ownership interest. We own fourteen sales center facilities, which includes six sales center facilities in Florida, three in Texas, and one in each of Alabama, California, Georgia, Mississippi and Tennessee. As part of our acquisition of Porpoise Pool & Patio, Inc. in December 2021, we own the corporate headquarters and the Sun Wholesale Supply, Inc. facilities located in Florida, which consist of approximately 200,000 square feet. We also acquired a chemical packaging plant in Florida, which is approximately 105,000 square feet.We lease all of our other properties and the majority of our leases have three to seven year terms. As of December 31, 2022, we had twenty-eight leases with remaining terms longer than seven years that expire between 2030 and 2036. Most of our leases contain renewal options, some of which involve rent increases. In addition to minimum rental payments, which are set at competitive rates, certain leases require reimbursement for taxes, maintenance and insurance.Our sales centers range in size from approximately 2,000 square feet to 95,000 square feet and generally consist of warehouse, counter, display and office space. Our centralized shipping locations (CSLs) range in size from approximately 115,000 square feet to 185,000 square feet.We believe that our facilities are well maintained, suitable for our business and occupy sufficient space to meet our operating needs. As part of our normal business, we regularly evaluate sales center performance and site suitability and may relocate a sales center or consolidate multiple locations if a sales center is redundant in a market, underperforming or otherwise deemed unsuitable. We do not believe that any single lease is material to our operations.The table below summarizes the changes in our sales centers during the year ended December 31, 2022:Network12/31/21NewLocationsClosedLocationAcquiredLocation12/31/22SCP (1)193 2 — 1 196 Superior73 — — — 73 Horizon84 5 (1)— 88 NPT (2)17 2 — — 19 Total Domestic367 9 (1)1 376 SCP International43 1 — — 44 Total410 10 (1)1 420 (1)Total includes one distribution location for Sun Wholesale Supply, Inc., which we acquired in December 2021. As part of the acquisition, we also acquired non-sales center properties including a chemical packaging plant and three Pinch A Penny, Inc. retail stores in Florida. (2)In addition to the stand-alone NPT sales centers, there are over 100 SCP and Superior locations that have consumer showrooms and serve as stocking locations that feature NPT brand tile and composite finish products. 21The table below identifies the number of sales centers in each state, territory or country by distribution network as of December 31, 2022:LocationSCPSuperiorHorizonNPTTotalUnited States California28 24 19 6 77 Florida39 5 17 1 62 Texas26 5 20 4 55 Arizona7 8 9 2 26 Washington3 — 8 — 11 Georgia7 2 — 1 10 North Carolina5 2 2 1 10 Tennessee6 4 — — 10 Nevada2 3 3 1 9 New York9 — — — 9 New Jersey5 2 — — 7 Pennsylvania5 1 — 1 7 Virginia3 1 3 — 7 Alabama4 2 — — 6 Louisiana5 — — 1 6 Illinois4 1 — — 5 Indiana2 3 — — 5 Oregon1 — 4 — 5 South Carolina4 1 — — 5 Missouri3 1 — — 4 Ohio2 2 — — 4 Oklahoma2 1 — 1 4 Arkansas3 — — — 3 Colorado— 2 1 — 3 Idaho1 — 2 — 3 Connecticut2 — — — 2 Kansas2 — — — 2 Massachusetts2 — — — 2 Michigan2 — — — 2 Minnesota1 1 — — 2 Mississippi2 — — — 2 Wisconsin1 1 — — 2 Hawaii1 — — — 1 Iowa1 — — — 1 Kentucky— 1 — — 1 Maryland1 — — — 1 Nebraska1 — — — 1 New Mexico1 — — — 1 Puerto Rico1 — — — 1 Utah1 — — — 1 West Virginia1 — — — 1 Total United States196 73 88 19 376 International Canada17 — — — 17 France8 — — — 8 Australia6 — — — 6 Mexico4 — — — 4 Portugal2 — — — 2 Spain2 — — — 2 Belgium1 — — — 1 Croatia1 — — — 1 Germany1 — — — 1 Italy1 — — — 1 United Kingdom1 — — — 1 Total International44 — — — 44 Total240 73 88 19 420 22Item 3. Legal ProceedingsFrom time to time, we are subject to various claims and litigation arising in the ordinary course of business, including product liability, personal injury, commercial, contract and employment matters. While the outcome of any litigation is inherently unpredictable, based on currently available facts, we do not believe that the ultimate resolution of any of these matters will have a material adverse impact on our financial condition, results of operations or cash flows. Item 4. Mine Safety DisclosuresNot applicable.23PART II.Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesOur common stock is traded on the Nasdaq Global Select Market under the trading symbol “POOL.” On February 17, 2023, there were approximately 740 holders of record of our common stock. We initiated quarterly dividend payments to our shareholders in the second quarter of 2004 and we have continued payments in each subsequent quarter. Our Board has increased the dividend amount seventeen times, including in the fourth quarter of 2004, annually in the second quarters of 2005 through 2008 and in the second quarters of 2011 through 2022. Our Board may declare future dividends at its discretion, after considering various factors, including our earnings, capital requirements, financial position, contractual restrictions and other relevant business considerations. For a description of restrictions on dividends in our Credit Facility, Term Facility and Receivables Facility, see Note 5 of “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K. We cannot assure shareholders or potential investors that dividends will be declared or paid any time in the future if our Board determines that there is a better use of our funds. Stock Performance GraphThe information included under the caption “Stock Performance Graph” in this Item 5 of this Annual Report on Form 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 (the 1934 Act) or to the liabilities of Section 18 of the 1934 Act, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the 1934 Act, except to the extent we specifically incorporate it by reference into such a filing.The following graph compares the cumulative total shareholder return on our common stock for the last five fiscal years with the total return on the S&P 500 Index (of which we have been a member since 2020) and the Nasdaq Index for the same period, in each case assuming the investment of $100 on December 31, 2017 and the reinvestment of all dividends. We believe the S&P 500 Index is comprised of similar-sized public companies that represent the most likely alternative investments for investors. Additionally, we chose the S&P 500 Index for comparison, as opposed to an industry index, because we do not believe that we can reasonably identify a peer group or a published industry or line-of-business index that contains a sufficient number of companies in a similar line of business.24BasePeriodIndexed ReturnsYears EndingCompany / Index12/31/1712/31/1812/31/1912/31/2012/31/2112/31/22Pool Corporation$100.00 $115.97 $167.58 $296.54 $453.64 $244.81 S&P 500 Index100.00 95.62 125.72 148.85 191.58 156.88 Nasdaq Index100.00 97.16 132.81 192.47 235.15 158.65 Purchases of Equity SecuritiesThe table below summarizes the repurchases of our common stock in the fourth quarter of 2022:PeriodTotal Numberof Shares Purchased (1)AveragePrice Paid per ShareTotal Number of Shares Purchasedas Part of PubliclyAnnounced Plan (2)Maximum ApproximateDollar Value of SharesThat May Yet be PurchasedUnder the Plan (3)October 1 – October 31, 202260 $318.77 — $230,242,715 November 1 – November 30, 2022— $— — $230,242,715 December 1 – December 31, 2022— $— — $230,242,715 Total60 $318.77 — (1)These shares may include shares of our common stock surrendered to us by employees in order to satisfy minimum tax withholding obligations in connection with certain exercises of employee stock options or lapses upon vesting of restrictions on previously restricted share awards, and/or to cover the exercise price of such options granted under our share-based compensation plans. There were 60 shares surrendered for this purpose in the fourth quarter of 2022.(2)In May 2022, our Board authorized an additional $196.2 million under our share repurchase program for the repurchase of shares of our common stock in the open market at prevailing market prices. (3)As of February 17, 2023, our total authorization remaining was $230.2 million. Item 6. [RESERVED]Not applicable. 25Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsFor a discussion of our base business calculations, see the RESULTS OF OPERATIONS section below.2022 FINANCIAL OVERVIEW Financial Results Net sales increased 17% to $6.2 billion for the year ended December 31, 2022 compared to $5.3 billion in 2021. Base business sales increased 12%. Net sales benefited approximately 10% from inflationary product cost increases and were aided by solid consumer demand for outdoor living products throughout the year. Net sales were also unfavorably impacted 1% from currency exchange rate fluctuations, 1% from softness in our European markets and generally less favorable weather conditions on a year-over-year comparison.Gross profit reached $1.9 billion for the year ended December 31, 2022, a 20% increase over gross profit of $1.6 billion in 2021. Gross margin improved 80 basis points to 31.3% in 2022 compared to 30.5% in 2021, reflecting benefits from acquisitions, increased pricing and supply chain management initiatives. These increases were partially offset by $13.0 million recorded within Cost of sales in the fourth quarter of 2022 related to increased duties and tariffs for certain imported chemicals. Given supply chain improvements through the latter half of 2022, we do not expect to import a significant portion of this product in 2023.Selling and administrative expenses (operating expenses) increased 16%, or $123.3 million, to $907.6 million in 2022, including a 1% benefit from currency exchange rate fluctuations. Base business operating expenses rose only 6% compared to 12% base business gross profit growth. As a percentage of net sales, operating expenses declined 10 basis points to 14.7% in 2022 compared to 14.8% in 2021. Our operating expenses have generally increased in line with sales growth to support our business, including recent acquisitions.Operating income for the year increased 23% to $1.0 billion, up from $832.8 million in 2021. Operating margin increased 90 basis points to 16.6% in 2022 compared to 15.7% in 2021. Interest and other non-operating expenses, net for the year increased $32.3 million compared to 2021, primarily reflecting higher average debt levels and higher average interest rates. We recorded a $10.8 million, or $0.27 per diluted share, tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, for the year ended December 31, 2022 compared to a tax benefit of $30.0 million, or $0.74 per diluted share, realized in 2021.Net income increased 15% to $748.5 million in 2022 compared to $650.6 million in 2021. Earnings per share increased 17% to $18.70 per diluted share compared to $15.97 per diluted share in 2021. Without the impact from ASU 2016-09 in both periods, earnings per diluted share increased 21% to $18.43 per diluted share compared to $15.23 per diluted share in 2021. See RESULTS OF OPERATIONS below for definitions of our non-GAAP measures and reconciliations of our non-GAAP measures to GAAP measures. Financial Position and LiquidityCash provided by operations was $484.9 million in 2022. Cash provided by operations throughout the year helped fund a portion of the following initiatives:•share repurchases, totaling $471.2 million for the year;•net working capital outflows of $342.4 million;•quarterly cash dividend payments to shareholders, totaling $150.6 million for the year; and•net capital expenditures of $43.6 million.Total net receivables, including pledged receivables, decreased 7% compared to December 31, 2021, primarily driven by slower December sales compared to last year. Our allowance for doubtful accounts was $9.5 million at December 31, 2022 and $5.9 million at December 31, 2021. Our days sales outstanding ratio, as calculated on a trailing four quarters basis, was 26.9 days at December 31, 2022 and 25.6 days at December 31, 2021.26Inventory levels grew 19% to $1.6 billion at December 31, 2022 compared to $1.3 billion at December 31, 2021, reflecting increased purchasing to stock new locations and ensure product availability across our sales center network and impacts from inflation. Our reserve for inventory obsolescence was $21.2 million at December 31, 2022 compared to $15.2 million at December 31, 2021. Our inventory turns, as calculated on a trailing four quarters basis, were 2.6 times at December 31, 2022 and 3.4 times at December 31, 2021.Accrued expenses and other current liabilities decreased $96.4 million to $168.5 million at December 31, 2022. As allowed for companies impacted by Hurricane Ida, we deferred our 2021 third and fourth quarter estimated federal tax payments totaling $79.5 million, which were paid in February 2022 and account for the majority of the decrease in accrued expenses and other current liabilities. Total debt outstanding of $1.4 billion at December 31, 2022 increased $203.5 million compared to December 31, 2021 as we have utilized debt proceeds over the past year to fund a portion of our share repurchases, dividend payments and investments in working capital.Current Trends and OutlookOver the past decade, consumers’ investments in their homes, including backyard renovations, have flourished. Particularly, over the past couple of years, steady increases in home values and lack of affordable new homes have prompted homeowners to stay in their homes longer and upgrade their home environments, including their backyards. Many families have spent more time at home and sought opportunities to create or expand home-based outdoor living and entertainment spaces. These trends resulted in an increase in new pool construction and greater expenditures for maintenance and remodeling products. More recent trends, including a lower number of permits issued for new pools, suggest that new construction activities are moderating after a period of significant growth. In 2022, we estimate that new pool construction decreased 16% to approximately 98,000 units from 117,000 units in 2021 when new pool construction units had increased 22% over 2020. We expect that consumers will continue to invest in outdoor living spaces, although at lower levels than observed in 2020 through the first half of 2022. Despite the recent decline in residential construction activities, we believe that we are well positioned to benefit from the inherent long-term growth opportunities in our industry fueled by favorable population migration trends, strong housing demand dynamics, increased interest in backyards and outdoor living and new product developments.Market conditions were challenged in 2022 by significant interest rate increases and geopolitical concerns. Supply chain constraints combined with strong consumer demand led to high inflation. General uncertainty around market and economic expectations for 2023 may significantly impact our industry. The recent uptick in overall affordability concerns, including higher mortgage interest rates and product cost and labor inflation, may lead to consumer hesitancy resulting in some cyclical suppression of demand. While an economic slowdown would impact new pool construction and remodeling (each of which comprises roughly 20% of our total consolidated business), non-discretionary maintenance product sales, which comprise about 60% of our business, are not expected to be significantly impacted. In view of current trends and economic concerns, we established our outlook for 2023 based on reasonable expectations for industry demand, pricing and inflationary conditions, focused expense management and ongoing leverage of existing investments in our business and continuous process improvements. We also plan to broaden our geographic presence by opening about 10 new sales centers in 2023 and by making selective acquisitions when appropriate opportunities arise. We base our assumptions on normal weather conditions and do not incorporate alternative weather predictions into our guidance. Favorable weather positively impacts industry activity by accelerating growth in any given year, expanding the number of available construction days, extending the pool season and pool usage and positively impacting demand for discretionary products. Conversely, unfavorable weather typically impedes growth. The following summarizes our outlook for 2023:•We expect sales to be flat to down 3% compared to 2022, impacted by the following factors and assumptions:◦normal weather patterns for 2023;◦inflationary product cost increases, which generally pass through to customers. We expect sales to benefit approximately 4% from price increases announced by our major equipment manufacturers;◦sustained demand for pool maintenance products; ◦a 15% to 20% decline in volumes of discretionary products used for swimming pool construction as pool construction activities return to 2019 levels (estimated at approximately 80,000 units);◦a 10% to 15% decline in volumes of products used in the remodeling, renovation and upgrading of swimming pools; 27◦a 1% benefit from expansion of the installed base of in-ground swimming pools; and◦one less selling day in the third quarter and for the full year of 2023 compared to 2022. •We project that sales for our Horizon sales centers, which are more affected by new home construction activities, may decline 5% to 10% compared to 2022. Our Horizon sales centers comprised 8% of our total net sales in 2022.•We expect that sales in Europe, which generated 4% of our total net sales in 2022, will be down approximately 10% to 20% compared to 2022 given the larger concentration of aftermarket versus maintenance activity in that market. •By quarter, we expect low to mid-single digit declines in the first half of 2023 compared to the first half of 2022 and modest growth in the second half of the year. •Our gross margin is dependent on amounts and timing of inflationary price increases, sales growth expectations and product mix. We project gross margin for the full year of 2023 to be in line with our long-term outlook at approximately 30.0%. We expect higher gross margin in the first half of 2023 compared to the latter half of the year as we sell through inventory purchased prior to recent price increases. •We expect to leverage our existing infrastructure and manage discretionary spending to maintain expenses in line with sales expectations to achieve operating margin of approximately 15.0%.In 2023, we expect our effective tax rate will be approximately 25.3% to 25.5%, without the impact of ASU 2016-09. Our effective tax rate is dependent upon our results of operations and may change if actual results are different from our current expectations. Due to ASU 2016-09 requirements, we expect our effective tax rate will fluctuate from quarter to quarter, particularly in periods when employees elect to exercise their vested stock options or when restrictions on share-based awards lapse. We estimate that we have approximately $1.1 million in unrealized excess tax benefits related to stock options that expire and restricted awards that vest in the first quarter of 2023. We may recognize additional tax benefits related to stock option exercises in 2023 from grants that expire in years after 2023, for which we have not included any expected benefits in our guidance. The estimated impact related to ASU 2016-09 is subject to several assumptions which can vary significantly, including our estimated share price and the period that our employees will exercise vested stock options. We recorded a $10.8 million benefit in our provision for income taxes for the year ended December 31, 2022 related to ASU 2016-09. We project that 2023 earnings will be in the range of $16.03 to $17.03 per diluted share, including an estimated $0.03 benefit from ASU 2016-09 during the first quarter of 2023. We expect to continue to use cash for the payment of cash dividends as and when declared by our Board and to fund opportunistic share repurchases over the next year.The forward-looking statements in this Current Trends and Outlook section are subject to significant risks and uncertainties, including the sensitivity of our business to weather conditions; changes in the economy, consumer discretionary spending, the housing market, interest or inflation rates; our ability to maintain favorable relationships with suppliers and manufacturers; the extent to which home-centric trends experienced during the height of the pandemic will moderate or reverse; competition from other leisure product alternatives or mass merchants; our ability to continue to execute our growth strategies; changes in the regulatory environment; new or additional taxes, duties or tariffs; excess tax benefits or deficiencies recognized under ASU 2016-09 and other risks detailed in Item 1A of this Form 10-K. Also see “Cautionary Statement for Purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995” prior to the heading “Risk Factors” in Item 1A.COVID-19 Pandemic and Other Economic TrendsWe continue to monitor the ongoing impact of the COVID-19 pandemic and its aftermath. Beginning in the second quarter of 2020, we experienced unprecedented demand as families spent more time at home and sought out opportunities to create or expand home-based outdoor living and entertainment spaces. This trend has had a positive impact on our financial performance over the past couple of years. As further described above, recent trends, including a lower number of permits issued for new pools, suggest that new construction activities are moderating.Our industry experienced substantial supply chain constraints beginning in 2021. In response, we proactively made significant investments in inventory in the last half of 2021 and early 2022 that enabled us to continue to meet strong customer demand and position ourselves to provide exceptional customer service. While we continued to be challenged by supply chain constraints through early 2022, we observed improvements in our supply chain dynamics beginning in the second quarter of 2022. Likewise, we expect inventory balances to normalize with seasonal trends as 2023 progresses. The extent to which contributory effects from the COVID-19 pandemic and the evolving macroeconomic environment will continue to impact our business, financial condition and results of operations remains uncertain.28CRITICAL ACCOUNTING ESTIMATESCritical accounting estimates are those estimates made in accordance with U.S. generally accepted accounting principles that involve a significant level of estimation uncertainty and have had, or are reasonably likely to have, a material impact on our financial condition or results of operations. Management has discussed the development, selection and disclosure of our critical accounting estimates with the Audit Committee of our Board. Our critical accounting estimates are discussed below, including, to the extent material and reasonably available, the impact such estimates have had, or are reasonably likely to have, on our financial condition or results of operations. Allowance for Doubtful AccountsWe maintain an allowance for doubtful accounts based on an estimate of the losses we will incur if our customers do not make required payments. We perform periodic credit evaluations of our customers and typically do not require collateral. Consistent with industry practices, we generally require payment from our North American customers within 30 days, except for sales under early buy programs for which we provide extended payment terms to qualified customers. The extended terms usually require payments in equal installments in April, May and June or May and June, depending on geographic location. Credit losses have generally been within or better than our expectations.Similar to our business, our customers’ businesses are seasonal. Sales are lowest in the winter months and our past due accounts receivable balance as a percentage of total receivables generally increases during this time. We provide reserves for uncollectible accounts based on our accounts receivable aging. These reserves range from 0.05% for amounts currently due to up to 100% for specific accounts more than 60 days past due.At the end of each quarter, we perform a reserve analysis of all accounts with balances greater than $20,000 and more than 60 days past due. Additionally, we perform a separate reserve analysis on the balance of our accounts receivables with emphasis on past due accounts. We estimate future losses based upon historical bad debts, customer receivable balances, age of customer receivable balances, customers’ financial conditions and current and forecasted economic trends, including certain trends in the housing market, the availability of consumer credit and general economic conditions (as commonly measured by Gross Domestic Product or GDP). We monitor housing market trends through review of the House Price Index as published by the Federal Housing Finance Agency, which measures the movement of single-family home prices. During the year, we write off account balances when we have exhausted reasonable collection efforts and determined that the likelihood of collection is remote. These write-offs are charged against our allowance for doubtful accounts. In the past five years, write-offs have averaged approximately 0.08% of net sales annually. Write-offs as a percentage of net sales approximated 0.08% in 2022, 0.06% in 2021 and 0.09% in 2020. We expect that write-offs will range from 0.05% to 0.10% of net sales in 2023. At the end of each fiscal year, we prepare a hindsight analysis by comparing the prior year-end allowance for doubtful accounts balance to (i) current year write-offs and (ii) any significantly aged outstanding receivable balances. Based on our most recent hindsight analysis, we concluded that the prior year allowance was within a range of acceptable estimates and that our estimation methodology is appropriate.If the balance of the accounts receivable reserve increased or decreased by 20% at December 31, 2022, pretax income would change by approximately $1.9 million and earnings per share would change by approximately $0.04 per diluted share (based on the number of weighted average diluted shares outstanding for the year ended December 31, 2022).Inventory ObsolescenceProduct inventories represent the largest asset on our balance sheet. Our goal is to manage our inventory such that we minimize stock-outs to provide the highest level of service to our customers. To do this, we maintain at each sales center an adequate inventory of stock keeping units (SKUs) with the highest sales volumes. At the same time, we continuously strive to better manage our slower moving classes of inventory, which are not as critical to our customers and thus, inherently turn at slower rates. 29We classify products at the sales center level based on sales at each location over the expected sellable period, which is the previous 12 months for most products, except for special order non-stock items that lack a SKU in our system and products with less than 12 months of usage. Below is a description of these inventory classifications: •new products with less than 12 months usage; •highest sales velocity items, which represent approximately 80% of net sales at the sales center;•lower sales velocity items, which we keep in stock to provide a high level of customer service;•products with no sales for the past 12 months at the local sales center level, excluding special order products not yet delivered to the customer; and•non-stock special order items.There is little risk of obsolescence for our highest sales velocity items because these products generally turn quickly. We establish our reserve for inventory obsolescence based on inventory with lower sales velocity and inventory with no sales for the past 12 months, which we believe represent some exposure to inventory obsolescence, with particular emphasis on SKUs with the least sales over the previous 12 months. The reserve is intended to reflect the value of inventory at net realizable value. We provide a reserve of 5% for inventory with lower sales velocity, inventory with no sales for the past 12 months and non-stock inventory as determined at the sales center level. We also provide an additional 5% reserve for excess lower sales velocity inventory and an additional 45% reserve for excess inventory with no sales for the past 12 months. We determine excess inventory, which is defined as the amount of inventory on hand in excess of the previous 12 months’ usage, on a company-wide basis. We also evaluate whether the calculated reserve provides sufficient coverage of total inventory with no sales for the past 12 months. We have not changed our methodology from prior years.In evaluating the adequacy of our reserve for inventory obsolescence, we consider a combination of factors, including:•the level of inventory in relation to historical sales by product, including inventory usage by class based on product sales at both the sales center level and on a company-wide basis;•changes in customer preferences or regulatory requirements;•seasonal fluctuations in inventory levels;•geographic location; and•superseded products and new product offerings.We periodically adjust our reserve for inventory obsolescence as changes occur in the above-identified factors. At the end of each fiscal year, we prepare a hindsight analysis by comparing the prior year-end obsolescence reserve balance to (i) current year inventory write-offs and (ii) the value of products with no sales for the past 12 months that remain in inventory. Based on our most recent hindsight analysis, we concluded that our prior year reserve was within a range of acceptable estimates and that our estimation methodology is appropriate.If the balance of our inventory reserve increased or decreased by 20% at December 31, 2022, pretax income would change by approximately $4.2 million and earnings per share would change by approximately $0.08 per diluted share (based on the number of weighted average diluted shares outstanding for the year ended December 31, 2022).Vendor ProgramsMany of our vendor arrangements provide for us to receive specified amounts of consideration when we achieve any of a number of measures. These measures generally relate to the volume level of purchases from our vendors, or our net cost of products sold, and may include negotiated pricing arrangements. We account for vendor programs as a reduction of the prices of the vendor’s products and therefore a reduction of inventory until we sell the product, at which time we recognize such consideration as a reduction of cost of sales in our income statement.Throughout the year, we estimate the amount earned based on our expectation of total purchases for the fiscal year relative to the purchase levels that mark our progress toward the attainment of various levels within certain vendor programs. We accrue vendor program benefits on a monthly basis using these estimates provided that we determine they are probable and reasonably estimable. Our estimates for annual purchases, future inventory levels and sales of qualifying products are driven by our sales projections, which can be significantly impacted by a number of external factors including changes in economic conditions and weather. Changes in our purchasing mix also impact our estimates, as certain program rates can vary depending on our volume of purchases from specific vendors. We continually revise these estimates throughout the year to reflect actual purchase levels and identifiable trends. As a result, our estimated quarterly vendor program benefits accrual may include cumulative catch-up adjustments to reflect any changes in 30our estimates between reporting periods. These adjustments tend to have a greater impact on gross margin in the fourth quarter since it is our seasonally slowest quarter and because the majority of our vendor arrangements are based on calendar year periods. We update our estimates for these arrangements at year end to reflect actual annual purchase or sales levels. In the first quarter of the subsequent year, we prepare a hindsight analysis by comparing actual vendor credits received to the prior year vendor receivable balances. Based on our most recent hindsight analysis, we concluded that our vendor program estimates were within a range of acceptable estimates and that our estimation methodology is appropriate.If market conditions were to change, vendors may change the terms of some or all of these programs. Although such changes would not affect the amounts we have recorded related to products already purchased, they may lower or raise our cost for products purchased and sold in future periods.Income TaxesWe record deferred tax assets and liabilities based on differences between the financial reporting and tax basis of assets and liabilities using currently enacted rates and laws that will be in effect when we expect the differences to reverse. Due to changing tax laws and state income tax rates, significant judgment is required to estimate the effective tax rate expected to apply to tax differences that are expected to reverse in the future.We record Global Intangible Low Tax Income (GILTI) on foreign earnings as period costs if and when incurred, although we have not realized any impacts since the December 2017 enactment of U.S. tax reform. As of December 31, 2022, U.S. income taxes were not provided on the earnings or cash balances of our foreign subsidiaries, outside of the provisions of the transition tax from U.S. tax reform. As we have historically invested or expect to invest the undistributed earnings indefinitely to fund current cash flow needs in the countries where held, additional income tax provisions may be required. Determining the amount of unrecognized deferred tax liability on these undistributed earnings and cash balances is not practicable due to the complexity of tax laws and regulations and the varying circumstances, tax treatments and timing of any future repatriation. We operate in 40 states, 1 United States territory and 11 foreign countries. We are subject to regular audits by federal, state and foreign tax authorities, and the amount of income taxes we pay is subject to adjustment by the applicable tax authorities. We recognize a benefit from an uncertain tax position only after determining it is more likely than not that the tax position will withstand examination by the applicable taxing authority. Our estimate for the potential outcome of any uncertain tax issue is highly judgmental. We regularly evaluate our tax positions and incorporate these expectations into our reserve estimates. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, or when statutes of limitation on potential assessments expire. These adjustments may include changes in valuation allowances that we have established. As a result of these uncertainties, our total income tax provision may fluctuate on a quarterly basis.Each year, we prepare a return to provision analysis upon filing our income tax returns. Based on our most recent hindsight analysis, we concluded that our prior year income tax provision was within a range of acceptable estimates and that our provision calculation methodology is appropriate. Differences between our effective income tax rate and federal and state statutory tax rates are primarily due to excess tax benefits associated with the exercise of deductible nonqualified stock options and the lapse of restrictions on deductible restricted stock awards. Performance-Based Compensation AccrualThe Compensation Committee of our Board (Compensation Committee) and our management have designed compensation programs intended to create a performance culture. The primary objectives of our compensation programs are to attract, motivate, reward and retain our employees without leading to unnecessary risk taking. Our compensation packages include bonus plans that are specific to groups of eligible participants and their levels and areas of responsibility. The majority of our bonus plans consist of annual cash payments that are based primarily on objective performance criteria. We calculate bonuses based on the achievement of certain key measurable financial and operational results, including operating income. We use an annual cash performance award (annual bonus) to focus corporate behavior on short-term goals for growth, financial performance and other specific financial and business improvement metrics. Management sets the company’s annual bonus objectives at the beginning of the bonus plan year using both historical information and forecasted results of operations for the current plan year. Management also establishes specific business improvement objectives for both our operating units and 31corporate employees. The Compensation Committee approves objectives for annual bonus plans involving executive management. We also utilize our medium-term (three-year) Strategic Plan Incentive Program (SPIP) to provide senior management with an additional cash-based, pay-for-performance award based on the achievement of specified earnings growth objectives. Payouts through the SPIP are based on three-year compound annual growth rates (CAGRs) of our diluted EPS.We record annual performance-based compensation accruals based on operating income achieved in a quarter as a percentage of total expected operating income for the year. We estimate total expected operating income for the current plan year using management’s estimate of the total overall incentives earned per the stated bonus plan objectives. Starting in June, and continuing each quarter through our fiscal year end, we adjust our estimated performance-based compensation accrual based on our detailed analysis of each bonus plan, the participants’ progress toward achievement of their specific objectives and management’s estimates related to the discretionary components of the bonus plans, if any.We record SPIP accruals based on our total expected EPS for the current fiscal year and earnings growth estimates for the succeeding two years. We base our current fiscal year estimates on the same assumptions used for our annual bonus calculation and we base our forward-looking estimates on historical growth trends and our projections for the remainder of the three-year performance periods. Our quarterly performance-based compensation expense and accrual balances may vary relative to actual annual bonus expense and payouts due to the following:•differences between estimated and actual performance; •our projections related to achievement of multiple-year performance objectives for our SPIP; and•the discretionary components of the bonus plans.We generally make bonus payments at the end of February following the most recently completed fiscal year. Each year, we compare the actual bonus payouts to amounts accrued at the previous year’s end to determine the accuracy of our performance-based compensation estimates. Based on our most recent hindsight analysis, we concluded that our performance-based compensation accrual balances were within a reasonable range of acceptable estimates and that our estimation methodologies are appropriate.Impairment of Goodwill and Other Indefinite-Lived Intangible AssetsGoodwill is our largest intangible asset. At December 31, 2022, our goodwill balance was $692.0 million, representing approximately 19% of total assets. Goodwill represents the excess of the amount we paid to acquire a company over the estimated fair value of tangible assets and identifiable intangible assets acquired, less liabilities assumed.We perform a goodwill impairment test in the fourth quarter of each year or on a more frequent basis if events or changes in circumstances occur that indicate potential impairment. To the extent the carrying value of a reporting unit is greater than its estimated fair value, we record a goodwill impairment charge for the difference, up to the carrying value of the goodwill. We recognize any impairment loss in operating income. Since we define an operating segment as an individual sales center and we do not have operations below the sales center level, we define a reporting unit as an individual sales center. As of October 1, 2022, we had 249 reporting units with allocated goodwill balances. The most significant goodwill balance for a reporting unit was our Porpoise reporting unit with $403.5 million of goodwill. Other than our Porpoise reporting unit, the next most significant goodwill balance for a reporting unit was $12.1 million and the average goodwill balance per reporting unit was $1.2 million. In October 2022, we performed our annual goodwill impairment test and recorded goodwill impairment of $0.6 million related to the closure of a Horizon reporting unit in that period. In October 2021 and 2020, we performed our annual goodwill impairment test and did not recognize any goodwill impairment at the reporting unit level. In the first quarter of 2020, we recorded impairment equal to the total goodwill and intangibles carrying amounts of our five Australian reporting units, which included goodwill impairment of $3.5 million and intangibles impairment, related to the Pool Systems tradename and trademark, of $0.9 million. The fair value estimates used in our impairment test is determined using discounted cash flow models, which require the use of significant unobservable inputs, representative of a Level 3 fair value measurement. To estimate the fair value of our reporting units, we project future cash flows using management’s assumptions for sales growth rates, operating margins and discount 32rates. These estimates can significantly affect the outcome of our impairment test. We also review for potential impairment indicators at the reporting unit level based on an evaluation of recent historical operating trends, current and projected local market conditions and other relevant factors as appropriate.To test the reasonableness of our fair value estimates, we compared our aggregate estimated fair values to our market capitalization as of the date of our annual impairment test. In 2022, our aggregate estimated fair values were modestly higher than our market capitalization. To facilitate a sensitivity analysis, we reduced our consolidated fair value estimate to reflect more conservative discounted cash flow assumptions, the sensitivity of a 50 basis point increase in our estimated weighted average cost of capital or a 50 basis point decrease in the estimated perpetuity growth rate. Our sensitivity analysis resulted in a fair value lower than our market capitalization and did not result in the identification of additional at-risk locations.Based on our 2022 goodwill impairment analysis, we consider one of our Horizon reporting units in Texas with goodwill of $0.5 million as most at risk for goodwill impairment due to marginal results in recent years. The most sensitive assumptions related to our fair value for this location relates to future projected operating results and management’s ability to effectively manage costs. If our assumptions or estimates in our fair value calculations change or if operating results are less than forecasted, we could incur impairment charges in future periods. Impairment charges would decrease operating income, negatively impact diluted EPS and result in lower asset values on our balance sheet. Recent Accounting PronouncementsSee Note 1 of “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K for details.33RESULTS OF OPERATIONSThe table below summarizes information derived from our Consolidated Statements of Income expressed as a percentage of net sales for the past three fiscal years: Year Ended December 31,202220212020Net sales100.0 %100.0 %100.0 %Cost of sales68.7 69.5 71.3 Gross profit31.3 30.5 28.7 Operating expenses14.7 14.8 16.9 Operating income16.6 15.7 11.8 Interest and other non-operating expenses, net0.7 0.2 0.3 Income before income taxes and equity in earnings15.9 %15.6 %11.5 %Note: Due to rounding, percentages may not add to operating income or income before income taxes and equity in earnings.Our discussion of consolidated operating results includes the operating results from acquisitions in 2022, 2021 and 2020. We have included the results of operations in our consolidated results since the respective acquisition dates.Fiscal Year 2022 compared to Fiscal Year 2021 The following table breaks out our consolidated results into the base business component and the excluded components (sales centers excluded from base business):(Unaudited)Base BusinessExcludedTotal(in thousands)Year EndedYear EndedYear Ended December 31,December 31,December 31, 202220212022202120222021Net sales$5,889,497 $5,281,773 $290,230 $13,811 $6,179,727 $5,295,584 Gross profit1,804,744 1,613,252 128,668 3,840 1,933,412 1,617,092 Gross margin30.6 %30.5 %44.3 %27.8 %31.3 %30.5 %Operating expenses 830,525 779,897 77,104 4,411 907,629 784,308 Expenses as a % of net sales14.1 %14.8 %26.6 %31.9 %14.7 %14.8 %Operating income (loss) 974,219 833,355 51,564 (571)1,025,783 832,784 Operating margin16.5 %15.8 %17.8 %(4.1)%16.6 %15.7 %34We have excluded the following acquisitions from base business for the periods identified:Acquired AcquisitionDateNetSales Centers AcquiredPeriodsExcludedTri-State Pool DistributorsApril 20221May - December 2022Porpoise Pool & Patio, Inc.December 20211January - December 2022 and December 2021Wingate Supply, Inc.December 20211January - December 2022 and December 2021Vak Pak Builders Supply, Inc.June 20211January - August 2022 and June - August 2021Pool Source, LLCApril 20211January - June 2022 and April - June 2021 TWC Distributors, Inc. December 202010January - February 2022 and January - February 2021When calculating our base business results, we exclude sales centers that are acquired, closed or opened in new markets for a period of 15 months. We also exclude consolidated sales centers when we do not expect to maintain the majority of the existing business and existing sales centers that are consolidated with acquired sales centers. We generally allocate corporate overhead expenses to excluded sales centers on the basis of their net sales as a percentage of total net sales. After 15 months of operations, we include acquired, consolidated and new market sales centers in the base business calculation including the comparative prior year period.The table below summarizes the changes in our sales centers during 2022:December 31, 2021410 Acquired location1 New locations10 Closed location(1)December 31, 2022420 For information about our recent acquisitions, see Note 2 of “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K.35Net Sales(in millions)Year Ended December 31, 20222021ChangeNet sales$6,179.7 $5,295.6 $884.1 17%Net sales increased 17% compared to 2021, with 12% of this increase resulting from base business sales growth. Our 2022 results were driven by elevated price inflation and sustained demand for outdoor-living products. Sales growth in our seasonally significant quarters (second and third quarters) were limited by industry capacity, including labor and supply chain constraints and less favorable weather conditions on a year-over-year comparison. We observed improvements in our supply chain dynamics in 2022 following the challenges that began in the second half of 2021 through early 2022.The following factors benefited our sales growth (listed in order of estimated magnitude):•inflationary product cost increases of approximately 10% (compared to 7% to 8% in 2021);•5% sales growth from recent acquisitions•favorable trends for our products including: ◦consistent demand for discretionary products, as evidenced by higher sales for product offerings such as equipment and building materials (see discussion below);◦market share gains, including those in building materials (see discussion below); and◦sustained demand for residential swimming pool maintenance supplies, as the installed base of pools continues to grow. Following our robust 33% sales growth (and 26% base business sales growth) in the first quarter of 2022, results through the remainder of the year were limited by several factors. We estimate that the benefits discussed above were partially offset by the following:•1% impact from softness in our European markets, reflecting the impact of the macro-economic environment;•1% unfavorable impact from currency exchange rate fluctuations; and•less favorable weather conditions compared to last year, particularly in our seasonal markets (see discussion below).Higher sales for certain product offerings, such as equipment and building materials, indicate consistent demand in traditionally discretionary areas, such as pool construction, pool remodeling and equipment upgrades. In 2022, sales of equipment for our base business, which includes swimming pool heaters, pumps, lights, filters and automation, increased approximately 9% compared to 2021 and represented approximately 28% of net sales (or an increase of 17% representing approximately 29% of net sales including our recent acquisition of Porpoise). Equipment growth for certain products was limited by continued supply chain constraints. Sales of building materials grew 18% compared to 2021 and represented approximately 13% of net sales in 2022. Sales of chemicals for our base business, representing 11% of total net sales, increased 32% compared to 2021 (or an increase of 57% representing approximately 13% of net sales including the impact of our December 2021 acquisition of Porpoise). The increase in chemical sales was driven by inflation, improved supply over last year and strong demand for non-discretionary maintenance products.Sales to specialty retailers that sell swimming pool supplies and customers who service large commercial installations are included in the appropriate existing product categories, and growth in these areas is reflected in the discussion above. In 2022, sales to base business retail customers increased 9% compared to 2021 and represented approximately 11% of our consolidated net sales. Sales to certain of our retail customers have been hindered by less favorable weather conditions compared to the prior year. Including the impact of our December 2021 acquisition of Porpoise, sales to retail customers increased 39% and represented approximately 14% of our net sales. Sales to commercial customers increased 27% compared to 2021 and represented approximately 4% of our consolidated net sales in 2022. Net sales in our seasonal markets (not considering Europe), representing 45% of our total base business net sales in 2022, increased 11% compared to 2021. Comparatively, net sales in our year-round markets, representing 51% of our total base business net sales in 2022, increased 15% compared to 2021. Net sales in Europe, representing 4% of our total net sales in 2022, declined 5% in local currency. While we estimate that net sales in Europe benefited 10% from inflationary product cost increases, beginning in the second quarter of 2022, our results were negatively impacted by a decline in the volume of sales driven by macroeconomic uncertainty.362022 Quarterly Sales Performance Compared to 2021 Quarterly Sales Performance•The increase in our sales in the first quarter of 2022 reflected continued strong demand for outdoor living products in addition to elevated price inflation of approximately 10% to 12%. Sales benefited approximately 5% from both accelerated customer early buys and an extra selling day in the first quarter of 2022 compared to the first quarter of 2021.•Our results in the second quarter of 2022 were indicative of healthy demand for our products as maintenance, replacement, refurbishment and construction activity remained strong. Net sales benefited approximately 10% to 11% from elevated price inflation, but were unfavorably impacted 2% from both currency exchange rate fluctuations and customer early buys shifted into the first quarter of 2022. •Net sales in the third quarter of 2022 benefited approximately 9% to 10% from inflationary product cost increases and were aided by healthy demand for our products and warmer weather in our year-round markets. We estimate that these increases were partially offset by 1% each from softness in our European markets, unfavorable currency exchange rate fluctuations and one less selling day in Q3 2022 versus Q3 2021. In the third quarter of 2022, we experienced a net sales shift of $9.0 million from Q3 2022 to Q4 2022 due to closures from Hurricane Ian.•Net sales benefited approximately 8% from inflationary product cost increases in the fourth quarter of 2022. Weather conditions, particularly in the month of December when an Arctic blast moved across the U.S., were much less favorable on a year-over-year comparison. Additionally, net sales were unfavorably impacted 1% from currency exchange rate fluctuations and 1% from softness in our European markets. Quarter2022FirstSecondThirdFourthNet Sales Growth33%15%14%6%Base Business Net Sales Growth26%10%10%1%In addition to the sales discussion above, see further details of significant weather impacts under the subheading Seasonality and Quarterly Fluctuations below.Gross Profit(in millions)Year Ended December 31, 20222021ChangeGross profit$1,933.4 $1,617.1 $316.3 20%Gross margin31.3 %30.5 % Gross margin improved 80 basis points to 31.3% in 2022 compared to 30.5% in 2021, reflecting benefits from acquisitions, increased pricing and supply chain management initiatives. These increases were partially offset by lower incentives earned under our volume-based vendor programs and $13.0 million recorded within Cost of sales in the fourth quarter of 2022 related to increased duties and tariffs for certain imported chemicals. Given supply chain improvements through the latter half of 2022, we do not expect to import a significant portion of this product in 2023. Operating Expenses(in millions)Year Ended December 31, 20222021ChangeSelling and administrative expenses$907.6 $784.3 $123.3 16%Operating expenses as a percentage of net sales14.7 %14.8 % Operating expenses increased 16%, or $123.3 million, to $907.6 million in 2022, up from $784.3 million in 2021. Base business operating expenses rose only 6% compared to 12% base business gross profit growth. The increase in operating expenses reflects inflationary increases and incremental costs to support our business growth, including recent acquisitions. Our expense growth reflects increases in growth-driven labor, facility and freight costs, along with increased investments in technology. 37Interest and Other Non-operating Expenses, netInterest and other non-operating expenses, net increased $32.3 million compared to 2021, primarily reflecting higher average debt levels and higher average interest rates. Our weighted average effective interest rate increased to 2.8% in 2022 from 2.5% in 2021 on average outstanding debt of $1.4 billion in 2022 versus $403.4 million in 2021. Our weighted average effective interest rate increased to 4.2% in the fourth quarter of 2022, reflecting the impact of rapidly increasing rates in the latter part of 2022.Income TaxesOur effective income tax rate was 24.0% at December 31, 2022 and 21.1% at December 31, 2021. We recorded a $10.8 million, or $0.27 per diluted share, benefit from ASU 2016-09 for the year ended December 31, 2022 compared to a benefit of $30.0 million, or $0.74 per diluted share, realized in 2021. Without the benefits from ASU 2016-09, our effective tax rate was 25.1% and 24.7% for the years ended 2022 and 2021, respectively.Net Income and Earnings Per ShareNet income increased 15% to $748.5 million in 2022 compared to $650.6 million in 2021. Earnings per share increased 17% to $18.70 per diluted share compared to $15.97 per diluted share in 2021. Reconciliation of Non-GAAP Financial MeasuresThe non-GAAP measures described below should be considered in the context of all of our other disclosures in this Form 10-K.Adjusted Diluted EPSWe have included adjusted diluted EPS, a non-GAAP financial measure, as a supplemental disclosure, because we believe this measure is useful to management, investors and others in assessing our year-over-year operating performance. Adjusted diluted EPS is a key measure used by management to demonstrate the impact of tax benefits from ASU 2016-09 on our diluted EPS and to provide investors and others with additional information about our potential future operating performance to supplement GAAP measures.We believe this measure should be considered in addition to, not as a substitute for, diluted EPS presented in accordance with GAAP, and in the context of our other disclosures. Other companies may calculate this non-GAAP financial measure differently than we do, which may limit their usefulness as a comparative measure. The table below presents a reconciliation of diluted EPS to adjusted diluted EPS. (Unaudited)Year EndedDecember 31,20222021Diluted EPS$18.70 $15.97 Less: ASU 2016-09 tax benefit0.27 0.74 Adjusted diluted EPS $18.43 $15.23 Fiscal Year 2021 compared to Fiscal Year 2020 For a detailed discussion of the Results of Operations in Fiscal Year 2021 compared to Fiscal Year 2020, see the Results of Operations section of Management’s Discussion and Analysis included in Part II, Item 7 of our 2021 Annual Report on Form 10-K. 38Seasonality and Quarterly FluctuationsFor discussion regarding the effects seasonality and weather have on our business, see Item 1, “Business,” of this Form 10-K.The following table presents certain unaudited quarterly data for 2022 and 2021. We have included income statement and balance sheet data for the most recent eight quarters to allow for a meaningful comparison of the seasonal fluctuations in these amounts. In our opinion, this information reflects all normal and recurring adjustments considered necessary for a fair presentation of this data. Due to the seasonal nature of our industry, the results of any one or more quarters are not necessarily a good indication of results for an entire fiscal year or of continuing trends.(Unaudited)QUARTER(in thousands)20222021 FirstSecondThirdFourthFirst Second Third FourthStatement of Income Data Net sales$1,412,650 $2,055,818 $1,615,339 $1,095,920 $1,060,745 $1,787,833 $1,411,448 $1,035,557 Gross profit447,189 666,804 503,687 315,731 301,131 551,685 441,899 322,376 Operating income235,723 418,888 263,877 107,295 129,031 338,586 237,276 127,891 Net income179,261 307,283 190,055 71,863 98,655 259,695 184,665 107,609 Net sales as a % of annual net sales23 %33 %26 %18 %20 %34 %27 %20 %Gross profit as a % of annual gross profit23 %34 %26 %16 %19 %34 %27 %20 %Operating income as a % of annual operating income23 %41 %26 %10 %15 %41 %28 %15 %Balance Sheet DataTotal receivables, net$679,927 $756,585 $549,796 $351,448 $487,602 $585,566 $476,150 $376,571 Product inventories, net1,641,155 1,579,101 1,539,572 1,591,060 977,228 894,654 1,043,407 1,339,100 Accounts payable685,946 604,225 442,226 406,667 634,998 439,453 414,156 398,697 Total debt1,505,073 1,595,398 1,512,545 1,386,803 433,171 423,116 362,819 1,183,350 Note: Due to rounding, the sum of quarterly percentage amounts may not equal 100%.Weather Impacts on Fiscal Year 2022 to Fiscal Year 2021 ComparisonsOverall, weather conditions in the first quarter of 2022 were less favorable than weather conditions in the first quarter of 2021. Sales benefited from above-average temperatures along much of the west and the east coast, although Texas experienced cooler-than-normal temperatures. In addition, some seasonal markets had unfavorable weather compared to the first quarter of 2021 when construction activity started earlier than normal. Similarly, results in Europe were hindered by unfavorable weather conditions. In the first quarter of 2021, sales benefited from favorable and generally mild weather conditions throughout the contiguous United States. In February 2021, Texas experienced the most costly winter storm event on record for the United States, which damaged many swimming pools and added to already strong replacement activity. We observed unfavorable weather conditions in certain markets throughout the second quarter of 2022. Heavy rainfall and cooler temperatures throughout the northeastern United States and Canada resulted in slower sales activity and limited sales growth in the second quarter of 2022. Additionally, results in Europe continued to be impacted by unfavorable weather conditions. In contrast, our southern markets benefited from above-average temperatures, particularly in Texas. In the second quarter of 2021, overall weather conditions favorably impacted sales growth with the average U.S. temperature in June 2021 being the hottest on record in 127 years.Sales in the third quarter of 2022 were generally aided by above-average temperatures throughout much of the contiguous United States. However, sales in Florida were negatively impacted by closures due to Hurricane Ian at the end of the quarter, which we believe we recovered in the fourth quarter of 2022. Compared to last year, weather conditions in Canada and the 39northern states were less favorable. Generally favorable weather conditions benefited sales in the third quarter of 2021 with most of the United States experiencing above-average temperatures and below-average precipitation. We observed generally unfavorable weather conditions throughout the fourth quarter of 2022, particularly in the month of December when an Arctic front brought freezing temperatures and above-average precipitation across much of the United States. Conditions were especially impactful in Canada and the Northeast compared to the prior year. In contrast, sales in the fourth quarter of 2021 benefited from above-average temperatures throughout much of the contiguous United States, including the fifth warmest December on record in a 127-year period. Weather Impacts on Fiscal Year 2021 to Fiscal Year 2020 ComparisonsFor a detailed discussion of Weather Impacts on Fiscal Year 2021 compared to Fiscal Year 2020, see the Seasonality and Quarterly Fluctuations section of Management’s Discussion and Analysis included in Part II, Item 7 of our 2021 Annual Report on Form 10-K. Geographic AreasSince all of our sales centers have similar operations and share similar economic characteristics, we aggregate our sales centers into a single reportable segment. For additional details, see Note 1 of our “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K. For a breakdown of net sales and property, plant and equipment between our United States and international operations, see Item 1, “Business,” of this Form 10-K.LIQUIDITY AND CAPITAL RESOURCESLiquidity is defined as the ability to generate adequate amounts of cash to meet short-term and long-term cash needs. We assess our liquidity in terms of our ability to generate cash to fund our operating activities, taking into consideration the seasonal nature of our business. Significant factors which could affect our liquidity include the following: •cash flows generated from operating activities;•the adequacy of available bank lines of credit;•the quality of our receivables;•acquisitions;•dividend payments;•capital expenditures;•changes in income tax laws and regulations; •the timing and extent of share repurchases; and•the ability to attract long-term capital with satisfactory terms.Our primary capital needs are seasonal working capital obligations, debt repayment obligations and other general corporate initiatives, including acquisitions, opening new sales centers, dividend payments and share repurchases. Our primary working capital obligations are for the purchase of inventory, payroll, rent, other facility costs and selling and administrative expenses. Our working capital obligations fluctuate during the year, driven primarily by seasonality and the timing of inventory purchases. Our primary sources of working capital are cash from operations supplemented by bank borrowings, which have historically been sufficient to support our growth and finance acquisitions. We have funded our capital expenditures and share repurchases in substantially the same manner.We prioritize our use of cash based on investing in our business, maintaining a prudent capital structure, including a modest amount of debt, and returning cash to our shareholders through dividends and share repurchases. Our specific priorities for the use of cash are as follows:•capital expenditures primarily for maintenance and growth of our sales center network, technology-related investments and fleet vehicles;•inventory and other operating expenses;•strategic acquisitions executed opportunistically; •payment of cash dividends as and when declared by our Board;•repayment of debt to maintain an average total target leverage ratio (as defined below) between 1.5 and 2.0; and40•repurchases of our common stock under our Board authorized share repurchase program.Our capital spending primarily relates to leasehold improvements, delivery and service vehicles and information technology. We focus our capital expenditure plans based on the needs of our sales centers. Historically, our capital expenditures have averaged roughly 1.0% of net sales. Capital expenditures were 0.7% of net sales in 2022 and 2021 and 0.6% of net sales in 2020. Since 2020, our capital expenditures as a percentage of net sales were lower than our historical average due to our significant sales growth. Capital expenditures in 2020 were also lower due to cost-saving measures implemented at the beginning of the COVID-19 pandemic. Based on management’s current plans, we project capital expenditures for 2023 will continue to approximate the historical average of 1% of net sales. We also plan to increase our investment in technology and automation enabling us to operate more efficiently.We believe we have adequate availability of capital to fund present operations and the current capacity to finance any working capital needs that may arise. We continually evaluate potential acquisitions and hold discussions with acquisition candidates. If suitable acquisition opportunities arise that would require financing, we believe that we have the ability to finance any such transactions.As of February 17, 2023, $230.2 million of the current Board authorized amount under our authorized share repurchase plan remained available. We expect to repurchase additional shares in the open market from time to time depending on market conditions. We plan to fund these repurchases with cash provided by operations and borrowings under our credit and receivables facilities.Sources and Uses of CashThe following table summarizes our cash flows (in thousands): Year Ended December 31, 20222021Operating activities$484,854 $313,490 Investing activities(50,870)(849,614)Financing activities(411,658)526,131 Cash provided by operations of $484.9 million for 2022 increased $171.4 million compared to 2021, primarily driven by an increase in net income and changes in working capital. Our operating cash flows were also impacted by federal tax payments of $79.5 million in 2022, which were allowed to be deferred and included in accrued expenses and other liabilities at December 31, 2021. Cash used in investing activities decreased $798.7 million to $50.9 million in 2022, reflecting a decrease of $802.7 million in payments for acquisitions compared to 2021, partially offset by a $6.0 million increase in net capital expenditures between years. Our higher 2021 investing activities were driven by our purchase of Porpoise Pool & Patio, Inc. for $788.7 million. Cash used in financing activities was $411.7 million in 2022 compared to cash provided by financing activities of $526.1 million in 2021. The change in financing activities primarily reflects a $566.7 million increase in net debt payments, additional share repurchases of $333.2 million and an increase in dividends paid of $31.0 million.For a discussion of our sources and uses of cash in 2020, see the Liquidity and Capital Resources – Sources and Uses of Cash section of Management’s Discussion and Analysis included in Part II, Item 7 of our 2021 Annual Report on Form 10-K.Future Sources and Uses of CashTo supplement cash from operations as our primary source of working capital, we will continue to utilize our three major credit facilities, which are the Amended and Restated Revolving Credit Facility (the Credit Facility), the Term Facility (the Term Facility) and the Receivables Securitization Facility (the Receivables Facility). For additional details regarding these facilities, see the summary descriptions below and more complete descriptions in Note 5 of our “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K. 41Credit FacilityOur Credit Facility, as amended through December 30, 2021, provides for $1.25 billion in borrowing capacity consisting of a $750.0 million five-year unsecured revolving credit facility and a $500.0 million term loan facility. The credit facility includes a $750.0 million revolving credit facility and sublimits for the issuance of swingline loans and standby letters of credit. The term loans require quarterly amortization payments beginning in September 2023 aggregating to 20% of the original principal amount of the loan during the third, fourth and fifth years of the loan, with all remaining principal due on the Credit Facility maturity date of September 25, 2026. We intend to continue to use the Credit Facility for general corporate purposes, for future share repurchases and to fund future growth initiatives.At December 31, 2022, there was $1.0 billion outstanding, including a $500.0 million term loan, with a $4.8 million standby letter of credit outstanding and $225.5 million available for borrowing under the Credit Facility. The weighted average effective interest rate for the Credit Facility as of December 31, 2022 was approximately 4.4%, excluding commitment fees.Term FacilityOur Term Facility provides for $185.0 million in borrowing capacity and matures on December 30, 2026. Proceeds from the Term Facility were used to pay down the Credit Facility in December 2019, adding borrowing capacity for future share repurchases, acquisitions and growth-oriented working capital expansion. The Term Facility is repaid in quarterly installments of 1.250% of the Term Facility on the last business day of each quarter beginning in the first quarter of 2020. We classify the entire outstanding balance as Long-term debt on our Consolidated Balance Sheets as we intend and have the ability to refinance the obligations on a long-term basis. The total of the quarterly payments will be equal to 33.75% of the Term Facility with the final principal repayment, equal to 66.25% of the Term Facility, due on the maturity date. We may prepay amounts outstanding under the Term Facility without penalty other than interest breakage costs.At December 31, 2022, the Term Facility had an outstanding balance of $157.3 million at a weighted average effective interest rate of 5.5%. Receivables Securitization FacilityOur two-year accounts receivable securitization facility (the Receivables Facility) offers us a lower-cost form of financing. Under this facility, we can borrow up to $350.0 million between April through August and from $210.0 million to $340.0 million during the remaining months of the year. The Receivables Facility matures on November 1, 2024. We classify the entire outstanding balance as Long-term debt on our Consolidated Balance Sheets as we intend and have the ability to refinance the obligations on a long-term basis.The Receivables Facility provides for the sale of certain of our receivables to a wholly-owned subsidiary (the Securitization Subsidiary). The Securitization Subsidiary transfers variable undivided percentage interests in the receivables and related rights to certain third-party financial institutions in exchange for cash proceeds, limited to the applicable funding capacities. Upon payment of the receivables by customers, rather than remitting to the financial institutions the amounts collected, we retain such collections as proceeds for the sale of new receivables until payments become due. At December 31, 2022, there was $199.5 million outstanding under the Receivables Facility at a weighted average effective interest rate of 5.2%, excluding commitment fees. Financial CovenantsFinancial covenants of the Credit Facility and the Term Facility include maintenance of a maximum average total leverage ratio and a minimum fixed charge coverage ratio, which are our most restrictive financial covenants. As of December 31, 2022, the calculations of these two covenants are detailed below:•Maximum Average Total Leverage Ratio. On the last day of each fiscal quarter, our average total leverage ratio must be less than 3.25 to 1.00. Average Total Leverage Ratio is the ratio of the sum of (i) Total Non-Revolving Funded Indebtedness as of such date, (ii) the trailing twelve months (TTM) Average Total Revolving Funded Indebtedness and (iii) the TTM Average Accounts Securitization Proceeds divided by TTM EBITDA (as those terms are defined in the Credit Facility). As of December 31, 2022, our average total leverage ratio equaled 1.37 (compared to 0.77 as of December 31, 2021) and the TTM average total indebtedness amount used in this calculation was $1.5 billion.42•Minimum Fixed Charge Coverage Ratio. On the last day of each fiscal quarter, our fixed charge ratio must be greater than or equal to 2.25 to 1.00. Fixed Charge Ratio is the ratio of the TTM EBITDAR divided by TTM Interest Expense paid or payable in cash plus TTM Rental Expense (as those terms are defined in the Credit Facility). As of December 31, 2022, our fixed charge ratio equaled 9.57 (compared to 11.76 as of December 31, 2021) and TTM Rental Expense was $121.3 million.The Credit Facility and Term Facility limit the declaration and payment of dividends on our common stock to a manner consistent with past practice, provided no default or event of default has occurred and is continuing, or would result from the payment of dividends. We may declare and pay quarterly dividends so long as (i) the amount per share of such dividends is not greater than the most recently publicly announced amount dividends per share and (ii) our Average Total Leverage Ratio is less than 3.25 to 1.00 both immediately before and after giving pro forma effect to such dividends. Under the Credit Facility and Term Facility, we may repurchase shares of our common stock provided no default or event of default has occurred and is continuing, or would result from the repurchase of shares, and our maximum average total leverage ratio (determined on a pro forma basis) is less than 3.25 to 1.00. Other covenants include restrictions on our ability to grant liens, incur indebtedness, make investments, merge or consolidate, and sell or transfer assets. Failure to comply with any of our financial covenants or any other terms of the Credit Facility and the Term Facility could result in higher interest rates on our borrowings or the acceleration of the maturities of our outstanding debt.Interest Rate SwapsWe utilize interest rate swap contracts and forward-starting interest rate swap contracts to reduce our exposure to fluctuations in variable interest rates for future interest payments on our variable rate borrowings. Interest expense related to the notional amounts under all swap contracts is based on applicable fixed rates plus the applicable margin on the respective borrowings. As of December 31, 2022, we had two interest rate swap contracts in place and one forward-starting interest rate swap contract, each of which has the effect of converting our exposure to variable interest rates on a portion of our variable rate borrowings to fixed interest rates. For more information, see Note 5 of “Notes to Consolidated Financial Statements” included in Item 8 of this Form 10-K.Compliance and Future AvailabilityAs of December 31, 2022, we were in compliance with all covenants and financial ratio requirements under our Credit Facility, our Term Facility and our Receivables Facility. We believe we will remain in compliance with all covenants and financial ratio requirements throughout 2023. For additional information regarding our debt arrangements, see Note 5 of “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K.Future ObligationsWe have certain fixed contractual obligations and commitments that include future estimated payments for general operating purposes. Changes in our business needs, fluctuating interest rates and other factors may result in actual payments differing from our estimates. We cannot provide certainty regarding the timing and amounts of these payments. The following table summarizes our obligations as of December 31, 2022 that are expected to impact liquidity and cash flow in future periods. We believe we will be able to fund these obligations through our existing cash, cash expected to be generated from operations and borrowings on our facilities. Payments Due by PeriodTotalLess than1 year1-3 years3-5 yearsMore than5 yearsLong-term debt$1,389,003 $34,292 $280,500 $1,074,211 $— Operating leases299,587 76,764 120,427 69,952 32,444 Purchase obligations11,720 4,304 4,764 2,652 — $1,700,310 $115,360 $405,691 $1,146,815 $32,444 43The significant assumptions used in our determination of amounts presented in the above table are as follows:•Long-term debt amounts represent the future principal payments on our debt as of December 31, 2022. For additional information regarding our debt arrangements, see Note 5 of our “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K. •Operating lease amounts include future rental payments for our operating leases. The amounts presented are consistent with contractual terms and are not expected to differ significantly from actual results under our existing leases. For additional information regarding our operating leases, see Note 9 of our “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K. •Purchase obligations include all legally binding contracts such as firm minimum commitments for inventory purchases and software commitments. We issue inventory purchase orders in the normal course of business, which represent authorizations to purchase that are cancellable by their terms. We do not consider purchase orders to be firm inventory commitments; therefore, they are excluded from the table above. For certain of our future obligations, such as unrecognized tax benefits, uncertainties exist regarding the timing of future payments and the amount by which these potential obligations will increase or decrease over time. As such, we have excluded unrecognized tax benefits from the table above. See Note 7 of “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10-K for additional discussion related to our unrecognized tax benefits. The table also excludes various other liabilities that are not contractual in nature, including contingent liabilities, litigation accruals and contract termination fees.The table below contains estimated interest payments (in thousands) related to our long-term debt obligations presented in the table above. We calculated estimates of future interest payments based on the December 31, 2022 outstanding debt balances, using the fixed rates under our interest rate swap agreements for the applicable notional amounts and the weighted average effective interest rates as of December 31, 2022 for the remaining outstanding balances not covered by our swap contracts. To project the estimated interest expense to coincide with the time periods used in the table above, we projected the estimated debt balances for future years based on the scheduled maturity dates of the Credit Facility, the Term Facility and the Receivables Facility. Our actual interest payments could vary substantially from the amounts projected. Estimated Interest Payments Due by PeriodTotalLess than1 year1-3 years3-5 yearsMore than5 yearsInterest$168,974 $52,022 $85,761 $31,191 $— Item 7A. Quantitative and Qualitative Disclosures about Market RiskWe are exposed to market risks, including interest rate risk and foreign currency risk. The adverse effects of potential changes in these market risks are discussed below. The following discussion does not consider the effects of the reduced level of overall economic activity that could exist following such changes. Further, in the event of changes of such magnitude, we would likely take actions to mitigate our exposure to such changes.Interest Rate RiskOur earnings are exposed to changes in short-term interest rates because of the variable interest rates on our debt. However, we have entered into interest rate swap contracts to reduce our exposure to market fluctuations. For information about our debt arrangements and interest rate swaps, see Note 5 of “Notes to Consolidated Financial Statements,” included in Item 8 of this Form 10‑K.In 2022, there was no interest rate risk related to the notional amounts under our interest rate swap contracts. The portions of our outstanding balances under the Credit Facility, Term Facility and the Receivables Facility that were not covered by our interest rate swap contracts were subject to variable interest rates. To calculate the potential impact in 2022 related to interest rate risk, we performed a sensitivity analysis assuming that we borrowed the monthly maximum available amount under the Credit Facility and the maximum amount available under the Receivables Facility. Our Term Facility, entered into on December 30, 2019, was fully drawn as of that date. In this analysis, we assumed that the variable interest rates for the Credit Facility and the Receivables Facility increased by 1.0%. Based on this calculation, our pretax income would have decreased by approximately $12.5 million and earnings per share would have decreased by approximately $0.23 per diluted share (based on the number of weighted average diluted shares outstanding for the year ended December 31, 2022). The maximum amount 44available under the Credit Facility is $1.25 billion and the maximum amount available under the Receivables Facility is $350.0 million.Failure of our swap counterparties would result in the loss of any potential benefit to us under our swap agreements. In this case, we would still be obligated to pay the variable interest payments underlying our debt agreements. Additionally, failure of our swap counterparties would not eliminate our obligation to continue to make payments under our existing swap agreements if we continue to be in a net pay position.Currency RiskChanges in the exchange rates for the functional currencies of our international subsidiaries, as shown in the table below, may positively or negatively impact our sales, operating expenses and earnings. Historically, we have not hedged our currency exposure and fluctuations in exchange rates have not materially affected our operating results. While our international operations, including Canada and Mexico, accounted for only 8% of total net sales in 2022, our exposure to currency rate fluctuations could be material in 2023 and future years to the extent that either currency rate changes are significant or that our international operations comprise a larger percentage of our consolidated results. Functional CurrenciesCanadaCanadian DollarUnited KingdomBritish PoundBelgiumEuroCroatiaEuroFranceEuroGermanyEuroItalyEuroPortugalEuroSpainEuroMexicoMexican PesoAustraliaAustralian Dollar45
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+Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" (MD&A).EBPB - Employee Benefit Plan Board. The administrator of PPL's U.S. qualified retirement plans, which is charged with the fiduciary responsibility to oversee and manage those plans and the investments associated with those plans.ECR - Environmental Cost Recovery. Pursuant to Kentucky Revised Statute 278.183, Kentucky electric utilities are entitled to the current recovery of costs of complying with the Clean Air Act, as amended, and those federal, state or local environmental requirements that apply to coal combustion wastes and byproducts from the production of energy from coal.ELG(s) - Effluent Limitation Guidelines, regulations promulgated by the EPA.EPA - Environmental Protection Agency, a U.S. government agency.EPS - earnings per share.FERC - Federal Energy Regulatory Commission, the U.S. federal agency that regulates, among other things, interstate transmission and wholesale sales of electricity, hydroelectric power projects and related matters.GAAP - Generally Accepted Accounting Principles in the U.S.GBP - British pound sterling.GHG(s) - greenhouse gas(es).GLT - gas line tracker. The KPSC approved mechanism for LG&E's recovery of certain costs associated with gas transmission lines, gas service lines, gas risers, leak mitigation, and gas main replacements.Green Tariff - a KPSC approved rate schedule, permitting customers to contract with LG&E or KU for the purchase of renewable energy certificates, construction of solar generation and use of the energy produced, or the purchase of energy from a renewable energy generator.GWh - gigawatt-hour, one million kilowatt hours.IBEW - International Brotherhood of Electrical Workers.ICPKE - The PPL Incentive Compensation Plan for Key Employees. The ICPKE provides for incentive compensation to certain employees below the level of senior executive.IRS - Internal Revenue Service, a U.S. government agency.ISO - Independent System Operator.KPSC - Kentucky Public Service Commission, the state agency that has jurisdiction over the regulation of rates and service of utilities in Kentucky.KU 2010 Mortgage Indenture - KU's Indenture, dated as of October 1, 2010, to The Bank of New York Mellon, as supplemented.kVA - kilovolt ampere.iiiTable of ContentskWh - kilowatt hour, basic unit of electrical energy.LCIDA - Lehigh County Industrial Development Authority.LG&E 2010 Mortgage Indenture - LG&E's Indenture, dated as of October 1, 2010, to The Bank of New York Mellon, as supplemented.LIBOR - London Interbank Offered Rate.Mcf - one thousand cubic feet, a unit of measure for natural gas.MMBtu - one million British Thermal Units.Moody's - Moody's Investors Service, Inc., a credit rating agency.MW - megawatt, one thousand kilowatts.MWac - megawatt, alternating current. The measure of the power output from a solar installation.NAAQS - National Ambient Air Quality Standards periodically adopted pursuant to the Clean Air Act.NEP - New England Power Company, a National Grid U.S. affiliate.NERC - North American Electric Reliability Corporation.NGCC - Natural gas combined cycle.NPNS - the normal purchases and normal sales exception as permitted by derivative accounting rules. Derivatives that qualify for this exception may receive accrual accounting treatment.OCI - other comprehensive income or loss.OVEC - Ohio Valley Electric Corporation, located in Piketon, Ohio, an entity in which LG&E owns a 5.63% interest and KU owns a 2.50% interest, which are recorded at cost. OVEC owns and operates two coal-fired power plants, the Kyger Creek plant in Ohio and the Clifty Creek plant in Indiana, with combined capacities of 2,120 MW.PAPUC - Pennsylvania Public Utility Commission, the state agency that regulates certain ratemaking, services, accounting and operations of Pennsylvania utilities.PEDFA - Pennsylvania Economic Development Financing Authority.Performance unit - stock-based compensation award that represents a variable number of shares of PPL common stock that a recipient may receive based on PPL's attainment of (i) relative total shareowner return (TSR) over a three-year performance period as compared to companies in the PHLX Utility Sector Index; or (ii) corporate return on equity (ROE) based on the average of the annual ROE for each year of the three-year performance period. In light of the transformational nature of the potential sale of the U.K. utility business in 2021, PPL's ROE-based performance units issued for 2021 were based on a one-year performance period from January 1, 2021 to December 31, 2021; however, these units retained the three year vesting schedule and other characteristics.PJM - PJM Interconnection, L.L.C., operator of the electricity transmission network and electricity energy market in all or parts of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia.PLR - Provider of Last Resort, the role of PPL Electric in providing default electricity supply within its delivery area to retail customers who have not chosen to select an alternative electricity supplier under the Customer Choice Act.PP&E - property, plant and equipment.PPA(s) - power purchase agreement(s).ivTable of ContentsPPL EnergyPlus - prior to the June 1, 2015 spinoff of PPL Energy Supply, LLC, PPL EnergyPlus, LLC, a subsidiary of PPL Energy Supply that marketed and traded wholesale and retail electricity and gas, and supplied energy and energy services in competitive markets.PPL Energy Supply - prior to the June 1, 2015 spinoff, PPL Energy Supply, LLC, a subsidiary of PPL Energy Funding and the indirect parent company of PPL Montana, LLC.PPL EU Services - PPL EU Services Corporation, a former subsidiary of PPL that, prior to being merged into PPL Services on December 31, 2021, provided administrative, management and support services primarily to PPL Electric.PPL Montana - prior to the June 1, 2015 spinoff of PPL Energy Supply, PPL Montana, LLC, an indirect subsidiary of PPL Energy Supply that generated electricity for wholesale sales in Montana and the Pacific Northwest.PPL WPD Investments Limited - PPL WPD Investments Limited, which was, prior to the sale of the U.K. utility business on June 14, 2021, a subsidiary of PPL WPD Limited and parent to WPD plc. PPL WPD Investments Limited was included in the sale of the U.K. utility business on June 14, 2021.RAR – Retired Asset Recovery rider, established by KPSC orders in 2021 to provide for recovery of and return on the remaining investment in certain electric generating units upon their retirement over a ten-year period following retirement.RCRA - Resource Conservation and Recovery Act of 1976.Registrant(s) - refers to the Registrants named on the cover of this Report (each a "Registrant" and collectively, the "Registrants").RIPUC - Rhode Island Public Utilities Commission, a three-member quasi-judicial tribunal with jurisdiction, powers, and duties to implement and enforce the standards of conduct under R.I. Gen. Laws § 39-1-27.6 and to hold investigations and hearings involving the rates, tariffs, tolls, and charges, and the sufficiency and reasonableness of facilities and accommodations of public utilities.Riverstone - Riverstone Holdings LLC, a Delaware limited liability company and, as of December 6, 2016, ultimate parent company of the entities that own the competitive power generation business contributed to Talen Energy.Rhode Island Division of Public Utilities and Carriers - the Rhode Island Division of Public Utilities and Carriers, which is headed by an Administrator who is not a Commissioner of the RIPUC, exercises the jurisdiction, supervision, power, and duties not specifically assigned to the RIPUC. RTO - Regional Transmission Operator, an electric power transmission system operator that coordinates, controls and monitors a multi-state electric grid.Safari Energy - Safari Energy, LLC, which was, prior to the sale of Safari Holdings on November 1, 2022, a subsidiary of Safari Holdings that provided solar energy solutions for commercial customers in the U.S.Safari Holdings - Safari Holdings, LLC, which was, prior to its sale on November 1, 2022, a subsidiary of PPL and parent holding company of Safari Energy.Sarbanes-Oxley - Sarbanes-Oxley Act of 2002, which sets requirements for management's assessment of internal controls for financial reporting. It also requires an independent auditor to make its own assessment.Scrubber - an air pollution control device that can remove particulates and/or gases (primarily sulfur dioxide) from exhaust gases.SEC - the U.S. Securities and Exchange Commission, a U.S. government agency primarily responsible to protect investors and maintain the integrity of the securities markets.SIP - PPL Corporation's Amended and Restated 2012 Stock Incentive Plan.vTable of ContentsSmart metering technology - technology that can measure, among other things, time of electricity consumption to permit offering rate incentives for usage during lower cost or demand intervals. The use of this technology also has the potential to strengthen network reliability.SOFR - Secured Overnight Financing Rate, a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.S&P - S&P Global Ratings, a credit rating agency.Superfund - federal environmental statute that addresses remediation of contaminated sites; states also have similar statutes.Talen Energy - Talen Energy Corporation, the Delaware corporation formed to be the publicly traded company and owner of the competitive generation assets of PPL Energy Supply and certain affiliates of Riverstone, which as of December 6, 2016, became wholly owned by Riverstone.Talen Energy Marketing - Talen Energy Marketing, LLC, the successor name of PPL EnergyPlus, after the spinoff of PPL Energy Supply that marketed and traded wholesale and retail electricity and gas, and supplied energy and energy services in competitive markets, after the June 1, 2015 spinoff of PPL Energy Supply.TCJA - Tax Cuts and Jobs Act. Comprehensive U.S. federal tax legislation enacted on December 22, 2017.Total shareowner return - the change in market value of a share of the company's common stock plus the value of all dividends paid on a share of the common stock during the applicable performance period, divided by the price of the common stock as of the beginning of the performance period. The price used for purposes of this calculation is the average share price for the 20 trading days at the beginning and end of the applicable period.Treasury Stock Method - a method applied to calculate diluted EPS that assumes any proceeds that could be obtained upon exercise of options and warrants (and their equivalents) would be used to purchase common stock at the average market price during the relevant period.U.K. utility business - PPL WPD Investments Limited and its subsidiaries, including, notably, WPD plc and the four distribution network operators, which substantially represented PPL's U.K. Regulated segment. The U.K. utility business was sold on June 14, 2021. USW - The United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial and Service Workers International Union, commonly known as the United Steelworkers.VEBA - Voluntary Employee Beneficiary Association. A tax-exempt trust under the Internal Revenue Code Section 501 (c)(9) used by employers to fund and pay eligible medical, life and similar benefits.VSCC - Virginia State Corporation Commission, the state agency that has jurisdiction over the regulation of Virginia corporations, including utilities.WPD - Prior to the sale of the U.K. utility business on June 14, 2021, refers to PPL WPD Limited Investments and its subsidiaries. WPD was included in the sale of the U.K. utility business on June 14, 2021.WPD plc - Western Power Distribution plc, prior to the sale of the U.K utility business, a U.K. indirect subsidiary of PPL WPD Limited. Its principal indirectly owned subsidiaries are WPD (East Midlands), WPD (South Wales), WPD (South West) and WPD (West Midlands). WPD plc was included in the sale of the U.K. utility business on June 14, 2021.viTable of Contents(THIS PAGE LEFT BLANK INTENTIONALLY.)Table of ContentsForward-looking Information Statements contained in this Annual Report concerning expectations, beliefs, plans, objectives, goals, strategies, future events or performance and underlying assumptions and other statements that are other than statements of historical fact are "forward-looking statements" within the meaning of the federal securities laws. Although the Registrants believe that the expectations and assumptions reflected in these statements are reasonable, there can be no assurance that these expectations will prove to be correct. Forward-looking statements are subject to many risks and uncertainties, and actual results may differ materially from the results discussed in forward-looking statements. In addition to the specific factors discussed in "Item 1A. Risk Factors" and in "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Annual Report, the following are among the important factors that could cause actual results to differ materially and adversely from the forward-looking statements:•strategic acquisitions, dispositions, or similar transactions, including the acquisition of Narragansett Electric, and our ability to consummate these business transactions or realize expected benefits from them;•COVID-19 or other pandemics and their impact on economic conditions, financial markets and supply chains; •other pandemic health events or other catastrophic events such as fires, earthquakes, explosions, floods, droughts, tornadoes, hurricanes and other extreme weather-related events (including events potentially caused or exacerbated by climate change);•capital market conditions, including the availability of capital, credit or insurance, changes in interest rates and certain economic indices, and decisions regarding capital structure;•volatility in or the impact of other changes in financial markets, commodity prices and economic conditions, including inflation;•the outcome of rate cases or other cost recovery or revenue proceedings;•the direct or indirect effects on PPL or its subsidiaries or business systems of cyber-based intrusion or the threat of cyberattacks;•significant changes in the demand for electricity;•expansion of alternative and distributed sources of electricity generation and storage;•the effectiveness of our risk management programs, including commodity and interest rate hedging;•defaults by counterparties or suppliers for energy, capacity, coal, natural gas or key commodities, goods or services;•a material decline in the market value of PPL's equity;•significant decreases in the fair value of debt and equity securities and their impact on the value of assets in defined benefit plans, and the related cash funding requirements if the fair value of those assets decline;•interest rates and their effect on pension and retiree medical liabilities, ARO liabilities and interest payable on certain debt securities, and the general economy;•the potential impact of any unrecorded commitments and liabilities of the Registrants and their subsidiaries;•new accounting requirements or new interpretations or applications of existing requirements;•adverse changes in the corporate credit ratings or securities analyst rankings of the Registrants and their securities;•any requirement to record impairment charges pursuant to GAAP with respect to any of our significant investments;•laws or regulations to reduce emissions of GHGs or the physical effects of climate change;•continuing ability to access fuel supply for LG&E and KU, as well as the ability to recover fuel costs and environmental expenditures in a timely manner at LG&E and KU and natural gas supply costs at LG&E and RIE;•weather and other conditions affecting generation, transmission and distribution operations, operating costs and customer energy use;•war, armed conflicts, terrorist attacks, or similar disruptive events, including the war in Ukraine;•changes in political, regulatory or economic conditions in states, regions or countries where the Registrants or their subsidiaries conduct business;•receipt of necessary governmental permits and approvals;•changes in state or federal tax laws or regulations;•changes in state, federal or foreign legislation or regulatory developments;•the impact of any state, federal or foreign investigations applicable to the Registrants and their subsidiaries and the energy industry;•our ability to attract and retain qualified employees;•the effect of changing expectations and demands of our customers, regulators, investors and stakeholders, including heightened emphasis on environmental, social and governance concerns;•the effect of any business or industry restructuring;•development of new projects, markets and technologies;•performance of new ventures;•collective labor bargaining negotiations and labor costs; and1Table of Contents•the outcome of litigation involving the Registrants and their subsidiaries.Any forward-looking statements should be considered in light of these important factors and in conjunction with other documents of the Registrants on file with the SEC.New factors that could cause actual results to differ materially from those described in forward-looking statements emerge from time to time, and it is not possible for the Registrants to predict all such factors, or the extent to which any such factor or combination of factors may cause actual results to differ from those contained in any forward-looking statement. Any forward-looking statement speaks only as of the date on which such statement is made, and the Registrants undertake no obligation to update the information contained in the statement to reflect subsequent developments or information. 2Table of ContentsPART IITEM 1. BUSINESS General (All Registrants) PPL, headquartered in Allentown, Pennsylvania, is a utility holding company, incorporated in 1994 to serve as the holding company for the regulated utility that is now PPL Electric and pursue other business activities in the deregulated power sector. PPL, through its regulated utility subsidiaries, delivers electricity to customers in Pennsylvania, Kentucky, Virginia, and Rhode Island; delivers natural gas to customers in Kentucky and Rhode Island; and generates electricity from power plants in Kentucky. PPL's principal subsidiaries at December 31, 2022 are shown below (* denotes a Registrant). PPL Corporation* PPL Capital FundingProvides financing for the operations of PPL and certain subsidiaries PPL Electric*Engages in the regulated transmission and distribution of electricity in Pennsylvania LKEA holding company that owns regulated utility operations through its subsidiaries, LG&E and KU RIEEngages in the regulated transmission, distribution and sale of electricity and regulated distribution and sale of natural gas in Rhode Island LG&E*Engages in the regulated generation, transmission, distribution and sale of electricity and regulated distribution and sale of natural gas in Kentucky KU*Engages in the regulated generation, transmission, distribution and sale of electricity, primarily in Kentucky PennsylvaniaRegulated Segment KentuckyRegulated Segment Rhode IslandRegulated Segment In addition to PPL, the other Registrants included in this filing are as follows. PPL Electric, headquartered in Allentown, Pennsylvania, is a wholly owned subsidiary of PPL and a regulated public utility that is an electricity transmission and distribution service provider in eastern and central Pennsylvania. PPL Electric is subject to regulation as a public utility by the PAPUC, and certain of its transmission activities are subject to the jurisdiction of the FERC under the Federal Power Act. PPL Electric delivers electricity in its Pennsylvania service area and provides electricity supply to retail customers in that area as a PLR under the Customer Choice Act. PPL Electric was organized in 1920 as Pennsylvania Power & Light Company. LG&E, headquartered in Louisville, Kentucky, is a wholly owned subsidiary of LKE and a regulated utility engaged in the generation, transmission, distribution and sale of electricity and distribution and sale of natural gas in Kentucky. LG&E is subject to regulation as a public utility by the KPSC, and certain of its transmission activities are subject to the jurisdiction of the FERC under the Federal Power Act. LG&E was incorporated in 1913.KU, headquartered in Lexington, Kentucky, is a wholly owned subsidiary of LKE and a regulated utility engaged in the generation, transmission, distribution and sale of electricity in Kentucky and Virginia. KU is subject to regulation as a public utility by the KPSC and the VSCC, and certain of its transmission and wholesale power activities are subject to the jurisdiction 3Table of Contentsof the FERC under the Federal Power Act. KU serves its Kentucky customers under the KU name and its Virginia customers under the Old Dominion Power name. KU was incorporated in Kentucky in 1912 and in Virginia in 1991. Segment Information (PPL) PPL is organized into three reportable segments as depicted in the chart above: Kentucky Regulated, which primarily represents the results of LG&E and KU, Pennsylvania Regulated, which primarily represents the results of PPL Electric, and Rhode Island Regulated, which primarily represents the results of RIE. "Corporate and Other" primarily includes financing and other costs incurred at the corporate level that have not been allocated or assigned to the segments, as well as certain non-recoverable costs resulting from commitments made to the Rhode Island Division of Public Utilities and Carriers and the Attorney General of the State of Rhode Island in conjunction with the acquisition of Narragansett Electric. A comparison of PPL's Regulated segments is shown below.KentuckyPennsylvaniaRhode IslandRegulatedRegulatedRegulated (a)For the year ended December 31, 2022: Operating Revenues (in billions)$3.8 $3.0 $1.0 Net Income (in millions) $507 $525 $(44)Electricity delivered (GWh) 30,892 37,593 4,494 Natural gas delivered (Bcf)31 — 14 At December 31, 2022: Regulatory Asset Base (in billions) (b) $11.7 $9.3 $3.2 Service area (in square miles)8,000 10,000 1,200 Customers (in millions)1.3 1.5 0.8 (a)On May 25, 2022, PPL Rhode Island Holdings acquired 100% of the outstanding shares of common stock of Narragansett Electric. The results of RIE are included in PPL’s Rhode Island Regulated segment. See Note 9 to the Financial Statements for additional information.(b)Represents capitalization for Kentucky Regulated, rate base for Pennsylvania Regulated and Rhode Island Regulated. The amount for Rhode Island Regulated excludes acquisition-related adjustments for non-earning assets. See Note 2 to the Financial Statements for additional financial information by segment. Beginning on January 1, 2023, the Kentucky Regulated segment will consist primarily of the regulated electricity generation, transmission and distribution operations conducted by LG&E and KU, as well as LG&E's regulated distribution and sale of natural gas. Prior to January 1, 2023, the Kentucky Regulated segment also included the financing activities of LKE. The financing activity of LKE will be presented in Corporate and Other beginning on January 1, 2023. As a result of this change, beginning on January 1, 2023, PPL’s segments will consist of the regulated operations of Kentucky, Pennsylvania and Rhode Island and will exclude any incremental financing activities of holding companies, which Management believes is a more meaningful presentation as it provides information on the core regulated operations of PPL.(PPL Electric, LG&E and KU)PPL Electric has two operating segments, distribution and transmission, which are aggregated into a single reportable segment. LG&E and KU are individually single operating and reportable segments.Kentucky Regulated Segment (PPL)The Kentucky Regulated segment consists primarily of the regulated electricity generation, transmission and distribution operations conducted by LG&E and KU, as well as LG&E's regulated distribution and sale of natural gas. In addition, the Kentucky Regulated segment includes certain financing and other costs at LKE.(PPL, LG&E and KU) LG&E and KU are engaged in the regulated generation, transmission, distribution and sale of electricity in Kentucky and, in KU's case, also Virginia. LG&E also engages in the distribution and sale of natural gas in Kentucky. LG&E provides electric service to approximately 433,000 customers in Louisville and adjacent areas in Kentucky, covering approximately 700 square miles in nine counties and provides natural gas service to approximately 334,000 customers in its electric service area and eight additional counties in Kentucky. KU provides electric service to approximately 541,000 customers in 77 counties in central, 4Table of Contentssoutheastern and western Kentucky and approximately 28,000 customers in five counties in southwestern Virginia, covering approximately 4,800 non-contiguous square miles. KU also sells wholesale electricity to two municipalities in Kentucky under load following contracts. See Note 3 to the Financial Statements for revenue information. Franchises and Licenses LG&E and KU provide electricity delivery service, and LG&E provides natural gas distribution service, in their respective service territories pursuant to certain franchises, licenses, statutory service areas, easements and other rights or permissions granted by state legislatures, cities or municipalities or other entities. CompetitionThere are currently no other electric public utilities operating within the electric service areas of LG&E and KU. From time to time, bills are introduced into the Kentucky General Assembly which seek to authorize, promote or mandate increased distributed generation, customer choice or other developments. Neither the Kentucky General Assembly nor the KPSC has adopted or approved a plan or timetable for retail electric industry competition in Kentucky. The nature or timing of legislative or regulatory actions, if any, regarding industry restructuring and their impact on LG&E and KU, which may be significant, cannot currently be predicted. Virginia, formerly a deregulated jurisdiction, has enacted legislation that implemented a hybrid model of cost-based regulation. KU's operations in Virginia have been and remain regulated. Alternative energy sources such as electricity, oil, propane and other fuels indirectly impact LG&E's natural gas revenues. Marketers may also compete to sell natural gas to certain large end-users. LG&E's natural gas tariffs include gas price pass-through mechanisms relating to its sale of natural gas as a commodity. Therefore, customer natural gas purchases from alternative suppliers do not generally impact LG&E's profitability. Some large industrial and commercial customers, however, may physically bypass LG&E's facilities and seek delivery service directly from interstate pipelines or other natural gas distribution systems.Power Supply At December 31, 2022, LG&E owned generating capacity of 2,760 MW and KU owned generating capacity of 4,775 MW. See "Item 2. Properties - Kentucky Regulated Segment" for a complete list of generating facilities. The system capacity of LG&E's and KU's owned generation is based upon several factors, including the operating experience and physical condition of the units, and may be revised periodically to reflect changes in circumstances. During 2022, LG&E's and KU's power plants generated the following amounts of electricity:GWhFuel SourceLG&EKUCoal10,488 13,880 Oil— 6 Gas1,816 5,039 Hydro278 61 Solar8 12 Total (a)12,590 18,998 (a)This generation represents an increase for LG&E of 5% and a decrease for KU of 1% from 2021 output. The majority of LG&E's and KU's generated electricity was used to supply their retail customer bases. LG&E and KU jointly dispatch their generation units with the lowest cost generation used to serve their customers. When LG&E has excess generation capacity after serving its own customers and its generation cost is lower than that of KU, KU purchases electricity from LG&E and vice versa. Due to environmental requirements and energy efficiency measures, as of December 31, 2022, LG&E and KU have retired approximately 1,200 MW of coal-fired generation plants since 2010.LG&E and KU received approval from the KPSC to develop a 4 MW Solar Share facility to service a Solar Share program. The Solar Share program is a voluntary program that allows customers to subscribe capacity in the Solar Share facility. Construction 5Table of Contentscommences, in 500-kilowatt phases, when subscription is complete. Construction of five 500-kilowatt phases was completed as of December 31, 2022. LG&E and KU continue to market the program and have started receiving subscriptions for the sixth 500-kilowatt phase.On January 23, 2020, LG&E and KU applied to the KPSC for approval of arrangements relating to the purchase of 100 MW of solar power in connection with the Green Tariff option established in the 2018 Kentucky base rate cases. Pursuant to the agreements, LG&E and KU would purchase the initial 20 years of output of a proposed third-party solar generation facility and resell the bulk of the power as renewable energy to two large industrial customers and use the remaining power for other customers. The generation facility is currently expected to be operational in the fourth quarter of 2024. In 2020, the KPSC approved LG&E’s and KU’s applications. PPL, LG&E and KU do not anticipate that these arrangements will have a significant impact on their results of operations or financial condition. On October 6, 2021, LG&E and KU entered into an agreement to purchase the initial 20 years of output of a proposed 125 MW third-party solar generation facility in connection with the Green Tariff option established in the 2018 Kentucky base rate cases. Pursuant to the agreements, LG&E and KU would purchase output of the facility and resell power as renewable energy to certain large customers. The generation facility is currently expected to be operational in the fourth quarter of 2024. PPL, LG&E and KU do not anticipate that this agreement will have a significant impact on their results of operations or financial condition. On December 15, 2022, LG&E and KU filed an application with the KPSC for a CPCN for the construction of two 621 MW net summer rating NGCC combustion turbine facilities, one at LG&E's Mill Creek Generating Station in Jefferson County, Kentucky and the other at KU's E.W. Brown Generating Station in Mercer County, Kentucky, including on-site natural gas and electric transmission construction associated with those facilities and site compatibility certificates. LG&E and KU also applied for a CPCN to construct a 120 MWac solar photovoltaic electric generating facility in Mercer County, Kentucky, and for a CPCN to acquire a 120 MWac solar facility to be built by a third-party solar developer in Marion County, Kentucky. LG&E and KU further applied for a CPCN to construct a 125 MW, 4-hour battery energy storage system facility at KU's E.W. Brown Generating Station and for approval of their proposed 2024-2030 DSM programs. The plan includes adding 14 new, adjusted or expanded energy efficiency programs, which would reduce LG&E's and KU's overall need by approximately 100 MW each. Finally, LG&E and KU requested a declaratory order to confirm that their entry into non-firm energy-only power-purchase agreements for the output of four solar photovoltaic facilities with a combined capacity of 637 MW does not require KPSC approval and that LG&E and KU may recover the costs of the solar PPAs through their fuel adjustment clause mechanisms as previously approved for a prior solar PPA. LG&E and KU plan to accrue AFUDC on the constructed NGCCs, solar facility in Mercer County, Kentucky and the battery energy storage system facility and have requested regulatory asset treatment to recover the financing costs of these projects. The new NGCC would be jointly owned by LG&E (31%) and KU (69%) and the solar units would be jointly owned by LG&E (37%) and KU (63%), the battery storage unit would be owned by LG&E, and the proposed PPA transactions and DSM programs would be entered into or conducted jointly by LG&E and KU, consistent with LG&E and KU's shared dispatch, cost allocation, tariff or other frameworks.The filing also notes planned retirement dates for certain existing coal-fired generation units, including Mill Creek 1 (300 MW) in 2024 and E.W. Brown 3 (412 MW) in 2028, and updates and advances the planned retirement dates for Mill Creek 2 (297 MW) to 2027 and Ghent 2 (486 MW) to 2028. LG&E and KU anticipate the recovery of associated retirement costs, including the remaining net book value, for these coal-fired generating units through the RAR or other rate mechanisms. The KPSC accepted the filing as of January 6, 2023 and has indicated its intention to issue an order on all issues by November 6, 2023. LG&E and KU cannot predict the outcome of these matters.Fuel Supply Coal and natural gas are expected to be the predominant fuels used by LG&E and KU for generation for the foreseeable future. Natural gas used for generation is primarily purchased using contractual arrangements separate from LG&E's natural gas distribution operations. Natural gas and oil are also used for intermediate and peaking capacity and flame stabilization in coal-fired boilers. Fuel inventory is maintained at levels estimated to be necessary to avoid operational disruptions at coal-fired generating units. Reliability of coal deliveries can be affected from time to time by several factors including fluctuations in demand, coal mine production issues, high or low river level events, lock outages and other supplier or transporter operating or financial difficulties. LG&E and KU have entered into coal supply agreements with various suppliers for coal deliveries through 2027 and augment their coal supply agreements with spot market purchases, as needed.6Table of Contents For their existing units, LG&E and KU expect, for the foreseeable future, to purchase most of their coal from western Kentucky, southern Indiana, southern Illinois, northern West Virginia and western Pennsylvania. LG&E and KU continue to purchase certain quantities of ultra-low sulfur content coal from Wyoming for blending at Trimble County Unit 2. Coal is delivered to the generating plants primarily by barge and rail. To enhance the reliability of natural gas supply, LG&E and KU have secured firm long-term pipeline transport capacity services with contracts of various durations through 2024 on the interstate pipeline serving Cane Run Unit 7. This pipeline also serves the six simple cycle combustion turbine units located at the Trimble County site as well as two other simple cycle units at the Paddy's Run site. For the seven simple cycle combustion turbines at the E.W. Brown facility, no firm long-term pipeline transport capacity has been purchased due to the facility's connection to two interstate pipelines and some of the units having dual fuel capability. LG&E and KU have firm contracts for a portion of the natural gas fuel for Cane Run Unit 7 through October 2024. The bulk of the natural gas fuel remains purchased on the spot market. (PPL and LG&E)Natural Gas Distribution Supply Five underground natural gas storage fields, with a current working natural gas capacity of approximately 15 billion cubic feet (Bcf), are used to provide natural gas service to LG&E's firm sales customers. Natural gas is stored during the summer season for withdrawal during the following winter heating season. Without this storage capacity, LG&E would need to purchase additional natural gas and pipeline transportation services during winter months when customer demand increases and the cost of natural gas supply and pipeline transportation services are expected to be higher. At December 31, 2022, LG&E had 10 Bcf of natural gas stored underground with a carrying value of $68 million. LG&E will continue work in 2023 on a multi-year project to retire one of its underground natural gas storage fields with a working natural gas capacity of 4 Bcf, with plans to complete by no later than 2025. LG&E has a portfolio of supply arrangements of varying durations and terms that provide competitively priced natural gas designed to meet its firm sales obligations. These natural gas supply arrangements include pricing provisions that are market-responsive. In tandem with pipeline transportation services, these natural gas supplies provide the reliability and flexibility necessary to serve LG&E's natural gas customers. LG&E purchases natural gas supply transportation services from two pipelines. LG&E has a set of contracts with one pipeline that are subject to termination by LG&E between 2025 and 2028. Total winter season capacity under these contracts is 184,900 MMBtu/day and summer season capacity is 60,000 MMBtu/day. LG&E has two additional contracts with this same pipeline. One contract is for pipeline capacity through 2026 for 60,000 MMBtu/day during both the winter and summer seasons. The other contract is for pipeline capacity through 2028 for 30,000 MMBtu/day during the winter season. LG&E has a single contract with a second pipeline with a total capacity of 20,000 MMBtu/day during both the winter and summer seasons that expires in 2030. LG&E expects to purchase natural gas supplies for its gas distribution operations from onshore producing regions in South Texas, East Texas, North Louisiana and Arkansas, as well as gas originating in the Marcellus and Utica production areas. (PPL, LG&E and KU)TransmissionLG&E and KU contract with the Tennessee Valley Authority to act as their transmission reliability coordinator and contract with TranServ International, Inc. to act as their independent transmission organization. Rates LG&E is subject to the jurisdiction of the KPSC and the FERC, and KU is subject to the jurisdiction of the KPSC, the FERC and the VSCC. LG&E and KU operate under a FERC-approved open access transmission tariff. LG&E's and KU's Kentucky base rates are calculated based on a return on capitalization (common equity, long-term debt and short-term debt) including adjustments for certain net investments and costs recovered separately through other means. As such, LG&E and KU generally earn a return on regulatory assets in Kentucky.7Table of ContentsKU's Virginia base rates are calculated based on a return on rate base (net utility plant plus working capital less accumulated deferred income taxes and miscellaneous deductions). As all regulatory assets and liabilities, except for regulatory assets and liabilities related to the levelized fuel factor, accumulated deferred income taxes, pension and postretirement benefits, and AROs related to certain CCR impoundments, are excluded from the return on rate base utilized in the calculation of Virginia base rates, no return is earned on the related assets. KU's rates to two municipal customers for wholesale power requirements are calculated based on annual updates to a formula rate that utilizes a return on rate base (net utility plant plus working capital less accumulated deferred income taxes and miscellaneous deductions). As all regulatory assets and liabilities, except accumulated deferred income taxes, are excluded from the return on rate base utilized in the development of municipal rates, no return is earned on the related assets.See "Financial and Operational Developments" in "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 7 to the Financial Statements for additional information on current rate proceedings and rate mechanisms.Pennsylvania Regulated Segment (PPL)The Pennsylvania Regulated segment consists of PPL Electric, a regulated public utility engaged in the distribution and transmission of electricity.(PPL and PPL Electric)PPL Electric delivers electricity to approximately 1.5 million customers in a 10,000-square mile territory in 29 counties within eastern and central Pennsylvania. PPL Electric also provides electricity to retail customers in this territory as a PLR under the Customer Choice Act. See Note 3 to the Financial Statements for revenue information.Franchise, Licenses and Other RegulationsPPL Electric is authorized to provide electric public utility service throughout its service area as a result of grants by the Commonwealth of Pennsylvania in corporate charters to PPL Electric and companies that it has succeeded, and as a result of certification by the PAPUC. PPL Electric is granted the right to enter the streets and highways by the Commonwealth subject to certain conditions. In general, such conditions have been met by ordinance, resolution, permit, acquiescence or other action by an appropriate local political subdivision or agency of the Commonwealth.CompetitionPursuant to authorizations from the Commonwealth of Pennsylvania and the PAPUC, PPL Electric operates a regulated distribution monopoly in its service area. Accordingly, PPL Electric does not face competition in its electricity distribution business. Pursuant to the Customer Choice Act, generation of electricity is a competitive business in Pennsylvania, and PPL Electric does not own or operate any generation facilities.The PPL Electric transmission business, operating under a FERC-approved PJM Open Access Transmission Tariff, is subject to competition pursuant to FERC Order 1000 from entities that are not incumbent PJM transmission owners with respect to the construction and ownership of transmission facilities within PJM.Rates and RegulationTransmissionPPL Electric's transmission facilities are within PJM, which operates the electricity transmission network and electric energy market in the Mid-Atlantic and Midwest regions of the U.S.PJM serves as a FERC-approved Regional Transmission Operator (RTO) to promote greater participation and competition in the region it serves. In addition to operating the electricity transmission network, PJM also administers regional markets for energy, capacity and ancillary services. A primary objective of any RTO is to separate the operation of, and access to, the transmission grid from market participants that buy or sell electricity in the same markets. Electric utilities continue to own the transmission assets and to receive their share of transmission revenues, but the RTO directs the control and operation of the transmission facilities. Certain types of transmission investments are subject to competitive processes outlined in the PJM tariff.8Table of ContentsAs a transmission owner, PPL Electric's transmission revenues are recovered through PJM and billed in accordance with a FERC-approved Open Access Transmission Tariff that allows recovery of incurred transmission costs, a return on transmission-related plant and an automatic annual update based on a formula-based rate recovery mechanism. Under this formula, rates are put into effect in June of each year based upon prior year actual expenditures and current year forecasted capital additions. Rates are then adjusted the following year to reflect actual annual expenses and capital additions, as reported in PPL Electric’s annual FERC Form 1, filed under the FERC’s Uniform System of Accounts. Any difference between the revenue requirement in effect for the prior year and actual expenditures incurred for that year is recorded as a regulatory asset or regulatory liability. Any change in the prior year PPL zonal peak load billing factor applied on January 1 of each year will result in an increase or decrease in revenue until the next annual rate update is effective on June 1 of that same year.As a PLR, PPL Electric also purchases transmission services from PJM. See "PLR" below.See "Financial and Operational Developments" in "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 7 to the Financial Statements for additional information on rate mechanisms and regulatory matters.DistributionPPL Electric's distribution base rates are calculated based on a return on rate base (net utility plant plus a cash working capital allowance less plant-related deferred taxes and other miscellaneous additions and deductions). All regulatory assets and liabilities, except accumulated deferred income taxes, are excluded from the return on rate base. Therefore, no return is earned on the related assets unless specifically provided for by the PAPUC. Currently, PPL Electric's Smart Meter rider and the DSIC are the only riders authorized to earn a return. Certain operating expenses are also included in PPL Electric's distribution base rates including wages and benefits, other operation and maintenance expenses, depreciation and taxes.Pennsylvania's Alternative Energy Portfolio Standard (AEPS) requires electric distribution companies and electricity generation suppliers to obtain from alternative energy resources a portion of the electricity sold to retail customers in Pennsylvania. Under the default service procurement plans approved by the PAPUC, PPL Electric purchases all of the alternative energy generation supply it needs to comply with the AEPS.Act 129 created an energy efficiency and conservation program, a demand side management program, smart metering technology requirements, new PLR generation supply procurement rules, remedies for market misconduct and changes to the existing AEPS.Act 11 authorizes the PAPUC to approve two specific ratemaking mechanisms: the use of a fully projected future test year in base rate proceedings and, subject to certain conditions, the use of a DSIC. Such alternative ratemaking procedures and mechanisms provide opportunity for accelerated cost-recovery and, therefore, are important to PPL Electric as it is in a period of significant capital investment to maintain and enhance the reliability of its delivery system, including the replacement of aging assets. PPL Electric utilized the fully projected future test year mechanism in its 2015 base rate proceeding. PPL has had the ability to utilize the DSIC recovery mechanism since July 2013.See Note 7 to the Financial Statements for additional information on rate mechanisms and legislative and regulatory matters.PLR The Customer Choice Act requires electric distribution companies, including PPL Electric, or an alternative supplier approved by the PAPUC, to act as a PLR of electricity supply for customers who do not choose to shop for supply with a competitive supplier and provides that electricity supply costs will be recovered by the PLR pursuant to PAPUC regulations. In 2022, the following average percentages of PPL Electric's customer load were provided by competitive suppliers: 37% of residential, 76% of small commercial and industrial and 95% of large commercial and industrial customers. PPL Electric’s electricity generation costs are established based upon the results of a competitive solicitation process. In December 2020, the PAPUC approved PPL Electric’s default service plan for the period June 1, 2021 through May 31, 2025, which includes a total of eight solicitations for electricity supply held semiannually in April and October. Through December 31, 2022, four auctions of the plan were completed. This plan also includes eight solicitations for alternative energy credits held semiannually in January and July. Through January 2023, four alternative energy credit solicitations have been completed.9Table of ContentsPursuant to the plans, PPL Electric contracts for all of the electricity supply for residential, commercial and industrial customers who elect to take default service from PPL Electric. These solicitations contain a mix of products including 5-year block energy contracts for residential customers, 6- and 12-month fixed-price load-following contracts for residential and small commercial and industrial customers, 12-month real-time pricing contracts for large commercial and industrial customers, and alternative energy credit contracts for residential, commercial and industrial customers. These contracts fulfill PPL Electric's obligation to provide customer electricity supply as a PLR.Numerous alternative suppliers have offered to provide generation supply in PPL Electric's service area. As the cost of generation supply is a pass-through cost for PPL Electric, its financial results are not impacted if its customers purchase electricity supply from these alternative suppliers.Rhode Island Regulated Segment (PPL)The Rhode Island Regulated segment consists primarily of the regulated electricity transmission and distribution operations and regulated distribution and sale of natural gas conducted by RIE.RIE is engaged in the regulated transmission, distribution and sale of electricity and regulated distribution and sale of natural gas in Rhode Island. RIE provides electric service to approximately 480,000 customers and natural gas service to approximately 270,000 customers. RIE's service area covers substantially all of Rhode Island. See Note 3 to the Financial Statements for revenue information.Franchises and LicensesRIE provides electricity delivery service and natural gas distribution service in its service territory pursuant to certain franchises, licenses, statutory service areas, easements and other rights or permissions granted by the Rhode Island state legislature, cities or municipalities or other entities. Competition There are currently no other electric or gas public utilities operating within the service area of RIE. Alternative energy sources such as electricity, oil, propane and other fuels indirectly impact RIE's natural gas revenues. Marketers may also compete to sell natural gas to certain large end-users. RIE's natural gas tariffs include gas price pass-through mechanisms relating to its sale of natural gas as a commodity. Therefore, customer natural gas purchases from alternative suppliers do not generally impact RIE's profitability. Some large industrial and commercial customers, however, may physically bypass RIE's facilities and seek delivery service directly from interstate pipelines or other natural gas distribution systems.Rates and RegulationIn general, RIE operates subject to the jurisdiction of the FERC, the RIPUC and the Rhode Island Division of Public Utilities and Carriers. DistributionRIE owns and maintains electric and natural gas distribution networks in Rhode Island. Distribution revenues are primarily from the sale of electricity, natural gas, and related services to retail customers. Distribution sales are regulated by the RIPUC, which is responsible for approving the rates and other terms of services as part of the rate making process. Natural gas and electric distribution revenues are derived from the regulated sale and distribution of electricity and natural gas to residential, commercial, and industrial customers within RIE’s service territory under the tariff rates. The tariff rates approved by the RIPUC are designed to recover the costs incurred by RIE for products and services provided, along with a return on investment.TransmissionRIE owns an electric transmission system in Rhode Island. RIE’s transmission services are regulated by the FERC and coordinated with ISO – New England. Additionally, RIE makes available its transmission facilities to NEP, for operation and 10Table of Contentscontrol pursuant to an integrated facilities agreement, Service Agreement No. 23 (Integrated Facilities Agreement or IFA). These revenues arise under tariff/rate agreements.Deferral MechanismsRIE records revenues in accordance with accounting principles for rate-regulated operations for arrangements between RIE and the applicable regulator. These include various deferral mechanisms such as capital trackers, energy efficiency programs, and other programs that qualify as Alternative Revenue Programs (ARPs). ARPs enable RIE to adjust rates in the future, in response to past activities or completed events. RIE’s electric and gas distribution rates both have a revenue decoupling mechanism, which allows for annual adjustments to the RIE’s delivery rates, as a result of the reconciliation between allowed revenue and billed revenue. RIE also has other ARPs related to the achievement of certain objectives, demand side management initiatives, and certain other rate making mechanisms. RIE recognizes ARPs with a corresponding offset to a regulatory asset or liability account when the regulatory specified events or conditions have been met, when the amounts are determinable, and are probable of recovery (or payment) through future rate adjustments.At December 31, 2022, all of RIE’s regulatory assets are authorized to earn a rate of return except $98 million of environmental response costs, $77 million of postretirement benefits and $61 million of net metering deferral costs.Last Resort ServiceRIE is required by the RIPUC and by statute to provide Last Resort Service. Last Resort Service is available to all customers who have not elected to receive their electric supply from a non-regulated power producer or any customer who, for any reason, has stopped receiving generation service from a non-regulated power producer.The charge for Last Resort Service is the sum of the applicable Last Resort Service charges in addition to all appropriate Retail Delivery charges as stated in the applicable tariff. The monthly charge for Last Resort Service also includes the costs incurred by RIE to comply with the Renewable Energy Standard, established in Rhode Island General Laws Section 39-26-1 and the costs to comply with the RIPUC’s Rules Governing Energy Source Disclosure. The charge for Last Resort Service includes the administrative costs associated with the procurement of Last Resort Service, including an adjustment for uncollectible accounts as approved by the RIPUC.Numerous alternative suppliers have offered to provide generation supply in RIE's service area. As the cost of generation supply is a pass-through cost for RIE, its financial results are not impacted if its customers purchase electricity supply from these alternative suppliers.See Note 7 to the Financial Statements for additional information on rate mechanisms and regulatory matters.Natural Gas Distribution SupplyTo meet the projected annual gas supply requirements of approximately 37 Bcf, RIE has a portfolio of gas supply arrangements of varying contractual terms and durations to provide service to its customers. These natural gas supply arrangements include contracts with natural gas producers and marketers that reflect market price signals. RIE also has firm pipeline and underground storage capacity contracts to support the delivery of natural gas supplies to its customers. To manage the winter peak requirements for RIE customers, RIE contracts for liquified natural gas (LNG) service and owns and operates certain LNG storage facilities.The RIE gas supply portfolio includes contracts for firm transportation service with eleven interstate pipeline companies and natural gas storage operators. These contracts have various termination dates with certain contracts being subject to evergreen renewal provisions providing RIE with flexibility in managing its upstream resource portfolio. RIE has purchased and expects to continue to purchase natural gas supplies for its gas distribution operations from onshore producing regions accessed by its pipeline capacity portfolio in South Texas, East Texas, and Louisiana, as well as gas originating in the Marcellus and Utica production areas. RIE expects to purchase certain natural gas supplies that originate in Canada and from regional LNG import terminals. 11Table of ContentsCorporate and Other (PPL)PPL Services provides PPL subsidiaries with administrative, management and support services. The costs of these services are charged directly to the respective recipients for the services provided or indirectly charged to applicable recipients based on an average of the recipients' relative invested capital, operation and maintenance expenses and number of employees or a ratio of overall direct and indirect costs.PPL Capital Funding provides financing for the operations of PPL and certain subsidiaries. PPL's growth in rate-regulated businesses provides the organization with an enhanced corporate level financing alternative, through PPL Capital Funding, that enables PPL to cost effectively support targeted credit profiles across all of PPL's rated companies. As a result, PPL utilizes PPL Capital Funding as a source of capital in financings, in addition to continued direct financing by certain operating subsidiaries.Unlike those of PPL Services, PPL Capital Funding's costs are not generally charged to PPL subsidiaries. Costs are charged directly to PPL. However, PPL Capital Funding participated significantly in the financing for the acquisition of LKE and certain associated financing costs were allocated to the Kentucky Regulated Segment. Prior to 2021, the associated financing costs, as well as the financing costs associated with prior issuances of certain other PPL Capital Funding securities, were assigned to the relevant segments for purposes of PPL management's assessment of segment performance. Beginning in 2021, corporate level financing costs are no longer allocated to the reportable segments. ENVIRONMENTAL MATTERS(All Registrants)The Registrants are subject to certain existing and developing federal, regional, state and local laws and regulations with respect to air and water quality, land use and other environmental matters, and may be subject to different and more stringent such laws and regulations enacted in the future. The EPA and other federal agencies with jurisdiction over environmental matters have issued numerous environmental regulations relating to air, water and waste that directly affect the electric power industry. Due to these environmental issues, it may be necessary for the Registrants to modify or cease certain operations or operation of certain facilities to comply with statutes, regulations and other requirements of regulatory bodies or courts. In addition, legal challenges to environmental permits or rules add uncertainty to estimating future costs of complying with such permits and rules. The Biden administration is currently undertaking changes in a wide range of environmental programs.See “Legal Matters” in Note 14 to the Financial Statements for a discussion of environmental commitments and contingencies. See "Financial Condition - Liquidity and Capital Resources - Forecasted Uses of Cash - Capital Expenditures" in "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" for information on projected environmental capital expenditures for 2023 through 2025. See Note 20 to the Financial Statements for information related to the impacts of CCRs on AROs.LG&E and KU are entitled to recover, through the ECR mechanism, certain costs of complying with the Clean Air Act, as amended, and other federal, state and local environmental requirements applicable to coal combustion wastes and by-products from coal-fired generating facilities upon KPSC review. Costs not covered by the ECR mechanism for LG&E and KU and all such costs for PPL Electric are subject to rate recovery at the discretion of the companies' respective state regulatory authorities, or the FERC, if applicable. Because PPL Electric and RIE do not own any generating plants, they have less exposure to related environmental compliance costs. The Registrants can provide no assurances as to the ultimate outcome of future proceedings before regulatory authorities.AirNAAQS (PPL, LG&E and KU)Applicable regulations require each state to identify areas within its boundaries that fail to meet the NAAQS, (known as nonattainment areas), and develop a state implementation plan to achieve and maintain compliance. States that are found to contribute significantly to another state's nonattainment with ozone standards are required to establish "good neighbor" state implementation plans. In addition, for attainment of ozone and fine particulates standards, certain states, including Kentucky, are subject to a regional EPA program known as the Cross-State Air Pollution Rule (CSAPR). 12Table of ContentsThe Clean Air Act has a significant impact on the operation of fossil fuel generation plants. The Clean Air Act requires the EPA periodically to establish and review NAAQS for six pollutants: carbon monoxide, lead, nitrogen dioxide, ozone (contributed to by nitrogen oxide emissions), particulate matter and sulfur dioxide. In December 2020, the EPA released final actions keeping the existing NAAQS standard for particulate matter and ozone without change, but the EPA subsequently announced reconsideration of those decisions in June 2021. On January 6, 2023, the EPA released a pre-publication proposed revision to the particulate matter standard that would lower the primary standard for fine particulates to a level to be determined after review of additional public comments. Depending on the final standard adopted by the EPA, the EPA could potentially designate Jefferson County, Kentucky (Louisville) as being in nonattainment with the new particulate matter standard and require additional particulate matter reductions from sources including LG&E’s Mill Creek Station. PPL, LG&E, and KU are unable to predict the outcome of future evaluations by the EPA and the states with respect to the NAAQS standards.In January 2018, the EPA designated Jefferson County, Kentucky (Louisville) as being in nonattainment with the existing 2015 ozone standard. In 2020 and 2021, LG&E entered into agreements with the Louisville Metro Air Pollution Control District for temporary nitrogen oxide emission limits at LG&E's Mill Creek Station during those years to facilitate compliance with the ozone standard. In October 2022, Jefferson County was “bumped up” to the moderate nonattainment classification, but the Louisville Air Pollution Control District has applied to the EPA for Jefferson County to be redesignated as in attainment. Although PPL and LG&E expect Jefferson County to be redesignated as in attainment, if the EPA declines to issue such a redesignation, Jefferson County could be subject to additional requirements including requirements for installation of reasonably available control technology on coal-fired generating units. Compliance with such requirements may require installation of additional pollution controls or other compliance actions. PPL and LG&E are unable to determine the impact on operations until certain compliance determinations are made by the EPA and Kentucky.In March 2021, the EPA released final revisions to the CSAPR, aimed at ensuring compliance with the 2008 ozone NAAQS and providing for reductions in ozone season nitrogen oxide emissions for 2021 and subsequent years from sources in 12 states, including Kentucky. Additionally, the EPA reversed its previous approval of the Kentucky State Implementation Plan with respect to these requirements. In February 2022, the EPA Administrator released a proposed Federal Implementation Plan under the Good Neighbor provisions of the Clean Air Act providing for significant additional nitrogen oxide emission reductions for compliance with the revised 2015 ozone NAAQS. The proposed reductions in Kentucky state-wide nitrogen oxide budgets are scheduled to commence in 2023, with the largest reductions planned for 2026, based on the installation time frame for certain selective catalytic reduction controls, subject to future specific allowance calculations. PPL, LG&E and KU are currently assessing the potential impact of the proposed Good Neighbor Plan revisions on operations. The current and proposed rules provide for reduced availability of nitrogen oxide allowances that have historically permitted operational flexibility for fossil units and could potentially result in constraints that may require implementation of additional emission controls or accelerate implementation of lower emission generation technologies. Pursuant to the President’s executive order, the EPA is currently reviewing its previous determinations made in December 2020 to retain the existing NAAQS for ozone and particulate matter without change, including a pre-publication proposed revision that was released by the EPA on January 6, 2023.PPL, LG&E, and KU are unable to predict future emission reductions that may be required by future federal rules or state implementation actions. Compliance with the NAAQS, CSAPR and related requirements may require installation of additional pollution controls or other compliance actions, inclusive of retirements, the costs of which PPL, LG&E and KU believe would be subject to rate recovery.Climate Change (All Registrants)The Biden administration is undertaking wide-ranging efforts to address climate change. Recent government actions and policy developments, including the President’s announced goal of a carbon free electricity sector by 2035, could have far-reaching impacts on PPL’s business operations, products, and services. On June 30, 2022, the Supreme Court ruled that provisions of the EPA's Clean Power Plan, premised on generation shifting from coal-fired plants to lower emitting natural gas-fired plants and renewables, exceeded the authority granted to the EPA under the Clean Air Act. The EPA has announced that it plans on issuing new greenhouse gas rules in the future. It is uncertain how the Supreme Court ruling may impact future EPA rulemaking. All of these developments are preliminary or ongoing in nature and the Registrants cannot predict the final outcome or ultimate impact on operations.PPL has adopted a goal of net-zero carbon emissions by 2050, which PPL expects will include continuing to retire coal-fired generation and investing in research and innovation that will help to achieve this goal, while maintaining reliable and affordable energy in our service territories. The net-zero goal relates to direct and indirect carbon emissions consistent with Greenhouse Gas Protocol guidance and referenced by the EPA Center for Corporate Climate Leadership. Through 2021, PPL reduced carbon emissions nearly 60% from 2010 levels and is targeting a 70% reduction from 2010 levels by 2035 and an 80% reduction by 2040. 13Table of ContentsPPL is also aware of the various risks associated with climate change, including increased frequency and severity of severe weather. To address these risks, PPL continues to work to advance grid modernization and improve the Company's equipment to help mitigate the impacts of extreme weather events and improve reliability.Water/Waste(PPL, LG&E and KU)Clean Water ActRegulations under the federal Clean Water Act dictate permitting and mitigation requirements for facilities and construction projects that impact "Waters of the United States". Many other requirements relate to power plant operations, including the treatment of pollutants in effluents prior to discharge, the temperature of effluent discharges and the location, design and construction of cooling water intake structures at generating facilities, and standards intended to protect aquatic organisms that become trapped at or pulled through cooling water intake structures at generating facilities. These requirements could impose significant costs for LG&E and KU, which are expected to be subject to rate recovery.Clean Water Act JurisdictionEnvironmental groups and others have claimed that discharges to groundwater from leaking CCR impoundments at power plants are subject to Clean Water Act permitting. On April 12, 2019, the EPA released regulatory clarification finding that Clean Water Act jurisdiction does not cover such discharges to groundwater. On January 23, 2020, the EPA announced a final rule modifying the jurisdictional scope of the Clean Water Act. The announced rule revises the definition of the "Waters of the United States," including a revision to exclude groundwater from the definition. In April 2020, the U.S. Supreme Court issued a ruling that Clean Water Act jurisdiction may apply to certain discharges to groundwater that result in the functional equivalent of a direct discharge to navigable waters. PPL, LG&E, and KU are unaware of any unpermitted releases from their facilities that are subject to Clean Water Act jurisdiction, but future regulatory developments and judicial rulings could potentially subject certain releases from CCR impoundments and landfills to additional permitting and remediation requirements, which could impose substantial costs. Any associated costs are expected to be subject to rate recovery. PPL, LG&E and KU are unable to predict the outcome or financial impact of future regulatory proceedings and litigation.Waters of the United StatesPPL, LG&E, and KU are subject to permitting and mitigation requirements for certain construction activities that impact "Waters of the United States." On April 21, 2020, the EPA and U.S. Army Corps of Engineers published a final rule revising the definition of "Waters of the United States" to exclude jurisdiction over certain surface waters. On August 30, 2021, a U.S. District Court in Arizona vacated and remanded the rule. On December 7, 2021, the EPA and U.S. Army Corps of Engineers proposed to repeal the rule and restore the definition of "Waters of the United States" that was in place prior to 2015. On January 24, 2022, the U.S. Supreme Court granted review of a case raising the issue of the appropriate scope of the definition of "Waters of the United States" under the Clean Water Act. On January 18, 2023, the EPA and U.S. Army Corps of Engineers published a final revision to the rule broadening the definition of Waters of the United States and reverting to the pre-2015 regulatory framework. Although the broader definition incorporates additional water bodies, any resulting permitting, construction, and operational expenses are expected to be immaterial and subject to rate recovery. PPL, LG&E and KU are unable to predict the outcome of current or future litigation or regulatory proceedings, but do not expect a material impact on operations.Superfund and Other Remediation(All Registrants)From time to time, PPL's subsidiaries undertake testing, monitoring or remedial action in response to spills or other releases at various on-site and off-site locations, negotiate with the EPA and state and local agencies regarding actions necessary to comply with applicable requirements, negotiate with property owners and other third parties alleging impacts from PPL's operations and undertake similar actions necessary to resolve environmental matters that arise in the course of normal operations. Based on analyses to date, resolution of these environmental matters is not expected to have a significant adverse impact on the operations of PPL, PPL Electric, LG&E and KU.Future cleanup or remediation work at sites not yet identified may result in significant additional costs for the Registrants. Insurance policies maintained by LG&E and KU may be available to cover certain of the costs or other obligations related to these matters, but the amount of insurance coverage or reimbursement cannot be estimated or assured. 14Table of ContentsSee “Legal Matters” in Note 14 to the Financial Statements for additional information.(All Registrants)SEASONALITYThe demand for and market prices of electricity and natural gas are affected by weather. As a result, the Registrants' operating results in the future may fluctuate substantially on a seasonal basis, especially when unpredictable weather conditions make such fluctuations more pronounced. The pattern of this fluctuation may change depending on the type and location of the facilities owned. FINANCIAL CONDITIONSee "Financial Condition" in "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" for this information.CAPITAL EXPENDITURE REQUIREMENTSSee "Financial Condition - Liquidity and Capital Resources - Forecasted Uses of Cash - Capital Expenditures" in "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" for information concerning projected capital expenditure requirements for 2023 through 2025. See "Item 1. Business - Environmental Matters" for additional information concerning the potential impact on capital expenditures from environmental matters.HUMAN CAPITAL PPL, together with its subsidiaries, is committed to fostering an exceptional workplace for employees. PPL pledges to enable the success of its current and future workforce by cultivating a diverse, equitable and inclusive culture, fostering professional development, encouraging employee engagement, and ensuring a safe and healthy work environment. Matters related to these priorities and corporate culture are overseen by PPL's senior management, which provides updates to the PPL Board of Directors (the Board). Pursuant to its charter, the Compensation Committee of the Board of Directors also periodically reviews and assesses the Company's strategy for human capital management. PPL's investment in the success of our workforce is embodied in the following areas with dedicated leadership and Board oversight: •Diversity, equity and inclusion (DEI) - Foster an inclusive, respectful and diverse workplace through a comprehensive DEI strategy and commitments. PPL created a chief diversity officer position in 2022 to lead the company's DEI efforts. Senior management reviews demographic metrics, DEI objectives and associated programs semi-annually. The Board also receives periodic updates from senior management on PPL's DEI strategy and initiatives.•Employee engagement - Create a workplace that fosters an engaged, high-quality workforce. PPL's operating companies regularly conduct assessments related to employee engagement, safety and culture. Senior management reviews corporate culture with the Board annually.•Professional development - Invest in our current and future workforce through training and development, succession planning and creation of a pipeline for internal advancement. Senior management reviews succession planning with the Compensation Committee of the Board on an annual basis.•Comprehensive benefits - In addition to challenging careers and competitive salaries, PPL offers competitive benefits programs to attract and retain talent and support employees' well-being. PPL offers competitive vacation time, expanded leave for new parents, retirement programs, and internal and external development opportunities, including tuition reimbursement offerings for undergraduate and certain graduate degrees. Senior management conducts annual benchmarking of employee compensation and benefits.•Safety and Compliance - PPL is also committed to maintaining an ethical and safe workplace culture. Additional steps to ensure Board oversight in these areas include: •Safety – PPL carries out programs focused on health and safety, including emergency preparedness, vehicle safety and accident prevention. Employees receive safety training and are encouraged to share, implement, and follow best practices. Senior management receives monthly safety data updates to determine whether additional safety measures should be implemented. The Board annually reviews the company's safety programs and results. The Board is also immediately engaged in the event of a fatality. •Compliance – The Corporate Compliance Committee, including senior executives, meets quarterly to discuss metrics and other matters related to the compliance and ethics culture. Among the items discussed are 15Table of Contentsstatistics regarding Ethics Helpline reports and employee concerns. This information is also reviewed with the Audit Committee of the Board quarterly. PPL will continue to engage with employees and to assess these priorities as we work to best position individuals and the company for future success. PPL had a turnover rate of 10.7% for the year ended December 31, 2022. Looking forward, we will maintain our strong focus on workforce planning to address future talent needs.At December 31, 2022, PPL and its subsidiaries had the following full-time employees and employees represented by labor unions:Total Full-TimeEmployeesNumber of UnionEmployeesPercentage of TotalWorkforcePPL6,527 2,411 37 %PPL Electric1,382 913 66 %LG&E964 618 64 %KU807 109 14 %(PPL and PPL Electric) In March 2022, members of the IBEW Local 1600 ratified a new five-year labor agreement with PPL and PPL Electric. The contract covers over 900 employees and was effective May 16, 2022. The current five-year agreement expires in May 2027. The terms of the new labor agreement are not expected to have a significant impact on the financial results of PPL or PPL Electric.(PPL and KU) Labor agreement negotiations with the KU USW are expected to commence in July 2023. The current contract covers over 40 employees and is scheduled to expire in August 2023.(PPL and LG&E) Labor agreement negotiations with the LG&E IBEW are expected to commence in October 2023. The current contract covers over 600 employees and is scheduled to expire in November 2023. CYBERSECURITY MANAGEMENTThe Registrants and their subsidiaries are subject to risks from cyber-attacks that have the potential to cause significant interruptions to the operation of their businesses. The frequency of these attempted intrusions has increased in recent years and the sources, motivations and techniques of attack continue to evolve and change rapidly. PPL has adopted a variety of measures to monitor and address cyber-related risks and continues to implement and explore additional cybersecurity measures. Cybersecurity and the effectiveness of PPL's cybersecurity strategy are regular topics of discussion at Board of Directors meetings. PPL's strategy for managing cyber-related risks is risk-based and, where appropriate, integrated within PPL's enterprise risk management processes. PPL's Vice President and Chief Security Officer (CSO), who reports directly to the President and Chief Executive Officer (CEO), leads a dedicated cybersecurity team and is responsible for the design, implementation, and execution of cyber-risk management strategy. In addition, among other things, the CSO and the cybersecurity team actively monitor the Registrants' systems, regularly review policies, compliance, regulations and best practices, perform penetration testing, conduct incident response exercises and internal ethical phishing campaigns, and provide training and communication across the organization to strengthen secure behavior and foster a culture of security. The cybersecurity team also routinely participates in industry-wide programs to further information sharing, intelligence gathering, and unity of effort in responding to potential or actual attacks. In addition, PPL has a formal internal policy and procedures for communicating cybersecurity incidents on an enterprise-wide basis. In addition to these enterprise-wide initiatives, PPL's Kentucky, Pennsylvania and Rhode Island operations are subject to extensive and rigorous mandatory cybersecurity requirements that are developed and enforced by NERC and approved by the FERC to protect grid security and reliability. LG&E is also subject to certain security directives related to cybersecurity issued by the Department of Homeland Security’s Transportation Security Administration in 2021. See Note 14 to the Financial Statements for additional information on these directives. Finally, PPL purchases insurance to protect against a wide range of costs that could be incurred in connection with cyber-related incidents. There can be no assurance, however, that these efforts will be effective to prevent interruption of services or other damage to the Registrants' businesses or operations or that PPL's insurance coverage will cover all costs incurred in connection with any cyber-related incident.16Table of ContentsAVAILABLE INFORMATIONPPL's Internet website is www.pplweb.com. Under the Investors heading of that website, PPL provides access to SEC filings of the Registrants (including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports filed or furnished pursuant to Section 13(d) or 15(d)) free of charge, as soon as reasonably practicable after filing with the SEC. The information contained on, or available through, PPL's Internet website is not, and shall not be deemed to be, incorporated by reference into this report. Additionally, the Registrants' filings are available at the SEC's website (www.sec.gov).17Table of ContentsITEM 1A. RISK FACTORSThe Registrants face various risks associated with their businesses. Our businesses, financial condition, cash flows or results of operations could be materially adversely affected by any of these risks. In addition, this report also contains forward-looking and other statements about our businesses that are subject to numerous risks and uncertainties. See "Forward-Looking Information," "Item 1. Business," "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 14 to the Financial Statements for additional information concerning the risks described below and for other risks, uncertainties and factors that could impact our businesses and financial results.As used in this Item 1A., the terms "we," "our" and "us" generally refer to PPL and its consolidated subsidiaries taken as a whole, or PPL Electric and its consolidated subsidiaries taken as a whole within the Pennsylvania Regulated segment discussion, LKE and its consolidated subsidiaries taken as a whole within the Kentucky Regulated segment discussion, and RIE and its consolidated subsidiaries taken as a whole within the Rhode Island Regulated segment discussion.Order of Subsection PresentationA.Risks Related to Registrant Holding CompanyB.Risks Related to Regulated Utility OperationsC.Risks Specific to Kentucky Regulated SegmentD.Risks Specific to Pennsylvania Regulated SegmentE.Risks Specific to Rhode Island Regulated SegmentF.Risks Related to All Segments(PPL)A. Risk Related to Registrant Holding CompanyPPL is a holding company and its cash flows and ability to meet its obligations with respect to indebtedness and under guarantees, and its ability to pay dividends, largely depends on the financial performance of its respective subsidiaries and, as a result, is effectively subordinated to all existing and future liabilities of those subsidiaries.PPL is a holding company and conducts its operations primarily through subsidiaries. Substantially all of the consolidated assets of PPL are held by its subsidiaries. Accordingly, PPL's cash flows and ability to meet debt and guaranty obligations, as well as PPL's ability to pay dividends, are largely dependent upon the earnings of those subsidiaries and the distribution or other payment of such earnings in the form of dividends, distributions, loans, advances or repayment of loans and advances. The subsidiaries are separate legal entities and have no obligation to pay dividends or distributions to their parents or to make funds available for such a payment. The ability of PPL's subsidiaries to pay dividends or distributions in the future will depend on the subsidiaries' future earnings and cash flows and the needs of their businesses, and may be restricted by their obligations to holders of their outstanding debt and other creditors, as well as any contractual or legal restrictions in effect at such time, including the requirements of state corporate law applicable to payment of dividends and distributions, and regulatory requirements, including restrictions on the ability of PPL Electric, LG&E, KU, and RIE to pay dividends under Section 305(a) of the Federal Power Act.Because PPL is a holding company, its debt and guaranty obligations are effectively subordinated to all existing and future liabilities of its subsidiaries. Although certain agreements to which certain subsidiaries are parties limit their ability to incur additional indebtedness, PPL and its subsidiaries retain the ability to incur substantial additional indebtedness and other liabilities. Therefore, PPL's rights and the rights of its creditors, including rights of debt holders, to participate in the assets of any of its subsidiaries, in the event that such a subsidiary is liquidated or reorganized, will be subject to the prior claims of such subsidiary's creditors.(All Registrants)B. Risks Related to Regulated Utility OperationsOur regulated utility businesses face many of the same risks, in addition to those risks that are unique to each of the Kentucky Regulated, Pennsylvania Regulated and Rhode Island Regulated segments. Set forth below are risk factors common to the regulated segments, followed by sections identifying separately the risks specific to each of these segments.18Table of ContentsOur profitability is highly dependent on our ability to recover the costs of providing energy and utility services to our customers and earn an adequate return on our capital investments. Regulators may not approve the rates we request and existing rates may be challenged.The rates we charge our utility customers must be approved by one or more federal or state regulatory commissions, including the FERC, KPSC, VSCC, PAPUC and RIPUC. Although rate regulation is generally premised on the recovery of prudently incurred costs and a reasonable rate of return on invested capital, there can be no assurance that regulatory authorities will consider all of our costs to have been prudently incurred or that the regulatory process by which rates are determined will always result in rates that achieve full or timely recovery of our costs or an adequate return on our capital investments. Federal or state agencies, intervenors and other permitted parties may challenge our current or future rate requests, structures or mechanisms, and ultimately reduce, alter or limit the rates we receive. Although our rates are generally regulated based on an analysis of our costs incurred in a base year or on future projected costs, the rates we are allowed to charge may or may not match our costs at any given time. Our regulated utility businesses are subject to substantial capital expenditure requirements over the next several years, which may require rate increase requests to the regulators in the future. If our costs are not adequately recovered through rates, it could have an adverse effect on our business, results of operations, cash flows and financial condition.Our utility businesses are subject to significant and complex governmental regulation.In addition to regulating the rates we charge, various federal and state regulatory authorities regulate many aspects of our utility operations, including: •the terms and conditions of our service and operations;•financial and capital structure matters;•siting, construction and operation of facilities;•mandatory reliability and safety standards under the Energy Policy Act of 2005 and other standards of conduct;•accounting, depreciation and cost allocation methodologies;•tax matters;•affiliate transactions;•acquisition and disposal of utility assets and issuance of securities; and•various other matters, including energy efficiency.Such regulations or changes thereto may subject us to higher operating costs or increased capital expenditures and failure to comply could result in sanctions or possible penalties which may not be recoverable from customers. Our regulated businesses undertake significant capital projects and these activities are subject to unforeseen costs, delays or failures, as well as risk of inadequate recovery of resulting costs. The regulated utility businesses are capital intensive and require significant investments in energy generation (in the case of LG&E and KU) and transmission, distribution and other infrastructure projects, such as projects for environmental compliance and system reliability. The completion of these projects without delays or cost overruns is subject to risks in many areas, including: •approval, licensing and permitting;•land acquisition and the availability of suitable land;•skilled labor or equipment shortages;•construction problems or delays, including disputes with third-party intervenors;•increases in commodity prices or labor rates; •potential supply chain disruptions or delays; and•contractor performance.Failure to complete our capital projects on schedule or on budget, or at all, could adversely affect our financial performance, operations and future growth if such expenditures are not granted rate recovery by our regulators. We are or may be subject to costs of remediation of environmental contamination at facilities owned or operated by our former subsidiaries. We may be subject to liability for the costs of environmental remediation of property now or formerly owned by us with respect to substances that we may have generated regardless of whether the liabilities arose before, during or after the time we owned 19Table of Contentsor operated the facilities. We also have current or previous ownership interests in sites associated with the production of manufactured gas for which we may be liable for additional costs related to investigation, remediation and monitoring of these sites. Remediation activities associated with our former manufactured gas plant operations are one source of such costs. Citizen groups or others may bring litigation regarding environmental issues including claims of various types, such as property damage, personal injury and citizen challenges to compliance decisions on the enforcement of environmental requirements, which could subject us to penalties, injunctive relief and the cost of litigation. We cannot predict the amount and timing of future expenditures (including the potential or magnitude of fines or penalties) related to such environmental matters, although they could be material.C. Risks Specific to Kentucky Regulated Segment (PPL, LG&E and KU) We are subject to financial, operational, regulatory and other risks related to requirements, developments and uncertainties in environmental regulation, including those affecting coal-fired generation facilities.Extensive federal, state and local environmental laws and regulations are applicable to LG&E's and KU's generation supply, including its air emissions, water discharges (ELGs) and the management of hazardous and solid wastes (CCRs), among other business-related activities, and the costs of compliance or alleged non-compliance cannot be predicted and could be material. In addition, our costs may increase significantly if the requirements or scope of environmental laws, regulations or similar rules are expanded or changed as the environmental standards governing LG&E’s and KU’s businesses, particularly as applicable to coal-fired generation and related activities, continue to be subject to uncertainties due to rulemaking and other regulatory developments, legislative activities and litigation, administrative and permit challenges. The Biden administration is considering a wide range of potential policies, executive orders, rules, legislation and other initiatives in connection with climate change that may affect these costs. Depending on the extent, frequency and timing of such changes, LG&E and KU may face higher risks of unsuccessful implementation of environmental-related business plans, noncompliance with applicable environmental rules, delayed or incomplete rate recovery or increased costs of implementation. Costs may take the form of increased capital expenditures or operating and maintenance expenses, monetary fines, penalties or forfeitures, operational changes, permit limitations or other restrictions. At some of our older generating facilities it may be uneconomic for us to install necessary pollution control equipment, which could cause us to retire those units. Market prices for energy and capacity also affect this cost-effectiveness analysis. Many of these environmental law considerations are also applicable to the operations of our key suppliers or customers, such as coal producers, power producers and industrial power users, and may impact the costs of their products and demand for our services.(PPL and LG&E)We are subject to operational, regulatory and other risks regarding natural gas supply infrastructure.A natural gas pipeline explosion or associated incident could have a significant impact on LG&E’s natural gas operations or result in significant damages and penalties that could have an adverse impact on LG&E’s financial position and results of operations. The Pipeline and Hazardous Materials Safety Administration enforces regulations that govern the design, construction, operation and maintenance of pipeline facilities. Failure to comply with these regulations could result in the assessment of fines or penalties against LG&E. These regulations require, among other things, that pipeline operators take certain measures with respect to pipeline integrity. Depending on the results of integrity tests and other integrity program activities, we could incur significant and unexpected costs to perform remedial activities on our natural gas infrastructure to ensure our continued safe and reliable operation. Recent pipeline incidents in the U.S. have also led to the introduction of proposed rules and possible federal legislative actions which could impose restrictions on LG&E’s operations or require more stringent testing to ensure pipeline integrity. Implementation of these regulations could increase our costs to comply with pipeline integrity and safety regulations.D. Risks Specific to Pennsylvania Regulated Segment(PPL and PPL Electric)We face competition for transmission projects, which could adversely affect our rate base growth.FERC Order 1000, issued in July 2011, establishes certain procedural and substantive requirements relating to participation, cost allocation and non-incumbent developer aspects of regional and inter-regional electricity transmission planning activities. The PPL Electric transmission business, operating under a FERC-approved PJM Open Access Transmission Tariff, is subject to 20Table of Contentscompetition pursuant to FERC Order 1000 from entities that are not incumbent PJM transmission owners with respect to the construction and ownership of transmission facilities within PJM. Increased competition can result in lower rate base growth.We could be subject to higher costs and/or penalties related to Pennsylvania Conservation and Energy Efficiency Programs.PPL Electric is subject to Act 129, which contains requirements for energy efficiency and conservation programs and for the use of smart metering technology, imposes PLR electricity supply procurement rules, provides remedies for market misconduct, and made changes to the existing Alternative Energy Portfolio Standard. The law also requires electric utilities to meet specified goals for reduction in customer electricity usage and peak demand. Utilities not meeting these Act 129 requirements are subject to significant penalties that cannot be recovered in rates. Numerous factors outside of our control could prevent compliance with these requirements and result in penalties to us.E. Risks Related to the Rhode Island Regulated Segment(PPL)PPL may not realize the anticipated benefits of the RIE acquisition, which could materially adversely affect PPL's business, financial condition and results of operations.PPL may not realize the anticipated financial and operational benefits from the RIE acquisition if the business is not integrated in an efficient and effective manner or if integration takes longer than anticipated. These integration risks include potential difficulties in conversion of systems and information, difficulties in harmonizing inconsistencies in standards, controls, procedures, practices and policies, disruption from the acquisition making it more difficult to maintain relationships with customers, employees or suppliers, and diversion of management time and attention to integration and other acquisition-related issues. In addition, PPL has incurred, and will continue to incur, significant costs in connection with the integration, and additional unanticipated costs may arise. No assurance can be given that the anticipated benefits from the acquisition will be achieved or, if achieved, the timing of their achievement. These risks and their consequences could result in increased costs or decreases in the amount of expected revenues and could have a material adverse effect on PPL's business, financial condition and results of operations. We are subject to operational, regulatory and other risks regarding natural gas supply infrastructure in Rhode Island. A natural gas pipeline explosion or associated incident could have a significant impact on RIE's natural gas operations or result in significant damages and penalties that could have an adverse impact on RIE’s financial position and results of operations. The Pipeline and Hazardous Materials Safety Administration enforces regulations that govern the design, construction, operation and maintenance of pipeline facilities. Failure to comply with these regulations could result in the assessment of fines or penalties against RIE. These regulations require, among other things, that pipeline operators take certain measures with respect to pipeline integrity. Depending on the results of integrity tests and other integrity program activities, we could incur significant and unexpected costs to perform remedial activities on our natural gas infrastructure to ensure our continued safe and reliable operation. F. Risks Related to All Segments(All Registrants)COVID-19 or other pandemics and resultant impact on business and economic conditions could negatively affect our business.The COVID-19 pandemic disrupted the U.S. and global economies. While its impact is waning in many respects, a resurgence, new variant or other pandemic and related remediation efforts could present challenges to businesses, communities, workforces, markets and supply chains. The COVID-19 virus continues to pose risks to the health and welfare of the Registrants’ customers, employees, contractors and suppliers, and to affect the conduct of their business. The COVID-19 pandemic has been a contributing factor to certain supply chain shortages that have created risks of potential equipment and fuel supply chain disruptions. These issues may continue or become worse, as a result of pandemics and other factors, and Registrants may be forced to rely on a larger pool of suppliers, which could pose operational risks. These factors have the potential to materially and adversely affect the Registrants’ business and operations, especially if they are exacerbated by a resurgence or other pandemics. At this time, the Registrants’ cannot predict the extent to which these or other pandemic-related factors may affect their business, earnings or other financial results.21Table of ContentsOur business operations are continually subject to cyber-based security and data integrity risks from vulnerabilities related to our IT systems, operational technology infrastructure and supply chain relationships.Numerous functions affecting the efficient operation of our businesses are dependent on the secure and reliable storage, processing and communication of electronic data and the use of sophisticated computer hardware and software systems. The operation of our transmission and distribution systems, including gas distribution systems, as well as our generation plants, are all reliant on cyber-based technologies and, therefore, subject to the risk that these systems could be the target of disruptive actions by terrorists, nation state actors or criminals or otherwise be compromised by unintentional events. Attacks may come through ransomware, software updates or patches, use of opensource software, firmware that hackers can manipulate to include malicious codes for exploitation at a later date, or the compromising of hardware by bad actors, creating serious risks to our security, the security of our customers' information, and potentially to our ability to provide power. As a result, operations could be interrupted, property could be damaged and sensitive customer information lost or stolen, causing us to incur significant losses of revenues, other substantial liabilities and damages, costs to replace or repair damaged equipment and damage to our reputation. Threats to our systems and operations continue to emerge as new ways to compromise components of our systems or networks are developed. Additionally, cybersecurity risks also threaten our supply chains, including aspects that are not under our control, such as the incorporation of opensource software in systems or software that we use, that despite our efforts do not meet our current security standards.In addition, under the Energy Policy Act of 2005, users, owners and operators of the bulk power transmission system, including PPL Electric, LG&E, KU and RIE, are subject to mandatory reliability standards promulgated by NERC and enforced by the FERC. As an operator of natural gas distribution systems, LG&E is also subject to mandatory reliability standards of the U.S. Department of Transportation and is also subject to certain security directives related to cybersecurity issued by the Department of Homeland Security (DHS) Transportation Security Administration (TSA) in 2021. The TSA has determined that LG&E is critical, while RIE has not been notified of this distinction and is therefore not currently subject to the security directives. Failure to comply with these standards could result in the imposition of fines or civil penalties, and potential exposure to third party claims for alleged violations of the standards.We are subject to risks associated with federal and state tax laws and regulations.Changes in tax law as well as the inherent difficulty in quantifying potential tax effects of business decisions could negatively impact our results of operations and cash flows. We are required to make judgments in order to estimate our obligations to taxing authorities. These tax obligations include income, property, gross receipts, franchise, sales and use, employment-related and other taxes. We also estimate our ability to utilize deferred tax assets and tax credits. Dependent upon the revenue needs of the jurisdictions in which our businesses operate, various tax and fee increases may be proposed or considered. We cannot predict changes in tax law or regulation or the effect of any such changes on our businesses. Any such changes could increase tax expense and could have a significant negative impact on our results of operations and cash flows. The effects of the TCJA have been reflected in our financial statements, and we continue to evaluate the application of the law in calculating income tax expense. Increases in electricity prices and/or a weak economy can lead to changes in legislative and regulatory policy, including the promotion of energy efficiency, conservation and distributed generation or self-generation, which may adversely impact our business. Energy consumption is significantly impacted by overall levels of economic activity and costs of energy supplies. Economic downturns or periods of high energy supply costs can lead to changes in or the development of legislative and regulatory policy designed to promote reductions in energy consumption and increased energy efficiency, alternative and renewable energy sources, and distributed or self-generation by customers. This focus on conservation, energy efficiency and self-generation may result in a decline in electricity demand, which could adversely affect our business.We could be negatively affected by rising interest rates, downgrades to our credit ratings, adverse credit market conditions or other negative developments in our ability to access capital markets. Our businesses are capital-intensive and, in the ordinary course of business, we are reliant upon adequate long-term and short-term financing to fund our significant capital expenditures, debt service and operating needs. As a result, we are sensitive to developments in interest rates, credit rating considerations, insurance, security or collateral requirements, market liquidity and credit availability and refinancing opportunities necessary or advisable to respond to credit market changes. Changes in these conditions could result in increased costs and decreased availability of credit. In addition, certain sources of debt and equity capital have expressed reservations about investing in companies that rely on fossil fuels. If sources of our capital are reduced, capital costs could increase materially.22Table of Contents A downgrade in our credit ratings could negatively affect our ability to access capital and increase the cost of maintaining our credit facilities and any new debt. Credit ratings assigned by Moody's and S&P to our businesses and their financial obligations have a significant impact on the cost of capital incurred by our businesses. A ratings downgrade could increase our short-term borrowing costs and negatively affect our ability to fund liquidity needs and access new long-term debt at acceptable interest rates. See "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Liquidity and Capital Resources - Ratings Triggers" for additional information on the financial impact of a downgrade in our credit ratings. Our operating revenues could fluctuate on a seasonal basis, especially as a result of extreme weather conditions, including conditions caused or exacerbated by climate change. Our businesses are subject to seasonal demand cycles. For example, in some markets demand for, and market prices of, electricity peak during hot summer months, while in other markets such peaks occur in cold winter months. As a result, our overall operating results may fluctuate substantially on a seasonal basis if weather conditions diverge adversely from seasonal norms. The effects of climate change may accelerate or magnify fluctuations in our operating results. Operating expenses could be affected by weather conditions, including storms, as well as by significant man-made or accidental disturbances, including terrorism or natural disasters. Weather and other factors can significantly affect our profitability or operations by causing outages, damaging infrastructure and requiring significant repair costs. Storm outages and damage often directly decrease revenues and increase expenses, due to reduced usage and restoration costs. Our businesses are subject to physical, market and economic risks relating to potential effects of climate change. Climate change may produce changes in weather or other environmental conditions, including temperature or precipitation levels, and thus may impact consumer demand for electricity. In addition, the potential physical effects of climate change, such as increased frequency and severity of storms, floods, and other climatic events, could disrupt our operations and cause us to incur significant costs to prepare for or respond to these effects. These or other meteorological changes could lead to increased operating costs, capital expenses or power purchase costs. Greenhouse gas regulation could increase the cost of electricity, particularly power generated by fossil fuels, and such increases could have a depressive effect on regional economies. Reduced economic and consumer activity in our service areas -- both generally and specific to certain industries and consumers accustomed to previously lower cost power -- could reduce demand for the power we generate, market and deliver. Also, demand for our energy-related services could be similarly lowered by consumers' preferences or market factors favoring energy efficiency, low-carbon power sources or reduced electricity usage. The Registrants' responses to such climate-related risks include compliance with evolving governmental policy and developing and implementing strategies designed to meet net zero carbon emissions goals, which may affect our financial condition, results of operations or cash flows. We cannot predict the outcome of legal proceedings or investigations related to our businesses in which we are periodically involved. An unfavorable outcome or determination in any of these matters could have a material adverse effect on our financial condition, results of operations or cash flows. We are involved in legal proceedings, claims and litigation and periodically are subject to state and federal investigations arising out of our business operations, the most significant of which are summarized in Item 1. Business and "Regulatory Matters" in Note 7 to the Financial Statements and in "Legal Matters" and "Regulatory Issues" in Note 14 to the Financial Statements. We cannot predict the ultimate outcome of these matters, nor can we reasonably estimate the costs or liabilities that could potentially result from a negative outcome in each case. Significant increases in our operation and maintenance expenses, including health care and pension costs, could adversely affect our future earnings and liquidity. We continually focus on limiting and reducing our operation and maintenance expenses. However, we expect to continue to face increased cost pressures in our operations. Increased costs of materials and labor may result from general inflation, increased regulatory requirements (especially in respect of environmental regulations), the need for higher-cost expertise in the workforce or other factors. In addition, pursuant to collective bargaining agreements, we are contractually committed to provide specified levels of health care and pension benefits to certain current employees and retirees. These benefits give rise to significant expenses. Due to general inflation with respect to such costs, the aging demographics of our workforce and other 23Table of Contentsfactors, we have experienced significant health care cost inflation in recent years, and we expect our health care costs, including prescription drug coverage, to continue to increase despite measures that we have taken and expect to take to require employees and retirees to bear a higher portion of the costs of their health care benefits. In addition, we expect to continue to incur significant costs with respect to the defined benefit pension plans for our employees and retirees. The measurement of our expected future health care and pension obligations, costs and liabilities is highly dependent on a variety of assumptions, most of which relate to factors beyond our control. These assumptions include investment returns, interest rates, health care cost trends, inflation rates, benefit improvements, salary increases and the demographics of plan participants. If our assumptions prove to be inaccurate, our future costs and cash contribution requirements to fund these benefits could increase significantly. We may incur liabilities in connection with divestitures. In connection with various divestitures, and certain other transactions, we have indemnified or guaranteed parties against certain liabilities. These indemnities and guarantees relate, among other things, to liabilities which may arise with respect to the period during which we or our subsidiaries operated a divested business, and to certain ongoing contractual relationships and entitlements with respect to which we or our subsidiaries made commitments in connection with a divestiture. See "Guarantees and Other Assurances" in Note 14 to the Financial Statements.We are subject to liability risks relating to our generation, transmission and distribution operations. The conduct of our physical and commercial operations subjects us to many risks, including risks of potential physical injury, property damage or other financial liability, caused to or by employees, customers, contractors, vendors, contractual or financial counterparties and other third parties. Our facilities may not operate as planned, which may increase our expenses and decrease our revenues and have an adverse effect on our financial performance. Operation of power plants, transmission and distribution facilities, information technology systems and other assets and activities subjects us to a variety of risks, including the breakdown or failure of equipment, accidents, security breaches, viruses or outages affecting information technology systems, labor disputes, obsolescence, delivery/transportation problems and disruptions of fuel supply and performance below expected levels. These events may impact our ability to conduct our businesses efficiently and lead to increased costs, expenses or losses. Operation of our delivery systems below our expectations may result in lost revenue and increased expense, including higher maintenance costs, which may not be recoverable from customers. Planned and unplanned outages at our power plants may require us to purchase power at then-current market prices to satisfy our commitments or, in the alternative, pay penalties and damages for failure to satisfy them. Although we maintain insurance coverage for certain of these risks, we do not carry insurance for all of these risks and no assurance can be given that such insurance coverage will be sufficient to compensate us in the event losses occur.We are required to obtain, and to comply with, government permits and approvals.We are required to obtain, and to comply with, numerous permits, approvals, licenses and certificates from governmental agencies. The process of obtaining and renewing necessary permits can be lengthy and complex and sometimes result in the establishment of permit conditions that make the project or activity for which a permit was sought unprofitable or otherwise unattractive. In addition, such permits or approvals may be subject to denial, revocation or modification under circumstances. Failure to obtain or comply with the conditions of permits or approvals, or failure to comply with any applicable laws or regulations, may result in delay or temporary suspension of our operations and electricity sales or the curtailment of our power delivery and may subject us to penalties and other sanctions. Although various regulators routinely renew existing licenses, renewal could be denied or jeopardized by various factors, including failure to provide adequate financial assurance for closure; failure to comply with environmental, health and safety laws and regulations or permit conditions; local community, political or other opposition; and executive, legislative or regulatory action. Our cost or inability to obtain and comply with the permits and approvals required for our operations could have a material adverse effect on our operations and cash flows. In addition, new environmental legislation or regulations, if enacted, or changed interpretations of existing laws may elicit claims that historical routine modification activities at our facilities violated applicable laws and regulations. In addition to the possible imposition of fines in such cases, we may be required to undertake significant capital investments in pollution control technology and obtain additional operating permits or approvals, which could have an adverse impact on our business, results of operations, cash flows and financial condition. 24Table of ContentsWar, other armed conflicts or terrorist attacks could have a material adverse effect on our business. War, terrorist attacks and unrest have caused and may continue to cause instability in the world's financial and commercial markets. In addition, unrest could lead to acts of terrorism in the United States or elsewhere, and acts of terrorism could be directed against companies such as ours. Armed conflicts and terrorism and their effects on us or our markets may significantly affect our business and results of operations in the future. In addition, we may incur increased costs for security, including additional physical plant security and security personnel or increased capability following a terrorist incident. We are subject to counterparty performance, credit or other risk in the provision of goods or services to us, which could adversely affect our ability to operate our facilities or conduct business activities. We purchase from a variety of suppliers energy, capacity, fuel, natural gas, transmission service and certain commodities used in the physical operation of our businesses, as well as goods or services, including information technology rights and services, used in the administration of our businesses. Delivery of these goods and services is dependent on the continuing operational performance and financial viability of our contractual counterparties and also the markets, infrastructure or third parties they use to provide such goods and services to us. As a result, we are subject to risks of disruptions, curtailments or increased costs in the operation of our businesses if such goods or services are unavailable or become subject to price spikes or if a counterparty fails to perform. Such disruptions could adversely affect our ability to operate our facilities or deliver services and collect revenues, which could result in lower sales and/or higher costs and thereby adversely affect our results of operations. The performance of coal markets and producers may be the subject of increased counterparty risk to LG&E and KU currently due to weaknesses in such markets and suppliers. The coal industry is subject to increasing competitive pressures from natural gas markets, political pressures and new or more stringent environmental regulation, including regulation of combustion byproducts and water inputs or discharges. We are subject to the risk that our workforce and its knowledge base may become depleted in coming years. We experience attrition due primarily to retiring employees, with the risk that critical knowledge will be lost and that it may be difficult to replace departed personnel, and to attract and retain new personnel, with appropriate skills and experience. ITEM 1B. UNRESOLVED STAFF COMMENTS PPL Corporation, PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities CompanyNone. 25Table of ContentsITEM 2. PROPERTIES Kentucky Regulated Segment (PPL, LG&E and KU) LG&E's and KU's properties consist primarily of regulated generation facilities, electricity transmission and distribution assets and natural gas transmission and distribution assets in Kentucky. The capacity of generation units is based on a number of factors, including the operating experience and physical condition of the units, and may be revised periodically to reflect changed circumstances. The electricity generating capacity at December 31, 2022 was: LG&EKUPrimary Fuel/PlantTotal MWCapacitySummer% Ownershipor OtherInterestOwnership orOther Interestin MW% Ownershipor OtherInterestOwnership orOther Interestin MWCoal Ghent - Units 1- 41,919100.001,919Mill Creek - Units 1- 41,465100.001,465E.W. Brown - Unit 3412100.00412Trimble County - Unit 1 (a)49375.00370Trimble County - Unit 2 (a)73214.2510460.754455,0211,9392,776Natural Gas/OilE.W. Brown Unit 5 (b)13053.006947.0061E.W. Brown Units 6 - 729238.0011162.00181E.W. Brown Units 8 - 11 (b)484100.00484Trimble County Units 5 - 631829.009271.00226Trimble County Units 7 - 1063637.0023563.00401Paddy's Run Unit 1223100.0023Paddy's Run Unit 1314753.007847.0069Haefling - Units 1 - 224100.0024Cane Run Unit 766222.0014678.005162,7167541,962HydroOhio Falls - Units 1-864100.0064Dix Dam - Units 1-332100.0032966432SolarE.W. Brown Solar (c)839.00361.005Total7,8412,7604,775 (a)Trimble County Unit 1 and Trimble County Unit 2 are jointly owned with Illinois Municipal Electric Agency and Indiana Municipal Power Agency. Each owner is entitled to its proportionate share of the units' total output and funds its proportionate share of capital, fuel and other operating costs. See Note 13 to the Financial Statements for additional information.(b)There is an inlet air cooling system attributable to these units. This inlet air cooling system is not jointly owned; however, it is used to increase production on the units to which it relates, resulting in an additional 12 MW of capacity for LG&E and an additional 86 MW of capacity for KU.(c)This unit is a 10 MW facility and achieves such production. The 8 MW solar facility summer capacity rating is reflective of an average expected output across the peak hours during the summer period based on average weather conditions at the solar facility.For a description of LG&E's and KU's service areas, see "Item 1. Business - General - Segment Information - Kentucky Regulated Segment." At December 31, 2022, LG&E's and KU's electricity transmission and distribution systems and LG&E's natural gas transmission and distribution systems were: 26Table of ContentsLG&EKUDistributionTransmissionDistributionTransmissionElectricity SystemSubstations (a)9678461211Capacity (in millions of kVA)58815Overhead lines (circuit miles)3,88366914,0624,056Underground lines (circuit miles)2,791—2,728—Natural Gas SystemDistribution mains (miles)4,439———Transmission pipeline (miles)—234——Transmission storage lines (miles)—112——Combustion turbine lines (miles)—19—11Storage fields—5——Storage field capacity (Bcf)—15——(a)191 substations (61 at LG&E and 130 at KU) are shared between the distribution and transmission systems.Substantially all of LG&E's and KU's respective real and tangible personal property located in Kentucky and used or to be used in connection with the generation, transmission and distribution of electricity and, in the case of LG&E, the storage and distribution of natural gas, is subject to the lien of either the LG&E 2010 Mortgage Indenture or the KU 2010 Mortgage Indenture. See Note 8 to the Financial Statements for additional information.LG&E and KU continuously reexamine development projects based on market conditions and other factors to determine whether to proceed with the projects, sell, cancel or expand them or pursue other options. See Item 1. Business for a discussion related to LG&E's and KU's Solar Share program. Pennsylvania Regulated Segment (PPL and PPL Electric)For a description of PPL Electric's service area, see "Item 1. Business - General - Segment Information - Pennsylvania Regulated Segment." PPL Electric has electric transmission and distribution lines in public streets and highways pursuant to franchises and rights-of-way secured from property owners. At December 31, 2022, PPL Electric's transmission system includes 52 substations with a total capacity of 31 million kVA and 5,307 circuit miles in service. PPL Electric's distribution system includes 353 substations with a total capacity of 14 million kVA, 36,524 circuit miles of overhead lines and 8,802 underground circuit miles. All of PPL Electric's facilities are located in Pennsylvania. Substantially all of PPL Electric's distribution properties and certain transmission properties are subject to the lien of the PPL Electric 2001 Mortgage Indenture. See Note 8 to the Financial Statements for additional information.Rhode Island Regulated Segment (PPL)For a description of RIE's service area, see "Item 1. Business - General - Segment Information - Rhode Island Regulated Segment." At December 31, 2022, RIE's electric transmission system includes 44 substations with capacity of 33 kVA or higher, 342 circuit miles of overhead lines and 19 underground circuit miles. RIE's electric distribution system includes 59 substations, 5,328 circuit miles of overhead lines and 1,259 underground circuit miles. RIE also has distribution mains for its natural gas system with mileage of 3,227 miles. All of RIE's facilities are located in Rhode Island.ITEM 3. LEGAL PROCEEDINGS See Notes 6, 7, 9 and 14 to the Financial Statements for information regarding legal, tax and regulatory matters and proceedings. ITEM 4. MINE SAFETY DISCLOSURES Not applicable. 27Table of ContentsPART IIITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY,RELATED STOCKHOLDER MATTERS ANDISSUER PURCHASES OF EQUITY SECURITIESSee "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Liquidity and Capital Resources - Forecasted Uses of Cash" for information regarding certain restrictions on the ability to pay dividends for all Registrants.PPL CorporationAdditional information for this item is set forth in the sections entitled "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters" and "Shareowner and Investor Information" of this report. At January 31, 2023 there were 46,380 common stock shareowners of record.There were no purchases by PPL of its common stock during the fourth quarter of 2022.PPL Electric Utilities CorporationThere is no established public trading market for PPL Electric's common stock, as PPL owns 100% of the outstanding common shares. Dividends paid to PPL on those common shares are determined by PPL Electric's Board of Directors. PPL Electric paid common stock dividends to PPL of $340 million in 2022 and $334 million in 2021.Louisville Gas and Electric CompanyThere is no established public trading market for LG&E's common stock, as LKE owns 100% of the outstanding common shares. Dividends paid to LKE on those common shares are determined by LG&E's Board of Directors. LG&E paid common stock dividends to LKE of $275 million in 2022 and $192 million in 2021.Kentucky Utilities CompanyThere is no established public trading market for KU's common stock, as LKE owns 100% of the outstanding common shares. Dividends paid to LKE on those common shares are determined by KU's Board of Directors. KU paid common stock dividends to LKE of $296 million in 2022 and $250 million in 2021.ITEM 6. SELECTED FINANCIAL AND OPERATING DATAPPL Corporation, PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities Company [Reserved]28Table of ContentsItem 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations (All Registrants) This "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" is separately filed by PPL, PPL Electric, LG&E and KU. Information contained herein relating to any individual Registrant is filed by such Registrant solely on its own behalf, and no Registrant makes any representation as to information relating to any other Registrant. The specific Registrant to which disclosures are applicable is identified in parenthetical headings in italics above the applicable disclosure or within the applicable disclosure for each Registrant's related activities and disclosures. Within combined disclosures, amounts are disclosed for individual Registrants when significant. The following should be read in conjunction with the Registrants' Consolidated Financial Statements and the accompanying Notes. Capitalized terms and abbreviations are defined in the glossary. Dollars are in millions, except per share data, unless otherwise noted. "Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the following information: •"Overview" provides a description of each Registrant's business strategy and a discussion of important financial and operational developments.•"Results of Operations" for all Registrants includes a "Statement of Income Analysis," which discusses significant changes in principal line items on the Statements of Income, comparing 2022 with 2021. For PPL, "Results of Operations" also includes "Segment Earnings" and "Adjusted Gross Margins," which provide a detailed analysis of earnings by reportable segment. These discussions include non-GAAP financial measures, including "Earnings from Ongoing Operations" and "Adjusted Gross Margins" and provide explanations of the non-GAAP financial measures and a reconciliation of the non-GAAP financial measures to the most comparable GAAP measure. •"Financial Condition - Liquidity and Capital Resources" provides an analysis of the Registrants' liquidity positions and credit profiles. This section also includes a discussion of forecasted sources and uses of cash and rating agency actions.•"Financial Condition - Risk Management" provides an explanation of the Registrants' risk management programs relating to market and credit risk.•"Application of Critical Accounting Policies" provides an overview of the accounting policies that are particularly important to the results of operations and financial condition of the Registrants and that require their management to make significant estimates, assumptions and other judgments of inherently uncertain matters.For comparison of the Registrants’ results of operations and cash flows for the years ended December 31, 2021 to December 31, 2020, refer to “Item 7. Combined Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2021 Form 10-K, filed with the SEC on February 18, 2022.Overview For a description of the Registrants and their businesses, see "Item 1. Business." Business Strategy(All Registrants)PPL operates four fully regulated high-performing utilities. These utilities are located in Pennsylvania, Kentucky and Rhode Island, constructive regulatory jurisdictions with distinct regulatory structures and customer classes. PPL's strategy, which is supported by the other Registrants and subsidiaries, is to achieve industry-leading performance in safety, reliability, customer satisfaction and operational efficiency; to advance a clean energy transition while maintaining affordability and reliability; to maintain a strong financial foundation and create long-term value for our shareowners; to foster a diverse and exceptional workplace; and to build strong communities in areas that we serve.Central to PPL's and the other Registrants' strategy is recovering capital project costs efficiently through various rate-making mechanisms, including periodic base rate case proceedings using forward test years, annual FERC formula rate mechanisms 29Table of Contentsand other regulatory agency-approved recovery mechanisms designed to limit regulatory lag. In Kentucky, in addition to FERC formula rates, the KPSC has adopted a series of regulatory mechanisms (ECR, DSM, GLT, fuel adjustment clause, and gas supply clause) and recovery on construction work-in-progress that reduce regulatory lag and provide timely recovery of and return on, as appropriate, prudently incurred costs. In Pennsylvania, the FERC transmission formula rate, DSIC mechanism, Smart Meter Rider and other recovery mechanisms operate to reduce regulatory lag and provide for timely recovery of and a return on, as appropriate, prudently incurred costs. In Rhode Island, FERC formula rates, the gas cost adjustment, net metering, infrastructure, safety and reliability (ISR) and revenue decoupling mechanisms and other rate adjustment mechanisms operate to reduce regulatory lag and provide timely recovery of and return on, as appropriate, prudently incurred costs. Financial and Operational Developments(PPL)Acquisition of Narragansett ElectricOn May 25, 2022, PPL Rhode Island Holdings acquired 100% of the outstanding shares of common stock of Narragansett Electric from National Grid U.S. (the Acquisition). The consideration for the Acquisition consisted of approximately $3.8 billion in cash and approximately $1.5 billion of long-term debt assumed through the transaction. The $3.8 billion total cash consideration paid was funded with proceeds from PPL's 2021 sale of its U.K. utility business. The Acquisition resulted in $1.6 billion of goodwill. The results of RIE are reported in PPL's Rhode Island Regulated segment.The acquisition of Narragansett Electric was deemed an asset acquisition for federal and state income tax purposes, as a result of PPL and National Grid making a tax election under Internal Revenue Code (IRC) §338(h)(10). Accordingly, the tax bases of substantially all of the assets acquired were increased to fair market value, which equaled net book value, thereby eliminating the related deferred tax assets and liabilities. This election resulted in tax goodwill that will be amortized for tax purposes over 15 years.See Note 9 to the Financial Statements for additional information.Sale of Safari HoldingsOn September 29, 2022, PPL signed a definitive agreement to sell all of Safari Holdings membership interests to Aspen Power Services, LLC. On November 1, 2022, PPL completed the sale (the Transaction).A loss on sale of $60 million ($46 million net of tax benefit) was recorded in "Other operation and maintenance" on the Statement of Income for the year ended December 31, 2022. As a result of the Transaction, $53 million of goodwill previously presented in the Corporate and Other category for segment reporting purposes was written-off.See Note 9 and Note 14 to the Financial Statements for additional information.Pennsylvania State Tax Reform (PPL and PPL Electric) On July 8, 2022, the Governor of Pennsylvania signed into law Pennsylvania House Bill 1342 (H.B. 1342). Among other changes to the state tax code, the bill reduces the corporate net income tax rate from 9.99% to 8.99% beginning January 1, 2023, and further reduces the rate annually by half a percentage point until the rate reaches 4.99% in 2031. GAAP requires that deferred tax assets and liabilities be measured at the enacted tax rate expected to apply when temporary book-to-tax differences are expected to be realized or settled. In 2022, PPL and PPL Electric recorded an increase in regulatory liabilities of $270 million for the remeasurement of regulated accumulated deferred tax balances and a deferred tax benefit of $5 million and $9 million, respectively, associated with the remeasurement of non-regulated accumulated deferred income tax balances. The amounts recorded are estimates that will be updated quarterly to reflect revised forecast, actual activity, and applicable orders from regulatory authorities.30Table of ContentsInflation Reduction Act (All Registrants)On August 16, 2022, the Inflation Reduction Act (IRA) was signed into law. Among other things, the IRA enacted a new 15% corporate "book minimum tax," which is based on adjusted GAAP pre-tax income and is only applicable to corporations whose pre-tax income exceeds a certain threshold. PPL continues to assess the impacts of the IRA on the financial statements of PPL and the other Registrants and will monitor guidance issued by the U.S. Treasury in the future. PPL does not anticipate a material cash tax impact in the foreseeable future. In addition, the IRA enacted numerous new tax credits, largely associated with renewable energy. PPL continues to assess the applicability of these provisions to PPL and its subsidiaries.Regulatory Requirements(All Registrants)The Registrants cannot predict the impact that future regulatory requirements may have on their financial condition or results of operations.Environmental Considerations for Coal-Fired Generation (PPL, LG&E and KU)The businesses of LG&E and KU are subject to extensive federal, state and local environmental laws, rules and regulations, including those pertaining to CCRs, GHG, and ELGs. See Notes 7, 14 and 20 to the Financial Statements for a discussion of these significant environmental matters. These and other environmental requirements led PPL, LG&E and KU to retire approximately 1,200 MW of coal-fired generating plants in Kentucky since 2010. As part of the long-term generation planning process, LG&E and KU evaluate a range of factors including the impact of potential stricter environmental regulations, fuel price scenarios, the cost of replacement generation, continued operations and major maintenance costs and the risk of major equipment failures in determining when to retire generation assets.As a result of environmental requirements and aging infrastructure, LG&E anticipates retiring two older coal-fired units at the Mill Creek Plant and KU anticipates retiring one coal-fired unit at each of the E.W. Brown and Ghent plants. Mill Creek Unit 1, with 300 MW of capacity, is expected to be retired in 2024. Mill Creek Unit 2, with 297 MW of capacity, is expected to be retired in 2027. E.W. Brown Unit 3, with 412 MW of capacity, and Ghent Unit 2, with 486 MW of capacity, are expected to be retired in 2028. LG&E and KU anticipate the recovery of associated retirement costs, including the remaining net book value, for these coal-fired generating units through the RAR or other rate mechanisms. CPCN (PPL, LG&E and KU)On December 15, 2022, LG&E and KU filed an application with the KPSC for a CPCN for the construction of two 621 MW net summer rating NGCC combustion turbine facilities, one at LG&E's Mill Creek Generating Station in Jefferson County, Kentucky and the other at KU's E.W. Brown Generating Station in Mercer County, Kentucky, including on-site natural gas and electric transmission construction associated with those facilities and site compatibility certificates. LG&E and KU also applied for a CPCN to construct a 120 MWac solar photovoltaic electric generating facility in Mercer County, Kentucky, and for a CPCN to acquire a 120 MWac solar facility to be built by a third-party solar developer in Marion County, Kentucky. LG&E and KU further applied for a CPCN to construct a 125 MW, 4-hour battery energy storage system facility at KU's E.W. Brown Generating Station and for approval of their proposed 2024-2030 DSM programs. The plan includes adding 14 new, adjusted or expanded energy efficiency programs, which would reduce LG&E's and KU's overall need by approximately 100 MW each. Finally, LG&E and KU requested a declaratory order to confirm that their entry into non-firm energy-only power-purchase agreements for the output of four solar photovoltaic facilities with a combined capacity of 637 MW does not require KPSC approval and that LG&E and KU may recover the costs of the solar PPAs through their fuel adjustment clause mechanisms as previously approved for a prior solar PPA. LG&E and KU plan to accrue AFUDC on the constructed NGCCs, solar facility in Mercer County, Kentucky and the battery energy storage system facility and have requested regulatory asset treatment to recover the financing costs of these projects.The plan is consistent with PPL's goal to achieve net-zero carbon emissions by 2050. The replacement strategy, if approved, would reduce the carbon intensity of LG&E and KU's generation fleet and result in nearly a 25% reduction in CO2 emissions from existing levels.The KPSC accepted the filing as of January 6, 2023 and has indicated its intention to issue an order on all issues by November 6, 2023. LG&E and KU cannot predict the outcome of these matters.31Table of ContentsFERC Transmission Rate Filing (PPL, LG&E and KU) In 2018, LG&E and KU applied to the FERC requesting elimination of certain on-going credits to a sub-set of transmission customers relating to the 1998 merger of LG&E's and KU's parent entities and the 2006 withdrawal of LG&E and KU from the Midcontinent Independent System Operator, Inc. (MISO), a regional transmission operator and energy market. The application sought termination of LG&E's and KU's commitment to provide certain Kentucky municipalities mitigation for certain horizontal market power concerns arising out of the 1998 LG&E and KU merger and 2006 MISO withdrawal. The amounts at issue are generally waivers or credits granted to a limited number of Kentucky municipalities for either certain LG&E and KU or MISO transmission charges incurred for transmission service received. In 2019, the FERC granted LG&E's and KU's request to remove the ongoing credits, conditioned upon the implementation by LG&E and KU of a transition mechanism for certain existing power supply arrangements, which was subsequently filed, modified, and approved by the FERC in 2020 and 2021. In 2020, LG&E and KU and other parties filed appeals with the D.C. Circuit Court of Appeals regarding the FERC's orders on the elimination of the mitigation and required transition mechanism. On August 4, 2022, the D.C. Circuit Court of Appeals issued an order remanding the proceedings back to the FERC. LG&E and KU cannot predict the outcome of the proceedings at the FERC on remand. LG&E and KU currently receive recovery of the waivers and credits provided through other rate mechanisms and such rate recovery would be anticipated to be adjusted consistent with potential changes or terminations of the waivers and credits, as such become effective.Rate Case Proceedings (KU)On August 31, 2021, KU filed a request with the VSCC for an annual increase in Virginia base electricity rates of approximately $12 million, based on an authorized 10.4% return on equity. On March 11, 2022, KU, certain intervenors and the VSCC staff reached a partial stipulation and recommendation agreement providing KU with an increase in base electricity rates of approximately $7 million based on an authorized 9.4% return on equity. A hearing on open issues occurred on March 17, 2022. On May 25, 2022, the VSCC issued an order approving the proposed agreement. New rates became effective June 1, 2022.Results of Operations(PPL) The "Statement of Income Analysis" discussion below describes significant changes in principal line items on PPL's Statements of Income, comparing 2022 with 2021. The "Segment Earnings" and "Adjusted Gross Margins" discussions for PPL provide a review of results by reportable segment. These discussions include non-GAAP financial measures, including "Earnings from Ongoing Operations" and "Adjusted Gross Margins," and provide explanations of the non-GAAP financial measures and a reconciliation of those measures to the most comparable GAAP measure. (PPL Electric, LG&E and KU) A "Statement of Income Analysis" is presented separately for PPL Electric, LG&E and KU. The "Statement of Income Analysis" discussion below describes significant changes in principal line items on the Statements of Income, comparing 2022 with 2021. The results of operations section for PPL Electric, LG&E and KU is presented in a reduced disclosure format in accordance with General Instructions (I)(2)(a) of Form 10-K. 32Table of ContentsPPL: Statement of Income Analysis, Segment Earnings and Adjusted Gross MarginsStatement of Income AnalysisNet income for the years ended December 31 includes the following results: Change202220212022 vs. 2021Operating Revenues$7,902 $5,783 $2,119 Operating ExpensesOperationFuel931 710 221 Energy purchases1,686 752 934 Other operation and maintenance2,398 1,608 790 Depreciation1,181 1,082 99 Taxes, other than income332 207 125 Total Operating Expenses6,528 4,359 2,169 Other Income (Expense) - net54 15 39 Interest Expense513 918 (405)Income from Continuing Operations Before Income Taxes915 521 394 Income Taxes201 503 (302)Income from Continuing Operations After Income Taxes714 18 696 Income (Loss) from Discontinued Operations (net of income taxes) (Note 9)42 (1,498)1,540 Net Income (Loss)$756 $(1,480)$2,236 Operating RevenuesThe increase (decrease) in operating revenues was due to:2022 vs. 2021PPL Electric distribution price (a)$(19)PPL Electric distribution volume (b)20PPL Electric PLR (c)520 PPL Electric transmission formula rate (d)92 LG&E fuel and other energy prices (e)142 LG&E retail rates (f)50 LG&E volumes 28 KU retail rates (f)55 KU fuel and other energy prices (e)160 KU volumes 29 Rhode Island Energy1,038 Other4 Total$2,119 (a) Distribution price variance was primarily due to reconcilable cost recovery mechanisms approved by the PAPUC.(b) The increase was due to colder weather combined with higher non-residential customer volumes.(c) The increase was primarily the result of higher energy prices, lower volumes of shopping customers and higher customer volumes due to colder weather. (d) The increase was primarily due to returns on additional transmission capital investments, a higher PPL zonal peak load billing factor in 2022 and the reduction in the transmission formula rate return on equity recorded in 2021. See Note 7 to the Financial Statements for additional information on the transmission formula rate return on equity reduction.(e) The increase was primarily due to higher recoveries of fuel and energy purchases due to higher commodity costs.(f) The increase was due to new base rates approved by the KPSC effective July 1, 2021. FuelFuel increased $221 million in 2022 compared with 2021, primarily due to an $81 million increase at LG&E and a $140 million increase at KU, primarily due to higher commodity costs.33Table of ContentsEnergy PurchasesEnergy purchases increased $934 million in 2022 compared with 2021, primarily due to higher PLR prices of $419 million and higher PLR volumes of $58 million at PPL Electric and a $78 million increase at LG&E, primarily due to an increase in commodity costs and an additional $365 million due to the operations of RIE. Other Operation and MaintenanceThe increase (decrease) in other operation and maintenance was due to:2022 vs. 2021PPL Electric Act 129 smart meter program $7 PPL Electric storm costs (10)PPL Electric IT cloud amortization costs 12 PPL Electric vegetation management costs12 PPL Electric bad debts 14 PPL Electric canceled projects 8 LG&E storm restoration costs6 LG&E natural gas inventory losses4 KU plant outages9 KU vegetation management costs10 Rhode Island Energy (a)684 Stock compensation expense5 Sale of Safari Holdings (b)60 Solar panel impairment(37)Charges related to the sale of the U.K. utility business(15)Other21 Total$790 (a)Includes activity associated with the operations of RIE and integration and related costs. See Note 9 to the Financial Statements for additional information.(b)Loss on sale of Safari Holdings. See Note 9 to the Financial Statements for additional information.DepreciationThe increase (decrease) in depreciation was due to:2022 vs. 2021Additions to PP&E, net (a)$(3)Depreciation rate change (b)12 Rhode Island Energy92 Other(2)Total$99 (a)The decrease was primarily due to decreases in software and computer hardware depreciation at PPL Electric, as a result of end-of-life retirements, partially offset by additional assets placed into service, net of retirements at PPL Electric, LG&E and KU.(b)The increase was due to higher depreciation rates at LG&E and KU effective July 2021.Taxes, Other Than IncomeThe increase (decrease) in taxes, other than income was due to:2022 vs. 2021State gross receipts tax (a)$63 Domestic property tax expense (a)59 Other3 Total$125 (a)Increase primarily due to the acquisition of RIE.34Table of ContentsOther Income (Expense) - netThe increase (decrease) in other income (expense) - net was due to:2022 vs. 2021Defined benefit plans - non-service credits (Note 12)$26 Interest income(8)AFUDC - equity component4 Other17 Total$39 Interest Expense The increase (decrease) in interest expense was due to: 2022 vs. 2021Loss on extinguishment of debt (a)$(395)Long-term debt (b)(53)Rhode Island Energy39 Other4 Total$(405)(a) In June and July 2021, in connection with a tender offer, PPL Capital Funding retired $3,034 million combined aggregate principal amount of its outstanding Senior Notes for $3,426 million aggregate cash purchase price. The loss on extinguishment activity included the tender premium, make-whole premiums, accrued interest, bank fees and unamortized fees, hedges and discounts. (b) The decrease in 2022 was primarily due to PPL Capital Funding debt that was redeemed in June and July 2021, partially offset by increases at LG&E, KU and PPL Electric.Income TaxesThe increase (decrease) in income taxes was due to:2022 vs. 2021Change in pre-tax income$128 Valuation allowance adjustments (a)(39)Impact of U.K. Finance Acts (b)(383)Other(8)Total$(302)(a)In 2021, PPL recorded a $31 million state deferred tax benefit on a net operating loss and an offsetting valuation allowance in connection with the loss on extinguishment associated with a tender offer to purchase and retire PPL Capital Funding's outstanding Senior Notes. (b)The U.K. Finance Act 2021, formally enacted on June 10, 2021, increased the U.K. corporation tax rate from 19% to 25%, effective April 1, 2023. The primary impact of the corporation tax rate increase was an increase in deferred tax liabilities of the U.K. utility business, which was sold on June 14, 2021, and a corresponding deferred tax expense of $383 million, which was recognized in continuing operations in 2021.See Note 6 to the Financial Statements for additional information on income taxes.Income (Loss) from Discontinued Operations (net of income taxes) Income (loss) from discontinued operations (net of income taxes) decreased $1,540 million in 2022 compared with 2021. The decrease was due to the completion of the U.K. utility business in the second quarter of 2021. See "Discontinued Operations" in Note 9 to the Financial Statements for summarized results of the operations of the U.K. utility business.35Table of ContentsSegment EarningsPPL's Net Income (Loss) by reportable segments was as follows: Change 202220212022 vs. 2021Kentucky Regulated $507 $468 $39 Pennsylvania Regulated525 445 80 Rhode Island Regulated (a)(44)— (44)Corporate and Other (b)(274)(895)621 Discontinued Operations (a)42 (1,498)1,540 Net Income (Loss)$756 $(1,480)$2,236 (a)See Note 9 to the Financial Statements for additional information.(b)Primarily represents financing and certain other costs incurred at the corporate level that have not been allocated or assigned to the segments, which are presented to reconcile segment information to PPL's consolidated results. Earnings from Ongoing OperationsManagement utilizes "Earnings from Ongoing Operations" as a non-GAAP financial measure that should not be considered as an alternative to net income, an indicator of operating performance determined in accordance with GAAP. PPL believes that Earnings from Ongoing Operations is useful and meaningful to investors because it provides management's view of PPL's earnings performance as another criterion in making investment decisions. In addition, PPL's management uses Earnings from Ongoing Operations in measuring achievement of certain corporate performance goals, including targets for certain executive incentive compensation. Other companies may use different measures to present financial performance.Earnings from Ongoing Operations is adjusted for the impact of special items. Special items are presented in the financial tables on an after-tax basis with the related income taxes on special items separately disclosed. Income taxes on special items, when applicable, are calculated based on the statutory tax rate of the entity where the activity is recorded. Special items may include items such as:• Gains and losses on sales of assets not in the ordinary course of business.• Impairment charges.• Significant workforce reduction and other restructuring effects.• Acquisition and divestiture-related adjustments.• Significant losses on early extinguishment of debt.• Other charges or credits that are, in management's view, non-recurring or otherwise not reflective of the company's ongoing operations.PPL's Earnings from Ongoing Operations by reportable segment were as follows: Change202220212022 vs. 2021Kentucky Regulated$515 $465 $50 Pennsylvania Regulated516 465 51 Rhode Island Regulated65 — 65 Corporate and Other (55)(124)69 Earnings from Ongoing Operations$1,041 $806 $235 See "Reconciliation of Earnings from Ongoing Operations" below for a reconciliation of this non-GAAP financial measure to Net Income.Kentucky Regulated SegmentThe Kentucky Regulated segment consists primarily of LG&E's and KU's regulated electricity generation, transmission and distribution operations, as well as LG&E's regulated distribution and sale of natural gas. Net Income and Earnings from Ongoing Operations include the following results:36Table of Contents Change 202220212022 vs. 2021Operating revenues$3,811 $3,348 $463 Fuel931 710 221 Energy purchases273 186 87 Other operation and maintenance959 905 54 Depreciation685 647 38 Taxes, other than income92 87 5 Total operating expenses2,940 2,535 405 Other Income (Expense) - net12 (2)14 Interest Expense205 196 9 Interest Expense with Affiliate (a)57 53 4 Income Taxes114 94 20 Net Income507 468 39 Less: Special Items(8)3 (11)Earnings from Ongoing Operations$515 $465 $50 (a)Borrowings between LKE and PPL were $1,744 million and $2,166 million as of December 31, 2022 and 2021.The following after-tax gains (losses), which management considers special items, impacted the Kentucky Regulated segment's results and are excluded from Earnings from Ongoing Operations:Income Statement Line Item20222021Valuation allowance adjustment (a)Income Taxes$— $4 Strategic corporate initiatives, net of tax of $3, $0 (b)Other operation and maintenance(8)— Strategic corporate initiatives, net of tax of $0, $0 Other Income (Expense) - net— (1)Total$(8)$3 (a)Adjustment of valuation allowances related to certain tax credits recorded in 2017 as a result of the TCJA.(b)Costs incurred related to PPL's corporate centralization efforts.The changes in the components of the Kentucky Regulated segment's results between these periods were due to the factors set forth below, which reflect amounts classified as Kentucky Adjusted Gross Margins and the items that management considers special on separate lines and not in their respective Statement of Income line item.2022 vs. 2021Kentucky Adjusted Gross Margins$205 Other operation and maintenance(39)Depreciation(90)Taxes, other than income(7)Other Income (Expense) - net13 Interest Expense(9)Interest Expense with Affiliate(4)Income Taxes(19)Earnings from Ongoing Operations50 Special Items, after-tax(11)Net Income$39 •See "Adjusted Gross Margins - Changes in Adjusted Gross Margins" for an explanation of Kentucky Adjusted Gross Margins.•Higher other operation and maintenance expense in 2022 compared to 2021, primarily due to a $10 million increase in vegetation management expenses, a $9 million increase in plant outage expenses, a $6 million increase related to certain ECR and GLT expenses transferred to base rates as a result of the 2020 Kentucky rate case and a $6 million increase in storm restoration expenses.•Higher depreciation expense in 2022 compared to 2021, primarily due to a $60 million increase related to certain ECR and GLT depreciation expenses transferred to base rates as a result of the 2020 Kentucky rate case, a $19 million increase due 37Table of Contentsto additional assets placed into service, net of retirements and an $11 million increase due to higher depreciation rates, effective July 1, 2021.Pennsylvania Regulated SegmentThe Pennsylvania Regulated segment includes the regulated electricity transmission and distribution operations of PPL Electric. Net Income and Earnings from Ongoing Operations include the following results: Change 202220212022 vs. 2021Operating revenues$3,030 $2,402 $628 Energy purchases1,048 566 482 Other operation and maintenance605 557 48 Depreciation393 424 (31)Taxes, other than income149 120 29 Total operating expenses2,195 1,667 528 Other Income (Expense) - net35 26 9 Interest Expense171 162 9 Income Taxes174 154 20 Net Income525 445 80 Less: Special Items9 (20)29 Earnings from Ongoing Operations$516 $465 $51 The following after-tax gains (losses), which management considers special items, impacted the Pennsylvania Regulated segment's results and are excluded from Earnings from Ongoing Operations:Income Statement Line Item20222021PA tax rate change (a)Income Taxes$9 $— Transmission formula rate return on equity reduction, net of tax of $0, $8 (b)Operating revenues— (20)Total$9 $(20)(a)Impact of Pennsylvania state tax reform. See Note 6 to the Financial Statements for additional information. (b)Represents the portion of the reduction recognized in the December 31, 2021 Statement of Income related to the period from May 21, 2020 through December 31, 2020. See Note 7 to the Financial Statements for additional information.The changes in the components of the Pennsylvania Regulated segment's results between these periods were due to the factors set forth below, which reflect amounts classified as Pennsylvania Adjusted Gross Margins and the items that management considers special on separate lines and not in their respective Statement of Income line items. 2022 vs. 2021Pennsylvania Adjusted Gross Margins$112 Other operation and maintenance(46)Depreciation6 Taxes, other than income1 Other Income (Expense) - net8 Interest Expense(9)Income Taxes(21)Earnings from Ongoing Operations51 Special Items, after-tax29 Net Income$80 •See "Adjusted Gross Margins - Changes in Adjusted Gross Margins" for an explanation of Pennsylvania Adjusted Gross Margins.•Higher other operation and maintenance expense in 2022 compared with 2021 primarily due to a $14 million increase in bad debt expenses, a $12 million increase in vegetation management expenses, a $12 million increase in IT cloud amortization and other items that were not individually significant.38Table of ContentsRhode Island Regulated SegmentThe Rhode Island Regulated segment consists primarily of the regulated electricity transmission and distribution operations and regulated distribution and sale of natural gas conducted by RIE.Net Loss and Earnings from Ongoing Operations include the following results:Change 202220212022 vs. 2021Operating revenues$1,038 $— $1,038 Energy purchases365 — 365 Other operation and maintenance531 — 531 Depreciation92 — 92 Taxes, other than income92 — 92 Total operating expenses1,080 — 1,080 Other Income (Expense) - net23 — 23 Interest Expense39 — 39 Income Taxes(14)— (14)Net Loss(44)— (44)Less: Special Items (109)— (109)Earnings from Ongoing Operations$65 $— $65 The following after-tax gains (losses), which management considers special items, impacted the Rhode Island Regulated segment's results and are excluded from Earnings from Ongoing Operations:Income Statement Line Item20222021Acquisition integration, net of tax of $18, $0 (a)Other operation and maintenance$(70)$— Acquisition integration, net of tax of $0, $0 (a)Other Income (Expense) - net1 — Acquisition integration, net of tax of $10, $0 (a)Operating revenues(40)— Total Special Items$(109)$— (a)Represents costs related to the acquisition of Rhode Island Energy including certain costs associated with its integration, commitments made during the acquisition process and related costs. See Note 9 to the Financial Statements for additional information related to the commitments made as a condition of the acquisition.Reconciliation of Earnings from Ongoing OperationsThe following tables contain after-tax gains (losses), in total, which management considers special items, that are excluded from Earnings from Ongoing Operations, and a reconciliation to PPL's "Net Income" for the years ended December 31: 2022KYRegulatedPARegulatedRIRegulatedCorporateand OtherDiscontinuedOperations (a)TotalNet Income (Loss)$507 $525 $(44)$(274)$42 $756 Less: Special Items (expense) benefit:Income (loss) from Discontinued Operations (a)— — — — 42 42 Talen litigation costs, net of tax of $0 (b)— — — 1 — 1 Strategic corporate initiatives, net of tax of $3, $4 (c)(8)— — (15)— (23)Acquisition integration, net of tax of $28, $39 (j)— — (109)(148)— (257)PA tax rate change (e)— 9 — (4)— 5 Sale of Safari Holdings, net of tax of $16 (i)— — — (53)— (53)Total Special Items(8)9 (109)(219)42 (285)Earnings from Ongoing Operations$515 $516 $65 $(55)$— $1,041 39Table of Contents 2021 KY RegulatedPA RegulatedRIRegulatedCorporate and Other Discontinued Operations (a)TotalNet Income (Loss)$468 $445 $— $(895)$(1,498)$(1,480)Less: Special Items (expense) benefit:Income (loss) from Discontinued Operations (a)— — — — (1,502)(1,502)Talen litigation costs, net of tax of $4 (b)— — — (16)— (16)Strategic corporate initiatives, net of tax of $0, $2 (c)(1)— — (8)— (9)Valuation allowance adjustment (d)4 — — (4)4 4 Transmission formula rate return on equity reduction, net of tax of $8— (20)— — — (20)Acquisition integration, net of tax of $6 (j)— — — (22)— (22)U.K. tax rate change (f)— — — (383)— (383)Solar panel impairment, net of tax of $9 (g)— — — (26)— (26)Loss on early extinguishment of debt, net of tax of $83 (h)— — — (312)— (312)Total Special Items3 (20)— (771)(1,498)(2,286)Earnings from Ongoing Operations$465 $465 $— $(124)$— $806 (a)See Note 9 to the Financial Statements for additional information.(b)PPL incurred legal expenses and received insurance reimbursement related to litigation with its former affiliate, Talen Montana. See Note 14 to the Financial Statements for additional information.(c)Costs incurred for 2022 relate to PPL's strategic repositioning and corporate centralization efforts. Costs incurred for 2021 are related to the sale of the U.K. utility business and PPL's strategic repositioning. (d)Adjustment of valuation allowances related to certain tax credits recorded in 2017 as a result of the TCJA.(e)Impact of Pennsylvania state tax reform. See Note 6 to the Financial Statements for additional information.(f)Impact of the U.K. Finance Acts on deferred tax balances. See Note 6 to the Financial Statements for additional information. (g)Reflects solar panel write-down due to extension of federal government’s solar investment tax credits, technological advances resulting in more efficient modules available on the market and rising commodity prices for materials used in various solar projects.(h)In June and July 2021, in connection with the tender offer, PPL Capital Funding retired $3,034 million combined aggregate principal amount of its outstanding Senior Notes for $3,426 million aggregate cash purchase price. The loss on extinguishment activity included the tender premium, make-whole premiums, accrued interest, bank fees and unamortized fees, hedges and discounts. (i)Primarily includes the loss on the sale of Safari Holdings, LLC. See Note 9 to the Financial Statements for more information.(j)Represents costs related to the acquisition of Rhode Island Energy including certain costs associated with its integration, commitments made during the acquisition process and related costs. See Note 9 to the Financial Statements for additional information related to the commitments made as a condition of the acquisition.Adjusted Gross MarginsManagement also utilizes the following non-GAAP financial measures as indicators of performance for its businesses.•"Kentucky Adjusted Gross Margins" is a single financial performance measure of the electricity generation, transmission and distribution operations of the Kentucky Regulated segment, as well as the Kentucky Regulated segment's distribution and sale of natural gas. In calculating this measure, fuel, energy purchases and certain variable costs of production (recorded in "Other operation and maintenance" on the Statements of Income) are deducted from operating revenues. In addition, certain other expenses, recorded in "Other operation and maintenance", "Depreciation" and "Taxes, other than income" on the Statements of Income, associated with approved cost recovery mechanisms are offset against the recovery of those expenses, which are included in revenues. These mechanisms allow for direct recovery of these expenses and, in some cases, returns on capital investments and performance incentives. As a result, this measure represents the net revenues from electricity and gas operations.•"Pennsylvania Adjusted Gross Margins" is a single financial performance measure of the electricity transmission and distribution operations of the Pennsylvania Regulated segment. In calculating this measure, utility revenues and expenses associated with approved recovery mechanisms, including energy provided as a PLR, are offset with minimal impact on earnings. Costs associated with these mechanisms are recorded in "Energy purchases," "Other operation and maintenance," (which are primarily Act 129, Storm Damage and Universal Service program costs), "Depreciation" (which is primarily related to the Act 129 Smart Meter program) and "Taxes, other than income," (which is primarily gross receipts tax) on the Statements of Income. This measure represents the net revenues from the Pennsylvania Regulated segment's electricity delivery operations.•"Rhode Island Adjusted Gross Margins" is a single financial performance measure of the electricity transmission and distribution operations of the Rhode Island Regulated segment, as well as the Rhode Island Regulated segment's 40Table of Contentsdistribution and sale of natural gas. In calculating this measure, utility revenues and expenses associated with approved recovery mechanisms are offset with minimal impact on earnings. Costs associated with these mechanisms are recorded in "Energy purchases," "Other operation and maintenance" (which are primarily regional network transmission service, energy efficiency and storm cost related) and "Taxes, other than income" (which is primarily gross earnings tax) on the Statements of Income. This measure represents the net revenues from Rhode Island Regulated segment's electricity and gas delivery operations.These measures are not intended to replace "Operating Income," which is determined in accordance with GAAP, as an indicator of overall operating performance. Other companies may use different measures to analyze and report their results of operations. Management believes these measures provide additional useful criteria to make investment decisions. These performance measures are used, in conjunction with other information, by senior management and PPL's Board of Directors to manage operations and analyze actual results compared with budget.Changes in Adjusted Gross MarginsThe following table shows Adjusted Gross Margins by PPL's reportable segment and by component, as applicable, for the year ended December 31 as well as the changes between periods. The factors that gave rise to the changes are described following the table. Change 202220212022 vs. 2021Kentucky Regulated Kentucky Adjusted Gross Margins$2,460 $2,255 $205 Pennsylvania Regulated Pennsylvania Adjusted Gross Margins Distribution$962 $915 $47 Transmission739 674 65 Total Pennsylvania Adjusted Gross Margins$1,701 $1,589 $112 Rhode Island RegulatedRhode Island Adjusted Gross Margins$441 $— $441 Kentucky Adjusted Gross MarginsKentucky Adjusted Gross Margins increased in 2022 compared with 2021, primarily due to higher base rates of $105 million, environmental and gas cost recoveries added to base rates of $66 million and higher sales volumes primarily due to weather of $29 million.The increase in base rates was the result of new rates approved by the KPSC effective July 1, 2021. The environmental and gas cost recoveries added to base rates were the result of the transfer of certain ECR and GLT expenses into base rates as a result of the 2020 Kentucky rate case. This transfer results in depreciation and other operation and maintenance expenses associated with the ECR and GLT programs being excluded from margins for all twelve months in 2022 compared to six months in 2021. Pennsylvania Adjusted Gross MarginsDistributionDistribution Adjusted Gross Margins increased in 2022 compared with 2021, primarily due to higher sales volumes of $17 million which included favorable weather of $11 million. Late payment charges increased $10 million as a result of not charging late payment fees for much of 2021 due to the COVID-19 pandemic. TCJA margins increased $11 million due to lower taxable income associated with the mechanism. Merchant Function Charge, which is added to the PTC rates to offset uncollectible expenses, increased by $8 million largely due to the energy price increases.TransmissionTransmission Adjusted Gross Margins increased in 2022 compared with 2021, primarily due to a $29 million increase as a result of a higher annual PPL zonal peak load billing factor in 2022 and $38 million of returns on additional transmission capital investments focused on replacing aging infrastructure and improving reliability.41Table of ContentsRhode Island Adjusted Gross MarginsRhode Island Adjusted Gross Margins increased for 2022 compared with 2021, due to the acquisition of Narragansett Electric on May 25, 2022.Reconciliation of Adjusted Gross Margins The following tables contain the components from the Statement of Income that are included in the non-GAAP financial measures and a reconciliation to PPL's "Operating Income" for the years ended December 31: 2022Kentucky Adjusted GrossMarginsPennsylvaniaAdjusted GrossMarginsRhode IslandAdjustedGrossMargins (a)Other (b)OperatingIncome (c)Operating Revenues$3,811 $3,030 $1,088 $(27)$7,902 Operating ExpensesFuel931 — — — 931 Energy purchases273 1,048 365 — 1,686 Other operation and maintenance92 111 249 1,946 2,398 Depreciation53 28 — 1,100 1,181 Taxes, other than income2 142 33 155 332 Total Operating Expenses1,351 1,329 647 3,201 6,528 Total$2,460 $1,701 $441 $(3,228)$1,374 2021Kentucky Adjusted GrossMarginsPennsylvaniaAdjusted GrossMarginsRhode IslandAdjustedGrossMarginsOther (b)OperatingIncome (c)Operating Revenues$3,348 $2,430 $— $5 $5,783 Operating ExpensesFuel710 — — — 710 Energy purchases186 566 — — 752 Other operation and maintenance88 111 — 1,409 1,608 Depreciation105 52 — 925 1,082 Taxes, other than income4 112 — 91 207 Total Operating Expenses1,093 841 — 2,425 4,359 Total$2,255 $1,589 $— $(2,420)$1,424 (a)Operating revenue excludes a $50 million customer bill credit to all electric and natural gas distribution customers that was treated as a special item. See Note 9 to the Financial Statements for additional information.(b)Represents amounts excluded from Adjusted Gross Margins.(c)As reported on the Statements of Income.42Table of ContentsPPL Electric: Statement of Income AnalysisNet income for the years ended December 31 includes the following results:Change202220212022 vs. 2021Operating Revenues$3,030 $2,402 $628 Operating ExpensesOperationEnergy purchases1,048 566 482 Other operation and maintenance605 557 48 Depreciation393 424 (31)Taxes, other than income149 120 29 Total Operating Expenses2,195 1,667 528 Other Income (Expense) - net30 21 9 Interest Income from Affiliate5 5 — Interest Expense171 162 9 Income Taxes174 154 20 Net Income$525 $445 $80 Operating RevenuesThe increase (decrease) in operating revenues was due to:2022 vs. 2021Distribution Price (a)$(19)Distribution volume (b)20 PLR (c)520 Transmission Formula Rate (d)92 Other (e)15 Total$628 (a)Distribution price variance was primarily due to reconcilable cost recovery mechanisms approved by the PAPUC.(b)The increase was due to colder weather combined with higher non-residential customer volumes.(c)The increase was primarily the result of higher energy prices, lower volumes of shopping customers and higher customer volumes due to colder weather.(d)The increase was primarily due to returns on additional transmission capital investments, a higher PPL zonal peak load billing factor in 2022 and the reduction in the transmission formula rate return on equity recorded in 2021. See Note 7 to the Financial Statements for additional information on the transmission formula rate return on equity reduction.(e) The increase was primarily due to higher late payment charges in 2022, which were not billed until the fourth quarter 2021 due to the COVID pandemic. Energy Purchases Energy purchases increased $482 million in 2022 compared with 2021. This increase was primarily due to higher PLR prices of $419 million and higher PLR volumes of $58 million. Other Operation and Maintenance The increase (decrease) in other operation and maintenance was due to:43Table of Contents2022 vs. 2021Act 129 smart meter program$7 Storm costs(10)IT cloud amortization costs12 Vegetation management costs12 Bad debts14 Canceled projects8 Support costs(9)Other14 Total$48 Depreciation Depreciation decreased $31 million in 2022 compared with 2021, primarily due to a $38 million decrease in software and computer hardware depreciation as a result of end-of-life retirements, partially offset by $11 million of additional assets placed into service, net of retirements.LG&E: Statement of Income Analysis Net income for the years ended December 31 includes the following results: Change202220212022 vs. 2021Operating RevenuesRetail and wholesale$1,762 $1,545 $217 Electric revenue from affiliate36 24 12 Total Operating Revenues1,798 1,569 229 Operating ExpensesOperationFuel346 265 81 Energy purchases245 167 78 Energy purchases from affiliates25 23 2 Other operation and maintenance416 400 16 Depreciation298 279 19 Taxes, other than income48 46 2 Total Operating Expenses1,378 1,180 198 Other Income (Expense) - net4 (5)9 Interest Expense89 81 8 Income Taxes63 54 9 Net Income$272 $249 $23 Operating Revenues The increase (decrease) in operating revenues was due to:2022 vs. 2021Fuel and other energy prices (a)$149 Retail rates (b)50 Volumes 33 Other(3)Total$229 (a)The increase was primarily due to higher recoveries of fuel and energy purchases due to higher commodity costs.(b)The increase was due to new base rates approved by the KPSC effective July 1, 2021. 44Table of ContentsFuel Fuel increased $81 million in 2022 compared with 2021, primarily due to a $67 million increase in commodity costs and a $14 million increase in volumes driven by weather.Energy PurchasesEnergy purchases increased $78 million in 2022 compared with 2021, primarily due to an increase in commodity costs.Other Operation and MaintenanceOther operation and maintenance increased $16 million in 2022 compared with 2021, primarily due to a $6 million increase in storm restoration costs and a $4 million increase in natural gas inventory losses. DepreciationDepreciation increased $19 million in 2022 compared with 2021, primarily due to a $12 million increase driven by additional assets placed into service, net of retirements, and an $8 million increase driven by higher depreciation rates effective July 1, 2021.KU: Statement of Income Analysis Net income for the years ended December 31 includes the following results:Change202220212022 vs. 2021Operating RevenuesRetail and wholesale$2,049 $1,803 $246 Electric revenue from affiliate25 23 2 Total Operating Revenues2,074 1,826 248 Operating ExpensesOperationFuel585 445 140 Energy purchases28 19 9 Energy purchases from affiliates36 24 12 Other operation and maintenance487 463 24 Depreciation386 366 20 Taxes, other than income45 41 4 Total Operating Expenses1,567 1,358 209 Other Income (Expense) - net8 4 4 Interest Expense117 109 8 Income Taxes76 67 9 Net Income$322 $296 $26 Operating RevenuesThe increase (decrease) in operating revenues was due to: 2022 vs. 2021Retail rates (a)$55 Fuel and energy prices (b)165 Volumes24 Other4 Total$248 (a)The increases were due to new base rates approved by the KPSC effective July 1, 2021.(b)The increases were primarily due to higher recoveries of fuel and energy purchases due to higher commodity costs.45Table of ContentsFuel Fuel increased $140 million in 2022 compared with 2021, primarily due to an increase in commodity costs.Other Operation and MaintenanceOther operations and maintenance increased $24 million in 2022 compared with 2021, primarily due to a $10 million increase in vegetation management expenses and a $9 million increase in plant outage expenses. Depreciation Depreciation increased $20 million in 2022 compared with 2021, primarily due to a $12 million increase driven by additional assets placed into service, net of retirements, and a $4 million increase driven by higher depreciation rates effective July 1, 2021. Financial Condition The remainder of this Item 7 in this Form 10-K is presented on a combined basis, providing information, as applicable, for all Registrants. Liquidity and Capital Resources(All Registrants)The Registrants' cash flows from operations and access to cost effective bank and capital markets are subject to risks and uncertainties. See "Item 1A. Risk Factors" for a discussion of risks and uncertainties that could affect the Registrants' cash flows.The Registrants had the following at:PPLPPLElectricLG&EKUDecember 31, 2022 Cash and cash equivalents$356 $25 $93 $21 Short-term debt985 145 179 101 Long-term debt due within one year354 340 — 13 Notes payable with affiliates— — — December 31, 2021 Cash and cash equivalents$3,571 $21 $9 $13 Short-term debt69 — 69 — Long-term debt due within one year474 474 — — Notes payable with affiliates— 324 294 (PPL)The statements of Cash Flows separately report the cash flows of discontinued operations. The "Operating Activities," "Investing Activities" and "Financing Activities" sections below include only the cash flows of continuing operations.(All Registrants)Net cash provided by (used in) operating, investing and financing activities for the years ended December 31 and the changes between periods were as follows:46Table of ContentsPPLPPLElectricLG&EKU2022 Operating activities$1,730 $757 $543 $661 Investing activities(5,654)(387)(360)(547)Financing activities709 (366)(99)(106)2021 Operating activities$1,544 $969 $458 $608 Investing activities8,564 (1,400)(466)(556)Financing activities(7,344)412 10 (61)2022 vs. 2021 Change Operating activities$186 $(212)$85 $53 Investing activities(14,218)1,013 106 9 Financing activities8,053 (778)(109)(45)Operating ActivitiesThe components of the change in cash provided by (used in) operating activities were as follows:PPLPPLElectricLG&EKU2022 vs. 2021 Change - Cash Provided (Used): Net income$696 $80 $23 $26 Non-cash components(153)(21)11 32 Working capital(414)(262)50 2 Defined benefit plan funding41 21 1 — Other operating activities16 (30)— (7)Total$186 $(212)$85 $53 (PPL) PPL cash provided by operating activities in 2022 increased $186 million compared with 2021.•Net income increased $696 million between periods and included a decrease in net non-cash charges of $153 million. The decrease in non-cash charges was primarily due to the loss on extinguishment of debt and the impairment of solar panels in 2021, partially offset by an increase in depreciation and an increase in deferred income taxes and investment tax credits.•The $414 million decrease in cash from changes in working capital was primarily due to a decrease in regulatory liabilities (primarily due to PPL Electric’s transmission formula rate return on equity reduction and the timing of rate recovery mechanisms) and a decrease in other current assets, partially offset by an increase in unbilled revenues (primarily due to weather and rate recovery mechanisms), an increase in accounts receivable (primarily due to pricing) and an increase in accounts payable (primarily due to timing). •The $41 million decrease in defined benefit plan funding was primarily due to a decrease in contribution to pension plans in 2022, as PPL's defined benefit pension plans have the option to utilize available prior year credit balances to meet current and future contribution requirements. •The $16 million increase in cash provided by other operating activities was driven by an increase in non-current liabilities (primarily related to an increase in ARO expenditures and an increase in non-current regulatory liabilities, partially offset by a decrease in accrued pension and postretirement obligations).47Table of Contents(PPL Electric) PPL Electric's cash provided by operating activities in 2022 decreased $212 million compared with 2021.•Net income increased $80 million between the periods and included a decrease in non-cash components of $21 million. The decrease in non-cash components was primarily due to a decrease in depreciation expense (primarily related to a decrease in software and computer hardware depreciation as a result of end-of-life retirements). •The $262 million decrease in cash from changes in working capital was primarily due to a decrease in regulatory liabilities (primarily due to refunds to customers related to the transmission formula rate return on equity reduction), partially offset by an increase in unbilled revenues (primarily due to weather and rate recovery mechanisms), an increase in accounts payable (due to timing) and an increase in accounts receivable (due to pricing).•The $21 million of activity in defined benefit plan funding was primarily due to a decrease in contribution to its pension plans in 2022, as PPL Electric's defined benefit pension plans have the option to utilize available prior year credit balances to meet current and future contribution requirements.•The $30 million decrease in cash provided by other operating activities was driven primarily by an increase in non-current assets (primarily related to cloud computing and a decrease in medical claim payments).(LG&E)LG&E's cash provided by operating activities in 2022 increased $85 million compared with 2021.•Net income increased $23 million between the periods and included an increase in non-cash components of $11 million. The increase in non-cash components was primarily driven by an increase in depreciation expense (primarily due to additional assets placed into service, net of retirements and higher depreciation rates effective July 1, 2021), partially offset by a decrease in deferred income tax expense (primarily due to book versus tax plant timing differences).•Cash from changes in working capital increased by $50 million. The increase was primarily due to a decrease in regulatory assets and liabilities, net (primarily due to the timing of rate recovery mechanisms), an increase in accounts payable to affiliates and other current liabilities (primarily due to timing of payments), partially offset by an increase in unbilled revenues (primarily due to weather and higher commodity costs). (KU) KU's cash provided by operating activities in 2022 increased $53 million compared with 2021.•Net income increased $26 million between the periods and included an increase in non-cash components of $32 million. The increase in non-cash components was primarily driven by an increase in depreciation expense (primarily due to additional assets placed into service, net of retirements and higher depreciation rates effective July 1, 2021).•Cash from changes in working capital increased $2 million. The increase was primarily due to an increase in accounts payable, an increase in accounts payable with affiliates, an increase in taxes payable and a decrease in other current liabilities (primarily due to timing of payments) and other insignificant changes, partially offset by an increase in fuels, materials and supplies (primarily due to higher commodity costs and the accumulation of inventory for upcoming transmission and distribution products) and an increase in unbilled revenues and accounts receivable (primarily due to weather and higher commodity costs).Investing Activities(All Registrants)The components of the change in cash provided by (used in) investing activities were as follows:48Table of ContentsPPLPPLElectricLG&EKU2022 vs. 2021 Change - Cash Provided (Used): Expenditures for PP&E$(182)$12 $95 $13 Proceeds from sale of Safari Holdings, net of cash divested146 — — — Proceeds from sale of U.K. utility business, net of cash divested(10,560)— — — Acquisition of Narragansett Electric, net of cash acquired(3,660)— — — Notes receivable from affiliate— 998 — — Other investing activities38 3 11 (4)Total$(14,218)$1,013 $106 $9 For PPL, in 2022 compared with 2021, the increase in expenditures was due to expenditures at RIE, partially offset by a decrease in expenditures at LG&E. The decrease in expenditures at LG&E was primarily due to lower spending on ELG projects and other projects that are not individually significant. See "Forecasted Uses of Cash" for detail regarding projected capital expenditures for the years 2023 through 2025.For PPL Electric, the changes in "Notes receivable from affiliate" activity resulted from payments received on the short-term note between affiliates in 2022, issued to support general corporate purposes. See Note 15 to the Financial Statements for further discussion of intercompany borrowings. Financing Activities(All Registrants)The components of the change in cash provided by (used in) financing activities were as follows:PPLPPLElectricLG&EKU2022 vs. 2021 Change - Cash Provided (Used): Long-term debt issuance/retirement, net$4,542 $(250)$300 $300 Dividends492 (6)(83)(46)Purchase of treasury stock1,003 — — — Capital contributions/distributions, net— (671)16 (16)Retirement of term loan300 — — — Retirement of commercial paper73 — 41 32 Changes in net short-term debt1,642 145 262 272 Note payable with affiliate— — (648)(588)Other financing activities1 4 3 1 Total$8,053 $(778)$(109)$(45)(All Registrants) See Note 8 to the Financial Statements in this Form 10-K for information on 2022 activity.See "Long-term Debt and Equity Securities" below for additional information on current year activity. See "Forecasted Sources of Cash" for a discussion of the Registrants' plans to issue debt and equity securities, as well as a discussion of credit facility capacity available to the Registrants. Also see "Forecasted Uses of Cash" for a discussion of PPL's plans to pay dividends on common securities in the future, as well as the Registrants' maturities of long-term debt.Long-term Debt and Equity SecuritiesLong-term debt and equity securities activity for 2022 included: 49Table of Contents DebtStock Issuances (a)RetirementsIssuances (b)RepurchasesCash Flow Impact: PPL$850 $264 $18 $— PPL Electric250 250 — — LG&E300 — — — KU300 — — — (a)Issuances are net of pricing discounts, where applicable, and exclude the impact of debt issuance costs. Includes debt issuances with affiliates.(b)Includes issuances of common stock and treasury stock, which are included in "Other financing activities" on the Statements of Cash Flows.See Note 8 to the Financial Statements for additional long-term debt information.Equity Securities Activities (PPL)Share RepurchaseIn August 2021, PPL's Board of Directors authorized share repurchases of up to $3 billion of PPL common shares. In 2021, PPL repurchased approximately $1 billion of PPL common shares. There were no share repurchases during the year ended December 31, 2022. Any additional amounts to be repurchased pursuant to this authority will depend on various factors, including PPL’s share price and market conditions. PPL may purchase shares on each trading day subject to market conditions and principles of best execution.Forecasted Sources of Cash(All Registrants)The Registrants expect to continue to have adequate liquidity available from operating cash flows, cash and cash equivalents, credit facilities and commercial paper issuances to meet their requirements with respect to their contractual obligations and anticipated capital expenditures. Additionally, subject to market conditions, the Registrants and their subsidiaries may access the capital markets, and PPL Electric, LG&E and KU anticipate receiving equity contributions from their parent or member in 2023.Credit FacilitiesThe Registrants maintain credit facilities to enhance liquidity, provide credit support and provide a backstop to commercial paper programs. Amounts borrowed under these credit facilities are reflected in "Short-term debt" on the Balance Sheets, except for borrowings under PPL Electric's term loan agreement due in 2024 and borrowings under LG&E's and KU's term loan agreements due in 2024, which are reflected in "Long-term debt". At December 31, 2022, the total committed borrowing capacity under credit facilities and the borrowings under these facilities were:ExternalCommitted CapacityBorrowedLetters ofCreditandCommercialPaperIssued (c)UnusedCapacityPPL Capital Funding Credit Facilities$1,350 $— $561 $789 PPL Electric Credit Facilities900 250 146 504 LG&E Credit Facilities800 300 180 320 KU Credit Facilities700 300 101 299 Total Credit Facilities (a) (b)$3,750 $850 $988 $1,912 (a)The syndicated credit facilities, term loans and PPL Capital Funding's bilateral facility, each contain a financial covenant requiring debt to total capitalization not to exceed 70% for PPL Capital Funding, PPL Electric, LG&E and KU, as calculated in accordance with the facility, and other customary covenants.The commitments under the credit facilities are provided by a diverse bank group, with no one bank and its affiliates providing an aggregate commitment of more than the following percentages of the total committed capacity: PPL - 14%, PPL Electric - 18%, LG&E - 19% and KU - 21%.50Table of Contents(b)Each company pays customary fees under its respective syndicated credit facility. Borrowings generally bear interest at LIBOR-based rates, or applicable SOFR, plus an applicable margin.(c)Commercial paper issued reflects the undiscounted face value of the issuance.In addition to the financial covenants noted in the table above, the credit agreements governing the above credit facilities contain various other covenants. Failure to comply with the covenants after applicable grace periods could result in acceleration of repayment of borrowings and/or termination of the agreements. The Registrants monitor compliance with the covenants on a regular basis. At December 31, 2022, the Registrants were in compliance with these covenants. At this time, the Registrants believe that these covenants and other borrowing conditions will not limit access to these funding sources.See Note 8 to the Financial Statements for further discussion of the Registrants' credit facilities.Intercompany (LG&E and KU) CommittedCapacityBorrowedCommercial Paper ProgramCapacityUnusedCapacityLG&E Money Pool (a)$750 $— $500 $250 KU Money Pool (a)650 — 400 250 (a)LG&E and KU participate in an intercompany money pool agreement whereby LKE and/or KU make available to LG&E, and LKE and/or LG&E make available to KU funds up to the difference between LG&E's and KU's FERC borrowing limit and LG&E's and KU's commercial paper capacity limit, at an interest rate based on the lower of a market index of commercial paper issues and two additional rate options based on LIBOR.See Note 15 to the Financial Statements for further discussion of intercompany credit facilities.Commercial Paper (All Registrants)The Registrants maintain commercial paper programs to provide an additional financing source to fund short-term liquidity needs, as necessary. Commercial paper issuances, included in "Short-term debt" on the Balance Sheets, are supported by the respective Registrant's credit facilities. The following commercial paper programs were in place at: December 31, 2022CapacityCommercialPaperIssuances (c)UnusedCapacityPPL Capital Funding$1,350 $561 $789 PPL Electric650 145 505 LG&E (a)500 180 320 KU (b)400 101 299 Total PPL$2,900 $987 $1,913 (a)In August 2022, the capacity for the LG&E commercial paper program was increased to $500 million.(b)In August 2022, the capacity for the KU commercial paper program was increased to $400 million.(c)Commercial paper issued reflects the undiscounted face value of the issuance.Long-term Debt and Equity Securities(PPL) PPL and its subsidiaries are authorized to issue, at the discretion of management and subject to market conditions, up to $3.50 billion of long-term debt securities, the proceeds of which would be used to fund capital expenditures and for general corporate purposes. RIE is authorized to issue, at the discretion of management and subject to market conditions and regulatory approvals, up to $500 million of long-term debt securities, the proceeds of which would be used to repay short-term debt incurred to fund capital expenditures and for general corporate purposes.(PPL Electric)PPL Electric is authorized to issue, at the discretion of management and subject to market conditions and regulatory approvals, up to $1 billion of long-term debt securities, the proceeds of which would be used to fund capital expenditures and for general corporate purposes. 51Table of Contents(LG&E) LG&E is authorized to issue, at the discretion of management and subject to market conditions and regulatory approvals, up to $500 million of long-term debt securities, the proceeds of which would be used to repay short-term debt incurred to fund capital expenditures and for general corporate purposes.(KU)KU is authorized to issue, at the discretion of management and subject to market conditions and regulatory approvals, up to $500 million of long-term debt securities, the proceeds of which would be used to repay short-term debt incurred to fund capital expenditures and for general corporate purposes.Contributions from Parent (PPL Electric, LG&E and KU)From time to time, the parents of PPL Electric, LG&E and KU make capital contributions to subsidiaries. The proceeds from these contributions are used to fund capital expenditures and for other general corporate purposes.Forecasted Uses of Cash(All Registrants)In addition to expenditures required for normal operating activities, such as purchased power, payroll, fuel and taxes, the Registrants currently expect to incur future cash outflows for capital expenditures, various contractual obligations, payment of dividends on its common stock, and possibly the purchase or redemption of a portion of debt securities.Capital ExpendituresThe table below shows the Registrants' current capital expenditure projections for the years 2023 through 2025. Expenditures for the domestic regulated utilities are expected to be recovered through rates, pending regulatory approval. Projected Total2023 (b)20242025PPL Generating facilities (a)$1,508 $252 $369 $887 Electric distribution facilities2,734 929 892 913 Gas distribution facilities1,005 272 313 420 Transmission facilities2,962 827 1,019 1,116 Other308 106 100 102 Total Capital Expenditures$8,517 $2,386 $2,693 $3,438 PPL Electric Electric distribution facilities$921 $318 $299 $304 Transmission facilities1,980 545 670 765 Total Capital Expenditures$2,901 $863 $969 $1,069 LG&E Generating facilities (a)$633 $92 $147 $394 Electric distribution facilities476 165 161 150 Gas distribution facilities203 54 55 94 Transmission facilities56 5 23 28 Other120 50 34 36 Total Capital Expenditures$1,488 $366 $420 $702 52Table of Contents Projected Total2023 (b)20242025KU Generating facilities (a)$875 $160 $222 $493 Electric distribution facilities520 210 163 147 Transmission facilities338 165 91 82 Other178 52 63 63 Total Capital Expenditures$1,911 $587 $539 $785 (a)Capital expenditure projections include $115 million at PPL ($42 million at LG&E and $73 million at KU) in 2023 and $44 million at PPL ($21 million at LG&E and $23 million at KU) in 2024 related to certain costs of complying with the Clean Air Act, as amended, and other federal, state and local environmental requirements applicable to coal combustion wastes and by-products from coal-fired generating facilities, which are expected to be subject to rate recovery through the ECR mechanism.(b)The 2023 total excludes amounts included in accounts payable as of December 31, 2022.Capital expenditure plans are revised periodically to reflect changes in operational, market and regulatory conditions. Contractual ObligationsThe Registrants have assumed various financial obligations and commitments in the ordinary course of conducting business. At December 31, 2022, estimated contractual cash obligations were as follows: Total20232024-20252026-2027After 2027PPL Long-term Debt (a)$13,353 $354 $2,052 $1,207 $9,740 Interest on Long-term Debt (b)9,067 557 984 881 6,645 Operating Leases (c)69 24 29 9 7 Purchase Obligations (d) 3,348 1,363 1,090 340 555 Total Contractual Cash Obligations $25,837 $2,298 $4,155 $2,437 $16,947 PPL Electric Long-term Debt (a)$4,539 $340 $900 $108 $3,191 Interest on Long-term Debt (b)3,038 183 299 289 2,267 Unconditional Power Purchase Obligations106 29 57 20 — Total Contractual Cash Obligations$7,683 $552 $1,256 $417 $5,458 LG&E Long-term Debt (a)$2,324 $— $600 $285 $1,439 Interest on Long-term Debt (b)1,367 92 160 130 985 Operating Leases (c)16 6 8 2 — Coal and Natural Gas Purchase Obligations (e)705 340 282 74 9 Unconditional Power Purchase Obligations (f)296 24 44 44 184 Construction Obligations (g)126 58 63 2 3 Other Obligations72 26 36 4 6 Total Contractual Cash Obligations$4,906 $546 $1,193 $541 $2,626 KU Long-term Debt (a)$2,942 $13 $550 $164 $2,215 Interest on Long-term Debt (b)2,045 123 220 191 1,511 Operating Leases (c)21 9 11 1 — Coal and Natural Gas Purchase Obligations (e)866 354 408 104 — Unconditional Power Purchase Obligations (f)131 10 20 20 81 Construction Obligations (g)103 54 43 2 4 Other Obligations128 60 50 12 6 Total Contractual Cash Obligations$6,236 $623 $1,302 $494 $3,817 53Table of Contents(a)Reflects principal maturities based on stated maturity, sinking fund payments, or earlier put dates. See Note 8 to the Financial Statements for a discussion of variable-rate remarketable bonds issued on behalf of LG&E and KU. The Registrants do not have any significant finance lease obligations.(b)Assumes interest payments through stated maturity or earlier put dates. The payments herein are subject to change, as payments for debt that is or becomes variable-rate debt have been estimated.(c)See Note 10 to the Financial Statements for additional information.(d)The amounts include agreements to purchase goods or services that are enforceable and legally binding and specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Primarily includes, as applicable, the purchase obligations of electricity, coal, natural gas and limestone, as well as certain construction expenditures, which are also included in the Capital Expenditures discussion above.(e)Represents contracts to purchase coal, natural gas and natural gas transportation. See Note 14 to the Financial Statements for additional information. (f)Represents future minimum payments under OVEC power purchase agreements through June 2040. See Note 14 to the Financial Statements for additional information.(g)Represents construction commitments, which are also reflected in the Capital Expenditures table presented above.Dividends/Distributions(PPL)PPL views dividends as an integral component of shareowner return and expects to continue to pay dividends in amounts intended to maintain a capitalization structure that supports investment grade credit ratings. In November 2022, PPL declared its quarterly common stock dividend, payable January 3, 2023, at 22.50 cents per share (equivalent to $0.90 per annum). On February 17, 2023, PPL announced a quarterly common stock dividend of 24.00 cents per share, payable April 3, 2023, to shareowners of record as of March 10, 2023. Future dividends will be declared at the discretion of the Board of Directors and will depend upon future earnings, cash flows, financial and legal requirements and other factors.Subject to certain exceptions, PPL may not declare or pay any cash dividend or distribution on its capital stock during any period in which PPL Capital Funding defers interest payments on its 2007 Series A Junior Subordinated Notes due 2067. At December 31, 2022, no interest payments were deferred.(PPL Electric, LG&E and KU)From time to time, as determined by their respective Board of Directors, the Registrants pay dividends, distributions or return capital, as applicable, to their respective shareholders or members. Certain of the credit facilities of PPL Electric, LG&E and KU include minimum debt covenant ratios that could effectively restrict the payment of dividends or distributions.(All Registrants) See Note 8 to the Financial Statements for these and other restrictions related to distributions on capital interests for the Registrants and their subsidiaries.Purchase or Redemption of Debt SecuritiesThe Registrants will continue to evaluate outstanding debt securities and may decide to purchase or redeem these securities in open market or privately negotiated transactions, in exchange transactions or otherwise, depending upon prevailing market conditions, available cash and other factors, and may be commenced or suspended at any time. The amounts involved may be material.Rating Agency ActionsMoody's and S&P periodically review the credit ratings of the debt of the Registrants and their subsidiaries. Based on their respective independent reviews, the rating agencies may make certain ratings revisions or ratings affirmations.A credit rating reflects an assessment by the rating agency of the creditworthiness associated with an issuer and particular securities that it issues. The credit ratings of the Registrants and their subsidiaries are based on information provided by the Registrants and other sources. The ratings of Moody's and S&P are not a recommendation to buy, sell or hold any securities of the Registrants or their subsidiaries. Such ratings may be subject to revisions or withdrawal by the agencies at any time and should be evaluated independently of each other and any other rating that may be assigned to the securities.The credit ratings of the Registrants and their subsidiaries affect their liquidity, access to capital markets and cost of borrowing under their credit facilities. A downgrade in the Registrants' or their subsidiaries' credit ratings could result in higher borrowing 54Table of Contentscosts and reduced access to capital markets. The Registrants and their subsidiaries have no credit rating triggers that would result in the reduction of access to capital markets or the acceleration of maturity dates of outstanding debt.The following table sets forth the Registrants' and their subsidiaries' credit ratings for outstanding debt securities or commercial paper programs as of December 31, 2022. Senior Unsecured Senior Secured Commercial PaperIssuer Moody's S&P Moody's S&P Moody's S&PPPL PPL Capital Funding Baa1 BBB+ P-2 A-2Rhode Island EnergyA3A- PPL and PPL Electric PPL Electric A1 A+ P-2 A-1 PPL, LG&E and KU LG&E A1 A P-2 A-2KU A1 A P-2 A-2The rating agencies have taken the following actions related to the Registrants and their subsidiaries.(PPL)In June 2022, Moody’s affirmed its commercial paper rating for PPL Capital Funding and upgraded the following ratings with astable outlook:• the long-term issuer rating from Baa2 to Baa1 for PPL;• the senior unsecured rating from Baa2 to Baa1 for PPL Capital Funding;• the junior subordinated rating from Baa3 to Baa2 for PPL Capital Funding; and• the senior unsecured bank credit facility rating from Baa2 to Baa1 for PPL Capital Funding.In June 2022, Moody’s upgraded the following ratings with a stable outlook:• the long-term issuer rating from Baa1 to A3 for RIE;• the senior unsecured rating from Baa1 to A3 for RIE; and• the preferred stock rating from Baa3 to Baa2 for RIE.In June 2022, S&P upgraded the following ratings with a stable outlook:• the long-term issuer rating from BBB+ to A- for RIE;• the senior unsecured rating from BBB+ to A- for RIE; and• the preferred stock rating from BBB- to BBB for RIE.(PPL and PPL Electric)In May 2022, S&P upgraded the following ratings with a stable outlook for PPL Electric:• the long-term issuer credit rating from A- to A;• the issue-level senior secured rating from A to A+; and• the short-term and commercial paper ratings from A-2 to A-1.Ratings Triggers (PPL, LG&E and KU)Various derivative and non-derivative contracts, including contracts for the sale and purchase of electricity and fuel, commodity transportation and storage, and interest rate instruments, contain provisions that require the posting of additional collateral or permit the counterparty to terminate the contract, if PPL's, LG&E's or KU's or their subsidiaries' credit rating, as applicable, were to fall below investment grade. See Note 18 to the Financial Statements for a discussion of "Credit Risk-Related Contingent Features," including a discussion of the potential additional collateral requirements for PPL and LG&E for derivative contracts in a net liability position at December 31, 2022.55Table of ContentsGuarantees for Subsidiaries (PPL)PPL guarantees certain consolidated affiliate financing arrangements. Some of the guarantees contain financial and other covenants that, if not met, would limit or restrict the consolidated affiliates' access to funds under these financing arrangements, accelerate maturity of such arrangements or limit the consolidated affiliates' ability to enter into certain transactions. At this time, PPL believes that these covenants will not limit access to relevant funding sources. See Note 14 to the Financial Statements for additional information about guarantees.Other Contingent Obligations (All Registrants)The Registrants have entered into certain agreements that may contingently require payment to a guaranteed or indemnified party. See Note 14 to the Financial Statements for a discussion of these agreements. Risk ManagementMarket Risk(All Registrants)See Notes 1, 17 and 18 to the Financial Statements for information about the Registrants' risk management objectives, valuation techniques and accounting designations.The forward-looking information presented below provides estimates of what may occur in the future, assuming certain adverse market conditions and model assumptions. Actual future results may differ materially from those presented. These are not precise indicators of expected future losses, but are rather only indicators of possible losses under normal market conditions at a given confidence level.Interest Rate RiskPPL and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk. A variety of financial derivative instruments are utilized to adjust the mix of fixed and floating interest rates in their debt portfolios, adjust the duration of the debt portfolios and lock in benchmark interest rates in anticipation of future financing, when appropriate. Risk limits under PPL's risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of the debt portfolio due to changes in benchmark interest rates. In addition, the interest rate risk of certain subsidiaries is potentially mitigated as a result of the existing regulatory framework or the timing of rate cases.The following interest rate hedges were outstanding at December 31: 20222021ExposureHedgedFair Value,Net - Asset(Liability) (a)Effect of a10% AdverseMovementin Rates (b)MaturitiesRangingThroughExposureHedgedFair Value,Net - Asset(Liability) (a)Effect of a10% AdverseMovementin Rates (b)PPL and LG&E Economic hedges Interest rate swaps (c)$64 $(7)$(1)2033$64 $(19)$(1)(a)Includes accrued interest, if applicable.(b)Effects of adverse movements decrease assets or increase liabilities, as applicable, which could result in an asset becoming a liability. Sensitivities represent a 10% adverse movement in interest rates.(c)Realized changes in the fair value of such economic hedges are recoverable through regulated rates and any subsequent changes in the fair value of these derivatives are included in regulatory assets or regulatory liabilities.The Registrants are exposed to a potential increase in interest expense and to changes in the fair value of their debt portfolios. The estimated impact of a 10% adverse movement in interest rates on the fair value of debt and interest expense at December 31 is shown below.56Table of Contents 10% Adverse Movement in Rates on Fair Value of Debt10% Adverse Movement in Rates on Interest Expense For Floating Exposure 2022202120222021PPL$495 $394 $16 $— PPL Electric178 164 6 — LG&E84 74 3 — KU127 115 2 — Commodity Price RiskPPL is exposed to commodity price risk through its subsidiaries as described below.•PPL Electric is required to purchase electricity to fulfill its obligation as a PLR. Potential commodity price risk is mitigated through its PAPUC-approved cost recovery mechanism and full-requirement supply agreements to serve its PLR customers which transfer the risk to energy suppliers.•LG&E's and KU's rates include certain mechanisms for fuel, fuel-related expenses and energy purchases. In addition, LG&E's rates include a mechanism for natural gas supply costs. These mechanisms generally provide for timely recovery of market price fluctuations associated with these costs.•RIE utilizes derivative instruments pursuant to its RIPUC-approved plan to manage commodity price risk associated with its natural gas purchases. RIE's commodity price risk management strategy is to reduce fluctuations in firm gas sales prices to its customers. RIE's costs associated with derivatives instruments are recoverable through its RIPUC- approved cost recovery mechanisms. RIE is required to purchase electricity to fulfill its obligation to provide Last Resort Service (LRS). Potential commodity price risk is mitigated through its RIPUC-approved cost recovery mechanisms and full requirements service agreements to serve LRS customers, which transfer the risk to energy suppliers. RIE is required to contract through long-term agreements for clean energy supply under the Rhode Island Renewable Energy Growth program and Long-term Clean Energy Standard. Potential commodity price risk is mitigated through its RIPUC-approved cost recovery mechanisms, which true-up cost differences between contract prices and market prices. Volumetric RiskVolumetric risk is the risk related to the changes in volume of retail sales due to weather, economic conditions or other factors. PPL is exposed to volumetric risk through its subsidiaries as described below.•PPL Electric, LG&E and KU are exposed to volumetric risk on retail sales, mainly due to weather and other economic conditions for which there is limited mitigation between rate cases. •RIE is exposed to volumetric risk, which is significantly mitigated by regulatory mechanisms. RIE's electric and gas distribution rates both have a revenue decoupling mechanism, which allows for annual adjustments to RIE's delivery rates.Defined Benefit Plans - Equity Securities Price RiskSee "Application of Critical Accounting Policies - Defined Benefits" for additional information regarding the effect of equity securities price risk on plan assets.Credit Risk(All Registrants)Credit risk is the potential loss that may be incurred due to a counterparty's non-performance.PPL is exposed to credit risk from "in-the-money" transactions with counterparties, as well as additional credit risk through certain of its subsidiaries, as discussed below.In the event a supplier of PPL, PPL Electric, LG&E or KU defaults on its contractual obligation, those Registrants would need to seek replacement power or replacement fuel in the market. In general, subject to regulatory review or other processes, appropriate incremental costs incurred by these entities would be recoverable from customers through applicable rate mechanisms, thereby mitigating the financial risk for these entities.57Table of ContentsPPL and its subsidiaries have credit policies in place to manage credit risk, including the use of an established credit approval process, daily monitoring of counterparty positions and the use of master netting agreements or provisions. These agreements generally include credit mitigation provisions, such as margin, prepayment or collateral requirements. PPL and its subsidiaries may request additional credit assurance, in certain circumstances, in the event that the counterparties' credit ratings fall below investment grade, their tangible net worth falls below specified percentages or their exposures exceed an established credit limit. (All Registrants)Related Party TransactionsThe Registrants are not aware of any material ownership interests or operating responsibility by senior management in outside partnerships, including leasing transactions with variable interest entities, or other entities doing business with the Registrants. See Note 15 to the Financial Statements for additional information on related party transactions for PPL Electric, LG&E and KU. Acquisitions, Development and DivestituresThe Registrants from time to time evaluate opportunities for potential acquisitions, divestitures, and development projects. See Note 9 to the Financial Statements for additional information on acquisition and divestiture activity. Development projects are reexamined based on market conditions and other factors to determine whether to proceed with, modify or terminate the projects. Any resulting transactions may impact future financial results. Environmental MattersExtensive federal, state and local environmental laws and regulations are applicable to the Registrants' air emissions, water discharges and the management of hazardous and solid waste, as well as other aspects of the Registrants' businesses. The costs of compliance or alleged non-compliance cannot be predicted with certainty but could be significant. In addition, costs may increase significantly if the requirements or scope of environmental laws or regulations, or similar rules, are expanded or changed. Costs may take the form of increased capital expenditures or operating and maintenance expenses, monetary fines, penalties or other restrictions. Many of these environmental law considerations are also applicable to the operations of key suppliers, or customers, such as coal producers and industrial power users, and may impact the costs for their products or their demand for the Registrants' services. Increased capital and operating costs are expected to be subject to rate recovery. The Registrants can provide no assurances as to the ultimate outcome of future environmental or rate proceedings before regulatory authorities.See "Legal Matters" in Note 14 to the Financial Statements for a discussion of the more significant environmental claims. See "Financial Condition - Liquidity and Capital Resources - Forecasted Uses of Cash - Capital Expenditures" in "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations" for information on projected environmental capital expenditures for 2023 through 2025. See Note 20 to the Financial Statements for information related to the impacts of CCRs on AROs. See "Item 1. Business - Environmental Matters" for additional information.SustainabilityIncreasing attention has been focused on a broad range of corporate activities under the heading of “sustainability”, which has resulted in a significant increase in the number of requests from interested parties for information on sustainability topics. These parties range from investor groups focused on environmental, social, governance and other matters to non-investors concerned with a variety of public policy matters. Often the scope of the information sought is very broad and not necessarily relevant to an issuer’s business or industry. As a result, a number of private groups have proposed to standardize the subject matter constituting sustainability, either generally or by industry. Those efforts remain ongoing. In addition, certain of these private groups have advocated that the SEC promulgate regulations requiring specific sustainability reporting under the Securities Exchange Act of 1934, as amended (the ’34 Act), or that issuers voluntarily include certain sustainability disclosure in their ’34 Act reports. In March 2022, the SEC proposed broad-based climate disclosure requirements for public companies. The proposed rule would require public companies to disclose direct and indirect GHG emissions, strategic insights, and certain financial implications in public disclosures. The proposed rulemaking elicited significant debate and comment. While a final rulemaking is currently expected to be issued in the spring of 2023, PPL cannot predict the final legal requirements or when the requirements will be effective.58Table of ContentsAs has been PPL’s practice, to the extent sustainability issues have or may have a material impact on the Registrants’ financial condition or results of operation, PPL discloses such matters in accordance with applicable securities law and SEC regulations. With respect to other sustainability topics that PPL deems relevant to investors but that are not required to be reported under applicable securities law and SEC regulation, PPL will continue each spring to publish its annual sustainability report including tracking reductions related to the company's goal to reduce carbon emissions and post that report on its corporate website at www.pplweb.com and on www.pplsustainability.com. Neither the information in such annual sustainability report nor the information at such websites is incorporated in this Form 10-K by reference, and it should not be considered a part of this Form 10-K. In preparing its sustainability report, PPL is guided by the framework established by the Global Reporting Initiative, which identifies environmental, social, governance and other subject matter categories. PPL also participates in efforts by the Edison Electric Institute and American Gas Association to provide the appropriate subset of sustainability information that can be applied consistently across the electric and gas utility industry. Additionally, PPL consults widely used reporting frameworks for discrete sustainability topics, including corporate political contributions and climate-related issues. PPL also responds to the climate survey of CDP, a not-for-profit organization based in the United Kingdom formerly known as the Carbon Disclosure Project, that runs the global disclosure system that enables investors, companies, cities, states and regions to measure and manage their environmental impacts.CybersecuritySee “Cybersecurity Management” in “Item 1. Business” and “Item 1A. Risk factors” for a discussion of cybersecurity risks affecting the Registrants and the related strategies for managing these risks.CompetitionSee "Competition" under each of PPL's reportable segments in "Item 1. Business - General - Segment Information" and "Item 1A. Risk Factors" for a discussion of competitive factors affecting the Registrants. New Accounting GuidanceThere has been no new accounting guidance adopted in 2022 and there is no new significant accounting guidance pending adoption as of December 31, 2022.Application of Critical Accounting PoliciesFinancial condition and results of operations are impacted by the methods, assumptions and estimates used in the application of critical accounting policies. The following accounting policies are particularly important to an understanding of the reported financial condition or results of operations and require management to make estimates or other judgments of matters that are inherently uncertain. Changes in the estimates or other judgments included within these accounting policies could result in a significant change to the information presented in the Financial Statements (these accounting policies are also discussed in Note 1 to the Financial Statements). Senior management has reviewed with PPL's Audit Committee these critical accounting policies, the following disclosures regarding their application, and the estimates and assumptions regarding them.Defined Benefits(All Registrants)Certain of the Registrants and/or their subsidiaries sponsor or participate in certain qualified funded and non-qualified unfunded defined benefit pension plans and both funded and unfunded other postretirement benefit plans. See Notes 1, 7 and 12 to the Financial Statements for additional information about the plans and the accounting for defined benefits.A summary of plan sponsors by Registrant and whether a Registrant or its subsidiaries sponsor (S) or participate in and receives allocations (P) from those plans is shown in the table below.Plan SponsorPPL PPL Electric LG&E KUPPL ServicesS P LKE P PManagement makes certain assumptions regarding the valuation of benefit obligations and the performance of plan assets. As such, annual net periodic defined benefit costs are recorded in current earnings or regulatory assets and liabilities based on 59Table of Contentsestimated results. Any differences between actual and estimated results are recorded in AOCI or, in the case of PPL Electric, LG&E and KU, regulatory assets and liabilities for amounts that are expected to be recovered through regulated customer rates. These amounts in AOCI or regulatory assets and liabilities are amortized to income over future periods. The significant assumptions are:•Discount Rate - In selecting the discount rates for defined benefit plans, the plan sponsors start with a cash flow analysis of the expected benefit payment stream for their plans. The plan-specific cash flows are matched against the coupons and expected maturity values of Aa-rated non-callable (or callable with make-whole provisions) bonds that could be purchased for a hypothetical settlement portfolio. The plan sponsors then use the single discount rate derived from matching the discounted benefit payment stream to the market value of the selected bond portfolio.•Expected Return on Plan Assets - The expected long-term rates of return for pension and other postretirement benefits are based on management's projections using a best-estimate of expected returns, volatilities and correlations for each asset class. Each plan's specific current and expected asset allocations are also considered in developing a reasonable return assumption.•Rate of Compensation Increase - Management projects employees' annual pay increases, which are used to project employees' pension benefits at retirement. In selecting a rate of compensation increase, plan sponsors consider past experience, the potential impact of movements in inflation rates and expectations of ongoing compensation practices.See Note 12 to the Financial Statements for details of the assumptions selected for pension and other postretirement benefits. A variance in the assumptions could significantly impact accrued defined benefit liabilities or assets, reported annual net periodic defined benefit costs and AOCI or regulatory assets and liabilities. The following tables reflect changes in certain assumptions based on the Registrants' primary defined benefit plans. The inverse of this change would have the opposite impact on accrued defined benefit liabilities or assets, reported annual net periodic defined benefit costs and AOCI or regulatory assets and liabilities. The sensitivities below reflect an evaluation of the change based solely on a change in that assumption.Increase (Decrease)Actuarial assumption Discount Rate(0.25 %)Expected Return on Plan Assets(0.25 %)Rate of Compensation Increase0.25 %60Table of ContentsIncrease (Decrease)Increase (Decrease)(Increase) DecreaseIncrease (Decrease)Increase (Decrease)Actuarial assumptionDefined BenefitAssetDefined BenefitLiabilitiesAOCI(pre-tax)Net RegulatoryAssetsDefined BenefitCostsPPL Discount rates$(14)$(78)$27 $65 $14 Expected return on plan assetsn/an/an/an/a10 Rate of compensation increase(2)(6)2 6 3 PPL Electric Discount rates— (34)— 34 5 Expected return on plan assetsn/an/a— n/a4 Rate of compensation increase— (2)— 2 1 LG&EDiscount rates(9)1 n/a10 2 Expected return on plan assetsn/an/an/an/a1 Rate of compensation increase(1)— n/a1 — KUDiscount rates(8)1 n/a9 2 Expected return on plan assetsn/an/an/an/a1 Rate of compensation increase(1)— n/a1 — Income Taxes (All Registrants)Significant management judgment is required in developing the Registrants' provision for income taxes, primarily due to the uncertainty related to tax positions taken or expected to be taken on tax returns and valuation allowances on deferred tax assets. Additionally, significant management judgment is required to determine the amount of benefit recognized related to an uncertain tax position. On a quarterly basis, uncertain tax positions are reassessed by considering information known as of the reporting date. Based on management's assessment of new information, a tax benefit may subsequently be recognized for a previously unrecognized tax position, a previously recognized tax position may be derecognized, or the benefit of a previously recognized tax position may be remeasured. The amounts ultimately paid upon resolution of issues raised by taxing authorities may differ materially from the amounts accrued and may materially impact the financial statements in the future.The need for valuation allowances to reduce deferred tax assets also requires significant management judgment. Valuation allowances are initially recorded and reevaluated each reporting period by assessing the likelihood of the ultimate realization of a deferred tax asset. Management considers several factors in assessing the expected realization of a deferred tax asset, including the reversal of temporary differences, future taxable income and ongoing prudent and feasible tax planning strategies. Any tax planning strategy utilized in this assessment must meet the recognition and measurement criteria utilized to account for an uncertain tax position. When evaluating the need for valuation allowances, the uncertainty posed by political risk on such factors is also considered by management. The amount of deferred tax assets ultimately realized may differ materially from the estimates utilized in the computation of valuation allowances and may materially impact the financial statements in the future.See Note 6 to the Financial Statements for income tax disclosures.Regulatory Assets and Liabilities (All Registrants)PPL Electric, LG&E, KU and RIE are subject to cost-based rate regulation. As a result, the effects of regulatory actions are required to be reflected in the financial statements. Assets and liabilities are recorded that result from the regulated ratemaking process that may not be recorded under GAAP for non-regulated entities. Regulatory assets generally represent incurred costs that have been deferred because such costs are probable of future recovery in regulated customer rates. Regulatory liabilities are recognized for amounts expected to be returned through future regulated customer rates. In certain cases, regulatory liabilities are recorded based on an understanding or agreement with the regulator that rates have been set to recover costs that are expected to be incurred in the future, and the regulated entity is accountable for any amounts charged pursuant to such rates and not yet expended for the intended purpose.61Table of ContentsManagement continually assesses whether the regulatory assets are probable of future recovery by considering factors such as changes in the applicable regulatory and political environments, the ability to recover costs through regulated rates, recent rate orders to the Registrants and other regulated entities, and the status of any pending or potential deregulation legislation. Based on this continual assessment, management believes the existing regulatory assets are probable of recovery. This assessment reflects the current political and regulatory climate at the state and federal levels and is subject to change in the future. If future recovery of costs ceases to be probable, the regulatory asset would be written-off. Additionally, the regulatory agencies can provide flexibility in the manner and timing of recovery of regulatory assets.See Note 7 to the Financial Statements for regulatory assets and regulatory liabilities recorded at December 31, 2022 and 2021, as well as additional information on those regulatory assets and liabilities. All regulatory assets are either currently being recovered under specific rate orders, represent amounts that are expected to be recovered in future rates or benefit future periods based upon established regulatory practices.Price Risk Management (PPL)See "Financial Condition - Risk Management" above.Goodwill Impairment (PPL, LG&E and KU) Goodwill is tested for impairment at the reporting unit level. The reporting units of PPL include the Kentucky Regulated reporting unit, the Pennsylvania Regulated reporting unit, and the Rhode Island Regulated reporting unit. LG&E and KU are individually single operating and reportable segments and each are single reporting units. A goodwill impairment test is performed annually or more frequently if events or changes in circumstances indicate that the carrying amount of the reporting unit may be greater than the reporting unit's fair value. Management assigned the assets acquired and liabilities assumed in the RIE acquisition to the Rhode Island Regulated reporting unit. For purposes of goodwill impairment testing, RIE goodwill of $1,586 million was assigned to PPL’s reporting units. To determine the amount of the RIE goodwill assigned to PPL’s reporting units, management calculated the fair value of the Kentucky Regulated and the Pennsylvania Regulated reporting units with-and-without the expected benefit to those reporting units. The difference in the fair values of the Kentucky Regulated and Pennsylvania Regulated reporting units with-and-without the expected benefit from the acquisition of RIE represents goodwill derived from the acquisition and was assigned to the respective reporting units. The remainder of the RIE goodwill was assigned to the Rhode Island Regulated reporting unit.The fair value of a reporting unit is compared with the carrying value and an impairment charge is recognized if the carrying amount exceeds the fair value of the reporting unit.PPL, for its reporting units, and individually LG&E and KU may elect either to initially make a qualitative evaluation about the likelihood of an impairment of goodwill or to bypass the qualitative evaluation and test goodwill for impairment using a quantitative test. See "Long-Lived and Intangible Assets - Asset Impairment (Excluding Investments)" in Note 1 to the Financial Statements for further discussion of goodwill impairment tests. See Note 19 to the Financial Statements for information on goodwill balances by reportable segment at December 31, 2022.As of October 1, 2022, PPL, for its reporting units, and individually, LG&E and KU, elected to perform quantitative annual goodwill impairment tests. Management used both discounted cash flows and market multiples, which required significant assumptions, to estimate the fair value of reporting units. Significant assumptions used in these approaches included discount and growth rates, projected outcomes of future rate filings, projected operating and capital cash flows, and select market data. Projected operating and capital cash flows are based on the internal business plan, which assumes the occurrence of certain future events. There were no indicators of impairment for any of the reporting units as the fair value of each of the reporting units significantly exceeded their carrying values. Asset Retirement Obligations (LG&E and KU)ARO liabilities are required to be recognized for legal obligations associated with the retirement of long-lived assets. Initial obligations are measured at estimated fair value. An ARO must be recognized when incurred if the fair value of the ARO can be reasonably estimated. An equivalent amount is recorded as an increase in the value of the capitalized asset and amortized to expense over the asset's useful life.62Table of ContentsIn determining AROs, management must make significant judgments and estimates to calculate fair value. Fair value is developed using an expected present value technique based on assumptions of market participants that consider estimated retirement costs in current period dollars, inflated to the anticipated retirement date and discounted back to the date the ARO was incurred. Changes in assumptions and estimates included within the calculations of the fair value of AROs could result in significantly different results than those identified and recorded in the financial statements. Estimated ARO costs and settlement dates, which affect the carrying value of the ARO and the related capitalized asset, are reviewed periodically to ensure that any material changes are incorporated into the ARO estimate. Any change to the capitalized asset is generally amortized over the remaining life of the associated long-lived asset.See "Long-Lived and Intangible Assets - Asset Retirement Obligations" in Note 1, Note 7 and Note 20 to the Financial Statements for additional information on AROs.At December 31, 2022, the total recorded balances and information on the most significant recorded AROs were as follows. Most Significant AROsTotalARORecordedAmountRecorded% of TotalDescriptionLG&E$86 $65 76 Ponds, landfills and natural gas mainsKU82 55 67 Ponds and landfillsThe most significant assumptions surrounding AROs are the forecasted retirement costs (including settlement dates and the timing of cash flows), discount and inflation rates. At December 31, 2022, a 10% increase to retirement cost would increase these ARO liabilities by $7 million at LG&E and $10 million at KU. A 0.25% decrease in the discount rate would increase these ARO liabilities by $5 million at LG&E and $1 million at KU and a 0.25% increase in the inflation rate would increase these ARO liabilities by $4 million at LG&E. There would be no significant change to the annual depreciation expense of the ARO asset or the annual accretion expense of the ARO liability as a result of these changes in assumptions. Revenue Recognition - Unbilled Revenues (All Registrants)For RIE, LG&E and KU, revenues related to the sale of energy are recorded when service is rendered or when energy is delivered to customers. Because customers are billed on cycles which vary based on the timing of actual meter reads taken throughout the month, estimates are recorded for unbilled revenues at the end of each reporting period. Such unbilled revenue amounts reflect estimates of deliveries to customers since the date of the last reading of their meters. The unbilled revenue estimates reflect consideration of factors including daily load models, estimated usage for each customer class, the effect of current and different rate schedules, the meter read schedule, the billing schedule, actual weather data, and, where applicable, the impact of weather normalization or other regulatory provisions of rate structures.For PPL Electric, unbilled revenues for a month are calculated by multiplying the actual unbilled volumes by the price per tariff. In the fourth quarter of 2022, PPL Electric estimated deliveries to customers due to a temporary technical system issue. These estimates took into consideration factors similar to those considered by RIE, LG&E and KU discussed above. The technical system issue has been resolved and unbilled revenues are expected to resume being calculated by multiplying the actual unbilled volumes by the price per tariff in the first quarter of 2023. Other Information (All Registrants) PPL's Audit Committee has approved the independent auditor to provide audit and audit-related services, tax services and other services permitted by Sarbanes-Oxley and SEC rules. The audit and audit-related services include services in connection with statutory and regulatory filings, reviews of offering documents and registration statements, and internal control reviews.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK PPL Corporation, PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities Company Reference is made to "Risk Management" for the Registrants in "Item 7. Combined Management's Discussion and Analysis of Financial Condition and Results of Operations."63Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareowners and the Board of Directors of PPL CorporationOpinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of PPL Corporation and subsidiaries (the "Company") as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income, equity, and cash flows, for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 17, 2023, expressed an unqualified opinion on the Company's internal control over financial reporting.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MatterThe critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.Regulatory Assets and Liabilities – Impact of Rate Regulation on Various Account Balances and Disclosures – Refer to Notes 1 and 7 to the financial statements Critical Audit Matter DescriptionAs discussed in Note 1 to the financial statements, the Company owns and operates four cost-based rate-regulated utilities for which rates are set by the Federal Energy Regulatory Commission (FERC), the Kentucky Public Service Commission (KPSC), the Virginia State Corporation Commission (VSCC), the Pennsylvania Public Utility Commission (PAPUC), and the Rhode Island Public Utilities Commission (RIPUC) to enable the regulated utilities to recover the costs of providing electric or gas services, as applicable, and to provide a reasonable return to shareholders. Base rates are generally established based on a future test period. As a result, the financial statements are subject to the accounting for certain types of regulation as prescribed by generally accepted accounting principles and reflect the effects of regulatory actions. Regulatory assets are recognized for the effect of transactions or events where future recovery of underlying costs is probable in regulated customer rates. The effect of such accounting is to defer certain or qualifying costs that would otherwise currently be charged to expense. Regulatory liabilities are recognized for amounts expected to be returned through future regulated customer rates. The accounting for regulatory assets and regulatory liabilities is based on specific ratemaking decisions or precedent for each transaction or event as prescribed by the FERC, KPSC, VSCC, PAPUC, RIPUC, and Rhode Island Division of Public Utilities 64Table of Contentsand Carriers. The accounting for the economics of rate-regulation impacts various account balances, disclosures, including regulated utility plant, regulatory assets and liabilities, operating revenues, depreciation and income taxes. As of December 31, 2022, the Company had a recorded regulatory assets balance of $2,077 million and regulatory liabilities balance of $3,650 million.The Company’s regulated utilities’ rates are subject to cost-based rate-setting processes and annual earnings oversight. Rates are established based on an analysis of the costs incurred and the regulated utility’s capital structure and must be approved by one or more federal or state regulatory commissions, including the FERC, KPSC, VSCC, PAPUC, RIPUC, and Rhode Island Division of Public Utilities and Carriers. Regulatory decisions can have an impact on the recovery of costs, the rate earned on invested capital, and the timing and amount of assets to be recovered by rates. The FERC, KPSC, VSCC, PAPUC, RIPUC, and Rhode Island Division of Public Utilities and Carriers regulation of rates is premised on the full recovery of prudently incurred costs and an adequate return on capital investments. Current and future regulatory decisions can impact the timing of future utility plant retirements, the rate of return earned on investments, and the timing and amounts of cost recovery. While the Company’s utilities have indicated that they expect to recover costs from customers through regulated rates, there is a risk that the FERC, KPSC, VSCC, PAPUC, RIPUC, and Rhode Island Division of Public Utilities and Carriers will not approve full recovery of such costs or approve recovery on a timely basis in future regulatory decisions. We identified the impact of rate regulation as a critical audit matter due to the significant judgments made by management in continually assessing whether the regulatory assets are probable of future recovery by considering factors, such as changes in the applicable regulatory and political environments, the ability to recover costs through regulated rates, recent rate orders, and the status of any pending legislation. Auditing these judgments required specialized knowledge of accounting for rate regulation and the rate-setting process due to its inherent complexities. How the Critical Audit Matter Was Addressed in the AuditOur audit procedures related to the uncertainty of future decisions by the FERC, KPSC, VSCC, PAPUC, RIPUC, and Rhode Island Division of Public Utilities and Carriers included the following, among others: •We tested the effectiveness of management’s internal controls over evaluating the likelihood of recovery in future rates of costs deferred as regulatory assets. We tested the effectiveness of management’s controls over the recognition of amounts as regulated utility plant, regulatory assets or liabilities, operating revenues, depreciation, income taxes, and note disclosures. We tested the effectiveness of management’s internal controls over the monitoring and evaluation of regulatory developments that may affect the likelihood of recovering costs in future rates or of a future reduction in rates. •We obtained and read relevant regulatory orders issued by the FERC, KPSC, VSCC, PAPUC, RIPUC and Rhode Island Division of Public Utilities and Carriers for the Company’s regulated utilities and other public utilities, regulatory statutes, interpretations, procedural memorandums, filings made by intervening parties, and other publicly available information to assess the likelihood of recovery in future rates or of a future reduction in rates based on precedents of the treatment of similar costs under similar circumstances. We evaluated the external information and compared it to management’s recorded regulatory asset and liability balances for completeness. •We inquired of management about regulated utility plant that may be abandoned. We inspected minutes of the Board of Directors, other public information, regulatory orders, and other filings with the commissions to identify any evidence that could indicate utility plant may be abandoned. •We evaluated the Company’s disclosures related to the impacts of rate-regulation, including the balances recorded and regulatory developments, in the financial statements. Goodwill arising from Acquisition of Rhode Island Energy – Refer to Notes 1, 9 and 19 to the Financial StatementsCritical Audit Matter DescriptionThe Company’s balance sheet includes $2,248 million of goodwill as of December 31, 2022, of which $1,586 million was recorded as a result of the acquisition of Rhode Island Energy (the "Acquisition") and assigned to the Company’s reporting units. To determine the amount of goodwill from the Acquisition assigned to each of the Company’s reporting units, management calculated the fair value of the Kentucky Regulated and the Pennsylvania Regulated reporting units with-and-without the expected benefit to those reporting units from the Acquisition. The difference in the fair values of the Kentucky Regulated and Pennsylvania Regulated reporting units with-and-without the expected benefit from the Acquisition represents goodwill derived from the Acquisition and was assigned to the respective reporting units. The remainder of the goodwill from the Acquisition was assigned to the Rhode Island Regulated reporting unit.65Table of ContentsWe identified the assignment of goodwill from the Acquisition to the Company’s reporting units as a critical audit matter due to the significant judgments made by management to determine the amount assigned to each reporting unit. This required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists, when performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions related to the assignment of goodwill to the Company’s reporting units. How the Critical Audit Matter Was Addressed in the AuditOur audit procedures related to the amount of goodwill from the Acquisition assigned to each of the Company’s reporting units based on management’s fair value calculation included the following, among others:•We tested the effectiveness of management’s internal controls over their assignment of goodwill from the Acquisition to each reporting unit, including those over the determination of the fair value calculated based on a with-and-without expected benefit. •We evaluated the reasonableness of management’s expected benefit by comparing to: ◦Historical results.◦Internal communications to management and the board of directors.◦Information included in the Company’s press releases as well as in analyst and industry reports for the Company.•With the assistance of our fair value specialists, we evaluated the reasonableness of the amount of goodwill from the Acquisition assigned to each reporting unit based on management’s fair value calculation by:◦Testing the source information underlying the determination of discount and growth rates.◦Testing the mathematical accuracy of the calculation./s/ Deloitte & Touche LLPMorristown, New Jersey February 17, 2023 We have served as the Company's auditor since 2015.66Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Shareowner and the Board of Directors of PPL Electric Utilities CorporationOpinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of PPL Electric Utilities Corporation and subsidiaries (the "Company") as of December 31, 2022 and 2021, the related consolidated statements of income, equity, and cash flows, for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.Basis for OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.Critical Audit MatterThe critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Regulatory Assets and Liabilities – Impact of Rate Regulation on Various Account Balances and Disclosures – Refer to Notes 1 and 7 to the financial statements Critical Audit Matter DescriptionAs discussed in Note 1 to the financial statements, PPL Electric Utilities Corporation (PPL Electric) is a cost-based rate-regulated utility for which rates are set by the Federal Energy Regulatory Commission (FERC) and the Pennsylvania Public Utility Commission (PAPUC) to enable the regulated utility to recover the costs of providing electric service and to provide a reasonable return to shareholders. Base rates are generally established based on a future test period. As a result, the financial statements are subject to the accounting for certain types of regulation as prescribed by generally accepted accounting principles and reflect the effects of regulatory actions. Regulatory assets are recognized for the effect of transactions or events where future recovery of underlying costs is probable in regulated customer rates. The effect of such accounting is to defer certain or qualifying costs that would otherwise currently be charged to expense. Regulatory liabilities are recognized for amounts expected to be returned through future regulated customer rates. The accounting for regulatory assets and regulatory liabilities is based on specific ratemaking decisions or precedent for each transaction or event as prescribed by the FERC and PAPUC. The accounting for the economics of rate-regulation impacts various account balances and disclosures, including regulated utility plant, regulatory assets and liabilities, operating revenues, depreciation, and income taxes. As of December 67Table of Contents31, 2022, PPL Electric had a recorded regulatory assets balance of $581 million and regulatory liabilities balance of $905 million.PPL Electric’s regulated utility’s rates are subject to cost-based rate-setting processes and annual earnings oversight. Rates are established based on an analysis of the costs incurred and the regulated utility’s capital structure and must be approved by one or more federal or state regulatory commissions, including the FERC and PAPUC. Regulatory decisions can have an impact on the recovery of costs, the rate earned on invested capital, and the timing and amount of assets to be recovered by rates. The FERC and PAPUC regulation of rates is premised on the full recovery of prudently incurred costs and an adequate return on capital investments. Current and future regulatory decisions can impact the rate of return earned on investments and the timing and amounts of cost recovery. While PPL Electric has indicated that it expects to recover costs from customers through regulated rates, there is a risk that the FERC or PAPUC will not approve full recovery of such costs or approve recovery on a timely basis in future regulatory decisions. We identified the impact of rate regulation as a critical audit matter due to the significant judgments made by management in continually assessing whether the regulatory assets are probable of future recovery by considering factors such as changes in the applicable regulatory and political environments, the ability to recover costs through regulated rates, recent rate orders, and the status of any pending legislation. Auditing these judgments required specialized knowledge of accounting for rate regulation and the rate-setting process due to its inherent complexities. How the Critical Audit Matter Was Addressed in the AuditOur audit procedures related to the uncertainty of future decisions by the FERC and PAPUC included the following, among others: •We tested the effectiveness of management’s internal controls over evaluating the likelihood of recovery in future rates of costs deferred as regulatory assets. We tested the effectiveness of management’s controls over the recognition of amounts as regulated utility plant, regulatory assets or liabilities, operating revenues, depreciation, income taxes, and note disclosures. We tested the effectiveness of management’s internal controls over the monitoring and evaluation of regulatory developments that may affect the likelihood of recovering costs in future rates or of a future reduction in rates. •We obtained and read relevant regulatory orders issued by the FERC and PAPUC for PPL Electric and other public utilities in Pennsylvania, regulatory statutes, interpretations, procedural memorandums, filings made by intervening parties, and other publicly available information to assess the likelihood of recovery in future rates or of a future reduction in rates based on precedents of the treatment of similar costs under similar circumstances. We evaluated the external information and compared it to management’s recorded regulatory asset and liability balances for completeness. •We inquired of management about regulated utility plant that may be abandoned. We inspected minutes of the Board of Directors, other public information, regulatory orders and other filings with the commissions to identify any evidence that may contradict management’s assertion regarding probability of an abandonment. •We evaluated PPL Electric’s disclosures related to the impacts of rate-regulation, including the balances recorded and regulatory developments, in the financial statements./s/ Deloitte & Touche LLPMorristown, New Jersey February 17, 2023 We have served as the Company's auditor since 2015.68Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Stockholder and the Board of Directors of Louisville Gas and Electric CompanyOpinion on the Financial Statements We have audited the accompanying balance sheets of Louisville Gas and Electric Company (the “Company”) as of December 31, 2022 and 2021, the related statements of income, equity, and cash flows, for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit MatterThe critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.Regulatory Assets and Liabilities– Impact of Rate-Regulation on Various Account Balances and Disclosures – Refer to Notes 1 and 7 to the financial statementsCritical Audit Matter DescriptionAs discussed in Note 1 to the financial statements, the Company is a cost-based rate-regulated utility for which rates are set by the Kentucky Public Service Commission (KPSC) and the Federal Energy Regulatory Commission (FERC) to enable the regulated utility to recover the costs of providing electric or gas services, as applicable, and to provide a reasonable return to shareholders. Base rates are generally established based on a future test period. As a result, the financial statements are subject to the accounting for certain types of regulation as prescribed by generally accepted accounting principles and reflect the effects of regulatory actions. Regulatory assets are recognized for the effect of transactions or events where future recovery of underlying costs is probable in regulated customer rates. The effect of such accounting is to defer certain or qualifying costs that would otherwise currently be charged to expense. Regulatory liabilities are recognized for amounts expected to be returned through future regulated customer rates. The accounting for regulatory assets and regulatory liabilities is based on specific ratemaking decisions or precedent for each transaction or event as prescribed by the KPSC and FERC. The accounting for the economics of rate-regulation impacts various account balances and disclosures, including regulated utility plant, regulatory assets and liabilities, operating revenues, depreciation, and income taxes. As of December 31, 2022, the Company had a recorded regulatory assets balance of $396 million and regulatory liabilities balance of $840 million.69Table of ContentsThe Company’s regulated utility’s rates are subject to cost-based rate-setting processes and annual earnings oversight. Rates are established based on an analysis of the costs incurred and the regulated utility’s capital structure and must be approved by one or more federal or state regulatory commissions, including the KPSC and FERC. Regulatory decisions can have an impact on the recovery of costs, the rate earned on invested capital and the timing and amount of assets to be recovered by rates. The KPSC and FERC regulation of rates is premised on the full recovery of prudently incurred costs and an adequate return on capital investments. Current and future regulatory decisions can impact the timing of future utility plant retirements, the rate of return earned on investments, and the timing and amounts of cost recovery. While the Company has indicated that it expects to recover costs from customers through regulated rates, there is a risk that the KPSC or FERC will not approve full recovery of such costs or approve recovery on a timely basis in future regulatory decisions.We identified the impact of rate regulation as a critical audit matter due to the significant judgments made by management in continually assessing whether the regulatory assets are probable of future recovery by considering factors such as changes in the applicable regulatory and political environments, the ability to recover costs through regulated rates, recent rate orders, and the status of any pending legislation. Auditing these judgments required specialized knowledge of accounting for rate regulation and the rate-setting process due to its inherent complexities. How the Critical Audit Matter Was Addressed in the AuditOur audit procedures related to the uncertainty of future decisions by the KPSC and FERC included the following, among others:•We tested the effectiveness of management’s internal controls over evaluating the likelihood of recovery in future rates of costs deferred as regulatory assets. We tested the effectiveness of management's controls over the recognition of amounts as regulated utility plant, regulatory assets or liabilities, operating revenues, depreciation, income taxes, and note disclosures. We tested the effectiveness of management's internal controls over the monitoring and evaluation of regulatory developments that may affect the timing and amount of future utility plant retirements and the likelihood of recovering costs in future rates or of a future reduction in rates.•We obtained and read relevant regulatory orders issued by the KPSC and FERC for the Company and other public utilities in Kentucky, regulatory statutes, interpretations, procedural memorandums, filings made by intervening parties, and other publicly available information to assess the likelihood of recovery in future rates or of a future reduction in rates based on precedents of the treatment of similar costs under similar circumstances. We evaluated the external information and compared it to management’s recorded regulatory asset and liability balances for completeness.•We inquired of management about regulated utility plant that may be abandoned. We inspected minutes of the board of directors, other public information, regulatory orders and other filings with the KPSC and FERC to identify any evidence that could indicate utility plant may be abandoned.•We evaluated the Company’s disclosures related to the impacts of rate-regulation, including the balances recorded and regulatory developments./s/ Deloitte & Touche LLPLouisville, KentuckyFebruary 17, 2023We have served as the Company’s auditor since 2015.70Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Stockholder and the Board of Directors of Kentucky Utilities CompanyOpinion on the Financial Statements We have audited the accompanying balance sheets of Kentucky Utilities Company (the “Company”) as of December 31, 2022 and 2021, the related statements of income, equity, and cash flows, for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit MatterThe critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.Regulatory Assets and Liabilities – Impact of Rate-Regulation on Various Account Balances and Disclosures – Refer to Notes 1 and 7 to the financial statementsCritical Audit Matter DescriptionAs discussed in Note 1 to the financial statements, the Company is a cost-based rate-regulated utility for which rates are set by the Kentucky Public Service Commission (KPSC), the Virginia State Corporation Commission (VSCC), and the Federal Energy Regulatory Commission (FERC) to enable the regulated utility to recover the costs of providing electric service, as applicable, and to provide a reasonable return to shareholders. Base rates are generally established based on a future test period. As a result, the financial statements are subject to the accounting for certain types of regulation as prescribed by generally accepted accounting principles and reflect the effects of regulatory actions. Regulatory assets are recognized for the effect of transactions or events where future recovery of underlying costs is probable in regulated customer rates. The effect of such accounting is to defer certain or qualifying costs that would otherwise currently be charged to expense. Regulatory liabilities are recognized for amounts expected to be returned through future regulated customer rates. The accounting for regulatory assets and regulatory liabilities is based on specific ratemaking decisions or precedent for each transaction or event as prescribed by the KPSC, VSCC, and FERC. The accounting for the economics of rate-regulation impacts various account balances and disclosures, including regulated utility plant, regulatory assets and liabilities, operating revenues, depreciation, 71Table of Contentsand income taxes. As of December 31, 2022, the Company had a recorded regulatory assets balance of $474 million and regulatory liabilities balance of $1,035 million.The Company’s regulated utility’s rates are subject to cost-based rate-setting processes and annual earnings oversight. Rates are established based on an analysis of the costs incurred and the regulated utility’s capital structure and must be approved by one or more federal or state regulatory commissions, including the KPSC, VSCC, and FERC. Regulatory decisions can have an impact on the recovery of costs, the rate earned on invested capital and the timing and amount of assets to be recovered by rates. The KPSC, VSCC, and FERC regulation of rates is premised on the full recovery of prudently incurred costs and an adequate return on capital investments. Current and future regulatory decisions can impact the timing of future utility plant retirements, the rate of return earned on investments, and the timing and amounts of cost recovery. While the Company has indicated that it expects to recover costs from customers through regulated rates, there is a risk that the KPSC, VSCC, or FERC will not approve full recovery of such costs or approve recovery on a timely basis in future regulatory decisions.We identified the impact of rate regulation as a critical audit matter due to the significant judgments made by management in continually assessing whether the regulatory assets are probable of future recovery by considering factors such as changes in the applicable regulatory and political environments, the ability to recover costs through regulated rates, recent rate orders, and the status of any pending legislation. Auditing these judgments required specialized knowledge of accounting for rate regulation and the rate-setting process due to its inherent complexities. How the Critical Audit Matter Was Addressed in the AuditOur audit procedures related to the uncertainty of future decisions by the KPSC, VSCC, and FERC included the following, among others:•We tested the effectiveness of management’s internal controls over evaluating the likelihood of recovery in future rates of costs deferred as regulatory assets. We tested the effectiveness of management’s controls over the recognition of amounts as regulated utility plant, regulatory assets or liabilities, operating revenues, depreciation, income taxes, and note disclosures. We tested the effectiveness of management’s internal controls over the monitoring and evaluation of regulatory developments that may affect the timing and amount of future utility plant retirements and the likelihood of recovering costs in future rates or of a future reduction in rates.•We obtained and read relevant regulatory orders issued by the KPSC, VSCC, and FERC for the Company and other public utilities in Kentucky and Virginia, regulatory statutes, interpretations, procedural memorandums, filings made by intervening parties, and other publicly available information to assess the likelihood of recovery in future rates or of a future reduction in rates based on precedents of the treatment of similar costs under similar circumstances. We evaluated the external information and compared it to management’s recorded regulatory asset and liability balances for completeness.•We inquired of management about regulated utility plant that may be abandoned. We inspected minutes of the board of directors, other public information, regulatory orders and other filings with the KPSC, VSCC, and FERC to identify any evidence that could indicate utility plant may be abandoned.•We evaluated the Company’s disclosures related to the impacts of rate-regulation, including the balances recorded and regulatory developments./s/ Deloitte & Touche LLPLouisville, KentuckyFebruary 17, 2023We have served as the Company’s auditor since 2015.72Table of Contents(THIS PAGE LEFT BLANK INTENTIONALLY.)73Table of ContentsITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATACONSOLIDATED STATEMENTS OF INCOME (LOSS) FOR THE YEARS ENDED DECEMBER 31,PPL Corporation and Subsidiaries(Millions of Dollars, except share data) 202220212020Operating Revenues$7,902 $5,783 $5,474 Operating Expenses Operation Fuel931 710 632 Energy purchases1,686 752 634 Other operation and maintenance2,398 1,608 1,420 Depreciation1,181 1,082 1,022 Taxes, other than income332 207 180 Total Operating Expenses6,528 4,359 3,888 Operating Income1,374 1,424 1,586 Other Income (Expense) - net (Note 16)54 15 2 Interest Expense513 918 634 Income from Continuing Operations Before Income Taxes915 521 954 Income Taxes201 503 314 Income from Continuing Operations After Income Taxes71418 640 Income (Loss) from Discontinued Operations (net of income taxes) (Note 9)42 (1,498)829 Net Income (Loss)$756 $(1,480)$1,469 Earnings Per Share of Common Stock: BasicIncome from Continuing Operations After Income Taxes$0.97 $0.03 $0.83 Income (Loss) from Discontinued Operations (net of income taxes) 0.06 (1.96)1.08 Net Income (Loss) Available to PPL Common Shareowners $1.03 $(1.93)$1.91 DilutedIncome from Continuing Operations After Income Taxes$0.96 $0.03 $0.83 Income (Loss) from Discontinued Operations (net of income taxes)0.06 (1.96)1.08 Net Income (Loss) Available to PPL Common Shareowners$1.02 $(1.93)$1.91 Weighted-Average Shares of Common Stock Outstanding (in thousands) Basic 736,027 762,902 768,590 Diluted736,902 764,819 769,384 The accompanying Notes to Financial Statements are an integral part of the financial statements.74Table of ContentsCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)FOR THE YEARS ENDED DECEMBER 31,PPL Corporation and Subsidiaries(Millions of Dollars)202220212020Net income (loss)$756 $(1,480)$1,469 Other comprehensive income (loss): Amounts arising during the period - gains (losses), net of tax (expense) benefit: Foreign currency translation adjustments, net of tax of $0, ($123), $0— 372 267 Qualifying derivatives, net of tax of $0, $11, $5— (39)(19)Equity investees' other comprehensive income (loss), net tax of $0, $0, $02 — — Defined benefit plans: Prior service costs, net of tax of $0, $0, $0(1)— (1)Net actuarial gain (loss), net of tax of ($2), $1, $7411 (1)(341)Reclassifications from AOCI - (gains) losses, net of tax expense (benefit): Qualifying derivatives, net of tax of ($1), ($5), ($8)2 25 24 Defined benefit plans: Prior service costs, net of tax of ($1), ($1), ($1)2 2 3 Net actuarial (gain) loss, net of tax of ($7), ($33), ($51)17 126 205 Reclassifications from AOCI due to sale of the U.K. utility business - (gains) losses, net of tax expense (benefit):Foreign currency translation adjustments, net of tax of $0, $140, $0— 786 — Qualifying derivatives, net of tax of $0, $0, $0— 15 — Defined benefit plans:Prior service costs, net of tax of $0, ($2), $0— 8 — Net actuarial (gain) loss, net of tax of $0, ($798), $0— 2,769 — Total other comprehensive income (loss)33 4,063 138 Comprehensive income$789 $2,583 $1,607 The accompanying Notes to Financial Statements are an integral part of the financial statements.75Table of ContentsCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,PPL Corporation and Subsidiaries(Millions of Dollars) 202220212020Cash Flows from Operating Activities Net income (loss)$756 $(1,480)$1,469 Loss (income) from discontinued operations (net of income taxes)(42)1,498 (829)Income from continuing operations (net of income taxes)714 18 640 Adjustments to reconcile net income to net cash provided by operating activities Depreciation1,181 1,082 1,022 Amortization52 39 58 Deferred income taxes and investment tax credits179 87 169 Loss on sale of Safari Holdings60 — — Impairment of solar panels— 37 — Loss on extinguishment of debt— 395 — Other35 20 67 Change in current assets and current liabilities Accounts receivable(176)(14)(70)Accounts payable358 24 (1)Unbilled revenues(197)(5)3 Fuel, materials and supplies(90)(21)(9)Taxes payable(80)27 131 Regulatory assets and liabilities, net(119)52 (63)Other(88)(41)124 Other operating activities Defined benefit plans - funding(12)(53)(119)Other assets(126)(111)(59)Other liabilities39 8 (21)Net cash provided by operating activities - continuing operations1,730 1,544 1,872 Net cash provided by operating activities - discontinued operations— 726 874 Net cash provided by operating activities1,730 2,270 2,746 Cash Flows from Investing Activities Expenditures for property, plant and equipment(2,155)(1,973)(2,270)Proceeds from sale of Safari Holdings, net of cash divested146 — — Proceeds from sale of U.K. utility business, net of cash divested— 10,560 — Acquisition of Narragansett Electric, net of cash acquired(3,660)— — Other investing activities15 (23)4 Net cash provided by (used in) investing activities - continuing operations(5,654)8,564 (2,266)Net cash provided by (used in) investing activities - discontinued operations— (607)(992)Net cash provided by (used in) investing activities(5,654)7,957 (3,258)Cash Flows from Financing Activities Issuance of long-term debt850 650 1,848 Retirement of long-term debt(264)(4,606)(975)Payment of common stock dividends(787)(1,279)(1,275)Purchase of treasury stock— (1,003)— Issuance of term loan— — 300 Issuance of commercial paper— — 73 Retirement of term loan— (300)— Retirement of commercial paper— (73)— Net increase (decrease) in short-term debt916 (726)(43)Other financing activities(6)(7)171 Net cash provided by (used in) financing activities - continuing operations709 (7,344)99 Net cash provided by (used in) financing activities - discontinued operations— (411)209 Contributions from discontinued operations— 365 78 Net cash provided by (used in) financing activities709 (7,390)386 Effect of Exchange Rates on Cash, Cash Equivalents and Restricted Cash included in Discontinued Operations— 8 17 Net (Increase) Decrease in Cash, Cash Equivalents and Restricted Cash included in Discontinued Operations— 284 (108)Net Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash(3,215)3,129 (217)Cash, Cash Equivalents and Restricted Cash at Beginning of Period3,572 443 660 Cash, Cash Equivalents and Restricted Cash at End of Period$357 $3,572 $443 Supplemental Disclosures of Cash Flow Information Cash paid (received) during the period for: Interest - net of amount capitalized$462 $191 $586 Income taxes - net$163 $284 $4 Significant non-cash transactions:Accrued expenditures for property, plant and equipment at December 31, $269 $245 $257 The accompanying Notes to Financial Statements are an integral part of the financial statements.76Table of ContentsCONSOLIDATED BALANCE SHEETS AT DECEMBER 31,PPL Corporation and Subsidiaries(Millions of Dollars, shares in thousands) 20222021Assets Current Assets Cash and cash equivalents$356 $3,571 Accounts receivable (less reserve: 2022, $87; 2021, $65) Customer896 583 Other150 58 Unbilled revenues (less reserve: 2022, $6; 2021, $2)552 307 Fuel, materials and supplies443 322 Prepayments92 60 Regulatory assets258 64 Other current assets77 42 Total Current Assets2,824 5,007 Property, Plant and Equipment Regulated utility plant36,961 30,477 Less: accumulated depreciation - regulated utility plant8,352 6,488 Regulated utility plant, net28,609 23,989 Non-regulated property, plant and equipment92 266 Less: accumulated depreciation - non-regulated property, plant and equipment46 41 Non-regulated property, plant and equipment, net46 225 Construction work in progress1,583 1,256 Property, Plant and Equipment, net30,238 25,470 Other Noncurrent Assets Regulatory assets1,819 1,236 Goodwill2,248 716 Other intangibles313 343 Other noncurrent assets (less reserve for accounts receivable: 2022, $2; 2021, $2)395 451 Total Other Noncurrent Assets4,775 2,746 Total Assets$37,837 $33,223 The accompanying Notes to Financial Statements are an integral part of the financial statements.77Table of ContentsCONSOLIDATED BALANCE SHEETS AT DECEMBER 31,PPL Corporation and Subsidiaries(Millions of Dollars, shares in thousands) 20222021Liabilities and Equity Current Liabilities Short-term debt$985 $69 Long-term debt due within one year354 474 Accounts payable1,201 679 Taxes124 96 Interest97 81 Dividends166 305 Regulatory liabilities238 182 Other current liabilities624 437 Total Current Liabilities3,789 2,323 Long-term Debt12,889 10,666 Deferred Credits and Other Noncurrent Liabilities Deferred income taxes3,007 3,151 Investment tax credits117 119 Accrued pension obligations206 183 Asset retirement obligations138 157 Regulatory liabilities3,412 2,422 Other deferred credits and noncurrent liabilities361 479 Total Deferred Credits and Other Noncurrent Liabilities7,241 6,511 Commitments and Contingent Liabilities (Notes 7 and 14)Equity Common stock - $0.01 par value (a)8 8 Additional paid-in capital12,317 12,303 Treasury stock(967)(1,003)Earnings reinvested2,681 2,572 Accumulated other comprehensive loss(124)(157)Total Shareowners' Common Equity13,915 13,723 Noncontrolling interests3— Total Equity13,918 13,723 Total Liabilities and Equity$37,837 $33,223 (a)1,560,000 shares authorized; 770,013 shares issued and 736,487 shares outstanding at December 31, 2022. 1,560,000 shares authorized; 769,890 shares issued and 735,112 shares outstanding at December 31, 2021.The accompanying Notes to Financial Statements are an integral part of the financial statements.78Table of ContentsCONSOLIDATED STATEMENTS OF EQUITYPPL Corporation and Subsidiaries(Millions of Dollars) Commonstock shares outstanding(a)Common stockAdditionalpaid-incapitalTreasury StockEarningsreinvestedAccumulated other comprehensivelossNoncontrolling interestTotalDecember 31, 2019767,233 $8 $12,214 $— $5,127 $(4,358)$— $12,991 Common stock issued1,674 51 51 Stock-based compensation 5 5 Net income (loss) 1,469 1,469 Dividends and dividend equivalents (b) (1,279) (1,279)Other comprehensive income (loss) 138 138 Adoption of financial instrument credit losses guidance cumulative effect adjustment (Note 1)(2)(2)December 31, 2020768,907 $8 $12,270 $— $5,315 $(4,220)$— $13,373 Common stock issued983 29 29 Treasury stock(34,778)(1,003)(1,003)Stock-based compensation 4 4 Net income (loss) (1,480) (1,480)Dividends and dividend equivalents (b) (1,263) (1,263)Other comprehensive income (loss) 4,063 4,063 December 31, 2021735,112 $8 $12,303 $(1,003)$2,572 $(157)$— $13,723 Common stock issued123 5 5 Treasury stock1,252 36 36 Stock-based compensation 9 9 Net income (loss) 756 756 Dividends and dividend equivalents (b) (647) (647)Preferred stock (Note 8)33 Other comprehensive income (loss) 33 33 December 31, 2022736,487 $8 $12,317 $(967)$2,681 $(124)$3 $13,918 (a)Shares in thousands. Each share entitles the holder to one vote on any question presented at any shareowners' meeting.(b)Dividends declared per share of common stock at December 31, 2022, 2021 and 2020 were: $0.875, $1.660 and $1.660.The accompanying Notes to Financial Statements are an integral part of the financial statements.79Table of Contents(THIS PAGE LEFT BLANK INTENTIONALLY.)80Table of ContentsCONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31,PPL Electric Utilities Corporation and Subsidiaries(Millions of Dollars) 202220212020Operating Revenues$3,030 $2,402 $2,331 Operating Expenses Operation Energy purchases1,048 566 491 Other operation and maintenance605 557 513 Depreciation393 424 403 Taxes, other than income149 120 107 Total Operating Expenses2,195 1,667 1,514 Operating Income835 735 817 Other Income (Expense) - net30 21 18 Interest Income from Affiliate5 5 2 Interest Expense171 162 173 Income Before Income Taxes699 599 664 Income Taxes174 154 167 Net Income (a)$525 $445 $497 (a)Net income equals comprehensive income.The accompanying Notes to Financial Statements are an integral part of the financial statements.81Table of ContentsCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,PPL Electric Utilities Corporation and Subsidiaries(Millions of Dollars) 202220212020Cash Flows from Operating Activities Net income$525 $445 $497 Adjustments to reconcile net income to net cash provided by (used in) operating activities Depreciation393 424 403 Amortization22 19 26 Defined benefit plans expense (income)(23)(10)(1)Deferred income taxes and investment tax credits91 79 83 Other(11)(19)(5)Change in current assets and current liabilities Accounts receivable(47)(9)(47)Accounts payable46 (3)21 Unbilled revenues(95)(8)13 Materials and supplies(11)(5)(18)Prepayments(2)(4)(3)Regulatory assets and liabilities, net(59)96 (40)Taxes payable5 14 4 Other(19)(1)(10)Other operating activities Defined benefit plans - funding— (21)(21)Other assets(47)(12)(28)Other liabilities(11)(16)10 Net cash provided by operating activities757 969 884 Cash Flows from Investing Activities Expenditures for property, plant and equipment(886)(898)(1,145)Expenditures for intangible assets(2)(6)(9)Net (increase) decrease in notes receivable from affiliate499 (499)— Other investing activities2 3 3 Net cash used in investing activities(387)(1,400)(1,151)Cash Flows from Financing Activities Issuance of long-term debt250 650 250 Retirement of long-term debt(250)(400)— Contributions from parent— 1,075 940 Payment of common stock dividends to parent(340)(334)(400)Return of capital to parent(170)(574)(745)Net increase in short-term debt145 — — Other financing activities(1)(5)(2)Net cash provided by (used in) financing activities(366)412 43 Net Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash4 (19)(224)Cash, Cash Equivalents and Restricted Cash at Beginning of Period21 40 264 Cash, Cash Equivalents and Restricted Cash at End of Period$25 $21 $40 Supplemental Disclosures of Cash Flow Information Cash paid during the period for: Interest - net of amount capitalized$164 $156 $158 Income taxes - net$111 $64 $67 Significant non-cash transactions:Accrued expenditures for property, plant and equipment at December 31, $133 $118 $156 The accompanying Notes to Financial Statements are an integral part of the financial statements.82Table of ContentsCONSOLIDATED BALANCE SHEETS AT DECEMBER 31,PPL Electric Utilities Corporation and Subsidiaries(Millions of Dollars, shares in thousands) 20222021Assets Current Assets Cash and cash equivalents$25 $21 Accounts receivable (less reserve: 2022, $28; 2021, $31) Customer357 305 Other12 22 Accounts receivable from affiliates3 11 Notes receivable from affiliate— 499 Unbilled revenues (less reserve: 2022, $2; 2021, $2)224 129 Materials and supplies69 61 Prepayments34 13 Regulatory assets13 22 Other current assets22 21 Total Current Assets759 1,104 Property, Plant and Equipment Regulated utility plant14,794 14,082 Less: accumulated depreciation - regulated utility plant3,544 3,386 Regulated utility plant, net11,250 10,696 Construction work in progress593 581 Property, Plant and Equipment, net11,843 11,277 Other Noncurrent Assets Regulatory assets568 488 Intangibles269 270 Pension benefit asset— 50 Other noncurrent assets (less reserve for accounts receivable: 2022, $2; 2021, $2)126 113 Total Other Noncurrent Assets963 921 Total Assets$13,565 $13,302 The accompanying Notes to Financial Statements are an integral part of the financial statements.83Table of ContentsCONSOLIDATED BALANCE SHEETS AT DECEMBER 31,PPL Electric Utilities Corporation and Subsidiaries(Millions of Dollars, shares in thousands) 20222021Liabilities and Equity Current Liabilities Short-term debt $145 $— Long-term debt due within one year340 474 Accounts payable480 367 Accounts payable to affiliates16 56 Taxes36 31 Interest35 35 Regulatory liabilities85 153 Other current liabilities86 108 Total Current Liabilities1,223 1,224 Long-term Debt4,146 4,010 Deferred Credits and Other Noncurrent Liabilities Deferred income taxes1,514 1,668 Regulatory liabilities820 559 Other deferred credits and noncurrent liabilities111 105 Total Deferred Credits and Other Noncurrent Liabilities2,445 2,332 Commitments and Contingent Liabilities (Notes 7 and 14)Equity Common stock - no par value (a)364 364 Additional paid-in capital4,084 4,254 Earnings reinvested1,303 1,118 Total Equity5,751 5,736 Total Liabilities and Equity$13,565 $13,302 (a)170,000 shares authorized; 66,368 shares issued and outstanding at December 31, 2022 and December 31, 2021.The accompanying Notes to Financial Statements are an integral part of the financial statements.84Table of ContentsCONSOLIDATED STATEMENTS OF EQUITYPPL Electric Utilities Corporation and Subsidiaries(Millions of Dollars) Common stock shares outstanding(a)CommonstockAdditional paid-incapitalEarningsreinvestedTotalDecember 31, 201966,368 $364 $3,558 $910 $4,832 Net income 497 497 Capital contributions from parent 940 940 Return of capital to parent(745)(745)Dividends declared on common stock (400)(400)December 31, 202066,368 $364 $3,753 $1,007 $5,124 Net income 445 445 Capital contributions from parent 1,075 1,075 Return of capital to parent(574)(574)Dividends declared on common stock (334)(334)December 31, 202166,368 $364 $4,254 $1,118 $5,736 Net income 525 525 Return of capital to parent(170)(170)Dividends declared on common stock (340)(340)December 31, 202266,368 $364 $4,084 $1,303 $5,751 (a)Shares in thousands. All common shares of PPL Electric stock are owned by PPL.The accompanying Notes to Financial Statements are an integral part of the financial statements.85Table of Contents(THIS PAGE LEFT BLANK INTENTIONALLY.)86Table of ContentsSTATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31,Louisville Gas and Electric Company(Millions of Dollars) 202220212020Operating Revenues Retail and wholesale$1,762 $1,545 $1,435 Electric revenue from affiliate36 24 21 Total Operating Revenues1,798 1,569 1,456 Operating Expenses Operation Fuel346 265 246 Energy purchases245 167 125 Energy purchases from affiliate25 23 19 Other operation and maintenance416 400 373 Depreciation298 279 259 Taxes, other than income48 46 40 Total Operating Expenses1,378 1,180 1,062 Operating Income420 389 394 Other Income (Expense) – net4 (5)(1)Interest Expense89 81 87 Income Before Income Taxes335 303 306 Income Taxes63 54 62 Net Income (a)$272 $249 $244 (a)Net income equals comprehensive income.The accompanying Notes to Financial Statements are an integral part of the financial statements.87Table of ContentsSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,Louisville Gas and Electric Company(Millions of Dollars) 202220212020Cash Flows from Operating Activities Net income$272 $249 $244 Adjustments to reconcile net income to net cash provided by (used in) operating activities Depreciation298 279 259 Amortization5 2 9 Defined benefit plans - expense— 1 3 Deferred income taxes and investment tax credits(6)8 3 Other4 — — Change in current assets and current liabilities Accounts receivable(19)(11)(3)Accounts receivable from affiliates(5)(13)4 Accounts payable22 32 (18)Accounts payable to affiliates30 (4)(5)Unbilled revenues(32)(1)(3)Fuel, materials and supplies(28)(17)4 Regulatory assets and liabilities, net17 (23)— Taxes payable7 2 (1)Other5 (18)(3)Other operating activities Defined benefit plans - funding(2)(3)(11)Expenditures for asset retirement obligations(13)(27)(20)Other assets(8)2 (2)Other liabilities(4)— 23 Net cash provided by operating activities543 458 483 Cash Flows from Investing Activities Expenditures for property, plant and equipment(371)(466)(456)Other investing activities11 — — Net cash used in investing activities(360)(466)(456)Cash Flows from Financing Activities Net increase (decrease) in notes payable with affiliates(324)324 — Issuance of long-term debt300 — — Payment of common stock dividends to parent(275)(192)(161)Contributions from parent90 74 103 Issuance of commercial paper— — 41 Retirement of commercial paper— (41)— Net increase (decrease) in short-term debt110 (152)(17)Other financing activities— (3)(1)Net cash provided by (used in) financing activities(99)10 (35)Net Increase (Decrease) in Cash and Cash Equivalents84 2 (8)Cash and Cash Equivalents at Beginning of Period9 7 15 Cash and Cash Equivalents at End of Period$93 $9 $7 Supplemental Disclosures of Cash Flow Information Cash paid during the period for: Interest - net of amount capitalized$83 $77 $82 Income taxes - net$57 $52 $63 Significant non-cash transactions:Accrued expenditures for property, plant and equipment at December 31,$43 $60 $60 The accompanying Notes to Financial Statements are an integral part of the financial statements.88Table of ContentsBALANCE SHEETS AT DECEMBER 31,Louisville Gas and Electric Company(Millions of Dollars, shares in thousands) 20222021Assets Current Assets Cash and cash equivalents$93 $9 Accounts receivable (less reserve: 2022, $4; 2021, $3) Customer157 130 Other13 25 Unbilled revenues (less reserve: 2022, $0; 2021, $0)112 80 Accounts receivable from affiliates37 31 Fuel, materials and supplies166 137 Prepayments13 14 Regulatory assets23 33 Other current assets2 2 Total Current Assets616 461 Property, Plant and Equipment Regulated utility plant7,429 7,192 Less: accumulated depreciation - regulated utility plant1,355 1,172 Regulated utility plant, net6,074 6,020 Construction work in progress268 242 Property, Plant and Equipment, net6,342 6,262 Other Noncurrent Assets Regulatory assets373 337 Goodwill389 389 Other intangibles24 30 Other noncurrent assets66 113 Total Other Noncurrent Assets852 869 Total Assets$7,810 $7,592 The accompanying Notes to Financial Statements are an integral part of the financial statements.89Table of ContentsBALANCE SHEETS AT DECEMBER 31,Louisville Gas and Electric Company(Millions of Dollars, shares in thousands) 20222021Liabilities and Equity Current Liabilities Short-term debt$179 $69 Notes payable with affiliates— 324 Accounts payable165 163 Accounts payable to affiliates60 31 Customer deposits32 32 Taxes41 34 Price risk management liabilities1 1 Regulatory liabilities7 21 Interest15 15 Asset retirement obligations13 10 Other current liabilities46 37 Total Current Liabilities559 737 Long-term Debt2,307 2,006 Deferred Credits and Other Noncurrent Liabilities Deferred income taxes771 751 Investment tax credits31 32 Price risk management liabilities6 17 Asset retirement obligations73 74 Regulatory liabilities833 818 Other deferred credits and noncurrent liabilities64 78 Total Deferred Credits and Other Noncurrent Liabilities1,778 1,770 Commitments and Contingent Liabilities (Notes 7 and 14)Equity Common stock - no par value (a)424 424 Additional paid-in capital2,087 1,997 Earnings reinvested655 658 Total Equity3,166 3,079 Total Liabilities and Equity$7,810 $7,592 (a)75,000 shares authorized; 21,294 shares issued and outstanding at December 31, 2022 and December 31, 2021.The accompanying Notes to Financial Statements are an integral part of the financial statements.90Table of ContentsSTATEMENTS OF EQUITYLouisville Gas and Electric Company(Millions of Dollars) Commonstocksharesoutstanding(a)CommonstockAdditionalpaid-incapitalEarningsreinvestedTotalDecember 31, 201921,294 $424 $1,820 $518 $2,762 Net income 244 244 Capital contributions from parent 103 103 Cash dividends declared on common stock (161)(161)December 31, 202021,294 $424 $1,923 $601 $2,948 Net income249 249 Capital contributions from parent 74 74 Cash dividends declared on common stock (192)(192)December 31, 202121,294 $424 $1,997 $658 $3,079 Net income272 272 Capital contributions from parent 90 90 Cash dividends declared on common stock (275)(275)December 31, 202221,294 $424 $2,087 $655 $3,166 (a)Shares in thousands. All common shares of LG&E stock are owned by LKE. The accompanying Notes to Financial Statements are an integral part of the financial statements.91Table of Contents(THIS PAGE LEFT BLANK INTENTIONALLY.)92Table of ContentsSTATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31,Kentucky Utilities Company(Millions of Dollars) 202220212020Operating Revenues Retail and wholesale$2,049 $1,803 $1,671 Electric revenue from affiliate25 23 19 Total Operating Revenues2,074 1,826 1,690 Operating Expenses Operation Fuel585 445 386 Energy purchases28 19 18 Energy purchases from affiliate36 24 21 Other operation and maintenance487 463 429 Depreciation386 366 346 Taxes, other than income45 41 37 Total Operating Expenses1,567 1,358 1,237 Operating Income507 468 453 Other Income (Expense) – net8 4 3 Interest Expense117 109 113 Income Before Income Taxes398 363 343 Income Taxes76 67 63 Net Income (a)$322 $296 $280 (a)Net income equals comprehensive income.The accompanying Notes to Financial Statements are an integral part of the financial statements.93Table of ContentsSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,Kentucky Utilities Company(Millions of Dollars) 202220212020Cash Flows from Operating Activities Net income$322 $296 $280 Adjustments to reconcile net income to net cash provided by (used in) operating activities Depreciation386 366 346 Amortization18 12 8 Defined benefit plans - expense (credit)(4)(3)— Deferred income taxes and investment tax credits2 1 20 Other3 (3)(1)Change in current assets and current liabilities Accounts receivable(16)6 (13)Accounts receivable from affiliates— 1 (1)Accounts payable26 (12)9 Accounts payable to affiliates37 15 (16)Unbilled revenues(23)6 (9)Fuel, materials and supplies(41)1 6 Regulatory assets and liabilities, net(19)(22)(26)Taxes payable7 (10)2 Accrued interest1 — — Other(3)(18)(5)Other operating activities Defined benefit plans - funding(1)(1)(3)Expenditures for asset retirement obligations(29)(36)(64)Other assets(1)9 (2)Other liabilities(4)— 12 Net cash provided by operating activities661 608 543 Cash Flows from Investing Activities Expenditures for property, plant and equipment(547)(560)(510)Other investing activities— 4 3 Net cash used in investing activities(547)(556)(507)Cash Flows from Financing Activities Net increase (decrease) in notes payable with affiliates(294)294 — Issuance of long-term debt300 — 498 Retirement of long-term debt— — (500)Payment of common stock dividends to parent(296)(250)(200)Contributions from parent84 100 128 Issuance of commercial paper— — 32 Retirement of commercial paper— (32)— Net increase (decrease) in short-term debt101 (171)21 Other financing activities(1)(2)(5)Net cash used in financing activities(106)(61)(26)Net Increase (Decrease) in Cash and Cash Equivalents8 (9)10 Cash and Cash Equivalents at Beginning of Period13 22 12 Cash and Cash Equivalents at End of Period$21 $13 $22 Supplemental Disclosures of Cash Flow Information Cash paid during the period for: Interest - net of amount capitalized$112 $105 $109 Income taxes - net$78 $72 $44 Significant non-cash transactions:Accrued expenditures for property, plant and equipment at December 31,$56 $67 $40 The accompanying Notes to Financial Statements are an integral part of the financial statements.94Table of ContentsBALANCE SHEETS AT DECEMBER 31,Kentucky Utilities Company(Millions of Dollars, shares in thousands) 20222021Assets Current Assets Cash and cash equivalents$21 $13 Accounts receivable (less reserve: 2022, $3; 2021, $3) Customer158 144 Other13 12 Unbilled revenues (less reserve: 2022, $0; 2021, $0)114 91 Fuel, materials and supplies167 124 Prepayments14 15 Regulatory assets32 9 Other current assets1 2 Total Current Assets520 410 Property, Plant and Equipment Regulated utility plant9,515 9,219 Less: accumulated depreciation - regulated utility plant2,201 1,929 Regulated utility plant, net7,314 7,290 Construction work in progress522 378 Property, Plant and Equipment, net7,836 7,668 Other Noncurrent Assets Regulatory assets442 411 Goodwill607 607 Other intangibles21 23 Other noncurrent assets116 153 Total Other Noncurrent Assets1,186 1,194 Total Assets$9,542 $9,272 The accompanying Notes to Financial Statements are an integral part of the financial statements.95Table of ContentsBALANCE SHEETS AT DECEMBER 31,Kentucky Utilities Company(Millions of Dollars, shares in thousands) 20222021Liabilities and Equity Current Liabilities Short-term debt$101 $— Notes payable with affiliates— 294 Long-term debt due within one year13 — Accounts payable123 108 Accounts payable to affiliates101 64 Customer deposits33 32 Taxes26 19 Regulatory liabilities6 8 Interest19 18 Asset retirement obligations26 22 Other current liabilities51 47 Total Current Liabilities499 612 Long-term Debt2,907 2,618 Deferred Credits and Other Noncurrent Liabilities Deferred income taxes896 865 Investment tax credits85 87 Asset retirement obligations56 83 Regulatory liabilities1,029 1,045 Other deferred credits and noncurrent liabilities32 34 Total Deferred Credits and Other Noncurrent Liabilities2,098 2,114 Commitments and Contingent Liabilities (Notes 7 and 14)Equity Common stock - no par value (a)308 308 Additional paid-in capital3,041 2,957 Earnings reinvested689 663 Total Equity4,038 3,928 Total Liabilities and Equity$9,542 $9,272 (a) 80,000 shares authorized; 37,818 shares issued and outstanding at December 31, 2022 and December 31, 2021. The accompanying Notes to Financial Statements are an integral part of the financial statements.96Table of ContentsSTATEMENTS OF EQUITYKentucky Utilities Company(Millions of Dollars) Commonstocksharesoutstanding(a)CommonstockAdditionalpaid-incapitalEarningsreinvestedTotalDecember 31, 201937,818 $308 $2,729 $537 $3,574 Net income 280 280 Capital contributions from parent 128 128 Cash dividends declared on common stock (200)(200)December 31, 202037,818 $308 $2,857 $617 $3,782 Net income296 296 Capital contributions from parent 100 100 Cash dividends declared on common stock (250)(250)December 31, 202137,818 $308 $2,957 $663 $3,928 Net income322 322 Capital contributions from parent84 84 Cash dividends declared on common stock (296)(296)December 31, 202237,818 $308 $3,041 $689 $4,038 (a)Shares in thousands. All common shares of KU stock are owned by LKE. The accompanying Notes to Financial Statements are an integral part of the financial statements. 97Table of ContentsCOMBINED NOTES TO FINANCIAL STATEMENTSIndex to Combined Notes to Consolidated Financial Statements The notes to the consolidated financial statements that follow are a combined presentation. The following list indicates the Registrants to which the footnotes apply: RegistrantPPLPPL ElectricLG&EKU1. Summary of Significant Accounting Policiesxxxx2. Segment and Related Informationxxxx3. Revenue from Contracts with Customersxxxx4. Preferred Securitiesxxxx5. Earnings Per Sharex6. Income and Other Taxesxxxx7. Utility Rate Regulationxxxx8. Financing Activitiesxxxx9. Acquisitions, Development and Divestituresx10. Leasesxxxx11. Stock-Based Compensationxx12. Retirement and Postemployment Benefitsxxxx13. Jointly Owned Facilitiesxxx14. Commitments and Contingenciesxxxx15. Related Party Transactionsxxx16. Other Income (Expense) - netxx17. Fair Value Measurementsxxxx18. Derivative Instruments and Hedging Activitiesxxxx19. Goodwill and Other Intangible Assetsxxxx20. Asset Retirement Obligationsxxxx21. Accumulated Other Comprehensive Income (Loss)x1. Summary of Significant Accounting Policies(All Registrants)GeneralCapitalized terms and abbreviations appearing in the combined notes to financial statements are defined in the glossary. Dollars are in millions, except per share data, unless otherwise noted. The specific Registrant to which disclosures are applicable is identified in parenthetical headings in italics above the applicable disclosure or within the applicable disclosure for each Registrants' related activities and disclosures. Within combined disclosures, amounts are disclosed for any Registrant when significant.Business and Consolidation(PPL)PPL is a utility holding company that, through its regulated subsidiaries, is primarily engaged in: 1) the generation, transmission, distribution and sale of electricity and the distribution and sale of natural gas, primarily in Kentucky; 2) the transmission, distribution and sale of electricity in Pennsylvania; and 3) the transmission, distribution and sale of electricity and the distribution and sale of natural gas in Rhode Island. Headquartered in Allentown, PA, PPL's principal subsidiaries are LG&E, KU, RIE and PPL Electric. PPL's corporate level financing subsidiary is PPL Capital Funding.98Table of ContentsOn March 17, 2021, PPL WPD Limited entered into a share purchase agreement to sell PPL's U.K. utility business, which prior to its sale substantially represented PPL's U.K. Regulated segment, to a subsidiary of National Grid plc. The sale was completed on June 14, 2021. The results of operations of the U.K. utility business are classified as Discontinued Operations on PPL's Statements of Income for all periods presented. PPL has elected to separately report the cash flows of continuing and discontinued operations on the Statements of Cash Flows for all periods presented. Unless otherwise noted, the notes to these financial statements exclude amounts related to discontinued operations. See Note 9 for additional information.On May 25, 2022, PPL Rhode Island Holdings, a wholly owned subsidiary of PPL, acquired 100% of the outstanding shares of common stock of Narragansett Electric from National Grid U.S., a subsidiary of National Grid plc. Narragansett Electric, whose service area covers substantially all of Rhode Island, is primarily engaged in the transmission, distribution and sale of electricity and the distribution and sale of natural gas. The results of Narragansett Electric are included in the consolidated results of PPL from the date of the acquisition. Following the closing of the acquisition, Narragansett Electric provides services doing business under the name Rhode Island Energy (RIE). See Note 9 for additional information.(PPL and PPL Electric)PPL Electric's principal business is the transmission and distribution of electricity to serve retail customers in its franchised territory in eastern and central Pennsylvania and the regulated supply of electricity to retail customers in that territory as a PLR.(PPL, LG&E and KU) LG&E and KU are engaged in the generation, transmission, distribution and sale of electricity. LG&E also engages in the distribution and sale of natural gas. LG&E and KU maintain their separate identities and serve customers in Kentucky under their respective names. KU also serves customers in Virginia under the Old Dominion Power name. (All Registrants)The financial statements of the Registrants include each company's own accounts as well as the accounts of all entities in which the company has a controlling financial interest. Entities for which a controlling financial interest is not demonstrated through voting interests are evaluated based on accounting guidance for Variable Interest Entities (VIEs). The Registrants consolidate a VIE when they are determined to have a controlling interest in the VIE and, as a result, are the primary beneficiary of the entity. Amounts consolidated under the VIE guidance are not material to the Registrants. All significant intercompany transactions have been eliminated.The financial statements of PPL, LG&E and KU include their share of any undivided interests in jointly owned facilities, as well as their share of the related operating costs of those facilities. See Note 13 for additional information.Regulation(All Registrants) PPL Electric, RIE, LG&E and KU are cost-based rate-regulated utilities for which rates are set by regulators to enable PPL Electric, RIE, LG&E and KU to recover the costs of providing electric or gas service, as applicable, and to provide a reasonable return to shareholders. Base rates are generally established based on a future test period. As a result, the financial statements are subject to the accounting for certain types of regulation as prescribed by GAAP and reflect the effects of regulatory actions. Regulatory assets are recognized for the effect of transactions or events where future recovery of underlying costs is probable in regulated customer rates. The effect of such accounting is to defer certain or qualifying costs that would otherwise currently be charged to expense. Regulatory liabilities are recognized for amounts expected to be returned through future regulated customer rates. In certain cases, regulatory liabilities are recorded based on an understanding or agreement with the regulator that rates have been set to recover expected future costs, and the regulated entity is accountable for any amounts charged pursuant to such rates and not yet expended for the intended purpose. The accounting for regulatory assets and regulatory liabilities is based on specific ratemaking decisions or precedent for each transaction or event as prescribed by the FERC or the applicable state regulatory commissions. See Note 7 for additional details regarding regulatory matters.Accounting RecordsThe system of accounts for regulated entities is maintained in accordance with the Uniform System of Accounts prescribed by the FERC and adopted by the applicable state regulatory commissions.99Table of ContentsUse of EstimatesThe preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.Loss AccrualsPotential losses are accrued when (1) information is available that indicates it is "probable" that a loss has been incurred, given the likelihood of uncertain future events and (2) the amount of loss can be reasonably estimated. Accounting guidance defines "probable" as cases in which "the future event or events are likely to occur." The Registrants continuously assess potential loss contingencies for environmental remediation, litigation claims, regulatory penalties and other events. Loss accruals for environmental remediation are discounted when appropriate.The accrual of contingencies that might result in gains is not recorded, unless realization is assured.Earnings Per Share (PPL)EPS is computed using the two-class method, which is an earnings allocation method for computing EPS that treats a participating security as having rights to earnings that would otherwise have been available to common shareowners. Share-based payment awards that provide recipients a non-forfeitable right to dividends or dividend equivalents are considered participating securities.Price Risk Management(All Registrants)Interest rate contracts are used to hedge exposure to changes in the fair value of debt instruments and to hedge exposure to variability in expected cash flows associated with existing floating-rate debt instruments or forecasted fixed-rate issuances of debt. Derivative instruments pursuant to regulator approved plans to manage commodity price risk associated with natural gas purchases to reduce fluctuations in natural gas prices and costs associated with these derivatives instruments are generally recoverable through approved cost recovery mechanism. Similar derivatives may receive different accounting treatment, depending on management's intended use and documentation.Certain contracts may not meet the definition of a derivative because they lack a notional amount or a net settlement provision. In cases where there is no net settlement provision, markets are periodically assessed to determine whether market mechanisms have evolved to facilitate net settlement. Certain derivative contracts may be excluded from the requirements of derivative accounting treatment because NPNS has been elected. These contracts are accounted for using accrual accounting. Contracts that have been classified as derivative contracts are reflected on the balance sheets at fair value. Cash inflows and outflows related to derivative instruments are included as a component of operating, investing or financing activities on the Statements of Cash Flows, depending on the classification of the hedged items.PPL and its subsidiaries have elected not to offset net derivative positions against the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) under master netting arrangements.(PPL)Processes exist that allow for subsequent review and validation of contract information as it relates to interest rate derivatives and commodity gas contracts. The accounting department provides the treasury department with guidelines on appropriate accounting classifications for various contract types and strategies. Examples of accounting guidelines provided to the treasury department staff include, but are not limited to:•Transactions to lock in an interest rate prior to a debt issuance can be designated as cash flow hedges, to the extent the forecasted debt issuances remain probable of occurring.•Transactions to hedge fluctuations in the fair value of existing debt can be designated as fair value hedges.100Table of Contents•Derivative transactions that do not qualify for cash flow or net investment hedge treatment are marked to fair value through earnings.(All Registrants)Derivative transactions may be marked to fair value through regulatory assets/liabilities at PPL Electric, RIE, LG&E and KU, if approved by the appropriate regulatory body. These transactions generally include the effect of interest rate swaps or commodity gas contracts that are included in customer rates.(PPL and PPL Electric)To meet their obligations as last resort providers to their customers, PPL Electric and RIE have entered into certain contracts that meet the definition of a derivative. However, NPNS has been elected for these contracts.(All Registrants)See Notes 17 and 18 for additional information on derivatives.Revenue (All Registrants)Operating revenues are primarily recorded based on energy deliveries through the end of each calendar month. Unbilled retail revenues result because customers' bills are rendered throughout the month, rather than at the end of the month. For RIE, LG&E and KU, unbilled revenues for a month are calculated by multiplying an estimate of unbilled kWh or Mcf by the estimated average cents per kWh or Mcf. Any difference between estimated and actual revenues is adjusted the following month when the previous unbilled estimate is reversed and actual billings occur. For PPL Electric, unbilled revenues for a month are calculated by multiplying the actual unbilled volumes by the price per tariff. In the fourth quarter of 2022, PPL Electric estimated deliveries to customers due to a temporary technical system issue. The issue has been resolved and unbilled revenues are expected to resume being calculated by multiplying the actual unbilled volumes by the price per tariff in the first quarter of 2023.PPL Electric's, RIE's, LG&E's and KU's base rates are determined based on cost of service. Some regulators have also authorized the use of additional alternative revenue programs, which enable PPL Electric, RIE, LG&E and KU to adjust future rates based on past activities or completed events. Revenues from alternative revenue programs are recognized when the specific events permitting future billings have occurred. Revenues from alternative revenue programs are required to be presented separately from revenues from contracts with customers. These amounts are, however, presented as revenues from contracts with customers, with an offsetting adjustment to alternative revenue program revenue, when they are billed to customers in future periods. See Note 3 for additional information.Financing and Other Receivables(All Registrants)Accounts receivable are reported on the Balance Sheets at the gross outstanding amount adjusted for an allowance for doubtful accounts. Financing receivables include accounts receivable, with the exception of those items within accounts receivable that are not subject to the current expected credit loss model.Financing receivable collectability is evaluated using a current expected credit loss model, consisting of a combination of factors, including past due status based on contractual terms, trends in write-offs and the age of the receivable. Specific events, such as bankruptcies, are also considered when applicable. The Registrants also evaluate the impact of observable external factors on the collectability of the financing receivables to determine if adjustments to the allowance for doubtful accounts should be made based on current conditions or reasonable and supportable forecasts. Adjustments to the allowance for doubtful accounts are made based on the results of these analyses. Accounts receivable are written off in the period in which the receivable is deemed uncollectible.PPL Electric, RIE, LG&E and KU have identified one class of financing receivables, “accounts receivable - customer”, which includes financing receivables for all billed and unbilled sales with customers. All other financing receivables are classified as other.101Table of Contents(PPL and PPL Electric)Within the credit loss model for the residential customer accounts receivables, customers are disaggregated based on their projected propensity to pay, which is derived from historical trends and the current activity of the individual customer accounts. Conversely, the non-residential customer accounts receivables are not further segmented due to the varying nature of the individual customers, which lack readily identifiable risk characteristics for disaggregation.(All Registrants)The changes in the allowance for doubtful accounts are included in the following table. Amounts relate to financing receivables, except as noted. AdditionsBalance atBeginning of PeriodCharged to IncomeDeductions (b)Balance atEnd of PeriodPPL 2022$69 $78 $52 $95 (d)202173 26 30 69 (d)2020 (a)58 (a)28 13 73 (d)PPL Electric 2022$35 $27 $29 $33 (c)202141 13 19 35 (c)202030 (a)19 8 41 (c)LG&E 2022$3 $6 $5 $4 20213 4 4 3 20201 4 2 3 KU 2022$3 $6 $6 $3 20212 8 7 3 20201 4 3 2 (a)Adjusted for $2 million cumulative-effect adjustment upon adoption of current expected credit loss guidance.(b)Primarily related to uncollectible accounts written off.(c)Includes $3 million related to other accounts receivables at December 31, 2022, 2021 and 2020.(d)Includes $36 million, $32 million and $30 million related to other accounts receivables at December 31, 2022, 2021 and 2020. Cash(All Registrants)Cash EquivalentsAll highly liquid investments with original maturities of three months or less are considered to be cash equivalents.(PPL)Restricted Cash and Cash EquivalentsBank deposits and other cash equivalents that are restricted by agreement or that have been clearly designated for a specific purpose are classified as restricted cash and cash equivalents. On the Balance Sheets, the current portion of restricted cash and cash equivalents is included in "Other current assets," while the noncurrent portion is included in "Other noncurrent assets." See Note 17 for a reconciliation of Cash, Cash Equivalents and Restricted Cash reported within the Balance Sheets to the amounts shown on the Statements of Cash Flows.102Table of Contents(All Registrants)Fair Value MeasurementsThe Registrants value certain financial and nonfinancial assets and liabilities at fair value. Generally, the most significant fair value measurements relate to price risk management assets and liabilities, investments in securities in defined benefit plans, and cash and cash equivalents. PPL and its subsidiaries use, as appropriate, a market approach (generally, data from market transactions), an income approach (generally, present value techniques and option-pricing models) and/or a cost approach (generally, replacement cost) to measure the fair value of an asset or liability. These valuation approaches incorporate inputs such as observable, independent market data and/or unobservable data that management believes are predicated on the assumptions market participants would use to price an asset or liability. These inputs may incorporate, as applicable, certain risks such as nonperformance risk, which includes credit risk.The Registrants classify fair value measurements within one of three levels in the fair value hierarchy. The level assigned to a fair value measurement is based on the lowest level input that is significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are as follows:•Level 1 - quoted prices (unadjusted) in active markets for identical assets or liabilities that are accessible at the measurement date. Active markets are those in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.•Level 2 - inputs other than quoted prices included within Level 1 that are either directly or indirectly observable for substantially the full term of the asset or liability.•Level 3 - unobservable inputs that management believes are predicated on the assumptions market participants would use to measure the asset or liability at fair value.Assessing the significance of a particular input requires judgment that considers factors specific to the asset or liability. As such, the Registrants' assessment of the significance of a particular input may affect how the assets and liabilities are classified within the fair value hierarchy.InvestmentsGenerally, the original maturity date of an investment and management's intent and ability to sell an investment prior to its original maturity determine the classification of investments as either short-term or long-term. Investments that would otherwise be classified as short-term, but are restricted as to withdrawal or use for other than current operations or are clearly designated for expenditure in the acquisition or construction of noncurrent assets or for the liquidation of long-term debts, are classified as long-term.Investments in entities in which a company has the ability to exercise significant influence but does not have a controlling financial interest are accounted for under the equity method. All other investments are carried at cost or fair value. These investments are included in "Other noncurrent assets" on the Balance Sheets. Earnings from these investments are recorded in "Other Income (Expense) - net" on the Statements of Income.Short-term investments generally include certain deposits as well as securities that are considered highly liquid or provide for periodic reset of interest rates. Investments with original maturities greater than three months and less than a year, as well as investments with original maturities of greater than a year that management has the ability and intent to sell within a year, are included in "Other current assets" on the Balance Sheets.Long-Lived and Intangible AssetsProperty, Plant and Equipment(All Registrants)PP&E is recorded at original cost, unless impaired. If impaired, the asset is written down to fair value at that time, which becomes the new cost basis of the asset. PP&E acquired in business combinations is recorded at fair value at the time of acquisition. Original cost for constructed assets includes material, labor, contractor costs, certain overheads and financing costs, 103Table of Contentswhere applicable. Included in PP&E are capitalized costs of software projects that were developed or obtained for internal use. The cost of repairs and minor replacements are charged to expense as incurred. The Registrants record costs associated with planned major maintenance projects in the period in which work is performed and costs are incurred.AFUDC is capitalized at PPL Electric and RIE as part of the construction costs for cost-based rate-regulated projects for which a return on such costs is recovered after the project is placed in service. The debt component of AFUDC is credited to "Interest Expense" and the equity component is credited to "Other Income (Expense) - net" on the Statements of Income. AFUDC capitalized at LG&E and KU is generally not significant because a return is provided on construction work in progress.(PPL and PPL Electric)RIE and PPL Electric capitalize interest costs as part of construction costs. Capitalized interest, including the debt component of AFUDC, for the years ended December 31 is as follows:202220212020PPL$7 $6 $7 PPL Electric 5 6 7 Depreciation (All Registrants)Depreciation is recorded over the estimated useful lives of property using various methods including the straight-line, composite and group methods. When a component of PP&E that was depreciated under the composite or group method is retired, the original cost is charged to accumulated depreciation. When all or a significant portion of an operating unit thatwas depreciated under the composite or group method is retired or sold, the property and the related accumulated depreciation account is reduced and any gain or loss is included in income, unless otherwise required by regulators. RIE, LG&E and KU accrue costs of removal net of estimated salvage value through depreciation, which is included in the calculation of customer rates over the assets' depreciable lives in accordance with regulatory practices. Cost of removal amounts accrued through depreciation rates are accumulated as a regulatory liability until the removal costs are incurred. For LG&E and KU, all ARO depreciation expenses are reclassified to a regulatory asset or regulatory liability. See "Asset Retirement Obligations" below and Note 7 for additional information. PPL Electric records net costs of removal when incurred as a regulatory asset. The regulatory asset is subsequently amortized through depreciation over a five-year period, which is recoverable in customer rates in accordance with regulatory practices.Following are the weighted-average annual rates of depreciation, for regulated utility plant, for the years ended December 31:202220212020PPL3.21 %3.61 %3.53 %PPL Electric2.75 %3.05 %2.99 %LG&E4.16 %3.99 %4.00 %KU4.01 %4.17 %4.00 %Goodwill and Other Intangible Assets (All Registrants)Goodwill represents the excess of the purchase price paid over the fair value of the identifiable net assets acquired in a business combination.Other acquired intangible assets are initially measured based on their fair value. Intangibles that have finite useful lives are amortized over their useful lives based upon the pattern in which the economic benefits of the intangible assets are consumed or otherwise used. Costs incurred to obtain an initial license and renew or extend terms of licenses are capitalized as intangible assets.When determining the useful life of an intangible asset, including intangible assets that are renewed or extended, PPL and its subsidiaries consider:•the expected use of the asset;•the expected useful life of other assets to which the useful life of the intangible asset may relate;•legal, regulatory, or contractual provisions that may limit the useful life;•the company's historical experience as evidence of its ability to support renewal or extension;•the effects of obsolescence, demand, competition, and other economic factors; and,104Table of Contents•the level of maintenance expenditures required to obtain the expected future cash flows from the asset.Asset Impairment (Excluding Investments)(All Registrants)The Registrants review long-lived assets that are subject to depreciation or amortization, including finite-lived intangibles, for impairment when events or circumstances indicate carrying amounts may not be recoverable.A long-lived asset classified as held and used is impaired when the carrying amount of the asset exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If impaired, the asset's carrying value is written down to its fair value.A long-lived asset classified as held for sale is impaired when the carrying amount of the asset (disposal group) exceeds its fair value less cost to sell. If impaired, the asset's (disposal group's) carrying value is written down to its fair value less cost to sell.PPL, LG&E and KU review goodwill for impairment at the reporting unit level annually or more frequently when events or circumstances indicate that the carrying amount of a reporting unit may be greater than the unit's fair value. Additionally, goodwill must be tested for impairment in circumstances when a portion of goodwill has been allocated to a business to be disposed. PPL's, LG&E's and KU's reporting units are primarily at the operating segment level.Goodwill recognized upon the acquisition of Narragansett Electric was assigned for impairment testing by PPL to its reporting units expected to benefit from the acquisition, which were the Rhode Island Regulated reporting unit, the Pennsylvania Regulated reporting unit and the Kentucky Regulated reporting unit. See Note 9 for additional information regarding the acquisition.PPL, for its reporting units, and individually LG&E and KU may elect either to initially make a qualitative evaluation about the likelihood of an impairment of goodwill or to bypass the qualitative evaluation and test goodwill for impairment using a quantitative test. If the qualitative evaluation (referred to as step zero) is elected and the assessment results in a determination that it is not more likely than not that the fair value of a reporting unit is less than the carrying amount, the quantitative impairment test is not necessary. However, the quantitative impairment test is required if management concludes it is more likely than not that the fair value of a reporting unit is less than the carrying amount based on the step zero assessment. If the carrying amount of the reporting unit, including goodwill, exceeds its fair value, an impairment loss is recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.As of October 1, 2022, PPL, for its reporting units, and individually, LG&E and KU, elected to perform quantitative annual goodwill impairment tests. There were no indicators of impairment for any of the reporting units as the fair value of each of the reporting units significantly exceeded their carrying values. (PPL, LG&E and KU)Asset Retirement Obligations PPL and its subsidiaries record liabilities to reflect various legal obligations associated with the retirement of long-lived assets. Initially, this obligation is measured at fair value and offset with an increase in the value of the capitalized asset, which is depreciated over the asset's useful life. Until the obligation is settled, the liability is increased through the recognition of accretion expense classified within "Other operation and maintenance" on the Statements of Income to reflect changes in the obligation due to the passage of time. For LG&E and KU, all ARO accretion and depreciation expenses are reclassified as a regulatory asset or regulatory liability. ARO regulatory assets associated with certain CCR projects are amortized to expense in accordance with regulatory approvals. For other AROs, deferred accretion and depreciation expense is recovered through cost of removal.Estimated ARO costs and settlement dates, which affect the carrying value of the ARO and the related capitalized asset, are reviewed periodically to ensure that any material changes are incorporated into the latest estimate of the ARO. Any change to the capitalized asset, positive or negative, is generally amortized over the remaining life of the associated long-lived asset. See Note 7 and Note 20 for additional information on AROs.105Table of ContentsCompensation and BenefitsDefined Benefits (All Registrants)Certain PPL subsidiaries sponsor various defined benefit pension and other postretirement plans. An asset or liability is recorded to recognize the funded status of all defined benefit plans with an offsetting entry to AOCI or, for LG&E, KU, RIE and PPL Electric, to regulatory assets or liabilities. Consequently, the funded status of all defined benefit plans is fully recognized on the Balance Sheets.The expected return on plan assets is determined based on a market-related value of plan assets, which is calculated by rolling forward the prior year market-related value with contributions, disbursements and long-term expected return on investments. One-fifth of the difference between the actual value and the expected value is added (or subtracted if negative) to the expected value to determine the new market-related value.PPL uses an accelerated amortization method for the recognition of gains and losses for its defined benefit pension plans. Under the accelerated method, actuarial gains and losses in excess of 30% of the plan's projected benefit obligation are amortized on a straight-line basis over one-half of the required amortization period. Actuarial gains and losses in excess of 10% of the greater of the plan's projected benefit obligation or the market-related value of plan assets and less than 30% of the plan's projected benefit obligation are amortized on a straight-line basis over the full required amortization period.See Note 7 for a discussion of the regulatory treatment of defined benefit costs and Note 12 for a discussion of defined benefits.Stock-Based Compensation (PPL and PPL Electric)PPL has several stock-based compensation plans for purposes of granting stock options, restricted stock, restricted stock units and performance units to certain employees as well as stock units and restricted stock units to directors. PPL grants most stock-based compensation awards in the first quarter of each year. PPL and its subsidiaries recognize compensation expense for stock-based compensation awards based on the fair value method. Forfeitures of awards are recognized when they occur. See Note 11 for a discussion of stock-based compensation. All awards are recorded as equity or a liability on the Balance Sheets. Stock-based compensation expense is primarily included in "Other operation and maintenance" on the Statements of Income. TaxesIncome Taxes(All Registrants)PPL and its domestic subsidiaries file a consolidated U.S. federal income tax return.Significant management judgment is required in developing the Registrants' provision for income taxes, primarily due to the uncertainty related to tax positions taken or expected to be taken on tax returns and valuation allowances on deferred tax assets. The Registrants use a two-step process to evaluate tax positions. The first step requires an entity to determine whether, based on the technical merits supporting a particular tax position, it is more likely than not (greater than a 50% chance) that the tax position will be sustained. This determination assumes that the relevant taxing authority will examine the tax position and is aware of all the relevant facts surrounding the tax position. The second step requires an entity to recognize in its financial statements the benefit of a tax position that meets the more-likely-than-not recognition criterion. The benefit recognized is measured at the largest amount of benefit that has a likelihood of realization upon settlement that exceeds 50%. Unrecognized tax benefits are classified as current to the extent management expects to settle the uncertain tax position by payment or receipt of cash within one year of the reporting date. The amounts ultimately paid upon resolution of issues raised by taxing authorities may differ materially from the amounts accrued and may materially impact the financial statements of the Registrants in future periods. At December 31, 2022, no significant changes in unrecognized tax benefits were projected over the next 12 months.Deferred income taxes reflect the net future tax effects of temporary differences between the carrying amounts of assets and liabilities for accounting purposes and their basis for income tax purposes, as well as the tax effects of net operating losses and tax credit carryforwards.The Registrants record valuation allowances to reduce deferred income tax assets to the amounts that are more-likely-than-not to be realized. The need for valuation allowances requires significant management judgment. If the Registrants determine that 106Table of Contentsthey are able to realize deferred tax assets in the future in excess of recorded net deferred tax assets, adjustments to the valuation allowances increase income by reducing tax expense in the period that such determination is made. Likewise, if the Registrants determine that they are not able to realize all or part of net deferred tax assets in the future, adjustments to the valuation allowances would decrease income by increasing tax expense in the period that such determination is made. The amount of deferred tax assets ultimately realized may differ materially from the estimates utilized in the computation of valuation allowances and may materially impact the financial statements in the future.The Registrants defer investment tax credits when the credits are generated and amortize the deferred amounts over the average lives of the related assets.The Registrants recognize tax-related interest and penalties in "Income Taxes" on their Statements of Income.The Registrants use the portfolio approach method of accounting for deferred taxes related to pre-tax OCI transactions. The portfolio approach involves a strict period-by-period cumulative incremental allocation of income taxes to the change in income and losses reflected in OCI. Under this approach, the net cumulative tax effect is ignored. The net change in unrealized gains and losses recorded in AOCI under this approach would be eliminated only on the date the investment portfolio is classified as held for sale or is liquidated.See Note 6 to the Financial Statements for income tax disclosures.The provision for the Registrants' deferred income taxes related to regulatory assets and liabilities is based upon the ratemaking principles reflected in rates established by relevant regulators. The difference in the provision for deferred income taxes for regulatory assets and liabilities and the amount that otherwise would be recorded under GAAP is deferred and included on the Balance Sheets in noncurrent "Regulatory assets" or "Regulatory liabilities."(PPL Electric, LG&E and KU) The income tax provision for PPL Electric, LG&E and KU is calculated in accordance with an intercompany tax sharing agreement, which provides that taxable income be calculated as if PPL Electric, LG&E, KU and any domestic subsidiaries each filed a separate return. Tax benefits are not shared between companies. The entity that generates a tax benefit is the entity that is entitled to the tax benefit. The effect of PPL filing a consolidated tax return is taken into account in the settlement of current taxes and the recognition of deferred taxes.At December 31, the following intercompany tax receivables (payables) were recorded: 20222021PPL Electric$2 $(4)LG&E(6)4 KU4 1 Taxes, Other Than Income (All Registrants)The Registrants present sales taxes in "Other current liabilities" on the Balance Sheets. These taxes are not reflected on the Statements of Income. See Note 6 for details of taxes included in "Taxes, other than income" on the Statements of Income.Other(All Registrants)LeasesThe Registrants determine whether contractual arrangements contain a lease by evaluating whether those arrangements either implicitly or explicitly identify an asset, whether the Registrants have the right to obtain substantially all of the economic benefits from use of the asset throughout the term of the arrangement, and whether the Registrants have the right to direct the use of the asset. Renewal options are included in the lease term if it is reasonably certain the Registrants will exercise those options. Periods for which the Registrants are reasonably certain not to exercise termination options are also included in the lease term. The Registrants have certain agreements with lease and non-lease components, such as office space leases, which are generally accounted for separately.107Table of ContentsShort-term leases are leases with a term that is 12 months or less and do not include a purchase option or option to extend the initial term of the lease to greater than 12 months that the Registrants are reasonably certain to exercise. The Registrants have made an accounting policy election to not recognize the right-of-use asset and the lease liability arising from leases classified as short-term.The discount rate for a lease is the rate implicit in the lease unless that rate cannot be readily determined. In that case, the Registrants are required to use their incremental borrowing rate, which is the rate the Registrants would have to pay to borrow, on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment.The Registrants receive secured borrowing rates from financial institutions based on their applicable credit profiles. The Registrants use the secured rate which corresponds with the term of the applicable lease. See Note 10 for additional information.Fuel, Materials and SuppliesFuel, natural gas stored underground and materials and supplies are valued using the average cost method. Fuel costs for electricity generation are charged to expense as used. For RIE, natural gas supply costs are charged to expense when delivered to customers. For LG&E, natural gas supply costs are charged to expense as delivered to the distribution system. See Note 7 for further discussion of the fuel adjustment clauses and gas supply clause."Fuel, materials and supplies" on the Balance Sheets consisted of the following at December 31: 2022 PPLPPL ElectricLG&EKUFuel$125 $— $44 $81 Natural gas stored underground91 — 68 — Materials and supplies227 69 54 86 Total$443 $69 $166 $167 2021 PPLPPL ElectricLG&EKUFuel$90 $— $32 $58 Natural gas stored underground54 — 54 — Materials and supplies178 61 51 66 Total$322 $61 $137 $124 (PPL)Renewable Energy Standard ObligationPurchased Renewable Energy Certificates (RECs) are stated at cost and are used to measure compliance with state renewable energy standards. RECs support new renewable generation standards and are held primarily to be utilized in fulfillment of RIE’s compliance obligations.(All Registrants)Guarantees Generally, the initial measurement of a guarantee liability is the fair value of the guarantee at its inception. However, there are certain guarantees excluded from the scope of accounting guidance and other guarantees that are not subject to the initial recognition and measurement provisions of accounting guidance that only require disclosure. See Note 14 for further discussion of recorded and unrecorded guarantees.108Table of Contents(PPL)Treasury Stock PPL generally restores all shares of common stock acquired to authorized but unissued shares of common stock upon or soon after acquisition. In connection with its share repurchases in 2021, PPL has not yet returned these shares to authorized but unissued shares; it intends to retain some portion of these shares as Treasury stock to use in connection with certain compensation plans. 2. Segment and Related Information(PPL)PPL is organized into three segments: Kentucky Regulated, Pennsylvania Regulated, and Rhode Island Regulated. PPL's segments are segmented by geographic location.The Kentucky Regulated segment consists primarily of LG&E's and KU's regulated electricity generation, transmission and distribution operations, as well as LG&E's regulated distribution and sale of natural gas. In addition, the Kentucky Regulated segment includes certain financing and other costs at LKE.The Pennsylvania Regulated segment includes the regulated electricity transmission and distribution operations of PPL Electric.The Rhode Island Regulated segment includes the regulated electricity transmission and distribution and natural gas distribution operations of RIE, which was acquired on May 25, 2022."Corporate and Other" primarily includes financing and other costs incurred at the corporate level that have not been allocated or assigned to the segments, as well as certain non-recoverable costs resulting from commitments made to the Rhode Island Division of Public Utilities and Carriers and the Attorney General of the State of Rhode Island in conjunction with the acquisition of Narragansett Electric. As a result of the June 14, 2021 sale of the U.K. utility business, PPL determined segment information for the U.K. Regulated segment would no longer be provided beginning with the March 31, 2021 Form 10-Q. See Note 9 for additional information.Income Statement data for the segments and reconciliation to PPL's consolidated results for the years ended December 31 are as follows:202220212020Operating Revenues from external customers (a) Kentucky Regulated$3,811 $3,348 $3,106 Pennsylvania Regulated3,030 2,402 2,330 Rhode Island Regulated1,038 — — Corporate and Other23 33 38 Total$7,902 $5,783 $5,474 Depreciation Kentucky Regulated$685 $647 $606 Pennsylvania Regulated393 424 403 Rhode Island Regulated92 — — Corporate and Other11 11 13 Total$1,181 $1,082 $1,022 Amortization (b) Kentucky Regulated$23 $15 $19 Pennsylvania Regulated22 19 26 Rhode Island Regulated2 — — Corporate and Other5 5 13 Total$52 $39 $58 109Table of Contents202220212020Interest Expense (c) Kentucky Regulated$262 $249 $300 Pennsylvania Regulated171 162 172 Rhode Island Regulated39 — — Corporate and Other (d)41 507 162 Total$513 $918 $634 Income Before Income Taxes Kentucky Regulated$621 $562 $516 Pennsylvania Regulated699 599 664 Rhode Island Regulated(58)— — Corporate and Other(347)(640)(226)Total$915 $521 $954 Income Taxes (e) Kentucky Regulated$114 $94 $98 Pennsylvania Regulated174 154 167 Rhode Island Regulated(14)— — Corporate and Other(73)255 49 Total$201 $503 $314 Deferred income taxes and investment tax credits (f) Kentucky Regulated$6 $272 $64 Pennsylvania Regulated91 79 82 Rhode Island Regulated39 — — Corporate and Other43 (264)23 Total$179 $87 $169 Net Income Kentucky Regulated$507 $468 $418 Pennsylvania Regulated525 445 497 Rhode Island Regulated(44)— — Corporate and Other (d)(274)(895)(275)Discontinued Operations42 (1,498)829 Total$756 $(1,480)$1,469 (a)See Note 1 and Note 3 for additional information on Operating Revenues.(b)Represents non-cash expense items that include amortization of operating lease right-of-use assets, regulatory assets and liabilities, debt discounts and premiums and debt issuance costs.(c)Beginning in 2021, corporate level financing costs are no longer allocated to the reportable segments and are being reported in Corporate and Other. For the year ended December 31, 2020, corporate level financing costs of $32 million, net of $8 million of income taxes, were allocated to the Kentucky Regulated segment. For the year ended December 31, 2020, an immaterial amount of financing costs was allocated to the Pennsylvania Regulated segment.(d)2021 includes losses from the extinguishment of PPL Capital Funding debt. See Note 8 for additional information.(e)Represents both current and deferred income taxes, including investment tax credits. (f)Represents a non-cash expense item that is also included in "Income Taxes."Cash Flow data for the segments and reconciliation to PPL's consolidated results for the years ended December 31 are as follows:202220212020Expenditures for long-lived assets Kentucky Regulated$917 $1,026 $966 Pennsylvania Regulated889 904 1,154 Rhode Island Regulated268 — — Corporate and Other84 49 158 Total$2,158 $1,979 $2,278 110Table of ContentsThe following provides Balance Sheet data for the segments and reconciliation to PPL's consolidated results as of: As of December 31,20222021Total Assets Kentucky Regulated$16,904 $16,360 Pennsylvania Regulated13,565 13,336 Rhode Island Regulated6,081 — Corporate and Other (a)1,287 3,527 Total$37,837 $33,223 (a)Primarily consists of unallocated items, including cash, PP&E, goodwill, and the elimination of inter-segment transactions.Beginning on January 1, 2023, the Kentucky Regulated segment will consist primarily of the regulated electricity generation, transmission and distribution operations conducted by LG&E and KU, as well as LG&E's regulated distribution and sale of natural gas. Prior to January 1, 2023, the Kentucky Regulated segment also included the financing activities of LKE. The financing activity of LKE will be presented in Corporate and Other beginning on January 1, 2023. As a result of this change, beginning on January 1, 2023, PPL’s segments will consist of the regulated operations of Kentucky, Pennsylvania and Rhode Island and will exclude any incremental financing activities of holding companies, which Management believes is a more meaningful presentation as it provides information on the core regulated operations of PPL.(PPL Electric, LG&E and KU)PPL Electric has two operating segments, distribution and transmission, which are aggregated into a single reportable segment. LG&E and KU are individually single operating and reportable segments.3. Revenue from Contracts with Customers(All Registrants)The following is a description of the principal activities from which the Registrants and PPL’s segments generate their revenues.(PPL and PPL Electric)Pennsylvania Regulated Segment RevenueThe Pennsylvania Regulated segment generates substantially all of its revenues from contracts with customers from PPL Electric’s tariff-based distribution and transmission of electricity.Distribution RevenuePPL Electric provides distribution services to residential, commercial, industrial, municipal and governmental end users of energy. PPL Electric satisfies its performance obligation to its distribution customers and revenue is recognized over-time as electricity is delivered and simultaneously consumed by the customer. The amount of revenue recognized is the volume of electricity delivered during the period multiplied by the price per tariff, plus a monthly fixed charge. This method of recognition fairly presents PPL Electric's transfer of electric service to the customer as the calculation is based on volumes delivered, and the price per tariff and the monthly fixed charge are set by the PAPUC. Customers are typically billed monthly and outstanding amounts are normally due within 21 days of the date of the bill. Distribution customers are "at will" customers of PPL Electric with no term contract and no minimum purchase commitment. Performance obligations are limited to the service requested and received to date. Accordingly, there is no unsatisfied performance obligation associated with PPL Electric’s retail account contracts.Certain customers have the option to obtain electricity or natural gas from other suppliers. In those circumstances, revenue is only recognized for providing delivery of the commodity to the customer.111Table of ContentsTransmission RevenuePPL Electric generates transmission revenues from a FERC-approved PJM Open Access Transmission Tariff. An annual revenue requirement for PPL Electric to provide transmission services is calculated using a formula-based rate. This revenue requirement is converted into a daily rate (dollars per day). PPL Electric satisfies its performance obligation to provide transmission services and revenue is recognized over-time as transmission services are provided and consumed. This method of recognition fairly presents PPL Electric's transfer of transmission services as the daily rate is set by a FERC approved formula-based rate. PJM remits payment on a weekly basis.PPL Electric's agreement to provide transmission services contains no minimum purchase commitment. The performance obligation is limited to the service requested and received to date. Accordingly, PPL Electric has no unsatisfied performance obligations.(PPL)Rhode Island Regulated Segment RevenuesThe Rhode Island Regulated segment generates substantially all of its revenues from contracts with customers from RIE’s regulated tariff-based transmission and distribution of electricity and regulated tariff-based distribution of natural gas.Distribution RevenueDistribution revenues are primarily from the sale of electricity, natural gas, and related services to retail customers. Distribution sales are regulated by the RIPUC, which is responsible for approving the rates and other terms of services as part of the rate making process. Natural gas and electric distribution revenues are derived from the regulated sale and distribution of electricity and natural gas to residential, commercial, and industrial customers within RIE’s service territory under the tariff rates. The performance obligation related to distribution sales is to provide electricity and natural gas to customers on demand. The performance obligation is satisfied over time because the customer simultaneously receives and consumes the electricity or natural gas as services are provided. RIE records revenues related to the distribution sales based upon the approved tariff rate and the volume delivered to the customers, which corresponds with the amount RIE has the right to invoice. Distribution revenue also includes estimated unbilled amounts, which represent the estimated amounts due from retail customers as a result of customer's bills rendered throughout the month, rather than bills being rendered at the end of the month. Unbilled revenues are determined based on estimated unbilled sales volumes and then applying tariff rates to those volumes. Any difference between estimated and actual revenues is adjusted the following month when the previous unbilled estimate is reversed and actual billings occur. This method of recognition fairly presents RIE's transfer of electricity and natural gas to the customer as the amount recognized is based on actual and estimated volumes delivered and the tariff rate per unit of energy and any applicable fixed charges or regulatory mechanisms as approved by the respective regulatory body.Certain customers have the option to obtain electricity or natural gas from other suppliers. In those circumstances, revenue is only recognized for providing delivery of the commodity to the customer.Transmission RevenueRIE’s transmission services are regulated by the FERC and coordinated with ISO – New England (ISO-NE). Additionally, RIE makes available its transmission facilities to NEP, for operation and control pursuant to an integrated facilities agreement, Service Agreement No. 23 (Integrated Facilities Agreement or IFA). As of December 31, 2022 these integrated facilities agreements have concluded as RIE is a transmission operator. These revenues arise under tariff/rate agreements and are collected primarily from RIE’s distribution customers. The revenue is recognized over-time as transmission services are provided and consumed. This method of recognition fairly presents RIE’s transfer of transmission services as the daily rate is set by a FERC-approved formula-based rate.(PPL, LG&E and KU)Kentucky Regulated Segment Revenue The Kentucky Regulated Segment generates substantially all of its revenues from contracts with customers from LG&E's and KU's regulated tariff-based sales of electricity and LG&E's regulated tariff-based sales of natural gas.112Table of ContentsLG&E and KU are engaged in the generation, transmission, distribution and sale of electricity in Kentucky and, in KU's case, Virginia. LG&E also engages in the distribution and sale of natural gas in Kentucky. Revenue from these activities is generated from tariffs approved by applicable regulatory authorities including the FERC, KPSC and VSCC. LG&E and KU satisfy their performance obligations upon LG&E's and KU's delivery of electricity and LG&E's delivery of natural gas to customers. This revenue is recognized over-time as the customer simultaneously receives and consumes the benefits provided by LG&E and KU. The amount of revenue recognized is the billed volume of electricity or natural gas delivered multiplied by a tariff rate per-unit of energy, plus any applicable fixed charges or additional regulatory mechanisms. Customers are billed monthly and outstanding amounts are typically due within 22 days of the date of the bill. Additionally, unbilled revenues are recognized as a result of customers' bills rendered throughout the month, rather than bills being rendered at the end of the month. Unbilled revenues for a month are calculated by multiplying an estimate of unbilled kWh or Mcf delivered but not yet billed by the estimated average cents per kWh or Mcf. Any difference between estimated and actual revenues is adjusted the following month when the previous unbilled estimate is reversed and actual billings occur. This method of recognition fairly presents LG&E's and KU's transfer of electricity and LG&E's transfer of natural gas to the customer as the amount recognized is based on actual and estimated volumes delivered and the tariff rate per-unit of energy and any applicable fixed charges or regulatory mechanisms as set by the respective regulatory body.LG&E's and KU's customers generally have no minimum purchase commitment. Performance obligations are limited to the service requested and received to date. Accordingly, there is no unsatisfied performance obligation associated with these customers.(All Registrants)The following table reconciles "Operating Revenues" included in each Registrant's Statement of Income with revenues generated from contracts with customers for the years ended December 31:2022PPLPPL ElectricLG&EKUOperating Revenues (a)$7,902 $3,030 $1,798 $2,074 Revenues derived from:Alternative revenue programs (b)(92)(56)9 5 Other (c)(24)(14)(6)(4)Revenues from Contracts with Customers$7,786 $2,960 $1,801 $2,075 2021PPLPPL ElectricLG&EKUOperating Revenues (a)$5,783 $2,402 $1,569 $1,826 Revenues derived from:Alternative revenue programs (b)77 83 (3)(3)Other (c)(22)(3)(8)(9)Revenues from Contracts with Customers$5,838 $2,482 $1,558 $1,814 2020PPLPPL ElectricLG&EKUOperating Revenues (a)$5,474 $2,331 $1,456 $1,690 Revenues derived from:Alternative revenue programs (b)(24)(12)(8)(4)Other (c)(21)(3)(7)(10)Revenues from Contracts with Customers$5,429 $2,316 $1,441 $1,676 (a)PPL includes $1,038 million for the twelve months ended December 31, 2022 of revenues from external customers reported by the Rhode Island Regulated segment. PPL Electric represents revenues from external customers reported by the Pennsylvania Regulated segment and LG&E and KU, net of intercompany power sales and transmission revenues, represent revenues from external customers reported by the Kentucky Regulated segment. See Note 2 for additional information.(b)This line item shows the over/under collection of rate mechanisms deemed alternative revenue programs with over-collections of revenue shown as positive amounts in the table above and under collections as negative amounts. For PPL Electric, revenue in 2022 includes $74 million related to the 113Table of Contentsamortization of the regulatory liability primarily recorded in 2021 for a reduction in the transmission formula rate return on equity that is reflected in rates in 2022. Revenue in 2021 was reduced by $78 million for a reduction in the transmission formula rate return on equity. See Note 7 for additional information. (c)Represents additional revenues outside the scope of revenues from contracts with customers such as leases and other miscellaneous revenues.The following table shows revenues from contracts with customers disaggregated by customer class for the years ended December 31:ResidentialCommercialIndustrialOther (a)Wholesale - municipalityWholesale - other (b)TransmissionRevenues from Contracts with CustomersPPL2022PA Regulated$1,647 $491 $85 $54 $— $— $683 $2,960 RI Regulated299 101 9 478 — — 101 988 KY Regulated1,637 1,068 662 323 28 97 — 3,815 Corp and Other— — — 23 — — — 23 Total PPL$3,583 $1,660 $756 $878 $28 $97 $784 $7,786 2021PA Regulated$1,299 $350 $53 $50 $— $— $730 $2,482 RI Regulated— — — — — — — — KY Regulated1,416 928 586 305 24 66 — 3,325 Corp and Other— — — 31 — — — 31 Total PPL$2,715 $1,278 $639 $386 $24 $66 $730 $5,838 2020PA Regulated$1,238 $314 $44 $50 $— $— $670 $2,316 RI Regulated— — — — — — — — KY Regulated1,347 871 538 261 20 40 — 3,077 Corp and Other— — — 36 — — — 36 Total PPL$2,585 $1,185 $582 $347 $20 $40 $670 $5,429 PPL Electric2022$1,647 $491 $85 $54 $— $— $683 $2,960 2021$1,299 $350 $53 $50 $— $— $730 $2,482 2020$1,238 $314 $44 $50 $— $— $670 $2,316 LG&E2022$835 $551 $199 $141 $— $75 $— $1,801 2021$711 $473 $180 $145 $— $49 $— $1,558 2020$676 $444 $173 $114 $— $34 $— $1,441 KU2022$802 $517 $463 $182 $28 $83 $— $2,075 2021$705 $455 $406 $160 $24 $64 $— $1,814 2020$671 $427 $365 $147 $20 $46 $— $1,676 (a)Primarily includes revenues from pole attachments, street lighting, other public authorities and other non-core businesses.(b)Includes wholesale power and transmission revenues. LG&E and KU amounts include intercompany power sales and transmission revenues, which are eliminated upon consolidation at PPL.As discussed in Note 2, PPL segments its business by geographic location. Revenues from external customers for each segment/geographic location are reconciled to revenues from contracts with customers in the footnotes to the tables above. PPL Electric's revenues from contracts with customers are further disaggregated by distribution and transmission as indicated in the above tables.Contract receivables from customers are primarily included in "Accounts receivable - Customer" and "Unbilled revenues" on the Balance Sheets.114Table of ContentsThe following table shows the accounts receivable and unbilled revenues balances that were impaired for the year ended December 31:202220212020PPL(a)$70 $22 $25 PPL Electric21 10 17 LG&E6 4 4 KU6 8 4 (a)Includes $23 million for the twelve months ended December 31, 2022 related to the commitment to forgive customer arrearages for low-income and protected residential customers at RIE. See Note 9 for additional information.The following table shows the balances and certain activity of contract liabilities resulting from contracts with customers:PPLPPL ElectricLG&EKUContract liabilities as of December 31, 2022$34 $23 $5 $6 Contract liabilities as of December 31, 202142 25 6 6 Revenue recognized during the year ended December 31, 2022 that was included in the contract liability balance at December 31, 202125 12 6 6 Contract liabilities as of December 31, 2021$42 $25 $6 $6 Contract liabilities as of December 31, 202040 23 5 6 Revenue recognized during the year ended December 31, 2021 that was included in the contract liability balance at December 31, 202024 11 5 6 Contract liabilities as of December 31, 2020$40 $23 $5 $6 Contract liabilities as of December 31, 201937 21 5 4 Revenue recognized during the year ended December 31, 2020 that was included in the contract liability balance at December 31, 201922 9 5 4 Contract liabilities result from recording contractual billings in advance for customer attachments to the Registrants' infrastructure and payments received in excess of revenues earned to date. Advanced billings for customer attachments are recognized as revenue ratably over the billing period. Payments received in excess of revenues earned to date are recognized as revenue as services are delivered in subsequent periods.4. Preferred Securities(PPL)PPL is authorized to issue up to 10 million shares of preferred stock. No PPL preferred stock was issued or outstanding in 2022, 2021 or 2020.RIE has $3 million of outstanding preferred stock. See Note 8 for additional information.(PPL Electric)PPL Electric is authorized to issue up to 20,629,936 shares of preferred stock. No PPL Electric preferred stock was issued or outstanding in 2022, 2021 or 2020.(LG&E)LG&E is authorized to issue up to 1,720,000 shares of preferred stock at a $25 par value and 6,750,000 shares of preferred stock without par value. LG&E had no preferred stock issued or outstanding in 2022, 2021 or 2020.115Table of Contents(KU)KU is authorized to issue up to 5,300,000 shares of preferred stock and 2,000,000 shares of preference stock without par value. KU had no preferred or preference stock issued or outstanding in 2022, 2021 or 2020. 5. Earnings Per Share(PPL)Basic EPS is computed by dividing income available to PPL common shareowners by the weighted-average number of common shares outstanding during the applicable period. Diluted EPS is computed by dividing income available to PPL common shareowners by the weighted-average number of common shares outstanding, increased by incremental shares that would be outstanding if potentially dilutive non-participating securities were converted to common shares as calculated using the Treasury Stock Method. Incremental non-participating securities that have a dilutive impact are detailed in the table below.Reconciliations of the amounts of income and shares of PPL common stock (in thousands) for the periods ended December 31, used in the EPS calculation are: 202220212020Income (Numerator) Income from continuing operations after income taxes$714 $18 $640 Less amounts allocated to participating securities1 — 1 Income from continuing operations after income taxes available to PPL common shareowners - Basic and Diluted$713 $18 $639 Income (loss) from discontinued operations (net of income taxes) available to PPL common shareowners - Basic and Diluted$42 $(1,498)$829 Net income (loss) attributable to PPL$756 $(1,480)1,469 Less amounts allocated to participating securities1 — 1 Net income (loss) available to PPL common shareowners - Basic and Diluted$755 $(1,480)$1,468 Shares of Common Stock (Denominator) Weighted-average shares - Basic EPS736,027 762,902 768,590 Add: Dilutive share-based payment awards (a)875 1,917 794 Weighted-average shares - Diluted EPS736,902 764,819 769,384 Basic EPS Available to PPL common shareowners:Income from continuing operations after income taxes$0.97 $0.03 $0.83 Income (loss) from discontinued operations (net of income taxes)0.06 (1.96)1.08 Net Income (Loss) available to PPL common shareowners$1.03 $(1.93)$1.91 Diluted EPS Available to PPL common shareowners:Income from continuing operations after income taxes$0.96 $0.03 $0.83 Income (loss) from discontinued operations (net of income taxes)0.06 (1.96)1.08 Net Income (Loss) available to PPL common shareowners$1.02 $(1.93)$1.91 (a)The Treasury Stock Method was applied to non-participating share-based payment awards.For the years ended December 31, PPL issued common stock related to stock-based compensation plans as follows (in thousands): 20222021Stock-based compensation plans (a)124 983 116Table of Contents(a)Includes stock options exercised, vesting of performance units, vesting of restricted stock and restricted stock units and conversion of stock units granted to directors.For the years ended December 31, the following shares (in thousands) were excluded from the computations of diluted EPS because the effect would have been antidilutive: 202220212020Stock-based compensation awards93 1,783 452 6. Income and Other Taxes(PPL)"Income (Loss) from Continuing Operations Before Income Taxes" is from domestic operations.Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for accounting purposes and their basis for income tax purposes and the tax effects of net operating loss and tax credit carryforwards. The provision for PPL's deferred income taxes for regulated assets and liabilities is based upon the ratemaking principles of the applicable jurisdiction. See Notes 1 and 7 for additional information.Net deferred tax assets have been recognized based on management's estimates of future taxable income.Significant components of PPL's deferred income tax assets and liabilities were as follows:20222021Deferred Tax Assets Deferred investment tax credits$29 $30 Regulatory liabilities88 94 Income taxes due to customers448 422 Accrued pension and postretirement costs86 75 State loss carryforwards230 483 Federal and state tax credit carryforwards68 15 Internal Revenue Code Section 197 intangibles (a)85 — Leases15 67 Contributions in aid of construction114 120 Other72 84 Valuation allowances(213)(462)Total deferred tax assets1,022 928 Deferred Tax Liabilities Plant - net3,609 3,812 Regulatory assets337 180 Prepayments46 — Other30 75 Total deferred tax liabilities4,022 4,067 Net deferred tax liability$3,000 $3,139 (a)Certain of the RIE assets acquired in 2022 are treated as intangibles for tax purposes that are amortized over a 15 year period. PPL recorded deferred tax assets on these intangibles, which will reverse as tax deductions are taken.State deferred taxes are determined by entity and by jurisdiction. As a result, $6 million and $12 million of net deferred tax assets are shown as "Other noncurrent assets" on the Balance Sheets for 2022 and 2021. At December 31, 2022, PPL had the following loss and tax credit carryforwards, related deferred tax assets and valuation allowances recorded against the deferred tax assets: GrossDeferred Tax AssetValuation AllowanceExpirationLoss and other carryforwards State net operating losses$5,830 $230 $(213)2023-2042117Table of ContentsGrossDeferred Tax AssetValuation AllowanceExpirationCredit carryforwards Federal investment tax credit20 — 2042Federal foreign tax credits32 — 2027Federal - other3 — 2042State recycling credit12 — 2028State - other1 — IndefiniteValuation allowances have been established for the amount that, more likely than not, will not be realized. The changes in deferred tax valuation allowances were as follows: Additions Balance atBeginningof PeriodChargedto IncomeCharged toOtherAccountsDeductionsBalanceat Endof Period2022$462 $10 $— $259 (a)$213 2021536 48 (b)— 122 (c)462 2020514 26 — 4 536 (a)In 2022, PPL recorded a $36 million decrease in a valuation allowance on a 2002 state net operating loss carryforward that expired in 2022 and a $213 million decrease in the valuation allowance due to the Pennsylvania rate change. See reconciliation of income tax table below. (b)In 2021, PPL recorded a $31 million increase in a valuation allowance on a state net operating loss carryforward in connection with the loss on extinguishment associated with a tender offer to purchase and retire PPL Capital Funding's outstanding Senior Notes. (c)In light of the disposition of PPL's U.K. utility business, there was a decrease in the valuation allowance of approximately $113 million.Details of the components of income tax expense, a reconciliation of federal income taxes derived from statutory tax rates applied to "Income Before Income Taxes" to income taxes for reporting purposes, and details of "Taxes, other than income" were as follows: 202220212020Income Tax Expense (Benefit) Current - Federal$(2)$(1)$(8)Current - State24 36 24 Current - Foreign— (1)(2)Total Current Expense (Benefit)22 34 14 Deferred - Federal122 28 135 Deferred - State68 105 94 Deferred - Foreign (a)— 383 101 Total Deferred Expense (Benefit), excluding operating loss carryforwards190 516 330 Amortization of investment tax credit(3)(3)(3)Tax expense (benefit) of operating loss carryforwards Deferred - Federal2 12 6 Deferred - State(10)(56)(33)Total Tax Expense (Benefit) of Operating Loss Carryforwards(8)(44)(27)Total income tax expense (benefit)$201 $503 $314 Total income tax expense (benefit) - Federal$119 $36 $130 Total income tax expense (benefit) - State82 85 85 Total income tax expense (benefit) - Foreign— 382 99 Total income tax expense (benefit)$201 $503 $314 (a)The U.K. Finance Act 2021, formally enacted on June 10, 2021, increased the U.K. corporation tax rate from 19% to 25%, effective April 1, 2023. The primary impact of the corporation tax rate increase was an increase in deferred tax liabilities of the U.K. utility business, which was sold on June 14, 2021, and a corresponding deferred tax expense of $383 million, which was recognized in continuing operations in 2021.In 2020, the U.K. Finance Act 2020 cancelled the tax rate reduction from 19% to 17%. The primary impact of the cancellation of the corporation tax rate reduction was an increase in deferred tax liabilities and a corresponding deferred tax expense of $106 million.In the table above, the following income tax expense (benefit) are excluded from income taxes:118Table of Contents202220212020Discontinued operations $(42)$759 $188 Reclassification from AOCI due to sale of UK utility business— 660 — Other comprehensive income11 150 (19)Total$(31)$1,569 $169 202220212020Reconciliation of Income Tax Expense (Benefit) Federal income tax on Income Before Income Taxes at statutory tax rate - 21%$192$109$200 State income taxes, net of federal income tax benefit682348Valuation allowance adjustments (a)94824Federal and state income tax return adjustments(1)(3)(9)Impact of the U.K. Finance Acts on deferred tax balances (b)—383101Depreciation and other items not normalized(8)(5)(5)Amortization of excess deferred federal and state income taxes (54)(54)(43)Non-deductible officer's salary567Other(10)(4)(9)Total increase (decrease)9394114Total income tax expense (benefit)$201$503$314Effective income tax rate22.0%96.5%32.9%(a)In 2021, PPL recorded a $31 million state deferred tax benefit on a net operating loss and an offsetting valuation allowance in connection with the loss on extinguishment associated with a tender offer to purchase and retire PPL Capital Funding's outstanding Senior Notes. In 2022, 2021, and 2020, PPL recorded deferred income tax expense of $5 million, $15 million and $24 million for valuation allowances primarily related to increased Pennsylvania net operating loss carryforwards expected to be unutilized. (b)In 2020, the U.K. Finance Act 2020 cancelled the tax rate reduction to 17%, thereby maintaining the corporation tax rate at 19% for financial years 2020 and 2021. The primary impact of the cancellation of the corporation tax rate reduction was an increase in deferred tax liabilities and a corresponding deferred tax expense of $106 million. The U.K. Finance Act 2021, formally enacted on June 10, 2021, increased the U.K. corporation tax rate from 19% to 25%, effective April 1, 2023. The primary impact of the corporation tax rate increase was an increase in deferred tax liabilities of the U.K. utility business, which was sold on June 14, 2021, and a corresponding deferred tax expense of $383 million, which was recognized in continuing operations in 2021. 202220212020Taxes, other than income State gross receipts (a)$175 $113 $100 Domestic - other (a)157 94 80 Total$332 $207 $180 (a)Increase primarily due to the acquisition of RIE.(PPL Electric)The provision for PPL Electric's deferred income taxes for regulated assets and liabilities is based upon the ratemaking principles reflected in rates established by the PAPUC and the FERC. The difference in the provision for deferred income taxes for regulated assets and liabilities and the amount that otherwise would be recorded under GAAP is deferred and included in "Regulatory assets" or "Regulatory liabilities" on the Balance Sheets.Significant components of PPL Electric's deferred income tax assets and liabilities were as follows:119Table of Contents20222021Deferred Tax Assets Accrued pension and postretirement costs$27 $14 Contributions in aid of construction87 95 Regulatory liabilities36 52 Income taxes due to customers193 154 Other18 21 Total deferred tax assets361 336 Deferred Tax Liabilities Electric utility plant - net1,745 1,891 Regulatory assets93 74 Prepayments35 — Other2 39 Total deferred tax liabilities1,875 2,004 Net deferred tax liability$1,514 $1,668 PPL Electric expects to have adequate levels of taxable income to realize its recorded deferred income tax assets.Details of the components of income tax expense, a reconciliation of federal income taxes derived from statutory tax rates applied to "Income Before Income Taxes" to income taxes for reporting purposes, and details of "Taxes, other than income" were as follows: 202220212020Income Tax Expense (Benefit) Current - Federal$63 $40 $61 Current - State20 35 23 Total Current Expense (Benefit)83 75 84 Deferred - Federal 60 59 45 Deferred - State31 20 38 Total Deferred Expense (Benefit), excluding operating loss carryforwards91 79 83 Total income tax expense (benefit)$174 $154 $167 Total income tax expense (benefit) - Federal$123 $99 $106 Total income tax expense (benefit) - State51 55 61 Total income tax expense (benefit)$174 $154 $167 202220212020Reconciliation of Income Tax Expense (Benefit) Federal income tax on Income Before Income Taxes at statutory tax rate - 21%$147$126$139Increase (decrease) due to: State income taxes, net of federal income tax benefit544652Federal and state income tax return adjustments(1)—(4)Depreciation and other items not normalized(7)(5)(5)Amortization of excess deferred federal income taxes (a)(12)(14)(16)State income tax rate change (b)(9)——Other211Total increase (decrease)272828Total income tax expense (benefit)$174$154$167Effective income tax rate24.9%25.7%25.2% (a)In 2022, 2021, and 2020, PPL Electric recorded lower income tax expense for the amortization of excess deferred taxes that primarily resulted from the U.S. federal corporate income tax rate reduction from 35% to 21% enacted by the TCJA. This amortization represents each year's refund amount, prior to a tax gross-up, to be paid to customers for previously collected deferred taxes at higher income tax rates.(b)On July 8, 2022, the Governor of Pennsylvania signed into law Pennsylvania House Bill 1342 (H.B. 1342). Among other changes to the state tax code, the bill reduces the corporate net income tax rate from 9.99% to 8.99% beginning January 1, 2023, and further reduces the rate annually by half a percentage point until the rate reaches 4.99% in 2031. The income statement impact of the corporate net income tax reduction was a deferred tax benefit of $9 million. 120Table of Contents 202220212020Taxes, other than income State gross receipts$142 $113 $100 Property and other7 7 7 Total$149 $120 $107 (LG&E) The provision for LG&E's deferred income taxes for regulated assets and liabilities is based upon the ratemaking principles reflected in rates established by the KPSC and the FERC. The difference in the provision for deferred income taxes for regulated assets and liabilities and the amount that otherwise would be recorded under GAAP is deferred and included in "Regulatory assets" or "Regulatory liabilities" on the Balance Sheets.Significant components of LG&E's deferred income tax assets and liabilities were as follows: 20222021Deferred Tax Assets Contributions in aid of construction$17 $15 Regulatory liabilities18 18 Deferred investment tax credits8 8 Income taxes due to customers119 125 State tax credit carryforwards9 11 Lease liabilities4 4 Valuation allowances(9)(11)Other8 11 Total deferred tax assets174 181 Deferred Tax LiabilitiesPlant - net869 854 Regulatory assets69 65 Lease right-of-use assets3 4 Other4 9 Total deferred tax liabilities945 932 Net deferred tax liability$771 $751 At December 31, 2022, LG&E had $9 million of state credit carryforwards that expire in 2028 and a $9 million valuation allowance related to state credit carryforwards due to insufficient projected Kentucky taxable income. Details of the components of income tax expense, a reconciliation of federal income taxes derived from statutory tax rates applied to "Income Before Income Taxes" to income taxes for reporting purposes, and details of "Taxes, other than income" were: 202220212020Income Tax Expense (Benefit) Current - Federal$60 $41 $53 Current - State9 5 7 Total Current Expense (Benefit)69 46 60 Deferred - Federal(10)1 (4)Deferred - State5 8 7 Total Deferred Expense (Benefit)(5)9 3 Amortization of investment tax credit - Federal(1)(1)(1)Total income tax expense (benefit)$63 $54 $62 Total income tax expense (benefit) - Federal$49 $41 $48 Total income tax expense (benefit) - State14 13 14 Total income tax expense (benefit)$63 $54 $62 121Table of Contents 202220212020Reconciliation of Income Tax Expense (Benefit) Federal income tax on Income Before Income Taxes at statutory tax rate - 21%$70$64$64Increase (decrease) due to: State income taxes, net of federal income tax benefit131212Amortization of excess deferred federal and state income taxes (18)(20)(11)Other(2)(2)(3)Total increase (decrease)(7)(10)(2)Total income tax expense (benefit)$63$54$62Effective income tax rate18.8%17.8%20.3% 202220212020Taxes, other than income Property and other$48 $46 $40 Total$48 $46 $40 (KU) The provision for KU's deferred income taxes for regulated assets and liabilities is based upon the ratemaking principles reflected in rates established by the KPSC, the VSCC and the FERC. The difference in the provision for deferred income taxes for regulated assets and liabilities and the amount that otherwise would be recorded under GAAP is deferred and included in "Regulatory assets" or "Regulatory liabilities" on the Balance Sheets.Significant components of KU's deferred income tax assets and liabilities were as follows: 20222021Deferred Tax Assets Contributions in aid of construction$9 $9 Regulatory liabilities23 23 Deferred investment tax credits21 22 Income taxes due to customers136 143 State tax credit carryforwards4 4 Lease liabilities5 7 Valuation allowances(3)(3)Other4 4 Total deferred tax assets199 209 Deferred Tax Liabilities Plant - net1,028 1,012 Regulatory assets56 41 Pension and postretirement costs6 13 Lease right-of-use assets5 6 Other— 2 Total deferred tax liabilities1,095 1,074 Net deferred tax liability$896 $865 At December 31, 2022, KU had $4 million of state credit carryforwards of which $3 million will expire in 2028 and $1 million that has an indefinite carryforward period. At December 31, 2022, KU had a $3 million valuation allowance related to state credit carryforwards due to insufficient projected Kentucky taxable income.122Table of ContentsDetails of the components of income tax expense, a reconciliation of federal income taxes derived from statutory tax rates applied to "Income Before Income Taxes" to income taxes for reporting purposes, and details of "Taxes, other than income" were: 202220212020Income Tax Expense (Benefit) Current - Federal$63 $58 $40 Current - State11 8 3 Total Current Expense (Benefit)74 66 43 Deferred - Federal(3)(4)11 Deferred - State7 7 11 Total Deferred Expense (Benefit)4 3 22 Amortization of investment tax credit - Federal(2)(2)(2)Total income tax expense (benefit)$76 $67 $63 Total income tax expense (benefit) - Federal$58 $52 $49 Total income tax expense (benefit) - State18 15 14 Total income tax expense (benefit)$76 $67 $63 202220212020Reconciliation of Income Tax Expense (Benefit) Federal income tax on Income Before Income Taxes at statutory tax rate - 21%$84$76$72Increase (decrease) due to: State income taxes, net of federal income tax benefit161414Amortization of investment tax credit(2)(2)(2)Amortization of excess deferred federal and state income taxes (21)(20)(17)Other(1)(1)(4)Total decrease(8)(9)(9)Total income tax expense (benefit)$76$67$63Effective income tax rate19.1%18.4%18.4% 202220212020Taxes, other than income Property and other$45 $41 $37 Total$45 $41 $37 (All Registrants) Unrecognized Tax BenefitsPPL or its subsidiaries file tax returns in four major tax jurisdictions. The income tax provisions for PPL Electric, LG&E and KU are calculated in accordance with an intercompany tax sharing agreement, which provides that taxable income be calculated as if each domestic subsidiary filed a separate consolidated return. PPL Electric or its subsidiaries indirectly or directly file tax returns in three major tax jurisdictions, and LG&E and KU indirectly or directly file tax returns in two major tax jurisdictions. With few exceptions, at December 31, 2022, these jurisdictions, as well as the tax years that are no longer subject to examination, were as follows. PPL PPL Electric LG&E KUU.S. (federal)2018 and prior 2018 and prior 2018 and prior 2018 and priorPennsylvania (state)2017 and prior 2017 and prior Kentucky (state)2017 and prior 2017 and prior 2017 and prior 2017 and priorU.K. (foreign)2019 and prior 123Table of ContentsOtherNarragansett Electric Acquisition (PPL) The acquisition of Narragansett Electric was deemed an asset acquisition for federal and state income tax purposes, as a result of PPL and National Grid making a tax election under Internal Revenue Code (IRC) §338(h)(10). Accordingly, the tax bases of substantially all of the assets acquired were increased to fair market value, which equaled net book value, thereby eliminating the related deferred tax assets and liabilities. This election resulted in tax goodwill that will be amortized for tax purposes over 15 years.Pennsylvania State Tax Reform (PPL and PPL Electric) On July 8, 2022, the Governor of Pennsylvania signed into law Pennsylvania House Bill 1342 (H.B. 1342). Among other changes to the state tax code, the bill reduces the corporate net income tax rate from 9.99% to 8.99% beginning January 1, 2023, and further reduces the rate annually by half a percentage point until the rate reaches 4.99% in 2031. GAAP requires that deferred tax assets and liabilities be measured at the enacted tax rate expected to apply when temporary book-to-tax differences are expected to be realized or settled. In 2022, PPL and PPL Electric recorded an increase in regulatory liabilities of $270 million for the remeasurement of regulated accumulated deferred tax balances and a deferred tax benefit of $5 million and $9 million, respectively, associated with the remeasurement of non-regulated accumulated deferred income tax balances. The amounts recorded are estimates that will be updated quarterly to reflect revised forecast, actual activity, and applicable orders from regulatory authorities.Inflation Reduction Act (All Registrants)On August 16, 2022, the Inflation Reduction Act (IRA) was signed into law. Among other things, the IRA enacted a new 15% corporate "book minimum tax," which is based on adjusted GAAP pre-tax income and is only applicable to corporations whose pre-tax income exceeds a certain threshold. PPL continues to assess the impacts of the IRA on the financial statements of PPL and the other Registrants and will monitor guidance issued by the U.S. Treasury in the future. In addition, the IRA enacted numerous new tax credits, largely associated with renewable energy. PPL continues to assess the applicability of these provisions to PPL and its subsidiaries.7. Utility Rate RegulationRegulatory Assets and Liabilities(All Registrants)PPL, PPL Electric, LG&E and KU reflect the effects of regulatory actions in the financial statements for their rate-regulated utility operations. Regulatory assets and liabilities are classified as current if, upon initial recognition, the entire amount related to an item will be recovered or refunded within a year of the balance sheet date.(PPL)RIE is subject to the jurisdiction of the RIPUC, the Rhode Island Division of Public Utilities and Carriers, and the FERC. RIE operates under a FERC-approved open access transmission tariff. RIE's base distribution rates are calculated based on recovery of costs as well as a return on rate base. Certain other recovery mechanisms exist to recover expenses and capital investments with a return on rate base separate from the base distribution rate case process.(PPL, LG&E and KU)LG&E is subject to the jurisdiction of the KPSC and the FERC, and KU is subject to the jurisdiction of the KPSC, the FERC and the VSCC.LG&E's and KU's Kentucky base rates are calculated based on recovery of costs as well as a return on capitalization (common equity, long-term debt and short-term debt) including adjustments for certain net investments and costs recovered separately through other means. As such, LG&E and KU generally earn a return on regulatory assets.124Table of Contents(PPL and KU)KU's Virginia base rates are calculated based on recovery of costs as well as a return on rate base (net utility plant plus working capital less accumulated deferred income taxes and miscellaneous deductions). As all regulatory assets and liabilities, except for regulatory assets and liabilities related to the levelized fuel factor, accumulated deferred income taxes, pension and postretirement benefits, and AROs related to certain CCR impoundments, are excluded from the return on rate base utilized in the calculation of Virginia base rates, no return is earned on the related assets.KU's rates to municipal customers for wholesale power requirements are calculated based on annual updates to a formula rate that utilizes a return on rate base (net utility plant plus working capital less accumulated deferred income taxes and miscellaneous deductions). As all regulatory assets and liabilities, except accumulated deferred income taxes, are excluded from the return on rate base utilized in the development of municipal rates, no return is earned on the related assets. (PPL and PPL Electric)PPL Electric is subject to the jurisdiction of the PAPUC and the FERC. PPL Electric's distribution base rates are calculated based on recovery of costs as well as a return on distribution rate base (net utility plant plus a working capital allowance less plant-related deferred taxes and other miscellaneous additions and deductions). PPL Electric's transmission revenues are billed in accordance with a FERC tariff that allows for recovery of transmission costs incurred, a return on transmission-related rate base (net utility plant plus a working capital allowance less plant-related deferred taxes and other miscellaneous additions and deductions) and an automatic annual update. See "Transmission Formula Rate" below for additional information on this tariff. All regulatory assets and liabilities are excluded from distribution and transmission return on investment calculations; therefore, generally no return is earned on PPL Electric's regulatory assets.(All Registrants)The following table provides information about the regulatory assets and liabilities of cost-based rate-regulated utility operations at December 31: PPLPPL Electric 2022202120222021Current Regulatory Assets: Gas supply clause$41 $21 $— $— Rate adjustment mechanism96 — — — Derivative Instruments41 — — — Smart meter rider5 11 5 11 Universal service rider3 — 3 — Fuel adjustment clause38 11 — — Other34 21 5 11 Total current regulatory assets $258 $64 $13 $22 Noncurrent Regulatory Assets: Defined benefit plans $778 $523 $353 $256 Plant outage cost46 54 — — Net Metering61 — — — Environmental Cost recovery102 — — — Taxes recoverable through future rates47 — — — Storm costs118 11 — — Unamortized loss on debt21 24 3 4 Interest rate swaps7 18 — — Terminated interest rate swaps63 70 — — Accumulated cost of removal of utility plant212 228 212 228 AROs295 302 — — Other69 6 — — Total noncurrent regulatory assets$1,819 $1,236 $568 $488 125Table of ContentsPPLPPL Electric2022202120222021Current Regulatory Liabilities:Generation supply charge$37 $10 $37 $10 Transmission service charge14 21 7 21 Universal service rider— 17 — 17 TCJA customer refund15 22 15 22 Act 129 compliance rider14 10 14 10 Transmission formula rate return on equity (b)— 73 — 73 Economic relief billing rate— 27 — — Transmission formula rate12 — 12 — Rate adjustment mechanism96 — — — Energy efficiency23 — — — Other27 2 — — Total current regulatory liabilities$238 $182 $85 $153 Noncurrent Regulatory Liabilities: Accumulated cost of removal of utility plant$950 $639 $— $— Power purchase agreement - OVEC26 35 — — Net deferred taxes2,094 1,591 775 531 Defined benefit plans187 95 45 28 Terminated interest rate swaps60 62 — — Energy efficiency32 — — — Other63 — — — Total noncurrent regulatory liabilities$3,412 $2,422 $820 $559 LG&EKU 2022202120222021Current Regulatory Assets: Gas supply clause$13 $21 $— $— Gas line tracker— 3 — — Generation formula rate— — — 2 Fuel adjustment clause9 4 29 7 Other1 5 3 — Total current regulatory assets$23 $33 $32 $9 Noncurrent Regulatory Assets: Defined benefit plans$209 $164 $140 $103 Storm costs7 8 3 3 Unamortized loss on debt11 12 7 8 Interest rate swaps7 18 — — Terminated interest rate swaps37 41 26 29 AROs76 75 219 227 Plant outage costs12 15 34 39 Other14 4 13 2 Total noncurrent regulatory assets$373 $337 $442 $411 126Table of Contents LG&EKU 2022202120222021Current Regulatory Liabilities:Economic relief billing credit$— $21 $— $6 Other7 — 6 2 Total current regulatory liabilities$7 $21 $6 $8 Noncurrent Regulatory Liabilities: Accumulated cost of removal of utility plant$287 $262 $389 $377 Power purchase agreement - OVEC18 24 8 11 Net deferred taxes477 491 546 569 Defined benefit plans21 10 56 57 Terminated interest rate swaps30 31 30 31 Total noncurrent regulatory liabilities$833 $818 $1,029 $1,045 (a)See “Regulatory Matters - Federal Matters - PPL Electric Transmission Formula Rate Return on Equity” below for additional information.Following is an overview of selected regulatory assets and liabilities detailed in the preceding tables. Specific developments with respect to certain of these regulatory assets and liabilities are discussed in "Regulatory Matters."Defined Benefit Plans(All Registrants)Defined benefit plan regulatory assets and liabilities represent prior service cost and net actuarial gains and losses that will be recovered in defined benefit plans expense through future base rates based upon established regulatory practices and, generally, are amortized over the average remaining service lives of plan participants. These regulatory assets and liabilities are adjusted at least annually or whenever the funded status of defined benefit plans is remeasured.(PPL, LG&E and KU)As a result of previous rate case settlements and orders, the difference between pension cost calculated in accordance with LG&E's and KU's pension accounting policy and pension cost calculated using a 15-year amortization period for actuarial gains and losses and settlements are recorded as a regulatory asset. As of December 31, 2022, the balances were $107 million for PPL, $57 million for LG&E and $50 million for KU. As of December 31, 2021, the balances were $98 million for PPL, $54 million for LG&E and $44 million for KU.(All Registrants)Storm CostsPPL Electric, LG&E and KU have the ability to request from the PAPUC, the KPSC and the VSCC, as applicable, the authority to treat expenses related to specific extraordinary storms as a regulatory asset and defer such costs for regulatory accounting and reporting purposes. Once such authority is granted, LG&E and KU can request recovery of those expenses in a base rate case and begin amortizing the costs when recovery starts. PPL Electric can recover qualifying expenses caused by major storm events, as defined in its retail tariff, over three years through the Storm Damage Expense Rider commencing in the application year after the storm occurred. Storm costs incurred in PPL Electric's territory from a March 2018 storm were amortized through 2021. LG&E's and KU's regulatory assets for storm costs are being amortized through various dates ending in 2031.As provided in the Amendment Settlement Agreement (ASA), RIE has the authority from the RIPUC to treat certain incremental O&M expenses related to specific extraordinary storms as a regulatory asset and defer such costs for regulatory accounting and reporting purposes. Once all expenses for the extraordinary storm have been finalized, RIE files a final accounting of those storm expenses with the RIPUC that is subject to review by the RIPUC and the Rhode Island Division of Public Utilities and Carriers.127Table of ContentsUnamortized Loss on DebtUnamortized loss on reacquired debt represents losses on long-term debt refinanced, reacquired or redeemed that have been deferred and will be amortized and recovered over either the original life of the extinguished debt or the life of the replacement debt (in the case of refinancing). Such costs are being amortized through 2029 for PPL Electric, through 2042 for KU, and through 2044 for LG&E.Accumulated Cost of Removal of Utility PlantRIE, LG&E and KU charge costs of removal through depreciation expense with an offsetting credit to a regulatory liability. The regulatory liability is relieved as costs are incurred.PPL Electric does not accrue for costs of removal. When costs of removal are incurred, PPL Electric records the costs as a regulatory asset. Such deferral is included in rates and amortized over the subsequent five-year period.Net Deferred TaxesRegulatory liabilities associated with net deferred taxes represent the future revenue impact from the adjustment of deferred income taxes required primarily for excess deferred taxes and unamortized investment tax credits, largely a result of the TCJA enacted in 2017. (PPL and PPL Electric)Generation Supply Charge (GSC)The GSC is a cost recovery mechanism that permits PPL Electric to recover costs incurred to provide generation supply to PLR customers who receive basic generation supply service. The recovery includes charges for generation supply, as well as administration of the acquisition process. In addition, the GSC contains a reconciliation mechanism whereby any over- or under-recovery from prior periods is refunded to, or recovered from, customers through the adjustment factor determined for the subsequent rate filing period.Transmission Service Charge (TSC)PPL Electric is charged by PJM for transmission service-related costs applicable to its PLR customers. PPL Electric passes these costs on to customers, who receive basic generation supply service through the PAPUC-approved TSC cost recovery mechanism. The TSC contains a reconciliation mechanism whereby any over- or under-recovery from customers is either refunded to, or recovered from, customers through the adjustment factor determined for the subsequent year.Transmission Formula RatePPL Electric's transmission revenues are billed in accordance with a FERC-approved Open Access Transmission Tariff that utilizes a formula-based rate recovery mechanism. Under this formula, rates are put into effect in June of each year based upon prior year actual expenditures and current year forecasted capital additions. Rates are then adjusted the following year to reflect actual annual expenses and capital additions, as reported in PPL Electric's annual FERC Form 1, filed under the FERC's Uniform System of Accounts. Any difference between the revenue requirement in effect for the prior year and actual expenditures incurred for that year is recorded as a regulatory asset or regulatory liability.Storm Damage Expense Rider (SDER)The SDER is a reconcilable automatic adjustment clause under which PPL Electric annually will compare actual storm costs to storm costs allowed in base rates and refund or recover any differences from customers. In the 2015 rate case settlement approved by the PAPUC in November 2015, it was determined that reportable storm damage expenses to be recovered annually through base rates will be set at $20 million. The SDER will recover from or refund to customers the applicable expenses from reportable storms as compared to the $20 million recovered annually through base rates. Act 129 Compliance RiderIn compliance with Pennsylvania's Act 129 of 2008 and implementing regulations, PPL Electric is currently in Phase IV of the energy efficiency and conservation plan which was approved in March 2021. Phase IV allows PPL Electric to recover the 128Table of Contentsmaximum $313 million over the five-year period, June 1, 2021 through May 31, 2026. The plan includes programs intended to reduce electricity consumption. The recoverable costs include direct and indirect charges, including design and development costs, general and administrative costs and applicable state evaluator costs. The rates are applied to customers who receive distribution service through the Act 129 Compliance Rider. The actual Phase IV program costs are reconcilable after each 12-month period, and any over- or under-recovery from customers will be refunded or recovered over the next rate filing period. PPL Electric's Act 129 Phase III plan ended May 31, 2021 and any over-or under-recovery from customers related to Phase III will be refunded or recovered over the next rate filing period.Smart Meter Rider (SMR)Act 129 requires each electric distribution company (EDC) with more than 100,000 customers to have a PAPUC approved Smart Meter Technology Procurement and Installation Plan (SMP). As of December 31, 2019, PPL Electric replaced substantially all of its old meters with meters that meet the Act 129 requirements under its SMP. In accordance with Act 129, EDCs are able to recover the costs and earn a return on capital of providing smart metering technology. PPL Electric uses the SMR to recover the costs to implement its SMP. The SMR is a reconciliation mechanism whereby any over- or under-recovery from prior years is refunded to, or recovered from, customers through the adjustment factor determined for the subsequent quarters.Universal Service Rider (USR)The USR provides for recovery of costs associated with universal service programs, OnTrack and Winter Relief Assistance Program (WRAP), provided by PPL Electric to residential customers. OnTrack is a special payment program for low-income households and WRAP provides low-income customers a means to reduce electric bills through energy saving methods. The USR rate is applied to residential customers who receive distribution service. The actual program costs are reconcilable, and any over- or under-recovery from customers will be refunded or recovered annually in the subsequent year.TCJA Customer RefundAs a result of the reduced U.S federal corporate income tax rate as enacted by the TCJA, the PAPUC ruled that these tax benefits should be refunded to customers. Timing differences between the recognition of these tax benefits and the refund of the benefit to the customer creates a regulatory liability. PPL Electric's liability is being credited back to distribution customers through a temporary negative surcharge and remains in place until PPL Electric files and the PAPUC approves new base rates. The TCJA is reconcilable, and any over- or under-recovery from customers will be refunded or recovered annually in the subsequent year.(PPL, LG&E and KU)Fuel Adjustment ClausesLG&E's and KU's retail electric rates contain a fuel adjustment clause, whereby variances in power purchases and the cost of fuel to generate electricity, including transportation costs, from the costs embedded in base rates are adjusted in LG&E's and KU's rates. The KPSC requires formal reviews at six-month intervals to examine past fuel adjustments and at two-year intervals to review past operations of the fuel adjustment clause and, to the extent appropriate, may conduct public hearings and reestablish the fuel charge included in base rates. The regulatory assets or liabilities represent the amounts that have been under- or over-recovered due to timing or adjustments to the mechanism and are typically recovered within 12 months. KU also employs a levelized fuel factor mechanism for Virginia customers using an average fuel cost factor based primarily on projected fuel costs and load for the fuel year (12 months ending March 31). The Virginia levelized fuel factor allows fuel recovery based on projected fuel costs for the fuel year plus an adjustment for any under- or over-recovery of fuel expenses from the prior fuel year. The regulatory assets or liabilities represent the amounts that have been under- or over-recovered due to timing or adjustments to the mechanism and are typically recovered or refunded within 12 months.Economic Relief Billing CreditThe Economic Relief Billing Credit represents regulatory liabilities at December 31, 2021, that were returned to customers through September 30, 2022, as approved in the 2020 Kentucky rate case in recognition of the economic impact of COVID-19.129Table of ContentsAROsAs discussed in Note 1, for LG&E and KU, all ARO accretion and depreciation expenses are reclassified as a regulatory asset or regulatory liability. ARO regulatory assets associated with certain CCR projects are amortized to expense in accordance with regulatory approvals. For other AROs, deferred accretion and depreciation expense is recovered through cost of removal.Power Purchase Agreement - OVECAs a result of purchase accounting associated with PPL's acquisition of LG&E and KU, the fair values of the OVEC power purchase agreement were recorded on the balance sheets of LG&E and KU with offsets to regulatory liabilities. The regulatory liabilities are being amortized using the units-of-production method until March 2026, the expiration date of the agreement at the date of the acquisition. LG&E's and KU's customer rates continue to reflect the original contracts. See Notes 14 and 19 for additional discussion of the power purchase agreement.Interest Rate SwapsLG&E's unrealized gains and losses are recorded as regulatory assets or regulatory liabilities until they are realized as interest expense. Interest expense from existing swaps is realized and recovered over the terms of the associated debt, which matures in 2033.Terminated Interest Rate SwapsNet realized gains and losses on all interest rate swaps are recovered through regulated rates. As such, any gains and losses on these derivatives are included in regulatory assets or liabilities and are primarily recognized in "Interest Expense" on the Statements of Income over the life of the associated debt.Plant Outage CostsFrom July 1, 2017 through June 30, 2021, plant outage costs were normalized for ratemaking purposes based on an average level of expenses. Plant outage expenses that were greater or less than the average will be collected from or returned to customers, through future base rates. Effective July 1, 2021 under-recovered plant outage costs are being amortized through 2029 for LG&E and KU.(PPL)Derivative InstrumentsRIE evaluates open derivative instruments for regulatory deferral by determining if they are probable of recovery from, or refund to, customers through future rates. Derivative instruments that qualify for recovery are recorded at fair value, with changes in fair value recorded as regulatory assets or regulatory liabilities in the period in which the change occurs. The balance is reconcilable, and any over- or under-recovery from customers will be refunded or recovered annually in the subsequent year.Energy Efficiency Energy efficiency represents the difference between revenue billed to customers through RIE's energy efficiency charge and the costs of the RIE’s energy efficiency programs as approved by the RIPUC.The energy efficiency charge is designed to collect the estimated costs of the RIE’s energy efficiency plan for the upcoming calendar year. The final annual over/under is reconciled in the next year's energy efficiency plan filing, as part of the reconciliation factor calculation. RIE may file to change the energy efficiency plan charge at any time should significant over-or under-recoveries occur.Net MeteringNet metering deferral reflects the recovery mechanism for costs associated with customer-installed on-site generation facilities, including the costs of renewable generation credits. This surcharge provides RIE with a mechanism to recover such amounts. Net metering is reconcilable annually, and any over- or under-recovery from customers will be refunded to, or recovered from, customers through the adjustment factor determined for the subsequent year.130Table of ContentsRate Adjustment MechanismsIn addition to commodity costs, RIE is subject to a number of additional rate adjustment mechanisms whereby an asset or liability is recognized resulting from differences between actual revenues and the underlying cost being recovered or differences between actual revenues and targeted amounts as approved by the RIPUC. The rate adjustment mechanisms are reconcilable, and any over- or under-recovery from customers are to be refunded or recovered annually in the subsequent year.Taxes Recoverable through Future RatesTaxes recoverable through future rates represent the portion of future income taxes that are anticipated to be recovered through future rates based upon established regulatory practices. Accordingly, this regulatory asset is recognized when the offsetting deferred tax liability is recognized. For general-purpose financial reporting, this regulatory asset and the deferred tax liability are not offset; rather, each is displayed separately. This regulatory asset is expected to be recovered over the period that the underlying book-tax timing differences reverse and the actual cash taxes are incurred.(PPL, LG&E and KU)Environmental Cost RecoveryKentucky law permits LG&E and KU to recover the costs, including a return of operating expenses and a return of and on capital invested, of complying with the Clean Air Act and those federal, state or local environmental requirements, which apply to coal combustion wastes and by-products from coal-fired electricity generating facilities. The KPSC requires reviews of the past operations of the environmental surcharge for six-month and two-year billing periods to evaluate the related charges, credits and rates of return, as well as to provide for the roll-in of ECR amounts to base rates each two-year period. The KPSC has authorized return on equity of 9.35% for existing approved ECR projects. The ECR regulatory asset or liability represents the amount that has been under- or over-recovered due to timing or adjustments to the mechanism and is typically recovered or refunded within 12 months.RIE's rate plans provide for specific rate allowances for RIE's share of the estimated costs to investigate and perform certain remediation activities at sites with which it may be associated, with variances deferred for future recovery from, or return to, customers. RIE believes future costs, beyond the expiration of current rate plans, will continue to be recovered through rates. The regulatory asset represents the excess of amounts incurred for RIE's actual site investigation and remediation costs versus amounts received in rates.(PPL and LG&E)Gas Supply Clause LG&E's natural gas rates contain a gas supply clause, whereby the expected cost of natural gas supply and variances between actual and expected costs and customer usage from prior periods are adjusted quarterly in LG&E's rates, subject to approval by the KPSC. The gas supply clause also includes a separate natural gas procurement incentive mechanism, which allows LG&E's rates to be adjusted annually to share savings between the actual cost of gas purchases and market indices, with the shareholders and the customers during each performance-based rate year (12 months ending October 31). The regulatory assets or liabilities represent the total amounts that have been under- or over-recovered due to timing or adjustments to the mechanisms and are typically recovered or refunded within 18 months.Regulatory MattersRhode Island Activities (PPL)Rate Case proceedingsAt its August 24, 2018 Open Meeting, and subsequently memorialized pursuant to Report and Order No. 23823 issued May 5, 2020, the RIPUC approved the terms of an ASA, reflecting an allowed return on equity (ROE) rate of 9.275% based on a common equity ratio of approximately 51%. RIE is currently in year four of the multi-year rate plan (Rate Plan). On June 30, 2021, the Rhode Island Division of Public Utilities and Carriers consented to an open-ended extension of the term of the Rate 131Table of ContentsPlan such that RIE was not required to file its next rate case in order for new rates take effect no later than September 1, 2022 as originally contemplated by the ASA. Pursuant to the settlement with the Rhode Island Office of the Attorney General in connection with the acquisition of RIE by PPL, RIE currently does not anticipate filing a new base rate case until at least three years following the closing of the acquisition on May 25, 2022. Pursuant to the open-ended extension, the Rate Year 3 level of base distribution rates under ASA will remain in effect and RIE will continue to operate under the current Rate Plan until a new Rate Plan is approved by the RIPUC.The ASA includes additional provisions, including (i) an Electric Transportation Initiative (the ET Initiative) to facilitate the growth of Electric Vehicle (EV) adoption and scaling of the market for EV charging equipment to advance Rhode Island's zero emission vehicles and greenhouse gas emissions policy goals, which the RIPUC is continuing to review in connection with certain underspending in the ET Initiative and the timing of crediting customers the deferral balance pursuant to the ASA, (ii) two energy storage demonstration projects, which are on track for timely completion, (iii) a new incentive-only performance incentive for System Efficiency: Annual Megawatt Capacity Savings, which sunset in 2021 and (iv) several additional metrics for tracking and reporting purposes only. The RIPUC discussed the ET Initiative at an Open Meeting on August 30, 2022, advising the Company to seek RIPUC authorization to continue the ET Initiative and/or to alter any of the targets established in the ASA for Rate Year 5 and beyond. No votes or official rulings were taken; however, based on this feedback, RIE has paused the ET programs in Rate Year 5. Advanced Metering Functionality and Grid ModernizationOn January 21, 2021, RIE filed its Updated Advance Metering Functionality (AMF) Business Case and Grid Modernization Plan (GMP) with the RIPUC in accordance with the ASA. The Updated AMF Business Case – a foundational component of the GMP – seeks approval to deploy smart meters throughout the service territory. Pursuant to the written order issued on July 14, 2021, the RIPUC stayed the AMF and GMP proceedings pending further consideration following the issuance of a final Order by the Rhode Island Division of Public Utilities and Carriers on the acquisition. RIE filed notice of withdrawal of the original Updated AMF Business Case and GMP with the RIPUC on September 12, 2022. RIE filed a new AMF Business Case with the RIPUC on November 18, 2022. The new AMF Business Case filing consists of a detailed proposal for full-scale deployment of AMF across its electric service territory. The proposal will enable significant customer and grid benefits in line with the state’s climate mandates. If approved, the program is estimated to cost $188 million on a net present value (NPV) basis and provide benefits of $729 million NPV over the 20-year project life, yielding a benefit-cost ratio of 3.9%. RIE’s proposal represents an opportunity to deploy this foundational technology, which is a necessary first step to transforming Rhode Island’s electric distribution system. In its filing, RIE requested a RIPUC decision by June 2023; the RIPUC issued a revised procedural schedule for the AMF Business Case filing that provides for hearings on July 19-20, and July 25-27, 2023. In addition, the RIPUC will hold a public comment hearing on February 28, 2023, and technical sessions on February 22, 2023, March 2, 2023, April 18, 2023 and May 10, 2023. RIE filed a new GMP with the RIPUC on December 30, 2022. The new GMP filing consists of a holistic suite of grid modernization investments that will provide RIE with the tools and capability to manage the electric distribution system more granularly considering a range of distributed energy resources adoption levels, accelerated by Rhode Island’s ambitious climate mandates, while at the same time maintaining a safe and reliable electric distribution system. The GMP is an informational guidance document that supports the foundational grid modernization investments proposed in RIE’s Fiscal Year (FY) 2024 Electric Infrastructure, Safety and Reliability (ISR) Plan and will support additional grid modernization investments to be proposed in future electric ISR plans. Consequently, RIE is not requesting approval from the RIPUC for any specific investments or seeking any cost recovery as part of this GMP; rather, RIE requested the RIPUC issue an order affirming RIE’s compliance with its obligation to file a GMP that meets the requirements of the ASA. The RIPUC has not yet established a procedural schedule for the GMP filing. COVID-19 Deferral FilingOn April 30, 2021, RIE filed a petition for approval to recognize regulatory assets related to COVID-19 impacts (RIPUC Docket No. 5154). In its petition, RIE seeks the RIPUC's authorization to create regulatory assets and consideration of future cost recovery for the following COVID-19 costs: (1) the increased cost of customer accounts receivable that RIE will be unable to collect as a result of the COVID-19 pandemic, and the executive orders and RIPUC orders restricting RIE's collection activities as a result of the pandemic, which will result in increased net charge-offs; (2) lost revenue from unassessed late payment charges; and (3) charges to RIE for other fees that RIE has waived pursuant to the RIPUC's orders in RIPUC Docket No. 5022. The RIPUC has not taken any action on the filing to date and RIE is continuing to monitor the docket. RIE is evaluating its request to create a regulatory asset for COVID-19-related bad debt expense to consider the impact, if any, of the proposed arrearage forgiveness sought in RIE’s Petition to Forgive Certain Arrearage Balances for Low-Income and Protected Customers in Docket No. 22-08-GE, which RIE filed with the RIPUC to fulfill its obligations under PPL's settlement with the Rhode Island Attorney General. 132Table of ContentsFY 2023 Gas ISR PlanAt an Open Meeting on March 29, 2022, the RIPUC conditionally approved RIE’s FY 2023 Gas ISR Plan and associated revenue requirement, subject to further review regarding RIE’s Proactive Main Replacement Program and its decision to reconstruct and purchase heating and pressure regulation equipment located at RIE’s Wampanoag and Tiverton take stations. The RIPUC held an Open Meeting on September 13, 2022, and issued its Order on November 18. 2022 regarding the Proactive Main Replacement Program and made the following rulings: (1) commencing with the Gas ISR plan to be filed in this calendar year 2022 (prospectively), new main constructed to replace leak prone pipe will not be considered used and useful, and therefore not eligible for rate base treatment, until the related old main is abandoned; and (2) approved the proactive main replacement revenue requirement set forth in the FY2023 Gas ISR plan. Also, the RIPUC directed RIE to submit prefiled testimony on the issue of its replacement of heating and pressure regulation facilities at the Wampanoag and Tiverton take stations and to address three issues, specifically: (i) a cost-benefit analysis arising from RIE's decision to take ownership of the reconstructed take station equipment; (ii) the potential that the benefits derived from the reconstruction and ownership transfer of the take station equipment will not be realized due to the future use of hydrogen or abandonment of the gas system; and (iii) the depreciation and accounting treatment of the reconstructed take station equipment. RIE filed this testimony with the RIPUC on May 16, 2022 and this issue is still pending before the RIPUC.FY 2024 Gas ISR PlanOn December 23, 2022, RIE filed its FY 2024 Gas ISR Plan with the RIPUC. To transition the filing of the ISR plan from National Grid’s fiscal year (April 1 – March 31) to PPL’s fiscal year (January 1 – December 31), RIE proposed a one-time 21-month plan to cover the period from April 1, 2023, through December 31, 2024; subsequent ISR plans would then align with PPL's fiscal year. The 21-month plan includes $389 million of capital investment spend and would result in the abandonment of approximately 123 miles of leak-prone pipe as well as continue significant investment into our custody transfer stations, pressure regulating facilities, and peak shaving plants/operations. The RIPUC directed RIE and the Rhode Island Division of Public Utilities and Carriers to brief the question of how the 21-month plan, which spans two fiscal years, is consistent with the Decoupling Act (R.I. Gen. Laws Section 39-1-27.7.1) on or before January 17, 2023. At its January 20, 2023 Open Meeting, the RIPUC directed RIE to file supplemental budget and rate schedules to reflect an April 1 to March 31 fiscal year, consistent with past ISR plan filings and the existing tariff. The supplemental budget that was filed with the RIPUC on January 27, 2023 includes $187 million of capital investment spend. The supplemental rate schedules were filed on February 3, 2023. The RIPUC has scheduled a hearing on the plan on March 14, 2023 and March 15, 2023, and is expected to render a decision by the end of March for rates effective April 1, 2023. FY 2024 Electric ISR PlanOn December 23, 2022, RIE filed its FY 2024 Electric ISR Plan with the RIPUC. To transition the filing of the ISR plan from National Grid’s fiscal year (April 1 – March 31) to PPL's fiscal year (January 1 – December 31), RIE proposed a one-time 21-month plan to cover the period from April 1, 2023, through December 31, 2024; subsequent ISR plans would then align with PPL’s fiscal year. The 21-month plan includes $328 million of capital investment spend; $24 million of vegetation management O&M expenses; and $6 million of Other O&M expenses. This year's Electric ISR Plan includes $82 million for capital investment spend included in RIE’s recently filed GMP, along with investments stemming from the completion of RIE’s area studies. The RIPUC directed RIE and the Rhode Island Division of Public Utilities and Carriers to brief the question of how the 21-month Plan, which spans two fiscal years, is consistent with the Decoupling Act (R.I. Gen. Laws Section 39-1-27.7.1) on or before January 17, 2023. At its January 20, 2023 Open Meeting, the RIPUC directed RIE to file supplemental budget and rate schedules to reflect an April 1 to March 31 fiscal year, consistent with past ISR plan filings and the existing tariff. The supplemental budget filed with the RIPUC on January 27, 2023 includes $176 million of capital investment spend, $14 million of vegetation management O&M spend and $3 million of Other O&M spend. The supplemental rate schedules were filed on February 3, 2023. The RIPUC has scheduled a hearing on March 8-9, 2023 and March 21-22, 2023 and is expected to render a decision by the end of March for rates effective April 1, 2023. Kentucky Activities (PPL, LG&E and KU)CPCN On December 15, 2022, LG&E and KU filed an application with the KPSC for a CPCN for the construction of two 621 MW net summer rating NGCC combustion turbine facilities, one at LG&E's Mill Creek Generating Station in Jefferson County, Kentucky and the other at KU's E.W. Brown Generating Station in Mercer County, Kentucky, including on-site natural gas and electric transmission construction associated with those facilities and site compatibility certificates. LG&E and KU also applied 133Table of Contentsfor a CPCN to construct a 120 MWac solar photovoltaic electric generating facility in Mercer County, Kentucky, and for a CPCN to acquire a 120 MWac solar facility to be built by a third-party solar developer in Marion County, Kentucky. LG&E and KU further applied for a CPCN to construct a 125 MW, 4-hour battery energy storage system facility at KU's E.W. Brown Generating Station and for approval of their proposed 2024-2030 DSM programs. The plan includes adding 14 new, adjusted or expanded energy efficiency programs, which would reduce LG&E's and KU's overall need by approximately 100 MW each. Finally, LG&E and KU requested a declaratory order to confirm that their entry into non-firm energy-only power-purchase agreements for the output of four solar photovoltaic facilities with a combined capacity of 637 MW does not require KPSC approval and that LG&E and KU may recover the costs of the solar PPAs through their fuel adjustment clause mechanisms as previously approved for a prior solar PPA. LG&E and KU plan to accrue AFUDC on the constructed NGCCs, solar facility in Mercer County, Kentucky and the battery energy storage system facility and have requested regulatory asset treatment to recover the financing costs of these projects.The new NGCC would be jointly owned by LG&E (31%) and KU (69%) and the solar units would be jointly owned by LG&E (37%) and KU (63%), the battery storage unit would be owned by LG&E, and the proposed PPA transactions and DSM programs would be entered into or conducted jointly by LG&E and KU, consistent with LG&E and KU's shared dispatch, cost allocation, tariff or other frameworks.The filing also notes planned retirement dates for certain existing coal-fired generation units, including Mill Creek 1 (300 MW) in 2024 and E.W. Brown 3 (412 MW) in 2028, and updates and advances the planned retirement dates for Mill Creek 2 (297 MW) to 2027 and Ghent 2 (486 MW) to 2028. LG&E and KU anticipate the recovery of associated retirement costs, including the remaining net book value, for these coal-fired generating units through the RAR or other rate mechanisms. The KPSC accepted the filing as of January 6, 2023 and has indicated its intention to issue an order on all issues by November 6, 2023. LG&E and KU cannot predict the outcome of these matters.Pennsylvania Activities (PPL and PPL Electric)PAPUC investigation into billing issuesOn January 31, 2023, the PAPUC initiated an investigation focused on billing issues related to estimated, irregular bills and customer service concerns following customer complaints, which for many customers were driven by increased prices for electricity supply. Certain bills issued during the time period of December 20, 2022 through January 9, 2023 were estimated due to a technical issue that prevented PPL Electric from providing actual collected meter data to customer facing and other internal systems. Customers also reported difficulties accessing PPL Electric’s website and contacting the customer service call center. The PAPUC’s Bureau of Investigation & Enforcement has directed PPL Electric to respond to certain inquiries and document requests. PPL Electric plans to submit its responses to the information request and cooperate fully with the investigation. PPL Electric cannot predict the outcome of this matter.Act 129 Act 129 requires Pennsylvania Electric Distribution Companies (EDCs) to meet, by specified dates, specified goals for reduction in customer electricity usage and peak demand. EDCs not meeting the requirements of Act 129 are subject to significant penalties. PPL Electric filed with the PAPUC its Act 129 Phase IV Energy Efficiency and Conservation Plan on November 30, 2020, for the five-year period starting June 1, 2021 and ending on May 31, 2026. PPL Electric's Phase IV Act 129 Plan was approved by the PAPUC at its March 25, 2021, public meeting. Act 129 also requires EDCs to act as a default service provider (DSP), which provides electricity generation supply service to customers pursuant to a PAPUC-approved default service procurement plan. A DSP is able to recover the costs associated with its default service procurement plan.134Table of ContentsFederal MattersPPL Electric Transmission Formula Rate Return on Equity (PPL and PPL Electric)In May 2020, PP&L Industrial Customer Alliance (PPLICA) filed a complaint with the FERC alleging that PPL Electric's base ROE of 11.18% used to determine PPL Electric's formula transmission rate was unjust and unreasonable. In August 2021, PPL Electric entered into a settlement agreement (the Settlement) with PPLICA and all other parties, including intervenors. The key aspects of the Settlement included changes to PPL Electric's base ROE. The settlement was approved by the FERC in November 2021. The interim rates reflecting the agreed-to-base ROE in the Settlement were effective December 1, 2021.In 2021, PPL Electric recorded a revenue reduction of $78 million ($55 million after-tax), of which $73 million ($52 million after-tax) represented revenue subject to refund for the period May 21, 2020 through November 30, 2021. The reduction recorded included $28 million ($20 million after-tax) related to the period from May 21, 2020 to December 31, 2020. At December 31, 2021, PPL and PPL Electric had a regulatory liability on the Balance Sheet of $73 million, which represented revenue subject to refund based on the difference between charges that were calculated using the ROE in effect at the time and charges calculated using the revised ROE provided for in the Settlement, plus interest at the FERC interest rate. The total balance at December 31, 2021, plus additional interest recorded was refunded to customers by May 31, 2022. FERC Transmission Rate Filing (PPL, LG&E and KU)In 2018, LG&E and KU applied to the FERC requesting elimination of certain on-going credits to a sub-set of transmission customers relating to the 1998 merger of LG&E's and KU's parent entities and the 2006 withdrawal of LG&E and KU from the Midcontinent Independent System Operator, Inc. (MISO), a regional transmission operator and energy market. The application sought termination of LG&E's and KU's commitment to provide certain Kentucky municipalities mitigation for certain horizontal market power concerns arising out of the 1998 LG&E and KU merger and 2006 MISO withdrawal. The amounts at issue are generally waivers or credits granted to a limited number of Kentucky municipalities for either certain LG&E and KU or MISO transmission charges incurred for transmission service received. In 2019, the FERC granted LG&E's and KU's request to remove the ongoing credits, conditioned upon the implementation by LG&E and KU of a transition mechanism for certain existing power supply arrangements, which was subsequently filed, modified, and approved by the FERC in 2020 and 2021. In 2020, LG&E and KU and other parties filed appeals with the D.C. Circuit Court of Appeals regarding the FERC's orders on the elimination of the mitigation and required transition mechanism. On August 4, 2022, the D.C. Circuit Court of Appeals issued an order remanding the proceedings back to the FERC. LG&E and KU cannot predict the outcome of the proceedings at the FERC on remand. LG&E and KU currently receive recovery of the waivers and credits provided through other rate mechanisms and such rate recovery would be anticipated to be adjusted consistent with potential changes or terminations of the waivers and credits, as such become effective.Recovery of Transmission Costs (PPL)Until December 2022, RIE's transmission facilities were operated in combination with the transmission facilities of National Grid's New England affiliates, Massachusetts Electric Company (MECO) and NEP, as a single integrated system with NEP designated as the combined operator. As of January 1, 2023, RIE operates its own transmission facilities. NE-ISO allocates RIE’s costs among transmission customers in New England, in accordance with the ISO Open Access Transmission Tariff (ISO-NE OATT).According to the FERC orders, RIE is compensated for its actual monthly transmission costs, with its authorized maximum ROE of 11.74% on its transmission assets. The amount remitted by NEP to RIE for the year ended December 31. 2022 was $122 million.The ROE for transmission rates under the ISO-NE OATT is the subject of four complaints that are pending before the FERC. On October 16, 2014, the FERC issued an order on the first complaint, Opinion No. 531-A, resetting the base ROE applicable to transmission assets under the ISO-NE OATT from 11.14% to 10.57% effective as of October 16, 2014 and establishing a maximum ROE of 11.74%. On April 14, 2017, this order was vacated and remanded by the D. C. Circuit Court of Appeals (Court of Appeals). After the remand, the FERC issued an order on October 16, 2018 applicable to all four pending cases where it proposed a new base ROE methodology that, with subsequent input and support from the New England Transmission Owners (NETO), yielded a base ROE of 10.41%. Subsequent to the FERC's October 2018 order in the New England Transmission Owners cases, the FERC further refined its ROE methodology in another proceeding and has applied that refined methodology to transmission owners’ ROEs in other jurisdictions, and the NETOs filed further information in the New England matters to distinguishing their case. Those determinations in other jurisdictions are currently on appeal before the Court of Appeals. The proceeding and the final base rate ROE determination in the New England matters remain open, pending a final order from the FERC. PPL cannot predict the outcome of this matter, and an estimate of the impact cannot be determined.135Table of ContentsOtherPurchase of Receivables Programs(PPL and PPL Electric)In accordance with a PAPUC-approved purchase of accounts receivable program, PPL Electric purchases certain accounts receivable from alternative electricity suppliers at a discount, which reflects a provision for uncollectible accounts. The alternative electricity suppliers have no continuing involvement or interest in the purchased accounts receivable. Accounts receivable that are acquired are initially recorded at fair value on the date of acquisition. During 2022, 2021 and 2020, PPL Electric purchased $1.3 billion, $1.2 billion and $1.1 billion of accounts receivable from alternative suppliers.(PPL)At its July 27, 2021, December 21, 2021, and March 2, 2022 Open Meetings, the RIPUC approved various components of a Purchase of Receivables Program (POR) in Rhode Island for effect on April 1, 2022. Municipal aggregators and non-regulated power producers (collectively, Competitive Suppliers) are eligible to participate in accordance with RIE’s approved electric tariffs for municipal aggregation and non-regulated power producers. Under the POR program, RIE will purchase the Competitive Suppliers' accounts receivables, including existing receivables, at discounted rates, regardless of whether RIE has collected the owed monies from customers. The program is intended to make RIE whole through the implementation of a discount rate or Standard Complete Bill Percentage (SCBP) paid by Competitive Suppliers. RIE will calculate the SCBP for each customer class and file the calculations with the RIPUC for review and approval by February 15 of each year. Once approved, the SCBP will be effective beginning on April 1 for a one-year period.8. Financing ActivitiesCredit Arrangements and Short-term Debt(All Registrants)The Registrants maintain credit facilities to enhance liquidity, provide credit support and provide a backstop to commercial paper programs. For reporting purposes, on a consolidated basis, the credit facilities and commercial paper programs of PPL Electric, LG&E and KU also apply to PPL. The amounts listed in the borrowed column below are recorded as "Short-term debt" on the Balance Sheets except for borrowings under PPL Electric's term loan agreement due March 2024 and borrowings under LG&E's and KU's term loan agreements due July 2024, which are reflected in "Long-term debt." The following credit facilities were in place at: December 31, 2022December 31, 2021 ExpirationDateCapacityBorrowedLetters ofCreditandCommercialPaperIssued (c)Unused CapacityBorrowedLetters ofCreditandCommercialPaperIssuedPPL PPL Capital Funding Syndicated Credit Facility (a) (b)Dec 2026$1,250 $— $561 $689 $— $— Bilateral Credit Facility (a) (b)Mar 2023100 — — 100 — — Bilateral Credit Facility (a) (b)Mar 2023100 — 58 42 — 15 Total PPL Capital Funding Credit Facilities$1,450 $— $619 $831 $— $15 PPL Electric Syndicated Credit Facility (a) (b)Dec 2026650 — 146 504 — 1 Term Loan Credit Facility (a) (b)Mar 2024250 250 — — — — Total PPL Electric Credit Facilities$900 $250 $146 $504 $— $1 136Table of Contents December 31, 2022December 31, 2021 ExpirationDateCapacityBorrowedLetters ofCreditandCommercialPaperIssued (c)Unused CapacityBorrowedLetters ofCreditandCommercialPaperIssuedLG&E Syndicated Credit Facility (a) (b)Dec 2026500 — 180 320 — 69 Term Loan Credit Facility (a) (b)Jul 2024300 300 — — — — Total LG&E Credit Facilities$800 $300 $180 $320 $— $69 KU Syndicated Credit Facility (a) (b)Dec 2026400 — 101 299 — — Term Loan Credit Facility (a) (b)Jul 2024300 300 — — — — Total KU Credit Facilities $700 $300 $101 $299 $— $— (a)Each company pays customary fees under its respective facility and borrowings generally bear interest at LIBOR-based rates, or applicable secured overnight financing rates, plus an applicable margin.(b)The facilities contain a financial covenant requiring debt to total capitalization not to exceed 70% for PPL Capital Funding, PPL Electric, LG&E and KU, as calculated in accordance with the facilities and other customary covenants. Additionally, subject to certain conditions, PPL Capital Funding may request that the capacity of one of its bilateral credit facilities expiring in March 2023 be increased by up to $30 million and PPL Capital Funding, PPL Electric, LG&E and KU may each request up to a $250 million increase in its syndicated credit facility's capacity. Participation in any such increase is at the sole discretion of each lender.(c)Commercial paper issued reflects the undiscounted face value of the issuance. (PPL)In March 2022, PPL Capital Funding amended and restated its two existing $50 million bilateral credit facilities to extend the termination dates from March 9, 2022 to March 6, 2023 and to increase the borrowing capacity under each facility to $100 million.(PPL and LG&E)In July 2022, LG&E entered into a $300 million term loan credit facility expiring in 2024. On July 29, 2022, LG&E borrowed $300 million under this facility at an initial interest rate of 3.23%. The per annum interest rate fluctuates based on the applicable secured overnight financing rate plus a spread. The proceeds were used to repay short-term debt and for general corporate purposes.(PPL and KU)In July 2022, KU entered into a $300 million term loan credit facility expiring in 2024. On July 29, 2022, KU borrowed $300 million under this facility at an initial interest rate of 3.23%. The per annum interest rate fluctuates based on the applicable secured overnight financing rate plus a spread. The proceeds were used to repay short-term debt and for general corporate purposes. (PPL and PPL Electric)In September 2022, PPL Electric entered into a $250 million term loan credit facility expiring in 2024. On September 16, 2022, PPL Electric borrowed $250 million under this facility at an initial interest rate of 3.77%. The per annum interest rate fluctuates based on the applicable secured overnight financing rate plus a spread. The proceeds were used to repay long-term debt.(All Registrants)The Registrants maintain commercial paper programs to provide an additional financing source to fund short-term liquidity needs. Commercial paper issuances, included in "Short-term debt" on the Balance Sheets, are supported by the respective Registrant's credit facilities. The following commercial paper programs were in place at:137Table of Contents December 31, 2022December 31, 2021Weighted -AverageInterest RateCapacityCommercialPaperIssuances (d)UnusedCapacityWeighted -AverageInterest RateCommercialPaperIssuances (d)PPL Capital Funding (a)4.84%$1,350 $561 $789 $— PPL Electric4.74%650 145 505 — LG&E (b)4.94%500 180 320 0.31%69 KU (c)4.90%400 101 299 — Total $2,900 $987 $1,913 $69 (a)PPL Capital Funding's obligations are fully and unconditionally guaranteed by PPL.(b)In August 2022, LG&E increased the size of their commercial paper program to $500 million.(c)In August 2022, KU increased the size of their commercial paper program to $400 million.(d)Commercial paper issued reflects the undiscounted face value of the issuance.(PPL Electric, LG&E and KU)See Note 15 for a discussion of intercompany borrowings.Long-term Debt (All Registrants) December 31, Weighted-AverageRate (d)Maturities (d)20222021PPL Senior Unsecured Notes3.95 %2026 - 2047$3,066 $1,566 Senior Secured Notes/First Mortgage Bonds (a) (b) (c)4.06 %2023 - 20508,957 9,205 Junior Subordinated Notes7.39 %2067480 480 Term Loan Credit Facility5.21 %2024850 — Total Long-term Debt before adjustments 13,353 11,251 Unamortized premium and (discount), net(32)(34)Unamortized debt issuance costs(78)(77)Total Long-term Debt13,243 11,140 Less current portion of Long-term Debt354 474 Total Long-term Debt, noncurrent$12,889 $10,666 PPL Electric Senior Secured Notes/First Mortgage Bonds (a) (b)4.26 %2023 - 2049$4,289 $4,539 Term Loan Credit Facility5.17 %2024250 — Total Long-term Debt Before Adjustments 4,539 4,539 Unamortized discount (22)(22)Unamortized debt issuance costs (31)(33)Total Long-term Debt 4,486 4,484 Less current portion of Long-term Debt 340 474 Total Long-term Debt, noncurrent $4,146 $4,010 138Table of Contents December 31, Weighted-AverageRate (d)Maturities (d)20222021LG&E Senior Secured Notes/First Mortgage Bonds (a) (c)3.70 %2025 - 2049$2,024 $2,024 Term Loan Credit Facility5.22 %2024300 — Total Long-term Debt Before Adjustments 2,324 2,024 Unamortized discount (4)(4)Unamortized debt issuance costs (13)(14)Total Long-term Debt 2,307 2,006 Less current portion of Long-term Debt — — Total Long-term Debt, noncurrent $2,307 $2,006 KU Senior Secured Notes/First Mortgage Bonds (a) (c)4.00 %2023 - 2050$2,642 $2,642 Term Loan Credit Facility5.22 %2024300 — Total Long-term Debt Before Adjustments 2,942 2,642 Unamortized premium5 5 Unamortized discount (9)(9)Unamortized debt issuance costs (18)(20)Total Long-term Debt 2,920 2,618 Less current portion of Long-term Debt 13 — Total Long-term Debt, noncurrent $2,907 $2,618 (a)Includes PPL Electric's senior secured and first mortgage bonds that are secured by the lien of PPL Electric's 2001 Mortgage Indenture, which covers substantially all of PPL Electric’s tangible distribution properties and certain of its tangible transmission properties located in Pennsylvania, subject to certain exceptions and exclusions. The carrying value of PPL Electric's property, plant and equipment was approximately $11.8 billion and $11.3 billion at December 31, 2022 and 2021.Includes LG&E's first mortgage bonds that are secured by the lien of the LG&E 2010 Mortgage Indenture which creates a lien, subject to certain exceptions and exclusions, on substantially all of LG&E's real and tangible personal property located in Kentucky and used or to be used in connection with the generation, transmission and distribution of electricity and the storage and distribution of natural gas. The aggregate carrying value of the property subject to the lien was $5.8 billion and $5.7 billion at December 31, 2022 and 2021.Includes KU's first mortgage bonds that are secured by the lien of the KU 2010 Mortgage Indenture which creates a lien, subject to certain exceptions and exclusions, on substantially all of KU's real and tangible personal property located in Kentucky and used or to be used in connection with the generation, transmission and distribution of electricity. The aggregate carrying value of the property subject to the lien was $7.1 billion and $6.9 billion at December 31, 2022 and 2021.(b)Includes PPL Electric's series of senior secured bonds that secure its obligations to make payments with respect to each series of Pollution Control Bonds that were issued by the LCIDA and the PEDFA on behalf of PPL Electric. These senior secured bonds were issued in the same principal amount, contain payment and redemption provisions that correspond to and bear the same interest rate as such Pollution Control Bonds. These senior secured bonds were issued under PPL Electric's 2001 Mortgage Indenture and are secured as noted in (a) above. The tax-exempt revenue bonds are subject to mandatory redemption upon determination that the interest rate on the bonds would be included in the holders' gross income for federal tax purposes. Includes $250 million of notes that may be called at a redemption price equal to 100% of the principal amount, plus accrued and unpaid interest to, but excluding, the redemption date.(c)Includes LG&E's and KU's series of first mortgage bonds that were issued to the respective trustees of tax-exempt revenue bonds to secure its respective obligations to make payments with respect to each series of bonds. The first mortgage bonds were issued in the same principal amounts, contain payment and redemption provisions that correspond to and bear the same interest rate as such tax-exempt revenue bonds. These first mortgage bonds were issued under the LG&E 2010 Mortgage Indenture and the KU 2010 Mortgage Indenture and are secured as noted in (a) above. The related tax-exempt revenue bonds were issued by various governmental entities, principally counties in Kentucky, on behalf of LG&E and KU. The related revenue bond documents allow LG&E and KU to convert the interest rate mode on the bonds from time to time to a commercial paper rate, daily rate, weekly rate, term rate of at least one year or, in some cases, an auction rate or a LIBOR index rate. At December 31, 2022, the aggregate tax-exempt revenue bonds issued on behalf of LG&E and KU that were in a term rate mode totaled $782 million for PPL, comprised of $473 million and $309 million for LG&E and KU. At December 31, 2022, the aggregate tax-exempt revenue bonds issued on behalf of LG&E and KU that were in a variable rate mode totaled $66 million and $33 million for LG&E and KU. These variable rate tax-exempt revenue bonds are subject to tender for purchase by LG&E and KU at the option of the holder and to mandatory tender for purchase by LG&E and KU upon the occurrence of certain events.(d)The table reflects principal maturities only, based on stated maturities, sinking fund requirements, or earlier put dates, and the weighted-average rates as of December 31, 2022.139Table of ContentsThe aggregate maturities of long-term debt, based on sinking fund requirements, stated maturities or earlier put dates, for the periods 2023 through 2027 and thereafter are as follows:PPLPPLElectricLG&EKU2023$354 $340 $— $13 20241,501 900 300 300 2025551 — 300 250 2026904 — 90 164 2027303 108 195 — Thereafter9,740 3,191 1,439 2,215 Total$13,353 $4,539 $2,324 $2,942 (PPL and PPL Electric)In August 2022, the Lehigh County Industrial Development Authority remarketed $108 million of Pollution Control Revenue Refunding Bonds (PPL Electric Utilities Corporation Project), 2016 Series B due 2027 previously issued on behalf of PPL Electric. The bonds were remarketed at a long-term rate and will bear interest at 2.63% through their maturity date of February 15, 2027.In September 2022, the Lehigh County Industrial Development Authority remarketed $116 million of Pollution Control Revenue Refunding Bonds (PPL Electric Utilities Corporation Project), 2016 Series A due 2029 previously issued on behalf of PPL Electric. The bonds were remarketed at a long-term rate and will bear interest at 3.00% through their maturity date of September 1, 2029.(PPL Electric, LG&E and KU)See Note 15 for additional information related to intercompany borrowings.Legal Separateness (All Registrants)The subsidiaries of PPL are separate legal entities. PPL's subsidiaries are not liable for the debts of PPL. Accordingly, creditors of PPL may not satisfy their debts from the assets of PPL's subsidiaries absent a specific contractual undertaking by a subsidiary to pay PPL's creditors or as required by applicable law or regulation. Similarly, PPL is not liable for the debts of its subsidiaries, nor are its subsidiaries liable for the debts of one another. Accordingly, creditors of PPL's subsidiaries may not satisfy their debts from the assets of PPL or its other subsidiaries absent a specific contractual undertaking by PPL or its other subsidiaries to pay the creditors or as required by applicable law or regulation.Similarly, the subsidiaries of PPL Electric are each separate legal entities. These subsidiaries are not liable for the debts of PPL Electric. Accordingly, creditors of PPL Electric may not satisfy its debts from the assets of its subsidiaries absent a specific contractual undertaking by a subsidiary to pay the creditors or as required by applicable law or regulation. Similarly, PPL Electric is not liable for the debts of its subsidiaries, nor are its subsidiaries liable for the debts of one another. Accordingly, creditors of these subsidiaries may not satisfy their debts from the assets of PPL Electric (or its other subsidiaries) absent a specific contractual undertaking by PPL Electric or any such other subsidiary to pay such creditors or as required by applicable law or regulation.(PPL)Equity SecuritiesShare Repurchases In August 2021, PPL's Board of Directors authorized share repurchases of up to $3 billion of PPL common shares. In 2021, PPL repurchased approximately $1 billion of PPL common shares. There were no share repurchases during the year ended December 31, 2022. Any additional amounts to be repurchased pursuant to this authority will depend on various factors, including PPL’s share price and market conditions. PPL may purchase shares on each trading day subject to market conditions and principles of best execution.140Table of ContentsDistributions and Related RestrictionsIn November 2022, PPL declared its quarterly common stock dividend, payable January 3, 2023, at 22.50 cents per share (equivalent to 0.90 cents per annum). On February 17, 2023, PPL announced a quarterly common stock dividend of 24.00 cents per share, payable April 3, 2023, to shareowners of record as of March 10, 2023. Future dividends will be declared at the discretion of the Board of Directors and will depend upon future earnings, cash flows, financial and legal requirements and other factors.Neither PPL Capital Funding nor PPL may declare or pay any cash dividend or distribution on its capital stock during any period in which PPL Capital Funding defers interest payments on its 2007 Series A Junior Subordinated Notes due 2067. At December 31, 2022, no interest payments were deferred.RIE has $3 million of certain issues of non-participating cumulative preferred stock outstanding that can be redeemed at the option of RIE. There are no mandatory redemption provisions on the cumulative preferred stock. Dividends on the cumulative preferred stock accrue quarterly and are prior to any dividends on the common stock of RIE. Pursuant to the preferred stock arrangement, as long as any preferred stock is outstanding, certain restrictions on payment of common stock dividends would come into effect if the common stock equity of RIE was, or by reason of payment of such dividends became, less than 25% of total capitalization of RIE. RIE was current on the preferred stock dividends and was in compliance with this covenant and accordingly, was not restricted as to the payment of common stock dividends under the foregoing provisions as of December 31, 2022.(All Registrants)PPL relies on dividends or loans from its subsidiaries to fund PPL's dividends to its common shareholders. The net assets of certain PPL subsidiaries are subject to legal restrictions. LG&E, KU and PPL Electric are subject to Section 305(a) of the Federal Power Act, which makes it unlawful for a public utility to make or pay a dividend from any funds "properly included in capital account." The meaning of this limitation has never been clarified under the Federal Power Act. LG&E, KU and PPL Electric believe, however, that this statutory restriction, as applied to their circumstances, would not be construed or applied by the FERC to prohibit the payment from retained earnings of dividends that are not excessive and are for lawful and legitimate business purposes. In February 2012, LG&E and KU petitioned the FERC requesting authorization to pay dividends in the future based on retained earnings balances calculated without giving effect to the impact of purchase accounting adjustments for PPL's 2010 acquisition of LG&E and KU. In May 2012, the FERC approved the petitions with the further condition that each utility may not pay dividends if such payment would cause its adjusted equity ratio to fall below 30% of total capitalization. Accordingly, at December 31, 2022, net assets of $1.4 billion for LG&E and $1.9 billion for KU were restricted for purposes of paying dividends to LKE, and net assets of $1.8 billion for LG&E and $2.1 billion for KU were available for payment of dividends to LKE. LG&E and KU believe they will not be required to change their current dividend practices as a result of the foregoing requirement. In addition, under Virginia law, KU is prohibited from making loans to affiliates without the prior approval of the VSCC. There are no comparable statutes under Kentucky law applicable to LG&E and KU, or under Pennsylvania law applicable to PPL Electric. However, orders from the KPSC require LG&E and KU to obtain prior consent or approval before lending amounts to PPL. 9. Acquisitions, Development and Divestitures(PPL)AcquisitionsAcquisition of Narragansett ElectricOn May 25, 2022, PPL Rhode Island Holdings acquired 100% of the outstanding shares of common stock of Narragansett Electric from National Grid U.S., a subsidiary of National Grid plc (the Acquisition). Narragansett Electric, whose service area covers substantially all of Rhode Island, is primarily engaged in the transmission and distribution of electricity and distribution of natural gas. The Acquisition expands PPL's portfolio of regulated natural gas and electricity transmission and distribution assets, has improved PPL's credit metrics and is expected to enhance long term earnings growth. Following the closing of the Acquisition, Narragansett Electric provides services doing business under the name Rhode Island Energy (RIE).The consideration for the Acquisition consisted of approximately $3.8 billion in cash and approximately $1.5 billion of long-term debt assumed through the transaction. The fair value of the consideration paid for Narragansett Electric was as follows (in billions):141Table of ContentsAggregate enterprise consideration$5.3 Less: fair value of assumed long-term debt outstanding1.5 Total cash consideration$3.8 The $3.8 billion total cash consideration paid was funded with proceeds from PPL's 2021 sale of its U.K. utility business.In connection with the Acquisition, National Grid USA Service Company, Inc., National Grid U.S. and Narragansett Electric have entered into a transition services agreement (TSA), pursuant to which National Grid has agreed to provide certain transition services to Narragansett Electric to facilitate the transition of the operation of Narragansett Electric to PPL following the Acquisition, as agreed upon in the Narragansett SPA. The TSA is for an initial two-year term and is subject to extension as necessary to complete the successful transition. TSA costs of $123 million were incurred for the twelve month period ended December 31, 2022.Acquisition ApprovalThe Acquisition required certain approvals or waivers, including, among others, approval of National Grid USA's shareholders, authorizations or waivers from the Rhode Island Division of Public Utilities and Carriers, the Massachusetts Department of Public Utilities, the Federal Communications Commission (FCC), and the FERC, as well as review under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. All such approvals were received prior to closing of the Acquisition.Commitments to the Rhode Island Division of Public Utilities and Carriers and the Attorney General of the State of Rhode IslandAs a condition to the Acquisition, PPL made certain commitments to the Rhode Island Division of Public Utilities and Carriers and the Attorney General of the State of Rhode Island. As a result:•RIE provided a credit to all its electric and natural gas distribution customers in the total amount of $50 million ($40 million net of tax benefit). Based on the relative number of electric distribution customers and natural gas distribution customers as of November 1, 2022, RIE refunded, in the form of a bill credit, $33 million to electric customers and $17 million to natural gas customers of amounts collected from customers since the Acquisition date. Each electric customer received the same credit, and each natural gas customer received the same credit. A reduction of revenue and a regulatory liability of $50 million for the amounts refunded were recorded during the quarter ended September 30, 2022. These credits were issued during the fourth quarter of 2022. The amounts refunded will not impact RIE's earnings sharing regulatory mechanism.•RIE forgave approximately $44 million ($21 million net of allowance for doubtful accounts) in arrearages for low-income and protected residential customers, which represents 100% of the arrearages over 90 days for those customers as of March 31, 2022. PPL deemed these accounts uncollectible and fully reserved for them as of September 30, 2022, resulting in an increase to "Other operations and maintenance expense" on the Statement of Income of $23 million for the year ended December 31, 2022.•RIE will not file a base rate case seeking an increase in base distribution rates for natural gas and/or electric service sooner than three years from the Acquisition date, and RIE will not submit a request for a change in base rates unless and until there is at least twelve months of operating experience under PPL's exclusive leadership and after the TSA with National Grid terminates.•RIE will forgo potential recovery of any and all transition costs which PPL estimates will be approximately $408 million through June 30, 2024, and includes (1) the installation of certain information technology systems; (2) modification and enhancements to physical facilities in Rhode Island; and (3) incurring costs related to severance payments, communications and branding changes, and other transition related costs. These costs, which are being expensed as incurred, were $181 million for the year ended December 31, 2022.•RIE will not seek to recover any transaction costs related to the Acquisition, which were $27 million through December 31, 2022, including $18 million for the year ended December 31, 2022 recorded in "Other operations and maintenance" on the Statement of Income.•RIE will not seek to recover in rates any markup charged by National Grid U.S. and/or its affiliates under the TSA. These amounts were $3 million as of December 31, 2022.•In June 2022, RIE expensed $20 million of regulatory assets as of the Acquisition date for the Gas Business Enablement (GBE) project and for certain Cybersecurity/IT investments related to GBE. The expense was recorded to "Other operations and maintenance" on the Statements of Income for the year ended December 31, 2022. RIE will not seek to recover these regulatory assets from customers in any future proceedings.•RIE will exclude all goodwill from the ratemaking capital structure.142Table of Contents•RIE will hold harmless Rhode Island customers from any changes to Accumulated Deferred Income Taxes (ADIT) as a result of the Acquisition. RIE reserves the right to seek rate adjustments based on future changes to ADIT that are not related to the Acquisition.•RIE will not increase its revenue requirement to a level higher than what would exist in the absence of the Acquisition as a result of any restatement of pension and other post-retirement benefits plan assets and liabilities to fair value after the close of the Acquisition.•Rhode Island Holdings contributed $2.5 million to the Rhode Island Commerce Corporation's Renewable Energy Fund and will not use any of the $2.5 million to meet its pre-existing renewable energy credit goals in Rhode Island or any other state. This contribution was made during the year ended December 31, 2022 and was recorded in "Other Income (Expense)" on the Statement of Income.•RIE will make available up to $2.5 million for the Rhode Island Attorney General to utilize as needed in evaluating PPL's report on RIE's specific decarbonization goals to support Rhode Island's 2021 Act on Climate or to assess the future of the gas distribution business in Rhode Island. This amount was accrued during the year ended December 31, 2022 and was recorded in "Other Income (Expense) - net" on the Statement of Income.•Various other operational and reporting commitments have been established.Purchase Price Allocation The operations of Narragansett Electric are subject to the accounting for certain types of regulation as prescribed by GAAP. The carrying value of Narragansett Electric’s assets and liabilities subject to rate-setting and cost recovery provisions provide revenues derived from costs, including a return on investment of net assets and liabilities included in rate base. As such, the fair values of these assets and liabilities equal their carrying values. Accordingly, neither the assets acquired or liabilities assumed, nor the unaudited pro forma financial information presented below, reflect any adjustments related to these amounts. As of December 31, 2022, the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed was $1,586 million, which has been recorded as goodwill. PPL has elected to not reflect the effects of purchase accounting in the separate financial statements of RIE or PPL's Rhode Island Regulated segment. Accordingly, the Rhode Island Regulated segment includes $725 million of acquired legacy goodwill. The remaining excess purchase price of $861 million is included in PPL's Corporate and Other category for segment reporting purposes. The goodwill reflects the value paid for the expected continued growth of a rate-regulated business located in a defined service area with a constructive regulatory environment, the ability of PPL to leverage its assembled workforce to take advantage of those growth opportunities and the attractiveness of stable, growing cash flows. The tax goodwill is deductible for income tax purposes over a 15 year period, and as such, deferred taxes will be recorded as the tax deductions are taken.The table below shows the preliminary allocation of the purchase price to the assets acquired and liabilities assumed that were recorded in PPL’s Consolidated Balance Sheet as of the Acquisition date. The allocation is subject to change during the one-year measurement period as additional information is obtained about the facts and circumstances that existed at closing. As a result, the amount of goodwill included below may change by a material amount as PPL finalizes the allocation of the purchase price. Adjustments to certain assets acquired and liabilities assumed resulted in an increase in goodwill of $5 million since the initial purchase price allocation as of the Acquisition date.Purchase Price Allocation as of December 31, 2022AssetsCurrent AssetsCash and Cash Equivalents$154 Accounts Receivable (a)195 Unbilled Revenues54 Price Risk Management Assets99 Regulatory Assets75 Other Current Assets65 Total Current Assets642 143Table of ContentsPurchase Price Allocation as of December 31, 2022Noncurrent AssetsProperty, Plant and Equipment, net3,988 Regulatory Assets395 Goodwill1,586 Other Noncurrent Assets166 Total Noncurrent Assets6,135 Total Assets$6,777 LiabilitiesCurrent LiabilitiesLong-Term Debt Due Within One Year$14 Accounts Payable180 Taxes Accrued44 Regulatory Liabilities239 Other Current Liabilities198 Total Current Liabilities675 Noncurrent LiabilitiesLong-Term Debt1,496 Regulatory Liabilities643 Other Deferred Credits and Noncurrent Liabilities143 Noncurrent Liabilities2,282 Total Purchase Price (Balance Sheet Net Assets)$3,820 (a)Amounts represent fair value as of May 25, 2022. The gross contractual amount is $255 million. Cash flows not expected to be collected as of May 25, 2022 were $60 million.Pro Forma Financial InformationThe actual RIE Operating Revenues and Net income attributable to PPL included in PPL's Statement of Income for the period ended December 31, 2022, and PPL's unaudited pro forma 2022 and 2021 Operating Revenues and Net Income (Loss) attributable to PPL, including RIE, as if the Acquisition had occurred on January 1, 2021 are as follows.Operating RevenuesNet Income (Loss) Actual RIE results included from May 25, 2022 - December 31, 2022 (a)$1,038 $(44)PPL Pro Forma for the year ended 20228,667 790 PPL Pro Forma for the year ended 20217,478 159 (a)Net Income (Loss) includes expenses of $98 million (pre-tax) related to commitments made as a condition of the Acquisition.The pro forma financial information presented above has been derived from the historical consolidated financial statements of PPL and Narragansett Electric. Non-recurring items included in the 2022 pro forma financial information include: (a) $18 million (pre-tax) of transaction costs related to the Acquisition, primarily for advisory, accounting and legal fees incurred, (b) $223 million (pre-tax) of Acquisition integration costs, (c) a $50 million reduction of revenue (pre-tax), write-offs of $43 million (pre-tax) of certain accounts receivable and regulatory assets of RIE and $5 million (pre-tax) of expenses accrued in support of Rhode Island's decarbonization goals, all of which were conditions of the Acquisition, and (d) the income tax effect of these items, which was tax effected at the statutory federal income tax rate of 21%.Non-recurring items included in the 2021 pro forma financial information include: (a) $38 million (pre-tax) of Acquisition integration costs and (b) the income tax effect of this item, which was tax effected at the statutory federal income tax rate of 144Table of Contents21%. Losses from the discontinued operations (net of income taxes) of PPL of $1,498 million in 2021 were excluded from the pro forma amount above.DivestituresSale of Safari HoldingsOn September 29, 2022, PPL signed a definitive agreement to sell all of Safari Holdings membership interests to Aspen Power Services, LLC (Aspen Power). On November 1, 2022, PPL completed the sale (the Transaction).A loss on sale of $60 million ($46 million net of tax benefit) was recorded in "Other operation and maintenance" on the Statement of Income for the year ended December 31, 2022. As a result of the Transaction, $53 million of goodwill previously presented in the Corporate and Other category for segment reporting purposes was written-off.The accounting for the closing of the Transaction was substantially completed in the fourth quarter of 2022. Final closing adjustments are expected to be completed in the first quarter of 2023.In connection with the closing of the Transaction, PPL provided certain guarantees and other assurances. See Note 14 to the Financial Statements for additional information.Discontinued OperationsSale of the U.K. Utility BusinessOn June 14, 2021, PPL WPD Limited completed the sale of PPL's utility business to National Grid Holdings One plc (National Grid U.K.), a subsidiary of National Grid plc. The transaction resulted in cash proceeds of $10.7 billion inclusive of foreign currency hedges executed by PPL. PPL received net proceeds, after taxes and fees, of $10.4 billion. PPL WPD Limited agreed to indemnify National Grid U.K. for certain tax related matters. See Note 14 for additional information. PPL has not had and will not have any significant involvement with the U.K. utility business since completion of the sale.Summarized Results of Discontinued OperationsThe operations of the U.K. utility business are included in "Income (Loss) from Discontinued Operations (net of income taxes)" on the Statements of Income. Following are the components of discontinued operations in the Statements of Income for the years ended December 31:202220212020Operating Revenues$— $1,344 $2,133 Operating Expenses— 467 916 Other Income (Expense) - net— 202 167 Interest Expense (a)— 209 367 Income before income taxes— 870 1,017 Loss on sale— (1,609)— Income tax (benefit) expense(42)759 188 Income (Loss) from Discontinued Operations (net of income taxes)$42 $(1,498)$829 (a)No interest from corporate level debt was allocated to discontinued operations.10. Leases(All Registrants)LG&E and KU have entered into various operating leases primarily for office space, vehicles and railcars. The leases generally have fixed payments with expiration dates ranging from 2023 to 2040, some of which have options to extend the leases from one year to ten years and some have options to terminate at LG&E's and KU's discretion.PPL has also entered into various operating leases primarily for office and warehouse space. These leases generally have fixed payments with expiration dates ranging from 2024 through 2030. RIE has various operating leases, primarily related to a transmission line, buildings, land, and fleet vehicles used to support the electric and gas operations, with lease terms ranging between 1 and 50 years. In measuring lease liabilities, the Company excludes variable lease payments, other than those that 145Table of Contentsdepend on an index or rate, or are in substance fixed payments, and includes lease payments made at or before the commencement date. The variable lease payments were not material for the year ended December 31, 2022.PPL Electric also has operating leases which do not have a significant impact to its operations.(PPL, LG&E and KU)Lessee TransactionsThe following table provides the components of lease cost for the Registrants' operating leases for the years ended December 31: 202220212020PPLLease cost: Operating lease cost$20 $24 $28 Short-term lease cost6 6 7 Total lease cost$26 $30 $35 LG&ELease cost:Operating lease cost$6 $6 $8 Short-term lease cost1 1 1 Total lease cost$7 $7 $9 KULease cost:Operating lease cost$9 $10 $13 Short-term lease cost2 1 1 Total lease cost$11 $11 $14 The following table provides other key information related to the Registrants' operating leases at December 31: 202220212020PPLCash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$26 $23 $24 Right-of-use asset obtained in exchange for new operating lease liabilities15 12 17 LG&ECash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$8 $6 $7 Right-of-use asset obtained in exchange for new operating lease liabilities4 4 6 KUCash paid for amounts included in the measurement of lease liabilities:Operating cash flows from operating leases$12 $10 $11 Right-of-use asset obtained in exchange for new operating lease liabilities5 7 9 The following table provides the total future minimum rental payments for operating leases, as well as a reconciliation of these undiscounted cash flows to the lease liabilities recognized on the Balance Sheets as of December 31, 2022. 146Table of ContentsPPLLG&EKU2023$24$6$920241757202512342026511202741—Thereafter7——Total$69$16$21Weighted-average discount rate 3.1%3.17%3.4%Weighted-average remaining lease term (in years) 433Current lease liabilities (a)$22$6$8Non-current lease liabilities (a)42912Right-of-use assets (b)601319(a) Current lease liabilities are included in "Other Current Liabilities" on the Balance Sheets. Non-current lease liabilities are included in "Other deferred credits and noncurrent liabilities" on the Balance Sheets. The difference between the total future minimum lease payments and the recorded lease liabilities is due to the impact of discounting.(b) Right-of-use assets are included in "Other noncurrent assets" on the Balance Sheets.Lessor TransactionsThird parties leased land from LG&E and KU at certain generation plants to produce refined coal used to generate electricity. The leases were operating leases and expired in 2021. Payments were allocated among lease and non-lease components as stated in the agreements. Lease payments were fixed or determined based on the amount of refined coal used in electricity generation at the facility. Payments received were primarily recorded as a regulatory liability and amortized in accordance with regulatory approvals. There are certain leases in which RIE is the lessor. Revenue under such leases was immaterial for the year ended December 31, 2022.The following table shows the lease income recognized for the years ended December 31: 202220212020PPL$6 11 16 LG&E2 5 6 KU— 5 9 11. Stock-Based Compensation(PPL and PPL Electric)Under the SIP and the ICPKE (together, the Plans), restricted shares of PPL common stock, restricted stock units, performance units and stock options may be granted to officers and other key employees of PPL, PPL Electric and other affiliated companies. Awards under the Plans are made by the Compensation Committee of the PPL Board of Directors, in the case of the SIP, and by the PPL Corporate Leadership Council (CLC), in the case of the ICPKE. The following table details the award limits under each of the Plans.Total PlanAnnual Grant LimitTotal As % ofOutstandingAnnual GrantAnnual Grant LimitFor Individual Participants -Performance Based AwardsAwardLimitPPL Common StockOn First Day ofLimitOptionsFor awardsdenominated inFor awardsdenominated inPlan(Shares)Each Calendar Year(Shares)shares (Shares)cash (in dollars)SIP15,000,000 2,000,000 750,000 $15,000,000 ICPKE14,199,796 2 %3,000,000 Any portion of these awards that has not been granted may be carried over and used in any subsequent year. If any award lapses, the rights of the participant terminate, or, with respect to certain awards, is forfeited, and the shares of PPL common stock underlying such an award are again available for grant. Shares delivered under the Plans may be in the form of authorized 147Table of Contentsand unissued PPL common stock, common stock held in treasury by PPL or PPL common stock purchased on the open market (including private purchases) in accordance with applicable securities laws.Restricted Stock UnitsRestricted stock units represent the right to receive shares of PPL common stock in the future, generally three years after the date of grant, in an amount based on the fair value of PPL common stock on the date of grant. Under the SIP, each restricted stock unit entitles the grant recipient to accrue additional restricted stock units equal to the amount of quarterly dividends paid on PPL stock. These additional restricted stock units are deferred and payable in shares of PPL common stock at the end of the restriction period. Dividend equivalents on restricted stock unit awards granted under the ICPKE are currently paid in cash when dividends are declared by PPL.The fair value of restricted stock units granted is recognized on a straight-line basis over the restriction period or through the date at which the employee reaches retirement eligibility. The fair value of restricted stock units granted to retirement-eligible employees is recognized as compensation expense immediately upon the date of grant. Recipients of restricted stock units granted under the ICPKE may also be granted the right to receive dividend equivalents through the end of the restriction period or until the award is forfeited. Restricted stock units are subject to forfeiture or accelerated payout under the plan provisions for termination, retirement, disability and death of employees. Restrictions lapse on restricted stock units fully, in certain situations, as defined by each of the Plans.The weighted-average grant date fair value of restricted stock units granted was: 202220212020PPL$27.52 $28.00 $35.30 PPL Electric26.66 27.96 35.37 Restricted stock unit activity for 2022 was:RestrictedShares/UnitsWeighted-AverageGrant Date FairValue Per SharePPL Nonvested, beginning of period1,004,583 $31.19 Granted620,708 27.52 Vested(427,095)31.55 Forfeited(15,779)29.61 Nonvested, end of period1,182,417 29.16 PPL Electric Nonvested, beginning of period131,287 $31.50 Transfer between registrants(30,353)30.03 Granted51,832 26.66 Vested(41,233)32.19 Forfeited(1,747)32.19 Nonvested, end of period109,786 28.91 Substantially all restricted stock unit awards are expected to vest.The total fair value of restricted stock units vesting for the years ended December 31 was: 202220212020PPL$12 $8 $19 PPL Electric1 1 3 148Table of ContentsPerformance Units - Total Shareowner ReturnPerformance units based on relative Total Shareowner Return (TSR) are intended to encourage and reward future corporate performance. Performance units represent a target number of shares (Target Award) of PPL's common stock that the recipient would receive upon PPL's attainment of the applicable performance goal. Performance is determined based on TSR during a three-year performance period. At the end of the period, payout is determined by comparing PPL's performance to the TSR of the companies included in the PHLX Utility Sector Index. Awards are payable on a graduated basis based on thresholds that measure PPL's performance relative to peers that comprise the applicable index on which each year's awards are measured. Awards can be paid up to 200% of the Target Award or forfeited with no payout if performance is below a minimum established performance threshold. Dividends payable during the performance cycle accumulate and are converted into additional performance units and are payable in shares of PPL common stock upon completion of the performance period based on the Compensation Committee's determination of achievement of the performance goals. Under the plan provisions, TSR performance units are subject to forfeiture upon termination of employment other than retirement, one year or more from commencement of the performance period, disability or death of an employee. The fair value of TSR performance units granted to retirement-eligible employees is recognized as compensation expense on a straight-line basis over a one-year period, the minimum vesting period required for an employee to be entitled to payout of the awards with no proration. For employees who are not retirement-eligible, compensation expense is recognized over the shorter of the three-year performance period or the period until the employee is retirement-eligible, with a minimum vesting and recognition period of one-year. If an employee retires before the one-year vesting period, the performance units are forfeited. Performance units vest on a pro rata basis, in certain situations, as defined by each of the Plans.The fair value of each performance unit granted was estimated using a Monte Carlo pricing model that considers stock beta, a risk-free interest rate, expected stock volatility and expected life. The stock beta was calculated comparing the risk of the individual securities to the average risk of the companies in the index group. The risk-free interest rate reflects the yield on a U.S. Treasury bond commensurate with the expected life of the performance unit. Volatility over the expected term of the performance unit is calculated using daily stock price observations for PPL and all companies in the index group and is evaluated with consideration given to prior periods that may need to be excluded based on events not likely to recur that had impacted PPL and the companies in the index group. PPL uses a mix of historic and implied volatility to value awards.The weighted-average assumptions used in the model were: 202220212020Expected stock volatility22.79%27.81%15.64%Expected life3 years3 years3 yearsThe weighted-average grant date fair value of TSR performance units granted was: 202220212020PPL$34.27 $32.44 $37.63 PPL Electric34.42 32.92 38.64 TSR performance unit activity for 2022 was:TSR Performance UnitsWeighted-Average GrantDate Fair ValuePer SharePPL Nonvested, beginning of period633,773 $34.68 Granted298,795 34.27 Forfeited (a)(245,861)35.48 Nonvested, end of period686,707 34.21 149Table of ContentsTSR Performance UnitsWeighted-Average GrantDate Fair ValuePer SharePPL Electric Nonvested, beginning of period15,354 $34.36 Granted14,238 34.42 Forfeited (a)(3,113)35.58 Nonvested, end of period26,479 34.25 (a)Primarily related to the forfeiture of 2019 domestic performance units as performance during the period was below the minimum established performance threshold, which resulted in no payout. For the year ended December 31, 2021, $2 million of TSR performance units vested. All awards vested were associated with the sale of the U.K. utility business. See Note 9 for additional information on the sale of the U.K. utility business. No TSR performance units vested for the years ended December 31, 2022 and 2020. Amounts for PPL Electric are insignificant.Performance Units - Return on EquityIn 2017, PPL changed its executive compensation mix to add performance units based on achievement of a corporate Return on Equity (ROE). ROE performance units were intended to further align compensation with the company’s strategy and reward for future corporate performance. The Compensation Committee, eliminated the use of ROE performance units due to changes in its long-term incentive mix beginning in January 2022.Payout of these performance units will be based on the calculated average of the annual corporate ROE for each year of the three-year performance period for PPL Corporation. In light of the transformational nature of the sale of the U.K. utility business in 2021, PPL’s ROE-based performance units issued for 2021 were based on a one-year performance period from January 1, 2021 to December 31, 2021; however, these units retained the three year vesting schedule and other characteristics. ROE performance units represent a target number of shares (Target Award) of PPL's common stock that the recipient would receive upon PPL's attainment of the applicable ROE performance goal. ROE performance units can be paid up to 200% of the Target Award or forfeited with no payout if performance is below a minimum established performance threshold. Dividends payable during the performance cycle accumulate and are converted into additional performance units and are payable in shares of PPL common stock upon completion of the performance period based on the Compensation Committee's determination of achievement of the performance goals. Under the plan provisions, these performance units are subject to forfeiture upon termination of employment other than retirement, disability or death of an employee.The fair value of each ROE performance unit is based on the closing price of PPL Common Stock on the date of grant. The fair value of ROE performance units is recognized on a straight-line basis over the service period or through the date at which the employee reaches retirement eligibility. The fair value awards granted to retirement-eligible employees is recognized as compensation expense immediately upon the date of grant. As these awards are based on performance conditions, the level of attainment is monitored each reporting period and compensation expense is adjusted based on the expected attainment level.The weighted-average grant date fair value of ROE performance units granted was: 202220212020PPL$30.81 $30.08 $34.95 PPL Electric30.70 29.39 35.59 150Table of ContentsROE performance unit activity for 2022 was: ROE Performance UnitWeighted-Average GrantDate Fair ValuePer SharePPL Nonvested, beginning of period722,353 $31.28 Granted (a)257,199 30.81 Vested(470,182)30.76 Nonvested, end of period 509,370 31.53 PPL Electric Nonvested, beginning of period15,354 $30.27 Granted (a)3,663 30.70 Vested(6,311)30.78 Nonvested, end of period12,706 30.14 (a)Represents attainment updates to the 2019 awards that paid out at 200% of target, as well as dividend equivalents that accumulated on outstanding 2020 and 2021 awards. The total fair value of ROE performance units vesting for the years ended December 31 was: 202220212020PPL$12 $16 $8 PPL Electric— — 1 Performance Units - Earnings Growth Beginning in 2022, PPL changed its executive compensation mix to add performance units based on achievement of corporate earnings growth (EG) metrics. EG performance units are intended to further align executive compensation with the company’s future strategy.Payout of these performance units will be based on the earnings growth above the projected midpoint of ongoing earnings for the three-year performance period for PPL Corporation. EG performance units represent a target number of shares (Target Award) of PPL's common stock that the recipient would receive upon PPL's attainment of the applicable EG performance goal. EG performance units can be paid up to 200% of the Target Award or forfeited with no payout if performance is below a minimum established performance threshold. Dividends payable during the performance cycle accumulate and are converted into additional performance units and are payable in shares of PPL common stock upon completion of the performance period based on the Compensation Committee's determination of achievement of the performance goals. Under the plan provisions, these performance units are subject to forfeiture upon termination of employment other than retirement, disability or death of an employee.The fair value of each EG performance unit is based on the closing price of PPL Common Stock on the date of grant. The fair value of EG performance units is recognized on a straight-line basis over the service period or through the date at which the employee reaches retirement eligibility. The fair value awards granted to retirement-eligible employees is recognized as compensation expense immediately upon the date of grant. As these awards are based on performance conditions, the level of attainment is monitored each reporting period and compensation expense is adjusted based on the expected attainment level.The weighted-average grant date fair value of EG performance units granted was: 2022PPL$29.29 PPL Electric29.35 151Table of ContentsEG performance unit activity for 2022 was: EG Performance UnitWeighted-Average GrantDate Fair ValuePer SharePPL Nonvested, beginning of period— $— Granted141,880 29.29 Nonvested, end of period 141,880 29.29 PPL Electric Nonvested, beginning of period— $— Granted6,888 29.35 Nonvested, end of period6,888 29.35 Performance Units - Environmental, Social and Governance Beginning in 2022, PPL changed its executive compensation mix to add performance units based on environmental, social and governance (ESG) metrics. ESG performance units are tied to climate-related performance and intended to further align executive compensation with the company’s future strategy.Payout of these performance units will be based on the attainment of reductions in company vehicle emissions and building energy use, as well as the retirement of Mill Creek Unit 1, a coal-fired generating facility in Kentucky. ESG performance units can be paid up to 200% of the Target Award or forfeited with no payout if performance is below a minimum established performance threshold. Dividends payable during the performance cycle accumulate and are converted into additional performance units and are payable in shares of PPL common stock upon completion of the performance period based on the Compensation Committee's determination of achievement of the performance goals. Under the plan provisions, these performance units are subject to forfeiture upon termination of employment other than retirement, disability or death of an employee.The fair value of each ESG performance unit is based on the closing price of PPL Common Stock on the date of grant. The fair value of ESG performance units is recognized on a straight-line basis over the service period or through the date at which the employee reaches retirement eligibility. The fair value awards granted to retirement-eligible employees is recognized as compensation expense immediately upon the date of grant. As these awards are based on performance conditions, the level of attainment is monitored each reporting period and compensation expense is adjusted based on the expected attainment level.The weighted-average grant date fair value of ESG performance units granted was: 2022PPL$29.29 PPL Electric29.35 152Table of ContentsESG performance unit activity for 2022 was: ESG Performance UnitWeighted-Average GrantDate Fair ValuePer SharePPL Nonvested, beginning of period— $— Granted141,880 29.29 Nonvested, end of period 141,880 29.29 PPL Electric Nonvested, beginning of period— $— Granted6,888 29.35 Nonvested, end of period6,888 29.35 Stock OptionsPPL's Compensation, Governance and Nominating Committee, now known as the Compensation Committee, eliminated the use of stock options due to changes in its long-term incentive mix beginning in January 2014.Under the Plans, stock options had been granted with an option exercise price per share not less than the fair value of PPL's common stock on the date of grant. Options outstanding at December 31, 2022, are fully vested. All options expire no later than 10 years from the grant date. The options become exercisable immediately in certain situations, as defined by each of the Plans. Stock option activity for 2022 was:Numberof OptionsWeightedAverageExercisePrice Per ShareWeighted-AverageRemainingContractualTerm (years)AggregateTotal IntrinsicValuePPL Outstanding at beginning of period766,002 $26.57 Exercised(594,450)26.44 Outstanding and exercisable at end of period171,552 27.04 0.1$— For 2022, 2021 and 2020, PPL received $18 million, $10 million and $8 million in cash from stock options exercised. The total intrinsic value of stock options exercised was insignificant in each of those years. The related income tax benefits realized were not significant.Compensation ExpenseCompensation expense for restricted stock, restricted stock units, performance units and stock options accounted for as equity awards was: 202220212020PPL$36 $34 $28 PPL Electric2 11 10 The income tax benefit related to above compensation expense was as follows: 202220212020PPL$10 $10 $8 PPL Electric1 3 3 At December 31, 2022, unrecognized compensation expense related to nonvested stock awards was:153Table of ContentsUnrecognizedCompensationExpenseWeighted-AveragePeriod forRecognitionPPL$23 1.8PPL Electric2 1.812. Retirement and Postemployment Benefits (All Registrants) Defined Benefits Certain employees of PPL's subsidiaries are eligible for pension benefits under non-contributory defined benefit pension plans with benefits based on length of service and final average pay, as defined by the plans. Effective January 1, 2012, PPL's primary defined benefit pension plan was closed to all newly hired salaried employees. Effective July 1, 2014, PPL's primary defined benefit pension plan was closed to all newly hired bargaining unit employees. Newly hired employees are eligible to participate in the PPL Retirement Savings Plan, a 401(k) savings plan with enhanced employer contributions.The defined benefit pension plans of LKE and its subsidiaries were closed to new salaried and bargaining unit employees hired after December 31, 2005. Employees hired after December 31, 2005 receive additional company contributions above the standard matching contributions to their savings plans. The pension plans sponsored by LKE and LG&E were merged effective January 1, 2020 into the LG&E and KU Pension Plan. The merged plan is sponsored by LKE. LG&E and KU participate in this plan.The Rhode Island defined benefit plans provide most union employees, as well as non-union employees hired before January 1, 2011, with a retirement benefit. Supplemental non-qualified, non-contributory executive retirement programs provide additional defined pension benefits for certain executives. PPL and certain of its subsidiaries also provide supplemental retirement benefits to executives and other key management employees through unfunded nonqualified retirement plans. Certain employees of PPL's subsidiaries are eligible for certain health care and life insurance benefits upon retirement through contributory plans. Effective January 1, 2014, the PPL Postretirement Medical Plan was closed to all newly hired salaried employees. Effective July 1, 2014, the PPL Postretirement Medical Plan was closed to all newly hired bargaining unit employees. Postretirement health benefits may be paid from 401(h) accounts established as part of the PPL Retirement Plan and the LG&E and KU Pension Plan within the PPL Services Corporation Master Trust, funded VEBA trusts and company funds. The Rhode Island postretirement benefit plans provide health care and life insurance coverage to eligible retired employees. Eligibility is based on age and length of service requirements and, in most cases, retirees must contribute to the cost of their coverage. 154Table of Contents(PPL) The following table provides the components of net periodic defined benefit costs (credits) for PPL's pension and other postretirement benefit plans for the years ended December 31. Pension BenefitsOther Postretirement Benefits 202220212020202220212020Net periodic defined benefit costs (credits): Service cost$51 $56 $56 $7 $6 $6 Interest cost144 121 146 20 16 19 Expected return on plan assets(276)(255)(246)(28)(23)(21)Amortization of: Prior service cost (credit)8 8 9 1 1 1 Actuarial (gain) loss51 93 89 (5)(1)— Net periodic defined benefit costs (credits) prior to settlements and termination benefits(22)23 54 (5)(1)5 Settlements (a)23 18 23 — — — Net periodic defined benefit costs (credits) $1 $41 $77 $(5)$(1)$5 Other Changes in Plan Assets and Benefit Obligations Recognized in OCI and Regulatory Assets/Liabilities - Gross:Net (loss)/gain allocated at acquisition$33 $— $— $(49)$— $— Settlement(23)(18)(23)— — — Net (gain) loss242 42 (221)— (53)(6)Prior service cost (credit)— 3 1 — — 5 Amortization of: Prior service (cost) credit(8)(8)(9)(1)(1)(1)Actuarial gain (loss)(51)(93)(89)5 1 — Total recognized in OCI and regulatory assets/liabilities193 (74)(341)(45)(53)(2)Total recognized in net periodic defined benefit costs, OCI and regulatory assets/liabilities$194 $(33)$(264)$(50)$(54)$3 (a)Settlement charges incurred as a result of the amount of lump sum payment distributions, primarily from the LKE qualified pension plan. In accordance with existing regulatory accounting treatment, LG&E and KU have primarily maintained the settlement charge in regulatory assets to be amortized in accordance with existing regulatory practice. The portion of the settlement attributed to LKE's operations outside of the jurisdiction of the KPSC has been charged to expense.For PPL's pension and postretirement benefits, the amounts recognized in OCI and regulatory assets/liabilities for the years ended December 31 were as follows: Pension BenefitsOther Postretirement Benefits 202220212020202220212020OCI$142 $(70)$(428)$13 $(42)$(12)Regulatory assets/liabilities51 (4)87 (58)(11)10 Total recognized in OCI andregulatory assets/liabilities$193 $(74)$(341)$(45)$(53)$(2) (PPL and LG&E) PPL and LG&E use base mortality tables issued by the Society of Actuaries for all defined benefit pension and other postretirement benefit plans. The Pri-2012 base table and the MP-2020 projection scale with varying adjustment factors based on the underlying demographic and geographic differences and experience of the plan participants was used for all periods. 155Table of ContentsThe following weighted-average assumptions were used in the valuation of the benefit obligations at December 31. Pension BenefitsOther Postretirement Benefits 2022202120222021PPL Discount rate5.80 %3.15 %5.81 %3.13 %Rate of compensation increase3.77 %3.76 %3.78 %3.77 % The following weighted-average assumptions were used to determine the net periodic defined benefit costs for the years ended December 31. Pension BenefitsOther Postretirement Benefits 202220212020202220212020PPL Discount rate 3.35 %2.92 %3.64 %3.54 %2.84 %3.60 %Rate of compensation increase3.74 %3.76 %3.79 %2.84 %3.75 %3.76 %Expected return on plan assets7.25 %7.25 %7.25 %6.52 %6.48 %6.44 % (a)The expected long-term rates of return for pension and other postretirement benefits are based on management's projections using a best-estimate of expected returns, volatilities and correlations for each asset class. Each plan's specific current and expected asset allocations are also considered in developing a reasonable return assumption.(PPL) The following table provides the assumed health care cost trend rates for the years ended December 31: 202220212020PPL Health care cost trend rate assumed for next year – obligations6.50 %6.25 %6.50 %– cost6.25 %6.50 %6.60 %Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) – obligations5.00 %5.00 %5.00 %– cost5.00 %5.00 %5.00 %Year that the rate reaches the ultimate trend rate – obligations202920272027– cost 202720272024156Table of ContentsThe funded status of PPL's plans at December 31 was as follows: Pension BenefitsOther Postretirement Benefits 2022202120222021Change in Benefit Obligation Benefit Obligation, beginning of period$3,989 $4,251 $504 $573 Service cost51 56 7 6 Interest cost144 121 20 16 Participant contributions— — 9 14 Plan amendments— 2 — — Actuarial (gain) loss(1,026)(88)(114)(50)Acquisition (a)553 — 163 — Settlements(111)(106)— — Gross benefits paid(267)(247)(55)(55)Benefit Obligation, end of period3,333 3,989 534 504 Change in Plan Assets Plan assets at fair value, beginning of period3,887 4,068 367 367 Actual return on plan assets(992)125 (86)25 Employer contributions9 47 19 18 Participant contributions— — 7 11 Acquisition (a)623 — 160 — Settlements(111)(106)— — Gross benefits paid(267)(247)(50)(54)Plan assets at fair value, end of period3,149 3,887 417 367 Funded Status, end of period$(184)$(102)$(117)$(137)Amounts recognized in the Balance Sheets consist of: Noncurrent asset$33 $91 $9 $— Current liability(10)(10)(14)(15)Noncurrent liability(207)(183)(112)(122)Net amount recognized, end of period$(184)$(102)$(117)$(137)Amounts recognized in AOCI and regulatory assets/liabilities (pre-tax) consist of: Prior service cost (credit)$14 $22 $11 $12 Net actuarial (gain) loss827 626 (95)(51)Total$841 $648 $(84)$(39)Total accumulated benefit obligationfor defined benefit pension plans$3,197 $3,786 (a)Related to the pension and other postretirement plans assumed for the employees of Rhode Island Energy. See Note 9 for additional details on the acquisition of Narragansett Electric.For PPL's pension and other postretirement benefit plans, the amounts recognized in AOCI and regulatory assets/liabilities at December 31 were as follows: Pension BenefitsOther Postretirement Benefits 2022202120222021AOCI$183 $239 $13 $(2)Regulatory assets/liabilities658 409 (97)(37)Total$841 $648 $(84)$(39) The actuarial gain for pension plans in 2022 was primarily related to a change in the discount rate used to measure the benefit obligations of those plans. The actuarial gain for pension plans in 2021 was related to a change in the discount rate used to measure the benefit obligations of those plans. 157Table of ContentsThe following tables provide information on pension plans where the projected benefit obligation (PBO) or accumulated benefit obligation (ABO) exceed the fair value of plan assets: PBO in excess of plan assets 20222021Projected benefit obligation$2,818 $193 Fair value of plan assets2,601 — ABO in excess of plan assets 20222021Accumulated benefit obligation$1,720 $177 Fair value of plan assets1,581 — (PPL Electric) Although PPL Electric does not directly sponsor any defined benefit plans, it is allocated a portion of the funded status and costs of plans sponsored by PPL Services based on its participation in those plans, which management believes are reasonable. The actuarially determined obligations of current active employees and retirees are used as a basis to allocate total plan activity, including active and retiree costs and obligations. Allocations to PPL Electric resulted in assets/(liabilities) at December 31 as follows: 20222021Pension$(34)$42 Other postretirement benefits(60)(78) (LG&E)Although LG&E does not directly sponsor any defined benefit plans, it is allocated a portion of the funded status and costs of plans sponsored by LKE. LG&E is also allocated costs of defined benefits plans from LKS for defined benefit plans sponsored by LKE. See Note 15 for additional information on costs allocated to LG&E from LKS. These allocations are based on LG&E's participation in those plans, which management believes are reasonable. The actuarially determined obligations of current active employees and retired employees of LG&E are used as a basis to allocate total plan activity, including active and retiree costs and obligations. Allocations to LG&E resulted in assets/(liabilities) at December 31 as follows:20222021Pension$41 $85 Other postretirement benefits(41)(51)(KU) Although KU does not directly sponsor any defined benefit plans, it is allocated a portion of the funded status and costs of plans sponsored by LKE. KU is also allocated costs of defined benefit plans from LKS for defined benefit plans sponsored by LKE. See Note 15 for additional information on costs allocated to KU from LKS. These allocations are based on KU's participation in those plans, which management believes are reasonable. The actuarially determined obligations of current active employees and retired employees of KU are used as a basis to allocate total plan activity, including active and retiree costs and obligations. Allocations to KU resulted in assets/(liabilities) at December 31 as follows. 20222021Pension$44 $75 Other postretirement benefits(9)(6) Plan Assets - Pension Plans (PPL) PPL's primary legacy pension plan and the pension plan sponsored by LKE are invested in the PPL Services Corporation Master Trust (the Master Trust) that also includes 401(h) accounts that are restricted for certain other postretirement benefit obligations of PPL and LKE. The investment strategy for the Master Trust is to achieve a risk-adjusted return on a mix of assets that, in combination with PPL's funding policy, will ensure that sufficient assets are available to provide long-term growth and 158Table of Contentsliquidity for benefit payments, while also managing the duration of the assets to complement the duration of the liabilities. The Master Trust benefits from a wide diversification of asset types, investment fund strategies and external investment fund managers, and therefore has no significant concentration of risk. The investment policy of the Master Trust outlines investment objectives and defines the responsibilities of the EBPB, external investment managers, investment advisor and trustee and custodian. The investment policy is reviewed annually by PPL's Board of Directors. The EBPB created a risk management framework around the trust assets and pension liabilities. This framework considers the trust assets as being composed of three sub-portfolios: growth, immunizing and liquidity portfolios. The growth portfolio is comprised of investments that generate a return at a reasonable risk, including equity securities, certain debt securities and alternative investments. The immunizing portfolio consists of debt securities, generally with long durations, and derivative positions. The immunizing portfolio is designed to offset a portion of the change in the pension liabilities due to changes in interest rates. The liquidity portfolio consists primarily of cash and cash equivalents. Target allocation ranges have been developed for each portfolio based on input from external consultants with a goal of limiting funded status volatility. The EBPB monitors the investments in each portfolio and seeks to obtain a target portfolio that emphasizes reduction of risk of loss from market volatility. In pursuing that goal, the EBPB establishes revised guidelines from time to time. EBPB investment guidelines as of the end of 2022 are presented below. The asset allocation for the trust and the target allocation by portfolio at December 31 are as follows: Percentage of trust assets202220222021Target AssetAllocationGrowth Portfolio55 %55 %55 %Equity securities31 %32 % Debt securities (a)13 %13 % Alternative investments11 %10 % Immunizing Portfolio43 %43 %43 %Debt securities (a)33 %35 % Derivatives (b)10 %8 % Liquidity Portfolio2 %2 %2 %Total100 %100 %100 % (a)Includes commingled debt funds, which PPL treats as debt securities for asset allocation purposes.(b)Includes posted collateral to support derivative instruments subject to counterparty risk. 159Table of Contents(PPL) The fair value of net assets in the Master Trust by asset class and level within the fair value hierarchy was: December 31, 2022December 31, 2021 Fair Value Measurements UsingFair Value Measurements Using TotalLevel 1Level 2Level 3TotalLevel 1Level 2Level 3PPL Services Corporation Master Trust Cash and cash equivalents$306 $306 $— $— $266 $266 $— $— Equity securities: U.S. Equity34 34 — — 41 41 — — U.S. Equity fund measured at NAV (a)574 — — — 754 — — — International equity fund at NAV (a)403 — — — 511 — — — Commingled debt measured at NAV (a)526 — — — 677 — — — Debt securities: U.S. Treasury and U.S. government sponsoredagency153 153 — — 281 280 1 — Corporate834 — 818 16 1,039 — 1,019 20 Other14 — 14 — 14 — 14 — Alternative investments: Real estate measured at NAV (a)60 — — — 69 — — — Private equity measured at NAV (a)96 — — — 92 — — — Private credit partnerships measured at NAV (a)6 — — — 2 — — — Hedge funds measured at NAV (a)194 — — — 236 — — — Derivatives8 — 8 — 35 — 35 — PPL Services Corporation Master Trust assets, atfair value3,208 $493 $840 $16 4,017 $587 $1,069 $20 Receivables and payables, net (b)67 25 401(h) accounts restricted for otherpostretirement benefit obligations(126) (155) Total PPL Services Corporation Master Trustpension assets$3,149 $3,887 (a)In accordance with accounting guidance, certain investments that are measured at fair value using the net asset value per share (NAV), or its equivalent, have not been classified in the fair value hierarchy. The fair value amounts presented in the table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the statement of financial position.(b)Receivables and payables, net represents amounts for investments sold/purchased but not yet settled along with interest and dividends earned but not yet received.A reconciliation of the Master Trust assets classified as Level 3 at December 31, 2022 is as follows:CorporatedebtBalance at beginning of period$20 Actual return on plan assets: Relating to assets still held at the reporting date(2)Relating to assets sold during the period2 Purchases, sales and settlements(4)Balance at end of period$16 A reconciliation of the Master Trust assets classified as Level 3 at December 31, 2021 is as follows: CorporatedebtBalance at beginning of period$15 Purchases, sales and settlements5 Balance at end of period$20 The fair value measurements of cash and cash equivalents are based on the amounts on deposit. 160Table of ContentsThe market approach is used to measure fair value of equity securities. The fair value measurements of equity securities (excluding commingled funds), which are generally classified as Level 1, are based on quoted prices in active markets. These securities represent actively and passively managed investments that are managed against various equity indices. Investments in commingled equity and debt funds are categorized as equity securities. Investments in commingled equity funds include funds that invest in U.S. and international equity securities. Investments in commingled debt funds include funds that invest in a diversified portfolio of emerging market debt obligations, as well as funds that invest in investment grade long-duration fixed-income securities.The fair value measurements of debt securities are generally based on evaluations that reflect observable market information, such as actual trade information for identical securities or for similar securities, adjusted for observable differences. The fair value of debt securities is generally measured using a market approach, including the use of pricing models, which incorporate observable inputs. Common inputs include benchmark yields, relevant trade data, broker/dealer bid/ask prices, benchmark securities and credit valuation adjustments. When necessary, the fair value of debt securities is measured using the income approach, which incorporates similar observable inputs as well as payment data, future predicted cash flows, collateral performance and new issue data. For the Master Trust, these securities represent investments in securities issued by U.S. Treasury and U.S. government sponsored agencies; investments securitized by residential mortgages, auto loans, credit cards and other pooled loans; investments in investment grade and non-investment grade bonds issued by U.S. companies across several industries; investments in debt securities issued by foreign governments and corporations. Investments in real estate represent an investment in a partnership whose purpose is to manage investments in core U.S. real estate properties diversified geographically and across major property types (e.g., office, industrial, retail, etc.). The strategy is focused on properties with high occupancy rates with quality tenants. This results in a focus on high income and stable cash flows with appreciation being a secondary factor. Core real estate generally has a lower degree of leverage when compared with more speculative real estate investing strategies. The partnership has limitations on the amounts that may be redeemed based on available cash to fund redemptions. Additionally, the general partner may decline to accept redemptions when necessary to avoid adverse consequences for the partnership, including legal and tax implications, among others. The fair value of the investment is based upon a partnership unit value. Investments in private equity represent interests in partnerships in multiple early-stage venture capital funds and private equity fund of funds that use a number of diverse investment strategies. The partnerships have limited lives of at least 10 years, after which liquidating distributions will be received. Prior to the end of each partnership's life, the investment cannot be redeemed with the partnership; however, the interest may be sold to other parties, subject to the general partner's approval. Fair value is based on an ownership interest in partners' capital to which a proportionate share of net assets is attributed.Investments in private credit represent pools of actively managed loans that span capital structure and borrower type. Strategies carry different types and levels of risk. Returns from those strategies will vary in terms of yield, fees generated, loan loss rates and the pace of principal repayment. Investments have limited lives of approximately 2-8 years. The investment cannot be redeemed with the general partner; however, the interest may be sold to other parties, subject to the general partner’s approval. Fair value is based on an ownership interest in partners’ capital to which a proportionate share of net assets is attributed. At December 31, 2022, the Master Trust had unfunded commitments of $116 million that may be required during the lives of the partnerships.Investments in hedge funds represent investments in a fund of hedge funds. Hedge funds seek a return utilizing a number of diverse investment strategies. The strategies, when combined aim to reduce volatility and risk while attempting to deliver positive returns under most market conditions. Major investment strategies for the fund of hedge funds include long/short equity, tactical trading, event driven, and relative value. Shares may be redeemed with 45 days prior written notice. The fund is subject to short term lockups and other restrictions. The fair value for the fund has been estimated using the net asset value per share. The fair value measurements of derivative instruments utilize various inputs that include quoted prices for similar contracts or market-corroborated inputs. In certain instances, these instruments may be valued using models, including standard option valuation models and standard industry models. These securities primarily represent investments in treasury futures, total return swaps, interest rate swaps and swaptions (the option to enter into an interest rate swap), which are valued based on quoted prices, changes in the value of the underlying exposure or on the swap details, such as swap curves, notional amount, index and term of index, reset frequency, volatility and payer/receiver credit ratings.161Table of Contents Plan Assets - Other Postretirement Benefit Plans The investment strategy with respect to other postretirement benefit obligations is to fund VEBA trusts and/or 401(h) accounts with voluntary contributions and to invest in a tax efficient manner. Excluding the 401(h) accounts included in the Master Trust, other postretirement benefit plans are invested in a mix of assets for long-term growth with an objective of earning returns that provide liquidity as required for benefit payments. These plans benefit from diversification of asset types, investment fund strategies and investment fund managers and, therefore, have no significant concentration of risk. Equity securities include investments in domestic large-cap commingled funds. Ownership interests in commingled funds that invest entirely in debt securities are classified as equity securities, but treated as debt securities for asset allocation and target allocation purposes. Ownership interests in money market funds are treated as cash and cash equivalents for asset allocation and target allocation purposes. The asset allocation for the PPL VEBA trusts and the target allocation, by asset class, at December 31 are detailed below.Percentage of plan assetsTarget AssetAllocation 202220212022Asset Class Equity securities45 %45 %44 %Debt securities (a)48 %52 %50 %Cash and cash equivalents (b)7 %3 %6 %Total100 %100 %100 %(a)Includes commingled debt funds and debt securities.(b)Includes money market funds. The fair value of assets in the other postretirement benefit plans by asset class and level within the fair value hierarchy was: December 31, 2022December 31, 2021 Fair Value Measurement UsingFair Value Measurement Using TotalLevel 1Level 2Level 3TotalLevel 1Level 2Level 3Money market funds$19 $19 $— $— $6 $6 $— $— Equity securities: Large-cap equity fund measure at NAV (a)71 — — — 96 — — — Commingled debt fund measured at NAV (a)77 — — — 75 — — — Global equity exchange-traded fund61 61 — — — — — —Long-term bond exchange-traded fund65 65 — — — — — —Debt securities: Corporate bonds— — — — 38 — 38 — Total VEBA trust assets, at fair value293 $145 $— $— 215 $6 $38 $— Receivables and payables, net (b)(2) (3) 401(h) account assets126 155 Total other postretirement benefit plan assets$417 $367 (a)In accordance with accounting guidance certain investments that are measured at fair value using the net asset value per share (NAV), or its equivalent, have not been classified in the fair value hierarchy. The fair value amounts presented in the table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the statement of financial position.(b)Receivables and payables represent amounts for investments sold/purchased but not yet settled along with interest and dividends earned but not yet received.Investments in money market funds represent investments in funds that invest primarily in a diversified portfolio of investment grade money market instruments, including, but not limited to, commercial paper, notes, repurchase agreements and other evidences of indebtedness with a maturity not exceeding 13 months from the date of purchase. The primary objective of the fund is a level of current income consistent with stability of principal and liquidity. Redemptions can be made daily on this fund. Investments in large-cap equity securities represent investments in a passively managed equity index fund that invests in securities and a combination of other collective funds. Fair value measurements are not obtained from a quoted price in an active market but are based on firm quotes of net asset values per share as provided by the trustee of the fund. Redemptions can be made daily on this fund. 162Table of ContentsInvestments in commingled debt securities represent investments in a fund that invests in a diversified portfolio of investment grade long-duration fixed income securities. Redemptions can be made daily on these funds.Investments in global equity exchange-traded fund represents a passively-managed pooled investment vehicle that invests in developed market equities and is designed to track the performance of the MSCI World Index. Fair value measurements can be obtained from a quoted price on the exchange. Redemptions can be made daily on this fund.Investments in long-term bond exchange-traded fund represents a passively-managed pooled investment vehicle that is designed to track the performance of the Bloomberg U.S. Long Government/Credit Float Adjusted Index, which includes all medium and larger issues of U.S. Government, investment-grade corporate and investment-grade international dollar-denominated bonds that have maturities of greater than 10 years. Fair value measurements can be obtained from a quoted price on the exchange. Redemptions can be made daily on this fund.Investments in corporate bonds represent investment in a diversified portfolio of investment grade long-duration fixed income securities. The fair value of debt securities are generally based on evaluations that reflect observable market information, such as actual trade information for identical securities or for similar securities, adjusted for observable differences.Expected Cash Flows - Defined Benefit Plans (PPL) PPL does not plan to contribute to its pension plans in 2023, as PPL's defined benefit pension plans have the option to utilize available prior year credit balances to meet current and future contribution requirements. PPL sponsors various non-qualified supplemental pension plans for which no assets are segregated from corporate assets. PPL expects to make approximately $10 million of benefit payments under these plans in 2023. PPL is not required to make contributions to its other postretirement benefit plans but has historically funded these plans in amounts equal to the postretirement benefit costs recognized. Continuation of this past practice would cause PPL to contribute $27 million to its other postretirement benefit plans in 2023. The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid by the plans and the following federal subsidy payments are expected to be received by PPL. Other PostretirementPensionBenefitPaymentExpectedFederalSubsidy2023$282 $51 $— 2024281 50 — 2025283 49 — 2026280 48 — 2027275 48 — 2028-20321,327 225 1 Savings Plans (All Registrants) Substantially, all employees of PPL's subsidiaries are eligible to participate in deferred savings plans (401(k)s). Employer contributions to the plans were: 202220212020PPL$36 $29 $29 PPL Electric6 5 6 LG&E7 7 6 KU5 5 5 13. Jointly Owned Facilities(PPL, LG&E and KU)At December 31, 2022 and 2021, the Balance Sheets reflect the owned interests in the generating plants listed below.163Table of ContentsOwnershipInterestElectric PlantAccumulatedDepreciationConstructionWorkin ProgressPPL December 31, 2022 Trimble County Unit 175.00 %$455 $94 $1 Trimble County Unit 275.00 %1,372 276 148 December 31, 2021 Trimble County Unit 175.00 %$457 $79 $— Trimble County Unit 275.00 %1,360 247 121 LG&E December 31, 2022 E.W. Brown Units 6-738.00 %$53 $25 $— Paddy's Run Unit 13 & E.W. Brown Unit 553.00 %51 27 — Trimble County Unit 175.00 %455 94 1 Trimble County Unit 214.25 %384 66 78 Trimble County Units 5-629.00 %36 16 — Trimble County Units 7-1037.00 %81 36 — Cane Run Unit 722.00 %126 21 2 E.W. Brown Solar Unit39.00 %10 3 — Solar Share44.00 %3 — — December 31, 2021 E.W. Brown Units 6-738.00 %$53 $24 $— Paddy's Run Unit 13 & E.W. Brown Unit 553.00 %51 25 — Trimble County Unit 175.00 %457 79 — Trimble County Unit 214.25 %379 57 64 Trimble County Units 5-629.00 %36 15 — Trimble County Units 7-1037.00 %81 34 — Cane Run Unit 722.00 %125 19 — E.W. Brown Solar Unit39.00 %10 2 — Solar Share44.00 %2— — KU December 31, 2022 E.W. Brown Units 6-762.00 %$87 $42 $— Paddy's Run Unit 13 & E.W. Brown Unit 547.00 %45 23 — Trimble County Unit 260.75 %987 210 70 Trimble County Units 5-671.00 %84 38 — Trimble County Units 7-1063.00 %133 61 — Cane Run Unit 778.00 %446 77 6 E.W. Brown Solar Unit61.00 %16 5 — Solar Share56.00 %4 — — December 31, 2021 E.W. Brown Units 6-762.00 %$88 $40 $— Paddy's Run Unit 13 & E.W. Brown Unit 547.00 %45 22 — Trimble County Unit 260.75 %981 190 57 Trimble County Units 5-671.00 %84 36 — Trimble County Units 7-1063.00 %133 57 — Cane Run Unit 778.00 %444 70 — E.W. Brown Solar Unit61.00 %16 4 — Solar Share56.00 %3 — — Each subsidiary owning these interests provides its own funding for its share of the facility. Each receives a portion of the total output of the generating plants equal to its percentage ownership. The share of fuel and other operating costs associated with the plants is included in the corresponding operating expenses on the Statements of Income.164Table of Contents 14. Commitments and ContingenciesEnergy Purchase Commitments (PPL, LG&E and KU)LG&E and KU enter into purchase contracts to supply the coal and natural gas requirements for generation facilities and LG&E's retail natural gas supply operations. These contracts include the following commitments: Contract TypeMaximum MaturityDateNatural Gas Fuel2024Natural Gas Retail Supply2023Coal2027Coal Transportation and Fleeting Services2027Natural Gas Transportation2030LG&E and KU have a PPA with OVEC expiring in June 2040. See footnote (e) to the table in "Guarantees and Other Assurances" below for information on the OVEC power purchase contract. Future obligations for power purchases from OVEC are demand payments, comprised of debt-service payments and contractually-required reimbursements of plant operating, maintenance and other expenses, and are projected as follows: LG&EKUTotal2023$24 $10 $34 202422 10 32 202522 10 32 202622 10 32 202722 10 32 Thereafter184 81 265 Total$296 $131 $427 LG&E and KU had total energy purchases under the OVEC PPA for the years ended December 31 as follows:202220212020LG&E$21 $13 $12 KU9 6 6 Total$30 $19 $18 (PPL)RIE has several long-term contracts for the purchase of electric power. Substantially all of these contracts require power to be delivered before RIE is obligated to make payment. Additionally, RIE has entered various contracts for gas delivery, storage, and supply services. Certain of these contracts require payment of annual demand charges, which are recoverable from customers. RIE is liable for these payments regardless of the level of service required from third-parties.These contracts include the following commitments: Contract TypeMaximum MaturityDateElectric power2024Gas-relatedBeyond 2027165Table of ContentsRIE’s commitments under these long-term contracts subsequent to December 31, 2022 are summarized in the table below.Total20232024-20252026-2027ThereafterEnergy Purchase Obligations$995 $471 $172 $73 $279 Long-term Contracts for Renewable Energy (PPL) Several of the obligations included in the table above relate to certain long-term contracts for renewable energy, including: •the Deepwater Wind PPA, involving a proposal for a small-scale renewable energy generation project of up to eight offshore wind turbines with an aggregate nameplate capacity of up to 30 MW to benefit the Town of New Shoreham and an underwater cable to Block Island, which entered into service in October 2016;•the Three-State Procurement, involving eight long-term contracts pursuant to the Rhode Island Long-Term Contracting Standard (LTCS) of which 36.75 MW is currently operational and with respect to which RIE collects 2.75% remunerations in the annual payments pursuant to the LTCS; and •the Offshore Wind Energy Procurement, pursuant to a 20-year PPA with Deep Water Wind Rev I, LLC (Revolution Wind), with an expected capacity of 408 MW expected to be operational in 2024; this contract was approved without remuneration but allows RIE to seek costs incurred under the agreement. In addition, RIE is obligated under the LTCS (as amended in 2014) to annually solicit for renewable projects until 90 MW of renewable contracting capacity has been secured. The RIPUC-approved solicitations currently in service include: (i) a 15-year PPA with Orbit Energy Rhode Island, LLC for a 3.2 MW nameplate anaerobic digester biogas project located in Johnston, Rhode Island, placed in service in 2017, (ii) a 15-year PPA with Black Bear Development Holdings, LLC for a 3.9 MW nameplate run-of-river hydroelectric plant located in Orono, Maine, placed in service in 2013, and (iii) a 15-year PPA with Copenhagen Wind Farm, LLC for an 80 MW nameplate land-based wind project located in Denmark, New York, placed in service in 2018. RIE will be required to backfill approximately 12 MW of renewable contracting capacity to fulfill the required 90 MW under LTCS. In addition to the LTCS, in July 2022, Rhode Island passed an amendment to the Affordable Clean Energy Security Act (ACES) that requires RIE to issue a request for proposals (RFP) for at least 600 MW but no greater than 1,000 MW of newly developed offshore wind capacity no later than October 15, 2022. The RFP was issued on October 14, 2022 following a public comment period. Based upon the RFP issued on October 14, 2022, and subsequently revised on November 7, 2022, RIE anticipates conditional project selection in June 2023. RIE must negotiate in good faith to achieve a commercially reasonable contract and must file such contract with the RIPUC for approval no later than March 15, 2024, unless RIE can show that the bids are unlikely to lead to a contract that meets all of the statutory requirements.As approved by the RIPUC, RIE is allowed to pass through commodity-related/purchased power costs to customers and collect remuneration equal to 2.75% for long-term contracts approved pursuant to LTCS that have achieved commercial operation. For long-term contracts approved pursuant to ACES, as amended, on or after January 1, 2022, RIE is entitled to financial remuneration equal to 1.0% through December 31, 2026 for those projects that are commercially operating. For long-term contracts approved pursuant to ACES on or after January 1, 2027, RIE is not entitled to any financial remuneration, unless otherwise granted by the RIPUC. Also, the amendments to ACES added a provision, which provides that for any calendar year in which RIE’s actual return on equity exceeds the return on equity allowed by the RIPUC in the last general rate case, the RIPUC may adjust any or all remuneration to assure that such remuneration does not result in or contribute toward RIE earning above its allowed return for such calendar year.Legal Matters(All Registrants)PPL and its subsidiaries are involved in legal proceedings, claims and litigation in the ordinary course of business. PPL and its subsidiaries cannot predict the outcome of such matters, or whether such matters may result in material liabilities, unless otherwise noted.166Table of ContentsTalen Litigation Background (PPL)In September 2013, one of PPL's former subsidiaries, PPL Montana entered into an agreement to sell its hydroelectric generating facilities. In June 2014, PPL and PPL Energy Supply, the parent company of PPL Montana, entered into various definitive agreements with affiliates of Riverstone to spin off PPL Energy Supply and ultimately combine it with Riverstone's competitive power generation businesses to form a stand-alone company named Talen Energy. In November 2014, after executing the spinoff agreements but prior to the closing of the spinoff transaction, PPL Montana closed the sale of its hydroelectric generating facilities. Subsequently, on June 1, 2015, the spinoff of PPL Energy Supply was completed. Following the spinoff transaction, PPL had no continuing ownership interest in or control of PPL Energy Supply. In connection with the spinoff transaction, PPL Montana became Talen Montana, LLC (Talen Montana), a subsidiary of Talen Energy and Talen Energy Marketing also became a subsidiary of Talen Energy. Talen Energy has owned and operated both Talen Montana and Talen Energy Marketing since the spinoff. At the time of the spinoff, affiliates of Riverstone acquired a 35% ownership interest in Talen Energy. Riverstone subsequently acquired the remaining interests in Talen Energy in a take private transaction in December 2016.On October 29, 2018, Talen Montana Retirement Plan and Talen Energy Marketing filed a putative class action complaint on behalf of current and contingent creditors of Talen Montana who allegedly suffered harm or allegedly will suffer reasonably foreseeable harm as a result of the November 2014 distribution of proceeds from the sale of then-PPL Montana's hydroelectric generating facilities. The action was filed in the Sixteenth Judicial District of the State of Montana, Rosebud County, against PPL and certain of its affiliates and current and former officers and directors (Talen Putative Class Action). Plaintiffs asserted claims for, among other things, fraudulent transfer, both actual and constructive; recovery against subsequent transferees; civil conspiracy; aiding and abetting tortious conduct; and unjust enrichment. Plaintiffs sought avoidance of the purportedly fraudulent transfer, unspecified damages, including punitive damages, the imposition of a constructive trust, and other relief. In January 2020, PPL defendants filed a motion to dismiss the Second Amended Complaint or, in the alternative, to stay the proceedings pending the resolution of the below mentioned Delaware Action and on September 11, 2020, the Court granted PPL defendants' alternative Motion for a Stay.On November 30, 2018, PPL, certain PPL affiliates, and certain current and former officers and directors (PPL plaintiffs) filed a complaint in the Court of Chancery of the State of Delaware seeking various forms of relief against Riverstone, Talen Energy and certain of their affiliates (Delaware Action), in response to and as part of the defense strategy for an action filed by Talen Montana, LLC (the Talen Direct Action, since dismissed) and the Talen Putative Class Action described above originally filed in Montana state court in October 2018. In the complaint, the PPL plaintiffs asked the Delaware Court of Chancery for declaratory and injunctive relief, including a declaratory judgment that under the separation agreement governing the spinoff of PPL Energy Supply, all related claims that arise must be heard in Delaware; that the statute of limitations in Delaware and the spinoff agreement bar these claims at this time; that PPL is not liable for the claims in either the Talen Direct Action or the Talen Putative Class Action because PPL Montana was solvent at all relevant times; and that the separation agreement requires that Talen Energy indemnify PPL for all losses arising from the debts of Talen Montana, among other things. PPL's complaint also sought damages against Riverstone for interfering with the separation agreement and against Riverstone affiliates for breach of the implied covenant of good faith and fair dealing. In October 2019, the Delaware Court of Chancery issued an opinion sustaining all of the PPL plaintiffs' claims except for the claim for breach of implied covenant of good faith and fair dealing. Talen Energy Supply, LLC et al. and Talen Montana LLC v. PPL Corp., PPL Capital Funding, Inc., PPL Electric Utilities Corp., and PPL Energy Funding (PPL and PPL Electric)On May 9, 2022, Talen Energy Supply, LLC and 71 affiliates, including Talen Montana, LLC, filed petitions for protection under Chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of Texas (Texas Bankruptcy Court).On May 10, 2022, Talen Montana, LLC, as debtor-in-possession, filed a complaint initiating an adversary proceeding (Adversary Proceeding) in the Texas Bankruptcy Court against PPL Corporation, PPL Capital Funding, Inc., PPL Electric Utilities Corporation, and PPL Energy Funding Corporation. Similar to the litigation in Montana, the Adversary Proceeding seeks the recovery of an allegedly fraudulent transfer relating to PPL Montana’s November 2014 sale of hydroelectric assets to Northwestern and subsequent distribution of certain proceeds of that sale of approximately $900 million, reiterating claims that the parties had already been litigating.167Table of ContentsBoth the Talen Putative Class Action and Delaware Action have now been transferred to and consolidated in the Texas Bankruptcy Court. PPL has filed its Answer and asserted a Counterclaim against the Talen and Riverstone entities, similar to the claims previously asserted in the Delaware Action, and has filed a motion for partial summary judgment that was heard on October 31, 2022. Upon agreement by the parties, mediation will commence on February 22, 2023 before Judge David R. Jones of the Texas Bankruptcy Court.PPL believes that the 2014 distribution of proceeds was made in compliance with all applicable laws and that PPL Montana was solvent at all relevant times. Additionally, the agreements entered into in connection with the spinoff, which PPL and affiliates of Talen Energy and Riverstone negotiated and executed prior to the 2014 distribution, directly address the treatment of the proceeds from the sale of PPL Montana's hydroelectric generating facilities; in those agreements, Talen Energy and Riverstone definitively agreed that PPL was entitled to retain the proceeds. PPL believes that it has meritorious defenses to the claims made in the Adversary Proceeding and intends to vigorously defend against this action. At this time, PPL cannot predict the outcome of the Adversary Proceeding or estimate the range of possible losses, if any, that PPL might incur as a result of the claims, although they could be material.Narragansett Electric Litigation (PPL) Aquidneck IslandIn January 2019, Narragansett Electric suffered a significant loss of gas supply to the distribution system that serves customers on Aquidneck Island in Rhode Island, affecting approximately 7,500 customers. Following Narraganset Electric’s efforts to address customer concerns and expenses following the incident, and an investigation by the Rhode Island Division of Public Utilities and Carriers, Narragansett Electric published a long-term capacity study for energy solutions for Aquidneck Island and gathered extensive stakeholder feedback. Narraganset Electric continues to discuss this matter with the Rhode Island Division of Public Utilities and Carriers. Narragansett Electric filed a supplemental application for its preferred long-term solution on April 1, 2022.Narragansett Electric is facing various lawsuits related to the Aquidneck Island gas supply interruption, including two purported class actions. Narragansett Electric is actively defending against these claims. This matter is covered by excess liability insurance, which is currently reimbursing RIE for ongoing costs and claim amounts, subject to reservation of rights, and is not expected to materially affect RIE’s results of operations, financial position or cash flows. Energy Efficiency Programs InvestigationNarragansett Electric, while under the ownership of National Grid, performed an internal investigation into conduct associated with its energy efficiency programs. Any adjustments that may be a result of the internal investigation remain subject to review and approval by the RIPUC. At this time, it is not possible to predict the final outcome or determine the total amount of any additional liabilities that may be incurred in connection with it by Narragansett Electric. This review by the RIPUC may be impacted by other investigations that are ongoing related to National Grid. Narragansett Electric does not expect this matter will have a material adverse effect on its results of operations, financial position or cash flows. On June 27, 2022, the RIPUC opened a new docket (RIPUC Docket 22-05-EE) to investigate RIE’s actions and the actions of its National Grid employees during the time RIE was a National Grid U.S. affiliate being provided services by National Grid USA Service Company, Inc. relating to the manipulation of the reporting of invoices affecting the calculation of past energy efficiency shareholder incentives and the resulting impact on customers. The Rhode Island Attorney General and National Grid USA intervened in the docket. On January 19, 2023, the Rhode Island Division of Public Utilities and Carriers (the Division) filed a motion to dismiss the docket without prejudice. As grounds for its motion, the Division stated that sufficient evidence exists in the docket to warrant an independent summary investigation by the Division, to include an audit of RIE, pursuant to Rhode Island General Laws Section 39-4-13. If the Division finds sufficient grounds, the Division may proceed to a formal hearing regarding the matters under investigation pursuant to Rhode Island General Laws Sections 39-4-14 and 39-4-15. Upon the conclusion of its investigation, the Division will provide the RIPUC with a report outlining the Division’s findings and final decision. On January 30, 2023, the Rhode Island Attorney General filed an objection to the Division’s motion to dismiss; RIE and National Grid each filed responses with the RIPUC requesting that any additional action taken by the RIPUC or the Division be considered after National Grid completes its internal investigation report to be filed with the RIPUC by March 1, 2023.168Table of ContentsE.W. Brown Environmental Assessment (PPL and KU)KU is undertaking extensive remedial measures at the E.W. Brown plant including closure of the former ash pond, implementation of a groundwater remedial action plan and performance of a corrective action plan including aquatic study of adjacent surface waters and risk assessment. The aquatic study and risk assessment are being undertaken pursuant to a 2017 agreed Order with the Kentucky Energy and Environment Cabinet (KEEC). KU conducted sampling of Herrington Lake in 2017 and 2018. In June 2019, KU submitted to the KEEC the required aquatic study and risk assessment, conducted by an independent third-party consultant, finding that discharges from the E.W. Brown plant have not had any significant impact on Herrington Lake and that the water in the lake is safe for recreational use and meets safe drinking water standards. On May 31, 2021, the KEEC approved the report and released a response to public comments. On August 6, 2021, KU submitted a Supplemental Remedial Alternatives Analysis report to the KEEC that outlines proposed additional fish, water, and sediment testing. On February 18, 2022, the KEEC provided approval to KU to proceed with the proposed sampling, which commenced in the spring of 2022. On November 17, 2022, KU submitted a Supplemental Performance Monitoring Report to the KEEC finding that there are no significant unaddressed risks to human health or the environment at the plant. Air (PPL and LG&E)Sulfuric Acid Mist Emissions In June 2016, the EPA issued a notice of violation under the Clean Air Act alleging that LG&E violated applicable rules relating to sulfuric acid mist emissions at its Mill Creek plant. The notice alleges failure to install proper controls, failure to operate the facility consistent with good air pollution control practice and causing emissions exceeding applicable requirements or constituting a nuisance or endangerment. LG&E believes it has complied with applicable regulations during the relevant time period. On July 31, 2020, the U.S. Department of Justice and Louisville Metro Air Pollution Control District filed a complaint in the U.S. District Court for the Western District of Kentucky alleging violations specified in the EPA notice of violation and seeking civil penalties and injunctive relief. In October 2020, LG&E filed a motion to dismiss the complaint. In December 2020, the U.S. Department of Justice and the Louisville Metro Air Pollution Control District filed an amended complaint. In February 2021, LG&E filed a renewed motion to dismiss regarding the amended complaint. On February 23, 2022, the court entered a consent decree negotiated by the parties to resolve the violations alleged in the complaint. As required by the consent decree, LG&E paid a civil penalty on March 4, 2022 and subsequently commenced implementation of a supplemental environmental project (SEP). The agreed penalty and SEP do not have a significant impact on LG&E's operations or financial condition.Water/Waste (PPL, LG&E and KU)ELGsIn 2015, the EPA finalized ELGs for wastewater discharge permits for new and existing steam electricity generating facilities. These guidelines require deployment of additional control technologies providing physical, chemical and biological treatment and mandate operational changes including "no discharge" requirements for certain wastewaters. The implementation date for individual generating stations was to be determined by the states on a case-by-case basis according to criteria provided by the EPA. Legal challenges to the final rule were consolidated before the U.S. Court of Appeals for the Fifth Circuit. In April 2017, the EPA announced that it would grant petitions for reconsideration of the rule. In September 2017, the EPA issued a rule to postpone the compliance date for certain requirements. In October 2020, the EPA published final revisions to its best available technology standards for certain wastewaters and potential extensions to compliance dates (the Reconsideration Rule). The rule is expected to be implemented by the states or applicable permitting authorities in the course of their normal permitting activities. LG&E and KU are currently implementing responsive compliance strategies and schedules. Certain aspects of these compliance plans and estimates relate to developments in state water quality standards, which are separate from the ELG rule or its implementation. Certain costs are included in the Registrants' capital plans and expected to be recovered from customers through rate recovery mechanisms, but additional costs and recovery will depend on further regulatory developments at the state level. In August 2021, the EPA published a notice of rulemaking announcing that it will propose revisions to the Reconsideration Rule and determine "whether more stringent limitations and standards are appropriate." Compliance with the Reconsideration Rule is required during the pendency of the rulemaking process. CCRsIn 2015, the EPA issued a final rule governing management of CCRs which include fly ash, bottom ash and sulfur dioxide scrubber wastes. The CCR Rule imposes extensive new requirements for certain CCR impoundments and landfills, including public notifications, location restrictions, design and operating standards, groundwater monitoring and corrective action 169Table of Contentsrequirements, and closure and post-closure care requirements, and specifies restrictions relating to the beneficial use of CCRs. In July 2018, the EPA issued a final rule extending the deadline for closure of certain impoundments and adopting other substantive changes. In August 2018, the D.C. Circuit Court of Appeals vacated and remanded portions of the CCR Rule. In December 2019, the EPA addressed the deficiencies identified by the court and proposed amendments to change the closure deadline. In August 2020, the EPA published a final rule extending the deadline to initiate closure to April 11, 2021, while providing for certain extensions. The EPA is conducting ongoing rulemaking actions regarding various other amendments to the rule. Certain ongoing legal challenges to various provisions of the CCR Rule have been held in abeyance pending review by the EPA pursuant to the President's executive order. PPL, LG&E, and KU are monitoring the EPA’s ongoing efforts to refine and implement the regulatory program under the CCR Rule. In January 2022, the EPA issued several proposed regulatory determinations, facility notifications, and public announcements which indicate increased scrutiny by the EPA to determine the adequacy of measures taken by facility owners and operators to achieve closure of CCR surface impoundments and landfills. In particular, the agency indicated that it will focus on certain practices which it views as posing a threat of continuing groundwater contamination. Future guidance, regulatory determinations, rulemakings, and other developments could potentially require revisions to current LG&E and KU compliance plans including additional monitoring and remediation at surface impoundments and landfills, the cost of which could be substantial. PPL, LG&E and KU are unable to predict the outcome of the ongoing litigation, rulemaking, and regulatory determinations or potential impacts on current LG&E and KU compliance plans. The Registrants are currently finalizing closure plans and schedules.In January 2017, Kentucky issued a new state rule relating to CCR management, effective May 2017, aimed at reflecting the requirements of the federal CCR rule. As a result of a subsequent legal challenge, in January 2018, the Franklin County, Kentucky Circuit Court issued an opinion invalidating certain procedural elements of the rule. LG&E and KU presently operate their facilities under continuing permits authorized under the former program and do not currently anticipate material impacts as a result of the judicial ruling. Associated costs are expected to be subject to rate recovery.LG&E and KU received KPSC approval for a compliance plan providing for the closure of impoundments at the Mill Creek, Trimble County, E.W. Brown, and Ghent stations, and construction of process water management facilities at those plants. In addition to the foregoing measures required for compliance with the federal CCR rule, KU also received KPSC approval for its plans to close impoundments at the retired Green River, Pineville and Tyrone plants to comply with applicable state law. LG&E and KU have completed planned closure measures at most of the subject impoundments and have commenced post closure groundwater monitoring as required at those facilities. LG&E and KU generally expect to complete all impoundment closures within five years of commencement, although a longer period may be required to complete closure of some facilities. Associated costs are expected to be subject to rate recovery.In connection with the final CCR rule, LG&E and KU recorded adjustments to existing AROs beginning in 2015 and continue to record adjustments as required. See Note 20 for additional information. Further changes to AROs, current capital plans or operating costs may be required as estimates are refined based on closure developments, groundwater monitoring results, and regulatory or legal proceedings. Costs relating to this rule are expected to be subject to rate recovery.Superfund and Other Remediation(All Registrants)The Registrants are potentially responsible for investigating and remediating contamination under the federal Superfund program and similar state programs. Actions are under way at certain sites including former coal gas manufacturing plants in Pennsylvania, Rhode Island and Kentucky previously owned or operated by, or currently owned by predecessors or affiliates of, PPL subsidiaries. Depending on the outcome of investigations at identified sites where investigations have not begun or been completed, or developments at sites for which information is incomplete, additional costs of remediation could be incurred. PPL, PPL Electric, LG&E and KU lack sufficient information about such additional sites to estimate any potential liability or range of reasonably possible losses, if any, related to these sites. Such costs, however, are not currently expected to be significant.The EPA is evaluating the risks associated with polycyclic aromatic hydrocarbons and naphthalene, chemical by-products of coal gas manufacturing. As a result, individual states may establish stricter standards for water quality and soil cleanup, that could require several PPL subsidiaries to take more extensive assessment and remedial actions at former coal gas manufacturing plants. The Registrants cannot reasonably estimate a range of possible losses, if any, related to these matters.170Table of Contents(PPL and PPL Electric) PPL Electric is potentially responsible for a share of clean-up costs at certain sites including the Columbia Gas Plant site and the Brodhead site. Cleanup actions have been or are being undertaken at these sites as requested by governmental agencies, the costs of which have not been and are not expected to be significant to PPL Electric.At December 31, 2022 and December 31, 2021, PPL Electric had a recorded liability of $11 million and $10 million representing its best estimate of the probable loss incurred to remediate the sites identified above.(PPL) RIE is potentially responsible for a share of clean-up costs at certain sites including former manufactured gas plant (MGP) facilities formerly owned by the Blackstone Valley Gas and Electric Company and the Rhode Island gas distribution assets of the New England Gas division of Southern Union Company and electric operations at certain RIE facilities. RIE is currently investigating and remediating, as necessary, those MGP sites and certain other properties under agreements with governmental agencies, the costs of which have not been and are not expected to be significant to PPL.On December 31, 2022, RIE had a recorded liability of $100 million representing its best estimate of the remaining costs of environmental remediation activities. These undiscounted costs are expected to be incurred over approximately 30 years and to be subject to rate recovery. However, remediation costs for each site may be materially higher than estimated, depending on changing technologies and regulatory standards, selected end uses for each site, and actual environmental conditions encountered. RIE has recovered amounts from certain insurers and potentially responsible parties, and, where appropriate, may seek additional recovery from other insurers and from other potentially responsible parties, but it is uncertain whether, and to what extent, such efforts will be successful. The RIPUC has approved two settlement agreements that provide for rate recovery of qualified remediation costs of certain contaminated sites located in Rhode Island and Massachusetts. Rate-recoverable contributions for electric operations of approximately $3 million are added annually to the Environmental Response Fund, along with interest and any recoveries from insurance carriers and other third-parties. In addition, RIE recovers approximately $1 million annually for gas operations under a distribution adjustment charge in which the qualified remediation costs are amortized over 10 years. See Note 7 for additional information on RIE's recorded environmental regulatory assets and liabilities. Regulatory IssuesSee Note 7 for information on regulatory matters related to utility rate regulation.Electricity - Reliability StandardsThe NERC is responsible for establishing and enforcing mandatory reliability standards (Reliability Standards) regarding the bulk electric system in North America. The FERC oversees this process and independently enforces the Reliability Standards.The Reliability Standards have the force and effect of law and apply to certain users of the bulk electric system, including electric utility companies, generators and marketers. Under the Federal Power Act, the FERC may assess civil penalties for certain violations.PPL Electric, LG&E, KU and RIE monitor their compliance with the Reliability Standards and self-report or self-log potential violations of applicable reliability requirements whenever identified, and submit accompanying mitigation plans, as required. The resolution of a small number of potential violations is pending. Penalties incurred to date have not been significant. Any Regional Reliability Entity determination concerning the resolution of violations of the Reliability Standards remains subject to the approval of the NERC and the FERC.In the course of implementing their programs to ensure compliance with the Reliability Standards by those PPL affiliates subject to the standards, certain other instances of potential non-compliance may be identified from time to time. The Registrants cannot predict the outcome of these matters, and an estimate or range of possible losses cannot be determined.171Table of ContentsGas - Security Directives (PPL and LG&E)In May and July of 2021, the Department of Homeland Security’s (DHS) Transportation Security Administration (TSA) released two security directives applicable to certain notified owners and operators of natural gas pipeline facilities (including local distribution companies) that the TSA has determined to be critical. The TSA has determined that LG&E is critical, while RIE has not been notified of this distinction. The first security directive required notified owners/operators to implement cybersecurity incident reporting to the DHS, designate a cybersecurity coordinator, and perform a gap assessment of current entity cybersecurity practices against certain voluntary TSA security guidelines and report relevant results and proposed mitigation to applicable DHS agencies. The second security directive required notified entities to implement a significant number of specified cyber security controls and processes. LG&E does not believe the security directives have had or will have a significant impact on LG&E’s operations or financial condition. Other Guarantees and Other Assurances(All Registrants)In the normal course of business, the Registrants enter into agreements that provide financial performance assurance to third parties on behalf of certain subsidiaries. Examples of such agreements include: guarantees, stand-by letters of credit issued by financial institutions and surety bonds issued by insurance companies. These agreements are entered into primarily to support or enhance the creditworthiness attributed to a subsidiary on a stand-alone basis or to facilitate the commercial activities in which these subsidiaries engage.(PPL)PPL fully and unconditionally guarantees all of the debt obligations of PPL Capital Funding.(All Registrants)The table below details guarantees provided as of December 31, 2022. "Exposure" represents the estimated maximum potential amount of future payments that could be required to be made under the guarantee. The Registrants believe the probability of expected payment/performance under each of these guarantees is remote, except for the guarantees and indemnifications related to the sale of Safari Holdings, which PPL believes are reasonably possible but not probable of occurring. For reporting purposes, on a consolidated basis, the guarantees of PPL include the guarantees of its subsidiary Registrants.Exposure at December 31, 2022ExpirationDatePPL Indemnifications related to certain tax liabilities related to the sale of the U.K. utility business £50 (a)2028PPL guarantee of Safari payment obligations under certain sale/leaseback financing transactions related to the sale of Safari Holdings$148 (b)2028PPL guarantee of Safari payment obligations under certain PPAs related to the sale of Safari Holdings 55 (c)Indemnifications for losses suffered related to items not covered by Aspen Power's representation and warranty insurance associated with the sale of Safari Holdings140 (d)VariousLG&E and KU LG&E and KU obligation of shortfall related to OVEC (e) (a)PPL WPD Limited entered into a Tax Deed dated June 9, 2021 in which it agreed to a tax indemnity regarding certain potential tax liabilities of the entities sold with respect to periods prior to the completion of the sale, subject to customary exclusions and limitations. Because National Grid Holdings One plc, the buyer, agreed to purchase indemnity insurance, the amount of the cap on the indemnity for these liabilities is £1, except with respect to certain surrenders of tax losses, for which the amount of the cap on the indemnity is £50 million. (b)PPL guaranteed the payment obligations of Safari under certain sale/leaseback financing transactions executed by Safari. These guarantees will remain in place until Safari exercises its option to buy-out the projects under the sale/leaseback financings by the year 2028. Safari will indemnify PPL for any payments made by PPL or claims against PPL under the sale/leaseback transaction guarantees up to $25 million. The estimated maximum exposure of this guarantee is $148 million. (c)PPL guaranteed the payment obligations of Safari under certain PPAs executed by Safari. Aspen Power is expected to replace these guarantees and retain liability for any payments made by PPL or claims against PPL under any guarantee that is not replaced. The estimated maximum exposure of this guarantee is $55 million. (d)Aspen Power has obtained representation and warranty insurance, therefore, PPL generally has no liability for its representations and warranties under the agreement except for losses suffered related to items not covered. Expiration of these indemnifications range from 18 months to 6 years from the date of the closing of the transaction, and PPL’s aggregate liability for these claims will not exceed $140 million subject to certain adjustments plus the support obligations provided by PPL under sale-leaseback financings and PPAs that will be replaced by Aspen Power.172Table of Contents(e)Pursuant to the OVEC power purchase contract, LG&E and KU are obligated to pay for their share of OVEC's excess debt service, post-retirement and decommissioning costs, as well as any shortfall from amounts included within a demand charge designed and expected to cover these costs over the term of the contract. PPL's proportionate share of OVEC's outstanding debt was $89 million at December 31, 2022, consisting of LG&E's share of $62 million and KU's share of $27 million. The maximum exposure and the expiration date of these potential obligations are not presently determinable. See "Energy Purchase Commitments" above for additional information on the OVEC power purchase contract.The Registrants provide other miscellaneous guarantees through contracts entered into in the normal course of business. These guarantees are primarily in the form of indemnification or warranties related to services or equipment and vary in duration. The amounts of these guarantees often are not explicitly stated, and the overall maximum amount of the obligation under such guarantees cannot be reasonably estimated. Historically, no significant payments have been made with respect to these types of guarantees and the probability of payment/performance under these guarantees is remote.PPL, on behalf of itself and certain of its subsidiaries, maintains insurance that covers liability assumed under contract for bodily injury and property damage. The coverage provides maximum aggregate coverage of $225 million. This insurance may be applicable to obligations under certain of these contractual arrangements.15. Related Party Transactions Wholesale Sales and Purchases (LG&E and KU) LG&E and KU jointly dispatch their generation units with the lowest cost generation used to serve their retail customers. When LG&E has excess generation capacity after serving its own retail customers and its generation cost is lower than that of KU, KU purchases electricity from LG&E and vice versa. These transactions are reflected in the Statements of Income as "Electric revenue from affiliate" and "Energy purchases from affiliate" and are recorded at a price equal to the seller's fuel cost plus any split savings. Savings realized from such intercompany transactions are shared equally between both companies. The volume of energy each company has to sell to the other is dependent on its retail customers' needs and its available generation.Support Costs (PPL Electric, LG&E and KU)PPL Services and LKS provide and, prior to its merger into PPL Services on December 31, 2021, PPL EU Services provided the Registrants and each other with administrative, management and support services. For all services companies, the costs of directly assignable and attributable services are charged to the respective recipients as direct support costs. General costs that cannot be directly attributed to a specific entity are allocated and charged to the respective recipients as indirect support costs. PPL Services and PPL EU Services use a three-factor methodology that includes the applicable recipients' invested capital, operation and maintenance expenses and number of employees to allocate indirect costs. PPL Services may also use a ratio of overall direct and indirect costs or a weighted average cost ratio. LKS bases its indirect allocations on the subsidiaries' number of employees, total assets, revenues, number of customers and/or other statistical information. PPL Services, PPL EU Services and LKS charged the following amounts for the years ended December 31, including amounts applied to accounts that are further distributed between capital and expense on the books of the recipients, based on methods that are believed to be reasonable. 202220212020PPL Electric from PPL Services$241 $54 $50 PPL Electric from PPL EU Services— 222 176 LG&E from LKS153 169 170 LG&E from PPL Services13 3 2 KU from LKS171 179 180 KU from PPL Services14 3 2 In addition to the charges for services noted above, LKS makes payments on behalf of LG&E and KU for fuel purchases and other costs for products or services provided by third parties. LG&E and KU also provide services to each other and to LKS. Billings between LG&E and KU relate to labor and overheads associated with union and hourly employees performing work for the other company, charges related to jointly-owned generating units and other miscellaneous charges. Tax settlements between PPL and LG&E and KU are reimbursed through LKS.173Table of ContentsIntercompany Borrowings(PPL Electric)PPL Energy Funding maintains a $1,200 million revolving line of credit with a PPL Electric subsidiary. At December 31, 2022, PPL Energy Funding had no borrowings outstanding. At December 31, 2021, $499 million was outstanding. This balance is reflected in "Notes receivable from affiliate" on the PPL Electric balance sheet. The interest rates on borrowings are equal to one-month LIBOR plus a spread. Interest income is reflected in "Interest Income from Affiliate" on the Income Statements.CEP Reserves maintains a $500 million revolving line of credit with a PPL Electric subsidiary. At December 31, 2022 and 2021, CEP Reserves had no borrowings outstanding. The interest rates on borrowings are equal to one-month LIBOR plus a spread. Interest income is reflected in "Interest Income from Affiliate" on the Income Statements.(LG&E)LG&E participates in an intercompany money pool agreement whereby LKE and/or KU make available to LG&E funds up to the difference between LG&E's FERC borrowing limit and LG&E's commercial paper limit at an interest rate based on the lower of a market index of commercial paper issues and two additional rate options based on LIBOR. At December 31, 2022, LG&E's money pool unused capacity was $250 million. At December 31, 2022, LG&E had no borrowings outstanding from KU and/or LKE. At December 31, 2021, LG&E had borrowings of $324 million outstanding from LKE. These balances are reflected in "Notes payable to affiliates" on the LG&E Balance Sheets.(KU)KU participates in an intercompany money pool agreement whereby LKE and/or LG&E make available to KU funds up to the difference between KU's FERC borrowing limit and KU's commercial paper limit at an interest rate based on the lower of a market index of commercial paper issues and two additional rate options based on LIBOR. At December 31, 2022, KU's money pool unused capacity was $250 million. At December 31, 2022, KU had no borrowings outstanding from LG&E and/or LKE. At December 31, 2021, KU had borrowings of $294 million outstanding from LKE. These balances are reflected in "Notes payable to affiliates" on the KU Balance Sheets.VEBA Funds Receivable (PPL Electric)In May 2018, PPL received a favorable private letter ruling from the IRS permitting a transfer of excess funds from the PPL Bargaining Unit Retiree Health Plan VEBA to a new subaccount within the VEBA, to be used to pay medical claims of active bargaining unit employees. Based on PPL Electric's participation in PPL’s Other Postretirement Benefit plan, PPL Electric was allocated a portion of the excess funds from PPL Services. These funds have been recorded as an intercompany receivable on the Balance Sheets. The receivable balance decreases as PPL Electric pays incurred medical claims and is reimbursed by PPL Services. The intercompany receivable balance associated with these funds was immaterial as of December 31, 2022. The intercompany receivable balance associated with these funds was $11 million as of December 31, 2021, of which $10 million was reflected in "Accounts receivable from affiliates" and $1 million was reflected in "Other noncurrent assets" on the Balance Sheets.Other (PPL Electric, LG&E and KU)See Note 1 for discussions regarding the intercompany tax sharing agreement (for PPL Electric, LG&E and KU) and intercompany allocations of stock-based compensation expense (for PPL Electric). For PPL Electric, LG&E and KU, see Note 12 for discussions regarding intercompany allocations associated with defined benefits. 16. Other Income (Expense) - net (PPL)The components of "Other Income (Expense) - net" for the years ended December 31, were:174Table of Contents 202220212020Defined benefit plans - non-service credits (Note 12)$47 $21 $(2)Interest income4 12 9 AFUDC - equity component22 18 20 Charitable contributions(14)(14)(3)Miscellaneous(5)(22)(22)Other Income (Expense) - net$54 $15 $2 (PPL Electric)The components of "Other Income (Expense) - net" for the years ended December 31, were:202220212020Defined benefit plans - non-service credits (Note 12)$15 $9 $4 Interest income3 — 2 AFUDC - equity component16 18 19 Charitable contributions(3)(3)(3)Miscellaneous(1)(3)(4)Other Income (Expense) - net$30 $21 $18 17. Fair Value Measurements(All Registrants)Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). A market approach (generally, data from market transactions), an income approach (generally, present value techniques and option-pricing models), and/or a cost approach (generally, replacement cost) are used to measure the fair value of an asset or liability, as appropriate. These valuation approaches incorporate inputs such as observable, independent market data and/or unobservable data that management believes are predicated on the assumptions market participants would use to price an asset or liability. These inputs may incorporate, as applicable, certain risks such as nonperformance risk, which includes credit risk. The fair value of a group of financial assets and liabilities is measured on a net basis. See Note 1 for information on the levels in the fair value hierarchy.Recurring Fair Value MeasurementsThe assets and liabilities measured at fair value were: December 31, 2022December 31, 2021 TotalLevel 1Level 2Level 3TotalLevel 1Level 2Level 3PPL Assets Cash and cash equivalents$356 $356 $— $— $3,571 $3,571 $— $— Restricted cash and cash equivalents (a)1 1 — — 1 1 — — Total Cash, Cash Equivalents and Restricted Cash (b)357 357 — — 3,572 3,572 — — Special use funds (a):Money market fund1 1 — — 2 2 — — Commingled debt fund measured at NAV (c)13 — — — 22 — — — Commingled equity fund measured at NAV (c)11 — — — 21 — — — Total special use funds25 1 — — 45 2 — — Price risk management assets (d):Gas contracts25 — 25 — — — — — Total assets$407 $358 $25 $— $3,617 $3,574 $— $— Liabilities Price risk management liabilities (d): Interest rate swaps$7 $— $7 $— $18 $— $18 $— Gas contracts66 — 10 56 — — — — Total price risk management liabilities$73 $— $17 $56 $18 $— $18 $— 175Table of Contents December 31, 2022December 31, 2021 TotalLevel 1Level 2Level 3TotalLevel 1Level 2Level 3PPL Electric Assets Cash and cash equivalents$25 $25 $— $— $21 $21 $— $— Total assets$25 $25 $— $— $21 $21 $— $— LG&E Assets Cash and cash equivalents$93 $93 $— $— $9 $9 $— $— Total assets$93 $93 $— $— $9 $9 $— $— Liabilities Price risk management liabilities: Interest rate swaps$7 $— $7 $— $18 $— $18 $— Total price risk management liabilities$7 $— $7 $— $18 $— $18 $— KU Assets Cash and cash equivalents$21 $21 $— $— $13 $13 $— $— Total assets$21 $21 $— $— $13 $13 $— $— (a)Current portion is included in "Other current assets" and long-term portion is included in "Other noncurrent assets" on the Balance Sheets.(b)Total Cash, Cash Equivalents and Restricted Cash provides a reconciliation of these items reported within the Balance Sheets to the sum shown on the Statements of Cash Flows.(c)In accordance with accounting guidance, certain investments that are measured at fair value using net asset value per share (NAV), or its equivalent, have not been classified in the fair value hierarchy. The fair value amounts presented in the table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the statement of financial position.(d)Current portion is included in "Other current liabilities" and noncurrent portion is included in "Other deferred credits and noncurrent liabilities" on the Balance Sheets.A reconciliation of net assets and liabilities classified as Level 3 for the year ended December 31 is as follows:Gas Contracts2022Balance at beginning of period$— Total realized/unrealized gains (losses):Included in regulatory assets56Balance at end of period$56 Special Use Funds (PPL)The special use funds are investments restricted for paying active union employee medical costs. In 2018, PPL received a favorable private letter ruling from the IRS permitting a transfer of excess funds from the PPL Bargaining Unit Retiree Health Plan VEBA to a new subaccount within the VEBA to be used to pay medical claims of active bargaining unit employees. The funds are invested primarily in commingled debt and equity funds measured at NAV and are classified as investments in equity securities. Changes in the fair value of the funds are recorded to the Statements of Income.Price Risk Management Assets/LiabilitiesInterest Rate Swaps (PPL, LG&E and KU) To manage interest rate risk, PPL, LG&E and KU use interest rate contracts such as forward-starting swaps, floating-to-fixed swaps and fixed-to-floating swaps. An income approach is used to measure the fair value of these contracts, utilizing readily observable inputs, such as forward interest rates (e.g., LIBOR, SOFR, and government security rates), as well as inputs that may not be observable, such as credit valuation adjustments. In certain cases, market information cannot practicably be obtained to value credit risk and therefore internal models are relied upon. These models use projected probabilities of default and estimated recovery rates based on historical observances. When the credit valuation adjustment is significant to the overall valuation, the contracts are classified as Level 3.176Table of ContentsGas Contracts (PPL)To manage gas commodity price risk associated with natural gas purchases, RIE utilizes over-the-counter (OTC) gas swaps contracts with pricing inputs obtained from the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE), except in cases where the ICE publishes seasonal averages or where there were no transactions within the last seven days. RIE may utilize discounting based on quoted interest rate curves, including consideration of non-performance risk, and may include a liquidity reserve calculated based on bid/ask spread. Substantially all of these price curves are observable in the marketplace throughout at least 95% of the remaining contractual quantity, or they could be constructed from market observable curves with correlation coefficients of 95% or higher. These contracts are classified as Level 2.RIE also utilizes gas option and purchase and capacity transactions, which are valued based on internally developed models. Industry-standard valuation techniques, such as the Black-Scholes pricing model, are used for valuing such instruments. For valuations that include both observable and unobservable inputs, if the unobservable input is determined to be significant to the overall inputs, the entire valuation is classified as Level 3. This includes derivative instruments valued using indicative price quotations whose contract tenure extends into unobservable periods. In instances where observable data is unavailable, consideration is given to the assumptions that market participants would use in valuing the asset or liability. This includes assumptions about market risks such as liquidity, volatility, and contract duration. Such instruments are classified as Level 3 as the model inputs generally are not observable. RIE considers non-performance risk and liquidity risk in the valuation of derivative instruments classified as Level 2 and Level 3.The significant unobservable inputs used in the fair value measurement of the gas derivative instruments are implied volatility and gas forward curves. A relative change in commodity price at various locations underlying the open positions can result in significantly different fair value estimates.Financial Instruments Not Recorded at Fair Value (All Registrants)The carrying amounts of long-term debt on the Balance Sheets and their estimated fair values are set forth below. Long-term debt is classified as Level 2. The effect of third-party credit enhancements is not included in the fair value measurement. December 31, 2022December 31, 2021CarryingAmount (a)Fair ValueCarryingAmount (a)Fair ValuePPL$13,243 $12,239 $11,140 $12,955 PPL Electric4,486 4,259 4,484 5,272 LG&E2,307 2,128 2,006 2,363 KU2,920 2,616 2,618 3,120 (a)Amounts are net of debt issuance costs.The carrying amounts of other current financial instruments (except for long-term debt due within one year) approximate their fair values because of their short-term nature. 18. Derivative Instruments and Hedging ActivitiesRisk Management Objectives(All Registrants)PPL has a risk management policy approved by the Board of Directors to manage market risk associated with commodities, interest rates on debt issuances (including price, liquidity and volumetric risk) and credit risk (including non-performance risk and payment default risk). The Risk Management Committee, comprised of senior management and chaired by the Senior Director-Risk Management, oversees the risk management function. Key risk control activities designed to ensure compliance with the risk policy and detailed programs include, but are not limited to, credit review and approval, validation of transactions, verification of risk and transaction limits, value-at-risk analyses (VaR, a statistical model that attempts to estimate the value of potential loss over a given holding period under normal market conditions at a given confidence level) and the coordination and reporting of the Enterprise Risk Management program.177Table of ContentsMarket RiskMarket risk includes the potential loss that may be incurred as a result of price changes associated with a particular financial or commodity instrument as well as market liquidity and volumetric risks. Forward contracts, futures contracts, options, swaps and structured transactions are utilized as part of risk management strategies to minimize unanticipated fluctuations in earnings caused by changes in commodity prices and interest rates. Many of these contracts meet the definition of a derivative. All derivatives are recognized on the Balance Sheets at their fair value, unless NPNS is elected.The following summarizes the market risks that affect PPL and its subsidiaries.Interest Rate Risk•PPL and its subsidiaries are exposed to interest rate risk associated with forecasted fixed-rate and existing floating-rate debt issuances. PPL and LG&E utilize over-the-counter interest rate swaps to limit exposure to market fluctuations on floating-rate debt. PPL, LG&E and KU utilize forward starting interest rate swaps to hedge changes in benchmark interest rates, when appropriate, in connection with future debt issuance.•PPL and its subsidiaries are exposed to interest rate risk associated with debt securities and derivatives held by defined benefit plans. This risk is significantly mitigated to the extent that the plans are sponsored at, or sponsored on behalf of, the regulated utilities due to the recovery methods in place.Commodity Price RiskPPL is exposed to commodity price risk through its subsidiaries as described below.•PPL Electric is required to purchase electricity to fulfill its obligation as a PLR. Potential commodity price risk is mitigated through its PAPUC-approved cost recovery mechanism and full-requirement supply agreements to serve its PLR customers which transfer the risk to energy suppliers.•LG&E's and KU's rates include certain mechanisms for fuel, fuel-related expenses and energy purchases. In addition, LG&E's rates include a mechanism for natural gas supply costs. These mechanisms generally provide for timely recovery of market price fluctuations associated with these costs.•RIE utilizes derivative instruments pursuant to its RIPUC-approved plan to manage commodity price risk associated with its natural gas purchases. RIE's commodity price risk management strategy is to reduce fluctuations in firm gas sales prices to its customers. RIE's costs associated with derivatives instruments are recoverable through its RIPUC- approved cost recovery mechanisms. RIE is required to purchase electricity to fulfill its obligation to provide Last Resort Service (LRS). Potential commodity price risk is mitigated through its RIPUC-approved cost recovery mechanisms and full requirements service agreements to serve LRS customers, which transfer the risk to energy suppliers. RIE is required to contract through long-term agreements for clean energy supply under the Rhode Island Renewable Energy Growth program and Long-term Clean Energy Standard. Potential commodity price risk is mitigated through its RIPUC-approved cost recovery mechanisms, which true-up cost differences between contract prices and market prices. Volumetric RiskVolumetric risk is the risk related to the changes in volume of retail sales due to weather, economic conditions or other factors. PPL is exposed to volumetric risk through its subsidiaries as described below:•PPL Electric, LG&E and KU are exposed to volumetric risk on retail sales, mainly due to weather and other economic conditions for which there is limited mitigation between rate cases. •RIE is exposed to volumetric risk, which is significantly mitigated by regulatory mechanisms. RIE's electric and gas distribution rates both have a revenue decoupling mechanism, which allows for annual adjustments to RIE's delivery rates.Equity Securities Price Risk•PPL and its subsidiaries are exposed to equity securities price risk associated with the fair value of the defined benefit plans' assets. This risk is significantly mitigated due to the recovery methods in place.•PPL is exposed to equity securities price risk from future stock sales and/or purchases.Credit RiskCredit risk is the potential loss that may be incurred due to a counterparty's non-performance.178Table of ContentsPPL is exposed to credit risk from "in-the-money" transactions with counterparties, as well as additional credit risk through certain of its subsidiaries, as discussed below.In the event a supplier of PPL, PPL Electric, LG&E or KU defaults on its contractual obligation, those Registrants would need to seek replacement power or replacement fuel in the market. In general, subject to regulatory review or other processes, appropriate incremental costs incurred by these entities would be recoverable from customers through applicable rate mechanisms, thereby mitigating the financial risk for these entities.PPL and its subsidiaries have credit policies in place to manage credit risk, including the use of an established credit approval process, daily monitoring of counterparty positions and the use of master netting agreements or provisions. These agreements generally include credit mitigation provisions, such as margin, prepayment or collateral requirements. PPL and its subsidiaries may request additional credit assurance, in certain circumstances, in the event that the counterparties' credit ratings fall below investment grade, their tangible net worth falls below specified percentages or their exposures exceed an established credit limit.Master Netting Arrangements (PPL, LG&E and KU)Net derivative positions on the balance sheets are not offset against the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) under master netting arrangements.PPL had $4 million cash collateral posted under master netting arrangements at December 31, 2022 and no cash collateral posted at December 31, 2021. PPL had no obligation to return cash collateral under master netting arrangements at December 31, 2022 and 2021.LG&E and KU had no cash collateral posted or obligation to return cash collateral under master netting arrangements at December 31, 2022 and 2021.See "Offsetting Derivative Instruments" below for a summary of derivative positions presented in the balance sheets where a right of setoff exists under these arrangements.Interest Rate Risk(All Registrants)PPL and its subsidiaries issue debt to finance their operations, which exposes them to interest rate risk. A variety of financial derivative instruments are utilized to adjust the mix of fixed and floating interest rates in their debt portfolios, adjust the duration of the debt portfolios and lock in benchmark interest rates in anticipation of future financing, when appropriate. Risk limits under PPL's risk management program are designed to balance risk exposure to volatility in interest expense and changes in the fair value of the debt portfolio due to changes in benchmark interest rates. In addition, the interest rate risk of certain subsidiaries is potentially mitigated as a result of the existing regulatory framework or the timing of rate case.Cash Flow Hedges (PPL)Interest rate risks include exposure to adverse interest rate movements for outstanding variable rate debt and for future anticipated financings. Financial interest rate swap contracts that qualify as cash flow hedges may be entered into to hedge floating interest rate risk associated with both existing and anticipated debt issuances. PPL had no such contracts at December 31, 2022.Cash flow hedges are discontinued if it is no longer probable that the original forecasted transaction will occur by the end of the originally specified time period and any amounts previously recorded in AOCI are reclassified into earnings once it is determined that the hedged transaction is not probable of occurring.For 2022, 2021 and 2020, PPL had no cash flow hedges reclassified into earnings associated with discontinued cash flow hedges. 179Table of ContentsAt December 31, 2022, the amount of accumulated net unrecognized after-tax gains (losses) on qualifying derivatives expected to be reclassified into earnings during the next 12 months is insignificant. Amounts are reclassified as the hedged interest expense is recorded. Economic Activity (PPL and LG&E)LG&E enters into interest rate swap contracts that economically hedge interest payments. Because realized gains and losses from the swaps, including terminated swap contracts, are recoverable through regulated rates, any subsequent changes in fair value of these derivatives are included in regulatory assets or liabilities until they are realized as interest expense. Realized gains and losses are recognized in "Interest Expense" on the Statements of Income at the time the underlying hedged interest expense is recorded. At December 31, 2022, LG&E held contracts with a notional amount of $64 million that mature in 2033.Commodity Price Risk (PPL)Economic ActivityRIE enters into financial and physical derivative contracts that economically hedge natural gas purchases. Realized gains and losses from the derivatives are recoverable through regulated rates, therefore subsequent changes in fair value are included in regulatory assets or liabilities until they are realized as purchased gas. Realized gains and losses are recognized in "Energy Purchases" on the Statements of Income upon settlement of the contracts. At December 31, 2022, RIE held contracts with a notional amount of $15 million that mature in 2024.Accounting and Reporting(All Registrants)All derivative instruments are recorded at fair value on the Balance Sheet as an asset or liability unless the NPNS is elected. NPNS contracts include certain full-requirement purchase contracts and other physical purchase contracts. Changes in the fair value of derivatives not designated as NPNS are recognized in earnings unless specific hedge accounting criteria are met and designated as such, except for the changes in fair values of LG&E's interest rate swaps that are recognized as regulatory assets or regulatory liabilities. See Note 7 for amounts recorded in regulatory assets and regulatory liabilities at December 31, 2022 and 2021.See Note 1 for additional information on accounting policies related to derivative instruments.(PPL)The following table presents the fair value and location of derivative instruments recorded on the Balance Sheets: December 31, 2022December 31, 2021Derivatives designated ashedging instrumentsDerivatives not designatedas hedging instrumentsDerivatives designated ashedging instrumentsDerivatives not designatedas hedging instruments AssetsLiabilitiesAssetsLiabilitiesAssetsLiabilitiesAssetsLiabilitiesCurrent: Price Risk Management Assets/Liabilities (a): Interest rate swaps (b)$— $— $— $1 $— $— $— $1 Gas contracts— — 20 62 — — — — Total current— — 20 63 — — — 1 Noncurrent: Price Risk Management Assets/Liabilities (a): Interest rate swaps (b)— — — 6 — — — 17 Gas contracts— — 5 4 — — — — Total noncurrent— — 5 10 — — — 17 Total derivatives$— $— $25 $73 $— $— $— $18 (a)Current portion is included in "Other current assets" and "Other current liabilities" and noncurrent portion is included in "Other noncurrent assets" and "Other deferred credits and noncurrent liabilities" on the Balance Sheets.180Table of Contents(b)Excludes accrued interest, if applicable.The following tables present the pre-tax effect of derivative instruments recognized in income, OCI or regulatory assets and regulatory liabilities:DerivativeRelationshipsDerivative Gain(Loss) Recognized in OCILocation of Gain (Loss)Recognized in Incomeon DerivativeGain (Loss) Reclassifiedfrom AOCI into Income2022Cash Flow Hedges:Interest rate swaps$— Interest Expense$(3)Total$— $(3)2021Cash Flow Hedges:Interest rate swaps$— Interest Expense$11 Income (Loss) from Discontinued operations (net of taxes)(2)Cross-currency swaps(50)Income (Loss) from Discontinued operations (net of taxes)(39)Total$(50)$(30)Net Investment Hedges: Foreign currency contracts in Discontinued operations$1 2020Cash Flow Hedges:Interest rate swaps$(9)Interest Expense$(8)Income(Loss) from Discontinued operations(net of taxes)(2)Cross-currency swaps(15)Income (Loss) from Discontinued operations (net of taxes)(22)Total$(24)$(32)Net Investment Hedges: Foreign currency contracts in Discontinued operations$1 Derivatives Not Designated asHedging InstrumentsLocation of Gain (Loss) Recognized inIncome on Derivative202220212020Foreign currency contractsIncome (Loss) from Discontinued Operations (net of taxes)$— $(266)$(98)Interest rate swapsInterest Expense(2)(2)(5)Gas contractsEnergy Purchases41 — — Total$39 $(268)$(103)Derivatives Not Designated asHedging InstrumentsLocation of Gain (Loss) Recognized asRegulatory Liabilities/Assets202220212020Gas contractsRegulatory assets - current$39 $— $— Interest rate swapsRegulatory assets - noncurrent11 5 (2)Total$50 $5 $(2)The following table presents the effect of cash flow hedge activity on the Statement of Income for the year ended December 31, 2022:181Table of ContentsLocation and Amount of Gain (Loss) Recognized in Income on Hedging RelationshipsInterest ExpenseOther Income (Expense) - netTotal income and expense line items presented in the income statement in which the effect of cash flow hedges are recorded$513 $54 The effects of cash flow hedges:Gain (Loss) on cash flow hedging relationships:Interest rate swaps:Amount of gain (loss) reclassified from AOCI to income(3)— Cross-currency swaps:Hedged items— — Amount of gain (loss) reclassified from AOCI to income— — The following table presents the effect of cash flow hedge activity on the Statement of Income for the year ended December 31, 2021:Location and Amount of Gain (Loss) Recognized in Income on Hedging RelationshipsInterest ExpenseIncome (Loss) from Discontinued Operations (net of income taxes)Total income and expense line items presented in the income statement in which the effect of cash flow hedges are recorded$918 $(1,498)The effects of cash flow hedges:Gain (Loss) on cash flow hedging relationships:Interest rate swaps:Amount of gain (loss) reclassified from AOCI to income11 (2)Cross-currency swaps:Hedged items— 39 Amount of gain (loss) reclassified from AOCI to income— (39)The following table presents the effect of cash flow hedge activity on the Statement of Income for the year ended December 31, 2020: Location and Amount of Gain (Loss) Recognized in Income on Hedging RelationshipsInterest ExpenseIncome (Loss) from Discontinued Operations (net of income taxes)Total income and expense line items presented in the income statement in which the effect of cash flow hedges are recorded$634 $829 The effects of cash flow hedges:Gain (Loss) on cash flow hedging relationships:Interest rate swaps:Amount of gain (loss) reclassified from AOCI to income(8)(2)Cross-currency swaps:Hedged items— 22 Amount of gain (loss) reclassified from AOCI to income— (22)182Table of Contents(LG&E)The following table presents the fair value and the location on the Balance Sheets of derivatives not designated as hedging instruments: December 31, 2022December 31, 2021 AssetsLiabilitiesAssetsLiabilitiesCurrent: Price Risk Management Assets/Liabilities: Interest rate swaps$— $1 $— $1 Total current— 1 — 1 Noncurrent: Price Risk Management Assets/Liabilities: Interest rate swaps— 6 — 17 Total noncurrent— 6 — 17 Total derivatives$— $7 $— $18 The following tables present the pre-tax effect of derivatives not designated as cash flow hedges that are recognized in income or regulatory assets:Derivative InstrumentsLocation of Gain (Loss)202220212020Interest rate swapsInterest Expense$(2)$(2)$(5)Derivative InstrumentsLocation of Gain (Loss)202220212020Interest rate swapsRegulatory assets - noncurrent$11 $5 $(2)(PPL, LG&E and KU)Offsetting Derivative InstrumentsPPL, LG&E and KU or certain of their subsidiaries have master netting arrangements in place and also enter into agreements pursuant to which they purchase or sell certain energy and other products. Under the agreements, upon termination of the agreement as a result of a default or other termination event, the non-defaulting party typically would have a right to set off amounts owed under the agreement against any other obligations arising between the two parties (whether under the agreement or not), whether matured or contingent and irrespective of the currency, place of payment or place of booking of the obligation.PPL, LG&E and KU have elected not to offset derivative assets and liabilities and not to offset net derivative positions against the right to reclaim cash collateral pledged (an asset) or the obligation to return cash collateral received (a liability) under derivatives agreements. The table below summarizes the derivative positions presented in the balance sheets where a right of setoff exists under these arrangements and related cash collateral received or pledged. AssetsLiabilities Eligible for Offset Eligible for Offset GrossDerivativeInstrumentsCashCollateralReceivedNetGrossDerivativeInstrumentsCashCollateralPledgedNetDecember 31, 2022 Derivatives PPL$25 $20 $— $5 $73 $62 $— $11 LG&E— — — — 7 — — 7 December 31, 2021 Derivatives PPL$— $— $— $— $18 $— $— $18 LG&E— — — — 18 — — 18 183Table of ContentsCredit Risk-Related Contingent FeaturesCertain derivative contracts contain credit risk-related contingent features which, when in a net liability position, would permit the counterparties to require the transfer of additional collateral upon a decrease in the credit ratings of PPL, LG&E and KU or certain of their subsidiaries. Most of these features would require the transfer of additional collateral or permit the counterparty to terminate the contract if the applicable credit rating were to fall below investment grade. Some of these features also would allow the counterparty to require additional collateral upon each downgrade in credit rating at levels that remain above investment grade. In either case, if the applicable credit rating were to fall below investment grade, and assuming no assignment to an investment grade affiliate were allowed, most of these credit contingent features require either immediate payment of the net liability as a termination payment or immediate and ongoing full collateralization on derivative instruments in net liability positions.Additionally, certain derivative contracts contain credit risk-related contingent features that require adequate assurance of performance be provided if the other party has reasonable concerns regarding the performance of PPL's, LG&E's and KU's obligations under the contracts. A counterparty demanding adequate assurance could require a transfer of additional collateral or other security, including letters of credit, cash and guarantees from a creditworthy entity. This would typically involve negotiations among the parties. However, amounts disclosed below represent assumed immediate payment or immediate and ongoing full collateralization for derivative instruments in net liability positions with "adequate assurance" features.(PPL)At December 31, 2022, there were an insignificant amount of derivative contracts in a net liability position that contain credit risk-related contingent features, collateral posted on those positions and the related effect of a decrease in credit ratings below investment grade.19. Goodwill and Other Intangible AssetsGoodwill(PPL)The changes in the carrying amount of goodwill by segment were:Kentucky RegulatedRhode Island RegulatedCorporate and Other Total 20222021202220212022202120222021Balance at beginning of period (a)$662 $662 $— $— $53 $53 $715 $715 Goodwill recognized during the period (b)— — 725 — 861 — 1,586 — Sale of Safari Holdings (c)— — — — (53)— (53)— Total$662 $662 $725 $— $861 $53 $2,248 $715 (a)There were no accumulated impairment losses related to goodwill.(b)Recognized as a result of the acquisition of RIE. See Note 9 for additional information.(c)See Note 9 for additional information.Other Intangible Assets(PPL) The gross carrying amount and the accumulated amortization of other intangible assets were:184Table of Contents December 31, 2022December 31, 2021 GrossCarryingAmountAccumulatedAmortizationGrossCarryingAmountAccumulatedAmortizationSubject to amortization: Contracts (a)$125 $99 $125 $90 Renewable Energy Credits14 — — — Land rights and easements407 138 406 135 Licenses and other2 1 20 6 Total subject to amortization548 238 551 231 Not subject to amortization due to indefinite life: Land rights and easements17 — 17 — Other— — 6 — Total not subject to amortization due to indefinite life17 — 23 — Total$565 $238 $574 $231 (a)Gross carrying amount in 2022 and 2021 includes the fair value at the acquisition date of the OVEC power purchase contract with terms favorable to market recognized as a result of the 2010 acquisition of LKE by PPL.Current intangible assets are included in "Other current assets" and long-term intangible assets are included in "Other intangibles" on the Balance Sheets.Amortization expense was as follows: 202220212020Intangible assets with no regulatory offset$5 $9 $7 Intangible assets with regulatory offset9 8 8 Total$14 $17 $15 Amortization expense for each of the next five years is estimated to be: 20232024202520262027Intangible assets with no regulatory offset$5 $5 $5 $4 $4 Intangible assets with regulatory offset9 8 8 2 — Total$14 $13 $13 $6 $4 (PPL Electric)The gross carrying amount and the accumulated amortization of other intangible assets were: December 31, 2022December 31, 2021 GrossCarryingAmountAccumulatedAmortizationGrossCarryingAmountAccumulatedAmortizationSubject to amortization: Land rights and easements$385 $134 $382 $130 Licenses and other2 1 2 1 Total subject to amortization387 135 384 131 Not subject to amortization due to indefinite life: Land rights and easements17 — 17 — Total$404 $135 $401 $131 Intangible assets are shown as "Intangibles" on the Balance Sheets.Amortization expense was as follows: 202220212020Intangible assets with no regulatory offset$4 $4 $4 185Table of ContentsAmortization expense for each of the next five years is estimated to be: 20232024202520262027Intangible assets with no regulatory offset$4 $4 $4 $4 $4 (LG&E)The gross carrying amount and the accumulated amortization of other intangible assets were: December 31, 2022December 31, 2021 GrossCarryingAmountAccumulatedAmortizationGrossCarryingAmountAccumulatedAmortizationSubject to amortization: Land rights and easements$7 $1 $7 $1 OVEC power purchase agreement (a)86 68 86 62 Total subject to amortization$93 $69 $93 $63 (a) Gross carrying amount represents the fair value at the acquisition date of the OVEC power purchase contract recognized as a result of the 2010 acquisition by PPL. An offsetting regulatory liability was recorded related to this contract, which is being amortized over the same period as the intangible asset, eliminating any income statement impact. See Note 7 for additional information.Long-term intangible assets are presented as "Other intangibles" on the Balance Sheets.Amortization expense was as follows: 202220212020Intangible assets with regulatory offset$6 $5 $6 Amortization expense for each of the next five years is estimated to be: 20232024202520262027Intangible assets with regulatory offset$6 $6 $6 $1 $— (KU)The gross carrying amount and the accumulated amortization of other intangible assets were: December 31, 2022December 31, 2021 GrossCarryingAmountAccumulatedAmortizationGrossCarryingAmountAccumulatedAmortizationSubject to amortization: Land rights and easements$16 $3 $16 $4 OVEC power purchase agreement (a)39 31 39 28 Total subject to amortization$55 $34 $55 $32 (a) Gross carrying amount represents the fair value at the acquisition date of the OVEC power purchase contract recognized as a result of the 2010 acquisition by PPL. An offsetting regulatory liability was recorded related to this contract, which is being amortized over the same period as the intangible asset, eliminating any income statement impact. See Note 7 for additional information.Long-term intangible assets are presented as "Other intangibles" on the Balance Sheets.Amortization expense was as follows: 202220212020Intangible assets with no regulatory offset$— $1 $— Intangible assets with regulatory offset3 3 2 Amortization expense for each of the next five years is estimated to be:186Table of Contents 20232024202520262027Intangible assets with regulatory offset$3 $2 $2 $1 $— 20. Asset Retirement Obligations(PPL and PPL Electric)PPL Electric has identified legal retirement obligations for the retirement of certain transmission assets that could not be reasonably estimated due to indeterminable settlement dates. These assets are located on rights-of-way that allow the grantor to require PPL Electric to relocate or remove the assets. Since this option is at the discretion of the grantor of the right-of-way, PPL Electric is unable to determine when these events may occur.(PPL, LG&E and KU)PPL's, LG&E's and KU's ARO liabilities are primarily related to CCR closure costs. See Note 14 for information on the CCR rule. LG&E also has AROs related to natural gas mains and wells. LG&E's and KU's transmission and distribution lines largely operate under perpetual property easement agreements, which do not generally require restoration upon removal of the property. Therefore, no material AROs are recorded for transmission and distribution assets. For LG&E and KU, all ARO accretion and depreciation expenses are reclassified as a regulatory asset or regulatory liability. ARO regulatory assets associated with certain CCR projects are amortized to expense in accordance with regulatory approvals. For other AROs, deferred accretion and depreciation expense is recovered through cost of removal.The changes in the carrying amounts of AROs were as follows: PPLLG&EKU 202220212022202120222021ARO at beginning of period$189 $182 $84 $67 $105 $115 Acquisition of RIE (a)10 — — — — — Accretion6 16 3 5 3 11 Obligations incurred2 — 2 — — — Changes in estimated timing or cost15 56 12 40 4 16 Obligations settled(45)(65)(15)(28)(30)(37)ARO at end of period$177 $189 $86 $84 $82 $105 21. Accumulated Other Comprehensive Income (Loss)(PPL)The after-tax changes in AOCI by component for the years ended December 31 were as follows: Defined benefit plans ForeigncurrencytranslationadjustmentsUnrealized gains (losses) onqualifyingderivativesEquityinvestees'AOCIPriorservicecostsActuarialgain(loss)TotalPPL December 31, 2019$(1,425)$(5)$— $(18)$(2,910)$(4,358)Amounts arising during the year267 (19)— (1)(341)(94)Reclassifications from AOCI— 24 — 3 205 232 Net OCI during the year267 5 — 2 (136)138 December 31, 2020$(1,158)$— $— $(16)$(3,046)$(4,220)Amounts arising during the year372 (39)— — (1)332 Reclassifications from AOCI— 25 — 2 126 153 Reclassifications from AOCI due to the sale of the U.K. utility business (Note 9)786 15 — 8 2,769 3,578 Net OCI during the year1,158 1 — 10 2,894 4,063 December 31, 2021$— $1 $— $(6)$(152)$(157)187Table of Contents Defined benefit plans ForeigncurrencytranslationadjustmentsUnrealized gains (losses) onqualifyingderivativesEquityinvestees'AOCIPriorservicecostsActuarialgain(loss)TotalAmounts arising during the year— — 2 (1)11 12 Reclassifications from AOCI— 2 — 2 17 21 Net OCI during the year— 2 2 1 28 33 December 31, 2022$— $3 $2 $(5)$(124)$(124)The following table presents PPL's gains (losses) and related income taxes for reclassifications from AOCI for the years ended December 31, 2022, 2021 and 2020. The defined benefit plan components of AOCI are not reflected in their entirety in the statement of income; rather, they are included in the computation of net periodic defined benefit costs (credits) and subject to capitalization. See Note 12 for additional information.PPLDetails about AOCI202220212020Affected Line Item on theStatements of IncomeQualifying derivatives Interest rate swaps$(3)$11 $(8)Interest Expense— (2)(2)Income (Loss) from Discontinued Operations (net of income taxes)Cross-currency swaps— (39)(22)Income (Loss) from Discontinued Operations (net of income taxes)Total Pre-tax(3)(30)(32) Income Taxes1 5 8 Total After-tax(2)(25)(24) Defined benefit plans Prior service costs(3)(3)(4) Net actuarial loss(24)(159)(256) Total Pre-tax(27)(162)(260) Income Taxes8 34 52 Total After-tax(19)(128)(208) Sale of the U.K. utility business (Note 9)Foreign currency translation adjustments— (646)— Income (Loss) from Discontinued Operations (net of income taxes)Qualifying derivatives— (15)— Income (Loss) from Discontinued Operations (net of income taxes)Defined benefit plans— (3,577)— Income (Loss) from Discontinued Operations (net of income taxes)Total Pre-tax— (4,238)— Income Taxes— 660 — Total After-tax— (3,578)— Total reclassifications during the year$(21)$(3,731)$(232) 188Table of ContentsITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSUREPPL Corporation, PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities CompanyNone.ITEM 9A. CONTROLS AND PROCEDURES(a)Evaluation of disclosure controls and procedures.PPL Corporation, PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities CompanyThe Registrants' principal executive officers and principal financial officers, based on their evaluation of the Registrants' disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934) have concluded that, as of December 31, 2022, the Registrants' disclosure controls and procedures are effective to ensure that material information relating to the Registrants and their consolidated subsidiaries is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms, particularly during the period for which this annual report has been prepared. The aforementioned principal officers have concluded that the disclosure controls and procedures are also effective to ensure that information required to be disclosed in reports filed under the Exchange Act is accumulated and communicated to management, including the principal executive officers and principal financial officers, to allow for timely decisions regarding required disclosure.PPL CorporationPPL acquired Narragansett Electric on May 25, 2022. Narragansett Electric is included in the 2022 financial statements as of the date of the acquisition and accounted for -5.8% of net income and 16.1% and 20.5% of consolidated total assets and net assets, respectively, of PPL Corporation for the year ended December 31, 2022. Due to the timing of deal close and Narragansett Electric’s heavily integrated systems and processes with National Grid, Narragansett Electric was excluded from a formal evaluation of effectiveness of PPL Corporation's disclosure controls and procedures. PPL is evaluating changes to processes, information technology systems and other components of internal controls over financial reporting as part of its ongoing integration activities.(b)Changes in internal control over financial reporting.PPL Corporation As reported in the 2022 second quarter 10-Q, PPL's principal executive officer and principal financial officer have concluded that there was a change in PPL’s internal controls over financial reporting resulting from the Narragansett Electric transaction during the second fiscal quarter that had a material effect on PPL’s internal control over financial reporting. PPL's principal executive officer and principal financial officer have concluded that there were no other changes in the Registrant's internal control over financial reporting during the Registrant's full fiscal year that have materially affected, or are reasonably likely to materially affect, the Registrant's internal control over financial reporting.PPL Corporation, PPL Electric Utilities Corporation, Louisville Gas and Electric Company, and Kentucky Utilities CompanyThe Registrants' principal executive officers and principal financial officers have concluded that there were no changes in the Registrants' internal control over financial reporting during the Registrants' fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Registrants' internal control over financial reporting.Management's Report on Internal Control over Financial ReportingPPL CorporationPPL's management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) or 15d-15(f). PPL's internal control over financial reporting is a process designed to provide reasonable assurance to PPL's management and Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted 189Table of Contentsaccounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in "Internal Control - Integrated Framework" (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in "Internal Control - Integrated Framework" (2013), our management concluded that our internal control over financial reporting was effective as of December 31, 2022. The effectiveness of our internal control over financial reporting has been audited by Deloitte & Touche LLP, an independent registered public accounting firm.In accordance with SEC rules, management excluded Narragansett Electric from its evaluation of internal control over financial reporting due to the timing of deal close and Narragansett Electric’s heavily integrated systems and processes with National Grid. Narragansett Electric accounted for -5.7% of net income and 15.9% and 20.5% of consolidated total assets and net assets, respectively, of PPL Corporation for the year ended December 31, 2022. As discussed above, PPL Corporation is evaluating changes to processes, information technology systems and other components of internal control over financial reporting as part of its ongoing integration activities.PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities CompanyManagement of PPL's non-accelerated filer companies, PPL Electric, LG&E and KU, are responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) or 15d-15(f). Each of the aforementioned companies' internal control over financial reporting is a process designed to provide reasonable assurance to management and Board of Directors of these companies regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.Under the supervision and with the participation of our management, including the principal executive officers and principal financial officers of the companies listed above, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in "Internal Control - Integrated Framework" (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in "Internal Control - Integrated Framework" (2013), management of these companies concluded that our internal control over financial reporting was effective as of December 31, 2022. This annual report does not include an attestation report of Deloitte & Touche LLP, the companies' independent registered public accounting firm regarding internal control over financial reporting for these non-accelerated filer companies. The effectiveness of internal control over financial reporting for the aforementioned companies was not subject to attestation by the companies' registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit these companies to provide only management's report in this annual report.190Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Shareowners and the Board of Directors of PPL CorporationOpinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of PPL Corporation and subsidiaries (the “Company”) as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended December 31, 2022, of the Company and our report dated February 17, 2023, expressed an unqualified opinion on those financial statements.As described in Management’s Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Narragansett Electric due to the timing of deal close and Narragansett Electric’s heavily integrated systems and processes with National Grid. Narragansett Electric accounted for -5.7% of net income and 15.9% and 20.5% of consolidated total assets and net assets, respectively, of PPL Corporation for the year ended December 31, 2022. Accordingly, our audit did not include the internal control over financial reporting at Narragansett Electric. Basis for OpinionThe Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate./s/ Deloitte & Touche LLPMorristown, New JerseyFebruary 17, 2023191Table of ContentsITEM 9B. OTHER INFORMATIONPPL Corporation, PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities CompanyNone. ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONSPPL Corporation, PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities CompanyNot applicable.192Table of ContentsPART IIIITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCEPPL CorporationAdditional information required by this Item is incorporated by reference to, and will be contained in, our definitive proxy statement, which will be filed within 120 days after December 31, 2022. Accordingly, we have omitted the information from this Item pursuant to General Instruction G(3) of Form 10-K.PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities CompanyItem 10 is omitted as PPL Electric, LG&E and KU meet the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K.193Table of ContentsEXECUTIVE OFFICERS OF THE REGISTRANTS Officers of the Registrants are elected annually by their Boards of Directors to serve at the pleasure of the respective Boards. There are no family relationships among any of the executive officers, nor is there any arrangement or understanding between any executive officer and any other person pursuant to which the officer was selected. There have been no events under any bankruptcy act, no criminal proceedings and no judgments or injunctions material to the evaluation of the ability and integrity of any executive officer during the past five years. Listed below are the executive officers at December 31, 2022. PPL CorporationNameAgePositions Held During the Past Five YearsDatesVincent Sorgi51President and Chief Executive OfficerJune 2020 - presentPresident and Chief Operating OfficerJuly 2019 - May 2020Executive Vice President and Chief Financial OfficerJanuary 2019 - June 2019Senior Vice President and Chief Financial OfficerJune 2014 - January 2019Joseph P. Bergstein, Jr.52Executive Vice President and Chief Financial OfficerApril 2021 - presentSenior Vice President and Chief Financial OfficerJuly 2019 - April 2021Vice President-Investor Relations and Corporate Development & PlanningJanuary 2018 - June 2019Vice President-Investor Relations and TreasurerJanuary 2016 - December 2017Gregory N. Dudkin (a)(b)65Executive Vice President and Chief Operating OfficerApril 2021 - December 2022President-PPL ElectricMarch 2012 - April 2021Angela K. Gosman (c)54Senior Vice President and Chief Human Resources OfficerJanuary 2022 - presentVice President and Chief Human Resources Officer-PPL ServicesAugust 2021 - December 2021Vice President - Human Resources-PPL EU ServicesMay 2020 - July 2021Director - Human Resources-LKESeptember 2016 - May 2020Wendy E. Stark (d)50Senior Vice President, General Counsel, Corporate Secretary and Chief Legal OfficerJanuary 2022 - presentSenior Vice President, General Counsel and Corporate SecretaryApril 2021 - December 2021Stephanie R. Raymond (e)52President-PPL ElectricApril 2021 - presentVice President-Distribution OperationsJanuary 2018 - April 2021Vice President-Transmission and SubstationsJanuary 2014 - December 2017John R. Crockett III (e)58President-LKEOctober 2021 - presentGeneral Counsel, Chief Compliance Officer and Corporate SecretaryJanuary 2018 - September 2021David J. Bonenberger (e)61President-RIEMay 2022 - presentVice President-Operations Integration-PPL ServicesApril 2021 - presentVice President-Transmission and Substations-PPL ElectricJanuary 2018 - April 2021Vice President-Distribution Operations-PPL ElectricJuly 2021 - December 2017194Table of ContentsNameAgePositions Held During the Past Five YearsDatesMarlene C. Beers51Vice President and ControllerMarch 2019 - presentVice President-Finance and Regulatory Affairs and Controller-PPL Electric August 2018 - February 2019Controller-PPL ElectricFebruary 2016 - July 2018Tadd J. Henninger (f)47Vice President-Finance and TreasurerJuly 2019 - presentVice President and TreasurerJanuary 2018 - July 2019Assistant TreasurerDecember 2015 - December 2017 (a)Effective January 1, 2023, Gregory N. Dudkin was elected as Executive Vice President of PPL Corporation. Mr. Dudkin was on extended medical leave and passed away on February 14, 2023.(b)Effective January 1, 2023, Francis X. Sullivan was elected Executive Vice President and Chief Operating Officer of PPL Corporation.(c)Effective January 1, 2023, Angela K. Gosman was elected as Executive Vice President and Chief Human Resources Officer of PPL Corporation.(d)Effective January 1, 2023, Wendy E. Stark was elected as Executive Vice President, Chief Legal Officer and Corporate Secretary of PPL Corporation.(e)Designated an executive officer of PPL by virtue of their respective positions at a PPL subsidiary.(f)Effective January 23, 2023, Tadd J. Henninger was elected as Senior Vice President-Finance and Treasurer of PPL Corporation.ITEM 11. EXECUTIVE COMPENSATION PPL CorporationThe information required by this Item is incorporated by reference to, and will be contained in, our definitive proxy statement, which will be filed within 120 days after December 31, 2022. Accordingly, we have omitted the information from this Item pursuant to General Instruction G(3) of Form 10-K. PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities Company Item 11 is omitted as PPL Electric, LG&E and KU meet the conditions set forth in General Instructions (I)(1)(a) and (b) of Form 10-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTAND RELATED STOCKHOLDER MATTERSPPL CorporationAdditional information required by this Item is incorporated by reference to, and will be contained in, our definitive proxy statement, which will be filed within 120 days after December 31, 2022. Accordingly, we have omitted the information from this Item pursuant to General Instruction G(3) of Form 10-K. In addition, provided below in tabular format is information as of December 31, 2022, with respect to compensation plans (including individual compensation arrangements) under which equity securities of PPL are authorized for issuance.Equity Compensation Plan Information Number of securities to beissued upon exercise ofoutstanding options, warrantsand rights (3)Weighted-average exerciseprice of outstanding options,warrants and rights (3)Number of securitiesremaining available for futureissuance under equitycompensation plans (4) Equity compensation1,279,543 – DDCPplans approved by9,173,480 – SIPsecurity holders (1)171,552 – ICPKE$27.04 – ICPKE146,982 – ICPKE 10,600,005 – TotalEquity compensation plans not approved by security holders (2) 195Table of Contents(1)Includes (a) the ICPKE, under which stock options, restricted stock, restricted stock units, performance units, dividend equivalents and other stock-based compensation awards may be awarded to non-executive key employees of PPL and its subsidiaries; (b) the SIP approved by shareowners in 2017 under which stock options, restricted stock, restricted stock units, performance units, dividend equivalents and other stock-based compensation awards may be awarded to executive officers of PPL and its subsidiaries; and (c) the DDCP, under which stock units may be awarded to directors of PPL. See Note 11 to the Financial Statements for additional information.(2)All of PPL's current compensation plans under which equity securities of PPL are authorized for issuance have been approved by PPL's shareowners.(3)Relates to common stock issuable upon the exercise of stock options awarded under the SIP and ICPKE as of December 31, 2022. In addition, as of December 31, 2022, the following other securities had been awarded and are outstanding under the SIP, ICPKE and DDCP: 265,566 restricted stock units, 453,846 TSR performance awards, 356,550 ROE performance awards, 92,011 EG performance awards and 92,011 ESG performance awards under the SIP; 916,851 restricted stock units 232,861 TSR performance awards, 152,820 ROE performance awards, 49,869 EG performance awards and 49,869 ESG performance awards under the ICPKE; and 561,013 stock units under the DDCP.(4)Based upon the following aggregate award limitations under the SIP, ICPKE and DDCP: (a) under the SIP, 15,000,000 awards; (b) under the ICPKE, 16,573,608 awards (i.e., 5% of the total PPL common stock outstanding as of January 1, 2003) granted after April 25, 2003, reduced by outstanding awards for which common stock was not yet issued as of such date of 2,373,812 resulting in a limit of 14,199,796; and (c) under the DDCP, the number of stock units available for issuance was reduced to 2,000,000 stock units in March 2012. In addition, the ICPKE includes an annual award limitation of 2% of total PPL common stock outstanding as of January 1 of each year.PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities CompanyItem 12 is omitted as PPL Electric, LG&E and KU meet the conditions set forth in General Instructions (I)(1)(a) and (b) of Form 10-K.196Table of ContentsITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE PPL Corporation The information required by this Item is incorporated by reference to, and will be contained in, our definitive proxy statement, which will be filed within 120 days after December 31, 2022. Accordingly, we have omitted the information from this Item pursuant to General Instruction G(3) of Form 10-K. PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities Company Item 13 is omitted as PPL Electric, LG&E and KU meet the conditions set forth in General Instructions (I)(1)(a) and (b) of Form 10-K. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICESPPL CorporationThe information required by this Item is incorporated by reference to, and will be contained in, our definitive proxy statement, which will be filed within 120 days after December 31, 2022. Accordingly, we have omitted the information from this Item pursuant to General Instruction G(3) of Form 10-K.PPL Electric Utilities Corporation For the fiscal years ended 2022 and 2021, Deloitte & Touche LLP (Deloitte) served as PPL Electric's independent auditor. The following table presents an allocation of fees billed, including expenses, by the independent auditor to PPL Electric, for professional services rendered for the audits of PPL Electric's annual financial statements and for fees billed for other services rendered by Deloitte.20222021 (in thousands)Audit fees (a)$1,221 $1,345 Audit-related fees (b)17 17 (a)Includes estimated fees for audit of annual financial statements and review of financial statements included in PPL Electric's Quarterly Reports on Form 10-Q and for services in connection with statutory and regulatory filings or engagements, including comfort letters and consents for financings and filings made with the SEC.(b)Fees for agreed-upon procedures related to annual EPA filings.Louisville Gas and Electric CompanyFor the fiscal years ended 2022 and 2021, Deloitte served as LG&E's independent auditor. The following table presents an allocation of fees billed, including expenses, by the independent auditor to LG&E, for professional services rendered for the audits of LG&E's annual financial statements and for fees billed for other services rendered by Deloitte. 20222021 (in thousands)Audit fees (a)$831 $952 (a)Includes estimated fees for audit of annual financial statements and review of financial statements included in LG&E's Quarterly Reports on Form 10-Q and for services in connection with statutory and regulatory filings or engagements, including comfort letters and consents for financings and filings made with the SEC.Kentucky Utilities CompanyFor the fiscal years ended 2022 and 2021, Deloitte served as KU's independent auditor. The following table presents an allocation of fees billed, including expenses, by the independent auditor to KU, for professional services rendered for the audits of KU's annual financial statements and for fees billed for other services rendered by Deloitte.197Table of Contents 20222021 (in thousands)Audit fees (a)$920 $928 (a)Includes estimated fees for audit of annual financial statements and review of financial statements included in KU's Quarterly Reports on Form 10-Q and for services in connection with statutory and regulatory filings or engagements, including comfort letters and consents for financings and filings made with the SEC.PPL Corporation, PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities CompanyApproval of Fees. The Audit Committee of PPL has procedures for pre-approving audit and non-audit services to be provided by the independent auditor. These procedures are designed to ensure the continued independence of the independent auditor. More specifically, the use of the independent auditor to perform either audit or non-audit services is prohibited unless specifically approved in advance by the Audit Committee of PPL. As a result of this approval process, the Audit Committee of PPL has pre-approved specific categories of services and authorization levels. All services outside of the specified categories and all amounts exceeding the authorization levels are approved by the Chair of the Audit Committee of PPL, who serves as the Committee designee to review and approve audit and non-audit related services during the year. A listing of the approved audit and non-audit services is reviewed with the full Audit Committee of PPL no later than its next meeting.The Audit Committee of PPL approved 100% of the 2022 and 2021 services provided by Deloitte.198Table of ContentsPART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULESPPL Corporation, PPL Electric Utilities Corporation, Louisville Gas and Electric Company and Kentucky Utilities Company(a) The following documents are filed as part of this report:1.Financial Statements - Refer to the "Table of Contents" for an index of the financial statements included in this report.2.Supplementary Data and Supplemental Financial Statement Schedule - included in response to
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS TABLE OF CONTENTS PageOverview54COVID-1955Outlook55Industry Trends56Current Market Conditions57Impact of Changes in the Interest Rate Environment57Results of Operations60Consolidated Results of Operations60Segment Results of Operations61Segment Measures62Impact of Foreign Currency Exchange Rates63Accounting Policies & Pronouncements65Application of Critical Accounting Estimates65Adoption of New Accounting Pronouncements76Results of Operations by Segment76PGIM76U.S. Businesses80Retirement Strategies81Group Insurance88Individual Life90Assurance IQ91International Businesses92Corporate and Other95Divested and Run-off Businesses96Closed Block Division97Income Taxes98Experience-Rated Contractholder Liabilities, Assets Supporting Experience-Rated Contractholder Liabilities and Other Related Investments99Valuation of Assets and Liabilities100General Account Investments102Liquidity and Capital Resources125Ratings139Risk Management14153Table of ContentsCertain of the statements included in this section constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are made based on management’s current expectations and beliefs concerning future developments and their potential effects upon Prudential Financial, Inc. and its subsidiaries. Prudential Financial, Inc.’s actual results may differ, possibly materially, from expectations or estimates reflected in such forward-looking statements. Certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements can be found in the “Risk Factors” and “Forward-Looking Statements” sections included herein.Pursuant to the FAST Act Modernization and Simplification of Regulation S-K, discussions related to the results of operations for the year ended December 31, 2021 in comparison to the year ended December 31, 2020 have been omitted. For such omitted discussions, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.Overview We have operations primarily in the United States of America (“U.S.”), Asia, Europe and Latin America. Through our subsidiaries and affiliates, we offer a wide array of financial products and services, including life insurance, annuities, retirement solutions, mutual funds and investment management. We offer these products and services to individual and institutional customers through one of the largest distribution networks in the financial services industry.In October 2021, we announced the creation of Retirement Strategies, a new U.S. business that would serve the retirement needs of both our institutional and individual customers by bringing the institutional investment and pension solutions offered through our Retirement business together with the financial solutions and capabilities of our Individual Annuities business. Commencing with the second quarter of 2022, this new structure has been fully operationalized; therefore, the results of our former Retirement segment (now known as the “Institutional Retirement Strategies” operating segment) and our former Individual Annuities segment (now known as the “Individual Retirement Strategies” operating segment) have been aggregated into the Retirement Strategies segment. Prior periods have been updated to conform to this new presentation.Our principal operations consist of PGIM (our global investment management business), our U.S. Businesses (consisting of our Retirement Strategies, Group Insurance, Individual Life and Assurance IQ businesses), our International Businesses, the Closed Block division, and our Corporate and Other operations. The Closed Block division is accounted for as a divested business that is reported separately from the Divested and Run-off Businesses that are included in Corporate and Other. Divested and Run-off Businesses are composed of businesses that have been, or will be, sold or exited, including businesses that have been placed in wind-down status that do not qualify for “discontinued operations” accounting treatment under generally accepted accounting principles in the United States of America (“U.S. GAAP”). Our Corporate and Other operations include corporate items and initiatives that are not allocated to business segments as well as the Divested and Run-off Businesses described above. See “Business—” for a description of our sources of revenue and details on how our profitability is impacted. In addition, our profitability is impacted by our ability to effectively deploy capital, utilize our tax capacity and manage expenses.Management expects that results in 2023 will continue to benefit from our differentiated mix of market-leading businesses that complement each other to provide competitive advantages, earnings diversification and capital benefits from a balanced risk profile. We believe we are well-positioned to tap into market opportunities to meet the evolving needs of individual customers, workplace clients, and society at large. Our mix of high-quality protection, retirement and investment management businesses enables us to offer solutions that cover a broad range of financial needs and to engage with our clients through multiple channels. We aim to expand our addressable market, build deeper and longer-lasting relationships with customers and clients, and meaningfully improve their financial wellness.In order to become more competitive, we are working to enhance the experience of our customers and the capabilities of our businesses, which we expect will improve margins. In 2019, we launched programs in pursuit of these objectives that have resulted and will continue to result in multi-year investments in technology and employee reskilling, as well as severance and related charges. In 2022, we incurred approximately $145 million of costs in connection with these programs. We expect these programs will generate significant expense efficiencies over several years that will mitigate the impact from increases in other expenses due to inflation and business growth initiatives. As of December 31, 2022, we have exceeded $750 million of annual run-rate cost savings, one year ahead of our target date.54Table of ContentsCOVID-19Since the first quarter of 2020, the COVID-19 pandemic has caused extreme stress and disruption in the global economy and financial markets and elevated mortality and morbidity for the global population. The COVID-19 pandemic impacted our results of operations in the current period and could continue to impact our results of operations in future periods.Throughout the pandemic, COVID-19 had a significant net negative impact on our underwriting results, reflecting unfavorable mortality and morbidity impacts in our Group Insurance, Individual Life and International businesses, partially offset by favorable mortality impacts in the Institutional portion of our Retirement Strategies business. Beginning with the third quarter of 2022, the Company has embedded COVID-19 considerations within its best estimate assumptions of future expected mortality impacts for its applicable businesses. The ultimate impact on our underwriting results, however, will continue to depend on various factors including: an insured’s age; geographic concentration; insured versus uninsured populations among the fatalities; the transmissibility and virulence of the virus, including the potential for further mutation; and the ongoing acceptance and efficacy of the vaccines and other therapeutics.In addition, other COVID-19 related impacts are discussed in the following sections of this document:•Business Outlooks. See “—Outlook” for a discussion of specific outlook considerations for each of our businesses, including any impacts related to COVID-19.•Results of Operations by Segment. See “—Results of Operations by Segment” for a discussion of COVID-19 impacts on segment results, where applicable.•Risk Management. See “—Risk Management—COVID-19” for a discussion of our risk management framework and its incorporation of pandemic stress scenarios.•Risk Factors. See “Risk Factors” for a discussion of the risks to our businesses posed by the COVID-19 pandemic.OutlookWe feel confident about our prospects for the future based on the foundation of our integrated and complementary businesses. We plan to continue our transformation towards becoming less market-sensitive, including efforts to further de-risk, such as through reinsurance transactions, and to deliver sustainable long-term growth, including through investing in products and solutions that meet the evolving needs of our customers. Our plan remains to reallocate capital across the businesses with the intention of increasing the earnings contribution from our higher-growth businesses and reducing capital allocated to lower-growth, more capital-intensive businesses. Specific outlook considerations for each of our businesses include the following:•PGIM. Our global investment management business, PGIM, is focused on maintaining strong investment performance while leveraging the scale of its approximately $1.228 trillion of assets under management and diversified global operations. We are broadening our distribution channels and asset management capabilities through acquisitions and organic initiatives to better serve our clients and support growth. In addition to serving third-party clients, we provide our U.S. and International businesses with a competitive advantage through our investment expertise across a broad array of asset classes, including public and private asset class capabilities. Underpinning our growth strategy is our ability to continue to deliver robust investment performance and to attract and retain high-caliber investment talent.There remain risks to earnings across the asset management industry as adverse changes in market conditions (e.g., market declines, higher rates or credit spread widening) could lead to lower fee-based revenues, incentive fees taking longer to be realized and losses in our seed and co-investments. An economic downturn could also have impacts on real estate prices as well as transaction volumes in certain private asset classes. We believe PGIM’s uniquely diversified global platform is well positioned to be resilient in the face of market and industry headwinds.55Table of Contents•Retirement Strategies. We remain focused on helping customers meet their investment and retirement needs. Consistent with the Company’s strategy of becoming higher growth and less market sensitive, the sales of our Full Service Retirement business and a portion of our traditional variable annuity block of business were completed in the second quarter of 2022. See Note 1 to the Consolidated Financial Statements for additional information regarding these dispositions. Our remaining Institutional Retirement Strategies business continues to be focused on providing products that respond to the needs of plan sponsors, retirees, and annuitants to manage risk and control their benefit costs while maintaining appropriate pricing and return expectations under changing market conditions. We expect our differentiated capabilities and demonstrated execution to drive our business momentum in the Pension Risk Transfer and International Reinsurance markets; however, we expect that growth will not be linear due to the episodic nature of these transactions. In Individual Retirement Strategies, we continue to execute on our strategy to pivot to less interest rate-sensitive products to ensure we realize appropriate returns within the current economic environment. We expect to continue to shift our focus to products that provide protected outcomes for our customers across a wide range of economic environments through simpler, technology-enabled channels. We expect account values, fee income, and spread income to be impacted by volatile market conditions. •Group Insurance. We are a leading group benefits provider with a focus on further diversifying our portfolio by expanding our Premier and Association segments and growing voluntary supplemental health, while maintaining leadership in the National segment.•Individual Life. We continue to focus on making life insurance solutions more accessible to financial professionals and direct customers by providing a broad product portfolio, including growing the amount of accumulation and simplified protection product options, coupled with our multi-channel distribution capabilities. We have taken pricing and product actions to ensure we realize appropriate returns for the current economic environment and to diversify our product mix to further limit our sensitivity to interest rates.•Assurance IQ. We remain focused on expanding our addressable market and increasing access to more retail customers through our agent and digital channels. We continue to expand carriers and product offerings on our platform in an effort to meet our customers’ evolving needs.•International Businesses. We remain focused on meeting customers’ protection and financial needs as well as maintaining the underlying strength of our distribution channels. Our strategy is to maintain and strengthen our position in Japan while expanding our footprint in select high-growth emerging markets. We believe our needs-based selling and death protection focus are even more valuable to consumers based on the global experience of COVID-19 and will help support the continued long-term growth of our businesses. We continue to invest in our existing businesses and regularly assess acquisition opportunities to build scale and complement our businesses in support of our long-term growth. We recently expanded into South Africa by acquiring a 33% ownership interest in Alexander Forbes Group Holdings Limited. Industry TrendsOur U.S. and International Businesses are impacted by financial markets, economic conditions, regulatory oversight, and a variety of trends that affect the industries in which we compete.Financial and Economic Environment: •U.S. Businesses. As discussed further under “—Impact of Changes in the Interest Rate Environment” below, interest rates in the U.S. have experienced a sustained period of historically low levels, followed by a sharp rise in 2022. We expect that a continued level of higher interest rates will benefit our results over time. We continue to monitor current market conditions and the impact to our businesses from slowing or negative economic growth. In addition, we are subject to financial impacts associated with movements in equity markets and the evolution of the credit cycle as discussed in “—Segment Results of Operations”, where applicable, and more broadly in “Item 1A. Risk Factors”.•International Businesses. Our International Businesses’ operations, especially in Japan, have operated in a low interest rate environment for many years, as discussed under “—Impact of Changes in the Interest Rate Environment” below, and these low interest rates negatively impact our net investment spread results and reinvestment yields. In addition, we are subject to financial impacts associated with movements in foreign currency rates, particularly the Japanese yen. Fluctuations in the value of the yen can impact the relative attractiveness to customers of both yen-denominated and non-yen denominated products thereby impacting both sales and surrenders. 56Table of ContentsIn addition, we are subject to financial impacts associated with movements in equity markets and the evolution of the credit cycle as discussed in “—Segment Results of Operations”, where applicable, and more broadly in “Item 1A. Risk Factors”.Demographics: •U.S. Businesses. Customer demographics continue to evolve and new opportunities present themselves in different consumer segments such as the millennial and multicultural markets. Consumer expectations and preferences are changing. We believe existing and potential customers are increasingly looking for cost-effective solutions that they can easily understand and access through technology-enabled devices. At the same time, income protection, wealth accumulation and the needs of retiring baby boomers are continuing to shape the insurance industry. A persistent retirement security gap exists in terms of both savings and protection. Despite the ongoing shift of the risk and responsibility of retirement savings from employers to employees, employers are increasingly focusing on the financial wellness of their employees.•International Businesses. Japan has an aging population as well as a large pool of household assets invested in low-yielding deposit and savings vehicles. The aging of Japan’s population, along with strains on government pension and healthcare programs, have led to a growing demand for products that provide financial solutions for retirement and wealth transfer, as well as for health-related products.Regulatory Environment. See “Business—Regulation” for a discussion of regulatory developments that may impact the Company and the associated risks.Competitive Environment. See “Business—” for a discussion of the competitive environment and the basis on which we compete in each of our segments.Current Market ConditionsGeopolitical risk, rapidly rising interest rates and significant equity market declines, as we saw throughout 2022, among other factors, adversely impact our liquidity and capital positions, cash flows, results of operations, and financial position. The statutory capital of certain of our insurance subsidiaries will also be negatively affected by increased reserve requirements due to our annual update of actuarial assumptions and other refinements, particularly in our Individual Life business, and will be negatively affected by asymmetrical and non-economic statutory accounting impacts from rising rates. As we navigate through the current environment, we may take actions consistent with our risk and capital frameworks, as necessary, to preserve our liquidity and capital positions. For additional information on how these conditions may also impact our income taxes, see Note 16 to the Consolidated Financial Statements. Impact of Changes in the Interest Rate Environment As a global financial services company, market interest rates are a key driver of our liquidity and capital positions, cash flows, results of operations and financial position. Changes in interest rates can affect these in several ways, including favorable or adverse impacts to:•investment-related activity, including: investment income returns, net investment spread results, new money rates, mortgage loan prepayments and bond redemptions;•the valuation of fixed income investments and derivative instruments;•collateral posting requirements, hedging costs and other risk mitigation activities;•customer account values and assets under management, including their impacts on fee-related income;•insurance reserve levels, market experience true-ups and amortization of both deferred policy acquisition costs (“DAC”) and value of business acquired (“VOBA”);•policyholder behavior, including surrender or withdrawal activity;•product offerings, design features, crediting rates and sales mix; and•the fair value of, and possible impairments on, intangible assets such as goodwill.See “—Current Market Conditions” above, for how rapidly rising interest rates, among other factors, adversely impact the Company’s financial results. For additional information regarding interest rate risks, see “Risk Factors—Market Risk”.57Table of ContentsSee below for a discussion of the current interest rate environment and its impact to net investment spread in our U.S. and Japanese operations along with the composition of their insurance liabilities and policyholder account balances.U.S. Operations excluding the Closed Block Division While interest rates in the U.S. have experienced a sustained period of historically low levels in recent years, rates increased throughout 2022 and our average reinvestment yield is generally now exceeding our current average portfolio yield.In order to manage the impacts that changes in interest rates have on our net investment spread, we employ a proactive asset/liability management program, which includes strategic asset allocation and hedging strategies within a disciplined risk management framework. These strategies seek to match the characteristics of our products, and to closely approximate the interest rate sensitivity of the assets with the estimated interest rate sensitivity of the product liabilities. Our asset/liability management program also helps manage duration gaps, currency and other risks between assets and liabilities through the use of derivatives. We adjust this dynamic process as products change, as customer behavior changes and as changes in the market environment occur. As a result, our asset/liability management process has permitted us to manage the interest rate risk associated with our products through several market cycles. Our interest rate exposure is also mitigated by our business mix, which includes lines of business for which fee-based and insurance underwriting earnings play a more prominent role in product profitability. We also regularly examine our product offerings and their profitability. As a result, we may reprice certain products and discontinue sales of other products that do not meet our profit expectations. The portion of the general account supporting our U.S. Businesses and our Corporate and Other operations has approximately $178 billion of fixed maturity securities and commercial mortgage loans (based on net carrying value) as of December 31, 2022, with an average portfolio yield of approximately 4.3%. For the portion of the general account attributable to these operations, we estimate annual principal payments and prepayments that we would be required to reinvest to be approximately 7.7% of the fixed maturity security and commercial mortgage loan portfolios through 2024. Included in the $178 billion of fixed maturity securities and commercial mortgage loans are approximately $142 billion that are subject to call or redemption features at the issuer’s option and have a weighted average interest rate of approximately 4%. Of this $142 billion, approximately 55% contain provisions for prepayment premiums. Future operating results will be impacted by (i) the reinvestment of scheduled payments or prepayments (not subject to a prepayment fee) at different rates compared to the current portfolio yield, including in some cases at rates below those guaranteed under our insurance contracts, and (ii) our utilization of other asset/liability management strategies, as described above, in order to maintain favorable net investment spread. The following table sets forth the insurance liabilities and policyholder account balances of our U.S. operations excluding the Closed Block Division, by type, for the date indicated:As ofDecember 31, 2022(in billions)Long-duration insurance products with fixed and guaranteed terms$156 Contracts with adjustable crediting rates subject to guaranteed minimums36 Participating contracts where investment income risk ultimately accrues to contractholders2 Total$194 The $156 billion above relates to long-duration products such as group annuities, structured settlements and other insurance products that have fixed and guaranteed terms. We seek to manage the impact of changes in interest rates on these contracts through asset/liability management, as discussed above. The $36 billion above relates to contracts with crediting rates that may be adjusted over the life of the contract, subject to guaranteed minimums. Although we may have the ability to lower crediting rates for those contracts above guaranteed minimums, our willingness to do so may be limited by competitive pressures. The following table sets forth the related account values by range of guaranteed minimum crediting rates and the related range of the difference, in basis points (“bps”), between rates being credited to contractholders as of December 31, 2022, and the respective guaranteed minimums. 58Table of Contents Account Values with Adjustable Crediting Rates Subject to Guaranteed Minimums: Atguaranteedminimum1-49bps aboveguaranteedminimum50-99bps aboveguaranteedminimum100-150bps aboveguaranteedminimumGreater than150bps aboveguaranteedminimumTotal ($ in billions)Range of Guaranteed Minimum Crediting Rates:Less than 1.00%$1.0 $0.9 $0.0 $0.0 $0.0 $1.9 1.00% - 1.99%1.2 0.1 0.1 0.9 2.5 4.8 2.00% - 2.99%1.1 0.0 1.6 1.6 2.8 7.1 3.00% - 4.00%18.5 0.0 1.9 0.5 0.2 21.1 Greater than 4.00%0.8 0.0 0.0 0.0 0.0 0.8 Total(1)$22.6 $1.0 $3.6 $3.0 $5.5 $35.7 Percentage of total63 %3 %10 %9 %15 %100 % __________(1)Includes approximately $0.2 billion related to contracts that impose a market value adjustment if the invested amount is not held to maturity.The remaining $2 billion of insurance liabilities and policyholder account balances in these operations relates to participating contracts for which the investment income risk is expected to ultimately accrue to contractholders. The crediting rates for these contracts are periodically adjusted based on the return earned on the related assets.Closed Block DivisionSubstantially all of the $49 billion of general account assets in the Closed Block division support obligations and liabilities relating to the Closed Block policies only. See Note 15 to the Consolidated Financial Statements for additional information regarding the Closed Block.Japanese Operations Japan has experienced a low interest rate environment for many years. In recent years, the Bank of Japan’s monetary policy has resulted in even lower and, at times, negative yields for certain tenors of government bonds; however, their monetary policy was eased in the fourth quarter of 2022, which led to an increase in rates. In order to manage, to the extent possible, the impact that the current interest rate environment has on our net investment spread, our Japanese operations employ a proactive asset/liability management program. We continue to purchase long-term bonds with tenors of 30 years or greater. We also regularly examine our product offerings and their profitability. As a result, we may reprice certain products, adjust commissions for certain products and discontinue sales of other products that do not meet our profit expectations. Additionally, our diverse product portfolio in terms of currency mix and premium payment structure allows us to further manage any impacts from changes in the interest rate environment. Our Japanese operations have continued to invest in U.S. dollar-denominated assets supporting our U.S. dollar-denominated product portfolio, which has now driven average reinvestment rates to exceed current average portfolio rates. For additional information regarding sales within these operations, see “—International Businesses—Sales Results,” below.The portion of the general account supporting our Japanese operations has approximately $152 billion of fixed maturity securities and commercial mortgage loans (based on net carrying value) as of December 31, 2022, with an average portfolio yield of approximately 2.6%. For the portion of the general account attributable to these operations, we estimate annual principal payments and prepayments that we would be required to reinvest to be approximately 6.4% of the fixed maturity security and commercial mortgage loan portfolios through 2024.Included in the $152 billion of fixed maturity securities and commercial mortgage loans are approximately $16 billion that are subject to call or redemption features at the issuer’s option and have a weighted average interest rate of approximately 4%. Of this $16 billion, approximately 7% contain provisions for prepayment premiums. Future operating results will be impacted by (i) the reinvestment of scheduled payments or prepayments (not subject to a prepayment fee) at different rates compared to the current portfolio yield, including in some cases at rates below those guaranteed under our insurance contracts, and (ii) our utilization of other asset/liability management strategies, as described above, in order to maintain favorable net investment spread. 59Table of ContentsThe following table sets forth the insurance liabilities and policyholder account balances of our Japanese operations, by type, for the date indicated:As ofDecember 31, 2022 (in billions)Insurance products with fixed and guaranteed terms$130 Contracts with a market value adjustment if invested amount is not held to maturity25 Contracts with adjustable crediting rates subject to guaranteed minimums10 Total$165 The $130 billion is primarily comprised of long-duration insurance products that have fixed and guaranteed terms, for which underlying assets may have to be reinvested at interest rates that are lower than current portfolio yields. The remaining insurance liabilities and policyholder account balances include $25 billion related to contracts that impose a market value adjustment if the invested amount is not held to maturity and $10 billion related to contracts with crediting rates that may be adjusted over the life of the contract, subject to guaranteed minimums. Most of the current crediting rates on these contracts, however, are at or near contractual minimums. Although we have the ability in some cases to lower crediting rates for those contracts that are above guaranteed minimum crediting rates, the majority of this business has interest crediting rates that are determined by formula.Results of Operations Consolidated Results of OperationsThe following table summarizes net income (loss) for the periods presented: Year ended December 31, 202220212020 (in millions)Revenues$60,050 $70,934 $57,033 Benefits and expenses61,826 61,553 57,356 Income (loss) before income taxes and equity in earnings of operating joint ventures(1,776)9,381 (323)Income tax expense (benefit)(370)1,674 (81)Income (loss) before equity in earnings of operating joint ventures(1,406)7,707 (242)Equity in earnings of operating joint ventures, net of taxes(56)87 96 Net income (loss)(1,462)7,794 (146)Less: Income attributable to noncontrolling interests(24)70 228 Net income (loss) attributable to Prudential Financial, Inc.$(1,438)$7,724 $(374) 2022 to 2021 Annual Comparison. The $9,162 million decrease in “Net income (loss) attributable to Prudential Financial, Inc.” reflected the following notable items on a pre-tax basis:•$6,878 million unfavorable variance from realized investment gains (losses), net, and related charges and adjustments for PFI, excluding the impact of the hedging program associated with certain variable annuities;•$2,651 million unfavorable variance from lower adjusted operating income from our business segments, including an unfavorable net impact from our annual reviews and update of assumptions and other refinements, primarily within the Individual Life business, and the absence of a gain from the sale of the Company’s 35% ownership stake in Pramerica SGR recorded in the prior year period, partially offset by a gain from the sale of PALAC; •$950 million unfavorable variance reflecting the impact from changes in the value of our embedded derivatives and related hedge positions, net of DAC and other costs, associated with certain variable annuities; and•$879 million unfavorable variance reflecting lower results from our Divested and Run-off Businesses in the current year period, partially offset by a gain from the sale of our Full Service Retirement business.Partially offsetting these decreases in “Net income (loss) attributable to Prudential Financial, Inc.” was a $2,044 million favorable variance from income taxes reflecting the decrease in pre-tax earnings.60Table of ContentsSegment Results of Operations We analyze the performance of our segments and Corporate and Other operations using a measure of segment profitability called adjusted operating income. See “—Segment Measures” for a discussion of adjusted operating income and its use as a measure of segment operating performance.Shown below are the adjusted operating income contributions of each segment and Corporate and Other operations for the periods indicated and a reconciliation of this segment measure of performance to “Income (loss) before income taxes and equity in earnings of operating joint ventures” as presented in the Consolidated Statements of Operations. Year ended December 31, 202220212020 (in millions)Adjusted operating income before income taxes by segment:PGIM$843 $1,643 $1,262 U.S. Businesses:Retirement Strategies4,223 4,079 2,855 Group Insurance(16)(455)(16)Individual Life(1,215)393 (48)Assurance IQ(113)(142)(88)Total U.S. Businesses2,879 3,875 2,703 International Businesses2,404 3,390 2,952 Corporate and Other(1,476)(1,607)(1,967)Total segment adjusted operating income before income taxes4,650 7,301 4,950 Reconciling items:Realized investment gains (losses), net, and related adjustments(5,670)1,947 (4,140)Charges related to realized investment gains (losses), net(1)(531)(320)(160)Market experience updates781 750 (640)Divested and Run-off Businesses(2):Closed Block division(32)140 (24)Other Divested and Run-off Businesses9 716 (450)Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests(3)(44)(41)90 Other adjustments(4)(939)(1,112)51 Consolidated income (loss) before income taxes and equity in earnings of operating joint ventures$(1,776)$9,381 $(323)__________(1)Includes charges that represent the impact of realized investment gains (losses), net, on the amortization of DAC and other costs, and on changes in reserves. Also includes charges resulting from payments related to market value adjustment features of certain of our annuity products and the impact of realized investment gains (losses), net, on the amortization of unearned revenue reserves (“URR”). (2)Represents the contribution to income (loss) of Divested and Run-off Businesses that have been or will be sold or exited, including businesses that have been placed in wind-down, but did not qualify for “discontinued operations” accounting treatment under U.S. GAAP. See “—Divested and Run-off Businesses” for additional information.(3)Equity in earnings of operating joint ventures are included in adjusted operating income but excluded from “Income (loss) before income taxes and equity in earnings of operating joint ventures” as they are reflected on an after-tax U.S. GAAP basis as a separate line in the Consolidated Statements of Operations. Earnings attributable to noncontrolling interests are excluded from adjusted operating income but included in “Income (loss) before income taxes and equity in earnings of operating joint ventures” as they are reflected on a U.S. GAAP basis as a separate line in the Consolidated Statements of Operations. Earnings attributable to noncontrolling interests represent the portion of earnings from consolidated entities that relates to the equity interests of minority investors.(4)Includes goodwill impairments of $903 million and $1,060 million recorded in the fourth quarters of 2022 and 2021, respectively, related to Assurance IQ. See Note 2 and Note 10 to the Consolidated Financial Statements for additional information.Segment results for 2022 presented above reflect the following: PGIM. Results for 2022 decreased in comparison to 2021, primarily reflecting the absence of a gain in the prior year period from the sale of our 35% ownership stake in Pramerica SGR, and lower net other related revenues and net asset management fees.Retirement Strategies. Results for 2022 increased in comparison to 2021, inclusive of a favorable comparative net impact from our annual reviews and update of assumptions and other refinements. Excluding this item, results increased, primarily 61Table of Contentsdriven by the gain on sale of PALAC, lower expenses and market value gains on a strategic investment, partially offset by lower fee income, net of distribution expenses and other associated costs, and lower net investment spread results.Group Insurance. Results for 2022 increased in comparison to 2021, inclusive of an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Excluding this item, results increased, primarily driven by higher underwriting results, partially offset by lower net investment spread results.Individual Life. Results for 2022 decreased in comparison to 2021, inclusive of an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Excluding this item, results decreased, primarily driven by lower net investment spread results, partially offset by higher underwriting results.Assurance IQ. Results for 2022 increased in comparison to 2021, inclusive of an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Excluding this item, results increased, primarily driven by an increase in the Medicare line, partially offset by a decrease in the Health Under 65 line.International Businesses. Results for 2022 decreased in comparison to 2021, inclusive of an unfavorable net impact from foreign currency exchange rates and an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Excluding these items, results decreased, primarily driven by lower net investment spread results, lower underwriting results and lower earnings from joint venture investments.Corporate and Other. Results for 2022 reflected decreased losses in comparison to 2021, primarily driven by favorable pension and employee benefit results and lower net charges from other corporate activities.Closed Block Division. Results for 2022 decreased in comparison to 2021, primarily driven by lower net investment activity results, partially offset by a reduction in the policyholder dividend obligation.Segment Measures Adjusted Operating Income. In managing our business, we analyze our segments’ operating performance using “adjusted operating income.” Adjusted operating income does not equate to “Income (loss) before income taxes and equity in earnings of operating joint ventures” or “Net income (loss)” as determined in accordance with U.S. GAAP but is the measure of segment profit or loss we use to evaluate segment performance and allocate resources and, consistent with authoritative guidance, is our measure of segment performance. The adjustments to derive adjusted operating income are important to an understanding of our overall results of operations. Adjusted operating income is not a substitute for income determined in accordance with U.S. GAAP, and our definition of adjusted operating income may differ from that used by other companies; however, we believe that the presentation of adjusted operating income as we measure it for management purposes enhances the understanding of our results of operations by highlighting the results from ongoing operations and the underlying profitability of our businesses. See Note 22 to the Consolidated Financial Statements for additional information regarding the presentation of segment results and our definition of adjusted operating income. Annualized New Business Premiums. In managing our Individual Life, Group Insurance and International Businesses segments, we analyze annualized new business premiums, which do not correspond to revenues under U.S. GAAP. Annualized new business premiums measure the current sales performance of the business, while revenues primarily reflect the renewal persistency of policies written in prior years and net investment income, in addition to current sales. Annualized new business premiums include 10% of first year premiums or deposits from single pay products. No other adjustments are made for limited pay contracts.The amount of annualized new business premiums for any given period can be significantly impacted by several factors, including but not limited to: addition of new products, discontinuation of existing products, changes in credited interest rates for certain products and other product modifications, changes in premium rates, changes in tax laws, changes in regulations or changes in the competitive environment. Sales volume may increase or decrease prior to certain of these changes becoming effective, and then fluctuate in the other direction following such changes.Assets Under Management. In managing our PGIM segment, we analyze assets under management (which do not correspond directly to U.S. GAAP assets) because the principal source of revenues is fees based on assets under management. Assets under management represent the fair market value or account value of assets that we manage directly for institutional clients, retail clients, and for our general account, as well as assets invested in our products that are managed by third-party managers.62Table of ContentsAccount Values. In managing our Retirement Strategies segment, we analyze account values, which do not correspond directly to U.S. GAAP assets. Net additions (withdrawals) in our Institutional Retirement Strategies business and sales (redemptions) in our Individual Retirement Strategies business do not correspond to revenues under U.S. GAAP but are used as a relevant measure of business activity.Impact of Foreign Currency Exchange RatesForeign currency exchange rate movements and related hedging strategies As a U.S.-based company with significant business operations outside the U.S., particularly in Japan, we are subject to foreign currency exchange rate movements that could impact our U.S. dollar (“USD”)-equivalent shareholder return on equity. We seek to mitigate this impact through various hedging strategies, including holding USD-denominated assets in certain of our foreign subsidiaries.In order to reduce equity volatility from foreign currency exchange rate movements, we primarily utilize a yen hedging strategy that calibrates the hedge level to preserve the relative contribution of our yen-based business to the Company’s overall return on equity on a leverage neutral basis. We implement this hedging strategy utilizing a variety of instruments, including USD-denominated assets and dual currency and synthetic dual currency investments held locally in our Japanese insurance subsidiaries. The total hedge level may vary based on our periodic assessment of the relative contribution of our yen-based business to the Company’s overall return on equity.The table below presents the aggregate amount of instruments that serve to hedge the impact of foreign currency exchange movements on our USD-equivalent shareholder return on equity from our Japanese insurance subsidiaries as of the dates indicated. December 31, 20222021 (in billions)Foreign currency hedging instruments:USD-denominated assets held in yen-based entities(1)$7.8 $9.5 Dual currency and synthetic dual currency investments(2)0.4 0.5 Total foreign currency hedges$8.2 $10.0 __________(1)Includes USD-denominated fixed maturities at amortized cost plus any related accrued investment income, as well as USD notional amount of foreign currency derivative contracts outstanding. Note this amount represents only those USD assets serving to hedge the impact of foreign currency volatility on equity. Separate from this program, our Japanese operations also have $70.1 billion and $74.3 billion as of December 31, 2022 and 2021, respectively, of USD-denominated assets supporting USD-denominated liabilities related to USD-denominated products.(2)Dual currency and synthetic dual currency investments are held by our yen-based entities in the form of fixed maturities and loans with a yen-denominated principal component and USD-denominated interest income. The amounts shown represent the present value of future USD-denominated cash flows. The USD-denominated investments that hedge the impact of foreign currency exchange rate movements on USD-equivalent shareholder return on equity from our Japanese insurance operations are reported within yen-based entities and, as a result, foreign currency exchange rate movements will impact their value reported within our yen-based Japanese insurance entities. We seek to mitigate the risk that future unfavorable foreign currency exchange rate movements will decrease the value of these USD-denominated investments reported within our yen-based Japanese insurance entities, and therefore negatively impact their equity and regulatory solvency margins, by having our Japanese insurance operations enter into currency hedging transactions with a subsidiary of Prudential Financial. These hedging strategies have the economic effect of moving the change in value of these USD-denominated investments due to foreign currency exchange rate movements from our Japanese yen-based entities to our USD-based entities. These USD-denominated investments also pay a coupon which is generally higher than what a similar yen-denominated investment would pay. The incremental impact of this higher yield on our USD-denominated investments, as well as our dual currency and synthetic dual currency investments, will vary over time, and is dependent on the duration of the underlying investments as well as interest rate environments in both the U.S. and Japan at the time of the investments. 63Table of ContentsImpact of intercompany foreign currency exchange rate arrangements on segment results of operations The financial results of our International Businesses and PGIM reflect the impact of intercompany arrangements with our Corporate and Other operations pursuant to which these segments’ non-USD-denominated earnings are translated at fixed currency exchange rates. Results of our Corporate and Other operations include differences between the translation adjustments recorded by the segments at the fixed currency exchange rate versus the actual average rate during the period. In addition, specific to our International Businesses where we hedge certain currencies, the results of our Corporate and Other operations also include the impact of any gains or losses recorded from the forward currency contracts that settled during the period, which include the impact of any over or under hedging of actual earnings that differ from projected earnings.For our International Businesses, the fixed currency exchange rates are generally determined in connection with a foreign currency income hedging program designed to mitigate the impact of exchange rate changes on the segment’s expected USD-equivalent earnings. Pursuant to this program, our Corporate and Other operations execute forward currency contracts with third-parties to sell the net exposure of projected earnings for certain currencies in exchange for USD at specified exchange rates. The maturities of these contracts correspond with the future periods (typically on a three-year rolling basis) in which the identified non-USD-denominated earnings are expected to be generated. For our International Businesses and PGIM, the fixed currency exchange rates for the current year are predetermined during the third quarter of the prior year using forward currency exchange rates. The table below presents, for the periods indicated, the increase (decrease) to revenues and adjusted operating income for the International Businesses, PGIM and Corporate and Other operations, reflecting the impact of these intercompany arrangements. Year ended December 31, 202220212020 (in millions)Segment impacts of intercompany arrangements:International Businesses$(57)$15 $64 PGIM11 (1)(4)Impact of intercompany arrangements(1)(46)14 60 Corporate and Other:Impact of intercompany arrangements(1)46 (14)(60)Settlement gains (losses) on forward currency contracts(2)21 33 67 Net benefit (detriment) to Corporate and Other67 19 7 Net impact on consolidated revenues and adjusted operating income$21 $33 $67 __________(1)Represents the difference between non-USD-denominated earnings translated on the basis of weighted average monthly currency exchange rates versus fixed currency exchange rates determined in connection with the foreign currency income hedging program.(2)As of December 31, 2022, 2021 and 2020, the total notional amounts of these forward currency contracts within our Corporate and Other operations were $0.7 billion, $0.6 billion and $1.0 billion, respectively. Impact of products denominated in non-local currencies on U.S. GAAP earnings While our international insurance operations offer products denominated in local currency, several also offer products denominated in non-local currencies. This is most notable in our Japanese operations, which currently offer primarily USD-denominated products, but have also historically offered Australian dollar (“AUD”)-denominated products. The non-local currency-denominated insurance liabilities related to these products are supported by investments denominated in corresponding currencies, including a significant portion designated as available-for-sale. While the impact from foreign currency exchange rate movements on these non-local currency-denominated assets and liabilities is economically matched, differences in the accounting for changes in the value of these assets and liabilities due to changes in foreign currency exchange rate movements have historically resulted in volatility in U.S. GAAP earnings. As a result, we implemented a structure in Gibraltar Life’s operations that disaggregated the USD- and AUD-denominated businesses into separate divisions, each with its own functional currency that aligns with the underlying products and investments. The result of this alignment was to reduce differences in the accounting for changes in the value of these assets and liabilities that arise due to changes in foreign currency exchange rate movements. For the USD- and AUD-denominated assets that were transferred under this structure, the net cumulative unrealized investment gains associated with foreign exchange remeasurement that were recorded in “Accumulated other comprehensive income (loss)” (“AOCI”) totaled $1.6 billion and $2.0 billion as of December 31, 2022 and 2021, respectively, and will be recognized in earnings within “Realized 64Table of Contentsinvestment gains (losses), net” over time as these assets mature or are sold. Absent the sale of any of these assets prior to their stated maturity, approximately 8% of the $1.6 billion balance as of December 31, 2022 will be recognized in 2023, approximately 8% will be recognized in 2024, and the remaining balance will be recognized from 2025 through 2051. Highly inflationary economy in Argentina Our insurance operations in Argentina, Prudential of Argentina (“POA”), have historically utilized the Argentine peso as the functional currency given it is the currency of the primary economic environment in which the entity operates. During 2018, Argentina experienced a cumulative inflation rate that exceeded 100% over a 3-year period. As a result, Argentina’s economy was deemed to be highly inflationary, resulting in reporting changes effective July 1, 2018. Under U.S. GAAP, the financial statements of a foreign entity in a highly inflationary economy are to be remeasured as if its functional currency (formerly the Argentine peso) is the reporting currency of its parent reporting entity (the USD) on a prospective basis. While this changed how the results of POA are remeasured and/or translated into USD, the impact to our financial statements was not material nor is it expected to be material in future periods given the relative size of our POA operations. It should also be noted that due to the macroeconomic environment in Argentina, the majority of POA’s balance sheet consists of USD-denominated product liabilities supported by USD-denominated assets. As a result, this accounting change serves to reduce the remeasurement impact reflected in net income given that the functional currency and currency in which the assets and liabilities are denominated will be more closely aligned.Accounting Policies & Pronouncements Application of Critical Accounting Estimates The preparation of financial statements in conformity with U.S. GAAP requires the application of accounting policies that often involve a significant degree of judgment. Management, on an ongoing basis, reviews the estimates and assumptions used in the preparation of our financial statements. If management determines that modifications to assumptions and estimates are appropriate given current facts and circumstances, the Company’s results of operations and financial position as reported in the Consolidated Financial Statements could change significantly.The following sections discuss the accounting policies applied in preparing our financial statements that management believes are most dependent on the application of estimates and assumptions and require management’s most difficult, subjective, or complex judgments.Insurance AssetsDeferred Policy Acquisition Costs and Deferred Sales Inducements We capitalize costs that are directly related to the acquisition or renewal of insurance and annuity contracts. These costs primarily include commissions, as well as costs of policy issuance and underwriting and certain other expenses that are directly related to successfully negotiated contracts. We have also deferred costs associated with sales inducements related to variable and fixed annuity contracts primarily within the Individual portion of our Retirement Strategies segment. Sales inducements are amounts that are credited to the policyholders’ account balances mainly as an incentive to purchase the contract. For additional information about sales inducements, see Note 13 to the Consolidated Financial Statements. We generally amortize DAC and deferred sales inducements (“DSI”) over the expected lives of the contracts, based on our estimates of the level and timing of gross premiums, gross profits, or gross margins, depending on the type of contract. As described in more detail below, in calculating DAC and DSI amortization, we are required to make assumptions about investment returns, mortality, persistency, and other items that impact our estimates of the level and timing of gross premiums, gross profits, or gross margins. We also periodically evaluate the recoverability of our DAC and DSI. For certain contracts, this evaluation is performed as part of our premium deficiency testing, as discussed further below in “—Insurance Liabilities—Future Policy Benefits.” As of December 31, 2022, DAC and DSI for PFI excluding the Closed Block division were $19.3 billion and $0.4 billion, respectively, and DAC in our Closed Block division was $0.2 billion.Amortization methodologies Gross Premiums. DAC, associated with the non-participating term life policies of our Individual Life segment and the whole life, term life, endowment and health policies of our International Businesses segment, is primarily amortized in proportion to gross premiums. Gross premiums are defined as the premiums charged to a policyholder for an insurance contract. Gross Profits. DAC and DSI, associated with the variable and universal life policies of our Individual Life and International Businesses segments and the variable and fixed annuity contracts of our Retirement Strategies and International Businesses segments, are generally amortized over the expected lives of these policies in proportion to total gross profits. Total 65Table of Contentsgross profits include both actual gross profits and estimates of gross profits for future periods. Gross profits are defined as: i) amounts assessed for mortality, contract administration, surrender charges, and other assessments plus amounts earned from investment of policyholder balances, less ii) benefits in excess of policyholder balances, costs incurred for contract administration, the net cost of reinsurance for certain businesses, interest credited to policyholder balances and other credits. If significant negative gross profits are expected in any periods, the amount of insurance in force is generally substituted as the base for computing amortization. U.S. GAAP gross profits and amortization rates also include the impacts of the embedded derivatives associated with certain of the optional living benefit features of our variable annuity contracts, and index-linked crediting features of certain universal life and annuity contracts and related hedging activities. For additional information regarding the significant inputs to the valuation models for these embedded derivatives including capital market assumptions and actuarially-determined assumptions, see below “—Insurance Liabilities—Future Policy Benefits.” In calculating amortization expense, we estimate the amounts of gross profits that will be included in our U.S. GAAP results and in adjusted operating income, and utilize these estimates to calculate distinct amortization rates and expense amounts. We also regularly evaluate and adjust the related DAC and DSI balances with a corresponding charge or credit to current period earnings for the impact of actual gross profits and changes in our projections of estimated future gross profits on our DAC and DSI amortization rates. Adjustments to the DAC and DSI balances include the impact to our estimate of total gross profits of the annual review of assumptions, our quarterly adjustments for current period experience, and our quarterly adjustments for market performance. Each of these adjustments is further discussed below in “—Annual assumptions review and quarterly adjustments.” Gross Margins. DAC associated with the traditional participating products of our Closed Block is amortized over the expected lives of these contracts in proportion to total gross margins. Total gross margins are defined as: i) amounts received from premiums, earned from investment of policyholder balances and other assessments, less ii) benefits paid, costs for contract administration, changes in the net level premium reserve for death and endowment benefits, annual policyholder dividends and other credits. We evaluate our estimates of future gross margins and adjust the related DAC balance with a corresponding charge or credit to current period earnings for the effects of actual gross margins and changes in our expected future gross margins. DAC adjustments for these participating products generally have not created significant volatility in our results of operations since many of the factors that affect gross margins are also included in the determination of our dividends to these policyholders and, during most years, the Closed Block has recognized a cumulative policyholder dividend obligation expense in “Policyholders’ dividends,” for the excess of actual cumulative earnings over expected cumulative earnings as determined at the time of demutualization. However, if actual cumulative earnings fall below expected cumulative earnings in future periods, thereby eliminating the cumulative policyholder dividend obligation expense, changes in gross margins and DAC amortization would result in a net impact to the Closed Block results of operations. As of December 31, 2022, the excess of actual cumulative earnings over the expected cumulative earnings was $3,207 million.The amortization methodologies for products not discussed above primarily relate to less significant DAC and DSI balances associated with products in our Group Insurance segment and the Institutional portion within our Retirement Strategies segment, which comprised approximately 1% of the Company’s total DAC and DSI balances as of December 31, 2022. Value of Business Acquired In addition to DAC and DSI, we also recognize an asset for VOBA, which is an intangible asset that represents an adjustment to the stated value of acquired in-force insurance contract liabilities to present them at fair value, determined as of the acquisition date. VOBA is amortized over the expected life of the acquired contracts using the same methodology and assumptions used to amortize DAC and DSI, as discussed above. VOBA is also subject to recoverability testing. As of December 31, 2022, VOBA was $595 million, and included $571 million related to the acquisition from American International Group (“AIG”) of AIG Star Life Insurance Co., Ltd, AIG Edison Life Insurance Company, AIG Financial Assurance Japan K.K. and AIG Edison Service Co., Ltd. (collectively, the “Star and Edison Businesses”) in 2011. The remaining balance primarily relates to previously-acquired traditional life businesses. The VOBA associated with the in-force contracts of the Star and Edison Businesses is less sensitive to assumption changes, as discussed below in “—Annual assumptions review and quarterly adjustments”, as the majority is amortized in proportion to gross premiums which are more predictably stable compared to gross profits.Annual assumptions review and quarterly adjustments We perform an annual comprehensive review of the assumptions used in estimating gross profits for future periods. Over the last several years, the Company’s most significant assumption updates that have resulted in a change to expected future gross profits and the amortization of DAC, DSI and VOBA have been related to lapse and other contractholder behavior assumptions, mortality, and revisions to expected future rates of returns on investments. These assumptions may also cause potential significant variability in amortization expense in the future. The impact on our results of operations of changes in these assumptions can be offsetting and we are unable to predict their movement or offsetting impact over time.66Table of ContentsThe quarterly adjustments for current period experience referred to above reflect the impact of differences between actual gross profits for a given period and the previously estimated expected gross profits for that period. To the extent each period’s actual experience differs from the previous estimate for that period, the assumed level of total gross profits may change. In these cases, we recognize a cumulative adjustment to all previous periods’ amortization, also referred to as an experience true-up adjustment.The quarterly adjustments for market performance referred to above reflect the impact of changes to our estimate of total gross profits to reflect actual fund performance and market conditions. A significant portion of gross profits for our variable annuity contracts and, to a lesser degree, our variable life contracts are dependent upon the total rate of return on assets held in separate account investment options. This rate of return influences the fees we earn on variable annuity and variable life contracts, costs we incur associated with the guaranteed minimum death and guaranteed minimum income benefit features related to our variable annuity contracts and expected claims to be paid on variable life contracts, as well as other sources of profit. Returns that are higher than our expectations for a given period produce higher than expected account balances, which increase the future fees we expect to earn on variable annuity and variable life contracts and decrease the future costs we expect to incur associated with the guaranteed minimum death and guaranteed minimum income benefit features related to our variable annuity contracts, as well as expected claims to be paid on variable life contracts. The opposite occurs when returns are lower than our expectations. The changes in future expected gross profits are used to recognize a cumulative adjustment to all prior periods’ amortization.The weighted average rate of return assumptions used in developing estimated market returns consider many factors specific to each product type, including asset durations, asset allocations and other factors. With regard to equity market assumptions, the near-term future rate of return assumption used in evaluating DAC, DSI and VOBA and liabilities for future policy benefits for certain of our products, primarily our domestic variable annuity and domestic and international variable life insurance products is generally updated each quarter and is derived using a reversion to the mean approach, a common industry practice. Under this approach, we consider historical equity returns and adjust projected equity returns over an initial future period of five years (the “near-term”) so that equity returns converge to the long-term expected rate of return. If the near-term projected future rate of return is greater than our near-term maximum future rate of return of 15.0%, we use our maximum future rate of return. If the near-term projected future rate of return is lower than our near-term minimum future rate of return of 0%, we use our minimum future rate of return. As of December 31, 2022, our domestic variable annuities and variable life insurance businesses assume an 8.0% long-term equity expected rate of return and a 6.9% near-term mean reversion equity expected rate of return, and our international variable life insurance business assumes a 4.8% long-term equity expected rate of return and a 3.1% near-term mean reversion equity expected rate of return.With regard to interest rate assumptions used in evaluating DAC, DSI and VOBA and liabilities for future policy benefits for certain of our products, we update the long-term and near-term future rates used to project fixed income returns annually and quarterly, respectively. As a result of our 2022 annual reviews and update of assumptions and other refinements, we kept our long-term expectation of the 10-year U.S. Treasury rate and 10-year Japanese Government Bond yield unchanged and continue to grade to rates of 3.25% and 1.00%, respectively, over ten years. As part of our quarterly market experience updates, we update our near-term projections of interest rates to reflect changes in current rates. Insurance Liabilities Future Policy Benefits Future Policy Benefit Reserves, including Unpaid Claims and Claim Adjustment Expenses We establish reserves for future policy benefits to, or on behalf of, policyholders using methodologies prescribed by U.S. GAAP. The reserving methodologies used include the following: •For most long-duration contracts, we utilize a net premium valuation methodology in measuring the liability for future policy benefits. Under this methodology, a liability for future policy benefits is accrued when premium revenue is recognized. The liability, which represents the present value of future benefits to be paid to or on behalf of policyholders and related expenses less the present value of future net premiums (portion of the gross premium required to provide for all benefits and expenses), is estimated using methods that include assumptions applicable at the time the insurance contracts are made with provisions for the risk of adverse deviation, as appropriate. Original assumptions continue to be used in subsequent accounting periods to determine changes in the liability for future policy benefits (often referred to as the “lock-in concept”) unless a premium deficiency exists. The result of the net premium valuation methodology is that the liability at any point in time represents an accumulation of the portion of premiums received to date expected to be needed to fund future benefits (i.e., net premiums received to date), less any benefits and expenses already paid. The liability does not necessarily reflect the full policyholder obligation the 67Table of ContentsCompany expects to pay at the conclusion of the contract since a portion of that obligation would be funded by net premiums received in the future and would be recognized in the liability at that time. We perform premium deficiency tests using best estimate assumptions as of the testing date without provisions for adverse deviation. If the liabilities determined based on these best estimate assumptions are greater than the net reserves (i.e., GAAP reserves net of any DAC, DSI or VOBA asset), the existing net reserves are first adjusted by reducing these assets by the amount of the deficiency or to zero through a charge to current period earnings. If the deficiency is more than these asset balances for insurance contracts, we then increase the net reserves by the excess, again through a charge to current period earnings. If a premium deficiency is recognized, the assumptions as of the premium deficiency test date are locked-in and used in subsequent valuations and the net reserves continue to be subject to premium deficiency testing. In addition, for limited-payment contracts, future policy benefit reserves also include a deferred profit liability representing gross premiums received in excess of net premiums. The deferred profits are generally recognized in revenue in a constant relationship with insurance in force or with the amount of expected future benefit payments.•For certain contract features, such as those related to guaranteed minimum death benefits (“GMDB”), guaranteed minimum income benefits (“GMIB”) and no-lapse guarantees, a liability is established when associated assessments (which include policy charges for administration, mortality, expense, surrender, and other, regardless of how characterized) are recognized. This liability is established using current best estimate assumptions and is based on the ratio of the present value of total expected excess payments (e.g., payments in excess of account value) over the life of the contract divided by the present value of total expected assessments (i.e., benefit ratio). The liability equals the current benefit ratio multiplied by cumulative assessments recognized to date, plus interest, less cumulative excess payments to date. The result of the benefit ratio method is that the liability at any point in time represents an accumulation of the portion of assessments received to date expected to be needed to fund future excess payments, less any excess payments already paid. The liability does not necessarily reflect the full policyholder obligation the Company expects to pay at the conclusion of the contract since a portion of that excess payment would be funded by assessments received in the future and would be recognized in the liability at that time. Similar to as described above for DAC, the reserves are subject to adjustments based on annual reviews of assumptions and quarterly adjustments for experience, including market performance. These adjustments reflect the impact on the benefit ratio of using actual historical experience from the issuance date to the balance sheet date plus updated estimates of future experience. The updated benefit ratio is then applied to all prior periods’ assessments to derive an adjustment to the reserve recognized through a benefit or charge to current period earnings.•For certain product guarantees, primarily certain optional living benefit features of the variable annuity products in the Individual portion of our Retirement Strategies segment including guaranteed minimum accumulation benefits (“GMAB”), guaranteed minimum withdrawal benefits (“GMWB”) and guaranteed minimum income and withdrawal benefits (“GMIWB”), the benefits are accounted for as embedded derivatives using a fair value accounting framework. The fair value of these contracts is calculated as the present value of expected future benefit payments to contractholders less the present value of assessed rider fees attributable to the embedded derivative feature. Under U.S. GAAP, the fair values of these benefit features are based on assumptions a market participant would use in valuing these embedded derivatives. Changes in the fair value of the embedded derivatives are recorded quarterly through a benefit or charge to current period earnings. For additional information regarding the valuation of these embedded derivatives, see Note 6 to the Consolidated Financial Statements.•In certain instances, the policyholder liability for a particular line of business may not be deficient in the aggregate to trigger loss recognition, but the pattern of earnings may be such that profits are expected to be recognized in earlier years followed by losses in later years. In these situations, accounting standards require that an additional liability (Profits Followed by Losses or “PFL” liability) be recognized by an amount necessary to sufficiently offset the losses that would be recognized in later years. The PFL liability is based on our current estimate of the present value of the amount necessary to offset losses anticipated in future periods. Because the liability is measured on a discounted basis, there will also be accretion into future earnings through an interest charge, and the liability will ultimately be released into earnings as an offset to future losses. Historically, the Company’s PFL liabilities have been predominantly associated with certain universal life contracts that measure net GAAP reserves using current best estimate assumptions and accordingly, have been updated each quarter using current in-force and market data and as part of the annual assumption update. At the target accrual date (i.e., date of peak deficiency), the PFL liability transitions to a premium deficiency reserve and, for universal life products, will continue to be updated each quarter using current in-force and market data and as part of the annual assumption update.The assumptions used in establishing reserves are generally based on the Company’s experience, industry experience and/or other factors, as applicable. We update our actuarial assumptions, such as mortality, morbidity, retirement and policyholder behavior assumptions, annually, unless a material change is observed in an interim period that we feel is indicative of a long-term trend. Generally, we do not expect trends to change significantly in the short-term and, to the extent these trends may change, we expect such changes to be gradual over the long-term.68Table of Contents The following paragraphs provide additional details about the reserves we have established: International Businesses. The reserves for future policy benefits of our International Businesses, which as of December 31, 2022, represented 43% of our total future policy benefit reserves, primarily relate to non-participating whole life and term life products and endowment contracts, and are generally calculated using the net premium valuation methodology, as described above. The primary assumptions used in determining expected future benefits and expenses include mortality, lapse, morbidity, investment yield and maintenance expense assumptions. Reserves also include claims reported but not yet paid, and claims incurred but not yet reported. In addition, future policy benefit reserves for certain contracts also include amounts related to our deferred profit liability, as described above. Retirement Strategies. The reserves for future policy benefits of our Institutional Retirement Strategies business, which as of December 31, 2022, represented 27% of our total future policy benefit reserves, primarily relate to our non-participating life contingent group annuity and structured settlement products and are generally calculated using the net premium valuation methodology, as described above. The primary assumptions used in establishing these reserves include mortality, retirement, maintenance expense and investment yield assumptions. In addition, future policy benefit reserves for certain contracts also include amounts related to our deferred profit liability, as described above.The reserves for future policy benefits of our Individual Retirement Strategies business, which as of December 31, 2022, represented 2% of our total future policy benefit reserves, primarily relate to reserves for the GMDB and GMIB features of our variable annuities, and for the optional living benefit features that are accounted for as embedded derivatives. As discussed above, in establishing reserves for GMDBs and GMIBs, we utilize current best estimate assumptions. The primary assumptions used in establishing these reserves generally include annuitization, lapse, withdrawal and mortality assumptions, as well as interest rate and equity market return assumptions. Lapse rates are adjusted at the contract level based on the in-the-moneyness of the benefit and reflect other factors, such as the applicability of any surrender charges. Lapse rates are reduced when contracts are more in-the-money. Lapse rates are also generally assumed to be lower for the period where surrender charges apply. For life contingent payout annuity contracts, we establish reserves using best estimate assumptions with provisions for adverse deviations as of inception or best estimate assumptions as of the most recent loss recognition date.The reserves for certain optional living benefit features, including GMAB, GMWB and GMIWB are accounted for as embedded derivatives at fair value, as described above. This methodology could result in either a liability or contra-liability balance, given changing capital market conditions and various actuarial assumptions. Since there is no observable active market for the transfer of these obligations, the valuations are calculated using internally-developed models with option pricing techniques. The models are based on a risk neutral valuation framework and incorporate premiums for risks inherent in valuation techniques, inputs, and the general uncertainty around the timing and amount of future cash flows. The significant inputs to the valuation models for these embedded derivatives include capital market assumptions, such as interest rate levels and volatility assumptions, the Company’s market-perceived risk of its own non-performance risk (“NPR”), as well as actuarially-determined assumptions, including mortality rates and contractholder behavior, such as lapse rates, benefit utilization rates and withdrawal rates. Capital market inputs and actual contractholders’ account values are updated each quarter based on capital market conditions as of the end of the quarter, including interest rates, equity markets and volatility. In the risk neutral valuation, the initial swap curve drives the total returns used to grow the contractholders’ account values. Through the first quarter of 2022, the Company’s discount rate assumption was based on the London Inter-Bank Offered Rate (“LIBOR”) swap curve adjusted for an additional spread, which included an estimate of NPR. As of the second quarter of 2022, the Company’s discount rate assumption substituted the Secured Overnight Financial Rate (“SOFR”) for LIBOR as part of the annual assumption update. The discount rate assumption continues to use an additional spread which includes an estimate of NPR. Actuarial assumptions, including contractholder behavior and mortality, are reviewed at least annually, and updated based upon emerging experience, future expectations and other data, including any observable market data, such as available industry studies or market transactions such as acquisitions and reinsurance transactions. For additional information regarding the valuation of these optional living benefit features, see Note 6 to the Consolidated Financial Statements.Individual Life. The reserves for future policy benefits of our Individual Life segment, which as of December 31, 2022, represented 7% of our total future policy benefit reserves, primarily relate to term life, universal life and variable life products. For term life contracts, the future policy benefit reserves are generally calculated using the net premium valuation methodology, as described above. The primary assumptions used in determining expected future benefits and expenses include mortality, lapse, investment yield and maintenance expense assumptions. For variable and universal life products, which include universal life contracts that contain no-lapse guarantees, reserves for future policy benefits are primarily established using the reserving methodology for GMDB and GMIB contracts, which utilizes current best estimate assumptions, as discussed above. The primary assumptions used in establishing these reserves generally include mortality, lapse, and premium pattern, as well as interest rate and equity market return assumptions. Reserves also include claims reported but not yet paid, and claims incurred but not yet reported.69Table of ContentsGroup Insurance. The reserves for future policy benefits of our Group Insurance segment, which as of December 31, 2022, represented 2% of our total future policy benefit reserves, primarily relate to reserves for group life and disability benefits. For short-duration contracts, a liability is established when the claim is incurred. The reserves for group life and disability benefits also include a liability for unpaid claims and claim adjustment expenses, which relates primarily to the group long-term disability product. This liability represents our estimate of the present value of future disability claim payments and expenses as well as estimates of claims that have been incurred, but have not yet been reported, as of the balance sheet date. The primary assumptions used in determining expected future claim payments are claim termination factors, an assumed interest rate and expected Social Security offsets. The remaining reserves for future policy benefits for group life and disability benefits relate primarily to our group life business, and include reserves for waiver of premium, claims reported but not yet paid, and claims incurred but not yet reported. The waiver of premium reserve is calculated as the present value of future benefits and utilizes assumptions such as expected mortality and recovery rates. The reserve for claims reported but not yet paid is based on the inventory of claims that have been reported but not yet paid. The reserve for claims incurred but not yet reported is estimated using expected patterns of claims reporting.Corporate and Other. The reserves for future policy benefits of our Corporate & Other operations, which as of December 31, 2022, represented 3% of our total future policy benefit reserves, primarily relate to our long-term care products and are generally calculated using the net premium valuation methodology, as described above. Due to the recognition of a premium deficiency in the first quarter of 2020 as a result of the decline in interest rates, the active life reserves associated with our long-term care contracts are valued with the best estimate assumptions at that time. The primary assumptions used in establishing these reserves include interest rate, morbidity, mortality, lapse, premium rate increase and maintenance expense assumptions. In addition, certain reserves for our long-term care products, including our disabled life reserves, are established each reporting period using current best estimate assumptions. Closed Block Division. The future policy benefit reserves for the traditional participating life insurance products of the Closed Block division, which as of December 31, 2022, represented 16% of our total future policy benefit reserves are determined using the net premium valuation methodology, as described above. In applying this method, we use mortality assumptions to determine our expected future benefits and expected future premiums, and apply an interest rate to determine the present value of both of these amounts. The mortality assumptions are based on standard industry mortality tables that were used to determine the cash surrender value of the policies, and the interest rates used are the interest rates used to calculate the cash surrender value of the policies.Policyholders’ Account Balances The policyholders’ account balances liability represents the contract value that has accrued to the benefit of the policyholder as of the balance sheet date. This liability is primarily associated with the accumulated account deposits, plus interest credited, less policyholder withdrawals and other charges assessed against the account balance, as applicable. Our unearned revenue reserve also reported as a component of “Policyholders’ account balances” primarily relates to the variable and universal life products within our Individual Life and International Businesses segments and represents policy charges for services to be provided in future periods. The charges are deferred as unearned revenue and are generally amortized over the expected life of the contract in proportion to the product’s estimated gross profits, similar to DAC, DSI and VOBA as discussed above. Policyholders’ account balances also include amounts representing the fair value of embedded derivative instruments associated with the index-linked features of certain universal life and annuity products. For additional information regarding the valuation of these embedded derivatives, see Note 6 to the Consolidated Financial Statements.Sensitivities for Insurance Assets and Liabilities The following table summarizes the aggregate impact that could result on each of the listed financial statement balances from changes in certain key assumptions. The figures below are presented in aggregate for the Company. The information below is for illustrative purposes and includes only the hypothetical direct impact on December 31, 2022 balances of changes in a single assumption and not changes in any combination of assumptions. Additionally, the illustration of the insurance assumption impacts below reflects a parallel shift in the insurance assumptions across the Company; however, these may be non-parallel in practice and only applicable to specific businesses. Changes in current assumptions could result in impacts to financial statement balances that are in excess of the amounts illustrated. A description of the estimates and assumptions used in the preparation of each of these financial statement balances is provided above. For traditional long-duration and limited-payment contracts, U.S. GAAP requires the original assumptions used when the contracts are issued to be locked-in and that those assumptions be used in all future liability calculations as long as the resulting liabilities are adequate to provide for the future benefits and expenses (i.e., there is no premium deficiency). Therefore, these products are not reflected in the sensitivity table below unless the hypothetical change in assumption would result in an adverse impact that would cause a premium deficiency. Similarly, the impact of any favorable hypothetical change in assumptions for traditional long-duration and limited-70Table of Contentspayment contracts is not reflected in the table below given that the current assumption is required to remain locked-in, and instead the positive impacts would be recognized into net income over the life of the policies in force.The impacts presented within this table exclude the following:•The impacts of our asset liability management strategy, which seeks to offset the changes in certain of the balances presented within this table and is primarily composed of investments and derivatives. See further below for a discussion of the estimates and assumptions involved with the application of U.S. GAAP accounting policies for these instruments and “Quantitative and Qualitative Disclosures about Market Risk” for hypothetical impacts on related balances as a result of changes in certain significant assumptions.•The impacts of our Long-Term Care business, a component of our Divested and Run-off Businesses within our Corporate and Other operations. Long-Term Care Business sensitivities are presented separately from the immediately following table in order to provide stand-alone and supplementary information (see “—Sensitivities for the Long-Term Care business within Corporate and Other”). December 31, 2022Increase (Decrease) inHypothetical change in current assumptions:Deferred Policy Acquisition Costs, Deferred Sales Inducements and Value of Business AcquiredFuture Policy Benefits and Policyholders’ Account BalancesNet Impact(in millions)Long-term interest rate:Increase by 25 basis points$50 $(75)$125 Decrease by 25 basis points$(45)$85 $(130)Long-term equity expected rate of return:Increase by 50 basis points$145 $(85)$230 Decrease by 50 basis points$(90)$70 $(160)NPR credit spread:Increase by 50 basis points$(255)$(1,195)$940 Decrease by 50 basis points$280 $1,275 $(995)Mortality:Increase by 1%$(35)$(85)$50 Decrease by 1%$35 $85 $(50)Lapse:Increase by 10%$(105)$(540)$435 Decrease by 10%$110 $555 $(445)Sensitivities for the Long-Term Care Business within Corporate and OtherThe following table summarizes certain significant assumptions made in establishing best estimate reserves for long-term care products to perform premium deficiency testing, and the net impact that could result to the best estimate reserves from changes in these assumptions should they occur. Under U.S. GAAP, reserves for long-term care products are primarily calculated using the locked-in assumptions concept described above. As such, the adverse hypothetical impacts illustrated in the table below are those that would increase our best estimate reserves and, when compared to our GAAP reserves, may cause a premium deficiency that would require us to unlock and update our assumptions and record a charge to net income. The favorable hypothetical impacts in the table below would decrease our best estimate reserves but would not result in an immediate decrease to our GAAP reserves (given that we would be required to leave the current assumptions locked-in); rather, the positive impacts would be recognized into net income over the life of the policies in force.71Table of ContentsThe information below is for illustrative purposes and includes the impacts of changes in a single assumption and not changes in any combination of assumptions. As a result of emerging experience, changes in current assumptions may result in impacts to the best estimate reserve in future periods that are in excess of or lower than the amounts illustrated. December 31, 2022AssumptionCurrent Best Estimate AssumptionBest Estimate Assumption ChangeIncrease (Decrease) in Best Estimate Reserve (in millions)Mortality ImprovementBased on “G2” industry mortality improvement scale applied to only healthy livesRemove all mortality improvement$(250)Claim IncidenceBased on Company and industry experience. No reflection of future claim management efficienciesIncrease / decrease in claim incidence: +5% to -5%$300 - $(300)Average Ultimate Lapse RateIndividual: 0.7%Group: 0.7%-10 basis points to +10 basis points$100 - $(100)Investment Rate(1)Weighted average of 5.18%-25 basis points to +25 basis points$375 - $(375)Expected Future Premium Rate Increase Approvals(2)Approximately $0.5 billion for the rate increase programDecrease / increase unapproved rate increases by: -10% to +10%$50 - $(50)__________(1)Investment rate reflects the expected investment yield over the life of the block of business, and is derived from the portfolio yield, current reinvestment rates and our intermediate and long-term assumptions for investment yields.(2)Includes expected future premium rate increases and benefit reductions in lieu of rate increases, not yet approved.Other Accounting PoliciesGoodwill As of December 31, 2022, our goodwill balance of $876 million is primarily reflected in the following reporting units: $549 million for PGIM, $177 million for Assurance IQ and $115 million for Gibraltar Life and Other. The Company recorded pre-tax impairment charges of $903 million and $1,060 million in 2022 and 2021, respectively, both related to the Assurance IQ reporting unit. There was no goodwill impairment in 2020.We test goodwill for impairment on an annual basis as of December 31 and more frequently if events or circumstances indicate the potential for impairment is more likely than not. The goodwill impairment analysis is performed at the reporting unit level, which is the same as, or one level below, our operating segments. Although the accounting guidance provides for an optional qualitative assessment for testing goodwill impairment, the Company performed the quantitative test for all reporting units and compared each reporting unit’s estimated fair value to its carrying value as of December 31, 2022. The carrying value represents the capital that the business would require if operating as a standalone entity. The annual quantitative goodwill impairment analysis for Assurance IQ utilized both an income approach based on discounted cash flow valuation techniques and a market approach based on forward sales multiples. The estimated fair value of Assurance IQ as of December 31, 2022 was based on weighting the results of each approach and included assumptions that a market participant would use to value the business. Based on the goodwill impairment test performed as of December 31, 2022, the Company recognized a non-cash goodwill impairment pre-tax charge of $903 million ($713 million after-tax) for Assurance IQ primarily driven by a reduction in the forecasted cash flows and higher discount rates as part of the income approach and, to a lesser extent, by decreases in the valuations of comparable companies as part of the market approach, as described further below. The income approach estimated the fair value of Assurance IQ by applying a discount rate, derived from a capital asset pricing model and reflecting a market expected rate of return for the reporting unit, to its projected future cash flows. The projected future cash flows involved significant judgement and were based on our internal forecasts including expected synergies, and a range of terminal values, which incorporated an expected long-term growth rate and sales and Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) market-based multiples. Revisions to the long-term forecasts, as part of the strategic review of the business in the fourth quarter of 2022, reflected lower growth rates across all product lines 72Table of Contentsdriven by challenges in scaling and extended expected timing of reaching sustained profitability. These revisions, combined with changes in, and challenges from, the current and expected industry and market conditions and trends, a higher applied discount rate, and lower expected synergies, led to declines in the present value of the projected cash flows and the estimated fair value of Assurance under the income approach, consistent with how a market participant would assess the value of the business as of December 31, 2022.The market approach derived the fair value of Assurance IQ based on comparable publicly traded companies by utilizing forward market multiples based on independent analysts’ consensus estimates for each company’s forecasted sales. The sales multiple was applied to Assurance IQ’s forecasted results, and an implied control premium, reflective of expected synergies a market participant would realize, was added to determine the estimated fair value of the reporting unit as of December 31, 2022. The market approach also resulted in a decline in the estimated fair value of Assurance IQ as of December 31, 2022 as the value of the comparable publicly traded companies declined during 2022, resulting in a lower multiple being applied to the forecasted revenues of the business. The fair value of the reporting unit was also negatively impacted by reductions in the forecasted revenue growth levels and a lower implied control premium reflective of a decline in the expected synergies that could be realized.The $903 million pre-tax impairment charge resulted in $177 million goodwill asset assigned to the Assurance IQ reporting unit as of December 31, 2022. The decreased carrying value of the goodwill asset as of December 31, 2022 makes it less sensitive to potential future changes in the inputs and assumptions used in the valuation of Assurance IQ. Both Gibraltar Life and Other and PGIM completed a quantitative impairment analysis using an earnings multiple approach, which resulted in their fair values exceeding their carrying values by a weighted average of 264% as of December 31, 2022.Estimating the fair value of reporting units is a subjective process that involves the use of significant estimates by management. While changes in individual factors or events impact the valuation of our reporting units, it is the magnitude of the change of all valuation inputs, considered in totality, that will ultimately determine the impact to the fair value of our businesses holding goodwill. For all reporting units tested, unanticipated changes in business performance or the regulatory environment, market declines or other events impacting the fair value of these businesses, including changes in market multiples, discount rates, and growth rate assumptions or increases in the level of equity required to support these businesses, could cause additional goodwill impairment charges in future periods. For additional information regarding goodwill and our reporting segments, see Note 2 and Note 10 to the Consolidated Financial Statements. Valuation of Investments, Including Derivatives, Measurement of Allowance for Credit Losses, and the Recognition of Other-than-Temporary Impairments Our investment portfolio consists of public and private fixed maturity securities, commercial mortgage and other loans, equity securities, other invested assets, and derivative financial instruments. Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices or the values of securities or commodities. Derivative financial instruments that are generally used include swaps, futures, forwards and options and may be exchange-traded or contracted in the over-the-counter (“OTC”) market. We are also party to financial instruments that contain derivative instruments that are “embedded” in the financial instruments. Management believes the following accounting policies related to investments, including derivatives, are most dependent on the application of estimates and assumptions. Each of these policies is discussed further within other relevant disclosures related to investments and derivatives, as referenced below: •Valuation of investments, including derivatives;•Measurement of the allowance for credit losses on fixed maturity securities classified as available-for-sale or held-to-maturity, commercial mortgage loans, and other loans; and•Recognition of other-than-temporary impairments (“OTTI”) for equity method investments and wholly-owned investment real estate. We present at fair value in the statements of financial position our debt security investments classified as available-for-sale, investments classified as trading such as our assets supporting experience-rated contractholder liabilities and certain fixed maturities, equity securities, and certain investments within “Other invested assets,” such as derivatives. For additional information regarding the key estimates and assumptions surrounding the determination of fair value of fixed maturity and equity securities, as well as derivative instruments, embedded derivatives and other investments, see Note 6 to the Consolidated Financial Statements and “—Valuation of Assets and Liabilities—Fair Value of Assets and Liabilities.” 73Table of ContentsFor our investments classified as available-for-sale, the impact of changes in fair value is recorded as an unrealized gain or loss in AOCI, a separate component of equity. For our investments classified as trading and equity securities, the impact of changes in fair value is recorded within “Other income (loss).” Our investments classified as held-to-maturity are carried at the acquisition price, net of any unamortized premiums or discounts, and a valuation allowance for losses. Our commercial mortgage and other loans are carried primarily at unpaid principal balances, net of unamortized deferred loan origination fees and expenses and unamortized premiums or discounts and a valuation allowance for losses.In addition, an allowance for credit losses is measured each quarter for available-for-sale fixed maturity securities, held-to-maturity fixed maturity securities, commercial mortgage and other loans. For additional information regarding our policies regarding the measurement of credit losses, see Note 2 to the Consolidated Financial Statements.For equity method investments and wholly-owned investment real estate, the carrying value of these investments is written down or impaired to fair value when a decline in value is considered to be other-than-temporary.Pension and Other Postretirement Benefits We sponsor pension and other postretirement benefit plans covering employees who meet specific eligibility requirements. Our net periodic costs for these plans consider an assumed discount (interest) rate, an expected rate of return on plan assets, expected increases in compensation levels, mortality and trends in health care costs. Of these assumptions, our expected rate of return assumptions and our discount rate assumptions have historically had the most significant effect on our net period costs associated with these plans. We determine our expected rate of return on plan assets based upon a building block approach that considers plan asset mix, risk free rates, inflation, real return, term premium, credit spreads, equity risk premium and capital appreciation as well as expenses, the effect of active management and the effect of rebalancing for the equity, debt and real estate asset mix applied on a weighted average basis to our pension asset portfolio. See Note 18 to the Consolidated Financial Statements for our actual asset allocations by asset category and the asset allocation ranges prescribed by our investment policy guidelines for both our pension and other postretirement benefit plans. Our assumed long-term rate of return for 2022 was 6.00% for our domestic pension plans and 7.00% for our other postretirement benefit plans. Given the amount of plan assets as of December 31, 2021, the beginning of the measurement year, if we had assumed an expected rate of return for both our domestic pension and other domestic postretirement benefit plans that was 100 bps higher or 100 bps lower than the rates we assumed, the change in our net periodic costs would have been as shown in the table below. The information provided in the table below considers only changes in our assumed long-term rate of return given the level and mix of invested assets at the beginning of the measurement year, without consideration of possible changes in any of the other assumptions described above that could ultimately accompany any changes in our assumed long-term rate of return. For the year ended December 31, 2022 Increase/(Decrease) in NetPeriodic Pension CostIncrease/(Decrease) in NetPeriodic Other Postretirement Cost (in millions)Increase in expected rate of return by 100 bps$(134)$(14)Decrease in expected rate of return by 100 bps$134 $14 Foreign pension plans represent 4% of plan assets at the beginning of 2022. An increase in expected rate of return by 100 bps would result in a decrease in net periodic pension costs of $5 million; conversely, a decrease in expected rate of return by 100 bps would result in an increase in net periodic pension costs of $4 million. We determine our discount rate, used to value the pension and postretirement benefit obligations, based upon rates commensurate with current yields on high quality corporate bonds. See Note 18 to the Consolidated Financial Statements for information regarding the December 31, 2021 methodology we employed to determine our discount rate for 2022. Our assumed discount rate for 2022 was 2.85% for our domestic pension plans and 2.75% for our other domestic postretirement benefit plans. Given the amount of pension and postretirement obligations as of December 31, 2021, the beginning of the measurement year, if we had assumed a discount rate for both our domestic pension and other postretirement benefit plans that was 100 bps higher or 100 bps lower than the rates we assumed, the change in our net periodic costs would have been as shown in the table below. The information provided in the table below considers only changes in our assumed discount rate without consideration of possible changes in any of the other assumptions described above that could ultimately accompany any changes in our assumed discount rate. 74Table of Contents For the year ended December 31, 2022 Increase/(Decrease) in NetPeriodic Pension CostIncrease/(Decrease) in NetPeriodic Other Postretirement Cost (in millions)Increase in discount rate by 100 bps$(91)$2 Decrease in discount rate by 100 bps$127 $(2) Foreign pension plans represent 12% of plan obligations at the beginning of 2022. An increase in discount rate by 100 bps would result in a decrease in net periodic pension costs of $7 million; conversely, a decrease in discount rate by 100 bps would result in an increase in net periodic pension costs of $9 million.Given the application of the authoritative guidance for accounting for pensions, and the deferral and amortization of actuarial gains and losses arising from changes in our assumed discount rate, the change in net periodic pension cost arising from an increase in the assumed discount rate by 100 bps would not always be expected to equal the change in net periodic pension cost arising from a decrease in the assumed discount rate by 100 bps.For a discussion of our expected rate of return on plan assets and discount rate for our qualified pension plan in 2022, see “—Results of Operations by Segment—Corporate and Other.” For purposes of calculating pension income from our own qualified pension plan for the year ended December 31, 2023, we increased the discount rate to 5.45% from 2.85% in 2022. The expected rate of return on plan assets increased to 7.50% in 2023 from 6.00% in 2022, and the assumed rate of increase in compensation remained unchanged at 4.50%. In addition to the effect of changes in our assumptions, the net periodic cost or benefit from our pension and other postretirement benefit plans may change due to factors such as actual experience being different from our assumptions, special benefits to terminated employees, or changes in benefits provided under the plans. At December 31, 2022, the sensitivity of our domestic and foreign pension and postretirement obligations to a 100 basis point change in discount rate was as follows. December 31, 2022 Increase/(Decrease) inPension Benefits ObligationIncrease/(Decrease) inAccumulated PostretirementBenefits Obligation (in millions)Increase in discount rate by 100 bps$(956)$(91)Decrease in discount rate by 100 bps$1,123 $99 Taxes on Income Our effective tax rate is based on income, non-taxable and non-deductible items, tax credits, statutory tax rates and tax planning opportunities available in the various jurisdictions in which we operate. Inherent in determining our annual tax rate are judgments regarding business plans, planning opportunities and expectations about future outcomes. The Dividend Received Deduction (“DRD”) is a major reason for the difference between the Company’s effective tax rate and the U.S. federal statutory rate. The DRD is an estimate that incorporates the prior and current year information, as well as the current year’s equity market performance. Both the current estimate of the DRD and the DRD in future periods can vary based on factors such as, but not limited to, changes in the amount of dividends received that are eligible for the DRD, changes in the amount of distributions received from underlying fund investments, changes in the account balances of variable life and annuity contracts, and the Company’s taxable income before the DRD.An increase or decrease in our effective tax rate by one percentage point would have resulted in a decrease or increase in our 2022 “Total income tax expense (benefit)” of $18 million.The CARES Act. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted into law. One provision of the CARES Act amends the Tax Act of 2017 and allows companies with net operating losses (“NOLs”) originating in 2018, 2019, or 2020 to carry back those losses up to five years. For 2020, the Company recorded an income tax benefit of $51 million and $149 million from carrying the 2018 and 2020 NOLs back to tax years that have a 35% tax rate. 75Table of ContentsContingencies A contingency is an existing condition that involves a degree of uncertainty that will ultimately be resolved upon the occurrence of future events. Under U.S. GAAP, accruals for contingencies are required to be established when the future event is probable and its impact can be reasonably estimated, such as in connection with an unresolved legal matter. The initial reserve reflects management’s best estimate of the probable cost of ultimate resolution of the matter and is revised accordingly as facts and circumstances change and, ultimately, when the matter is brought to closure. Commission Revenue For digital insurance brokerage placement services, the Company earns both initial and renewal commissions as compensation for the placement of insurance policies with insurance carriers. At the effective date of the policy, the Company records within “Other income” the expected lifetime revenue for the initial and renewal commissions considering estimates of the timing of future policy cancellations. These estimates are reassessed each reporting period and any changes in estimates are reflected in the current period.Adoption of New Accounting Pronouncements ASU 2018-12, Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, was issued by the FASB on August 15, 2018, and was amended by ASU 2019-09, Financial Services - Insurance (Topic 944): Effective Date, issued in October 2019, and ASU 2020-11, Financial Services—Insurance (Topic 944): Effective Date and Early Application, issued in November 2020. The Company will adopt ASU 2018-12 effective January 1, 2023 using the modified retrospective transition method where permitted, and apply the guidance as of January 1, 2021 (and record transition adjustments as of January 1, 2021) in the 2023 financial statements.The Company has an established governance framework to manage the implementation of the standard. The Company has substantially completed its implementation efforts including, but not limited to, implementing refinements to key accounting policy decisions, modifications to actuarial valuation models, updates to data sourcing capabilities, automation of key financial reporting and analytical processes and updates to internal control over financial reporting and disclosure.ASU 2018-12 will impact, at least to some extent, the accounting and disclosure requirements for all long-duration insurance and investment contracts issued by the Company. The Company expects the standard to have a significant financial impact on its Consolidated Financial Statements and will significantly increase disclosures. As of the January 1, 2021 transition date, the Company estimates that the implementation of the standard will result in a decrease to “Retained earnings” of approximately $3 billion primarily from reclassifying the cumulative effect of changes in non-performance risk on market risk benefits from “Retained earnings” to “Accumulated other comprehensive income” (“AOCI”) and other changes in reserves, and will result in a decrease to AOCI of approximately $42 billion primarily from remeasuring in-force non-participating traditional and limited-pay insurance contract liabilities using upper-medium grade fixed income instrument yields as of the transition date. As of December 31, 2021, the estimated impacts amounted to a decrease to “Retained earnings” of approximately $2 billion and a decrease to AOCI of approximately $31 billion. As of September 30, 2022, the estimated impacts amounted to a decrease to “Retained earnings” of approximately $2 billion and an increase to AOCI of approximately $17 billion. The changes in the estimates impacting AOCI from January 1, 2021 to September 30, 2022 are primarily due to the increases in interest rates during 2021 and 2022. In addition to the impacts to the balance sheet, the Company also expects an impact to the pattern of earnings emergence following the transition date.Results of Operations by SegmentPGIMOperating Results The following table sets forth PGIM’s operating results for the periods indicated: 76Table of Contents Year ended December 31, 202220212020 (in millions)Operating results(1):Revenues(2)$3,622 $4,493 $4,153 Expenses2,779 2,850 2,891 Adjusted operating income843 1,643 1,262 Realized investment gains (losses), net, and related adjustments(8)(3)0 Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests(4)69 159 Other adjustments(3)(22)(13)0 Income (loss) before income taxes and equity in earnings of operating joint ventures$809 $1,696 $1,421 __________(1)Certain of PGIM’s investment activities are based in currencies other than the U.S. dollar and are therefore subject to foreign currency exchange rate risk. The financial results of PGIM include the impact of an intercompany arrangement with our Corporate and Other operations designed to mitigate the impact of exchange rate changes on PGIM’s U.S. dollar-equivalent earnings. For additional information related to this intercompany arrangement, see “—Results of Operations—Impact of Foreign Currency Exchange Rates,” above.(2)Revenues for the year ended December 31, 2021 include a $378 million pre-tax gain related to the sale of our 35% ownership stake in Pramerica SGR, an asset management joint venture in Italy.(3)Includes certain components of consideration for business acquisitions, which are recognized as compensation expense over the requisite service periods.Adjusted Operating Income 2022 to 2021 Annual Comparison. Adjusted operating income decreased $800 million, reflecting a decrease in service, distribution and other revenues, driven by the absence of a gain in the prior year period from the sale of our Pramerica SGR joint venture, and lower other related revenues and asset management fees, net of related expenses.Revenues and Expenses The following table sets forth PGIM’s revenues, presented on a basis consistent with the table above under “—Operating Results,” by type: Year ended December 31, 202220212020 (in millions)Revenues by type:Asset management fees by source:Institutional customers$1,443 $1,439 $1,350 Retail customers(1)1,081 1,275 1,003 General account508 588 557 Total asset management fees3,032 3,302 2,910 Other related revenues by source:Incentive fees85 154 206 Transaction fees14 27 26 Seed and co-investments3 49 122 Commercial mortgage(2)127 173 198 Total other related revenues229 403 552 Service, distribution and other revenues(3)361 788 691 Total revenues$3,622 $4,493 $4,153 __________(1)Consists of fees from: individual mutual funds and variable annuities and variable life insurance separate account assets; funds invested in proprietary mutual funds through our defined contribution plan products; and third-party sub-advisory relationships. Revenues from fixed annuities and the fixed-rate accounts of variable annuities and variable life insurance are included in the general account.(2)Includes mortgage origination revenues from our commercial mortgage origination and servicing business.(3)Results for the year ended December 31, 2021 include a $378 million pre-tax gain related to the sale of our 35% ownership stake in Pramerica SGR, an asset management joint venture in Italy. 77Table of Contents2022 to 2021 Annual Comparison. Revenues decreased $871 million. Service, distribution and other revenues decreased, primarily reflecting the absence of a gain in the prior year period from the sale of our Pramerica SGR joint venture, and lower revenues from certain consolidated funds (which were fully offset by lower variable expenses related to noncontrolling interests in these funds). Asset management fees decreased primarily due to a decrease in average assets under management, driven by market depreciation reflecting higher interest rates and widening credit spreads, as well as unfavorable equity markets. Also contributing to the decrease were lower other related revenues primarily driven by lower performance-based incentive fees, reflecting investment underperformance, lower commercial mortgage origination revenues driven by higher interest rates and general economic uncertainty, and lower seed and co-investments results. Expenses decreased $71 million, primarily reflecting lower variable expenses associated with a decrease in overall segment earnings and lower revenues from certain consolidated funds, as discussed above. The decrease was partially offset by higher operating expenses primarily driven by an increase in travel and entertainment costs, and an increase in compensation expenses.Assets Under Management The following table sets forth assets under management by asset class as of the dates indicated: December 31, 202220212020 (in billions)Assets Under Management(1) (at fair value):Public equity$147.8 $216.2 $202.4 Public fixed income776.8 980.7 1,004.5 Real estate129.6 132.6 121.5 Private credit and other alternatives103.4 108.7 106.5 Multi-asset70.8 85.6 63.7 Total PGIM assets under management$1,228.4 $1,523.8 $1,498.6 Assets under management within other reporting segments(2)148.9 218.5 222.3 Total PFI assets under management$1,377.3 $1,742.3 $1,720.9 __________(1)“Public equity” represents stock ownership interest in a corporation or partnership (excluding hedge funds) or real estate investment trust. “Public fixed income” represents debt instruments that pay interest and usually have a maturity (excluding mortgages). “Real estate” includes direct real estate equity and real estate mortgages. “Private credit and other alternatives” includes private credit, private equity, hedge funds and other alternative strategies. “Multi-asset” includes funds or products that invest in more than one asset class, balancing equity and fixed income funds and target date funds.(2)Primarily includes assets related to certain annuity, variable life, retirement and group life products in our U.S. Businesses and Corporate & Other operations, and certain general account assets in our International Businesses. These assets are not directly managed by PGIM, but rather are invested in non-proprietary funds or are managed by either the divisions themselves or by our Chief Investment Officer Organization.2022 to 2021 Annual Comparison. PGIM’s assets under management decreased $295 billion in 2022, primarily driven by market depreciation resulting from higher interest rates and widening credit spreads, as well as unfavorable equity markets. The decrease also reflects a reduction in assets under management from the sales of the Full Service Retirement business and PALAC in the second quarter of 2022, public fixed income and public equity net outflows, and unfavorable foreign exchange rate impacts. 78Table of ContentsThe following table sets forth assets under management by source as of the dates indicated: December 31, 202220212020 (in billions)Assets Under Management(1) (at fair value):Institutional customers$549.2 $629.4 $614.9 Retail customers299.6 401.4 372.0 General account379.6 493.0 511.7 Total PGIM assets under management$1,228.4 $1,523.8 $1,498.6 Assets under management within other reporting segments(2)148.9 218.5 222.3 Total PFI assets under management$1,377.3 $1,742.3 $1,720.9 __________(1)“Institutional customers” consist of third-party institutional assets and group insurance contracts. “Retail customers” consist of individual mutual funds and variable annuities and variable life insurance separate account assets, funds invested in proprietary mutual funds through our defined contribution plan products, and third-party sub-advisory relationships. “General account” also includes fixed annuities and the fixed-rate accounts of variable annuities and variable life insurance.(2)Primarily includes assets related to certain annuity, variable life, retirement and group life products in our U.S. Businesses and Corporate & Other operations, and certain general account assets in our International Businesses. These assets are not directly managed by PGIM, but rather are invested in non-proprietary funds or are managed by either the divisions themselves or by our Chief Investment Officer Organization.The following table sets forth the component changes in PGIM’s assets under management for the periods indicated: December 31,202220212020 (in billions)Beginning assets under management$1,523.8 $1,498.6 $1,331.0 Institutional third-party flows3.0 10.9 3.0 Retail third-party flows(23.2)0.1 17.2 Total third-party flows(20.2)11.0 20.2 Affiliated flows(1)13.2 (12.2)(8.5)Market appreciation (depreciation)(2)(240.9)35.4 146.7 Foreign exchange rate impact(16.0)(12.4)6.8 Net money market activity and other increases (decreases)(3)(31.5)3.4 2.4 Ending assets under management$1,228.4 $1,523.8 $1,498.6 __________(1)Represents assets that PGIM manages for the benefit of other reporting segments within the Company. Additions and withdrawals of these assets are attributable to third-party product inflows and outflows in other reporting segments.(2)Includes income reinvestment, where applicable.(3)Results for the year ended December 31, 2022 include a reduction in assets under management from the sales of the Full Service Retirement business and PALAC.Private Capital DeploymentPrivate capital deployment is indicative of the pace and magnitude of capital that is invested and will result in future revenues that may include management fees, transaction fees, incentive fees and servicing revenues, as well as future costs to manage these assets. Private capital deployment represents the gross value of private capital invested in real estate debt and equity, and private credit and equity asset classes. Assets under management resulting from private capital deployment are included in “Real estate” and “Private credit and other alternatives” in the “—Assets Under Management—by asset class table” above. As of December 31, 2022, these assets decreased approximately $7.7 billion compared to December 31, 2021, primarily reflecting market depreciation.Private capital deployment includes PGIM’s real estate agency debt business, which consists of agency commercial loans that are originated and sold to third-party investors. PGIM continues to service these commercial loans; however, they are not included in assets under management.79Table of ContentsThe following table sets forth PGIM’s private capital deployed by asset class for the periods indicated: December 31,202220212020 (in billions)Private capital deployed:Real estate debt and equity$26.9 $34.7 $24.4 Private credit and equity16.1 14.5 12.6 Total private capital deployed$43.0 $49.2 $37.0 Seed and Co-InvestmentsAs of December 31, 2022 and 2021, PGIM had approximately $1,444 million and $1,175 million of seed investments and $497 million and $517 million of co-investments at carrying value, respectively, primarily consisting of public fixed income, public equity and real estate investments.U.S. BusinessesOperating Results The following table sets forth the operating results for our U.S. Businesses for the periods indicated: Year ended December 31, 202220212020(in millions)Adjusted operating income before income taxes:U.S. Businesses:Retirement Strategies$4,223 $4,079 $2,855 Group Insurance(16)(455)(16)Individual Life(1,215)393 (48)Assurance IQ(113)(142)(88)Total U.S. Businesses2,879 3,875 2,703 Reconciling items:Realized investment gains (losses), net, and related adjustments(3,411)1,839 (2,510)Charges related to realized investment gains (losses), net(654)(296)(121)Market experience updates748 747 (591)Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests2 7 4 Other adjustments(1)(917)(1,099)51 Income (loss) before income taxes and equity in earnings of operating joint ventures$(1,353)$5,073 $(464)________(1)Includes goodwill impairments of $903 million and $1,060 million recorded in the fourth quarters of 2022 and 2021, respectively, related to Assurance IQ. See Note 2 and Note 10 to the Consolidated Financial Statements for additional information.2022 to 2021 Annual Comparison. Adjusted operating income for our U.S. Businesses decreased by $996 million primarily due to:•An unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements, primarily reflecting a net charge from these updates in the second quarter of 2022 in our Individual Life business, mainly driven by unfavorable impacts related to assumptions for policyholder behavior and mortality;•Lower net investment spread results driven by lower income on non-coupon investments, partially offset by higher reinvestment rates and business growth; and•Lower fee income, net of distribution expenses and other associated costs, primarily in our Individual Retirement Strategies business due to a reduction in account values as a result of the sale of PALAC and unfavorable equity markets.80Table of Contents•Partially offsetting these decreases were a gain in our Individual Retirement Strategies business from the sale of PALAC in the second quarter of 2022; and•Higher underwriting results, including lower COVID-19 related mortality claims, in our Group Insurance and Individual Life businesses, as well as more favorable disability results in our Group Insurance business.Retirement Strategies In October 2021, the Company announced the creation of Retirement Strategies, a new U.S. business that would serve the retirement needs of both our institutional and individual customers by bringing the institutional investment and pension solutions offered through our Retirement business together with the financial solutions and capabilities of our Individual Annuities business. Commencing with the second quarter of 2022, this new structure has been fully operationalized; therefore, the results of our former Retirement segment (now known as the “Institutional Retirement Strategies” operating segment) and our former Individual Annuities segment (now known as the “Individual Retirement Strategies” operating segment) have been aggregated into the Retirement Strategies segment. Prior periods have been updated to conform to this new presentation. Business Updates•In April 2022, the Company completed the sale of its Full Service Retirement business to Great-West Life & Annuity Insurance Company (“Great-West”). The transaction involved the sale of legal entities, reinsurance, and the transfer of contracts and brokerage accounts to Great-West. See Note 1 to the Consolidated Financial Statements for additional information.Beginning in the third quarter of 2021, the Company reported the assets and liabilities of the Full Service Retirement business as “held-for-sale” and transferred the results of this business to Divested and Run-off Businesses within Corporate and Other operations. As such, the following results for the Institutional Retirement Strategies operating segment are now solely reflective of the Company’s Institutional Investment Products business. •In April 2022, the Company completed the sale of PALAC, which represented a portion of its in-force traditional variable annuity block of business, to Fortitude Group Holdings, LLC, resulting in a pre-tax gain of $852 million. See Note 1 to the Consolidated Financial Statements for additional information. Beginning in the third quarter of 2021, the Company reported the assets and liabilities of this block of business as “held-for-sale” with the results continuing to be reported within the former Individual Annuities segment’s operating results until the sale was completed.Operating Results The following table sets forth Retirement Strategies’ operating results for the periods indicated:81Table of Contents Year ended December 31, 202220212020 (in millions)Operating results:Revenues:Institutional Retirement Strategies$19,441 $15,298 $10,051 Individual Retirement Strategies5,312 4,914 4,440 Total revenues24,753 20,212 14,491 Benefits and expenses:Institutional Retirement Strategies17,900 13,120 8,666 Individual Retirement Strategies2,630 3,013 2,970 Total benefits and expenses20,530 16,133 11,636 Adjusted operating income:Institutional Retirement Strategies1,541 2,178 1,385 Individual Retirement Strategies2,682 1,901 1,470 Total adjusted operating income4,223 4,079 2,855 Realized investment gains (losses), net, and related adjustments(1,806)1,938 (2,918)Charges related to realized investment gains (losses), net(629)(482)3 Market experience updates379 657 (324)Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests2 6 3 Income (loss) before income taxes and equity in earnings of operating joint ventures$2,169 $6,198 $(381)Adjusted Operating Income 2022 to 2021 Annual Comparison. Adjusted operating income from our Institutional Retirement Strategies business decreased $637 million, including a favorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results for 2022 had no net impact from our annual reviews and update of assumptions, while results for 2021 included a $14 million net charge. Excluding this item, adjusted operating income decreased $651 million, driven by lower net investment spread results, primarily reflecting lower income on non-coupon investments, partially offset by higher reinvestment rates and business growth. Adjusted operating income from our Individual Retirement Strategies business increased $781 million, including a favorable comparative net impact from our annual reviews and update of assumptions and other refinements, which resulted in a $25 million net benefit in 2022 compared to a $15 million charge in 2021. Excluding this item, adjusted operating income increased $741 million primarily driven by the gain on sale of PALAC. Also contributing to the increase were higher net investment spread results, driven by growth in indexed variable annuities and more favorable interest rates, as well as lower expenses and market value gains on a strategic investment. These increases were partially offset by lower fee income, net of distribution expenses and other associated costs, resulting from lower separate account values due to the impact of the sale of PALAC, net outflows and unfavorable equity markets.Our Individual Retirement Strategies business includes both fixed and variable annuities which may include optional guaranteed living benefit riders (e.g., GMIB, GMAB, GMWB and GMIWB), and/or optional death benefit riders (e.g., GMDB). We also offer fixed annuities that provide a guarantee of principal and interest credited at rates we determine (subject to certain contractual minimums) or at rates based upon the performance of an index (subject to caps or participation rates), as well as indexed variable annuities that provide several index crediting strategies and varying levels of downside protection at predetermined levels and durations. The drivers of our business results are generally included in adjusted operating income, with exceptions related to certain guarantees, as discussed below.The U.S. GAAP accounting and our adjusted operating income treatment for our guarantees differ depending upon the specific contractual features. Under U.S. GAAP, the reserves for GMIB and GMDB are accounted for in accordance with an insurance fulfillment accounting framework and the results are included in adjusted operating income in a manner generally consistent with U.S. GAAP.82Table of ContentsIn contrast, certain of our guaranteed living benefit riders (e.g., GMAB, GMWB and GMIWB) are accounted for under U.S. GAAP as embedded derivatives and reported using a fair value accounting framework. For purposes of measuring segment performance, adjusted operating income excludes the changes in fair value and instead reflects the performance of these riders using an insurance fulfillment accounting framework. Under this framework, adjusted operating income recognized each period reflects the rider fees earned during the period, less the portion of such fees estimated to be required to cover future benefit payments and hedging costs. Sales of traditional variable annuities with guaranteed living benefit riders were discontinued as of December 31, 2020, and, in April 2022, the sale of a portion of our in-force traditional variable annuity block was completed, as discussed above. Revenues, Benefits and Expenses 2022 to 2021 Annual Comparison. Revenues from our Institutional Retirement Strategies business increased $4,143 million. This increase primarily reflected higher pension risk transfer premiums due to new sales in the current year, with corresponding offsets in policyholders’ benefits, as discussed below, partially offset by lower net investment income and other income, primarily reflecting lower income on non-coupon investments.Benefits and expenses of our Institutional Retirement Strategies business increased $4,780 million. Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, benefits and expenses increased $4,794 million. Policyholders’ benefits, including the change in policy reserves, increased primarily related to the higher pension risk transfer premiums discussed above.Revenues from our Individual Retirement Strategies business increased $398 million. The increase was primarily driven by the gain on sale of PALAC and market value gains on a strategic investment, partially offset by lower policy charges and fee income, reflecting lower average separate account values due to the impact of the sale of PALAC, as discussed below, net outflows and unfavorable equity markets. Benefits and expenses of our Individual Retirement Strategies business decreased $383 million. Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, benefits and expenses decreased $343 million primarily driven by lower general and administrative expenses, net of capitalization, driven by lower distribution and asset management expenses reflecting lower average separate account values, as discussed above, as well as lower operating and other expenses. Account Values Institutional Retirement Strategies. Account values are a significant driver of our operating results and are primarily driven by net additions (withdrawals) and the impact of market changes. The investment income and interest we credit to policyholders on our spread-based products varies with the level of general account values. The income we earn on most of our fee-based products varies with the level of fee-based account values as many policy fees are determined by these values. The following table shows the changes in the account values of Institutional Retirement Strategies’ products for the periods indicated. Account values include both internally- and externally-managed client balances as the total balances drive revenue for the Institutional Retirement Strategies business. For additional information regarding internally-managed balances, see “—PGIM.”Year ended December 31, 202220212020 (in millions)Total Institutional Retirement Strategies:Beginning total account value$245,720 $243,387 $227,596 Additions(1)31,773 21,967 22,469 Withdrawals and benefits(16,398)(20,825)(18,288)Change in market value, interest credited and interest income(4,110)1,881 8,854 Other(2)(5,167)(690)2,756 Ending total account value$251,818 $245,720 $243,387 __________(1)Additions primarily include: group annuities and funded pension reinsurance calculated based on premiums received; international longevity reinsurance contracts calculated as the present value of future projected benefits; investment-only stable value contracts calculated as the fair value of customers’ funds held in a client-owned trust; and funding agreements issued calculated based on premiums received.83Table of Contents(2)“Other” activity includes the effect of foreign exchange rate changes associated with our British pounds sterling denominated international reinsurance business and changes in asset balances for externally-managed accounts. For the years ended December 31, 2022 and 2021, “Other” activity also includes $3,800 million in receipts offset by $3,516 million in payments and $3,079 million in receipts offset by $3,224 million in payments, respectively, related to funding agreements backed by commercial paper which typically have maturities of less than 90 days. 2022 to 2021 Annual Comparison. The increase in Institutional Retirement Strategies account values reflects net additions primarily driven by significant pension risk transfer transactions, including funded pension risk transfer and international reinsurance sales, and interest credited on customer funds, partially offset by the decline in the market value of account assets and the negative impact of foreign exchange rate changes.Individual Retirement Strategies. Account values are a significant driver of our operating results. Since most fees are determined by the level of separate account assets, fee income varies primarily based on the level of account values. Additionally, our fee income generally drives other items such as the pattern of amortization of DAC and other costs. Account values are driven by net flows from new business sales, surrenders, withdrawals and benefit payments, policy charges and the impact of positive or negative market value changes. The annuity industry’s competitive and regulatory landscapes may impact our net flows, including new business sales. The following table sets forth account value information for the periods indicated: Year ended December 31,202220212020 (in millions)Total Individual Retirement Strategies(1):Beginning total account value$182,305 $176,280 $169,681 Sales6,027 6,599 6,815 Full surrenders and death benefits(6,115)(10,401)(7,845)Sales, net of full surrenders and death benefits(88)(3,802)(1,030)Partial withdrawals and other benefit payments(4,670)(5,712)(5,191)Net flows(4,758)(9,514)(6,221)Change in market value, interest credited and other activity(2)(54,846)19,188 16,360 Policy charges(2,679)(3,649)(3,540)Ending total account value(3)$120,022 $182,305 $176,280 __________(1)Includes gross variable and fixed annuities sold as retail investment products. Variable annuity account values were $113.9 billion, $176.4 billion and $170.5 billion as of December 31, 2022, 2021 and 2020, respectively. Fixed annuity account values were $6.1 billion, $5.9 billion and $5.7 billion as of December 31, 2022, 2021 and 2020, respectively.(2)Results for the year ended December 31, 2022 reflect the reduction in account values resulting from the sale of PALAC, as discussed above.(3)Ending total account values for the year ended December 31, 2021 include approximately $30 billion of account values that were classified as “held-for-sale” as of December 31, 2021 in relation to the PALAC sale, as discussed above.2022 to 2021 Annual Comparison. The decrease in account values during 2022 was primarily driven by the impact of the sale of PALAC and market value depreciation.The increase in sales, net of full surrenders and death benefits, reflects general uncertainty and volatility in financial markets in the current year that led to lower full surrenders by policyholders, partially offset by lower sales.Risks and Risk MitigantsThe following is a summary of certain risks associated with Individual Retirement Strategies’ products, certain strategies in mitigating those risks including any updates to those strategies since the previous year-end, and the related financial results. Fixed Annuity Risks and Risk Mitigants. The primary risk exposure of our fixed annuity products relates to investment risks we bear for providing customers a minimum guaranteed interest rate or an index-linked interest rate required to be credited to the customer’s account value, which include interest rate fluctuations and/or sustained periods of low interest rates, and credit risk related to the underlying investments. We manage these risk exposures primarily through our investment strategies and product design features, which include credit rate resetting subject to the minimum guaranteed interest rate as well as surrender charges applied during the early years of the contract that help to provide protection for premature withdrawals. In addition, a portion of our fixed products has a market value adjustment provision that affords protection of lapse in the case of rising interest rates. We also manage these risk exposures through external reinsurance for certain of our fixed annuity products. For additional information regarding our external reinsurance agreements, see “Business—Retirement Strategies” and Note 14 to the Consolidated Financial Statements. 84Table of ContentsIndexed Variable Annuity Risks and Risk Mitigants. The primary risk exposure of our indexed variable annuity products relates to the investment risks we bear in order to credit to the customer’s account balance the required crediting rate based on the performance of the elected indices at the end of each term. We manage this risk primarily through our investment strategies and product design features, which include credit rate resetting subject to contractual minimums as well as surrender charges applied during the early years of the contract that help to provide protection for premature withdrawals. In addition, our indexed variable annuity strategies have an interim value provision that provides some protection from lapse in the case of rising interest rates.Variable Annuity Risks and Risk Mitigants. The primary risk exposures of our variable annuity contracts relate to actual deviations from, or changes to, the assumptions used in the original pricing of these products, including capital markets assumptions such as equity market returns, interest rates and market volatility, along with actuarial assumptions such as contractholder mortality, the timing and amount of annuitization and withdrawals, and contract lapses. For these risk exposures, achievement of our expected returns is subject to the risk that actual experience will differ from the assumptions used in the original pricing of these products. We manage our exposure to certain risks driven by fluctuations in capital markets primarily through a combination of i) Product Design Features, ii) our Asset Liability Management Strategy, and iii) our Capital Hedge Program, as discussed below. We also manage these risk exposures through external reinsurance for certain of our variable annuity products. For additional information regarding our external reinsurance agreements, see “Business—Retirement Strategies” and Note 14 to the Consolidated Financial Statements. Sales of traditional variable annuities with guaranteed living benefit riders were discontinued as of December 31, 2020, and, in April 2022, the sale of a portion of our in-force traditional variable annuity block was completed, as discussed above. i.Product Design Features:A portion of the variable annuity contracts that we offered include an automatic rebalancing feature, also referred to as an asset transfer feature. This feature is implemented at the contract level, and transfers assets between certain variable investment sub-accounts selected by the annuity contractholder and, depending on the benefit feature, a fixed-rate account in the general account or a bond fund sub-account within the separate accounts. The objective of the automatic rebalancing feature is to reduce our exposure to equity market risk and market volatility. Other product design features we utilize include, among others, asset allocation restrictions, minimum issuance age requirements and certain limitations on the amount of purchase payments, as well as a required minimum allocation to our general account for certain of our products. In addition, there is diversity in our fee arrangements, as certain fees are primarily based on the benefit guarantee amount, the contractholder account value and/or premiums, which helps preserve certain revenue streams when market fluctuations cause account values to decline.ii.Asset Liability Management (“ALM”) Strategy (including fixed income instruments and derivatives):We employ an ALM strategy that utilizes a combination of both traditional fixed income instruments and derivatives to meet expected liabilities associated with our variable annuity living benefit guarantees. The economic liability we manage with this ALM strategy consists of expected living benefit claims under less severe market conditions, which are managed using fixed income instruments, derivatives, or a combination thereof, and potential living benefit claims resulting from more severe market conditions, which are hedged using derivative instruments. For our Prudential Defined Income (“PDI”) variable annuity, we utilize fixed income instruments to meet expected liabilities. For the portion of our ALM strategy executed with derivatives, we enter into a range of exchange-traded and OTC equity, interest rate and credit derivatives, including, but not limited to: equity and treasury futures; total return, credit default and interest rate swaps; and options including equity options, swaptions, and floors and caps. The intent of this strategy is to more efficiently manage the capital and liquidity associated with these products while continuing to mitigate fluctuations in net income due to movements in capital markets. To achieve this, we periodically review and recalibrate the ALM strategy by optimizing the mix of derivatives and fixed income instruments to achieve expected outcomes.The valuation of the economic liability we seek to defray excludes certain items that are included within the U.S. GAAP liability, such as NPR in order to maximize protection irrespective of the possibility of our own default, as well as risk margins (required by U.S. GAAP but different from our best estimate) and valuation methodology differences. The following table provides a reconciliation between the liability reported under U.S. GAAP and the economic liability we manage through our ALM strategy as of the periods indicated:85Table of Contents December 31,20222021(1) (in millions)U.S. GAAP liability, including NPR, net of reinsurance recoverables$4,753 $13,028 NPR adjustment, net of reinsurance recoverables3,413 2,832 Subtotal8,166 15,860 Adjustments including risk margins and valuation methodology differences(2,499)(3,444)Economic liability managed through the ALM strategy$5,667 $12,416 __________(1)Includes the portion of the traditional variable annuities block of business that was classified as “held-for-sale” as of December 31, 2021 in relation to the PALAC sale, as discussed above.As of December 31, 2022, the fair value of our fixed income instruments and derivative assets exceed the economic liability within the entities in which the risks reside.Under our ALM strategy, we expect differences in the U.S. GAAP net income impact between the changes in value of the fixed income instruments (either designated as available-for-sale or designated as trading) and derivatives as compared to the changes in the embedded derivative liability these assets support. These differences can be primarily attributed to three distinct areas:•Different valuation methodologies in measuring the liability we intend to cover with fixed income instruments and derivatives versus the liability reported under U.S. GAAP. The valuation methodology utilized in estimating the economic liability we intend to defray with fixed income instruments and derivatives is different from that required to be utilized to measure the liability under U.S. GAAP. Additionally, the valuation of the economic liability excludes certain items that are included within the U.S. GAAP liability, such as NPR in order to maximize protection irrespective of the possibility of our own default and risk margins (required by U.S. GAAP but different from our best estimate).•Different accounting treatment between liabilities and assets supporting those liabilities. Under U.S. GAAP, changes in the fair value of the embedded derivative liability, derivative instruments and fixed income instruments designated as trading are immediately reflected in net income, while changes in the fair value of fixed income instruments that are designated as available-for-sale are recorded as unrealized gains (losses) in other comprehensive income.•General hedge results. For the derivative portion of the ALM strategy, the net hedging impact (the extent to which the changes in value of the hedging instruments offset the change in value of the portion of the economic liability we are hedging) may be impacted by a number of factors, including: cash flow timing differences between our hedging instruments and the corresponding portion of the economic liability we are hedging, basis differences attributable to actual underlying contractholder funds to be hedged versus hedgeable indices, rebalancing costs related to dynamic rebalancing of hedging instruments as markets move, certain elements of the economic liability that may not be hedged (including certain actuarial assumptions), and implied and realized market volatility on the hedge positions relative to the portion of the economic liability we seek to hedge.iii. Capital Hedge Program:We employ a capital hedge program to protect a portion of the overall capital position of the variable annuities business against its exposure to the equity markets. The capital hedge program is conducted using equity derivatives which include equity call and put options, total return swaps and futures contracts. Changes in value of these derivatives are excluded from adjusted operating income, which the Company believes enhances the understanding of underlying performance trends.Product Specific Risks and Risk MitigantsFor certain living benefit guarantees, claims will primarily represent the funding of contractholder lifetime withdrawals after the cumulative withdrawals have first exhausted the contractholder account value. Due to the age of the in-force block, limited claim payments have occurred to date, and they are not expected to increase significantly within the next five years, based upon current assumptions. The timing and amount of future claims will depend on actual returns on contractholder account value and actual contractholder behavior relative to our assumptions. The majority of our current living benefit guarantees provide for guaranteed lifetime contractholder withdrawal payments inclusive of a “highest daily” contract value guarantee. Our PDI variable annuity complements our variable annuity products with the highest daily benefit and provides for guaranteed lifetime contractholder withdrawal payments but restricts contractholder asset allocation to a single bond fund sub-account within the separate accounts.86Table of ContentsThe majority of our traditional variable annuity contracts with living benefit guarantees, and contracts with our highest daily living benefit features, include risk mitigants in the form of an automatic rebalancing feature and/or inclusion in our ALM strategy. We may also utilize external reinsurance as a form of additional risk mitigation. The risks associated with the guaranteed benefits of certain legacy products that were sold prior to our development of the automatic rebalancing feature are also managed through our ALM strategy. Certain legacy products with GMAB rider options include the automatic rebalancing feature but are not included in the ALM strategy. Sales of traditional variable annuities with living benefit guarantees and automatic rebalancing features were discontinued as of December 31, 2020, and, in April 2022, the sale of a portion of our in-force traditional variable annuity block was completed, as discussed above.For our GMDBs, we provide a benefit payable in the event of death. Our base GMDB is generally equal to a return of cumulative deposits adjusted for any partial withdrawals. Certain products include an optional enhanced GMDB based on the greater of a minimum return on the contract value or an enhanced value. We have retained the risk that the total amount of death benefit payable may be greater than the contractholder account value; however, a substantial portion of the account values associated with GMDBs are subject to an automatic rebalancing feature because the contractholder also selected a living benefit guarantee which includes an automatic rebalancing feature. All of the variable annuity account values with living benefit guarantees also contain GMDBs. The living and death benefit features for these contracts cover the same insured life and, consequently, we have insured both the longevity and mortality risk on these contracts.The following table sets forth the risk management profile of our living benefit guarantees and GMDB features as of the periods indicated: December 31,202220212020Account Value% of TotalAccount Value(1)% of TotalAccount Value% of Total (in millions)Living benefit/GMDB features(2):Both ALM strategy and automatic rebalancing(3)(4)$69,282 61 %$112,543 64 %$112,177 66 %ALM strategy only(4)1,972 2 %7,278 4 %7,410 4 %Automatic rebalancing only83 0 %567 0 %634 1 %External reinsurance(5)2,482 2 %3,303 2 %3,173 2 %PDI11,988 11 %16,909 10 %18,540 11 %Other products1,561 1 %2,444 1 %2,492 1 %Total living benefit/GMDB features87,368 143,044 144,426 GMDB features and other(6)26,573 23 %33,395 19 %26,120 15 %Total variable annuity account value$113,941 $176,439 $170,546 _________(1) Includes approximately $30 billion of account values that were classified as “held-for-sale” as of December 31, 2021 in relation to the PALAC sale, as discussed above.(2) All contracts with living benefit guarantees also contain GMDB features, which cover the same insured contract.(3) Contracts with living benefits that are included in our ALM strategy and that have an automatic rebalancing feature.(4) Excludes PDI which is presented separately within this table.(5) Represents contracts subject to a reinsurance transaction with an external counterparty covering certain Highest Daily Lifetime Income (“HDI”) v.3.0 business for the period April 1, 2015 through December 31, 2016. These contracts with living benefits also have an automatic rebalancing feature. See Note 14 to the Consolidated Financial Statements for additional information. (6) Includes contracts that have a GMDB feature and do not have an automatic rebalancing feature.Results excluded from adjusted operating incomeThe following table provides the net impact to the Consolidated Statements of Operations from the portion of Retirement Strategies’ results excluded from adjusted operating income: 87Table of ContentsYear ended December 31,20222021(1)2020(1)Results excluded from adjusted operating income:(in millions)(2)Change in the value of U.S. GAAP liability, pre-NPR(3)$4,035 $7,417 $(4,979)Change in the NPR adjustment1,277 (1,272)581 Change in the fair value of hedge assets, excluding capital hedges(4)(4,226)(4,270)2,251 Change in the fair value of capital hedges(5)598 (1,268)(900)Other(6)(3,490)1,331 129 Realized investment gains (losses), net, and related adjustments(1,806)1,938 (2,918)Market experience updates(7)379 657 (324)Charges related to realized investment gains (losses), net(629)(482)3 Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests2 6 3 Total results excluded from adjusted operating income(8)$(2,054)$2,119 $(3,236)__________(1)Prior periods have been updated to reflect the aggregated results of the Retirement Strategies segment.(2)Positive amounts represent income; negative amounts represent a loss.(3)Represents the change in the liability (excluding NPR) for our variable annuities living benefit guarantees, which is measured utilizing a valuation methodology that is required under U.S. GAAP. This liability includes such items as risk margins which are required by U.S. GAAP but not included in our best estimate of the liability. (4)Represents the change in fair value of the derivatives utilized to hedge potential claims associated with our variable annuity living benefit guarantees.(5)Represents the changes in fair value of equity derivatives of the capital hedge program intended to protect a portion of the overall capital position of the variable annuities business against its exposure to the equity markets.(6)Largely represents realized gains (losses) associated with sales and changes in the market value of fixed maturity securities as well as changes in the market value of derivative instruments.(7)Represents the immediate impacts in current period results from changes in current market conditions on estimates of profitability.(8)Excludes amounts from the change in unrealized gains and losses on fixed income instruments recorded in OCI (versus net income) of ($289) million, ($1,727) million and $1,384 million as of December 31, 2022, 2021 and 2020, respectively.For 2022, the loss of $2,054 million was driven by the impact of rising interest rates on fixed maturity securities and derivatives as well as unfavorable impacts related to the amortization of DAC and other costs. These losses were partially offset by favorable NPR adjustments largely due to favorable impacts from our annual reviews and update of assumptions and other refinements and widening credit spreads, gains associated with our capital hedges driven by unfavorable equity markets as well as favorable market experience updates resulting from the impact of rising interest rates. Changes related to the U.S. GAAP liability before NPR and the fair value of hedge assets (excluding capital hedges) were largely offsetting. Group Insurance Operating Results The following table sets forth Group Insurance’s operating results and benefits and administrative operating expense ratios for the periods indicated:88Table of Contents Year ended December 31, 202220212020 (in millions)Operating results:Revenues$6,123 $6,217 $5,786 Benefits and expenses6,139 6,672 5,802 Adjusted operating income(16)(455)(16)Realized investment gains (losses), net, and related adjustments(137)(16)48 Income (loss) before income taxes and equity in earnings of operating joint ventures$(153)$(471)$32 Benefits ratio(1)(4):Group life(2)93.2 %102.7 %93.4 %Group disability(2)73.9 %83.8 %78.4 % Total Group Insurance(2)88.4 %98.3 %90.2 %Administrative operating expense ratio(3)(4):Group life10.8 %11.3 %12.4 %Group disability31.3 %32.1 %26.1 % Total Group Insurance15.8 %16.3 %15.4 %__________(1)Ratio of policyholder benefits to earned premiums plus policy charges and fee income.(2)Benefits ratios reflect the impacts of our annual reviews and update of assumptions and other refinements. Excluding these impacts, the group life, group disability and total Group Insurance benefits ratios were 93.3%, 73.3% and 88.4% for 2022, respectively, 102.7%, 83.8% and 98.3% for 2021, respectively, and 93.6%, 78.8% and 90.4% for 2020, respectively.(3)Ratio of general and administrative expenses (excluding commissions) to gross premiums plus policy charges and fee income.(4)The benefits and administrative ratios are measures used to evaluate profitability and efficiency. Adjusted Operating Income 2022 to 2021 Annual Comparison. Adjusted operating income increased $439 million, including an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results for 2022 included a $3 million net charge from these updates while 2021 included a $1 million net benefit from these updates. Excluding this item, adjusted operating income increased $443 million, primarily reflecting higher underwriting results in our group life business, driven by a decline in COVID-19 impacts on non-experience-rated contracts, and higher underwriting results in our group disability business driven by more favorable claims experience and a favorable impact to reserves from higher interest rates on long-term disability contracts, as well as business growth. These increases were partially offset by lower net investment spread results driven by lower income on non-coupon investments.Revenues, Benefits and Expenses 2022 to 2021 Annual Comparison. Revenues decreased $94 million. Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, revenues decreased $90 million. The decrease primarily reflected lower net investment income driven by lower income on non-coupon investments.Benefits and expenses decreased $533 million. The decrease primarily reflected lower policyholders’ benefits and changes in reserves in our group life business driven by less unfavorable claim experience from a decline in COVID-19 impacts, as well as in our group disability business driven by a more favorable impact from claims experience and a favorable impact to reserves from higher interest rates on long-term disability contracts. Sales Results The following table sets forth Group Insurance’s annualized new business premiums, as defined under “—Segment Measures” above, for the periods indicated:89Table of Contents Year ended December 31, 202220212020 (in millions)Annualized new business premiums(1):Group life$283 $265 $243 Group disability196 221 163 Total$479 $486 $406 __________(1)Amounts exclude new premiums resulting from rate changes on existing policies, from additional coverage under our Servicemembers’ Group Life Insurance contract and from excess premiums on group universal life insurance that build cash value but do not purchase face amounts. 2022 to 2021 Annual Comparison. Total annualized new business premiums decreased $7 million, primarily driven by lower sales in our group disability business in the National segment due to the absence of a large sale in the prior year period, partially offset by an increase in supplemental health product sales, primarily in the Premier segment. Higher group life sales, primarily in the National segment, served as a partial offset.Individual Life Operating Results The following table sets forth Individual Life’s operating results for the periods indicated: Year ended December 31, 202220212020 (in millions)Operating results:Revenues$7,074 $6,897 $6,398 Benefits and expenses8,289 6,504 6,446 Adjusted operating income(1,215)393 (48)Realized investment gains (losses), net, and related adjustments(1,468)(83)359 Charges related to realized investment gains (losses), net(25)186 (124) Market experience updates369 90 (267)Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests0 1 1 Income (loss) before income taxes and equity in earnings of operating joint ventures$(2,339)$587 $(79) Adjusted Operating Income 2022 to 2021 Annual Comparison. Adjusted operating income decreased $1,608 million, primarily reflecting an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results for 2022 included a $1,401 million net charge from these updates, mainly driven by unfavorable impacts related to assumptions for policyholder behavior and mortality, and inclusive of out of period adjustments (see Note 1 and Note 22 to the Consolidated Financial Statements for additional information). Results for 2021 included a $7 million net benefit from these updates. Excluding this item, adjusted operating income decreased $200 million, primarily reflecting lower net investment spread results driven by lower income on non-coupon investments, partially offset by higher underwriting results, driven by the impact from less unfavorable mortality experience, net of reinsurance, including lower COVID-19 related claims. Revenues, Benefits and Expenses 2022 to 2021 Annual Comparison. Revenues increased $177 million. Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, revenues decreased $163 million. This decrease was primarily driven by lower policy charges and fee income, driven by the absence of a benefit from the recapture of previously reinsured liabilities in the prior year period, which was mostly offset by reserve changes in policyholders’ benefits, as well as the impact of unfavorable equity markets on account values. Also contributing to the decrease was lower net investment income driven by lower income on non-coupon investments, partially offset by business growth and higher interest rates. These decreases were partially offset by higher premiums due to lower ceded reinsurance, which was mostly offset in policyholders’ benefits below.90Table of ContentsBenefits and expenses increased $1,785 million. Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, benefits and expenses increased $37 million. This increase was primarily driven by higher interest credited on policyholders’ account balances due to business growth and higher interest expense driven by higher interest rates, as discussed above. These increases were partially offset by lower policyholders’ benefits and changes in reserves, driven by a favorable comparative impact from mortality experience, net of reinsurance, including lower COVID-19 related claims, and the absence of a charge from the reinsurance recapture in the prior year period, as described above, partially offset by lower ceded reinsurance, as described above.Sales Results The following table sets forth Individual Life’s annualized new business premiums, as defined under “—Results of Operations—Segment Measures” above, by distribution channel and product, for the periods indicated: 202220212020 PrudentialAdvisorsThirdPartyTotalPrudentialAdvisorsThirdPartyTotalPrudentialAdvisorsThirdPartyTotal (in millions)Variable Life$109 $315 $424 $121 $417 $538 $100 $349 $449 Term Life18 75 93 20 95 115 26 122 148 Universal Life(1)6 86 92 8 94 102 20 165 185 Total$133 $476 $609 $149 $606 $755 $146 $636 $782 __________(1)Prior period amounts have been updated to conform to current period presentation. 2022 to 2021 Annual Comparison. Total annualized new business premiums decreased $146 million, primarily from lower third-party sales across variable life, term life and universal life products due to pricing and product actions taken in the prior year period.Assurance IQOperating ResultsThe following table sets forth Assurance IQ’s operating results for the periods indicated. Year ended December 31, 202220212020(in millions)Operating results:Revenues$510 $558 $391 Expenses623 700 479 Adjusted operating income(113)(142)(88)Realized investment gains (losses), net, and related adjustments0 0 1 Other adjustments(1)(2)(917)(1,099)51 Income (loss) before income taxes and equity in earnings of operating joint ventures$(1,030)$(1,241)$(36) __________(1)Includes certain components of the consideration for the Assurance IQ acquisition, which are recognized as compensation expense over the requisite service periods, as well as changes in the fair value of associated contingent consideration. For additional information regarding contingent consideration, see Note 23 to the Consolidated Financial Statements.(2)Includes goodwill impairments of $903 million and $1,060 million recorded in the fourth quarters of 2022 and 2021, respectively. See Note 2 and Note 10 to the Consolidated Financial Statements for additional information.91Table of ContentsAdjusted Operating Income2022 to 2021 Annual Comparison. Adjusted operating income increased $29 million, including an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results for 2022 included a $17 million net charge from these updates primarily reflecting updates to persistency assumptions in the Medicare line. Excluding this item, adjusted operating income increased $46 million primarily reflecting an increase in the Medicare line driven by higher commission revenue, partially offset by a decrease in the Health Under 65 line driven by lower commission and case referral revenues.Revenues and Expenses2022 to 2021 Annual Comparison. Revenues decreased $48 million. Excluding the impact of our annual reviews and update of assumptions and other refinements, as discussed above, revenues decreased $31 million, primarily due to lower commission and case referral revenues in the Health Under 65 and Life lines, as well as lower case referral revenue in the Personal Finance line. These decreases were partially offset by an increase in commission revenue in the Medicare line. Expenses decreased $77 million, primarily driven by lower variable expenses from the Life, Health Under 65 and Personal Finance lines, partially offset by higher variable expenses from the Medicare line, as well as higher general and administrative expenses.International BusinessesBusiness Update•In the third quarter of 2022, the Company completed the acquisition of a 33% minority interest in Alexander Forbes Group Holdings Limited, a leading provider of financial advice, retirement, investment and holistic wealth management services in South Africa. This investment is consistent with the Company’s strategic focus internationally on higher-growth emerging markets and furthers the partnership’s specific objective to identify and make strategic investments in high quality financial services companies in selected African geographies. Operating Results The results of our International Businesses’ operations are translated on the basis of weighted average monthly exchange rates, inclusive of the effects of the intercompany arrangement discussed in “—Results of Operations—Impact of Foreign Currency Exchange Rates” above. To provide a better understanding of operating performance within the International Businesses, where indicated below, we have analyzed our results of operations excluding the effect of the year over year change in foreign currency exchange rates. Our results of operations, excluding the effect of foreign currency fluctuations, were derived by translating foreign currencies to USD at uniform exchange rates for all periods presented, including for constant dollar information discussed below. For our Japan operations, we used an exchange rate of 104 yen per USD, which was determined in connection with the foreign currency income hedging program discussed in “—Results of Operations—Impact of Foreign Currency Exchange Rates” above. In addition, for constant dollar information discussed below, activity denominated in USD is generally reported based on the amounts as transacted in USD. Annualized new business premiums presented on a constant exchange rate basis in the “Sales Results” section below reflect translation based on these same uniform exchange rates. The following table sets forth the International Businesses’ operating results for the periods indicated: 92Table of Contents Year ended December 31, 202220212020 (in millions)Operating results:Revenues:Life Planner $10,063 $10,643 $10,122 Gibraltar Life and Other 10,011 11,272 11,454 Total revenues20,074 21,915 21,576 Benefits and expenses:Life Planner8,625 8,869 8,618 Gibraltar Life and Other 9,045 9,656 10,006 Total benefits and expenses17,670 18,525 18,624 Adjusted operating income:Life Planner 1,438 1,774 1,504 Gibraltar Life and Other 966 1,616 1,448 Total adjusted operating income2,404 3,390 2,952 Realized investment gains (losses), net, and related adjustments(2,213)17 727 Charges related to realized investment gains (losses), net118 (32)(42)Market experience updates110(39)Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests5 (79)(48)Income (loss) before income taxes and equity in earnings of operating joint ventures$325 $3,296 $3,550 Adjusted Operating Income 2022 to 2021 Annual Comparison. Adjusted operating income from our Life Planner operations decreased $336 million, including a net unfavorable impact of $23 million from currency fluctuations, inclusive of the currency hedging program discussed above. Both periods also include the impact of our annual reviews and update of assumptions and other refinements, which resulted in a $19 million net charge in 2022 compared to a $2 million net benefit in 2021.Excluding the impact of currency fluctuations, as well as the impact from our annual reviews and update of assumptions and other refinements as discussed above, adjusted operating income from our Life Planner operations decreased $292 million, primarily reflecting lower net investment spread results driven by lower income on non-coupon investments, lower underwriting results, primarily driven by unfavorable policyholder behavior and unfavorable mortality and morbidity experience from COVID-19 related claims in Japan, and higher operating expenses.Adjusted operating income from our Gibraltar Life and Other operations decreased $650 million, including a net favorable impact of $11 million from currency fluctuations, inclusive of the currency hedging program discussed above. Both periods also include the impact of our annual reviews and update of assumptions and other refinements, which resulted in a $12 million net charge in 2022 compared to a $16 million net charge in 2021.Excluding the impact of currency fluctuations, as well as the impact from our annual reviews and update of assumptions and other refinements as discussed above, adjusted operating income from our Gibraltar Life and Other operations decreased $665 million, primarily reflecting lower net investment spread results driven by lower income on non-coupon investments and lower prepayment fee income, as well as lower underwriting results, primarily driven by unfavorable mortality and morbidity experience from COVID-19 related claims in Japan. Also contributing to the decrease were lower earnings from joint venture investments.Revenues, Benefits and Expenses 2022 to 2021 Annual Comparison. Revenues from our Life Planner operations decreased $580 million, including a net unfavorable impact of $632 million from currency fluctuations and a net benefit of $12 million from our annual reviews and update of assumptions and other refinements. Excluding these items, revenues increased $40 million, primarily reflecting higher premiums and policy charges and fee income, driven by the growth of business in force, partially offset by lower net investment income driven by lower income on non-coupon investments. 93Table of ContentsBenefits and expenses from our Life Planner operations decreased $244 million, including a net favorable impact of $609 million from currency fluctuations and a net charge of $33 million from our annual reviews and update of assumptions and other refinements. Excluding these items, benefits and expenses increased $332 million, primarily reflecting higher policyholders’ benefits, including changes in reserves, driven by unfavorable mortality and morbidity experience from COVID-19 related claims, higher amortization, including write offs of deferred policy acquisition costs related to unfavorable policyholder behavior, and higher operating expenses.Revenues from our Gibraltar Life and Other operations decreased $1,261 million, including a net unfavorable impact of $865 million from currency fluctuations. Excluding this item, revenues decreased $396 million, primarily reflecting lower premiums and policy charges and fee income due to the decline of business in force, lower net investment income driven by lower income on non-coupon investments and lower prepayment fee income, and lower other income from a decline in earnings from joint venture investments. Benefits and expenses from our Gibraltar Life and Other operations decreased $611 million, including a net favorable impact of $876 million from currency fluctuations and a net benefit of $4 million from our annual reviews and update of assumptions and other refinements. Excluding these items, benefits and expenses increased $269 million, primarily reflecting higher policyholders’ benefits, including changes in reserves, driven by unfavorable mortality and morbidity experience from COVID-19 related claims, and higher amortization, including write offs of deferred policy acquisition costs related to unfavorable policyholder behavior.Sales Results The following table sets forth annualized new business premiums, as defined under “—Results of Operations—Segment Measures” above, on an actual and constant exchange rate basis for the periods indicated: Year ended December 31, 202220212020 (in millions)Annualized new business premiums:On an actual exchange rate basis:Life Planner $941 $940 $1,041 Gibraltar Life and Other878 1,000 1,149 Total$1,819 $1,940 $2,190 On a constant exchange rate basis:Life Planner 1,022 960 1,044 Gibraltar Life and Other907 1,005 1,152 Total$1,929 $1,965 $2,196 The amount of annualized new business premiums and the sales mix in terms of types and currency denomination of products for any given period can be significantly impacted by several factors, including but not limited to: the addition of new products, discontinuation of existing products, changes in credited interest rates for certain products and other product modifications, changes in premium rates, changes in interest rates or fluctuations in currency markets, changes in tax laws, changes in life insurance regulations or changes in the competitive environment. Sales volume may increase or decrease prior to certain of these changes becoming effective, and then fluctuate in the other direction following such changes.Our diverse product portfolio in Japan, in terms of currency mix and premium payment structure, allows us to adapt to changing market and competitive dynamics, including the low interest rate environment. We regularly examine our product offerings and their related profitability and, as a result, we have repriced or discontinued sales of certain products that do not meet our profit expectations. The impact of these actions, coupled with the introduction of certain new products, has generally resulted in an increase in sales of products denominated in USD relative to products denominated in other currencies.2022 to 2021 Annual Comparison. The table below presents annualized new business premiums on a constant exchange rate basis, by product category and distribution channel, for the periods indicated: 94Table of Contents Year Ended December 31, 2022Year Ended December 31, 2021 LifeAccident&HealthRetirement(1)Investment Contracts(2)TotalLifeAccident&HealthRetirement(1)Investment Contracts(2)Total (in millions)Life Planner$566 $80 $333 $43 $1,022 $521 $67 $368 $4 $960 Gibraltar Life and Other:Life Consultants179 28 30 301 538 260 26 40 161 487 Banks(3)76 04 88 168 252 012 54 318 Independent Agency83 12 105 1 201 73 23 96 8 200 Subtotal338 40 139 390 907 585 49 148 223 1,005 Total$904 $120 $472 $433 $1,929 $1,106 $116 $516 $227 $1,965 __________(1)Includes retirement income, endowment and savings variable universal life.(2)Includes market value adjusted investment contracts and single-pay whole life products. 2021 also includes annuity products. (3)Single pay life annualized new business premiums, which include 10% of first year premiums, and 3-year limited pay annualized new business premiums, which include 100% of new business premiums, represented 0% and 51%, respectively, of total Japanese bank distribution channel annualized new business premiums, excluding investment contracts, for the year ended December 31, 2022, and 3% and 66%, respectively, of total Japanese bank distribution channel annualized new business premiums, excluding investment contracts, for the year ended December 31, 2021. Annualized new business premiums, on a constant exchange rate basis, from our Life Planner operations increased $62 million, primarily driven by higher life product sales in Brazil and Argentina. In Japan, higher sales of USD-denominated market value adjusted investment contacts, driven by higher interest rates, were partially offset by lower sales of USD-denominated retirement products.Annualized new business premiums, on a constant exchange rate basis, from our Gibraltar Life and Other operations decreased $98 million. Bank channel sales decreased $150 million reflecting lower USD-denominated life product sales, partially offset by higher sales of USD-denominated market value adjusted investment contacts, driven by higher interest rates. Life Consultants sales increased $51 million reflecting higher sales of USD-denominated market value adjusted investment contacts, driven by rising interest rates, partially offset by lower USD-denominated life product sales. Independent Agency sales increased $1 million, primarily driven by higher sales of life products and USD-denominated endowment products, largely offset by the absence of accident & health product sales made to a single large client in the prior year period and lower sales of investment contracts.Sales Force The following table sets forth the number of Life Planners and Life Consultants for the periods indicated: Year Ended December 31, 202220212020Life Planners:Japan4,446 4,566 4,555 All other countries1,478 1,458 1,511 Gibraltar Life Consultants6,821 7,100 7,254 Total12,745 13,124 13,320 2022 to 2021 Comparison. The number of Life Planners decreased by 100, driven by a decrease of 120 in our Japan operations, primarily reflecting our selective recruiting efforts and higher resignations. Life Planners in our other operations increased by 20, primarily reflecting an increase in Brazil. The number of Gibraltar Life Consultants decreased by 279, primarily reflecting continued recruiting challenges and higher resignations due to more selective retention standards.Corporate and Other Corporate and Other includes corporate operations, after allocations to our business segments, and Divested and Run-off Businesses other than those that qualify for “discontinued operations” accounting treatment under U.S. GAAP.95Table of Contents Year ended December 31, 202220212020 (in millions)Operating results:Interest expense on debt$(829)$(827)$(894)Investment income177 174 134 Pension and employee benefits387 284 191 Other corporate activities(1,211)(1,238)(1,398)Adjusted operating income(1,476)(1,607)(1,967)Realized investment gains (losses), net, and related adjustments(38)94 (2,357)Charges related to realized investment gains (losses), net5 8 3 Market experience updates22 3 (10)Divested and Run-off Businesses9 716 (450)Equity in earnings of operating joint ventures and earnings attributable to noncontrolling interests(47)(38)(25)Income (loss) before income taxes and equity in earnings of operating joint ventures$(1,525)$(824)$(4,806) 2022 to 2021 Annual Comparison. The loss from Corporate and Other operations, on an adjusted operating income basis, decreased $131 million. Pension and employee benefits were favorable by $103 million, driven by higher earnings from our pension and post-retirement plans resulting from higher returns on plan assets, lower benefit costs for these plans resulting from the sale of the Full Service Retirement business, and a favorable impact from design changes to the Company’s Retiree Medical Savings Account plan. Net charges from other corporate activities decreased by $27 million, primarily driven by the absence of costs related to the early extinguishment of debt in the prior year period, favorable exchange rate impacts, gains from the sales of certain home office properties, and lower costs for long-term compensation plans, partially offset by higher expenses, including an increase in costs related to corporate initiatives.For purposes of calculating pension income from our qualified pension plan for the year ended December 31, 2023, we increased the discount rate from 2.85% to 5.45% as of December 31, 2022. The expected rate of return on plan assets increased from 6.00% in 2022 to 7.50% in 2023. The assumed rate of increase in compensation remained unchanged at 4.50%. Giving effect to the foregoing changes and other factors, we expect income from our qualified pension plan in 2023 to be approximately $20 million to $30 million higher than 2022 levels. This increase is primarily driven by higher earnings from an increase in the expected rate of return and lower loss amortization, partially offset by higher interest costs on the plan obligation due to a higher discount rate. For purposes of calculating postretirement benefit expenses for the year ended December 31, 2023, we increased the discount rate from 2.75% to 5.55% as of December 31, 2022. The expected rate of return on plan assets increased from 7.00% in 2022 to 7.75% in 2023. Giving effect to the foregoing changes and other factors, we expect postretirement income in 2023 to be approximately $30 million to $40 million lower than 2022 levels. This decrease is primarily driven by higher interest costs on the plan obligation due to a higher discount rate and unfavorable equity returns in 2022, partially offset by higher earnings from an increase in the expected rate of return and lower loss amortization. In 2023, pension and other postretirement benefit service costs related to active employees will continue to be allocated to our business segments. For further information regarding our pension and postretirement plans, including the changes to the Company’s Retiree Medical Savings Account plan, see Note 18 to the Consolidated Financial Statements.Divested and Run-off BusinessesDivested and Run-off Businesses Included in Corporate and OtherIncome from our Divested and Run-off Businesses includes results from several businesses that have been or will be sold or exited, including businesses that have been placed in wind down status that do not qualify for “discontinued operations” accounting treatment under U.S. GAAP. The results of these Divested and Run-off Businesses are reflected in our Corporate and Other operations but are excluded from adjusted operating income. A summary of the results of the Divested and Run-off Businesses reflected in our Corporate and Other operations is as follows for the periods indicated:96Table of Contents Year ended December 31, 202220212020 (in millions)Long-Term Care$(418)$458 $351 Other427 258 (801)Total Divested and Run-off Businesses income (loss) excluded from adjusted operating income$9 $716 $(450) Long-Term Care. Results for the year ended December 31, 2022 decreased $876 million compared to 2021, including an unfavorable comparative net impact from our annual reviews and update of assumptions and other refinements. Results for 2022 included a $28 million net charge from these updates, while results for 2021 included a $62 million net benefit. Excluding this item, results decreased $786 million primarily driven by unfavorable impacts from changes in the market value of equity securities, changes in the market value of derivatives used for duration management and lower income on non-coupon investments.Other Divested and Run-off Businesses. Results for the year ended December 31, 2022 increased $169 million compared to 2021, primarily driven by the gain on the sale of the Full Service Retirement business. See Note 1 to the Consolidated Financial Statements for additional information regarding this sale. The results for 2022 also include losses related to the Full Service Retirement business in the first quarter, largely driven by the impact of rising interest rates on the market value of assets supporting experience-rated contractholder liabilities. For additional information, see “—Experience-Rated Contractholder Liabilities, Assets Supporting Experience-Rated Contractholder Liabilities and Other Related Investments.”Closed Block Division The Closed Block division includes certain in-force traditional domestic participating life insurance and annuity products and assets that are used for the payment of benefits and policyholder dividends on these policies (collectively, the “Closed Block”), as well as certain related assets and liabilities. We no longer offer these traditional domestic participating policies. See Note 15 to the Consolidated Financial Statements for additional information. Each year, the Board of Directors of The Prudential Insurance Company of America (“PICA”) determines the dividends payable on participating policies for the following year based on the experience of the Closed Block, including investment income, net realized and unrealized investment gains (losses), mortality experience and other factors. Although the Closed Block experience for dividend action decisions is based upon statutory results, at the time the Closed Block was established, we developed, as required by U.S. GAAP, an actuarial calculation of the timing of the maximum future earnings from the policies included in the Closed Block. Actual cumulative earnings, as required by U.S. GAAP, reflect the recognition of realized investment gains and losses in the current period, as well as changes in assets and related liabilities that support the Closed Block policies. If actual cumulative earnings in any given period are greater than the cumulative earnings we expected, we record this excess as a policyholder dividend obligation. Additionally, any accumulated net unrealized investment gains that have arisen subsequent to the establishment of the Closed Block are reflected as a policyholder dividend obligation, with a corresponding amount reported in AOCI, while any accumulated net unrealized investment losses are reflected as a reduction of the policyholder dividend obligation, to the extent the overall policyholder dividend obligation is otherwise positive.We will subsequently pay this excess to Closed Block policyholders as an additional dividend unless it is otherwise offset by future Closed Block performance that is less favorable than we originally expected. The policyholder dividends we charge to expense within the Closed Block division will include any change in our policyholder dividend obligation that we recognize for the excess of actual cumulative earnings in any given period over the cumulative earnings we expected in addition to the actual policyholder dividends declared by the Board of Directors of PICA. If actual cumulative earnings fall below expected cumulative earnings in future periods, earnings volatility in the Closed Block division, which is primarily due to changes in investment results, may not be offset by changes in the cumulative earnings policyholder dividend obligation. For a discussion of the Closed Block division’s realized investment gains (losses), net, see “—General Account Investments.” As of December 31, 2022, the excess of actual cumulative earnings over the expected cumulative earnings was $3,207 million; however, due to the accumulation of net unrealized investment losses in excess of this amount, the policyholder dividend obligation balance as of December 31, 2022 was reduced to zero. Operating Results The following table sets forth the Closed Block division’s results for the periods indicated:97Table of Contents Year ended December 31, 202220212020 (in millions)U.S. GAAP results:Revenues$2,957 $5,947 $4,766 Benefits and expenses2,989 5,807 4,790 Income (loss) before income taxes and equity in earnings of operating joint ventures$(32)$140 $(24)Income (loss) Before Income Taxes and Equity in Earnings of Operating Joint Ventures 2022 to 2021 Annual Comparison. Income (loss) before income taxes and equity in earnings of operating joint ventures decreased $172 million. Net investment activity results decreased primarily reflecting lower other income driven by unfavorable changes in the value of equity securities, a decrease in realized investment gains (losses) driven by losses on the sale of fixed income investments in the current year, and lower net investment income on non-coupon investments. Net insurance activity results increased driven by a favorable comparative change in claims experience and reserves, partially offset by lower premiums due to the runoff of policies in force. As a result of the above, a $1,180 million reduction in the policyholder dividend obligation was recorded in 2022, compared to a $1,469 million increase in 2021. Revenues, Benefits and Expenses 2022 to 2021 Annual Comparison. Revenues decreased $2,990 million primarily driven by a decrease in other income, realized investment gains (losses), net investment income and premiums, as discussed above.Benefits and expenses decreased $2,818 million primarily driven by a decrease in dividends to policyholders, reflecting a reduction in the policyholder dividend obligation expense due to changes in cumulative earnings, as discussed above.Income Taxes The differences between income taxes expected at the U.S. federal statutory income tax rate of 21% applicable for 2022, 2021 and 2020, and the reported income tax expense (benefit) are provided in the following table:Year Ended December 31, 20222021(1)2020(1) (in millions)Expected federal income tax expense (benefit) at federal statutory rate$(373)$1,970 $(68)Non-taxable investment income(86)(292)(228)Foreign taxes at other than U.S. rate11 149 250 Low-income housing and other tax credits(128)(126)(112)Changes in tax law(11)10 (192)GILTI101 (1)(2)Sale of subsidiary84 (26)277 Non-controlling interest5 (14)(48)Non-deductible expenses21 11 14 Change in valuation allowance16 13 17 State taxes13 18 10 Other(23)(38)1 Reported income tax expense (benefit)$(370)$1,674 $(81)Effective tax rate20.8 %17.8 %25.1 % __________(1)Prior period amounts have been updated to conform to current period presentation.98Table of ContentsEffective Tax RateThe effective tax rate is the ratio of “Total income tax expense (benefit)” divided by “Income before income taxes and equity in earnings of operating joint ventures.” Our effective tax rate for fiscal years 2022, 2021 and 2020 was 20.8%, 17.8%, and 25.1%, respectively. For a detailed description of the nature of each significant reconciling item, see Note 16 to the Consolidated Financial Statements.Unrecognized Tax BenefitsThe Company’s liability for income taxes includes the liability for unrecognized tax benefits and interest that relate to tax years still subject to review by the Internal Revenue Service or other taxing authorities. The completion of review or the expiration of the Federal statute of limitations for a given audit period could result in an adjustment to the liability for income taxes. The total unrecognized benefit as of December 31, 2022, 2021 and 2020 was $84 million, $12 million and $17 million, respectively. The Company cannot predict with reasonable accuracy whether there will be any significant changes within the next twelve months to our total unrecognized tax benefits related to tax years for which the statute of limitations has not expired.Income Tax Expense vs. Income Tax Paid in CashIncome tax expense recorded under U.S. GAAP routinely differs from the income taxes paid in cash in any given year. Income tax expense recorded under U.S. GAAP is based on income reported in our Consolidated Statements of Operations for the current period and it includes both current and deferred taxes. Income taxes paid during the year include tax installments made for the current year as well as tax payments and refunds related to prior periods.For additional information regarding income tax related items, see “Business—Regulation” and Note 16 to the Consolidated Financial Statements.Experience-Rated Contractholder Liabilities,Assets Supporting Experience-Rated Contractholder Liabilities and Other Related InvestmentsInternational Businesses. Certain products included in our International Businesses are experience-rated in that investment results associated with these products are expected to ultimately accrue to contractholders. The majority of investments supporting these experience-rated products are carried at fair value. These experience-rated products are fully participating, and as a result, the entire return on the underlying investments is passed back to policyholders through a corresponding adjustment to the related liability. The investments and related liabilities are reflected on the Consolidated Statements of Financial Position as “Assets supporting experience-rated contractholder liabilities, at fair value” and “Policyholders’ account balances,” respectively The associated realized and unrealized gains (losses) on the investments are reported on the Consolidated Statements of Operations as “Other income (loss)”, while interest and dividend income are reported in “Net investment income.”Adjusted operating income excludes net investment gains (losses) on assets supporting experience-rated contractholder liabilities. This is consistent with the exclusion of realized investment gains (losses) with respect to other investments supporting insurance liabilities managed on a consistent basis. In addition, to be consistent with the historical treatment of charges related to realized investment gains (losses) on investments, adjusted operating income also excludes the change in contractholder liabilities due to asset value changes in the pool of investments supporting these experience-rated contracts, which are reflected in “Interest credited to policyholders’ account balances.” The result of this approach is that adjusted operating income for these products includes net fee revenue and interest spread we earn on these experience-rated contracts, and excludes changes in fair value of the pool of investments, both realized and unrealized, that we expect will ultimately accrue to the contractholders.Full Service Retirement Business. Prior to the second quarter of 2022, the Full Service Retirement business included within the Company’s Divested and Run-off Businesses held two types of experience-rated products that were supported by assets supporting experience-rated contractholder liabilities and other related investments. On April 1, 2022, the Company completed the sale of its Full Service Retirement business to Great-West. See Note 1 to the Consolidated Financial Statements for additional information regarding this disposition.The following table sets forth the impact on results for the periods indicated of these items that are excluded from adjusted operating income: 99Table of Contents Year ended December 31, 202220212020 (in millions)International Businesses:Investment gains (losses) on assets supporting experience-rated contractholder liabilities, net$(201)$369 $68 Change in experience-rated contractholder liabilities due to asset value changes201 (369)(68)Gains (losses), net, on experienced rated contracts$0 $0 $0 Divested and Run-off Businesses:Investment gains (losses) on assets supporting experience-rated contractholder liabilities, net$(950)$(616)$602 Change in experience-rated contractholder liabilities due to asset value changes818 657 (625)Gains (losses), net, on experienced rated contracts$(132)$41 $(23)Total:Investment gains (losses) on assets supporting experience-rated contractholder liabilities, net$(1,151)$(247)$670 Change in experience-rated contractholder liabilities due to asset value changes1,019 288 (693)Gains (losses), net, on experienced rated contracts$(132)$41 $(23) For our divested Full Service Retirement business, the net impact of changes in experience-rated contractholder liabilities and investment gains (losses) on assets supporting experience-rated contractholder liabilities and other related investments reflects timing differences between the recognition of the mark-to-market adjustments and the recognition of the recovery of these adjustments in future periods through subsequent increases in asset values or reductions in crediting rates on contractholder liabilities for partially participating products. This includes certain assets that are designated as available-for-sale where mark-to-market adjustments are recorded as unrealized gains (losses) in “Other comprehensive income”. These impacts also reflect the difference between the fair value of underlying commercial mortgages and other loans and the amortized cost, less any valuation allowance, of these loans. Valuation of Assets and Liabilities Fair Value of Assets and Liabilities The authoritative guidance related to fair value measurement establishes a framework that includes a three-level hierarchy used to classify the inputs used in measuring fair value. The level in the hierarchy within which the fair value falls is determined based on the lowest level input that is significant to the measurement. The fair values of assets and liabilities classified as Level 3 include at least one significant unobservable input in the measurement. See Note 6 to the Consolidated Financial Statements for an additional description of the valuation hierarchy levels as well as for the balances of assets and liabilities measured at fair value on a recurring basis by hierarchy level presented on a consolidated basis. The table below presents the balances of assets and liabilities measured at fair value on a recurring basis, as of the periods indicated, and the portion of such assets and liabilities that are classified in Level 3 of the valuation hierarchy. The table also provides details about these assets and liabilities excluding those held in the Closed Block division. We believe the amounts excluding the Closed Block division are most relevant to an understanding of our operations that are pertinent to investors in Prudential Financial because substantially all Closed Block division assets support obligations and liabilities relating to the Closed Block policies only. See Note 15 to the Consolidated Financial Statements for additional information regarding the Closed Block. 100Table of Contents As of December 31, 2022As of December 31, 2021(1) PFI excluding Closed Block DivisionClosed Block DivisionPFI excluding Closed Block DivisionClosed Block Division Total atFair ValueTotalLevel 3(2)Total atFair ValueTotalLevel 3(2)Total atFair ValueTotalLevel 3(2)Total atFair ValueTotalLevel 3(2) (in millions)Fixed maturities, available-for-sale$277,648 $4,345 $30,071 $817 $334,006 $5,810 $38,404 $1,510 Assets supporting experience-rated contractholder liabilities:Fixed maturities945 0 0 0 1,057 0 0 0 Equity securities1,899 0 0 0 2,271 0 0 0 All other(3)0 0 0 0 20 0 0 0 Subtotal2,844 0 0 0 3,348 0 0 0 Fixed maturities, trading5,051 289 900 15 7,686 403 1,137 18 Equity securities5,416 528 1,734 99 6,089 699 2,288 100 Commercial mortgage and other loans137 0 0 0 1,263 0 0 0 Other invested assets(4)1,990 537 3 2 3,749 489 7 4 Short-term investments3,637 18 150 0 5,186 268 457 62 Cash equivalents6,398 0 1,076 0 4,857 48 402 22 Other assets176 176 0 0 164 164 0 0 Separate account assets171,805 1,081 0 0 219,971 1,283 0 0 Total assets$475,102 $6,974 $33,934 $933 $586,319 $9,164 $42,695 $1,716 Future policy benefits$4,746 $4,746 $0 $0 $9,068 $9,068 $0 $0 Policyholders’ account balances3,492 3,492 0 0 1,436 1,436 0 0 Other liabilities(4)2,682 1 0 0 1,860 0 0 0 Total liabilities$10,920 $8,239 $0 $0 $12,364 $10,504 $0 $0 __________(1)Excludes amounts for financial instruments reclassified to “Assets held-for-sale” of $129,579 million and “Liabilities held-for-sale” of $6,214 million. Assets held-for-sale and liabilities held-for-sale are valued on a basis consistent with similar instruments described herein. See Note 1 to the Consolidated Financial Statements for additional information.(2)Level 3 assets expressed as a percentage of total assets measured at fair value on a recurring basis for PFI excluding the Closed Block division and for the Closed Block division totaled 1.5% and 2.7%, respectively, as of December 31, 2022 and 1.6% and 4.0%, respectively, as of December 31, 2021.(3)“All other” represents cash equivalents and short-term investments.(4)“Other invested assets” and “Other liabilities” primarily include derivatives. The amounts include the impact of netting subject to master netting agreements. The determination of fair value, which for certain assets and liabilities is dependent on the application of estimates and assumptions, can have a significant impact on our results of operations and may require the application of a greater degree of judgment depending on market conditions, as the ability to value assets and liabilities can be significantly impacted by a decrease in market activity or a lack of transactions executed in an orderly manner. Fixed maturity securities included in Level 3 in our fair value hierarchy are generally priced based on internally-developed valuations or indicative broker quotes. For certain private fixed maturity and equity securities, the internal valuation models use significant unobservable inputs and, accordingly, such securities are included in Level 3 in our fair value hierarchy. Level 3 fixed maturity securities for PFI excluding the Closed Block division included approximately $1.1 billion of public fixed maturities as of December 31, 2022 with values primarily based on indicative broker quotes, and approximately $3.5 billion of private fixed maturities, with values primarily based on internally-developed models. Significant unobservable inputs used in their valuation included: issue specific spread adjustments, material non-public financial information, management judgment, estimation of future earnings and cash flows, default rate assumptions, liquidity assumptions and indicative quotes from market makers. Separate account assets included in Level 3 in our fair value hierarchy primarily include corporate securities and commercial mortgage loans. Embedded derivatives reported in “Future policy benefits” and “Policyholders’ account balances” that are included in level 3 of our fair value hierarchy represent general account liabilities pertaining to living benefit features of the Company’s 101Table of Contentsvariable annuity contracts and the index-linked interest credited features on certain life and annuity products. These are carried at fair value with changes in fair value included in “Realized investment gains (losses), net.” These embedded derivatives are valued using internally-developed models that require significant estimates and assumptions developed by management. Changes in these estimates and assumptions can have a significant impact on the results of our operations.For additional information about the valuation techniques and the key estimates and assumptions used in our determination of fair value, see Note 6 to the Consolidated Financial Statements. General Account InvestmentsWe maintain diversified investment portfolios in our general account to support our liabilities to customers as well as our other general liabilities. Investments and other assets that do not support general account liabilities, and are therefore excluded from our general account, are as follows:•assets of our derivative operations; •assets of our investment management operations, including investments managed for third-parties; and •those assets classified as “Separate account assets” on our balance sheet.The general account portfolios are managed pursuant to the distinct objectives and investment policy statements of PFI excluding the Closed Block division and of the Closed Block division. The primary investment objectives of PFI excluding the Closed Block division include:•hedging and otherwise managing the market risk characteristics of the major product liabilities and other obligations of the Company;•optimizing investment income yield within risk constraints over time; and•for certain portfolios, optimizing total return, including both investment income yield and capital appreciation, within risk constraints over time, while managing the market risk exposures associated with the corresponding product liabilities.We pursue our objective to optimize investment income yield for PFI excluding the Closed Block division over time through:•the investment of net operating cash flows, including new product premium inflows, and proceeds from investment sales, repayments and prepayments into investments with attractive risk-adjusted yields; and•the sale of investments, where appropriate, either to meet various cash flow needs or to manage the portfolio's risk exposure profile with respect to duration, credit, currency and other risk factors, while considering the impact on taxes and capital.The primary investment objectives of the Closed Block division include:•providing for the reasonable dividend expectations of the participating policyholders within the Closed Block division; and•optimizing total return, including both investment income yield and capital appreciation, within risk constraints, while managing the market risk exposures associated with the major products in the Closed Block division.Our portfolio management approach, while emphasizing our investment income yield and asset/liability risk management objectives, also takes into account the capital and tax implications of portfolio activity and our assertions regarding our ability and intent to hold debt securities to recovery. For a further discussion of our allowance for credit losses, including our assertions regarding any intention or requirement to sell debt securities before anticipated recovery, see “—Realized Investment Gains and Losses—Credit Losses” below.Management of InvestmentsThe Investment Committee of our Board of Directors (“Board”) oversees our proprietary investments, including our general account portfolios, and regularly reviews performance and risk positions. Our Chief Investment Officer Organization (“CIO Organization”) develops investment policies subject to risk limits proposed by our Enterprise Risk Management (“ERM”) group for the general account portfolios of our domestic and international insurance subsidiaries and directs and oversees management of the general account portfolios within risk limits and exposure ranges approved annually by the Investment Committee.102Table of ContentsThe CIO Organization, including related functions within our insurance subsidiaries, works closely with product actuaries and ERM to understand the characteristics of our products and their associated market risk exposures. This information is incorporated into the development of target asset portfolios that manage market risk exposures associated with the liability characteristics and establish investment risk exposures, within tolerances prescribed by Prudential’s investment risk limits, on which we expect to earn an attractive risk-adjusted return. We develop asset strategies for specific classes of product liabilities and attributed or accumulated surplus, each with distinct risk characteristics. Market risk exposures associated with the liabilities include interest rate risk, which is addressed through the duration characteristics of the target asset mix, and currency risk, which is addressed by the currency profile of the target asset mix. In certain of our smaller markets outside of the U.S. and Japan, capital markets limitations hinder our ability to hedge interest rate exposure to the same extent we do for our U.S. and Japan businesses and lead us to accept a higher degree of interest rate risk in these smaller portfolios. General account portfolios typically include allocations to credit and other investment risks as a means to enhance investment yields and returns over time.Most of our products can be categorized into the following three classes:•interest-crediting products for which the rates credited to customers are periodically adjusted to reflect market and competitive forces and actual investment experience, such as fixed annuities and universal life insurance; •participating individual and experience-rated group products in which customers participate in actual investment and business results through annual dividends, interest or return of premium; and•products with fixed or guaranteed terms, such as traditional whole life and endowment products, guaranteed investment contracts (“GICs”), funding agreements and payout annuities.Our total investment portfolio is composed of a number of operating portfolios. Each operating portfolio backs a specific set of liabilities, and the portfolios have a target asset mix that supports the liability characteristics, including duration, cash flow, liquidity needs and other criteria. As of December 31, 2022, the average duration of our domestic general account investment portfolios attributable to PFI excluding the Closed Block division, including the impact of derivatives, was approximately 7 years. As of December 31, 2022, the average duration of our international general account portfolios attributable to our Japanese insurance operations, including the impact of derivatives, was between 11 and 12 years and represented a blend of yen-denominated and U.S. dollar and Australian dollar-denominated investments, which have distinct average durations supporting the insurance liabilities we have issued in those currencies. Our asset/liability management process has enabled us to manage our portfolios through several market cycles.We implement our portfolio strategies primarily through investment in a broad range of fixed income assets, including government and agency securities, public and private corporate bonds and structured securities and commercial mortgage loans. In addition, we hold allocations of non-coupon investments, which include equity securities and other invested assets such as LPs/LLCs, real estate held through direct ownership, derivative instruments, and seed money investments in separate accounts.We manage our public fixed maturity portfolio to a risk profile directed or overseen by the CIO Organization and ERM groups and to a profile that also reflects the market environments impacting both our domestic and international insurance portfolios. The return that we earn on the portfolio will be reflected in investment income and in realized gains or losses on investments.We use privately-placed corporate debt securities and commercial mortgage loans, which consist of mortgages on diversified properties in terms of geography, property type and borrowers, to enhance the yield on our portfolio and to improve the overall diversification of the portfolios. Private placements typically offer enhanced yields due to an illiquidity premium and generally offer enhanced credit protection in the form of covenants. Our origination capability offers the opportunity to lead transactions and gives us the opportunity for better terms, including covenants and call protection, and to take advantage of innovative deal structures.Derivative strategies are employed in the context of our risk management framework to enhance our ability to manage interest rate and currency risk exposures of the asset portfolio relative to the liabilities and to manage credit and equity positions in the investment portfolios. For a discussion of our risk management process, see “Quantitative and Qualitative Disclosures About Market Risk” below.Our portfolio asset allocation reflects our emphasis on diversification across asset classes, sectors and issuers. The CIO Organization, directly and through related functions within the insurance subsidiaries, implements portfolio strategies primarily through various investment management units within Prudential’s PGIM segment. Activities of the PGIM segment on behalf of the general account portfolios are directed and overseen by the CIO Organization and monitored by ERM for compliance with investment risk limits.103Table of ContentsIn executing the activities on behalf of the general account portfolio, Prudential investment management units are incorporating environmental, social and governance factors into their respective investment processes as appropriate. These factors include investing in opportunities to support diversity and inclusion and to help mitigate climate change by pursuing relevant investments across asset classes.Portfolio Composition Our investment portfolio consists of public and private fixed maturity securities, commercial mortgage and other loans, policy loans and non-coupon investments as defined above. The composition of our general account reflects, within the discipline provided by our risk management approach, our need for competitive results and the selection of diverse investment alternatives available primarily through our PGIM segment. The size of our portfolio enables us to invest in asset classes that may be unavailable to the typical investor.The following tables set forth the composition of our general account investment portfolio apportioned between PFI excluding the Closed Block division and the Closed Block division, as of the dates indicated:104Table of Contents December 31, 2022 PFI ExcludingClosed Block DivisionClosed Block DivisionTotal ($ in millions)Fixed maturities:Public, available-for-sale, at fair value$221,106 60.8 %$21,140 $242,246 Public, held-to-maturity, at amortized cost, net of allowance1,229 0.3 0 1,229 Private, available-for-sale, at fair value55,814 15.4 8,931 64,745 Private, held-to-maturity, at amortized cost, net of allowance67 0.0 0 67 Fixed maturities, trading, at fair value 4,838 1.3 900 5,738 Assets supporting experience-rated contractholder liabilities, at fair value2,844 0.8 0 2,844 Equity securities, at fair value4,671 1.3 1,733 6,404 Commercial mortgage and other loans, at book value, net of allowance48,682 13.4 7,926 56,608 Policy loans, at outstanding balance6,409 1.8 3,637 10,046 Other invested assets, net of allowance(1)13,277 3.7 4,254 17,531 Short-term investments, net of allowance4,236 1.2 337 4,573 Total general account investments363,173 100.0 %48,858 412,031 Invested assets of other entities and operations(2)5,410 0 5,410 Total investments$368,583 $48,858 $417,441 December 31, 2021 PFI ExcludingClosed Block Division(3)Closed Block DivisionTotal ($ in millions)Fixed maturities:Public, available-for-sale, at fair value$276,868 65.0 %$28,167 $305,035 Public, held-to-maturity, at amortized cost, net of allowance1,413 0.3 0 1,413 Private, available-for-sale, at fair value56,660 13.3 10,237 66,897 Private, held-to-maturity, at amortized cost, net of allowance101 0.1 0 101 Fixed maturities, trading, at fair value 7,473 1.8 1,137 8,610 Assets supporting experience-rated contractholder liabilities, at fair value3,358 0.8 0 3,358 Equity securities, at fair value5,587 1.3 2,288 7,875 Commercial mortgage and other loans, at book value, net of allowance49,146 11.6 8,241 57,387 Policy loans, at outstanding balance6,571 1.5 3,815 10,386 Other invested assets, net of allowance(1)12,485 2.9 4,358 16,843 Short-term investments, net of allowance6,043 1.4 557 6,600 Total general account investments425,705 100.0 %58,800 484,505 Invested assets of other entities and operations(2)7,694 0 7,694 Total investments$433,399 $58,800 $492,199 __________(1)Other invested assets consist of investments in LPs/LLCs, investment real estate held through direct ownership, derivative instruments and other miscellaneous investments. For additional information regarding these investments, see “—Other Invested Assets” below.(2)Includes invested assets of our investment management and derivative operations. Excludes assets of our investment management operations that are managed for third-parties and those assets classified as “Separate account assets” on our balance sheet. For additional information regarding these investments, see “—Invested Assets of Other Entities and Operations” below.(3)Excludes “Assets held-for-sale” of $40,669 million as of December 31, 2021. See Note 1 to the Consolidated Financial Statements for additional information.The decrease in general account investments attributable to PFI excluding the Closed Block division in 2022 was primarily due to an increase in U.S. interest rates and the translation impact of the U.S. dollar strengthening against the yen, 105Table of Contentspartially offset by the reinvestment of net investment income and net business inflows. For information regarding the methodology used in determining the fair value of our fixed maturities, see Note 6 to the Consolidated Financial Statements. As of December 31, 2022 and 2021, 45% and 48%, respectively, of our general account investments attributable to PFI excluding the Closed Block division related to our Japanese insurance operations. The following table sets forth the composition of the investments of our Japanese insurance operations’ general account, as of the dates indicated: December 31, 20222021 (in millions)Fixed maturities:Public, available-for-sale, at fair value$112,013 $146,600 Public, held-to-maturity, at amortized cost, net of allowance1,2291,413 Private, available-for-sale, at fair value19,26821,079 Private, held-to-maturity, at amortized cost, net of allowance67101 Fixed maturities, trading, at fair value 612839 Assets supporting experience-rated contractholder liabilities, at fair value 2,8443,328 Equity securities, at fair value1,8062,187 Commercial mortgage and other loans, at book value, net of allowance18,08019,969 Policy loans, at outstanding balance2,6072,726 Other invested assets(1)5,2724,203 Short-term investments, net of allowance100692 Total Japanese general account investments$163,898 $203,137 __________(1)Other invested assets consist of investments in LPs/LLCs, investment real estate held through direct ownership, derivative instruments and other miscellaneous investments. The decrease in general account investments related to our Japanese insurance operations in 2022 was primarily attributable to an increase in U.S. interest rates and the translation impact of the U.S. dollar strengthening against the yen, partially offset by the reinvestment of net investment income and net business inflows.As of December 31, 2022, our Japanese insurance operations had $77.5 billion, at carrying value, of investments denominated in U.S. dollars, including $1.5 billion that were hedged to yen through third-party derivative contracts and $67.4 billion that support liabilities denominated in U.S. dollars, with the remainder constituting part of the hedging of foreign currency exchange rate exposure to U.S. dollar-equivalent equity. As of December 31, 2021, our Japanese insurance operations had $92.5 billion, at carrying value, of investments denominated in U.S. dollars, including $2.1 billion that were hedged to yen through third-party derivative contracts and $80.2 billion that support liabilities denominated in U.S. dollars, with the remainder constituting part of the hedging of foreign currency exchange rate exposure to U.S. dollar-equivalent equity. The $15.0 billion decrease in the carrying value of U.S. dollar-denominated investments from December 31, 2021 was primarily attributable to an increase in U.S. interest rates, partially offset by reinvestment of net investment income.Our Japanese insurance operations had $5.2 billion and $8.0 billion, at carrying value, of investments denominated in Australian dollars that support liabilities denominated in Australian dollars as of December 31, 2022 and 2021, respectively. The $2.8 billion decrease in the carrying value of Australian dollar-denominated investments from December 31, 2021 was primarily attributable to run-off of the portfolio and an increase in Australian government bond rates. For additional information regarding U.S. and Australian dollar investments held in our Japanese insurance operations and a discussion of our yen hedging strategy, see “Results of Operations by Segment—Impact of Foreign Currency Exchange Rates” above. Investment ResultsThe following tables set forth the investment results of our general account apportioned between PFI excluding the Closed Block division, and the Closed Block division, for the periods indicated. The yields are based on net investment income as reported under U.S. GAAP and as such do not include certain interest-related items, such as settlements of duration management swaps which are included in “Realized investment gains (losses), net.” 106Table of ContentsYear Ended December 31, 2022PFI Excluding Closed Block Division and Japanese OperationsJapanese Insurance OperationsPFI Excluding Closed Block DivisionClosed Block DivisionTotal(5)Yield(1)AmountYield(1)AmountYield(1)AmountAmountAmount($ in millions)Fixed maturities(2)4.56 %$7,036 2.75 %$3,831 3.71 %$10,867 $1,375 $12,242 Assets supporting experience-rated contractholder liabilities 1.68 123 1.01 30 1.49 153 0 153 Equity securities1.95 56 3.59 67 2.59 123 37 160 Commercial mortgage and other loans3.67 1,164 3.67 686 3.67 1,850 322 2,172 Policy loans4.94 184 3.90 99 4.52 283 216 499 Short-term investments and cash equivalents2.70 340 3.75 31 2.75 371 24 395 Gross investment income4.19 8,903 2.86 4,744 3.61 13,647 1,974 15,621 Investment expenses(0.13)(350)(0.13)(281)(0.13)(631)(155)(786)Investment income after investment expenses4.06 %8,553 2.73 %4,463 3.48 %13,016 1,819 14,835 Other invested assets(3)744 208 952 157 1,109 Investment results of other entities and operations(4)93 0 93 0 93 Total investment income$9,390 $4,671 $14,061 $1,976 $16,037 107Table of ContentsYear Ended December 31, 2021PFI Excluding Closed Block Division and Japanese Operations(6)Japanese Insurance OperationsPFI Excluding Closed Block Division(6)Closed Block DivisionTotal(5)Yield(1)AmountYield(1)AmountYield(1)AmountAmountAmount($ in millions)Fixed maturities(2)4.68 %$7,084 2.72 %$3,921 3.72 %$11,005 $1,461 $12,466 Assets supporting experience-rated contractholder liabilities 3.48 561 0.93 30 3.05 591 0 591 Equity securities1.44 42 3.52 76 2.32 118 44 162 Commercial mortgage and other loans4.16 1,401 3.92 768 4.07 2,169 367 2,536 Policy loans5.09 196 4.05 114 4.65 310 222 532 Short-term investments and cash equivalents0.48 55 0.48 4 0.48 59 3 62 Gross investment income4.26 9,339 2.85 4,913 3.63 14,252 2,097 16,349 Investment expenses(0.14)(254)(0.14)(241)(0.14)(495)(124)(619)Investment income after investment expenses4.12 %9,085 2.71 %4,672 3.49 %13,757 1,973 15,730 Other invested assets(3)1,413 457 1,870 527 2,397 Investment results of other entities and operations(4)160 0 160 0 160 Total investment income$10,658 $5,129 $15,787 $2,500 $18,287 Year Ended December 31, 2020PFI Excluding Closed Block Division and Japanese OperationsJapanese Insurance OperationsPFI Excluding Closed Block DivisionClosed Block DivisionTotal(5)Yield(1)AmountYield(1)AmountYield(1)AmountAmountAmount($ in millions)Fixed maturities(2)4.59 %$7,416 2.78 %$3,875 3.75 %$11,291 $1,566 $12,857 Assets supporting experience-rated contractholder liabilities 3.22 637 1.88 52 3.06 689 0 689 Equity securities2.01 48 3.62 72 2.74 120 42 162 Commercial mortgage and other loans3.95 1,377 2.89 731 3.91 2,108 358 2,466 Policy loans5.31 238 3.23 98 4.47 336 247 583 Short-term investments and cash equivalents0.83 171 0.86 14 0.83 185 6 191 Gross investment income4.06 9,887 2.89 4,842 3.58 14,729 2,219 16,948 Investment expenses(0.12)(272)(0.14)(245)(0.13)(517)(136)(653)Investment income after investment expenses3.94 %9,615 2.75 %4,597 3.45 %14,212 2,083 16,295 Other invested assets(3)413 245 658 157 815 Investment results of other entities and operations(4)300 0 300 0 300 Total investment income$10,328 $4,842 $15,170 $2,240 $17,410 __________(1)The denominator in the yield percentage is based on quarterly average carrying values for all asset types except for fixed maturities which are based on amortized cost, net of allowance. Amounts for fixed maturities, short-term investments and cash equivalents are also netted for securities lending activity (i.e., income netted for rebate expenses and asset values netted for securities lending liabilities). A yield is not presented for other invested assets as it is not considered a meaningful measure of investment performance. Yields exclude investment income and assets related to other invested assets. (2)Includes fixed maturity securities classified as available-for-sale and held-to-maturity and excludes fixed maturity securities classified as trading, which are included in other invested assets.108Table of Contents(3)Other invested assets consist of investments in LPs/LLCs, investment real estate held through direct ownership, derivative instruments, fixed maturities classified as trading and other miscellaneous investments.(4)Includes net investment income of our investment management operations.(5)The total yield was 3.54%, 3.57% and 3.54% for the years ended December 31, 2022, 2021 and 2020, respectively.(6)The denominator in the yield percentage includes “Assets held-for-sale”. See Note 1 to the Consolidated Financial Statements for additional information.The decrease in investment income after investment expenses yield attributable to our general account investments, excluding both the Closed Block division and the Japanese insurance operations’ portfolio, for 2022 compared to 2021 was primarily due to lower prepayment income, asset sales within the PALAC and Full Service Retirement businesses, and reinvestment at lower rates for a portion of 2022, partially offset by higher returns on short-term investments based on an increase in short-term rates.The increase in investment income after investment expenses yield attributable to the Japanese insurance operations’ portfolio for 2022 compared to 2021 was primarily the result of higher returns on short-term investments based on an increase in short-term rates and higher fixed income reinvestment rates.Both the U.S. dollar-denominated and Australian dollar-denominated fixed maturities that are not hedged to yen through third-party derivative contracts provide a yield that is substantially higher than the yield on comparable yen-denominated fixed maturities. The average amortized cost of U.S. dollar-denominated fixed maturities that are not hedged to yen through third-party derivative contracts was approximately $60.0 billion and $60.5 billion, for the years ended December 31, 2022 and 2021, respectively. The majority of U.S. dollar-denominated fixed maturities support liabilities that are denominated in U.S. dollars. The average amortized cost of Australian dollar-denominated fixed maturities that are not hedged to yen through third-party derivative contracts was approximately $6.1 billion and $7.9 billion, for the years ended December 31, 2022 and 2021, respectively. The majority of Australian dollar-denominated fixed maturities support liabilities that are denominated in Australian dollars. For additional information regarding U.S. and Australian dollar investments held in our Japanese insurance operations, see “—Results of Operations by Segment—Impact of Foreign Currency Exchange Rates” above.Realized Investment Gains and LossesThe following table sets forth “Realized investment gains (losses), net” of our general account apportioned between PFI excluding Closed Block division, and the Closed Block division, by investment type as well as “Related adjustments” and “Charges related to realized investment gains (losses), net” for the periods indicated: 109Table of Contents Years Ended December 31, 202220212020 (in millions)PFI excluding Closed Block Division:Realized investment gains (losses), net: (Addition to) release of allowance for credit losses on fixed maturities$(5)$16 $(105)Write-downs on fixed maturities(1)(85)(1)(220)Net gains (losses) on sales and maturities (1,027)1,445 777 Fixed maturity securities(2)(1,117)1,460 452 (Addition to) release of allowance for credit losses on loans(65)87 0 Net gains (losses) on sales and maturities(70)1 10 Commercial mortgage and other loans(135)88 10 Derivatives(2,060)1,463 (4,571)OTTI losses on other invested assets recognized in earnings(69)(52)(33)(Addition to) release of allowance for credit losses on other invested assets(4)0 (1)Other net gains (losses)48 162 17 Other(25)110 (17)Subtotal (3,337)3,121 (4,126)Investment results of other entities and operations(3)238 96 57 Total — PFI excluding Closed Block Division(3,099)3,217 (4,069)Related adjustments(2,571)(1,270)(71)Realized investment gains (losses), net, and related adjustments(5,670)1,947 (4,140)Charges related to realized investment gains (losses), net(531)(320)(160)Realized investment gains (losses), net, and charges related to realized investment gains (losses), net and adjustments$(6,201)$1,627 $(4,300)Closed Block Division:Realized investment gains (losses), net:(Addition to) release of allowance for credit losses on fixed maturities$(17)$8 $(27)Write-downs on fixed maturities(1)(31)0 (84)Net gains (losses) on sales and maturities(318)466 388 Fixed maturity securities(2)(366)474 277 (Addition to) release of allowance for credit losses on loans(14)11 3 Net gains (losses) on sales and maturities(26)0 (3)Commercial mortgage and other loans(40)11 0 Derivatives145 318 (87)OTTI losses on other invested assets recognized in earnings0 0 0 (Addition to) release of allowance for credit losses on other invested assets(2)0 0 Other net gains (losses)(7)4 (8)Other(9)4 (8)Subtotal — Closed Block Division(270)807 182 Consolidated PFI realized investment gains (losses), net $(3,369)$4,024 $(3,887)__________(1)Amounts represent write-downs of credit adverse securities and securities actively marketed for sale. In addition, for the year ended December 31, 2020, amounts also include write-downs on securities approaching maturities related to foreign exchange movements.(2)Includes fixed maturity securities classified as available-for-sale and held-to-maturity and excludes fixed maturity securities classified as trading. (3)Includes “realized investment gains (losses), net” of our investment management operations. 110Table of Contents2022 to 2021 Annual ComparisonNet losses on sales and maturities of fixed maturity securities were $1,027 million for the year ended December 31, 2022 primarily driven by rotation sales of public securities into private securities and mortgage loans coupled with relative value trading in a higher interest rate environment, partially offset by the impact of foreign currency exchange rate movements on U.S. and Australian dollar-denominated securities that matured or were sold within our International Businesses segment. Net gains on sales and maturities of fixed maturity securities were $1,445 million for the year ended December 31, 2021 primarily driven by sales of U.S. treasuries acquired in a higher interest-rate environment within our domestic segments and the impact of foreign currency exchange rate movements on U.S. and Australian dollar-denominated securities that matured or were sold within our International Businesses segment. Net realized losses on derivative instruments of $2,060 million, for the year ended December 31, 2022, primarily included:•$4,489 million of losses on interest rate derivatives due to an increase in the swap and U.S. Treasury ratesPartially offsetting these losses were:•$1,692 million of gains on product-related embedded derivatives and related hedge positions associated with certain variable annuity contracts; •$402 million of gains on capital hedges due to decreases in equity indices; and•$329 million of gains on foreign currency hedges due to U.S. dollar appreciation versus the Euro, British Pound, and Australian dollar.Net realized gains on derivative instruments of $1,463 million for the year ended December 31, 2021, primarily included:•$2,471 million of gains on product-related embedded derivatives and related hedge positions associated with certain variable annuity contracts; and•$371 million of gains on foreign currency hedges due to U.S. dollar appreciation versus the Euro.Partially offsetting these gains were:•$1,248 million of losses on capital hedges due to increases in equity indices; and•$318 million of losses on interest rate derivatives due to increases in swap and U.S. Treasury rates.For a discussion of living benefit guarantees and related hedge positions in our Individual Annuities segment, see “—Results of Operations by Segment—U.S. Businesses—Individual Annuities” above.Included in the table above are “Related adjustments,” which include the portions of “Realized investment gains (losses), net” that are either (1) included in adjusted operating income or (2) included in other reconciling line items to adjusted operating income, such as “Market experience updates” and “Divested and Run-off Businesses.” “Related adjustments” also includes the portions of “Other income (loss)” and “Net investment income” that are excluded from adjusted operating income. These adjustments are made to arrive at “Realized investment gains (losses), net, and related adjustments” which is excluded from adjusted operating income. See Note 22 to the Consolidated Financial Statements for additional details on adjusted operating income and its reconciliation to “Income (loss) before income taxes and equity in earnings of operating joint ventures.” Results for the years ended December 31, 2022 and 2021 reflect net related adjustments of $(2,571) million and $(1,270) million, respectively. Both periods include changes in the fair value of equity securities and fixed income securities that are designated as trading, as well as settlements and changes in the value of derivatives. Additionally, the results for 2022 include the impact of foreign currency exchange rate movements on certain non-local currency denominated assets and liabilities.Also included in the table above are “Charges related to realized investment gains (losses), net,” which are excluded from adjusted operating income and which may be reflected as either a net charge or net benefit. Results for the years ended December 31, 2022 and 2021 reflect net charges of $531 million and $320 million, respectively, and were primarily driven by the impact of derivative activity on the amortization of DAC and other costs, and certain policyholder reserves, inclusive of impacts from our annual reviews and update of assumptions and other refinements.111Table of ContentsCredit LossesThe level of credit losses generally reflects current and expected economic conditions and is expected to increase when economic conditions worsen and to decrease when economic conditions improve. Historically, the causes of credit losses have been specific to each individual issuer and have not directly resulted in credit losses to other securities within the same industry or geographic region. We may also realize additional credit and interest rate-related losses through sales of investments pursuant to our credit risk and portfolio management objectives.We maintain separate monitoring processes for public and private fixed maturities and create watch lists to highlight securities that require special scrutiny and management. For private placements, our credit and portfolio management processes help ensure prudent controls over valuation and management. We have separate pricing and authorization processes to establish “checks and balances” for new investments. We apply consistent standards of credit analysis and due diligence for all transactions, whether they originate through our own in-house staff or through agents. Our regional offices closely monitor the portfolios in their regions. We set all valuation standards centrally, and we assess the fair value of all investments quarterly. Our public and private fixed maturity investment managers formally review all public and private fixed maturity holdings on a quarterly basis and more frequently when necessary to identify potential credit deterioration whether due to ratings downgrades, unexpected price variances and/or company or industry-specific concerns.For LPs/LLCs accounted for using the equity method and for wholly-owned investment real estate, the carrying value of these investments is written down or impaired to fair value when a decline in value is considered to be other-than-temporary. For additional information regarding our OTTI policies, See Note 2 to the Consolidated Financial Statements.Russia and Ukraine ExposureIn April 2022, we divested all of our holdings in Russian sovereign and state-owned enterprises and have no direct investment exposure in either country as of the date of this filing.General Account Investments of PFI excluding Closed Block Division In the following sections, we provide details about our investment portfolio, excluding investments held in the Closed Block division. We believe the details of the composition of our investment portfolio excluding the Closed Block division are most relevant to an understanding of our operations that are pertinent to investors in Prudential Financial because substantially all Closed Block division assets support obligations and liabilities relating to the Closed Block policies only. See Note 15 to the Consolidated Financial Statements for additional information regarding the Closed Block.Fixed Maturity SecuritiesIn the following sections, we provide details about our fixed maturity securities portfolio, which excludes fixed maturity securities classified as assets supporting experienced-rated contractholder liabilities and classified as trading. Fixed Maturity Securities by Contractual Maturity Date The following table sets forth the breakdown of the amortized cost of our fixed maturity securities portfolio by contractual maturity, as of the date indicated: 112Table of Contents December 31, 2022 AmortizedCost% of Total ($ in millions)Corporate & government securities:Maturing in 2023$7,890 2.6 %Maturing in 202410,824 3.6 Maturing in 202510,646 3.5 Maturing in 202611,174 3.7 Maturing in 202714,088 4.7 Maturing in 202811,420 3.8 Maturing in 202912,771 4.2 Maturing in 203010,942 3.6 Maturing in 203112,044 4.0 Maturing in 203211,465 3.8 Maturing in 20336,831 2.3 Maturing in 2034 and beyond161,752 53.6 Total corporate & government securities281,847 93.4 Asset-backed securities10,060 3.3 Commercial mortgage-backed securities7,331 2.4 Residential mortgage-backed securities2,624 0.9 Total fixed maturities$301,862 100.0 % Fixed Maturity Securities by IndustryThe following table sets forth the composition of the portion of our fixed maturity, available-for-sale portfolio by industry category attributable to PFI excluding the Closed Block division and the associated gross unrealized gains and losses, as well as the allowance for credit losses (“ACL”), as of the dates indicated: 113Table of Contents December 31, 2022December 31, 2021Industry(1)AmortizedCostGrossUnrealizedGainsGrossUnrealizedLossesACLFair ValueAmortizedCostGrossUnrealizedGainsGrossUnrealizedLossesACLFairValue (in millions)Corporate securities:Finance$40,144 $277 $4,719 $2 $35,700 $37,669 $3,362 $175 $1 $40,855 Consumer non-cyclical31,546 387 4,219 16 27,698 30,345 3,675 182 0 33,838 Utility25,871 350 3,443 27 22,751 23,617 3,076 114 21 26,558 Capital goods16,612 196 2,100 36 14,672 14,556 1,352 85 9 15,814 Consumer cyclical10,659 165 1,026 0 9,798 10,504 1,049 52 0 11,501 Foreign agencies3,952 123 289 0 3,786 5,204 603 21 0 5,786 Energy11,488 181 1,166 0 10,503 11,487 1,336 60 0 12,763 Communications6,556 160 898 14 5,804 6,524 1,041 53 39 7,473 Basic industry6,746 103 780 2 6,067 6,385 662 41 1 7,005 Transportation9,894 175 1,183 4 8,882 9,532 997 69 19 10,441 Technology4,460 32 523 0 3,969 4,723 274 41 3 4,953 Industrial other4,544 35 953 0 3,626 4,340 540 35 0 4,845 Total corporate securities172,472 2,184 21,299 101 153,256 164,886 17,967 928 93 181,832 Foreign government(2)73,638 4,490 5,316 0 72,812 82,752 11,741 521 1 93,971 Residential mortgage-backed(3)2,481 28 215 0 2,294 2,451 117 13 0 2,555 Asset-backed10,060 151 206 0 10,005 8,678 114 10 0 8,782 Commercial mortgage-backed7,331 18 521 0 6,828 8,434 459 15 0 8,878 U.S. Government24,857 1,089 3,482 0 22,464 20,747 5,133 21 0 25,859 State & Municipal9,725 226 690 0 9,261 9,992 1,667 8 0 11,651 Total fixed maturities, available-for-sale(4)$300,564 $8,186 $31,729 $101 $276,920 $297,940 $37,198 $1,516 $94 $333,528 __________(1)Investment data has been classified based on standard industry categorizations for domestic public holdings and similar classifications by industry for all other holdings.(2)As of both December 31, 2022 and 2021, based on amortized cost, 89% represent Japanese government bonds held by our Japanese insurance operations with no other individual country representing no more than 5% of the balance.(3)As of December 31, 2022 and 2021, based on amortized cost, 99% and 97% were rated A or higher, respectively.(4)Excluded from the table above are securities held outside the general account in other entities and operations. For additional information regarding investments held outside the general account, see “—Invested Assets of Other Entities and Operations” below. Also excludes “Assets held-for-sale” of $13,569 million (amortized cost of $13,145 million) as of December 31, 2021. Unrealized gains of $572 million, unrealized losses of $147 million and the allowance for credit losses of $1 million related to these held for sale assets are also excluded from the presentation. See Note 1 to the Consolidated Financial Statements for additional information.The change in net unrealized gains (losses) from December 31, 2021 to December 31, 2022 was primarily due to an increase in U.S. interest rates.The following table sets forth the composition of the portion of our fixed maturity, held-to-maturity portfolio by industry category attributable to PFI excluding the Closed Block division and the associated gross unrealized gains and losses, as well as the allowance for credit losses, as of the dates indicated:114Table of Contents December 31, 2022December 31, 2021Industry(1)AmortizedCostGrossUnrealizedGainsGrossUnrealizedLossesFairValueACLAmortizedCostGrossUnrealizedGainsGrossUnrealizedLossesFairValueACL (in millions)Corporate securities:Finance$430 $24 $0 $454 $2 $486 $49 $0 $535 $5 Basic industry0 0 0 0 0 9 0 0 9 0 Total corporate securities430 24 0 454 2 495 49 0 544 5 Foreign government(2)725 128 0 853 0 833 221 0 1,054 0 Residential mortgage-backed(3)143 5 0 148 0 191 14 0 205 0 Total fixed maturities, held-to-maturity$1,298 $157 $0 $1,455 $2 $1,519 $284 $0 $1,803 $5 __________(1)Investment data has been classified based on standard industry categorizations for domestic public holdings and similar classifications by industry for all other holdings.(2)As of both December 31, 2022 and 2021, based on amortized cost, 97%, represent Japanese government bonds held by our Japanese insurance operations.(3)As of December 31, 2022 and 2021, based on amortized cost, 94% and all were rated A or higher, respectively. Fixed Maturity Securities Credit Quality The Securities Valuation Office (“SVO”) of the National Association of Insurance Commissioners (“NAIC”) evaluates the investments of insurers for statutory reporting purposes and assigns fixed maturity securities to one of six categories called “NAIC Designations.” In general, NAIC Designations of “1” highest quality, or “2” high quality, include fixed maturities considered investment grade, which include securities rated Baa3 or higher by Moody’s Investor Service, Inc. (“Moody’s”) or BBB- or higher by Standard & Poor’s Rating Services (“S&P”). NAIC Designations of “3” through “6” generally include fixed maturities referred to as below investment grade, which include securities rated Ba1 or lower by Moody’s and BB+ or lower by S&P. The NAIC Designations for commercial mortgage-backed securities and non-agency residential mortgage-backed securities, including our asset-backed securities collateralized by sub-prime mortgages, are based on security level expected losses as modeled by an independent third-party (engaged by the NAIC) and the statutory carrying value of the security, including any purchase discounts or impairment charges previously recognized.As a result of time lags between the funding of investments, the finalization of legal documents, and the completion of the SVO filing process, the fixed maturity portfolio includes certain securities that have not yet been designated by the SVO as of each balance sheet date. Pending receipt of SVO designations, the categorization of these securities by NAIC Designation is based on the expected ratings indicated by internal analysis.Ratings assigned by nationally recognized rating agencies include S&P, Moody’s, Fitch Ratings Inc. (“Fitch”) and Morningstar, Inc. (“Morningstar”). Low issue composite rating uses ratings from the major credit rating agencies or if these are not available an equivalent internal rating. For securities where the ratings assigned are not equivalent, the second lowest rating is utilized.Investments of our international insurance companies are not subject to NAIC guidelines. Investments of our Japanese insurance operations are regulated locally by the Financial Services Agency (“FSA”), an agency of the Japanese government. The FSA has its own investment quality criteria and risk control standards. Our Japanese insurance companies comply with the FSA’s credit quality review and risk monitoring guidelines. The credit quality ratings of the investments of our Japanese insurance companies are based on ratings assigned by nationally recognized credit rating agencies, including Moody’s and S&P, or rating equivalents based on ratings assigned by Japanese credit ratings agencies.The following table sets forth our fixed maturity, available-for-sale portfolio by NAIC Designation or equivalent rating attributable to PFI excluding the Closed Block division, as of the dates indicated: 115Table of ContentsDecember 31, 2022December 31, 2021NAIC Designation(1)(2)AmortizedCostGrossUnrealizedGainsGrossUnrealizedLosses(3)ACLFairValueAmortizedCostGrossUnrealizedGainsGrossUnrealizedLosses(3)ACLFairValue (in millions)1$206,050 $7,044 $20,290 $0 $192,804 $207,926 $28,904 $666 $0 $236,164 276,161 940 9,519 0 67,582 70,437 7,283 408 0 77,312 Subtotal High or Highest Quality Securities(4)282,211 7,984 29,809 0 260,386 278,363 36,187 1,074 0 313,476 310,938 104 1,163 0 9,879 12,279 716 235 0 12,760 45,016 50 435 1 4,630 5,475 194 140 9 5,520 51,921 17 258 24 1,656 1,389 68 47 27 1,383 6478 31 64 76 369 434 33 20 58 389 Subtotal Other Securities(5)(6)18,353 202 1,920 101 16,534 19,577 1,011 442 94 20,052 Total fixed maturities, available-for-sale(7)$300,564 $8,186 $31,729 $101 $276,920 $297,940 $37,198 $1,516 $94 $333,528 __________(1)Reflects equivalent ratings for investments of the international insurance operations. (2)Includes, as of December 31, 2022 and 2021, 422 securities with amortized cost of $4,836 million (fair value, $4,610 million) and 617 securities with amortized cost of $4,547 million (fair value, $4,596 million), respectively, that have been categorized based on expected NAIC Designations pending receipt of SVO ratings.(3)As of December 31, 2022, includes gross unrealized losses of $1,116 million on public fixed maturities and $804 million on private fixed maturities considered to be other than high or highest quality and, as of December 31, 2021, includes gross unrealized losses of $295 million on public fixed maturities and $147 million on private fixed maturities considered to be other than high or highest quality.(4)On an amortized cost basis, as of December 31, 2022, includes $229,327 million of public fixed maturities and $52,884 million of private fixed maturities and, as of December 31, 2021, includes $234,323 million of public fixed maturities and $44,040 million of private fixed maturities.(5)On an amortized cost basis, as of December 31, 2022, includes $8,710 million of public fixed maturities and $9,643 million of private fixed maturities and, as of December 31, 2021, includes $9,824 million of public fixed maturities and $9,753 million of private fixed maturities.(6)On an amortized cost basis, as of December 31, 2022, securities considered below investment grade based on low issue composite ratings total $15,340 million, or 5% of the total fixed maturities, and include securities considered high or highest quality by the NAIC based on the rules described above. (7)Excludes “Assets held-for-sale” of $13,569 million at fair value as of December 31, 2021. See Note 1 to the Consolidated Financial Statements for additional information.The following table sets forth our fixed maturity, held-to-maturity portfolio by NAIC Designation or equivalent rating attributable to PFI excluding the Closed Block division, as of the dates indicated:116Table of ContentsDecember 31, 2022December 31, 2021NAIC Designation(1)AmortizedCostGrossUnrealizedGainsGrossUnrealizedLosses(2)FairValueACLAmortizedCostGrossUnrealizedGainsGrossUnrealizedLosses(2)FairValueACL (in millions)1$1,217 $153 $0 $1,370 $1 $1,428 $276 $0 $1,704 $3 281 4 0 85 1 91 8 0 99 2 Subtotal High or Highest Quality Securities(3)1,298 157 0 1,455 2 1,519 284 0 1,803 5 30 0 0 0 0 0 0 0 0 0 40 0 0 0 0 0 0 0 0 0 50 0 0 0 0 0 0 0 0 0 60 0 0 0 0 0 0 0 0 0 Subtotal Other Securities0 0 0 0 0 0 0 0 0 0 Total fixed maturities, held-to-maturity$1,298 $157 $0 $1,455 $2 $1,519 $284 $0 $1,803 $5 __________ (1)Reflects equivalent ratings for investments of the international insurance operations. (2)As of December 31, 2022 and 2021, there were less than $1 million and no gross unrealized losses, respectively, on public fixed maturities and private fixed maturities considered to be other than high or highest quality.(3)On an amortized cost basis, as of December 31, 2022, includes $1,231 million of public fixed maturities and $67 million of private fixed maturities and, as of December 31, 2021, includes $1,418 million of public fixed maturities and $101 million of private fixed maturities. Asset-Backed and Commercial Mortgage-Backed SecuritiesThe following table sets forth the amortized cost and fair value of asset-backed and commercial mortgage-backed securities within our fixed maturity available-for-sale portfolio attributable to PFI excluding the Closed Block division by credit quality, as of the dates indicated:December 31, 2022December 31, 2021Asset-BackedSecurities(2)Commercial Mortgage-Backed Securities(3)Asset-Backed Securities(2)Commercial Mortgage-Backed Securities(3)Low Issue Composite Rating(1)Amortized CostFair ValueAmortized CostFair ValueAmortized CostFair ValueAmortized CostFair Value(in millions)AAA$7,078 $7,070 $7,320 $6,817 $7,180 $7,225 $8,423 $8,867 AA2,741 2,660 0 0 1,395 1,395 0 0 A162 151 2 2 12 12 2 2 BBB20 20 9 9 18 20 9 9 BB and below59 104 0 0 73 130 0 0 Total(4)$10,060 $10,005 $7,331 $6,828 $8,678 $8,782 $8,434 $8,878 __________ (1)The table above provides ratings as assigned by nationally recognized rating agencies as of December 31, 2022, including S&P, Moody’s, Fitch Ratings Inc. (“Fitch”) and Morningstar, Inc. (“Morningstar”). Low issue composite rating uses ratings from the major credit rating agencies or if these are not available an equivalent internal rating. For securities where the ratings assigned are not equivalent, the second lowest rating is utilized. (2)Includes collateralized loan obligations (“CLOs”), credit-tranched securities collateralized by education loans, auto loans and other asset types.(3)As of both December 31, 2022 and 2021, based on amortized cost, 99% were securities with vintages of 2013 or later.(4)Excludes fixed maturity securities classified as “Assets supporting experience-rated contractholder liabilities” and “Fixed maturities, trading” as well as securities held outside the general account in other entities and operations. Also excludes “Assets held-for-sale” of $1,391 million and $1,024 million at fair value of asset-backed securities and commercial mortgage-backed securities, respectively, as of December 31, 2021. See Note 1 to the Consolidated Financial Statements for additional information.117Table of ContentsIncluded in “Asset-backed securities” above are investments in CLOs. The following table sets forth information pertaining to these investments in CLOs within our fixed maturity available-for-sale portfolio attributable to PFI excluding the Closed Block division, as of the dates indicated:December 31, 2022December 31, 2021Collateralized Loan ObligationsLow Issue Composite Rating(1)Amortized CostFair ValueAmortized CostFair Value(in millions)AAA$6,132 $6,143 $6,361 $6,388 AA2,687 2,606 1,295 1,292 A13 12 10 10 BBB15 13 10 10 BB and below11 9 8 8 Total(2)(3)$8,858 $8,783 $7,684 $7,708 __________ (1)The table above provides ratings as assigned by nationally recognized rating agencies as of December 31, 2022, including S&P, Moody’s, Fitch and Morningstar. Low issue composite rating uses ratings from the major credit rating agencies or if these are not available an equivalent internal rating. For securities where the ratings assigned are not equivalent, the second lowest rating is utilized. (2)There was no allowance for credit losses as of both December 31, 2022 and 2021.(3)Excludes fixed maturity securities classified as “Assets supporting experience-rated contractholder liabilities” and “Fixed maturities, trading” as well as securities held outside the general account in other entities and operations. Also excludes “Assets held-for-sale” of $1,277 million at fair value as of December 31, 2021. See Note 1 to the Consolidated Financial Statements for additional information.Assets Supporting Experience-Rated Contractholder Liabilities For information regarding the composition of “Assets supporting experience-rated contractholder liabilities,” see Note 3 to the Consolidated Financial Statements. Commercial Mortgage and Other Loans Investment Mix The following table sets forth the composition of our commercial mortgage and other loans portfolio attributable to PFI excluding the Closed Block division, as of the dates indicated: December 31, 2022December 31, 2021 (in millions)Commercial mortgage and agricultural property loans$48,240 $48,550 Uncollateralized loans463 561 Residential property loans43 67 Other collateralized loans108 70 Total recorded investment gross of allowance(1)48,854 49,248 Allowance for credit losses(172)(102)Total net commercial mortgage and other loans(2)$48,682 $49,146 __________(1)As a percentage of recorded investment gross of allowance, 99% of these assets were current as of both December 31, 2022 and 2021.(2)Excluded from the table above are commercial mortgage and other loans held outside the general account in other entities and operations. For additional information regarding commercial mortgage and other loans held outside the general account, see “—Invested Assets of Other Entities and Operations” below. Also excluded are “Assets held-for-sale” of $6,565 million net of allowance for credit losses of $15 million as of December 31, 2021. See Note 1 to the Consolidated Financial Statements for additional information. We originate commercial mortgage and agricultural property loans using a dedicated sales and underwriting staff through our various regional offices in the U.S. and international offices primarily in London and Tokyo. All loans are underwritten consistently to our standards using a proprietary quality rating system that has been developed from our industry experience in real estate and mortgage lending.Uncollateralized loans primarily represent corporate loans held by the Company’s international insurance operations.118Table of Contents Residential property loans primarily include Japanese recourse loans. To the extent there is a default on these recourse loans, we can make a claim against the personal assets of the property owner, in addition to the mortgaged property. These loans are also backed by third-party guarantors.Other collateralized loans include mezzanine real estate debt investments and consumer loans.Composition of Commercial Mortgage and Agricultural Property Loans Our commercial mortgage and agricultural property loan portfolio strategy emphasizes diversification by property type and geographic location. The following tables set forth the breakdown of the gross carrying values of commercial mortgage and agricultural property loans attributable to PFI excluding the Closed Block division by geographic region and property type, as of the dates indicated: December 31, 2022December 31, 2021 GrossCarryingValue% ofTotalGrossCarryingValue% ofTotal ($ in millions)Commercial mortgage and agricultural property loans by region:U.S. Regions(1):Pacific$17,509 36.3 %$17,744 36.5 %South Atlantic7,642 15.8 7,570 15.6 Middle Atlantic5,364 11.1 5,179 10.7 East North Central2,587 5.4 2,490 5.1 West South Central5,091 10.6 4,965 10.2 Mountain2,025 4.2 2,203 4.5 New England1,286 2.7 1,409 2.9 West North Central485 1.0 468 1.0 East South Central1,247 2.6 1,099 2.3 Subtotal-U.S.43,236 89.7 43,127 88.8 Europe3,157 6.5 3,308 6.8 Asia789 1.6 919 1.9 Other1,058 2.2 1,196 2.5 Total commercial mortgage and agricultural property loans(2)$48,240 100.0 %$48,550 100.0 %__________(1)Regions as defined by the United States Census Bureau.(2)Excludes “Assets held-for-sale” of $6,580 million as of December 31, 2021. See Note 1 to the Consolidated Financial Statements for additional information.119Table of Contents December 31, 2022December 31, 2021 GrossCarryingValue% ofTotalGrossCarryingValue% ofTotal ($ in millions)Commercial mortgage and agricultural property loans by property type:Industrial$11,853 24.6 %$11,773 24.3 %Retail4,800 10.0 5,294 10.9 Office7,568 15.7 8,454 17.4 Apartments/Multi-Family13,503 28.0 13,734 28.3 Agricultural properties5,587 11.5 4,375 9.0 Hospitality1,733 3.6 1,601 3.3 Other3,196 6.6 3,319 6.8 Total commercial mortgage and agricultural property loans(1)$48,240 100.0 %$48,550 100.0 %________(1)Excludes “Assets held-for-sale” of $6,580 million as of December 31, 2021. See Note 1 to the Consolidated Financial Statements for additional information.Loan-to-value and debt service coverage ratios are measures commonly used to assess the quality of commercial mortgage and agricultural property loans. The loan-to-value ratio compares the amount of the loan to the fair value of the underlying property collateralizing the loan and is commonly expressed as a percentage. A loan-to-value ratio less than 100% indicates an excess of collateral value over the loan amount. Loan-to-value ratios greater than 100% indicate that the loan amount exceeds the collateral value. The debt service coverage ratio compares a property’s net operating income to its debt service payments. Debt service coverage ratios less than 1.0 times indicate that property operations do not generate enough income to cover the loan’s current debt payments. A debt service coverage ratio greater than 1.0 times indicates an excess of net operating income over the debt service payments. As of December 31, 2022, our commercial mortgage and agricultural property loans attributable to PFI excluding the Closed Block division had a weighted-average debt service coverage ratio of 2.39 times and a weighted-average loan-to-value ratio of 56%. As of December 31, 2022, 96% of commercial mortgage and agricultural property loans were fixed rate loans. For those commercial mortgage and agricultural property loans that were originated in 2022, the weighted-average debt service coverage ratio was 2.12 times, and the weighted-average loan-to-value ratio was 60%. The values utilized in calculating these loan-to-value ratios are developed as part of our periodic review of the commercial mortgage and agricultural property loan portfolio, which includes an internal evaluation of the underlying collateral value. Our periodic review also includes a credit quality re-rating process, whereby we update the internal quality rating originally assigned at underwriting based on the proprietary quality rating system mentioned above. As discussed below, the internal credit quality rating is a key input in determining our allowance for credit losses. For loans with collateral under construction, renovation or lease-up, a stabilized value and projected net operating income are used in the calculation of the loan-to-value and debt service coverage ratios. Our commercial mortgage and agricultural property loan portfolio included $2.4 billion and $2.3 billion of such loans as of December 31, 2022 and 2021, respectively. All else being equal, these loans are inherently riskier than those collateralized by properties that have already stabilized. As of both December 31, 2022 and 2021, there were less than $1 million of allowance related to these loans. In addition, these unstabilized loans are included in the calculation of our portfolio reserve, as discussed below. The following table sets forth the gross carrying value of our commercial mortgage and agricultural property loans attributable to PFI excluding the Closed Block division by loan-to-value and debt service coverage ratios, as of the date indicated: 120Table of Contents December 31, 2022 Debt Service Coverage Ratio > 1.2x1.0xto< 1.2x< 1.0xTotalCommercial Mortgage and Agricultural PropertyLoansLoan-to-Value Ratio(in millions)0%-59.99%$25,806 $1,368 $596 $27,770 60%-69.99%12,211 1,047 979 14,237 70%-79.99%3,918 719 271 4,908 80% or greater885 160 280 1,325 Total commercial mortgage and agricultural property loans$42,820 $3,294 $2,126 $48,240 The following table sets forth the breakdown of our commercial mortgage and agricultural property loans attributable to PFI excluding the Closed Block division by year of origination, as of the date indicated: December 31, 2022GrossCarryingValue% ofTotalYear of Origination($ in millions)2022$4,669 9.7 %20217,515 15.5 20203,680 7.6 20196,682 13.9 20186,584 13.6 20174,331 9.0 20164,300 8.9 2015 & Prior10,446 21.7 Revolving Loans33 0.1 Total commercial mortgage and agricultural property loans$48,240 100.0 %Commercial Mortgage and Other Loans by Contractual Maturity Date The following table sets forth the breakdown of our commercial mortgage and other loans portfolio by contractual maturity, as of the date indicated:121Table of Contents December 31, 2022 GrossCarrying Value% of TotalVintage($ in millions)Maturing in 2023$1,930 4.0 %Maturing in 20243,262 6.7 Maturing in 20255,930 12.1 Maturing in 20265,276 10.8 Maturing in 20274,643 9.5 Maturing in 20285,643 11.6 Maturing in 20294,905 10.0 Maturing in 20303,773 7.7 Maturing in 20312,900 5.9 Maturing in 20322,970 6.1 Maturing in 20331,335 2.7 Maturing in 2034 and beyond6,287 12.9 Total commercial mortgage and other loans$48,854 100.0 %Commercial Mortgage and Other Loans Quality The commercial mortgage and other loans portfolio is monitored on an ongoing basis. If certain criteria are met, loans are assigned to either of the following “watch list” categories: (1) “Closely Monitored,” which includes a variety of considerations, such as when loan metrics fall below acceptable levels, the borrower is not cooperative or has requested a material modification, or the portfolio manager has directed a change in category; or (2) “Not in Good Standing,” which includes loans in default or with a high probability of loss of principal, such as when the loan is in the process of foreclosure or the borrower is in bankruptcy. Our workout and special servicing professionals manage the loans on the watch list.The current expected credit loss (“CECL”) allowance represents the Company’s best estimate of expected credit losses over the remaining life of the assets. The determination of the allowance considers historical credit loss experience, current conditions, and reasonable and supportable forecasts. The allowance is calculated separately for commercial mortgage loans, agricultural mortgage loans, uncollateralized loans, other collateralized loans and residential property loans. For commercial mortgage and agricultural mortgage loans, the allowance is calculated using an internally developed CECL model. Key inputs to the CECL model include unpaid principal balances, internal credit ratings, annual expected loss factors, average lives of the loans adjusted for prepayment considerations, current and historical interest rate assumptions and other factors influencing the Company’s view of the current stage of the economic cycle and future economic conditions. Subjective considerations include a review of whether historical loss experience is representative of current market conditions and the Company’s view of the credit cycle. Model assumptions and factors are reviewed and updated as appropriate. When individual loans no longer have the credit risk characteristics of the commercial or agricultural mortgage loan pools, they are removed from the pools and are evaluated individually for an allowance. The allowance is determined based on the outstanding loan balance less the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. The CECL allowance for other collateralized and uncollateralized loans carried at amortized cost is determined based on probability of default and loss given default assumptions by sector, credit quality and average lives of the loans. 122Table of ContentsThe following table sets forth the change in allowance for credit losses for our commercial mortgage and other loans portfolio, as of the dates indicated: December 31, 2022December 31, 2021 (in millions)Allowance, beginning of year$102 $207 Addition to (release of) allowance for credit losses 66 (87)Reclassified (to) from “Assets held-for-sale”(1)0 (15)Other4 (3)Allowance, end of period$172 $102 __________(1) See Note 1 to the Consolidated Financial Statements for additional information.The allowance for credit losses as of December 31, 2022 increased compared to December 31, 2021, primarily due to declining market conditions. Equity Securities The equity securities attributable to PFI excluding the Closed Block division consist principally of investments in Common and Preferred Stock of publicly-traded companies, as well as mutual fund shares. The following table sets forth the composition of our equity securities portfolio and the associated gross unrealized gains and losses, as of the dates indicated: December 31, 2022December 31, 2021 CostGrossUnrealizedGainsGrossUnrealizedLossesFairValueCostGrossUnrealizedGainsGrossUnrealizedLossesFairValue (in millions)Mutual funds$759 $433 $2 $1,190 $1,158 $699 $0 $1,857 Other Common Stocks2,581 921 87 3,415 2,553 1,073 34 3,592 Non-redeemable Preferred Stocks30 41 5 66 97 49 8 138 Total equity securities, at fair value(1)$3,370 $1,395 $94 $4,671 $3,808 $1,821 $42 $5,587 __________(1)Amounts presented exclude investments in private equity and hedge funds and other investments which are reported in “Other invested assets.” Excludes “Assets held-for-sale” of $322 million at fair value as of December 31, 2021. See Note 1 to the Consolidated Financial Statements for additional information.The net change in unrealized gains (losses) from equity securities attributable to PFI excluding Closed Block division, still held at period end, recorded within “Other income (loss),” was $(477) million and $406 million during the year ended December 31, 2022 and 2021, respectively.Other Invested Assets The following table sets forth the composition of “Other invested assets” attributable to PFI excluding the Closed Block division, as of the dates indicated:123Table of Contents December 31, 2022December 31, 2021(in millions)LPs/LLCs: Equity method:Private equity$5,760 $5,163 Hedge funds2,420 2,044 Real estate-related1,763 1,487 Subtotal equity method9,943 8,694 Fair value:Private equity909 1,124 Hedge funds1,000 1,078 Real estate-related37 34 Subtotal fair value1,946 2,236 Total LPs/LLCs11,889 10,930 Real estate held through direct ownership(1)705 889 Derivative instruments 21 337 Other(2)662 329 Total other invested assets(3)$13,277 $12,485 __________(1)As of December 31, 2022 and 2021, real estate held through direct ownership had mortgage debt of $208 million and $274 million, respectively.(2)Primarily includes equity investments accounted for under the measurement alternative, leveraged leases and member and activity stock held in the Federal Home Loan Bank of New York. For additional information regarding our holdings in the Federal Home Loan Bank of New York, see Note 17 to the Consolidated Financial Statements.(3)Excludes “Assets held-for-sale” of $104 million as of December 31, 2021. See Note 1 to the Consolidated Financial Statements for additional information. Invested Assets of Other Entities and Operations “Invested Assets of Other Entities and Operations” presented below includes investments held outside the general account and primarily represents investments associated with our investment management operations and derivative operations. Our derivative operations act on behalf of affiliates primarily to manage interest rate, foreign currency, credit and equity exposures. Assets within our investment management operations that are managed for third-parties and those assets classified as “Separate account assets” on our balance sheet are not included. December 31, 2022December 31, 2021 (in millions)Fixed maturities:Public, available-for-sale, at fair value(1)$523 $478 Private, available-for-sale, at fair value205 0 Fixed maturities, trading, at fair value(1) 213 213 Equity securities, at fair value746 699 Commercial mortgage and other loans, at book value(2)137 1,279 Other invested assets3,568 4,990 Short-term investments18 35 Total investments$5,410 $7,694 __________(1)As of December 31, 2022 and 2021, balances include investments in CLOs with fair value of $294 million and $329 million, respectively.(2)Book value is generally based on unpaid principal balance, net of any allowance for credit losses, or at fair value, when the fair value option has been elected.124Table of ContentsFixed Maturities, Trading “Fixed maturities, trading, at fair value” are primarily related to assets associated with consolidated variable interest entities (“VIEs”) for which the Company is the investment manager. The assets of the consolidated VIEs are generally offset by liabilities for which the fair value option has been elected. For further information regarding these consolidated VIEs, see Note 4 to the Consolidated Financial Statements. Commercial Mortgage and Other Loans Our investment management operations include our commercial mortgage operations, which provide mortgage origination, investment management and servicing for our general account, institutional clients, the Federal Housing Administration and government-sponsored entities such as Fannie Mae and Freddie Mac. The mortgage loans of our commercial mortgage operations are included in “Commercial mortgage and other loans.” Derivatives and other hedging instruments related to our commercial mortgage operations are primarily included in “Other invested assets.” Other Invested Assets “Other invested assets” primarily include assets of our derivative operations used to manage interest rate, foreign currency, credit, and equity exposures. Furthermore, other invested assets include strategic investments made as part of our investment management operations. We make these strategic investments in real estate, as well as fixed income, public equity and real estate securities, including controlling interests. Certain of these investments are made primarily for purposes of co-investment in our managed funds and structured products. Other strategic investments are made with the intention to sell or syndicate to investors, including our general account, or for placement in funds and structured products that we offer and manage (seed investments). As part of our investment management operations, we also make loans to our managed funds that are secured by equity commitments from investors or assets of the funds. “Other invested assets” also includes certain assets in consolidated investment funds where the Company is deemed to exercise control over the funds.Liquidity and Capital ResourcesOverview Liquidity refers to the ability to generate sufficient cash resources to meet the payment obligations of the Company. Capital refers to the long-term financial resources available to support the operations of our businesses, fund business growth, and provide a cushion to withstand adverse circumstances. Our ability to generate and maintain sufficient liquidity and capital depends on the profitability of our businesses, general economic conditions and our access to the capital markets and the alternate sources of liquidity and capital described herein.Effective and prudent liquidity and capital management is a priority across the Company. Management monitors the liquidity of Prudential Financial and its subsidiaries on a daily basis and projects borrowing and capital needs over a multi-year time horizon. We use a Risk Appetite Framework (“RAF”) to ensure that all risks taken across the Company align with our capacity and willingness to take those risks. The RAF provides a dynamic assessment of capital and liquidity stress impacts and is intended to ensure that sufficient resources are available to absorb those impacts. We believe that our capital and liquidity resources are sufficient to satisfy the capital and liquidity requirements of Prudential Financial and its subsidiaries.See “—Current Market Conditions” above for a discussion of recent market conditions and the impacts to our liquidity and capital positions. Our businesses are subject to comprehensive regulation and supervision by domestic and international regulators. These regulations currently include requirements (many of which are the subject of ongoing rule-making) relating to capital and liquidity management. For information regarding these regulatory initiatives and their potential impact on us, see “Business—Regulation” and “Risk Factors.”From the beginning of 2022 through the date of this report, we took the following significant actions that have impacted, or are expected to impact, our liquidity and capital positions:125Table of Contents•In February, we issued $1.0 billion of junior subordinated notes. We used these proceeds in September to redeem $1.0 billion of junior subordinated notes due in 2042.•In April, we completed the sale of our Full Service Retirement business. Also, in April, we completed the sale of a portion of our in-force traditional variable annuities block of business through the sale of PALAC. See Note 1 to the Consolidated Financial Statements for additional information regarding these dispositions.•In August, we issued $1.5 billion of junior subordinated notes. We intend to use these proceeds for general corporate purposes, which may include the redemption or repurchase of our $1.5 billion of junior subordinated notes due in 2043.•In September, we redeemed $1.0 billion of junior subordinated notes due in 2042, as discussed above.Capital Our capital management framework is primarily based on statutory Risk-Based Capital (“RBC”) and solvency margin measures. Due to our diverse mix of businesses and applicable regulatory requirements, we apply certain refinements to the framework that are designed to more appropriately reflect risks associated with our businesses on a consistent basis across the Company. We believe Prudential Financial’s capitalization and financial profile are consistent with its ratings targets. Our long-term senior debt rating targets for Prudential Financial are “A” for S&P, Moody’s, and Fitch, and “a” for A.M. Best Company (“A.M. Best”). Our financial strength rating targets for our life insurance companies are “AA/Aa/AA” for S&P, Moody’s and Fitch, respectively, and “A+” for A.M. Best. Some entities may currently be rated below these targets, and not all of our insurance company subsidiaries are rated by each of these rating agencies. See “—Ratings” below for a description of the potential impacts of ratings downgrades.Capital Governance Our capital management framework is ultimately reviewed and approved by our Board. The Board has authorized our Chairman and Chief Executive Officer and Vice Chair to approve certain capital actions on behalf of the Company and to further delegate authority with respect to capital actions to appropriate officers, up to specified limits. Any capital commitment that exceeds the authority granted to senior management must be separately authorized by the Board.In addition, our Capital and Finance Committee (“CFC”) reviews the use and allocation of capital above certain threshold amounts to promote the efficient use of capital, consistent with our strategic objectives, ratings aspirations and other goals and targets. This management committee provides a multi-disciplinary due diligence review of specific initiatives or transactions requiring the use of capital, including mergers and acquisitions. The CFC also reviews our annual capital plan (and updates to this plan), as well as our capital, liquidity and financial position, borrowing plans, and related matters prior to the discussion of these items with the Board. Capitalization The primary components of the Company’s capitalization consist of equity and outstanding capital debt, including junior subordinated debt. As shown in the table below, as of December 31, 2022, the Company had $50.1 billion in capital, all of which was available to support the aggregate capital requirements of its businesses and its Corporate and Other operations. Based on our assessment of these businesses and operations, we believe this level of capital is consistent with our ratings targets. December 31, 20222021 (in millions)Equity(1)$36,077 $40,552 Junior subordinated debt (including hybrid securities)9,0947,619Other capital debt4,9775,073Total capital$50,148 $53,244 __________ (1)Amounts attributable to Prudential Financial, excluding AOCI. Insurance Regulatory Capital We manage PICA, The Prudential Life Insurance Company, Ltd. (“Prudential of Japan”), Gibraltar Life, and other significant insurance subsidiaries to regulatory capital levels consistent with our “AA” ratings targets. We utilize the RBC ratio 126Table of Contentsas a primary measure of the capital adequacy of our domestic insurance subsidiaries and the solvency margin ratio as a primary measure of the capital adequacy of our Japanese insurance subsidiaries.RBC is calculated based on statutory financial statements and risk formulas consistent with the practices of the NAIC. RBC considers, among other things, risks related to the type and quality of the invested assets, insurance related risks associated with an insurer’s products and liabilities, interest rate risks, and general business risks. RBC ratio calculations are intended to assist insurance regulators in measuring an insurer’s solvency and ability to pay future claims. The reporting of RBC measures is not intended for the purpose of ranking any insurance company or for use in connection with any marketing, advertising, or promotional activities, but is available to the public. PICA’s RBC ratio as of December 31, 2021, its most recent statutory fiscal year-end and RBC reporting date, was 456%. PICA’s RBC ratio is calculated on a consolidated basis and included Prudential Retirement Insurance and Annuity Company (“PRIAC”), Pruco Life Insurance Company (“Pruco Life”), Pruco Life Insurance Company of New Jersey (“PLNJ”), which is a subsidiary of Pruco Life, and Prudential Legacy Insurance Company of New Jersey (“PLIC”).Although not yet filed, we expect these RBC ratios as of December 31, 2022 to be above our “AA” financial strength target levels.Similar to the RBC ratios that are employed by U.S. insurance regulators, regulatory authorities in the international jurisdictions in which we operate generally establish some form of minimum solvency margin requirements for insurance companies based on local statutory accounting practices. These solvency margins are a primary measure of the capital adequacy of our international insurance operations. Maintenance of our solvency margins at certain levels is also important to our competitive positioning, as in certain jurisdictions, such as Japan, these solvency margins are required to be disclosed to the public and therefore impact the public perception of an insurer’s financial strength.The table below presents the solvency margin ratios of our most significant international insurance subsidiaries as of September 30, 2022, the most recent date for which this information is available.RatioPrudential of Japan consolidated(1)771 %Gibraltar Life consolidated(2)874 %__________ (1)Includes Prudential Trust Co., Ltd., a subsidiary of Prudential of Japan.(2)Includes Prudential Gibraltar Financial Life Insurance Co., Ltd. (“PGFL”), a subsidiary of Gibraltar Life.Although not yet filed, we expect the solvency margin ratio for each of these subsidiaries to be greater than 700% (3.5 times the regulatory required minimums) as of December 31, 2022.All of our domestic and significant international insurance subsidiaries have capital levels that substantially exceed the minimum level required by applicable insurance regulations. The statutory capital of our insurance companies and our overall capital flexibility could be impacted by, among other things, market conditions and changes in insurance reserves, including those stemming from updates to our actuarial assumptions. Our regulatory capital levels also may be affected in the future by changes to the applicable regulations, proposals for which are currently under consideration by both domestic and international insurance regulators. For additional information regarding the calculation of RBC and solvency margin ratios, as well as regulatory minimums, see Note 19 to the Consolidated Financial Statements.Captive Reinsurance Companies We use captive reinsurance companies to more effectively manage our reserves and capital on an economic basis and to enable the aggregation and transfer of risks. Our captive reinsurance companies assume business from affiliates only. To support the risks they assume, our captives are capitalized to a level we believe is consistent with the “AA” financial strength rating targets of our insurance subsidiaries. All of our captives are subject to internal policies governing their activities. In the normal course of business, we contribute capital to the captives to support business growth and other needs. Prudential Financial has also entered into support agreements with several of the captives in connection with financing arrangements. For a description of captive reinsurance company financing activities, see below under “—Financing Activities—Subsidiary Borrowings—Term and Universal Life Reserve Financing.” 127Table of ContentsShareholder Distributions Share Repurchase Program and Shareholder Dividends Prudential Financial’s Board of Directors authorized the Company to repurchase at management’s discretion up to an aggregate of $1.5 billion of its outstanding Common Stock during the period from January 1, 2022 through December 31, 2022. We utilized the entirety of this $1.5 billion share repurchase authorization in 2022. In February 2023, the Board authorized the Company to repurchase, at management’s discretion, up to $1 billion of its outstanding Common Stock during the period from January 1, 2023 through December 31, 2023.In general, the timing and amount of share repurchases are determined by management based on market conditions and other considerations, including any increased capital needs of our businesses due to, among other things, credit migration and losses in our investment portfolio, changes in regulatory capital requirements and opportunities for growth and acquisitions. Repurchases may be executed in the open market, through derivative, accelerated repurchase and other negotiated transactions and through plans designed to comply with Rule 10b5-1(c) under the Securities Exchange Act of 1934. The following table sets forth information about declarations of Common Stock dividends, as well as repurchases of shares of Prudential Financial’s Common Stock, for each of the quarterly periods in 2022 and for the prior four years: Dividend AmountShares RepurchasedQuarterly period ended:Per ShareAggregateSharesTotal Cost (in millions, except per share data)December 31, 2022$1.20 $449 3.7 $375 September 30, 2022$1.20 $454 3.9 $375 June 30, 2022$1.20 $457 3.6 $375 March 31, 2022$1.20 $462 3.3 $375 Dividend AmountShares RepurchasedYear ended:Per ShareAggregateSharesTotal Cost (in millions, except per share data)December 31, 2022$4.80 $1,822 14.5 $1,500 December 31, 2021$4.60 $1,821 24.5 $2,500 December 31, 2020$4.40 $1,769 6.7 $500 December 31, 2019$4.00 $1,644 27.2 $2,500 December 31, 2018$3.60 $1,525 14.9 $1,500 In addition, on February 7, 2023, Prudential Financial’s Board of Directors declared a cash dividend of $1.25 per share of Common Stock, payable on March 16, 2023 to shareholders of record as of February 21, 2023.LiquidityLiquidity management and stress testing are performed on a legal entity basis as the ability to transfer funds between subsidiaries is limited due in part to regulatory restrictions. Liquidity needs are determined through daily and quarterly cash flow forecasting at the holding company and within our operating subsidiaries. We seek to maintain a minimum balance of highly liquid assets to ensure that adequate liquidity is available at Prudential Financial to cover fixed expenses in the event that we experience reduced cash flows from our operating subsidiaries at a time when access to capital markets is also not available.We seek to mitigate the risk of having limited or no access to financing due to stressed market conditions by generally pre-funding debt in advance of maturity. We mitigate the refinancing risk associated with our debt that is used to fund operating needs by matching the term of debt with the assets financed. To ensure adequate liquidity in stress scenarios, stress testing is performed for our major operating subsidiaries. We seek to further mitigate liquidity risk by maintaining our access to alternative sources of liquidity, as discussed below.Liquidity of Prudential Financial The principal sources of funds available to Prudential Financial, the parent holding company, are dividends, returns of capital and loans from subsidiaries, and proceeds from debt issuances and certain stock-based compensation activity. These sources of funds may be supplemented by Prudential Financial’s access to the capital markets as well as the “—Alternative Sources of Liquidity” described below. 128Table of ContentsThe primary uses of funds at Prudential Financial include servicing debt, making capital contributions and loans to subsidiaries, making acquisitions, paying declared shareholder dividends and repurchasing outstanding shares of Common Stock executed under authority from the Board. As of December 31, 2022, Prudential Financial had highly liquid assets with a carrying value totaling $5,413 million, an increase of $1,187 million from December 31, 2021. Highly liquid assets predominantly include cash, short-term investments, U.S. Treasury securities, obligations of other U.S. government authorities and agencies, and/or foreign government bonds. We maintain an intercompany liquidity account that is designed to optimize the use of cash by facilitating the lending and borrowing of funds between Prudential Financial and its subsidiaries on a daily basis. Excluding the net borrowings from this intercompany liquidity account, Prudential Financial had highly liquid assets of $4,535 million as of December 31, 2022, an increase of $982 million from December 31, 2021. The following table sets forth Prudential Financial’s principal sources and uses of highly liquid assets, excluding net borrowings from our intercompany liquidity account, for the periods indicated:Year Ended December 31, 20222021 (in millions)Highly Liquid Assets, beginning of period$3,553 $5,560 Dividends and/or returns of capital from subsidiaries(1)1,584 3,339 Affiliated loans/(borrowings) - (capital activities)(417)406 Capital contributions to subsidiaries(2)(2,527)(197)Total Business Capital Activity(1,360)3,548 Share repurchases(3)(1,488)(2,500)Common Stock dividends(4)(1,817)(1,814)Acquisition/Disposition activity(5)4,481 648 Total Share Repurchases, Dividends and Acquisition/Disposition Activity1,176 (3,666)Proceeds from the issuance of debt2,474 0 Repayments of debt(1,005)(1,308)Total Debt Activity1,469 (1,308)Proceeds from stock-based compensation and exercise of stock options317 343 Interest income from subsidiaries on intercompany agreements, net of interest paid219 238 Swap terminations(27)(94)Net income tax receipts & payments231 330 Interest paid on external debt(942)(963)Affiliated (borrowings)/loans - (operating activities)(6)110 (331)Other, net(211)(104)Total Other Activity(303)(581)Net increase (decrease) in highly liquid assets982 (2,007)Highly Liquid Assets, end of period$4,535 $3,553 __________(1)2022 includes $1,313 million from international insurance subsidiaries, $156 million from PGIM subsidiaries, $74 million from Prudential Annuities Holding Company, and $41 million from other subsidiaries . See “Item 15—Schedule II—Notes to Condensed Financial Information of Registrant—Dividends and Returns of Capital” for dividends and returns of capital by subsidiary. (2)2022 includes capital contributions of $1,000 million to PICA, $780 million to an international reinsurance subsidiary, $487 million to international insurance subsidiaries, and $260 million to other subsidiaries. The majority of the capital contribution to our international reinsurance subsidiary was to fund the payment of ceding commissions to our domestic insurance subsidiaries. 2021 includes capital contributions of $181 million to international insurance subsidiaries, $9 million to PGIM, and $7 million to other corporate subsidiaries.(3)Excludes cash payments made on trades that settled in the subsequent period.(4)Includes cash payments made on dividends declared in prior periods.(5)2022 includes proceeds and capital releases related to the sales of the Full Service Retirement business and PALAC. 2021 represents the net proceeds from the sales of The Prudential Life Insurance Company of Taiwan Inc. (“POT”) and PGIM’s joint venture in Italy that were distributed to PFI.(6)Represents loans to and from affiliated subsidiaries to support business operating needs.129Table of ContentsDividends and Returns of Capital from Subsidiaries Domestic insurance subsidiaries. During 2022, Prudential Financial received dividends of $74 million from Prudential Annuities Holding Company. In addition to paying Common Stock dividends, our domestic insurance operations may return capital to Prudential Financial by other means, such as affiliated lending, and reinsurance with Bermuda-based affiliates. International insurance subsidiaries. During 2022, Prudential Financial received dividends of $1,313 million from its international insurance subsidiaries. In addition to paying Common Stock dividends, our international insurance operations may return capital to Prudential Financial through or facilitated by other means, such as the repayment of preferred stock obligations held by Prudential Financial or other affiliates, affiliated lending, affiliated derivatives and reinsurance with U.S.- and Bermuda-based affiliates.Other subsidiaries. During 2022, Prudential Financial received dividends and returns of capital of $156 million from PGIM subsidiaries and dividends of $41 million from other subsidiaries.Restriction on dividends and returns of capital from subsidiaries. Our insurance companies are subject to limitations on the payment of dividends and other transfers of funds to Prudential Financial and other affiliates under applicable insurance law and regulation. Further, market conditions could negatively impact capital positions of our insurance companies, which could further restrict their ability to pay dividends. More generally, the payment of dividends by any of our subsidiaries is subject to declaration by their Board of Directors and can be affected by market conditions and other factors. With respect to our domestic insurance subsidiaries, PICA is permitted to pay ordinary dividends based on calculations specified under New Jersey insurance law, subject to prior notification to the New Jersey Department of Banking and Insurance (“NJDOBI”). Any distributions above this amount in any twelve-month period are considered to be “extraordinary” dividends, and the approval of the NJDOBI is required prior to payment. The laws regulating dividends of the states where our other domestic insurance companies are domiciled are similar, but not identical, to those of New Jersey. Capital redeployment from our international insurance subsidiaries is subject to local regulatory requirements in the international jurisdictions in which they operate. Our most significant international insurance subsidiaries, Prudential of Japan and Gibraltar Life, are permitted to pay Common Stock dividends based on calculations specified by Japanese insurance law, subject to prior notification to the FSA. Dividends in excess of these amounts and other forms of capital distribution require the prior approval of the FSA. The regulatory fiscal year end for both Prudential of Japan and Gibraltar Life is March 31, 2023, after which time the Common Stock dividend amount permitted to be paid without prior approval from the FSA can be determined.The ability of our PGIM subsidiaries and the majority of our other operating subsidiaries to pay dividends is largely unrestricted from a regulatory standpoint.See Note 19 to the Consolidated Financial Statements for information regarding specific dividend restrictions. Liquidity of Insurance Subsidiaries We manage the liquidity of our insurance operations to ensure stable, reliable and cost-effective sources of cash flows to meet all of our obligations. Liquidity within each of our insurance subsidiaries is provided by a variety of sources, including portfolios of liquid assets. The investment portfolios of our subsidiaries are integral to the overall liquidity of our insurance operations. We segment our investment portfolios and employ an asset/liability management approach specific to the requirements of each of our product lines. This enhances the discipline applied in managing the liquidity, as well as the interest rate and credit risk profiles, of each portfolio in a manner consistent with the unique characteristics of the product liabilities. Liquidity is measured against internally-developed benchmarks that take into account the characteristics of both the asset portfolio and the liabilities that they support. We consider attributes of the various categories of liquid assets (for example, type of asset and credit quality) in calculating internal liquidity measures to evaluate our insurance operations’ liquidity under various stress scenarios, including company-specific and market-wide events. We continue to believe that cash generated by ongoing operations and the profile of our assets provide sufficient liquidity under reasonably foreseeable stress scenarios for each of our insurance subsidiaries. Cash Flow The principal sources of liquidity for our insurance subsidiaries are premiums, investment and fee income, investment maturities, sales of investments, and sales associated with our insurance and annuity operations, as well as internal and external borrowings. The principal uses of liquidity include benefits, claims and dividends paid to policyholders, and payments to 130Table of Contentspolicyholders and contractholders in connection with surrenders, withdrawals and net policy loan activity. Other uses of liquidity may include commissions, general and administrative expenses, purchases of investments, the payment of dividends to the parent holding company, hedging and reinsurance activity and payments in connection with financing activities. In each of our major insurance subsidiaries, we believe that the cash flows from operations are adequate to satisfy current liquidity requirements. The continued adequacy of this liquidity will depend upon factors such as future securities market conditions, changes in interest rate levels, policyholder perceptions of our financial strength, policyholder behavior, catastrophic events and the relative safety and attractiveness of competing products, each of which could lead to reduced cash inflows or increased cash outflows. Our insurance operations’ cash flows from investment activities result from repayments of principal, proceeds from maturities and sales of invested assets and investment income, net of amounts reinvested. The primary liquidity risks with respect to these cash flows are the risk of default by debtors or bond insurers, our counterparties’ willingness to extend repurchase and/or securities lending arrangements, commitments to invest and market volatility. We closely manage these risks through our credit risk management process and regular monitoring of our liquidity position. Domestic insurance operations. In managing the liquidity of our domestic insurance operations, we consider the risk of policyholder and contractholder withdrawals of funds earlier than our assumptions when selecting assets to support these contractual obligations. We use surrender charges and other contract provisions to mitigate the extent, timing and profitability impact of withdrawals of funds by customers. The following table sets forth the liabilities for future policy benefits and policyholders’ account balances of certain of our domestic insurance subsidiaries as of the dates indicated: December 31, 20222021 (in billions)PICA$232.2 $227.1 PLIC48.4 49.6 Pruco Life64.9 56.1 PRIAC0.0 0.6 PALAC0.0 0.0 Other(1)(85.1)(90.0)Total future policy benefits and policyholders’ account balances(2)(3)$260.4 $243.4 __________(1)Includes the impact of intercompany eliminations.(2)Amounts are reflected gross of affiliated reinsurance recoverables. (3)Excludes “Liabilities held-for-sale” of $28.3 billion and $16.3 billion for PRIAC and PALAC, respectively, as of December 31, 2021. See Note 1 to the Consolidated Financial Statements for additional information. The liabilities presented above are primarily supported by invested assets in our general account. As noted above, when selecting assets to support these contractual obligations, we consider the risk of policyholder and contractholder withdrawals of funds earlier than our assumptions. As a result, assets will include both liquid assets, as discussed below, and other assets that we believe adequately support our liabilities. For PICA and other subsidiaries, the liabilities presented above primarily include annuity reserves and deposit liabilities and individual life insurance policy reserves. Individual life insurance policies may impose surrender charges and policyholders may be subject to a new underwriting process in order to obtain a new insurance policy. PICA’s reserves for group annuity contracts primarily relate to pension risk transfer contracts, which are generally not subject to early withdrawal. For our individual annuity contracts, to encourage persistency, most of our variable and fixed annuities have surrender or withdrawal charges for a specified number of years. In addition, certain fixed annuities impose a market value adjustment if the invested amount is not held to maturity. The living benefit features of our variable annuities also encourage persistency because the potential value of the living benefit is fully realized only if the contract persists. Gross account withdrawals for our domestic insurance operations’ products in 2022 were generally consistent with our assumptions in asset/liability management, and the associated cash outflows did not have a material adverse impact on our overall liquidity. International insurance operations. As with our domestic operations, in managing the liquidity of our international insurance operations, we consider the risk of policyholder and contractholder withdrawals of funds earlier than our assumptions in selecting assets to support these contractual obligations. The following table sets forth the liabilities for future policy benefits and policyholders’ account balances of certain of our international insurance subsidiaries as of the dates indicated: 131Table of Contents December 31, 20222021 (in billions)Prudential of Japan(1)$61.6 $63.7 Gibraltar Life(2)102.7 110.5 Other international insurance subsidiaries, excluding Japan3.4 2.8 Other(3)(8.0)(7.9)Total future policy benefits and policyholders’ account balances(4)$159.7 $169.1 __________(1)As of December 31, 2022 and 2021, $22.6 billion and $21.0 billion, respectively, of the insurance-related liabilities for Prudential of Japan are associated with U.S. dollar-denominated products that are coinsured to our domestic insurance operations and supported by U.S. dollar-denominated assets. As of December 31, 2022 and 2021, $2.1 billion and $1.9 billion, respectively, of the insurance-related liabilities for Prudential of Japan are primarily associated with yen- and U.S. dollar-denominated products that are coinsured to Gibraltar Re, a Bermuda-based reinsurance affiliate, and primarily supported by yen- and U.S. dollar-denominated assets. (2)Includes PGFL. As of December 31, 2022 and 2021, $7.9 billion and $8.1 billion, respectively, of the insurance-related liabilities for PGFL are associated with U.S. dollar-denominated products that are coinsured to our domestic insurance operations and supported by U.S. dollar-denominated assets. As of December 31, 2022 and 2021, $10.8 billion and $7.6 billion, respectively, of the insurance-related liabilities for Gibraltar Life are primarily associated with yen- and U.S. dollar-denominated products that are coinsured to Gibraltar Re and primarily supported by yen- and U.S. dollar-denominated assets. (3)Reflects the impact of intercompany eliminations.(4)Amounts are reflected gross of affiliated reinsurance recoverables. The liabilities presented above are primarily supported by invested assets in our general account. When selecting assets to support these contractual obligations, we consider the risk of policyholder and contractholder withdrawals of funds earlier than our assumptions. As a result, assets will include both liquid assets, as discussed below, and other assets that we believe adequately support our liabilities. We believe most of the longer-term recurring pay individual life insurance policies sold by our Japanese operations do not have significant withdrawal risk because policyholders may incur surrender charges and must undergo a new underwriting process to obtain a new insurance policy. Prudential of Japan and Gibraltar Life sell U.S. dollar denominated investment contracts with a market value adjustment feature to mitigate the profitability impact for surrenders, as these contracts may be subject to increased surrenders should the yen depreciate or if interest rates in the U.S. decline relative to Japan. As of December 31, 2022, products with a market value adjustment feature represented $25.2 billion of our Japan operations’ insurance-related liabilities.Liquid Assets Liquid assets include cash and cash equivalents, short-term investments, U.S. Treasury securities, fixed maturities that are not designated as held-to-maturity and public equity securities. In addition to access to substantial investment portfolios, our insurance companies’ liquidity is managed through access to a variety of instruments available for funding and/or managing cash flow mismatches, including from time to time those arising from claim levels in excess of projections. Our ability to utilize assets and liquidity between our subsidiaries is limited by regulatory and other constraints. We believe that ongoing operations and the liquidity profile of our assets provide sufficient liquidity under reasonably foreseeable stress scenarios for each of our insurance subsidiaries. The following table sets forth the fair value of certain of our domestic insurance operations’ portfolio of liquid assets, as of the dates indicated. December 31, 2022 PrudentialInsurance(1)PLICPruco LifeTotalDecember 31, 2021(2) (in billions)Cash and short-term investments$4.1 $1.7 $2.5 $8.3 $14.0 Fixed maturity investments(3):High or highest quality109.7 27.1 19.1 155.9 214.9 Other than high or highest quality7.6 2.7 1.9 12.2 16.2 Subtotal117.3 29.8 21.0 168.1 231.1 Public equity securities, at fair value1.2 1.7 0.1 3.0 4.2 Total$122.6 $33.2 $23.6 $179.4 $249.3 132Table of Contents__________(1)Represents a legal entity view and as such includes both domestic and international activity.(2)Includes $24.4 billion and $12.2 billion related to PRIAC and PALAC, respectively. See Note 1 to the Consolidated Financial Statements for additional information regarding these dispositions.(3)Excludes fixed maturities designated as held-to-maturity. Credit quality is based on NAIC or equivalent rating. The following table sets forth the fair value of our international insurance operations’ portfolio of liquid assets, as of the dates indicated. December 31, 2022 Prudentialof JapanGibraltarLife(1)AllOther(2)TotalDecember 31, 2021 (in billions)Cash and short-term investments$0.3 $0.7 $0.1 $1.1 $4.9 Fixed maturity investments(3):High or highest quality(4)32.2 65.7 10.9 108.8 138.0 Other than high or highest quality0.4 1.2 2.4 4.0 5.0 Subtotal32.6 66.9 13.3 112.8 143.0 Public equity securities2.1 1.6 0.1 3.8 4.5 Total$35.0 $69.2 $13.5 $117.7 $152.4 __________(1)Includes PGFL.(2)Represents our international insurance operations, excluding Japan.(3)Excludes fixed maturities designated as held-to-maturity. Credit quality is based on NAIC or equivalent rating. (4)As of December 31, 2022, $79.3 billion, or 73%, were invested in government or government agency bonds. Given the size and liquidity profile of our investment portfolios, we believe that claim experience, including policyholder withdrawals and surrenders, varying from our projections does not constitute a significant liquidity risk. Our ALM process takes into account the expected maturity of investments and expected claim payments as well as the specific nature and risk profile of the liabilities. To the extent we need to pay claims in excess of projections, we may borrow temporarily or sell investments sooner than anticipated to pay these claims, which may result in increased borrowing costs or realized investment gains or losses, including from changes in interest rates or credit spreads. The payment of claims and sale of investments earlier than anticipated would have an impact on the reported level of cash flow from operating, investing, and financing activities, in our financial statements. Historically, there has been no significant variation between the expected maturities of our investments and the payment of claims. Liquidity associated with other activities Hedging activities associated with Individual Retirement Strategies For the portion of our Individual Retirement Strategies’ ALM strategy executed through hedging, as well as the capital hedge program, we enter into a range of exchange-traded, cleared and other OTC equity and interest rate derivatives in order to hedge certain capital market risks related to more severe market conditions. For a full discussion of our Individual Retirement Strategies’ risk management strategy, see “—Results of Operations by Segment—U.S. Businesses—Retirement Strategies.” This portion of our Individual Retirement Strategies’ ALM strategy and capital hedge program requires access to liquidity to meet payment obligations relating to these derivatives, such as payments for periodic settlements, purchases, maturities and terminations. These liquidity needs can vary materially due to, among other items, changes in interest rates, equity markets, mortality and policyholder behavior. The hedging portion of our Individual Retirement Strategies’ ALM strategy and capital hedge program may also result in derivative related collateral postings to (when we are in a net post position) or from (when we are in a net receive position) counterparties. The net collateral position depends on changes in interest rates and equity markets related to the amount of the exposures hedged. Depending on market conditions, the collateral posting requirements can result in material liquidity needs when we are in a net post position. As of December 31, 2022, the derivatives comprising the hedging portion of our Individual Retirement Strategies’ ALM strategy and capital hedge program were in a net post position of $10.8 billion compared to a net post position of $5.5 billion as of December 31, 2021. The change in collateral position was primarily driven by the impact of increasing interest rates partially offset by equity market depreciation. 133Table of ContentsForeign exchange hedging activities We employ various hedging strategies to manage potential exposure to foreign currency exchange rate movements, particularly those associated with the yen. Our overall yen hedging strategy calibrates the hedge level to preserve the relative contribution of our yen-based business to the Company’s overall return on equity on a leverage neutral basis. The hedging strategy includes two primary components: Income Hedges—We hedge a portion of our prospective yen-based earnings streams by entering into external forward currency derivative contracts that effectively fix the currency exchange rates for that portion of earnings, thereby reducing volatility from foreign currency exchange rate movements.Equity Hedges—We hold both internal and external hedges primarily to hedge our USD-equivalent equity. These hedges also mitigate volatility in the solvency margins of yen-based subsidiaries resulting from changes in the market value of their USD-denominated investments hedging our USD-equivalent equity attributable to changes in the yen-USD exchange rate. For additional information regarding our hedging strategy, see “—Results of Operations—Impact of Foreign Currency Exchange Rates.” Cash settlements from these hedging activities result in cash flows between subsidiaries of Prudential Financial and either international-based subsidiaries or external parties. The cash flows are dependent on changes in foreign currency exchange rates and the notional amount of the exposures hedged. For example, a significant yen depreciation over an extended period of time could result in net cash inflows, while a significant yen appreciation could result in net cash outflows. The following tables set forth information about net cash settlements and the net asset or liability resulting from these hedging activities related to the yen and other currencies for the periods indicated. Year ended December 31,Cash Settlements: Received (Paid)20222021 (in millions)Income Hedges (External)(1)$21 $33 Equity Hedges:Internal(2)691 488 External(3)10 (137)Total Equity Hedges701 351 Total Cash Settlements$722 $384 As of December 31,Assets (Liabilities):20222021 (in millions)Income Hedges (External)(4)$(9)$47 Equity Hedges:Internal(2)1,229 955 External(123)(20)Total Equity Hedges(5)1,106 935 Total Assets (Liabilities)$1,097 $982 __________(1)Includes non-yen related cash settlements of $13 million, primarily denominated in Chilean peso, Australian dollar and Brazilian real, and $19 million, primarily denominated in Brazilian real, Australian dollar and Chilean peso for the years ended December 31, 2022 and 2021, respectively.(2)Represents internal transactions between international-based and U.S.-based entities. Amounts noted are from the U.S.-based entities’ perspectives.(3)Includes non-yen related cash settlements of $4 million, denominated in Korean won for the year ended December 31, 2021.(4)Includes non-yen related assets (liabilities) of $(19) million, primarily denominated in Brazilian real, Australian dollar and Chilean peso, and assets of $28 million, primarily denominated in Brazilian real, Chilean peso and Australian dollar, as of December 31, 2022 and 2021, respectively. (5)As of December 31, 2022, approximately $622 million, $301 million and $183 million of the net market values are scheduled to settle in 2023, 2024 and thereafter, respectively. The net market value of the assets (liabilities) will vary with changing market conditions to the extent there are no corresponding offsetting positions. 134Table of ContentsPGIM operations The principal sources of liquidity for our fee-based PGIM businesses include asset management fees, commercial mortgage origination and servicing fees, and internal and external funding facilities. The principal uses of liquidity include general and administrative expenses, facilitating our commercial mortgage loan business, and distributions of dividends and returns of capital to Prudential Financial. The primary liquidity risks for our fee-based PGIM businesses relate to their profitability, which is impacted by market conditions, our investment management performance and client redemptions. We believe the cash flows from our fee-based PGIM businesses are adequate to satisfy the current liquidity requirements of these operations, as well as requirements that could arise under reasonably foreseeable stress scenarios, which are monitored through the use of internal measures. The principal sources of liquidity for our seed and co-investments held in our PGIM businesses are cash flows from investments, borrowing lines from internal sources, including Prudential Financial and Prudential Funding, LLC (“Prudential Funding”), a wholly-owned subsidiary of PICA, and external sources, including PGIM’s limited-recourse credit facility. The principal uses of liquidity for our seed and co-investments include making investments to support business growth and paying interest expense from the internal and external borrowings used to fund those investments. The primary liquidity risks include the inability to sell assets in a timely manner, declines in the value of assets and credit defaults. Alternative Sources of Liquidity In addition to asset-based financing as discussed below, Prudential Financial and certain subsidiaries have access to other sources of liquidity, including syndicated, unsecured committed credit facilities, membership in the Federal Home Loan Bank of New York, commercial paper programs, and contingent financing facilities in the form of a put option agreement and facility agreement. For additional information regarding these sources of liquidity, see Note 17 to the Consolidated Financial Statements. Asset-based Financing We conduct asset-based or secured financing within our insurance and other subsidiaries, including transactions such as securities lending, repurchase agreements and mortgage dollar rolls, to earn spread income, to borrow funds, or to facilitate trading activity. These programs are primarily driven by portfolio holdings of securities that are lendable based on counterparty demand for these securities in the marketplace. The collateral received in connection with these programs is primarily used to purchase securities in the short-term spread portfolios of our insurance entities. Investments held in the short-term spread portfolios include cash and cash equivalents, short-term investments (primarily corporate bonds), mortgage loans and fixed maturities (primarily collateralized loan obligations and other structured securities), with a weighted average life at time of purchase by the short-term portfolios of four years or less. Floating rate assets comprise the majority of our short-term spread portfolio. These short-term portfolios are subject to specific investment policy statements, which among other things, do not allow for significant asset/liability interest rate duration mismatch. The following table sets forth our liabilities under asset-based or secured financing programs as of the dates indicated: December 31, 2022December 31, 2021 PFIExcludingClosed Block DivisionClosedBlock DivisionConsolidatedPFIExcludingClosed Block DivisionClosedBlock DivisionConsolidated ($ in millions)Securities sold under agreements to repurchase$3,548 $3,041 $6,589 $7,393 $2,792 $10,185 Cash collateral for loaned securities(1)5,847 253 6,100 4,168 82 4,250 Securities sold but not yet purchased0 0 0 3 0 3 Total(2)(3)$9,395 $3,294 $12,689 $11,564 $2,874 $14,438 Portion of above securities that may be returned to the Company overnight requiring immediate return of the cash collateral$8,622 $3,189 $11,811 $10,637 $2,874 $13,511 Weighted average maturity, in days(4)17 5 31 N/A__________(1)Excludes “Liabilities held-for-sale” of $5,680 as of December 31, 2021.(2)The daily average outstanding balance for the years ended December 31, 2022 and 2021 was $11,385 million and $11,484 million, respectively, for PFI excluding the Closed Block division, and $2,814 million and $3,290 million, respectively, for the Closed Block division.(3)Includes utilization of external funding facilities for PGIM’s commercial mortgage origination business.135Table of Contents(4)Excludes securities that may be returned to the Company overnight. “N/A” reflects that all outstanding balances may be returned to the Company overnight. As of December 31, 2022, our domestic insurance entities had assets eligible for the asset-based or secured financing programs of $83.2 billion, of which $12.4 billion were on loan. Taking into account market conditions and outstanding loan balances as of December 31, 2022, we believe approximately $9.8 billion of the remaining eligible assets are readily lendable, including approximately $7.9 billion relating to PFI excluding the Closed Block division, of which $1.9 billion relates to certain separate accounts and may only be used for financing activities related to those accounts, and the remaining $1.9 billion relating to the Closed Block division. Financing Activities As of December 31, 2022, total short-term and long-term debt of the Company on a consolidated basis was $20.7 billion, an increase of $1.3 billion from December 31, 2021. The following table sets forth total consolidated borrowings of the Company as of the dates indicated. We may, from time to time, seek to redeem or repurchase our outstanding debt securities through open market purchases, individually negotiated transactions or otherwise. Any such actions will depend on prevailing market conditions, our liquidity position and other factors. December 31, 2022December 31, 2021 PrudentialFinancialSubsidiariesConsolidatedPrudentialFinancialSubsidiariesConsolidated(in millions)General obligation short-term debt:Commercial paper$25 $413 $438 $25 $395 $420 Current portion of long-term debt0 173 173 0 0 0 Other short-term debt0 0 0 0 98 98 Subtotal25 586 611 25 493 518 General obligation long-term debt:Senior debt10,115 0 10,115 10,109 173 10,282 Junior subordinated debt9,047 47 9,094 7,564 54 7,618 Surplus notes(1)0 345 345 0 344 344 Subtotal19,162 392 19,554 17,673 571 18,244 Total general obligations19,187 978 20,165 17,698 1,064 18,762 Limited and non-recourse borrowings(2)Short-term debt0 9 9 0 7 7 Current portion of long-term debt0 155 155 0 197 197 Long-term debt0 354 354 0 378 378 Subtotal0 518 518 0 582 582 Total borrowings$19,187 $1,496 $20,683 $17,698 $1,646 $19,344 __________(1)Amounts are net of assets under set-off arrangements of $12,290 million and $10,691 million as of December 31, 2022 and 2021, respectively.(2)Limited and non-recourse borrowing primarily represents mortgage debt of our subsidiaries that has recourse only to real estate investment property of $208 million and $274 million as of December 31, 2022 and 2021, respectively, and a draw on a credit facility with recourse only to collateral pledged by the Company of $300 million as of both December 31, 2022 and 2021. As of December 31, 2022 and 2021, we were in compliance with all debt covenants related to the borrowings in the table above. For additional information regarding our short- and long-term debt obligations, see Note 17 to the Consolidated Financial Statements.Based on the use of proceeds, we classify our borrowings as capital debt and operating debt. Capital debt, which is debt utilized to meet the capital requirements of our businesses, was $14.1 billion and $12.7 billion as of December 31, 2022 and 2021, respectively. Operating debt was $6.1 billion as of December 31, 2022 and 2021, and is utilized for business funding to meet specific purposes, which may include activities associated with our PGIM and Assurance IQ businesses. Operating debt also consists of debt issued to finance specific portfolios of investment assets, the proceeds from which will service the debt. Specifically, this includes assets supporting reserve requirements under Regulation XXX and Guideline AXXX as described below, as well as funding for institutional and insurance company portfolio cash flow timing differences.136Table of Contents Prudential Financial Borrowings Long-term borrowings are conducted primarily by Prudential Financial. It borrows these funds to meet its capital and other funding needs, as well as the capital and funding needs of its subsidiaries. Prudential Financial maintains a shelf registration statement with the SEC that permits the issuance of public debt, equity and hybrid securities. As a “Well-Known Seasoned Issuer” under SEC rules, Prudential Financial’s shelf registration statement provides for automatic effectiveness upon filing and has no stated issuance capacity.Prudential Financial’s borrowings increased $1.5 billion from December 31, 2021, primarily driven by $2.5 billion in junior subordinated notes issuances, offset by $1.0 billion in debt redemptions. In February, 2022, the Company issued $1 billion in aggregate principal amount of 5.125% junior subordinated notes due in March 2052. In August 2022, the Company issued $1.2 billion in aggregate principal amount of 5.95% junior subordinated notes due in September 2052 and $300 million in aggregate principal amount of 6.00% junior subordinated notes due in September 2062. In September, 2022, the Company redeemed, in full, $1.0 billion in aggregate principal amount of 5.875% junior subordinated notes due in 2042. For additional information regarding long-term debt, see Note 17 to the Consolidated Financial Statements. Subsidiary Borrowings Subsidiary borrowings principally consist of commercial paper borrowings by Prudential Funding, asset-based financing and real estate investment financing. Borrowings of our subsidiaries decreased $150 million from December 31, 2021, due primarily to debt maturities of $98 million in other short-term debt and a $64 million decrease in limited and non-recourse borrowings. Term and Universal Life Reserve Financing For business written prior to the implementation of principle-based reserving, Regulation XXX and Guideline AXXX require domestic life insurers to establish statutory reserves for term and universal life insurance policies with long-term premium guarantees that are consistent with the statutory reserves required for other individual life policies with similar guarantees. Many market participants believe that these levels of reserves are excessive relative to the levels reasonably required to maintain solvency for moderately adverse experience. The difference between the statutory reserve and the amount necessary to maintain solvency for moderately adverse experience is considered to be the non-economic portion of the statutory reserve.We use captive reinsurance subsidiaries to finance the portion of the statutory reserves required to be held by our domestic life insurance companies under Regulation XXX and Guideline AXXX that we consider to be non-economic. The financing arrangements involve the reinsurance of term and universal life business to our captive reinsurers and the issuance of surplus notes by those captives that are treated as capital for statutory purposes. These surplus notes are subordinated to policyholder obligations, and the payment of principal and interest on the surplus notes can only be made with prior insurance regulatory approval. We have entered into agreements with external counterparties providing for the issuance of surplus notes by our captive reinsurers in return for the receipt of credit-linked notes (“Credit-Linked Note Structures”). Under the agreements, the captive receives in exchange for the surplus notes one or more credit-linked notes issued by a special-purpose affiliate of the Company with an aggregate principal amount equal to the surplus notes outstanding. The captive holds the credit-linked notes as assets supporting Regulation XXX or Guideline AXXX non-economic reserves, as applicable. The captive can redeem the principal amount of the outstanding credit-linked notes for cash upon the occurrence of, and in an amount necessary to remedy, a specified liquidity stress event affecting the captive. Under the agreements, the external counterparties have agreed to fund any such payments under the credit-linked notes in return for the receipt of fees. Under certain of the transactions, Prudential Financial has agreed to make capital contributions to the captive to reimburse it for investment losses in excess of specified amounts and/or has agreed to reimburse the external counterparties for any payments made under the credit-linked notes. To date, no such payments under the credit-linked notes have been required. Under these transactions, because valid rights of set-off exist, interest and principal payments on the surplus notes and on the credit-linked notes are settled on a net basis, and the surplus notes are reflected in the Company’s total consolidated borrowings on a net basis. As of December 31, 2022, we had Credit-Linked Note Structures with an aggregate issuance capacity of $16,050 million, of which $14,070 million was outstanding, as compared to an aggregate issuance capacity of $14,600 million, of which $12,721 million was outstanding, as of December 31, 2021. These amounts reflect a Credit Link Note Structure for Guideline AXXX reserves that was expanded in December 2022, of which $2,100 million was outstanding as of December 31, 2022.137Table of ContentsThe following table summarizes our Credit-Linked Note Structures, which are reported on a net basis, as of December 31, 2022: Surplus NotesOutstanding as ofDecember 31, 2022Credit-Linked Note Structures:OriginalIssue DatesMaturityDatesFacilitySize ($ in millions)XXX2012-20212022-2036$1,600 (1)$1,750 AXXX201320333,500 3,500 XXX2014-20182022-20342,080 (2)2,100 XXX2014-20172024-20372,330 2,400 AXXX201720371,540 2,000 XXX20182038920 1,600 AXXX202020322,100 2,700 Total Credit-Linked Note Structures$14,070 $16,050 __________(1)Prudential Financial has agreed to reimburse amounts paid under the credit-linked notes issued in this structure up to $500 million. (2)The $2,080 million of surplus notes represents an intercompany transaction that eliminates upon consolidation. Prudential Financial has agreed to reimburse amounts paid under credit-linked notes issued in this structure up to $1,000 million. As of December 31, 2022, we also had outstanding an aggregate of $3,025 million of debt issued for the purpose of financing $925 million of Regulation XXX and $2,100 million of Guideline AXXX non-economic reserves. In addition, as of December 31, 2022, for purposes of financing Guideline AXXX non-economic reserves, one captive had $3,982 million of surplus notes outstanding that were issued to affiliates.The Company has introduced updated versions of its individual life products in conjunction with the requirement to adopt principle-based reserving by January 1, 2020. These updated products are currently priced to support the principle-based statutory reserve level without the need for reserve financing. Contractual Obligations The table below summarizes the future estimated cash payments related to certain contractual obligations as of December 31, 2022. The estimated payments reflected in this table are based on management’s estimates and assumptions about these obligations. Because these estimates and assumptions are necessarily subjective, the actual cash outflows in future periods will vary, possibly materially, from those reflected in the table. In addition, we do not believe that our cash flow requirements can be adequately assessed based solely upon an analysis of these obligations, as the table below does not contemplate all aspects of our cash inflows, such as the level of cash flow generated by certain of our investments, nor all aspects of our cash outflows. Estimated Payments Due by Period 20232024-20252026-20272028 and thereafterTotal (in millions)Short-term and long-term debt obligations(1)$1,770 $2,591 $2,391 $36,072 $42,824 Operating lease obligations(2)116 172 57 57 402 Purchase obligations:Commitments to purchase or fund investments(3)4,263 2,515 570 1,211 8,559 Commercial mortgage loan commitments(4)1,828 110 5 52 1,995 Other liabilities:Insurance liabilities(5)38,631 56,401 56,757 797,018 948,807 Other(6)12,754 182 65 82 13,083 Total$59,362 $61,971 $59,845 $834,492 $1,015,670 __________(1)The estimated payments due by period for long-term debt reflects the contractual maturities of principal, as disclosed in Note 17 to the Consolidated Financial Statements, as well as estimated future interest payments. The payment of principal and estimated future interest for short-term debt are reflected in estimated payments due in 2023. The estimate for future interest payments includes the effect of derivatives that qualify for hedge accounting treatment. See Note 17 to the Consolidated Financial Statements for additional information concerning our short-term and long-term debt.(2)The estimated payments due by period for operating leases reflect the future minimum lease payments under non-cancelable operating leases, as disclosed in Note 11 to the Consolidated Financial Statements.138Table of Contents(3)As discussed in Note 23 to the Consolidated Financial Statements, we have commitments to purchase or fund investments, some of which are contingent upon events or circumstances not under our control, including those at the discretion of our counterparties. The timing of the fulfillment of certain of these commitments cannot be estimated, therefore the settlements of these obligations are reflected in estimated payments due in less than one year. Commitments to purchase or fund investments include $183 million that we anticipate will ultimately be funded from our separate accounts.(4)As discussed in Note 23 to the Consolidated Financial Statements, loan commitments of our commercial mortgage operations, which are legally binding commitments to extend credit to a counterparty, have been reflected in the contractual obligations table above principally based on the expiration date of the commitment; however, it is possible these loan commitments could be funded prior to their expiration date. In certain circumstances the counterparty may also extend the date of the expiration in exchange for a fee.(5)The estimated cash flows due by period for insurance liabilities reflect future estimated cash payments to be made to policyholders and others for future policy benefits, policyholders’ account balances, policyholder’s dividends, reinsurance payables and separate account liabilities, net of premium receipts and reinsurance recoverables. Contractual obligations are contingent upon the receipt of premiums. These future estimated cash flows for current policies in force generally reflect our best estimate economic and actuarial assumptions. These cash flows are undiscounted with respect to interest. Therefore, the sum of the cash flows shown for all years in the table of $949 billion exceeds the corresponding liability amounts of approximately $622 billion included in the Consolidated Financial Statements as of December 31, 2022. Separate account liabilities are legally insulated from general account obligations, and it is generally expected these liabilities will be fully funded by separate account assets and their related cash flows. We have made significant assumptions to determine the future estimated cash flows related to the underlying policies and contracts. Due to the significance of the assumptions used and the contingent nature of contractual terms, actual cash flows and their timing will differ, possibly materially, from these estimates. Timing of cash flows in the “2028 and thereafter” category include long term liabilities that may extend beyond 100 years.(6)The estimated payments due by period for other liabilities includes securities sold under agreements to repurchase, cash collateral for loaned securities, liabilities for unrecognized tax benefits, bank customer liabilities, and other miscellaneous liabilities. Amounts presented in the table also exclude $374 million of notes issued by consolidated VIE’s which recourse for these obligations is limited to the assets of the respective VIE and do not have recourse to the general credit of the company. We also enter into agreements to purchase goods and services in the normal course of business; however, these purchase obligations are not material to our consolidated results of operations or financial position as of December 31, 2022. Off-Balance Sheet Arrangements See additional information regarding off-balance sheet arrangements in Note 17 and other commitments in Note 23 to the Consolidated Financial Statements. We do not have retained or contingent interests in assets transferred to unconsolidated entities, or variable interests in unconsolidated entities or other similar transactions, arrangements or relationships that serve as credit, liquidity or market risk support, that we believe are reasonably likely to have a material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or our access to or requirements for capital resources. In addition, we do not have relationships with any unconsolidated entities that are contractually limited to narrow activities that facilitate our transfer of or access to associated assets. Ratings Financial strength ratings (which are sometimes referred to as “claims-paying” ratings) and credit ratings are important factors affecting public confidence in an insurer and its competitive position in marketing products. Our credit ratings are also important for our ability to raise capital through the issuance of debt and for the cost of such financing. Nationally Recognized Statistical Ratings Organizations continually review the financial performance and financial condition of the entities they rate, including Prudential Financial and its rated subsidiaries. A downgrade in the credit or financial strength ratings of Prudential Financial or its rated subsidiaries could potentially, among other things, limit our ability to market products, reduce our competitiveness, increase the number or value of policy surrenders and withdrawals, increase our borrowing costs and potentially make it more difficult to borrow funds, adversely affect the availability of financial guarantees, such as letters of credit, cause additional collateral requirements or other required payments under certain agreements, allow counterparties to terminate derivative agreements and/or hurt our relationships with creditors, distributors, or trading counterparties thereby potentially negatively affecting our profitability, liquidity, and/or capital. In addition, we consider our own risk of non-performance in determining the fair value of our liabilities. Therefore, changes in our credit or financial strength ratings may affect the fair value of our liabilities. Financial strength ratings represent the opinions of rating agencies regarding the financial ability of an insurance company to meet its obligations under an insurance policy. Credit ratings represent the opinions of rating agencies regarding an entity’s ability to repay its indebtedness. The following table summarizes the ratings for Prudential Financial and certain of its subsidiaries as of the date of this filing: 139Table of Contents A.M.Best(1)S&P(2)Moody’s(3)Fitch(4)Last review date12/15/202211/29/202211/22/202112/16/2022Current outlookStableStableStableStableFinancial Strength Ratings:The Prudential Insurance Company of AmericaA+AA-Aa3AA-Pruco Life Insurance CompanyA+AA-Aa3AA-Pruco Life Insurance Company of New JerseyA+AA-NR*AA-The Prudential Life Insurance Company Ltd. (Prudential of Japan)NRA+NRNRGibraltar Life Insurance Company, Ltd.NRA+NRNRThe Prudential Gibraltar Financial Life Insurance Co. LtdNRA+NRNRCredit Ratings:Prudential Financial, Inc.:Short-term borrowingsAMB-1A-1P-2F1Long-term senior debta-AA3A-Junior subordinated long-term debtbbbBBB+Baa1BBBThe Prudential Insurance Company of America:Capital and surplus notesaAA2APrudential Funding, LLC:Short-term debtAMB-1A-1+P-1F1+Long-term senior debta+AA-A1A+PRICOA Global Funding I:Long-term senior debtaa-AA-Aa3AA-__________* “NR” indicates not rated.(1)A.M. Best Company, which we refer to as A.M. Best, financial strength ratings for insurance companies range from “A++ (superior)” to “D (Poor)”. A rating of A+ is the second highest of thirteen rating categories. A.M. Best long-term credit ratings range from “aaa (exceptional)” to “c (Poor)”. A.M. Best short-term credit ratings range from “AMB-1+”, which represents the strongest ability to repay short-term debt obligations, to “AMB-4 (Questionable)”. (2)Standard & Poor’s Rating Services, which we refer to as S&P, financial strength ratings for insurance companies range from “AAA (extremely strong)” to “D (default)”. A rating of AA- is the fourth highest of twenty-two rating categories. S&P’s long-term issue credit ratings range from “AAA (extremely strong)” to “D (default)”. S&P short-term ratings range from “A-1 (extremely strong)” to “D (default)”.(3)Moody’s Investors Service, Inc., which we refer to as Moody’s, insurance financial strength ratings range from “Aaa (highest quality)” to “C (lowest)”. A rating of Aa3 is the fourth highest of twenty-one rating categories. Numeric modifiers are used to refer to the ranking within the group—with 1 being the highest and 3 being the lowest. These modifiers are used to indicate relative strength within a category. Moody’s long-term credit ratings range from “Aaa (highest)” to “C (default)”. Moody’s short-term ratings range from “Prime-1 (P-1)”, which represents a superior ability for repayment of short-term debt obligations, to “Prime-3 (P-3)”, which represents an acceptable ability for repayment of such obligations. Issuers rated “Not Prime” do not fall within any of the Prime rating categories.(4)Fitch Ratings Inc., which we refer to as Fitch, financial strength ratings range from “AAA (exceptionally strong)” to “C (distressed)”. A rating of AA- is the fourth highest of twenty-one rating categories. Fitch long-term credit ratings range from “AAA (highest credit quality)”, which denotes exceptionally strong capacity for timely payment of financial commitments, to “D (default)”. Short-term ratings range from “F1+ (highest credit quality)” to “D (default)”. The ratings set forth above reflect current opinions of each rating agency. Each rating should be evaluated independently of any other rating. These ratings are not directed toward shareholders and do not in any way reflect evaluations of the safety and security of the Common Stock. These ratings are reviewed periodically and may be changed at any time by the rating agencies. As a result, we cannot assure stakeholders that we will maintain our current ratings in the future. Rating agencies use an “outlook” statement for both industry sectors and individual companies. For an industry sector, a stable outlook generally implies that over the next 12 to 18 months the rating agency expects ratings to remain unchanged among companies in the sector. AM Best, Fitch, S&P, and Moody’s currently have a Stable outlook on the U.S. life insurance sector. For a particular company, an outlook generally indicates a medium- or long-term trend (generally six months to two years) in credit fundamentals, which if continued, may lead to a rating change. These indicators are not necessarily a precursor of a rating change nor do they preclude a rating agency from changing a rating at any time without notice. A.M. Best, Fitch, S&P and Moody’s currently have the Company’s ratings on Stable outlook.Requirements to post collateral or make other payments because of ratings downgrades under certain agreements, including derivative agreements, can be satisfied in cash or by posting permissible securities held by the subsidiaries subject to the agreements. In addition, a ratings downgrade by A.M. Best to “A-” for our domestic life insurance companies would require PICA to either post collateral or a letter of credit in the amount of approximately $1.2 billion, based on the level of statutory 140Table of Contentsreserves related to the variable annuity business acquired from Allstate. We believe that the posting of such collateral would not be a material liquidity event for PICA. Risk Management Overview We employ a risk governance structure, overseen by senior management and our Board and managed by Enterprise Risk Management (“ERM”), to provide a common framework for: evaluating the risks embedded in and across our businesses and corporate centers; developing risk appetites; managing these risks; and identifying current and future risk challenges and opportunities. For a discussion of the risks of our businesses, see “Risk Factors”. Risk Governance Framework Each of our businesses has a risk governance structure that is supported by a framework at the corporate level. Generally, our businesses are authorized to make day-to-day risk decisions that are consistent with enterprise risk policies and limits, and subject to enterprise oversight. Board of Directors Oversight Our Board oversees our risk profile and management’s processes for assessing and managing risk, through both the whole Board and its committees. The Board also reviews strategic risks and opportunities facing the Company and its businesses. Other important categories of risk are assigned to designated Board committees that report back to the full Board. In general, the committees oversee the following risks: •Audit Committee: insurance risk and operational risk, including model risk, as well as risks related to financial controls, legal, regulatory, cyber security and compliance risk;•Compensation Committee: the design and operation of the Company’s compensation programs so that they do not encourage unnecessary or excessive risk-taking;•Corporate Governance and Business Ethics Committee: the Company’s overall ethical culture, political contributions, lobbying expenses and overall political strategy, as well as the Company’s environmental risk (which includes climate risk), sustainability and corporate social responsibility to minimize reputational risk and focus on future sustainability;•Finance Committee: liquidity risk and risk involving our capital and liquidity management, the incurrence and repayment of borrowings, the capital structure of the Company, funding of benefit plans and statutory insurance reserves. The Finance Committee oversees our capital plan and receives regular updates on the sources and uses of capital relative to plan, as well as on our Risk Appetite Framework;•Investment Committee: investment risk, market risk, and review of investment performance and risk positions. The Investment Committee approves investment and market risk limits based on asset class, issuer, credit quality and geography; and•Risk Committee: the governance of significant risk throughout the Company, the establishment and ongoing monitoring of our risk profile, risk capacity and risk appetite, and coordination of the risk oversight functions of the other Board committees. Management Oversight Our primary risk management committee is the Enterprise Risk Committee (“ERC”). The ERC is chaired by our Chief Risk Officer and otherwise consists of the Vice Chairman, Head of U.S. Businesses, Head of International Businesses and PGIM, General Counsel, Chief Financial Officer, Chief Investment Officer, Chief Information Officer and Chief Actuary. Our Chief Auditor also attends meetings of the ERC. The ERC oversees the Company’s risk management framework, including the identification, assessment, monitoring and management of risks and how those risks align with the Company’s loss absorption resources. The primary focus of the ERC is the critical analysis of significant quantitative and qualitative risks and the appropriateness and alignment to the defined risk appetite of the Company.The ERC is supported by five Risk Oversight Committees, each of which consists of subject matter experts and is dedicated to one of the following risk types: investment, market (including liquidity), insurance, operational, and model. Significant matters or matters where there are unresolved points of view are reviewed by the ERC. The Risk Oversight Committees provide an opportunity for subject matter experts within the various risk areas to evaluate complex issues. They evaluate the effectiveness of risk mitigation options, identify stakeholders of risks and issues, review material assumptions for reasonability and consistency across the Company, and develop recommendations for risk limits, among other responsibilities.141Table of ContentsIn addition, each of our businesses and certain corporate centers maintain their own risk committee as a forum for leaders to identify, assess, and monitor risk and exposure issues and to review new business activities and initiatives. Enterprise Risk Management Oversight ERM manages the risk management framework. The function operates independently and is responsible for recommending policies, limits and standards for all risks. ERM oversees these risks under the guidance of the ERC and Risk Oversight Committees. Additionally, ERM along with our business unit Chief Risk Officers and Heads of Operational Risk Management work with our businesses and corporate areas to identify, monitor and manage risks. The ERM infrastructure is generally aligned by risk type, with certain groups within ERM working across risk types. Risk Identification We rely on a combination of activities to ensure that all material risks have been identified and managed as appropriate. There are three levels of activities that seek to ensure that changes in risk levels or new risks to the Company are identified and escalated as appropriate: (1) business activities, (2) corporate center activities, and (3) processes involving senior management and the Board.•Business Activities: Each business area has a risk committee that allows senior leaders to discuss and evaluate current, new, and emerging risks in their own operations. Businesses are required to develop and maintain documented risk inventories that facilitate the identification of current risk exposures.•Corporate Center Activities: The corporate centers review the results of the business activities and examine risks from an enterprise view across businesses under normal and stressed conditions. As a result, the corporate centers, particularly ERM, use several processes and activities to identify and assess the risks of the Company. Most corporate centers have their own risk committees.•Senior Management and the Board: Senior management plays a critical role in reviewing the risk profile of the Company, including identifying impacts to the business strategy and risks in any new strategies under consideration. These risks are discussed with the ERC as appropriate, and with the Board if significant. As discussed above, the Board oversees the Company’s risk profile and management’s processes for assessing and managing risk, both as a full Board and through its committees.Risk Measurement and Monitoring Our Risk Appetite Framework is a comprehensive process designed to reasonably ensure that risks taken across the Company align with the Company’s capacity and willingness to take those risks. Using the Risk Appetite Framework, the Company measures, evaluates, and manages its financial risks. The comprehensive models, metrics, and stress scenarios used enable the Company to understand its current risk profile as well as how the risk profile may change over time through varying degrees of stress. The Risk Appetite Framework anchors the risk and capital management processes and supports management and the Board in making well-informed business decisions..The Risk Appetite Framework is centered around a comprehensive and cohesive stress testing regime which includes a variety of stress scenarios designed to explore outcomes across the investment portfolios and businesses. This robust stress testing examines the sensitivity of assets and liabilities and how they interact with each other through time to identify places where the Company’s capacity may be challenged by the risks taken. These analytics provide insight into the impact of stress scenarios on capital and liquidity.Additionally, the Qualitative Risk Appetite Framework helps the Company understand and manage risks that are not easily quantifiable. By continuously scanning the internal environment and reporting findings to leadership and the Board on a regular basis, the Company can monitor and mitigate operational risks in qualitative areas, such as: culture; reputation; compliance with laws, regulations, and policies; and decision-making incentives.COVID-19Our risk management framework incorporates severe to very severe stresses across equities, interest rates, credit migration and defaults, currencies and mortality. This framework includes a specific “pandemic and sell-off” scenario with a mortality calamity (1.5 extra deaths per 1,000 lives in the first year) based on a modern-day interpretation of the 1918 Spanish Flu experience that is aligned with most regulatory frameworks. As COVID-19 transitions to an endemic state, we continue to 142Table of Contentsupdate our analysis and take management actions in response to this specific event. The impacts of this scenario on our key metrics are assessed periodically. As of December 31, 2022, the COVID-19 pandemic has not reached the most severe levels of financial impacts included in the Company’s stress testing. In addition, the net mortality impact of COVID-19 has been moderated by the balance between our mortality exposure (such as in our Individual Life and Group Insurance businesses) and our offsetting longevity exposure (such as in the Institutional portion of our Retirement Strategies business) and is influenced by the age distribution of COVID-19 mortality. The future evolution of the virus, among other factors, could cause the actual course of the pandemic to differ from our current expectations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market Risk Market risk is defined as the risk of loss from changes in interest rates, equity prices and foreign currency exchange rates resulting from asset/liability mismatches where the change in the value of our liabilities is not offset by the change in value of our assets. For additional information regarding the potential impacts of interest rate and other market fluctuations, as well as general economic and market conditions on our businesses and profitability, see Item 1A. “Risk Factors” above. See “—Current Market Conditions” above, for how rapidly rising interest rates, among other factors, adversely impact the Company’s financial results. For additional information regarding the overall management of our general account investments and our asset mix strategies, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—General Account Investments—Management of Investments” above. For additional information regarding our liquidity and capital resources, which may be impacted by changing market risks, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” above. Market Risk Management Management of market risk, which we consider to be a combination of both investment risk and market risk exposures, includes the identification and measurement of various forms of risk, the establishment of risk thresholds and the creation of processes intended to maintain risks within these thresholds while optimizing returns on the underlying assets or liabilities. Our risk management process utilizes a variety of tools and techniques, including: •Measures of price sensitivity to market changes (e.g., interest rates, equity index prices, foreign exchange);•Asset/liability management;•Stress scenario testing;•Hedging programs; and•Risk management governance, including policies, limits, and a committee that oversees investment and market risk. For additional information regarding our overall risk management framework and governance structure, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Management” above. Market Risk Mitigation Risk mitigation takes three primary forms: •Asset/Liability Management: Managing assets to liability-based measures. For example, investment policies identify target durations for assets based on liability characteristics and asset portfolios are managed within ranges around them. This mitigates potential unanticipated economic losses from interest rate movements.•Hedging: Using derivatives to offset risk exposures. For example, for our variable annuities business, potential living benefit claims resulting from more severe market conditions are hedged using derivative instruments.•Management of portfolio concentration risk. For example, ongoing monitoring and management at the enterprise level of key rate, currency and other concentration risks support diversification efforts to mitigate exposure to individual markets and sources of risk. 143Table of ContentsMarket Risk Related to Interest Rates We perform liability-driven investing and engage in careful asset/liability management. Asset/liability mismatches create the risk that changes in liability values will differ from the changes in the value of the related assets. Additionally, changes in interest rates may impact other items including, but not limited to, the following: •Net investment spread between the amounts that we are required to pay and the rate of return we are able to earn on investments for certain products supported by general account investments;•Asset-based fees earned on assets under management or contractholder account values;•Estimated total gross profits and the amortization of deferred policy acquisition and other costs;•Net exposure to the guarantees provided under certain products; and•Capital levels of our regulated entities. We use duration and convexity analyses to measure price sensitivity to interest rate changes. Duration measures the relative sensitivity of the fair value of a financial instrument to changes in interest rates. Convexity measures the rate of change in duration with respect to changes in interest rates. We use asset/liability management and derivative strategies to manage our interest rate exposure by legal entity by matching the relative sensitivity of asset and liability values to interest rate changes, or controlling “duration mismatch” of assets and liability duration targets. In certain markets, capital market limitations that hinder our ability to acquire assets that approximate the duration of some of our liabilities are considered in setting duration targets. We consider risk-based capital and tax implications as well as current market conditions in our asset/liability management strategies. We assess the impact of interest rate movements on the value of our financial assets, financial liabilities and derivatives using hypothetical test scenarios that assume either upward or downward 100 basis point parallel shifts in the yield curve from prevailing interest rates, reflecting changes in either credit spreads or the risk-free rate. The following table sets forth the net estimated potential loss in fair value on these financial instruments from a hypothetical 100 basis point upward shift as of December 31, 2022 and 2021. This table is presented on a gross basis and excludes offsetting impacts to insurance liabilities that are not considered financial liabilities under U.S GAAP. This scenario results in the greatest net exposure to interest rate risk of the hypothetical scenarios tested at those dates. While the test scenario is for illustrative purposes only and does not reflect our expectations regarding future interest rates or the performance of fixed income markets, it is a near-term, reasonably possible hypothetical change that illustrates the potential impact of such events. These test scenarios do not measure the changes in value that could result from non-parallel shifts in the yield curve which we would expect to produce different changes in discount rates for different maturities. As a result, the actual loss in fair value from a 100 basis point change in interest rates could be different from that indicated by these calculations. The estimated changes in fair values are inclusive of any assets or liabilities held-for-sale as of December 31, 2021, but do not include separate account assets. 144Table of Contents As of December 31, 2022As of December 31, 2021NotionalFairValueHypotheticalChange in Fair ValueNotionalFairValueHypotheticalChange in Fair Value (in millions)Financial assets with interest rate risk:Fixed maturities(1)$316,070 $(30,524)$415,769 $(43,547)Commercial mortgage and other loans52,479 (2,300)67,998 (3,069)Derivatives with interest rate risk:Swaps$268,764 (8,565)(3,631)$269,823 (1,748)(5,389)Futures19,452 (12)(309)25,122 57 (1,327)Options49,351 (938)241 97,101 (187)(209)Forwards38,899 (581)(185)38,394 (159)(73)Synthetic GICs84,338 0 (6)81,984 1 0 Variable annuity and other living benefit feature embedded derivatives(4,746)2,357 (13,231)5,807 Indexed universal life contracts(986)190 (1,436)205 Indexed annuity contracts(2,506)(457)(2,041)(344)Total embedded derivatives(2)(8,238)2,090 (16,708)5,668 Financial liabilities with interest rate risk(3):Short-term and long-term debt19,441 3,091 22,648 4,231 Policyholders’ account balances—investment contracts66,602 1,944 103,064 3,520 Net estimated potential loss$(29,589)$(40,195)__________(1)Includes assets classified as “Fixed maturities, available-for-sale, at fair value,” “Assets supporting experience-rated contractholder liabilities, at fair value” and “Fixed maturities, trading, at fair value.” Approximately $308 billion and $386 billion as of December 31, 2022 and 2021, respectively, of fixed maturities are classified as available-for-sale.(2)Excludes any offsetting impact of derivative instruments purchased to hedge changes in the embedded derivatives. Amounts reported net of third-party reinsurance.(3)Excludes approximately $349 billion and $356 billion as of December 31, 2022 and 2021, respectively, of insurance reserve and deposit liabilities which are not considered financial liabilities. We believe that the interest rate sensitivities of these insurance liabilities would serve as an offset to the net interest rate risk of the financial assets and liabilities, including investment contracts. Under U.S. GAAP, the fair value of the embedded derivatives for certain features associated with variable annuity, indexed universal life, and indexed annuity contracts, reflected in the table above, includes the impact of the market’s perception of our NPR. For additional information regarding NPR related to the sensitivity of the embedded derivatives to our NPR credit spread, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Accounting Policies & Pronouncements—Application of Critical Accounting Estimates—Sensitivities for Insurance Assets and Liabilities” above. For an additional discussion of our variable annuity optional living benefit guarantees accounted for as embedded derivatives and related derivatives used to hedge the changes in fair value of these embedded derivatives, see “Market Risk Related to Certain Variable Annuity Products” below. For additional information about the key estimates and assumptions used in our determination of fair value, see Note 6 to the Consolidated Financial Statements. For information regarding the impacts of changes in the interest rate environment, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Executive Summary—Impact of Changes in the Interest Rate Environment” above. Market Risk Related to Equity Prices We have exposure to equity risk through asset/liability mismatches, including our investments in equity securities held in our general account investment portfolio and unhedged exposure in our insurance liabilities, principally related to certain variable annuity living benefit feature embedded derivatives. Our equity-based derivatives primarily hedge the equity risk embedded in these living benefit feature embedded derivatives, and are also part of our capital hedging program. Changes in equity prices create risk that the resulting changes in asset values will differ from the changes in the value of the liabilities relating to the underlying or hedged products. Additionally, changes in equity prices may impact other items including, but not limited to, the following: •Asset-based fees earned on assets under management or contractholder account value;145Table of Contents•Estimated total gross profits and the amortization of deferred policy acquisition and other costs; and•Net exposure to the guarantees provided under certain products. We manage equity risk against benchmarks in respective markets. We benchmark our return on equity holdings against a blend of market indices, mainly the S&P 500 and Russell 2000 for U.S. equities. We benchmark foreign equities against the Tokyo Price Index, and the MSCI EAFE, a market index of European, Australian, and Far Eastern equities. We target price sensitivities that approximate those of the benchmark indices. We estimate our equity risk from a hypothetical 10% decline in equity benchmark market levels. The following table sets forth the net estimated potential loss in fair value from such a decline as of December 31, 2022 and 2021. While these scenarios are for illustrative purposes only and do not reflect our expectations regarding future performance of equity markets or of our equity portfolio, they represent near-term reasonably possible hypothetical changes that illustrate the potential impact of such events. These scenarios consider only the direct impact on fair value of declines in equity benchmark market levels and not changes in asset-based fees recognized as revenue, changes in our estimates of total gross profits used as a basis for amortizing deferred policy acquisition and other costs, or changes in any other assumptions such as market volatility or mortality, utilization or persistency rates in our variable annuity contracts that could also impact the fair value of our living benefit features. In addition, these scenarios do not reflect the impact of basis risk, such as potential differences in the performance of the investment funds underlying the variable annuity products relative to the market indices we use as a basis for developing our hedging strategy. The impact of basis risk could result in larger differences between the change in fair value of the equity-based derivatives and the related living benefit features in comparison to these scenarios. In calculating these amounts, we include assets and liabilities held-for-sale as of December 31, 2021, but exclude separate account equity securities.As of December 31, 2022As of December 31, 2021NotionalFairValueHypotheticalChange inFair ValueNotionalFairValueHypotheticalChange inFair Value (in millions)Equity securities(1)$9,049 $(905)$11,296 $(1,130)Equity-based derivatives(2)$51,501 (961)(73)$103,944 (1,095)(934)Variable annuity and other living benefit feature embedded derivatives(4,746)(627)(13,231)(1,563)Indexed universal life contracts(986)24 (1,436)54 Indexed annuity contracts(2,506)841 (2,041)680 Total embedded derivatives(2)(3)(8,238)238 (16,708)(829)Net estimated potential loss$(740)$(2,893)__________(1)Includes equity securities classified as “Assets supporting experience-rated contractholder liabilities” and “Equity securities, at fair value.”(2)The notional and fair value of equity-based derivatives and the fair value of embedded derivatives are also reflected in amounts under “Market Risk Related to Interest Rates” above, and are not cumulative.(3)Excludes any offsetting impact of derivative instruments purchased to hedge changes in the embedded derivatives. Amounts reported net of third-party reinsurance. Market Risk Related to Foreign Currency Exchange Rates As a U.S.-based company with significant business operations outside of the U.S., particularly in Japan, we are exposed to foreign currency exchange rate risk related to these operations, as well as in our general account investment portfolio and other proprietary investment portfolios. For our international insurance operations, changes in foreign currency exchange rates create risk that we may experience volatility in the U.S. dollar-equivalent earnings and equity of these operations. We actively manage this risk through various hedging strategies, including the use of foreign currency hedges and through holding U.S. dollar-denominated securities in the investment portfolios of certain of these operations. Additionally, our Japanese insurance operations offer a variety of non-yen denominated products which are supported by investments in corresponding currencies. While these non-yen denominated assets are economically matched to the currency of the product liabilities, the accounting treatment may differ for changes in the value of these assets and liabilities due to moves in foreign currency exchange rates, resulting in volatility in reported U.S. GAAP earnings. This volatility has been mitigated by disaggregating the U.S. and Australian dollar-denominated businesses in Gibraltar Life into separate divisions, each with its own functional currency that aligns with the underlying products and investments. For certain of our international insurance operations outside of Japan, we elect to not hedge the risk of changes in our equity investments due to foreign exchange rate movements. For further information, see “Management’s Discussion and 146Table of ContentsAnalysis of Financial Condition and Results of Operations—Impact of Foreign Currency Exchange Rates—Impact of products denominated in non-local currencies on U.S. GAAP earnings” above. For our domestic general account investment portfolios supporting our U.S. insurance operations and other proprietary investment portfolios, our foreign currency exchange rate risk arises primarily from investments that are denominated in foreign currencies. We manage this risk by hedging substantially all domestic foreign currency denominated fixed income investments into U.S. dollars. We generally do not hedge all of the foreign currency risk of our investments in equity securities of unaffiliated foreign entities. We manage our foreign currency exchange rate risks within specified limits, and estimate our exposure, excluding equity in our Japanese insurance operations, to a hypothetical 10% change in foreign currency exchange rates. The following table sets forth the net estimated potential loss in fair value from such a change as of December 31, 2022 and 2021. While these scenarios are for illustrative purposes only and do not reflect our expectations regarding future changes in foreign exchange markets, they represent reasonably possible near-term hypothetical changes that illustrate the potential impact of such events. As of December 31, 2022As of December 31, 2021FairValueHypotheticalChange inFair ValueFairValueHypotheticalChange inFair Value (in millions)Unhedged portion of equity investment in international subsidiaries and foreign currency denominated investments in domestic general account portfolio$3,797 $380 $3,375 $338 For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—General Account Investments—Portfolio Composition” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations by Segment—International Businesses” above. Derivatives We use derivative financial instruments primarily to reduce market risk from changes in interest rates, equity prices and foreign currency exchange rates, including their use to alter interest rate or foreign currency exposures arising from mismatches between assets and liabilities. Our derivatives primarily include swaps, futures, options and forward contracts that are exchange-traded or contracted in the OTC market. Our derivatives also include interest rate guarantees we provide on our synthetic GIC products. Synthetic GICs simulate the performance of traditional insurance-related GICs but are accounted for as derivatives under U.S. GAAP due to the fact that the policyholders own the underlying assets, and we only provide a book value “wrap” on the customers’ funds, which are held in a client-owned trust. Since these wraps provide payment of guaranteed principal and interest to the customer, changes in interest rates create risk such that declines in the market value of customers’ funds would increase our net exposure to these guarantees; however, our obligation is limited to payments that are in excess of the existing customers’ fund value. Additionally, we have the ability to periodically reset crediting rates, subject to a 0% minimum floor, as well as the ability to increase prices. Further, our contract provisions provide that, although participants may withdraw funds at book value, contractholder withdrawals may only occur at market value immediately, or at book value over time. These factors, among others, result in these contracts experiencing minimal changes in fair value, despite a more significant notional value. Our derivatives also include those that are embedded in certain financial instruments, and primarily relate to certain optional living benefit features associated with our variable annuity products, as discussed in more detail in “Market Risk Related to Certain Variable Annuity Products” below. For additional information regarding our derivative activities, see Note 5 to the Consolidated Financial Statements. Market Risk Related to Certain Variable Annuity Products The primary risk exposures of our variable annuity contracts relate to actual deviations from, or changes to, the assumptions used in the original pricing of these products, including capital markets assumptions, such as equity market returns, interest rates and market volatility and actuarial assumptions. For our capital markets assumptions, we manage our exposure to the risk created by capital markets fluctuations through a combination of product design elements, such as an automatic rebalancing element and inclusion of certain optional living benefits in our living benefits hedging program. In addition, we consider external reinsurance a form of risk mitigation as well as our capital hedge program. Certain variable annuity optional living benefit features are accounted for as embedded derivatives and recorded at fair value. The market risk sensitivities associated with U.S. GAAP values of both the embedded derivatives and the related derivatives used to hedge the changes in 147Table of Contentsfair value of these embedded derivatives are provided under “Market Risk Related to Interest Rates” and “Market Risk Related to Equity Prices” above. For additional information regarding our risk management strategies, including our living benefit hedging program and other product design elements, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations by Segment—Retirement Strategies” above.148Table of Contents
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+ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSOverviewOur home sales revenues increased 18% in 2022 compared to 2021, while our gross margins increased 330 bps. These results were driven by increases in selling prices in response to robust consumer demand in 2021 and early 2022, when the majority of the homes closed in 2022 were placed under contract with customers. However, the strength of new home demand rapidly declined starting in the second quarter of 2022 as the Federal Reserve increased benchmark interest rates in response to inflation, which, in turn, drove national mortgage and other interest rates higher, impacting home affordability and consumer sentiment. These increases in interest rates, along with ongoing high inflation, waning consumer confidence, and other macroeconomic factors, have tempered new home demand in all of our markets. As a result, net new orders declined 27% for the year ended 2022 compared to 2021. This decline was concentrated in the back half of the year, with net new orders declining 28% and 41% in the third and fourth quarters, respectively, compared with the same periods in 2021. As a result, our order backlog in units decreased 32% from December 31, 2021 to December 31, 2022. In addition to lower new orders, our order cancellation rate also increased significantly in the second half of 2022, ending the year with a fourth quarter cancellation rate of 32% compared with 11% in the fourth quarter of 2021.Supply chain constraints that began after the onset of the COVID-19 pandemic have continued to limit the availability of certain materials and construction labor, which, combined with delays in municipal approvals and inspections, continue to pressure production cycle times of the homes we are constructing. The time required to construct a home was approximately two months longer in 2022 compared with 2021. The noted supply chain and labor issues have led to significant cost pressures in almost all areas of our business, but especially related to construction labor and materials. For example, lumber experienced heightened volatility during 2022, evidenced by a nearly 75% decrease from its early 2022 peak to its price on December 31, 2022. Despite these challenges, pricing remained elevated in 2022 overall as average selling prices increased 17% compared to 2021. In 2021 and the first half of 2022, we were able to increase pricing to offset the majority of such cost increases, but pricing may be significantly more challenged in the near term given the lower demand for new homes. In response to the significant shift in market conditions in 2022, we have slowed the pace of our housing starts, have increased sales incentives, and are taking additional pricing actions in the majority of our communities. We are updating the underwriting for each of our land option contracts prior to buying additional land and have made decisions in recent months to terminate a number of land option agreements, which resulted in write-offs of deposits and pre-acquisition costs totaling $63.6 million in 2022. We plan to work with our trade partners to update the costs for materials, labor, and services to reflect current market conditions and will adjust our overhead cost structure as necessary to align with demand. Despite these challenges, we remain focused on taking a measured approach to our capital allocation strategy in response to the current operating environment. Accordingly, we are focused on protecting liquidity and closely managing our cash flows, including the following planned actions:–Limiting our investment in land acquisition and development spend in 2023;–Updating the underwriting on each of our land option contracts prior to buying additional land;–Continuing our focus on increasing our lot optionality within our land pipeline for increased flexibility;–Maintaining a sufficient level of spec inventory in response to buyer preference to close in 30 to 90 days;–Taking a more opportunistic approach to share buybacks; and–Maintaining ample liquidity.We expect that the more challenging environment for new residential housing will continue through at least 2023 and will result in lower revenues and profitability during those periods. Despite these conditions, there remains a housing shortage across the United States, and we are confident in our ability to navigate this environment and to position the Company to take advantage of opportunities as they arise.19The following tables and related discussion set forth key operating and financial data for our Homebuilding and Financial Services operations as of and for the fiscal years ended December 31, 2022 and 2021. For similar operating and financial data and discussion of our fiscal 2021 results compared to our fiscal 2020 results, refer to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Part II of our annual report on Form 10-K for the fiscal year ended December 31, 2021, which was filed with the SEC on February 7, 2022. The following is a summary of our operating results by line of business ($000's omitted, except per share data): Years Ended December 31, 20222021Income before income taxes:Homebuilding$3,307,328 $2,288,128 Financial Services132,230 221,717 Income before income taxes3,439,558 2,509,845 Income tax expense(822,241)(563,525)Net income$2,617,317 $1,946,320 Per share data - assuming dilution:Net income$11.01 $7.43 •Homebuilding income before income taxes increased 45% in 2022, primarily as the result of a 17% higher average selling price combined with a 330 bps increase in gross margin due to the robust consumer demand environment in 2021 and early 2022 when the majority of the homes closed in 2022 were placed under contract with the customers. •Financial Services income before income taxes decreased 40% in 2022 compared with 2021 primarily as the result of a lower capture rate and revenue per loan due to increased competitiveness in the mortgage industry in 2022.•Our effective income tax rate was 23.9% and 22.5% for 2022 and 2021, respectively. The higher effective tax rate in 2022 was primarily due to changes in valuation allowances relating to projected utilization of certain state net operating loss carryforwards (see Note 8).20Homebuilding OperationsThe following is a summary of income before income taxes for our Homebuilding operations ($000’s omitted): Years Ended December 31, 2022FY 2022 vs. FY 20212021Home sale revenues$15,774,135 18 %$13,376,812 Land sale and other revenues143,144 (11)%160,538 Total Homebuilding revenues15,917,279 18 %13,537,350 Home sale cost of revenues (a)(11,093,895)13 %(9,841,961)Land sale and other cost of revenues(119,906)(11)%(134,013)Selling, general, and administrative expenses ("SG&A")(1,381,222)14 %(1,208,698)Loss on debt retirement— (b)(61,469)Other expense, net (c)(14,928)(b)(3,081)Income before income taxes$3,307,328 45 %$2,288,128 Supplemental data:Gross margin from home sales (a)29.7 %330 bps26.4 %SG&A % of home sale revenues8.8 %(20) bps9.0 %Closings (units)29,111 1 %28,894 Average selling price$542 17 %$463 Net new orders:Units23,277 (27)%31,739 Dollars$13,589,392 (17)%$16,442,441 Cancellation rate19 %9 %Average active communities810 1 %799 Backlog at December 31:Units12,169 (32)%18,003 Dollars$7,674,068 (22)%$9,858,811 (a)Includes the amortization of capitalized interest.(b)Percentage not meaningful.(c)See "Other expense, net" for a table summarizing significant items (see Note 1).21Home sale revenuesHome sale revenues for 2022 were higher than 2021 by $2.4 billion, or 18%. The increase was attributable to a 17% increase in average selling price combined with a 1% increase in closings. The increase in average selling price reflects the impact of pricing actions taken in response to robust consumer demand in 2021 and early 2022 when the majority of the homes that closed in 2022 were placed under contract with customers, partially offset by an increase in the mix of first-time buyer homes, which typically carry a lower sales price. The year-over-year increase in average selling price occurred in substantially all of our markets.Home sale gross margins Home sale gross margins were 29.7% in 2022, compared with 26.4% in 2021. Gross margins remained strong in both 2022 and 2021 relative to historical levels. Gross margins reflect the robust consumer demand that existed in 2021 and early 2022 when the majority of the homes that closed were placed under contract with customers, combined with limited supplies of new and existing housing inventory. This resulted in a strong pricing environment, which allowed us to offset increases in house and land costs through pricing actions in 2022.Land sale and other revenuesWe periodically elect to sell parcels of land to third parties in the event such assets no longer fit into our strategic operating plans or are zoned for commercial or other development. Land sale and other revenues and their related gains or losses vary between periods, depending on the timing of land sales and our strategic operating decisions. Land sales and other revenues contributed income of $23.2 million and $26.5 million in 2022 and 2021, respectively. Income in 2021 included a gain of $12.9 million related to a land sale transaction in California that had been in the entitlement process for a number of years.SG&ASG&A as a percentage of home sale revenues was 8.8% and 9.0% in 2022 and 2021, respectively. The gross dollar amount of our SG&A increased $172.5 million, or 14%, in 2022 compared with 2021. This increase resulted primarily from higher sales commissions expense due to the higher revenues, increased headcount, and other overhead costs to support the increased number of homes in production. These results also reflect insurance reserve reversals of $65.0 million and $81.1 million in 2022 and 2021, respectively, based on favorable claims experience in recent years relative to historical expectations. Other expense, netOther expense, net includes the following ($000’s omitted):20222021Write-offs of deposits and pre-acquisition costs (Note 2)$(63,559)$(12,283)Amortization of intangible assets (Note 1)(11,118)(16,502)Interest income1,971 1,953 Interest expense(284)(502)Equity in earnings of unconsolidated entities (Note 4)50,680 17,200 Miscellaneous, net7,382 7,053 Total other expense, net$(14,928)$(3,081)The higher write-offs of deposits and pre-acquisition costs in 2022 occurred primarily in the second half of 2022 as we made decisions to terminate a number of land option agreements due to the aforementioned lower consumer demand in recent months. Equity in earnings of unconsolidated entities reflects our share of earnings from joint ventures and other investments with independent third parties, and varies between periods based on the performance of the underlying investments. The 2022 results included a gain of $49.1 million related to a property sale in an unconsolidated entity in Northern California.Net new ordersNet new orders in units decreased 27% in 2022 compared with 2021, while net new orders in dollars decreased by 17% compared with 2021. The lower new order volume began in mid-2022 as the market responded to increased affordability 22challenges resulting from a historic increase in mortgage interest rates, increases in the price of homes, and the impact of inflationary pressures in the broader economy. Likewise, the annual cancellation rate (canceled orders for the period divided by gross new orders for the period) increased significantly to 19% in 2022 compared to 9% in 2021, including a fourth quarter cancellation rate of 32% compared with 11% in the fourth quarter of 2021. Ending backlog dollars, which represents orders for homes that have not yet closed, decreased 22% in 2022 compared with 2021 as the result of the lower net new orders.Homes in productionThe following is a summary of our homes in production at December 31, 2022 and 2021:20222021Sold10,247 14,228 UnsoldUnder construction6,874 4,105 Completed982 90 7,856 4,195 Models1,298 1,275 Total19,401 19,698 The number of homes in production at December 31, 2022 was 2% lower compared to December 31, 2021. This decrease is primarily attributable to the lower number of sold homes as a result of decreased new orders and higher cancellations. This decrease was partially offset by a higher level of unsold homes, or speculative homes, under construction, which reflects our strategic decision to increase housing starts of speculative units in response to the noted supply chain challenges and to have product available that can close quickly for customers that are concerned about potentially higher mortgage interest rates. The higher cancellation rate in 2022 also contributed to the increase in unsold inventory.23Controlled lotsThe following is a summary of our lots under control at December 31, 2022 and 2021:December 31, 2022December 31, 2021OwnedOptionedControlledOwnedOptionedControlledNortheast4,295 7,502 11,797 4,422 7,637 12,059 Southeast16,692 23,433 40,125 15,604 28,887 44,491 Florida26,413 29,667 56,080 27,654 32,240 59,894 Midwest12,923 13,128 26,051 11,723 17,118 28,841 Texas20,197 14,438 34,635 20,538 21,235 41,773 West28,328 14,096 42,424 29,137 12,101 41,238 Total108,848 102,264 211,112 109,078 119,218 228,296 52 %48 %100 %48 %52 %100 %Developed (%)43 %16 %30 %38 %13 %25 %While competition for well-positioned land remains robust, we continue to pursue land investments that we believe can achieve appropriate risk-adjusted returns on invested capital. We also continue to seek to maintain a high percentage of our lots that are controlled via land option agreements as such contracts enable us to defer acquiring portions of properties owned by third parties or unconsolidated entities until we have determined whether and when to exercise our option, which reduces our financial risks associated with long-term land holdings. However, the percentage of lots controlled via land option agreements decreased in 2022 as the result of our decision to terminate a number of pending transactions. The remaining purchase price under our land option agreements totaled $5.4 billion at December 31, 2022.Homebuilding Segment OperationsOur homebuilding operations represent our core business. Homebuilding offers a broad product line to meet the needs of homebuyers in our targeted markets. As of December 31, 2022, we conducted our operations in 42 markets located throughout 24 states. For reporting purposes, our Homebuilding operations are aggregated into six reportable segments: Northeast: Connecticut, Maryland, Massachusetts, New Jersey, Pennsylvania, VirginiaSoutheast: Georgia, North Carolina, South Carolina, TennesseeFlorida:FloridaMidwest:Illinois, Indiana, Kentucky, Michigan, Minnesota, OhioTexas:TexasWest: Arizona, California, Colorado, Nevada, New Mexico, WashingtonWe also have a reportable segment for our financial services operations, which consist principally of mortgage banking, title, and insurance brokerage operations. The Financial Services segment operates generally in the same markets as the Homebuilding segments.24The following table presents selected financial information for our reportable Homebuilding segments: Operating Data by Segment ($000's omitted) Years Ended December 31, 2022FY 2022 vs. FY 20212021Home sale revenues:Northeast$1,076,710 (4)%$1,127,182 Southeast2,792,324 25 %2,231,002 Florida3,867,855 27 %3,040,360 Midwest2,314,600 17 %1,971,593 Texas2,227,379 24 %1,800,767 West3,495,267 9 %3,205,908 $15,774,135 18 %$13,376,812 Income before income taxes (a):Northeast$244,233 13 %$215,193 Southeast692,279 66 %417,880 Florida939,034 60 %585,680 Midwest363,028 26 %287,956 Texas465,461 44 %322,979 West (b)687,403 16 %592,845 Other homebuilding (c)(84,110)37 %(134,405)$3,307,328 45 %$2,288,128 Closings (units):Northeast1,614 (18)%1,963 Southeast5,105 3 %4,956 Florida6,928 4 %6,640 Midwest4,579 4 %4,397 Texas5,692 1 %5,617 West5,193 (2)%5,321 29,111 1 %$28,894 Average selling price:Northeast$667 16 %$574 Southeast547 22 %450 Florida558 22 %458 Midwest505 13 %448 Texas391 22 %321 West673 12 %603 $542 17 %$463 (a)Includes land-related charges as summarized in the following land-related charges table (see Notes 2 and 3).(b)West includes a gain of $49.1 million related to a property sale in an unconsolidated entity in Northern California.(c) Other homebuilding includes the amortization of intangible assets, amortization of capitalized interest, and other items not allocated to the operating segments. Also includes: insurance reserve reversals of $65.0 million and $81.1 million in 2022 and 2021, respectively (see Note 11), and a loss on debt retirement of $61.5 million in 2021 (see Note 5).25The following table presents additional selected financial information for our reportable Homebuilding segments: Operating Data by Segment ($000's omitted)Years Ended December 31,2022FY 2022 vs. FY 20212021Net new orders - units:Northeast1,300(28)%1,798Southeast4,535(11)%5,092Florida6,139(27)%8,416Midwest3,241(34)%4,886Texas4,382(23)%5,663West3,680(37)%5,88423,277(27)%31,739Net new orders - dollars:Northeast$908,136(16)%$1,077,091Southeast2,561,279—%2,562,954Florida3,941,197(12)%4,470,326Midwest1,753,351(25)%2,329,112Texas1,779,578(16)%2,121,278West2,645,851(32)%3,881,680$13,589,392(17)%$16,442,441Cancellation rates:Northeast11%7%Southeast12%6%Florida15%8%Midwest12%7%Texas26%13%West30%11%19%9%Unit backlog:Northeast474(40)%788Southeast1,906(23)%2,476Florida4,641(15)%5,430Midwest1,350(50)%2,688Texas1,789(42)%3,099West2,009(43)%3,52212,169(32)%18,003Backlog dollars:Northeast$342,658(33)%$511,231Southeast1,131,817(17)%1,362,863Florida3,131,1742%3,057,832Midwest786,905(42)%1,348,155Texas853,801(34)%1,301,602West1,427,713(37)%2,277,128$7,674,068(22)%$9,858,81126The following table presents additional selected financial information for our reportable Homebuilding segments:Operating Data by Segment ($000's omitted)Years Ended December 31,20222021Land-related charges*:Northeast$4,597 $1,433 Southeast18,381 5,365 Florida13,515 1,088 Midwest6,517 2,150 Texas6,745 1,357 West16,406 909 Other homebuilding495 — $66,656 $12,302 * Land-related charges include land impairments, net realizable value adjustments for land held for sale, and write-offs of deposits and pre-acquisition costs. Other homebuilding consists primarily of write-offs of capitalized interest resulting from land-related charges. See Notes 2 and 3 to the Consolidated Financial Statements for additional discussion of these charges.Northeast:For 2022, Northeast home sale revenues decreased 4% compared with 2021 due to an 18% decrease in closings partially offset by a 16% increase in average selling price. The decrease in closings and increase in average selling price occurred across all markets. Income before income taxes increased 13% primarily due to improved gross margins across the majority of markets. Net new orders decreased across all markets.Southeast:For 2022, Southeast home sale revenues increased 25% compared with 2021 due to a 3% increase in closings combined with a 22% increase in average selling price. The increase in closings occurred across the majority of markets while the increase in average selling price occurred across all markets. Income before income taxes increased 66% primarily due to increased revenues, as well as improved gross margins across all markets. Net new orders decreased across all markets.Florida:For 2022, Florida home sale revenues increased 27% compared with 2021 due to a 4% increase in closings combined with a 22% increase in average selling price. The increase in closings occurred across the majority of markets while the increase in average selling price occurred across all markets. Income before income taxes increased 60% due to increased revenues, as well as improved gross margins across all markets. Net new orders decreased across the majority of markets. Midwest:For 2022, Midwest home sale revenues increased 17% compared with 2021 due to a 4% increase in closings combined with a 13% increase in average selling price. The increase in closings occurred across the majority of markets while the increase in average selling price occurred across all markets. Income before income taxes increased 26% primarily due to increased revenues, as well as improved gross margins across substantially all markets. Net new orders decreased across all markets.27Texas:For 2022, Texas home sale revenues increased 24% compared with 2021 due to a 1% increase in closings combined with a 22% increase in the average selling price. The increase in closings occurred across the majority of markets while the increase in average selling price occurred across all markets. Income before income taxes increased 44% primarily due to increased revenues, as well as improved gross margins across substantially all markets. Net new orders decreased across the majority of markets.West:For 2022, West home sale revenues increased 9% compared with 2021 primarily due to a 12% increase in the average selling price partially offset by a 2% decrease in closings. The decrease in closings occurred across the majority of markets while the increase in average selling price occurred across all markets. Income before income taxes increased 16% primarily due to increased revenues, as well as improved gross margins, which were mixed among markets. Results for 2022 included a gain of $49.1 million related to a property sale in an unconsolidated entity in Northern California, while the 2021 results included a gain of $12.9 million related to a land sale transaction in California that had been in the entitlement process for a number of years. Net new orders decreased across all markets.Financial Services OperationsWe conduct our Financial Services operations, which include mortgage banking, title, and insurance brokerage operations, through Pulte Mortgage and other subsidiaries. In originating mortgage loans, we initially use our own funds, including funds available pursuant to credit agreements with third parties. Substantially all of the loans we originate are sold in the secondary market within a short period of time after origination, generally within 30 days. We also sell the servicing rights for the loans we originate through fixed price servicing sales contracts to reduce the risks and costs inherent in servicing loans. This strategy results in owning the loans and related servicing rights for only a short period of time. Operating as a captive business model primarily targeted to supporting our Homebuilding operations, the business levels of our Financial Services operations are highly correlated to Homebuilding. Our Homebuilding customers continue to account for substantially all loan production. We believe that our capture rate, which represents loan originations from our Homebuilding operations as a percentage of total loan opportunities from our Homebuilding operations, excluding cash closings, is an important metric in evaluating the effectiveness of our captive mortgage business model. The following tables present selected financial information for our Financial Services operations ($000’s omitted): Years Ended December 31, 2022FY 2022 vs. FY 20212021Mortgage revenues$206,932 (32)%$304,287 Title services revenues80,198 14 %70,084 Insurance brokerage commissions24,586 62 %15,161 Total Financial Services revenues311,716 (20)%389,532 Expenses(180,696)7 %(168,486)Other income (expense), net1,210 (a)671 Income before income taxes$132,230 (40)%$221,717 Total originations:Loans18,186 (14)%21,213 Principal$7,105,486 (5)%$7,454,108 (a) Percentage not meaningful28 Years Ended December 31, 20222021Supplemental data:Capture rate77.6 %85.8 %Average FICO score748 751 Funded origination breakdown:Government (FHA, VA, USDA)19 %19 %Other agency74 %73 %Total agency93 %92 %Non-agency7 %8 %Total funded originations100 %100 %RevenuesThe demand for refinancing within the mortgage industry waned in 2021 and throughout 2022 as mortgage interest rates began to rise, which led to an increase in competition among lenders and lower margins per loan. As a result, total Financial Services revenues during 2022 decreased 20% compared with 2021. These factors were partially offset by a higher average loan amount as the result of the higher average selling price within Homebuilding.Income before income taxesThe decrease in income before income taxes for 2022 as compared with 2021 was primarily due to a lower capture rate and revenue per loan due to increased competitiveness in the mortgage industry in 2022.Income TaxesOur effective income tax rate was 23.9% and 22.5% for 2022 and 2021, respectively. The higher effective tax rate in 2022 was primarily due to changes in valuation allowances relating to projected utilization of certain state net operating loss carryforwards in 2022 (see Note 8).Liquidity and Capital ResourcesWe finance our land acquisition, development, and construction activities and financial services operations using internally-generated funds, supplemented by credit arrangements with third parties and capital market financing. We routinely monitor current and expected operational requirements and financial market conditions to evaluate accessing available financing sources, including revolving bank credit and securities offerings.At December 31, 2022, we had unrestricted cash and equivalents of $1.1 billion, restricted cash balances of $41.4 million, and $946.6 million available under our Revolving Credit Facility (as defined below). We follow a diversified investment approach for our cash and equivalents by maintaining such funds with a broad portfolio of banks within our group of relationship banks in high quality, highly liquid, short-term deposits and investments. Our ratio of debt-to-total capitalization, excluding our Financial Services debt, was 18.7% at December 31, 2022 as compared with 21.3% at December 31, 2021. For the next twelve months, we expect our principal demand for funds will be for the acquisition and development of land inventory, construction of house inventory, and operating expenses, including our general and administrative expenses. The elongation of our production cycle has required a greater investment of cash in our homes under production. Additionally, we plan to continue our dividend payments and repurchases of common stock. Within the next twelve months, we need to repay or refinance Pulte Mortgage's master repurchase agreement with third-party lenders (the "Repurchase Agreement"). While we intend to refinance the Repurchase Agreement prior to its maturity, there can be no assurances that the Repurchase Agreement can be renewed or replaced on commercially reasonable terms upon its expiration. However, we believe we have adequate liquidity to meet Pulte Mortgage's anticipated financing needs. Beyond the next twelve months, we will need to repay or refinance our Revolving Credit Facility, which matures in June 2027, and our unsecured senior notes, the next tranche of which comes due in 2026.29We believe that our current cash position and other available financing resources, coupled with our ongoing operating activities, will provide sufficient liquidity to fund our business needs over the next twelve months and beyond. To the extent the sources of capital described above are insufficient to meet our needs, we may also conduct additional public offerings of our securities, refinance debt, dispose of certain assets to fund our operating activities, or draw on existing or new debt facilities.Unsecured senior notesAt December 31, 2022, we had $2.0 billion of unsecured senior notes outstanding with no repayments due until March 2026 when $500.0 million of notes are scheduled to mature.During 2021, we retired $426.0 million of senior notes at their scheduled maturity date and also accelerated the retirement of $200.0 million and $100.0 million of our unsecured notes scheduled to mature in 2026 and 2027, respectively, through a cash tender offer. The tender offer resulted in a loss of $61.5 million, which included the write-off of debt issuance costs, unamortized discounts and premiums, and transaction fees.Other notes payableOther notes payable include non-recourse and limited recourse secured notes with third parties that totaled $55.2 million at December 31, 2022. These notes have maturities ranging up to four years, are secured by the applicable land positions to which they relate, and generally have no recourse to other assets. The stated interest rates on these notes range up to 6%.Joint venture debtAt December 31, 2022, aggregate outstanding debt of unconsolidated joint ventures was $77.3 million, of which $42.0 million related to one joint venture in which we have a 50% interest. In connection with this loan, we and our joint venture partner provided customary limited recourse guaranties in which our maximum financial loss exposure is limited to our pro rata share of the debt outstanding.Revolving credit facilityWe maintain a revolving credit facility ("Revolving Credit Facility") maturing in June 2027 that has a maximum borrowing capacity of $1.3 billion and contains an uncommitted accordion feature that could increase the capacity to $1.8 billion, subject to certain conditions and availability of additional bank commitments. The Revolving Credit Facility also provides for the issuance of letters of credit that reduce the available borrowing capacity under the Revolving Credit Facility, up to the maximum borrowing capacity. The interest rate on borrowings under the Revolving Credit Facility may be based on either the Secured Overnight Financing Rate or a base rate plus an applicable margin, as defined therein. The Revolving Credit Facility contains financial covenants that require us to maintain a minimum Tangible Net Worth and a maximum Debt-to-Capitalization Ratio (as each term is defined in the Revolving Credit Facility). As of December 31, 2022, we were in compliance with all covenants.At December 31, 2022, we had no borrowings outstanding, $303.4 million of letters of credit issued, and $946.6 million of remaining capacity under the Revolving Credit Facility. At December 31, 2021, we had no borrowings outstanding, $298.8 million of letters of credit issued, and $701.2 million of remaining capacity under the Revolving Credit Facility.Financial Services debtPulte Mortgage provides mortgage financing for the majority of our home closings by utilizing its own funds and funds made available pursuant to credit agreements with third parties. Pulte Mortgage uses these resources to finance its lending activities until the loans are sold in the secondary market, which generally occurs within 30 days. Pulte Mortgage maintains the Repurchase Agreement, which matures on July 27, 2023. The maximum aggregate commitment was $800.0 million during the seasonally high borrowing period from December 27, 2022 through January 12, 2023. At all other times, the maximum aggregate commitment ranges from $360.0 million to $500.0 million. The purpose of the changes in capacity during the term of the agreement is to lower associated fees during seasonally lower volume periods of mortgage origination activity. Borrowings under the Repurchase Agreement are secured by residential mortgage loans available-for-sale. The Repurchase Agreement contains various affirmative and negative covenants applicable to Pulte Mortgage, including quantitative thresholds related to net worth, net income, and liquidity. Pulte Mortgage had $586.7 million and $626.1 million 30outstanding under the Repurchase Agreement at December 31, 2022 and 2021, respectively, and was in compliance with its covenants and requirements as of such dates.Dividends and share repurchase programWe declared quarterly cash dividends totaling $143.1 million and $148.1 million in 2022 and 2021, respectively, and repurchased 24.2 million and 17.7 million shares in 2022 and 2021, respectively, for a total of $1.1 billion and $897.3 million in 2022 and 2021, respectively. On January 31, 2022, the Board of Directors increased our share repurchase authorization by $1.0 billion. At December 31, 2022, we had remaining authorization to repurchase $382.9 million of common shares. Contractual ObligationsWe are a party to many contractual obligations involving commitments to make payments to third parties. These obligations impact our short-term and long-term liquidity and capital resource needs. Certain contractual obligations are reflected on the Consolidated Balance Sheet as of December 31, 2022, while others are considered future commitments. Our contractual obligations primarily consist of long-term debt and related interest payments, purchase obligations related to expected acquisitions and development of land, operating leases, and obligations under our various compensation and benefit plans.We use letters of credit and surety bonds to guarantee our performance under various contracts, principally in connection with the development of our homebuilding projects. The expiration dates of the letter of credit contracts coincide with the expected completion date of the related homebuilding projects. If the obligations related to a project are ongoing, annual extensions of the letters of credit are typically granted on a year-to-year basis. At December 31, 2022, we had outstanding letters of credit of $303.4 million. Our surety bonds generally do not have stated expiration dates; rather, we are released from the bonds as the contractual performance is completed. These bonds, which approximated $2.2 billion at December 31, 2022, are typically outstanding over a period of approximately three to five years. Because significant construction and development work has been performed related to the applicable projects but has not yet received final acceptance by the respective counterparties, the aggregate amount of surety bonds outstanding is in excess of the projected cost of the remaining work to be performed.In the ordinary course of business, we enter into land option agreements in order to procure land for the construction of houses in the future. At December 31, 2022, these agreements had an aggregate remaining purchase price of $5.4 billion. Pursuant to these land option agreements, we provide a deposit to the seller as consideration for the right to purchase land at different times in the future, usually at predetermined prices. At December 31, 2022, outstanding deposits totaled $278.9 million, of which $14.6 million is refundable.For further information regarding our primary obligations, refer to Note 5, "Debt" and Note 11, "Commitments and Contingencies" to the Consolidated Financial Statements included elsewhere in this Annual Report on 10-K for amounts outstanding as of December 31, 2022, related to debt and commitments and contingencies, respectively.Cash flowsOperating activitiesNet cash provided by operating activities in 2022 was $668.5 million, compared with net cash provided by operating activities of $1.0 billion in 2021. Generally, the primary drivers of our cash flow from operations are profitability and changes in inventory levels and residential mortgage loans available-for-sale, each of which experiences seasonal fluctuations. Our positive cash flow from operations for 2022 was primarily due to our net income of $2.6 billion, which was partially offset by a $2.3 billion net increase in inventories primarily attributable to higher house inventory in production resulting from more unsold units and extended production cycle times combined with investment in land inventory. Cash flow from operations was also favorably impacted by a $266.3 million decrease in residential mortgage loans available-for-sale.Net cash provided by operating activities in 2021 was primarily due to our net income of $1.9 billion, which was partially offset by a $1.3 billion increase in inventories which was primarily attributable to higher house inventory in production, resulting from higher sales activity and extended production cycle times combined with higher investment in land inventory to support future growth. Cash flow from operations was also favorably impacted by an increase of $395.3 million in customer deposits resulting from the higher order backlog but unfavorably impacted by an increase of $382.8 million in residential mortgage loans available-for-sale, resulting from higher loan originations to support revenue growth.31Investing activitiesNet cash used in investing activities totaled $171.7 million in 2022, compared with $124.1 million in 2021. The 2022 cash outflows primarily reflect $64.7 million of investments in unconsolidated entities primarily in support of our land development activities and capital expenditures of $112.7 million related to our ongoing investment in new communities, construction operations, and certain information technology applications.Net cash used in investing activities in 2021 primarily reflected $101.6 million of investments in unconsolidated entities primarily in support of our land development activities and capital expenditures of $72.8 million related to our ongoing investment in new communities, construction operations, and certain information technology applications.Financing activitiesNet cash used in financing activities was $1.2 billion in 2022 compared with $1.7 billion during 2021. The net cash used in financing activities for 2022 resulted primarily from the repurchase of 24.2 million common shares for $1.1 billion under our repurchase authorization and cash dividends of $144.1 million.Net cash used in financing activities for 2021 resulted primarily from the repurchase of 17.7 million common shares for $897.3 million under our repurchase authorization, repayments of debt of $836.9 million, and cash dividends of $147.8 million, partially offset by net Financial Services borrowings of $214.3 million. SeasonalityAlthough significant changes in market conditions have impacted our seasonal patterns in the past and could do so again, we have historically experienced variability in our quarterly results from operations due to the seasonal nature of the homebuilding industry. We generally experience increases in revenues and cash flow from operations during the fourth quarter based on the timing of home closings. This seasonal activity increases our working capital requirements in our third and fourth quarters to support our home production and loan origination volumes. As a result of the seasonality of our operations, our quarterly results of operations are not necessarily indicative of the results that may be expected for the full year. Additionally, given the disruption in economic activity caused by the COVID-19 pandemic, supply chain challenges, increase in mortgage interest rates, and other macroeconomic factors, our quarterly results in 2022 and 2021 are not necessarily indicative of results that may be achieved in the future.Supplemental Guarantor Financial InformationAs of December 31, 2022 PulteGroup, Inc. had outstanding $2.0 billion principal amount of unsecured senior notes due at dates from March 2026 through February 2035 and no amounts outstanding on its Revolving Credit Facility.All of our unsecured senior notes and the Revolving Credit Facility are fully and unconditionally guaranteed, on a joint and several basis, by certain subsidiaries of PulteGroup, Inc. ("Guarantors" or "Guarantor Subsidiaries"). Each of the Guarantor Subsidiaries is 100% owned, directly or indirectly, by PulteGroup, Inc. Our subsidiaries associated with our financial services operations and certain other subsidiaries do not guarantee the unsecured senior notes or the Revolving Credit Facility (collectively, "Non-Guarantor Subsidiaries"). The guarantees are senior unsecured obligations of each Guarantor and rank equal with all existing and future senior debt of such Guarantor and senior to all subordinated debt of such Guarantor. The guarantees are effectively subordinated to any secured debt of such Guarantor to the extent of the value of the assets securing such debt. A court could void or subordinate any Guarantor’s guarantee under the fraudulent conveyance laws if existing or future creditors of any such Guarantor were successful in establishing that such Guarantor:(a) incurred the guarantee with the intent of hindering, delaying or defrauding creditors; or(b) received less than reasonably equivalent value or fair consideration in return for incurring the guarantee and, in the case of and any one of the following is also true at the time thereof:•such Guarantor was insolvent or rendered insolvent by reason of the issuance of the incurrence of the guarantee;•the incurrence of the guarantee left such Guarantor with an unreasonably small amount of capital or assets to carry on its business;•such Guarantor intended to, or believed that it would, incur debts beyond its ability to pay as they mature;32•such Guarantor was a defendant in an action for money damages, or had a judgment for money damages docketed against it, if the judgment is unsatisfied after final judgment.The measures of insolvency for purposes of determining whether a fraudulent conveyance occurred would vary depending upon the laws of the relevant jurisdiction and upon the valuation assumptions and methodology applied by the court. However, in general, a court would deem a company insolvent if:•the sum of its debts, including contingent and unliquidated liabilities, was greater than the fair saleable value of all of its assets;•the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or•it could not pay its debts as they became due.The guarantees of the senior notes contain a provision to limit each Guarantor’s liability to the maximum amount that it could incur without causing the incurrence of obligations under its guarantee to be a fraudulent transfer. However, under recent case law, this provision may not be effective to protect such guarantee from being voided under fraudulent transfer law or otherwise determined to be unenforceable. If a court were to find that the incurrence of a guarantee was a fraudulent transfer or conveyance, the court could void the payment obligations under that guarantee, could subordinate that guarantee to presently existing and future indebtedness of the Guarantor or could require the holders of the senior notes to repay any amounts received with respect to that guarantee. In the event of a finding that a fraudulent transfer or conveyance occurred, holders may not receive any repayment on the senior notes.Finally, as a court of equity, a bankruptcy court may subordinate the claims in respect of the guarantees to other claims against us under the principle of equitable subordination if the court determines that (1) the holder of senior notes engaged in some type of inequitable conduct, (2) the inequitable conduct resulted in injury to our other creditors or conferred an unfair advantage upon the holders of senior notes and (3) equitable subordination is not inconsistent with the provisions of the bankruptcy code.On the basis of historical financial information, operating history and other factors, we believe that each of the Guarantors, after giving effect to the issuance of the guarantees when such guarantees were issued, was not insolvent, did not have unreasonably small capital for the business in which it engaged and did not and has not incurred debts beyond its ability to pay such debts as they mature. We cannot assure you, however, as to what standard a court would apply in making these determinations or that a court would agree with our conclusions in this regard.The following tables present summarized financial information for PulteGroup, Inc. and the Guarantor Subsidiaries on a combined basis after intercompany transactions and balances have been eliminated among PulteGroup, Inc. and the Guarantor Subsidiaries, as well as their investment in and equity in earnings from the Non-Guarantor Subsidiaries ($000’s omitted):PulteGroup, Inc. and Guarantor SubsidiariesSummarized Balance Sheet DataDecember 31,ASSETS20222021Cash, cash equivalents, and restricted cash$786,073 $1,598,328 House and land inventory10,925,830 8,859,163 Amount due from Non-Guarantor Subsidiaries674,898 278,531 Total assets13,074,398 11,658,352 LIABILITIESAccounts payable, customer deposits, accrued and other liabilities$2,785,286 $2,788,465 Notes payable2,045,527 2,029,044 Total liabilities5,049,079 4,986,491 33Years Ended December 31,Summarized Statement of Operations Data20222021Revenues$15,637,507 $13,173,753 Cost of revenues10,985,982 9,697,959 Selling, general, and administrative expenses1,330,994 1,164,553 Income before income taxes3,245,925 2,213,419 Critical Accounting EstimatesThe preparation of the Company's financial statements in conformity with U.S. generally accepted accounting principles and the discussion and analysis of its financial condition and operating results requires management to make estimates and assumptions, including estimates about the future resolution of existing uncertainties that affect the amounts reported. As a result, actual results could differ from these estimates. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances. We believe the following critical accounting estimates reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements. For a discussion of all of our significant accounting policies, refer to Note 1, "Summary of Significant Account Policies".Inventory and cost of revenuesCost of revenues includes the construction cost, average lot cost, estimated warranty costs, and closing costs applicable to the home. The construction cost of the home includes amounts paid through the closing date of the home, plus an accrual for costs incurred but not yet paid, based on an analysis of budgeted construction costs. This accrual is reviewed for accuracy based on actual payments made after closing compared with the amount accrued, and adjustments are made if needed. Land acquisition and development costs are allocated to individual lots using an average lot cost determined based on the total expected land acquisition and development costs and the total expected home closings for the community. Total community land acquisition and development costs are based on an analysis of budgeted costs compared with actual costs incurred to date and estimates to complete. The development cycles for our communities range from under one year to in excess of ten years for certain master planned communities. Adjustments to estimated total land acquisition and development costs for the community affect the amounts costed for the community’s remaining lots.We test inventory for impairment when events and circumstances indicate that the undiscounted cash flows estimated to be generated by the community may be less than its carrying amount. Such indicators include gross margins or sales paces significantly below expectations, construction costs or land development costs significantly in excess of budgeted amounts, significant delays or changes in the planned development for the community, and other known qualitative factors. Communities that demonstrate potential impairment indicators are tested for impairment by comparing the expected undiscounted cash flows for the community to its carrying value. For those communities whose carrying values exceed the expected undiscounted cash flows, we determine the fair value of the community and impairment charges are recorded if the fair value of the community’s inventory is less than its carrying value.We generally determine the fair value of each community using a combination of discounted cash flow models and market comparable transactions, where available. These estimated cash flows are significantly impacted by estimates related to expected average selling prices, expected sales paces, expected land development and construction timelines, and anticipated land development, construction, and overhead costs. The assumptions used in the discounted cash flow models are specific to each community. Due to uncertainties in the estimation process, the significant volatility in demand for new housing, the long life cycles of many communities, and potential changes in our strategy related to certain communities, actual results could differ significantly from such estimates.Generally, a community must have projected gross margin percentages in the single digits or lower to potentially fail the undiscounted cash flow step and proceed to the fair value step. Our overall gross margin realized during 2022 and our average gross margin in backlog at December 31, 2022 both exceeded 25%, and we have only a small minority of communities with gross margins below 10%. However, in the event of an extended economic slowdown that leads to moderate or significant decreases in the price of new homes in certain geographic or buyer submarkets, we could have a larger number of communities that begin to approach these levels such that more detailed impairment analyses would be necessary, and the resulting impairments could be material. Additionally, we have $478.8 million of deposits and pre-acquisition costs at December 31, 2022 related to option agreements to acquire additional land. In the event of an extended economic slowdown, we could elect to 34cancel a large portion of such land option agreements, which would generally result in the write-off of the related deposits and pre-acquisition costs.Self-insured risksAt any point in time, we are managing numerous individual claims related to general liability, property, errors and omission, workers compensation, and other business insurance coverage. We reserve for costs associated with such claims (including expected claims management expenses) on an undiscounted basis at the time product revenue is recognized for each home closing and periodically evaluate the recorded liabilities based on actuarial analyses of our historical claims. The actuarial analyses calculate estimates of the ultimate cost of all unpaid losses, including estimates for incurred but not reported losses ("IBNR"). IBNR represents losses related to claims incurred but not yet reported plus development on reported claims.Our recorded reserves for all such claims totaled $635.9 million and $627.1 million at December 31, 2022 and 2021, respectively, the vast majority of which relate to general liability claims. The recorded reserves include loss estimates related to both (i) existing claims and related claim expenses and (ii) IBNR and related claim expenses. Liabilities related to IBNR and related claim expenses represented approximately 74% and 70% of the total general liability reserves at December 31, 2022 and 2021, respectively. The actuarial analyses that determine the IBNR portion of reserves consider a variety of factors, including the frequency and severity of losses, which are based on our historical claims experience supplemented by industry data. The actuarial analyses of the reserves also consider historical third party recovery rates and claims management expenses. Because of the inherent uncertainty in estimating future losses related to these claims, actual costs could differ significantly from estimated costs. Based on the actuarial analyses performed, we believe the range of reasonably possible losses related to these claims is $525 million to $725 million. While this range represents our best estimate of our ultimate liability related to these claims, due to a variety of factors, including those factors described above, there can be no assurance that the ultimate costs realized by us will fall within this range.Volatility in both national and local housing market conditions can affect the frequency and cost of construction defect claims. Additionally, IBNR estimates comprise the majority of our liability and are subject to a high degree of uncertainty due to a variety of factors, including changes in claims reporting and resolution patterns, third party recoveries, insurance industry practices, the regulatory environment, and legal precedent. State regulations vary, but construction defect claims are reported and resolved over an extended period often exceeding ten years. Changes in the frequency and timing of reported claims and estimates of specific claim values can impact the underlying inputs and trends utilized in the actuarial analyses, which could have a material impact on the recorded reserves. Additionally, the amount of insurance coverage available for each policy period also impacts our recorded reserves. Because of the inherent uncertainty in estimating future losses and the timing of such losses related to these claims, actual costs could differ significantly from estimated costs. Adjustments to reserves are recorded in the period in which the change in estimate occurs. During 2022 and 2021, we reduced general liability reserves by $65.0 million and $81.1 million, respectively, as a result of changes in estimates resulting from actual claim experience observed being less than anticipated in previous actuarial projections. The changes in actuarial estimates were driven by changes in actual claims experience that, in turn, impacted actuarial estimates for potential future claims. These changes in actuarial estimates did not involve any changes in actuarial methodology but did impact the development of estimates for future periods, which resulted in adjustments to the IBNR portion of our recorded liabilities. There were no material adjustments to individual claims. Rather, the adjustments reflect an overall lower level of losses related to construction defect claims in recent years as compared with our previous experience. We attribute this favorable experience to a variety of factors, including improved construction techniques, rising home values, and increased participation from our subcontractors in resolving claims.35ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are subject to market risk on our debt instruments primarily due to fluctuations in interest rates. We utilize both fixed-rate and variable-rate debt. For fixed-rate debt, changes in interest rates generally affect the fair value of the debt instrument but not our earnings or cash flows. Conversely, for variable-rate debt, changes in interest rates generally do not affect the fair value of the debt instrument but could affect our earnings and cash flows. Except in very limited circumstances, we do not have an obligation to prepay our debt prior to maturity. As a result, interest rate risk and changes in fair value should not have a significant impact on our fixed-rate debt until we are required or elect to refinance or repurchase such debt.The following table sets forth the principal cash flows by scheduled maturity, weighted-average interest rates, and estimated fair value of our debt obligations as of December 31, 2022 and 2021 ($000’s omitted). As of December 31, 2022 for theYears ended December 31, 20232024202520262027ThereafterTotalFairValueRate-sensitive liabilities:Fixed rate debt$20,841 $30,792 $— $503,595 $500,000 $1,000,000 $2,055,228 $2,079,218 Average interest rate2.45 %4.72 %— %5.49 %5.00 %6.71 %5.92 %Variable rate debt (a)$586,711 $— $— $— $— $— $586,711 $586,711 Average interest rate5.39 %— %— %— %— %— %5.39 % As of December 31, 2021 for theYears ended December 31, 20222023202420252026ThereafterTotalFairValueRate-sensitive liabilities:Fixed rate debt$8,652 $12,555 $18,978 $— $500,000 $1,500,000 $2,040,185 $2,496,875 Average interest rate1.16 %3.55 %5.28 %— %5.50 %6.14 %5.94 %Variable rate debt (a)$626,123 $— $— $— $— $— $626,123 $626,123 Average interest rate2.20 %— %— %— %— %— %2.20 %(a) Includes the Pulte Mortgage Repurchase Agreement. There were no borrowings outstanding under our Revolving Credit Facility at either December 31, 2022 or 2021.Derivative instruments and hedging activitiesPulte Mortgage is exposed to market risks from commitments to lend, movements in interest rates, and canceled or modified commitments to lend. A commitment to lend at a specific interest rate (an interest rate lock commitment) is a derivative financial instrument (interest rate is locked to the borrower). The interest rate risk continues through the loan closing and until the loan is sold to an investor. We are generally not exposed to variability in cash flows of derivative instruments for more than approximately 60 days. In periods of rising interest rates, the length of exposure will generally increase due to customers locking in an interest rate sooner as opposed to letting the interest rate float. In periods of low or decreasing interest rates, the length of exposure will also generally increase as customers desire to lock before the possibility of rising rates. In order to reduce these risks, we use derivative financial instruments, principally cash forward placement contracts on mortgage-backed securities and whole loan investor commitments, to economically hedge the interest rate lock commitment. We generally enter into one of the aforementioned derivative financial instruments upon accepting interest rate lock commitments. Changes in the fair value of interest rate lock commitments and the other derivative financial instruments are recognized in Financial Services revenues. We do not use any derivative financial instruments for trading purposes. At December 31, 2022 and 2021, residential mortgage loans available-for-sale had an aggregate fair value of $677.2 million and $947.1 million, respectively. At December 31, 2022 and 2021, we had aggregate interest rate lock commitments of $653.2 million and $337.9 million, respectively, which were originated at interest rates prevailing at the date of commitment. Unexpired forward contracts totaled $1.0 billion and $903.0 million at December 31, 2022 and 2021, respectively, and whole loan investor commitments totaled $285.9 million and $310.0 million, respectively, at such dates. Hypothetical changes in the fair values of our financial instruments arising from immediate parallel shifts in long-term mortgage rates would not be material to our financial results due to the offsetting nature in the movements in fair value of our financial instruments.36SPECIAL NOTES CONCERNING FORWARD-LOOKING STATEMENTSAs a cautionary note, except for the historical information contained herein, certain matters discussed in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 7A, Quantitative and Qualitative Disclosures About Market Risk, are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to a number of risks, uncertainties and other factors that could cause our actual results, performance, prospects or opportunities, as well as those of the markets we serve or intend to serve, to differ materially from those expressed in, or implied by, these statements. You can identify these statements by the fact that they do not relate to matters of a strictly factual or historical nature and generally discuss or relate to forecasts, estimates or other expectations regarding future events. Generally, the words "believe," "expect," "intend," "estimate," "anticipate," "plan," "project," "may," "can," "could," "might," "should," "will," and similar expressions identify forward-looking statements, including statements related to any potential impairment charges and the impacts or effects thereof, expected operating and performing results, planned transactions, planned objectives of management, future developments or conditions in the industries in which we participate and other trends, developments and uncertainties that may affect our business in the future.Such risks, uncertainties and other factors include, among other things: interest rate changes and the availability of mortgage financing; competition within the industries in which we operate; the availability and cost of land and other raw materials used by us in our homebuilding operations; the impact of any changes to our strategy in responding to the cyclical nature of the industry, including any changes regarding our land positions and the levels of our land spend; the availability and cost of insurance covering risks associated with our businesses; shortages and the cost of labor; weather related slowdowns; slow growth initiatives and/or local building moratoria; governmental regulation directed at or affecting the housing market, the homebuilding industry or construction activities; uncertainty in the mortgage lending industry, including revisions to underwriting standards and repurchase requirements associated with the sale of mortgage loans; the interpretation of or changes to tax, labor and environmental laws which could have a greater impact on our effective tax rate or the value of our deferred tax assets than we anticipate; economic changes nationally or in our local markets, including inflation, deflation, changes in consumer confidence and preferences and the state of the market for homes in general; legal or regulatory proceedings or claims; our ability to generate sufficient cash flow in order to successfully implement our capital allocation priorities; required accounting changes; terrorist acts and other acts of war; the negative impact of the COVID-19 pandemic on our financial position and ability to continue our Homebuilding or Financial Services activities at normal levels or at all in impacted areas; the duration, effect and severity of the COVID-19 pandemic; the measures that governmental authorities take to address the COVID-19 pandemic which may precipitate or exacerbate one or more of the above-mentioned and/or other risks and significantly disrupt or prevent us from operating our business in the ordinary course for an extended period of time; and other factors of national, regional and global scale, including those of a political, economic, business and competitive nature. See Item 1A – Risk Factors for a further discussion of these and other risks and uncertainties applicable to our businesses. We undertake no duty to update any forward-looking statement, whether as a result of new information, future events or changes in our expectations. 37
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Total Remaining Deal Value, was $3.7 billion. Of our total remaining deal value, as of December 31, 2022, $2.0 billion was the remaining deal value of our contracts with commercial customers and $1.7 billion was the remaining deal value of our contracts with government customers. Many of these contracts are subject to termination for convenience provisions. Additionally, the U.S. federal government is prohibited from exercising contract options more than one year in advance. As a result, there can be no guarantee that our customer contracts will not be terminated or that contract options will be exercised.We historically have not realized all of the revenue from the full deal value of our customer contracts, and we may not do so in the future. This is because the actual timing and amount of revenue under contracts included are subject to various contingencies, including exercise of contractual options, customers not terminating their contracts, renegotiation of contracts, and other macroeconomic factors that may potentially inhibit a customer’s ability to pay. In addition, delays in the completion of the U.S. government’s budgeting process, the use of continuing resolutions, and a potential lapse in appropriations, or similar events in other jurisdictions, has and could in the future adversely affect our ability to timely recognize revenue under certain government contracts. If we are unable to realize all of the revenue from the full deal value of our customer contracts, our financial condition and results of operations could be adversely affected.Our results of operations and our key business measures are likely to fluctuate significantly on a quarterly basis in future periods and may not fully reflect the underlying performance of our business, which makes our future results difficult to predict and could cause our results of operations to fall below expectations. Our quarterly results of operations, including cash flows, have fluctuated significantly in the past and are likely to continue to do so in the future. Accordingly, the results of any one quarter should not be relied upon as an indication of future performance. Our quarterly results, financial position, and operations are likely to fluctuate as a result of a variety of factors, many of which are outside of our control, and as a result, may not fully reflect the underlying performance of our business. Fluctuation in quarterly results may negatively impact the value of our Class A common stock. We typically close a large portion of our sales in the last several weeks of a quarter, which impacts our ability to plan and manage margins and cash flows. Our sales cycle is often long, and it is difficult to predict exactly when, or if, we will actually make a sale with a potential customer, particularly large government and commercial customers. As a result, large individual sales have, in some cases, occurred in quarters subsequent to those we anticipated, or have not occurred at all. The loss or delay of one or more large sales transactions in a quarter would impact our results of operations and cash flow for that quarter and any future quarters in which revenue from that transaction is lost or delayed. In addition, downturns in new sales may not be immediately reflected in our revenue because we generally recognize revenue over the term of our contracts. The timing of customer billing and payment varies from contract to contract. A delay in the timing of receipt of such collections, or a default on a large contract, may negatively impact our liquidity for the period and in the future. Because a substantial portion of our expenses are relatively fixed in the short term and require time to adjust, our results of operations and liquidity would suffer if revenue fell below our expectations in a particular period. Other factors that may cause fluctuations in our quarterly results of operations and financial position include, without limitation, those listed below: •the success of our sales and marketing efforts, including the success of our pilot deployments; •our ability to increase our contribution margins; 16Table of Contents•the timing of expenses and revenue recognition; •the timing and amount of payments received from our customers; •termination of one or more large contracts by customers, including for convenience; •the time and cost-intensive nature of our sales efforts and the length and variability of sales cycles; •the amount and timing of operating expenses related to the maintenance and expansion of our business and operations; •the timing and effectiveness of new sales and marketing initiatives; •changes in our pricing policies or those of our competitors; •the timing and success of new products, features, and functionality introduced by us or our competitors; •interruptions or delays in our operations and maintenance (“O&M”) services; •cyberattacks and other actual or perceived data or security breaches or incidents; •our ability to hire and retain employees, in particular, those responsible for operations and maintenance of and the selling or marketing of our platforms, and develop and retain talented sales personnel who are able to achieve desired productivity levels in a reasonable period of time and provide sales leadership in areas in which we are expanding our sales and marketing efforts; •the amount and timing of our stock-based compensation expenses; •changes in the way we organize and compensate our sales teams; •changes in the way we operate and maintain our platforms; •unforeseen negative results in operations from our partnerships, including those accounted for under the equity method; •changes in the competitive dynamics of our industry; •the cost of and potential outcomes of existing and future claims or litigation, which could have a material adverse effect on our business; •changes in laws and regulations that impact our business, such as the FASA; •indemnification payments to our customers or other third parties; •ability to scale our business with increasing demands; •the timing of expenses related to any future acquisitions; and •general economic, regulatory, and market conditions, including the impacts of the ongoing COVID-19 pandemic, the ongoing Russia-Ukraine conflict and related economic sanctions and regional instability, rising inflation and interest rates, and monetary policy changes.In addition, many of our contracts contain termination for convenience provisions, and we may be obligated to repay prepaid amounts or otherwise not realize anticipated future revenue should we fail to provide future services as anticipated. These factors make it difficult for us to accurately predict financial metrics for any particular period. The variability and unpredictability of our quarterly results of operations, cash flows, or other operating metrics could result in our failure to meet our expectations or those of analysts that cover us or investors with respect to revenue or other key metrics for a particular period. If we fail to meet or exceed such expectations for these or any other reasons, the trading price of our Class A common stock could fall, and we could face costly lawsuits. We and certain of our officers and directors were recently sued in purported class action lawsuits and derivative lawsuits, which could result in substantial costs and a diversion of our management’s attention and resources. For more information see Note 8. Commitments and Contingencies in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Seasonality may cause fluctuations in our results of operations and financial position. Historically, the first quarter of our year generally has relatively lower sales, and sales generally increase in each subsequent quarter with substantial increases during our third and fourth quarters ending September 30 and December 31, respectively. We believe that this seasonality results from a number of factors, including: •the fiscal year end procurement cycle of our government customers, and in particular U.S. government customers which have a fiscal year end of September 30; 17Table of Contents•the fiscal year budgeting process for our commercial customers, many of which have a fiscal year end of December 31; •seasonal reductions in business activity during the summer months in the United States, Europe, and certain other regions; and •timing of projects and our customers’ evaluation of our work progress.This seasonality has historically impacted and may in the future continue to impact the timing of collections and recognized revenue. Because a significant portion of our customer contracts are typically finalized near the end of the year, and we typically invoice customers shortly after entering into a contract, we may receive a portion of our customer payments near the end of the year and record such payment as an increase in deferred revenue or customer deposits (“contract liabilities”), while the revenue from our customer contracts is generally recognized over the contract term. While we have historically billed and collected payments for multiple contract years from certain customers in advance, we have and may continue to shift to collecting payments on an annual or other basis. While this has been the historical seasonal pattern of our quarterly sales, we believe that our customers’ required timing for certain new government or commercial programs requiring new software may outweigh the nature or magnitude of seasonal factors that might have influenced our business to date. As a result, we may experience future growth from additional government or commercial mandates that do not follow the seasonal purchasing and evaluation decisions by our customers that we have historically observed. For example, increased government spending on technology aimed at national defense, financial or policy regulation, cybersecurity, or healthcare mandates may drive customer demand at different times throughout our year, the timing of which we may not be able to anticipate and may cause fluctuations in our results of operations. The timing of our fiscal quarters and the U.S. federal government’s September 30 fiscal year end also may impact sales to governmental agencies in the third quarter of our year, offsetting, at least in part, the otherwise seasonal downturn we have historically observed in later summer months. Our rapid growth in recent years may obscure the extent to which seasonality trends have affected our business and may continue to affect our business. We expect that seasonality will continue to materially impact our business in the future and may become more pronounced over time. The seasonality of our business may cause continued or increased fluctuations in our results of operations and cash flows, which may prevent us from achieving our quarterly or annual forecasts or meeting or exceeding the expectations of research analysts or investors, which in turn may cause a decline in the trading price of our Class A common stock. Our platforms are complex and may have a lengthy implementation process, and any failure of our platforms to satisfy our customers or perform as desired could harm our business, results of operations, and financial condition. Our platforms and services are complex and are deployed in a wide variety of network environments. Implementing our platforms can be a complex and lengthy process since we often configure our existing platforms for a customer’s unique environment. Inability to meet the unique needs of our customers may result in customer dissatisfaction and/or damage to our reputation, which could materially harm our business. Further, the proper use of our platforms may require training of the customer and the initial or ongoing services of our technical personnel as well as O&M services over the contract term. If training and/or ongoing services require more of our expenditures than we originally estimated, our margins will be lower than projected. In addition, if our customers do not use our platforms correctly or as intended, inadequate performance or outcomes may result. It is possible that our platforms may also be intentionally misused or abused by customers or their employees or third parties who obtain access and use of our platforms. Similarly, our platforms sometimes are used by customers with smaller or less sophisticated IT departments, potentially resulting in sub-optimal performance at a level lower than anticipated by the customer. Because our customers rely on our platforms and services to address important business goals and challenges, the incorrect or improper use or configuration of our platforms and O&M services, failure to properly train customers on how to efficiently and effectively use our platforms, or failure to properly provide implementation or analytical or maintenance services to our customers may result in contract terminations or non-renewals, reduced customer payments, negative publicity, or legal claims against us. For example, as we continue to expand our customer base, any failure by us to properly provide these services may result in lost opportunities for follow-on expansion sales of our platforms and services. Furthermore, if customer personnel are not well trained in the use of our platforms, customers may defer the deployment of our platforms and services, may deploy them in a more limited manner than originally anticipated, or may not deploy them at all. If there is substantial turnover of the Company or customer personnel responsible for procurement and use of our platforms, our platforms may go unused or be adopted less broadly, and our ability to make additional sales may be substantially limited, which could negatively impact our business, results of operations, and growth prospects. 18Table of ContentsIf we do not successfully develop and deploy new technologies to address the needs of our customers, our business and results of operations could suffer. Our success has been based on our ability to design software and products that enable the integration of data into a common operating environment to facilitate advanced data analysis, knowledge management, and collaboration. We spend substantial amounts of time and money researching and developing new technologies and enhanced versions of existing features to meet our customers’ and potential customers’ rapidly evolving needs. There is no assurance that our enhancements to our platforms or our new product features, capabilities, or offerings, including new product modules, will be compelling to our customers or gain market acceptance. If our research and development investments do not accurately anticipate customer demand or if we fail to develop our platforms in a manner that satisfies customer preferences in a timely and cost-effective manner, we may fail to retain our existing customers or increase demand for our platforms. The introduction of new products and services by competitors or the development of entirely new technologies to replace existing offerings could make our platforms obsolete or adversely affect our business, financial condition, and results of operations. We may experience difficulties with software development, design, or marketing that delay or prevent our development, introduction, or implementation of new platforms, features, or capabilities. We have in the past experienced delays in our internally planned release dates of new features and capabilities, and there can be no assurance that new platforms, features, or capabilities will be released according to schedule. Any delays could result in adverse publicity, loss of revenue or market acceptance, or claims by customers brought against us, any of which could harm our business. Moreover, the design and development of new platforms or new features and capabilities to our existing platforms may require substantial investment, and we have no assurance that such investments will be successful. If customers do not widely adopt our new platforms, experiences, features, and capabilities, we may not be able to realize a return on our investment and our business, financial condition, and results of operations may be adversely affected. Our new and existing platforms and changes to our existing platforms could fail to attain sufficient market acceptance for many reasons, including: •our failure to predict market demand accurately in terms of product functionality and to supply offerings that meet this demand in a timely fashion; •product defects, errors, or failures or our inability to satisfy customer service level requirements; •negative publicity or negative private statements about the security, performance, or effectiveness of our platforms or product enhancements; •delays in releasing to the market our new offerings or enhancements to our existing offerings, including new product modules; •introduction or anticipated introduction of competing platforms or functionalities by our competitors; •inability of our platforms or product enhancements to scale and perform to meet customer demands; •receiving qualified or adverse opinions in connection with security or penetration testing, certifications or audits, such as those related to IT controls and security standards and frameworks or compliance; •poor business conditions for our customers, causing them to delay software purchases; •reluctance of customers to purchase proprietary software products; •reluctance of our customers to purchase products hosted by our vendors and/or service interruption from such providers; and •reluctance of customers to purchase products incorporating open source software.If we are not able to continue to identify challenges faced by our customers and develop, license, or acquire new features and capabilities to our platforms in a timely and cost-effective manner, or if such enhancements do not achieve market acceptance, our business, financial condition, results of operations, and prospects may suffer and our anticipated revenue growth may not be achieved. Because we derive, and expect to continue to derive, substantially all of our revenue from customers purchasing our platforms and products, market acceptance of these platforms and products, and any enhancements or changes thereto, is critical to our success. 19Table of ContentsThe competitive position of our platforms depends in part on their ability to operate with third-party products and services, and if we are not successful in maintaining and expanding the compatibility of our platforms with such third-party products and services, our business, financial condition, and results of operations could be adversely impacted. The competitive position of our platforms depends in part on their ability to operate with products and services of third parties, software services, and infrastructure, including but not limited to, in connection with our joint ventures, channel sales relationships, platform partnerships, strategic alliances, and other similar arrangements where applicable. As such, we must continuously modify and enhance our platforms to adapt to changes in, or to be integrated or otherwise compatible with, hardware, software, networking, browser, and database technologies. In the future, one or more technology companies may choose not to support the operation of their hardware, software, or infrastructure, or our platforms may not support the capabilities needed to operate with such hardware, software, or infrastructure. In addition, to the extent that a third party were to develop software or services that compete with ours, that provider may choose not to support one or more of our platforms. We intend to facilitate the compatibility of our platforms with various third-party hardware, software, and infrastructure by maintaining and expanding our business and technical relationships. If we are not successful in achieving this goal, our business, financial condition, and results of operations could be adversely impacted. If we fail to manage future growth effectively, our business could be harmed. Since our founding in 2003, we have experienced rapid growth. We operate in a growing market and have experienced, and may continue to experience, significant expansion of our operations. This growth has placed, and may continue to place, a strain on our employees, management systems, operational, financial, and other resources. As we have grown, we have increasingly managed larger and more complex deployments of our platforms and services with a broader base of government and commercial customers. As we continue to grow, we face challenges of integrating, developing, retaining, and motivating a rapidly growing employee base in various countries around the world. For example, our headcount has grown from 313 full-time employees as of December 31, 2010 to 3,838 full-time employees as of December 31, 2022, with employees located both in the United States and outside the United States. In the event of continued growth of our operations, our operational resources, including our information technology systems, our employee base, or our internal controls and procedures may not be adequate to support our operations and deployments. Managing our growth may require significant expenditures and allocation of valuable management resources, improving our operational, financial, and management processes and systems, and effectively expanding, training, and managing our employee base. If we fail to achieve the necessary level of efficiency in our organization as it grows, our business, financial condition, and results of operations would be harmed. As our organization continues to grow, we may find it increasingly difficult to maintain the benefits of our traditional company culture, including our ability to quickly respond to customers, and avoid unnecessary delays that may be associated with a formal corporate structure. This could negatively affect our business performance or ability to hire or retain personnel in the near- or long-term. In addition, our rapid growth may make it difficult to evaluate our future prospects. Our ability to forecast our future results of operations is subject to a number of uncertainties, including our ability to effectively plan for and model future growth. We have encountered in the past, and may encounter in the future, risks and uncertainties frequently experienced by growing companies with global operations in rapidly changing industries. If we fail to achieve the necessary level of efficiency in our organization as it grows, or if we are not able to accurately forecast future growth, our business, financial condition, and results of operations would be harmed. If we are unable to hire, retain, train, and motivate qualified personnel and senior management, including Alexander Karp, one of our founders and our Chief Executive Officer, and deploy our personnel and resources to meet customer demand around the world, our business could suffer. Our ability to compete in the highly competitive technology industry depends upon our ability to attract, motivate, and retain qualified personnel. We are highly dependent on the continued contributions and customer relationships of our management, and particularly on the services of Alexander Karp, our Chief Executive Officer. Mr. Karp was part of our founding team and has been integral to our growth since our founding. We believe that Mr. Karp’s management experience would be difficult to replace. All of our executive officers and many key personnel are at-will employees and may terminate their employment relationship with us at any time. The loss of the services of our key personnel and any of our other executive officers, and our inability to find suitable replacements, could result in a decline in sales, delays in product development, and harm to our business and operations. At times, we have experienced, and we may continue to experience, difficulty in hiring and retaining personnel with appropriate qualifications, and we may not be able to fill positions in a timely manner or at all. Our recruiting personnel, methodology, and approach may need to be altered to address a changing candidate pool and profile. We may not be able to identify or implement such changes in a timely manner. In addition, we may incur significant costs to attract and recruit skilled personnel, and we may lose new personnel to our competitors or other technology companies before we realize the benefit of our investment in recruiting and training them. As we move into new geographies, we will need to attract and recruit skilled personnel in those geographic areas, but it may be challenging for us to compete with traditional local employers in these regions for talent. If we 20Table of Contentsfail to attract new personnel or fail to retain and motivate our current personnel who are capable of meeting our growing technical, operational, and managerial requirements on a timely basis or at all, our business may be harmed. In addition, certain personnel may be required to receive various security clearances and substantial training in order to work on certain customer engagements or to perform certain tasks. Necessary security clearances may be delayed or unsuccessful, which may negatively impact our ability to perform on our U.S. and non-U.S. government contracts in a timely manner or at all. Our success depends on our ability to effectively source and staff people with the right mix of skills and experience to perform services for our customers, including our ability to transition personnel to new assignments on a timely basis. If we are unable to effectively utilize our personnel on a timely basis to fulfill the needs of our customers, our business could suffer. Further, if we are not able to utilize the talent we need because of increased regulation of immigration or work visas, including limitations placed on the number of visas granted, limitations on the type of work performed or location in which the work can be performed, and new or higher minimum salary requirements, it could be more difficult to staff our personnel on customer engagements and could increase our costs. We face intense competition for qualified personnel, especially engineering personnel, in major U.S. markets, where a large portion of our personnel are based, as well as in other non-U.S. markets where we have expanded or expect to expand our non-U.S. operations. We incur costs related to attracting, relocating, and retaining qualified personnel in these highly competitive markets, including leasing real estate in prime areas in these locations. Further, many of the companies with which we compete for qualified personnel have greater resources than we have. If the perceived value of our equity awards declines, or if the mix of equity and cash compensation that we offer is less attractive than that of our competitors, it may adversely affect our ability to recruit and retain highly skilled personnel. Additionally, laws and regulations, such as restrictive immigration laws, may limit our ability to recruit outside of the United States. We seek to retain and motivate existing personnel through our compensation practices, company culture, and career development opportunities. If we fail to attract new personnel or to retain our current personnel, our business and operations could be harmed. Volatility or lack of appreciation in the trading price of our Class A common stock may also affect our ability to attract and retain qualified personnel. Many of our senior personnel and other key personnel hold equity awards that have vested in part or are exercisable, which could adversely affect our ability to retain these personnel. Personnel may be more likely to leave us if the shares they own or the shares underlying their vested options or restricted stock units (“RSUs”) have significantly appreciated in value. In addition, many of our personnel may be able to receive significant proceeds from sales of our equity in the public markets, which may reduce their motivation to continue to work for us. Any of these factors could harm our business, financial condition, and results of operations. If we are unable to successfully build, expand, and deploy our marketing and sales organization in a timely manner, or at all, or to successfully hire, retain, train, and motivate our sales personnel, our growth and long-term success could be adversely impacted. We have a growing direct sales force and our sales efforts have historically depended on the significant direct involvement of our senior management team, including Mr. Karp. The successful execution of our strategy to increase our sales to existing customers, identify and engage new customers, and enter new U.S. and non-U.S. markets will depend, among other things, on our ability to successfully build and expand our sales organization and operations. Identifying, recruiting, training, and managing sales personnel requires significant time, expense, and attention, including from our senior management and other key personnel, which could adversely impact our business, financial condition, and results of operations in the short and long term. In order to successfully scale our unique sales model, we must, and we intend to continue to, increase the size of our direct sales force, both in the United States and outside of the United States, to generate additional revenue from new and existing customers while preserving the cultural and mission-oriented elements of our company. If we do not hire a sufficient number of qualified sales personnel, our future revenue growth and business could be adversely impacted. It may take a significant period of time before our sales personnel are fully trained and productive, particularly in light of our unique sales model, and there is no guarantee we will be successful in adequately training and effectively deploying our sales personnel. In addition, we have invested, and may need to continue investing, significant resources in our sales operations to enable our sales organization to run effectively and efficiently, including supporting sales strategy planning, sales process optimization, data analytics and reporting, and administering incentive compensation arrangements. Furthermore, hiring personnel in new countries requires additional setup and upfront costs that we may not recover if those personnel fail to achieve full productivity in a timely manner. Our business would be adversely affected if our efforts to build, expand, train, and manage our sales organization are not successful. We periodically change and make adjustments to our sales organization in response to market opportunities, competitive threats, management changes, product introductions or enhancements, acquisitions, sales performance, increases in sales headcount, cost levels, and other internal and external considerations. Any future sales organization changes may result in a temporary reduction of productivity, which could negatively affect our rate of growth. In addition, any significant change to 21Table of Contentsthe way we structure and implement the compensation of our sales organization may be disruptive or may not be effective and may affect our revenue growth. If we are unable to attract, hire, develop, retain, and motivate qualified sales personnel, if our new sales personnel are unable to achieve sufficient sales productivity levels in a reasonable period of time or at all, if our marketing programs are not effective or if we are unable to effectively build, expand, and manage our sales organization and operations, our sales and revenue may grow more slowly than expected or materially decline, and our business may be significantly harmed. Our ability to sell our platforms and satisfy our customers is dependent on the quality of our services, and our failure to offer high quality services could have a material adverse effect on our sales and results of operations. Once our platforms are deployed and integrated with our customers’ existing information technology investments and data, our customers depend on our O&M services to resolve any issues relating to our platforms. Increasingly, our platforms have been deployed in large-scale, complex technology environments, and we believe our future success will depend on our ability to increase sales of our platforms for use in such deployments. Further, our ability to provide effective ongoing services, or to provide such services in a timely, efficient, or scalable manner, may depend in part on our customers’ environments and their upgrading to the latest versions of our platforms and participating in our centralized platform management and services. In addition, our ability to provide effective services is largely dependent on our ability to attract, train, and retain qualified personnel with experience in supporting customers on platforms such as ours. The number of our customers has grown significantly, and that growth has and may continue to put additional pressure on our services teams. We may be unable to respond quickly enough to accommodate short-term increases in customer demand for our O&M services. We also may be unable to modify the future scope and delivery of our O&M services to compete with changes in the services provided by our competitors. Increased customer demand for support, without corresponding revenue, could increase costs and negatively affect our business and results of operations. In addition, as we continue to grow our operations and expand outside of the United States, we need to be able to provide efficient services that meet our customers’ needs globally at scale, and our services teams may face additional challenges, including those associated with operating the platforms and delivering support, training, and documentation in languages other than English and providing services across expanded time-zones. If we are unable to provide efficient O&M services globally at scale, our ability to grow our operations may be harmed, and we may need to hire additional services personnel, which could negatively impact our business, financial condition, and results of operations. Our customers typically need training in the proper use of and the variety of benefits that can be derived from our platforms to maximize the potential of our platforms. If we do not effectively deploy, update, or upgrade our platforms, succeed in helping our customers quickly resolve post-deployment issues, and provide effective ongoing services, our ability to sell additional products and services to existing customers could be adversely affected, we may face negative publicity, and our reputation with potential customers could be damaged. Many enterprise and government customers require higher levels of service than smaller customers. If we fail to meet the requirements of the larger customers, it may be more difficult to execute on our strategy to increase our penetration with larger customers. As a result, our failure to maintain high quality services may have a material adverse effect on our business, financial condition, results of operations, and growth prospects. If we are not able to maintain and enhance our brand and reputation, our relationships with our customers, partners, and employees may be harmed, and our business and results of operations may be adversely affected. We believe that maintaining and enhancing our brand identity and reputation is important to our relationships with, and to our ability to attract and retain customers, partners, investors, and employees. The successful promotion of our brand depends upon our ability to continue to offer high-quality software, maintain strong relationships with our customers, the community, and others, while successfully differentiating our platforms from those of our competitors. Unfavorable media coverage may adversely affect our brand and reputation. We anticipate that as our market becomes increasingly competitive, maintaining and enhancing our brand may become increasingly difficult and expensive. If we do not successfully maintain and enhance our brand identity and reputation, we may fail to attract and retain employees, customers, investors, or partners, grow our business, or sustain pricing power, all of which could adversely impact our business, financial condition, results of operations, and growth prospects. Additionally, despite our internal safeguards and efforts to the contrary, we cannot guarantee that our customers will not ultimately use our platforms for purposes inconsistent with our company values, and such uses may harm our brand and reputation. Our reputation and business may be harmed by news or social media coverage of Palantir, including but not limited to coverage that presents, or relies on, inaccurate, misleading, incomplete, or otherwise damaging information. Publicly available information regarding Palantir has historically been limited, in part due to the sensitivity of our work with customers or contractual requirements limiting or preventing public disclosure of certain aspects of our work or relationships with certain customers. As our business has grown and as interest in Palantir and the technology industry overall has increased and we have engaged more actively with media and marketing efforts, we have attracted, and may continue to attract, significant attention from news and social media outlets, including unfavorable coverage and coverage that is not directly 22Table of Contentsattributable to statements authorized by our leadership, that incorrectly reports on statements made by our leadership or employees and the nature of our work, perpetuates unfounded speculation about company involvements, or that is otherwise misleading. If such news or social media coverage presents, or relies on, inaccurate, misleading, incomplete, or otherwise damaging information regarding Palantir, such coverage could damage our reputation in the industry and with current and potential customers, employees, and investors, and our business, financial condition, results of operations, and growth prospects could be adversely affected. Due to the sensitive nature of our work and our confidentiality obligations and despite our ongoing efforts to provide increased transparency into our business, operations, and product capabilities, we may be unable to or limited in our ability to respond to such harmful coverage, which could have a negative impact on our business. Our relationships with government customers and customers that are engaged in certain sensitive industries, including organizations whose products or activities are or are perceived to be harmful, has resulted in public criticism, including from political and social activists, and unfavorable coverage in the media. Activists have also engaged in public protests at our properties. Activist criticism of our relationships with customers could potentially engender dissatisfaction among potential and existing customers, investors, and employees with how we address political and social concerns in our business activities. Conversely, being perceived as yielding to activism targeted at certain customers could damage our relationships with certain customers, including governments and government agencies with which we do business, whose views may or may not be aligned with those of political and social activists. Actions we take in response to the activities of our customers, up to and including terminating our contracts or refusing a particular product use case could harm our brand and reputation. In either case, the resulting harm to our reputation could: •cause certain customers to cease doing business with us; •impair our ability to attract new customers, or to expand our relationships with existing customers; •diminish our ability to recruit, hire, or retain employees; •undermine our standing in professional communities to which we contribute and from which we receive expert knowledge; or •prompt us to cease doing business with certain customers.Any of these factors could adversely impact our business, financial condition, and results of operations. Because we recognize a substantial portion of our revenue from our platforms and O&M services over the contractual term, downturns or upturns in new sales and renewals may not be immediately reflected in our results of operations. We generally recognize revenue from our platforms and O&M services over the contractual term. As a result, a portion of the revenue we recognize in each quarter is derived from customer contracts generally entered into during previous periods. Consequently, a decline in new or renewed contracts in any single quarter may have an immaterial impact on the revenue that we recognize for that quarter. However, such a decline would negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in sales or renewals, significant customer terminations, and potential changes in our contracting terms and pricing policies would not be fully reflected in our results of operations until future periods. The timing of our revenue recognition model also makes it difficult for us to rapidly increase our revenue through additional sales in any given period, as revenue is generally recognized over the applicable contractual term. Our pricing structures for our platforms and services change from time to time, which could adversely impact our business, financial condition, and results of operations. We have in the past changed, and we expect that in the future we may change, our pricing models, including as a result of competition, global economic conditions, general reductions in our customers’ spending levels, pricing studies, or changes in how our platforms are broadly consumed. Similarly, as we introduce new products and services, or as a result of the evolution of our existing platforms and services, we may have difficulty determining the appropriate price structure for our products and services, or customers may request or demand different pricing structures. In addition, as new and existing competitors introduce new products or services that compete with ours, or revise their pricing structures, we may be unable to attract new customers at the same price or based on the same pricing model as we have used historically. Moreover, as we continue to target selling our platforms and services to larger organizations, these larger organizations may demand different pricing structures or substantial price concessions. As we expand access to our products to increasingly broad swaths of the market, our pricing model and product and service offerings for such customers have been, and will continue to be, tailored to be attractive for such customers. In addition, we may need to change pricing policies to accommodate government pricing guidelines for our contracts with federal, state, local, and foreign governments and government agencies. If we are unable to modify or develop pricing models and strategies that are attractive to existing and prospective customers, while enabling us to significantly grow our sales and revenue relative to our associated costs and expenses in a reasonable period of time, our business, financial condition, and results of operations may be adversely impacted. 23Table of ContentsIf our customers are not able or willing to accept our product-based business model, instead of a labor-based business model, our business and results of operations could be negatively impacted. Our platforms are generally offered on a productized basis to minimize our customers’ overall cost of acquisition, maintenance, and deployment time of our platforms. Many of our customers and potential customers are instead generally familiar with the practice of purchasing or licensing software through labor contracts, where custom software is written for specific applications, the intellectual property in such software is often owned by the customer, and the software typically requires additional labor contracts for modifications, updates, and services during the life of that specific software. Customers may be unable or unwilling to accept our model of commercial software procurement. Should our customers be unable or unwilling to accept this model of commercial software procurement, our growth could be materially diminished, which could adversely impact our business, financial condition, results of operations, and growth prospects. We have entered into, and expect in the future to enter into, agreements with our customers that include exclusivity arrangements or unique contractual, pricing, or payment terms, which may result in significant risks or liabilities to us. Our contracts with our customers are typically non-exclusive, but we have historically entered into arrangements with our customers and our partners that include exclusivity provisions, and we expect to continue to do so in the future. These exclusivity provisions limit our ability to license our platforms and provide services to specific customers, or to compete in certain geographic markets and industries, which may limit our growth and negatively impact our results. In addition, we have entered into joint ventures and strategic alliances with our customers, as described below, which also limit our ability to compete in certain geographic markets or industry verticals. We have entered into and may continue to enter into, in limited circumstances, unique contractual, pricing, and payment arrangements with our customers, including some that may be outside of our typical scope of business, including arrangements relating to non-cash items. We face intense competition in our markets, and we may lack sufficient financial or other resources to maintain or improve our competitive position. The markets for our platforms are very competitive, and we expect such competition to continue or increase in the future. A significant number of companies are developing products that currently, or in the future may, compete with some or all aspects of our proprietary platforms. We may not be successful in convincing the management teams of our potential customers to deploy our platforms in lieu of existing software solutions or in-house software development projects often favored by internal IT departments or other competitive products and services. In addition, our competitors include large enterprise software companies, government contractors, and system integrators, and we may face competition from emerging companies as well as established companies who have not previously entered this market. Additionally, we may be required to make substantial additional investments in our research, development, services, marketing, and sales functions in order to respond to competition, and there can be no assurance that we will be able to compete successfully in the future. Many of our existing competitors have, and some of our potential competitors could have, substantial competitive advantages such as: •greater name recognition, longer operating histories, and larger customer bases; •larger sales and marketing budgets and resources and the capacity to leverage their sales efforts and marketing expenditures across a broader portfolio of products; •broader, deeper, or otherwise more established relationships with technology, channel and distribution partners, and customers; •wider geographic presence or greater access to larger potential customer bases; •greater focus in specific geographies; •lower labor and research and development costs; •larger and more mature intellectual property portfolios; and •substantially greater financial, technical, and other resources to provide services, to make acquisitions, and to develop and introduce new products and capabilities.In addition, some of our larger competitors have substantially broader and more diverse product and service offerings and may be able to leverage their relationships with distribution partners and customers based on other products or incorporate functionality into existing products to gain business in a manner that discourages customers from purchasing our platforms, including by selling at zero or negative margins, product bundling, or offering closed technology platforms. Potential customers may also prefer to purchase from their existing provider rather than a new provider regardless of platform performance or 24Table of Contentsfeatures. As a result, even if the features of our platforms offer advantages that others do not, customers may not purchase our platforms. These larger competitors often have broader product lines and market focus or greater resources and may therefore not be as susceptible to economic downturns or other significant reductions in capital spending by customers. If we are unable to sufficiently differentiate our platforms from the integrated or bundled products of our competitors, such as by offering enhanced functionality, performance, or value, we may see a decrease in demand for those platforms, which could adversely affect our business, financial condition, and results of operations. In addition, new, innovative start-up companies and larger companies that are making significant investments in research and development may introduce products that have greater performance or functionality, are easier to implement or use, incorporate technological advances that we have not yet developed, or implemented or may invent similar or superior platforms and technologies that compete with our platforms. Our current and potential competitors may also establish cooperative relationships among themselves or with third parties that may further enhance their resources. Some of our competitors have made or could make acquisitions of businesses that allow them to offer more competitive and comprehensive solutions. As a result of such acquisitions, our current or potential competitors may be able to accelerate the adoption of new technologies that better address customer needs, devote greater resources to bring these products and services to market, initiate or withstand substantial price competition, or develop and expand their product and service offerings more quickly than we do. These competitive pressures in our market, or our failure to compete effectively, may result in fewer orders, reduced revenue and margins, and loss of market share. In addition, it is possible that industry consolidation may impact customers’ perceptions of the viability of smaller or even mid-size software firms and consequently customers’ willingness to purchase from such firms. We may not compete successfully against our current or potential competitors. If we are unable to compete successfully, or if competing successfully requires us to take costly actions in response to the actions of our competitors, our business, financial condition and results of operations could be adversely affected. In addition, companies competing with us may have an entirely different pricing or distribution model. Increased competition could result in fewer customer orders, price reductions, reduced margins, and loss of market share, any of which could harm our business and results of operations. Our culture emphasizes rapid innovation and advancement of successful hires who may in some cases have limited prior industry expertise and prioritizes customer outcomes over short-term financial results, and if we cannot maintain or properly manage our culture as we grow, our business may be harmed. We have a culture that encourages employees to quickly develop and launch key technologies and platforms intended to solve our customers’ most important problems and prioritizes the advancement of employees to positions of significant responsibility based on merit despite, in some cases, limited prior work or industry experience. Much of our hiring into technical roles comes through our internship program or from candidates joining us directly from undergraduate or graduate engineering programs rather than industry hires. Successful entry-level hires are often quickly advanced and rewarded with significant responsibilities, including in important customer-facing roles as project managers, development leads, and product managers. Larger competitors, such as defense contractors, system integrators, and large software and service companies that traditionally target large enterprises typically have more sizeable direct sales forces staffed by individuals with significantly more industry experience than our customer-facing personnel, which may negatively impact our ability to compete with these larger competitors. We have historically operated with a relatively flat reporting and organization structure and have few formal promotions. As our business grows and becomes more complex, the staffing of customer-facing personnel, some of whom may have limited industry experience, may result in unintended outcomes or in decisions that are poorly received by customers or other stakeholders. For example, in many cases we launch, at our expense, pilot deployments with customers without a long-term contract in place, and some of those deployments have not resulted in the customer’s adoption or expansion of its use of our platforms and services, or the generation of significant, or any, revenue or payments. In addition, as we continue to grow, including geographically, we may find it difficult to maintain our culture. Our culture also prioritizes customer outcomes over short-term financial results, and we frequently make service and product decisions that may reduce our short-term revenue or cash flow if we believe that the decisions are consistent with our mission and responsive to our customers’ goals and thereby have the potential to improve our financial performance over the long term. These decisions may not produce the long-term benefits and results that we expect or may be poorly received in the short term by the public markets, in which case our customer growth and our business, financial condition, and results of operations may be harmed. We may not enter into relationships with potential customers if we consider their activities to be inconsistent with our organizational mission or values. We generally do not enter into business with customers or governments whose positions or actions we consider inconsistent with our mission to support Western liberal democracy and its strategic allies. Our decisions to not enter into these relationships 25Table of Contentsmay not produce the long-term financial benefits and results that we expect, in which case our growth prospects, business, and results of operations could be harmed. Although we endeavor to do business with customers and governments that are aligned with our mission and values, we cannot predict how the activities and values of our government and private sector customers will evolve over time, and they may evolve in a manner inconsistent with our mission. We do not work with the Chinese communist party and have chosen not to host our platforms in China, which may limit our growth prospects. Our leadership believes that working with the Chinese communist party is inconsistent with our culture and mission. We do not consider any sales opportunities with the Chinese communist party, do not host our platforms in China, and impose limitations on access to our platforms in China in order to protect our intellectual property, to promote respect for and defend privacy and civil liberties protections, and to promote data security. Our decision to avoid this large potential market may limit our growth prospects and could adversely impact our business, results of operations, and financial condition, and we may not compete successfully against our current or potential competitors who choose to work in China. Joint ventures, channel sales relationships, platform partnerships, and strategic alliances may have a material adverse effect on our business, results of operations and prospects. We expect to continue to enter into joint ventures, channel sales relationships (including original equipment manufacturer (“OEM”) and reseller relationships), platform partnerships, and strategic alliances as part of our long-term business strategy. Joint ventures, channel sales relationships, platform partnerships, strategic alliances, and other similar arrangements involve significant investments of both time and resources, and there can be no assurances that they will be successful. They may present significant challenges and risks, including that they may not advance our business strategy, we may get an unsatisfactory return on our investment or lose some or all of our investment, they may distract management and divert resources from our core business, including our business development and product development efforts, they may expose us to unexpected liabilities, they may conflict with our increased sales hiring and direct sales strategy, or we may choose a partner that does not cooperate as we expect them to and that fails to meet its obligations or that has economic, business, or legal interests or goals that are inconsistent with ours. For example, in January 2021, we entered into a channel sales relationship with International Business Machines Corporation (“IBM”), pursuant to which IBM is supplying a new product leveraging certain components of Foundry integrated with IBM’s Cloud Pak for Data. In addition, in November 2019, we created a jointly controlled entity in Japan with SOMPO Holdings, Inc., in which we subsequently obtained a controlling interest in November 2022. For more information see Note 14. Business Combinations in the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. We also created a jointly-owned entity in South Korea with HD Hyundai Co. Ltd. in December 2022 in which we also have a controlling interest. We believe these arrangements offer our business strategic operational advantages within the Japanese and Korean markets, but they also limit our ability to independently sell our platforms, provide certain services, engage certain customers, or compete in the Japanese and Korean markets or related industry verticals, which in turn limits our opportunities for growth in Japan and Korea and, depending on the success of each respective entity, may negatively impact our results. Additionally, in 2016, we entered into a partnership with Airbus that, over time, developed into the Skywise platform partnership, which provides our business strategic advantages but also limits our ability to independently provide our platforms to certain airlines and companies that compete with Airbus. Entry into certain joint ventures, channel sales relationships, platform partnerships, or strategic alliances now or in the future may be subject to government regulation, including review by U.S. or foreign government entities related to foreign direct investment. If a joint venture or similar arrangement were subject to regulatory review, such regulatory review might limit our ability to enter into the desired strategic alliance and thus our ability to carry out our long-term business strategy. As our joint ventures, channel sales relationships, platform partnerships, and strategic alliances come to an end or terminate, we may be unable to renew or replace them on comparable terms, or at all. When we enter into joint ventures, channel sales relationships, platform partnerships, and strategic alliances, our partners may be required to undertake some portion of sales, marketing, implementation services, engineering services, or software configuration that we would otherwise provide. In such cases, our partner may be less successful than we would have otherwise been absent the arrangement and our ability to influence, or have visibility into, the sales, marketing, and related efforts of our partners may be limited. In the event we enter into an arrangement with a particular partner, we may be less likely (or unable) to work with one or more direct competitors of our partner with which we would have worked absent the arrangement. We may have interests that are different from our joint venture partners and/or which may affect our ability to successfully collaborate with a given partner. Similarly, one or more of our partners in a joint venture, channel sales relationship, platform partnership, or strategic alliance may independently suffer a bankruptcy or other economic hardship that negatively affects its ability to continue as a going concern or successfully perform on its obligation under the arrangement. In addition, customer satisfaction with our products provided in connection with these arrangements may be less favorable than anticipated, negatively impacting anticipated revenue growth and results of operations of arrangements in question. Further, some of our strategic partners offer competing products and services or work with our competitors. As a result of these and other factors, many of the companies with which we have or are seeking joint ventures, channel sales relationships, platform partnerships, or strategic alliances may choose to pursue alternative technologies and 26Table of Contentsdevelop alternative products and services in addition to or in lieu of our platforms, either on their own or in collaboration with others, including our competitors. If we are unsuccessful in establishing or maintaining our relationships with these partners, our ability to compete in a given marketplace or to grow our revenue would be impaired, and our results of operations may suffer. Even if we are successful in establishing and maintaining these relationships with our partners, we cannot assure you that these relationships will result in increased customer usage of our platforms or increased revenue. Additionally, if our partners’ brand, reputation, or products are negatively impacted in any way, that could impact our expected outcomes in those markets.Further, winding down joint ventures, channel sales relationships, platform partnerships, or other strategic alliances can result in additional costs, litigation, and negative publicity. Any of these events could adversely affect our business, financial condition, results of operations, and growth prospects. If we are not successful in executing our sales strategy, our results of operations may suffer. An important part of our growth strategy is to increase sales of our platforms to large enterprises and government entities. Sales to large enterprises and government entities involve risks that may not be present (or that are present to a lesser extent) with sales to small-to-mid-sized entities. These risks include: •increased leverage held by large customers in negotiating contractual arrangements with us; •changes in key decision makers within these organizations that may negatively impact our ability to negotiate in the future; •customer IT departments may perceive that our platforms and services pose a threat to their internal control and advocate for legacy or internally developed solutions over our platforms; •resources may be spent on a potential customer that ultimately elects not to purchase our platforms and services; •more stringent requirements in our service contracts, including stricter service response times, and increased penalties for any failure to meet service requirements; •increased competition from larger competitors, such as defense contractors, system integrators, or large software and service companies that traditionally target large enterprises and government entities and that may already have purchase commitments from those customers; and •less predictability in completing some of our sales than we do with smaller customers.Large enterprises and government entities often undertake a significant evaluation process that results in a lengthy sales cycle, in some cases over twelve months, requiring approvals of multiple management personnel and more technical personnel than would be typical of a smaller organization. Due to the length, size, scope, and stringent requirements of these evaluations, we typically provide short-term pilot deployments of our platforms at no or low cost initially. We sometimes spend substantial time, effort, and money in our sales efforts without producing any sales. The success of the investments that we make in the earlier stages of our sales cycle depends on factors such as our ability to identify potential customers for which our platforms have an opportunity to add significant value to the customer’s organization, our ability to identify and agree with the potential customer on an appropriate pilot deployment to demonstrate the value of our platforms, and whether we successfully execute on such pilot deployment. Even if the pilot deployment is successful, we or the customer could choose not to enter into a larger contract for a variety of reasons. For example, product purchases by large enterprises and government entities are frequently subject to budget constraints, leadership changes, multiple approvals, and unplanned administrative, processing, and other delays, any of which could significantly delay or entirely prevent our realization of sales. Finally, large enterprises and government entities typically (i) have longer implementation cycles, (ii) require greater product functionality and scalability and a broader range of services, including design services, (iii) demand that vendors take on a larger share of risks, (iv) sometimes require acceptance provisions that can lead to a delay in revenue recognition, (v) typically have more complex IT and data environments, and (vi) expect greater payment flexibility from vendors. Customers, and sometimes we, may also engage third parties to be the users of our platforms, which may result in contractual complexities and risks, require additional investment of time and human resources to train the third parties and allow third parties (who may be building competitive projects or engaging in other competitive activities) to influence our customers’ perception of our platforms. All these factors can add further risk to business conducted with these customers. If sales expected from a large customer for a particular quarter are not realized in that quarter or at all, our business, financial condition, results of operations, and growth prospects could be materially and adversely affected. In addition, part of our growth strategy involves supporting a broader set of potential customers. Sales to such customers involve risks that vary from those present with sales to large or otherwise established organizations, due to their limited operating history, limited resources for adopting new technologies, and uncertain resources for future operations, among other things. Accordingly, we will continue to refine our business strategy and pricing structures to attract and retain such customers, 27Table of Contentsas well as existing and larger customers across the potential customer base. There is no guarantee that our existing or proposed business strategies, including subscription-based or usage-based pricing structures, will achieve broad adoption by current or prospective customers or be appropriately structured to attract and retain other potential customers across the customer base. If we are not successful in executing our sales strategy, our business, financial condition, results of operations, and growth prospects could be adversely affected.The ongoing global COVID-19 pandemic, ongoing Russia-Ukraine conflict, and related challenging macroeconomic conditions may adversely affect our business and operations, and the duration and extent to which these factors may impact our future business, financial condition, and results of operations remain uncertain. While the ongoing COVID-19 pandemic and the ongoing Russia-Ukraine conflict have provided certain new opportunities for our business to expand, they have also created many negative headwinds that present risks to our business and results of operations. The ongoing COVID-19 pandemic, the ongoing Russia-Ukraine conflict, and related challenging macroeconomic conditions have generally disrupted the operations of our customers and prospective customers, and may continue to disrupt their operations, including as a result of widespread supply chain disruptions, increases in the prices of many goods and services, uncertainty in the financial markets or other harm to their business and financial results. Challenging macroeconomic conditions could decrease information technology budgets for our customers and prospective customers; adversely affect demand for our platform and services; cause one or more of our customers or partners to file for bankruptcy protection or go out of business; cause one or more of our customers to fail to renew, terminate, or seek to renegotiate their contracts with us; cause delayed purchasing decisions, longer sales cycles, extended or alternative payment terms or delayed payments; impact our ability to attract new customers on similar contractual terms or at all, or retain and expand our relationships with existing customers; and result in postponed or canceled projects, all of which would negatively impact our business, financial condition, and results of operations, including sales and cash flows. For example, one of our early-stage Investee (as defined below) customers filed for bankruptcy in 2022 and we may not realize the full value of our commercial contract with that customer as a result. It is not possible at this time to estimate the full impact that the COVID-19 pandemic, Russia-Ukraine conflict, and related challenging macroeconomic conditions will have on our business, as the impact will depend on future developments, which are highly uncertain and cannot be predicted. We cannot guarantee that it will not be materially negative.In addition, as a result of the COVID-19 pandemic and the related work and travel restrictions, many of our field sales, operations and maintenance, and professional services activities were conducted remotely, and a majority of our workforce worked remotely. We have reopened our offices and have allowed business travel to resume, but some of our employees will continue to work remotely. We have a limited history of operating with a hybrid workforce. There is no guarantee that we will realize any anticipated benefits to our business from this model, including cost savings, operational efficiencies, or productivity. It is also possible that remote work arrangements may have a negative impact on our operations; the execution of our business plans; our ability to recruit, train, manage, and retain employees; our ability to maintain and strengthen our company culture; the productivity and availability of key personnel and other employees necessary to conduct our business; and on third-party service providers who perform critical services for us, or otherwise cause operational failures due to changes in our normal business practices. If a natural disaster, power outage, connectivity issue or other event occurred that impacted our employees’ ability to work remotely, it may be difficult or, in certain cases, impossible, for us to continue our business for a substantial period of time. The increase in remote working may also result in increased consumer privacy, data security, and fraud risks, and our understanding of applicable legal and regulatory requirements, as well as the latest guidance from regulatory authorities may be subject to legal or regulatory challenge, particularly as regulatory guidance evolves in response to future developments. If we are unable to successfully address the foregoing risks and challenges as we encounter them, our business and operations could be adversely affected.Moreover, to the extent the ongoing COVID-19 pandemic, the ongoing Russia-Ukraine conflict, and related challenging macroeconomic conditions adversely affect our business, financial condition, and results of operations, these events, alone or in combination, may also have the effect of heightening many of the other risks described in this “Risk Factors” section, including but not limited to, those related to our ability to increase sales to existing and new customers, continue to perform on existing contracts, develop and deploy new technologies, expand our marketing capabilities and sales organization, generate sufficient cash flow to service our indebtedness, volatility in the trading price of our Class A common stock and comply with the covenants in the agreements that govern our indebtedness. If the market for our platforms and services develops more slowly than we expect, our growth may slow or stall, and our business, financial condition, and results of operations could be harmed. The market for our platforms is rapidly evolving. Our future success will depend in large part on the growth and expansion of this market, which is difficult to predict and relies on a number of factors, including customer adoption, customer demand, changing customer needs, the entry of competitive products, the success of existing competitive products, potential customers’ willingness to adopt an alternative approach to data collection, storage, and processing and their willingness to invest in new 28Table of Contentssoftware after significant prior investments in legacy data collection, storage, and processing software. The estimates and assumptions that are used to calculate our market opportunity are subject to change over time, and there is no guarantee that any particular number or percentage of the organizations covered by our market opportunity estimates will pay for our platforms and services at all or generate any particular level of revenue for us. Even if the market in which we compete meets the size estimates and growth forecasts, our business could fail to grow at the levels we expect or at all for a variety of reasons outside our control, including competition in our industry. Further, if we or other data management and analytics providers experience security breaches or incidents, loss, corruption, or unavailability of or unauthorized access to customer data, disruptions in delivery, or other problems, this market as a whole, including our platforms, may be negatively affected. If software for the challenges that we address does not achieve widespread adoption, or there is a reduction in demand caused by a lack of customer acceptance, technological challenges, weakening economic conditions (including due to the ongoing COVID-19 pandemic, the ongoing Russia-Ukraine conflict and related economic sanctions, rising inflation and interest rates, and monetary policy changes), security or privacy concerns, competing technologies and products, decreases in corporate spending, or otherwise, or, alternatively, if the market develops but we are unable to continue to penetrate it due to the cost, performance, and perceived value associated with our platforms, or other factors, it could result in decreased revenue and our business, financial condition, and results of operations could be adversely affected. We will face risks associated with the growth of our business in new commercial markets and with new customer verticals, and we may neither be able to continue our organic growth nor have the necessary resources to dedicate to the overall growth of our business. We plan to continue to expand our operations in new commercial markets, including those where we may have limited operating experience, and may be subject to increased business, technology and economic risks that could affect our financial results. In recent periods, we have increased our focus on commercial customers. In the future, we may increasingly focus on such customers, including in the banking, financial services, healthcare, pharmaceutical, manufacturing, telecommunication, automotive, airlines and aerospace, consumer packaged goods, insurance, retail, transportation, shipping and logistics, energy, and other emerging industries. Entering new verticals and expanding in the verticals in which we are already operating will continue to require significant resources and there is no guarantee that such efforts will be successful or beneficial to us. Historically, sales to new customers have often led to additional sales to the same customers or similarly situated customers. As we expand into and within new and emerging markets and heavily regulated industry verticals, we will likely face additional regulatory scrutiny, risks, and burdens from the governments and agencies which regulate those markets and industries. While this approach to expansion within new commercial markets and verticals has proven successful in the past, it is uncertain we will achieve the same penetration and organic growth in the future and our reputation, business, financial condition, and results of operations could be negatively impacted. In the future, we may not be able to secure the financing necessary to operate and grow our business as planned, or to make acquisitions. In the future, we may seek to raise or borrow additional funds to expand our product or business development efforts, make acquisitions or otherwise fund or grow our business and operations. During April 2021, we fully repaid the outstanding term loans in an aggregate principal amount of $200.0 million and mutually agreed with the lenders and other applicable parties under our revolving credit facility to amend our credit facility to, among other things, increase the commitments under the revolving credit facility by $200.0 million, for total revolving commitments of $400.0 million. In March 2022, our revolving credit facility was further amended to, among other things, extend the maturity date of the revolving loan facility and increase the commitments under the revolving credit facility by $100.0 million, and in July 2022, our revolving credit facility was further amended to, among other things, provide a new incremental delayed draw term loan (“DDTL”) commitment in an aggregate principal amount of $450.0 million, upon the terms and conditions set forth in the credit agreement, as amended, with new and existing lenders. The DDTL commitment is available to draw upon through July 1, 2023 and any drawn amounts will mature on March 31, 2027. The existing revolving credit facility, as amended, matures in March 2027. The DDTL commitment together with our existing revolving commitments under our credit facility, as amended, provides for total commitments of up to $950.0 million, all of which are undrawn as of the date of this Annual Report on Form 10-K. Any interest or facility payments are due and payable quarterly or more or less frequently in certain circumstances. Additional equity or debt financing may not be available on favorable terms, or at all. Historically, we have funded our operations and capital expenditures primarily through equity issuances, proceeds from option exercises, and payments received from our customers. Although we currently anticipate that our existing cash and cash equivalents will be sufficient to meet our cash needs for at least the next twelve months, we may require additional financing, and we may not be able to obtain debt or equity financing on favorable terms, if at all. If we raise equity financing to fund operations or on an opportunistic basis, our stockholders may experience significant dilution of their ownership interests. If adequate funds are not available on acceptable terms, or at all, we may be unable to, among other things: •develop new products, features, capabilities, and enhancements; •continue to expand our product development, sales, and marketing organizations; 29Table of Contents•recruit, hire, train, and retain employees; •respond to competitive pressures or unanticipated working capital requirements; or •pursue acquisition or other growth or investment opportunities.Our inability to take any of these actions because adequate funds are not available on acceptable terms could have an adverse impact on our business, financial condition, results of operations, and growth prospects. Our debt agreements contain restrictions that may limit our flexibility in operating our business. Our credit agreement and related documents, including our pledge and security agreements, contain, and instruments governing any future indebtedness of ours would likely contain, a number of covenants that will impose significant operating and financial restrictions on us, including restrictions on our ability to, among other things: •create liens on certain assets; •incur additional debt; •consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; •sell certain assets; •pay dividends on or make distributions in respect of our capital stock; •place restrictions on certain activities of subsidiaries; •transact with our affiliates; and •use a portion of our cash resources.Any of these restrictions could limit our ability to plan for or react to market conditions and could otherwise restrict corporate activities. Any failure to comply with these covenants could result in a default under our credit facility or instruments governing any future indebtedness of ours. Additionally, our credit facility is secured by substantially all of our assets. Upon a default, unless waived, the lenders under our credit facility could elect to terminate their commitments and cease making further loans, and, when amounts are outstanding, foreclose on our assets pledged to such lenders to secure our obligations under our credit agreement and force us into bankruptcy or liquidation. In addition, a default under our credit facility could trigger a cross default under agreements governing any future indebtedness. If we experience a default under our credit facility or instruments governing our future indebtedness, our business, financial condition, and results of operations may be adversely impacted. In addition, a portion of our cash is pledged as cash collateral for letters of credit and bank guarantees which support certain of our real estate leases, customer contracts, and other guarantees and financing obligations. While these obligations remain outstanding and are cash collateralized, we do not have access to and cannot use the pledged cash for our operations or to repay our other indebtedness. As of December 31, 2022, we were in compliance with all covenants and restrictions associated with our credit facility. Variable rate indebtedness that we may incur under our credit facility will subject us to interest rate risk, which could cause our debt service obligations to increase significantly. As of December 31, 2022, no borrowings were outstanding under our credit facility. Any borrowings under the credit facility bear interest at variable rates, which exposes us to interest rate risk. Our loans under our credit facility would incur interest at the Secured Overnight Financing Rate (“SOFR”) as administered by the Federal Reserve Bank of New York, or a successor administrator of the SOFR (or the applicable benchmark replacement) plus 2.00% or a base rate plus 1.00%, subject to certain adjustments, and is payable quarterly or more or less frequently in certain circumstances.We have invested in, and may in the future acquire or invest in, companies and technologies, which may divert our management’s attention, and result in additional dilution to our stockholders. We may be unable to integrate acquired businesses and technologies successfully or achieve the expected benefits of such acquisitions or investments. We are subject to risks associated with our investments, including a partial or complete loss of invested capital.As part of our business strategy, we have engaged in strategic transactions and alternative investments in the past and expect to evaluate and consider potential strategic transactions, including acquisitions of, or investments in, businesses, technologies, services, products and other assets in the future. We also may enter into relationships with other businesses to complement or expand our products or our ability to provide services. An acquisition, investment or business relationship may result in unforeseen risks, operating difficulties and expenditures, including the following: 30Table of Contents•any such transactions may negatively affect our financial results because it may require us to incur charges or assume substantial debt or other liabilities, may cause adverse tax consequences or unfavorable accounting treatment, may expose us to claims and disputes by third parties, including intellectual property claims and disputes, or may not generate sufficient financial return to offset additional costs and expenses related to such transactions; •costs and potential difficulties associated with the requirement to test and assimilate the internal control processes of the acquired business; •we may encounter difficulties or unforeseen expenditures assimilating or integrating the businesses, technologies, infrastructure, products, personnel, or operations of the acquired companies, particularly if the key personnel of the acquired company choose not to work for us or if we are unable to retain key personnel, if their technology is not easily adapted to work with ours, or if we have difficulty retaining the customers of any acquired business due to changes in ownership, management, or otherwise; •we may not realize the expected benefits of the transaction; •an acquisition may disrupt our ongoing business, divert resources, increase our expenses, result in unfavorable public perception, and distract our management; •an acquisition may result in a delay or reduction of customer purchases for both us and the company acquired due to customer uncertainty about continuity and effectiveness of service from either company; •the potential impact on relationships with existing customers, vendors, and distributors as business partners as a result of acquiring another company or business that competes with or otherwise is incompatible with those existing relationships;•the potential that our due diligence of the applicable company or business does not identify significant problems or liabilities, or that we underestimate the costs and effects of identified liabilities; •exposure to litigation or other claims in connection with, or inheritance of claims or litigation risk as a result of, the transaction, including but not limited to claims from former employees, customers, or other third parties, which may differ from or be more significant than the risks our business faces; •potential goodwill impairment charges related to acquisitions; •we may encounter difficulties in, or may be unable to, successfully sell any acquired products; •the transaction may involve the entry into geographic or business markets in which we have little or no prior experience or where competitors have stronger market positions; •an acquisition may require us to comply with additional laws and regulations, or to engage in substantial remediation efforts to cause the acquired company to comply with applicable laws or regulations, or result in liabilities resulting from the acquired company’s failure to comply with applicable laws or regulations; •our use of cash to pay for the transaction would limit other potential uses for our cash; •if we incur debt to fund such a transaction, such debt may subject us to material restrictions on our ability to conduct our business as well as financial maintenance covenants; and •to the extent that we issue a significant amount of equity securities in connection with such transactions, existing stockholders may be diluted and earnings per share may decrease.We have made and may continue to make strategic investments pursuant to certain approved agreements (“Investment Agreements”) to purchase, or commit to purchase, securities of various entities, including special purpose acquisition companies and/or other privately-held or publicly-traded entities (each, an “Investee” and such purchases, the “Investments”). However, we do not currently anticipate entering into new Investment Agreements to purchase, or commit to purchase, securities of special purpose acquisition companies.Additionally, in connection with approving and signing the Investment Agreements, we and each Investee or an associated entity entered into a commercial contract for access to our products and services (collectively, the “Strategic Commercial Contracts”). As of December 31, 2022, the terms of such Strategic Commercial Contracts, including contractual options, range from three to eight years, and are subject to termination for cause provisions. The total value of such Strategic Commercial Contracts as of December 31, 2022 was $492.7 million, inclusive of $63.7 million of contractual options. When determining the total value of such Strategic Commercial Contracts, we assess customers’ financial condition, including the consideration of their ability and intention to pay, and whether all or some portion of the value of the contracts continue to meet the criteria for revenue recognition, among other factors. As a result of these assessments, the above $492.7 million of total value of Strategic Commercial Contracts excludes an aggregate of $262.2 million of the value of certain contracts when compared to amounts as of September 30, 2022. Certain companies with which we have entered into commercial contracts have been, and may continue 31Table of Contentsto be, unable to generate sufficient revenues or profitability or to access any necessary financing or funding in a timely manner or on favorable terms to them, which has negatively impacted, and may continue to negatively impact, our expected revenue and collections. These companies are generally engaged in businesses that involve novel and unproven technologies, products, and services and such companies have been, and may continue to be, unable to perform all or some of their obligations under any commercial contracts that we enter into with them in a timely manner or at all. For example, one of our early-stage Investee customers filed for bankruptcy in 2022, and the remaining value of the commercial contract with such customer that is not expected to be recognized as revenue has been excluded from the total value of Strategic Commercial Contracts above. As of December 31, 2022, the cumulative amount of revenue recognized from Strategic Commercial Contracts was $166.6 million, of which $118.4 million was recognized by us during the fiscal year ended December 31, 2022.Our ability to sell or transfer, or realize value from our Investments may be limited by applicable securities laws and regulations, including the requirement that offers or sales of securities must be registered with the SEC pursuant to applicable laws or qualify for an exemption from such registration, and our ability to liquidate and realize value from our Investments may be negatively and materially impacted by any delays or limitations on our ability to offer, sell, or transfer our Investments. In addition, our Investments are speculative in nature and may be volatile or decline in value or be entirely lost. We have realized, and may continue to realize, losses related to these marketable securities, which could have a negative impact on our future financial position, results of operations, earnings per share, and cash flows.The occurrence of any of these risks could have a material adverse effect on our business, results of operations, and financial condition. Moreover, we cannot assure you that we would not be exposed to unknown liabilities. Risks Related to Intellectual Property, Information Technology, Data Privacy, and SecurityIf any of the systems of any third parties upon which we rely, our customers’ cloud or on-premises environments, or our internal systems, are breached or if unauthorized access to customer or third-party data is otherwise obtained, public perception of our platforms and O&M services may be harmed, and we may lose business and incur losses or liabilities. Our success depends in part on our ability to provide effective data security protection in connection with our technology platforms and services, and we rely on information technology networks and systems to securely store, transmit, index, and otherwise process electronic information. Because our platforms and services are used by our customers to store, transmit, index, or otherwise process and analyze large data sets that often contain proprietary, confidential, and/or sensitive information (including in some instances personal or identifying information and personal health information), our software is perceived as an attractive target for attacks by computer hackers or others seeking unauthorized access, and our software faces threats of unintended exposure, exfiltration, alteration, deletion, loss, or unavailability of data. Additionally, because many of our customers use our platforms to store, transmit, and otherwise process proprietary, confidential, or sensitive information, and complete mission critical tasks, they have a lower risk tolerance for security vulnerabilities in our platforms and services than for vulnerabilities in other, less critical, software products and services. Our platforms and services operate in conjunction with, and we are dependent upon, third-party products and components across a broad ecosystem, including our customer environments. There have been and may continue to be significant attacks on certain third-party providers, and we cannot guarantee that our or any third-party providers’ systems and networks have not been breached or that they do not contain exploitable defects or bugs that could result in a breach of or disruption to our systems and networks or the systems and networks of third parties that support or otherwise interface with us and our platforms and services. If there is a security vulnerability, error, or other bug in one of these third-party products or components and if there is a security exploit targeting them, we could face increased costs, claims, liability, reduced revenue, and harm to our reputation or competitive position. The natural sunsetting or phasing out of third-party products and operating systems that we use requires that our infrastructure teams reallocate time and attention to migration and updates, during which period potential security vulnerabilities could be exploited. In addition, our software is deployed on-premises at customer sites and in other locations where we may not have full control over how our products are deployed or managed. If our products are not appropriately secured in these environments, they could be compromised, inappropriately accessed, or undergo unauthorized copying and distribution, which could adversely affect our business, financial condition, and results of operations. Further, as we increase the number of customers we serve on our cloud environment, the likelihood increases that some usage of our products may occur that violates our terms of service or is otherwise improper or perceived as improper, which could cause reputational damage and adversely affect our business, financial condition, and results of operations.We, and the third-party vendors upon which we rely, have experienced, and may in the future experience, cybersecurity attacks and threats, including threats or attempts to disrupt our information technology infrastructure and unauthorized attempts to gain access to sensitive or confidential information. Our and our third-party vendors’ technology systems may be damaged, disrupted, or compromised by malicious events, such as cyberattacks (including computer viruses, ransomware, and other malicious and destructive code, phishing attacks, and denial of service attacks), physical or electronic security breaches and incidents, natural disasters, fire, power loss, telecommunications failures, personnel misconduct, and human error. Such attacks 32Table of Contentsor security breaches or incidents may be perpetrated by internal bad actors, such as employees or contractors, or by third parties (including traditional computer hackers, persons involved with organized crime, or foreign state or foreign state-supported actors). Cybersecurity threats can employ a wide variety of methods and techniques, may include the use of social engineering techniques or supply-chain attacks, are constantly evolving, and have become increasingly complex and sophisticated, all of which increase the difficulty of detecting and successfully defending against them. Furthermore, because the techniques used to obtain unauthorized access or sabotage systems change frequently and generally are not identified until after they are launched against a target, we and our third-party vendors may not have the capacity to immediately detect such efforts, may be unable to anticipate these techniques, or may be unable to implement adequate preventative measures. Although prior known cyberattacks directed at us have not had a material impact on our financial results, and we are continuing to bolster our threat detection and mitigation processes and procedures, we cannot guarantee that past, future, or ongoing cyberattacks or other security breaches or incidents against us or a third party, if successful, will not have a material impact on our business or financial results, whether directly or indirectly. For instance, due to political uncertainty, geopolitical tensions, and military actions associated with the ongoing Russia-Ukraine conflict, we and our third-party vendors have been vulnerable to a heightened risk of cybersecurity attacks, phishing attacks, viruses, malware, ransomware, hacking or similar breaches and incidents from nation-state actors or affiliated actors, including attacks that could materially disrupt our systems and operations, supply chain, and ability to produce, sell, and distribute our products and services. While we have security measures in place to protect our information and our customers’ information and to prevent data loss and other security breaches and incidents, we have not always been able to do so and there can be no assurance that in the future we will be able to anticipate or prevent security breaches or incidents, or unauthorized access of our information technology systems or the information technology systems of the third-party vendors upon which we rely. Despite our implementation of network security measures and internal information security policies, data stored on personnel computer systems is also vulnerable to similar security breaches and incidents, unauthorized tampering or human error. Many governments have enacted laws requiring companies to provide notice of data security breaches or incidents involving certain types of data, including personal data. In addition, most of our customers, including U.S. government customers, contractually require us to notify them of certain data security breaches and incidents. If an actual or perceived breach of security measures, unauthorized access to our system or the systems of the third-party vendors that we rely upon, or any other cybersecurity attack, threat, or incident occurs, we may face direct or indirect liability, costs, or damages, contract termination, our reputation in the industry and with current and potential customers may be compromised, our ability to attract new customers could be negatively affected, and our business, financial condition, and results of operations could be materially and adversely affected. Further, unauthorized access to our or our third-party vendors’ information technology systems or data or other security breaches or incidents could result in the loss, corruption, or unavailability of information; significant remediation costs; litigation, disputes, regulatory action, or investigations that could result in damages, material fines, and penalties; indemnity obligations; interruptions in the operation of our business, including our ability to provide new product features, new platforms, or services to our customers; damage to our operation technology networks and information technology systems; and other liabilities. Moreover, our remediation efforts may not be successful. Any or all of these issues, or the perception that any of them have occurred, could negatively affect our ability to attract new customers, cause existing customers to terminate or not renew their agreements, hinder our ability to obtain and maintain required or desirable cybersecurity certifications, and result in reputational damage, any of which could materially adversely affect our results of operations, financial condition, and future prospects. There can be no assurance that any limitations of liability provisions in our license arrangements with customers or in our agreements with vendors, partners, or others would be enforceable, applicable, or adequate or would otherwise protect us from any such liabilities or damages with respect to any particular claim. We maintain cybersecurity insurance and other types of insurance, subject to applicable deductibles and policy limits, but our insurance may not be sufficient to cover all costs associated with a potential data security incident. We also cannot be sure that our existing general liability insurance coverage and coverage for cyber liability or errors or omissions will continue to be available on acceptable terms or will be available in sufficient amounts to cover one or more large claims or that the insurer will not deny coverage as to any future claim. The successful assertion of one or more large claims against us that exceed available insurance coverage, or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could harm our financial condition. Issues raised by the use of artificial intelligence (“AI”) (including machine learning) in our platforms may result in reputational harm or liability. AI is enabled by or integrated into some of our technology platforms and is a significant and potentially growing element of our business. As with many developing technologies, AI presents risks and challenges that could affect its further development, adoption, and use, and therefore our business. AI algorithms may be flawed. Datasets in AI training, development, or operations may be insufficient, of poor quality, or reflect unwanted forms of bias. Inappropriate or controversial data practices by, or practices reflecting inherent biases of, data scientists, engineers, and end-users of our systems could impair the acceptance of AI 33Table of Contentssolutions. If the recommendations, forecasts, or analyses that AI applications assist in producing are deficient or inaccurate, we could be subjected to competitive harm, potential legal liability, including under new proposed legislation regulating AI in jurisdictions such as the European Union (“EU”) and brand or reputational harm. Some AI scenarios present ethical issues. Though our technologies and business practices are designed to mitigate many of these risks, if we enable or offer AI solutions that are controversial or problematic because of their purported or real impact on human rights, privacy, employment, or other social issues, we may experience brand or reputational harm, as well as regulatory or legal scrutiny. We depend on computing infrastructure operated by Amazon Web Services (“AWS”), Microsoft, and other third parties to support some of our customers and any errors, disruption, performance problems, or failure in their or our operational infrastructure could adversely affect our business, financial condition, and results of operations.We rely on the technology, infrastructure, and software applications, including software-as-a-service offerings, of certain third parties, such as AWS and Microsoft Azure, in order to host or operate some or all of certain key technology platform features or functions of our business, including our cloud-based services (including Palantir Cloud, as defined in the section titled “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Components of Results of Operations”), customer relationship management activities, billing and order management, and financial accounting services. Additionally, we rely on computer hardware purchased in order to deliver our platforms and services. We do not have control over the operations of the facilities of the third parties that we use. If any of these third-party services experience errors, disruptions, security issues, or other performance deficiencies, if they are updated such that our platforms become incompatible, if these services, software, or hardware fail or become unavailable due to extended outages, interruptions, defects, or otherwise, or if they are no longer available on commercially reasonable terms or prices (or at all), these issues could result in errors or defects in our platforms, cause our platforms to fail, our revenue and margins could decline, or our reputation and brand could be damaged, we could be exposed to legal or contractual liability, our expenses could increase, our ability to manage our operations could be interrupted, and our processes for managing our sales and servicing our customers could be impaired until equivalent services or technology, if available, are identified, procured, and implemented, all of which may take significant time and resources, increase our costs, and could adversely affect our business. Many of these third-party providers attempt to impose limitations on their liability for such errors, disruptions, defects, performance deficiencies, or failures, and if enforceable, we may have additional liability to our customers which may not be compensated by our third-party providers which are responsible for the liability. We have experienced, and may in the future experience, disruptions, failures, data loss, corruption, unavailability, outages, and other performance problems with our infrastructure or cloud-based offerings due to a variety of factors, which have included or may in the future include infrastructure changes, introductions of new functionality, human or software errors, employee misconduct, capacity constraints, denial of service attacks, phishing attacks, computer viruses, ransomware, and other malicious or destructive code, or other security-related incidents, and our disaster recovery planning may not be sufficient for all situations. If we experience disruptions, failures, data loss, outages, or other performance problems, our business, financial condition, and results of operations could be adversely affected. Our systems and the third-party systems upon which we and our customers rely are also vulnerable to damage or interruption from catastrophic occurrences such as earthquakes, floods, fires, power loss, telecommunication failures, cybersecurity threats, terrorist attacks, natural disasters, public health crises such as the ongoing COVID-19 pandemic, geopolitical tensions such as those that may be caused by the ongoing Russia-Ukraine conflict, or acts of misconduct. Moreover, we have business operations in the San Francisco Bay Area, which is a seismically active region. Despite any precautions we may take, the occurrence of a catastrophic event or other unanticipated problems at our or our third-party vendors’ hosting facilities, or within our systems or the systems of third parties upon which we rely, could result in interruptions, performance problems, or failure of our infrastructure, technology, or platforms, which may adversely impact our business. In addition, our ability to conduct normal business operations could be severely affected. In the event of significant physical damage to one of these facilities, it may take a significant period of time to achieve full resumption of our services, and our disaster recovery planning may not account for all eventualities. In addition, any negative publicity arising from these disruptions could harm our reputation and brand and adversely affect our business. Furthermore, our platforms are in many cases important or essential to our customers’ operations, including in some cases, their cybersecurity or oversight and compliance programs, and subject to service level agreements (“SLAs”). Any interruption in our service, whether as a result of an internal or third-party issue, could damage our brand and reputation, cause our customers to terminate or not renew their contracts with us or decrease use of our platforms and services, require us to indemnify our customers against certain losses, result in our issuing credit or paying penalties or fines, subject us to other losses or liabilities, cause our platforms to be perceived as unreliable or unsecure, and prevent us from gaining new or additional business from current or future customers, any of which could harm our business, financial condition, and results of operations. Moreover, to the extent that we do not effectively address capacity constraints, upgrade our systems as needed, and continually develop our technology and network architecture to accommodate actual and anticipated changes in technology, our business, 34Table of Contentsfinancial condition, and results of operations could be adversely affected. The provisioning of additional cloud hosting capacity requires lead time. AWS, Microsoft Azure, and other third parties have no obligation to renew their agreements with us on commercially reasonable terms, or at all. If AWS, Microsoft Azure, or other third parties increase pricing terms, terminate or seek to terminate our contractual relationship, establish more favorable relationships with our competitors, or change or interpret their terms of service or policies in a manner that is unfavorable to us, we may be required to transfer to other cloud providers or invest in a private cloud. If we are required to transfer to other cloud providers or invest in a private cloud, we could incur significant costs and experience possible service interruption in connection with doing so, or risk loss of customer contracts if they are unwilling to accept such a change. A failure to maintain our relationships with our third-party providers (or obtain adequate replacements), and to receive services from such providers that do not contain any material errors or defects, could adversely affect our ability to deliver effective products and solutions to our customers and adversely affect our business and results of operations. Our policies regarding customer confidential information and support for individual privacy and civil liberties could cause us to experience adverse business and reputational consequences. We strive to protect our customers’ confidential information and individuals’ privacy interests consistent with applicable laws, directives, and regulations. Consequently, we do not provide information about our customers to third parties without legal process. From time to time, government entities may seek our assistance with obtaining information about our customers or could request that we modify our technology platforms in a manner to permit access or monitoring. In light of our confidentiality and privacy commitments, we may legally challenge law enforcement or other government requests to provide information, to obtain encryption keys, or to modify or weaken encryption. To the extent that we do not provide assistance to or comply with requests from government entities, or if we challenge those requests publicly or in court, we may experience adverse political, business, and reputational consequences among certain customers or portions of the public. Conversely, to the extent that we do provide such assistance, or do not challenge those requests publicly in court, we may experience adverse political, business, and reputational consequences from other customers or portions of the public arising from concerns over privacy or the government’s activities. Failure to adequately obtain, maintain, protect and enforce our intellectual property and other proprietary rights could adversely affect our business. Our success and ability to compete depends in part on our ability to protect proprietary methods and technologies that we develop under a combination of patent and other intellectual property and proprietary rights in the United States and other jurisdictions outside the United States so that we can prevent others from using our inventions and proprietary information and technology. Despite our efforts, third parties may attempt to disclose, obtain, copy, or use our intellectual property or other proprietary information or technology without our authorization, and our efforts to protect our intellectual property and other proprietary rights may not prevent such unauthorized disclosure or use, misappropriation, infringement, reverse engineering or other violation of our intellectual property or other proprietary rights. Effective protection of our rights may not be available to us in every country in which our technology platforms or services are available. The laws of some countries may not be as protective of intellectual property and other proprietary rights as those in the United States, and mechanisms for enforcement of intellectual property and other proprietary rights may be inadequate. Also, our involvement in standard setting activity or the need to obtain licenses from others may require us to license our intellectual property. Accordingly, despite our efforts, we may be unable to prevent third parties from using our intellectual property or other proprietary information or technology. In addition, we may be the subject of intellectual property infringement or misappropriation claims, which could be very time-consuming and expensive to settle or litigate and could divert our management’s attention and other resources. These claims could also subject us to significant liability for damages if we are found to have infringed patents, copyrights, trademarks, or other intellectual property rights, or breached trademark co-existence agreements or other intellectual property licenses and could require us to cease using or to rebrand all or portions of our platforms. Any of our patents, copyrights, trademarks, or other intellectual property rights may be challenged by others or invalidated through administrative process or litigation. While we have issued patents and patent applications pending, we may be unable to obtain patent protection for the technology covered in our patent applications or such patent protection may not be obtained quickly enough to meet our business needs. Furthermore, the patent prosecution process is expensive, time-consuming, and complex, and we may not be able to prepare, file, prosecute, maintain, and enforce all necessary or desirable patent applications at a reasonable cost or in a timely manner. The scope of patent protection also can be reinterpreted after issuance and issued patents may be invalidated. Even if our patent applications do issue as patents, they may not issue in a form that is sufficiently broad to protect our technology, prevent competitors or other third parties from competing with us or otherwise provide us with any competitive advantage. Even if our patents issue in a form that covers our technology, enforcing patents against suspected infringers is time consuming, expensive, and involves risks associated with litigation, including the risk the suspected infringers file counterclaims against us.35Table of ContentsIn addition, any of our patents, copyrights, trademarks, or other intellectual property or proprietary rights may be challenged, narrowed, invalidated, held unenforceable, or circumvented in litigation or other proceedings, including, where applicable, opposition, re-examination, inter partes review, post-grant review, interference, nullification and derivation proceedings, and equivalent proceedings in foreign jurisdictions, and such intellectual property or other proprietary rights may be lost or no longer provide us meaningful competitive advantages. Such proceedings may result in substantial cost and require significant time from our management, even if the eventual outcome is favorable to us. Third parties also may legitimately and independently develop products, services, and technology similar to or duplicative of our platforms. In addition to protection under intellectual property laws, we rely on confidentiality or license agreements that we generally enter into with our corporate partners, employees, consultants, advisors, vendors, and customers, and generally limit access to and distribution of our proprietary information. However, we cannot be certain that we have entered into such agreements with all parties who may have or have had access to our confidential information or that the agreements we have entered into will not be breached or challenged, or that such breaches will be detected. Furthermore, non-disclosure provisions can be difficult to enforce, and even if successfully enforced, may not be entirely effective. Additionally, as more information about us and our platforms is made or becomes publicly available, it may be more difficult to manage actions by third parties with respect to, or other use of, such information. We cannot guarantee that any of the measures we have taken will prevent infringement, misappropriation, or other violation of our technology or other intellectual property or proprietary rights. Because we may be an attractive target for cyberattacks, we also may have a heightened risk of unauthorized access to, and misappropriation of, our proprietary and competitively sensitive information. We may be required to spend significant resources to monitor and protect our intellectual property and other proprietary rights, and we may conclude that in at least some instances the benefits of protecting our intellectual property or other proprietary rights may be outweighed by the expense or distraction to our management. We may initiate claims or litigation against third parties for infringement, misappropriation, or other violation of our intellectual property or other proprietary rights or to establish the validity of our intellectual property or other proprietary rights. Any such litigation, whether or not it is resolved in our favor, could be time-consuming, result in significant expense to us and divert the efforts of our technical and management personnel. Furthermore, attempts to enforce our intellectual property rights against third parties could also provoke these third parties to assert their own intellectual property or other rights against us, or result in a holding that invalidates or narrows the scope of our rights, in whole or in part. We have been, and may in the future be, subject to intellectual property rights claims, which are extremely costly to defend, could require us to pay significant damages and could limit our ability to use certain technologies. Our success and ability to compete also depends in part on our ability to operate without infringing, misappropriating or otherwise violating the intellectual property or other proprietary rights of third parties. Companies in the software and technology industries, including some of our current and potential competitors, own large numbers of patents, copyrights, trademarks and trade secrets and frequently pursue litigation based on allegations of infringement, misappropriation or other violations of intellectual property rights. In addition, many of these companies have the capability to dedicate substantial resources to enforce their intellectual property rights and to defend claims that may be brought against them. Such litigation also may involve non-practicing patent assertion entities or companies who use their patents as a means to extract license fees by threatening costly litigation or that have minimal operations or relevant product revenue and against whom our patents may provide little or no deterrence or protection. We have received notices, and may continue to receive notices in the future, that claim we have infringed, misappropriated, misused or otherwise violated other parties’ intellectual property rights, and, to the extent we have made or will make more information about our platforms publicly available and become exposed to greater visibility, we face a higher risk of being the subject of intellectual property infringement, misappropriation or other violation claims, which is not uncommon with respect to software technologies in particular. There may be third-party intellectual property rights, including issued patents or pending patent applications, that cover significant aspects of our technologies, or business methods. There may also be third-party intellectual property rights, including trademark registrations and pending applications, that cover the goods and services that we offer in certain regions. We may also be exposed to increased risk of being the subject of intellectual property infringement, misappropriation, or other violation claims as a result of acquisitions and our incorporation of open source and other third-party software into, or new branding for, our technology platforms, as, among other things, we have a lower level of visibility into the development process with respect to such technology or the care taken to safeguard against infringement, misappropriation, or other violation risks. In addition, former employers of our current, former, or future employees may assert claims that such employees have improperly disclosed to us confidential or proprietary information of these former employers. Any intellectual property claims, with or without merit, are difficult to predict, could be very time-consuming and expensive to settle or litigate, could divert our management’s attention and other resources, and may not be covered by the insurance that we carry. These claims could subject us to significant liability for damages, potentially including treble damages if we are found to have willfully infringed a third party’s intellectual property rights. These claims could also result in our having to stop using technology, branding or marks found to be in violation of a third party’s rights and any necessary rebranding could result in the loss of goodwill. We could be required to seek a license for the intellectual property, which may not be available on commercially reasonable terms or at all. Even if a license were available, we could be required to pay significant royalties, which would increase our expenses. As a result, we could be required to develop alternative non-infringing technology, branding or marks, which could require significant effort and expense. If we cannot license rights or develop technology for any infringing aspect of our business, we would be forced to limit or stop sales of one 36Table of Contentsor more of our platforms or features, we could lose existing customers, and we may be unable to compete effectively. Any of these results would harm our business, financial condition, and results of operations. Further, our agreements with customers and other third parties generally include indemnification provisions under which we agree to indemnify them for losses suffered or incurred as a result of third-party claims of intellectual property infringement, misappropriation, or other violations of intellectual property rights, damages caused by us to property or persons, or other liabilities relating to or arising from our platforms, services, or other contractual obligations. Large indemnity payments could harm our business, financial condition, and results of operations. Any dispute with a customer with respect to such obligations could have adverse effects on our relationship with that customer and other existing customers and new customers and harm our business and results of operations. Real or perceived errors, failures, defects, or bugs in our platforms could adversely affect our results of operations and growth prospects.Because we offer very complex technology platforms, undetected errors, defects, failures, or bugs have occurred and may in the future occur, especially when platforms or capabilities are first introduced or when new versions or other product or infrastructure updates are released. Our platforms are often installed and used in large-scale computing environments with different operating systems, software products and equipment, and data source and network configurations, which may cause errors or failures in our platforms or may expose undetected errors, failures, or bugs in our platforms. Despite testing by us, errors, failures, or bugs may not be found in new software or releases until after commencement of commercial shipments. In the past, errors have affected the performance of our platforms and can also delay the development or release of new platforms or capabilities or new versions of platforms, adversely affect our reputation and our customers’ willingness to buy platforms from us, and adversely affect market acceptance or perception of our platforms. Many of our customers use our platforms in applications that are critical to their businesses or missions and may have a lower risk tolerance to defects in our platforms than to defects in other, less critical, software products. Any errors or delays in releasing new software or new versions of platforms or allegations of unsatisfactory performance, errors, defects, or failures in released software could cause us to lose revenue or market share, increase our service costs, cause us to incur substantial costs in redesigning the software, cause us to lose significant customers, subject us to liability for damages and divert our resources from other tasks, any one of which could materially and adversely affect our business, results of operations and financial condition. In addition, our platforms could be perceived to be ineffective for a variety of reasons outside of our control. Hackers or other malicious parties could circumvent our or our customers’ security measures, and customers may misuse our platforms resulting in a security breach or perceived product failure. Real or perceived errors, failures, or bugs in our platforms and services, or dissatisfaction with our services and outcomes, could result in customer terminations and/or claims by customers for losses sustained by them. In such an event, we may be required, or we may choose, for customer relations or other reasons, to expend additional resources in order to help correct any such errors, failures, or bugs. Although we have limitation of liability provisions in our standard software licensing and service agreement terms and conditions, these provisions may not be enforceable in some circumstances, may vary in levels of protection across our agreements, or may not fully or effectively protect us from such claims and related liabilities and costs. We generally provide a warranty for our software products and services and an SLA for our performance of software operations via our O&M services to customers. In the event that there is a failure of warranties in such agreements, we are generally obligated to correct the product or service to conform to the warranty provision as set forth in the applicable SLA, or, if we are unable to do so, the customer is entitled to seek a refund of the purchase price of the product and service (generally prorated over the contract term). The sale and support of our products also entail the risk of product liability claims. We maintain insurance to protect against certain claims associated with the use of our products, but our insurance coverage may not adequately cover any claim asserted against us. In addition, even claims that ultimately are unsuccessful could result in our expenditure of funds in litigation and divert management’s time and other resources. In addition, our platforms integrate a wide variety of other elements, and our platforms must successfully interoperate with products from other vendors and our customers’ internally developed software. As a result, when problems occur for a customer using our platforms, it may be difficult to identify the sources of these problems, and we may receive blame for a security, access control, or other compliance breach that was the result of the failure of one of the other elements in a customer’s or another vendor’s IT, security, or compliance infrastructure. The occurrence of software or errors in data, whether or not caused by our platforms, could delay or reduce market acceptance of our platforms and have an adverse effect on our business and financial performance, and any necessary revisions may cause us to incur significant expenses. The occurrence of any such problems could harm our business, financial condition, and results of operations. If an actual or perceived breach of information correctness, auditability, integrity, or availability occurs in one of our customers’ systems, regardless of whether the breach is attributable to our platforms, the market perception of the effectiveness of our platforms could be harmed. Alleviating any of these problems could require additional significant expenditures of our capital and other resources and could cause interruptions, delays, or cessation of our product licensing, which could cause us to lose existing or potential customers and could adversely affect our business, financial condition, results of operations, and growth prospects. 37Table of ContentsWe rely on the availability of licenses to third-party technology that may be difficult to replace or that may cause errors or delay implementation of our platforms and services should we not be able to continue or obtain a commercially reasonable license to such technology. Our technology platforms include software or other intellectual property licensed from third parties. It may be necessary in the future to renew licenses relating to various aspects of these platforms or to seek new licenses for existing or new platforms or other products. There can be no assurance that the necessary licenses would be available on commercially acceptable terms, if at all. Third parties may terminate their licenses with us for a variety of reasons, including actual or perceived failures or breaches of security or privacy, or reputational concerns, or they may choose not to renew their licenses with us. In addition, we may be subject to liability if third-party software that we license is found to infringe, misappropriate, or otherwise violate intellectual property or privacy rights of others. The loss of, or inability to obtain, certain third-party licenses or other rights or to obtain such licenses or rights on favorable terms, or the need to engage in litigation regarding these matters, could result in product roll-backs, delays in product releases until equivalent technology can be identified, licensed or developed, if at all, and integrated into our platforms, and may have a material adverse effect on our business, financial condition, and results of operations. Moreover, the inclusion in our platforms of software or other intellectual property licensed from third parties on a nonexclusive basis could limit our ability to differentiate our platforms from products of our competitors and could inhibit our ability to provide the current level of service to existing customers. In addition, any data that we license from third parties for potential use in our platforms may contain errors or defects, which could negatively impact the analytics that our customers perform on or with such data. This may have a negative impact on how our platforms are perceived by our current and potential customers and could materially damage our reputation and brand. Changes in or the loss of third-party licenses could lead to our platforms becoming inoperable or the performance of our platforms being materially reduced resulting in our potentially needing to incur additional research and development costs to ensure continued performance of our platforms or a material increase in the costs of licensing, and we may experience decreased demand for our platforms. Our platforms contain “open source” software, and any failure to comply with the terms of one or more of these open source licenses could negatively affect our business. Our technology platforms are distributed with software licensed by its authors or other third parties under “open source” licenses. Some of these licenses contain requirements that we make available source code for modifications or derivative works we create based upon the open source software, and that we license these modifications or derivative works under the terms of a particular open source license or other license granting third parties certain rights of further use. If we combine our proprietary software with open source software in a certain manner, we could, under certain provisions of the open source licenses, be required to release the source code of our proprietary software. In addition to risks related to license requirements, usage of open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide updates, warranties, support, indemnities, assurances of title, or controls on origin of the software, and are provided on an “as-is” basis. Likewise, some open source projects have known security and other vulnerabilities and architectural instabilities, or are otherwise subject to security attacks due to their wide availability, and are provided on an “as-is” basis. We have established processes to help alleviate these risks, including a review process for screening requests from our development organization for the use of open source software, and the use of software tools to review our source code for open source software, but we cannot be sure that all open source software is submitted for approval prior to use in our platforms or that such software tools will be effective. In addition, open source license terms may be ambiguous and many of the risks associated with usage of open source software cannot be eliminated, and could, if not properly addressed, negatively affect our business. If we were found to have inappropriately used open source software, we may be required to re-engineer our platforms, to release proprietary source code, to discontinue the sale of our platforms in the event re-engineering could not be accomplished on a timely basis, or to take other remedial action that may divert resources away from our development efforts, any of which could adversely affect our business, results of operations, financial condition, and growth prospects. In addition, if the open source software we use is no longer maintained by the relevant open source community, then it may be more difficult to make the necessary revisions to our software, including modifications to address security vulnerabilities, which could impact our ability to mitigate cybersecurity risks or fulfill our contractual obligations to our customers. We may also face claims from copyright owners seeking to enforce the terms of an open source license governing the software, including by demanding release of the open source software, derivative works or our proprietary source code that was developed using such software. Such claims, with or without merit, could result in litigation, could be time-consuming and expensive to settle or litigation, including copyright infringement claims, could divert our management’s attention and other resources, could require us to lease some of our proprietary code, or could require us to devote additional research and development resources to change our software, any of which could adversely affect our business. Additionally, we have intentionally made certain proprietary software available on an open source basis, both by contributing modifications back to existing open source projects, and by making certain internally developed tools available pursuant to open source licenses, and we plan to continue to do so in the future. While we have established procedures, including a review 38Table of Contentsprocess for any such contributions, which is designed to protect any code that may be competitively sensitive, we cannot guarantee that this process has always been applied consistently. Even when applied, because any software source code we contribute to open source projects is publicly available, our ability to protect our intellectual property rights with respect to such software source code may be limited or lost entirely, and we may be unable to prevent our competitors or others from using such contributed software source code for competitive purposes, or for commercial or other purposes beyond what we intended. Many of these risks associated with usage of open source software could be difficult to eliminate or manage, and could, if not properly addressed, negatively affect the performance of our offerings and our business. Risks Related to Legal, Regulatory, and AccountingOur business is subject to complex and evolving U.S. and non-U.S. laws and regulations regarding privacy, data protection and security, technology protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, monetary penalties, increased cost of operations, or otherwise harm our business. We are subject to a variety of local, state, national, and international laws, directives, and regulations in the United States and abroad that involve matters central to our business, including privacy and data protection, data security, data storage, retention, transfer and deletion, technology protection, and personal information. International data protection, data security, privacy, and other laws and regulations can impose different obligations or be more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations, which, depending on the regime, may be enforced by private parties or government entities, are constantly evolving and can be subject to significant change, and they are likely to continue to develop and evolve for the foreseeable future. In addition, the application, interpretation, and enforcement of these laws and regulations are often uncertain, particularly in the new and rapidly evolving software and technology industry in which we operate, and may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices. A number of proposals are pending before U.S. federal, state, and foreign legislative and regulatory bodies that could significantly affect our business. For example, despite recent developments including an in-principle agreement between the United States and the European Commission and a subsequent Executive Order directing the steps that the United States will take to implement the U.S. commitments under the new EU-U.S. Data Privacy Framework, new legal challenges to the mechanisms allowing companies to transfer personal data from the European Economic Area to certain other jurisdictions, including the United States, could emerge, resulting in further limitations on the ability to transfer data across borders. The California state legislature passed the California Consumer Privacy Act (“CCPA”) in 2018 and California voters approved a ballot measure subsequently establishing the California Privacy Rights Act (“CPRA”) in 2020, which regulate the processing of personal information of California residents and increase the privacy and security obligations of entities handling certain personal information of California residents, including requiring covered companies to provide new disclosures to California consumers, and affords such consumers new abilities to opt-out of certain sales of personal information. The CCPA went into effect on January 1, 2020, and the California Attorney General may bring enforcement actions, with penalties for violations of the CCPA. The CPRA went into effect on January 1, 2023 instilling enforcement authority in a new dedicated regulatory body, the California Privacy Protection Agency, which will begin carrying out enforcement actions as soon as six months after the enactment date. While aspects of both the CCPA and CPRA and their interpretations remain to be determined in practice, we are committed to complying with their applicable obligations. More generally, some observers have noted the CCPA could mark the beginning of a trend toward more stringent privacy legislation in the United States, as observed with the subsequent adoption of state-level comprehensive consumer privacy legislation, including the following (collectively, the “State Privacy Laws”):•the Virginia Consumer Data Protection Act, enacted in March 2021 and became effective on January 1, 2023; •the Colorado Privacy Act, which was enacted in June 2021, will become effective on July 1, 2023;•the Utah Consumer Privacy Act, which was enacted in March 2022, and will become effective December 31, 2023; and •Connecticut’s Act Concerning Personal Data Privacy and Online Monitoring, which was enacted in May 2022 and most of which will become effective July 1, 2023. We cannot yet fully predict the impact of the State Privacy Laws and other new laws or regulations on our business or operations, but developments regarding these and all privacy and data protection laws and regulations around the world may require us to modify our data processing practices and policies and to incur substantial costs and expenses in an effort to maintain compliance on an ongoing basis. Outside of the United States, virtually every jurisdiction in which we operate has established its own legal framework relating to privacy, data protection, and information security matters with which we and/or our customers must comply. Laws and regulations in these jurisdictions apply broadly to the collection, use, storage, retention, disclosure, security, transfer, and other processing of data that identifies or may be used to identify or locate an individual. Some countries and regions, including the EU, are considering or have passed legislation that imposes significant obligations in 39Table of Contentsconnection with privacy, data protection, and information security that could increase the cost and complexity of delivering our platforms and services, including the European General Data Protection Regulation (“GDPR”) which took effect in May 2018. Complying with the GDPR or other data protection laws, directives, and regulations as they emerge may cause us to incur substantial operational costs or require us to modify our data handling practices on an ongoing basis. Non-compliance with the GDPR specifically may result in administrative fines or monetary penalties of up to 4% of worldwide annual revenue in the preceding financial year or €20 million (whichever is higher) for the most serious infringements, and could result in proceedings against us by governmental entities or other related parties and may otherwise adversely impact our business, financial condition, and results of operations.Additionally, post-Brexit updates to U.K. data protection laws and regulations, while largely conforming to EU GDPR standards paving the way for a 2021 European Commission adequacy determination for export of personal data from the European Economic Area to the U.K., may change over time as the U.K. and its regulator, the Information Commissioner’s Office, continue to examine its global market standing. Modifications in the standards for valid data transfer to the U.S. from the U.K., the EU, Switzerland, and other countries using standard contractual clauses or similar mechanisms may further require us to change our product and business practices, as well as to update client agreements in ways that introduce additional costs to our business.The overarching complexity of laws and regulations relating to privacy, data protection, and information security around the world pose a compliance challenge that could manifest in costs, damages, or liability in other forms as a result of failure to implement proper programmatic controls, failure to adhere to those controls or to the commitments we make, or the malicious or inadvertent breach of applicable legal, regulatory, or contractual privacy or data protection requirements by us, our employees, our business partners, or our customers. In addition to government regulation, self-regulatory standards and other industry standards may legally or contractually apply to us, be argued to apply to us, or we may elect to comply with such standards or to facilitate our customers’ compliance with such standards. Because privacy, data protection, and information security are critical competitive factors in our industry, we may make statements on our website, in marketing materials, or in other settings about our data security measures and our compliance with, or our ability to facilitate our customers’ compliance with, these standards. We also expect that there will continue to be new proposed laws and regulations concerning privacy, data protection, and information security, and we cannot yet determine the impact such future laws, regulations and standards, or amendments to or re-interpretations of existing laws and regulations, industry standards, or other obligations may have on our business. New laws, amendments to or re-interpretations of existing laws and regulations, industry standards, and contractual and other obligations may require us to incur additional costs and restrict our business operations. As these legal regimes relating to privacy, data protection, and information security continue to evolve, they may result in ever-increasing public scrutiny and escalating levels of enforcement and sanctions. Furthermore, because the interpretation and application of laws, standards, contractual obligations and other obligations relating to privacy, data protection, and information security are uncertain, these laws, standards, and contractual and other obligations may be interpreted and applied in a manner that is, or is alleged to be, inconsistent with our data management practices, our policies or procedures, or the features of our platforms, or we may simply fail to properly develop or implement our practices, policies, procedures, or features in compliance with such obligations. If so, in addition to the possibility of fines, lawsuits, and other claims, we could be required to fundamentally change our business activities and practices or modify our platforms, which could have an adverse effect on our business. We may be unable to make such changes and modifications in a commercially reasonable manner or at all, and our ability to fulfill existing obligations, make enhancements, or develop new platforms and features could be limited. Furthermore, the costs of compliance with, and other burdens imposed by, the laws, regulations, and policies that are applicable to the businesses of our customers may limit the use and adoption of, and reduce the overall demand for, our platforms. These existing and proposed laws and regulations can be costly to comply with and can make our platforms and services less effective or valuable, delay or impede the development of new products, result in negative publicity, increase our operating costs, require us to modify our data handling practices, limit our operations, impose substantial fines and penalties, require significant management time and attention, or put our data or technology at risk. Any failure or perceived failure by us or our platforms to comply with the laws, regulations, directives, policies, industry standards, or legal obligations of the United States, EU, or other governmental or non-governmental bodies at the regional, national, or supra-national level relating to privacy, data protection, or information security, or any security incident that results in actual or suspected loss of or the unauthorized access to, or acquisition, use, release, or transfer of, personal information, personal data, or other customer or sensitive data or information may result in governmental investigations, inquiries, enforcement actions and prosecutions, private claims and litigation, indemnification or other contractual obligations, other remedies, including fines or demands that we modify or cease existing business practices, or adverse publicity, and related costs and liabilities, which could significantly and adversely affect our business and results of operations. 40Table of ContentsOur non-U.S. sales and operations subject us to additional risks and regulations that can adversely affect our results of operations. Our successes to date have primarily come from customers in relatively stable and developed countries, but we are in the process of entering new and emerging markets in non-U.S. countries, including with COVID-19 response efforts and defense, law enforcement, national security, and other government agencies, as part of our growth strategy. These new and emerging markets may involve uncertain business, technology, and economic risks and may be difficult or impossible for us to penetrate, even if we were to commit significant resources to do so. We currently have sales personnel and sales and services operations in the United States and certain countries around the world. To the extent that we experience difficulties in recruiting, training, managing, or retaining non-U.S. staff, and specifically sales management and sales personnel staff, we may experience difficulties in sales productivity in, or market penetration of, non-U.S. markets. Our ability to convince customers to expand their use of our platforms or renew their subscription, license, or maintenance and service agreements with us is correlated to, among other things, our direct engagement with the customer. To the extent we are restricted or unable to engage with non-U.S. customers effectively with our limited sales force and services capacity, we may be unable to grow sales to existing customers to the same degree we have experienced in the United States. Our non-U.S. operations subject us to a variety of risks and challenges, including: •increased management, travel, infrastructure, and legal and financial compliance costs and time associated with having multiple non-U.S. operations, including but not limited to compliance with local employment laws and other applicable laws and regulations; •longer payment cycles, greater difficulty in enforcing contracts, difficulties in collecting accounts receivable, especially in emerging markets, and the likelihood that revenue from non-U.S. system integrators, government contractors, and customers may need to be recognized when cash is received, at least until satisfactory payment history has been established, or upon confirmation of certain acceptance criteria or milestones; •the need to adapt our platforms for non-U.S. customers whether to accommodate customer preferences or local law; •differing regulatory and legal requirements and possible enactment of additional regulations or restrictions on the use, import, or re-export of our platforms or the provision of services, which could delay, restrict, or prevent the sale or use of our platforms and services in some jurisdictions; •compliance with multiple and changing foreign laws and regulations, including those governing employment, privacy, data protection, information security, data transfer, and the risks and costs of non-compliance with such laws and regulations; •new and different sources of competition not present in the United States; •heightened risks of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may cause us to withdraw from particular markets, or impact financial results and result in restatements of financial statements and irregularities in financial statements; •volatility in non-U.S. political and economic environments, including by way of examples, the potential effects of the ongoing COVID-19 pandemic, and the ongoing Russia-Ukraine conflict, as well as economic sanctions the United States and other countries have imposed on Russia; •weaker protection of intellectual property rights in some countries and the risk of potential theft, copying, or other compromises of our technology, data, or intellectual property in connection with our non-U.S. operations, whether by state-sponsored malfeasance or other foreign entities or individuals; •volatility and fluctuations in currency exchange rates, including that, because many of our non-U.S. contracts are denominated in U.S. dollars, an increase in the strength of the U.S. dollar has made our products more expensive for non-U.S. dollar denominated customers, which may make doing business with us less appealing to such customers; •management and employee communication and integration problems resulting from language differences, cultural differences, and geographic dispersion; •difficulties in repatriating or transferring funds from, or converting currencies in, certain countries; •potentially adverse tax consequences, including multiple and possibly overlapping tax regimes, the complexities of foreign value-added tax systems, and changes in tax laws; •lack of familiarity with local laws, customs, and practices, and laws and business practices favoring local competitors or partners; and 41Table of Contents•interruptions to our business operations and our customers’ business operations subject to events such as war, incidents of terrorism, natural disasters, public health concerns or epidemics (such as the ongoing COVID-19 pandemic), shortages or failures of power, internet, telecommunications, or hosting service providers, cyberattacks or malicious acts, or responses to these events. In addition to the factors above, foreign governments may take administrative, legislative, or regulatory action that could materially interfere with our ability to sell our platforms in certain countries. For example, foreign governments may require a percentage of prime contracts be fulfilled by local contractors or provide special incentives to government-backed local customers to buy from local competitors, even if their products are inferior to ours. Moreover, both the U.S. government and foreign governments may regulate the acquisition of or import of our technologies or our entry into certain foreign markets or partnership with foreign third parties through investment screening or other regulations. Such regulations may apply to certain non-U.S. joint ventures, platform partnerships, and strategic alliances that may be integral to our long-term business strategy. Compliance with laws and regulations applicable to our non-U.S. operations increases our cost of doing business in foreign jurisdictions. We may be unable to keep current with changes in foreign government requirements and laws as they change from time to time. Failure to comply with these regulations could subject us to investigations, sanctions, enforcement actions, disgorgement of profits, fines, damages, civil and criminal penalties, injunctions, or other collateral consequences. In many foreign countries, it is common for others to engage in business practices that are prohibited by our internal policies and procedures or U.S. regulations applicable to us. In addition, although we have implemented policies and procedures designed to ensure compliance with these laws and policies, there can be no assurance that all of our employees, contractors, partners, and agents will comply with these laws and policies. Violations of laws or key control policies by our employees, contractors, partners, or agents could result in delays in revenue recognition, financial reporting misstatements, governmental sanctions, fines, penalties, or the prohibition of the importation or exportation of our platforms. In addition, responding to any action may result in a significant diversion of management’s attention and resources and an increase in professional fees. Enforcement actions and sanctions or failure to prevail in any possible civil or criminal litigation could harm our business, reputation, financial condition, and results of operations. Also, we are expanding operations, including our work with existing commercial customers, into countries in Asia, Europe, the Middle East, and elsewhere, which may place restrictions on the transfer of data and potentially the import and use of foreign encryption technology. Any of these risks could harm our non-U.S. operations and reduce our non-U.S. sales, adversely affecting our business, results of operations, financial condition, and growth prospects. Some of our business partners also have non-U.S. operations and are subject to the risks described above. Even if we are able to successfully manage the risks of our own non-U.S. operations, our business may be adversely affected if our business partners are not able to successfully manage these risks. Failure to comply with governmental laws and regulations could harm our business, and we have been, and expect to be, the subject of legal and regulatory inquiries, which may result in monetary payments or may otherwise negatively impact our reputation, business, and results of operations. Our business is subject to regulation by various federal, state, local, and foreign governments in which we operate. In certain jurisdictions, the regulatory requirements imposed by foreign governments may be more stringent than those in the United States. Noncompliance with applicable regulations or requirements could subject us to investigations, administrative proceedings, sanctions, enforcement actions, disgorgement of profits, fines, damages, litigation, civil and criminal penalties, termination of contracts, exclusion from sales channels or sales opportunities, injunctions, or other consequences. Such matters may include, but are not limited to, claims, disputes, allegations, or investigations related to alleged violations of laws or regulations relating to anti-corruption requirements, lobbying or conflict-of-interest requirements, export or other trade controls, data privacy or data protection requirements, or laws or regulations relating to employment, procurement, cybersecurity, securities, or antitrust/competition requirements. The effects of recently imposed and proposed actions are uncertain because of the dynamic nature of governmental action and responses. We may be subject to government inquiries that drain our time and resources, tarnish our brand among customers and potential customers, prevent us from doing business with certain customers or markets, including government customers, affect our ability to hire, attract and maintain qualified employees, or require us to take remedial action or pay penalties. From time to time, we receive formal and informal inquiries from governmental agencies and regulators regarding our compliance with laws and regulations or otherwise relating to our business or transactions. Any negative outcome from such inquiries or investigations or failure to prevail in any possible civil or criminal litigation could adversely affect our business, reputation, financial condition, results of operations, and growth prospects. 42Table of ContentsWe have previously been, and are currently, or in the future may become, involved in a number of legal, regulatory, and administrative inquiries and proceedings, and unfavorable outcomes in litigation or other of these matters could negatively impact our business, financial conditions, and results of operations. We have previously been, and are currently, and from time to time going forward may become involved in and subject to regulatory or other governmental inquiries or investigations, or government or private-party litigation or proceedings for a variety of claims or disputes. These claims, lawsuits, and proceedings have involved, and could in the future involve, labor and employment, discrimination and harassment, commercial disputes, intellectual property rights (including patent, trademark, copyright, trade secret, and other proprietary rights), class actions, general contract, tort, defamation, data privacy rights, antitrust, common law fraud, government regulation, or compliance, alleged federal and state securities and “blue sky” law violations or other investor claims, and other matters. Derivative claims, lawsuits, and proceedings involving breach of fiduciary duty, failure of oversight, corporate waste claims, and other matters have been, and may in the future be, asserted against our officers and directors by our stockholders. In addition, we and certain of our officers and directors were recently sued in purported class action lawsuits and derivative lawsuits. Our business and results may be adversely affected by the outcome of any currently pending or any future legal, regulatory, and/or administrative claims or proceedings, including through monetary damages or injunctive relief. The number and significance of our legal disputes and inquiries may increase as we continue to grow larger, as our business expands in employee headcount, scope, and geographic reach, and as our platforms and services become more complex. Additionally, if customers fail to pay us under the terms of our agreements, we may be adversely affected due to the cost of enforcing the terms of our contracts through litigation. Litigation or other proceedings can be expensive and time consuming and can divert our resources and leadership’s attention from our primary business operations. The results of our litigation also cannot be predicted with certainty. If we are unable to prevail in litigation, we could incur payments of substantial monetary damages or fines, or undesirable changes to our platforms or business practices, and accordingly, our business, financial condition, or results of operations could be materially and adversely affected. Furthermore, if we accrue a loss contingency for pending litigation and determine that it is probable, any disclosures, estimates, and reserves we reflect in our financial statements with regard to these matters may not reflect the ultimate disposition or financial impact of litigation or other such matters. These proceedings could also result in negative publicity, which could harm customer and public perception of our business, regardless of whether the allegations are valid or whether we are ultimately found liable. Additional information regarding certain of the lawsuits we are involved in is described further in Note 8. Commitments and Contingencies in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Failure to comply with anti-bribery and anti-corruption laws could subject us to penalties and other adverse consequences. As we operate and sell our platforms and services around the world, we are subject to the United States Foreign Corrupt Practices Act (“FCPA”), the U.K. Bribery Act, the U.S. domestic bribery statute contained in 18 U.S.C. § 201, the United States Travel Act, and other anti-corruption and anti-bribery laws and regulations in the jurisdictions in which we do business, both domestic and abroad. These laws and regulations generally prohibit improper payments or offers of improper payments to government officials, political parties, or commercial partners for the purpose of obtaining or retaining business or securing an improper business advantage. We have operations, deal with and make sales to governmental or quasi-governmental entities in the United States and in non-U.S. countries, including those known to experience corruption, particularly certain emerging countries in East Asia, Eastern Europe, Africa, South America, and the Middle East, and further expansion of our non-U.S. sales efforts may involve additional regions. Corruption issues pose a risk in every country and jurisdiction, but in many countries, particularly in countries with developing economies, it may be more common for businesses to engage in practices that are prohibited by the FCPA or other applicable laws and regulations, and our activities in these countries pose a heightened risk of unauthorized payments or offers of payments by one of our employees or third-party business partners, representatives, and agents that could be in violation of various laws including the FCPA. The FCPA, U.K. Bribery Act and other applicable anti-bribery and anti-corruption laws also may hold us liable for acts of corruption and bribery committed by our third-party business partners, representatives, and agents. We and our third-party business partners, representatives, and agents may have direct or indirect interactions with officials and employees of government agencies or state-owned or affiliated entities and we may be held liable for the corrupt or other illegal activities of our employees or such third parties even if we do not explicitly authorize such activities. The FCPA or other applicable laws and regulations also require that we keep accurate books and records and maintain internal controls and compliance procedures designed to prevent any such actions. While we have implemented policies and procedures to address compliance with such laws, we cannot ensure that our employees or other third parties working on our behalf will not engage in conduct in violation of our policies or applicable law for which we might ultimately be held responsible. Violations of the FCPA, the U.K. Bribery Act, and other laws may result in whistleblower complaints, adverse media coverage, investigations, imposition of significant legal fees, loss of export privileges, as well as severe criminal or civil sanctions, including suspension or debarment from U.S. government contracting, and we may be subject to other liabilities and adverse effects on our 43Table of Contentsreputation, which could negatively affect our business, results of operations, financial condition, and growth prospects. In addition, responding to any enforcement action may result in a significant diversion of management’s attention and resources and significant defense costs and other professional fees. Our exposure for violating these laws increases as our non-U.S. presence expands and as we increase sales and operations in foreign jurisdictions. Governmental trade controls, including export and import controls, sanctions, customs requirements, and related regimes, could subject us to liability or loss of contracting privileges or limit our ability to compete in certain markets. Our offerings are subject to U.S. export controls, and we incorporate encryption technology into certain of our offerings. Our controlled software offerings and the underlying technology may be exported outside of the United States only with the required export authorizations, which may include license requirements in some circumstances. Additionally, our current or future products may be classified under the Commerce Department Export Administration Regulations (“EAR”) or as defense articles subject to the United States International Traffic in Arms Regulations (“ITAR”). Most of our products, including our core software platforms, have been classified under the EAR and are generally exportable without needing a specific license, under an EAR exception for encrypted software. If a product, or component of a product, is classified under the ITAR, or is ineligible for the EAR encryption exception, then those products could be exported outside the United States only if we obtain the applicable export license or qualify for a different license exception. In certain contexts, the services we provide might be classified as defense services subject to the ITAR separately from the products we provide. Compliance with the EAR, ITAR, and other applicable regulatory requirements regarding the export of our products, including new releases of our products and/or the performance of services, may create delays in the introduction of our products in non-U.S. markets, prevent our customers with non-U.S. operations from deploying our products throughout their global systems or, in some cases, prevent the export of our products to some countries altogether. Furthermore, our activities are subject to the economic sanctions, laws and regulations of the United States and other jurisdictions. Such controls prohibit the shipment or transfer of certain products and services without the required export authorizations or export to countries, governments, and persons targeted by applicable sanctions. We take precautions to prevent our offerings from being exported in violation of these laws, including: (i) seeking to proactively classify our platforms and obtain authorizations for the export and/or import of our platforms where appropriate, (ii) implementing certain technical controls and screening practices to reduce the risk of violations, and (iii) requiring compliance with U.S. export control and sanctions obligations in customer and vendor contracts. However, we cannot guarantee the precautions we take will prevent violations of export control and sanctions laws. As discussed above, if we misclassify a product or service, export or provide access to a product or service in violation of applicable restrictions, or otherwise fail to comply with export regulations, we may be denied export privileges or subjected to significant per violation fines or other penalties, and our platforms may be denied entry into other countries. Any decreased use of our platforms or limitation on our ability to export or sell our platforms would likely adversely affect our business, results of operations and financial condition. Violations of U.S. sanctions or export control laws can result in fines or penalties, including civil penalties of over $300,000 or twice the value of the transaction, whichever is greater, per EAR violation and a civil penalty of over $1,000,000 for ITAR violations. In the event of criminal knowing and willful violations of these laws, fines of up to $1,000,000 per violation and possible incarceration for responsible employees and managers could be imposed. We also note that if we or our business partners or counterparties, including licensors and licensees, prime contractors, subcontractors, sublicensors, vendors, customers, shipping partners, or contractors, fail to obtain appropriate import, export, or re-export licenses or permits, notwithstanding regulatory requirements or contractual commitments to do so, or if we fail to secure such contractual commitments where necessary, we may also be adversely affected, through reputational harm as well as other negative consequences, including government investigations and penalties. For instance, violations of U.S. sanctions or export control laws can result in fines or penalties, including significant civil and criminal penalties per violation, depending on the circumstances of the violation or violations. Negative consequences for violations or apparent violations of trade control requirements may include the absolute loss of the right to sell our platforms or services to the government of the United States, or to other public bodies, or a reduction in our ability to compete for such sales opportunities. Further, complying with export control and sanctions regulations for a particular sale may be time-consuming and may result in the delay or loss of sales opportunities. Also, various countries, in addition to the United States, regulate the import and export of certain encryption and other technology, including import and export permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our platforms or could limit our customers’ abilities to implement our platforms in those countries. For example, following Russia’s invasion of Ukraine, the United States and other countries imposed economic sanctions and severe export control restrictions against Russia, Belarus, and certain regions of Ukraine, and the United States and other countries could impose wider sanctions and export restrictions and take other actions should the conflict further escalate. Any new export restrictions, new legislation, changes in economic sanctions, or shifting approaches in the enforcement or scope of existing 44Table of Contentsregulations, or in the countries, persons, or technologies targeted by such regulations, could result in decreased use of our platforms by existing customers with non-U.S. operations, declining adoption of our platforms by new customers with non-U.S. operations, limitation of our expansion into new markets, and decreased revenue. Changes in accounting principles or their application to us could result in unfavorable accounting charges or effects, which could adversely affect our results of operations and growth prospects. We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”). In particular, we make certain estimates and assumptions related to the adoption and interpretation of these principles including the recognition of our revenue and the accounting for our provision for income taxes. If these assumptions turn out to be incorrect, our financial results and position could materially differ from our expectations and could be materially adversely affected. A change in any of these principles or guidance, or in their interpretations or application to us, may have a significant effect on our reported results, as well as our processes and related controls, and may retroactively affect previously reported results or our forecasts, which may negatively impact our financial statements. If our judgments or estimates relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our results of operations could fall below expectations of securities analysts and investors, resulting in a decline in our stock price. The preparation of our financial statements in conformity with GAAP requires management to make judgments, estimates, and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, as provided in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” the results of which form the basis for making judgments about the carrying values of assets, liabilities, and equity, and the amount of revenue and expenses that are not readily apparent from other sources. Our results of operations may be adversely affected if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our results of operations to fall below the expectations of securities analysts and investors, resulting in a decline in the trading price of our Class A common stock. Significant judgments, estimates, and assumptions used in preparing our consolidated financial statements include, or may in the future include, those related to revenue recognition and income taxes. We could be subject to additional tax liabilities. We are subject to federal, state, and local income taxes in the United States and numerous foreign jurisdictions. Determining our provision for income taxes requires significant management judgment, and the ultimate tax outcome may be uncertain. In addition, our provision for income taxes is subject to volatility and could be adversely affected by many factors, including, among other things, changes to our operating or holding structure, changes in the amounts of earnings in jurisdictions with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, and changes in U.S. and foreign tax laws. Moreover, we are subject to the examination of our income tax returns by tax authorities in the United States and various foreign jurisdictions, which may disagree with our calculation of research and development tax credits, cross-jurisdictional transfer pricing, or other matters and assess additional taxes, interest or penalties. While we regularly assess the likely outcomes of these examinations to determine the adequacy of our provision for income taxes and we believe that our financial statements reflect adequate reserves to cover any such contingencies, there can be no assurance that the outcomes of such examinations will not have a material impact on our results of operations and cash flows. If U.S. or other foreign tax authorities change applicable tax laws, our overall taxes could increase, and our financial condition or results of operations may be adversely impacted.Provisions enacted by the 2017 Tax Cuts and Jobs Act related to the capitalization for tax purposes of research and experimental (“R&E”) expenditures became effective on January 1, 2022. Beginning January 1, 2022, all U.S. and non-U.S. based R&E expenditures must be capitalized and amortized over five years and 15 years, respectively. Beginning January 1, 2022, we began capitalizing and amortizing R&E expenditures over five years for domestic research and 15 years for international research rather than expensing these costs as incurred.We may not be able to utilize a significant portion of our net operating loss carryforwards and tax credits, which could adversely affect our results of operations. We record an asset for the future tax benefits from unused U.S. federal, state, and non-U.S. net operating losses (“NOLs”) and tax credits subject to a full valuation allowance. Federal, state, and non-U.S. taxing bodies often place limitations on NOLs and tax credit carryforward benefits. As a result, we may not be able to utilize our NOLs and tax credits. In general, under Section 382 of the United States Internal Revenue Code of 1986 (the “Code”), a corporation that undergoes an ownership change is subject to limitations on its ability to utilize its pre-change NOLs to offset future taxable income. Future changes in our stock ownership, some of which are outside of our control, could result in an ownership change under Section 382 of the Code. If our existing NOLs are subject to limitations arising from an ownership change, our ability to utilize NOLs could be limited by 45Table of ContentsSection 382 of the Code, and a certain amount of our prior year NOLs could expire without benefit. Changes in the law may also impact our ability to use our NOLs and tax credit carryforwards.There is also a risk that the expiration of our existing NOLs or tax credits or a limitation on their use to offset future income tax liabilities could result from statutory or regulatory changes, especially in reaction to the COVID-19 pandemic. Our results of operations may be harmed if we are required to collect sales or other related taxes for our license arrangements in jurisdictions where we have not historically done so. States and some local taxing jurisdictions have differing rules and regulations governing sales and use taxes, and these rules and regulations are subject to varying interpretations that may change over time. We collect and remit U.S. sales and use tax, value-added tax (“VAT”), and goods and services tax (“GST”) in a number of jurisdictions. It is possible, however, that we could face sales tax, VAT, or GST audits and that our liability for these taxes could exceed our estimates as state and non-U.S. tax authorities could still assert that we are obligated to collect additional tax amounts from our customers and remit those taxes to those authorities. We could also be subject to audits in states and non-U.S. jurisdictions for which we have not accrued tax liabilities. One or more states or countries may seek to impose incremental or new sales, use, or other tax collection obligations on us or may determine that such taxes should have, but have not been, paid by us.Risks Related to Relationships and Business with the Public SectorA significant portion of our business depends on sales to the public sector, and our failure to receive and maintain government contracts or changes in the contracting or fiscal policies of the public sector has adversely affected and could continue to adversely affect our business, results of operations, financial condition, and growth prospects. We derive a significant portion of our revenue from contracts with federal, state, local, and foreign governments and government agencies, and we believe that the success and growth of our business will continue to depend on our successful procurement of government contracts. For example, we have historically derived, and expect to continue to derive, a significant portion of our revenue from sales to agencies of the U.S. federal government, either directly by us or through other government contractors. Our perceived relationship with the U.S. government could adversely affect our business prospects in certain non-U.S. geographies or with certain non-U.S. governments. Sales to such government agencies are subject to a number of challenges and risks. Selling to government agencies can be highly competitive, expensive, and time-consuming, often requiring significant upfront time and expense without any assurance that these efforts will generate a sale. We also must comply with laws and regulations relating to the formation, administration, and performance of contracts, which provide public sector customers rights, many of which are not typically found in commercial contracts. Accordingly, our business, financial condition, results of operations, and growth prospects may be adversely affected by certain events or activities, including, but not limited to: •changes in fiscal or contracting policies or decreases in available government funding; •changes in government programs or applicable requirements; •restrictions in the grant of personnel security clearances to our employees; •ability to maintain facility clearances required to perform on classified contracts for U.S. federal government and foreign government agencies;•ability to achieve or maintain one or more government certifications, including, but not limited to, our existing FedRAMP, IL5, and IL6 authorizations;•changes in the political environment, including before or after a change to the leadership within the government administration, or due to the ongoing Russia-Ukraine conflict and related economic sanctions and regional instability, and any resulting uncertainty or changes in policy or priorities and resultant funding; •changes in the government’s attitude towards the capabilities that we offer, especially in the areas of national defense, cybersecurity, and critical infrastructure, including the financial, energy, telecommunications, and healthcare sectors; •changes in the government’s attitude towards us as a company or our platforms as viable or acceptable software solutions; •appeals, disputes, or litigation relating to government procurement, including but not limited to bid protests by unsuccessful bidders on potential or actual awards of contracts to us or our partners by the government; •the adoption of new laws or regulations or changes to existing laws or regulations; 46Table of Contents•budgetary constraints, including automatic reductions as a result of “sequestration” or similar measures and constraints imposed by any lapses in appropriations for the federal government or certain of its departments and agencies; •influence by, or competition from, third parties with respect to pending, new, or existing contracts with government customers; •changes in political or social attitudes with respect to security or data privacy issues; •potential delays or changes in the government appropriations or procurement processes, including as a result of events such as war, incidents of terrorism, natural disasters, and public health concerns or epidemics, such as the coronavirus pandemic; and •increased or unexpected costs or unanticipated delays caused by other factors outside of our control, such as performance failures of our subcontractors.Such events or activities, among others, have caused and could continue to cause governments and governmental agencies to delay or refrain from purchasing our platforms and services in the future, reduce the size or payment amounts of purchases from existing or new government customers, or otherwise have an adverse effect on our business, results of operations, financial condition, and growth prospects. We have contracts with governments that involve classified programs, which may limit investor insight into portions of our business. We derive a portion of our revenue from programs with governments and government agencies that are subject to security restrictions (e.g., contracts involving classified information, classified contracts, and classified programs), which preclude the dissemination of information and technology that is classified for national security purposes under applicable law and regulation. In general, access to classified information, technology, facilities, or programs requires appropriate personnel security clearances, is subject to additional contract oversight and potential liability, and may also require appropriate facility clearances and other specialized infrastructure. In the event of a security incident involving classified information, technology, facilities, or programs or personnel holding clearances, we may be subject to legal, financial, operational, and reputational harm. We are limited in our ability to provide specific information about these classified programs, their risks, or any disputes or claims relating to such programs. As a result, investors have less insight into our classified programs than our other businesses and therefore less ability to fully evaluate the risks related to our classified business or our business overall. However, historically the business risks associated with our work on classified programs have not differed materially from those of our other government contracts. Our business could be adversely affected if our employees cannot obtain and maintain required personnel security clearances or we cannot establish and maintain a required facility security clearance. Certain government contracts may require our employees to maintain various levels of security clearances and may require us to maintain a facility security clearance to comply with U.S. and international government agency requirements. Many governments have strict security clearance requirements for personnel who perform work in support of classified programs. Obtaining and maintaining security clearances for employees typically involves a lengthy process, and it can be difficult to identify, recruit, and retain employees who already hold security clearances. If our employees are unable to obtain security clearances in a timely manner, or at all, or if our employees who hold security clearances are unable to maintain their clearances or terminate employment with us, then we may be unable to comply with relevant U.S. and international government agency requirements, or our customers requiring classified work could choose to terminate or decide not to renew one or more contracts requiring employees to obtain or maintain security clearances upon expiration. To the extent we are not able to obtain or maintain a facility security clearance, we may not be able to bid on or win new classified contracts, and existing contracts requiring a facility security clearance could be terminated, either of which would have an adverse impact on our business, financial condition, and results of operations. Many of our customer contracts may be terminated by the customer at any time for convenience and may contain other provisions permitting the customer to discontinue contract performance, and if terminated contracts are not replaced, our results of operations may differ materially and adversely from those anticipated. In addition, our contracts with government customers often contain provisions with additional rights and remedies favorable to such customers that are not typically found in commercial contracts. Many of our contracts, including our government contracts, contain termination for convenience provisions. Customers that terminate such contracts may also be entitled to a pro rata refund of the amount of the customer deposit for the period of time remaining in the contract term after the applicable termination notice period expires. Government contracts often contain provisions and are subject to laws and regulations that provide government customers with additional rights and remedies not typically found in commercial contracts. These rights and remedies allow government customers, among other things, to: 47Table of Contents•terminate existing contracts for convenience with short notice; •reduce orders under or otherwise modify contracts; •for contracts subject to the Truth in Negotiations Act, reduce the contract price or cost where it was increased because a contractor or subcontractor furnished cost or pricing data during negotiations that was not complete, accurate, and current; •for some contracts, (i) demand a refund, make a forward price adjustment, or terminate a contract for default if a contractor provided inaccurate or incomplete data during the contract negotiation process and (ii) reduce the contract price under triggering circumstances, including the revision of price lists or other documents upon which the contract award was predicated; •cancel multi-year contracts and related orders if funds for contract performance for any subsequent year become unavailable; •decline to exercise an option to renew a multi-year contract or issue task orders in connection with indefinite delivery/indefinite quantity (“IDIQ”) contracts; •claim rights in solutions, systems, or technology produced by us, appropriate such work-product for their continued use without continuing to contract for our services, and disclose such work-product to third parties, including other government agencies and our competitors, which could harm our competitive position; •prohibit future procurement awards with a particular agency due to a finding of organizational conflicts of interest based upon prior related work performed for the agency that would give a contractor an unfair advantage over competing contractors, or the existence of conflicting roles that might bias a contractor’s judgment; •subject the award of contracts to protest by competitors, which may require the contracting federal agency or department to suspend our performance pending the outcome of the protest and may also result in a requirement to resubmit offers for the contract or in the termination, reduction, or modification of the awarded contract; •suspend or debar us from doing business with the applicable government; and •control or prohibit the export of our services.If a customer were to unexpectedly terminate, cancel, or decline to exercise an option to renew with respect to one or more of our significant contracts, or if a government were to suspend or debar us from doing business with such government, our business, financial condition, and results of operations would be materially harmed. Failure to comply with laws, regulations, or contractual provisions applicable to our business could cause us to lose government customers or our ability to contract with the U.S. and other governments. As a government contractor, we must comply with laws, regulations, and contractual provisions relating to the formation, administration, and performance of government contracts and inclusion on government contract vehicles, which affect how we and our partners do business with government agencies. As a result of actual or perceived noncompliance with government contracting laws, regulations, or contractual provisions, we may be subject to audits and internal investigations which may prove costly to our business financially, divert management time, or limit our ability to continue selling our platforms and services to our government customers. These laws and regulations may impose other added costs on our business, and failure to comply with these or other applicable regulations and requirements, including non-compliance in the past, could lead to claims for damages from our channel partners, penalties, and termination of contracts and suspension or debarment from government contracting for a period of time with government agencies. Any such damages, penalties, disruption, or limitation in our ability to do business with a government could adversely impact, and could have a material adverse effect on, our business, results of operations, financial condition, public perception, and growth prospects. Evolving government procurement policies and increased emphasis on cost over performance could adversely affect our business. Federal, state, local, and foreign governments and government agencies could implement procurement policies that negatively impact our profitability. Changes in procurement policy favoring more non-commercial purchases, different pricing, or evaluation criteria or government contract negotiation offers based upon the customer’s view of what our pricing should be may affect the predictability of our margins on such contracts or make it more difficult to compete on certain types of programs. Governments and government agencies are continually evaluating their contract pricing and financing practices, and we have no assurance regarding the full scope and recurrence of any study and what changes will be proposed, if any, and their impact on our financial position, cash flows, or results of operations. 48Table of ContentsIncreased competition and bid protests in a budget-constrained environment may make it more difficult to maintain our financial performance and customer relationships. A substantial portion of our business is awarded through competitive bidding. Even if we are successful in obtaining an award, we may encounter bid protests from unsuccessful bidders on any specific award. Bid protests could result, among other things, in significant expenses to us, contract modifications, or even loss of the contract award. Even where a bid protest does not result in the loss of a contract award, the resolution can extend the time until contract activity can begin and, as a result, delay the recognition of revenue. We also may not be successful in our efforts to protest or challenge any bids for contracts that were not awarded to us, and we would be required to incur significant time and expense in such efforts. In addition, governments and agencies increasingly have relied on competitive contract award types, including IDIQ and other multi-award contracts, which have the potential to create pricing pressure and to increase our costs by requiring us to submit multiple bids and proposals. Multi-award contracts require us to make sustained efforts to obtain orders under the contract. The competitive bidding process entails substantial costs and managerial time to prepare bids and proposals for contracts that may not be awarded to us or may be split among competitors. We are experiencing increased competition while, at the same time, many of our customers are facing budget pressures, cutting costs, identifying more affordable solutions, performing certain work internally rather than hiring contractors, and reducing product development cycles. To remain competitive, we must maintain consistently strong customer relationships, seek to understand customer priorities, and provide superior performance, advanced technology solutions, and service at an affordable cost with the agility that our customers require to satisfy their objectives in an increasingly price competitive environment. Failure to do so could have an adverse impact on our business, financial condition, and results of operations. The U.S. government may procure non-commercial developmental services rather than commercial products, which could materially impact our future U.S. government business and revenue. U.S. government agencies, including our customers, often award large developmental item and service contracts to build custom software rather than firm fixed-price contracts for commercial products. We sell commercial items and services and do not contract for non-commercial developmental services. The U.S. government is required to procure commercial items and services to the maximum extent practicable in accordance with FASA, 10 U.S.C. § 2377; 41 U.S.C. § 3307, and the U.S. government may instead decide to procure non-commercial developmental items and services if commercial items and services are not practicable. In order to challenge a government decision to procure developmental items and services instead of commercial items and services, we would be required to file a bid protest at the agency level and/or with the Government Accountability Office. This can result in contentious communications with government agency legal and contracting offices, and may escalate to litigation in federal court. The results of any future challenges or potential litigation cannot be predicted with certainty, however, and any dispute or litigation with the U.S. government may not be resolved in our favor; moreover, whether or not it is resolved in our favor, such disputes or litigation could result in significant expense and divert the efforts of our technical and management personnel. These proceedings could adversely affect our reputation and relationship with government customers and could also result in negative publicity, which could harm customer and public perception of our business. The enforcement of FASA has resulted in a significant increase in our business with the U.S. federal government. Any change in or repeal of FASA, or a contrary interpretation of FASA by a court of competent jurisdiction, would adversely affect our competitive position for U.S. federal government contracts. A decline in the U.S. and other government budgets, changes in spending or budgetary priorities, or delays in contract awards have affected and may continue to significantly and adversely affect our future revenue and limit our growth prospects. Because we generate a substantial portion of our revenue from contracts with governments and government agencies, and in particular from contracts with the U.S. government and government agencies, our results of operations could be adversely affected by government spending caps or changes in government budgetary priorities, as well as by delays in the government budget process, program starts, or the award of contracts or orders under existing contract vehicles, including as a result of a new U.S. administration. Current U.S. government spending levels for defense-related and other programs may not be sustained beyond government fiscal year 2023. Future spending and program authorizations may not increase or may decrease or shift to programs in areas in which we do not provide services or are less likely to be awarded contracts. Such changes in spending authorizations and budgetary priorities may occur as a result of shifts in spending priorities from defense-related and other programs as a result of competing demands for federal funds and the number and intensity of military conflicts or other factors. The U.S. government also conducts periodic reviews of U.S. defense strategies and priorities which may shift Department of Defense budgetary priorities, reduce overall spending, or delay contract or task order awards for defense-related programs from which we would otherwise expect to derive a significant portion of our future revenue. A significant decline in overall U.S. government spending, a significant shift in spending priorities, the substantial reduction or elimination of particular defense-49Table of Contentsrelated programs, or significant budget-related delays in contract or task order awards for large programs have affected and could continue to adversely affect our future revenue and limit our growth prospects. Risks Related to Ownership of Our Class A Common Stock The public trading price of our Class A common stock may be volatile and may decline regardless of our operating performance. Prior to the listing of our Class A common stock, there was no public market for shares of our Class A common stock. The market prices of the securities of other recently public companies have historically been highly volatile. The public trading price of our Class A common stock has been, and may in the future be, subject to fluctuations in response to various factors, including those listed in this Annual Report on Form 10-K, some of which are beyond our control. These fluctuations could cause you to lose all or part of your investment in our Class A common stock since you might be unable to sell your shares at or above the price you paid. Factors that could cause fluctuations in the public trading price of our Class A common stock include the following: •the number of shares of our Class A common stock publicly owned and available for trading; •price and volume fluctuations in the overall stock market from time to time; •volatility in the trading prices and trading volumes of technology stocks; •changes in operating performance and stock market valuations of other technology companies generally, or those in our industry in particular; •sales or expected sales of shares of our Class A common stock by us or our stockholders; •short-selling of our Class A common stock or related derivative securities; •failure of securities analysts to maintain coverage of us, changes in financial estimates by securities analysts who follow our company or our failure to meet these estimates or the expectations of investors; •any financial projections we may provide to the public, any changes in those projections or our failure to meet those projections; •announcements by us or our competitors of new services or platform features; •the public’s reaction to our press releases, other public announcements, and filings with the SEC; •rumors and market speculation involving us or other companies in our industry; •actual or anticipated changes in our results of operations or fluctuations in our results of operations; •actual or anticipated developments in our business, our competitors’ businesses, or the competitive landscape generally; •litigation involving us, our industry or both, or investigations by regulators into our operations or those of our competitors; •actual or perceived privacy or security breaches or other incidents; •developments or disputes concerning our intellectual property or other proprietary rights; •announced or completed acquisitions of businesses, services or technologies by us or our competitors; •changes in our management, including any departures of one of our Founders; •new laws or regulations, public expectations regarding new laws or regulations or new interpretations of existing laws or regulations applicable to our business; •changes in accounting standards, policies, guidelines, interpretations, or principles; •any significant change in our management; •other events or factors, including those resulting from war, including the ongoing Russia-Ukraine conflict, incidents of terrorism, pandemics, including the ongoing COVID-19 pandemic, or responses to these events; and •general macroeconomic conditions, such as rising inflation and interest rates and slow or negative growth of our markets.In addition, stock markets, and the market for technology companies in particular, have experienced price and volume fluctuations that have affected and continue to affect the trading prices of equity securities of many companies. Stock prices of 50Table of Contentsmany companies, including technology companies, have fluctuated in a manner often unrelated to the operating performance of those companies. In the past, following periods of volatility in the overall market and the trading price of a particular company’s securities, securities class action litigation has often been instituted against these companies. Such litigation, including the recent purported class action lawsuits and derivative lawsuits filed against us and certain of our officers and directors, could result in substantial costs and a diversion of our management’s attention and resources and harm our business, financial condition, and results of operations. Further, in the future, we may be the target of additional litigation of this type.Our amended and restated bylaws designate a state or federal court located within the State of Delaware as the exclusive forum for substantially all disputes between us and our stockholders, and also provide that the federal district courts will be the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act of 1933, as amended, each of which could limit our stockholders’ ability to choose the judicial forum for disputes with us or our directors, officers, stockholders, or employees. Our amended and restated bylaws provide that, unless we consent in writing to the selection of an alternative forum, the sole and exclusive forum for (a) any derivative action or proceeding brought on our behalf, (b) any action asserting a claim of breach of a fiduciary duty owed by any of our current or former directors, stockholders, officers, or other employees to us or our stockholders, (c) any action or proceeding asserting a claim arising pursuant to, or seeking to enforce any right, obligation or remedy under, any provision of the Delaware General Corporation Law, our amended and restated certificate of incorporation, or our amended and restated bylaws, (d) any action or proceeding as to which the Delaware General Corporation Law confers jurisdiction on the Court of Chancery of the State of Delaware, or (e) any action or proceeding asserting a claim that is governed by the internal affairs doctrine shall be the Court of Chancery of the State of Delaware (or, if the Court of Chancery does not have jurisdiction, another state court in Delaware or, if no state court in Delaware has jurisdiction, the federal district court for the District of Delaware) and any appellate court therefrom, in all cases subject to the court having jurisdiction over the claims at issue and the indispensable parties; provided that the exclusive forum provision will not apply to suits brought to enforce any liability or duty created by the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Section 22 of the Securities Act of 1933, as amended (the “Securities Act”), creates concurrent jurisdiction for federal and state courts over all such Securities Act actions. Accordingly, both state and federal courts have jurisdiction to entertain such claims. To prevent having to litigate claims in multiple jurisdictions and the threat of inconsistent or contrary rulings by different courts, among other considerations, our amended and restated bylaws also provide that the federal district courts of the United States of America will be the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act. Any person or entity purchasing or otherwise acquiring or holding or owning (or continuing to hold or own) any interest in any of our securities shall be deemed to have notice of and consented to the foregoing bylaw provisions. Although we believe these exclusive forum provisions benefit us by providing increased consistency in the application of Delaware law and federal securities laws in the types of lawsuits to which each applies, the exclusive forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum of its choosing for disputes with us or any of our directors, officers, stockholders, or other employees, which may discourage lawsuits with respect to such claims against us and our current and former directors, officers, stockholders, or other employees. Our stockholders will not be deemed to have waived our compliance with the federal securities laws and the rules and regulations thereunder as a result of our exclusive forum provisions. Further, in the event a court finds either exclusive forum provision contained in our amended and restated bylaws to be unenforceable or inapplicable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could harm our results of operations. Sales of substantial amounts of our Class A common stock in the public markets or the perception that sales might occur, including sales by our Founders and their affiliates, could cause the trading price of our Class A common stock to decline. Sales of substantial amounts of our Class A common stock in the public markets or the perception that sales might occur, could cause the trading price of our Class A common stock to decline. In addition to the supply and demand and volatility risk factors discussed above, sales of a substantial number of shares of our Class A common stock into the public market, particularly sales by our directors, executive officers, and principal stockholders, or the perception that these sales might occur in large quantities, could cause the trading price of our Class A common stock to decline. As of December 31, 2022, approximately 9.4 million options will expire through December 2023 if not exercised prior to their respective expiration dates, and we expect many holders will elect to exercise such options prior to expiration. Upon exercise, the holders will receive shares of our Class A or Class B common stock, which may subsequently be sold. As of December 31, 2022, there were 1,995,413,508 shares of our Class A common stock outstanding, 102,656,175 shares of our Class B common stock outstanding and 1,005,000 shares of our Class F common stock outstanding. Substantially all of 51Table of Contentsthese shares may be immediately sold, although sales by our affiliates remain subject to compliance with the volume limitations of Rule 144. Further, as of December 31, 2022, there were outstanding options to purchase an aggregate of 136,930,225 shares of our Class A common stock and 189,982,548 shares of our Class B common stock, and 78,575,574 shares of our Class A common stock and 47,850,000 shares of Class B common stock subject to RSUs. All shares of our common stock reserved for future issuance under our equity compensation plans have been registered for sale under the Securities Act. Subject to compliance with Rule 144 or the availability of an alternative exemption, the shares issued upon exercise of stock options or upon settlement of RSUs will be available for immediate resale in the United States in the open market. While the registration rights of our non-affiliates pursuant to our Amended and Restated Investors’ Rights Agreement dated August 24, 2020 requiring us to register shares owned by them for public sale in the United States have expired under the terms of that agreement, our affiliates who are party to the Amended and Restated Investors’ Rights Agreement, including our Founders and certain of the entities affiliated with Peter Thiel, will retain the right to cause us to register shares held by them for resale until such rights terminate in accordance with our Amended and Restated Investors’ Rights Agreement. Any registration statement we file to register additional shares, whether as a result of registration rights or otherwise and whether in connection with the exercise of stock options, the settlement of RSUs, or the exercise or settlement of other awards or otherwise, could cause the trading price of our Class A common stock to decline or be volatile. We also may issue our capital stock or securities convertible into our capital stock from time to time in connection with a financing, acquisition, investments or otherwise. Any such issuance could result in substantial dilution to our existing stockholders and cause the trading price of our Class A common stock to decline. Provisions in our amended and restated certificate of incorporation and amended and restated bylaws may discourage certain types of transactions that may involve an actual or threatened acquisition of the Company, which will likely depress the trading price of our Class A common stock. Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may make the acquisition of our company more difficult, including the following: •our multi-class common stock structure, which provides our Founders and their affiliates with the ability to effectively control the outcome of matters requiring stockholder approval, even if they own significantly less than a majority of the shares of our outstanding common stock; •prior to the Final Class F Conversion Date (as defined in our amended and restated certificate of incorporation), the holders of our common stock will only be able to take action by written consent if the action also receives the affirmative consent of a majority of the outstanding shares of our Class F common stock, and after such point the holders of our common stock will only be able to take action at a meeting of the stockholders and will not be able to take action by written consent for any matter;•from and after the Final Class F Conversion Date, our Board of Directors will be classified into three classes of directors with staggered three-year terms;•our amended and restated certificate of incorporation does not provide for cumulative voting; •certain transactions, other than restructuring transactions or transactions that otherwise do not involve a Change of Control (as defined in our amended and restated certificate of incorporation), which transactions require, pursuant to Section 251(c) or Section 271(a) of the Delaware General Corporation Law, the approval of the holders of a majority of the voting power of all of the outstanding shares of our capital stock entitled to vote thereon, will require approval by the holders of at least 55.0% of the voting power of all of the outstanding shares of our capital stock entitled to vote thereon if the record date for determining the stockholders entitled to vote to approve such transaction occurs prior to the Final Class F Conversion Date;•certain transactions prior to the Final Class F Conversion Date, that would require disclosure pursuant to Item 404(a) of Regulation S-K, between any of our Founders (or their controlled affiliates), on the one hand, and us, on the other, in which consideration exchanges hands between our Founders (or their controlled affiliates) and us, and such consideration has a fair market value in excess of $50.0 million as determined in accordance with our amended and restated bylaws will require approval by either (i) the holders of at least 66 2/3% of the voting power of all of the outstanding shares of our capital stock, voting together as a single class, or (ii) an Independent Committee (as defined in our amended and restated bylaws); •the acquisition of our equity securities by our Founders (including their controlled affiliates), prior to the Final Class F Conversion Date, in a “Rule 13e-3 transaction” (as defined in Rule 13e-3 under the Exchange Act) will be conditioned on approval by (i) an Independent Committee and (ii) the holders of a majority of the voting power of our capital stock 52Table of Contentsthat is held by our stockholders other than the Founders (including their controlled affiliates) and any holder of the Class F Common Stock;•vacancies on our Board of Directors will be able to be filled only by our Board of Directors and not by stockholders; •our directors may only be removed as provided in the Delaware General Corporation Law; •a special meeting of our stockholders may only be called by the chairperson of our Board of Directors, our Chief Executive Officer, our President, or our Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized directorships, whether or not there exist any vacancies or other unfilled seats in previously authorized directorships; •our amended and restated certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established and shares of which may be issued without further action by our stockholders, except that any designation and issuance of preferred stock must receive the affirmative vote of a majority of the outstanding shares of our Class F common stock; and •advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders.These provisions, alone or together, could discourage, delay or prevent a transaction involving a change in control of our company. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors of their choosing and to cause us to take other corporate actions they desire, any of which, under certain circumstances, could limit the opportunity for our stockholders to receive a premium for their shares of our Class A common stock, and could also affect the price that some investors are willing to pay for our Class A common stock. If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about us, our business or our market, or if they change their recommendation regarding our Class A common stock adversely, the trading price and trading volume of our Class A common stock could decline. The trading market for our Class A common stock will depend in part on the research and reports that securities or industry analysts publish about us, our business, our market or our competitors. If one or more of the analysts who cover us downgrade our ordinary shares or publish inaccurate or unfavorable research about us, the trading price of our Class A common stock would likely decline. If these analysts publish target prices for our Class A common stock that are below the then-current public price of our Class A common stock, it could cause the trading price of our Class A common stock to decline significantly. Further, if one or more of these analysts cease coverage of Palantir or fail to publish reports on us regularly, demand for our Class A common stock could decrease, which might cause our Class A common stock trading price and trading volume to decline. Although we currently are not considered to be a “controlled company” under the NYSE corporate governance rules, we may in the future become a controlled company due to the concentration of voting power among our Founders and their affiliates. Although we currently are not considered to be a “controlled company” under the NYSE corporate governance rules, we may in the future become a controlled company due to the concentration of voting power among our Founders and their affiliates resulting from the issuance of our Class F common stock. See “Risks Related to the Multiple Class Structure of our Common Stock, the Founder Voting Trust Agreement, and the Founder Voting Agreement” below. A “controlled company” pursuant to the NYSE corporate governance rules is a company of which more than 50% of the voting power is held by an individual, group, or another company. In the event that our Founders and their affiliates or other stockholders acquire more than 50% of the voting power of the Company, we may in the future be able to rely on the “controlled company” exemptions under the NYSE corporate governance rules due to this concentration of voting power and the ability of our Founders and their affiliates to act as a group. If we were a controlled company, we would be eligible, and could elect, not to comply with certain of the NYSE corporate governance standards. Such standards include the requirement that a majority of directors on our Board of Directors are independent directors, subject to certain phase-in periods, and the requirement that our compensation, nominating and governance committee consist entirely of independent directors. In such a case, if the interests of our stockholders differ from the group of stockholders holding a majority of the voting power, our stockholders would not have the same protection afforded to stockholders of companies that are subject to all of the NYSE corporate governance standards, and the ability of our independent directors to influence our business policies and corporate matters may be reduced. We do not expect to pay dividends in the foreseeable future. We have never declared nor paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not anticipate declaring or paying any dividends to holders of our capital stock in the foreseeable future. In addition, our credit facility contains restrictions on our ability to pay dividends. 53Table of ContentsAny determination to pay dividends in the future will be at the discretion of our Board of Directors. Consequently, stockholders must rely on sales of their Class A common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Risks Related to the Multiple Class Structure of our Common Stock, the Founder Voting Trust Agreement, and the Founder Voting Agreement The multiple class structure of our common stock has the effect of concentrating voting power with certain stockholders, in particular, our Founders and their affiliates, which will effectively eliminate your ability to influence the outcome of important transactions, including a change in control. Our Class A common stock has one (1) vote per share, and our Class B common stock has ten (10) votes per share with respect to each matter submitted to our stockholders. Assuming that the Founders and certain of their affiliates collectively meet the Ownership Threshold (as defined below) on the applicable record date for a vote of the stockholders (except as provided in our amended and restated certificate of incorporation), shares of Class F common stock will generally have a number of votes per share in respect of a matter submitted to our stockholders that would cause the total votes of all shares of Class F common stock, together with the votes attributable to shares of Class A common stock and Class B common stock held by our Founders and their affiliates that are subject to the voting agreement among our Founders and Wilmington Trust, National Association (the “Founder Voting Agreement”) and the votes attributable to shares of Class A common stock and Class B common stock held by our Founders and their affiliates that are designated as Designated Founders’ Excluded Shares (as defined in our amended and restated certificate of incorporation), in each case entitled to vote on such matter, to equal, with respect to such matter, 49.999999% of the voting power of (i) all of the outstanding shares of capital stock of the Company entitled to vote on such matter (including in the case of the election of directors); or (ii) the shares present in person or represented by proxy and entitled to vote on such matter only if a majority of the shares present in person or represented by proxy and entitled to vote on such matter is the applicable voting standard (as applicable, “49.999999% of the Voting Power”). Accordingly, subject to limited exceptions described in our amended and restated certificate of incorporation and amended and restated bylaws, such Founders will effectively control all matters submitted to the stockholders for the foreseeable future, including the election of directors, amendments of our organizational documents, compensation matters, and any merger, consolidation, sale of all or substantially all of our assets, or other major corporate transaction requiring stockholder approval. Our Founders and their affiliates also hold the substantial majority of our outstanding Class B common stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, even without regard to the voting power of the Class F common stock, our Founders and their affiliates collectively control a significant portion of the voting power of our capital stock based on their current ownership and may significantly increase their ownership of Class B common stock in the future due to the exercise of currently outstanding warrants and stock options or the settlement of RSUs. The Founders may have interests that differ from yours and may vote in a way with which you disagree, and which may be adverse to your interests. This concentration of voting power is likely to have the effect of limiting the likelihood of an unsolicited merger proposal, unsolicited tender offer, or proxy contest for the removal of directors. As a result, our governance structure, including the provisions of our amended and restated certificate of incorporation, may have the effect of depriving our stockholders of an opportunity to sell their shares at a premium over prevailing market prices and make it more difficult to replace our directors and management. The Founder Voting Trust Agreement and the Founder Voting Agreement also have the effect of concentrating voting power with our Founders and their affiliates, which will effectively eliminate your ability to influence the outcome of important transactions, including a change in control. All shares of our Class F common stock are held in a voting trust (the “Founder Voting Trust”), established by our Founders pursuant to a voting trust agreement (the “Founder Voting Trust Agreement”) with Wilmington Trust, National Association as trustee (the “Trustee”). Our Founders are also currently party to the Founder Voting Agreement. Our Founders have agreed through the Founder Voting Trust Agreement and Founder Voting Agreement that all of the shares of Class F common stock and all of the shares of our capital stock over which they and their affiliates have granted a proxy under the Founder Voting Agreement will be voted in the manner instructed by a majority of our Founders who are then party to the Founder Voting Agreement. Accordingly, together with the multiple class structure of our common stock and subject to limited exceptions described in our amended and restated certificate of incorporation and amended and restated bylaws, such Founders will effectively control all matters submitted to the stockholders for the foreseeable future, including the election of directors, amendments of our organizational documents, compensation matters, and any merger, consolidation, sale of all or substantially all of our assets, or other major corporate transaction requiring stockholder approval. Upon the withdrawal or removal of any of our Founders from the Founder Voting Agreement, including upon their death or disability, the remaining Founders or Founder, as the case may be, will determine the manner in which the shares of our Class F common stock as well as the shares subject to the Founder Voting Agreement are voted. In such cases, the voting power of our outstanding capital stock will be further concentrated among the remaining Founders, which may be as few as one. Further, if 54Table of Contentsthere are only two Founders who are party to the Founder Voting Agreement, one Founder will be able to effectively defeat any stockholder action, except for the election of directors or other matters that are decided by a plurality of votes, if his instruction to vote the shares of Class F common stock differs from the other Founder. The Founders who are then party to the Founder Voting Agreement will retain the right to direct the voting of the Class F common stock without regard to their employment status with us. All shares of our Class F common stock are held in the Founder Voting Trust and voted pursuant to the Founder Voting Trust Agreement. Accordingly, our Founders who are then party to the Founder Voting Agreement will control any vote that requires the affirmative vote of the holders of a majority of our Class F common stock, including action of our stockholders by written consent, the designation or issuance by us of shares of preferred stock, and certain amendments to our amended and restated certificate of incorporation relating to our preferred stock. Although we are a third-party beneficiary of the Founder Voting Agreement and the Founder Voting Trust Agreement, we do not have a general consent right with respect to amendments thereto, and either agreement may be amended or modified in the future in a manner that is adverse to our stockholders, which may include increasing the ability of one or more of our Founders to exercise control over matters submitted to a vote of our stockholders. In certain circumstances in the future, the Founders and their affiliates could have voting power that exceeds 49.999999% of the Voting Power. If the voting power of shares of Class A common stock and Class B common stock held by the Founders or their affiliates that are subject to the Founder Voting Agreement or are Designated Founders’ Excluded Shares collectively equals greater than 49.999999% of the Voting Power with respect to a matter submitted to our stockholders, then the Class F common stock will have zero votes with respect to such matter. In this case, although the shares of our Class F common stock would generally be entitled to zero votes per share on that matter, all of the shares that are then subject to the Founder Voting Agreement would continue to be voted in accordance with the decision of a majority in number of the Founders who are then party to the Founder Voting Agreement. For example, if the Founders and their affiliates hold shares other than the Class F common stock, such as Class B common stock, that, in the aggregate, have voting power that exceeds 49.999999% of the Voting Power with respect to a matter submitted to our stockholders, then the total voting power of the Founders and their affiliates would exceed 49.999999% of the Voting Power with respect to such matter. Our Founders and their affiliates may acquire additional shares of our Class A common stock or Class B common stock. Shares of our Class B common stock may be transferred (without converting into shares of Class A common stock) to, among others, our Founders or their affiliates, and such transfers to our Founders or their affiliates could increase the total voting power of the Founders and their affiliates above 49.999999% of the Voting Power with respect to such matter. Excluding the voting power of the Class F common stock, our Founders and their affiliates owned shares entitled to approximately 27.1% of the voting power of our outstanding capital stock in the aggregate as of February 14, 2023.In addition, if one or two Founders withdraw from the Founder Voting Agreement, the total voting power of the Founders and their affiliates in the aggregate could exceed 49.999999% of the Voting Power. For instance, if one Founder has withdrawn from the Founder Voting Agreement and such withdrawing Founder votes his shares in the same manner as the shares of Class F common stock are voted pursuant to the Founder Voting Trust Agreement, then our Founders and their affiliates, in the aggregate, could exercise 49.999999% of the Voting Power of our capital stock plus the voting power of shares held by the withdrawing Founder (which would no longer represent a subset of the 49.999999% of the Voting Power of our capital stock voted by those Founders that remain party to the Founder Voting Agreement). As a result of future issuances of our common stock or the disposal of shares of our common stock by our Founders and their affiliates, our Founders and their affiliates could have voting power that is substantially greater than, and outsized in comparison to, their economic interests and the percentage of our common stock that they hold. In certain circumstances, our Founders and their affiliates could have voting power that is substantially greater than, and outsized in comparison to, their economic interests and the percentage of our common stock that they hold. This separation between voting power and economic interests could cause conflicts of interest between our Founders and our other stockholders, which may result in our Founders undertaking, or causing us to undertake, actions that would be desirable for the Founders or their affiliates but would not be desirable for our other stockholders. In the event that our Founders and their affiliates have less than 49.999999% of the Voting Power prior to giving effect to the voting power of the Class F common stock, the issuance of additional shares by us in the future to stockholders other than our Founders who are then party to the Founder Voting Agreement or their affiliates will dilute the economic interests of our Founders but will generally not result in further dilution of the voting power of such Founders and their affiliates. Because of the voting rights of the Class F common stock, such issuances will instead correspondingly increase the voting power of the 55Table of ContentsClass F common stock. Any future issuances of additional shares of Class A common stock and Class B common stock will not be subject to approval by our stockholders except as required by the listing standards of the NYSE.In addition, our Founders and their affiliates are free to transfer or otherwise dispose of their shares of Class A common stock and Class B common stock without diminishing their voting power so long as our Founders and certain of their affiliates continue to collectively hold 100,000,000 Corporation Equity Securities (as defined in our amended and restated certificate of incorporation) on the applicable record date (subject to equitable adjustments as provided in our amended and restated certificate of incorporation) (the “Ownership Threshold”). Shares of our Class F common stock will not convert into shares of our Class B common stock, and our multi-class structure will not terminate, solely because our Founders and certain of their affiliates do not satisfy this Ownership Threshold on the applicable record date. Upon the withdrawal, or removal, of one or more of our Founders from the Founder Voting Agreement (including as a result of death or disability), the Ownership Threshold that must be met on the applicable record date will be reduced on a pro rata basis based on the ownership of Corporation Equity Securities (which excludes Designated Founders’ Excluded Shares) of the Founders and certain of their affiliates as of August 10, 2020, which could substantially decrease the Ownership Threshold without reducing the effective voting power of the Class F common stock. Accordingly, our Founders who are then party to the Founder Voting Agreement will be able to achieve substantial liquidity in their holdings, and substantially diminish their economic interest in us, without diminishing their voting power. Furthermore, meeting the Ownership Threshold on the applicable record date will not ensure that the Founders and their affiliates do not or will not have differing economic interests from the interests of holders of the Class A common stock. For example, the Founder Voting Agreement does not prohibit a Founder from hedging his economic exposure to our common stock; however, we have implemented a policy that will prohibit hedging by our directors, officers and employees, which currently includes the Founders. In addition, the trustee will vote shares of Class F common stock in accordance with the decision of a majority in number of the Founders who are then party to the Founder Voting Agreement, regardless of such Founders’ relative ownership of any class of our common stock. In August 2020, we granted two of our Founders, Mr. Karp, our Chief Executive Officer and a member of our Board of Directors, and Mr. Cohen, our President and a member of our Board of Directors, options and RSUs for an aggregate of 207.0 million shares of our Class B common stock (collectively, the “Founder Grants”), the substantial majority of which remain subject to vesting, exercise, and/or settlement upon the future satisfaction of service conditions and certain other conditions. These awards are expected to contribute to the Founders’ ability to meet the Ownership Threshold on the applicable record date at least until the sale of such shares by Mr. Karp and Mr. Cohen. Shares of our common stock designated by one or more of our Founders pursuant to our amended and restated certificate of incorporation may be voted or not voted by such Founders or their affiliates in their discretion and will reduce the voting power exercised in accordance with the decision of a majority in number of the Founders who are then party to the Founder Voting Agreement. Mr. Thiel has identified a portion of the shares of Class B common stock and Class A common stock beneficially owned by him and his affiliates as Designated Founders’ Excluded Shares, which will not be subject to the Founder Voting Agreement. Such Designated Founders’ Excluded Shares would reduce the total voting power that will be exercised in accordance with the decision of a majority in number of the Founders who are then party to the Founder Voting Agreement. Mr. Thiel or his affiliates would vote or not vote such Designated Founders’ Excluded Shares in their discretion, which may include in a manner different than the voting power exercised in accordance with the decision of a majority in number of the Founders who are then party to the Founder Voting Agreement. Depending on certain circumstances, including the extent to which other holders of Class B common stock convert or sell such shares of Class B common stock, such Designated Founders’ Excluded Shares may have significant voting power and increase Mr. Thiel or his affiliates’ relative voting power compared to the other Founders. The shares identified by Mr. Thiel as Designated Founders’ Excluded Shares represented less than 5% of the voting power of our outstanding capital stock as of February 14, 2023. In the future, Mr. Thiel or our other Founders could designate additional shares as Designated Founders’ Excluded Shares. The Ownership Threshold that must be met on any applicable record date is a small minority of our outstanding Corporation Equity Securities, and future issuances of Corporation Equity Securities may decrease this percentage. The Ownership Threshold that must be met on any applicable record date is currently 100,000,000 Corporation Equity Securities, which is a small minority of our outstanding Corporation Equity Securities. While the number of outstanding Corporation Equity Securities may exceed the number of shares of our outstanding capital stock, as a comparison, there were 2,099,074,683 shares of our common stock outstanding as of December 31, 2022. Except for certain equitable adjustments as provided in our amended and restated certificate of incorporation, future issuances of Corporation Equity Securities by us will not increase the Ownership Threshold that must be met on any applicable record date and, accordingly, will decrease the percentage of outstanding Corporation Equity Securities represented by the Ownership Threshold. 56Table of ContentsUpon the withdrawal, or removal, of one or more of our Founders from the Founder Voting Agreement (including as a result of death or disability), the Ownership Threshold that must be met on the applicable record date will be reduced on a pro rata basis based on the ownership of Corporation Equity Securities of the Founders and certain of their affiliates as of August 10, 2020. We expect that the Ownership Threshold will be reduced by approximately 57 million Corporation Equity Securities upon the withdrawal or removal from the Founder Voting Agreement of Alexander Karp, approximately 12 million Corporation Equity Securities upon the withdrawal or removal of Stephen Cohen, and approximately 31 million Corporation Equity Securities upon the withdrawal or removal of Peter Thiel if such withdrawals or removals were to happen. In addition, in the future we could create a new class of equity securities with different economic or voting rights than existing classes. If we were to create a new class of equity security, because of the broad definition of “Corporation Equity Securities,” such security could qualify as Corporation Equity Securities and therefore count towards the Ownership Threshold if held by our Founders who are then party to the Founder Voting Agreement or certain of their affiliates. If such security has lesser or no economic rights, it could have the effect of further increasing the divergence between the economic interests of our Founders who are then party to the Founder Voting Agreement and their affiliates, on the one hand, and the voting power of such Founders and their affiliates, on the other. Further, Corporation Equity Securities includes, among other things, any warrants, calls, options or other right, whether vested or unvested, to acquire from the Company certain voting or equity securities from the Company. Accordingly, the Board of Directors could issue additional equity securities, or additional options, RSUs, warrants or other rights to acquire equity securities (whether vested or unvested), to our Founders or certain of their affiliates, which would increase the number of Corporation Equity Securities they hold and enable them to meet the Ownership Threshold notwithstanding sales of Corporation Equity Securities that they currently hold. As a result, any Founders who are then party to the Founder Voting Agreement or certain of their affiliates could hold a nominal equity interest with little to no voting rights but meet the Ownership Threshold and therefore have voting power that provides effective control of our company. The multiple class structure of our common stock features certain provisions that are novel or otherwise not common among other corporations with multiple class structures. A number of provisions relating to the multiple class structure of our common stock are novel or otherwise not common among other corporations with multiple class structures. For instance, our Founders who are then party to the Founder Voting Agreement are free to transfer or otherwise dispose of their shares of Class A common stock and Class B common stock without diminishing their voting control so long as our Founders who are then party to the Founder Voting Agreement and certain of their affiliates meet the Ownership Threshold on the applicable record date. Shares of our Class B common stock, which have ten (10) votes per share, may remain outstanding in perpetuity. Additionally, shares of our Class B common stock may be transferred (without converting into shares of Class A common stock) to, among others, our Founders or their affiliates, which could result in our Founders and their affiliates or other stockholders obtaining additional voting control. Additionally, certain provisions of our amended and restated certificate of incorporation related to the calculation of the voting power of the Class F common stock may have an adverse effect on our stockholders other than our Founders. Under our amended and restated certificate of incorporation, our Founders have the right to challenge the calculation of the voting power of the Class F common stock. Such a challenge may cause delays in the certification of any vote of our stockholders or in the effectiveness of any action of our stockholders. The multi-class structure of our common stock, the Founder Voting Trust Agreement and the Founder Voting Agreement by which our Founders exercise effective control over all matters submitted to a vote of our stockholders will exist for the foreseeable future. Shares of our Class F common stock will convert automatically into shares of our Class B common stock only if the Founder Voting Trust Agreement or the Founder Voting Agreement is terminated. Each of these agreements could remain in place until the death of our last living Founder. As of December 31, 2022, our Founders were 55, 55, and 40 years old. Further, upon a discretionary or compulsory withdrawal of a Founder as a beneficiary of the Founder Voting Trust Agreement, the Trustee will instruct our transfer agent and us to convert the withdrawing Founder’s pro rata portion of the shares of Class F common stock held in the Founder Voting Trust at the time of the withdrawal into shares of Class B common stock in accordance with our amended and restated certificate of incorporation. Because of the ten-to-one voting ratio between our Class B and Class A common stock, even if the Class F common stock converts to Class B common stock, our Founders will collectively control a significant portion of the voting power of our capital stock based on their current ownership. Future transfers by holders of shares of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning purposes and transfers between related entities. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those individual holders of Class B common stock who retain their shares in the long term. If our Founders and their affiliates, individually or collectively, retain a significant portion of their holdings of Class B common stock for an extended period of time, they could, in the future, 57Table of Contentsindividually or collectively, continue to control a significant portion of the combined voting power of our Class A common stock and Class B common stock, even without the use of the Class F common stock, and such voting power could enable holders of Class B common stock to effectively control all matters subject to the stockholder approval. Shares of our Class B common stock may remain outstanding in perpetuity. Further, if all, or a large portion, of the Founder Grants should be exercised or vest and settle, our Founders will increase their voting power of our Class B common stock. Although the terms of our amended and restated certificate of incorporation only provide for a separate vote of the holders of our Class B common stock on limited matters, under Delaware law, certain actions may require the approval of the holders of the Class B common stock voting as a separate class. For example, if we amend our amended and restated certificate of incorporation to adversely affect the special rights, powers, or preferences of our Class B common stock in a manner that does not so affect the Class A common stock or Class F common stock, Delaware law could require approval of the holders of our Class B common stock voting separately as single class. For any vote of the Class B common stock voting as a separate class, our Founders will significantly influence such vote if all, or a large portion, of the Founder Grants should vest and settle and the Founders retain such shares. Our governance structure may negatively affect the decision by certain institutional investors to purchase or hold shares of our Class A common stock. The holding of low-voting stock, such as our Class A common stock, may not be permitted by the investment policies of certain institutional investors or may be less attractive to the portfolio managers of certain institutional investors. In addition, in July 2017, FTSE Russell and Standard & Poor’s announced that they would cease to allow most newly public companies utilizing dual- or multi-class capital structures to be included in their indices. Affected indices include the Russell 2000 and the S&P 500, S&P MidCap 400, and S&P SmallCap 600, which together make up the S&P Composite 1500. Our multi-class capital structure may make us ineligible for inclusion in any of these and certain other indices, and as a result, mutual funds, exchange-traded funds, and other investment vehicles that attempt to passively track these indices would not invest in our stock. These policies may depress our valuation compared to those of other similar companies that are included. Future issuances of our Class A common stock will dilute the voting power of our Class A common stockholders but may not result in further dilution of the voting power of our Founders who are then party to the Founder Voting Agreement. Future issuances of our Class A common stock will dilute the voting power of our Class A common stockholders, and future issuances to stockholders other than our Founders who are then party to the Founder Voting Agreement will dilute the economic interests of our Founders and their affiliates. However, because of the voting rights of the shares of Class F common stock, in the event that our Founders and their affiliates have less than 49.999999% of the Voting Power prior to giving effect to the voting power of the Class F common stock, future issuances of Class A common stock to stockholders other than our Founders and their affiliates will generally not result in dilution of the voting power of our Founders who are then party to the Founder Voting Agreement or their affiliates, but rather, will correspondingly increase the voting power of the Class F common stock. Any future issuances of additional shares of Class A common stock will not be subject to approval by our stockholders except as required by the listing standards of the NYSE. General Risk FactorsAdverse economic conditions or reduced technology spending may adversely impact our business. Our business depends on the economic health of our current and prospective customers and overall demand for technology. In addition, the purchase of our platforms and services is often discretionary and typically involves a significant commitment of capital and other resources. Over the past year, the United States, the EU, and the U.K. have experienced historically high levels of inflation. In response to high levels of inflation and recession fears, the U.S. Federal Reserve, the European Central Bank, and the Bank of England have raised, and may continue to raise, interest rates and implement fiscal policy interventions. Even if these interventions lower inflation, they may also reduce economic growth rates, create a recession, and have other similar effects. A further downturn in macroeconomic conditions, including rising inflation and interest rates; supply chain disruptions; global political and economic uncertainty; geopolitical tensions, such as the ongoing Russia-Ukraine conflict; a lack of availability of credit; a reduction in business confidence and activity; the curtailment of government or corporate spending; public health concerns or emergencies; financial market volatility; and other factors have in the past, and may in the future, negatively affect the industries to which we sell our platforms and services. Our customers may suffer from reduced operating budgets, which could cause them to defer, reduce, or forego purchases of our platforms or services. Moreover, competitors may respond to market conditions by lowering prices and attempting to lure away our customers, and the increased pace of consolidation in certain industries may result in reduced overall spending on our offerings. Uncertainty about global and regional economic conditions, a downturn in the technology sector or any sectors in which our customers operate, or a reduction in information technology spending even if economic conditions are stable, could adversely impact our business, financial condition, and results of operations in a number of ways, including longer sales cycles, lower prices for our platforms 58Table of Contentsand services, material default rates among our customers, contract terminations or renegotiations by our customers, reduced sales of our platforms or services, and lower or no growth. We cannot predict the timing, strength, or duration of any crises, economic slowdown or any subsequent recovery generally, or for any industry in particular. Although certain aspects of the effects of a crisis or an economic slowdown may provide potential new opportunities for our business, we cannot guarantee that the net impact of any such events will not be materially negative. Accordingly, if the conditions in the general economy and the markets in which we operate worsen from present levels, our business, financial condition, and results of operations could be adversely affected. We may face exposure to foreign currency exchange rate fluctuations. Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro and the British pound sterling (“GBP”). We expect our non-U.S. operations to continue to grow in the near term and we are continually monitoring our foreign currency exposure to determine if we should consider a hedging program. Today, our non-U.S. contracts are denominated in either U.S. dollars or local currency, while our non-U.S. operating expenses are often denominated in local currencies. Additionally, as we expand our non-U.S. operations, a larger portion of our operating expenses may be denominated in local currencies. Volatility in exchange rates and global financial markets is expected to continue due to political and economic uncertainty globally. In recent months, the U.S. dollar has strengthened compared to other currencies, which has increased and may continue to increase the real cost of our platforms to our customers outside of the United States, which could reduce demand for our platforms and adversely affect our financial condition and results of operations. Continued increases in the value of the U.S. dollar and decreases in the value of foreign currencies could result in the dollar equivalent of our revenues being lower, result in increased expenses for our non-U.S. operations, or otherwise impact our financial condition and results of operations. Natural disasters, including climate change, and other catastrophic events beyond our control could harm our business. Natural disasters, including climate change, or other catastrophic events may cause damage or disruption to our operations, non-U.S. commerce and the global economy, and thus could have a negative effect on us. Our business operations are subject to interruption by natural disasters, earthquakes, flooding, fire, power shortages, pandemics such as COVID-19, terrorism, political unrest, cyberattacks including as may be exacerbated by the ongoing Russia-Ukraine conflict, geopolitical tensions including those related to the invasion of Ukraine, the effects of climate change such as drought, wildfires, increased storm severity, and sea level rise, telecommunications failure, vandalism, and other events beyond our control. Although we maintain crisis management and disaster response plans, such events could make it difficult or impossible for us to deliver our services to our customers, could decrease demand for our services, could make existing customers unable or unwilling to fulfill their contractual requirements to us, including their payment obligations, and could cause us to incur substantial expense, including expenses or liabilities arising from potential litigation. Our insurance may not be sufficient to cover losses or additional expense that we may sustain. Customer data could be lost, significant recovery time could be required to resume operations and our financial condition and results of operations could be adversely affected in the event of a major natural disaster or catastrophic event. In addition, the impacts of climate change on the global economy and our industry are rapidly evolving. We may be subject to increased regulations, reporting requirements, standards or expectations regarding the environmental impacts of our business. While we seek to mitigate our business risks associated with climate change, there are inherent climate-related risks wherever business is conducted. Any of our primary locations may be vulnerable to the adverse effects of climate change. For example, our Colorado headquarters have experienced and may continue to experience, climate-related events and at an increasing frequency, including drought, water scarcity, heat waves, wildfires and resultant air quality impacts and power shutoffs associated with the wildfires. Additionally, while some employees have returned to our offices, it will remain difficult to mitigate the impact of these events on our employees continuing to work remotely. Changing market dynamics, global policy developments and increasing frequency and impact of extreme weather events on critical infrastructure in the United States and elsewhere have the potential to disrupt our business, the business of our partners, suppliers, and customers, and may cause us to experience higher attrition, losses and additional costs to maintain or resume operations.If we fail to maintain an effective system of internal controls, our ability to produce timely and accurate financial statements or comply with applicable regulations could be impaired. We are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, and the rules and regulations of the listing standards of the NYSE. The requirements of these rules and regulations may continue to increase our legal, accounting, and financial compliance costs, make some activities more difficult, time-consuming, and costly, and place significant strain on our personnel, systems, and resources. 59Table of ContentsThe Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. We have developed and refined our financial reporting and other disclosure controls and procedures, and will continue to do so. Our controls are designed to ensure that information required to be disclosed by us in the reports that we will file with the SEC is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and that information required to be disclosed in reports under the Exchange Act is accumulated and communicated to our principal executive and financial officers. We are also continuing to improve our internal control over financial reporting as our business continues to grow in size and complexity. We expect to continue to hire and integrate additional accounting and financial staff with appropriate company experience and technical accounting knowledge, as well as implement and integrate new technological systems. In order to maintain and improve the effectiveness of our financial statement and disclosure controls and procedures and internal control over financial reporting, we have expended, and anticipate that we will continue to expend, significant resources, including accounting-related costs and significant management oversight. Our current controls and any new controls that we develop may become inadequate because of changes in conditions in our business. Further, we have identified in the past, and may identify in the future, deficiencies in our controls. Any failure to develop or maintain effective controls or any difficulties encountered in their implementation or improvement could harm our results of operations or cause us to fail to meet our reporting obligations and may result in a restatement of our financial statements for prior periods. Any failure to implement and maintain effective internal control over financial reporting also could adversely affect the results of periodic management evaluations and annual independent registered public accounting firm attestation reports. Ineffective disclosure controls and procedures and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which could have a negative effect on the trading price of our Class A common stock. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on the NYSE. We are required to annually comply with the SEC rules that implement Section 404 of the Sarbanes-Oxley Act and are therefore required to make a formal assessment of the effectiveness of our internal control over financial reporting for that purpose. Our independent registered public accounting firm must also formally attest to the effectiveness of our internal control over financial reporting annually. Any failure to maintain effective disclosure controls and internal control over financial reporting could have an adverse effect on our business, financial condition and results of operations and could cause a decline in the market price of our Class A common stock. We have incurred and will continue to incur increased costs and demands upon management as a result of complying with the laws and regulations affecting public companies which could adversely affect our business, financial condition, and results of operations. As a public company, we have incurred and will continue to incur greater legal, accounting, finance, and other expenses than we incurred as a private company. We are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and the rules and regulations of the NYSE. These requirements have increased and will continue to increase our legal, accounting, and financial compliance costs and have made, and will continue to make, some activities more time-consuming and costly. For example, the Exchange Act requires, among other things, that we file annual, quarterly, and current reports with respect to our business and results of operations. As a result of the complexity involved in complying with the rules and regulations applicable to public companies, our management’s attention may be diverted from the day-to-day management of our business, which could harm our business, financial condition, and results of operations. Although we have already hired additional employees to assist us in complying with these requirements, we may need to hire more employees in the future or engage outside consultants, which will increase our operating expenses. Additionally, as a public company subject to additional rules and regulations and oversight, we may not have the same flexibility we had as a private company. In addition, changing laws, regulations, and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs, and making some activities more time-consuming. These laws, regulations, and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We have and intend to continue to invest substantial resources to comply with evolving laws, regulations, and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from business operations to compliance activities. If our efforts to comply with new laws, regulations, and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us and our business may be harmed. 60Table of ContentsWe also expect these rules and regulations to make it more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to maintain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our Board of Directors or as our executive officers. As a result of disclosure of information in this Annual Report on Form 10-K and other filings required of a public company, our business and financial condition has become more visible, which may result in an increased risk of threatened or actual litigation, including by competitors and other third parties. If such claims are successful, our business, financial condition, and results of operations could be harmed, and even if the claims do not result in litigation or are resolved in our favor, these claims, and the time and resources necessary to resolve them, could divert the resources of our management and harm our business, financial condition, and results of operations. ITEM 1B. UNRESOLVED STAFF COMMENTSNone. ITEM 2. PROPERTIESFacilitiesWe have leased principal properties in Denver, Colorado, which is the location of our corporate headquarters; in Palo Alto, California; New York City, New York; and London, England. In addition, we lease various office space throughout the world.We believe that our existing facilities are adequate to meet current requirements, and that suitable additional or substitute space will be available as needed to accommodate any further physical expansion of operations and for any additional offices.ITEM 3. LEGAL PROCEEDINGSFrom time to time we are subject to legal proceedings and claims arising in the ordinary course of business. Based on our current knowledge, we believe that the amount or range of reasonably possible losses will not, either individually or in the aggregate, have a material adverse effect on our business, results of operations, or financial condition. The results of any litigation cannot be predicted with certainty, and an unfavorable resolution in any legal proceedings could materially affect our future business, results of operations, or financial condition. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors. For information on legal proceedings, refer to Note 8. Commitments and Contingencies—Litigation and Legal Proceedings in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. ITEM 4. MINE SAFETY DISCLOSURESNot applicable.61Table of ContentsPART IIITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIESMarket Information for Common StockOur Class A common stock has been listed on the NYSE under the symbol “PLTR” since September 30, 2020. Prior to that date, there was no public trading market for our Class A common stock.Our Class B common stock and Class F common stock are not listed on any stock exchange nor traded on any public market.Holders of RecordAs of February 14, 2023, there were 850 holders of record of our Class A common stock, 32 holders of record of our Class B common stock, and one holder of record of our Class F common stock. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.Dividend PolicyWe have never declared or paid any cash dividends on our capital stock. We intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future. Any future determination to declare cash dividends will be made at the discretion of our Board of Directors, subject to applicable laws, and will depend on a number of factors, including our financial condition, results of operations, capital requirements, contractual restrictions, general business conditions, and other factors that our Board of Directors may deem relevant. In addition, the terms of our credit facility contain restrictions on our ability to declare and pay cash dividends on our capital stock, and we may enter into credit agreements or other borrowing arrangements in the future that may restrict our ability to declare and pay cash dividends. Performance GraphThis performance graph shall not be deemed “soliciting material” or to be “filed” with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any of our filings under the Securities Act or the Exchange Act.The following graph compares the cumulative total return to stockholders on our Class A common stock since September 30, 2020 (the date our Class A common stock commenced trading on the NYSE (“Direct Listing”)) relative to the cumulative total returns of the Standard & Poor’s 500 Index and the Standard & Poor’s Information Technology Index over the same period. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our Class A common stock and in each index at the market close on September 30, 2020, and its relative performance is tracked through December 31, 2022. The returns shown are based on historical results and are not intended to suggest future performance.62Table of ContentsUnregistered Sales of Equity Securities None.ITEM 6. [RESERVED]ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the accompanying notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based upon current plans, expectations, and beliefs, involving risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements. You should review the section titled “Special Note Regarding Forward-Looking Statements” for a discussion of forward-looking statements and the section titled “Risk Factors” for a discussion of factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis and elsewhere in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results that may be expected for any period in the future. This section of this Annual Report on Form 10-K generally discusses fiscal years 2022 and 2021 items and year-to-year comparisons between fiscal years 2022 and 2021. Discussions of fiscal year 2021 items and year-to-year comparisons between fiscal years 2021 and 2020 that are not included in this Annual Report on Form 10-K can be found in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, which was filed with the SEC on February 24, 2022 and is incorporated herein by reference.OverviewWe build software that empowers organizations to effectively integrate their data, decisions, and operations at scale.We were founded in 2003 and started building software for the intelligence community in the United States to assist in counterterrorism investigations and operations. We later began working with commercial enterprises, who often faced fundamentally similar challenges in working with data.We have built three principal software platforms, Gotham, Foundry, and Apollo. Gotham and Foundry enable institutions to transform massive amounts of information into an integrated data asset that reflects their operations. For over a decade, Gotham 63has surfaced insights for global defense agencies, the intelligence community, disaster relief organizations and beyond. Foundry is becoming a central operating system not only for individual institutions but also for entire industries. Apollo, which we began offering as a commercial solution in 2021, is a cloud-agnostic, single control layer that coordinates ongoing delivery of new features, security updates, and platform configurations, helping to ensure the continuous operation of critical systems. Apollo allows our customers to run their software in virtually any environment.While our focus in the short term remains on making our principal software platforms available to increasingly broad swaths of the market, we are also working to identify additional component parts and products embedded within those platforms that have potential as commercial offerings on their own.We believe that every institution faces challenges that our platforms and products were designed to address. Our approach with all our clients is to establish a partnership that transforms the way they use data in pursuit of their goals. We regularly evaluate partnerships and investment opportunities in complementary businesses, employee teams, technologies, and intellectual property rights in an effort to expand our product and service offerings. Our Business Our customers pay us to use the software platforms we have built. While we generally offer contract terms of one to five years in length, our customers sometimes enter into shorter-term contracts. Revenue is generally recognized ratably over the contract term. Many of our customer contracts contain termination for convenience provisions. For the year ended December 31, 2022, we generated $1.9 billion in revenue, reflecting a 24% growth rate from the year ended December 31, 2021, when we generated $1.5 billion in revenue.In the year ended December 31, 2022, we incurred losses from operations of $161.2 million, or adjusted income from operations of $420.8 million when excluding stock-based compensation and related employer payroll taxes. In the year ended December 31, 2021, our losses from operations were $411.0 million, or adjusted income from operations of $473.5 million when excluding stock-based compensation and related employer payroll taxes.In the year ended December 31, 2022, our gross profit was $1.5 billion, reflecting a gross margin of 79%, or 81% when excluding stock-based compensation. In the year ended December 31, 2021, our gross profit was $1.2 billion, reflecting a gross margin of 78%, or 82% when excluding stock-based compensation.For more information about our adjusted income from operations, which excludes stock-based compensation and related employer payroll taxes; and gross profit and gross margin, when excluding stock-based compensation; as well as reconciliations from loss from operations and gross profit, see the section titled “Non-GAAP Reconciliations” below.Our CustomersWe define a customer as an organization from which we have recognized revenue during the trailing twelve-month period. During the period ended December 31, 2022, we had 367 customers, including companies in various commercial sectors and government agencies around the world. During the period ended December 31, 2021, we had 237 customers.For large government agencies, where a single institution has multiple divisions, units, or subsidiary agencies, each such division, unit, or subsidiary agency that enters into a separate contract with us and is invoiced as a separate entity is treated as a separate customer. For example, while the U.S. Food and Drug Administration, Centers for Disease Control and Prevention, and National Institutes of Health are subsidiary agencies of the U.S. Department of Health and Human Services, we treat each of those agencies as a separate customer given that the governing structures and procurement processes of each agency are independent. We have built lasting and significant customer relationships and partnerships with some of the world’s leading government institutions and companies. As of December 31, 2022, we expect to generate revenue under our existing customer contracts for an additional 2.8 years on a dollar-weighted average contract duration basis. Dollar-weighted average contract duration represents the length of time we expect to generate revenue on average, including existing contractual obligations and assuming that our customers will exercise all of the contractual options available to them, and is subject to change as we enter into new contracts or if customers terminate for convenience. We calculate this duration on a dollar-weighted basis to adjust for smaller deals. The timing of our customer billings and receipt of payments varies from contract to contract. Our average revenue for the top twenty customers during the trailing twelve months ended December 31, 2022 was $49.4 million, which grew 13% from an average of $43.6 million in revenue from the top twenty customers during the trailing twelve months ended December 31, 2021, demonstrating our expanding relationships with existing customers. 64Organizations in the commercial and government sectors face similar challenges when it comes to managing data, and we intend to expand our reach in both markets moving forward. Our decisions about which customer relationships require further investment may change over time, based on our assessment of the potential long-term value that our software can generate for them. We enter into initial pilots with customers, generally at our own expense and without a guarantee of future returns, in order to access a unique set of opportunities that others may pass over for lack of resources and shorter investment horizons. We manage customers at the account level, not by industry or sector, so that we can optimize on the specific growth opportunities for each customer. In the year ended December 31, 2022, 56% of our revenue came from government customers and 44% came from commercial customers. Our U.S. customers have been a meaningful source of revenue growth for our business. In the year ended December 31, 2022, we generated 61% of our revenue from customers in the United States and the remaining 39% from non-U.S. customers. Revenue from our U.S. customers during the trailing twelve months ended December 31, 2022 was $1.2 billion, which grew 32% from the prior twelve-month period. We expect that U.S. customers will continue to be a source of significant revenue growth for us.We continue to believe that our government customers remain a meaningful and resilient source of revenue for our business, particularly during periods of economic uncertainty. However, large government customers, in particular, are generally subject to a number of uncertainties regarding budgets and spending levels, changes in timing and spending priorities, and regulatory and policy changes, which can make it difficult to predict when, or if, we will make sales to such customers or the size and scope of any contract awards. See also the discussion of “Risks Related to Relationships and Business with the Public Sector” within Item 1A. Risk Factors included in this Annual Report on Form 10-K.Expansion of Access to Platforms The speed with which our platforms can be deployed has significantly expanded the range of potential customers with which we plan on partnering over the long term. We anticipate that our reach among an increasingly broad set of customers, in both the commercial and government sectors, will accelerate moving forward. We believe that, as these new partners grow, we will grow with them. We have also made a number of investments in companies whose businesses rely on the ability of their organizations to manage and analyze data effectively at scale.Our proximity to these businesses and the industries in which they are operating has enhanced, and is expected to continue enhancing, our own product and business development efforts, as we continue expanding access to our platforms to the broadest possible set of customers.Total Remaining Deal ValueWe are focused on building strategic relationships with, and delivering significant outcomes for, our customers over the long term. Our contracts with our customers reflect that long-term orientation, often lasting for multiple years at a time.Total remaining deal value is the total remaining value of contracts that have been awarded by our government and commercial customers and includes existing contractual obligations and unexercised contract options available to those customers. Total remaining deal value presumes the exercise of all contract options and no termination of contracts; however, the majority of our contracts are subject to termination provisions, including for convenience, and there can be no guarantee that contracts are not terminated or that contract options will be exercised. Total remaining deal value also includes remaining contract value from Strategic Commercial Contracts, which are subject to termination for cause provisions. Total remaining deal value excludes all or some portion of the value of certain commercial contracts as a result of our ongoing assessments of customers’ financial condition, including the consideration of such customers’ ability and intention to pay, and whether such contracts continue to meet the criteria for revenue recognition, among other factors.As of December 31, 2022, the total remaining deal value of the contracts, as defined above, was $3.7 billion, down 3% from December 31, 2021, when our total remaining deal value of such contracts was $3.8 billion.Of our total remaining deal value, as of December 31, 2022, the total remaining deal value of the contracts that we entered into with commercial customers, including existing contractual obligations and available contractual options, as defined above, was $2.0 billion, down 23% from December 31, 2021, when the total remaining deal value of such contracts was $2.6 billion. The decrease was due to the exclusion of certain contracts, as described above, as well as decreases resulting from the recognition of revenue and renegotiation of a commercial contract.As of December 31, 2022, the total remaining deal value of the contracts that we had been awarded by government agencies in the United States and allied countries around the world, including existing contractual obligations and contractual options 65available to those government agencies, was $1.7 billion, up 37% from December 31, 2021, when the total value of such contracts was $1.2 billion. When calculating the total remaining deal value of government contracts, we do not include government contracts known as IDIQ contracts, totaling $2.8 billion, as of December 31, 2022, that we have been awarded, but where the funding of such contracts has not yet been determined. The funding of these contracts is not guaranteed. Many of our government and commercial contracts are subject to termination for convenience provisions. Additionally, the U.S. federal government is prohibited from exercising contract options more than one year in advance. As a result, there can be no guarantee that our customer contracts will not be terminated or that contract options will be exercised. Macroeconomic TrendsAs a corporation with an international presence, we are subject to risks and uncertainties caused by significant events with macroeconomic impacts, including, but not limited to, the ongoing COVID-19 pandemic, the impact of the ongoing Russia-Ukraine conflict, rising inflation and interest rates, monetary policy changes, and foreign currency fluctuations. Additionally, these macroeconomic impacts have generally disrupted the operations of our customers and prospective customers. We continuously monitor the direct and indirect impacts of these circumstances on our business and financial results, as well as the overall global economy and geopolitical landscape.See the section titled “Risk Factors” included elsewhere in this Annual Report on Form 10-K for further discussion of the impact of macroeconomic trends on our business. COVID-19 Impact The COVID-19 pandemic continues to impact the global economy. The extent to which COVID-19 may impact our financial conditions or results of operations in future periods remains uncertain, but to date has not had a material adverse impact on our results of operations. We continue to prioritize the health and safety of our employees, our customers, and the communities in which we operate. We have reopened our offices and have allowed business travel and in-person events to resume, while continuing to closely monitor developments around the evolving nature of the pandemic. As such, our travel and office-related expenditures have increased, and may continue to increase moving forward. However, we expect that some of our employees will continue to work remotely. The economic effects of the pandemic and resulting societal changes are currently not predictable.The COVID-19 pandemic has made clear to many of our customers that accommodating the extended timelines ordinarily required to realize results from implementing new software solutions is not an option during a crisis. As a result, customers are increasingly adopting our software, which can be ready in days, over internal software development efforts, which may take months or years. Russia-Ukraine ConflictWe continue to closely monitor the impact of the ongoing Russia-Ukraine conflict and its global impacts on our business. While the conflict is still evolving and the outcome remains highly uncertain, we do not expect that the Russian invasion will have a material impact on our business and results of operations. We do not currently have office locations in Russia and none of our revenues came from sales to entities headquartered in Russia. In June 2022, our Chief Executive Officer, Alexander Karp, met with the President of Ukraine and other senior officials to discuss opening an office in Ukraine and providing ongoing support. Our current operations related to Ukraine are not material to our financial position or results of operations. However, if the conflict continues or worsens, leading to greater disruptions and uncertainty within the technology industry or global economy, our business and results of operations could be negatively impacted. Foreign Currency Exchange RatesExchange rates are subject to significant and rapid fluctuations due to a number of factors, including interest rate changes and political and economic uncertainty which may adversely affect our results of operations or financial position.Our contracts with customers are primarily denominated in U.S. dollars. As a result, the general strengthening of the U.S. dollar relative to other major foreign currencies (primarily the Euro and GBP) had an unfavorable impact on our revenues from certain non-U.S. customers; however, that impact for the year ended December 31, 2022 was not material to our financial position or results of operations. 66Customer ImpactsCurrent macroeconomic conditions may also adversely impact our customers’ business, particularly our early- and growth-stage customers. Relationships with early- or growth-stage customers carry inherent risks because, among other things, such customers may be unable to generate sufficient revenues or profitability or to access any necessary financing or funding in a timely manner or on favorable terms to them in the current macroeconomic environment, which has impacted, and may continue to impact, our expected revenue and collections. As a result, current macroeconomic conditions may continue to impact our ability to realize the full value of our commercial contracts with such early- or growth-stage customers. For additional information see Note 4. Investments and Fair Value Measurements in the consolidated financials statements included elsewhere in this Annual Report on Form 10-K.Key Business Measure In addition to the measures presented in our consolidated financial statements, we use the following key non-GAAP business measure to help us evaluate our business, identify trends affecting our business, formulate business plans and financial projections, and make strategic decisions. Contribution Margin We believe that the revenue we generate relative to the costs we incur in order to generate such revenue is an important measure of the efficiency of our business. We define contribution margin as revenue less our cost of revenue and sales and marketing expenses, excluding stock-based compensation, divided by revenue.Revenue is allocated to each customer account directly. The cost of revenue and sales and marketing costs include both the costs associated with the deployment and operation of our software as well as expenses associated with identifying new customers and expanding partnerships with existing ones. Our software engineers working with existing customers often manage the deployment and operation of our platforms as well as identify new ways that those platforms can be used. To calculate the contribution by segment, we allocate cost of revenue and sales and marketing expenses, excluding stock-based compensation, to an account pro rata based on headcount and time spent on the account during the period. To the extent certain costs or personnel are not directly assigned to a specific account, they are allocated pro rata based on total headcount staffed during such period. Direct costs, such as third-party cloud hosting services, are directly allocated to the account to which they relate. Allocated revenues and expenses are then aggregated into a segment based upon the customer account to which they relate.Contribution margin, both across our business and segments, is intended to capture how much we have earned from customers after accounting for the costs associated with deploying and operating our software, as well as any sales and marketing expenses involved in acquiring and expanding our partnerships with those customers, including allocated overhead. We exclude stock-based compensation as it is a non-cash expense. We believe that our contribution margin provides an important measure of the efficiency of our operations over time. We have included contribution margin because it is a key measure used by our management to evaluate our performance, and we believe that it also provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management team. Our calculation of contribution margin may differ from similarly titled measures, if any, reported by other companies. Contribution margin should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. For more information about contribution margin, including the limitations of this measure, and a reconciliation to loss from operations, see the section titled “Non-GAAP Reconciliations” below.Non-GAAP Reconciliations We use the non-GAAP measures contribution margin; gross profit and gross margin, excluding stock-based compensation; and adjusted income from operations, which excludes stock-based compensation and related employer payroll taxes to help us evaluate our business, identify trends affecting our business, formulate business plans and financial projections, and make strategic decisions. We exclude stock-based compensation, which is a non-cash expense, from these non-GAAP financial measures because we believe that excluding this item provides meaningful supplemental information regarding operational performance and provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management team. Additionally, we exclude employer payroll taxes related to stock-based compensation as it is difficult to predict and outside of our control.67Our definitions may differ from the definitions used by other companies and therefore comparability may be limited. In addition, other companies may not publish these or similar metrics. Further, these metrics have certain limitations, as they do not include the impact of certain expenses that are reflected in our consolidated statement of operations. Thus, our non-GAAP contribution margin; gross profit and gross margin, excluding stock-based compensation; and adjusted income from operations should be considered in addition to, not as a substitute for, or in isolation from, measures prepared in accordance with GAAP. We compensate for these limitations by providing reconciliations of these non-GAAP measures to the most comparable GAAP measures. We encourage investors and others to review our business, results of operations, and financial information in its entirety, not to rely on any single financial measure, and to view these non-GAAP measures in conjunction with the most directly comparable GAAP financial measures.Contribution MarginThe following table provides a reconciliation of contribution margin for the years ended December 31, 2022 and 2021 (in thousands, except percentages): Years Ended December 31,20222021Loss from operations$(161,201)$(411,046)Add:Research and development expenses (1)265,808 237,189 General and administrative expenses (1)365,768 295,071 Total stock-based compensation expense564,798 778,215 Total contribution$1,035,173 $899,429 Contribution margin54 %58 %————(1) Excludes stock-based compensation.Gross Profit and Gross Margin, Excluding Stock-Based CompensationThe following table provides a reconciliation of gross profit and gross margin, excluding stock-based compensation for the years ended December 31, 2022 and 2021 (in thousands, except percentages): Years Ended December 31,20222021Gross profit$1,497,322 $1,202,485 Add: stock-based compensation44,061 68,546 Gross profit, excluding stock-based compensation$1,541,383 $1,271,031 Gross margin, excluding stock-based compensation81 %82 %Adjusted Income from OperationsThe following table provides a reconciliation of adjusted income from operations, which excludes stock-based compensation and related employer payroll taxes for the years ended December 31, 2022 and 2021 (in thousands): Years Ended December 31,20222021Loss from operations$(161,201)$(411,046)Add: stock-based compensation564,798 778,215 Add: employer payroll taxes related to stock-based compensation17,156 106,283 Adjusted income from operations$420,753 $473,452 68Components of Results of Operations Revenue We generate revenue from the sale of subscriptions to access our software in our hosted environment along with ongoing O&M services (“Palantir Cloud”), software subscriptions in our customers’ environments with ongoing O&M services (“On-Premises Software”), and professional services. Palantir Cloud Our Palantir Cloud subscriptions grant customers the right to access the software functionality in a hosted environment controlled by Palantir and are sold together with stand-ready O&M services, as further described below. We promise to provide continuous access to the hosted software throughout the contract term. Revenue associated with Palantir Cloud subscriptions is generally recognized over the contract term on a ratable basis, which is consistent with the transfer of control of the Palantir services to the customer. On-Premises Software Sales of our software subscriptions grant customers the right to use functional intellectual property, either on their internal hardware infrastructure or on their own cloud instance, over the contractual term and are also sold together with stand-ready O&M services. O&M services include critical updates and support and maintenance services required to operate the software and, as such, are necessary for the software to maintain its intended utility over the contractual term. Because of this requirement, we have concluded that the software subscriptions and O&M services, which together we refer to as our On-Premises Software, are highly interdependent and interrelated and represent a single distinct performance obligation within the context of the contract. Revenue is generally recognized over the contract term on a ratable basis. Professional Services Our professional services support the customers’ use of the software and include, as needed, on-demand user support, user-interface configuration, training, and ongoing ontology and data modeling support. Professional services contracts typically include the provision of on-demand professional services for the duration of the contractual term. These services are typically coterminous with a Palantir Cloud or On-Premises Software subscriptions. Professional services are on-demand, whereby we perform services throughout the contract period; therefore, the revenue is recognized over the contractual term. Cost of Revenue Cost of revenue primarily includes salaries, stock-based compensation expense, and benefits for personnel involved in performing O&M and professional services, as well as field service representatives, third-party cloud hosting services, travel costs, allocated overhead, and other direct costs. We expect that cost of revenue will increase in absolute dollars as our revenue grows and will vary from period to period as a percentage of revenue. Sales and Marketing Our sales and marketing efforts span all stages of our sales cycle, including personnel involved with sales functions, and executing pilots at new or existing customers. Sales and marketing costs primarily include salaries, stock-based compensation expense, and benefits for our sales force and personnel involved in sales functions, executing on pilots and customer growth activities; as well as third-party cloud hosting services for our pilots, marketing and sales event-related costs, travel costs, and allocated overhead. Sales and marketing costs are generally expensed as incurred. We expect that sales and marketing expenses will increase in absolute dollars as we continue to invest in our potential and current customers, in growing our business, sales force, and enhancing our brand awareness. Research and Development Our research and development efforts are aimed at continuing to develop and refine our platforms, including adding new features and modules, increasing their functionality, and enhancing the usability of our platforms. Research and development costs primarily include salaries, stock-based compensation expense, and benefits for personnel involved in performing the activities to develop and refine our platforms, internal use third-party cloud hosting services and other IT-related costs, travel costs, and allocated overhead. Research and development costs are expensed as incurred. 69We plan to continue to invest in personnel to support our research and development efforts. As a result, we expect that research and development expenses will increase in absolute dollars for the foreseeable future as we continue to invest to support these activities. General and Administrative General and administrative costs include salaries, stock-based compensation expense, and benefits for personnel involved in our executive, finance, legal, human resources, and administrative functions, as well as third-party professional services and fees, travel costs, and allocated overhead. We expect that general and administrative expenses will increase in absolute dollars as we hire additional personnel and enhance our systems, processes, and controls to support the growth in our business as well as our increased compliance and reporting requirements as a public company. Interest Income Interest income consists primarily of interest income earned on our cash, cash equivalents, and restricted cash balances. Interest Expense Interest expense consists primarily of interest expense and commitment fees incurred under our credit facility. Other Income (Expense), Net Other income (expense), net consists primarily of foreign currency exchange gains and losses, realized and unrealized losses from Investments, and our share of income and losses from our equity method investments. The year ended December 31, 2022 also included a gain from a step acquisition. Provision for (Benefit from) Income Taxes Provision for (benefit from) income taxes consists of income taxes related to foreign and state jurisdictions in which we conduct business and withholding taxes. Net Income (Loss) Attributable to Noncontrolling Interests Net income (loss) attributable to noncontrolling interests represents our joint venture partners’ proportionate share of the results of operations of the respective joint venture.Segments We have two operating segments, commercial and government, which were determined based on the manner in which the chief operating decision maker (“CODM”), who is our chief executive officer, manages our operations for purposes of allocating resources and evaluating performance. Various factors, including our organizational and management reporting structure and customer type, were considered in determining these operating segments. Our operating segments are described below: •Commercial: This segment primarily serves customers working in non-government industries. •Government: This segment primarily serves customers that are U.S. government and non-U.S. government agencies. Segment profitability is evaluated based on contribution and contribution margin. Contribution is segment revenue less the related costs of revenue and sales and marketing expenses, excluding stock-based compensation expense. Contribution margin is contribution divided by revenue. To the extent costs of revenue or sales and marketing expenses are not directly attributable to a particular segment, they are allocated based upon headcount at each operating segment during the period. We use it, in part, to evaluate the performance of, and allocate resources to, each of our operating segments, which excludes certain operating expenses that are not allocated to operating segments because they are separately managed at the consolidated corporate level. These unallocated costs include stock-based compensation expense, research and development costs, and general and administrative costs, such as legal and accounting. 70Results of Operations The following table summarizes our consolidated statements of operations data (in thousands): Years Ended December 31,202220212020Revenue$1,905,871 $1,541,889 $1,092,673 Cost of revenue (1)408,549 339,404 352,547 Gross profit1,497,322 1,202,485 740,126 Operating expenses:Sales and marketing (1)702,511 614,512 683,701 Research and development (1)359,679 387,487 560,660 General and administrative (1)596,333 611,532 669,444 Total operating expenses1,658,523 1,613,531 1,913,805 Loss from operations(161,201)(411,046)(1,173,679)Interest income20,309 1,607 4,680 Interest expense(4,058)(3,640)(14,139)Other income (expense), net(216,077)(75,415)4,111 Loss before provision for (benefit from) income taxes(361,027)(488,494)(1,179,027)Provision for (benefit from) income taxes10,067 31,885 (12,636)Net loss(371,094)(520,379)(1,166,391)Less: Net income attributable to noncontrolling interests2,611 — — Net loss attributable to common stockholders$(373,705)$(520,379)$(1,166,391)————(1) Includes stock-based compensation expense as follows (in thousands): Years Ended December 31,202220212020Cost of revenue$44,061 $68,546 $139,627 Sales and marketing196,301 242,910 398,205 Research and development93,871 150,298 357,063 General and administrative230,565 316,461 375,807 Total stock-based compensation expense (i)$564,798 $778,215 $1,270,702 ————(i) On September 30, 2020, in connection with our Direct Listing, we incurred $769.5 million and $8.4 million of stock-based compensation using the accelerated attribution method related to the satisfaction of the performance-based vesting condition for RSUs and growth units, respectively, that had satisfied the service-based vesting condition as of such date.71The following table sets forth the components of our consolidated statements of operations data as a percentage of revenue: Years Ended December 31,202220212020Revenue100 %100 %100 %Cost of revenue21 22 32 Gross profit79 78 68 Operating expenses:Sales and marketing37 40 63 Research and development19 25 51 General and administrative31 40 61 Total operating expenses87 105 175 Loss from operations(8)(27)(107)Interest income1 — — Interest expense— — (1)Other income (expense), net(12)(5)— Loss before provision for (benefit from) income taxes(19)(32)(108)Provision for (benefit from) income taxes1 2 (1)Net loss(20)(34)(107)Less: Net income attributable to noncontrolling interests— — — Net loss attributable to common stockholders(20)%(34)%(107)%Comparison of the Years Ended December 31, 2022 and 2021 Revenue Years Ended December 31,Change20222021Amount%Revenue:Government$1,071,776 $897,356 $174,420 19 %Commercial834,095 644,533 189,562 29 %Total revenue$1,905,871 $1,541,889 $363,982 24 %Revenue increased by $364.0 million, or 24%, for the year ended December 31, 2022 compared to 2021. Revenue from government customers increased by $174.4 million, or 19%, for the year ended December 31, 2022 compared to 2021, primarily from customers in the United States. Revenue growth slowed compared to the prior year as a result of increased delays in the completion of the U.S. government budgeting process when compared to their budgeting process in the prior year. Of the increase, $151.1 million was from government customers existing as of December 31, 2021. Generally, increases in revenue from our existing customers are a result of expanded use of our products and services within their organizations. Revenue from U.S. government customers was $826.3 million for the year ended December 31, 2022 compared to $678.2 million for the same period in 2021. Revenue from commercial customers increased by $189.6 million, or 29%, for the year ended December 31, 2022 compared to 2021. Of the increase, $96.8 million was from new customers as of December 31, 2021, of which $27.0 million was revenue from customers with which we had entered into concurrent Investment Agreements. See Note 4. Investments and Fair Value Measurements in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information. 72Cost of Revenue and Gross ProfitYears Ended December 31,Change20222021Amount%Cost of revenue$408,549 $339,404 $69,145 20 %Gross profit1,497,322 1,202,485 294,837 25 %Gross margin79 %78 %Cost of revenue for the year ended December 31, 2022 increased by $69.1 million, or 20%, compared to 2021. The increase was primarily due to increases of $33.0 million in third-party cloud hosting services driven by increased usage from customer growth and expansion, $29.4 million in field service representatives mainly related to new projects, $18.1 million in payroll and other payroll-related costs as a result of increased headcount attributable to our cost of revenue function, and $11.9 million in travel and office-related costs. The increases were partially offset by a decrease of $31.0 million in stock-based compensation expense and related expenses. For additional information, see the section titled “Stock-Based Compensation” below.Our gross margin for the year ended December 31, 2022 increased by 1% compared to 2021. Gross margin increased as a result of revenue growth outpacing costs of revenue. The primary cause of this growth rate variation was the decrease in stock-based compensation expense and related expenses in cost of revenue relative to total expense growth as compared to the prior year. Operating ExpensesYears Ended December 31,Change20222021Amount%Sales and marketing$702,511 $614,512 $87,999 14 %Research and development359,679 387,487 (27,808)(7)%General and administrative596,333 611,532 (15,199)(2)%Total operating expenses$1,658,523 $1,613,531 $44,992 3 %Sales and MarketingSales and marketing expenses increased by $88.0 million, or 14%, for the year ended December 31, 2022 compared to 2021. The increase was primarily due to increases of $93.1 million in payroll and other payroll-related costs driven by increased headcount attributable to our sales and marketing function, $36.3 million in travel and office-related costs, and $23.5 million in marketing and advertising expenses. The increases were partially offset by a decrease of $81.3 million in stock-based compensation expense and related expenses. For additional information, see the section titled “Stock-Based Compensation” below.Research and Development Research and development expenses decreased by $27.8 million, or 7%, for the year ended December 31, 2022 compared to 2021. The decrease was primarily due to a decrease of $75.1 million in stock-based compensation expense and related expenses. For additional information, see the section titled “Stock-Based Compensation” below. The decrease was partially offset by increases of $22.8 million in payroll and other payroll-related costs driven by increased headcount attributable to our research and development function, $12.0 million in travel and office-related costs, and $11.6 million in third-party cloud hosting services and other IT costs driven by increased usage to support customer growth and expansion, as well as other IT costs to support company growth.General and Administrative General and administrative expenses decreased by $15.2 million, or 2%, for the year ended December 31, 2022 compared to 2021. The decrease was primarily due to a decrease of $113.0 million in stock-based compensation expense and related expenses. For additional information see the section titled “Stock-Based Compensation” below. This decrease was partially offset by increases of $34.1 million in travel and office-related costs, $28.9 million in payroll and other payroll-related costs driven by increased headcount attributable to our general and administrative functions, $15.0 million in professional service fees mainly related to legal and financial services, and a $10.1 million allowance for credit losses.73Stock-Based CompensationYears Ended December 31,Change20222021Amount%Cost of revenue$44,061 $68,546 $(24,485)(36)%Sales and marketing196,301 242,910 (46,609)(19)%Research and development93,871 150,298 (56,427)(38)%General and administrative230,565 316,461 (85,896)(27)%Total stock-based compensation expense$564,798 $778,215 $(213,417)(27)%Stock-based compensation expenses decreased by $213.4 million, or 27%, for the year ended December 31, 2022 compared to 2021. The decrease was primarily driven by forfeitures and lower expense under the accelerated attribution method for RSUs granted prior to September 30, 2020, the date of our Direct Listing, during the year ended December 31, 2022 compared to the same period in 2021, partially offset by an increase related to awards granted after December 31, 2021.Interest Income Years Ended December 31,Change20222021AmountInterest income$20,309 $1,607 $18,702 Interest income increased by $18.7 million for the year ended December 31, 2022 compared to 2021 primarily due to an increase in U.S. interest rates on interest earned from our cash, cash equivalents, and restricted cash.Interest Expense Years Ended December 31,Change20222021AmountInterest expense$(4,058)$(3,640)$(418)Interest expense increased by $0.4 million for the year ended December 31, 2022 compared to 2021 driven by the amendments to our credit facility during the year.Other Income (Expense), NetYears Ended December 31,Change20222021AmountOther income (expense), net$(216,077)$(75,415)$(140,662)Other income (expense), net changed by $140.7 million for the year ended December 31, 2022 compared to 2021 primarily due to $272.1 million of net unrealized and realized losses from our investments in marketable securities, partially offset by a $44.3 million gain from a “step acquisition” (as defined by U.S. GAAP). For additional information see Note 4. Investments and Fair Value Measurements and Note 14. Business Combinations in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.Provision for Income Taxes Years Ended December 31,Change20222021AmountProvision for income taxes$10,067 $31,885 $(21,818)Provision for income taxes decreased by $21.8 million for the year ended December 31, 2022 compared to 2021 primarily due to the prior year establishment of a full valuation allowance against its U.K. deferred tax assets during the fourth quarter of 2021 partially offset by permanent differences associated with U.S. Base Erosion and Anti Abuse Tax elections. The Company maintains a full valuation allowance against its U.S. federal and state and U.K. deferred tax assets. For additional information see Note 11. Income Taxes in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.74Liquidity and Capital Resources We generated positive cash flow from operations for the year ended December 31, 2022 and had $2.6 billion in cash and cash equivalents available as of December 31, 2022. We believe that cash flows generated from operations, cash, cash equivalents, available funds and access to financing sources, including our credit facility, will be sufficient to meet our anticipated operating cash needs for at least the next twelve months. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. We have generated significant losses from our operations as reflected in our consolidated balance sheets and we expect cash flow from operations may fluctuate for the foreseeable future. Historically, we have financed our operations primarily through the sale of our equity securities, including proceeds from option exercises, and payments received from our customers. As of December 31, 2022, our accumulated deficit balance was $5.9 billion, and our principal sources of liquidity were $2.6 billion of cash and cash equivalents.During April 2021, we repaid our outstanding term loans of $200.0 million. As of December 31, 2022, we had no outstanding debt balances and additional available and undrawn revolving and DDTL commitments of $950.0 million under our credit agreement to fund working capital and general corporate expenditures. No amounts were drawn as of the date of this Annual Report on Form 10-K. For more information, see Note 6. Debt in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.Our future capital requirements will depend on many factors, including, but not limited to the rate of our growth, our ability to attract and retain customers and their willingness and ability to pay for our products and services, and the timing and extent of spending to support our efforts to market and develop our products. Further, we may enter into future arrangements to acquire or invest in businesses, products, services, strategic partnerships, and technologies. As such, we may be required to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If additional funds are not available to us on acceptable terms, or at all, our business, financial condition, and results of operations could be adversely affected.The following table summarizes our cash flows for the periods indicated (in thousands): Years Ended December 31,202220212020Net cash provided by (used in):Operating activities$223,737 $333,851 $(296,608)Investing activities(45,427)(397,912)(14,920)Financing activities85,996 306,747 1,036,453 Effect of foreign exchange on cash, cash equivalents, and restricted cash(3,885)(3,918)1,259 Net increase in cash, cash equivalents, and restricted cash$260,421 $238,768 $726,184 Operating Activities Net cash provided by operating activities was $223.7 million and $333.9 million for the year ended December 31, 2022 and 2021, respectively. The decrease was primarily driven by timing of payments to vendors and timing of the receipt of payments from our customers. Investing Activities Net cash used in investing activities was $45.4 million and $397.9 million for the year ended December 31, 2022 and 2021, respectively. The decrease in cash used in investing activities was primarily due to a reduction of our purchases of alternative investments and marketable securities, as well as increases from cash acquired from business combinations and sales or redemption of certain marketable securities.Financing Activities Net cash provided by financing activities was $86.0 million and $306.7 million for the year ended December 31, 2022 and 2021, respectively. The decrease in cash provided by financing activities was driven by a decrease in proceeds from the exercise of common stock options, partially offset by the principal repayments on borrowings of $200.0 million made during the year ended December 31, 2021. 75Contractual Obligations and CommitmentsThe following table summarizes our contractual obligations and commitments as of December 31, 2022 (in thousands):Payments Due by PeriodTotalLess than 1 year1-3 years3-5 yearsMore than 5 yearsNoncancelable purchase commitments(1)$1,275,377 $169,124 $591,000 $515,253 $— Operating lease commitments, net of sublease income amounts(2)193,075 40,385 74,633 38,550 39,507 Total contractual obligations and commitments$1,468,452 $209,509 $665,633 $553,803 $39,507 —————(1) Noncancelable purchase commitments primarily relate to purchase commitments for third-party cloud hosting services and represents only contracts which are enforceable and legally binding. Obligations under contracts that we can cancel without a significant penalty are not included in the table above. Refer to Note 8. Commitments and Contingencies in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information.(2) The contractual commitment amounts under operating leases in the table above are primarily related to facility and equipment leases. Operating lease commitments are reflected net of $120.8 million of sublease income from tenants in certain of our leased facilities. Refer to Note 7. Leases in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information.The contractual obligations and commitments in the table above are associated with agreements that are enforceable and legally binding.Contract LiabilitiesOur contract liabilities consist of deferred revenue and customer deposits.Deferred revenue represents billings under noncancelable contracts before the related product or service is transferred to the customer. The portion of deferred revenue that is anticipated to be recognized as revenue during the succeeding twelve-month period is recorded as deferred revenue and the remaining portion is recorded as deferred revenue, noncurrent.Customer deposits consist of amounts billed and/or paid for anticipated revenue generating activities in advance of the start of the contractual term or for the portion of a contract term that is subject to cancellation by our customers. The portion of customer deposits that is anticipated to be recognized as revenue during the succeeding twelve-month period is recorded as customer deposits and the remaining portion is recorded as customer deposits, noncurrent.Our deferred revenue and deferred revenue, noncurrent as of December 31, 2022 were $183.4 million and $10.0 million, respectively. Our customer deposits and customer deposits, noncurrent as of December 31, 2022 were $142.0 million and $3.9 million, respectively. Our deferred revenue and deferred revenue, noncurrent as of December 31, 2021 were $227.8 million and $40.2 million, respectively. Our customer deposits and customer deposits, noncurrent as of December 31, 2021 were $161.6 million and $33.7 million, respectively. Critical Accounting Policies and Estimates Our consolidated financial statements and the accompanying notes thereto included elsewhere in this Annual Report on Form 10-K are prepared in accordance with GAAP. The preparation of consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from our estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected. We believe that the accounting policies described below involve a significant degree of judgment and complexity. Accordingly, we believe these are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations. For further information, see Note 2. Significant Accounting Policies in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. 76Revenue RecognitionWe generate revenue from the sale of subscriptions to access our software Palantir Cloud and On-Premises Software, with ongoing O&M services and professional services.In accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, we recognized revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for promised goods or services. We apply the following five-step revenue recognition model in accounting for our revenue arrangements:•identification of the contract(s) with the customer, including whether collectability of the consideration is probable by considering the customers’ ability and intention to pay;•identification of the performance obligations in the contract;•determination of the transaction price;•allocation of the transaction price to the performance obligations in the contract; and•recognition of revenue when, or as, we satisfy a performance obligation.Each of our significant performance obligations and our application of ASC 606 to our revenue arrangements is discussed in further detail below.Palantir CloudOur Palantir Cloud subscriptions grant customers the right to access the software functionality in a hosted environment controlled by Palantir and are also sold together with stand-ready O&M services. We promise to provide continuous access to the hosted software throughout the contract term. Revenue associated with Palantir Cloud subscriptions is generally recognized over the contract term on a ratable basis, which is consistent with the transfer of control of the Palantir Cloud services to the customer.On-Premises SoftwareSales of our software subscriptions grant customers the right to use functional intellectual property, either on their internal hardware infrastructure or on their own cloud instance, over the contractual term and are sold together with stand-ready O&M services. The O&M services include critical updates, support, and maintenance services required to operate our software and, as such, are necessary for our software to maintain its intended utility over the contractual term. Because of this requirement, we have concluded that the software subscriptions and O&M services, which together we refer to as our On-Premises Software, are highly interdependent and interrelated and represent a single distinct performance obligation within the context of the contract. Revenue is generally recognized over the contract term on a ratable basis.Professional ServicesOur professional services support the customers’ use of the software and include, as needed, on-demand user support, user-interface configuration, training, and ongoing ontology and data modeling support. Professional services contracts typically include the provision of on-demand professional services for the duration of the contractual term. These services are typically coterminous with a Palantir Cloud subscription or the On-Premises Software. Professional services are on-demand, whereby we perform services throughout the contract period; therefore, the revenue is recognized over the contractual term.Contract LiabilitiesThe timing of customer billing and payment relative to the start of the service period varies from contract to contract; however, we bill many of our customers in advance of the provision of services under our contracts, resulting in contract liabilities consisting of either deferred revenue or customer deposits. Deferred revenue represents billings under noncancelable contracts before the related product or service is transferred to the customer. Customer deposits consist of amounts billed and/or paid in advance of the start of the contractual term or for anticipated revenue generating activities for the portion of a contract term that is subject to cancellation by our customers. Many of our arrangements include terms that allow the customer to terminate the contract for convenience and receive a pro-rata refund of the amount of the customer deposit for the period of time remaining in the contract term after the applicable termination notice period expires. In these arrangements, we concluded there are no enforceable rights and obligations after such notice period and therefore the consideration received or due from the customer that is subject to termination for convenience is recorded as customer deposits.The payment terms and conditions vary by contract; however, our terms generally require payment within 30 to 60 days from the invoice date. In instances where the timing of revenue recognition differs from the timing of payment, we elected to apply 77the practical expedient in accordance with ASC 606 to not adjust contract consideration for the effects of a significant financing component as we expect, at contract inception, that the period between when promised goods and services are transferred to the customer and when the customer pays for those goods and services will be one year or less. As such, we determined our contracts do not generally contain a significant financing component.Areas of Judgment and EstimationOur contracts with customers can include multiple promises to transfer goods or services to the customer. Determining whether promises are distinct performance obligations that should be accounted for separately – or not distinct within the context of the contract and, thus, accounted for together – requires significant judgment. We concluded that the promise to provide a software subscription is highly interdependent and interrelated with the promise to provide O&M services and such promises are not distinct within the context of our contracts and are accounted for as a single performance obligation for our On-Premises Software.Additionally, the pricing of our contracts is generally fixed; however, it is possible for contracts to include variable consideration, which can be based on subjective or objective criteria. We include the estimated amount of variable consideration that we expect to receive to the extent it is probable that a significant revenue reversal will not occur. Variable consideration received was not material in the periods presented.Significant estimates and assumptions are used in the identification of performance obligations in customer contracts and collectability of contract consideration, including accounts receivable. Estimates and judgments are based on historical experience, forecasted events, and various other assumptions that management believes to be reasonable under the circumstances. Actual results could differ from those estimates and such differences could affect our financial position and results of operations. Recent Accounting Pronouncements For information on recently issued accounting pronouncements, if any, refer to Note 2. Significant Accounting Policies in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risks in the ordinary course of our business, which primarily relate to fluctuations in the value of our investments, interest rates, foreign exchange, and inflation.Market RiskAs of December 31, 2022, we had outstanding investments in marketable securities valued at $35.1 million. We have sold, and may continue to sell, some or all of our existing investments. These Investments are often in early- or growth-stage companies that have minimal public trading history; as such the fair value of these Investments may fluctuate depending on the financial outcome and prospects of the Investees, as well as global market conditions including recent and ongoing volatility related to the impacts of the ongoing COVID-19 pandemic, the ongoing Russia-Ukraine conflict, and rising interest rates. Additionally, investing in early- or growth-stage companies carries inherent risks because, among other things, the technologies or products that are being developed by these companies are typically in the early phases and may never materialize or they may not achieve their growth or other business objectives, and they have and may continue to experience a decline in financial condition, which could result in a loss of all or a substantial part of our investment in these companies. We record gains or losses as the fair value of these Investments change and as we sell them. We anticipate additional volatility to our consolidated statements of operations due to changes in market prices and declines in financial conditions of Investees, and as such gains and losses are realized. During the fiscal year ended December 31, 2022, net unrealized losses of $159.0 million and net realized losses of $113.1 million related to marketable securities were recorded in other income (expense), net on the consolidated statements of operations. We do not currently anticipate entering into new Investment Agreements to purchase, or commit to purchase, securities of special purpose acquisition companies.Interest Rate Risk Our cash, cash equivalents, and restricted cash consist of cash, certificates of deposit, and money market funds. Our primary investment policy and strategies are focused on the preservation of capital and supporting our liquidity requirements; however, to a lesser extent we have made and may continue to make investments in early- and growth-stage companies as disclosed in Note 4. Investments and Fair Value Measurements in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. We do not currently anticipate entering into new Investment Agreements to purchase, or commit to purchase, securities of special purpose acquisition companies.78Due to the short-term nature of the financial instruments, we have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in interest rates.Foreign Currency Exchange Risk Our contracts with customers are primarily denominated in U.S. dollars, with the remaining denominated in foreign currencies. Our expenses are generally denominated in the currencies of the jurisdictions in which we conduct our operations, which are primarily in the United States, United Kingdom, and other European countries. Our results of current and future operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro and GBP. We have experienced, and may continue to experience, fluctuations in net loss as a result of transaction gains or losses related to remeasuring certain assets and liability balances that are denominated in foreign currencies. These exposures may change over time as business practices evolve and economic conditions change. To date, foreign currency transaction gains and losses have not been material to our consolidated financial statements, and we have not engaged in any foreign currency hedging transactions. Inflation Risk We do not believe that inflation has had a material effect on our business, results of operations, or financial condition. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition, or results of operations.79
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. The following discussion and analysis contains forward-looking statements based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those anticipated or implied by any forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Annual Report on Form 10-K, and in particular, the risks discussed under the caption “Risk Factors” in Part I, Item 1A of this report.Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is organized as follows:•Overview. A discussion of our business and overall analysis of financial and other highlights in order to provide context for the remainder of MD&A.•Key Financial Metrics. A summary of our U.S. GAAP and non-GAAP key financial metrics, which management monitors to evaluate our performance.•Results of Operations. A discussion of the nature and trends in our financial results and an analysis of our financial results comparing fiscal 2023 to fiscal 2022. For discussion and analysis related to our financial results comparing fiscal 2022 to 2021, refer to Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for fiscal 2022, which was filed with the Securities and Exchange Commission on September 6, 2022.•Liquidity and Capital Resources. An analysis of changes on our balance sheets and cash flows, and a discussion of our financial condition and our ability to meet cash needs.•Critical Accounting Estimates. A discussion of our accounting policies that require critical estimates, assumptions, and judgments.OverviewWe empower enterprises, organizations, service providers, and government entities to protect themselves against today’s most sophisticated cyber threats. Our cybersecurity platforms and services help secure enterprise users, networks, clouds, and endpoints by delivering comprehensive cybersecurity backed by industry-leading artificial intelligence and automation. We are a leading provider of zero trust solutions, starting with next-generation zero trust network access to secure today’s remote hybrid workforces and extending to securing all users, applications, and infrastructure with zero trust principles. Our security solutions are designed to reduce customers’ total cost of ownership by improving operational efficiency and eliminating the need for siloed point products. Our company focuses on delivering value in four fundamental areas:Network Security:•Our network security platform, designed to deliver complete zero trust solutions to our customers, includes our hardware and software ML-Powered Next-Generation Firewalls, as well as a cloud-delivered Secure Access Service Edge (“SASE”). Prisma® Access, our Security Services Edge (“SSE”) solution, when combined with Prisma SD-WAN, provides a comprehensive single-vendor SASE offering that is used to secure remote workforces and enable the cloud-delivered branch. We have been recognized as a leader in network firewalls, SSE, and SD-WAN. Our network security platform also includes our cloud-delivered security services, such as Advanced Threat Prevention, Advanced WildFire®, Advanced URL Filtering, DNS Security, IoT/OT Security, GlobalProtect®, Enterprise Data Loss Prevention (“Enterprise DLP”), Artificial Intelligence for Operations (“AIOps”), SaaS Security API, and SaaS Security Inline. Through these add-on security services, our customers are able to secure their content, applications, users, and devices across their entire organization. Panorama®, our network security management solution, can centrally manage our network security platform irrespective of form factor, location, or scale.Cloud Security:•We enable cloud-native security through our Prisma Cloud platform. As a comprehensive Cloud Native Application Protection Platform (“CNAPP”), Prisma Cloud secures multi- and hybrid-cloud environments for applications, data, and the entire cloud native technology stack across the full development lifecycle; from code to runtime. For inline network security on multi- and hybrid-cloud environments, we also offer our VM-Series and CN-Series Firewall offerings.- 38 -Table of ContentsSecurity Operations:•We deliver the next generation of security automation, security analytics, endpoint security, and attack surface management solutions through our Cortex portfolio. These include Cortex XSIAM, our AI security automation platform, Cortex XDR® for the prevention, detection, and response to complex cybersecurity attacks on the endpoint, Cortex XSOAR® for security orchestration, automation, and response (“SOAR”), and Cortex XpanseTM for attack surface management (“ASM”). These products are delivered as SaaS or software subscriptions.Threat Intelligence and Security Consulting (Unit 42):•Unit 42 brings together world-renowned threat researchers with an elite team of incident responders and security consultants to create an intelligence-driven, response-ready organization to help customers proactively manage cyber risk. Our consultants serve as trusted advisors to our customers by assessing and testing their security controls against the right threats, transforming their security strategy with a threat-informed approach, and responding to security incidents on behalf of our clients.For fiscal 2023 and 2022, total revenue was $6.9 billion and $5.5 billion, respectively, representing year-over-year growth of 25.3%. Our growth reflects the increased adoption of our portfolio, which consists of product, subscriptions, and support. We believe our portfolio will enable us to benefit from recurring revenues and new revenues as we continue to grow our end-customer base. As of July 31, 2023, we had end-customers in over 180 countries. Our end-customers represent a broad range of industries, including education, energy, financial services, government entities, healthcare, Internet and media, manufacturing, public sector, and telecommunications, and include almost all of the Fortune 100 companies and a majority of the Global 2000 companies. We maintain a field sales force that works closely with our channel partners in developing sales opportunities. We primarily use a two-tiered, indirect fulfillment model whereby we sell our products, subscriptions, and support to our distributors, which, in turn, sell to our resellers, which then sell to our end-customers. Our product revenue grew to $1.6 billion or 22.9% of total revenue for fiscal 2023, representing year-over-year growth of 15.8%. Product revenue is derived from sales of our appliances, primarily our ML-Powered Next-Generation Firewall. Product revenue also includes revenue derived from software licenses of Panorama, SD-WAN, and the VM-Series. Our ML-Powered Next-Generation Firewall incorporates our PAN-OS operating system, which provides a consistent set of capabilities across our entire network security product line. Our appliances and software licenses include a broad set of built-in networking and security features and functionalities. Our products are designed for different performance requirements throughout an organization, ranging from our PA-410, which is designed for small organizations and remote or branch offices, to our top-of-the-line PA-7080, which is designed for large-scale data centers and service provider use. The same firewall functionality that is delivered in our physical appliances is also available in our VM-Series virtual firewalls, which secure virtualized and cloud-based computing environments, and in our CN-Series container firewalls, which secure container environments and traffic.Our subscription and support revenue grew to $5.3 billion or 77.1% of total revenue for fiscal 2023, representing year-over-year growth of 28.4%. Our subscriptions provide our end-customers with near real-time access to the latest antivirus, intrusion prevention, web filtering, modern malware prevention, data loss prevention, and cloud access security broker capabilities across the network, endpoints, and the cloud. When end-customers purchase our physical, virtual, or container firewall appliances, or certain cloud offerings, they typically purchase support in order to receive ongoing security updates, upgrades, bug fixes, and repairs. In addition to the subscriptions purchased with these appliances, end-customers may also purchase other subscriptions on a per-user, per-endpoint, or capacity-based basis. We also offer professional services, including incident response, risk management, and digital forensic services.We continue to invest in innovation as we evolve and further extend the capabilities of our portfolio, as we believe that innovation and timely development of new features and products are essential to meeting the needs of our end-customers and improving our competitive position. During fiscal 2023, we introduced several new offerings, including: Cortex XSIAM 1.0, major updates to Prisma Cloud (including three new security modules), Prisma Access 4.0, PAN-OS 11.0, Cloud NGFW for AWS, and Cloud NGFW for Azure. Additionally, we acquired productive investments that fit well within our long-term strategy. For example, in December 2022, we acquired Cider, which we expect will support our Prisma Cloud’s platform approach to securing the entire application security lifecycle from code to cloud.We believe that the growth of our business and our short-term and long-term success are dependent upon many factors, including our ability to extend our technology leadership, grow our base of end-customers, expand deployment of our portfolio and support offerings within existing end-customers, and focus on end-customer satisfaction. To manage any future growth effectively, we must continue to improve and expand our information technology and financial infrastructure, our operating and administrative systems and controls, and our ability to manage headcount, capital, and processes in an efficient manner. While these areas present significant opportunities for us, they also pose challenges and risks that we must successfully address in order to sustain the growth of our business and improve our operating results. For additional information regarding the challenges and risks we face, see the “Risk Factors” section in Part I, Item 1A of this Annual Report on Form 10-K.- 39 -Table of ContentsImpact of Macroeconomic Developments and Other Factors on Our BusinessOur overall performance depends in part on worldwide economic and geopolitical conditions and their impact on customer behavior. Worsening economic conditions, including inflation, higher interest rates, slower growth, fluctuations in foreign exchange rates, and other conditions, may adversely affect our results of operations and financial performance. We continue to experience supply chain disruption and incur increased costs resulting from inflationary pressures. We are monitoring the tensions between China and Taiwan, and between the U.S. and China, which could have an adverse impact on our business or results of operations in future periods.Key Financial Metrics We monitor the key financial metrics set forth in the tables below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts, and assess operational efficiencies. We discuss revenue, gross margin, and the components of operating income (loss) and margin below under “Results of Operations.”July 31,20232022(in millions)Total deferred revenue$9,296.4 $6,994.0 Cash, cash equivalents, and investments$5,437.9 $4,686.4 Year Ended July 31,202320222021(dollars in millions)Total revenue$6,892.7 $5,501.5 $4,256.1 Total revenue year-over-year percentage increase25.3 %29.3 %24.9 %Gross margin72.3 %68.8 %70.0 %Operating income (loss)$387.3 $(188.8)$(304.1)Operating margin5.6 %(3.4)%(7.1)%Billings$9,194.4 $7,471.5 $5,452.2 Billings year-over-year percentage increase23.1 %37.0 %26.7 %Cash flow provided by operating activities$2,777.5 $1,984.7 $1,503.0 Free cash flow (non-GAAP)$2,631.2 $1,791.9 $1,387.0 •Deferred Revenue. Our deferred revenue primarily consists of amounts that have been invoiced but have not been recognized as revenue as of the period end. The majority of our deferred revenue balance consists of subscription and support revenue that is recognized ratably over the contractual service period. We monitor our deferred revenue balance because it represents a significant portion of revenue to be recognized in future periods.•Billings. We define billings as total revenue plus the change in total deferred revenue, net of acquired deferred revenue, during the period. We consider billings to be a key metric used by management to manage our business. We believe billings provides investors with an important indicator of the health and visibility of our business because it includes subscription and support revenue, which is recognized ratably over the contractual service period, and product revenue, which is recognized at the time of hardware shipment or delivery of software license, provided that all other conditions for revenue recognition have been met. We consider billings to be a useful metric for management and investors, particularly if we continue to experience increased sales of subscriptions and strong renewal rates for subscription and support offerings, and as we monitor our near-term cash flows. While we believe that billings provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management, it is important to note that other companies, including companies in our industry, may not use billings, may calculate billings differently, may have different billing frequencies, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of billings as a comparative measure. We calculate billings in the following manner:- 40 -Table of ContentsYear Ended July 31,202320222021(in millions)Billings:Total revenue$6,892.7 $5,501.5 $4,256.1 Add: change in total deferred revenue, net of acquired deferred revenue2,301.7 1,970.0 1,196.1 Billings$9,194.4 $7,471.5 $5,452.2 •Cash Flow Provided by Operating Activities. We monitor cash flow provided by operating activities as a measure of our overall business performance. Our cash flow provided by operating activities is driven in large part by sales of our products and from up-front payments for subscription and support offerings. Monitoring cash flow provided by operating activities enables us to analyze our financial performance without the non-cash effects of certain items such as share-based compensation costs, depreciation and amortization, thereby allowing us to better understand and manage the cash needs of our business.•Free Cash Flow (non-GAAP). We define free cash flow, a non-GAAP financial measure, as cash provided by operating activities less purchases of property, equipment, and other assets. We consider free cash flow to be a profitability and liquidity measure that provides useful information to management and investors about the amount of cash generated by the business after necessary capital expenditures. A limitation of the utility of free cash flow as a measure of our financial performance and liquidity is that it does not represent the total increase or decrease in our cash balance for the period. In addition, it is important to note that other companies, including companies in our industry, may not use free cash flow, may calculate free cash flow in a different manner than we do, or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of free cash flow as a comparative measure. A reconciliation of free cash flow to cash flow provided by operating activities, the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP, is provided below:Year Ended July 31,202320222021(in millions)Free cash flow (non-GAAP):Net cash provided by operating activities$2,777.5 $1,984.7 $1,503.0 Less: purchases of property, equipment, and other assets146.3 192.8 116.0 Free cash flow (non-GAAP)$2,631.2 $1,791.9 $1,387.0 Net cash used in investing activities$(2,033.8)$(933.4)$(1,480.6)Net cash used in financing activities$(1,726.3)$(806.6)$(1,104.0)- 41 -Table of ContentsResults of OperationsThe following table summarizes our results of operations for the periods presented and as a percentage of our total revenue for those periods based on our consolidated statements of operations data. The period-to-period comparison of results is not necessarily indicative of results for future periods.Year Ended July 31,202320222021Amount% of RevenueAmount% of RevenueAmount% of Revenue(dollars in millions)Revenue:Product$1,578.4 22.9 %$1,363.1 24.8 %$1,120.3 26.3 %Subscription and support5,314.3 77.1 %4,138.4 75.2 %3,135.8 73.7 %Total revenue6,892.7 100.0 %5,501.5 100.0 %4,256.1 100.0 %Cost of revenue:Product418.3 6.1 %455.5 8.3 %308.5 7.2 %Subscription and support1,491.4 21.6 %1,263.2 22.9 %966.4 22.8 %Total cost of revenue(1)1,909.7 27.7 %1,718.7 31.2 %1,274.9 30.0 %Total gross profit4,983.0 72.3 %3,782.8 68.8 %2,981.2 70.0 %Operating expenses:Research and development1,604.0 23.3 %1,417.7 25.8 %1,140.4 26.8 %Sales and marketing2,544.0 36.9 %2,148.9 39.0 %1,753.8 41.1 %General and administrative447.7 6.5 %405.0 7.4 %391.1 9.2 %Total operating expenses(1)4,595.7 66.7 %3,971.6 72.2 %3,285.3 77.1 %Operating income (loss)387.3 5.6 %(188.8)(3.4)%(304.1)(7.1)%Interest expense(27.2)(0.4)%(27.4)(0.5)%(163.3)(3.8)%Other income, net206.2 3.0 %9.0 0.1 %2.4 — %Income (loss) before income taxes566.3 8.2 %(207.2)(3.8)%(465.0)(10.9)%Provision for income taxes126.6 1.8 %59.8 1.1 %33.9 0.8 %Net income (loss)$439.7 6.4 %$(267.0)(4.9)%$(498.9)(11.7)%(1)Includes share-based compensation as follows:Year Ended July 31,202320222021(in millions)Cost of product revenue $9.8 $9.3 $6.2 Cost of subscription and support revenue 123.4 110.2 93.0 Research and development488.4 471.1 428.9 Sales and marketing335.3 304.7 269.9 General and administrative130.4 118.1 128.9 Total share-based compensation$1,087.3 $1,013.4 $926.9 - 42 -Table of ContentsREVENUEOur revenue consists of product revenue and subscription and support revenue. Revenue is recognized upon transfer of control of the corresponding promised products and subscriptions and support to our customers in an amount that reflects the consideration we expect to be entitled to in exchange for those products and subscriptions and support. We expect our revenue to vary from quarter to quarter based on seasonal and cyclical factors. PRODUCT REVENUEProduct revenue is derived from sales of our appliances, primarily our ML-Powered Next-Generation Firewall. Product revenue also includes revenue derived from software licenses of Panorama, SD-WAN, and the VM-Series. Our appliances and software licenses include a broad set of built-in networking and security features and functionalities. We recognize product revenue at the time of hardware shipment or delivery of software license.Year Ended July 31,Year Ended July 31, 20232022Change20222021ChangeAmountAmountAmount%AmountAmountAmount% (dollars in millions)Product$1,578.4 $1,363.1 $215.3 15.8 %$1,363.1 $1,120.3 $242.8 21.7 %Product revenue increased for fiscal 2023 compared to fiscal 2022 driven by increased demand for our new generation of hardware products, increased software revenue primarily due to a new go-to-market strategy for certain Network Security offerings and an increased demand for our VM-Series virtual firewalls, partially offset by decreased revenue from our prior generation of hardware products. SUBSCRIPTION AND SUPPORT REVENUESubscription and support revenue is derived primarily from sales of our subscription and support offerings. Our subscription and support contracts are typically one to five years. We recognize revenue from subscriptions and support over time as the services are performed. As a percentage of total revenue, we expect our subscription and support revenue to vary from quarter to quarter and increase over the long term as we introduce new subscriptions, renew existing subscription and support contracts, and expand our installed end-customer base.Year Ended July 31,Year Ended July 31, 20232022Change20222021ChangeAmountAmountAmount%AmountAmountAmount% (dollars in millions)Subscription$3,335.4 $2,539.0 $796.4 31.4 %$2,539.0 $1,898.8 $640.2 33.7 %Support1,978.9 1,599.4 379.5 23.7 %1,599.4 1,237.0 362.4 29.3 %Total subscription and support$5,314.3 $4,138.4 $1,175.9 28.4 %$4,138.4 $3,135.8 $1,002.6 32.0 %Subscription and support revenue increased for fiscal 2023 compared to fiscal 2022 due to increased demand for our subscription and support offerings from our end-customers. The mix between subscription revenue and support revenue will fluctuate over time, depending on the introduction of new subscription offerings, renewals of support services, and our ability to increase sales to new and existing end-customers.- 43 -Table of ContentsREVENUE BY GEOGRAPHIC THEATERYear Ended July 31,Year Ended July 31, 20232022Change20222021ChangeAmountAmountAmount%AmountAmountAmount% (dollars in millions)Americas$4,719.9 $3,802.6 $917.3 24.1 %$3,802.6 $2,937.5 $865.1 29.5 %EMEA1,359.6 1,055.8 303.8 28.8 %1,055.8 817.3 238.5 29.2 %APAC813.2 643.1 170.1 26.5 %643.1 501.3 141.8 28.3 %Total revenue$6,892.7 $5,501.5 $1,391.2 25.3 %$5,501.5 $4,256.1 $1,245.4 29.3 %Revenue from the Americas, Europe, the Middle East, and Africa (“EMEA”) and Asia Pacific and Japan (“APAC”) increased year-over-year for fiscal 2023 as we continued to increase investment in our global sales force in order to support our growth and innovation. Our three geographic theaters had similar year-over-year revenue growth rates for fiscal 2023, with the Americas contributing the highest increase in revenue due to its larger scale. COST OF REVENUEOur cost of revenue consists of cost of product revenue and cost of subscription and support revenue.COST OF PRODUCT REVENUECost of product revenue primarily includes costs paid to our manufacturing partners for procuring components and manufacturing our products. Our cost of product revenue also includes personnel costs, which consist of salaries, benefits, bonuses, share-based compensation, and travel associated with our operations organization, amortization of intellectual property licenses, product testing costs, shipping and tariff costs, and shared costs. Shared costs consist of certain facilities, depreciation, benefits, recruiting, and information technology costs that we allocate based on headcount. We expect our cost of product revenue to fluctuate with our revenue from hardware products. Year Ended July 31,Year Ended July 31, 20232022Change20222021ChangeAmountAmountAmount%AmountAmountAmount% (dollars in millions)Cost of product revenue$418.3 $455.5 $(37.2)(8.2)%$455.5 $308.5 $147.0 47.6 %Cost of product revenue decreased for fiscal 2023 compared to fiscal 2022 due to a favorable hardware product mix.COST OF SUBSCRIPTION AND SUPPORT REVENUECost of subscription and support revenue includes personnel costs for our global customer support and technical operations organizations, customer support and repair costs, third-party professional services costs, data center and cloud hosting service costs, amortization of acquired intangible assets and capitalized software development costs, and shared costs. We expect our cost of subscription and support revenue to increase as our installed end-customer base grows and adoption of our cloud-based subscription offerings increases. Year Ended July 31,Year Ended July 31, 20232022Change20222021ChangeAmountAmountAmount%AmountAmountAmount% (dollars in millions)Cost of subscription and support revenue$1,491.4 $1,263.2 $228.2 18.1 %$1,263.2 $966.4 $296.8 30.7 %Cost of subscription and support revenue increased for fiscal 2023 compared to fiscal 2022 primarily due to increased costs to support the growth of our subscription and support offerings. Cloud hosting service costs, which support our cloud-based subscription offerings, increased $101.0 million for fiscal 2023 compared to fiscal 2022. Personnel costs grew $97.0 million for fiscal 2023 compared to fiscal 2022 primarily due to headcount growth. - 44 -Table of ContentsGROSS MARGINGross margin has been and will continue to be affected by a variety of factors, including the introduction of new products, manufacturing costs, the average sales price of our products, cloud hosting service costs, personnel costs, the mix of products sold, and the mix of revenue between product and subscription and support offerings. Our virtual and higher-end firewall products generally have higher gross margins than our lower-end firewall products within each product series. We expect our gross margins to vary over time depending on the factors described above. Year Ended July 31, 202320222021 AmountGrossMarginAmountGrossMarginAmountGrossMargin (dollars in millions)Product$1,160.1 73.5 %$907.6 66.6 %$811.8 72.5 %Subscription and support3,822.9 71.9 %2,875.2 69.5 %2,169.4 69.2 %Total gross profit$4,983.0 72.3 %$3,782.8 68.8 %$2,981.2 70.0 %Product gross margin increased for fiscal 2023 compared to fiscal 2022 primarily due to increased software revenue and a favorable hardware product mix.Subscription and support gross margin increased for fiscal 2023 compared to fiscal 2022, primarily due to our growth in subscription and support revenue, which outpaced the subscription and support costs.OPERATING EXPENSESOur operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, bonuses, share-based compensation, travel and entertainment, and with regard to sales and marketing expense, sales commissions. Our operating expenses also include shared costs, which consist of certain facilities, depreciation, benefits, recruiting, and information technology costs that we allocate based on headcount to each department. We expect operating expenses generally to increase in absolute dollars and decrease over the long term as a percentage of revenue as we continue to scale our business. As of July 31, 2023, we expect to recognize approximately $2.0 billion of share-based compensation expense over a weighted-average period of approximately 2.6 years, excluding additional share-based compensation expense related to any future grants of share-based awards. Share-based compensation expense is generally recognized on a straight-line basis over the requisite service periods of the awards.RESEARCH AND DEVELOPMENTResearch and development expense consists primarily of personnel costs. Research and development expense also includes prototype-related expenses and shared costs. We expect research and development expense to increase in absolute dollars as we continue to invest in our future products and services, although our research and development expense may fluctuate as a percentage of total revenue. Year Ended July 31,Year Ended July 31, 20232022Change20222021ChangeAmountAmountAmount%AmountAmountAmount% (dollars in millions)Research and development$1,604.0 $1,417.7 $186.3 13.1 %$1,417.7 $1,140.4 $277.3 24.3 %Research and development expense increased for fiscal 2023 compared to fiscal 2022 primarily due to increased personnel costs, which grew $154.2 million, largely due to headcount growth.- 45 -Table of ContentsSALES AND MARKETINGSales and marketing expense consists primarily of personnel costs, including commission expense. Sales and marketing expense also includes costs for market development programs, promotional and other marketing costs, professional services, and shared costs. We continue to strategically invest in headcount and have grown our sales presence. We expect sales and marketing expense to continue to increase in absolute dollars as we increase the size of our sales and marketing organizations to grow our customer base, increase touch points with end-customers, and expand our global presence, although our sales and marketing expense may fluctuate as a percentage of total revenue. Year Ended July 31,Year Ended July 31, 20232022Change20222021ChangeAmountAmountAmount%AmountAmountAmount% (dollars in millions)Sales and marketing$2,544.0 $2,148.9 $395.1 18.4 %$2,148.9 $1,753.8 $395.1 22.5 %Sales and marketing expense increased for fiscal 2023 compared to fiscal 2022 primarily due to increased personnel costs, which grew $290.7 million, largely due to headcount growth and increased travel and entertainment expenses. The increase in sales and marketing expense was further driven by increased costs associated with sales and marketing events and go-to-market initiatives.GENERAL AND ADMINISTRATIVEGeneral and administrative expense consists primarily of personnel costs and shared costs for our executive, finance, human resources, information technology, and legal organizations, and professional services costs, which consist primarily of legal, auditing, accounting, and other consulting costs. We expect general and administrative expense to increase in absolute dollars over time as we increase the size of our general and administrative organizations and incur additional costs to support our business growth, although our general and administrative expense may fluctuate as a percentage of total revenue. Year Ended July 31,Year Ended July 31, 20232022Change20222021ChangeAmountAmountAmount%AmountAmountAmount% (dollars in millions)General and administrative$447.7 $405.0 $42.7 10.5 %$405.0 $391.1 $13.9 3.6 %General and administrative expenses increased for fiscal 2023 compared to fiscal 2022 primarily due to increased personnel costs, which grew $23.2 million, largely due to share-based compensation related to our recent acquisitions and headcount growth. The increase in general and administrative expense was further driven by slightly higher reserves due to increased receivables as a result of our business growth. INTEREST EXPENSEInterest expense primarily consists of interest expense related to our 0.75% Convertible Senior Notes due 2023 (the “2023 Notes”) and the 0.375% Convertible Senior Notes due 2025 (the “2025 Notes,” and together with “2023 Notes,” the “Notes”). Year Ended July 31,Year Ended July 31, 20232022Change20222021ChangeAmountAmountAmount%AmountAmountAmount% (dollars in millions)Interest expense$27.2 $27.4 $(0.2)(0.7)%$27.4 $163.3 $(135.9)(83.2)%Interest expense remained relatively flat for fiscal 2023 compared to fiscal 2022. - 46 -Table of ContentsOTHER INCOME, NETOther income, net includes interest income earned on our cash, cash equivalents, and investments, and gains and losses from foreign currency remeasurement and foreign currency transactions. Year Ended July 31,Year Ended July 31, 20232022Change20222021ChangeAmountAmountAmount%AmountAmountAmount% (dollars in millions)Other income, net$206.2 $9.0 $197.2 2,191.1 %$9.0 $2.4 $6.6 275.0 %Other income, net increased for fiscal 2023 compared to fiscal 2022 primarily due to higher interest income as a result of higher interest rates and higher average cash, cash equivalent, and investments balances for fiscal 2023 compared to fiscal 2022.PROVISION FOR INCOME TAXESProvision for income taxes consists primarily of U.S. taxes driven by capitalization of research and development expenditures, foreign income taxes, and withholding taxes. We maintain a full valuation allowance for domestic and certain foreign deferred tax assets, including net operating loss carryforwards and certain domestic tax credits. Our valuation allowance has caused, and may continue to cause, disproportionate relationships between our overall effective tax rate and other jurisdictional measures. We regularly evaluate the need for a valuation allowance. Due to recent profitability, a reversal of our valuation allowance in certain jurisdictions in the foreseeable future is reasonably possible. Year Ended July 31,Year Ended July 31, 20232022Change20222021Change AmountAmountAmount%AmountAmountAmount% (dollars in millions)Provision for income taxes$126.6 $59.8 $66.8 111.7 %$59.8 $33.9 $25.9 76.4 %Effective tax rate22.4 %(28.9)%(28.9)%(7.3)%Our provision for income taxes for fiscal 2023 was primarily due to U.S. federal and state income taxes, withholding taxes, and foreign income taxes. Our effective tax rate varied for fiscal 2023 compared to fiscal 2022, primarily due to our profitability in fiscal 2023 and an increase in U.S. taxes driven by capitalization of research and development expenditures with no offsetting deferred benefit due to our valuation allowance. This increase was offset by releases of uncertain tax positions during fiscal 2023 resulting from tax settlements. Refer to Note 15. Income Taxes in Part II, Item 8 of this Annual Report on Form 10-K for more information.Liquidity and Capital ResourcesJuly 31,20232022(in millions)Working capital(1)$(1,689.5)$(1,891.4)Cash, cash equivalents, and investments:Cash and cash equivalents$1,135.3 $2,118.5 Investments4,302.6 2,567.9 Total cash, cash equivalents, and investments$5,437.9 $4,686.4 (1)Current liabilities included net carrying amounts of convertible senior notes of $2.0 billion and $3.7 billion as of July 31, 2023 and 2022, respectively. Refer to Note 10. Debt in Part II, Item 8 of this Annual Report on Form 10-K for information on the Notes.As of July 31, 2023, our total cash, cash equivalents, and investments of $5.4 billion were held for general corporate purposes. As of July 31, 2023, we had no unremitted earnings when evaluating our outside basis difference relating to our U.S. investment in foreign subsidiaries. However, there could be local withholding taxes due to various foreign countries if certain lower tier earnings are distributed. Withholding taxes that would be payable upon remittance of these lower tier earnings are not expected to be material.- 47 -Table of ContentsDEBTIn July 2018, we issued the 2023 Notes with an aggregate principal amount of $1.7 billion. The 2023 Notes were converted prior to or settled on the maturity date of July 1, 2023. During fiscal 2023, we repaid in cash $1.7 billion in aggregate principal amount of the 2023 Notes and issued 11.4 million shares of common stock to the holders for the conversion value in excess of the principal amount of the 2023 Notes converted, which were fully offset by shares we received from our exercise of the associated note hedges. In June 2020, we issued the 2025 Notes with an aggregate principal amount of $2.0 billion. The 2025 Notes mature on June 1, 2025; however, under certain circumstances, holders may surrender their 2025 Notes for conversion prior to the applicable maturity date. Upon conversion of the 2025 Notes, we will pay cash equal to the aggregate principal amount of the 2025 Notes to be converted, and, at our election, will pay or deliver cash and/or shares of our common stock for the amount of our conversion obligation in excess of the aggregate principal amount of the 2025 Notes being converted. The sale price condition for the 2025 Notes was met during the fiscal quarter ended July 31, 2023, and as a result, holders may convert their 2025 Notes during the fiscal quarter ending October 31, 2023. If all of the holders convert their 2025 Notes during this period, we would be obligated to settle the $2.0 billion principal amount of the 2025 Notes in cash. We believe that our cash provided by operating activities, our existing cash, cash equivalents and investments, and existing sources of and access to financing will be sufficient to meet our anticipated cash needs should the holders choose to convert their 2025 Notes during the fiscal quarter ending October 31, 2023 or hold the 2025 Notes until maturity on June 1, 2025. As of July 31, 2023, substantially all of our 2025 Notes remained outstanding. Refer to Note 10. Debt in Part II, Item 8 of this Annual Report on Form 10-K for more information on the Notes.In April 2023, we entered into a new credit agreement (the “2023 Credit Agreement”) that provides for a $400.0 million unsecured revolving credit facility (the “2023 Credit Facility”), with an option to increase the amount of the 2023 Credit Facility by up to an additional $350.0 million, subject to certain conditions. The interest rates and commitment fees are also subject to upward and downward adjustments based on our progress towards the achievement of certain sustainability goals related to greenhouse gas emissions. As of July 31, 2023, there were no amounts outstanding, and we were in compliance with all covenants under the 2023 Credit Agreement. Refer to Note 10. Debt in Part II, Item 8 of this Annual Report on Form 10-K for more information on the Credit Agreement. CAPITAL RETURNIn February 2019, our board of directors authorized a $1.0 billion share repurchase program. In December 2020, August 2021, and August 2022, our board of directors authorized additional $700.0 million, $676.1 million, and $915.0 million increases to this share repurchase program, respectively, bringing the total authorization under this share repurchase program to $3.3 billion. Repurchases will be funded from available working capital and may be made at management’s discretion from time to time. The expiration date of this repurchase authorization was extended to December 31, 2023, and our repurchase program may be suspended or discontinued at any time. As of July 31, 2023, $750.0 million remained available for future share repurchases under this repurchase program. Refer to Note 13. Stockholders’ Equity in Part II, Item 8 of this Annual Report on Form 10-K for information on these repurchase programs. LEASES AND OTHER MATERIAL CASH REQUIREMENTSWe have entered into various non-cancelable operating leases primarily for our facilities with original lease periods expiring through the year ending July 31, 2033, with the most significant leases relating to our corporate headquarters in Santa Clara, California. As of July 31, 2023, we have total operating lease obligations of $339.4 million recorded on our consolidated balance sheet.As of July 31, 2023, our commitments to purchase products, components, cloud and other services totaled $1.8 billion. Refer to Note 12. Commitments and Contingencies in Part II, Item 8 of this Annual Report on Form 10-K for more information on these commitments.CASH FLOWSThe following table summarizes our cash flows for the years ended July 31, 2023, 2022, and 2021:Year Ended July 31,202320222021(in millions)Net cash provided by operating activities$2,777.5 $1,984.7 $1,503.0 Net cash used in investing activities(2,033.8)(933.4)(1,480.6)Net cash used in financing activities(1,726.3)(806.6)(1,104.0)Net increase (decrease) in cash, cash equivalents, and restricted cash$(982.6)$244.7 $(1,081.6)- 48 -Table of ContentsCash from operations could be affected by various risks and uncertainties detailed in Part I, Item 1A “Risk Factors” in this Form 10-K. We believe that our cash flow from operations with existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for at least the next 12 months and thereafter for the foreseeable future. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products and subscription and support offerings, the costs to acquire or invest in complementary businesses and technologies, the costs to ensure access to adequate manufacturing capacity, the investments in our infrastructure to support the adoption of our cloud-based subscription offerings, the repayment obligations associated with our Notes, the continuing market acceptance of our products and subscription and support offerings and macroeconomic events. In addition, from time to time, we may incur additional tax liability in connection with certain corporate structuring decisions.We may also choose to seek additional equity or debt financing. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition may be adversely affected.OPERATING ACTIVITIESOur operating activities have consisted of net income (losses) adjusted for certain non-cash items and changes in assets and liabilities. Our largest source of cash provided by our operations is receipts from our billings.Cash provided by operating activities during fiscal 2023 was $2.8 billion, an increase of $792.8 million compared to fiscal 2022. The increase was primarily due to growth of our business as reflected by increases in collections during fiscal 2023, partially offset by higher cash expenditure to support our business growth.INVESTING ACTIVITIESOur investing activities have consisted of capital expenditures, net investment purchases, sales, and maturities, and business acquisitions. We expect to continue such activities as our business grows.Cash used in investing activities during fiscal 2023 was $2.0 billion, an increase of $1.1 billion compared to fiscal 2022. The increase was primarily due to an increase in purchases of investments and an increase in net cash payments for business acquisitions, partially offset by an increase in proceeds from sales and maturities of investments during fiscal 2023.FINANCING ACTIVITIES Our financing activities have consisted of cash used to repurchase shares of our common stock, proceeds from sales of shares through employee equity incentive plans, and payments for tax withholding obligations of certain employees related to the net share settlement of equity awards. Cash used in financing activities during fiscal 2023 was $1.7 billion, an increase of $919.7 million compared to fiscal 2022. The increase was primarily due to repayments of our 2023 Notes upon maturity, partially offset by a decrease in repurchases of our common stock during fiscal 2023.Critical Accounting Estimates Our consolidated financial statements have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results could differ materially from those estimates due to risks and uncertainties, including uncertainty in the current economic environment. To the extent that there are material differences between these estimates and our actual results, our future consolidated financial statements will be affected. We believe that of our significant accounting policies described in Note 1. Description of Business and Summary of Significant Accounting Policies in Part II, Item 8 of this Annual Report on Form 10-K, the critical accounting estimates, assumptions, and judgments that have the most significant impact on our consolidated financial statements are described below.- 49 -Table of ContentsREVENUE RECOGNITIONThe majority of our contracts with our customers include various combinations of our products and subscriptions and support. Our appliances and software licenses have significant standalone functionalities and capabilities. Accordingly, these appliances and software licenses are distinct from our subscriptions and support services as the customer can benefit from the product without these services and such services are separately identifiable within the contract. We account for multiple agreements with a single customer as a single contract if the contractual terms and/or substance of those agreements indicate that they may be so closely related that they are, in effect, parts of a single contract. The amount of consideration we expect to receive in exchange for delivering on the contract is allocated to each performance obligation based on its relative standalone selling price.We establish standalone selling price using the prices charged for a deliverable when sold separately. If the standalone selling price is not observable through past transactions, we estimate the standalone selling price based on our pricing model and our go-to-market strategy, which include factors such as type of sales channel (channel partner or end-customer), the geographies in which our offerings were sold (domestic or international), and offering type (products, subscriptions, or support). As our business offerings evolve over time, we may be required to modify our estimated standalone selling prices, and as a result the timing and classification of our revenue could be affected.INCOME TAXESWe account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. In addition, deferred tax assets are recorded for all future benefits including, but not limited to, net operating losses, research and development credit carryforwards, and basis differences relating to our global intangible low-taxed income. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount more likely than not to be realized.Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step requires us to estimate and measure the tax benefit as the largest amount that is more likely than not to be realized upon ultimate settlement.Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe our reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences may impact the provision for income taxes in the period in which such determination is made.MANUFACTURING PARTNER AND SUPPLIER LIABILITIESWe outsource most of our manufacturing, repair, and supply chain management operations to our EMS provider, which procures components and assembles our products based on our demand forecasts. These forecasts of future demand are based upon historical trends and analysis from our sales and product management functions as adjusted for overall market conditions. We accrue costs for manufacturing purchase commitments in excess of our forecasted demand, including costs for excess components or for carrying costs incurred by our manufacturing partners and component suppliers. Actual component usage and product demand may be materially different from our forecast and could be caused by factors outside of our control, which could have an adverse impact on our results of operations. Through July 31, 2023, we have not accrued significant costs associated with this exposure.LOSS CONTINGENCIESWe are subject to the possibility of various loss contingencies arising in the ordinary course of business. We accrue for loss contingencies when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. If we determine that a loss is reasonably possible, then we disclose the possible loss or range of the possible loss or state that such an estimate cannot be made. We regularly evaluate current information available to us to determine whether an accrual is required, an accrual should be adjusted, or a range of possible loss should be disclosed.- 50 -Table of ContentsFrom time to time, we are involved in disputes, litigation, and other legal actions. However, there are many uncertainties associated with any litigation, and these actions or other third-party claims against us may cause us to incur substantial settlement charges, which are inherently difficult to estimate and could adversely affect our results of operations. The actual liability in any such matters may be materially different from our estimates, which could result in the need to adjust our liability and record additional expenses. Refer to the “Litigation” subheading in Note 12. Commitments and Contingencies in Part II, Item 8 of this Annual Report on Form 10-K for more information regarding our litigation.Item 7A. Quantitative and Qualitative Disclosures About Market RiskForeign Currency Exchange RiskOur sales contracts are denominated in U.S. dollars. A portion of our operating expenditures are incurred outside of the United States and are denominated in foreign currencies and are subject to fluctuations due to changes in foreign currency exchange rates. Additionally, fluctuations in foreign currency exchange rates may cause us to recognize transaction gains and losses in our statement of operations. The effect of an immediate 10% adverse change in foreign exchange rates on monetary assets and liabilities at July 31, 2023 would not be material to our financial condition or results of operations. As of July 31, 2023, foreign currency transaction gains and losses and exchange rate fluctuations have not been material to our consolidated financial statements. We enter into foreign currency derivative contracts with maturities of 24 months or less, which we designate as cash flow hedges, to manage the foreign currency exchange risk associated with our foreign currency denominated operating expenditures. The effectiveness of our existing hedging transactions and the availability and effectiveness of any hedging transactions we may decide to enter into in the future may be limited, and we may not be able to successfully hedge our exposure, which could adversely affect our financial condition and operating results. Refer to Note 6. Derivative Instruments in Part II, Item 8 of this Annual Report on Form 10-K for more information.As our international operations grow, our risks associated with fluctuations in foreign currency exchange rates will become greater, and we will continue to reassess our approach to managing this risk. In addition, a weakening U.S. dollar can increase the costs of our international expansion and a strengthening U.S. dollar can increase the real cost of our products and services to our end-customers outside of the United States, leading to delays in the purchase of our products and services. For additional information, see the risk factor entitled “We are exposed to fluctuations in foreign currency exchange rates, which could negatively affect our financial condition and operating results.” in Part 1, Item 1A of this Annual Report on Form 10-K.Interest Rate RiskThe primary objectives of our investment activities are to preserve principal, provide liquidity, and maximize income without significantly increasing risk. Most of the securities we invest in are subject to interest rate risk. To minimize this risk, we maintain a diversified portfolio of cash, cash equivalents, and investments, consisting only of investment-grade securities. To assess the interest rate risk, we performed a sensitivity analysis to determine the impact a change in interest rates would have on the value of the investment portfolio. Based on investment positions as of July 31, 2023, a hypothetical 100 basis point increase in interest rates across all maturities would result in a $55.5 million decline in the fair market value of the portfolio. Such losses would only be realized if we sold the investments prior to maturity. Conversely, a hypothetical 100 basis point decrease in interest rates would lead to a $55.5 million increase in the fair market value of the portfolio.In June 2020, we issued $2.0 billion aggregate principal amount of 0.375% Convertible Senior Notes due 2025 (the “2025 Notes”). We carry these instruments at face value less unamortized issuance costs on our consolidated balance sheets. As these instruments have a fixed annual interest rate, we have no financial and economic exposure associated with changes in interest rates. However, the fair value of fixed rate debt instruments fluctuates when interest rates change, and additionally, in the case of the 2025 Notes, when the market price of our common stock fluctuates.- 51 -Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations This Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with management’s perspective on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the audited and unaudited consolidated financial statements (prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and related notes included elsewhere in this Annual Report on Form 10-K (this “Form 10-K”). The following discussion contains forward-looking statements that are subject to risks and uncertainties. See “Cautionary Statements” for a discussion of the uncertainties, risks, and assumptions associated with those statements. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Form 10-K, particularly in the section entitled “Risk Factors.” Unless we state otherwise or the context otherwise requires, the terms “we,” “us,” “our” and the “Company” refer to Paycom Software, Inc. and its consolidated subsidiaries. All amounts presented in tables, other than per share amounts, are in thousands unless otherwise noted. Overview We are a leading provider of a comprehensive, cloud-based human capital management (“HCM”) solution delivered as Software-as-a-Service. We provide functionality and data analytics that businesses need to manage the complete employment lifecycle, from recruitment to retirement. Our solution requires virtually no customization and is based on a core system of record maintained in a single database for all HCM functions, including talent acquisition, time and labor management, payroll, talent management and human resources management applications. Our user-friendly software allows for easy adoption of our solution by employees, enabling self-management of their HCM activities in the cloud, which reduces the administrative burden on employers and increases employee productivity. We generate revenues from (i) fixed amounts charged per billing period plus a fee per employee or transaction processed and (ii) fixed amounts charged per billing period. We do not require clients to enter into long-term contractual commitments with us. Our billing period varies by client based on when each client pays its employees, which may be weekly, bi-weekly, semi-monthly or monthly. We serve a diverse client base in terms of size and industry. None of our clients constituted more than one-half of one percent of our revenues for the year ended December 31, 2022. Our revenues are primarily generated through our sales force that solicits new clients and our client relations representatives, (“CRRs”) who sell new applications to existing clients. Our continued growth depends on attracting new clients through further penetration of our existing markets and geographic expansion into new markets, targeting a high degree of client employee usage across our solution, and introducing new applications to our existing client base. We believe our ability to continue to develop new applications and to improve existing applications will enable us to increase revenues in the future, and the number of our new applications adopted by our clients has been a significant factor in our revenue growth. In January 2022, we added new sales teams in Las Vegas, Jacksonville, New England and South Jersey, bringing our total to 55 sales teams (including one team consisting of CRRs and inside sales representatives) located in 28 states. We plan to open additional sales offices in the future to further expand our market presence. Our principal marketing efforts include national and local advertising campaigns, email campaigns, social and digital media campaigns, search engine marketing methods, tradeshows, print advertising and outbound marketing including personalized direct mail campaigns. In addition, we generate leads and build recognition of our brand and thought leadership with relevant and informative content, such as white papers, blogs, podcast episodes and webinars. Throughout our history, we have built strong relationships with our clients. As the HCM needs of our clients evolve, we believe that we are well-positioned to expand the HCM spending of our clients and we believe this opportunity is significant. To be successful, we must continue to demonstrate the operational and economic benefits of our solution, as well as effectively hire, train, motivate and retain qualified personnel. Growth Outlook, Opportunities and Challenges As a result of our significant revenue growth and geographic expansion, we are presented with a variety of opportunities and challenges. Our payroll application is the foundation of our solution and all of our clients are required to utilize this application in order to access our other applications. Consequently, we have historically generated the majority of our revenues from our payroll applications, although our revenue mix has evolved and will continue to evolve as we develop and add new non-payroll applications to our solution. We believe our strategy of focusing on increased employee usage is key to long-term client satisfaction and client retention. Client adoption of new applications and client employee usage of both new and existing applications have been significant factors in our revenue growth, and we expect the continuation of this trajectory will depend, in part, on the introduction of applications to our existing client base that encourage and promote more employee usage. For example, in 2021, we launched our industry-first Beti technology, which further automates and streamlines the payroll process by empowering employees to do their own payroll. Moreover, in order to increase revenues and continue to improve our operating results, we must also attract new clients. We intend to 34 obtain new clients by (i) continuing to leverage our sales force productivity within markets where we currently have existing sales offices, (ii) expanding our presence in metropolitan areas where we currently have an existing sales office through adding sales teams or offices, thereby increasing the number of sales professionals within such markets, and (iii) opening sales offices in new metropolitan areas. Our target client size range is 50 to 10,000 employees. While we continue to serve a diversified client base ranging in size from one employee to many thousands of employees, the average size of our clients has grown significantly as we have organically grown our operations, increased the number of applications we offer and gained traction with larger companies. We believe larger employers represent a substantial opportunity to increase our revenues per client, with limited incremental cost to us. Because we charge our clients on a per employee basis for certain services we provide, any increase or decrease in the number of employees of our clients will have a positive or negative impact, respectively, on our results of operations. Generally, we expect that changes in certain factors affecting our performance will correlate with improvement or deterioration in the labor market. Based on our total revenues, we have grown at a 25% compound annual growth rate from January 1, 2019 through December 31, 2022. Growing our business has resulted in, and will continue to result in, substantial investments in sales professionals, operating expenses, system development and programming costs and general and administrative expenses, which have increased and will continue to increase our expenses. Specifically, our revenue growth and geographic expansion drive increases in our employee headcount, which in turn precipitates increases in (i) salaries and benefits, (ii) stock-based compensation expense and (iii) facility costs related to the expansion of our corporate headquarters and operations facilities and additional sales office leases. We believe the challenges of managing the ever-changing complexity of payroll and human resources will continue to drive companies to turn to outsourced providers for help with their HCM needs. The HCM industry historically has been driven, in part, by legislation and regulatory action, including COBRA, changes to the minimum wage laws or overtime rules, and legislation from federal, state or municipal taxation authorities. The implementation of the Affordable Care Act (the “ACA”) is an example of legislation that has created demand in the HCM industry. We generate ACA-related revenues (i) on an annual basis in connection with processing and filing Forms 1094 and 1095 on behalf of clients and (ii) from clients who have purchased our Enhanced ACA application as part of the fixed, bundled price charged per billing period. While we generally do not track our revenues on an application-by-application basis (because applications are often sold in various groupings and configurations for a single price), we estimate that, if the ACA is not modified or repealed, revenues from our Enhanced ACA application and ACA forms filings business will represent approximately 2% of total projected revenues for the year ending December 31, 2023. For each of the years ended December 31, 2022, 2021 and 2020, our gross margin was approximately 85%. Although our gross margin may fluctuate from quarter to quarter due to seasonality and hiring trends, we expect that our gross margin will remain relatively consistent in future periods. Key Metrics In addition to the U.S. GAAP and non-GAAP metrics discussed elsewhere in this Form 10-K, we also monitor the following metrics to evaluate our business, measure our performance and identify trends affecting our business: Year Ended December 31, 2022 2021 2020 Key performance indicators: Clients 36,561 33,875 30,994 Clients (based on parent company grouping) 19,081 17,703 16,063 Sales teams 55 51 50 Annual revenue retention rate 93 % 94 % 93 % •Clients. When we calculate the number of clients at period end, we treat client accounts with separate taxpayer identification numbers (or, in certain circumstances, separate client codes) as separate clients, which often separates client accounts that are affiliated with the same parent organization. We track the number of our clients to provide an accurate gauge of the size of our business. Unless we state otherwise or the context otherwise requires, references to clients throughout this Form 10-K refer to this metric. •Clients (based on parent company grouping). When we calculate the number of clients based on parent company grouping at period end, we combine client accounts that have identified the same person(s) as their decision-maker regardless of whether the client accounts have separate taxpayer identification numbers (or, in certain circumstances, separate client codes), which often combines client accounts that are affiliated with the same parent organization. We track the number of our clients based on parent company grouping to provide an alternate measure of the size of our business and clients. 35 •Sales Teams. We monitor our sales professionals by the number of sales teams at period end. CRRs and inside sales representatives are counted as one sales team. Each outside sales team consists of a sales manager and approximately six to eight sales professionals. Certain larger metropolitan areas can support more than one sales team. We believe the number of sales teams is an indicator of potential revenues for future periods. •Annual Revenue Retention Rate. Our annual revenue retention rate tracks the percentage of revenues that we retain from our existing clients. We monitor this metric because it is an indicator of client satisfaction and revenues for future periods. Components of Results of Operations Sources of Revenues Revenues are comprised of recurring revenues, and implementation and other revenues. We expect our revenues to increase as we introduce new applications, expand our client base and renew and expand relationships with existing clients. As a percentage of total revenues, we expect our mix of recurring revenues, and implementation and other revenues to remain relatively constant. Recurring Revenues Recurring revenues include fees for our talent acquisition, time and labor management, payroll, talent management and HR management applications as well as fees charged for form filings and delivery of client payroll checks and reports. These revenues are derived from (i) fixed amounts charged per billing period plus a fee per employee or transaction processed or (ii) fixed amounts charged per billing period. We do not require clients to enter into long-term contractual commitments with us. Our billing period varies by client based on when each client pays its employees, which may be weekly, bi-weekly, semi-monthly or monthly. Because recurring revenues are based, in part, on fees for use of our applications and the delivery of checks and reports that are levied on a per-employee basis, our recurring revenues increase as our clients hire more employees. Recurring revenues are recognized in the period services are rendered. Recurring revenues include revenues relating to the annual processing of payroll tax filing forms, such as Form W-2 and Form 1099, and revenues from processing unscheduled payroll runs (such as bonuses) for our clients. These payroll forms are typically processed in the first quarter of the year and many of our clients are subject to ACA form filing requirements in the first quarter, which positively impacts first quarter revenues and margins. We anticipate our revenues will continue to exhibit this seasonal pattern related to ACA form filings for so long as the ACA (or replacement legislation) includes employer reporting requirements. In addition, our recurring revenues during the fourth quarter are positively impacted by unscheduled payroll runs for our clients that occur before the end of the year. Nonetheless, we expect the magnitude of these seasonal fluctuations in our revenues to decrease to the extent clients utilize more of our non-payroll applications. Recurring revenues also include interest earned on funds held for clients. We collect funds from clients in advance of either the applicable due date for payroll tax submissions or the applicable disbursement date for employee payment services. These collections from clients are typically disbursed from one to 30 days after receipt, with some funds being held for up to 120 days. We typically invest funds held for clients in money market funds, demand deposit accounts, commercial paper and certificates of deposit until they are paid to the applicable tax or regulatory agencies or to client employees. We expect interest earned on funds held for clients will increase as we introduce new applications, expand our client base and renew and expand relationships with existing clients. The amount of interest we earn from the investment of client funds is also impacted by changes in interest rates. Implementation and Other Revenues Implementation and other revenues are comprised of implementation fees for the deployment of our solution and other revenues from sales of time clocks as part of our time and attendance services. Non-refundable implementation fees are charged to new clients at inception and upon the addition of certain incremental applications for existing clients. These fees generally range from 10% to 30% of the annualized value of the transaction. Implementation revenues are recognized as deferred revenue and amortized into income over the life of the client, which is estimated to be ten years, and other revenues are recognized upon shipment of time clocks. Implementation and other revenues comprised approximately 1.7% and 1.8% of our total revenues for the years ended December 31, 2022 and 2021, respectively. Cost of Revenues Cost of revenues consists of expenses related to hosting and supporting our applications, hardware costs, systems support and technology and depreciation and amortization. These costs include employee-related expenses (including non-cash stock-based compensation expenses) and other expenses related to client support, bank charges for processing ACH transactions, certain implementation expenses, delivery charges and paper costs. They also include our cost for time clocks sold and ongoing technology and support costs related to our systems. The amount of depreciation and amortization of property and equipment allocated to cost of revenues is determined based upon an estimate of assets used to support our operations. 36 Administrative Expenses Administrative expenses consist of sales and marketing, research and development, general and administrative and depreciation and amortization. Sales and marketing expenses consist primarily of employee-related expenses for our direct sales and marketing staff (such as the amortization of commissions and bonuses and non-cash stock-based compensation expenses), marketing expenses and other related costs. Based on positive results from our advertising campaigns, we plan to continue to invest in our marketing program and may adjust spending levels in future periods as we see opportunities for favorable returns on our investments. Research and development expenses consist primarily of employee-related expenses (including non-cash stock-based compensation expenses) for our development staff, net of capitalized software costs for internally developed software. We expect to grow our research and development efforts as we continue to broaden our payroll and HR solution offerings and extend our technological solutions by investing in the development of new applications and enhancements for existing applications. General and administrative expenses consist of employee-related expenses for finance and accounting, legal, human resources and management information systems personnel (including non-cash stock-based compensation expenses), legal costs, professional fees and other corporate expenses. Depreciation and amortization expenses consist of (i) the amount of depreciation and amortization of property and equipment allocated to administrative expenses (based upon an estimate of assets used to support our selling, general and administrative functions) and (ii) amortization of intangible assets. Interest Expense Interest expense includes interest on our debt and settlements related to an interest rate swap prior to the termination of the interest rate swap agreement on August 24, 2022. We capitalize interest incurred for indebtedness related to construction in progress. Other Income (Expense), net Other income (expense), net includes interest earned on our own funds, any gain or loss on the sale or disposal of fixed assets, costs associated with the early repayment of debt, and the realized gain which resulted from the settlement of our interest rate swap agreement. Provision for Income Taxes Our consolidated financial statements include a provision for income taxes incurred for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, as well as for any operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize a valuation allowance to reduce deferred tax assets to the net amount we believe is more likely than not to be realized. Results of Operations The following table sets forth selected consolidated statements of income data and such data as a percentage of total revenues for each of the periods indicated, as well as year-over-year changes with respect to each line item. Refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 17, 2022,for a discussion of results for the year ended December 31, 2020, including a discussion of the changes in our results of operations for the year ended December 31, 2021 compared to the year ended December 31, 2020. Year Ended December 31, 2022 2021 % Change Revenues Recurring $ 1,351,856 98.3 % $ 1,036,691 98.2 % 30.4% Implementation and other 23,362 1.7 % 18,833 1.8 % 24.0% Total revenues 1,375,218 100.0 % 1,055,524 100.0 % 30.3% Cost of revenues Operating expenses 169,806 12.4 % 130,475 12.3 % 30.1% Depreciation and amortization 42,935 3.1 % 31,411 3.0 % 36.7% Total cost of revenues 212,741 15.5 % 161,886 15.3 % 31.4% Administrative expenses Sales and marketing 346,561 25.2 % 275,994 26.1 % 25.6% Research and development 148,343 10.8 % 118,426 11.2 % 25.3% General and administrative 239,130 17.4 % 209,840 19.9 % 14.0% Depreciation and amortization 49,764 3.6 % 35,811 3.4 % 39.0% Total administrative expenses 783,798 57.0 % 640,071 60.6 % 22.5% Total operating expenses 996,539 72.5 % 801,957 75.9 % 24.3% Operating income 378,679 27.5 % 253,567 24.1 % 49.3% Interest expense (2,536 ) -0.2 % — 0.0 % -100.0% Other income (expense), net 13,435 1.0 % 2,395 0.2 % 461.1% Income before income taxes 389,578 28.3 % 255,962 24.3 % 52.2% Provision for income taxes 108,189 7.8 % 60,002 5.7 % 80.3% Net income $ 281,389 20.5 % $ 195,960 18.6 % 43.6% 37 Revenues The increase in total revenues for the year ended December 31, 2022 from the year ended December 31, 2021 was primarily the result of the addition of new clients and productivity and efficiency gains in mature sales offices, which are offices that have been open for at least 24 months, and the sale of additional applications to our existing clients. In addition, our tax forms filing business in the first quarter of 2022 contributed to the increase in total revenues for the year ended December 31, 2022 as compared to the year ended December 31, 2021. Because we charge our clients on a per-employee basis for certain services we provide, the drivers of revenue for the year ended December 31, 2022 described above were impacted by the headcount fluctuations within our client base. Additionally, rising interest rates and a higher average funds held for clients balance during year ended December 31, 2022 as compared to the year ended December 31, 2021, resulted in increased interest earned on funds held for clients, which had a positive impact on recurring revenue. The increase in implementation and other revenues for the year ended December 31, 2022 from the year ended December 31, 2021 was primarily the result of the increased non-refundable upfront conversion fees collected from the addition of new clients. These fees are deferred and recognized ratably over the ten-year estimated life of our clients. Expenses Cost of Revenues During the year ended December 31, 2022, operating expenses increased from the prior year by $39.3 million primarily due to a $33.2 million increase in employee-related expenses attributable to growth in the number of operating personnel, a $3.6 million increase in shipping and supplies fees, and a $2.2 million increase in automated clearing house fees in connection with the increase in revenues. Depreciation and amortization expense increased $11.5 million, or 37%, primarily due to the development of additional technology and purchases of other related fixed assets. Administrative Expenses Sales and marketing During the year ended December 31, 2022, sales and marketing expenses increased from the prior year by $70.6 million due to a $54.8 million increase in employee-related expenses, including commissions and bonuses, and a $15.8 million increase in marketing and advertising expense attributable to increased spending across many components of our marketing program. Based on positive results from our advertising campaigns, we plan to continue to make significant investments in our marketing program and may adjust spending levels in future periods as we see opportunities for returns on our investments. Research and development During the year ended December 31, 2022, research and development expenses increased $29.9 million from the prior year primarily due to an increase in employee-related expenses. As we continue the ongoing development of our platform and product offerings, we generally expect research and development expenses (exclusive of stock-based compensation) to continue to increase, particularly as we hire more personnel to support our growth. While we expect this trend to continue on an absolute dollar basis and as a percentage of total revenues, we also anticipate the rate of increase to decline over time as we leverage our growth and realize additional economies of scale. As is customary for our business, we also expect fluctuations in research and development expense as a percentage of revenue on a quarter-to-quarter basis due to seasonal revenue trends, the introduction of new products, the amount and timing of research and development costs that may be capitalized and the timing of onboarding new hires and restricted stock vesting events. Expenditures for software developed or obtained for internal use are capitalized and amortized over a three-year period on a straight-line basis. The nature of the development projects underway during a particular period directly impacts the timing and extent of these capitalized expenditures and can affect the amount of research and development expenses in such period. The table below sets forth the amounts of capitalized and expensed research and development costs for the years ended December 31, 2022 and 2021: Year Ended December 31, 2022 2021 % Change Capitalized portion of research and development $ 66,407 $ 52,876 26% Expensed portion of research and development 148,343 118,426 25% Total research and development costs $ 214,750 $ 171,302 25% 38 General and administrative During the year ended December 31, 2022, general and administrative expenses increased by $29.3 million from the prior year due to a $40.4 million increase in employee-related expenses, which was partially offset by a $11.1 million decrease in non-cash stock-based compensation expense. Non-Cash Stock-Based Compensation Expense The following table presents the non-cash stock-based compensation expense that is included within the specified line items in our consolidated statements of comprehensive income: Year Ended December 31, 2022 2021 % Change Non-cash stock-based compensation expense Operating expenses $ 4,671 $ 4,570 2% Sales and marketing 18,659 13,801 35% Research and development 11,063 7,527 47% General and administrative 60,505 71,608 -16% Total non-cash stock-based compensation expense $ 94,898 $ 97,506 -3% Depreciation and Amortization During the year ended December 31, 2022, depreciation and amortization expense increased from the prior year primarily due to the development of additional technology and purchases of other related fixed assets. Interest Expense The increase in interest expense for the year ended December 31, 2022 was due to the timing and progress of construction of the expansion of our corporate headquarters and our expanded operations facility, which resulted in a lower capitalization rate of interest in 2022. Other Income (Expense), net The change in other income (expense), net for the year ended December 31, 2022 was primarily due to the realized gain which resulted from the settlement of our interest rate swap agreement, the settlement of an insurance matter and increased interest income. Provision for Income Taxes The provision for income taxes is based on a current estimate of the annual effective income tax rate adjusted to reflect the impact of discrete items. Our effective income tax rate was 28% and 23% for the years ended December 31, 2022 and 2021, respectively. Liquidity and Capital Resources Our principal sources of capital and liquidity are our operating cash flow and cash and cash equivalents. Our cash and cash equivalents consist primarily of demand deposit accounts, money market funds and certificates of deposit. Additionally, we maintain a $650.0 million senior secured revolving credit facility (the “July 2022 Revolving Credit Facility”), and a $750.0 million senior secured delayed draw term loan facility (the “July 2022 Term Loan Facility”), which can be accessed as needed to supplement our operating cash flow and cash balances. As of December 31, 2022, we have $29.0 million of outstanding borrowings under the July 2022 Revolving Credit Facility and no outstanding borrowings under the July 2022 Term Loan Facility. We have historically funded our operations from cash flows generated from operations, cash from the sale of equity securities and debt financing. Although we have funded most of the costs for construction projects at our corporate headquarters and other facilities from available cash, we have incurred indebtedness for a portion of these costs. We are funding the current building expansion at our Oklahoma City headquarters from available cash. Further, all purchases under our stock repurchase plans were paid for from available cash. We believe our existing cash and cash equivalents, cash generated from operations and available sources of liquidity will be sufficient to maintain operations, make necessary capital expenditures and opportunistically repurchase shares for at least the next 12 months. In addition, based on our strong profitability and continued growth, we expect to meet our longer-term liquidity needs with cash flows from operations and, as needed, financing arrangements. Interest Rate Swap Agreement. In December 2017, we entered into a floating-to-fixed interest rate swap agreement (the “Interest Rate Swap Agreement”) to limit our exposure to interest rate risk related to the term loans used to finance construction projects at our corporate headquarters (the “2017 Term Loans”). The Interest Rate Swap Agreement, which had a maturity date of September 7, 2025, provided that we received quarterly variable interest payments based on the LIBOR rate and paid interest at a fixed rate. We have elected not to designate this interest rate swap as a hedge and, as such, changes in the fair value of the derivative instrument are 39 recognized in our consolidated statements of comprehensive income. On August 24, 2022, we terminated the Interest Rate Swap Agreement by settling the contract. The settlement of the interest rate swap contract resulted in a cash receipt of $0.5 million. The realized gain from the settlement of the interest rate swap is included in other income (expense), net in the consolidated statements of comprehensive income. May 2022 Revolving Credit Agreement. On May 4, 2022, we entered into a credit agreement (the “May 2022 Revolving Credit Agreement”) with Bank of America, N.A., as a lender, swingline lender and letters of credit issuer, the lenders from time to time party thereto, and Bank of America, N.A., as the administrative agent, which provided for a senior secured revolving credit facility in the initial aggregate principal amount of up to $250.0 million and the ability to request an incremental facility of up to an additional $100.0 million, subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions (the “May 2022 Facility”). The May 2022 Facility included a $25.0 million sublimit for swingline loans and a $2.5 million sublimit for letters of credit. On May 4, 2022, we borrowed $29.0 million under the May 2022 Facility to repay the 2017 Term Loans, along with accrued interest, expenses and fees. On June 7, 2022, the aggregate commitments under the May 2022 Revolving Credit Agreement were increased from $250.0 million to $350.0 million. The May 2022 Facility was scheduled to mature on May 4, 2027. As discussed below, on July 29, 2022, we entered into the July 2022 Credit Agreement (as defined below) and borrowed $29.0 million to repay the outstanding indebtedness under the May 2022 Facility along with accrued interest, expenses and fees. In connection with the repayment, the May 2022 Revolving Credit Agreement was terminated on July 29, 2022. July 2022 Credit Agreement. On July 29, 2022 (the “July 2022 Facility Closing Date”), we entered into a new credit agreement (the “July 2022 Credit Agreement”) with JPMorgan Chase Bank, N.A., as a lender, swingline lender and issuing bank, the lenders from time to time party thereto (collectively with JPMorgan Chase Bank, N.A., the “July 2022 Lenders”), and JPMorgan Chase Bank, N.A., as the administrative agent. The July 2022 Credit Agreement provides for the July 2022 Revolving Credit Facility in the aggregate principal amount of up to $650.0 million, and the ability to request an incremental facility of up to an additional $500.0 million, subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions. The July 2022 Credit Agreement includes a $25.0 million sublimit for swingline loans and a $6.5 million sublimit for letters of credit. The July 2022 Credit Agreement also provides for the July 2022 Term Loan Facility in the aggregate amount of up to $750.0 million. All loans under the July 2022 Credit Agreement will mature on July 29, 2027 (the “Scheduled Maturity Date”). The borrowings under the July 2022 Credit Agreement will bear interest at a rate per annum equal to (i) the Alternate Base Rate (“ABR”) plus an applicable margin (“ABR Loans”) or (ii) (x) the term Secured Overnight Financing Rate (“SOFR”) plus 0.10% (the “Adjusted Term SOFR Rate”) or (y) the daily SOFR plus 0.10%, in each case plus an applicable margin (“SOFR Rate Loans”). ABR is calculated as the highest of (i) the rate of interest last quoted by The Wall Street Journal in the United States as the prime rate in effect, (ii) the federal funds rate plus 0.5% and (iii) the Adjusted Term SOFR Rate for a one-month interest period plus 1.00%; provided that, if the ABR as determined pursuant to the foregoing would be less than 1.00%, such rate shall be deemed to be 1.00%. The applicable margin for ABR Loans is (i) 0.25% if the Company’s consolidated leverage ratio is less than 1.0 to 1.0; (ii) 0.50% if the Company’s consolidated leverage ratio is greater than or equal to 1.0 to 1.0 but less than 2.0 to 1.0; (iii) 0.75% if the Company’s consolidated leverage ratio is greater than or equal to 2.0 to 1.0 but less than 3.0 to 1.0; or (iv) 1.00% if the Company’s consolidated leverage ratio is greater than or equal to 3.0 to 1.0. The applicable margin for SOFR Rate Loans is (i) 1.25% if the Company’s consolidated leverage ratio is less than 1.0 to 1.0; (ii) 1.5% if the Company’s consolidated leverage ratio is greater than or equal to 1.0 to 1.0 but less than 2.0 to 1.0; (iii) 1.75% if the Company’s consolidated leverage ratio is greater than or equal to 2.0 to 1.0 but less than 3.0 to 1.0; or (iv) 2.00% if the Company’s consolidated leverage ratio is greater than or equal to 3.0 to 1.0. We are required to pay a quarterly commitment fee on the daily amount of the undrawn portion of the revolving commitments under the July 2022 Revolving Credit Facility and a quarterly ticking fee on the daily amount of the undrawn portion of the July 2022 Term Loan Facility, in each case at a rate per annum of (i) 0.20% if the Company’s consolidated leverage ratio is less than 1.0 to 1.0; (ii) 0.225% if the Company’s consolidated leverage ratio is greater than or equal to 1.0 to 1.0 but less than 2.0 to 1.0; (iii) 0.25% if the Company’s consolidated leverage ratio is greater than or equal to 2.0 to 1.0 but less than 3.0 to 1.0; or (iv) 0.275% if the Company’s consolidated leverage ratio is greater than or equal to 3.0 to 1.0. We are also required to pay customary letter of credit fees upon drawing any letter of credit. Under the July 2022 Credit Agreement, we are required to maintain as of the end of each fiscal quarter a consolidated interest ratio of not less than 3.0 to 1.0 and a consolidated leverage ratio of not greater than 3.75 to 1.0, stepping down to 3.0 to 1.0 at intervals thereafter. We may make up to ten draws under the July 2022 Term Loan Facility at any time during the period from and after the July 2022 Facility Closing Date through twelve months after the July 2022 Facility Closing Date. Loans under the July 2022 Term Loan Facility will amortize in equal quarterly installments commencing with the first full fiscal quarter after the earlier of (x) the date on which the July 2022 Term Loan Facility has been fully drawn and (y) the expiration of the draw period, in an aggregate annual amount equal to 7.5% in year one (if applicable) and year two, and 10% thereafter. 40 On the July 2022 Facility Closing Date, we borrowed $29.0 million under the July 2022 Revolving Credit Facility to repay the outstanding indebtedness under the May 2022 Facility, along with accrued interest, expenses and fees. The loan bears interest at the Adjusted Term SOFR Rate for the interest period in effect plus 1.25%. In connection with the repayment of the May 2022 Facility, the May 2022 Revolving Credit Agreement was terminated on July 29, 2022. Stock Repurchase Plan and Withholding Shares to Cover Taxes. In May 2016, our Board of Directors authorized a stock repurchase plan allowing for the repurchase of shares of our common stock in open market transactions at prevailing market prices, in privately negotiated transactions or by other means in accordance with federal securities laws, including Rule 10b5-1 programs. Since the initial authorization of the stock repurchase plan, our Board of Directors has amended and extended and authorized new stock repurchase plans from time to time. Most recently, in August 2022, our Board of Directors authorized the repurchase of up to $1.1 billion of our common stock. As of December 31, 2022, there was $1.1 billion available for repurchases under our stock repurchase plan. Our stock repurchase plan may be suspended or discontinued at any time. The actual timing, number and value of shares repurchased depends on a number of factors, including the market price of our common stock, general market and economic conditions, the shares withheld for taxes associated with the vesting of restricted stock and other corporate considerations. The current stock repurchase plan will expire on August 15, 2024. During the year ended December 31, 2022, we repurchased an aggregate of 364,667 shares of common stock at an average cost of $273.74 per share, including 17,355 shares withheld to satisfy tax withholding obligations for certain employees upon the vesting of restricted stock. Our payment of the taxes on behalf of those employees resulted in an aggregate cash expenditure of $5.2 million and, as such, we generally subtract the amounts attributable to such withheld shares from the aggregate amount available for future purchases under our stock repurchase plan. Cash Flow Analysis Our cash flows from operating activities have historically been significantly impacted by profitability, implementation revenues received but deferred, our investment in sales and marketing to drive growth, and research and development. Our ability to meet future liquidity needs will be driven by our operating performance and the extent of continued investment in our operations. Failure to generate sufficient revenues and related cash flows could have a material adverse effect on our ability to meet our liquidity needs and achieve our business objectives. As our business grows, we expect our capital expenditures and our investment activity to continue to increase. We are currently focused on the expansion of our corporate headquarters. Capital expenditures related to this expansion began in the fourth quarter of 2021 and continued during 2022. We estimate that the cost of construction will be between $70 million and $75 million and we expect construction to be completed in the first half of 2024. In addition, we purchased the naming rights to the downtown Oklahoma City arena that is home to the Oklahoma City Thunder National Basketball Association franchise. Under the terms of the naming rights agreement, we committed to make payments escalating annually from $4.0 million in 2021 to $6.1 million in 2035. The payments are due in the fourth quarter of each year. Upon the conclusion of the initial term, the agreement may be extended upon the mutual agreement of both parties for an additional five-year period. Depending on certain growth opportunities, we may choose to accelerate investments in sales and marketing, acquisitions, technology and services. Actual future capital requirements will depend on many factors, including our future revenues, cash from operating activities and the level of expenditures in all areas of our business. As part of our payroll and payroll tax filing services, we collect funds from our clients for federal, state and local employment taxes, which we remit to the appropriate tax agencies. We invest these funds in money market funds, demand deposit accounts, commercial paper and certificates of deposit from which we earn interest income during the period between their receipt and disbursement. Our cash flows from investing and financing activities are influenced by the amount of funds held for clients, which can vary significantly from quarter to quarter. The balance of the funds we hold depends on our clients’ payroll calendars, and therefore such balance changes from period to period in accordance with the timing of each payroll cycle. Our cash flows from financing activities are also affected by the extent to which we use available cash to purchase shares of common stock under our stock repurchase plan as well as restricted stock vesting events that result in net share settlements and the Company paying withholding taxes on behalf of certain employees. 41 The following table summarizes the consolidated statements of cash flows for the years ended December 31, 2022 and 2021: Year Ended December 31, 2022 2021 % Change Net cash provided by (used in): Operating activities $ 365,103 $ 319,362 14% Investing activities (23,286 ) (257,670 ) -91% Financing activities 254,587 165,724 54% Change in cash, cash equivalents, restricted cash and restricted cash equivalents $ 596,404 $ 227,416 162% Operating Activities Cash flows provided by operating activities for the year ended December 31, 2022 primarily consisted of payments received from our clients and interest earned on funds held for clients. Cash used in operating activities primarily consisted of personnel-related expenditures to support the growth and infrastructure of our business. These payments included costs of operations, advertising and other sales and marketing efforts, IT infrastructure development, product research and development and security and administrative costs. Compared to the year ended December 31, 2021, our operating cash flows for the year ended December 31, 2022 were positively impacted by the growth of our business. Investing Activities Cash flows used in investing activities for the year ended December 31, 2022 decreased from the prior year period due to a $130.1 million decrease in purchases of investments from funds held for clients, a $114.9 million increase in proceeds from investments from funds held for clients, and a $1.4 million decrease in purchases of intangible assets, which were partially offset by a $12.0 million increase in purchases of property and equipment. Financing Activities Cash flows provided by financing activities for the year ended December 31, 2022 increased from the prior year period primarily due to the impact of a $128.1 million change related to the client funds obligation, which is due to the timing of receipts from our clients and payments made to our clients’ employees and applicable taxing authorities on their behalf, a $60.4 million decrease in withholding taxes paid related to net share settlements, and a $29.0 million increase in proceeds from the issuance of debt. The increase in cash flows provided by financing activities was partially offset by a $94.7 million increase in common stock repurchases, a $27.5 million increase payments on long-term debt, and a $6.4 million increase in payment of debt issuance costs. Contractual Obligations Our principal commitments primarily consist of long-term debt, leases for office space and the naming rights agreement. As discussed in “Note 6. Long-Term Debt, Net” and elsewhere in this Form 10-K, on May 4, 2022, we entered into the May 2022 Revolving Credit Agreement, repaid the 2017 Term Loans and terminated the 2017 Term Credit Agreement. On July 29, 2022, we entered into the July 2022 Credit Agreement and terminated the May 2022 Revolving Credit Agreement. For additional information regarding our naming rights agreement, leases, long-term debt and our commitments and contingencies, see “Note 4. Goodwill and Intangible Assets, Net”, “Note 5. Leases”, “Note 6. Long-Term Debt, Net” and “Note 13. Commitments and Contingencies”. We plan to continue to lease additional office space to support our growth. In addition, many of our existing lease agreements provide us with the option to renew. When applicable, our future operating lease obligations include payments due during any renewal period provided for in the lease where the lease imposes a penalty for failure to renew. Additional details on our leases, including the related future cash outflows, are included within “Note 5. Leases” in the notes to our consolidated financial statements included elsewhere within this Form 10-K. Critical Accounting Policies and Estimates Our consolidated financial statements and accompanying notes have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. Estimates made in accordance with U.S. GAAP that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition are described below. On an ongoing basis, we evaluate our estimates and assumptions to ensure that management believes them to be reasonable under the then-current facts and circumstances. Actual amounts and results may materially differ from these estimates made by management under different assumptions and conditions. Certain accounting policies that require significant management estimates, and are deemed critical to our results of operations or financial position, are described below. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations. 42 Revenue Recognition Revenues are recognized when control of the promised goods or services is transferred to our clients in an amount that reflects the consideration we expect to be entitled to for those goods or services. Substantially all of our revenues are comprised of revenue from contracts with clients. Sales and other applicable taxes are excluded from revenues. Recurring revenues are derived primarily from our talent acquisition, time and labor management, payroll, talent management and HR management applications as well as fees charged for form filings and delivery of client payroll checks and reports. Talent acquisition includes our Applicant Tracking, Candidate Tracker, Enhanced Background Checks, Onboarding, E-Verify and Tax Credit Services applications. Time and labor management includes Time and Attendance, Scheduling/Schedule exchange, Time-Off Requests, Labor Allocation, Labor Management Reports/Push Reporting, Geofencing/Geotracking and Microfence tools and applications. Payroll includes Beti, Payroll and Tax Management, Vault Card, Paycom Pay, Expense Management, Mileage Tracker/FAVR, Garnishment Administration and GL Concierge applications. Talent management includes our Employee Self-Service, Compensation Budgeting, Performance Management, Position Management, My Analytics and Paycom Learning and Content Subscriptions applications. HR management includes our Manager on-the-Go, Direct Data Exchange, Ask Here, Documents and Checklists, Government and Compliance, Benefits Administration/Benefits to Carrier, Benefit Enrollment Service, COBRA Administration, Personnel Action Forms and Performance Discussion Forms, Surveys, Enhanced ACA and Clue applications. The performance obligations related to recurring revenues are satisfied during each client’s payroll period, with the agreed-upon fee being charged and collected as part of our processing of the client’s payroll. Recurring revenues are recognized at the conclusion of processing of each client’s payroll period, when each respective payroll client is billed. Collectability is reasonably assured as the fees are collected through an automated clearing house as part of the client’s payroll cycle or through direct wire transfer, which minimizes the default risk. The contract period for substantially all contracts associated with these revenues is one month due to the fact that both we and the client have the unilateral right to terminate a wholly unperformed contract without compensating the other party by providing 30 days’ notice of termination. Our payroll application is the foundation of our solution, and all of our clients are required to utilize this application in order to access our other applications. For clients who purchase multiple applications, due to the short-term nature of our contracts, we do not believe it is meaningful to separately assess and identify whether or not each application potentially represents its own, individual, performance obligation as the revenue generated from each application is recognized within the same month as the revenue from the core payroll application. Similarly, we do not believe it is meaningful to individually determine the standalone selling price for each application. We consider the total price charged to a client in a given period to be indicative of the standalone selling price, as the total amount charged is within a reasonable range of prices typically charged for our goods and services for comparable classes of client groups. Implementation and other revenues consist of nonrefundable upfront conversion fees which are charged to new clients to offset the expense of new client set-up as well as revenues from the sale of time clocks as part of our employee time and attendance services. Although these revenues are related to our recurring revenues, they represent distinct performance obligations. Implementation activities primarily represent administrative activities that allow us to fulfill future performance obligations for our clients and do not represent services transferred to the client. However, the nonrefundable upfront fee charged to our clients results in an implied performance obligation in the form of a material right to the client related to the client’s option to renew at the end of each 30-day contract period. Further, given that all other services within the contract are sold at a total price indicative of the standalone selling price, coupled with the fact that the upfront fees are consistent with upfront fees charged in similar contracts that we have with clients, the standalone selling price of the client’s option to renew the contract approximates the dollar amount of the nonrefundable upfront fee. The nonrefundable upfront fee is typically included on the client’s first invoice, and is deferred and recognized ratably over the estimated renewal period (i.e. ten-year estimated client life). Revenues from the sale of time clocks are recognized when control is transferred to the client upon delivery of the product. We estimate the standalone selling price for the time clocks by maximizing the use of observable inputs such as our specific pricing practices for time clocks. Goodwill and Other Intangible Assets Goodwill is not amortized, but we are required to test the carrying value of goodwill for impairment at least annually, or earlier if, at the reporting unit level, an indicator of impairment arises. Our business is largely homogeneous and, as a result, goodwill is associated with one reporting unit. We have selected June 30 as our annual goodwill impairment testing date. A review of goodwill may be initiated before or after conducting the annual analysis if events or changes in circumstances indicate the carrying value of goodwill may no longer be recoverable. The Company performed a qualitative assessment to determine if it is more-likely-than-not that the fair value of the reporting units had declined below its carrying value. In the qualitative assessment, we consider the macroeconomic conditions, including any deterioration of general economic conditions, industry and market conditions, including any deterioration in the environment where the reporting unit operates, changes in the products/services and regulator and political developments; cost of doing business; overall financial performance; other relevant reporting unit specific facts, such as changes in 43 management or key personnel or pending litigation. Based on our assessment, there was no impairment recorded as of June 30, 2022. For the years ended December 31, 2022, 2021 and 2020, there were no indicators of impairment. Intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives. Impairment of Long-Lived Assets Long-lived assets, including intangible assets with finite lives, are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset. We have determined that there is no impairment of long-lived assets for the years ended December 31, 2022, 2021 and 2020. Market-Based Restricted Stock Awards and Performance-Based Restricted Stock Units We measure non-cash stock-based compensation expense based on the fair value of the award on the date of grant. We determine the fair value of stock awards and units issued by using a Monte Carlo simulation model. This model considers various subjective assumptions as inputs, and represent our best estimates, which involve inherent uncertainties and the application of our judgment as it relates to market volatilities, the historical volatility of our stock price, risk-free rates and expected life. The valuation model also incorporates exercise and forfeiture assumptions based on an analysis of historical data. Determining these assumptions is subjective and complex, and therefore, a change in the assumptions utilized could impact the calculation of the fair value of our market-based stock awards and performance-based restricted stock units and the associated compensation expense. Refer to Note 12 in the notes to our consolidated financial statements for further information regarding our stock-based compensation awards. Recent Accounting Pronouncements Refer to Note 2 in the notes to the consolidated financial statements for a full description of recent accounting pronouncements. Non-GAAP Financial Measures Management uses adjusted EBITDA and non-GAAP net income as supplemental measures to review and assess the performance of our core business operations and for planning purposes. We define (i) adjusted EBITDA as net income plus interest expense, taxes, depreciation and amortization, non-cash stock-based compensation expense, certain transaction expenses that are not core to our operations (if any) and the change in fair value of our interest rate swap and (ii) non-GAAP net income as net income plus non-cash stock-based compensation expense, certain transaction expenses that are not core to our operations (if any) and the change in fair value of our interest rate swap, all of which are adjusted for the effect of income taxes. Adjusted EBITDA and non-GAAP net income are metrics that provide investors with greater transparency to the information used by management in its financial and operational decision-making. We believe these metrics are useful to investors because they facilitate comparisons of our core business operations across periods on a consistent basis, as well as comparisons with the results of peer companies, many of which use similar non-GAAP financial measures to supplement results under U.S. GAAP. In addition, adjusted EBITDA is a measure that provides useful information to management about the amount of cash available for reinvestment in our business, repurchasing common stock and other purposes. Management believes that the non-GAAP measures presented in this Form 10-K, when viewed in combination with our results prepared in accordance with U.S. GAAP, provide a more complete understanding of the factors and trends affecting our business and performance. Adjusted EBITDA and non-GAAP net income are not measures of financial performance under U.S. GAAP, and should not be considered a substitute for net income, which we consider to be the most directly comparable U.S. GAAP measure. Adjusted EBITDA and non-GAAP net income have limitations as analytical tools, and when assessing our operating performance, you should not consider adjusted EBITDA or non-GAAP net income in isolation, or as a substitute for net income or other consolidated statements of comprehensive income data prepared in accordance with U.S. GAAP. Adjusted EBITDA and non-GAAP net income may not be comparable to similarly titled measures of other companies and other companies may not calculate such measures in the same manner as we do. 44 The following tables reconcile net income to adjusted EBITDA, net income to non-GAAP net income and earnings per share to non-GAAP net income per share on a basic and diluted basis. Refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 17, 2022, for a presentation of the 2020 amounts: Year Ended December 31, 2022 2021 Net income to adjusted EBITDA: Net income $ 281,389 $ 195,960 Interest expense 2,536 — Provision for income taxes 108,189 60,002 Depreciation and amortization 92,699 67,222 EBITDA 484,813 323,184 Non-cash stock-based compensation expense 94,898 97,506 Change in fair value of interest rate swap — (1,403 ) Adjusted EBITDA $ 579,711 $ 419,287 Year Ended December 31, 2022 2021 Net income to non-GAAP net income: Net income $ 281,389 $ 195,960 Non-cash stock-based compensation expense 94,898 97,506 Change in fair value of interest rate swap — (1,403 ) Income tax effect on non-GAAP adjustments (19,053 ) (31,652 ) Non-GAAP net income $ 357,234 $ 260,411 Weighted average shares outstanding: Basic 57,928 57,885 Diluted 58,175 58,191 Earnings per share, basic $ 4.86 $ 3.39 Earnings per share, diluted $ 4.84 $ 3.37 Non-GAAP net income per share, basic $ 6.17 $ 4.50 Non-GAAP net income per share, diluted $ 6.14 $ 4.48 Year Ended December 31, 2022 2021 Earnings per share to non-GAAP net income per share, basic: Earnings per share, basic $ 4.86 $ 3.39 Non-cash stock-based compensation expense 1.64 1.68 Change in fair value of interest rate swap — (0.02 ) Income tax effect on non-GAAP adjustments (0.33 ) (0.55 ) Non-GAAP net income per share, basic $ 6.17 $ 4.50 Year Ended December 31, 2022 2021 Earnings per share to non-GAAP net income per share, diluted: Earnings per share, diluted $ 4.84 $ 3.37 Non-cash stock-based compensation expense 1.63 1.68 Change in fair value of interest rate swap — (0.02 ) Income tax effect on non-GAAP adjustments (0.33 ) (0.55 ) Non-GAAP net income per share, diluted $ 6.14 $ 4.48 45 Item 7A. Quantitative and Qualitative Disclosures about Market Risk Interest rate sensitivity We had cash and cash equivalents totaling $400.7 million as of December 31, 2022. These amounts are invested primarily in demand deposit accounts and money market funds. We consider all highly liquid debt instruments purchased with a maturity of three months or less and SEC-registered money market mutual funds to be cash equivalents. The primary objectives of our investing activities are capital preservation, meeting our liquidity needs and, with respect to investing client funds, generating interest income while maintaining the safety of principal. We do not enter into investments for trading or speculative purposes. Our cash equivalents are subject to market risk due to changes in interest rates. The market value of fixed rate securities may be adversely affected due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates, or we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. As of December 31, 2022, we had $29.0 million of indebtedness outstanding under the July 2022 Revolving Credit Facility. As described elsewhere in this Form 10-K, our borrowings under the July 2022 Revolving Credit Facility bear interest at the Adjusted Term SOFR Rate for the interest period in effect plus 1.25%, and as a result, we may be exposed to increased interest rate risk. As of December 31, 2022, an increase or decrease in interest rates of 100 basis points would not have had a material effect on our operating results or financial condition. 46
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. In March 2008, we became a U.S. public company listed on the New York Stock Exchange and subject to the rules of the Securities and Exchange Commission (the "SEC").In 2021, we laid the foundation for our long-term growth ambitions beyond nicotine in wellness and healthcare, including the milestone acquisitions of Vectura Group PLC and Fertin Pharma A/S, which provide essential capabilities for future product development. Now, through our Vectura Fertin Pharma subsidiary, with a strong foundation and significant expertise in life sciences, we aim to expand into wellness and healthcare areas.In the fourth quarter of 2022, we acquired Swedish Match, a market leader in oral nicotine delivery with a significant presence in the United States market. The Swedish Match acquisition is a key milestone in PMI’s transformation to becoming a smoke-free company. PMI consolidated statements of earnings for the year ended December 31, 2022, include the results of operations of Swedish Match from November 11, 2022 (acquisition date) to December 31, 2022. The operating results of Swedish Match are included in a separate segment. In the fourth quarter of 2022, we also completed an agreement with Altria Group, Inc. to end our commercial relationship in the U.S. covering IQOS as of April 30, 2024. Thereafter, PMI will have the full rights to commercialize IQOS in the U.S.For further details of our 2021 and 2022 acquisitions, see Item 8, Note 3. Acquisitions and Note 13. Segment Reporting.Smoke-free products ("SFPs") is the term we primarily use to refer to all of our products that are not combustible tobacco products, such as heat-not-burn, e-vapor, and oral nicotine. In addition, SFPs include wellness and healthcare products, as well as consumer accessories such as lighters and matches.Reduced-risk products ("RRPs") is the term we use to refer to products that present, are likely to present, or have the potential to present less risk of harm to smokers who switch to these products versus continuing to smoke. We have a range of RRPs in various stages of development, scientific assessment and commercialization. Our RRPs are smoke-free products that contain and/or generate far lower quantities of harmful and potentially harmful constituents than found in cigarette smoke.Our IQOS smoke-free product brand portfolio includes heated tobacco and nicotine-containing vapor products. Our leading smoke-free platform ("Platform 1") uses a precisely controlled heating device into which a specially designed and proprietary tobacco unit is inserted and heated to generate an aerosol. Heated tobacco units ("HTU") is the term we use to refer to heated tobacco consumables, which include our BLENDS, HEETS, HEETS Creations, HEETS Dimensions, HEETS Marlboro and HEETS FROM MARLBORO (defined collectively as "HEETS"), Marlboro Dimensions, Marlboro HeatSticks, Parliament HeatSticks, SENTIA and TEREA, as well as the KT&G-licensed brands, Fiit and Miix (outside of South Korea). Platform 1 was first introduced in Nagoya, Japan, in 2014. As of December 31, 2022, our smoke-free products were available for sale in 73 markets. Swedish Match already has a leading nicotine pouch franchise in the U.S. under the ZYN brand name. The Swedish Match product portfolio is complementary to our existing portfolio, permitting us to bring together a leading oral nicotine product with the leading 1heat-not-burn product. By joining forces with Swedish Match, we expect to accelerate the achievement of our joint smoke-free ambitions, switching more adults who would otherwise continue to smoke to better alternatives faster than either company could achieve separately. Our cigarettes are sold in approximately 175 markets, and in many of these markets they hold the number one or number two market share position. We have a wide range of premium, mid-price and low-price brands. Our portfolio comprises both international and local brands and is led by Marlboro, the world’s best-selling international cigarette, which accounted for approximately 39% of our total 2022 cigarette shipment volume. Marlboro is complemented in the premium-price category by Parliament. Our other leading international cigarette brands are Chesterfield, L&M, and Philip Morris. These five international cigarette brands contributed approximately 77% of our cigarette shipment volume in 2022. We also own a number of important local cigarette brands, such as Dji Sam Soe and Sampoerna A in Indonesia, and Fortune and Jackpot in the Philippines. Source of Funds — Dividends We are a legal entity separate and distinct from our direct and indirect subsidiaries. Accordingly, our right, and thus the right of our creditors and stockholders, to participate in any distribution of the assets or earnings of any subsidiary is subject to the prior rights of creditors of such subsidiary, except to the extent that claims of our company itself as a creditor may be recognized. As a holding company, our principal sources of funds, including funds to make payment on our debt securities, are from the receipt of dividends and repayment of debt from our subsidiaries. Our principal wholly owned and majority-owned subsidiaries currently are not limited by long-term debt or other agreements in their ability to pay cash dividends or to make other distributions that are otherwise compliant with law. Description of Business As of December 31, 2022, we managed our business in six geographical segments, a Swedish Match segment and a Wellness and Healthcare segment: •The European Union Region (“EU”) is headquartered in Lausanne, Switzerland, and covers all the European Union countries and also Switzerland, Norway, Iceland and the United Kingdom;•The Eastern Europe Region (“EE”) is also headquartered in Lausanne, and includes Southeast Europe, Central Asia, Ukraine, Israel and Russia;•The Middle East & Africa Region (“ME&A”) is also headquartered in Lausanne, and covers the African continent, the Middle East, Turkey and our international duty free business;•The South & Southeast Asia Region (“S&SA”) is headquartered in Hong Kong, and includes Indonesia, the Philippines and other markets in this region; •The East Asia & Australia Region (“EA&A”) is also headquartered in Hong Kong, and includes Australia, Japan, South Korea, the People's Republic of China ("China") and other markets in this region, as well as Malaysia and Singapore;•The Americas Region (“AMCS”) is headquartered in Stamford, Connecticut, and covers the South American continent, Central America, Mexico, the Caribbean and Canada; •Swedish Match, which reflects our fourth quarter 2022 acquisition of the company; and•Wellness and Healthcare ("W&H"), which includes the operating results of our new Wellness and Healthcare business, Vectura Fertin Pharma. In the third quarter of 2021, we acquired Fertin Pharma A/S, Vectura Group plc. (also known as Vectura Group Ltd.) and OtiTopic, Inc. On March 31, 2022, we launched a new Wellness and Healthcare business consolidating these entities, Vectura Fertin Pharma. The operating results of this new business are reported in the Wellness and Healthcare segment. To further support the growth of our smoke-free business, reinforce consumer centricity, and increase the speed of innovation and deployment, in January 2023, we rearranged our operations in four geographical segments, down from the current six and as follows:•Europe Region is headquartered in Lausanne, Switzerland, and covers all the European Union countries, Switzerland, the United Kingdom, and also Ukraine, Moldova and Southeast Europe; •South and Southeast Asia, Commonwealth of Independent States, Middle East and Africa Region is headquartered in Dubai, United Arab Emirates. It covers South and Southeast Asia, the African continent, the Middle East, Turkey, as well as Israel, Central Asia, Caucasus and Russia;2•East Asia, Australia, and PMI Duty Free Region is headquartered in Hong Kong, and includes the consolidation of our international duty free business with East Asia & Australia; and•Americas Region is headquartered in Stamford, Connecticut, and covers the United States, Canada and Latin America. The operations of Swedish Match and our Wellness and Healthcare segment remained unchanged. We will report our financial results based on the new geographical segments as of the first quarter of 2023.In November 2022, we completed the relocation of our corporate headquarters, including our AMCS headquarters, from New York, New York, to Stamford, Connecticut. Our total shipment volume, including cigarettes and heated tobacco units, increased by 1.6% in 2022 to 731.1 billion units, with shipment volume of heated tobacco units reaching 109.2 billion units in 2022, up from 95.0 billion units in 2021. Shipment volume of our principal cigarette brand, Marlboro, increased by 2.0% in 2022.References in this Form 10-K to total international market, defined as worldwide cigarette and heated tobacco unit volume, excluding the United States, total industry, total market and market shares, are our estimates for tax-paid products based on the latest available data from a number of internal and external sources, and may, in defined instances, exclude China and/or our duty free business. Unless otherwise stated, references to total industry, total market, our shipment volume and our market share performance reflect cigarettes and heated tobacco units. Estimates for total industry volume and market share in certain geographies reflect limitations on the availability and accuracy of industry data during pandemic-related restrictions.Key data regarding total market and market share were as follows:202220212020Total Market, billion units (excluding China and the U.S.)2,6262,6202,561Total International Market Share (1) 27.6%27.2%27.6%Cigarettes23.6%23.7%24.6%HTU4.1%3.5%3.0%PMI Cigarette over Cigarette Market Share (2)24.9%24.8%25.6%Marlboro Cigarette over Cigarette Market Share (3)9.8%9.5%9.4%(1) Defined as PMI's cigarette and heated tobacco unit in-market sales volume as a percentage of total industry cigarette and heated tobacco unit sales volume, excluding China and the U.S., including cigarillos in Japan(2) Defined as PMI's cigarette in-market sales volume as a percentage of total industry cigarette sales volume, excluding China and the U.S., including cigarillos in Japan(3) Defined as Marlboro's cigarette in-market sales volume as a percentage of total industry cigarette sales volume, excluding China and the U.S., including cigarillos in JapanNote: Sum of share of market by product categories might not foot to total due to roundingsWe have a market share of at least 15% in approximately 100 markets, including Algeria, Argentina, Australia, Austria, Belgium, Brazil, the Czech Republic, Egypt, France, Germany, Greece, Hong Kong, Hungary, Indonesia, Israel, Italy, Japan, Kazakhstan, Kuwait, Mexico, the Netherlands, the Philippines, Poland, Portugal, Romania, Russia, Saudi Arabia, the Slovak Republic, South Korea, Spain, Switzerland, Turkey and Ukraine. 3Distribution & Sales Our main types of distribution and sales are tailored to the characteristics of each market and are often used simultaneously: •Direct sales and distribution, where we have set up our own distribution selling directly to the retailers; •Distribution through independent distributors that often distribute other fast-moving consumer goods and are responsible for distribution in a particular market;•Exclusive zonified distribution, where the dedicated multicategory product distributors are assigned to exclusive territories within a market; •Distribution through national or regional wholesalers that then supply the retail trade; •Our own e-commerce infrastructure for product sales to trade partners and to consumers; and •Our own brand retail infrastructure for our RRP products and accessories for sales to consumers. Competition We are subject to highly competitive conditions in all aspects of our business. We compete primarily on the basis of product quality, brand recognition, brand loyalty, taste, R&D, innovation, packaging, customer service, marketing, advertising and retail price and, increasingly, adult smoker willingness to convert to our RRPs. In the combustible product category, we predominantly sell American blend cigarette brands, such as Marlboro, L&M, Parliament, Philip Morris and Chesterfield, which are the most popular across many of our markets. In the RRP product category, we primarily sell Platform 1 devices and heated tobacco units under the IQOS brand. We also sell other smoke-free products, including those commercialized through Swedish Match. We seek to compete in all profitable retail price categories, although our brand portfolio is weighted towards the premium-price category.The competitive environment and our competitive position can be significantly influenced by weak economic conditions, erosion of consumer confidence; competitors' introduction of lower-price products or innovative products; novel products which given their taste characteristics may be more commercially successful; higher tobacco product taxes; higher absolute prices and larger gaps between retail price categories; and product regulation that diminishes the ability to differentiate tobacco products and restricts adult consumer access to truthful and non-misleading information about our RRPs. Competitors in our industry include British American Tobacco plc, Japan Tobacco Inc., Imperial Brands plc, new market entrants, particularly with respect to innovative products, several regional and local tobacco companies and, in some instances, state-owned tobacco enterprises, principally in Algeria, Egypt, China, Taiwan, Thailand and Vietnam. Some competitors have different profit, volume and regulatory objectives, and some international competitors may be less susceptible to changes in currency exchange rates than we are. Certain new market entrants in the non-combustible product category may alienate consumers from innovative products through inappropriate marketing campaigns, messaging and inferior product satisfaction, while not relying on scientific substantiation based on appropriate R&D protocols and standards. The growing use of digital media could increase the speed and extent of the dissemination of inaccurate and misleading information about our RRPs, all of which could have a material adverse effect on our profitability and results of operations. Procurement and Raw Materials We purchase tobacco leaf of various types, grades and styles throughout the world, mostly through independent tobacco suppliers. In 2022, we also contracted directly with farmers in several countries, including Argentina, Brazil, Italy, Pakistan and Poland. In 2022, direct sourcing from farmers represented approximately 16% of PMI’s global leaf requirements. The largest supplies of tobacco leaf are sourced from Argentina, Brazil, China, Italy, Indonesia (mostly for domestic use in kretek products), Malawi, Mozambique, the Philippines, Turkey and the United States. We believe that there is an adequate supply of tobacco leaf in the world markets to satisfy our current and anticipated production requirements.Given the global reach of our value chain, properly managing land and water resources and utilizing a geographically diversified sourcing strategy for agricultural products are priorities as we seek to increase the resilience of our production systems and minimize operational risks. We conduct a global water risk assessment annually in tobacco-growing regions to identify potential hotspots for physical water risks that require adaptation measures. Our water stewardship strategy includes guidance for applying a landscape approach to water optimization projects, protecting natural resources and recharge areas, and improving the efficiency of irrigation systems to integrate better farm water management. These business practices are intended to mitigate the risk that climate change could influence weather patterns in ways that negatively impact the quality or cost of the agricultural products used to manufacture our products. 4In addition to tobacco leaf, we purchase a wide variety of direct materials from a total of approximately 360 suppliers. In 2022, our top ten suppliers of direct materials combined represented approximately 60% of our total direct materials purchases. The four most significant direct materials that we purchase are printed paper board used in packaging, acetate tow used in filter making and fine paper used in the manufacturing of cigarettes and heated tobacco units, as well as susceptors used for the TEREA heated tobacco units. In addition, the adequate supply and procurement of cloves are of particular importance to our Indonesian business.We discuss the details of our supply chain for our RRPs in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K (“Item 7”) in Business Environment—Reduced-Risk Products. Business Environment Information called for by this Item is hereby incorporated by reference to the paragraphs in Item 7, Business Environment to this Annual Report on Form 10-K. Other Matters Customers As described in more detail in “Distribution & Sales” above, in many of our markets we sell our products to distributors. In 2022, sales to a distributor in the European Union Region and a distributor in the East Asia & Australia Region each amounted to 10 percent or more of our consolidated net revenues. See Item 8, Note 13. Segment Reporting for more information. We believe that none of our business segments is dependent upon a single customer or a few customers, the loss of which would have a material adverse effect on our consolidated results of operations. In some of our markets, particularly in the European Union, Eastern Europe, the Middle East and Africa, and in the East Asia & Australia Regions, a loss of a distributor may result in a temporary market disruption. Human Capital Our Workforce. At December 31, 2022, including Swedish Match's employees, we employed approximately 79,800 people worldwide of more than 130 different nationalities, including full-time, temporary and part-time staff. Our businesses are subject to a number of laws and regulations relating to our relationship with our employees. Generally, these laws and regulations are specific to the location of each business. We engage with legally recognized employee representative bodies and we have collective bargaining agreements in several of the countries in which we operate. In addition, in accordance with European Union requirements, we have established a European Works Council composed of management and elected members of our workforce. We believe we maintain good relations with our employees and their representative organizations. Our Internal Transformation. To be successful in our transformation to a smoke-free future, we must continue transforming our culture and ways of working, align our talent with our business needs, successfully integrate acquired businesses and innovate to become a truly consumer-centric business. To achieve our strategic goals, we need to attract, retain and motivate the best global talent with the right degree of diversity, experience, competencies and skills. Therefore, we strive to ensure the development of our existing talent while increasingly recruiting those with the expertise in areas that are relatively new to us such as digital and technical solutions. Our compensation and benefit programs are set at the levels that we believe are necessary to attract the best talent and remain competitive with other consumer product companies.Oversight and Management. Our Board of Directors (the "Board") provides oversight of various matters pertaining to our workforce. The Compensation and Leadership Development Committee of the Board is responsible for executive compensation matters and oversight of the risks and programs related to talent management. Our Code of Conduct highlights our commitment to ethical business conduct and honesty, respect, fairness in our ways of working.Inclusion & Diversity. At PMI, we believe that a diverse workforce and an inclusive culture are strategic priorities which help fuel innovation and business success. As part of our commitment to workplace diversity, in 2020, our Chief Executive Officer appointed a Chief Diversity Officer. Improving gender balance, especially in management positions, continues to be one of our priorities:•In 2022, we achieved the global target of 40% female representation in management positions;•In 2021, we started our Women in Leadership program to support our female talents; and•We were the first multinational company to receive a global EQUAL-SALARY certification from the EQUAL-SALARY Foundation in 2019. In 2022, we were re-certified as a global EQUAL-SALARY organization for the second time, verifying that PMI continues to pay female and male employees equally for equal work everywhere where we operate. This achievement is an important milestone toward the creation of a more inclusive gender-balanced workplace and the continuation of our reputation as a top employer. 5In recognition of our efforts, we were again added to the 2022 Bloomberg Gender-Equality Index for transparency in gender reporting and advancing women’s equity (among the 414 companies from 11 different sectors in 45 countries, who scored at or above the global threshold established by Bloomberg L.P.). Creation of employee resource groups ("ERGs") was another important milestone to drive further inclusion at PMI. We believe these groups serve as a platform for building an enhanced sense of belonging, visibility, and greater understanding of different experiences and dimensions of diversity in our company. Currently, we have established global ERGs for race and ethnicity, LGBTQ+, gender and disability matters concerning our employees. Each global ERG is sponsored by a member of the PMI senior leadership team, to reinforce the fact that our strong commitment to Inclusion & Diversity comes from the top. In 2022, we continued to focus on the growth of our global ERGs and to expand them locally, to be able to meet the specific needs of different markets and regions. By the end of 2022, our global parental leave principles were implemented in every market in which we operate, with the exception of Russia. PMI’s minimum leave principles provide primary caregivers with a minimum of 18 weeks fully paid parental leave and secondary caregivers with a minimum of 8 weeks fully paid parental leave. These global and gender-neutral guidelines demonstrate how PMI is creating a more inclusive, diverse work environment to meet the challenges and expectations of our people for the 21st century workplace.To further strengthen our commitment to drive inclusion and equality, we also commissioned an independent academic study exploring the methods organizations can adopt to drive lasting cultural change. Findings of this study informed the development of practices and programs focused on employee inclusion at PMI.Our Initiatives in Response to COVID-19. Since the outbreak of the global COVID-19 pandemic, we have focused on business continuity, health and safety of our employees, and have adapted our ways of working to a new environment. We have implemented additional safety measures for essential employees in our facilities and offices. We have also enhanced remote and flexible work arrangements and digital collaboration, and related risk management, and to date, many of our employees continue to have the ability work remotely for up to 60% of their working time, where applicable.Government Regulation As a company with global operations in a heavily regulated industry, we are subject to multiple laws and regulations of jurisdictions in which we operate. We discuss our regulatory environment in Item 7, Business Environment. The regulatory landscape related to environmental, social, and governance ("ESG”) matters is rapidly evolving. We closely monitor these developments and implement initiatives addressing PMI’s priority ESG areas in line with our sustainability strategy. In particular, we are subject to international, national and local environmental laws and regulations in the countries in which we do business. We have specific programs across our business units designed to meet applicable environmental compliance requirements and reduce our carbon footprint, wastage, as well as water and energy consumption. We report externally about our climate change mitigation strategy, together with associated targets and results in reducing our carbon footprint, through CDP (formerly known as the Carbon Disclosure Project), the leading international non-governmental organization assessing the work of thousands of companies worldwide in the area of environmental impact, including climate change. Our environmental and occupational health and safety management program includes policies, standard practices and procedures at all our manufacturing centers. Furthermore, we have engaged an external certification body to validate the effectiveness of this management program at our manufacturing centers around the world, in accordance with internationally recognized standards for safety and environmental management. Our subsidiaries expect to continue to make investments in order to drive improved performance and maintain compliance with environmental laws and regulations. We assess and report to our management the compliance status of all our legal entities on a regular basis. Based on current regulations, the management and controls we have in place and our review of climate change risks (both physical and regulatory), environmental expenditures have not had, and are not expected to have, a material adverse effect on our consolidated results of operations, capital expenditures, financial position, earnings or competitive position.Based on current regulations, compliance with government regulations, including environmental regulations, has not had, and is not expected to have a material adverse effect on our results of operations, capital expenditures, financial position, earnings, or competitive position. As discussed in more detail in Item 1A. Risk Factors, our financial results could be significantly affected by regulatory initiatives that could result in a significant decrease in demand for our brands or by climate-related regulations that increase our cost of operation. More specifically, any regulatory requirements that lead to a commoditization of tobacco products or impede adult consumers' ability to convert to our RRPs, as well as any significant increase in the cost of complying with new regulatory requirements could have a 6material adverse effect on our financial results. Further, tightened climate-related regulation may lead to additional carbon taxation or energy price increases impacting our cost of operation. These shifts in regulation and other market trends could, amongst others, impact current deforestation rates. Availability of deforestation-free materials, could be impacted by increased demand for alternative energy sources and low-carbon fuels, such as biomass, which could result in increased sourcing costs.We discuss additional information regarding regulatory matters relating to climate change in Item 7, Climate Change Laws and Regulations. Information About Our Executive Officers The disclosure regarding executive officers is hereby incorporated by reference to the discussion under the heading “Information about our Executive Officers as of February 10, 2023” in Part III, Item 10. Directors, Executive Officers and Corporate Governance of this Annual Report on Form 10-K (“Item 10”).Intellectual Property Our trademarks are valuable assets, and their protection and reputation are essential to us. We own the trademark rights to all of our principal brands, including Marlboro, HEETS, IQOS, IQOS ILUMA, TEREA, and ZYN or have the right to use them in all countries in which these brands are advertised or sold. In addition, we have a large number of granted patents and pending patent applications worldwide. Our patent portfolio, as a whole, is material to our business. However, no one patent, or group of related patents, is material to us. We also have registered industrial designs, as well as unregistered proprietary trade secrets, technology, know-how, processes and other unregistered intellectual property rights. Effective January 1, 2008, PMI entered into an Intellectual Property Agreement with Philip Morris USA Inc., a wholly owned subsidiary of Altria Group, Inc. (“PM USA”). The Intellectual Property Agreement allocates ownership of jointly funded intellectual property as follows:•PMI owns all rights to jointly funded intellectual property outside the United States, its territories and possessions; and•PM USA owns all rights to jointly funded intellectual property in the United States, its territories and possessions.The parties agreed to submit disputes under the Intellectual Property Agreement first to negotiation between senior executives and then to binding arbitration.An agreement reached with PM USA in 2022 relating to IQOS commercialization rights in the U.S. includes, among other things, an agreement relating to intellectual property rights consistent with the commercialization rights for relevant IQOS products.Seasonality Our business segments are not significantly affected by seasonality, although in certain markets cigarette consumption may be lower during the winter months due to the cold weather and may rise during the summer months due to outdoor use, longer daylight, and tourism. Available Information We are required to file with the SEC annual, quarterly and current reports, proxy statements and other information required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The SEC maintains an Internet website at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, from which investors can electronically access our SEC filings. We make available free of charge on, or through, our website at www.pmi.com our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Investors can access our filings with the SEC by visiting www.pmi.com. The information on our website is not, and shall not be deemed to be, a part of this report or incorporated into any other filings we make with the SEC.7Item 1A. Risk Factors. The following risk factors should be read carefully in connection with evaluating our business and the forward-looking statements contained in this Annual Report on Form 10-K. Any of the following risks could materially adversely affect our business, our operating results, our financial condition and the actual outcome of matters as to which forward-looking statements are made in this Annual Report on Form 10-K.Forward-Looking and Cautionary StatementsWe may from time to time make written or oral forward-looking statements, including statements contained in this Annual Report on Form 10-K and other filings with the SEC, in reports to stockholders and in press releases and investor webcasts. You can identify these forward-looking statements by use of words such as "strategy," "expects," "continues," "plans," "anticipates," "believes," "will," "aspires," "estimates," "intends," "projects," "aims," "goals," "targets," "forecasts" and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.We cannot guarantee that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Our RRPs constitute a new product category that is less predictable than our mature cigarette business. Achievement of future results is subject to risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements and whether to invest in or remain invested in our securities. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we are identifying important factors that, individually or in the aggregate, could cause actual results and outcomes to differ materially from those contained in any forward-looking statements made by us; any such statement is qualified by reference to the following cautionary statements. We elaborate on these and other risks we face throughout this document, particularly in Item 7, Business Environment. You should understand that it is not possible to predict or identify all risk factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. We do not undertake to update any forward-looking statement that we may make from time to time, except in the normal course of our public disclosure obligations.Overall Business RisksWe may be unsuccessful in our attempts to introduce reduced-risk products, and regulators may not permit the commercialization of these products or the communication of scientifically substantiated information and claims.Our key strategic priorities are to: (i) develop and commercialize products that present less risk of harm to adult smokers who switch to those products versus continued smoking; and (ii) encourage and educate current adult smokers who would otherwise continue to smoke to switch to those RRPs. For our efforts to be successful, we must: •develop RRPs that adult smokers find acceptable alternatives to smoking;•conduct rigorous scientific studies to substantiate that RRPs reduce exposure to harmful and potentially harmful constituents in smoke and, ultimately, that these products present, are likely to present, or have the potential to present less risk of harm to adult smokers who switch to them versus continued smoking; and•effectively advocate for a timely development of science-based regulatory frameworks for the development and commercialization of RRPs, including communication of scientifically substantiated information to enable adult smokers to make better consumer choices. We might not succeed in our efforts. If we do not succeed, but others do, or if heat-not-burn products are inequitably regulated compared to other RRP categories without regard to the totality of the scientific evidence available for such products, we may be at a competitive disadvantage. In addition, actions of some market entrants, such as the inappropriate marketing of e-vapor products to youth, as well as alleged health consequences associated with the use of certain e-vapor products, may unfavorably impact public opinion and/or mischaracterize all e-vapor products or other RRPs to consumers, regulators and policy makers without regard to the totality of scientific evidence available for specific products. This may impede our efforts to advocate for the development of science-based regulatory frameworks for the development and commercialization of RRPs. We cannot predict whether regulators will permit the sale and/or marketing of RRPs with scientifically substantiated information and claims. Such restrictions could limit the success of our RRPs. The WHO study group on tobacco product regulation published their eighth report on the scientific basis of tobacco product regulation in May 2021. The report is based on a review of scientific evidence related to novel and emerging nicotine and tobacco products, such 8as electronic nicotine delivery systems ("ENDS"), electronic non-nicotine delivery systems and heated tobacco products ("HTPs") on a number of scientific topics. The report concludes by making a number of policy recommendations on HTPs and ENDS that, if implemented, could restrict both the availability of these products, and the access to accurate information about them. In August 2021, the World Health Organization's Framework Convention on Tobacco Control (the "FCTC") Secretariat published two reports on novel and emerging tobacco products to the ninth session of the Conference of the Parties ("CoP") of the FCTC, which are not materially different from the WHO study group report. Substantive decisions based on these reports were deferred to CoP 10, currently scheduled to take place in the fourth quarter of 2023. It is not possible to predict whether or to what extent measures recommended by the WHO's reports will be implemented as the reports are not binding to the WHO Member States.Additionally, any claims, regardless of merit, challenging our research and clinical data available to date, may impact the development of science-based regulatory frameworks for the commercialization of the RRP category and the commercialization of the RRP category in general.Our RRPs and commercial activities for these products are designed for, and directed toward, current adult smokers and users of nicotine-containing products, and not for non-smokers or youth. We put significant effort to restrict access of our products from non-smokers or youth. Nevertheless, technological, operational, regulatory and/or commercial setbacks might impact the implementation or effectiveness of youth access prevention mechanisms and surrounding infrastructure. If nonetheless there is a significant usage of our products or competitive products among youth or non-smokers, even in situations over which we have no control, our reputation and credibility may suffer, the regulatory approach to our products may become more restrictive, and our efforts to advocate for the development of science-based regulatory frameworks for the development and commercialization of RRPs may be significantly impacted.Moreover, the FDA’s premarket tobacco product and modified risk tobacco product authorizations of two versions of our Platform 1 product are subject to strict marketing, reporting and other requirements. Although we have received these authorizations from the FDA, there is no guarantee that the product will remain authorized for sale in the U.S., or whether new versions of the products (Platform 1 or other smoke-free platforms) will receive necessary authorizations, particularly if there is a significant uptake in youth or non-smoker initiation.The financial and business performance of our reduced-risk products is less predictable than our cigarette business.Our RRPs are novel products in a new category, and the pace at which adult smokers adopt them may vary, depending on the competitive, regulatory, fiscal and cultural environment, and other factors in a specific market. There may be periods of accelerated growth and periods of slower growth for these products, the timing and drivers of which may be more difficult for us to predict versus our mature cigarette business. The impact of this lower predictability on our projected results for a specific period may be significant, particularly during the early stages of this new product category, during the COVID-19 pandemic as a result of unpredictability due to shortage of key components in our supply chain, or due to geopolitical or macroeconomic events that negatively impact RRP availability or adoption, which in turn may have a material adverse effect on our results of operation.We may be unsuccessful in our efforts to differentiate reduced-risk products and cigarettes with respect to taxation.To date, we have been largely successful in demonstrating to regulators that our RRPs are not cigarettes due to the absence of combustion, and as such they are generally taxed either as a separate category or as other tobacco products, which typically yields more favorable tax rates than cigarettes. Nevertheless, we are unable to predict whether regulators will be issuing new regulations where RRP will be equally taxed in line with other tobacco products such as ordinary cigarettes. However, if we cease to be successful in these efforts, RRP unit margins may be materially adversely affected, which in turn may have a material adverse effect on our results of operation.Consumption of tax-paid cigarettes continues to decline in many of our markets.This decline is due to multiple factors, including increased taxes and pricing, governmental actions, the diminishing social acceptance of smoking and health concerns, competition, continuing economic and geopolitical uncertainty, and the continuing prevalence of illicit products. These factors and their potential consequences are discussed more fully below and in Item 7, Business Environment. A continuous decline in the consumption of cigarettes could have a material adverse effect on our revenue and profitability, which in turn may have a material adverse effect on our ability to fund our smoke-free transformation.Cigarettes are subject to substantial taxes. Significant increases in cigarette-related taxes have been proposed or enacted and are likely to continue to be proposed or enacted in numerous jurisdictions. These tax increases may disproportionately affect our profitability and make us less competitive versus certain of our competitors.Tax regimes, including excise taxes, sales taxes and import duties, can disproportionately affect the retail price of cigarettes versus other combustible tobacco products, or disproportionately affect the relative retail price of our cigarette brands versus cigarette brands manufactured by certain of our competitors. Because our portfolio is weighted toward the premium-price cigarette category, tax 9regimes based on sales price can place us at a competitive disadvantage in certain markets. Furthermore, our volume and profitability may be adversely affected in these markets.In addition, increases in cigarette taxes are expected to continue to have an adverse impact on our sales of cigarettes, due to resulting lower consumption levels, a shift in sales from manufactured cigarettes to other combustible tobacco products and from the premium-price to the mid-price or low-price cigarette categories, where we may be under-represented, from local sales to legal cross-border purchases of lower price products, or to illicit products such as contraband, counterfeit and "illicit whites." Each of these risks could have a material adverse effect on our business, operations, results of operations, revenues, cash flow and profitability. Our business faces significant governmental action aimed at increasing regulatory requirements with the goal of reducing or preventing the use of tobacco products.Governmental actions, combined with the diminishing social acceptance of smoking and private actions to restrict smoking, have resulted in reduced industry volumes for our products in many of our markets, and we expect that such factors will continue to reduce consumption levels and will increase down-trading and the risk of counterfeiting, contraband, "illicit whites" and legal cross-border purchases. Significant regulatory developments will continue to take place over the next few years in most of our markets, driven principally by the FCTC. Since it came into force in 2005, the FCTC has led to increased efforts by tobacco control advocates and public health organizations to promote increasingly restrictive regulatory measures on the marketing and sale of tobacco products to adult smokers. Regulatory initiatives that have been proposed, introduced or enacted by governmental authorities in various jurisdictions include:•restrictions on or licensing of outlets permitted to sell cigarettes;•the levying of substantial and increasing tax and duty charges;•restrictions or bans on advertising, marketing and sponsorship;•the display of larger health warnings, graphic health warnings and other labeling requirements;•restrictions on packaging design, including the use of colors, and mandating plain packaging;•restrictions on packaging and cigarette formats and dimensions;•restrictions or bans on the display of tobacco product packaging at the point of sale and restrictions or bans on vending machines;•generation sales bans, under which the sale of certain tobacco or nicotine products to people born after a certain year would be prohibited;•requirements regarding testing, disclosure and performance standards for tar, nicotine, carbon monoxide and other smoke constituents;•disclosure, restrictions, or bans of tobacco product ingredients, including bans on the flavors of certain tobacco products;•increased restrictions on smoking and use of tobacco and nicotine-containing products in public and work places and, in some instances, in private places and outdoors;•restrictions or prohibitions of novel tobacco or nicotine-containing products or related devices;•elimination of duty free sales and duty free allowances for travelers;•restrictions in terms of importing or exporting our products impacting our logistics activities and ability to ship our products;•encouraging litigation against tobacco companies; and•excluding tobacco companies from transparent public dialogue regarding public health and other policy matters.Our financial results could be materially affected by regulatory initiatives resulting in a significant decrease in demand for our brands. More specifically, requirements that lead to a commoditization of tobacco products or impede adult consumers' ability to convert to our RRPs, as well as any significant increase in the cost of complying with new regulatory requirements could have a material adverse effect on our financial results.10Changes in the earnings mix and changes in tax laws may result in significant variability in our effective tax rates. Our ability to receive payments from foreign subsidiaries or to repatriate royalties and dividends could be restricted by local country currency exchange controls and other regulations. We are subject to income tax laws in the United States and numerous foreign jurisdictions. Changes in the U.S. tax system, including significant increases in the U.S. corporate income tax rate and the minimum tax rate on certain earnings of foreign subsidiaries could be enacted. Such changes could have a material adverse impact on our effective tax rate thereby reducing our net earnings. Further changes in the tax laws of foreign jurisdictions could arise as a result of the base erosion and profit shifting project undertaken by the Organisation for Economic Co-operation and Development, which recommended changes to numerous long-standing tax principles. If implemented, such changes, as well as changes in taxing jurisdictions’ administrative interpretations, decisions, policies, or positions, could also have a material adverse impact on our effective tax rate thereby reducing our net earnings. In future periods, our ability to recover deferred tax assets could be subject to additional uncertainty as a result of such developments. Furthermore, changes in the earnings mix or applicable foreign tax laws may result in significant variability in our effective tax rates. As a result of Russia’s invasion of Ukraine, certain taxing jurisdictions, including the U.S., have proposed punitive tax legislation applicable to companies doing business in Russia, which could also have a material adverse impact on our effective tax rate if enacted thereby reducing our net earnings. Because we are a U.S. holding company, our most significant source of funds is distributions from our non-U.S. subsidiaries. Certain countries in which we operate have adopted or could institute currency exchange controls and other regulations that limit or prohibit our local subsidiaries' ability to convert local currency into U.S. dollars or to make payments outside the country. This could subject us to the risks of local currency devaluation and business disruption.Risks Related to the Impact of the War in Ukraine on our Business Our business, results of operations, cash flows and financial position may be adversely impacted by the continuation and consequences of the war in Ukraine.In 2022, Russia accounted for around 9% of our total cigarette and heated tobacco unit shipment volume, and around 7% of our total net revenues. Ukraine accounted for around 2% of our total cigarette and heated tobacco unit shipment volume, and around 1% of our total net revenues. Historically, we also produced finished goods in Ukraine for export and manufactured products in Russia. In 2022, as a result of Russia’s invasion of Ukraine, we suspended planned investments and scaled down our manufacturing operations in Russia. In Ukraine, we have temporarily reduced operations, including closing our factory in the country. The short and long-term implications of the Russian invasion of Ukraine for our operations in those countries are impossible to predict at this time. The likelihood of retaliatory action by the Russian government against companies, including us, as a result of actions and statements made in response to the Russian invasion, including the possibility of legal action against us or our employees or nationalization of foreign businesses or assets, including cash reserves held in Russia and intangible assets such as trademarks, is impossible to predict. We are continuously assessing the evolving situation in Russia, including: recent regulatory constraints in the market that entail very complex terms and conditions that must be met for any divestment transaction to be granted approval by the authorities; and restrictions resulting from international regulations. In Ukraine, there is no way to know when and to what extent we will be able to fully normalize our operations or to what extent our workforce, facilities, inventory, and other assets will remain intact. These developments have and will continue to have a material adverse impact on our business, results of operations, cash flows and financial position, and may result in impairment charges. The conflict also continues to elevate the likelihood of supply chain disruptions, both in the region and globally, and may inhibit our ability to timely source materials and services needed to make and sell our products. For example, historically we sourced certain finished goods, production materials and components from both Russia and Ukraine, including printed materials and filters, and the invasion has, and may continue to, disrupt the availability of and impact our supply chain for these materials. These disruptions, to the extent we are unable to find alternative sources or otherwise address these supply constraints, may impact the availability and cost of our products in other markets, which would adversely impact our business, results of operations, cash flows and financial position, and may result in impairment charges. Furthermore, the imposition of various restrictions on transactions with parties from certain jurisdictions, the ban on exports of various products, and other economic and financial restrictions may adversely affect certain third parties with which we do business in Russia, such as customers, suppliers, intermediaries, service providers and banks.The broader consequences of the invasion are also impossible to predict, but could include reputational consequences, further sanctions, financial or currency restrictions, punitive tax law changes, embargoes, regional instability, and geopolitical shifts as well as adverse effects on macroeconomic conditions, security conditions, currency exchange rates, and financial markets. Given the nature of our business and global operations, such geo-political instability and uncertainty could increase the costs of our materials and operations; reduce demand for our products; have a negative impact on our supply chains, manufacturing capabilities, or distribution capabilities; increase our exposure to currency fluctuations; constrain our liquidity or our ability to access capital markets; create staffing or operations difficulties; or subject us to increased cyber-attacks. While we will continue to monitor this fluid situation and 11develop contingency plans as necessary to address any disruptions to our business operations as they develop, the extent of the conflict’s effect on our business and results of operations as well as the global economy, cannot be predicted.The conflict may also have the effect of heightening many other risks disclosed in this Form 10-K, any of which could adversely affect our business, results of operations, cash flows or financial position. Such risks could affect, without limitation, the achievement of our strategic priorities, including achievement of our RRP growth targets; the availability of third-party manufacturing resources; the availability of attractive acquisition and strategic business opportunities and our ability to fully realize the benefits of these transactions; our ability to attract, motivate, and retain the best global talent; and our loss of revenue from counterfeiting and similar illicit activities.Risks Related to Sourcing and Distribution of Products, Services and MaterialsUse of third-parties may negatively impact the distribution, quality, and availability of our products and services, and we may be required to replace third-party contract distributors, manufacturers or service providers.We increasingly rely on third-parties and their subcontractors/suppliers, sometimes concentrated in a specific geographic area, for product distribution and to manufacture some of our products and product parts (particularly, the electronic devices and accessories), as well as to provide services, including to support our finance, commercialization and information technology processes. While many of these arrangements improve efficiencies and decrease our operating costs, they also diminish our direct control. Such diminished control may lead to disruption in the distribution of our products and may have a material adverse effect on the quality and availability of products or services, our supply chain, and the speed and flexibility in our response to changing market conditions and adult consumer preferences, all of which may place us at a competitive disadvantage. In addition, we may be unable to renew these agreements on satisfactory terms for numerous reasons, including government regulations, and our costs may increase significantly if we must replace such third parties with other partners or our own resources.The effects of climate change and legal or regulatory responses related to climate change may have a negative impact on our business and results of operations.While we seek to mitigate our business risks associated with climate change by establishing environmental goals and standards and seeking business partners, including within our supply chain, that are committed to operating in ways that protect the environment or mitigate environmental impacts, we recognize that there are inherent climate-related risks wherever business is conducted. Among other potential impacts, climate change could influence the quality and volume of the agricultural products we rely on, including tobacco, due to a number of factors beyond our control, including more frequent variations in weather patterns, extreme weather events causing unexpected downtime and inventory losses, other adverse weather conditions, and governmental restrictions on trade, all of which may lead to disruption of operations at factories, warehouses and other premises. Furthermore, risks related to natural ecosystems degradation, decreased agricultural productivity in certain regions of the world, biodiversity loss, water resource depletion and deforestation, which are partially driven or exacerbated by climate change, may disrupt our business operations or those of our suppliers and business partners.There is an increased focus by foreign, federal, state and local regulatory and legislative bodies regarding environmental policies relating to climate change. New climate-related legal or regulatory requirements may lead to additional carbon taxation, energy price increases, new compliance costs, increased distribution and supply chain costs, and other expenses impacting our cost of operation. Even if we make changes to align ourselves with legal or regulatory requirements, we may still be subject to significant penalties if such laws or regulations are interpreted and applied in a manner inconsistent with our practices.Government mandated prices, production control programs, and shifts in crops driven by economic conditions may increase the cost or reduce the quality of the tobacco and other agricultural products used to manufacture our products.As with other agricultural commodities, the price of tobacco leaf and cloves can be influenced by imbalances in supply and demand and the impacts of natural disasters and pandemics such as COVID-19. Tobacco production in certain countries is subject to a variety of controls, including government mandated prices and production control programs. Changes in the patterns of demand for agricultural products could cause farmers to produce less tobacco or cloves. Any significant change in tobacco leaf and clove prices, quality and quantity could affect our profitability and our business.Risks Related to our International OperationsBecause we have operations in numerous countries, our results may be adversely impacted by economic, regulatory and political developments, natural disasters, pandemics or conflicts.Some of the countries in which we operate face the threat of civil unrest and can be subject to regime changes. In others, nationalization, terrorism, conflict and the threats of war or acts of war may have a significant impact on the business environment. Natural disasters, extreme weather events, pandemics, economic, political, regulatory, acts of war or threats of war, or other 12developments could disrupt or increase the expenses related to our supply chain, manufacturing capabilities, distribution capabilities, or the energy and other utility services required to operate our factories, warehouses, and other premises. Our business continuity plans and other safeguards might not always be effective to fully mitigate their impact. In addition, such developments – including the impact on energy prices and availability in the EU and elsewhere resulting from the invasion of Ukraine by Russia – could increase costs of our materials and operations and lead to loss of property or equipment that are critical to our business in certain markets and difficulty in staffing and managing our operations, all of which could have a material adverse effect on our operations, volumes, revenue, net earnings and profitability. We discuss additional risks associated with Russia's invasion of Ukraine and climate change above and with the COVID-19 pandemic below.In certain markets, we are dependent on governmental approvals of various actions such as price changes, and failure to obtain such approvals could impair growth of our profitability.In addition, despite our high ethical standards and rigorous controls and compliance policies aimed at preventing and detecting unlawful conduct, given the breadth and scope of our international operations, we may not be able to detect all potential improper or unlawful conduct by our employees and partners. Such improper or unlawful conduct (actual or alleged) could lead to litigation and regulatory action, cause damage to our reputation and that of our brands, and result in substantial costs. Our reported results could be adversely affected by unfavorable currency exchange rates, and currency fluctuations could impair our competitiveness.We conduct our business primarily in local currency and, for purposes of financial reporting, the local currency results are translated into U.S. dollars based on average exchange rates prevailing during a reporting period. Foreign currencies may fluctuate significantly against the U.S. dollar reducing our net revenues, operating income and EPS. Our primary local currency cost bases may be different from our primary currency revenue markets, and U.S. dollar fluctuations against various currencies may have disproportionate negative impact on net revenues as compared to our gross profit and operating income margins.A sustained period of elevated inflation across the markets in which we operate could result in higher operating and financing costs and lead to reduced demand for our products.Increasing inflationary pressures may result in significant increases to our expenses, including direct materials, wages, energy, and transportation costs. While we take actions, wherever possible, to reduce the impact of the effects of inflation, in cases of sustained and elevated inflation across several of our major markets, it may be difficult to effectively control the increases to our costs. Increased inflation also has and may continue to lead to interest rate increases, thereby increasing our interest expense. Increasing inflationary pressures may also negatively impact consumer purchasing power, which could result in reduced demand for our products. If we are unable to increase our prices or take other actions to mitigate the effect of increasing inflationary pressures, our profitability and financial position could be negatively impacted.Risks Related to Legal Challenges and InvestigationsLitigation related to tobacco use and exposure to environmental tobacco smoke could substantially reduce our profitability and could severely impair our liquidity.There is litigation related to tobacco products pending in certain jurisdictions in which we operate. Damages claimed in some tobacco-related litigation are significant and, in certain cases in Brazil, Canada, and Nigeria, range into the billions of U.S. dollars. We anticipate that new cases will continue to be filed. The FCTC encourages litigation against tobacco product manufacturers. It is possible that our consolidated results of operations, cash flows or financial position could be materially adversely affected in a particular fiscal quarter or fiscal year by an unfavorable outcome or settlement of certain pending litigation. We face various administrative and legal challenges related to certain RRP activities, including allegations concerning product classification, advertising restrictions, corporate communications, product coach activities, scientific substantiation, product liability, antitrust, and unfair competition. While we design our programs to comply with relevant regulations, we expect these or similar challenges to continue as we expand our efforts to commercialize RRPs and to communicate publicly. The outcomes of these matters may affect our RRP commercialization and public communication activities and performance in one or more markets. Also see Item 8, Note 18. Contingencies to our consolidated financial statements for a discussion of pending litigation.From time to time, we are subject to governmental investigations on a range of matters.Investigations include allegations of contraband shipments of cigarettes, allegations of unlawful pricing activities within certain markets, allegations of underpayment of income taxes, customs duties and/or excise taxes, allegations of false and misleading usage of descriptors, allegations of unlawful advertising, and allegations of unlawful labor practices. We cannot predict the outcome of those investigations or whether additional investigations may be commenced, and it is possible that our business could be materially adversely affected by an unfavorable outcome of pending or future investigations. See Item 8, Note 18. Contingencies—Other Litigation and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Operating Results 13by Business Segment—Business Environment—Governmental Investigations” for a description of certain governmental investigations to which we are subject.We may be unable to adequately protect our intellectual property rights, and disputes relating to intellectual property rights could harm our business.Our intellectual property rights are valuable assets, their protection is important to our business, and that protection may not be equally available in every country in which we operate or in which our products are sold. If the steps we take to protect our intellectual property rights globally, including through applying for, prosecuting, maintaining and enforcing, where relevant, a combination of trademark, design, copyright, patent, trade secrets and other intellectual property rights, are inadequate, or if others infringe or misappropriate our intellectual property rights, notwithstanding legal protection, our business, financial condition, and results of operations could be adversely impacted. Moreover, failing to manage our existing and/or future intellectual property may place us at a competitive disadvantage. Intellectual property rights of third parties may limit our ability to develop, manufacture and/or commercialize our products in one or more markets. Competitors or other third parties may claim that we infringe their intellectual property rights. Any such claims, regardless of merit, could divert management’s attention, be costly, disruptive, time-consuming and unpredictable and expose us to significant litigation costs and damages, and may impede our ability to develop, manufacture and/or commercialize new RRPs and improve our products, and thus have a material adverse effect on our revenue and our profitability. In addition, if, as a result, we are unable to manufacture or sell our RRPs or improve their quality in one or more markets, our ability to convert adult smokers to our RRPs in such markets would be adversely affected. See Item 8, Note 18. Contingencies—Other Litigation to our consolidated financial statements for a description of certain intellectual property proceedings.Risks Related to our Competitive EnvironmentWe face intense competition, and our failure to compete effectively could have a material adverse effect on our profitability and results of operations.We are subject to highly competitive conditions in all aspects of our business. We compete primarily on the basis of product quality, brand recognition, brand loyalty, taste, R&D, innovation, packaging, customer service, marketing, advertising and retail price and, increasingly, adult smoker willingness to convert to our RRPs. The competitive environment and our competitive position can be significantly influenced by weak economic conditions, erosion of consumer confidence, competitors' introduction of lower-price products or innovative products, novel products which given their taste characteristics may be more commercially successful, higher tobacco product taxes, higher absolute prices and larger gaps between retail price categories, and product regulation that diminishes the ability to differentiate tobacco products and restricts adult consumer access to truthful and non-misleading information about our RRPs. Competitors in our industry include British American Tobacco plc, Japan Tobacco Inc., Imperial Brands plc, new market entrants, particularly with respect to innovative products, several regional and local tobacco companies and, in some instances, state-owned tobacco enterprises, principally in Algeria, Egypt, China, Taiwan, Thailand and Vietnam. Some competitors have different profit, volume and regulatory objectives, and some international competitors may be less susceptible to changes in currency exchange rates than we are. Certain new market entrants in the non-combustible product category may alienate consumers from innovative products through inappropriate marketing campaigns, messaging and inferior product satisfaction, while not relying on scientific substantiation based on appropriate R&D protocols and standards. The growing use of digital media could increase the speed and extent of the dissemination of inaccurate and misleading information about our RRPs, all of which could have a material adverse effect on our profitability and results of operations. We may be unable to anticipate changes in adult consumer preferences.Our business is subject to changes in adult consumer preferences, which may be influenced by local economic conditions, accessibility to our products and availability of accurate information related to our products. 14To be successful, we must: •promote brand equity successfully;•anticipate and respond to new adult consumer trends;•ensure that our products meet our quality standards;•develop new products and markets and broaden brand portfolios;•improve productivity;•educate and encourage adult smokers to convert to our RRPs;•ensure effective adult consumer engagement, including communication about product characteristics and usage of RRPs;•provide excellent customer care;•ensure adequate production capacity to meet demand for our products; and•be able to protect or enhance margins through price increases.In periods of economic uncertainty, adult consumers may tend to purchase lower-price brands, and the volume of our premium-price and mid-price brands and our profitability could be materially adversely impacted as a result. Such down-trading trends may be reinforced by regulation that limits branding, communication and product differentiation.Our ability to grow profitability may be limited by our inability to introduce new products, enter new markets or improve our margins through higher pricing and improvements in our brand and geographic mix.Our profit growth may be materially adversely impacted if we are unable to introduce new products or enter new markets successfully, to raise prices or to improve the proportion of our sales of higher margin products and in higher margin geographies.We may be unable to expand our brand portfolio through successful acquisitions or the development of strategic business relationships, and the intended benefits from our investments may not materialize.One element of our growth strategy is to expand our brand portfolio and market positions through selective acquisitions and the development of strategic business relationships. Acquisition and strategic business development opportunities are limited and present risks of failing to achieve efficient and effective integration, strategic objectives and/or anticipated revenue improvements and cost savings. There is no assurance that we will be able to acquire attractive businesses or enter into strategic business relationships on favorable terms ahead of our competitors, or that such acquisitions or strategic business development relationships will be accretive to earnings or improve our competitive position. In addition, we may not have a controlling position in certain strategic investments or relationships, which could impact the extent to which the intended financial growth and other benefits from these investments or relationships may ultimately materialize.Our ability to achieve our strategic goals may be impaired if we fail to attract, motivate and retain the best global talent and effectively align our organizational design with the goals of our transformation.To be successful, we must continue transforming our culture and ways of working, align our talent and organizational design with our increasingly complex business needs, and innovate and transform to a consumer-centric business. We compete for talent, including in areas that are new to us, such as digital, information technology, life sciences, with companies in the consumer products, technology, pharmaceutical and other sectors that enjoy greater societal acceptance. As a result, we may be unable to attract, motivate and retain the best global talent with the right degree of diversity, experience and skills to achieve our strategic goals. 15Risks Related to the Impact of a Pandemic on our BusinessOur business, results of operations, cash flows and financial position may be materially adversely impacted by an epidemic, endemic or pandemic, such as COVID-19.The outbreak of the global COVID-19 pandemic in 2020 has created significant societal and economic disruption, and resulted in the closures of stores, factories and offices, and restrictions on manufacturing, distribution and travel, all of which have and may continue to adversely impact our business, results of operations, cash flows and financial position. Our business continuity plans and other safeguards may not be effective to mitigate the ongoing or potential impact of COVID-19 or other epidemics, endemics, or pandemics.The production of our RRP portfolio requires various components and materials, and we believe that there is an adequate supply of such components and materials in the world markets to satisfy our current and anticipated production requirements. However, some components and materials necessary for the production of our RRPs, including those for the electronic devices, are obtained from single or limited sources, and can be subject to industry-wide shortages and price fluctuations. While we have been successful in maintaining adequate supply of such components and materials during the ongoing COVID-19 pandemic so far, the COVID-19 pandemic, or another epidemic, endemic or pandemic, may disrupt that supply, whether through regulatory enforced actions taken to contain its spread, or through other supply chain disruptions caused by such epidemic, endemic or pandemic. This could negatively impact the commercialization of our RRPs. Significant risks to our business during an epidemic, endemic or pandemic, such as the ongoing consequences of the COVID-19 outbreak, also include: •our diminished ability to convert adult smokers to our RRPs;•significant volume declines in our duty-free business and certain other key markets;•disruptions or delays in our manufacturing and supply chain, including delays and increased costs in the shipment of parts to manufacture our products or for the products themselves;•increased currency volatility; and•delays in certain cost saving, transformation and restructuring initiatives.The significant adverse effect of an epidemic, endemic or pandemic on the economic or political conditions in markets in which we operate could result in changes to the preferences of our adult consumers and lower demand for our products, particularly for our mid-price or premium-price brands. Each of these risks could have a material adverse effect on our business, operations, results of operations, revenues, cash flow and profitability.Risks Related to Illicit TradeWe lose revenues as a result of counterfeiting, contraband, cross-border purchases, "illicit whites," non-tax-paid volume produced by local manufacturers, and counterfeiting of our Platform 1 device and heated tobacco units.Large quantities of counterfeit cigarettes are sold in the international market. We believe that Marlboro is the most heavily counterfeited international cigarette brand, although we cannot quantify the revenues we lose as a result of this activity. In addition, our revenues are reduced by contraband, legal cross-border purchases, "illicit whites" and non-tax-paid volume produced by local manufacturers. Our revenues and consumer satisfaction with our Platform 1 device and heated tobacco units may be materially adversely affected by counterfeit products that do not meet our product quality standards and scientific validation procedures.16Risks Related to Cybersecurity and Data GovernanceThe failure or disruption of our information technology networks and systems, or those managed by third-party service providers or owned by our business partners and used in furtherance of PMI’s business, due to cybersecurity attacks; unauthorized attempts to corrupt or extract data; security vulnerabilities; misconfigurations; human error; or failure or inability by us, third-parties, or our business partners to adhere to cybersecurity industry best practices, could place us at a competitive disadvantage, cause reputational damage, impact our operations, result in data breaches, significant business disruption, litigation, regulatory action including significant fines or penalties, financial impact, loss of revenue or assets, including our intellectual property, personal, confidential, or sensitive data.We and our business partners heavily rely on information technology networks and systems, including those connected to the Internet, to help manage business processes and operations, including the collection, storage, interpretation, and processing of confidential, sensitive, personal and other data; internal and external communications; marketing and e-commerce activities; the manufacture, sale, and distribution of our products; management of third-party business relationships; engagement with governmental authorities; innovation through research and development; and other activities necessary for business operations. Some of these information systems and networks are developed, supplied, or managed by third-party service providers that may make us vulnerable to “supply chain” style cyberattacks.Cyberattacks, security incidents and vulnerabilities impacting PMI, newly acquired companies, our business partners, or our third-party providers, continue to dynamically evolve in sophistication and volume, making it difficult for us to predict probability, frequency, and impact severity of security incidents. Further, it may be inherently difficult to detect vulnerabilities during due diligence, for long periods of time, or soon enough to mitigate exploitation. There can be no assurance that such security incidents or vulnerabilities will not have a material adverse effect on us in the future. We continue to make investments in administrative, technical, and physical safeguards to maintain information security protections in line with industry standards and best practices. We evaluate the adequacy of preventative actions to reduce security incidents on an ongoing basis. Our safeguards may not, however, be effective in mitigating the impact of service disruptions or other failures of these information technology networks and systems. Failure to timely respond and mitigate security incidents, could result in wide-ranging business interruptions. Such security incidents could place us at a competitive disadvantage; result in financial impacts, a loss of revenue, assets, including our intellectual property, personal or other sensitive data; result in litigation and regulatory action including significant fines or penalties; impact our operations; cause damage to our reputation and that of our brands; and result in significant remediation and other costs. Our or our business partners’ failure or inability to adhere to privacy, data, artificial intelligence and information security laws could result in business disruption, loss of reputation and consumer trust, litigation, regulatory action including significant fines or penalties, financial impact, and loss of revenue, assets or personal, confidential, or sensitive data.An actual or alleged failure to comply with complex and changing privacy, data, artificial intelligence and information security laws and regulations under the EU General Data Protection Regulation, various United States state and federal laws, and other similar privacy and information security laws across the jurisdictions in which PMI operates, such as the failure to protect personal data; implement appropriate technological and reasonable security measures; respect the privacy rights of data subjects; provide sufficient detailed notices of personal data processing; retrieve consent and provide opt-outs; meet stringent timeframe requirements for incident reporting to regulatory authorities; comply with artificial intelligence regulations; and others, could have a material adverse effect on us, subject us to substantial fines and/or legal challenges, and/or harm our business, reputation, financial condition, or operating results. Such laws and regulations across the jurisdictions in which PMI operates may vary, resulting in inconsistent or conflicting legal obligations.Risks Related to the Acquisitions of Swedish Match, OtiTopic, Inc. ("OtiTopic"), Fertin Pharma A/G ("Fertin Pharma") and Vectura Group Ltd. ("Vectura") (collectively, the "Acquisitions")As previously disclosed in this Form 10-K, since 2021, we have acquired Swedish Match, OtiTopic, Fertin Pharma and Vectura, and have launched a new Wellness and Healthcare business consolidating OtiTopic, Fertin Pharma and Vectura: Vectura Fertin Pharma.We may be unable to successfully integrate and realize the expected benefits from the Acquisitions.The successful integration of the acquired businesses and their operations into those of our own and our ability to realize the benefits of the Acquisitions, are subject to a number of risks and uncertainties, many of which are not in our control. The risks and uncertainties relating to integrating the businesses acquired include, among other things: (i) the challenge of integrating complex organizations, systems, operating procedures, industry specific compliance programs, technology, networks and other assets of the businesses that we acquire, and the costs related to such integration efforts; (ii) the possibility that we are unable to gain access to 17differentiated intellectual property, proprietary technology, and pharmaceutical development expertise as anticipated by these Acquisitions, and thus fail to realize our desired entry into additional smoke-free, wellness, therapeutic and healthcare platforms; (iii) the challenge of integrating the cultures and business practices of each of Swedish Match, Fertin Pharma and Vectura to our culture and business practices, which if not managed correctly, could lead to difficulties in retaining key management and other key employees; and (iv) the challenge of achieving a successful integration as a result of our affiliation to our combustible product portfolio. In addition, even if we are able to successfully integrate, the anticipated benefits of the Acquisitions may not be realized fully, or at all, or may take longer to realize than expected. Furthermore, the success of the Acquisitions also depends on Swedish Match's continued growth in highly competitive markets and on the success of the research and development efforts of Vectura Fertin Pharma, including the ability to obtain regulatory approval for new products, and the ability to commercialize or license these new products developed by them. Moreover, our combustible product portfolio may stand in the way of introducing and growing new product categories, and may prevent our business from developing a long-term sustainable ecosystem of products in the wellness, therapeutic, and healthcare categories.The businesses that we acquire in the Acquisitions may have liabilities that are not known to us.The businesses that we have acquired in the Acquisitions may have liabilities that we were unable to identify, or were unable to discover, in the course of performing our due diligence investigations during the Acquisitions thereof. We cannot assure you that the indemnification available to us under the respective acquisition agreements, will be sufficient in amount, scope or duration to fully offset the possible liabilities associated with the respective business or property that we will assume upon consummation of each acquisition. Furthermore, the acquisition of Swedish Match was structured as a direct purchase of shares from Swedish Match shareholders and therefore did not include an acquisition agreement or indemnification rights. Any such liabilities, individually or in the aggregate, could have a material adverse effect on our business, financial condition and results of operations.Accounting adjustments related to the Acquisitions could adversely affect our financial results.We have accounted for the completion of the Acquisitions using the acquisition method of accounting. Differences between preliminary estimates and the final acquisition accounting may occur, and these differences could have a material impact on the consolidated financial statements and our future results of operations and financial position in combination with the businesses acquired. Furthermore, given the nature of the assets being acquired in the Acquisitions, we may not be able to avoid future impairments of those assets, which may also have a material impact on our future results of operation and financial position.PMI, Swedish Match and Vectura Fertin Pharma may be subject to uncertainties that could adversely affect our respective businesses, and adversely affect the financial results of our combined businesses.Our success following these Acquisitions will depend in part upon our ability and the ability of each of Swedish Match and Vectura Fertin Pharma to maintain business relationships. Uncertainty about the effect of the Acquisitions on customers, suppliers, employees and other constituencies of each of Swedish Match, Fertin Pharma and Vectura, may have a material adverse effect on us and/or the businesses that we have acquired through the Acquisitions. Customers, suppliers and others who do business with Swedish Match or Vectura Fertin Pharma may delay or defer business decisions, decide to terminate, modify or renegotiate their relationships, or take other actions as a result of the Acquisitions, which could negatively affect the revenues, earnings and cash flows of our company or the businesses that we have acquired. Regulatory changes may have an impact on the development and/or commercialization of products which originate from the Swedish Match or Vectura Fertin Pharma value chains, as well as our revenues, earnings and cash flow. If we are unable to maintain the business and operational relationships of Swedish Match, or of Vectura Fertin Pharma, our financial position, results of operations or cash flows upon combining with these companies could be adversely affected.Item 1B.Unresolved Staff Comments. None.Item 2. Properties. We own or lease various manufacturing, office and research and development facilities in locations around the world. We own properties in Switzerland where our operations center and state-of-the-art research and development facility are located. At December 31, 2022, we operated and owned a total of 53 manufacturing facilities across our segments. Among them, 8 factories produced heated tobacco units. The Swedish Match acquisition expanded our manufacturing footprint with the addition of 14 owned manufacturing facilities, which are included in the total above. The manufacturing facilities acquired from Swedish Match are primarily engaged in the production of smoke-free products. In 2022, certain facilities each manufactured over 30 billion units (cigarettes and heated tobacco units combined). The largest manufacturing facilities, in terms of volume, are located in Turkey (ME&A), Indonesia (S&SA), Poland (EU), Russia (EE), Italy (EU), the Philippines (S&SA), Lithuania (EU), Czech Republic (EU) and Portugal (EU). As part of our global operating model, 18products manufactured in a particular manufacturing facility are not necessarily distributed in the operating segment where the facility is located. We have integrated the production of our heated tobacco units into a number of our existing manufacturing facilities, and we are progressing with our plans to build manufacturing capacity for our other RRP and smoke-free platforms. We will continue to optimize our manufacturing infrastructure. We believe the properties owned or leased by our subsidiaries are maintained in good condition and are believed to be suitable and adequate for our present needs.Item 3.Legal Proceedings. The information called for by this Item is incorporated herein by reference to Item 8, Note 18. Contingencies.Item 4.Mine Safety Disclosures. Not applicable.PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. The principal stock exchange on which our common stock (no par value) is listed is the New York Stock Exchange (ticker symbol "PM"). At January 31, 2023, there were approximately 43,700 holders of record of our common stock. 19Performance Graph The graph below compares the cumulative total shareholder return on PMI's common stock with the cumulative total return for the same period of PMI's Peer Group and the S&P 500 Index. The graph assumes the investment of $100 as of December 31, 2017, in PMI common stock (at prices quoted on the New York Stock Exchange), and each of the indices as of the market close and reinvestment of dividends on a quarterly basis. DatePMIPMI Peer Group (1)S&P 500 IndexDecember 31, 2017$100.00$100.00$100.00December 31, 2018$66.80$89.40$93.80December 31, 2019$90.10$110.80$120.80December 31, 2020$93.60$118.50$140.50December 31, 2021$113.10$137.10$178.30December 31, 2022$127.00$132.90$143.60(1) The PMI Peer Group presented in this graph is the same as that used in the prior year. The PMI Peer Group was established based on a review of four characteristics: global presence; a focus on consumer products; and net revenues and a market capitalization of a similar size to those of PMI. The review also considered the primary international tobacco companies. As a result of this review, the following companies constitute the PMI Peer Group: Altria Group, Inc., Anheuser-Busch InBev SA/NV, British American Tobacco p.l.c., The Coca-Cola Company, Colgate-Palmolive Co., Diageo plc, Heineken N.V., Imperial Brands PLC, Japan Tobacco Inc., Johnson & Johnson, Kimberly-Clark Corporation, The Kraft-Heinz Company, McDonald's Corp., Mondelēz International, Inc., Nestlé S.A., PepsiCo, Inc., The Procter & Gamble Company, Roche Holding AG, and Unilever NV and PLC. Note: Figures are rounded to the nearest $0.10. 20Issuer Purchases of Equity Securities During the Quarter Ended December 31, 2022 Our share repurchase activity for each of the three months in the quarter ended December 31, 2022, was as follows: PeriodTotalNumber ofSharesRepurchasedAveragePrice Paidper ShareTotal Numberof SharesPurchased asPart of PubliclyAnnouncedPlans orProgramsApproximateDollar Valueof Shares thatMay Yet bePurchasedUnder the Plansor ProgramsOctober 1, 2022 –October 31, 2022 (1)$— 10,481,359 $6,016,847,275 November 1, 2022 –November 30, 2022 (1)$— 10,481,359 $6,016,847,275 December 1, 2022 –December 31, 2022 (1)$— 10,481,359 $6,016,847,275 Pursuant to Publicly Announced Plans or Programs— $— October 1, 2022 –October 31, 2022 (2)3,753 $85.29 November 1, 2022 –November 30, 2022 (2)3,421 $90.52 December 1, 2022 –December 31, 2022 (2)1,703 $97.40 For the Quarter Ended December 31, 20228,877 $89.63 (1)On June 11, 2021, our Board of Directors authorized a new share repurchase program of up to $7 billion, with target spending of $5 billion to $7 billion over a three-year period that commenced in July 2021. These share repurchases have been made pursuant to the $7 billion program. On May 11, 2022, we announced the suspension of our three-year share repurchase program following the recommended public offer to acquire the outstanding shares of Swedish Match from its shareholders. For further details on the offer, see the Acquisitions and Other Business Arrangements section of Part II, Item 7 of this Form 10-K. (2)Shares repurchased represent shares tendered to us by employees who vested in restricted and performance share unit awards and used shares to pay all, or a portion of, the related taxes. 21Item 6. [Reserved].Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations.The following discussion should be read in conjunction with the other sections of this Annual Report on Form 10-K, including the consolidated financial statements and related notes contained in Item 8, and the discussion of risks and cautionary factors that may affect future results in Item 1A. Risk Factors.Description of Our Company We are a leading international tobacco company working to deliver a smoke-free future and to evolve our portfolio for the long term to include products outside of the tobacco and nicotine sector. Our current product portfolio primarily consists of cigarettes and smoke-free products, which include heat-not-burn, vapor, and oral nicotine products. Since 2008, we have invested more than $10.5 billion to develop, scientifically substantiate and commercialize innovative smoke-free products for adults who would otherwise continue to smoke, with the goal of completely ending the sale of cigarettes. This investment includes the building of world-class scientific assessment capabilities, notably in the areas of pre-clinical systems toxicology, clinical and behavioral research, as well as post-market studies. In November 2022, we acquired Swedish Match AB ("Swedish Match") – a leader in oral nicotine delivery – creating a global smoke-free combination led by the companies’ IQOS and ZYN brands. The U.S. Food and Drug Administration ("FDA") has authorized versions of our IQOS Platform 1 devices and consumables, and Swedish Match's General snus, as Modified Risk Tobacco Products (MRTPs). We describe the MRTP orders in more detail in the "Business Environment" section of this Item 7. As of December 31, 2022, we managed our business in six geographical segments, a Swedish Match segment and a Wellness and Healthcare segment: •European Union ("EU");•Eastern Europe ("EE");•Middle East & Africa ("ME&A"), which includes our international duty free business;•South & Southeast Asia ("S&SA"); •East Asia & Australia ("EA&A"); •Americas ("AMCS"); •Swedish Match, which reflects our fourth quarter 2022 acquisition of the company; and•Wellness and Healthcare ("W&H"), which includes the operating results of our new Wellness and Healthcare business, Vectura Fertin Pharma. In the third quarter of 2021, we acquired Fertin Pharma A/S, Vectura Group plc. (also known as Vectura Group Ltd.) and OtiTopic, Inc. On March 31, 2022, we launched a new Wellness and Healthcare business consolidating these entities, Vectura Fertin Pharma. The operating results of this new business are reported in the Wellness and Healthcare segment.To further support the growth of our smoke-free business, reinforce consumer centricity, and increase the speed of innovation and deployment, in January 2023, we rearranged our operations in four geographical segments, down from the current six and as follows:•Europe Region is headquartered in Lausanne, Switzerland, and covers all the European Union countries, Switzerland, the United Kingdom, and also Ukraine, Moldova and Southeast Europe; •South and Southeast Asia, Commonwealth of Independent States, Middle East and Africa Region is headquartered in Dubai, United Arab Emirates. It covers South and Southeast Asia, the African continent, the Middle East, Turkey, as well as Israel, Central Asia, Caucasus and Russia;•East Asia, Australia, and PMI Duty Free Region is headquartered in Hong Kong, and includes the consolidation of our international duty free business with East Asia & Australia; and•Americas Region is headquartered in Stamford, Connecticut, and covers the United States, Canada and Latin America. 22The operations of Swedish Match and our Wellness and Healthcare segment remained unchanged. We will report our financial results based on the new geographical segments as of the first quarter of 2023.In November 2022, we completed the relocation of our corporate headquarters, including our AMCS headquarters, from New York, New York, to Stamford, Connecticut. Our cigarettes are sold in approximately 175 markets, and in many of these markets they hold the number one or number two market share position. We have a wide range of premium, mid-price and low-price brands. Our portfolio comprises both international and local brands. Smoke-free products ("SFPs") is the term we primarily use to refer to all of our products that are not combustible tobacco products, such as heat-not-burn, e-vapor, and oral nicotine. In addition, SFPs include wellness and healthcare products, as well as consumer accessories such as lighters and matches.In addition to the manufacture and sale of cigarettes, we are engaged in the development and commercialization of reduced-risk products ("RRPs"). RRPs is the term we use to refer to products that present, are likely to present, or have the potential to present less risk of harm to smokers who switch to these products versus continuing smoking. We have a range of RRPs in various stages of development, scientific assessment and commercialization. Our RRPs are SFPs that contain and/or generate far lower quantities of harmful and potentially harmful constituents than found in cigarette smoke. IQOS is the leading brand in our SFP portfolio. As of December 31, 2022, our smoke-free products were available for sale in 73 markets. In 2021, we laid the foundation for our long-term growth ambitions beyond nicotine in wellness and healthcare, including the milestone acquisitions of Vectura Group plc and Fertin Pharma A/S, as noted above, which provide essential capabilities for future product development. Now, through our Vectura Fertin Pharma subsidiary, with a strong foundation and significant expertise in life sciences, we aim to expand into wellness and healthcare areas.In 2022, we acquired Swedish Match AB, a market leader in oral nicotine delivery with a significant presence in the United States market. The Swedish Match acquisition is a key milestone in PMI’s transformation to becoming a smoke-free company. Swedish Match already has a leading nicotine pouch franchise in the U.S. under the ZYN brand name. The Swedish Match product portfolio is complementary to our existing portfolio, permitting us to bring together a leading oral nicotine product with the leading heat-not-burn product. By joining forces with Swedish Match, we expect to accelerate the achievement of our joint smoke-free ambitions, switching more adults who would otherwise continue to smoke to better alternatives faster than either company could achieve separately. For further details of our 2021 and 2022 acquisitions, see Item 8, Note 3. Acquisitions and Note 13. Segment ReportingWe use the term net revenues to refer to our operating revenues from the sale of our products, including shipping and handling charges billed to customers, net of sales and promotion incentives, and excise taxes. Our net revenues and operating income are affected by various factors, including the volume of products we sell, the price of our products, changes in currency exchange rates and the mix of products we sell. Mix is a term used to refer to the proportionate value of premium-price brands to mid-price or low-price brands in any given market (product mix). Mix can also refer to the proportion of shipment volume in more profitable markets versus shipment volume in less profitable markets (geographic mix). Our cost of sales consists principally of: tobacco leaf, non-tobacco raw materials, labor and manufacturing costs; shipping and handling costs; and the cost of devices produced by third-party electronics manufacturing service providers. Estimated costs associated with device warranty programs are generally provided for in cost of sales in the period the related revenues are recognized.Our marketing, administration and research costs include the costs of marketing and selling our products, other costs generally not related to the manufacture of our products (including general corporate expenses), and costs incurred to develop new products. The most significant components of our marketing, administration and research costs are marketing and sales expenses and general and administrative expenses.Philip Morris International Inc. is a legal entity separate and distinct from its direct and indirect subsidiaries. Accordingly, our right, and thus the right of our creditors and stockholders, to participate in any distribution of the assets or earnings of any subsidiary is subject to the prior rights of creditors of such subsidiary, except to the extent that claims of our company itself as a creditor may be recognized. As a holding company, our principal sources of funds, including funds to make payment on our debt securities, are from the receipt of dividends and repayment of debt from our subsidiaries. Our principal wholly owned and majority-owned subsidiaries currently are not limited by long-term debt or other agreements in their ability to pay cash dividends or to make other distributions that are otherwise compliant with law.23Executive Summary The following executive summary provides the business update and significant highlights from the Discussion and Analysis that follows.War in Ukraine Since the onset of the war in Ukraine, our main priority has been the safety and security of our more than 1,300 employees and their families in the country. PMI has helped to evacuate more than 1,000 people from Ukraine and relocate over 2,700 others from conflict zones to locations in the country away from the heaviest fighting; provided critical aid to employees who cannot leave or who decide to remain in Ukraine; and provided those who have left the country with a range of support in neighboring countries. We are continuing to pay salaries to all our Ukrainian employees and are also providing substantial in-kind support to them and their families. In addition, we have contributed approximately $10 million in funds and donated essential items across the country.On February 25, 2022, in order to preserve the safety of our employees, we announced the temporary suspension of our commercial and manufacturing operations in Ukraine, including at our factory in Kharkiv. We subsequently resumed some retail activities where safety allowed, in order to provide product availability and service to adult consumers, and began to supply the market from production centers outside Ukraine, as well as through a contract manufacturing arrangement. Production at our factory in Kharkiv remains suspended.In 2022, Ukraine accounted for around 2% of our total cigarette and heated tobacco unit shipment volume and around 1% of our total net revenues. As of December 31, 2022, our Ukrainian operations had approximately $0.4 billion in total assets, excluding intercompany balances.We employ more than 3,200 people in Russia and will continue to support our employees there, including paying their salaries, while continuing to fulfill our legal obligations. We will continue to make decisions with employee safety and security as a priority. On March 24, 2022, we announced the concrete steps we had taken to suspend planned investments and scale down our manufacturing operations in Russia, including: the discontinuation of a number of cigarette products; the suspension of our marketing activities; the cancellation of all product launches planned for 2022, including ILUMA; and the cancellation of our plans to manufacture heated tobacco units for ILUMA in Russia.We are continuously assessing the evolving situation in Russia, including: recent regulatory constraints in the market that entail very complex terms and conditions that must be met for any divestment transaction to be granted approval by the authorities; and restrictions resulting from international regulations.In 2022, Russia accounted for approximately 9% of total shipment volumes and around 7% of our total net revenues. As of December 31, 2022, our Russian operations had approximately $2.5 billion in total assets, excluding intercompany balances, of which approximately $0.6 billion consisted of cash and equivalents held mostly in local currency (Russian rubles).We recorded pre-tax charges related to the war in Ukraine of approximately $151 million in 2022 (including humanitarian efforts). This includes charges in Russia related to the cancellation of the planned launch of ILUMA and the planned production of related heated tobacco units.These developments above have and will continue to have a material adverse impact on our business, results of operations, cash flows and financial position, and may result in impairment charges.For further details, see Item 8, Note 4. War in Ukraine to our consolidated financial statements as well as Item 1A. Risk Factors and the "Trade Policy" section of this MD&A. Agreement with Altria Group, Inc. regarding Commercialization of IQOS in the U.S. On October 20, 2022, PMI announced that it had reached an agreement with Altria Group, Inc. to end the companies' relationship regarding the IQOS commercialization rights in the U.S. as of April 30, 2024. As a result of PMI reacquiring these rights, effective May 1, 2024, PMI will have the full rights to commercialize IQOS in the U.S. As part of the agreement, PMI agreed to pay a total cash consideration of $2.7 billion, with $1.0 billion paid at the inception of the agreement and the remaining $1.7 billion (plus interest, at a per annum rate equal to six percent (6%)), to be paid by July 2023 at the latest.For further details, see Item 8, Note 3. Acquisitions.24Swedish Match Acquisition On November 11, 2022, Philip Morris Holland Holdings B.V. (“PMHH”), a wholly owned subsidiary of PMI, acquired a controlling interest of 85.87% of the total issued and outstanding shares in Swedish Match. Swedish Match's operating results beginning on November 11, 2022 through December 31, 2022, are included in PMI's consolidated statement of earnings and disclosed as a separate segment.On November 28, 2022, PMHH announced that it had acquired 93.11% of the shares in Swedish Match and intended to: (i) initiate compulsory redemption under the Swedish Companies Act to acquire all remaining shares in Swedish Match; and (ii) request delisting of Swedish Match’s shares from Nasdaq Stockholm.On December 16, 2022, Swedish Match announced that the compulsory redemption process had been initiated. On December 30, 2022, the shares of Swedish Match were delisted from Nasdaq Stockholm, by which time PMHH had become the owner of 94.81% of Swedish Match's shares.For further details, see Item 8, Note 3. Acquisitions. KT&G On January 30, 2023, PMI announced a long-term collaboration with KT&G, South Korea’s leading tobacco and nicotine manufacturer, to continue to commercialize KT&G’s innovative smoke-free devices and consumables on an exclusive, worldwide basis (excluding South Korea). The agreement covers fifteen years, to January 29, 2038, with performance-review cycles and associated commitments, based on volume, to be confirmed for each three-year period, to allow flexibility for evolving market conditions.For further details, see "Acquisitions and Other Business Arrangements" section of this MD&A.Consolidated Operating Results•Net Revenues – Net revenues of $31.8 billion for the year ended December 31, 2022, increased by $0.4 billion, or 1.1%, from the comparable 2021 amount. The change in our net revenues from the comparable 2021 amount was driven by the following (variances not to scale): Net revenues, excluding currency and acquisitions, increased by 8.0%, mainly reflecting: favorable volume/mix, primarily driven by higher heated tobacco units ("HTU") volume and device volume, partly offset by lower cigarette volume and unfavorable device mix, cigarette mix and HTU mix; a favorable pricing variance, driven by higher combustible tobacco pricing, partly offset by lower device pricing and lower HTU (net) pricing; and a favorable comparison related to the Saudi Arabia customs assessments of $246 million in 2021, shown in "Other" and further described in the following "Diluted Earnings Per Share" discussion. In 2022, Russia and Ukraine accounted for around 8% of PMI's total net revenues.25Net revenues by product category for the years ended December 31, 2022 and 2021, are shown below: Following the Swedish Match acquisition and a review of PMI and Swedish Match’s combined product portfolio, PMI reclassified certain of its own products previously reported under its combustible tobacco product category to the newly created smoke-free product category to better reflect the characteristics of these products. This reclassification did not impact PMI’s segment reporting, consolidated financial position, results of operations or cash flows in any of the periods presented. For further details, see Item 8, Note 13. Segment Reporting.26•Diluted Earnings Per Share – The changes in our reported diluted earnings per share (“diluted EPS”) for the year ended December 31, 2022, from the comparable 2021 amounts, were as follows: Diluted EPS% ChangeFor the year ended December 31, 2021$5.83 2021 Asset impairment and exit costs0.12 2021 Saudi Arabia customs assessments0.14 2021 Asset acquisition cost0.03 2021 Equity investee ownership dilution(0.04)2021 Amortization and impairment of intangibles0.05 2021 Tax items— Subtotal of 2021 items0.30 2022 Charges related to the war in Ukraine(0.08)2022 Fair value adjustment for equity security investments0.02 2022 Amortization and impairment of intangibles(0.15)2022 Costs associated with Swedish Match AB offer(0.06)2022 Swedish Match AB acquisition accounting related item(0.06)2022 Tax benefit associated with Swedish Match AB financing0.13 2022 Tax items0.03 Subtotal of 2022 items(0.17)Currency(0.77)Interest0.02 Change in tax rate0.03 Operations0.57 For the year ended December 31, 2022$5.81 (0.3)%Asset impairment and exit costs – During 2021, we recorded pre-tax asset impairment and exit costs of $216 million, representing $181 million net of income tax and a diluted EPS charge of $0.12 per share, related to the organizational design optimization plan, primarily in Switzerland, and the product distribution restructuring in South Korea. The pre-tax charge was recorded in marketing, administration and research costs in the consolidated statements of earnings for the year ended December 31, 2021. For further details, see Item 8, Note 20. Asset Impairment and Exit Costs. Saudi Arabia customs assessments – In June 2021, the Customs Appeal Committee in Riyadh notified our distributors in Saudi Arabia of its decisions to largely reject their challenges of the Saudi Arabia Customs General Authority assessments as described in Item 8, Note 18. Contingencies. On the basis of these decisions and in line with arrangements with the distributors, we recorded a pre-tax charge of $246 million in the second quarter of 2021 (representing $215 million net of income tax and a diluted EPS charge of $0.14 per share). The pre-tax charge was recorded as a reduction of net revenues on the consolidated statement of earnings for the year ended December 31, 2021, and was included in the Middle East & Africa segment results. Asset acquisition cost – In August 2021, we acquired 100% of OtiTopic, Inc., a U.S. respiratory drug development company with a late-stage dry powder inhalation aspirin treatment for acute myocardial infarction. We accounted for this transaction as an asset acquisition since the acquired in-process research and development ("IPR&D") of the dry powder inhalation aspirin treatment represented substantially all of the fair value of the gross assets acquired. At the date of acquisition, we determined that the acquired IPR&D had no alternative future use. As a result, we recorded a pre-tax charge of $51 million (representing a $0.03 per share charge to diluted EPS) to research and development costs within marketing, administration and research costs in the consolidated statements of earnings for the year ended December 31, 2021. For further details, see Item 8, Note 3. Acquisitions.Equity investee ownership dilution – In 2021, our equity method investee, Medicago Inc., initiated additional rounds of equity funding in which we did not participate. As a result, our share of holdings in Medicago Inc. was reduced from approximately 32% at December 31, 2020, to approximately 23% as of December 31, 2021. The ownership dilution resulted in a $0.04 per share 27favorable impact to diluted EPS and income of $55 million to equity investments and securities (income)/loss, net in the consolidated statements of earnings for the year ended December 31, 2021. For further details, see Item 8, Note 18. Contingencies - Third Party Guarantees. Amortization and impairment of intangibles – During 2022 and 2021, we recorded amortization and impairment of intangibles of $271 million (representing $227 million net of income tax or $0.15 per share decrease in diluted EPS) and $96 million (representing $78 million net of income tax or $0.05 per share decrease in diluted EPS), respectively. The pre-tax amortization and impairment of intangibles amount in 2022 consisted of amortization expense of $159 million primarily due to increased acquired intangible assets recorded as a result of our acquisitions in the third quarter of 2021, and an impairment charge of $112 million reflecting the impact of general economic and market conditions resulting in a reduction in future estimated cash flows on certain products within the Wellness and Healthcare segment. For further details, see Item 8, Note 3. Acquisitions and Note 5. Goodwill and Other Intangible Assets, net.Charges related to the war in Ukraine – During 2022, we recorded a pre-tax charge of $151 million, representing $128 million net of income tax and a diluted EPS charge of $0.08 per share, related to circumstances driven by the war, including machinery and inventory write-downs, additional allowances for receivables and the cost of PMI’s humanitarian efforts. For further details, see Item 8, Note 4. War in Ukraine. Fair Value adjustment for equity security investments – During 2022, we recorded a favorable fair value adjustment for our equity security investments in India and Sri Lanka ($0.02 per share increase in diluted EPS). For further details, see Item 8, Note 6. Related Parties - Equity Investments and Other. Costs associated with Swedish Match AB offer – During 2022, we incurred pre-tax costs associated with the Swedish Match acquisition of $116 million (representing $99 million net of income tax and a diluted EPS charge of $0.06 per share) primarily related to financing costs, derivative financials instruments and certain transaction related costs. These pre-tax costs of $116 million were recorded in marketing, administration and research costs ($115 million expense) and interest expense, net ($1 million expense) on our consolidated statement of earnings for the year ended December 31, 2022. Swedish Match AB acquisition accounting related item – Following the Swedish Match acquisition, we recorded pre-tax purchase accounting adjustments of $125 million related to the sale of acquired inventories stepped up to fair value (representing $94 million net of income tax and a diluted EPS charge of $0.06 per share). These pre-tax adjustments were recorded in cost of sales in the consolidated statements of earnings for the year ended December 31, 2022. For further details, see Item 8, Note 3. Acquisitions.Income taxes – The 2022 Tax benefit associated with Swedish Match AB financing that increased our 2022 diluted EPS by $0.13 per share in the table above was due to a deferred tax benefit for unrealized foreign currency losses on intercompany loans related to the Swedish Match acquisition financing reflected in the consolidated statements of earnings, while the underlying pre-tax foreign currency movements fully offset in the consolidated statements of earnings and were reflected as currency translation adjustments in the consolidated statements of stockholders' (deficit) equity at December 31, 2022. The 2022 Tax items that increased our 2022 diluted EPS by $0.03 per share in the table above were due to a reduction in deferred tax liabilities related to pension plan assets of $40 million. The change in the tax rate that increased our diluted EPS by $0.03 per share in the table above was primarily due to changes in income tax reserves. Currency – The unfavorable impact of $0.77 per share during the reporting period primarily results from the fluctuations of the U.S. dollar, especially against the Egyptian pound, Euro, Hungarian forint, Japanese yen and Polish zloty, partially offset by the Russian ruble and Swiss franc. This unfavorable currency movement has impacted our profitability across our primary revenue markets and local currency cost bases. Interest – The favorable impact of $0.02 per share from interest in the table above was primarily driven by the repayment of long-term debt maturing in 2021 and 2022, and higher net interest income driven by higher interest rates, partially offset by higher interest expense in connection with the Swedish Match acquisition.Operations – The increase in diluted EPS of $0.57 per share from our operations in the table above was due primarily to the following segments: •European Union: Favorable volume/mix, partly offset by unfavorable pricing, higher manufacturing costs and higher marketing, administration and research costs; •Middle East & Africa: Favorable volume/mix, favorable pricing and lower marketing, administration and research costs, partly offset by higher manufacturing costs; and 28•South & Southeast Asia: Lower marketing, administration and research costs and favorable pricing, partly offset by unfavorable volume/mix; partially offset by•East Asia & Australia: Unfavorable volume/mix and higher manufacturing costs, partly offset by lower marketing, administration and research costs;•Wellness and Healthcare: Primarily reflecting investments in research and development, as well as expenses related to employee retention programs; •Americas: Higher marketing, administration and research costs and higher manufacturing costs, partly offset by favorable pricing; and•Eastern Europe: Unfavorable volume/mix, higher manufacturing costs and higher marketing, administration and research costs, partly offset by favorable pricing. For further details, see the Consolidated Operating Results and Operating Results by Business Segment sections of the following Discussion and Analysis. Discussion and Analysis Critical Accounting Estimates Item 8, Note 2. Summary of Significant Accounting Policies to our consolidated financial statements includes a summary of the significant accounting policies and methods used in the preparation of our consolidated financial statements. In most instances, we must use a particular accounting policy or method because it is the only one that is permitted under U.S. GAAP.The preparation of financial statements requires that we use estimates and assumptions that affect the reported amounts of our assets, liabilities, net revenues and expenses, as well as our disclosure of contingencies. If actual amounts differ from previous estimates, we include the revisions in our consolidated results of operations in the period during which we know the actual amounts. Historically, aggregate differences, if any, between our estimates and actual amounts in any year have not had a significant impact on our consolidated financial statements.The selection and disclosure of our critical accounting estimates have been discussed with our Audit Committee. The following is a discussion of the more significant assumptions, estimates, accounting policies and methods used in the preparation of our consolidated financial statements:Acquisitions - PMI accounts for business combinations using the acquisition method of accounting. PMI allocates the purchase price of an acquired business to the assets acquired and liabilities assumed based upon their estimated fair values at the acquisition date with the excess recorded as Goodwill. The fair value of the applicable assets acquired and liabilities assumed is determined through established valuation techniques, such as the income, cost or market approach. PMI may utilize third-party valuation experts to assist in the fair value determination of certain assets acquired and liabilities assumed. The determination of fair value requires management to make judgements and may involve the use of significant estimates, including assumptions with respect to estimated projected revenue growth, future cash flows, terminal growth rates, useful economic lives of intangible assets acquired, discount rates, royalty rates and other factors. Certain acquired intangibles are expected to have indefinite lives based on their history and PMI’s intent to continue to support and build the intangible. Although PMI believes its estimates of fair value are reasonable, actual financial results could differ from those estimates. Changes in assumptions related to future financial results or other underlying assumptions could have a significant impact on the determination of the fair value of the intangible assets acquired. See Item 8, Note 3. Acquisitions to our consolidated financial statements for details of the critical accounting estimates relevant to the business combinations in the periods presented in this Form 10-K. Revenue Recognition - We recognize revenue as performance obligations are satisfied. Our primary performance obligation is the distribution and sales of cigarettes and smoke-free products, including heat-not-burn, vapor and oral nicotine products. Our performance obligations are typically satisfied upon shipment or delivery to our customers. PMI estimates the cost of sales returns based on historical experience, and these estimates are immaterial. Estimated costs associated with warranty programs for IQOS devices are generally provided for in cost of sales in the period the related revenues are recognized, based on a number of factors, including historical experience, product failure rates and warranty policies. The transaction price is typically based on the amount 29billed to the customer and includes estimated variable consideration where applicable. Such variable consideration is typically not constrained and is estimated based on the most likely amount that PMI expects to be entitled to under the terms of the contracts with customers, historical experience of discount or rebate redemption, where relevant, and the terms of any underlying discount or rebate programs, which may change from time to time as the business and product categories evolve.Inventories - Our inventories are valued at the lower of cost or market based upon assumptions about future demand and market conditions. The valuation of inventory also requires us to estimate obsolete and excess inventory. We perform regular reviews of our inventory on hand, as well as our future purchase commitments with our suppliers, considering multiple factors, including demand forecasts, product life cycle, current sales levels, pricing strategy and cost trends. If our review indicates that inventories of raw materials, components or finished products have become obsolete or are in excess of anticipated demand or that inventory cost exceeds net realizable value, we may be required to make adjustments that will impact the results of operations. Goodwill and Non-Amortizable Intangible Assets Valuation - We test goodwill and non-amortizable intangible assets for impairment annually or more frequently if events occur that would warrant such review. While PMI has the option to perform a qualitative assessment for both goodwill and non-amortizable intangible assets to determine if it is more likely than not that an impairment exists, PMI elects to perform the quantitative assessment for our annual impairment analysis. The impairment analysis involves comparing the fair value of each reporting unit or non-amortizable intangible asset to the carrying value. If the carrying value exceeds the fair value, goodwill or a non-amortizable intangible asset is considered impaired. To determine the fair value of goodwill, we primarily use the market approach using earnings multiples of comparable global companies within the tobacco industry, supported by a discounted cash flow model. At December 31, 2022, the carrying value of our goodwill was $19.7 billion, which is related to ten geographical reporting units, each of which consists of a group of markets with similar operating and economic characteristics, Wellness and Healthcare business, Vectura Fertin Pharma and our 2022 acquisition. The acquisition of Swedish Match in 2022 is considered a separate operating segment. For additional information, see Item 8, Note 3. Acquisitions. The estimated fair value of each of our ten geographical reporting units, Wellness and Healthcare business and Swedish Match exceeded the carrying value as of December 31, 2022. To determine the fair value of non-amortizable intangible assets, we primarily use a discounted cash flow model applying the relief-from-royalty method. We concluded that the fair value of our non-amortizable intangible assets exceeded the carrying value. These discounted cash flow models include management assumptions relevant for forecasting operating cash flows, which are subject to changes in business conditions, such as volumes and prices, costs to produce, discount rates and estimated capital needs. Management considers historical experience and all available information at the time the fair values are estimated, and we believe these assumptions are consistent with the assumptions a hypothetical marketplace participant would use. Since the March 28, 2008, spin-off from Altria Group, Inc., we have not recorded a charge to earnings for an impairment of goodwill or non-amortizable intangible assets. Marketing Costs - We incur certain costs to support our products through programs that include advertising, marketing, consumer engagement and trade promotions. The costs of our advertising and marketing programs are expensed in accordance with U.S. GAAP. Recognition of the cost related to our consumer engagement and trade promotion programs contain uncertainties due to the judgment required in estimating the potential performance and compliance for each program. For volume-based incentives provided to customers, management continually assesses and estimates, by customer, the likelihood of the customer's achieving the specified targets, and records the reduction of revenue as the sales are made. For other trade promotions, management relies on estimated utilization rates that have been developed from historical experience. Changes in the assumptions used in estimating the cost of any individual marketing program would not result in a material change in our financial position, results of operations or operating cash flows. Employee Benefit Plans - As discussed in Item 8, Note 14. Benefit Plans to our consolidated financial statements, we provide a range of benefits to our employees and retired employees, including pensions, postretirement health care and postemployment benefits (primarily severance). We record annual amounts relating to these plans based on calculations specified by U.S. GAAP. These calculations include various actuarial assumptions, such as discount rates, assumed rates of return on plan assets, compensation increases, mortality, turnover rates and health care cost trend rates. We review actuarial assumptions on an annual basis and make modifications to the assumptions based on current rates and trends when it is deemed appropriate to do so. As permitted by U.S. GAAP, any effect of the modifications is generally amortized over future periods. We believe that the assumptions utilized in calculating our obligations under these plans are reasonable based upon our historical experience and advice from our actuaries. Weighted-average discount rate assumptions for pension and postretirement plan obligations at December 31, 2022 and 2021 are as follows:20222021Pension plans3.03%0.86%Postretirement plans5.89%3.08%30We anticipate that assumption changes will decrease 2023 pre-tax pension and postretirement expense to approximately $91 million as compared with approximately $152 million in 2022, excluding amounts related to employee severance and early retirement programs. The anticipated decrease is primarily due to lower amortization of unrecognized actuarial losses of $168 million, coupled with lower service cost of $74 million, partially offset by higher interest cost of $167 million and other movements of $14 million.Weighted-average expected rate of return and discount rate assumptions have a significant effect on the amount of expense reported for the employee benefit plans. A fifty-basis-point decrease in our discount rate would increase our 2023 pension and postretirement expense by approximately $40 million, and a fifty-basis-point increase in our discount rate would increase our 2023 pension and postretirement expense by approximately $1 million. Similarly, a fifty-basis-point decrease (increase) in the expected return on plan assets would increase (decrease) our 2023 pension expense by approximately $37 million. Income Taxes - Income tax provisions for jurisdictions outside the United States, as well as state and local income tax provisions, are determined on a separate company basis, and the related assets and liabilities are recorded in our consolidated balance sheets.The extent of our operations involves dealing with uncertainties and judgments in the application of complex tax regulations in a multitude of jurisdictions. The final taxes paid are dependent upon many factors, including negotiations with taxing authorities in various jurisdictions and resolution of disputes arising from federal, state, and international tax audits. In accordance with the authoritative guidance for income taxes, we evaluate potential tax exposures and record tax liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes will be due. We adjust these reserves in light of changing facts and circumstances; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. If our estimate of tax liabilities proves to be less than the ultimate assessment, an additional charge to expense would generally result. If payment of these amounts ultimately proves to be less than the recorded amounts, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary.We are required to assess the likelihood of recovering deferred tax assets against future sources of taxable income. If we determine, using all available evidence, that we do not reach the more likely than not threshold for recovery, a valuation allowance is recorded. Significant judgment is required in determining the need for and amount of valuation allowances for deferred tax assets including estimates of future taxable income in the applicable jurisdictions and the feasibility of on-going tax planning strategies, as applicable. The effective tax rates used for interim reporting are based on our full-year geographic earnings mix projections. Changes in currency exchange rates, earnings mix by taxing jurisdiction or future regulatory developments may have an impact on the effective tax rates. Significant judgment is required in determining income tax provisions and in evaluating tax positions. For further details, see Item 8, Note 12. Income Taxes to our consolidated financial statements.Hedging - As discussed below in “Market Risk,” we use derivative financial instruments principally to reduce exposures to market risks resulting from fluctuations in foreign currency exchange and interest rates by creating offsetting exposures. For derivative contracts that are designated and qualify as fair value hedges the gain or loss on the derivative, as well as the offsetting gain or loss on the hedged items attributable to the hedged risk, is recognized in the consolidated statement of earnings. For our other derivatives to which we have elected to apply hedge accounting, gains and losses on these derivatives are initially deferred in accumulated other comprehensive losses on the consolidated balance sheet and recognized in the consolidated statement of earnings into the same line item as the impact of the underlying transaction and in the periods when the related hedged transactions are also recognized in operating results. If we had elected not to use the hedge accounting provisions, gains (losses) deferred in stockholders’ (deficit) equity would have been recorded in our net earnings for these derivatives.Contingencies - As discussed in Item 8, Note 18. Contingencies, to our consolidated financial statements, legal proceedings covering a wide range of matters are pending or threatened against us, and/or our subsidiaries, and/or our indemnitees in various jurisdictions. We and our subsidiaries record provisions in the consolidated financial statements for pending litigation when we determine that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. The variability in pleadings in multiple jurisdictions, together with the actual experience of management in litigating claims, demonstrate that the monetary relief that may be specified in a lawsuit bears little relevance to the ultimate outcome. Much of the tobacco-related litigation is in its early stages, and litigation is subject to uncertainty. At the present time, except as stated otherwise in Item 8, Note 18. Contingencies, while it is reasonably possible that an unfavorable outcome in a case may occur, after assessing the information available to it: (i) management has not concluded that it is probable that a loss has been incurred in any of the pending tobacco-related cases; (ii) management is unable to estimate the possible loss or range of loss for any of the pending tobacco-related cases; and (iii) accordingly, no estimated loss has been accrued in the consolidated financial statements for unfavorable outcomes in these cases, if any. Legal defense costs are expensed as incurred.31Consolidated Operating Results Our net revenues and operating income by segment were as follows: (in millions)202220212020Net RevenuesEuropean Union$12,119 $12,275 $10,702 Eastern Europe3,725 3,544 3,378 Middle East & Africa3,901 3,293 3,088 South & Southeast Asia4,395 4,396 4,396 East Asia & Australia5,132 5,953 5,429 Americas 1,903 1,843 1,701 Swedish Match316 — — Wellness and Healthcare271 101 — Net revenues$31,762 $31,405 $28,694 Operating Income (Loss)European Union$5,788 $6,119 $5,098 Eastern Europe1,166 1,213 871 Middle East & Africa1,758 1,146 1,026 South & Southeast Asia1,459 1,506 1,709 East Asia & Australia1,919 2,556 2,400 Americas 436 487 564 Swedish Match(22)— — Wellness and Healthcare(258)(52)— Operating income$12,246 $12,975 $11,668 Items affecting the comparability of results from operations were as follows: •Charges related to the war in Ukraine - See Item 8, Note 4. War in Ukraine for details of the $151 million pre-tax charges in the Eastern Europe segment for the year ended December 31, 2022.•Swedish Match AB acquisition accounting related item - See Item 8, Note 3. Acquisitions for details of the $125 million pre-tax purchase accounting adjustments related to the sale of acquired inventories stepped up to fair value included in the Swedish Match segment for the year ended December 31, 2022. •Impairment of intangibles - See Item 8, Note 5. Goodwill and Other Intangible Assets, net for the details of the $112 million pre-tax impairment charge included in the Wellness and Healthcare segment within the operating income table above for the year ended December 31, 2022.•Asset impairment and exit costs - See Item 8, Note 20. Asset Impairment and Exit Costs for details of the $216 million and $149 million pre-tax charges for the year ended December 31, 2021 and 2020, respectively, as well as a breakdown of these costs by segment. •Saudi Arabia customs assessments - See Item 8, Note 18. Contingencies for the details of the $246 million reduction in net revenues of combustible tobacco products included in the Middle East & Africa segment for the year ended December 31, 2021. •Asset acquisition cost - See Item 8, Note 3. Acquisitions for the details of the $51 million pre-tax charge associated with the asset acquisition of OtiTopic, Inc. included in the Wellness and Healthcare segment within the operating income table above for the year ended December 31, 2021.•Brazil indirect tax credit - Following a final and enforceable decision by the highest court in Brazil in October 2020, PMI recorded a gain of $119 million for tax credits representing overpayments of indirect taxes for the period from March 2012 through December 2019; these tax credits were applied to tax liabilities in Brazil during 2021. This amount was included as a 32reduction in marketing, administration and research costs in the consolidated statements of earnings for the year ended December 31, 2020 and was included in the operating income of the Americas segment. An additional amount of overpaid indirect taxes of approximately $90 million is dependent on the outcome of a challenge by the local tax authority. Our net revenues by product category were as follows: PMI Net Revenues by Product Category(in millions)202220212020Combustible tobacco productsEuropean Union$7,212 $8,211 $8,052 Eastern Europe2,410 2,240 2,250 Middle East & Africa3,567 3,110 3,005 South & Southeast Asia4,372 4,385 4,395 East Asia & Australia2,138 2,414 2,468 Americas1,804 1,706 1,577 Swedish Match70 — — Total combustible tobacco products21,572 22,067 21,747 Smoke-free productsSmoke-free products excluding Wellness and Healthcare:European Union4,907 4,064 2,650 Eastern Europe1,315 1,304 1,128 Middle East & Africa334 183 83 South & Southeast Asia23 11 1 East Asia & Australia2,994 3,539 2,961 Americas99 137 124 Swedish Match246 — — Total smoke-free products excluding Wellness and Healthcare9,919 9,237 6,947 Wellness and Healthcare271 101 — Total smoke-free products 10,190 9,338 6,947 Total PMI net revenues$31,762 $31,405 $28,694 Note: Sum of product categories or Regions might not foot to total PMI due to rounding. Following the Swedish Match acquisition and a review of PMI and Swedish Match’s combined product portfolio, PMI reclassified certain of its own products previously reported under its combustible tobacco product category to the newly created smoke-free product category to better reflect the characteristics of these products. This reclassification did not impact PMI’s segment reporting, consolidated financial position, results of operations or cash flows in any of the periods presented. For further details, see Item 8, Note 13. Segment Reporting.Net revenues related to combustible tobacco products refer to the operating revenues generated from the sale of these products, including shipping and handling charges billed to customers, net of sales and promotion incentives, and excise taxes. These net revenue amounts consist of the sale of our cigarettes and other tobacco products that are combusted. Other tobacco products primarily include roll-your-own and make-your-own cigarettes, pipe tobacco, cigars and cigarillos and do not include smoke-free products.Net revenues related to smoke-free products refer to the operating revenues generated from the sale of these products, including shipping and handling charges billed to customers, net of sales and promotion incentives, and excise taxes, if applicable. These net revenue amounts consist of the sale of all of our products that are not combustible tobacco products, such as heat-not-burn, e-vapor, and oral nicotine, also including wellness and healthcare products, as well as consumer accessories such as lighters and matches.Net revenues related to wellness and healthcare products consist of operating revenues generated from the sale of products primarily associated with inhaled therapeutics, and oral and intra-oral delivery systems that are included in the operating results of PMI's new 33Wellness and Healthcare business, Vectura Fertin Pharma.PMI's heat-not-burn products include licensed KT&G heat-not-burn products.References to "Cost/Other" in the Consolidated Financial Summary table of total PMI and the six geographical segments throughout this "Discussion and Analysis" reflects the currency-neutral variances of: cost of sales (excluding the volume/mix cost component); marketing, administration and research costs (including asset impairment and exit costs); and amortization and impairment of intangibles. “Cost/Other” also includes the currency-neutral net revenue variance, unrelated to volume/mix and price components, attributable to: fees for certain distribution rights billed to customers in certain markets in the ME&A Region, and the Saudi Arabia customs assessment net revenue adjustment.Our shipment volume by segment for cigarettes and heated tobacco units was as follows: PMI Shipment Volume (Million Units)202220212020CigarettesEuropean Union153,890 157,843163,420Eastern Europe81,460 88,69893,462Middle East & Africa134,110 127,911117,999South & Southeast Asia143,982 141,923144,788East Asia & Australia42,493 43,91345,100Americas65,973 64,58763,749Total Cigarettes621,908 624,875628,518Heated Tobacco UnitsEuropean Union39,515 28,208 19,842 Eastern Europe24,806 25,650 20,898 Middle East & Africa4,456 2,140 1,022 South & Southeast Asia469 240 36 East Asia & Australia39,391 38,162 33,862 Americas532 576 451 Total Heated Tobacco Units109,169 94,976 76,111 Cigarettes and Heated Tobacco UnitsEuropean Union193,405 186,051 183,262 Eastern Europe106,266 114,348 114,360 Middle East & Africa138,566 130,051 119,021 South & Southeast Asia144,451 142,163 144,824 East Asia & Australia81,884 82,075 78,962 Americas66,505 65,163 64,200 Total Cigarettes and Heated Tobacco Units731,077 719,851 704,629 Following the deconsolidation of our Canadian subsidiary, we continue to report the volume of brands sold by RBH for which other PMI subsidiaries are the trademark owners. These include HEETS, Next, Philip Morris and Rooftop.Heated tobacco units ("HTU") is the term we use to refer to heated tobacco consumables, which include our BLENDS, HEETS, HEETS Creations, HEETS Dimensions, HEETS Marlboro and HEETS FROM MARLBORO (defined collectively as HEETS), Marlboro Dimensions, Marlboro HeatSticks, Parliament HeatSticks, SENTIA and TEREA, as well as the KT&G-licensed brands, Fiit and Miix (outside of South Korea). Market share for HTUs is defined as the in-market sales volume for HTUs as a percentage of the total estimated industry sales volume for cigarettes and HTUs.34References to total industry, total market, our shipment volume and our market share performance reflect cigarettes and heated tobacco units, unless otherwise stated.As of 2022 and on a comparative basis, total industry volume, PMI in-market sales volume and PMI market share for the following geographies include the cigarillo category in Japan: the total international market, East Asia & Australia Region, and Japanese domestic market. References to total international market, defined as worldwide cigarette and heated tobacco unit volume excluding the United States, total industry, total market and market shares throughout this "Discussion and Analysis" are our estimates for tax-paid products based on the latest available data from a number of internal and external sources and may, in defined instances, exclude China and/or our duty free business. Estimates for total industry volume and market share in certain geographies reflect limitations on the availability and accuracy of industry data during pandemic-related restrictions.In-market sales ("IMS") is defined as sales to the retail channel, depending on the market and distribution model. Central Asia is defined as Kyrgyzstan, Mongolia, Tajikistan and Uzbekistan.North Africa is defined as Algeria, Egypt, Libya, Morocco and Tunisia.The Gulf Cooperation Council ("GCC") is defined as Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE).Southeast Europe is defined as Albania, Bosnia & Herzegovina, Kosovo, Montenegro, North Macedonia and Serbia.From time to time, PMI’s shipment volumes are subject to the impact of distributor inventory movements, and estimated total industry/market volumes are subject to the impact of inventory movements in various trade channels that include estimated trade inventory movements of PMI’s competitors arising from market-specific factors that significantly distort reported volume disclosures. Such factors may include changes to the manufacturing supply chain, shipment methods, consumer demand, timing of excise tax increases or other influences that may affect the timing of sales to customers. In such instances, in addition to reviewing PMI shipment volumes and certain estimated total industry/market volumes on a reported basis, management reviews these measures on an adjusted basis that excludes the impact of distributor and/or estimated trade inventory movements. Management also believes that disclosing PMI shipment volumes and estimated total industry/market volumes in such circumstances on a basis that excludes the impact of distributor and/or estimated trade inventory movements improves the comparability of performance and trends for these measures over different reporting periods.2022 compared with 2021 The following discussion compares our consolidated operating results for the year ended December 31, 2022, with the year ended December 31, 2021. Estimated international industry cigarette and heated tobacco unit volume (excluding China and the U.S.) of 2.6 trillion, increased by 0.2%, driven by the EU, South & Southeast Asia and Americas Regions, partly offset by the Eastern Europe, Middle East & Africa and East Asia & Australia Regions, as described in the Regional sections.Excluding Russia and Ukraine, estimated international industry volume increased by 0.9%. Our total shipment volume increased by 1.6%, driven by an increase of 14.9% for HTUs, partly offset by a 0.5% decline for cigarettes.Excluding Russia and Ukraine, our total shipment volume increased by 3.2%, reflecting increases of 21.5% and 0.8% for HTUs and cigarettes, respectively. Our total shipment volume in the Eastern Europe Region increased by 2.7%, on the same basis.For additional detail on PMI's shipment volume performance by Region, please refer to the "Total Market, PMI Shipment & Market Share Commentaries" sections for PMI's regional operating segments.35Impact of Inventory Movements The net unfavorable impact of estimated distributor inventory movements was immaterial in the year, with PMI’s total in-market sales increasing by 1.7%, or by 3.2% excluding Russia and Ukraine, both essentially in-line with the respective shipment volumes.Our total HTU in-market sales volume for the year was 106.9 billion units, or 86.4 billion units excluding Russia and Ukraine, representing growth of 15.6% and 21.4%, respectively.Our cigarette shipment volume by brand and heated tobacco unit shipment volume was as follows: PMI Shipment Volume by Brand (Million Units)20222021ChangeCigarettesMarlboro244,649 239,905 2.0 %L&M82,588 84,342 (2.1)%Chesterfield67,054 58,800 14.0 %Parliament43,999 41,621 5.7 %Philip Morris39,620 42,395 (6.5)%Others143,998 157,812 (8.8)%Total Cigarettes621,908 624,875 (0.5)%Heated Tobacco Units 109,169 94,976 14.9 %Total Cigarettes and Heated Tobacco Units731,077 719,851 1.6 %Note: Philip Morris includes Philip Morris/Dubliss.Shipment volume for our HTU brands increased, primarily driven by the EU, Middle East & Africa and East Asia & Australia Regions, partly offset by the Eastern Europe Region.Our cigarette shipment volume of the following international brands increased:•Marlboro, mainly driven by the Eastern Europe, Middle East & Africa and Americas Regions, partly offset by the EU Region;•Chesterfield, primarily driven by the Eastern Europe and South & Southeast Asia Regions, partly offset by the Middle East & Africa Region; and•Parliament, mainly driven by the Middle East & Africa Region.Our cigarette shipment volume of the following international brands decreased:•L&M, primarily due to the EU, Eastern Europe and South & Southeast Asia Regions, partly offset by the Middle East & Africa and Americas Regions; and•Philip Morris, mainly due to the Eastern Europe and Americas Regions, partly offset by the East Asia & Australia Region.The cigarette shipment volume decline for "Others" was mainly due to: Bond Street (primarily Eastern Europe) and Lark (mainly Japan and Turkey), partly offset by Dji Sam Soe (Indonesia).Excluding Russia and Ukraine, our cigarette shipment volume increased by 1.8% for Marlboro, 5.6% for Chesterfield, 10.3% for Parliament and 6.3% for Philip Morris, and decreased by 0.3% for L&M.36International Share of Market (Excluding China and the United States)20222021Change (pp)Total International Market Share (1) 27.6 %27.2 %0.4 Cigarettes23.6 %23.7 %(0.1)HTU4.1 %3.5 %0.6 Cigarette over Cigarette Market Share (2)24.9 %24.8 %0.1 (1) Defined as PMI's cigarette and heated tobacco unit in-market sales volume as a percentage of total industry cigarette and heated tobacco unit sales volume, excluding China and the U.S., including cigarillos in Japan(2) Defined as PMI's cigarette in-market sales volume as a percentage of total industry cigarette sales volume, excluding China and the U.S., including cigarillos in JapanNote: Sum of share of market by product categories might not foot to total due to roundingsInternational Share of Market (Excluding China and the United States, as well as Russia and Ukraine) 20222021Change (pp)Total International Market Share (1) 27.3 %26.7 %0.6 Cigarettes23.7 %23.7 %— HTU3.6 %3.0 %0.6 Cigarette over Cigarette Market Share (2)24.9 %24.6 %0.3 (1) Defined as PMI's cigarette and heated tobacco unit in-market sales volume as a percentage of total industry cigarette and heated tobacco unit sales volume, excluding China and the U.S., including cigarillos in Japan(2) Defined as PMI's cigarette in-market sales volume as a percentage of total industry cigarette sales volume, excluding China and the U.S., including cigarillos in JapanNote: Sum of share of market by product categories might not foot to total due to roundings37Key Market Data Key market data regarding total market size, our shipments and market share were as follows: PMI Shipments (billion units)PMI Market Share (%)(1)MarketTotal Market (billion units) TotalCigaretteHeated Tobacco UnitTotalHeated Tobacco Unit202220212022202120222021202220212022202120222021Total (2)2,626.42,620.5731.1719.9621.9624.9109.295.027.627.24.13.5European UnionFrance32.534.314.015.213.715.00.20.243.643.90.70.7Germany70.374.128.228.624.826.33.42.340.138.64.83.1Italy72.870.440.838.628.629.712.38.954.153.014.611.5Poland55.749.321.718.417.115.34.53.138.937.38.26.3Spain44.642.713.613.212.712.60.90.530.031.11.71.2Eastern EuropeRussia208.9216.864.768.849.352.515.416.331.131.77.67.4Middle East & AfricaEgypt93.693.421.019.520.019.21.00.222.220.70.80.2Turkey117.2125.156.155.756.155.7——47.944.5——South & Southeast Asia Indonesia309.6296.286.882.886.882.8——28.028.0——Philippines51.855.232.234.432.034.20.20.262.162.30.40.3East Asia & Australia Australia8.99.73.03.13.03.1——33.432.3——Japan (2)148.3150.555.555.221.122.134.433.137.635.723.621.3South Korea72.671.713.914.19.49.44.54.719.219.76.26.5AmericasArgentina30.330.019.319.919.319.9——63.866.3——Mexico32.231.921.020.520.820.40.10.165.164.10.40.3(1) Market share estimates are calculated using IMS data(2) Total market and market share estimates include cigarillos in Japan38Financial SummaryFinancial Summary -Years Ended December 31,ChangeFav./(Unfav.)VarianceFav./(Unfav.)20222021TotalExcl.Curr. & Acquis.TotalCur-rencyAcqui-sitionsPriceVol/MixCost/Other(in millions)Net Revenues (1)$ 31,762 $ 31,405 1.1 %8.0 %$357 $(2,656)$515 $528 $1,719 $251 Cost of Sales (2)(11,402)(10,030)(13.7)%(16.5)%(1,372)695 (414)— (1,089)(564)Marketing, Administration and Research Costs (3)(8,114)(8,400)3.4 %0.3 %286 454 (197)— — 29 Operating Income$ 12,246 $ 12,975 (5.6)%6.7 %$(729)$(1,507)$(96)$528 $630 $(284)(1) Favorable Cost/Other variance includes a $246 million reduction in net revenues in 2021 related to the Saudi Arabia customs assessments. For more details, see Item 8, Note 18. Contingencies.(2) Cost/Other variance includes charges in 2022 of $112 million related to an impairment charge of intangible assets, $62 million related to the war in Ukraine and $125 million of Swedish Match AB acquisition accounting related item. For more details, Item 8, see Note 3. Acquisitions, Note 4. War in Ukraine and Note 5. Goodwill and Other Intangible Assets, net. (3) Cost/Other variance includes charges in 2022 of $89 million related to the war in Ukraine and $115 million in 2022 related to costs associated with the Swedish Match AB offer, offset by charges in 2021 of $216 million related to asset impairment and exit costs and $51 million in 2021 associated with the asset acquisition cost of OtiTopic, Inc. For more details, see Item 8, Note 3. Acquisitions, Note 4. War in Ukraine and Note 20. Asset Impairment and Exit Costs. Net revenues, excluding currency and acquisitions, increased by 8.0%, mainly reflecting: favorable volume/mix, primarily driven by higher HTU volume and device volume, partly offset by lower cigarette volume and unfavorable device mix, cigarette mix and HTU mix; a favorable pricing variance, driven by higher combustible tobacco pricing, partly offset by lower device pricing and lower HTU (net) pricing; and a favorable comparison related to the Saudi Arabia customs assessments of $246 million in 2021, shown in "Cost/Other". In 2022, Russia and Ukraine accounted for around 8% of PMI's total net revenues. The unfavorable currency in net revenues was due primarily to the Egyptian pound, Euro, Japanese yen, Philippine peso, Polish zloty and Turkish lira, partly offset by the Russian ruble. Net revenues include $10.2 billion in 2022 and $9.3 billion in 2021 related to the sale of smoke-free products. In 2022, IQOS devices accounted for approximately 5% of our full year smoke-free net revenues both including and excluding Russia and Ukraine.Operating income decreased by 5.6%. Operating income, excluding currency and acquisitions, increased by 6.7%, which included: favorable comparisons versus the prior year period related to the 2021 Saudi Arabia customs assessments of $246 million (as noted above for net revenues), 2021 asset impairment and exit costs of $216 million and 2021 asset acquisition cost of $51 million, partly offset by the impact of 2022 costs associated with the Swedish Match AB offer of $115 million, higher amortization and impairment of intangibles (primarily $112 million related to impairment charges in 2022), 2022 charges related to the war in Ukraine of $151 million and $125 million of Swedish Match AB acquisition accounting related item in 2022. In addition to these items, operating income was impacted by: a favorable volume/mix, primarily driven by higher HTU volume, partly offset by lower cigarette volume, unfavorable cigarette mix, HTU mix and device mix, and the unfavorable impact on profitability of higher device volume; and a favorable pricing variance; partially offset by higher manufacturing costs (primarily due to higher logistics costs and other inflationary impacts, partly offset by productivity); and higher marketing, administration and research costs. As reduced-risk products grow as a proportion of our business, notably for IQOS ILUMA where unit costs of devices and both the unit costs and weight of consumables are not yet fully optimized, a temporary dilutive margin impact is likely to continue in the coming quarters.Like many other global companies, we are facing significant inflationary forces in the world economy. Inflationary pressures are growing as we renew pricing arrangements, notably for certain direct materials, wages, energy, and transportation costs. These inflationary pressures, including margin pressure from inflation as well as the cost of capital, could continue to grow in the upcoming quarters.39Interest expense, net, of $588 million decreased by $40 million (6.4%) primarily driven by the repayment of long-term debt maturing in 2021 and 2022 and higher net interest income driven by higher interest rates, partially offset by higher interest expense in connection with the Swedish Match acquisition.Our effective tax rate decreased by 2.5 percentage points to 19.3%. We estimate that our 2023 effective tax rate will be approximately 20.5% to 21.5%, excluding discrete tax events. For further details, see Item 8, Note 12. Income Taxes. Net earnings attributable to PMI of $9.0 billion decreased by $0.1 billion or 0.7%. This decrease was due primarily to lower operating income as discussed above, partially offset by a lower effective income tax rate. Basic EPS of $5.82 and diluted EPS of $5.81 decreased by 0.2% and 0.3%, respectively. Excluding an unfavorable currency impact of $0.77, diluted EPS increased by 12.9%. 2021 compared with 2020 For a discussion comparing our consolidated operating results for the year ended December 31, 2021, with the year ended December 31, 2020, refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Discussion and Analysis - Consolidated Operating Results in our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the U.S. Securities and Exchange Commission on February 11, 2022. This section is incorporated by reference into this Annual Report on Form 10-K for the year ended December 31, 2022.Operating Results by Business Segment Business Environment Taxes, Legislation, Regulation and Other Matters Regarding the Manufacture, Marketing, Sale and Use of Tobacco ProductsThe tobacco industry and our company face a number of challenges that may adversely affect our business, volume, results of operations, cash flows and financial position. These challenges, which are discussed below and in “Cautionary Factors That May Affect Future Results,” include:•regulatory restrictions on our products, including restrictions on the packaging, marketing, and sale of tobacco or other nicotine-containing products or related devices that could reduce our competitiveness, eliminate our ability to communicate with adult consumers, or even ban certain of our products;•fiscal challenges, such as excessive excise tax increases and discriminatory tax structures;•illicit trade in cigarettes and other tobacco and nicotine-containing products, including counterfeit, contraband and so-called "illicit whites"; •intense competition, including from non-tax paid volume by certain local manufacturers;•pending and threatened litigation as discussed in Item 8, Note 18. Contingencies; and•governmental investigations.Regulatory Restrictions: The tobacco industry operates in a highly regulated environment. The well-known risks of smoking have led regulators to impose significant restrictions and high excise taxes on cigarettes. Much of the regulation that shapes the business environment in which we operate is driven by the FCTC, which entered into force in 2005. The FCTC has as its main objective to establish a global agenda for tobacco regulation, with the purpose of reducing tobacco use. To date, 182 countries and the European Union are Parties to the FCTC. The treaty requires Parties to have in place various tobacco control measures and recommends others. The FCTC governing body, the Conference of the Parties (“CoP”), has also adopted non-binding guidelines and policy recommendations related to certain articles of the FCTC that go beyond the text of the treaty. In October 2018, the CoP recognized the need for more scientific assessment and improved reporting to define policy on heated tobacco products. Similar to its previous policy recommendations on e-cigarettes, the CoP invited countries to regulate, restrict or prohibit heated tobacco products, as appropriate under their national laws. Prior to CoP 9 that took place in November 2021, the WHO and the WHO FCTC Secretariat published two reports on novel and emerging tobacco products. The reports were noted by CoP 9 and related substantive discussions and decisions were deferred to CoP 10, currently scheduled for 2023. It is not possible to predict whether or to what extent measures recommended by the WHO's reports will be implemented as the reports are not binding to the WHO Member States.40We believe that when better alternatives to cigarettes exist, the discussion should not be whether these alternatives should be made available to the more than one billion people who smoke today, but how fast, and within what regulatory framework to maximize their adoption while minimizing unintended use. Therefore, we advocate for regulatory frameworks that are based on a continuum of risk where non-combustible products fall below combustible cigarettes. Product regulation should include measures that encourage and accelerate switching to non-combustible products, for example, by allowing adult consumers who would not otherwise quit to receive truthful and non-misleading information about such products to enable them to make informed decisions and by applying uniform product standards to enable manufacturers to demonstrate the reduction in harmful and potentially harmful constituents, as well as the absence of combustion. Regulation should also include specific rules for ingredients, labeling and consumer communication, and should ensure that the public is informed about the health risks of all combustible and non-combustible tobacco and nicotine-containing products. Importantly, regulation must include measures designed to prevent initiation by youth and non-smokers. We support mandated health warnings, minimum age laws, restrictions on advertising, and public place smoking restrictions. We also support regulatory measures that help reduce illicit trade. Certain measures are discussed in more detail below and in the Reduced-Risk Products (RRPs) section.Fiscal Challenges: Excessive and disruptive excise, sales and other tax increases and discriminatory tax structures are expected to continue to have an adverse impact on our profitability, due to lower consumption and consumer down-trading to non-premium, discount, other low-price or low-taxed combustible tobacco products such as fine cut tobacco and illicit cigarettes. In addition, in certain jurisdictions, some of our combustible tobacco products are subject to tax structures that discriminate against premium-price products and manufactured cigarettes. We believe that such tax policies undermine public health by encouraging consumers to turn to illicit trade, and ultimately undercut government revenue objectives, disrupt the competitive environment, and encourage criminal activity. Other jurisdictions have imposed, or are seeking to impose, levies or other taxes specifically on tobacco companies, such as taxes on revenues and/or profits. World Customs Organization Developments: In 2020, the World Customs Organization (the “WCO”) amended the harmonized system nomenclature to introduce dedicated custom codes for novel tobacco and nicotine products, including heated tobacco products, e-cigarettes and other nicotine-containing products. The amendments became effective as of January 1, 2022. These amendments are not expected to significantly impact current customs duty rates. As of December 2022, and out of 160 contracting parties to the WCO’s Harmonized System Convention, 94 contracting parties, including the EU, U.S., have notified the WCO that they have implemented the 2022 edition of the Harmonized System creating new dedicated customs codes for novel tobacco and nicotine products.EU Tobacco Products Directive: In April 2014, the EU adopted a significantly revised TPD, which entered into force in May 2016. All member states have adopted laws transposing the TPD. The TPD sets forth a comprehensive set of regulatory requirements for tobacco products, including:•health warnings covering 65% of the front and back panels of cigarette packs, with an option for member states to further standardize tobacco packaging, including the introduction of plain packaging;•a ban on characterizing flavors in some tobacco products, with a transition period for menthol that expired in May 2020; •security features and tracking and tracing measures that became effective in May 2019; and•a framework for the regulation of novel tobacco products and e-cigarettes, including requirements for health warnings and information leaflets, a prohibition on product packaging text related to reduced risk, and the introduction of notification requirements or authorization procedures in advance of commercialization.In May 2021, the European Commission published its first report on the application of the TPD. The report identifies significant progress made due to the implementation of the TPD and where there is still room for improvement. Most notably, it finds that the EU legislation has enhanced tobacco control, contributed to protecting the health of EU citizens by providing Member States with strong rules to address the use of tobacco products in the EU. The TPD reportedly achieved the 2% reduction target of the impact assessment with decreased smoking prevalence among youth. The report also concludes that there is scope for improvement in certain areas, such as enforcement at national level, assessment of ingredients, and a better consideration for novel and emerging products.In November 2021, the European Commission published the implementation roadmap to Europe's Beating Cancer Plan (the "Plan"). According to the Plan, a revision of the TPD is planned for 2024.EU Tobacco Excise Directive ("TED"): The EU Commission is preparing a legislative proposal for the revision of the 2011 EU Tobacco Excise Directive that may include definitions and tax treatment for novel tobacco and nicotine-containing products, including heated tobacco products, e-cigarettes and nicotine pouches. The proposal, after several delays, is now expected to be published during 41the first half of 2023 and adopted by the EU Council in the course of 2024. Any final amendments to TED require unanimous agreement by all EU member states, followed by transposition of TED into national legislation. The earliest potential effective date for any changes to TED, after the transposition period, is 2025.Plain Packaging and Other Packaging Restrictions: Plain packaging legislation bans the use of branding, logos and colors on packaging other than the brand name and variant that may be printed only in specified locations and in a uniform font. To date, plain packaging laws have been adopted in certain markets in all of our operating segments, including the key markets of Australia, France, Saudi Arabia and Turkey. Some countries, such as Canada, Denmark and Israel adopted plain packaging regulations that apply to all tobacco products, including RRPs. Other countries are also considering plain packaging legislation.Some countries have adopted, or are considering adopting, packaging restrictions that could have an impact similar to plain packaging. Examples of such restrictions include standardizing the shape and size of packages, prohibiting certain colors or the use of certain descriptive phrases on packaging, and requiring very large graphic health warnings that leave little space for branding. Restrictions and Bans on the Use of Ingredients: The WHO and others in the public health community have recommended restrictions or total bans on the use of some or all ingredients in tobacco products, including menthol. Broad restrictions and ingredient bans would require us to reformulate our American blend tobacco products and could reduce our ability to differentiate these products in the market in the long term. In many countries, menthol bans would eliminate the entire category of mentholated tobacco products. The European Union banned cigarettes and roll-your-own tobacco products with characterizing flavors. Other tobacco products, including heated tobacco products, are currently exempted from this characterizing flavor ban. However, on November 23, 2022, the European Union Commission published a delegated directive that will end this exemption. All EU Member States are required to apply the delegated directive as of October 23, 2023, and ban the use of characterizing flavors in heated tobacco products in the European Union, impacting a significant proportion of our RRP products currently sold in the European Union. While we cannot predict the ultimate impact on our business from this ban, consumer switching to non-flavored products was high in reaction to past bans on flavors in other categories and markets. We therefore believe any impact will be manageable, with consumers switching to non-flavored products partially mitigating the effect of the ban. We will actively monitor relevant developments in the European Union market. Other countries may follow the EU’s approach toward tobacco product ingredients. Turkey banned menthol as of May 2020. Broader ingredient bans have been adopted by Brazil and Canada. Bans on Display of Tobacco Products at Retail: In a number of our markets, including, but not limited to, Australia and Russia, governments have banned the display of tobacco products at the point of sale. Other countries are considering similar bans. Bans and Restrictions on Advertising, Marketing, Promotions and Sponsorships: For many years, the FCTC has called for, and countries have imposed, partial or total bans on tobacco advertising, marketing, promotions and sponsorships, including bans and restrictions on advertising on radio and television, in print and on the Internet. The FCTC's non-binding guidelines recommend that governments prohibit all forms of communication with adult smokers.Restrictions on Product Design: Some members of the public health community are calling for the further standardization of tobacco products by requiring, for example, that cigarettes have a certain minimum diameter, which would amount to a ban on slim cigarettes, or requiring the use of standardized filter and cigarette paper designs. In addition, at its meeting in November 2016, the CoP adopted non-binding guidelines recommending that countries regulate product design features that increase the attractiveness of tobacco products, such as the diameter of cigarettes and the use of flavor capsules. Restrictions on Public Smoking and Use of Nicotine-Containing Products in Public: The pace and scope of restrictions on the use of our products have increased significantly in most of our markets. Many countries around the world have adopted, or are likely to adopt, regulations that restrict or ban smoking and use of nicotine-containing products in public and/or work places, restaurants, bars and nightclubs. Some public health groups have called for, and some countries, regional governments and municipalities have adopted or proposed, bans on smoking in outdoor places, as well as bans on smoking in cars (typically, when minors are present) and private homes.Other Regulatory Issues: Some regulators are considering, or in some cases have adopted, regulatory measures designed to reduce the supply of tobacco products. These include regulations intended to reduce the number of retailers selling tobacco products by, for example, reducing the overall number of tobacco retail licenses available or banning the sale of tobacco products within specified distances of certain public facilities. Other regulators are also considering generation sales bans, under which the sale of certain tobacco or nicotine products to people born after a certain year would be prohibited. On December 13, 2022 the New Zealand parliament passed a bill introducing regulatory measures restricting the sale and supply of smoked tobacco products, including reducing the number of retail outlets licensed to sell smoked tobacco products, imposing a maximum limit of nicotine content for smoked tobacco products and prohibiting the sale of smoked tobacco products to anyone born on or after January 1, 2009. These measures are limited to smoked tobacco products and do not apply to heated tobacco products and e-cigarettes. In Mexico, a new law 42came into force on December 12, 2022 prohibiting imports and exports of certain nicotine and non-nicotine delivery and consumption systems, as well as the consumables used in those systems, including much of our RRP portfolio. On December 16, 2022, the Federal Government enacted an implementation regulation for the tobacco control law, which includes (i) a point of sale display ban of tobacco products; (ii) restrictions on where tobacco products can be consumed, and (iii) prohibition to communicate corporate social responsibility programs funded by the tobacco industry.On January 1, 2023 a law regulating the marketing of nicotine pouches went into effect in Slovakia. The regulatory framework contains a minimum purchase legal age (18 years), a nicotine limit, and a labelling requirement. On December 6, 2022 the Dutch Government published a draft bill to ban the placing on the market of nicotine pouches in the Netherlands. On December 16, 2022 a notification period to the EU Commission expired for a Belgian Royal Decree to ban nicotine pouches. Based on this decree the Belgian Government could ban the placing on the market of nicotine pouches in Belgium. In a limited number of markets, most notably Japan, we are dependent on governmental approvals that may limit our pricing flexibility.The EU Single-Use Plastics Directive, which will require tobacco manufacturers and importers to cover the costs of public collection systems for tobacco product filters, under Extended Producer Responsibility ("EPR") schemes, entered into force on July 2, 2019. To date, some member states transposed the Directive into national legislation. We expect remaining member states to transpose the EU Single-Use Plastics Directive into national legislation including EPR schemes by January 2023. While we cannot predict the impact of this initiative on our business at this time, we are monitoring developments in this area.In some countries, including in the EU, cigarettes are subject to testing, disclosure and mandatory emissions limits for tar, nicotine, carbon monoxide and other smoke constituents. In the Netherlands, several public health organizations have requested that the Dutch enforcement body enforce the requirements for maximum tar, nicotine, and carbon monoxide ("TNCO") emissions levels for cigarettes using a test method other than the method currently set forth in the EU TPD and transposed into national legislation. This request followed publication of a report by the Dutch State Institute for Public Health & Environment, which found that all cigarette brands sold in the Netherlands exceeded the maximum TNCO levels when measured under an alternative method. While the Dutch enforcement body declined the request, the applicants have challenged that decision in pending legal proceedings in the Netherlands. While we are not parties to the proceeding and cannot predict the outcome, a decision to enforce the existing TNCO ceilings in the Netherlands using an alternative test method could impact a significant portion of the manufactured cigarettes available on the market in the Netherlands and could lead to similar actions in other EU countries. Illicit Trade: Illicit tobacco trade creates a cheap and unregulated supply of tobacco products, undermines efforts to reduce smoking prevalence, especially among youth, damages legitimate businesses and intellectual property rights, stimulates organized crime, increases corruption and reduces government tax revenue. We generally estimate that, excluding China and the U.S., illicit trade may account for as much as 12% of global cigarette consumption; this includes counterfeit, contraband and the persistent problem of "illicit whites," which are cigarettes legally purchased in one jurisdiction for the sole purpose of being exported and illegally sold in another jurisdiction where they have no legitimate market. Currently, we estimate that illicit trade in the European Union accounted for approximately 8% of total cigarette consumption in 2022. A number of jurisdictions are considering actions to prevent illicit trade. In November 2012, the FCTC adopted the Protocol to Eliminate Illicit Trade in Tobacco Products (the “Protocol”), which includes supply chain control measures, such as licensing of manufacturers and distributors, enforcement of these control measures in free trade zones, controls on duty free and Internet channels and the implementation of tracking and tracing technologies. To date, 66 Parties, including the European Union, have ratified it. The Protocol came into force in September 2018. Parties must start implementing its provisions in their national legislation. In November 2021, the second Meeting of the Parties to the Protocol decided, among others, to focus on the implementation of a framework for global information sharing to combat illicit tobacco trade and enable the parties to exchange products' tracking and tracing information in a secure manner. We welcome this decision and expect that other Parties will ratify the Protocol.We devote substantial resources to help prevent illicit trade in combustible tobacco products and RRPs. For example, we engage with governments, our business partners and other stakeholders to implement effective measures to combat illicit trade and, in some instances, pursue legal remedies to protect our intellectual property rights.The tracking and tracing regulations for cigarettes and roll-your-own products manufactured or destined for the EU became effective on May 20, 2019. The effective date for other tobacco-containing products, including some of our RRPs such as heated tobacco units, is May 20, 2024. While we expect that this regulation will increase our operating expenses, we do not expect this increase to be significant.In 2009, our Colombian subsidiaries entered into an Investment and Cooperation Agreement with the national and regional governments of Colombia to promote investment in, and cooperation on, anti-contraband and anti-counterfeit efforts. The agreement 43provides $200 million in funding over a 20-year period to address issues such as combating illegal cigarette trade and increasing the quality and quantity of locally-grown tobacco.In May 2016, PMI launched PMI IMPACT, a global initiative that supports third-party projects dedicated to fighting illegal trade and related crimes such as corruption, organized criminal networks and money laundering. The centerpiece of PMI IMPACT is a council of external independent experts in the fields of law, anti-corruption and law enforcement. The experts are responsible for evaluating and approving funding proposals for PMI IMPACT grants. PMI has pledged $100 million to fund projects within PMI IMPACT over three funding rounds.Reduced-Risk Products (RRPs) Our Approach to RRPs: We recognize that smoking cigarettes causes serious diseases and that the best way to avoid the harms of smoking is never to start or to quit. Nevertheless, it is predicted that by 2025, the number of smokers will remain largely unchanged from the current estimate of 1.1 billion, despite the considerable efforts to discourage smoking. Cigarettes burn tobacco, which produces smoke. As a result of the combustion process, the smoker inhales various toxic substances. In contrast, RRPs do not burn tobacco and therefore contain significantly lower levels of harmful and potentially harmful constituents ("HPHCs") than found in cigarette smoke.For adult smokers who would otherwise continue to smoke, we believe that RRPs, while not risk-free, offer a much better consumer choice. Accordingly, our key strategic priorities are to: (i) to develop and commercialize products that present less risk of harm to adult smokers who switch to those products versus continued smoking; and (ii) educate and encourage current adult smokers who would otherwise continue to smoke to switch to those products.We recognize that this transformation from cigarettes to RRPs will take time and that the speed of transformation will depend in part upon factors beyond our control, such as the willingness of governments, regulators and other policy groups to embrace RRPs as a desired alternative to continued cigarette smoking. For as long as a significant number of adult smokers continues to smoke, responsible leadership of the category is critical. We aim to maintain our competitive position in the cigarette market through selective investment. As a leading international cigarette manufacturer, we will continue to accelerate this transformation by using our regulatory and commercial expertise and extensive commercial and distribution infrastructure as an effective platform for the commercialization of our RRPs and communication with adult smokers and trade partners about the benefits of switching to our RRPs.While seeking to remain competitive in the cigarette market, we are judiciously reallocating resources from cigarettes to RRPs and are streamlining our cigarette portfolio.We have a range of RRPs in various stages of development, scientific assessment and commercialization. We conduct rigorous scientific assessments of our RRP platforms to substantiate that they reduce exposure to HPHCs and, ultimately, that these products present, are likely to present, or have the potential to present less risk of harm to adult smokers who switch to them versus continued smoking. We draw upon a team of expert scientists and engineers from a broad spectrum of scientific disciplines and our extensive learnings of adult consumer preferences to develop and assess our RRPs. Our efforts are guided by the following key objectives:•to develop RRPs that adult smokers who would otherwise continue to smoke find to be satisfying alternatives to smoking;•for those adult smokers, our goal is to offer RRPs with a scientifically substantiated risk-reduction profile that approaches as closely as possible that associated with smoking cessation; •to substantiate the reduction of risk for the individual adult smoker and the reduction of harm to the population as a whole, based on scientific evidence of the highest standard that is made available for scrutiny and review by external independent scientists and relevant regulatory bodies; and•to advocate for the development of science-based regulatory frameworks for the development and commercialization of RRPs, including the communication of scientifically substantiated information to enable adult smokers to make better consumer choices.Our RRP Platforms: Our product development is based on the elimination of combustion via tobacco heating and other innovative systems, which we believe are the most promising path to providing a better consumer choice for those who would otherwise continue to smoke. We recognize that no single product will appeal to all adult smokers. Therefore, we are developing a portfolio of products intended to appeal to a variety of distinct adult consumer preferences.44Five PMI-developed or improved RRP platforms are in various stages of development and commercialization readiness: Platform 1 uses a precisely controlled heating device incorporating our IQOS HeatControl technology, into which a specially designed and proprietary tobacco unit is inserted and heated to generate an aerosol. We have conducted a series of clinical studies for this platform, the results of which were included in our submission to the U.S. Food and Drug Administration (“FDA”). In addition to the original version of Platform 1 which relies on a heating technology using a blade, a new version of Platform 1 is now available using induction instead of heating a blade. All studies referenced above were conducted with the blade version of Platform 1. We believe that there is full comparability between the subsequent Platform 1 versions, and therefore the data from these studies remain valid. In 2022, we also began the initial launch of a heated tobacco product using external resistive heating technology and commercialized under the BONDS brand. Platform 2 used a pressed carbon heat source which, when ignited, generates a nicotine-containing aerosol by heating tobacco. As a result of consumer testing feedback, the design of our current Platform 2 technology has been discontinued. We are assessing alternative designs for this consumer segment. Platform 3 is a product using nicotine salt that is composed of two parts: a consumable that contains a highly soluble encapsulated nicotine powder and a non-electric device that activates it. Once a consumable is inserted into the mechanical device, the nicotine powder is aerosolized and inhaled. The results of our pharmacokinetic study related to this version indicate this product's potential as an acceptable alternative to continued cigarette smoking in terms of product satisfaction. We are working on product modifications to enable switching by those adult smokers who are looking for better alternatives to cigarettes. Platform 4 covers e-vapor products, which are battery-powered devices that produce an aerosol by vaporizing a tobacco-free liquid solution. Recently, we developed a new e-liquid for our e-vapor mesh technology to deliver real tobacco taste satisfaction in an E-Vapor product liquid-using patented technology, where flavors and nicotine are extracted directly from the tobacco leaves and captured in a liquid solution, without having to add flavoring ingredients. We also entered into a licensing agreement with Kaival Brands International, LLC in June 2022 to distribute an e-vapor product, known in the U.S. as the BIDI® Stick. The agreement grants PMI certain intellectual property rights relating to the premium e-vapor device and, potentially, other newly developed devices, to permit PMI to manufacture, promote, sell, and distribute the e-vapor device and, to the extent included, other newly developed devices in international markets outside of the U.S. We have begun commercializing an improved version of the BIDI® Stick under the brand VEEV now in Canada, U.K., Serbia and Ukraine.Platform 5 covers Snus and Modern Oral Nicotine Pouches. Snus refers to dried loose tobacco, or snuff, which is consumed by sniffing the product through the nose, moist loose tobacco which is put in the mouth between the lower or upper lip and gum, and Snus pouches which contain grinded tobacco, water, salt and flavors. Modern Oral Nicotine Pouches consist of white pre-conditioned pouches containing nicotine derived from tobacco. Users place a pouch between the upper lip and gum and leave it there while the nicotine and taste are being released. At the end of the use, the user can dispose of the pouch. Nicotine pouches are inherently smoke-free as they are consumed orally, and no combustion process occurs during use. They contain primarily nicotine, flavors, and a cellulose substrate. The nicotine used in the pouches is of pharmaceutical-grade like the nicotine used in medicinal products, such as gums and inhalers, while the flavors are approved for use in food in accordance with the product quality standards for nicotine pouches developed by the Swedish Institute for Standards. In 2021, PMI acquired AG Snus as well as Fertin Pharma, two companies manufacturing and/or marketing nicotine pouches. In 2022, we significantly expanded our Platform 5 products portfolio with the acquisition of Swedish Match. The acquisition also represented an expansion of our RRP presence in the United States market, where Swedish Match's ZYN brand is the leading nicotine pouch franchise.We aim to expand our brand portfolio and market positions with additional RRPs. In addition, we are continuing to use our expertise, technology and capabilities to explore new growth opportunities beyond our current business, including products that do not contain nicotine or tobacco.After we receive the results of our scientific studies, including those mentioned above, in accordance with standard scientific practices, we share the conclusions in scientific forums and submit them for inclusion in peer-reviewed publications. The research and development expense for our smoke-free portfolio accounted for 99% of our total research and development expense for each of the three years ended December 31, 2022, 2021 and 2020. The research and development expense for the years ended December 31, 2022, 2021 and 2020, is set forth in Item 8, Note 15. Additional Information to the consolidated financial statements.45Commercialization of RRPs: We are developing a multicategory product approach and tailoring our commercialization strategy to the characteristics of each specific market. We focus our commercialization efforts on consumer retail experience, guided consumer trials and customer care, and increasingly, digital communication programs and e-commerce. In order to accelerate switching to our Platform 1 products, our initial market introductions typically entail one-to-one consumer engagement (in person or by digital means) and device discounts. These initial commercialization efforts require substantial investment, which we believe will moderate over time and further benefit from the increased use of digital engagement capabilities. During the COVID-19 pandemic, we accelerated our investments in, and pivot to, digital consumer engagement.As of December 31, 2022, PMI's smoke-free products were available for sale in 73 markets. In 2014, we introduced our Platform 1 product in pilot city launches in Nagoya, Japan, and in Milan, Italy. Since then, we have continuously expanded our commercialization activities. Data shows that only a very small percentage of adult smokers who convert to our Platform 1 product switch back to cigarettes.We have integrated the production of our heated tobacco units into a number of our existing manufacturing facilities, are progressing with our plans to build manufacturing capacity for our other RRP platforms, continue to optimize our manufacturing infrastructure and expand our commercialization activities to new products and markets. We discuss certain risks related to the commercialization and supply of our RRP portfolio in Item 1.A. Risk Factors.We discuss product warranties in more detail in Item 8, Note 7. Product Warranty. The significance of warranty claims is dependent on a number of factors, including device version mix, product failure rates, logistics and service delivery costs, and warranty policies, and may increase with the number of devices sold. On October 20, 2022, PMI announced that it had reached an agreement with Altria Group, Inc. to end the companies' commercial relationship covering Platform 1 in the U.S. as of April 30, 2024. Thereafter, PMI will have the full rights to commercialize Platform 1 in the U.S.- the world’s largest smoke-free market, as of April 30, 2024. This agreement provides a clear path to fulfilling Platform 1 international success in a market where around 31 million adults continue to smoke. Our near-term planned commercialization efforts for the other PMI-developed RRP platforms are as follows: •In late 2022, we began commercializing our BONDS product in the Philippines and Colombia.•Following the consumer test conducted in 2020, and the results of the product use and adaptation study described above, we are incorporating our learnings into our plans to improve our Platform 3 product.•We started commercializing a new version of IQOS MESH in Canada, Croatia, the Czech Republic, Finland, France, Greece, Italy, Ukraine, New Zealand and the Slovak Republic under the IQOS VEEV or VEEV brand names.•We launched a Platform 5 product in Sweden in January 2022, and have since launched it in ten additional markets, that is a reformulated version of the already commercialized nicotine pouches bearing the Shiro brand by our newly acquired affiliate AG Snus. In addition, Swedish Match’s commercialization efforts in 2022 included the launch of several variants of existing snus and nicotine pouch brands in different markets, such as the launch of various ZYN variants in multiple markets, as well as the new Volt Pearls nicotine pouch product in Denmark, Iceland and Sweden.RRP Regulation and Taxation: RRPs contain nicotine and are not risk-free. As we describe in more detail above, we support science-based regulation and taxation of RRPs, and believe that regulation and taxation should differentiate between cigarettes and products that present, are likely to present, or have the potential to present less risk of harm to adult smokers who switch to these products versus continued smoking and should recognize a continuum of risk for tobacco and other nicotine-containing products. Regulation, as well as industry practices, should reflect the fact that youth should not consume nicotine in any form.Some governments have banned or are seeking to ban or severely restrict emerging tobacco and nicotine-containing products such as our RRPs and communication of truthful and non-misleading information about such products. These regulations might foreclose or unreasonably restrict adult consumer access even to products that might be shown to be a better consumer choice than continuing to smoke. During the COVID-19 pandemic, some governments have been and may continue to be 46temporarily unable to focus on the development of science-based regulatory frameworks for the development and commercialization of RRPs or on the enforcement or implementation of regulations that are significant to our business.We oppose blanket bans and unreasonable restrictions of products that have the potential to present less risk of harm compared to continued smoking. By contrast, we support regulation that sets clear standards for all RRP categories and propels innovation to benefit adult smokers who would otherwise continue to smoke. In the United States, an established regulatory framework for assessing “Modified Risk Tobacco Products” and “New Tobacco Products” exists under the jurisdiction of the FDA. We submitted to the FDA a Modified Risk Tobacco Product Application (“MRTPA”) for our Platform 1 product in December 2016, and a Premarket Tobacco Product Application (“PMTA”) for our Platform 1 product in March 2017. On April 30, 2019, the FDA determined that a version of our Platform 1 product, namely, IQOS 2.4 and three related consumables, is appropriate for the protection of public health ("APPH") and authorized it for sale in the United States. The FDA’s decision followed its comprehensive assessment of our PMTA. On December 7, 2020, the FDA reached the same determination for the IQOS 3 device and authorized that version of our Platform 1 product for sale in the United States.On July 7, 2020, the FDA determined that the available scientific evidence demonstrates that the issuance of an exposure modification order would be appropriate for the promotion of public health and authorized the marketing of a version of our Platform 1 product, namely IQOS 2.4 and three related consumables, as a "modified risk tobacco product." The FDA authorized the marketing of this product in the U.S. with the following information:"AVAILABLE EVIDENCE TO DATE:•the IQOS system heats tobacco but does not burn it. •this significantly reduces the production of harmful and potentially harmful chemicals. •scientific studies have shown that switching completely from conventional cigarettes to the IQOS system significantly reduces your body’s exposure to harmful or potentially harmful chemicals."We must request and receive authorization from the FDA in order to continue marketing this product with the same modified exposure information after the present order expires in four years from the date of the orders.On March 18, 2021, we submitted to the FDA a supplemental MRTPA ("sMRTPA") for IQOS 3 requesting authorization to market this version of the device as a Modified Risk Tobacco Product with reduced exposure information like IQOS 2.4. In June 2021, the FDA formally accepted and filed our sMRTPA for substantive scientific review, following a period for the public to provide comments on our application. The FDA authorized our sMRTPA for IQOS 3 by issuing a Modified Risk Granted Order – Exposure Modification on March 11, 2022.There are two types of MRTP orders the FDA may issue: a “risk modification” order or an “exposure modification” order. We had requested both types of orders for IQOS 2.4 and an initial selection of 3 consumables' variants. After review, the FDA determined that the evidence did not support issuing a "risk modification" order at this time but that it did support issuing an "exposure modification" order for the product. This determination included a finding that issuance of the exposure modification order is expected to benefit the health of the population as a whole. We also received an exposure modification order for IQOS 3.On April 29, 2022, we submitted the Annual Report for the IQOS Tobacco Heating System ("THS") to the US Food and Drug Administration. The report included a systematic review of the literature covering publications related to the IQOS THS between March 1, 2021 and February 28, 2022. 226 publications were identified, of which 132 were in English and contained original research or data on Heated Tobacco Products (27 from PMI or other tobacco manufacturers and 105 from independent researchers). The report concludes that, although the scientific evidence continues to develop and evolve, the extensive data reviewed confirms that while HTPs are not risk-free, the risks of HTPs are significantly reduced for both users and non-users against the well-proven risks of continued smoking, and therefore continue to support the APPH status of IQOS THS.We look forward to working with the FDA to provide any additional information they may require in order to market this product with reduced risk claims.The FDA’s PMTA and MRTP orders do not mean that the agency “approved” our Platform 1 product. These authorizations are subject to strict marketing, reporting and other requirements, and are not a guarantee that the product will remain authorized, particularly if there is a significant uptake in youth or non-smoker initiation. The FDA will monitor the marketing of the product.47On September 29, 2021, the International Trade Commission ("ITC") issued its Final Determination ("FD"), Limited Exclusion Order ("LEO") and Cease and Desist Order ("CDO"). The ITC upheld the finding of infringement in the FD and found a subsequent violation. The ITC issued a LEO prohibiting the importation of infringing tobacco heating articles and components thereof and CDOs against Philip Morris USA, Inc. and Altria Client Services, LLC, which went into effect at the end of the 60-day Presidential review period on November 28, 2021. We have appealed the patent issues. Furthermore, lawsuits based on the same patent families have been repeatedly and universally rejected in European courts and the European Patent Office. The decision has no bearing outside the United States. For further details, see Item 8, Note 18. Contingencies to our consolidated financial statements. Some states and municipalities in the U.S. have introduced severe restrictions for the sale of certain e-cigarettes and tobacco products, including those authorized by the FDA. We believe that such restrictions on FDA-authorized products will not advance public health and will unreasonably limit adult consumer access to products that are shown to be a better alternative to continued smoking.In March 2020, the FDA issued a final rule to require new text and graphic health warnings on cigarette packs and advertisements. Heated tobacco products are technically covered by this rule, however the FDA stated that it would make product-specific decisions about health warnings when issuing or revising individual product or marketing orders. This approach would be consistent with the original marketing order for Heatsticks where FDA required Philip Morris Products S.A. to remove the Surgeon General’s health warning for carbon monoxide from packaging and advertising, and to use a nicotine addiction health warning instead. Philip Morris Products S.A. is committed to providing adult consumers with complete, accurate, and non-misleading information about possible health risks associated with its products. We have shared our views with the FDA on the application of the new warnings to our heated tobacco products. The final rule is the subject of litigation in the U.S. and was vacated nationwide by a federal court in November 2022. Philip Morris Products S.A. is not a party to this litigation. In the U.S., tobacco and nicotine-containing products that were not commercially marketed as of February 15, 2007, are subject to review and authorization by the FDA. Manufacturers of all non-authorized products currently on the market were required to file a PMTA with the FDA by September 9, 2020. The FDA announced on September 9, 2020 that it will prioritize enforcement against any tobacco and nicotine-containing product sold without a PMTA. On October 5, 2021, FDA published its final PMTA rule in the Federal Register, which is effective November 4, 2021. All future applications will have to comply with the requirements in the PMTA rule, which is substantially similar to the version of the final PMTA rule which was posted on Advanced Federal Register on January 19, 2021.FDA actions may influence the regulatory approach of other governments.Currently, national standards in certain countries set minimum quality and safety requirements for heat-not-burn products with technical heat-not-burn specifications and/or methods for demonstrating the absence of combustion. These standards are mandatory in Colombia, Egypt, Jordan, Saudi Arabia, Tajikistan, Tunisia, the UAE, Uzbekistan and Bahrain, and voluntary in Armenia, Costa Rica, Dominican Republic, Indonesia, Kazakhstan, Kyrgyzstan, Morocco, Philippines, Russia, Vietnam, the U.K. and Ukraine. In Japan, a voluntary standard sets minimum safety requirements for tobacco heating devices. For e-vapor products (e-cigarettes) national standards setting minimum quality and safety requirements have been adopted in several markets. These standards are mandatory in Armenia, Bahrain, China, Egypt, Jordan, New Zealand, United Arab Emirates, and Saudi Arabia, and voluntary in Costa Rica, France, Kazakhstan, Philippines, Russia, the U.K. and Ukraine.Currently, industry standards setting minimum quality and safety requirements for tobacco-free oral nicotine products (nicotine pouches) have been adopted in the U.K. and Sweden. Both standards are voluntary. We expect other governments to consider similar product standards for all novel tobacco and nicotine-containing products and encourage making them mandatory.All EU member states have transposed the EU Tobacco Products Directive, including the provisions on novel tobacco products, such as heated tobacco units, and e-cigarettes. Most of the EU member states require a notification submitted six months before the intended placing on the market of such products, while some require pre-market authorizations for the introduction of such products. To date, we have filed a comprehensive dossier summarizing our scientific assessment of our Platform 1 product in over 20 member states. On September 12, 2022, Norway rejected a submission for authorization of HEETS as a novel tobacco product. Norway partially transposed the EU Tobacco Products Directive (the “TPD”) under the European Free Trade Association ("EFTA") agreement and introduced an authorization system for novel tobacco products following article 19 of TPD. So far Norway has not granted authorization of any novel tobacco product. E-cigarettes and tobacco free nicotine pouches have not been granted access either.48In addition, in Italy, in April 2018, we submitted an application for HEETS, used with the IQOS device, requesting regulatory recognition of the reduction of toxic substances and potential risk reduction resulting from switching to this product compared to continued cigarette smoking. In January 2019, our application was not granted primarily on the grounds of insufficient data and questions of methodology. Due to the constraints of the review process, we were unable to supplement the application with all the data filed with the FDA and to address methodological questions during the review. We plan to submit a new application where we will clarify the concerns raised by the decision and further strengthen our application by submitting additional evidence generated since we submitted our first application, consistent with our FDA filings. We are confident that our evidence supports our application.On October 31, 2019, our Australian subsidiary, Philip Morris Limited (“PML”), submitted an application to the Scheduling Committee of the Therapeutic Goods Administration of Australia (“TGA”) seeking to exempt heated tobacco products from being prohibited in Australia. In August 2020, the TGA issued its decision denying the application and stating that it did not present compelling evidence to establish a public health benefit from greater access to nicotine in heated tobacco products. To date, several governmental agencies have published their scientific findings that analyze the harm-reduction potential of certain RRPs versus continuing smoking, including:In December 2017, at the request of the U.K. Department of Health and Public Health England, the U.K. Committee on Toxicity published its assessment of the risk of heat-not-burn products relative to cigarette smoking. This assessment included analysis of scientific data for two heat-not-burn products, one of which was our Platform 1 product. The assessment concluded that, while still harmful to health, compared with the known risks from cigarettes, heat-not-burn products are probably less harmful. Subsequently, in February 2018, Public Health England published a report stating that the available evidence suggests that heat-not-burn products may be considerably less harmful than cigarettes and more harmful than e-cigarettes. In May 2018, the German Federal Institute for Risk Assessment (“BfR”) published a study on the Platform 1 aerosol relative to cigarette smoke using the Health Canada Intense Smoking Regimen. BfR found reductions in selected HPHCs in a range of 80-99%. This publication indicates that significant reductions in the levels of selected toxicants are likely to reduce toxicant exposure, which BfR stated might be regarded as a discrete benefit compared to combustible cigarettes.In May 2018, the Dutch National Institute for Public Health and Environment (“RIVM”) published a factsheet on novel tobacco products that heat rather than burn tobacco, focusing on our Platform 1 product. RIVM analyzed the aerosol generated by our Platform 1 product and concluded that the use of this product, while still harmful to health, is probably less harmful than continued smoking. In June 2018, the Korean Food and Drug Administration (“KFDA”) issued a statement on products that heat rather than burn tobacco. The KFDA tested three heat-not-burn products, one of which was our Platform 1 product. The KFDA confirmed that the levels of the nine HPHCs tested in the aerosol of these products were on average approximately 90% lower compared to those measured in the cigarette smoke of the top five cigarette brands in South Korea. However, the KFDA stated that it could not establish that the tested heat-not-burn products are less harmful than cigarettes. In October 2018, our Korean subsidiary filed a request with a local court seeking information underlying KFDA’s analysis, conclusions and public statements. In May 2020, the court ordered KFDA to produce certain records.In August 2018, the Science & Technology Committee of the U.K. House of Commons published a report of its inquiry into e-cigarettes and heat-not-burn products. The report concluded that e-cigarettes are significantly less harmful to health than smoking tobacco. The report also observed that for those smokers who do not accept e-cigarettes, heat-not-burn products may offer a public health benefit despite their relative risk. The report called for a risk-proportionate regulatory environment for both e-cigarettes and heat-not-burn products and noted that e-cigarettes should remain the least taxed, cigarettes the most taxed, with heat-not-burn products falling between the two. The U.K. Committee on Advertising Practice announced the removal of a prohibition of health claims in the advertising of e-cigarettes in the U.K. effective November 2018.In November 2018, the Eurasian Economic Commission (regulatory body of the Eurasian Union consisting of Armenia, Belarus, Kazakhstan, Kyrgyzstan and Russia) published the results of its commissioned study on novel nicotine-containing products, including our Platform 1 product. The study confirms significantly lower levels of HPHCs in the aerosol generated by this product compared to cigarette smoke.In January 2019, scientific media published the results of the study of the China National Tobacco Quality Supervision and Test Centre (“CNTQST”) comparing the aerosol generated by our Platform 1 product with cigarette smoke. The CNTQST found that the former contained fewer, and lower levels of, harmful constituents than the latter and concluded that the lower temperature of heating 49tobacco in our Platform 1 product contributed to the difference. The CNTQST stated that the reduction in emissions of harmful constituents cannot be interpreted as a harm/risk reduction for smokers in the same proportion.In 2020, the Superior Health Council of Belgium (“SHC”) published results of its inquiry into heat-not-burn products. The SHC concluded that heat-not-burn products, while not safe, have a more favorable toxicity profile than cigarettes. However, in light of the uncertainty of such products’ short and long-term impacts, the toxic effects of the dual use with cigarettes, and the existence of approved smoking cessation tools, the SHC recommended that current regulations for cigarettes should apply to heat-not-burn products.In June 2022, the SHC published new advice on e-cigarettes in which they confirm that e-cigarettes are substantially less harmful than smoking cigarettes and therefore a better alternative for smokers. The SHC underlines that the vast majority of the risks of tobacco smoking are not caused by nicotine, but by the harmful substances that are released by the combustion of tobacco. Based on the cited science they call for legislation that makes a clear distinction between cigarettes and e-cigarettes, by focusing on better-informing smokers about the benefits of the lower-risk (but not risk-free) alternative, as well as on protecting non-smokers and young people.The foregoing scientific findings of government agencies may not be indicative of the measures that the relevant government authorities could take in regulating our products.We make our scientific findings publicly available for scrutiny and peer review through several channels, including our websites. From time to time, adult consumers, competitors, members of the scientific community, and others inquire into our scientific methodologies, challenge our scientific conclusions or request further study of certain aspects of our RRPs and their health effects. We are committed to a robust and open scientific debate and believe that such debate should be based on accurate and reliable scientific information. We seek to provide accurate and reliable scientific information about our RRPs; nonetheless, we may not be able to prevent third-party dissemination of false, misleading or unsubstantiated information about these products. The dissemination of scientifically unsubstantiated information or studies with a strong confirmation bias by third parties may cause confusion among adult smokers and affect their decision to switch to better alternatives to continued smoking, such as our RRPs. To date, we have been largely successful in demonstrating to regulators that our heated tobacco units are not cigarettes due to the absence of combustion, and as such they are generally taxed either as a separate category or as other tobacco products, which typically yields more favorable tax rates than cigarettes. Although we believe that this is sensible from the public health perspective, we cannot guarantee that regulators will continue this approach. There can be no assurance that we will succeed in our efforts to replace cigarettes with RRPs or that regulation will allow us to commercialize RRPs in all markets, to communicate about our RRPs, including making scientifically substantiated risk-reduction claims, or to treat RRPs differently from cigarettes.Legal Challenges to RRPs: We face various administrative and legal challenges related to certain RRP activities, including allegations concerning product classification, advertising restrictions, corporate communications, product coach activities, scientific substantiation, product liability, and unfair competition. While we design our programs to comply with relevant regulations, we expect these or similar challenges to continue as we expand our efforts to commercialize RRPs and to communicate publicly. The outcomes of these matters may affect our RRP commercialization and public communication activities and performance in one or more markets. Our RRP Business Development Initiatives: In December 2013, we established a strategic framework with Altria Group, Inc. (“Altria”) setting out terms on how the parties would collaborate to develop and commercialize e-vapor products and commercialize two of our RRPs in the U.S. In late 2018, Altria announced that it will participate in the e-vapor category only through another e-vapor company in which Altria acquired a minority interest. In September 2019, Altria's subsidiary, Philip Morris USA Inc. (“PM USA”), began commercialization of a version of our Platform 1 product in the U.S. Under the agreement, PM USA was required to achieve certain milestones in order to maintain its exclusive distribution right and additional milestones to extend the agreement after the initial 5-year term. On October 20, 2022, PMI announced that it had reached an agreement with Altria Group, Inc. to end the companies' commercial relationship covering IQOS in the U.S. as of April 30, 2024. Thereafter, PMI will have the full rights to commercialize IQOS in the U.S. (For more details, please refer to Note 3. Acquisitions, and Note 18. Contingencies).In January 2020, we announced an agreement with KT&G, a leading tobacco and nicotine company in South Korea, for the commercialization of KT&G’s smoke-free products outside of South Korea on an exclusive basis. On January 30, 2023, we announced a renewal and extension of this arrangement. For more information, see Acquisitions and Other Business Arrangements below.50Other Developments: In September 2017, we announced our support of the Foundation for a Smoke-Free World. In September 2020, our pledge agreement with the Foundation was amended. We contributed $45 million in 2020, $40 million in 2021, $17.5 million in 2022, and expect to contribute up to $35 million annually from 2023 through 2029, as specified in the amended pledge agreement. To date, we contributed a total of $267 million. The Foundation is an independent body and is governed by its independent Board of Directors. The Foundation’s role, as set out in its corporate charter, includes funding research in the field of tobacco harm reduction, encouraging measures that reduce the harm caused by smoking, and assessing the effect of reduced cigarette consumption on the industry value chain.Governmental InvestigationsFrom time to time, we are subject to governmental investigations on a range of matters, including tax, customs, antitrust, advertising, and labor practices. We describe certain matters pending in Russia, South Korea and Thailand in Item 8, Note 18. Contingencies. In November 2010, a World Trade Organization ("WTO") panel issued its decision in a dispute between the Philippines and Thailand, concerning a series of Thai customs and tax measures affecting cigarettes imported by PM Thailand into Thailand (see Item 8, Note 18. Contingencies for additional information). The decision concluded that Thailand had no basis to find that PM Thailand's declared customs values and taxes paid were too low, as alleged by the Thai government and created obligations for Thailand to revise its laws, regulations, or practices affecting the customs valuation and tax treatment of future cigarette imports. Thailand agreed to fully comply with the decision, but the Philippines asserts that to date Thailand has not fully complied with the WTO panel decision and commenced challenges at the WTO Appellate Body. The WTO Appellate Body is not operational, and the appeals by Thailand are suspended indefinitely. In December 2020, the Philippines and Thailand agreed to pursue facilitator-assisted discussions aimed at progressing and resolving outstanding issues and the countries have since agreed to seek the establishment of a bilateral consultative mechanism, with the goal of reaching a comprehensive settlement of their dispute, consistent with their rights and obligations under the WTO Agreement, as well as the recommendations and rulings of the WTO Dispute Settlement Body.The Public Prosecutor’s office of Rome, Italy, notified our Italian subsidiary, Philip Morris Italia S.r.l. (“PM Italia”), as well as three former or current employees and a former external consultant of PM Italia in July 2020 and March 2020, respectively, that it concluded a preliminary investigation against them for alleged contravention of anti-corruption laws and related disruption of trade freedom. The Public Prosecutor alleges that the individuals involved promised certain personal favors to government officials from January to July of 2018 in exchange for favorable treatment for PM Italia, and that PM Italia lacked appropriate organizational controls to prevent the alleged actions by the individuals. BAT has filed a civil claim against PM Italia claiming vicarious liability for any wrongdoing of its former or current employees and seeking EUR 50 million in damages. The court admitted the claim as a matter of course and issued summons for PM Italia to appear as civil party in the case. The next trial hearing is scheduled for February 13, 2023. PM Italia believes the charges brought against it by the Public Prosecutor are without merit and will defend them vigorously. Asset Impairment and Exit Costs We discuss asset impairment and exit costs related to restructuring activities in Item 8, Note 20. Asset Impairment and Exit Costs to our consolidated financial statements.U.S. GAAP Treatment of Turkey as a Highly Inflationary Economy Following the categorization of Turkey by the International Practices Task Force of the Center for Audit Quality as a country with a three-year cumulative inflation rate greater than 100%, the country is considered highly inflationary in accordance with U.S. GAAP. Consequently, PMI has begun to account for the operations of its Turkish affiliates as highly inflationary, and treat the U.S. dollar as the functional currency of the affiliates, effective April 1, 2022. The impact of this accounting change was not material to our consolidated financial statements for the year ended December 31, 2022.Climate Change Laws and Regulations While, to date, the effect of climate-related laws and regulations on PMI has not been material to our business, results of operations or financial conditions, consideration of environmental and climate-related laws and regulations is an integral aspect of PMI’s climate-related risk assessment process. To this end, we actively monitor the existing and potential impact on PMI of significant pending or existing climate change-related legislation, regulations, international accords, reporting frameworks, standards, principles, and other forms of guidance. Examples include, but are not limited to, the EU Emissions Trading System, the 2015 Paris Climate Agreement, recommendations of the Task Force on Climate-related Financial Disclosures, the SEC’s proposed rules regarding climate-related 51disclosures, the Taskforce on Nature-related Financial Disclosures, the European Commission Corporate Sustainability Reporting Directive, and the International Sustainability Standards Board proposed standards.Acquisitions and Other Business ArrangementsWe discuss our acquisitions in Item 8, Note 3. Acquisitions to our consolidated financial statements.KT&G On January 30, 2023, PMI announced a long-term collaboration with KT&G, South Korea’s leading tobacco and nicotine manufacturer, to continue to commercialize KT&G’s innovative smoke-free devices and consumables on an exclusive, worldwide basis (excluding South Korea). The agreement covers fifteen years, to January 29, 2038, with performance-review cycles and associated commitments, based on volume, to be confirmed for each three-year period, to allow flexibility for evolving market conditions.The agreement gives PMI continued exclusive access to KT&G’s smoke-free brands and product-innovation pipeline, including offerings for low- and middle-income markets, that will enhance PMI’s existing portfolio of smoke-free products. Products sold under the agreement will be subject to assessment to ensure they meet the regulatory requirements in the markets where they are launched, as well as PMI’s high standards of quality and scientific substantiation. PMI and KT&G will seek any necessary regulatory approvals that may be required on a market-by-market basis.Equity InvestmentsWe discuss our equity investments in Item 8, Note 6. Related Parties - Equity Investments and Other to our consolidated financial statements.Trade Policy PMI complies with all applicable trade restrictions and requirements, including sanctions, in the markets in which it operates. We have taken appropriate actions in response to the latest sanctions to ensure full compliance with the relevant restrictions.We are subject to various trade restrictions imposed by the U.S., EU, Switzerland, the U.K., and other jurisdictions in which we do business (“Trade Sanctions”), including the trade and economic sanctions administered by the U.S. Department of the Treasury's Office of Foreign Assets Control and the U.S. Department of State. It is our policy to comply fully with these Trade Sanctions.Pursuant to specific exemptions or licenses, or where sanctions do not apply to our business, PMI may make sales in countries subject to Trade Sanctions. We do not do business or sell products in Iran, North Korea or Syria. We sell cigarettes in Cuba under a distribution agreement. These sales are permitted by U.S. law under a License Exception for Agricultural Commodities, issued by the United States Department of Commerce (Bureau of Industry and Security), and specifically granted to our distributor. Certain states within the U.S. have enacted legislation permitting or requiring state pension funds to divest or abstain from future investment in stocks of companies that do business with certain countries that are sanctioned by the U.S. Because we do business in certain of these countries, consistent with our policy to fully comply with Trade Sanctions and as described above, these state pension funds may have divested of our stock or may not invest in our stock. We do not believe such legislation has had a material effect on the price of our shares.PMI is also subject to various Trade Sanctions imposed by the EU and other jurisdictions. We comply fully with these Trade Sanctions.On June 24, 2021, the EU introduced sanctions regarding Belarus aimed at specific sectors of the Belarus economy, including the tobacco sector. Subsequently, seven non-EU countries (Norway, Iceland, Liechtenstein, North Macedonia, Bosnia and Herzegovina, 52Montenegro, and Albania) announced that they “aligned themselves” with the majority of the EU sanctions. Switzerland and the UK have also imposed sanctions similar in scope to the EU sanctions.On August 9, 2021, the U.S. imposed blocking sanctions on certain Belarusian individuals and entities pursuant to an Executive Order, which expanded the bases for the imposition of sanctions, including, among others, by authorizing the imposition by OFAC of blocking sanctions on persons operating in the tobacco sector of the Belarus economy. In 2021 and 2022, the U.S., the EU, the U.K., Switzerland and several other jurisdictions supplemented their respective sanctions lists by including additional Belarusian sanctions targets.Following the start of the conflict in Ukraine on February 24, 2022, the U.S., the EU, the UK, Switzerland, Canada, Australia, New Zealand, Singapore, South Korea, Japan and other countries introduced extensive economic sanctions and export controls regarding Russia. While the introduced sanctions slightly vary from jurisdiction to jurisdiction, they are largely aligned. The restrictions are primarily targeted at the Russian financial, banking, oil, military, aviation and marine sectors. The U.S. has also introduced a prohibition on new investment in the Russian Federation by a U.S. person, wherever located. Among sanctions targets are Russian political figures and military personnel, certain oligarchs and journalists, and companies operating in the above-mentioned sectors. Export to Russia of certain luxury goods, and goods and technology which might contribute to Russia’s technological enhancement was banned. Seven non-EU countries (Norway, Iceland, Liechtenstein, North Macedonia, Bosnia and Herzegovina, Montenegro, and Albania) announced that they “aligned themselves” with the majority of the EU sanctions. The EU and Switzerland introduced additional trade restrictions banning, among many other goods, the export of certain non-tobacco materials used to produce cigarettes and heated tobacco consumables in Russia as well as related technical assistance and other related services. In addition, the EU, the UK, Switzerland, Canada, Australia, New Zealand and Ukraine sanctioned Mr. Igor Kesaev, a non-majority shareholder of Megapolis Distribution B.V.The U.K. banned the export of electronic cigarettes and similar personal electric vaporizing devices to Russia as well as related technical assistance, and financial and brokering services. Certain countries also banned the delivery of services to Russia, such as information technology consultancy services, accounting and business and management consulting services, most with exceptions for subsidiaries of U.S., E.U., or Swiss owned companies. Russia introduced certain countermeasures aimed at reducing the effect of Western sanctions. Countermeasures include restrictions on export of certain goods from Russia, including tobacco-related production equipment, restrictions on lending to foreign borrowers, repatriation of dividends and transactions with securities and real estate involving companies from “hostile” countries (i.e., those which introduced sanctions regarding Russia).PMI continues to monitor the development of new sanctions and ensure full compliance. 2022 compared with 2021 The following discussion compares operating results within each of our segments for 2022 with 2021.Unless otherwise stated, references to total industry, total market, our shipment volume and our market share performance reflect cigarettes and heated tobacco units. Estimates for total industry volume and market share in certain geographies reflect limitations on the availability and accuracy of industry data during pandemic-related restrictions. European Union: Financial Summary -Years Ended December 31,ChangeFav./(Unfav.)VarianceFav./(Unfav.)20222021TotalExcl.Curr. & Acquis.TotalCur-rencyAcqui-sitionsPriceVol/MixCost/Other(in millions)Net Revenues$ 12,119 $ 12,275 (1.3)%10.6 %$(156)$(1,472)$10 $(127)$1,433 $— Operating Income$ 5,788 $ 6,119 (5.4)%10.5 %$(331)$(972)$(2)$(127)$977 $(207)Net revenues, excluding currency and acquisitions, increased by 10.6%, reflecting: favorable volume/mix, mainly driven by higher HTU volume and device volume, partly offset by lower cigarette volume, unfavorable HTU mix, and unfavorable cigarette mix; 53partially offset by an unfavorable pricing variance, mainly due to lower HTU (net) pricing and lower device pricing, partly offset by higher combustible tobacco pricing.The unfavorable pricing variance is impacted by the supplemental excise tax surcharge on heated tobacco units in Germany, which went into effect in 2022. The legality of the surcharge is currently being assessed in court and the obligation to pay the surcharge is temporarily suspended. PMI currently accounts for the surcharge as a reduction in net revenues and in accrued liabilities in its consolidated financial statements. The accrued liability balance will continue to increase with the continuation of the HTU selling activities and in the case of an unfavorable ruling would negatively impact PMI’s future cash provided by operating activities. The favorable ruling would positively impact future PMI’s operating results.Operating income, excluding currency and acquisitions, increased by 10.5%, primarily reflecting favorable volume/mix, mainly driven by higher HTU volume, partly offset by lower cigarette volume, unfavorable HTU mix, unfavorable cigarette mix and the unfavorable impact on profitability of higher device volume; partially offset by an unfavorable pricing variance; higher manufacturing costs; and higher marketing, administration and research costs (including the unfavorable impact of 2022 costs associated with the Swedish Match AB offer of $51 million and a favorable comparison versus the prior year period related to asset impairment and exit costs of $68 million).European Union - Total Market, PMI Shipment Volume and Market Share Commentaries Total market and market share performance are shown in the table below: European Union Key DataFull-YearChange20222021% / ppTotal Market (billion units)484.3478.91.1 %PMI Market ShareMarlboro15.9 %16.6 %(0.7)L&M5.3 %5.6 %(0.3)Chesterfield5.5 %5.5 %— Philip Morris2.1 %2.2 %(0.1)Heated Tobacco Units7.7 %5.7 %2.0 Others3.0 %3.0 %— Total European Union39.5 %38.6 %0.9 Note: Sum may not foot due to roundings.The estimated total market in the EU increased by 1.1% to 484.3 billion units, primarily driven by: •Italy, up by 3.4%, mainly reflecting the impact on adult smoker average daily consumption of the easing of pandemic-related measures (particularly in the first half of the year);•Poland, up by 13.0%, primarily reflecting a lower estimated prevalence of illicit trade, as well as higher border sales (largely due to the easing of pandemic-related measures); and•Romania, up by 8.2%, mainly reflecting a lower estimated prevalence of illicit trade, as well as higher border sales (largely due to the easing of pandemic-related measures);partly offset by•Germany, down by 5.1%, primarily reflecting the impact of excise tax-driven price increases and higher cross-border (non-domestic) purchases due to the easing of pandemic-related measures; and•the U.K., down by 13.4%, notably reflecting the impact of increased out-bound tourism compared to the pandemic-affected prior year period.Our Regional market share increased by 0.9 points to 39.5%, with gains in Germany, Italy and Poland, partly offset by declines in France and Spain.54Our total shipment volume increased by 4.0% to 193.4 billion units, mainly driven by:•Italy, up by 5.8%, primarily reflecting a higher market share driven by HTUs, as well as a higher total market;•Poland, up by 17.6%, mainly reflecting the higher total market and a higher market share driven by HTUs; and•Romania, up by 36.1%. Excluding the net favorable impact of estimated distributor inventory movements, total in-market sales volume increased by 27.3%, primarily reflecting a higher market share driven by HTUs, as well as the higher total market;partly offset by•France, down by 8.1%, primarily reflecting a lower total market and a lower market share.Eastern Europe: Financial Summary -Years Ended December 31,ChangeFav./(Unfav.)VarianceFav./(Unfav.)20222021TotalExcl.Curr. & Acquis.TotalCur-rencyAcqui-sitionsPriceVol/MixCost/Other(in millions)Net Revenues$ 3,725 $ 3,544 5.1 %3.7 %$181 $51 $— $334 $(204)$— Operating Income$ 1,166 $ 1,213 (3.9)%(13.9)%$(47)$122 $— $334 $(212)$(291)Net revenues, excluding currency and acquisitions, increased by 3.7%, reflecting: a favorable pricing variance, primarily driven by higher combustible tobacco pricing; partly offset by unfavorable volume/mix, mainly due to lower cigarette volume, lower HTU volume and unfavorable cigarette mix.In 2022, Russia and Ukraine accounted for around 70% of PMI's total net revenues in the Region. Operating income, excluding currency and acquisitions, decreased by 13.9%, notably reflecting the impact of 2022 charges related to the war in Ukraine ($151 million) shown in "Cost/Other", as well as unfavorable volume/mix, mainly due to the same factors as for net revenues; higher manufacturing costs (notably related to Ukraine); and higher marketing, administration and research costs; partly offset by a favorable pricing variance.55Eastern Europe - Total Market, PMI Shipment Volume and Market Share Commentaries The estimated total market in Eastern Europe decreased by 4.4% to 358.0 billion units, primarily due to:•Russia, down by 3.6%, mainly due to the impact of price increases; and•Ukraine, down by 18.3%.The estimated total market in Eastern Europe, excluding Russia and Ukraine, was essentially stable at 113.3 billion units.Our Regional market share decreased by 0.8 points to 29.8%. Excluding Russia and Ukraine, our Regional market share increased by 0.4 points to 26.7%. Our total shipment volume decreased by 7.1% to 106.3 billion units, primarily due to: •Russia, down by 6.0%, due to cigarettes and HTUs; and•Ukraine, down by 30.1%, due to cigarettes and HTUs.In 2022, Russia and Ukraine accounted for around 71% of PMI's total shipment volume in the Region. Excluding Russia and Ukraine, total shipment volume increased by 2.7%. Middle East & Africa: Financial Summary -Years Ended December 31,ChangeFav./(Unfav.)VarianceFav./(Unfav.)20222021TotalExcl.Curr. & Acquis.TotalCur-rencyAcqui-sitionsPriceVol/MixCost/Other(in millions)Net Revenues $ 3,901 $ 3,293 18.5 %29.0 %$608 $(348)$— $200 $503 $253 Operating Income$ 1,758 $ 1,146 53.4 %67.6 %$612 $(163)$— $200 $364 $211 56Net revenues, excluding currency and acquisitions, increased by 29.0%, notably reflecting a favorable comparison related to the Saudi Arabia customs assessments of $246 million in 2021, shown in "Cost/Other", favorable volume/mix, primarily driven by higher cigarette volume and higher HTU volume; and a favorable pricing variance, mainly driven by combustible tobacco pricing.Operating income, excluding currency and acquisitions, increased by 67.6%, notably reflecting a favorable comparison related to the Saudi Arabia customs assessments in 2021 (as noted above for net revenues), favorable volume/mix, primarily driven by the same factors as for net revenues; a favorable pricing variance; and lower marketing, administration and research costs (including the unfavorable impact of 2022 costs associated with the Swedish Match AB offer of $13 million and a favorable comparison versus the prior year period related to asset impairment and exit costs of $17 million); partly offset by higher manufacturing costs.Middle East & Africa - Total Market, PMI Shipment Volume and Market Share Commentaries The estimated total market in the Middle East & Africa decreased by 0.8% to 557.2 billion units, mainly due to: •Algeria, down by 16.1%, or by 6.8% excluding the net unfavorable impact of estimated trade inventory movements, primarily reflecting industry supply chain disruptions, as well as the impact of excise tax-driven price increases in the first quarter of 2021; and•Turkey, down by 6.3%, mainly reflecting a higher estimated prevalence of illicit trade, partly offset by the impact on adult smoker average daily consumption of the easing of pandemic-related measures, coupled with increased in-bound tourism;partly offset by•International Duty Free, up by 43.8%, primarily reflecting the impact of reduced government travel restrictions and increased passenger traffic in certain geographies.Our Regional market share increased by 1.6 points to 24.7%.Our total shipment volume increased by 6.5% to 138.6 billion units, mainly driven by: •Egypt, up by 8.2%, primarily reflecting a higher market share driven by cigarettes and HTUs; and •PMI Duty Free, up by 61.3%, or by 47.3% excluding the net favorable impact of estimated distributor inventory movements (primarily due to cigarettes), reflecting the higher total market and a higher market share.57South & Southeast Asia: Financial Summary -Years Ended December 31,ChangeFav./(Unfav.)VarianceFav./(Unfav.)20222021TotalExcl.Curr. & Acquis.TotalCur-rencyAcqui-sitionsPriceVol/MixCost/Other(in millions)Net Revenues$ 4,395 $ 4,396 — %6.2 %$(1)$(274)$— $45 $228 $— Operating Income$ 1,459 $ 1,506 (3.1)%5.7 %$(47)$(133)$— $45 $(16)$57 Net revenues, excluding currency and acquisitions, increased by 6.2%, reflecting: favorable volume/mix, primarily driven by higher cigarette volume and favorable cigarette mix; and a favorable pricing variance, mainly due to combustible tobacco pricing.Operating income, excluding currency and acquisitions, increased by 5.7%, primarily reflecting: lower marketing, administration and research costs (including a favorable comparison versus the prior year period related to asset impairment and exit costs of $21 million and the unfavorable impact of 2022 costs associated with the Swedish Match AB offer of $13 million); and a favorable pricing variance; partly offset by unfavorable volume/mix, mainly due to lower cigarette mix. South & Southeast Asia - Total Market, PMI Shipment Volume and Market Share Commentaries The estimated total market in South & Southeast Asia increased by 2.9% to 743.3 billion units, mainly driven by: •India, up by 16.8%, primarily reflecting a favorable comparison versus the prior year, during which pandemic-related restrictions impacted the movement of certain products, including tobacco; and•Indonesia, up by 4.5%, mainly reflecting the impact on adult smoker consumption of the easing of pandemic-related measures, which drove growth in the tax-advantaged 'below tier one' segment;partly offset by•Bangladesh, down by 4.0%, primarily reflecting the impact of pandemic-related restrictions on mobility during February 2022, as well as the impact of second-quarter 2022 excise tax-driven price increases; and•the Philippines, down by 6.1%, mainly reflecting the impact of first-quarter 2022 excise tax-driven price increases.Our Regional market share decreased by 0.3 points to 19.4%.58Our total shipment volume increased by 1.6% to 144.5 billion units, mainly driven by: •India, up by 73.9%, primarily reflecting a higher market share (driven by geographic expansion) and the higher total market; and•Indonesia, up by 4.8%, mainly reflecting the higher total market;partly offset by•the Philippines, down by 6.3%, mainly reflecting the lower total market.East Asia & Australia: Financial Summary -Years Ended December 31,ChangeFav./(Unfav.)VarianceFav./(Unfav.)20222021TotalExcl.Curr. & Acquis.TotalCur-rencyAcqui-sitionsPriceVol/MixCost/Other(in millions)Net Revenues$ 5,132 $ 5,953 (13.8)%(3.9)%$(821)$(587)$— $(16)$(218)$— Operating Income$ 1,919 $ 2,556 (24.9)%(10.9)%$(637)$(358)$— $(16)$(477)$214 Net revenues, excluding currency and acquisitions, decreased by 3.9%, primarily reflecting: unfavorable volume/mix, mainly due to unfavorable device mix, lower cigarette volume and unfavorable cigarette mix, partly offset by higher HTU volume and higher device volume; and an unfavorable pricing comparison.Operating income, excluding currency and acquisitions, decreased by 10.9%, mainly reflecting: unfavorable volume/mix, primarily due to unfavorable HTU mix, lower cigarette volume, unfavorable cigarette mix and unfavorable device mix; and higher manufacturing costs; partly offset by lower marketing, administration and research costs (including a favorable comparison versus the prior year period related to asset impairment and exit costs of $88 million and the unfavorable impact of 2022 costs associated with the Swedish Match AB offer of $21 million).59East Asia & Australia - Total Market, PMI Shipment Volume and Market Share Commentaries The estimated total market in East Asia & Australia, excluding China, decreased by 0.9% to 292.8 billion units, mainly due to: •Japan, down by 1.5%, primarily reflecting the impact of the October 2021 excise tax-driven price increases.Our Regional market share, excluding China, increased by 0.8 points to 27.3%.Our total shipment volume decreased by 0.2% to 81.9 billion units, mainly due to: •Australia, down by 5.1%, mainly reflecting a lower total market, partly offset by a higher market share; and•South Korea, down by 1.6%, primarily reflecting a lower market share; partly offset by•Japan, up by 0.6%, or by 3.9% excluding the net unfavorable impact of estimated distributor inventory movements (primarily due to HTUs), reflecting a higher market share, partly offset by the lower total market.Excluding the net unfavorable impact of estimated distributor inventory movements, our total in-market sales volume increased by 1.9%.Americas: Financial Summary -Years Ended December 31,ChangeFav./(Unfav.)VarianceFav./(Unfav.)20222021TotalExcl.Curr. & Acquis.TotalCur-rencyAcqui-sitionsPriceVol/MixCost/Other(in millions)Net Revenues$ 1,903 $ 1,843 3.3 %4.1 %$60 $(15)$— $102 $(23)$(4)Operating Income$ 436 $ 487 (10.5)%(8.2)%$(51)$(11)$— $102 $(6)$(136)60Net revenues, excluding currency and acquisitions, increased by 4.1%, primarily reflecting: a favorable pricing variance, driven by combustible tobacco pricing; partly offset by unfavorable volume/mix, mainly due to unfavorable cigarette mix.Operating income, excluding currency and acquisitions, decreased by 8.2%, mainly reflecting: higher marketing, administration and research costs (including the unfavorable impact of 2022 costs associated with the Swedish Match AB offer of $5 million and a favorable comparison versus the prior year period related to asset impairment and exit costs of $8 million); and higher manufacturing costs; partly offset by a favorable pricing variance. Volume/mix was slightly unfavorable, mainly due to unfavorable cigarette mix, largely offset by higher cigarette volume.Americas - Total Market, PMI Shipment Volume and Market Share Commentaries The estimated total market in the Americas, excluding the U.S., increased by 1.7% to 190.8 billion units, primarily driven by: •Brazil, up by 7.6%, primarily reflecting a lower estimated prevalence of illicit trade;partly offset by•Canada, down by 12.8%, notably reflecting the impact of price increases and out-switching from cigarettes to e-vapor products.Our Regional market share, excluding the U.S., increased by 0.3 points to 34.8%. Our total shipment volume increased by 2.1% to 66.5 billion units, mainly driven by: •Brazil, up by 13.3%, primarily reflecting the higher total market and a higher market share; and•Mexico, up by 2.5%, mainly reflecting a higher total market and a higher market share for cigarettes;partly offset by•Argentina, down by 2.8%, primarily reflecting a lower market share due to adult smoker downtrading to ultra-low-price brands produced by local manufacturers, partly offset by a higher total market.61Swedish Match: Our results for the Swedish Match operating segment for the full-year include Swedish Match's results beginning on November 11, 2022, when PMI became the owner of a majority position in Swedish Match, through December 31, 2022. The business operations of our Swedish Match segment are managed and evaluated separately from the geographical segments. Financial Summary -Years Ended December 31,ChangeFav./(Unfav.)VarianceFav./(Unfav.)20222021TotalExcl.Curr. & Acquis.TotalCur-rencyAcqui-sitionsPriceVol/MixCost/Other(in millions)Net Revenues$ 316 $ — — %— %$316 $— $316 $— $— $— Operating Income / (Loss)$ (22)$ — — %— %$(22)$— $(22)$— $— $— We recorded net revenues of $316 million in the Swedish Match segment, with an operating loss of $22 million, primarily reflecting $125 million in an acquisition accounting-related item and $26 million related to the amortization of acquired intangibles.Wellness and Healthcare:In the third quarter of 2021, we acquired Fertin Pharma A/S, Vectura Group plc. and OtiTopic, Inc. On March 31, 2022, we launched a new Wellness and Healthcare business, Vectura Fertin Pharma, consolidating these entities. The operating results of this business are reported in the Wellness and Healthcare segment. The business operations of our Wellness and Healthcare segment are managed and evaluated separately from the geographical segments. Financial Summary -Years Ended December 31,ChangeFav./(Unfav.)VarianceFav./(Unfav.)20222021TotalExcl.Curr. & Acquis.TotalCur-rencyAcqui-sitionsPriceVol/MixCost/Other(in millions)Net Revenues$ 271 $ 101 +100%(7.9)%$170 $(11)$189 $(10)$— $2 Operating Income / (Loss)$ (258)$ (52)-(100)%-(100)%$(206)$8 $(72)$(10)$— $(132)Net revenues, excluding currency and acquisitions, decreased by 7.9%, primarily reflecting lower product supply revenues and lower royalties.The operating loss of $258 million in 2022 included $171 million of amortization and impairment of intangibles. The remaining operating loss in 2022 of $87 million mainly reflected investments in research and development, as well as expenses related to employee retention programs.2021 compared with 2020 For a discussion comparing our consolidated operating results within each of our geographical segments for the year ended December 31, 2021, with the year ended December 31, 2020, refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Operating Results by Business Segment in our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the U.S. Securities and Exchange Commission on February 11, 2022. This section is incorporated by reference into this Annual Report on Form 10-K for the year ended December 31, 2022.62Financial Review For the Years Ended December 31,(in millions)202220212020Net cash provided by operating activities$10,803 $11,967 $9,812 Net cash used in investing activities(15,679)(2,358)(1,154)Net cash provided by (used in) financing activities3,806 (11,977)(8,496)2022 compared with 2021 •Net Cash Provided by Operating Activities Net cash provided by operating activities for the year ended December 31, 2022 decreased by $1.2 billion compared with 2021. Excluding unfavorable currency movements of $1.5 billion, net cash provided by operating activities increased by $0.3 billion, due primarily to higher currency-neutral net earnings of $1.1 billion and lower pension plan contributions, net of refunds, of $0.3 billion, partially offset by higher working capital requirements of $1.0 billion and other movements. The unfavorable currency movements primarily related to the currency impact on net earnings and represented the fluctuations of the U.S. dollar, especially against Egyptian pound, Euro, Hungarian forint, Japanese yen and Polish zloty, partially offset by the Russian ruble and Swiss franc.The higher working capital requirements in 2022 as compared with 2021 were primarily due to more cash used for accounts receivable in 2022 mainly reflecting the timing of sales and cash collections, and more cash used for inventory mainly reflecting stock movements related to excise tax increases, partially offset by more cash provided by accrued liabilities and other current assets mainly reflecting the timing of excise tax-paid inventory movements and excise tax payments. •Net Cash Used in Investing Activities Net cash used in investing activities of $15.7 billion for the year ended December 31, 2022, increased by $13.3 billion from the comparable 2021 period. This increase was due primarily to the $14.0 billion of cash used in 2022 for the Swedish Match acquisition, net of acquired cash, the 2022 cash payment to Altria Group, Inc. of $1.0 billion for PMI to reacquire the IQOS commercialization 63rights in the U.S. and higher capital expenditures. These increases were partially offset by the $2.1 billion of cash used in 2021 for our acquisitions, net of acquired cash. For further detail on our acquisitions and the Altria Group, Inc. Agreement, see Item 8, Note 3. Acquisitions.Our capital expenditures were $1.1 billion in 2022 and $0.7 billion in 2021. The 2022 expenditures were primarily related to our ongoing investments in smoke-free product manufacturing capacity. We expect total capital expenditures in 2023 of approximately $1.3 billion, partly reflecting increased investments behind smoke-free product manufacturing capacity, including for ILUMA and Swedish Match's portfolio. •Net Cash Provided by (Used in) Financing Activities Net cash provided by financing activities of $3.8 billion for the year ended December 31, 2022, increased by $15.8 billion from the comparable 2021 period. The increase was primarily due to higher borrowings in 2022 reflecting net borrowings of $9.9 billion under credit facilities related to the Swedish Match acquisition, proceeds from long-term debt issuances of $6.0 billion and net short-term borrowings of $1.0 billion (primarily commercial paper), as well as lower share repurchases and lower repayments of long-term debt in 2022. These increases were partially offset by higher cash usage primarily reflecting payments made after the acquisition date to acquire additional Swedish Match shares from noncontrolling interests, higher dividend payments and the purchase of the remaining stakes in our Turkish affiliates in the first quarter of 2022. For further details on the purchases of additional Swedish Match shares and the remaining stakes in our Turkish affiliates, see Item 8, Note 3. Acquisitions. Dividends paid in 2022 and 2021 were $7.8 billion and $7.6 billion, respectively.2021 compared with 2020 For a discussion comparing our net cash activities (operating, investing and financing) for the year ended December 31, 2021, with the year ended December 31, 2020, refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation - Financial Review in our Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the U.S. Securities and Exchange Commission on February 11, 2022. This section is incorporated by reference into this Annual Report on Form 10-K for the year ended December 31, 2022.•Debt and LiquidityWe define cash and cash equivalents as short-term, highly liquid investments, readily convertible to known amounts of cash that mature within a maximum of three months and have an insignificant risk of change in value due to interest rate or credit risk changes. As a policy, we do not hold any investments in structured or equity-linked products. Our cash and cash equivalents are predominantly held with institutions that have investment-grade long-term credit rating. As part of our cash management strategy and in order to manage counterparty exposure, we also enter into reverse repurchase agreements. Such agreements are collateralized with government or corporate securities held by a custodial bank and, at maturity, cash is paid back to PMI, and the collateral is returned to the bank. For 2022 and 2021, the activities for such reverse repurchase agreements were not material. In August 2021, we published a business transformation-linked financing framework (“Framework”), which integrates PMI's smoke-free transformation into its financing strategy. The Framework outlines the guidelines that we will follow in issuing business transformation-linked financing instruments in the debt capital and loan markets, which may include public notes offerings, private placements, loans, and other relevant financing instruments. Credit Ratings – The cost and terms of our financing arrangements as well as our access to commercial paper markets may be affected by applicable credit ratings. On November 10, 2022, Fitch affirmed our long-term credit rating at “A” and short-term at “F1”, and revised our outlook to “Stable” from “Rating Watch Negative”. On November 11, 2022, Moody’s affirmed our long-term credit rating at “A2” and short-term at “P-1”, and revised our outlook to “Stable” from “Rating(s) Under Review”. On November 11, 2022, Standard & Poor’s revised our long-term credit rating to “A-” from “A” and short-term to “A-2” from “A-1” with “Stable” outlook (previously “CreditWatch Negative”). At February 10, 2023, our credit ratings and outlook by major credit rating agencies were as follows:Short-termLong-termOutlookMoody’sP-1A2StableStandard & Poor’sA-2A-StableFitchF1AStable64Revolving Credit Facilities – On January 25, 2023, we entered into an agreement to amend and extend the term of our $1.8 billion 364-day committed revolving credit facility from January 31, 2023, to January 30, 2024. At February 10, 2023, our committed revolving credit facilities were as follows:Type(in billions)Committed Revolving Credit Facilities364-day revolving credit, expiring January 30, 2024 $1.8 Multi-year revolving credit, expiring February 10, 2026(1)2.0 Multi-year revolving credit, expiring September 29, 2026(2) (3)2.5 Total facilities$6.3 (1) On January 28, 2022, we entered into an agreement, effective February 10, 2022, to amend and extend the term of our $2.0 billion multi-year revolving credit facility, for an additional year covering the period February 11, 2026 to February 10, 2027, in the amount of $1.9 billion. (2) Includes business transformation-linked pricing adjustments that may result in the reduction or increase in both the interest rate and commitment fee under the credit agreement if PMI achieves, or fails to achieve, certain specified targets based on its business transformation goals.(3) On September 20, 2022, we entered into an agreement, effective September 29, 2022, to amend and extend the term of our $2.5 billion multi-year revolving credit facility, for an additional year covering the period September 30, 2026 to September 29, 2027, in the amount of $2.3 billion.At February 10, 2023, there were no borrowings under the committed revolving credit facilities, and the entire committed amounts were available for borrowing. Subject to market conditions, PMI currently expects to request a further extension of the terms of its $2.5 billion multi-year revolving credit facility for an additional one-year period, in accordance with and subject to the terms and conditions of the relevant revolving credit facility agreement.All banks participating in our committed revolving credit facilities have an investment-grade long-term credit rating from the credit rating agencies. We continuously monitor the credit quality of our banking group, and at this time we are not aware of any potential non-performing credit provider.These committed revolving credit facilities do not include any credit rating triggers, material adverse change clauses or any provisions that could require us to post collateral. We expect to continue to meet our covenants.In addition to the committed revolving credit facilities discussed above, certain of our subsidiaries maintain short-term credit arrangements to meet their respective working capital needs. These credit arrangements, which amounted to approximately $1.9 billion at December 31, 2022 and approximately $2.3 billion at December 31, 2021, are for the sole use of our subsidiaries. Borrowings under these arrangements and other bank loans amounted to $295 million at December 31, 2022, and $225 million at December 31, 2021.Financing of the Swedish Match Acquisition – In connection with PMI’s all-cash recommended public offer to the shareholders of Swedish Match AB ("Swedish Match"), a public limited liability company organized under the laws of Sweden, for all the outstanding shares of Swedish Match, on May 11, 2022, PMI entered into a credit agreement relating to a 364-day senior unsecured bridge facility. The facility provided for borrowings up to an aggregate principal amount of $17 billion, expiring 364 days after the occurrence of certain events unless extended. On June 23, 2022, PMI entered into a new €5.5 billion (approximately $5.8 billion at the date of signing) senior unsecured term loan credit agreement consisting of a €3.0 billion (approximately $3.2 billion at the date of signing) tranche expiring three years after the occurrence of certain events and a €2.5 billion (approximately $2.6 billion at the date of signing) tranche expiring on June 23, 2027. In connection with the term loan facility, the aggregate principal amount of commitments under the 364-day senior unsecured bridge facility was reduced from $17 billion to $11 billion. On November 11, 2022, PMI acquired a controlling interest of 85.87% of the total issued shares in Swedish Match and has acquired 94.81% of its outstanding shares as of December 31, 2022. PMI borrowed $8.4 billion under the bridge facility by delivering notices of borrowing for advances of $7.9 billion and $0.5 billion on November 7, 2022 and November 10, 2022, respectively. All amounts borrowed under the bridge facility will become due on November 8, 2023 unless prepaid or such maturity date is extended pursuant to the terms of the bridge facility. On November 7, 2022, PMI also delivered notices of borrowing for advances totaling €5.5 billion under the term loan facility, of which €3.0 billion will become due on November 9, 2025 and €2.5 billion will become due on June 23, 2027 unless prepaid pursuant to the terms of the credit 65agreement. On November 21, 2022, PMI repaid $4.0 billion under the bridge facility. As of December 31, 2022, outstanding borrowings under the bridge facility amounted to $4.4 billion and $1.1 billion commitments remained available for drawing. As of December 31, 2022, the €5.5 billion (approximately $5.9 billion) term loan facility was fully drawn and remained outstanding. The proceeds under the bridge facility and the term loan facility were used, directly or indirectly, to finance the acquisition, including, the payment of related fees and expenses. For further details, see Item 8, Note 3. Acquisitions to our consolidated financial statements. Commercial Paper Program – We continue to have access to liquidity in the commercial paper market through programs in place in the U.S. and in Europe having an aggregate issuance capacity of $8.0 billion. At December 31, 2022, we had $0.9 billion of commercial paper outstanding. At December 31, 2021, we had no commercial paper outstanding. The average commercial paper balance outstanding during 2022 and 2021 was $3.1 billion and $1.1 billion, respectively. Sale of Accounts Receivable – To mitigate credit risk and enhance cash and liquidity management, we sell trade receivables to unaffiliated financial institutions. These arrangements allow us to sell, on an ongoing basis, certain trade receivables without recourse. The trade receivables sold are generally short-term in nature and are removed from the consolidated balance sheets. We sell trade receivables under two types of arrangements, servicing and nonservicing. Our operating cash flows were positively impacted by the amount of the trade receivables sold and derecognized from the consolidated balance sheets, which remained outstanding with the unaffiliated financial institutions. The trade receivables sold that remained outstanding under these arrangements as of December 31, 2022, 2021 and 2020, were $1.0 billion, $0.9 billion and $1.2 billion, respectively. The net proceeds received are included in cash provided by operating activities in the consolidated statements of cash flows.For further details, see Item 8, Note 19. Sale of Accounts Receivable to our consolidated financial statements.Debt – Our total debt was $43.1 billion at December 31, 2022, and $27.8 billion at December 31, 2021. Our total debt is primarily fixed rate in nature. The weighted-average all-in financing cost of our total debt was 2.5% in 2022 and 2.4% in 2021. For further details, including the fair value of our debt, see Item 8, Note 8. Indebtedness. The amount of debt that we can issue is subject to approval by our Board of Directors.On February 11, 2020, we filed a shelf registration statement with the U.S. Securities and Exchange Commission, under which we may from time to time sell debt securities and/or warrants to purchase debt securities over a three-year period. During February 2023, we plan to file a new shelf registration statement with the Securities and Exchange Commission.Our notes issuances in 2022 were as follows: (in millions)TypeFace Value Interest RateIssuanceMaturityU.S. dollar notes(a)$1,0005.125%November 2022November 2024U.S. dollar notes(b)$7505.000%November 2022November 2025U.S. dollar notes(b)$1,5005.125%November 2022November 2027U.S. dollar notes(b)$1,2505.625%November 2022November 2029U.S. dollar notes(b)$1,5005.750%November 2022November 2032(a) Interest is payable semi-annually on each May 15 and November 15, commencing May 15, 2023.(b) Interest is payable semi-annually on each May 17 and November 17, commencing May 17, 2023.The weighted-average time to maturity of our long-term debt was approximately 8 years at the end of 2022 and 10 years at the end of 2021. Cash Requirements – At December 31, 2022, our material short-term and long-term cash requirements for various contractual obligations and commitments primarily consisted of the following: •principal payments related to long-term debt and the associated interest payments. For further details, see Item 8, Note 8. Indebtedness to our consolidated financial statements;•accounts payable and accrued liabilities on our consolidated balance sheet (primarily short-term in nature);66•purchase obligations for inventory and production costs to be utilized in the normal course of business such as raw materials, electronic devices, indirect materials and supplies, packaging, co-manufacturing arrangements, storage and distribution, as well as capital expenditures. These purchase obligations are expected to be approximately $3.3 billion in 2023 and approximately $1.6 billion for years beyond;•As part of the agreement with Altria Group, Inc. for PMI to reacquire the IQOS commercialization rights in the U.S., PMI agreed to pay the remaining cash consideration of $1.7 billion (plus interest, at a per annum rate equal to six percent (6%)) by July 2023 at the latest. For further details, see Item 8, Note 3. Acquisitions to our consolidated financial statements; •operating lease liabilities, on an undiscounted basis, which were included in our consolidated balance sheets. For further details, see Item 8, Note 21. Leases to our consolidated financial statements; and•other long-term liabilities mainly related to transition tax. For further details, see Item 8, Note 12. Income Taxes to our consolidated financial statements.We utilize long-term and short-term debt financing, including a commercial paper program that is regularly used to finance ongoing liquidity requirements, as part of our overall cash management strategy. Our ability to access the capital and credit markets as well as overall dynamics of these markets may impact borrowing costs. We expect that the combination of our long-term and short-term debt financing, the commercial paper program and the committed credit facilities, coupled with our operating cash flows, will enable us to meet our liquidity requirements. •Off-Balance Sheet ArrangementsWe have no off-balance sheet arrangements, including special purpose entities, other than guarantees, and cash requirements discussed above.Guarantees – At December 31, 2022, we have guarantees of our own performance, which are primarily related to excise taxes on the shipment of our products. There is no liability in the consolidated financial statements associated with these guarantees. These guarantees have not had, and are not expected to have, a significant impact on PMI’s liquidity. In October 2020, we guaranteed an obligation for an equity method investee. For further details, see Item 8, Note 18. Contingencies to our consolidated financial statements. Equity and DividendsWe discuss our stock awards as of December 31, 2022, in Item 8, Note 10. Stock Plans to our consolidated financial statements. On June 11, 2021, our Board of Directors authorized a new share repurchase program of up to $7 billion, with target spending of $5 billion to $7 billion over a three-year period. On July 22, 2021, we began repurchasing shares under this new share repurchase program. From July 22, 2021 through March 31, 2022, we repurchased 10.5 million shares of our common stock at a cost of approximately $1.0 billion. During the first three months of 2022, we repurchased 2.0 million shares of our common stock at a cost of $199 million. On May 11, 2022, we announced the suspension of our three-year share repurchase program following the recommended public offer to acquire the outstanding shares of Swedish Match from its shareholders. Prior to the suspension of the program, we made no share repurchases during the second quarter of 2022. For further details on Swedish Match, see the Item 8, Note 3. Acquisitions.Dividends paid in 2022 were $7.8 billion. During the third quarter of 2022, our Board of Directors approved a 1.6% increase in the quarterly dividend to $1.27 per common share. As a result, the present annualized dividend rate is $5.08 per common share. Market Risk Counterparty Risk - We predominantly work with financial institutions with strong short- and long-term credit ratings as assigned by Standard & Poor’s and Moody’s. These banks are also part of a defined group of relationship banks. Non-investment grade institutions are only used in certain emerging markets to the extent required by local business needs. We have a conservative approach when it comes to choosing financial counterparties and financial instruments. As such we do not invest or hold investments in any structured or equity-linked products. The majority of our cash and cash equivalents is currently invested with maturities of less than 30 days. We continuously monitor and assess the credit worthiness of all our counterparties. 67 Derivative Financial Instruments - We operate in markets primarily outside of the United States of America, with manufacturing and sales facilities in various locations around the world. Consequently, we use certain financial instruments to manage our foreign currency and interest rate exposure. We use derivative financial instruments principally to reduce our exposure to market risks resulting from fluctuations in foreign exchange and interest rates by creating offsetting exposures. We are not a party to leveraged derivatives and, by policy, do not use derivative financial instruments for speculative purposes. See Item 8, Note 16. Financial Instruments to our consolidated financial statements for further details on our derivative financial instruments and the related collateral arrangements. Value at Risk - We use a value at risk computation to estimate the potential one-day loss in the fair value of our interest-rate-sensitive and foreign currency price-sensitive derivative financial instruments. This computation includes our debt and foreign currency forwards, swaps and options. Anticipated transactions, foreign currency trade payables and receivables, and net investments in foreign subsidiaries, which the foregoing instruments are intended to hedge, were excluded from the computation.The computation estimates were made assuming normal market conditions, using a 95% confidence interval and a one-day holding period using a "parametric delta-gamma" approximation technique to determine the observed interrelationships between movements in interest rates and various currencies and in calculating the risk of the underlying positions in the portfolio. These interrelationships were determined by observing interest rate and forward currency rate movements primarily over the preceding quarter for determining value at risk at December 31, 2022 and 2021, and primarily over each of the four preceding quarters for the calculation of average, high and low value at risk amounts during each year. Fair Value Impact (in millions)At December 31, 2022Average High Low Instruments sensitive to: Foreign currency rates$33$55$73$33Interest rates$233$253$317$195Fair Value Impact (in millions)At December 31, 2021Average High Low Instruments sensitive to: Foreign currency rates$24$36$45$24Interest rates$217$200$217$179The significant year-over-year increase in "average" and "high" impact on the value at risk computation above was primarily due to trends in foreign currency and interest rate volatility.The value at risk computation is a risk analysis tool designed to statistically estimate the maximum probable daily loss from adverse movements in interest and foreign currency rates under normal market conditions. The computation does not purport to represent actual losses in fair value or earnings to be incurred by us, nor does it consider the effect of favorable changes in market rates. We cannot predict actual future movements in such market rates and do not present these results to be indicative of future movements in market rates or to be representative of any actual impact that future changes in market rates may have on our future results of operations or financial position.ContingenciesSee Item 3 and Item 8, Note 18. Contingencies to our consolidated financial statements for a discussion of contingencies.68Cautionary Factors That May Affect Future Results Forward-Looking and Cautionary StatementsWe may from time to time make written or oral forward-looking statements, including statements contained in filings with the SEC, in reports to stockholders and in press releases and investor webcasts. You can identify these forward-looking statements by use of words such as "strategy," "expects," "continues," "plans," "anticipates," "believes," "will," "aspires," "estimates," "intends," "projects," "aims," "goals," "targets," "forecasts" and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts.We cannot guarantee that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Our RRPs constitute a new product category that is less predictable than our mature cigarette business. Achievement of future results is subject to risks, uncertainties and inaccurate assumptions. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from those anticipated, estimated or projected. Investors should bear this in mind as they consider forward-looking statements and whether to invest in or remain invested in our securities. In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we are identifying important factors that, individually or in the aggregate, could cause actual results and outcomes to differ materially from those contained in any forward-looking statements made by us; any such statement is qualified by reference to the following cautionary statements. We elaborate on these and other risks we face throughout this document, particularly in Item 1A. Risk Factors and Business Environment of this section. You should understand that it is not possible to predict or identify all risk factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. We do not undertake to update any forward-looking statement that we may make from time to time, except in the normal course of our public disclosure obligations.Item 7A.Quantitative and Qualitative Disclosures About Market Risk. The information called for by this Item is included in Item 7, Market Risk. 69
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+Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSManagement’s Discussion and Analysis is the company’s analysis of its financial performance and financial condition, and of significant trends that may affect future performance. It should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.The terms “earnings” and “loss” as used in Management’s Discussion and Analysis refer to net income (loss) attributable to Phillips 66. The terms “results,” “before-tax income” or “before-tax loss” as used in Management’s Discussion and Analysis refer to income (loss) before income taxes. EXECUTIVE OVERVIEW AND BUSINESS ENVIRONMENTPhillips 66 is a diversified energy company with Midstream, Chemicals, Refining, and Marketing and Specialties (M&S) operating segments. At December 31, 2022, we had total assets of $76.4 billion.Executive OverviewWe reported earnings of $11 billion and generated $10.8 billion in cash from operating activities for the full year of 2022. During 2022, we used available cash to pay down $2.4 billion in debt, fund capital expenditures and investments of $2.2 billion, pay dividends on our common stock of $1.8 billion and repurchase $1.5 billion of our common stock. We ended 2022 with $6.1 billion of cash and cash equivalents and approximately $6.7 billion of total committed capacity available under our credit facilities.DCP Midstream, LLC (DCP Midstream) and Gray Oak Holdings LLC (Gray Oak Holdings) MergerOn August 17, 2022, we announced a realignment of our economic and governance interests in DCP Midstream, LP (DCP LP) and Gray Oak Pipeline, LLC (Gray Oak Pipeline) resulting from the merger of DCP Midstream and Gray Oak Holdings. In connection with the merger, we were delegated DCP Midstream’s governance rights over DCP LP and its general partner entities, referred to as DCP Midstream Class A Segment. Additionally, Enbridge Inc., our co-venturer, was delegated governance rights over Gray Oak Pipeline, referred to as DCP Midstream Class B Segment. In connection with the merger of DCP Midstream and Gray Oak Holdings, our NGL and Other business includes DCP Midstream Class A Segment, DCP Sand Hills Pipeline, LLC (DCP Sand Hills) and DCP Southern Hills Pipeline, LLC (DCP Southern Hills). Prior to August 18, 2022, our investments in DCP Midstream, DCP Sand Hills and DCP Southern Hills were accounted for using the equity method. We account for our remaining investment in Gray Oak Pipeline, now held through DCP Midstream Class B Segment, using the equity method.See Note 3—DCP Midstream, LLC and Gray Oak Holdings LLC Merger, in the Notes to Consolidated Financial Statements, for additional information on the merger of DCP Midstream and Gray Oak Holdings.40Table of ContentsIndex to Financial StatementsDCP LP Public Common Unit Acquisition AgreementOn January 5, 2023, we entered into a definitive agreement with DCP LP, its subsidiaries and its general partner entities, pursuant to which one of our wholly owned subsidiaries will merge with and into DCP LP, with DCP LP surviving as a Delaware limited partnership. Under the terms of the agreement, at the effective time of the merger, each publicly held common unit representing a limited partner interest in DCP LP (other than the common units owned by DCP LP and DCP Midstream GP, LP) issued and outstanding as of immediately prior to the effective time will be converted into the right to receive $41.75 per common unit in cash, without interest. The merger will increase our economic interest in DCP LP from 43.3% to 86.8%. The transaction is expected to close in the second quarter of 2023, subject to customary closing conditions. The transaction was unanimously approved by the board of the general partner of DCP LP, based on the unanimous approval and recommendation of its special committee comprised entirely of independent directors after evaluation of the transaction by the special committee in consultation with independent financial and legal advisors. Concurrently with the execution of the agreement, affiliates of Phillips 66, which together own greater than a majority of the outstanding DCP LP common units, delivered their consent to approve the transaction. As a result, DCP LP has not solicited and is not soliciting approval of the transaction by any other holders of DCP LP common units. See Note 29—DCP Midstream Class A Segment, in the Notes to Consolidated Financial Statements, for additional information on the common unit acquisition agreement.Phillips 66 Partners MergerOn March 9, 2022, we completed the merger between us and Phillips 66 Partners LP (Phillips 66 Partners). The merger resulted in the acquisition of all limited partnership interests in Phillips 66 Partners not already owned by us. Upon closing, Phillips 66 Partners became a wholly owned subsidiary of Phillips 66 and its common units are no longer publicly traded. See Note 30—Phillips 66 Partners LP, in the Notes to Consolidated Financial Statements, for additional information on this merger transaction.CEO TransitionOn April 12, 2022, Greg C. Garland, announced his intention to retire from his position as Chief Executive Officer of Phillips 66, effective July 1, 2022. Mr. Garland continues to serve as Executive Chairman of the Board with an expected retirement date from this position in 2024. Mark E. Lashier was promoted to the position of President and Chief Executive Officer effective July 1, 2022.We continue to focus on the following strategic priorities:•Operating Excellence. Our commitment to operating excellence guides everything we do. We are committed to protecting the health and safety of everyone who has a role in our operations and the communities in which we operate. Continuous improvement in safety, environmental stewardship, reliability and cost efficiency is a fundamental requirement for our company and employees. We employ rigorous training and audit programs to drive ongoing improvement in both personal and process safety as we strive for zero incidents. In 2022, we achieved a combined workforce total recordable rate of 0.11.Since we cannot control commodity prices, controlling operating expenses and overhead costs, within the context of our commitment to safety and environmental stewardship, is a high priority. We continue to progress our multi-year business transformation initiative focused on identifying and implementing opportunities to improve our cost structure enterprise wide. We are executing on our initiatives to achieve a sustainable run-rate cost reduction of at least $800 million and a sustaining capital reduction of at least $200 million per year by the end of 2023.We are committed to protecting the environment and strive to reduce our environmental footprint throughout our operations. Optimizing utilization rates and product yield at our refineries through reliable and safe operations enables us to capture the value available in the market in terms of prices and margins. During 2022, our worldwide refining crude oil capacity utilization rate was 90% and our worldwide refining clean product yield was 84%.41Table of ContentsIndex to Financial Statements•Growth. A disciplined capital allocation process ensures we invest in projects that are expected to generate competitive returns. Our strategy primarily focuses on investing in high-return growth opportunities in the Midstream and Chemicals segments, as well as our investments in renewable fuels projects to advance a lower-carbon future. In 2023, we have budgeted $2 billion in capital expenditures and investments, which includes $1.1 billion of growth capital. Approximately 50% of growth capital is expected to support lower-carbon opportunities. In Midstream, we have budgeted $639 million for capital expenditures and investments, of which $310 million is for growth capital projects directed towards enhancing our integrated natural gas liquids (NGL) value chain from wellhead to market. In Refining, we have budgeted $1.1 billion for capital expenditures and investments, of which $448 million is for the continued conversion of the San Francisco Refinery in Rodeo, California into a renewable fuels facility. In Chemicals, our share of expected self-funded capital spending by Chevron Phillips Chemical Company LLC (CPChem) is $925 million, of which $702 million is for growth capital projects. CPChem plans to use its growth capital to fund development of its petrochemical projects in the U.S. Gulf Coast and Qatar, as well as expand its propylene splitting capacity and normal alpha olefins production.As part of our strategy to grow our Midstream NGL business, on January 5, 2023, we entered into a definitive agreement to acquire all of the publicly held common units of DCP LP, which will increase our economic interest in DCP LP from 43.3% to 86.8% at closing. This transaction will be accounted for as an equity transaction and is expected to close in the second quarter of 2023, subject to customary closing conditions. We expect to fund this transaction with a combination of cash and debt.•Returns. We plan to enhance Refining returns by focusing on low-capital, higher-return projects that increase asset reliability, improve market capture and reduce costs. Our M&S segment will continue to develop and enhance our retail network, including energy transition opportunities.•Distributions. We believe shareholder value is enhanced through, among other things, a secure, competitive and growing dividend, complemented by share repurchases. In 2022, we paid $1.8 billion of dividends on our common stock. In the second quarter of 2022, we increased our quarterly dividend by 5% to $0.97 per common share. In the first quarter of 2023, we increased our quarterly dividend by 8% to $1.05 per common share. Regular dividends demonstrate the confidence our Board of Directors and management have in our capital structure and operations’ capability to generate free cash flow throughout the business cycle. In the second quarter of 2022, we resumed repurchasing shares under our share repurchase program. In 2022, we repurchased $1.5 billion, or 16.6 million shares, of our common stock. On November 7, 2022, our Board of Directors approved a $5 billion increase to our share repurchase program, bringing the total amount of share repurchases authorized by our Board of Directors since July 2012 to an aggregate of $20 billion. At the discretion of our Board of Directors, we are targeting to return $10 billion to $12 billion to our shareholders through a combination of dividends and share repurchases in the period from July 1, 2022 through December 31, 2024. The amount and timing of future dividend payments and the level and timing of future share repurchases will depend on various factors including our share price, results of operations, financial condition and cash required for future business plans.•High-Performing Organization. We strive to attract, develop and retain individuals with the knowledge and skills to implement our business strategy and who support our values and culture. Throughout the company, we focus on promoting an inclusive workplace that enables our diverse workforce to innovate, create value and deliver extraordinary performance. We also focus on getting results in the right way and embracing our values as a common bond, and we believe success is both what we do and how we do it. We encourage collaboration throughout our company, while valuing differences, respecting diversity, and creating a great place to work. We foster an environment of learning and development through structured programs focused on enhancing functional and technical skills where employees are engaged in our business and committed to their own, as well as the company’s, success.42Table of ContentsIndex to Financial StatementsBusiness EnvironmentThe Midstream segment includes our Transportation and NGL businesses. Our Transportation business contains fee-based operations not directly exposed to commodity price risk. Our NGL business, including DCP Midstream Class A Segment, DCP Sand Hills and DCP Southern Hills from August 18, 2022, forward, contains both fee-based operations and operations directly impacted by NGL, natural gas and condensate prices. During 2022, NGL and natural gas prices increased, compared with 2021, supported by increasing liquified natural gas exports and higher crude oil prices. The Chemicals segment consists of our 50% equity investment in CPChem. The chemicals and plastics industry is mainly a commodity-based industry where the margins for key products are based on supply and demand, as well as cost factors. Compared with 2021, the benchmark high-density polyethylene chain margin decreased significantly in 2022, due to soft demand and increasing capacity, resulting in lower plant operating rates.Our Refining segment results are driven by several factors, including market crack spreads, refinery throughput, feedstock costs, product yields, turnaround activity, and other operating costs. The price of U.S. benchmark crude oil, West Texas Intermediate (WTI) at Cushing, Oklahoma, increased to an average of $94.44 per barrel during 2022, compared with an average of $67.96 per barrel in 2021. Market crack spreads are used as indicators of refining margins and measure the difference between market prices for refined petroleum products and crude oil. Worldwide market crack spreads increased to an average of $34.26 per barrel during 2022, compared with an average of $17.09 per barrel in 2021. The increases in crude oil prices and market crack spreads were primarily driven by improving demand for refined petroleum products, as economic activities gradually recovered as the impacts from the COVID-19 pandemic moderated, as well as tightening supply due to the Russia-Ukraine war and refinery closures that occurred during the pandemic.Results for our M&S segment depend largely on marketing fuel and lubricant margins and sales volumes of our refined petroleum products. While marketing fuel and lubricant margins are primarily driven by market factors, largely determined by the relationship between supply and demand, marketing fuel margins, in particular, are influenced by trends in spot prices, and where applicable, retail prices for refined petroleum products in the regions and countries where we operate. 43Table of ContentsIndex to Financial StatementsRESULTS OF OPERATIONSBasis of PresentationEffective August 18, 2022, forward, in connection with the merger of DCP Midstream and Gray Oak Holdings we began consolidating the results of DCP Midstream Class A Segment, DCP Sand Hills and DCP Southern Hills. As a result of this transaction, we began presenting the results of DCP Midstream Class A Segment within the results of our NGL and Other business. Prior periods also have been updated to reflect the results of our equity investment in DCP Midstream prior to August 18, 2022, within the results of our NGL and Other business. See Note 3—DCP Midstream, LLC and Gray Oak Holdings LLC Merger, Note 4—Business Combination, and Note 18—Fair Value Measurements, in the Notes to Consolidated Financial Statements, for additional information on the merger of DCP Midstream and Gray Oak Holdings.Effective October 1, 2022, we changed the organizational structure of the internal financial information reviewed by our President and Chief Executive Officer, and determined this resulted in a change in the composition of our operating segments. As part of the realignment, we moved the results and net assets of our Merey Sweeny vacuum distillation and delayed coker units at our Sweeny Refinery and the isomerization unit at our Lake Charles Refinery from our Midstream segment to our Refining segment. Additionally, commissions charged to the Refining segment by the M&S segment related to sales of specialty products were eliminated and the costs of the sales organization were reclassified from the M&S segment to the Refining segment. Further, we are no longer presenting disaggregated business line results for our Chemicals and M&S segments to align with changes in our internal financial reporting.Effective January 1, 2022, we began reporting our investment in NOVONIX Limited (NOVONIX) as a separate business line within our Midstream segment. Previously it was included in our NGL and Other business line.The segment realignment and business line reporting changes are presented for the year ended December 31, 2022, with the prior periods recast for comparability.Consolidated ResultsA summary of income (loss) before income taxes by business segment with a reconciliation to net income (loss) attributable to Phillips 66 follows: Millions of DollarsYear Ended December 31 202220212020Midstream$4,734 1,500 (116)Chemicals856 1,844 635 Refining7,816 (2,353)(6,023)Marketing and Specialties2,402 1,723 1,421 Corporate and Other(1,169)(974)(881)Income (loss) before income taxes14,639 1,740 (4,964)Income tax expense (benefit)3,248 146 (1,250)Net income (loss)11,391 1,594 (3,714)Less: net income attributable to noncontrolling interests367 277 261 Net income (loss) attributable to Phillips 66$11,024 1,317 (3,975)44Table of ContentsIndex to Financial Statements2022 vs. 2021 Net income attributable to Phillips 66 for the year ended December 31, 2022, was $11,024 million, compared with $1,317 million for the year ended December 31, 2021. The improvement was primarily due to higher realized refining margins, an aggregate before-tax gain of $3,013 million recognized in our Midstream segment in connection with the merger of DCP Midstream and Gray Oak Holdings, lower impairments in the Refining segment, and improved international marketing fuel margins. These improvements were partially offset by an increase in income tax expense, lower equity earnings from CPChem, and an unrealized decrease in the fair value of our investment in NOVONIX.2021 vs. 2020 Net income attributable to Phillips 66 for the year ended December 31, 2021, was $1,317 million, compared with net loss attributable to Phillips 66 of $3,975 million for the year ended December 31, 2020. The improvement was primarily due to lower impairments, improved realized refining margins and higher equity earnings from CPChem, partially offset by income tax impacts from improved results.See Note 4—Business Combination, and Note 18—Fair Value Measurements, in the Notes to Consolidated Financial Statements, for additional information on the gain recognized in connection with the merger of DCP Midstream and Gray Oak Holdings. See Note 11—Impairments, and Note 18—Fair Value Measurements, in the Notes to Consolidated Financial Statements, for information on impairments recorded in 2021 and 2020. See Note 23—Income Taxes, in the Notes to Consolidated Financial Statements, for additional information on income taxes.See the “Segment Results” section for additional information on our segment results.45Table of ContentsIndex to Financial StatementsStatement of Operations Analysis2022 vs. 2021 Sales and other operating revenues and purchased crude oil and products increased 52% and 47%, respectively, in 2022. These increases were mainly due to higher prices for refined petroleum products, crude oil and NGL.Other income increased $2,283 million in 2022, primarily due to an aggregate gain of $3,013 million recognized in our Midstream segment in connection with the merger of DCP Midstream and Gray Oak Holdings. The impact of this gain was partially offset by an unrealized investment loss on our investment in NOVONIX, compared with an unrealized gain in 2021. See Note 4—Business Combination, and Note 18—Fair Value Measurements, in the Notes to Consolidated Financial Statements, for additional information on the aggregate gain. See Note 8—Investments, Loans and Long-Term Receivables, in the Notes to Consolidated Financial Statements, for additional information regarding our investment in NOVONIX.Operating expenses increased 19% in 2022, mainly attributable to higher utility costs driven by increased natural gas and power prices and higher turnaround and other maintenance expenses.Selling, general and administrative expenses increased 24% in 2022, primarily driven by higher employee-related expenses, restructuring costs due to our business transformation and increased selling expenses driven by rising refined petroleum product prices.Impairments decreased 96% in 2022 primarily due to a before-tax impairment of $1,298 million recorded in the third quarter of 2021 associated with our Alliance Refinery. See Note 11—Impairments, in the Notes to Consolidated Financial Statements, for additional information.Taxes other than income taxes increased 29% in 2022, primarily due to tax credits received from renewable diesel blending activity at our San Francisco Refinery in the third quarter of 2021, as well as higher property and other taxes.Income tax expense increased $3,102 million in 2022 primarily due to improved results. See Note 23—Income Taxes, in the Notes to Consolidated Financial Statements, for more information regarding our income taxes.Net income attributable to noncontrolling interests increased 32% in 2022. The increase was primarily driven by the consolidation of DCP Midstream Class A Segment, DCP Sand Hills and DCP Southern Hills, which resulted in us reflecting the additional noncontrolling interest owned by the public common and preferred unitholders of DCP LP, as well as Enbridge’s noncontrolling interest in DCP Midstream Class A Segment, on our consolidated statement of operations. The increase was partially offset by a decrease due to the merger between us and Phillips 66 Partners that occurred in the first quarter of 2022 and resulted in Phillips 66 Partners becoming a wholly owned subsidiary of Phillips 66. See Note 3—DCP Midstream, LLC and Gray Oak Holdings LLC Merger, and Note 30—Phillips 66 Partners LP, in the Notes to Consolidated Financial Statements, for additional information on the merger of DCP Midstream and Gray Oak Holdings and the Phillips 66 Partners merger, respectively.46Table of ContentsIndex to Financial Statements2021 vs. 2020 Sales and other operating revenues and purchased crude oil and products increased 74% and 77%, respectively, in 2021. These increases were mainly due to higher prices for refined petroleum products, crude oil and NGL, as well as increased volumes for refined petroleum products and crude oil. Equity in earnings of affiliates increased $1,713 million in 2021. The increase was primarily due to higher equity earnings from CPChem mainly driven by increased margins, WRB Refining LP (WRB) resulting from improved realized refining margins and higher refinery production, and Excel Paralubes LLC (Excel Paralubes) attributable to higher base oil margins. See Chemicals segment analysis in the “Segment Results” section for additional information on CPChem.Net gain on dispositions decreased 83% in 2021, mainly reflecting a before-tax gain of $84 million recognized in the second quarter of 2020 associated with a co-venturer’s acquisition of an ownership interest in the consolidated holding company that owned an interest in Gray Oak Pipeline. See Note 30—Phillips 66 Partners LP, in the Notes to Consolidated Financial Statements, for additional information.Other income increased $388 million in 2021, primarily driven by an unrealized gain of $365 million related to the change in fair value of our investment in NOVONIX, which we acquired in the third quarter of 2021. See Note 8—Investments, Loans and Long-Term Receivables, in the Notes to Consolidated Financial Statements, for additional information on our investment in NOVONIX.Operating expenses increased 13% in 2021, mainly attributable to higher utility costs driven by increased commodity prices, higher employee-related expenses, and increased maintenance and repair costs.Selling, general and administrative expenses increased 13% in 2021, primarily driven by higher selling expenses due to rising refined petroleum product prices and demand, increased employee-related expenses, and a benefit received from a legal settlement in the first quarter of 2020.Depreciation and amortization increased 15% in 2021, mainly due to asset retirements related to the shutdown of our Alliance Refinery. See Note 9—Properties, Plants and Equipment, in the Notes to Consolidated Financial Statements, for additional information regarding asset retirements related to the Alliance Refinery. Impairments decreased 65% in 2021. See Note 11—Impairments, in the Notes to Consolidated Financial Statements, for additional information regarding impairments.Taxes other than income taxes decreased 12% in 2021, primarily driven by tax credits received from renewable diesel blending activity at our San Francisco Refinery in 2021, and lower property and franchise taxes.Interest and debt expense increased 16% in 2021, primarily driven by lower capitalized interest due to the completion of capital projects and the placement of assets into service, as well as higher average debt principal balances resulting from new debt issuances in the second and fourth quarters of 2020.We had income tax expense of $146 million in 2021, compared with an income tax benefit of $1,250 million in 2020, primarily due to before-tax income in 2021 versus a before-tax loss in 2020. See Note 23—Income Taxes, in the Notes to Consolidated Financial Statements, for more information regarding our income taxes.47Table of ContentsIndex to Financial StatementsSegment ResultsMidstream Year Ended December 31 202220212020 Millions of DollarsIncome (Loss) Before Income TaxesTransportation$1,176 678 508 NGL and Other4,000 452 (624)NOVONIX(442)370 — Total Midstream$4,734 1,500 (116)Thousands of Barrels DailyTransportation VolumesPipelines*3,089 3,271 3,005 Terminals2,981 2,790 2,971 Operating StatisticsNGL fractionated**529 410 249 NGL production***423 394 399 * Pipelines represent the sum of volumes transported through each separately tariffed consolidated pipeline segment, excluding NGL pipelines.** Includes 100% of DCP Midstream Class A Segment’s volumes from August 18, 2022, forward.*** Includes 100% of DCP Midstream Class A Segment’s volumes. Dollars Per GallonMarket IndicatorWeighted-Average NGL Price*$1.00 0.83 0.41 * Based on index prices from the Mont Belvieu market hub, which are weighted by NGL component mix.The Midstream segment provides crude oil and refined petroleum product transportation, terminaling and processing services; NGL production, transportation, storage, fractionation, processing and marketing services; natural gas gathering, compressing, treating, processing, storage, transportation and marketing services; and condensate recovery. These activities are mainly in the United States. This segment also includes our investment in NOVONIX.In connection with the merger of DCP Midstream and Gray Oak Holdings, the results of our Transportation business reflect a decrease in our indirect economic interest in Gray Oak Pipeline to 6.5% from August 18, 2022, forward. Prior to August 18, 2022, the Transportation results presented in the table above reflect Gray Oak Holdings’ 65% economic interest in Gray Oak Pipeline. In addition, the results of our NGL and Other business include the consolidated results of DCP Midstream Class A Segment, DCP Sand Hills and DCP Southern Hills from August 18, 2022, forward. Prior to August 18, 2022, our investments in DCP Midstream, DCP Sand Hills and DCP Southern Hills were accounted for using the equity method. As a result of the merger and consolidation, equity earnings from our investment in DCP Midstream prior to the merger have been included with the results of our NGL and Other business.48Table of ContentsIndex to Financial Statements2022 vs. 2021 Results from our Midstream segment increased $3,234 million in 2022, compared with 2021. Results from our Transportation business increased $498 million in 2022, compared with 2021. The increase was primarily due to a before-tax impairment of $198 million recorded in the first quarter of 2021 related to Phillips 66 Partners’ decision to exit the Liberty Pipeline project, a before-tax gain of $182 million from the transfer of a 35.75% indirect economic interest in Gray Oak Pipeline to our co-venturer as part of the merger of DCP Midstream and Gray Oak Holdings, and lower depreciation and amortization expense from logistic assets that were retired in the fourth quarter of 2021 as part of the planned conversion of the Alliance Refinery to a terminal.Results from our NGL and Other business increased $3,548 million in 2022, compared with 2021. The increase was primarily due to before-tax gains totaling $2,831 million recognized from remeasuring our previously held equity investments in DCP Midstream, DCP Sand Hills and DCP Southern Hills to their fair values in connection with the merger of DCP Midstream and Gray Oak Holdings. Additionally, the increased results reflect the consolidation of DCP Midstream Class A Segment, DCP Sand Hills and DCP Southern Hills from August 18, 2022, forward, as well as improved Sweeny Hub results.In 2022, the fair value of our investment in NOVONIX decreased by $442 million compared with an increase of $370 million in 2021. We acquired this investment in September 2021. See Note 11—Impairments, and Note 8—Investments, Loans and Long-Term Receivables, in the Notes to Consolidated Financial Statements, for additional information on impairments and our investment in NOVONIX, respectively. See Note 4—Business Combination, and Note 18—Fair Value Measurements, in the Notes to Consolidated Financial Statements, for additional information regarding the before-tax gains. See the “Executive Overview and Business Environment” section for information on market factors impacting 2022 results.2021 vs. 2020 Midstream’s results increased $1,616 million in 2021, compared with 2020. Results from our Transportation business increased $170 million in 2021, compared with 2020. The increase was primarily due to improved earnings from our equity affiliates, lower asset impairments, and increased pipeline volumes and tariffs. These increases were partially offset by a before-tax gain of $84 million recognized in the second quarter of 2020 associated with a co-venturer’s acquisition of an ownership interest in the consolidated holding company that owned an interest in Gray Oak Pipeline, and increased depreciation and amortization expense from logistic assets that were retired in the fourth quarter of 2021 as part of the planned conversion of the Alliance Refinery to a terminal.Results from our NGL and Other business increased $1,076 million in 2021, compared with 2020. The increase in 2021 reflects a $1,161 million before-tax impairment of our investment in DCP Midstream recorded in the first quarter of 2020, partially offset by higher utility costs due to increased natural gas prices. The fair value of our investment in NOVONIX increased $370 million in 2021, compared with 2020. We acquired this investment in September 2021.See Note 11—Impairments, Note 30—Phillips 66 Partners LP and Note 8—Investments, Loans and Long-Term Receivables, in the Notes to Consolidated Financial Statements, for additional information on impairments, the before-tax gain and our investment in NOVONIX, respectively.49Table of ContentsIndex to Financial StatementsChemicals Year Ended December 31 202220212020 Millions of DollarsIncome Before Income Taxes$856 1,844 635 Millions of PoundsCPChem Externally Marketed Sales Volumes*23,749 24,067 25,360 * Represents 100% of CPChem’s outside sales of produced petrochemical products, as well as commission sales from equity affiliates.Olefins and Polyolefins Capacity Utilization (percent)91 %95 99 The Chemicals segment consists of our 50% interest in CPChem, which we account for under the equity method. CPChem uses NGL and other feedstocks to produce petrochemicals. These products are then marketed and sold or used as feedstocks to produce plastics and other chemicals. CPChem produces and markets ethylene and other olefin products. Ethylene produced is primarily consumed within CPChem for the production of polyethylene, normal alpha olefins and polyethylene pipe. CPChem manufactures and markets aromatics and styrenics products, such as benzene, cyclohexane, styrene and polystyrene, as well as manufactures and/or markets a variety of specialty chemical products. Unless otherwise noted, amounts referenced below reflect our net 50% interest in CPChem.2022 vs. 2021 Before-tax income from the Chemicals segment decreased $988 million in 2022, compared with 2021. The decrease was primarily due to lower margins driven by decreased sale prices, higher feedstock and utility costs, as well as decreased results from CPChem’s equity affiliates.See the “Executive Overview and Business Environment” section for information on market factors impacting CPChem’s 2022 results.2021 vs. 2020 Before-tax income from the Chemicals segment increased $1,209 million in 2021, compared with 2020. The increase was primarily due to improved margins driven by increased sale prices reflecting strong demand and tight supply, partially offset by higher utility, turnaround, maintenance and repair costs.50Table of ContentsIndex to Financial StatementsRefining Year Ended December 31 202220212020Millions of DollarsIncome (Loss) Before Income TaxesAtlantic Basin/Europe$2,402 1 (1,207)Gulf Coast2,091 (1,759)(1,964)Central Corridor2,415 72 (642)West Coast908 (667)(2,210)Worldwide$7,816 (2,353)(6,023)Dollars Per BarrelIncome (Loss) Before Income TaxesAtlantic Basin/Europe$12.05 0.01 (7.08)Gulf Coast10.29 (7.30)(9.18)Central Corridor24.64 0.75 (6.97)West Coast7.86 (5.90)(19.98)Worldwide12.69 (3.69)(10.26)Realized Refining Margins*Atlantic Basin/Europe$20.30 7.48 2.17 Gulf Coast18.25 5.65 2.64 Central Corridor24.96 9.65 7.17 West Coast24.31 7.70 3.43 Worldwide21.55 7.42 3.77 * See the “Non-GAAP Reconciliations” section for a reconciliation of this non-GAAP measure to the most directly comparable measure under generally accepted accounting principles in the United States (GAAP), income (loss) before income taxes per barrel.51Table of ContentsIndex to Financial StatementsThousands of Barrels Daily Year Ended December 31 202220212020Operating StatisticsRefining operations*Atlantic Basin/EuropeCrude oil capacity537 537 537 Crude oil processed524 479 434 Capacity utilization (percent)98 %89 81 Refinery production549 522 470 Gulf Coast**Crude oil capacity529 720 769 Crude oil processed488 592 533 Capacity utilization (percent)92 %82 69 Refinery production565 662 586 Central CorridorCrude oil capacity531 531 530 Crude oil processed469 461 431 Capacity utilization (percent)88 %87 81 Refinery production487 476 446 West CoastCrude oil capacity364 364 364 Crude oil processed290 284 279 Capacity utilization (percent)80 %78 77 Refinery production315 308 301 WorldwideCrude oil capacity1,961 2,152 2,200 Crude oil processed1,771 1,816 1,677 Capacity utilization (percent)90 %84 76 Refinery production1,916 1,968 1,803 * Includes our share of equity affiliates.** Excludes operating statistics of the Alliance Refinery beginning on October 1, 2021.The Refining segment refines crude oil and other feedstocks into petroleum products, such as gasoline, distillates and aviation fuels, as well as renewable fuels, at 12 refineries in the United States and Europe. In the fourth quarter of 2021, we shut down our Alliance Refinery.2022 vs. 2021 Results from the Refining segment increased $10,169 million in 2022, compared with 2021. The improved results were primarily due to higher realized refining margins driven by improved market crack spreads, partially offset by higher operating costs. In addition, 2021 included a before-tax impairment of $1,288 million associated with our Alliance Refinery. See Note 11—Impairments, in the Notes to Consolidated Financial Statements, for additional information regarding this impairment.Our worldwide refining crude oil capacity utilization rate was 90% and 84% in 2022 and 2021, respectively. The increase in 2022 was primarily driven by improved demand for refined petroleum products due to supply constraints caused by the conflict between Russia and Ukraine and easing of restrictions from the COVID-19 pandemic.See the “Executive Overview and Business Environment” section for information on industry crack spreads and other market factors impacting this year’s results.52Table of ContentsIndex to Financial Statements2021 vs. 2020 Results from the Refining segment increased $3,670 million in 2021, compared with 2020. The improved results in 2021 were primarily due to higher realized refining margins and lower asset impairments, partially offset by increased utility expenses and higher costs related to the shutdown of our Alliance Refinery. The improved realized refining margins in 2021 were mainly attributable to increased market crack spreads, partially offset by higher RIN costs, lower clean product differentials and decreased secondary products margins. See Note 11—Impairments, in the Notes to Consolidated Financial Statements, for additional information regarding impairments recorded in our Refining segment during 2021 and 2020.Our worldwide refining crude oil capacity utilization rate was 84% and 76% in 2021 and 2020, respectively. The increase in 2021 was primarily driven by improved market demand for refined petroleum products following the administration of COVID-19 vaccines and the easing of pandemic restrictions.53Table of ContentsIndex to Financial StatementsMarketing and Specialties Year Ended December 31202220212020Millions of DollarsIncome Before Income Taxes$2,402 1,723 1,421 Dollars Per BarrelIncome Before Income TaxesU.S.$1.95 1.74 1.42 International7.44 4.13 4.84 Realized Marketing Fuel Margins*U.S.$2.34 2.19 1.87 International8.29 5.96 6.34 * See the “Non-GAAP Reconciliations” section for a reconciliation of this non-GAAP measure to the most directly comparable GAAP measure, income before income taxes per barrel.Dollars Per GallonU.S. Average Wholesale Prices*Gasoline$3.30 2.46 1.56 Distillates3.86 2.36 1.47 * On third-party branded refined petroleum product sales, excluding excise taxes.Thousands of Barrels DailyMarketing Refined Petroleum Product SalesGasoline1,167 1,154 1,021 Distillates962 959 895 Other18 17 17 2,147 2,130 1,933 The M&S segment purchases for resale and markets refined petroleum products, such as gasoline, distillates and aviation fuels, as well as renewable fuels, mainly in the United States and Europe. In addition, this segment includes the manufacturing and marketing of base oils and lubricants. 2022 vs. 2021 Before-tax income from the M&S segment increased $679 million in 2022, compared with 2021. The increase in 2022 was primarily driven by improved realized international marketing fuel margins and higher results from our specialty lubricants and other businesses.See the “Executive Overview and Business Environment” section for information on marketing fuel margins and other market factors impacting 2022 results.2021 vs. 2020 Before-tax income from the M&S segment increased $302 million in 2021, compared with 2020. The increase in 2021 was primarily driven by higher realized U.S. marketing fuel margins and increased equity earnings from Excel Paralubes due to improved base oil margins, partially offset by lower realized international marketing fuel margins.54Table of ContentsIndex to Financial StatementsCorporate and Other Millions of DollarsYear Ended December 31 202220212020Loss Before Income TaxesNet interest expense$(537)(583)(485)Corporate overhead and other(632)(391)(396)Total Corporate and Other$(1,169)(974)(881)Net interest expense consists of interest and financing expense, net of interest income and capitalized interest. Corporate overhead and other includes general and administrative expenses, technology costs, environmental costs associated with sites no longer in operation, restructuring costs related to our business transformation, foreign currency transaction gains and losses, and other costs not directly associated with an operating segment.2022 vs. 2021 Net interest expense decreased $46 million in 2022, compared with 2021, primarily driven by increased interest income, partially offset by increased interest expense as a result of consolidating DCP Midstream Class A Segment from August 18, 2022, forward. See Note 14—Debt, in the Notes to Consolidated Financial Statements, for additional information regarding debt.Corporate overhead and other increased $241 million in 2022, compared with 2021. The increase was primarily due to restructuring costs associated with our business transformation for consulting fees, severance and an impairment related to assets held for sale, as well as higher employee related expenses. See Note 28—Segment Disclosures and Related Information, and Note 31—Restructuring, in the Notes to Consolidated Financial Statements, for additional information regarding restructuring costs.2021 vs. 2020 Net interest expense increased $98 million in 2021, compared with 2020, primarily driven by lower capitalized interest due to the completion of capital projects and the placement of assets into service, and higher average debt principal balances reflecting debt issuances in the second and fourth quarters of 2020, as well as costs associated with early debt retirement in 2021. See Note 14—Debt, in the Notes to Consolidated Financial Statements, for additional information on the debt repayment in 2021. Corporate overhead and other decreased $5 million in 2021, compared with 2020.55Table of ContentsIndex to Financial StatementsCAPITAL RESOURCES AND LIQUIDITYFinancial IndicatorsMillions of Dollars, Except as Indicated202220212020Cash and cash equivalents$6,133 3,147 2,514 Net cash provided by operating activities10,813 6,017 2,111 Short-term debt529 1,489 987 Total debt17,190 14,448 15,893 Total equity34,106 21,637 21,523 Percent of total debt to capital*34 %40 42 Percent of floating-rate debt to total debt— %3 12 * Capital includes total debt and total equity.To meet our short- and long-term liquidity requirements, we use a variety of funding sources but rely primarily on cash generated from operating activities and debt financing. During 2022, we generated $10.8 billion in cash from operations. We used available cash to pay down $2.4 billion in debt, fund capital expenditures and investments of $2.2 billion, pay dividends on our common stock of $1.8 billion and repurchase $1.5 billion of our common stock. During 2022, cash and cash equivalents increased $3 billion to $6.1 billion.Significant Sources of CapitalOperating ActivitiesDuring 2022, cash generated by operating activities was $10.8 billion, a $4.8 billion increase compared with 2021. The increase was primarily due to higher earnings resulting from improved realized refining margins, partially offset by working capital impacts and lower distributions from equity affiliates.During 2021, cash generated by operating activities was $6 billion, a $3.9 billion increase compared with 2020. The increase was primarily due to improved realized refining margins, a U.S. federal income tax refund of $1.1 billion received in the second quarter of 2021, and higher cash distributions from our equity affiliates, partially offset by higher operating expenses.Our short- and long-term operating cash flows are highly dependent upon refining and marketing margins, NGL prices and chemicals margins. Prices and margins in our industry are typically volatile, and are driven by market conditions over which we have little or no control. Absent other mitigating factors, as these prices and margins fluctuate, we would expect a corresponding change in our operating cash flows. The level and quality of output from our refineries also impact our cash flows. Factors such as operating efficiency, maintenance turnarounds, market conditions, feedstock availability, and weather conditions can affect output. We actively manage the operations of our refineries, and any variability in their operations typically has not been as significant to cash flows as that caused by margins and prices. Our worldwide refining crude oil capacity utilization was 90%, 84% and 76% in 2022, 2021 and 2020, respectively. Our worldwide refining clean product yield was 84%, 83% and 84% in 2022, 2021 and 2020, respectively.Equity Affiliate Operating DistributionsOur operating cash flows are also impacted by distribution decisions made by our equity affiliates, including CPChem. Over the three years ended December 31, 2022, our operating cash flows included aggregate distributions from our equity affiliates of $6 billion, including $2.8 billion from CPChem. We cannot control the amount of future dividends from equity affiliates; therefore, future dividend payments by these equity affiliates are not assured.56Table of ContentsIndex to Financial StatementsTax RefundsWe received a U.S. federal income tax refund of $1.1 billion in the second quarter of 2021. Credit Facilities and Commercial PaperPhillips 66 and Phillips 66 CompanyOn June 23, 2022, we entered into a new $5 billion revolving credit facility (the Facility) with Phillips 66 Company as the borrower and Phillips 66 as the guarantor and a scheduled maturity date of June 22, 2027. The Facility replaced our previous $5 billion revolving credit facility with Phillips 66 as the borrower and Phillips 66 Company as the guarantor. The Facility contains usual and customary covenants that are similar to the previous revolving credit facility, including a maximum consolidated net debt-to-capitalization ratio of 65% as of the last day of each fiscal quarter. We have the option to increase the overall capacity to $6 billion, subject to certain conditions. We also have the option to extend the scheduled maturity of the Facility for up to two additional one-year terms, subject to, among other things, the consent of the lenders holding the majority of the commitments and of each lender extending its commitment. Outstanding borrowings under the Facility bear interest at either (a) the Adjusted Term Secured Overnight Financing Rate (SOFR) (as described in the Facility) in effect from time to time plus the applicable margin; or (b) the reference rate (as described in the Facility) plus the applicable margin. The Facility also provides for customary fees, including commitment fees. The pricing levels for the commitment fees and interest-rate margins are determined based on the ratings in effect for our senior unsecured long-term debt from time to time. We may at any time prepay outstanding borrowings, in whole or in part, without premium or penalty. At December 31, 2022 and 2021, no amount had been drawn under our revolving credit facilities.Phillips 66 also has a $5 billion uncommitted commercial paper program for short-term working capital needs that is supported by the Facility. Commercial paper maturities are contractually limited to 365 days. At December 31, 2022 and 2021, no borrowings were outstanding under the program. Phillips 66 PartnersIn connection with entering into the Facility, we terminated Phillips 66 Partners’ $750 million revolving credit facility.DCP Midstream Class A SegmentDCP LP has a credit facility under its amended credit agreement (the Credit Agreement), with a borrowing capacity of up to $1.4 billion that matures on March 18, 2027. The Credit Agreement grants DCP LP the option to increase the revolving loan commitment by an aggregate principal amount of up to $500 million and to extend the term for up to two additional one-year periods, subject to requisite lender approval. Indebtedness under the Credit Agreement bears interest at either: (a) an adjusted SOFR (as described in the Credit Agreement) plus the applicable margin; or (b) the base rate (as described in the Credit Agreement) plus the applicable margin. The Credit Agreement also provides for customary fees, including commitment fees. The cost of borrowing under the Credit Agreement is determined by a ratings-based pricing grid based on DCP LP’s credit rating. At December 31, 2022, DCP LP had no borrowings outstanding under the Credit Agreement. At December 31, 2022, $10 million in letters of credit had been issued that are supported by the Credit Agreement.DCP LP has an accounts receivable securitization facility (the Securitization Facility) that provides for up to $350 million of borrowing capacity through August 2024 at an adjusted SOFR and includes an uncommitted option to increase the total commitments under the Securitization Facility by up to an additional $400 million. Under the Securitization Facility, certain of DCP LP’s wholly owned subsidiaries sell or contribute receivables to another of DCP LP’s consolidated subsidiaries, DCP Receivables LLC (DCP Receivables), a bankruptcy-remote special purpose entity created for the sole purpose of the Securitization Facility. At December 31, 2022, $40 million of borrowings were outstanding under the Securitization Facility, which are secured by its accounts receivable at DCP Receivables.57Table of ContentsIndex to Financial StatementsTotal Committed Capacity AvailableAt December 31, 2022, we had approximately $6.7 billion of total committed capacity available under the credit facilities described above. At December 31, 2021, we had approximately $5.7 billion of total committed capacity available under our revolving credit facilities.Other Debt Issuances and FinancingsSenior Unsecured NotesIn November 2021, Phillips 66 closed its public offering of $1 billion aggregate principal amount of 3.300% senior unsecured notes due 2052. Interest on the Senior Notes due 2052 is payable semiannually on March 15 and September 15 of each year, commencing on March 15, 2022. Proceeds received from the public offering were $982 million, net of underwriters’ discounts and commissions, as well as debt issuance costs. In December 2021, Phillips 66 used the proceeds from this offering, together with cash on hand, to repay $1 billion in aggregate principal amount of its $2 billion 4.300% Senior Notes due April 2022.In November 2020, Phillips 66 closed its public offering of $1.75 billion aggregate principal amount of senior unsecured notes consisting of:•$450 million aggregate principal amount of Floating Rate Senior Notes due 2024.•$800 million aggregate principal amount of 0.900% Senior Notes due 2024.•$500 million aggregate principal amount of 1.300% Senior Notes due 2026.The Floating Rate Senior Notes bear interest at a floating rate, reset quarterly, equal to the three-month London Interbank Offered Rate plus 0.62% per year, subject to adjustment. In December 2021, we used cash on hand to repay the $450 million Floating Rate Senior Notes due 2024. Interest on the Senior Notes due 2024 and 2026 is payable semiannually on February 15 and August 15 of each year, commencing on February 15, 2021. Proceeds received from the public offering of senior unsecured notes in November 2020 were $1.74 billion, net of underwriters’ discounts and commissions, as well as debt issuance costs. In June 2020, Phillips 66 closed its public offering of $1 billion aggregate principal amount of senior unsecured notes consisting of:•$150 million aggregate principal amount of 3.850% Senior Notes due 2025.•$850 million aggregate principal amount of 2.150% Senior Notes due 2030.In April 2020, Phillips 66 closed its public offering of $1 billion aggregate principal amount of senior unsecured notes consisting of:•$500 million aggregate principal amount of 3.700% Senior Notes due 2023.•$500 million aggregate principal amount of 3.850% Senior Notes due 2025. Interest on the Senior Notes due 2023 is payable semiannually on April 6 and October 6 of each year, commencing on October 6, 2020. The Senior Notes due 2025 issued in June 2020 constitute a further issuance of the Senior Notes due 2025 originally issued in April 2020. The $650 million in aggregate principal amount of Senior Notes due 2025 is treated as a single class of debt securities. Interest on the Senior Notes due 2025 is payable semiannually on April 9 and October 9 of each year, commencing on October 9, 2020. Interest on the Senior Notes due 2030 is payable semiannually on June 15 and December 15 of each year, commencing on December 15, 2020. Proceeds received from the public offerings of senior unsecured notes in June and April of 2020 were $1,008 million exclusive of accrued interest received, and $993 million, respectively, net of underwriters’ discounts or premiums and commissions, as well as debt issuance costs. 58Table of ContentsIndex to Financial StatementsTerm Loan FacilityIn April 2021, Phillips 66 Partners entered into a $450 million term loan agreement with a one-year term and borrowed the full amount. The term loan agreement was repaid upon maturity in April 2022 without premium or penalty.In March 2020, we entered into a $1 billion 364-day delayed draw term loan agreement (the Facility) and borrowed $1 billion under the Facility shortly thereafter. In November 2020, we repaid $500 million of borrowings outstanding under the Facility, and the Facility was amended to extend the maturity date of the remaining $500 million to November 20, 2023. In September 2021, we repaid the outstanding borrowings of $500 million.Phillips 66 Availability of Debt FinancingWe have an A3 credit rating, with a stable outlook, from Moody’s Investors Service and a BBB+ credit rating, with a stable outlook, from Standard & Poor’s. These investment grade ratings have served to lower our borrowing costs and facilitate access to a variety of lenders. We do not have any ratings triggers on any of our corporate debt that would cause an automatic default, and thereby impact our access to liquidity, in the event of a rating downgrade by one or both rating agencies. Failure to maintain investment grade ratings could prohibit us from accessing the commercial paper market, although we would expect to be able to access funds under our liquidity facilities mentioned above.DCP LP Availability of Debt FinancingDCP LP has a BBB+ credit rating, with a stable outlook, from Standard and Poor’s; a BBB- credit rating, with a stable outlook, from Fitch Ratings; and a Ba1 credit rating, with a positive outlook, from Moody’s Investors Service. These ratings facilitate DCP LP access to a variety of lenders. DCP LP does not have any ratings triggers on any of its corporate debt that would cause an automatic default, and thereby impact access to liquidity, in the event of a rating downgrade by one or more rating agencies.59Table of ContentsIndex to Financial StatementsOff-Balance Sheet ArrangementsLease Residual Value GuaranteesUnder the operating lease agreement for our headquarters facility in Houston, Texas, we have the option, at the end of the lease term in September 2025, to request to renew the lease, purchase the facility or assist the lessor in marketing it for resale. We have a residual value guarantee associated with the operating lease agreement with a maximum potential future exposure of $514 million at December 31, 2022. We also have residual value guarantees associated with railcar and airplane leases with maximum potential future exposures totaling $156 million. These leases have remaining terms of five to nine years.Dakota Access, LLC (Dakota Access) and Energy Transfer Crude Oil Company, LLC (ETCO)In 2020, the trial court presiding over litigation brought by the Standing Rock Sioux Tribe (the Tribe) ordered the U.S. Army Corps of Engineers (USACE) to prepare an Environmental Impact Statement (EIS) addressing an easement under Lake Oahe in North Dakota. The court later vacated the easement. Although the easement is vacated, the USACE has no plans to stop pipeline operations while it proceeds with the EIS, and the Tribe’s request for a shutdown was denied in May 2021. In June 2021, the trial court dismissed the litigation entirely. Once the EIS is completed, new litigation or challenges may be filed.In February 2022, the U.S. Supreme Court (the Court) denied Dakota Access’ writ of certiorari requesting the Court to review the lower court’s decision to order the EIS and vacate the easement. Therefore, the requirement to prepare the EIS stands. Also in February 2022, the Tribe withdrew as a cooperating agency, causing the USACE to halt the EIS process while the USACE engaged with the Tribe on their reasons for withdrawing. The draft EIS process resumed in August 2022, and release is expected in Spring 2023.Dakota Access and ETCO have guaranteed repayment of senior unsecured notes issued by a wholly owned subsidiary of Dakota Access in March 2019. On April 1, 2022, Dakota Access’ wholly owned subsidiary repaid $650 million aggregate principal amount of its outstanding senior notes upon maturity. We funded our 25% share, or $163 million, with a capital contribution of $89 million in March 2022 and $74 million of distributions we elected not to receive from Dakota Access in the first quarter of 2022. At December 31, 2022, the aggregate principal amount outstanding of Dakota Access’ senior unsecured notes was $1.85 billion.In conjunction with the notes offering, Phillips 66 Partners, now a wholly owned subsidiary of Phillips 66, and its co-venturers in Dakota Access also provided a Contingent Equity Contribution Undertaking (CECU). Under the CECU, the co-venturers may be severally required to make proportionate equity contributions to Dakota Access if there is an unfavorable final judgment in the above-mentioned ongoing litigation. At December 31, 2022, our 25% share of the maximum potential equity contributions under the CECU was approximately $467 million.If the pipeline is required to cease operations, and should Dakota Access and ETCO not have sufficient funds to pay ongoing expenses, we could be required to support our 25% share of the ongoing expenses, including scheduled interest payments on the notes of approximately $20 million annually, in addition to the potential obligations under the CECU at December 31, 2022.See Note 15—Guarantees, in the Notes to Consolidated Financial Statements, for additional information on our guarantees.60Table of ContentsIndex to Financial StatementsCapital RequirementsCapital Expenditures and InvestmentsFor information about our capital expenditures and investments, see the “Capital Spending” section below. Debt FinancingOur debt balance at December 31, 2022, was $17.2 billion and our total debt-to-capital ratio was 34%. In December 2022, Phillips 66 repaid its 3.700% senior notes due April 2023 with an aggregate principal amount of $500 million.After our consolidation of DCP Midstream Class A Segment on August 17, 2022, DCP LP repaid $470 million of borrowings under its accounts receivable securitization and revolving credit facilities that were outstanding on the acquisition date.In April 2022, upon maturity, Phillips 66 repaid its 4.300% senior notes with an aggregate principal amount of $1.0 billion and Phillips 66 Partners repaid its $450 million term loan.See Note 14—Debt, in the Notes to Consolidated Financial Statements, for our annual debt maturities over the next five years and more information on debt repayments.Debt ExchangeOn May 5, 2022, Phillips 66 Company, a wholly owned subsidiary of Phillips 66, completed offers to exchange (the Exchange Offers) all validly tendered notes of seven different series of notes issued by Phillips 66 Partners (collectively, the Old Notes), with an aggregate principal amount of approximately $3.5 billion, for notes issued by Phillips 66 Company (collectively, the New Notes). The New Notes are fully and unconditionally guaranteed by Phillips 66 and rank equally with Phillips 66 Company’s other unsecured and unsubordinated indebtedness, and the guarantees rank equally with Phillips 66’s other unsecured and unsubordinated indebtedness.Old Notes with an aggregate principal amount of approximately $3.2 billion were tendered in the Exchange Offers. The New Notes have the same interest rates, interest payment dates and maturity dates as the Old Notes. Holders that validly tendered before the end of the early participation period on April 19, 2022 (the Early Participation Date), received New Notes with an aggregate principal amount equivalent to the Old Notes, while holders that validly tendered after the Early Participation Date, but before the Expiration Date, received New Notes with an aggregate principal amount 3% less than the Old Notes. Substantially all of the Old Notes exchanged were tendered during the Early Participation Period.Joint Venture LoansStarting in 2020 and extending through the second quarter of 2022, we and our co-venturer provided member loans to WRB. By December 31, 2022, WRB had repaid all outstanding member loans. At December 31, 2021, our share of the outstanding member loan balance, including accrued interest, was $595 million. The need for additional loans to WRB in 2023 will depend on market conditions.DCP Midstream and Gray Oak Holdings MergerOn August 17, 2022, we and our co-venturer, Enbridge, agreed to merge DCP Midstream and Gray Oak Holdings with DCP Midstream as the surviving entity. As part of the merger, we made a net cash payment of $306 million.DCP LP Public Common Unit Acquisition AgreementOn January 5, 2023, we entered into a definitive agreement with DCP LP, its subsidiaries and its general partner entities, pursuant to which one of our wholly owned subsidiaries will merge with and into DCP LP, with DCP LP surviving as a Delaware limited partnership. Under the terms of the agreement, at the effective time of the merger, each publicly held common unit representing a limited partner interest in DCP LP (other than the common units owned by DCP LP and DCP Midstream GP, LP) issued and outstanding as of immediately prior to the effective time will be converted into the right to receive $41.75 per common unit in cash, without interest. The merger will increase our economic interest in DCP LP from 43.3% to 86.8%. The transaction is expected to close in the second quarter of 2023, subject to customary closing conditions. 61Table of ContentsIndex to Financial StatementsIf the merger is successfully completed, we will pay approximately $3.8 billion in cash consideration, which we expect to fund through a combination of cash generated from operating activities and debt. The transaction was unanimously approved by the board of the general partner of DCP LP, based on the unanimous approval and recommendation of its special committee comprised entirely of independent directors after evaluation of the transaction by the special committee in consultation with independent financial and legal advisors. Concurrently with the execution of the agreement, affiliates of Phillips 66, which together own greater than a majority of the outstanding DCP LP common units, delivered their consent to approve the transaction. As a result, DCP LP has not solicited and is not soliciting approval of the transaction by any other holders of DCP LP common units. See Note 3—DCP Midstream, LLC and Gray Oak Holdings LLC Merger and Note 29—DCP Midstream Class A Segment, in the Notes to the Consolidated Financial Statements, for additional information on the merger of DCP Midstream and Gray Oak Holdings.DCP LP Cash Distributions to UnitholdersDCP LP’s partnership agreement requires that, within 45 days after the end of each quarter, DCP LP distributes all available cash. Since the merger on August 18, 2022, DCP LP made cash distributions of $51 million to common unitholders other than Phillips 66, $19 million to Series A preferred unitholders, $6 million to Series B preferred unitholders and $2 million to Series C preferred unitholders. See Note 29—DCP Midstream Class A Segment, in the Notes to the Consolidated Financial Statements, for additional information.On January 24, 2023, the board of directors of DCP Midstream GP, LLC, declared a quarterly distribution on DCP LP’s common units of $0.43 per common unit and a quarterly distribution on DCP LP’s Series B and Series C Preferred Units of $0.4922 and $0.4969 per unit, respectively. The distribution on the common units was paid on February 14, 2023, to unitholders of record on February 3, 2023. The Series B distribution will be paid on March 15, 2023, to unitholders of record on March 1, 2023. The Series C distribution will be paid on April 17, 2023, to unitholders of record on April 3, 2023.DCP LP Preferred UnitsDCP LP redeemed its Series A preferred units with an aggregate liquidation preference of $500 million in December 2022. DCP LP funded this redemption from available cash and borrowings under its accounts receivable securitization facility.Merger with Phillips 66 PartnersOn March 9, 2022, we completed a merger between us and Phillips 66 Partners. The merger resulted in the acquisition of all limited partnership interests in Phillips 66 Partners not already owned by us in exchange for 41.8 million shares of Phillips 66 common stock issued from treasury stock. Phillips 66 Partners common unitholders received 0.50 shares of Phillips 66 common stock for each outstanding Phillips 66 Partners common unit. Phillips 66 Partners’ perpetual convertible preferred units were converted into common units at a premium to the original issuance price prior to being exchanged for Phillips 66 common stock. Upon closing, Phillips 66 Partners became a wholly owned subsidiary of Phillips 66 and its common units are no longer publicly traded. See Note 30—Phillips 66 Partners LP, in the Notes to Consolidated Financial Statements, for additional information on the merger transaction.DividendsOn February 8, 2023, our Board of Directors declared a quarterly cash dividend of $1.05 per common share, representing an 8% increase. The dividend is payable March 1, 2023, to holders of record at the close of business on February 21, 2023. 62Table of ContentsIndex to Financial StatementsShare RepurchasesIn March 2020, we announced that we had temporarily suspended our share repurchases to preserve liquidity in response to the global economic disruption caused by the COVID-19 pandemic. We resumed purchasing shares under our share repurchase program in the second quarter of 2022. On November 7, 2022, our Board of Directors approved a $5 billion increase to our share repurchase program. Since July 2012, our Board of Directors has authorized an aggregate of $20 billion of repurchases of our outstanding common stock. The authorizations do not have expiration dates. Future share repurchases are expected to be funded primarily through available cash. We are not obligated to repurchase any shares of common stock pursuant to these authorizations and may commence, suspend or terminate repurchases at any time. In 2022, we repurchased 16.6 million shares at an aggregate cost of $1.5 billion. Since the inception of our share repurchase program in 2012, we have repurchased 175.9 million shares at an aggregate cost of $14 billion. Shares of stock repurchased are held as treasury shares.Employee Benefit Plan ContributionsDuring the year ended December 31, 2022, we contributed $125 million to our U.S. pension and other postretirement benefit plans and $23 million to our international pension plans.Contractual ObligationsOur contractual obligations primarily consist of purchase obligations, outstanding debt principal and interest obligations, operating and finance lease obligations, and asset retirement and environmental obligations.Purchase ObligationsOur purchase obligations represent agreements to purchase goods or services that are enforceable, legally binding and specify all significant terms. We expect these purchase obligations will be fulfilled with operating cash flows in the period when due. As of December 31, 2022, our purchase obligations totaled $106.5 billion, with $44.4 billion due within one year. The majority of our purchase obligations are market-based contracts, including exchanges and futures, for the purchase of products such as crude oil and raw NGL. The products are used to supply our refineries and fractionators and optimize our supply chain. At December 31, 2022, product purchase commitments with third parties and related parties were $54.6 billion and $26.1 billion, respectively. The remaining purchase obligations mainly represent agreements to access and utilize the capacity of third-party equipment and facilities, including pipelines and product terminals, to transport, process, treat, and store products, and our net share of purchase commitments for materials and services for jointly owned facilities where we are the operator.Debt Principal and Interest ObligationsAs of December 31, 2022, our aggregate principal amount of outstanding debt was $17.2 billion, with $529 million due within one year. Our obligations for interest on the debt totaled $10.2 billion, with $776 million due within one year. See Note 14—Debt, in the Notes to Consolidated Financial Statements, for additional information regarding our outstanding debt principal and interest obligations. Finance and Operating Lease ObligationsSee Note 20—Leases, in the Notes to Consolidated Financial Statements, for information regarding our lease obligations and timing of our expected lease payments.Asset Retirement and Environmental ObligationsSee Note 12—Asset Retirement Obligations and Accrued Environmental Costs, in the Notes to Consolidated Financial Statements, for information regarding asset retirement and environmental obligations.63Table of ContentsIndex to Financial StatementsCapital Spending Our capital expenditures and investments represent consolidated capital spending. Millions of Dollars 2023Budget202220212020Capital Expenditures and InvestmentsMidstream*$639 1,043 733 1,735 Chemicals— — — — Refining1,118 928 784 828 Marketing and Specialties134 89 202 173 Corporate and Other108 134 141 184 Total Capital Expenditures and Investments1,999 2,194 1,860 2,920 Selected Equity Affiliates**CPChem925 701 367 284 WRB216 177 229 175 $1,141 878 596 459 * Includes 100% of DCP Midstream Class A Segment, DCP Sand Hills and DCP Southern Hills capital expenditures and investments from August 18, 2022, forward, net of acquired cash.** Our share of joint ventures’ capital spending.MidstreamCapital spending in our Midstream segment was $3.5 billion for the three-year period ended December 31, 2022, including:•Continued development and expansion of fractionation capacity at our Sweeny Hub. We completed two NGL fractionators (Sweeny Fracs 2 and 3) which commenced operations in 2020. We completed and started operations of Sweeny Frac 4 in the third quarter of 2022.•Completion of construction on our C2G Pipeline, a new 16-inch ethane pipeline that connects our Clemens Caverns storage facility to petrochemical facilities in Gregory, Texas, near Corpus Christi. •Net cash payment in connection with the merger of DCP Midstream and Gray Oak Holdings.•Contributions to fund the Gray Oak Pipeline project and South Texas Gateway Terminal development activities.•Investments in NOVONIX and a renewable feedstock processing plant.•Contributions to Dakota Access for a pipeline optimization project, including a contribution to fund our 25% share of Dakota Access’ debt repayment. •Spending associated with other return, reliability, and maintenance projects in our Transportation and NGL businesses. ChemicalsDuring the three-year period ended December 31, 2022, CPChem had a self-funded capital program that totaled $2.7 billion on a 100% basis. Capital spending was primarily for the development of petrochemical projects on the U.S. Gulf Coast and in the Middle East, as well as sustaining, debottlenecking and optimization projects on existing assets.64Table of ContentsIndex to Financial StatementsRefiningCapital spending for the Refining segment during the three-year period ended December 31, 2022, was $2.5 billion, primarily for refinery upgrade projects to enhance the yield of high-value products, renewable fuels projects, improvements to the operating integrity of key processing units, and safety-related projects. Key projects funded during the three-year period included:•Installation of facilities to improve clean product yield at the Ponca City and Sweeny refineries, as well as the jointly owned Wood River Refinery.•Installation of facilities to improve product value at the Lake Charles Refinery.•Installation of facilities to produce renewable fuels at our San Francisco and Humber refineries.Marketing and SpecialtiesCapital spending for the M&S segment during the three-year period ended December 31, 2022, was primarily for investment in retail marketing joint ventures in the U.S. West Coast and Central regions; the continued acquisition, development and enhancement of retail sites in Europe; and acquisition of a commercial fleet fueling business in California, which will provide further placement opportunities for renewable diesel production to end-use customers.Corporate and OtherCapital spending for Corporate and Other during the three-year period ended December 31, 2022, was primarily for information technology and facilities.2023 BudgetOur 2023 capital budget is $2 billion, including $865 million for sustaining capital and $1.1 billion for growth capital. Approximately 50% of growth capital is expected to support lower-carbon opportunities. Our projected $2 billion capital budget excludes our portion of planned capital spending by our major joint ventures CPChem and WRB totaling $1.1 billion.The Midstream capital budget of $639 million includes a growth capital budget of $310 million which will be directed toward enhancing our integrated NGL value chain from wellhead to market. The Midstream capital budget also includes $329 million for sustaining projects. The Midstream expected spend includes 100% of DCP LP’s sustaining capital of $150 million and $125 million of growth capital. In Refining, the total capital budget of $1.1 billion consists of $389 million for reliability, safety and environmental projects and $729 million for growth capital. Refining’s growth capital includes the continued conversion of the San Francisco Refinery into a renewable fuels facility. The M&S capital budget of $134 million reflects the continued development and enhancement of our retail network, including energy transition opportunities. The Corporate and Other capital budget is $108 million primarily for digital transformation and information technology projects.65Table of ContentsIndex to Financial StatementsContingenciesA number of lawsuits involving a variety of claims that arose in the ordinary course of business have been filed against us or are subject to indemnifications provided by us. We also may be required to remove or mitigate the effects on the environment of the placement, storage, disposal or release of certain chemical, mineral and petroleum substances at various active and inactive sites. We regularly assess the need for financial recognition or disclosure of these contingencies. In the case of all known contingencies (other than those related to income taxes), we accrue a liability when the loss is probable and the amount is reasonably estimable. If a range of amounts can be reasonably estimated and no amount within the range is a better estimate than any other amount, then the minimum of the range is accrued. We do not reduce these liabilities for potential insurance or third-party recoveries. If applicable, we accrue receivables for probable insurance or other third-party recoveries. In the case of income tax-related contingencies, we use a cumulative probability-weighted loss accrual in cases where sustaining a tax position is uncertain.Based on currently available information, we believe it is remote that future costs related to known contingent liability exposures will exceed current accruals by an amount that would have a material adverse impact on our consolidated financial statements. As we learn new facts concerning contingencies, we reassess our position both with respect to accrued liabilities and other potential exposures. Estimates particularly sensitive to future changes include contingent liabilities recorded for environmental remediation, tax and legal matters. Estimated future environmental remediation costs are subject to change due to such factors as the uncertain magnitude of cleanup costs, the unknown time and extent of such remedial actions that may be required, and the determination of our liability in proportion to that of other potentially responsible parties. Estimated future costs related to tax and legal matters are subject to change as events evolve and as additional information becomes available during the administrative and litigation processes.Legal and Tax MattersOur legal and tax matters are handled by our legal and tax organizations. These organizations apply their knowledge, experience and professional judgment to the specific characteristics of our cases and uncertain tax positions. We employ a litigation management process to manage and monitor the legal proceedings. Our process facilitates the early evaluation and quantification of potential exposures in individual cases and enables the tracking of those cases that have been scheduled for trial and/or mediation. Based on professional judgment and experience in using these litigation management tools and available information about current developments in all our cases, our legal organization regularly assesses the adequacy of current accruals and determines if adjustment of existing accruals, or establishment of new accruals, is required. In the case of income tax-related contingencies, we monitor tax legislation and court decisions, the status of tax audits and the statute of limitations within which a taxing authority can assert a liability. See Note 23—Income Taxes, in the Notes to Consolidated Financial Statements, for additional information about income tax-related contingencies.66Table of ContentsIndex to Financial StatementsEnvironmentalWe are subject to numerous international, federal, state and local environmental laws and regulations. Among the most significant of these international and federal environmental laws and regulations are the:•U.S. Federal Clean Air Act, which governs air emissions.•U.S. Federal Clean Water Act, which governs discharges into bodies of water.•European Union Regulation for Registration, Evaluation, Authorization and Restriction of Chemicals (EU REACH), which governs production, marketing and use of chemicals and the United Kingdom’s legislation for the Registration, Evaluation, Authorization and Restriction of Chemicals (UK REACH), which replaced EU REACH in the United Kingdom in 2021 following the United Kingdom’s exit from the European Union (BREXIT). •U.S. Federal Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), which imposes liability on generators, transporters and arrangers of hazardous substances at sites where hazardous substance releases have occurred or are threatening to occur.•U.S. Federal Resource Conservation and Recovery Act (RCRA), which governs the treatment, storage and disposal of solid waste.•U.S. Federal Emergency Planning and Community Right-to-Know Act (EPCRA), which requires facilities to report toxic chemical inventories to local emergency planning committees and response departments.•U.S. Federal Oil Pollution Act of 1990 (OPA90), under which owners and operators of onshore facilities and pipelines as well as owners and operators of vessels are liable for removal costs and damages that result from a discharge of crude oil into navigable waters of the United States.•European Union Trading Directive resulting in the European Union Emissions Trading Scheme (EU ETS), which uses a market-based mechanism to incentivize the reduction of greenhouse gas (GHG) emissions, as well as the United Kingdom Emissions Trading Scheme (UK ETS), which replaced the EU ETS in the United Kingdom in 2021, following BREXIT. These laws and their implementing regulations set limits on emissions and, in the case of discharges to water, establish water quality limits. They also, in most cases, require permits in association with new or modified operations. These permits can require an applicant to collect substantial information in connection with the application process, which can be expensive and time consuming. In addition, there can be delays associated with notice and comment periods and the agency’s processing of the application. Many of the delays associated with the permitting process are beyond the control of the applicant.Other foreign countries and many states where we operate also have, or are developing, similar environmental laws and regulations governing these same types of activities. While similar, in some cases these regulations may impose additional, or more stringent, requirements that can add to the cost and difficulty of developing infrastructure and marketing and transporting products across state and international borders. For example, in California the South Coast Air Quality Management District (SCAQMD) approved amendments to the Regional Clean Air Incentives Market (RECLAIM) that became effective in 2016, which require a phased reduction of nitrogen oxide emissions through 2022, affecting refineries in the Los Angeles metropolitan area. In 2017, SCAQMD required additional nitrogen oxide emissions reductions through 2025 and, on November 5, 2021, promulgated new regulations to replace the RECLAIM program with a traditional command and control regulatory regime.The ultimate financial impact arising from environmental laws and regulations is neither clearly known nor easily determinable as new standards, such as air emission standards, water quality standards and stricter fuel regulations, continue to evolve. However, environmental laws and regulations, including those that may arise to address concerns about global climate change, are expected to continue to have an increasing impact on our operations in the United States and in other countries in which we operate. Notable areas of potential impacts include air emissions compliance and remediation obligations in the United States.67Table of ContentsIndex to Financial StatementsAn example of this in the fuels area is the Energy Independence and Security Act of 2007 (EISA). It requires fuel producers and importers to provide additional renewable fuels for transportation motor fuels and stipulates a mix of various types. RINs form the mechanism used by the EPA to record compliance with the Renewable Fuel Standard (RFS). If an obligated party has more RINs than it needs to meet its obligation, it may sell or trade the extra RINs, or instead choose to “bank” them for use the following year. We have met the requirements to date while establishing implementation, operating and capital strategies, along with advanced technology development, to address projected future renewable volume obligation (RVO) requirements. On December 1, 2022, the EPA proposed RVO for the 2023, 2024 and 2025 compliance years, as well as RIN generation from renewable electricity utilized as a transportation fuel (eRINs). These standards increase cellulosic volumes, which reflect the EPA’s forecast for increasing eRIN volumes beginning in 2024. They also increase total advanced biofuel volumes, which reflect the EPA’s forecast for increasing eRIN volumes beginning in 2024. In addition, they increase total advanced biofuel volumes from the 5.63 billion gallons established for the 2022 compliance year to 7.43 billion gallons in 2025. If adopted, we may experience a decrease in demand for refined petroleum products and increased program costs if not fully recovered in the market. This program continues to be the subject of possible Congressional review and re-promulgation in revised form, and the EPA’s final regulations establishing RVO requirements have been and continue to be subject to legal challenge, further creating uncertainty regarding RVO requirements.We are required to purchase RINs in the open market to satisfy the portion of our obligation under the RFS that is not fulfilled by blending renewable fuels into the motor fuels we produce. For the years ended December 31, 2022, 2021 and 2020, we incurred expenses of $478 million, $441 million and $342 million, respectively, associated with our obligation to purchase RINs in the open market to comply with the RFS for our wholly owned refineries. These expenses are included in the “Purchased crude oil and products” line item on our consolidated statement of operations. Our jointly owned refineries also incurred expenses associated with the purchase of RINs in the open market, of which our share was $437 million, $351 million and $133 million for the years ended December 31, 2022, 2021 and 2020, respectively. These expenses are included in the “Equity in earnings of affiliates” line item on our consolidated statement of operations. The amount of these expenses and fluctuations between periods is primarily driven by the market price of RINs, refinery production, blending activities, and RVO requirements.We also are subject to certain laws and regulations relating to environmental remediation obligations associated with current and past operations. Such laws and regulations include CERCLA and RCRA and their state equivalents. Remediation obligations include cleanup responsibility arising from petroleum releases from underground storage tanks located at numerous previously and currently owned and/or operated petroleum-marketing outlets throughout the United States. Federal and state laws require contamination caused by such underground storage tank releases be assessed and remediated to meet applicable standards. In addition to other cleanup standards, many states have adopted cleanup criteria for methyl tertiary-butyl ether (MTBE) for both soil and groundwater and both the EPA and many states may adopt cleanup standards for per- and polyfluoroalkyl substances (PFAS), which may have been a constituent in certain firefighting foams used or stored at or near some of our facilities.At RCRA-permitted facilities, we are required to assess environmental conditions. If conditions warrant, we may be required to remediate contamination caused by prior operations. In contrast to CERCLA, which is often referred to as “Superfund,” the cost of corrective action activities under RCRA corrective action programs typically is borne solely by us. We anticipate increased expenditures for RCRA remediation activities may be required, but such annual expenditures for the near term are not expected to vary significantly from the range of such expenditures we have experienced over the past few years. Longer-term expenditures are subject to considerable uncertainty and may fluctuate significantly.We occasionally receive requests for information or notices of potential liability from the EPA and state environmental agencies alleging that we are a potentially responsible party under CERCLA or an equivalent state statute. On occasion, we also have been made a party to cost recovery litigation by those agencies or by private parties. These requests, notices and lawsuits assert potential liability for remediation costs at various sites that typically are not owned by us, but allegedly contain wastes attributable to our past operations. As of December 31, 2021, we reported that we had been notified of potential liability under CERCLA and comparable state laws at 25 sites within the United States. In 2022, we were notified of one potentially new site through a CERCLA Section 104(e) information request issued by the EPA, and four sites that were deemed resolved and closed, accordingly, leaving 22 unresolved sites with potential liability at December 31, 2022.68Table of ContentsIndex to Financial StatementsFor the majority of Superfund sites, our potential liability will be less than the total site remediation costs because the percentage of waste attributable to us, versus that attributable to all other potentially responsible parties, is relatively low. Although liability of those potentially responsible is generally joint and several for federal sites and frequently so for state sites, other potentially responsible parties at sites where we are a party typically have had the financial strength to meet their obligations, and where they have not, or where potentially responsible parties could not be located, our share of liability has not increased materially. Many of the sites for which we are potentially responsible are still under investigation by the EPA or the state agencies concerned. Prior to actual cleanup, those potentially responsible normally assess site conditions, apportion responsibility and determine the appropriate remediation. In some instances, we may have no liability or attain a settlement of liability. Actual cleanup costs generally occur after the parties obtain the EPA or equivalent state agency approval of a remediation plan. There are relatively few sites where we are a major participant, and given the timing and amounts of anticipated expenditures, neither the cost of remediation at those sites nor such costs at all CERCLA sites, in the aggregate, is expected to have a material adverse effect on our competitive or financial condition.We incur costs related to the prevention, control, abatement or elimination of environmental pollution. Expensed environmental costs were $728 million in 2022 and are expected to be approximately $800 million in 2023 and 2024. Capitalized environmental costs were $88 million in 2022 and are expected to be approximately $140 million and $250 million, in 2023 and 2024, respectively. These amounts do not include capital expenditures made for other purposes that have an indirect benefit on environmental compliance. Accrued liabilities for remediation activities are not reduced for potential recoveries from insurers or other third parties and are not discounted (except those assumed in a business combination, which we record on a discounted basis).Many of these liabilities result from CERCLA, RCRA and similar state laws that require us to undertake certain investigative and remedial activities at sites where we conduct, or once conducted, operations or at sites where our generated waste was disposed. We also have accrued for a number of sites we identified that may require environmental remediation, but which are not currently the subject of CERCLA, RCRA or state enforcement activities. If applicable, we accrue receivables for probable insurance or other third-party recoveries. In the future, we may incur significant costs under both CERCLA and RCRA. Remediation activities vary substantially in duration and cost from site to site, depending on the mix of unique site characteristics, evolving remediation technologies, diverse regulatory agencies and enforcement policies, and the presence or absence of potentially liable third parties. Therefore, it is difficult to develop reasonable estimates of future site remediation costs.Notwithstanding any of the foregoing, and as with other companies engaged in similar businesses, environmental costs and liabilities are inherent concerns in certain of our operations and products, and there can be no assurance that those costs and liabilities will not be material. However, we currently do not expect any material adverse effect on our results of operations or financial position as a result of compliance with current environmental laws and regulations.Climate ChangeThere has been a broad range of proposed or promulgated state, national and international laws focusing on GHG emissions reduction, including various regulations proposed or issued by the EPA. These proposed or promulgated laws apply or could apply in states and/or countries where we have interests or may have interests in the future. Laws regulating GHG emissions continue to evolve, and while it is not possible to accurately estimate either a timetable for implementation or our future compliance costs relating to implementation, such laws potentially could have a material impact on our results of operations and financial condition as a result of increasing costs of compliance, lengthening project implementation and agency reviews, or reducing demand for certain hydrocarbon products. Examples of legislation or precursors for possible regulation that do or could affect our operations include: •EU ETS, which is part of the European Union’s policy to combat climate change and is a key tool for reducing industrial GHG emissions. EU ETS impacts factories, power stations and other installations across all EU member states. As a result of the United Kingdom’s exit from the EU (BREXIT), those types of entities in the United Kingdom are now subject to the UK ETS, rather than the EU ETS.•EU Renewable Energy Directive II, which increases the EU’s energy consumption from renewable sources in the electricity, heat, and transportation sectors to 32% by 2030. 69Table of ContentsIndex to Financial Statements•United Kingdom’s Renewable Fuel Obligation, which is intended to reduce the GHG emissions from fuel used in the United Kingdom transportation sector by encouraging the supply of renewable fuels. •California’s Senate Bill No. 32, which requires reduction of California's GHG emissions to 40% below the 1990 emission level by 2030, and Assembly Bill 398, which extends the California GHG emission cap and trade program through 2030. Other GHG emissions programs in the western U.S. states have been enacted or are under consideration or development, including amendments to California's Low Carbon Fuel Standard, California’s Advanced Clean Cars and Trucks Programs, California’s Carbon Neutrality by 2045 Scoping Plan, Oregon's Low Carbon Fuel Standard and Climate Protection Plan, and Washington's carbon reduction programs.•United States’ Inflation Reduction Act, which contains tax inducements and other provisions that incentivize investment, development, and deployment of alternative energy sources and technologies, which is intended to accelerate the energy transition.•The U.S. Supreme Court decision in Massachusetts v. EPA, 549 U.S. 497, 127 S. Ct. 1438 (2007), confirming that the EPA has the authority to regulate carbon dioxide as an “air pollutant” under the Federal Clean Air Act.•The EPA’s announcement on March 29, 2010 (published as “Interpretation of Regulations that Determine Pollutants Covered by Clean Air Act Permitting Programs,” 75 Fed. Reg. 17004 (April 2, 2010)), and the EPA’s and U.S. Department of Transportation’s joint promulgation of a Final Rule on April 1, 2010, that triggers regulation of GHGs under the Clean Air Act. These collectively may lead to more climate-based claims for damages, and may result in longer agency review time for development projects to determine the extent of potential climate change. •The EPA's 2015 Final Rule regulating GHG emissions from existing fossil fuel-fired electrical generating units under the Federal Clean Air Act, commonly referred to as the Clean Power Plan. The EPA commenced rulemaking in 2017 to rescind the Clean Power Plan and, in August 2018, the EPA proposed the Affordable Clean Energy (ACE) rule as its replacement. On January 19, 2021, the U.S. Court of Appeals for the District of Columbia invalidated the ACE rule and remanded the matter to the EPA, essentially restarting this rulemaking process. •Carbon taxes in certain jurisdictions.•GHG emission cap and trade programs in certain jurisdictions.In the EU, the first phase of the EU ETS completed at the end of 2007. Phase II was undertaken from 2008 through 2012, and Phase III ran from 2013 through to 2020. Phase IV runs from January 1, 2021 through 2030 and sectors covered under the ETS must reduce their GHG emissions by 43% compared to 2005 levels and there is agreement between the EU Member States, the European Parliament, and the EU Commission (which is pending ratification by the EU Council and European Parliament) to increase the Phase IV GHG emissions reduction to 63% by 2030 compared to 2005 levels. The United Kingdom is no longer part of the EU ETS and, instead, has been under the UK ETS since 2021. Phillips 66 has assets that are subject to the EU ETS and assets that are subject to the UK ETS.From November 30 to December 12, 2015, more than 190 countries, including the United States, participated in the United Nations Climate Change Conference in Paris, France. The conference culminated in what is known as the “Paris Agreement,” which, upon certain conditions being met, entered into force on November 4, 2016. The Paris Agreement establishes a commitment by signatory parties to pursue domestic GHG emission reductions. In 2017, President Trump announced his intention to withdraw the United States from the Paris Agreement and that withdrawal became effective on November 4, 2020. On January 20, 2021, President Biden signed the “Acceptance on Behalf of the United States of America,” which allows the United States to rejoin the Paris Agreement. The United States officially rejoined the Paris Agreement in February 2021, which could lead to additional GHG emission reduction requirements for sources in the United States.In the United States, some additional form of regulation is likely to be forthcoming at the state or federal levels with respect to GHG emissions. Such regulation could take any of several forms that may result in additional financial burden in the form of taxes, the restriction of output, investments of capital to maintain compliance with laws and regulations, or required acquisition or trading of emission allowances. 70Table of ContentsIndex to Financial StatementsCompliance with changes in laws and regulations that create a GHG emission trading program, GHG reduction requirements or carbon taxes could significantly increase our costs, reduce demand for fossil energy derived products, impact the cost and availability of capital and increase our exposure to litigation. Such laws and regulations could also increase demand for less carbon intensive energy sources. An example of one such program is California’s cap and trade program, which was promulgated pursuant to the State’s Global Warming Solutions Act. The program had been limited to certain stationary sources, which include our refineries in California, but beginning in January 2015 was expanded to include emissions from transportation fuels distributed in California. Inclusion of transportation fuels in California’s cap and trade program as currently promulgated has increased our cap and trade program compliance costs. The ultimate impact on our financial performance, either positive or negative, from this and similar programs, will depend on a number of factors, including, but not limited to:•Whether and to what extent legislation or regulation is enacted.•The nature of the legislation or regulation, such as a cap and trade system or a tax on emissions.•The GHG reductions required.•The price and availability of offsets.•The demand for, and amount and allocation of allowances.•Technological and scientific developments leading to new products or services.•Any potential significant physical effects of climate change, such as increased severe weather events, changes in sea levels and changes in temperature.•Whether, and the extent to which, increased compliance costs are ultimately reflected in the prices of our products and services.We consider and take into account anticipated future GHG emissions in designing and developing major facilities and projects, and implement energy efficiency initiatives to reduce GHG emissions. Data on our GHG emissions, legal requirements regulating such emissions, and the possible physical effects of climate change on our coastal assets are incorporated into our planning, investment, and risk management decision-making. We are working to continuously improve operational and energy efficiency through resource and energy conservation throughout our operations.In February 2022, we announced our intention to reduce our Scope 1 and Scope 2 GHG emissions intensity related to our operations by 50% of 2019 levels by the year 2050. This new target builds upon our previously announced 2030 GHG emissions intensity targets to reduce Scope 1 and Scope 2 emissions from our operations by 30% and Scope 3 emissions from our energy products by 15% compared to 2019 levels.In addition to the disclosures above, we have issued our 2022 Sustainability Report that is accessible on our website and provides more detailed information on our Environmental, Social and Corporate Governance initiatives, including detailed information on environmental metrics.71Table of ContentsIndex to Financial StatementsCRITICAL ACCOUNTING ESTIMATESThe preparation of financial statements in conformity with GAAP requires management to select appropriate accounting policies and to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. See Note 1—Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements, for descriptions of our major accounting policies. Some of these accounting policies involve judgments and uncertainties to such an extent that there is a reasonable likelihood that materially different amounts would have been reported under different conditions, or if different assumptions had been used. The following discussion of critical accounting estimates addresses accounting areas where the nature of accounting estimates or assumptions could be material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change.Business CombinationIn accounting for a business combination, assets acquired, liabilities assumed and noncontrolling interests are recorded based on estimated fair values as of the date of acquisition. The excess or shortfall of the purchase price when compared to the fair value of the net tangible and identifiable intangible assets acquired, if any, is recorded as goodwill or a bargain purchase gain, respectively. A significant amount of judgment is made in estimating the individual fair value of property, plant and equipment, intangible assets, noncontrolling interests and other assets and liabilities. We use available information to make these fair value determinations and engage third-party specialists in the valuation process as necessary.The fair values of assets acquired, liabilities assumed and noncontrolling interests as of the acquisition date are often estimated using a combination of approaches, including the income approach, which requires us to project future cash flows and apply an appropriate discount rate; the cost approach, which requires estimates of replacement costs and depreciation and obsolescence estimates; and the market approach which uses market data and adjusts for entity specific differences. The estimates used in determining fair values are based on assumptions believed to be reasonable, but which are inherently uncertain. Accordingly, actual results may differ materially from the estimated results used to determine fair value.See Note 4—Business Combination, and Note 18—Fair Value Measurements, in the Notes to Consolidated Financial Statements, for additional information on the merger of DCP Midstream and Gray Oak Holdings and fair value measurements.Impairment of Long-Lived Assets and Equity Method InvestmentsLong-lived assets used in operations are assessed for impairment whenever changes in facts and circumstances indicate a possible significant deterioration in future expected cash flows. If the sum of the undiscounted expected future before-tax cash flows of an asset group is less than the carrying value, including applicable liabilities, the carrying value is written down to estimated fair value. Individual assets are grouped for impairment purposes based on a judgmental assessment of the lowest level for which there are identifiable cash flows that are largely independent of the cash flows of other assets. Because there usually is a lack of quoted market prices for long-lived assets, the fair value of impaired assets is typically determined using one or more of the following methods: the present value of expected future cash flows using discount rates and other assumptions believed to be consistent with those used by principal market participants; a market multiple for similar assets; historical market transactions including similar assets, adjusted using principal market participant assumptions when necessary; or replacement cost adjusted for physical deterioration and economic obsolescence. The expected future cash flows used for impairment reviews and related fair value calculations are based on judgmental assessments, including future volumes, commodity prices, operating costs, margins, discount rates and capital project decisions, considering all available information at the date of review.72Table of ContentsIndex to Financial StatementsInvestments in nonconsolidated entities accounted for under the equity method are assessed for impairment when there are indicators of a loss in value, such as a lack of sustained earnings capacity or a current fair value less than the investment’s carrying amount. When it is determined that an indicated impairment is other than temporary, a charge is recognized for the difference between the investment’s carrying value and its estimated fair value. When determining whether a decline in value is other than temporary, management considers factors such as the duration and extent of the decline, the investee’s financial condition and near-term prospects, and our ability and intention to retain our investment for a period that allows for recovery. When quoted market prices are not available, the fair value is usually based on the present value of expected future cash flows using discount rates and other assumptions believed to be consistent with those used by principal market participants and observed market earnings multiples of comparable companies, if appropriate. Different assumptions could affect the timing and the amount of an impairment of an investment in any period.See Note 11—Impairments, in the Notes to Consolidated Financial Statements, for information about impairments recorded in 2022, 2021 and 2020.73Table of ContentsIndex to Financial StatementsGUARANTOR FINANCIAL INFORMATIONWe have various cross guarantees between Phillips 66 and its wholly owned subsidiary Phillips 66 Company (together, the Obligor Group) with respect to publicly held debt securities. Phillips 66 conducts substantially all of its operations through subsidiaries, including Phillips 66 Company, and those subsidiaries generate substantially all of its operating income and cash flow. Phillips 66 has fully and unconditionally guaranteed the payment obligations of Phillips 66 Company with respect to its publicly held debt securities. In addition, Phillips 66 Company has fully and unconditionally guaranteed the payment obligations of Phillips 66 with respect to its publicly held debt securities. All guarantees are full and unconditional. At December 31, 2022, $12 billion of senior unsecured notes outstanding has been guaranteed by the Obligor Group.See the “Significant Sources of Capital” section for additional information regarding the Exchange Offers by Phillips 66 Company for existing senior notes of Phillips 66 Partners that settled in May 2022.Summarized financial information of the Obligor Group is presented on a combined basis. Intercompany transactions among the members of the Obligor Group have been eliminated. The financial information of non-guarantor subsidiaries has been excluded from the summarized financial information. Significant intercompany transactions and receivable/payable balances between the Obligor Group and non-guarantor subsidiaries are presented separately in the summarized financial information.74Table of ContentsIndex to Financial StatementsThe summarized results of operations for the year ended December 31, 2022, and the summarized financial position at December 31, 2022, of the Obligor Group on a combined basis were:Summarized Combined Statement of OperationsMillions of DollarsSales and other operating revenues$131,315 Revenues and other income—non-guarantor subsidiaries3,643 Purchased crude oil and products—third parties74,787 Purchased crude oil and products—related parties21,125 Purchased crude oil and products—non-guarantor subsidiaries25,240 Income before income taxes7,244 Net income5,240 Summarized Combined Balance SheetMillions of DollarsAccounts and notes receivable—third parties$5,485 Accounts and notes receivable—related parties1,376 Due from non-guarantor subsidiaries, current741 Total current assets15,566 Investments and long-term receivables 10,433 Net properties, plants and equipment11,652 Goodwill1,047 Due from non-guarantor subsidiaries, noncurrent2,163 Other assets associated with non-guarantor subsidiaries2,144 Total noncurrent assets29,209 Total assets44,775 Due to non-guarantor subsidiaries, current$2,297 Total current liabilities11,148 Long-term debt12,060 Due to non-guarantor subsidiaries, noncurrent 7,088 Total noncurrent liabilities25,223 Total liabilities36,371 Total equity8,404 Total liabilities and equity44,775 75Table of ContentsIndex to Financial StatementsNON-GAAP RECONCILIATIONSRefiningOur realized refining margins measure the difference between (a) sales and other operating revenues derived from the sale of petroleum products manufactured at our refineries and (b) costs of feedstocks, primarily crude oil, used to produce the petroleum products. The realized refining margins are adjusted to include our proportional share of our joint venture refineries’ realized margins, as well as to exclude those items that are not representative of the underlying operating performance of a period, which we call “special items.” The realized refining margins are converted to a per-barrel basis by dividing them by total refinery processed inputs (primarily crude oil) measured on a barrel basis, including our share of inputs processed by our joint venture refineries. Our realized refining margin per barrel is intended to be comparable with industry refining margins, which are known as “crack spreads.” As discussed in “Executive Overview and Business Environment—Business Environment,” industry crack spreads measure the difference between market prices for refined petroleum products and crude oil. We believe realized refining margin per barrel calculated on a similar basis as industry crack spreads provides a useful measure of how well we performed relative to benchmark industry refining margins.The GAAP performance measure most directly comparable to realized refining margin per barrel is the Refining segment’s “income (loss) before income taxes per barrel.” Realized refining margin per barrel excludes items that are typically included in a manufacturer’s gross margin, such as depreciation and operating expenses, and other items used to determine income (loss) before income taxes, such as general and administrative expenses. It also includes our proportional share of joint venture refineries’ realized refining margins and excludes special items. Because realized refining margin per barrel is calculated in this manner, and because realized refining margin per barrel may be defined differently by other companies in our industry, it has limitations as an analytical tool. Following are reconciliations of income (loss) before income taxes to realized refining margins:76Table of ContentsIndex to Financial StatementsMillions of Dollars, Except as IndicatedRealized Refining MarginsAtlantic Basin/EuropeGulf CoastCentral CorridorWest CoastWorldwideYear Ended December 31, 2022Income before income taxes$2,402 2,091 2,415 908 7,816 Plus:Taxes other than income taxes53 87 57 91 288 Depreciation, amortization and impairments203 250 147 279 879 Selling, general and administrative expenses41 19 62 31 153 Operating expenses1,242 1,230 809 1,486 4,767 Equity in (earnings) losses of affiliates9 7 (763)— (747)Other segment (income) expense, net(6)1 2 (1)(4)Proportional share of refining gross margins contributed by equity affiliates93 — 1,668 — 1,761 Special items:Regulatory compliance costs9 26 22 13 70 Realized refining margins$4,046 3,711 4,419 2,807 14,983 Total processed inputs (thousands of barrels)199,319 203,269 97,997 115,457 616,042 Adjusted total processed inputs (thousands of barrels)*199,319 203,269 177,112 115,457 695,157 Income before income taxes per barrel (dollars per barrel)**$12.05 10.29 24.64 7.86 12.69 Realized refining margins (dollars per barrel)***20.30 18.25 24.96 24.31 21.55 Year Ended December 31, 2021Income (loss) before income taxes$1 (1,759)72 (667)(2,353)Plus:Taxes other than income taxes69 74 51 49 243 Depreciation, amortization and impairments210 1,683 139 240 2,272 Selling, general and administrative expenses32 34 30 37 133 Operating expenses981 1,352 648 1,220 4,201 Equity in losses of affiliates9 11 164 — 184 Other segment (income) expense, net9 (7)(11)4 (5)Proportional share of refining gross margins contributed by equity affiliates123 — 609 — 732 Special items:Certain tax impacts(4)— — — (4)Regulatory compliance costs(20)(28)(27)(13)(88)Realized refining margins$1,410 1,360 1,675 870 5,315 Total processed inputs (thousands of barrels)188,697 240,859 95,595 112,994 638,145 Adjusted total processed inputs (thousands of barrels)*188,697 240,859 173,230 112,994 715,780 Income (loss) before income taxes per barrel (dollars per barrel)**$0.01 (7.30)0.75 (5.90)(3.69)Realized refining margins (dollars per barrel)***7.48 5.65 9.65 7.70 7.42 * Adjusted total processed inputs include our proportional share of processed inputs of an equity affiliate. ** Income (loss) before income taxes divided by total processed inputs.*** Realized refining margins per barrel, as presented, are calculated using the underlying realized refining margin amounts, in dollars, divided by adjusted total processed inputs, in barrels. As such, recalculated per barrel amounts using the rounded margins and barrels presented may differ from the presented per barrel amounts.77Table of ContentsIndex to Financial StatementsMillions of Dollars, Except as IndicatedRealized Refining MarginsAtlantic Basin/EuropeGulf CoastCentral CorridorWest CoastWorldwideYear Ended December 31, 2020Loss before income taxes$(1,207)(1,964)(642)(2,210)(6,023)Plus:Taxes other than income taxes61 110 51 89 311 Depreciation, amortization and impairments643 985 571 1,460 3,659 Selling, general and administrative expenses27 37 28 35 127 Operating expenses775 1,394 497 1,000 3,666 Equity in losses of affiliates10 3 363 — 376 Other segment (income) expense, net1 1 (2)5 5 Proportional share of refining gross margins contributed by equity affiliates67 — 298 — 365 Special items:Certain tax impacts(6)— — — (6)Realized refining margins$371 566 1,164 379 2,480 Total processed inputs (thousands of barrels)170,536 213,871 92,050 110,602 587,059 Adjusted total processed inputs (thousands of barrels)*170,536 213,871 162,693 110,602 657,702 Loss before income taxes per barrel (dollars per barrel)**$(7.08)(9.18)(6.97)(19.98)(10.26)Realized refining margins (dollars per barrel)***2.17 2.64 7.17 3.43 3.77 * Adjusted total processed inputs include our proportional share of processed inputs of an equity affiliate. ** Loss before income taxes divided by total processed inputs.*** Realized refining margins per barrel, as presented, are calculated using the underlying realized refining margin amounts, in dollars, divided by adjusted total processed inputs, in barrels. As such, recalculated per barrel amounts using the rounded margins and barrels presented may differ from the presented per barrel amounts.78Table of ContentsIndex to Financial StatementsMarketingOur realized marketing fuel margins measure the difference between (a) sales and other operating revenues derived from the sale of fuels in our M&S segment and (b) costs of those fuels. The realized marketing fuel margins are adjusted to exclude those items that are not representative of the underlying operating performance of a period, which we call “special items.” The realized marketing fuel margins are converted to a per-barrel basis by dividing them by sales volumes measured on a barrel basis. We believe realized marketing fuel margin per barrel demonstrates the value uplift our marketing operations provide by optimizing the placement and ultimate sale of our refineries’ fuel production.Within the M&S segment, the GAAP performance measure most directly comparable to realized marketing fuel margin per barrel is the marketing business’ “income before income taxes per barrel.” Realized marketing fuel margin per barrel excludes items that are typically included in gross margin, such as depreciation and operating expenses, and other items used to determine income before income taxes, such as general and administrative expenses. Because realized marketing fuel margin per barrel excludes these items, and because realized marketing fuel margin per barrel may be defined differently by other companies in our industry, it has limitations as an analytical tool. Following are reconciliations of income before income taxes to realized marketing fuel margins: Millions of Dollars, Except as IndicatedU.S.International202220212020202220212020Realized Marketing Fuel MarginsIncome before income taxes$1,329 1,180 870 765 403 454 Plus:Depreciation and amortization14 14 12 72 76 70 Selling, general and administrative expenses808 758 623 251 253 246 Equity in earnings of affiliates(71)(48)(31)(115)(113)(108)Other operating (revenues) expenses*(508)(424)(327)(62)8 (27)Other (income) expense, net24 9 1 (7)7 6 Marketing margins1,596 1,489 1,148 904 634 641 Less: margin for nonfuel related sales— — — 51 53 46 Realized marketing fuel margins$1,596 1,489 1,148 853 581 595 Total fuel sales volumes (thousands of barrels)680,930 680,102 613,869 102,862 97,529 93,773 Income before income taxes per barrel (dollars per barrel)$1.951.741.427.444.134.84 Realized marketing fuel margins (dollars per barrel)**2.34 2.19 1.87 8.29 5.96 6.34* Includes other nonfuel revenues and expenses.** Realized marketing fuel margins per barrel, as presented, are calculated using the underlying realized marketing fuel margin amounts, in dollars, divided by sales volumes, in barrels. As such, recalculated per barrel amounts using the rounded margins and barrels presented may differ from the presented per barrel amounts.79Table of ContentsIndex to Financial StatementsItem 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKFinancial Instrument Market RiskWe and certain of our subsidiaries are exposed to market risks produced by changes in the prices of crude oil, refined petroleum product, NGL, natural gas, renewable feedstock and electric power, as well as fluctuations in interest rates and foreign currency exchange rates. We and certain of our subsidiaries may hold and use derivative contracts to manage these risks.As a result of the merger, we included the assets and liabilities of DCP Midstream, LLC’s Class A Segment (DCP Midstream Class A Segment), DCP Sand Hills Pipeline, LLC and DCP Southern Hills Pipeline, LLC in our consolidated balance sheet as of December 31, 2022, and the results of their operations and cash flows are reported in our consolidated statements of operations and cash flows from August 18, 2022 through December 31, 2022.DCP Midstream Class A Segment’s market risks are solely attributable to market risks of DCP Midstream, LP (DCP LP), because DCP LP is the sole operational asset in DCP Midstream Class A Segment.DCP LP is exposed to market risks, including changes in commodity prices and interest rates. DCP LP uses financial instruments such as forward contracts, swaps and futures to mitigate the effects of these risks. See Note 3—DCP Midstream, LLC and Gray Oak Holdings LLC Merger, in the Notes to Consolidated Financial Statements, for additional information on the structure of the merger.Commodity Price RiskGenerally, our policy is to remain exposed to the market prices of commodities. Consistent with this policy, we use derivative contracts to convert our exposure from fixed-price sales or purchase contracts, often specified in contracts with refined petroleum product customers, back to floating market prices. We also use futures, forwards, swaps and options in various markets to accomplish the following objectives:•Balance physical systems or meet our refinery requirements and market demand. In addition to cash settlement prior to contract expiration, certain exchange-traded futures may be settled by physical delivery of the underlying commodity.•Enable us to use the market knowledge gained from our physical commodity market activities to capture market opportunities, such as moving physical commodities to more profitable locations, storing commodities to capture seasonal or time premiums, and blending commodities to capture quality upgrades. Derivatives may be utilized to optimize these activities. •Manage the risk to our cash flows from price exposures on specific crude oil, refined petroleum product, NGL, renewable feedstock and natural gas transactions.These objectives optimize the value of our supply chain and may reduce our exposure to fluctuations in market prices.Phillips 66’s use of derivative instruments is governed by an “Authority Limitations” document approved by our Board of Directors. This document prohibits the use of highly leveraged derivatives or derivative instruments without sufficient market liquidity for comparable valuations, and establishes Value at Risk (VaR) limits. Compliance with these limits is monitored daily by our global risk group. 80Table of ContentsIndex to Financial StatementsPhillips 66 uses a VaR model to estimate the loss in fair value that could potentially result on a single day from the effect of adverse changes in market conditions on the derivative commodity instruments held or issued. Using Monte Carlo simulation, a 95% confidence level and a one-day holding period, the VaR for derivative commodity instruments issued or held at December 31, 2022 and 2021, was immaterial to our cash flows and results of operations.DCP LP’s use of derivative instruments is governed by a comprehensive risk management policy and a risk management committee that monitors and manages market risks associated with commodity prices. The risk management committee is composed of DCP LP’s senior executives who receive regular briefings on positions and exposures, credit exposures and overall risk management in the context of market activities. The risk management committee is responsible for the overall management of commodity price and credit risks, including monitoring exposure limits. The estimated loss in fair value that could potentially result on a single day from the effect of adverse changes in market conditions on derivative commodity instruments held or issued is not expected to be material to our cash flows and results of operations.Interest Rate RiskOur use of fixed- or variable-rate debt directly exposes us to interest rate risk. Fixed-rate debt, such as our senior notes, exposes us to changes in the fair value of our debt due to changes in market interest rates. Fixed-rate debt also exposes us to the risk that we may need to refinance maturing debt with new debt at higher rates, or that we may be obligated to pay rates higher than the current market. Variable-rate debt, such as our floating-rate notes or borrowings under our revolving credit facility, exposes us to short-term changes in market rates that impact our interest expense. The following tables provide information about our debt instruments that are sensitive to changes in U.S. interest rates. These tables present principal cash flows and related weighted-average interest rates by expected maturity dates. Weighted-average variable rates are based on effective rates at each reporting date. The carrying amount of our floating-rate debt approximates its fair value. The fair value of the fixed-rate financial instruments is estimated based on observable market prices.Millions of Dollars, Except as IndicatedExpected Maturity DateFixed Rate MaturityAverage Interest RateFloating Rate MaturityAverage Interest RateYear-End 20222023$500 3.88 %$— — %20241,100 1.32 40 5.33 20251,975 4.43 — — 2026992 2.42 — — 2027500 5.63 — — Remaining years12,040 4.67 25 4.72 Total$17,107 $65 Fair value$15,871 $65 Millions of Dollars, Except as IndicatedExpected Maturity DateFixed Rate MaturityAverage Interest RateFloating Rate MaturityAverage Interest RateYear-End 20212022$1,000 4.30 %$450 0.98 %2023500 3.70 — — 20241,100 1.32 — — 20251,150 3.74 — — 20261,000 2.43 — — Remaining years9,026 4.31 25 0.70 Total$13,776 $475 Fair value$15,353 $475 81Table of ContentsIndex to Financial StatementsForeign Currency RiskWe are exposed to foreign currency exchange rate fluctuations related to our international operations. Generally, we do not hedge our foreign currency risk.Phillips 66’s Chief Executive Officer and Chief Financial Officer monitor risks effecting its operations resulting from commodity prices, interest rates and foreign currency exchange rates. In addition, DCP LP’s risk management committee monitors risks effecting its operations resulting from commodity prices and interest rates. For additional information about our use of derivative instruments, see Note 17—Derivatives and Financial Instruments, in the Notes to Consolidated Financial Statements.82Table of ContentsIndex to Financial StatementsCAUTIONARY STATEMENT FOR THE PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995This report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can normally identify our forward-looking statements by the words “anticipate,” “estimate,” “believe,” “budget,” “continue,” “could,” “intend,” “may,” “plan,” “potential,” “predict,” “seek,” “should,” “will,” “would,” “expect,” “objective,” “projection,” “forecast,” “goal,” “guidance,” “outlook,” “effort,” “target” and similar expressions that convey the prospective nature of events or outcomes, but the absence of such words does not mean a statement is not forward-looking.We based the forward-looking statements on our current expectations, estimates and projections about us, our operations, our joint ventures and entities in which we have equity interests, as well as the industries in which we and they operate. We caution you not to place undue reliance on these forward-looking statements as they are not guarantees of future performance and involve assumptions that, while made in good faith, may prove to be incorrect, and involve risks and uncertainties we cannot predict. In addition, we based many of these forward-looking statements on assumptions about future events that may prove to be inaccurate. Accordingly, our actual outcomes and results may differ materially from what we have expressed or forecast in any forward-looking statements. Such differences could result from a variety of factors, including:•Fluctuations in NGL, crude oil, refined petroleum product and natural gas prices and refining, marketing and petrochemical margins.•Changes in governmental policies relating to NGL, crude oil, natural gas or refined petroleum products pricing, regulation or taxation, including exports.•Capacity constraints in, or other limitations on, the pipelines, storage and fractionation facilities to which we deliver natural gas or NGL and the availability of alternative markets and arrangements for our natural gas and NGL.•Actions taken by OPEC and non-OPEC oil producing countries impacting supply and demand and correspondingly, commodity prices.•The ability to achieve the expected benefits of the integration of DCP LP and any other benefits that may result from the buy-in of DCP’s publicly-held common units, if consummated.•Unexpected changes in costs or technical requirements for constructing, modifying or operating our facilities or transporting our products.•Unexpected technological or commercial difficulties in manufacturing, refining or transporting our products, including chemical products.•Lack of, or disruptions in, adequate and reliable transportation for our NGL, crude oil, natural gas and refined petroleum products.•The level and success of drilling and quality of production volumes around our midstream assets.•The inability to timely obtain or maintain permits, including those necessary for capital projects.•The inability to comply with government regulations or make capital expenditures required to maintain compliance.•Changes to worldwide government policies relating to renewable fuels, climate change and greenhouse gas emissions that adversely affect programs like the renewable fuel standards program, low carbon fuel standards and tax credits for biofuels.•General domestic and international economic and political developments including armed hostilities, including the Russia-Ukraine war, expropriation of assets, and other political, economic or diplomatic developments, including those caused by public health issues, outbreaks of diseases and pandemics.•The impact on commercial activity and demand for refined petroleum products from any widespread public health crisis, as well as the extent and duration of recovery of economies and demand for our products following any such crisis. 83Table of ContentsIndex to Financial Statements•Failure to complete definitive agreements and feasibility studies for, and to complete construction of, announced and future capital projects on time and within budget.•Potential disruption or interruption of our operations or damage to our facilities due to accidents, weather and climate events, civil unrest, insurrections, political events, terrorism or cyberattacks.•The inability to meet our sustainability goals, including reducing our GHG emissions intensity, developing and protecting new technologies, and commercializing lower-carbon opportunities.•Failure of new products and services to achieve market acceptance.•International monetary conditions and exchange controls.•Substantial investments required, or reduced demand for products, as a result of existing or future environmental rules and regulations, including GHG emissions reductions and reduced consumer demand for refined petroleum products.•Liability resulting from litigation or for remedial actions, including removal and reclamation obligations under environmental regulations.•Changes in tax, environmental and other laws and regulations (including alternative energy mandates) applicable to our business.•Political and societal concerns about climate change that could result in changes to our business or operations or increase expenditures, including litigation-related expenses.•Changes in estimates or projections used to assess fair value of intangible assets, goodwill and property and equipment and/or strategic decisions or other developments with respect to our asset portfolio that cause impairment charges.•Limited access to capital or significantly higher cost of capital related to changes to our credit profile or illiquidity or uncertainty in the domestic or international financial markets.•The creditworthiness of our customers and the counterparties to our transactions, including the impact of bankruptcies.•The operation, financing and distribution decisions of our joint ventures that we do not control.•The factors generally described in “Item 1A. Risk Factors” in this report. 84Table of ContentsIndex to Financial Statements
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+ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsManagement’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our consolidated financial statements and notes thereto.Critical Accounting Estimates:The preparation of consolidated financial statements and related disclosures in conformity with U.S. generally accepted accounting principles (“GAAP”) requires us to make judgments, assumptions, and estimates that affect the amounts reported. On an ongoing basis, we evaluate our estimates and assumptions. These estimates and assumptions are based on current facts, historical experience, and various other factors that we believe are reasonable under the circumstances to determine reported amounts of assets, liabilities, revenues, and expenses that are not readily apparent from other sources. We believe the following are our critical accounting estimates, because they are reasonably likely to have a material impact on the portrayal of our financial condition and results, and they require us to make judgments and estimates about matters that involve a significant level of uncertainty.Impairment of Long-Lived Assets: The analysis of impairment of our long-lived assets, including our real estate facilities, involves identification of indicators of impairment, including unfavorable operational results and significant cost overruns on construction, projections of future operating cash flows, and estimates of fair values, all of which require significant judgment and subjectivity. In particular, these estimates are sensitive to significant assumptions, such as the projections of future rental rates, stabilized occupancy level, future profit margin, discount rates, and capitalization rates, all of which could be affected by our expectations about future market or economic conditions. Others could come to materially different conclusions.Allocating Purchase Price for Acquired Real Estate Facilities: We estimate the fair values of the assets and liabilities of acquired real estate facilities, which consist principally of land and buildings, for purposes of allocating the aggregate purchase price of acquired real estate facilities. We estimate the fair value of land based upon price per square foot derived from observable transactions involving comparable land in similar locations as adjusted for location quality, parcel size, and date of sale associated with the acquired facilities. The fair value estimate of land is sensitive to the adjustments made to the land market transactions used in the estimate, particularly when there is a lack of recent comparable land market data. For large portfolio acquisitions, we estimate the fair value of buildings primarily using the income approach by estimating the fair value of hypothetical vacant acquired facilities and adjusting for the estimated fair value of land. For individual and small portfolio acquisitions, we estimate the fair value of buildings primarily based upon the estimated current replacement cost, which we calculate by estimating the replacement cost of new purpose-built self-storage facilities in similar geographic regions and adjusting for age, quality, amenities, and configuration associated with 22the buildings acquired. The fair value estimate of buildings is sensitive to assumptions used in both the income approach, such as lease-up period, future stabilized operating cash flows, capitalization rate and discount rate, and in the replacement cost approach, such as current cost adjustment, soft cost and developer profit estimates. Others could come to materially different conclusions as to the estimated fair values of land and buildings, which would result in different depreciation and amortization expense, gains and losses on sale of real estate assets, as well as the level of land and buildings on our consolidated balance sheet. Overview Our self-storage operations generate most of our net income, and our earnings growth is impacted by the levels of growth within our Same Store Facilities (as defined below) as well as within our Acquired Facilities and Newly Developed and Expanded Facilities (both as defined below). Accordingly, a significant portion of management’s time is devoted to maximizing cash flows from our existing self-storage facility portfolio. During 2022, revenues generated by our Same Store Facilities increased by 14.8% ($409.9 million), as compared to 2021, while Same Store cost of operations increased by 5.7% ($39.9 million). Demand and operating trends softened in the second half of 2022 and returned to historical seasonal patterns as compared to what we experienced in 2020 and 2021. We expect the trends to continue in 2023. In addition to managing our existing facilities for organic growth, we have grown and plan to continue to grow through the acquisition and development of new facilities and expansion of our existing self-storage facilities. Since the beginning of 2020, we acquired a total of 368 facilities with 31.7 million net rentable square feet for $6.6 billion. In our non-same store portfolio, we also have developed and expanded self-storage facilities of 17.7 million net rentable square feet for a total cost of $1.6 billion. During 2022, net operating income generated by our Acquired Facilities and Newly Developed and Expanded Facilities increased 98.2% ($226.3 million), as compared to 2021.We have experienced recent inflationary impacts on our cost of operations, including labor, utilities, and repairs and maintenance, and costs of development and expansion activities, and we may continue to experience such impacts in the future. We have implemented various initiatives to manage the adverse impacts, such as enhancements in operational processes and investments in technology to reduce payroll hours, achievement of economies of scale from recent acquisitions with supervisory payroll allocated over a broader number of self-storage facilities, and investments in solar power and LED lights to lower utility usage.In order to enhance the competitive position of certain of our facilities relative to local competitors (including newly developed facilities), we have embarked on our multi-year Property of Tomorrow program to (i) rebrand our properties with more pronounced, attractive, and clearly identifiable color schemes and signage, (ii) enhance the energy efficiency of our properties, and (iii) upgrade the configuration and layout of the offices and other customer zones to improve the customer experience. We expect to complete the program by the end of 2025. We spent approximately $189 million on the program in 2022 and expect to spend approximately $160 million in 2023 on this effort.On April 24, 2022, PSB entered into an Agreement and Plan of Merger whereby affiliates of Blackstone Real Estate (“Blackstone”) agreed to acquire all outstanding shares of PSB’s common stock for $187.50 per share in cash. On July 20, 2022, PSB announced that it completed the merger transaction with Blackstone. Each share of PSB common stock and each common unit of partnership interest we held in PSB were converted into the right to receive the merger consideration of $187.50 per share or unit, including a $5.25 closing cash dividend per share or unit, and a $0.22 prorated quarterly cash dividend per share or unit, for a total of $187.72 per share or unit. At the close of the merger transaction, we received a total of $2.7 billion of cash proceeds and recognized a gain of $2.1 billion, which was classified within gain on sale of our equity investment in PS Business Parks, Inc. in the Consolidated Statement of Income.In connection with the sale of our equity investment in PSB, on August 4, 2022, we paid a special cash dividend of $13.15 per common share, totaling approximately $2.3 billion, to shareholders of record as of August 1, 2022.On February 5, 2023, we disclosed that we made a proposal to acquire all of the outstanding shares and units of Life Storage for consideration consisting of Public Storage common shares at an exchange ratio of 0.4192 Public Storage common shares for each outstanding Life Storage share or unit. Our public offer followed prior rebuffs by Life Storage of our attempts to negotiate privately. For more detail about the proposal, please see our Current Report on Form 8-K filed with the SEC on February 6, 2023. On February 16, 2023, Life Storage announced it had rejected the offer. We currently 23intend to pursue the proposed transaction. In the event we enter into and consummate an acquisition of Life Storage, the acquisition would have a significant impact on our future results of operations.On February 4, 2023, our Board of Trustees declared a 50% increase in its regular common quarterly dividend from $2.00 to $3.00 per share, payable on March 30, 2023 to shareholders of record as of March 15, 2023. The distribution equates to an annualized increase to the Company’s regular common dividend from $8.00 to $12.00 per share.Results of Operations Operating Results for 2022 and 2021In 2022, net income allocable to our common shareholders was $4,142.3 million or $23.50 per diluted common share, compared to $1,732.4 million or $9.87 per diluted common share in 2021, representing an increase of $2,409.9 million or $13.63 per diluted common share. The increase is due primarily to (i) a $2.1 billion gain on sale of our equity investment in PSB and (ii) a $614.3 million increase in self-storage net operating income, partially offset by (iii) a $174.7 million increase in depreciation and amortization expense, (iv) a $125.1 million decrease in equity in earnings of unconsolidated real estate entities due to sale of our equity investment in PSB, and (v) a $45.5 million increase in interest expense.The $614.3 million increase in self-storage net operating income in 2022 as compared to 2021 is a result of a $370.1 million increase attributable to our Same Store Facilities and a $244.2 million increase attributable to our non-same store facilities. Revenues for the Same Store Facilities increased 14.8% or $409.9 million in 2022 as compared to 2021, due primarily to higher realized annual rent per occupied square foot, partially offset by a decline in occupancy. Cost of operations for the Same Store Facilities increased by 5.7% or $39.9 million in 2022 as compared to 2021, due primarily to increased property tax expense, on-site property manager payroll expense, marketing expense, other direct property costs, and centralized management costs. The increase in net operating income of $244.2 million for the non-same store facilities is due primarily to the impact of facilities acquired in 2021 and the fill-up of recently developed and expanded facilities.Operating Results for 2021 and 2020In 2021, net income allocable to our common shareholders was $1,732.4 million or $9.87 per diluted common share, compared to $1,098.3 million or $6.29 per diluted common share in 2020, representing an increase of $634.1 million or $3.58 per diluted common share. The increase is due primarily to (i) a $437.4 million increase in self-storage net operating income, (ii) a $209.7 million increase in foreign currency exchange gains associated with our Euro denominated notes payable, and (iii) our $149.0 million equity share of gains on sale of real estate recorded by PSB in 2021, partially offset by (iv) a $160.2 million increase in depreciation and amortization expense.The $437.4 million increase in self-storage net operating income in 2021 as compared to 2020 is a result of a $279.5 million increase in our Same Store Facilities and a $157.9 million increase in our non-Same Store Facilities. Revenues for the Same Store Facilities increased 10.6% or $265.8 million in 2021 as compared to 2020, due primarily to higher realized annual rent per available square foot and weighted average square foot occupancy. Cost of operations for the Same Store Facilities decreased by 1.9% or $13.8 million in 2021 as compared to 2020, due primarily to (i) a 36.1% ($22.4 million) decrease in marketing expenses and (ii) an 11.2% ($14.4 million) decrease in on-site property manager payroll. The increase in net operating income of $157.9 million for the Non-Same Store Facilities is due primarily to the impact of facilities acquired in 2021 and 2020 and the fill-up of recently developed and expanded facilities.24Funds from Operations and Core Funds from OperationsFunds from Operations (“FFO”) and FFO per share are non-GAAP measures defined by Nareit. We believe that FFO and FFO per share are useful to REIT investors and analysts in measuring our performance because Nareit’s definition of FFO excludes items included in net income that do not relate to or are not indicative of our operating and financial performance. FFO represents net income before depreciation and amortization, which is excluded because it is based upon historical costs and assumes that building values diminish ratably over time, while we believe that real estate values fluctuate due to market conditions. FFO also excludes gains or losses on sale of real estate assets and real estate impairment charges, which are also based upon historical costs and are impacted by historical depreciation. FFO and FFO per share are not a substitute for net income or earnings per share. FFO is not a substitute for net cash flow in evaluating our liquidity or ability to pay dividends, because it excludes investing and financing activities presented on our consolidated statements of cash flows. In addition, other REITs may compute these measures differently, so comparisons among REITs may not be helpful. For the year ended December 31, 2022, FFO was $16.46 per diluted common share as compared to $13.36 and $9.75 per diluted common share for the years ended December 31, 2021 and 2020, respectively, representing an increase in 2022 of 23.2%, or $3.10 per diluted common share, as compared to 2021.We also present “Core FFO” and “Core FFO per share” non-GAAP measures that represent FFO and FFO per share excluding the impact of (i) foreign currency exchange gains and losses, (ii) charges related to the redemption of preferred securities, and (iii) certain other non-cash and/or nonrecurring income or expense items primarily representing, with respect to the periods presented below, the impact of loss contingency accruals and casualties, unrealized gain on private equity investments and our equity share of merger transaction costs, severance of a senior executive, lease termination income, and casualties from our equity investees. We review Core FFO and Core FFO per share to evaluate our ongoing operating performance and we believe they are used by investors and REIT analysts in a similar manner. However, Core FFO and Core FFO per share are not substitutes for net income and net income per share. Because other REITs may not compute Core FFO or Core FFO per share in the same manner as we do, may not use the same terminology or may not present such measures, Core FFO and Core FFO per share may not be comparable among REITs.25The following table reconciles net income to FFO and Core FFO and reconciles diluted earnings per share to FFO per share and Core FFO per share: Year Ended December 31,Year Ended December 31, 20222021Percentage Change20212020Percentage Change(Amounts in thousands, except per share data)Reconciliation of Net Income to FFO and Core FFO:Net income allocable to common shareholders$4,142,288 $1,732,444 139.1 %$1,732,444 $1,098,335 57.7 %Eliminate items excluded from FFO:Depreciation and amortization881,569 709,349 709,349 549,975 Depreciation from unconsolidated real estate investments54,822 73,729 73,729 70,681 Depreciation allocated to noncontrolling interests and restricted share unitholders(6,622)(4,415)(4,415)(3,850)Gains on sale of real estate investments, including our equity share from investments(54,403)(165,272)(165,272)(12,791)Gain on sale of equity investment in PS Business Parks, Inc.(2,116,839)— — — FFO allocable to common shares$2,900,815 $2,345,835 23.7 %$2,345,835 $1,702,350 37.8 %Eliminate the impact of items excluded from Core FFO, including our equity share from investments:Foreign currency exchange (gain) loss(98,314)(111,787)(111,787)97,953 Preferred share redemption charge— 31,604 31,604 48,265 Property losses and tenant claims due to casualties (a)4,817 4,909 4,909 — Other items(338)(543)(543)4,412 Core FFO allocable to common shares$2,806,980 $2,270,018 23.7 %$2,270,018 $1,852,980 22.5 %Reconciliation of Diluted Earnings per Share to FFO per Share and Core FFO per Share:Diluted earnings per share$23.50 $9.87 138.1 %$9.87 $6.29 56.9 %Eliminate amounts per share excluded from FFO:Depreciation and amortization5.27 4.44 4.44 3.53 Gains on sale of real estate investments, including our equity share from investments(0.31)(0.95)(0.95)(0.07)Gain on sale of equity investment in PS Business Parks, Inc.(12.00)— — — FFO per share $16.46 $13.36 23.2 %$13.36 $9.75 37.0 %Eliminate the per share impact of items excluded from Core FFO, including our equity share from investments:Foreign currency exchange (gain) loss(0.57)(0.64)(0.64)0.56 Preferred share redemption charge— 0.18 0.18 0.28 Property losses and tenant claims due to casualties (a)0.03 0.03 0.03 — Other items— — — 0.02 Core FFO per share $15.92 $12.93 23.1 %$12.93 $10.61 21.9 %Diluted weighted average common shares176,280 175,568 175,568 174,642 (a)Property losses and tenant claims due to casualties were related to Hurricane Ian in 2022, and Hurricane Ida in 2021, and were included in general and administrative expenses and ancillary cost of operations on the Consolidated Statements of Income.26Analysis of Net Income - Self-Storage OperationsOur self-storage operations are analyzed in four groups: (i) the 2,276 facilities that we have owned and operated on a stabilized basis since January 1, 2020 (the “Same Store Facilities”), (ii) 368 facilities we acquired since January 1, 2020 (the “Acquired Facilities”), (iii) 153 facilities that have been newly developed or expanded, or that had commenced expansion by December 31, 2022 (the “Newly Developed and Expanded Facilities”), and (iv) 72 other facilities, which are otherwise not stabilized with respect to occupancies or rental rates since January 1, 2020 (the “Other Non-same Store Facilities”). See Note 13 to our December 31, 2022 consolidated financial statements “Segment Information,” for a reconciliation of the amounts in the tables below to our total net income.27Self-Storage Operations SummaryYear Ended December 31,Year Ended December 31, 20222021Percentage Change20212020Percentage Change (Dollar amounts and square footage in thousands)Revenues:Same Store Facilities$3,175,207 $2,765,263 14.8 %$2,765,263 $2,499,486 10.6 %Acquired Facilities402,892 161,364 149.7 %161,364 11,365 1319.8 %Newly Developed and Expanded Facilities269,245 197,058 36.6 %197,058 145,360 35.6 %Other Non-Same Store Facilities98,684 79,881 23.5 %79,881 65,419 22.1 %3,946,028 3,203,566 23.2 %3,203,566 2,721,630 17.7 %Cost of operations:Same Store Facilities738,491 698,629 5.7 %698,629 712,390 (1.9)%Acquired Facilities135,911 57,921 134.6 %57,921 6,742 759.1 %Newly Developed and Expanded Facilities79,466 70,029 13.5 %70,029 62,871 11.4 %Other Non-Same Store Facilities26,341 25,451 3.5 %25,451 25,540 (0.3)%980,209 852,030 15.0 %852,030 807,543 5.5 %Net operating income (a):Same Store Facilities2,436,716 2,066,634 17.9 %2,066,634 1,787,096 15.6 %Acquired Facilities266,981 103,443 158.1 %103,443 4,623 2137.6 %Newly Developed and Expanded Facilities189,779 127,029 49.4 %127,029 82,489 54.0 %Other Non-Same Store Facilities72,343 54,430 32.9 %54,430 39,879 36.5 %Total net operating income 2,965,819 2,351,536 26.1 %2,351,536 1,914,087 22.9 %Depreciation and amortization expense:Same Store Facilities471,458 451,802 4.4 %451,802 452,622 (0.2)%Acquired Facilities309,312 167,119 85.1 %167,119 11,904 1303.9 %Newly Developed and Expanded Facilities63,362 56,411 12.3 %56,411 48,573 16.1 %Other Non-Same Store Facilities44,014 38,096 15.5 %38,096 40,158 (5.1)%Total depreciation and amortization expense888,146 713,428 24.5 %713,428 553,257 29.0 %Net income (loss):Same Store Facilities1,965,258 1,614,832 21.7 %1,614,832 1,334,474 21.0 %Acquired Facilities(42,331)(63,676)(33.5)%(63,676)(7,281)774.6 %Newly Developed and Expanded Facilities126,417 70,618 79.0 %70,618 33,916 108.2 %Other Non-Same Store Facilities28,329 16,334 73.4 %16,334 (279)(5954.5)%Total net income$2,077,673 $1,638,108 26.8 %$1,638,108 $1,360,830 20.4 %Number of facilities at period end:Same Store Facilities2,276 2,276 —2,276 2,276 —Acquired Facilities368 294 25.2 %294 62 374.2 %Newly Developed and Expanded Facilities153 145 5.5 %145 137 5.8 %Other Non-Same Store Facilities72 72 —72 73 —2,869 2,787 2.9 %2,787 2,548 9.4 %Net rentable square footage at period end:Same Store Facilities149,118 149,118 —149,118 149,118 —Acquired Facilities31,709 26,905 17.9 %26,905 5,075 430.1 %Newly Developed and Expanded Facilities17,700 16,606 6.6 %16,606 15,088 10.1 %Other Non-Same Store Facilities5,690 5,690 —5,690 5,770 (1.4)%204,217 198,319 3.0 %198,319 175,051 13.3 %28(a)Net operating income or “NOI” is a non-GAAP financial measure that excludes the impact of depreciation and amortization expense, which is based upon historical real estate costs and assumes that building values diminish ratably over time, while we believe that real estate values fluctuate due to market conditions. We utilize NOI in determining current property values, evaluating property performance, and in evaluating property operating trends. We believe that investors and analysts utilize NOI in a similar manner. NOI is not a substitute for net income, operating cash flow, or other related financial measures, in evaluating our operating results. See Note 13 to our December 31, 2022 consolidated financial statements for a reconciliation of NOI to our total net income for all periods presented.Same Store FacilitiesThe Same Store Facilities consist of facilities we have owned and operated on a stabilized level of occupancy, revenues, and cost of operations since January 1, 2020. The composition of our Same Store Facilities allows us more effectively to evaluate the ongoing performance of our self-storage portfolio in 2020, 2021, and 2022 and exclude the impact of fill-up of unstabilized facilities, which can significantly affect operating trends. We believe investors and analysts use Same Store information in a similar manner. However, because other REITs may not compute Same Store Facilities in the same manner as we do, may not use the same terminology or may not present such a measure, Same Store Facilities may not be comparable among REITs. The following table summarizes the historical operating results of these 2,276 facilities (149.1 million net rentable square feet) that represent approximately 73% of the aggregate net rentable square feet of our U.S. consolidated self-storage portfolio at December 31, 2022. It includes various measures and detail that we do not include in the analysis of the developed, acquired, and other non-same store facilities, due to the relative magnitude and importance of the Same Store Facilities relative to our other self-storage facilities.29Selected Operating Data for the Same Store Facilities (2,276 facilities) Year Ended December 31,Year Ended December 31, 20222021Percentage Change20212020Percentage Change (Dollar amounts in thousands, except for per square foot data)Revenues (a):Rental income $3,074,192 $2,683,116 14.6%$2,683,116 $2,415,822 11.1%Late charges and administrative fees101,015 82,147 23.0%82,147 83,664 (1.8)%Total revenues3,175,207 2,765,263 14.8%2,765,263 2,499,486 10.6%Direct cost of operations (a):Property taxes279,388 267,961 4.3%267,961 258,453 3.7%On-site property manager payroll119,139 114,426 4.1%114,426 128,819 (11.2)%Repairs and maintenance 58,468 52,703 10.9%52,703 50,700 4.0%Utilities 43,457 40,548 7.2%40,548 41,345 (1.9)%Marketing45,906 39,682 15.7%39,682 62,101 (36.1)%Other direct property costs80,991 73,646 10.0%73,646 68,332 7.8%Total direct cost of operations627,349 588,966 6.5%588,966 609,750 (3.4)%Direct net operating income (b)2,547,858 2,176,297 17.1%2,176,297 1,889,736 15.2%Indirect cost of operations (a):Supervisory payroll(35,017)(37,058)(5.5)%(37,058)(40,965)(9.5)%Centralized management costs(61,922)(55,350)11.9%(55,350)(49,129)12.7%Share-based compensation(14,203)(17,255)(17.7)%(17,255)(12,546)37.5%Net operating income2,436,716 2,066,634 17.9%2,066,634 1,787,096 15.6%Depreciation and amortization expense(471,458)(451,802)4.4%(451,802)(452,622)(0.2)%Net income$1,965,258 $1,614,832 21.7%$1,614,832 $1,334,474 21.0%Gross margin (before indirect costs, depreciation and amortization expense)80.2%78.7%1.9%78.7%75.6%4.1%Gross margin (before depreciation and amortization expense)76.7%74.7%2.7%74.7%71.5%4.5%Weighted average for the period:Square foot occupancy 94.9%96.3%(1.5)%96.3%94.5%1.9%Realized annual rental income per (c):Occupied square foot$21.73$18.6716.4%$18.67$17.158.9%Available square foot$20.61$17.9914.6%$17.99$16.2011.0%At December 31:Square foot occupancy92.4%94.8%(2.5)%94.8%94.2%0.6%Annual contract rent per occupied square foot (d)$23.02$19.9615.3%$19.96$17.8112.1%30(a)Revenues and cost of operations do not include tenant reinsurance and merchandise sale revenues and expenses generated at the facilities. See “Ancillary Operations” below for more information.(b)Direct net operating income (“Direct NOI”), a subtotal within NOI, is a non-GAAP financial measure that excludes the impact of supervisory payroll, centralized management costs, and share-based compensation in addition to depreciation and amortization expense. We utilize direct net operating income in evaluating property performance and in evaluating property operating trends as compared to our competitors. (c)Realized annual rent per occupied square foot is computed by dividing rental income, before late charges and administrative fees, by the weighted average occupied square feet for the period. Realized annual rent per available square foot (“REVPAF”) is computed by dividing rental income, before late charges and administrative fees, by the total available net rentable square feet for the period. These measures exclude late charges and administrative fees in order to provide a better measure of our ongoing level of revenue. Late charges are dependent upon the level of delinquency, and administrative fees are dependent upon the level of move-ins. In addition, the rates charged for late charges and administrative fees can vary independently from rental rates. These measures take into consideration promotional discounts, which reduce rental income. (d)Annual contract rent represents the agreed upon monthly rate that is paid by our tenants in place at the time of measurement. Contract rates are initially set in the lease agreement upon move-in, and we adjust them from time to time with notice. Contract rent excludes other fees that are charged on a per-item basis, such as late charges and administrative fees, does not reflect the impact of promotional discounts, and does not reflect the impact of rents that are written off as uncollectible.Analysis of Same Store RevenueWe believe a balanced occupancy and rate strategy maximizes our revenues over time. We regularly adjust rental rates and promotional discounts offered (generally, “$1.00 rent for the first month”), as well as our marketing efforts to maximize revenue from new tenants to replace tenants that vacate. We typically increase rental rates to our long-term tenants (generally, those who have been with us for at least a year) every six to twelve months. As a result, the number of long-term tenants we have in our facilities is an important factor in our revenue growth. The level of rate increases to long-term tenants is based upon evaluating the additional revenue from the increase against the negative impact of incremental move-outs, by considering customers’ in-place rent and prevailing market rents, among other factors. Revenues generated by our Same Store Facilities increased 14.8% and 10.6% in 2022 and 2021, respectively, in each case as compared to the previous year. The increase in 2022 is due primarily to (i) a 16.4% increase in realized annual rent per occupied square foot for 2022 as compared to 2021, partially offset by (ii) a 1.5% decrease in average occupancy for 2022 as compared to 2021. The increase in 2021 is due primarily to (i) an 8.9% increase in realized annual rent per occupied square foot for 2021 as compared to 2020 and, to a lesser extent, (ii) a 1.9% increase in average occupancy for 2021 as compared to 2020.Our growth in revenues, realized annual rent per occupied square foot, and REVPAF for 2022 as compared to 2021 was evident in each of our markets. Our weighted average square foot occupancy remained strong across our markets for 2022.The increase in realized annual rent per occupied square foot in 2022 as compared to the same periods in 2021 was due to rate increases to existing long-term tenants in substantially all of our markets in 2022 as compared to curtailed increases in certain markets in 2021, combined with a 6.2% increase in average rates per square foot charged to new tenants moving in, as a result of strong customer demand in most of our markets. These improvements were partially offset by increases in move-out activity and promotional discounts given during 2022 as compared to 2021. At December 31, 2022, annual contract rent per occupied square foot was 15.3% higher as compared to December 31, 2021. We experienced high occupancy levels throughout 2022 with a weighted average square foot occupancy of 94.9%, although representing a decrease of 1.5% during 2022 as compared to 2021. Year-over-year move-out volumes increased 9.7% and year-over-year move-in volumes increased 4.5% in 2022 as compared to 2021, leading to a lower square foot occupancy at December 31, 2022 of 92.4% as compared to 94.8% at December 31, 2021. Move-out volumes were partially impacted by rental rate increases to our existing tenants in 2022 as compared to 2021. However, move-out activity from tenants not receiving increases was also higher in 2022 compared to 2021 but remains below pre-2020 levels. Average length of stay of our tenants increased in 2022 as compared to 2021, which supported our revenue growth by contributing to the number of tenants eligible for rental rate increases in 2022.31In order to attract more new tenants to replace those that vacated in the second half of 2022, we took a number of actions including increasing promotional discounting, reducing rental rates to new customers, and increasing marketing expense.Demand historically has been higher in the summer months than in the winter months and, as a result, rental rates charged to new tenants have typically been higher in the summer months than in the winter months. More typical seasonal patterns of demand with lower demand in the winter months returned in 2022. Demand fluctuates due to various local and regional factors, including the overall economy. Demand for our facilities is also impacted by new supply of self-storage space and alternatives to self-storage.We expect weaker demand in 2023 as compared to 2022 driven by a weaker macroeconomic outlook and more limited moving activities, with move-out activities and occupancy levels returning to pre-2020 levels. We will continue to support demand levels with increased marketing expense, lowering rental rates to new customers, and increased promotional discounting. As a result, we expect revenue growth to decline significantly in 2023 as compared to high levels of growth in 2022 and 2021. With a wide range of potential macroeconomic pathways for 2023, the range of potential revenue growth rates is wide including the potential for year-over-year declines in revenue in the second half of 2023.Late Charges and Administrative FeesLate charges and administrative fees increased 23.0% in 2022 and decreased 1.8% in 2021, in each case as compared to the previous year. The increase in 2022 is due to (i) higher late charges collected on delinquent accounts driven by more delinquent accounts compared to 2021 and to a lesser extent (ii) higher administrative fees charged per move-in combined with higher move-in volumes. The decrease in 2021 as compared to 2020 is due to (i) an acceleration in average collections whereby a greater percentage of tenants paid their monthly rent promptly to avoid the incurrence of such fees and (ii) reduced move-in administrative fees due to lower move-ins.Selected Key Statistical DataThe following table sets forth average annual contract rent per square foot and total square footage for tenants moving in and moving out during the years ended December 31, 2022, 2021, and 2020. It also includes promotional discounts, which vary based upon the move-in contractual rates, move-in volume, and percentage of tenants moving in who receive the discount. Year Ended December 31,Year Ended December 31,20222021Change20212020Change(Amounts in thousands, except for per square foot amounts)Tenants moving in during the period:Average annual contract rent per square foot$18.11 $17.06 6.2%$17.06 $13.53 26.1%Square footage 97,783 93,607 4.5%93,607 104,636 (10.5)%Contract rents gained from move-ins$1,770,850 $1,596,935 10.9%$1,596,935 $1,415,725 12.8%Promotional discounts given$46,087 $38,203 20.6%$38,203 $75,785 (49.6)%Tenants moving out during the period:Average annual contract rent per square foot$20.65 $17.52 17.9%$17.52 $15.52 12.9%Square footage 101,399 92,466 9.7%92,466 100,670 (8.1)%Contract rents lost from move-outs$2,093,889 $1,620,004 29.3%$1,620,004 $1,562,398 3.7%Analysis of Same Store Cost of Operations Cost of operations (excluding depreciation and amortization) increased 5.7% in 2022 as compared to 2021 due primarily to increased property tax expense, on-site property manager payroll expense, marketing expense, other direct property costs, and centralized management costs. Cost of operations (excluding depreciation and amortization) decreased 1.9% in 2021 as compared to 2020 due primarily to decreased marketing expense and on-site property manager payroll expense, partially offset by increased property tax expense, other direct property costs, and centralized management costs.32Property tax expense increased 4.3% and 3.7% in 2022 and 2021, respectively, in each case as compared to the previous year, as a result of higher assessed values. We expected property tax expense growth of approximately 5.3% in 2023 due primarily to higher assessed values.On-site property manager payroll expense increased 4.1% in 2022 as compared to 2021 and decreased 11.2% in 2021 as compared to 2020. The increase in 2022 is primarily due to competitive labor conditions experienced in most geographical markets, partially offset by a decline in hours worked driven by revisions in operational processes. The decrease in 2021 is primarily due to (i) a year-over-year decline in hours worked due to staffing reductions from reduced move-in and move-out activity and revisions to other operational processes and (ii) a temporary $3.00 hourly incentive increase and enhancement of paid time off benefits to all of our property managers between April 1, 2020 and June 30, 2020 in response to the COVID Pandemic, partially offset by wage increases in response to competitive labor conditions experienced in most geographical markets since the second quarter of 2021. We expect on-site property manager payroll expense to increase in 2023 driven by increased wage rates, partially offset by expected reduction in labor hours driven by revisions in operational processes.Marketing expense includes Internet advertising and the operating costs of our telephone reservation center. Internet advertising expense, comprising keyword search fees assessed on a “per click” basis, varies based upon demand for self-storage space, the quantity of people inquiring about self-storage through online search, occupancy levels, the number and aggressiveness of bidding competitors, and other factors. These factors are volatile; accordingly, Internet advertising can increase or decrease significantly in the short-term. We increased marketing expense by 15.7% in 2022 as compared to 2021, by utilizing a higher volume of online paid search programs to attract new tenants. We decreased marketing expense by 36.1% in 2021 as compared to 2020 due primarily to lower volume of paid search programs we utilized in 2021 given strong demand and high occupancies in many of our same store properties.Other direct property costs include administrative expenses specific to each self-storage facility, such as property loss, telephone and data communication lines, business license costs, bank charges related to processing the facilities’ cash receipts, tenant mailings, credit card fees, eviction costs, and the cost of operating each property’s rental office. These costs increased 10.0% in 2022 as compared to 2021 and 7.8% in 2021 as compared to 2020. These increases were due primarily to an increase in credit card fees as result of year-over-year increases in revenues, and to a lesser extent, a long-term trend of more customers paying with credit cards rather than cash, checks, or other methods of payment with lower transaction costs. We expect a moderate increase in other direct property costs in 2023 primarily driven by increase in credit card fees.Centralized management costs represents administrative and cash compensation expenses for shared general corporate functions to the extent their efforts are devoted to self-storage operations. Such functions include information technology support, hardware, and software, as well as centralized administration of payroll, benefits, training, facilities management, customer service, pricing and marketing, operational accounting and finance, and legal costs. Centralized management costs increased 11.9% in 2022 as compared to 2021 and 12.7% in 2021 as compared to 2020. These increases were due primarily to an increase in technology and data team costs that support property operations. We expect centralized managements costs to remain flat in 2023 compared to 2022.33Analysis of Market TrendsThe following tables set forth selected market trends in our Same Store Facilities:Same Store Facilities Operating Trends by Market As of December 31, 2022Year Ended December 31, Numberof FacilitiesSquareFeet(millions)Realized Rent perOccupied Square FootAverage OccupancyRealized Rent perAvailable Square Foot 20222021Change20222021Change20222021ChangeLos Angeles 21215.3$32.55 $27.32 19.1 %96.9 %98.2 %(1.3)%$31.55 $26.83 17.6 %San Francisco 1287.831.43 28.08 11.9 %95.3 %97.2 %(2.0)%29.95 27.29 9.7 %New York 906.430.60 27.44 11.5 %94.5 %96.3 %(1.9)%28.92 26.43 9.4 %Miami 835.827.92 22.42 24.5 %95.6 %97.1 %(1.5)%26.70 21.77 22.6 %Seattle-Tacoma 865.725.11 21.95 14.4 %94.2 %95.3 %(1.2)%23.67 20.93 13.1 %Washington DC 905.525.42 22.65 12.2 %93.4 %95.3 %(2.0)%23.74 21.58 10.0 %Chicago 1298.119.28 16.63 15.9 %93.6 %95.7 %(2.2)%18.05 15.92 13.4 %Dallas-Ft. Worth 1067.017.28 14.72 17.4 %94.6 %95.8 %(1.3)%16.35 14.11 15.9 %Atlanta 1016.617.39 14.49 20.0 %93.7 %96.0 %(2.4)%16.29 13.91 17.1 %Houston 956.815.88 13.58 16.9 %93.6 %94.3 %(0.7)%14.86 12.81 16.0 %Orlando-Daytona 694.417.96 14.87 20.8 %95.9 %95.7 %0.2 %17.22 14.23 21.0 %Philadelphia 563.520.92 18.55 12.8 %94.4 %97.1 %(2.8)%19.75 18.02 9.6 %West Palm Beach 372.625.40 21.15 20.1 %95.9 %96.8 %(0.9)%24.35 20.48 18.9 %Tampa 513.418.87 15.51 21.7 %95.0 %96.2 %(1.2)%17.93 14.92 20.2 %Charlotte503.815.01 12.46 20.5 %95.0 %95.9 %(0.9)%14.26 11.95 19.3 %All other markets 89356.417.91 15.51 15.5 %94.8 %96.2 %(1.5)%16.98 14.93 13.7 %Totals2,276149.1$21.73 $18.67 16.4 %94.9 %96.3 %(1.5)%$20.61 $17.99 14.6 % 34Same Store Facilities Operating Trends by Market (Continued) Year Ended December 31, Revenues ($000's)Direct Expenses ($000's)Indirect Expenses ($000's)Net Operating Income ($000's) 20222021Change20222021Change20222021Change20222021ChangeLos Angeles $492,438 $417,935 17.8 %$62,909 $58,765 7.1 %$11,287 $11,014 2.5 %$418,242 $348,156 20.1 %San Francisco 238,642 216,832 10.1 %35,100 33,929 3.5 %6,645 6,689 (0.7)%196,897 176,214 11.7 %New York 190,639 174,251 9.4 %44,968 42,982 4.6 %5,335 5,450 (2.1)%140,336 125,819 11.5 %Miami 160,813 131,175 22.6 %28,259 26,100 8.3 %4,016 4,182 (4.0)%128,538 100,893 27.4 %Seattle-Tacoma 138,426 122,217 13.3 %23,295 22,457 3.7 %3,894 4,060 (4.1)%111,237 95,700 16.2 %Washington DC 135,483 122,902 10.2 %27,850 26,531 5.0 %4,140 4,079 1.5 %103,493 92,292 12.1 %Chicago 152,089 133,771 13.7 %57,184 51,764 10.5 %5,917 5,797 2.1 %88,988 76,210 16.8 %Dallas-Ft. Worth 118,577 102,074 16.2 %26,047 24,196 7.7 %4,548 4,645 (2.1)%87,982 73,233 20.1 %Atlanta 113,572 96,721 17.4 %22,299 19,041 17.1 %4,756 4,879 (2.5)%86,517 72,801 18.8 %Houston 105,071 90,192 16.5 %28,554 27,281 4.7 %4,289 4,397 (2.5)%72,228 58,514 23.4 %Orlando-Daytona 78,622 64,982 21.0 %14,883 13,543 9.9 %3,487 3,284 6.2 %60,252 48,155 25.1 %Philadelphia 72,597 66,000 10.0 %15,685 15,105 3.8 %2,717 2,730 (0.5)%54,195 48,165 12.5 %West Palm Beach 66,203 55,558 19.2 %13,232 11,710 13.0 %1,917 2,010 (4.6)%51,054 41,838 22.0 %Tampa 63,047 52,443 20.2 %13,033 11,767 10.8 %2,385 2,404 (0.8)%47,629 38,272 24.4 %Charlotte56,671 47,411 19.5 %9,405 9,113 3.2 %2,324 2,208 5.3 %44,942 36,090 24.5 %All other markets 992,317 870,799 14.0 %204,646 194,682 5.1 %43,485 41,835 3.9 %744,186 634,282 17.3 %Totals$3,175,207 $2,765,263 14.8 %$627,349 $588,966 6.5 %$111,142 $109,663 1.3 %$2,436,716 $2,066,634 17.9 %35Same Store Facilities Operating Trends by Market (Continued) As of December 31, 2022Year Ended December 31, Numberof FacilitiesSquareFeet(millions)Realized Rent perOccupied Square FootAverage OccupancyRealized Rent perAvailable Square Foot 20212020Change20212020Change20212020ChangeLos Angeles 21215.3$27.32 $25.81 5.9 %98.2 %96.6 %1.7 %$26.83 $24.93 7.6 %San Francisco 1287.828.08 26.59 5.6 %97.2 %96.0 %1.3 %27.29 25.53 6.9 %New York 906.427.44 25.86 6.1 %96.3 %95.1 %1.3 %26.43 24.58 7.5 %Miami 835.822.42 19.73 13.6 %97.1 %94.4 %2.9 %21.77 18.62 16.9 %Seattle-Tacoma 865.721.95 20.23 8.5 %95.3 %94.1 %1.3 %20.93 19.04 9.9 %Washington DC 905.522.65 21.05 7.6 %95.3 %94.4 %1.0 %21.58 19.88 8.6 %Chicago 1298.116.63 14.96 11.2 %95.7 %93.8 %2.0 %15.92 14.04 13.4 %Dallas-Ft. Worth 1067.014.72 13.33 10.4 %95.8 %93.0 %3.0 %14.11 12.40 13.8 %Atlanta 1016.614.49 13.11 10.5 %96.0 %92.8 %3.4 %13.91 12.17 14.3 %Houston 956.813.58 12.45 9.1 %94.3 %92.2 %2.3 %12.81 11.48 11.6 %Orlando-Daytona 694.414.87 13.57 9.6 %95.7 %94.4 %1.4 %14.23 12.81 11.1 %Philadelphia 563.518.55 16.86 10.0 %97.1 %96.1 %1.0 %18.02 16.20 11.2 %West Palm Beach 372.621.15 18.36 15.2 %96.8 %94.7 %2.2 %20.48 17.39 17.8 %Tampa 513.415.51 13.71 13.1 %96.2 %93.4 %3.0 %14.92 12.80 16.6 %Charlotte503.812.46 11.10 12.3 %95.9 %92.9 %3.2 %11.95 10.31 15.9 %All other markets 89356.415.51 14.09 10.1 %96.2 %94.5 %1.8 %14.93 13.31 12.2 %Totals2,276149.1$18.67 $17.15 8.9 %96.3 %94.5 %1.9 %$17.99 $16.20 11.0 %36Same Store Facilities Operating Trends by Market (Continued) Year Ended December 31, Revenues ($000's)Direct Expenses ($000's)Indirect Expenses ($000's)Net Operating Income ($000's) 20212020Change20212020Change20212020Change20212020ChangeLos Angeles $417,935 $389,109 7.4 %$58,765 $62,787 (6.4)%$11,014 $10,371 6.2 %$348,156 $315,951 10.2 %San Francisco 216,832 202,927 6.9 %33,929 35,029 (3.1)%6,689 6,337 5.6 %176,214 161,561 9.1 %New York 174,251 162,637 7.1 %42,982 43,849 (2.0)%5,450 4,881 11.7 %125,819 113,907 10.5 %Miami 131,175 112,742 16.3 %26,100 26,353 (1.0)%4,182 4,115 1.6 %100,893 82,274 22.6 %Seattle-Tacoma 122,217 111,693 9.4 %22,457 23,228 (3.3)%4,060 4,057 0.1 %95,700 84,408 13.4 %Washington DC 122,902 113,694 8.1 %26,531 26,926 (1.5)%4,079 3,667 11.2 %92,292 83,101 11.1 %Chicago 133,771 118,560 12.8 %51,764 50,338 2.8 %5,797 5,473 5.9 %76,210 62,749 21.5 %Dallas-Ft. Worth 102,074 90,153 13.2 %24,196 25,744 (6.0)%4,645 4,365 6.4 %73,233 60,044 22.0 %Atlanta 96,721 85,125 13.6 %19,041 19,633 (3.0)%4,879 4,366 11.7 %72,801 61,126 19.1 %Houston 90,192 81,144 11.2 %27,281 27,830 (2.0)%4,397 4,141 6.2 %58,514 49,173 19.0 %Orlando-Daytona 64,982 58,793 10.5 %13,543 14,604 (7.3)%3,284 2,910 12.9 %48,155 41,279 16.7 %Philadelphia 66,000 59,666 10.6 %15,105 15,461 (2.3)%2,730 2,633 3.7 %48,165 41,572 15.9 %West Palm Beach 55,558 47,364 17.3 %11,710 11,708 — %2,010 1,904 5.6 %41,838 33,752 24.0 %Tampa 52,443 45,205 16.0 %11,767 12,410 (5.2)%2,404 2,155 11.6 %38,272 30,640 24.9 %Charlotte47,411 41,106 15.3 %9,113 9,627 (5.3)%2,208 2,027 8.9 %36,090 29,452 22.5 %All other markets 870,799 779,568 11.7 %194,682 204,223 (4.7)%41,835 39,238 6.6 %634,282 536,107 18.3 %Totals$2,765,263 $2,499,486 10.6 %$588,966 $609,750 (3.4)%$109,663 $102,640 6.8 %$2,066,634 $1,787,096 15.6 %37Acquired FacilitiesThe Acquired Facilities represent 368 facilities that we acquired in 2020, 2021, and 2022. As a result of the stabilization process and timing of when these facilities were acquired, year-over-year changes can be significant. The following table summarizes operating data with respect to the Acquired Facilities:ACQUIRED FACILITIES Year Ended December 31,Year Ended December 31,20222021Change (a)20212020Change (a)($ amounts in thousands, except for per square foot amounts)Revenues (b):2020 Acquisitions$75,647$54,890$20,757$54,890$11,365$43,5252021 Acquisitions312,300106,474205,826106,474—106,4742022 Acquisitions14,945—14,945——— Total revenues 402,892161,364241,528161,36411,365149,999Cost of operations (b): 2020 Acquisitions26,16825,21695225,2166,74218,4742021 Acquisitions101,85932,70569,15432,705—32,7052022 Acquisitions7,884—7,884——— Total cost of operations 135,91157,92177,99057,9216,74251,179Net operating income:2020 Acquisitions49,47929,67419,80529,6744,62325,0512021 Acquisitions210,44173,769136,67273,769—73,7692022 Acquisitions7,061—7,061——— Net operating income 266,981103,443163,538103,4434,62398,820Depreciation and amortization expense(309,312)(167,119)(142,193)(167,119)(11,904)(155,215) Net loss$(42,331)$(63,676)$21,345$(63,676)$(7,281)$(56,395)At December 31:Square foot occupancy:2020 Acquisitions88.4%88.2%0.2%88.2%63.5%38.9%2021 Acquisitions83.1%79.9%4.0%79.9%——2022 Acquisitions79.4%—————83.4%81.4%2.5%81.4%63.5%28.2%Annual contract rent per occupied square foot:2020 Acquisitions$17.39$14.8217.3%$14.82$12.5018.6%2021 Acquisitions17.8115.6214.0%15.62——2022 Acquisitions11.48—————$16.84$15.468.9%$15.46$12.5023.7%Number of facilities:2020 Acquisitions6262—6262—2021 Acquisitions232232—232—2322022 Acquisitions74—74———3682947429462232Net rentable square feet (in thousands) (c):2020 Acquisitions5,0755,075—5,0755,075—2021 Acquisitions21,90821,8307821,830—21,8302022 Acquisitions4,726—4,726———31,70926,9054,80426,9055,07521,830 38ACQUIRED FACILITIES (Continued) As of December 31, 2022Costs to acquire (in thousands): 2020 Acquisitions$796,0652021 Acquisitions5,115,2762022 Acquisitions730,480 $6,641,821(a)Represents the percentage change with respect to square foot occupancy and annual contract rent per occupied square foot, and the absolute nominal change with respect to all other items. (b)Revenues and cost of operations do not include tenant reinsurance and merchandise sale revenues and expenses generated at the facilities. See “Ancillary Operations” below for more information.(c)The Acquired Facilities have an aggregate of approximately 31.7 million net rentable square feet, including 11.2 million in Texas, 3.9 million in Maryland, 1.8 million in Florida, 1.2 million in Oklahoma, 1.1 million in Virginia, 0.9 million in North Carolina, 0.8 million in each of Arizona, Colorado and Ohio, 0.6 million in each of California, Georgia, Illinois, Minnesota, and South Carolina, 0.5 million in each of Idaho, Indiana, Michigan, Missouri, Nebraska, Oregon, and Pennsylvania, 0.4 million in each of Alabama, Nevada, and Tennessee, 0.3 million in Washington, and 1.2 million in other states.We have been active in acquiring facilities in recent years. Since the beginning of 2020, we acquired a total of 368 facilities with 31.7 million net rentable square feet for $6.6 billion. During 2022, these facilities contributed net operating income of $267.0 million.During 2022, we acquired the Neighborhood Storage portfolio in the Ocala, Florida market, consisting of 28 properties with 1.2 million net rentable square feet, which includes 26 properties closed in December 2022 for $179.8 million and two properties that are under construction and expected to close in early 2023.During 2021, we acquired the ezStorage portfolio, consisting of 48 properties (4.1 million net rentable square feet) for acquisition cost of $1.8 billion. Included in the Acquisition results in the table above are ezStorage portfolio revenues of $100.8 million, NOI of $79.9 million (including Direct NOI of $82.7 million), and average square footage occupancy of 89.6% for 2022. During 2021, we acquired the All Storage portfolio, consisting of 56 properties (7.5 million net rentable square feet) for $1.5 billion. Included in the Acquisition results in the table above are All Storage portfolio revenues of $79.2 million, NOI of $48.4 million (including Direct NOI of $51.2 million), and average square footage occupancy of 79.4% for 2022. We remain active in seeking to acquire additional self-storage facilities. Subsequent to December 31, 2022, we acquired or were under contract to acquire eight self-storage facilities across five states with 0.5 million net rentable square feet, for $70.5 million. Future acquisition volume is likely to be impacted by increasing cost of capital requirements and overall macro-economic uncertainties.39Developed and Expanded FacilitiesThe developed and expanded facilities include 62 facilities that were developed on new sites since January 1, 2017, and 91 facilities expanded to increase their net rentable square footage. Of these expansions, 51 were completed before 2021, 27 were completed in 2021 or 2022, and 13 are currently in process at December 31, 2022. The following table summarizes operating data with respect to the Developed and Expanded Facilities:DEVELOPED AND EXPANDED FACILITIESYear Ended December 31,Year Ended December 31,20222021Change (a)20212020Change (a)($ amounts in thousands, except for per square foot amounts)Revenues (b):Developed in 2017$35,216$27,593$7,623$27,593$21,541$6,052Developed in 201836,78928,3088,48128,30820,1638,145Developed in 201916,44411,9214,52311,9216,4555,466Developed in 20206,8383,4053,4333,4053013,104Developed in 20218,3331,6026,7311,602—1,602Developed in 2022687—687———Expansions completed before 202195,02970,09124,93870,09147,88622,205Expansions completed in 2021 or 202251,37433,74617,62833,74629,3334,413Expansions in process18,53520,392(1,857)20,39219,681711 Total revenues 269,245197,05872,187197,058145,36051,698Cost of operations (b): Developed in 201710,4169,9324849,9329,625307Developed in 201810,7429,9837599,98310,364(381)Developed in 20195,6225,2403825,2404,685555Developed in 20201,7021,679231,6793831,296Developed in 20213,5391,5461,9931,546—1,546Developed in 2022738—738———Expansions completed before 202130,35728,5541,80328,55425,0833,471Expansions completed in 2021 or 202212,5548,9493,6058,9498,187762Expansions in process3,7964,146(350)4,1464,544(398) Total cost of operations 79,46670,0299,43770,02962,8717,158Net operating income (loss):Developed in 201724,80017,6617,13917,66111,9165,745Developed in 201826,04718,3257,72218,3259,7998,526Developed in 201910,8226,6814,1416,6811,7704,911Developed in 20205,1361,7263,4101,726(82)1,808Developed in 20214,794564,73856—56Developed in 2022(51)—(51)———Expansions completed before 202164,67241,53723,13541,53722,80318,734Expansions completed in 2021 or 202238,82024,79714,02324,79721,1463,651Expansions in process14,73916,246(1,507)16,24615,1371,109 Net operating income 189,779127,02962,750127,02982,48944,540Depreciation and amortization expense(63,362)(56,411)(6,951)(56,411)(48,573)(7,838) Net income$126,417$70,618 $55,799 $70,618$33,916 $36,702 40DEVELOPED AND EXPANDED FACILITIES (Continued) As of December 31,As of December 31, 20222021Change (a)20212020Change (a) ($ amounts in thousands, except for per square foot amounts)Square foot occupancy: Developed in 201789.3%91.4%(2.3)%91.4%88.7%3.0%Developed in 201887.5%88.6%(1.2)%88.6%86.5%2.4%Developed in 201987.3%87.3%—87.3%84.6%3.2%Developed in 202094.3%88.9%6.1%88.9%34.0%161.5%Developed in 202182.4%48.8%68.9%48.8%——Developed in 202241.6%—————Expansions completed before 202186.7%86.6%0.1%86.6%75.0%15.5%Expansions completed in 2021 or 202280.0%81.4%(1.7)%81.4%90.8%(10.4)%Expansions in process81.8%89.2%(8.3)%89.2%94.4%(5.5)%84.1%85.3%(1.4)%85.3%81.2%5.0%Annual contract rent per occupied square foot:Developed in 2017$19.77$16.0323.3%16.0312.6426.8%Developed in 201820.8417.0822.0%17.0812.7334.2%Developed in 201918.1914.5824.8%14.589.6950.5%Developed in 202021.7517.6723.1%17.6710.0875.3%Developed in 202118.0415.4117.1%15.41——Developed in 202213.84— ————Expansions completed before 202116.1713.6418.5%13.6410.4131.0%Expansions completed in 2021 or 202221.5219.1412.4%19.1418.195.2%Expansions in process26.4924.0310.2%24.0321.879.9% $18.98$16.0818.0%16.0812.7925.7%Number of facilities: Developed in 20171616—1616—Developed in 20181818—1818—Developed in 20191111—1111—Developed in 202033—33—Developed in 202166—6—6Developed in 20228—8———Expansions completed before 20215151—5151—Expansions completed in 2021 or 20222727—27252Expansions in process1313—1313— 15314581451378Net rentable square feet (in thousands) (c): Developed in 20172,0402,040—2,0402,040—Developed in 20182,0692,069—2,0692,069—Developed in 20191,0571,057—1,0571,057—Developed in 2020347347—347347—Developed in 2021681681—681—681Developed in 2022631—631———Expansions completed before 20216,8796,879—6,8796,8736Expansions completed in 2021 or 20223,2472,6366112,6361,741895Expansions in process749897(148)897961(64) 17,70016,6061,09416,60615,0881,51841 As of December 31, 2022Costs to develop (in thousands): Developed in 2017$239,871Developed in 2018262,187Developed in 2019150,387Developed in 202042,063Developed in 2021115,632Developed in 2022100,089Expansions completed before 2021 (d)478,659Expansions completed in 2021 or 2022 (d)231,270 $1,620,158(a)Represents the percentage change with respect to square foot occupancy and annual contract rent per occupied square foot, and the absolute nominal change with respect to all other items. (b)Revenues and cost of operations do not include tenant reinsurance and merchandise sales generated at the facilities. See “Ancillary Operations” below for more information.(c)The facilities included above have an aggregate of approximately 17.7 million net rentable square feet at December 31, 2022, including 5.0 million in Texas, 3.2 million in Florida, 2.2 million in California, 1.5 million in Colorado, 1.4 million in Minnesota, 0.9 million in North Carolina, 0.7 million in Michigan, 0.4 million in each of Missouri, New Jersey, South Carolina, and Washington, 0.3 million in Virginia, and 0.9 million in other states.(d)These amounts only include the direct cost incurred to expand and renovate these facilities, and do not include (i) the original cost to develop or acquire the facility or (ii) the lost revenue on space demolished during the construction and fill-up period. It typically takes at least three to four years for a newly developed or expanded self-storage facility to stabilize with respect to revenues. Physical occupancy can be achieved as early as two to three years following completion of the development or expansion through offering lower rental rates during fill-up. As a result, even after achieving high occupancy, there can still be a period of elevated revenue growth as the tenant base matures and higher rental rates are achieved. We believe that our development and redevelopment activities generate favorable risk-adjusted returns over the long run. However, in the short run, our earnings are diluted during the construction and stabilization period due to the cost of capital to fund the development cost, as well as the related construction and development overhead expenses included in general and administrative expense. We typically underwrite new developments to stabilize at approximately an 8.0% NOI yield on cost. Our developed facilities have thus far leased up as expected and are at various stages of their revenue stabilization periods. The actual annualized yields that we may achieve on these facilities upon stabilization will depend on many factors, including local and current market conditions in the vicinity of each property and the level of new and existing supply.The facilities under “expansions completed” represent those facilities where the expansions have been completed at December 31, 2022. We incurred a total of $709.9 million in direct cost to expand these facilities, demolished a total of 1.2 million net rentable square feet of storage space, and built a total of 6.3 million net rentable square feet of new storage space. At December 31, 2022, we had 22 additional facilities in development, which will have a total of 2.1 million net rentable square feet of storage space and have an aggregate development cost totaling approximately $492.3 million. We expect these facilities to open over the next 18 to 24 months. The facilities under “expansion in process” represent those facilities where construction is in process at December 31, 2022, and together with additional future expansion activities primarily related to our Same Store Facilities at December 31, 2022, we expect to add a total of 2.5 million net rentable square feet of storage space by expanding existing self-storage facilities for an aggregate direct development cost of $487.3 million. 42Other Non-Same Store FacilitiesThe “Other Non-Same Store Facilities” represent facilities which, while not newly acquired, developed, or expanded, are not fully stabilized since January 1, 2020, including facilities undergoing fill-up as well as facilities damaged in casualty events such as hurricanes, floods, and fires. The Other Non-Same Store Facilities have an aggregate of 5.7 million net rentable square feet, including 1.1 million in Texas, 0.6 million in each of Florida and Washington, 0.4 million in each of California and Virginia, 0.3 million in each of Indiana and South Carolina, 0.2 million in each of Arizona, Georgia, Kentucky, Massachusetts, and Tennessee, and 1.0 million in other states. During 2022, 2021, and 2020, the average occupancy for these facilities totaled 91.4%, 92.7%, and 85.5%, respectively, and the realized rent per occupied square foot totaled $18.42, $14.61, and $12.69, respectively.Depreciation and amortization expenseDepreciation and amortization expense for Self-Storage Operations increased $174.7 million in 2022 as compared to 2021 and increased $160.2 million in 2021 as compared to 2020, primarily due to newly acquired facilities of $5.1 billion in 2021. We expect continued increases in depreciation expense in 2023 as a result of elevated levels of capital expenditures and new facilities that are acquired, developed or expanded in 2023.43The following discussion and analysis of the components of net income, including Ancillary Operations and items not allocated to segments, present a comparison for the year ended December 31, 2022 to the year ended December 31, 2021. The results of these components for the years ended December 31, 2021 compared to December 31, 2020 was included in our Annual Report on Form 10-K for the year ended December 31, 2021 on page 23, under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which was filed with the SEC on February 22, 2022.Ancillary OperationsAncillary revenues and expenses include amounts associated with the reinsurance of policies against losses to goods stored by tenants in our self-storage facilities, sale of merchandise at our self-storage facilities, and management of property owned by unrelated third parties. The following table sets forth our ancillary operations: Year Ended December 31, 20222021Change (Amounts in thousands)Revenues:Tenant reinsurance premiums $188,201$166,585$21,616Merchandise 28,30328,466(163)Third party property management19,63117,2072,424Total revenues 236,135212,25823,877Cost of operations:Tenant reinsurance 36,83033,9322,898Merchandise 17,11317,274(161)Third party property management18,75517,3621,393Total cost of operations 72,69868,5684,130Net operating income (loss):Tenant reinsurance 151,371132,65318,718Merchandise 11,19011,192(2)Third party property management876(155)1,031Total net operating income$163,437$143,690$19,747 Tenant reinsurance operations: Tenant reinsurance premium revenue increased $21.6 million or 13.0% in 2022 over 2021, as a result of an increase in our tenant base with respect to acquired, newly developed, and expanded facilities and the third party properties we manage. Tenant reinsurance premium revenue generated from tenants at our Same-Store Facilities were $139.0 million and $133.9 million in 2022 and 2021, respectively, representing a 3.8% year over year increase in 2022.We expect future growth will come primarily from customers of newly acquired and developed facilities, as well as additional tenants at our existing unstabilized self-storage facilities.Cost of operations primarily includes claims paid as well as claims adjustment expenses. Claims expenses vary based upon the number of insured tenants and the volume of events that drive covered customer losses, such as burglary, as well as catastrophic weather events affecting multiple properties such as hurricanes and floods. Included in cost of operations are $2.7 million of estimated claims costs related to Hurricane Ian for 2022, as compared to $2.0 million of estimated claims costs related to Hurricane Ida for 2021.Merchandise sales: Sales of locks, boxes, and packing supplies at our self-storage facilities are primarily impacted by the level of move-ins and other customer traffic at our self-storage facilities. We do not expect any significant changes in revenues or profitability from our merchandise sales in 2023.Third-party property management: At December 31, 2022, in our third-party property management program, we managed 114 facilities for unrelated third parties, and were under contract to manage 78 additional facilities including 73 44facilities that are currently under construction. During 2022, we added 60 facilities to the program, acquired three facilities from the program, and had 17 properties exit the program due to sales to other buyers. While we expect this business to increase in scope and size, we do not expect any significant changes in overall profitability of this business in the near term as we seek new properties to manage and are in the earlier stages of fill-up for newly managed properties.Analysis of items not allocated to segmentsEquity in earnings of unconsolidated real estate entitiesWe account for the equity investments in PSB and Shurgard using the equity method and record our pro-rata share of the net income of these entities. The following table, and the discussion below, sets forth our equity in earnings of unconsolidated real estate entities: Year Ended December 31, 20222021Change (Amounts in thousands)Equity in earnings:PSB $80,596$207,722$(127,126)Shurgard26,38524,3712,014Total equity in earnings $106,981$232,093$(125,112)Investment in PSB: On April 24, 2022, PSB entered into an Agreement and Plan of Merger whereby affiliates of Blackstone agreed to acquire all outstanding shares of PSB’s common stock for $187.50 per share in cash. On July 20, 2022, PSB announced that it completed the merger transaction with Blackstone. Each share of PSB common stock and each common unit of partnership interest we held in PSB were converted into the right to receive the merger consideration of $187.50 per share or unit, including a $5.25 closing cash dividend per share or unit, and a $0.22 prorated quarterly cash dividend per share or unit, for a total of $187.72 per share or unit. At the close of the merger transaction, we received a total of $2.7 billion of cash proceeds and recognized a gain of $2.1 billion, which was classified within gain on sale of our equity investment in PS Business Parks, Inc. in the Consolidated Statement of Income. Accordingly, equity in earnings from PSB for the year ended December 31, 2022 reflect activities through the merger date, July 20, 2022.Included in our equity earnings from PSB is our equity share of gains on sale of real estate totaling $49.1 million and $149.0 million for the years ended December 31, 2022 and 2021, respectively. Our equity share of earnings from PSB contributed $57.7 million and $99.3 million to Core FFO in 2022 and 2021, respectively.As a result of closing the sale of PSB, we will no longer recognize equity in earnings from PSB in the future.Investment in Shurgard: Included in our equity earnings from Shurgard for the year ended December 31, 2022 is our equity share of gains on sale of real estate totaling $3.5 million.For purposes of recording our equity in earnings from Shurgard, the Euro was translated at exchange rates of approximately 1.070 U.S. Dollars per Euro at December 31, 2022 (1.134 at December 31, 2021), and average exchange rates of 1.054 for 2022 and 1.183 for 2021. Accordingly, our equity in earnings from Shurgard was negatively impacted by the strengthening of the U.S. Dollar against the Euro by approximately 10.9% during the year ended December 31, 2022.45General and administrative expense: The following table sets forth our general and administrative expense: Year Ended December 31, 20222021Change (Amounts in thousands)Share-based compensation expense $37,865 $37,760 $105 Development and acquisition costs17,540 8,892 8,648 Federal and State tax expense and related compliance costs16,086 11,530 4,556 Legal costs 4,014 6,194 (2,180)Corporate management costs21,808 18,594 3,214 Other costs 17,429 18,284 (855)Total $114,742 $101,254 $13,488 Development and acquisition costs primarily represent internal and external expenses related to our development and acquisition of real estate facilities and varies primarily based upon the level of activities. The amounts in the above table are net of $17.4 million and $14.6 million in 2022 and 2021, respectively, in development costs that were capitalized to newly developed and redeveloped self-storage facilities. During 2022, we wrote off $7.0 million of accumulated development costs for cancelled development and redevelopment projects driven by significant increases in construction costs from when the projects were initiated.Interest and other income: The following table sets forth our interest and other income: Year Ended December 31,20222021Change(Amounts in thousands)Interest earned on cash balances$20,824 $101 $20,723 Commercial operations9,846 8,127 1,719 Unrealized gain on private equity investments4,685 — 4,685 Other5,212 4,078 1,134 Total $40,567 $12,306 $28,261 Interest expense: For 2022 and 2021, we incurred $142.4 million and $94.3 million, respectively, of interest on our outstanding notes payable. In determining interest expense, these amounts were offset by capitalized interest of $6.0 million and $3.5 million during 2022 and 2021, respectively, associated with our development activities. The increase of interest expense in 2022 as compared to 2021 is due to our issuances of debt to fund our 2021 acquisition activity. At December 31, 2022, we had $6.9 billion of notes payable outstanding, with a weighted average interest rate of approximately 2.0%.Foreign Currency Exchange Gain: For 2022, we recorded foreign currency gains of $98.3 million, representing primarily the changes in the U.S. Dollar equivalent of our Euro-denominated unsecured notes due to fluctuations in exchange rates (gains of $111.8 million for 2021). The Euro was translated at exchange rates of approximately 1.070 U.S. Dollars per Euro at December 31, 2022 and 1.134 at December 31, 2021. Future gains and losses on foreign currency will be dependent upon changes in the relative value of the Euro to the U.S. Dollar and the level of Euro-denominated notes payable outstanding. Gain on Sale of Real Estate: In 2022 and 2021, we recorded gains on sale of real estate totaling $1.5 million and $13.7 million, respectively, in connection with the partial sale of real estate facilities pursuant to eminent domain proceedings.46Liquidity and Capital ResourcesOverview and our Sources of CapitalWhile operating as a REIT allows us to minimize the payment of U.S. federal corporate income tax expense, we are required to distribute at least 90% of our taxable income to our shareholders. Notwithstanding this requirement, our annual operating retained cash flow increased from $200 million to $300 million per year in recent years to approximately $700 million in 2021 and $1 billion in 2022. Retained operating cash flow represents our expected cash flow provided by operating activities (including property operating costs and interest payments described below), less shareholder distributions and capital expenditures. We expect retained cash flow of approximately $500 million for 2023.The REIT distribution requirement limits cash flow from operations that can be retained and reinvested in the business, increasing our reliance upon raising capital to fund growth. Capital needs in excess of retained cash flow are met with: (i) medium and long-term debt, (ii) preferred equity, and (iii) common equity. We select among these sources of capital based upon relative cost, availability, the desire for leverage, and considering potential constraints caused by certain features of capital sources, such as debt covenants. We view our line of credit, as well as any short-term bank loans, as bridge financing. Because raising capital is important to our growth, we endeavor to maintain a strong financial profile characterized by strong credit metrics, including low leverage relative to our total capitalization and operating cash flows. We are one of the highest rated REITs, as rated by major rating agencies Moody’s and Standard & Poor’s. Our senior notes payable have an “A” credit rating by Standard & Poor’s and “A2” by Moody’s. Our credit ratings on each of our series of preferred shares are “A3” by Moody’s and “BBB+” by Standard & Poor’s. Our credit profile enables us to effectively access both the public and private capital markets to raise capital.We have a $500.0 million revolving line of credit that we are able to use as temporary “bridge” financing until we are able to raise longer term capital. As of December 31, 2022 and February 21, 2023, there were no borrowings outstanding on the revolving line of credit; however, we do have approximately $18.6 million of outstanding letters of credit, which limits our borrowing capacity to $481.4 million as of February 21, 2023. Our line of credit matures on April 19, 2024. We believe that we have significant financial flexibility to adapt to changing conditions and opportunities, and we have significant access to sources of capital including debt and preferred equity. While the costs of financing have increased recently, based on our strong credit profile and our substantial current liquidity relative to our capital requirements noted below, we would not expect any potential capital market dislocations to have a material impact upon our expected capital and growth plans over the next 12 months. However, if capital market conditions were to change significantly in the long run, our access to or cost of debt and preferred equity capital could be negatively impacted and potentially affect future investment activities.Our current and expected capital resources include: (i) $775.3 million of cash as of December 31, 2022 and (ii) approximately $500.0 million of expected retained operating cash flow over the next twelve months. We believe that our cash provided by our operating activities will continue to be sufficient to enable us to meet our ongoing cash requirements for interest payments on debt, maintenance capital expenditures, and distributions to our shareholders for the foreseeable future.As described below, our current committed cash requirements consist of (i) $70.5 million in property acquisitions currently under contract and (ii) $606.6 million of remaining spending on our current development pipeline, which will be incurred primarily in the next 18 to 24 months. Our cash requirements may increase over the next year as we add projects to our development pipeline and acquire additional properties. Additional potential cash requirements could result from various activities including the redemption of outstanding preferred securities, repurchases of common stock, or merger and acquisition activities, as and to the extent we determine to engage in such activities.Over the long term, to the extent that our cash requirements exceed our capital resources, we believe we have a variety of possibilities to raise additional capital including issuing common or preferred securities, issuing debt, or entering into joint venture arrangements to acquire or develop facilities.47Cash RequirementsThe following summarizes our expected material cash requirements, which comprise (i) contractually obligated expenditures, including payments of principal and interest, (ii) other essential expenditures, including property operating expenses, maintenance capital expenditures and dividends paid in accordance with REIT distribution requirements, and (iii) opportunistic expenditures, including acquisitions and developments and repurchases of our securities. We expect to satisfy these cash requirements through operating cash flow and opportunistic debt and equity financings.Required Debt Repayments: As of December 31, 2022, the principal outstanding on our debt totaled approximately $6.9 billion, consisting of $10.1 million of secured notes payable, $1.7 billion of Euro-denominated unsecured notes payable and $5.3 billion of U.S. Dollar denominated unsecured notes payable. Approximate principal maturities and interest payments are as follows (amounts in thousands):2023$151,5322024933,3852025367,56120261,251,4042027587,643Thereafter 4,349,115 $7,640,640Capital Expenditure Requirements: Capital expenditures include general maintenance, major repairs, or replacements to elements of our facilities to keep our facilities in good operating condition and maintain their visual appeal. Capital expenditures do not include costs relating to the development of new facilities or redevelopment of existing facilities to increase their available rentable square footage. Capital expenditures totaled $452.3 million in 2022 and are expected to approximate $450 million in 2023. In addition to standard capital repairs of building elements reaching the end of their useful lives, our capital expenditures in recent years have included incremental expenditures to enhance the competitive position of certain of our facilities relative to local competitors pursuant to a multi-year program. Such investments include development of more pronounced, attractive, and clearly identifiable color schemes and signage and upgrades to the configuration and layout of the offices and other customer zones to improve the customer experience. We spent approximately $189 million in 2022 and expect to spend $160 million in 2023 on this effort. In addition, we have made investments in LED lighting and the installation of solar panels, which approximated $56 million for the year ended December 31, 2022 and we expect to spend $132 million in 2023.We believe that these incremental investments improve customer satisfaction, the attractiveness and competitiveness of our facilities to new and existing customers and, in the case of LED lighting and solar panels, reduce operating costs. Requirement to Pay Distributions: For all periods presented herein, we have elected to be treated as a REIT, as defined in the Code. For each taxable year in which we qualify for taxation as a REIT, we will not be subject to U.S. federal corporate income tax on our “REIT taxable income” (generally, taxable income subject to specified adjustments, including a deduction for dividends paid and excluding our net capital gain) that is distributed to our shareholders. We believe we have met these requirements in all periods presented herein, and we expect to continue to qualify as a REIT. On February 4, 2023, our Board declared a regular common quarterly dividend of $3.00 per common share totaling approximately $526 million, which will be paid at the end of March 2023. Our consistent, long-term dividend policy has been to distribute our taxable income. Future quarterly distributions with respect to the common shares will continue to be determined based upon our REIT distribution requirements after taking into consideration distributions to the preferred shareholders and will be funded with cash flows from operating activities. Our future aggregate annual common dividend distributions may increase as a result of the issuance of additional common shares, including any shares that would be issued if we were to consummate our recently proposed acquisition of Life Storage.The annual distribution requirement with respect to our preferred shares outstanding at December 31, 2022 is approximately $194.7 million per year. 48Real Estate Investment Activities: We continue to seek to acquire additional self-storage facilities from third parties. Subsequent to December 31, 2022, we acquired or were under contract to acquire eight self-storage facilities for a total purchase price of $70.5 million.We are actively seeking to acquire additional facilities. However, future acquisition volume will depend upon whether additional owners will be motivated to market their facilities, which will in turn depend upon factors such as economic conditions and the level of seller confidence. As of December 31, 2022, we had development and expansion projects at a total cost of approximately $979.6 million. Costs incurred through December 31, 2022 were $373.0 million, with the remaining cost to complete of $606.6 million expected to be incurred primarily in the next 18 to 24 months. Some of these projects are subject to contingencies such as entitlement approval. We expect to continue to seek to add projects to maintain and increase our robust pipeline. Our ability to do so continues to be challenged by various constraints such as difficulty in finding projects that meet our risk-adjusted yield expectations and challenges in obtaining building permits for self-storage facilities in certain municipalities.Property Operating Expenses: The direct and indirect cost of our operations impose significant cash requirements. Direct operating costs include property taxes, on-site property manager payroll, repairs and maintenance, utilities, and marketing. Indirect operating costs include supervisory payroll and centralized management costs. The cash requirements from these operating costs will vary year to year based on, among other things, changes in the size of our portfolio and changes in property tax rates and assessed values, wage rates, and marketing costs in our markets.Redemption of Preferred Securities: Historically, we have taken advantage of refinancing higher coupon preferred securities with lower coupon preferred securities. In the future, we may also elect to finance the redemption of preferred securities with proceeds from the issuance of debt. As of February 21, 2023, we have two series of preferred securities that are eligible for redemption, at our option and with 30 days’ notice: our 5.150% Series F Preferred Shares ($280.0 million) and our 5.050% Series G Preferred Shares ($300.0 million). See Note 9 to our December 31, 2022 consolidated financial statements for the redemption dates of all of our series of preferred shares. Redemption of such preferred shares will depend upon many factors, including the rate at which we could issue replacement preferred securities. None of our preferred securities are redeemable at the option of the holders. Repurchases of Common Shares: Our Board has authorized management to repurchase up to 35,000,000 of our common shares on the open market or in privately negotiated transactions. During 2022, we did not repurchase any of our common shares. From the inception of the repurchase program through February 21, 2023, we have repurchased a total of 23,721,916 common shares at an aggregate cost of approximately $679.1 million. Future levels of common share repurchases will be dependent upon our available capital, investment alternatives and the trading price of our common shares.49ITEM 7A. Quantitative and Qualitative Disclosures about Market RiskTo limit our exposure to market risk, we are capitalized primarily with preferred and common equity. Our preferred shares are redeemable at our option generally five years after issuance, but the holder has no redemption option. Our debt, which totals approximately $6.9 billion at December 31, 2022, is the only market-risk sensitive portion of our capital structure. The fair value of our debt at December 31, 2022 is approximately $6.0 billion. The table below summarizes the annual maturities of our debt, which had a weighted average effective rate of 2.0% at December 31, 2022. See Note 7 to our December 31, 2022 consolidated financial statements for further information regarding our debt (amounts in thousands). 20232024202520262027 Thereafter TotalDebt $8,270$807,159$259,170$1,150,138$500,140$4,185,709$6,910,586We have foreign currency exposure at December 31, 2022 related to (i) our investment in Shurgard, with a book value of $275.8 million, and a fair value of $1.4 billion based upon the closing price of Shurgard’s stock on December 31, 2022, and (ii) €1.5 billion ($1.7 billion) of Euro-denominated unsecured notes payable, providing a natural hedge against the fair value of our investment in Shurgard.
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 17, 2022. Supplemental Earnings Information We use certain non-GAAP measures, in addition to certain performance metrics determined under GAAP, as we believe these measures improve the understanding of our operating results. We believe these non-GAAP measures provide useful information to our Board of Directors, management and investors regarding certain trends relating to our financial condition and results of operations. Our management uses these non-GAAP measures to compare our performance to that of prior periods for trend analyses, purposes of determining management incentive compensation and budgeting, forecasting and planning purposes. We provide Pro-rata financial information because we believe it assists investors and analysts in estimating our economic interest in our consolidated and unconsolidated partnerships, when read in conjunction with our reported results under GAAP. We believe presenting our Pro-rata share of operating results, along with other non-GAAP measures, may assist in comparing our operating results to other REITs. We continually evaluate the usefulness, relevance, limitations, and calculation of our reported non-GAAP measures to determine how best to provide relevant information to the public, and thus such reported non-GAAP measures could change. See "Defined Terms" in "Item 1. Business" for additional information regarding the definition of and other information regarding the non-GAAP measures we present in this Report. We do not consider non-GAAP measures an alternative to financial measures determined in accordance with GAAP, rather they supplement GAAP measures by providing additional information we believe to be useful to shareholders. The principal limitation of these non-GAAP measures is they may exclude significant expense and income items that are required by GAAP to be recognized in our Consolidated Financial Statements. In addition, they reflect the exercise of management's judgment about which expense and income items are excluded or included in determining these non-GAAP measures. In order to compensate for these limitations, reconciliations of the non-GAAP measures we use to their most directly comparable GAAP measures are provided, including as set forth below. Non-GAAP measures should not be relied upon in evaluating our financial condition, results of operations, or future prospects. 57 Pro-rata Same Property NOI: Pro-rata same property NOI, excluding termination fees/expenses, changed from the following major components: (in thousands) 2022 2021 Change Real estate revenues: Base rent $ 892,253 861,382 30,871 Recoveries from tenants 302,171 292,319 9,852 Percentage rent 11,004 7,701 3,303 Termination fees 5,007 6,734 (1,727 ) Uncollectible lease income 14,816 25,734 (10,918 ) Other lease income 11,847 11,556 291 Other property income 8,338 9,863 (1,525 ) Total real estate revenue 1,245,436 1,215,289 30,147 Real estate operating expenses: Operating and maintenance 197,481 190,017 7,464 Real estate taxes 159,189 159,620 (431 ) Ground rent 11,761 11,829 (68 ) Total real estate operating expenses 368,431 361,466 6,965 Pro-rata same property NOI $ 877,005 853,823 23,182 Less: Termination fees / expense 5,007 6,734 (1,727 ) Pro-rata same property NOI, excluding termination fees / expense $ 871,998 847,089 24,909 Pro-rata same property NOI growth, excluding termination fees / expense 2.9 % Real estate revenue increased $30.1 million, on a net basis, as follows: Base rent increased $30.9 million due to increases from occupancy, rent steps in existing leases, and positive rental spreads on new and renewal leases. Recoveries from tenants increased $9.9 million due to increases in recoverable expenses and greater recovery rates from higher average occupancy. Percentage rent increased $3.3 million, primarily due to improved tenant sales. Termination fees decreased $1.7 million primarily due to termination fees from several tenants at various properties during 2021, both wholly owned and within our partnerships. Uncollectible lease income decreased $10.9 million primarily driven by the higher level of 2021 collections of previously reserved amounts, which have continued but to a lesser degree in 2022. Other property income decreased $1.5 million primarily due to a decrease in settlements from 2021. Real estate operating expenses increased $7.0 million, on a net basis, as follows: Operating and maintenance increased $7.5 million primarily due to increases in insurance and other reimbursable costs. Same Property Roll-forward: Our same property pool includes the following property count, Pro-rata GLA, and changes therein: 2022 2021 (GLA in thousands) PropertyCount GLA PropertyCount GLA Beginning same property count 393 41,294 393 40,228 Acquired properties owned for entirety of comparable periods (1) — 327 2 924 Developments that reached completion by beginning of earliest comparable period presented 1 72 6 683 Disposed properties (5 ) (195 ) (8 ) (420 ) SF adjustments (2) — (115 ) — (121 ) Ending same property count 389 41,383 393 41,294 (1)Includes an adjustment to GLA arising from the acquisition of our partners' share of properties previously held in the RegCal and USAA partnerships, of which our previous ownership share was already included in our same property pool. (2)SF adjustments arising from re-measurements or redevelopments. 58 Nareit FFO and Core Operating Earnings: Our reconciliation of net income attributable to common stock and unit holders to Nareit FFO and to Core Operating Earnings is as follows: (in thousands, except share information) 2022 2021 Reconciliation of Net income to Nareit FFO Net income attributable to common stockholders $ 482,865 361,411 Adjustments to reconcile to Nareit FFO: (1) Depreciation and amortization (excluding FF&E) 344,629 330,364 Provision for impairment of real estate — 95,815 Gain on sale of real estate (121,835 ) (100,499 ) Exchangeable operating partnership units 2,105 1,615 Nareit FFO attributable to common stock and unit holders $ 707,764 688,706 Reconciliation of Nareit FFO to Core Operating Earnings Nareit Funds From Operations $ 707,764 688,706 Adjustments to reconcile to Core Operating Earnings: (1) Not Comparable Items Early extinguishment of debt 176 — Promote income — (13,589 ) Certain Non Cash Items Straight-line rent (11,327 ) (13,534 ) Uncollectible straight-line rent (14,155 ) (5,965 ) Above/below market rent amortization, net (21,434 ) (23,889 ) Debt premium/discount amortization (184 ) (565 ) Core Operating Earnings $ 660,840 631,164 (1)Includes Regency's Pro-rata share of unconsolidated investment partnerships, net of Pro-rata share attributable to noncontrolling interests. Reconciliation of Same Property NOI to Nearest GAAP Measure: Our reconciliation of Net income attributable to common stockholders to Same Property NOI, on a Pro-rata basis, is as follows: (in thousands) 2022 2021 Net income attributable to common stockholders $ 482,865 361,411 Less: Management, transaction, and other fees 25,851 40,337 Other (1) 51,090 46,860 Plus: Depreciation and amortization 319,697 303,331 General and administrative 79,903 78,218 Other operating expense 6,166 5,751 Other expense 44,102 132,977 Equity in income of investments in real estate excluded from NOI (2) 35,824 53,119 Net income attributable to noncontrolling interests 5,170 4,877 Pro-rata NOI 896,786 852,487 Less non-same property NOI (3) (19,781 ) 1,336 Pro-rata same property NOI $ 877,005 853,823 (1)Includes straight-line rental income and expense, net of reserves, above and below market rent amortization, other fees, and noncontrolling interest. (2)Includes non-NOI income earned and expenses incurred at our unconsolidated real estate partnerships, including those separated out above for our consolidated properties. (3)Includes revenues and expenses attributable to non-same properties, sold properties, development properties, and corporate activities. Also includes adjustments for earnings at the four and seven properties we acquired from our former unconsolidated RegCal and USAA partnerships in 2022 and 2021, respectively, in order to calculate growth on a comparable basis for the periods presented. 59 Liquidity and Capital Resources General We use cash flows generated from operating, investing, and financing activities to strengthen our balance sheet, finance our development and redevelopment projects, fund our investment activities, and maintain financial flexibility. A significant portion of our cash from operations is distributed to our common shareholders in the form of dividends in order to maintain our status as a REIT. Except for $200 million of private placement debt, our Parent Company has no capital commitments other than its guarantees of the commitments of our Operating Partnership. All remaining debt is held by our Operating Partnership or by our co-investment partnerships. The Operating Partnership is a co-issuer and a guarantor of the $200 million of outstanding debt of our Parent Company. The Parent Company will from time to time access the capital markets for the purpose of issuing new equity, and will simultaneously contribute all of the offering proceeds to the Operating Partnership in exchange for additional partnership units. We continually assess our available liquidity and our expected cash requirements, including monitoring our tenant rent collections. We have access to and draw on multiple financing sources to fund our operations and our long-term capital needs, including the requirements of our in process and planned developments, redevelopments, and other capital expenditures, and the repayment of debt. We expect to meet these needs by using a combination of the following: cash flow from operations after funding our dividend, borrowings from our Line, proceeds from the sale of real estate, mortgage loan and unsecured bank financing, distributions received from our co-investment partnerships, and when the capital markets are favorable, proceeds from the sale of equity securities or the issuance of new unsecured debt. We continually evaluate alternative financing options, and we believe we can obtain new financing on reasonable terms, although likely at higher interest rates than that of our debt currently outstanding. We have no unsecured debt maturities in 2023, $250 million of unsecured debt maturing in 2024, and what we believe is a manageable level of secured mortgage maturities during the next 12 months, including those mortgages within our real estate partnerships. Based upon our available cash balance, sources of capital, our current credit ratings, and the number of high quality, unencumbered properties we own, we believe our available capital resources are sufficient to meet our expected capital needs for the next year. In addition to our $66.5 million of unrestricted cash, we have the following additional sources of capital available: (in thousands) December 31, 2022 ATM equity program (see note 12 to our Consolidated Financial Statements) Original offering amount $ 500,000 Available capacity $ 350,363 Line of Credit (see note 9 to our Consolidated Financial Statements) Total commitment amount $ 1,250,000 Available capacity (1) $ 1,240,619 Maturity (2) March 23, 2025 (1)Net of letters of credit. (2)The Company has the option to extend the maturity for two additional six-month periods. The declaration of dividends is determined quarterly by our Board of Directors. On February 8, 2023, our Board of Directors declared a common stock dividend of $0.65 per share, payable on April 5, 2023, to shareholders of record as of March 15, 2023. While future dividends will be determined at the discretion of our Board of Directors, we plan to continue paying an aggregate amount of distributions to our stock and unit holders that, at a minimum, meet the requirements to continue qualifying as a REIT for federal income tax purposes. We have historically generated sufficient cash flow from operations to fund our dividend distributions. During the years ended December 31, 2022 and 2021, we generated cash flow from operations of $655.8 million and $659.4 million, respectively, and paid $430.1 million and $404.9 million in dividends to our common stock and unit holders, respectively. We currently have development and redevelopment projects in various stages of construction, along with a pipeline of potential projects for future development or redevelopment. After funding our common stock dividend payment in January 2023, we estimate that we will require capital during the next 12 months of approximately $351.4 million related to leasing commissions, tenant improvements, in-process developments and redevelopments, capital contributions to our co-investment partnerships, and repaying maturing debt. These capital requirements are being impacted by current levels of high inflation resulting in increased costs of construction materials, labor, and services from third party contractors and suppliers. In response, we have implemented mitigation strategies such as entering into fixed cost construction contracts, pre-ordering materials, and other planning efforts. Further, continued challenges from permitting delays, labor shortages, and supply chain disruptions may extend the time to completion of these projects. 60 If we start new developments or redevelopments, commit to property acquisitions, repay debt prior to maturity, declare future dividends, or repurchase shares of our common stock, our cash requirements will increase. If we refinance maturing debt, our cash requirements will decrease. We endeavor to maintain a high percentage of unencumbered assets. As of December 31, 2022, 89.5% of our wholly-owned real estate assets were unencumbered. Our low level of encumbered assets allows us to more readily access the secured and unsecured debt markets and to maintain availability on the Line. Our trailing 12 month fixed charge coverage ratio, including our Pro-rata share of our partnerships, was 4.6x and 4.5x for the periods ended December 31, 2022 and 2021, respectively, and our Pro-rata net debt-to-operating EBITDAre ratio on a trailing 12 month basis was 5.0x and 5.1x, respectively, for the same periods. Our Line and unsecured debt require that we remain in compliance with various covenants, which are described in note 9 to the Consolidated Financial Statements. We are in compliance with these covenants at December 31, 2022, and expect to remain in compliance. Please also refer to the Risk Factors discussed in Item 1A of Part I herein. Summary of Cash Flow Activity The following table summarizes net cash flows related to operating, investing, and financing activities of the Company: (in thousands) 2022 2021 Change Net cash provided by operating activities $ 655,815 659,388 (3,573 ) Net cash used in investing activities (206,108 ) (286,352 ) 80,244 Net cash used in financing activities (475,958 ) (656,459 ) 180,501 Net (decrease) increase in cash, cash equivalents, and restricted cash (26,251 ) (283,423 ) 257,172 Total cash, cash equivalents, and restricted cash $ 68,776 95,027 (26,251 ) Net cash provided by operating activities: Net cash provided by operating activities changed by $3.6 million due to: •$10.5 million decrease in operating cash flow distributions from Investments in real estate partnerships attributable to the reduced portfolio within partnerships and the higher distributions in 2021 from collecting past due rents, partially offset by, •$4.4 million net increase in cash from operations; and •$2.5 million increase driven by cash used in 2021 to settle interest rate swaps on our term loan which was repaid in January 2021 Net cash used in investing activities: Net cash used in investing activities changed by $80.2 million as follows: (in thousands) 2022 2021 Change Cash flows from investing activities: Acquisition of operating real estate, net of cash acquired of $3,061 and $2,991 in 2022 and 2021, respectively $ (169,639 ) (392,051 ) 222,412 Real estate development and capital improvements (195,418 ) (177,631 ) (17,787 ) Proceeds from sale of real estate 143,133 206,193 (63,060 ) Collection (issuance) of notes receivable, net 1,823 (20 ) 1,843 Investments in real estate partnerships (36,266 ) (23,476 ) (12,790 ) Return of capital from investments in real estate partnerships 48,473 99,945 (51,472 ) Dividends on investment securities 1,113 813 300 Acquisition of investment securities (21,112 ) (23,971 ) 2,859 Proceeds from sale of investment securities 21,785 23,846 (2,061 ) Net cash used in investing activities $ (206,108 ) (286,352 ) 80,244 Significant changes in investing activities include: •We paid $169.6 million to purchase seven operating properties during 2022, including four properties in which we previously held a 25% interest through an unconsolidated Investment in real estate partnership. We paid $392.1 million for the acquisition of 12 operating properties during 2021, including seven properties in which we previously held a 20% interest through an unconsolidated Investment in real estate partnership. 61 •We invested $17.8 million more in 2022 than 2021 in real estate development, redevelopment, and capital improvements, as further detailed in the tables below. •We sold two operating properties, four land parcels, and one development project interest in 2022 for proceeds of $143.1 million compared to seven operating properties and five land parcels in 2021 for proceeds of $206.2 million. •We collected $1.8 million in notes receivable during 2022. •We invested $36.3 million in our real estate partnerships during 2022, including: o$6.1 million to fund our share of acquiring one operating property within an existing co-investment partnership, o$20.2 million to fund our share of secured debt maturities, and o$10.0 million to fund our share of development and redevelopment activities. During the same period in 2021, we invested $23.5 million in our real estate partnerships, including: o$18.7 million to fund our share of debt refinancing activities, and o$4.8 million to fund our share of development and redevelopment activities. •Return of capital from our unconsolidated investments in real estate partnerships includes sales or financing proceeds. The $48.5 million received in 2022 is our share of $11.6 million from debt refinancing activities and $36.9 million from real estate sales. The $99.9 million received in 2021 is our share of $28.1 million proceeds from debt refinancing activities and $71.8 million proceeds from real estate sales. •Acquisition of securities and proceeds from sale of securities pertain to investment activities held in our captive insurance company and our deferred compensation plan. We plan to continue developing and redeveloping shopping centers for long-term investment. During 2022, we deployed capital of $195.4 million for the development, redevelopment, and improvement of our real estate properties, comprised of the following: (in thousands) 2022 2021 Change Capital expenditures: Land acquisitions $ 12,484 11,820 664 Building and tenant improvements 75,420 53,752 21,668 Redevelopment costs 68,730 78,056 (9,326 ) Development costs 27,861 19,426 8,435 Capitalized interest 4,133 4,085 48 Capitalized direct compensation 6,790 10,492 (3,702 ) Real estate development and capital improvements $ 195,418 177,631 17,787 •We paid $12.5 million to acquire one land parcel for development and one land parcel formerly under ground lease at one of our existing centers in 2022, and paid $11.8 million in 2021 to purchase land formerly under ground leases at two of our existing centers. •Building and tenant improvements increased $21.7 million during the year ended December 31, 2022, primarily related to the timing of capital projects. •Redevelopment costs decreased $9.3 million during 2022 due to the timing and magnitude of projects in process. We intend to continuously improve our portfolio of shopping centers through redevelopment which may include adjacent land acquisition, existing building expansion, facade renovation, new out-parcel building construction, and redevelopment related tenant improvement costs. The size and magnitude of each redevelopment project varies with each redevelopment plan. The timing and duration of these projects could also result in volatility in NOI. See the tables below for more details about our redevelopment projects. •Development costs increased $8.4 million based on the timing and magnitude of our development projects currently in process. See the tables below for more details about our development projects. 62 •Interest is capitalized on our development and redevelopment projects and is based on cumulative actual costs expended. We cease interest capitalization when the property is no longer being developed or is available for occupancy upon substantial completion of tenant improvements, but in no event would we capitalize interest on the project beyond 12 months after the anchor opens for business. If we reduce our development and redevelopment activity, the amount of interest that we capitalize may be lower than historical averages. •We have a staff of employees who directly support our development program, which includes redevelopment of our existing properties. Internal compensation costs directly attributable to these activities are capitalized as part of each project. The following table summarizes our development projects in-process and completed: (in thousands, except cost PSF) December 31, 2022 Property Name Market Ownership Start Date Estimated Stabilization Year (1) Estimated / Actual NetDevelopmentCosts (2) (3) GLA (3) Cost PSFof GLA (2) (3) % of CostsIncurred Developments In-Process Glenwood Green Old Bridge, NJ 70% Q1-22 2025 $ 45,530 248 $ 184 45 % Eastfield at Baybrook - Phase 1B Houston, TX 50% Q2-22 2025 10,384 25 415 37 % Total Developments In-Process $ 55,914 273 $ 205 44 % Developments Completed Carrytown Exchange - Phase I & II Richmond, VA 64% Q4-18 2024 $ 29,268 74 $ 396 East San Marco Jacksonville, FL 100% Q4-20 2023 18,970 59 322 Total Developments Completed $ 48,238 133 $ 363 (1)Estimated Stabilization Year represents the estimated first full calendar year that the project will reach our expected stabilized yield. (2)Includes leasing costs and is net of tenant reimbursements. (3)Estimated Net Development Costs and GLA are reported based on Regency’s ownership interest in the real estate partnership at completion. (4)Estimated Net Development Costs for Baybrook East 1A is limited to our ownership interest in the value of land and site improvements to deliver a parcel to a grocer, under a ground lease agreement, to construct their building and improvements. This property is included in our Investments in real estate partnerships. The following table summarizes our redevelopment projects in-process and completed: (in thousands) December 31, 2022 Property Name Market Ownership Start Date Estimated Stabilization Year (1) Estimated Incremental Project Costs (2) (3) GLA (3) % of Costs Incurred Redevelopments In-Process The Crossing Clarendon Metro, DC 100% Q4-18 2024 $ 56,002 129 71 % The Abbot Boston, MA 100% Q2-19 2024 59,033 64 87 % Westbard Square Phase I Bethesda, MD 100% Q2-21 2025 37,269 123 47 % Buckhead Landing Atlanta, GA 100% Q2-22 2025 27,709 152 10 % Town & Country Center Los Angeles, CA 35% Q4-22 2027 24,525 51 3 % Various Properties Various 20%-100% Various Various 40,403 1,502 46 % Total Redevelopments In-Process $ 244,941 2,021 52 % Redevelopments Completed Sheridan Plaza Hollywood, FL 100% Q3-19 2023 $ 11,915 507 Preston Oaks Dallas, TX 100% Q4-20 2023 19,658 103 Serramonte Center-Phases 1 & 2 San Francisco, CA 100% Q4-20 2022 33,229 1,072 Various Properties Various 100% Various Various 8,916 243 Total Redevelopments Completed $ 73,718 1,925 (1)Estimated Stabilization Year represents the estimated first full calendar year that the project will reach our expected stabilized yield. (2)Includes leasing costs and is net of tenant reimbursements. (3)Estimated Net Development Costs and GLA are reported based on Regency’s ownership interest in the real estate partnership at completion. 63 Net cash used in financing activities: Net cash flows used in financing activities changed during 2022, as follows: (in thousands) 2022 2021 Change Cash flows from financing activities: Net proceeds from common stock issuances $ 61,284 82,510 (21,226 ) Repurchase of common shares in conjunction with equity award plans (6,447 ) (4,083 ) (2,364 ) Common shares repurchased through share repurchase program (75,419 ) — (75,419 ) Distributions to limited partners in consolidated partnerships, net (7,245 ) (4,345 ) (2,900 ) Dividend payments and operating partnership distributions (430,143 ) (404,900 ) (25,243 ) Repayments of unsecured credit facilities, net — (265,000 ) 265,000 Debt repayment, including early redemption costs (17,964 ) (53,269 ) 35,305 Payment of loan costs (88 ) (7,468 ) 7,380 Proceeds from sale of treasury stock, net 64 96 (32 ) Net cash used in financing activities $ (475,958 ) (656,459 ) 180,501 Significant financing activities during the years ended December 31, 2022 and 2021 included the following: •We received proceeds of $61.3 million, net of issue costs, in April 2022 upon settling forward equity sales under our ATM program. During 2021, we received proceeds of $82.5 million, net of issue costs, upon settling forward equity sales under our ATM program. •We repurchased for cash a portion of the common stock granted to employees for stock based compensation to satisfy employee tax withholding requirements, which totaled $6.4 million and $4.1 million during the years ended December 31, 2022 and 2021, respectively. •We paid $75.4 million to repurchase 1,294,201 common shares through our Authorized Repurchase Program during 2022. •We paid $7.2 million, net to limited partners, including $15.0 million in distributions to limited partners for both operating cash flows as well as a partner buyout, partially offset by $7.8 million of contributions from limited partners in new consolidated Investments in real estate partnerships during 2022. During 2021, we paid $4.3 million in distributions to limited partners. •We paid $25.2 million more in dividends primarily as a result of an increase in our dividend rate per share. •We had the following debt related activity during 2022: oWe paid $18.0 million for secured debt payments, including: ▪$6.0 million to repay one mortgage, and ▪$12.0 million in principal mortgage payments. •We had the following debt related activity during 2021: oWe paid $265 million to repay our outstanding term loan, and oWe paid $53.3 million for secured debt payments, including: ▪$42.0 million to repay four mortgages; and ▪$11.3 million in principal mortgage payments. oWe paid $7.5 million of loan costs in connection with the renewal of our Line. 64 Contractual Obligations We have contractual obligations at December 31, 2022, which are discussed in our notes to Consolidated Financial Statements and include: •Mortgage loans, unsecured notes, and unsecured credit facilities as discussed in note 9, and related interest rate swaps as discussed in note 10; •We have shopping centers that are subject to non-cancelable long-term ground leases where a third party owns and has leased the underlying land to us to construct and/or operate a shopping center. We also have non-cancelable operating leases pertaining to office space from which we conduct our business. These lease obligations are discussed in note 7; •Our share of mortgage loans within our Investments in real estate partnerships, as discussed in note 4; •Letters of credit of $9.4 million issued to cover our captive insurance program and performance obligations on certain development projects, the latter of which will be satisfied upon completion of the development projects; •Obligations for retirement savings plans due to uncertainty around timing of participant withdrawals, which are solely within the control of the participant, and are further discussed in note 14; and •We will also incur obligations related to construction or development contracts on projects in process; however, future amounts under these construction contracts are not due until future satisfactory performance under the contracts. Critical Accounting Estimates Knowledge about our accounting policies is necessary for a complete understanding of our Consolidated Financial Statements. The preparation of our Consolidated Financial Statements requires that we make certain estimates that impact the balance of assets and liabilities as of a financial statement date and the reported amount of income and expenses during a financial reporting period. These accounting estimates are based upon, but not limited to, our judgments about historical and expected future results, current market conditions, and interpretation of industry accounting standards. While the following is not intended to be a comprehensive list of our accounting estimates, the estimates discussed below are believed to be critical because of their significance to the Consolidated Financial Statements and the possibility that future events may differ from those judgments, or that the use of different assumptions could result in materially different estimates. We review these estimates on a periodic basis to ensure reasonableness; however, the amounts we may ultimately realize could differ from such estimates. Valuation of Real Estate Investments In accordance with GAAP, we evaluate our real estate for impairment whenever there are events or changes in circumstances, including property operating performance, general market conditions or changes in expected hold periods, that indicate that the carrying value of our real estate properties (including any related amortizable intangible assets or liabilities) may not be recoverable. If such events or changes occur, we compare the current carrying value of the asset to the estimated undiscounted cash flows that are directly associated with the use and ultimate disposition of the asset. Our estimated cash flows are based on several key assumptions, including rental rates, expected leasing activity, costs of tenant improvements, leasing commissions, expected hold period, comparable sales information, and assumptions regarding the residual value upon disposition, including the exit capitalization rate. These key assumptions are subjective in nature and the resulting impairment, if any, could differ from the actual gain or loss recognized upon ultimate sale in an arm's length transaction. If the carrying value of the asset exceeds the estimated undiscounted cash flows, an impairment loss is recognized equal to the excess of carrying value over the estimated fair value. The estimated fair value of real estate assets is subjective and is estimated through comparable sales information and other market data if available, as well as the use of an income approach such as the direct capitalization method or the discounted cash flow approach. The discounted cash flow method uses similar assumptions to the undiscounted cash flow method above, as well as a discount rate. Such cash flow projections and rates are subject to management judgment and changes in those assumptions could impact the estimation of fair value. In estimating the fair value of undeveloped land, we generally use market data and comparable sales information. Changes in events or changes in circumstances may alter the expected hold period of an asset or asset group, which may result in an impairment loss and such loss could be material to the Company's financial condition or operating performance. Recent Accounting Pronouncements See note 1 to Consolidated Financial Statements. 65 Environmental Matters We are subject to numerous environmental laws and regulations as they apply to our shopping centers, pertaining primarily to chemicals historically used by certain current and former dry cleaning and gas station tenants and the existence of asbestos in older shopping centers. We believe that the few tenants who currently operate dry cleaning plants or gas stations do so in accordance with current laws and regulations. Generally, we endeavor to require tenants to remove dry cleaning plants from our shopping centers or convert them to more environmentally friendly systems, in accordance with the terms of our leases. We carry an environmental insurance policy for certain third-party liabilities and remediation costs on shopping centers that currently have no known environmental contamination. We have also secured environmental insurance policies, where appropriate, on a relatively small number of specific properties with known contamination, in order to mitigate our environmental risk. We monitor the shopping centers containing environmental issues and in certain cases voluntarily remediate the sites. We also have legal obligations to remediate certain sites and we are in the process of doing so. As of December 31, 2022, we had accrued liabilities of $12.1 million for our Pro-rata share of environmental remediation, including our Investments in real estate partnerships. We believe that the ultimate remediation of currently known environmental matters will not have a material effect on our financial position, cash flows, or results of operations. We can give no assurance that existing environmental studies on our shopping centers have revealed all potential environmental contamination; that our estimate of liabilities will not change as more information becomes available; that any previous owner, occupant or tenant did not create any material environmental condition not known to us; that the current environmental condition of the shopping centers will not be affected by tenants and occupants, by the condition of nearby properties, or by unrelated third parties; or that changes in applicable environmental laws and regulations or their interpretation will not result in additional environmental liability to us. Item 7A. Quantitative and Qualitative Disclosures about Market Risk We are exposed to two significant components of interest rate risk: •We have a Line commitment, as further described in note 9 to the Consolidated Financial Statements, which has a variable interest rate that as of December 31, 2022, was based upon an annual rate of LIBOR plus 0.865%. On January 12, 2023, the Line was amended to convert the reference rate from LIBOR to the secured overnight financing rate ("SOFR") plus a 10 basis point market adjustment, with no changes in the applicable margin, which is dependent upon maintaining specific credit ratings. The current applicable margin is 0.865%. If our credit ratings are downgraded, the margin on the Line would increase, resulting in higher interest costs. The interest rate plus applicable margin based on our credit rating ranges from SOFR plus 0.690% to SOFR plus 1.540%. •We are also exposed to changes in interest rates when we refinance our existing long-term fixed rate debt. The objective of our interest rate risk management program is to limit the impact of interest rate changes on earnings and cash flows. To achieve these objectives, we borrow primarily at fixed interest rates and may enter into derivative financial instruments such as interest rate swaps, caps, or treasury locks in order to mitigate our interest rate risk on a related financial instrument. We do not enter into derivative or interest rate transactions for speculative purposes. Our interest rate swaps are structured solely for the purpose of interest rate protection. We continuously monitor the capital markets and evaluate our ability to issue new debt, to repay maturing debt, or fund our commitments. We continue to believe, in light of our credit ratings, the available capacity under our unsecured credit facility, and the number of high quality, unencumbered properties that we own which could collateralize borrowings, we will be able to successfully issue new secured or unsecured debt to fund maturing debt obligations. It is uncertain the degree to which capital market volatility and rising interest rates will adversely impact the interest rates on any new debt that we may issue. Our interest rate risk is monitored using a variety of techniques. The table below presents the principal cash flows, weighted average interest rates of remaining debt, and the fair value of total debt as of December 31, 2022. For variable rate mortgages and unsecured credit facilities for which we have interest rate swaps in place to fix the interest rate, they are included in the Fixed rate debt section below at their all-in fixed rate. The table is presented by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes. Although the average interest rate for variable rate debt is included in the table, those rates represent rates that existed as of December 31, 2022, and are subject to change on a monthly basis. In addition, the Company continually assesses the market risk for its floating rate debt and believes that a 1% increase in interest rates would decrease future earnings and cash flows by approximately $42,500 per year based on $4.3 million of floating rate mortgage debt outstanding at December 31, 2022. If the Company increases its line of credit balance in the future, additional decreases to future earnings and cash flows could occur. 66 Further, the table below incorporates only those exposures that exist as of December 31, 2022, and does not consider exposures or positions that could arise after that date or obligations repaid before maturity. Since firm commitments are not presented, the table has limited predictive value. As a result, our ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period, our hedging strategies at that time, and actual interest rates. The table below presents the principal cash flow payments associated with our outstanding debt by year, weighted average interest rates on debt outstanding at each year-end, and fair value of total debt as of December 31, 2022. (dollars in thousands) 2023 2024 2025 2026 2027 Thereafter Total Fair Value Fixed rate debt (1) $ 69,078 345,607 293,732 316,287 666,703 2,053,192 3,744,599 3,329,135 Average interest rate for all fixed rate debt (2) 3.82 % 3.82 % 3.83 % 3.84 % 3.84 % 3.89 % Variable rate SOFR debt (1) $ — — 4,250 — — — 4,250 4,243 Average interest rate for all variable rate debt (2) 3.07 % 3.07 % 3.07 % — % — % — % (1)Reflects amount of debt maturities during each of the years presented as of December 31, 2022. (2)Reflects weighted average interest rates of debt outstanding at the end of each year presented. For variable rate debt, the rate as of December 31, 2022, was used to determine the average interest rate for all future periods. Item 8. Consolidated Financial Statements and Supplementary Data Regency Centers Corporation and Regency Centers, L.P. Index to Financial Statements Reports of Independent Registered Public Accounting Firm 68 Regency Centers Corporation: Consolidated Balance Sheets as of December 31, 2022 and 2021 74 Consolidated Statements of Operations for the years ended December 31, 2022, 2021, and 2020 75 Consolidated Statements of Comprehensive Income for the years ended December 31, 2022, 2021, and 2020 76 Consolidated Statements of Equity for the years ended December 31, 2022, 2021, and 2020 77 Consolidated Statements of Cash Flows for the years ended December 31, 2022, 2021, and 2020 80 Regency Centers, L.P.: Consolidated Balance Sheets as of December 31, 2022 and 2021 82 Consolidated Statements of Operations for the years ended December 31, 2022, 2021, and 2020 83 Consolidated Statements of Comprehensive Income for the years ended December 31, 2022, 2021, and 2020 84 Consolidated Statements of Capital for the years ended December 31, 2022, 2021, and 2020 85 Consolidated Statements of Cash Flows for the years ended December 31, 2022, 2021, and 2020 87 Notes to Consolidated Financial Statements 89 Financial Statement Schedule Schedule III - Consolidated Real Estate and Accumulated Depreciation - December 31, 2022 122 All other schedules are omitted because of the absence of conditions under which they are required, materiality or because information required therein is shown in the Consolidated Financial Statements or notes thereto. 67 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Regency Centers Corporation: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Regency Centers Corporation and subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2022, and the related notes and financial statement schedule III - Consolidated Real Estate and Accumulated Depreciation (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 17, 2023 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Evaluation of expected hold periods for certain real estate assets As discussed in Note 1 to the consolidated financial statements and presented on the consolidated balance sheet, real estate assets, less accumulated depreciation was $9.4 billion as of December 31, 2022. The Company evaluates real estate properties (including any related amortizable intangible assets or liabilities) for impairment whenever there are events or changes in circumstances that indicate the carrying value of the real estate properties may not be recoverable. We identified the Company’s assessment of events or changes in circumstances that could indicate a shortened expected hold period for certain real estate properties as a critical audit matter. Subjective auditor judgment was required to evaluate the events or changes in circumstances assessed by the Company that could indicate shortened expected hold periods for certain real estate properties. A shortening of the expected hold period could indicate a potential impairment. 68 The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of a control related to the Company’s assessment of events or changes in circumstances that could indicate shortened expected hold periods for certain real estate properties. To evaluate relevant events or changes in circumstances indicating a potential shortening of the expected holding period, we: •inquired of management and obtained written representations regarding potential property disposal plans, if any •read minutes of the meetings of the Company’s board of directors •inquired about the Company’s plans with those in the organization who are responsible for, and have authority over, potential disposition activities •compared management’s assessment of properties with potential shortened expected hold periods to information obtained from those in the organization responsible for disposition activity •inspected listings from external sources of real estate properties for sale by the Company. /s/ KPMG LLP We have served as the Company's auditor since 1993. Jacksonville, Florida February 17, 2023 69 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Regency Centers Corporation: Opinion on Internal Control Over Financial Reporting We have audited Regency Centers Corporation and subsidiaries' (the Company) internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2022, and the related notes and financial statement schedule III - Consolidated Real Estate and Accumulated Depreciation (collectively, the consolidated financial statements), and our report dated February 17, 2023 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP Jacksonville, Florida February 17, 2023 70 Report of Independent Registered Public Accounting Firm To the Board of Directors of Regency Centers Corporation and the Partners of Regency Centers, L.P.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Regency Centers, L.P. and subsidiaries (the Partnership) as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive income, capital, and cash flows for each of the years in the three-year period ended December 31, 2022, and the related notes and financial statement schedule III - Consolidated Real Estate and Accumulated Depreciation (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Partnership as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2022, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Partnership’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 17, 2023 expressed an unqualified opinion on the effectiveness of the Partnership’s internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Partnership in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Evaluation of expected hold periods for certain real estate assets As discussed in Note 1 to the consolidated financial statements and presented on the consolidated balance sheet, real estate assets, less accumulated depreciation was $9.4 billion as of December 31, 2022. The Partnership evaluates real estate properties (including any related amortizable intangible assets or liabilities) for impairment whenever there are events or changes in circumstances that indicate the carrying value of the real estate properties may not be recoverable. We identified the Partnership’s assessment of events or changes in circumstances that could indicate a shortened expected hold period for certain real estate properties as a critical audit matter. Subjective auditor judgment was required to evaluate the events or changes in circumstances assessed by the Partnership that could indicate shortened expected hold periods for certain real estate properties. A shortening of the expected hold period could indicate a potential impairment. 71 The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of a control related to the Partnership’s assessment of events or changes in circumstances that could indicate shortened expected hold periods for certain real estate properties. To evaluate relevant events or changes in circumstances indicating a potential shortening of the expected hold period, we: •inquired of management and obtained written representations regarding potential property disposal plans, if any •read minutes of the meetings of the general partner’s board of directors •inquired about the Partnership’s plans with those in the organization who are responsible for, and have authority over, potential disposition activities •compared management’s assessment of properties with potential shortened expected hold periods to information obtained from those in the organization responsible for disposition activity •inspected listings from external sources of real estate properties for sale by the Partnership. /s/ KPMG LLP We have served as the Partnership's auditor since 1998. Jacksonville, Florida February 17, 2023 72 Report of Independent Registered Public Accounting Firm To the Board of Directors of Regency Centers Corporation and the Partners of Regency Centers, L.P.: Opinion on Internal Control Over Financial Reporting We have audited Regency Centers, L.P. and subsidiaries' (the Partnership) internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Partnership maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Partnership as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive income, capital, and cash flows for each of the years in the three-year period ended December 31, 2022, and the related notes and financial statement schedule III - Consolidated Real Estate and Accumulated Depreciation (collectively, the consolidated financial statements), and our report dated February 17, 2023 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Partnership’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Partnership’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Partnership in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP Jacksonville, Florida February 17, 2023 73 REGENCY CENTERS CORPORATION Consolidated Balance Sheets December 31, 2022 and 2021 (in thousands, except share data) 2022 2021 Assets Net real estate investments: Real estate assets, at cost (note 1) $ 11,858,064 11,495,581 Less: accumulated depreciation 2,415,860 2,174,963 Real estate assets, net 9,442,204 9,320,618 Investments in real estate partnerships (note 4) 350,377 372,591 Net real estate investments 9,792,581 9,693,209 Properties held for sale — 25,574 Cash, cash equivalents, and restricted cash, including $2,310 and $1,930 of restricted cash at December 31, 2022 and 2021, respectively (note 1) 68,776 95,027 Tenant and other receivables (note 1) 188,863 153,091 Deferred leasing costs, less accumulated amortization of $117,137 and $117,878 at December 31, 2022 and 2021, respectively 68,945 65,741 Acquired lease intangible assets, less accumulated amortization of $338,053 and $312,186 at December 31, 2022 and 2021, respectively (note 6) 197,745 212,707 Right of use assets, net 275,513 280,783 Other assets (note 5) 267,797 266,431 Total assets $ 10,860,220 10,792,563 Liabilities and Equity Liabilities: Notes payable (note 9) $ 3,726,754 3,718,944 Accounts payable and other liabilities 317,259 322,271 Acquired lease intangible liabilities, less accumulated amortization of $193,315 and $172,293 at December 31, 2022 and 2021, respectively (note 6) 354,204 363,276 Lease liabilities 213,722 215,788 Tenants’ security, escrow deposits and prepaid rent 70,242 62,352 Total liabilities 4,682,181 4,682,631 Commitments and contingencies (note 16) — — Equity: Stockholders’ equity (note 12): Common stock $0.01 par value per share, 220,000,000 shares authorized; 171,124,593 and 171,213,008 shares issued at December 31, 2022 and 2021, respectively 1,711 1,712 Treasury stock at cost, 465,415 and 427,901 shares held at December 31, 2022 and 2021, respectively (24,461 ) (22,758 ) Additional paid-in capital 7,877,152 7,883,458 Accumulated other comprehensive income (loss) 7,560 (10,227 ) Distributions in excess of net income (1,764,977 ) (1,814,814 ) Total stockholders’ equity 6,096,985 6,037,371 Noncontrolling interests (note 12): Exchangeable operating partnership units, aggregate redemption value of $46,340 and $56,844 at December 31, 2022 and 2021, respectively 34,489 35,447 Limited partners’ interests in consolidated partnerships (note 1) 46,565 37,114 Total noncontrolling interests 81,054 72,561 Total equity 6,178,039 6,109,932 Total liabilities and equity $ 10,860,220 10,792,563 See accompanying notes to Consolidated Financial Statements. 74 REGENCY CENTERS CORPORATION Consolidated Statements of Operations For the years ended December 31, 2022, 2021, and 2020 (in thousands, except per share data) 2022 2021 2020 Revenues: Lease income $ 1,187,452 1,113,368 980,166 Other property income 10,719 12,456 9,508 Management, transaction, and other fees 25,851 40,337 26,501 Total revenues 1,224,022 1,166,161 1,016,175 Operating expenses: Depreciation and amortization 319,697 303,331 345,900 Property operating expense 196,148 184,553 170,073 Real estate taxes 149,795 142,129 143,004 General and administrative 79,903 78,218 75,001 Other operating expenses 6,166 5,751 12,642 Total operating expenses 751,709 713,982 746,620 Other expense (income): Interest expense, net 146,186 145,170 156,678 Goodwill impairment — — 132,128 Provision for impairment of real estate — 84,389 18,536 Gain on sale of real estate, net of tax (109,005 ) (91,119 ) (67,465 ) Early extinguishment of debt — — 21,837 Net investment loss (income) 6,921 (5,463 ) (5,307 ) Total other expense (income) 44,102 132,977 256,407 Income from operations before equity in income of investments in real estate partnerships 428,211 319,202 13,148 Equity in income of investments in real estate partnerships (note 4) 59,824 47,086 34,169 Net income 488,035 366,288 47,317 Noncontrolling interests: Exchangeable operating partnership units (2,105 ) (1,615 ) (203 ) Limited partners’ interests in consolidated partnerships (3,065 ) (3,262 ) (2,225 ) Income attributable to noncontrolling interests (5,170 ) (4,877 ) (2,428 ) Net income attributable to common stockholders $ 482,865 361,411 44,889 Income per common share - basic (note 15) $ 2.82 2.12 0.27 Income per common share - diluted (note 15) $ 2.81 2.12 0.26 See accompanying notes to Consolidated Financial Statements. 75 REGENCY CENTERS CORPORATION Consolidated Statements of Comprehensive Income For the years ended December 31, 2022, 2021, and 2020 (in thousands) 2022 2021 2020 Net income $ 488,035 366,288 47,317 Other comprehensive income (loss): Effective portion of change in fair value of derivative instruments: Effective portion of change in fair value of derivative instruments 20,061 5,391 (19,187 ) Reclassification adjustment of derivative instruments included in net income 833 4,141 11,262 Unrealized (loss) gain on available-for-sale securities (1,309 ) (405 ) 320 Other comprehensive income (loss) 19,585 9,127 (7,605 ) Comprehensive income 507,620 375,415 39,712 Less: comprehensive income attributable to noncontrolling interests: Net income attributable to noncontrolling interests 5,170 4,877 2,428 Other comprehensive income (loss) attributable to noncontrolling interests 1,798 729 (977 ) Comprehensive income attributable to noncontrolling interests 6,968 5,606 1,451 Comprehensive income attributable to the Company $ 500,652 369,809 38,261 See accompanying notes to Consolidated Financial Statements. 76 REGENCY CENTERS CORPORATION Consolidated Statements of Equity For the years ended December 31, 2022, 2021, and 2020 (in thousands, except per share data) 77 Stockholders' Equity Noncontrolling Interests CommonStock TreasuryStock AdditionalPaid InCapital AccumulatedOtherComprehensiveLoss Distributionsin Excess ofNet Income TotalStockholders’Equity ExchangeableOperatingPartnershipUnits LimitedPartners’Interest inConsolidatedPartnerships TotalNoncontrollingInterests TotalEquity Balance at December 31, 2019 $ 1,676 (23,199 ) 7,654,930 (11,997 ) (1,408,062 ) 6,213,348 36,100 40,513 76,613 6,289,961 Net income — — — — 44,889 44,889 203 2,225 2,428 47,317 Other comprehensive (loss) income: Other comprehensive loss before reclassifications — — — (17,589 ) — (17,589 ) (79 ) (1,199 ) (1,278 ) (18,867 ) Amounts reclassified from accumulated other comprehensive income — — — 10,961 — 10,961 50 251 301 11,262 Deferred compensation plan, net — (1,237 ) 1,237 — — — — — — — Restricted stock issued, net of amortization 2 — 14,246 — — 14,248 — — — 14,248 Common stock repurchased for taxes withheld for stock based compensation, net — — (5,059 ) — — (5,059 ) — — — (5,059 ) Common stock issued under dividend reinvestment plan — — 1,139 — — 1,139 — — — 1,139 Common stock issued, net of issuance costs 19 — 125,589 — — 125,608 — — — 125,608 Contributions from partners — — — — — — — 606 606 606 Issuance of exchangeable operating partnership units — — — — — — 1,275 — 1,275 1,275 Distributions to partners — — — — — — — (4,888 ) (4,888 ) (4,888 ) Cash dividends declared: Common stock/unit ($2.380 per share) — — — — (402,633 ) (402,633 ) (1,822 ) — (1,822 ) (404,455 ) Balance at December 31, 2020 $ 1,697 (24,436 ) 7,792,082 (18,625 ) (1,765,806 ) 5,984,912 35,727 37,508 73,235 6,058,147 Net income — — — — 361,411 361,411 1,615 3,262 4,877 366,288 Other comprehensive income: Other comprehensive income before reclassifications — — — 4,603 — 4,603 23 360 383 4,986 Amounts reclassified from accumulated other comprehensive income — — — 3,795 — 3,795 17 329 346 4,141 Deferred compensation plan, net — 1,678 (1,603 ) — — 75 — — — 75 Restricted stock issued, net of amortization 2 — 12,650 — — 12,652 — — — 12,652 Common stock repurchased for taxes withheld for stock based compensation, net — — (3,553 ) — — (3,553 ) — — — (3,553 ) Common stock issued under dividend reinvestment plan — — 1,286 — — 1,286 — — — 1,286 Common stock issued for partnership units exchanged — — 99 — — 99 (99 ) — (99 ) — Common stock issued, net of issuance costs 13 — 82,497 — — 82,510 — — — 82,510 Distributions to partners — — — — — — — (4,345 ) (4,345 ) (4,345 ) Cash dividends declared: Common stock/unit ($2.410 per share) — — — — (410,419 ) (410,419 ) (1,836 ) — (1,836 ) (412,255 ) Balance at December 31, 2021 $ 1,712 (22,758 ) 7,883,458 (10,227 ) (1,814,814 ) 6,037,371 35,447 37,114 72,561 6,109,932 78 Stockholders' Equity Noncontrolling Interests CommonStock TreasuryStock AdditionalPaid InCapital AccumulatedOtherComprehensiveLoss Distributionsin Excess ofNet Income TotalStockholders’Equity ExchangeableOperatingPartnershipUnits LimitedPartners’Interest inConsolidatedPartnerships TotalNoncontrollingInterests TotalEquity Balance at December 31, 2021 $ 1,712 (22,758 ) 7,883,458 (10,227 ) (1,814,814 ) 6,037,371 35,447 37,114 72,561 6,109,932 Net income — — — — 482,865 482,865 2,105 3,065 5,170 488,035 Other comprehensive income Other comprehensive income before reclassifications — — — 17,008 — 17,008 80 1,664 1,744 18,752 Amounts reclassified from accumulated other comprehensive income — — — 779 — 779 5 49 54 833 Deferred compensation plan, net — (1,703 ) 1,702 — — (1 ) — — — (1 ) Restricted stock issued, net of amortization 2 — 16,665 — — 16,667 — — — 16,667 Common stock repurchased for taxes withheld for stock based compensation, net — — (5,858 ) — — (5,858 ) — — — (5,858 ) Common stock repurchased and retired (13 ) — (75,406 ) — — (75,419 ) — — — (75,419 ) Common stock issued under dividend reinvestment plan — — 524 — — 524 — — — 524 Common stock issued for partnership units exchanged — — 1,275 — — 1,275 (1,275 ) — (1,275 ) — Common stock issued, net of issuance costs 10 — 61,274 — — 61,284 — — — 61,284 Reallocation of noncontrolling interest, net of transaction costs — — (6,482 ) — — (6,482 ) — 6,266 6,266 (216 ) Contributions from partners — — — — — — — 13,223 13,223 13,223 Distributions to partners — — — — — — — (14,816 ) (14,816 ) (14,816 ) Cash dividends declared: Common stock/unit ($2.525 per share) — — — — (433,028 ) (433,028 ) (1,873 ) — (1,873 ) (434,901 ) Balance at December 31, 2022 $ 1,711 (24,461 ) 7,877,152 7,560 (1,764,977 ) 6,096,985 34,489 46,565 81,054 6,178,039 See accompanying notes to Consolidated Financial Statements. 79 REGENCY CENTERS CORPORATION Consolidated Statements of Cash Flows For the years ended December 31, 2022, 2021, and 2020 (in thousands) 2022 2021 2020 Cash flows from operating activities: Net income $ 488,035 366,288 47,317 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 319,697 303,331 345,900 Amortization of deferred loan costs and debt premiums 5,799 6,003 9,023 (Accretion) and amortization of above and below market lease intangibles, net (20,995 ) (22,936 ) (40,540 ) Stock-based compensation, net of capitalization 16,521 12,515 13,581 Equity in income of investments in real estate partnerships (59,824 ) (47,086 ) (34,169 ) Gain on sale of real estate, net of tax (109,005 ) (91,119 ) (67,465 ) Provision for impairment of real estate — 84,389 18,536 Goodwill impairment — — 132,128 Early extinguishment of debt — — 21,837 Distribution of earnings from investments in real estate partnerships 61,416 71,934 47,703 Settlement of derivative instrument — (2,472 ) — Deferred compensation (revenue) expense (6,128 ) 4,572 4,668 Realized and unrealized loss (gain) on investments 7,040 (5,348 ) (5,519 ) Changes in assets and liabilities: Tenant and other receivables (35,274 ) (24,869 ) 16,944 Deferred leasing costs (10,801 ) (6,966 ) (6,973 ) Other assets 1,292 (1,226 ) (1,200 ) Accounts payable and other liabilities (9,088 ) 6,677 997 Tenants’ security, escrow deposits and prepaid rent 7,130 5,701 (3,650 ) Net cash provided by operating activities 655,815 659,388 499,118 Cash flows from investing activities: Acquisition of operating real estate, net of cash acquired of $3,061 and $2,991 in 2022 and 2021, respectively (169,639 ) (392,051 ) (16,767 ) Real estate development and capital improvements (195,418 ) (177,631 ) (180,804 ) Proceeds from sale of real estate 143,133 206,193 189,444 Proceeds from property insurance casualty claims — — 7,957 Collection (issuance) of notes receivable, net 1,823 (20 ) (1,340 ) Investments in real estate partnerships (36,266 ) (23,476 ) (51,440 ) Return of capital from investments in real estate partnerships 48,473 99,945 32,125 Dividends on investment securities 1,113 813 353 Acquisition of investment securities (21,112 ) (23,971 ) (25,155 ) Proceeds from sale of investment securities 21,785 23,846 19,986 Net cash used in investing activities (206,108 ) (286,352 ) (25,641 ) 80 2022 2021 2020 Cash flows from financing activities: Net proceeds from common stock issuance 61,284 82,510 125,608 Repurchase of common shares in conjunction with equity award plans (6,447 ) (4,083 ) (5,512 ) Proceeds from sale of treasury stock 64 96 269 Common shares repurchased through share repurchase program (75,419 ) — — Distributions to limited partners in consolidated partnerships, net (7,245 ) (4,345 ) (2,770 ) Distributions to exchangeable operating partnership unit holders (1,867 ) (1,815 ) (1,366 ) Dividends paid to common stockholders (428,276 ) (403,085 ) (300,537 ) Repayment of fixed rate unsecured notes — — (300,000 ) Proceeds from issuance of fixed rate unsecured notes, net — — 598,830 Proceeds from unsecured credit facilities 95,000 — 610,000 Repayments of proceeds from unsecured credit facilities, net (95,000 ) (265,000 ) (830,000 ) Repayment of notes payable (6,745 ) (42,014 ) (67,189 ) Scheduled principal payments (11,219 ) (11,255 ) (11,104 ) Payment of loan costs (88 ) (7,468 ) (5,063 ) Early redemption costs — — (21,755 ) Net cash used in financing activities (475,958 ) (656,459 ) (210,589 ) Net (decrease) increase in cash, cash equivalents, and restricted cash (26,251 ) (283,423 ) 262,888 Cash, cash equivalents, and restricted cash at beginning of the year 95,027 378,450 115,562 Cash, cash equivalents, and restricted cash at end of the year $ 68,776 95,027 378,450 Supplemental disclosure of cash flow information: Cash paid for interest (net of capitalized interest of $4,166, $4,202, and $4,355 in 2022, 2021, and 2020, respectively) $ 141,359 140,084 151,338 Cash paid for income taxes, net of refunds $ 570 378 1,870 Supplemental disclosure of non-cash transactions: Common stock and exchangeable operating partnership dividends declared but not paid $ 111,709 107,480 101,412 Exchangeable operating partnership units issued for acquisition of real estate $ — — 1,275 Previously held equity investments in real estate assets acquired $ 17,179 (4,609 ) 5,986 Mortgage loans assumed by Company with the acquisition of real estate $ 22,779 111,104 16,359 Mortgage loan assumed by purchaser with the sale of real estate $ — — 8,250 Common stock issued by Parent Company for partnership units exchanged $ 1,275 99 — Real estate received in lieu of promote interest $ — 13,589 — Change in fair value of securities $ 1,658 513 315 Change in accrued capital expenditures $ 4,888 10,188 12,166 Common stock issued for dividend reinvestment plan $ 524 1,286 1,139 Stock-based compensation capitalized $ 735 666 1,119 Contributions from (distributions to) limited partners in consolidated partnerships, net $ 5,436 — (1,512 ) Reallocation of equity upon acquisition of a limited partner's interest in a consolidated partnership $ 6,266 — — Common stock issued for dividend reinvestment in trust $ 1,126 1,084 819 Contribution of stock awards into trust $ 2,250 1,416 1,524 Distribution of stock held in trust $ 786 3,647 1,052 See accompanying notes to Consolidated Financial Statements. 81 REGENCY CENTERS, L.P. Consolidated Balance Sheets December 31, 2022 and 2021 (in thousands, except unit data) 2022 2021 Assets Net real estate investments: Real estate assets, at cost (note 1) $ 11,858,064 11,495,581 Less: accumulated depreciation 2,415,860 2,174,963 Real estate assets, net 9,442,204 9,320,618 Investments in real estate partnerships (note 4) 350,377 372,591 Net real estate investments 9,792,581 9,693,209 Properties held for sale — 25,574 Cash, cash equivalents, and restricted cash, including $2,310 and $1,930 of restricted cash at December 31, 2022 and 2021, respectively (note 1) 68,776 95,027 Tenant and other receivables (note 1) 188,863 153,091 Deferred leasing costs, less accumulated amortization of $117,137 and $117,878 at December 31, 2022 and 2021, respectively 68,945 65,741 Acquired lease intangible assets, less accumulated amortization of $338,053 and $312,186 at December 31, 2022 and 2021, respectively (note 6) 197,745 212,707 Right of use assets, net 275,513 280,783 Other assets (note 5) 267,797 266,431 Total assets $ 10,860,220 10,792,563 Liabilities and Capital Liabilities: Notes payable (note 9) $ 3,726,754 3,718,944 Accounts payable and other liabilities 317,259 322,271 Acquired lease intangible liabilities, less accumulated amortization of $193,315 and $172,293 at December 31, 2022 and 2021, respectively (note 6) 354,204 363,276 Lease liabilities 213,722 215,788 Tenants’ security, escrow deposits and prepaid rent 70,242 62,352 Total liabilities 4,682,181 4,682,631 Commitments and contingencies (note 16) — — Capital: Partners’ capital (note 12): General partner; 171,124,593 and 171,213,008 units outstanding at December 31, 2022 and 2021, respectively 6,089,425 6,047,598 Limited partners; 741,433 and 760,046 units outstanding at December 31, 2022 and 2021 34,489 35,447 Accumulated other comprehensive income (loss) 7,560 (10,227 ) Total partners’ capital 6,131,474 6,072,818 Noncontrolling interests: Limited partners’ interests in consolidated partnerships 46,565 37,114 Total capital 6,178,039 6,109,932 Total liabilities and capital $ 10,860,220 10,792,563 See accompanying notes to Consolidated Financial Statements. 82 REGENCY CENTERS, L.P. Consolidated Statements of Operations For the years ended December 31, 2022, 2021, and 2020 (in thousands, except per unit data) 2022 2021 2020 Revenues: Lease income $ 1,187,452 1,113,368 980,166 Other property income 10,719 12,456 9,508 Management, transaction, and other fees 25,851 40,337 26,501 Total revenues 1,224,022 1,166,161 1,016,175 Operating expenses: Depreciation and amortization 319,697 303,331 345,900 Property operating expense 196,148 184,553 170,073 Real estate taxes 149,795 142,129 143,004 General and administrative 79,903 78,218 75,001 Other operating expenses 6,166 5,751 12,642 Total operating expenses 751,709 713,982 746,620 Other expense (income): Interest expense, net 146,186 145,170 156,678 Goodwill impairment — — 132,128 Provision for impairment of real estate — 84,389 18,536 Gain on sale of real estate, net of tax (109,005 ) (91,119 ) (67,465 ) Early extinguishment of debt — — 21,837 Net investment loss (income) 6,921 (5,463 ) (5,307 ) Total other expense (income) 44,102 132,977 256,407 Income from operations before equity in income of investments in real estate partnerships 428,211 319,202 13,148 Equity in income of investments in real estate partnerships (note 4) 59,824 47,086 34,169 Net income 488,035 366,288 47,317 Limited partners’ interests in consolidated partnerships (3,065 ) (3,262 ) (2,225 ) Net income attributable to common unit holders $ 484,970 363,026 45,092 Income per common unit - basic (note 15): $ 2.82 2.12 0.27 Income per common unit - diluted (note 15): $ 2.81 2.12 0.26 See accompanying notes to Consolidated Financial Statements. 83 REGENCY CENTERS, L.P. Consolidated Statements of Comprehensive Income For the years ended December 31, 2022, 2021, and 2020 (in thousands) 2022 2021 2020 Net income $ 488,035 366,288 47,317 Other comprehensive income (loss): Effective portion of change in fair value of derivative instruments: Effective portion of change in fair value of derivative instruments 20,061 5,391 (19,187 ) Reclassification adjustment of derivative instruments included in net income 833 4,141 11,262 Unrealized (loss) gain on available-for-sale securities (1,309 ) (405 ) 320 Other comprehensive income (loss) 19,585 9,127 (7,605 ) Comprehensive income 507,620 375,415 39,712 Less: comprehensive income attributable to noncontrolling interests: Net income attributable to noncontrolling interests 3,065 3,262 2,225 Other comprehensive income (loss) attributable to noncontrolling interests 1,713 689 (948 ) Comprehensive income attributable to noncontrolling interests 4,778 3,951 1,277 Comprehensive income attributable to the Company $ 502,842 371,464 38,435 See accompanying notes to Consolidated Financial Statements. 84 REGENCY CENTERS, L.P. Consolidated Statements of Capital For the years ended December 31, 2022, 2021, and 2020 (in thousands) General PartnerPreferred andCommon Units LimitedPartners AccumulatedOtherComprehensiveLoss TotalPartners’Capital NoncontrollingInterests inLimited Partners’Interest inConsolidatedPartnerships TotalCapital Balance at December 31, 2019 $ 6,225,345 36,100 (11,997 ) 6,249,448 40,513 6,289,961 Net income 44,889 203 — 45,092 2,225 47,317 Other comprehensive income Other comprehensive loss before reclassifications — (79 ) (17,589 ) (17,668 ) (1,199 ) (18,867 ) Amounts reclassified from accumulated other comprehensive income — 50 10,961 11,011 251 11,262 Contributions from partners — — — — 606 606 Issuance of exchangeable operating partnership units — 1,275 — 1,275 — 1,275 Distributions to partners (402,633 ) (1,822 ) — (404,455 ) (4,888 ) (409,343 ) Restricted units issued as a result of restricted stock issued by Parent Company, net of amortization 14,248 — — 14,248 — 14,248 Common units issued as a result of common stock issued by Parent Company, net of issuance costs 125,608 — — 125,608 — 125,608 Common units repurchased as a result of common stock repurchased by Parent Company, net of issuances (3,920 ) — — (3,920 ) — (3,920 ) Balance at December 31, 2020 $ 6,003,537 35,727 (18,625 ) 6,020,639 37,508 6,058,147 Net income 361,411 1,615 — 363,026 3,262 366,288 Other comprehensive income Other comprehensive income before reclassifications — 23 4,603 4,626 360 4,986 Amounts reclassified from accumulated other comprehensive income — 17 3,795 3,812 329 4,141 Deferred compensation plan, net 75 — — 75 — 75 Distributions to partners (410,419 ) (1,836 ) — (412,255 ) (4,345 ) (416,600 ) Restricted units issued as a result of restricted stock issued by Parent Company, net of amortization 12,652 — — 12,652 — 12,652 Common units issued as a result of common stock issued by Parent Company, net of issuance costs 82,510 — — 82,510 — 82,510 Common units repurchased as a result of common stock repurchased by Parent Company, net of issuances (2,267 ) — — (2,267 ) — (2,267 ) Common units exchanged for common stock of Parent Company 99 (99 ) — — — — Balance at December 31, 2021 $ 6,047,598 35,447 (10,227 ) 6,072,818 37,114 6,109,932 85 General PartnerPreferred andCommon Units LimitedPartners AccumulatedOtherComprehensiveLoss TotalPartners’Capital NoncontrollingInterests inLimited Partners’Interest inConsolidatedPartnerships TotalCapital Balance at December 31, 2021 $ 6,047,598 35,447 (10,227 ) 6,072,818 37,114 6,109,932 Net income 482,865 2,105 — 484,970 3,065 488,035 Other comprehensive income Other comprehensive income before reclassifications — 80 17,008 17,088 1,664 18,752 Amounts reclassified from accumulated other comprehensive income — 5 779 784 49 833 Deferred compensation plan, net (1 ) — — (1 ) — (1 ) Contribution from partners — — — — 13,223 13,223 Distributions to partners (433,028 ) (1,873 ) — (434,901 ) (14,816 ) (449,717 ) Reallocation of limited partners' interest, net of transaction costs (6,482 ) — — (6,482 ) 6,266 (216 ) Restricted units issued as a result of restricted stock issued by Parent Company, net of amortization 16,667 — — 16,667 — 16,667 Common units repurchased and retired as a result of common stock repurchased and retired by Parent Company (75,419 ) — — (75,419 ) — (75,419 ) Common units issued as a result of common stock issued by Parent Company, net of issuance costs 61,284 — — 61,284 — 61,284 Common units repurchased as a result of common stock repurchased by Parent Company, net of issuances (5,334 ) — — (5,334 ) — (5,334 ) Common units exchanged for common stock of Parent Company 1,275 (1,275 ) — — — — Balance at December 31, 2022 $ 6,089,425 34,489 7,560 6,131,474 46,565 6,178,039 See accompanying notes to Consolidated Financial Statements. 86 REGENCY CENTERS, L.P. Consolidated Statements of Cash Flows For the years ended December 31, 2022, 2021, and 2020 (in thousands) 2022 2021 2020 Cash flows from operating activities: Net income $ 488,035 366,288 47,317 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 319,697 303,331 345,900 Amortization of deferred loan costs and debt premiums 5,799 6,003 9,023 (Accretion) and amortization of above and below market lease intangibles, net (20,995 ) (22,936 ) (40,540 ) Stock-based compensation, net of capitalization 16,521 12,515 13,581 Equity in income of investments in real estate partnerships (59,824 ) (47,086 ) (34,169 ) Gain on sale of real estate, net of tax (109,005 ) (91,119 ) (67,465 ) Provision for impairment of real estate — 84,389 18,536 Goodwill impairment — — 132,128 Early extinguishment of debt — — 21,837 Distribution of earnings from investments in real estate partnerships 61,416 71,934 47,703 Settlement of derivative instrument — (2,472 ) — Deferred compensation (revenue) expense (6,128 ) 4,572 4,668 Realized and unrealized loss (gain) on investments 7,040 (5,348 ) (5,519 ) Changes in assets and liabilities: Tenant and other receivables (35,274 ) (24,869 ) 16,944 Deferred leasing costs (10,801 ) (6,966 ) (6,973 ) Other assets 1,292 (1,226 ) (1,200 ) Accounts payable and other liabilities (9,088 ) 6,677 997 Tenants’ security, escrow deposits and prepaid rent 7,130 5,701 (3,650 ) Net cash provided by operating activities 655,815 659,388 499,118 Cash flows from investing activities: Acquisition of operating real estate, net of cash acquired of $3,061 and $2,991 in 2022 and 2021, respectively (169,639 ) (392,051 ) (16,767 ) Real estate development and capital improvements (195,418 ) (177,631 ) (180,804 ) Proceeds from sale of real estate 143,133 206,193 189,444 Proceeds from property insurance casualty claims — — 7,957 Collection (issuance) of notes receivable, net 1,823 (20 ) (1,340 ) Investments in real estate partnerships (36,266 ) (23,476 ) (51,440 ) Return of capital from investments in real estate partnerships 48,473 99,945 32,125 Dividends on investment securities 1,113 813 353 Acquisition of investment securities (21,112 ) (23,971 ) (25,155 ) Proceeds from sale of investment securities 21,785 23,846 19,986 Net cash used in investing activities (206,108 ) (286,352 ) (25,641 ) 87 2022 2021 2020 Cash flows from financing activities: Net proceeds from common stock issuance 61,284 82,510 125,608 Repurchase of common units in conjunction with equity award plans (6,447 ) (4,083 ) (5,512 ) Proceeds from treasury units issued as a result of treasury stock sold by Parent Company 64 96 269 Common shares repurchased through share repurchase program (75,419 ) — — Distributions to limited partners in consolidated partnerships, net (7,245 ) (4,345 ) (2,770 ) Distributions to partners (430,143 ) (404,900 ) (301,903 ) Repayment of fixed rate unsecured notes — — (300,000 ) Proceeds from issuance of fixed rate unsecured notes, net — — 598,830 Proceeds from unsecured credit facilities 95,000 — 610,000 Repayments of proceeds from unsecured credit facilities, net (95,000 ) (265,000 ) (830,000 ) Proceeds from notes payable — — — Repayment of notes payable (6,745 ) (42,014 ) (67,189 ) Scheduled principal payments (11,219 ) (11,255 ) (11,104 ) Payment of loan costs (88 ) (7,468 ) (5,063 ) Early redemption costs — — (21,755 ) Net cash used in financing activities (475,958 ) (656,459 ) (210,589 ) Net (decrease) increase in cash, cash equivalents, and restricted cash (26,251 ) (283,423 ) 262,888 Cash, cash equivalents, and restricted cash at beginning of the year 95,027 378,450 115,562 Cash, cash equivalents, and restricted cash at end of the year $ 68,776 95,027 378,450 Supplemental disclosure of cash flow information: Cash paid for interest (net of capitalized interest of $4,166, $4,202, and $4,355 in 2022, 2021, and 2020, respectively) $ 141,359 140,084 151,338 Cash paid for income taxes, net of refunds $ 570 378 1,870 Supplemental disclosure of non-cash transactions: Common stock and exchangeable operating partnership dividends declared but not paid $ 111,709 107,480 101,412 Common stock issued by Parent Company for partnership units exchanged $ — — 1,275 Previously held equity investments in real estate assets acquired $ 17,179 (4,609 ) 5,986 Mortgage loans assumed by Company with the acquisition of real estate $ 22,779 111,104 16,359 Mortgage loan assumed by purchaser with the sale of real estate $ — — 8,250 Common stock issued by Parent Company for partnership units exchanged $ 1,275 99 — Real estate received in lieu of promote interest $ — 13,589 — Change in fair value of securities $ 1,658 513 315 Change in accrued capital expenditures $ 4,888 10,188 12,166 Common stock issued by Parent Company for dividend reinvestment plan $ 524 1,286 1,139 Stock-based compensation capitalized $ 735 666 1,119 Contributions from (distributions to) limited partners in consolidated partnerships, net $ 5,436 — (1,512 ) Reallocation of equity upon acquisition of a limited partner's interest in a consolidated partnership $ 6,266 — — Common stock issued for dividend reinvestment in trust $ 1,126 1,084 819 Contribution of stock awards into trust $ 2,250 1,416 1,524 Distribution of stock held in trust $ 786 3,647 1,052 See accompanying notes to Consolidated Financial Statements. 88 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Notes to Consolidated Financial Statements December 31, 2022 1.Summary of Significant Accounting Policies(a)Organization and Principles of ConsolidationGeneralRegency Centers Corporation (the "Parent Company") began its operations as a REIT in 1993 and is the general partner of Regency Centers, L.P. (the "Operating Partnership"). The Parent Company primarily engages in the ownership, management, leasing, acquisition, development and redevelopment of shopping centers through the Operating Partnership, and has no other assets other than through its investment in the Operating Partnership, and its only liabilities are $200 million of unsecured private placement notes, which are co-issued and guaranteed by the Operating Partnership. The Parent Company guarantees all of the unsecured debt of the Operating Partnership. As of December 31, 2022, the Parent Company, the Operating Partnership, and their controlled subsidiaries on a consolidated basis (the "Company" or "Regency") owned 308 properties and held partial interests in an additional 96 properties through unconsolidated Investments in real estate partnerships (also referred to as "joint ventures" or "investment partnerships").Estimates, Risks, and UncertaintiesThe preparation of the Consolidated Financial Statements in conformity with U.S. GAAP requires the Company's management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of commitments and contingent assets and liabilities, at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates in the Company's financial statements relate to the net carrying values of its real estate investments, collectibility of lease income, and acquired lease intangible assets and liabilities. It is possible that the estimates and assumptions that have been utilized in the preparation of the Consolidated Financial Statements could change significantly if economic conditions were to weaken.ConsolidationThe accompanying Consolidated Financial Statements include the accounts of the Parent Company, the Operating Partnership, its wholly-owned subsidiaries, and consolidated partnerships in which the Company has a controlling interest. Investments in real estate partnerships not controlled by the Company are accounted for under the equity method. All significant inter-company balances and transactions are eliminated in the Consolidated Financial Statements.The Company consolidates properties that are wholly-owned and properties where it owns less than 100%, but has control over the activities most important to the overall success of the partnership. Control is determined using an evaluation based on accounting standards related to the consolidation of Variable Interest Entities ("VIEs") and voting interest entities. For joint ventures that are determined to be a VIE, the Company consolidates the entity where it is deemed to be the primary beneficiary. Determination of the primary beneficiary is based on whether an entity has (1) the power to direct the activities of the VIE that most significantly impact the entity's economic performance, and (2) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE.Ownership of the Parent CompanyThe Parent Company has a single class of common stock outstanding.Ownership of the Operating PartnershipThe Operating Partnership's capital includes general and limited common Partnership Units. As of December 31, 2022, the Parent Company owned approximately 99.6%, or 171,124,593, of the 171,866,026 outstanding common Partnership Units of the Operating Partnership, with the remaining limited common Partnership Units held by third parties ("Exchangeable operating partnership units" or "EOP units"). Each EOP unit is exchangeable for cash or one share of common stock of the Parent Company, at the discretion of the Parent Company, and the unit holder cannot require redemption in cash or other assets (i.e. registered shares of the Parent). The Parent Company has evaluated the conditions as specified under Accounting Standards Codification ("ASC") Topic 480, Distinguishing Liabilities from Equity, as it relates to exchangeable operating 89 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 partnership units outstanding and concluded that it has the right to satisfy the redemption requirements of the units by delivering unregistered common stock. Accordingly, the Parent Company classifies EOP units as permanent equity in the accompanying Consolidated Balance Sheets and Consolidated Statements of Equity and Comprehensive Income. The Parent Company serves as general partner of the Operating Partnership. The EOP unit holders have limited rights over the Operating Partnership such that they do not have the power to direct the activities of the Operating Partnership. As such, the Operating Partnership is considered a VIE, and the Parent Company, which consolidates it, is the primary beneficiary. The Parent Company's only investment is the Operating Partnership. Net income and distributions of the Operating Partnership are allocable to the general and limited common Partnership Units in accordance with their ownership percentages.Real Estate PartnershipsRegency has a partial ownership interest in 107 properties through partnerships, of which 11 are consolidated. Regency's partners include institutional investors and other real estate developers and/or operators (the "Partners" or "Limited Partners"). The assets of these partnerships are restricted to the use of the partnerships and cannot be used by general creditors of the Company. And similarly, the obligations of these partnerships can only be settled by the assets of these partnerships or additional contributions by the partners. Regency has a variable interest in these partnerships through its equity interests. As managing member, Regency maintains the books and records and typically provides leasing and property and asset management services to the partnerships. The Partners' level of involvement in these partnerships varies from protective decisions (debt, bankruptcy, selling primary asset(s) of business) to participating involvement such as approving leases, operating budgets, and capital budgets. •Those partnerships for which the Partners are involved in the day to day decisions and do not have any other aspects that would cause them to be considered VIEs, are evaluated for consolidation using the voting interest model.oThose partnerships in which Regency does not have a controlling financial interest are accounted for using the equity method and Regency's ownership interest is recognized through single-line presentation as Investments in real estate partnerships, in the Consolidated Balance Sheet, and Equity in income of investments in real estate partnerships, in the Consolidated Statements of Operations. Cash distributions of earnings from operations from Investments in real estate partnerships are presented in Cash flows provided by operating activities in the accompanying Consolidated Statements of Cash Flows. Cash distributions from the sale of a property or loan proceeds received from the placement of debt on a property included in Investments in real estate partnerships are presented in Cash flows provided by investing activities in the accompanying Consolidated Statements of Cash Flows. If distributed proceeds from debt refinancing and real estate sales in excess of Regency's carrying value of its investment results in a negative investment balance for a partnership, it is recorded within Accounts payable and other liabilities in the Consolidated Balance Sheets. The net difference in the carrying amount of investments in real estate partnerships and the underlying equity in net assets is accreted to earnings and recorded in Equity in income of investments in real estate partnerships in the accompanying Consolidated Statements of Operations over the expected useful lives of the properties and other intangible assets, which range in lives from 10 to 40 years.oThose partnerships in which Regency has a controlling financial interest are consolidated. Additionally, those partnerships for which the Partners only have protective rights are considered VIEs under ASC Topic 810, Consolidation. Regency is the primary beneficiary of these VIEs as Regency has power over these partnerships, and they operate primarily for the benefit of Regency. As such, Regency consolidates these entities. The limited partners' ownership interest and share of net income is recorded as noncontrolling interest. 90 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 The majority of the operations of the VIEs are funded with cash flows generated by the properties, or in the case of developments, with capital contributions or third party construction loans. The major classes of assets, liabilities, and noncontrolling equity interests held by the Company's consolidated VIEs, exclusive of the Operating Partnership, are as follows: (in thousands) December 31, 2022 December 31, 2021 Assets Net real estate investments $ 107,725 379,075 Cash, cash equivalents, and restricted cash 2,420 5,202 Liabilities Notes payable 4,188 5,000 Equity Limited partners’ interests in consolidated partnerships 24,364 27,950 Noncontrolling InterestsNoncontrolling Interests of the Parent CompanyThe Consolidated Financial Statements of the Parent Company include the following ownership interests held by owners other than the common stockholders of the Parent Company: (i) the limited Partnership Units in the Operating Partnership held by third parties ("Exchangeable operating partnership units") and (ii) the minority-owned interest held by third parties in consolidated partnerships ("Limited partners' interests in consolidated partnerships"). The Parent Company has included all of these noncontrolling interests in permanent equity, separate from the Parent Company's stockholders' equity, in the accompanying Consolidated Balance Sheets and Consolidated Statements of Equity. The portion of net income or comprehensive income attributable to these noncontrolling interests is included in net income and comprehensive income in the accompanying Consolidated Statements of Operations and Consolidated Statements of Comprehensive Income of the Parent Company.Limited partners' interests in consolidated partnerships are not redeemable by the holders. The Parent Company also evaluated its fiduciary duties to itself, its shareholders, and, as the managing general partner of the Operating Partnership, to the Operating Partnership, and concluded its fiduciary duties are not in conflict with each other or the underlying agreements. Therefore, the Parent Company classifies such units and interests as permanent equity in the accompanying Consolidated Balance Sheets and Consolidated Statements of Equity.Noncontrolling Interests of the Operating PartnershipThe Operating Partnership has determined that limited partners' interests in consolidated partnerships are noncontrolling interests. Subject to certain conditions and pursuant to the terms of the partnership agreements, the Company generally has the right, but not the obligation, to purchase the other members' interest or sell its own interest in these consolidated partnerships. The Operating Partnership has included these noncontrolling interests in permanent capital, separate from partners' capital, in the accompanying Consolidated Balance Sheets and Consolidated Statements of Capital. The portion of net income (loss) or comprehensive income (loss) attributable to these noncontrolling interests is included in Net income and Comprehensive income in the accompanying Consolidated Statements of Operations and Consolidated Statements Comprehensive Income of the Operating Partnership.(b)Revenues and Tenant ReceivableLeasing Income and Tenant ReceivablesThe Company leases space to tenants under agreements with varying terms that generally provide for fixed payments of base rent, with stated increases over the term of the lease. Some of the lease agreements contain provisions that provide for additional rents based on tenants' sales volume ("percentage rent"), which are recognized when the tenants achieve the specified targets as defined in their lease agreements. Additionally, most lease agreements contain provisions for reimbursement of the tenants' share of actual real estate taxes and insurance and common area maintenance ("CAM") costs (collectively "Recoverable Costs") incurred. 91 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 Lease terms generally range from three to seven years for tenant space under 10,000 square feet ("Shop Space") and in excess of five years for spaces greater than 10,000 square feet ("Anchor Space"). Many leases also provide tenants the option to extend their lease beyond the initial term of the lease. If a tenant does not exercise its option or otherwise negotiate to renew, the lease expires and the lease contains an obligation for the tenant to relinquish its space, allowing it to be leased to a new tenant. This generally involves some level of cost to prepare the space for re-leasing, which is capitalized and depreciated over the shorter of the life of the subsequent lease or the life of the improvement.The Company accounts for its leases under ASC Topic 842, Leases ("Topic 842"), as follows:ClassificationUnder Topic 842, new leases or modifications thereto must be evaluated against specific classification criteria, which, based on the customary terms of the Company's leases, are classified as operating leases. However, certain longer-term leases (both lessee and lessor leases) may be classified as direct financing or sales type leases, which may result in selling profit and an accelerated pattern of earnings recognition. At December 31, 2022, all of the Company's leases were classified as operating leases.Recognition and PresentationLease income for operating leases with fixed payment terms is recognized on a straight-line basis over the expected term of the lease for all leases for which collectibility is considered probable. CAM is considered a non-lease component of the lease contract under Topic 842. However, as the timing and pattern of providing the CAM service to the tenant is the same as the timing and pattern of the tenant's use of the underlying lease asset, the Company elected, as part of an available practical expedient, to combine CAM with the remaining lease components, along with tenant's reimbursement of real estate taxes and insurance, and recognize them together as Lease income in the accompanying Consolidated Statements of Operations.CollectibilityAt lease commencement, the Company generally expects that collectibility of substantially all payments due under the lease is probable due to the Company's credit checks on tenants and other creditworthiness analysis undertaken before entering into a new lease; therefore, income from most operating leases is initially recognized on a straight-line basis. For operating leases in which collectibility of Lease income is not considered probable, Lease income is recognized on a cash basis and all previously recognized straight-line rent receivables are reversed in the period in which the Lease income is determined not to be probable of collection. Should collectibility of Lease income become probable again, through evaluation of qualitative and quantitative measures on a tenant by tenant basis, accrual basis accounting resumes and all commencement-to-date straight-line rent is recognized in that period. In addition to the lease-specific collectibility assessment performed under Topic 842, the Company may also recognize a general reserve, as a reduction to Lease income, for its portfolio of operating lease receivables which are not expected to be fully collectible based on the Company's historical collection experience. The Company estimates the collectibility of the accounts receivable related to base rents, straight-line rents, recoveries from tenants, and other revenue taking into consideration the Company's historical write-off experience, tenant credit-worthiness, current economic trends, and remaining lease terms. Uncollectible lease income is a direct charge against Lease income. Although we estimate uncollectible receivables and provide for them through charges against income, actual experience may differ from those estimates.The following table represents the components of Tenant and other receivables, net of amounts considered uncollectible, in the accompanying Consolidated Balance Sheets: December 31, (in thousands) 2022 2021 Tenant receivables $ 31,486 27,354 Straight-line rent receivables 128,214 103,942 Other receivables (1) 29,163 21,795 Total tenant and other receivables, net $ 188,863 153,091 (1)Other receivables include construction receivables, insurance receivables, and amounts due from real estate partnerships for Management, transaction and other fee income. 92 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 Real Estate Sales The Company accounts for sales of nonfinancial assets under ASC Subtopic 610-20, Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets, whereby the Company derecognizes real estate and recognizes a gain or loss on sales when a contract exists and control of the property has transferred to the buyer. Control of the property, including controlling financial interest, is generally considered to transfer upon closing through transfer of the legal title and possession of the property. While generally rare, any retained noncontrolling interest is measured at fair value at that time.Management Services and Other Property IncomeThe Company recognizes revenue under ASC Topic 606, Revenue from Contracts with Customers ("Topic 606"), when or as control of the promised services are transferred to its customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those services. The following is a description of the Company's revenue from contracts with customers within the scope of Topic 606.Property and Asset Management ServicesThe Company is engaged under agreements with its joint venture partnerships, which are generally perpetual in nature and cancellable through unanimous partner approval, absent an event of default. Under these agreements, the Company is to provide asset and property management and leasing services for the joint ventures' shopping centers. The fees are market-based, generally calculated as a percentage of either revenues earned or the estimated values of the properties managed or the proceeds received, and are recognized over the monthly or quarterly periods as services are rendered. Property management and asset management services represent a series of distinct daily services. Accordingly, the Company satisfies its performance obligation as service is rendered each day and the variability associated with that compensation is resolved each day. Amounts due from the partnerships for such services are paid during the month following the monthly or quarterly service periods.Several of the Company's partnership agreements provide for incentive payments, generally referred to as "promotes" or "earnouts," to Regency for appreciation in property values in Regency's capacity as manager. The terms of these promotes are based on appreciation in real estate value over designated time intervals or upon designated events. The Company evaluates its expected promote payout at each reporting period, which generally does not result in revenue recognition until the measurement period has completed, when the amount can be reasonably determined and the amount is not probable of significant reversal. Leasing ServicesLeasing service fees are based on a percentage of the total rent due under the lease. The leasing service is considered performed upon successful execution of an acceptable tenant lease for the joint ventures' shopping centers, at which time revenue is recognized. Payment of the first half of the fee is generally due upon lease execution and the second half is generally due upon tenant opening or rent payments commencing.Transaction ServicesThe Company also receives transaction fees, as contractually agreed upon with each joint venture, which include acquisition fees, disposition fees, and financing service fees. Control of these services is generally transferred at the time the related transaction closes, which is the point in time when the Company recognizes the related fee revenue. Any unpaid amounts related to transaction-based fees are included in Tenant and other receivables within the Consolidated Balance Sheets. Other Property IncomeOther property income includes parking fee and other incidental income from the properties and is generally recognized at the point in time that the performance obligation is met. 93 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 All income from contracts with the Company's real estate partnerships is included within Management, transaction and other fees on the Consolidated Statements of Operations. The primary components of these revenue streams, the timing of satisfying the performance obligations, and amounts are as follows: Year ended December 31, (in thousands) Timing ofsatisfaction ofperformanceobligations 2022 2021 2020 Management, transaction, and other fees: Property management services Over time $ 13,470 14,415 14,444 Asset management services Over time 6,752 6,921 6,963 Promote income Over time — 13,589 (1) — Leasing services Point in time 3,945 4,096 3,150 Other transaction fees Point in time 1,684 1,316 1,944 Total management, transaction, and other fees $ 25,851 40,337 26,501 (1)The Company recognized $13.6 million in promote revenue during the year ended December 31, 2021, for exceeding partnership return thresholds from the Company's performance as managing member in the USAA partnership. The consideration was paid in the form of a real estate asset.The accounts receivable for management services, which are included within Tenant and other receivables in the accompanying Consolidated Balance Sheets, are $16.4 million and $13.2 million, as of December 31, 2022 and 2021, respectively. (c)Real Estate AssetsThe following table details the components of Real estate assets in the Consolidated Balance Sheets: (in thousands) December 31, 2022 December 31, 2021 Land $ 4,379,877 4,340,084 Land improvements 707,227 684,613 Buildings 5,465,877 5,270,540 Building and tenant improvements 1,171,650 1,061,044 Construction in progress 133,433 139,300 Total real estate assets $ 11,858,064 11,495,581 Capitalization and DepreciationMaintenance and repairs that do not improve or extend the useful lives of the respective assets are recorded in operating and maintenance expense.As part of the leasing process, the Company may provide the lessee with an allowance for the construction of leasehold improvements. These leasehold improvements are capitalized and recorded as tenant improvements, and depreciated over the shorter of the useful life of the improvements or the remaining lease term. If the allowance represents a payment for a purpose other than funding leasehold improvements, or in the event the Company is not considered the owner of the improvements, the allowance is considered to be a lease incentive and is recognized over the lease term as a reduction of Lease income. Factors considered during this evaluation include, among other things, who holds legal title to the improvements as well as other controlling rights provided by the lease agreement and provisions for substantiation of such costs (e.g. unilateral control of the tenant space during the build-out process). Determination of the appropriate accounting for the payment of a tenant allowance is made on a lease-by-lease basis, considering the facts and circumstances of the individual tenant lease.Depreciation is computed using the straight-line method over estimated useful lives of approximately 15 years for land improvements, 40 years for buildings and improvements, and the shorter of the useful life or the remaining lease term subject to a maximum of 10 years for tenant improvements, and three to seven years for furniture and equipment. 94 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 Development and Redevelopment CostsLand, buildings, and improvements are recorded at cost. All specifically identifiable costs related to development and redevelopment activities are capitalized into Real estate assets in the accompanying Consolidated Balance Sheets, and are included in Construction in progress within the above table. The capitalized costs include pre-development costs essential to the development or redevelopment of the property, construction costs, interest costs, real estate taxes, and allocated direct employee costs incurred during the period of development or redevelopment. Pre-development costs represent the costs the Company incurs prior to land acquisition or pursuing a redevelopment including contract deposits, as well as legal, engineering, and other external professional fees related to evaluating the feasibility of developing or redeveloping a shopping center. As of December 31, 2022 and 2021, the Company had nonrefundable deposits and other pre-development costs of approximately $6.9 million and $10.8 million, respectively. If the Company determines that the development or redevelopment of a particular shopping center is no longer probable, any related pre-development costs previously capitalized are immediately expensed. During the years ended December 31, 2022, 2021, and 2020, the Company expensed pre-development costs of approximately $588,000, $1.5 million, and $10.5 million, respectively, in Other operating expenses in the accompanying Consolidated Statements of Operations.Interest costs are capitalized into each development and redevelopment project based upon applying the Company's weighted average borrowing rate to that portion of the actual development or redevelopment costs expended. The Company discontinues interest and real estate tax capitalization when the property is no longer being developed or is available for occupancy upon substantial completion of tenant improvements, but in no event would the Company capitalize interest on the project beyond 12 months after substantial completion of the building shell. During the years ended December 31, 2022, 2021, and 2020, the Company capitalized interest of $4.2 million, $4.2 million, and $4.4 million, respectively, on our development and redevelopment projects. We have a staff of employees directly supporting our development and redevelopment program. All direct internal costs attributable to these development activities are capitalized as part of each development and redevelopment project. The capitalization of costs is directly related to the actual level of development activity occurring. During the years ended December 31, 2022, 2021, and 2020, we capitalized $10.8 million, $11.3 million, and $10.2 million, respectively, of direct internal costs incurred to support our development and redevelopment program. Acquisitions Upon acquisition of operating real estate properties, the Company estimates the fair value of acquired tangible assets (consisting of land, building, building improvements and tenant improvements) and identified intangible assets and liabilities (consisting of above and below-market leases and in-place leases), assumed debt, and any noncontrolling interest in the acquiree at the date of acquisition, based on evaluation of information and estimates available at that date. Based on these estimates, the Company allocates the relative fair value to the applicable assets and liabilities. The acquisition of operating properties are generally considered asset acquisitions and therefore transaction costs are capitalized. Fair value is determined based on an exit price approach, which contemplates the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company's methodology includes estimating an "as-if vacant" fair value of the physical property, which includes land, building, and improvements. In addition, the Company determines the estimated fair value of identifiable intangible assets and liabilities, considering the following categories: (i) value of in-place leases, and (ii) above and below-market value of in-place leases.The value of in-place leases is estimated based on the value associated with the costs avoided in originating leases compared to the acquired in-place leases as well as the value associated with lost rental and recovery revenue during the assumed lease-up period. The value of in-place leases is recorded to Depreciation and amortization expense in the Consolidated Statements of Operations over the remaining expected term of the respective leases. Above-market and below-market in-place lease values for acquired properties are recorded based on the present value of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management's estimate of fair market lease rates for comparable in-place leases, measured over a period equal to the remaining non-cancelable term of the lease, including below-market renewal options, if applicable. The value of above-market leases is amortized as a reduction of Lease income over the remaining terms of the respective leases and the value of below-market leases is accreted to Lease income over the remaining terms of the respective leases, including below-market renewal options, if applicable. If tenants do not remain in their lease through the expected term or exercise an assumed renewal option, there could be a material impact to earnings. 95 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 The Company does not assign value to customer relationship intangibles if it has pre-existing business relationships with the major retailers at the acquired property since they do not provide incremental value over the Company's existing relationships.Held for SaleThe Company classifies land, an operating property, or a property in development as held-for-sale upon satisfaction of the following criteria: (i) management commits to a plan to sell a property (or group of properties), (ii) the property is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such properties, (iii) an active program to locate a buyer and other actions required to complete the plan to sell the property have been initiated, (iv) the sale of the property is probable and transfer of the asset is expected to be completed within one year, (v) the property is being actively marketed for sale, and (vi) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Properties held-for-sale are carried at the lower of cost or fair value less costs to sell.Valuation of Real Estate InvestmentsThe Company evaluates whether there are any events or changes in circumstances, including property operating performance, and general market conditions, or changes in expected hold periods, that indicate the carrying value of the real estate properties (including any related amortizable intangible assets or liabilities) may not be recoverable. For those properties with such events or changes, management evaluates recoverability of the property's carrying amount. Through the evaluation, the current carrying value of the asset is compared to the estimated undiscounted cash flows that are directly associated with the use and ultimate disposition of the asset. Estimated cash flows are based on several key assumptions, including rental rates, expected leasing activity, costs of tenant improvements, leasing commissions, expected hold period, and assumptions regarding the residual value upon disposition, including the exit capitalization rate. These key assumptions are subjective in nature and could differ materially from actual results. Changes in events or changes in circumstances may alter the hold period of an asset or asset group which may result in an impairment loss and such loss could be material to the Company's financial condition or operating performance. To the extent that the carrying value of the asset exceeds the estimated undiscounted cash flows, an impairment loss is recognized equal to the excess of carrying value over the estimated fair value. If such indicators are not identified, management will not assess the recoverability of a property's carrying value. If a property previously classified as held and used is changed to held for sale, the Company estimates fair value, less expected costs to sell, which could cause the Company to determine that the property is impaired.The estimated fair value of real estate assets is subjective and is estimated through comparable sales information and other market data if available, or through use of an income approach such as the direct capitalization method or the discounted cash flow approach. The discounted cash flow approach uses similar assumptions to the undiscounted cash flow approach above, as well as a discount rate. Such cash flow projections and rates are subject to management judgment and changes in those assumptions could impact the estimate of fair value. In estimating the fair value of undeveloped land, the Company generally uses market data and comparable sales information.A loss in value of investments in real estate partnerships under the equity method of accounting, other than a temporary decline, must be recognized in the period in which the loss occurs. If management identifies events or circumstances that indicate that the value of the Company's investment in real estate partnerships may be impaired, it evaluates the investment by calculating the estimated fair value of the investment by discounting estimated future cash flows over the expected term of the investment.Tax BasisThe net book basis of the Company's real estate assets exceeds the net tax basis by approximately $2.6 billion at December 31, 2022 and 2021, primarily due to the tax free merger with Equity One and inheriting lower carryover tax basis.(d)Cash, Cash Equivalents, and Restricted CashAny instruments which have an original maturity of 90 days or less when purchased are considered cash equivalents. As of December 31, 2022 and 2021, $2.3 million and $1.9 million, respectively, of cash was restricted through escrow agreements and certain mortgage loans. 96 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 (e)Other AssetsGoodwillGoodwill represents the excess of the purchase price consideration from the Equity One merger in 2017 over the fair value of the assets acquired and liabilities assumed. The Company accounts for goodwill in accordance with ASC Topic 350, Intangibles - Goodwill and Other, and allocates its goodwill to its reporting units, which have been determined to be at the individual property level. The Company performs an impairment evaluation of its goodwill at least annually, in November of each year, or more frequently as triggers occur. See note 5.The goodwill impairment evaluation is completed using either a qualitative or quantitative approach. Under a qualitative approach, the impairment review for goodwill consists of an assessment of whether it is more-likely-than-not that the reporting unit's fair value is less than its carrying value, including goodwill. If a qualitative approach indicates it is more likely-than-not that the estimated carrying value of a reporting unit (including goodwill) exceeds its fair value, or if the Company chooses to bypass the qualitative approach for any reporting unit, the Company will perform the quantitative approach described below.The quantitative approach consists of estimating the fair value of each reporting unit using discounted projected future cash flows and comparing those estimated fair values with the carrying values, which include the allocated goodwill. If the estimated fair value is less than the carrying value, the Company would then recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to that reporting unit.InvestmentsThe Company determines the appropriate classification of its investments in debt and equity securities at the time of purchase and reevaluates such determinations at each balance sheet date. The fair value of securities is determined using quoted market prices.Debt securities are classified as held to maturity when the Company has the positive intent and ability to hold the securities to maturity. Debt securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value, with unrealized gains and losses recognized through earnings in Investment income in the Consolidated Statements of Operations. Debt securities not classified as held to maturity or as trading, are classified as available-for-sale, and are carried at fair value, with the unrealized gains and losses, net of tax, included in the determination of comprehensive income and reported in the Consolidated Statements of Comprehensive Income.Equity securities with readily determinable fair values are measured at fair value with changes in the fair value recognized through net income and presented within Investment income in the Consolidated Statements of Operations.(f)Deferred Leasing CostsDeferred leasing costs consist of costs associated with leasing the Company's shopping centers, and are presented net of accumulated amortization. Such costs are amortized over the period through lease expiration. If the lease is terminated early, the remaining leasing costs are written off. Under ASC Topic 842, the Company, as a lessor, may only defer as initial direct costs the incremental costs of a tenant's operating lease that would not have been incurred if the lease had not been obtained. These costs generally consist of third party broker payments. Non-contingent internal leasing and legal costs associated with leasing activities are expensed within General and administrative expenses. 97 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 (g)Derivative Financial InstrumentsThe Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or future payment of known and uncertain cash amounts, the amount of which are determined by interest rates. The Company's derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company's known or expected cash payments principally related to the Company's borrowings.All derivative instruments, whether designated in hedging relationships or not, are recorded on the accompanying Consolidated Balance Sheets at their fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.The Company uses interest rate swaps to mitigate its interest rate risk on a related financial instrument or forecasted transaction, and the Company designates these interest rate swaps as cash flow hedges. Interest rate swaps designated as cash flow hedges generally involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. The Company may also utilize cash flow hedges to lock U.S. Treasury rates in anticipation of future fixed-rate debt issuances. The gains or losses resulting from changes in fair value of derivatives that qualify as cash flow hedges are recognized in Accumulated other comprehensive income (loss) ("AOCI"). Upon the settlement of a hedge, gains and losses remaining in AOCI are amortized through earnings over the underlying term of the hedged transaction. The cash receipts or payments related to interest rate swaps are presented in cash flows provided by operating activities in the accompanying Consolidated Statements of Cash Flows.The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objectives and strategies for undertaking various hedge transactions. The Company assesses, both at inception of the hedge and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in the cash flows and/or forecasted cash flows of the hedged items.In assessing the valuation of the hedges, the Company uses standard market conventions and techniques such as discounted cash flow analysis, option pricing models, and termination costs at each balance sheet date. All methods of assessing fair value result in a general approximation of value, and such value may never actually be realized.(h)Income TaxesThe Parent Company believes it qualifies, and intends to continue to qualify, as a REIT under the Code. As a REIT, the Parent Company will generally not be subject to federal income tax, provided that distributions to its stockholders are at least equal to REIT taxable income. All wholly-owned corporate subsidiaries of the Operating Partnership have elected to be a TRS or qualify as a REIT. The TRS's are subject to federal and state income taxes and file separate tax returns. As a pass through entity, the Operating Partnership generally does not pay taxes, but its taxable income or loss is reported by its partners, of which the Parent Company, as general partner and approximately 99.6% owner, is allocated its Pro-rata share of tax attributes. 98 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 The Company accounts for income taxes related to its TRS's under the asset and liability approach, which requires the recognition of the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company records net deferred tax assets to the extent it believes it is more likely than not that these assets will be realized. A valuation allowance is recorded to reduce deferred tax assets when it is believed that it is more likely than not that all or some portion of the deferred tax asset will not be realized. The Company considers all available positive and negative evidence, including forecasts of future taxable income, the reversal of other existing temporary differences, available net operating loss carryforwards, tax planning strategies and recent and projected results of operations in order to make that determination.In addition, tax positions are initially recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions shall initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts. The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accruals for tax liabilities are adequate for all open tax years (2018 and forward for federal and state) based on an assessment of many factors including past experience and interpretations of tax laws applied to the facts of each matter. (i)Lease ObligationsThe Company has certain properties within its consolidated real estate portfolio that are either partially or completely on land subject to ground leases with third parties, which are all classified as operating leases. Accordingly, the Company owns only a long-term leasehold or similar interest in these properties. The building and improvements constructed on the leased land are capitalized as Real estate assets in the accompanying Consolidated Balance Sheets and depreciated over the shorter of the useful life of the improvements or the lease term.In addition, the Company has non-cancelable operating leases pertaining to office space from which it conducts its business. Leasehold improvements are capitalized as tenant improvements, included in Other assets in the Consolidated Balance Sheets, and depreciated over the shorter of the useful life of the improvements or the lease term.Under Topic 842, the Company recognizes Lease liabilities on its Consolidated Balance Sheets for its ground and office leases and corresponding Right of use assets related to these same ground and office leases which are classified as operating leases. A key input in estimating the Lease liabilities and resulting Right of use assets is establishing the discount rate in the lease, which since the rates implicit in the lease contracts are not readily determinable, requires additional inputs for the longer-term ground leases, including market-based interest rates that correspond with the remaining term of the lease, the Company's credit spread, and a securitization adjustment necessary to reflect the collateralized payment terms present in the lease. This discount rate is applied to the remaining unpaid minimum rental payments for each lease to measure the operating lease liabilities.The ground and office lease expenses are recognized on a straight-line basis over the term of the leases, including management's estimate of expected option renewal periods. For ground leases, the Company generally assumes it will exercise options through the latest option date of that shopping center's anchor tenant lease. (j)Earnings per Share and UnitBasic earnings per share of common stock and unit are computed based upon the weighted average number of common shares and units, respectively, outstanding during the period. Diluted earnings per share and unit reflect the conversion of obligations and the assumed exercises of securities including the effects of shares issuable under the Company's share-based payment arrangements, if dilutive. Dividends paid on the Company's share-based compensation awards are not participating securities as they are forfeitable. 99 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 (k)Stock-Based CompensationThe Company grants stock-based compensation to its employees and directors. The Company recognizes the cost of stock-based compensation based on the grant-date fair value of the award, which is expensed over the vesting period.When the Parent Company issues common stock as compensation, it receives a like number of common units from the Operating Partnership. The Company is committed to contributing to the Operating Partnership all proceeds from the share-based awards granted under the Parent Company's Long-Term Omnibus Plan (the "Plan"). Accordingly, the Parent Company's ownership in the Operating Partnership will increase based on the amount of proceeds contributed to the Operating Partnership for the common units it receives. As a result of the issuance of common units to the Parent Company for stock-based compensation, the Operating Partnership records the effect of stock-based compensation for awards of equity in the Parent Company.(l)Segment ReportingThe Company's business is investing in retail shopping centers through direct ownership or partnership interests. The Company actively manages its portfolio of retail shopping centers and may from time to time make decisions to sell lower performing properties or developments not meeting its long-term investment objectives. The proceeds from sales are generally reinvested into higher quality retail shopping centers, through acquisitions, new developments, or redevelopment of existing centers, which management believes will generate sustainable revenue growth and attractive returns. It is management's intent that all retail shopping centers will be owned or developed for investment purposes; however, the Company may decide to sell all or a portion of a development upon completion. The Company's revenues and net income are generated from the operation of its investment portfolio. The Company also earns fees for services provided to manage and lease retail shopping centers owned through joint ventures.The Company's portfolio is located throughout the United States. Management does not distinguish or group its operations on a geographical basis for purposes of allocating resources or capital. The Company reviews operating and financial data for each property on an individual basis; therefore, the Company defines an operating segment as its individual properties. The individual properties have been aggregated into one reportable segment based upon their similarities with regard to both the nature and economics of the centers, tenants and operational processes, as well as long-term average financial performance.(m)Business ConcentrationGrocer anchor tenants represent approximately 20% of Pro-rata annual base rent. No single tenant accounts for 5% or more of revenue and none of the shopping centers are located outside the United States.(n)Fair Value of Assets and LiabilitiesFair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement is determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, the Company uses a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from independent sources (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the Company's own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). The three levels of inputs used to measure fair value are as follows:•Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.•Level 2 - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.•Level 3 - Unobservable inputs for the asset or liability, which are typically based on the Company's own assumptions, as there is little, if any, related market activity.The Company also re-measures nonfinancial assets and nonfinancial liabilities, initially measured at fair value in a business combination or other new basis event, at fair value in subsequent periods if a re-measurement event occurs. 100 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Notes to Consolidated Financial Statements December 31, 2022 (o)Recent Accounting PronouncementsThe following table provides a brief description of recent accounting pronouncements and expected impact on our financial statements: Standard Description Date of adoption Effect on the financial statements or other significant matters Recently adopted: ASU 2021-05, Leases (Topic 842): Lessors - Certain Leases with Variable Lease Payments The amendments in this update affect lessor lease classification. Lessors should classify and account for a lease as an operating lease if both of the following criteria are met: (1) have variable lease payments that do not depend on a reference index or a rate and (2) would have resulted in the recognition of a selling loss at lease commencement if classified as sales-type or direct financing. This update results in similar treatment under the current Topic 842 as under the previous Topic 840. January 2022 The adoption of this standard did not have a material impact to the Company's financial condition, results of operations, cash flows or related footnote disclosures as the Company's customary lease terms do not result in sales-type or direct financing classification, although future leases may. ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting In March 2020, the Financial Accounting Standards Board (“FASB”) issued ASU 2020-04, Reference Rate Reform (Topic 848). ASU 2020-04 contains practical expedients for reference rate reform related activities that impact debt, leases, derivatives, and other contracts. The guidance in ASU 2020-04 is optional and may be elected over time as reference rate reform activities occur. The amendments in this update provide exceptions to the guidance in Topic 815 related to changes to the critical terms of a hedging relationship due to reference rate reform, which if criteria are met, provide such changes should not result in the dedesignation and redesignation of the hedging relationship. March 2020 through December 31, 2022 The Company has elected to apply the hedge accounting expedients and exceptions related to changes to the reference rate from LIBOR to SOFR in the Company’s interest rate swaps. Application of these exceptions preserves the hedge designation of interest rate swaps and the related accounting and presentation consistent with past presentation. 101 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Notes to Consolidated Financial Statements December 31, 2022 2.Real Estate InvestmentsAcquisitionsThe following tables detail consolidated shopping centers acquired or land acquired for development or redevelopment for the periods set forth below: (in thousands) December 31, 2022 DatePurchased Property Name City/State PropertyType Regency Ownership PurchasePrice (1) DebtAssumed,Net ofPremiums (1) IntangibleAssets (1) IntangibleLiabilities (1) 3/1/22 Glenwood Green Old Bridge, NJ Development 70% $ 11,000 — — — 3/31/22 Island Village Bainbridge Island, WA Operating 100% 30,650 — 2,900 6,839 4/1/22 Apple Valley (2) Apple Valley, MN Operating 100% 34,070 — 4,773 490 4/1/22 Cedar Commons (2) Minneapolis, MN Operating 100% 29,330 — 4,369 58 4/1/22 Corral Hollow (2) Tracy, CA Operating 100% 40,600 — 3,410 74 4/1/22 Shops at the Columbia (2) Washington, DC Operating 100% 14,000 — 889 181 5/6/22 Baederwood Shoppes Jenkintown, PA Operating 80% 51,603 22,779 5,796 1,062 10/12/22 East Meadow Plaza East Meadow, NY Operating 100% 30,000 — 3,295 10,867 Total property acquisitions $ 241,253 22,779 25,432 19,571 (1)Amounts reflected for purchase price and allocation are reflected at 100%.(2)These properties were part of the four-property portfolio purchased from an existing unconsolidated real estate partnership, RegCal, LLC, in which the company held a 25% ownership interest. The basis allocated to Real estate assets was $93.2 million on a combined basis, including the Company's carryover basis related to its 25% previously owned equity interest in the partnership. In addition to the acquisitions listed above, the Company acquired, for $9.0 million, the remaining 50% ownership interest from its partner in Kroger New Albany Center, an existing consolidated property. (in thousands) December 31, 2021 DatePurchased Property Name City/State PropertyType Regency Ownership PurchasePrice (1) DebtAssumed,Net ofPremiums (1) IntangibleAssets (1) IntangibleLiabilities (1) 7/30/21 Willa Springs (2) Winter Springs, FL Operating 100% $ 34,500 17,682 1,562 643 8/1/21 Dunwoody Hall (2) Dunwoody, GA Operating 100% 32,000 14,612 2,255 973 8/1/21 Alden Bridge (2) Woodlands, TX Operating 100% 43,000 27,529 3,198 2,308 8/1/21 Hasley Canyon Village (2) Castaic, CA Operating 100% 31,000 16,941 2,037 — 8/1/21 Shiloh Springs (2) Garland, TX Operating 100% 19,500 — 1,825 1,079 8/1/21 Bethany Park Place (2) Allen, TX Operating 100% 18,000 10,800 996 1,732 8/1/21 Blossom Valley (2) Mountain View, CA Operating 100% 44,000 23,611 2,895 732 11/18/21 Blakeney Shopping Center Charlotte, NC Operating 100% 181,000 — 14,096 4,431 12/30/21 Valley Stream Long Island, NY Operating 100% 48,000 — 21,505 1,675 12/30/21 East Meadow Long Island, NY Operating 100% 38,000 — 6,521 1,197 12/30/21 Wading River Long Island, NY Operating 100% 35,000 — 4,998 1,469 12/30/21 Eastport Long Island, NY Operating 100% 9,000 — 1,366 498 Total property acquisitions $ 533,000 111,175 63,254 16,737 (1)Amounts reflected for purchase price and allocation are reflected at 100%.(2)These properties were part of the seven-property portfolio purchased from an existing unconsolidated real estate partnership, US Regency Retail I, LLC. The basis allocated to Real estate assets was $192.9 million, including the Company's carryover basis related to its 20% previously owned equity interest in the partnership. 102 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Notes to Consolidated Financial Statements December 31, 2022 3.Property DispositionsDispositionsThe following table provides a summary of consolidated shopping centers and land parcels sold during the periods set forth below: Year ended December 31, (in thousands, except number sold data) 2022 2021 2020 Net proceeds from sale of real estate investments $ 143,133 206,193 189,444 Gain on sale of real estate, net of tax $ 109,005 91,119 67,465 Provision for impairment of real estate sold $ — 112 958 Number of operating properties sold 2 7 6 Number of land parcels sold 5 5 11 Percent interest sold 100% 100 % 50% - 100% 4.Investments in Real Estate PartnershipsThe Company invests in real estate partnerships, which consist of the following: December 31, 2022 (in thousands) Regency's Ownership Number of Properties Total Investment Total Assets of the Partnership The Company's Share of Net Income of the Partnership Net Income of the Partnership GRI - Regency, LLC (GRIR) 40.00% 66 $ 155,302 1,501,876 35,819 83,989 New York Common Retirement Fund (NYC) (1) 30.00% — 674 2,468 9,173 35,673 Columbia Regency Retail Partners, LLC (Columbia I) 20.00% 7 7,423 138,493 1,817 9,392 Columbia Regency Partners II, LLC (Columbia II) 20.00% 13 41,757 405,927 1,735 8,674 Columbia Village District, LLC 30.00% 1 5,836 96,002 1,669 5,597 RegCal, LLC (RegCal) (2) 25.00% 1 5,789 24,326 4,499 18,258 Individual Investors Ballard Bocks 49.90% 2 62,624 126,482 1,300 2,925 Town & Country Center 35.00% 1 40,409 206,931 819 2,404 Others 50.00% 5 30,563 105,500 2,993 6,254 Total investments in real estate partnerships 96 $ 350,377 2,608,005 59,824 173,166 (1)On May 25, 2022, the NYC partnership sold the remaining two properties and distributed sales proceeds to the members. Dissolution will follow final distributions, which are expected in 2023.(2)During April 2022, we acquired our partner's 75% share in four properties held in the RegCal, LLC, partnership for a total purchase price of $88.5 million. Upon acquisition, these four properties were consolidated into Regency's financial statements. A single operating property remains within RegCal, LLC, at December 31, 2022. 103 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 December 31, 2021 (in thousands) Regency's Ownership Number of Properties Total Investment Total Assets of the Partnership The Company's Share of Net Income of the Partnership Net Income of the Partnership GRI - Regency, LLC (GRIR) 40.00% 67 $ 153,125 1,537,411 34,655 78,112 New York Common Retirement Fund (NYC) 30.00% 2 11,688 82,446 315 6,939 Columbia Regency Retail Partners, LLC (Columbia I) 20.00% 7 7,360 135,537 1,976 10,256 Columbia Regency Partners II, LLC (Columbia II) 20.00% 12 35,251 352,469 10,987 55,059 Columbia Village District, LLC 30.00% 1 5,554 94,536 1,522 5,131 RegCal, LLC (RegCal) 25.00% 6 24,995 103,587 2,058 8,448 US Regency Retail I, LLC (USAA) (1) 20.01% — — — 631 3,155 Individual Investors Ballard Bocks 49.90% 2 63,783 128,959 1,742 3,811 Town & Country Center 35.00% 1 39,021 207,339 (733 ) 2,014 Others 50.00% 5 31,814 113,160 (6,067 ) 26,351 Total investments in real estate partnerships 103 $ 372,591 2,755,444 47,086 199,276 (1)On August 1, 2021, the Company acquired the partner's 80% interest in the seven properties held in the USAA partnership and therefore all earnings of this property are included in consolidated results from the date of acquisition and excluded from partnership earnings. See note 2.The summarized balance sheet information for the investments in real estate partnerships, on a combined basis, is as follows: December 31, (in thousands) 2022 2021 Investments in real estate, net $ 2,359,289 2,530,964 Acquired lease intangible assets, net 16,821 18,735 Other assets 231,895 205,745 Total assets $ 2,608,005 2,755,444 Notes payable $ 1,398,297 1,444,867 Acquired lease intangible liabilities, net 17,619 20,978 Other liabilities 81,714 90,097 Capital - Regency 412,784 438,510 Capital - Third parties 697,591 760,992 Total liabilities and capital $ 2,608,005 2,755,444 The following table reconciles the Company's capital recorded by the unconsolidated partnerships to the Company's investments in real estate partnerships reported in the accompanying Consolidated Balance Sheet: December 31, (in thousands) 2022 2021 Capital - Regency $ 412,784 438,510 Basis difference (62,407 ) (65,919 ) Investments in real estate partnerships $ 350,377 372,591 104 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 The revenues and expenses for the investments in real estate partnerships, on a combined basis, are summarized as follows: Year ended December 31, (in thousands) 2022 2021 2020 Total revenues $ 378,096 416,222 381,094 Operating expenses: Depreciation and amortization 86,193 94,026 101,590 Property operating expense 61,224 66,061 65,146 Real estate taxes 42,010 54,618 53,747 General and administrative 5,615 5,837 5,870 Other operating expenses 3,851 3,624 3,126 Total operating expenses $ 198,893 224,166 229,479 Other expense (income): Interest expense, net 54,874 58,109 66,786 Gain on sale of real estate (49,424 ) (75,162 ) (7,146 ) Early extinguishment of debt 587 — 554 Provision for impairment — 9,833 — Total other expense (income) 6,037 (7,220 ) 60,194 Net income of the Partnerships $ 173,166 199,276 91,421 The Company's share of net income of the Partnerships $ 59,824 47,086 34,169 AcquisitionsThe following table provides a summary of shopping centers and land parcels acquired through our unconsolidated real estate partnerships during 2022, which had no such acquisitions in 2021: (in thousands) Year ended December 31, 2022 DatePurchased PropertyName City/State PropertyType Co-investmentPartner Ownership% Purchase Price (1) Debt Assumed, Net of Premiums (1) Intangible Assets (1) Intangible Liabilities (1) 03/25/22 Naperville Plaza Naperville, IL Operating Columbia II 20.00% $ 52,380 22,074 4,336 814 06/24/22 Baybrook East 1B Houston, TX Development Other 50.00% 5,540 — — — Total property acquisitions $ 57,920 22,074 4,336 814 (1)Amounts reflected for purchase price and allocation are reflected at 100%.DispositionsThe following table provides a summary of shopping centers and land parcels disposed of through our unconsolidated real estate partnerships: Year ended December 31, (in thousands) 2022 2021 2020 Proceeds from sale of real estate investments $ 116,377 224,708 27,974 Gain on sale of real estate $ 49,424 75,162 7,147 The Company's share of gain on sale of real estate $ 12,748 9,380 2,413 Number of operating properties sold 4 4 2 Number of land out-parcels sold — 1 — 105 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 Notes PayableScheduled principal repayments on notes payable held by our unconsolidated investments in real estate partnerships as of December 31, 2022, were as follows: (in thousands)Scheduled Principal Payments and Maturities by Year: ScheduledPrincipalPayments MortgageLoanMaturities UnsecuredMaturities Total Regency'sPro-RataShare 2023 $ 3,194 125,108 — 128,302 51,187 2024 2,205 33,690 — 35,895 14,298 2025 3,433 139,683 — 143,116 43,908 2026 3,807 218,883 23,800 246,490 79,741 2027 3,802 32,800 — 36,602 12,420 Beyond 5 Years 9,194 809,650 — 818,844 300,506 Net unamortized loan costs, debt premium / (discount) — (10,952 ) — (10,952 ) (3,800 ) Total notes payable $ 25,635 1,348,862 23,800 1,398,297 498,260 These fixed and variable rate notes payable are all non-recourse to the partnerships, and mature through 2034, with 97.9% having a weighted average fixed interest rate of 3.7%. The remaining notes payable float with LIBOR or SOFR and had a weighted average variable interest rate of 5.9% at December 31, 2022. As notes payable mature, they will be repaid from proceeds from new borrowings and/or partner capital contributions. Refinancing debt at maturity in the current interest rate environment could result in higher interest expense in future periods if rates remain elevated. The Company is obligated to contribute its Pro-rata share to fund maturities if the loans are not refinanced, and it has the capacity to do so from existing cash balances, availability on its line of credit, and operating cash flows. The Company believes that its partners are financially sound and have sufficient capital or access thereto to fund future capital requirements. In the event that a co-investment partner was unable to fund its share of the capital requirements of the co-investment partnership, the Company would have the right, but not the obligation, to loan the defaulting partner the amount of its capital call which would be secured by the partner's membership interest. Management fee incomeIn addition to earning our Pro-rata share of net income or loss in each of these co-investment partnerships, we receive fees as discussed in Note 1, as follows: Year ended December 31, (in thousands) 2022 2021 2020 Asset management, property management, leasing, and investment and financing services $ 25,851 40,301 (1) 26,618 (1)In connection with the USAA partnership, we received and recognized a one-time promote fee of $13.6 million during the year ended December 31, 2021, in consideration for exceeding return thresholds resulting from our performance as managing member. 5.Other AssetsThe following table represents the components of Other assets in the accompanying Consolidated Balance Sheets as of the periods set forth below: (in thousands) December 31, 2022 December 31, 2021 Goodwill $ 167,062 167,095 Investments 54,581 65,112 Prepaid and other 28,615 21,332 Derivative assets 6,575 — Furniture, fixtures, and equipment, net 5,808 5,444 Deferred financing costs, net 5,156 7,448 Total other assets $ 267,797 266,431 106 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 The following table presents the goodwill balances and activity during the year to date periods ended: December 31, 2022 December 31, 2021 (in thousands) Goodwill AccumulatedImpairmentLosses Total Goodwill AccumulatedImpairmentLosses Total Beginning of year balance $ 300,529 (133,434 ) 167,095 $ 307,413 (133,545 ) 173,868 Goodwill allocated to Provision for impairment — — — — — — Goodwill allocated to Properties held for sale — — — (2,465 ) — (2,465 ) Goodwill associated with disposed reporting units: Goodwill allocated to Provision for impairment — — — (111 ) 111 — Goodwill allocated to Gain on sale of real estate (33 ) — (33 ) (4,308 ) — (4,308 ) End of year balance $ 300,496 (133,434 ) 167,062 $ 300,529 (133,434 ) 167,095 As the Company identifies properties ("reporting units") that no longer meet its investment criteria, it will evaluate the property for potential sale. A decision to sell a reporting unit results in the need to evaluate its goodwill for recoverability and may result in impairment. Additionally, other changes impacting a reporting unit may be considered a triggering event. If events occur that trigger an impairment evaluation at multiple reporting units, a goodwill impairment may be significant. 6.Acquired Lease IntangiblesThe Company had the following acquired lease intangibles as of the periods set forth below: December 31, (in thousands) 2022 2021 In-place leases $ 452,868 443,460 Above-market leases 82,930 81,433 Total intangible assets 535,798 524,893 Accumulated amortization (338,053 ) (312,186 ) Acquired lease intangible assets, net $ 197,745 212,707 Below-market leases 547,519 535,569 Accumulated amortization (193,315 ) (172,293 ) Acquired lease intangible liabilities, net $ 354,204 363,276 The following table provides a summary of amortization and net accretion amounts from acquired lease intangibles: Year ended December 31, (in thousands) 2022 2021 2020 Line item in Consolidated Statements of Operations In-place lease amortization $ 34,568 33,621 48,297 Depreciation and amortization Above-market lease amortization 5,828 5,487 7,658 Lease income Acquired lease intangible asset amortization $ 40,396 39,108 55,955 Below-market lease amortization $ 28,642 30,378 50,103 Lease income 107 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 The estimated aggregate amortization and net accretion amounts from acquired lease intangibles for the next five years are as follows: (in thousands) In Process Year EndingDecember 31, Amortization of In-place lease intangibles Net accretion of Above/ Below market leaseintangibles 2023 $ 28,033 22,518 2024 21,830 20,406 2025 17,611 19,814 2026 14,421 19,098 2027 11,392 17,956 7.LeasesLessor AccountingAll of the Company's leases are classified as operating leases. The Company's Lease income is comprised of both fixed and variable income. Fixed and in-substance fixed lease income includes stated amounts per the lease contract, which are primarily related to base rent, and in some cases stated amounts for CAM, real estate taxes, and insurance ("Recoverable Costs"). Income for these amounts is recognized on a straight-line basis.Variable lease income includes the following two main items in the lease contracts:(i)Recoveries from tenants represents the tenants' contractual obligations to reimburse the Company for their portion of Recoverable Costs incurred. Generally the Company's leases provide for the tenants to reimburse the Company based on the tenants' share of the actual costs incurred in proportion to the tenants' share of leased space in the property.(ii)Percentage rent represents amounts billable to tenants based on the tenants' actual sales volume in excess of levels specified in the lease contract.The following table provides a disaggregation of lease income recognized as either fixed or variable lease income based on the criteria specified in Topic 842: (in thousands) December 31, 2022 December 31, 2021 December 31, 2020 Operating lease income Fixed and in-substance fixed lease income $ 851,409 797,502 807,603 Variable lease income 287,149 262,619 247,384 Other lease related income, net: Above/below market rent and tenant rent inducement amortization, net 22,543 24,539 42,219 Uncollectible straight-line rent (1) 12,510 5,227 (34,673 ) Uncollectible amounts billable in lease income (1) 13,841 23,481 (82,367 ) Total lease income $ 1,187,452 1,113,368 980,166 (1)During the years ended December 31, 2022 and 2021, the Company had improved rent collections following lifting of pandemic-related restrictions which resulted in more favorable income than experienced in 2020 during the height of the pandemic.Future minimum rents under non-cancelable operating leases, excluding variable lease payments, are as follows: 108 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 (in thousands) For the year ended December 31, December 31, 2022 2023 $ 850,211 2024 768,797 2025 657,870 2026 552,735 2027 440,844 Thereafter 1,579,740 Total $ 4,850,197 109 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 Lessee AccountingThe Company has shopping centers that are subject to non-cancelable, long-term ground leases where a third party owns the underlying land and has leased the land to the Company to construct and/or operate a shopping center.The Company has 19 properties within its consolidated real estate portfolio that are either partially or completely on land subject to ground leases with third parties. Accordingly, the Company owns only a long-term leasehold or similar interest in these properties. These ground leases expire through the year 2101, and in most cases, provide for renewal options. In addition, the Company has non-cancelable operating leases pertaining to office space from which it conducts its business. Office leases expire through the year 2029, and in many cases, provide for renewal options. The ground and office lease expense is recognized on a straight-line basis over the term of the leases, including management's estimate of expected option renewal periods. Operating lease expense under the Company's ground and office leases was as follows, including straight-line rent expense and variable lease expenses such as CPI increases, percentage rent and reimbursements of landlord costs: (in thousands) December 31, 2022 December 31, 2021 December 31, 2020 Fixed operating lease expense Ground leases $ 13,759 13,862 13,716 Office leases 4,162 4,309 4,334 Total fixed operating lease expense 17,921 18,171 18,050 Variable lease expense Ground leases 1,591 1,032 1,044 Office leases 611 615 585 Total variable lease expense 2,202 1,647 1,629 Total lease expense $ 20,123 19,818 19,679 Cash paid for amounts included in the measurement of operating lease liabilities Operating cash flows for operating leases $ 14,656 15,165 15,003 The following table summarizes the undiscounted future cash flows by year attributable to the operating lease liabilities for ground and office leases as of December 31, 2022, and provides a reconciliation to the Lease liability included in the accompanying Consolidated Balance Sheets: (in thousands) Lease Liabilities For the year ended December 31, Ground Leases Office Leases Total 2023 $ 10,750 4,046 14,796 2024 10,799 3,082 13,881 2025 10,801 2,880 13,681 2026 10,722 2,715 13,437 2027 10,722 1,517 12,239 Thereafter 516,564 741 517,305 Total undiscounted lease liabilities $ 570,358 14,981 585,339 Present value discount (370,486 ) (1,131 ) (371,617 ) Lease liabilities $ 199,872 13,850 213,722 Weighted average discount rate 5.2 % 3.6 % Weighted average remaining term (in years) 46.8 4.4 110 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Notes to Consolidated Financial Statements December 31, 2022 8. Income TaxesThe Company has elected to be taxed as a REIT under the applicable provisions of the Internal Revenue Code with certain of its subsidiaries treated as taxable REIT subsidiary entities, which are subject to federal and state income taxes.The following table summarizes the tax status of dividends paid on our common shares: Year ended December 31, (in thousands) 2022 2021 2020 Dividend per share $ 2.53 (1) 2.53 (2) 2.19 Ordinary income 100 % 92 % 100 % Capital gain (3) — % 8 % — % Additional tax status information: Qualified dividend income — % 1 % — % Section 199A dividend 100 % 91 % 100 % Section 897 ordinary dividends — % 2 % — % Section 897 capital gains — % 4 % — % (1)During 2022, the Company declared four quarterly dividends, the last of which was paid on January 4, 2023, with a portion allocated to the 2022 dividend period, and the balance allocated to 2023.(2)During 2021, the Company declared four quarterly dividends, the last of which was paid on January 5, 2022, with a portion allocated to the 2021 devidend period, and the balance allocated to 2022.(3)Of the total capital gain distribution during 2021, 42% is excluded under Reg. 1.1061-4(b)(7). The remaining 58% is a Three Year Amount under Reg. 1.1061-6(c).Our consolidated expense (benefit) for income taxes for the years ended December 31, 2022, 2021, and 2020 was as follows: Year ended December 31, (in thousands) 2022 2021 2020 Income tax expense (benefit): Current $ (332 ) 620 2,157 Deferred 293 421 (891 ) Total income tax expense (benefit) (1) $ (39 ) 1,041 1,266 (1)Includes $(39,000), $943,000 and $(355,000) of tax expense (benefit) presented within Other operating expenses during the years ended December 31, 2022, 2021, and 2020, respectively. Additionally, $1,600,000 of tax expense is presented within Gain on sale of real estate (or Provision for impairment), net of tax, during the year ended December 31, 2020.The TRS entities are subject to federal and state income taxes and file separate tax returns. Income tax expense (benefit) differed from the amounts computed by applying the U.S. Federal income tax rate to pretax income of the TRS entities, as follows: Year ended December 31, (in thousands) 2022 2021 2020 Computed expected tax expense (benefit) $ 504 544 (3,665 ) State income tax, net of federal benefit 52 477 (593 ) Valuation allowance (323 ) 15 1,043 Permanent items 1 1 5,079 All other items (273 ) 4 (598 ) Total income tax expense (1) (39 ) 1,041 1,266 Income tax expense attributable to operations (1) $ (39 ) 1,041 1,266 (1)Includes $(39,000), $943,000, and $(355,000) of tax expense (benefit) presented within Other operating expenses during the years ended December 31, 2022, 2021, and 2020, respectively. Additionally, $1,600,000 of tax expense is presented within Gain on sale of real estate (or Provision for impairment), net of tax, during the year ended December 31, 2020.111 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 The tax effects of temporary differences (included in Accounts payable and other liabilities in the accompanying Consolidated Balance Sheets) are summarized as follows: December 31, (in thousands) 2022 2021 Deferred tax assets Fixed assets $ — 1,039 Other 1,007 1,379 Deferred tax assets 1,007 2,418 Valuation allowance (1,007 ) (2,418 ) Deferred tax assets, net $ — — Deferred tax liabilities Fixed assets (12,527 ) (13,004 ) Other (61 ) (340 ) Deferred tax liabilities (12,588 ) (13,344 ) Net deferred tax liabilities $ (12,588 ) (13,344 ) The Company believes it is more likely than not that the remaining deferred tax assets will not be realized unless tax planning strategies are implemented. 9.Notes Payable and Unsecured Credit FacilitiesThe Company's outstanding debt, net of unamortized debt premium (discount) and debt issuance costs, consisted of the following as of the dates set forth below: MaturingThrough WeightedAverageContractualRate WeightedAverageEffectiveRate December 31, (in thousands) 2022 2021 Notes payable: Fixed rate mortgage loans 3/1/2032 3.9% 3.5% $ 342,135 359,414 Variable rate mortgage loans (1) 6/2/2027 3.4% 3.7% 136,246 115,539 Fixed rate unsecured debt 3/15/2049 3.8% 4.0% 3,248,373 3,243,991 Total notes payable 3,726,754 3,718,944 Unsecured credit facilities: Line of Credit (2) 3/23/2025 5.0% 5.3% — — Total debt outstanding $ 3,726,754 3,718,944 (1)Five of these six variable rate loans, representing $132.1 million of debt in the aggregate, have interest rate swaps in place to mitigate interest rate fluctuation risk. With these swap agreements, the fixed rates of the loans range from 2.5% to 4.1%.(2)Weighted-average effective rate for the Line is calculated based on a fully drawn Line balance using the period end variable rate.Notes PayableNotes payable consist of mortgage loans secured by properties and unsecured public and private debt. Mortgage loans may be repaid before maturity, but could be subject to yield maintenance premiums, and are generally due in monthly installments of principal and interest or interest only. Unsecured public debt may be repaid before maturity subject to accrued and unpaid interest through the proposed redemption date and a make-whole premium. Interest on unsecured public and private debt is payable semi-annually.The Company is required to comply with certain financial covenants for its unsecured public debt as defined in the indenture agreements such as the following ratios: Consolidated Debt to Consolidated Assets, Consolidated Secured Debt to Consolidated Assets, Consolidated Income for Debt Service to Consolidated Debt Service, and Unencumbered Consolidated Assets to Unsecured Consolidated Debt. As of December 31, 2022, management of the Company believes it is in compliance with all financial covenants for its unsecured public debt.112 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 Unsecured Credit FacilitiesThe Company has an unsecured line of credit commitment (the "Line") with a syndicate of banks. At December 31, 2022, the Line had a borrowing capacity of $1.25 billion, which is reduced by the balance of outstanding borrowings and commitments from issued letters of credit. The Line bears interest at a variable rate of LIBOR plus an applicable margin of 0.865% and is subject to a commitment fee of 0.15%, both of which are based on the Company's corporate credit rating. On January 12, 2023, the Line was amended to convert the reference rate from LIBOR to SOFR plus a 0.10% market adjustment, with no changes in the applicable margin.The Company is required to comply with certain financial covenants as defined in the Line credit agreement, such as Ratio of Indebtedness to Total Asset Value ("TAV"), Ratio of Unsecured Indebtedness to Unencumbered Asset Value, Ratio of Adjusted EBITDA to Fixed Charges, Ratio of Secured Indebtedness to TAV, Ratio of Unencumbered Net Operating Income to Unsecured Interest Expense, and other covenants customary with this type of unsecured financing. As of December 31, 2022, the Company is in compliance with all financial covenants for the Line.Scheduled principal payments and maturities on notes payable and unsecured credit facilities were as follows: (in thousands) December 31, 2022 Scheduled Principal Payments and Maturities by Year: ScheduledPrincipalPayments MortgageLoanMaturities UnsecuredMaturities (1) Total 2023 $ 9,695 59,383 — 69,078 2024 4,849 90,758 250,000 345,607 2025 3,732 44,250 250,000 297,982 2026 3,922 112,365 200,000 316,287 2027 3,788 137,915 525,000 666,703 Beyond 5 Years 2,873 319 2,050,000 2,053,192 Unamortized debt premium/(discount) and issuance costs — 4,532 (26,627 ) (22,095 ) Total notes payable $ 28,859 449,522 3,248,373 3,726,754 (1)Includes unsecured public and private debt and unsecured credit facilities.The Company has $59.4 million of debt maturing over the next 12 months, which is in the form of five non-recourse mortgage loans. The Company currently intends to repay three of the maturing balances, leaving the properties unencumbered, with plans to refinance the two remaining. The Company has sufficient capacity on its Line to repay the maturing debt, if necessary. 10.Derivative Financial InstrumentsThe Company may use derivative financial instruments, including interest rate swaps, caps, options, floors, and other interest rate derivative contracts, to hedge all or a portion of the interest rate risk associated with its borrowings. The principal objective of such arrangements is to minimize the risks and/or costs associated with the Company's operating and financial structure as well as to hedge specific anticipated transactions. The Company does not intend to utilize derivatives for speculative transactions or purposes other than mitigation of interest rate risk. The use of derivative financial instruments carries certain risks, including the risk that the counterparties to these contractual arrangements are not able to perform under the agreements. To mitigate this risk, the Company only enters into derivative financial instruments with counterparties with quality credit ratings. The Company does not anticipate that any of the counterparties will fail to meet their obligations.113 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 The Company's objectives in using interest rate derivatives are to attempt to stabilize interest expense where possible and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.The following table summarizes the terms and fair values of the Company's derivative financial instruments, as well as their classification on the Consolidated Balance Sheets: Fair Value at December 31, (in thousands) Assets (Liabilities) (1) EffectiveDate MaturityDate NotionalAmount Bank Pays VariableRate of Regency PaysFixed Rate of 2022 2021 4/7/16 4/1/23 $ 18,637 LIBOR 1.303 % $ 152 (175 ) 12/1/16 11/1/23 31,131 SOFR 1.490 % 883 (412 ) 9/17/19 3/17/25 24,000 SOFR 1.443 % 1,443 (364 ) 6/2/17 6/2/27 35,446 SOFR 2.261 % 2,158 (1,907 ) 12/20/19 (2) 12/19/26 24,365 LIBOR 1.750 % 1,939 — Total derivative financial instruments $ 6,575 (2,858 ) (1)Derivatives in an asset position are included within Other assets in the accompanying Consolidated Balance Sheets, while those in a liability position are included within Accounts payable and other liabilities. (2)The Company assumed this interest rate swap which hedges debt also assumed with the purchase of Baederwood Shoppes in May 2022.These derivative financial instruments are all interest rate swaps, which are designated and qualify as cash flow hedges. The Company does not use derivatives for trading or speculative purposes and, as of December 31, 2022, does not have any derivatives that are not designated as hedges.The changes in the fair value of derivatives designated and qualifying as cash flow hedges are recorded in Accumulated other comprehensive income (loss) ("AOCI") and subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The following table represents the effect of the derivative financial instruments on the accompanying Consolidated Financial Statements: Location and Amount of Gain (Loss) Recognized in OCI on Derivative Location and Amount of Loss (Gain) Reclassified from AOCI into Income Total amounts presented in the Consolidated Statements of Operations in which the effects of cash flow hedges are recorded Year ended December 31, Year ended December 31, Year ended December 31, (in thousands) 2022 2021 2020 2022 2021 2020 2022 2021 2020 Interest rate swaps $ 20,061 5,391 (19,187 ) Interest expense, net $ 833 4,141 8,790 Interest expense, net $ 146,186 145,170 156,678 Early extinguishment of debt (1) $ — — 2,472 Early extinguishment of debt $ — — 21,837 (1)At December 31, 2020, based on intent to repay the Term Loan in January 2021, the Company recognized the Accumulated other comprehensive loss for the Term Loan swap in earnings within Early extinguishment of debt. As of December 31, 2022, the Company expects approximately $5.4 million of accumulated comprehensive income on derivative instruments in AOCI, including the Company's share from its Investments in real estate partnerships, to be reclassified into earnings during the next 12 months. 114 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Notes to Consolidated Financial Statements December 31, 2022 11.Fair Value Measurements(a)Disclosure of Fair Value of Financial InstrumentsAll financial instruments of the Company are reflected in the accompanying Consolidated Balance Sheets at amounts which, in management's estimation, reasonably approximates their fair values, except for the following: December 31, 2022 2021 (in thousands) CarryingAmount Fair Value CarryingAmount Fair Value Financial liabilities: Notes payable $ 3,726,754 3,333,378 $ 3,718,944 4,103,533 The above fair values represent management's estimate of the amounts that would be received from selling those assets or that would be paid to transfer those liabilities in an orderly transaction between market participants as of December 31, 2022 and 2021, respectively. These fair value measurements maximize the use of observable inputs which are classified within Level 2 of the fair value hierarchy. However, in situations where there is little, if any, market activity for the asset or liability at the measurement date, the fair value measurement reflects the Company's own judgments about the assumptions that market participants would use in pricing the asset or liability.The Company develops its judgments based on the best information available at the measurement date, including expected cash flows, appropriately risk-adjusted discount rates, and available observable and unobservable inputs. Service providers involved in fair value measurements are evaluated for competency and qualifications on an ongoing basis. As considerable judgment is often necessary to estimate the fair value of these financial instruments, the fair values presented above are not necessarily indicative of amounts that will be realized upon disposition of the financial instruments.(b)Fair Value MeasurementsThe following financial instruments are measured at fair value on a recurring basis:SecuritiesThe Company has investments in marketable securities that are included within Other assets on the accompanying Consolidated Balance Sheets. The fair value of the securities was determined using quoted prices in active markets, which are considered Level 1 inputs of the fair value hierarchy. Changes in the value of securities are recorded within Net investment loss (income) in the accompanying Consolidated Statements of Operations, and includes unrealized losses of $8.0 million for the year ended December 31, 2022, and unrealized gains of $1.7 million and $3.0 million for the years ended December 31, 2021, and 2020, respectively.Available-for-Sale Debt SecuritiesAvailable-for-sale debt securities consist of investments in certificates of deposit and corporate bonds, and are recorded at fair value using either recent trade prices for the identical debt instrument or comparable instruments by issuers of similar industry sector, issuer rating, and size, to estimate fair value, which are considered Level 2 inputs of the fair value hierarchy. Unrealized gains or losses on these debt securities are recognized through other comprehensive income.Interest Rate DerivativesThe fair value of the Company's interest rate derivatives is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty's nonperformance risk in the fair value measurements. 115 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by the Company and its counterparties. The Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its interest rate swaps. As a result, the Company determined that its interest rate swaps valuation in its entirety is classified in Level 2 of the fair value hierarchy.The following tables present the placement in the fair value hierarchy of assets and liabilities that are measured at fair value on a recurring basis: Fair Value Measurements as of December 31, 2022 (in thousands) Balance Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Assets: Securities $ 40,089 40,089 — — Available-for-sale debt securities 14,492 — 14,492 — Interest rate derivatives 6,575 — 6,575 — Total $ 61,156 40,089 21,067 — Fair Value Measurements as of December 31, 2021 (in thousands) Balance Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Assets: Securities $ 49,513 49,513 — — Available-for-sale debt securities 15,599 — 15,599 — Total $ 65,112 49,513 15,599 — Liabilities: Interest rate derivatives $ (2,858 ) — (2,858 ) — The following tables present the placement in the fair value hierarchy of assets and liabilities that are measured at fair value on a non-recurring basis: Fair Value Measurements as of December 31, 2021 (in thousands) Balance Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Gains (Losses) Operating properties $ 140,500 — — 140,500 (84,277 ) During the year ended December 31, 2022, there were no real estate assets re-measured to estimated fair value on a nonrecurring basis. During the year ended December 31, 2021, the Company revalued two shopping centers to estimated fair value due to a change in expected hold period using a discounted cash flow model. 116 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Notes to Consolidated Financial Statements December 31, 2022 12.Equity and CapitalCommon Stock of the Parent CompanyDividends Declared On February 8, 2023, our Board of Directors declared a common stock dividend of $0.65 per share, payable on April 5,2023, to shareholders of record as of March 15, 2023.At the Market ("ATM") ProgramUnder the Parent Company's ATM equity offering program, the Parent Company may sell up to $500 million of common stock at prices determined by the market at the time of sale. During 2021, the Company entered into forward sale agreements under its ATM program to issue shares of its common stock which were issued and settled as follows:•1,332,142 shares were issued during 2021 at a weighted average offering price of $63.71 before any underwriting discounts and offerring expenses. The net proceeds received at settlement were approximately $82.5 million, after approximately $1.1 million underwriting discounts and offering expenses;•984,618 shares were issued during 2022 at a weighted average offering price of $65.78 before underwriting discounts and offering expenses. The net proceeds received at settlement were approximately $61.3 million, after approximately $3.5 million in underwriting discounts and offering expenses. The proceeds were used to fund acquisitions. All shares are now settled under the forward sales agreements. No other sales occurred under the ATM program during 2022.As of December 31, 2022, $350.4 million of common stock remained available for issuance under this ATM equity program.Share Repurchase ProgramOn February 3, 2021, the Company’s Board authorized a common share repurchase program under which the Company could purchase, from time to time, up to a maximum of $250 million of its outstanding common stock through open market purchases or in privately negotiated transactions (referred to as the "Authorized Repurchase Program"). Any shares purchased, if not retired, were treated as treasury shares. During the year ended December 31, 2022, the Company executed multiple trades to repurchase 1,294,201 common shares under the Authorized Repurchase Program for a total of $75.4 million at a weighted average price of $58.25 per share. All repurchased shares were retired on the respective settlement dates. At December 31, 2022, $174.6 million remained available under this Authorized Repurchase Program. This Authorized Repurchase Program expired on February 3, 2023.On February 8, 2023, the Company's Board authorized a new common share repurchase program under which the Company may purchase, from time to time, up to a maximum of $250 million of its outstanding common stock through open market purchases, and/or in privately negotiated transactions. The timing and price of share repurchases, if any, will be dependent upon market conditions and other factors. Any shares repurchased, if not retired, will be treated as treasury shares. This new authorization will expire on February 7, 2025, unless modified of earlier terminated by the Board. 117 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 Common Units of the Operating PartnershipCommon units of the operating partnership are issued or redeemed and retired for each of the shares of Parent Company common stock issued or repurchased and retired, as described above. During the year ended December 31, 2022, 18,613 Partnership Units were converted to Parent Company common stock.General PartnersThe Parent Company, as general partner, owned the following Partnership Units outstanding: December 31, (in thousands) 2022 2021 Partnership units owned by the general partner 171,125 171,213 Partnership units owned by the limited partners 741 760 Total partnership units outstanding 171,866 171,973 Percentage of partnership units owned by the general partner 99.6 % 99.6 % 13.Stock-Based CompensationThe Company recorded stock-based compensation in General and administrative expenses in the accompanying Consolidated Statements of Operations, the components of which are further described below: Year ended December 31, (in thousands) 2022 2021 2020 Restricted stock (1) $ 16,667 12,651 14,248 Directors' fees paid in common stock and other employee stock grants 589 530 452 Capitalized stock-based compensation (735 ) (666 ) (1,119 ) Stock-based compensation, net of capitalization $ 16,521 12,515 13,581 (1)Includes amortization of the grant date fair value of restricted stock awards over the respective vesting periods.The Company established its Omnibus Incentive Plan (the "Plan") under which the Board of Directors may grant stock options and other stock-based awards to officers, directors, and other key employees. The Plan allows the Company to issue up to 5.0 million shares in the form of the Parent Company's common stock or stock options. As of December 31, 2022, there were 4.1 million shares available for grant under the Plan.Restricted Stock AwardsThe Company grants restricted stock under the Plan to its employees as a form of long-term compensation and retention. The terms of each restricted stock grant vary depending upon the participant's responsibilities and position within the Company. The Company's stock grants can be categorized as either time-based awards, performance-based awards, or market-based awards. All awards are valued at fair value, earn dividends throughout the vesting period, and have no voting rights. Fair value is measured using the grant date market price for all time-based or performance-based awards. Market based awards are valued using a Monte Carlo simulation to estimate the fair value based on the probability of satisfying the market conditions and the projected stock price at the time of payout, discounted to the valuation date over a three year performance period. Assumptions include historic volatility over the previous three year period, risk-free interest rates, and Regency's historic daily return as compared to the market index. Since the award payout includes dividend equivalents and the total shareholder return includes the value of dividends, no dividend yield assumption is required for the valuation. Compensation expense is measured at the grant date and recognized on a straight-line basis over the requisite vesting period for the entire award.118 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 The following table summarizes non-vested restricted stock activity: Year ended December 31, 2022 Number of Shares Intrinsic Value (in thousands) Weighted Average Grant Price Non-vested as of December 31, 2021 691,862 Time-based awards granted (1) (4) 148,048 $ 71.36 Performance-based awards granted (2) (4) 15,674 $ 71.68 Market-based awards granted (3) (4) 112,759 $ 74.98 Change in market-based awards earned for performance (3) 5,153 $ 71.58 Vested (5) (250,491 ) $ 71.05 Forfeited (11,306 ) $ 62.65 Non-vested as of December 31, 2022 (6) 711,699 $ 44,481 (1)Time-based awards vest beginning on the first anniversary following the grant date over a one or four year service period. These grants are subject only to continued employment and are not dependent on future performance measures. Accordingly, if such vesting criteria are not met, compensation cost previously recognized would be reversed.(2)Performance-based awards are earned subject to future performance measurements. Once the performance criteria are achieved and the actual number of shares earned is determined, shares vest over a required service period. The Company considers the likelihood of meeting the performance criteria based upon management's estimates from which it determines the amounts recognized as expense on a periodic basis.(3)Market-based awards are earned dependent upon the Company's total shareholder return in relation to the shareholder return of a NAREIT index over a three-year period. Once the performance criteria are met and the actual number of shares earned is determined, the shares are immediately vested and distributed. The probability of meeting the criteria is considered when calculating the estimated fair value on the date of grant using a Monte Carlo simulation. These awards are accounted for as awards with market criteria, with compensation cost recognized over the service period, regardless of whether the performance criteria are achieved and the awards are ultimately earned. The significant assumptions underlying determination of fair values for market-based awards granted were as follows: Year ended December 31, 2022 2021 2020 Volatility 43.10 % 42.60 % 18.50 % Risk free interest rate 1.39 % 0.18 % 1.30 % (4)The weighted-average grant price for restricted stock granted during the years is summarized below: Year ended December 31, 2022 2021 2020 Weighted-average grant price for restricted stock $ 72.86 $ 46.55 $ 64.14 (5)The total intrinsic value of restricted stock vested during the years is summarized below (in thousands): Year ended December 31, 2022 2021 2020 Intrinsic value of restricted stock vested $ 17,797 $ 10,939 $ 14,423 (6)As of December 31, 2022, there was $16.6 million of unrecognized compensation cost related to non-vested restricted stock granted under the Parent Company's Plan. When recognized, this compensation results in additional paid in capital in the accompanying Consolidated Statements of Equity of the Parent Company and in general partner preferred and common units in the accompanying Consolidated Statements of Capital of the Operating Partnership. This unrecognized compensation cost is expected to be recognized over the next three years. The Company issues new restricted stock from its authorized shares available at the date of grant. 119 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Notes to Consolidated Financial Statements December 31, 2022 14.Saving and Retirement Plans401(k) Retirement PlanThe Company maintains a 401(k) retirement plan covering substantially all employees and permits participants to defer eligible compensation up to the maximum allowable amount determined by the IRS. This deferred compensation, together with Company matching contributions equal to 100% of employee deferrals up to a maximum of $5,000 of their eligible compensation, is fully vested and funded as of December 31, 2022. Additionally, an annual profit sharing contribution may be made, which are fully vested after three years in service. Costs for Company contributions to the plan totaled $4.4 million, $4.1 million, and $3.5 million for the years ended December 31, 2022, 2021, and 2020, respectively.Non-Qualified Deferred Compensation Plan ("NQDCP")The Company maintains a NQDCP which allows select employees and directors to defer part or all of their cash bonus, director fees, and vested restricted stock awards. All contributions into the participants' accounts are fully vested upon contribution to the NQDCP and are deposited in a Rabbi trust.The following table reflects the balances of the assets and deferred compensation liabilities of the Rabbi trust and related participant account obligations in the accompanying Consolidated Balance Sheets, excluding Regency stock: Year ended December 31, (in thousands) 2022 2021 Location in Consolidated Balance Sheets Assets: Securities $ 36,163 44,464 Other assets Liabilities: Deferred compensation obligation $ 36,085 44,388 Accounts payable and other liabilities Realized and unrealized gains and losses on securities held in the NQDCP are recognized within Net investment loss (income) in the accompanying Consolidated Statements of Operations. Changes in participant obligations, which is based on changes in the value of their investment elections, is recognized within General and administrative expenses within the accompanying Consolidated Statements of Operations.Investments in shares of the Company's common stock are included, at cost, as Treasury stock in the accompanying Consolidated Balance Sheets of the Parent Company and as a reduction of General partner capital in the accompanying Consolidated Balance Sheets of the Operating Partnership. The participant's deferred compensation liability attributable to the participants' investments in shares of the Company's common stock are included, at cost, within Additional paid in capital in the accompanying Consolidated Balance Sheets of the Parent Company and as a reduction of General partner capital in the accompanying Consolidated Balance Sheets of the Operating Partnership. Changes in participant account balances related to the Regency common stock fund are recorded directly within stockholders' equity. 15.Earnings per Share and UnitParent Company Earnings per ShareThe following summarizes the calculation of basic and diluted earnings per share: Year ended December 31, (in thousands, except per share data) 2022 2021 2020 Numerator: Income attributable to common stockholders - basic $ 482,865 361,411 44,889 Income attributable to common stockholders - diluted $ 482,865 361,411 44,889 Denominator: Weighted average common shares outstanding for basic EPS 171,404 170,236 169,231 Weighted average common shares outstanding for diluted EPS (1) (2) 171,791 170,694 169,460 Income per common share – basic $ 2.82 2.12 0.27 Income per common share – diluted $ 2.81 2.12 0.26 (1)Includes the dilutive impact of unvested restricted stock.(2)Using the treasury stock method, weighted average common shares outstanding for basic and diluted earnings per share exclude 1.0 million shares issuable under the forward ATM equity offering outstanding during 2021 as they would be anti-dilutive. 120 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Notes to Consolidated Financial StatementsDecember 31, 2022 Income allocated to noncontrolling interests of the Operating Partnership has been excluded from the numerator and exchangeable Operating Partnership units have been omitted from the denominator for the purpose of computing diluted earnings per share since the effect of including these amounts in the numerator and denominator would be anti-dilutive. Weighted average exchangeable Operating Partnership units outstanding for the years ended December 31, 2022, 2021, and 2020, were 748,336, 761,955, and 765,046, respectively. Operating Partnership Earnings per UnitThe following summarizes the calculation of basic and diluted earnings per unit: Year ended December 31, (in thousands, except per share data) 2022 2021 2020 Numerator: Income attributable to common unit holders - basic $ 484,970 363,026 45,092 Income attributable to common unit holders - diluted $ 484,970 363,026 45,092 Denominator: Weighted average common units outstanding for basic EPU 172,152 170,998 169,997 Weighted average common units outstanding for diluted EPU (1) (2) 172,540 171,456 170,225 Income per common unit – basic $ 2.82 2.12 0.27 Income per common unit – diluted $ 2.81 2.12 0.26 (1)Includes the dilutive impact of unvested restricted stock.(2)Using the treasury stock method, weighted average common shares outstanding for basic and diluted earnings per share exclude 1.0 million shares issuable under the forward ATM equity offering outstanding during 2021 as they would be anti-dilutive. 16.Commitments and ContingenciesLitigationThe Company is involved in litigation on a number of matters, and is subject to other disputes that arise in the ordinary course of business. While the outcome of any particular lawsuit or dispute cannot be predicted with certainty, in the opinion of management, the Company's currently pending litigation and disputes are not expected to have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity. Legal fees are expensed as incurred.EnvironmentalThe Company is subject to numerous environmental laws and regulations pertaining primarily to chemicals historically used by certain current and former dry cleaning tenants, the existence of asbestos in older shopping centers, older underground petroleum storage tanks and other historic land use. The Company believes that the ultimate disposition of currently known environmental matters will not have a material effect on its financial position, liquidity, or operations. The Company can give no assurance that existing environmental studies with respect to its shopping centers have revealed all potential environmental contaminants; that its estimate of liabilities will not change as more information becomes available; that any previous owner, occupant or tenant did not create any material environmental condition not known to the Company; that the current environmental condition of the shopping centers will not be affected by tenants and occupants, by the condition of nearby properties, or by unrelated third parties; and that changes in applicable environmental laws and regulations or their interpretation will not result in additional environmental liability to the Company.Letters of CreditThe Company has the right to issue letters of credit under the Line up to an amount not to exceed $50.0 million, which reduces the credit availability under the Line. These letters of credit are primarily issued as collateral on behalf of its captive insurance program and to facilitate the construction of development projects. As of December 31, 2022 and 2021, the Company had $9.4 million in letters of credit outstanding. 121 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Schedule III - Consolidated Real Estate and Accumulated Depreciation December 31, 2022 (in thousands) 122 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Schedule III - Consolidated Real Estate and Accumulated Depreciation December 31, 2022 (in thousands) Initial Cost Total Cost Net Cost Shopping Centers (1) Land & LandImprovements Building &Improvements CostCapitalizedSubsequent toAcquisition (2) Land & LandImprovements Building &Improvements Total AccumulatedDepreciation Net ofAccumulatedDepreciation Mortgages 101 7th Avenue $ 48,340 34,895 (57,260 ) 15,378 10,597 25,975 (1,550 ) 24,425 — 1175 Third Avenue 40,560 25,617 33 40,560 25,650 66,210 (4,361 ) 61,849 — 1225-1239 Second Ave 23,033 17,173 (33 ) 23,033 17,140 40,173 (3,112 ) 37,061 — 200 Potrero 4,860 2,251 135 4,860 2,386 7,246 (450 ) 6,796 — 22 Crescent Road 2,198 272 (318 ) 2,152 — 2,152 — 2,152 — 4S Commons Town Center 30,760 35,830 1,743 30,812 37,521 68,333 (29,841 ) 38,492 (80,812 ) 6401 Roosevelt 2,685 934 193 2,685 1,127 3,812 (88 ) 3,724 — 90 - 30 Metropolitan Avenue 16,614 24,171 271 16,614 24,442 41,056 (4,272 ) 36,784 — 91 Danbury Road 732 851 46 732 897 1,629 (205 ) 1,424 — Alafaya Village 3,004 5,852 215 3,004 6,067 9,071 (1,188 ) 7,883 — Alden Bridge 17,014 21,958 597 17,014 22,555 39,569 (1,436 ) 38,133 (26,000 ) Amerige Heights Town Center 10,109 11,288 1,211 10,109 12,499 22,608 (6,361 ) 16,247 — Anastasia Plaza 9,065 — 1,025 3,338 6,752 10,090 (3,587 ) 6,503 — Apple Valley Square 5,438 21,328 (56 ) 5,382 21,328 26,710 (1,196 ) 25,514 — Ashford Place 2,584 9,865 1,126 2,584 10,991 13,575 (9,016 ) 4,559 — Atlantic Village 4,282 18,827 2,093 4,868 20,334 25,202 (5,198 ) 20,004 — Aventura Shopping Center 2,751 10,459 11,129 9,486 14,853 24,339 (4,497 ) 19,842 — Aventura Square 88,098 20,771 1,799 89,657 21,011 110,668 (4,541 ) 106,127 (2,340 ) Baederwood Shopping Center 12,016 33,556 323 12,016 33,879 45,895 (859 ) 45,036 (24,365 ) Balboa Mesa Shopping Center 23,074 33,838 14,057 27,758 43,211 70,969 (19,638 ) 51,331 — Banco Popular Building 2,160 1,137 (1,294 ) 2,003 — 2,003 — 2,003 — Belleview Square 8,132 9,756 3,942 8,323 13,507 21,830 (10,116 ) 11,714 — Belmont Chase 13,881 17,193 (368 ) 14,372 16,334 30,706 (8,092 ) 22,614 — Berkshire Commons 2,295 9,551 2,957 2,965 11,838 14,803 (9,463 ) 5,340 — Bethany Park Place 4,832 12,405 166 4,832 12,571 17,403 (835 ) 16,568 (10,200 ) Bird 107 Plaza 10,371 5,136 56 10,371 5,192 15,563 (1,241 ) 14,322 — Bird Ludlam 42,663 38,481 935 42,663 39,416 82,079 (8,188 ) 73,891 — Black Rock 22,251 20,815 497 22,251 21,312 43,563 (6,766 ) 36,797 (18,637 ) Blakeney Town Center (fka Blakeney Shopping Center) 82,411 89,165 1,431 82,411 90,596 173,007 (4,278 ) 168,729 — Bloomingdale Square 3,940 14,912 22,981 8,639 33,194 41,833 (12,435 ) 29,398 — Blossom Valley 31,988 5,850 767 31,988 6,617 38,605 (515 ) 38,090 (22,300 ) 123 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Boca Village Square 43,888 9,726 274 43,888 10,000 53,888 (2,903 ) 50,985 — Boulevard Center 3,659 10,787 3,001 3,659 13,788 17,447 (9,205 ) 8,242 — Boynton Lakes Plaza 2,628 11,236 5,203 3,606 15,461 19,067 (9,494 ) 9,573 — Boynton Plaza 12,879 20,713 280 12,879 20,993 33,872 (4,581 ) 29,291 — Brentwood Plaza 2,788 3,473 357 2,788 3,830 6,618 (1,897 ) 4,721 — Briarcliff La Vista 694 3,292 600 694 3,892 4,586 (3,407 ) 1,179 — Briarcliff Village 4,597 24,836 5,750 5,519 29,664 35,183 (21,385 ) 13,798 — Brick Walk 25,299 41,995 2,071 25,299 44,066 69,365 (12,220 ) 57,145 (31,131 ) BridgeMill Market 7,521 13,306 969 7,522 14,274 21,796 (3,693 ) 18,103 — Bridgeton 3,033 8,137 621 3,067 8,724 11,791 (3,743 ) 8,048 — 124 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) 125 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Initial Cost Total Cost Net Cost Shopping Centers (1) Land & LandImprovements Building &Improvements CostCapitalizedSubsequent toAcquisition (2) Land & LandImprovements Building &Improvements Total AccumulatedDepreciation Net ofAccumulatedDepreciation Mortgages Brighten Park 3,983 18,687 11,395 4,234 29,831 34,065 (21,759 ) 12,306 — Broadway Plaza 40,723 42,170 2,100 40,723 44,270 84,993 (9,024 ) 75,969 — Brooklyn Station on Riverside 7,019 8,688 283 6,998 8,992 15,990 (3,053 ) 12,937 — Brookside Plaza 35,161 17,494 6,104 36,163 22,596 58,759 (6,220 ) 52,539 — Buckhead Court 1,417 7,432 4,422 1,417 11,854 13,271 (9,809 ) 3,462 — Buckhead Landing 45,502 16,642 103 45,502 16,745 62,247 (6,221 ) 56,026 — Buckhead Station 70,411 36,518 2,094 70,448 38,575 109,023 (10,036 ) 98,987 — Buckley Square 2,970 5,978 1,402 2,970 7,380 10,350 (4,999 ) 5,351 — Caligo Crossing 2,459 4,897 148 2,546 4,958 7,504 (3,993 ) 3,511 — Cambridge Square 774 4,347 605 774 4,952 5,726 (3,437 ) 2,289 — Carmel Commons 2,466 12,548 5,206 3,422 16,798 20,220 (11,975 ) 8,245 — Carriage Gate 833 4,974 3,224 1,302 7,729 9,031 (7,203 ) 1,828 — Carytown Exchange 23,720 19,270 (53 ) 23,721 19,216 42,937 (2,641 ) 40,296 — Cashmere Corners 3,187 9,397 647 3,187 10,044 13,231 (2,638 ) 10,593 — Cedar Commons 4,704 16,748 54 4,704 16,802 21,506 (728 ) 20,778 — Centerplace of Greeley III 6,661 11,502 1,295 5,694 13,764 19,458 (7,161 ) 12,297 — Charlotte Square 1,141 6,845 1,008 1,141 7,853 8,994 (2,308 ) 6,686 — Chasewood Plaza 4,612 20,829 5,603 6,886 24,158 31,044 (20,840 ) 10,204 — Chastain Square 30,074 12,644 2,307 30,074 14,951 45,025 (4,491 ) 40,534 — Cherry Grove 3,533 15,862 5,080 3,533 20,942 24,475 (13,651 ) 10,824 — Chimney Rock 23,623 48,200 440 23,623 48,640 72,263 (15,623 ) 56,640 — Circle Center West 22,930 9,028 183 22,930 9,211 32,141 (2,140 ) 30,001 — Circle Marina Center 29,303 18,437 153 29,303 18,590 47,893 (2,210 ) 45,683 (24,000 ) CityLine Market 12,208 15,839 341 12,306 16,082 28,388 (5,640 ) 22,748 — CityLine Market Phase II 2,744 3,081 104 2,744 3,185 5,929 (997 ) 4,932 — Clayton Valley Shopping Center 24,189 35,422 2,248 24,538 37,321 61,859 (29,371 ) 32,488 — Clocktower Plaza Shopping Ctr 49,630 19,624 702 49,630 20,326 69,956 (4,310 ) 65,646 — Clybourn Commons 15,056 5,594 496 15,056 6,090 21,146 (2,008 ) 19,138 — Cochran's Crossing 13,154 12,315 2,549 13,154 14,864 28,018 (11,607 ) 16,411 — Compo Acres Shopping Center 28,627 10,395 874 28,627 11,269 39,896 (2,312 ) 37,584 — Concord Shopping Plaza 30,819 36,506 1,616 31,272 37,669 68,941 (7,356 ) 61,585 — Copps Hill Plaza 29,515 40,673 2,411 29,514 43,085 72,599 (7,436 ) 65,163 (8,962 ) Coral Reef Shopping Center 14,922 15,200 2,441 15,332 17,231 32,563 (3,981 ) 28,582 — Corkscrew Village 8,407 8,004 851 8,407 8,855 17,262 (4,397 ) 12,865 — Cornerstone Square 1,772 6,944 1,678 1,772 8,622 10,394 (6,862 ) 3,532 — 126 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Corral Hollow 8,887 24,121 39 8,887 24,160 33,047 (706 ) 32,341 — Corvallis Market Center 6,674 12,244 472 6,696 12,694 19,390 (7,892 ) 11,498 — Country Walk Plaza 18,713 20,373 194 18,713 20,567 39,280 (2,143 ) 37,137 (16,000 ) Countryside Shops 17,982 35,574 13,718 23,175 44,099 67,274 (12,190 ) 55,084 — Courtyard Shopping Center 5,867 4 3 5,867 7 5,874 (3 ) 5,871 — Culver Center 108,841 32,308 2,329 108,841 34,637 143,478 (7,932 ) 135,546 — 127 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) 128 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Initial Cost Total Cost Net Cost Shopping Centers (1) Land & LandImprovements Building &Improvements CostCapitalizedSubsequent toAcquisition (2) Land & LandImprovements Building &Improvements Total AccumulatedDepreciation Net ofAccumulatedDepreciation Mortgages Danbury Green 30,303 19,255 1,038 30,303 20,293 50,596 (4,172 ) 46,424 — Dardenne Crossing 4,194 4,005 727 4,343 4,583 8,926 (2,563 ) 6,363 — Darinor Plaza 693 32,140 1,236 711 33,358 34,069 (7,099 ) 26,970 — Diablo Plaza 5,300 8,181 2,499 5,300 10,680 15,980 (6,750 ) 9,230 — Dunwoody Hall 15,145 12,110 189 15,145 12,299 27,444 (700 ) 26,744 (13,800 ) Dunwoody Village 3,342 15,934 6,409 3,342 22,343 25,685 (17,574 ) 8,111 — East Meadow 12,325 21,378 91 12,267 21,527 33,794 (946 ) 32,848 — East Meadow Plaza 13,135 25,070 (29 ) 13,135 25,041 38,176 (380 ) 37,796 — East Pointe 1,730 7,189 2,607 1,941 9,585 11,526 (7,081 ) 4,445 — East San Marco 4,517 13,528 — 4,517 13,528 18,045 (357 ) 17,688 — Eastport 2,985 5,649 (32 ) 2,925 5,677 8,602 (282 ) 8,320 — El Camino Shopping Center 7,600 11,538 15,334 10,328 24,144 34,472 (12,157 ) 22,315 — El Cerrito Plaza 11,025 27,371 3,570 11,025 30,941 41,966 (14,632 ) 27,334 — El Norte Pkwy Plaza 2,834 7,370 3,000 3,263 9,941 13,204 (6,644 ) 6,560 — Encina Grande 5,040 11,572 20,175 10,518 26,269 36,787 (16,314 ) 20,473 — Fairfield Center 6,731 29,420 1,550 6,731 30,970 37,701 (8,265 ) 29,436 — Falcon Marketplace 1,340 4,168 487 1,246 4,749 5,995 (3,136 ) 2,859 — Fellsway Plaza 30,712 7,327 9,963 34,923 13,079 48,002 (8,109 ) 39,893 (35,446 ) Fenton Marketplace 2,298 8,510 (7,934 ) 512 2,362 2,874 (1,336 ) 1,538 — Fleming Island 3,077 11,587 3,380 3,111 14,933 18,044 (9,610 ) 8,434 — Fountain Square 29,722 29,041 (183 ) 29,784 28,796 58,580 (12,810 ) 45,770 — French Valley Village Center 11,924 16,856 554 11,822 17,512 29,334 (15,494 ) 13,840 — Friars Mission Center 6,660 28,021 2,541 6,660 30,562 37,222 (18,551 ) 18,671 — Gardens Square 2,136 8,273 769 2,136 9,042 11,178 (5,974 ) 5,204 — Gateway Shopping Center 52,665 7,134 12,097 55,087 16,809 71,896 (19,483 ) 52,413 — Gelson's Westlake Market Plaza 3,157 11,153 5,942 4,654 15,598 20,252 (9,632 ) 10,620 — Glen Oak Plaza 4,103 12,951 1,564 4,124 14,494 18,618 (5,568 ) 13,050 — Glengary Shoppes 9,120 11,541 1,010 9,120 12,551 21,671 (3,076 ) 18,595 — Glenwood Village 1,194 5,381 428 1,194 5,809 7,003 (4,906 ) 2,097 — Golden Hills Plaza 12,699 18,482 3,718 11,521 23,378 34,899 (12,797 ) 22,102 — Grand Ridge Plaza 24,208 61,033 5,886 24,918 66,209 91,127 (29,671 ) 61,456 — Greenwood Shopping Centre 7,777 24,829 975 7,777 25,804 33,581 (5,936 ) 27,645 — Hammocks Town Center 28,764 25,113 1,337 28,764 26,450 55,214 (6,132 ) 49,082 — Hancock 8,232 28,260 (12,901 ) 4,692 18,899 23,591 (11,890 ) 11,701 — Harpeth Village Fieldstone 2,284 9,443 807 2,284 10,250 12,534 (6,472 ) 6,062 — 129 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Hasley Canyon Village 17,630 8,231 16 17,630 8,247 25,877 (540 ) 25,337 (16,000 ) Heritage Plaza 12,390 26,097 14,665 12,215 40,937 53,152 (21,674 ) 31,478 — Hershey 7 808 11 7 819 826 (567 ) 259 — Hewlett Crossing I & II 11,850 18,205 821 11,850 19,026 30,876 (3,166 ) 27,710 (8,879 ) Hibernia Pavilion 4,929 5,065 239 4,929 5,304 10,233 (4,242 ) 5,991 — Hillcrest Village 1,600 1,909 51 1,600 1,960 3,560 (1,196 ) 2,364 — 130 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) 131 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Initial Cost Total Cost Net Cost Shopping Centers (1) Land & LandImprovements Building &Improvements CostCapitalizedSubsequent toAcquisition (2) Land & LandImprovements Building &Improvements Total AccumulatedDepreciation Net ofAccumulatedDepreciation Mortgages Hilltop Village 2,995 4,581 4,354 3,104 8,826 11,930 (4,705 ) 7,225 — Hinsdale Lake Commons (fka Hinsdale) 5,734 16,709 11,805 8,343 25,905 34,248 (17,075 ) 17,173 — Holly Park 8,975 23,799 2,274 8,828 26,220 35,048 (8,282 ) 26,766 — Howell Mill Village 5,157 14,279 7,444 9,610 17,270 26,880 (8,580 ) 18,300 — Hyde Park 9,809 39,905 7,299 9,809 47,204 57,013 (30,450 ) 26,563 — Indian Springs Center 24,974 25,903 1,143 25,050 26,970 52,020 (8,011 ) 44,009 — Indigo Square 8,087 9,849 (4 ) 8,087 9,845 17,932 (2,336 ) 15,596 — Inglewood Plaza 1,300 2,159 946 1,300 3,105 4,405 (1,928 ) 2,477 — Island Village 12,354 23,660 171 12,361 23,824 36,185 (724 ) 35,461 — Keller Town Center 2,294 12,841 816 2,404 13,547 15,951 (7,842 ) 8,109 — Kirkman Shoppes 9,364 26,243 693 9,367 26,933 36,300 (5,742 ) 30,558 — Kirkwood Commons 6,772 16,224 1,384 6,802 17,578 24,380 (6,661 ) 17,719 — Klahanie Shopping Center 14,451 20,089 408 14,451 20,497 34,948 (4,608 ) 30,340 — Kroger New Albany Center 3,844 6,599 1,392 3,844 7,991 11,835 (6,528 ) 5,307 — Lake Mary Centre 24,036 57,476 2,507 24,036 59,983 84,019 (14,241 ) 69,778 — Lake Pine Plaza 2,008 7,632 1,137 2,029 8,748 10,777 (5,546 ) 5,231 — Lebanon/Legacy Center 3,913 7,874 1,179 3,913 9,053 12,966 (6,923 ) 6,043 — Littleton Square 2,030 8,859 (3,527 ) 2,433 4,929 7,362 (3,197 ) 4,165 — Lloyd King Center 1,779 10,060 1,651 1,779 11,711 13,490 (7,454 ) 6,036 — Lower Nazareth Commons 15,992 12,964 4,099 16,343 16,712 33,055 (13,077 ) 19,978 — Mandarin Landing 7,913 27,230 671 7,913 27,901 35,814 (7,095 ) 28,719 — Market at Colonnade Center 6,455 9,839 184 6,160 10,318 16,478 (5,678 ) 10,800 — Market at Preston Forest 4,400 11,445 1,867 4,400 13,312 17,712 (8,446 ) 9,266 — Market at Round Rock 2,000 9,676 8,650 1,996 18,330 20,326 (11,494 ) 8,832 — Market at Springwoods Village 12,592 12,781 76 12,592 12,857 25,449 (4,302 ) 21,147 (4,250 ) Marketplace at Briargate 1,706 4,885 347 1,727 5,211 6,938 (3,406 ) 3,532 — Mellody Farm 35,628 66,847 (458 ) 35,628 66,389 102,017 (14,087 ) 87,930 — Melrose Market 4,451 10,807 (74 ) 4,451 10,733 15,184 (1,818 ) 13,366 — Millhopper Shopping Center 1,073 5,358 5,920 1,901 10,450 12,351 (8,007 ) 4,344 — 132 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Mockingbird Commons 3,000 10,728 3,026 3,000 13,754 16,754 (8,214 ) 8,540 — Monument Jackson Creek 2,999 6,765 1,321 2,999 8,086 11,085 (6,426 ) 4,659 — Morningside Plaza 4,300 13,951 969 4,300 14,920 19,220 (9,276 ) 9,944 — Murrayhill Marketplace 2,670 18,401 14,396 2,903 32,564 35,467 (18,563 ) 16,904 — Naples Walk 18,173 13,554 2,264 18,173 15,818 33,991 (8,109 ) 25,882 — Newberry Square 2,412 10,150 1,338 2,412 11,488 13,900 (9,815 ) 4,085 — Newland Center 12,500 10,697 8,721 16,276 15,642 31,918 (11,114 ) 20,804 — Nocatee Town Center 10,124 8,691 8,629 11,045 16,399 27,444 (9,765 ) 17,679 — North Hills 4,900 19,774 4,342 4,900 24,116 29,016 (14,104 ) 14,912 — Northgate Marketplace 5,668 13,727 (51 ) 4,995 14,349 19,344 (7,629 ) 11,715 — Northgate Marketplace Ph II 12,189 30,171 133 12,189 30,304 42,493 (9,159 ) 33,334 — Northgate Plaza (Maxtown Road) 1,769 6,652 4,973 2,840 10,554 13,394 (6,739 ) 6,655 — 133 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) 134 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Initial Cost Total Cost Net Cost Shopping Centers (1) Land & LandImprovements Building &Improvements CostCapitalizedSubsequent toAcquisition (2) Land & LandImprovements Building &Improvements Total AccumulatedDepreciation Net ofAccumulatedDepreciation Mortgages Northgate Square 5,011 8,692 1,126 5,011 9,818 14,829 (5,269 ) 9,560 — Northlake Village 2,662 11,284 5,433 2,662 16,717 19,379 (6,970 ) 12,409 — Oakshade Town Center 6,591 28,966 915 6,591 29,881 36,472 (12,266 ) 24,206 (4,869 ) Oakbrook Plaza 4,000 6,668 6,038 4,766 11,940 16,706 (6,362 ) 10,344 — Oakleaf Commons 3,503 11,671 1,811 3,190 13,795 16,985 (8,550 ) 8,435 — Ocala Corners 1,816 10,515 611 1,816 11,126 12,942 (5,686 ) 7,256 — Old St Augustine Plaza 2,368 11,405 13,513 3,455 23,831 27,286 (11,850 ) 15,436 — Pablo Plaza 11,894 21,407 11,347 14,135 30,513 44,648 (7,846 ) 36,802 — Paces Ferry Plaza 2,812 12,639 20,927 13,803 22,575 36,378 (13,670 ) 22,708 — Panther Creek 14,414 14,748 6,002 15,212 19,952 35,164 (15,633 ) 19,531 — Pavillion 15,626 22,124 1,079 15,626 23,203 38,829 (5,971 ) 32,858 — Peartree Village 5,197 19,746 890 5,197 20,636 25,833 (14,605 ) 11,228 — Persimmon Place 25,975 38,114 623 26,692 38,020 64,712 (15,824 ) 48,888 — Pike Creek 5,153 20,652 7,238 5,850 27,193 33,043 (15,288 ) 17,755 — Pine Island 21,086 28,123 3,778 21,086 31,901 52,987 (8,835 ) 44,152 — Pine Lake Village 6,300 10,991 1,835 6,300 12,826 19,126 (7,989 ) 11,137 — Pine Ridge Square 13,951 23,147 1,129 13,951 24,276 38,227 (5,550 ) 32,677 — Pine Tree Plaza 668 6,220 980 668 7,200 7,868 (4,385 ) 3,483 — Pinecrest Place 4,193 13,275 (189 ) 3,992 13,287 17,279 (2,943 ) 14,336 — Plaza Escuela 24,829 104,395 3,446 24,829 107,841 132,670 (17,147 ) 115,523 — Plaza Hermosa 4,200 10,109 3,610 4,202 13,717 17,919 (8,598 ) 9,321 — Point 50 15,239 11,367 328 14,628 12,306 26,934 (1,468 ) 25,466 — Point Royale Shopping Center 18,201 14,889 6,614 19,386 20,318 39,704 (6,474 ) 33,230 — Post Road Plaza 15,240 5,196 176 15,240 5,372 20,612 (1,204 ) 19,408 — Potrero Center 133,422 116,758 (88,642 ) 85,205 76,333 161,538 (13,169 ) 148,369 — Powell Street Plaza 8,248 30,716 3,728 8,248 34,444 42,692 (18,905 ) 23,787 — Powers Ferry Square 3,687 17,965 10,011 5,758 25,905 31,663 (21,120 ) 10,543 — Powers Ferry Village 1,191 4,672 501 1,191 5,173 6,364 (4,206 ) 2,158 — Prairie City Crossing 4,164 13,032 504 4,164 13,536 17,700 (7,411 ) 10,289 — Preston Oaks 763 30,438 (899 ) 1,505 28,797 30,302 (4,255 ) 26,047 — Prestonbrook 7,069 8,622 1,181 7,069 9,803 16,872 (7,867 ) 9,005 — Prosperity Centre 11,682 26,215 765 11,681 26,981 38,662 (5,582 ) 33,080 — Ralphs Circle Center 20,939 6,317 147 20,939 6,464 27,403 (1,784 ) 25,619 — Red Bank Village 10,336 9,500 1,192 9,755 11,273 21,028 (4,539 ) 16,489 — Regency Commons 3,917 3,616 347 3,917 3,963 7,880 (2,947 ) 4,933 — Regency Square 4,770 25,191 6,581 5,060 31,482 36,542 (26,489 ) 10,053 — Rivertowns Square 15,505 52,505 3,201 16,853 54,358 71,211 (8,303 ) 62,908 — 135 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Rona Plaza 1,500 4,917 331 1,500 5,248 6,748 (3,501 ) 3,247 — Roosevelt Square 40,371 32,108 7,523 40,382 39,620 80,002 (5,539 ) 74,463 — Russell Ridge 2,234 6,903 1,503 2,234 8,406 10,640 (6,019 ) 4,621 — Ryanwood Square 10,581 10,044 332 10,581 10,376 20,957 (3,013 ) 17,944 — 136 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) 137 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Initial Cost Total Cost Net Cost Shopping Centers (1) Land & LandImprovements Building &Improvements CostCapitalizedSubsequent toAcquisition (2) Land & LandImprovements Building &Improvements Total AccumulatedDepreciation Net ofAccumulatedDepreciation Mortgages Sammamish-Highlands 9,300 8,075 8,756 9,592 16,539 26,131 (11,463 ) 14,668 — San Carlos Marketplace 36,006 57,886 416 36,006 58,302 94,308 (10,008 ) 84,300 — San Leandro Plaza 1,300 8,226 975 1,300 9,201 10,501 (5,666 ) 4,835 — Sandy Springs 6,889 28,056 4,352 6,889 32,408 39,297 (11,213 ) 28,084 — Sawgrass Promenade 10,846 12,525 666 10,846 13,191 24,037 (3,334 ) 20,703 — Scripps Ranch Marketplace 59,949 26,334 881 59,949 27,215 87,164 (5,065 ) 82,099 — Serramonte Center 390,106 172,652 91,745 416,378 238,125 654,503 (64,161 ) 590,342 — Shaw's at Plymouth 3,968 8,367 — 3,968 8,367 12,335 (2,118 ) 10,217 — Sheridan Plaza 82,260 97,273 15,030 83,483 111,080 194,563 (21,348 ) 173,215 — Sherwood Crossroads 2,731 6,360 969 2,454 7,606 10,060 (4,218 ) 5,842 — Shiloh Springs 5,236 11,802 340 5,236 12,142 17,378 (857 ) 16,521 — Shoppes @ 104 11,193 — 2,784 7,078 6,899 13,977 (3,783 ) 10,194 — Shoppes at Homestead 5,420 9,450 2,250 5,420 11,700 17,120 (7,406 ) 9,714 — Shoppes at Lago Mar 8,323 11,347 205 8,323 11,552 19,875 (2,952 ) 16,923 — Shoppes at Sunlake Centre 16,643 15,091 3,049 17,247 17,536 34,783 (4,826 ) 29,957 — Shoppes of Grande Oak 5,091 5,985 714 5,091 6,699 11,790 (5,849 ) 5,941 — Shoppes of Jonathan's Landing 4,474 5,628 452 4,474 6,080 10,554 (1,464 ) 9,090 — Shoppes of Oakbrook 20,538 42,992 336 20,538 43,328 63,866 (8,722 ) 55,144 (410 ) Shoppes of Silver Lakes 17,529 21,829 1,203 17,529 23,032 40,561 (5,645 ) 34,916 — Shoppes of Sunset 2,860 1,316 595 2,860 1,911 4,771 (375 ) 4,396 — Shoppes of Sunset II 2,834 715 556 2,834 1,271 4,105 (296 ) 3,809 — Shops at County Center 9,957 11,296 2,057 9,973 13,337 23,310 (11,645 ) 11,665 — Shops at Erwin Mill 9,082 6,124 540 9,087 6,659 15,746 (3,940 ) 11,806 (10,000 ) Shops at John's Creek 1,863 2,014 (84 ) 1,501 2,292 3,793 (1,617 ) 2,176 — Shops at Mira Vista 11,691 9,026 299 11,691 9,325 21,016 (3,171 ) 17,845 (179 ) Shops at Quail Creek 1,487 7,717 1,351 1,448 9,107 10,555 (4,799 ) 5,756 — Shops at Saugus 19,201 17,984 375 18,811 18,749 37,560 (13,100 ) 24,460 — Shops at Skylake 84,586 39,342 2,221 85,117 41,032 126,149 (10,755 ) 115,394 — 138 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Shops at The Columbia 3,117 8,869 — 3,117 8,869 11,986 (293 ) 11,693 — Shops on Main 17,020 27,055 16,180 18,534 41,721 60,255 (16,276 ) 43,979 — Sope Creek Crossing 2,985 12,001 3,477 3,332 15,131 18,463 (10,243 ) 8,220 — South Beach Regional 28,188 53,405 1,296 28,188 54,701 82,889 (12,254 ) 70,635 — South Point 6,563 7,939 368 6,563 8,307 14,870 (2,063 ) 12,807 — Southbury Green 26,661 34,325 6,603 29,743 37,846 67,589 (8,206 ) 59,383 — Southcenter 1,300 12,750 2,300 1,300 15,050 16,350 (9,452 ) 6,898 — Southpark at Cinco Ranch 18,395 11,306 7,482 21,438 15,745 37,183 (9,122 ) 28,061 — SouthPoint Crossing 4,412 12,235 1,416 4,382 13,681 18,063 (8,443 ) 9,620 — Starke 71 1,683 12 71 1,695 1,766 (943 ) 823 — Star's at Cambridge 31,082 13,520 (1 ) 31,082 13,519 44,601 (2,925 ) 41,676 — Star's at Quincy 27,003 9,425 1 27,003 9,426 36,429 (2,638 ) 33,791 — Star's at West Roxbury 21,973 13,386 76 21,973 13,462 35,435 (2,884 ) 32,551 — 139 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) 140 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Initial Cost Total Cost Net Cost Shopping Centers (1) Land & LandImprovements Building &Improvements CostCapitalizedSubsequent toAcquisition (2) Land & LandImprovements Building &Improvements Total AccumulatedDepreciation Net ofAccumulatedDepreciation Mortgages Sterling Ridge 12,846 12,162 1,546 12,846 13,708 26,554 (11,002 ) 15,552 — Stroh Ranch 4,280 8,189 1,108 4,280 9,297 13,577 (7,277 ) 6,300 — Suncoast Crossing 9,030 10,764 4,533 13,374 10,953 24,327 (9,079 ) 15,248 — Talega Village Center 22,415 12,054 80 22,415 12,134 34,549 (2,539 ) 32,010 — Tamarac Town Square 12,584 9,221 1,407 12,584 10,628 23,212 (2,738 ) 20,474 — Tanasbourne Market 3,269 10,861 (294 ) 3,149 10,687 13,836 (6,776 ) 7,060 — Tassajara Crossing 8,560 15,464 2,416 8,560 17,880 26,440 (10,680 ) 15,760 — Tech Ridge Center 12,945 37,169 4,099 13,589 40,624 54,213 (18,146 ) 36,067 (715 ) The Abbot 72,910 6,086 47,165 79,187 46,974 126,161 (867 ) 125,294 — The Crossing Clarendon 154,932 126,328 34,127 157,814 157,573 315,387 (26,426 ) 288,961 — The Field at Commonwealth 30,955 18,242 5 30,956 18,246 49,202 (7,338 ) 41,864 — The Gallery at Westbury Plaza 108,653 216,771 3,903 108,653 220,674 329,327 (41,384 ) 287,943 — The Hub Hillcrest Market 18,773 61,906 6,531 19,611 67,599 87,210 (20,874 ) 66,336 — The Marketplace 10,927 36,052 957 10,927 37,009 47,936 (7,104 ) 40,832 — The Plaza at St. Lucie West 1,718 6,204 26 1,718 6,230 7,948 (1,303 ) 6,645 — The Point at Garden City Park 741 9,764 5,871 2,559 13,817 16,376 (4,474 ) 11,902 — The Pruneyard 112,136 86,918 2,162 112,136 89,080 201,216 (11,275 ) 189,941 (2,200 ) The Shops at Hampton Oaks 843 372 120 737 598 1,335 (183 ) 1,152 — The Village at Hunter's Lake 9,735 12,923 16 9,735 12,939 22,674 (2,079 ) 20,595 — The Village at Riverstone 17,179 13,013 (73 ) 17,179 12,940 30,119 (3,118 ) 27,001 — Town and Country 4,664 5,207 22 4,664 5,229 9,893 (1,836 ) 8,057 — Town Square 883 8,132 270 883 8,402 9,285 (5,386 ) 3,899 — Treasure Coast Plaza 7,553 21,554 1,127 7,553 22,681 30,234 (5,120 ) 25,114 (1,166 ) Tustin Legacy 13,829 23,922 (3 ) 13,828 23,920 37,748 (6,190 ) 31,558 — Twin City Plaza 17,245 44,225 2,612 17,263 46,819 64,082 (21,174 ) 42,908 — Twin Peaks 5,200 25,827 9,483 6,557 33,953 40,510 (17,764 ) 22,746 — Unigold Shopping Center 5,490 5,144 6,637 5,561 11,710 17,271 (4,807 ) 12,464 — University Commons 4,070 30,785 588 4,070 31,373 35,443 (9,142 ) 26,301 — 141 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Valencia Crossroads 17,921 17,659 1,178 17,921 18,837 36,758 (17,231 ) 19,527 — Valley Stream 13,297 16,241 573 13,887 16,224 30,111 (713 ) 29,398 — Village at La Floresta 13,140 20,559 (303 ) 13,156 20,240 33,396 (7,629 ) 25,767 — Village at Lee Airpark 11,099 12,975 3,532 11,803 15,803 27,606 (13,669 ) 13,937 — Village Center 3,885 14,131 9,610 5,480 22,146 27,626 (12,613 ) 15,013 — Von's Circle Center 49,037 22,618 895 49,037 23,513 72,550 (5,236 ) 67,314 (5,031 ) Wading River 14,969 18,641 (260 ) 14,915 18,435 33,350 (718 ) 32,632 — Walker Center 3,840 7,232 4,039 3,878 11,233 15,111 (8,273 ) 6,838 — Walmart Norwalk 20,394 21,261 9 20,394 21,270 41,664 (5,443 ) 36,221 — Waterstone Plaza 5,498 13,500 62 5,498 13,562 19,060 (3,040 ) 16,020 — Welleby Plaza 1,496 7,787 2,140 1,496 9,927 11,423 (8,702 ) 2,721 — Wellington Town Square 2,041 12,131 2,707 2,600 14,279 16,879 (7,451 ) 9,428 — West Bird Plaza 12,934 18,594 331 15,386 16,473 31,859 (2,950 ) 28,909 — 142 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P.Schedule III - Consolidated Real Estate and Accumulated DepreciationDecember 31, 2022(in thousands) Initial Cost Total Cost Net Cost Shopping Centers (1) Land & LandImprovements Building &Improvements CostCapitalizedSubsequent toAcquisition (2) Land & LandImprovements Building &Improvements Total AccumulatedDepreciation Net ofAccumulatedDepreciation Mortgages West Chester Plaza 1,857 7,572 678 1,857 8,250 10,107 (6,706 ) 3,401 — West Lake Shopping Center 10,561 9,792 239 10,561 10,031 20,592 (2,773 ) 17,819 — West Park Plaza 5,840 5,759 2,892 5,840 8,651 14,491 (5,236 ) 9,255 — Westbard Square 127,859 21,514 (18,733 ) 117,732 12,908 130,640 (11,941 ) 118,699 — Westbury Plaza 116,129 51,460 6,005 117,559 56,035 173,594 (12,517 ) 161,077 (88,000 ) Westchase 5,302 8,273 1,127 5,302 9,400 14,702 (4,675 ) 10,027 — Westchester Commons 3,366 11,751 11,062 4,894 21,285 26,179 (10,450 ) 15,729 — Westlake Village Plaza and Center 7,043 27,195 30,533 17,620 47,151 64,771 (33,500 ) 31,271 — Westport Plaza 9,035 7,455 (40 ) 9,035 7,415 16,450 (1,947 ) 14,503 (1,457 ) Westport Row 43,597 16,428 6,349 45,260 21,114 66,374 (5,505 ) 60,869 — Westwood Village 19,933 25,301 (1,626 ) 18,979 24,629 43,608 (17,551 ) 26,057 — Willa Springs 13,322 15,314 177 13,322 15,491 28,813 (809 ) 28,004 (16,700 ) Williamsburg at Dunwoody 7,435 3,721 974 7,444 4,686 12,130 (1,506 ) 10,624 — Willow Festival 1,954 56,501 3,478 1,976 59,957 61,933 (21,751 ) 40,182 — Willow Oaks 6,664 7,908 (343 ) 6,294 7,935 14,229 (3,518 ) 10,711 — Willows Shopping Center 51,964 78,029 2,358 51,992 80,359 132,351 (15,214 ) 117,137 — Woodcroft Shopping Center 1,419 6,284 1,617 1,421 7,899 9,320 (5,547 ) 3,773 — Woodman Van Nuys 5,500 7,195 383 5,500 7,578 13,078 (4,628 ) 8,450 — Woodmen Plaza 7,621 11,018 1,330 7,621 12,348 19,969 (12,043 ) 7,926 — Woodside Central 3,500 9,288 691 3,489 9,990 13,479 (6,203 ) 7,276 — Corporate Assets — — 1,325 — 1,325 1,325 (1,325 ) — — Land held for future development 11,349 — (4,615 ) 6,734 — 6,734 — 6,734 — Construction in progress — — 133,433 — 133,433 133,433 — 133,433 — $ 5,041,114 5,911,477 905,473 5,087,104 6,770,960 11,858,064 (2,415,860 ) 9,442,204 (473,849 ) (1)See "Item 2 - Properties" of this Report, for geographic location and year each operating property was acquired.(2)The negative balance for costs capitalized subsequent to acquisition could include out-parcels sold, provision for loss recorded, and demolition of part of the property for redevelopment.See accompanying report of independent registered public accounting firm. 143 REGENCY CENTERS CORPORATION AND REGENCY CENTERS, L.P. Schedule III - Consolidated Real Estate and Accumulated Depreciation December 31, 2022 (in thousands) Depreciation and amortization of the Company's investment in buildings and improvements reflected in the statements of operations is calculated over the estimated useful lives of the assets, which are up to 40 years. The aggregate cost for federal income tax purposes was approximately $9.7 billion at December 31, 2022.The changes in total real estate assets for the years ended December 31, 2022, 2021, and 2020 are as follows: (in thousands) 2022 2021 2020 Beginning balance $ 11,495,581 11,101,858 11,095,294 Acquired properties and land 224,653 479,708 39,087 Developments and improvements 171,629 172,012 154,657 Disposal of building and tenant improvements (29,523 ) (10,898 ) (35,034 ) Sale of properties (4,276 ) (107,090 ) (95,780 ) Properties held for sale — (50,873 ) (38,122 ) Provision for impairment — (89,136 ) (18,244 ) Ending balance $ 11,858,064 11,495,581 11,101,858 The changes in accumulated depreciation for the years ended December 31, 2022, 2021, and 2020 are as follows: (in thousands) 2022 2021 2020 Beginning balance $ 2,174,963 1,994,108 1,766,162 Depreciation expense 270,520 253,437 278,861 Disposal of building and tenant improvements (29,523 ) (10,898 ) (35,034 ) Sale of properties (100 ) (28,715 ) (10,812 ) Accumulated depreciation related to properties held for sale — (28,110 ) (4,357 ) Provision for impairment — (4,859 ) (712 ) Ending balance $ 2,415,860 2,174,963 1,994,108 See accompanying report of independent registered public accounting firm. 144 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Item 9A. Controls and Procedures Controls and Procedures (Regency Centers Corporation) Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures Under the supervision and with the participation of the Parent Company's management, including its chief executive officer and chief financial officer, the Parent Company conducted an evaluation of its disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e) promulgated under the Exchange Act. Based on this evaluation, the Parent Company's chief executive officer and chief financial officer concluded that as of December 31, 2022, the Parent Company's disclosure controls and procedures were effective to ensure information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time period specified in the SEC's rules and forms. These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by the Parent Company in the reports it files or submits is accumulated and communicated to management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Management's Report on Internal Control over Financial Reporting The Parent Company's management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of its management, including its chief executive officer and chief financial officer, the Parent Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation under the framework in Internal Control - Integrated Framework (2013), the Parent Company's management concluded that its internal control over financial reporting was effective as of December 31, 2022. KPMG LLP, an independent registered public accounting firm, has audited the Consolidated Financial Statements included in this Report and, as part of their audit, has issued a report, included within "
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+Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations - Revenues" for a complete listing of net product sales recorded by the Company. Not included in this line item are net product sales of ARCALYST subsequent to the first quarter of 2021, which are recorded by Kiniksa.Programs in Clinical DevelopmentProduct candidates in clinical development, which are being developed by us and/or our collaborators, are summarized in the table below. There are numerous uncertainties associated with drug development, including uncertainties related to safety and efficacy data from each phase of drug development (including any post-approval studies), uncertainties related to the enrollment and performance of clinical trials, changes in regulatory requirements, changes to drug pricing and reimbursement regulations and requirements, and changes in the competitive landscape affecting a product candidate. The planning, execution, and results of our clinical programs are significant factors that can affect our operating and financial results.Refer to Part I, Item 1A. "Risk Factors" for a description of risks and uncertainties that may affect our clinical programs. Any of such risks and uncertainties may, among other matters, negatively impact the development timelines set forth in the table below.5Table of ContentsClinical ProgramPhase 1Phase 2Phase 3Regulatory Review(h)2022 and 2023 Events to DateSelect Upcoming MilestonesOphthalmologyEYLEA (aflibercept)(a)–ROP(c)–ROP (U.S.)–Granted pediatric exclusivity by U.S. Food and Drug Administration ("FDA") in connection with ROP study, extending period of EYLEA U.S. market exclusivity by six months through May 17, 2024–Approved by European Commission ("EC") for ROP–Approved by Ministry of Health, Labour and Welfare ("MHLW") for ROP in Japan–Withdrew supplemental Biologics License Application ("sBLA") for every-16-weeks dosing regimen in patients with DR–FDA decision on sBLA for ROP (target action date of February 11, 2023)Aflibercept 8 mg(a)–Wet AMD–DME–Wet AMD and DME (U.S.)–Reported that Phase 3 trials in wet AMD and DME met their primary endpoints–FDA decision on BLA for wet AMD and DME (third quarter 2023) –Submit regulatory application in the EU for wet AMD and DME (first quarter 2023)–Report two-year data from Phase 3 studies in wet AMD and DME (third quarter 2023)6Table of ContentsClinical Program (continued)Phase 1Phase 2Phase 3Regulatory Review(h)2022 and 2023 Events to DateSelect Upcoming MilestonesImmunology & InflammationDupixent (dupilumab)(b)Antibody to IL-4R alpha subunit–EoE in pediatrics(c)–Chronic obstructive pulmonary disease ("COPD")–Bullous pemphigoid (Phase 2/3)(c)–Chronic spontaneous urticaria ("CSU")–Chronic inducible urticaria - cold–Chronic rhinosinusitis without nasal polyposis –Allergic fungal rhinosinusitis–Chronic pruritus of unknown origin –Atopic dermatitis in pediatrics (6 months–5 years of age) (EU) and in pediatrics and adolescents (6 months–14 years of age (Japan)–Prurigo nodularis (Japan)–CSU in adults and adolescents (U.S.)–Approved by FDA for atopic dermatitis in pediatrics (6 months–5 years of age)–European Medicines Agency's ("EMA") Committee for Medicinal Products for Human Use ("CHMP") adopted positive opinion for atopic dermatitis in pediatrics (6 months–5 years of age)–Approved by EC for severe asthma in pediatrics (6–11 years of age)–Approved by FDA and EC for EoE in adults and adolescents–Reported that Phase 3 trial in EoE in pediatrics (1–11 years of age) met its primary endpoint–Approved by FDA and EC for prurigo nodularis–Stopped one of the Phase 3 trials in CSU (in patients refractory to omalizumab) due to futility, based on pre-specified interim analysis–Initiated additional Phase 3 trial in CSU (in biologic-naïve patients)–Discontinued further clinical development in peanut allergy–EC decision on regulatory submission for atopic dermatitis in pediatrics (6 months–5 years of age) (first half 2023)–MHLW decision on regulatory submission for atopic dermatitis in pediatrics and adolescents (6 months–14 years of age) in Japan (second half 2023)–Submit sBLA for EoE in pediatrics (mid-2023)–Report results from first Phase 3 study in COPD (first half 2023)–FDA decision on sBLA for CSU in adults and adolescents (second half 2023)–Report results from Phase 3 study in chronic inducible urticaria - cold (first half 2023)7Table of ContentsClinical Program (continued)Phase 1Phase 2Phase 3Regulatory Review(h)2022 and 2023 Events to DateSelect Upcoming MilestonesKevzara (sarilumab)(b)Antibody to IL-6R–Polyarticular-course juvenile idiopathic arthritis ("pcJIA")–Systemic juvenile idiopathic arthritis ("sJIA")–Polymyalgia rheumatica ("PMR") (U.S.)–FDA decision on sBLA for PMR (target action date of February 28, 2023)Itepekimab(b) (REGN3500)Antibody to IL-33–COPD–Report results from Phase 3 study in COPD (2024)REGN5713-5714-5715Multi-antibody therapy to Bet v 1–Birch allergySolid Organ OncologyLibtayo (cemiplimab)(n)(g)Antibody to PD-1–Neoadjuvant CSCC–Second-line cervical cancer, ISA101b combination–Adjuvant CSCC–First-line NSCLC, chemotherapy combination (EU)–Approved by FDA in combination with chemotherapy for NSCLC–Approved by EC and MHLW for cervical cancer–Voluntarily withdrew sBLA for cervical cancer due to inability to align with FDA on certain post-marketing studies–Positive data from Phase 2 trial in neoadjuvant CSCC presented at European Society for Medical Oncology ("ESMO") Congress 2022 and published in New England Journal of Medicine–EC decision on regulatory submission for NSCLC, chemotherapy combination (first half 2023)Fianlimab(f) (REGN3767)Antibody to LAG-3 –Solid tumors and advanced hematologic malignancies–First-line metastatic melanoma–First-line adjuvant melanoma–Presented positive data from Phase 1 trial (in combination with Libtayo) in advanced melanoma at ESMO Congress 2022–Initiate Phase 3 study (in combination with Libtayo) in perioperative melanoma (mid-2023) 8Table of ContentsClinical Program (continued)Phase 1Phase 2Phase 3Regulatory Review(h)2022 and 2023 Events to DateSelect Upcoming MilestonesFianlimab(f)(continued)–Positive initial data from Phase 1 trial (in combination with Libtayo) in NSCLC presented at ESMO Immuno-Oncology Congress 2022–Initiate Phase 2/3 studies (in combination with Libtayo) in first-line advanced NSCLC (first half 2023) –Initiate Phase 2 study (in combination with Libtayo) in perioperative NSCLC (second half 2023) VidutolimodImmune activator targeting TLR9–Solid tumors–Initiate Phase 2 study in melanoma Ubamatamab(f)(REGN4018)Bispecific antibody targeting MUC16 and CD3–Platinum-resistant ovarian cancer–Presented positive initial data from monotherapy dose escalation portion of Phase 1/2 study in platinum-resistant ovarian cancer at ESMO Congress 2022–Report results from Phase 1/2 study (in combination with Libtayo) in platinum-resistant ovarian cancer (2023)REGN5668(o)Bispecific antibody targeting MUC16 and CD28–Platinum-resistant ovarian cancerREGN5678Bispecific antibody targeting PSMA and CD28–Prostate cancer–Reported preliminary data from dose escalation portion of Phase 1/2 study (in combination with Libtayo) in prostate cancer–Report additional results from Phase 1/2 study (in combination with Libtayo) in prostate cancer (2023)REGN4336Bispecific antibody targeting PSMA and CD3–Prostate cancerREGN5093Bispecific antibody targeting two distinct MET epitopes–MET-altered advanced NSCLC–Presented positive initial data from dose escalation portion of Phase 1/2 study in MET-altered advanced NSCLC at ESMO Congress 2022REGN5093-M114Bispecific antibody-drug conjugate targeting two distinct MET epitopes–MET overexpressing advanced cancerREGN6569Antibody to GITR–Solid tumors9Table of ContentsClinical Program (continued)Phase 1Phase 2Phase 3Regulatory Review(h)2022 and 2023 Events to DateSelect Upcoming MilestonesREGN7075Bispecific antibody targeting EGFR and CD28–Solid tumorsHematologyOdronextamab(i) (REGN1979)Bispecific antibody targeting CD20 and CD3–Certain B-cell malignancies(c)(m)–B-cell non-Hodgkin lymphoma ("B-NHL")(m) (pivotal study)–Presented positive data from two cohorts of pivotal Phase 2 study in patients with diffuse large B-cell lymphoma ("DLBCL") and follicular lymphoma ("FL") at American Society of Hematology ("ASH") Annual Meeting–Initiate Phase 3 studies in FL and DLBCL, including earlier lines of therapy (first half 2023)–Submit BLA for relapsed/refractory FL and DLBCL (second half 2023)Linvoseltamab(f)(REGN5458)Bispecific antibody targeting BCMA and CD3–Multiple myeloma(c)–Multiple myeloma (pivotal study)(c)–Completed enrollment in pivotal Phase 2 study in multiple myeloma–Presented positive data from pivotal Phase 2 study in multiple myeloma at ASH Annual Meeting–Initiate Phase 3 study in multiple myeloma, including earlier lines of therapy (first half 2023) –Submit BLA for relapsed/refractory multiple myeloma (second half 2023)REGN5459(f)Bispecific antibody targeting BCMA and CD3–Transplant desensitization in patients with chronic kidney diseasePozelimab(f) (REGN3918)Antibody to C5; studied as monotherapy and in combination with cemdisiran–CD55-deficient protein-losing enteropathy ("CHAPLE"), monotherapy(c)(e) (potentially pivotal study)–Myasthenia gravis, cemdisiran combination(k) –Paroxysmal nocturnal hemoglobinuria ("PNH"), cemdisiran combination(c)(k)–CHAPLE, monotherapy (U.S.)–FDA decision on BLA for CHAPLE, monotherapy (second half 2023)REGN7257Antibody to IL2Rg–Aplastic anemiaNTLA-2001(j)TTR gene knockout using CRISPR/Cas9–Transthyretin ("ATTR") amyloidosis(c)–Reported positive interim data from Phase 1 trial in ATTRREGN9933Antibody to Factor XI–Thrombosis10Table of ContentsClinical Program (continued)Phase 1Phase 2Phase 3Regulatory Review(h)2022 and 2023 Events to DateSelect Upcoming MilestonesREGN7508Antibody to Factor XI–ThrombosisREGN7999Antibody to TMPRSS6–Transfusion dependent iron overloadGeneral Medicine"Next Generation" Covid AntibodiesAntibodies to SARS-CoV-2 variants–Initiate clinical development of "next generation" antibodyPraluent (alirocumab)Antibody to PCSK9–HeFH in pediatrics–Submit sBLA for HeFH in pediatrics (mid-2023)Evkeeza (evinacumab)(f)(l)Antibody to ANGPTL3–HoFH in pediatrics (5–11 years of age) (U.S.)–Reported that Phase 3 trial for HoFH in pediatrics (5–11 years of age) met its primary endpoint–FDA decision on sBLA for HoFH in pediatrics (5–11 years of age) (target action date of March 30, 2023)Garetosmab(f) (REGN2477)Antibody to Activin A–Fibrodysplasia ossificans progressiva ("FOP")(c)(d)(e)Mibavademab(f)(REGN4461)Agonist antibody to leptin receptor ("LEPR")–Generalized lipodystrophy(e)–Partial lipodystrophyREGN5381/REGN9035Agonist antibody to NPR1/reversal agent to REGN5381–Reversal agent in healthy volunteers–Heart failure–Report initial data in healthy volunteers (2023)ALN-HSD(p)RNAi therapeutic targeting HSD17B13–Nonalcoholic steatohepatitis("NASH")–Reported preliminary data from Phase 1 study in NASH–Initiate Phase 2 study in NASH (first quarter 2023)ALN-PNP(k)RNAi therapeutic targeting PNPLA3–NASHALN-APP(k)RNAi therapeutic targeting APP–Early-onset Alzheimer’s disease–Report results from Phase 1 study in early-onset Alzheimer’s disease (mid-2023)11Table of ContentsNote 1: For purposes of the table above, a program is classified in Phase 1, 2, or 3 clinical development after recruitment for the corresponding study or studies has commenced.Note 2: We have discontinued further clinical development of fasinumab (REGN475), an antibody to NGF, which was previously being studied in osteoarthritis pain of the knee or hip in collaboration with Teva and Mitsubishi Tanabe Pharma Corporation ("MTPC"); REGN6490, an antibody to IL-36R, which was previously being studied in palmo-plantar pustulosis; and the Phase 3 study of REGN1908-1909, a multi-antibody therapy to Fel d 1, in cat allergy, due to futility.(a) In collaboration with Bayer outside the United States(b) In collaboration with Sanofi(c) FDA granted orphan drug designation(d) FDA granted Breakthrough Therapy designation(e) FDA granted Fast Track designation(f) Sanofi did not opt-in to or elected not to continue to co-develop the product candidate. Under the terms of our agreement, Sanofi is entitled to receive royalties on sales of the product, if any.(g) Studied as monotherapy and in combination with other antibodies and treatments(h) Information in this column relates to U.S., EU, and Japan regulatory submissions only(i) In collaboration with Zai Lab in mainland China, Hong Kong, Taiwan, and Macau(j) In collaboration with Intellia(k) In collaboration with Alnylam(l) In collaboration with Ultragenyx outside the United States(m) FDA granted Fast Track designation for follicular lymphoma and diffuse large B-cell lymphoma(n) In collaboration with Sanofi prior to July 2022. Effective July 2022, the Company is solely responsible for the research, development, and commercialization of Libtayo. Refer to "Collaboration, License, and Other Agreements" section below for further details.(o) Studied in combination with ubamatamab(p) Alnylam elected to opt-out of the product candidate. Under the terms of our agreement, Alnylam is entitled to receive royalties on sales of the product, if any.12Table of ContentsAdditional Information - Clinical Development ProgramsAflibercept 8 mgIn September 2022, the Company announced that the primary endpoints were met in two pivotal trials investigating aflibercept 8 mg with 12- and 16-week dosing regimens in patients with DME and wet AMD. The PHOTON trial in DME and the PULSAR trial in wet AMD both demonstrated that aflibercept 8 mg 12- and 16-week dosing regimens achieved non-inferiority in vision gains compared to the EYLEA 8-week dosing regimen. Furthermore, of the patients randomized to 12- and 16-week dosing intervals, 91% and 89% of DME patients, respectively, and 79% and 77% of wet AMD patients, respectively, maintained those intervals through 48 weeks. The safety of aflibercept 8 mg was similar to EYLEA in both trials, and consistent with the known safety profile of EYLEA from previous clinical trials. The Company is utilizing a priority review voucher in connection with the December 2022 submission of the BLA for DME and wet AMD.REGEN-COV (casirivimab and imdevimab)REGEN-COV, a multi-antibody therapy to SARS-CoV-2 virus, previously received an EUA for use in certain post-exposure prophylaxis settings and as a treatment for people with mild to moderate COVID-19 who are at high risk of serious consequences from COVID-19. Based on laboratory data, in January 2022, the FDA revised the EUA for REGEN-COV to exclude its use in geographic regions where, based on available information including variant susceptibility and regional variant frequency, infection or exposure is likely due to a variant such as an Omicron-lineage variant that is not susceptible to the treatment. With this EUA revision, REGEN-COV is not currently authorized for use in any U.S. states, territories, or jurisdictions, since Omicron-lineage variants are currently dominant across the United States. In December 2022, the FDA issued a complete response letter ("CRL") on the BLA for REGEN-COV to treat COVID-19 in non-hospitalized patients and as prophylaxis in certain individuals. Descriptions of Marketed Products Studied in Additional Indications and Product Candidates in Late-Stage Clinical Development EYLEA (aflibercept)EYLEA is a soluble fusion protein that acts as a vascular endothelial growth factor ("VEGF") inhibitor, formulated as a 2 mg intravitreal injection for the eye. It is designed to block the growth of new blood vessels and decrease the ability of fluid to pass through blood vessels (vascular permeability) in the eye by blocking VEGF-A and PLGF, two growth factors involved in angiogenesis.Aflibercept 8 mgAflibercept 8 mg is an investigational soluble fusion protein that acts as a VEGF inhibitor. Through a novel formulation, it is designed to deliver a concentrated dose of aflibercept to block VEGF-A and PLGF and inhibit the growth of new blood vessels and decrease vascular permeability. Aflibercept 8 mg is being studied in wet AMD and DME using extended dosing intervals of every 12 weeks and every 16 weeks.Dupixent (dupilumab)Dupixent is a fully human monoclonal antibody that inhibits signaling of the IL-4 and IL-13 pathways, and is not an immunosuppressant. IL-4 and IL-13 are key and central drivers of the type 2 inflammation that plays a major role in atopic dermatitis, asthma, CRSwNP, EoE, prurigo nodularis, and potentially other chronic allergic and inflammatory diseases.Kevzara (sarilumab)Kevzara is a fully human monoclonal antibody that binds specifically to the IL-6 receptor and inhibits IL-6-mediated signaling. IL-6 is a signaling protein produced in increased quantities in patients with RA and has been associated with disease activity, joint destruction, and other systemic problems.ItepekimabItepekimab is an investigational, fully human monoclonal antibody that inhibits IL-33, a protein that is believed to play a key role in lung inflammation in COPD.REGN5713-5714-5715REGN5713-5714-5715 is an investigational combination of three fully human monoclonal antibodies designed to treat allergic inflammatory conditions caused by the allergen Betv1, which is the main allergen responsible for birch pollen allergies. Birch pollen allergy is one of the most common causes of seasonal allergies that occur in the spring, and is also believed to trigger "oral allergy syndrome" food reactions to related allergens found in nuts and fruits such as apples, pears, and cherries.13Table of ContentsLibtayo (cemiplimab)Libtayo is a fully human monoclonal antibody targeting the immune checkpoint receptor PD-1 on T-cells. The PD-1/PD-L1 immune checkpoint pathway is a well-known mechanism by which cancers evade immune destruction. Regeneron is studying Libtayo as monotherapy and in combination with either conventional or novel therapeutic approaches in various solid tumors and blood cancers. It is also being studied in combination with proprietary anti-cancer assets of other companies. FianlimabFianlimab is an investigational, fully human monoclonal antibody targeting the immune checkpoint receptor LAG-3 on T-cells. In melanoma, LAG-3 expression in the tumor microenvironment may be associated with therapeutic resistance to PD-1 inhibitors. Fianlimab is being investigated in combination with Libtayo to determine whether concurrent blockade of LAG-3 and PD-1 can help overcome this resistance and release the brakes on T-cell activation.OdronextamabOdronextamab is an investigational bispecific monoclonal antibody designed to bind to a component of the T-cell receptor ("TCR") complex (CD3), while also binding and bridging T-cells to a protein expressed on B-cells (CD20). We are studying whether odronextamab may help to activate T-cells via their CD3 receptors and trigger targeted, T-cell mediated killing of cancerous cells in several types of B-cell non-Hodgkin lymphoma.LinvoseltamabLinvoseltamab is an investigational bispecific monoclonal antibody designed to bind to CD3 while also binding and bridging T-cells to the BCMA protein on multiple myeloma cells. We are studying whether linvoseltamab may help to activate T-cells via their CD3 receptors and trigger targeted, T-cell mediated killing of multiple myeloma.PozelimabPozelimab is an investigational, fully human monoclonal antibody designed to block complement factor C5 in order to treat diseases mediated by abnormal complement pathway activity, including PNH, CHAPLE, and myasthenia gravis. Pozelimab is being studied as monotherapy and also in combination with Alnylam’s investigational small interfering RNA ("siRNA") therapy, cemdisiran.Praluent (alirocumab)Praluent is a fully human monoclonal antibody that inhibits the binding of PCSK9 to the LDL receptor. Through inhibiting PCSK9, Praluent increases the number of available LDL receptors on the surface of liver cells to clear LDL, which lowers LDL cholesterol levels in the blood. Evkeeza (evinacumab)Evkeeza is a fully human monoclonal antibody that specifically binds to and blocks ANGPTL3. ANGPTL3 plays a key role in regulating plasma lipid levels, including triglycerides, LDL cholesterol, and HDL cholesterol, through inhibition of lipase enzymes (lipoprotein lipase and endothelial lipase).GaretosmabGaretosmab is an investigational, fully-human monoclonal antibody that binds to and neutralizes Activin A, which drives the abnormal bone formation that is the main pathology of the ultra-rare genetic disorder FOP. This abnormal bone formation in soft tissue outside of the normal skeleton, a process known as heterotopic ossification, leads to loss of mobility and premature death in FOP patients. Garetosmab is being investigated to determine whether it can help reduce and/or prevent the formation of heterotopic bone lesions by neutralizing the Activin A protein.Other ProgramsOur preclinical research programs include the areas of oncology/immuno-oncology, angiogenesis, ophthalmology, metabolic and related diseases, muscle diseases and disorders, inflammation and immune diseases, bone and cartilage, pain and neurobiology, auditory conditions, enzyme replacement therapy, cardiovascular diseases, infectious diseases, and diseases related to aging. These preclinical research programs include both rare diseases and those involving broader populations.14Table of ContentsResearch and Development TechnologiesMany proteins that play an important role in biology and disease are secreted by cells or located on the cell surface. Moreover, cells communicate through secreted factors and surface molecules. Our scientists have developed two different technologies to make protein therapeutics that potently and specifically block, activate, or inhibit the action of specific cell surface or secreted molecules. The first technology fuses receptor components to the constant region of an antibody molecule to make a class of drugs we call "Traps". EYLEA, ZALTRAP, and ARCALYST are drugs generated using our Trap technology. VelociSuite® is our second technology platform, which is used for discovering, developing, and producing fully human antibodies that can address both secreted and cell-surface targets.VelociSuite VelociSuite consists of VelocImmune®, VelociGene®, VelociMouse®, VelociMab®, Veloci-Bi®, VelociT®, VelociHum®, and other related technologies. The VelocImmune mouse platform is utilized to produce fully human antibodies. VelocImmune was generated by leveraging our VelociGene technology (see below), in a process in which six megabases of mouse immunoglobulin gene loci were replaced, or "humanized," with corresponding human immunoglobulin gene loci. VelocImmune mice can be used efficiently to generate fully human antibodies to targets of therapeutic interest. VelocImmune and our entire VelociSuite offer the potential to increase the speed and efficiency through which human antibody therapeutics may be discovered and validated, thereby improving the overall efficiency of our early-stage drug development activities. We are utilizing the VelocImmune technology to produce our next generation of therapeutic antibody drug candidates for preclinical and clinical development.Our VelociGene platform allows custom and precise manipulation of very large sequences of DNA to produce highly customized alterations of a specified target gene, or genes, and accelerates the production of knock-out and transgenic expression models. In producing knock-out models, a color or fluorescent marker may be substituted in place of the actual gene sequence, allowing for high-resolution visualization of precisely where the gene is active in the body during normal body functioning as well as in disease processes. For the optimization of preclinical development and pharmacology programs, VelociGene offers the opportunity to humanize targets by replacing the mouse gene with the human homolog or variants thereof. Thus, VelociGene allows scientists to rapidly identify the physical and biological effects of deleting or over-expressing the target gene, as well as to characterize and test potential therapeutic molecules.Our VelociMouse technology platform allows for the direct and immediate generation of genetically altered mice from embryonic stem cells ("ES cells"), thereby avoiding the lengthy process involved in generating and breeding knockout mice from chimeras. Mice generated through this method are normal and healthy and exhibit a 100% germ-line transmission. Furthermore, mice developed using our VelociMouse technology are suitable for direct phenotyping or other studies. We have also developed our VelociMab platform for the rapid screening of antibodies and rapid generation of expression cell lines for our Traps and our VelocImmune human antibodies.We have utilized our VelociSuite technologies to develop a class of potential drug candidates, known as bispecific antibodies. Veloci-Bi allows for the generation of full-length bispecific antibodies similar to native antibodies that are amenable to production by standard antibody manufacturing techniques, and are likely to have favorable antibody-like pharmacokinetic properties. In the area of immunotherapies in oncology, we are exploring the use of bispecific antibodies that target tumor antigens and the CD3 receptor on T-cells to harness the oncolytic properties of T-cells. We are exploring additional indications and applications for our bispecific technologies, including a new class of CD28 and 4-1BB costimulatory bispecifics. We are also exploring a variety of alternative antibody formats (Altibodies™) that can bring binding partners together in restrained geometries.The VelociT mouse extends our research and drug discovery capabilities into cell-mediated immunity and therapeutic TCRs for oncology and other indications. VelociT was developed by using our VelociGene technology to humanize genes encoding TCRα and TCRβ variable sequences, CD4 and CD8 co-receptors, β2m, and class-I and -II major histocompatibility complexes. As a result, VelociT mice generate fully human TCRs, providing for customized modeling of T-cell function in different diseases and a powerful platform for the discovery of unique TCR-based therapies. We are also able to produce antibodies that recognize intracellular peptides bound in the groove of human leukocyte antigen ("HLA"), enabling the targeting of intracellular proteins in cancer cells.VelociHum is our immunodeficient mouse platform that can be used to accurately test human therapeutics against human immune cells and to study human tumor models. Through genetic humanizations, VelociHum mice have been optimized to allow for better development of human immune cells in vivo, as well as to allow for engraftment of primary patient-derived tumors that do not take in other commercially available mice.15Table of ContentsRegeneron Genetics Center® Regeneron Genetics Center LLC (RGC™), a wholly owned subsidiary of Regeneron Pharmaceuticals, Inc., leverages de-identified clinical, genomic, and other types of molecular data from properly consented human volunteers from around the world to identify medically relevant associations in a blinded fashion designed to preserve a patients' privacy while uncovering the unique characteristics of their health and wellness. The objective of RGC is to expand the use of human genetics for discovering and validating genetic factors that cause or influence a range of diseases where there are major unmet medical needs, with the prospect of improving the drug discovery and development process and to advance innovation in clinical care design. RGC is undertaking multiple collaborative approaches to study design and implementation, including large population-based efforts that engage study participants to more discrete disease specific and founder populations with data on strategic phenotypes of interest. RGC utilizes laboratory automation and innovative approaches to cloud computing to achieve high-quality throughput, attaining approximately 2 million samples sequenced to date.Central to the work of RGC is the portfolio of collaborations with over 100 academic and clinical collaborators around the world, including the University of Colorado, Geisinger Health System, Mayo Clinic, University of Pennsylvania, UCLA Medical Center, UK Biobank, University of Oxford, University of Cambridge, and the University of Helsinki. These collaborations provide access to biological samples and associated phenotype data from properly consented patient volunteers for purposes of genomic research. RGC undertakes genetic sequencing of these samples to create a unique resource of de-identified genetic data and associated phenotype data for research. Furthermore, the RGC has deployed bulk RNA sequencing, whole genome sequencing, and an O-LINK proteomic assay to complement whole exome sequencing and genotyping. In addition, the RGC leverages organoid models, siRNA, and CRISPR knockout models to validate genetic associations that lead to new therapeutic targets. The RGC continues to publish results from its research efforts in journals and publications in partnership with its collaborators to advance the field of genomics.These efforts at the RGC have led to the identification of more than 20 novel genetic targets. Through our Regeneron Genetics Medicines initiative, we are currently advancing these targets using either our VelociSuite technologies or other technologies, such as siRNA gene silencing, genome editing, and targeted viral-based gene delivery and expression. See the "Collaboration, License, and Other Agreements" section below for descriptions of our collaborations with Alnylam and Intellia.Agreements Related to COVID-19U.S. GovernmentIn 2020, the Company expanded its Other Transaction Agreement with the Biomedical Advanced Research Development Authority ("BARDA"), pursuant to which the U.S. Department of Health and Human Services ("HHS") was obligated to fund certain of our costs incurred for research and development activities related to COVID-19 treatments. In 2020, the Company also entered into an agreement with entities acting at the direction of BARDA and the U.S. Department of Defense to manufacture and deliver filled and finished drug product of REGEN-COV to the U.S. government. The agreement, as subsequently amended, provided for payments to the Company of up to $465.9 million in the aggregate for bulk manufacturing of the drug substance, as well as fill/finish, storage, and other activities. In January 2021, the Company entered into an agreement with the U.S. Department of Defense and HHS to manufacture and deliver additional filled and finished drug product of REGEN-COV to the U.S. government. Pursuant to the agreement, the U.S. government was obligated to purchase 1.25 million doses of drug product, resulting in payments to the Company of $2.625 billion. In September 2021, the Company entered into an amendment to its January 2021 agreement to supply the U.S. government with an additional 1.4 million doses of REGEN-COV. Pursuant to the agreement, the U.S. government was obligated to purchase all filled and finished doses of such additional drug product delivered by January 31, 2022, resulting in payments to the Company of $2.940 billion in the aggregate. Additionally, Roche supplied a portion of the doses to Regeneron to fulfill our agreement with the U.S. government (see "Roche" section below for further details regarding our collaboration agreement with Roche).As of December 31, 2021, the Company had completed its final deliveries of drug product under the agreements described above. RocheIn 2020, we entered into a collaboration agreement with Roche to develop, manufacture, and distribute the casirivimab and imdevimab antibody cocktail (known as REGEN-COV in the United States and Ronapreve in other countries). We have the right to distribute the product in the United States and Roche has the right to distribute the product outside of the United States. The parties share gross profits from worldwide sales based on a pre-specified formula, depending on the amount of manufactured product supplied by each party to the market.16Table of ContentsCollaboration, License, and Other AgreementsSanofiAntibodyWe are collaborating with Sanofi on the global development and commercialization of Dupixent, Kevzara, and itepekimab (the "Antibody Collaboration"). Under the terms of the Antibody License and Collaboration Agreement (the "LCA"), Sanofi is generally responsible for funding 80% to 100% of agreed-upon development costs. We are obligated to reimburse Sanofi for 30% to 50% of worldwide development expenses that were funded by Sanofi based on our share of collaboration profits from commercialization of collaboration products. Under the terms of the LCA, we were required to apply 10% of our share of the profits from the Antibody Collaboration in any calendar quarter to reimburse Sanofi for these development costs. On July 1, 2022, an amendment to the LCA became effective, pursuant to which the percentage of Regeneron’s share of profits used to reimburse Sanofi for such development costs increased from 10% to 20%.Under our collaboration agreement, Sanofi records product sales for commercialized products, and Regeneron has the right to co-commercialize such products on a country-by-country basis. We co-commercialize Dupixent in the United States and in certain countries outside the United States. We supply certain commercial bulk product to Sanofi. We and Sanofi equally share profits and losses from sales within the United States. We and Sanofi share profits outside the United States on a sliding scale based on sales starting at 65% (Sanofi)/35% (us) and ending at 55% (Sanofi)/45% (us), and share losses outside the United States at 55% (Sanofi)/45% (us). In each of 2020 and 2021, we earned a $50.0 million sales-based milestone from Sanofi, upon aggregate annual sales of antibodies outside the United States (including Praluent) exceeding $1.0 billion and $1.5 billion, respectively, on a rolling twelve-month basis. In 2022, we earned two additional $50.0 million sales-based milestones, upon aggregate annual sales of antibodies outside the United States (including Praluent) exceeding $2.0 billion and $2.5 billion, respectively, on a rolling twelve-month basis. We are entitled to receive the final sales milestone payment of $50.0 million when such sales outside the United States exceed $3.0 billion on a rolling twelve-month basis. In April 2020, the Company and Sanofi entered into an amendment to the LCA in connection with, among other things, the removal of Praluent from the LCA such that (i) effective April 1, 2020, the LCA no longer governs the development, manufacture, or commercialization of Praluent and (ii) the quarterly period ended March 31, 2020 was the last quarter for which Sanofi and the Company shared profits and losses for Praluent under the LCA. The parties also entered into a Praluent Cross License & Commercialization Agreement (the "Praluent Agreement") pursuant to which, effective April 1, 2020, the Company, at its sole cost, became solely responsible for the development and commercialization of Praluent in the United States, and Sanofi, at its sole cost, is solely responsible for the development and commercialization of Praluent outside of the United States. Under the Praluent Agreement, Sanofi pays the Company a 5% royalty on Sanofi’s net product sales of Praluent outside the United States until March 31, 2032. The Company does not owe Sanofi royalties on the Company’s net product sales of Praluent in the United States. Although each party will be responsible for manufacturing Praluent for its respective territory, the parties have entered into definitive supply agreements under which, for a certain transitional period, the Company will continue to supply drug substance to Sanofi and Sanofi will continue to supply finished product to Regeneron. With respect to any intellectual property or product liability litigation relating to Praluent, the parties have agreed that, effective April 1, 2020, Regeneron and Sanofi each will be solely responsible for any such litigation (including damages and other costs and expenses thereof) in the United States and outside the United States, respectively, arising out of Praluent sales or other activities on or after April 1, 2020 (subject to Sanofi's right to set off a portion of any third-party royalty payments resulting from certain patent litigation proceedings against up to 50% of any Praluent royalty payment owed to Regeneron). The parties will each bear 50% of any damages arising out of Praluent sales or other activities prior to April 1, 2020.Immuno-OncologyWe previously collaborated with Sanofi for antibody-based cancer treatments in the field of immuno-oncology (the "IO Collaboration"). Under the terms of the Immuno-oncology License and Collaboration Agreement, the parties were co-developing and co-commercializing Libtayo. The parties shared equally, on an ongoing basis, development and commercialization expenses for Libtayo. We had principal control over the development of Libtayo and led commercialization activities in the United States, while Sanofi led commercialization activities outside of the United States. The parties shared equally in profits and losses in connection with the commercialization of Libtayo.Effective July 1, 2022, the Company obtained the exclusive right to develop, commercialize, and manufacture Libtayo worldwide under an Amended and Restated Immuno-oncology License and Collaboration Agreement with Sanofi (the "A&R IO LCA"). In connection with the A&R IO LCA, in 2022, the Company made a $900.0 million up-front payment to Sanofi, as well as a $100.0 million regulatory milestone payment. In addition, Sanofi earned a $65.0 million sales-based milestone upon the achievement of a specified amount of worldwide net product sales of Libtayo in 2022, and is eligible to receive an additional $35.0 million sales-based milestone upon the achievement of a specified amount of worldwide net product sales of Libtayo in 2023. We also pay 17Table of ContentsSanofi an 11% royalty on net product sales of Libtayo through March 31, 2034. The parties have also entered into a transition services agreement, a transitional distribution agreement, and a manufacturing services agreement, pursuant to which, during certain transitional periods, Sanofi will perform for Regeneron certain transition, distribution, and manufacturing services, respectively.Under the Amended and Restated Immuno-oncology Discovery and Development Agreement, we were obligated to reimburse Sanofi for half of the development costs it funded that were attributable to clinical development of product candidates from our share of profits from commercialized IO Collaboration products. Under the A&R IO LCA, the amount of development costs incurred under the IO Collaboration for which we are obligated to reimburse Sanofi was $35.0 million as of the effective date of the A&R IO LCA, and we pay Sanofi a 0.5% royalty on net product sales of Libtayo until all such development costs have been reimbursed by us.Bayer We and Bayer are parties to a license and collaboration agreement for the global development and commercialization of EYLEA and aflibercept 8 mg outside the United States. Agreed-upon development expenses incurred by the Company and Bayer are generally shared equally. Bayer markets EYLEA outside the United States, and the companies share equally in profits and losses from such sales. In Japan, we were entitled to receive a tiered percentage of between 33.5% and 40.0% of EYLEA net sales through 2021, and, effective January 1, 2022, the companies share equally in profits and losses from sales. We are obligated to reimburse Bayer for 50% of the development costs that it has incurred under the agreement from our share of the collaboration profits. The reimbursement payment in any quarter will equal 5% of the then outstanding repayment obligation, but never more than our share of the collaboration profits in the quarter unless we elect to reimburse Bayer at a faster rate. Within the United States, we retain exclusive commercialization rights and are entitled to all profits from such sales.TevaWe and Teva are parties to a collaboration agreement to develop and commercialize fasinumab globally, excluding certain Asian countries that are subject to our collaboration agreement with MTPC. In connection with the agreement, Teva made a $250.0 million non-refundable up-front payment in 2016. We led global development activities, including the manufacturing of fasinumab, and the parties shared development costs equally. As of December 31, 2022, we had received an aggregate $120.0 million of development milestones from Teva.During the third quarter of 2022, we discontinued further clinical development of fasinumab.AlnylamIn 2018, we and Alnylam Pharmaceuticals, Inc. entered into a collaboration to discover RNA interference ("RNAi") therapeutics for NASH and potentially other related diseases, as well as to research, co-develop and commercialize any therapeutic product candidates that emerge from these discovery efforts (including ALN-HSD, which is currently in clinical development). Under the terms of the collaboration agreement, the parties share development costs equally. During the fourth quarter of 2022, Alnylam elected to opt-out of further development activities related to ALN-HSD; as a result, we retain the exclusive right to develop and commercialize such product and Alnylam will receive a royalty on sales (if any).In 2019, we and Alnylam entered into a global, strategic collaboration to discover, develop, and commercialize RNAi therapeutics for a broad range of diseases by addressing therapeutic disease targets expressed in the eye and central nervous system ("CNS"), in addition to a select number of targets expressed in the liver. In connection with the collaboration, the Company made an up-front payment of $400.0 million to Alnylam, and also purchased shares of Alnylam common stock for $400.0 million. For each program, we provide Alnylam with a specified amount of funding at program initiation and at lead candidate designation, and Alnylam is eligible to receive up to an aggregate of $200.0 million in clinical proof-of-principle milestones for eye and CNS programs. Under the collaboration, the parties plan to perform discovery research until designation of lead candidates. Following designation of a lead candidate, the parties may further advance such lead candidate under either a co-development/co-commercialization collaboration agreement ("Co-Co Collaboration Agreement") (under which the parties are advancing ALN-APP and ALN-PNP, which are currently in clinical development) or a License Agreement structure. The initial target nomination and discovery period is five years (which may under certain situations automatically be extended for up to seven years in the aggregate) (the "Research Term"). In addition, we have an option to extend the Research Term for an additional five-year period for a research extension fee ranging from $200.0 million to $400.0 million; the actual amount of the fee will be determined based on the acceptance of one or more Investigational New Drug Applications ("INDs") (or their equivalent in certain other countries) for programs in the eye and CNS.18Table of ContentsAt the stage of designation of a lead candidate for CNS programs and liver programs, the parties have alternating rights to be a lead party for collaboration products. At the stage of designation of a lead candidate for eye programs, we have the sole right to take the product forward as a licensee. The lead party is required to take the program forward under the License Agreement structure unless the other party exercises its rights to opt-in to a Co-Co Collaboration Agreement as a participating party, in which case the lead party is required to take the program forward under the Co-Co Collaboration Agreement structure. Alnylam does not have rights to opt-in to a Co-Co Collaboration Agreement for eye programs.Under a License Agreement, the lead party is designated as the licensee and has the right to develop and commercialize the collaboration product under such program. The licensee will be responsible for its own costs and expenses incurred in connection with the development and commercialization of the collaboration products under the License Agreement. The licensee will pay to the licensor certain development and/or commercialization milestone payments, as well as certain tiered royalty payments to the licensor based on the aggregate annual net sales of the collaboration product.For CNS programs and liver programs, under a Co-Co Collaboration Agreement, the party designated as the lead party will lead development and commercialization of the program and the parties will split profits and share costs equally, subject to certain co-funding opt-outs at specified clinical trial phases or under other conditions. If a party exercises its co-funding opt-out right, the lead party will be required to make certain tiered royalty payments to the other party based on the aggregate annual net sales of the collaboration product and the timing of the exercise of the co-funding opt-out right.Under the collaboration, when we are the licensee under a License Agreement or the lead party under a Co-Co Collaboration Agreement, Alnylam will be responsible for the manufacture and supply of the product to us for Phase 1 and Phase 2 clinical trials.In addition, during 2019, the parties entered into a Co-Co Collaboration Agreement for cemdisiran, an siRNA therapeutic targeting the C5 component of the human complement pathway being developed by Alnylam, with Alnylam as the lead party, and a License Agreement for a combination consisting of cemdisiran and pozelimab, with us as the licensee. Under the C5 siRNA Co-Co Collaboration Agreement, the parties shared costs equally, and under the License Agreement, we as the licensee are responsible for our own costs and expenses. The C5 siRNA License Agreement contains a flat low double-digit royalty payable to Alnylam on potential future net sales of the combination only subject to customary reductions, as well as up to $325.0 million in sales milestones.During the fourth quarter of 2022, we elected to opt-out of further development activities pursuant to the Co-Co Collaboration Agreement for cemdisiran as a monotherapy; as a result, Alnylam retains the right to develop and commercialize such product and we will receive a royalty on sales (if any).IntelliaIn 2016, we entered into a license and collaboration agreement with Intellia Therapeutics, Inc. to advance CRISPR/Cas9 gene-editing technology for in vivo therapeutic development. NTLA-2001, which is in clinical development, is subject to a co-development and co-commercialization arrangement pursuant to which Intellia will lead development and commercialization activities and the parties share an agreed-upon percentage of development expenses and profits (if commercialized).In 2020, we expanded our existing collaboration with Intellia to provide us with rights to develop products for additional in vivo CRISPR/Cas9-based therapeutic targets and for the companies to jointly develop potential products for the treatment of hemophilia A and B, with Regeneron leading development and commercialization activities. In addition, we also received non-exclusive rights to independently develop and commercialize ex vivo gene edited products. In connection with the 2020 agreement, we made a $70.0 million up-front payment to Intellia.BARDAWe and BARDA are parties to agreements pursuant to which HHS provided certain funding to develop, test, and manufacture a treatment for Ebola virus infection. In 2020, HHS exercised its option under an existing agreement to provide additional funding for the manufacture and supply of Inmazeb. We expect to deliver a pre-specified number of Inmazeb treatment doses over the course of approximately six years.See "Agreements Related to COVID-19 - U.S. Government" section above for information related to our COVID-19 agreements.KiniksaPursuant to a 2017 license agreement, we granted Kiniksa Pharmaceuticals, Ltd. the right to develop and commercialize certain new indications for ARCALYST. During the first quarter of 2021, Kiniksa received marketing approval in the United States for a new indication of ARCALYST, recurrent pericarditis. The quarterly period ended March 31, 2021 was the last quarter for which the Company recorded net product sales of ARCALYST. 19Table of ContentsFollowing this approval, Kiniksa is solely responsible for the U.S. development and commercialization of ARCALYST in all approved indications, and Regeneron will continue to supply clinical and commercial product to Kiniksa. Kiniksa will pay Regeneron 50% of its profits from sales of ARCALYST and the parties will not share in any losses incurred by Kiniksa in connection with commercialization of ARCALYST.Ultragenyx In January 2022, we entered into a license and collaboration agreement for Ultragenyx Pharmaceutical Inc. to develop and commercialize Evkeeza in countries outside of the United States. In connection with the agreement, Ultragenyx made a $30.0 million non-refundable up-front payment to the Company. Ultragenyx will share in certain costs for global trials led by the Company and also have the right to continue to clinically develop Evkeeza in countries outside of the U.S. We will supply commercial product to Ultragenyx at a tiered purchase price, which is calculated as a percentage of net sales of the product (subject to adjustment in certain circumstances), and are eligible to receive additional regulatory and sales milestone payments.CheckmateIn May 2022, the Company completed its acquisition of Checkmate Pharmaceuticals, Inc. for a total equity value of approximately $250 million. In connection with the acquisition, the Company obtained the rights to vidutolimod, which is in clinical development for oncology.ManufacturingWe currently manufacture bulk drug materials and products at our manufacturing facilities in Rensselaer, New York and Limerick, Ireland. These facilities consist of owned and leased research, manufacturing, office, laboratory, and warehouse space. In addition, the construction of a fill/finish facility in Rensselaer, New York is in process.We currently have approximately 100,000 liters of cell culture capacity at our Rensselaer facility and approximately 120,000 liters of cell culture capacity at our Limerick facility. Each of these facilities is approved by the FDA and certain other regulatory agencies to manufacture our bulk drug materials and products. Certain bulk drug materials and products are also manufactured by our collaborators, and certain raw materials or products necessary for the manufacture and formulation of our products and product candidates are provided by single-source unaffiliated third-party suppliers. In addition, we rely on our collaborators or third parties to perform packaging, filling, finishing, labeling, distribution, laboratory testing, and other services related to the manufacture of our products and product candidates, and to supply various raw materials and other products. See Part I, Item 1A. "Risk Factors - Risks Related to Manufacturing and Supply" for further information.Among the conditions for regulatory marketing approval of a medicine is the requirement that the prospective manufacturer's quality control and manufacturing procedures conform to the good manufacturing practice ("GMP") regulations of the health authority. In complying with standards set forth in these regulations, manufacturers must continue to expend time, money, and effort in the areas of production and quality control to ensure full technical compliance. Manufacturing establishments, both foreign and domestic, are also subject to inspections by or under the authority of the FDA and by other national, federal, state, and local agencies. Commercial Our medicines are marketed through our commercial group, which includes experienced professionals in the fields of marketing, sales, professional education, patient education, reimbursement and market access, trade and distribution, commercial operations, commercial analytics, and market research.In the United States, we sell our marketed products primarily to wholesalers and specialty distributors that serve pharmacies, hospitals, government agencies, physicians, and other healthcare providers. We had sales to two customers (Besse Medical, a subsidiary of AmerisourceBergen Corporation, and McKesson Corporation) that each accounted for more than 10% of total gross product revenue for the year ended December 31, 2022. On a combined basis, our product sales to these customers accounted for 83% of our total gross product revenue for the year ended December 31, 2022. We promote approved medicines to healthcare professionals via our team of field employees, as well as medical journals, medical exhibitions, distribution of literature and samples, and online channels. In addition, we advertise certain products directly to consumers and maintain websites with information about our medicines. The commercial group also evaluates opportunities for our targets and product candidates and prepares for market launches of new medicines.20Table of ContentsWe have established certain commercial capabilities outside the United States in connection with co-commercializing some products in accordance with our collaboration agreements. In addition, we are in process of building additional commercial capabilities outside the United States as a result of us obtaining the rights, in 2022, to commercialize Libtayo outside the United States. Refer to "Collaboration, License, and Other Agreements" section above for additional information related to these agreements.CompetitionWe face substantial competition from pharmaceutical, biotechnology, and chemical companies. Our ability to compete depends, to a great extent, on how fast we can develop safe and effective product candidates, complete clinical testing and approval processes, and supply commercial quantities of the product to the market. Competition among products approved for sale is based on efficacy, safety, reliability, availability, price, patent and other intellectual property position, and other factors. Marketed ProductsThe table below provides an overview of the current competitive landscape for the key products marketed by us and/or our collaborators in such products' currently approved indications. The table below is provided for illustrative purposes only and is not exhaustive. For additional information regarding the substantial competition these marketed products face, including potential future competition from product candidates in clinical development, see also Part I, Item 1A. "Risk Factors - Risks Related to Commercialization of Our Marketed Products, Product Candidates, and New Indications for Our Marketed Products - The commercial success of our products and product candidates is subject to significant competition."Marketed ProductCompetitor ProductCompetitorIndicationTerritory(a)EYLEALucentis® (ranibizumab injection)Novartis AG and Genentech/RocheWet AMD, DME, macular edema following RVO (including CRVO and BRVO), diabetic retinopathy, mCNV, and ROPWorldwideByooviz™ (ranibizumab-nuna) (biosimilar referencing Lucentis)Samsung Bioepis Co., Ltd. and Biogen Inc.Wet AMD, DME, macular edema following RVO (including CRVO and BRVO), diabetic retinopathy, and mCNVUnited States, EUXimluci® (ranibizumab) (biosimilar referencing Lucentis)Xbrane Biopharma AB, Bausch + Lomb, and STADA Arzneimittel AGWet AMD, DME, macular edema following RVO (including CRVO and BRVO), diabetic retinopathy, and CNVEUCimerli™ (ranibizumab-eqrn) (biosimilar referencing Lucentis)Formycon AG, Bioeq AG, Coherus BioSciences, Inc., and Teva Ltd.Wet AMD, DME, macular edema following RVO (including CRVO and BRVO), diabetic retinopathy, and CNVUnited States, EUSusvimo® (ranibizumab ocular implant) Genentech/RocheWet AMDUnited StatesVabysmo™ (faricimab-svoa)Genentech/RocheWet AMD, DMEWorldwideAvastin® (bevacizumab) (off-label and repackaged)Genentech/RocheWet AMD, DME, and macular edema following RVOWorldwideBeovu® (brolucizumab) InjectionNovartis AGWet AMD, DMEWorldwideOzurdex® (dexamethasone intravitreal implant) Allergan/AbbVie Inc.DME, RVOUnited States, EU21Table of ContentsMarketed Product (continued)Competitor ProductCompetitorIndicationTerritory(a)EYLEA (continued)Iluvien® (fluocinolone acetonide intravitreal implant)Alimera Sciences, Inc.DMEUnited States, EUConberceptChengdu Kanghong Pharmaceutical Group Co., Ltd.Wet AMD, DME, mCNVChinaDupixentEucrisa®/Staquis® (crisaborole)Pfizer Inc.Mild-to-moderate atopic dermatitisUnited States, EUOpzelura® (ruxolitinib)Incyte CorporationMild-to-moderate atopic dermatitisUnited StatesOlumiant® (baricitinib)Eli Lilly and Company/Incyte CorporationModerate-to-severe atopic dermatitisEU, JapanCibinqo® (abrocitinib)PfizerModerate-to-severe atopic dermatitisWorldwideRinvoq® (upadacitinib)AbbVieModerate-to-severe atopic dermatitisWorldwideAdbry™/Adtralza® (tralokinumab)LEO Pharma Inc.Moderate-to-severe atopic dermatitisWorldwideCorectim® (delgocitinib)Japan Tobacco Inc./Torii Pharmaceutical Co., Ltd.Atopic dermatitisJapanMitchga® (nemolizumab)Maruho Co., Ltd./Chugai Pharmaceutical Co., Ltd.Pruritus associated with atopic dermatitisJapanXolair® (omalizumab)Roche/NovartisAsthma, nasal polypsWorldwide (asthma); United States, EU (nasal polyps)Nucala® (mepolizumab)GlaxoSmithKline ("GSK")Asthma, nasal polypsWorldwide (asthma); United States, EU (nasal polyps)Cinqair® (reslizumab)TevaAsthmaUnited States, EUFasenra® (benralizumab)AstraZeneca AsthmaWorldwideTezspire™ (tezepelumab-ekko)AstraZeneca/AmgenAsthmaWorldwideLibtayoKeytruda® (pembrolizumab)Merck & Co., Inc.Various cancersWorldwideOpdivo® (nivolumab)Bristol-Myers SquibbVarious cancersWorldwideTecentriq® (atezolizumab)RocheVarious cancersWorldwideImfinzi® (durvalumab)AstraZenecaVarious cancersWorldwideBavencio® (avelumab)Pfizer/Merck KGaAVarious cancersWorldwideJemperli® (dostarlimab)GSKVarious cancersUnited States, EUPraluentRepatha® (evolocumab)AmgenReduce the risk of myocardial infarction, stroke, and coronary revascularization in adults with established cardiovascular disease; primary hyperlipidemia; and HoFHWorldwide22Table of ContentsMarketed Product (continued)Competitor ProductCompetitorIndicationTerritory(a)Praluent (continued)Leqvio® (inclisiran) NovartisPrimary hypercholesterolemia (heterozygous familial and non-familial) or mixed dyslipidemiaUnited States, EUKevzaraActemra® (tocilizumab)Genentech/Roche/Chugai Pharmaceutical Co., Ltd.Rheumatoid arthritisWorldwideOrencia® (abatacept)Bristol-Myers SquibbRheumatoid arthritisWorldwideXeljanz® (tofacitinib)PfizerRheumatoid arthritisWorldwideOlumiant® (baricitinib)Eli Lilly/IncyteRheumatoid arthritisWorldwideRinvoq® (upadacitinib)AbbVieRheumatoid arthritisWorldwideJyseleca® (filgotinib)Gilead Sciences, Inc./Galapagos NVRheumatoid arthritisEU, Japan(a) This table focuses primarily on the United States, EU, and Japan. "Worldwide" indicates that the relevant product is approved in the United States, EU, Japan, and at least one other country. Product CandidatesOur late-stage and earlier-stage clinical candidates (including those being developed in collaboration with our collaborators) face competition from many pharmaceutical and biotechnology companies. For example, we are aware of other pharmaceutical and biotechnology companies actively engaged in the research and development of antibody-based products against targets that are also the targets of our early- and late-stage product candidates. These companies are using various technologies in competition with our VelocImmune technology and our other antibody generation technologies, including their own antibody generation technologies and other approaches such as RNAi, chimeric antigen receptor T cell (CAR-T cell), and gene therapy technologies. We are also aware of several companies developing or marketing small molecules that may compete with our antibody product candidates in various indications, if such product candidates obtain regulatory approval in those indications.For additional information regarding our product candidates (including those being developed in collaboration with our collaborators) and the substantial competition they face, see also Part I, Item 1A. "Risk Factors - Risks Related to Commercialization of Our Marketed Products, Product Candidates, and New Indications for Our Marketed Products - The commercial success of our products and product candidates is subject to significant competition." Other AreasMany pharmaceutical and biotechnology companies are attempting to discover new therapeutics for indications in which we invest substantial time and resources. In these and related areas, intellectual property rights have been sought and certain rights have been granted to competitors and potential competitors of ours, and we may be at a substantial competitive disadvantage in such areas as a result of, among other things, our inferior intellectual property position or lack of experience, trained personnel, and expertise. A number of corporate and academic competitors are involved in the discovery and development of novel therapeutics that are the focus of other research or development programs we are now conducting. Some of these competitors are currently conducting advanced preclinical and clinical research programs in these areas. These and other competitors also may have established substantial intellectual property and other competitive advantages.If any of these or other competitors announces a successful clinical study involving a product that may be competitive with one of our product candidates or the grant of marketing approval by a regulatory agency for a competitive product, such developments may have an adverse effect on our business, operating results, financial condition, cash flows, or future prospects.We also compete with academic institutions, governmental agencies, and other public or private research organizations, which conduct research, seek patent and other intellectual property protection, and establish collaborative arrangements for the development and marketing of products that would provide royalties or other consideration for use of their technology. These institutions are becoming more active in seeking patent and other intellectual property protection and licensing arrangements to collect royalties or other consideration for use of the technology they have developed. Products developed in this manner may compete directly with products we develop. We also compete with others in acquiring technology from these institutions, agencies, and organizations.23Table of ContentsPatents, Trademarks, and Trade SecretsWe rely on a combination of intellectual property laws, including patent, trademark, copyright, trade secret, and domain name protection laws, as well as confidentiality and license agreements, to protect our intellectual property and proprietary rights.Our success depends, in part, on our ability to obtain patents, maintain trade secret protection, and operate without infringing on the proprietary rights of third parties (see Part I, Item 1A. "Risk Factors - Risks Related to Intellectual Property and Market Exclusivity - We may be restricted in our development, manufacturing, and/or commercialization activities by patents or other proprietary rights of others, and could be subject to awards of damages if we are found to have infringed such patents or rights"; and Note 16 to our Consolidated Financial Statements). Our policy is to file patent applications to protect technology, inventions, and improvements that we consider important to our business and operations. We hold an ownership interest in a number of issued patents in the United States and foreign countries with respect to our products and technologies. In addition, we hold an ownership interest in thousands of patent applications in the United States and foreign countries. Our patent portfolio includes granted patents and pending patent applications covering our VelociSuite technologies, including our VelocImmune mouse platform which produces fully human antibodies. Our issued patents covering these technologies generally expire between 2022 and 2032. However, we continue to file patent applications directed to improvements to these technology platforms.Our patent portfolio also includes issued patents and pending applications relating to commercialized products and our product candidates in clinical development. These patents cover, among other things, proteins, DNA and RNA molecules, manufacturing patents, method of use patents, and pharmaceutical compositions and formulations. The following table describes our U.S. patents, European patents ("EP"), and Japanese patents ("JP") that are of particular relevance to key products marketed or otherwise commercialized by us and/or our collaborators, including the territory, patent number, general subject matter class, and expected expiration dates. The noted expiration dates include any patent term adjustments. Certain of these patents may also be entitled to term extensions. We continue to pursue additional patents and patent term extensions in the United States and other jurisdictions covering various aspects of our products that may, if issued, extend exclusivity beyond the expiration of the patents listed in the table below. One or more patents with the same or earlier expiry date may fall under the same "general subject matter class" for certain products and may not be separately listed.ProductMoleculeTerritoryPatent No.General Subject Matter ClassExpirationEYLEA(a)afliberceptUS7,070,959Composition of MatterJune 16, 2023(b)US8,092,803FormulationJune 21, 2027US10,464,992FormulationJune 14, 2027US10,857,231FormulationMarch 22, 2026US11,066,458FormulationJune 14, 2027US11,084,865FormulationJune 14, 2027US9,254,338Methods of TreatmentMay 22, 2032US10,857,205Methods of TreatmentJanuary 11, 2032US10,828,345Methods of TreatmentJanuary 11, 2032US10,888,601Methods of TreatmentJanuary 11, 2032US11,253,572Methods of TreatmentJanuary 11, 2032US10,406,226Method of ManufacturingMarch 22, 2026EP1183353Composition of Matter (Supplementary Protection Certificate)(May 23, 2025)(c)EP2364691FormulationJune 14, 2027EP2944306FormulationJune 14, 2027JP4,723,140Composition of MatterDecember 29, 2022 – December 25, 2023(d)JP5,273,746Methods of TreatmentJune 24, 2022JP5,216,002FormulationFebruary 27, 2028 – October 1, 2029(d)24Table of ContentsProduct (continued)MoleculeTerritoryPatent No.General Subject Matter ClassExpirationDupixentdupilumabUS7,608,693Composition of MatterMarch 28, 2031(e)US8,945,559FormulationOctober 17, 2032US9,238,692FormulationOctober 5, 2031US10,435,473FormulationOctober 5, 2031US11,059,896FormulationOctober 5, 2031US8,075,887Methods of TreatmentApril 17, 2028US8,337,839Methods of TreatmentOctober 2, 2027US9,290,574Methods of TreatmentJuly 10, 2034US9,574,004Methods of TreatmentDecember 22, 2033US11,421,036Methods of TreatmentJuly 10, 2034US10,137,193Methods of TreatmentMarch 18, 2036US10,485,844Methods of TreatmentSeptember 21, 2037US10,059,771Methods of TreatmentJune 20, 2034US11,214,621Methods of TreatmentMarch 11, 2036US11,167,004Methods of TreatmentSeptember 21, 2037US11,034,768Methods of TreatmentMarch 23, 2039US11,292,847Methods of TreatmentMay 10, 2039EP2356151Composition of MatterOctober 27, 2029(c)EP2356151(Supplementary Protection Certificate)(September 28, 2032)(c)EP3010539Methods of TreatmentJune 20, 2034EP2888281Methods of TreatmentAugust 20, 2033EP3064511Methods of TreatmentOctober 27, 2029EP3107575Methods of TreatmentFebruary 20, 2035EP3470432Methods of TreatmentAugust 20, 2033EP3019191Methods of TreatmentJuly 10, 2034EP2624865FormulationOctober 5, 2031EP3354280FormulationOctober 5, 2031JP5,291,802Composition of MatterOctober 27, 2029 – October 27, 2034(d)JP5,918,246FormulationOctober 5, 2031 – September 14, 2035(d)JP6,306,588Methods of TreatmentAugust 20, 2033 – August 29, 2034(d)JP6,353,838Methods of TreatmentSeptember 4, 2033JP6,673,840Methods of TreatmentFebruary 20, 2035JP6,463,351Methods of TreatmentJune 20, 2034 – September 2, 2035(d)JP6,861,630Methods of TreatmentNovember 13, 2035JP7,164,530Methods of TreatmentSeptember 21, 2037LibtayocemiplimabUS9,987,500Composition of MatterSeptember 18, 2035US10,737,113Composition of MatterApril 10, 2035US10,457,725Methods of TreatmentMay 12, 2037US11,292,842Methods of TreatmentJuly 18, 2038US11,505,600Methods of TreatmentJuly 2, 2038EP3097119Composition of MatterJanuary 23, 2035EP3455258Methods of TreatmentMay 12, 2037EP3932951Methods of TreatmentMay 12, 2037JP6,425,730Composition of MatterJanuary 23, 203525Table of ContentsProduct (continued)MoleculeTerritoryPatent No.General Subject Matter ClassExpirationLibtayo (continued)JP6,999,577Methods of TreatmentMay 12, 2037JP7,054,680Methods of TreatmentMay 12, 2037Praluent(a)(f)alirocumabUS8,062,640Composition of MatterDecember 15, 2029US10,023,654Composition of MatterDecember 15, 2029US10,472,425FormulationJuly 27, 2032US8,357,371Methods of TreatmentDecember 21, 2029US9,550,837Methods of TreatmentDecember 15, 2029US9,724,411Methods of TreatmentJanuary 15, 2031US11,246,925Methods of TreatmentApril 11, 2032US11,306,155Methods of TreatmentJuly 16, 2035US10,428,157Methods of TreatmentDecember 26, 2037US10,544,232Methods of TreatmentMarch 13, 2035US10,995,150Methods of TreatmentJune 6, 2034US11,116,839Methods of TreatmentJune 14, 2033EP2358756Composition of MatterDecember 15, 2029(c)EP2358756(Supplementary Protection Certificate)(September 25, 2030)(c)EP3156422Composition of MatterDecember 15, 2029EP2756004Methods of TreatmentSeptember 12, 2032EP3055333Methods of TreatmentOctober 10, 2034EP3689913Methods of TreatmentOctober 10, 2034EP3169353Methods of TreatmentJuly 16, 2035EP3169362Methods of TreatmentJuly 16, 2035EP3004171Methods of Treatment June 6, 2034EP3068803Methods of TreatmentNovember 12, 2034EP3395836Methods of ManufacturingJanuary 27, 2032KevzarasarilumabUS7,582,298Composition of MatterMay 22, 2031(g)US10,072,086FormulationSeptember 19, 2031US11,098,127FormulationJanuary 7, 2031US8,080,248Methods of TreatmentJune 1, 2027US8,568,721Methods of TreatmentJune 1, 2027US9,943,594Methods of TreatmentDecember 28, 2033US10,927,435Methods of TreatmentOctober 10, 2032EP2041177Composition of MatterJune 1, 2027(c)EP2041177(Supplementary Protection Certificate)(June 1, 2032)(c)EP2766039Methods of TreatmentOctober 10, 2032EP3071230Methods of TreatmentNovember 21, 2034EP3409269FormulationJanuary 7, 2031EP3756652FormulationJanuary 7, 2031JP5,307,708Composition of MatterJune 1, 2027 – August 22, 2031(d)JP5,805,660FormulationJanuary 7, 2031 – October 24, 2031(d)JP6,122,018Methods of TreatmentOctober 10, 2032 – March 29, 2033(d)JP7,025,477Methods of TreatmentOctober 10, 203226Table of ContentsProduct (continued)MoleculeTerritoryPatent No.General Subject Matter ClassExpirationKevzara (continued)JP6,657,089Methods of TreatmentNovember 21, 2034JP7,166,925Methods of TreatmentMarch 7, 2037(a) See Note 16 to our Consolidated Financial Statements for information regarding inter partes review and post-grant review petitions filed in the U.S. Patent and Trademark Office relating to EYLEA and patent infringement proceedings relating to Praluent.(b) A patent term extension has been granted by the U.S. Patent and Trademark Office, extending the original patent term (May 23, 2020), insofar as it covers EYLEA, to June 16, 2023.(c) Supplementary protection certificates ("SPCs") are pending and/or have been granted in various European countries, extending the original patent terms in those countries, where granted, to the applicable dates indicated in parentheses.(d) The patent term extension ("PTE") system in Japan allows for a patent to be extended more than once provided the later approval is directed to a different indication from that of the previous approval. This may result in multiple PTE approvals for a given patent, each with its own expiration date. In this table, date ranges are shown for the expiration of Japanese patents for which multiple PTEs have been granted, with the later date indicating the latest expiring PTE for the corresponding patent.(e) A patent term extension has been granted by the U.S. Patent and Trademark Office, extending the original patent term (October 2, 2027), insofar as it covers Dupixent, to March 28, 2031.(f) This table excludes Japanese patents related to Praluent because Praluent is not being commercialized in Japan at this time.(g) A patent term extension has been granted by the U.S. Patent and Trademark Office, extending the original patent term (June 1, 2027), insofar as it covers Kevzara, to May 22, 2031.In addition to our patent portfolio, in the United States and certain other countries, our competitive position may be enhanced due to the availability of market exclusivity under relevant law (for additional information regarding market exclusivity, see Part I, Item 1A. "Risk Factors - Risks Related to Intellectual Property and Market Exclusivity - Loss or limitation of patent rights, and regulatory pathways for biosimilar competition, could reduce the duration of market exclusivity for our products"). For example, in the United States, the regulatory exclusivity period for EYLEA (i.e., the period during which no biosimilar product can be approved by the FDA) extends through May 17, 2024 following the pediatric exclusivity granted by the FDA. The effect of expiration of a patent relating to a particular product also depends upon other factors, such as the nature of the market and the position of the product in it, the growth of the market, the complexities and economics of the process for manufacture of the active ingredient of the product, and the requirements of new drug provisions of the Federal Food, Drug and Cosmetic Act or similar laws and regulations in other countries.We also are the nonexclusive licensee of a number of additional patents and patent applications. These include a license agreement with Bristol-Myers Squibb, E. R. Squibb & Sons, L.L.C., and Ono Pharmaceutical Co., Ltd. to obtain a license under certain patents owned and/or exclusively licensed by one or more of these parties that includes the right to develop and sell Libtayo. Under the agreement, we pay royalties of 8.0% on worldwide sales of Libtayo through December 31, 2023, and royalties of 2.5% from January 1, 2024 through December 31, 2026. Patent law relating to the patentability and scope of claims in the biotechnology field is evolving and our patent rights are subject to this additional uncertainty. The degree of patent protection that will be afforded to our products in the United States and other important commercial markets is uncertain and is dependent upon the scope of protection decided upon by the patent offices, courts, and governments in these countries. There is no certainty that our existing patents or others, if obtained, will provide us protection from competition or provide commercial benefit. Others may independently develop similar products or processes to those developed by us, duplicate any of our products or processes or, if patents are issued to us, design around any products and processes covered by our patents. We expect to continue, when appropriate, to file product and process applications with respect to our inventions. However, we may not file any such applications or, if filed, the patents may not be issued. Patents issued to or licensed by us may be infringed by the products or processes of others.We seek to file and maintain trademarks around the world based on commercial activities in most jurisdictions where we have, or desire to have, a business presence for a particular product or service. Trademark protection varies in accordance with local law, and continues in some countries as long as the trademark is used and in other countries as long as the trademark is registered. Trademark registrations generally are for fixed but renewable terms.Defense and enforcement of our intellectual property rights is expensive and time consuming, even if the outcome is favorable to us. It is possible that patents issued or licensed to us will be successfully challenged, that a court may find that we are infringing validly issued patents of third parties, or that we may have to alter or discontinue the development of our products or pay licensing fees to take into account patent rights of third parties (see Part I, Item 1A. "Risk Factors - Risks Related to Intellectual Property 27Table of Contentsand Market Exclusivity - We may be restricted in our development, manufacturing, and/or commercialization activities by patents or other proprietary rights of others, and could be subject to awards of damages if we are found to have infringed such patents or rights"; and Note 16 to our Consolidated Financial Statements).Government RegulationRegulation by government authorities in the United States and foreign countries is a significant factor in the research, development, manufacture, and marketing of our products and our product candidates. A summary of the primary areas of government regulation that are relevant to our business is provided below. For a description of material regulatory risks we face, also refer to Part I, Item 1A. "Risk Factors."Preclinical RequirementsThe activities required before a product candidate may be marketed in the United States or elsewhere begin with preclinical tests. Preclinical tests include laboratory evaluations of, among other things, product chemistry and formulation and toxicological and pharmacological studies in animal species to assess the toxicity and dosing of the product candidate. In the United States, certain preclinical trials must comply with the FDA's Good Laboratory Practice requirements ("GLPs") and the U.S. Department of Agriculture's Animal Welfare Act. The results of these studies must be submitted to the FDA or the relevant regulatory authority outside the United States as part of an IND or clinical trial application (as applicable), which must be reviewed by the FDA or the relevant government authority before proposed clinical testing can begin in the applicable country or jurisdiction. In the United States, unless the FDA raises concerns, the IND becomes effective 30 days following its receipt by the FDA, and the clinical trial proposed in the IND may begin. The FDA or other regulatory authorities may ask for additional data in order to begin a clinical trial. Rules that are equivalent in scope but which vary in application apply in foreign countries.Product ApprovalAll of our product candidates require regulatory approval by relevant government authorities before they can be commercialized. In particular, human therapeutic products are subject to rigorous preclinical and clinical trials and other pre-market approval requirements by the FDA, EMA, and other foreign regulatory authorities. The structure and substance of the FDA and foreign pharmaceutical regulatory practices may evolve over time. The ultimate outcome and impact of such developments cannot be predicted.Clinical trials involve the administration of a drug to healthy human volunteers or to patients under the supervision of a qualified investigator. The conduct of clinical trials is subject to extensive regulation, including compliance with the FDA's bioresearch monitoring regulations and Good Clinical Practice requirements ("GCPs"), which establish standards for conducting, recording data from, and reporting the results of, clinical trials, and are intended to assure that the data and reported results are credible and accurate, and that the rights, safety, and well-being of study participants are protected. Clinical trials must be conducted under protocols that detail the study objectives, parameters for monitoring safety, and the efficacy criteria, if any, to be evaluated. In addition, each clinical trial must be reviewed and approved by, and conducted under the auspices of, an Institutional Review Board ("IRB") for each clinical site within the United States or, where applicable, an Ethics Committee and/or the competent authority for clinical sites outside the United States. Companies sponsoring the clinical trials, investigators, and IRBs/Ethics Committees also must comply with, as applicable, regulations and guidelines for obtaining informed consent from the study patients, following the protocol and investigational plan, adequately monitoring the clinical trial, and timely reporting of adverse events. Foreign studies conducted under an IND must meet the same requirements that apply to studies being conducted in the United States. Data from a foreign study not conducted under an IND may be submitted in support of a BLA if the study was conducted in accordance with GCPs and the FDA is able to validate the data. The sponsor of a clinical trial or the sponsor's designated responsible party may be required to register certain information about the trial and disclose certain results on government or independent registry websites, such as clinicaltrials.gov.Typically, clinical testing involves a three-phase process, which may overlap or be subdivided in some cases. Phase 1 trials are usually conducted with a small number of healthy volunteers to determine the early safety profile, metabolism, and pharmacological actions of the product candidate, the side effects associated with increasing doses, and, if possible, to gain early evidence of effectiveness. Although Phase 1 trials are typically conducted in healthy human subjects, in some instances, the trial subjects are patients with the targeted disease or condition. Phase 2 clinical trials are conducted with a relatively small sample of the intended patient population to provide enough data to evaluate the preliminary safety, tolerability, and efficacy of different potential doses of the product candidate. Phase 3 clinical trials are larger trials conducted with patients with the target disease or disorder intended to gather additional information about dosage, safety, and effectiveness necessary to evaluate the drug's overall risk-benefit profile. Phase 3 data often form the core basis on which the FDA and comparable foreign regulatory authorities evaluate a product candidate's safety and effectiveness when considering the product application for regulatory approval. If concerns arise about the safety of the product candidate, the FDA or other regulatory authorities can stop clinical trials by placing them on a "clinical hold" pending receipt of additional data, which can result in a delay or termination of a clinical development 28Table of Contentsprogram. The sponsoring company, the FDA or other regulatory authorities, or the IRB or Ethics Committee and competent authority may suspend or terminate a clinical trial at any time on various grounds, including a finding that the patients are being exposed to an unacceptable health risk.The results of the preclinical and clinical testing of a biologic product candidate are then submitted to the FDA in the form of a BLA for evaluation to determine whether the product candidate may be approved for commercial sale under the Public Health Service Act. Under the Prescription Drug User Fee Act, we typically must pay fees to the FDA for review of any BLA. When a BLA is submitted, the FDA makes an initial determination as to whether the application is sufficiently complete to be accepted for review. If the application is not, the FDA may refuse to accept the BLA for filing and request additional information. A refusal to file, which requires resubmission of the BLA with the requested additional information, delays review of the application. If the application is accepted for review, the FDA reviews the application to determine, among other things, whether a product is safe and effective for its intended use and whether the manufacturing controls are adequate to assure and preserve the product's identity, strength, quality, and purity. FDA performance goals generally provide for action on a BLA within 10 months of the 60-day filing date (or within 12 months of the BLA submission). That deadline can be extended by FDA under certain circumstances, including by the FDA's requests for additional information. The targeted action date can be 6 months after the 60-day filing date (or 8 months after BLA submission) for product candidates that are granted priority review designation because they are intended to treat serious or life-threatening conditions and demonstrate the potential to address unmet medical needs. The FDA has other programs to expedite development and review of product candidates that address serious or life-threatening conditions.For some BLAs, the FDA may convene an advisory committee to seek insights and recommendations on issues relevant to approval of the application. Although the FDA is not bound by the recommendation of an advisory committee, the agency considers such recommendations carefully when making decisions. Before approving a new drug or biologic product, the FDA also requires that the facilities at which the product will be manufactured or advanced through the supply chain be in compliance with current Good Manufacturing Practices, or cGMP, requirements and regulations governing, among other things, the manufacture, shipment, and storage of the product. The FDA also can audit the sponsor of the BLA to determine if the clinical studies were conducted in compliance with current GCPs. After review of a BLA, the FDA may grant marketing approval, request additional information, or issue a CRL outlining the deficiencies in the submission. The CRL may require additional testing or information, including additional preclinical or clinical data, for the FDA to reconsider the application. Even if such additional information and data are submitted, the FDA may decide that the BLA still does not meet the standards for approval. Data from clinical trials are not always conclusive and the FDA may interpret data differently than the sponsor. If FDA grants approval, an approval letter authorizes commercial marketing of the product candidate with specific prescribing information for specific indications.Any approval required by the FDA for any of our product candidates may not be obtained on a timely basis, or at all. The designation of a clinical trial as being of a particular phase is not necessarily indicative that such a trial will be sufficient to satisfy the parameters of a particular phase, and a clinical trial may contain elements of more than one phase notwithstanding the designation of the trial as being of a particular phase. The results of preclinical studies or early-stage clinical trials may not predict long-term safety or efficacy of our compounds when they are tested or used more broadly in humans. Additionally, as a condition of approval, the FDA may impose restrictions that could affect the commercial prospects of a product and increase our costs, such as a Risk Evaluation and Mitigation Strategy ("REMS") to mitigate certain specific safety risks, and/or post-approval commitments or requirements to conduct additional clinical trials or non-clinical studies or to conduct surveillance programs to monitor the product's effects.Approval of a product candidate by comparable regulatory authorities in foreign countries is generally required prior to commencement of marketing of the product in those countries. The approval procedure varies among countries and may involve different or additional testing, and the time required to obtain such approval may differ from that required for FDA approval. Approval by a regulatory authority in one jurisdiction does not guarantee approval by comparable regulatory authorities in other jurisdictions. In the European Economic Area ("EEA") (which is comprised of 27 Member States of the EU plus Norway, Iceland, and Liechtenstein), medicinal products can only be commercialized after a related Marketing Authorization has been granted. Marketing authorization for biologics must be obtained through a centralized procedure, which allows a company to submit a single application to the EMA. If a related positive opinion is provided by the EMA, the EC will grant a centralized marketing authorization that is valid in the EEA.In many jurisdictions, pediatric data or an approved Pediatric Investigation Plan ("PIP"), or a waiver of such studies, is required to have been approved by regulatory authorities prior to submission of a marketing application. In some EU countries, we may also be required to have an approved PIP before we can begin enrolling pediatric patients in a clinical trial. In the United States, under the Pediatric Research Equity Act ("PREA"), certain applications for approval must include an assessment, generally based on clinical study data, of the safety and effectiveness of the subject product in relevant pediatric populations, unless a waiver or 29Table of Contentsdeferral is granted. However, a pediatric study plan is not required for orphan products and the timing of the submission is subject to negotiation with FDA, but such plan cannot be submitted later than submission of a BLA.Various federal, state, and foreign statutes and regulations also govern or influence the research, manufacture, safety, labeling, storage, record keeping, marketing, transport, and other aspects of developing and commercializing pharmaceutical product candidates. The lengthy process of seeking these approvals and the compliance with applicable statutes and regulations require the expenditure of substantial resources. Any failure by us or our collaborators or licensees to obtain, or any delay in obtaining, regulatory approvals could adversely affect the manufacturing or marketing of our products and our ability to receive product or royalty revenue. For additional information regarding U.S. and foreign regulatory approval processes and requirements, see Part I, Item 1A. "Risk Factors - Risks Related to Maintaining Approval of Our Marketed Products and the Development and Obtaining Approval of Our Product Candidates and New Indications for Our Marketed Products - Obtaining and maintaining regulatory approval for drug products is costly, time-consuming, and highly uncertain."Emergency Use AuthorizationThe Secretary of HHS may authorize unapproved medical products to be marketed in the context of an actual or potential emergency that has been designated by the U.S. government. The COVID-19 pandemic has been designated as such a national emergency, with such designation currently expected to expire on May 11, 2023. After an emergency has been announced, the Secretary of HHS may authorize the issuance of, and the FDA Commissioner may issue, EUAs for the use of specific products based on criteria established by the Food, Drug, and Cosmetic Act, including that the product at issue may be effective in diagnosing, treating, or preventing serious or life-threatening diseases when there are no adequate, approved, and available alternatives. Although the criteria of an EUA differ from the criteria for approval of a BLA, EUAs nevertheless require the development and submission of data to satisfy the relevant FDA standards, as well as a number of ongoing compliance obligations. The FDA expects EUA holders to work toward submission of full applications, such as a BLA, as soon as possible. An EUA is also subject to additional conditions and restrictions and is product-specific. An EUA terminates when the emergency determination underlying the EUA terminates. An EUA is not a long-term alternative to obtaining FDA approval, licensure, or clearance for a product. The FDA may revoke, revise, or restrict an EUA for a variety of reasons, including where it is determined that the underlying health emergency no longer exists or warrants such authorization or the medical product is no longer effective in diagnosing, treating, or preventing the underlying health emergency.Post-Approval RegulationThe FDA and comparable regulatory authorities in other jurisdictions may also require us to conduct additional clinical trials or to make certain changes related to a product after granting approval of the product. The FDA has the explicit authority to require postmarketing studies (also referred to as post-approval or Phase 4 studies) and labeling changes based on new safety information, and may impose and enforce a REMS at the time of approval or after the product is on the market. Post-approval modifications to the drug, such as changes in indications, labeling, or manufacturing processes or facilities, may require a sponsor to develop additional data or conduct additional preclinical studies or clinical trials, to be submitted in a new or supplemental BLA, which would require FDA approval. Following approval, the FDA and comparable regulatory authorities outside the United States regulate the marketing and promotion of our products, which must comply with the Food, Drug, and Cosmetic Act and applicable FDA regulations and standards thereunder and equivalent foreign laws. The review of promotional activities by the FDA and comparable regulatory authorities outside the United States includes, but is not limited to, healthcare provider-directed and direct-to-consumer advertising, communications regarding unapproved uses, industry-sponsored scientific and educational activities, promotional activities involving the Internet, and sales representatives' communications. After approval, product promotion can include only those claims relating to safety and effectiveness that are consistent with the labeling approved by the FDA and comparable foreign regulatory authorities. FDA and comparable foreign regulatory authorities' regulations impose restrictions on manufacturers' communications regarding unapproved uses, but under certain conditions may engage in non-promotional, balanced, scientific communication regarding such use. Failure to comply with applicable FDA and comparable foreign regulatory authorities' requirements and restrictions in this area may subject a company to adverse publicity and enforcement action by the FDA, the Department of Justice, or the Office of the Inspector General of the Department of Health and Human Services, as well as state authorities and comparable regulatory authorities outside the United States. This could subject a company to a range of penalties that could have a significant commercial impact, including civil and criminal fines and agreements that materially restrict the manner in which a company promotes or distributes a drug. See Part I, Item 1A. "Risk Factors - Other Regulatory and Litigation Risks - Our business activities have been, and may in the future be, challenged under U.S. federal or state and foreign healthcare laws, which may subject us to civil or criminal proceedings, investigations, or penalties."30Table of ContentsAdverse-event reporting and submission of periodic reports are required following marketing approval. The FDA requires BLA holders to employ a system for obtaining and reviewing safety information, adverse events, and product complaints associated with each drug and to submit safety reports to the FDA, with expedited reporting timelines in certain situations. Based on new safety information after approval, the FDA can, among other things, mandate product labeling changes, require new post-marketing studies, impose or modify a risk evaluation and mitigation strategy for the product, or suspend or withdraw approval of the product. We may be subject to audits by the FDA and other regulatory authorities to ensure that we are complying with the applicable requirements. Rules that are equivalent in scope but which vary in application apply in foreign countries in which we conduct clinical trials.The holder of an EU marketing authorization for a medicinal product must also comply with the EU's pharmacovigilance legislation. This includes requirements to conduct pharmacovigilance, or the assessment and monitoring of the safety of medicinal products. Marketing authorization holders are required to maintain a Pharmacovigilance System Master File ("PSMF"), which supports and documents the compliance of the marketing authorization holder with the requirements of EU pharmacovigilance legislation. Marketing authorization holders are also required to have a Qualified Person for Pharmacovigilance ("QPPV"), who, among other things, maintains the PSMF. A QPPV must reside in the EEA and must also prepare pharmacovigilance reports, respond to potential requests from competent authorities concerning pharmacovigilance on a 24 hour basis, and provide competent authorities with any other information that may be relevant to the safety of the medicinal product in accordance with Good Pharmacovigilance Practices. The EC can also require marketing authorization holders to conduct post-authorization safety and/or efficacy studies. A post-authorization safety study ("PASS") is a study that is carried out after a medicinal product has been authorized to obtain further information on a medicinal product's safety, or to measure the effectiveness of risk-management measures. Such studies may be clinical trials or non-interventional studies. A post-authorization efficacy study ("PAES") is a study that is carried out for complementing available efficacy data in the light of well-reasoned scientific uncertainties on aspects of the evidence of benefits that is to be or only can be addressed post-authorization. The EC may, in particular, impose a PASS and/or PAES on marketing authorization holders when a marketing authorization is granted upon conditions. The EC may grant conditional marketing authorizations in the interest of public health, when there is less comprehensive clinical data available than would be required, if the EC considers that the benefit of immediate availability may outweigh the risk that the absence of the required clinical data poses.In addition, we and our third-party suppliers are required to maintain compliance with cGMP, and are subject to inspections by the FDA or comparable regulatory authorities in other jurisdictions to confirm such compliance. Changes of suppliers or modifications of methods of manufacturing may require amending our application(s) to the FDA or such comparable foreign regulatory authorities and acceptance of the change by the FDA or such comparable foreign regulatory authorities prior to release of product(s). FDA regulations also require investigation and correction of any deviations from cGMP and impose reporting and documentation requirements upon us and our third-party suppliers. Prescription drug manufacturers in the U.S. must comply with applicable provisions of the Drug Supply Chain Security Act and provide and receive product tracing information, maintain appropriate licenses, ensure they only work with other properly licensed entities, and have procedures in place to identify and properly handle suspect and illegitimate products. We may also be subject to state regulations related to the manufacturing and distribution of our products.Failure to comply with these laws, regulations, and conditions of product approval may lead the FDA and comparable regulatory authorities in other jurisdictions to take regulatory action or seek sanctions, including fines, issuance of warning letters, civil penalties, injunctions, suspension of manufacturing operations, operating restrictions, withdrawal of FDA approval of a product, seizure or recall of products, and criminal prosecution.Pricing and ReimbursementSales in the United States of our marketed products are dependent, in large part, on the availability and extent of reimbursement from third-party payors, including private payor healthcare and insurance programs, health maintenance organizations, pharmacy benefit management companies, and government programs such as Medicare and Medicaid. Sales of our marketed products in other countries are dependent, in large part, on coverage and reimbursement mechanisms and programs administered by health authorities in those countries. See Part I, Item 1A. "Risk Factors - Risks Related to Commercialization of Our Marketed Products, Product Candidates, and New Indications for Our Marketed Products - Sales of our marketed products are dependent on the availability and extent of reimbursement from third-party payors, and changes to such reimbursement may materially harm our business, prospects, operating results, and financial condition."We participate in, and have certain price reporting obligations to, the Medicaid Drug Rebate program, state Medicaid supplemental rebate program(s), and other governmental pricing programs. We also have obligations to report the average sales price for certain drugs to the Medicare program. Under the Medicaid Drug Rebate program, we are required to pay a rebate to each state Medicaid program for our covered outpatient drugs that are dispensed to Medicaid beneficiaries and paid for by a state 31Table of ContentsMedicaid program as a condition of having federal funds being made available for our drugs under Medicaid and Part B of the Medicare program.Medicaid is a joint federal and state program that is administered by the states for low-income and disabled beneficiaries. Medicaid rebates are based on pricing data reported by us on a monthly and quarterly basis to the Centers for Medicare & Medicaid Services ("CMS"), the federal agency that administers the Medicaid and Medicare programs. These data include the average manufacturer price and, in the case of innovator products, the best price for each drug which, in general, represents the lowest price available from the manufacturer to any entity in the U.S. in any pricing structure, calculated to include all sales and associated rebates, discounts, and other price concessions. The amount of the rebate is adjusted upward if average manufacturer price increases more than inflation (measured by reference to the Consumer Price Index - Urban). Currently, the rebate is capped at 100 percent of the average manufacturer price, but effective January 1, 2024, this cap on the rebate will be removed, and our rebate liability could increase accordingly.If we become aware that our reporting for a prior quarter was incorrect, or has changed as a result of recalculation of the pricing data, we are obligated to resubmit the corrected data for up to three years after those data originally were due, which revisions could affect our rebate liability for prior quarters. The federal Patient Protection and Affordable Care Act (the "PPACA") made significant changes to the Medicaid Drug Rebate program, and CMS issued a final regulation, which became effective on April 1, 2016, to implement the changes to the Medicaid Drug Rebate program under the PPACA. CMS recently modified Medicaid Drug Rebate program regulations to, among other things, permit reporting multiple best price figures with regard to value‑based purchasing arrangements and provide definitions for "line extension," "new formulation," and related terms with the practical effect of expanding the scope of drugs considered to be line extensions (beginning in 2022).Medicare is a federal program that is administered by the federal government that covers individuals age 65 and over or that are disabled as well as those with certain health conditions. Medicare Part B generally covers drugs that must be administered by physicians or other health care practitioners; are provided in connection with certain durable medical equipment; or are certain oral anti-cancer drugs and certain oral immunosuppressive drugs. Medicare Part B pays for such drugs under a payment methodology based on the average sales price of the drugs. Manufacturers, including us, are required to report average sales price information to CMS on a quarterly basis. The manufacturer-submitted information may be used by CMS to calculate Medicare payment rates. Starting in 2023, manufacturers must pay refunds to Medicare for single-source drugs or biological products, or biosimilar biological products, reimbursed under Medicare Part B and packaged in single-dose containers or single-use packages for units of discarded drug reimbursed by Medicare Part B in excess of 10 percent of total allowed charges under Medicare Part B for that drug. Manufacturers that fail to pay refunds could be subject to civil monetary penalties. Further, starting in 2023, the Inflation Reduction Act ("IRA") establishes a Medicare Part B inflation rebate scheme under which, generally speaking, manufacturers will owe rebates if the average sales price of a Part B drug increases faster than the pace of inflation. Failure to timely pay a Part B inflation rebate is subject to a civil monetary penalty. The IRA also creates a drug price negotiation program under which, after being on the market for a certain period of time, the prices for certain high Medicare spending drugs and biological products provided to Medicare patients without generic or biosimilar competition will be capped by reference to, among other things, a specified non-federal average manufacturer price, starting in 2026. Failure to comply with requirements under the drug price negotiation program is subject to an excise tax and a civil monetary penalty. This or any other legislative change could impact the market conditions for our products. See Part I, Item 1A. "Risk Factors - Risks Related to Commercialization of Our Marketed Products, Product Candidates, and New Indications for Our Marketed Products - Sales of our marketed products are dependent on the availability and extent of reimbursement from third-party payors, and changes to such reimbursement may materially harm our business, prospects, operating results, and financial condition."Civil monetary penalties can be applied if we are found to have knowingly submitted any false pricing or other information to the government, if we are found to have made a misrepresentation in the reporting of our average sales price, or if we fail to submit the required data on a timely basis. Such conduct also could be grounds for CMS to terminate our Medicaid drug rebate agreement, in which case federal payments may not be available under Medicaid or Medicare Part B for our covered outpatient drugs.Federal law requires that any company that participates in the Medicaid Drug Rebate program also participate in the Public Health Service's 340B drug pricing program (the "340B program") in order for federal funds to be available for the manufacturer's drugs under Medicaid and Medicare Part B. The 340B program, which is administered by the Health Resources and Services Administration ("HRSA"), requires participating manufacturers to agree to charge statutorily defined covered entities no more than the 340B "ceiling price" for the manufacturer's covered outpatient drugs. Covered entities include hospitals that serve a disproportionate share of financially needy patients, community health clinics, and other entities that receive certain types of grants under the Public Health Service Act. The PPACA expanded the list of covered entities to include certain free-standing cancer hospitals, critical access hospitals, rural referral centers, and sole community hospitals, but exempts "orphan drugs" from 32Table of Contentsthe ceiling price requirements for these covered entities. The 340B ceiling price is calculated using a statutory formula, which is based on the average manufacturer price and Medicaid rebate amount for the covered outpatient drug as calculated under the Medicaid Drug Rebate program. In general, products subject to Medicaid price reporting and rebate liability are also subject to the 340B ceiling price calculation and discount requirement.HRSA issued a final regulation regarding the calculation of the 340B ceiling price and the imposition of civil monetary penalties on manufacturers that knowingly and intentionally overcharge covered entities, which became effective on January 1, 2019. It is currently unclear how HRSA will apply its enforcement authority under this regulation. Any charge by HRSA that we have violated the requirements of the regulation could result in civil monetary penalties. Moreover, under a final regulation effective January 13, 2021, HRSA established a new administrative dispute resolution ("ADR") process for claims by covered entities that a manufacturer has engaged in overcharging, and by manufacturers that a covered entity violated the prohibitions against diversion or duplicate discounts. Such claims are to be resolved through an ADR panel of government officials rendering a decision that could be appealed only in federal court. An ADR proceeding could subject us to onerous procedural requirements and could result in additional liability. On November 30, 2022, HRSA issued a notice of proposed rulemaking that proposes several changes to the ADR process. HRSA also implemented a price reporting system under which we are required to report our 340B ceiling prices to HRSA on a quarterly basis, which then publishes those prices to 340B covered entities. In addition, legislation could be passed that would further expand the 340B program to additional covered entities or would require participating manufacturers to agree to provide 340B discounted pricing on drugs used in an inpatient setting.In order to be eligible to have our products paid for with federal funds under the Medicaid and Medicare Part B programs and purchased by certain federal agencies and grantees, we participate in the U.S. Department of Veterans Affairs ("VA") Federal Supply Schedule ("FSS") pricing program. FSS participation is required for our products to be purchased by the VA, Department of Defense ("DoD"), Coast Guard, and Public Health Service ("PHS"). Prices for innovator drugs purchased by the VA, DoD, Coast Guard, and PHS are subject to a cap (known as the "Federal Ceiling Price") equal to 76% of the annual non-federal average manufacturer price ("non-FAMP") minus, if applicable, an additional discount. The additional discount applies if non-FAMP increases more than inflation (measured by reference to the Consumer Price Index - Urban). We also participate in the Tricare Retail Pharmacy Program, under which we pay quarterly rebates to DoD for prescriptions of our innovator drugs dispensed to Tricare beneficiaries through Tricare Retail network pharmacies. The governing statute provides for civil monetary penalties for failure to provide information timely or for knowing submission of false information to the government.Medicare Part D provides coverage to enrolled Medicare patients for self-administered drugs (i.e., drugs that are not administered by a physician). Medicare Part D is administered by private prescription drug plans approved by the U.S. government and, subject to detailed program rules and government oversight, each drug plan establishes its own Medicare Part D formulary for prescription drug coverage and pricing, which the drug plan may modify from time to time. The prescription drug plans negotiate pricing with manufacturers and pharmacies, and may condition formulary placement on the availability of manufacturer discounts. In addition, manufacturers, including us, are required to provide to CMS a 70% discount on brand name prescription drugs utilized by Medicare Part D beneficiaries when those beneficiaries are in the coverage gap phase of the Part D benefit design. The IRA includes a sunset provision with respect to the coverage gap discount program starting in 2025 and replaces it with a new manufacturer discount program. In addition, as of October 2022, the IRA established a Medicare Part D inflation rebate scheme under which, generally speaking, manufacturers will owe additional rebates if the average manufacturer price of a Part D drug increases faster than the pace of inflation. Failure to timely pay a Part D inflation rebate is subject to a civil monetary penalty.Private payor healthcare and insurance providers, health maintenance organizations, and pharmacy benefit managers in the United States are adopting more aggressive utilization management techniques and are increasingly requiring significant discounts and rebates from manufacturers as a condition to including products on formulary with favorable coverage and copayment/coinsurance. These payors may not cover or adequately reimburse for use of our products or may do so at levels that disadvantage them relative to competitive products. Outside the United States, within the EU, our products are paid for by a variety of payors, with governments being the primary source of payment. Government health authorities in the EU determine or influence reimbursement of products, and set prices or otherwise regulate pricing. Negotiating prices with governmental authorities can delay commercialization of our products. Governments may use a variety of cost-containment measures to control the cost of products, including price cuts, mandatory rebates, value-based pricing, and reference pricing (i.e., referencing prices in other countries or prices of competitive products and using those reference prices to set a price). Budgetary pressures in many EU countries are continuing to cause governments to consider or implement various cost-containment measures, such as price freezes, increased price cuts and rebates, and expanded generic substitution and patient cost-sharing.33Table of ContentsOther Regulatory RequirementsWe are subject to health care "fraud and abuse" laws, such as the federal civil False Claims Act, the anti-kickback provisions of the federal Social Security Act, and other state and federal laws and regulations. Federal and state anti-kickback laws prohibit, among other things, payments or other remuneration to induce or reward someone to purchase, prescribe, endorse, or recommend a product that is reimbursed under federal or state healthcare programs. Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment of government funds, or knowingly making, or causing to be made, a false statement to get a false claim paid. See Part I, Item 1A. "Risk Factors - Other Regulatory and Litigation Risks - Our business activities have been, and may in the future be, challenged under U.S. federal or state and foreign healthcare laws, which may subject us to civil or criminal proceedings, investigations, or penalties."We are subject to the Foreign Corrupt Practices Act, or FCPA, and similar anti-bribery or anti-corruption laws, regulations or rules of other countries in which we operate, including the U.K. Bribery Act. See Part I, Item 1A. "Risk Factors - Other Regulatory and Litigation Risks - Risks from the improper conduct of employees, agents, contractors, or collaborators could adversely affect our reputation and our business, prospects, operating results, and financial condition."In the United States, there are numerous federal and state laws and regulations governing data privacy of personal data and the collection, use, disclosure, and protection of health data, genetic data, consumer data, and children's data. Such laws and regulations include the Health Insurance Portability and Accountability Act of 1996 and its implementing regulations (collectively, "HIPAA"), as well as state data breach notification laws, state health information and/or genetic privacy laws, and federal and state consumer protection laws (such as Section 5 of the Federal Trade Commission Act (the "FTC Act") and the California Consumer Privacy Act (the "CCPA")). Many of these laws differ from each other in significant ways and have different effects. Many of the state laws enable a state attorney general to bring actions and provide private rights of action to consumers as enforcement mechanisms. There is also heightened sensitivity around certain types of health data, which may be subject to additional protections. The landscape of federal and state laws regulating personal data is constantly evolving. Failure to comply with these laws and regulations could result in government enforcement actions and create liability for us (which could include civil and/or criminal penalties), private litigation, and/or adverse publicity. Federal regulators, state attorneys general, and plaintiffs' attorneys have been active in this space. HIPAA imposes privacy and security obligations on covered entity health care providers, health plans, and health care clearinghouses, as well as their "business associates" – certain persons or covered entities that create, receive, maintain, or transmit protected health information ("PHI") in connection with providing a specified service or performing a function on behalf of a covered entity. Most health care providers, including research institutions from which we or our collaborators obtain clinical trial data, are subject to HIPAA. Although we are not directly subject to HIPAA other than with respect to providing certain employee benefits, we could potentially be subject to criminal penalties if we, our affiliates, or our agents knowingly receive PHI maintained by a HIPAA-covered entity in a manner that is not permitted under HIPAA. The Federal Trade Commission ("FTC") also sets expectations for failing to take appropriate steps to keep consumers' personal information secure, or failing to provide a level of security commensurate to promises made to individuals about the security of their personal information (such as in a privacy notice) may constitute unfair or deceptive acts or practices in violation of Section 5 of the FTC Act. The FTC expects a company's data security measures to be reasonable and appropriate in light of the sensitivity and volume of consumer information it holds, the size and complexity of its business, and the cost of available tools to improve security and reduce vulnerabilities. Individually identifiable health information is considered sensitive data that merit stronger safeguards. With respect to privacy, the FTC also sets expectations that companies honor the privacy promises made to individuals about how the company handles consumers' personal information; and any failure to honor promises, such as the statements made in a privacy policy or on a website, may also constitute unfair or deceptive acts or practices in violation of the FTC Act. The FTC has the power to enforce promises as it interprets them, and events that we cannot fully control, such as data breaches, may result in FTC enforcement. Enforcement by the FTC under the FTC Act can result in civil penalties or enforcement actions.To the extent we collect California resident personal data, we are also subject to the CCPA. The CCPA, which became effective on January 1, 2020, created new transparency requirements and granted California residents several new rights with regard to their personal data. In addition, in November 2020, California voters approved the California Privacy Rights Act ("CPRA") ballot initiative which introduced significant amendments to the CCPA and established and funded a dedicated California privacy regulator, the California Privacy Protection Agency ("CPPA"). The amendments introduced by the CPRA go into effect on January 1, 2023, and new implementing regulations are expected to be introduced by the CPPA. Failure to comply with the CCPA may result in, among other things, significant civil penalties and injunctive relief, or statutory or actual damages. In addition, California residents have the right to bring a private right of action in connection with data privacy incidents involving certain elements of personal data. These claims may result in significant liability and damages. Similarly, there are a number of legislative proposals in the United States, at both the federal and state level, that could impose new obligations or limitations in 34Table of Contentsthe area of consumer protection. For example, states such as Virginia, Colorado, and Utah have enacted similar privacy laws that impose new obligations or limitations in areas affecting our business, and efforts at the federal level to enact similar laws have been ongoing. We may be subject to fines, penalties, or private actions in the event of non-compliance with such laws. Outside the United States, our clinical trial programs, research collaborations, and other processing activities implicate international data protection laws, including the EU General Data Protection Regulation 2016/679 ("GDPR"). The GDPR has increased our responsibility and liability in relation to the processing of personal data of individuals located in the EU. The GDPR, together with the national legislation of the EU member states governing the processing of personal data, impose strict obligations and restrictions on the ability to collect, analyze, and transfer personal data, including health data and samples from clinical trials and adverse event reporting. In particular, these obligations and restrictions may concern the consent of the individuals to whom the personal data relate, the information provided to the individuals, the sharing of personal data with third parties, the transfer of personal data out of the EU, security breach notifications, security and confidentiality of the personal data and imposition of substantial potential fines for violations of the data protection obligations. With respect to the transfer of personal data outside of the EU, while there are legal mechanisms available to lawfully transfer personal data outside of the EU, including to the United States, there are certain unsettled legal issues regarding such data transfers, the resolution of which may adversely affect our ability to transfer personal data or otherwise may cause us to incur significant costs to come into compliance with applicable data transfer impact assessments and implementation of legal data transfer mechanisms. In 2021, the European Commission published new standard contractual clauses required to be incorporated into new and existing agreements within prescribed timeframes in order to continue to lawfully transfer personal data outside of the EU. Different EU member states, as well as the United Kingdom and Switzerland, have promulgated national privacy laws that impose additional requirements, which add to the complexity of processing and transferring EU personal data. In October 2022, the United States issued an executive order to implement EU-U.S. data privacy safeguards. The European Commission is now expected to review the executive order and could propose an adequacy decision concerning the level of personal data protection in the United States under which personal data could flow freely from the EU to the United States.Some countries outside of the EU have reacted to the GDPR by promulgating and enacting new privacy legislation that reflects similar principles and obligations on companies that operate and process their citizens' personal data. Any failure or perceived failure to comply with privacy-related legal obligations, or any compromise of security of personal data, may result in governmental enforcement actions, litigation, contractual indemnity claims, or restraining orders that would impact our ability to process and share data globally. As we expand our presence into new countries, we must continue to assess our privacy controls to enable the processing of personal data. Guidance on implementation and compliance practices are often updated or otherwise revised. See Part I, Item 1A. "Risk Factors - Other Regulatory and Litigation Risks - We face risks related to the personal data we collect, process, and share."In addition to the foregoing, our present business is, and our future business may be, subject to regulation under the United States Atomic Energy Act, the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act, the National Environmental Policy Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act, national restrictions, and other current and potential future local, state, federal, and foreign regulations.Business SegmentsWe manage our business as one segment which includes all activities related to the discovery, development, and commercialization of medicines for serious diseases. For financial information related to our one segment, see our Consolidated Financial Statements and related notes. Human Capital ResourcesWe compete in the highly competitive biotechnology and pharmaceuticals industries. Attracting, developing, and retaining skilled and experienced employees in research and development, manufacturing, sales and marketing, and other positions is crucial to our ability to compete effectively. Our ability to recruit and retain such employees depends on a number of factors, including our corporate culture and work environment, informed by our values and behaviors (which we call The Regeneron Way) and our philosophy of "Doing Well by Doing Good"; talent development and career opportunities; and compensation and benefits.Integrity is a core value at Regeneron. Both the Company and each of our employees have a responsibility to act ethically and with integrity at all times. Our Code of Business Conduct and Ethics brings together Regeneron's key policy principles and establishes the Company's expectations for all of our employees to act in accordance with applicable laws, rules, and regulations. Employee ProfileAs of December 31, 2022, we had 11,851 full-time employees, consisting of 9,843 employed in the United States, 1,721 employed in Ireland, and 287 employed in other countries (primarily in the United Kingdom and Germany). Of these employees, 2,174 were within our research and preclinical development organization, 1,669 were within our global clinical development and 35Table of Contentsregulatory affairs organization, and 5,534 were within our industrial operations and product supply organization. Company-wide, nearly 1,400 of our full-time employees hold a Ph.D. and/or M.D. We also supplement our workforce with independent contractors, contingent workers, and temporary workers, as needed. None of our employees are represented by a labor union, and our management considers its relations with our employees to be good.Diversity, Equity, and InclusionOur employees represent a broad range of backgrounds, just like the people who take our medicines, and bring a wide array of perspectives and experiences that have helped us achieve our leadership position in the biotechnology and pharmaceuticals industries and the global marketplace. A key component of our culture is our commitment to diversity, equity, and inclusion ("DEI"). We believe this commitment allows us to better drive innovation and achieve our mission to repeatedly bring important new medicines to patients with serious diseases. Our DEI principles are reflected in our efforts in building a better workplace where employees can be themselves and succeed, advance medicine for all with better science, and use their voice and influence to create a better world. We empower employee-led cross-functional resource groups, functional/site-level DEI councils, and other interest groups, who connect around a common passion to build a culture of inclusion and collaborate to support under-served science and global communities. In 2022, we introduced inclusive leadership education for some of our most senior leaders and launched a pilot mentorship program focused on our diverse talent base to increase visibility, connection, and the leadership skills of underrepresented talent.While we are proud of our workforce diversity representation shown in the table below, we seek to continuously improve in this area. In April 2020, we announced our 2025 global responsibility goals, including a commitment to increase diversity in leadership and foster inclusion. Making progress toward this goal, since then we hired our Chief DEI Officer; launched a DEI strategy focused on creating a better workplace, better science, and better world; and implemented a new governance model that includes both an executive DEI council and a DEI leadership council. These councils are comprised of senior leaders who provide oversight and guidance on our DEI efforts and support the execution of our DEI strategy. In order to better understand our employees' perspectives, we also measure inclusion and belonging as part of our annual employee engagement survey. Our board of directors receives a detailed update on our DEI efforts at least once a year and continues to monitor our progress.2022 Workforce Diversity Representation*Female Representation (Global)49.8%People of Color Representation (U.S. Only)**28.7%* Based on full-time employees as of December 31, 2022** Represents the percentage of our full-time employees in the United States that self-identified as belonging to a racial or ethnic minority group. The denominator used in this calculation includes employees who did not disclose information related to their race or ethnicity. Excluding those that did not disclose such information, the percentage shown in this table would be 33.6%.Externally, we support DEI efforts in our community, including by supporting young scientific talent in underrepresented communities. For example, as part of our $100 million, 10-year commitment to support the Regeneron Science Talent Search, we allocate $3.1 million annually to fund the Society for Science’s science, technology, engineering, and math ("STEM") outreach and equity programs. In 2022, we also continued our $24 million, 5-year title sponsorship of Regeneron International Science and Engineering Fair, with representation from over 1,700 student scientists representing 63 countries and 49 U.S. states. In addition, we have developed a STEM pilot program with post-primary-school and high-school students in the New York State Capital Region and Limerick, Ireland that aspires to build long-term relationships with students from disadvantaged socio-economic groups, to encourage and support them in their studies, to inspire them to attend college, and, ultimately, to build a deeper more diverse talent pipeline. We also continue to take steps to further integrate diversity considerations into the design and selection of sites for our clinical studies to make sure they reflect the diversity of patients with the diseases under investigation.Employee Wellness, Health, and SafetyThe wellbeing of our employees is a primary focus as we believe that the most productive people are those who are at their best, both physically and mentally. We provide several programs related to employee health and wellness, including onsite amenities and programs such as meditation and prayer rooms and fitness centers. We also prioritize mental health initiatives and have taken further action to reduce or remove barriers to quality mental healthcare for our employees and their family members. In addition, we provide support for work-life balance through flex-time, remote working arrangements, child and elder care, and paid parental leave, among others.Occupational health and safety is critical to our success. We are committed to meeting or exceeding all environmental, health, safety ("EHS") and security regulations and have a range of programs, plans, and procedures to ensure the safety of all people 36Table of Contentswho come to work at Regeneron. In addition, our 2025 global responsibility goals include a commitment to focus on workplace injury prevention in our drive toward zero incidents.Employee Growth and DevelopmentWe invest significant resources to develop talent with the right capabilities to deliver the growth and innovation needed to support our continued success. Our Talent department is dedicated to promoting individual, leader, team, and organizational development through a number of tools and services. We offer a variety of professional development courses for our employees and support employee continuing education, including through educational reimbursement and tuition forgiveness programs. In addition, we continue to invest in our current and future leaders through a number of leadership development courses and programs and feedback and coaching opportunities. In 2022, nearly 30% of job openings were filled by existing employees who were seeking career development opportunities.Employee EngagementWe believe engaging our employees, from their first day and throughout their career, is key to fostering new ideas and driving commitment and productivity. We communicate frequently and transparently with our employees through a variety of communication methods, including video and written communications, company forums and summits, annual engagement surveys, and pulse surveys.We are also committed to fostering employee volunteerism to reach our 2025 global responsibility goal of driving employee volunteer levels above national standards. Employees are encouraged and empowered to support organizations and causes that are important to them including through, among other things, our matching gift program, volunteer-time-off policy, and our annual company-wide service event, Day for Doing Good. In 2022, nearly 7,000 employees volunteered approximately 31,200 hours, including approximately 55% of our employees who volunteered nearly 20,000 hours to approximately 190 nonprofits during our Day for Doing Good. Additionally, through our Matching Gift Program, we matched over $2 million in employee contributions in 2022, supporting over 2,000 charities. In 2022, we were named to the Civic 50 of most community-minded companies in the United States for the sixth consecutive year.The success of our employee engagement efforts is demonstrated by our employee retention rate of 91% in 2022, as well as the fact that 87% of our employees who responded to our annual engagement survey said Regeneron is a great place to work. Additionally, we have placed in the top five for the past 12 years in Science magazine’s annual "Top Employers Survey" of the global biotechnology and pharmaceutical industry.Compensation and BenefitsWe are committed to rewarding and supporting our employees in order to continue to attract and retain top talent. We believe this commitment supports our core strategy of creating and advancing a high-quality product pipeline and delivering medicines to people in need. Employee engagement, commitment, and achievements are key drivers of pipeline success and therefore our long-term performance. The primary underpinning of our pay philosophy is to award equity-based pay to all eligible employees to ensure that when we deliver for patients and for shareholders, everyone shares in the upside growth. Our practice, therefore, has been to award initial equity grants to all new hires, in addition to our comprehensive annual equity program. Total employee compensation packages (which varies by country and region) include market-competitive pay (with the opportunity to receive above-market rewards), broad-based grants of equity-based awards, comprehensive healthcare benefits, parental leave, child and elder care support, retirement savings options, and matching contributions. We annually review our workforce demographic and pay equity data to track our performance and inform new initiatives. Our analysis indicates favorable performance in these areas, and we are committed to continued monitoring.Corporate InformationWe were incorporated in the State of New York in 1988 and publicly listed in 1991. Our principal executive offices are located at 777 Old Saw Mill River Road, Tarrytown, New York 10591, and our telephone number at that address is (914) 847-7000. We make available free of charge on or through our Internet website (http://www.regeneron.com) our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission ("SEC"). Investors and other interested parties should note that we use our media and investor relations website (http://newsroom.regeneron.com) and our social media channels to publish important information about Regeneron, including information that may be deemed material to investors. We encourage investors and other interested parties to review the 37Table of Contentsinformation we may publish through our media and investor relations website and the social media channels listed on our media and investor relations website, in addition to our SEC filings, press releases, conference calls, and webcasts.The information contained on our websites and social media channels is not included as a part of, or incorporated by reference into, this report. Item 1A. Risk FactorsWe operate in an environment that involves a number of significant risks and uncertainties. We caution you to read the following risk factors, which have affected, and/or in the future could affect, our business, prospects, operating results, and financial condition. The risks described below include forward-looking statements, and actual events and our actual results may differ materially from these forward-looking statements. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also impair our business, prospects, operating results, and financial condition. Furthermore, additional risks and uncertainties are described under other captions in this report and should also be considered by our investors. For purposes of this section (as well as this report in general), references to our products encompass products marketed or otherwise commercialized by us and/or our collaborators or licensees; and references to our product candidates encompass product candidates in development by us and/or our collaborators or licensees (in the case of collaborated or licensed products or product candidates under the terms of the applicable collaboration or license agreements), unless otherwise stated or required by the context. In this section, we first provide a summary of the more significant risks and uncertainties we face and then provide a full set of risk factors and discuss them in greater detail.Summary of Risk FactorsAs noted above, we are subject to a number of risks that if realized could materially harm our business, prospects, operating results, and financial condition. Some of the more significant risks and uncertainties we face include those summarized below. The summary below is not exhaustive and is qualified by reference to the full set of risk factors set forth in this "Risk Factors" section. Please carefully consider all of the information in this Form 10-K, including the full set of risks set forth in this "Risk Factors" section, and in our other filings with the SEC before making an investment decision regarding Regeneron.Risks Related to the COVID-19 Pandemic•Our business may be further adversely affected by the effects of the COVID-19 pandemic, including those impacting our manufacturing and supply chain operations, research and development efforts, commercial operations and sales force, administrative personnel, third-party service providers, and business partners and customers, as well as the demand for our marketed products.•We face risks related to the development, manufacturing, and potential future commercialization of monoclonal antibodies targeting SARS-CoV-2.Commercialization Risks •We are substantially dependent on the success of EYLEA and Dupixent. •Sales of our products are dependent on the availability and extent of reimbursement from third-party payors, including private payors and government programs such as Medicare and Medicaid, which could change due to various factors such as drug price control measures that have been or may be enacted or introduced in the United States by various federal and state authorities.•The commercial success of our products is subject to significant competition from products or product candidates that may be superior to, or more cost effective than, our products or product candidates.•We and our collaborators on which we rely to commercialize some of our marketed products may be unable to continue to successfully commercialize or co-commercialize our products, both in the United States and abroad.Regulatory and Development Risks•Drug development and obtaining and maintaining regulatory approval for drug products is costly, time-consuming, and highly uncertain.•Serious complications or side effects in connection with the use or development of our products or product candidates could cause our regulatory approvals to be revoked or limited or lead to delay or discontinuation of development of our product candidates or new indications for our marketed products.•We may be unable to formulate or manufacture our product candidates in a way that is suitable for clinical or commercial use, which would delay or prevent continued development of such candidates and/or receipt of regulatory approval or commercial sale.•Many of our products are intended to be used in combination with drug-delivery devices, which may result in additional regulatory, commercialization, and other risks.38Table of ContentsIntellectual Property and Market Exclusivity Risks•We may not be able to protect the confidentiality of our trade secrets, and our patents or other means of defending our intellectual property may be insufficient to protect our proprietary rights.•Patents or proprietary rights of others may restrict our development, manufacturing, and/or commercialization efforts and subject us to patent litigation and other proceedings that could find us liable for damages.•Loss or limitation of patent rights, and regulatory pathways for biosimilar competition, could reduce the duration of market exclusivity for our products, including EYLEA.Manufacturing and Supply Risks•We rely on limited internal and contracted manufacturing and supply chain capacity, which could adversely affect our ability to commercialize our products and to advance our clinical pipeline. As we increase our production in response to higher product demand or in anticipation of a potential regulatory approval, our current manufacturing capacity will likely not be sufficient, and our dependence on our collaborators and/or contract manufacturers may increase, to produce adequate quantities of drug material for both commercial and clinical purposes.•Expanding our manufacturing capacity and establishing fill/finish capabilities will be costly and we may be unsuccessful in doing so in a timely manner, which could delay or prevent the launch and successful commercialization of our products approved for marketing and could jeopardize our clinical development programs.•Our ability to manufacture products may be impaired if any of our or our collaborators' manufacturing activities, or the activities of other third parties involved in our manufacture and supply chain, are found to infringe patents of others.•If sales of our marketed products do not meet the levels currently expected, or if the launch of any of our product candidates is delayed or unsuccessful, we may face costs related to excess inventory or unused capacity at our manufacturing facilities and at the facilities of third parties or our collaborators.•Third-party service or supply failures, failures at our manufacturing facilities in Rensselaer, New York and Limerick, Ireland, or failures at the facilities of any other party participating in the supply chain would adversely affect our ability to supply our products.•Our or our collaborators' failure to meet the stringent requirements of governmental regulation in the manufacture of drug products or product candidates could result in incurring substantial remedial costs, delays in the development or approval of our product candidates or new indications for our marketed products and/or in their commercial launch if regulatory approval is obtained, and a reduction in sales.Other Regulatory and Litigation Risks•If the testing or use of our products harms people, or is perceived to harm them even when such harm is unrelated to our products, we could be subject to costly and damaging product liability claims.•Our business activities have been, and may in the future be, challenged under U.S. federal or state and foreign healthcare laws, which may subject us to civil or criminal proceedings, investigations, or penalties.•If we fail to comply with our reporting and payment obligations under the Medicaid Drug Rebate program or other governmental pricing programs, we could be subject to additional reimbursement requirements, penalties, sanctions, and fines.•We face risks from the improper conduct of our employees, agents, contractors, or collaborators, including those relating to potential non-compliance with relevant laws and regulations such as the Foreign Corrupt Practices Act and the U.K. Bribery Act.•Our operations are subject to environmental, health, and safety laws and regulations, including those governing the use of hazardous materials.•Changes in laws and regulations affecting the healthcare industry could adversely affect our business.•Tax liabilities and risks associated with our operations outside of the United States could adversely affect our business.•We face risks related to the personal data we collect, process, and share.Risks Related to Our Reliance on or Transactions with Third Parties•If our collaborations with Sanofi or Bayer or other third parties are terminated or breached, our ability to develop, manufacture, and commercialize certain of our products and product candidates in the time expected, or at all, would be materially harmed.•Our collaborators and service providers may fail to perform adequately in their efforts to support the development, manufacture, and commercialization of our drug candidates and current and future products.•We have undertaken and may in the future undertake strategic acquisitions, and any difficulties from integrating such acquisitions could adversely affect our business, operating results, and financial condition.39Table of ContentsOther Risks Factors – Risks Related to Employees, Information Technology, Financial Results and Liquidity, and Our Common Stock•Our business is dependent on our key personnel and will be harmed if we cannot recruit and retain leaders in our research, development, manufacturing, and commercial organizations.•Significant disruptions of information technology systems or breaches of data security could adversely affect our business.•We may need additional funding in the future, which may not be available to us, and which may force us to delay, reduce, or eliminate our product development programs or commercialization efforts.•Our indebtedness could adversely impact our business.•Our stock price is extremely volatile.•Our existing shareholders may be able to exert substantial influence over matters requiring shareholder approval and over our management.* * *Risks Related to the COVID-19 PandemicOur business may be further adversely affected by the effects of the COVID-19 pandemic.In December 2019, a novel strain of coronavirus, SARS-CoV-2, causing a disease referred to as COVID-19, was reported to have surfaced in Wuhan, China. It has since spread around the world, evolved into multiple new variants, and caused a global pandemic. This pandemic has adversely affected and/or has the potential to adversely affect, among other things, the economic and financial markets and labor resources of the countries in which we operate; our manufacturing and supply chain operations, research and development efforts, commercial operations and sales force, administrative personnel, third-party service providers, and business partners and customers; and the demand for our marketed products.The COVID-19 pandemic has previously resulted and may again result in the imposition of various restrictions and mandates around the world to reduce the spread of the disease, including governmental orders that direct individuals to shelter at their places of residence, direct businesses and governmental agencies to cease non-essential operations at physical locations, prohibit certain non-essential gatherings, maintain social distancing, order cessation of non-essential travel, and require proof of vaccination and/or negative COVID-19 test results. The COVID-19 pandemic has continued to ebb and flow, with different jurisdictions having higher levels of infections than others and new variants of the SARS-CoV-2 virus (such as the Omicron-lineage variants) emerging and spreading more easily and quickly than other variants. The trajectory and the ultimate impact of the pandemic are highly uncertain and subject to change and we do not yet know the full extent of potential delays or impacts on our business, our clinical trials, healthcare systems, or the global economy as a whole. These effects could have a material impact on our operations. By way of example, continuation or re-imposition of various government-imposed or private-sector measures relating to the COVID-19 pandemic (including those we previously implemented, such as work-from-home policies for some employees) may further negatively impact productivity, disrupt our business, and delay our clinical programs and development timelines beyond the delays we have already experienced and disclosed. Such restrictions and limitations may also further negatively impact our access to regulatory authorities (which are affected, among other things, by applicable travel restrictions and may be delayed in responding to inquiries, reviewing filings, and conducting inspections); our ability to perform regularly scheduled quality checks and maintenance; and our ability to obtain services from third-party specialty vendors and other providers or to access their expertise as fully and timely as needed. The COVID-19 pandemic may also result in the loss of some of our key personnel, either temporarily or permanently. We and our employees may also be subject to government vaccine mandates, which may have a negative impact on our ability to retain employees or hire new employees and could adversely impact our business. In addition, our sales and marketing efforts were previously negatively impacted and may be further negatively impacted by postponement or cancellation of face-to-face meetings and restrictions on access by non-essential personnel to hospitals or clinics to the extent such measures slow down adoption or further commercialization of our marketed products. The demand for our marketed products may also be adversely impacted by the restrictions and limitations adopted in response to the COVID-19 pandemic, particularly to the extent they affect the patients' ability or willingness to start or continue treatment with our marketed products. Any of the foregoing factors may result in lower net product sales of our marketed products. For example, net product sales of EYLEA in the United States decreased for the three months ended June 30, 2020, compared to the same period in 2019, due in part to the impact of the COVID-19 pandemic. Demand for some or all of our marketed products may be further reduced if shelter-in-place, social distancing, or similar orders remain in effect or are re-implemented and, as a result, some of our inventory may become obsolete and may need to be written off, impacting our operating results. These and similar, and perhaps more severe, disruptions in our operations may materially adversely impact our business, prospects, operating results, and financial condition.40Table of ContentsVarious government-imposed or private-sector measures relating to the COVID-19 pandemic (or the perception that such restrictions or limitations on the conduct of business operations could occur) previously impacted, and may impact in the future, personnel at our research and manufacturing facilities, our suppliers, and other third parties on which we rely, as well as the availability or cost of materials produced by or purchased from such parties, resulting in supply chain strains or disruptions that may become material. While some materials and services may be obtained from more than one supplier or provider, port closures and other restrictions, whether resulting from the COVID-19 pandemic or otherwise (including any government restrictions or limitations, such as those that may be imposed under the Defense Production Act), could materially disrupt our supply chain or limit our ability to obtain sufficient materials or services (including fill/finish services) required for the development and manufacturing of our products and product candidates as well as our research efforts. If microbial, viral (including COVID-19), or other contaminations are discovered in our products, product candidates, the materials used for their production, or in our facilities, or in the facilities of our collaborators, third-party contract manufacturers, or other providers or suppliers, the affected facilities may need to be closed or may otherwise be affected for an extended period of time, or the contamination may result in other delays or disruptions in our direct or indirect supply chain. In addition, infections, hospitalizations, and deaths related to COVID-19 previously disrupted and may in the future disrupt the healthcare and healthcare regulatory systems in the United States and abroad. These and other possible disruptions relating to the COVID-19 pandemic could divert healthcare resources away from, or materially delay, regulatory review and potential approval of our product candidates and new indications for our marketed products. In addition, some of our clinical trials were previously and may in the future be affected by the COVID-19 pandemic. This impact could result in further delays in site initiation and patient enrollment due to prioritization of hospital resources toward the COVID-19 pandemic, patients' inability to comply with clinical trial protocols if quarantines impede patient movement or interrupt healthcare services, and restrictions on trial initiations imposed by hospitals and other trial sites as a result of the COVID-19 pandemic. Similarly, our ability to recruit and retain patients and principal investigators and site staff who, as healthcare providers, may have heightened exposure to COVID-19, was previously and may in the future be delayed or disrupted. Any such disruptions may further negatively impact the progress of our clinical trials, including the readouts of trial results, the timing of regulatory review, and any anticipated program milestones. While the potential economic impact brought by, and the duration of, the COVID-19 pandemic may be difficult to assess or predict, it previously caused significant disruption of global financial markets and could cause more economic disruption in the future, making it more difficult for us to access capital if needed. In addition, a recession or market correction resulting from the spread of COVID-19 could materially affect our business and the value of our Common Stock.To the extent the COVID-19 pandemic adversely affects our business, prospects, operating results, or financial condition, it may also have the effect of heightening many of the other risks described in this "Risk Factors" section.We face risks related to the development, manufacturing, and potential future commercialization of monoclonal antibodies targeting SARS-CoV-2.In response to the COVID-19 pandemic, we developed REGEN-COV (known as Ronapreve in countries outside the United States), a novel investigational antibody cocktail treatment designed to prevent and treat infection from the SARS-CoV-2 virus. REGEN-COV received an EUA from the FDA in November 2020 for the treatment of mild to moderate COVID-19 in certain patients, which was revised in January 2022 to exclude its use in geographic regions (currently including all U.S. states, territories, and jurisdictions) where infection or exposure is likely due to a variant such as an Omicron-lineage variant that is not susceptible to the treatment. In December 2022, the FDA issued a complete response letter concerning our BLA for REGEN-COV to treat COVID-19 in non-hospitalized patients and as prophylaxis in certain individuals. In light of these developments, we cannot predict whether (if at all) or to what extent REGEN-COV may be reauthorized or approved for use by the FDA in the future.As discussed in this report, we are progressing "next generation" monoclonal antibodies targeting SARS-CoV-2 (together with REGEN-COV referred to below as "our COVID-19 monoclonal antibodies"). There can be no assurance as to the timing or success of any of these efforts or studies evaluating "next generation" antibodies and whether any of such antibodies will retain activity against present or future variants of concern. We also face risks related to our significant investment in the development, supply, allocation, distribution, pricing, and potential future commercialization of our COVID-19 monoclonal antibodies. We have committed and may continue to commit significant capital and resources to fund and supply clinical trials and to accelerate and scale up the production of our COVID-19 monoclonal antibodies, which involves a complex manufacturing process that is both resource- and time-sensitive. For example, the impact of prioritizing certain manufacturing-related resources for our COVID-19 monoclonal antibodies has included and may in the future include, among other things, drawing down inventory safety stock levels for certain of our other products (including Dupixent and EYLEA). Depending on the demand for our products (including any future demand for our COVID-19 monoclonal antibodies), our ability to re-establish successfully our customary manufacturing cadence, and other relevant factors, we may not be able to replenish our inventory safety stock to the levels we deem prudent or supply our products and product candidates in sufficient 41Table of Contentsquantities to satisfy our commercial and development needs. We expect our investment in the development and manufacture of our COVID-19 monoclonal antibodies to continue in 2023 and potentially beyond, although the magnitude of our investment will be subject to clinical data results, the duration of the COVID-19 pandemic, and other factors, including regulatory outcomes. If we are unable to obtain a new EUA for any of our "next generation" monoclonal antibodies, or obtain regulatory approvals for any of the foregoing, or if we make a strategic decision to discontinue development of, or not commercialize, our "next generation" COVID-19 monoclonal antibodies or are otherwise not successful in their commercialization, we may be unable to recoup our significant expenses incurred to date and/or in the future related to the development and production of such antibodies. While we previously recognized significant revenues in connection with sales of REGEN-COV, the degree to which any future sales of our COVID-19 monoclonal antibodies will continue to impact our results of operations is highly uncertain.Risks Related to Commercialization of Our Marketed Products, Product Candidates, and New Indications for Our Marketed ProductsWe are substantially dependent on the success of EYLEA and Dupixent.EYLEA net product sales represent a substantial portion of our revenues and this concentration of our net sales in a single product makes us substantially dependent on that product. For the years ended December 31, 2022 and 2021, EYLEA net product sales in the United States represented 51% and 36% of our total revenues, respectively, with EYLEA net product sales as a percentage of our total revenues for the year ended December 31, 2021 being significantly lower due to the net product sales of REGEN-COV we recorded in that period under our agreements with the U.S. government. If we were to experience difficulty with the commercialization of EYLEA in the United States or if Bayer were to experience any difficulty with the commercialization of EYLEA outside the United States (including as a result of the COVID-19 pandemic discussed above), or if we and Bayer are unable to maintain current marketing approvals of EYLEA, we may experience a reduction in revenue and may not be able to sustain profitability, and our business, prospects, operating results, and financial condition would be materially harmed. In the United States, the regulatory exclusivity period for EYLEA (i.e., the period during which no biosimilar product can be approved by the FDA) will expire after May 17, 2024. See "Risks Related to Intellectual Property and Market Exclusivity - Loss or limitation of patent rights, and regulatory pathways for biosimilar competition, could reduce the duration of market exclusivity for our products" below. As a result, we face the risk of lower EYLEA net product sales due to biosimilar competition following such expiration, which may have a material adverse impact on our results of operations. While we have submitted a BLA for aflibercept 8 mg with the FDA, the degree to which any future net product sales of aflibercept 8 mg (if approved) may offset any potential decrease in EYLEA net product sales is highly uncertain.In addition, we are dependent on our share of profits from the commercialization of Dupixent under our Antibody Collaboration with Sanofi. If we or Sanofi were to experience any difficulty with the commercialization of Dupixent or if we or Sanofi are unable to maintain current marketing approvals of Dupixent, we may experience a reduction in revenue and our business, prospects, operating results, and financial condition would be materially harmed.If we or our collaborators are unable to continue to successfully commercialize our products, our business, prospects, operating results, and financial condition will be materially harmed.We expect that the degree of commercial success of our marketed products will continue to depend on many factors, including the following (as applicable):•any continued or future impact of SARS-CoV-2 (the virus that has caused the COVID-19 pandemic) on our business and the demand for our marketed products, as well as any continued or future impact on, among other things, our employees, collaborators, suppliers, and other third parties on which we rely, our ability to continue to manage our supply chain, and the global economy (as further discussed above under "Risks Related to the COVID-19 Pandemic - Our business may be further adversely affected by the effects of the COVID-19 pandemic"); •effectiveness of the commercial strategy in and outside the United States for the marketing of our products, including pricing strategy;•sufficient coverage of, and reimbursement for, our marketed products by third-party payors, including Medicare and Medicaid in the United States and other government and private payors in the United States and foreign jurisdictions, as well as U.S. and foreign payor restrictions on eligible patient populations and the reimbursement process (including drug price control measures that have been or may be enacted or introduced in the United States by various federal and state authorities);•our ability and our collaborators' ability to maintain sales of our marketed products in the face of competitive products and to differentiate our marketed products from competitive products, including as applicable product candidates currently in clinical development (such as aflibercept 8 mg); and, in the case of EYLEA, the existing and potential new branded and biosimilar competition for EYLEA (discussed further under "The commercial success of our products and product candidates is subject to significant competition - Marketed Products" below) and the willingness of retinal specialists and patients to start or continue treatment with EYLEA or to switch from another product to EYLEA;42Table of Contents•the effect of existing and new health care laws and regulations currently being considered or implemented in the United States, including measures requiring the U.S. government in the future to negotiate the prices of certain drugs and price reporting and other disclosure requirements and the potential impact of such requirements on physician prescribing practices and payor coverage;•serious complications or side effects in connection with the use of our marketed products, as discussed under "Risks Related to Maintaining Approval of Our Marketed Products and the Development and Obtaining Approval of Our Product Candidates and New Indications for Our Marketed Products - Serious complications or side effects in connection with the use of our products and in clinical trials for our product candidates and new indications for our marketed products could cause our regulatory approvals to be revoked or limited or lead to delay or discontinuation of development of our product candidates or new indications for our marketed products, which could severely harm our business, prospects, operating results, and financial condition" below;•maintaining and successfully monitoring commercial manufacturing arrangements for our marketed products with third parties who perform fill/finish or other steps in the manufacture of such products to ensure that they meet our standards and those of regulatory authorities, including the FDA, which extensively regulate and monitor pharmaceutical manufacturing facilities;•our ability to meet the demand for commercial supplies of our marketed products;•the outcome of the pending proceedings relating to EYLEA, Praluent, and REGEN-COV (described further in Note 16 to our Consolidated Financial Statements included in this report), as well as other risks relating to our marketed products and product candidates associated with intellectual property of other parties and pending or future litigation relating thereto (as discussed under "Risks Related to Intellectual Property and Market Exclusivity" below);•the outcome of the pending government proceedings and investigations and other matters described in Note 16 to our Consolidated Financial Statements included in this report (including the civil complaint filed against us on June 24, 2020 in the U.S. District Court for the District of Massachusetts by the U.S. Attorney's Office for the District of Massachusetts); and•the results of post-approval studies, whether conducted by us or by others and whether mandated by regulatory agencies or voluntary, and studies of other products that could implicate an entire class of products or are perceived to do so.More detailed information about the risks related to the commercialization of our marketed products is provided in the risk factors below.We and our collaborators are subject to significant ongoing regulatory obligations and oversight with respect to the products we or our collaborators commercialize. If we or our collaborators fail to maintain regulatory compliance for any of such products, the applicable marketing approval may be withdrawn, which would materially harm our business, prospects, operating results, and financial condition.We and our collaborators are subject to significant ongoing regulatory obligations and oversight with respect to the products we or they commercialize for the products' currently approved indications in the United States, EU, and other countries where such products are approved. If we or our collaborators fail to maintain regulatory compliance or satisfy other obligations for such products' currently approved indications (including because the product does not meet the relevant endpoints of any required post-approval studies (such as those required under an accelerated approval by the FDA or other similar type of approval), or for any of the reasons discussed below under "Risks Related to Maintaining Approval of Our Marketed Products and the Development and Obtaining Approval of Our Product Candidates and New Indications for Our Marketed Products - Obtaining and maintaining regulatory approval for drug products is costly, time-consuming, and highly uncertain"), the applicable marketing approval may be withdrawn, which would materially harm our business, prospects, operating results, and financial condition. Failure to comply may also subject us to sanctions, product recalls, or withdrawals of previously approved marketing applications. See also "Risks Related to Manufacturing and Supply - Our or our collaborators' failure to meet the stringent requirements of governmental regulation in the manufacture of drug products or product candidates could result in incurring substantial remedial costs, delays in the development or approval of our product candidates or new indications for our marketed products and/or in their commercial launch if regulatory approval is obtained, and a reduction in sales" below.Sales of our marketed products are dependent on the availability and extent of reimbursement from third-party payors, and changes to such reimbursement may materially harm our business, prospects, operating results, and financial condition.Sales of our marketed products in the United States are dependent, in large part, on the availability and extent of reimbursement from third-party payors, including private payor healthcare and insurance programs, health maintenance organizations, pharmacy benefit management companies ("PBMs"), and government programs such as Medicare and Medicaid. Sales of our marketed products in other countries are dependent, in large part, on similar reimbursement mechanisms and programs in those countries. Our future revenues and profitability will be adversely affected in a material manner if such third-party payors do not adequately defray or reimburse the cost of our marketed products. If these entities do not provide coverage and reimbursement with respect to 43Table of Contentsour marketed products or provide an insufficient level of coverage and reimbursement, such products may be too costly for many patients to afford them, and physicians may not prescribe them. Many third-party payors cover only selected drugs, or may prefer selected drugs, making drugs that are not covered or preferred by such payors more expensive for patients. Third-party payors may also require prior authorization for reimbursement, or require failure on another type of treatment before covering a particular drug, particularly with respect to higher-priced drugs. As our currently marketed products and most of our product candidates are biologics, bringing them to market may cost more than bringing traditional, small-molecule drugs to market due to the complexity associated with the research, development, production, supply, and regulatory review of such products. Given cost sensitivities in many health care systems (which may continue to be exacerbated as a result of the COVID-19 pandemic), our currently marketed products and product candidates are likely to be subject to continued pricing pressures, which may have an adverse impact on our business, prospects, operating results, and financial condition.In addition, in order for private insurance and governmental payors (such as Medicare and Medicaid in the United States) to reimburse the cost of our marketed products, we must maintain, among other things, our FDA registration and our National Drug Code, formulary approval by PBMs, and recognition by insurance companies and CMS. There is no certainty that we will be able to obtain or maintain the applicable requirements for reimbursement (including relevant formulary coverage, as discussed further below) of our current and future marketed products, which may have a material adverse effect on our business.Government and other third-party payors (including PBMs) are challenging the prices charged for healthcare products and increasingly limiting, and attempting to limit, both coverage and level of reimbursement for prescription drugs, such as by requiring outcomes-based or other pay-for-performance pricing arrangements. They are also imposing restrictions on eligible patient populations and the reimbursement process, including by means of required prior authorizations and utilization management criteria, such as step therapy (i.e., requiring the use of less costly medications before more costly medications are approved for coverage). Some states are also considering legislation that would control the prices and reimbursement of prescription drugs, and state Medicaid programs are increasingly requesting manufacturers to pay supplemental rebates and requiring prior authorization by the state program for use of any prescription drug for which supplemental rebates are not being paid. It is likely that federal and state legislatures and health agencies will continue to focus on additional health care reform measures in the future that will impose additional constraints on prices and reimbursements for our marketed products.Further, there have been several recent U.S. Congressional inquiries and recently approved or proposed federal and state legislation and policies (in addition to those already in effect) designed to, among other things, bring more transparency to drug pricing, review the relationship between pricing and manufacturer patient programs, reduce the out-of-pocket cost of prescription drugs, and reform government program reimbursement methodologies for drugs. Notably, the U.S. Congress recently passed the IRA, which includes measures requiring the government to negotiate, with respect to drugs provided to Medicare patients and subject to a specified cap, the prices of a set number of certain high Medicare spending drugs and biological products per year starting in 2026 (including those covered under Medicare Part B, such as EYLEA and, potentially in the future, aflibercept 8 mg), measures penalizing manufacturers of certain Medicare Parts B and D drugs for price increases above inflation, and measures redesigning the Medicare Part D benefit to limit patient out-of-pocket drug costs and shift liabilities among stakeholders, including manufacturers. While enacted into law, it is unclear how the provisions of the IRA will be implemented and the extent to which the policy changes will ultimately impact reimbursement levels of our marketed products, including those covered under Medicare Part B (such as EYLEA) or our product candidates that may in the future be covered under Medicare Part B (such as aflibercept 8 mg). At the state level, legislatures are becoming increasingly aggressive in passing legislation and implementing regulations designed to control pharmaceutical and biological product pricing, including price or patient reimbursement constraints, discounts, restrictions on certain product access, and price and marketing cost disclosure and transparency measures. In some cases, these measures are designed to encourage importation from other countries and bulk purchasing. A reduction in the availability or extent of reimbursement from U.S. government programs (including as a result of the legislation, proposals, initiatives, and developments described above) could have a material adverse effect on the sales of EYLEA or our other marketed products. Economic pressure on state budgets may also have a similar impact. In addition, PBMs and other managed-care organizations often develop formularies to reduce their cost for medications. The breadth of the products covered by formularies varies considerably from one PBM to another. Failure to be included in such formularies or to achieve favorable formulary status may negatively impact the utilization and market share of our marketed products. If our marketed products are not included within an adequate number of formularies, adequate reimbursement levels are not provided, the eligible insured patient population for our products is limited, or a key payor refuses to provide reimbursement for our products in a particular jurisdiction altogether, this could have a material adverse effect on our and our collaborators' ability to commercialize the applicable product.In certain foreign countries, pricing, coverage, and level of reimbursement of prescription drugs are subject to governmental control, and we and our collaborators may be unable to obtain coverage, pricing, and/or reimbursement on terms that are favorable to us or necessary for us or our collaborators to successfully commercialize our marketed products in those countries. In some foreign countries, the proposed pricing for a drug must be approved before it may be lawfully marketed. The requirements 44Table of Contentsgoverning drug pricing and reimbursement vary widely from country to country, and may take into account the clinical effectiveness, cost, and service impact of existing, new, and emerging drugs and treatments. For example, the EU provides options for its member states to restrict the range of medicinal products for which their national health insurance systems provide reimbursement and to control the prices of medicinal products for human use. A member state may approve a specific price for the medicinal product or it may instead adopt a system of direct or indirect controls on the profitability of the company placing the medicinal product on the market. Our results of operations may suffer if we or our collaborators are unable to market our products in foreign countries or if coverage and reimbursement for our marketed products in foreign countries is limited or delayed.The commercial success of our products and product candidates is subject to significant competition.Marketed ProductsThere is substantial competition in the biotechnology and pharmaceutical industries from biotechnology, pharmaceutical, and chemical companies. Many of our competitors have substantially greater research, preclinical and clinical product development and manufacturing capabilities, as well as financial, marketing, and human resources, than we do. Our competitors, regardless of their size, may also enhance their competitive position if they acquire or discover patentable inventions, form collaborative arrangements, or merge with other pharmaceutical or biotechnology companies. There is significant actual and potential future competition for each of our marketed products. EYLEA and (if approved) aflibercept 8 mg. EYLEA faces and, if approved, aflibercept 8 mg will face, significant competition in the marketplace. For example, EYLEA competes in one or more of its approved indications with other VEGF inhibitors, including Novartis and Genentech/Roche's Lucentis, Novartis' Beovu, and Genentech/Roche's Susvimo and Vabysmo, as well as biosimilar versions of Lucentis commercialized in the United States by Biogen Inc. and Coherus BioSciences, Inc. Ophthalmologists are also using off-label, third-party repackaged versions of Genentech/Roche's approved VEGF antagonist, bevacizumab, for the treatment of certain of EYLEA's indications, and we are aware of another company developing an ophthalmic formulation of such product. In DME and RVO, EYLEA also competes with intravitreal implants of corticosteroids. We are also aware of a number of companies working on the development of product candidates and extended delivery devices for the potential treatment of one or more of EYLEA's indications, including those that act by blocking VEGF and VEGF receptors (including therapies designed to extend the treatment interval) and/or other targets. In addition, we are aware of several companies developing biosimilar versions of EYLEA and other approved anti-VEGF treatments. Other potentially competitive products in development include products for use in combination with EYLEA and/or other anti-VEGF treatments, small-molecule tyrosine kinase inhibitors, gene therapies, and other eye-drop formulations, devices, and oral therapies. There also is a risk that third parties repackage ZALTRAP for off-label use and sale for the treatment of diseases of the eye, even though ZALTRAP has not been manufactured and formulated for use in intravitreal injections. We are aware of claims by third parties, including those based on published clinical data, alleging that ZALTRAP may be safely administered to the eye. If approved, we expect that aflibercept 8 mg will be entering a highly competitive environment; and our success in potentially commercializing aflibercept 8 mg will depend on a number of factors, including the extent to which we and our collaborators are able to differentiate aflibercept 8 mg from competitive products and the applicability of any restrictions imposed by payors at the time, such as step therapy. Dupixent. The market for Dupixent's current and potential future indications is also increasingly competitive. In atopic dermatitis, there are topical and systemic JAK inhibitors and an antibody against IL-13 approved for atopic dermatitis and others are in development. In addition, a number of companies are developing antibodies against IL-4Ra, IL-13Ra1, OX40(L), and/or IL-31R that may compete with Dupixent in atopic dermatitis and other indications (including asthma and/or prurigo nodularis), as applicable. In asthma, competitors to Dupixent include antibodies against the IL-5 ligand or the IL-5 receptor, immunoglobulin E, or thymic stromal lymphopoietin ("TSLP"); and some of these antibodies are either approved or in development for indications that also compete or may compete in the future with Dupixent in CRSwNP and EoE. There are several other potentially competitive products in development that may compete with Dupixent in asthma, as well as potential future indications, including antibodies against the IL-33 ligand or receptor. Dupixent also faces competition from inhaled products in asthma and potential future indications.Libtayo. Libtayo also faces significant competition. There are several competitors that are marketing and/or developing antibodies against PD-1 and/or PDL-1 (some of which were approved in the relevant indications and commercialized before Libtayo), including Merck's Keytruda, Bristol-Myers Squibb's Opdivo, Roche's Tecentriq, and AstraZeneca's Imfinzi.Other marketed products. There is also significant actual and potential future competition for other products marketed or otherwise commercialized by us and/or our collaborators under our collaboration agreements with them. For example, there are several companies that are marketing and/or developing antibodies or other molecules (such as small interfering RNA molecules, or siRNAs) against PCSK9, ANGPTL3 and IL-6 and/or IL-6R, which currently (or, for product candidates in development, may in the future if approved) compete with Praluent, Evkeeza, and Kevzara, respectively.45Table of ContentsProduct CandidatesOur VelocImmune technology, other antibody generation technologies, and late-stage and earlier-stage clinical candidates face competition from many pharmaceutical and biotechnology companies using various technologies, including antibody generation technologies and other approaches such as RNAi, chimeric antigen receptor T cell (CAR-T cell), and gene therapy technologies. For example, we are aware of other pharmaceutical and biotechnology companies actively engaged in the research and development of antibody-based products against targets that are also the targets of our early- and late-stage product candidates. We are also aware of other companies developing or marketing small molecules or other treatments that may compete with our antibody-based product candidates in various indications, if such product candidates obtain regulatory approval in those indications. If any of these or other competitors announces a successful clinical study involving a product that may be competitive with one of our product candidates or the grant of marketing approval by a regulatory agency for a competitive product, such developments may have an adverse effect on our business or future prospects. In addition, the first product to reach the market in a therapeutic area is often at a significant competitive advantage relative to later entrants to the market. Accordingly, the relative speed with which we, or our collaborators, can develop our product candidates, complete the clinical trials and approval processes, and, if such product candidates are approved for marketing and sale, supply commercial quantities to the market is expected to continue to be an important competitive factor. Due to the uncertainties associated with developing biopharmaceutical products, we may not be the first to obtain marketing approval for a product against any particular target, which may have a material adverse effect on our business or future prospects.We rely on our collaborations with Bayer and Sanofi for commercializing some of our marketed products.While we have established our own sales and marketing organization for EYLEA in the United States for its currently approved indications, we have no sales, marketing, commercial, or distribution capabilities for EYLEA outside the United States. Under the terms of our license and collaboration agreement with Bayer (which is terminable by Bayer at any time upon six or twelve months' advance notice, depending on the circumstances giving rise to termination), we rely on Bayer (and, in Japan, Santen pursuant to a Co-Promotion and Distribution Agreement with Bayer's Japanese affiliate) for sales, marketing, and distribution of EYLEA (and, if approved, will rely on Bayer for such activities relating to aflibercept 8 mg) in countries outside the United States.In addition, under the terms of our Antibody Collaboration, we and Sanofi co-commercialize Dupixent in the United States and, as further discussed below, certain jurisdictions outside the United States. As a result, we rely in part on Sanofi's sales and marketing organization for Dupixent. If we and Sanofi fail to coordinate our sales and marketing efforts effectively, sales of Dupixent may be materially affected. Sanofi also maintains other important responsibilities relating to Dupixent. For example, Sanofi records product sales for Dupixent in the United States and leads negotiations with payors relating to this product. We also rely on Sanofi for sales, marketing, and distribution of Dupixent in countries outside the United States. While we exercised our option under the Antibody Collaboration to co-commercialize Dupixent in certain jurisdictions outside the United States, we will continue to rely in part on Sanofi's sales and marketing organization in such jurisdictions.If we and our collaborators are unsuccessful in continuing to commercialize the marketed products subject to such collaborations, or if Bayer or Sanofi terminate their respective collaborations with us, our business, prospects, operating results, and financial condition would be materially impaired. We have limited commercial capabilities outside the United States and would have to develop or outsource these capabilities. Therefore, termination of the Bayer collaboration agreement or our Antibody Collaboration would create substantial new and additional risks to the successful commercialization of the applicable products, particularly outside the United States. For additional information regarding our collaborations with Bayer and Sanofi, see "Risks Related to Our Reliance on or Transactions with Third Parties - If our collaboration with Bayer for EYLEA is terminated, or Bayer materially breaches its obligations thereunder, our business, prospects, operating results, and financial condition, and our ability to continue to commercialize EYLEA outside the United States would be materially harmed" below and "Risks Related to Our Reliance on or Transactions with Third Parties - If our Antibody Collaboration with Sanofi is terminated, or Sanofi materially breaches its obligations thereunder, our business, prospects, operating results, and financial condition, and our ability to develop, manufacture, and commercialize certain of our products and product candidates in the time expected, or at all, would be materially harmed" below.Sales of our marketed products recorded by us and our collaborators could be reduced by imports from countries where such products may be available at lower prices.Our sales of products we commercialize in the United States and our collaborators' sales of products they commercialize or co-commercialize with us under our collaboration agreements with them in the United States and other countries (which impact our share of any profits or losses from the commercialization of these products under the relevant collaboration agreements and, therefore, our results of operations) may be reduced if the applicable product is imported into those countries from lower priced markets, whether legally or illegally (a practice known as parallel trading or reimportation). Parallel traders (who may repackage or otherwise alter the original product or sell it through alternative channels such as mail order or the Internet) take advantage of 46Table of Contentsthe price differentials between markets arising from factors including sales costs, market conditions (such as intermediate trading stages), tax rates, or national regulation of prices. Under our arrangement with Bayer, pricing and reimbursement for EYLEA outside the United States is the responsibility of Bayer. Similarly, under our Antibody Collaboration with Sanofi, pricing and reimbursement for the products commercialized or co-commercialized thereunder outside the United States are the responsibility of Sanofi. Prices for our marketed products in jurisdictions outside the United States are based on local market economics and competition and are likely to differ from country to country. In the United States, prices for pharmaceuticals are generally higher than in the bordering nations of Canada and Mexico and sales of our marketed products in the United States may be reduced if the applicable product marketed in those bordering nations is imported into the United States. In addition, there are proposals to legalize the import of pharmaceuticals from outside the United States into the United States. If such proposals were implemented, our future revenues derived from sales of our marketed products could be reduced. Parallel-trading practices also are of particular relevance to the EU, where they have been encouraged by the current regulatory framework. These types of imports may exert pressure on the pricing of our marketed products in a particular market or reduce sales recorded by us or our collaborators, thereby adversely affecting our results of operations.We may be unsuccessful in continuing the commercialization of our marketed products or in commercializing our product candidates or new indications for our marketed products, if approved, which would materially and adversely affect our business, profitability, and future prospects.Even if clinical trials demonstrate the safety and effectiveness of any of our product candidates for a specific disease and the necessary regulatory approvals are obtained, the commercial success of any of our product candidates or new indications for our marketed products will depend upon, among other things, their acceptance by patients, the medical community, and third-party payors and on our and our collaborators' ability to successfully manufacture, market, and distribute those products in substantial commercial quantities or to establish and manage the required infrastructure to do so, including large-scale information technology systems and a large-scale distribution network. Establishing and maintaining sales, marketing, and distribution capabilities are expensive and time-consuming. Even if we obtain regulatory approval for our product candidates or new indications, if they are not successfully commercialized, we will not be able to recover the significant investment we have made in developing such products and our business, prospects, operating results, and financial condition would be severely harmed.The commercial success of our products may also be adversely affected by guidelines or recommendations to healthcare providers, administrators, payors, and patient communities that result in decreased use of our products. Such guidelines or recommendations may be published not only by governmental agencies, but also professional societies, practice management groups, private foundations, and other interested parties.Our product candidates are delivered either by intravenous infusion or by intravitreal or subcutaneous injections, which are generally less well received by patients than tablet or capsule delivery and this could adversely affect the commercial success of those products if they receive marketing approval.We are dependent upon a small number of customers for a significant portion of our revenue, and the loss of or significant reduction in sales to these customers would adversely affect our results of operations.We sell our marketed products for which we record net product sales in the United States to several distributors and specialty pharmacies, as applicable, which generally sell the product directly to healthcare providers or other pharmacies (as applicable). For the years ended December 31, 2022 and 2021, our gross product sales of such products to two customers accounted on a combined basis for 83% and 48% of our total gross product revenue, respectively, and gross product sales of REGEN-COV to the U.S. government accounted for an additional 43% of our total gross product revenue for the year ended December 31, 2021. We expect significant customer concentration to continue for the foreseeable future. Our ability to generate and grow sales of these products will depend, in part, on the extent to which our distributors and specialty pharmacies are able to provide adequate distribution of these products to healthcare providers. Although we believe we can find additional distributors, if necessary, our revenue during any period of disruption could suffer and we might incur additional costs. In addition, these customers are responsible for a significant portion of our net trade accounts receivable balances. The loss of any large customer, a significant reduction in sales we make to them, any cancellation of orders they have made with us, or any failure to pay for the products we have shipped to them could adversely affect our results of operations.If we are unable to establish commercial capabilities outside the United States for products we intend to commercialize or co-commercialize outside the United States, our business, prospects, operating results, and financial condition may be adversely affected.We have limited commercial capabilities outside the United States and do not currently have a fully established organization for the sales, marketing, and distribution of marketed products outside the United States. We will need to establish some or all of these capabilities outside the United States for any product we decide to independently commercialize or co-commercialize outside the United States. For example, following the exercise of our option under the Antibody Collaboration to co-47Table of Contentscommercialize Dupixent in certain jurisdictions outside the United States, we have established certain commercial capabilities for Dupixent in some of these jurisdictions and are in the process of establishing these capabilities in others. In addition, in 2022, we and Sanofi amended the IO Collaboration to transfer all rights to develop, commercialize, and manufacture Libtayo exclusively to our Company, on a worldwide basis, over the course of a defined transition period, and we will need to establish certain sales, marketing, distribution, and manufacturing capabilities for Libtayo to support certain markets outside the United States. See Part I, Item 1. "Business - Collaboration, License, and Other Agreements - Sanofi." We will also need to obtain and/or maintain regulatory approvals for Libtayo in many jurisdictions outside of the United States. There may be other circumstances in which we need to establish commercial capabilities outside the United States, including because we decide to commercialize a particular product independently; we are unable to find an appropriate collaborator; or an existing collaborator decides to opt out or breaches its obligations to us with respect to a particular product.In order to commercialize or co-commercialize any products outside the United States, we must build our sales, marketing, distribution, regulatory, managerial, and other capabilities in the relevant markets or make arrangements with third parties to perform these services, any of which will likely be expensive and time consuming and could delay product launch or the co-commercialization of a product in one or more markets outside the United States. We cannot be certain that we will be able to successfully develop commercial capabilities outside the United States (including as it relates to Dupixent and Libtayo) within an acceptable time frame, without incurring substantial expenses, or at all. These and other difficulties relating to commercializing our products outside the United States may harm our business, prospects, operating results, and financial condition.Risks Related to Maintaining Approval of Our Marketed Products and the Development and Obtaining Approval of Our Product Candidates and New Indications for Our Marketed ProductsIf we or our collaborators do not maintain regulatory approval for our marketed products, and obtain regulatory approval for our product candidates or new indications for our marketed products, we will not be able to market or sell them, which would materially and negatively impact our business, prospects, operating results, and financial condition.We cannot sell or market products without regulatory approval or other authorization. If we or our collaborators do not maintain regulatory approval for our marketed products, and obtain regulatory approval for our product candidates or new indications of our marketed products (or are materially delayed in doing so), the value of our Company and our business, prospects, operating results, and financial condition may be materially harmed.Obtaining and maintaining regulatory approval for drug products is costly, time-consuming, and highly uncertain.In the United States, we (which, for purposes of this risk factor, includes our collaborators, unless otherwise stated or required by the context) must obtain and maintain approval from the FDA for each drug we intend to sell. Obtaining FDA approval for a new drug or indication is typically a lengthy and expensive process, and approval is highly uncertain. We cannot predict with certainty if or when we might submit for regulatory approval for any of our product candidates currently under development. Any approvals we may obtain may not cover all of the clinical indications for which we are seeking approval. Also, an approval might contain significant limitations in the form of narrow indications, warnings, precautions, or contra-indications with respect to conditions of use. Additionally, the FDA may determine that a REMS is necessary to ensure that the benefits of a new product outweigh its risks, and the product can therefore be approved. A REMS may include various elements, ranging from a medication guide or patient package insert to limitations on who may prescribe or dispense the drug, depending on what the FDA considers necessary for the safe use of the drug. The FDA has substantial discretion in the approval process (including with respect to setting specific conditions for submission) and may either refuse to accept an application for substantive review or may form the opinion after review of an application that the application is insufficient to allow approval of a product candidate. If the FDA does not accept our application for review or approve our application, it may require that we conduct additional clinical, preclinical, or manufacturing validation studies and submit the data before it will reconsider our application. Depending on the extent of these or any other studies that might be required, approval of any applications that we submit may be delayed significantly, or we may be required to expend more resources. It is also possible that any such additional studies, if performed and completed, may not be considered sufficient by the FDA to make our applications approvable. If any of these outcomes occur, we may be forced to delay or abandon our applications for approval.In certain instances (such as when we use a biomarker-based test to identify and enroll specific patients in a clinical trial), regulatory approval of a companion diagnostic to our therapeutic product candidate may be required as a condition to regulatory approval of the therapeutic product candidate. We may need to rely on third parties to provide companion diagnostics for use with our product candidates. Such third parties may be unable or unwilling on terms acceptable to us to provide such companion diagnostics or to obtain timely regulatory approval of or product labeling updates for such companion diagnostics, which could negatively impact regulatory approval of our product candidates or may result in increased development costs or delays.The FDA may also require us to conduct additional clinical trials after granting approval of a product. The FDA has the explicit authority to require post-marketing studies (also referred to as post-approval or Phase 4 studies), labeling changes based on new 48Table of Contentssafety information, and compliance with FDA-approved risk evaluation and mitigation strategies. Post-approval studies, whether conducted by us or by others and whether mandated by regulatory agencies or voluntary, and other data about our marketed products (or data about products similar to our marketed products that implicate an entire class of products or are perceived to do so) may result in changes in product labeling, restrictions on use, product withdrawal or recall, loss of approval, or lower sales of our products. Obligations equivalent in scope, but which can vary widely in application, apply in foreign countries.According to the FDA policies under the Prescription Drug User Fee Act, the FDA system of review times for new drugs includes standard review and priority review. The FDA's goal for a standard review is to review the application within a 10-month time frame from the time the application is filed by the FDA (filing date), which typically occurs approximately 60 days following submission of the application by the applicant. The FDA has stated the goal to act on 90% of standard new molecular entity ("NME") New Drug Application ("NDA") and original BLA submissions within 10 months of the filing date. A priority review designation is given to drugs that treat a serious condition and offer major advances in treatment, or provide a treatment where no adequate therapy exists, and may also be afforded to a human drug application based on a priority review voucher. The FDA has stated the goal to act on 90% of priority NME NDA and original BLA submissions within six months of the filing date. However, the FDA's review goals are subject to change and the duration of the FDA's review depends on a number of factors, including the number and types of other applications that are submitted to the FDA around the same time period or are pending, and may be delayed for reasons beyond our control. For example, an FDA travel complication related to scheduling a routine clinical trial site inspection in eastern Europe recently delayed the FDA's approval of our sBLA for the combination treatment of Libtayo with chemotherapy in NSCLC. If we believe we meet eligibility requirements, we may apply for various regulatory incentives in the United States, such as breakthrough therapy designation, fast track designation, accelerated approval, or priority review, where available, that serve to expedite drug development and/or review, and we may also seek similar designations elsewhere in the world. Often, regulatory agencies have broad discretion in determining whether or not product candidates qualify for such regulatory incentives and benefits, and we cannot guarantee we would be successful in obtaining beneficial regulatory designations by the FDA or other regulatory agencies. Even if obtained, such designations may not result in faster development processes, reviews, or approvals compared to drugs considered for approval under conventional FDA procedures. In addition, the FDA may later decide that any of our development programs no longer meets the conditions for a beneficial regulatory designation (including due to factors beyond our control, such as intervening competitive developments) or decide that the time period for FDA review or approval will not be shortened.The FDA and comparable foreign regulatory authorities enforce GCPs and other regulations and legal requirements through periodic inspections of trial sponsors, clinical research organizations ("CROs"), principal investigators, and trial sites. If we or any of the third parties conducting our clinical studies are determined to have failed to fully comply with GCPs, the study protocol or applicable regulations, the clinical data generated in those studies may be deemed unreliable. This and similar instances of non-compliance with GCPs could result in non-approval of our product candidates by the FDA or foreign regulatory authorities such as the EC, or we or the FDA or such other regulatory authorities may decide to conduct additional inspections or require additional clinical studies, which would delay our development programs, require us to incur additional costs, and could substantially harm our business, prospects, operating results, and financial condition.Before approving a new drug or biologic product, the FDA and such comparable foreign regulatory authorities require that the facilities at which the product will be manufactured or advanced through the supply chain be in compliance with current Good Manufacturing Practices, or cGMP, requirements and regulations governing the manufacture, shipment, and storage of the product. Additionally, manufacturers of biological products and their facilities are subject to payment of substantial user fees and continual review and periodic inspections by the FDA and other regulatory authorities for compliance with cGMP regulations and adherence to any commitments made in the applicable BLA. These cGMP requirements and regulations are not prescriptive instructions on how to manufacture products, but rather a series of principles that must be observed during manufacturing; as a result, their implementation may not be clearly delineated and may present a challenging task. Manufacturing product candidates in compliance with these regulatory requirements is complex, time-consuming, and expensive. To be successful, our products must be manufactured in compliance with regulatory requirements, and at competitive costs. If we or any of our third-party manufacturers, product packagers, labelers, or other parties performing steps in the supply chain are unable to maintain regulatory compliance with cGMP, the FDA and comparable foreign regulatory authorities can impose monetary penalties or other civil or criminal sanctions, including, among other things, refusal to approve a pending application for a new drug or biologic product, or revocation of a pre-existing approval. For additional information, see "Risks Related to Manufacturing and Supply - Our or our collaborators' failure to meet the stringent requirements of governmental regulation in the manufacture of drug products or product candidates could result in incurring substantial remedial costs, delays in the development or approval of our product candidates or new indications for our marketed products and/or in their commercial launch if regulatory approval is obtained, and a reduction in sales." Our business, prospects, operating results, and financial condition may be materially harmed as a result of noncompliance with the requirements and regulations described in this paragraph.49Table of ContentsWe are also subject to ongoing requirements imposed by the FDA and comparable foreign regulatory authorities governing the labeling, packaging, storage, distribution, safety surveillance, advertising, promotion, record-keeping, and reporting of safety and other post-marketing information. The holder of an approved BLA or foreign equivalent is obligated to monitor and report adverse events and any failure of a product to meet the specifications in the BLA. The holder of an approved BLA or foreign equivalent must also submit new or supplemental applications and obtain FDA approval for certain changes to the approved product, product labeling, or manufacturing process. Advertising and promotional materials must comply with FDA regulations and those of foreign regulatory authorities and may be subject to other potentially applicable federal and state laws. The applicable regulations in countries outside the U.S. grant similar powers to the competent authorities and impose similar obligations on companies.In addition to the standard drug approval process, the Secretary of HHS may authorize the issuance of, and the FDA Commissioner may issue, an EUA to allow an unapproved medical product to be used in an emergency based on criteria established by the Food, Drug, and Cosmetic Act, including that the product at issue may be effective in diagnosing, treating, or preventing serious or life-threatening diseases when there are no adequate, approved, and available alternatives. An EUA terminates when the emergency determination underlying the EUA terminates. The FDA may also revoke, revise, or restrict an EUA for a variety of reasons, including where it is determined that the underlying health emergency no longer exists or warrants such authorization or the medical product is no longer effective in diagnosing, treating, or preventing the underlying health emergency. For example, in January 2022, the FDA revised the EUA previously granted for REGEN-COV to exclude its use in geographic regions (currently including all U.S. states, territories, and jurisdictions) where, based on available information including variant susceptibility and regional variant frequency, infection or exposure is likely due to a variant such as an Omicron-lineage variant that is not susceptible to the treatment. Any such termination, revocation, or revision of an EUA could adversely impact our business in a variety of ways, including by having to absorb related manufacturing and overhead costs as well as potential inventory write-offs if regulatory approval is not obtained timely or at all. For example, we have recorded a charge to write down inventory related to REGEN-COV as described in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations."In addition to the FDA and other regulatory agency regulations in the United States, we are subject to a variety of foreign regulatory requirements governing human clinical trials, manufacturing, marketing and approval of drugs, and commercial sale and distribution of drugs in foreign countries. The foreign regulatory approval process is similarly a lengthy and expensive process, the result of which is highly uncertain, and foreign regulatory requirements include all of the risks associated with FDA approval as well as country specific regulations. We and our collaborators must maintain regulatory compliance for the products we or they commercialize in foreign jurisdictions. From time to time, we may hold a product's marketing approval in a jurisdiction outside the United States where we may have less experience and where our regulatory capabilities may be more limited. In addition, actions by a regulatory agency in a country or region with respect to a product candidate may have an impact on the approval process for that product candidate in another country or region. Foreign regulatory authorities may ask for additional data in order to begin a clinical study, including Phase 3 clinical trials required to submit a Marketing Authorization Application ("MAA") in the EU. In addition, such authorities often have the authority to require post-approval studies, such as a PASS and/or PAES, which involve various risks similar to those described above. Whether or not we obtain FDA approval for a product in the United States, we must obtain approval of the product by the comparable regulatory authorities in foreign countries before we can market that product or any other product in those countries.Furthermore, we are subject to pharmacovigilance reporting and other pharmacovigilance requirements, which may differ in the numerous countries in which we conduct clinical trials. Failure to comply with any such requirements may result in the premature closure of the clinical trials and other enforcement actions by the relevant regulatory authorities. For example, if we do not manage to retain a QPPV, to maintain a PSMF, or to comply with other pharmacovigilance obligations in the EEA, we may be at risk of our clinical trials being closed prematurely, our marketing authorization being suspended, and we may be subject to other enforcement actions by the national competent authorities of the EEA or the EC. Preclinical and clinical studies required for our product candidates and new indications of our marketed products are expensive and time-consuming, and their outcome is highly uncertain. If any such studies are delayed or yield unfavorable results, regulatory approval for our product candidates or new indications of our marketed products may be delayed or become unobtainable.As described above, we must conduct extensive testing of our product candidates and new indications of our marketed products before we can obtain regulatory approval to market and sell them. We need to conduct both preclinical animal testing and human clinical trials. Conducting such studies is a lengthy, time-consuming, and expensive process. These tests and trials may not achieve favorable results for many reasons, including, among others, failure of the product candidate to demonstrate safety or efficacy, the development of serious or life-threatening adverse events (or side effects) caused by or connected with exposure to the product candidate (or prior or concurrent exposure to other products or product candidates), difficulty in enrolling and maintaining subjects in a clinical trial, clinical trial design that may not make it possible to enroll or retain a sufficient number of 50Table of Contentspatients to achieve a statistically significant result or the desired level of statistical significance for the endpoint in question, lack of sufficient supplies of the product candidate or comparator drug, and the failure of clinical investigators, trial monitors, contractors, consultants, or trial subjects to comply with the trial plan, protocol, or applicable regulations related to the FDA's GLPs or GCPs. A clinical trial may also fail because the dose(s) of the investigational drug included in the trial were either too low or too high to determine the optimal effect of the investigational drug in the disease setting.Additionally, conducting clinical trials in foreign countries presents additional risks, including political and economic risks that are not present in the United States, such as armed conflict and economic embargoes or boycotts. For example, we and our collaborators are currently conducting and may in the future conduct or initiate clinical trials with sites in Russia and/or Ukraine. While we currently do not expect the conflict between Russia and Ukraine and related developments to have a significant impact on our ability to obtain results from clinical trials conducted by us or our collaborators, actions taken by Russia or potentially other countries in Ukraine and surrounding areas may adversely affect our ability to adequately conduct certain clinical trials and maintain compliance with relevant protocols due to, among other reasons, the prioritization of hospital resources away from clinical trials, reallocation or evacuation of site staff and subjects, or as a result of government-imposed curfews, warfare, violence, or other governmental action or other events that restrict movement. These developments may also result in our inability to access sites for monitoring or to obtain data from affected sites or patients going forward. We could also experience disruptions in our supply chain or limits to our ability to provide sufficient investigational materials in Ukraine and surrounding regions. Clinical trial sites may suspend or terminate the trials being conducted and patients could be forced to evacuate or choose to relocate, making them unavailable for initial or further participation in such trials. Alternative sites in these areas may not be available and we may need to find other countries to conduct the relevant trials. Furthermore, military action may prevent the FDA or other regulatory agencies from inspecting clinical sites in these countries. Such interruptions may delay our plans for clinical development and approvals for our product candidates.We will need to reevaluate any drug candidate that does not test favorably and either conduct new studies, which are expensive and time consuming, or abandon that drug development program. If preclinical testing yields unfavorable results, product candidates may not advance to clinical trials. The failure of clinical trials to demonstrate the safety and effectiveness of our clinical candidates for the desired indication(s) would preclude the successful development of those candidates for such indication(s), in which event our business, prospects, operating results, and financial condition may be materially harmed.Furthermore, some of our products and product candidates (such as Libtayo) are studied in combination with agents and treatments developed by us or our collaborators. There may be additional risks and unforeseen safety issues resulting from such combined administration, any of which may materially adversely impact clinical development of these product candidates and our ability to obtain regulatory approval.In some jurisdictions such as the EU, initiating Phase 3 clinical trials and clinical trials in the pediatric population is subject to a requirement to obtain approval or a waiver from the competent authorities of the EU Member States and/or the EMA. If we do not obtain such approval, our ability to conduct clinical trials and obtain marketing authorizations or approvals may be severely impaired and our business may be adversely impacted.Certain of our research and development activities are conducted at our existing facilities primarily located in Tarrytown, New York. As we continue to expand, we may lease, operate, purchase, or construct additional facilities to expand our research and development capabilities in the future. Expanding our research and laboratory facilities may require significant time and resources. Further, we may be unable to pursue our research and development efforts if the relevant facility were to cease operations due to fire, climate change, natural disasters, acts of war or terrorism, or other disruptions. Any related delays may interfere with our research and development efforts and our business may be adversely impacted.Successful development of our current and future product candidates is uncertain.Only a small minority of all research and development programs ultimately result in commercially successful drugs. Clinical trials may not demonstrate statistically sufficient effectiveness and safety to obtain the requisite regulatory approvals for these product candidates in these indications. Many companies in the biopharmaceutical industry, including our Company, have suffered significant setbacks in clinical trials, even after promising results had been obtained in earlier trials. In a number of instances, we have terminated the development of product candidates due to a lack of or only modest effectiveness and/or safety concerns, and clinical trials evaluating our product candidates have failed to meet the relevant endpoints. Moreover, even if we obtain positive results from preclinical testing or clinical trials, we may not achieve the same success in future trials, or the FDA and analogous foreign regulatory authorities may deem the results insufficient for an approval. Many of our clinical trials are conducted under the oversight of Independent Data Monitoring Committees ("IDMCs"). These independent oversight bodies are made up of external experts who review the progress of ongoing clinical trials, including available safety and efficacy data, and make recommendations concerning a trial's continuation, modification, or termination based on interim, unblinded data. Any of our ongoing clinical trials may be discontinued or amended in response to 51Table of Contentsrecommendations made by responsible IDMCs based on their review of such interim trial results. For example, we previously discontinued actively treating patients with fasinumab following a recommendation from the responsible IDMC that the program be terminated based on available evidence to date; and we later discontinued further clinical development of fasinumab. The recommended termination or material modification of any of our ongoing late-stage clinical trials by an IDMC could negatively impact the future development of our product candidate(s), and our business, prospects, operating results, and financial condition may be materially harmed.We are studying our product candidates in a wide variety of indications in clinical trials. Many of these trials are exploratory studies designed to evaluate the safety profile of these compounds and to identify what diseases and uses, if any, are best suited for these product candidates. These product candidates may not demonstrate the requisite efficacy and/or safety profile to support continued development for some or all of the indications that are being, or are planned to be, studied, which would diminish our clinical "pipeline" and could negatively affect our future prospects and the value of our Company.Serious complications or side effects in connection with the use of our products and in clinical trials for our product candidates and new indications for our marketed products could cause our regulatory approvals to be revoked or limited or lead to delay or discontinuation of development of our product candidates or new indications for our marketed products, which could severely harm our business, prospects, operating results, and financial condition.During the conduct of clinical trials, patients report changes in their health, including illnesses, injuries, and discomforts, to their study doctor. Often, it is not possible to determine whether or not the drug candidate being studied caused these conditions. Various illnesses, injuries, and discomforts have been reported from time-to-time during clinical trials of our product candidates and new indications for our marketed products. It is possible that as we test our drug candidates or new indications in larger, longer, and more extensive clinical programs, or as use of these drugs becomes more widespread if they receive regulatory approval, illnesses, injuries, and discomforts that were observed in earlier trials, as well as conditions that did not occur or went undetected in previous trials, will be reported by patients. Many times, side effects are only detectable after investigational drugs are tested in large-scale, Phase 3 clinical trials or, in some cases, after they are made available to patients after approval. If additional clinical experience indicates that any of our product candidates or new indications for our marketed products has many side effects or causes serious or life-threatening side effects, the development of the product candidate may be delayed or fail, or, if the product candidate has received regulatory approval, such approval may be revoked, which would severely harm our business, prospects, operating results, and financial condition.With respect to EYLEA and aflibercept 8 mg, there are many potential safety concerns associated with significant blockade of VEGF that may limit our ability to further successfully commercialize EYLEA and to obtain regulatory approval for aflibercept 8 mg. These serious and potentially life-threatening risks, based on clinical and preclinical experience of VEGF inhibitors, include bleeding, intestinal perforation, hypertension, proteinuria, congestive heart failure, heart attack, and stroke. Other VEGF blockers have reported side effects that became evident only after large-scale trials or after marketing approval when large numbers of patients were treated. There are risks inherent in the intravitreal administration of drugs like aflibercept (such as intraocular inflammation ("IOI"), sterile and culture positive endophthalmitis, corneal decomposition, retinal detachment, and retinal tear), which can cause injury to the eye and other complications. The side effects previously reported for aflibercept include conjunctival hemorrhage, macular degeneration, eye pain, retinal hemorrhage, and vitreous floaters. There is no guarantee that we will be able to successfully obtain regulatory approval for aflibercept 8 mg. In addition, commercialization of EYLEA or our other products and potential future commercialization of aflibercept 8 mg or our other product candidates may be impacted by actions of third parties on which we rely, such as manufacturers of syringes or other devices used in the administration of our products. These and other complications or issues or side effects could harm further development and/or commercialization of EYLEA as well as further development and potential future commercialization of aflibercept 8 mg. Dupixent and Libtayo are being studied in additional indications, as shown in the table under Part I, Item 1. "Business - Programs in Clinical Development." There is no guarantee that regulatory approval of Dupixent or Libtayo (as applicable) in any of these indications will be successfully obtained. The side effects previously reported for Dupixent include hypersensitivity reactions, eye problems (including conjunctivitis and keratitis), injection-site reactions, eye and eyelid inflammation, cold sores, oropharyngeal pain, eosinophilia, insomnia, toothache, gastritis, joint pain (arthralgia), parasitic (helminth) infections, and facial rash or redness; and the side effects previously reported for Libtayo include certain immune-mediated adverse reactions that may occur in any organ system or tissue, including pneumonitis, colitis, hepatitis, endocrinopathies, nephritis, and dermatologic reactions, as well as infusion-related reactions, cellulitis, sepsis, pneumonia, urinary tract infection, fatigue, rash, and diarrhea. These and other complications or side effects could harm further development and/or commercialization of Dupixent and Libtayo (as applicable).There also are risks inherent in subcutaneous injections (which are used for administering most of our antibody-based products and product candidates), such as injection-site reactions (including redness, itching, swelling, pain, and tenderness) and other side effects. In addition, there are risks inherent in intravenous administration (which are used for some of our antibody-based products and product candidates), such as infusion-related reactions (including nausea, pyrexia, rash, and dyspnea). These and other 52Table of Contentscomplications or side effects could harm further development and/or commercialization of our antibody-based products and product candidates utilizing this method of administration.Many of our product candidates in development are recombinant proteins that could cause an immune response, resulting in the creation of harmful or neutralizing antibodies against the therapeutic protein.In addition to the safety, efficacy, manufacturing, and regulatory hurdles faced by our product candidates, the administration of recombinant proteins frequently causes an immune response, sometimes resulting in the creation of antibodies against the therapeutic protein. The antibodies can have no effect or can totally neutralize the effectiveness of the protein, or require that higher doses be used to obtain a therapeutic effect. In some cases, the antibody can cross-react with the patient's own proteins, resulting in an "auto-immune" type disease. Whether antibodies will be created can often not be predicted from preclinical or clinical experiments, and their detection or appearance is often delayed, so neutralizing antibodies may be detected at a later date, in some cases even after pivotal clinical trials have been completed.We may be unable to formulate or manufacture our product candidates in a way that is suitable for clinical or commercial use, which would delay or prevent continued development of such candidates and/or receipt of regulatory approval or commercial sale, which could materially harm our business, prospects, operating results, and financial condition.If we are unable to continue to develop suitable product formulations or manufacturing processes to support large-scale clinical testing of our product candidates, including our antibody-based product candidates, we may be unable to supply necessary materials for our clinical trials, which would delay or prevent the development of our product candidates. Similarly, if we are unable, directly or through our collaborators or third parties, to supply sufficient quantities of our products or develop formulations of our product candidates suitable for commercial use, we will be unable to obtain regulatory approval for those product candidates.Many of our products are intended to be used and, if approved, our product candidates may be used in combination with drug-delivery devices, which may result in additional regulatory, commercialization, and other risks.Many of our products are used and some of our products and product candidates may be used, if approved, in combination with a drug-delivery device, including a pre-filled syringe, patch pump, auto-injector, or other delivery system. For example, in the United States and the EU, EYLEA is approved in the 2mg pre-filled syringe. The success of our products and product candidates may depend to a significant extent on the performance of such devices, some of which may be novel or comprised of complex components. Given the increased complexity of the review process when approval of the product and device is sought under a single marketing application and the additional risks resulting from a product candidate's designation as a combination product discussed below, our product candidates used with such drug-delivery devices may be substantially delayed in receiving regulatory approval or may not be approved at all. The FDA review process and criteria for such applications are not well established, which could also lead to delays in the approval process. In addition, some of these drug-delivery devices may be provided by single-source, third-party providers or our collaborators. In any such case, we may be dependent on the sustained cooperation of those third-party providers or collaborators to supply and manufacture the devices; to conduct the studies and prepare related documentation required for approval or clearance by the applicable regulatory agencies; and to continue to meet the applicable regulatory and other requirements to maintain approval or clearance once it has been received. In addition, other parties may allege that our drug-delivery devices infringe patents or other intellectual property rights. For example, we are currently party to patent infringement and other proceedings relating to the EYLEA pre-filled syringe, as described in Note 16 to our Consolidated Financial Statements. Failure to successfully develop or supply the devices, delays in or failure of the studies conducted by us, our collaborators, or third-party providers, or failure of our Company, our collaborators, or the third-party providers to obtain or maintain regulatory approval or clearance of the devices could result in increased development costs, delays in or failure to obtain regulatory approval, and associated delays in a product or product candidate reaching the market. Loss of regulatory approval or clearance of a device that is used with our product may also result in the removal of our product from the market. Further, failure to successfully develop or supply and manufacture these devices, or to gain or maintain their approval, could adversely affect sales of the related products.In the United States, each component of a combination product is subject to the requirements established by the FDA for that type of component, whether a drug, biologic, or device. The determination whether a product is a combination product or two separately regulated products is made by the FDA on a case-by-case basis. Although a single marketing application is generally sufficient for the approval, clearance, or licensure of a combination product, the FDA may determine that separate marketing applications are necessary. In addition, submitting separate marketing applications may be necessary to receive some benefit that accrues only from approval under a particular type of application. This could significantly increase the resources and time required to bring a particular combination product to market.53Table of ContentsRisks Related to Intellectual Property and Market ExclusivityFor purposes of this subsection, references to our intellectual property (including patents, trademarks, copyrights, and trade secrets) include that of our collaborators and licensees, unless otherwise stated or required by the context.If we cannot protect the confidentiality of our trade secrets, or our patents or other means of defending our intellectual property are insufficient to protect our proprietary rights, our business and competitive position will be harmed.Our business requires using sensitive and proprietary technology and other information that we protect as trade secrets. We seek to prevent improper disclosure of these trade secrets through confidentiality agreements and other means. If our trade secrets are improperly disclosed, by our current or former employees, our collaborators, or otherwise, it could help our competitors and adversely affect our business. We will be able to protect our proprietary rights only to the extent that our proprietary technologies and other information are covered by valid and enforceable patents or are effectively maintained as trade secrets. The patent position of biotechnology companies, including our Company, involves complex legal and factual questions and, therefore, enforceability cannot be predicted with certainty. Our patents may be challenged, invalidated, held to be unenforceable, or circumvented. For example, certain of our U.S. patents (including those pertaining to our key products, such as EYLEA) have been and may in the future be challenged by parties who file a request for post-grant review or inter partes review under the America Invents Act of 2011 or ex parte reexamination, as described in Note 16 to our Consolidated Financial Statements included in this report. Post-grant proceedings are increasingly common in the United States and are costly to defend. In addition, patent applications filed outside the United States may be challenged by other parties, for example, by filing pre-grant third-party observations that argue against patentability or a post-grant opposition. Such opposition proceedings are increasingly common in Europe and are costly to defend. For example, in 2021, anonymous parties initiated opposition proceedings in the European Patent Office ("EPO") against our European Patent No. 2,944,306 (which concerns pre-filled syringes comprising ophthalmic formulations containing VEGF antagonists such as aflibercept for intravitreal administration), as described in Note 16 to our Consolidated Financial Statements included in this report. We have pending patent applications in the United States Patent and Trademark Office (the "USPTO"), the EPO, and the patent offices of other foreign jurisdictions, and it is likely that we will need to defend patents from challenges by others from time to time in the future. Our patent rights may not provide us with a proprietary position or competitive advantages against competitors. Furthermore, even if the outcome is favorable to us, the enforcement of our intellectual property rights can be extremely expensive and time consuming.Changes in either the patent laws or their interpretation in the United States and other countries may diminish our ability to protect our inventions or our ability to obtain, maintain, and enforce our intellectual property rights. Any such changes could also affect the value of our intellectual property or narrow the scope of our patents. For example, the World Trade Organization ("WTO") is currently considering an extension of a recently adopted waiver of certain intellectual property rights under the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights for COVID-19 vaccines to include therapeutics. The timing of a decision on whether or not to extend the waiver is unknown. We cannot be certain that our intellectual property rights related to our COVID-19 monoclonal antibodies or any other current or future product or product candidate or technology would not be eliminated, narrowed, or weakened by any such extension or other rulemaking.Additionally, the United States and other government actions related to Russia's invasion of Ukraine may limit or prevent filing, prosecution, and maintenance of patent applications in Russia. These actions could result in abandonment or lapse of our patents or patent applications, resulting in partial or complete loss of patent rights in Russia. Further, a decree was adopted by the Russian government in March 2022, allowing Russian companies and individuals to exploit inventions owned by patent holders from the United States without consent or compensation. Consequently, we would not be able to prevent third parties from practicing our inventions in Russia or from selling or importing products made using our inventions in and into Russia.We also currently hold issued trademark registrations and have trademark applications pending in the United States and other jurisdictions, any of which may be the subject of a governmental or third-party objection, which could prevent the maintenance or issuance of the trademark. As our products mature, our reliance on our trademarks to differentiate us from our competitors increases and as a result, if we are unable to prevent third parties from adopting, registering, or using trademarks that infringe, dilute or otherwise violate our trademark rights, our business could be adversely affected. We may be restricted in our development, manufacturing, and/or commercialization activities by patents or other proprietary rights of others, and could be subject to awards of damages if we are found to have infringed such patents or rights.Our commercial success depends significantly on our ability to operate without infringing the patents and other proprietary rights of others (including those relating to trademarks, copyrights, and trade secrets). Other parties may allege that they own blocking patents to our products in clinical development or even to products that have received regulatory approval and are being or have been commercialized, either because they claim to hold proprietary rights to the composition of a product or the way it is manufactured or the way it is used. Moreover, other parties may allege that they have blocking patents to antibody-based products 54Table of Contentsmade using our VelocImmune technology, or any other of our technologies, either because of the way the antibodies are discovered or produced or because of a proprietary composition covering an antibody or the antibody's target.We have been in the past, are currently, and may in the future be involved in patent litigation and other proceedings involving patents and other intellectual property. For example, we and/or Sanofi are currently party to patent infringement proceedings initiated by Amgen against us and/or Sanofi relating to Praluent, as described in Note 16 to our Consolidated Financial Statements. In addition, we are currently party to patent infringement and other proceedings relating to EYLEA and REGEN-COV, as described in Note 16 to our Consolidated Financial Statements.We are aware of patents and pending patent applications owned by others that claim compositions and methods of treatment relating to targets and conditions that we are also pursuing with our products and/or product candidates. Although we do not believe that any of our products or our late-stage antibody-based product candidates infringe any valid claim in these patents or patent applications, these other parties could initiate lawsuits for patent infringement and assert that their patents are valid and cover our products or our late-stage antibody-based product candidates, similar to the patent infringement proceedings referred to above. Further, we are aware of a number of patent applications of others that, if granted with claims as currently drafted, may cover our current or planned activities. It could be determined that our products and/or actions in manufacturing or selling our products or product candidates infringe such patents.Patent holders could assert claims against us for damages and seek to prevent us from manufacturing, selling, or developing our products or product candidates, and a court may find that we are infringing validly issued patents of others. In the event that the manufacture, use, or sale of any of our products or product candidates infringes on the patents or violates other proprietary rights of others, we may be prevented from pursuing product development, manufacturing, and commercialization of those drugs and may be required to pay costly damages. In addition, in the event that we assert our patent rights against other parties that we believe are infringing our patent rights, such parties may challenge the validity of our patents and we may become the target of litigation, which may result in an outcome that is unfavorable to us. Any of these adverse developments may materially harm our business, prospects, operating results, and financial condition. In any event, legal disputes are likely to be costly and time consuming to defend.We seek to obtain licenses to patents when, in our judgment, such licenses are needed or advisable. For example, in 2018, we and Sanofi entered into a license agreement with Bristol-Myers Squibb, E. R. Squibb & Sons, and Ono Pharmaceutical to obtain a license under certain patents owned and/or exclusively licensed by one or more of these parties that includes the right to develop and sell Libtayo. If any licenses are required, we may not be able to obtain such licenses on commercially reasonable terms, if at all. The failure to obtain any such license could prevent us from developing or commercializing any one or more of our products or product candidates, which could severely harm our business.In addition, other parties may have regulatory exclusivity in the United States or foreign jurisdictions for products relating to targets or conditions we are also pursuing, which could prevent or delay our ability to apply for or obtain regulatory approval for our product candidates in such jurisdictions. For example, in the EU, a designated orphan drug is provided up to 10 years of market exclusivity in the orphan indication, during which time the EMA is generally precluded from accepting a MAA for a similar medicinal product unless it can be demonstrated that it is safer, more effective, or otherwise clinically superior to the original orphan medicinal product.Loss or limitation of patent rights, and regulatory pathways for biosimilar competition, could reduce the duration of market exclusivity for our products.In the pharmaceutical and biotechnology industries, the majority of an innovative product's commercial value is usually realized during the period in which it has market exclusivity. In the United States and some other countries, when market exclusivity expires and generic versions of a product are approved and marketed, there usually are very substantial and rapid declines in the product's sales.If our late-stage product candidates or other clinical candidates are approved for marketing in the United States or elsewhere, market exclusivity for those products will generally be based upon patent rights and/or certain regulatory forms of exclusivity. As described above under "If we cannot protect the confidentiality of our trade secrets, or our patents or other means of defending our intellectual property are insufficient to protect our proprietary rights, our business and competitive position will be harmed," the scope and enforceability of our patent rights may vary from country to country. The failure to obtain patent and other intellectual property rights, or limitations on the use, or the loss, of such rights could materially harm us. Absent patent protection or regulatory exclusivity for our products, it is possible, both in the United States and elsewhere, that generic, biosimilar, and/or interchangeable versions of those products may be approved and marketed, which would likely result in substantial and rapid reductions in revenues from sales of those products.55Table of ContentsUnder the PPACA, there is an abbreviated path in the United States for regulatory approval of products that are demonstrated to be "biosimilar" or "interchangeable" with an FDA-approved biological product. The PPACA provides a regulatory mechanism that allows for FDA approval of biologic drugs that are similar to innovative drugs on the basis of less extensive data than is required by a full BLA. Under this regulation, an application for approval of a biosimilar may be filed four years after approval of the innovator product. However, qualified innovative biological products receive 12 years of regulatory exclusivity, meaning that the FDA may not approve a biosimilar version until 12 years after the innovative biological product was first approved by the FDA. However, the term of regulatory exclusivity may not remain at 12 years in the United States and could be shortened if, for example, the PPACA is amended.A number of jurisdictions outside of the United States have also established abbreviated pathways for regulatory approval of biological products that are biosimilar to earlier versions of biological products. For example, the EU has had an established regulatory pathway for biosimilars since 2005.The increased likelihood of biosimilar competition has increased the risk of loss of innovators' market exclusivity. It is also not possible to predict changes in United States regulatory law that might reduce biological product regulatory exclusivity. Due to this risk, and uncertainties regarding patent protection, it is not possible to predict the length of market exclusivity for any particular product we currently or may in the future commercialize with certainty based solely on the expiration of the relevant patent(s) or the current forms of regulatory exclusivity. We are aware of several companies developing biosimilar versions of EYLEA, as discussed further under "Risks Related to Commercialization of Our Marketed Products, Product Candidates, and New Indications for Our Marketed Products - The commercial success of our products and product candidates is subject to significant competition - Marketed Products" above. In the United States, the regulatory exclusivity period for EYLEA (i.e., the period during which no biosimilar product can be approved by the FDA) extends through May 17, 2024 following the pediatric exclusivity granted by the FDA. The loss of market exclusivity for a product (such as EYLEA) would likely materially and negatively affect revenues from product sales of that product and thus our financial results and condition.Risks Related to Manufacturing and SupplyWe rely on limited internal and contracted manufacturing and supply chain capacity, which could adversely affect our ability to commercialize our marketed products and, if approved, our product candidates and to advance our clinical pipeline.We have large-scale manufacturing operations in Rensselaer, New York and Limerick, Ireland. Manufacturing facilities operated by us and by third-party contract manufacturers engaged by us would be inadequate to produce the active pharmaceutical ingredients of our current marketed products and our product candidates in sufficient clinical quantities if our clinical pipeline advances as planned. In addition to expanding our internal capacity, we intend to continue to rely on our collaborators, and may also rely on contract manufacturers, to produce commercial quantities of drug material needed for commercialization of our products. For example, as described in Part I, Item 1. "Business," in 2020, we entered into a collaboration agreement with Roche to develop, manufacture, and distribute REGEN-COV (known as Ronapreve in other countries outside the United States). As we increase our production in anticipation of potential regulatory approval for our product candidates, our current manufacturing capacity will likely not be sufficient, and our dependence on our collaborators and/or contract manufacturers may increase, to produce adequate quantities of drug material for both commercial and clinical purposes. The COVID-19 pandemic has exacerbated and may in the future further exacerbate certain of these risks. For example, the impact of prioritizing certain manufacturing-related resources for our COVID-19 monoclonal antibodies has included and may in the future include, among other things, drawing down inventory safety stock levels for certain of our other products (including Dupixent and EYLEA). Depending on the demand for our products (including any future demand for our COVID-19 monoclonal antibodies), our ability to re-establish successfully our customary manufacturing cadence, and other relevant factors, we may not be able to replenish our inventory safety stock to the levels we deem prudent or supply our products and product candidates in sufficient quantities to satisfy our commercial and development needs. We also rely entirely on other parties and our collaborators for filling and finishing services. Generally, in order for other parties to perform any step in the manufacturing and supply chain, we must transfer technology to the other party, which can be time consuming and may not be successfully accomplished without considerable cost and expense, or at all. We will have to depend on these other parties to perform effectively on a timely basis and to comply with regulatory requirements. If for any reason they are unable to do so, and as a result we are unable to directly or through other parties manufacture and supply sufficient commercial and clinical quantities of our products on acceptable terms, or if we should encounter delays or other difficulties with our collaborators, contract manufacturers, warehouses, shipping, testing laboratories, or other parties involved in our supply chain which adversely affect the timely manufacture and supply of our products or product candidates, our business, prospects, operating results, and financial condition may be materially harmed.56Table of ContentsExpanding our manufacturing capacity and establishing fill/finish capabilities will be costly and we may be unsuccessful in doing so in a timely manner, which could delay or prevent the launch and successful commercialization of our marketed products and product candidates or other indications for our marketed products if they are approved for marketing and could jeopardize our current and future clinical development programs.In addition to our existing manufacturing facilities in Rensselaer, New York and Limerick, Ireland, we may lease, operate, purchase, or construct additional facilities to conduct expanded manufacturing or other related activities in the future. Expanding our manufacturing capacity to supply commercial quantities of the active pharmaceutical ingredients for our marketed products and our product candidates if they are approved for marketing, and to supply clinical drug material to support the continued growth of our clinical programs, will require substantial additional expenditures, time, and various regulatory approvals and permits. This also holds true for establishing fill/finish capabilities in the future, for which we are in the process of constructing fill/finish facilities (refer to Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources" for information about expected capital expenditures relating to this and other projects). In addition, we may need to develop or acquire additional manufacturing capabilities to the extent we or our collaborators pursue the development of drugs generated by means other than our existing "Trap" or VelociSuite technologies, such as siRNA gene silencing, genome editing, and targeted viral-based gene delivery and expression. Further, we will need to hire and train significant numbers of employees and managerial personnel to staff our expanding manufacturing and supply chain operations, as well as any future fill/finish activities. Start-up costs can be large, and scale-up entails significant risks related to process development and manufacturing yields. In addition, we may face difficulties or delays in developing or acquiring the necessary production equipment and technology to manufacture sufficient quantities of our product candidates at reasonable costs and in compliance with applicable regulatory requirements. The FDA and analogous foreign regulatory authorities must determine that our existing and any expanded manufacturing facilities and any future fill/finish activities comply, or continue to comply, with cGMP requirements for both clinical and commercial production and license them, or continue to license them, accordingly, and such facilities must also comply with applicable environmental, safety, and other governmental permitting requirements. We may not successfully expand or establish sufficient manufacturing or any future fill/finish capabilities or manufacture our products economically or in compliance with cGMPs and other regulatory requirements, and we and our collaborators may not be able to build or procure additional capacity in the required timeframe to meet commercial demand for our product candidates if they receive regulatory approval, and to continue to meet the requirements of our clinical programs. This would interfere with our efforts to successfully commercialize our marketed products, and it could also delay or require us to discontinue one or more of our clinical development programs. As a result, our business, prospects, operating results, and financial condition could be materially harmed.Our ability to manufacture products may be impaired if any of our or our collaborators' manufacturing activities, or the activities of other third parties involved in our manufacture and supply chain, are found to infringe patents of others.Our ability to continue to manufacture products in our Rensselaer, New York and Limerick, Ireland facilities and at additional facilities (if any) in the future (including our ability to conduct any fill/finish activities in the future), the ability of our collaborators to manufacture products at their facilities, and our ability to utilize other third parties to produce our products, to supply raw materials or other products, or to perform fill/finish services or other steps in our manufacture and supply chain, depends on our and their ability to operate without infringing the patents or other intellectual property rights of others. Other parties may allege that our or our collaborators' manufacturing activities, or the activities of other third parties involved in our manufacture and supply chain (which may be located in jurisdictions outside the United States), infringe patents or other intellectual property rights. For example, we are currently party to patent infringement and other proceedings relating to the EYLEA pre-filled syringe, as described in Note 16 to our Consolidated Financial Statements. A judicial or regulatory decision in favor of one or more parties making such allegations could directly or indirectly preclude the manufacture of our products to which those intellectual property rights apply on a temporary or permanent basis, which could materially harm our business, prospects, operating results, and financial condition.57Table of ContentsIf sales of our marketed products do not meet the levels currently expected, or if the launch of any of our product candidates is delayed or unsuccessful, we may face costs related to excess inventory or unused capacity at our manufacturing facilities and at the facilities of third parties or our collaborators.We use our manufacturing facilities primarily to produce bulk product for commercial supply of our marketed products and clinical and preclinical candidates for ourselves and our collaborations. We also plan to use such facilities to produce bulk product for commercial supply of new indications of our marketed products and new product candidates if they are approved for marketing or otherwise authorized for use. If our clinical candidates are discontinued or their clinical development is delayed, if the launch of new indications for our marketed products or new product candidates is delayed or does not occur, or if such products are launched and the launch is unsuccessful or the product is subsequently recalled or marketing approval is rescinded, we may have to absorb one hundred percent of related overhead costs and inefficiencies, as well as similar costs of third-party contract manufacturers performing services for us. In addition, if we or our collaborators experience excess inventory, it may be necessary to write down or write off such excess inventory or incur an impairment charge with respect to the facility where such product is manufactured, which could adversely affect our operating results. For example, during each of the years ended December 31, 2022 and 2021, we recorded a charge to write down inventory related to REGEN-COV as described in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations."Third-party service or supply failures, or other failures, business interruptions, or other disasters affecting our manufacturing facilities in Rensselaer, New York and Limerick, Ireland, the manufacturing facilities of our collaborators, or the facilities of any other party participating in the supply chain, would adversely affect our ability to supply our products.Bulk drug materials are currently manufactured at our manufacturing facilities in Rensselaer, New York and Limerick, Ireland, as well as at our collaborators' facilities. We and our collaborators would be unable to manufacture these materials if the relevant facility were to cease production due to regulatory requirements or actions, business interruptions, labor shortages or disputes, supply chain interruptions or constraints (including with respect to natural gas and other raw materials), contaminations, fire, climate change, natural disasters, acts of war or terrorism, or other problems.Many of our products and product candidates are very difficult to manufacture. As our products and most of our product candidates are biologics, they require processing steps that are more difficult than those required for many other chemical pharmaceuticals. Accordingly, multiple steps are needed to control the manufacturing processes. Problems with these manufacturing processes, even minor deviations from the normal process or from the materials used in the manufacturing process (which may not be detectable by us or our collaborators in a timely manner), could lead to product defects or manufacturing failures, resulting in lot failures, product recalls, product liability claims, and insufficient inventory. Also, the complexity of our manufacturing process may make it difficult, time-consuming, and expensive to transfer our technology to our collaborators or contract manufacturers.Also, certain raw materials or other products necessary for the manufacture and formulation of our marketed products and product candidates, some of which are difficult to source, are provided by single-source unaffiliated third-party suppliers. In addition, we rely on certain third parties or our collaborators to perform filling, finishing, distribution, laboratory testing, and other services related to the manufacture of our marketed products and product candidates, and to supply various raw materials and other products. We would be unable to obtain these raw materials, other products, or services for an indeterminate period of time if any of these third parties were to cease or interrupt production or otherwise fail to supply these materials, products, or services to us for any reason, including due to regulatory requirements or actions (including recalls), adverse financial developments at or affecting the supplier, failure by the supplier to comply with cGMPs, contaminations, business interruptions, or labor shortages or disputes (in each case, including as a result of the COVID-19 pandemic and Russia's invasion of Ukraine, which have exacerbated many of these issues). In any such circumstances, we may not be able to engage a backup or alternative supplier or service provider in a timely manner or at all. This, in turn, could materially and adversely affect our or our collaborators' ability to manufacture or supply marketed products and product candidates, which could materially and adversely affect our business and future prospects.Certain of the raw materials required in the manufacture and testing of our products and product candidates may be derived from biological sources, including mammalian tissues, bovine serum, and human serum albumin. There are certain regulatory restrictions on using these biological source materials. If we or our collaborators are required to substitute for these sources to comply with such regulatory requirements, our clinical development or commercial activities may be delayed or interrupted.58Table of ContentsOur or our collaborators' failure to meet the stringent requirements of governmental regulation in the manufacture of drug products or product candidates could result in incurring substantial remedial costs, delays in the development or approval of our product candidates or new indications for our marketed products and/or in their commercial launch if regulatory approval is obtained, and a reduction in sales.We and our collaborators and other third-party providers are required to maintain compliance with cGMPs, and are subject to inspections by the FDA or comparable agencies in other jurisdictions to confirm such compliance. Changes of suppliers or modifications of methods of manufacturing may require amending our application(s) to the FDA or such comparable foreign agencies and acceptance of the change by the FDA or such comparable foreign agencies prior to release of product(s). Because we produce multiple products and product candidates at our facilities in Rensselaer, New York and Limerick, Ireland, there are increased risks associated with cGMP compliance. Our inability, or the inability of our collaborators and third-party fill/finish or other service providers, to demonstrate ongoing cGMP compliance could require us to engage in lengthy and expensive remediation efforts, withdraw or recall product, halt or interrupt clinical trials, and/or interrupt commercial supply of any marketed products, and could also delay or prevent our obtaining regulatory approval for our product candidates or new indications for our marketed products. Any delay, interruption, or other issue that arises in the manufacture, fill/finish, packaging, or storage of any drug product or product candidate as a result of a failure of our facilities or the facilities or operations of our collaborators or other third parties to pass any regulatory agency inspection or maintain cGMP compliance could significantly impair our ability to develop, obtain approval for, and successfully commercialize our products, which would substantially harm our business, prospects, operating results, and financial condition. Any finding of non-compliance could also increase our costs, cause us to delay the development of our product candidates, result in delay in our obtaining, or our not obtaining, regulatory approval of product candidates or new indications for our marketed products, and cause us to lose revenue from any marketed products, which could be seriously detrimental to our business, prospects, operating results, and financial condition. Significant noncompliance could also result in the imposition of monetary penalties or other civil or criminal sanctions and damage our reputation.Other Regulatory and Litigation RisksIf the testing or use of our products harms people, or is perceived to harm them even when such harm is unrelated to our products, we could be subject to costly and damaging product liability claims.The testing, manufacturing, marketing, and sale of drugs for use in people expose us to product liability risk. Any informed consent or waivers obtained from people who enroll in our clinical trials may not protect us from liability or the cost of litigation. We may also be subject to claims by patients who use our approved products, or our product candidates if those product candidates receive regulatory approval and become commercially available, that they have been injured by a side effect associated with the drug. Even in a circumstance in which we do not believe that an adverse event is related to our products or product candidates, the related investigation may be time consuming or inconclusive and may have a negative impact on our reputation or business. We may face product liability claims and be found responsible even if injury arises from the acts or omissions of third parties who provide fill/finish or other services. To the extent we maintain product liability insurance in relevant periods, such insurance may not cover all potential liabilities or may not completely cover any liability arising from any such litigation. Moreover, in the future we may not have access to liability insurance or be able to maintain our insurance on acceptable terms.Our business activities have been, and may in the future be, challenged under U.S. federal or state and foreign healthcare laws, which may subject us to civil or criminal proceedings, investigations, or penalties.The FDA regulates the marketing and promotion of our products, which must comply with the Food, Drug, and Cosmetic Act and applicable FDA implementing standards. The FDA's review of promotional activities includes healthcare provider-directed and direct-to-consumer advertising, communications regarding unapproved uses, industry-sponsored scientific and educational activities, and sales representatives' communications. Failure to comply with applicable FDA requirements and restrictions in this area may subject a company to adverse enforcement action by the FDA, the Department of Justice, or the Office of the Inspector General of the HHS, as well as state authorities. This could subject a company to a range of penalties that could have a significant commercial impact, including civil and criminal fines and agreements that materially restrict the manner in which a company promotes or distributes a drug. Any such failures could also cause significant reputational harm. The FDA may take enforcement action for promoting unapproved uses of a product or other violations of its advertising laws and regulations. The applicable regulations in countries outside the U.S. grant similar powers to the competent authorities and impose similar obligations on companies.59Table of ContentsIn addition to FDA and related regulatory requirements, we are subject to health care "fraud and abuse" laws, such as the federal civil False Claims Act, the anti-kickback provisions of the federal Social Security Act, and other state and federal laws and regulations. The U.S. federal healthcare program anti-kickback statute (the "AKS") prohibits, among other things, knowingly and willfully offering, paying, soliciting, or receiving payments or other remuneration, directly or indirectly, to induce or reward someone to purchase, prescribe, endorse, arrange for, or recommend a product or service that is reimbursed under federal healthcare programs such as Medicare or Medicaid. If we provide payments or other remuneration to a healthcare professional to induce the prescribing of our products, we could face liability under state and federal anti-kickback laws. The Bipartisan Budget Act of 2018 has increased the criminal and civil penalties that can be imposed for violating certain federal health care laws, including the federal anti-kickback statute.The federal civil False Claims Act prohibits any person from, among other things, knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, or causing to be made, a false statement to get a false claim paid. The False Claims Act also permits a private individual acting as a "whistleblower" to bring actions on behalf of the federal government alleging violations of the statute and to share in any monetary recovery. Pharmaceutical companies have been investigated and/or prosecuted under these laws for a variety of alleged promotional and marketing activities, such as allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product; reporting to pricing services inflated average wholesale prices that were then used by federal programs to set reimbursement rates; engaging in promotion for uses that the FDA has not approved, known as off-label uses, that caused claims to be submitted to Medicaid for non-covered off-label uses; and submitting inflated best price information to the Medicaid Rebate program. Pharmaceutical and other healthcare companies also are subject to other federal false claims laws, including, among others, federal criminal fraud and false statement statutes that extend to non-government health benefit programs.The majority of states also have statutes or regulations similar to the federal anti-kickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. Sanctions under these federal and state laws may include civil monetary penalties, damages, exclusion of a manufacturer's products from reimbursement under government programs, criminal fines, and imprisonment for individuals and the curtailment or restructuring of operations. Even if it is determined that we have not violated these laws, government investigations into these issues typically require the expenditure of significant resources and generate negative publicity, which would harm our business, prospects, operating results, and financial condition. Because of the breadth of these laws and the narrowness of the safe harbors, it is possible that some of our business activities could be challenged under one or more of such laws. As described further in Note 16 to our Consolidated Financial Statements included in this report, we are party to civil litigation initiated in 2020 by the U.S. Attorney's Office for the District of Massachusetts concerning our support of a 501(c)(3) organization that provides financial assistance to patients; and we are cooperating with pending government investigations concerning certain other business activities. Any adverse decision, finding, allegation, or exercise of enforcement or regulatory discretion in any such proceedings or investigations could harm our business, prospects, operating results, and financial condition.As part of the PPACA, the federal government requires that pharmaceutical manufacturers record any "transfers of value" made to U.S. licensed physicians and teaching hospitals as well as ownership and investment interests held by physicians and their immediate family members. Information provided by companies is aggregated and posted annually on an "Open Payments" website, which is managed by CMS, the agency responsible for implementing these disclosure requirements. Applicable manufacturers also are required to report information regarding payments and transfers of value provided to physician assistants, nurse practitioners, clinical nurse specialists, certified nurse anesthetists, anesthesiologist assistants, and certified nurse-midwives. We also have similar reporting obligations in other countries based on laws, regulations, and/or industry trade association requirements.We continue to dedicate significant resources to comply with these requirements and need to be prepared to comply with additional reporting obligations outside the United States that may apply in the future. In addition, several states have legislation requiring pharmaceutical companies to establish marketing compliance programs, file periodic reports with the state, or make periodic public disclosures on sales, marketing, pricing, clinical trials, and other activities; restrict when pharmaceutical companies may provide meals or gifts to prescribers or engage in other marketing-related activities; require identification or licensing of sales representatives; and restrict the ability of manufacturers to offer co-pay support to patients for certain prescription drugs. Many of these requirements and standards are new or uncertain, and the penalties for failure to comply with these requirements may be unclear. If we are found not to be in full compliance with these laws, we could face enforcement actions, fines, and other penalties, and could receive adverse publicity, which would harm our business, prospects, operating results, and financial condition. Additionally, access to such data by fraud-and-abuse investigators and industry critics may draw scrutiny to our collaborations with reported entities.60Table of ContentsIf we fail to comply with our reporting and payment obligations under the Medicaid Drug Rebate program or other governmental pricing programs, we could be subject to additional reimbursement requirements, penalties, sanctions and fines, which could have a material adverse effect on our business, financial condition, results of operations, and future prospects.We participate in the Medicaid Drug Rebate program, the Public Health Service's 340B drug pricing program (the "340B program") (which is administered by the Health Resources and Services Administration ("HRSA")), the U.S. Department of Veterans Affairs ("VA") Federal Supply Schedule ("FSS") pricing program, and the Tricare Retail Pharmacy Program. See Part I, Item 1, "Business - Government Regulation - Pricing and Reimbursement" for a description of these programs.Pricing and rebate calculations vary across products and programs, are complex, and are often subject to interpretation by us, governmental or regulatory agencies, and the courts. Such interpretation can change and evolve over time. In the case of our Medicaid pricing data, if we become aware that our reporting for a prior quarter was incorrect, or has changed as a result of recalculation of the pricing data, we are obligated to resubmit the corrected data for up to three years after those data originally were due. Such restatements and recalculations increase our costs for complying with the laws and regulations governing the Medicaid Drug Rebate program and could result in an overage or underage in our rebate liability for past quarters. Price recalculations also may affect the ceiling price at which we are required to offer our products under the 340B program.Civil monetary penalties can be applied if we are found to have knowingly submitted any false price or product information to the government, if we are found to have made a misrepresentation in the reporting of our average sales price, if we fail to submit the required price data on a timely basis, or if we are found to have charged 340B covered entities more than the statutorily mandated ceiling price. CMS could also decide to terminate our Medicaid drug rebate agreement, or HRSA could decide to terminate our 340B program participation agreement, in which case federal payments may not be available under Medicaid or Medicare Part B for our covered outpatient drugs.Our failure to comply with our reporting and payment obligations under the Medicaid Drug Rebate program and other governmental programs could negatively impact our financial results. The final regulation governing the Medicaid Drug Rebate program issued by CMS has increased and will continue to increase our costs and the complexity of compliance, has been and will continue to be time-consuming to implement, and could have a material adverse effect on our results of operations, particularly if CMS challenges the approach we have taken in our implementation of the final regulation. Other regulations and coverage expansion by various governmental agencies relating to the Medicaid Drug Rebate program may have a similar impact.In addition, the final regulation issued by HRSA regarding the calculation of the 340B ceiling price and the imposition of civil monetary penalties on manufacturers that knowingly and intentionally overcharge covered entities has affected our obligations and potential liability under the 340B program. We are also required to report the 340B ceiling prices for our covered outpatient drugs to HRSA, which then publishes them to 340B covered entities. Any charge by HRSA that we have violated the requirements of the program or the regulation could negatively impact our financial results. Moreover, under a final regulation effective January 13, 2021, HRSA established an ADR process for claims by covered entities that a manufacturer has engaged in overcharging, and by manufacturers that a covered entity violated the prohibitions against diversion or duplicate discounts. Such claims are to be resolved through an ADR panel of government officials rendering a decision that could be appealed only in federal court. An ADR proceeding could subject us to onerous procedural requirements and could result in additional liability. On November 30, 2022, HRSA issued a notice of proposed rulemaking that proposes several changes to the ADR process. Further, any additional future changes to the definition of average manufacturer price and the Medicaid rebate amount under the PPACA or otherwise could affect our 340B ceiling price calculations and negatively impact our results of operations. We have obligations to report the average sales price for certain of our drugs to the Medicare program. Statutory or regulatory changes or CMS guidance could affect the average sales price calculations for our products and the resulting Medicare payment rate, and could negatively impact our results of operations.Starting in 2023, manufacturers must pay refunds to Medicare for single-source drugs or biological products, or biosimilar biological products, reimbursed under Medicare Part B and packaged in single-dose containers or single-use packages for units of discarded drug reimbursed by Medicare Part B in excess of 10 percent of total allowed charges under Medicare Part B for that drug. Manufacturers that fail to pay refunds could be subject to civil monetary penalties of 125 percent of the refund amount.Pursuant to applicable law, knowing provision of false information in connection with price reporting or contract‑based requirements under the VA/FSS and/or Tricare programs can subject a manufacturer to civil monetary penalties. These program and contract-based obligations also contain extensive disclosure and certification requirements. If we overcharge the government in connection with our arrangements with FSS or Tricare, we are required to refund the difference to the government. Failure to make necessary disclosures or to identify contract overcharges can result in allegations against us under the False Claims Act and other laws and regulations. Unexpected refunds to the government, and/or response to a government investigation or enforcement action, would be expensive and time-consuming, and could have a material adverse effect on our business, financial condition, results of operations, and future prospects.61Table of ContentsRisks from the improper conduct of employees, agents, contractors, or collaborators could adversely affect our reputation and our business, prospects, operating results, and financial condition.We cannot ensure that our compliance controls, policies, and procedures will in every instance protect us from acts committed by our employees, agents, contractors, or collaborators that would violate the laws or regulations of the jurisdictions in which we operate, including, without limitation, healthcare, employment, foreign corrupt practices, trade restrictions and sanctions, environmental, competition, and privacy laws and regulations. Such improper actions could subject us to civil or criminal investigations, and monetary and injunctive penalties, and could adversely impact our ability to conduct business, operating results, and reputation.In particular, our business activities outside the United States (which have recently increased, and are expected to continue to increase, due to, in part, our efforts to establish our commercialization and co-commercialization capabilities in certain jurisdictions outside the United States) are subject to the Foreign Corrupt Practices Act, or FCPA, and similar anti-bribery or anti-corruption laws, regulations or rules of other countries in which we operate, including the U.K. Bribery Act. The FCPA generally prohibits offering, promising, giving, or authorizing others to give anything of value, either directly or indirectly, to a non-U.S. government official in order to influence official action, or otherwise obtain or retain business. The FCPA also requires public companies to make and keep books and records that accurately and fairly reflect the transactions of the corporation and to devise and maintain an adequate system of internal accounting controls. Our business is heavily regulated and therefore involves significant interaction with public officials, including officials of non-U.S. governments. Additionally, in many other countries, the health care providers who prescribe pharmaceuticals are employed by their government, and the purchasers of pharmaceuticals are government entities; therefore, our dealings with these prescribers and purchasers are subject to regulation under the FCPA. Recently the SEC and Department of Justice have increased their FCPA enforcement activities with respect to pharmaceutical companies. There is no certainty that all of our employees, agents, contractors, or collaborators, or those of our affiliates, will comply with all applicable laws and regulations, particularly given the high level of complexity of these laws. Violations of these laws and regulations could result in fines, criminal sanctions against us, our officers, or our employees, requirements to obtain export licenses, cessation of business activities in sanctioned countries, implementation of compliance programs, and prohibitions on the conduct of our business. Any such violations could include prohibitions on our ability to offer our products in one or more countries and could materially damage our reputation, our brand, our ability to expand internationally, our ability to attract and retain employees, and our business, prospects, operating results, and financial condition.Our operations are subject to environmental, health, and safety laws and regulations, including those governing the use of hazardous materials. Compliance with these laws and regulations is costly, and we may incur substantial liability arising from our activities involving the use of hazardous materials.As a fully integrated biotechnology company with significant research and development and manufacturing operations, we are subject to extensive environmental, health, and safety laws and regulations, including those governing the use of hazardous materials. Our research and development and manufacturing activities involve the controlled use of chemicals, infectious agents (such as viruses, bacteria, and fungi), radioactive compounds, and other hazardous materials. The cost of compliance with environmental, health, and safety regulations is substantial. If an accident involving these materials or an environmental discharge were to occur, we could be held liable for any resulting damages, or face regulatory actions, which could exceed our resources or insurance coverage.Our business is subject to increasingly complex corporate governance, public disclosure, and accounting requirements and regulations that could adversely affect our business, operating results, and financial condition.We are subject to changing rules and regulations of various federal and state governmental authorities as well as the stock exchange on which our Common Stock is listed. These entities, including the SEC and The NASDAQ Stock Market LLC, have issued a significant number of new and increasingly complex requirements and regulations over the course of the last several years and continue to develop additional requirements and regulations. For example, in March 2022, the SEC proposed new rules for extensive and prescriptive climate-related disclosure in annual reports and registration statements, which would also require inclusion of certain climate-related financial metrics in companies' audited financial statements. Also in March 2022, the SEC proposed rules that are intended to enhance and standardize disclosures regarding cybersecurity risk management, strategy, and governance, as well as cybersecurity incident reporting, by public companies. Our efforts to comply with these requirements and regulations (as well as corporate governance and disclosure expectations of investors and other stakeholders) have resulted in, and are likely to continue to result in, an increase in expenses and a diversion of management's time from other business activities.62Table of ContentsChanges in laws and regulations affecting the healthcare industry could adversely affect our business.All aspects of our business, including research and development, manufacturing, marketing, pricing, sales, intellectual property rights, and the framework for dispute resolution and asserting our rights against others, are subject to extensive legislation and regulation. Changes in applicable federal and state laws and agency regulations could have a materially negative impact on our business. These include:•changes in the FDA and foreign regulatory processes for new therapeutics that may delay or prevent the approval of any of our current or future product candidates;•new laws, regulations, or judicial decisions related to healthcare availability or the payment for healthcare products and services, including prescription drugs, that would make it more difficult for us to market and sell products once they are approved by the FDA or foreign regulatory agencies;•changes in FDA and foreign regulations that may require additional safety monitoring prior to or after the introduction of new products to market, which could materially increase our costs of doing business; and•changes in FDA and foreign cGMP requirements that may make it more difficult and costly for us to maintain regulatory compliance and/or manufacture our marketed product and product candidates in accordance with cGMPs.As described above, the PPACA and potential regulations thereunder easing the entry of competing follow-on biologics into the marketplace, other new legislation or implementation of existing statutory provisions on importation of lower-cost competing drugs from other jurisdictions, and legislation on comparative effectiveness research are examples of previously enacted and possible future changes in laws that could adversely affect our business.The U.S. federal or state governments could carry out other significant changes in legislation, regulation, or government policy, including with respect to government reimbursement changes or drug price control measures (such as those discussed above under "Risks Related to Commercialization of Our Marketed Products, Product Candidates, and New Indications for Our Marketed Products - Sales of our marketed products are dependent on the availability and extent of reimbursement from third-party payors, and changes to such reimbursement may materially harm our business, prospects, operating results, and financial condition") or the PPACA or other healthcare reform laws. While it is not possible to predict whether and when any such changes will occur, changes in the laws, regulations, and policies governing the development and approval of our product candidates and the commercialization, importation, and reimbursement of our products could adversely affect our business. In addition, our development and commercialization activities could be harmed or delayed by a shutdown of the U.S. government, including the FDA. For example, a prolonged shutdown may significantly delay the FDA's ability to timely review and process any submissions we have filed or may file or cause other regulatory delays, which could materially and adversely affect our business.Risks associated with our operations outside the United States could adversely affect our business.We have operations and conduct business in several countries outside the United States and we plan to expand these activities. For example, as discussed above, we perform co-commercialization activities under the Antibody Collaboration related to Dupixent in certain jurisdictions outside the United States and we will need to establish commercial capabilities related to Libtayo in certain markets outside the United States following the amendment to the IO Collaboration. Consequently, we are, and will continue to be, subject to risks related to operating in foreign countries, and many of these risks will increase as we expand our activities in such jurisdictions. These risks include:•unfamiliar foreign laws or regulatory requirements or unexpected changes to those laws or requirements, including those with which we and/or our collaborators must comply in order to maintain our marketing authorizations outside the United States;•other laws and regulatory and industry trade association requirements to which our business activities abroad are subject, such as the FCPA and the U.K. Bribery Act (discussed in greater detail above under "Risks from the improper conduct of employees, agents, contractors, or collaborators could adversely affect our reputation and our business, prospects, operating results, and financial condition");•changes in the political or economic condition of a specific country or region, including as a result of Russia's invasion of Ukraine;•fluctuations in the value of foreign currency versus the U.S. dollar;•tariffs, trade protection measures, import or export licensing requirements, trade embargoes, and sanctions (including those administered by the Office of Foreign Assets Control of the U.S. Department of the Treasury), and other trade barriers; •difficulties in attracting and retaining qualified personnel; and •cultural differences in the conduct of business.We have large-scale manufacturing operations in Limerick, Ireland and have also established offices in the United Kingdom, Germany, and other countries outside the United States. Changes impacting our ability to conduct business in the those countries, 63Table of Contentsor changes to the regulatory regime applicable to our operations in those countries (such as with respect to the approval of our product candidates), may materially and adversely impact our business, prospects, operating results, and financial condition.We may incur additional tax liabilities related to our operations.We are subject to income tax in the United States and various foreign jurisdictions. Significant judgment is required in determining our worldwide tax liabilities, and our effective tax rate is derived from a combination of the applicable statutory rates in the various jurisdictions in which we operate. We record liabilities for uncertain tax positions that involve significant management judgment as to the application of law. The Internal Revenue Service or other domestic or foreign taxing authorities have previously disagreed, and may in the future disagree, with our interpretation of tax law as applied to the operations of Regeneron and its subsidiaries or with the positions we may take with respect to particular tax issues on our tax returns (see also Note 15 to our Consolidated Financial Statements included in this report). Consequently, our reported effective tax rate and our after-tax cash flows may be materially and adversely affected by tax assessments or judgments in excess of accrued amounts we have estimated in preparing our financial statements. Further, our effective tax rate may also be adversely affected by numerous other factors, including changes in the mix of our profitability from country to country, changes in tax laws and regulations, and tax effects of the accounting for stock-based compensation (which depend in part on the price of our stock and, therefore, are beyond our control). For example, the IRA has created a new corporate alternative minimum tax of 15% on adjusted financial statement income that applies to certain corporations for tax years beginning after December 31, 2022. Further specifics of this legislation will be outlined in Treasury regulations and any impact to the Company will depend on a number of factors, including any offsets for foreign tax credits or general business credits. The IRA also created an excise tax of 1% of the value of certain stock repurchases after December 31, 2022 that generally applies to publicly traded domestic corporations. We are in the process of evaluating the potential impact of these alternative minimum and excise tax provisions of the IRA. Other changes to U.S. tax laws and/or recommendations from the Organization for Economic Co-operation and Development (the "OECD") regarding a global minimum tax and other changes being considered and/or implemented in countries where we operate could materially impact our tax provision, cash tax liability, and effective tax rate. In addition, recommendations by the OECD and the EU could require companies to disclose more information to tax authorities on operations around the world, which may lead to greater audit scrutiny. Even though we regularly assess the information provided to tax authorities in determining the appropriateness of our tax reserves, such tax authorities could take a position that is contrary to our expectations, and the result could adversely affect our provision for income tax and our current rate.We face risks related to the personal data we collect, process, and share.Our ability to conduct our business is significantly dependent on the data that we collect, process, and share in discovering, developing, and commercializing drug products. These data are often considered personal data and are therefore regulated by data privacy laws in applicable jurisdictions. Our activities outside the U.S., including clinical trial programs and research collaborations (such as our consortium with a group of companies to fund the generation of genetic exome sequence data from the UK Biobank health resource), implicate non-U.S. data protection laws, including the EU's General Data Protection Regulations ("GDPR"). The GDPR has a wide range of compliance obligations, including increased transparency requirements and data subject rights. Violations of the GDPR carry significant financial penalties for noncompliance (including possible fines of up to 4% of global annual turnover for the preceding financial year or €20 million (whichever is higher)). In addition to the GDPR, certain EU Member States have issued or will be issuing their own implementation legislation. In June 2021, the European Commission introduced new standard contractual clauses required to be incorporated into certain new and existing agreements within prescribed timeframes in order to continue to lawfully transfer personal data outside the EU. Compliance with these requirements has been and is expected to continue to be costly and time consuming.We conduct clinical trials in many countries around the world, which have new or evolving data privacy laws that have resulted in increased liability in the management of clinical trial data, and additional contractual and due-diligence obligations that could lead to a delay in clinical trial site start-up. There is an increase of enforcement activities in various EU countries that require evidence of compliance with local data privacy requirements. While we continue to monitor these developments, there remains some uncertainty surrounding the legal and regulatory environment for these evolving privacy and data protection laws. Complying with varying jurisdictional requirements could increase the costs and complexity of compliance, including the risk of substantial financial penalties for insufficient notice and consent, failure to respond to data subject rights requests, lack of a legal basis for the transfer of personal information out of the EU, or improper processing of personal data under the GDPR. Failure by our collaborators to comply with the strict rules on the transfer of personal data outside the EU into the U.S. may result in the imposition of criminal and administrative sanctions on such collaborators or impact the flow of personal data outside the EU, which could adversely affect our business and could create liability for us. Most U.S. health care providers, including research institutions from which we or our collaborators obtain clinical trial data, are subject to privacy and security regulations promulgated under HIPAA. For example, as part of our human genetics initiative, our 64Table of Contentswholly-owned subsidiary, Regeneron Genetics Center LLC, has entered into collaborations with many research institutions, which are subject to HIPAA. Regeneron is not a covered entity or business associate under HIPAA and thus is not subject to its requirements. However, we could be subject to criminal penalties if we, our affiliates, or our agents knowingly receive PHI in a manner that is not permitted under HIPAA. Consequently, depending on the facts and circumstances, we could face substantial criminal penalties if we knowingly receive PHI from a health care provider or research institution that has not satisfied HIPAA's requirements for its disclosure. There are instances where we collect and maintain personal data, which may include health information that is outside the scope of HIPAA but within the scope of state health privacy laws or similar state level privacy legislation. This information may be received throughout the clinical trial process, in the course of our research collaborations, directly from individuals who enroll in our patient assistance programs, and from our own employees in a pandemic response process (such as in connection with the COVID-19 pandemic).Consumer protection laws impact the manner in which we develop and maintain processes to support our patient assistance programs, product marketing activities, and the sharing of employee and clinical data for internal and third-party commercial activities. Several U.S. states have proposed and passed consumer privacy laws, which were modeled after the CCPA and influenced by the GDPR. The CCPA is a consumer protection law that establishes requirements for data use and sharing transparency and provides California residents with personal data privacy rights regarding the use, disclosure, and retention of their personal data. Amendments to the CCPA have, among other things, imposed new obligations to provide notice where personal data will be de-identified. Failure to comply with the CCPA may result in, among other things, significant civil penalties and injunctive relief, or statutory or actual damages. In addition, California residents have the right to bring a private right of action in connection with data privacy incidents involving certain elements of personal data. These claims may result in significant liability and damages. These laws and regulations are constantly evolving and may impose limitations on our business activities. Several other U.S. states have introduced similar consumer protection laws, some of which are set to go into effect in the near future. At the federal level, Section 5 of the FTC Act is a consumer protection law that bars unfair and deceptive acts and practices and requires, among other things, companies to notify individuals that they will safeguard their personal data and that they will fulfil the commitments made in their privacy notices. The FTC has brought legal actions against organizations that have violated consumers' privacy rights or have misled them by failing to maintain appropriate security.Furthermore, health privacy laws, data breach notification laws, consumer protection laws, data localization laws, and genetic privacy laws may apply directly to our operations and/or those of our collaborators and may impose restrictions on our collection, use, and dissemination of individuals' health and other personal data. New state level genetic privacy and consumer protection laws in the United States may require additional transparency and permissions in our informed consent forms. Moreover, individuals about whom we or our collaborators obtain health or other personal data, as well as the providers and third parties who share this information with us, may have statutory or contractual limits that impact our ability to use and disclose the information. We are likely to be required to expend significant capital and other resources to ensure ongoing compliance with applicable privacy and data security laws both inside and outside the United States. Many of these laws differ from each other in significant ways and have different effects. Many of the state laws enable a state attorney general to bring actions and provide private rights of action to consumers as enforcement mechanisms. Compliance with these laws requires a flexible privacy framework as they are constantly evolving. Failure to comply with these laws and regulations could result in government enforcement actions and create liability for us (which could include civil and/or criminal penalties), private litigation, and/or adverse publicity. Federal regulators, state attorneys general, and plaintiffs' attorneys have been active in this space. Claims that we have violated individuals' privacy rights or breached our contractual obligations, even if we are not found liable, could be expensive and time-consuming to defend and could result in adverse publicity that could harm our business.If we or any collaborators fail to comply with applicable federal, state, local, or foreign regulatory requirements, we could be subject to a range of regulatory actions that could affect our or any collaborators' ability to commercialize our products and could harm, prevent, or substantially increase the cost of marketing and sales of any affected products that we are able to commercialize. Any threatened or actual government enforcement action could also generate adverse publicity and require that we devote substantial resources that could otherwise be used in other aspects of our business.65Table of ContentsIncreasing use of social media could give rise to liability, breaches of data security, or reputational damage.We and our employees are increasingly utilizing social media tools as a means of communication both internally and externally. Despite our efforts to monitor evolving social media communication guidelines and comply with applicable rules, there is a risk that the use of social media by us or our employees to communicate about our products or business may cause us to be found in violation of applicable requirements. In addition, our employees may knowingly or inadvertently make use of social media in ways that may not comply with our social media policy or other legal or contractual requirements, which may give rise to liability, lead to the loss of trade secrets or other intellectual property, or result in public exposure of personal data of our employees, clinical trial patients, customers, and others. Furthermore, negative posts or comments about us or our products in social media could seriously damage our reputation, brand image, and goodwill. Any of these events could have a material adverse effect on our business, prospects, operating results, and financial condition and could adversely affect the price of our Common Stock.Risks Related to Our Reliance on or Transactions with Third PartiesIf our Antibody Collaboration with Sanofi is terminated, or Sanofi materially breaches its obligations thereunder, our business, prospects, operating results, and financial condition, and our ability to develop, manufacture, and commercialize certain of our products and product candidates in the time expected, or at all, would be materially harmed.We rely on support from Sanofi to develop, manufacture, and commercialize certain of our products and product candidates. With respect to the products that we are co-developing with Sanofi under our Antibody Collaboration (currently consisting of Dupixent, Kevzara, and itepekimab), Sanofi funds a significant portion of development expenses incurred in connection with the development of these products. In addition, we rely on Sanofi to lead much of the clinical development efforts, assist with or lead efforts to obtain and maintain regulatory approvals, and lead the commercialization efforts for these products and product candidates.If Sanofi terminates the Antibody Collaboration or fails to comply with its payment obligations under any of our collaborations, our business, prospects, operating results, and financial condition would be materially harmed. We would be required to either expend substantially more resources than we have anticipated to support our research and development efforts, which could require us to seek additional funding that might not be available on favorable terms or at all, or materially cut back on such activities. If Sanofi does not perform its obligations with respect to the product candidates it is co-developing with us, our ability to develop, manufacture, and commercialize these product candidates will be significantly adversely affected. We have limited commercial capabilities outside the United States and would have to develop or outsource these capabilities for products commercialized under our Antibody Collaboration (see also "Risks Related to Commercialization of Our Marketed Products, Product Candidates, and New Indications for Our Marketed Products - If we are unable to establish commercial capabilities outside the United States for products we intend to commercialize or co-commercialize outside the United States, our business, prospects, operating results, and financial condition may be adversely affected" above). Termination of the Antibody Collaboration would create substantial new and additional risks to the successful development and commercialization of the products subject to such collaborations, particularly outside the United States.If our collaboration with Bayer for EYLEA is terminated, or Bayer materially breaches its obligations thereunder, our business, prospects, operating results, and financial condition, and our ability to continue to commercialize EYLEA outside the United States would be materially harmed.We rely heavily on Bayer with respect to the commercialization of EYLEA outside the United States (and, if approved, will rely on Bayer with respect to any potential future commercialization of aflibercept 8 mg outside the United States, including the activities discussed below). Bayer is responsible for obtaining and maintaining regulatory approval outside the United States, as well as providing all sales, marketing, and commercial support for the product outside the United States. In particular, Bayer has responsibility for selling EYLEA outside the United States using its sales force and, in Japan, in cooperation with Santen pursuant to a Co-Promotion and Distribution Agreement with Bayer's Japanese affiliate. If Bayer and, in Japan, Santen do not perform their obligations in a timely manner, or at all, our ability to commercialize EYLEA outside the United States will be significantly adversely affected. Bayer has the right to terminate its collaboration agreement with us at any time upon six or twelve months' advance notice, depending on the circumstances giving rise to termination. If Bayer were to terminate its collaboration agreement with us, we may not have the resources or skills to replace those of our collaborator, which could require us to seek another collaboration that might not be available on favorable terms or at all, and could cause significant issues for the commercialization of EYLEA outside the United States and result in substantial additional costs and/or lower revenues to us. We have limited commercial capabilities outside the United States and would have to develop or outsource these capabilities (see also "Risks Related to Commercialization of Our Marketed Products, Product Candidates, and New Indications for Our Marketed Products - If we are unable to establish commercial capabilities outside the United States for products we intend to commercialize or co-commercialize outside the United States, our business, prospects, operating results, and financial condition may be adversely 66Table of Contentsaffected" above). Termination of the Bayer collaboration agreement would create substantial new and additional risks to the successful commercialization of EYLEA and, if approved, any potential future commercialization of aflibercept 8 mg outside the United States.Our collaborators and service providers may fail to perform adequately in their efforts to support the development, manufacture, and commercialization of our drug candidates and current and future products.We depend upon third-party collaborators, including Sanofi and Bayer, and service providers such as CROs, outside testing laboratories, clinical investigator sites, third-party manufacturers, fill/finish providers, and product packagers and labelers, to assist us in the manufacture and preclinical and clinical development of our product candidates. We also depend, or will depend, on some of these or other third parties in connection with the commercialization of our marketed products and our product candidates and new indications for our marketed products if they are approved for marketing. If any of our existing collaborators or service providers breaches or terminates its agreement with us or does not perform its development or manufacturing services under an agreement in a timely manner (including as a result of its inability to perform due to financial or other relevant constraints, such as due to Russia's invasion of Ukraine) or in compliance with applicable GMPs, GLPs, or GCP standards, we could experience additional costs, delays, and difficulties in the manufacture or development of, or in obtaining approval by regulatory authorities for, or successfully commercializing our product candidates.We and our collaborators rely on third-party service providers to support the distribution of our marketed products and for many other related activities in connection with the commercialization of these marketed products. Despite our or our collaborators' arrangements with them, these third parties may not perform adequately. If these service providers do not perform their services adequately, sales of our marketed products will suffer.We have undertaken and may in the future undertake strategic acquisitions, and any difficulties from integrating such acquisitions could adversely affect our business, operating results, and financial condition.We may acquire companies, businesses, products, or product candidates that complement or augment our existing business. For example, in May 2022, we completed our acquisition of Checkmate Pharmaceuticals, Inc. The process of proposing, negotiating, completing, and integrating any such acquisition is lengthy and complex. Other companies may compete with us for such acquisitions. In addition, we may not be able to integrate any acquired business successfully or operate any acquired business profitably. Integrating any newly acquired business could be expensive and time consuming. Integration efforts often take a significant amount of time, place a significant strain on managerial, operational, and financial resources, result in a loss of key personnel of the acquired business, and could prove to be more difficult or expensive than we predict. The diversion of our management’s attention and any delay or difficulties encountered in connection with any acquisitions we may consummate could result in the disruption of our ongoing business or inconsistencies in standards and controls that could negatively affect our ability to maintain third-party relationships. Moreover, we may need to raise additional funds through public or private debt or equity financing to acquire any businesses, products, or product candidates, which may result in dilution for shareholders or the incurrence of indebtedness.As part of our efforts to acquire companies, businesses, products, or product candidates or to enter into other significant transactions, we will conduct business, legal, and financial due diligence with the goal of identifying and evaluating material risks involved in the transaction. Despite our efforts, we ultimately may be unsuccessful in ascertaining or evaluating all such risks and, as a result, might not realize the intended advantages of the transaction. If we fail to realize the expected benefits from acquisitions we have consummated or may consummate in the future, whether as a result of unidentified risks or liabilities, integration difficulties, regulatory setbacks, litigation with current or former employees and other events, our business, operating results, and financial condition could be adversely affected. For any acquired product candidates, we will also need to make certain assumptions about, among other things, development costs, the likelihood of receiving regulatory approval, and the market for any such product candidates. Our assumptions may prove to be incorrect, which could cause us to fail to realize the anticipated benefits of these transactions.In addition, we may experience significant charges to earnings in connection with our efforts, if any, to consummate acquisitions. For transactions that are ultimately not consummated, these charges may include fees and expenses for investment bankers, attorneys, accountants, and other advisors in connection with our efforts. Even if our efforts are successful, we may incur, as part of a transaction, substantial charges for closure costs associated with elimination of duplicate operations and facilities and acquired in-process research and development charges. In either case, the incurrence of these charges could adversely affect our operating results for particular periods.67Table of ContentsRisks Related to EmployeesWe are dependent on our key personnel and if we cannot recruit and retain leaders in our research, development, manufacturing, and commercial organizations, our business will be harmed.We are highly dependent on certain of our executive officers, other key members of our senior management team, and the Chair of our board of directors. If we are not able to retain (or for any other reason lose the services of) any of these persons, our business may suffer. In particular, we depend on the services of P. Roy Vagelos, M.D., the Chair of our board of directors; Leonard S. Schleifer, M.D., Ph.D., our President and Chief Executive Officer; and George D. Yancopoulos, M.D., Ph.D., our President and Chief Scientific Officer. We are also highly dependent on the expertise and services of other senior management members leading our research, development, manufacturing, and commercialization efforts. There is intense competition in the biotechnology industry for qualified scientists and managerial personnel in the research, development, manufacture, and commercialization of drugs. We may not be able to continue to attract and retain the qualified personnel necessary to continue to advance our business and achieve our strategic objectives.Information Technology RisksSignificant disruptions of information technology systems or breaches of data security could adversely affect our business.Our business is increasingly dependent on critical, complex, and interdependent information technology systems, including Internet-based systems, to support business processes as well as internal and external communications. These systems are also critical to enable remote working arrangements, which have been growing in importance due in part to the COVID-19 pandemic and related developments. The size and complexity of our computer systems make us potentially vulnerable to IT system breakdowns, internal and external malicious intrusion, and computer viruses and ransomware, which may impact product production and key business processes. We also have outsourced significant elements of our information technology infrastructure and operations to third parties, which may allow them to access our confidential information and may also make our systems vulnerable to service interruptions or to security breaches from inadvertent or intentional actions by such third parties or others.In addition, our systems are potentially vulnerable to data security breaches - whether by employees or others - which may expose sensitive data to unauthorized persons. Data security breaches could lead to the loss of trade secrets or other intellectual property, result in demands for ransom or other forms of blackmail, or lead to the public exposure of personal information (including sensitive personal information) of our employees, clinical trial patients, customers, and others. Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives (including industrial espionage or extortion) and expertise, including by organized criminal groups, "hacktivists," nation states, and others. As a company with an increasingly global presence, our systems are subject to frequent attacks. There is the potential that our systems may be directly or indirectly affected as nation-states conduct global cyberwarfare, including in connection with the current Russia-Ukraine hostilities.Due to the nature of some of these attacks, there is a risk that an attack may remain undetected for a period of time. While we continue to make investments to improve the protection of data and information technology, and to oversee and monitor the security measures of our suppliers and/or service providers, there can be no assurance that our efforts will prevent service interruptions or security breaches. In addition, we depend in part on third-party security measures over which we do not have full control to protect against data security breaches.If we or our suppliers and/or service providers fail to maintain or protect our information technology systems and data security effectively and in compliance with U.S. and foreign laws, or fail to anticipate, plan for, or manage significant disruptions to these systems, we or our suppliers and/or service providers could have difficulty preventing, detecting, or controlling such disruptions or security breaches, which could result in legal proceedings, liability under U.S. and foreign laws that protect the privacy of personal information, disruptions to our operations, government investigations, breach of contract claims, and damage to our reputation (in each case in the U.S. or globally), which could have a material adverse effect on our business, prospects, operating results, and financial condition.68Table of ContentsRisks Related to Our Financial Results, Liquidity, and Need for Additional FinancingWe may need additional funding in the future, which may not be available to us, and which may force us to delay, reduce or eliminate our product development programs or commercialization efforts.We expend substantial resources for research and development, including costs associated with clinical testing of our product candidates and new indications of our marketed products, the commercialization of products, and capital expenditures. We believe our existing capital resources and borrowing availability under our revolving credit facility, together with funds generated by our current and anticipated EYLEA net product sales and funding we are entitled to receive under our collaboration agreements and other similar agreements (including our share of profits in connection with commercialization of EYLEA and Dupixent under our collaboration agreements with Bayer and Sanofi, respectively), will enable us to meet our anticipated operating needs for the foreseeable future. However, one or more of our collaboration agreements may terminate, our revenues may fall short of our projections or be delayed, or our expenses may increase, any of which could result in our capital being consumed significantly faster than anticipated. Our expenses may increase for many reasons, including expenses in connection with the commercialization of our marketed products and the potential commercial launches of our product candidates and new indications for our marketed products, manufacturing scale-up, expenses related to clinical trials testing of antibody-based product candidates we are developing on our own (without a collaborator), and expenses for which we are responsible in accordance with the terms of our collaboration agreements.We cannot be certain that our existing capital resources and our current and anticipated revenues will be sufficient to meet our operating needs. We may require additional financing in the future and we may not be able to raise additional funds on acceptable terms or at all. For example, there is no guarantee that we will have the ability to pay the principal amount due on our senior unsecured notes at maturity or redeem, repurchase, or refinance the notes prior to maturity on acceptable terms or at all. In addition, in March 2022, we completed an extension of the $720.0 million lease financing for our existing corporate headquarters and other rentable area consisting of approximately 150 acres of predominately office buildings and laboratory space located in Tarrytown, New York, which is set to expire in March 2027. Refer to Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Tarrytown, New York Leases" for further details. Our ability to refinance or to obtain additional financing could be adversely affected if there is a significant decline in the demand for our products or other significantly unfavorable changes in economic conditions. Volatility in the financial markets could increase borrowing costs or affect our ability to raise capital. If additional financing is necessary and we obtain it through the sale of equity securities, such sales will likely be dilutive to our shareholders. Debt financing arrangements may require us to pledge certain assets or enter into covenants that would restrict our business activities or our ability to incur further indebtedness and may be at interest rates and contain other terms that are not favorable to our shareholders. Should we require and be unable to raise sufficient funds (i) to complete the development of our product candidates, (ii) to successfully commercialize our product candidates or new indications for our marketed products if they obtain regulatory approval, and (iii) to continue our manufacturing and marketing of our marketed products, we may face delay, reduction, or elimination of our research and development or preclinical or clinical programs and our commercialization activities, which would significantly limit our potential to generate revenue.Our indebtedness could adversely impact our business.We have certain indebtedness and contingent liabilities, including milestone and royalty payment obligations. As of December 31, 2022, we had an aggregate of $2.701 billion of outstanding indebtedness under our senior unsecured notes and the lease financing facility. We may also incur additional debt in the future. Any such indebtedness could:•limit our ability to access capital markets and incur additional debt in the future;•require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow for other purposes, including business development efforts, research and development, and mergers and acquisitions; and•limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, thereby placing us at a competitive disadvantage compared to competitors that have less debt.69Table of ContentsChanges in foreign currency exchange rates could have a material adverse effect on our operating results.Our revenue from outside the United States will increase as our products, whether marketed or otherwise commercialized by us or our collaborators, gain marketing approval in such jurisdictions. Our primary foreign currency exposure relates to movements in the Japanese yen, euro, British pound sterling, Canadian dollar, and Australian dollar. If the U.S. dollar weakens against a specific foreign currency, our revenues will increase, having a positive impact on net income, but our overall expenses will increase, having a negative impact. Conversely, if the U.S. dollar strengthens against a specific foreign currency, our revenues will decrease, having a negative impact on net income, but our overall expenses will decrease, having a positive impact. Therefore, significant changes in foreign exchange rates can impact our operating results and the financial condition of our Company. See Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations."Our investments are subject to risks and other external factors that may result in losses or affect the liquidity of these investments.As of December 31, 2022, we had $3.106 billion in cash and cash equivalents and $11.228 billion in marketable securities (including $1.210 billion in equity securities). Our investments consist primarily of debt securities, including investment-grade corporate bonds. These fixed-income investments are subject to external factors that may adversely affect their market value or liquidity, such as interest rate, liquidity, market, and issuer credit risks, including actual or anticipated changes in credit ratings. The equity securities we hold may experience significant volatility and may decline in value or become worthless if the issuer experiences an adverse development. Furthermore, our equity investments could be subject to dilution (and decline in value) as a result of the issuance of additional equity interests by the applicable issuer. If any of our investments suffer market price declines, such declines may have an adverse effect on our financial condition and operating results.70Table of ContentsRisks Related to Our Common StockOur stock price is extremely volatile.There has been significant volatility in our stock price and generally in the market prices of biotechnology companies' securities. Various factors and events may have a significant impact on the market price of our Common Stock. These factors include, by way of example:•net product sales of our marketed products (as recorded by us or our collaborators), in particular EYLEA, Dupixent, and Libtayo, as well as our overall operating results;•if any of our product candidates (such as aflibercept 8 mg) or our new indications for our marketed products receive regulatory approval, net product sales of, and profits from, these product candidates and new indications;•market acceptance of, and the market share for, our marketed products, especially EYLEA, Dupixent, and Libtayo;•whether our net product sales and net profits underperform, meet, or exceed the expectations of investors or analysts;•announcement of actions by the FDA or foreign regulatory authorities or their respective advisory committees regarding our, or our collaborators', or our competitors', currently pending or future application(s) for regulatory approval of product candidate(s) or new indications for marketed products;•announcement of submission of an application for regulatory approval of one or more of our, or our competitors', product candidates or new indications for marketed products;•progress, delays, or results in clinical trials of our or our competitors' product candidates or new indications for marketed products;•impact of the COVID-19 pandemic on our business, including the degree of success (if any) of our efforts to develop "next generation" COVID-19 monoclonal antibodies and any potential future sales of our COVID-19 monoclonal antibodies;•announcement of technological innovations or product candidates by us or competitors;•claims by others that our products or technologies infringe their patents;•challenges by others to our patents in the EPO and in the USPTO;•public concern as to the safety or effectiveness of any of our marketed products or product candidates or new indications for our marketed products;•pricing or reimbursement actions, decisions, or recommendations by government authorities, insurers, or other organizations (such as health maintenance organizations and PBMs) affecting the coverage, reimbursement, or use of any of our marketed products or competitors' products;•our ability to raise additional capital as needed on favorable terms;•developments in our relationships with collaborators or key customers;•developments in the biotechnology industry or in government regulation of healthcare, including those relating to compounding (i.e., a practice in which a pharmacist, a physician, or, in the case of an outsourcing facility, a person under the supervision of a pharmacist, combines, mixes, or alters ingredients of a drug to create a medication tailored to the needs of an individual patient);•large sales of our Common Stock by our executive officers or other employees, directors, or significant shareholders (or the expectation of any such sales);•changes in tax rates, laws, or interpretation of tax laws;•arrivals and departures of key personnel; •general market conditions;•our ability to repurchase our Common Stock under any share repurchase program on favorable terms or at all;•trading activity that results from the rebalancing of stock indices in which our Common Stock is included, or the inclusion or exclusion of our Common Stock from such indices; •other factors identified in these "Risk Factors"; and •the perception by the investment community or our shareholders of any of the foregoing factors.The trading price of our Common Stock has been, and could continue to be, subject to wide fluctuations in response to these and other factors, including the sale or attempted sale of a large amount of our Common Stock in the market. As discussed in greater detail under "Future sales of our Common Stock by our significant shareholders or us may depress our stock price and impair our ability to raise funds in new share offerings" below, a large percentage of our Common Stock is owned by a small number of our principal shareholders. As a result, the public float of our Common Stock (i.e., the portion of our Common Stock held by public investors, as opposed to the Common Stock held by our directors, officers, and principal shareholders) may be lower than the public float of other large public companies with broader public ownership. Therefore, the trading price of our Common Stock may fluctuate significantly more than the stock market as a whole. These factors may exacerbate the volatility in the trading price of our Common Stock and may negatively impact your ability to liquidate your investment in Regeneron at the time you wish at a price you consider satisfactory. Broad market fluctuations may also adversely affect the market price of our Common Stock. In the past, securities class action litigation has often been initiated against companies following periods of volatility in their stock 71Table of Contentsprice. This type of litigation could result in substantial costs and divert our management's attention and resources, and could also require us to make substantial payments to satisfy judgments or to settle litigation, which may harm our business, prospects, operating results, and financial condition.Future sales of our Common Stock by our significant shareholders or us may depress our stock price and impair our ability to raise funds in new share offerings.A small number of our shareholders beneficially own a substantial amount of our Common Stock. As of December 31, 2022, our five largest shareholders plus Dr. Schleifer, our Chief Executive Officer, beneficially owned approximately 39.4% of our outstanding shares of Common Stock, assuming, in the case of our Chief Executive Officer, the conversion of his Class A Stock into Common Stock and the exercise of all options held by him which are exercisable within 60 days of December 31, 2022. If our significant shareholders or we sell substantial amounts of our Common Stock in the public market, or there is a perception that such sales may occur, the market price of our Common Stock could fall. Sales of Common Stock by our significant shareholders also might make it more difficult for us to raise funds by selling equity or equity-related securities in the future at a time and price that we deem appropriate.There can be no assurance that we will repurchase shares of our Common Stock or that we will repurchase shares at favorable prices.In November 2021, our board of directors authorized a share repurchase program to repurchase up to $3.0 billion of our Common Stock (of which $745.2 million remained available as of December 31, 2022); and, in January 2023, our board of directors authorized an additional $3.0 billion for share repurchases. There can be no assurance of any future share repurchases or share repurchase program authorizations. Any share repurchases will depend upon, among other factors, our cash balances and potential future capital requirements, our results of operations and financial condition, the price of our Common Stock on the NASDAQ Global Select Market, and other factors that we may deem relevant. We can provide no assurance that we will repurchase shares of our Common Stock at favorable prices, if at all.Our existing shareholders may be able to exert substantial influence over matters requiring shareholder approval and over our management.Holders of Class A Stock, who are generally the shareholders who purchased their stock from us before our initial public offering, are entitled to ten votes per share, while holders of Common Stock are entitled to one vote per share. As of December 31, 2022, holders of Class A Stock held 14.4% of the combined voting power of all shares of Common Stock and Class A Stock then outstanding. These shareholders, if acting together, would be in a position to substantially influence the election of our directors and the vote on certain corporate transactions that require majority or supermajority approval of the combined classes, including mergers and other business combinations. This may result in our taking corporate actions that other shareholders may not consider to be in their best interest and may affect the price of our Common Stock. As of December 31, 2022:•our current executive officers and directors beneficially owned 7.1% of our outstanding shares of Common Stock, assuming conversion of their Class A Stock into Common Stock and the exercise of all options held by such persons which are exercisable within 60 days of December 31, 2022, and 18.5% of the combined voting power of our outstanding shares of Common Stock and Class A Stock, assuming the exercise of all options held by such persons which are exercisable within 60 days of December 31, 2022; and•our five largest shareholders plus Dr. Schleifer, our Chief Executive Officer, beneficially owned approximately 39.4% of our outstanding shares of Common Stock, assuming, in the case of our Chief Executive Officer, the conversion of his Class A Stock into Common Stock and the exercise of all options held by him which are exercisable within 60 days of December 31, 2022. In addition, these five shareholders plus our Chief Executive Officer held approximately 46.6% of the combined voting power of our outstanding shares of Common Stock and Class A Stock, assuming the exercise of all options held by our Chief Executive Officer which are exercisable within 60 days of December 31, 2022.72Table of ContentsThe anti-takeover effects of provisions of our charter, by-laws, and of New York corporate law, as well as the contractual provisions in our investor and collaboration agreements and certain provisions of our compensation plans and agreements, could deter, delay, or prevent an acquisition or other "change of control" of us and could adversely affect the price of our Common Stock.Our certificate of incorporation, our by-laws, and the New York Business Corporation Law contain various provisions that could have the effect of delaying or preventing a change in control of our Company or our management that shareholders may consider favorable or beneficial. Some of these provisions could discourage proxy contests and make it more difficult for shareholders to elect directors and take other corporate actions. These provisions could also limit the price that investors might be willing to pay in the future for shares of our Common Stock. These provisions include:•authorization to issue "blank check" preferred stock, which is preferred stock that can be created and issued by the board of directors without prior shareholder approval, with rights senior to those of our Common Stock and Class A Stock;•a staggered board of directors, so that it would take three successive annual shareholder meetings to replace all of our directors;•a requirement that removal of directors may only be effected for cause and only upon the affirmative vote of at least eighty percent (80%) of the outstanding shares entitled to vote for directors, as well as a requirement that any vacancy on the board of directors may be filled only by the remaining directors;•a provision whereby any action required or permitted to be taken at any meeting of shareholders may be taken without a meeting, only if, prior to such action, all of our shareholders consent, the effect of which is to require that shareholder action may only be taken at a duly convened meeting;•a requirement that any shareholder seeking to bring business before an annual meeting of shareholders must provide timely notice of this intention in writing and meet various other requirements; and•under the New York Business Corporation Law, in addition to certain restrictions which may apply to "business combinations" involving our Company and an "interested shareholder," a plan of merger or consolidation of our Company must be approved by two-thirds of the votes of all outstanding shares entitled to vote thereon. See the risk factor above captioned "Our existing shareholders may be able to exert substantial influence over matters requiring shareholder approval and over our management."Further, certain of our collaborators are currently bound by "standstill" provisions under their respective agreements with us. These include the January 2014 amended and restated investor agreement between us and Sanofi, as amended, and our 2016 ANG2 license and collaboration agreement with Bayer, which contractually prohibit Sanofi and Bayer, respectively, from seeking to directly or indirectly exert control of our Company or acquiring more than a specified percentage of our Class A Stock and Common Stock, taken together (30% in the case of Sanofi and 20% in the case of Bayer). In addition, our Change in Control Severance Plan and the employment agreement with our Chief Executive Officer, each as amended and restated, provide for severance benefits in the event of termination as a result of a change in control of our Company. Also, equity awards issued under our long-term incentive plans may become fully vested in connection with a "change in control" of our Company, as defined in the plans. These contractual provisions may also have the effect of deterring, delaying, or preventing an acquisition or other change in control.Item 1B. Unresolved Staff CommentsNone.Item 2. PropertiesWe conduct our research, development, manufacturing, and administrative activities at our owned and leased facilities. A summary of our significant owned and leased properties is provided below. Tarrytown, New YorkAt our Tarrytown, New York location, we lease approximately 1,467,000 square feet of laboratory and office space. Refer to Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Tarrytown, New York Leases" for further details. We also own an approximate 100-acre parcel of land adjacent to our Tarrytown, New York location, which we are in the process of developing, primarily in connection with expanding our research and support facilities to accommodate our growth.Rensselaer, New YorkWe own facilities in Rensselaer, New York totaling approximately 1,189,000 square feet of manufacturing, research, office, and warehouse space. This includes approximately 452,000 square feet of warehouse, laboratory, and office space which we 73Table of Contentsconstructed on a 130-acre parcel of land near our Rensselaer facility. We are in the process of further developing this property, primarily in connection with constructing a fill/finish facility.Limerick, IrelandWe own a facility in Limerick, Ireland totaling approximately 555,000 square feet of manufacturing, warehouse, laboratory, and office space. Item 3. Legal ProceedingsThe information called for by this item is incorporated herein by reference to the information set forth in Note 16 to our Consolidated Financial Statements included in this report.Item 4. Mine Safety DisclosuresNot applicable.PART IIItem 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity SecuritiesMarket for Registrant's Common EquityOur Common Stock, par value $.001 per share, is quoted on The NASDAQ Global Select Market under the symbol "REGN." Our Class A Stock, par value $.001 per share, is not publicly quoted or traded.As of January 26, 2023, there were 161 shareholders of record of our Common Stock and 14 shareholders of record of our Class A Stock. We have never paid cash dividends on our Common Stock or Class A Stock and do not anticipate paying any in the foreseeable future. STOCK PERFORMANCE GRAPHSet forth below is a line graph comparing the cumulative total shareholder return on Regeneron's Common Stock with the cumulative total return of (i) the NASDAQ US Benchmark Pharmaceuticals Total Return Index ("NQ US Pharma TR Index"), and (ii) Standard & Poor's 500 Stock Index ("S&P 500") for the period from December 31, 2017 through December 31, 2022. The comparison assumes that $100 was invested on December 31, 2017 in our Common Stock and in both of the foregoing indices. All values assume reinvestment of the pre-tax value of dividends paid by companies included in these indices. The historical stock price performance of our Common Stock shown in the graph below is not necessarily indicative of future stock price performance. 74Table of Contents12/31/201712/31/201812/31/201912/31/202012/31/202112/31/2022Regeneron$100.00 $99.35 $99.87 $128.50 $167.98 $191.91 S&P 500$100.00 $93.76 $120.84 $140.49 $178.27 $143.61 NQ US Pharma TR Index$100.00 $106.80 $122.30 $135.17 $168.13 $187.21 This performance graph shall not be deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing of ours under the Securities Act of 1933, as amended, or the Securities Exchange Act, except as shall be expressly set forth by specific reference to such filing.75Table of ContentsIssuer Purchases of Equity SecuritiesThe table below reflects shares of Common Stock we repurchased under our share repurchase programs, as well as Common Stock withheld by us for employees to satisfy their tax withholding obligations arising upon the vesting of restricted stock granted under one of our long-term incentive plans, during the three months ended December 31, 2022. Refer to Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" for further details of our share repurchase programs.PeriodTotal Number of Shares PurchasedAverage Price Paid per ShareTotal Number of Shares Purchased as Part of Publicly Announced ProgramsApproximate Dollar Value of Shares that May Yet Be Purchased Under the Programs(b)(in millions)10/1/2022–10/31/202248,078 $719.10 48,078 $1,151.7 11/1/2022–11/30/2022236,526 $737.86 234,834 $978.4 12/1/2022–12/31/2022418,427 $737.15 317,470 $745.2 Total703,031 (a)600,382 (a)(a) The difference between the total number of shares purchased and the total number of shares purchased as part of publicly announced programs relates to Common Stock withheld by us for employees to satisfy their tax withholding obligations arising upon the vesting of restricted stock granted under one of our long-term incentive plans.(b) In January 2023, our board of directors authorized a new share repurchase program to repurchase up to an additional $3.0 billion of our Common Stock. See Item 7. "Liquidity and Capital Resources - Share Repurchase Programs" for further details.76Table of ContentsItem 6. [Reserved]Item 7. Management's Discussion and Analysis of Financial Condition and Results and Results of OperationsThe following discussion should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report. Refer to Part II, Item 7 in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 (filed with the SEC on February 7, 2022) for additional discussion of our financial condition and results of operations for the year ended December 31, 2020, as well as our financial condition and results of operations for the year ended December 31, 2021 compared to the year ended December 31, 2020.OverviewRegeneron Pharmaceuticals, Inc. is a fully integrated biotechnology company that invents, develops, manufactures, and commercializes medicines for people with serious diseases. Our products and product candidates in development are designed to help patients with eye diseases, allergic and inflammatory diseases, cancer, cardiovascular and metabolic diseases, pain, hematologic conditions, infectious diseases, and rare diseases. We currently have nine FDA-approved products that have received marketing approval and approximately 35 product candidates in clinical development, almost all of which were homegrown in our laboratories. In addition, REGEN-COV was authorized under an EUA for COVID-19 from November 2020 until January 2022 when the EUA was revised to exclude its use in geographic regions where infection or exposure is likely due to a variant that is not susceptible to the treatment (see Part I, Item 1. "Business - Additional Information - Clinical Development Programs"). Refer to Part I, Item 1. "Business - Products" and "Business - Programs in Clinical Development" for additional information related to marketed products and product candidates. Our ability to generate profits and to generate positive cash flow from operations over the next several years depends significantly on the continued success in commercializing EYLEA and Dupixent, as well as on whether we are able to obtain regulatory approval for aflibercept 8 mg and are successful in commercializing it. We expect to continue to incur substantial expenses related to our research and development activities, a portion of which we expect to be reimbursed by our collaborators. In addition, our research and development activities and related costs which are not reimbursed are expected to expand and require additional resources. We also expect to incur substantial costs related to the commercialization of our marketed products. Our financial results may fluctuate from quarter to quarter and will depend on, among other factors, the net sales of our products; the scope and progress of our research and development efforts; the timing of certain expenses; the continuation of our collaborations, in particular with Sanofi and Bayer, including our share of collaboration profits from sales of commercialized products and the amount of reimbursement of our research and development expenses that we receive from collaborators; and the amount of income tax expense we incur, which is partly dependent on the profits or losses we earn in each of the countries in which we operate. We cannot predict whether or when new products or new indications for marketed products will receive regulatory approval or, if any such approval is received, whether we will be able to successfully commercialize such product(s) and whether or when they may become profitable.Critical Accounting EstimatesThe preparation of financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect reported amounts and related disclosures in the financial statements. Critical accounting estimates are those estimates made in accordance with GAAP that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our results of operations or financial condition.Management believes the current assumptions used to estimate amounts reflected in our Consolidated Financial Statements are appropriate. However, if actual experience differs from the assumptions used in estimating amounts reflected in our Consolidated Financial Statements, the resulting changes could have a material adverse effect on our results of operations, and, in certain situations, could have a material adverse effect on our liquidity and financial condition. The critical accounting estimates that impact our Consolidated Financial Statements are described below. Revenue Recognition - Product RevenueWe recognize revenue from product sales at a point in time when our customer is deemed to have obtained control of the product, which generally occurs upon receipt or acceptance by our customer. The amount of revenue we recognize from product sales may vary due to rebates, chargebacks, and discounts provided under governmental and other programs, distribution-related fees, and other sales-related deductions. In order to determine the transaction price, we estimate, utilizing the expected value method, the amount of variable consideration to which we will be entitled. This estimate is based upon contracts with customers, healthcare providers, payors and government agencies, statutorily-defined discounts applicable to government-funded programs, historical experience, estimated payor mix, and other relevant factors. Calculating these provisions involves estimates and judgments. We 77Table of Contentsreview our estimates of rebates, chargebacks, and other applicable provisions each period and record any necessary adjustments in the current period's net product sales. Refer to the "Results of Operations - Revenues - Net Product Sales" section below for further details regarding our provisions, and credits/payments, for sales-related deductions.Collaborative Arrangements We have entered into various collaborative arrangements to research, develop, manufacture, and commercialize products and/or product candidates. Our collaboration agreements may require us to deliver various rights, services, and/or goods across the entire life cycle of a product or product candidate. In agreements involving multiple goods or services promised to be transferred to our collaborator, we must assess, at the inception of the contract, whether each promise represents a separate obligation (i.e., is "distinct"), or whether such promises should be combined as a single unit of account. When we have a combined unit of account which includes a license and providing research and development services to our collaborator, recognition of up-front payments and development milestones earned from our collaborator is deferred (as a liability) and recognized over the development period (i.e., over time) typically using an input method on the basis of our research and development costs incurred relative to the total expected cost which determines the extent of our progress toward completion (see "Results of Operations - Expenses - Other Operating (Income) Expense" below for further information related to amounts recognized in connection with such estimates). We review our estimates each period and make revisions to such estimates as necessary. Due to the variability in the scope of activities and length of time necessary to develop a drug product, potential delays in development programs, changes to development plans and budgets as programs progress, including if we and our collaborators decide to expand or contract our clinical plans for a drug candidate in various disease indications, and uncertainty in the ultimate requirements to obtain governmental approval for commercialization, revisions to our estimates are likely to occur periodically, potentially resulting in material changes to amounts recognized. If our collaborator performs research and development work or commercialization-related activities and the parties share the related costs, we also recognize, as expense (e.g., research and development expense or selling, general and administrative expense, as applicable) in the period when our collaborator incurs such expenses, the portion of the collaborator's expenses that we are obligated to reimburse. Our collaborators provide us with estimated expenses for the most recent fiscal quarter. The estimates are revised, if necessary, in subsequent periods if actual expenses differ from those estimates.Under certain of the Company's collaboration agreements, product sales and cost of sales may be recorded by the Company's collaborators as they are deemed to be the principal in the transaction. In arrangements where we:•supply commercial product to our collaborator, we may be reimbursed for our manufacturing costs as commercial product is shipped to the collaborator (however, recognition of such cost reimbursements may be deferred until the product is sold by our collaborator to third-party customers); •share in any profits or losses arising from the commercialization of such products, we record our share of the variable consideration, representing net product sales less cost of goods sold and shared commercialization and other expenses, in the period in which such underlying sales occur and costs are incurred by the collaborator; and •receive royalties and/or sales-based milestone payments from our collaborator, we recognize such amounts in the period earned.Our collaborators provide us with estimates of product sales and our share of profits or losses, as applicable, for each quarter. The estimates are revised, if necessary, in subsequent periods if our actual share of profits or losses differ from those estimates. Stock-based CompensationWe recognize stock-based compensation expense for equity grants under our long-term incentive plans to employees and non-employee members of our board of directors (as applicable) based on the grant-date fair value of those awards. The grant-date fair value of an award is generally recognized as compensation expense over the award's requisite service period. Stock-based compensation expense also includes an estimate, which is made at the time of grant, of the number of awards that are expected to be forfeited. This estimate is revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In addition, we reassess our forfeiture rate assumptions at least annually, considering both historical forfeiture experience and an estimate of future forfeitures for currently outstanding unvested awards. The assumptions used in computing the fair value of equity awards reflect our best estimates but involve uncertainties related to market and other conditions, many of which are outside our control. Changes in any of these assumptions may materially affect the fair value of awards granted and the amount of stock-based compensation recognized in future periods. We use the Black-Scholes model to compute the estimated fair value of stock option awards. Using this model, fair value is calculated based on assumptions with respect to (i) expected volatility of our Common Stock price, (ii) the periods of time over which employees and members of our board of directors are expected to hold their options prior to exercise (expected lives), (iii) expected dividend yield on our Common Stock, and (iv) risk-free interest rates, which are based on quoted U.S. Treasury rates for 78Table of Contentssecurities with maturities approximating the options' expected lives. Expected volatility is estimated based on actual movements in our stock price over the most recent historical periods equivalent to the options' expected lives. Expected lives are principally based on our historical exercise experience with previously issued employee and board of director option grants. The expected dividend yield is zero as we have never paid dividends and do not currently anticipate paying any in the foreseeable future. We use a Monte Carlo simulation to compute the estimated fair value of performance-based restricted stock units that are subject to vesting based on the Company's attainment of pre-established performance criteria that include a market condition. For performance-based restricted stock units that contain a performance condition, we recognize stock-based compensation expense if and when we determine that it is probable the performance condition will be achieved (based on the number of shares expected to be vested and issued). We reassess the probability of achievement at each reporting period and adjust compensation cost, as necessary. If there are any changes in our probability assessment, we recognize a cumulative catch-up adjustment in the period of the change in estimate, with the remaining unrecognized expense recognized prospectively over the remaining requisite service period. If we subsequently determine that the performance criteria are not met or are not expected to be met, any amounts previously recognized as compensation expense are reversed in the period when such determination is made.See Note 13 to our Consolidated Financial Statements for stock-based compensation expense and related assumptions used in determining the fair value of our awards.Income TaxesWe recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns, including deferred tax assets and liabilities for expected amounts of global intangible low-taxed income ("GILTI") inclusions. Deferred tax assets and liabilities are determined as the difference between the tax basis of assets and liabilities and their respective financial reporting amounts ("temporary differences") at enacted tax rates in effect for the years in which the differences are expected to reverse. A valuation allowance is established for deferred tax assets for which it is more likely than not that some portion or all of the deferred tax assets will not be realized. We periodically re-assess the need for a valuation allowance against our deferred tax assets based on all available evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, results of recent operations, and our historical earnings experience by taxing jurisdiction. Significant judgment is required in making this assessment. The Company recognizes the financial statement effects of a tax position when management's assessment is that there is more than a 50% probability that the position will be sustained upon examination by a taxing authority based upon its technical merits. Uncertain tax positions are recorded based upon certain recognition and measurement criteria. Significant judgment is required in making this assessment, and, therefore, we re-evaluate uncertain tax positions and consider various factors, including, but not limited to, changes in tax law, the measurement of tax positions taken or expected to be taken in tax returns, and changes in facts or circumstances related to a tax position. We adjust the amount of the liability to reflect any subsequent changes in the relevant facts and circumstances surrounding the uncertain tax positions. InventoriesWe capitalize inventory costs associated with our products prior to regulatory approval when, based on management's judgment, future commercialization is considered probable and the future economic benefit is expected to be realized; otherwise, such costs are expensed. The determination to capitalize inventory costs is based on various factors, including status and expectations of the regulatory approval process, any known safety or efficacy concerns, potential labeling restrictions, and any other impediments to obtaining regulatory approval. We periodically analyze our inventory levels to identify inventory that may expire prior to expected sale or has a cost basis in excess of its estimated realizable value, and write down such inventories as appropriate. In addition, our products are subject to strict quality control and monitoring which we perform throughout the manufacturing process. If certain batches or units of product no longer meet quality specifications or become obsolete due to expiration, we record a charge to write down such inventory to its estimated realizable value. See "Results of Operations - Expenses - Cost of Goods Sold" below for further information related to our inventory write-offs and reserves.Intangible AssetsIntangible assets acquired in connection with an asset acquisition are recorded at cost. Intangible assets are amortized over the estimated useful lives of the assets based on the pattern in which the economic benefits of the intangible assets are consumed; if that pattern cannot be reliably determined, a straight-line basis is used. If contingent consideration is recognized subsequent to the acquisition date in an asset acquisition, the amount of such consideration is recorded as an addition to the cost basis of the 79Table of Contentsintangible asset with a cumulative catch-up adjustment for amortization expense as if the additional amount of consideration had been accrued from the outset of the acquisition. Our intangible assets are reviewed for recoverability whenever events or changes in circumstances (e.g., changes in economic, regulatory, or legal conditions) indicate that the carrying amount of the asset may not be recoverable. If an indicator of impairment exists, we compare the projected undiscounted cash flows to be generated by the asset to the intangible asset's carrying amount. If the projected undiscounted cash flows of the intangible asset are less than the carrying amount, the intangible asset is written down to its fair value in the period in which the impairment occurs.As described in Part I, Item 1. "Business - Collaboration, License, and Other Agreements - Sanofi - Immuno-Oncology," effective July 1, 2022, the Company obtained the exclusive right to develop, commercialize, and manufacture Libtayo worldwide under the A&R IO LCA with Sanofi. The transaction was accounted for as an asset acquisition and amounts paid to Sanofi in connection with obtaining the worldwide rights to Libtayo, including the up-front payment and any contingent consideration, are recorded as an intangible asset. Due to the complexity of the terms of the amendments to the collaboration agreements in contemplation of the acquisition of the worldwide rights to Libtayo, significant judgment was applied in identifying the elements of the transaction and evaluating the timing and recognition of contingent consideration.See Note 8 to our Consolidated Financial Statements for further information related to our intangible assets.ContingenciesWe accrue, based on management's judgment, for an estimated loss when the potential loss from claims or legal proceedings is considered probable and the amount can be reasonably estimated. As additional information becomes available, or, based on specific events such as the outcome of litigation or settlement of claims, we reassess the potential liability related to pending claims and litigation, and may change our estimates. Results of Operations Net IncomeYear Ended December 31,(In millions, except per share data)202220212020Revenues$12,172.9 $16,071.7 $8,497.1 Operating expenses7,434.0 7,124.9 4,920.5 Income from operations4,738.9 8,946.8 3,576.6 Other income (expense)119.9 379.0 233.8 Income before income taxes4,858.8 9,325.8 3,810.4 Income tax expense520.4 1,250.5 297.2 Net income$4,338.4 $8,075.3 $3,513.2 Net income per share - diluted$38.22 $71.97 $30.52 80Table of ContentsRevenuesYear Ended December 31,$ Change(In millions)2022202120202022 vs. 20212021 vs. 2020Net product sales:EYLEA - U.S.$6,264.6 $5,792.3 $4,947.2 $472.3 $845.1 Libtayo - U.S.374.5 306.3 270.7 68.2 35.6 Libtayo - ROW73.0 — —**Praluent - U.S.**130.0 170.0 150.9(40.0)*REGEN-COV - U.S.— 5,828.0 185.7 (5,828.0)5,642.3Evkeeza - U.S.48.6 18.4 — 30.218.4Inmazeb - U.S.3.0 — — 3.0—ARCALYST - U.S.***— 2.2 13.1 **Total net product sales$6,893.7 $12,117.2 $5,567.6 $(5,294.3)$6,541.4 Collaboration revenue:Sanofi$2,855.7 $1,902.2 $1,186.4 $953.5 $715.8 Bayer1,430.7 1,409.3 1,186.1 21.4 223.2 Roche627.3 361.8 — 265.5 361.8 Other0.4 — — 0.4 — Other revenue365.1 281.2 557.0 83.9 (275.8)Total revenues$12,172.9 $16,071.7 $8,497.1 $(3,969.6)$7,566.4 * Not meaningful** Net product sales of Praluent in the United States were recorded by Sanofi prior to April 1, 2020.*** Effective April 1, 2021, Kiniksa records net product sales of ARCALYST in the United States. Previously, the Company recorded net product sales of ARCALYST in the United States.Net Product SalesNet product sales of EYLEA in the United States increased in 2022, compared to 2021, due to higher sales volume partly offset by an increase in sales-related deductions. As described in Part I, Item. 1. "Business - Collaboration, License, and Other Agreements - Sanofi - Immuno-oncology", effective July 1, 2022, the Company became solely responsible for the research, development, and commercialization of Libtayo worldwide and began recording net product sales of Libtayo outside the United States.During the years ended December 31, 2021 and 2020, we recorded net product sales of REGEN-COV in connection with our agreements with the U.S. government. As of December 31, 2021, the Company had completed its final deliveries of drug product under its agreements with the U.S. government; as a result, there were no net product sales of REGEN-COV in the United States recorded during the year ended December 31, 2022. Refer to Part I, Item 1. "Business - Agreements Related to COVID-19 - U.S. Government" for further details. 81Table of ContentsRevenue from product sales is recorded net of applicable provisions for rebates, chargebacks, and discounts; distribution-related fees; and other sales-related deductions. The following table summarizes the provisions, and credits/payments, for sales-related deductions.(In millions)Rebates, Chargebacks,and DiscountsDistribution-Related FeesOther Sales-Related DeductionsTotalBalance as of December 31, 2019$80.3 $46.4 $29.4 $156.1 Provisions762.9 279.9 94.1 1,136.9 Credits/payments(641.0)(249.1)(78.7)(968.8)Balance as of December 31, 2020202.2 77.2 44.8 324.2 Provisions1,047.1 363.6 150.4 1,561.1 Credits/payments(1,034.7)(360.8)(127.6)(1,523.1)Balance as of December 31, 2021214.6 80.0 67.6 362.2 Provisions1,537.3 431.1 141.1 2,109.5 Credits/payments(1,398.0)(399.7)(127.2)(1,924.9)Balance as of December 31, 2022$353.9 $111.4 $81.5 $546.8 Sanofi Collaboration RevenueYear Ended December 31,(In millions)202220212020Antibody: Regeneron's share of profits in connection with commercialization of antibodies$2,082.0 $1,363.0 $785.2 Sales-based milestones earned100.0 50.0 50.0 Reimbursement for manufacturing of commercial supplies(a)633.7 488.8 368.0 Other28.7 — — Total Antibody2,844.4 1,901.8 1,203.2 Total Immuno-oncology11.3 0.4 (16.8)Total Sanofi collaboration revenue$2,855.7 $1,902.2 $1,186.4 (a) Corresponding costs incurred by the Company in connection with such production is recorded within Cost of collaboration and contract manufacturingAs the A&R IO LCA became effective July 1, 2022, the three months ended June 30, 2022 was the last period in which Sanofi collaboration revenue was recognized in connection with the immuno-oncology collaborative arrangement. AntibodyGlobal net product sales of Dupixent and Kevzara are recorded by Sanofi. The increase in our share of profits in connection with commercialization of antibodies during the year ended December 31, 2022, compared to 2021, was driven by profits associated with higher Dupixent sales, partly offset by the impact of the amendment to the Antibody License and Collaboration Agreement. As described in Part I, Item 1. "Business - Collaboration, License, and Other Agreements - Sanofi - Antibody", on July 1, 2022, an amendment to the Antibody License and Collaboration Agreement became effective, pursuant to which the percentage of Regeneron's share of profits in any calendar quarter used to reimburse Sanofi for development costs which were funded by Sanofi increased from 10% to 20%. In addition, the amount of our share of profits we earned in connection with commercialization of antibodies outside the United States was adversely impacted in 2022 by the U.S. dollar strengthening against foreign currencies, including the Japanese yen and the euro.82Table of ContentsRegeneron's share of profits in connection with the commercialization of Dupixent, Praluent (through March 31, 2020), and Kevzara is summarized below:Year Ended December 31,(In millions)202220212020Dupixent, Praluent, and Kevzara net product sales(a)$9,039.2$6,536.3$4,394.5 Regeneron's share of collaboration profits2,405.51,511.5871.5 Reimbursement of development expenses incurred by Sanofi in accordance with Regeneron's payment obligation(266.6)(148.5)(86.3)One-time payment in connection with amendment to the Antibody License and Collaboration Agreement(56.9)—— Regeneron's share of profits in connection with commercialization of antibodies $2,082.0$1,363.0$785.2Regeneron's share of collaboration profits as a percentage of Dupixent, Praluent, and Kevzara net product sales23%21%18%(a) Global net product sales of Dupixent and Kevzara are recorded by Sanofi. The quarter ended March 31, 2020 was the last quarter for which Sanofi and the Company shared profits and losses in connection with Sanofi's global net sales and the related commercialization of Praluent (see further details below); therefore, the quarter ended March 31, 2020 was the last quarter for which net product sales of Praluent were included in the table above. As described in Part I, Item 1. "Business - Collaboration, License, and Other Agreements - Sanofi - Antibody", effective April 1, 2020, the Company became solely responsible for the development and commercialization of Praluent in the United States. Under the new agreement, Sanofi is solely responsible for the development and commercialization of Praluent outside of the United States, and pays the Company a 5% royalty on Sanofi’s net product sales of Praluent outside the United States.During the year ended December 31, 2022, we earned two $50.0 million sales-based milestones from Sanofi, upon aggregate annual sales of antibodies outside the United States (including Praluent) exceeding $2.0 billion and $2.5 billion, respectively, on a rolling twelve-month basis. During the year ended December 31, 2021, we earned a $50.0 million sales-based milestone from Sanofi, upon aggregate annual sales of antibodies outside the United States (including Praluent) exceeding $1.5 billion on a rolling twelve-month basis. We are entitled to receive the final sales milestone payment of $50.0 million that would be earned when such sales outside the United States exceed $3.0 billion on a rolling twelve-month basis.The increase in reimbursements for manufacturing of commercial supplies in 2022, compared to 2021, was primarily due to higher Dupixent sales, as revenue for such cost reimbursements is recognized when the product is sold by Sanofi to third-party customers.Bayer Collaboration RevenueYear Ended December 31,(In millions)202220212020Regeneron's share of profits in connection with commercialization of EYLEA outside the United States$1,317.4 $1,349.2 $1,107.9 Reimbursement for manufacturing of ex-U.S. commercial supplies(a)91.4 60.1 78.2 One-time payment in connection with change in Japan arrangement21.9 — — Total Bayer collaboration revenue$1,430.7 $1,409.3 $1,186.1 (a) Corresponding costs incurred by the Company in connection with such production is recorded within Cost of collaboration and contract manufacturing83Table of ContentsBayer records net product sales of EYLEA outside the United States. The amount of the share of profits we earned in connection with commercialization of EYLEA outside the United States was adversely impacted in 2022 by the U.S. dollar strengthening against foreign currencies, including the Japanese yen and the euro.Regeneron's share of profits in connection with commercialization of EYLEA outside the United States is summarized below: Year Ended December 31,(In millions)202220212020EYLEA net product sales outside the United States $3,382.8$3,450.9*$2,820.7*Regeneron's share of collaboration profit from sales outside the United States$1,375.1$1,408.3$1,165.8Reimbursement of development expenses incurred by Bayer in accordance with Regeneron's payment obligation(57.7)(59.1)(57.9)Regeneron's share of profits in connection with commercialization of EYLEA outside the United States$1,317.4$1,349.2$1,107.9Regeneron's share of profits as a percentage of EYLEA net product sales outside the United States39%39%39%* Effective January 1, 2022, the Company and Bayer commenced sharing equally in profits and losses based on sales from Bayer to its distributor in Japan. Previously, the Company received from Bayer a tiered percentage of sales based on sales by Bayer's distributor in Japan. Consequently, the prior year net product sales amount has been revised for comparability purposes.Roche Collaboration RevenueAs described in Part I, Item 1. "Business - Agreements Related to COVID-19 - Roche", Roche distributes and records net product sales of Ronapreve outside the United States, and the parties share gross profits from worldwide sales of REGEN-COV and Ronapreve, depending on the amount of manufactured product supplied by each party to the market. Each quarter, a single payment is due from one party to the other to true-up the global gross profits between the parties. If Regeneron is to receive a true-up payment from Roche, such amount will be recorded to collaboration revenue. If Regeneron is to make a true-up payment to Roche, such amount will be recorded to Cost of goods sold.During the years ended December 31, 2022 and 2021, the Company recognized $627.3 million and $361.8 million, respectively, of global gross profit payments from Roche within collaboration revenue. Other RevenueOther revenue increased in 2022, compared to 2021, primarily due to higher reimbursements for the manufacture of commercial supplies for Sanofi related to Praluent outside the United States.ExpensesYear Ended December 31,Change(In millions, except headcount data)2022202120202022 vs. 20212021 vs. 2020Research and development(a)$3,592.5 $2,860.1 $2,647.0 $732.4 $213.1 Acquired in-process research and development255.1 48.0 88.0 207.1 (40.0)Selling, general, and administrative(a)2,115.9 1,824.9 1,346.0 291.0 478.9 Cost of goods sold800.0 1,773.1 491.9 (973.1)1,281.2 Cost of collaboration and contract manufacturing(b)760.4 664.4 628.0 96.0 36.4 Other operating (income) expense, net(89.9)(45.6)(280.4)(44.3)234.8 Total operating expenses$7,434.0 $7,124.9 $4,920.5 $309.1 $2,204.4 Average headcount11,115 9,884 8,495 1,231 1,389 (a) Includes costs incurred net of any cost reimbursements from collaborators who are not deemed to be our customers(b) Cost of collaboration and contract manufacturing includes costs we incur in connection with producing commercial drug supplies for collaborators and others.84Table of ContentsOperating expenses in 2022, 2021, and 2020 included a total of $725.0 million, $601.7 million, and $432.0 million, respectively, of stock-based compensation expense related to equity awards granted under our long-term incentive plans. As of December 31, 2022, unrecognized stock-based compensation expense related to unvested stock options and unvested restricted stock (including performance-based restricted stock units) was $572.0 million and $1.064 billion, respectively. We expect to recognize this stock-based compensation expense related to stock options and restricted stock over weighted-average periods of 1.8 years and 2.6 years, respectively.Research and Development ExpensesThe following table summarizes our estimates of direct research and development expenses by clinical development program and other significant categories of research and development expenses. Direct research and development expenses are comprised primarily of costs paid to third parties for clinical and product development activities, including costs related to preclinical research activities, clinical trials, and the portion of research and development expenses incurred by our collaborators that we are obligated to reimburse. Indirect research and development expenses have not been allocated directly to each program, and primarily consist of costs to compensate personnel, overhead and infrastructure costs to maintain our facilities, and other costs related to activities that benefit multiple projects. Clinical manufacturing costs primarily consist of costs to manufacture bulk drug product for clinical development purposes as well as related external drug filling, packaging, and labeling costs. Clinical manufacturing costs also includes pre-launch commercial supplies which did not meet the criteria to be capitalized as inventory (see "Critical Accounting Policies and Use of Estimates - Inventories" above). The table below also includes reimbursements of research and development expenses by collaborators, as when we are entitled to reimbursement of all or a portion of such expenses that we incur under a collaboration, we record those reimbursable amounts in the period in which such costs are incurred.Year Ended December 31,$ Change(In millions)20222021*2020*2022 vs. 20212021 vs. 2020Direct research and development expenses:Dupixent (dupilumab)$156.5 $146.4 $129.7 $10.1 $16.7 Libtayo (cemiplimab)138.0 146.2 155.3 (8.2)(9.1)EYLEA and aflibercept 8 mg81.2 102.2 72.2 (21.0)30.0 Pozelimab72.4 28.3 16.0 44.1 12.3 Odronextamab66.0 34.9 35.0 31.1 (0.1)Linvoseltamab45.5 18.7 11.4 26.8 7.3 Fianlimab43.4 8.7 9.1 34.7 (0.4)REGEN-COV32.8 309.8 290.7 (277.0)19.1 Other product candidates in clinical development and other research programs407.1 401.0 587.8 6.1 (186.8)Total direct research and development expenses1,042.9 1,196.2 1,307.2 (153.3)(111.0)Indirect research and development expenses:Payroll and benefits1,195.5 981.4 816.6 214.1 164.8 Lab supplies and other research and development costs181.0 142.0 138.3 39.0 3.7 Occupancy and other operating costs508.5 414.9 335.7 93.6 79.2 Total indirect research and development expenses1,885.0 1,538.3 1,290.6 346.7 247.7 Clinical manufacturing costs938.3 621.7 686.1 316.6 (64.4)Reimbursement of research and development expenses by collaborators(273.7)(496.1)(636.9)222.4 140.8 Total research and development expenses$3,592.5 $2,860.1 $2,647.0 $732.4 $213.1 * Certain prior year amounts have been reclassified to conform to the current year's presentation 85Table of ContentsTotal research and development expenses increased in 2022, compared to 2021, partially due to the impact of the amendments to the Sanofi collaboration agreements described above in Part I, Item 1. "Business - Collaboration, License, and Other Agreements - Sanofi," as (i) Sanofi is no longer reimbursing us for 50% of Libtayo development costs, and (ii) effective July 1, 2022, we recognize our 50% share of research and development expenses in connection with the Sanofi Antibody Collaboration.Research and development expenses included stock-based compensation expense of $406.8 million and $316.6 million in 2022 and 2021, respectively.Reimbursement of research and development expenses by collaborators included reimbursements from Roche related to REGEN-COV of $128.1 million for the year ended December 31, 2021. For the year ended December 31, 2022, such reimbursements from Roche related to REGEN-COV were not material.There are numerous uncertainties associated with drug development, including uncertainties related to safety and efficacy data from each phase of drug development, uncertainties related to the enrollment and performance of clinical trials, changes in regulatory requirements, changes in the competitive landscape affecting a product candidate, and other risks and uncertainties described in Part I, Item 1A. "Risk Factors". There is also variability in the duration and costs necessary to develop a pharmaceutical product, potential opportunities and/or uncertainties related to future indications to be studied, and the estimated cost and scope of the projects. The lengthy process of seeking FDA and other applicable approvals, and subsequent compliance with applicable statutes and regulations, require the expenditure of substantial resources. Any failure by us to obtain, or delay in obtaining, regulatory approvals could materially adversely affect our business. We are unable to reasonably estimate if our product candidates in clinical development will generate material product revenues and net cash inflows.Acquired In-process Research and Development ("IPR&D")Acquired IPR&D in 2022 included a $195.0 million charge related to our acquisition of Checkmate, a $30.0 million up-front payment in connection with our collaboration agreement with CytomX Therapeutics, Inc., and a $20.0 million opt-in payment in connection with a product candidate under our collaboration agreement with Adicet Bio, Inc. Acquired IPR&D in 2021 included $34.0 million in aggregate up-front payments in connection with our collaboration agreement with Nykode Therapeutics and in 2020 included $85.0 million in aggregate up-front payments in connection with our collaboration agreement with Intellia.Selling, General, and Administrative ExpensesSelling, general, and administrative expenses increased in 2022, compared to 2021, primarily due to higher headcount and headcount-related costs, an increase in commercialization-related expenses for Libtayo (as effective July 1, 2022, the Company became solely responsible for the commercialization of Libtayo worldwide), and higher contributions to an independent not-for-profit patient assistance organization, partly offset by costs in 2021 for educational campaigns related to COVID-19 that did not recur during 2022. Selling, general, and administrative expenses also included $256.4 million and $213.3 million of stock-based compensation expense in 2022 and 2021, respectively.Cost of Goods Sold Cost of goods sold decreased in 2022, compared to 2021, primarily due to the Company recognizing REGEN-COV net product sales (and corresponding cost of goods sold) in the United States during 2021 and a 2021 payment of $259.6 million owed in connection with global gross profits under our Roche collaboration agreement; such transactions did not recur in 2022. Cost of goods sold also decreased during 2022 since effective July 1, 2022, as a result of the A&R IO LCA described in Part I, Item 1. "Business - Collaboration, License, and Other Agreements - Sanofi - Immuno-Oncology", we are no longer obligated to pay Sanofi for their share of Libtayo U.S. gross profits (during the six months ended June 30, 2022, Cost of goods sold included $70.1 million related to our obligation for Sanofi's share of Libtayo U.S. gross profits compared to $133.0 million for full year 2021). Cost of goods sold in 2022 also decreased, compared to 2021, due to lower inventory write-offs and reserves. Inventory write-offs and reserves were $258.7 million in 2022 (including $157.4 million in the fourth quarter of 2022) compared to $457.1 million in 2021 (including $269.2 million in the fourth quarter of 2021). These inventory write-offs and reserves were primarily related to REGEN-COV. Refer to Part I, Item 1. "Business - Additional Information - Clinical Development Programs - REGEN-COV (casirivimab and imdevimab)" for further information related to regulatory developments for REGEN-COV which negatively impacted the estimated realizable value of inventory on hand. 86Table of ContentsCost of Collaboration and Contract ManufacturingCost of collaboration and contract manufacturing increased in 2022, compared to 2021, primarily due to the recognition of costs in connection with manufacturing additional commercial supplies for Sanofi related to Praluent outside the United States and Dupixent, and manufacturing costs associated with EYLEA outside the United States.Other Operating (Income) ExpenseOther operating (income) expense, net, includes recognition of a portion of amounts previously deferred in connection with up-front and development milestone payments, as applicable, received in connection with Sanofi IO, Teva, and MTPC collaborative arrangements. During 2022, the Company discontinued further clinical development of fasinumab, and, as a result, recorded $44.4 million (as an increase to other operating income) related to our Teva and MTPC collaborative arrangements as we deemed our obligation to provide development services in connection with these collaborative arrangements to be complete.As the A&R IO LCA became effective July 1, 2022, the three months ended June 30, 2022 was the last period in which such amounts were recognized in connection with our Sanofi immuno-oncology collaborative arrangement. During 2021, we updated our estimate of the total research and development costs expected to be incurred (which resulted in a change to the estimate of the stage of completion) in connection with the Sanofi IO Collaboration, and, as a result, recorded a cumulative catch-up adjustment of $66.9 million as a reduction to other operating income. Other Income (Expense)Other income (expense) consists of the following:Year Ended December 31,(In millions)202220212020Unrealized (losses) gains on equity securities, net$(39.8)$386.1$196.0Interest income160.145.875.4Other59.04.419.3Other income (expense), net179.3 436.3 290.7 Interest expense(59.4)(57.3)(56.9)Total other income (expense)$119.9 $379.0 $233.8 Income TaxesYear Ended December 31,(In millions, except effective tax rate)202220212020Income tax expense$520.4$1,250.5$297.2Effective tax rate10.7%13.4%7.8%The effective tax rate for 2022, compared to 2021, included a favorable benefit from the proportion of income earned in foreign jurisdictions with tax rates lower than the U.S. federal statutory rate (including the impact from REGEN-COV income earned in the United States during 2021).87Table of ContentsLiquidity and Capital ResourcesOur financial condition is summarized as follows:As of December 31,(In millions)20222021$ ChangeFinancial assets:Cash and cash equivalents$3,105.9 $2,885.6 $220.3 Marketable securities - current 4,636.4 2,809.1 1,827.3 Marketable securities - noncurrent6,591.8 6,838.0 (246.2)$14,334.1 $12,532.7 $1,801.4 Working capital:Current assets$15,884.1 $14,014.9 $1,869.2 Current liabilities3,141.3 3,932.5 *(791.2)$12,742.8 $10,082.4 $2,660.4 Borrowings and finance lease liabilities:Long-term debt$1,981.4 $1,980.0 $1.4 Finance lease liabilities$720.0 $719.7 *$0.3 * The $719.7 million related to finance lease liabilities was classified within current liabilities as of December 31, 2021. See "Tarrytown, New York Leases" section below for details. As of December 31, 2022, we also had borrowing availability of $750.0 million under a revolving credit facility (see further description under "Credit Facility" below).Sources and Uses of Cash for the Years Ended December 31, 2022, 2021, and 2020 As of December 31,$ Change(In millions)2022202120202022 vs. 20212021 vs. 2020Cash flows provided by operating activities$5,014.9 $7,081.3 $2,618.1 $(2,066.4)$4,463.2 Cash flows used in investing activities$(3,784.6)$(5,384.7)$(70.6)$1,600.1 $(5,314.1)Cash flows used in financing activities$(1,009.0)$(1,005.8)$(1,970.5)$(3.2)$964.7 Cash Flows from Operating Activities2022As of December 31, 2022, Accounts receivable had decreased by $707.8 million, compared to December 31, 2021, driven by the Company's collection of amounts due from the U.S. government in connection with REGEN-COV sales in the fourth quarter of 2021. Other non-cash items, net, in 2022 included inventory write-offs and reserves. As of December 31, 2022, deferred tax assets increased by $746.4 million, compared to December 31, 2021, primarily related to the impact of the Tax Cuts and Jobs Act of 2017, which requires, for tax purposes, the capitalization and amortization of research and development expenses effective for years beginning after December 31, 2021.2021As of December 31, 2021, Accounts receivable had increased by $1.927 billion, compared to December 31, 2020, primarily due to REGEN-COV sales in connection with our September 2021 agreement to supply drug product to the U.S. government. Other non-cash items, net, in 2021 included inventory write-offs and reserves. Accounts payable, accrued expenses, and other liabilities as of December 31, 2021 included a $259.6 million fourth quarter 2021 payment owed in connection with global gross profits under our Roche collaboration agreement. 88Table of Contents2020As of December 31, 2020, Accounts receivable had increased by $1.356 billion, compared to December 31, 2019, partly as a result of extending payment terms to EYLEA customers due to the COVID-19 pandemic. Inventories increased as of December 31, 2020, compared to December 31, 2019, partially as a result of purchasing additional raw materials in anticipation of potential disruptions to our supply chain due to the COVID-19 pandemic.Cash Flows from Investing ActivitiesCapital expenditures in 2022 included costs associated with the expansion of our manufacturing facilities in Rensselaer, New York (including the ongoing construction of a fill/finish facility and related equipment) and Limerick, Ireland, as well as costs incurred in connection with the expansion of the Tarrytown, New York campus. We expect to incur capital expenditures of $825 million to $950 million in 2023 primarily in connection with the continued expansion of our research, preclinical manufacturing, and support facilities at our Tarrytown, New York campus and our manufacturing facilities (including the fill/finish facility). We expect continued significant capital expenditures over the next several years in connection with the planned expansion of our Tarrytown, New York campus.Payments for Libtayo intangible asset of $1.027 billion in 2022 were related to our acquisition of the exclusive right to develop, commercialize, and manufacture Libtayo worldwide.Asset acquisition, net of cash acquired, of $230.3 million in 2022 was related to our acquisition of Checkmate.Cash Flows from Financing ActivitiesProceeds from issuances of Common Stock, in connection with exercises of employee stock options, were $1.520 billion during 2022, compared to $1.672 billion during 2021 and $2.575 billion during 2020. For additional information related to cash flows from financing activities, see "Share Repurchase Programs", "Sanofi Funding of Certain Development Costs", "Secondary Offering and Purchase of Regeneron Common Stock Held by Sanofi", and "Issuance of Senior Notes" sections below.Credit FacilityIn December 2018, we entered into an agreement with a syndicate of lenders (the "2018 Credit Agreement") which provided for a $750.0 million senior unsecured five-year revolving credit facility. The 2018 Credit Agreement, which was set to mature in December 2023, included an option for us to elect to increase the commitments under the Credit Facility and/or to enter into one or more tranches of term loans in the aggregate principal amount of up to $250.0 million, subject to the consent of the lenders providing the additional commitments or term loans, as applicable, and certain other conditions. In December 2022, we entered into an agreement with a syndicate of lenders (the "2022 Credit Agreement") which provides for a $750.0 million senior unsecured five-year revolving credit facility (the "2022 Credit Facility") and replaces the 2018 Credit Agreement, which was contemporaneously terminated. The 2022 Credit Agreement includes an option for the Company to elect to increase the commitments under the 2022 Credit Facility and/or to enter into one or more tranches of term loans in the aggregate principal amount of up to $500.0 million, subject to the consent of the lenders providing the additional commitments or term loans, as applicable, and certain other conditions. The 2022 Credit Agreement also provides a $50.0 million sublimit for letters of credit. As set forth in the 2022 Credit Agreement, we have the option to amend the 2022 Credit Agreement to establish environmental, social, and governance targets which will be used to adjust pricing under the 2022 Credit Facility, subject to parameters to be provided in the 2022 Credit Agreement.Proceeds of the loans under the 2022 Credit Facility may be used to finance working capital needs, and for general corporate or other lawful purposes, of Regeneron and its subsidiaries. Regeneron Pharmaceuticals, Inc. has guaranteed all obligations under the 2022 Credit Facility. The 2022 Credit Agreement includes an option for us to elect to extend the maturity date of the 2022 Credit Facility beyond December 2027, subject to the consent of the extending lenders and certain other conditions. Amounts borrowed under the 2022 Credit Facility may be prepaid, and the commitments under the 2022 Credit Facility may be terminated, at any time without premium or penalty. We had no borrowings outstanding under the 2022 Credit Facility as of December 31, 2022. The 2022 Credit Agreement contains operating covenants and a maximum total leverage ratio financial covenant. We were in compliance with all covenants of the 2022 Credit Agreement as of December 31, 2022.Share Repurchase ProgramsIn November 2019, our board of directors authorized a share repurchase program to repurchase up to $1.0 billion of our Common Stock. The share repurchase program permitted the Company to make repurchases through a variety of methods, including open-89Table of Contentsmarket transactions (including pursuant to a trading plan adopted in accordance with Rule 10b5-1 of the Exchange Act), privately negotiated transactions, accelerated share repurchases, block trades, and other transactions in compliance with Rule 10b-18 of the Exchange Act. As of December 31, 2020, the Company had repurchased the entire $1.0 billion of its Common Stock that it was authorized to repurchase under the program.In January 2021, our board of directors authorized a share repurchase program to repurchase up to $1.5 billion of our Common Stock. The share repurchase program was approved under terms substantially similar to the November 2019 share repurchase program. As of December 31, 2021, the Company had repurchased the entire $1.5 billion of its Common Stock that it was authorized to repurchase under the program.In November 2021, our board of directors authorized a share repurchase program to repurchase up to $3.0 billion of our Common Stock. The share repurchase program was approved under terms substantially similar to the share repurchase programs described above. The program has no time limit and can be discontinued at any time. As of December 31, 2022, $745.2 million remained available for share repurchases under the November 2021 program.The table below summarizes the shares of our Common Stock we repurchased under the programs described above and the cost of the shares, which were recorded as Treasury Stock.Year Ended December 31,(In millions)202220212020Number of shares 3.3 3.0 1.6 Total cost of shares $2,099.8 $1,655.0 $746.0 In January 2023, our board of directors authorized a new share repurchase program to repurchase up to an additional $3.0 billion of our Common Stock. The share repurchase program was approved under terms substantially similar to the share repurchase programs described above. The program has no time limit and can be discontinued at any time. Share repurchases may be made from time to time at management's discretion, and the timing and amount of any such repurchases will be determined based on share price, market conditions, legal requirements, and other relevant factors. There can be no assurance as to the timing or number of shares of any repurchases in the future.Sanofi Funding of Certain Development CostsPursuant to a 2018 agreement, we agreed to allow Sanofi to satisfy in whole or in part its funding obligations with respect to Libtayo development and/or certain activities relating to dupilumab and itepekimab incurred in periods through September 30, 2020 by selling shares of our Common Stock owned by Sanofi. During 2020, Sanofi elected to sell, and we elected to purchase, shares of our Common Stock to satisfy Sanofi's funding obligation related to such activities. Consequently, we recorded the cost of the shares received, or $135.0 million, as Treasury Stock during 2020.Secondary Offering and Purchase of Regeneron Common Stock Held by Sanofi In May 2020, a secondary offering of 13,014,646 shares of our Common Stock (the "Secondary Offering") held by Sanofi was completed. In connection with the Secondary Offering, we also purchased 9,806,805 shares of our Common Stock directly from Sanofi for an aggregate purchase amount of $5.0 billion (the "Stock Purchase").We funded the Stock Purchase with a combination of cash on hand, proceeds from the sale of marketable securities, and proceeds from loans under a $1.5 billion senior unsecured bridge loan facility (the "Bridge Facility") which was entered into in May 2020. The Bridge Facility was repaid in August 2020 following the issuance and sale of the Company's senior unsecured notes (as described below). Issuance of Senior NotesIn August 2020, we issued and sold $1.250 billion aggregate principal amount of senior unsecured notes due 2030 (the "2030 Notes") and $750 million aggregate principal amount of senior unsecured notes due 2050 (the "2050 Notes" and, together with the 2030 Notes, the "Notes"). Net proceeds from the issuance and sale of the Notes (after deducting underwriting discounts and offering expenses) were used in part to repay in full the Bridge Facility described above, including accrued interest and related fees and expenses in connection therewith. The 2030 Notes accrue interest at the rate of 1.750% per year and will mature on September 15, 2030. The 2050 Notes accrue interest at the rate of 2.800% per year and will mature on September 15, 2050. Interest on each series of Notes is payable semi-annually in arrears on March 15 and September 15 of each year until their respective maturity dates.90Table of ContentsThe Notes may be redeemed at the Company’s option at any time at 100% of the principal amount plus accrued and unpaid interest, and, until a specified period before maturity, a specified make-whole amount. The Notes contain a change-of-control provision that, under certain circumstances, may require the Company to offer to repurchase the Notes at a price equal to 101% of the principal amount plus accrued and unpaid interest.The Notes also contain certain limitations on the Company’s ability to incur liens and enter into sale and leaseback transactions, as well as customary events of default.Tarrytown, New York LeasesWe lease laboratory and office facilities in Tarrytown, New York (the "Facility"). In 2016, we entered into a Purchase Agreement with the then lessor, pursuant to which we agreed to purchase the Facility for a purchase price of $720.0 million. In March 2017, we entered into a Participation Agreement with BA Leasing BSC, LCC, an affiliate of Banc of America Leasing & Capital, LLC ("BAL"), as lessor, and a syndicate of lenders (collectively with BAL, the "Lease Participants"), which provided for lease financing in connection with the acquisition by BAL of the Facility and our lease of the Facility from BAL. In March 2017, we assigned our right to take title to the Facility under the Purchase Agreement to BAL, and the Lease Participants advanced $720.0 million, which was used by BAL to finance the purchase price for the Facility. Concurrent with entering into the Participation Agreement, we also entered into a lease agreement for the Facility with BAL for a five-year term that was set to expire in March 2022.In March 2022, we entered into a Second Amended and Restated Lease and Remedies Agreement (the "Restated Lease") with BAL, as lessor (the "Lessor"), which amends, restates, and extends our lease of the Facility. In March 2022, we also entered into a Second Amended and Restated Participation Agreement (the "Restated Participation Agreement") with Bank of America, N.A., as administrative agent, the Lessor, and a syndicate of financial institutions as rent assignees (collectively with the Lessor, the "Participants"), which amends and restates the original Participation Agreement entered into in March 2017.The original Participation Agreement and certain related agreements were amended and restated in order to, among other things, (i) effect a five-year extension of the original March 2022 maturity date of the $720.0 million lease financing and the end of the term of our lease of the Facility from the Lessor to March 2027, at which time all amounts outstanding thereunder will become due and payable in full, and (ii) modify the rate of the interest or yield that is payable to the Participants. In accordance with the terms of the Restated Lease, we continue to pay all maintenance, insurance, taxes, and other costs arising out of the use of the Facility. We are also required to make monthly payments of basic rent during the term of the Restated Lease in an amount equal to a variable rate per annum, which was modified in connection with the Restated Lease, to be an adjusted one-month forward-looking term rate based on the Secured Overnight Financing Rate ("SOFR"), plus an applicable margin that varies with our debt rating and total leverage ratio.The Restated Participation Agreement and Restated Lease include an option for us to elect to further extend the maturity date of the Restated Participation Agreement and the term of the Restated Lease for an additional five-year period, subject to the consent of all the Participants and certain other conditions. We also have the option prior to the end of the term of the Restated Lease to (a) purchase the Facility by paying an amount equal to the outstanding principal amount of the Participants' advances under the Restated Participation Agreement, all accrued and unpaid yield thereon, and all other outstanding amounts under the Restated Participation Agreement, Restated Lease, and certain related documents or (b) sell the Facility to a third party on behalf of the Lessor.The Restated Lease is classified as a finance lease as we have the option to purchase the Facility under terms that make it reasonably certain to be exercised. The agreements governing the Restated Lease financing contain financial and operating covenants. Such financial covenants and certain of the operating covenants are substantially similar to the covenants set forth in our 2018 Credit Agreement. The Company was in compliance with all such covenants as of December 31, 2022.Additional Funding RequirementsThe amount required to fund operations will depend on various factors, including the potential regulatory approval and commercialization of our product candidates and the timing thereof and the extent and cost of our research and development programs. We believe that our existing capital resources, borrowing availability under the 2022 Credit Facility, funds generated by anticipated product sales, and funding for reimbursement of research and development costs that we are entitled to receive under our collaboration agreements, will enable us to meet our anticipated operating needs for the foreseeable future.We expect continued increases in our expenditures, particularly in connection with our research and development activities (including preclinical and clinical programs). The amount of funding that will be required for our clinical programs depends upon the results of our research and preclinical programs and early-stage clinical trials, regulatory requirements, the duration and results of clinical trials underway and of additional clinical trials that we decide to initiate, and the various factors that affect the cost of 91Table of Contentseach trial, including the size of trials, fees charged for services provided by clinical trial investigators and other third parties, the costs for manufacturing the product candidate for use in the trials, and other expenses. We also anticipate continuing to incur substantial commercialization costs for our marketed products. Commercialization costs over the next few years will depend on, among other things, the market potential for product candidates, whether commercialization costs are shared with a collaborator, and regulatory approval of additional product candidates.We expect that expenses related to the filing, prosecution, defense, and enforcement of patents and other intellectual property will be substantial. Liabilities for unrecognized tax benefits totaled $542.8 million as of December 31, 2022. Due to their nature, there is a high degree of uncertainty regarding the period and amounts of potential future cash settlement with tax authorities. See Note 15 to our Consolidated Financial Statements.We enter into collaboration and licensing agreements that may require us to pay (i) amounts contingent upon the occurrence of various future events (e.g., upon the achievement of various development and commercial milestones), which, in the aggregate, could be significant, and/or (ii) royalties calculated based on a percentage of net product sales. The payment of these amounts, however, is contingent upon the occurrence of various future events, which have a high degree of uncertainty of occurring and for which the specific timing cannot be predicted. See Note 3 and Note 11 to our Consolidated Financial Statements.Under our collaboration with Bayer for EYLEA outside the United States and our Antibody Collaboration with Sanofi, we and our collaborator share profits and losses in connection with commercialization of drug products. If the applicable collaboration is profitable, we have contingent contractual obligations to reimburse Bayer and Sanofi for a defined percentage (generally 50%) of agreed-upon development expenses funded by Bayer and Sanofi (i.e., "development balance"). These reimbursements are deducted each quarter, in accordance with a formula, from our share of the collaboration profits otherwise payable to us, unless, in the case of EYLEA, we elect to reimburse these expenses at a faster rate. As of December 31, 2022, our contingent reimbursement obligation to Bayer for EYLEA was approximately $273 million and our contingent reimbursement obligation to Sanofi in connection with the companies' Antibody Collaboration was approximately $2.864 billion. Therefore, we expect that, for the foreseeable future, a portion of our share of profits from sales under our collaborations with Bayer and Sanofi will be used to reimburse our collaborators for these obligations.Off-Balance Sheet ArrangementsWe do not have any off-balance sheet arrangements that are currently material or reasonably likely to be material to our consolidated financial position or results of operations.Future Impact of Recently Issued Accounting StandardsAs of December 31, 2022, the future adoption of recently issued accounting standards is not expected to have a material impact on the Company's financial position or results of operations.Item 7A. Quantitative and Qualitative Disclosures About Market RiskInterest Rate RiskOur earnings and cash flows are subject to fluctuations due to changes in interest rates, principally in connection with our investments in marketable securities, which consist primarily of corporate bonds and U.S. treasury securities. We do not believe we are materially exposed to changes in interest rates related to our investments, and we do not currently use interest rate derivative instruments to manage exposure to interest rate changes of our investments. We estimate that a 100 basis point, or 1%, unfavorable change in interest rates would have resulted in approximately a $102.7 million and $120.0 million decrease in the fair value of our investment portfolio as of December 31, 2022 and 2021, respectively. We have exposure to market risk for changes in interest rates, including the interest rate risk relating to our variable rate Tarrytown, New York lease (as described in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Tarrytown, New York Leases"). Our interest rate exposure is primarily offset by our investments in marketable securities. We continue to monitor our interest rate risk and may utilize derivative instruments and/or other strategies in the future to further mitigate our interest rate exposure. 92Table of ContentsCredit Quality RiskWe have an investment policy that includes guidelines on acceptable investment securities, minimum credit quality, maturity parameters, and concentration and diversification. Nonetheless, deterioration of the credit quality of an investment security subsequent to purchase may subject us to the risk of not being able to recover the full principal value of the security. In 2022, 2021, and 2020, we did not record any charges for credit-related impairments of our available-for-sale debt securities.We are subject to credit risk associated with the receivables due from our collaborators, including Bayer and Sanofi. We are also subject to credit risk in connection with trade accounts receivable due from our customers from our product sales. We have contractual payment terms with each of our collaborators and customers. We also monitor financial performance and credit worthiness so that we can properly assess and respond to any changes in collaborator and/or customer credit profiles. In 2022, 2021 and 2020, we did not recognize any charges for write-offs and allowances of accounts receivable related to credit risk for our collaborators or customers. As of December 31, 2022, two customers accounted on a combined basis for 86% of our net trade accounts receivables.Foreign Exchange RiskAs discussed further above, our collaborators market certain products outside the United States, and we share in profits and losses with these collaborators from commercialization of products. In addition, pursuant to the applicable terms of the agreements with our collaborators, we also share in certain worldwide development expenses incurred by our collaborators. We also incur worldwide development expenses for clinical products we are developing independently, incur expenses outside of the United States in connection with our international operations, and, effective July 1, 2022, market Libtayo outside of the United States as a result of obtaining worldwide rights to Libtayo under an A&R IO LCA with Sanofi. Therefore, significant changes in foreign exchange rates of the countries outside the United States where our products are sold, where development expenses are incurred by us or our collaborators, or where we incur operating expenses can impact our operating results and financial condition. As sales outside the United States continue to grow, and as we expand our international operations, we will continue to assess potential steps, including foreign currency hedging and other strategies, to mitigate our foreign exchange risk. Market Price RiskWe are exposed to price risk on equity securities included in our investment portfolio. Our marketable securities include equity investments in publicly traded stock of companies, including common stock of companies with which we have entered into collaboration arrangements. Changes in the fair value of our equity investments are included in Other income (expense), net on the Consolidated Statements of Income. We recorded $39.8 million of net unrealized losses and $386.1 million of net unrealized gains on equity securities in Other income (expense), net in 2022 and 2021, respectively.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended September 30, 2022. We believe that at June 30, 2023, there has been no material change to this information, except as noted below.Goodwill - Sensia Reporting UnitThe quantitative test of Goodwill for impairment requires us to estimate the fair value of our reporting units. During the second quarter of fiscal 2023, we performed a quantitative impairment test for our Sensia reporting unit. We determined the fair value of the reporting unit under a combination of an income approach derived from discounted cash flows and a market multiples approach using selected comparable public companies.Critical assumptions used in this approach included management’s estimated future revenue growth rates and margins, a discount rate, and a market multiple. Estimated future revenue growth and margins are based on management’s best estimate about current and future conditions. The revenue growth rate assumption reflects significant growth over the next five years before moderating back to a growth rate approximating longer term average inflationary rates. The forecasted near-term growth rate assumes that revenue will return to pre-pandemic levels due to the abatement of pandemic and supply chain related disruptions. Margin assumptions reflect that recent cost pressure related to inflation and supply chain challenges will be compensated through pricing achieved on future orders. We believe the assumptions and estimates made were reasonable and appropriate, which are based on a number of factors, including historical experience, reference to external product available market and industry growth publications, analysis of peer group projections, and information obtained from reporting unit management, including backlog. Actual results and forecasts of revenue growth and margins for our Sensia reporting unit may be impacted by its concentration within the Oil & Gas industry and with its customer base. Demand for Sensia hardware and software products, solutions, and services is sensitive to industry volatility and risks, including those related to commodity prices, supply and demand dynamics, production costs, geological activity, and political activities. If such factors impact our ability to achieve forecasted revenue growth rates and margins, the fair value of the reporting unit could decrease, which may result in an impairment. We determined the discount rate using our weighted average cost of capital adjusted for risk factors including risk associated with our above market revenue growth assumptions, historical performance, and industry-specific and economic factors. Additionally, industry-specific and economic factors that increase the discount rate or decrease the market multiple can decrease the fair value of the Sensia reporting unit, which may result in an impairment.Based on these assumptions and estimates, the fair value of the Sensia reporting unit exceeded its carrying value by approximately 10 percent. We also assessed the changes in events and circumstances subsequent to our annual test and concluded that no triggering events, which would require interim quantitative testing, occurred. Therefore, as of June 30, 2023, we deemed that no impairment existed on $318.2 million of Goodwill allocated to the Sensia reporting unit.Retirement Benefits - PensionIn June 2023, we remeasured our U.S. pension plan assets and liabilities in accordance with U.S GAAP settlement accounting rules. The discount rate used in the remeasurement was 5.45 percent compared to 5.65 percent at our September 30, 2022, annual measurement date. The 5.45 percent discount rate was set as of a June 30, 2023, measurement date and was determined by modeling a portfolio of bonds that match the expected cash flow of our benefit plans. See Note 10 in the Consolidated Financial Statements for additional information regarding the settlement accounting.Environmental MattersInformation with respect to the effect of compliance with environmental protection requirements and resolution of environmental claims on us and our manufacturing operations is contained in Note 17 in the Consolidated Financial Statements in
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+Item 7.A.​Quantitative and Qualitative Disclosures about Market Risk.​25Item 8.​Financial Statements and Supplementary Data.​26Item 9.​Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.​60Item 9.A.​Controls and Procedures.​63Item 9.B.​Other Information.​61Item 9.C.​Disclosure Regarding Foreign Jurisdictions that Prevent Inspections​62​​​​​Part III​​​​Item 10.​Directors, Executive Officers and Corporate Governance.​62Item 11.​Executive Compensation.​62Item 12.​Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.​62Item 13.​Certain Relationships and Related Party Transactions, and Director Independence.​62Item 14.​Principal Accounting Fees and Services.​62​​​​​Part IV​​​​Item 15.​Exhibits, Financial Statement Schedules.​63​​Signatures.​65​​​2 Table of Contents​PART IItem 1. BusinessGeneral OverviewRollins, Inc. (“Rollins,” “we,” “us,” “our,” or the “Company”), is an international services company headquartered in Atlanta, Georgia. Through our family of leading brands, we provide essential pest and wildlife control services and protection against termite damage, rodents and insects to more than two million residential and commercial customers from more than 800 Company-owned and franchised locations in approximately 70 countries. Over the course of our lengthy operating history, we have garnered a reputation for providing great customer service. The contracted and recurring nature of our services provide us with visibility into a significant portion of our future earnings.In 1964, brothers O. Wayne and John Rollins acquired Orkin Exterminating Company and in 1965 we changed our name from Rollins Broadcasting, Inc to Rollins, Inc. In 1968, Rollins began trading on the New York Stock Exchange under the symbol “ROL.” Since then, we have grown into a premier consumer and commercial services business with numerous industry leading brands including the world renowned Orkin, as well as HomeTeam Pest Defense, Clark Pest Control, Western Pest Services, Critter Control Wildlife, and Northwest Exterminating, among others.We operate under one reportable segment which contains our three business lines: ●Residential: Pest control services protecting residential properties from common pests, including rodents, insects and wildlife; ●Commercial: Workplace pest control solutions for customers across diverse end markets such as healthcare, foodservice, logistics; and ●Termite: Termite protection services and ancillary services for both residential and commercial customers.Our Competitive StrengthsRollins is a global leader in pest control. We have established a portfolio of premier brands with extensive service capabilities across a deep operating network. Our scale enables delivery of great service and provides a significant and reinforcing competitive advantage through (i) comprehensive capabilities to win new residential and commercial accounts, (ii) technology investments for operations optimization and enhanced customer experience, (iii) route density to manage variable costs, and (iv) financial flexibility to generate organic growth and pursue M&A.Robust Operating Platform with Proprietary TechnologyOur extensive footprint creates an efficient and scalable operating platform to facilitate exceptional customer service delivery, increased cross-selling opportunities, and cost efficiencies. We have strategically invested in proprietary routing and scheduling technologies to increase our competitive advantage, which includes real-time service tracking and customer internet communication to personalize the customer experience. We run our proprietary Branch Operating Support System (“BOSS”), which offers a back-end interface to facilitate service tracking and payment processing for technicians. BOSS also provides virtual route management tools to increase route efficiency across our network, reducing miles driven and associated costs while increasing customer retention through on-time and rapid response service. Differentiated Employee Base and Service DeliveryOur employees are critical to delivering an outstanding customer experience, and we are highly focused on providing our team with best-in-class training and development opportunities. We operate the 27,000 square foot Rollins Learning Center training facility located in Atlanta, GA, which is a distance-learning and global broadcast facility with simulated environments and classrooms for training. In addition to in-person training, the Rollins Learning Center offers on-demand training sessions that employees can access from anywhere in the world that are produced at our on-site, state-of-the-art broadcast studio. Our unique programs contribute to our position as an 3 Table of Contents​employer of choice and have earned us recognition from Training magazine among the Top 125 U.S. Training Companies 17 times in the past 20 years. We were also recognized by the Top Workplaces program as a top workplace on both a national and local level. This marks the seventh consecutive year to be recognized in Atlanta. We continuously monitor co-worker engagement and customer loyalty.Experienced Management TeamOur management team combines extensive business and consumer services experience with robust local pest control leadership. Consistent with our culture of attracting, developing and progressing talented individuals, our senior leadership team consists of a combination of long-term internal leaders and strategic hires from well-respected external platforms. Our Chairman, Gary Rollins, is the son of Rollins, Inc. co-founder O. Wayne Rollins and has spent his entire career with the Company, serving as Chief Executive Officer (“CEO”) from 2001 to 2022. Effective January 1, 2023, Jerry Gahlhoff, Jr. assumed the role of CEO and now serves as President and CEO.International BusinessWe continue to expand our international presence through organic growth, acquisitions, and our international franchise programs. In 2022, we saw revenue growth in our operations in Canada, Australia, and the United Kingdom. We believe geographic diversity allows us to increase brand recognition, meet demands of global customers, and draw on business and technical expertise from teams in several countries, and offers us an opportunity to access new markets.Franchising ProgramsWe have franchise programs through Orkin, Critter Control and our Australian subsidiaries. We had a total of 137, 135 and 128 domestic franchise agreements as of December 31, 2022, 2021 and 2020, respectively. International franchise agreements totaled 89, 103 and 101 as of December 31, 2022, 2021 and 2020, respectively. Transactions with our franchises involve sales of territories and customer contracts to establish new franchises and the payment of initial franchise fees and royalties by franchisees. The territories, customer contracts and initial franchise fees are typically paid for by a combination of cash and notes. Acquisition StrategyWe have extensive experience acquiring companies of all sizes. Over the last three years, we have completed approximately 100 acquisitions, including 31 acquisitions in 2022. Our acquisition strategy targets high quality, profitable businesses with strong leadership that would benefit from incremental growth capital and have the potential to achieve margin expansion through cost and revenue synergies.Seasonality Our business is somewhat affected by weather conditions, including climate change and the seasonal nature of our pest and termite control services. The increase in pest presence and activity, as well as the metamorphosis of termites in the spring and summer (the occurrence of which is determined by the timing of the change in seasons), has historically resulted in an increase in the revenue of our pest and termite control operations during such periods as evidenced by the following chart.​​​​​​​​​​​ Consolidated Net Revenues(in thousands) 2022 2021 2020First Quarter​$ 590,680​$ 535,554​$ 487,901Second Quarter​ 714,049​ 638,204​ 553,329Third Quarter​ 729,704​ 650,199​ 583,698Fourth Quarter​ 661,390​ 600,343​ 536,292Year to date​$ 2,695,823​$ 2,424,300​$ 2,161,220​Our quarterly profitability correlates with our revenue due to seasonality, as profit is lower in the first and fourth quarters and higher in the second and third quarters.4 Table of Contents​Materials and SuppliesOur Company has relationships with a vast network of national pest control product distributors, manufacturers and other suppliers for pest and termite treatment products. We maintain a sufficient level of products, materials, and other supplies to fulfill our immediate servicing needs and to mitigate any potential short-term shortage in availability from our national network of suppliers. We also have qualified comparable products and materials for key categories to have alternatives ready as needed. However, at any time supply chain disruptions that are more than short-term in nature could impact our levels of products, materials and other supplies.CompetitionWe operate in a highly competitive environment. The principal factors of competition in our pest and termite control markets are quality and speed of service, customer proximity, customer satisfaction, brand awareness and reputation, terms of guarantees, safety, technical proficiency and price. Due to our strong direct partnerships with product manufacturers, distributors, and visibility into the inventories, ordering and distribution of materials and supplies, we are able to foresee potential supply disruptions and to quickly adapt. The use of an innovative and industry changing distribution model and technology enables us to maintain adequate supplies for our field operations without a significant investment in warehousing and inventory. We believe that, through our wholly-owned subsidiaries, we compete effectively and favorably with our competitors as one of the world’s largest pest and termite control companies. Our major competitors include Rentokil, Ecolab, and Anticimex.Research and DevelopmentOur expenditures on research activities relating to the development of new products or services are not significant. We utilize the relationships with our manufacturer and materials suppliers to provide new and innovative products and services, coupled with in-depth reviews by our tenured Technical Services department to ensure they meet our strict requirements. We also conduct tests of new products with the specific manufacturers of such products and we rely on research performed by leading universities. We maintain close relationships with several universities for research and validation of treatment procedures and material selection. Some of the new and improved service methods and products are also researched, developed and produced by unaffiliated universities and companies with a portion of these methods and products being produced to the specifications provided by us.Environmental and Regulatory ConsiderationsOur business is subject to various local and national legislative and regulatory enactments including, but not limited to, environmental laws, antitrust laws, employment laws (including wage and hour laws, payroll taxes and anti-discrimination laws), immigration laws, motor vehicle laws and regulations, human health and safety laws, securities laws including, but not limited to, SEC regulations, and federal, state and local laws and regulations governing worker safety and the pest and termite control industry. If we were to fail to comply with any of these applicable laws or regulations, we could be subject to substantial fines or damages, be involved in lawsuits, enforcement actions and other claims by third parties or governmental authorities, suffer losses to our reputation and our business or suffer the loss of licenses or penalties that may affect how the business is operated, which, in turn, could have a material adverse effect on our financial condition, results of operations and cash flows.Environmental, Health and Safety MattersSpecifically, our businesses are subject to various international, federal, state and local laws and regulations regarding environmental, health and safety matters. Among other things, these laws regulate the emission or discharge of materials into the environment, govern the use, storage, treatment, disposal, transportation and management of hazardous substances and wastes and protect the health and safety of our employees. These laws also impose liability for the costs of investigating and remediating, and damages resulting from, present and past releases of hazardous substances, including releases by prior owners or operators of sites we currently own or operate. Compliance with environmental, health and safety laws increases our operating costs, limits or restricts the services we provide and subjects us to the possibility of regulatory or private actions or proceedings.5 Table of Contents​Consumer Protection, Privacy and Solicitation MattersAdditionally, we are subject to international, federal, state, provincial and local laws and regulations designed to protect consumers generally, including laws governing lending, debt collection and consumer finance, consumer privacy and fraud, the collection and use of consumer data, telemarketing and other forms of solicitation. The telemarketing rules adopted by the Federal Communications Commission pursuant to the Federal Telephone Consumer Protection Act of 1991 and the Federal Telemarketing Sales Rule issued by the Federal Trade Commission, along with state laws and other legal authorities, govern our telephone and texting sales practices. The CAN-SPAM Act regulates our email solicitations and the Consumer Review Fairness Act regulates consumer opinions on social media regarding our products and services. The California Consumer Privacy Act, the first of its kind and followed by the California Privacy Rights Act, and laws in other states provide consumers and sometimes employees the right to know what personal data businesses collect, how the data is used, and give them the right to access, delete and opt out of the sale of their personal information to third parties. We are subject to some of these states’ laws depending on the number of customers or amount of revenue in the specific state.Franchise MattersCertain of our subsidiaries are subject to various international, federal, state, provincial and local laws and regulations governing franchise sales, marketing and licensing and franchise trade practices generally, including applicable rules and regulations of the Federal Trade Commission. These laws and regulations generally require disclosure of business information in connection with the sale and licensing of our franchises. Certain state regulations also affect our ability as a franchisor to revoke or refuse to renew a franchise. From time to time, we and one or more franchisees have been, and may in the future become, involved in a dispute regarding the franchise relationship, including payment of royalties or fees, location of branches, advertising, purchase of products by franchisees, non-competition covenants, compliance with our standards or franchise renewal criteria. Any such franchise dispute could possibly have an adverse effect on our reputation, financial condition, results of operations and cash flows.Intellectual PropertyWe rely on a combination of intellectual property rights, including patents, trademarks, copyrights, trade secrets, and contractual provisions to protect our intellectual property. Our worldwide intellectual property portfolio is strengthened through innovation and brand recognition, and a comprehensive approach for protection and enforcement. Risk factors associated with our intellectual property are discussed in Item 1.A. "Risk Factors".We protect and promote our intellectual property portfolio and take those actions we deem appropriate to enforce our intellectual property rights and to defend our rights both domestically and internationally. Although in the aggregate, our global portfolio of more than 450 trademarks is a valuable asset that is important to our operations, we believe that our competitive advantage is also largely attributable to the technical, marketing, and sales competence and capabilities of our employees, rather than on any individual trademark. Therefore, we do not consider the expiration or loss of any single trademark or intellectual property right, to be material to our business as a whole.Human CapitalWe believe one of the largest contributors to our Company’s success is the quality of our people. Attracting, developing and retaining high-quality talent is the primary objective of our human capital management. The development and retention of high-quality talent leads to a better customer experience and better customer retention. We develop and engage our people through our training at all levels of our organization.As of December 31, 2022, the Company had 17,515 employees. Approximately 15,800 of our employees were located in the United States, with approximately 14,700 employees at U.S. branch offices. Of the U.S. employees, less than 2% are represented by a labor union or covered by a collective bargaining agreement.​​​​​​​At December 31, 2022 2021 2020Employees 17,515 16,482 15,616​6 Table of Contents​Leadership DevelopmentDeveloping existing and future leaders is critical to our ongoing success as a company. Each year, we conduct in-depth leadership talent reviews for each people leader in our organization. During those reviews, we identify top talent leaders who have both the capability and desire to perform at the next level of leadership. For those leaders, we either build or update focused development plans to proactively develop the leadership skills needed at that next level of leadership. We also identify peer mentorship opportunities where our seasoned leaders are able to assist in the development of their peers. Each Rollins brand cultivates its own leadership development programs that support its own values and culture while considering the best practices of all Rollins brands. Our leaders are trained on the fundamentals of people leadership, business acumen, sales excellence, and technical expertise. Rollins, Inc. owns senior-level leadership training at the highest levels where top talent is identified to participate in our annual Region Manager Development Program (RMDP). RMDP is a one-year class with several different stages and is focused on helping selected leaders prepare for leading leaders and building high-performing teams across multiple locations within a defined geographical region. Since 2018, we have graduated a total of 69 senior leaders in four different RMDP classes, with continued successes with promotions to our Division President level.Workplace InclusionWe make it a priority to promote and create a diverse, equitable and inclusive workplace that results in higher levels of satisfaction and engagement, stronger staff retention, higher productivity, and a heightened sense of belonging. Our mission is to have a culture of inclusion, where all individuals feel respected, are treated fairly, with an equitable opportunity to excel. Our Workplace Inclusion (WPI) mission to build an inclusive workplace has continued since 2020 under the guidance of our Executive Sponsor and Inclusion Advisory Council which is made up of employees from Rollins brands across the United States. In January 2022 the role of fulltime Director of WPI became active. The Director’s primary role is to implement the WPI Strategic Plan (the “Plan”) which was approved by the Executive Leadership team in April of 2022. The Plan includes 5 Strategic Focus Areas which will be implemented across all brands. The 5 Strategic Focus areas are Training & Education, Talent Acquisition & Career Development, Policies & Programs, Communication and Employee Resource Groups. We formed six (6) taskforces, led by functional and brand subject matter experts, to execute on the Plan goals.With the continued focus on inclusion, the employee demographic year-over-year comparison showed positive trends in the percentage of women and people of color in underrepresented job categories. Additionally, we changed various policies, practices and programs to be more inclusive, we recognized cultural holidays and events that are celebrated by our employees throughout the year, and we launched our first Employee Resource Groups (ERGs). Our ERGs are led by Rollins employees, are inclusive to all and include eight (8) categories representing our employee population. Four (4) ERGs are now active. We are excited about the accomplishments on our journey to create a workplace of inclusion and will continue to execute on the strategic plan.Health and SafetyWe are committed to the health and safety of our employees, customers and communities where we work, live and play. During fiscal 2022, as a result of the COVID-19 pandemic (“COVID-19”), we continued to execute our pre-established business continuity plans including our pandemic “SAFE Workplace” procedures to maintain compliance with state and local jurisdictions. Management also regularly updates our employees and customers on COVID-19 developments in a consistent and timely manner which includes contact information for our Employee Assistance Program. We saw a significant decline in COVID-19 related challenges in 2022.In 2022, to enhance our already strong benefits offering, we signed an agreement with Everside Health to provide free primary care to our employees who participate in one of our medical insurance plans. We built an on-site medical clinic at our company headquarters in Atlanta. That facility is available to all employees in the state of Georgia who participate in one of our medical insurance plans. Our employees outside of Georgia have access to approximately 70 Everside Health clinics around the country and access to virtual care through the Everside network in all 50 states. 7 Table of Contents​Community InvolvementWe offer employees the opportunity to participate in various community outreach programs and believe that this commitment helps the Company to meet its goals of attracting, developing and retaining high-quality employees. We created Rollins United in 2019 to unify our brands’ philanthropic visions and consolidate our community outreach efforts. Our overarching goal is to create a significant impact in local communities over an extended period of time. The core mission of Rollins United is that everyone deserves a safe place to live, work, and play.Over the last 40 years, we have partnered with the United Way of Greater Atlanta through employee and company-matching funds, helping make Rollins a community leader for many years. Rollins ranked #9 in the top 25 corporate contributors in 2021 compared to ranking #11 in 2020. Along with personal contributions from employees, the company hosts rallies, contests, and a silent auction to raise funds. Rollins has contributed over $1 million annually for the past 3 years.We also have a partnership with the Grove Park Foundation (the “Foundation”) to help serve our Atlanta community. The partnership allows our employees to volunteer and support the Foundation, which is committed to neighborhood revitalization to improve the quality of life in the Grove Park neighborhood. Representatives from our Atlanta family of brands participate in volunteer opportunities in the Grove Park neighborhood throughout the year. Additionally, many of our operations engage regularly with their local community efforts throughout the year.Available InformationOur Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports, are available free of charge on our website at www.rollins.com, under the heading “SEC Filings,” as soon as reasonably practicable after those reports are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”).Forward-Looking StatementsThis Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include, but are not limited to, statements regarding:(1) our visibility into our future earnings because of the contracted and recurring nature of our services; (2) our investments in proprietary routing and scheduling technologies to increase our competitive advantage; (3) our belief that we will continue to expand our international presence through organic growth, international acquisitions, and our international franchise programs and our belief that such international expansion and geographic diversity allow us to increase brand recognition, meet demands of global customers and draw on business and technical expertise from teams in several countries, as well as access new markets; (4) our ability to foresee and quickly adapt to potential supply disruptions because of our strong direct partnerships with product manufacturers, distributors, and visibility into the inventories, ordering and distribution of materials and supplies; (5) our ability to maintain adequate supplies for our field operations without a significant investment in warehousing and inventory because of the use of an innovative and industry changing distribution model and technology; (6) our belief that our competitive advantage is largely attributable to the technical, marketing, and sales competence and capabilities of our employees, rather than on any individual trademark and our belief that the expiration or loss of any single trademark or intellectual property right would not be material to our business as a whole; (7) our belief that we compete effectively and favorably with our competitors as one of the world’s largest pest and termite control companies; (8) our belief that we maintain a sufficient level of products, materials and other supplies to fulfill our immediate servicing needs and to alleviate any potential short-term shortage in availability from our national network of suppliers; (9) the suitability and adequacy of our facilities to meet our current and reasonably anticipated future needs; (10) our belief that one of the largest contributors to our success is the quality of our people and our belief that the development and retention of high-quality talent leads to a better customer experience and better customer retention; (11) our belief that if we make it a priority to promote and create a diverse, equitable and inclusive workplace, it will result in higher levels of satisfaction and engagement, stronger staff retention, higher productivity, and a heightened sense of belonging; (12) our excitement with respect to our accomplishments on our journey to create a workplace of inclusion and our plans to continue to execute on the strategic plan with respect thereto; (13) our belief that our commitment to offer employees the opportunity to participate in various community outreach programs will help us meet our goals of attracting, developing and retaining high-quality employees and create a significant impact in local communities over time; (14) our belief that no pending claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on our business, results of operations, financial condition, cash flow or prospects; (15) our belief that we establish sufficient loss contingency reserves based upon outcomes of such pending claims, proceedings or litigation that 8 Table of Contents​we currently believe to be probable and reasonably estimable; (16) our plans to continue to monitor COVID-19 and plans to take actions that may alter our operations, including those that may be required by federal, state, or local authorities, or that we determine are in the best interests of our employees and customers; (17) our plans to continue to carry out various strategies previously implemented to help mitigate the impact of certain economic disruptors (such as high inflation, increased fuel costs, business interruptions due to natural disasters, employee shortages and supply chain issues), including revamping its routing and scheduling process to decrease the number of miles per stop, advanced scheduling to compensate for employee and vehicle shortages, shipping delays, and maintaining higher purchasing levels to allow for sufficient inventory; (18) our belief that we are starting 2023 with a strong foundation and demand for our business remains strong; (19) our belief that strategic pricing efforts helped offset inflationary pressures we experienced in fleet, material and other people associated cost and our expectations to pull forward our price increase again in 2023 and raise prices for services in the first quarter; (20) our assertion that we continue to be permanently reinvested with respect to our investments in our foreign subsidiaries; (21) our belief that our current cash and cash equivalents balances, future cash flows expected to be generated from operating activities, and available borrowings under our $175.0 million revolving credit facility and $300.0 million term loan facility (as amended January 27, 2022) will be sufficient to finance our current operations and obligations, and fund expansion of our business for the foreseeable future and our plans to evaluate opportunities to renegotiate our current credit facility that will be expiring in April 2024; (22) our expectation to continue our payment of cash dividends, subject to our earnings and financial condition and other relevant factors; (23) our belief that we maintain adequate liquidity and capital resources, without regard to its foreign deposits, to finance domestic operations and obligations and to fund expansion of our domestic business; (24) our belief that our pipeline for acquisitions is strong, our plans to seek new acquisitions and expectation to make additional acquisitions in 2023; (25) our belief that we remain very well positioned to drive growth across all of our services lines in 2023; (26) our intentions to grow the business in foreign markets through reinvestment of foreign deposits and future earnings and through acquisitions of unrelated companies with the expectation to repatriate unremitted foreign earnings from our foreign subsidiaries and the expectation that any additional future repatriations of unremitted earnings are expected to be completed in a largely tax-free manner with any residual impacts being immaterial to the financial statements; (27) our belief that we have adequate liquid assets, funding sources and insurance accruals to accommodate certain insurance claims; (28) our expectation that we will maintain compliance with applicable covenants throughout 2023; (29) the expected impact and amount of our contractual obligations; (30) our expectations regarding termite claims and factors that impact future costs from those claims; (31) the expected collectability of accounts receivable; (32) our belief that our tax positions are fully supportable; (33) our beliefs about our accounting policies and the impact of recent accounting pronouncements; (34) our belief that our exposure to market risks arising from changes in foreign exchange rates will not have a material impact upon our results of operations going forward; (35) our ability to utilize all of our foreign net operating losses; (36) our reasonable certainty that we will exercise the renewal options on our vehicle leases; (37) expectations regarding the recognition of compensation costs related to time-lapse restricted shares; (38) our ability to be proactive in safety and risk management to develop and maintain ongoing programs to reduce and prevent incidents and claims under our insurance programs and arrangements; and (39) our potential suspension of future services for customers with past due balances.Our actual results could differ materially from those indicated by the forward-looking statements because of various risks, timing and uncertainties including, without limitation, the failure to maintain and enhance our brands and develop a positive client reputation; our ability to protect our intellectual property and other proprietary rights that are material to our business and our brand recognition; actions taken by our franchisees, subcontractors or vendors that may harm our business; general economic conditions; the impact of the extent and duration of economic contraction related to COVID-19 on general economic activity for the remainder of 2023 and beyond; the impact of future developments related to the COVID-19 pandemic on the Company’s business, results of operations, accounting assumptions and estimates and financial condition, including, without limitation, restrictions in customer discretionary expenditures, disruptions in credit or financial markets, increases in fuel prices, raw material costs or other operating costs; potential increases in labor costs; labor shortages and/or our inability to attract and retain skilled workers; competitive factors and pricing practices; changes in industry practices or technologies; the degree of success of our termite process reforms and pest control selling and treatment methods; our ability to identify, complete and successfully integrate potential acquisitions; unsuccessful expansion into international markets; climate change and unfavorable weather conditions; a breach of data security resulting in the unauthorized access of personal, financial, proprietary, confidential or other personal data or information about our customers, employees, third parties, or of our proprietary confidential information; damage to our brands or reputation; possibility of an adverse ruling against us in pending litigation, regulatory action or investigation; changes in various government laws and regulations, including environmental regulations; the adequacy of our insurance coverage to cover all significant risk exposures; the effectiveness of our risk management and safety program; general market risk; management’s substantial ownership interest and its impact on public stockholders and the availability of the Company’s common stock to the investing public; and the existence of certain anti-takeover provisions in our governance documents, which could make a tender offer, change in control or takeover attempt that is opposed by the Company’s Board of Directors more difficult or expensive. All of the foregoing risks and uncertainties are beyond our ability to control, and in many cases, we cannot predict the risks and 9 Table of Contents​uncertainties that could cause our actual results to differ materially from those indicated by the forward-looking statements. The Company does not undertake to update its forward-looking statements.​Item 1.A. Risk FactorsAn investment in our common stock involves certain risks. Before making an investment decision, you should carefully consider the following risks and all of the other information included in this Annual Report on Form 10-K. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. This Annual Report on Form 10-K also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced by us described below and elsewhere in this Annual Report on Form 10-K. You are cautioned that the risk factors discussed below are not exhaustive. Risks Related to our Business, Brand, Industry and OperationsWe face risks regarding our ability to maintain our competitive position in the pest control industry in the future.We operate in a highly competitive industry. Our revenues and earnings are affected by changes in competitors’ prices and general economic issues. We compete with other large pest control companies, as well as numerous smaller pest control companies, for a finite number of customers. We believe that the principal competitive factors in the market areas that we serve are quality and speed of service, customer proximity, customer satisfaction, brand awareness and reputation, terms of guarantees, safety, technical proficiency and price. Although we believe that our experience, safety and quality service are excellent, we cannot assure investors that we will be able to maintain our competitive position in the future and any competitive pressures we may face could have a material adverse effect on our reputation, business, financial condition, results of operations and cash flows.We may not be able to identify, complete or successfully integrate acquisitions or guarantee that any acquisitions will achieve the anticipated financial benefits, all of which could have a negative impact on our financial condition and results of operations.Acquisitions have been and may continue to be an important element of our business strategy. We cannot assure investors that we will be able to identify and acquire acceptable acquisition targets on terms favorable to us in the future, or that any acquisitions will achieve the anticipated financial benefits. Our inability to achieve the anticipated financial benefits from any acquisition transactions may not be realized due to any number of factors, including, but not limited to, unsuccessful integration efforts, unexpected or underestimated liabilities or increased costs, fees, expenses and charges related to such transactions. Such adverse events could result in a decrease in the estimated fair value of goodwill or other intangible assets established as a result of such transactions, triggering an impairment. These and other factors could have a material adverse effect on our financial condition and results of operations.Expanding into international markets presents unique challenges, and our expansion efforts with respect to international operations may not be successful.An element of our business includes further expansion into international markets. Our ability to successfully operate in international markets may be adversely affected by political, economic and social conditions beyond our control, local laws and customs, and legal and regulatory constraints, including compliance with applicable anti-corruption and currency laws and regulations of the countries or regions in which we currently operate or intend to operate in the future. Risks inherent in our existing and future international operations also include, among others, the costs and difficulties of managing international operations, difficulties in identifying and gaining access to local suppliers, suffering possible adverse tax consequences from changes in tax laws or the unfavorable resolution of tax assessments or audits, maintaining product quality and greater difficulty in enforcing intellectual property rights. Additionally, foreign currency exchange rates and fluctuations could have an adverse effect on our financial results.Our business depends on our strong brands and failing to maintain and enhance our brands and develop a positive client reputation could hurt our ability to retain and expand our base of customers.Our strong brands, Orkin, HomeTeam Pest Defense, Clark Pest Control, Northwest Exterminating, Trutech, Western Pest Services, The Industrial Fumigant Company (IFC), Waltham Services, Okolona Pest Control (OPC), Critter Control, and others, have significantly 10 Table of Contents​contributed to the success of our business. Maintaining and enhancing our brands increases our ability to enter new markets and launch new and innovative services that better serve the needs of our customers. Our brands may be negatively impacted by a number of factors, including, among others, reputational issues and product/technical failures. Further, if our brands are significantly damaged, our reputation, business, results of operations, and financial condition could be materially adversely affected. We continue to develop strategies and innovative tools to gain a deeper understanding of customer acquisition and retention in order to more effectively expand and retain our customer base. Maintaining and enhancing our brands will depend largely on our brands’ ability to remain a service leader and continue to provide high-quality pest control services that are truly beneficial and play a meaningful role in people’s lives.Our franchisees, subcontractors, and vendors could take actions that could harm our business.Our franchisees, subcontractors, and vendors are contractually obligated to operate their businesses in accordance with the standards set forth in our agreements with them and applicable laws and regulations. Each of our brands that are franchised also provides training and support to franchisees. However, franchisees, subcontractors, and vendors are independent third parties that we do not control, and who own, operate and oversee the daily operations of their businesses, and the ultimate success of any business operation rests with the business owner. If franchisees do not successfully operate their businesses in a manner consistent with required standards, royalty payments owed to us will be adversely affected and our brands’ image and reputation could be harmed. This could materially adversely impact our reputation, business, financial condition, results of operations and cash flows. Similarly, if franchisees, subcontractors, and vendors do not successfully operate their businesses in a manner consistent with required laws, standards and regulations, we could be subject to claims from regulators or legal claims for the actions or omissions of such third-party franchisees, subcontractors, and vendors. In addition, our relationship with our franchisees, subcontractors, and vendors could become strained (including resulting in litigation) as we impose new standards or assert more rigorous enforcement practices of the existing required standards. These strains in our relationships or any resulting claims could have a material adverse effect on our reputation, business, financial condition, results of operations and cash flows.From time to time, we receive communications from our franchisees regarding complaints, disputes or questions about our practices and standards in relation to our franchised operations and certain economic terms of our franchise arrangements. If franchisees or groups representing franchisees were to bring legal proceedings against us, our reputation, business, financial condition, results of operations and cash flows could be materially adversely affected.Labor shortages and/or our ability to attract and retain skilled workers may impair growth potential and profitability.Our ability to remain productive and profitable will depend substantially on our ability to compete with other pest control companies to attract and retain skilled workers, create leadership opportunities and successfully implement diversity, equity and inclusion initiatives. Our ability to expand our operations is in part impacted by our ability to increase our labor force. The demand for employees is high, and the supply is limited. Ongoing labor shortages could negatively affect our ability to efficiently operate at full capacity or lead to increased costs, such as increased overtime to meet demand and increased wage rates to attract and retain employees. A significant increase in the wages paid and benefits offered by competing employers could also result in a reduction in our labor force, increases in our labor costs, or both. Prolonged labor shortages, increased turnover or labor inflation could diminish our profitability and impair our growth potential which could have a material adverse effect on our reputation, business, financial condition, results of operations or cash flows.In addition, decisions and rules by the National Labor Relations Board, including “expedited elections” and restrictions on appeals, could lead to increased organizing activities at our subsidiaries. If these labor organizing activities are successful, it could further increase labor costs, decrease operating efficiency and productivity in the future, or otherwise disrupt or negatively impact our operations which could have a material adverse effect on our reputation and business.Climate change and unfavorable weather conditions could adversely impact our financial results.Our operations are directly impacted by the weather conditions worldwide, including catastrophic events, natural disasters and potential impacts from climate change. Climate change continues to receive increasing global attention. The possible effects of climate change could include changes in rainfall patterns, water shortages, changing storm patterns and intensities, changing temperature levels and changes in legislation, regulation, and international accords, all of which could adversely impact our costs and business operations. The business of our Company is also affected by seasonality associated with our pest and termite control services. The increase in pest presence and activity, as well as the metamorphosis of termites in the spring and summer (the occurrence of which is determined by the 11 Table of Contents​timing of the change in seasons), has historically resulted in an increase in the revenue and income of our pest and termite control operations during such periods. The business of the Company is also affected by extreme weather such as drought which can greatly reduce the pest population for extended periods. Because of the uncertainty of weather volatility related to climate change and any resulting unfavorable weather conditions, we cannot predict its potential impact on our business, financial condition, results of operations and cash flows.Risks Related to the Global Economy and Public Health CrisesThe effects of a pandemic, such as the COVID-19 pandemic, or other major public health concern, could materially impact our business, results of operations and financial condition. The impact of a pandemic, such as COVID-19, or other major public health concerns, including changes in consumer behavior and discretionary spending, market downturns, and restrictions on business and individual activities, could create significant volatility in the global economy. Additionally, government or regulatory responses to pandemics or other public health concerns, such as mandatory lockdowns, vaccine mandates or other restrictions on operations, could negatively impact our business. The ultimate impact of a pandemic or other major public health concern also depends on events beyond our knowledge or control, including the duration and severity of such pandemics and other major public health concerns, and related remedial or containment measures taken by parties other than us to respond to them, and in the case of COVID-19, on the emergence and spread of COVID-19 variants and the effectiveness of vaccines. We are unable to completely predict the full impact that a pandemic, or other major public health concern will have on our business due to numerous uncertainties. In addition, our compliance with remedial or containment measures could impact our day-to-day operations and could disrupt our business and operations, as well as that of our customers and suppliers, for an indefinite period of time. Furthermore, labor force availability may be impaired due to exposure, reluctance to comply with governmental, regulatory or contractual mandates, or other restrictions, which could negatively affect our operating costs and profitability or negatively impact our ability to provide quality services. Any of these disruptions could have a negative impact on our business, results of operations and financial condition.Adverse economic conditions, including inflation and restrictions in customer discretionary expenditures, increases in interest rates or other disruptions in credit or financial markets, increases in fuel prices, raw material costs, or other operating costs could materially adversely affect our business. Economic downturns may adversely affect our commercial customers, including food service, hospitality and food processing industries whose business levels are particularly sensitive to adverse economies. For example, we may lose commercial customers and related revenues because of consolidation or cessation of commercial businesses or because these businesses switch to a lower cost provider. Pest and termite services represent discretionary expenditures to many of our residential customers. If consumers restrict their discretionary expenditures, due to inflation or other economic hardships, we may suffer a decline in revenues from our residential service lines. Disruptions in credit or financial markets could make it more difficult for us to obtain, or increase the cost of obtaining, financing in the future. Increases in interest rates may cause a reduction in new home construction or real estate transactions, which could result in a decrease in revenue. In addition, there can be no assurances that fuel prices, raw material costs, or other operating costs, all of which may be subject to inflationary pressures, will not materially increase in future years and we cannot predict the extent to which any such future increases could materially adversely affect our financial condition, results of operations and cash flows.Risks Related to Cybersecurity, Privacy Compliance and Business Disruptions The Company, its wholly-owned subsidiaries, third-party business partners and service providers have been subject to cybersecurity incidents in the past and could be the targets of future attacks which could result in the disruption to the Company’s business operations, economic and reputational damage, and possible fines, penalties and private litigation, if there is unauthorized access to or unintentional distribution of personal, financial, proprietary, confidential, or other protected data or information the Company is entrusted to keep about its customers, employees, business practices, or third parties.Our internal information technology (“IT”) systems contain certain personal, financial, health, or other protected and confidential information that is entrusted to us by our customers and employees. Our IT systems also contain the Company’s and its wholly-owned 12 Table of Contents​subsidiaries’ proprietary and other confidential information related to our business, such as business plans, customer lists and product and service development initiatives. From time to time, we have integration with new IT systems due to organic growth and acquisitions. In addition, we grant third-party business partners and service providers access to confidential information in order to facilitate business operations and administer employee benefits. Employees, third-party business partners, and service providers can knowingly or unknowingly disseminate such information or serve as an entry point for bad actors to access such information. Our privacy compliance and digital risk management initiatives focus on the threats and risks to enterprise information and the underlying IT systems processing such information as part of the implementation of business processes. The Company also relies on, among other things, commercially available vendors, cybersecurity protection systems, software, tools and monitoring to provide security for processing, transmission and storage of protected information and data. The systems currently used for transmission and approval of payment card transactions, and the technology utilized in payment cards themselves, all of which can put payment card data at risk, meet standards set by the payment card industry (“PCI”). We have also implemented policies and procedures, internal training, system controls, and monitoring and audit processes to protect the Company from internal and external vulnerabilities and to comply with consumer privacy laws in the areas in which we operate. Further, the Company limits retention of certain data, encrypts certain data and otherwise protects information to comply with consumer privacy laws in the areas in which we operate.We continue to evaluate and modify our systems and protocols for data security compliance purposes, and such standards may change from time to time. We monitor certain third-party business partners and service providers for compliance and vulnerabilities. Activities by bad actors, changes in computer and software capabilities and encryption technology, new tools and discoveries, cloud applications, changes in multi-jurisdictional regulations, and other events or developments may result in a compromise or breach of our systems. Any compromises, breaches, application errors or human mistakes related to our systems or failures to comply with applicable standards could not only disrupt our financial operations, including our customers’ ability to pay for our services and products by credit card or their willingness to purchase our services and products, but could also result in violations of applicable laws, regulations, orders, industry standards or agreements and subject us to costs, penalties and liabilities which could have a material adverse impact on our reputation, business, financial condition, results of operations and cash flows. A breach of data security or failure to comply with rigorous multi-jurisdictional consumer privacy requirements could expose us to customer litigation, regulatory actions and costs related to the reporting and handling of such a violation or breach. Furthermore, while we maintain cybersecurity insurance, our insurance may not cover all liabilities incurred due to a security breach or incident and this could have a material adverse effect on our reputation, financial condition, results of operations and cash flows.Risks Related to Certain Intellectual Property Rights Our brand recognition or reputation could be impacted if we are not able to adequately protect our intellectual property and other proprietary rights that are material to our business. Our ability to compete effectively depends in part on our rights to service marks, trademarks, trade names and other intellectual property rights we own or license. Although we have sought to register or protect many of our marks either in the United States or in the countries in which they are or may be used, we have not sought to protect our marks in every country. Furthermore, because of the differences in foreign trademark, patent and other intellectual property or proprietary rights laws, we may not receive the same protection in other countries as we would in the United States. If we are unable to protect our proprietary information and brand names, we could suffer a material adverse effect to our reputation, business, financial condition, results of operations and cash flows. Litigation may be necessary to enforce our intellectual property rights and protect our proprietary information, or to defend against claims by third parties that our products, services or activities infringe their intellectual property rights. Risks Related to Legal, Regulatory and Risk Management Matters Our business is subject to various federal, state and local laws and regulations pertaining to environmental, public health and safety matters, including those related to the pest control industry, and any noncompliance with, changes to, or increased enforcement of such laws, could significantly impact our business, financial condition, results of operations or reputation.Our business is subject to various federal, state, and local laws and regulations pertaining to environmental, public health and safety matters, including those related to the pest control industry. Among other things, these laws also govern the use, storage, treatment, disposal, transportation and management of certain pesticides and hazardous substances and waste and regulate the emission or discharge of materials into the environment. In addition, the use of certain pesticide products is also regulated by various international, federal, 13 Table of Contents​state, provincial and local environmental and public health agencies. These regulations may also apply to our third-party suppliers. Penalties for noncompliance with these laws may include criminal sanctions or civil remedies, including, but not limited to, cancellation of licenses, fines, and other corrective actions, which could negatively affect our business, financial condition, results of operations or reputation. In addition, in recent years, a number of new laws and regulations have been adopted, there has been expanded enforcement of certain existing laws and regulations by federal, state and local agencies, and the interpretation of certain laws and regulations have become increasingly complex. Noncompliance with, changes in, expanded enforcement of, or adoption of new federal, state or local laws and regulations governing hazardous waste disposal and other environmental matters, could result in operational changes and increased costs that might significantly impact our business, financial condition or reputation. New or proposed regulation regarding climate change, could have uncertain impacts on our business, financial condition and reputation.Climate change has been the subject of increased focus by various governmental authorities and regulators around the world. In particular, the US is considering the enactment of legislative and regulatory proposals that would impose requirements on greenhouse gas emissions. Such laws, if enacted, are likely to impact our business in a number of ways. For example, we use gasoline and electricity in conducting our operations. Increased government regulations to limit carbon dioxide and other greenhouse gas emissions may result in increased compliance costs and legislation or regulation affecting energy inputs, which could materially affect our profitability. Further the SEC has proposed rule amendments that would implement a framework for reporting of climate-related risks and create new climate-related disclosure obligations for all registrants, including us. Compliance with any new or more stringent laws or requirements, or stricter interpretations of existing laws, could require additional expenditures by us or our suppliers. Our inability to appropriately respond to such changes could adversely impact our business, financial condition, results of operations or cash flows. We cannot predict how the proposed rules, if finalized, or any future legislation or regulations pertaining to climate change, will ultimately affect our business, financial condition including results of operations and cash flows, or reputation.We are from time to time subject to lawsuits, investigations and other proceedings which could have a material adverse effect on our business, financial condition and results of operations.In the normal course of business, we are involved in various claims, contractual disputes, investigations, arbitrations and litigation, including claims that our acts, omissions, services or vehicles caused damage or injury, claims that our services did not achieve the desired results, claims related to acquisitions, allegations by federal, state or local authorities, including the Securities and Exchange Commission, of violations of regulations or statutes, claims related to wage and hour law violations and claims related to environmental matters. These claims, proceedings or litigation, either alone or in the aggregate, could have a material adverse effect on our business, financial condition, results of operations, and cash flows.Additionally, our business is significantly affected by and subject to regulation by various federal, state, provincial, regional and local governments in the countries in which we operate, including, but not limited to, environmental laws, antitrust laws, consumer protection laws, employment laws, including wage and hour laws, payroll taxes and anti-discrimination laws, immigration, human health and safety laws and other regulations relating to the pest control industry. We are unable to predict whether such laws will, in the future, materially affect our operations and financial condition. Risks Related to our Capital and Ownership StructureA control group that includes members of Company’s Board of Directors and management has a majority ownership interest; public stockholders may have no effective voice in the Company’s management.The Company has elected the “Controlled Company” exemption under Section 303A of the New York Stock Exchange (“NYSE”) Listed Company Manual. The Company is a “Controlled Company” because a group that includes the Company’s Executive Chairman of the Board, Gary W. Rollins, Board member, Pam Rollins, and certain persons acting as a group with them (the “Controlling Group”), controls in excess of fifty percent of the Company’s voting power. As a “Controlled Company,” the Company need not comply with certain NYSE rules, including, without limitation, the requirements that the Company have a majority of independent directors, and an independent compensation and nominating committee of the Board.The Controlling Group holds directly, or through indirect beneficial ownership, in the aggregate, approximately 51 percent of the Company’s outstanding shares of common stock as of December 31, 2022. As a result, these persons will effectively control the 14 Table of Contents​operations of the Company, including the election of directors and approval of significant corporate transactions such as acquisitions and approval of matters requiring stockholder approval. This concentration of ownership could also have the effect of delaying or preventing a third party from acquiring control of the Company at a premium.A Controlling Group has a substantial ownership interest, and the availability of the Company’s common stock to the investing public may be limited.The availability of Rollins’ common stock to the investing public is limited to those shares not held by the Controlling Group, which could negatively impact Rollins’ stock trading prices and affect the ability of minority stockholders to sell their shares. Future sales by the Controlling Group of all or a portion of their shares could also negatively affect the trading price of our common stock.The Controlling Group could take various actions or engage in certain transactions that could negatively impact our common stock price, cause volatility in the market for our common stock or have a material adverse impact on our results of operations and our financial condition.The Controlling Group may from time to time and at any time, in their sole discretion, acquire or cause to be acquired, additional equity or other instruments of the Company, its subsidiaries or affiliates, or derivative instruments the value of which is linked to Company securities, or dispose or cause to be disposed, such equity or other securities or instruments, in any amount that the Controlling Group may determine in their sole discretion, through open market transactions, privately negotiated transactions or otherwise. In addition, depending upon a variety of factors, the Controlling Group may at any time engage in discussions with the Company and its affiliates, and other persons, including retained outside advisers, concerning the Company’s business, management, strategic alternatives and direction, and in their sole discretion, consider, formulate and implement various plans or proposals intended to enhance the value of their investment in the Company, including, among other things, proposing or effecting any matter that would constitute or result in: (i) the acquisition by any person of additional securities of the Company or the disposition of securities of the Company, in addition to the possible normal course dissolution of additional entities for estate or tax planning purposes; (ii) an extraordinary corporate transaction, such as a merger, reorganization or liquidation, involving the Company or any subsidiary thereof; (iii) a sale or transfer of a material amount of assets of the Company or any subsidiary thereof; (iv) a change in the present board of directors or management of the Company, including any plans or proposals to change the number or term of directors or to fill any existing vacancies on the board; (v) a material change in the present capitalization or dividend policy of the Company; (vi) other material changes in the Company’s business or corporate structure; (vii) changes in the Company’s charter, bylaws, or instruments corresponding thereto, or other actions which may impede the acquisition of control of the Company by any person; (viii) causing a class of securities of the Company to be delisted from a national securities exchange or to cease to be authorized to be quoted in an inter-dealer quotation system of a registered national securities association; or (ix) a class of equity securities of the Company becoming eligible for termination of registration pursuant to Section 12(g)(4) of the Securities Exchange Act of 1934, as amended. In the event the Controlling Group were to engage in any of the actions enumerated above, our common stock price could be negatively impacted, such actions could cause volatility in the market for our common stock or could have a material adverse effect on our results of operations and our financial condition.Certain provisions in Rollins, Inc.’s certificate of incorporation and bylaws may inhibit a takeover of the Company.Rollins, Inc.’s certificate of incorporation, bylaws and other documents contain provisions including advance notice requirements for stockholder proposals and staggered terms for the Board of Directors. These provisions may make a tender offer, change in control or takeover attempt that is opposed by the Company’s Board of Directors more difficult or expensive.​Item 1.B. Unresolved Staff CommentsNone.​Item 2. Properties.The Company’s administrative headquarters are owned by the Company, and are located at 2170 Piedmont Road, N.E., Atlanta, Georgia 30324. The Company owns or leases over 600 branch offices and operating facilities used in its business as well as the Rollins Training Center located in Atlanta, Georgia, and the Pacific Division Administration and Training Center in Riverside, California. None of the 15 Table of Contents​branch offices, individually considered, represents a materially important physical property of the Company. The facilities are suitable and adequate to meet the current and reasonably anticipated future needs of the Company.​Item 3. Legal Proceedings.In the normal course of business, the Company and its subsidiaries are involved in, and will continue to be involved in, various claims, arbitrations, contractual disputes, investigations, litigation, environmental and tax and other regulatory matters relating to, and arising out of, our businesses and our operations. These matters may involve, but are not limited to, allegations that our services or vehicles caused damage or injury, claims that our services did not achieve the desired results, claims related to acquisitions and allegations by federal, state or local authorities, including taxing authorities, of violations of regulations or statutes. In addition, we are parties to employment-related cases and claims from time to time, which may include claims on a representative or class action basis alleging wage and hour law violations. We are also involved from time to time in certain environmental and tax matters primarily arising in the normal course of business. We evaluate pending and threatened claims and establish loss contingency reserves based upon outcomes we currently believe to be probable and reasonably estimable. The Company retains, up to specified limits, certain risks related to general liability, workers’ compensation and auto liability. The estimated costs of existing and future claims under the retained loss program are accrued based upon historical trends as incidents occur, whether reported or unreported (although actual settlement of the claims may not be made until future periods) and may be subsequently revised based on developments relating to such claims. The Company contracts with an independent third party to provide the Company an estimated liability based upon historical claims information. The actuarial study is a major consideration in establishing the reserve, along with management’s knowledge of changes in business practice and existing claims compared to current balances. Management’s judgment is inherently subjective as a number of factors are outside management’s knowledge and control. Additionally, historical information is not always an accurate indication of future events. The accruals and reserves we hold are based on estimates that involve a degree of judgment and are inherently variable and could be overestimated or insufficient. If actual claims exceed our estimates, our operating results could be materially affected, and our ability to take timely corrective actions to limit future costs may be limited.Management does not believe that any pending claim, proceeding or litigation, regulatory action or investigation, either alone or in the aggregate, will have a material adverse effect on the Company’s financial position, results of operations or liquidity; however, it is possible that an unfavorable outcome of some or all of the matters could result in a charge that might be material to the results of an individual quarter or year.​Item 4. Mine Safety Disclosures.Not applicable.​​PART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.The common stock of the Company is listed on the New York Stock Exchange and is traded on the Philadelphia, Chicago and Boston Exchanges under the symbol ROL.As of January 31, 2023, there were 177,950 holders of record of the Company’s common stock. However, a large number of our shareholders hold their shares in “street name” in brokerage accounts and, therefore, do not appear on the shareholder list maintained by our transfer agent.16 Table of Contents​Issuer Purchases of Equity SecuritiesDuring the years ended December 31, 2022 and 2021, the Company did not repurchase shares on the open market. ​​​​​​​​​​​​​​​​​Total number of ​​​​​​Weighted-​shares purchased as ​Maximum number of ​​Total number of​average ​part of publicly ​shares that may yet be ​​ shares ​price paid ​announced ​purchased under the Period purchased(1) per share repurchases (2) repurchase plan (2)October 1 to 31, 2022​ —​$ —​ —​ 11,415,625November 1 to 30, 2022​ 3,062​​ 34.37​ —​ 11,415,625December 1 to 31, 2022​ —​​ —​ —​ 11,415,625Total​ 3,062​$ 34.37​ —​ 11,415,625​(1)Includes repurchases from employees for the payment of taxes on vesting of restricted shares.(2)The Company has a share repurchase plan, adopted in 2012, to repurchase up to 16.9 million shares of the Company’s common stock. There are 11.4 million shares authorized to be repurchased under prior board approval. The repurchase plan has no expiration date.​17 Table of Contents​PERFORMANCE GRAPHThe following graph sets forth a five-year comparison of the cumulative total stockholder return based on the performance of the stock of the Company as compared with both a broad equity market index and an industry index. The indices included in the following graph are the S&P 500 Index and the S&P 500 Commercial Services & Supplies Index.COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN*​​​​​​​​​​​​​​ 2017 2018 2019 2020 2021 2022Rollins Inc. 100.00 117.89​ 109.68​ 195.81​ 173.43​ 187.47S&P 500 100.00 95.62 125.72 148.85 191.58 156.89S&P 500 Commercial Services & Supplies 100.00 100.49​ 140.84​ 170.39​ 224.30​ 212.33​ASSUMES INITIAL INVESTMENT OF $100*TOTAL RETURN ASSUMES REINVESTMENT OF DIVIDENDSNOTE: TOTAL RETURNS BASED ON MARKET CAPITALIZATION​​18 Table of Contents​Item 6. [Reserved]​​​Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.PresentationThis discussion should be read in conjunction with our audited financial statements and related notes included elsewhere in this document. Discussions of 2020 items and year-to-year comparisons of 2021 and 2020 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 on our Annual report on Form 10-K for the year ended December 31, 2021. The following discussion (as well as other discussions in this document) contains forward-looking statements. Please see “Cautionary Statement Regarding Forward-Looking Statements” for a discussion of uncertainties, risks and assumptions associated with these statements.The CompanyRollins, Inc. (“Rollins,” “we,” “us,” “our,” or the “Company”), is an international services company headquartered in Atlanta, Georgia that provides pest and termite control services to both residential and commercial customers through its wholly-owned subsidiaries and independent franchises in the United States, Canada, Australia, Europe, and Asia with international franchises in Canada, Central and South America, the Caribbean, Europe, the Middle East, Asia, Africa, and Australia. Our pest and termite control services are performed pursuant to terms of contracts that specify the pricing arrangement with the customer. The Company operates as one reportable segment and the results of operations and its financial condition are not reliant upon any single customer.General Operating CommentsWe finished 2022 with record revenue of $2.7 billion. We have consistently grown revenue and 2022 represented another strong year for growth. We experienced strong growth across all major service lines driving 11% total growth in revenues. Residential service revenue increased 10%, commercial revenue growth was also 10% and termite and ancillary revenue growth was 15%. Income before income taxes increased 3.4% to $498.9 million compared to $482.5 million the prior year. Net income increased 3.4% to $368.6 million, with earnings per diluted share of $0.75 compared to $356.6 million, or $0.72 per diluted share for the prior year. Operating cash flow remained strong in 2022 and finished at $465.9 million up from $401.8 million in 2021. We repaid debt by $100 million in 2022, we paid $119 million for 31 acquisitions in 2022 and a final payment on a 2021 acquisition, and continued to increase dividends to investors. The Company paid dividends to investors of $0.43 per diluted share in 2022 as compared to $0.42 per diluted share for the prior year, resulting in a 2.4% increase in dividends per share. While we continue to monitor macro-economic and other risks facing our business, we are starting 2023 with a strong foundation. Demand remains strong in our business with revenue growth of 11% in January 2023. Our balance sheet also provides us flexibility with debt remaining at very low levels to start the new year. We plan to evaluate opportunities to renegotiate our current credit facility that will be expiring in April 2024. Our pipeline for acquisitions is strong and we remain very well positioned to drive growth across all of our service lines in 2023.IMPACT OF THE PANDEMIC AND OTHER ECONOMIC TRENDSThe global spread and unprecedented impact of COVID-19 has continued to create uncertainty and economic disruption around the world during 2022. We have and will continue to monitor COVID-19 and may again take actions that may alter our operations, including those that may be required by federal, state, or local authorities, or that we determine are in the best interests of our employees and customers. We do not know when, or if, it will become practical to eliminate all of these measures entirely as there is no guarantee that COVID-19 will be fully contained.In addition, continued disruption in economic markets due to high inflation, increases in interest rates, increased fuel costs, business interruptions due to natural disasters, employee shortages and supply chain issues, all pose challenges which may adversely affect our future performance. The Company continues to carry out various strategies previously implemented to help mitigate the impact of these economic disruptors, including revamping its routing and scheduling process to decrease the number of miles per stop, advanced scheduling to compensate for employee and vehicle shortages, and maintaining higher purchasing levels to allow for sufficient inventory. 19 Table of Contents​However, the Company cannot reasonably estimate whether these strategies will help mitigate the impact of these economic disruptors in the future. The Company’s condensed consolidated financial statements reflect estimates and assumptions made by management that affect the reported amounts of assets and liabilities and related disclosures as of the date of the condensed consolidated financial statements. The Company considered the impact of COVID-19 and other economic trends on the assumptions and estimates used in preparing the condensed consolidated financial statements. In the opinion of management, all material adjustments necessary for a fair presentation of the Company’s financial results for the year have been made. These adjustments are of a normal recurring nature but complicated by the continued uncertainty surrounding COVID-19 and other economic trends. The severity, magnitude and duration of certain economic trends, as well as the economic consequences of COVID-19, continue to be uncertain and are difficult to predict. Therefore, our accounting estimates and assumptions may change over time in response to COVID-19 and other economic trends and may change materially in future periods. The extent to which COVID-19, increasing interest rates, inflation and other economic trends will continue to impact the Company’s business, financial condition and results of operations is uncertain. Therefore, we cannot reasonably estimate the full future impacts of these matters at this time.Results of Operations—2022 Versus 2021​​​​​​​​​​​​​​​​ ​​​​​ ​​​Years ended December 31,​Variance​As a % of Revenue(in thousands) 2022 2021 $​%​2022 2021Revenues​$ 2,695,823​$ 2,424,300 271,523​11.2​100.0 100.0Cost of services provided (exclusive of depreciation and amortization below)​ 1,308,399​ 1,162,617 145,782​12.5​48.5 48.0Gross profit​​ 1,387,424​​ 1,261,683​ 125,741​10.0​51.5​52.0Sales, general and administrative​ 802,710​ 727,489 75,221​10.3​29.8 30.0Depreciation and amortization​ 91,326​ 86,558 4,768​5.5​3.4 3.6Operating income​ 493,388​ 447,636 45,752​10.2​18.3 18.5Interest expense, net​​ 2,638​ 830​ 1,808​217.8​0.1 0.0Other income, net​​ (8,167)​​ (35,679)​ 27,512​(77.1)​0.3 1.5Consolidated income before income taxes​​ 498,917​​ 482,485​ 16,432​3.4​18.5​19.9Provision for income taxes​ 130,318​ 125,920 4,398​3.5​4.8 5.2Net income​$ 368,599​$ 356,565 12,034​3.4​13.7 14.7​​20 Table of Contents​RevenuesThe following presents a summary of revenues by product and service offering and revenues by geography: ​Revenues for the year ended December 31, 2022 were $2.7 billion, an increase of $271.5 million, or 11.2%, from 2021 revenues of $2.4 billion. Comparing 2022 to 2021, residential pest control revenue increased 10%, commercial pest control revenue increased 10% and termite and ancillary services grew 15%. The Company’s foreign operations accounted for approximately 7% and 8% of total revenues for the years ended December 31, 2022 and 2021, respectively. Gross ProfitGross profit for the year ended December 31, 2022 was $1.4 billion, an increase of $125.7 million, or 10.0%, compared to $1.3 billion for the year ended December 31, 2021. Gross margin was 51.5% in 2022 compared to 52.0% in 2021. For the year, we saw higher expenses associated with casualty reserves and people cost, notably medical costs. Excluding the increases we experienced in these areas, strategic pricing efforts helped offset inflationary pressures we experienced in fleet, material and other people associated costs. We remain focused on executing our pricing strategies and expect to pull forward our price increase again in 2023 and expect to raise prices for services in the first quarter.Sales, General and AdministrativeFor the twelve months ended December 31, 2022, sales, general and administrative (SG&A) expenses increased $75.2 million, or 10.3%, compared to the twelve months ended December 31, 2021. As a percentage of revenue, SG&A decreased to 29.8% from 30.0% in the prior year. Despite investing in additional people, advertising and other customer facing activities to drive growth, we saw an 21 Table of Contents​improvement in SG&A as a percentage of sales as we continue to manage our cost structure. Although casualty reserves and people costs, notably medical costs, had an impact on SG&A, they had a lesser impact on SG&A than cost of services.Depreciation and AmortizationFor the twelve months ended December 31, 2022, depreciation and amortization increased $4.8 million, or 5.5%, compared to the twelve months ended December 31, 2021. The increase was due to the additional amortization of customer contracts from several acquisitions offset by a decrease in the depreciation of operating equipment and internal-use software.Operating IncomeFor the twelve months ended December 31, 2022, operating income increased $45.8 million or 10.2% compared to the prior year. As a percentage of revenue, operating income decreased to 18.3% from 18.5% in the prior year. The increase in revenue was offset primarily by an increase in expense associated with the casualty reserve as well as medical costs for people. Without these additional costs, pricing initiatives helped offset inflationary pressures we experienced in fleet, material and other people associated costs.Interest Expense, NetDuring the twelve months ended December 31, 2022, interest expense, net increased $1.8 million compared to the prior year, primarily due to the increase in weighted average interest rates which was partially offset by the lower average debt balance in 2022 compared to 2021.Other Income, NetDuring the twelve months ended December 31, 2022, other income decreased $27.5 million primarily due to the Company recognizing a $31.5 million gain in the prior year related to multiple sale-leaseback transactions where the Company sold and leased back properties that it acquired in 2019 with the Clark Pest Control acquisition.Income TaxesThe Company’s effective tax rate was 26.1% in both 2022 and 2021. The 2022 rate was favorably impacted by lower foreign income taxes and officer’s compensation deductions, offset by an increase in state income taxes and lower restricted stock adjustments.Liquidity and Capital ResourcesCash and Cash FlowThe Company’s $95.3 million of total cash at December 31, 2022 is held at various banking institutions. Approximately $68.6 million is held in cash accounts at international bank institutions and the remaining $26.7 million is held in Federal Deposit Insurance Corporation (“FDIC”) insured non-interest-bearing accounts at various domestic banks which at times exceed federally insured amounts.The Company’s international business is expanding, and we intend to continue to grow the business in foreign markets in the future through reinvestment of foreign deposits and future earnings as well as acquisitions of unrelated companies. The Company has historically asserted that the undistributed earnings of our foreign subsidiaries are permanently reinvested. However, in the fourth quarter of 2022, the Company has partially changed this assertion and expects to repatriate unremitted foreign earnings from our foreign subsidiaries. The Company asserts that we continue to be permanently reinvested with respect to our investments in our foreign subsidiaries. In April 2019, the Company entered into a Revolving Credit Agreement with Truist Bank N.A. (formerly SunTrust Bank N.A.) and Bank of America, N.A. (the “2019 Credit Agreement”) for an unsecured revolving commitment of up to $175.0 million, which includes a $75.0 million letter of credit subfacility and a $25.0 million swingline subfacility (the “Revolving Commitment”), and an unsecured variable rate $250.0 million term loan (the “Term Loan”). On January 27, 2022, the Company entered into an amendment (the “Amendment”) to the Credit Agreement with Truist Bank and Bank of America, N.A. whereby additional term loans in an aggregate principal amount of $252.0 million were advanced to the Company. The Amendment also replaced LIBOR as the benchmark interest 22 Table of Contents​rate for borrowings with the Bloomberg Short-Term Bank Yield Index rate (“BSBY”) and reset the amortization schedule for all term loans under the Credit Agreement. As of December 31, 2022, the Company had outstanding borrowings of $54.9 million under the Term Loan and there were no outstanding borrowings under the Revolving Commitment. The aggregate effective interest rate on the debt outstanding as of December 31, 2022 was 5.123%. The effective interest rate is comprised of the BSBY plus a margin of 75.0 basis points as determined by the Company’s leverage ratio calculation. As of December 31, 2021, the Revolving Commitment had outstanding borrowings of $107.0 million and the Term Loan had outstanding borrowings of $48.0 million. The Company maintains approximately $71.3 million in letters of credit as of December 31, 2022. These letters of credit are required by the Company’s insurance companies, due to the Company’s high deductible insurance program, to secure various workers’ compensation and casualty insurance contracts coverage and were increased from $37.2 million as of December 31, 2021. The Company believes that it has adequate liquid assets, funding sources and insurance accruals to accommodate potential future insurance claims.In order to comply with applicable debt covenants, the Company is required to maintain at all times a leverage ratio of not greater than 3.00:1.00. The leverage ratio is calculated as of the last day of the fiscal quarter most recently ended. The Company remained in compliance with applicable debt covenants at December 31, 2022. We plan to evaluate opportunities to renegotiate our credit facility that will be expiring in April 2024.The following table sets forth a summary of our cash flows from operating, investing and financing activities for the year ended December 31, 2022 and 2021:​​​​​​​​​​​​ Year Ended December 31, ​Variance(in thousands) 2022 2021 $​%Net cash provided by operating activities​$ 465,930​$ 401,805​ 64,125​16.0 Net cash used in investing activities​ (134,141)​ (98,965)​ (35,176)​(35.5)Net cash used in financing activities​ (336,017)​ (290,159)​ (45,858)​(15.8)Effect of exchange rate on cash​ (5,727)​ (5,857)​ 130​2.2 Net (decrease) increase in cash and cash equivalents​$ (9,955)​$ 6,824​ (16,779)​(245.9)​Cash Provided by Operating ActivitiesCash from operating activities is the principal source of cash generation for our businesses. The most significant source of cash in our cash flow from operations is customer-related activities, the largest of which is collecting cash resulting from services sold. The most significant operating use of cash is to pay our suppliers, employees, and tax and regulatory authorities. The Company’s operations generated cash of $465.9 million for the year ended December 31, 2022 compared with cash provided by operating activities of $401.8 million in 2021. The $64.1 million increase was driven primarily by strong operating results and the timing of cash receipts from customers and cash payments to vendors, employees, and tax and regulatory authorities.Cash Used in Investing ActivitiesThe Company used $134.1 million of cash in investing activities for the year ended December 31, 2022 and used $99.0 million for the year ended December 31, 2021. The Company invested approximately $30.6 million in capital expenditures during 2022 compared to $27.2 million during 2021. Capital expenditures for the year consisted primarily of property purchases, equipment replacements and technology-related projects. Cash paid for acquisitions totaled $119.2 million for the year ended December 31, 2022 as compared to $146.1 million for the year ended December 31, 2021. The expenditures for the Company’s acquisitions were funded through existing cash balances and operating cash flows. The Company remains very active in evaluating opportunities for acquisitions and expects to make additional acquisitions in 2023. The year ended December 31, 2021 included approximately $67 million in cash proceeds from the sale of assets related to the Clark Pest Control property sale-leaseback transactions.Cash Used in Financing ActivitiesThe Company used $336.0 million of cash in financing activities for the year ended December 31, 2022 and $290.2 million in financing activities for the year ended December 31, 2021. The Company made net debt repayments of $100.0 million during the year ended 23 Table of Contents​December 31, 2022, compared to net repayments of $48.0 million during 2021. A total of $211.6 million was paid in cash dividends, $0.43 per share, during the year ended December 31, 2022 compared to $208.7 million in cash dividends paid, $0.42 per share, during the year ended December 31, 2021.In 2012, the Company’s Board of Directors authorized the purchase of up to 5 million shares of the Company’s common stock. After adjustments for stock splits, the total authorized shares under the share repurchase plan are 16.9 million shares. The Company did not purchase shares on the open market during the years ended December 31, 2022, 2021 and 2020. There remain 11.4 million shares authorized to be repurchased under prior Board approval and the repurchase plan does not expire. The Company repurchased $7.1 million, $10.7 million, and $8.3 million of common stock for the years ended December 31, 2022, 2021 and 2020, respectively, from employees for the payment of taxes on vesting restricted shares.Rollins maintains adequate liquidity and capital resources, without regard to its foreign deposits, that are directed to finance domestic operations and obligations and to fund expansion of its domestic business. The Company believes its current cash and cash equivalents balances, future cash flows expected to be generated from operating activities, and available borrowings under its $175 million revolving credit facility and $300 million term loan facility will be sufficient to finance its current operations and obligations, and fund expansion of the business for the foreseeable future. We expect to maintain compliance with applicable debt covenants throughout 2023.LitigationFor discussion on the Company’s legal contingencies, see Note 13 – Commitments and Contingencies to the accompanying financial statements, and Part I, Item 3, Legal Proceedings.Contractual Obligations and Contingent Liabilities and CommitmentsThe impact that the Company’s contractual obligations as of December 31, 2022 are expected to have on our liquidity and cash flow in future periods is as follows:​​​​​​​​​​​​​​​​​​Payments due by period​​​​​Less than​​​​​​More thanContractual obligations (in thousands)​Total​ 1 year​2-3 years​4-5 years​ 5 yearsTerm loan $ 54,898 $ 15,000 $ 39,898 $ — $ —Acquisition holdbacks and earnouts ​ 13,496 ​ 10,988 ​ 2,508 ​ — ​ —Non-cancelable operating leases ​ 315,259 ​ 93,779 ​ 122,862 ​ 48,675 ​ 49,943Total ​$ 383,653​$ 119,767​$ 165,268​$ 48,675​$ 49,943​Critical Accounting EstimatesThe Company views critical accounting estimates to be those that are very important to the portrayal of our financial condition and results of operations, and that require management’s most difficult, complex or subjective judgments. The circumstances that make these judgments difficult or complex relate to the need for management to make estimates about the effect of matters that are inherently uncertain. We believe our critical accounting estimate to be as follows:Accrued Insurance—The Company retains, up to specified limits, certain risks related to general liability, workers’ compensation and auto liability. Risks are managed through either high deductible insurance or, for Clark Pest Control only, a non-affiliated group captive insurance member arrangement. The estimated costs of existing and future claims under the retained loss program are accrued based upon historical trends as incidents occur, whether reported or unreported (although actual settlement of the claims may not be made until future periods) and may be subsequently revised based on developments relating to such claims. The group captive is subject to a third-party actuary retained by the captive manager, independent from the Company. For the high deductible insurance program, the Company contracts with an independent third-party actuary to provide the Company an estimated liability based upon historical claims information. The actuarial study is a major consideration in establishing the reserve, along with management’s knowledge of changes in business practice and existing claims compared to current balances. Management’s judgment is inherently subjective as a number of factors are outside management’s knowledge and control. Additionally, historical information is not always an accurate indication of future events. The Company continues to be proactive in safety and risk management to develop and maintain ongoing programs to reduce and prevent incidents and claims. Initiatives that have been implemented include required pre-employment screening and ongoing 24 Table of Contents​motor vehicle record review for all drivers, post-offer physicals for new employees, pre-hire, random and post incident drug testing, driver training and post-injury nurse triage for work-related injuries. The accruals and reserves we hold are based on estimates that involve a degree of judgment and are inherently variable and could be overestimated or insufficient. If actual claims exceed our estimates, our operating results could be materially affected, and our ability to take timely corrective actions to limit future costs may be limited.Recent Accounting Guidance and Other Policies and EstimatesSee Note 1 - Summary of Significant Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.​Item 7A. Quantitative and Qualitative Disclosures about Market RiskMarket RiskThe Company maintained an investment portfolio (included in cash and cash equivalents) subject to short-term interest rate risk exposure; and other current and long-term investments. The Company is subject to interest rate risk exposure through borrowings on its $175.0 million revolving credit facility and amended $300.0 million term loan facility. As of December 31, 2022, the Company had outstanding borrowings of $54.9 million under the Term Loan and there were no outstanding borrowings under the Revolving Commitment. Additionally, the Company maintained $71.3 million in Letters of Credit. See Note 10 to the accompanying financial statements for further details regarding debt. These letters of credit are required by the Company’s insurance companies, due to the Company’s high deductible insurance program, to secure various workers’ compensation and casualty insurance contracts coverage. The Company believes that it has adequate liquid assets, funding sources and insurance accruals to accommodate such claims. The Company is also exposed to market risks arising from changes in foreign exchange rates. The Company believes that this foreign exchange rate risk will not have a material impact upon the Company’s results of operations going forward. For a discussion of the Company’s activities to manage risks relative to fluctuations in foreign currency exchange rates, see Note 11 to the accompanying financial statements.​25 Table of Contents​​​
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSAll currency amounts are in millions unless specifiedOverviewRoper Technologies is a diversified technology company. Roper has a proven, long-term, successful track record of compounding cash flow and shareholder value. We operate market leading businesses that design and develop vertical software and technology enabled products for a variety of defensible niche markets.We pursue consistent and sustainable growth in revenue, earnings and cash flow by enabling continuous improvement in the operating performance of our existing businesses and by acquiring other businesses that offer high value-added software, services, technology-enabled products and solutions that we believe are capable of achieving growth and maintaining high margins. Discontinued OperationsOn November 22, 2022, the Company completed the divestiture of a majority 51% equity stake in its industrial businesses, including its entire historical Process Technologies reportable segment and the industrial businesses within its historical Measurement & Analytical Solutions reportable segment, to Clayton, Dubilier & Rice, LLC. The businesses included in this transaction were Alpha, AMOT, CCC, Cornell, Dynisco, FTI, Hansen, Hardy, Logitech, Metrix, PAC, Roper Pump, Struers, Technolog, Uson, and Viatran (collectively “Indicor”). Following the sale of the majority stake, the Company retained an initial 49% minority equity interest in the new standalone parent company, Indicor, LLC. This transaction is referred to herein as the “Indicor Transaction.”During 2021, Roper entered into definitive agreements to divest our TransCore, Zetec and CIVCO Radiotherapy businesses (“2021 Divestitures”). As of March 31, 2022, Roper had completed the 2021 Divestitures. The aggregate of the 2021 Divestitures and the Indicor Transaction have greatly reduced the cyclicality and asset intensity of the Company. In addition, the Company has an increased mix of recurring revenue and a higher margin profile. The financial results for Indicor and the 2021 Divestitures are reported as discontinued operations for all periods presented. Unless otherwise noted, discussion within Management’s Discussion and Analysis of Financial Condition and Results of Operations relate to continuing operations. Information regarding discontinued operations is included in Note 3 of the Notes to Consolidated Financial Statements.Update to Segment Reporting StructureDuring the second quarter of 2022, we updated our reportable segment structure following the announcement of the Indicor Transaction. The Company’s new reporting segment structure is classified based on business model and delivery of performance obligations. The three updated reportable segments (and businesses within each; including changes due to acquisitions since the realignment) are as follows:–Application Software - Aderant, CBORD/Horizon, CliniSys, Data Innovations, Deltek, Frontline Education, IntelliTrans, PowerPlan, Strata, Vertafore–Network Software - ConstructConnect, DAT, Foundry, iPipeline, iTradeNetwork, Loadlink, MHA, SHP, SoftWriters–Technology Enabled Products - CIVCO Medical Solutions, FMI, Inovonics, IPA, Neptune, Northern Digital, rf IDEAS, VerathonFollowing the Indicor Transaction and the realignment of our reportable segments, the day-to-day operations of our businesses, our organizational structure, and our strategy remain unchanged. All prior periods have been recast to reflect the changes noted above. Financial information about our reportable segments is presented in Note 14 of the Notes to Consolidated Financial Statements included in this Annual Report.20Application of Critical Accounting PoliciesOur Consolidated Financial Statements are prepared in conformity with generally accepted accounting principles in the United States (“GAAP”). A discussion of our significant accounting policies can also be found in the Notes to Consolidated Financial Statements for the year ended December 31, 2022 included in this Annual Report.GAAP offers acceptable alternative methods for accounting for certain issues affecting our financial results, such as determining inventory cost, depreciating long-lived assets and recognizing revenue. We have not changed the application of acceptable accounting methods or the significant estimates affecting the application of these principles in the last three years in a manner that had a material effect on our Consolidated Financial Statements.The preparation of financial statements in accordance with GAAP requires the use of estimates, assumptions, judgments and interpretations that can affect the reported amounts of assets, liabilities, revenues and expenses, the disclosure of contingent assets and liabilities and other supplemental disclosures.The development of accounting estimates is the responsibility of our management. Our management discusses those areas that require significant judgments with the Audit Committee of our Board of Directors. The Audit Committee has reviewed all financial disclosures in our annual filings with the SEC. Although we believe the positions we have taken with regard to uncertainties are reasonable, others might reach different conclusions and our positions can change over time as more information becomes available. If an accounting estimate changes, its effects are accounted for prospectively or through a cumulative catch up adjustment.Our most significant accounting uncertainties are encountered in the areas of income taxes, valuation of other intangible assets, goodwill and indefinite-lived impairment analyses, and valuation of our initial 49% equity interest in Indicor. Estimates are considered to be significant if they meet both of the following criteria: (1) the estimate requires assumptions about matters that are uncertain at the time the estimate is made, and (2) changes in the estimate are reasonably likely to have a material financial impact from period-to-period. Income taxes can be affected by estimates of whether and within which jurisdictions future earnings will occur and if, how and when cash is repatriated to the U.S., combined with other aspects of an overall income tax strategy. Additionally, taxing jurisdictions could retroactively disagree with our tax treatment of certain items, and some historical transactions have income tax effects going forward. Accounting rules require these future effects to be evaluated using current laws, rules and regulations, each of which can change at any time and in an unpredictable manner. If there is a material change in the actual effective tax rates, the time period within which the underlying temporary differences become taxable or deductible, or if the tax law changes are unfavorable there could be a resulting increase to income tax expense and the effective tax rate. During 2022, our effective income tax rate was 23.1%, as compared to the 2021 rate of 22.0%. The rate was unfavorably impacted by the recognition of a net tax expense associated with an internal restructuring plan associated with the Indicor Transaction. We expect the effective tax rate for 2023 to be approximately 21% to 22%.We account for goodwill in a purchase business combination as the excess purchase price over the fair value of the net identifiable assets acquired. Goodwill, which is not amortized, is tested for impairment on an annual basis in conjunction with our annual forecast process during the fourth quarter (or an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value).When testing goodwill for impairment, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the estimated fair value of a reporting unit is less than its carrying amount. If we elect to perform a qualitative assessment and determine that an impairment is more likely than not, we are then required to perform the quantitative impairment test; otherwise, no further analysis is required. Under the qualitative assessment, we consider various qualitative factors, including macroeconomic conditions, relevant industry and market trends, cost factors, overall financial performance, other entity-specific events and events affecting the reporting unit that could indicate a potential change in the fair value of our reporting unit or the composition of its carrying values. We also consider the specific future outlook for the reporting unit.We also may elect not to perform the qualitative assessment and, instead, proceed directly to the quantitative impairment test. The quantitative assessment utilizes an equal weighted income approach (discounted cash flows) and market approach (consisting of a comparable company earnings multiples methodology) to estimate the fair value of a reporting unit. To determine the reasonableness of the estimated fair values, we review the assumptions to ensure that neither the income approach nor the market approach provides significantly different valuations. If the estimated fair value exceeds the carrying value, no 21further work is required and no impairment loss is recognized. If the carrying value exceeds the estimated fair value, a non-cash impairment loss is recognized in the amount of that excess.Key assumptions used in the income and market approaches are updated when the analysis is performed for each reporting unit. The assumptions that have the most significant effect on the fair value calculations are the projected revenue growth rates, future operating margins, discount rates, terminal values and earnings multiples. While we use reasonable and timely information to prepare our cash flow and discount rate assumptions, actual future cash flows or market conditions could differ significantly and could result in future non-cash impairment charges related to recorded goodwill balances.Recently acquired reporting units generally represent a higher inherent risk of impairment, which typically decreases as the businesses are integrated into our enterprise. Negative industry or economic trends, disruptions to our business, actual results significantly below projections, unexpected significant changes or planned changes in the use of the assets, divestitures and market capitalization declines may have a negative effect on the fair value of our reporting units.As of the annual impairment test, the Company has 21 reporting units with individual goodwill amounts ranging from $17.5 to $3,363.1. In 2022, the Company performed its annual impairment test in the fourth quarter for all reporting units. The Company conducted its analysis qualitatively and assessed whether it was more likely than not that the respective fair value of these reporting units was less than the carrying amount. The Company determined that impairment of goodwill was not likely in any of its reporting units and thus was not required to perform a quantitative assessment for these reporting units as of October 1, 2022. Trade names that are determined to have an indefinite useful economic life are not amortized, but separately tested for impairment during the fourth quarter of the fiscal year or on an interim basis if an event occurs that indicates the fair value is more likely than not below the carrying value. We first qualitatively assess whether the existence of events or circumstances leads to a determination that it is more likely than not that the estimated fair value of the indefinite-lived trade name is less than its carrying amount. If necessary, we conduct a quantitative assessment using the relief-from-royalty method, which we believe to be an acceptable methodology due to its common use by valuation specialists in determining the fair value of intangible assets. This methodology assumes that, in lieu of ownership, a third-party would be willing to pay a royalty in order to exploit the related benefits of these assets. The assumptions that have the most significant effect on the fair value calculations are the royalty rates, projected revenue growth rates, discount rates and terminal values. Each royalty rate is determined based on the profitability of the trade name to which it relates and observed market royalty rates. Revenue growth rates are determined after considering current and future economic conditions, recent sales trends, discussions with customers, planned timing of new product launches or other variables. Trade names resulting from recent acquisitions generally represent the highest risk of impairment, which typically decreases as the businesses are integrated into our enterprise.During the fourth quarter of 2021, the Company determined the use of the Sunquest trade name would be discontinued given the strategic action to merge the Sunquest business into our CliniSys business, both of which are reported in our Application Software reportable segment. Considering the planned merger and updated market comparisons, the royalty rate utilized in the quantitative impairment assessment of the trade name was 0.5% as compared to a royalty rate of 3.5% used in the prior year. The royalty rate reduction was the significant assumption that resulted in a non-cash impairment charge of $94.4 recognized as a component of “Impairment of intangible assets” within the Consolidated Statements of Earnings.The assessment of fair value for impairment purposes requires significant judgments to be made by management. Although our forecasts are based on assumptions that are considered reasonable by management and consistent with the plans and estimates management uses to operate the underlying businesses, there is significant judgment in determining the expected results attributable to the businesses and/or reporting units. Changes in estimates or the application of alternative assumptions could produce significantly different results.The most significant identifiable intangible assets with definite useful economic lives recognized from our acquisitions are customer relationships. The fair value for customer relationships is determined as of the acquisition date using the excess earnings method. Under this methodology the fair value is determined based on the estimated future after-tax cash flows arising from the acquired customer relationships over their estimated lives after considering customer attrition and contributory asset charges. The assumptions that have the most significant effect on the fair value calculations are the customer attrition rates, projected customer revenue growth rates, margins, contributory asset charges and discount rates. When testing customer relationship intangible assets for potential impairment, management considers historical customer attrition rates and projected revenues and profitability related to customers that existed at acquisition. In evaluating the amortizable life for customer relationship intangible assets, management considers historical customer attrition patterns.22We evaluate whether there has been an impairment of identifiable intangible assets with definite useful economic lives, or of the remaining life of such assets, when certain indicators of impairment are present. In the event that facts and circumstances indicate that the cost or remaining period of amortization of any asset may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future gross, undiscounted cash flows associated with the asset would be compared to the asset’s carrying amount to determine if a write-down to fair value or a revision in the remaining amortization period is required.The Company has an initial 49% minority equity interest in Indicor which provides us with the ability to exercise significant influence, but not control, over the investee. We elected to apply the fair value option as we believe this is the most reasonable method to value the equity investment. This investment is classified within Level 3 of the fair value hierarchy as valuation of the investment at future dates will reflect management’s estimate of assumptions that market participants would use in pricing the asset. Any changes to the valuation estimates or assumptions as described further in Note 10 of the Notes to the Consolidated Financial Statements could produce significantly different results.23Results of OperationsAll currency amounts are in millions unless specified, percentages are net of revenuesPercentages may not sum due to rounding.The following table sets forth selected information for the years indicated. Years ended December 31, 202220212020Net revenues: Application Software (1)$2,639.5 $2,366.7 $1,785.8 Network Software (2)1,378.5 1,223.8 1,069.4 Technology Enabled Products1,353.8 1,243.3 1,167.2 Total$5,371.8 $4,833.8 $4,022.4 Gross margin: Application Software 68.8 %69.4 %68.4 %Network Software84.6 84.1 83.1 Technology Enabled Products56.9 59.2 61.5 Total69.9 %70.5 %70.3 %Selling, general and administrative expenses:Application Software41.8 %42.7 %42.2 %Network Software43.2 45.1 47.3 Technology Enabled Products23.8 25.7 26.2 Total37.6 %38.9 %38.9 %Segment operating margin: Application Software27.1 %26.8 %26.2 %Network Software41.4 39.0 35.8 Technology Enabled Products33.2 33.4 35.3 Total32.3 %31.6 %31.4 %Corporate administrative expenses (3)(3.9)%(3.9)%(4.5)%Loss from impairment— (2.0)— Income from operations28.4 25.7 26.9 Interest expense, net(3.6)(4.8)(5.4)Other income (expense), net(0.9)0.5 (0.1)Earnings before income taxes23.9 21.3 21.4 Income taxes(5.5)(4.7)(4.7)Net earnings from continuing operations18.3 %16.7 %16.7 %(1)Includes results from the acquisitions of Vertafore from September 3, 2020, EPSi from October 15, 2020, American Legal Net from December 30, 2021, Horizon Lab Systems, LLC from January 3, 2022, Common Cents Systems, Inc. from April 6, 2022, MGA Systems Holdings, Inc. from June 27, 2022, Common Sense Solutions, Inc. from July 12, 2022, viDesktop Inc. from August 19, 2022, TIP Technologies Inc. from September 23, 2022 and Frontline Education from October 4, 2022.(2)Includes results from the acquisitions of FMIC from June 9, 2020, Team TSI from June 15, 2020, IFS from September 15, 2020, WELIS from September 18, 2020 and Construction Journal from December 21, 2021.(3)Includes unallocated corporate administrative expenses and enterprise-wide stock-based compensation.24Year Ended December 31, 2022 Compared to Year Ended December 31, 2021 Net revenues for the year ended December 31, 2022 were $5,371.8 as compared to $4,833.8 for the year ended December 31, 2021, an increase of 11.1%. The components of revenue growth for the year ended December 31, 2022 were as follows: Application SoftwareNetwork SoftwareTechnology Enabled ProductsRoperTotal Revenue Growth11.5 %12.6 %8.9 %11.1 %Less Impact of:Acquisitions/Divestitures5.3 1.2 — 2.9 Foreign Exchange(1.3)(1.3)(0.9)(1.2)Organic Revenue Growth7.5 %12.7 %9.8 %9.4 %In our Application Software segment, net revenues for the year ended December 31, 2022 were $2,639.5 as compared to $2,366.7 for the year ended December 31, 2021. The growth of 7.5% in organic revenues was broad-based across the segment led by our businesses serving the property and casualty insurance, acute healthcare, and government contracting markets. Gross margin decreased to 68.8% for the year ended December 31, 2022 as compared to 69.4% for the year ended December 31, 2021 due primarily to increased headcount to support growth, and a higher mix of SaaS and professional service revenue across a number of businesses. Selling, general and administrative (“SG&A”) expenses as a percentage of revenues in the year ended December 31, 2022 decreased to 41.8%, as compared to 42.7% in the year ended December 31, 2021, due primarily to improved operating leverage on higher organic revenues partially offset by higher amortization of acquired intangibles from the acquisition of Frontline Education. The resulting operating margin was 27.1% in the year ended December 31, 2022 as compared to 26.8% in the year ended December 31, 2021.In our Network Software segment, net revenues were $1,378.5 for the year ended December 31, 2022 as compared to $1,223.8 for the year ended December 31, 2021. The growth of 12.7% in organic revenues was led by our network software businesses serving the freight match, life insurance, and media and entertainment markets. Gross margin increased to 84.6% for the year ended December 31, 2022 from 84.1% for the year ended December 31, 2021, due primarily to favorable revenue mix. SG&A expenses as a percentage of net revenues decreased to 43.2% in the year ended December 31, 2022, as compared to 45.1% in the year ended December 31, 2021, due primarily to operating leverage on higher organic sales. The resulting operating margin was 41.4% in the year ended December 31, 2022 as compared to 39.0% in the year ended December 31, 2021.In our Technology Enabled Products segment, net revenues were $1,353.8 for the year ended December 31, 2022 as compared to $1,243.3 the year ended December 31, 2021. The growth of 9.8% in organic revenues was primarily due to our water meter technology business and medical products businesses. Gross margin decreased to 56.9% in the year ended December 31, 2022, as compared to 59.2% in the year ended December 31, 2021, due primarily to higher material, component and freight costs as our businesses navigate the widespread global supply chain challenges. SG&A expenses as a percentage of net revenues decreased to 23.8% in the year ended December 31, 2022, as compared to 25.7% in the year ended December 31, 2021 due primarily to improved operating leverage on higher organic sales. The resulting operating margin was 33.2% in the year ended December 31, 2022 as compared to 33.4% in the year ended December 31, 2021.Corporate expenses increased by $19.3 to $209.2, or 3.9% of revenues, in 2022 as compared to $189.9, or 3.9% of revenues, in 2021. The dollar increase was due primarily to higher professional service and acquisition related expenses partially offset by lower compensation expense.Impairment of intangible assets was $94.4 for the year ended December 31, 2021, due to the strategic action to merge the Sunquest business into our CliniSys business resulting in impairment of the Sunquest trade name. Interest expense, net, decreased $41.5, or 17.7%, for the year ended December 31, 2022 as compared to the year ended December 31, 2021. The decrease was due to lower weighted average debt balances and higher interest income earned on our cash and cash equivalents.Other expense, net, of $50.1 for the year ended December 31, 2022 was composed primarily of a legal settlement expense of $45.0 related to the Berall v. Verathon patent litigation matter. Other income, net of $24.6 for the year ended December 31, 2021, was composed primarily of a gain on sale of minority investment of $27.1. 25During 2022, our effective income tax rate was 23.1% as compared to our 2021 rate of 22.0%. The rate was unfavorably impacted by the recognition of a net tax expense associated with an internal restructuring plan related to the Indicor Transaction.Order backlog is equal to our remaining performance obligations expected to be recognized within the next 12 months as discussed in Note 1 of the Notes to Consolidated Financial Statements. Backlog increased 25.3% to $2,912.6 at December 31, 2022 as compared to $2,325.1 at December 31, 2021. Organic growth in backlog was 18% and acquisitions contributed 8% which was partially offset by foreign exchange impact of 1%. 20222021ChangeApplication Software$1,796.3 $1,541.9 16.5 %Network Software507.5 448.3 13.2 Technology Enabled Products608.8 334.9 81.8 Total$2,912.6 $2,325.1 25.3 % Year Ended December 31, 2021 Compared to Year Ended December 31, 2020 Net revenues for the year ended December 31, 2021 were $4,833.8 as compared to $4,022.4 for the year ended December 31, 2020, an increase of 20.2%. The components of revenue growth for the year ended December 31, 2021 were as follows: Application SoftwareNetwork SoftwareTechnology Enabled ProductsRoperTotal Revenue Growth32.5 %14.4 %6.5 %20.2 %Less Impact of:Acquisitions/Divestitures23.2 2.1 — 10.9 Foreign Exchange0.2 1.0 0.6 0.5 Organic Revenue Growth9.1 %11.3 %5.9 %8.8 %In our Application Software segment, net revenues for the year ended December 31, 2021 were $2,366.7 as compared to $1,785.8 for the year ended December 31, 2020. The growth of 9.1% in organic revenues was broad-based across the segment led by our businesses serving the government contracting, acute healthcare and legal markets. Gross margin increased to 69.4% for the year ended December 31, 2021 as compared to 68.4% for the year ended December 31, 2020 due primarily to the acquisition of Vertafore and operating leverage on higher organic revenues. SG&A expenses as a percentage of revenues in the year ended December 31, 2021 increased to 42.7%, as compared to 42.2% in the year ended December 31, 2020, due primarily to higher amortization of acquired intangibles from the Vertafore and EPSi acquisitions, partially offset by operating leverage on higher organic revenues. The resulting operating margin was 26.8% in the year ended December 31, 2021 as compared to 26.2% in the year ended December 31, 2020.In our Network Software segment, net revenues were $1,223.8 for the year ended December 31, 2021 as compared to $1,069.4 for the year ended December 31, 2020. The growth of 11.3% in organic revenues was broad-based across the segment led by our network software businesses serving the freight match, post-acute care and construction markets. Gross margin increased to 84.1% for the year ended December 31, 2021 from 83.1% for the year ended December 31, 2020, due primarily to revenue mix and operating leverage on higher organic revenues. SG&A expenses as a percentage of net revenues decreased to 45.1% in the year ended December 31, 2021, as compared to 47.3% in the year ended December 31, 2020, due primarily to operating leverage on higher organic sales. The resulting operating margin was 39.0% in the year ended December 31, 2021 as compared to 35.8% in the year ended December 31, 2020.In our Technology Enabled Products segment, net revenues were $1,243.3 for the year ended December 31, 2021 as compared to $1,167.2 the year ended December 31, 2020. The growth of 5.9% in organic revenues was broad-based led by our water meter technology, and medical products businesses excluding Verathon, which declined due to unprecedented demand for their products used in the treatment of COVID-19 during 2020. Gross margin decreased to 59.2% in the year ended December 31, 2021, as compared to 61.5% in the year ended December 31, 2020, due primarily to reduced operating leverage associated with Verathon’s normalized 2021 revenues and costs associated with navigating the widespread supply chain challenges. SG&A expenses as a percentage of net revenues decreased to 25.7% in the year ended December 31, 2021, as compared to 26.2% in 26the year ended December 31, 2020, due primarily to revenue mix. The resulting operating margin was 33.4% in the year ended December 31, 2021 as compared to 35.3% in the year ended December 31, 2020.Corporate expenses increased by $10.1 to $189.9, or 3.9% of revenues, in 2021 as compared to $179.8, or 4.5% of revenues, in 2020. The dollar increase was due primarily to higher compensation related expenses, partially offset by lower acquisition related expenses.Interest expense, net, increased $15.4, or 7.0%, for the year ended December 31, 2021 as compared to the year ended December 31, 2020. The increase was due to higher weighted average debt balances, partially offset by lower weighted average interest rates and $7.2 in interest expense for the origination fee on our bridge financing associated with the Vertafore acquisition in 2020.Other income, net, of $24.6 for the year ended December 31, 2021 was composed primarily of a gain on sale of minority investment of $27.1. Other expense, net of $3.1 for the year ended December 31, 2020, was composed primarily of foreign exchange losses at our non-U.S. based subsidiaries. During 2021, our effective income tax rate was 22.0% as compared to our 2020 rate of 21.8%. The increase was due primarily to a non-recurring item related to a UK tax rate change, which had a $20.4 unfavorable impact in 2021.Order backlog is equal to our remaining performance obligations expected to be recognized within the next 12 months as discussed in Note 1 of the Notes to Consolidated Financial Statements. Backlog increased 22.0% to $2,325.1 at December 31, 2021 as compared to $1,905.5 at December 31, 2020, with the increase driven primarily by organic growth. 20212020ChangeApplication Software$1,541.9 $1,366.9 12.8 %Network Software448.3 361.4 24.0 Technology Enabled Products334.9 177.2 89.0 Total$2,325.1 $1,905.5 22.0 %Financial Condition, Liquidity and Capital ResourcesAll currency amounts are in millions unless specifiedSelected cash flows for the years ended December 31, 2022, 2021 and 2020 are as follows. 202220212020Cash provided by/(used in) continuing operations from:Operating activities$606.6 $1,655.8 $1,123.2 Investing activities(4,351.8)(249.2)(6,067.6)Financing activities(1,453.9)(1,807.1)4,138.7 Cash provided by discontinued operations5,677.9 456.0 393.8 Operating activities - The decrease in cash provided by operating activities from continuing operations in 2022 as compared to 2021 was due primarily to (i) the non-recurrence of $953.8 of cash taxes paid in connection with the 2021 Divestitures and the Indicor Transaction, (ii) $97.8 of higher cash taxes associated with changes to Internal Revenue Code Section 174 and (iii) less cash provided by working capital. These cash outflows were partially offset by higher net income from continuing operations net of non-cash expenses.The increase in cash provided by operating activities from continuing operations in 2021 as compared to 2020 was due primarily to higher net income net of non-cash expenses and the non-recurrence of $201.9 of cash taxes paid on the disposal of Gatan in 2020. These increases were partially offset by lower cash provided by working capital as compared to 2020.Investing activities - Cash used in investing activities from continuing operations during 2022 was primarily for business acquisitions, most notably Frontline Education, viDesktop and MGA Systems. Cash used in investing activities from continuing operations during 2021 was primarily for business acquisitions partially offset by proceeds from the sale of a minority investment. Cash used in investing activities from continuing operations during 2020 was primarily for business acquisitions, most notably Vertafore and EPSi.27Financing activities - Cash used in financing activities from continuing operations during 2022 was primarily due to repayments of $800.0 for our senior notes, net repayments of $470.0 on our unsecured credit facility and dividend payments. Cash used in financing activities from continuing operations during 2021 was primarily due to net repayments of $1,150.0 on our unsecured credit facility, $500.0 of repayments for our senior notes and dividend payments. Cash provided by financing activities from continuing operations during 2020 was primarily from the issuance of $3,300.0 of senior notes and $1,620.0 of net borrowings on the revolver, partially offset by $600.0 of repayments for senior notes and to a lesser extent dividend payments.Discontinued operations - Cash provided by discontinued operations for the year ended December 31, 2022 was primarily due to proceeds from the sale of the majority stake in Indicor, TransCore and Zetec, slightly offset by less cash provided by operating cash flows from discontinued operations which was impacted by the timing of our divestiture activity. Cash provided by discontinued operations during the year ended December 31, 2021 was primarily due to cash provided by operating activities and proceeds from the sale of CIVCO Radiotherapy. Cash provided by discontinued operations during the year ended December 31, 2020 was primarily due to cash provided by operating activities.Net working capital (total current assets, excluding cash and current assets held for sale, less total current liabilities, excluding debt and current liabilities held for sale) was negative $1,053.7 at December 31, 2022 compared to negative $990.9 at December 31, 2021, due primarily to increased deferred revenue, partially offset by movements in income tax-related balances and greater inventory build associated with mitigating supply chain challenges. Consistent negative net working capital demonstrates Roper’s focus on asset-light business models. Total debt excluding unamortized debt issuance costs was $6,700.3 at December 31, 2022 (29.5% of total capital) compared to $7,970.3 at December 31, 2021 (40.8% of total capital). Our total debt decreased at December 31, 2022 compared to December 31, 2021, due primarily to repayments of $800.0 for our senior notes and net repayments of $470.0 on our unsecured credit facility.On July 21, 2022, the Company entered into a new five-year unsecured credit facility (the “Credit Agreement”) among Roper, the financial institutions from time to time party thereto, JPMorgan Chase Bank, N.A., as administrative agent, Bank of America, N.A. and Wells Fargo Bank, N.A., as syndication agents, and Mizuho Bank, Ltd., MUFG Bank, Ltd., PNC Bank, National Association, TD Bank, N.A., Truist Bank and U.S Bank, National Association, as documentation agents, which replaced the existing $3,000.0 unsecured credit facility, dated as of September 2, 2020, as amended. The new facility comprises a five-year $3,500.0 revolving credit facility, which includes availability of up to $150.0 for letters of credit. Loans under the facility will be available in dollars, and letters of credit will be available in dollars and other currencies to be agreed. The Company may also, subject to compliance with specified conditions, request additional term loans or revolving credit commitments in an aggregate amount not to exceed $500.0.The Credit Agreement requires the Company to maintain a Total Debt to Total Capital Ratio (as defined in the Credit Agreement) of 0.65 to 1.00 or less. Borrowings under the Credit Agreement are prepayable at Roper’s option at any time in whole or in part without premium or penalty.We were in compliance with all debt covenants related to our credit facility throughout the years ended December 31, 2022 and 2021.At December 31, 2022, we had $6,700.0 of senior unsecured notes and no outstanding revolver borrowings. We had $19.0 of outstanding letters of credit at December 31, 2022, of which $18.3 was covered by our lending group, thereby reducing our revolving credit capacity commensurately.We may redeem some or all of our senior unsecured notes at any time or from time to time, at 100% of their principal amount, plus a make-whole premium based on a spread to U.S. Treasury securities.See Note 9 of the Notes to Consolidated Financial Statements included in this Annual Report for additional information regarding our credit facility and senior notes.Cash and cash equivalents at our foreign subsidiaries at December 31, 2022 totaled $234.0 as compared to $310.8 at December 31, 2021, a decrease of 24.7%. The decrease was due primarily due to repatriation of $285.6 and cash divested in connection with the Indicor Transaction partially offset by cash generated from foreign operations. We intend to repatriate substantially all historical and future earnings.28Capital expenditures of $40.1, $28.5 and $24.7 were incurred during 2022, 2021 and 2020, respectively. Capitalized software expenditures of $30.2, $29.7 and $17.7 were incurred during 2022, 2021 and 2020, respectively. Capital expenditures and capitalized software expenditures were relatively consistent in 2022 as compared to 2021 and 2020. In the future, we expect the aggregate of capital expenditures and capitalized software expenditures as a percentage of annual net revenues to be between 1.0% and 1.5%.Contractual Cash Obligations and Other Commercial Commitments and ContingenciesAll currency amounts are in millionsThe following tables quantify our contractual cash obligations and commercial commitments at December 31, 2022. Payments Due in Fiscal Year ContractualCash Obligations 1Total20232024202520262027ThereafterTotal debt$6,700.3 $700.2 $500.1 $1,000.0 $700.0 $700.0 $3,100.0 Senior note interest851.0 176.0 150.5 138.7 120.2 93.6 172.0 Purchase obligations 2790.7 411.9 138.5 126.4 81.5 12.1 20.3 Total$8,342.0 $1,288.1 $789.1 $1,265.1 $901.7 $805.7 $3,292.3 1 We have excluded the liability for uncertain tax positions and certain other tax liabilities as we are not able to reasonably estimate the timing of the payments. See Note 8 of the Notes to Consolidated Financial Statements included in this Annual Report.2 Represents minimum fixed price purchase commitments that are legally binding across Roper.We believe that internally generated cash flows and the remaining availability under our credit facility will be adequate to finance normal operating requirements. Although we maintain an active acquisition program, any future acquisitions will be dependent on numerous factors and it is not feasible to reasonably estimate if or when any such acquisitions will occur and what the impact will be on our business, financial condition and results of operations. Such acquisitions may be financed by the use of existing credit lines, future cash flows from operations, future divestitures, the proceeds from the issuance of new debt or equity securities or any combination of these methods, the terms and availability of which will be subject to market and economic conditions generally.We anticipate that our businesses will generate positive cash flows from operating activities, and that these cash flows will permit the reduction of currently outstanding debt in accordance with the repayment schedule. However, the rate at which we can reduce our debt during 2023 (and reduce the associated interest expense) will be affected by, among other things, the financing and operating requirements of any new acquisitions, the financial performance of our existing companies and the financial markets generally. None of these factors can be predicted with certainty.Recently Issued Accounting StandardsSee Note 1 of the Notes to Consolidated Financial Statements included in this Annual Report for information regarding the effect of new accounting pronouncements on our Consolidated Financial Statements.29ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are exposed to interest rate risks on our outstanding revolving credit borrowings, and to foreign currency exchange risks on our transactions denominated in currencies other than the U.S. dollar. We are also exposed to equity market risks pertaining to the traded price of our common stock.At December 31, 2022, we had $6,700.0 of fixed rate borrowings with interest rates ranging from 1.00% to 4.20%. At December 31, 2022, the prevailing market rates for each of our long-term notes was at least 0.7% but no more than 4.1% higher than the fixed rates on our debt instruments. Our credit facility contains a $3,500.0 variable-rate revolver with no outstanding borrowings at December 31, 2022.Several of our businesses have transactions and balances denominated in currencies other than the U.S. dollar. Most of these transactions or balances are denominated in euros, Canadian dollars or British pounds. Net revenues recognized by companies whose functional currency was not the U.S. dollar were 11% of our total revenues in 2022 and 89% of these revenues were recognized by companies with a functional currency that was either the euro, Canadian dollar or British pound. If these currency exchange rates had been 10% different throughout 2022 compared to currency exchange rates actually experienced, the impact on our net earnings would have been approximately 1%.The trading price of our common stock influences the valuation of stock award grants and the effects these grants have on our results of operations. The stock price also influences the computation of potentially dilutive common stock to determine diluted earnings per share. In addition, the stock price also affects our employees’ perceptions of programs that involve our common stock. The quantification of the effects of these changing prices on our future earnings and cash flows is not readily determinable.30
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the Consolidated Financial Statements and related notes included in this Form 10-K. We urge you to consider carefully the risks described below, which discuss the material factors that make an investment in our securities speculative or risky, as well as in other reports and materials that we file with the SEC and the other information included or incorporated by reference in this Form 10-K, any of which could materially adversely affect our financial condition, results of operations and cash flows. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also materially adversely affect our business, reputation, financial condition, results of operations, cash flows and prospects. Business and Operational Risks Demand for our products and services is substantially dependent on the levels of expenditures by our customers. Recent oil and gas industry downturns have resulted in reduced demand for oilfield products and services and lower expenditures by our customers, which has in the past had, and may in the future have, a material adverse effect on our financial condition, results of operations and cash flows. Demand for our products and services depends substantially on expenditures by our customers for the exploration, development and production of oil and gas reserves. These expenditures are generally dependent on our customers’ views of future demand for oil and gas and future oil and gas prices, as well as our customers’ ability to access capital. In addition, the transition of the global energy sector from primarily a fossil fuel-based system to renewable energy sources could affect our customers’ levels of expenditures. Actual and anticipated declines in oil and gas prices have in the past resulted in, and may in the future result in, lower capital expenditures, project modifications, delays or cancellations, general business disruptions, and delays in payment of, or nonpayment of, amounts that are owed to us. These effects have had, and may in the future have, a material adverse effect on our financial condition, results of operations and cash flows. Historically, oil and gas prices have experienced significant volatility and can be affected by a variety of factors, including: • changes in the supply of and demand for hydrocarbons, which are affected by general economic and business conditions; • the costs of exploring for, producing, and delivering oil and gas; • the ability or willingness of the Organization of Petroleum Exporting Countries and the expanded alliance known as OPEC+ to set and maintain production levels for oil; • the level of oil and gas exploration and production activity; • the level of excess production capacity; • the level of refining capacity; • the level of oil and gas inventories; • access to potential resources; • political and economic uncertainty and geopolitical unrest; • governmental laws, policies, regulations, subsidies, and other actions, including initiatives to promote the use of renewable energy sources; • speculation as to the future price of oil and the speculative trading of oil and gas futures contracts; • technological advances affecting energy consumption; and • extreme weather conditions, natural disasters, and public health or similar issues, such as pandemics and epidemics. 10 The oil and gas industry has historically experienced periodic downturns, which have been characterized by diminished demand for our products and services and downward pressure on the prices that we are able to charge. Sustained market uncertainty can also result in lower demand and pricing for our products and services. A significant industry downturn, sustained market uncertainty, or increased availability of economical alternative energy sources could result in a reduction in demand for our products and services, which could adversely affect our business, financial condition, results of operations, cash flows and prospects. Disruptions in the political, regulatory, economic, and social environments of the countries in which we operate could adversely affect our reputation, financial condition, results of operations and cash flows. We are a global technology company, and our non-US operations accounted for approximately 84% of our consolidated revenue in 2022, 85% in 2021 and 81% in 2020. Instability and unforeseen changes in any of the markets in which we operate could result in business disruptions or operational challenges that may adversely affect the demand for our products and services, or our reputation, financial condition, results of operations or cash flows. These factors include, but are not limited to, the following: • uncertain or volatile political, social, and economic conditions; • exposure to expropriation, nationalization, deprivation or confiscation of our assets or the assets of our customers, or other governmental actions; • social unrest, acts of terrorism, war, or other armed conflict; • public health crises and other catastrophic events, such as the COVID-19 pandemic; • confiscatory taxation or other adverse tax policies; • theft of, or lack of sufficient legal protection for, proprietary technology and other intellectual property; • deprivation of contract rights; • trade and economic sanctions or other restrictions imposed by the European Union, the United States, the United Kingdom, China, or other regions or countries that could restrict or curtail our ability to operate in certain markets; • unexpected changes in legal and regulatory requirements, including changes in interpretation or enforcement of existing laws; • restrictions on the repatriation of income or capital; • currency exchange controls; • inflation; and • currency exchange, rate fluctuations and devaluations. As an example of a risk resulting from our global operations, in March 2022 we decided to immediately suspend new investment and technology deployment to our Russia operations. Russia represented approximately 6% of our worldwide revenue during 2022. The carrying value of our net assets in Russia was approximately $0.7 billion as of December 31, 2022. This consisted of $0.3 billion of receivables, $0.3 billion of fixed assets, $0.5 billion of current assets, and $0.4 billion of current liabilities. We continue to actively monitor the dynamic situation in Ukraine and applicable laws, sanctions and trade control restrictions resulting from the conflict. The extent to which our operations and financial results may be affected by the ongoing conflict in Ukraine will depend on various factors, including the extent and duration of the conflict; the effects of the conflict on regional and global economic and geopolitical conditions; the effect of further laws, sanctions and trade control restrictions on our business, the global economy and global supply chains; and the impact of fluctuations in the exchange rate of the ruble. Continuation or escalation of the conflict may also aggravate this and other risk factors identified in this Form 10-K, including cybersecurity, regulatory, and reputational risks. Failure to effectively and timely address the energy transition could adversely affect our business, results of operations and cash flows. Our long-term success depends on our ability to effectively address the energy transition, which will require adapting our technology portfolio to changing customer preferences and government requirements, developing solutions to decarbonize oil and gas operations, and scaling innovative low-carbon and carbon-neutral technologies. If the energy transition landscape changes faster than anticipated or in a manner that we do not anticipate, demand for our products and services could be adversely affected. Furthermore, if we fail or are perceived to not effectively implement an energy transition strategy, or if investors or financial institutions shift funding away from companies in fossil fuel-related industries, our access to capital or the market for our securities could be negatively impacted. Our operations are subject to cyber incidents that could have a material adverse effect on our business, financial condition, and results of operations. Our success depends in part on our ability to provide effective data security protection in connection with our digital technologies and services. We rely on information technology networks and systems for internal purposes, including secure data storage, processing, and transmission, as well as in our interactions with our business associates, such as customers and suppliers. We also develop software and other digital products and services that store, retrieve, manipulate, and manage our customers’ information and data, external data, personal data, and our own data. Our digital technologies and services, and those of our business associates, are subject to the risk of cyberattacks and, given the nature of such attacks, some incidents can remain undetected for a period of time despite efforts to detect and respond to them in a timely manner. There can be no assurance that the systems we have designed to prevent or limit the effects of cyber incidents or attacks will be sufficient to prevent or detect material consequences arising from such incidents or attacks, or to avoid a material adverse impact on our systems after such incidents or attacks do occur. We have experienced and will continue to experience varying degrees of cyber incidents in the normal conduct of our business, including attacks resulting from phishing emails and ransomware infections. Even if we successfully defend our own digital technologies and services, we 11 also rely on third-party business associates, with whom we may share data and services, to defend their digital technologies and services against attack. Unauthorized access to or modification of, or actions disabling our ability to obtain authorized access to, our customers’ data, other external data, personal data, or our own data, as a result of a cyber incident, attack or exploitation of a security vulnerability, could result in significant damage to our reputation or disruption of the services we provide to our customers. In addition, allegations, reports, or concerns regarding vulnerabilities affecting our digital products or services could damage our reputation. This could lead to fewer customers using our digital products and services, which could have a material adverse impact on our financial condition, results of operations or prospects. In addition, if our systems, or our third-party business associates’ systems, for protecting against cybersecurity risks prove to be insufficient, we could be adversely affected by, among other things, loss of or damage to intellectual property, proprietary or confidential information, or customer, supplier, or employee data; breach of personal data; interruption of our business operations; increased legal and regulatory exposure, including fines and remediation costs; and increased costs required to prevent, respond to, or mitigate cybersecurity attacks. These risks could harm our reputation and our relationships with our employees, business associates and other third parties, and may result in claims against us. We operate in a highly competitive environment. If we are unable to maintain technology leadership, this could adversely affect any competitive advantage we hold. The energy industry is highly competitive and rapidly evolving. Our business may be adversely affected if we fail to continue developing and producing innovative technologies in response to changes in the market, including customer and government requirements, or if we fail to deliver such technologies to our customers in a timely and cost-competitive manner. If we are unable to maintain technology leadership in our industry, our ability to maintain market share, defend, maintain, or increase prices for our products and services, and negotiate acceptable contract terms with our customers could be adversely affected. Furthermore, competing or new technologies may accelerate the obsolescence of our products or services and reduce the value of our intellectual property. Limitations on our ability to obtain, maintain, protect, or enforce our intellectual property rights, including our trade secrets, could cause a loss in revenue and any competitive advantage we hold. There can be no assurance that the steps we take to obtain, maintain, protect, and enforce our intellectual property rights will be adequate. Some of our products or services, and the processes we use to produce or provide them, have been granted patent protection, have patent applications pending, or are trade secrets. Our business may be adversely affected when our patents are unenforceable, the claims allowed under our patents are not sufficient to protect our technology, our patent applications are denied, or our trade secrets are not adequately protected. Patent protection on some types of technology, such as software or machine learning processes, may not be available in certain countries in which we operate. Our competitors may also be able to develop technology independently that is similar to ours without infringing on our patents or gaining access to our trade secrets. Third parties may claim that we have infringed upon or otherwise violated their intellectual property rights. The tools, techniques, methodologies, programs, and components we use to provide our services and products may infringe upon or otherwise violate the intellectual property rights of others or be challenged on that basis. Regardless of the merits, any such claims generally result in significant legal and other costs, including reputational harm, and may distract management from running our business. Resolving such claims could increase our costs, including through royalty payments to acquire licenses, if available, from third parties and through the development of replacement technologies. If a license to resolve a claim were not available, we might not be able to continue providing a particular service or product. Legal and Regulatory Risks Our operations require us to comply with numerous laws and regulations, violations of which could have a material adverse effect on our reputation, financial condition, results of operations or cash flows. Our operations are subject to international, regional, national, and local laws and regulations in every place where we operate, relating to matters such as environmental protection, health and safety, labor and employment, human rights, import/export controls, currency exchange, bribery and corruption, data privacy and cybersecurity, intellectual property, immigration, and taxation. These laws and regulations are complex, frequently change, and have tended to become more stringent over time. In the event the scope of these laws and regulations expands in the future, the incremental cost of compliance could adversely affect our financial condition, results of operations, or cash flows. Our operations are subject to anti-corruption and anti-bribery laws and regulations, such as the Foreign Corrupt Practices Act, the UK Bribery Act, and other similar laws. We are also subject to trade control regulations and trade sanctions laws that restrict the movement of certain goods and services to, and certain operations in, various countries or with certain persons. Our ability to transfer people, products and data among certain countries is subject to maintaining required licenses and complying with these laws and regulations. The internal controls, policies and procedures, and employee training and compliance programs we have implemented to deter prohibited practices may not be effective in preventing employees, contractors, or agents from violating or circumventing such internal policies or from material violations of applicable laws and regulations. Any determination that we have violated or are responsible for violations of applicable laws, including anti-bribery, trade control, trade sanctions or anti-corruption laws, could have a material adverse effect on our financial condition. Violations of international and US laws and regulations or the loss of any required licenses may result in fines and penalties, criminal sanctions, administrative remedies, or restrictions on business conduct, and could have a material 12 adverse effect on our business, operations, and financial condition. In addition, any major violations could have a significant effect on our reputation and consequently on our ability to win future business and maintain existing customer and supplier relationships. Existing or future laws, regulations, court orders or other public- or private-sector initiatives to limit greenhouse gas emissions or relating to climate change may reduce demand for our products and services. Continuing political and social attention to the issue of climate change has resulted in both existing and proposed international agreements and national, regional, and local legislation and regulatory measures to limit GHG emissions. The implementation of these agreements, including the Paris Agreement, the Europe Climate Law, and other existing or future regulatory mandates, may adversely affect the demand for our products and services, impose taxes on us or our customers, require us or our customers to reduce GHG emissions from our technologies or operations, or accelerate the obsolescence of our products or services. In addition, increasing attention to the risks of climate change has resulted in an increased possibility of litigation or investigations brought by public and private entities against oil and gas companies in connection with their GHG emissions. As a result, we or our customers may become subject to court orders compelling a reduction of GHG emissions or requiring mitigation of the effects of climate change. There is also increased focus by our customers, investors and other stakeholders on climate change, sustainability, and energy transition matters. Actions to address these concerns or negative perceptions of our industry or fossil fuel products and their relationship to the environment have led to initiatives to conserve energy and promote the use of alternative energy sources, which may reduce the demand for and production of oil and gas in areas of the world where our customers operate, and thus reduce future demand for our products and services. In addition, initiatives by investors and financial institutions to limit funding to companies in fossil fuel-related industries may adversely affect our liquidity or access to capital. Any of these initiatives may, in turn, adversely affect our financial condition, results of operations and cash flows. Environmental compliance costs and liabilities arising as a result of environmental laws and regulations could have a material adverse effect on our business, financial condition and results of operations. We are subject to numerous laws and regulations relating to environmental protection, including those governing air and GHG emissions, water discharges and waste management, as well as the importation and use of hazardous materials, radioactive materials, chemicals, and explosives. The technical requirements of these laws and regulations are becoming increasingly complex, stringent, and expensive to implement. These laws sometimes provide for “strict liability” for remediation costs, damages to natural resources or threats to public health and safety. Strict liability can render us liable for damages without regard to our degree of care or fault. Some environmental laws provide for joint and several strict liability for remediation of spills and releases of hazardous substances, and, as a result, we could be liable for the actions of others. We use and generate hazardous substances and wastes in our operations. In addition, many of our current and former properties are, or have been, used for industrial purposes. Accordingly, we could become subject to material liabilities relating to the investigation and cleanup of potentially contaminated properties, and to claims alleging personal injury or property damage as a result of exposures to, or releases of, hazardous substances. In addition, stricter enforcement or changing interpretations of existing laws and regulations, the enactment of new laws and regulations, the discovery of previously unknown contamination or the imposition of new or increased requirements could require us to incur costs or become the basis for new or increased liabilities that could have a material adverse effect on our business, operations, and financial condition. We could be subject to substantial liability claims, including as a result of well incidents, which could adversely affect our reputation, financial condition, results of operations and cash flows. The technical complexities of our operations expose us to a wide range of significant health, safety, and environmental risks. Our operations involve production-related activities, radioactive materials, chemicals, explosives and other equipment and services that are deployed in challenging exploration, development, and production environments. Accidents or acts of malfeasance involving these services or equipment, or a failure of a product (including as a result of a cyberattack), could cause personal injury, loss of life, damage to or destruction of property, equipment or the environment, or suspension of operations, which could materially adversely affect us. Any well incidents, including blowouts at a well site or any loss of containment or well control, may expose us to additional liabilities, which could be material. Generally, we rely on contractual indemnities, releases, and limitations on liability with our customers and insurance to protect us from potential liability related to such events. However, our insurance may not protect us against liability for certain kinds of events, including events involving pollution, or against losses resulting from business interruption. Moreover, we may not be able to maintain insurance at levels of risk coverage or policy limits that we deem adequate. Any damages caused by our services or products that are not covered by insurance or are in excess of policy limits or subject to substantial deductibles, could adversely affect our financial condition, results of operations and cash flows. General Risk Factors The COVID-19 pandemic and resulting adverse economic conditions have had, and may continue to have, a material adverse effect on our financial condition, results of operations and cash flows. The COVID-19 pandemic caused, and any resurgence of the pandemic could again cause, a significant reduction in global economic activity, significantly weakening demand for oil and gas, and in turn, for our products and services. Other effects of the pandemic included, and may continue to include, significant volatility and disruption of the global financial markets; adverse revenue and net 13 income effects; disruptions to our operations, including suspension or deferral of drilling activities; customer shutdowns of oil and gas exploration and production; downward revisions to customer budgets; limitations on access to sources of liquidity; supply chain disruptions; limitations on access to raw materials; employee impacts from illness; and local and regional closures or lockdowns, including temporary closures of our facilities and the facilities of our customers and suppliers. The extent to which our operating and financial results will continue to be affected by the pandemic will depend on various factors beyond our control, such as the continued severity of the pandemic, including any sustained geographic resurgence; the emergence of new variants and strains of the COVID-19 virus; and the success of actions to contain or treat the virus. COVID-19, and volatile regional and global economic conditions stemming from the pandemic, could also aggravate our other risk factors described in this Form 10-K. Our aspirations, goals, and initiatives related to sustainability and emissions reduction, and our public statements and disclosures regarding them, expose us to numerous risks. We have developed, and will continue to develop and set, goals, targets, and other objectives related to sustainability matters, including our net-zero target and our energy transition strategy. Statements related to these goals, targets and objectives reflect our current plans and aspirations and do not constitute a guarantee that they will be achieved. Our efforts to research, establish, accomplish, and accurately report on these goals, targets, and objectives expose us to numerous operational, reputational, financial, legal, and other risks. Our ability to achieve any stated goal, target, or objective, including with respect to emissions reduction, is subject to numerous factors and conditions, some of which are outside of our control. Our targets are based on empirical data and estimates that reflect the current best practices for measuring or estimating emissions, but we anticipate that future innovations in both measurement technologies and estimation methodologies could cause us to revise our baseline as well as re-calculate progress toward our targets. Our business faces increased scrutiny from certain investors and other stakeholders related to our sustainability activities, including the goals, targets, and objectives that we announce, and our methodologies and timelines for pursuing them. If our sustainability practices do not meet investor or other stakeholder expectations and standards, which continue to evolve, our reputation, our ability to attract or retain employees, and our attractiveness as an investment or business partner could be negatively affected. Similarly, our failure or perceived failure to pursue or fulfill our sustainability-focused goals, targets, and objectives, to comply with ethical, environmental, or other standards, regulations, or expectations, or to satisfy various reporting standards with respect to these matters, within the timelines we announce, or at all, could adversely affect our business or reputation, as well as expose us to government enforcement actions and private litigation. Failure to attract and retain qualified personnel could impede our operations. Our future success depends on our ability to recruit, train, and retain qualified personnel. We require highly skilled personnel to operate and provide technical services and support for our business. Competition for the personnel necessary for our businesses intensifies as activity increases, technology evolves and customer demands change. In periods of high utilization, it is often more difficult to find and retain qualified individuals. This could increase our costs or have other material adverse effects on our operations. Severe weather events, including extreme weather conditions associated with climate change, have in the past and may in the future adversely affect our operations and financial results. Our business has been, and in the future will be, affected by severe weather events in areas where we operate, which could materially affect our operations and financial results. Extreme weather conditions such as hurricanes, flooding, landslides, and heat waves have in the past resulted in, and may in the future result in, the evacuation of personnel, stoppage of services and activity disruptions at our facilities, in our supply chain, or at well-sites, or result in disruptions of our customers’ operations. Particularly severe weather events affecting platforms or structures may result in a suspension of activities. In addition, acute or chronic physical impacts of climate change, such as sea level rise, coastal storm surge, inland flooding from intense rainfall, and hurricane-strength winds may damage our facilities. Any such extreme weather events may result in increased operating costs or decreases in revenue. 14 Item 1B. Unresolved Staff Comments. None. Item 2. Properties. SLB owns or leases numerous manufacturing facilities, administrative offices, service centers, research centers, data processing centers, mines, and other facilities throughout the world, none of which are individually material. Item 3. Legal Proceedings. The information with respect to this Item 3. Legal Proceedings is set forth in Note 14 – Contingencies, in the accompanying Consolidated Financial Statements. Item 4. Mine Safety Disclosures. Information concerning mine safety violations or other regulatory matters required by section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act and Item 104 of Regulation S-K is included in Exhibit 95 to this Form 10-K. 15 PART II Item 5. Market for SLB’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities. As of December 31, 2022, there were 22,341 stockholders of record. The principal US market for SLB’s common stock is the New York Stock Exchange (“NYSE”), where it is traded under the symbol “SLB.” The following graph compares the cumulative total stockholder return on SLB common stock with the cumulative total return on the Standard & Poor’s 500 Index (“S&P 500 Index”) and the cumulative total return on the Philadelphia Oil Service Index. It assumes $100 was invested on December 31, 2017 in SLB common stock, in the S&P 500 Index and in the Philadelphia Oil Service Index, as well as the reinvestment of dividends on the last day of the month of payment. The stockholder return set forth below is not necessarily indicative of future performance. The following graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that SLB specifically incorporates it by reference into such filing. Comparison of Five-Year Cumulative Total Return Among SLB Common Stock, the S&P 500 Index and the Philadelphia Oil Service Index Share Repurchases On January 21, 2016, the SLB Board of Directors approved a $10 billion share repurchase program for SLB common stock. SLB had repurchased $1.0 billion of its common stock under this program as of December 31, 2022. SLB did not repurchase any of its common stock during 2022. Unregistered Sales of Equity Securities None. Item 6. [Reserved]. 16 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis contains forward-looking statements, including, without limitation, statements relating to our plans, strategies, objectives, expectations, intentions and resources. Such forward-looking statements should be read in conjunction with our disclosures under “Item 1A. Risk Factors” of this Form 10-K. This section of the Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparison between 2021 and 2020 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of SLB’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021. 2022 Executive Overview We delivered strong fourth quarter results and concluded a remarkable year for SLB with great success. Full-year 2022 revenue of $28.1 billion increased 23% year on year. All Divisions and geographical areas experienced double digit revenue growth. 2022 was transformative for SLB as we set new safety, operational, and performance benchmarks for our customers and strengthened our market position both internationally and in North America. We launched our bold new brand identity, reinforcing our leadership position in energy technology, digital, and sustainability, and demonstrated our ability to deliver superior earnings in this early phase of a structural upcycle in energy. In North America, we seized the growth cycle throughout the year, increased our pretax operating margins close to 600 basis points (“bps”), and almost doubled our pretax operating income. We effectively harnessed our refocused portfolio, fit-for-basin technology, and performance differentiation to gain greater market access and improved pricing, particularly in the drilling markets where we significantly outperformed rig count growth. Today, we have built one of the highest-quality oilfield services and equipment businesses in North America through the implementation of our returns-focused strategy. In the international markets, after a first half of the year that was impacted by geopolitical conflict and supply chain bottlenecks, activity began to visibly expand in the second half of the year, resulting in full year revenue growth of 20% and margin expansion of more than 150 bps. We laid the foundation for further growth and margin expansion through pricing improvements and a solid pipeline of incremental contract awards. In the Middle East, SLB is well positioned to be a key beneficiary of this visible market expansion, and we expect record levels of upstream investment by national oil companies to continue in the next few years. During the year, we secured a sizeable share of tender awards in the region, driven by our differentiated performance, fit-for-purpose technology, and best-in-class local content. Similarly, across offshore basins, we continue to consolidate our advantaged position with new contract awards, particularly in Latin America and Africa. Beyond our financial results, we made significant progress in our sustainability initiatives during the year, including launching several new Transition Technologies to support the decarbonization of oil and gas. Our Transition Technologies portfolio revenue grew more than 30% year-on-year, and we project it will cross the $1 billion revenue mark in 2023. Finally, we initiated increased returns to shareholders, demonstrating confidence in our strategy, our financial outperformance, and our commitment to superior returns. We increased our dividend by 40% in April 2022, followed by a further 43% increase in January 2023, and we resumed our share buyback program in the first quarter of 2023. The fourth quarter affirmed a distinctive new phase in the upcycle with the much-anticipated acceleration of activity in the Middle East, as revenue in the region increased by double digits. Offshore activity continued to strengthen, partially offset by seasonality in the Northern Hemisphere. In North America, the US land rig count remains at robust levels, although the pace of growth is moderating. Additionally, pricing continues to trend favorably, extending beyond North America and into the international regions, supported by new technology and very tight equipment and service capacity in certain markets. These activity dynamics, improved pricing, and our commercial success—particularly in the Middle East, offshore, and North American markets—combine to set a very strong foundation for outperformance in 2023. We strengthened our balance by reducing our net debt by $1.7 billion to $9.3 billion, its lowest level since the second quarter of 2016, and repaid approximately $1.7 billion of gross debt during the year. Looking ahead, we believe the macro backdrop and market fundamentals that underpin a strong multi-year upcycle for energy remain very compelling in both oil and gas and in low-carbon energy resources. First, oil and gas demand is forecasted by the International Energy Agency (“IEA”) to grow by 1.7 million barrels per day in 2023 despite concerns for a potential economic slowdown in certain regions. In parallel, markets remain very tightly supplied. Second, energy security is prompting a sense of urgency to make further investments to ensure capacity expansion and diversity of supply. And third, the secular trends of digital and decarbonization are set to accelerate with significant digital technology advancements, favorable government policy support, and increased spending on low-carbon initiatives and resources. Based on these factors, global upstream spending projections continue to trend positively. Activity growth is expected to be broad-based, marked by an acceleration in international basins. These positive activity dynamics will be amplified by higher service pricing 17 and tighter service sector capacity. The impact of loosening COVID-19 restrictions and an earlier than expected reopening of China could support further upside potential over 2023. Overall, the combination of these effects will result in a very favorable mix for SLB with significant growth opportunities in our Core, Digital, and New Energy and we expect another year of very strong growth and margin expansion. Fourth Quarter 2022 Results (Stated in millions) Fourth Quarter 2022 Third Quarter 2022 Pretax Pretax Revenue Income Revenue Income Digital & Integration $ 1,012 $ 382 $ 900 $ 305 Reservoir Performance 1,554 282 1,456 244 Well Construction 3,229 679 3,084 664 Production Systems 2,215 238 2,150 224 Eliminations & other (131 ) (24 ) (113 ) (37 ) Pretax segment operating income 1,557 1,400 Corporate & other (1) (169 ) (155 ) Interest income (2) 14 8 Interest expense (3) (118 ) (119 ) Charges & credits (4) 63 - $ 7,879 $ 1,347 $ 7,477 $ 1,134 (1) Comprised principally of certain corporate expenses not allocated to the segments, stock-based compensation costs, amortization expense associated with certain intangible assets, certain centrally managed initiatives and other nonoperating items. (2) Excludes interest income included in the segments’ income (fourth quarter 2022: $19 million; third quarter 2022: $25 million). (3) Excludes interest expense included in the segments’ income (fourth quarter 2022: $3 million; third quarter 2022: $3 million). (4) Charges & credits are described in detail in Note 3 to the Consolidated Financial Statements. Fourth-quarter revenue of $7.9 billion increased 5% sequentially. Revenue grew across all Divisions and geographical areas, with robust year-end sales in digital and particularly strong service activity offshore and in the Middle East where a significant inflection was witnessed as capacity expansion projects mobilized. International revenue of $6.2 billion grew 5% sequentially, driven by continued strengthening activity. This revenue increase was led by the Middle East & Asia and Latin America, both of which grew 7%. In North America, revenue of $1.6 billion increased 6% sequentially driven by strong year-end exploration data licensing sales in the US Gulf of Mexico boosting North America offshore revenue. US land revenue increased 4% sequentially due to drilling revenue growth, which outperformed the rig count growth. Fourth-quarter pretax segment operating margin of 19.8% was the highest since 2015. Digital & Integration Digital & Integration fourth-quarter revenue of $1.0 billion increased 12% sequentially, propelled by the year-end exploration data licensing sales in the US Gulf of Mexico and Africa; increased Asset Performance Solutions (“APS”) project activity in Ecuador and higher digital sales internationally. Digital & Integration pretax operating margin of 38% expanded 386 bps sequentially, due to improved profitability in exploration data licensing and digital solutions. Reservoir Performance Reservoir Performance revenue of $1.6 billion increased 7% sequentially from new projects and activity gains internationally, particularly in the Middle East and Africa. Reservoir Performance pretax operating margin of 18% expanded 146 bps sequentially. Profitability was boosted by higher offshore and exploration activity, mainly in Africa, and strong development activity, particularly in US land and Middle East & Asia. Well Construction Well Construction revenue of $3.2 billion increased 5% sequentially, outperforming global rig count growth due to strong activity from new projects and solid pricing improvements internationally, particularly in the Middle East & Asia and Latin America. 18 Well Construction pretax operating margin of 21% contracted 50 bps sequentially, as improved profitability from increasing activity in the Middle East & Asia, North America, and Latin America was more than offset by the onset of seasonal effects in the Northern Hemisphere. Production Systems Production Systems revenue of $2.2 billion increased 3% sequentially primarily due to higher international sales of artificial lift, completions, and midstream productions systems. Production Systems pretax operating margin of 11% expanded 32 bps sequentially primarily due to an improved revenue mix. Full-Year 2022 Results (Stated in millions) 2022 2021 Pretax Pretax Revenue Income Revenue Income Digital & Integration $ 3,725 $ 1,357 $ 3,290 $ 1,141 Reservoir Performance 5,553 881 4,599 648 Well Construction 11,397 2,202 8,706 1,195 Production Systems 7,862 748 6,710 634 Eliminations & other (446 ) (177 ) (376 ) (253 ) Pretax segment operating income 5,011 3,365 Corporate & other (1) (637 ) (573 ) Interest income (2) 27 31 Interest expense (3) (477 ) (514 ) Charges & credits (4) 347 65 $ 28,091 $ 4,271 $ 22,929 $ 2,374 (1) Comprised principally of certain corporate expenses not allocated to the segments, stock-based compensation costs, amortization expense associated with certain intangible assets, certain centrally managed initiatives and other nonoperating items. (2) Excludes interest income included in the segments’ income (2022: $72 million; 2021: $2 million). (3) Excludes interest expense included in the segments’ income (2022: $13 million; 2021: $15 million) and $10 million interest expense included in Charges & credits in 2021. (4) Charges and credits are described in detail in Note 3 to the Consolidated Financial Statements. Full-year 2022 revenue of $28.1 billion increased 23% year-on-year driven by activity increases internationally, in North America and across all Divisions. International revenue increased 20% to $21.9 billion led by Latin America and Europe/CIS/Africa with revenue growth of 27% and 25%, respectively, while revenue in the Middle East & Asia increased 12%. In North America, revenue increased 34% to $6.0 billion primarily driven by robust onshore drilling activity; higher sales of production systems; a strong contribution from the APS project in Canada; and increased exploration data licensing in the US Gulf of Mexico. Full-year pretax operating margin of 18% increased 316 bps due to improved operating leverage from higher activity, a favorable activity mix, and an improving pricing environment. Digital & Integration Digital & Integration full-year revenue of $3.7 billion increased 13% year on year, primarily driven by increased APS project activity in Ecuador and Canada and higher exploration data licensing sales in the US Gulf of Mexico. Digital & Integration pretax operating margin of 36% expanded 177 bps year on year largely due to improved profitability in exploration data licensing. Reservoir Performance Reservoir Performance full-year revenue of $5.6 billion increased 21% year on year as a result of strong international activity led by the Middle East & Asia and Latin America on higher activity and improved pricing. 19 Reservoir Performance pretax operating margin of 16% increased 177 bps year on year primarily due to improved profitability in intervention activity. Well Construction Well Construction full-year revenue of $11.4 billion grew 31% year on year with strong growth across all geographical areas led by North America and Latin America, which grew 56% and 53%, respectively. This growth was driven by higher land and offshore activity along with improved pricing. Well Construction pretax operating margin of 19% expanded 560 bps year on year driven by the higher activity and improved pricing. Production Systems Production Systems full-year revenue of $7.9 billion increased 17% year on year driven by new projects and increased sales activity primarily in Europe, Africa, and North America. Double digit growth was posted in midstream, artificial lift, surface production systems and subsea production systems. Production Systems pretax operating margin of 10% was essentially flat primarily as a result of higher logistics costs and a less favorable revenue mix. Interest & Other Income, Net Interest & other income, net consisted of the following: (Stated in millions) 2022 2021 Gain on sale of Liberty shares $ 325 $ 28 Loss on Blue Chip Swap transactions (139 ) - Gain on ADC equity investment 107 - Earnings of equity method investments 164 40 Interest income 99 33 Gain on sale of real estate 43 - Gain on repurchase of bonds 11 - Unrealized gain on marketable securities - 47 $ 610 $ 148 During 2022, SLB sold 47.8 million of its shares of Liberty and recognized a gain of $325 million. During 2021, SLB sold 9.5 million of its shares of Liberty and recognized a gain of $28 million. SLB’s functional currency in Argentina is the US dollar and it uses Argentina’s official exchange rate to remeasure its Argentine peso-denominated net assets into US dollars. The Central Bank of Argentina maintains certain currency controls that limit SLB’s ability to access US dollars in Argentina and remit cash from its Argentine operations. A legal indirect foreign exchange mechanism exists-in the form of capital market transactions known as Blue Chip Swaps, which effectively results in a parallel US dollar exchange rate. This parallel rate, which cannot be used as the basis to remeasure SLB’s net monetary assets in US dollars under US GAAP, was approximately 93% higher than Argentina’s official exchange rate at December 31, 2022. During the fourth quarter of 2022, SLB entered into Blue Chip Swap transactions that resulted in a loss of $139 million. SLB’s peso-denominated net assets in Argentina were approximately $40 million at December 31, 2022 (as compared to approximately $270 million at September 30, 2022), primarily consisting of cash. If Argentina’s official exchange rate converges with the parallel rate, SLB would incur a loss on its peso-denominated net assets in Argentina. Additionally, SLB may enter into further Blue Chip Swap transactions in the future. Argentina represented less than 5% of SLB’s consolidated revenue in 2022. SLB has an investment in the Arabian Drilling Company (“ADC”), an onshore and offshore gas and oil rig drilling company in Saudi Arabia, that it accounts for under the equity method. During the fourth quarter of 2022, ADC completed an initial public offering (“IPO”). In connection with the IPO, SLB sold a portion of its interest in a secondary offering that resulted in SLB receiving net proceeds of $223 million. As a result of these transactions, SLB’s ownership interest in ADC decreased from 49% to approximately 34%. SLB recognized a gain of $107 million, representing the gain on the sale of a portion of its interest as well as the effect of the ownership dilution of its equity investment due to the IPO. The increase in earnings of equity method investments in 2022 as compared to 2021 is primarily due to SLB’s investment in Liberty, as Liberty experienced net losses in 2021 as compared to net income in 2022, as well as higher earnings from SLB’s investment in ADC. The increase in interest income was primarily driven by the effect of higher cash and short-term investment balances and interest rates in Argentina. This increase was more than offset by approximately $100 million of foreign exchange losses recorded during 2022 ($13 20 million during 2021) relating to the remeasurement of Argentine peso-denominated net monetary assets as the official Argentine peso exchange rate devalued compared to the US dollar throughout 2022. During 2022, SLB sold certain real estate and recognized a gain of $43 million. During the fourth quarter of 2022, SLB repurchased $395 million of its 3.75% Senior Notes due 2024 and $409 million of its 4.00% Senior Notes due 2025 for $790 million, resulting in a gain of $11 million after considering the write-off of the related deferred financing fees and other costs. During 2021, a start-up company that SLB previously invested in was acquired. As a result of this transaction, SLB’s ownership interest was converted into shares of a publicly traded company. SLB recognized an unrealized pretax gain of $47 million to increase the carrying value of this investment to its estimated fair value of approximately $55 million. Interest Expense Interest expense of $490 million in 2022 decreased $49 million compared to 2021 primarily as a result of the repayment of $1.7 billion and $2.1 billion of debt during 2022 and 2021, respectively. Other Research & engineering and General & administrative expenses, as a percentage of Revenue, were as follows: 2022 2021 Research & engineering 2.3 % 2.4 % General & administrative 1.3 % 1.5 % Income Taxes The SLB effective tax rate is sensitive to the geographic mix of earnings. When the percentage of pretax earnings generated outside of North America increases, the SLB effective tax rate generally decreases. Conversely, when the percentage of pretax earnings generated outside of North America decreases, the SLB effective tax rate generally increases. The effective tax rate was 18% in 2022 as compared to 19% in 2021. The decrease in the effective tax rate was primarily due to the charges and credits described in Note 3 to the Consolidated Financial Statements. These charges and credits reduced the effective tax rate in 2022 by approximately one percentage point. Charges and Credits SLB recorded charges and credits during 2022 and 2021. These charges and credits, which are summarized below, are more fully described in Note 3 to the Consolidated Financial Statements. The following is a summary of the 2022 charges and credits: (Stated in millions) Pretax Tax Benefit Charge (Credit) (Expense) Net First quarter: Gain on sale of Liberty shares $ (26 ) $ (4 ) $ (22 ) Second quarter: Gain on sale of Liberty shares (215 ) (14 ) (201 ) Gain on sale of real estate (43 ) (2 ) (41 ) Fourth quarter: Gain on sale of Liberty shares (84 ) (19 ) (65 ) Loss on Blue Chip Swap transactions 139 - 139 Gain on ADC equity investment (107 ) (3 ) (104 ) Gain on repurchase of bonds (11 ) (2 ) (9 ) $ (347 ) $ (44 ) $ (303 ) 21 The following is a summary of the 2021 charges and credits: (Stated in millions) Pretax Tax Benefit Charge (Credit) (Expense) Net Third quarter: Unrealized gain on marketable securities $ (47 ) $ (11 ) $ (36 ) Fourth quarter: Gain on sale of Liberty shares (28 ) (4 ) (24 ) Early repayment of bonds 10 - 10 $ (65 ) $ (15 ) $ (50 ) Liquidity and Capital Resources Details of the components of liquidity as well as changes in liquidity follow: (Stated in millions) Dec. 31, Dec. 31, Components of Liquidity: 2022 2021 Cash $ 1,655 $ 1,757 Short-term investments 1,239 1,382 Short-term borrowings and current portion of long-term debt (1,632 ) (909 ) Long-term debt (10,594 ) (13,286 ) Net debt (1) $ (9,332 ) $ (11,056 ) Changes in Liquidity: 2022 2021 Net income $ 3,492 $ 1,928 Charges and credits (347 ) (65 ) Depreciation and amortization (2) 2,147 2,120 Stock-based compensation expense 313 324 Deferred taxes (39 ) (31 ) Earnings of equity method investments, less dividends received (96 ) 10 Increase in working capital (1,709 ) (45 ) US Federal tax refund - 477 Other (41 ) (67 ) Cash flow from operations 3,720 4,651 Capital expenditures (1,618 ) (1,141 ) APS investments (587 ) (474 ) Exploration data capitalized (97 ) (39 ) Free cash flow (3) 1,418 2,997 Dividends paid (848 ) (699 ) Proceeds from employee stock purchase plan 141 137 Proceeds from exercise of stock options 81 - Taxes paid on net-settled stock-based compensation awards (93 ) (24 ) Business acquisitions and investments, net of cash acquired plus debt assumed (58 ) (103 ) Proceeds from sale of Liberty shares 732 109 Proceeds from sale of ADC shares 223 - Proceeds from sale of real estate 120 - Purchases of Blue Chip Swap securities (259 ) - Proceeds from sales of Blue Chip Swap securities 111 - Other (105 ) (81 ) Change in net debt before impact of changes in foreign exchange rates on net debt 1,463 2,336 Impact of changes in foreign exchange rates on net debt 261 488 Decrease in Net Debt 1,724 2,824 Net Debt, Beginning of period (11,056 ) (13,880 ) Net Debt, End of period $ (9,332 ) $ (11,056 ) 22 (1) “Net debt” represents gross debt less cash and short-term investments. Management believes that Net debt provides useful information regarding the level of SLB’s indebtedness by reflecting cash and investments that could be used to repay debt. Net debt is a non-GAAP financial measure that should be considered in addition to, not as a substitute for or superior to, total debt. (2) Includes depreciation of property, plant and equipment and amortization of intangible assets, exploration data costs and APS investments. (3) “Free cash flow” represents cash flow from operations less capital expenditures, APS investments and exploration data costs capitalized. Management believes that free cash flow is an important liquidity measure for the company and that it is useful to investors and management as a measure of our ability to generate cash. Once business needs and obligations are met, this cash can be used to reinvest in the company for future growth or to return to shareholders through dividend payments or share repurchases. Free cash flow does not represent the residual cash flow available for discretionary expenditures. Free cash flow is a non-GAAP financial measure that should be considered in addition to, not as a substitute for or superior to, cash flow from operations. Key liquidity events during 2022 and 2021 included: • Cash flow from operations of $3.7 billion in 2022 decreased approximately $1.0 billion as compared to 2021. This decrease was primarily due to working capital consuming $1.7 billion of liquidity in 2022 compared to $45 million in 2021. The increase in working capital was largely the result of receivables increasing $1.7 billion (32%) and inventories increasing $0.7 billion (22%), respectively, from 2021 to 2022, while these balances were relatively flat at the end of 2021 as compared to 2020. The increase in receivables was driven primarily by the fact that SLB’s fourth quarter 2022 revenue increased 27% as compared to the same period last year. The increase in inventories was a result of the significant activity growth that SLB experienced in 2022 that is expected to continue in 2023. These increases in working capital were partially offset by increases in accounts payable and accrued liabilities that were a source of cash of $0.7 billion in 2022 compared to $0.2 billion in 2021. The increase in working capital in 2022 was partially offset by the effects of a $1.3 billion increase in net income, excluding the effects of the previously mentioned charges and credits (which had no impact on cash flow from operations), in 2022 as compared to 2021. In addition, cash flow from operations in 2021 benefited from a federal tax refund of $477 million relating to the carryback of US net operating losses pursuant to the Coronavirus Aid, Relief and Economic Security Act. • In April 2022, SLB announced a 40% increase to its quarterly cash dividend from $0.125 per share of outstanding common stock to $0.175 per share, beginning with the dividend payable in July 2022. Dividends paid during 2022 and 2021 were $0.8 billion and $0.7 billion, respectively. In January 2023, SLB announced a further 43% increase to its quarterly cash dividend from $0.175 per share of outstanding common stock to $0.25 per share, beginning with the dividend payable in April 2023. • On January 21, 2016, the SLB Board of Directors approved a $10 billion share repurchase program for SLB common stock. SLB had repurchased $1.0 billion of SLB common stock under this program as of December 31, 2022. SLB did not repurchase any of its common stock during 2022 and 2021. SLB resumed repurchases under this program in the first quarter of 2023. • Capital investments (consisting of capital expenditures, APS investments and exploration data capitalized) were $2.3 billion in 2022 and $1.7 billion in 2021. Capital investments during 2023 are expected to be approximately $2.5 to $2.6 billion as SLB continues to support the strong revenue growth that is expected to continue in 2023. • During 2022, SLB sold 47.8 million of its shares of Liberty and received proceeds of $732 million. During 2021, SLB sold 9.5 million of its shares of Liberty and received proceeds of $109 million. • During the fourth quarter of 2022, SLB repurchased $395 million of its 3.75% Senior Notes due 2024 and $409 million of its 4.00% Senior Notes due 2025 for $790 million. • During the fourth quarter of 2022, SLB sold a portion of its equity interest in ADC in a secondary offering that resulted in SLB receiving net proceeds of $223 million. • During the second quarter of 2022, SLB sold certain real estate and received proceeds of $120 million. • During the fourth quarter of 2021, SLB deposited sufficient funds with the trustee for its $1.0 billion of 2.40% Senior Notes due 2022 to satisfy and discharge all of its obligations relating to such notes. • During the second quarter of 2021, SLB repurchased all $665 million of its 3.30% Senior Notes due 2021. As of December 31, 2022, SLB had $2.89 billion of cash and short-term investments and committed credit facility agreements with commercial banks aggregating $6.55 billion, all of which was available and unused. SLB believes these amounts, along with cash generated by ongoing operations, will be sufficient to meet future business requirements for the next 12 months and beyond. 23 The following table reflects the carrying amounts of SLB’s debt at December 31, 2022 by year of maturity: (Stated in millions) After 2023 2024 2025 2026 2027 2028 2029 2030 2031 Total Fixed rate debt 3.65% Senior Notes $ 1,499 1,499 4.00% Notes 79 79 0.00% Notes $ 531 531 3.75% Senior Notes 355 355 3.70% Notes 54 54 4.00% Senior Notes $ 522 522 1.40% Senior Notes 499 499 1.375% Guaranteed Notes $ 1,060 1,060 1.00% Guaranteed Notes 636 636 0.25% Notes $ 955 955 3.90% Senior Notes $ 1,464 1,464 4.30% Senior Notes $ 847 847 2.65% Senior Notes $ 1,250 1,250 2.00% Guaranteed Notes $ 1,055 1,055 0.50% Notes 954 954 7.00% Notes 202 202 5.95% Notes 112 112 5.13% Notes 98 98 Total fixed rate debt $ 1,578 $ 940 $ 1,021 $ 1,696 $ 955 $ 1,464 $ 847 $ 1,250 $ 2,421 $ 12,172 Variable rate debt 54 - - - - - - - - 54 Total $ 1,632 $ 940 $ 1,021 $ 1,696 $ 955 $ 1,464 $ 847 $ 1,250 $ 2,421 $ 12,226 Interest payments on fixed rate debt obligations by year are as follows: (Stated in millions) 2023 $ 386 2024 320 2025 301 2026 265 2027 235 Thereafter 706 $ 2,213 See Note 13, Leases of the Consolidated Financial Statements for details regarding SLB’s lease obligations. SLB has outstanding letters of credit/guarantees that relate to business performance bonds, custom/excise tax commitments, facility lease/rental obligations, etc. These were entered into in the ordinary course of business and are customary practices in the various countries where SLB operates. Critical Accounting Policies and Estimates The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires SLB to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenue and expenses. The following accounting policies involve “critical accounting estimates” because they are particularly dependent on estimates and assumptions made by SLB about matters that are inherently uncertain. SLB bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Allowance for Doubtful Accounts SLB maintains an allowance for doubtful accounts in order to record accounts receivable at their net realizable value. Judgment is involved in recording and making adjustments to this reserve. Allowances have been recorded for receivables believed to be uncollectible, including amounts for the resolution of potential credit and other collection issues such as disputed invoices. Adjustments 24 to the allowance may be required in future periods depending on how such potential issues are resolved, or if the financial condition of SLB’s customers were to deteriorate resulting in an impairment of their ability to make payments. As a large multinational company with a long history of operating in a cyclical industry, SLB has extensive experience in working with its customers during difficult times to manage its accounts receivable. During weak economic environments or when there is an extended period of weakness in oil and gas prices, SLB typically experiences delays in the payment of its receivables. However, except for a $469 million accounts receivable write-off during 2017 as a result of the political and economic condition in Venezuela, SLB has not historically had material write-offs due to uncollectible accounts receivable. SLB has a global footprint in more than 100 countries. As of December 31, 2022, three of those countries individually accounted for greater than 5% of SLB’s net accounts receivable balance, of which only two (the United States and Mexico) accounted for greater than 10% of such receivables. Included in Receivables, less allowance for doubtful accounts in the Consolidated Balance Sheet as of December 31, 2022 is approximately $1.0 billion of receivables relating to Mexico. SLB’s receivables from its primary customer in Mexico are not in dispute and SLB has not historically had any material write-offs due to uncollectible accounts receivable relating to this customer. Goodwill, Intangible Assets and Long-Lived Assets SLB records the excess of purchase price over the fair value of the tangible and identifiable intangible assets acquired and liabilities assumed as goodwill. The goodwill relating to each of SLB’s reporting units is tested for impairment annually as well as when an event, or change in circumstances, indicates an impairment may have occurred. Under generally accepted accounting principles, SLB has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of one or more of its reporting units is greater than its carrying amount. If, after assessing the totality of events or circumstances, SLB determines it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, there is no need to perform any further testing. However, if SLB concludes otherwise, then it is required to perform a quantitative impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded based on that difference. SLB has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the quantitative goodwill impairment test. SLB elected to perform the qualitative assessment described above for purposes of its annual goodwill impairment test in 2022. Based on this assessment, SLB concluded it was more likely than not that the fair value of each of its reporting units was significantly greater than its carrying amount. Accordingly, no further testing was required. Long-lived assets, including fixed assets, intangible assets, and investments in APS projects, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In reviewing for impairment, the carrying value of such assets is compared to the estimated undiscounted future cash flows expected from the use of the assets and their eventual disposition. If such cash flows are not sufficient to support the asset’s recorded value, an impairment charge is recognized to reduce the carrying value of the long-lived asset to its estimated fair value. The determination of future cash flows as well as the estimated fair value of long-lived assets involves significant estimates on the part of management. If there is a material change in economic conditions or other circumstances influencing the estimate of future cash flows or fair value, SLB could be required to recognize impairment charges in the future. Income Taxes SLB conducts business in more than 100 tax jurisdictions, a number of which have tax laws that are not fully defined and are evolving. SLB’s tax filings are subject to regular audits by the tax authorities. These audits may result in assessments for additional taxes that are resolved with the authorities or, potentially, through the courts. SLB recognizes the impact of a tax position in its financial statements if that position is more likely than not of being sustained on audit, based on the technical merits of the position. Tax liabilities are recorded based on estimates of additional taxes that will be due upon the conclusion of these audits. Estimates of these tax liabilities are judgmental and are made based upon prior experience, and are updated in light of changes in facts and circumstances. However, due to the uncertain and complex application of tax regulations, the ultimate resolution of audits may result in liabilities that could be materially different from these estimates. In such an event, SLB will record additional tax expense or tax benefit in the period in which such resolution occurs. Revenue Recognition for Certain Long-term Construction-type Contracts SLB recognizes revenue for certain long-term construction-type contracts over time. These contracts involve significant design and engineering efforts in order to satisfy custom designs for customer-specific applications. Under this method, revenue is recognized as work progresses on each contract. Progress is measured by the ratio of actual costs incurred to date on the project in relation to total estimated project costs. Approximately 5% of SLB’s revenue in 2022, 6% in 2021, and 5% in 2020, was recognized under this method. The estimate of total project costs has a significant impact on both the amount of revenue recognized as well as the related profit on a project. Revenue and profits on contracts can also be significantly affected by change orders and claims. Profits are recognized based on the estimated project profit multiplied by the percentage complete. Due to the nature of these projects, adjustments to estimates of contract revenue and total contract costs are often required as work progresses. Any expected losses on a project are recorded in full in the period in which they become probable. 25 Pension and Postretirement Benefits SLB’s pension and postretirement benefit obligations are described in detail in Note 16 to the Consolidated Financial Statements. The obligations and related costs are calculated using actuarial concepts, which include critical assumptions related to the discount rate and the expected rate of return on plan assets. These assumptions are important elements of expense and/or liability measurement and are updated on an annual basis, or upon the occurrence of significant events. The discount rate that SLB uses reflects the prevailing market rate of a portfolio of high-quality debt instruments with maturities matching the expected timing of payment of the related benefit obligations. The following summarizes the discount rates utilized by SLB for its various pension and postretirement benefit plans: • The discount rate utilized to determine the liability for SLB’s United States pension plans and postretirement medical plan was 5.50% at December 31, 2022 and 3.00% at December 31, 2021. • The weighted-average discount rate utilized to determine the liability for SLB’s international pension plans was 5.41% at December 31, 2022 and 2.83% at December 31, 2021. • The discount rate utilized to determine expense for SLB’s United States pension plans and postretirement medical plan was 3.00% in 2022 and 2.60% in 2021. • The weighted-average discount rate utilized to determine expense for SLB’s international pension plans was 2.83% in 2022 and 2.38% in 2021. The expected rate of return for SLB’s retirement benefit plans represents the long-term average rate of return expected to be earned on plan assets based on expectations regarding future rates of return for the portfolio considering the asset allocation and related historical rate of return. The average expected rate of return on plan assets for the United States pension plans was 4.40% in 2022 and 6.60% in 2021. The weighted average expected rate of return on plan assets for the international pension plans was 5.05% in 2022 and 6.73% in 2021. A lower expected rate of return increases pension expense. The following illustrates the sensitivity to changes in certain assumptions, holding all other assumptions constant, for SLB’s United States and international pension plans: (Stated in millions) Effect on Effect on 2022 Dec. 31, 2022 Change in Assumption Pretax Expense Obligation 25 basis point decrease in discount rate +$31 +$334 25 basis point increase in discount rate -$30 -$321 25 basis point decrease in expected return on plan assets +$38 - 25 basis point increase in expected return on plan assets -$38 - The following illustrates the sensitivity to changes in certain assumptions, holding all other assumptions constant, for SLB’s United States postretirement medical plans: (Stated in millions) Effect on Effect on 2022 Dec. 31, 2022 Change in Assumption Pretax Expense Obligation 25 basis point decrease in discount rate -$3 +$23 25 basis point increase in discount rate +$3 -$22 26 Item 7A. Quantitative and Qualitative Disclosures About Market Risk. SLB is subject to market risks primarily associated with changes in foreign currency exchange rates. SLB’s functional currency is primarily the US dollar. Approximately 72% of SLB’s revenue in 2022 was denominated in US dollars. However, outside the United States, a significant portion of SLB’s expenses is incurred in foreign currencies. Therefore, when the US dollar weakens in relation to the foreign currencies of the countries in which SLB conducts business, the US dollar-reported expenses will increase. SLB is exposed to risks on future cash flows relating to its fixed rate debt denominated in currencies other than the functional currency. SLB uses cross-currency interest rate swaps to provide a hedge against these cash flow risks and effectively convert the debt to US-dollar denominated fixed rate debt. SLB maintains a foreign-currency risk management strategy that uses derivative instruments to manage the impact of changes in foreign exchange rates on its earnings. SLB enters into foreign currency forward contracts to provide a hedge against currency fluctuations on certain monetary assets and liabilities, and certain expenses denominated in currencies other than the functional currency. A 10% appreciation in the US dollar from the December 31, 2022 market rates would increase the unrealized value of SLB’s forward contracts by $28 million. Conversely, a 10% depreciation in the US dollar from the December 31, 2022 market rates would decrease the unrealized value of SLB’s forward contracts by $36 million. In either scenario, the gain or loss on the forward contract would be offset by the gain or loss on the underlying transaction, and therefore, would have no impact on future earnings. At December 31, 2022, contracts were outstanding for the US dollar equivalent of $7.2 billion in various foreign currencies, of which $5.1 billion related to hedges of debt balances denominated in currencies other than the functional currency. Forward-Looking Statements This Form 10-K, as well as other statements we make, contains “forward-looking statements” within the meaning of the federal securities laws, which include any statements that are not historical facts. Such statements often contain words such as “expect,” “may,” “can,” “believe,” “predict,” “plan,” “potential,” “projected,” “projections,” “precursor,” “forecast,” “outlook,” “expectations,” “estimate,” “intend,” “anticipate,” “ambition,” “goal,” “target,” “scheduled,” “think,” “should,” “could,” “would,” “will,” “see,” “likely,” and other similar words. Forward-looking statements address matters that are, to varying degrees, uncertain, such as statements about SLB’s financial and performance targets and other forecasts or expectations regarding, or dependent on, its business outlook; growth for SLB as a whole and for each of its Divisions (and for specified business lines, geographic areas or technologies within each Division); oil and natural gas demand and production growth; oil and natural gas prices; forecasts or expectations regarding energy transition and global climate change; improvements in operating procedures and technology; capital expenditures by SLB and the oil and gas industry; the business strategies of SLB, including digital and “fit for basin,” as well as the strategies of SLB’s customers; SLB’s effective tax rate; SLB’s APS projects, joint ventures, and other alliances; SLB’s response to the COVID-19 pandemic and its preparedness for other widespread health emergencies; the impact of the ongoing conflict in Ukraine on global energy supply; access to raw materials; future global economic and geopolitical conditions; future liquidity; and future results of operations, such as margin levels. These statements are subject to risks and uncertainties, including, but not limited to, changing global economic and geopolitical conditions; changes in exploration and production spending by SLB’s customers and changes in the level of oil and natural gas exploration and development; the results of operations and financial condition of SLB’s customers and suppliers; SLB’s inability to achieve its financial and performance targets and other forecasts and expectations; SLB’s inability to achieve net-zero carbon emissions goals or interim emissions reduction goals; general economic, geopolitical and business conditions in key regions of the world; the ongoing conflict in Ukraine; foreign currency risk; inflation; changes in monetary policy by governments; pricing pressure; weather and seasonal factors; unfavorable effects of health pandemics; availability and cost of raw materials; operational modifications, delays or cancellations; challenges in SLB’s supply chain; production declines; the extent of future charges; SLB’s inability to recognize efficiencies and other intended benefits from its business strategies and initiatives, such as digital or new energy, as well as its cost reduction strategies; changes in government regulations and regulatory requirements, including those related to offshore oil and gas exploration, radioactive sources, explosives, chemicals and climate-related initiatives; the inability of technology to meet new challenges in exploration; the competitiveness of alternative energy sources or product substitutes; and other risks and uncertainties detailed in this Form 10-K and other filings that we make with the SEC. If one or more of these or other risks or uncertainties materialize (or the consequences of any such development changes), or should our underlying assumptions prove incorrect, actual results or outcomes may vary materially from those reflected in our forward-looking statements. Forward-looking and other statements in this Form 10-K regarding our environmental, social, and other sustainability plans and goals are not an indication that these statements are necessarily material to investors or required to be disclosed in our filings with the SEC. In addition, historical, current, and forward-looking environmental, social, and sustainability-related statements may be based on standards for measuring progress that are still developing, internal controls and processes that continue to evolve, and assumptions that are subject to change in the future. Statements in this Form 10-K are made as of January 25, 2023, and SLB disclaims any intention or obligation to update publicly or revise such statements, whether as a result of new information, future events or otherwise. 27
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+Item 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSPageCombined Management's Discussion and Analysis of Financial Condition and Results of OperationsOverviewII-3Results of OperationsII-7Southern CompanyII-7Alabama PowerII-17Georgia PowerII-21Mississippi PowerII-26Southern PowerII-30Southern Company GasII-32Future Earnings PotentialII-38Accounting PoliciesII-46Financial Condition and LiquidityII-53This section generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Annual Report on Form 10-K can be found in Item 7 of each Registrant's Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on February 16, 2022. The following Management's Discussion and Analysis of Financial Condition and Results of Operations is a combined presentation; however, information contained herein relating to any individual Registrant is filed by such Registrant on its own behalf and each Registrant makes no representation as to information related to the other Registrants.Item 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKSee MANAGEMENT'S DISCUSSION AND ANALYSIS – FINANCIAL CONDITION AND LIQUIDITY – "Market Price Risk" in Item 7 herein and Note 1 to the financial statements under "Financial Instruments" in Item 8 herein. Also see Notes 13 and 14 to the financial statements in Item 8 herein.II-2 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISOVERVIEWBusiness ActivitiesSouthern Company is a holding company that owns all of the common stock of three traditional electric operating companies, Southern Power, and Southern Company Gas and owns other direct and indirect subsidiaries. The primary businesses of the Southern Company system are electricity sales by the traditional electric operating companies and Southern Power and the distribution of natural gas by Southern Company Gas. Southern Company's reportable segments are the sale of electricity by the traditional electric operating companies, the sale of electricity in the competitive wholesale market by Southern Power, and the sale of natural gas and other complementary products and services by Southern Company Gas. See Note 16 to the financial statements for additional information.•The traditional electric operating companies – Alabama Power, Georgia Power, and Mississippi Power – are vertically integrated utilities providing electric service to retail customers in three Southeastern states in addition to wholesale customers in the Southeast.•Southern Power develops, constructs, acquires, owns, and manages power generation assets, including renewable energy projects, and sells electricity at market-based rates in the wholesale market. Southern Power continually seeks opportunities to execute its strategy to create value through various transactions including acquisitions, dispositions, and sales of partnership interests, development and construction of new generating facilities, and entry into PPAs primarily with investor-owned utilities, IPPs, municipalities, electric cooperatives, and other load-serving entities, as well as commercial and industrial customers. In general, Southern Power commits to the construction or acquisition of new generating capacity only after entering into or assuming long-term PPAs for the new facilities.•Southern Company Gas is an energy services holding company whose primary business is the distribution of natural gas. Southern Company Gas owns natural gas distribution utilities in four states – Illinois, Georgia, Virginia, and Tennessee – and is also involved in several other complementary businesses. Southern Company Gas manages its business through three reportable segments – gas distribution operations, gas pipeline investments, and gas marketing services, which includes SouthStar, a Marketer and provider of energy-related products and services to natural gas markets – and one non-reportable segment, all other. Prior to the sale of Sequent on July 1, 2021, Southern Company Gas' reportable segments also included wholesale gas services. See Notes 7, 15, and 16 to the financial statements for additional information.Southern Company's other business activities include providing distributed energy and resilience solutions and deploying microgrids for commercial, industrial, governmental, and utility customers, as well as investments in telecommunications. Management continues to evaluate the contribution of each of these activities to total shareholder return and may pursue acquisitions, dispositions, and other strategic ventures or investments accordingly.See FUTURE EARNINGS POTENTIAL herein for a discussion of the many factors that could impact the Registrants' future results of operations, financial condition, and liquidity.Recent DevelopmentsAlabama PowerOn July 12, 2022, the Alabama PSC approved the following items:•Alabama Power's petition for a certificate of convenience and necessity authorizing Alabama Power to complete the acquisition of the Calhoun Generating Station. The transaction closed on September 30, 2022 and the related costs are being recovered through Rate CNP New Plant, which reflected an increase in annual revenues of $34 million, or 0.6%, effective with November 2022 billings.•An increase to Rate ECR effective with August 2022 billings, which resulted in an increase of approximately $310 million annually. The approved changes in the Rate ECR factor have no significant effect on Alabama Power's net income, but do impact the related operating cash flows.•Modifications to Rate NDR.•An accounting order authorizing Alabama Power to create a reliability reserve separate from the NDR and transition the previous Rate NDR authority related to reliability expenditures to the reliability reserve. Alabama Power may make accruals to the reliability reserve if the NDR balance exceeds $35 million. At December 31, 2022, Alabama Power accrued $166 million to the reserve.II-3 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISOn September 23, 2022, the FERC authorized Alabama Power to use updated depreciation rates from its 2021 depreciation study effective January 2023. The updated depreciation rates are expected to result in an approximately $500 million increase in annual depreciation expense.On November 1, 2022, the Alabama PSC approved an increase to Rate ECR of approximately $500 million annually effective with December 2022 billings. The approved changes in the Rate ECR factor have no significant effect on Alabama Power's net income, but do impact operating cash flows related to fuel cost recovery.On December 1, 2022, Alabama Power submitted calculations for Rate CNP Compliance for 2023 which resulted in an annual revenue increase of approximately $255 million, or 3.7%, effective with January 2023 billings, primarily due to updated depreciation rates.On December 6, 2022, the Alabama PSC approved Rate CNP Depreciation, which allows Alabama Power to recover changes in depreciation resulting from updates to certain depreciation rates. Rate CNP Depreciation will result in an annual revenue increase of approximately $318 million, or 4.6%, effective with January 2023 billings. In addition, the Alabama PSC directed Alabama Power to accelerate the amortization of a regulatory liability associated with excess federal accumulated deferred income taxes, which is being returned to customers through bill credits of up to approximately $318 million in 2023 to offset the impact of the Rate CNP Depreciation increase. The Alabama PSC will determine the treatment of any remaining excess federal accumulated deferred income taxes at a future date. The ultimate outcome of this matter cannot be determined at this time.During 2022, Alabama Power continued construction of Plant Barry Unit 8, which is expected to be placed in service in November 2023. At December 31, 2022, associated project expenditures totaled approximately $518 million.For the year ended December 31, 2022, Alabama Power's weighted common equity return exceeded 6.15%, resulting in Alabama Power establishing a current regulatory liability of $62 million. On February 7, 2023, the Alabama PSC directed Alabama Power to issue the 2022 refund to customers through bill credits in August 2023.See Note 2 to the financial statements under "Alabama Power" for additional information.Georgia PowerPlant Vogtle Units 3 and 4 Construction and Start-Up StatusConstruction continues on Plant Vogtle Units 3 and 4 (with electric generating capacity of approximately 1,100 MWs each), in which Georgia Power currently holds a 45.7% ownership interest. Georgia Power's share of the total project capital cost forecast to complete Plant Vogtle Units 3 and 4, including contingency, through the end of the second quarter 2023 and the first quarter 2024, respectively, is $10.6 billion.On July 29, 2022, Southern Nuclear announced that all Unit 3 ITAACs had been submitted to the NRC. On August 3, 2022, the NRC published its 103(g) finding that the acceptance criteria in the combined license for Unit 3 had been met, which allowed nuclear fuel to be loaded and start-up testing to begin. Fuel load for Unit 3 was completed on October 17, 2022. In early 2023, during the start-up and pre-operational testing for Unit 3, Southern Nuclear identified and is remediating certain equipment and component issues. As a result, Unit 3 is projected to be placed in service during May or June 2023. The projected schedule for Unit 3 primarily depends on the progression of final component and pre-operational testing and start-up, which may be impacted by further equipment, component, and/or other operational challenges. After considering the timeframe and duration of hot functional and other testing and recent experience with Unit 3 start-up and pre-operational testing, Unit 4 is now projected to be placed in service during late fourth quarter 2023 or the first quarter 2024. The projected schedule for Unit 4 primarily depends on potential impacts arising from Unit 4 testing activities overlapping with Unit 3 start-up and commissioning; maintaining overall construction productivity and production levels, particularly in subcontractor scopes of work; and maintaining appropriate levels of craft laborers. Any further delays could result in later in-service dates and cost increases.During 2022, established construction contingency and additional costs totaling $307 million were assigned to the base capital cost forecast for costs primarily associated with schedule extensions, construction productivity, the pace of system turnovers, additional craft and support resources, procurement for Units 3 and 4, and the equipment and component issues identified during Unit 3 start-up and pre-operational testing. During 2022, Georgia Power also increased its total project capital cost forecast by $125 million to replenish construction contingency and $9 million for construction monitoring costs, which were approved for recovery by the Georgia PSC in its nineteenth VCM order. After considering the significant level of uncertainty that exists regarding the future recoverability of these costs since the ultimate outcome of these matters is subject to the outcome of future assessments by management, as well as Georgia PSC decisions in future regulatory proceedings, Georgia Power recorded pre-tax charges to income in the second quarter 2022, the third quarter 2022, and the fourth quarter 2022 of $36 million ($27 million after tax), $32 million ($24 million after tax), and $148 million ($110 million after tax), respectively, for the increases in the total project capital cost forecast. Georgia Power may request the Georgia PSC to evaluate those expenditures for rate recovery during II-4 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISthe prudence review following the Unit 4 fuel load pursuant to the twenty-fourth VCM stipulation described in Note 2 to the financial statements under "Georgia Power – Nuclear Construction – Regulatory Matters."Georgia Power and the other Vogtle Owners do not agree on the starting dollar amount for the determination of cost increases subject to the cost-sharing and tender provisions of the Global Amendments (as defined in Note 2 to the financial statements under Georgia Power – Nuclear Construction – Joint Owner Contracts"). The other Vogtle Owners notified Georgia Power that they believe the project capital cost forecast approved by the Vogtle Owners on February 14, 2022 triggered the tender provisions.On June 17, 2022 and July 26, 2022, OPC and Dalton, respectively, notified Georgia Power of their purported exercises of their tender options. Georgia Power did not accept these purported tender exercises. On June 18, 2022, OPC and MEAG Power each filed a separate lawsuit against Georgia Power in the Superior Court of Fulton County, Georgia seeking a declaratory judgment that the starting dollar amount is $17.1 billion and that the cost-sharing and tender provisions have been triggered. On July 25, 2022 and July 28, 2022, Georgia Power filed its answers in the lawsuits filed by MEAG Power and OPC, respectively, and included counterclaims seeking a declaratory judgment that the starting dollar amount is $18.38 billion and that costs related to force majeure events are excluded prior to calculating the cost-sharing and tender provisions and when calculating Georgia Power's related financial obligations. On September 26, 2022, Dalton filed complaints in each of these lawsuits.On September 29, 2022, Georgia Power and MEAG Power reached an agreement to resolve their dispute regarding the proper interpretation of the cost-sharing and tender provisions of the Global Amendments. Under the terms of the agreement, among other items, (i) MEAG Power will not exercise its tender option and will retain its full ownership interest in Plant Vogtle Units 3 and 4; (ii) Georgia Power will reimburse a portion of MEAG Power's costs of construction for Plant Vogtle Units 3 and 4 as such costs are incurred and with no further adjustment for force majeure costs, which payments will total approximately $92 million based on the current project capital cost forecast; and (iii) Georgia Power will reimburse 20% of MEAG Power's costs of construction with respect to any amounts over the current project capital cost forecast, with no further adjustment for force majeure costs. On October 4, 2022, MEAG Power and Georgia Power filed a notice of settlement and voluntary dismissal of the pending litigation described above, including Georgia Power's counterclaim, and, on October 6, 2022, Dalton dismissed its related complaint. Georgia Power recorded pre-tax charges (credits) to income in the fourth quarter 2021, the second quarter 2022, the third quarter 2022, and the fourth quarter 2022 of approximately $440 million ($328 million after tax), $16 million ($12 million after tax), $(102) million ($(76) million after tax), and $53 million ($40 million after tax), respectively, associated with the cost-sharing and tender provisions of the Global Amendments, including the settlement with MEAG Power. A total of $407 million associated with these provisions is included in the total project capital cost forecast and will not be recovered from retail customers. The settlement with MEAG Power does not resolve the separate pending litigation with OPC, including Dalton's associated complaint, described above. Georgia Power may be required to record further pre-tax charges to income of up to approximately $345 million associated with the cost-sharing and tender provisions of the Global Amendments for OPC and Dalton based on the current project capital cost forecast.Georgia Power's ownership interest in Plant Vogtle Units 3 and 4 continues to be 45.7%. Georgia Power believes the increases in the total project capital cost forecast through December 31, 2022 will trigger the tender provisions, but Georgia Power disagrees with OPC and Dalton on the tender provisions trigger date. Valid notices of tender from OPC and Dalton would require Georgia Power to pay 100% of their respective remaining shares of the costs necessary to complete Plant Vogtle Units 3 and 4. Georgia Power's incremental ownership interest will be calculated and conveyed to Georgia Power after Plant Vogtle Units 3 and 4 are placed in service.The ultimate impact of these matters on the construction schedule and project capital cost forecast and related cost recovery for Plant Vogtle Units 3 and 4 cannot be determined at this time. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" for additional information.2022 ARPOn December 20, 2022, the Georgia PSC voted to approve the 2022 ARP, including estimated net rate increases totaling $216 million, $377 million, and $403 million effective January 1, 2023, January 1, 2024, and January 1, 2025, respectively. See Note 2 to the financial statements under "Georgia Power – Rate Plans – 2022 ARP" for additional information.Integrated Resource PlansOn July 21, 2022, the Georgia PSC approved Georgia Power's triennial IRP (2022 IRP), as modified by a stipulated agreement among Georgia Power, the staff of the Georgia PSC, and certain intervenors and as further modified by the Georgia PSC. In the 2022 IRP decision, the Georgia PSC approved several requests, including the following:•Decertification and retirement of Plant Wansley Units 1 and 2 (926 MWs based on 53.5% ownership), which occurred on August 31, 2022, and Plant Scherer Unit 3 (614 MWs based on 75% ownership) by December 31, 2028, as well as the II-5 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISreclassification to regulatory asset accounts of the remaining net book values of these units and any remaining unusable materials and supplies inventories upon retirement.•Decertification and retirement of Plant Gaston Units 1 through 4 (500 MWs based on 50% ownership through SEGCO) by December 31, 2028. See Note 7 to the financial statements under "SEGCO" for additional information.•Georgia Power's environmental compliance strategy, including approval of Georgia Power's plans to address CCR at its ash ponds and landfills.The Georgia PSC deferred a decision on the requested decertification and retirement of Plant Bowen Units 1 and 2 (1,400 MWs) to the 2025 IRP.See Note 2 to the financial statements under "Georgia Power – Integrated Resource Plans" for additional information.Mississippi PowerOn June 7, 2022, the Mississippi PSC approved Mississippi Power's annual retail PEP filing for 2022, resulting in an annual increase in revenues of approximately $18 million, or 1.9%, effective with the first billing cycle of April 2022.On August 26, 2022, the FERC accepted an amended shared service agreement (SSA) between Mississippi Power and Cooperative Energy, effective July 1, 2022, under which Cooperative Energy will continue to decrease its use of Mississippi Power's generation services under the MRA tariff up to 2.5% annually through 2035. At December 31, 2022, Mississippi Power is serving approximately 400 MWs of Cooperative Energy's annual demand. Beginning in 2036, Cooperative Energy will provide 100% of its electricity requirements at the MRA delivery points under the tariff. Neither party has the option to cancel the amended SSA. Mississippi Power expects to remarket this capacity, including the potential development of future arrangements with Cooperative Energy.On July 15, 2022, Mississippi Power filed a request with the FERC for a $23 million increase in annual wholesale base revenues under the MRA tariff. Cooperative Energy filed a complaint with the FERC challenging the new rates. On September 13, 2022, the FERC issued an order that accepted Mississippi Power's request effective September 14, 2022, subject to refund, and established hearing and settlement judge procedures. The ultimate outcome of this matter cannot be determined at this time.On November 15, 2022, Mississippi Power filed a request with the Mississippi PSC to increase retail fuel revenues by $25 million annually effective with the first billing cycle of February 2023 and an additional $25 million annually effective with the first billing cycle of June 2023. On January 10, 2023, the Mississippi PSC voted to defer approval of the filing. Mississippi Power is allowed to maintain current billing rates and continue accruing its weighted-average cost of capital on any under or over fuel recovery balance. The ultimate outcome of this matter cannot be determined at this time.On December 6, 2022, the Mississippi PSC approved an accounting order authorizing Mississippi Power to create a reliability reserve for the purpose of deferring generation, transmission, and distribution reliability-related expenditures for use in a future year, under certain conditions. At December 31, 2022, Mississippi Power accrued $25 million to the reliability reserve.See Note 2 to the financial statements under "Mississippi Power" for additional information.Southern PowerDuring 2022, Southern Power completed construction of and placed in service the remaining 40 MWs of the Tranquillity battery energy storage facility (72 MWs total) and the remaining 15 MWs of the Garland battery energy storage facility (88 MWs total).Southern Power calculates an investment coverage ratio for its generating assets, including those owned with various partners, based on the ratio of investment under contract to total investment using the respective facilities' net book value (or expected in-service value for facilities under construction) as the investment amount. With the inclusion of investments associated with facilities under construction, as well as other capacity and energy contracts, Southern Power's average investment coverage ratio at December 31, 2022 was 96% through 2027 and 90% through 2032, with an average remaining contract duration of approximately 12 years.See Note 15 to the financial statements under "Southern Power" for additional information.Southern Company GasOn August 1, 2022, Virginia Natural Gas filed a general base rate case with the Virginia Commission seeking an increase in annual base rate revenues of $69 million, including $15 million related to the recovery of investments under the SAVE program, primarily to recover investments and increased costs associated with infrastructure, technology, and workforce development. The requested increase is based on a projected 12-month period beginning January 1, 2023, a ROE of 10.35%, and an equity ratio of II-6 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSIS53.2%. Rate adjustments became effective January 1, 2023, subject to refund. The Virginia Commission is expected to rule on the requested increase in the third quarter 2023. The ultimate outcome of this matter cannot be determined at this time.On September 7, 2022, certain affiliates of Southern Company Gas entered into agreements to sell two natural gas storage facilities located in California and Texas for an aggregate purchase price of $186 million, plus working capital and certain other adjustments. The sale of the Texas facility was completed on November 18, 2022 and completion of the sale of the California facility is expected later in 2023. The ultimate outcome of this matter cannot be determined at this time. Southern Company Gas recorded pre-tax impairment charges totaling approximately $131 million ($99 million after tax) in the fourth quarter 2022 related to the facilities. See Note 15 to the financial statements under "Southern Company Gas" for additional information.On December 20, 2022, the Georgia PSC approved Atlanta Gas Light's annual GRAM filing, which resulted in an annual rate increase of $53 million effective January 1, 2023.On January 3, 2023, Nicor Gas filed a general base rate case with the Illinois Commission requesting a $321 million increase in annual base rate revenues, including $59 million related to the recovery of investments under the Investing in Illinois program through December 31, 2023. The requested increase is based on a projected test year for the 12-month period ending December 31, 2024, a return on equity of 10.35%, and an equity ratio of 54.5%. Further, Nicor Gas is seeking to recover an additional $32 million under three proposed riders related to recovery of vehicle fuel costs, company use gas, and customer payment fees. The Illinois Commission is expected to rule on the requested increase within the 11-month statutory time limit, after which rate adjustments will be effective. The ultimate outcome of this matter cannot be determined at this time.Key Performance IndicatorsIn striving to achieve attractive risk-adjusted returns while providing cost-effective energy to approximately 8.8 million electric and gas utility customers collectively, the traditional electric operating companies and Southern Company Gas continue to focus on several key performance indicators. These indicators include, but are not limited to, customer satisfaction, plant availability, electric and natural gas system reliability, and execution of major construction projects. In addition, Southern Company and the Subsidiary Registrants focus on earnings per share (EPS) and net income, respectively, as a key performance indicator. See RESULTS OF OPERATIONS herein for information on the Registrants' financial performance. See RESULTS OF OPERATIONS – "Southern Company Gas – Operating Metrics" for additional information on Southern Company Gas' operating metrics, including Heating Degree Days, customer count, and volumes of natural gas sold.The financial success of the traditional electric operating companies and Southern Company Gas is directly tied to customer satisfaction. Key elements of ensuring customer satisfaction include outstanding service, high reliability, and competitive prices. The traditional electric operating companies use customer satisfaction surveys to evaluate their results and generally target the top quartile of these surveys in measuring performance. Reliability indicators are also used to evaluate results. See Note 2 to the financial statements under "Alabama Power – Rate RSE" and "Mississippi Power – Performance Evaluation Plan" for additional information on Alabama Power's Rate RSE and Mississippi Power's PEP rate plan, respectively, both of which contain mechanisms that directly tie customer service indicators to the allowed equity return.Southern Power continues to focus on several key performance indicators, including, but not limited to, the equivalent forced outage rate and contract availability to evaluate operating results and help ensure its ability to meet its contractual commitments to customers.RESULTS OF OPERATIONSSouthern CompanyConsolidated net income attributable to Southern Company was $3.5 billion in 2022, an increase of $1.1 billion, or 47.3%, from 2021. The increase was primarily due to a $1.1 billion decrease in after-tax charges related to the construction of Plant Vogtle Units 3 and 4, increases in retail electric revenues associated with rates and pricing, warmer weather, primarily in the second quarter 2022, and sales growth, and increases in natural gas revenues from base rate increases and continued infrastructure replacement, partially offset by higher non-fuel operations and maintenance costs and higher interest expense. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" for additional information.Basic EPS was $3.28 in 2022 and $2.26 in 2021. Diluted EPS, which factors in additional shares related to stock-based compensation, was $3.26 in 2022 and $2.24 in 2021. EPS for 2022 and 2021 was negatively impacted by $0.04 and $0.01 per share, respectively, as a result of increases in the average shares outstanding. See Note 8 to the financial statements under "Outstanding Classes of Capital Stock – Southern Company" for additional information.Dividends paid per share of common stock were $2.70 in 2022 and $2.62 in 2021. In January 2023, Southern Company declared a quarterly dividend of 68 cents per share. For 2022, the dividend payout ratio was 82% compared to 116% for 2021.II-7 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISDiscussion of Southern Company's results of operations is divided into three parts – the Southern Company system's primary business of electricity sales, its gas business, and its other business activities.20222021(in millions)Electricity business$3,672 $2,247 Gas business572 539 Other business activities(720)(393)Net Income$3,524 $2,393 Electricity BusinessSouthern Company's electric utilities generate and sell electricity to retail and wholesale customers. A condensed statement of income for the electricity business follows: 2022Increase (Decrease) from 2021 (in millions)Electric operating revenues$22,873 $4,573 Fuel6,835 2,825 Purchased power1,593 615 Cost of other sales114 5 Other operations and maintenance5,268 459 Depreciation and amortization3,029 76 Taxes other than income taxes1,125 63 Estimated loss on Plant Vogtle Units 3 and 4183 (1,509)Impairment charges— (2)Gain on dispositions, net(39)20 Total electric operating expenses18,108 2,552 Operating income4,765 2,021 Allowance for equity funds used during construction210 31 Interest expense, net of amounts capitalized1,067 99 Other income (expense), net516 89 Income taxes848 629 Net income3,576 1,413 Less:Dividends on preferred stock of subsidiaries11 (4)Net loss attributable to noncontrolling interests(107)(8)Net Income Attributable to Southern Company$3,672 $1,425 II-8 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISElectric Operating RevenuesElectric operating revenues for 2022 were $22.9 billion, reflecting a $4.6 billion, or 25.0%, increase from 2021. Details of electric operating revenues were as follows: 20222021 (in millions)Retail electric — prior year$14,852 Estimated change resulting from —Rates and pricing451 Sales growth165 Weather244 Fuel and other cost recovery2,485 Retail electric — current year$18,197 $14,852 Wholesale electric revenues3,641 2,455 Other electric revenues747 718 Other revenues288 275 Electric operating revenues$22,873 $18,300 Retail electric revenues increased $3.3 billion, or 22.5%, in 2022 as compared to 2021. The significant factors driving this change are shown in the preceding table. The increase in rates and pricing in 2022 was primarily due to increases at Georgia Power resulting from higher contributions by commercial and industrial customers with variable demand-driven pricing, base tariff increases in accordance with the 2019 ARP, and pricing effects associated with customer usage. In addition, Alabama Power made a larger Rate RSE customer refund in 2021. These increases were partially offset by revenue reductions resulting from Georgia Power's retail ROE exceeding the allowed retail ROE range in 2022.Electric rates for the traditional electric operating companies include provisions to adjust billings for fluctuations in fuel costs, including the energy component of purchased power costs. Under these provisions, fuel revenues generally equal fuel expenses, including the energy component of PPA costs, and do not affect net income. The traditional electric operating companies each have one or more regulatory mechanisms to recover other costs such as environmental and other compliance costs, storm damage, new plants, and PPA capacity costs.See Note 2 to the financial statements under "Alabama Power" and "Georgia Power" for additional information. Also see "Energy Sales" herein for a discussion of changes in the volume of energy sold, including changes related to sales growth (decline) and weather.Wholesale electric revenues from power sales were as follows:20222021 (in millions)Capacity and other$625 $550 Energy3,016 1,905Total$3,641 $2,455 In 2022, wholesale electric revenues increased $1.2 billion, or 48.3%, as compared to 2021 due to increases of $1.1 billion in energy revenues and $75 million in capacity revenues. Energy revenues increased $744 million at Southern Power primarily due to fuel and purchased power increases compared to 2021 and an increase in the volume of KWHs sold primarily associated with natural gas PPAs. Energy revenues increased $367 million at the traditional electric operating companies primarily due to higher natural gas and coal prices. The increase in capacity revenues was primarily due to a net increase in natural gas PPAs at Southern Power and increased opportunity sales at Alabama Power due to warmer weather.Wholesale electric revenues consist of revenues from PPAs and short-term opportunity sales. Wholesale electric revenues from PPAs (other than solar and wind PPAs) have both capacity and energy components. Capacity revenues generally represent the greatest contribution to net income and are designed to provide recovery of fixed costs plus a return on investment. Energy revenues will vary depending on fuel prices, the market prices of wholesale energy compared to the Southern Company system's generation, demand for energy within the Southern Company system's electric service territory, and the availability of the Southern Company system's generation. Increases and decreases in energy revenues that are driven by fuel prices are II-9 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISaccompanied by an increase or decrease in fuel costs and do not have a significant impact on net income. Energy sales from solar and wind PPAs do not have a capacity charge and customers either purchase the energy output of a dedicated renewable facility through an energy charge or through a fixed price related to the energy. As a result, the ability to recover fixed and variable operations and maintenance expenses is dependent upon the level of energy generated from these facilities, which can be impacted by weather conditions, equipment performance, transmission constraints, and other factors. Wholesale electric revenues at Mississippi Power include FERC-regulated MRA sales under cost-based tariffs as well as market-based sales. Short-term opportunity sales are made at market-based rates that generally provide a margin above the Southern Company system's variable cost to produce the energy.Other Electric RevenuesOther electric revenues increased $29 million, or 4.0%, in 2022 as compared to 2021. The increase was primarily due to increases of $54 million in transmission revenues primarily associated with open access transmission tariff sales, $18 million in outdoor lighting sales at Georgia Power, $13 million in cogeneration steam revenues associated with higher natural gas prices at Alabama Power, and $11 million in rent revenues at the traditional electric operating companies, partially offset by a decrease of $32 million resulting from the termination of a transmission service contract, an increase of $18 million in realized losses associated with price stability products for retail customers on variable demand-driven pricing tariffs, and a decrease of $17 million from retail solar programs as a result of higher avoided cost credits to customers, all at Georgia Power.Energy SalesChanges in revenues are influenced heavily by the change in the volume of energy sold from year to year. KWH sales for 2022 and the percent change from 2021 were as follows:2022TotalKWHsTotal KWHPercent ChangeWeather-AdjustedPercent Change(*)(in billions)Residential49.6 4.8 %0.2 %Commercial48.3 3.5 2.0 Industrial49.5 1.5 1.5 Other0.6 (4.8)(4.8)Total retail148.0 3.2 1.2 %Wholesale56.3 12.6 Total energy sales204.3 5.6 %(*)Weather-adjusted KWH sales are estimated using statistical models of the historical relationship between temperatures and energy sales, and then removing the estimated effect of deviations from normal temperature conditions. Normal temperature conditions are defined as those experienced in the applicable service territory over a specified historical period. This metric is useful because it allows trends in historical operations to be evaluated apart from the influence of weather conditions. Management also considers this metric in developing long-term capital and financial plans.Changes in retail energy sales are generally the result of changes in electricity usage by customers, weather, and the number of customers. Weather-adjusted retail energy sales increased 1.8 billion KWHs in 2022 as compared to 2021. Weather-adjusted residential KWH sales and weather-adjusted commercial KWH sales increased 0.2% and 2.0%, respectively, in 2022 when compared to 2021 largely due to customer growth. In addition, commercial customer usage increased and residential customer usage decreased in 2022 when compared to 2021 as customers returned to pre-pandemic levels of activity outside the home. Industrial KWH sales increased 1.5% in 2022 when compared to 2021 primarily due to increases in the pipeline and paper sectors, partially offset by a decrease in the chemicals sector.See "Electric Operating Revenues" above for a discussion of significant changes in wholesale revenues related to changes in price and KWH sales.Other RevenuesOther revenues increased $13 million, or 4.7%, in 2022 as compared to 2021. The increase was primarily due to increases of $10 million in unregulated lighting sales at Alabama Power and $7 million associated with energy conservation projects at Georgia Power.II-10 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISFuel and Purchased Power ExpensesThe mix of fuel sources for the generation of electricity is determined primarily by demand, the unit cost of fuel consumed, and the availability of generating units. Additionally, the electric utilities purchase a portion of their electricity needs from the wholesale market.Details of the Southern Company system's generation and purchased power were as follows:20222021Total generation (in billions of KWHs)(a)186 179 Total purchased power (in billions of KWHs)25 18 Sources of generation (percent) —Gas51 48 Coal22 22 Nuclear16 18 Hydro3 4 Wind, Solar, and Other8 8 Cost of fuel, generated (in cents per net KWH) —Gas(a)5.29 3.07 Coal3.67 2.85 Nuclear0.72 0.75 Average cost of fuel, generated (in cents per net KWH)(a)4.05 2.55 Average cost of purchased power (in cents per net KWH)(b)7.66 5.85 (a)Excludes Central Alabama Generating Station KWHs and associated cost of fuel through July 12, 2022 as its fuel was previously provided by the purchaser under a power sales agreement. See Note 15 to the financial statements under "Alabama Power" for additional information.(b)Average cost of purchased power includes fuel purchased by the Southern Company system for tolling agreements where power is generated by the provider.In 2022, total fuel and purchased power expenses were $8.4 billion, an increase of $3.4 billion, or 69.0%, as compared to 2021. The increase was primarily the result of a $2.8 billion increase in the average cost of fuel generated and purchased and a $653 million increase in the volume of KWHs generated and purchased.Fuel and purchased power energy transactions at the traditional electric operating companies are generally offset by fuel revenues and do not have a significant impact on net income. See Note 2 to the financial statements for additional information. Fuel expenses incurred under Southern Power's PPAs are generally the responsibility of the counterparties and do not significantly impact net income.FuelIn 2022, fuel expense was $6.8 billion, an increase of $2.8 billion, or 70.4%, as compared to 2021. The increase was primarily due to a 72.3% increase in the average cost of natural gas per KWH generated, a 28.8% increase in the average cost of coal per KWH generated, an 11.1% decrease in the volume of KWHs generated by hydro, and a 9.0% increase in the volume of KWHs generated by natural gas.Purchased PowerIn 2022, purchased power expense was $1.6 billion, an increase of $615 million, or 62.9%, as compared to 2021. The increase was primarily due to a 38.2% increase in the volume of KWHs purchased and a 30.9% increase in the average cost per KWH purchased primarily due to higher natural gas and coal prices.Energy purchases will vary depending on demand for energy within the Southern Company system's electric service territory, the market prices of wholesale energy as compared to the cost of the Southern Company system's generation, and the availability of the Southern Company system's generation.Other Operations and Maintenance ExpensesOther operations and maintenance expenses increased $459 million, or 9.5%, in 2022 as compared to 2021. The increase was primarily associated with increases of $247 million in transmission and distribution expenses, $95 million in generation expenses primarily related to scheduled outage and maintenance costs, $25 million for a reliability reserve accrual in 2022 at Mississippi II-11 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISPower, and $22 million in amortization of cloud software. The transmission and distribution increase was primarily due to increased line maintenance, as well as the net impact of Alabama Power accruals of $166 million to the reliability reserve in 2022 and an incremental $65 million to the NDR in 2021. See Note 1 to the financial statements under "Storm Damage and Reliability Reserves" for additional information.Depreciation and AmortizationDepreciation and amortization increased $76 million, or 2.6%, in 2022 as compared to 2021. The increase was primarily due to additional plant in service.Taxes Other Than Income TaxesTaxes other than income taxes increased $63 million, or 5.9%, in 2022 as compared to 2021. The increase primarily reflects an increase in municipal franchise fees associated with higher retail revenues at Georgia Power.Estimated Loss on Plant Vogtle Units 3 and 4Georgia Power recorded pre-tax charges to income for the estimated probable loss on Plant Vogtle Units 3 and 4 totaling $183 million and $1.7 billion in 2022 and 2021, respectively. The charges to income in each year were recorded to reflect Georgia Power's revised total project capital cost forecast to complete construction and start-up of Plant Vogtle Units 3 and 4. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" for additional information.Gain on Dispositions, NetGain on dispositions, net decreased $20 million, or 33.9%, in 2022 as compared to 2021 primarily due to a net decrease of $39 million in gains at Southern Power related to contributions of wind turbine equipment to various equity method investments in 2021, partially offset by $17 million in gains from sales of integrated transmission system assets at Georgia Power in 2022. See Notes 7 and 15 to the financial statements under "Southern Power" for additional information.Allowance for Equity Funds Used During ConstructionAllowance for equity funds used during construction increased $31 million, or 17.3%, in 2022 as compared to 2021. The increase was primarily associated with an increase in capital expenditures related to Plant Barry Unit 8 construction at Alabama Power and an increase in capital expenditures subject to AFUDC at Georgia Power. See Note 2 to the financial statements under "Alabama Power – Certificates of Convenience and Necessity" for additional information.Interest Expense, Net of Amounts CapitalizedInterest expense, net of amounts capitalized increased $99 million, or 10.2%, in 2022 as compared to 2021. The increase reflects approximately $54 million related to higher average outstanding borrowings and $43 million related to higher interest rates. See Note 8 to the financial statements for additional information.Other Income (Expense), NetOther income (expense), net increased $89 million, or 20.8%, in 2022 as compared to 2021 primarily due to a $68 million increase in non-service cost-related retirement benefits income and a $23 million increase in interest income, partially offset by a $33 million increase in charitable donations at the traditional electric operating companies. See Note 11 to the financial statements for additional information.Income TaxesIncome taxes increased $629 million in 2022 as compared to 2021. The increase was primarily due to higher pre-tax earnings largely resulting from a decrease in charges associated with the construction of Plant Vogtle Units 3 and 4 and an increase in a valuation allowance and other adjustments related to certain state tax credit carryforwards at Georgia Power. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" and Note 10 to the financial statements for additional information.Net Loss Attributable to Noncontrolling InterestsSubstantially all noncontrolling interests relate to renewable projects at Southern Power. Net loss attributable to noncontrolling interests increased $8 million, or 8.1%, in 2022 as compared to 2021. The increased loss was primarily due to $28 million in higher HLBV loss allocations to Southern Power's tax equity partners in 2022, largely offset by $23 million in loss allocations associated with the Garland and Tranquillity battery energy storage facilities being placed in service in 2021. See Notes 9 and 15 to the financial statements under "Lessor" and "Southern Power," respectively, for additional information.II-12 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISGas BusinessSouthern Company Gas distributes natural gas through utilities in four states and is involved in several other complementary businesses including gas pipeline investments, wholesale gas services (until the sale of Sequent on July 1, 2021), and gas marketing services.A condensed statement of income for the gas business follows: 2022Increase (Decrease) from 2021 (in millions)Operating revenues$5,962 $1,582 Cost of natural gas3,004 1,385 Other operations and maintenance1,176 104 Depreciation and amortization559 23 Taxes other than income taxes282 57 Impairment charges131 131 Gain on dispositions, net(4)123 Total operating expenses5,148 1,823 Operating income814 (241)Earnings from equity method investments148 98 Interest expense, net of amounts capitalized263 25 Other income (expense), net53 106 Income taxes180 (95)Net income$572 $33 Seasonality of ResultsDuring the period from November through March when natural gas usage and operating revenues are generally higher (Heating Season), more customers are connected to Southern Company Gas' distribution systems and natural gas usage is higher in periods of colder weather. Prior to the sale of Sequent, wholesale gas services' operating revenues were occasionally impacted due to peak usage by power generators in response to summer energy demands. Southern Company Gas' base operating expenses, excluding cost of natural gas, bad debt expense, and certain incentive compensation costs, are incurred relatively equally over any given year. Thus, operating results can vary significantly from quarter to quarter as a result of seasonality. For 2022, the percentage of operating revenues and net income generated during the Heating Season (January through March and November through December) were 67% and 66%, respectively. For 2021, the percentage of operating revenues and net income generated during the Heating Season were 70% and 102%, respectively.II-13 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISOperating RevenuesOperating revenues in 2022 were $6.0 billion, reflecting a $1.6 billion, or 36.1%, increase compared to 2021. Details of operating revenues were as follows:2022(in millions)Operating revenues – prior year$4,380 Estimated change resulting from –Infrastructure replacement programs and base rate changes252 Gas costs and other cost recovery1,468 Gas marketing services15 Wholesale gas services(187)Other34 Operating revenues – current year$5,962 Revenues at the natural gas distribution utilities increased in 2022 compared to 2021 due to rate increases at Nicor Gas, Atlanta Gas Light, and Chattanooga Gas and continued investment in infrastructure replacement. See Note 2 to the financial statements under "Southern Company Gas" for additional information.Revenues associated with gas costs and other cost recovery increased in 2022 compared to 2021 primarily due to higher natural gas cost recovery as a result of higher volumes of natural gas sold and an increase in natural gas prices. The natural gas distribution utilities have weather or revenue normalization mechanisms that mitigate revenue fluctuations from customer consumption changes. Natural gas distribution rates include provisions to adjust billings for fluctuations in natural gas costs. Therefore, gas costs recovered through natural gas revenues generally equal the amount expensed in cost of natural gas and do not affect net income from the natural gas distribution utilities. See "Cost of Natural Gas" herein for additional information.The change in 2022 revenues related to wholesale gas services was due to the sale of Sequent on July 1, 2021. See Note 15 to the financial statements under "Southern Company Gas" for additional information.Southern Company Gas hedged its exposure to warmer-than-normal weather in Illinois for gas distribution operations and in Illinois and Georgia for gas marketing services. The remaining impacts of weather on earnings were immaterial.Cost of Natural GasExcluding Atlanta Gas Light, which does not sell natural gas to end-use customers, the natural gas distribution utilities rates include provisions to adjust billings for fluctuations in natural gas costs. Therefore, gas costs recovered through natural gas revenues generally equal the amount expensed in cost of natural gas and do not affect net income from the natural gas distribution utilities. See Note 2 to the financial statements under "Southern Company Gas – Natural Gas Cost Recovery" for additional information. Cost of natural gas at the natural gas distribution utilities represented 87.5% of the total cost of natural gas for 2022.Gas marketing services customers are charged for actual and estimated natural gas consumed. Cost of natural gas includes the cost of fuel and associated transportation costs, lost and unaccounted for gas, adjustments to reduce the value of inventories to market value, if applicable, and gains and losses associated with certain derivatives.Cost of natural gas was $3.0 billion, an increase of $1.4 billion, or 85.5%, in 2022 compared to 2021, which reflects higher gas cost recovery in 2022 as a result of higher volumes sold and a 73.0% increase in natural gas prices compared to 2021.Other Operations and Maintenance ExpensesOther operations and maintenance expenses increased $104 million, or 9.7%, in 2022 compared to 2021. Excluding $66 million of expenses related to Sequent in 2021, other operations and maintenance expenses increased approximately $174 million. The increase was primarily due to increases of $64 million in compensation and benefit expenses, $43 million in expenses passed through directly to customers primarily related to bad debt at the natural gas distribution utilities, $31 million primarily related to bad debt, customer service, and sales expenses, and $18 million primarily related to pipeline compliance.II-14 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISDepreciation and AmortizationDepreciation and amortization increased $23 million, or 4.3%, in 2022 compared to 2021. The increase was primarily due to continued infrastructure investments at the natural gas distribution utilities. See Note 2 to the financial statements under "Southern Company Gas – Infrastructure Replacement Programs and Capital Projects" for additional information.Taxes Other Than Income TaxesTaxes other than income taxes increased $57 million, or 25.3%, in 2022 compared to 2021. The increase was primarily due to a $39 million increase in revenue tax expenses as a result of higher natural gas revenues and an $11 million increase in invested capital tax expense at Nicor Gas. Revenue tax expenses are passed through directly to customers and have no impact on net income.Impairment ChargesIn 2022, Southern Company Gas recorded pre-tax impairment charges totaling approximately $131 million ($99 million after tax) as a result of an agreement to sell two natural gas storage facilities. See Note 15 to the financial statements under "Southern Company Gas" for additional information.Gain on Dispositions, NetIn 2021, Southern Company Gas recorded a $121 million gain on the sale of Sequent. See Note 15 to the financial statements under "Southern Company Gas" for additional information.Earnings from Equity Method InvestmentsEarnings from equity method investments increased $98 million in 2022 compared to 2021. The increase was primarily due to pre-tax impairment charges totaling $84 million in 2021 related to the PennEast Pipeline project and higher earnings at SNG resulting from higher revenues primarily due to increased demand. See Note 7 to the financial statements under "Southern Company Gas" for additional information.Interest Expense, Net of Amounts CapitalizedInterest expense, net of amounts capitalized increased $25 million, or 10.5%, in 2022 compared to 2021. The increase reflects approximately $16 million related to higher average outstanding borrowings and $8 million related to higher interest rates. See Note 8 to the financial statements for additional information.Other Income (Expense), NetOther income (expense), net increased $106 million in 2022 compared to 2021. The increase was largely due to charitable contributions by Sequent prior to its sale totaling $101 million in 2021 and an increase of $10 million primarily related to non-service cost-related retirement benefits income. See Note 11 to the financial statements under "Southern Company Gas" for additional information.Income TaxesIncome taxes decreased $95 million, or 34.5%, in 2022 compared to 2021. The decrease was primarily due to additional tax benefit of $110 million resulting from the sale of Sequent in 2021 and $32 million as a result of the impairment related to the agreement to sell two natural gas storage facilities in 2022. The decrease was partially offset by $17 million of tax benefits in 2021 resulting from the impairment charge related to the PennEast Pipeline project and higher pre-tax earnings in 2022. See Notes 7 and 15 to the financial statements under "Southern Company Gas" and Note 10 to the financial statements for additional information.Other Business ActivitiesSouthern Company's other business activities primarily include the parent company (which does not allocate operating expenses to business units); PowerSecure, which provides distributed energy and resilience solutions and deploys microgrids for commercial, industrial, governmental, and utility customers; Southern Holdings, which invests in various projects; and Southern Linc, which provides digital wireless communications for use by the Southern Company system and also markets these services to the public and provides fiber optics services within the Southeast.II-15 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISA condensed statement of operations for Southern Company's other business activities follows:2022Increase (Decrease) from 2021(in millions)Operating revenues$444 $11 Cost of other sales268 19 Other operations and maintenance201 (6)Depreciation and amortization75 — Taxes other than income taxes4 — Impairment charges119 119 Gain on dispositions, net(14)(14)Total operating expenses653 118 Operating income (loss)(209)(107)Earnings from equity method investments3 (23)Interest expense692 61 Impairment of leveraged leases— (7)Other income (expense), net(55)(149)Income taxes (benefit)(233)(6)Net loss$(720)$(327)Cost of Other SalesCost of other sales for these other business activities increased $19 million, or 7.6%, in 2022 as compared to 2021 primarily due to distributed infrastructure projects at PowerSecure.Impairment ChargesIn 2022, a goodwill impairment charge of $119 million was recorded at PowerSecure. See Note 1 to the financial statements under "Goodwill and Other Intangible Assets and Liabilities" for additional information.Gain on Dispositions, NetIn 2022, a $14 million gain was recorded at the parent company as a result of the early termination of the transition services agreement related to the 2019 sale of Gulf Power.Earnings from Equity Method InvestmentsEarnings from equity method investments for these other business activities decreased $23 million, or 88.5%, in 2022 as compared to 2021 primarily due to a decrease in investment income at Southern Holdings.Interest ExpenseInterest expense for these other business activities increased $61 million, or 9.7%, in 2022 as compared to 2021. The increase primarily results from parent company financing activities and includes approximately $52 million related to higher average outstanding borrowings, $15 million related to fair value hedge amortization, $11 million related to higher interest rates, and $7 million in fees associated with remarketing the 2019 Series A Equity Units (Equity Units), partially offset by a $23 million loss in 2021 associated with the extinguishment of debt. See Note 8 to the financial statements for additional information.Other Income (Expense), NetOther income (expense), net for these other business activities decreased $149 million in 2022 as compared to 2021 primarily due to a $93 million pre-tax gain ($99 million gain after tax) recorded at Southern Holdings in 2021 related to the termination of two leveraged leases and a $24 million decrease in leveraged lease income as a result of the terminations. See Note 15 to the financial statements under "Southern Company" for additional information.II-16 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISAlabama PowerAlabama Power's 2022 net income after dividends on preferred stock was $1.34 billion, representing a $102 million, or 8.2%, increase from 2021. The increase was primarily due to an increase in retail revenues associated with a larger Rate RSE customer refund in 2021, warmer weather in Alabama Power's service territory in 2022 compared to 2021, and sales growth. Also contributing to the increase in net income were increases in other operating revenues associated with transmission revenues and unregulated lighting sales, as well as an increase in AFUDC, partially offset by higher non-fuel operations and maintenance costs associated with a reliability reserve accrual and higher interest expense.A condensed income statement for Alabama Power follows:2022Increase(Decrease)from 2021(in millions)Operating revenues$7,817 $1,404 Fuel1,840 605 Purchased power801 433 Other operations and maintenance1,935 200 Depreciation and amortization875 16 Taxes other than income taxes424 14 Total operating expenses5,875 1,268 Operating income1,942 136 Allowance for equity funds used during construction70 18 Interest expense, net of amounts capitalized382 42 Other income (expense), net144 37 Income taxes423 51 Net income1,351 98 Dividends on preferred stock11 (4)Net income after dividends on preferred stock$1,340 $102 Operating RevenuesOperating revenues for 2022 were $7.8 billion, reflecting a $1.4 billion, or 21.9%, increase from 2021. Details of operating revenues were as follows:20222021(in millions)Retail — prior year$5,499 Estimated change resulting from —Rates and pricing138 Sales growth53 Weather100 Fuel and other cost recovery680 Retail — current year$6,470 $5,499 Wholesale revenues —Non-affiliates726 377 Affiliates202 171 Total wholesale revenues928 548 Other operating revenues419 366 Total operating revenues$7,817 $6,413 II-17 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISRetail revenues increased $971 million, or 17.7%, in 2022 as compared to 2021. The significant factors driving this change are shown in the preceding table. The increase was primarily due to an increase in fuel and other cost recovery, as well as an increase in revenue driven by a larger Rate RSE customer refund in 2021, warmer weather in 2022 compared to 2021, and sales growth in all major retail classes.See Note 2 to the financial statements under "Alabama Power – Rate ECR," " – Rate RSE," and " – Rate CNP Compliance" for additional information. See "Energy Sales" herein for a discussion of changes in the volume of energy sold, including changes related to sales growth and weather.Electric rates include provisions to recognize the recovery of fuel costs, purchased power costs, PPAs certificated by the Alabama PSC, and costs associated with the NDR. Under these provisions, fuel and other cost recovery revenues generally equal fuel and other cost recovery expenses and do not affect net income. See Note 2 to the financial statements under "Alabama Power" for additional information.Wholesale revenues from sales to non-affiliated utilities were as follows:20222021(in millions)Capacity and other$213 $173 Energy513 204 Total non-affiliated$726 $377 In 2022, wholesale revenues from sales to non-affiliates increased $349 million, or 92.6%, as compared to 2021 due to a $309 million increase in energy revenues primarily related to higher natural gas prices and a $40 million increase in capacity revenues primarily related to increased opportunity sales due to warmer weather in 2022 as compared to 2021.Wholesale revenues from sales to non-affiliates will vary depending on fuel prices, the market prices of wholesale energy compared to the cost of Alabama Power's and the Southern Company system's generation, demand for energy within the Southern Company system's electric service territory, and the availability of the Southern Company system's generation. Increases and decreases in energy revenues that are driven by fuel prices are accompanied by an increase or decrease in fuel costs and do not affect net income. Short-term opportunity energy sales are also included in wholesale energy sales to non-affiliates. These opportunity sales are made at market-based rates that generally provide a margin above Alabama Power's variable cost to produce the energy.In 2022, wholesale revenues from sales to affiliates increased $31 million, or 18.1%, as compared to 2021. The revenue increase reflects a 64.7% increase in the price of energy due to higher natural gas prices, partially offset by a 28.1% decrease in KWH sales due to the availability of lower cost Southern Company system resources compared to Alabama Power's generation.Wholesale revenues from sales to affiliated companies will vary depending on demand and the availability and cost of generating resources at each company. These affiliate sales and purchases are made in accordance with the IIC, as approved by the FERC. These transactions do not have a significant impact on earnings since this energy is generally sold at marginal cost and energy purchases are generally offset by energy revenues through Alabama Power's energy cost recovery clause.In 2022, other operating revenues increased $53 million, or 14.5%, as compared to 2021 primarily due to increases of $19 million in transmission revenues primarily due to open access transmission tariff sales, $13 million in cogeneration steam revenue associated with higher natural gas prices, $10 million in unregulated lighting sales, and $9 million in rent revenues.II-18 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISEnergy SalesChanges in revenues are influenced heavily by the change in the volume of energy sold from year to year. KWH sales for 2022 and the percent change from 2021 were as follows:2022TotalKWHsTotal KWHPercent ChangeWeather-AdjustedPercent Change(*)(in billions)Residential18.4 5.4 %0.1 %Commercial13.1 2.6 0.1 Industrial20.9 0.5 0.5 Other0.1 (10.1)(10.1)Total retail52.5 2.7 0.2 %Wholesale Non-affiliates12.7 29.1 Affiliates3.7 (28.1)Total wholesale16.4 9.3 Total energy sales68.9 4.2 %(*)Weather-adjusted KWH sales are estimated using statistical models of the historical relationship between temperatures and energy sales, and then removing the estimated effect of deviations from the normal temperature conditions. Normal temperature conditions are defined as those experienced in Alabama Power's service territory over a specified historical period. This metric is useful because it allows trends in historical operations to be evaluated apart from the influence of weather conditions. Management also considers this metric in developing long-term capital and financial plans.Changes in retail energy sales are generally the result of changes in electricity usage by customers, weather, and the number of customers. Revenues attributable to changes in sales increased in 2022 when compared to 2021. In 2022, weather-adjusted residential and commercial KWH sales were flat compared to 2021. Industrial KWH sales increased 0.5% as a result of an increase in demand resulting from changes in production levels primarily in the forest product and pipeline sectors.See "Operating Revenues" above for a discussion of significant changes in wholesale revenues from sales to non-affiliates and wholesale revenues from sales to affiliated companies related to changes in price and KWH sales.Fuel and Purchased Power ExpensesThe mix of fuel sources for generation of electricity is determined primarily by the unit cost of fuel consumed, demand, and the availability of generating units. Additionally, Alabama Power purchases a portion of its electricity needs from the wholesale market.II-19 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISDetails of Alabama Power's generation and purchased power were as follows:20222021Total generation (in billions of KWHs)(a)58.358.5 Total purchased power (in billions of KWHs)11.66.4 Sources of generation (percent)(a) —Coal46 46 Nuclear22 26 Gas24 19 Hydro8 9 Cost of fuel, generated (in cents per net KWH) —Coal3.39 2.77 Nuclear0.67 0.70 Gas(a)5.12 2.89 Average cost of fuel, generated (in cents per net KWH)(a)3.19 2.22 Average cost of purchased power (in cents per net KWH)(b)8.00 6.52 (a)Excludes Central Alabama Generating Station KWHs and associated cost of fuel through July 12, 2022 as its fuel was previously provided by the purchaser under a power sales agreement. See Note 15 to the financial statements under "Alabama Power" for additional information.(b)Average cost of purchased power includes fuel, energy, and transmission purchased by Alabama Power for tolling agreements where power is generated by the provider.Fuel and purchased power expenses were $2.6 billion in 2022, an increase of $1.0 billion, or 64.8%, compared to 2021. The increase was primarily due to a $648 million increase in the average cost of fuel and purchased power and a $390 million increase related to the volume of KWHs generated and purchased.Fuel and purchased power energy transactions do not have a significant impact on earnings, since energy expenses are generally offset by energy revenues through Alabama Power's energy cost recovery clause. Alabama Power, along with the Alabama PSC, continuously monitors the under/over recovered balance to determine whether adjustments to billing rates are required. See Note 2 to the financial statements under "Alabama Power – Rate ECR" for additional information.FuelFuel expense was $1.8 billion in 2022, an increase of $605 million, or 49.0%, compared to 2021. The increase was primarily due to a 77.2% increase in the average cost of natural gas per KWH generated, which excludes tolling agreements, a 22.4% increase in the average cost of coal per KWH generated, a 24.1% increase in the volume of KWHs generated by natural gas, and a 9.7% decrease in the volume of KWHs generated by hydro, partially offset by a 13.3% decrease in the volume of KWHs generated by nuclear as a result of the extension of a planned outage.Purchased Power – Non-AffiliatesPurchased power expense from non-affiliates was $441 million in 2022, an increase of $220 million, or 99.5%, compared to 2021. The increase was primarily due to a 90.8% increase in the volume of KWHs purchased as a result of higher weather-related demand in 2022 compared to 2021 and a 10.3% increase in the average cost per KWH purchased due to higher natural gas and coal prices.Energy purchases from non-affiliates will vary depending on the market prices of wholesale energy as compared to the cost of the Southern Company system's generation, demand for energy within the Southern Company system's electric service territory, and the availability of the Southern Company system's generation.Purchased Power – AffiliatesPurchased power expense from affiliates was $360 million in 2022, an increase of $213 million, or 144.9%, compared to 2021. The increase was primarily due to a 58.3% increase in the volume of KWHs purchased as a result of higher weather-related demand in 2022 compared to 2021 and a 54.4% increase in the average cost per KWH purchased due to higher natural gas and coal prices.II-20 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISEnergy purchases from affiliates will vary depending on demand for energy and the availability and cost of generating resources at each company within the Southern Company system. These purchases are made in accordance with the IIC or other contractual agreements, as approved by the FERC.Other Operations and Maintenance ExpensesOther operations and maintenance expenses increased $200 million, or 11.5%, in 2022 as compared to 2021. The increase was primarily due to increases of $147 million in transmission and distribution expenses primarily associated with a $166 million reliability reserve accrual in 2022, partially offset by an incremental $65 million NDR accrual in 2021, as well as other line maintenance, $33 million in generation expenses primarily associated with maintenance and Rate CNP Compliance-related expenses, and $17 million in customer accounts, customer service, and sales expenses primarily associated with labor and bad debt expense. See Note 2 to the financial statements under "Alabama Power – Reliability Reserve Accounting Order" and " – Rate CNP Compliance" for additional information.Depreciation and AmortizationDepreciation and amortization increased $16 million, or 1.9%, in 2022 as compared to 2021 primarily due to an increase of $28 million in depreciation related to an increase in additional plant in service, largely offset by a decrease of $16 million in amortization of regulatory assets associated with the retirement of certain generating plants.Allowance for Equity Funds Used During ConstructionAllowance for equity funds used during construction increased $18 million, or 34.6%, in 2022 as compared to 2021 primarily due to an increase in capital expenditures related to Plant Barry Unit 8 construction, as well as an increase in capital expenditures related to hydro production. See Note 2 to the financial statements under "Alabama Power – Certificates of Convenience and Necessity" for additional information.Interest Expense, Net of Amounts CapitalizedInterest expense, net of amounts capitalized increased $42 million, or 12.4%, in 2022 as compared to 2021. The increase reflects approximately $36 million related to higher average outstanding borrowings and $12 million related to higher interest rates. See Note 8 to the financial statements for additional information.Other Income (Expense), NetOther income (expense), net increased $37 million, or 34.6%, in 2022 as compared to 2021 primarily due to increases in interest income and non-service cost-related retirement benefits income. See Note 11 to the financial statements for additional information.Income Taxes Income taxes increased $51 million, or 13.7%, in 2022 as compared to 2021 primarily due to higher pre-tax earnings and a decrease in state tax credits. See Note 10 to the financial statements for additional information.Georgia PowerGeorgia Power's 2022 net income was $1.8 billion, representing a $1.2 billion, or 210.4%, increase from the previous year. The increase was primarily due to a $1.1 billion decrease in after-tax charges related to the construction of Plant Vogtle Units 3 and 4, as well as an increase in retail revenues associated with rates and pricing, warmer weather in Georgia Power's service territory compared to 2021, and sales growth. These increases were partially offset by higher non-fuel operations and maintenance costs. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" for additional information on the construction of Plant Vogtle Units 3 and 4.II-21 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISA condensed income statement for Georgia Power follows:2022Increase(Decrease)from 2021(in millions)Operating revenues$11,584 $2,324 Fuel2,486 1,037 Purchased power2,257 766 Other operations and maintenance2,349 136 Depreciation and amortization1,430 59 Taxes other than income taxes527 51 Estimated loss on Plant Vogtle Units 3 and 4183 (1,509)Total operating expenses9,232 540 Operating income2,352 1,784 Allowance for equity funds used during construction140 13 Interest expense, net of amounts capitalized485 64 Other income (expense), net176 34 Income taxes (benefit)370 538 Net income$1,813 $1,229 Operating RevenuesOperating revenues for 2022 were $11.6 billion, reflecting a $2.3 billion, or 25.1%, increase from 2021. Details of operating revenues were as follows:20222021(in millions)Retail — prior year$8,478 Estimated change resulting from —Rates and pricing288 Sales growth109 Weather130 Fuel cost recovery1,787 Retail — current year$10,792 $8,478 Wholesale revenues235 197 Other operating revenues557 585 Total operating revenues$11,584 $9,260 Retail revenues increased $2.3 billion, or 27.3%, in 2022 as compared to 2021. The significant factors driving this change are shown in the preceding table. The increase in rates and pricing was primarily due to higher contributions from commercial and industrial customers with variable demand-driven pricing, base tariff increases in accordance with the 2019 ARP, and pricing effects associated with customer usage, partially offset by revenue reductions resulting from Georgia Power's retail ROE exceeding the allowed retail ROE range in 2022. See Note 2 to the financial statements under "Georgia Power – Rate Plans – 2019 ARP" for additional information.See "Energy Sales" below for a discussion of changes in the volume of energy sold, including changes related to the sales growth in 2022.Electric rates include provisions to adjust billings for fluctuations in fuel costs, including the energy component of purchased power costs. Under these fuel cost recovery provisions, fuel revenues generally equal fuel expenses and do not affect net income. See Note 2 to the financial statements under "Georgia Power – Fuel Cost Recovery" for additional information.II-22 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISWholesale revenues from power sales were as follows:20222021(in millions)Capacity and other$48 $63 Energy187 134 Total $235 $197 In 2022, wholesale revenues increased $38 million, or 19.3%, as compared to 2021 largely due to an increase of $78 million related to the average cost of fuel primarily due to higher natural gas and coal prices, partially offset by a $27 million decrease in KWH sales associated with lower market demand and a $10 million decrease in capacity revenues due to the expiration of a non-affiliate PPA in 2021.Wholesale revenues from sales to non-affiliates consist of PPAs and short-term opportunity sales. Wholesale revenues from PPAs have both capacity and energy components. Wholesale capacity revenues from PPAs are recognized in amounts billable under the contract terms and provide for recovery of fixed costs and a return on investment. Wholesale revenues from sales to non-affiliates will vary depending on fuel prices, the market prices of wholesale energy compared to the cost of Georgia Power's and the Southern Company system's generation, demand for energy within the Southern Company system's electric service territory, and the availability of the Southern Company system's generation. Increases and decreases in energy revenues that are driven by fuel prices are accompanied by an increase or decrease in fuel costs and do not have a significant impact on net income. Short-term opportunity sales are made at market-based rates that generally provide a margin above Georgia Power's variable cost of energy.Wholesale revenues from sales to affiliated companies will vary depending on demand and the availability and cost of generating resources at each company. These affiliate sales are made in accordance with the IIC, as approved by the FERC. These transactions do not have a significant impact on earnings since this energy is generally sold at marginal cost.In 2022, other operating revenues decreased $28 million, or 4.8%, as compared to 2021 primarily due to a decrease of $32 million resulting from the termination of a transmission service contract, an increase of $18 million in realized losses associated with price stability products for retail customers on variable demand-driven pricing tariffs, and decreases of $17 million from retail solar programs as a result of higher avoided cost credits to customers and $16 million from power delivery construction and maintenance contracts. These reductions were largely offset by increases of $27 million associated with unregulated outdoor lighting sales and energy conservation projects, $20 million in open access transmission tariff sales, and $4 million from maintenance services provided to integrated transmission system owners.Energy SalesChanges in revenues are influenced heavily by the change in the volume of energy sold from year to year. KWH sales for 2022 and the percent change from 2021 were as follows:2022TotalKWHsTotal KWHPercent ChangeWeather-AdjustedPercent Change(*)(in billions)Residential29.1 4.4 %0.4 %Commercial32.6 3.9 2.9 Industrial23.9 2.5 2.4 Other0.4 (3.0)(2.9)Total retail86.0 3.6 1.9 %Wholesale2.4 (23.0)Total energy sales88.4 2.6 %(*)Weather-adjusted KWH sales are estimated using statistical models of the historical relationship between temperatures and energy sales, and then removing the estimated effect of deviations from normal temperature conditions. Normal temperature conditions are defined as those experienced in Georgia Power's service territory over a specified historical period. This metric is useful because it allows trends in historical operations to be evaluated apart from the influence of weather conditions. Management also considers this metric in developing long-term capital and financial plans.Changes in retail energy sales are generally the result of changes in electricity usage by customers, weather, and the number of customers. Revenues attributable to changes in sales increased in 2022 when compared to 2021. Weather-adjusted residential and commercial KWH sales increased 0.4% and 2.9%, respectively, in 2022 when compared to 2021 primarily due to customer II-23 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISgrowth. In addition, commercial customer usage increased and residential customer usage decreased in 2022 when compared to 2021 as customers returned to pre-pandemic levels of activity outside the home. Weather-adjusted industrial KWH sales increased 2.4% primarily due to increases in the pipeline, lumber, paper, and electronic sectors, partially offset by decreases in the textiles and chemicals sectors.See "Operating Revenues" above for a discussion of significant changes in wholesale sales to non-affiliates and affiliated companies.Fuel and Purchased Power ExpensesFuel costs constitute one of the largest expenses for Georgia Power. The mix of fuel sources for the generation of electricity is determined primarily by demand, the unit cost of fuel consumed, and the availability of generating units. Additionally, Georgia Power purchases a portion of its electricity needs from the wholesale market.Details of Georgia Power's generation and purchased power were as follows:20222021Total generation (in billions of KWHs)59.758.1 Total purchased power (in billions of KWHs)33.631.7 Sources of generation (percent) —Gas48 48 Nuclear27 28 Coal21 20 Hydro and other4 4 Cost of fuel, generated (in cents per net KWH) —Gas5.06 3.05 Nuclear0.75 0.79 Coal4.12 2.99 Average cost of fuel, generated (in cents per net KWH)3.64 2.39 Average cost of purchased power (in cents per net KWH)(*)7.88 5.07 (*) Average cost of purchased power includes fuel purchased by Georgia Power for tolling agreements where power is generated by the provider.Fuel and purchased power expenses were $4.7 billion in 2022, an increase of $1.8 billion, or 61.3%, compared to 2021. The increase was due to an increase of $1.7 billion related to the average cost of fuel and purchased power and an increase of $148 million related to the volume of KWHs generated and purchased.Fuel and purchased power energy transactions do not have a significant impact on earnings since these fuel expenses are generally offset by fuel revenues through Georgia Power's fuel cost recovery mechanism. See Note 2 to the financial statements under "Georgia Power – Fuel Cost Recovery" for additional information.FuelFuel expense was $2.5 billion in 2022, an increase of $1.0 billion, or 71.6%, compared to 2021. The increase was primarily due to increases of 65.9% and 37.8% in the average cost per KWH generated by natural gas and coal, respectively, and a 10.8% increase in the volume of KWHs generated by coal.Purchased Power - Non-AffiliatesPurchased power expense from non-affiliates was $856 million in 2022, an increase of $224 million, or 35.4%, compared to 2021. The increase was primarily due to an increase of 26.5% in the average cost per KWH purchased primarily due to higher natural gas and coal prices and an increase of 25.4% in the volume of KWHs purchased primarily due to higher demand.Energy purchases from non-affiliates will vary depending on the market prices of wholesale energy as compared to the cost of the Southern Company system's generation, demand for energy within the Southern Company system's electric service territory, and the availability of the Southern Company system's generation.II-24 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISPurchased Power - AffiliatesPurchased power expense from affiliates was $1.4 billion in 2022, an increase of $542 million, or 63.1%, compared to 2021. The increase was primarily due to an increase of 75.3% in the average cost per KWH purchased primarily due to higher natural gas and coal prices.Energy purchases from affiliates will vary depending on the demand and the availability and cost of generating resources at each company within the Southern Company system. These purchases are made in accordance with the IIC or other contractual agreements, all as approved by the FERC.Other Operations and Maintenance ExpensesOther operations and maintenance expenses increased $136 million, or 6.1%, in 2022 as compared to 2021. The increase was primarily due to increases of $96 million in distribution expenses primarily associated with line maintenance, $45 million in certain compensation and benefit expenses, $11 million in amortization of cloud software, and $9 million in maintenance costs at corporate and field support facilities, partially offset by $17 million in gains from sales of integrated transmission system assets, a decrease of $15 million in generation expenses primarily related to scheduled generation outages partially offset by environmental projects, and a $12 million reduction in billing adjustments with integrated transmission system owners largely resulting from a terminated transmission service agreement.Depreciation and AmortizationDepreciation and amortization increased $59 million, or 4.3%, in 2022 as compared to 2021 primarily due to increases of $46 million associated with additional plant in service and $12 million associated with amortization of regulatory assets related to CCR AROs under the terms of the 2019 ARP. See Note 2 to the financial statements under "Georgia Power – Integrated Resource Plans" and " – Rate Plans – 2019 ARP" for additional information.Taxes Other Than Income TaxesTaxes other than income taxes increased $51 million, or 10.7%, in 2022 as compared to 2021 primarily due to an increase in municipal franchise fees resulting from higher retail revenues.Estimated Loss on Plant Vogtle Units 3 and 4Georgia Power recorded pre-tax charges to income for the estimated probable loss on Plant Vogtle Units 3 and 4 totaling $183 million and $1.7 billion in 2022 and 2021, respectively. The charges to income in each year were recorded to reflect revisions to the total project capital cost forecast to complete construction and start-up of Plant Vogtle Units 3 and 4. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" for additional information.Allowance for Equity Funds Used During ConstructionAllowance for equity funds used during construction increased $13 million, or 10.2%, in 2022 as compared to 2021 primarily due to an increase in capital expenditures subject to AFUDC.Interest Expense, Net of Amounts CapitalizedInterest expense, net of amounts capitalized increased $64 million, or 15.2%, in 2022 as compared to 2021. The increase primarily reflects approximately $39 million related to higher average outstanding borrowings and $24 million related to higher interest rates. See FINANCIAL CONDITION AND LIQUIDITY – "Sources of Capital" and "Financing Activities" herein and Note 8 to the financial statements for additional information.Other Income (Expense), NetOther income (expense), net increased $34 million, or 23.9%, in 2022 as compared to 2021 primarily due to an increase in non-service cost-related retirement benefits income. See Note 11 to the financial statements for additional information on Georgia Power's net periodic pension and other postretirement benefit costs.Income Taxes (Benefit)In 2022, income tax expense was $370 million compared to income tax benefit of $168 million for 2021, a change of $538 million. The change was primarily due to higher pre-tax earnings largely resulting from a decrease in charges associated with the construction of Plant Vogtle Units 3 and 4 and an increase in a valuation allowance and other adjustments related to certain state tax credit carryforwards. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" and Note 10 to the financial statements for additional information.II-25 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISMississippi PowerMississippi Power's net income was $164 million in 2022 compared to $159 million in 2021. The increase was primarily due to an increase in revenues, largely offset by increases in non-fuel operations and maintenance costs.A condensed income statement for Mississippi Power follows:2022Increase(Decrease)from 2021(in millions)Operating revenues$1,694 $372 Fuel and purchased power789 293 Other operations and maintenance376 63 Depreciation and amortization181 1 Taxes other than income taxes124 (4)Total operating expenses1,470 353 Operating income 224 19 Interest expense, net of amounts capitalized56 (4)Other income (expense), net33 (2)Income taxes37 16 Net income $164 $5 Operating RevenuesOperating revenues for 2022 were $1.7 billion, reflecting a $372 million, or 28.1%, increase from 2021. Details of operating revenues were as follows:20222021(in millions)Retail — prior year$875 Estimated change resulting from —Rates and pricing24 Sales growth4 Weather13 Fuel and other cost recovery19 Retail — current year$935 $875 Wholesale revenues —Non-affiliates252 230 Affiliates460 188 Total wholesale revenues712 418 Other operating revenues47 29 Total operating revenues$1,694 $1,322 Total retail revenues for 2022 increased $60 million, or 6.9%, compared to 2021 primarily due to an increase in revenues in accordance with new PEP rates that became effective for the first billing cycle of April 2022, an increase in fuel and other cost recovery revenues primarily as a result of higher recoverable fuel costs, and an increase in customer usage. See Note 2 to the financial statements under "Mississippi Power" for additional information.See "Energy Sales" below for a discussion of changes in the volume of energy sold, including changes related to sales and weather.Electric rates for Mississippi Power include provisions to adjust billings for fluctuations in fuel costs, including the energy component of purchased power costs. Under these provisions, fuel revenues generally equal fuel expenses, including the energy component of purchased power costs, and do not affect net income. Recoverable fuel costs include fuel and purchased power II-26 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISexpenses reduced by the fuel and emissions portion of wholesale revenues from energy sold to customers outside Mississippi Power's service territory. See Note 2 to the financial statements under "Mississippi Power – Fuel Cost Recovery" for additional information.Wholesale revenues from power sales to non-affiliated utilities, including FERC-regulated MRA sales as well as market-based sales, were as follows:20222021(in millions)Capacity and other$3 $3 Energy249 227 Total non-affiliated$252 $230 Wholesale revenues from sales to non-affiliates increased $22 million, or 9.6%, compared to 2021. The increase was primarily due to higher fuel costs and an increase in base revenue from MRA customers primarily due to increased demand as a result of weather impacts in 2022.Wholesale revenues from sales to non-affiliates will vary depending on fuel prices, the market prices of wholesale energy compared to the cost of Mississippi Power's and the Southern Company system's generation, demand for energy within the Southern Company system's electric service territory, and the availability of the Southern Company system's generation. Increases and decreases in energy revenues that are driven by fuel prices are accompanied by an increase or decrease in fuel costs and do not have a significant impact on net income. In addition, Mississippi Power provides service under long-term contracts with rural electric cooperative associations and a municipality located in southeastern Mississippi under requirements cost-based electric tariffs which are subject to regulation by the FERC. The contracts with these wholesale customers represented 12.4% of Mississippi Power's total operating revenues in 2022. Historically, these wholesale customers have acted as a group and any changes in contractual relationships for one customer are likely to be followed by the other wholesale customers. Short-term opportunity energy sales are also included in sales for resale to non-affiliates. These opportunity sales are made at market-based rates that generally provide a margin above Mississippi Power's variable cost to produce the energy. See Note 2 under "Mississippi Power – Municipal and Rural Associations Tariff" for additional information.Wholesale revenues from sales to affiliates increased $272 million, or 144.7%, in 2022 compared to 2021. The increase was primarily due to increases of $243 million associated with higher fuel costs, primarily for natural gas, and $29 million associated with higher KWH sales due to lower cost available Mississippi Power resources as compared to the available affiliate company generation.Wholesale revenues from sales to affiliates will vary depending on demand and the availability and cost of generating resources at each company. These affiliate sales are made in accordance with the IIC, as approved by the FERC. These transactions do not have a significant impact on earnings since this energy is generally sold at marginal cost.In 2022, other operating revenues increased $18 million, or 62.1%, as compared to 2021 primarily due to increases of $13 million in unregulated sales associated with power delivery construction and maintenance projects and $4 million in open access transmission tariff revenues.II-27 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISEnergy SalesChanges in revenues are influenced heavily by the change in the volume of energy sold from year to year. KWH sales for 2022 and the percent change from 2021 were as follows:2022TotalKWHsTotal KWHPercent ChangeWeather-Adjusted Percent Change(*)(in millions)Residential2,134 4.2 %(1.8)%Commercial2,632 2.9 1.4 Industrial4,686 1.6 1.6 Other31 (8.8)(8.8)Total retail9,483 2.5 %0.7 %WholesaleNon-affiliated3,465 (4.0)Affiliated5,489 15.8 Total wholesale8,954 7.2 Total energy sales18,437 4.7 %(*)Weather-adjusted KWH sales are estimated using statistical models of the historical relationship between temperatures and energy sales, and then removing the estimated effect of deviations from normal temperature conditions. Normal temperature conditions are defined as those experienced in Mississippi Power's service territory over a specified historical period. This metric is useful because it allows trends in historical operations to be evaluated apart from the influence of weather conditions. Management also considers this metric in developing long-term capital and financial plans.Changes in retail energy sales are generally the result of changes in electricity usage by customers, weather, and the number of customers. Revenues attributable to changes in sales increased in 2022 when compared to 2021. Weather-adjusted residential KWH sales decreased 1.8% compared to 2021 due to a decrease in customer usage resulting from increased activity outside the home as customers returned to pre-pandemic levels of activity. Weather-adjusted commercial KWH sales increased 1.4% primarily due to customer growth. Industrial KWH sales increased 1.6% primarily due to increases in the petroleum, pipeline, and transportation sectors.See "Operating Revenues" above for a discussion of significant changes in wholesale revenues to affiliated companies.Fuel and Purchased Power ExpensesThe mix of fuel sources for generation of electricity is determined primarily by demand, the unit cost of fuel consumed, and the availability of generating units. Additionally, Mississippi Power purchases a portion of its electricity needs from the wholesale market.Details of Mississippi Power's generation and purchased power were as follows:20222021Total generation (in millions of KWHs)18,303 17,377 Total purchased power (in millions of KWHs)617 675 Sources of generation (percent) –Gas90 92 Coal10 8 Cost of fuel, generated (in cents per net KWH) –Gas4.34 2.85 Coal4.13 3.24 Average cost of fuel, generated (in cents per net KWH)4.31 2.88 Average cost of purchased power (in cents per net KWH)6.91 3.90 Fuel and purchased power expenses were $789 million in 2022, an increase of $293 million, or 59.1%, as compared to 2021. The increase was primarily due to a $266 million increase related to the average cost of fuel and purchased power and a $27 million net increase related to the volume of KWHs generated and purchased.II-28 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISFuel and purchased power energy transactions do not have a significant impact on earnings since energy expenses are generally offset by energy revenues through Mississippi Power's fuel cost recovery clauses. See Note 2 to the financial statements under "Mississippi Power – Fuel Cost Recovery" and Note 1 to the financial statements under "Fuel Costs" for additional information.Fuel expense increased $276 million, or 58.8%, in 2022 compared to 2021 primarily due to a 52.3% increase in the average cost of natural gas per KWH generated, a 29.1% increase in the volume of KWHs generated by coal, a 27.5% increase in the average cost of coal per KWHs generated, and a 3.9% increase in the volume of KWHs generated by natural gas.Purchased power expense increased $16 million, or 62.0%, in 2022 compared to 2021 primarily due to a 77.2% increase in the average cost per KWH purchased, partially offset by an 8.6% decrease in the volume of KWHs purchased.Energy purchases will vary depending on the market prices of wholesale energy as compared to the cost of the Southern Company system's generation, demand for energy within the Southern Company system's service territory, and the availability of the Southern Company system's generation. These purchases are made in accordance with the IIC or other contractual agreements, as approved by the FERC.Other Operations and Maintenance ExpensesOther operations and maintenance expenses increased $63 million, or 20.1%, in 2022 compared to 2021. The increase was primarily due to a $25 million reliability reserve accrual in 2022 and increases of $12 million related to unregulated power delivery construction and maintenance projects, $7 million associated with storm reserve accruals, $6 million in employee compensation and benefits, $4 million in transmission and distribution line maintenance, and $4 million associated with the Kemper County energy facility primarily related to sales and use taxes. See Note 2 to the financial statements under "Mississippi Power – System Restoration Rider" and " – Reliability Reserve Accounting Order" and Note 3 to the financial statements under "Other Matters – Mississippi Power" for additional information.Income TaxesIncome taxes increased $16 million, or 76.2%, in 2022 compared to 2021 primarily due to an increase of $11 million in the flowback of excess deferred income taxes associated with new PEP rates that became effective in April 2022, as well as an increase of $5 million due to higher pre-tax earnings. See Note 2 to the financial statements under "Mississippi Power – Performance Evaluation Plan" and Note 10 to the financial statements for additional information.II-29 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISSouthern PowerNet income attributable to Southern Power for 2022 was $354 million, an $88 million increase from 2021. The increase was primarily due to higher revenues driven by higher market prices of energy and new natural gas PPAs and higher income associated with tax equity partnerships, partially offset by higher other operations and maintenance expenses, gains from contributions of wind turbine equipment to various equity method investments in 2021, and a tax benefit due to a change in state apportionment methodology resulting from tax legislation enacted by the State of Alabama in 2021.A condensed statement of income follows:2022Increase(Decrease)from 2021(in millions)Operating revenues$3,369 $1,153 Fuel1,614 812 Purchased power311 172 Other operations and maintenance482 59 Depreciation and amortization516 (1)Taxes other than income taxes49 4 Loss on sales-type leases1 (39)Gain on dispositions, net(2)39 Total operating expenses2,971 1,046 Operating income398 107 Interest expense, net of amounts capitalized138 (9)Other income (expense), net7 (3)Income taxes (benefit)20 33 Net income247 80 Net loss attributable to noncontrolling interests(107)(8)Net income attributable to Southern Power$354 $88 Operating RevenuesTotal operating revenues include PPA capacity revenues, which are derived primarily from long-term contracts involving natural gas facilities, and PPA energy revenues from Southern Power's generation facilities. To the extent Southern Power has capacity not contracted under a PPA, it may sell power into an accessible wholesale market, or, to the extent those generation assets are part of the FERC-approved IIC, it may sell power into the Southern Company power pool.Natural Gas Capacity and Energy RevenueCapacity revenues generally represent the greatest contribution to operating income and are designed to provide recovery of fixed costs plus a return on investment.Energy is generally sold at variable cost or is indexed to published natural gas indices. Energy revenues will vary depending on the energy demand of Southern Power's customers and their generation capacity, as well as the market prices of wholesale energy compared to the cost of Southern Power's energy. Energy revenues also include fees for support services, fuel storage, and unit start charges. Increases and decreases in energy revenues under PPAs that are driven by fuel or purchased power prices are generally accompanied by an increase or decrease in fuel and purchased power costs and do not have a significant impact on net income.Solar and Wind Energy RevenueSouthern Power's energy sales from solar and wind generating facilities are predominantly through long-term PPAs that do not have capacity revenue. Customers either purchase the energy output of a dedicated renewable facility through an energy charge or pay a fixed price related to the energy generated from the respective facility and sold to the grid. As a result, Southern Power's ability to recover fixed and variable operations and maintenance expenses is dependent upon the level of energy generated from these facilities, which can be impacted by weather conditions, equipment performance, transmission constraints, and other factors. II-30 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISSee FUTURE EARNINGS POTENTIAL – "Southern Power's Power Sales Agreements" herein for additional information regarding Southern Power's PPAs.Operating Revenues DetailsDetails of Southern Power's operating revenues were as follows:20222021(in millions)PPA capacity revenues $451 $408 PPA energy revenues 2,121 1,311 Total PPA revenues2,572 1,719 Non-PPA revenues 761 467 Other revenues36 30 Total operating revenues$3,369 $2,216 Operating revenues for 2022 were $3.4 billion, a $1.2 billion, or 52.0% increase from 2021. The increase in operating revenues was primarily due to the following:•PPA capacity revenues increased $43 million, or 10.5%, primarily due to a net increase in MW capacity under contract from natural gas PPAs and an increase associated with a change in rates from natural gas PPAs.•PPA energy revenues increased $810 million, or 61.8%, primarily due to a $656 million increase in sales under existing natural gas PPAs resulting from a $539 million increase in the price of fuel and purchased power and a $117 million increase in the volume of KWHs sold. Also contributing to the increase was a $164 million increase in sales associated with new natural gas PPAs, net of contractual expirations.•Non-PPA revenues increased $294 million, or 63.0%, due to a $338 million increase in the market price of energy, partially offset by a $42 million decrease in the volume of KWHs sold through short-term sales.Fuel and Purchased Power ExpensesDetails of Southern Power's generation and purchased power were as follows:TotalKWHsTotal KWH % ChangeTotalKWHs20222021(in billions of KWHs)Generation4844Purchased power33Total generation and purchased power518.5%47Total generation and purchased power (excluding solar, wind, fuel cells, and tolling agreements)3110.7%28Southern Power's PPAs for natural gas generation generally provide that the purchasers are responsible for either procuring the fuel (tolling agreements) or reimbursing Southern Power for substantially all of the cost of fuel relating to the energy delivered under such PPAs. Consequently, changes in such fuel costs are generally accompanied by a corresponding change in related fuel revenues and do not have a significant impact on net income. Southern Power is responsible for the cost of fuel for generating units that are not covered under PPAs. Power from these generating units is sold into the wholesale market or into the Southern Company power pool for capacity owned directly by Southern Power.Purchased power expenses will vary depending on demand, availability, and the cost of generating resources throughout the Southern Company system and other contract resources. Load requirements are submitted to the Southern Company power pool on an hourly basis and are fulfilled with the lowest cost alternative, whether that is generation owned by Southern Power, an affiliate company, or external parties. Such purchased power costs are generally recovered through PPA revenues.II-31 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISDetails of Southern Power's fuel and purchased power expenses were as follows:20222021(in millions)Fuel$1,614 $802 Purchased power311 139 Total fuel and purchased power expenses$1,925 $941 In 2022, total fuel and purchased power expenses increased $984 million, or 104.6%, compared to 2021. Fuel expense increased $812 million, or 101.2%, primarily due to a $719 million increase associated with the average cost of fuel and a $93 million increase associated with the volume of KWHs generated. Purchased power expense increased $172 million, or 123.7%, largely due to a $168 million increase associated with the average cost of purchased power.Other Operations and Maintenance ExpensesIn 2022, other operations and maintenance expenses increased $59 million, or 14.0%, compared to 2021. The increase was primarily due to increases of $42 million related to generation maintenance and outage expenses and $10 million in transmission expenses to serve new natural gas PPAs, partially offset by $6 million related to the allocation in 2021 of uncollected settlements by the Energy Reliability Council of Texas market as a result of Winter Storm Uri.Loss on Sales-Type LeasesIn 2021, a $40 million loss on sales-type leases was recorded upon commencement of the Garland and Tranquillity battery energy storage facilities' PPAs, $26 million of which was allocated through noncontrolling interests to Southern Power's partners in the projects. The loss was due to ITCs retained and expected to be realized by Southern Power and its partners. See Notes 9 and 15 to the financial statements under "Lessor" and "Southern Power," respectively, for additional information.Gain on Dispositions, NetIn 2022, gain on dispositions, net decreased $39 million, or 95.1%, compared to 2021 primarily due to contributions of wind turbine equipment to various equity method investments in 2021. See Notes 7 and 15 to the financial statements under "Southern Power" for additional information.Income Taxes (Benefit)In 2022, income tax expense was $20 million compared to income tax benefit of $13 million for 2021, a change of $33 million. The change was primarily due to higher pre-tax earnings in 2022 and a change in state apportionment methodology resulting from tax legislation enacted by the State of Alabama in the first quarter 2021, partially offset by higher wind PTCs in 2022. See Notes 1 and 10 to the financial statements under "Income Taxes" and "Effective Tax Rate," respectively, for additional information.Net Loss Attributable to Noncontrolling InterestsIn 2022, net loss attributable to noncontrolling interests increased $8 million, or 8.1%, compared to 2021. The increased loss was primarily due to $28 million in higher HLBV loss allocations to tax equity partners in 2022, largely offset by $23 million in loss allocations associated with the Garland and Tranquillity battery energy storage facilities being placed in service in 2021. See Notes 9 and 15 to the financial statements under "Lessor" and "Southern Power," respectively, for additional information.Southern Company GasOperating MetricsSouthern Company Gas continues to focus on several operating metrics, including Heating Degree Days, customer count, and volumes of natural gas sold.Southern Company Gas measures weather and the effect on its business using Heating Degree Days. Generally, increased Heating Degree Days result in higher demand for natural gas on Southern Company Gas' distribution system. Southern Company Gas has various regulatory mechanisms, such as weather and revenue normalization and straight-fixed-variable rate design, which limit its exposure to weather changes within typical ranges in each of its utility's respective service territory. Southern Company Gas also utilizes weather hedges to limit the negative income impacts in the event of warmer-than-normal weather.The number of customers served by gas distribution operations and gas marketing services can be impacted by natural gas prices, economic conditions, and competition from alternative fuels. Gas distribution operations and gas marketing services' customers are primarily located in Georgia and Illinois.II-32 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISSouthern Company Gas' natural gas volume metrics for gas distribution operations and gas marketing services illustrate the effects of weather and customer demand for natural gas. Wholesale gas services' physical sales volumes represent the daily average natural gas volumes sold to its customers.Seasonality of ResultsDuring the Heating Season, natural gas usage and operating revenues are generally higher as more customers are connected to the gas distribution systems and natural gas usage is higher in periods of colder weather. Prior to the sale of Sequent on July 1, 2021, wholesale gas services' operating revenues occasionally were impacted due to peak usage by power generators in response to summer energy demands. Southern Company Gas' base operating expenses, excluding cost of natural gas, bad debt expense, and certain incentive compensation costs, are incurred relatively evenly throughout the year. Seasonality also affects the comparison of certain balance sheet items across quarters, including receivables, unbilled revenues, natural gas for sale, and notes payable. However, these items are comparable when reviewing Southern Company Gas' annual results. Thus, Southern Company Gas' operating results can vary significantly from quarter to quarter as a result of seasonality, which is illustrated in the table below.Percent Generated DuringHeating SeasonOperating RevenuesNetIncome202267 %66 %202170 %102 %Net IncomeNet income attributable to Southern Company Gas in 2022 was $572 million, an increase of $33 million, or 6.1%, compared to 2021. Net income increased $88 million at gas pipeline investments primarily as a result of a 2021 impairment charge related to the PennEast Pipeline project and $58 million at gas distribution operations primarily due to base rate increases and continued investment in infrastructure replacement, largely offset by after-tax impairment charges in 2022 totaling $99 million related to the sale of natural gas storage facilities. The 2021 results also included $107 million of net income from Sequent, including a $92 million after-tax gain and $85 million of additional tax expense resulting from its July 1, 2021 sale. See Notes 7 and 15 to the financial statements under "Southern Company Gas" for additional information.A condensed income statement for Southern Company Gas follows:2022Increase (Decrease) from 2021(in millions)Operating revenues$5,962 $1,582 Cost of natural gas3,004 1,385 Other operations and maintenance1,176 104 Depreciation and amortization559 23 Taxes other than income taxes282 57 Impairment charges131 131 Gain on dispositions, net (4)123 Total operating expenses5,148 1,823 Operating income814 (241)Earnings from equity method investments148 98 Interest expense, net of amounts capitalized263 25 Other income (expense), net53 106 Earnings before income taxes752 (62)Income taxes180 (95)Net Income$572 $33 II-33 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISOperating RevenuesOperating revenues in 2022 were $6.0 billion, reflecting a $1.6 billion, or 36.1%, increase compared to 2021. Details of operating revenues were as follows:2022(in millions)Operating revenues – prior year$4,380 Estimated change resulting from –Infrastructure replacement programs and base rate changes252 Gas costs and other cost recovery1,468 Gas marketing services15 Wholesale gas services(187)Other34 Operating revenues – current year$5,962 Revenues at the natural gas distribution utilities increased in 2022 due to rate increases at Nicor Gas, Atlanta Gas Light, and Chattanooga Gas and continued investment in infrastructure replacement. See Note 2 to the financial statements under "Southern Company Gas" for additional information.Revenues associated with gas costs and other cost recovery increased in 2022 primarily due to higher natural gas cost recovery as a result of higher volumes of natural gas sold and an increase in natural gas prices. The natural gas distribution utilities have weather or revenue normalization mechanisms that mitigate revenue fluctuations from customer consumption changes. Natural gas distribution rates include provisions to adjust billings for fluctuations in natural gas costs. Therefore, gas costs recovered through natural gas revenues generally equal the amount expensed in cost of natural gas and do not affect net income from gas distribution operations. See "Cost of Natural Gas" herein for additional information.The changes in 2022 revenues related to wholesale gas services were due to the sale of Sequent on July 1, 2021. See Note 15 to the financial statements under "Southern Company Gas" for additional information.Heating Degree DaysSouthern Company Gas' natural gas distribution utilities have various regulatory mechanisms that limit their exposure to weather changes. Southern Company Gas also uses hedges for the majority of any remaining exposure to warmer-than-normal weather in Illinois for gas distribution operations and in Illinois and Georgia for gas marketing services; therefore, weather typically does not have a significant net income impact. The following table presents Heating Degree Days information for Illinois and Georgia, the primary locations where Southern Company Gas' operations are impacted by weather.Years Ended December 31,2022 vs. normal2022 vs. 2021Normal(*)20222021coldercolder(in thousands)Illinois5,690 5,708 5,326 0.3 %7.2 %Georgia2,303 2,303 2,113 — %9.0 %(*)Normal represents the 10-year average from January 1, 2012 through December 31, 2021 for Illinois at Chicago Midway International Airport and for Georgia at Atlanta Hartsfield-Jackson International Airport, based on information obtained from the National Oceanic and Atmospheric Administration, National Climatic Data Center.II-34 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISCustomer Count The following table provides the number of customers served by Southern Company Gas at December 31, 2022 and 2021:20222021(in thousands, except market share %)Gas distribution operations4,358 4,337 Gas marketing servicesEnergy customers(*)622 603 Market share of energy customers in Georgia29.3 %28.7 %(*)Gas marketing services' customers are primarily located in Georgia and Illinois.Southern Company Gas anticipates customer growth and uses a variety of targeted marketing programs to attract new customers and to retain existing customers.Cost of Natural Gas Excluding Atlanta Gas Light, which does not sell natural gas to end-use customers, natural gas distribution rates include provisions to adjust billings for fluctuations in natural gas costs. Therefore, gas costs recovered through natural gas revenues generally equal the amount expensed in cost of natural gas and do not affect net income from gas distribution operations. See Note 2 to the financial statements under "Southern Company Gas – Natural Gas Cost Recovery" for additional information. Cost of natural gas at gas distribution operations represented 87.5% of the total cost of natural gas for 2022.Gas marketing services customers are charged for actual and estimated natural gas consumed. Cost of natural gas includes the cost of fuel and associated transportation costs, lost and unaccounted for gas, adjustments to reduce the value of inventories to market value, if applicable, and gains and losses associated with certain derivatives.In 2022, cost of natural gas was $3.0 billion, an increase of $1.4 billion, or 85.5%, compared to 2021, which reflects higher gas cost recovery in 2022 as a result of higher volumes sold and a 73.0% increase in natural gas prices compared to 2021.Volumes of Natural Gas SoldThe following table details the volumes of natural gas sold during all periods presented.2022 vs. 202120222021% ChangeGas distribution operations (mmBtu in millions)Firm707 656 7.8 %Interruptible93 98 (5.1)Total800 754 6.1 %Gas marketing services (mmBtu in millions)Firm:Georgia35 34 2.9 %Other 18 18 — Interruptible large commercial and industrial14 14 — Total67 66 1.5 %Other Operations and Maintenance ExpensesIn 2022, other operations and maintenance expenses increased $104 million, or 9.7%, compared to 2021. Excluding $66 million of expenses related to Sequent in 2021, other operations and maintenance expenses increased approximately $174 million. The increase was primarily due to increases of $64 million in compensation and benefit expenses, $43 million in expenses passed through directly to customers primarily related to bad debt at gas distribution operations, $31 million primarily related to bad debt, customer service, and sales expenses, and $18 million primarily related to pipeline compliance.II-35 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISDepreciation and AmortizationIn 2022, depreciation and amortization increased $23 million, or 4.3%, compared to 2021. The increase was primarily due to continued infrastructure investments at the natural gas distribution utilities. See Note 2 to the financial statements under "Southern Company Gas – Infrastructure Replacement Programs and Capital Projects" for additional information.Taxes Other Than Income TaxesIn 2022, taxes other than income taxes increased $57 million, or 25.3%, compared to 2021. The increase was primarily due to a $39 million increase in revenue tax expenses as a result of higher natural gas revenues and an $11 million increase in invested capital tax expense at Nicor Gas. Revenue tax expenses are passed through directly to customers and have no impact on net income.Impairment ChargesIn 2022, Southern Company Gas recorded pre-tax impairment charges totaling approximately $131 million ($99 million after tax) as a result of an agreement to sell two natural gas storage facilities. See Note 15 to the financial statements under "Southern Company Gas" for additional information.Gain on Dispositions, NetIn 2021, Southern Company Gas recorded a $121 million gain on the sale of Sequent. See Note 15 to the financial statements under "Southern Company Gas" for additional information.Earnings from Equity Method InvestmentsIn 2022, earnings from equity method investments increased $98 million compared to 2021. The increase was primarily due to pre-tax impairment charges totaling $84 million in 2021 related to the PennEast Pipeline project and higher earnings at SNG resulting from higher revenues primarily due to increased demand. See Note 7 to the financial statements under "Southern Company Gas" for additional information.Interest Expense, Net of Amounts CapitalizedIn 2022, interest expense, net of amounts capitalized increased $25 million, or 10.5%, compared to 2021. The increase reflects approximately $16 million related to higher average outstanding borrowings and $8 million related to higher interest rates. See Note 8 to the financial statements for additional information.Other Income (Expense), NetIn 2022, other income (expense), net increased $106 million compared to 2021. The increase was largely due to charitable contributions by Sequent prior to its sale totaling $101 million in 2021 and an increase of $10 million at gas distribution operations primarily related to non-service cost-related retirement benefits income. See Note 11 to the financial statements under "Southern Company Gas" for additional information.Income TaxesIn 2022, income taxes decreased $95 million, or 34.5%, compared to 2021. The decrease was primarily due to additional tax benefit of $110 million resulting from the sale of Sequent in 2021 and $32 million as a result of the impairment related to the agreement to sell two natural gas storage facilities in 2022. The decrease was partially offset by $17 million of tax benefits in 2021 resulting from the impairment charge related to the PennEast Pipeline project and higher pre-tax earnings in 2022. See Notes 7 and 15 to the financial statements under "Southern Company Gas" and Note 10 to the financial statements for additional information.II-36 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISSegment Information20222021Operating RevenuesOperating ExpensesNet Income (Loss)Operating RevenuesOperating ExpensesNet Income (Loss)(in millions)(in millions)Gas distribution operations$5,267 $4,464 $470 $3,679 $2,971 $412 Gas pipeline investments32 11 107 32 11 19 Wholesale gas services(*)— — — 188 (53)107 Gas marketing services638 505 94 475 350 88 All other55 190 (99)38 78 (87)Intercompany eliminations(30)(22)— (32)(32)— Consolidated$5,962 $5,148 $572 $4,380 $3,325 $539 (*)As a result of the sale of Sequent, wholesale gas services was no longer a reportable segment in 2022. See Note 15 to the financial statements under "Southern Company Gas" for additional information.Gas Distribution OperationsGas distribution operations is the largest component of Southern Company Gas' business and is subject to regulation and oversight by regulatory agencies in each of the states it serves. These agencies approve natural gas rates designed to provide Southern Company Gas with the opportunity to generate revenues to recover the cost of natural gas delivered to its customers and its fixed and variable costs, including depreciation, interest expense, operations and maintenance, taxes, and overhead costs, and to earn a reasonable return on its investments.With the exception of Atlanta Gas Light, Southern Company Gas' second largest utility that operates in a deregulated natural gas market and has a straight-fixed-variable rate design that minimizes the variability of its revenues based on consumption, the earnings of the natural gas distribution utilities can be affected by customer consumption patterns that are a function of weather conditions, price levels for natural gas, and general economic conditions that may impact customers' ability to pay for natural gas consumed. Southern Company Gas has various regulatory and other mechanisms, such as weather and revenue normalization mechanisms and weather derivative instruments, that limit its exposure to changes in customer consumption, including weather changes within typical ranges in its natural gas distribution utilities' service territories. See Note 2 to the financial statements under "Southern Company Gas" for additional information.In 2022, net income increased $58 million, or 14.1%, compared to 2021. Operating revenues increased $1.6 billion primarily due to higher gas cost recovery, rate increases, and continued investment in infrastructure replacement. Gas costs recovered through natural gas revenues generally equal the amount expensed in cost of natural gas. Operating expenses increased $1.5 billion primarily due to a $1.2 billion increase in cost of gas as a result of higher natural gas prices compared to 2021, a $52 million increase in compensation and benefit expenses, and a $34 million increase in depreciation resulting from additional assets placed in service. The increase in operating expenses also includes increases of $83 million in costs passed through directly to customers primarily related to bad debt expenses and revenue taxes. Other income and expense increased $10 million primarily due to an increase in non-service cost-related retirement benefits income. Interest expense, net of amounts capitalized increased $22 million primarily due to additional debt issued to finance continued investments. Income taxes increased $25 million primarily due to higher pre-tax earnings. See Note 2 to the financial statements under "Southern Company Gas" and Note 11 to the financial statements for additional information.Gas Pipeline InvestmentsGas pipeline investments consists primarily of joint ventures in natural gas pipeline investments including SNG, Dalton Pipeline, and PennEast Pipeline. In 2022, net income increased $88 million compared to 2021. The increase was primarily due to impairment charges in 2021 totaling $84 million ($67 million after tax) related to the PennEast Pipeline project and higher earnings at SNG resulting from higher revenues primarily due to increased demand. See Note 7 to the financial statements under "Southern Company Gas" for additional information.Gas Marketing ServicesGas marketing services provides energy-related products and services to natural gas markets and participants in customer choice programs that were approved in various states to increase competition. These programs allow customers to choose their natural gas supplier while the local distribution utility continues to provide distribution and transportation services. Gas marketing II-37 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISservices is weather sensitive and uses a variety of hedging strategies, such as weather derivative instruments and other risk management tools, to partially mitigate potential weather impacts.In 2022, net income increased $6 million, or 6.8%, compared to 2021. The increase was primarily due to a $163 million increase in operating revenues as a result of higher commodity prices, colder weather, and higher sales to commercial customers, partially offset by a $155 million increase in operating expenses primarily due to $149 million in higher cost of natural gas and an increase of $3 million in income taxes as a result of higher pre-tax earnings.All OtherAll other includes natural gas storage businesses, a renewable natural gas business, AGL Services Company, and Southern Company Gas Capital, as well as various corporate operating expenses that are not allocated to the reportable segments and interest income (expense) associated with affiliate financing arrangements. See Note 15 to the financial statements under "Southern Company Gas" for information regarding agreements by certain affiliates of Southern Company Gas to sell two natural gas storage facilities.In 2022, net income decreased $12 million compared to 2021. The decrease was primarily due to pre-tax impairment charges in 2022 totaling approximately $131 million ($99 million after tax) related to the sale of natural gas storage facilities, largely offset by $84 million of additional tax expense as a result of the sale of Sequent in 2021, an increase in operating revenues of $17 million primarily related to higher demand fees and favorable hedge gains at the natural gas storage businesses and higher sales from the renewable natural gas business, lower depreciation in 2022, and an increase in charitable contributions in 2022. See Note 10 to the financial statements and Note 15 to the financial statements under "Southern Company Gas" for additional information.FUTURE EARNINGS POTENTIALGeneralPrices for electric service provided by the traditional electric operating companies and natural gas distribution service provided by the natural gas distribution utilities to retail customers are set by state PSCs or other applicable state regulatory agencies under cost-based regulatory principles. Retail rates and earnings are reviewed through various regulatory mechanisms and/or processes and may be adjusted periodically within certain limitations. Effectively operating pursuant to these regulatory mechanisms and/or processes and appropriately balancing required costs and capital expenditures with customer prices will continue to challenge the traditional electric operating companies and natural gas distribution utilities for the foreseeable future. Prices for wholesale electricity sales, interconnecting transmission lines, and the exchange of electric power are regulated by the FERC. Southern Power continues to focus on long-term PPAs. See ACCOUNTING POLICIES – "Application of Critical Accounting Policies and Estimates – Utility Regulation" herein and Note 2 to the financial statements for additional information about regulatory matters.Each Registrant's results of operations are not necessarily indicative of its future earnings potential. The disposition activities described in Note 15 to the financial statements have reduced earnings for the applicable Registrants. The level of the Registrants' future earnings depends on numerous factors that affect the opportunities, challenges, and risks of the Registrants' primary businesses of selling electricity and/or distributing natural gas, as described further herein.For the traditional electric operating companies, these factors include the ability to maintain constructive regulatory environments that allow for the timely recovery of prudently-incurred costs during a time of increasing costs, including those related to projected long-term demand growth, stringent environmental standards, including CCR rules, safety, system reliability and resiliency, fuel, restoration following major storms, and capital expenditures, including constructing new electric generating plants and expanding and improving the transmission and distribution systems; continued customer growth; and the trends of higher inflation and reduced electricity usage per customer, especially in residential and commercial markets. For Georgia Power, completing construction of Plant Vogtle Units 3 and 4 and the related cost recovery proceedings is another major factor.Earnings in the electricity business will also depend upon maintaining and growing sales, considering, among other things, the adoption and/or penetration rates of increasingly energy-efficient technologies and increasing volumes of electronic commerce transactions, which could contribute to a net reduction in customer usage.Global and U.S. economic conditions continue to be significantly affected by a series of demand and supply shocks that caused a global and national economic recession in 2020 and have been further impacted by the invasion of Ukraine and significant declines in labor force participation rates. The confluence of these disruptions has resulted in the highest levels of inflation globally in 40 years and driven a significant policy response by central banks across the global economy. The U.S. Federal Reserve has increased policy interest rates faster than any rate increase cycle in the last 40 years and to levels high enough to slow economic activity. These actions and impacts, including increased costs for goods and services and borrowing costs, have led to a significantly increased risk of recession. Additionally, inflation remains elevated in part due to continued supply chain constraints and labor markets remaining tight. Electricity sales across all classes have recovered to pre-COVID-19 pandemic levels and II-38 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSIScustomer growth at both the traditional electric operating companies and natural gas distribution utilities has remained strong. However, weakening economic activity increases the risk of slowing to declining energy sales. Additionally, the current economic environment has increased the uncertainty of future energy demand and operating costs. See RESULTS OF OPERATIONS herein for information on energy sales in the Southern Company system's service territory during 2022.The level of future earnings for Southern Power's competitive wholesale electric business depends on numerous factors including the parameters of the wholesale market and the efficient operation of its wholesale generating assets; Southern Power's ability to execute its growth strategy through the development or acquisition of renewable facilities and other energy projects while containing costs; regulatory matters; customer creditworthiness; total electric generating capacity available in Southern Power's market areas; Southern Power's ability to successfully remarket capacity as current contracts expire; renewable portfolio standards; continued availability of federal and state ITCs and PTCs, which could be impacted by future tax legislation; transmission constraints; cost of generation from units within the Southern Company power pool; and operational limitations. See "Income Tax Matters" herein for information regarding recent tax legislation expanding the availability of federal ITCs and PTCs. Also see Notes 10 and 15 to the financial statements for additional information.The level of future earnings for Southern Company Gas' primary business of distributing natural gas and its complementary businesses in the gas pipeline investments and gas marketing services sectors depends on numerous factors. These factors include the natural gas distribution utilities' ability to maintain constructive regulatory environments that allow for the timely recovery of prudently-incurred costs, including those related to projected long-term demand growth, safety, system reliability and resiliency, natural gas, and capital expenditures, including expanding and improving the natural gas distribution systems; the completion and subsequent operation of ongoing infrastructure and other construction projects; customer creditworthiness; and certain policies to limit the use of natural gas, such as the potential across certain parts of the U.S. for state or municipal bans on the use of natural gas or policies designed to promote electrification. The volatility of natural gas prices has an impact on Southern Company Gas' customer rates, its long-term competitive position against other energy sources, and the ability of Southern Company Gas' gas marketing services business to capture value from locational and seasonal spreads. Additionally, changes in commodity prices, primarily driven by tight gas supplies, geopolitical events, and diminished gas production, subject a portion of Southern Company Gas' operations to earnings variability and have resulted in higher natural gas prices. Additional economic factors may contribute to this environment. The demand for natural gas may increase, which may cause natural gas prices to rise and drive higher volatility in the natural gas markets on a longer-term basis. Alternatively, a significant drop in oil and natural gas prices could lead to a consolidation of natural gas producers or reduced levels of natural gas production.Earnings for both the electricity and natural gas businesses are subject to a variety of other factors. These factors include weather; competition; developing new and maintaining existing energy contracts and associated load requirements with wholesale customers; customer energy conservation practices; the use of alternative energy sources by customers; government incentives to reduce overall energy usage; fuel, labor, and material prices in an environment of heightened inflation and material and labor supply chain disruptions; and the price elasticity of demand. Demand for electricity and natural gas in the Registrants' service territories is primarily driven by the pace of economic growth or decline that may be affected by changes in regional and global economic conditions, which may impact future earnings.Mississippi Power provides service under long-term contracts with rural electric cooperative associations and a municipality located in southeastern Mississippi under requirements cost-based electric tariffs which are subject to regulation by the FERC. The contracts with these wholesale customers represented 12.4% of Mississippi Power's total operating revenues in 2022. Historically, these wholesale customers have acted as a group and any changes in contractual relationships for one customer are likely to be followed by the other wholesale customers.As part of its ongoing effort to adapt to changing market conditions, Southern Company continues to evaluate and consider a wide array of potential business strategies. These strategies may include business combinations, partnerships, and acquisitions involving other utility or non-utility businesses or properties, disposition of, or the sale of interests in, certain assets or businesses, internal restructuring, or some combination thereof. Furthermore, Southern Company may engage in new business ventures that arise from competitive and regulatory changes in the utility industry. Pursuit of any of the above strategies, or any combination thereof, may significantly affect the business operations, risks, and financial condition of Southern Company. In addition, Southern Power and Southern Company Gas regularly consider and evaluate joint development arrangements as well as acquisitions and dispositions of businesses and assets as part of their business strategies. See Note 15 to the financial statements for additional information.Environmental MattersThe Southern Company system's operations are regulated by state and federal environmental agencies through a variety of laws and regulations governing air, water, land, avian and other wildlife and habitat protection, and other natural resources. The Southern Company system maintains comprehensive environmental compliance and GHG strategies to assess both current and II-39 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISupcoming requirements and compliance costs associated with these environmental laws and regulations. New or revised environmental laws and regulations could further affect many areas of operations for the Subsidiary Registrants. The costs required to comply with environmental laws and regulations and to achieve stated goals, including capital expenditures, operations and maintenance costs, and costs reflected in ARO liabilities, may impact future electric generating unit retirement and replacement decisions (which are subject to approval from the traditional electric operating companies' respective state PSCs), results of operations, cash flows, and/or financial condition. Related costs may result from the installation of additional environmental controls, closure and monitoring of CCR facilities, unit retirements, or changing fuel sources for certain existing units, as well as related upgrades to the Southern Company system's transmission and distribution (electric and natural gas) systems. A major portion of these costs is expected to be recovered through retail and wholesale rates, including existing ratemaking and billing provisions. The ultimate impact of environmental laws and regulations and the GHG goals discussed herein cannot be determined at this time and will depend on various factors, such as state adoption and implementation of requirements, the availability and cost of any deployed technology, fuel prices, the outcome of pending and/or future legal challenges, and the ability to continue recovering the related costs, through rates for the traditional electric operating companies and the natural gas distribution utilities and/or through long-term wholesale agreements for the traditional electric operating companies and Southern Power.Alabama Power and Mississippi Power recover environmental compliance costs through separate mechanisms, Rate CNP Compliance and the ECO Plan, respectively. Georgia Power's base rates include an ECCR tariff that allows for the recovery of environmental compliance costs. The natural gas distribution utilities of Southern Company Gas generally recover environmental remediation expenditures through rate mechanisms approved by their applicable state regulatory agencies. See Notes 2 and 3 to the financial statements for additional information.Southern Power's PPAs generally contain provisions that permit charging the counterparty for some of the new costs incurred as a result of changes in environmental laws and regulations. Since Southern Power's units are generally newer natural gas and renewable generating facilities, costs associated with environmental compliance for these facilities have been less significant than for similarly situated coal or older natural gas generating facilities. Environmental, natural resource, and land use concerns, including the applicability of air quality limitations, the potential presence of wetlands or threatened and endangered species, the availability of water withdrawal rights, uncertainties regarding impacts such as increased light or noise, and concerns about potential adverse health impacts can, however, increase the cost of siting and operating any type of future facility. The impact of such laws, regulations, and other considerations on Southern Power and subsequent recovery through PPA provisions cannot be determined at this time.Further, increased costs that are recovered through regulated rates could contribute to reduced demand for electricity and natural gas, which could negatively affect results of operations, cash flows, and/or financial condition. Additionally, many commercial and industrial customers may also be affected by existing and future environmental requirements, which may have the potential to affect their demand for electricity and natural gas.Although the timing, requirements, and estimated costs could change as environmental laws and regulations are adopted or modified, as compliance plans are revised or updated, and as legal challenges to rules are initiated or completed, estimated capital expenditures through 2027 based on the current environmental compliance strategy for the Southern Company system and the traditional electric operating companies are as follows:20232024202520262027Total(in millions)Southern Company$139 $125 $108 $91 $50 $513 Alabama Power53 35 46 28 18 180 Georgia Power82 86 56 53 24 301 Mississippi Power5 3 7 11 7 33 These estimates do not include any costs associated with potential regulation of GHG emissions. See "Global Climate Issues" herein for additional information. The Southern Company system also anticipates substantial expenditures associated with ash pond closure and groundwater monitoring under the CCR Rule and related state rules, which are reflected in the applicable Registrants' ARO liabilities. See FINANCIAL CONDITION AND LIQUIDITY – "Cash Requirements" herein and Note 6 to the financial statements for additional information.II-40 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISEnvironmental Laws and RegulationsAir QualitySince 1990, the Southern Company system reduced SO2 and NOX air emissions by 99% and 92%, respectively, through 2021. Since 2005, the Southern Company system reduced mercury air emissions by 97% through 2021.On March 11, 2022, the EPA released a proposed Federal Implementation Plan to require reductions in NOX emissions from sources in 26 states, including Alabama and Mississippi, to assure those states satisfy their interstate transport (good neighbor) obligations under the 2015 Ozone National Ambient Air Quality Standards (NAAQS) in downwind states. Georgia and North Carolina have approved interstate transport state implementation plans related to the 2015 Ozone NAAQS and are not subject to this rule. The EPA is anticipated to issue a final rule by March 2023 with initial applicability for 2023. The ultimate impact of a final rule cannot be determined at this time; however, it may result in increased compliance costs.Water QualityIn 2020, the EPA published the final steam electric ELG reconsideration rule (ELG Reconsideration Rule), a reconsideration of the 2015 ELG rule's limits on bottom ash transport water and flue gas desulfurization wastewater that extended the latest applicability date for both discharges to December 31, 2025. The ELG Reconsideration Rule also updated the voluntary incentive program and provided new subcategories for low utilization electric generating units and electric generating units that will permanently cease coal combustion by 2028. As required by the ELG Reconsideration Rule, in October 2021, Alabama Power and Georgia Power each submitted initial notices of planned participation (NOPP) for applicable units seeking to qualify for these subcategories.Alabama Power submitted its NOPP to the Alabama Department of Environmental Management (ADEM) indicating plans to retire Plant Barry Unit 5 (700 MWs) and to cease using coal and begin operating solely on natural gas at Plant Barry Unit 4 (350 MWs) and Plant Gaston Unit 5 (880 MWs). Alabama Power, as agent for SEGCO, indicated plans to retire Plant Gaston Units 1 through 4 (1,000 MWs). These plans are expected to be completed on or before the compliance date of December 31, 2028. The NOPP submittals are subject to the review of the ADEM. With the completion of the Calhoun Generating Station acquisition on September 30, 2022, Alabama Power expects to retire Plant Barry Unit 5 in late 2023 or early 2024 subject to certain operating conditions. Plant Barry Unit 4 ceased using coal and began to operate solely on natural gas in December 2022. See Notes 2 and 7 to the financial statements under "Alabama Power – Certificates of Convenience and Necessity" and "SEGCO," respectively, for additional information.The remaining assets for which Alabama Power has indicated retirement, due to early closure or repowering of the unit to natural gas, have net book values totaling approximately $1.4 billion (excluding capitalized asset retirement costs which are recovered through Rate CNP Compliance) at December 31, 2022. The net book value of $42 million for retired coal equipment at Plant Barry Unit 4 was reclassified to a regulatory asset at December 31, 2022. Based on an Alabama PSC order, Alabama Power is authorized to establish a regulatory asset to record the unrecovered investment costs, including the plant asset balance and the site removal and closure costs, associated with unit retirements caused by environmental regulations (Environmental Accounting Order). Under the Environmental Accounting Order, the regulatory asset would be amortized and recovered over an affected unit's remaining useful life, as established prior to the decision regarding early retirement, through Rate CNP Compliance. See Note 2 to the financial statements under "Alabama Power – Rate CNP Compliance" and " – Environmental Accounting Order" for additional information.Georgia Power submitted its NOPP to the Georgia Environmental Protection Division (EPD) indicating plans to retire Plant Wansley Units 1 and 2 (926 MWs based on 53.5% ownership), Plant Bowen Units 1 and 2 (1,400 MWs), and Plant Scherer Unit 3 (614 MWs based on 75% ownership) on or before the compliance date of December 31, 2028. Georgia Power also submitted a NOPP indicating plans to pursue compliance with the ELG Reconsideration Rule for Plant Scherer Units 1 and 2 (137 MWs based on 8.4% ownership) through the voluntary incentive program by no later than December 31, 2028. Georgia Power intends to comply with the ELG Rules for Plant Bowen Units 3 and 4 through the generally applicable requirements by December 31, 2025; therefore, no NOPP submission was required for these units. The NOPP submittals and generally applicable requirements are subject to the review of the Georgia EPD.The Georgia PSC approved the retirements of Plant Wansley Units 1 and 2 (which occurred on August 31, 2022) and Plant Scherer Unit 3 in its 2022 IRP order, but deferred a decision on the requested decertification and retirement of Plant Bowen Units 1 and 2 to the 2025 IRP. See Note 2 to the financial statements under "Georgia Power – Integrated Resource Plans" for additional information.II-41 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISThe ELG Reconsideration Rule has been challenged by several environmental organizations and the cases have been consolidated in the U.S. Court of Appeals for the Fourth Circuit. The case is being held in abeyance while the EPA undertakes a new rulemaking to revise the ELG Reconsideration Rule. A proposed rule, referred to as the ELG Supplemental Rule, is expected to be released by mid-2023. Any revisions could require changes in the traditional electric operating companies' compliance strategies.The ultimate outcome of these matters cannot be determined at this time.Coal Combustion ResidualsIn 2015, the EPA finalized non-hazardous solid waste regulations for the management and disposal of CCR, including coal ash and gypsum, in landfills and surface impoundments (ash ponds) at active electric generating power plants. The CCR Rule requires landfills and ash ponds to be evaluated against a set of performance criteria and potentially closed if certain criteria are not met. Closure of existing landfills and ash ponds requires installation of equipment and infrastructure to manage CCR in accordance with the CCR Rule. In addition to the federal CCR Rule, the States of Alabama and Georgia finalized state regulations regarding the management and disposal of CCR within their respective states. In 2019, the State of Georgia received partial approval from the EPA for its state CCR permitting program, which has broader applicability than the federal rule. The State of Mississippi has not developed a state CCR permit program.The Holistic Approach to Closure: Part A rule, finalized in 2020, revised the deadline to stop sending CCR and non-CCR wastes to unlined surface impoundments to April 11, 2021 and established a process for the EPA to approve extensions to the deadline. The traditional electric operating companies stopped sending CCR and non-CCR wastes to their unlined impoundments prior to April 11, 2021 and, therefore, did not submit requests for extensions. Beginning on January 11, 2022, the EPA has issued numerous Part A determinations that state its current positions on a variety of CCR Rule compliance requirements, such as criteria for groundwater corrective action and CCR unit closure. The traditional electric operating companies are working with state regulatory agencies to determine whether the EPA's current positions may impact closure and groundwater monitoring plans.On April 8, 2022, the Utilities Solid Waste Activities Group and a group of generating facility operators filed petitions for review in the U.S. Court of Appeals for the D.C. Circuit challenging whether the EPA's January 11, 2022 actions establish new legislative rules that should have gone through notice-and-comment rulemaking. A decision by the court is expected in late 2023. The ultimate impacts of the EPA's current positions are subject to the outcome of the pending litigation and any potential future rulemaking and cannot be determined at this time.Based on requirements for closure and monitoring of landfills and ash ponds pursuant to the CCR Rule and applicable state rules, the traditional electric operating companies have periodically updated, and expect to continue periodically updating, their related cost estimates and ARO liabilities for each CCR unit as additional information related to closure methodologies, schedules, and/or costs becomes available. Some of these updates have been, and future updates may be, material. Additionally, the closure designs and plans in the States of Alabama and Georgia are subject to approval by environmental regulatory agencies. Absent continued recovery of ARO costs through regulated rates, results of operations, cash flows, and financial condition for Southern Company and the traditional electric operating companies could be materially impacted. See FINANCIAL CONDITION AND LIQUIDITY – "Cash Requirements," Notes 2 and 3 to the financial statements under "Georgia Power – Rate Plans" and "General Litigation Matters – Alabama Power," respectively, and Note 6 to the financial statements for additional information.Environmental RemediationThe Southern Company system must comply with environmental laws and regulations governing the handling and disposal of waste and releases of hazardous substances. Under these various laws and regulations, the Southern Company system could incur substantial costs to clean up affected sites. The traditional electric operating companies and Southern Company Gas conduct studies to determine the extent of any required cleanup and have recognized the estimated costs to clean up known impacted sites in their financial statements. Amounts for cleanup and ongoing monitoring costs were not material for any year presented. The traditional electric operating companies and the natural gas distribution utilities in Illinois and Georgia (which represent substantially all of Southern Company Gas' accrued remediation costs) have all received authority from their respective state PSCs or other applicable state regulatory agencies to recover approved environmental remediation costs through regulatory mechanisms. These regulatory mechanisms are adjusted annually or as necessary within limits approved by the state PSCs or other applicable state regulatory agencies. The traditional electric operating companies and Southern Company Gas may be liable for some or all required cleanup costs for additional sites that may require environmental remediation. See Note 3 to the financial statements under "Environmental Remediation" for additional information.Global Climate IssuesIn 2019, the EPA published the final Affordable Clean Energy rule (ACE Rule), which repealed and replaced the Clean Power Plan (CPP) and would have required states to develop unit-specific CO2 emission rate standards for existing coal-fired units based on heat-rate efficiency improvements. On June 30, 2022, the U.S. Supreme Court issued an opinion limiting the EPA's authority II-42 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISto regulate GHG emissions under the Clean Air Act with a focus on whether such authority allows the EPA to regulate the electric industry in a manner as broad as the CPP. The EPA has announced its intent to propose a new rule for existing fossil fuel-fired electric generating units and to propose revised performance standards for new fossil fuel-fired electric generating units pursuant to the Clean Air Act by April 2023. The ultimate impact of these actions cannot be determined at this time.In February 2021, the United States officially rejoined the Paris Agreement. The Paris Agreement establishes a non-binding universal framework for addressing GHG emissions based on nationally determined emissions reduction contributions and sets in place a process for tracking progress towards the goals every five years. In April 2021, President Biden announced a new target for the United States to achieve a 50% to 52% reduction in economy-wide GHG emissions from 2005 levels by 2030. The target was accepted by the United Nations as the United States' nationally determined emissions reduction contribution under the Paris Agreement.Additional GHG policies, including legislation, may emerge in the future requiring the United States to accelerate its transition to a lower GHG emitting economy; however, associated impacts are currently unknown. The Southern Company system has transitioned from an electric generating mix of 70% coal and 15% natural gas in 2007 to a mix of 22% coal and 51% natural gas in 2022. This transition has been supported in part by the Southern Company system retiring over 6,700 MWs of coal-fired generating capacity since 2010 and converting 3,700 MWs of generating capacity from coal to natural gas since 2015. In addition, the Southern Company system's capacity mix consists of over 11,500 MWs of renewable and storage facilities through ownership and long-term PPAs. See "Environmental Laws and Regulations – Water Quality" herein for information on plans to retire or convert to natural gas additional coal-fired generating capacity. In addition, Southern Company Gas has replaced over 6,000 miles of pipe material that was more prone to fugitive emissions (unprotected steel and cast-iron pipe), resulting in mitigation of more than 3.3 million metric tons of CO2 equivalents from its natural gas distribution system since 1998.The following table provides the Registrants' 2021 and preliminary 2022 Scope 1 GHG emissions based on equity share of facilities:2021Preliminary 2022(in million metric tons of CO2 equivalent)Southern Company(*)8285Alabama Power(*)3435Georgia Power2323Mississippi Power89Southern Power1113Southern Company Gas(*)22(*)Includes GHG emissions attributable to disposed assets through the date of the applicable disposition and to acquired assets beginning with the date of the applicable acquisition. See Note 15 to the financial statements for additional information.Southern Company system management has established an intermediate goal of a 50% reduction in GHG emissions from 2007 levels by 2030 and a long-term goal of net zero GHG emissions by 2050. Based on the preliminary 2022 emissions, the Southern Company system has achieved an estimated GHG emission reduction of 46% since 2007. GHG emissions increased in 2022 due to an increase in generation when compared to 2021 resulting from increased electricity sales, as discussed further under RESULTS OF OPERATIONS – "Southern Company – Electricity Business" herein. Southern Company system management expects to achieve sustained GHG emissions reductions of at least 50% as early as 2025. While none of Southern Company's subsidiaries are currently subject to renewable portfolio standards or similar requirements, management of the traditional electric operating companies is working with applicable regulators through their IRP processes to continue the generating fleet transition in a manner responsible to customers, communities, employees, and other stakeholders. Achievement of these goals is dependent on many factors, including natural gas prices and the pace and extent of development and deployment of low- to no-GHG energy technologies and negative carbon concepts. Southern Company system management plans to continue to pursue a diverse portfolio including low-carbon and carbon-free resources and energy efficiency resources; continue to transition the Southern Company system's generating fleet and make the necessary related investments in transmission and distribution systems; implement initiatives to reduce natural gas distribution operational emissions; continue its research and development with a particular focus on technologies that lower GHG emissions, including methods of removing carbon from the atmosphere; and constructively engage with policymakers, regulators, investors, customers, and other stakeholders to support outcomes leading to a net zero future.II-43 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISRegulatory MattersSee OVERVIEW – "Recent Developments" herein and Note 2 to the financial statements for a discussion of regulatory matters related to Alabama Power, Georgia Power, Mississippi Power, and Southern Company Gas, including items that could impact the applicable Registrants' future earnings, cash flows, and/or financial condition.Construction ProgramsThe Subsidiary Registrants are engaged in continuous construction programs to accommodate existing and estimated future loads on their respective systems. The Southern Company system strategy continues to include developing and constructing new electric generating facilities, expanding and improving the electric transmission and electric and natural gas distribution systems, and undertaking projects to comply with environmental laws and regulations.For the traditional electric operating companies, major generation construction projects are subject to state PSC approval in order to be included in retail rates. The largest construction project currently underway in the Southern Company system is Plant Vogtle Units 3 and 4. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" for additional information. Also see Note 2 to the financial statements under "Alabama Power – Certificates of Convenience and Necessity" for information regarding Alabama Power's construction of Plant Barry Unit 8.See Note 15 to the financial statements under "Southern Power" for information about costs relating to Southern Power's construction of renewable energy facilities.Southern Company Gas is engaged in various infrastructure improvement programs designed to update or expand the natural gas distribution systems of the natural gas distribution utilities to improve reliability, reduce emissions, and meet operational flexibility and growth. The natural gas distribution utilities recover their investment and a return associated with these infrastructure programs through their regulated rates. See Note 2 to the financial statements under "Southern Company Gas – Infrastructure Replacement Programs and Capital Projects" for additional information on Southern Company Gas' construction program.See FINANCIAL CONDITION AND LIQUIDITY – "Cash Requirements" herein for additional information regarding the Registrants' capital requirements for their construction programs, including estimated totals for each of the next five years.Southern Power's Power Sales AgreementsGeneralSouthern Power has PPAs with some of the traditional electric operating companies, other investor-owned utilities, IPPs, municipalities, and other load-serving entities, as well as commercial and industrial customers. The PPAs are expected to provide Southern Power with a stable source of revenue during their respective terms.Many of Southern Power's PPAs have provisions that require Southern Power or the counterparty to post collateral or an acceptable substitute guarantee if (i) S&P or Moody's downgrades the credit ratings of the respective company to an unacceptable credit rating, (ii) the counterparty is not rated, or (iii) the counterparty fails to maintain a minimum coverage ratio.Southern Power works to maintain and expand its share of the wholesale market. During 2022, Southern Power continued to be successful in remarketing up to 1,175 MWs of annual natural gas generation capacity to load-serving entities through several PPAs extending over the next eight years. Market demand is being driven by load-serving entities replacing expired purchase contracts and/or retired generation, as well as planning for future growth.Natural GasSouthern Power's electricity sales from natural gas facilities are primarily through long-term PPAs that consist of two types of agreements. The first type, referred to as a unit or block sale, is a customer purchase from a dedicated generating unit where all or a portion of the generation from that unit is reserved for that customer. Southern Power typically has the ability to serve the unit or block sale customer from an alternate resource. The second type, referred to as requirements service, provides that Southern Power serve the customer's capacity and energy requirements from a combination of the customer's own generating units and from Southern Power resources not dedicated to serve unit or block sales. Southern Power has rights to purchase power provided by the requirements customers' resources when economically viable.As a general matter, substantially all of the PPAs provide that the purchasers are responsible for either procuring the fuel (tolling agreements) or reimbursing Southern Power for substantially all of the cost of fuel or purchased power relating to the energy delivered under such PPAs. To the extent a particular generating facility does not meet the operational requirements contemplated in the PPAs, Southern Power may be responsible for excess fuel costs. With respect to fuel transportation risk, most of Southern II-44 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISPower's PPAs provide that the counterparties are responsible for the availability of fuel transportation to the particular generating facility.Capacity charges that form part of the PPA payments are designed to recover fixed and variable operation and maintenance costs based on dollars-per-kilowatt year. In general, to reduce Southern Power's exposure to certain operation and maintenance costs, Southern Power has LTSAs. See Note 1 to the financial statements under "Long-Term Service Agreements" for additional information.Solar and WindSouthern Power's electricity sales from solar and wind generating facilities are also primarily through long-term PPAs; however, these PPAs do not have a capacity charge and customers either purchase the energy output of a dedicated renewable facility through an energy charge or provide Southern Power a certain fixed price for the electricity sold to the grid. As a result, Southern Power's ability to recover fixed and variable operations and maintenance expenses is dependent upon the level of energy generated from these facilities, which can be impacted by weather conditions, equipment performance, transmission constraints, and other factors. Generally, under the renewable generation PPAs, the purchasing party retains the right to keep or resell the associated renewable energy credits.Income Tax MattersConsolidated Income TaxesThe impact of certain tax events at Southern Company and/or its other subsidiaries can, and does, affect each Registrant's ability to utilize certain tax credits. See "Tax Credits" and ACCOUNTING POLICIES – "Application of Critical Accounting Policies and Estimates – Accounting for Income Taxes" herein and Note 10 to the financial statements for additional information.Tax CreditsSouthern Company has received ITCs and PTCs in connection with investments in solar, wind, fuel cell facilities, and battery energy storage facilities (co-located with existing solar facilities) primarily at Southern Power and Georgia Power.Southern Power's ITCs relate to its investment in new solar facilities and battery energy storage facilities (co-located with existing solar facilities) that are acquired or constructed and its PTCs relate to the first 10 years of energy production from its wind facilities, which have had, and may continue to have, a material impact on Southern Power's cash flows and net income. At December 31, 2022, Southern Company and Southern Power had approximately $1.1 billion and $0.8 billion, respectively, of unutilized federal ITCs and PTCs, which are currently expected to be fully utilized by 2026, but could be further delayed. Since 2018, Southern Power has been utilizing tax equity partnerships for wind, solar, and battery energy storage projects, where the tax partner takes significantly all of the respective federal tax benefits. These tax equity partnerships are consolidated in Southern Company's and Southern Power's financial statements using the HLBV methodology to allocate partnership gains and losses. See Note 1 to the financial statements under "General" for additional information on the HLBV methodology and Note 1 to the financial statements under "Income Taxes" and Note 10 to the financial statements under "Deferred Tax Assets and Liabilities – Tax Credit Carryforwards" and "Effective Tax Rate" for additional information regarding utilization and amortization of credits and the tax benefit related to associated basis differences.Inflation Reduction ActOn August 16, 2022, the Inflation Reduction Act (IRA) was signed into law. The IRA extends, expands, and increases ITCs and PTCs for clean energy projects, allows PTCs for solar projects, adds ITCs for stand-alone energy storage projects with an option to elect out of the tax normalization requirement, and allows for the transferability of the tax credits. The IRA extends and increases the tax credits for carbon capture and sequestration projects and adds tax credits for clean hydrogen and nuclear projects. Additional ITC and PTC amounts are available if the projects meet domestic content requirements or are located in low-income or energy communities. The IRA also enacted a 15% corporate minimum tax on book income, with material adjustments for pension costs and tax depreciation. The 15% corporate minimum tax on book income can be reduced by energy tax credits.For solar projects placed in service in 2022 through 2032, the IRA provides for a 30% ITC and an option to claim a PTC instead of an ITC. Starting in 2023 and through 2032, the IRA provides for a 30% ITC for stand-alone energy storage projects. For wind projects placed in service in 2022 through 2032, the IRA provides for a 100% PTC, adjusted for inflation annually. For projects placed in service before 2022, the 2022 PTC rate is 2.6 cents per KWH. For projects placed in service in 2022, the 2022 PTC rate II-45 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISis 2.75 cents per KWH. The same PTC rate applies for solar projects for which the PTC option has been elected. To realize the full value of ITCs and PTCs, the IRA requires satisfaction of prevailing wage and apprenticeship requirements.Implementation of the IRA provisions is subject to the issuance of additional guidance by the U.S. Treasury Department and the IRS, and the ultimate impacts cannot be determined at this time; however, the IRA is not expected to have a material impact on the Registrants' financial statements for the year ending December 31, 2023.General Litigation and Other MattersThe Registrants are involved in various matters being litigated and/or regulatory and other matters that could affect future earnings, cash flows, and/or financial condition. The ultimate outcome of such pending or potential litigation against each Registrant and any subsidiaries or regulatory and other matters cannot be determined at this time; however, for current proceedings and/or matters not specifically reported herein or in Notes 2 and 3 to the financial statements, management does not anticipate that the ultimate liabilities, if any, arising from such current proceedings and/or matters would have a material effect on such Registrant's financial statements. See Notes 2 and 3 to the financial statements for a discussion of various contingencies, including matters being litigated, regulatory matters, and other matters which may affect future earnings potential.ACCOUNTING POLICIESApplication of Critical Accounting Policies and EstimatesThe Registrants prepare their financial statements in accordance with GAAP. Significant accounting policies are described in the notes to the financial statements. In the application of these policies, certain estimates are made that may have a material impact on the results of operations and related disclosures of the applicable Registrants (as indicated in the section descriptions herein). Different assumptions and measurements could produce estimates that are significantly different from those recorded in the financial statements. Senior management has reviewed and discussed the following critical accounting policies and estimates with the Audit Committee of Southern Company's Board of Directors.Utility Regulation (Southern Company, Alabama Power, Georgia Power, Mississippi Power, and Southern Company Gas)The traditional electric operating companies and the natural gas distribution utilities are subject to retail regulation by their respective state PSCs or other applicable state regulatory agencies and wholesale regulation by the FERC. These regulatory agencies set the rates the traditional electric operating companies and the natural gas distribution utilities are permitted to charge customers based on allowable costs, including a reasonable ROE. As a result, the traditional electric operating companies and the natural gas distribution utilities apply accounting standards which require the financial statements to reflect the effects of rate regulation. Through the ratemaking process, the regulators may require the inclusion of costs or revenues in periods different than when they would be recognized by a non-regulated company. This treatment may result in the deferral of expenses and the recording of related regulatory assets based on anticipated future recovery through rates or the deferral of gains or creation of liabilities and the recording of related regulatory liabilities. The application of the accounting standards for rate regulated entities also impacts their financial statements as a result of the estimates of allowable costs used in the ratemaking process. These estimates may differ from those actually incurred by the traditional electric operating companies and the natural gas distribution utilities; therefore, the accounting estimates inherent in specific costs such as depreciation, AROs, and pension and other postretirement benefits have less of a direct impact on the results of operations and financial condition of the applicable Registrants than they would on a non-regulated company.Revenues related to regulated utility operations as a percentage of total operating revenues in 2022 for the applicable Registrants were as follows: 88% for Southern Company, 98% for Alabama Power, 97% for Georgia Power, 99% for Mississippi Power, and 88% for Southern Company Gas.As reflected in Note 2 to the financial statements, significant regulatory assets and liabilities have been recorded. Management reviews the ultimate recoverability of these regulatory assets and any requirement to refund these regulatory liabilities based on applicable regulatory guidelines and GAAP. However, adverse legislative, judicial, or regulatory actions could materially impact the amounts of such regulatory assets and liabilities and could adversely impact the financial statements of the applicable Registrants.Estimated Cost, Schedule, and Rate Recovery for the Construction of Plant Vogtle Units 3 and 4(Southern Company and Georgia Power)In 2016, the Georgia PSC approved the Vogtle Cost Settlement Agreement, which resolved certain prudency matters in connection with Georgia Power's fifteenth VCM report. In 2017, the Georgia PSC approved Georgia Power's seventeenth VCM report, which included a recommendation to continue construction of Plant Vogtle Units 3 and 4, with Southern Nuclear serving as project manager and Bechtel serving as the primary construction contractor, as well as a modification of the Vogtle Cost II-46 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISSettlement Agreement. The Georgia PSC's related order stated that under the modified Vogtle Cost Settlement Agreement, (i) none of the $3.3 billion of costs incurred through December 31, 2015 should be disallowed as imprudent; (ii) the Contractor Settlement Agreement was reasonable and prudent and none of the $0.3 billion paid pursuant to the Contractor Settlement Agreement should be disallowed from rate base on the basis of imprudence; (iii) capital costs incurred up to $5.68 billion would be presumed to be reasonable and prudent with the burden of proof on any party challenging such costs; (iv) Georgia Power would have the burden of proof to show that any capital costs above $5.68 billion were prudent; (v) Georgia Power's total project capital cost forecast of $7.3 billion (net of $1.7 billion received under the Guarantee Settlement Agreement and approximately $188 million in related customer refunds) was found reasonable and did not represent a cost cap; and (vi) a prudence proceeding on cost recovery will occur subsequent to achieving fuel load for Unit 4. In its order, the Georgia PSC also stated if other conditions change and assumptions upon which Georgia Power's seventeenth VCM report are based do not materialize, the Georgia PSC reserved the right to reconsider the decision to continue construction.As of December 31, 2022, Georgia Power revised its total project capital cost forecast to $10.6 billion (net of $1.7 billion received under the Guarantee Settlement Agreement and approximately $188 million in related customer refunds). This forecast includes construction contingency of $60 million and is based on projected in-service dates at the end of the second quarter 2023 and the first quarter 2024 for Units 3 and 4, respectively. Since 2018, established construction contingency and additional costs totaling $2.5 billion have been assigned to the base capital cost forecast. Although Georgia Power believes these incremental costs are reasonable and necessary to complete the project and the Georgia PSC's order in the seventeenth VCM proceeding specifically states that the construction of Plant Vogtle Units 3 and 4 is not subject to a cost cap, Georgia Power will not seek rate recovery for the $0.7 billion increase to the base capital cost forecast included in the nineteenth VCM report and charged to income by Georgia Power in the second quarter 2018 and has not sought rate recovery for any subsequent construction and additional contingency costs assigned to the base capital cost forecast. After considering the significant level of uncertainty that exists regarding the future recoverability of these costs since the ultimate outcome of these matters is subject to the outcome of future assessments by management, as well as Georgia PSC decisions in these future regulatory proceedings, Georgia Power recorded total pre-tax charges to income of $1.1 billion ($0.8 billion after tax) in 2018; $149 million ($111 million after tax) and $176 million ($131 million after tax) in the second quarter and the fourth quarter 2020, respectively; $48 million ($36 million after tax), $460 million ($343 million after tax), $264 million ($197 million after tax), and $480 million ($358 million after tax) in the first quarter 2021, the second quarter 2021, the third quarter 2021, and the fourth quarter 2021, respectively; and $36 million ($27 million after tax), $32 million ($24 million after tax), and $148 million ($110 million after tax) in the second quarter 2022, the third quarter 2022, and the fourth quarter 2022, respectively.Georgia Power and the other Vogtle Owners do not agree on either the starting dollar amount for the determination of cost increases subject to the cost-sharing and tender provisions of the Global Amendments (as defined in Note 2 to the financial statements under "Georgia Power – Nuclear Construction – Joint Owner Contracts") or the extent to which COVID-19-related costs impact those provisions. The other Vogtle Owners notified Georgia Power that they believe the project capital cost forecast approved by the Vogtle Owners on February 14, 2022 triggered the tender provisions. On June 17, 2022 and July 26, 2022, OPC and Dalton, respectively, notified Georgia Power of their purported exercises of their tender options. Georgia Power did not accept these purported tender exercises. On September 29, 2022, Georgia Power and MEAG Power reached an agreement to resolve their dispute regarding the proper interpretation of the cost-sharing and tender provisions of the Global Amendments. Under the terms of the agreement, among other items, (i) MEAG Power will not exercise its tender option and will retain its full ownership interest in Plant Vogtle Units 3 and 4; (ii) Georgia Power will reimburse a portion of MEAG Power's costs of construction for Plant Vogtle Units 3 and 4 as such costs are incurred and with no further adjustment for force majeure costs, which payments will total approximately $92 million based on the current project capital cost forecast; and (iii) Georgia Power will reimburse 20% of MEAG Power's costs of construction with respect to any amounts over the current project capital cost forecast, with no further adjustment for force majeure costs.Georgia Power recorded additional pre-tax charges (credits) to income of approximately $440 million ($328 million after tax) in the fourth quarter 2021 and approximately $16 million ($12 million after tax), $(102) million ($(76) million after tax), and $53 million ($40 million after tax) in the second quarter 2022, the third quarter 2022, and the fourth quarter 2022, respectively, associated with the cost-sharing and tender provisions of the Global Amendments, including the settlement with MEAG Power. A total of $407 million associated with these provisions is included in the total project capital cost forecast and will not be recovered from retail customers. The settlement with MEAG Power does not resolve the separate pending litigation with OPC, including Dalton's associated complaint, regarding the cost-sharing and tender provisions of the Global Amendments described in Note 2 to the financial statements under "Georgia Power – Nuclear Construction – Joint Owner Contracts." Georgia Power may be required to record further pre-tax charges to income of up to approximately $345 million associated with these provisions for OPC and Dalton based on the current project capital cost forecast.Georgia Power's ownership interest in Plant Vogtle Units 3 and 4 continues to be 45.7%. Georgia Power believes the increases in the total project capital cost forecast through December 31, 2022 will trigger the tender provisions, but Georgia Power disagrees II-47 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISwith OPC and Dalton on the tender provisions trigger date. Valid notices of tender from OPC and Dalton would require Georgia Power to pay 100% of their respective remaining shares of the costs necessary to complete Plant Vogtle Units 3 and 4. Georgia Power's incremental ownership interest will be calculated and conveyed to Georgia Power after Plant Vogtle Units 3 and 4 are placed in service.As part of its ongoing processes, Southern Nuclear continues to evaluate cost and schedule forecasts on a regular basis to incorporate current information available, particularly in the areas of start-up testing and related test results, engineering support, commodity installation, system turnovers, and workforce statistics.The projected schedule for Unit 3 primarily depends on the progression of final component and pre-operational testing and start-up, which may be impacted by further equipment, component, and/or other operational challenges. The projected schedule for Unit 4 primarily depends on potential impacts arising from Unit 4 testing activities overlapping with Unit 3 start-up and commissioning; maintaining overall construction productivity and production levels, particularly in subcontractor scopes of work; and maintaining appropriate levels of craft laborers. Any further delays could result in later in-service dates and cost increases.Various design and other licensing-based compliance matters, including the timely submittal by Southern Nuclear of the ITAAC documentation and the related reviews and approvals by the NRC necessary to support NRC authorization to load fuel for Unit 4, may arise, which may result in additional license amendment requests or require other resolution. If any license amendment requests or other licensing-based compliance issues, including inspections and ITAACs for Unit 4, are not resolved in a timely manner, there may be delays in the project schedule that could result in increased costs.The ultimate outcome of these matters cannot be determined at this time. However, any extension of the in-service date beyond the second quarter 2023 for Unit 3 or the first quarter 2024 for Unit 4, including the joint owner cost sharing and tender impacts described in Note 2, is estimated to result in additional base capital costs for Georgia Power of up to $15 million per month for Unit 3 and $35 million per month for Unit 4, as well as the related AFUDC and any additional related construction, support resources, or testing costs. While Georgia Power is not precluded from seeking retail recovery of any future capital cost forecast increase other than the amounts related to the cost-sharing and tender provisions of the joint ownership agreements described above, management will ultimately determine whether or not to seek recovery. Any further changes to the capital cost forecast that are not expected to be recoverable through regulated rates will be required to be charged to income and such charges could be material.Given the significant complexity involved in estimating the future costs to complete construction and start-up of Plant Vogtle Units 3 and 4 and the significant management judgment necessary to assess the related uncertainties surrounding future rate recovery of any projected cost increases, as well as the potential impact on results of operations and cash flows, Southern Company and Georgia Power consider these items to be critical accounting estimates. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" for additional information.Accounting for Income Taxes (Southern Company, Georgia Power, Mississippi Power, Southern Power, and Southern Company Gas)The consolidated income tax provision and deferred income tax assets and liabilities, as well as any unrecognized tax benefits and valuation allowances, require significant judgment and estimates. These estimates are supported by historical tax return data, reasonable projections of taxable income, the ability and intent to implement tax planning strategies if necessary, and interpretations of applicable tax laws and regulations across multiple taxing jurisdictions. The effective tax rate reflects the statutory tax rates and calculated apportionments for the various states in which the Southern Company system operates.Southern Company files a consolidated federal income tax return and the Registrants file various state income tax returns, some of which are combined or unitary. Under a joint consolidated income tax allocation agreement, each Southern Company subsidiary's current and deferred tax expense is computed on a stand-alone basis and each subsidiary is allocated an amount of tax similar to that which would be paid if it filed a separate income tax return. In accordance with IRS regulations, each company is jointly and severally liable for the federal tax liability. Certain deductions and credits can be limited or utilized at the consolidated or combined level resulting in tax credit and/or state NOL carryforwards that would not otherwise result on a stand-alone basis. Utilization of these carryforwards and the assessment of valuation allowances are based on significant judgment and extensive analysis of Southern Company's and its subsidiaries' current financial position and results of operations, including currently available information about future years, to estimate when future taxable income will be realized. See Note 10 to the financial statements under "Deferred Tax Assets and Liabilities – Tax Credit Carryforwards" and " – Net Operating Loss Carryforwards" for additional information.Current and deferred state income tax liabilities and assets are estimated based on laws of multiple states that determine the income to be apportioned to their jurisdictions. States have various filing methodologies and utilize specific formulas to calculate the apportionment of taxable income. The calculation of deferred state taxes considers apportionment factors and filing II-48 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISmethodologies that are expected to apply in future years. Any apportionments and/or filing methodologies ultimately finalized in a manner inconsistent with expectations could have a material effect on the financial statements of the applicable Registrants.Given the significant judgment involved in estimating tax credit and/or state NOL carryforwards and multi-state apportionments for all subsidiaries, the applicable Registrants consider deferred income tax liabilities and assets to be critical accounting estimates.Asset Retirement Obligations (Southern Company, Alabama Power, Georgia Power, Mississippi Power, and Southern Company Gas)AROs are computed as the present value of the estimated costs for an asset's future retirement and are recorded in the period in which the liability is incurred. The estimated costs are capitalized as part of the related long-lived asset and depreciated over the asset's useful life. In the absence of quoted market prices, AROs are estimated using present value techniques in which estimates of future cash outlays associated with the asset retirements are discounted using a credit-adjusted risk-free rate. Estimates of the timing and amounts of future cash outlays are based on projections of when and how the assets will be retired and the cost of future removal activities.The ARO liabilities for the traditional electric operating companies primarily relate to facilities that are subject to the CCR Rule and the related state rules, principally ash ponds. In addition, Alabama Power and Georgia Power have retirement obligations related to the decommissioning of nuclear facilities (Alabama Power's Plant Farley and Georgia Power's ownership interests in Plant Hatch and Plant Vogtle Units 1 and 2). Other significant AROs include various landfill sites and asbestos removal for Alabama Power, Georgia Power, and Mississippi Power and gypsum cells and mine reclamation for Mississippi Power.The traditional electric operating companies and Southern Company Gas also have identified other retirement obligations, such as obligations related to certain electric transmission and distribution facilities, certain asbestos-containing material within long-term assets not subject to ongoing repair and maintenance activities, certain wireless communication towers, the disposal of polychlorinated biphenyls in certain transformers, leasehold improvements, equipment on customer property, and property associated with the Southern Company system's rail lines and natural gas pipelines. However, liabilities for the removal of these assets have not been recorded because the settlement timing for certain retirement obligations related to these assets is indeterminable and, therefore, the fair value of the retirement obligations cannot be reasonably estimated. A liability for these retirement obligations will be recognized when sufficient information becomes available to support a reasonable estimation of the ARO.The cost estimates for AROs related to the disposal of CCR are based on information using various assumptions related to closure and post-closure costs, timing of future cash outlays, inflation and discount rates, and the potential methods for complying with the CCR Rule and the related state rules. The traditional electric operating companies have periodically updated, and expect to continue periodically updating, their related cost estimates and ARO liabilities for each CCR unit as additional information related to these assumptions becomes available. Some of these updates have been, and future updates may be, material. See Note 6 to the financial statements for additional information, including updates to AROs related to ash ponds recorded during 2022 by certain Registrants.Given the significant judgment involved in estimating AROs, the applicable Registrants consider the liabilities for AROs to be critical accounting estimates.Pension and Other Postretirement Benefits (Southern Company, Alabama Power, Georgia Power, Mississippi Power, and Southern Company Gas)The applicable Registrants' calculations of pension and other postretirement benefits expense are dependent on a number of assumptions. These assumptions include discount rates, healthcare cost trend rates, expected long-term rate of return (LRR) on plan assets, mortality rates, expected salary and wage increases, and other factors. Components of pension and other postretirement benefits expense include interest and service cost on the pension and other postretirement benefit plans, expected return on plan assets, and amortization of certain unrecognized costs and obligations. Actual results that differ from the assumptions utilized are accumulated and amortized over future periods and, therefore, generally affect recognized expense and the recorded obligation in future periods. While the applicable Registrants believe the assumptions used are appropriate, differences in actual experience or significant changes in assumptions would affect their pension and other postretirement benefit costs and obligations.Key elements in determining the applicable Registrants' pension and other postretirement benefit expense are the LRR and the discount rate used to measure the benefit plan obligations and the periodic benefit plan expense for future periods. For purposes of determining the applicable Registrants' liabilities related to the pension and other postretirement benefit plans, Southern Company discounts the future related cash flows using a single-point discount rate for each plan developed from the weighted average of market-observed yields for high quality fixed income securities with maturities that correspond to expected benefit payments. The II-49 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISdiscount rate assumption impacts both the service cost and non-service costs components of net periodic benefit costs as well as the projected benefit obligations.The LRR on pension and other postretirement benefit plan assets is based on Southern Company's investment strategy, as described in Note 11 to the financial statements, historical experience, and expectations that consider external actuarial advice, and represents the average rate of earnings expected over the long term on the assets invested to provide for anticipated future benefit payments. Southern Company determines the amount of the expected return on plan assets component of non-service costs by applying the LRR of various asset classes to Southern Company's target asset allocation. The LRR only impacts the non-service costs component of net periodic benefit costs for the following year and is set annually at the beginning of the year.The following table illustrates the sensitivity to changes in the applicable Registrants' long-term assumptions with respect to the discount rate, salary increases, and the long-term rate of return on plan assets:Increase/(Decrease) in25 Basis Point Change in:Total Benefit Expense for 2023Projected Obligation for Pension Plan at December 31, 2022Projected Obligation forOther PostretirementBenefit Plans at December 31, 2022(in millions)Discount rate:Southern Company$33/$(25)$395/$(375)$35/$(33)Alabama Power$9/$(9)$95/$(90)$9/$(8)Georgia Power$9/$(9)$116/$(111)$12/$(12)Mississippi Power$2/$(1)$18/$(17)$1/$(1)Southern Company Gas$2/$(2)$25/$(24)$4/$(4)Salaries:Southern Company$16/$(15)$81/$(79)$–/$–Alabama Power$5/$(4)$23/$(22)$–/$–Georgia Power$5/$(4)$22/$(22)$–/$–Mississippi Power$1/$(1)$3/$(3)$–/$–Southern Company Gas$1/$(0)$2/$(2)$–/$–Long-term return on plan assets:Southern Company$39/$(39)N/AN/AAlabama Power$10/$(10)N/AN/AGeorgia Power$12/$(12)N/AN/AMississippi Power$2/$(2)N/AN/ASouthern Company Gas$3/$(3)N/AN/ASee Note 11 to the financial statements for additional information regarding pension and other postretirement benefits.Asset Impairment (Southern Company, Southern Power, and Southern Company Gas)Goodwill (Southern Company and Southern Company Gas)The acquisition method of accounting for business combinations requires the assets acquired and liabilities assumed to be recorded at the date of acquisition at their respective estimated fair values. The applicable Registrants have recognized goodwill as of the date of their acquisitions, as a residual over the fair values of the identifiable net assets acquired. Goodwill is tested for impairment at the reporting unit level on an annual basis in the fourth quarter of the year and on an interim basis if events and circumstances occur that indicate goodwill may be impaired. A reporting unit is the operating segment, or a business one level below the operating segment (a component), if discrete financial information is prepared and regularly reviewed by management. Components are aggregated if they have similar economic characteristics.As part of the goodwill impairment tests, the applicable Registrant may perform an initial qualitative assessment to determine whether it is more likely than not that the fair value of each reporting unit is less than its carrying amount before applying the quantitative goodwill impairment test. If the applicable Registrant elects to perform the qualitative assessment, it evaluates relevant events and circumstances, including but not limited to, macroeconomic conditions, industry and market conditions, cost II-50 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISfactors, financial performance, entity specific events, and events specific to each reporting unit. If the applicable Registrant determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, or it elects not to perform a qualitative assessment, it compares the fair value of the reporting unit to its carrying amount to determine if the fair value is greater than its carrying amount.Goodwill for Southern Company and Southern Company Gas was $5.2 billion and $5.0 billion, respectively, at December 31, 2022. During the fourth quarter 2022, Southern Company recorded a $119 million impairment loss as a result of its annual goodwill impairment test for PowerSecure.The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can significantly impact the applicable Registrant's results of operations. Fair values and useful lives are determined based on, among other factors, the expected future period of benefit of the asset, the various characteristics of the asset, and projected cash flows. As the determination of an asset's fair value and useful life involves management making certain estimates and because these estimates form the basis for the determination of whether or not an impairment charge should be recorded, the applicable Registrants consider these estimates to be critical accounting estimates.See Note 1 to the financial statements under "Goodwill and Other Intangible Assets and Liabilities" for additional information regarding the applicable Registrants' goodwill.Long-Lived Assets (Southern Company, Southern Power, and Southern Company Gas)The applicable Registrants assess their other long-lived assets for impairment whenever events or changes in circumstances indicate that an asset's carrying amount may not be recoverable. If an indicator exists, the asset is tested for recoverability by comparing the asset carrying amount to the sum of the undiscounted expected future cash flows directly attributable to the asset's use and eventual disposition. If the estimate of undiscounted future cash flows is less than the carrying amount of the asset, the fair value of the asset is determined and a loss is recorded equal to the difference between the carrying amount and the fair value of the asset. In addition, when assets are identified as held for sale, an impairment loss is recognized to the extent the carrying amount of the assets or asset group exceeds their fair value less cost to sell. A high degree of judgment is required in developing estimates related to these evaluations, which are based on projections of various factors, some of which have been quite volatile in recent years. Impairments of long-lived assets of the traditional electric utilities and natural gas distribution utilities are generally related to specific regulatory disallowances.Southern Power's investments in long-lived assets are primarily generation assets. Excluding the natural gas distribution utilities, Southern Company Gas' investments in long-lived assets are primarily natural gas transportation and storage facility assets.For Southern Power, examples of impairment indicators could include significant changes in construction schedules, current period losses combined with a history of losses or a projection of continuing losses, a significant decrease in market prices, changes in tax legislation, the inability to remarket generating capacity for an extended period, the unplanned termination of a customer contract, or the inability of a customer to perform under the terms of the contract. For Southern Company Gas, examples of impairment indicators could include, but are not limited to, significant changes in the U.S. natural gas storage market, construction schedules, current period losses combined with a history of losses or a projection of continuing losses, a significant decrease in market prices, the inability to renew or extend customer contracts or the inability of a customer to perform under the terms of the contract, attrition rates, or the inability to deploy a development project.As the determination of the expected future cash flows generated from an asset, an asset's fair value, and useful life involves management making certain estimates and because these estimates form the basis for the determination of whether or not an impairment charge should be recorded, the applicable Registrants consider these estimates to be critical accounting estimates.During 2021 and 2020, Southern Company recorded impairment charges totaling $7 million ($6 million after tax) and $206 million ($105 million after tax), respectively, related to its leveraged lease investments. During 2022, Southern Company Gas recorded pre-tax impairment charges totaling $131 million ($99 million after tax) related to natural gas storage facilities. During 2021, Southern Company Gas recorded total pre-tax impairment charges of $84 million ($67 million after tax) related to its equity method investment in the PennEast Pipeline project. See Notes 7 and 9 to the financial statements under "Southern Company Gas" and "Southern Company Leveraged Lease," respectively, and Note 15 to the financial statements for additional information on recent asset impairments.Revenue Recognition (Southern Power)Southern Power's power sale transactions, which include PPAs, are classified in one of four general categories: leases, non-derivatives or normal sale derivatives, derivatives designated as cash flow hedges, and derivatives not designated as hedges. Southern Power's revenues are dependent upon significant judgments used to determine the appropriate transaction classification, II-51 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISwhich must be documented upon the inception of each contract. The two categories with the most judgment required for Southern Power are described further below.Lease TransactionsSouthern Power considers the terms of a sales contract to determine whether it should be accounted for as a lease. A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. If the contract meets the criteria for a lease, Southern Power performs further analysis to determine whether the lease is classified as operating, financing, or sales-type. Generally, Southern Power's power sales contracts that are determined to be leases are accounted for as operating leases and the capacity revenue is recognized on a straight-line basis over the term of the contract and is included in Southern Power's operating revenues. Energy revenues and other contingent revenues are recognized in the period the energy is delivered or the service is rendered. For those contracts that are determined to be sales-type leases, capacity revenues are recognized by accounting for interest income on the net investment in the lease and are included in Southern Power's operating revenues. See Note 9 to the financial statements for additional information.Non-Derivative and Normal Sale Derivative TransactionsIf the power sales contract is not classified as a lease, Southern Power further considers whether the contract meets the definition of a derivative. If the contract does meet the definition of a derivative, Southern Power will assess whether it can be designated as a normal sale contract. The determination of whether a contract can be designated as a normal sale contract requires judgment, including whether the sale of electricity involves physical delivery in quantities within Southern Power's available generating capacity and that the purchaser will take quantities expected to be used or sold in the normal course of business.Contracts that do not meet the definition of a derivative or are designated as normal sales are accounted for as executory contracts. For contracts that have a capacity charge, the revenue is generally recognized in the period that it becomes billable. Revenues related to energy and ancillary services are recognized in the period the energy is delivered or the service is rendered. See Note 4 to the financial statements for additional information.Acquisition Accounting (Southern Power)Southern Power may acquire generation assets as part of its overall growth strategy. At the time of an acquisition, Southern Power will assess if these assets and activities meet the definition of a business. Acquisitions that meet the definition of a business are accounted for under the acquisition method, whereby the purchase price, including any contingent consideration, is allocated based on the fair value of the identifiable assets acquired and liabilities assumed (including any intangible assets, primarily related to acquired PPAs). Assets acquired that do not meet the definition of a business are accounted for as an asset acquisition. The purchase price of each asset acquisition is allocated based on the relative fair value of assets acquired. Determining the fair value of assets acquired and liabilities assumed requires management judgment and Southern Power may engage independent valuation experts to assist in this process. Fair values are determined by using market participant assumptions, and typically include the timing and amounts of future cash flows, incurred construction costs, the nature of acquired contracts, discount rates, power market prices, and expected asset lives. Any due diligence or transition costs incurred by Southern Power for potential or successful acquisitions are expensed as incurred.See Note 13 to the financial statements for additional fair value information and Note 15 to the financial statements for additional information on recent acquisitions.Variable Interest Entities (Southern Power)Southern Power enters into partnerships with varying ownership structures. Upon entering into these arrangements, membership interests and other variable interests are evaluated to determine if the legal entity is a VIE. If the legal entity is a VIE, Southern Power will assess if it has both the power to direct the activities of the VIE that most significantly impact the VIE's economic performance and the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE, making it the primary beneficiary. Making this determination may require significant management judgment.If Southern Power is the primary beneficiary and is considered to have a controlling ownership, the assets, liabilities, and results of operations of the entity are consolidated. If Southern Power is not the primary beneficiary, the legal entity is generally accounted for under the equity method of accounting. Southern Power reconsiders its conclusions as to whether the legal entity is a VIE and whether it is the primary beneficiary for events that impact the rights of variable interests, such as ownership changes in membership interests.Southern Power has controlling ownership in certain legal entities for which the contractual provisions represent profit-sharing arrangements because the allocations of cash distributions and tax benefits are not based on fixed ownership percentages. For these arrangements, the noncontrolling interest is accounted for under a balance sheet approach utilizing the HLBV method. The II-52 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISHLBV method calculates each partner's share of income based on the change in net equity the partner can legally claim in a HLBV at the end of the period compared to the beginning of the period.Contingent Obligations (All Registrants)The Registrants are subject to a number of federal and state laws and regulations, as well as other factors and conditions that subject them to environmental, litigation, and other risks. See FUTURE EARNINGS POTENTIAL herein and Notes 2 and 3 to the financial statements for more information regarding certain of these contingencies. The Registrants periodically evaluate their exposure to such risks and record reserves for those matters where a non-tax-related loss is considered probable and reasonably estimable. The adequacy of reserves can be significantly affected by external events or conditions that can be unpredictable; thus, the ultimate outcome of such matters could materially affect the results of operations, cash flows, or financial condition of the Registrants.Recently Issued Accounting StandardsIn March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (ASU 2020-04) providing temporary guidance to ease the potential burden in accounting for reference rate reform primarily resulting from the discontinuation of LIBOR, which began phasing out on December 31, 2021. The discontinuation date of the overnight 1-, 3-, 6-, and 12-month tenors of LIBOR is June 30, 2023, which is beyond the original effective date of ASU 2020-04; therefore, on December 21, 2022, the FASB issued ASU 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848 (ASU 2022-06) to defer the sunset date of ASU 2020-04 from December 31, 2022 to December 31, 2024.The amendments are elective and apply to all entities that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued. The guidance (i) simplifies accounting analyses under current GAAP for contract modifications; (ii) simplifies the assessment of hedge effectiveness and allows hedging relationships affected by reference rate reform to continue; and (iii) allows a one-time election to sell or transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform. An entity may elect to apply the amendments prospectively from March 12, 2020 through December 31, 2024 by accounting topic. The Registrants have elected to apply the amendments to modifications of debt and derivative arrangements that meet the scope of ASU 2020-04 and ASU 2022-06.The Registrants currently reference LIBOR for certain debt and hedging arrangements. In addition, certain provisions in PPAs at Southern Power include references to LIBOR. Contract language has been, or is expected to be, incorporated into each of these agreements to address the transition to an alternative rate for agreements that will be in place at the transition date. No material impacts are expected from modifications to the arrangements and effective hedging relationships are expected to continue. See FINANCIAL CONDITION AND LIQUIDITY – "Overview" and "Financing Activities" herein and Note 14 to the financial statements under "Interest Rate Derivatives" for additional information.FINANCIAL CONDITION AND LIQUIDITYOverviewThe financial condition of each Registrant remained stable at December 31, 2022. The Registrants' cash requirements primarily consist of funding ongoing operations, including unconsolidated subsidiaries, as well as common stock dividends, capital expenditures, and debt maturities. Southern Power's cash requirements also include distributions to noncontrolling interests. Capital expenditures and other investing activities for the traditional electric operating companies include investments to build new generation facilities to meet projected long-term demand requirements and to replace units being retired as part of the generation fleet transition, to maintain existing generation facilities, to comply with environmental regulations including adding environmental modifications to certain existing generating units and closures of ash ponds, to expand and improve transmission and distribution facilities, and for restoration following major storms. Southern Power's capital expenditures and other investing activities may include acquisitions or new construction associated with its overall growth strategy and to maintain its existing generation fleet's performance. Southern Company Gas' capital expenditures and other investing activities include investments to meet projected long-term demand requirements, to maintain existing natural gas distribution systems as well as to update and expand these systems, and to comply with environmental regulations. See "Cash Requirements" herein for additional information.Operating cash flows provide a substantial portion of the Registrants' cash needs. During 2022, Southern Power utilized tax credits, which provided $49 million in operating cash flows. For the three-year period from 2023 through 2025, projected stock dividends, capital expenditures, and debt maturities are expected to exceed operating cash flows for each of Southern Company, the traditional electric operating companies, and Southern Company Gas. Southern Company plans to finance future cash needs in excess of its operating cash flows through one or more of the following: accessing borrowings from financial institutions, issuing debt and hybrid securities in the capital markets, and/or through its stock plans. Each Subsidiary Registrant plans to finance its II-53 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISfuture cash needs in excess of its operating cash flows primarily through external securities issuances, borrowings from financial institutions, and equity contributions from Southern Company. In addition, Southern Power plans to utilize tax equity partnership contributions. The Registrants plan to use commercial paper to manage seasonal variations in operating cash flows and for other working capital needs and continue to monitor their access to short-term and long-term capital markets as well as their bank credit arrangements to meet future capital and liquidity needs. See "Sources of Capital" and "Financing Activities" herein for additional information.To facilitate an orderly transition from LIBOR to alternative benchmark rate(s), the Registrants have established an initiative to assess and mitigate risks associated with the discontinuation of LIBOR. As part of this initiative, several alternative benchmark rates have been, and continue to be, evaluated and implemented. Substantially all of the Registrants' credit facilities allow for LIBOR to be phased out and replaced with SOFR and interest rate derivatives address the LIBOR transition through the adoption of the ISDA 2020 IBOR Fallbacks Protocol and subsequent amendments. None of the Registrants expects the transition from LIBOR to have a material impact.The Registrants' investments in their qualified pension plans and Alabama Power's and Georgia Power's investments in their nuclear decommissioning trust funds decreased in value at December 31, 2022 as compared to December 31, 2021. No contributions to the qualified pension plan were made during 2022 and no mandatory contributions to the qualified pension plans are anticipated during 2023. See Notes 6 and 11 to the financial statements under "Nuclear Decommissioning" and "Pension Plans," respectively, for additional information.At the end of 2022, the market price of Southern Company's common stock was $71.41 per share (based on the closing price as reported on the NYSE) and the book value was $27.93 per share, representing a market-to-book value ratio of 256%, compared to $68.58, $26.30, and 261%, respectively, at the end of 2021.Cash RequirementsCapital ExpendituresTotal estimated capital expenditures, including LTSA and nuclear fuel commitments, for the Registrants through 2027 based on their current construction programs are as follows:20232024202520262027(in billions)Southern Company(a)(b)(c)$9.1 $8.1 $7.7 $7.9 $7.7 Alabama Power(a)2.0 1.9 1.9 1.8 1.9 Georgia Power(b)4.6 3.9 3.6 3.9 3.6 Mississippi Power0.3 0.3 0.3 0.2 0.2 Southern Power(c)0.1 0.1 0.1 0.1 0.1 Southern Company Gas1.8 1.8 1.8 1.8 1.8 (a)Includes expenditures of approximately $0.1 billion in 2023 for the construction of Plant Barry Unit 8. See Note 2 to the financial statements under "Alabama Power" for additional information.(b)Includes expenditures of approximately $1.0 billion and $0.2 billion in 2023 and 2024, respectively, for the construction of Plant Vogtle Units 3 and 4.(c)Excludes approximately $0.5 billion in 2023 and $0.8 billion per year for 2024 through 2027 for Southern Power's planned acquisitions and placeholder growth, which may vary materially due to market opportunities and Southern Power's ability to execute its growth strategy.These capital expenditures include estimates to comply with environmental laws and regulations, but do not include any potential compliance costs associated with any future regulation of CO2 emissions from fossil fuel-fired electric generating units. See FUTURE EARNINGS POTENTIAL – "Environmental Matters" herein for additional information. At December 31, 2022, significant purchase commitments were outstanding in connection with the Registrants' construction programs.II-54 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISThe traditional electric operating companies also anticipate continued expenditures associated with closure and monitoring of ash ponds and landfills in accordance with the CCR Rule and the related state rules, which are reflected in the applicable Registrants' ARO liabilities. The cost estimates for Alabama Power and Mississippi Power are based on closure-in-place for all ash ponds. The cost estimates for Georgia Power are based on a combination of closure-in-place for some ash ponds and closure by removal for others. These estimated costs are likely to change, and could change materially, as assumptions and details pertaining to closure are refined and compliance activities continue. Current estimates of these costs through 2027 are provided in the table below. Material expenditures in future years for ARO settlements will also be required for ash ponds, nuclear decommissioning (for Alabama Power and Georgia Power), and other liabilities reflected in the applicable Registrants' AROs, as discussed further in Note 6 to the financial statements. Also see FUTURE EARNINGS POTENTIAL – "Environmental Matters – Environmental Laws and Regulations – Coal Combustion Residuals" herein.20232024202520262027(in millions)Southern Company$672 $730 $765 $816 $712 Alabama Power330 346 364 299 237 Georgia Power295 330 345 482 469 Mississippi Power21 25 31 17 2 The construction programs are subject to periodic review and revision, and actual construction costs may vary from these estimates because of numerous factors. These factors include: changes in business conditions; changes in load projections; changes in environmental laws and regulations; the outcome of any legal challenges to environmental rules; changes in electric generating plants, including unit retirements and replacements and adding or changing fuel sources at existing electric generating units, to meet regulatory requirements; changes in FERC rules and regulations; state regulatory agency approvals; changes in the expected environmental compliance program; changes in legislation and/or regulation; the cost, availability, and efficiency of construction labor, equipment, and materials; project scope and design changes; abnormal weather; delays in construction due to judicial or regulatory action; storm impacts; and the cost of capital. The continued impacts of the COVID-19 pandemic could also impair the ability to develop, construct, and operate facilities, as discussed further in Item 1A herein. In addition, there can be no assurance that costs related to capital expenditures and AROs will be fully recovered. Additionally, expenditures associated with Southern Power's planned acquisitions may vary due to market opportunities and the execution of its growth strategy. See Note 15 to the financial statements under "Southern Power" for additional information regarding Southern Power's plant acquisitions and construction projects.The construction program of Georgia Power includes Plant Vogtle Units 3 and 4, which includes components based on new technology that only within the last few years began initial operation in the global nuclear industry at this scale and which may be subject to additional revised cost estimates during construction. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" for information regarding Plant Vogtle Units 3 and 4 and additional factors that may impact construction expenditures.See FUTURE EARNINGS POTENTIAL – "Construction Programs" herein for additional information.Other Significant Cash RequirementsLong-term debt maturities and the interest payable on long-term debt each represent a significant cash requirement for the Registrants. See Note 8 to the financial statements for information regarding the Registrants' long-term debt at December 31, 2022, the weighted average interest rate applicable to each long-term debt category, and a schedule of long-term debt maturities over the next five years. The Registrants plan to continue, when economically feasible, to retire higher-cost securities and replace these obligations with lower-cost capital if market conditions permit.II-55 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISFuel and purchased power costs represent a significant component of funding ongoing operations for the traditional electric operating companies and Southern Power. See Note 3 to the financial statements under "Commitments" for information on Southern Company Gas' commitments for pipeline charges, storage capacity, and gas supply. Total estimated costs for fuel and purchased power commitments at December 31, 2022 for the applicable Registrants are provided in the table below. Fuel costs include purchases of coal (for the traditional electric operating companies) and natural gas (for the traditional electric operating companies and Southern Power), as well as the related transportation and storage. In most cases, these contracts contain provisions for price escalation, minimum purchase levels, and other financial commitments. Natural gas purchase commitments are based on various indices at the time of delivery; the amounts reflected below have been estimated based on the NYMEX future prices at December 31, 2022. As discussed under "Capital Expenditures" herein, estimated expenditures for nuclear fuel are included in the applicable Registrants' construction programs for the years 2023 through 2027. Nuclear fuel commitments at December 31, 2022 that extend beyond 2027 are included in the table below. Purchased power costs represent estimated minimum obligations for various PPAs for the purchase of capacity and energy, except for those accounted for as leases, which are discussed in Note 9 to the financial statements.20232024202520262027Thereafter(in millions)Southern Company(*)$5,985 $3,605 $2,485 $1,260 $1,136 $6,052 Alabama Power1,623 1,067 820 343 313 1,363 Georgia Power(*)2,413 1,347 946 487 452 4,255 Mississippi Power789 496 280 160 143 418 Southern Power1,159 695 438 269 228 16 (*)Excludes capacity payments related to Plant Vogtle Units 1 and 2, which are discussed in Note 3 to the financial statements under "Commitments."In connection with Georgia Power's 2022 IRP, the Georgia PSC approved five affiliate PPAs with Southern Power, which are expected to be accounted for as leases, and are contingent upon approval by the FERC. The expected capacity payments associated with the PPAs total $5 million in 2024, $68 million in 2025, $75 million in 2026, $76 million in 2027, and $670 million thereafter. See Note 2 to the financial statements under "Georgia Power – Integrated Resource Plans" for additional information.The traditional electric operating companies and Southern Power have entered into LTSAs for the purpose of securing maintenance support for certain of their generating facilities. See Note 1 to the financial statements under "Long-term Service Agreements" for additional information. As discussed under "Capital Expenditures" herein, estimated expenditures related to LTSAs are included in the applicable Registrants' construction programs for the years 2023 through 2027. Total estimated payments for LTSA commitments at December 31, 2022 that extend beyond 2027 are provided in the following table and include price escalation based on inflation indices:SouthernCompanyAlabama PowerGeorgiaPowerMississippi PowerSouthern Power(in millions)LTSA commitments (after 2027)$1,779 $303 $305 $163 $1,008 In addition, Southern Power has certain other operations and maintenance agreements. Total estimated costs for these commitments at December 31, 2022 are provided in the table below.20232024202520262027Thereafter(in millions)Southern Power's operations and maintenance agreements$69 $58 $41 $30 $29 $251 See Note 9 to the financial statements for information on the Registrants' operating lease obligations, including a maturity analysis of the lease liabilities over the next five years and thereafter.Sources of CapitalSouthern Company intends to meet its future capital needs through operating cash flows, borrowings from financial institutions, and debt, hybrid, and/or equity issuances. Equity capital can be provided from any combination of Southern Company's stock plans, private placements, or public offerings.II-56 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISThe Subsidiary Registrants plan to obtain the funds to meet their future capital needs from sources similar to those they used in the past, which were primarily from operating cash flows, external securities issuances, borrowings from financial institutions, and equity contributions from Southern Company. In addition, Southern Power plans to utilize tax equity partnership contributions (as discussed further herein). Georgia Power intends to continue utilizing short-term floating rate bank loans and commercial paper issuances to fund operating cash flows related to fuel cost under recovery.The amount, type, and timing of any financings in 2023, as well as in subsequent years, will be contingent on investment opportunities and the Registrants' capital requirements and will depend upon prevailing market conditions, regulatory approvals (for certain of the Subsidiary Registrants), and other factors. See "Cash Requirements" herein for additional information.Southern Power utilizes tax equity partnerships as one of its financing sources, where the tax partner takes significantly all of the federal tax benefits. These tax equity partnerships are consolidated in Southern Power's financial statements and are accounted for using HLBV methodology to allocate partnership gains and losses. During 2022, Southern Power obtained tax equity funding for existing tax equity partnerships totaling $51 million. See Notes 1 and 15 to the financial statements under "General" and "Southern Power," respectively, for additional information.The issuance of securities by the traditional electric operating companies and Nicor Gas is generally subject to the approval of the applicable state PSC or other applicable state regulatory agency. The issuance of all securities by Mississippi Power and short-term securities by Georgia Power is generally subject to regulatory approval by the FERC. Additionally, with respect to the public offering of securities, Southern Company, the traditional electric operating companies, and Southern Power (excluding its subsidiaries), Southern Company Gas Capital, and Southern Company Gas (excluding its other subsidiaries) file registration statements with the SEC under the Securities Act of 1933, as amended (1933 Act). The amounts of securities authorized by the appropriate regulatory authorities, as well as the securities registered under the 1933 Act, are closely monitored and appropriate filings are made to ensure flexibility in the capital markets.The Registrants generally obtain financing separately without credit support from any affiliate. See Note 8 to the financial statements under "Bank Credit Arrangements" for additional information. The Southern Company system does not maintain a centralized cash or money pool. Therefore, funds of each company are not commingled with funds of any other company in the Southern Company system, except in the case of Southern Company Gas, as described below.The traditional electric operating companies and SEGCO may utilize a Southern Company subsidiary organized to issue and sell commercial paper at their request and for their benefit. Proceeds from such issuances for the benefit of an individual company are loaned directly to that company. The obligations of each traditional electric operating company and SEGCO under these arrangements are several and there is no cross-affiliate credit support. Alabama Power also maintains its own separate commercial paper program.Southern Company Gas Capital obtains external financing for Southern Company Gas and its subsidiaries, other than Nicor Gas, which obtains financing separately without credit support from any affiliates. Southern Company Gas maintains commercial paper programs at Southern Company Gas Capital and Nicor Gas. Nicor Gas' commercial paper program supports its working capital needs as Nicor Gas is not permitted to make money pool loans to affiliates. All of the other Southern Company Gas subsidiaries benefit from Southern Company Gas Capital's commercial paper program.By regulation, Nicor Gas is restricted, to the extent of its retained earnings balance, in the amount it can dividend or loan to affiliates and is not permitted to make money pool loans to affiliates. At December 31, 2022, the amount of subsidiary retained earnings restricted to dividend totaled $1.5 billion. This restriction did not impact Southern Company Gas' ability to meet its cash obligations, nor does management expect such restriction to materially impact Southern Company Gas' ability to meet its currently anticipated cash obligations.II-57 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISCertain Registrants' current liabilities frequently exceed their current assets because of long-term debt maturities and the periodic use of short-term debt as a funding source, as well as significant seasonal fluctuations in cash needs. The Registrants generally plan to refinance long-term debt as it matures. See Note 8 to the financial statements for additional information. Also see "Financing Activities" herein for information on financing activities that occurred subsequent to December 31, 2022. The following table shows the amount by which current liabilities exceeded current assets at December 31, 2022 for the applicable Registrants:At December 31, 2022SouthernCompanyGeorgiaPowerMississippi PowerSouthern PowerSouthern Company Gas(in millions)Current liabilities in excess of current assets$5,308 $3,179 $50 $263 $532 The Registrants believe the need for working capital can be adequately met by utilizing operating cash flows, as well as commercial paper, lines of credit, and short-term bank notes, as market conditions permit. In addition, under certain circumstances, the Subsidiary Registrants may utilize equity contributions and/or loans from Southern Company.Bank Credit ArrangementsAt December 31, 2022, the Registrants' unused committed credit arrangements with banks were as follows:At December 31, 2022SouthernCompanyparentAlabama PowerGeorgiaPowerMississippi PowerSouthern Power(a)Southern Company Gas(b)SEGCOSouthernCompany(in millions)Unused committed credit$1,998 $1,250 $1,726 $275 $569 $1,748 $30 $7,596 (a)At December 31, 2022, Southern Power also had two continuing letters of credit facilities for standby letters of credit, of which $14 million was unused. Southern Power's subsidiaries are not parties to its bank credit arrangements or letter of credit facilities.(b)Includes $798 million and $950 million at Southern Company Gas Capital and Nicor Gas, respectively.Subject to applicable market conditions, the Registrants, Nicor Gas, and SEGCO expect to renew or replace their bank credit arrangements as needed, prior to expiration. In connection therewith, the Registrants, Nicor Gas, and SEGCO may extend the maturity dates and/or increase or decrease the lending commitments thereunder. A portion of the unused credit with banks is allocated to provide liquidity support to the revenue bonds of the traditional electric operating companies and the commercial paper programs of the Registrants, Nicor Gas, and SEGCO. The amount of variable rate revenue bonds of the traditional electric operating companies outstanding requiring liquidity support at December 31, 2022 was approximately $1.7 billion (comprised of approximately $789 million at Alabama Power, $819 million at Georgia Power, and $69 million at Mississippi Power). In addition, at December 31, 2022, Alabama Power and Georgia Power had approximately $120 million and $288 million, respectively, of fixed rate revenue bonds outstanding that are required to be remarketed within the next 12 months. See Note 8 to the financial statements under "Bank Credit Arrangements" for additional information.II-58 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISShort-term BorrowingsThe Registrants, Nicor Gas, and SEGCO make short-term borrowings primarily through commercial paper programs that have the liquidity support of the committed bank credit arrangements described above. Southern Power's subsidiaries are not issuers or obligors under its commercial paper program. Commercial paper and short-term bank term loans are included in notes payable in the balance sheets. Details of the Registrants' short-term borrowings were as follows:Short-term Debt at the End of the PeriodAmountOutstandingWeighted AverageInterest RateDecember 31,December 31,202220212020202220212020(in millions)Southern Company$2,609 $1,440 $609 4.9 %0.4 %0.3 %Georgia Power1,600 — 60 5.0 — 0.3 Mississippi Power— — 25 — — 0.4 Southern Power225 211 175 4.7 0.3 0.3 Southern Company Gas:Southern Company Gas Capital$285 $379 $220 4.8 %0.3 %0.3 %Nicor Gas483 830 104 4.7 0.4 0.2 Southern Company Gas Total$768 $1,209 $324 4.7 %0.4 %0.2 %Short-term Debt During the Period(*)Average Amount OutstandingWeighted AverageInterest RateMaximum Amount Outstanding202220212020202220212020202220212020(in millions)(in millions)Southern Company$1,995 $1,141 $1,017 2.2 %0.3 %1.6 %$2,894 $1,809 $2,113 Alabama Power6 27 20 2.1 0.1 1.1 200 200 155 Georgia Power673 95 264 3.1 0.2 1.7 1,710 407 478 Mississippi Power8 15 9 1.6 0.2 1.6 71 81 40 Southern Power166 133 64 2.3 0.2 1.5 350 520 550 Southern Company Gas:Southern Company Gas Capital$279 $206 $316 1.8 %0.2 %1.4 %$547 $485 $641 Nicor Gas349 420 49 2.1 0.4 1.4 830 897 278 Southern Company Gas Total$628 $626 $365 2.0 %0.4 %1.4 %(*) Average and maximum amounts are based upon daily balances during the 12-month periods ended December 31, 2022, 2021, and 2020.II-59 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISAnalysis of Cash FlowsNet cash flows provided from (used for) operating, investing, and financing activities in 2022 and 2021 are presented in the following table:Net cash provided from (used for):Southern CompanyAlabama PowerGeorgiaPowerMississippi PowerSouthern PowerSouthern Company Gas(in millions)2022Operating activities$6,302 $1,639 $2,038 $383 $815 $1,519 Investing activities(8,430)(2,263)(3,954)(317)(194)(1,580)Financing activities2,336 251 2,363 (68)(623)96 2021Operating activities$6,169 $2,053 $2,747 $246 $951 $663 Investing activities(7,353)(1,961)(3,590)(257)(803)(1,379)Financing activities1,945 438 867 33 (195)745 Fluctuations in cash flows from financing activities vary from year to year based on capital needs and the maturity or redemption of securities.Southern CompanyNet cash provided from operating activities increased $133 million in 2022 as compared to 2021 primarily due to the timing of vendor payments and increased natural gas cost recovery at the natural gas distribution utilities, largely offset by decreased fuel cost recovery at the traditional electric operating companies.The net cash used for investing activities in 2022 and 2021 was primarily related to the Subsidiary Registrants' construction programs.The net cash provided from financing activities in 2022 was primarily related to net issuances of long-term debt, the issuance of common stock to settle the purchase contracts entered into as part of the Equity Units (as discussed in Note 8 to the financial statements under "Equity Units"), and an increase in short-term borrowings, partially offset by common stock dividend payments. The net cash provided from financing activities in 2021 was primarily related to net issuances of long-term and short-term debt, partially offset by common stock dividend payments.Alabama PowerNet cash provided from operating activities decreased $414 million in 2022 as compared to 2021 primarily due to decreased fuel cost recovery, the timing of customer receivable collections, and fossil fuel stock purchases, partially offset by the timing of vendor payments.The net cash used for investing activities in 2022 and 2021 was primarily related to gross property additions, including approximately $211 million and $240 million, respectively, related to the construction of Plant Barry Unit 8 and, for 2022, $171 million related to the acquisition of the Calhoun Generating Station. See Notes 2 and 15 to the financial statements under "Alabama Power" for additional information.The net cash provided from financing activities in 2022 and 2021 was primarily related to net long-term debt issuances and capital contributions from Southern Company, partially offset by common stock dividend payments and, in 2022, preferred stock redemptions.Georgia PowerNet cash provided from operating activities decreased $709 million in 2022 as compared to 2021 primarily due to decreased fuel cost recovery and the timing of customer receivable collections, partially offset by lower income and property tax payments.The net cash used for investing activities in 2022 and 2021 was primarily related to gross property additions, including approximately $1.0 billion and $1.3 billion, respectively, related to the construction of Plant Vogtle Units 3 and 4. See Note 2 to the financial statements under "Georgia Power – Nuclear Construction" for additional information on construction of Plant Vogtle Units 3 and 4.II-60 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISThe net cash provided from financing activities in 2022 was primarily related to a net increase in short-term bank debt, capital contributions from Southern Company, and net issuances of senior notes, partially offset by common stock dividend payments. The net cash provided from financing activities in 2021 was primarily related to capital contributions from Southern Company, borrowings from the FFB for construction of Plant Vogtle Units 3 and 4, and net issuances and reofferings of other debt, partially offset by common stock dividend payments.Mississippi PowerNet cash provided from operating activities increased $137 million in 2022 as compared to 2021 primarily due to the timing of vendor payments, partially offset by the timing of customer receivable collections.The net cash used for investing activities in 2022 and 2021 was primarily related to gross property additions.The net cash used for financing activities in 2022 was primarily related to common stock dividend payments, partially offset by capital contributions from Southern Company and the issuance of revenue bonds. The net cash provided from financing activities in 2021 was primarily related to the issuance of senior notes and capital contributions from Southern Company, partially offset by debt redemptions, common stock dividend payments, and a decrease in commercial paper borrowings.Southern PowerNet cash provided from operating activities decreased $136 million in 2022 as compared to 2021 primarily due to a decrease in the utilization of federal ITCs, partially offset by an increase in wholesale revenues driven by higher market prices of energy.The net cash used for investing activities in 2022 was primarily related to ongoing construction activities. The net cash used for investing activities in 2021 was primarily related to the acquisition of the Deuel Harvest wind facility and ongoing construction activities. See Note 15 to the financial statements under "Southern Power" for additional information.The net cash used for financing activities in 2022 was primarily related to the repayment of senior notes at maturity, common stock dividend payments, and net capital distributions to noncontrolling interests, partially offset by capital contributions from Southern Company. The net cash used for financing activities in 2021 was primarily related to a return of capital to Southern Company and common stock dividend payments, partially offset by net capital contributions from noncontrolling interests and net issuances of senior notes.Southern Company GasNet cash provided from operating activities increased $856 million in 2022 as compared to 2021 primarily due to increased natural gas cost recovery and the timing of vendor payments, partially offset by the timing of customer receivable collections.The net cash used for investing activities in 2022 and 2021 was primarily related to construction of transportation and distribution assets recovered through base rates and infrastructure investment recovered through replacement programs at gas distribution operations, partially offset by proceeds from dispositions. See Note 15 to the financial statements for additional information.The net cash provided from financing activities in 2022 was primarily related to net issuances of long-term debt and capital contributions from Southern Company, partially offset by common stock dividend payments and a decrease in short-term borrowings. The net cash provided from financing activities in 2021 was primarily related to net issuances of long-term and short-term debt and capital contributions from Southern Company, partially offset by common stock dividend payments.Significant Balance Sheet ChangesSouthern CompanySignificant balance sheet changes in 2022 for Southern Company included:•an increase of $3.5 billion in total property, plant, and equipment primarily related to the Subsidiary Registrants' construction programs, net of the reclassification of $0.6 billion to other regulatory assets and $0.4 billion to regulatory assets associated with AROs upon Georgia Power's retirement of Plant Wansley Units 1 and 2;•an increase of $2.7 billion in long-term debt (including securities due within one year) related to new issuances;•an increase of $2.5 billion in total common stockholders' equity primarily related to net income and the issuance of common stock to settle the purchase contracts entered into as part of the Equity Units (as discussed in Note 8 to the financial statements under "Equity Units"), partially offset by common stock dividend payments;•an increase of $1.6 billion in deferred under recovered fuel clause revenues due to higher fuel and purchased power costs at Georgia Power;•an increase of $1.4 billion in accounts payable primarily related to the timing of vendor payments;II-61 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSIS•an increase of $1.2 billion in accumulated deferred income taxes primarily related to the increase in under recovered fuel clause revenues, an increase in property-related timing differences, and continued flowback of excess deferred income taxes;•an increase of $1.2 billion in notes payable due to an increase in short-term bank debt;•a decrease of $0.8 billion in AROs primarily related to cost estimate updates for ash pond closures at Georgia Power; and•an increase of $0.6 billion in prepaid pension costs primarily related to actuarial gains resulting from increases in the assumed discount rates, partially offset by actual losses on plan assets.See "Financing Activities" herein and Notes 2, 5, 6, 8, 10, and 11 to the financial statements for additional information.Alabama PowerSignificant balance sheet changes in 2022 for Alabama Power included: •an increase of $1.2 billion in total property, plant, and equipment primarily related to the construction of Plant Barry Unit 8, the acquisition of the Calhoun Generating Station, and construction of distribution and transmission facilities;•an increase of $1.0 billion in total common stockholder's equity primarily due to net income and capital contributions from Southern Company, partially offset by dividends paid to Southern Company;•an increase of $0.9 billion in long-term debt (including securities due within one year) primarily due to net issuances of senior notes;•an increase of $0.6 billion in other regulatory assets primarily due to an increase in under recovered fuel clause revenues;•an increase of $0.4 billion in accumulated deferred income taxes primarily due to an increase in under recovered fuel clause revenues; and•a decrease of $0.4 billion in cash and cash equivalents, as discussed further under "Analysis of Cash Flows – Alabama Power" herein.See "Financing Activities – Alabama Power" herein and Notes 2, 5, 8, and 15 to the financial statements for additional information.Georgia PowerSignificant balance sheet changes in 2022 for Georgia Power included:•an increase of $1.7 billion in total property, plant, and equipment primarily related to the construction of generation, transmission, and distribution facilities, including $1.0 billion for Plant Vogtle Units 3 and 4, net of $0.6 billion reclassified to other regulatory assets and $0.4 billion reclassified to regulatory assets associated with AROs due to the retirement of Plant Wansley Units 1 and 2 as approved in Georgia Power's 2022 IRP;•an increase of $1.6 billion in common stockholder's equity primarily due to net income and capital contributions from Southern Company, partially offset by dividends paid to Southern Company;•an increase of $1.6 billion in deferred under recovered fuel clause revenues resulting from higher fuel and purchased power costs;•an increase of $1.6 billion in notes payable due to an increase in short-term bank debt;•an increase of $1.1 billion in long-term debt (including securities due within one year) primarily due to net issuances of senior notes;•a decrease of $0.8 billion in AROs primarily due to cost estimate updates for ash pond closures; and•an increase of $0.7 billion in accumulated deferred income taxes primarily due to the increase in under recovered fuel clause revenues and the expected reduction in federal and state credit carryforward balances in 2022.See "Financing Activities – Georgia Power" herein and Notes 2, 5, 6, 8, and 10 to the financial statements for additional information.II-62 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISMississippi PowerSignificant balance sheet changes in 2022 for Mississippi Power included:•an increase of $131 million in total property, plant, and equipment primarily related to the construction of transmission and distribution facilities;•a decrease of $68 million in other regulatory assets, deferred primarily related to amortization of regulatory assets and the annual remeasurement of pension and other postretirement benefit obligations;•an increase of $64 million in common stockholder's equity related to net income and capital contributions from Southern Company, partially offset by dividends paid to Southern Company;•an increase of $59 million in other accounts payable due to the timing of vendor payments; and•an increase of $53 million in affiliated receivables primarily due to power pool sales.See Notes 2 and 5 to the financial statements for additional information.Southern PowerSignificant balance sheet changes in 2022 for Southern Power included:•a decrease of $709 million in long-term debt (including securities due within one year) primarily due to the redemption of senior notes;•a decrease of $351 million in total property, plant, and equipment in service primarily due to continued depreciation of assets; and•an increase of $318 million in total stockholder's equity primarily due to capital contributions from Southern Company and net income, partially offset by dividends paid to Southern Company and net distributions to noncontrolling interests.See "Financing Activities – Southern Power" herein and Notes 5 and 8 to the financial statements for additional information.Southern Company GasSignificant balance sheet changes in 2022 for Southern Company Gas included:•an increase of $859 million in total property, plant, and equipment primarily related to the construction of transportation and distribution assets and additional infrastructure investment;•an increase of $540 million in long-term debt (including securities due with one year) due to issuances of senior notes and first mortgage bonds, partially offset by the repayment of medium-term notes and adjustments related to fair value hedges;•an increase of $481 million in common stockholder's equity related to net income and capital contributions from Southern Company, partially offset by dividends paid to Southern Company;•a decrease of $441 million in notes payable due to repayments of short-term debt and commercial paper borrowings;•an increase of $356 million in total accounts receivable primarily relating to increases of $154 million in customer accounts receivable and $175 million in unbilled revenues as a result of seasonality;•an increase of $340 million in other accounts payable due to the timing of vendor payments; and•a decrease of $192 million in other regulatory assets, deferred primarily due to a $207 million reduction in natural gas cost under recovery.See "Financing Activities – Southern Company Gas" herein and Notes 2, 5, and 8 to the financial statements for additional information.II-63 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISFinancing ActivitiesThe following table outlines the Registrants' long-term debt financing activities for the year ended December 31, 2022:Issuances/ReofferingsMaturities, Redemptions, and RepurchasesCompanySenior NotesRevenueBondsOther Long-Term DebtSeniorNotesRevenue BondsOther Long-Term Debt(a)(in millions)Southern Company parent$1,000 $— $— $— $— $— Alabama Power1,700 — — 750 — 1 Georgia Power1,500 200 — 400 53 228 Mississippi Power— 35 — — — — Southern Power— — — 677 — — Southern Company Gas500 — 197 — — 46 Other— — — — — 11 Elimination(b)— — — — — (8)Southern Company$4,700 $235 $197 $1,827 $53 $278 (a)Includes reductions in finance lease obligations resulting from cash payments under finance leases and, for Georgia Power, principal amortization payments totaling $88 million for FFB borrowings. See Note 8 to the financial statements under "Long-term Debt – DOE Loan Guarantee Borrowings" for additional information.(b)Represents reductions in affiliate finance lease obligations at Georgia Power, which are eliminated in Southern Company's consolidated financial statements.Except as otherwise described herein, the Registrants used the proceeds of debt issuances for their redemptions and maturities shown in the table above, to repay short-term indebtedness, and for general corporate purposes, including working capital. The Subsidiary Registrants also used the proceeds for their construction programs.In addition to any financings that may be necessary to meet capital requirements and contractual obligations, the Registrants plan to continue, when economically feasible, a program to retire higher-cost securities and replace these obligations with lower-cost capital if market conditions permit.Southern CompanyDuring 2022, Southern Company issued approximately 3.6 million shares of common stock primarily through equity compensation plans and received proceeds of approximately $83 million.In May 2022, Southern Company remarketed its Series 2019A and Series 2019B Remarketable Junior Subordinated Notes pursuant to the terms of its 2019 Series A Equity Units (Equity Units). Southern Company did not receive any proceeds from the remarketing, which were used to purchase a portfolio of treasury securities maturing on July 28, 2022. On August 1, 2022, the proceeds from this portfolio were used to settle the purchase contracts entered into as part of the Equity Units and Southern Company issued approximately 25.2 million shares of common stock and received proceeds of $1.725 billion. See Note 8 to the financial statements under "Equity Units" for additional information.In March 2022, Southern Company entered into a $400 million short-term floating rate bank loan, which it repaid in August 2022.In May 2022, Southern Company borrowed $100 million pursuant to a short-term uncommitted bank credit arrangement, which it repaid in August 2022.In October 2022, Southern Company issued $500 million aggregate principal amount of Series 2022A 5.15% Senior Notes due October 6, 2025 and $500 million aggregate principal amount of Series 2022B 5.70% Senior Notes due October 15, 2032.Subsequent to December 31, 2022, Southern Company redeemed all $550 million aggregate principal amount of its Series 2016B Junior Subordinated Notes due March 15, 2057.Alabama PowerIn February 2022, Alabama Power redeemed all $550 million aggregate principal amount of its Series 2017A 2.45% Senior Notes due March 30, 2022.In March 2022, Alabama Power issued $700 million aggregate principal amount of Series 2022A 3.05% Senior Notes due March 15, 2032.II-64 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISIn June 2022, Alabama Power redeemed the following series of preferred stock: 4.20% Preferred Stock, Par Value $100 Per Share, 4.60% Preferred Stock, Par Value $100 Per Share, 4.92% Preferred Stock, Par Value $100 Per Share, 4.52% Preferred Stock, Par Value $100 Per Share, 4.64% Preferred Stock, Par Value $100 Per Share, and 4.72% Preferred Stock, Par Value $100 Per Share. The redemption price per share for each series of preferred stock equaled the redemption price per share provided in Note 8 to the financial statements under "Outstanding Classes of Capital Stock – Alabama Power", plus accrued and unpaid dividends to the redemption date.In August 2022, Alabama Power issued $550 million aggregate principal amount of Series 2022B 3.75% Senior Notes due September 1, 2027 and $450 million aggregate principal amount of Series 2022C 3.94% Senior Notes due September 1, 2032. An amount equal to the net proceeds of the Series 2022C Senior Notes is being allocated to finance or refinance, in whole or in part, one or more renewable energy projects and/or expenditures and programs related to enabling opportunities for diverse and small businesses/suppliers.In October 2022, Alabama Power redeemed all of its 5.00% Class A Preferred Stock, Par Value $1 Per Share (Stated Capital $25 Per Share) at a redemption price of $25.00 per share plus accrued and unpaid dividends to the redemption date.In December 2022, Alabama Power repaid at maturity $200 million aggregate principal amount of its Series S 5.875% Senior Notes.Georgia PowerIn January 2022, Georgia Power redeemed all $400 million aggregate principal amount of its Series 2012B 2.85% Senior Notes due May 15, 2022.In February 2022, Georgia Power borrowed $250 million pursuant to a short-term uncommitted bank credit arrangement, which it repaid in May 2022.In each of March and April 2022, Georgia Power entered into a $200 million short-term floating rate bank loan bearing interest based on term SOFR.In May 2022, Georgia Power issued $700 million aggregate principal amount of Series 2022A 4.70% Senior Notes due May 15, 2032 and $800 million aggregate principal amount of Series 2022B 5.125% Senior Notes due May 15, 2052. An amount equal to the net proceeds of the Series 2022B Senior Notes is being allocated to finance or refinance, in whole or in part, one or more renewable energy projects and/or expenditures and programs related to enabling opportunities for diverse and small businesses/suppliers.In May 2022, Georgia Power repaid its $125 million long-term bank loan that was scheduled to mature in June 2022.In July 2022, Georgia Power repaid at maturity $53 million aggregate principal amount of Development Authority of Floyd County (Georgia) Pollution Control Revenue Bonds (Georgia Power Company Plant Hammond Project), First Series 2010.In October 2022, Georgia Power borrowed $250 million pursuant to a short-term uncommitted bank credit arrangement, which it repaid in November 2022.In November 2022, the Development Authority of Bartow County (Georgia) issued for the benefit of Georgia Power approximately $200 million aggregate principal amount of Solid Waste Disposal Facility Revenue Bonds (Georgia Power Company Plant Bowen Project), First Series 2022 ($100 million aggregate principal amount) and Second Series 2022 ($100 million aggregate principal amount) due November 1, 2062. The proceeds from the revenue bonds were used to finance certain solid waste disposal facilities at Plant Bowen.Also in November 2022, Georgia Power entered into a $1.2 billion short-term floating rate bank loan bearing interest based on term SOFR.Mississippi PowerIn June 2022, Mississippi Power repaid $20 million, which was borrowed in March 2022 under its $125 million revolving credit arrangement.In November 2022, the Mississippi Business Finance Corporation issued for the benefit of Mississippi Power $35 million aggregate principal amount of Solid Waste Disposal Facility and Wastewater Facility Revenue Bonds (Mississippi Power Company Project), First Series 2022 due November 1, 2052. The proceeds from the revenue bonds were used to finance certain solid waste disposal and wastewater facilities at Plant Daniel.II-65 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISSouthern PowerIn June 2022, Southern Power repaid at maturity €600 million (approximately $677 million) aggregate principal amount of its Series 2016A 1.00% Senior Notes.In October 2022, Southern Power borrowed $100 million pursuant to a short-term uncommitted bank credit arrangement, which it repaid in December 2022.Subsequent to December 31, 2022, Southern Power borrowed $100 million pursuant to the short-term uncommitted bank credit arrangement bearing interest at a mutually agreed upon rate and payable on demand.Southern Company GasDuring the first quarter 2022, Nicor Gas repaid one of its three $100 million short-term floating rate bank loans entered into in March 2021. Nicor Gas also repaid $50 million of one of the other loans and increased the borrowing amount under the other loan to $150 million. In addition, both loans were renewed and amended to extend the maturity dates and change the interest rate provisions so the loans bear interest based on term SOFR.During the second quarter 2022, Atlanta Gas Light repaid at maturity $46 million aggregate principal amount of medium-term notes with a weighted average interest rate of 8.63%.In August 2022, Nicor Gas issued in a private placement $100 million aggregate principal amount of 2.21% Series First Mortgage Bonds due August 31, 2032.In September 2022, Southern Company Gas Capital issued $500 million aggregate principal amount of Series 2022A 5.15% Senior Notes due September 15, 2032, guaranteed by Southern Company Gas.In October 2022, Nicor Gas issued in a private placement $75 million aggregate principal amount of 3.18% Series First Mortgage Bonds due October 27, 2062.During 2022, Southern Company Gas received $22 million under a long-term financing agreement related to a construction contract.Credit Rating RiskAt December 31, 2022, the Registrants did not have any credit arrangements that would require material changes in payment schedules or terminations as a result of a credit rating downgrade.There are certain contracts that could require collateral, but not accelerated payment, in the event of a credit rating change of certain Registrants to BBB and/or Baa2 or below. These contracts are primarily for physical electricity and natural gas purchases and sales, fuel purchases, fuel transportation and storage, energy price risk management, transmission, interest rate management, and, for Georgia Power, construction of new generation at Plant Vogtle Units 3 and 4.The maximum potential collateral requirements under these contracts at December 31, 2022 were as follows:Credit RatingsSouthern Company(*)Alabama PowerGeorgia PowerMississippi PowerSouthernPower(*)Southern Company Gas(in millions)At BBB and/or Baa2$33 $1 $— $— $32 $— At BBB- and/or Baa3395 2 61 1 334 — At BB+ and/or Ba1 or below2,036 434 948 330 1,225 21 (*)Southern Power has PPAs that could require collateral, but not accelerated payment, in the event of a downgrade of Southern Power's credit. The PPAs require credit assurances without stating a specific credit rating. The amount of collateral required would depend upon actual losses resulting from a credit downgrade. Southern Power had $106 million of cash collateral posted related to PPA requirements at December 31, 2022.The amounts in the previous table for the traditional electric operating companies and Southern Power include certain agreements that could require collateral if either Alabama Power or Georgia Power has a credit rating change to below investment grade. Generally, collateral may be provided by a Southern Company guaranty, letter of credit, or cash. Additionally, a credit rating downgrade could impact the ability of the Registrants to access capital markets and would be likely to impact the cost at which they do so.Mississippi Power and its largest retail customer, Chevron Products Company (Chevron), have agreements under which Mississippi Power provides retail service to the Chevron refinery in Pascagoula, Mississippi through at least 2038. The II-66 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISagreements grant Chevron a security interest in the co-generation assets owned by Mississippi Power located at the refinery that is exercisable upon the occurrence of (i) certain bankruptcy events or (ii) other events of default coupled with specific reductions in steam output at the facility and a downgrade of Mississippi Power's credit rating to below investment grade by two of the three rating agencies.On February 22, 2022, Fitch downgraded the senior unsecured long-term debt rating of Georgia Power to BBB+ from A- with a stable outlook.Also on February 22, 2022, Fitch revised the ratings outlook of Southern Company, Alabama Power, Southern Power, Nicor Gas, and SEGCO to negative from stable.On December 15, 2022, Moody's revised its rating outlook for Mississippi Power from stable to positive.Market Price RiskThe Registrants had no material change in market risk exposure for the year ended December 31, 2022 when compared to the year ended December 31, 2021. See Note 14 to the financial statements for an in-depth discussion of the Registrants' derivatives, as well as Note 1 to the financial statements under "Financial Instruments" for additional information.Due to cost-based rate regulation and other various cost recovery mechanisms, the traditional electric operating companies and the natural gas distribution utilities that sell natural gas directly to end-use customers continue to have limited exposure to market volatility in interest rates, foreign currency exchange rates, commodity fuel prices, and prices of electricity. The traditional electric operating companies and certain of the natural gas distribution utilities manage fuel-hedging programs implemented per the guidelines of their respective state PSCs or other applicable state regulatory agencies to hedge the impact of market fluctuations in natural gas prices for customers. Mississippi Power also manages wholesale fuel-hedging programs under agreements with its wholesale customers. Because energy from Southern Power's facilities is primarily sold under long-term PPAs with tolling agreements and provisions shifting substantially all of the responsibility for fuel cost to the counterparties, Southern Power's exposure to market volatility in commodity fuel prices and prices of electricity is generally limited. However, Southern Power has been and may continue to be exposed to market volatility in energy-related commodity prices as a result of uncontracted generating capacity. To mitigate residual risks relative to movements in electricity prices, the traditional electric operating companies and Southern Power may enter into physical fixed-price contracts for the purchase and sale of electricity through the wholesale electricity market and, to a lesser extent, financial hedge contracts for natural gas purchases; however, a significant portion of contracts are priced at market.Certain of Southern Company Gas' non-regulated operations routinely utilize various types of derivative instruments to economically hedge certain commodity price and weather risks inherent in the natural gas industry. These instruments include a variety of exchange-traded and OTC energy contracts, such as forward contracts, futures contracts, options contracts, and swap agreements. Southern Company Gas' gas marketing services business also actively manages storage positions through a variety of hedging transactions for the purpose of managing exposures arising from changing natural gas prices. These hedging instruments are used to substantially protect economic margins (as spreads between wholesale and retail natural gas prices widen between periods) and thereby minimize exposure to declining earnings. Some of these economic hedge activities may not qualify, or may not be designated, for hedge accounting treatment.The following table provides information related to variable interest rate exposure on long-term debt (including amounts due within one year) at December 31, 2022 for the applicable Registrants:At December 31, 2022Southern Company(*)AlabamaPowerGeorgiaPowerMississippiPowerSouthern CompanyGas(in millions, except percentages)Long-term variable interest rate exposure$5,071 $834 $819 $269 $500 Weighted average interest rate on long-term variable interest rate exposure5.14 %3.89 %3.91 %3.88 %4.70 %Impact on annualized interest expense of 100 basis point change in interest rates$51 $8 $8 $3 $5 (*)Includes $2.550 billion of long-term variable interest rate exposure at the Southern Company parent entity, $550 million of which was redeemed subsequent to December 31, 2022. See "Financing Activities" herein for additional information.The Registrants may enter into interest rate derivatives designated as hedges, which are intended to mitigate interest rate volatility related to forecasted debt financings and existing fixed and floating rate obligations. See Note 14 to the financial statements under "Interest Rate Derivatives" for additional information.II-67 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISSouthern Company and Southern Power had foreign currency denominated debt at December 31, 2022 and have each mitigated exposure to foreign currency exchange rate risk through the use of foreign currency swaps. See Note 14 to the financial statements under "Foreign Currency Derivatives" for additional information.Changes in fair value of energy-related derivative contracts for Southern Company and Southern Company Gas for the years ended December 31, 2022 and 2021 are provided in the table below. At December 31, 2022 and 2021, substantially all of the traditional electric operating companies' and certain of the natural gas distribution utilities' energy-related derivative contracts were designated as regulatory hedges and were related to the applicable company's fuel-hedging program.Southern Company(a)Southern Company Gas(a)(in millions)Contracts outstanding at December 31, 2020, assets (liabilities), net$107 $101 Contracts realized or settled(252)(85)Current period changes(b)243 (84)Sale of Sequent(c)76 76 Contracts outstanding at December 31, 2021, assets (liabilities), net$174 $8 Contracts realized or settled(327)10 Current period changes(b)142 (55)Contracts outstanding at December 31, 2022, assets (liabilities), net$(11)$(37)(a)Excludes cash collateral held on deposit in broker margin accounts of $41 million, $3 million, and $28 million at December 31, 2022, 2021, and 2020, respectively, and immaterial premium and intrinsic value associated with weather derivatives for all periods presented.(b)The changes in fair value of energy-related derivative contracts are substantially attributable to both the volume and the price of natural gas. Current period changes also include the changes in fair value of new contracts entered into during the period, if any.(c)As a result of the sale of Sequent on July 1, 2021, Southern Company Gas' market risk exposure decreased significantly. See Note 15 to the financial statements under "Southern Company Gas" for information regarding the sale of Sequent.The net hedge volumes of energy-related derivative contracts for natural gas purchased (sold) at December 31, 2022 and 2021 for Southern Company and Southern Company Gas were as follows:Southern CompanySouthern Company GasmmBtu Volume (in millions)At December 31, 2022:Commodity – Natural gas swaps217 — Commodity – Natural gas options214 93 Total hedge volume431 93 At December 31, 2021:Commodity – Natural gas swaps57 — Commodity – Natural gas options253 68 Total hedge volume310 68 Southern Company Gas' derivative contracts are comprised of both long and short natural gas positions. A long position is a contract to purchase natural gas, and a short position is a contract to sell natural gas. The volumes presented above for Southern Company Gas represent the net of long natural gas positions of 98 million mmBtu and short natural gas positions of 5 million mmBtu at December 31, 2022 and the net of long natural gas positions of 74 million mmBtu and short natural gas positions of 6 million mmBtu at December 31, 2021.For the Southern Company system, the weighted average swap contract cost per mmBtu was approximately $0.08 per mmBtu above market prices at December 31, 2022 and was approximately $0.74 per mmBtu below market prices at December 31, 2021. The change in option fair value is primarily attributable to the volatility of the market and the underlying change in the natural gas price. Substantially all of the traditional electric operating companies' natural gas hedge gains and losses are recovered through their respective fuel cost recovery clauses.II-68 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISThe Registrants use over-the-counter contracts that are not exchange traded but are fair valued using prices which are market observable, and thus fall into Level 2 of the fair value hierarchy. In addition, Southern Company Gas uses exchange-traded market-observable contracts, which are categorized as Level 1. See Note 13 to the financial statements for further discussion of fair value measurements. The maturities of the energy-related derivative contracts for Southern Company and Southern Company Gas at December 31, 2022 were as follows:Fair Value Measurements of Contracts atDecember 31, 2022TotalFair ValueMaturity20232024 – 20252026 – 2027Thereafter(in millions)Southern CompanyLevel 1(a)$(14)$(11)$(3)$— $— Level 2(b)3 (11)7 2 5 Southern Company total(c)$(11)$(22)$4 $2 $5 Southern Company GasLevel 1(a)$(14)$(11)$(3)$— $— Level 2(b)(23)(23)— — — Southern Company Gas total(c)$(37)$(34)$(3)$— $— (a)Valued using NYMEX futures prices.(b)Level 2 amounts for Southern Company Gas are valued using basis transactions that represent the cost to transport natural gas from a NYMEX delivery point to the contract delivery point. These transactions are based on quotes obtained either through electronic trading platforms or directly from brokers.(c)Excludes cash collateral of $41 million as well as immaterial premium and associated intrinsic value associated with weather derivatives.The Registrants are exposed to risk in the event of nonperformance by counterparties to energy-related and interest rate derivative contracts, as applicable. The Registrants only enter into agreements and material transactions with counterparties that have investment grade credit ratings by Moody's and S&P, or with counterparties who have posted collateral to cover potential credit exposure. Therefore, the Registrants do not anticipate market risk exposure from nonperformance by the counterparties. For additional information, see Note 1 to the financial statements under "Financial Instruments" and Note 14 to the financial statements.Credit RiskSouthern Company (except as discussed herein), the traditional electric operating companies, and Southern Power are not exposed to any concentrations of credit risk. Southern Company Gas' exposure to concentrations of credit risk is discussed herein.Southern Company GasGas Distribution OperationsConcentration of credit risk occurs at Atlanta Gas Light for amounts billed for services and other costs to its customers, which consist of the 14 Marketers in Georgia. The credit risk exposure to the Marketers varies seasonally, with the lowest exposure in the non-peak summer months and the highest exposure in the peak winter months. Marketers are responsible for the retail sale of natural gas to end-use customers in Georgia. The provisions of Atlanta Gas Light's tariff allow Atlanta Gas Light to obtain credit security support in an amount equal to a minimum of two times a Marketer's highest month's estimated bill from Atlanta Gas Light. For 2022, the four largest Marketers based on customer count, which includes SouthStar, accounted for 13% of Southern Company Gas' operating revenues and 15% of operating revenues for Southern Company Gas' gas distribution operations segment.Several factors are designed to mitigate Southern Company Gas' risks from the increased concentration of credit that has resulted from deregulation. In addition to the security support described above, Atlanta Gas Light bills intrastate delivery service to Marketers in advance rather than in arrears. Atlanta Gas Light accepts credit support in the form of cash deposits, letters of credit/surety bonds from acceptable issuers, and corporate guarantees from investment-grade entities. Southern Company Gas reviews the adequacy of credit support coverage, credit rating profiles of credit support providers, and payment status of each Marketer. Southern Company Gas believes that adequate policies and procedures are in place to properly quantify, manage, and report on Atlanta Gas Light's credit risk exposure to Marketers.II-69 Table of Contents Index to Financial Statements COMBINED MANAGEMENT'S DISCUSSION AND ANALYSISAtlanta Gas Light also faces potential credit risk in connection with assignments of interstate pipeline transportation and storage capacity to Marketers. Although Atlanta Gas Light assigns this capacity to Marketers, in the event that a Marketer fails to pay the interstate pipelines for the capacity, the interstate pipelines would likely seek repayment from Atlanta Gas Light.Gas Marketing ServicesSouthern Company Gas obtains credit scores for its firm residential and small commercial customers using a national credit reporting agency, enrolling only those customers that meet or exceed Southern Company Gas' credit threshold. Southern Company Gas considers potential interruptible and large commercial customers based on reviews of publicly available financial statements and commercially available credit reports. Prior to entering into a physical transaction, Southern Company Gas also assigns physical wholesale counterparties an internal credit rating and credit limit based on the counterparties' Moody's, S&P, and Fitch ratings, commercially available credit reports, and audited financial statements.II-70 Table of Contents Index to Financial Statements
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations,” “Item 7A. Quantitative and Qualitative Disclosures About Market Risk,” and the Consolidated Financial Statements and related Notes thereto. The Company's business could also be affected by additional risks and uncertainties not currently known to the Company or that it currently deems to be immaterial. If any of these risks actually occur, it could materially harm the Company's business, financial condition, or results of operations, or impair the Company's ability to implement its strategic plans. In that case, the market price of the Company's common stock could decline. The following risk factors are summarized as financial; operational; information technology; COVID-19; and legal, regulatory, compliance, and reputational.Financial Risks•The airline industry is particularly sensitive to changes in economic conditions, and continued or future unfavorable economic conditions could negatively affect the Company’s results of operations and require the Company to adjust its business strategies.•The Company's business can be significantly impacted by the availability of jet fuel and high and/or volatile fuel prices, and the Company's operations are subject to disruption in the event of any delayed supply of fuel; therefore, the Company's strategic plans and future profitability are likely to be impacted by the Company's ability to effectively address fuel price increases and fuel price volatility and availability.•The Company's low-cost structure has historically been one of its primary competitive advantages, and many factors have affected and could continue to affect the Company's ability to control its costs.•The Company's results of operations could be adversely impacted if it is unable to effectively execute its strategic plans.•The airline industry is intensely competitive.Operational Risks29Table of Contents•The Company is currently dependent on Boeing as the sole manufacturer of the Company's aircraft. Prolonged delays in the FAA issuing required certifications or approvals for the -7, or further regulatory actions by the FAA with respect to the MAX aircraft, could materially and adversely affect the Company’s business plans, strategies, and results of operations.•The Company's business is labor intensive, with most Employees represented by labor unions; therefore, the Company could be materially adversely affected in the event of conflict with its Employees or its Employees' representatives or if the Company were unable to employ sufficient numbers of qualified Employees to maintain its operations.•The Company is currently dependent on a single engine supplier, as well as single suppliers of certain other aircraft parts and equipment; therefore, the Company could be materially adversely affected (i) if it were unable to obtain timely or sufficient delivery of aircraft parts or equipment from Boeing or other suppliers or adequate maintenance or other support from any of these suppliers, (ii) if Boeing or other suppliers were unable to achieve and/or maintain required regulatory certifications or approvals of their parts or equipment, or (iii) in the event of a mechanical or regulatory issue associated with the Company's aircraft parts or equipment.•The airline industry has faced on-going security concerns and related cost burdens; further threatened or actual terrorist attacks, or other hostilities, even if not made directly on the airline industry, could significantly harm the airline industry and the Company's operations.•Interruptions or disruptions in service at one of the Company’s core stations could have a material adverse impact on its operations.•The Company’s operations have been, and in the future may again be, materially and adversely disrupted by extreme weather events. An inability to quickly and effectively restore operations following adverse weather or a localized disaster or disturbance in a key geography has adversely and materially impacted, and in the future could again adversely and materially impact, the Company’s business, results of operations, and financial condition.•The airline industry is made up of inherently complex systems, and is affected by many conditions that are beyond its control, which can impact the Company's business strategies and results of operations.Information Technology Risks•The Company is increasingly dependent on technology to operate its business and continues to implement substantial changes to its information systems; any failure, disruption, breach, or delay in implementation of the Company's information systems could materially adversely affect its operations.•Developing and expanding data security and privacy requirements could increase the Company's operating costs, and any failure of the Company to maintain the security of certain Customer, Employee, and business-related information could result in damage to the Company's reputation and could be costly to remediate. COVID-19 Risks•The COVID-19 pandemic, including associated variants, has materially and adversely affected, and could in the future materially and adversely affect, the Company’s results of operations, financial position, and liquidity.•The Company has entered into agreements with Treasury with respect to funding support; pursuant to these agreements the Company has agreed to certain restrictions on how it operates its business and uses its cash, which could limit the ability of the Company to take actions that it otherwise might have determined were in the best interests of the Company and its Shareholders.Legal, Regulatory, Compliance, and Reputational Risks•The Company is subject to extensive FAA regulation that may necessitate modifications to the Company’s operations, business plans, and strategies.30Table of Contents•Airport capacity constraints and air traffic control inefficiencies have limited and could continue to limit the Company's growth; changes in or additional governmental regulation could increase the Company's operating costs or otherwise limit the Company's ability to conduct business.•The Company is subject to various environmental requirements and risks, including increased regulation, changing consumer preferences, physical, environmental, and climate risks, and risks associated with climate change.•The Company is subject to risks related to its voluntary sustainability goals and disclosures, which may affect stakeholder sentiment and the Company’s reputation and brand.•The Company's future results will suffer if it is unable to effectively manage its international operations and/or Extended Operations.•The Company is currently subject to pending litigation, and if judgment were to be rendered against the Company in litigation, such judgment could adversely affect the Company's operating results.•Conflicting federal, state, and local laws and regulations may impose additional requirements and restrictions on the Company’s operations, which could increase the Company’s operating costs, result in service disruptions, and increase litigation risk.•The Company’s reputation and brand could be harmed if it were to experience significant negative publicity through social media or otherwise, including with respect to the Company's voluntary ESG-related goals and disclosures.•The Company’s Bylaws designate specific courts as the exclusive forum for certain legal actions between the Company and its Shareholders, which could increase costs to bring a claim, discourage claims, or limit the ability of the Company’s Shareholders to bring a claim in a judicial forum viewed by the Shareholders as more favorable for disputes with the Company or the Company’s directors, officers, or other Employees.Financial RisksThe airline industry is particularly sensitive to changes in economic conditions; in the event of continued or future unfavorable economic conditions or economic uncertainty, the Company's results of operations could be further negatively affected, which could require the Company to further adjust its business strategies.The airline industry, which is subject to relatively high fixed costs and highly variable and unpredictable demand, is particularly sensitive to changes in economic conditions, including changes in consumer discretionary spending as a result of inflation, rising interest rates, or other factors. Historically, unfavorable U.S. economic conditions have driven changes in travel patterns and have resulted in reduced spending for both leisure and business travel. For some consumers, leisure travel is a discretionary expense, and short-haul travelers, in particular, have the option to replace air travel with surface travel. As has become particularly evident as a result of the COVID-19 pandemic, businesses and other travelers are able to forego air travel by using other communications such as videoconferencing, business communication platforms, and the Internet. In addition, to the extent business travel recovers from the COVID-19 pandemic, businesses may require the purchase of less expensive tickets to reduce costs. This, in turn, can result in a decrease in average revenue per seat. During unfavorable economic conditions, low fares are often used to stimulate traffic. However, offering low fares typically hampers the ability of airlines to counteract any increases in fuel, labor, and other costs. Any continuing or future U.S. or global economic uncertainty could further negatively affect the Company's results of operations and could cause the Company to further adjust its business strategies. Additionally, because expenses of a flight do not vary significantly with the number of passengers carried, a relatively small change in the number of passengers can have a disproportionate effect on an airline’s operating and financial results. Therefore, any general reduction in airline passenger traffic could adversely affect the Company's results of operations.The Company's business can be significantly impacted by the availability of jet fuel and high and/or volatile fuel prices, and the Company's operations are subject to disruption in the event of any delayed supply of fuel; therefore, the Company's strategic plans and future profitability are likely to be impacted by the Company's ability to effectively address fuel price increases and fuel price volatility and availability.31Table of ContentsAirlines are inherently dependent upon energy to operate, and jet fuel and oil represented approximately 26.2 percent of the Company's operating expenses for 2022. As discussed under "Business - Cost Structure," Fuel and oil expense for 2022 increased significantly compared with 2021, primarily due to higher market jet fuel prices and in part due to higher capacity in response to consumer demand. The cost of fuel can be extremely volatile and unpredictable and subject to factors outside of the Company’s control. Even a small change in market fuel prices can significantly affect profitability. Furthermore, volatility in fuel prices can be due to many external factors that are beyond the Company's control. For example, fuel prices can be impacted by political, environmental (including those related to climate change), and economic factors, such as (i) dependency on foreign imports of crude oil and the potential for hostilities or other conflicts in oil producing areas; (ii) limitations and/or disruptions in domestic refining or pipeline operations or capacity due to weather, natural disasters, or other factors; (iii) worldwide demand for fuel, particularly in developing countries, which can result in inflated energy prices; (iv) changes in U.S. governmental policies on fuel production, transportation, taxes, and marketing; and (v) changes in currency exchange rates. In addition, the occurrence of extreme weather events (regardless of cause), such as flooding, acute or prolonged winter storms, tropical storms, and hurricanes, can also disrupt the jet fuel supply chain and affect fuel prices.The Company's ability to mitigate the impact of fuel price increases could also be limited by factors such as its historical low-fare reputation, the portion of its Customer base that purchases travel for leisure purposes, the competitive nature of the airline industry generally, and the risk that higher fares will drive a decrease in demand. The Company attempts to manage its risk associated with volatile jet fuel prices by utilizing over-the-counter fuel derivative instruments to hedge a portion of its future jet fuel purchases. However, energy prices can fluctuate significantly in a relatively short amount of time. Because the Company uses a variety of different derivative instruments at different price points, the Company is subject to the risk that the fuel derivatives it uses will not provide adequate protection against significant increases in fuel prices and in some cases could in fact result in hedging losses, which could result in the Company effectively paying higher than market prices for fuel, thus creating additional volatility in the Company's earnings. In addition, the Company is subject to the risk that its fuel derivatives will no longer qualify for hedge accounting under applicable accounting standards, or that the derivative instruments utilized will not effectively offset changes in the price of the jet fuel consumed, which can create additional earnings volatility. Adjustments in the Company's overall fuel hedging strategy, as well as the ability of the commodities used in fuel hedging to qualify for special hedge accounting, could continue to affect the Company's results of operations. In addition, there can be no assurance that the Company will be able to cost-effectively hedge against increases in fuel prices.The Company's fuel hedging arrangements and the various potential impacts of hedge accounting on the Company's financial position, cash flows, and results of operations are discussed in more detail under "Management’s Discussion and Analysis of Financial Condition and Results of Operations," "Quantitative and Qualitative Disclosures About Market Risk," and in Note 1 and Note 11 to the Consolidated Financial Statements.The Company is also reliant upon the readily available supply and timely delivery of jet fuel to the airports that it serves. A disruption in that supply could present significant challenges to the Company's operations and could ultimately cause the cancellation of flights and/or the inability of the Company to provide service to a particular airport. The airline industry could face potential fuel shortages in 2023 due to pipeline capacity constraints resulting from the shifting of jet fuel allocations during the COVID-19 pandemic as well as a national shortage of interstate trucking capacity. The Company is working with aviation industry stakeholders to address these issues. However, unless there is additional jet fuel distribution capacity, whether by pipeline and/or by truck, there could be temporary disruptions (e.g., flight cancellations or passenger caps) at one or more of the Company’s airports in 2023, especially during peak travel periods. For additional discussion of the availability of jet fuel and SAF, please see “The Company is subject to risks related to its voluntary sustainability goals and disclosures, which may affect stakeholder sentiment and the Company’s reputation and brand.”The Company's low-cost structure has historically been one of its primary competitive advantages, and many factors have affected and could continue to affect the Company's ability to control its costs.32Table of ContentsThe Company's low-cost structure has been one of its primary competitive advantages, as it has generally enabled the Company to offer low fares, drive traffic volume, grow market share, and protect profits. The COVID-19 pandemic has forced the Company and the Company's competitors to implement significant cost reduction measures. Competitor cost reduction measures such as accelerated fleet retirements, capacity cuts, and network reductions, could have a negative impact on the Company's relative cost position. Even before the pandemic, the Company's low-cost position had been challenged by the significant growth of "Ultra-Low Cost Carriers" ("ULCCs"), which in some cases have surpassed the Company's cost advantage with larger aircraft, increased seat density, and lower wages. ULCCs have further introduced "unbundled" service offerings which appeal to price-sensitive travelers through promotion to consumers of an extremely low relative base fare for a seat, while separately charging for related services and products. In response, most major U.S. airlines now offer expanded cabin segmentation fare products, such as "basic economy" and "premium economy" products. A basic economy product provides for a lower base fare to compete with a ULCC base fare, but may include significant additional restrictions on amenities such as seat assignments (including restrictions on group and family seating), order of boarding, checked baggage and use of overhead bin space, flight changes and refunds, and eligibility for upgrades. A "premium economy" fare targets consumers willing to pay a premium for certain amenities that were previously included in the carriers' base fare (e.g., more favorable seating locations in the main cabin). Also in response to competitive ULCC pricing, some carriers removed fare floors for certain routes, leading to a lower fare offering across the industry.The Company's low-cost structure can also be negatively impacted by costs over which the Company has limited control. These include costs such as fuel, labor, airport, and regulatory compliance costs. Jet fuel and oil constituted approximately 26.2 percent of the Company's operating expenses during 2022, and the Company's ability to control the cost of fuel is subject to the external factors discussed in “The Company's business can be significantly impacted by the availability of jet fuel and high and/or volatile fuel prices, and the Company's operations are subject to disruption in the event of any delayed supply of fuel; therefore, the Company's strategic plans and future profitability are likely to be impacted by the Company's ability to effectively address fuel price increases and fuel price volatility and availability.”Salaries, wages, and benefits constituted approximately 41.0 percent of the Company's operating expenses during 2022. The Company's ability to control labor costs is limited by the terms of its collective-bargaining agreements. This limited control has negatively impacted the Company's low-cost position, in particular in the context of the Company's cost reduction efforts during the COVID-19 pandemic. As discussed further under "Management’s Discussion and Analysis of Financial Condition and Results of Operations," the Company's unionized workforce makes up approximately 83 percent of its Employees and has had pay scale increases as a result of contractual rate increases, which has put pressure on the Company's labor costs. Additionally, as indicated under "Business - Employees," the majority of Southwest's unionized Employees, including its Pilots; Flight Attendants; Ramp, Operations, Provisioning, and Freight Agents; and Meteorologists are in unions currently in negotiations for labor agreements, which could result in additional pressure on the Company's low-cost structure. Further, in response to staffing challenges, the Company has increased the minimum pay for certain of its workforce and provided incentive pay in certain instances.As discussed under "Business - Regulation," the airline industry is heavily regulated, and the Company's regulatory compliance costs are subject to potentially significant increases from time to time based on actions by regulatory agencies that are out of the Company's control. Additionally, because of airport infrastructure updates and other factors, the Company has experienced increased space rental rates at various airports in its network. Further, the Company cannot control decisions by other airlines to reduce their capacity. When this occurs, as it has at times during the pandemic, certain fixed airport costs are allocated among a fewer number of total flights, which can result in increased landing fees and other costs for the Company.The Company is reliant upon third-party vendors and service providers, and the Company's low-cost advantage is dependent in part on its ability to obtain and maintain commercially reasonable terms with those parties. Disruptions 33Table of Contentsto capital markets, shortages of skilled personnel, supply chain disruptions, increased regulation, geopolitical developments, and/or adverse economic conditions could subject certain of the Company's third-party vendors and service providers to significant financial pressures, which could lead to delays and other performance issues, ceased operations, or even bankruptcies among these third-party vendors and service providers. If a third-party vendor or service provider is unable to fulfill its commitments to the Company, the Company may be unable to replace that third-party vendor or service provider in a short period of time, or at competitive terms, which could have a material adverse effect on the Company's results of operations.As discussed under "Business - Insurance," the Company carries insurance of types customary in the airline industry. Although the Company has been able to purchase aviation, property, liability, pollution, cybersecurity, and D&O/fiduciary insurance via the commercial insurance marketplace, costs have generally increased, and it is more difficult and, in some cases not possible, to obtain insurance for certain activities and weather-related events. For instance, the cost of insurance premiums related to hail and wind damage has increased for certain facilities, and certain flood insurance is no longer available. Available commercial insurance could be more expensive in the future and/or have material differences in coverage than insurance that has historically been provided and may not be adequate to protect against the Company's risk of loss from future events, including acts of terrorism and severe weather events. With respect to any insurance claims, policy coverages and claims are subject to acceptance by the many insurers involved and may require arbitration and/or mediation to effectively settle the claims over prolonged periods of time. In addition, an aircraft accident or other incident involving Southwest could result in costs in excess of its related insurance coverage, which costs could be substantial. Any aircraft accident or other incident involving Southwest, even if fully insured, could also have a material adverse effect on the public's perception of the Company, which could harm its reputation and business.As discussed below under "Management’s Discussion and Analysis of Financial Condition and Results of Operations," the Company experienced significant unit cost pressure in 2020, 2021, and 2022 following the onset of the COVID-19 pandemic. Except for changes in the price of fuel, changes in operating expenses for airlines have been largely driven by changes in capacity. However, the Company's operating expenses are largely fixed once flight schedules are published; and the Company experienced capacity lower than 2019 during 2020, 2021, and 2022 due to the COVID-19 pandemic, which has continued to pressure unit costs. During the COVID-19 pandemic, the Company has made schedule adjustments based on consumer demand, booking trends, and available crew resources. The limits on availability of crew resources could continue to require the Company to make additional schedule adjustments and could have a material adverse impact on the Company's results of operations. The Company's results of operations could be adversely impacted if it is unable to effectively execute its strategic plans.The Company is reliant on the success of its revenue strategies and other strategic plans and initiatives to grow and to help offset increasing costs. The execution of the Company's strategic plans has been significantly negatively affected by the COVID-19 pandemic. Nevertheless, the Company began to take actions in 2021 and 2022 to add staffing and increase the starting wage rate for certain workgroups, manage its fleet and fleet order book, and better optimize its network in an effort to position itself to opportunistically recover and grow as the pandemic subsides. The timely and effective execution of the Company's strategies is dependent upon, among other factors, (i) the Company's ability to balance its network schedule and capacity with the availability and location of its crew resources; (ii) the Company's ability to effectively balance its investment of incremental operating expenses and capital expenditures related to its strategies against the need to effectively control costs; (iii) the Company's ability to timely and effectively implement, transition, and maintain related information technology systems and infrastructure; (iv) as discussed below, the Company’s ability to maintain satisfactory relations with its Employees or its Employees’ representatives; and (v) the Company's dependence on third parties with respect to the execution of its strategic plans.The airline industry is intensely competitive.34Table of ContentsAs discussed in more detail under "Business - Competition," the airline industry is intensely competitive. The Company's primary competitors include other major domestic airlines, as well as regional and new entrant airlines, surface transportation, and alternatives to transportation such as videoconferencing, business communication platforms, and the Internet. The Company's revenues are sensitive to the actions of other carriers with respect to pricing, routes, loyalty programs, scheduling, capacity, customer service, operational reliability, comfort and amenities, cost structure, aircraft fleet, strategic alliances, and code-sharing and similar activities.Operational RisksThe Company is currently dependent on Boeing as the sole manufacturer of the Company's aircraft. Prolonged delays in the FAA issuing required certifications or approvals for the -7, or further regulatory actions by the FAA with respect to the MAX aircraft, could materially and adversely affect the Company’s business plans, strategies, and results of operations.The Boeing 737 MAX aircraft are crucial to the Company’s growth plans and fleet modernization initiatives. The Company operates the -8 out of the 737 MAX family of aircraft and is awaiting delivery of the -7 out of the 737 MAX family of aircraft. The Company's contractual delivery schedule for the -7 is dependent on the FAA issuing required certifications and approvals to Boeing and the Company. The FAA will ultimately determine the timing of the -7 certification and entry into service, and the Company therefore offers no assurances that current estimations and timelines are correct.Boeing no longer manufactures versions of the 737 other than the 737 MAX family of aircraft. If the 737 MAX aircraft were to again become unavailable for the Company’s flight operations, or if the -7 certification is not completed in a timely manner, the Company’s growth would be restricted unless and until it could procure and operate other types of aircraft from Boeing or another manufacturer, seller, or lessor, and the Company’s operations would be materially adversely affected. In particular, if the Company’s growth were to be dependent upon the introduction of a new aircraft make and model to the Company’s fleet, the Company would need to, among other things, (i) develop and implement new maintenance, operating, and training programs; (ii) secure extensive regulatory approvals; and (iii) implement new technologies. The requirements associated with operating a new aircraft make and model could take an extended period of time to fulfill and would likely impose substantial costs on the Company. A shift away from a single fleet type could also add complexity to the Company’s operations, present operational and compliance risks and materially increase the Company's costs. Any of these events would have a material, adverse effect on the Company's business, operating results, and financial condition. The Company could also be materially adversely affected if the pricing or operational attributes of its aircraft were to become less competitive.The Company's business is labor intensive, with most Employees represented by labor unions; therefore, the Company could be materially adversely affected in the event of conflict with its Employees or its Employees' representatives.The airline business is labor intensive, and for the year ended December 31, 2022, Salaries, wages, and benefits expense represented approximately 41.0 percent of the Company's operating expenses. As of December 31, 2022, approximately 83 percent of the Company's Employees were represented for collective bargaining purposes by labor unions, making the Company particularly exposed in the event of labor-related job actions. Employment-related matters (some of which relate to negotiated items) that have impacted the Company's results of operations include hiring/retention rates, attendance, pay rates, outsourcing, work rules, health care costs, and retirement benefits. Additionally, the majority of the Company’s unionized Employees are in unions currently in negotiations for labor agreements which could result in additional pressure on the Company's low-cost structure. The Company’s results could be materially adversely affected in the event of conflicts with its Employees or its Employees’ representatives.The Company’s business is labor intensive; therefore, the Company would be adversely affected if it were to continue to be unable to employ sufficient numbers of qualified Employees to maintain its operations.35Table of ContentsThe Company’s success depends on its ability to attract and retain skilled personnel. The impact of the COVID-19 pandemic has heightened the Company’s exposure to its labor risks. In connection with the drastic reduction in travel demand due to the pandemic, in 2020 the Company offered voluntary separation and extended time-off programs to Employees. This negatively impacted the Company's ability to staff appropriately when demand for leisure travel returned. At the same time, competition for skilled personnel became fierce, which led to operational challenges in the first half of 2022. In addition, the Company has been required to provide incentive pay and increase certain starting wage rates to address these challenges. Staffing-related challenges could continue to intensify and limit the Company's ability to optimally adjust capacity. The inability to recruit and retain skilled personnel or the unexpected loss of key skilled personnel could continue to adversely affect the Company’s operations.The Company is currently dependent on a single engine supplier, as well as single suppliers of certain other aircraft parts and equipment; therefore, the Company could be materially adversely affected (i) if it were unable to obtain timely or sufficient delivery of aircraft parts or equipment from Boeing or other suppliers or adequate maintenance or other support from any of these suppliers, (ii) if Boeing or other suppliers were unable to achieve and/or maintain required regulatory certifications or approvals of their parts or equipment, or (iii) in the event of a mechanical or regulatory issue associated with the Company's aircraft parts or equipment.The Company is dependent on Boeing as its sole supplier for many of its aircraft parts. The Company is also dependent on sole or limited suppliers for certain other aircraft parts, equipment, and services. If Boeing, or other suppliers, were unable or unwilling to timely provide adequate products or support for their products, were unable to achieve and/or maintain required regulatory certifications or approvals of their parts or equipment, or in the event of a mechanical or regulatory issue associated with engines or other parts, the Company's operations could be materially adversely affected. The Company could also be materially adversely affected if the pricing or operational attributes of its aircraft equipment were to become less competitive.The airline industry has faced on-going security concerns and related cost burdens; further threatened or actual terrorist attacks, or other hostilities, even if not made directly on the airline industry, could significantly harm the airline industry and the Company's operations.Terrorist attacks or other crimes and hostilities, actual and threatened, have from time to time materially adversely affected the demand for air travel and also have necessitated increased safety and security measures and related costs for the Company and the airline industry generally. Safety and security measures can create delays and inconveniences, which in turn can reduce the Company's competitiveness against surface transportation for short-haul routes and alternatives to transportation such as videoconferencing, business communication platforms, and the Internet. Additional terrorist attacks or other hostilities, even if not made directly on the airline industry, or the fear of such attacks or other hostilities (including elevated national threat warnings, government travel warnings to certain destinations, travel restrictions, or selective cancellation or redirection of flights due to terror threats) would likely have a further significant negative impact on the Company and the airline industry.Interruptions or disruptions in service at one of the Company’s core stations could have a material adverse impact on its operations.In recent years, the Company has increasingly focused on designing its network around core stations in an effort to provide greater connectivity and support operational reliability and recoverability. A significant interruption or disruption in service at one of the Company’s core stations, resulting from air traffic control systems, weather incidents, performance by third-party service providers, interruption of the Company’s technology, the availability and location of the Company’s crew resources, fuel supplies, or otherwise, could result in the cancellation or delay of a significant portion of the Company’s flights and, as a result, could have a severe impact on its business, results of operations and financial condition. The Company’s operations have been, and in the future may again be, materially and adversely disrupted by extreme weather events. An inability to quickly and effectively restore operations following adverse weather or 36Table of Contentsa localized disaster or disturbance in a key geography has adversely and materially impacted, and in the future could again adversely and materially impact, the Company’s business, results of operations, and financial condition. While the Company operates across a diverse geographic footprint, its operations at times have been adversely and materially impacted by severe weather, such as Hurricanes Harvey and Irma in 2017 and Winter Storm Elliott in December 2022. Depending on location, the Company’s assets and route network are or could be exposed to ongoing risks arising from a variety of adverse weather conditions or localized natural or manmade disasters such as earthquakes, volcanoes, wildfires, hurricanes, tropical storms, tornadoes, floods, sea-level rise, severe winter weather, sustained or extreme cold or heat, drought, or other disturbances, actual or threatened. Extreme weather conditions, including increases in the frequency, severity, or duration of severe weather events (whether or not caused by anthropogenic climate change), can disrupt air travel from time to time, ground planes, damage equipment and increase maintenance costs, cause delays and cancellations or other network disruptions, require implementation of weight limitations due to increased temperatures, increase turbulence-related injuries, cause increases in fuel consumption to avoid such weather, disrupt the Company’s supply chains (including fuel, parts, and service provider disruptions), and otherwise adversely affect the Company’s assets, operations, and infrastructure. These events can decrease revenue, increase costs, and adversely impact the Company’s financial condition. Prolonged interruptions or disruptions at airports can and do also adversely impact the Company’s business and results of operations. The Company also may incur significant costs to reestablish or relocate affected business functions, aircraft, and Employees. Moreover, any resulting economic dislocations could adversely affect demand for the Company’s services, resulting in an adverse effect on its business, results of operations, and financial condition.The airline industry is made up of inherently complex systems, and is affected by many conditions that are beyond its control, which can impact the Company's business strategies and results of operations.In addition to the unpredictable economic conditions and fuel costs previously discussed, the Company, like the airline industry in general, is affected by conditions that are largely unforeseeable and outside of its control, including, among others:•adverse weather and natural disasters and the associated effects on the Company's operations, which have, in certain circumstances, such as Winter Storm Elliott, impacted the Company's operational recovery to a greater degree than other airlines;•changes in consumer preferences, perceptions, spending patterns, or demographic trends (including, for example, changes in travel patterns due to weather, government restrictions or sequestration);•actual or potential disruptions in the air traffic control system (including, for example, as a result of FAA system outages or inadequate FAA staffing levels due to government restrictions or sequestration);•actual or perceived delays at various airports resulting from government restrictions (including, for example, longer wait-times at TSA checkpoints due to inadequate TSA staffing levels);•changes in the competitive environment due to industry consolidation, industry bankruptcies, and other factors;•delays in deliveries of new aircraft (including, for example, due to delays in FAA certification or due to the closure of the FAA's aircraft registry during government restrictions);•collective bargaining requirements and demands;•reliance on third-party facilities, goods, and/or services essential to its operations and/or business such as airports, de-icing services, fuel supply and delivery, and weather data and other critical information;•outbreaks of disease such as the COVID-19 pandemic; and•actual or threatened war, terrorist attacks, government travel warnings to certain destinations, travel restrictions, and political instability.37Table of ContentsBecause airline systems are inherently and unavoidably complex, large or small events, especially when in combination, can create opportunity for a systemic incident. The potential triggers for incidents and failures change constantly because of changing technology, work organization, efforts to eradicate those potential triggers, and other factors. Events or combinations of events such as those described above, have had, and could have, a material adverse effect on the Company’s business, results of operations, and financial condition.Information Technology RisksThe Company is increasingly dependent on technology to operate its business and continues to implement substantial changes to its information systems; any failure, disruption, breach, or delay in implementation of the Company's information systems could materially adversely affect its operations.The Company is increasingly dependent on the use of complex technology and systems to run its ongoing operations and support its strategic objectives. These technologies and systems include, among others, the Company's website and reservation system; flight dispatch and tracking systems; flight simulators; check-in kiosks; aircraft maintenance, planning, and record keeping systems; telecommunications systems; flight planning and scheduling systems; crew scheduling systems; human resources systems; and financial planning, management, and accounting systems. The performance, reliability, and security of the Company's technology infrastructure and supporting systems are critical to the Company's operations and initiatives.Implementation and integration of complex systems and technology present significant challenges in terms of costs, human resources, and development of effective internal controls. Implementation and integration require a balancing between the introduction of new capabilities and the managing of existing systems, and present the risk of operational or security inadequacy or interruption, which could materially affect the Company's ability to effectively operate its business and/or could negatively impact the Company's results of operations.The Company is also reliant upon the performance of third parties for timely and effective implementation and support of many of its technology initiatives, to provide required data and information services, and for maintaining adequate information security measures within the services and/or software they deliver, and such third parties are occasionally not timely in providing the services required by the Company. If any of the Company's significant technologies or automated systems were to cease functioning, or if its third-party service providers or data providers were to fail to adequately and timely provide required information or reports, technical support, system maintenance, security, or software upgrades for any of the Company's existing systems, the Company could experience service interruptions, delays, and loss of critical data, which could harm its operations and result in financial losses and reputational damage.In the ordinary course of business, the Company's systems will continue to require modification and refinements to address operational reliability, growth, and changing business requirements. In addition, the Company's systems may require modification to enable the Company to comply with changing regulatory requirements. Modifications and refinements to the Company's systems have been and are expected to continue to be expensive to implement and can divert management’s attention from other matters. In addition, the Company's operations could be adversely affected, or the Company could face imposition of regulatory penalties, if it were unable to timely or effectively modify its systems as necessary or appropriately balance the introduction of new capabilities with the management of existing systems.The Company has experienced material technology system interruptions and delays that have made its websites and operational systems unavailable or slow to respond, which has prevented the Company from efficiently processing Customer transactions or providing services. Any future system interruptions or delays could reduce the Company's operating revenues and the attractiveness of its services, as well as increase the Company's costs. Similarly, the Company has experienced operational challenges in connection with severe weather events and associated crew scheduling, such as during and subsequent to Winter Storm Elliott. While the Company is still assessing the causes of the disruption, the Company’s preliminary assessment is that the crew scheduling software worked as designed during this event. However, due to a number of factors, including unanticipated changes in the severity of the 38Table of Contentsweather, the Company began implementing frequent close-in flight cancellations. As the situation escalated and close-in flight cancellations grew, the volume of unanticipated changes was too great to efficiently address through the crew scheduling software, resulting in individual crew member assignment updates being delayed in a significant number of instances. Without updated, accurate crew member data, the Company’s crew scheduling software could not reassign crew members to solve for flights with crew coverage issues. As a result, the Company is working to enhance its crew scheduling software to help the Company during events that could result in a large number of broken crew pairings. The Company believes the unanticipated crew scheduling challenges, together with several other factors, contributed to the extent of the operational disruption. Any future operational disruptions or delays could reduce the Company’s operating revenues and the attractiveness of its services, as well as increase the Company’s costs.The Company's technologies and related systems and functions could be damaged or interrupted by catastrophic events beyond its control such as fires, floods, earthquakes, tornadoes and hurricanes, power loss, computer and telecommunications failures, acts of war or terrorism, computer viruses, malware, ransomware, security breaches, and similar events or disruptions generally beyond the Company’s control. Any of these events could cause system interruptions, delays, and loss of critical data, and could prevent the Company from processing Customer transactions or providing services, which could make the Company's business and services less attractive and subject the Company to liability. Any of these events could damage the Company's reputation and be expensive to remedy.Developing and expanding data security and privacy requirements could increase the Company's operating costs, and any failure of the Company to maintain the security of certain Customer, Employee, and business-related information could result in damage to the Company's reputation and could be costly to remediate. Many of these laws and regulations are subject to change and reinterpretation, and could result in claims, changes to the Company’s business practices, monetary penalties, increased cost of operations, or other harm to the Company’s business.The Company must receive information related to its Customers and Employees in order to run its business, and the Company's operations depend upon secure retention and the secure transmission of information over public networks, including information permitting cashless payments. This information is subject to the continually evolving risk of intrusion, tampering, and theft. Although the Company maintains systems to prevent or defend against these risks, these systems require ongoing monitoring and updating as technologies change, and security could be compromised, personal or confidential information could be misappropriated, or system disruptions could occur. In the ordinary course of its business, the Company also provides certain confidential, proprietary, and personal information to third parties. While the Company seeks to obtain assurances that these third parties will protect this information, there is a risk the security of data held by third parties could be breached. A compromise of the Company's security systems could adversely affect the Company's reputation and disrupt its operations and could also result in litigation against the Company or the imposition of penalties. In addition, it could be costly to remediate. Although the Company has not experienced cyber incidents that are individually, or in the aggregate, material, the Company has experienced cyber-attacks in the past, which have thus far been mitigated by preventative, detective, and responsive measures put in place by the Company.In addition, in response to these types of threats, there has been heightened legislative and regulatory focus on data privacy and security in the United States and elsewhere. The regulatory framework for data privacy and security worldwide is continuously evolving and developing and, as a result, the Company must monitor a growing and fast-evolving set of legal requirements in this area. This regulatory environment is increasingly challenging and may present material obligations and risks to the Company's business, including significantly expanded compliance requirements, costs, and enforcement risks. It is possible that these types of inquiries regarding cybersecurity breaches increase in frequency and scope. In addition, new laws, amendments to or reinterpretations of existing laws, regulations, standards, and other obligations may require the Company to incur additional costs and restrict its business operations, and may require the Company to change how it uses, collects, stores, transfers, or otherwise processes certain types of personal information and to implement new processes to comply with those laws and its Customers’ exercise of their rights thereunder. These laws also are not uniform, as certain laws may be more 39Table of Contentsstringent or broader in scope, or offer greater individual rights, with respect to sensitive and personal information, and such laws may differ from each other, which may complicate compliance efforts. Compliance in the event of a widespread data breach may be costly. Any failure or perceived failure by the Company or its third-party service providers to comply with any applicable federal, state, or similar foreign laws, rules, regulations, industry standards, policies, certifications, or orders relating to data privacy and security, or any compromise of security that results in the theft, unauthorized access, acquisition, use, disclosure, or misappropriation of personal data or other customer data, could result in significant awards, fines, civil and/or criminal penalties or judgments, proceedings, or litigation by governmental agencies or customers, including class action privacy litigation in certain jurisdictions and negative publicity and reputational harm, one or all of which could have an adverse effect on the Company’s reputation, business, financial condition, and results of operations.The Company has a dedicated cybersecurity team and program that focuses on current and emerging data security matters. The Company continues to assess and invest in the growing needs of the cybersecurity team through the allocation of skilled personnel, ongoing training, and support of the adoption and implementation of technologies coupled with cybersecurity risk management frameworks. Additionally, as cyber incidents and disruptions to technology networks become increasingly sophisticated, the Company may also incur significant costs to modify, upgrade, or enhance its cybersecurity measures to protect against such attacks. The Company may not be able to anticipate, detect, or prevent cyberattacks or security breaches, particularly because the methodologies used by attackers change frequently or may not be recognized until such attack is launched, and because attackers are increasingly using technologies specifically designed to circumvent cybersecurity measures and avoid detection. During the majority of 2020, and continuing through 2021 and 2022, the Company has offered the ability to work remotely to many of the Company's office and clerical Employees, including many of its Employees at the Company's headquarters campus. Maintaining a remote work force significantly increases the risk of cyber incidents and events, such as computer viruses and security breaches, due to increased targeted attacks, which have thus far been mitigated by preventative, detective, and responsive measures put in place by the Company.The Company carries a cybersecurity insurance policy with regards to data protection and business interruption associated with both security breaches from malicious parties and from certain system failures. However, available cybersecurity insurance with regards to data protection and business interruption could be more expensive in the future and/or have material differences in coverage than insurance that has historically been provided and may not be adequate to protect the Company's risk of loss of its data or proprietary and confidential information.COVID-19 RisksThe COVID-19 pandemic, including associated variants, has materially and adversely affected, and could in the future materially and adversely affect, the Company’s results of operations, financial position, and liquidity.The COVID-19 pandemic, including associated variants materially and adversely affected passenger demand and bookings, thereby materially and adversely affecting operating income and cash flows from operations during 2020, 2021, and early 2022. Any further impact of the COVID-19 pandemic on the Company’s business and its financial and operational performance will depend on future developments, including (i) the duration, spread, severity, or any recurrence of the COVID-19 pandemic, including through any new variant strains of the underlying virus; (ii) the effectiveness, availability, and usage of vaccines; (iii) the impact of government mandates, directives, orders, regulations, and other governmental actions related to the COVID-19 pandemic; (iv) the extent of the impact of the COVID-19 pandemic on overall demand for air travel and the Company's related business plans and decisions; (v) the impact of the COVID-19 pandemic on the Company's ability to retain key Employees; and (vi) the impact of the COVID-19 pandemic on the Company’s access to capital, all of which are highly uncertain and cannot be predicted. The COVID-19 pandemic may also materially and adversely affect the Company’s supply chain. For example, the Company is dependent on Boeing as its sole supplier for many of its aircraft parts. The Company is also dependent on (i) sole or limited suppliers for aircraft engines and certain other aircraft parts, equipment, and services; (ii) third-40Table of Contentsparty vendors; and (iii) service providers. The COVID-19 pandemic has resulted, and could continue to result, in delays and other performance issues, ceased operations, or even bankruptcies among these suppliers, third-party vendors, and service providers. Further failures of suppliers, third-party vendors, or service providers to timely provide adequate products or support for their products, or otherwise fulfill their commitments to the Company, could materially adversely affect the Company’s operations.The effects of the COVID-19 pandemic on the financial markets may materially and adversely affect the Company’s access to capital and cost of capital, including its ability to raise funds through equity or debt financings. If the Company’s credit ratings were to be downgraded, or general market conditions were to ascribe higher risk to the Company’s rating levels, the airline industry, or the Company, the Company’s access to capital and the cost of any debt financing would be negatively affected. The terms of future debt agreements could include more restrictive covenants or require incremental collateral, which could further restrict the Company’s business operations. There is no guarantee that debt or equity financings will be available in the future to fund the Company’s obligations, or that they will be available on terms consistent with the Company’s expectations.Some businesses have continued to restrict non-essential travel for their employees, which has kept demand for business air travel below pre-pandemic levels. Consumer behavior related to traveling may continue to be negatively impacted by adverse changes in business travel patterns or adverse changes in the perceived or actual economic climate, including declines in income levels and/or loss of wealth resulting from the impact of the COVID-19 pandemic or from economic conditions. The COVID-19 pandemic continues to evolve. The Company has entered into agreements with Treasury with respect to funding support; pursuant to these agreements the Company has agreed to certain restrictions on how it operates its business and uses its cash, which could limit the ability of the Company to take actions that it otherwise might have determined were in the best interests of the Company and its Shareholders.Since the start of the pandemic, the Company entered into definitive documentation with Treasury with respect to Payroll Support pursuant to three separate Payroll Support programs: the "PSP1 Payroll Support Program" in April 2020 under the Coronavirus Aid, Relief, and Economic Security Act; the "PSP2 Payroll Support Program” in January 2021 under the Consolidated Appropriations Act, 2021; and the "PSP3 Payroll Support Program" in April 2021 under the American Rescue Plan Act of 2021. Pursuant to these agreements, the Company has agreed to certain ongoing restrictions on, and requirements with respect to, its business and operations, including the following:•The Company was prohibited from repurchasing its common stock and from paying dividends or making capital contributions with respect to its common stock through September 30, 2022;•The Company must place certain restrictions on certain higher-paid employee and executive pay, including limiting pay increases and severance pay or other benefits upon terminations, until April 1, 2023; and•The Company must maintain certain internal controls and records relating to the Payroll Support funds, and is subject to additional reporting requirements.These restrictions and requirements may necessitate that the Company take, or limit taking, actions it might otherwise believe to be in the best interests of the Company and its Shareholders. For example, the restrictions could require that the Company change certain of its business practices, risk the Company's ability to retain key personnel, and expose the Company to additional costs (including increased compliance costs).Legal, Regulatory, Compliance, and Reputational RisksThe Company is subject to extensive FAA regulation that may necessitate modifications to the Company’s operations, business plans, and strategies.The FAA promulgates and enforces regulations affecting the airline industry, and exercises extensive regulatory oversight of the Company’s operations. The FAA from time to time also issues orders or directives relating to the 41Table of Contentsmaintenance and operation of aircraft. FAA orders and directives can be issued with little or no notice, and in certain instances, require the temporary grounding of aircraft and/or the responsive investment of operational and financial resources. The issuance of new FAA regulations, regulatory amendments, or orders or directives, such as FAA restrictions associated with certain wireless telecommunications systems, could result in flight schedule adjustments and groundings or delays in aircraft deliveries, as well as lower operating revenues, operating income, and net income due to a variety of factors, including, among others, (i) lost revenue due to flight cancellations and disruptions as a result of a smaller operating aircraft fleet, (ii) the lack of ability to make corresponding reductions in expenses because of the fixed nature of many expenses, and (iii) possible negative effects on Customer confidence and airline choice. Government regulation affecting the Company is discussed in more detail in “Airport capacity constraints and air traffic control inefficiencies have limited and could continue to limit the Company's growth; changes in or additional governmental regulation could increase the Company's operating costs or otherwise limit the Company's ability to conduct business” and under “Business - Regulation.”Airport capacity constraints and air traffic control inefficiencies have limited and could continue to limit the Company's growth; changes in or additional governmental regulation could increase the Company's operating costs or otherwise limit the Company's ability to conduct business.Almost all commercial service airports are owned and/or operated by units of local or state governments. Airlines are largely dependent on these governmental entities to provide adequate airport facilities and capacity at an affordable cost. In order to operate efficiently, as well as to add service in current and new markets, the Company must be able to maintain and/or obtain space and facilities at desirable airports with adequate infrastructure. Airport space, facility, and infrastructure constraints may prevent the Company from maintaining existing service and/or implementing new service in a commercially viable manner.Similarly, the federal government singularly controls all U.S. airspace, and airlines are dependent on the FAA controlling that airspace in a safe and efficient manner. The current air traffic control system is mainly radar-based, supported in large part by antiquated equipment and technologies, and heavily dependent on skilled personnel. As a result, the air traffic control system may not be able to effectively keep pace with future air traffic growth. The FAA's protracted transition to modernized air traffic control systems and newer technologies could adversely impact airspace capacity and the overall efficiency of the system, resulting in limited opportunities for the Company to grow, longer scheduled flight times, increased delays and cancellations, and increased fuel consumption and aircraft emissions. The continuation of these air traffic control constraints or the FAA's inability to meet staffing needs on a long-term basis may have a material adverse effect on the Company's operations.As discussed under "Business - Regulation," airlines are also subject to other extensive regulatory requirements. These requirements often impose substantial costs on airlines. The Company's strategic plans and results of operations could be negatively affected by changes in law and future actions taken by domestic and foreign governmental agencies having jurisdiction over its operations, including, but not limited to:•increases in airport rates and charges;•limitations on airport gate capacity or use of other airport facilities;•limitations on route authorities;•actions and decisions that create difficulties in obtaining access at slot-controlled airports (a "slot" is the right of an air carrier, pursuant to regulations of the FAA or local authorities, to operate a takeoff or landing at certain airports);•actions and decisions that create difficulties in obtaining operating permits and approvals;•changes to environmental regulations;•enhanced emissions and climate reporting obligations;•mandates on and regulation of existing products and services;•new or increased taxes or fees, such as with respect to potential increases to the federal corporate income tax rate, and such as those contained in the Inflation Reduction Act, including a potential corporate alternative minimum tax or potential taxes imposed on share repurchases, which may affect the Company’s decisions with respect to capital markets;42Table of Contents•changes to laws that affect the services that can be offered by airlines in particular markets and at particular airports;•restrictions on competitive practices;•changes in laws that increase costs for safety, security, compliance, or other Customer Service standards;•changes in laws that may limit the Company's ability to enter into fuel derivative contracts to hedge against increases in fuel prices;•changes in laws that may limit or regulate the Company's ability to promote the Company’s business or fares;•airspace closures or restrictions, such as restrictions on operations in markets where certain wireless telecommunications systems may cause interference with certain aircraft avionics;•grounding of commercial air traffic by the FAA; and•the adoption of more restrictive locally-imposed noise regulations.The Company is subject to various environmental requirements and risks, including increased regulation, changing consumer preferences, physical, environmental, and climate risks, and risks associated with climate change.The Company is subject to federal, state, local, and international laws and regulations relating to the protection of the environment, including those relating to aircraft and ground-based emissions, discharges to water systems, safe drinking water, and the management of hazardous substances and waste materials. In addition, while the Company cannot predict what requirements may be imposed in the future, federal, state, local, and international legislative and regulatory bodies are generally increasingly focused on climate change and reducing greenhouse gas emissions (“GHG”), including CO2 emissions. For example, as discussed in more detail under “Business – Regulation,” the federal government, as well as several state and local governments, the governments of other countries, and the United Nations’ International Civil Aviation Organization have implemented legislative and regulatory proposals and voluntary measures intended to reduce GHG emissions. Future policy, legal, regulatory, or other market developments could require the Company to reduce its emissions, modify its supply chain practices or aspects of its operations, make capital investments to purchase specific types of equipment or technologies, secure carbon offset credits, disclose or report additional GHG information, or otherwise incur additional costs related to climate objectives or because of the Company’s GHG emissions. Until the timing, scope, and extent of such future policy, legal, regulatory, or other market developments become known, the Company cannot predict their effect on the Company’s cost structure or its operating results. The Company could also face increased risks of litigation resulting from any enhanced disclosure requirements related to climate change.Furthermore, to the extent that the Company may seek to achieve its voluntary climate goals and mandatory climate obligations through the use of carbon offsets, it may be exposed to additional costs associated with the procurement of offsets or limited supply in the voluntary carbon offsets market. In addition, to the extent the Company does utilize offsets, it will need to obtain these offsets from third parties, and while the Company generally seeks to purchase only quality offsets verified by reputable third parties, it can make no guarantees that the underlying offset project will provide the full or any claimed GHG emission reduction benefits.Concern among consumers of the impacts of climate change may mean some customers choose to fly less frequently or fly on an airline they perceive as operating in a manner that is more sustainable to the climate, and customers may choose to use alternatives to travel, such as virtual meetings and workspaces. Greater development of high-speed rail in markets now served by short-haul flights could provide passengers with lower-carbon alternatives to flying. Longer-term changes in weather patterns could adversely impact any of the Company’s destination cities and, as a result, alter the travel behavior of its Customers. The Company’s collateral to secure loans, including in the form of aircraft, could lose value as customer demand shifts and economies move to low-carbon alternatives, which may increase the Company’s financing costs. In addition, major financial institutions have begun to announce greenhouse gas emissions reductions targets for their financed activities in the aviation sector. To the extent that the Company's climate targets are not perceived to align with those of its lenders, the Company's access to credit may be adversely impacted.43Table of ContentsFinally, the potential acute and chronic physical effects of climate change, such as increased frequency, duration, and severity of extreme weather events, longer-term changes in weather patterns, and other climate-related events, could affect the Company’s operations, infrastructure, and financial results. The Company could incur significant costs to improve the climate resiliency of its operations, infrastructure, and supply chain, and otherwise prepare for, respond to, and mitigate such physical effects of climate change. The Company could also incur additional airport fees or other costs related to the infrastructure which supports the commercial aviation industry. The Company is not able to predict accurately the materiality of any potential losses or costs associated with the physical effects of climate change. For additional disclosure related to impacts to the Company’s operations resulting from extreme weather events, see the Risk Factor entitled, “The Company's operations have been, and in the future may again be, materially and adversely disrupted by extreme weather events. An inability to quickly and effectively restore operations following adverse weather or a localized disaster or disturbance in a key geography has adversely and materially impacted, and in the future could again adversely and materially impact, the Company's business, results of operations, and financial condition” in the “Operational Risks” section.The Company is subject to risks related to its voluntary sustainability goals and disclosures, which may affect stakeholder sentiment and the Company’s reputation and brand.In addition to responding to legislative and regulatory requirements, the Company has voluntarily set near- and long-term environmental sustainability plans and goals. The achievement of these plans and goals is materially dependent on the performance of third parties and government action, and these goals could be adversely affected by changes in third party expectations, methodologies, and priorities. The Company expects its path toward achievement of these goals to depend on, among other things (i) increased use of SAF, which is not presently available at scale or at prices competitive to jet fuel; (ii) improved fuel efficiency from fleet modernization; (iii) operational initiatives; and (iv) technological innovation. The Company is attempting to diversify its sources of jet fuel or otherwise seek to limit its reliance on fossil-fuel based fuels, such as through increasing the volumes of SAF used in its operations. Supplies of SAF are limited and may not be developed in sufficient quantities to support the Company’s business or sustainability goals. The Company cannot guarantee that it will be able to purchase SAF on a cost-effective basis due to supply constraints; technology challenges in the production, development, transportation, storage, and distribution of SAF; inability to scale SAF on a commercially competitive basis; failures by governments to implement or extend policies and incentives (including tax credits) to reduce the cost or incentivize production of SAF; compliance with and/or changes to taxes and regulations; failure of industry standards, accounting protocols, or other applicable requirements to allow the Company to realize benefits from SAF (including blend limitations); or requirements related to GHG emissions, carbon costs, or climate related goals. In addition, SAF has a limited distribution system and is subject to higher transportation risks than jet fuel. The Company’s ability to achieve its environmental sustainability goals is subject to risks and uncertainties, many of which are outside of its control. These risks and uncertainties include, but are not limited to: the Company’s ability to successfully implement its business strategy, effectively respond to changes in market dynamics and achieve the anticipated benefits and associated cost savings of such strategies and actions; the Company’s ability to implement its fleet modernization or planned fuel efficiency initiatives; availability and ability to utilize SAF at economical prices and with expected carbon intensity reductions; advancement in modernizing air traffic control systems; unforeseen production, design, operational, and technological difficulties; the outcome of research efforts and future technology developments, including the ability to scale projects and technologies on a commercially competitive basis; compliance with, and changes or additions to, global and regional regulations, taxes, charges, mandates, or requirements relating to GHG emissions, carbon costs, or climate-related goals; changes to emission accounting methodologies; adapting products to customer preferences and customer acceptance of sustainable supply chain solutions; the actions of competitors and competitive pressures; or other new developments related to the potential impacts of climate change. There is no assurance that the Company will be able to successfully execute its strategies and achieve its previously announced environmental and sustainability goals. 44Table of ContentsThe Company also makes certain disclosures regarding sustainability, including the Company’s sustainability goals to address carbon emissions, and many of these disclosures are necessarily based on (i) estimates and assumptions that are inherently difficult to assess and may involve third party data that the Company does not independently verify, and (ii) timelines that are longer than the timelines associated with the Company’s required disclosures. Given the estimates, assumptions, and timelines used to create these disclosures, the materiality of these disclosures is inherently difficult to assess in advance, and given the uncertainty of the estimates and assumptions used to create these disclosures, the Company may not be able to anticipate in advance whether or the degree to which it will or will not be able to meet its sustainability plans or goals, or how expensive it will be to do so.The Company’s reputation or brand, as well as its Customer and other stakeholder relationships, could be adversely impacted as a result of, among other things, (i) any failure to meet its sustainability plans or goals, including those that relate to climate change; (ii) the Company’s impact on the environment; or (iii) public pressure from investors or policy groups to change the Company's policies. In the future, the Company's efforts to meet its sustainability plans or goals may divert Company resources or management's attention from other matters.The Company's future results will suffer if it is unable to effectively manage its international operations and/or Extended Operations ("ETOPS").The Company's international flights are subject to CBP-mandated procedures, which can affect the Company's operations, costs, and Customer experience. The Company has made significant investments in facilities, equipment, and technologies at certain airports in order to improve the Customer experience and to assist CBP with its inspection and processing duties; however, the Company is not able to predict the impact, if any, that various CBP measures or the lack of CBP resources will have on Company revenues and costs, either in the short-term or the long-term.International flying requires the Company to modify certain processes, as the airport environment is dramatically different in certain international locations with respect to, among other things, common-use ticket counters and gate areas, passenger entry requirements (including health requirements imposed in response to the COVID-19 pandemic), local operating requirements, and cultural preferences. Certain international routes served by the Company are also subject to specific aircraft equipage requirements and unique consumer behavior. Route-specific equipage requirements and unique consumer behavior, together or individually, may (i) restrict the Company's flexibility when scheduling and routing aircraft and crews; (ii) require the Company to modify its policies or procedures; and (iii) impact the Company's operational performance, costs, and Customer Experience. In addition, international flying exposes the Company to certain foreign currency risks to the extent the Company chooses to, or is required to, transact in currencies other than the U.S. dollar. To the extent the Company seeks to serve additional international destinations in the future, or to renew its authority to serve certain routes, it may be required to obtain necessary authority from the DOT and/or approvals from the FAA, as well as any applicable foreign government entity.The Company's operations in non-U.S. jurisdictions may subject the Company to the laws of those jurisdictions rather than, or in addition to, U.S. laws. Laws in some jurisdictions differ in significant respects from those in the United States, and these differences can affect the Company's ability to react to changes in its business, and its rights or ability to enforce rights may be different than would be expected under U.S. laws. Furthermore, enforcement of laws in some jurisdictions can be inconsistent and unpredictable, which can affect both the Company's ability to enforce its rights and to undertake activities that it believes are beneficial to its business. As a result, the Company's ability to generate revenue and its expenses in non-U.S. jurisdictions may differ from what would be expected if U.S. laws governed these operations. Although the Company has policies and procedures in place that are designed to promote compliance with the laws of the jurisdictions in which it operates, a violation by the Company's Employees, contractors, or agents or other intermediaries could nonetheless occur. Any violation (or alleged or perceived violation), even if prohibited by the Company's policies, could have an adverse effect on the Company's reputation and/or its results of operations.45Table of ContentsIn 2019, the Company began service to Hawaii after receiving approval from the FAA for ETOPS, a regulatory requirement to operate between the U.S. mainland and the Hawaiian Islands. The Company is subject to additional, ongoing, ETOPS-specific regulatory and procedural requirements, which present operational and compliance risks to the Company’s business, including costs associated therewith.The Company is currently subject to pending litigation, and if judgment were to be rendered against the Company in litigation, such judgment could adversely affect the Company's operating results.As discussed below under "Legal Proceedings," the Company is subject to pending litigation. Regardless of merit, these litigation matters and any potential future claims against the Company may be both time consuming and disruptive to the Company's operations and cause significant expense and diversion of management attention. Should the Company fail to prevail in these or other matters, the Company may be faced with significant monetary damages or injunctive relief that could materially adversely affect its business and might materially affect its financial condition and operating results and could cause reputational harm.Conflicting federal, state, and local laws and regulations may impose additional requirements and restrictions on the Company’s operations, which could increase the Company’s operating costs, result in service disruptions, and increase litigation risk.Airlines are subject to extensive regulatory and legal requirements at the federal, state, and local levels that require substantial compliance costs and that may be inconsistent with each other. These laws could affect the Company’s relationship with its workforce and cause its expenses to increase without an ability to pass through these costs. In recent years, the airline industry has experienced an increase in litigation asserting the application of state and local employment laws, particularly in California. On June 30, 2022, the U.S. Supreme Court denied review of the Ninth Circuit’s ruling in Bernstein v. Virgin America, Inc., which held that federal law did not preempt the California state meal-and-rest-break regulations for flight attendants at issue. The Company is a defendant in multiple proceedings asserting wage and hour claims with respect to certain employees who work in, or are based in, California. The Bernstein decision may adversely affect the Company’s defenses in some or all of those proceedings and may give rise to additional litigation in these or other areas previously believed to be preempted by federal law. Application of state and local laws to the Company’s operations may conflict with federal laws—or with the laws of other states and local governments—and may subject the Company to additional requirements and restrictions. Moreover, application of these state and local laws may result in operational disruption, increased litigation risk, and negative effects on the Company’s collective bargaining agreements. Adverse litigation results in any of these cases could adversely impact the Company’s operational flexibility and result in the imposition of damages and fines, which could potentially be significant.The Company’s reputation and brand could be harmed if it were to experience significant negative publicity through social media or otherwise, including with respect to the Company's voluntary ESG-related goals and disclosures.The Company operates in a public-facing industry with significant exposure to social media. Negative publicity, whether or not justified, can spread rapidly through social media. The Company’s reputation or brand, as well as its customer and other stakeholder relationships, could be adversely impacted as a result of, among other things, (i) any failure to meet its ESG plans or goals; (ii) customer perceptions of the Company’s advertising campaigns, sponsorship arrangements or marketing programs; (iii) customer perceptions of the Company’s use of social media; (iv) customer perceptions of statements made by the Company, its Employees and executives, agents, or other third parties; or (v) public pressure from investors or policy groups to change the Company's policies. To the extent that the Company is unable to respond timely and appropriately to negative publicity, the Company’s reputation and brand can be harmed. Damage to the Company’s overall reputation and brand could have a negative impact on its financial results and require additional resources for the Company to rebuild its reputation.The Company’s Bylaws designate specific courts as the exclusive forum for certain legal actions between the Company and its Shareholders, which could increase costs to bring a claim, discourage claims, or limit the 46Table of Contentsability of the Company’s Shareholders to bring a claim in a judicial forum viewed by the Shareholders as more favorable for disputes with the Company or the Company’s directors, officers, or other Employees.The Company’s Bylaws provide, to the fullest extent permitted by law, that, unless the Company consents in writing to the selection of an alternative forum, the United States District Court for the Northern District of Texas or, if such court lacks jurisdiction, the state district court of Dallas County, Texas, will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (a) any derivative action or proceeding brought on behalf of the Company; (b) any action asserting a claim of breach of a fiduciary duty owed by any director, officer, or other Employee of the Company to the Company or the Company’s Shareholders; (c) any action asserting a claim against the Company or any director, officer, or other Employee of the Company pursuant to any provision of the Company’s Restated Certificate of Formation or Bylaws (as either may be amended from time to time) or the Texas Business Organizations Code; and (d) any action asserting a claim against the Company or any director, officer, or other Employee of the Company governed by the internal affairs doctrine.The Company’s Bylaws also provide that, unless the Company consents in writing to the selection of an alternative forum, the federal district courts of the United States of America will be the sole and exclusive forum for the resolution of any complaint asserting a cause of action under the Securities Act of 1933 (the “Securities Act”). We note, however, that there is uncertainty as to whether a court would enforce this provision and that investors cannot waive compliance with the federal securities laws and the rules and regulations thereunder. Section 22 of the Securities Act creates concurrent jurisdiction for state and federal courts over all suits brought to enforce any duty or liability created by the Securities Act or the rules and regulations thereunder.The forum selection provision may increase costs to bring a claim, discourage claims, or limit a Shareholder’s ability to bring a claim in a judicial forum that such Shareholder finds favorable for disputes with the Company or the Company’s directors, officers, or other Employees, which may discourage such lawsuits against the Company or the Company’s directors, officers, and other Employees. Alternatively, if a court were to find the forum selection provision contained in the Company’s Bylaws to be inapplicable or unenforceable in an action, the Company could incur additional costs associated with resolving such action in other jurisdictions.Item 1B. Unresolved Staff CommentsNone.47Table of ContentsItem 2. PropertiesAircraft Southwest operated a total of 770 Boeing 737 aircraft as of December 31, 2022, of which 58 and 36 were under operating and finance leases, respectively. The following table details information on the 770 aircraft as of December 31, 2022:TypeSeatsAverageAge(Yrs)Number ofAircraftNumberOwned (a)NumberLeased (b)737-70014318 426 378 48 737-8001757 207 190 17 737 -81752 137 108 29 Totals12 770 676 94 (a)As discussed further in Note 7 to the Consolidated Financial Statements, 83 of the Company's aircraft were pledged as collateral as of December 31, 2022, associated with outstanding secured borrowings.(b)See Note 8 to the Consolidated Financial Statements for more information on the Company's lease transactions.The delivery schedule below reflects contractual commitments, although the timing of future deliveries is uncertain. For purposes of the delivery schedule below, the Company has included the remaining 46 of its 2022 contractual undelivered aircraft within its 2023 contractual commitments, and has not made any further adjustments to this schedule based on current estimations. The Company is planning for approximately 100 -8 aircraft deliveries in 2023. The delivery schedule for the -7 is dependent on the FAA issuing required certifications and approvals to Boeing and the Company. The FAA will ultimately determine the timing of the -7 certification and entry into service, and the Company therefore offers no assurances that current estimations and timelines are correct. As of December 31, 2022, the Company had firm deliveries and options for Boeing 737 -7 and 737 -8 aircraft as follows:The Boeing Company-7 Firm Orders-8 Firm Orders-7 or -8 OptionsTotal202331 105 — 136 (a)202441 — 45 86 (b)202530 — 56 86 202630 15 40 85 202715 15 6 36 202815 15 — 30 202920 30 — 50 2030— 55 — 55 182 235 (c)147 (b)564 (a) The Company has included the remaining 46 of its 2022 contractual undelivered aircraft (14 -7s and 32 -8s) within its 2023 contractual commitments. Due to Boeing's supply chain challenges and the current status of the -7 certification, the Company currently estimates approximately 100 MAX aircraft deliveries in 2023. The 2023 contractual detail is as follows:The Boeing Company-7 Firm Orders-8 Firm OrdersTotal2022 Contractual Deliveries Remaining14 32 46 2023 Contractual Deliveries17 73 90 2023 Contractual Total31 105 136 (b) In January 2023, the Company exercised 10 -7 options for delivery in 2024.48Table of Contents(c ) The Company has flexibility to designate firm orders or options as -7s or -8s, upon written advance notification as stated in the contract.Ground Facilities and ServicesSouthwest either leases or pays a usage fee for terminal passenger service facilities at each of the airports it serves, to which various leasehold improvements have been made. The Company leases the land and/or structures on a long-term basis for its aircraft maintenance centers (located at Dallas Love Field, Houston Hobby, Phoenix Sky Harbor, Chicago Midway, Hartsfield-Jackson Atlanta International Airport, Denver International Airport, and Orlando International Airport) and its main corporate headquarters building, also located near Dallas Love Field. The Company also leases a warehouse and engine repair facility in Atlanta. The Company has announced its intent to build a new aircraft maintenance facility, expected to be completed in 2025, at Baltimore-Washington International Airport.The Company has commitments associated with various airport improvement projects, including construction at Houston Hobby International Airport. This project includes the construction of new facilities and the rebuilding or modernization of existing facilities. Additional information regarding these projects is provided in Note 5 to the Consolidated Financial Statements.The Company owns two additional headquarters buildings, located across the street from the Company's main headquarters building, on land owned by the Company including (a) an energy-efficient, modern building, called TOPS, which houses certain operational and training functions, including the Company's 24-hour operations and (b) the Wings Complex, consisting of a Leadership Education and Aircrew Development (LEAD) Center (housing the Company's 26 Boeing 737 flight simulators and classroom space for Pilot training), an additional office building, and a parking garage. As of December 31, 2021, the Company operated seven Customer Support and Services call centers. During 2022, the Company closed all seven physical locations of the Customer Support and Services call centers and transitioned Customer Support and Services Employees to remote work.The Company performs substantially all line maintenance on its aircraft and provides ground support services at most of the airports it serves. However, the Company has arrangements with certain aircraft maintenance providers for major component inspections and repairs for its airframes and engines, which comprise the majority of the Company's annual aircraft maintenance costs.Item 3. Legal Proceedings On June 30, 2015, the U.S. Department of Justice ("DOJ") issued a Civil Investigative Demand ("CID") to the Company. The CID sought information and documents about the Company’s capacity from January 2010 to the date of the CID, including public statements and communications with third parties about capacity. In June 2015, the Company also received a letter from the Connecticut Attorney General requesting information about capacity. The Company is cooperating fully with the DOJ CID and the state inquiry.Further, on July 1, 2015, a complaint was filed in the United States District Court for the Southern District of New York on behalf of putative classes of consumers alleging collusion among the Company, American Airlines, Delta Air Lines, and United Airlines to limit capacity and maintain higher fares in violation of Section 1 of the Sherman Act. Since then, a number of similar class action complaints were filed in the United States District Courts for the Central District of California, the Northern District of California, the District of Columbia, the Middle District of Florida, the Southern District of Florida, the Northern District of Georgia, the Northern District of Illinois, the Southern District of Indiana, the Eastern District of Louisiana, the District of Minnesota, the District of New Jersey, the Eastern District of New York, the Southern District of New York, the Middle District of North Carolina, the District of Oklahoma, the Eastern District of Pennsylvania, the Northern District of Texas, the District of Vermont, 49Table of Contentsand the Eastern District of Wisconsin. On October 13, 2015, the Judicial Panel on Multi-District Litigation centralized the cases to the United States District Court in the District of Columbia. On March 25, 2016, the plaintiffs filed a Consolidated Amended Complaint in the consolidated cases alleging that the defendants conspired to restrict capacity from 2009 to present. The plaintiffs seek to bring their claims on behalf of a class of persons who purchased tickets for domestic airline travel on the defendants' airlines from July 1, 2011 to present. They seek treble damages, injunctive relief, and attorneys' fees and expenses. On May 11, 2016, the defendants moved to dismiss the Consolidated Amended Complaint, which the Court denied on October 28, 2016. On December 20, 2017, the Company reached an agreement to settle these cases with a proposed class of all persons who purchased domestic airline transportation services from July 1, 2011, to the date of the settlement. The Company agreed to pay $15 million and to provide certain cooperation with the plaintiffs as set forth in the settlement agreement. After notice was provided to the proposed settlement class and the Court held a fairness hearing the Court issued an order granting final approval of the settlement on May 9, 2019. On June 10, 2019, certain objectors filed notices of appeal to the United States Court of Appeals for the District of Columbia Circuit, which the Court dismissed on July 9, 2021, for lack of jurisdiction because the district court's order approving the settlements was not a final appealable order. The case is continuing as to the remaining defendants. The Company denies all allegations of wrongdoing.On July 11, 2019, a complaint alleging violations of federal and state laws and seeking certification as a class action was filed against Boeing and the Company in the United States District Court for the Eastern District of Texas in Sherman ("Sherman Complaint"). The complaint alleges that Boeing and the Company colluded to conceal defects with the Boeing 737 MAX ("MAX") aircraft in violation of the Racketeer Influenced and Corrupt Organization Act ("RICO") and also asserts related state law claims based upon the same alleged facts. The complaint seeks damages on behalf of putative classes of customers who purchased tickets for air travel from either the Company or American Airlines between August 29, 2017, and March 13, 2019. The complaint generally seeks money damages, equitable monetary relief, injunctive relief, declaratory relief, and attorneys’ fees and other costs. On September 13, 2019, the Company filed a motion to dismiss the complaint and to strike certain class allegations. Boeing also moved to dismiss. On February 14, 2020, the trial court issued a ruling that granted in part and denied in part the motions to dismiss the complaint. The trial court order, among other things: (i) dismissed without prejudice various state law claims that the plaintiffs abandoned in response to the motions, (ii) dismissed with prejudice the remaining state law claims, including fraud by concealment, fraud by misrepresentation, and negligent misrepresentation on the grounds that federal law preempts those claims, and (iii) found that plaintiffs lack Article III standing to pursue one of the plaintiffs’ theories of RICO injury. The order denied the motion to dismiss with respect to two RICO claims premised upon a second theory of RICO injury and denied the motion to strike the class allegations at the pleadings stage. On September 3, 2021, the trial court issued an order under Rule 23(a) and 23(b)(3) certifying four classes of persons associated with ticket purchases for flights during the period of August 29, 2017, through March 13, 2019, comprised of (i) those who purchased tickets (without being reimbursed) for flights on Southwest Airlines during the class period, except for those whose flights were solely on routes where, at the time of the ticket purchase(s), a MAX plane was not scheduled for use (or actually used) and had not previously been used, (ii) those who reimbursed a Southwest Airlines ticket purchaser and thus bore the economic burden for a Southwest Airlines ticket for a flight meeting the preceding criteria set forth in (i) above, (iii) those who purchased tickets (without being reimbursed) for flights on American Airlines during the class period, except for those whose flights were solely on routes where, at the time of ticket purchase(s), a MAX plane was not scheduled for use (or actually used) and had not previously been used, and (iv) those who reimbursed an American Airlines ticket purchaser and thus bore the economic burden for an American Airlines ticket for a flight meeting the preceding criteria set forth in (iii) above. On September 17, 2021, the Company filed a petition for permission immediately to appeal the class certification ruling to the Fifth Circuit Court of Appeals. Boeing also filed such a petition. Plaintiffs filed their oppositions to the petitions on September 27, 2021. On September 30, 2021, the Fifth Circuit Court of Appeals granted the Company (and Boeing) permission to appeal the class certification ruling. On December 22, 2021, in response to a motion to stay the trial court proceedings filed by the Company and Boeing, the Fifth Circuit stayed all proceedings, including the pursuit of any discovery, in the trial court pending disposition of the class certification appeal by the Fifth Circuit. Following full briefing on the merits of the appeal, a three-judge panel of the Fifth Circuit heard oral argument of the appeal on July 5, 2022. On November 21, 2022, the Fifth Circuit issued an opinion concluding that, among other things, the plaintiffs "have offered no plausible theory of economic harm" and "have suffered no injury in fact and lack Article III standing," and so their "case therefore must be dismissed." The 50Table of ContentsFifth Circuit reversed the trial court's September 3, 2021 certification order and remanded the case to the trial court with instructions to dismiss the case for lack of jurisdiction. On December 5, 2022, the plaintiffs filed a Petition for Rehearing En Banc, which seeks to have the appeal reheard by the Fifth Circuit. On January 10, 2023, the Company and Boeing filed a joint response to the Petition. The Petition remains pending before the Fifth Circuit. The Company denies all allegations of wrongdoing, believes the plaintiffs' positions are without merit, and intends to continue vigorously defending itself in all respects.On February 19, 2020, a complaint alleging violations of federal securities laws and seeking certification as a class action was filed against the Company and certain of its officers in the United States District Court for the Northern District of Texas in Dallas. A lead plaintiff has been appointed in the case, and an amended complaint was filed on July 2, 2020. The amended complaint seeks damages on behalf of a putative class of persons who purchased the Company’s common stock between February 7, 2017, and January 29, 2020. The amended complaint asserts claims under Sections 10(b) and 20 of the Securities Exchange Act and alleges that the Company made material misstatements to investors regarding the Company’s safety and maintenance practices and its compliance with federal regulations and requirements. The amended complaint generally seeks money damages, pre-judgment and post-judgment interest, and attorneys’ fees and other costs. On August 17, 2020, the Company and the individual defendants filed a motion to dismiss. On October 1, 2020, the lead plaintiff filed a response in opposition to the motion to dismiss. The Company filed a reply on or about October 21, 2020, such that the motion is now fully briefed, although the parties have each supplemented their prior briefing with regard to more recent case holdings in other matters. The Company denies all allegations of wrongdoing, including those in the amended complaint. The Company believes the plaintiffs' positions are without merit and intends to vigorously defend itself in all respects.On June 22, 2020, a derivative action for breach of fiduciary duty was filed in the United States District Court for the Northern District of Texas naming the members of the Company's Board of Directors as defendants and the Company as a nominal defendant (the "Derivative Action"). The plaintiff alleges unspecified damage to Company’s reputation, goodwill, and standing in the community, as well as damage from exposure to civil and regulatory liability and defense costs. According to the lawsuit, these damages arise from the Company’s alleged failure to comply with safety and record maintenance regulations and false statements in public filings regarding the Company’s safety practices. The plaintiff alleges the Board, in the absence of good faith, exhibited reckless disregard for its duties of oversight. On October 7, 2020, the Court entered an order staying and administratively closing the Derivative Action. The plaintiff in the Derivative Action shall have the right to reopen the action following the resolution of the Company's motion to dismiss in the ongoing litigation brought under the federal securities laws or upon the occurrence of certain other conditions. The Board and Company deny all allegations of wrongdoing made in the Derivative Action.On August 26, 2021, a complaint alleging breach of contract and seeking certification as a class action was filed against the Company in the United States District Court for the Western District of Texas in Waco. The complaint alleges that the Company breached its Contract of Carriage and other alleged agreements in connection with its use of the allegedly defective MAX aircraft manufactured by The Boeing Company. The complaint seeks damages on behalf of putative classes of customers who provided valuable consideration, whether in money or other form (e.g., voucher, miles/points, etc.), in exchange for a ticket for air transportation with the Company, which transportation took place between August 29, 2017, and March 13, 2019. The complaint generally seeks money damages, declaratory relief, and attorneys’ fees and other costs. On October 27, 2021, the Company filed a multi-faceted motion challenging the complaint based upon lack of subject matter jurisdiction, the existence of the prior-filed Sherman Complaint on appeal in the Fifth Circuit, improper venue, and failure to state a claim, and seeking to have the complaint's class contentions stricken. That motion was fully briefed by both parties and was argued to a United States Magistrate Judge on June 27, 2022. On July 5, 2022, the Magistrate Judge granted the motion in part and ordered the case stayed until the issuance of the Fifth Circuit's opinion in the Sherman Complaint. On November 28, 2022, the parties jointly notified the Court of the Fifth Circuit's decision regarding the Sherman Complaint. The Company denies all allegations of wrongdoing, believes the plaintiffs' positions are without merit, and intends to vigorously defend itself in all respects.51Table of ContentsOn January 12, 2023, a complaint alleging violations of federal securities laws and seeking certification as a class action was filed against the Company and certain of its officers in the United States District Court for the Southern District of Texas in Houston. The complaint seeks damages on behalf of a putative class of persons who purchased the Company's common stock between June 13, 2020, and December 31, 2022. The complaint asserts claims under Sections 10(b) and 20 of the Securities Exchange Act and alleges that the Company made material misstatements to investors regarding the Company's internal technology and alleged vulnerability to large-scale flight disruptions. The complaint generally seeks money damages, pre-judgment and post-judgment interest, and attorneys' fees and other costs. The Company denies all allegations of wrongdoing in the complaint, believes the plaintiff's positions are without merit, and intends to vigorously defend itself in all respects.On or about January 24, 2023, legal counsel for a purported Southwest shareholder sent a letter to the Company’s senior officers and Board of Directors demanding that the Board investigate claims, initiate legal action, and take remedial measures in connection with the service disruptions occurring in December 2022. The demand letter broadly asserts that the Company’s directors and senior officers did not make sufficient investments in internal technology systems to prevent large-scale flight disruptions, did not exercise sufficient oversight over the Company’s operations, approved or received unwarranted compensation, caused the Company to make materially misleading public statements, and breached their fiduciary duties to the Company. The Company is from time to time subject to various legal proceedings and claims arising in the ordinary course of business, including, but not limited to, examinations by the Internal Revenue Service.The Company’s management does not expect that the outcome in any of its currently ongoing legal proceedings or the outcome of any proposed adjustments presented to date by the Internal Revenue Service, individually or collectively, will have a material adverse effect on the Company’s financial condition, results of operations, or cash flow.Item 4. Mine Safety Disclosures Not applicable.52Table of ContentsINFORMATION ABOUT OUR EXECUTIVE OFFICERS The following information regarding the Company’s executive officers is as of February 1, 2023. NamePositionAgeGary C. KellyExecutive Chairman of the Board67Robert E. JordanPresident & Chief Executive Officer 62Andrew M. WattersonChief Operating Officer56Ryan C. GreenExecutive Vice President & Chief Commercial Officer46Tammy RomoExecutive Vice President & Chief Financial Officer 60Linda B. RutherfordChief Administration & Communications Officer56Mark R. ShawExecutive Vice President & Chief Legal & Regulatory Officer & Corporate Secretary60Set forth below is a description of the background of each of the Company’s executive officers.Gary C. Kelly has served as the Company's Executive Chairman of the Board since February 2022 and has served as the Company's Chairman of the Board since May 2008. Mr. Kelly also served as Chief Executive Officer from July 2004 to February 2022, President from July 2008 to January 2017, Executive Vice President & Chief Financial Officer from June 2001 to July 2004, and Vice President Finance & Chief Financial Officer from 1989 to 2001. Mr. Kelly joined the Company in 1986 as its Controller.Robert E. Jordan has served as the Company's Chief Executive Officer since February 2022 and as its President since January 2023. Mr. Jordan has been a member of the Company's Board of Directors since February 2022. Mr. Jordan also served as Executive Vice President & Incoming Chief Executive Officer from June 2021 to February 2022, Executive Vice President Corporate Services from July 2017 to June 2021, Executive Vice President & Chief Commercial Officer from September 2011 to July 2017, Executive Vice President Strategy & Planning from May 2008 to September 2011, Executive Vice President Strategy & Technology from September 2006 to May 2008, Senior Vice President Enterprise Spend Management from August 2004 to September 2006, Vice President Technology from 2002 to 2004, Vice President Purchasing from 2001 to 2002, Controller from 1997 to 2001, Director Revenue Accounting from 1994 to 1997, and Manager Sales Accounting from 1990 to 1994. Mr. Jordan joined the Company in 1988 as a programmer.Andrew M. Watterson has served as the Company's Chief Operating Officer since October 2022. Mr. Watterson also served as Executive Vice President & Chief Commercial Officer from January 2020 to October 2022, Executive Vice President & Chief Revenue Officer from July 2017 to January 2020, Senior Vice President & Chief Revenue Officer from January 2017 to July 2017, Senior Vice President of Network & Revenue from January 2016 to January 2017, and as Vice President of Network Planning & Performance from October 2013 to January 2016.Ryan C. Green has served as the Company’s Executive Vice President & Chief Commercial Officer since October 2022. Mr. Green also served as Senior Vice President & Chief Marketing Officer from February 2019 to October 2022, Vice President & Chief Marketing Officer from April 2017 to February 2019, Vice President Marketing from February 2016 to April 2017, Managing Director Customer Strategy and Development from October 2013 to February 2016, Senior Director Loyalty & Partnerships from July 2010 to October 2013, Director Customer Loyalty from November 2007 to July 2010, Senior Manager Loyalty Marketing from January 2007 to November 2007, and Manager Business Development from July 2004 to January 2007. Mr. Green joined the Company in 2002 in the Marketing Department.Tammy Romo has served as the Company's Executive Vice President & Chief Financial Officer since July 2015. Ms. Romo also served as Senior Vice President Finance & Chief Financial Officer from September 2012 to July 2015, Senior Vice President of Planning from February 2010 to September 2012, Vice President of Financial Planning from September 2008 to February 2010, Vice President Controller from February 2006 to August 2008, Vice President Treasurer from September 2004 to February 2006, Senior Director of Investor Relations from March 2002 to September 2004, Director of Investor Relations from December 1994 to March 2002, Manager of Investor 53Table of ContentsRelations from September 1994 to December 1994, and Manager of Financial Reporting from September 1991 to September 1994.Linda B. Rutherford has served as the Company’s Chief Administration & Communications Officer since October 2022. Ms. Rutherford also served as Executive Vice President People & Communications from June 2021 to October 2022, Senior Vice President & Chief Communications Officer from October 2017 to June 2021, Vice President & Chief Communications Officer from January 2016 to October 2017, Vice President Communications & Strategic Outreach from April 2007 to January 2016, Vice President Public Relations & Community Affairs from December 2005 to April 2007, Director Public Relations from May 2001 to December 2005, Senior Manager Public Relations from February 1999 to May 2001, and Manager Public Relations from February 1997 to February 1999. Ms. Rutherford joined the Company in 1992 as a Public Relations Coordinator. Mark R. Shaw has served as the Company's Executive Vice President & Chief Legal & Regulatory Officer since November 2018. Mr. Shaw has also served as the Company’s Corporate Secretary since August 2022. Mr. Shaw also served as Executive Vice President, Chief Legal & Regulatory Officer, & Corporate Secretary from August 2018 to November 2018, Senior Vice President, General Counsel, & Corporate Secretary from July 2015 to August 2018, Vice President, General Counsel, & Corporate Secretary from February 2013 to July 2015, and as Associate General Counsel - Corporate & Transactions from February 2008 to February 2013. Mr. Shaw joined the Company in 2000 as an Attorney in the General Counsel Department.54Table of ContentsPART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity SecuritiesThe Company’s common stock is listed on the New York Stock Exchange ("NYSE") and is traded under the symbol "LUV." Although the Company has a history of declaring dividends on a quarterly basis, the Company suspended the payment of dividends following its 174th consecutive quarterly dividend which was declared and paid in first quarter 2020. Pursuant to the "PSP1 Payroll Support Program" under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"), as supplemented by the "PSP2 Payroll Support Program” under the Consolidated Appropriations Act, 2021, and the "PSP3 Payroll Support Program" under the American Rescue Plan Act of 2021, the Company was prohibited from paying dividends with respect to its common stock through September 30, 2022. On December 6, 2022, the Company reinstated and declared a quarterly cash dividend of $.18 per share to Shareholders of record at the close of business on January 10, 2023, on all shares then issued and outstanding. The quarterly dividend was paid on January 31, 2023. The Company currently intends to continue declaring dividends on a quarterly basis for the foreseeable future; however, the Company’s Board of Directors may elect to alter the timing, amount, and payment of dividends on the basis of operational results, financial condition, cash requirements, future prospects, and other factors deemed relevant by the Board. As of February 3, 2023, there were approximately 11,378 holders of record of the Company’s common stock.55Table of ContentsStock Performance GraphThe following Performance Graph and related information shall not be deemed "soliciting material" or "filed" with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934.The following graph compares the cumulative total shareholder return on the Company’s common stock over the five-year period ended December 31, 2022, with the cumulative total return during such period of the Standard and Poor’s 500 Stock Index and the NYSE ARCA Airline Index. The comparison assumes $100 was invested on December 31, 2017, in the Company’s common stock and in each of the foregoing indices and assumes reinvestment of dividends. The stock performance shown on the graph below represents historical stock performance and is not necessarily indicative of future stock price performance. COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN AMONG SOUTHWEST AIRLINES CO., S&P 500 INDEX, AND NYSE ARCA AIRLINE INDEX12/31/201712/31/201812/31/201912/31/202012/31/202112/31/2022Southwest Airlines Co.$100 $72 $85 $73 $67 $53 S&P 500$100 $96 $126 $149 $191 $157 NYSE ARCA Airline$100 $79 $96 $73 $72 $47 56Table of ContentsIssuer RepurchasesOn May 15, 2019, the Company’s Board of Directors authorized the repurchase of up to $2.0 billion of the Company’s common stock. Subject to certain conditions, including restrictions on the Company pursuant to the PSP3 Payroll Support Program through September 30, 2022, repurchases may be made in accordance with applicable securities laws in open market or private, including accelerated, repurchase transactions from time to time, depending on market conditions. The Company has suspended share repurchase activity until further notice. The Company has approximately $899 million remaining under its current share repurchase authorization.57Table of ContentsItem 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsYEAR IN REVIEWThe Company's financial results in 2021 and 2022, on both an accounting principles generally accepted in the United States ("GAAP") basis and non-GAAP basis, continued to be affected by the COVID-19 pandemic, which began in early 2020. The Omicron variant of COVID-19 both impacted travel demand and created staffing challenges for the Company, particularly during January and February 2022. However, strong travel demand, especially associated with leisure travel, accelerated during March 2022 and continued through the remainder of the year, producing record operating revenues of $23.8 billion for 2022. Managed business revenues improved during 2022, but remained below 2019 levels, including approximately 20 percent below fourth quarter 2019 levels in fourth quarter 2022.In late December 2022, the Company experienced wide-scale operational disruptions as extreme winter weather across a significant portion of the United States impacted its operational plan and flight schedules. Subsequent to Winter Storm Elliott, the Company was challenged in its efforts to realign flight crews, flight schedules, and fleet for a period of several days during this peak demand travel period. The Company returned to a normal operating schedule on December 30, 2022. However, this disruption and subsequent recovery efforts resulted in the cancellation of more than 16,700 flights during the period from December 21 to December 31, 2022. The Company estimates the financial impact of this disruption was approximately $800 million on a pre-tax basis, and resulted in the Company reporting a net loss of $220 million for fourth quarter 2022. A significant portion of this impact was due to the loss of Operating revenue associated with the flight cancellations that is estimated to be approximately $410 million. The remaining impact primarily related to a net increase of approximately $390 million in operating expenses, primarily due to travel expense reimbursements to Customers, the estimated value of Rapid Rewards points offered as a gesture of goodwill to Customers that are expected to be redeemed, and premium pay and additional compensation for Employees, which were partially offset by lower fuel and oil and profitsharing expenses.Following the disruption, the Company has put mitigation elements in place to reduce the risk of future operational disruptions that could impede the travel plans of its Customers. These elements, along with efforts that remain in progress, currently include:•Creating an early indicator dashboard that closely monitors operational health and signals an alert if the Company approaches predefined operational thresholds,•Establishing supplemental staffing that can quickly mobilize to support Crew recovery efforts,•Enhancing its Crew engagement technology to better communicate with large numbers of Crew Members during frequent schedule changes, and•Updating and upgrading the Company’s Crew recovery system to not only solve current and future schedules, but also provide the ability to optimize established schedules as they are being revised during irregular operations.Going forward, the Company is also taking additional steps to understand and review the disruption, which will determine the Company's future actions. The Company has engaged Oliver Wyman, a third-party global aviation consulting firm, to complete an assessment of the event and make recommendations of additional mitigation steps for consideration. In addition, the Company’s Board of Directors has established an Operations Review Committee that is working with the Company's Management to help oversee the Company's response. The Company will continue to provide further information regarding these ongoing efforts in future periods.The Company recorded year-to-date GAAP and non-GAAP results for 2022, 2021, and 2019 as noted in the following tables. The Company believes comparisons of current year financial results to 2019 are relevant and show how the Company has continued to recover from the pandemic. See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures.58Table of Contents(in millions, except per share amounts)Year ended December 31,GAAP202220212022 Change to 202120192022 Change to 2019Operating income$1,017 $1,721 (40.9)$2,957 (65.6)Net income$539 $977 (44.8)$2,300 (76.6)Net income per share, diluted$0.87 $1.61 (45.7)$4.27 (79.5) Non-GAAPOperating income (loss)$1,120 $(1,281)n.m.$2,957 (62.1)Net income (loss)$723 $(1,271)n.m.$2,300 (68.6)Net income (loss) per share, diluted$1.16 $(2.15)n.m.$4.27 (72.8)The comparison of the Company's financial results, as shown above on a GAAP basis for the year ended December 31, 2022, versus the year ended December 31, 2021, were impacted by the Company's receipt of $2.7 billion in grant allocations of payroll funding support ("Payroll Support") from the United States Department of the Treasury ("Treasury") in 2021 that significantly benefited 2021 results. See Note 2 to the Consolidated Financial Statements for further information. Operating revenues for year ended December 31, 2022, increased 50.8 percent versus 2021 and operating revenues for the year ended December 31, 2022, exceeded the comparative 2019 pre-pandemic levels and was a Company annual record primarily due to strong leisure demand and higher yields. Operating expenses for the year ended December 31, 2022, exceeded the comparative pre-pandemic 2019 levels primarily due to higher salaries, wages, and benefits expense and fuel prices.On a non-GAAP basis, the Company's financial results improved significantly for the year ended December 31, 2022, versus the same prior year period due to the significant recovery in travel demand, which was aided by a reduction in COVID-19 cases and hospitalizations, an increase in vaccinations, and a decline in travel-related restrictions across the United States. See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures. Operating StatisticsThe Company provides the operating data below for the years ended December 31, 2022, 2021, and 2019 because these statistics are commonly used in the airline industry and, therefore, allow readers to compare the Company’s performance against its results for prior periods, as well as against the performance of the Company’s peers.For the year ended December 31, 2022, the Company believes a comparison of its 2022 to 2019 (pre-pandemic) operating statistics is relevant and useful as the Company continues to recover from the pandemic. For the twelve months ended December 31, 2022 and 2021, most of these operating statistics were significantly impacted by the COVID-19 pandemic and decisions the Company made as a result of the pandemic although the effect in 2022 was primarily in first quarter. See Note 2 to the Consolidated Financial Statements for further information.Year ended December 31, 202220212022 Change to 202120192022 Change to 2019Operating Data:Revenue passengers carried (000s)126,586 99,111 27.7 %134,056 (5.6)%59Table of ContentsEnplaned passengers (000s)156,982 123,264 27.4 %162,681 (3.5)%Revenue passenger miles (RPMs) (in millions)(a)123,843 103,562 19.6 %131,345 (5.7)%Available seat miles (ASMs) (in millions)(b)148,467 132,006 12.5 %157,254 (5.6)%Load factor(c)83.4 %78.5 %26.1 pts.83.5 %(5.0) pts.Average length of passenger haul (miles)978 1,045 (6.4)%980 (0.2)%Average aircraft stage length (miles)728 790 (7.8)%748 (2.7)%Trips flown1,298,219 1,066,934 21.7 %1,367,727 (5.1)%Seats flown (000s)(d)201,913 165,580 21.9 %206,390 (2.2)%Seats per trip(e)155.5 155.2 0.2 %150.9 3.0 %Average passenger fare$169.12 $141.92 19.2 %$154.98 9.1 %Passenger revenue yield per RPM (cents)(f)17.29 13.58 27.3 %15.82 9.3 %Operating revenues per ASM (cents)(g)(j)16.04 11.96 34.1 %14.26 12.5 %Passenger revenue per ASM (cents)(h)14.42 10.66 35.3 %13.21 9.2 %Operating expenses per ASM (cents)(i)15.36 10.66 44.1 %12.38 24.1 %Operating expenses per ASM, excluding fuel (cents)11.33 8.15 39.0 %9.62 17.8 %Operating expenses per ASM, excluding fuel and profitsharing (cents)11.25 7.98 41.0 %9.19 22.4 %Fuel costs per gallon, including fuel tax$3.10 $1.98 56.6 %$2.09 48.3 %Fuel costs per gallon, including fuel tax, economic$3.07 $2.01 52.7 %$2.09 46.9 %Fuel consumed, in gallons (millions)1,922 1,668 15.2 %2,077 (7.5)%Active full-time equivalent Employees (j)66,656 55,093 21.0 %60,767 9.7 %Aircraft at end of period (k)770 728 5.8 %747 3.1 %(a)A revenue passenger mile is one paying passenger flown one mile. Also referred to as "traffic," which is a measure of demand for a given period.(b)An available seat mile is one seat (empty or full) flown one mile. Also referred to as "capacity," which is a measure of the space available to carry passengers in a given period.(c)Revenue passenger miles divided by available seat miles.(d)Seats flown is calculated using total number of seats available by aircraft type multiplied by the total trips flown by the same aircraft type during a particular period.(e)Seats per trip is calculated by dividing seats flown by trips flown.(f)Calculated as passenger revenue divided by revenue passenger miles. Also referred to as "yield," this is the average cost paid by a paying passenger to fly one mile, which is a measure of revenue production and fares.(g)Calculated as operating revenues divided by available seat miles. Also referred to as "operating unit revenues" or "RASM," this is a measure of operating revenue production based on the total available seat miles flown during a particular period. (h)Calculated as passenger revenue divided by available seat miles. Also referred to as "passenger unit revenues," this is a measure of passenger revenue production based on the total available seat miles flown during a particular period.(i)Calculated as operating expenses divided by available seat miles. Also referred to as "unit costs" or "cost per available seat mile," this is the average cost to fly an aircraft seat (empty or full) one mile, which is a measure of cost efficiencies.(j)Included less than 250 Employees on Extended Emergency Time Off program as of December 31, 2021. See Note 2 to the Consolidated Financial Statements for further information.(k)Included four and six Boeing 737-700 ("700") Next Generation aircraft in temporary storage as of December 31, 2022 and December 31, 2021, respectively. Also included 34 Boeing 737 MAX aircraft in long-term storage as of December 31, 2019. See Note 17 to the Consolidated Financial Statements for further information.60Table of Contents2023 OutlookThe following tables present selected financial guidance for first quarter and full year 2023: 1Q 2023 Estimation Operating revenue, year-over-yearUp 20% to 24%ASMs, year-over-year (a)Up ~10%Economic fuel costs per gallon (b) (c)$3.25 to $3.35Fuel hedging premium expense per gallon$0.06Fuel hedging cash settlement gains per gallon$0.16ASMs per gallon (fuel efficiency)78 to 80CASM-X, year-over-year (d) (e)Up 2% to 4%Scheduled debt repayments (millions) (f)~$60Interest expense (millions)~$65 2023 EstimationASMs, year-over-year (a)Up 16% to 17%Economic fuel costs per gallon (b) (c)$2.90 to $3.00Fuel hedging premium expense per gallon$0.06Fuel hedging cash settlement gains per gallon$0.14CASM-X, year-over-year (d) (e)Down 6% to 8%Scheduled debt repayments (millions)~$85Interest expense (millions)~$250Aircraft (g)843Effective tax rate23% to 24%Capital spending (billions) (h)$4.0 to $4.5(a) Available seat miles (ASMs, or capacity). The Company's flight schedule is currently published for sale through August 14, 2023. The Company continues to expect second quarter 2023 capacity to increase approximately 14 percent, year-over-year.(b) See Note Regarding Use of Non-GAAP Financial Measures for additional information on special items. In addition, information regarding special items and economic results is included in the accompanying table Reconciliation of Reported Amounts to Non-GAAP Items (also referred to as "excluding special items").(c) Based on the Company's existing fuel derivative contracts and market prices as of January 20, 2023, first quarter and full year 2023 economic fuel costs per gallon are estimated to be in the range of $3.25 to $3.35 and $2.90 to $3.00, respectively, compared with the Company's previous estimations in the range of $3.00 to $3.10 and $2.85 to $2.95, respectively. Economic fuel cost projections do not reflect the potential impact of special items because the Company cannot reliably predict or estimate the hedge accounting impact associated with the volatility of the energy markets, or the impact to its financial statements in future periods. Accordingly, the Company believes a reconciliation of non-GAAP financial measures to the equivalent GAAP financial measures for projected results is not meaningful or available without unreasonable effort. See Note Regarding Use of Non-GAAP Financial Measures.(d) Operating expenses per available seat mile, excluding fuel and oil expense, special items, and profitsharing.(e) Projections do not reflect the potential impact of fuel and oil expense, special items, and profitsharing because the Company cannot reliably predict or estimate those items or expenses or their impact to its financial statements in future periods, especially considering the significant volatility of the fuel and oil expense line item. Accordingly, the Company believes a reconciliation of non-GAAP financial measures to the equivalent GAAP financial measures for these projected results is not meaningful or available without unreasonable effort. (f) The Company expects to retire approximately $50 million in principal related to a lease buyout transaction in first quarter 2023, shifting this payment forward from the previous monthly payments scheduled throughout the remainder of 2023 and beyond. Combined with the retirement of $191 million in principal related to a lease buyout transaction in fourth quarter 2022, the Company's full year 2023 scheduled debt repayments remained roughly the same as its previous guidance.(g) Aircraft on property, end of period. The Company ended 2022 with 770 Boeing 737 aircraft. The Company continues to estimate approximately 100 Boeing 737 MAX ("MAX") aircraft deliveries in 2023, including 30 Boeing 737-8 ("-8") aircraft deliveries expected in first quarter 2023. The Company continues to expect to retire 27 Boeing -700 aircraft in 2023, including 61Table of Contents5 -700 retirements in first quarter 2023. As a result of receiving two additional -8 deliveries in fourth quarter 2022, as compared with the Company's previous estimation, the Company now expects to end 2023 with 843 aircraft, compared with its previous guidance of 841 aircraft. The delivery schedule for the Boeing 737-7 ("-7") is dependent on the Federal Aviation Administration ("FAA") issuing required certifications and approvals to The Boeing Company ("Boeing") and the Company. The FAA will ultimately determine the timing of the -7 certification and entry into service, and the Company therefore offers no assurances that current estimations and timelines are correct. See Note 5 to the Consolidated Financial Statements for further information on the Company's aircraft commitments with Boeing.(h) Represents the Company's current estimate which continues to assume approximately 100 Boeing MAX aircraft deliveries and $1.2 billion in non-aircraft capital spending in 2023.Thus far in January 2023, the Company has experienced an increase in flight cancellations and a deceleration in bookings, primarily for January and February 2023 travel, which are assumed to be associated with the operational disruptions in December 2022. As a result, the Company currently estimates a negative revenue impact in the range of $300 million to $350 million in first quarter 2023. Encouragingly, booking trends have improved sequentially this month, including notable strength in Rapid Rewards® redemptions. Currently, March 2023 leisure booking and yield trends appear strong, and are trending in line with the Company's expectations at the time of its Investor Day in early December 2022. The recent improvements in close-in booking trends are encouraging, and the Company currently expects March 2023 managed business revenues to be roughly restored to March 2019 levels. The Company continues to experience year-over-year inflationary and other cost pressures in first quarter 2023, in particular from higher labor rates and accruals for all Employee work groups, as well as higher rate estimates for benefits and airport costs. The Company currently expects its first quarter 2023 CASM-X to increase in the range of 2 percent to 4 percent, year-over-year—approximately two points higher than its previous guidance of flat to up 2 percent, year-over year. Half of the two-point increase is attributable to a continuation of premium pay in January 2023 related to the December 2022 operational disruptions, and the remainder of the increase is primarily due to an increase in labor accruals for the Company's open labor contracts. The Company currently expects its full year 2023 CASM-X to decrease in the range of 6 percent to 8 percent, year-over-year—approximately five points lower than its previous guidance to decrease in the range of 1 percent to 3 percent, year-over-year. The vast majority of the five-point decrease in 2023 is due to the year-over-year impact from lower fourth quarter 2022 available seat miles and higher fourth quarter 2022 operating expenses than expected—both attributable to the December 2022 operational disruptions—offset slightly by an increase in 2023 labor accruals for the Company’s open labor contracts. The Company plans to hire more than 7,000 new Employees, net of attrition, in 2023, a nearly 40 percent decrease from 2022 net hiring levels.COVID-19 Pandemic ImpactsAs detailed in Notes 2 and 7 to the Consolidated Financial Statements, in connection with the major negative impact of COVID-19 on air carriers, the Company received significant financial assistance from Treasury in the form of Payroll Support, and this assistance had a significant impact on the Company's reported GAAP financial results in 2021. Such impact ended in third quarter 2021, and the Company's 2022 results do not reflect the benefit of this Payroll Support, and its future periods are not expected to benefit from such Payroll Support. However, future cash flows will be impacted through the portion of Payroll Support that was in the form of loans that remain outstanding and will have to be repaid to Treasury.During second quarter 2020, the Company introduced Voluntary Separation Program 2020 ("Voluntary Separation Program") and the Extended Emergency Time Off ("Extended ETO") program which helped closer align staffing to reduced flight schedules and enabled the Company to avoid involuntary furloughs and layoffs associated with the impacts of the pandemic. Approximately 16,000 Employees elected to participate in one of these programs. All Employees that elected to participate in the Extended ETO program have since returned or been recalled to work, or have chosen to permanently separate from the Company, and no Employees were on Extended ETO past March 31, 2022. The Company realized approximately $1.1 billion of full year 2021 cost savings from the Voluntary Separation Program and Extended ETO but experienced no material cost savings from these programs beyond 2021. See Note 2 to the Consolidated Financial Statements for further information. 62Table of ContentsFor the year ended December 31, 2022, the Company hired more than 11,500 Employees, net of attrition, and had returned to overall pre-pandemic staffing levels in May 2022. Thus, the Company's number of active full-time equivalents Employees increased by 21.0 percent from December 31, 2021 to December 31, 2022, while the year-over-year increase in capacity or ASMs was 12.5 percent. The Company has been making additional investments to attract and retain talent, including the decision in fourth quarter 2021 to further raise the Company's starting hourly pay rates from $15 per hour to $17 per hour for certain of its workgroups, subject, in each case, to acceptance of such change by the applicable union. Company OverviewThe Company has entered into supplemental agreements in 2022 with The Boeing Company ("Boeing") to increase aircraft orders and accelerate certain options with the goals of improving potential growth opportunities and frequencies to better align with the pre-pandemic operational route network, lowering operating costs, and further modernizing its fleet with less carbon-intensive aircraft. See Note 5 to the Consolidated Financial Statements for further information. The Company expects that more than half of the MAX aircraft in its firm order book will replace a significant amount of its 426 -700 aircraft over the next 10 to 15 years to support the modernization of the Company's fleet, a key component of the Company's environmental sustainability efforts. The Company's order book with Boeing as of December 31, 2022, consists of a total of 417 MAX firm orders (182 -7 aircraft and 235 -8 aircraft) for the years 2023 through 2030 and 147 MAX options (-7s or -8s) for years 2024 through 2027. Given Boeing's supply chain challenges and the current status of the -7 certification, aircraft delivery delays are currently expected to extend into 2024.The Company ended 2022 with 770 Boeing 737 aircraft, including 137 -8 aircraft. During 2022, the Company retired 26 -700 aircraft and took delivery of 68 -8 aircraft. The Company also completed the purchase of 31 finance lease -700 aircraft and is expecting to finalize the purchase of eight additional finance lease -700 aircraft by the end of February 2023. See Note 8 to the Consolidated Financial Statements for further detail. The Company has published its flight schedule through August 14, 2023. The Company is expected to be limited by Pilot staffing constraints for the majority of 2023; therefore, it is not expected that aircraft delivery delays would result in required changes to the Company's published flight schedules. During 2022, the Company has primarily focused on restoring its network, principally in cities with a very strong Customer base, by adding city pair frequencies and connecting new service with existing points-of-strength to increase Customer depth.On March 24, 2022, the Company announced a new fare product, Wanna Get Away Plus™, which became available to Customers in May 2022. Wanna Get Away Plus provides Customers with more flexibility, choice, and rewards for a modest buy-up from the Company's Wanna Get Away® fare product. In addition to all of the usual day of travel benefits and booking flexibility offered to Customers across all of the Company's fares, Wanna Get Away Plus provides additional benefits as compared with the Wanna Get Away fare product, including:•Transferable flight credit(s), a new benefit that generally enables Customers to make a one-time transfer of eligible unused flight credit(s) to a new traveler for future use;•More flexibility through same-day confirmed change/same-day standby; and•More earning power in the Company's Rapid Rewards® loyalty program, with 8X points awarded on flights instead of the 6X points awarded on Wanna Get Away fares.In July 2022, the Company announced that flight credits will no longer expire. The Company expects that this policy change, combined with its other attractive brand attributes, will contribute to an increase in Customer loyalty. Flight credits resulting from canceling reservations previously were valid for no longer than one year from the date of original purchase. Flight credits for non-refundable fares will be issued as long as the reservation is cancelled more than 10 minutes prior to the scheduled departure. Flight credits or refunds for refundable fares will be issued regardless of cancellation time. Flight credits unexpired on, or created on or after July 28, 2022 do not expire and will show an expiration date (12/31/2040) until the Company's systems are updated. A flight credit with an 63Table of Contentsexpiration date on or before July 27, 2022, has expired in accordance with its previously stated expiration date. See Note 6 to the Consolidated Financial Statements for further information.On December 6, 2022, the Company's Board of Directors reinstated and declared a quarterly cash dividend of $0.18 per share to Shareholders of record at the close of business on January 10, 2023, on all shares then issued and outstanding, to be paid on January 31, 2023. The Company's quarterly dividend of $0.18 per share, or $0.72 per share annualized, is equivalent to its dividend prior to the pandemic.In 2021, the Company announced near- and long-term environmental sustainability goals, in addition to a series of actions and initiatives designed to assist the Company in achieving these goals. The Company continually monitors developments related to climate change and evaluates its goals and progress against these developments. The Company expects its path toward achievement of these goals will depend on, among other things (i) increased use of sustainable aviation fuel (“SAF”), which is not presently available at scale or at prices competitive to jet fuel; (ii) improved fuel efficiency from fleet renewal or planned fuel efficiency initiatives; (iii) operational initiatives; and (iv) technological innovation.During 2022, the Company joined the Vision 2045 campaign, a collaboration among multiple organizations and companies to share films and resources that aim to inspire businesses and people to take action toward a more sustainable future. In addition, during 2022, the Company invested in SAFFiRE Renewables, LLC (“SAFFiRE”), a company formed by D3MAX, LLC, as part of a Department of Energy (“DOE”)-backed project to develop and produce scalable, SAF. Funded with a DOE grant matched by the Company's investment, SAFFiRE intends to utilize technology developed by the DOE's National Renewable Energy Laboratory to convert corn stover, a widely available waste feedstock in the United States, into renewable ethanol that then would be upgraded into SAF.As part of its commitment to corporate sustainability, on April 22, 2022, the Company published its 2021 One Report describing the Company's sustainability strategies, which include the Company’s fuel conservation and emissions mitigation initiatives and other efforts to minimize greenhouse gas emissions and address other environmental matters such as energy and water conservation, waste minimization, and recycling. The Company also published its first ever Diversity, Equity, and Inclusion ("DEI") Report on April 22, 2022. A companion piece to the One Report, the DEI Report takes a deeper dive into the Company's DEI goals, and initiatives and highlights the expected path forward. Information contained in the Southwest One Report and/or the DEI Report is not incorporated by reference into, and does not constitute a part of, this Form 10-K. While the Company believes that the disclosures contained in the Southwest One Report, the DEI Report, and other voluntary disclosures regarding environmental, social, and governance (“ESG”) matters are responsive to various areas of investor interest, the Company believes that certain of these disclosures do not currently address matters that are material in the near term to the Company’s operations, strategy, financial condition, or financial results, although this view may change in the future based on new information that could materially alter the estimates, assumptions, or timelines used to create these disclosures. Given the estimates, assumptions, and timelines used to create the Southwest One Report, the DEI Report, and other voluntary disclosures, the materiality of these disclosures is inherently difficult to assess.2022 Compared with 2021 Operating RevenuesPassenger revenues for 2022 increased by $7.3 billion, or 52.2 percent, compared with 2021. On a unit basis, Passenger revenues increased 35.3 percent, year-over-year. The increase in Passenger revenues on both a dollar and unit basis was primarily due to the easing of negative impacts associated with the COVID-19 pandemic, which resulted in improvements in Passenger demand and bookings, the majority of which were for leisure oriented travel, in 2022, compared with the severe decline in demand and bookings resulting from the COVID-19 pandemic for the majority of 2021. For 2022, the year-over-year RASM increase was primarily driven by an increase in yield of 27.3 percent coupled with an increase in Load factor of 4.9 points.Freight revenues for 2022 decreased by $10 million, or 5.3 percent, compared with 2021, primarily due to capacity challenges driven by an increase in Passenger demand resulting in reduced space for cargo shipments.64Table of ContentsOther revenues for 2022 increased by $692 million, or 45.0 percent, compared with 2021. On a dollar basis, approximately 55 percent of the increase was associated with additional revenues generated from the Company's new co-brand credit card agreement with Chase Bank USA, N.A. ("Chase") secured in December 2021. The remaining increase in Other revenues was primarily due to revenue from business partners, including Chase, as the rebound in travel demand also resulted in higher spend on the Company's co-brand credit card, as well as additional revenues earned through the Company's rental car and hotel partners.Operating ExpensesOperating expenses for 2022 increased by $8.7 billion, or 62.0 percent, compared with 2021, while capacity increased 12.5 percent over the same prior year period. Approximately 30 percent of the operating expense increase was due to $2.7 billion in Payroll Support allocated to offset a portion of salaries, wages, and benefits in 2021, compared with no support received in 2022. In addition, approximately 30 percent of the increase was due to higher Fuel and oil expense and approximately 20 percent of the increase was due to higher Salaries, wages, and benefits. Historically, except for changes in the price of fuel, changes in Operating expenses for airlines have been largely driven by changes in capacity, or ASMs. The following table presents the Company's Operating expenses per ASM for 2022 and 2021, followed by explanations of these changes on a dollar basis. Unless otherwise specified, changes on a per ASM basis were driven by changes in capacity, which increased with the improvement of travel demand, causing the Company's fixed costs to be spread over significantly more ASMs. Year ended December 31,Per ASMPercent(in cents, except for percentages)20222021changechangeSalaries, wages, and benefits6.31 ¢5.87 ¢0.44 ¢7.5 %Payroll support and voluntary Employee programs, net— (2.24)2.24 n.m.Fuel and oil4.03 2.51 1.52 60.6 Maintenance materials and repairs0.58 0.65 (0.07)(10.8)Landing fees and airport rentals1.02 1.10 (0.08)(7.3)Depreciation and amortization0.91 0.96 (0.05)(5.2)Other operating expenses2.51 1.81 0.70 38.7 Total15.36 ¢10.66 ¢4.70 ¢44.1 %Operating expenses per ASM for 2022 increased by 44.1 percent, compared with 2021. Approximately, 50 percent of the year-over-year unit cost increase was driven by Payroll Support received in 2021, including from the Consolidated Appropriations Act, 2021 and the American Rescue Plan Act of 2021. Approximately, 30 percent of the increase was due to an increase in fuel expense. Operating expenses per ASM for 2022, excluding Fuel and oil expense, profitsharing, and special items (a non-GAAP financial measure), increased, year-over-year primarily due to an increase in Other Operating Expense due to Winter Storm Elliott and the operation disruption. See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures.Salaries, wages, and benefits expense for 2022 increased by $1.6 billion, or 21.1 percent, compared with 2021. On a per ASM basis, Salaries, wages, and benefits expense for 2022 increased 7.5 percent, compared with 2021. On a dollar basis, approximately 40 percent of the increase was driven by an increase in capacity and number of trips flown, approximately 30 percent of the increase was due to step/pay rate increases for certain workgroups, which included open labor contract accruals, and approximately 15 percent of the increase was a result of incentive, gratitude, and premium pay offered to the Company's Operations Employees in an effort to address available staffing challenges related to the Omicron variant in first quarter 2022 and challenges related to the operational disruption in December 2022.65Table of ContentsThe following table sets forth the Company’s unionized Employee groups with amendable contracts that are currently in negotiations on collective-bargaining agreements: Employee GroupApproximate Number of Full-time Equivalent EmployeesRepresentativesAmendable DateSouthwest Pilots9,342Southwest Airlines Pilots' Association ("SWAPA")September 2020Southwest Flight Attendants18,105Transportation Workers of America, AFL-CIO, Local 556 ("TWU 556")November 2018Southwest Ramp, Operations, Provisioning, Freight Agents15,260Transportation Workers of America, AFL-CIO, Local 555 ("TWU 555")February 2021Southwest Meteorologists12TWU 550June 2019On October 11, 2022, the Company's nearly 170 Aircraft Appearance Technicians, represented by the Aircraft Mechanics Fraternal Association ("AMFA"), ratified a new five-year collective-bargaining agreement with the Company. The newly ratified agreement becomes amenable in July 2027.On December 15, 2022, the Company's more than 8,000 Customer Service Agents, Customer Representatives, and Source of Support Representatives, represented by the International Association of Machinists and Aerospace Workers, AFL-CIO ("IAM"), ratified a new five-year collective-bargaining agreement with the Company. The newly ratified agreement becomes amendable in December 2027. On December 30, 2022, the Company's more than 200 Flight Instructors, represented by the Transport Workers Union ("TWU"), ratified a new four-year collective bargaining agreement with the Company. The newly ratified agreement becomes amendable in January 2027. On January 31, 2023, the Company's 50 Facilities Maintenance Technicians, represented by AMFA, ratified a new four-year collective bargaining agreement with the Company. The newly ratified agreement becomes amendable in November 2027.On February 4, 2023, the Company's more than 400 Dispatchers, represented by the TWU, ratified a new four-year collective bargaining agreement with the Company. The newly ratified agreement becomes amendable in June 2027. Payroll support and voluntary Employee programs, net had no amounts for 2022, and was a reduction to expense in 2021 and consisted primarily of the following items:•$2.7 billion of Payroll Support proceeds allocated (credit to expense);•$140 million net reduction in the Extended ETO liability (reduction to expense) relating to certain Employees being recalled prior to their previously elected return dates; and•$117 million credit to expense associated with the Employee Retention Tax Credit for continuing to pay Employees' salaries during the time they were not working, as allowed under the CARES Act, and subsequent legislation.See Note 2 to the Consolidated Financial Statements for further information. Fuel and oil expense for 2022 increased by $2.7 billion, or 80.5 percent, compared with 2021. On a per ASM basis, Fuel and oil expense for 2022 increased 60.6 percent. On a dollar basis, approximately 80 percent of the increase was attributable to an increase in jet fuel prices per gallon, and the remainder of the increase was due to an increase in fuel gallons consumed. On a per ASM basis, the increase was primarily due to higher jet fuel prices. The 66Table of Contentsfollowing table provides more information on the Company's economic fuel cost per gallon, including the impact of fuel hedging premium expense and fuel derivative contracts: Year ended December 31,(per gallon)20222021Economic fuel costs per gallon$3.07 $2.01 Fuel hedging premium expense (in millions)$78 $100 Fuel hedging premium expense per gallon$0.04 $0.06 Fuel hedging cash settlement gains per gallon$0.49 $0.05 See Note Regarding Use of Non-GAAP Financial Measures and the Reconciliation of Reported Amounts to Non-GAAP Financial Measures for additional detail regarding non-GAAP financial measures. The Company's 2022 available seat miles per gallon ("fuel efficiency") declined 2.4 percent, year-over-year, due to increased load factors and the removal from storage and increased usage of certain of the Company's least fuel-efficient aircraft, the -700, to support sequentially increasing flight schedules. When compared with 2019, fuel efficiency increased by 2.1 percent due to the March 2021 return to service of the Company's most fuel-efficient aircraft, the MAX. The MAX remains critical to the Company's efforts to modernize its fleet, reduce carbon emissions intensity, and achieve its near-term environmental sustainability goals. See Note 17 to the Consolidated Financial Statements for further information.As of January 20, 2023, on an economic basis, the Company had derivative contracts in place related to expected future fuel consumption as follows:PeriodMaximum fuel hedged percentage (a)(b)202350%202439%(a) Based on the Company's current available seat mile plans. The Company is currently 56 percent hedged in first quarter 2023, 51 percent hedged in second quarter 2023, and 47 percent hedged in second half 2023.(b)The Company's maximum fuel hedged percentage is calculated using the maximum number of gallons that are covered by derivative contracts divided by the Company's estimate of total fuel gallons to be consumed for each respective period. The Company's maximum number of gallons that are covered by derivative contracts may be at different strike prices and at strike prices materially higher than the current market prices. The volume of gallons covered by derivative contracts that ultimately get exercised in any given period may vary significantly from the volumes used to calculate the Company's maximum fuel hedged percentages, as market prices and the Company's fuel consumption fluctuate.As a result of applying hedge accounting in prior periods, the Company has amounts in Accumulated other comprehensive income (loss) ("AOCI") that will be recognized in earnings in future periods when the underlying fuel derivative contracts settle. The following table displays the Company's estimated fair value of remaining fuel derivative contracts (not considering the impact of the cash collateral provided to or received from counterparties - see Note 11 to the Consolidated Financial Statements for further information), as well as the deferred amounts in AOCI at December 31, 2022, and the expected future periods in which these items are expected to settle and/or be recognized in earnings (in millions):YearFair value of fuelderivative contractsat December 31, 2022Amount of gains deferredin AOCI at December 31,2022 (net of tax)2023$352 $177 2024160 57 Total$512 $234 67Table of ContentsAssuming no changes to the Company's current fuel derivative portfolio, but including all previous hedge activity for fuel derivatives that have not yet settled, and considering only the expected net cash receipts related to hedges that will settle, the Company is providing the below sensitivity table for first quarter 2023 and full year 2023 jet fuel prices at different crude oil assumptions as of January 20, 2023, and for expected premium costs associated with settling contracts each period, respectively.Estimated economic fuel price per gallon, including taxes and fuel hedging premiums (b)Average Brent Crude Oilprice per barrelFirst Quarter 2023Full Year 2023$60$2.45 to $2.55$2.20 to $2.30$70$2.80 to $2.90$2.50 to $2.60$80$3.10 to $3.20$2.80 to $2.90Current Market (a)$3.25 to $3.35$2.90 to $3.00$90$3.40 to $3.50$3.05 to $3.15$100$3.65 to $3.75$3.35 to $3.45$110$3.90 to $4.00$3.60 to $3.70Fair market value$80 million$363 millionEstimated premium costs$30 million$121 million(a) Brent crude oil average market prices as of January 20, 2023, were approximately $87 and $85 per barrel for first quarter 2023 and full year 2023, respectively.(b) The Company's current fuel derivative contracts contain a combination of instruments based in West Texas Intermediate ("WTI") and Brent crude oil; however, the economic fuel price per gallon sensitivities provided, assume the relationship between Brent crude oil and refined products based on market prices as of January 20, 2023. Economic fuel cost projections do not reflect the potential impact of special items because the Company cannot reliably predict or estimate the hedge accounting impact associated with the volatility of the energy markets, or the impact to its financial statements in future periods. Accordingly, the Company believes a reconciliation of non-GAAP financial measures to the equivalent GAAP financial measures for projected results is not meaningful or available without unreasonable effort. See Note Regarding Use of Non-GAAP Financial Measures.Maintenance materials and repairs expense for 2022 decreased by $2 million, or 0.2 percent, compared with 2021. On a per ASM basis, Maintenance materials and repairs expense decreased 10.8 percent, compared with 2021. On a dollar and per ASM basis, the decrease was primarily due to a decrease in engines and components expense driven by the Company's "power-by-the-hour" contract for the -700 engines expiring at the end of 2021, in which expense was incurred based primarily upon engine hours flown. At January 1, 2022, a time and materials contract commenced, pursuant to which -700 engine expense is based on actual repairs. This decrease was partially offset by an increase in the cost of various airframe and engine repairs as a result of maintenance vendor price escalation and an increase in heavy airframe check volume due to deferring costs and reduced operations in 2021 due to the COVID-19 pandemic.Landing fees and airport rentals expense for 2022 increased by $52 million, or 3.6 percent, compared with 2021. On a per ASM basis, Landing fees and airport rentals expense decreased 7.3 percent, compared with 2021. On a dollar basis, approximately 50 percent of the increase was due to an increase in landing fees from the increased number of trips flown and approximately 50 percent was due to an increase in space rental rates and usage at various stations throughout the network, partially offset by higher settlements received from various airports in 2022.Depreciation and amortization expense for 2022 increased by $79 million, or 6.2 percent, compared with 2021. On a per ASM basis, Depreciation and amortization expense decreased by 5.2 percent, compared with 2021. On a dollar basis, approximately 50 percent of the increase was due to several technology assets being placed into service since 2021, 35 percent of the increase was primarily due to the purchase of 68 -8 aircraft since 2021, and the remainder 68Table of Contentswas due to decreasing the airframe salvage value for the entire owned -700 fleet and accelerating the depreciation for certain -700 aircraft planned for early retirement in 2023.Other operating expenses for 2022 increased by $1.3 billion, or 56.0 percent, compared with 2021. Included within this line item was aircraft rentals expenses in the amount of $195 million and $205 million for 2022 and 2021, respectively. On a per ASM basis, Other operating expenses increased 38.7 percent, compared with 2021. On a dollar and per ASM basis, approximately 40 percent of the increase was driven by costs associated with the December 2022 operational disruption, including estimated travel expense reimbursements being provided to impacted Customers and the estimated value of Rapid Rewards points offered as a gesture of goodwill to Customers that are expected to be redeemed. Approximately 20 percent of the increase was due to higher revenue related expenses (including credit card processing charges) associated with the significant increase in Passenger revenues versus 2021. The majority of the remainder of the year-over-year increases on a dollar and per ASM basis was due to various flight-driven expenses.Other expenses (income)Interest expense for 2022 decreased by $127 million, or 27 percent, compared with 2021. Approximately 60 percent of the decrease was due to elimination of the debt discount due to the adoption of ASU 2020-06, and 40 percent of the decrease was due to various debt repurchases throughout 2022, resulting in less fixed interest expense. See Note 3 to the Consolidated Financial Statements for further information.Capitalized interest for 2022 increased by $3 million, or 8.3 percent, compared with 2021, primarily due to an increase in average progress payment balances for scheduled future aircraft deliveries.Interest income for 2022 increased by $204 million, compared with 2021, due to higher interest rates.Loss on extinguishment of debt for 2022 increased by $165 million, compared with 2021, primarily due to repurchases of $486 million face value of the Company's 1.25% Convertible Notes due 2025 (the "Convertible Notes") during 2022. See Note 7 to the Consolidated Financial Statements for further information. Other (gains) losses, net, primarily includes amounts recorded as a result of the Company's hedging activities. See Note 11 to the Consolidated Financial Statements for further information on the Company's hedging activities. The following table displays the components of Other (gains) losses, net, for 2022 and 2021: Year ended December 31, (in millions)20222021Mark-to-market impact from fuel contracts settling in current and future periods$(41)$(7)Premium cost of fuel contracts not designated as hedges(28)43 Unrealized mark-to-market adjustment on available for sale securities4 — Mark-to-market impact on deferred compensation plan investment74 (33)Correction on investment gains related to prior periods— (60)Other3 7 $12 $(50)Income TaxesThe Company's annual 2022 effective tax rate was 25.9 percent, compared with 26.3 percent in 2021. The year-over-year decline in the tax rate is due to higher state taxes in 2021 and tax planning benefits recognized in 2022 related to federal tax credits and a partial tax deduction for losses incurred on repurchases of the Convertible Notes.69Table of Contents2021 Compared with 2020The Company's comparison of 2021 results to 2020 results is included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2021, under Part II Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations. 70Table of ContentsReconciliation of Reported Amounts to Non-GAAP Financial Measures (excluding special items) (unaudited) (in millions, except per share amounts and per ASM amounts)Year ended December 31,Percent 20222021ChangeFuel and oil expense, unhedged$6,780 $3,350 Add: Premium cost of fuel contracts designated as hedges105 57 Deduct: Fuel hedge gains included in Fuel and oil expense, net(910)(97)Fuel and oil expense, as reported$5,975 $3,310 Add (Deduct): Fuel hedge contracts settling in the current period, but for which losses (gains) were reclassified from AOCI (a)(40)8 Add (Deduct): Premium cost of fuel contracts not designated as hedges(28)43 Fuel and oil expense, excluding special items (economic)$5,907 $3,361 75.8 %Total operating expenses, net, as reported$22,797 $14,069 Add: Payroll support and voluntary Employee programs, net— 2,960 Add (Deduct): Fuel hedge contracts settling in the current period, but for which losses (gains) were reclassified from AOCI (a)(40)8 Add: Interest rate swap agreements terminated in a prior period, but for which losses were reclassified from AOCI (a)— 3 Add (Deduct): Premium cost of fuel contracts not designated as hedges(28)43 Deduct: Impairment of long-lived assets(35)(12)Total operating expenses, excluding special items$22,694 $17,071 32.9 %Deduct: Fuel and oil expense, excluding special items (economic)(5,907)(3,361)Operating expenses, excluding Fuel and oil expense and special items$16,787 $13,710 22.4 %Deduct: Profitsharing expense(127)(230)Operating expenses, excluding Fuel and oil expense, special items, and profitsharing$16,660 $13,480 23.6 %Operating income, as reported$1,017 $1,721 Deduct: Payroll support and voluntary Employee programs, net— (2,960)Add (Deduct): Fuel hedge contracts settling in the current period, but for which losses (gains) were reclassified from AOCI (a)40 (8)Deduct: Interest rate swap agreements terminated in a prior period, but for which losses were reclassified from AOCI (a)— (3)Add (Deduct): Premium cost of fuel contracts not designated as hedges28 (43)Add: Impairment of long-lived assets35 12 Operating income (loss), excluding special items$1,120 $(1,281)n.m.Other (gains) losses, net, as reported$12 $(50)Add: Mark-to-market impact from fuel contracts settling in current and future periods41 7 Add (Deduct): Premium cost of fuel contracts not designated as hedges28 (43)Deduct: Unrealized mark-to-market adjustment on available for sale securities(4)— Other (gains) losses, net, excluding special items$77 $(86)n.m.Year ended December 31,Percent20222021ChangeIncome before income taxes, as reported$728 $1,325 Deduct: Payroll support and voluntary Employee programs, net— (2,960)Add (Deduct): Fuel hedge contracts settling in the current period, but for which losses (gains) were reclassified from AOCI (a)40 (8)Deduct: Interest rate swap agreements terminated in a prior period, but for which losses were reclassified from AOCI (a)— (3)Add: Impairment of long-lived assets35 12 Deduct: Mark-to-market impact from fuel contracts settling in current and future periods(41)(7)Add: Unrealized mark-to-market adjustment on available for sale securities4 — Add: Loss on extinguishment of debt193 28 Income (loss) before income taxes, excluding special items$959 $(1,613)n.m.Provision for income taxes, as reported$189 $348 Add (Deduct): Net income (loss) tax impact of fuel and special items (b)47 (690)Provision (benefit) for income taxes, net, excluding special items$236 $(342)n.m.Net income, as reported$539 $977 Deduct: Payroll support and voluntary Employee programs, net— (2,960)Add (Deduct): Fuel hedge contracts settling in the current period, but for which losses (gains) were reclassified from AOCI (a)40 (8)Deduct: Interest rate swap agreements terminated in a prior period, but for which losses were reclassified from AOCI (a)— (3)Add: Impairment of long-lived assets35 12 Deduct: Mark-to-market impact from fuel contracts settling in current and future periods (a)(41)(7)Add: Loss on extinguishment of debt193 28 Add: Unrealized mark-to-market adjustment on available for sale securities4 — Add (Deduct): Net income (loss) tax impact of special items (b) (47)690 Net income (loss), excluding special items$723 $(1,271)n.m.Net income per share, diluted, as reported$0.87 $1.61 Add (Deduct): Impact of special items0.36 (4.80)Deduct: Net impact of net income (loss) above from fuel contracts divided by dilutive shares— (0.02)Add (Deduct): Net income (loss) tax impact of special items (b)(0.07)1.12 Deduct: GAAP to Non-GAAP diluted weighted average shares difference (c)— $(0.06)Net income (loss) per share, diluted, excluding special items$1.16 $(2.15)n.m.Operating expenses per ASM (cents)15.36 ¢10.66 ¢Add (Deduct): Impact of special items(0.03)2.23 Deduct: Fuel and oil expense divided by ASMs(4.03)(2.51)Deduct: Profitsharing expense divided by ASMs(0.08)(0.17)Operating expenses per ASM, excluding Fuel and oil expense, profitsharing, and special items (cents)11.22 ¢10.21 ¢9.9 %(a) See Note 11 to Consolidated Financial Statements for further information. (b) Tax amounts for each individual special item are calculated at the Company's effective rate for the applicable period and totaled in this line item.(c) Adjustment related to GAAP and Non-GAAP diluted weighted average shares difference, due to the Company being in a Net income position on a GAAP basis versus a Net loss position on a Non-GAAP basis for the year ended December 31, 2021. See Note 4 to the Consolidated Financial Statements for further information.71Table of ContentsNote Regarding Use of Non-GAAP Financial Measures The Company's Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). These GAAP financial statements may include (i) unrealized noncash adjustments and reclassifications, which can be significant, as a result of accounting requirements and elections made under accounting pronouncements relating to derivative instruments and hedging and (ii) other charges and benefits the Company believes are unusual and/or infrequent in nature and thus may make comparisons to its prior or future performance difficult.As a result, the Company also provides financial information in this filing that was not prepared in accordance with GAAP and should not be considered as an alternative to the information prepared in accordance with GAAP. The Company provides supplemental non-GAAP financial information (also referred to as "excluding special items"), including results that it refers to as "economic," which the Company's management utilizes to evaluate its ongoing financial performance and the Company believes provides additional insight to investors as supplemental information to its GAAP results. The non-GAAP measures provided that relate to the Company’s performance on an economic fuel cost basis include Fuel and oil expense, non-GAAP; Total operating expenses, non-GAAP; Operating expenses, non-GAAP excluding Fuel and oil expense; Operating expenses, non-GAAP excluding Fuel and oil expense and profitsharing; Operating income (loss), non-GAAP; Other (gains) losses, net, non-GAAP; Income (loss) before income taxes, non-GAAP; Provision (benefit) for income taxes, net, non-GAAP; Net income (loss), non-GAAP; Net income (loss) per share, diluted, non-GAAP; and Operating expenses per ASM, non-GAAP, excluding Fuel and oil expense and profitsharing (cents). The Company's economic Fuel and oil expense results differ from GAAP results in that they only include the actual cash settlements from fuel hedge contracts - all reflected within Fuel and oil expense in the period of settlement. Thus, Fuel and oil expense on an economic basis has historically been utilized by the Company, as well as some of the other airlines that utilize fuel hedging, as it reflects the Company’s actual net cash outlays for fuel during the applicable period, inclusive of settled fuel derivative contracts. Any net premium costs paid related to option contracts that are designated as hedges are reflected as a component of Fuel and oil expense, for both GAAP and non-GAAP (including economic) purposes in the period of contract settlement. The Company believes these economic results provide further insight into the impact of the Company's fuel hedges on its operating performance and liquidity since they exclude the unrealized, noncash adjustments and reclassifications that are recorded in GAAP results in accordance with accounting guidance relating to derivative instruments, and they reflect all cash settlements related to fuel derivative contracts within Fuel and oil expense. This enables the Company's management, as well as investors and analysts, to consistently assess the Company's operating performance on a year-over-year or quarter-over-quarter basis after considering all efforts in place to manage fuel expense. However, because these measures are not determined in accordance with GAAP, such measures are susceptible to varying calculations, and not all companies calculate the measures in the same manner. As a result, the aforementioned measures, as presented, may not be directly comparable to similarly titled measures presented by other companies.Further information on (i) the Company's fuel hedging program, (ii) the requirements of accounting for derivative instruments, and (iii) the causes of hedge ineffectiveness and/or mark-to-market gains or losses from derivative instruments is included in Note 11 to the Consolidated Financial Statements.The Company’s GAAP results in the applicable periods may include other charges or benefits that are also deemed "special items," that the Company believes make its results difficult to compare to prior periods, anticipated future periods, or industry trends. Financial measures identified as non-GAAP (or as excluding special items) have been adjusted to exclude special items. For the periods presented, in addition to the items discussed above, special items include:1.Proceeds related to the Payroll Support programs, which were used to pay a portion of Employee salaries, wages, and benefits;2.Charges and adjustments to previously accrued amounts related to the Company's extended leave programs;3.Adjustments for prior period losses reclassified from AOCI associated with forward-starting interest rate swap agreements that were terminated in prior periods related to 12 -8 aircraft leases;72Table of Contents4.Noncash impairment charges, primarily associated with adjustments to the salvage values for previously retired airframes;5.Unrealized mark-to-market adjustment associated with certain available for sale securities; and6.Losses associated with the partial extinguishment of the Company's convertible notes and early prepayment of debt. In third quarter 2022, management determined that presentation within its income statement would be enhanced by classification of Loss on extinguishment of debt as a separate line item, rather than its prior presentation where it was included as a component of Other (gains) losses, net. Such losses are incurred as a result of opportunistic decisions made by the Company to prepay portions of its debt, most of which was taken on during the pandemic in order to provide liquidity during the prolonged downturn in air travel. Due to the nature of these losses, which are difficult to accurately predict, and due to the fact that they are not representative of the Company’s day-to-day airline operating performance, the Company has included such amounts as special items and thus excluded them from certain of its non-GAAP measures in the accompanying reconciliations.Because management believes special items can distort the trends associated with the Company’s ongoing performance as an airline, the Company believes that evaluation of its financial performance can be enhanced by a supplemental presentation of results that exclude the impact of special items in order to enhance consistency and comparativeness with results in prior periods that do not include such items and as a basis for evaluating operating results in future periods. The following measures are often provided, excluding special items, and utilized by the Company’s management, analysts, and investors to enhance comparability of year-over-year results, as well as to industry trends: Fuel and oil expense, non-GAAP; Total operating expenses, non-GAAP; Operating expenses, non-GAAP excluding Fuel and oil expense; Operating expenses, non-GAAP excluding Fuel and oil expense and profitsharing; Operating income (loss), non-GAAP; Other (gains) losses, net, non-GAAP; Income (loss) before income taxes, non-GAAP; Provision (benefit) for income taxes, net, non-GAAP; Net income (loss), non-GAAP; Net income (loss) per share, diluted, non-GAAP; and Operating expenses per ASM, non-GAAP, excluding Fuel and oil expense and profitsharing (cents).73Table of ContentsLiquidity and Capital ResourcesThe enormous impact of the COVID-19 pandemic on the U.S. travel industry created an urgent liquidity crisis, especially during 2020, for the entire airline industry, including the Company. However, due to the Company's pre-pandemic low balance sheet leverage, large base of unencumbered assets, and investment-grade credit ratings, the Company was able to quickly access additional liquidity during 2020, as Customer cancellations and ticket refunds spiked and sales and revenues dropped while the Company continued to experience significant fixed operating expenses. See Note 2 and Note 11 to the Consolidated Financial Statements for further information regarding the impact of the COVID-19 pandemic, as well as the transactions completed and assistance obtained under Payroll Support programs.Net cash provided by operating activities for 2022 was $3.8 billion, and net cash provided by operating activities for 2021 was $2.3 billion. Operating cash inflows are historically primarily derived from providing air transportation to Customers. The vast majority of tickets are purchased prior to the day on which travel is provided and, in some cases, several months before the anticipated travel date. Operating cash outflows are related to the recurring expenses of airline operations. The operating cash flows for 2022 were largely impacted by the Company's net income (as adjusted for noncash items), a $525 million increase in Air traffic liability driven by higher ticket sales related to an increase in travel demand, a $472 million cash tax refund from the Internal Revenue Service associated with the 2020 tax year, and a $139 million cash excise tax refund for excise taxes remitted to taxing authorities for which the subsequent flights were canceled by Customers, resulting in amounts due back to the Company. Cash flows associated with entering into new fuel derivatives, which are classified as Other, net, operating cash flows, were net outflows of $81 million in 2022 and $34 million in 2021. See Note 11 to the Consolidated Financial Statements for further information. Operating cash flows for 2021 included $2.7 billion in Payroll Support program grant proceeds received and $591 million increase in Air traffic liability driven by increased ticket sales related to an increase in leisure travel demand. Net cash provided by operating activities is primarily used to finance capital expenditures, repay debt, and provide working capital. Historically, the Company has also used Net cash provided by operating activities to fund stock repurchases and pay dividends; however these shareholder return activities were suspended through September 30, 2022, due to restrictions associated with the payroll assistance under the Payroll Support programs and the Company's amended and restated revolving credit facility. On December 6, 2022, the Company reinstated and declared a quarterly cash dividend of $0.18 per share to Shareholders of record at the close of business on January 10, 2023, on all shares then issued and outstanding, to be paid on January 31, 2023. See Note 2 to the Consolidated Financial Statements for further information on restrictions associated with the Payroll Support Programs. Net cash used in investing activities for 2022 was $3.7 billion, and net cash used in investing activities for 2021 was $1.3 billion. Investing activities in both years included Capital expenditures, and changes in the balance of the Company's short-term and noncurrent investments. Capital expenditures were $3.9 billion, compared with $505 million in the same prior year period. Capital expenditures increased, year-over-year, largely due to a substantial increase in progress and delivery payments made for current period and future aircraft deliveries during 2022, compared to the same prior year period, when progress payments were not made through November 2021 due to delivery credits provided by Boeing to the Company resulting from the settlement of 2020 estimated damages relating to the FAA grounding of the MAX aircraft. See Note 17 to the Consolidated Financial Statements for further information. Capital expenditures during 2022 also included approximately $174 million associated with the Company's purchase of 31 finance leased aircraft from the lessor. See Note 8 to the Consolidated Financial Statements for further information. The Company estimates its 2023 capital spending to be in the range of $4.0 billion to $4.5 billion, which assumes approximately 100 MAX aircraft deliveries in 2023. The Company's 2023 capital spending guidance continues to include approximately $1.2 billion in non-aircraft capital spending. Including both capital spending and operating expense budgets, the Company currently expects to spend approximately $1.3 billion in 2023 on technology investments, upgrades, and system maintenance.74Table of ContentsNet cash used in financing activities for 2022 was $3.0 billion, and net cash provided by financing activities for 2021 was $359 million, respectively. During 2022, the Company repaid $3.1 billion in debt and finance lease obligations, including a $1.3 billion prepayment for all of its outstanding 4.75% Notes due 2023 and the extinguishment of $486 million in principal of its Convertible Notes for cash payments totaling $648 million. The Company may engage in early debt repurchases from time to time and some of these early future repurchases are not included in the Company's current maturities of long-term debt. Also, see investing activities section above and Note 8 to the Consolidated Financial Statements for further information on the Company's purchase of finance leased aircraft, which resulted in a $191 million elimination of the Company's remaining finance lease obligations for these aircraft. During 2021, the Company's financing activities included borrowing $1.1 billion under Payroll Support programs. See Note 2 to the Consolidated Financial Statements for further information. The Company also repaid $905 million in debt and finance lease obligations, including the extinguishment of $203 million in principal of its Convertible Notes for cash payments totaling $293 million during 2021.A discussion of the Company's most significant drivers impacting cash flow for 2020 are included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2021, under Part II Item 7, Liquidity and Capital Resources. The Company is a "well-known seasoned issuer" and currently has an effective shelf registration statement registering an indeterminate amount of debt and equity securities for future sales. The Company currently intends to use the proceeds from any future securities sales off this shelf registration statement for general corporate purposes.The Company has access to $1.0 billion under its amended and restated revolving credit facility (the "Amended A&R Credit Agreement"). There were no amounts outstanding under the Amended A&R Credit Agreement as of December 31, 2022. See Note 7 to the Consolidated Financial Statements for further information. Although not the case at December 31, 2022 due to the Company's significant financing activities throughout the early stages of the pandemic, the Company has historically carried a working capital deficit, in which its current liabilities exceed its current assets. This is common within the airline industry and is primarily due to the nature of the Air traffic liability account, which is related to advance ticket sales, unused flight credits available to Customers, and loyalty deferred revenue, which are performance obligations for future Customer flights, do not require future settlement in cash, and are mostly nonrefundable. See Note 6 to the Consolidated Financial Statements for further information. The Company believes it has various options available to meet its capital and operating commitments, including unrestricted cash and short-term investments of $12.3 billion as of December 31, 2022, and anticipated future internally generated funds from operations. See Note 2 to the Consolidated Financial Statements for further information on the impacts of the COVID-19 pandemic.The following discussion includes various short-term and long-term material cash requirements from known contractual and other obligations, but does not include amounts that are contingent on events or other factors that are uncertain or unknown at this time. Given the Company's current liquidity position, available resources, and prevailing outlook, it expects to be able to fulfill both its short-term and long-term material cash requirements. The amounts disclosed are based on various estimates, including estimates regarding the timing of payments, prevailing interest rates, volumes purchased, the occurrence of certain events and other factors. Accordingly, the actual results may vary materially from the amounts discussed herein.DebtSee Note 7 to the Consolidated Financial Statements for further detail on the Company's debt and the timing of expected and future principal payments. The Company also has significant future obligations associated with fixed interest payments associated with its debt. As of December 31, 2022, future interest payments associated with its fixed rate debt (excluding interest associated with finance leases) were $239 million in 2023, $238 million in 2024, $198 million in 2025, $166 million in 2026, $114 million in 2027, and $161 million thereafter.75Table of ContentsThe Company's Convertible Notes did not meet the criteria to be converted by holders as of the date of the financial statements, and thus are classified as Long-term debt in the accompanying Consolidated Balance Sheet as of December 31, 2022. If the provisions were met to allow holders to exercise their conversion option on these instruments, all of the remaining convertible notes would be reclassified as a current obligation. Also, the Company has engaged in transactions with certain convertible debt holders to purchase their instruments in private transactions from time to time in cash, and may continue to do so in future periods. The Company considers its prevailing stock price, the trading price of its convertible debt instruments, and its available liquidity in determining how much of these instruments it may attempt to repurchase in such transactions.LeasesThe Company enters into leases for aircraft, airports and other real property, and other types of equipment in the normal course of business. See Note 8 to the Consolidated Financial Statements for further detail.Aircraft purchase commitmentsThe Company is required to make cash deposits toward the purchase of aircraft in advance. These deposits are classified as Deposits on flight equipment purchase contracts in the Consolidated Balance Sheet until the aircraft is delivered, at which time deposits previously made are deducted from the final purchase price of aircraft and are reclassified as Flight equipment. See Part I, Item 2 for a complete table of the Company's contractual firm deliveries and options for -7 and -8 aircraft, and Note 5 to the Consolidated Financial Statements for the financial commitments related to these firm deliveries.OtherThe Company's other material cash requirements primarily consist of outlays associated with normal operating expenses of the airline, including payroll, fuel, airport costs, etc. While many of these expenses are variable in nature, some of the expenditures can be somewhat fixed in the short-term due to the lead-time involved in publishing the Company's flight schedule in advance and providing for resources to be available to operate those schedules.The Company has a large net deferred tax liability on its Consolidated Balance Sheet. The deferral of income taxes has resulted in a significant benefit to the Company and its liquidity position. Since the Company purchases the majority of the aircraft it acquires, it has been able to utilize accelerated depreciation methods (including bonus depreciation) available under the Internal Revenue Code of 1986, as amended, in 2022 and in previous years, which has enabled the Company to accelerate cash tax benefits of depreciation. Based on the Company’s scheduled future aircraft deliveries from Boeing and existing tax laws in effect, the Company will continue to accelerate the cash income tax benefits related to aircraft purchases. Due to the Company's net taxable loss incurred in 2020, and a provision within the CARES Act that allowed entities to carry back such 2020 losses to prior periods of up to five years, and claim refunds of federal taxes paid, the Company received a significant cash tax refund of $472 million associated with this taxable loss from the Internal Revenue Service during second quarter 2022. The Company was in a net taxable loss position in 2022 and has federal and state operating loss carryforwards, $275 million and $43 million (tax-effected), respectively, to reduce taxable income in future periods. See Note 15 to the Consolidated Financial Statements for further information. The Company has paid in the past, and will continue to pay in the future, cash taxes to the various taxing jurisdictions where it operates. The Company expects to be able to continue to meet such obligations utilizing cash and investments on hand, as well as cash generated from its ongoing operations.76Table of ContentsCRITICAL ACCOUNTING POLICIES AND ESTIMATESThe Company’s Consolidated Financial Statements have been prepared in accordance with GAAP. The Company’s significant accounting policies are described in Note 1 to the Consolidated Financial Statements. The preparation of financial statements in accordance with GAAP requires the Company’s management to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying footnotes. The Company’s estimates and assumptions are based on historical experience and changes in the business environment. However, actual results may differ from estimates under different conditions, sometimes materially. Critical accounting policies and estimates are defined as those that both (i) are most important to the portrayal of the Company’s financial condition and results and (ii) require management’s most subjective judgments. The Company’s critical accounting policies and estimates are described below. Revenue RecognitionTickets sold for Passenger air travel are initially deferred as Air traffic liability. Passenger revenue is recognized and Air traffic liability is reduced when the service is provided (i.e., when the flight takes place). Air traffic liability primarily represents tickets sold for future travel dates, flight credits that are expected to be used in the future, and loyalty benefits that are expected to be redeemed in the future. Air traffic liability typically fluctuates throughout the year based on seasonal travel patterns, fare sale activity, and activity associated with the Company’s loyalty program. See Note 1 to the Consolidated Financial Statements for information about the Company's revenue recognition policies.For air travel on Southwest, the amount of tickets (which includes flight credits--also referred to as partial tickets), that will go unused, referred to as breakage, is estimated and recognized in Passenger revenue once the scheduled flight date has passed, in proportion to the pattern of rights exercised by the Customer, in accordance with Accounting Standards Codification 606, Revenue From Contracts With Customers ("ASC 606"). Estimating the amount of tickets that will ultimately go unused involves some level of subjectivity and judgment. The majority of the Company's tickets sold are nonrefundable, although flight credits created when a Customer cancels or modifies an existing flight itinerary can be applied towards the purchase of future travel. Unused flight credits are the primary source of breakage. Breakage estimates are based on historical experience over many years. Fully refundable tickets rarely go unused. As a result of the COVID-19 pandemic, for all Customer flight credits created or scheduled to expire between March 1 and September 7, 2020 associated with flight cancellations, the Company initially extended the expiration date to September 7, 2022. See Note 6 to the Consolidated Financial Statements for further information regarding these extended flight credits. Since the Company did not have historical data to enable it to accurately estimate the pattern of usage of these extended credits, these credits have been classified as a current liability throughout their history. Subsequently, on July 28, 2022, the Company modified its policy and announced that all unexpired flight credits as of that date, including these extended flight credits, will no longer have an expiration date and thus will be able to be redeemed by Customers indefinitely. This change in policy was considered a contract modification under ASC 606 and the Company accounted for such change prospectively in third quarter 2022. The Company’s balance of existing Customer flight credits as of the modification date was approximately $1.9 billion, including the extended flight credits that had been set to expire on September 7, 2022. As a result of changes in observed Customer travel habits and behaviors during 2021 and 2022, the Company increased its estimates of “normal” Customer flight credits that are expected to go unused, as Customer redemptions of these "normal" credits had been at a slower rate than the Company’s historical data for similar credits in periods prior to the COVID-19 pandemic. Although the Company continues to believe a portion of Customer flight credits will go unused following the Company's change in policy, including a portion of flight credits issued after July 28, 2022, the Company expects its prospective breakage rate associated with such flight credits to be at or slightly lower than historical pre-pandemic levels due to the fact that such flight credits no longer have an expiration date. 77Table of ContentsObserved Customer behavior that differs from historical experience can cause actual ticket breakage to differ significantly from estimates. Assumptions about Customer behavior are reviewed frequently and corresponding adjustments are made to breakage estimates, as needed, when observed behaviors differ from historical experience. Assumptions about Customer behavior can be impacted by several factors including, but not limited to: fare increases, fare sales, changes to the Company's ticketing policies, changes to the Company’s refund, exchange and unused flight credit policies, seat availability, and economic factors. The Company’s estimation techniques have been consistently applied from year to year; however, as with any estimates, actual ticket breakage may vary from estimated amounts. Fair Value Measurements and Financial Derivative InstrumentsThe Company utilizes unobservable (Level 3) inputs in determining the fair value of certain assets and liabilities. At December 31, 2022, these consisted of its fuel derivative option contracts, which were an asset of $512 million. The Company utilizes financial derivative instruments primarily to manage its risk associated with changing jet fuel prices. See "Quantitative and Qualitative Disclosures about Market Risk" for more information on these risk management activities, Note 11 to the Consolidated Financial Statements for more information on the Company’s fuel hedging program and financial derivative instruments, and Note 12 to the Consolidated Financial Statements for more information about fair value measurements. All derivatives are required to be reflected at fair value and recorded on the Consolidated Balance Sheet. At December 31, 2022, the Company was a party to over 125 separate financial derivative instruments related to its fuel hedging program for future periods. Changes in the fair values of these instruments can vary dramatically based on changes in the underlying commodity prices. For example, during 2022, market "spot" prices for Brent crude oil peaked at a high average daily price of approximately $128 per barrel and hit a low average daily price of approximately $76 per barrel. During 2021, market spot prices ranged from a high average daily price of approximately $86 per barrel to a low average daily price of approximately $51 per barrel. Market price changes can be driven by factors such as supply and demand, inventory levels, weather events, refinery capacity, political agendas, the value of the U.S. dollar, geopolitical events, the extent of the COVID-19 pandemic, and general economic conditions, among other items. Historically, the financial derivative instruments utilized by the Company primarily are a combination of collars, purchased call options, call spreads, put spreads, and fixed price swap agreements.The Company enters into financial derivative instruments with third party institutions in "over-the-counter" markets. Since the majority of the Company’s financial derivative instruments are not traded on a market exchange, the Company estimates their fair values. Depending on the type of instrument, the values are determined by the use of present value methods or standard option value models with assumptions about commodity prices based on those observed in underlying markets. The Company determines the fair value of fuel derivative option contracts utilizing an option pricing model based on inputs that are either readily available in public markets, can be derived from information available in publicly quoted markets, or are quoted by its counterparties. In situations where the Company obtains inputs via quotes from its counterparties, it verifies the reasonableness of these quotes via similar quotes from another counterparty as of each date for which financial statements are prepared. The Company has consistently applied these valuation techniques in all periods presented and believes it has obtained the most accurate information available for the types of derivative contracts it holds. Due to the fact that certain inputs used in determining the estimated fair value of its option contracts are considered unobservable (primarily implied volatility), the Company has categorized these option contracts as Level 3. Although implied volatility is not directly observable, it is derived primarily from changes in market prices, which are observable. Based on the Company’s portfolio of option contracts as of December 31, 2022, a 10 percent change in implied volatility, holding all other factors constant, would have resulted in a change in the fair value of this portfolio of less than $194 million.Fair values for financial derivative instruments are estimated prior to the time that the financial derivative instruments settle. However, once settlement of the financial derivative instruments occurs and the hedged jet fuel is 78Table of Contentspurchased and consumed, all values and prices are known and are recognized in the financial statements. Although the Company continues to use a prospective assessment to determine that commodities continue to qualify for hedge accounting in specific locations where the Company hedges, there are no assurances that these commodities will continue to qualify in the future. This is due to the fact that future price changes in these refined products may not be consistent with historical price changes. Increased volatility in these commodity markets for an extended period of time, especially if such volatility were to worsen, could cause the Company to lose hedge accounting altogether for the commodities used in its fuel hedging program. Further, should the anticipated fuel purchases covered by the Company's fuel hedges no longer be probable of occurring, the Company would discontinue hedge accounting. The loss of hedge accounting would create further volatility in the Company’s GAAP financial results.As discussed in Note 11 to the Consolidated Financial Statements, any changes in fair value of cash flow derivatives designated as hedges are offset within AOCI until the period in which the expected future cash flow impacts earnings. Any changes in the fair value of fuel derivatives that do not qualify for hedge accounting are reflected in earnings within Other (gains) losses, net, in the period of the change. Because the Company has extensive historical experience in valuing the derivative instruments it holds, and such experience is continually evaluated against its counterparties each period when such instruments expire and are settled for cash, the Company believes it is unlikely that an independent third party would value the Company’s derivative contracts at a significantly different amount than what is reflected in the Company’s financial statements. In addition, the Company also has bilateral credit provisions in some of its counterparty agreements, which provide for parties (or the Company) to provide cash collateral when the fair value of fuel derivatives with a single party exceeds certain threshold levels. Since this cash collateral is based on the estimated fair value of the Company’s outstanding fuel derivative contracts, this provides further validation to the Company’s estimate of fair values.Loyalty AccountingThe Company utilizes estimates in the recognition of revenues and liabilities associated with its loyalty program. These estimates primarily include the liability associated with Rapid Rewards loyalty member ("Member") account balances that are expected to be redeemed for travel or other products at a future date. Loyalty account balances include points earned through flights taken, points sold to Customers, or points earned through business partners participating in the loyalty program.Under the Southwest Rapid Rewards loyalty program, Members earn points for every dollar spent on Southwest base fares. The amount of points earned under the program is based on the fare amount and fare type, with higher fare types (e.g., Business Select) earning more points than lower fare types (e.g., Wanna Get Away). Each fare type is associated with a points earning multiplier, and points for flights are calculated by multiplying the fare amount for the flight by the fare type multiplier. Likewise, the amount of points required to be redeemed for a flight can differ based on the fare type purchased. Under the program, (i) Members are able to redeem their points for every available seat, every day, on every flight, with no blackout dates; and (ii) points do not expire. In addition, Members are able to redeem their points for items other than travel on Southwest Airlines, such as international flights on other airlines, cruises, hotel stays, rental cars, gift cards, event tickets, and more. In addition to earning points for revenue flights and qualifying purchases with Rapid Rewards Partners, Members also have the ability to purchase, gift, and transfer points, as well as the ability to donate points to selected charities.The Company utilizes the deferred revenue method of accounting for points earned through flights taken in its loyalty program. The Company also sells points and related services to business partners participating in the loyalty program. Liabilities are recorded for the relative standalone selling price of the Rapid Rewards points which are awarded each period. The liabilities recorded represent the total number of points expected to be redeemed by Members, regardless of whether the Members may have enough to qualify for a full travel award. At December 31, 2022, the loyalty liabilities were approximately $5.2 billion, including $3.0 billion classified within Air traffic liability and $2.2 billion classified as Air traffic liability – noncurrent.In order to determine the value of each loyalty point, certain assumptions must be made at the time of measurement, which include an allocation of passenger revenue between the flight and loyalty points earned by passengers, and the fair value of Rapid Rewards points, which are generally based on their redemption value to the Customer. See 79Table of ContentsNote 6 to the Consolidated Financial Statements for further information on determining the estimated fair value of each loyalty point.The majority of the points sold to business partners are through the Southwest co-branded credit card agreement ("Agreement") with Chase Bank USA, N.A. Consideration received as part of this Agreement is subject to ASC 606. The most recent instance in which the Agreement was amended was in fourth quarter 2021. The Agreement has the following multiple elements: travel points to be awarded, use of the Southwest Airlines’ brand and access to Rapid Rewards Member lists, advertising elements, and the Company’s resource team. These elements are combined into two performance obligations, transportation and marketing, and consideration from the Agreement is allocated based on the relative selling price of each performance obligation.Significant management judgment was used to estimate the selling price of each of the performance obligations in the Agreement at inception, including each time in which the Agreement has been materially amended. The objective is to determine the price at which the Company would transact a sale if the product or service was sold on a stand-alone basis. The Company determines the best estimate of selling price by considering multiple inputs and methods including, but not limited to, the estimated selling price of comparable travel, discounted cash flows, brand value, published selling prices, number of points awarded, and the number of points redeemed. The Company estimates the selling prices and volumes over the term of the Agreement in order to determine the allocation of proceeds to each of the multiple performance obligations. The Company records revenue related to air transportation when the transportation is delivered and revenue related to marketing elements when the performance obligation is satisfied. A one percent increase or decrease in the Company's estimate of the standalone selling prices, implemented as of January 1, 2022, causing a change to the allocation of proceeds to air transportation would not have had a material impact on the Company's Operating revenues for the year ended December 31, 2022.Under its current program, Southwest estimates the portion of loyalty points that will not be redeemed. In estimating the breakage, the Company takes into account the Member’s past behavior, as well as several factors related to the Member’s account that are expected to be indicative of the likelihood of future point redemption. These factors are typically representative of a Member’s level of engagement in the loyalty program. They include, but are not limited to, tenure with the program, points accrued in the program, and points redeemed in the program. The Company believes it has obtained sufficient historical behavioral data to develop a predictive statistical model to analyze the amount of breakage expected for all loyalty points. The Company updates this model at least annually, and applies the new breakage rates effective October 1st each year, or more frequently if required by changes in the business. Changes in the breakage rates applied annually in recent years have not had a material impact on Passenger revenues. For the year ended December 31, 2022, based on actual redemptions of points sold to business partners and earned through flights, a hypothetical one percentage point change in the estimated breakage rate would have resulted in a change to Passenger revenue of approximately $152 million (an increase in breakage would have resulted in an increase in revenue and a decrease in breakage would have resulted in a decrease in revenue). Given that Member behavior will continue to develop as the program matures, the Company expects the current estimates may change in future periods. However, the Company believes its current estimates are reasonable given current facts and circumstances.80Table of ContentsItem 7A. Quantitative and Qualitative Disclosures About Market RiskThe Company has interest rate risk in its interest rate swaps, commodity price risk in jet fuel required to operate its aircraft fleet, and market risk in the derivatives used to manage its fuel hedging program and in the form of fixed-rate debt instruments. As of December 31, 2022, the Company operated a total of 94 aircraft under operating and finance leases. However, except for a small number of aircraft that have lease payments that fluctuate based in part on changes in market interest rates, the remainder of the leases are not considered market sensitive financial instruments and, therefore, are not included in the interest rate sensitivity analysis below. The Company does not purchase or hold any derivative financial instruments for trading purposes. See Note 11 to the Consolidated Financial Statements for information on the Company’s accounting for its hedging program and for further details on the Company’s financial derivative instruments.HedgingThe Company purchases jet fuel at prevailing market prices, but seeks to manage market risk through execution of a documented hedging strategy. The Company utilizes financial derivative instruments, on both a short-term and a long-term basis, as a form of insurance against the potential for significant increases in fuel prices. The Company believes there can be significant risk in not hedging against the possibility of such fuel price increases, especially in energy markets in which prices are high and/or rising. The Company expects to consume approximately 2.2 billion gallons of jet fuel in 2023. Based on this anticipated usage, a change in jet fuel prices of just one cent per gallon would impact the Company’s Fuel and oil expense by approximately $22 million for 2023, excluding any impact associated with fuel derivative instruments held.As of December 31, 2022, the Company held a net position of fuel derivative instruments that represented a hedge for a portion of its anticipated jet fuel purchases for future periods. See Note 11 to the Consolidated Financial Statements for further information. The Company may increase or decrease the volume of fuel hedged based on its expectation of future market prices and its forecasted fuel consumption levels, while considering the significant cost that can be associated with different types of hedging strategies. The gross fair value of outstanding financial derivative instruments related to the Company’s jet fuel market price risk at December 31, 2022, was an asset of $512 million. In addition, $106 million in cash collateral deposits were held by the Company in connection with these instruments based on their fair value as of December 31, 2022. The fair values of the derivative instruments, depending on the type of instrument, were determined by use of present value methods or standard option value models with assumptions about commodity prices based on those observed in underlying markets. An immediate 10 percent increase or decrease in underlying fuel-related commodity prices from the December 31, 2022, prices would correspondingly change the fair value of the commodity derivative instruments in place by approximately $191 million. Fluctuations in the related commodity derivative instrument cash flows may change by more or less than this amount based upon further fluctuations in futures prices, as well as related income tax effects. In addition, this does not consider changes in cash or letters of credit utilized as collateral provided to or by counterparties, which would fluctuate in an amount equal to or less than this amount, depending on the type of collateral arrangement in place with each counterparty. This sensitivity analysis uses industry standard valuation models and holds all inputs constant at December 31, 2022, levels, except underlying futures prices.The Company’s credit exposure related to fuel derivative instruments is represented by the fair value of contracts that are in an asset position to the Company. At such times, these outstanding instruments expose the Company to credit loss in the event of nonperformance by the counterparties to the agreements. As of December 31, 2022, the Company had eight counterparties for which the derivatives held were an asset. To manage credit risk, the Company selects and periodically reviews counterparties based on credit ratings, limits its exposure with respect to each counterparty, and monitors the market position of the fuel hedging program and its relative market position with each counterparty. However, if one or more of these counterparties were in a liability position to the Company and were unable to meet their obligations, any open derivative contracts with the counterparty could be subject to early termination, which could result in substantial losses for the Company. At December 31, 2022, the Company had agreements with all of its active counterparties containing early termination rights and/or bilateral collateral provisions whereby security is required if market risk exposure exceeds a specified threshold amount based on the 81Table of Contentscounterparty’s credit rating. The Company also had agreements with counterparties in which cash deposits and/or letters of credit are required to be posted as collateral whenever the net fair value of derivatives associated with those counterparties exceeds specific thresholds. Refer to the counterparty credit risk and collateral table provided in Note 11 to the Consolidated Financial Statements for the fair values of fuel derivatives, amounts held as collateral, and applicable collateral posting threshold amounts as of December 31, 2022, at which such postings are triggered.The Company is also subject to the risk that the fuel derivatives it uses to hedge against fuel price volatility do not provide adequate protection. The Company has found that financial derivative instruments in commodities, such as West Texas Intermediate ("WTI") crude oil, Brent crude oil, and refined products, such as heating oil and unleaded gasoline, can be useful in decreasing its exposure to jet fuel price volatility. In addition, to add further protection, the Company may periodically enter into jet fuel derivatives for short-term timeframes. Jet fuel is not widely traded on an organized futures exchange and, therefore, there are limited opportunities to hedge directly in jet fuel for time horizons longer than approximately 24 months into the future. The Company also has agreements with each of its counterparties associated with its outstanding interest rate swap agreements in which cash collateral may be required based on the fair value of outstanding derivative instruments, as well as the Company’s and its counterparty’s credit ratings. As of December 31, 2022, no cash collateral deposits were provided by or held by the Company based on its outstanding interest rate swap agreements.Due to the significance of the Company’s fuel hedging program and the emphasis that the Company places on utilizing fuel derivatives to reduce its fuel price risk, the Company has created a system of governance and management oversight and has put in place a number of internal controls designed so that procedures are properly followed and accountability is present at the appropriate levels. For example, the Company has put in place controls designed to: (i) create and maintain a comprehensive risk management policy; (ii) provide for proper authorization by the appropriate levels of management; (iii) provide for proper segregation of duties; (iv) maintain an appropriate level of knowledge regarding the execution of and the accounting for derivative instruments; and (v) have key performance indicators in place in order to adequately measure the performance of its hedging activities. The Company believes the governance structure that it has in place is adequate given the size and sophistication of its hedging program. Financial Market RiskThe vast majority of the Company’s tangible assets are aircraft, which are long-lived. The Company’s strategy is to maintain a conservative balance sheet and grow capacity steadily and profitably under the right conditions. While the Company uses financial leverage, it strives to maintain a strong balance sheet and has a "BBB+" rating with Fitch, a "BBB" rating with Standard & Poor’s, and a "Baa1" credit rating with Moody’s as of December 31, 2022, all of which are considered "investment grade." See Note 7 to the Consolidated Financial Statements for more information on the material terms of the Company’s short-term and long-term debt.The Company's senior unsecured notes outstanding as of December 31, 2022 are all fixed-rate obligations. See Note 7 to the Consolidated Financial Statements for further information.The $100 million 7.375% debentures due 2027 had at one point been converted to a floating rate, but the Company subsequently terminated the fixed-to-floating interest rate swap agreements related to it. The effect of this termination was that the interest associated with this debt prospectively reverted back to its original fixed rate. As a result of the gain realized on this transaction, which is being amortized over the remaining term of the corresponding notes, and based on projected interest rates at the date of termination, the Company does not believe its future interest expense, based on projected future interest rates at the date of termination, associated with these notes will significantly differ from the expense it would have recorded had the notes remained at floating rates. The Company's total debt divided by total assets was 22.9 percent as of December 31, 2022.82Table of ContentsThe Company also has some risk associated with changing interest rates due to the short-term nature of its invested cash, which totaled $9.5 billion, and short-term investments, which totaled $2.8 billion at December 31, 2022. See Notes 1 and 12 to the Consolidated Financial Statements for further information. The Company currently invests available cash in certificates of deposit, highly rated money market instruments, investment grade commercial paper, treasury securities, U.S. government agency securities, and other highly rated financial instruments, depending on market conditions and operating cash requirements. Because of the short-term nature of these investments, the returns earned parallel closely with short-term floating interest rates. The Company has not undertaken any additional actions to cover interest rate market risk and is not a party to any other material market interest rate risk management activities.A hypothetical 10 percent change in market interest rates as of December 31, 2022, would have resulted in an approximate $100 million change in the fair value of the Company’s fixed-rate debt instruments. See Note 12 to the Consolidated Financial Statements for further information on the fair value of financial instruments. A change in market interest rates could, however, have a corresponding effect on earnings and cash flows associated with the Company’s invested cash (excluding cash collateral deposits held, if applicable) and short-term investments because of the floating-rate nature of these items. Assuming floating market rates in effect as of December 31, 2022 were held constant throughout a 12-month period, a hypothetical 10 percent change in those rates would have resulted in an approximate $47 million impact on the Company’s net earnings and cash flows. Utilizing these assumptions and considering the Company’s cash balance (excluding the impact of cash collateral deposits held from or provided to counterparties, if applicable) and short-term investments outstanding at December 31, 2022, an increase in rates would have a net positive effect on the Company’s earnings and cash flows, while a decrease in rates would have a net negative effect on the Company’s earnings and cash flows. However, a 10 percent change in market rates would not impact the Company’s earnings or cash flow associated with the Company’s publicly traded fixed-rate debt.The Company is also subject to a financial covenant included in its Amended A&R Credit Agreement, and is subject to credit rating triggers related to its credit card transaction processing agreements, the pricing related to any funds drawn under its Amended A&R Credit Agreement, and some of its hedging counterparty agreements. Certain covenants include the maintenance of minimum credit ratings and/or triggers that are based on changes in these ratings. The Company’s Amended A&R Credit Agreement contains a financial covenant to maintain total liquidity, as defined therein, of $1.5 billion at all times. As of December 31, 2022, the Company was in compliance with this covenant and there were no amounts outstanding under the Amended A&R Credit Agreement. However, if conditions change and the Company fails to meet the minimum standards set forth in the Amended A&R Credit Agreement, there could be a reduction in the availability of cash under the facility, or an increase in the costs to keep the facility intact as written. The Company’s hedging counterparty agreements contain ratings triggers in which cash collateral could be required to be posted with the counterparty if the Company’s credit rating were to fall below investment grade by two of the three major rating agencies, and if the Company were in a net liability position with the counterparty. See Note 11 to the Consolidated Financial Statements for further information.The Company currently has agreements with organizations that process credit card transactions arising from purchases of air travel tickets by its Customers utilizing American Express, Discover, and MasterCard/VISA. Credit card processors have financial risk associated with tickets purchased for travel because the processor generally forwards the cash related to the purchase to the Company soon after the purchase is completed, but the air travel generally occurs after that time; therefore, the processor will have liability if the Company does not ultimately provide the air travel. Under these processing agreements, and based on specified conditions, increasing amounts of cash reserves could be required to be posted with the counterparty. There was no cash reserved for this purpose as of December 31, 2022. A majority of the Company’s sales transactions are processed by Chase Paymentech. Should chargebacks processed by Chase Paymentech reach a certain level, proceeds from advance ticket sales could be held back and used to establish a reserve account to cover such chargebacks and any other disputed charges that might occur. Additionally, cash reserves are required to be established if the Company’s credit rating falls to specified levels below investment grade. Cash reserve requirements are based on the Company’s public debt rating and a 83Table of Contentscorresponding percentage of the Company’s Air traffic liability. As of December 31, 2022, no holdbacks were in place.As of December 31, 2022, the Company was in compliance with all credit card processing agreements. The inability to enter into credit card processing agreements would have a material adverse effect on the business of the Company. The Company believes that it will be able to continue to renew its existing credit card processing agreements or will be able to enter into new credit card processing agreements with other processors in the future.84Table of Contents
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSGENERALThis Management's Discussion and Analysis should be read in conjunction with our consolidated financial statements and accompanying notes in this Form 10-K. Certain previously reported amounts presented in this Form 10-K have been reclassified to conform to current-period presentation. As of December 31, 2022, we had consolidated total assets of $301.45 billion, consolidated total deposits of $235.46 billion, consolidated total shareholders' equity of $25.19 billion and approximately 42,000 employees. Through our two lines of business, Investment Servicing and Investment Management, we operate in more than 100 geographic markets worldwide, including the U.S., Canada, Latin America, Europe, the Middle East and Asia. For the description of our lines of business, refer to "Lines of Business” in Item 1 in this Form 10-K. For financial and other information about our lines of business, refer to “Line of Business Information” in this Management's Discussion and Analysis and Note 24 to the consolidated financial statements in this Form 10-K.We prepare our consolidated financial statements in conformity with U.S. GAAP. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions in its application of certain accounting policies that materially affect the reported amounts of assets, liabilities, equity, revenue and expenses. Information about the significant accounting policies that require us to make judgments, estimates and assumptions that are difficult, subjective or complex about matters that are uncertain and may change in subsequent periods is included under “Significant Accounting Estimates” in this Management's Discussion and Analysis and in Note 1 to the consolidated financial statements in this Form 10-K. Certain financial information provided in this Form 10-K, including this Management's Discussion and Analysis, is presented using both a U.S. GAAP, or reported basis, and a non-GAAP basis, including certain non-GAAP measures used in the calculation of identified regulatory ratios. We measure and compare certain financial information on a non-GAAP basis, including information that management uses in evaluating our business and activities. Non-GAAP financial information should be considered in addition to, and not as a substitute for or as superior to, financial information prepared in conformity with U.S. GAAP. Any non-GAAP financial information presented in this Form 10-K, including this Management’s Discussion and Analysis, is reconciled to its most directly comparable currently applicable regulatory ratio or U.S. GAAP-basis measure. As part of our non-GAAP-basis measures, we present a fully taxable-equivalent NII that reports non-taxable revenue, such as interest income associated with tax-exempt investment securities, on a fully taxable-equivalent basis, which we believe facilitates an investor's understanding and analysis of our underlying financial performance and trends.In this Management’s Discussion and Analysis, where we describe the effects of changes in foreign currency translation, those effects are determined by applying applicable weighted average FX rates from the relevant 2021 period to the relevant 2022 period results.This Management's Discussion and Analysis contains statements that are considered "forward-looking statements" within the meaning of U.S. securities laws. These forward-looking statements involve certain risks and uncertainties which could cause actual results to differ materially. Additional information about forward-looking statements and related risks and uncertainties is provided in "Forward-Looking Statements", "Risk Factors Summary" and "Risk Factors" in this Form 10-K.Information regarding additional disclosures and materials available on our corporate website is provided under "Additional Information" in Item 1 in this Form 10-K. State Street Corporation | 59MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSOVERVIEW OF FINANCIAL RESULTSTABLE 1: OVERVIEW OF FINANCIAL RESULTSYears Ended December 31,(Dollars in millions, except per share amounts)202220212020Total fee revenue$9,606 $10,012 $9,499 Net interest income2,544 1,905 2,200 Total other income(2)110 4 Total revenue12,148 12,027 11,703 Provision for credit losses20 (33)88 Total expenses8,801 8,889 8,716 Income before income tax expense3,327 3,171 2,899 Income tax expense 553 478 479 Net income$2,774 $2,693 $2,420 Adjustments to net income:Dividends on preferred stock(1)$(112)$(119)$(162)Earnings allocated to participating securities(2)(2)(2)(1)Net income available to common shareholders$2,660 $2,572 $2,257 Earnings per common share:Basic$7.28 $7.30 $6.40 Diluted7.19 7.19 6.32 Average common shares outstanding (in thousands):Basic365,214 352,565 352,865 Diluted370,109 357,962 357,106 Cash dividends declared per common share$2.40 $2.18 $2.08 Return on average common equity11.1 %10.7 %10.0 %Pre-tax margin27.4 26.4 24.8 Return on average assets1.0 0.9 0.9 Common dividend payout33.4 30.3 32.9 Average common equity to average total assets8.3 8.0 8.3 (1) Additional information about our preferred stock dividends is provided in Note 15 to the consolidated financial statements in this Form 10-K.(2) Represents the portion of net income available to common equity allocated to participating securities, composed of unvested and fully vested SERP (Supplemental executive retirement plans) shares and fully vested deferred director stock awards, which are equity-based awards that contain non-forfeitable rights to dividends, and are considered to participate with the common stock in undistributed earnings.The following section provides information related to significant events, as well as highlights of our consolidated financial results for the year ended December 31, 2022 presented in Table 1: Overview of Financial Results. More detailed information about our consolidated financial results, including the comparison of our financial results for the year ended December 31, 2022 to those of the year ended December 31, 2021, is provided under “Consolidated Results of Operations”, "Line of Business Information" and "Capital" sections which follow “Financial Results and Highlights”, as well as in our consolidated financial statements in this Form 10-K.The comparison of our financial results for the year ended December 31, 2021 to those of the year ended December 31, 2020 is included in the Management's Discussion and Analysis in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC on February 17, 2022.Financial Results and Highlights•2022 financial performance:◦EPS of $7.19, flat compared to 2021.◦Total revenue increased 1% compared to 2021, as higher NII was partially offset by lower fee revenue and the impact of currency translation, which decreased total revenue by 2% in 2022 relative to the same period in 2021.◦Total expenses decreased 1% compared to 2021, as continued productivity and optimization savings, as well as the benefit from currency translation were partially offset by ongoing business investments and merit increases, professional fees, recoverable client-related expenses, marketing and travel costs. Currency translation reduced expenses by 3% in 2022 compared to 2021.◦Return on equity of 11.1% increased from 10.7% in 2021, primarily due to an increase in net income available to common shareholders. Pre-tax margin of 27.4% increased from 26.4% in 2021, primarily due to the increase in total revenue and lower expenses.◦Positive operating leverage of 2.0% points. Operating leverage represents the difference between the percentage change in total revenue and the percentage change in total expenses, in each case relative to the prior year period.◦Negative fee operating leverage of 3.1% points. Fee operating leverage represents the difference between the percentage change in total fee revenue and the percentage change in total expenses, in each case relative to the prior year period.◦Returned approximately $2.4 billion to our shareholders in the form of common stock dividends and common share repurchases compared to approximately $1.7 billion in 2021. State Street Corporation | 60MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSRevenue•Total fee revenue decreased 4% compared to 2021, primarily driven by lower servicing fees, management fees, and other fee revenue, partially offset by higher foreign exchange trading services revenue and software and processing fees. Currency translation negatively impacted both total revenue and total fee revenue by 2% each in 2022 compared to 2021.•Servicing fee revenue decreased 8% compared to 2021, primarily due to normal pricing headwinds, lower average market levels and lower client activity and adjustments, partially offset by net new business. Currency translation contributed 3% to the decrease in servicing fee revenue in 2022 compared to 2021.•Management fee revenue decreased 6% compared to 2021, primarily due to lower average equity and fixed income market levels, a previously reported client-specific pricing adjustment and institutional net outflows, partially offset by the absence of the impact of money market fee waivers and net inflows from cash and ETFs. Currency translation contributed 2% to the decrease in management fee revenue in 2022 compared to 2021.•Foreign exchange trading services revenue increased 14% compared to 2021, primarily reflecting higher FX spreads and a revenue- related recovery from a 2018 FX benchmark litigation resolution, partially offset by lower client FX volumes.•Securities finance revenue was flat compared to 2021, reflecting higher spreads, offset by lower agency and enhanced custody balances.▪Software and processing fees revenue increased 7% compared to 2021, primarily due to higher front office software and data revenue associated with CRD, partially offset by lower lending fees.•Other fee revenue decreased $64 million compared to 2021, primarily driven by negative market-related adjustments.•NII increased 34% compared to 2021, primarily due to higher interest rates from U.S. and international central bank rate hikes, partially offset by lower client deposits.Provision for Credit Losses•We recorded a $20 million provision for credit losses, due to a downward shift in management's economic outlook that was partially offset by a reduction in overall loan portfolio risk, compared to a $33 million release of credit reserves in 2021. Expenses•Total expenses decreased 1% compared to 2021, as continued productivity and optimization savings, as well as the benefit from currency translation were partially offset by ongoing business investments and merit increases, professional fees, recoverable client-related expenses, marketing and travel costs. Currency translation reduced expenses by 3% in 2022 compared to 2021. Notable Items•The impact of notable items in 2022 includes:◦Revenue-related recovery of $23 million from settlement proceeds associated with the 2018 FX benchmark litigation resolution, which is reflected in foreign exchange trading services revenue;◦Repositioning charges of approximately $78 million, consisting of $50 million of compensation and benefits expenses primarily related to streamlining the Investment Services organization, and $20 million of occupancy charges related to real estate footprint optimization and $8 million of BBH-related repositioning charges; and◦Acquisition and restructuring costs of approximately $65 million related to the BBH Investor Services acquisition transaction we are no longer pursuing.•The impact of notable items in 2021 includes:◦Gain on the sale of a majority share of our Wealth Management Services (WMS) business of $53 million recorded in other income;◦Gain on sale of investment securities of $58 million related to a one-time transfer of LIBOR and Euro Interbank Offered Rate based securities from HTM to AFS, and the subsequent sale of the majority of those securities in 2021;◦Net repositioning release of approximately $3 million, consisting of $32 million release of previously accrued severance charges, partially offset by $29 million of occupancy charges related to footprint optimization; State Street Corporation | 61MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS◦Deferred compensation expense acceleration of approximately $147 million associated with an amendment of certain outstanding deferred cash incentive compensation awards;◦Acquisition and restructuring costs of approximately $65 million, of which $53 million related to CRD and $13 million related to the BBH Investor Services acquisition transaction we are no longer pursuing;◦Net legal and other expenses of approximately $18 million, including $20 million in information systems and communications, $8 million in transaction processing services and $1 million in other expenses, partially offset by a legal accrual release of approximately $11 million associated with a settlement related to the invoicing matter; and◦Costs of $5 million due to the partial redemption of outstanding Series F non-cumulative perpetual preferred stock representing the difference between the redemption value and the net carrying value of the preferred stock.AUC/A and AUM•AUC/A of $36.74 trillion as of December 31, 2022 decreased 16% compared to December 31, 2021, primarily due to lower market levels, a previously disclosed client transition and the impact of currency translation, partially offset by new business installations. In 2022, newly announced asset servicing mandates totaled approximately $1.9 trillion. Servicing assets remaining to be installed in future periods totaled approximately $3.60 trillion as of December 31, 2022.•AUM of $3.48 trillion as of December 31, 2022 decreased 16% compared to December 31, 2021, primarily due to lower market levels, institutional net outflows and the impact of currency translation, partially offset by net inflows from ETFs.Capital •In 2022, we returned approximately $2.4 billion to our shareholders in the form of common stock dividends and common share repurchases compared to approximately $1.7 billion in 2021.•We declared aggregate common stock dividends of $2.40 per share, totaling $871 million compared to $2.18 per share, totaling $779 million in 2021.•We did not repurchase any common stock during the first three quarters of 2022. In October 2022, we resumed our share repurchases under the 2021 Program, and purchased an aggregate of 19.5 million shares of common stock, at an average per share cost of $76.81 and an aggregate cost of approximately $1.5 billion in the fourth quarter of 2022.•In January 2023, our Board approved a share repurchase program authorizing the purchase of up to $4.5 billion of our common stock through December 31, 2023. •Our standardized CET1 capital ratio decreased to 13.6% as of December 31, 2022, compared to 14.3% as of December 31, 2021, primarily reflecting lower AOCI related to AFS securities, largely recognized in the first half of 2022 driven by the significant increase in interest rates across the yield curve and the resumption of common share repurchases in the fourth quarter of 2022, partially offset by higher retained earnings and episodically lower RWA. However, we anticipate RWA to increase over the coming quarter as market volatility levels normalize and we efficiently deploy capital to our businesses. Our Tier 1 leverage ratio decreased to 6.0% as of December 31, 2022 compared to 6.1% as of December 31, 2021, primarily driven by lower AOCI and resumption of share repurchases in the fourth quarter of 2022, partially offset by a decline in consolidated average assets. During 2022, we completed a number of actions designed to mitigate additional AOCI risk in the current environment including a $23.56 billion transfer of securities from AFS to HTM. Given the current global economic environment, we currently expect our CET1 and Tier 1 leverage capital ratios to move into our target ranges of 10-11% and 5.25-5.75%, respectively. State Street Corporation | 62MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSDebt Issuances and Redemptions•On February 7, 2022, we issued $300 million aggregate principal amount of 1.746% fixed-to-floating rate senior notes due 2026, $650 million aggregate principal amount of 2.203% fixed-to-floating rate senior notes due 2028 and $550 million aggregate principal amount of 2.623% fixed-to-floating rate senior notes due 2033.•On March 30, 2022, we redeemed $750 million aggregate principal amount of 2.825% Fixed-to-Floating Rate Senior Notes due 2023.•On May 13, 2022, we issued $500 million aggregate principal amount of 4.421% fixed-to-floating rate senior notes due 2033.•On May 15, 2022, we redeemed $750 million aggregate principal amount of 2.653% fixed-to-floating rate senior notes due 2023.•On August 4, 2022, we issued $750 million aggregate principal amount of 4.164% fixed-to-floating rate senior notes due 2033.•On November 4, 2022, we issued $500 million aggregate principal amount of 5.751% fixed-to-floating rate senior notes due 2026 and $500 million aggregate principal amount of 5.820% fixed-to-floating rate senior notes due 2028.•On January 26, 2023, we issued $500 million aggregate principal amount of 4.857% fixed-to-floating rate senior notes due 2026 and $750 million aggregate principal amount of 4.821% fixed-to-floating rate senior notes due 2034.CONSOLIDATED RESULTS OF OPERATIONSThis section discusses our consolidated results of operations for 2022 compared to 2021 and should be read in conjunction with the consolidated financial statements and accompanying notes to the consolidated financial statements in this Form 10-K.Total RevenueTABLE 2: TOTAL REVENUEYears Ended December 31,% Change 2022 vs. 2021% Change 2021 vs. 2020(Dollars in millions)202220212020Fee revenue:Back office services$4,714 $5,117 $4,758 (8)%8 %Middle office services373 414 399 (10)4 Servicing fees(1)5,087 5,531 5,157 (8)7 Management fees1,939 2,053 1,880 (6)9 Foreign exchange trading services1,376 1,211 1,363 14 (11)Securities finance416 416 356 — 17 Front office software and data550 484 446 14 9 Lending related and other fees239 254 239 (6)6 Software and processing fees(1)789 738 685 7 8 Other fee revenue(1)(1)63 58 nm9 Total fee revenue9,606 10,012 9,499 (4)5 Net interest income:Interest income4,088 1,908 2,575 nm(26)Interest expense1,544 3 375 nm(99)Net interest income2,544 1,905 2,200 34 (13)Other income:Gains (losses) related to investment securities, net(2)57 4 nmnmOther income— 53 — nmnmTotal other income(2)110 4 nmnmTotal revenue$12,148 $12,027 $11,703 1 3 (1) In the first quarter of 2022, we reclassified certain fee revenue in our Consolidated Statement of Operations, primarily moving revenues that are not directly associated with software and processing fees to a new Other fee revenue line item. In addition, we provided a disaggregation of servicing fees into Back office services and Middle office services and of software and processing fees into Front office software and data and Lending related and other fees. Prior periods have been revised to reflect these changes.nm Not meaningful State Street Corporation | 63MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSFee RevenueTable 2: Total Revenue, provides the breakout of fee revenue for the years ended December 31, 2022, 2021 and 2020. Servicing and management fees collectively made up approximately 73%, 76% and 74% of the total fee revenue in 2022, 2021 and 2020, respectively.Servicing Fee RevenueServicing fees, as presented in Table 2: Total Revenue, decreased 8% in 2022 compared to 2021 primarily due to normal pricing headwinds, lower average market levels and lower client activity and adjustments, partially offset by net new business. Currency translation decreased servicing fee revenue by 3% in 2022 relative to 2021.Servicing fees generated outside the U.S. were approximately 46% of total servicing fees in 2022, compared to approximately 48% in 2021.Servicing fee revenue comprises revenue from both back office and middle office services. Generally, our servicing fee revenues are affected by several factors including changes in market valuations, client activity and asset flows, net new business and the manner in which we price our services. We provide a range of services to our clients, including core custody services, accounting, reporting and administration, which we refer to collectively as back office services and middle office services. The nature and mix of services provided and the asset classes for which the services are performed affect our servicing fees. The basis for fees will differ across regions and clients. Changes in Market ValuationsOur servicing fee revenue is impacted by both our levels and the geographic and product mix of our AUC/A. Increases or decreases in market valuations have a corresponding impact on the level of our AUC/A and servicing fee revenues, though the degree of impact will vary depending on asset types and classes and geography of assets held within our clients’ portfolios. For certain asset classes where the valuation process is more complex, including alternative investments, or where our valuation is dependent on third party information, AUC/A is reported on a time lag, typically one-month. For those asset classes, the impact of market levels on our reported AUC/A does not reflect current period-end market levels.We estimate that worldwide market valuations impacted our servicing fee revenues by approximately (2)% and 7% in 2022 and 2021, respectively. Over the five years ended December 31, 2022, we estimate this impact was 2% on average with a range of (2)% to 7% annually. See Table 3: Daily Averages, Month-End Averages and Year-End Equity Indices for selected indices. While the specific indices presented are indicative of general market trends, the asset types and classes relevant to individual client portfolios can and do differ, and the performance of associated relevant indices and of client portfolios can therefore differ from the performance of the indices presented. In addition, our asset classifications may differ from those industry classifications presented.Assuming that all other factors remain constant, including client activity, asset flows and pricing, we estimate, using relevant information as of December 31, 2022, that a 10% increase or decrease in worldwide equity valuations, on a weighted average basis, over the relevant periods for which our servicing fees are calculated, would result in a corresponding change in our total servicing fee revenues, on average and over multiple quarters, of approximately 3%. We estimate, similarly assuming all other factors remain constant and using relevant information as of December 31, 2022, that changes in worldwide fixed income markets, which on a weighted average basis and over time are typically less volatile than worldwide equity markets, have a significantly smaller impact on our servicing fee revenues on average and over time.TABLE 3: DAILY AVERAGES, MONTH-END AVERAGES AND YEAR-END EQUITY INDICES(1)Daily Averages of IndicesMonth-End Averages of IndicesYear-End IndicesYears Ended December 31,Years Ended December 31,Years Ended December 31,20222021% Change20222021% Change20222021% ChangeS&P 500®4,099 4,273 (4)%4,078 4,279 (5)%3,840 4,766 (19)%MSCI EAFE®1,976 2,289 (14)1,965 2,272 (14)1,944 2,336 (17)MSCI® Emerging Markets1,033 1,315 (21)1,026 1,303 (21)956 1,232 (22)(1) The index names listed in the table are service marks of their respective owners.TABLE 4: YEAR-END DEBT INDICES(1)As of December 31,20222021% ChangeBloomberg U.S. Aggregate Bond Index®2,049 2,355 (13)%Bloomberg Global Aggregate Bond Index®446 532 (16)(1) The index names listed in the table are service marks of their respective owners. State Street Corporation | 64MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSClient Activity and Asset FlowsClient activity and asset flows are impacted by the number of transactions we execute on behalf of our clients, including FX settlements, equity and derivative trades, and wire transfer activity, as well as actions by our clients to change the asset class in which their assets are invested. Our servicing fee revenues are impacted by a number of factors, including transaction volumes, asset levels and asset classes in which funds are invested, as well as industry trends associated with these client-related activities.Our clients may change the asset classes in which their assets are invested, based on their market outlook, risk acceptance tolerance or other considerations. We estimate that client activity and asset flows, together, impacted our servicing fee revenues by approximately (2)% and 0% in 2022 and 2021, respectively. Over the five years ended December 31, 2022, we estimate this impact was 0% on average with a range of (2)% to 2% annually. See Table 5: Industry Asset Flows for selected asset flow information. While the asset flows presented are indicative of general market trends, the asset types and classes relevant to individual client portfolios can and do differ, and our flows may differ from those market trends. In addition, our asset classifications may differ from those industry classifications presented.TABLE 5: INDUSTRY ASSET FLOWSYears Ended December 31, (In billions)20222021North America - (US Domiciled) - Morningstar Direct Market Data(1)(2)(3)Long-Term Funds(4)$(890.9)$612.4 Money Market(35.3)405.4 Exchange-Traded Fund572.5 504.6 Total Flows$(353.7)$1,522.4 Europe - Morningstar Direct Market Data(1)(2)(5)Long-Term Funds(4)$(254.1)$809.4 Money Market63.7 4.5 Exchange-Traded Fund67.0 176.8 Total Flows$(123.4)$990.7 (1) Industry data is provided for illustrative purposes only. It is not intended to reflect our activity or our clients' activity and is indicative of only segments of the entire industry.(2) Source: Morningstar. The data includes long-term mutual funds, ETFs and money market funds. Mutual fund data represents estimates of net new cash flow, which is new sales minus redemptions combined with net exchanges, while ETF data represents net issuance, which is gross issuance less gross redemptions. Data for Fund of Funds, Feeder funds and Obsolete funds were excluded from the series to prevent double counting. Data is from the Morningstar Direct Asset Flows database.(3) The year ended December 31, 2022 data for North America (US domiciled) includes Morningstar direct actuals for January 2022 through November 2022 and Morningstar direct estimates for December 2022. (4) The long-term fund flows reported by Morningstar direct in North America are composed of US domiciled market flows mainly in Equities, Allocation and Fixed-Income asset classes. The long-term fund flows reported by Morningstar direct in EMEA are composed of the European market flows mainly in Equities, Allocation and Fixed-Income asset classes.(5) The year ended December 31, 2022 data for Europe is on a rolling twelve month basis for December 2021 through November 2022, sourced by Morningstar. Net New BusinessNet new business, which includes business both won and lost, has affected our servicing fee revenues by approximately 1% in both 2022 and 2021. Over the five years ended December 31, 2022, this impact was 0% on average with a range of 0% to 1% annually. Gross investment servicing mandates were $1.94 trillion in 2022 and $2.00 trillion per year on average over the past five years. Over the five years ended December 31, 2022, gross annual investment servicing mandates ranged from approximately $0.79 trillion to $3.52 trillion. Servicing fee revenue associated with new servicing mandates may vary based on the breadth of services provided, the time required to install the assets, and the types of assets installed.Revenues associated with new mandates are not reflected in our servicing fee revenue until the assets have been installed. Our installation timeline, in general, can range from 6 to 36 months, with the average installation timeline being approximately 9 to 12 months over the past 2 years. Our more complex installations, including new State Street Alpha mandates, will generally be on the longer end of that range. With respect to the current asset mandates of approximately $3.61 trillion that are yet to be installed as of December 31, 2022, we expect the conversion will occur over the coming 36 months.PricingThe industry in which we operate has historically faced pricing pressure, and our servicing fee revenues are also affected by such pressures today. Consequently, no assumption should be drawn as to future revenue run rate from announced servicing wins, as the amount of revenue associated with AUC/A, once installed, can vary materially. We estimate that pricing pressure with respect to existing clients has impacted our servicing fees by approximately (2)% in both 2022 and 2021. On average, over the five years ended December 31, 2022, this impact State Street Corporation | 65MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSwas approximately (3)% annually, with the impact ranging from (2)% to (4)% in any given year. Pricing concessions can be a part of a contract renegotiation with a client including terms that may benefit us, such as extending the term of our relationship with the client, expanding the scope of services that we provide or reducing our dependency on manual processes through the standardization of the services we provide. The timing of the impact of additional revenue generated by anticipated additional services, and the amount of revenue generated, may differ from expectations due to the impact of pricing concessions on existing services due to the necessary time required to onboard those new services, the nature of those services and client investment practices and other factors. These same market pressures also impact the fees we negotiate when we win business from new clients.In order to offset the typical client attrition and normal pricing headwinds, we estimate that we need at least $1.5 trillion of new AUC/A per year; although, notwithstanding increases in AUC/A, servicing fees remain subject to several factors, including changes in market valuations, client activity and asset flows, the manner in which we price our services, the nature of the assets being serviced and the type of services and the other factors described in this Form 10-K.Historically, and based on an indicative sample of revenue, we estimate that approximately 60%, on average, of our servicing fee revenues have been variable due to changes in asset valuations including changes in daily average valuations of AUC/A; another 15%, on average, of our servicing fees are impacted by the volume of activity in the funds we serve; and the remaining approximately 25% of our servicing fees tend not to be variable in nature nor impacted by market fluctuations or values. Based on the impact of the above, client activity and asset flows, net new business and pricing, noted drivers of our servicing fee revenue will vary depending on the mix of products and services we provide to our clients. The full impact of changes in market valuations and the volume of activity in the funds may not be fully reflected in our servicing fee revenues in the periods in which the changes occur, particularly in periods of higher volatility.TABLE 6: ASSETS UNDER CUSTODY AND/OR ADMINISTRATION BY PRODUCT(1)(2)(In billions)December 31, 2022December 31, 2021December 31, 2020% Change2022 vs. 2021% Change2021 vs. 2020Collective funds, including ETFs$12,261 $15,722 $13,387 (22)%17 %Mutual funds9,610 11,575 9,810 (17)18 Pension products7,734 8,443 7,594 (8)11 Insurance and other products7,138 7,938 8,000 (10)(1)Total $36,743 $43,678 $38,791 (16)13 TABLE 7: ASSETS UNDER CUSTODY AND/OR ADMINISTRATION BY ASSET CLASS(2)(In billions)December 31, 2022December 31, 2021December 31, 2020% Change2022 vs. 2021% Change2021 vs. 2020Equities$20,575 $25,974 $21,626 (21)%20 %Fixed-income10,318 12,587 12,834 (18)(2)Short-term and other investments5,850 5,117 4,331 14 18 Total $36,743 $43,678 $38,791 (16)13 TABLE 8: ASSETS UNDER CUSTODY AND/OR ADMINISTRATION BY GEOGRAPHY(2)(3)(In billions)December 31, 2022December 31, 2021December 31, 2020% Change2022 vs. 2021% Change2021 vs. 2020Americas$26,981 $32,427 $28,245 (17)%15 %Europe/Middle East/Africa7,136 8,599 8,101 (17)6 Asia/Pacific2,626 2,652 2,445 (1)8 Total$36,743 $43,678 $38,791 (16)13 (1) Certain previously reported amounts presented have been reclassified to conform to current-period presentation.(2) Consistent with past practice, AUC/A values for certain asset classes are based on a lag, typically one-month.(3) Geographic mix is generally based on the domicile of the entity servicing the funds and is not necessarily representative of the underlying asset mix.Asset servicing mandates newly announced in 2022 totaled approximately $1.94 trillion. Servicing assets remaining to be installed in future periods totaled approximately $3.61 trillion as of December 31, 2022, which will be reflected in AUC/A in future periods after installation and will generate servicing fee revenue in subsequent periods. The full revenue impact of such mandates will be realized as the assets are installed and additional services are added over that period. New asset servicing mandates may be subject to completion of definitive agreements, approval of applicable boards and shareholders and customary regulatory approvals. New asset servicing mandates and servicing assets remaining to be installed in future periods exclude certain new business which has been contracted, but for which the client has not yet provided permission to publicly disclose and the expected installation date extends beyond one quarter. These excluded assets, which from time to time may be significant, will be included in new asset State Street Corporation | 66MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSservicing mandates and reflected in servicing assets remaining to be installed in the period in which the client provides its permission. Servicing mandates and servicing assets remaining to be installed in future periods are presented on a gross basis and therefore also do not include the impact of clients who have notified us during the period of their intent to terminate or reduce their relationship with us, which may from time to time be significant. With respect to these new servicing mandates, once installed we may provide various services, including back office services such as custody and safekeeping, transaction processing and trade settlement, fund administration, reporting and record keeping, security servicing, fund accounting, middle office services such as investment book of records (IBOR), transaction management, loans, cash derivatives and collateral services, recordkeeping, client reporting and investment analytics, markets services such as FX trading services, liquidity solutions, currency and collateral management and securities finance, and front office services such as portfolio management solutions, risk analytics, scenario analysis, performance and attribution, trade order and execution management, pre-trade compliance and ESG investment tools. Revenues associated with new servicing mandates may vary based on the breadth of services provided, the timing of installation, and the types of assets.As previously disclosed, in early 2021, due to a decision to diversify providers, one of our large asset servicing clients has advised us it expects to move a significant portion of its ETF assets currently with State Street to one or more other providers, pending necessary approvals. We expect to continue as a significant service provider for this client after this transition and for the client to continue to be meaningful to our business. The transition began in 2022, but will principally occur in 2023 and 2024 and will impact our fee revenue and income growth trends through 2025. For the year ended December 31, 2022, the fee revenue associated with the assets yet to transition represented approximately 1.7% of our total fee revenue. The actual total revenue and income impact of this transition will reflect a range of factors, including potential growth in our continuing business with the client and expense reductions associated with the transition.Management Fee RevenueManagement fees decreased 6% in 2022 compared to 2021, primarily due to lower average equity and fixed income market levels, a previously reported client-specific pricing adjustment and institutional net outflows, partially offset by the absence of the impact of money market fee waivers and net inflows from cash and ETFs.Management fees generated outside the U.S. were approximately 26% of total management fees in both 2022 and 2021.Management fees generally are affected by our level of AUM, which we report based on month-end valuations. Management fees for certain components of managed assets, such as ETFs, mutual funds and UCITS, are affected by daily average valuations of AUM. Management fee revenue is more sensitive to market valuations than servicing fee revenue, as a higher proportion of the underlying services provided, and the associated management fees earned, are dependent on equity and fixed-income security valuations. Additional factors, such as the relative mix of assets managed, may have a significant effect on our management fee revenue. While certain management fees are directly determined by the values of AUM and the investment strategies employed, management fees may reflect other factors, including performance fee arrangements, as well as our relationship pricing for clients. From the second half of 2020 through the first quarter of 2022, we were in a prolonged low-interest rate environment, and waived certain fees for our clients for money market products. Following the Federal Reserve rate hikes in March and September 2022, money market fee waivers did not have a significant impact on our management fee revenue in the last three quarters of 2022.Asset-based management fees for passively managed products, to which our AUM is currently primarily weighted, are generally charged at a lower fee on AUM than for actively managed products. Actively managed products may also include performance fee arrangements which are recorded when the fee is earned, based on predetermined benchmarks associated with the applicable account's performance. In light of the above, we estimate, using relevant information as of December 31, 2022 and assuming that all other factors remain constant, including the impact of business won and lost and client flows, that:•A 10% increase or decrease in worldwide equity valuations, on a weighted average basis, over the relevant periods for which our management fees are calculated, would result in a corresponding change in our total management fee revenues, on average and over multiple quarters, of approximately 5%; and•changes in worldwide fixed income markets, which on a weighted average basis and over time are typically less volatile than worldwide equity markets, will have a significantly smaller impact on our management fee revenues on average and over time. State Street Corporation | 67MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSDaily averages, month-end averages and year-end indices demonstrate worldwide changes in equity and debt markets that affect our management fee revenue. Year-end indices affect the values of AUM as of those dates. See Table 3: Daily Averages, Month-End Averages and Year-End Equity Indices for selected indices. While the specific indices presented are indicative of general market trends, the asset types and classes relevant to individual client portfolios can and do differ, and the performance of associated relevant indices and of client portfolios can therefore differ from the performance of the indices presented. In addition, our asset classifications may differ from those industry classifications presented. TABLE 9: ASSETS UNDER MANAGEMENT BY ASSET CLASS AND INVESTMENT APPROACH(In billions)December 31, 2022December 31, 2021December 31, 2020% Change2022 vs. 2021% Change2021 vs. 2020Equity: Active$54 $80 $85 (33)%(6)% Passive2,074 2,594 2,086 (20)24 Total equity(1)2,128 2,674 2,171 (20)23 Fixed-income: Active83 103 90 (19)14 Passive471 520 459 (9)13 Total fixed-income(1)554 623 549 (11)13 Cash(1)(2)376 368 349 2 5 Multi-asset-class solutions: Active28 34 40 (18)(15) Passive181 188 146 (4)29 Total multi-asset-class solutions(1)209 222 186 (6)19 Alternative investments(3): Active35 56 39 (38)44 Passive179 195 173 (8)13 Total alternative investments(1)214 251 212 (15)18 Total$3,481 $4,138 $3,467 (16)19 (1) The implementation of an improved internal data management system for product level data in the first quarter of 2021 resulted in some AUM reclassifications between the categories presented for prior periods to align with the current presentation. There was no impact to the total level of reported AUM.(2) Includes both floating- and constant-net-asset-value portfolios held in commingled structures or separate accounts.(3) Includes real estate investment trusts, currency and commodities, including SPDR® Gold Shares and SPDR® Gold MiniSharesSM Trust. We are not the investment manager for the SPDR® Gold Shares and SPDR®Gold MiniSharesSM Trust, but act as the marketing agent. TABLE 10: GEOGRAPHIC MIX OF ASSETS UNDER MANAGEMENT(1)(In billions)December 31, 2022December 31, 2021December 31, 2020% Change2022 vs. 2021% Change2021 vs. 2020North America$2,544 $2,931 $2,411 (13)%22 %Europe/Middle East/Africa511 592 512 (14)16 Asia/Pacific426 615 544 (31)13 Total$3,481 $4,138 $3,467 (16)19 (1) Geographic mix is based on client location or fund management location..TABLE 11: EXCHANGE - TRADED FUNDS BY ASSET CLASS(1)(In billions)December 31, 2022December 31, 2021December 31, 2020% Change2022 vs. 2021% Change2021 vs. 2020Alternative Investments(2)$67 $72 $83 (7)%(13)%Equity(3)817 970 708 (16)37 Multi Asset1 1 — — nmFixed-Income(3)134 135 115 (1)17 Total Exchange-Traded Funds$1,019 $1,178 $906 (13)30 (1) ETFs are a component of AUM presented in the preceding table.(2) Includes real estate investment trusts, currency and commodities, including SPDR® Gold Shares and SPDR® Gold MiniSharesSM Trust. We are not the investment manager for the SPDR® Gold Shares and SPDR®Gold MiniSharesSM Trust, but act as the marketing agent. (3) The implementation of an improved internal data management system for product level data in the first quarter of 2021 resulted in some AUM reclassifications between the categories presented for prior periods to align with the current presentation. There was no impact to the total level of reported AUM.nm Not meaningful State Street Corporation | 68MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSTABLE 12: ACTIVITY IN ASSETS UNDER MANAGEMENT BY PRODUCT CATEGORY(In billions)Equity(1)Fixed-Income(1)Cash(1)(2)Multi-Asset-Class Solutions(1)Alternative Investments(1)(3)TotalBalance as of December 31, 2019$1,990 $479 $317 $157 $173 $3,116 Long-term institutional flows, net(4)(101)4 (1)9 (11)(100)Exchange-traded fund flows, net12 16 — — 16 44 Cash fund flows, net— — 32 — — 32 Total flows, net(89)20 31 9 5 (24)Market appreciation (depreciation)241 42 (1)18 30 330 Foreign exchange impact29 8 2 2 4 45 Total market/foreign exchange impact270 50 1 20 34 375 Balance as of December 31, 2020$2,171 $549 $349 $186 $212 $3,467 Long-term institutional flows, net(4)(25)70 (2)16 10 69 Exchange-traded fund flows, net94 23 — — (10)107 Cash fund flows, net— — 20 — — 20 Total flows, net69 93 18 16 — 196 Market appreciation (depreciation)476 (7)2 22 43 536 Foreign exchange impact(42)(12)(1)(2)(4)(61)Total market/foreign exchange impact434 (19)1 20 39 475 Balance as of December 31, 2021$2,674 $623 $368 $222 $251 $4,138 Long-term institutional flows, net(4)(97)18 1 19 — (59)Exchange-traded fund flows, net— 22 — — — 22 Total flows, net(97)40 1 19 — (37)Market appreciation (depreciation)(398)(94)9 (28)(30)(541)Foreign exchange impact(51)(15)(2)(4)(7)(79)Total market/foreign exchange impact(449)(109)7 (32)(37)(620)Balance as of December 31, 2022$2,128 $554 $376 $209 $214 $3,481 (1) The implementation of an improved internal data management system for product level data in the first quarter of 2021 resulted in some AUM reclassifications between the categories presented for prior periods to align with the current presentation. There was no impact to the total level of reported AUM.(2) Includes both floating- and constant-net-asset-value portfolios held in commingled structures or separate accounts.(3) Includes real estate investment trusts, currency and commodities, including SPDR® Gold Shares and SPDR® Gold MiniSharesSM Trust. We are not the investment manager for the SPDR® Gold Shares and SPDR®Gold MiniSharesSM Trust, but act as the marketing agent.(4) Amounts represent long-term portfolios, excluding ETFs.Foreign Exchange Trading ServicesForeign exchange trading services revenue, as presented in Table 2: Total Revenue, increased 14% in 2022 compared to 2021, primarily reflecting higher FX spreads and a revenue- related recovery from a 2018 FX benchmark litigation resolution, partially offset by lower client FX volumes. The negative impact on foreign exchange trading services revenue for fee waivers to money market funds participating on the Fund Connect platform, including State Street Global Advisors funds, was $12 million in 2022, compared to $53 million in 2021. The lower impact in 2022 was driven by the higher interest rate environment. Foreign exchange trading services revenue comprises revenue generated by FX trading and revenue generated by brokerage and other trading services, which made up 68% and 32%, respectively, of foreign exchange trading services revenue in 2022, and 67% and 33%, respectively in 2021. We primarily earn FX trading revenue by acting as a principal market-maker through both "direct sales and trading” and “indirect FX trading.”•Direct sales and trading: Represent FX transactions at negotiated rates with clients and investment managers that contact our trading desk directly. These principal market-making activities include transactions for funds serviced by third party custodians or prime brokers, as well as those funds under custody with us.•Indirect FX trading: Represents FX transactions with clients, for which we are the funds' custodian, or their investment managers, routed to our FX desk through our asset-servicing operation. We execute indirect FX trades as a principal at rates disclosed to our clients.Our FX trading revenue is influenced by multiple factors, including: the volume and type of client FX transactions and related spreads; currency volatility, reflecting market conditions; and our management of exchange rate, interest rate and other market risks associated with our FX activities. The relative impact of these factors on our total FX trading revenues often differs from period to period. For example, assuming all other factors remain constant, increases or decreases in volumes or bid-offer spreads across product mix tend to result in increases or decreases, as the case may be, in client-related FX revenue. Our clients that utilize indirect FX trading can, in addition to executing their FX transactions through dealers not affiliated with us, transition from indirect FX trading to either direct sales and trading execution, including our “Street FX” service, or to one of our electronic trading platforms. Street FX, in which we continue to act as a principal State Street Corporation | 69MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSmarket-maker, enables our clients to define their FX execution strategy and automate the FX trade execution process, both for funds under custody with us as well as those under custody at another bank. We also earn foreign exchange trading services revenue through "electronic FX services" and "other trading, transition management and brokerage revenue." •Electronic FX services: Our clients may choose to execute FX transactions through one of our electronic trading platforms. These transactions generate revenue through a “click” fee.•Other trading, transition management and brokerage revenue: As our clients look to us to enhance and preserve portfolio values, they may choose to utilize our Transition or Currency Management capabilities or transact with our Equity Trade execution group. These transactions, which are not limited to foreign exchange, generate revenue via commissions charged for trades transacted during the management of these portfolios. Fund Connect is another one of our electronic trading platforms: it is a global trading, analytics and cash management tool with access to more than 400 money market funds from leading providers.Securities FinanceSecurities finance revenue, as presented in Table 2: Total Revenue, was flat in 2022 compared to 2021, primarily driven by higher spreads, offset by lower agency and enhanced custody balances.Our securities finance business consists of three components: (1) an agency lending program for State Street Global Advisors managed investment funds with a broad range of investment objectives, which we refer to as the State Street Global Advisors lending funds; (2) an agency lending program for third-party investment managers and asset owners, which we refer to as the agency lending funds; and (3) security lending transactions which we enter into as principal, which we refer to as our enhanced custody business.Securities finance revenue earned from our agency lending activities, which is composed of our split of both the spreads related to cash collateral and the fees related to non-cash collateral, is principally a function of the volume of securities on loan, the interest rate spreads and fees earned on the underlying collateral and our share of the fee split.As principal, our enhanced custody business borrows securities from the lending client or other market participants and then lends such securities to the subsequent borrower, either our client or a broker/dealer. We act as principal when the lending client is unable to, or elects not to, transact directly with the market and execute the transaction and furnish the securities. In our role as principal, we provide support to the transaction through our credit rating. While we source a significant proportion of the securities furnished by us in our role as principal from third parties, we have the ability to source securities through assets under custody from clients who have designated us as an eligible borrower.Market influences may continue to affect client demand for securities finance, and as a result our revenue from, and the profitability of, our securities lending activities in future periods. In addition, the constantly evolving regulatory environment, including revised or proposed capital and liquidity standards, interpretations of those standards, and our own balance sheet management activities, may influence modifications to the way in which we deliver our agency lending or enhanced custody businesses, the volume of our securities lending activity and related revenue and profitability in future periods.Software and Processing FeesSoftware and processing fees revenue, presented in Table 2: Total Revenue, increased 7% in 2022 compared to 2021, primarily driven by higher front office software and data revenue associated with CRD, partially offset by lower lending fees. Software and processing fees revenue includes diverse types of fees and revenue, including fees from software licensing and maintenance and fees from our structured products business. Front office software and data revenue, which primarily includes revenue from CRD, Alpha Data Platform and Alpha Data Services, increased 14% in 2022 compared to 2021, primarily driven by higher on-premises renewals and software-enabled revenue.Revenue related to the front office solutions provided by CRD is primarily driven by the sale of term software licenses and SaaS, including professional services such as consulting and implementation services, software support and maintenance. Approximately 50%-70% of revenue associated with a sale of software to be installed on-premises is recognized at a point in time when the customer benefits from obtaining access to and use of the software license, with the percentage varying based on the length of the contract and other contractual terms. The State Street Corporation | 70MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSremainder of revenue for on-premise installations is recognized over the length of the contract as maintenance and other services are provided. Upon renewal of an on-premises software contract, the same pattern of revenue recognition is followed with 50%-70% recognized upon renewal and the remaining balance recognized over the term of the contract. Revenue for a SaaS related arrangement, where the customer does not take possession of the software, is recognized over the term of the contract as services are provided. Upon renewal of a SaaS arrangement, revenue continues to be recognized as services are provided under the new contract. As a result of these differences in how portions of CRD revenue are accounted for, CRD revenue may vary more than other business units quarter to quarter. Lending related and other fees decreased 6% in 2022 compared to 2021, reflecting lower unfunded commitments relating to our municipal and fund finance products, driven by changes in product mix. Lending related and other fees primarily consists of fee revenue associated with our fund finance, leverage loans, municipal finance, insurance and stable value wrap businesses.Other Fee RevenueOther fee revenue includes market-related adjustments and income associated with certain tax-advantaged investments and other equity method investments.Other fee revenue decreased $64 million in 2022, compared to 2021, primarily driven by negative market-related adjustments which impacted other fee revenue by approximately $57 million compared to the same period in 2021.Additional information about fee revenue is provided under "Line of Business Information" included in this Management's Discussion and Analysis.Net Interest IncomeSee Table 2: Total Revenue, for the breakout of interest income and interest expense for the years ended December 31, 2022, 2021 and 2020. NII is defined as interest income earned on interest-earning assets less interest expense incurred on interest-bearing liabilities. Interest-earning assets, which principally consist of investment securities, interest-bearing deposits with banks, loans, resale agreements and other liquid assets, are financed primarily by client deposits, short-term borrowings and long-term debt.NIM represents the relationship between annualized FTE NII and average total interest-earning assets for the period. It is calculated by dividing FTE NII by average interest-earning assets. Revenue that is exempt from income taxes, mainly earned from certain investment securities (state and political subdivisions), is adjusted to a FTE basis using the U.S. federal and state statutory income tax rates.NII on an FTE basis increased in 2022 compared to 2021, primarily due to higher interest rates from U.S. and international central bank rate hikes, partially offset by lower client deposits.Net premium amortization on investment securities, which is included in interest income, was $225 million in 2022, compared to $556 million in 2021 and $575 million in 2020. The decrease in MBS premium amortization is primarily due to lower prepayments from higher long-end interest rates.Interest income related to debt securities is recognized in our consolidated statement of income using the effective interest method, or on a basis approximating a level rate of return over the contractual or estimated life of the security. The rate of return considers any non-refundable fees or costs, as well as purchase premiums or discounts, resulting in amortization or accretion, accordingly. The amortization of premiums and accretion of discounts are adjusted for prepayments when they occur, which primarily impact mortgage-backed securities.The following table presents the investment securities amortizable purchase premium net of discount accretion for the periods indicated:TABLE 13: INVESTMENT SECURITIES NET PREMIUM AMORTIZATIONYears Ended December 31,202220212020(Dollars in millions)MBSNon-MBSTotal(1)MBSNon-MBSTotal(1)MBSNon-MBSTotal(1)Unamortized premiums, net of discounts at period end$520 $208 $728 $712 $502 $1,214 $1,173 $736 $1,909 Net premium amortization(2)142 83 225 342 214 556 399 176 575 (1) The investment securities portfolio duration was 2.6 years in 2022, 2.9 years in 2021 and 3.0 years in 2020. Totals exclude premiums or discounts created from the transfer of securities from AFS to HTM. Additional information on the transfer of securities is provided in Note 3 to the consolidated financial statements in this Form 10-K. (2) Net of discount accretion on MMLF HTM securities. State Street Corporation | 71MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSSee Table 14: Average Balances and Interest Rates - Fully Taxable-Equivalent Basis, for the breakout of NII on a FTE basis for the years ended December 31, 2022, 2021 and 2020.TABLE 14: AVERAGE BALANCES AND INTEREST RATES - FULLY TAXABLE-EQUIVALENT BASIS(1)Years Ended December 31, 202220212020(Dollars in millions; fully taxable-equivalent basis)AverageBalanceInterestRevenue/ExpenseRateAverageBalanceInterestRevenue/ExpenseRateAverageBalanceInterestRevenue/ExpenseRateInterest-bearing deposits with banks(2)$76,498 $842 1.10 %$89,996 $(15)(.02)%$76,588 $76 .10 %Securities purchased under resale agreements(3)2,116 188 8.88 4,193 27 .63 3,452 126 3.64 Trading account assets721 — .01 752 — .01 878 — — Investment securities:Investment securities available for sale53,613 733 1.37 66,584 583 .88 58,036 761 1.31 Investment securities held-to-maturity58,316 979 1.68 44,832 665 1.48 42,956 830 1.93 Investment securities held-to-maturity purchased under money market liquidity facility— — — 314 4 1.35 8,183 117 1.43 Total Investment securities111,929 1,712 1.53 111,730 1,252 1.12 109,175 1,708 1.56 Loans35,117 973 2.77 31,009 640 2.07 27,525 627 2.28 Other interest-earning assets(4)20,850 383 1.84 22,355 17 .08 11,256 55 .49 Average total interest-earning assets247,231 4,098 1.66 260,035 1,921 .74 228,874 2,592 1.13 Cash and due from banks3,652 5,057 3,849 Other assets35,547 34,651 36,611 Average total Assets$286,430 $299,743 $269,334 Interest-bearing deposits:U.S.$98,252 $887 .90 %$104,848 $10 .01 %$87,444 $114 .13 %Non-U.S.(2)(5)76,842 80 .10 82,126 (273)(.33)68,806 (231)(.34)Total interest-bearing deposits(5)(6)175,094 967 .55 186,974 (263)(.07)156,250 (117)(.07)Securities sold under repurchase agreements3,633 14 .39 667 — — 2,615 4 .14 Short-term borrowings under money market liquidity facility— — — 315 4 1.21 8,207 101 1.22 Other short-term borrowings1,188 26 2.18 788 2 .21 2,226 18 0.78 Long-term debt14,132 376 2.66 13,383 219 1.64 14,371 312 2.17 Other interest-bearing liabilities(7)2,725 161 5.91 5,486 41 .75 3,176 57 1.82 Average total interest-bearing liabilities196,772 1,544 .78 207,613 3 — 186,845 375 .20 Non-interest bearing deposits47,780 48,430 36,975 Other liabilities15,992 17,615 20,464 Preferred shareholders' equity1,976 2,076 2,569 Common shareholders' equity23,910 24,009 22,481 Average total liabilities and shareholders' equity$286,430 $299,743 $269,334 Excess of rate earned over rate paid.87 %.74 %.93 %Net interest income, fully taxable-equivalent basis$2,554 $1,918 $2,217 Net interest margin, fully taxable-equivalent basis1.03 %.74 %.97 %Tax-equivalent adjustment(10)(13)(17)Net interest income, GAAP basis $2,544 $1,905 $2,200 (1) Rates earned/paid on interest-earning assets and interest-bearing liabilities include the impact of hedge activities associated with our asset and liability management activities where applicable.(2) Negative values reflect the impact of interest rate environments outside of the U.S. where central bank rates were below zero for several major currencies.(3) Reflects the impact of balance sheet netting under enforceable netting agreements of approximately $71.02 billion, $62.15 billion and $100.45 billion for the years ended December 31, 2022, 2021 and 2020, respectively. Excluding the impact of netting, the average interest rates would be approximately 0.26%, 0.04% and 0.12% for the years ended December 31, 2022, 2021 and 2020, respectively.(4) Reflects the impact of balance sheet netting under enforceable netting agreements of approximately $5.39 billion, $$5.60 billion and $$5.65 billion for the years ended December 31, 2022, 2021 and 2020, respectively. Excluding the impact of netting, the average interest rates would be approximately 1.46%, 0.06% and 0.32% for the years ended December 31, 2022, 2021 and 2020, respectively.(5) Average rate includes the impact of FX swap costs of approximately ($20) million, ($68) million and ($63) million for the years ended December 31, 2022, 2021 and 2020, respectively. Average rates for total interest-bearing deposits excluding the impact of FX swap costs were (0.55)%, (0.10)% and (0.03)% for the years ended December 31, 2022, 2021 and 2020, respectively. (6) Total deposits averaged $222.87 billion, $235.40 billion and $193.23 billion for the years ended December 31, 2022, 2021 and 2020, respectively.(7) Reflects the impact of balance sheet netting under enforceable netting agreements of approximately $4.59 billion, $5.48 billion and $6.38 billion for the years ended December 31, 2022, 2021 and 2020, respectively. Excluding the impact of netting, the average interest rates would be approximately 2.20%, 0.38% and 0.60% for the years ended December 31, 2022, 2021 and 2020, respectively. State Street Corporation | 72MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSChanges in the components of interest-earning assets and interest-bearing liabilities are discussed in more detail below. Additional information about the components of interest income and interest expense is provided in Note 17 to the consolidated financial statements in this Form 10-K.Average total interest-earning assets were $247.23 billion in 2022 compared to $260.04 billion in 2021. The decrease is primarily due to lower client deposit balances. Interest-bearing deposits with banks averaged $76.50 billion in 2022 compared to $90.00 billion in 2021. These deposits primarily reflect our maintenance of cash balances at the Federal Reserve, the European Central Bank (ECB) and other non-U.S. central banks. The lower levels of average cash balances reflect lower levels of client deposits.Securities purchased under resale agreements averaged $2.12 billion in 2022 compared to $4.19 billion in 2021. As a member of FICC, we may net securities sold under repurchase agreements against those purchased under resale agreements with counterparties that are also members of the clearing organization, when specific netting criteria are met. The impact of balance sheet netting was $71.02 billion on average in 2022 compared to $62.15 billion in 2021, primarily driven by an increase in FICC repo volumes.We are a direct and sponsoring member of FICC. As a sponsoring member within FICC, we enter into repurchase and resale transactions in eligible securities with sponsored clients and with other FICC members and, pursuant to FICC Government Securities Division rules, submit, novate and net the transactions. We may sponsor clients to clear their eligible repurchase transactions with FICC, backed by our guarantee to FICC of the prompt and full payment and performance of our sponsored member clients’ respective obligations. We generally obtain a security interest from our sponsored clients in the high quality securities collateral that they receive, which is designed to mitigate our potential exposure to FICC.Additionally, as a member of FICC, we may be required to pay a pro rata share of the losses incurred by the organization and provide liquidity support in the event of the default of another member to the extent that the defaulting member’s clearing fund obligation and the prescribed loss allocation to FICC is depleted. It is difficult to estimate our maximum possible exposure under the membership agreement, since this would require an assessment of future claims that may be made against us that have not yet occurred. At December 31, 2022 and 2021, we did not record any liabilities under these arrangements.Average investment securities increased to $111.93 billion in 2022 from $111.73 billion in 2021, primarily driven by growth in U.S. Treasuries, MBS and CMBS balances, partially offset by a reduction in credit-sensitive assets.Loans averaged $35.12 billion in 2022 compared to $31.01 billion in 2021. Average core loans, which exclude overdrafts and highlight our efforts to grow our lending portfolio, averaged $29.10 billion in 2022 compared to $26.76 billion in 2021. The increase is primarily due to growth in CLOs in loan form and consumer real estate loans, partially offset by a decline in leveraged loans. Additional information about these loans is provided in Note 4 to the consolidated financial statements in this Form 10-K.Average other interest-earning assets, largely associated with our enhanced custody business, decreased to $20.85 billion in 2022 from $22.36 billion in 2021, primarily driven by a decrease in the level of cash collateral posted. Enhanced custody is our securities financing business where we act as principal with respect to our custody clients and generate securities finance revenue. Aggregate average total interest-bearing deposits decreased to $175.09 billion in 2022 from $186.97 billion in 2021. The decrease is driven by higher market rates from central bank rate hikes, the impact of quantitative tightening, currency translation and equity market declines. Future deposit levels will be influenced by the underlying asset servicing business, client deposit behavior and market conditions, including the general levels of U.S. and non-U.S. interest rates.Average other short-term borrowings increased to $1.19 billion in 2022 from $0.79 billion in 2021.Average long-term debt was $14.13 billion in 2022 compared to $13.38 billion in 2021. These amounts reflect issuances, redemptions and maturities of senior debt during the respective periods.Average other interest-bearing liabilities were $2.73 billion in 2022 compared to $5.49 billion in 2021. Other interest-bearing liabilities primarily reflect our level of cash collateral received from clients in connection with our enhanced custody business, which is presented on a net basis where we have enforceable netting agreements.Several factors could affect future levels of NII and NIM, including the volume and mix of client deposits and funding sources; central bank actions; balance sheet management activities; changes in the level and slope of U.S. and non-U.S. interest rates; revised or proposed regulatory capital or liquidity standards, or interpretations of those standards; the yields earned on securities purchased compared to the yields earned on securities sold or matured and State Street Corporation | 73MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSchanges in the type and amount of credit or other loans we extend.Based on market conditions and other factors, including regulatory standards, we continue to reinvest the majority of the proceeds from pay-downs and maturities of investment securities in highly-rated U.S. and non-U.S. securities, such as federal agency MBS, sovereign debt securities and U.S. Treasury and agency securities. The pace at which we reinvest and the types of investment securities purchased will depend on the impact of market conditions, the implementation of regulatory standards, including interpretation of those standards and other factors over time. We expect these factors and the levels of global interest rates to impact our reinvestment program and future levels of NII and NIM.Provision for Credit LossesWe recorded a $20 million provision for credit losses in 2022, due to a downward shift in management's economic outlook that was partially offset by a reduction in overall loan portfolio risk, compared to a $33 million release of credit reserves in 2021. Additional information is provided under “Loans” in "Financial Condition" in this Management's Discussion and Analysis and in Note 4 to the consolidated financial statements in this Form 10-K.ExpensesTable 15: Expenses, provides the breakout of expenses for the years ended December 31, 2022, 2021 and 2020. Total expenses decreased 1% compared to 2021, as continued productivity and optimization savings, as well as the benefit from currency translation were partially offset by ongoing business investments and merit increases, professional fees, recoverable client-related expenses, marketing and travel costs. Currency translation reduced expenses by 3% in 2022 compared to 2021. TABLE 15: EXPENSESYears Ended December 31,% Change 2022 vs. 2021% Change 2021 vs. 2020(Dollars in millions)202220212020Compensation and employee benefits$4,428 $4,554 $4,450 (3)%2 %Information systems and communications1,630 1,661 1,550 (2)7 Transaction processing services971 1,024 978 (5)5 Occupancy394 444 489 (11)(9)Amortization of other intangible assets238 245 234 (3)5 Acquisition and restructuring costs65 65 50 — 30 Other:Professional services375 334 364 12 (8)Other700 562 601 25 (6)Total other1,075 896 965 20 (7)Total expenses$8,801 $8,889 $8,716 (1)2 Number of employees at year-end42,226 38,784 39,439 9 (2)Compensation and employee benefits expenses decreased 3% in 2022 compared to 2021, primarily due to the impact of currency translation and a decrease in notable items, partially offset by higher headcount and merit increases. Currency translation decreased compensation and employee benefits expenses by 3% in 2022 relative to 2021.Total headcount increased 9% as of December 31, 2022 compared to December 31, 2021, primarily in global hubs driven by operational support for new business growth segments, as well as technology investments and in-sourcing.Information systems and communications expenses decreased 2% in 2022 compared to 2021, primarily due to productivity and vendor savings initiatives, partially offset by technology infrastructure investments. Transaction processing services expenses decreased 5% in 2022 compared to 2021, primarily due to lower sub-custody costs and the impact of currency translation which reduced transaction processing services expenses by 2% in 2022 compare to 2021.Occupancy expenses decreased 11% in 2022 compared 2021, primarily due to footprint optimization and the impact of currency translation which reduced occupancy expenses by 4% in 2022 compared to 2021. Amortization of other intangible assets decreased 3% in 2022 compared to 2021, primarily reflecting the impact of currency translation which reduced amortization of other intangible assets by 3% in 2022 compared to 2021.Other expenses increased 20% in 2022 compared to 2021, primarily due to higher professional services, recoverable client-related expenses, securities processing costs, travel costs and marketing expenses.Acquisition and Restructuring CostsAcquisition and restructuring costs were $65 million in 2022, unchanged compared to 2021. We recorded approximately $65 million and $13 million in 2022 and 2021, respectively, of acquisition costs related to the BBH Investor Services acquisition transaction we are no longer pursuing. In addition, in 2021, we also recorded approximately $52 million of acquisition costs related to our 2018 acquisition of CRD for which we no longer distinguished certain costs as acquisition costs starting in 2022. Repositioning ChargesExpenses for 2022 included repositioning charges of $78 million, consisting of $50 million of compensation and benefits expenses primarily related to streamlining the Investment Services organization, $20 million of occupancy charges State Street Corporation | 74MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSrelated to real estate footprint optimization and $8 million of BBH-related repositioning charges. The BBH-related repositioning charges were recognized in acquisition and restructuring expenses. Expenses included a net repositioning release of $3 million in 2021.The following table presents aggregate activity for repositioning charges and activity related to previous Beacon restructuring charges for the periods indicated:TABLE 16: RESTRUCTURING AND REPOSITIONING CHARGES(In millions)EmployeeRelated CostsReal EstateActionsAsset and Other Write-offsTotalAccrual Balance at December 31, 2019$190 $7 $1 $198 Accruals for Beacon(4)— — (4)Accruals for Repositioning Charges82 51 — 133 Payments and Other Adjustments(78)(52)(1)(131)Accrual Balance at December 31, 2020190 6 — 196 Accruals for Beacon(1)— — (1)Accruals for Repositioning Charges(32)29 — (3)Payments and Other Adjustments(89)(29)— (118)Accrual Balance at December 31, 202168 6 — 74 Accruals for Repositioning Charges58 20 — 78 Payments and other adjustments(43)(21)— (64)Accrual Balance at December 31, 2022$83 $5 $— $88 Income Tax ExpenseIncome tax expense was $553 million in 2022 compared to $478 million in 2021. Our effective tax rate was 16.6% in 2022 compared to 15.1% in 2021. The 2021 effective tax rate included higher discrete benefits from the completion of tax audits than we experienced in 2022.Additional information regarding income tax expense, including unrecognized tax benefits and tax contingencies, are provided in Notes 13 and 22 to the consolidated financial statements in this Form 10-K.LINE OF BUSINESS INFORMATIONOur operations are organized into two lines of business: Investment Servicing and Investment Management, which are defined based on products and services provided. The results of operations for these lines of business are not necessarily comparable with those of other companies, including companies in the financial services industry. For the description of our lines of business, refer to "Lines of Business” in Item 1 in this Form 10-K. Certain amounts that are not allocated to our two lines of business, including repositioning charges, employee costs, acquisition costs, revenue-related recoveries and certain legal accruals. See Note 24 to the consolidated financial statements in this Form 10-K.Investment ServicingTABLE 17: INVESTMENT SERVICING LINE OF BUSINESS RESULTS(Dollars in millions, except where otherwise noted)Years Ended December 31, % Change 2022 vs. 2021% Change 2021 vs. 2020202220212020Servicing fees$5,087 $5,531 $5,157 (8)%7 %Foreign exchange trading services1,271 1,149 1,299 11 (12)Securities finance397 402 342 (1)18 Software and processing fees789 738 685 7 8 Other fee revenue46 59 31 (22)90 Total fee revenue7,590 7,879 7,514 (4)5 Net interest income2,551 1,919 2,211 33 (13)Total other income(2)(1)4 nmnmTotal revenue10,139 9,797 9,729 3 1 Provision for credit losses20 (33)88 nmnmTotal expenses7,260 7,182 7,071 1 2 Income before income tax expense$2,859 $2,648 $2,570 8 3 Pre-tax margin28 %27 %26 %Average assets (in billions)$283.2 $296.5 $266.4 nm Not meaningfulServicing FeesServicing fees, as presented in Table 17: Investment Servicing Line of Business Results, decreased 8% in 2022 compared to 2021 primarily due to normal pricing headwinds, lower average market levels and lower client activity and adjustments, partially offset by net new business. Currency translation decreased servicing fees revenue by 3% in 2022 relative to 2021.For additional information about servicing fees and the impact of worldwide equity and fixed-income valuations on our fee revenue, as well as other key drivers of our servicing fee revenue, refer to "Fee Revenue" in "Consolidated Results of Operations" included in this Management's Discussion and Analysis.ExpensesTotal expenses for Investment Servicing increased 1% in 2022 compared to 2021, as expense growth from higher technology infrastructure investments, higher headcount and merit increases was partially offset by productivity savings, on-going expense management initiatives and the benefit of currency translation, which reduced expenses for Investment Servicing by 3% in 2022 relative to 2021. Seasonal deferred incentive compensation expense and payroll taxes were $143 million in 2022 compared to $124 million in 2021. Additional information about expenses is provided under "Expenses" in "Consolidated Results of Operations" included in this Management's Discussion and Analysis. State Street Corporation | 75MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSInvestment ManagementTABLE 18: INVESTMENT MANAGEMENT LINE OF BUSINESS RESULTS(Dollars in millions, except where otherwise noted)Years Ended December 31, % Change 2022 vs. 2021% Change 2021 vs. 2020202220212020Management fees(1)$1,939 $2,053 $1,880 (6)%9 %Foreign exchange trading services(2)82 62 64 32 (3)Securities finance19 14 14 36 — Other fee revenue(3)(47)4 27 nm(85)Total fee revenue1,993 2,133 1,985 (7)7 Net interest income(7)(14)(11)(50)27 Total revenue1,986 2,119 1,974 (6)7 Total expenses1,396 1,445 1,471 (3)(2)Income before income tax expense$590 $674 $503 (12)34 Pre-tax margin30 %32 %25 %Average assets (in billions)$3.2 $3.2 $2.9 (1) Includes revenues from SPDR® Gold Shares and SPDR® Gold MiniSharesSM Trust AUM where we are not the investment manager but act as the marketing agent.(2) Includes revenue for reimbursements received for certain ETFs associated with State Street Global Advisors where we act as the distribution and marketing agent.(3) Includes other revenue items that are primarily driven by equity market movements. nm Not meaningfulInvestment Management total revenue decreased 6% in 2022 compared to 2021. Management FeesManagement fees decreased 6% in 2022 compared to 2021, primarily due to lower average equity and fixed income market levels, a previously reported client-specific pricing adjustment and institutional net outflows, partially offset by the absence of the impact of money market fee waivers and net inflows from cash and ETFs. Currency translation decreased management fees by 2% in 2022 relative to 2021.For additional information about the impact of worldwide equity and fixed-income valuations, as well as other key drivers of our management fees revenue, refer to "Fee Revenue" in "Consolidated Results of Operations" included in this Management's Discussion and Analysis.Expenses Total expenses for Investment Management decreased 3% in 2022 compared to 2021, as savings from on-going expense management initiatives and lower incentive compensation were partially offset by merit increases. Currency translation reduced expenses for Investment Management by 2% in 2022 relative to 2021. Seasonal deferred incentive compensation expense and payroll taxes were $65 million in 2022, compared to $52 million in 2021.Additional information about expenses is provided under "Expenses" in "Consolidated Results of Operations" included in this Management's Discussion and Analysis.For additional information about our two lines of business, as well as the revenues, expenses and capital allocation methodologies associated with them, refer to Note 24 to the consolidated financial statements in this Form 10-K.FINANCIAL CONDITIONThe structure of our consolidated statement of condition is primarily driven by the liabilities generated by our Investment Servicing and Investment Management lines of business. Our clients' needs and our operating objectives determine the volume, mix and currency denomination of our assets and liabilities. As our clients execute their worldwide cash management and investment activities, they utilize deposits and short-term investments that constitute the majority of our liabilities. These liabilities are generally in the form of interest-bearing transaction account deposits, which are denominated in a variety of currencies; non-interest-bearing demand deposits; and repurchase agreements, which generally serve as short-term investment alternatives for our clients.Deposits and other liabilities resulting from client initiated transactions are invested in assets that generally have contractual maturities significantly longer than our liabilities; however, we evaluate the operational nature of our deposits and seek to maintain appropriate short-term liquidity of those liabilities that are not operational in nature and maintain longer-termed assets for our operational deposits. Our assets consist primarily of securities held in our AFS or HTM portfolios and short-duration financial instruments, such as interest-bearing deposits with banks and securities purchased under resale agreements. The actual mix of assets is determined by the characteristics of the client liabilities and our desire to maintain a well-diversified portfolio of high-quality assets.Additional information on our financial condition is presented in Table 14: Average Balances and Interest Rates - Fully Taxable-Equivalent Basis. We believe the average statement of condition is a better measure of the balance State Street Corporation | 76MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSsheet trends as period-end balances can be impacted by the timing of client activities including deposits and withdrawals.Investment SecuritiesTABLE 19: CARRYING VALUES OF INVESTMENT SECURITIESAs of December 31,(In millions)202220212020Available-for-sale:U.S. Treasury and federal agencies:Direct obligations$7,981 $17,939 $6,575 Mortgage-backed securities8,509 18,208 14,305 Total U.S. Treasury and federal agencies16,490 36,147 20,880 Non-U.S. debt securities:Mortgage-backed securities1,623 1,995 1,996 Asset-backed securities(1)1,669 2,087 2,291 Non-U.S. sovereign, supranational and non-U.S. agency14,089 23,547 22,087 Other(2)2,091 3,098 3,355 Total non-U.S. debt securities19,472 30,727 29,729 Asset-backed securities:Student loans(3) 115 211 314 Collateralized loan obligations(4)2,355 91 2,966 Non-agency CMBS and RMBS(5)231 52 78 Other88 2,155 90 Total asset-backed securities2,789 2,509 3,448 State and political subdivisions823 1,272 1,548 Other U.S. debt securities(6)1,005 2,744 3,443 Total available-for-sale securities$40,579 $73,399 $59,048 Held-to-maturity:U.S. Treasury and federal agencies:Direct obligations$11,693 $2,170 $6,057 Mortgage-backed securities42,307 33,481 36,901 Total U.S. Treasury and federal agencies54,000 35,651 42,958 Non-U.S. debt securities:Mortgage-backed securities— — 303 Non-U.S. sovereign, supranational and non-U.S. agency6,603 1,564 342 Total non-U.S. debt securities6,603 1,564 645 Asset-backed securities:Student loans(3)3,955 4,908 4,774 Non-agency CMBS and RMBS(7)142 307 554 Total asset-backed securities4,097 5,215 5,328 Total(8)64,700 42,430 48,931 Held-to-maturity under money market mutual fund liquidity facility(8)— — 3,300 Total held-to-maturity securities(8)$64,700 $42,430 $52,231 (1) As of December 31, 2022, 2021 and 2020, the fair value non-U.S. collateralized loan obligations of $0.86 billion, $0.83 billion and $0.96 billion, respectively.(2) As of December 31, 2022, 2021 and 2020, the fair value includes non-U.S. corporate bonds of $1.14 billion, $1.53 billion and $1.88 billion, respectively.(3) Primarily comprised of securities guaranteed by the federal government with respect to at least 97% of defaulted principal and accrued interest on the underlying loans.(4) Excludes collateralized loan obligations in loan form. Refer to Note 4 to the consolidated financial statements in this Form 10-K for additional information.(5) Consists entirely of non-agency CMBS as of December 31, 2022, 2021 and 2020.(6) As of December 31, 2022, 2021 and 2020, the fair value of U.S. corporate bonds was $1.01 billion, $2.44 billion and $3.44 billion, respectively. (7) As of December 31, 2022, 2021 and 2020, the total amortized cost included $133 million, $292 million and $464 million, respectively, of non-agency CMBS and $9 million, $14 million and $90 million, respectively, of non-agency RMBS. (8) As of December 31, 2020, we recognized an allowance for credit losses on all HTM securities of $3 million, inclusive of $1 million related to HTM securities purchased under the money market mutual fund liquidity facility.Additional information about our investment securities portfolio is provided in Note 3 to the consolidated financial statements in this Form 10-K.We manage our investment securities portfolio to align with the interest rate and duration characteristics of our client liabilities and in the context of the overall structure of our consolidated statement of condition, in consideration of the global interest rate environment. We consider a well-diversified, high-credit quality investment securities portfolio to be an important element in the management of our consolidated statement of condition.In 2022, we completed a number of actions to mitigate additional AOCI risk in the current environment including a $23.56 billion transfer of securities from AFS to HTM. While these measures may serve to mitigate additional AOCI risk, we continue to be exposed to risks associated with sudden or significant AOCI deterioration, particularly in an environment of continuing significant, and potentially, historic interest rate increases. There can be no assurance that we will not experience further, potentially material AOCI deterioration.Average duration of our investment securities portfolio was 2.6 years and 2.9 years as of December 31, 2022 and 2021, respectively. Approximately 95% of the carrying value of the portfolio was rated “AA” or higher as of both December 31, 2022 and 2021 as follows:TABLE 20: INVESTMENT PORTFOLIO BY EXTERNAL CREDIT RATINGDecember 31, 2022December 31, 2021AAA(1)84 %79 %AA11 13 A3 4 BBB2 4 100 %100 %(1) Includes U.S. Treasury and federal agency securities that are split-rated, “AAA” by Moody’s Investors Service and “AA+” by Standard & Poor’s and also includes Agency MBS securities which are not explicitly rated but which have an explicit or assumed guarantee from the U.S. government. State Street Corporation | 77MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSAs of December 31, 2022 and 2021, the investment portfolio was diversified with respect to asset class composition. The following table presents the composition of these asset classes.TABLE 21: INVESTMENT PORTFOLIO BY ASSET CLASSDecember 31, 2022December 31, 2021U.S. Agency Mortgage-backed securities37 %33 %Non-U.S. sovereign, supranational and non-U.S. agency19 21 U.S. Treasuries19 17 Asset-backed securities9 10 Other credit16 19 100 %100 %Non-U.S. Debt Securities Approximately 25% and 28% of the aggregate carrying value of our investment securities portfolio was non-U.S. debt securities as of December 31, 2022 and 2021, respectively.TABLE 22: NON-U.S. DEBT SECURITIES(1)(In millions)December 31, 2022December 31, 2021Available-for-sale:Canada$3,685 $4,502 Australia2,159 3,019 United Kingdom1,449 1,961 Germany1,147 2,130 France1,059 2,180 Austria769 1,478 Japan768 1,332 Hong Kong701 — Netherlands542 1,109 Italy290 803 Spain250 1,227 Republic of Korea230 201 Brazil202 — Finland185 837 Other(2)6,036 9,948 Total$19,472 $30,727 Held-to-maturity:Spain$804 $— Belgium703 — France638 — Ireland442 — Austria362 — Singapore269 222 Finland213 — Netherlands172 — Germany123 — Other(2)2,877 1,342 Total$6,603 $1,564 (1) Geography is determined primarily based on the domicile of collateral or issuer.(2) As of December 31, 2022, other non-U.S. investments include $5.7 billion supranational bonds in AFS securities and $2.9 billion supranational bonds in HTM securities.Approximately 86% and 81% of the aggregate carrying value of these non-U.S. debt securities was rated “AAA” or “AA” as of December 31, 2022 and 2021, respectively. The majority of these securities comprised senior positions within the security structures; these positions have a level of protection provided through subordination and other forms of credit protection. As of December 31, 2022 and 2021, approximately 26% and 24%, respectively, of the aggregate carrying value of these non-U.S. debt securities was floating-rate.As of December 31, 2022, our non-U.S. debt securities had an average market-to-book ratio of 96.5%, and an aggregate pre-tax net unrealized loss of $937 million, composed of gross unrealized gains of $1 million and gross unrealized losses of $938 million. These unrealized amounts included:•a pre-tax net unrealized loss of $633 million, composed of gross unrealized gains of $1 million and gross unrealized losses of $634 million, associated with non-U.S. AFS debt securities; and•a pre-tax net unrealized loss of $304 million associated with non-U.S. HTM debt securities.As of December 31, 2022, the underlying collateral for non-U.S. MBS and ABS primarily included mortgages in Australia, the U.K., the Netherlands and Italy. The securities listed under “Canada” were composed of Canadian government securities and provincial bonds, corporate debt and non-U.S. agency securities. The securities listed under “France” were composed of sovereign bonds, corporate debt, covered bonds, ABS and Non-U.S. agency securities. The securities listed under “Japan” were substantially composed of Japanese government securities.Municipal ObligationsWe carried approximately $0.82 billion of municipal securities classified as state and political subdivisions in our investment securities portfolio as of December 31, 2022, as shown in Table 19: Carrying Values of Investment Securities, all of which were classified as AFS. As of December 31, 2022, we also provided approximately $6.98 billion of credit and liquidity facilities to municipal issuers. State Street Corporation | 78MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSTABLE 23: STATE AND MUNICIPAL OBLIGORS(1)(Dollars in millions)Total MunicipalSecuritiesCredit and Liquidity Facilities(2)Total% of Total MunicipalExposureDecember 31, 2022State of Issuer:Texas$178 $2,395 $2,573 33 %New York154 1,607 1,761 23 California84 1,299 1,383 18 Total$416 $5,301 $5,717 December 31, 2021State of Issuer:Texas$221 $2,357 $2,578 25 %California108 2,005 2,113 21 New York271 1,112 1,383 14 Massachusetts245 696 941 9 Tennessee— 491 491 5 Total$845 $6,661 $7,506 (1) Represented 5% or more of our aggregate municipal credit exposure of approximately $7.81 billion and $10.22 billion across our businesses as of December 31, 2022 and 2021, respectively.(2) Includes municipal loans which are also presented within Table 25: U.S. and Non-U.S. Loans .Our aggregate municipal securities exposure presented in Table 23: State and Municipal Obligors, was concentrated primarily with highly-rated counterparties, with approximately 93% of the obligors rated “AA” or higher as of December 31, 2022. As of that date, approximately 31% and 69% of our aggregate municipal securities exposure was associated with general obligation and revenue bonds, respectively. The portfolios are also diversified geographically, with the states that represent our largest exposures widely dispersed across the U.S.Additional information with respect to our assessment of impairment of our municipal securities is provided in Note 3 to the consolidated financial statements in this Form 10-K.TABLE 24: CONTRACTUAL MATURITIES AND YIELDSAs of December 31, 2022Under 1 Year1 to 5 Years6 to 10 YearsOver 10 YearsTotal(Dollars in millions)AmountYieldAmountYieldAmountYieldAmountYieldAmountAvailable-for-sale(1):U.S. Treasury and federal agencies:Direct obligations$1,940 0.52 %$5,496 1.08 %$545 1.66 %$— — %$7,981 Mortgage-backed securities49 4.38 454 4.35 6,345 4.06 1,661 3.02 8,509 Total U.S. treasury and federal agencies1,989 5,950 6,890 1,661 16,490 Non-U.S. debt securities:Mortgage-backed securities58 3.19 382 3.04 — — 1,183 3.87 1,623 Asset-backed securities342 2.37 578 2.43 444 3.05 305 2.50 1,669 Non-U.S. sovereign, supranational and non-U.S. agency4,567 0.74 6,897 1.52 2,625 3.10 — — 14,089 Other187 1.94 1,769 2.24 120 2.60 15 2.12 2,091 Total non-U.S. debt securities5,154 9,626 3,189 1,503 19,472 Asset-backed securities:Student loans39 6.88 — — — — 76 4.82 115 Collateralized loan obligations182 5.10 390 4.30 1,205 5.08 578 5.40 2,355 Non-agency CMBS and RMBS— — — — — — 231 5.57 231 Other— — 88 5.06 — — — — 88 Total asset-backed securities221 478 1,205 885 2,789 State and political subdivisions(2)144 6.24 266 4.71 373 5.99 40 6.21 823 Other U.S. debt securities117 2.13 850 2.16 38 3.67 — — 1,005 Total$7,625 $17,170 $11,695 $4,089 $40,579 Held-to-maturity(1):U.S. Treasury and federal agencies:Direct obligations$2,329 0.37 %$9,327 0.86 %$24 1.66 %$13 4.29 %$11,693 Mortgage-backed securities154 2.86 578 3.26 4,627 1.93 36,948 2.36 42,307 Total U.S. treasury and federal agencies2,483 9,905 4,651 36,961 54,000 Non-U.S. debt securities:Non-U.S. sovereign, supranational and non-U.S. agency1,518 1.04 4,520 1.70 565 0.49 — — 6,603 Total non-U.S. debt securities1,518 4,520 565 — 6,603 Asset-backed securities:Student loans290 4.83 8 4.80 931 5.30 2,726 4.87 3,955 Non-agency CMBS and RMBS122 4.94 — — — — 20 4.13 142 Total asset-backed securities412 8 931 2,746 4,097 Total$4,413 $14,433 $6,147 $39,707 $64,700 (1) The maturities of MBS, ABS and CMOs are based on expected principal payments.(2) Yields were calculated on a FTE basis, using applicable statutory tax rates (21.0% as of December 31, 2022). State Street Corporation | 79MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSLoansTABLE 25: U.S. AND NON- U.S. LOANSAs of December 31,(In millions)202220212020Domestic(1):Commercial and financial:Fund Finance(2)$12,154 $12,296 $11,531 Leveraged Loans2,431 3,106 2,923 Overdrafts1,707 1,796 1,894 Collateralized loan obligations in loan form100 100 — Other(3)1,871 2,262 2,688 Commercial real estate2,985 2,554 2,096 Total domestic21,248 22,114 21,132 Foreign(1):Commercial and financial:Fund Finance(2)3,949 4,965 4,432 Leveraged Loans1,118 1,328 1,242 Overdrafts1,094 1,312 1,088 Collateralized loan obligations in loan form4,741 2,813 — Other(3)— — 31 Total foreign10,902 10,418 6,793 Total loans(4)32,150 32,532 27,925 Allowance for loan losses(97)(87)(122)Loans, net of allowance$32,053 $32,445 $27,803 (1) Domestic and foreign categorization is based on the borrower’s country of domicile.(2) Fund finance loans include primarily $7.57 billion private equity capital call finance loans, $6.61 billion loans to real money funds and $1.11 billion loans to business development companies as of December 31, 2022, compared to $9.15 billion and $8.38 billion private equity capital call finance loans, $6.40 billion and $6.04 billion loans to real money funds and $1.39 billion and $832 million loans to business development companies as of December 31, 2021 and 2020, respectively.(3) Includes $1.51 billion securities finance loans, $321 million loans to municipalities and $42 million other loans as of December 31, 2022, $1.78 billion securities finance loans, $455 million loans to municipalities and $23 million other loans as of December 31, 2021 and $1.91 billion securities finance loans, $754 million loans to municipalities and $54 million other loans as of December 31, 2020.(4) As of December 31, 2022, excluding overdrafts, floating rate loans totaled $26.57 billion and fixed rate loans totaled $2.77 billion. We have entered into interest rate swap agreements to hedge the forecasted cash flows associated with LIBOR indexed floating-rate loans. See Note 10 to the consolidated financial statements in this Form 10-K for additional details.The decrease in domestic loans was primarily driven by leveraged loans and the increase in foreign loans was primarily driven by an increase in collateralized loan obligations in loan forms, partially offset by a decrease in fund finance loans as of December 31, 2022 compared to December 31, 2021.As of December 31, 2022 and 2021, our leveraged loans totaled approximately $3.55 billion and $4.43 billion, respectively. We sold $935 million of leveraged loans in 2022.In addition, we had binding unfunded commitments as of December 31, 2022 and 2021 of $98 million and $124 million, respectively, to participate in syndications of leveraged loans. Additional information about these unfunded commitments is provided in Note 12 to the consolidated financial statements in this Form 10-K.These leveraged loans, which are primarily rated “speculative” under our internal risk-rating framework (refer to Note 4 to the consolidated financial statements in this Form 10-K), are externally rated “BBB,” “BB” or “B,” with approximately 96% and 94% of the loans rated “BB” or “B” as of December 31, 2022 and 2021, respectively. Our investment strategy involves generally limiting our investment to larger, more liquid credits underwritten by major global financial institutions, applying our internal credit analysis process to each potential investment and diversifying our exposure by counterparty and industry segment. However, these loans have significant exposure to credit losses relative to higher-rated loans in our portfolio. Additional information about all of our loan segments, as well as underlying classes, is provided in Note 4 to the consolidated financial statements in this Form 10-K.No loans were modified in troubled debt restructurings as of both December 31, 2022 and 2021.TABLE 26: CONTRACTUAL MATURITIES FOR LOANSAs of December 31, 2022(In millions)Under 1 year1 to 5 years5 to 15 yearsTotalDomestic:Commercial and financial$11,843 $4,951 $1,469 $18,263 Commercial real estate89 1,218 1,678 2,985 Total domestic11,932 6,169 3,147 21,248 Foreign:Commercial and financial3,838 1,873 5,191 10,902 Total foreign3,838 1,873 5,191 10,902 Total loans $15,770 $8,042 $8,338 $32,150 TABLE 27: CLASSIFICATION OF LOAN BALANCES DUE AFTER ONE YEARAs of December 31, 2022(In millions)Loans with predetermined interest ratesLoans with floating or adjustable interest ratesDomestic:Commercial and financial$321 $6,098 Commercial real estate2,409 488 Total domestic2,730 6,586 Foreign:Commercial and financial— 7,064 Total foreign— 7,064 Total loans$2,730 $13,650 State Street Corporation | 80MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSAllowance for credit lossesTABLE 28: ALLOWANCE FOR CREDIT LOSSESYears Ended December 31,(In millions)202220212020Allowance for credit losses:Beginning balance$108 $148 $93 Provision for credit losses (funded commitments)(1)16 (29)83 Provisions for credit losses (unfunded commitments)4 (2)3 Provisions for credit losses (investment securities and all other)— (2)2 Charge-offs(2)(7)(2)(41)Other(3)— (5)8 Ending balance$121 $108 $148 (1) The provision for credit losses is primarily related to commercial and financial loans.(2) The charge-offs are related to commercial and financial loans.(3) Consists primarily of foreign currency translation.We recorded a provision for credit losses of $20 million in 2022, due to a downward shift in management's economic outlook that was partially offset by a reduction in overall loan portfolio risk, compared to $33 million release of credit reserves in 2021.As of December 31, 2022, approximately $73 million of our allowance for credit losses was related to leveraged loans included in the commercial and financial segment compared to $61 million as of December 31, 2021. As our view on current and future economic scenarios changes, our allowance for credit losses related to these loans may be impacted through a change to the provisions for credit losses, reflecting credit migration within our loan portfolio, as well as changes in management's economic outlook as of year-end. The remaining $48 million and $47 million as of December 31, 2022 and 2021, respectively, was related to other loans, commercial real estate loans, off-balance sheet commitments and other financial assets held at amortized cost, including investment securities. As of December 31, 2022, the allowance for credit losses represented 0.3% of total loans.Additional information with respect to the allowance for credit losses, net impairment losses and gross unrealized losses related to investment securities, is provided in "Allowance for Credit Losses" under Significant Accounting Estimates and Note 3 to the consolidated financial statements in this Form 10-K.RISK MANAGEMENTOverviewIn the normal course of our business activities, we are exposed to a variety of risks, some that are inherent in the financial services industry, and others that are more specific to our business activities. Our risk management framework focuses on material risks, which include the following:•credit and counterparty risk;•liquidity risk, funding and management; •operational risk;•information technology risk;•operational resiliency risk; •market risk associated with our trading activities;•market risk associated with our non-trading activities, referred to as asset and liability management, consisting primarily of interest rate risk; •model risk;•strategic risk; and •reputational, fiduciary and business conduct risk. Many of these risks, as well as certain factors underlying each of them, could affect our businesses and our consolidated financial statements, and are discussed in detail under "Risk Factors" in this Form 10-K.The identification, assessment, monitoring, mitigation and reporting of risks are essential to our financial performance and successful management of our businesses. Accordingly, the scope of our business requires that we consider these risks as part of a comprehensive and well-integrated risk management function. These risks, if not effectively managed, can result in losses to us as well as erosion of our capital and damage to our reputation. Our approach to risk management, including Board and senior management oversight and a system of policies, procedures, limits, risk measurement and monitoring and internal controls, allows for an assessment of risks within a framework for evaluating opportunities for the prudent use of capital that appropriately balances risk and return. Our objective is to optimize our returns while operating at a prudent level of risk. In support of this objective, we have instituted a risk appetite framework that aligns our business strategy and financial objectives with the level of risk that we are willing to incur. State Street Corporation | 81MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSWe manage risk with a focus on the following objectives:•A culture of risk awareness that extends across all of our business activities;•The identification, classification and quantification of our material risks;•The establishment of our risk appetite and associated limits and policies, and our compliance with these limits;•The establishment of a risk management structure at the “top of the house” that enables the control and coordination of risk-taking across the business lines;•The implementation of stress testing practices and a dynamic risk-assessment capability (additional information with respect to our stress-testing process and practices is provided under "Capital" in this Management's Discussion and Analysis); •A direct link between risk and strategic-decision making processes and incentive compensation practices; and•The overall flexibility to adapt to the ever-changing business and market conditions.Our risk appetite framework outlines the quantitative limits and qualitative goals that define the level and type of risk we are willing to undertake in the course of executing our business strategy, and also serves as a guide in setting risk limits across our business units. It further defines responsibilities for measuring and monitoring risk against limits, and for reporting, escalating, approving and addressing exceptions. Our risk appetite framework is established by ERM, a corporate risk oversight group, in conjunction with the MRAC and the RC of the Board. The Board formally reviews and approves our risk appetite statement annually, or more frequently in response to shifts in endogenous or exogenous risk conditions. Governance and StructureOur approach to risk management involves all levels of management, from the Board and its committees, including its Examining and Audit Committee (E&A Committee), the RC, the Human Resources Committee (HRC) and the TOPS, to each business unit and employee. We allocate responsibility for risk oversight so that risk/return decisions are made at an appropriate level, and are subject to robust and effective review and challenge.Risk management is the responsibility of each employee, and is implemented through three lines of defense: •The business units, which own and manage the risks inherent in their business, are considered the first line of defense; •ERM and other support functions, such as Compliance, Finance and Vendor Management, provide the second line of defense; and •Corporate Audit is the third line of defense, reports to the E&A committee of the Board and is independent from the business units, ERM and other corporate functions. Corporate Audit provides independent assurance to the Board over the design and operating effectiveness of key internal controls included within the risk management framework.The responsibilities for effective review and challenge reside with senior managers, management oversight committees, Corporate Audit and, ultimately, the Board and its committees. Corporate-level risk committees provide focused oversight, and establish corporate standards and policies for specific risks, including credit, sovereign exposure, market, liquidity, operational, information technology as well as new business products, regulatory compliance and ethics, vendor risk and model risks. These committees have been delegated the responsibility to develop recommendations and remediation strategies to address issues that affect or have the potential to affect us.We maintain a risk governance committee structure which serves as the formal governance mechanism through which we seek to undertake the consistent identification, management and mitigation of various risks facing us in connection with our business activities. This governance structure is enhanced and integrated through multi-disciplinary involvement, particularly through ERM. The following chart presents this structure.While our risk management program is designed to manage the risks in our businesses, internal and external factors may create risks that cannot always be identified or anticipated. State Street Corporation | 82MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSManagement Risk Governance Committee StructureExecutive Management Committees:Management Risk and Capital Committee(MRAC)Business Conduct Committee(BCC)Technology and Operational Risk Committee(TORC)Risk Committees:Asset-Liability Committee (ALCO)Credit and Market Risk Committee (CMRC)Fiduciary Review CommitteeOperational Risk and Controls CommitteeTechnology Risk CommitteeRecovery and Resolution Planning (RRP) Executive Review BoardBasel Oversight Committee (BOC)New Business and Product CommitteeGlobal Third Party and Outsourcing Risk CommitteeEnterprise Continuity Steering CommitteeCCAR Steering CommitteeModel Risk Committee (MRC)Core Compliance and Ethics CommitteeExecutive Operations Management CommitteeEnterprise Data Management CommitteeCountry Risk CommitteeSSGA Risk CommitteeLegal Entity Oversight CommitteeRegulatory Reporting Oversight CommitteeConduct Standards Committee State Street Corporation | 83MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSEnterprise Risk ManagementThe goal of ERM is to ensure that risks are proactively identified, well-understood and prudently managed in support of our business strategy. ERM provides risk oversight, support and coordination to allow for the consistent identification, measurement and management of risks across business units separate from the business units' activities, and is responsible for the formulation and maintenance of corporate-wide risk management policies and guidelines. In addition, ERM establishes and reviews limits and, in collaboration with business unit management, monitors key risks. Ultimately, ERM works to validate that risk-taking occurs within the risk appetite statement approved by the Board and conforms to associated risk policies, limits and guidelines.The Chief Risk Officer (CRO) is responsible for our risk management globally, leads ERM and has a dual reporting line to our CEO and the Board’s RC. ERM manages its responsibilities globally through a three-dimensional organization structure: •“Vertical” business unit-aligned risk groups that support business managers with risk management, measurement and monitoring activities; •“Horizontal” risk groups that monitor the risks that cross all of our business units (for example, credit and operational risk); and•Risk oversight for international activities, which combines intersecting “Verticals” and “Horizontals” through a hub and spoke model to provide important regional and legal entity perspectives to the global risk framework.Sitting on top of this three-dimensional organization structure is a centralized group responsible for the aggregation of risk exposures across the vertical, horizontal and regional dimensions, for consolidated reporting, for setting the corporate-level risk appetite framework and associated limits and policies, and for dynamic risk assessment across our business.Board CommitteesThe Board has four committees which assist it in discharging its responsibilities with respect to risk management: the RC, the E&A Committee, the HRC and the TOPS. •The RC is responsible for oversight related to the operation of our global risk management framework, including policies and procedures establishing risk management governance and processes and risk control infrastructure. It is responsible for reviewing and discussing with management our assessment and management of all risks applicable to our operations, including credit, market, interest rate, liquidity, operational, regulatory, technology, business, compliance and reputation risks, and related policies. In addition, the RC provides oversight of capital policies, capital planning and balance sheet management, resolution planning and monitors capital adequacy in relation to risk. It is also responsible for discharging the duties and obligations of the Board under applicable Basel and other regulatory requirements. •The E&A Committee oversees management's operation of our comprehensive system of internal controls covering the integrity of our consolidated financial statements and reports, compliance with laws, regulations and corporate policies. The E&A Committee acts on behalf of the Board in monitoring and overseeing the performance of Corporate Audit and in reviewing certain communications with banking regulators. The E&A Committee has direct responsibility for the appointment, compensation, retention, evaluation and oversight of the work of our independent registered public accounting firm, including sole authority for the establishment of pre-approval policies and procedures for all audit engagements and any non-audit engagements.•The HRC has direct responsibility for the oversight of human capital management, all compensation plans, policies and programs in which executive officers participate and incentive, retirement, welfare as well as equity plans in which certain of our other employees participate. In addition, it oversees the alignment of our incentive compensation arrangements with our safety and soundness, including the integration of risk management objectives, and related policies, arrangements and control processes consistent with applicable related regulatory rules and guidance.•The TOPS leads and assists in the Board’s oversight of technology and operational risk management and the role of these risks in executing our strategy and supporting our global business requirements. The TOPS reviews strategic initiatives from a technology and operational risk perspective and reviews and approves technology-related risk matters. In addition, the TOPS reviews matters related to corporate information security and cybersecurity programs, operational and technology resiliency, data State Street Corporation | 84MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSand access management and third-party risk management.Executive Management CommitteesMRAC is the senior management decision-making body for risk and capital issues, and oversees our financial risks, our consolidated statement of condition, and our capital adequacy, liquidity and recovery and resolution planning. Its responsibilities include: •The approval of our global risk policies, capital and liquidity management frameworks, including our risk appetite framework; •The monitoring and assessment of our capital adequacy based on internal policies and regulatory requirements; •The oversight of our firm-wide risk identification, model risk governance, stress testing and Recovery and Resolution Plan programs; and•The ongoing monitoring and review of risks undertaken within the businesses, and our senior management oversight and approval of risk strategies and tactics. MRAC is co-chaired by our CRO and Chief Financial Officer, who regularly present to the RC on developments in the risk environment and performance trends in our key business areas.BCC provides oversight of our business conduct and culture risks and standards, our commitments to clients and others with whom we do business, and our potential reputational risks, on an enterprise-wide basis. Management considers adherence to high ethical standards to be critical to the success of our business and to our reputation. The BCC is co-chaired by our Chief Compliance Officer and our General Counsel.TORC provides oversight of, and assesses the effectiveness of, corporate-wide technology and operational risk management programs, and reviews areas of improvement to manage and control technology and operational risk consistently across the organization. TORC is co-chaired by the Chief Operating Officer and the CRO.Risk CommitteesThe following second line risk committees, under the oversight of the respective executive management committees, have focused responsibilities for oversight of specific areas of risk management:Management Risk and Capital Committee•ALCO is the senior corporate oversight and decision-making body for balance sheet strategy, Global Treasury business activities and risk management for interest rate risk, liquidity risk and non-trading market risk. ALCO’s roles and responsibilities are designed to be complementary to, and in coordination with the MRAC, which approves the corporate risk appetite and associated balance sheet strategy; •CMRC is the independent risk oversight and decision-making body for our credit, counterparty, and trading-related activities. It is responsible, as part of the second line of defense within ERM, for overseeing alignment of these activities with our appetite for risk and prevailing policy and guidelines. This committee also serves as a forum to discuss, address, and escalate material risk issues;•BOC provides oversight and governance over Basel related regulatory requirements, assesses compliance with respect to Basel regulations and approves all material methodologies and changes, policies and reporting;•RRP Executive Review Board oversees the development of recovery and resolution plans as required by banking regulators; •MRC monitors the overall level of model risk and provides oversight of the model governance process pertaining to all models, including the validation of key models and the ongoing monitoring of model performance. The MRC may also, as appropriate, mandate remedial actions and compensating controls to be applied to models to address modeling deficiencies as well as other issues identified; •CCAR Steering Committee provides primary supervision of the stress tests performed in conformity with the Federal Reserve's CCAR process and the Dodd-Frank Act, and is responsible for the overall management, review, and approval of all material assumptions, methodologies, and results of each stress scenario;•State Street Global Advisors Risk Committee is the most senior oversight and decision making committee for risk management within State Street Global Advisors; the committee is responsible for overseeing the alignment of State Street Global Advisors' strategy, and risk appetite, as well as alignment with our corporate-wide strategy and risk management standards; •Country Risk Committee oversees the identification, assessment, monitoring, reporting and mitigation, where necessary, of country risks; and State Street Corporation | 85MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS•Regulatory Reporting Oversight Committee is responsible for providing oversight of regulatory reporting and related report governance processes and accountabilities.Business Conduct Committee•Fiduciary Review Committee reviews and assesses the fiduciary risk management programs of those units in which we serve in a fiduciary capacity; •New Business and Product Committee provides oversight of the evaluation of the risk inherent in proposed new products or services and new business, and extensions of existing products or services, evaluations including economic justification, material risk, compliance, regulatory and legal considerations, and capital and liquidity analyses;•Core Compliance and Ethics Committee provides review and oversight of our compliance programs, including our culture of compliance and high standards of ethical behavior;•Legal Entity Oversight Committee establishes standards with respect to the governance of our legal entities, monitors adherence to those standards, and oversees the ongoing evaluation of our legal entity structure, including the formation, maintenance and dissolution of legal entities; and•The Conduct Standards Committee provides oversight of our enforcement of employee conduct standards.Technology and Operational Risk Committee•Operational Risk and Controls Committee along with the support of regional business or entity-specific working groups and committees, is responsible for oversight of our operational risk programs, including determining that the implementation of those programs is designed to identify, manage and control operational risk in an effective and consistent manner across the firm;•Technology Risk Committee is responsible for the global oversight, review and monitoring of operational, legal and regulatory compliance and reputational risk that may result in a significant change to our Information Technology risk profile or a material financial loss or reputational impact to global technology services. The Committee serves as a forum to provide regular reporting to TORC and escalate technology risk and control issues to TORC, as appropriate; •Enterprise Continuity Steering Committee considers matters pertaining to continuity and related risks, including oversight in determining the direction of the continuity program;•Global Third Party and Outsourcing Risk Committee is responsible for overseeing our framework and processes for the identification, assessment, and ongoing management of third party and outsourcing-related risks. This committee is also a decision-making body for outsourcing strategy, third party risk acceptance, and the end-to-end third party management process, including the oversight of appropriate controls and risk mitigants that comply with applicable regulatory standards;•Executive Operations Management Committee is a forum for the development of strategy, decision-making, and escalation for operations, regulatory remediation, product management, technology, and the operating model; and•Enterprise Data Management Committee oversees the enterprise-wide data management strategy, provides independent oversight of the programs associated with enterprise-wide data management, serves as an escalation point for material and emerging enterprise-wide data management issues, and determines / oversees enterprise-wide data management priorities and strategy.Credit Risk ManagementCore Policies and PrinciplesWe define credit risk as the risk of financial loss if a counterparty, borrower or obligor, collectively referred to as a counterparty, is either unable or unwilling to repay borrowings or settle a transaction in accordance with contractual terms. We assume credit risk in our traditional non-trading lending activities, such as overdrafts, loans and contingent commitments, in our investment securities portfolio, where recourse to a counterparty exists, and in our direct and indirect trading activities, such as securities purchased under a resale agreement, principal securities lending and foreign exchange and indemnified agency securities lending. We also assume credit risk in our treasury and securities and other settlement operations, in the form of deposit placements and other cash balances, with central banks or private sector institutions and fee receivables. We distinguish between three major types of credit risk: State Street Corporation | 86MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS•Default risk - the risk that a counterparty fails to meet its contractual payment obligations;•Country risk - the risk that we may suffer a loss, in any given country, due to any of the following reasons: deterioration of economic conditions, political and social upheaval, nationalization and appropriation of assets, government repudiation of indebtedness, exchange controls and disruptive currency depreciation or devaluation; and •Settlement risk - the risk that the settlement or clearance of transactions will fail, which arises whenever the exchange of cash, securities or other assets is not simultaneous.The acceptance of credit risk by us is governed by corporate policies and guidelines, which include standardized procedures applied across the entire organization. These policies and guidelines include specific requirements related to each counterparty's risk profile; the markets served; counterparty, industry and country concentrations; and regulatory compliance. These policies and procedures also implement a number of core principles, which include the following:•We measure and consolidate credit risks attributed to each counterparty, or group of counterparties, in accordance with a “one-obligor” principle that aggregates risks across our business units;•ERM reviews and approves all material extensions of credit, and material changes to such extensions of credit (such as changes in term, collateral structure or covenants), in accordance with assigned credit-approval authorities; •Credit-approval authorities are assigned to individuals according to their qualifications, experience and training, and these authorities are periodically reviewed. Our largest exposures require approval by the Credit Committee, a sub-committee of the CMRC. With respect to small and low-risk extensions of credit to certain types of counterparties, approval authority may be granted to individuals outside of ERM;•We seek to avoid or limit undue concentrations of risk. Counterparty (or groups of counterparties), industry, country and product-specific concentrations of risk are subject to frequent review and approval in accordance with our risk policies and appetite;•We evaluate the creditworthiness of counterparties through a detailed risk assessment, including the use of internal risk-rating methodologies; •We review all extensions of credit and the creditworthiness of counterparties at least annually. The nature and extent of these reviews are determined by the size, nature and term of the extensions of credit and the creditworthiness of the counterparty; and•We subject all corporate policies and guidelines to annual review as an integral part of our periodic assessment of our risk appetite.Our corporate policies and guidelines require that all extensions of credit are consistent with the bank's standards, limit credit-related losses, and our goal of maintaining a strong financial condition.Structure and OrganizationThe Credit and Global Markets Risk group within ERM is responsible for the assessment, approval and monitoring of credit risk across our business. The group is managed centrally, has dedicated teams in a number of locations worldwide, and is responsible for related policies and procedures, and for our internal credit-rating systems and methodologies. In addition, the group, in conjunction with the business units, establishes measurements and limits to control the amount of credit risk accepted across its various business activities, both at the portfolio level and for each individual counterparty or group of counterparties, to individual sectors, and also to counterparties by product and country of risk. These measurements and limits are reviewed periodically, but at least annually. In conjunction with other groups in ERM, the Credit and Global Markets Risk group is jointly responsible for the design, implementation and oversight of our credit risk measurement and management systems, including data and assessment systems, quantification systems and the reporting framework. Various key committees within our company are responsible for the oversight of credit risk and associated credit risk policies, systems and models. All credit-related activities are governed by our risk appetite framework and our credit risk guidelines, which define our general philosophy with respect to credit risk and the manner in which we control, manage and monitor such risks. The previously described CMRC (refer to "Risk Committees") has primary responsibility for the oversight, review and approval of the credit risk guidelines and policies. Credit risk guidelines and State Street Corporation | 87MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSpolicies are reviewed periodically, but at least annually.The Credit Committee, a sub-committee of the CMRC, has responsibility for assigning credit authority and approving the largest and higher-risk extensions of credit to individual counterparties or groups of counterparties. CMRC provides periodic updates to MRAC and the Board's RC.Credit Ratings We perform initial and ongoing reviews to exercise due diligence on the creditworthiness of our counterparties when conducting any business with them or approving any credit limits. This due diligence process generally includes the assignment of an internal credit rating, which is determined by the use of internally developed and validated methodologies, scorecards and a 15-grade rating scale. This risk-rating process incorporates the use of risk-rating tools in conjunction with management judgment; qualitative and quantitative inputs are captured in a replicable manner and, following a formal review and approval process, an internal credit rating based on our rating scale is assigned. We generally rate our counterparties individually, although some counterparties defined by us as low-risk are rated on a pooled basis. Credit ratings are reviewed and approved by the Credit and Global Markets Risk group or its delegates. We evaluate and rate the credit risk of our counterparties on an ongoing basis. To facilitate comparability across the portfolio, counterparties within a given sector are rated using a risk-rating tool developed for that sector. Our risk-rating methodologies are approved for use by the Portfolio Risk Committee, a subcommittee of the CMRC, after completion of internal model validation processes, and are subject to an annual review, including re-validation. Risk Parameter EstimatesOur internal risk-rating system promotes a clear and consistent approach to determining appropriate credit risk classifications for our credit counterparties and exposures. This allows us to track the changes in risk associated with these counterparties and exposures over time. This capability enhances our ability to calculate both risk exposures and capital, and enables better strategic decision making across the organization. More specifically, our internal risk rating system is used for the following purposes:•The assessment of the creditworthiness of new counterparties and, in conjunction with our risk appetite statement, the development of appropriate credit limits for our products and services, including loans, foreign exchange, securities finance, placements and repurchase agreements;•The automation of limit approvals for certain low-risk counterparties, as defined in our credit risk guidelines and based on the counterparty’s probability-of-default; •The development of approval authority matrices based on PD; riskier counterparties with higher PDs require higher levels of approval for a comparable PD and limit size compared to less risky counterparties with lower PDs;•The analysis of risk concentration trends using historical PD and exposure-at-default (EAD), data; •The determination of the level of management review of short-duration advances depending on PD; riskier counterparties with higher rating class values generally trigger higher levels of management escalation for comparable short-duration advances compared to less risky counterparties with lower rating-class values;•The monitoring of credit facility utilization levels using EAD values and the identification of instances where counterparties have exceeded limits; •The aggregation and comparison of counterparty exposures with risk appetite levels to determine if businesses are maintaining appropriate risk levels; and•The determination of our regulatory capital requirements for the AIRB set forth in the Basel framework.Credit Risk MitigationWe seek to limit our credit exposure and reduce any potential credit losses through the use of various types of credit risk mitigation. The Basel III final rule permits us to reflect the application of credit risk mitigation when it meets the standards outlined therein. Examples of forms of credit risk mitigation include a security interest in financial and non financial assets (collateral), netting and guarantees. Where permissible, we apply the recognition of collateral, guarantees and netting to mitigate overall risk within our counterparty credit portfolio. While credit default swaps are permitted under the Basel III final rule, we do not actively use credit default swaps as a risk mitigation tool. State Street Corporation | 88MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSCollateralIn many parts of our business, we regularly require or agree for collateral to be received from or provided to clients and counterparties in connection with contracts that involve credit risk. In our trading businesses, this collateral is typically in the form of cash, as well as highly-rated and/or liquid securities (i.e. government securities and other bonds or equity securities). Credit risks in our non-trading and securities finance businesses are also often secured by bonds and equity securities and by other types of assets. Collateral serves to reduce the risk of loss inherent in an exposure. However, changing market values of the collateral we hold, unexpected increases in the credit exposure to a client or counterparty, reductions in the value or change in the type of securities held by us, as well as operational errors or errors in the manner in which we seek to exercise our rights, may reduce the risk mitigation effects of collateral. While collateral is often an alternative source of repayment, it does not replace the requirement within our policies and guidelines for high-quality underwriting. We also may choose to incur credit exposure without the benefit of collateral or other risk mitigating credits rights. Our credit risk guidelines require that the collateral we accept for risk mitigation purposes is of high quality, can be reliably valued and is supported by a valid security interest that permits liquidation if or when required. Generally, when collateral is of lower quality, more difficult to value or more challenging to liquidate, higher discounts to market values are applied for the purposes of measuring credit risk. For certain less liquid collateral, longer liquidation periods are assumed when determining the credit exposure.All types of collateral are assessed regularly by ERM, as is the basis on which the collateral is valued. Our assessment of collateral, including the ability to liquidate collateral in the event of a counterparty default, and also with regard to market values of collateral under a variety of hypothetical market conditions, is an integral component of our assessment of risk and approval of credit limits. We also seek to identify, limit and monitor instances of "wrong-way" risk, where a counterparty’s risk of default is positively correlated with the risk of our collateral eroding in value.We maintain policies and procedures requiring that documentation used to collateralize a transaction is legal, valid, binding and enforceable in the relevant jurisdictions. We also conduct legal reviews to assess whether our documentation meets these standards on an ongoing basis. Netting Netting is a mechanism that allows institutions and counterparties to net offsetting exposures and payment obligations against one another through the use of qualifying master netting agreements. A master netting agreement allows for certain rights and remedies upon a counterparty default, including the right to net obligations arising under derivatives or other transactions under such agreement. In such an event, the netting of obligations would result in a single net claim owed by, or to, the counterparty. This is commonly referred to as "close-out netting,” and is pursued wherever possible. We may also enter into master agreements that allow for the netting of amounts payable on a given day and in the same currency, reducing our settlement risk. This is commonly referred to as “payment netting,” and is widely used in our foreign exchange activities. As with collateral, we have policies and procedures in place to apply close-out and payment netting only to the extent that we have verified legal validity and enforceability of the master agreement. In the case of payment netting, operational constraints may preclude us from reducing settlement risk, notwithstanding the legal right to require the same under the master netting agreement. In the event we become unable, due to operational constraints, actions by regulators, changes in accounting principles, law or regulation (or related interpretations) or other factors, to net some or all of our offsetting exposures and payment obligations under those agreements, we would be required to gross up our assets and liabilities on our statement of condition and our calculation of RWA, accordingly. This would result in a potentially material change in our regulatory ratios, including LCR, and present increased credit, liquidity, asset-and-liability management and operational risks, some of which could be material.Guarantees A guarantee is a financial instrument that results in credit support being provided by a third party, (i.e., the protection provider) to the underlying obligor (the beneficiary of the provided protection) on account of an exposure owing by the obligor. The protection provider may support the underlying exposure either in whole or in part. Support of this kind may take different forms. Typical forms of guarantees provided to us include financial guarantees, letters of credit, bankers’ acceptances, purchase undertaking agreement contracts and insurance.We have established a review process to evaluate guarantees under the applicable requirements of our policies and Basel III requirements. Governance for this evaluation is covered under policies and procedures that require regular reviews of documentation, jurisdictions and credit quality of protection providers. State Street Corporation | 89MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSCredit Limits Central to our philosophy for our management of credit risk is the approval and imposition of credit limits, against which we monitor the actual and potential future credit exposure arising from our business activities with counterparties or groups of counterparties. Credit limits are a reflection of our risk appetite, which may be determined by the creditworthiness of the counterparty, the nature of the risk inherent in the business undertaken with the counterparty, or a combination of relevant credit factors. Our risk appetite for certain sectors and certain countries and geographic regions may also influence the level of risk we are willing to assume to certain counterparties. The analysis and approval of credit limits is undertaken similarly across our businesses, although the nature and extent of the analysis may vary, based on the type, term and magnitude of the risk being assumed. Credit limits and underlying exposures are assessed and measured on both a gross and net basis where appropriate, with net exposure determined by deducting the value of any collateral held. For certain types of risk being assumed, we will also assess and measure exposures under a variety of hypothetical market conditions. Credit limit approvals across our business are undertaken by the Credit and Global Markets Risk group, by individuals to whom credit authority has been delegated, or by the Credit Committee. Credit limits are re-evaluated annually, or more frequently as needed, and are revised periodically on prevailing and anticipated market conditions, changes in counterparty or country-specific credit ratings and outlook, changes in our risk appetite for certain counterparties, sectors or countries, and enhancements to the measurement of credit utilization.Reporting Ongoing active monitoring and management of our credit risk is an integral part of our credit risk management framework. We maintain management information systems to identify, measure, monitor and report credit risk across businesses and legal entities, enabling ERM and our businesses to have timely access to information on credit limits and exposures. Monitoring is performed along the dimensions of counterparty, industry, country and product-specific risks to facilitate the identification of concentrations of risk and emerging trends. Key aspects of this credit risk reporting structure include governance and oversight groups and policies that define standards for the reporting of credit risk, data aggregation and sourcing systems.The Credit and Global Markets Risk group routinely assesses the composition of our overall credit risk portfolio for alignment with our stated risk appetite. This assessment includes routine analysis and reporting of the portfolio, monitoring of market-based indicators, the assessment of industry trends and developments and regular reviews of concentrated risks. The Credit and Global Markets Risk group is also responsible, in conjunction with the business units, for defining the appetite for credit risk in the major sectors in which we have a concentration of business activities. These sector-level risk appetite statements, which include counterparty selection criteria and granular underwriting guidelines, are reviewed periodically and approved by the CMRC.MonitoringRegular surveillance of credit and counterparty risks is undertaken by our business units, the Credit and Global Markets Risk group and designees with ERM, allowing for oversight. This surveillance process includes, but is not limited to, the following components:•Annual Reviews. A formal review of counterparties is conducted at least annually and includes a review of operating performance, primary risk factors and our internal credit risk rating. This annual review also includes a review of current and proposed credit limits, an assessment of our ongoing risk appetite and assessment that supporting legal documentation remains effective.•Interim Monitoring. Monitoring of our largest and riskiest counterparties is undertaken more frequently, utilizing financial information, market indicators and other relevant credit and performance measures. The nature and extent of this interim monitoring is individually tailored to certain counterparties and/or industry sectors to identify material changes to the risk profile of a counterparty (or group of counterparties) and assign an updated internal risk rating in a timely manner.We maintain an active "watch list" for all counterparties. The watch list status denotes a concern with some aspect of a counterparty's risk profile that warrants closer monitoring of the counterparty's financial performance and related risk factors. Our ongoing monitoring processes are designed to facilitate the early identification of counterparties whose creditworthiness is deteriorating; any counterparty may be placed on the watch list by ERM at its sole discretion.Counterparties on the watch list generally correspond with the non-investment grade or near non-investment grade ratings established by the major independent credit-rating agencies. The watch State Street Corporation | 90MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSlist also includes any counterparties rated “Special Mention,” “Substandard,” “Doubtful” and “Loss.”The Credit and Global Markets Risk group maintains primary responsibility for our watch list processes, and generates a quarterly report of all watch list counterparties. The watch list is formally reviewed at least on a quarterly basis, with participation from senior ERM staff, and representatives from the business units and our corporate finance and legal groups as appropriate. These meetings include a review of individual watch list counterparties, together with credit limits and prevailing exposures, and are focused on actions to contain, reduce or eliminate the risk of loss to us. Identified actions are documented and monitored.ControlsGCR provides a separate level of surveillance and oversight over the integrity of our credit risk management processes, including the internal risk-rating system. GCR reviews counterparty credit ratings for all identified sectors on an ongoing basis. GCR is subject to oversight by the CMRC, and provides periodic updates to the Board’s RC. Specific activities of GCR include the following:•Perform separate and objective assessments of our credit and counterparty exposures to determine the nature and extent of risk undertaken by the business units;•Execute periodic credit process and credit product reviews to assess the quality of credit analysis, compliance with policies, guidelines and relevant regulation, transaction structures and underwriting standards, and risk-rating integrity;•Identify and monitor developing counterparty, market and/or industry sector trends to limit risk of loss and protect capital;•Deliver regular and formal reporting to stakeholders, including exam results, identified issues and the status of requisite actions to remedy identified deficiencies;•Allocate resources for specialized risk assessments (on an as-needed basis); and•Liaise with assurance partners and regulatory personnel on matters relating to risk rating, reporting and measurement.Allowance for Credit LossesWe record an allowance for credit losses related to certain on-balance sheet credit exposures, including our financial assets held at amortized cost, as well as certain off-balance sheet credit exposures, including unfunded commitments and letters of credit. Review and evaluation of the adequacy of the allowance for credit losses is ongoing throughout the year, but occurs at least quarterly, and is based, among other factors, on our evaluation of the level of risk in the portfolio and the estimated effects of our forecasts on our counterparties. We utilize multiple economic scenarios, consisting of a baseline, upside and downside scenarios, to develop our forecast of expected losses.In 2022, the allowance estimate reflected a downward shift in our economic outlook, which was partially offset by a reduction in loan portfolio risk. Allowance estimates are subject to uncertainties, including those inherent in our model and economic assumptions, and management may use qualitative adjustments. If future data and forecasts deviate relative to the forecasts utilized to determine our allowance for credit losses as of December 31, 2022, or if credit risk migration is higher or lower than forecasted for reasons independent of the economic forecast, our allowance for credit losses will also change.Additional information about the allowance for credit losses is provided in Note 4 to the consolidated financial statements in this Form 10-K.Liquidity Risk ManagementOur liquidity framework contemplates areas of potential risk to our liquidity based on our activities, size and other appropriate risk-related factors. In managing liquidity risk we employ limits, maintain established metrics and early warning indicators and perform routine stress testing to identify potential liquidity needs. This process involves the evaluation of a combination of internal and external scenarios which assist us in measuring our liquidity position and in identifying potential increases in cash needs or decreases in available sources of cash, as well as the potential impairment of our ability to access the global capital markets.We manage our liquidity on a global, consolidated basis as well as on a stand-alone basis at our Parent Company and at certain branches and subsidiaries of State Street Bank. State Street Bank generally has access to markets and funding sources limited to banks, such as the federal funds market and the Federal Reserve's discount window. The Parent Company is managed to a more conservative liquidity profile, reflecting narrower market access. Additionally, the Parent Company typically holds, or has direct access to, primarily through SSIF, a direct subsidiary of the Parent Company, and the support agreement, as discussed in "Supervision and Regulation" in Business in this Form 10-K, cash and equivalents intended to meet its current debt maturities and other cash needs, as well as those projected over the next twelve-month period. Absent financial distress at the Parent Company, the liquid assets available at SSIF continue to be available to State Street Corporation | 91MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSthe Parent Company. As of December 31, 2022, the value of our Parent Company's net liquid assets totaled $460 million, compared with $482 million as of December 31, 2021, excluding available liquidity through SSIF. As of December 31, 2022, our Parent Company and State Street Bank had approximately $1.99 billion of senior notes or subordinated debentures outstanding that will mature in the next twelve months.As a SIFI, our liquidity risk management activities are subject to heightened and evolving regulatory requirements, including interpretations of those requirements, under specific U.S. and international regulations and also resulting from published and unpublished guidance, supervisory activities, such as stress tests, resolution planning, examinations and other regulatory interactions. Satisfaction of these requirements could, in some cases, result in changes in the composition of our investment portfolio, reduced NII or NIM, a reduction in the level of certain business activities or modifications to the way in which we deliver our products and services. If we fail to meet regulatory requirements to the satisfaction of our regulators, we could receive negative regulatory stress test results, incur a resolution plan deficiency or determination of a non-credible resolution plan or otherwise receive an adverse regulatory finding. Our efforts to satisfy, or our failure to satisfy, these regulatory requirements could materially adversely affect our business, financial condition or results of operations.GovernanceGlobal Treasury is responsible for our management of liquidity. This includes the day-to-day management of our global liquidity position, the development and monitoring of early warning indicators, key liquidity risk metrics, the creation and execution of stress tests, the evaluation and implementation of regulatory requirements, the maintenance and execution of our liquidity guidelines and contingency funding plan (CFP), and routine management reporting to ALCO, MRAC and the Board's RC.Global Treasury Risk Management, part of ERM, provides separate oversight over the identification, communication and management of Global Treasury’s risks in support of our business strategy. Global Treasury Risk Management reports to the CRO. Global Treasury Risk Management’s responsibilities relative to liquidity risk management include the development and review of policies and guidelines; the monitoring of limits related to adherence to the liquidity risk guidelines and associated reporting.Liquidity FrameworkWe manage liquidity according to several principles that are equally important to our overall liquidity risk management framework:•Structural liquidity management addresses liquidity by monitoring and directing the composition of our consolidated statement of condition. Structural liquidity is measured by metrics such as the percentage of total wholesale funds to consolidated total assets, and the percentage of non-government investment securities to client deposits. In addition, on a regular basis and as described below, our structural liquidity is evaluated under various stress scenarios.•Tactical liquidity management addresses our day-to-day funding requirements and is largely driven by changes in our primary source of funding, which are client deposits. Fluctuations in client deposits may be supplemented with short-term borrowings, repurchase agreements, FHLB products and certificates of deposit.•Stress testing and contingent funding planning are longer-term strategic liquidity risk management practices. Regular and ad hoc liquidity stress testing are performed under various severe but plausible scenarios at the consolidated level and at significant subsidiaries, including State Street Bank. These tests contemplate severe market and events specific to us under various time horizons and severities. Tests contemplate the impact of material changes in key funding sources, credit ratings, additional collateral requirements, contingent uses of funding, systemic shocks to the financial markets and operational failures based on market and assumptions specific to us. The stress tests evaluate the required level of funding versus available sources in an adverse environment. As stress testing contemplates potential forward-looking scenarios, results also serve as a trigger to activate specific liquidity stress levels and contingent funding actions.CFPs are designed to assist senior management with decision-making associated with any contingency funding response to a possible or actual crisis scenario. The CFPs define roles, responsibilities and management actions to be taken in the event of deterioration of our liquidity profile caused by either an event specific to us or a broader disruption in the capital markets. Specific actions are linked to the level of stress indicated by these measures or by management judgment of market conditions. State Street Corporation | 92MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSLiquidity Risk MetricsIn managing our liquidity, we employ early warning indicators and metrics intended to detect situations which may result in a liquidity stress, including changes in our stock price and spreads on our long-term debt. Additional metrics that are critical to the management of our consolidated statement of condition and monitored as part of our routine liquidity management include measures of our fungible cash position, purchased wholesale funds, unencumbered liquid assets, deposits and the total of investment securities and loans as a percentage of total client deposits.Asset LiquidityCentral to the management of our liquidity is asset liquidity, which consists primarily of HQLA. HQLA is the amount of liquid assets that qualify for inclusion in the LCR. As a banking organization, we are subject to a minimum LCR under the LCR rule approved by U.S. banking regulators. The LCR is intended to promote the short-term resilience of internationally active banking organizations, like us, to improve the banking industry's ability to absorb shocks arising from market stress over a 30 calendar day period and improve the measurement and management of liquidity risk. The LCR measures an institution’s HQLA against its net cash outflows. HQLA primarily consists of unencumbered cash and certain high quality liquid securities that qualify for inclusion under the LCR rule. We report LCR to the Federal Reserve daily. For the quarters ended December 31, 2022 and 2021, daily average LCR for the Parent Company was 106% and 105%, respectively. The impact of higher deposits on the Parent Company's LCR is offset by a cap, known as the transferability restriction, on the HQLA from State Street Bank and Trust that can be recognized at the Parent Company as defined in the U.S. LCR Final Rule as it prohibits the upstreaming of liquidity under stress. The average HQLA, post-prescribed haircuts for the Parent Company under the LCR final rule definition was $139.88 billion and $159.36 billion for the quarters ended December 31, 2022 and 2021, respectively. The decrease in average HQLA for the quarter ended December 31, 2022, compared to the quarter ended December 31, 2021, was primarily driven by a decrease in client deposits. For the quarter ended December 31, 2022, LCR for State Street Bank and Trust was approximately 122%. State Street Bank and Trust's LCR is higher than the Parent Company's LCR, primarily due to application of the transferability restriction in the LCR final rule to the calculation of the Parent Company's LCR. This restriction limits the HQLA used in the calculation of the Parent Company's LCR to the amount of net cash outflows of its principal banking subsidiary (State Street Bank and Trust). This transferability restriction does not apply in the calculation of State Street Bank and Trust's LCR, and therefore State Street Bank and Trust's LCR reflects the benefit of all of its HQLA holdings.We maintained average cash balances in excess of regulatory requirements governing deposits with the Federal Reserve of approximately $79.52 billion at the Federal Reserve, the ECB and other non-U.S. central banks for the quarter ended December 31, 2022, and $83.48 billion for the quarter ended December 31, 2021. The higher levels of average cash balances with central banks reflect higher levels of client deposits. Liquid securities carried in our asset liquidity include securities pledged without corresponding advances from the Federal Reserve Bank of Boston (FRBB), the FHLB, and other non-U.S. central banks. State Street Bank is a member of the FHLB. This membership allows for advances of liquidity in varying terms against high-quality collateral, which helps facilitate asset-and-liability management. As of December 31, 2022 and 2021, we had no outstanding borrowings from the FHLB.Access to primary, intra-day and contingent liquidity provided by these utilities is an important source of contingent liquidity with utilization subject to underlying conditions. As of December 31, 2022 and 2021, we had no outstanding primary credit borrowings from the FRBB discount window or any other central bank facility.In addition to the securities included in our asset liquidity, we have other unencumbered investment securities. These securities are available sources of liquidity, although not as rapidly deployed as those included in our asset liquidity.The average fair value of total unencumbered securities was $78.25 billion for the quarter ended December 31, 2022, compared to $99.47 billion for the quarter ended December 31, 2021.Measures of liquidity include LCR and NSFR, which are described in "Supervision and Regulation" in Business in this Form 10-K.Uses of LiquiditySignificant uses of our liquidity could result from the following: withdrawals of client deposits; draw-downs by our custody clients of lines of credit; advances to clients to settle securities transactions; increases in our investment and loan portfolios; or other permitted purposes. Such circumstances would generally arise under stress conditions including deterioration in credit ratings. A recurring use of our liquidity involves our deployment of HQLA from our investment portfolio to post collateral to financial institutions serving as sources of securities under our enhanced custody program.We had unfunded commitments to extend credit with gross contractual amounts totaling $31.20 billion State Street Corporation | 93MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSand $33.03 billion and standby letters of credit totaling $2.13 billion and $3.24 billion as of December 31, 2022 and 2021, respectively. These amounts do not reflect the value of any collateral. As of December 31, 2022, approximately 77% of our unfunded commitments to extend credit and 22% of our standby letters of credit expire within one year. Since many of our commitments are expected to expire or renew without being drawn upon, the gross contractual amounts do not necessarily represent our future cash requirements.Information about our resolution planning and the impact actions under our resolution plans could have on our liquidity is provided in "Supervision and Regulation" in Business in this Form 10-K.FundingDepositsWe provide products and services including custody, accounting, administration, daily pricing, FX services, cash management, financial asset management, securities finance and investment advisory services. As a provider of these products and services, we generate client deposits, which have generally provided a stable, low-cost source of funds. As a global custodian, clients place deposits with our entities in various currencies. As of both December 31, 2022 and 2021, approximately 65% of our average total deposit balances were denominated in U.S. dollars, 15% in EUR, 10% in GBP and 10% in all other currencies.Short-Term FundingOur on-balance sheet liquid assets are also an integral component of our liquidity management strategy. These assets provide liquidity through maturities of the assets, but more importantly, they provide us with the ability to raise funds by pledging the securities as collateral for borrowings or through outright sales. In addition, our access to the global capital markets gives us the ability to source incremental funding from wholesale investors. As discussed earlier under “Asset Liquidity,” State Street Bank's membership in the FHLB allows for advances of liquidity with varying terms against high-quality collateral.Short-term secured funding also comes in the form of securities lent or sold under agreements to repurchase. These transactions are short-term in nature, generally overnight and are collateralized by high-quality investment securities. These balances were $1.18 billion and $1.58 billion as of December 31, 2022 and 2021, respectively.State Street Bank currently maintains a line of credit with a financial institution of CAD $1.40 billion, or approximately $1.03 billion, as of December 31, 2022, to support its Canadian securities processing operations. The line of credit has no stated termination date and is cancelable by either party with prior notice. As of both December 31, 2022 and 2021, there was no balance outstanding on this line of credit.Long-Term FundingWe have the ability to issue debt and equity securities under our current universal shelf registration statement to meet current commitments and business needs. In addition, State Street Bank also has current authorization from the Board to issue unsecured senior debt. The total amount remaining for issuance pursuant to this authority is $2.15 billion as of December 31, 2022.On February 7, 2022, we issued $300 million aggregate principal amount of 1.746% fixed-to-floating rate senior notes due 2026, $650 million aggregate principal amount of 2.203% fixed-to-floating rate senior notes due 2028 and $550 million aggregate principal amount of 2.623% fixed-to-floating rate senior notes due 2033.On March 30, 2022, we redeemed $750 million aggregate principal amount of 2.825% fixed-to-floating rate senior notes due 2023. On May 13, 2022, we issued $500 million aggregate principal amount of 4.421% fixed-to-floating rate senior notes due 2033. On May 15, 2022, we redeemed $750 million aggregate principal amount of 2.653% fixed-to-floating rate senior notes due 2023. On August 4, 2022, we issued $750 million aggregate principal amount of 4.164% fixed-to-floating rate senior notes due 2033.On November 4, 2022, we issued $500 million aggregate principal amount of 5.751% fixed-to-floating rate senior notes due 2026 and $500 million aggregate principal amount of 5.820% fixed-to-floating rate senior notes due 2028.On January 26, 2023, we issued $500 million aggregate principal amount of 4.857% fixed-to-floating rate senior notes due 2026 and $750 million aggregate principal amount of 4.821% fixed-to-floating rate senior notes due 2034. State Street Corporation | 94MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSAgency Credit RatingsOur ability to maintain consistent access to liquidity is fostered by the maintenance of high investment grade ratings as measured by the major independent credit rating agencies. TABLE 29: CREDIT RATINGSAs of December 31, 2022 Standard & Poor’sMoody’s Investors ServiceFitchState Street:Senior debtAA1AA-Subordinated debtA-A2AJunior subordinated debtBBBA3NRPreferred stockBBBBaa1BBB+OutlookStableStableStableState Street Bank:Short-term depositsA-1+P-1F1+Long-term depositsAA-Aa1AA+Senior debt/Long-term issuerAA-Aa3AASubordinated debtAAa3NROutlookStableStableStableFactors essential to maintaining high credit ratings include:•diverse and stable core earnings;•relative market position;•strong risk management;•strong capital ratios;•diverse liquidity sources, including the global capital markets and client deposits;•strong liquidity monitoring procedures; and•preparedness for current or future regulatory developments.High ratings limit borrowing costs and enhance our liquidity by:•providing confidence for unsecured funding and depositors;•increasing the potential market for our debt and improving our ability to offer products;•facilitating reduced collateral haircuts in secured lending transactions; and•engaging in transactions in which clients value high credit ratings.A downgrade or reduction in our credit ratings could have a material adverse effect on our liquidity by restricting our ability to access the capital markets, which could increase the related cost of funds. In turn, this could cause the sudden and large-scale withdrawal of unsecured deposits by our clients, which could lead to drawdowns of unfunded commitments to extend credit or trigger requirements under securities purchase commitments; or require additional collateral or force terminations of certain trading derivative contracts.A majority of our derivative contracts have been entered into under bilateral agreements with counterparties who may require us to post collateral or terminate the transactions based on changes in our credit ratings. We assess the impact of these arrangements by determining the collateral that would be required assuming a downgrade by the major rating agencies. The additional collateral or termination payments related to our net derivative liabilities under these arrangements that could have been called by counterparties in the event of a downgrade in our credit ratings below levels specified in the agreements is provided in Note 10 to the consolidated financial statements in this Form 10-K. Other funding sources, such as secured financing transactions and other margin requirements, for which there are no explicit triggers, could also be adversely affected. State Street Corporation | 95MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSContractual Cash Obligations and Other CommitmentsThe long-term contractual cash obligations included within Table 30: Long-Term Contractual Cash Obligations were recorded in our consolidated statement of condition as of December 31, 2022, except for the interest portions of long-term debt and finance leases.TABLE 30: LONG-TERM CONTRACTUAL CASH OBLIGATIONSDecember 31, 2022Payments Due by Period(In millions)Less than 1year1-3years4-5yearsOver 5yearsTotalLong-term debt(1)(2)$1,991 $3,661 $2,607 $6,561 $14,820 Operating leases189 232 154 101 676 Finance lease obligations(2)50 104 31 — 185 Tax liability10 47 — — 57 Total contractual cash obligations$2,240 $4,044 $2,792 $6,662 $15,738 (1) Long-term debt excludes finance lease obligations (presented as a separate line item) and the effect of interest rate swaps. Interest payments were calculated at the stated rate with the exception of floating-rate debt, for which payments were calculated using the indexed rate in effect as of December 31, 2022. (2) Additional information about contractual cash obligations related to long-term debt and operating and finance leases is provided in Notes 9 and 20 to the consolidated financial statements in this Form 10-K.Total contractual cash obligations shown in Table 30: Long-Term Contractual Cash Obligations do not include:•Obligations which will be settled in cash, primarily in less than one year, such as client deposits, federal funds purchased, securities sold under repurchase agreements and other short-term borrowings. Additional information about deposits, federal funds purchased, securities sold under repurchase agreements and other short-term borrowings is provided in Note 8 to the consolidated financial statements in this Form 10-K. •Obligations related to derivative instruments because the derivative-related amounts recorded in our consolidated statement of condition as of December 31, 2022 did not represent the amounts that may ultimately be paid under the contracts upon settlement. Additional information about our derivative instruments is provided in Note 10 to the consolidated financial statements in this Form 10-K. We have obligations under pension and other post-retirement benefit plans, with additional information provided in Note 19 to the consolidated financial statements in this Form 10-K, which are not included in Table 30: Long-Term Contractual Cash Obligations.TABLE 31: OTHER COMMERCIAL COMMITMENTS Duration of Commitment as of December 31, 2022(In millions)Less than1 year1-3years4-5yearsOver 5yearsTotal amountscommitted(1)Indemnified securities financing$348,924 $— $— $— $348,924 Unfunded credit facilities21,682 4,170 5,172 184 31,208 Standby letters of credit467 812 846 — 2,125 Purchase obligations(2)236 502 297 192 1,227 Total commercial commitments$371,309 $5,484 $6,315 $376 $383,484 (1) Total amounts committed reflect participations to independent third parties, if any. (2) Amounts represent obligations pursuant to legally binding agreements, where we have agreed to purchase products or services with a specific minimum quantity defined at a fixed, minimum or variable price over a specified period of time.Additional information about the commitments presented in Table 31: Other commercial commitments, except for purchase obligations, is provided in Note 12 to the consolidated financial statements in this Form 10-K. State Street Corporation | 96MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSOperational Risk ManagementOverviewOperational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Tight labor markets, challenging conditions in the global equity and fixed income markets, and heightened geopolitical tensions, including the ongoing war in Ukraine, are resulting in stress on the operating environment and have increased, and may continue to increase, operational risk. The war in Ukraine may also heighten information technology risk exposures, including cyber-threats. See also “Information Technology Risk Management” below.Operational risk encompasses fiduciary risk and legal risk. Fiduciary risk is defined as the risk that we fail to properly exercise our fiduciary duties in our provision of products or services to clients. Legal risk is the risk of loss resulting from failure to comply with laws and contractual obligations.Operational risk is inherent in the performance of investment servicing and investment management activities on behalf of our clients. Whether it be fiduciary risk, risk associated with execution and processing or other types of operational risk, a consistent, transparent and effective operational risk framework is key to identifying, monitoring and managing operational risk. We have established an operational risk framework that is based on three major goals:•Strong, active governance;•Ownership and accountability; and•Consistency and transparency.GovernanceOur Board is responsible for the approval and oversight of our overall operational risk framework. It does so through its TOPS, which reviews our operational risk framework and recommends RC approval of our operational risk policy annually. Our operational risk policy establishes our approach to our management of operational risk across our business. The policy identifies the responsibilities of individuals and committees charged with oversight of the management of operational risk, and articulates a broad mandate that supports implementation of the operational risk framework.ERM and other control groups provide the oversight, validation and verification of the management and measurement of operational risk. Executive management actively manages and oversees our operational risk framework through membership on various risk management committees, including MRAC, the BCC, TORC, the Operational Risk and Controls Committee, the Cybersecurity Risk Committee, the Enterprise Continuity Steering Committee, the Compliance and Ethics Committee, the Third Party and Outsourcing Risk Committee, and the Fiduciary Review Committee, all of which ultimately report to the appropriate committee of the Board.The Operational Risk and Controls Committee, chaired by the global head of Operational Risk, provides cross-business oversight of operational risk, operational risk programs and their implementation to identify, measure, manage and control operational risk in an effective and consistent manner and reviews and approves operational risk guidelines intended to maintain a consistent implementation of our corporate operational risk policy and framework. Ownership and AccountabilityWe have implemented our operational risk framework to support the broad mandate established by our operational risk policy. This framework represents a set of processes and tools that assists us in the management and measurement of operational risk, including our calculation of required capital and RWA.The framework utilizes aspects of the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework and other industry leading practices, and is designed foremost to address our risk management needs while complying with regulatory requirements. The operational risk framework is intended to provide a number of important benefits, including: •A common understanding of operational risk management and its supporting processes; •The clarification of responsibilities for the management of operational risk across our business;•The alignment of business priorities with risk management objectives;•The active management of risk and early identification of emerging risks;•The consistent application of policies and the collection of data for risk management and measurement; and•The estimation of our operational risk capital requirement.The operational risk framework employs a distributed risk management infrastructure executed by ERM groups aligned with the business units, which are responsible for the implementation of the operational risk framework at the business unit level.As with other risks, senior business unit management is responsible for the day-to-day operational risk management of their respective State Street Corporation | 97MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSbusinesses. It is business unit management's responsibility to provide oversight of the implementation and ongoing execution of the operational risk framework within their respective organizations, as well as coordination and communication with ERM. Consistency and TransparencyA number of corporate control functions are directly responsible for implementing and assessing various aspects of our operational risk framework, with the overarching goal of consistency and transparency to meet the evolving needs of the business:•The global head of Operational Risk, a member of the CRO’s executive management team, leads ERM’s corporate ORM group. ORM is responsible for the strategy, evolution and consistent implementation of our operational risk guidelines, framework and supporting tools across our business. ORM reviews and analyzes operational key risk information, events, metrics and indicators at the business unit and corporate level for purposes of risk management, reporting and escalation to the CRO, senior management and governance committees; •ERM’s Centralized Modeling and Analytics group develops and maintains operational risk capital estimation models, and ORM's Capital Analysis group calculates our required capital for operational risk;•ERM’s MVG validates the quantitative models used to measure operational risk, and ORM performs validation checks on the output of the model;•GCS establishes the framework, policies and related programs to measure, monitor and report on information security risks, including the effectiveness of cybersecurity program protections. GCS defines and manages the enterprise-wide information security program. GCS coordinates with Information Technology, control functions and business units to support the confidentiality, integrity and availability of corporate information assets. GCS identifies and employs a risk-based methodology consistent with applicable regulatory cybersecurity requirements and monitors the compliance of our systems with information security policies; and•Corporate Audit performs separate reviews of the application of operational risk management practices and methodologies utilized across our business.Our operational risk framework consists of five components, each described below. Risk Identification and AssessmentsThe objective of risk identification and assessments is to understand business unit strategy, risk profile and potential exposures. It is achieved through a series of risk assessments across our business using techniques for the identification, assessment and measurement of risk across a spectrum of potential frequency and severity combinations, including business-specific programs to identify, assess and measure risk, such as new business and product review and approval, new client screening, and, as deemed appropriate, targeted risk assessments. Two primary risk assessment programs, which occur annually, augmented by other business-specific programs, are the core of this component:•The risk and control assessment program seeks to understand the risks associated with day-to-day activities, and the effectiveness of controls intended to manage potential exposures arising from these activities. These risks are typically frequent in nature but generally not severe in terms of exposure; and•The Material Risk Identification process utilizes a bottom-up approach to identify our most significant risk exposures across all on- and off-balance sheet risk-taking activities. The program is specifically designed to consider risks that could have a material impact irrespective of their likelihood or frequency. This can include risks that may have an impact on longer-term business objectives, such as significant change management activities or long-term strategic initiatives.Capital AnalysisThe primary measurement tool used is an internally developed loss distribution approach (LDA) model. We use the LDA model to quantify required operational risk capital, from which we calculate RWA related to operational risk. Such required capital and RWA totaled $3.42 billion and $42.76 billion, respectively, as of December 31, 2022, compared to $3.64 billion and $45.60 billion, respectively, as of December 31, 2021; refer to the "Capital" section in "Financial Condition," of this Management's Discussion and Analysis.The LDA model incorporates the three required operational risk elements described below:•Internal loss event data is collected from across our business in conformity with our operating loss policy that establishes the State Street Corporation | 98MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSrequirements for collecting and reporting individual loss events. We categorize the data into seven Basel-defined event types and further subdivide the data by business unit, as deemed appropriate. Each of these loss events are represented in a UOM which is used to estimate a specific amount of capital required for the types of loss events that fall into each specific category. Some UOMs are measured at the corporate level because they are not “business specific,” such as damage to physical assets, where the cause of an event is not primarily driven by the behavior of a single business unit. Internal losses of $500 or greater are captured, analyzed and included in the modeling approach. Loss event data is collected using a corporate-wide data collection tool, Incident Capture and Management System (ICAMS), to support processes related to analysis, management reporting and the calculation of required capital. Internal loss event data provides our frequency and severity information to our capital calculation process for historical loss events experienced by us. Internal loss event data may be incorporated into our LDA model in a future quarter following the realization of the losses, with the timing and categorization dependent on the processes for model updates and, if applicable, model revalidation and regulatory review and related supervisory processes. An individual loss event can have a significant effect on the output of our LDA model and our operational risk RWA under the advanced approaches depending on the severity of the loss event, its categorization among the seven Basel-defined UOMs and the stability of the distributional approach for a particular UOM;•External loss event data provides information with respect to loss event severity from other financial institutions to inform our capital estimation process of events in similar business units at other banking organizations. This information supplements the data pool available for use in our LDA model. Assessments of the sufficiency of internal data and the relevance of external data are completed before pooling the two data sources for use in our LDA model; and•Business environment and internal control factors are gathered from internal loss event data and business-relevant metrics, such as risk assessment program results, along with industry loss event data and case studies where appropriate. Business environment and internal control factors are those characteristics of a bank’s internal and external operating environment that bear an exposure to operational risk. The use of this information indirectly influences our calculation of required capital by providing additional relevant data to workshop participants when reviewing specific UOM risks. Monitoring, Reporting and AnalyticsThe objective of risk monitoring is to proactively monitor the changing business environment and corresponding operational risk exposure. It is achieved through a series of quantitative and qualitative monitoring tools that are designed to allow us to understand changes in the business environment, internal control factors, risk metrics, risk assessments, exposures and operating effectiveness, as well as details of loss events and progress on risk initiatives implemented to mitigate potential risk exposures.Operational risk reporting is intended to provide transparency, thereby enabling management to manage risk, provide oversight and escalate issues in a timely manner. It is designed to allow the business units, executive management, and the Board's control functions and committees to gain insight into activities that may result in risks and potential exposures. Reports are intended to identify business activities that are experiencing processing issues, whether or not they result in actual loss events. Reporting includes results of monitoring activities, internal and external examinations, regulatory reviews and control assessments. These elements combine in a manner designed to provide a view of potential and emerging risks facing us and information that details its progress on managing risks.Effectiveness and TestingThe objective of effectiveness and testing is to verify that internal controls are designed appropriately, are consistent with corporate and regulatory standards, and are operating effectively. It is achieved through a series of assessments by both internal and external parties, independent registered public accounting firms, business self-assessments and other control function reviews, such as a Sarbanes-Oxley Act of 2002 (SOX) testing program.Consistent with our standard model validation process, the operational risk LDA model is subject to a detailed review, overseen by the MRC. In addition, the model is subject to a rigorous internal governance process. All changes to the model or input parameters, and the deployment of model updates, are reviewed and approved by the Operational Risk and Controls Committee, which has oversight State Street Corporation | 99MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSresponsibility for the model, with technical input from the MRC.Documentation and GuidelinesDocumentation and guidelines allow for consistency and repeatability of the various processes that support the operational risk framework across our business. Operational risk guidelines document our practices and describe the key elements in a business unit's operational risk management program. The purpose of the guidelines is to set forth and define key operational risk terms, provide further detail on our operational risk programs, and detail the business units' responsibilities to identify, assess, measure, monitor and report operational risk. The guideline supports our operational risk policy.Data standards have been established with the intent of maintaining consistent data repositories and systems that are controlled, accurate and available on a timely basis to support operational risk management.Information Technology Risk ManagementOverview and PrinciplesWe define information technology risk as the risk associated with the use, ownership, operation, involvement, influence and adoption of information technology. Information technology risk includes risks potentially triggered by technology non-compliance with regulatory obligations, information security and privacy incidents, business disruption, technology internal control and process gaps, technology operational events and adoption of new business technologies.The principal technology risks within our technology risk policy and risk appetite framework include:•Third party and vendor management risk;•Business disruption and technology resiliency risk;•Technology change management risk;•Cyber and information security risk;•Technology asset and configuration risk; and•Technology obsolescence risk.GovernanceOur Board is responsible for the approval and oversight of our overall technology risk framework and program. It does so through its TOPS, which reviews and approves our technology risk policy and appetite framework annually. Our technology risk policy establishes our approach to our management of technology risk across our business. The policy identifies the responsibilities of individuals and committees charged with oversight of the management of technology risk and articulates a broad mandate that supports implementation of the technology risk framework.Risk control functions in the business are responsible for adopting and executing the information technology risk framework and reporting requirements. They do this, in part, by developing and maintaining an inventory of critical applications and supporting infrastructure, as well as identifying, assessing and measuring technology risk utilizing the technology risk framework. They are also responsible for monitoring and evaluating risk on a continual basis using key risk indicators, risk reporting and adopting appropriate risk responses to risk issues. The Chief Technology Risk Officer, a member of the CRO’s executive management team, leads the Enterprise Technology Risk Management (ETRM) function. ETRM is the separate risk function responsible for the technology risk strategy and appetite, and technology risk framework development and execution. ETRM also performs overall technology risk monitoring and reporting to the Board, and provides a separate view of the technology risk posture to executive leadership. We manage technology risks by:•Coordinating various risk assessment and risk management activities, including ERM operational risk programs;•Establishing, through TORC and TOPS of the Board, the enterprise level technology risk and cyber risk appetite and limits;•Producing enterprise level risk reporting, aggregation, dashboards, profiles and risk appetite statements;•Validating appropriateness of reporting of information technology risks and risk acceptance to senior management risk committees and the Board;•Promoting a strong technology risk culture through communication;•Serving as an escalation and challenge point for technology risk policy guidance, expectations and clarifications; •Assessing effectiveness of key enterprise information technology risk and internal control remediation programs; and •Providing risk oversight, challenge and monitoring for the Global Continuity and Third Party Vendor Management Program, including the collection of risk appetite, metrics and key risk indicators, and reviewing issue management processes and consistent program adoption. State Street Corporation | 100MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSCybersecurity Risk ManagementCybersecurity risk is managed as part of our overall information technology risk framework as outlined above under the direction of our Chief Information Security Officer.We recognize the significance of cyber-attacks and have taken steps to mitigate the risks associated with them. We have invested in building a mature cybersecurity program to leverage people, technology and processes to protect our systems and the data in our care. We have also implemented a program to help us better measure and manage the cybersecurity risk we face when we engage with third parties for services.All employees are required to adhere to our cybersecurity policy and standards. Our centralized information security group provides education and training. This training includes a required annual online training class for all employees, multiple simulated phishing attacks and regular information security awareness materials. We employ Information Security Officers to help the business better understand and manage their information security risks, as well as to work with the centralized Information Security team to drive awareness and compliance throughout the business. We use independent third parties to perform ethical hacks of key systems to help us better understand the effectiveness of our controls and to better implement more effective controls, and we engage with third parties to conduct reviews of our overall program to help us better align our cybersecurity program with what is required of a large financial services organization.We have an incident response program in place that is designed to enable a well-coordinated response to mitigate the impact of cyber-attacks, recover from the attack and to drive the appropriate level of communication to internal and external stakeholders. The TORC assesses and manages the effectiveness of our cybersecurity program, which is overseen by the TOPS of our Board. The TOPS receives regular cybersecurity updates throughout the year and is responsible for reviewing and approving the program on an annual basis. Market Risk ManagementMarket risk is defined by U.S. banking regulators as the risk of loss that could result from broad market movements, such as changes in the general level of interest rates, credit spreads, foreign exchange rates or commodity prices. We are exposed to market risk in both our trading and certain of our non-trading, or asset-and-liability management, activities. Information about the market risk associated with our trading activities is provided below under “Trading Activities.” Information about the market risk associated with our non-trading activities, which consists primarily of interest rate risk, is provided below under “Asset-and-Liability Management Activities.”Trading ActivitiesIn the conduct of our trading activities, we assume market risk, the level of which is a function of our overall risk appetite, business objectives and liquidity needs, our clients' requirements and market volatility and our execution against those factors. We engage in trading activities primarily to support our clients' needs and to contribute to our overall corporate earnings and liquidity. In connection with certain of these trading activities, we enter into a variety of derivative financial instruments to support our clients' needs and to manage our interest rate and currency risk. These activities are generally intended to generate foreign exchange trading services revenue and to manage potential earnings volatility. In addition, we provide services related to derivatives in our role as both a manager and a servicer of financial assets.Our clients use derivatives to manage the financial risks associated with their investment goals and business activities. With the growth of cross-border investing, our clients often enter into foreign exchange forward contracts to convert currency for international investments and to manage the currency risk in their international investment portfolios. As an active participant in the foreign exchange markets, we provide foreign exchange forward and option contracts in support of these client needs, and also act as a dealer in the currency markets. As part of our trading activities, we assume positions in the foreign exchange and interest rate markets by buying and selling cash instruments and entering into derivative instruments, including foreign exchange forward contracts, foreign exchange and interest rate options and interest rate swaps, interest rate forward contracts and interest rate futures. As of December 31, 2022, the notional amount of these derivative contracts was $2.31 trillion, of which $2.28 trillion was composed of foreign exchange forward, swap and spot contracts. We seek to match positions closely with the objective of mitigating related currency and interest rate risk. All foreign exchange contracts are valued daily at current market rates. State Street Corporation | 101MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSGovernanceOur assumption of market risk in our trading activities is an integral part of our corporate risk appetite. The RC of the Board reviews and oversees our management of market risk, including the approval of key market risk policies and the receipt and review of regular market risk reporting, as well as periodic updates on selected market risk topics. The previously described CMRC (refer to "Risk Committees") oversees all market risk-taking activities across our business associated with trading. The CMRC, which reports to MRAC, is composed of members of ERM, our global markets business and our Global Treasury group, as well as our senior executives who manage our trading businesses and other members of management who possess specialized knowledge. The CMRC meets regularly to monitor the management of our trading market risk activities.Our business units identify, manage and are responsible for the market risks inherent in their businesses. A dedicated market risk management group within ERM, and other groups within ERM, work with those business units to assist them in the identification, assessment, monitoring, management and control of market risk, and assist business unit managers with their market risk management and measurement activities. ERM provides an additional line of oversight, support and coordination designed to promote the consistent identification, measurement and management of market risk across business units, separate from those business units' discrete activities. The ERM market risk management group is responsible for the management of corporate-wide market risk, the monitoring of key market risks and the development and maintenance of market risk management policies, guidelines and standards aligned with our corporate risk appetite. This group also establishes and approves market risk tolerance limits and trading authorities based on, but not limited to, measures of notional amounts, sensitivity, VaR and stress. Such limits and authorities are specified in our trading and market risk guidelines which govern our management of trading market risk.Risk Appetite Our corporate market risk appetite is specified in policy statements that outline the governance, responsibilities and requirements surrounding the identification, measurement, analysis, management and communication of market risk arising from our trading activities. These policy statements also set forth the market risk control framework designed to monitor, support, manage and control this portion of our risk appetite. All groups involved in the management and control of market risk associated with trading activities are required to comply with the qualitative and quantitative elements of these policy statements. Our trading market risk control framework is composed of the following:•A trading market risk management process led by ERM, separate from the business units' discrete activities; •Defined responsibilities and authorities for the primary groups involved in trading market risk management; •A trading market risk measurement methodology that captures correlation effects and allows aggregation of market risk across risk types, markets and business lines; •Daily monitoring, analysis and reporting of market risk exposures associated with trading activities against market risk limits; •A defined limit structure and escalation process in the event of a market risk limit excess; •Use of VaR models to measure the one-day market risk exposure of trading positions;•Use of VaR as a ten-day-based regulatory capital measure of the market risk exposure of trading positions; •Use of non-VaR-based limits and other controls; •Use of stressed-VaR models, stress-testing analysis and scenario analysis to support the trading market risk measurement and management process by assessing how portfolios and global business lines perform under extreme market conditions; •Use of back-testing as a diagnostic tool to assess the accuracy of VaR models and other risk management techniques; and •A new product approval process that requires market risk teams to assess trading-related market risks and apply risk tolerance limits to proposed new products and business activities. We use our CAP to assess our overall capital and liquidity in relation to our risk profile and provide a comprehensive strategy for maintaining appropriate capital and liquidity levels. With respect to market risk associated with trading activities, our risk management and our calculations of regulatory capital are based primarily on our internal VaR models and stress testing analysis. As discussed in detail under “Value-at-Risk and Stressed VaR” below, VaR is measured daily by ERM. The CMRC oversees our market risk exposure in relation to limits established within our risk appetite framework. These limits define threshold levels for State Street Corporation | 102MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSVaR- and stressed VaR-based measures and are applicable to all trading positions subject to regulatory capital requirements. These limits are designed to mitigate undue concentration of market risk exposure, in light of the primarily non-proprietary nature of our trading activities. The risk appetite framework and associated limits are reviewed and approved by the Board's RC. Covered Positions Our trading positions are subject to regulatory market risk capital requirements if they meet the regulatory definition of a “covered position.” A covered position is generally defined by U.S. banking regulators as an on- or off-balance sheet position associated with the organization's trading activities that is free of any restrictions on its tradability, but does not include intangible assets, certain credit derivatives recognized as guarantees and certain equity positions not publicly traded. All FX and commodity positions are considered covered positions, regardless of the accounting treatment they receive. The identification of covered positions for inclusion in our market risk capital framework is governed by our trading and market risk guidelines, which outlines the standards we use to determine whether a trading position is a covered position. Our covered positions consist primarily of the trading portfolios held by our global markets business. They also arise from certain positions held by our Global Treasury group. These trading positions include products such as foreign exchange spot, foreign exchange forwards, non-deliverable forwards, foreign exchange options, foreign exchange funding swaps, currency futures, financial futures and interest rate futures. New activities are analyzed to determine if the positions arising from such new activities meet the definition of a covered position and conform to our trading and market risk guidelines. This documented analysis, including any decisions with respect to market risk treatments, must receive approval from the CMRC. We use spot rates, forward points, yield curves and discount factors imported from third-party sources to measure the value of our covered positions, and we use such values to mark our covered positions to market on a daily basis. These values are subject to separate validation by us in order to evaluate reasonableness and consistency with market experience. The mark-to-market gain or loss on spot transactions is calculated by applying the spot rate to the foreign currency principal and comparing the resultant base currency amount to the original transaction principal. The mark-to-market gain or loss on a forward foreign exchange contract or forward cash flow contract is determined as the difference between the life-to-date (historical) value of the cash flow and the value of the cash flow at the inception of the transaction. The mark-to-market gain or loss on interest rate swaps is determined by discounting the future cash flows from each leg of the swap transaction.Value-at-Risk and Stressed VaRWe use a variety of risk measurement tools and methodologies, including VaR, which is an estimate of potential loss for a given period within a stated statistical confidence interval. We use a risk measurement methodology to measure trading-related VaR daily. We have adopted standards for measuring trading-related VaR, and we maintain regulatory capital for market risk associated with our trading activities in conformity with currently applicable bank regulatory market risk requirements. We utilize an internal VaR model to calculate our regulatory market risk capital requirements. We use a historical simulation model to calculate daily VaR- and stressed VaR-based measures for our covered positions in conformity with regulatory requirements. Our VaR model seeks to capture identified material risk factors associated with our covered positions, including risks arising from market movements such as changes in foreign exchange rates, interest rates and option-implied volatilities.We have adopted standards and guidelines to value our covered positions which govern our VaR- and stressed VaR-based measures. Our regulatory VaR-based measure is calculated based on historical volatilities of market risk factors during a two-year observation period calibrated to a one-tail, 99% confidence interval and a ten-business-day holding period. We also use the same platform to calculate a one-tail, 99% confidence interval, one-business-day VaR for internal risk management purposes. A 99% one-tail confidence interval implies that daily trading losses are not expected to exceed the estimated VaR more than 1% of the time, or less than three business days out of a year. Our market risk models, including our VaR model, are subject to change in connection with the governance, validation and back-testing processes described below. These models can change as a result of changes in our business activities, our historical experiences, market forces and events, regulations and regulatory interpretations and other factors. In addition, the models are subject to continuing regulatory review and approval. Changes in our models may result in changes in our measurements of our market risk exposures, including VaR, and related measures, including regulatory capital. These changes could result in material changes in those risk measurements and related measures as calculated and compared from period to period. State Street Corporation | 103MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSValue-at-Risk MeasuresVaR measures are based on the most recent two years of historical price movements for instruments and related risk factors to which we have exposure. The instruments in question are limited to foreign exchange spot, forward and options contracts and interest rate contracts, including futures and interest rate swaps. Historically, these instruments have exhibited a higher degree of liquidity relative to other available capital markets instruments. As a result, the VaR measures shown reflect our ability to rapidly adjust exposures in highly dynamic markets. For this reason, risk inventory, in the form of net open positions, across all currencies is typically limited. In addition, long and short positions in major, as well as minor, currencies provide risk offsets that limit our potential downside exposure. Our VaR methodology uses a historical simulation approach based on market-observed changes in foreign exchange rates, U.S. and non-U.S. interest rates and implied volatilities, and incorporates the resulting diversification benefits provided from the mix of our trading positions. Our VaR model incorporates approximately 5,000 risk factors and includes correlations among currency, interest rates and other market rates.All VaR measures are subject to limitations and must be interpreted accordingly. Some, but not all, of the limitations of our VaR methodology include the following:•Compared to a shorter observation period, a two-year observation period is slower to reflect increases in market volatility (although temporary increases in market volatility will affect the calculation of VaR for a longer period); consequently, in periods of sudden increases in volatility or increasing volatility, in each case relative to the prior two-year period, the calculation of VaR may understate current risk; •Compared to a longer observation period, a two-year observation period may not reflect as many past periods of volatility in the markets, because such past volatility is no longer in the observation period; consequently, historical market scenarios of high volatility, even if similar to current or likely future market circumstances, may fall outside the two-year observation period, resulting in a potential understatement of current risk; •The VaR-based measure is calibrated to a specified level of confidence and does not indicate the potential magnitude of losses beyond this confidence level; •In certain cases, VaR-based measures approximate the impact of changes in risk factors on the values of positions and portfolios; this may happen because the number of inputs included in the VaR model is necessarily limited; for example, yield curve risk factors do not exist for all future dates; •The use of historical market information may not be predictive of future events, particularly those that are extreme in nature; this “backward-looking” limitation can cause VaR to understate or overstate risk; •The effect of extreme and rare market movements is difficult to estimate; this may result from non-linear risk sensitivities as well as the potential for actual volatility and correlation levels to differ from assumptions implicit in the VaR calculations; and •Intra-day risk is not captured.We calculate a stressed VaR-based measure using the same model we use to calculate VaR, but with model inputs calibrated to historical data from a range of continuous twelve-month periods that reflect significant financial stress. The stressed VaR model is designed to identify the second-worst outcome occurring in the worst continuous one-year rolling period since July 2007. This stressed VaR meets the regulatory requirement as the rolling ten-day period with an outcome that is worse than 99% of other outcomes during that twelve-month period of financial stress. For each portfolio, the stress period is determined algorithmically by seeking the one-year time horizon that produces the largest ten-business-day VaR from within the available historical data. This historical data set includes the financial crisis of 2008, the highly volatile period surrounding the Eurozone sovereign debt crisis and the Standard & Poor's downgrade of U.S. Treasury debt in August 2011. As the historical data set used to determine the stress period expands over time, future market stress events will be incorporated. State Street Corporation | 104MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSStress TestingWe have a corporate-wide stress testing program in place that incorporates techniques to measure the potential loss we could suffer in a hypothetical scenario of adverse economic and financial conditions. We also monitor concentrations of risk such as concentration by branch, risk component, and currency pairs. We conduct stress testing on a daily basis based on selected historical stress events that are relevant to our positions in order to estimate the potential impact to our current portfolio should similar market conditions recur, and we also perform stress testing as part of the Federal Reserve's CCAR process. Stress testing is conducted, analyzed and reported at the corporate, trading desk, division and risk-factor level (for example, exchange risk, interest rate risk and volatility risk). Stress testing results and limits are actively monitored on a daily basis by ERM and reported to the CMRC. Limit breaches are addressed by ERM risk managers in conjunction with the business units, escalated as appropriate, and reviewed by the CMRC if material. In addition, we have established several action triggers that prompt immediate review by management and the implementation of a remediation plan.We perform scenario analysis daily based on selected historical stress events that are relevant to our positions in order to estimate the potential impact to our current portfolio should similar market conditions recur. Relevant scenarios are chosen from an inventory of historical financial stresses and applied to our current portfolio. These historical event scenarios involve spot foreign exchange, credit, equity, unforeseen geo-political events and natural disasters, and government and central bank intervention scenarios. Examples of the specific historical scenarios we incorporate in our stress testing program may include the Asian financial crisis of 1997, the September 11, 2001 terrorist attacks in the U.S. and the 2008 financial crisis. We continue to update our inventory of historical stress scenarios as new stress conditions emerge in the financial markets.As each of the historical stress events is associated with a different time horizon, we normalize results by scaling down the longer horizon events to a ten-day horizon and keeping the shorter horizon events (i.e., events that are shorter than ten days) at their original terms. We also conduct sensitivity analysis daily to calculate the impact of a large predefined shock in a specific risk factor or a group of risk factors on our current portfolio. These predefined shocks include parallel and non-parallel yield curve shifts and foreign exchange spot and volatility surface shifts. In a parallel shift scenario, we apply a constant factor shift across all yield curve tenors. In a non-parallel shift scenario, we apply different shock levels to different tenors of a yield curve, rather than shifting the entire curve by a constant amount. Non-parallel shifts include steepening, flattening and butterflies. Validation and Back-TestingWe perform frequent back-testing to assess the accuracy of our VaR-based model in estimating loss at the stated confidence level. This back-testing involves the comparison of estimated VaR model outputs to daily, actual profit-and-loss (P&L) outcomes observed from daily market movements. We back-test our VaR model using “clean” P&L, which excludes non-trading revenue such as fees, commissions and NII, as well as estimated revenue from intra-day trading. Our VaR definition of trading losses excludes items that are not specific to the price movement of the trading assets and liabilities themselves, such as fees, commissions, changes to reserves and gains or losses from intra-day activity.We experienced three back-testing exceptions in 2022 and one back-testing exception in 2021. At a 99% confidence interval, the statistical expectation for a VaR model is to witness one exception every hundred trading days (or two to three exceptions per year). Two 2022 back-testing exceptions occurred on days of higher volatility on the back of market concerns on economic outlook, inflation and central bank rate policy. A third back-testing exception occurred during the UK market turmoil in late September 2022. The 2021 back-testing exception has been attributed to dislocation in FX markets caused by greater demand for funding over year-end periods. Our model validation process also evaluates the integrity of our VaR models through the use of regular outcome analysis. This outcome analysis includes back-testing, which compares the VaR model's predictions to actual outcomes using out-of-sample information. Consistent with regulatory guidance, the back-testing compared “clean” P&L, defined above, with the one-day VaR produced by the model. The back-testing was performed for a time period not used for model development. The number of occurrences where “clean” trading-book P&L exceeded the one-day VaR was within our expected VaR tolerance level. State Street Corporation | 105MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSMarket Risk ReportingOur ERM market risk management group is responsible for market risk monitoring and reporting. We use a variety of systems and controlled market feeds from third-party services to compile data for several daily, weekly and monthly management reports.The following tables present VaR and stressed VaR associated with our trading activities for covered positions held during the years ended December 31, 2022 and 2021, respectively, as measured by our VaR methodology. Diversification effect in the tables below represents the difference between total VaR and the sum of the VaRs for each trading activity. This effect arises because the risks present in our trading activities are not perfectly correlated.TABLE 32: TEN-DAY VALUE-AT-RISK ASSOCIATED WITH TRADING ACTIVITIES FOR COVERED POSITIONSYear Ended December 31, 2022As of December 31, 2022Year Ended December 31, 2021As of December 31, 2021(In thousands)AverageMaximumMinimumVaRAverageMaximumMinimumVaRGlobal Markets$8,567 $25,779 $2,631 $7,591 $15,214 $30,485 $5,252 $16,998 Global Treasury2,661 7,255 559 5,632 3,189 9,762 220 3,556 Diversification(2,591)(6,959)311 (6,075)(2,115)(7,958)1,024 (4,519)Total VaR$8,637 $26,075 $3,501 $7,148 $16,288 $32,289 $6,496 $16,035 TABLE 33: TEN-DAY STRESSED VALUE-AT-RISK ASSOCIATED WITH TRADING ACTIVITIES FOR COVERED POSITIONSYear Ended December 31, 2022As of December 31, 2022Year Ended December 31, 2021As of December 31, 2021(In thousands)AverageMaximumMinimumVaRAverageMaximumMinimumVaRGlobal Markets$35,391 $97,420 $16,413 $30,778 $41,698 $101,535 $13,037 $65,840 Global Treasury4,629 17,695 778 8,431 9,601 29,651 814 12,419 Diversification(5,693)(19,176)(1,014)(12,206)(5,607)(20,018)2,918 (17,505)Total Stressed VaR$34,327 $95,939 $16,177 $27,003 $45,692 $111,168 $16,769 $60,754 The average and period-end stressed VaR-based measures were approximately $34 million and $27 million, respectively, for the year ended December 31, 2022, compared to $46 million and $61 million, respectively, for the year ended December 31, 2021. The decrease in the average and period-end VaR-based and stressed VaR-based measures is primarily attributed to lower foreign exchange and interest rate risk positions.The VaR-based measures as presented in the preceding tables are primarily a reflection of the overall level of market volatility and our appetite for taking market risk in our trading activities. While overall levels of volatility have varied over the historical observation periods, smaller residual market risk positions during the quarter have led to a reduction in VaR measures presented.We have in the past and may in the future modify and adjust our models and methodologies used to calculate VaR and stressed VaR, subject to regulatory review and approval, and any future modifications and adjustments may result in changes in our VaR-based and stressed VaR-based measures.The following tables present the VaR and stressed-VaR associated with our trading activities attributable to foreign exchange risk, interest rate risk and volatility risk as of December 31, 2022 and 2021, respectively. The totals of the VaR-based and stressed VaR-based measures for the three attributes in total exceeded the related total VaR and total stressed VaR presented in the foregoing tables as of each period-end, primarily due to the benefits of diversification across risk types. Diversification effect in the tables below represents the difference between total VaR and the sum of the VaRs for each trading activity. This effect arises because the risks present in our trading activities are not perfectly correlated.TABLE 34: TEN-DAY VaR ASSOCIATED WITH TRADING ACTIVITIES BY RISK FACTOR(1)Year Ended December 31, 2022Year Ended December 31, 2021(In thousands)Foreign Exchange RiskInterest Rate RiskVolatility RiskForeign Exchange RiskInterest Rate RiskVolatility RiskBy component:Global Markets$5,562 $4,656 $358 $6,945 $16,424 $108 Global Treasury5,602 1,442 — 531 3,688 — Diversification(6,344)(1,155)— (877)(3,682)— Total VaR$4,820 $4,943 $358 $6,599 $16,430 $108 State Street Corporation | 106MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSTABLE 35: TEN-DAY STRESSED VaR ASSOCIATED WITH TRADING ACTIVITIES BY RISK FACTOR(1)Year Ended December 31, 2022Year Ended December 31, 2021(In thousands)Foreign Exchange RiskInterest Rate RiskVolatility RiskForeign Exchange RiskInterest Rate RiskVolatility RiskBy component:Global Markets$9,527 $37,077 $565 $9,445 $63,368 $157 Global Treasury7,623 9,941 — 667 13,218 — Diversification(8,189)(15,328)— (1,551)(17,500)— Total Stressed VaR$8,961 $31,690 $565 $8,561 $59,086 $157 (1) For purposes of risk attribution by component, foreign exchange refers only to the risk from market movements in period-end rates. Forwards, futures, options and swaps with maturities greater than period-end have embedded interest rate risk that is captured by the measures used for interest rate risk. Accordingly, the interest rate risk embedded in these foreign exchange instruments is included in the interest rate risk component. Asset and Liability Management ActivitiesThe primary objective of asset and liability management is to provide sustainable NII under varying economic conditions, while protecting the economic value of the assets and liabilities carried on our consolidated statement of condition from the adverse effects of changes in interest rates. While many market factors affect the level of NII and the economic value of our assets and liabilities, one of the most significant factors is our exposure to movements in interest rates. Most of our NII is earned from the investment of client deposits generated by our businesses. We invest these client deposits in assets that conform generally to the liquidity characteristics of our balance sheet liabilities, as well as the currency composition of our significant non-U.S. dollar denominated client deposits.We quantify NII sensitivity using an earnings simulation model that includes our expectations for new business growth, changes in balance sheet mix and investment portfolio positioning. This measure compares our baseline view of NII over a twelve-month horizon, based on our internal forecast of interest rates, to a wide range of rate shocks. Our baseline view of NII is updated on a regular basis. Table 36, Key Interest Rates for Baseline Forecasts, presents the spot and 12-month forward rates used in our baseline forecasts at December 31, 2022 and 2021. Our baseline rate forecast as of December 31, 2022 was generally consistent with common market expectations for global central bank actions at that point in time, which implied rates to reach peak levels in the first half of 2023 and rate cuts to begin as early as the fourth quarter of 2023.TABLE 36: KEY INTEREST RATES FOR BASELINE FORECASTSDecember 31, 2022December 31, 2021Fed Funds TargetECB Target(1)10-Year TreasuryFed Funds TargetECB Target(1)10-Year TreasurySpot rates4.50 %2.00 %3.87 %0.25 %(0.50)%1.77 %12-month forward rates4.75 3.00 3.81 1.00 (0.50)1.95 (1) European Central Bank deposit facility rate.In Table 37: Net Interest Income Sensitivity, we report the expected change in NII over the next twelve months from instantaneous shocks to various tenors on the yield curve relative to our baseline rate forecast, including the impacts from U.S. and non-U.S. rates. Each scenario assumes no management action is taken to mitigate the adverse effects of changes in interest rates on our financial performance. While investment securities balances and composition can fluctuate with the level of rates as prepayment assumptions change, for purposes of this analysis our deposit balances and mix are assumed to remain consistent with the baseline forecast which assumes client deposit balance rotation including reductions in non-interest-bearing deposit balances. In lower rate scenarios, the full impact of the shock is realized for all currencies even if the result is negative interest rates.TABLE 37: NET INTEREST INCOME SENSITIVITYDecember 31, 2022December 31, 2021(In millions)U.S. DollarAll Other CurrenciesTotalU.S. DollarAll Other CurrenciesTotalRate change:Benefit (Exposure)Benefit (Exposure)Parallel shifts:+100 bps shock$(225)$432 $207 $447 $306 $753 –100 bps shock207 (419)(212)384 (39)345 Steeper yield curve:'+100 bps shift in long-end rates(1)42 23 65 114 16 130 '-100 bps shift in short-end rates(1)250 (397)(147)519 (22)497 Flatter yield curve:'+100 bps shift in short-end rates(1)(267)409 142 337 290 627 '-100 bps shift in long-end rates(1)(43)(22)(65)(132)(16)(148)(1) The short end is 0-3 months. The long end is 5 years and above. Interim term points are interpolated. State Street Corporation | 107MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSOur overall balance sheet, including all currencies, continues to be asset sensitive with an NII benefit in higher rate scenarios. However, our USD balance sheet has become liability sensitive driven by rising USD deposit betas and deposit balance rotation. Our NII sensitivities assumes no management actions are taken to change modeled outcomes including the +100 basis point scenario which assumes that the level of Fed Funds reaches a peak of 6.0%.As of December 31, 2022,USD NII benefits in lower rate scenarios and is exposed to higher rates primarily driven by our sensitivities on the short-end of the yield curve. Compared to December 31, 2021, our short-end USD sensitivity has changed due to the higher level of market interest rates and the Federal Reserve’s quantitative tightening program resulting in higher deposit betas and deposit balance rotation and reductions. Long end USD sensitivities have decreased since December 31, 2021 as the implementation of investment portfolio risk reduction strategies lowered our forecasted long-end reinvestment.As of December 31, 2022, non-USD NII benefits in higher rate scenarios and is exposed to lower rates primarily driven by our sensitivities on the short-end of the yield curve. Compared to December 31, 2021, our short-end non-USD sensitivity to higher rates has increased due to the ECB shifting from negative to positive interest rates resulting in lower deposit betas. Our short-end non-USD sensitivity to lower rates has become negative due to higher non-USD yield curves which are no longer impacted by negative interest rates in the -100bp scenario. The December 31, 2021 sensitivities included a significant NII benefit from negative rates by charging interest on client deposits and the impacts of contractual floors on loans and securities. EVE sensitivity is a discounted cash flow model designed to estimate the fair value of assets and liabilities under a series of interest rate shocks over a long-term horizon. In the following table, we report our EVE sensitivity to 200 bps instantaneous rate shocks, relative to spot interest rates. Management compares the change in EVE sensitivity against our aggregate Tier 1 and Tier 2 risk-based capital, calculated in conformity with current applicable regulatory requirements. EVE sensitivity is dependent on the timing of interest and principal cash flows. Also, the measure only evaluates the spot balance sheet and does not include the impact of new business assumptions.TABLE 38: ECONOMIC VALUE OF EQUITY SENSITIVITYAs of December 31,(In millions)20222021Rate change:Benefit (Exposure)+200 bps shock$(917)$(1,380)–200 bps shock1,082 3,829 As of December 31, 2022, EVE sensitivity remains exposed to upward shifts in interest rates. Compared to December 31, 2021, our sensitivity in the up 200bp shock scenario decreased due to the implementation of investment portfolio risk reduction strategies resulting in lower securities duration, partially offset by-reduced deposit duration due to higher rates and modelling updates. Compared to December 31, 2021, the change in the down 200 bps scenario is primarily driven by deposit valuation changes between positive and negative rate environments.Both NII sensitivity and EVE sensitivity are routinely monitored as market conditions change. For additional information about our Asset and Liability Management Activities, refer to Management's Discussion and Analysis of Financial Condition and Results of Operations, "Risk Management." State Street Corporation | 108MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSModel Risk Management The use of models is widespread throughout the financial services industry, with large and complex organizations relying on sophisticated models to support numerous aspects of their financial decision making. The models contemporaneously represent both a significant advancement in financial management and a source of risk. In large banking organizations like us, model results influence business decisions, and model failure could have a harmful effect on our financial performance. As a result, the MRM Framework seeks to mitigate our model risk.Our MRM program has three principal components: •A model risk governance program that defines roles and responsibilities, including the authority to restrict model usage, provides policies and guidance, monitors compliance and reports regularly to the Board on the overall degree of model risk across the corporation; •A model development process that focuses on sound design and computational accuracy, and includes activities designed to assess data quality, to test for robustness, stability and sensitivity to assumptions, and to conduct ongoing monitoring of model performance; and •An independent model validation function designed to verify that models are conceptually sound, computationally accurate, are performing as expected, and are in line with their intended use.The MRM Framework, highlighted above, also provides insight and guidance into addressing key model risks that arise.GovernanceModels used in the regulatory capital calculation can only be deployed for use after undergoing a model validation by ERM's MRM group. The model validation results and/or a decision by the Model Risk Committee must permit model usage or the model may not be used.ERM’s MRM group is responsible for defining the corporate-wide model risk management framework, maintaining policies that are designed to achieve the framework’s objectives. All regulatory capital calculation models, including any artificial intelligence and machine learning models, must comply with the model risk management framework and corresponding policies. The team is responsible for overall model risk governance capabilities, with particular emphasis in the areas of model validation, model risk reporting, model performance monitoring, tracking of new model development status and committee-level review and challenge.MRC, which is composed of senior managers responsible for representing functional areas and business units with key models across the organization, reports to MRAC, and provides guidance and oversight to the MRM function.Model Development and Ongoing MonitoringModels are developed under standards governing data sourcing, methodology selection and model integrity testing. Model development includes a statement of purpose to align development with intended use. It may also include a comparison of alternative approaches to promote a sound modeling approach.Model developers conduct an assessment of data quality and relevance. The development teams conduct a variety of tests of the accuracy, robustness and stability of each model. Model owners submit models to the MVG for validation on a regular basis, as per the existing policy. The model owners also conduct ongoing monitoring of each model.Model ValidationMVG is part of MRM within ERM and performs model validations and reviews. MVG is independent, as contemplated by applicable bank regulatory requirements, of both the developers and users of the models. MVG validates models through an evaluation process that assesses the appropriateness, accuracy, and suitability of data inputs, methodologies, documentation, assumptions, and processing code. Model validation also encompasses an assessment of model performance, sensitivity, and robustness, as well as a model’s potential limitations given its particular assumptions or deficiencies. Based on the results of its review, MVG issues a model use decision and may require remedial actions and/or compensating controls on model use. MVG also maintains a model risk rating system, which assigns a risk rating to each model based on an assessment of a model's inherent and residual risks. These ratings aid in the understanding and reporting of model risk across the model portfolio, and enable the triaging of needs for remediation.Although model validation is the primary method of subjecting models to independent review and challenge, in practice, a multi-step governance process provides the opportunity for challenge by multiple parties. First, MVG conducts a model validation and issues a model use decision. MVG communicates their result as one of the following three outcomes: “Approved”, “Approved with conditions”, or “Not Approved”. There are three ways State Street Corporation | 109MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSin which a model can be deemed “Not approved for Use” given a validation: 1) the aggregation of the model scoring within MRM’s model risk rating system is poor enough to result in a “high” rating, 2) the scoring of one or more model risk rating system element(s) is deemed “critical” resulting in an automatic “high” rating irrespective of the other elements as the “critical” element(s) undermines the model, or 3) the remediation action is not properly taken by the due date resulting in a severe compliance breach that undercuts the model rating. Second, these decisions may be reviewed, challenged, and confirmed by the MRC. Finally, model use decisions, risk ratings, and overall levels of model risk may be reported to and reviewed by MRAC. MRM also reports regularly on model risk issues to the Board.Strategic Risk ManagementWe define strategic risk as the current or prospective impact on earnings or capital arising from adverse business decisions, improper implementation of strategic initiatives, or lack of responsiveness to industry-wide changes. Strategic risks are influenced by changes in the competitive environment; decline in market performance or changes in our business activities; and the potential secondary impacts of reputational risks, not already captured as market, interest rate, credit, operational, model or liquidity risks. We incorporate strategic risk into our assessment of our business plans and risk and capital management processes. Management of strategic risk is an integral component of all aspects of our business.Separating the effects of a potential material adverse event into operational and strategic risk is sometimes difficult. For instance, the direct financial impact of an unfavorable event in the form of fines or penalties would be classified as an operational risk loss, while the impact on our reputation and consequently the potential loss of clients and corresponding decline in revenue would be classified as a strategic risk loss. An additional example of strategic risk is the integration of a major acquisition. Failure to successfully integrate the operations of an acquired business, and the resultant inability to retain clients and the associated revenue, would be classified as a loss due to strategic risk.Strategic risk is managed with a long-term focus. Techniques for its assessment and management include the development of business plans, which are subject to review and challenge from senior management and the Board of Directors, as well as a formal review and approval process for all new business and product proposals. The potential impact of the various elements of strategic risk is difficult to quantify with any degree of precision. We use a combination of historical earnings volatility, scenario analysis, stress-testing and management judgment to help assess the potential effect on us attributable to strategic risk. Management and control of strategic risks are generally the responsibility of the business units, with oversight from the control functions, as part of their overall strategic planning and internal risk management processes.CAPITALManaging our capital involves evaluating whether our actual and projected levels of capital are commensurate with our risk profile, are in compliance with all applicable regulatory requirements, and are sufficient to provide us with the financial flexibility to undertake future strategic business initiatives. We assess capital adequacy based on relevant regulatory capital requirements, as well as our own internal capital goals, targets and other relevant metrics.FrameworkOur objective with respect to management of our capital is to maintain a strong capital base in order to provide financial flexibility for our business needs, including funding corporate growth and supporting clients’ cash management needs, and to provide protection against loss to depositors and creditors. We strive to maintain an appropriate level of capital, commensurate with our risk profile, on which an attractive return to shareholders is expected to be realized over both the short and long-term, while protecting our obligations to depositors and creditors and complying with regulatory capital requirements.Our capital management focuses on our risk exposures, the regulatory requirements applicable to us with respect to multiple capital measures, the evaluations and resulting credit ratings of the major independent rating agencies, our return on capital at both the consolidated and line-of-business level and our capital position relative to our peers.Assessment of our overall capital adequacy includes the comparison of capital sources with capital uses, as well as the consideration of the quality and quantity of the various components of capital. The assessment seeks to determine the optimal level of capital and composition of capital instruments to satisfy all constituents of capital, with the lowest overall cost to shareholders. Other factors considered in our assessment of capital adequacy are strategic and contingency planning, stress testing and planned capital actions.Capital Adequacy Process (CAP)Our primary federal banking regulator is the Federal Reserve. Both we and State Street Bank are subject to the minimum regulatory capital requirements established by the Federal Reserve and defined in the Federal Deposit Insurance Corporation State Street Corporation | 110MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSImprovement Act. State Street Bank must exceed the regulatory capital thresholds for “well capitalized” in order for our Parent Company to maintain its status as a financial holding company. Accordingly, one of our primary objectives with respect to capital management is to exceed all applicable minimum regulatory capital requirements and for State Street Bank to be “well capitalized” under the PCA guidelines established by the FDIC. Our capital management activities are conducted as part of our corporate-wide CAP and associated Capital Policy and Guidelines.We consider capital adequacy to be a key element of our financial well-being, which affects our ability to attract and maintain client relationships; operate effectively in the global capital markets; and satisfy regulatory, security holders and shareholder needs. Capital is one of several elements that affect our credit ratings and the ratings of our principal subsidiaries.In conformity with our Capital Policy and Guidelines, we strive to achieve and maintain specific internal capital levels, not just at a point in time, but over time and during periods of stress, to account for changes in our strategic direction, evolving economic conditions, and financial and market volatility. We have developed and implemented a corporate-wide CAP to assess our overall capital in relation to our risk profile and to provide a comprehensive strategy for maintaining appropriate capital levels. The CAP considers material risks under multiple scenarios, with an emphasis on stress scenarios, and encompasses existing processes and systems used to measure our capital adequacy. Capital Contingency PlanningContingency planning is an integral component of capital management. The objective of contingency planning is to monitor current and forecast levels of select capital, liquidity and other measures that serve as early indicators of a potentially adverse capital or liquidity adequacy situation. These measures are one of the inputs used to set our internal capital adequacy level. We review these measures annually for appropriateness and relevance in relation to our financial budget and capital plan. In addition, we maintain an inventory of capital contingency actions designed to conserve or generate capital to support the unique risks in our business model, our client and investor demands and regulatory requirements.Stress TestingWe administer a robust business-wide stress-testing program that executes stress tests each year to assess the institution’s capital adequacy and/or future performance under adverse conditions. Our stress testing program is structured around what we determine to be the key risks inherent in our business, as assessed through a recurring material risk identification process. The material risk identification process represents a bottom-up approach to identifying the institution’s most significant risk exposures across all on- and off-balance sheet risk-taking activities, including credit, market, liquidity, interest rate, operational, fiduciary, business, reputation and regulatory risks. These key risks serve as an organizing principle for much of our risk management framework, as well as reporting, including the “risk dashboard” provided to the Board. In connection with the focus on our key risks, each stress test incorporates idiosyncratic loss events tailored to our unique risk profile and business activities. Due to the nature of our business model and our consolidated statement of condition, our risks differ from those of a traditional commercial bank. Over the past few years, stress scenarios have included a deep recession in the U.S., including impacts from the COVID-19 pandemic, a break-up of the Eurozone, a severe recession in China and an oil shock precipitated by turmoil in the Middle East/North Africa region.The Federal Reserve requires bank holding companies with total consolidated assets of $50 billion or more, which includes us, to submit a capital plan on an annual basis. The Federal Reserve uses its annual CCAR process, which incorporates hypothetical financial and economic stress scenarios, to review those capital plans and assess whether banking organizations have capital planning processes that account for idiosyncratic risks and provide for sufficient capital to continue operations throughout times of economic and financial stress. As part of its CCAR process, the Federal Reserve assesses each organization’s capital adequacy, capital planning process and plans to distribute capital, such as dividend payments or stock purchase programs. Management and Board risk committees review, challenge and approve CCAR results and assumptions before submission to the Federal Reserve.Through the evaluation of our capital adequacy and/or future performance under adverse conditions, the stress testing process provides us important insights for capital planning, risk management and strategic decision-making. GovernanceIn order to support integrated decision making, we have identified three management elements to aid in the compatibility and coordination of our CAP:•Risk Management - identification, measurement, monitoring and forecasting of different types of risk and their combined impact on capital adequacy; State Street Corporation | 111MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS•Capital management - determination of optimal capital levels; and•Business Management - strategic planning, budgeting, forecasting and performance management.We have a hierarchical structure supporting appropriate committee review of relevant risk and capital information. The ongoing responsibility for capital management rests with our Treasurer. The Capital Management group within Global Treasury is responsible for the Capital Policy and Guidelines, development of the Capital Plan, the oversight of global capital management and optimization.The MRAC provides oversight of our capital management, our capital adequacy, our internal targets and the expectations of the major independent credit rating agencies. In addition, MRAC approves our balance sheet strategy and related activities. The Board’s RC assists the Board in fulfilling its oversight responsibilities related to the assessment and management of risk and capital. Our Capital Policy is reviewed and approved annually by the Board's RC.Global Systemically Important BankWe have been identified by the Financial Stability Board and the Basel Committee on Banking Supervision as a G-SIB. Our designation as a G-SIB is based on a number of factors, as evaluated by banking regulators, and requires us to maintain an additional capital surcharge above the minimum capital ratios set forth in the Basel III rule.We and our depositary institution subsidiaries are subject to the current Basel III minimum risk-based capital and leverage ratio guidelines. Additional information about G-SIBs is provided under "Regulatory Capital Adequacy and Liquidity Standards" in "Supervision and Regulation" in Business in this Form 10-K.Regulatory CapitalWe and State Street Bank, as advanced approaches banking organizations, are subject to the U.S. Basel III framework. We are also subject to the final market risk capital rule issued by U.S. banking regulators.The Basel III rule provides for two frameworks for monitoring capital adequacy: the “standardized approach" and the “advanced approaches", applicable to advanced approaches banking organizations, like us. The standardized approach prescribes standardized calculations for credit risk RWA, including specified risk weights for certain on- and off-balance sheet exposures. The advanced approaches consist of the Advanced Internal Ratings-Based Approach used for the calculation of RWA related to credit risk, and the Advanced Measurement Approach used for the calculation of RWA related to operational risk.As required by the Dodd-Frank Act enacted in 2010, we and State Street Bank, as advanced approaches banking organizations, are subject to a "capital floor," also referred to as the Collins Amendment, in the assessment of our regulatory capital adequacy, such that our risk-based capital ratios for regulatory assessment purposes are the lower of each ratio calculated under the advanced approaches and the standardized approach. Under the advanced approaches, State Street and State Street Bank are subject to a 2.5% CCB requirement, plus any applicable countercyclical capital buffer requirement, which is currently set at 0%. Under the standardized approach, State Street Bank is subject to the same CCB and countercyclical capital buffer requirements, but for State Street, the 2.5% CCB requirement is replaced by the SCB requirement according to the SCB rule issued in 2020. In addition, State Street is subject to a G-SIB surcharge.The SCB replaced, under the standardized approach, the CCB with a buffer calculated as the difference between the institution’s starting and lowest projected CET1 ratio under the CCAR severely adverse scenario plus planned common stock dividend payments (as a percentage of RWA) from the fourth through seventh quarter of the CCAR planning horizon. The SCB requirement can be no less than 2.5% of RWA. Breaching the SCB or other regulatory buffer or surcharge will limit a banking organization’s ability to make capital distributions and discretionary bonus payments to executive officers. The countercyclical capital buffer is currently set at zero by U.S. banking regulators.Our minimum risk-based capital ratios as of January 1, 2022 include a CCB of 2.5% and a SCB of 2.5% for the advanced approaches and standardized approach, respectively, a G-SIB surcharge of 1.0%, and a countercyclical buffer of 0.0%. This results in minimum risk-based ratios of 8.0% for the Common Equity Tier 1 (CET1) capital ratio, 9.5% for the tier 1 capital ratio, and 11.5% for the total capital ratio.Our current G-SIB surcharge, through December 31, 2023, is 1.0%. Based upon preliminary calculations using data as of December 31, 2022, we currently anticipate that our surcharge will remain at 1% through December 31, 2024; however, that calculation has not yet been finalized and is subject to many financial, balance sheet, market and other factors, and consequently there is a risk that a higher G-SIB surcharge of 1.5% will result from the final calculation. State Street Corporation | 112MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSTo maintain the status of the Parent Company as a financial holding company, we and our insured depository institution subsidiaries are required, among other requirements, to be "well capitalized" as defined by Regulation Y and Regulation H.The market risk capital rule requires us to use internal models to calculate daily measures of VaR, which reflect general market risk for certain of our trading positions defined by the rule as “covered positions,” as well as stressed-VaR measures to supplement the VaR measures. The rule also requires a public disclosure composed of qualitative and quantitative information about the market risk associated with our trading activities and our related VaR and stressed-VaR measures. The qualitative and quantitative information required by the rule is provided under "Market Risk Management" included in this Management's Discussion and Analysis.The following table presents the regulatory capital structure and related regulatory capital ratios for us and State Street Bank as of the dates indicated. We are subject to the more stringent of the risk-based capital ratios calculated under the standardized approach and those calculated under the advanced approaches in the assessment of our capital adequacy under applicable bank regulatory standards.TABLE 39: REGULATORY CAPITAL STRUCTURE AND RELATED REGULATORY CAPITAL RATIOSState Street CorporationState Street Bank(Dollars in millions)Basel III Advanced Approaches December 31, 2022Basel III Standardized Approach December 31, 2022Basel III Advanced Approaches December 31, 2021Basel III Standardized Approach December 31, 2021Basel III Advanced Approaches December 31, 2022Basel III Standardized Approach December 31, 2022Basel III Advanced Approaches December 31, 2021Basel III Standardized Approach December 31, 2021 Common shareholders' equity:Common stock and related surplus$11,234 $11,234 $11,291 $11,291 $13,033 $13,033 $13,047 $13,047 Retained earnings27,028 27,028 25,238 25,238 16,975 16,975 15,700 15,700 Accumulated other comprehensive income (loss)(3,711)(3,711)(1,133)(1,133)(3,428)(3,428)(926)(926)Treasury stock, at cost(11,336)(11,336)(10,009)(10,009)— — — — Total23,215 23,215 25,387 25,387 26,580 26,580 27,821 27,821 Regulatory capital adjustments:Goodwill and other intangible assets, net of associated deferred tax liabilities (8,545)(8,545)(8,935)(8,935)(8,288)(8,288)(8,667)(8,667)Other adjustments(1)(123)(123)(505)(505)(19)(19)(309)(309) Common equity tier 1 capital14,547 14,547 15,947 15,947 18,273 18,273 18,845 18,845 Preferred stock1,976 1,976 1,976 1,976 — — — — Tier 1 capital16,523 16,523 17,923 17,923 18,273 18,273 18,845 18,845 Qualifying subordinated long-term debt1,376 1,376 1,588 1,588 542 542 752 752 Allowance for credit losses— 120 — 108 — 120 — 108 Total capital$17,899 $18,019 $19,511 $19,619 $18,815 $18,935 $19,597 $19,705 Risk-weighted assets:Credit risk(2)$61,108 $105,739 $63,735 $109,554 $54,675 $104,184 $57,405 $106,405 Operational risk(3)42,763 NA45,550 NA42,325 NA42,813 NAMarket risk1,488 1,488 2,113 2,113 1,488 1,488 2,113 2,113 Total risk-weighted assets$105,359 $107,227 $111,398 $111,667 $98,488 $105,672 $102,331 $108,518 Capital Ratios:2022 Minimum Requirements Including Capital Conservation Buffer and G-SIB Surcharge(4)2021 Minimum Requirements Including Capital Conservation Buffer and G-SIB Surcharge(4)Common equity tier 1 capital8.0 %8.0 %13.8 %13.6 %14.3 %14.3 %18.6 %17.3 %18.4 %17.4 %Tier 1 capital9.5 9.5 15.7 15.4 16.1 16.1 18.6 17.3 18.4 17.4 Total capital11.5 11.5 17.0 16.8 17.5 17.6 19.1 17.9 19.2 18.2 (1) Other adjustments within CET1 capital include accumulated other comprehensive income (loss) on cash flow hedges that are not recognized at fair value on the balance sheet, the overfunded portion of our defined benefit pension plan obligation net of associated deferred tax liabilities, disallowed deferred tax assets, and other required credit risk-based deductions. (2) Under the advanced approaches, credit risk RWA includes a CVA which reflects the risk of potential fair value adjustments for credit risk reflected in our valuation of over-the-counter (OTC) derivative contracts. We used a simple CVA approach in conformity with the Basel III advanced approaches.(3) Under the current advanced approaches rules and regulatory guidance concerning operational risk models, RWA attributable to operational risk can vary substantially from period-to-period, without direct correlation to the effects of a particular loss event on our results of operations and financial condition and impacting dates and periods that may differ from the dates and periods as of and during which the loss event is reflected in our financial statements, with the timing and categorization dependent on the processes for model updates and, if applicable, model revalidation and regulatory review and related supervisory processes. An individual loss event can have a significant effect on the output of our operational RWA under the advanced approaches depending on the severity of the loss event and its categorization among the seven Basel-defined UOMs. (4) Minimum requirements include a CCB of 2.5% and a SCB of 2.5% for the advanced approaches and the standardized approach, respectively, a G-SIB surcharge of 1.0% and a countercyclical capital buffer of 0%.NA Not applicable State Street Corporation | 113MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSOur CET1 capital decreased $1.40 billion as of December 31, 2022 compared to December 31, 2021, primarily reflecting lower AOCI from unrealized losses related to AFS securities, largely recognized in the first half of 2022 driven by the significant increase in rates across the yield curve and the resumption of common share repurchases in the fourth quarter of 2022, partially offset by net income. We utilize a hedging program that is designed to minimize volatility in our capital ratios due to impacts of foreign exchange translation on both the numerator (capital) and denominator (RWA and leverage assets). This hedging program, which includes net investment hedging with derivatives, investing in foreign currency and capital repatriation, was generally effective in 2022, contributing to limit the foreign exchange translation impact on CET1 capital ratio. Our Tier 1 capital decreased $1.40 billion as of December 31, 2022 compared to December 31, 2021 under both the advanced approaches and standardized approach, primarily due to the decrease in CET1 capital.Our Tier 2 capital decreased under the advanced approaches and standardized approach, as of December 31, 2022 compared to December 31, 2021, by $0.21 billion and $0.20 billion, respectively, mainly driven by the maturity of our Tier 2 qualifying debt.Total capital decreased under the advanced approaches and standardized approach, as of December 31, 2022 compared to December 31, 2021, by $1.61 billion and $1.60 billion, respectively, mainly driven by the decrease in CET1 capital.The table below presents a roll-forward of CET1 capital, Tier 1 capital and total capital for the years ended December 31, 2022 and 2021.TABLE 40: CAPITAL ROLL-FORWARD(In millions)Basel III Advanced Approaches December 31, 2022Basel III Standardized Approach December, 31, 2022Basel III Advanced Approaches December 31, 2021Basel III Standardized Approach December 31, 2021Common equity tier 1 capital:Common equity tier 1 capital balance, beginning of period$15,947 $15,947 $14,377 $14,377 Net income2,774 2,774 2,693 2,693 Changes in treasury stock, at cost(1,327)(1,327)600 600 Dividends declared(984)(984)(897)(897)Goodwill and other intangible assets, net of associated deferred tax liabilities390 390 84 84 Accumulated other comprehensive income (loss)(1)(2,578)(2,578)(1,320)(1,320)Other adjustments(1)325 325 410 410 Changes in common equity tier 1 capital(1,400)(1,400)1,570 1,570 Common equity tier 1 capital balance, end of period14,547 14,547 15,947 15,947 Additional tier 1 capital:Tier 1 capital balance, beginning of period17,923 17,923 16,848 16,848 Changes in common equity tier 1 capital(1,400)(1,400)1,570 1,570 Net issuance (redemption) of preferred stock— — (495)(495)Changes in tier 1 capital(1,400)(1,400)1,075 1,075 Tier 1 capital balance, end of period16,523 16,523 17,923 17,923 Tier 2 capital:Tier 2 capital balance, beginning of period1,588 1,696 962 1,109 Net issuance (redemption) and changes in long-term debt qualifying as tier 2 capital(212)(212)627 627 Changes in allowance for credit losses— 12 (1)(40)Changes in tier 2 capital(212)(200)626 587 Tier 2 capital balance, end of period1,376 1,496 1,588 1,696 Total capital:Total capital balance, beginning of period19,511 19,619 17,810 17,957 Changes in tier 1 capital(1,400)(1,400)1,075 1,075 Changes in tier 2 capital(212)(200)626 587 Total capital balance, end of period$17,899 $18,019 $19,511 $19,619 (1) Accumulated other comprehensive income (loss) includes losses on cash flow hedges where the hedged exposures are not recognized at fair value on the balance sheet, which, under the Capital Rule, must be excluded from CET1 capital. This adjustment is captured in the Other Adjustments line. State Street Corporation | 114MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSThe following table presents a roll-forward of the Basel III advanced approaches and standardized approach RWA for the years ended December 31, 2022 and 2021.TABLE 41: ADVANCED & STANDARDIZED APPROACHES RISK-WEIGHTED ASSETS ROLL-FORWARD(In millions)Basel III Advanced Approaches December 31, 2022Basel III Advanced Approaches December 31, 2021Basel III Standardized Approach December 31, 2022Basel III Standardized Approach December 31, 2021Total risk-weighted assets, beginning of period$111,398 $109,705 $111,667 $117,080 Changes in credit risk-weighted assets:Net increase (decrease) in investment securities-wholesale(4,850)(476)(3,591)(707)Net increase (decrease) in loans (3,054)2,017 (5,387)946 Net increase (decrease) in securitization exposures(5)(404)(5)(489)Net increase (decrease) in repo-style transaction exposures(1,420)(440)(5,157)(1,658)Net increase (decrease) in over-the-counter derivatives exposures(1)2,161 (1,353)6,295 (863)Net increase (decrease) in all other(2)4,541 1,024 4,030 (2,567)Net increase (decrease) in credit risk-weighted assets(2,627)368 (3,815)(5,338)Net increase (decrease) in market risk-weighted assets(625)(75)(625)(75)Net increase (decrease) in operational risk-weighted assets(2,787)1,400 N/AN/ATotal risk-weighted assets, end of period$105,359 $111,398 $107,227 $111,667 (1) Under the advanced approaches, includes CVA RWA.(2) Includes assets not in a definable category, non-material portfolio, cleared transactions, other wholesale, cash and due from banks, interest-bearing deposits with banks and equity exposures.NA Not applicable.As of December 31, 2022, total advanced approaches RWA decreased $6.04 billion compared to December 31, 2021, mainly driven by a decrease in operational risk and credit risk RWA. The decrease in operational risk RWA was primarily due to a decrease in the frequency of certain operational loss events. The decrease in credit risk RWA was primarily driven by a net decrease in wholesale investment securities, loans, and repo-style transactions RWA, partially offset by an increase in all other and OTC derivatives RWA. As of December 31, 2022, total standardized approach RWA decreased $4.44 billion compared to December 31, 2021, mainly driven by a decrease in credit risk RWA. The decrease in credit risk RWA was primarily driven by a net decrease in loans, repo-style transactions, and wholesale investment securities RWA, partially offset by an increase in OTC derivatives and all other RWA.The regulatory capital ratios as of December 31, 2022, presented in Table 39: Regulatory Capital Structure and Related Regulatory Capital Ratios, are calculated under the advanced approaches and standardized approach in conformity with the Basel III final rule. The advanced approaches based ratios reflect calculations and determinations with respect to our capital and related matters as of December 31, 2022, based on our and external data, quantitative formulae, statistical models, historical correlations and assumptions, collectively referred to as “advanced systems,” in effect and used by us for those purposes as of the time we first reported such ratios in a quarterly report on Form 10-Q or an annual report on Form 10-K. Significant components of these advanced systems involve the exercise of judgment by us and our regulators, and our advanced systems may not, individually or collectively, precisely represent or calculate the scenarios, circumstances, outputs or other results for which they are designed or intended. Our advanced systems are subject to update and periodic revalidation in response to changes in our business activities and our historical experiences, forces and events experienced by the market broadly or by individual financial institutions, changes in regulations and regulatory interpretations and other factors, and are also subject to continuing regulatory review and approval. For example, a significant operational loss experienced by another financial institution, even if we do not experience a related loss, could result in a material change in the output of our advanced systems and a corresponding material change in our risk exposures, our total RWA, and our capital ratios compared to prior periods. An operational loss that we experience could also result in a material change in our capital requirements for operational risk under the advanced approaches, depending on the severity of the loss event, its characterization among the seven Basel-defined UOM, and the stability of the distributional approach for a particular UOM, and without direct correlation to the effects of the loss event, or the timing of such effects, on our results of operations.Due to the influence of changes in these advanced systems, whether resulting from changes in data inputs, regulation or regulatory supervision or interpretation, specific to us or market activities or experiences or other updates or factors, we expect that our advanced systems and our capital ratios calculated in conformity with the Basel III final rule will change and may be volatile over time, and that those latter changes or volatility could be material as calculated and measured from period to period. We and State Street Bank are subject to further regulatory guidance, action, and rule-making. State Street Corporation | 115MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSTier 1 and Supplementary Leverage RatiosWe are subject to a minimum Tier 1 leverage ratio and a supplementary leverage ratio. The Tier 1 leverage ratio is based on Tier 1 capital and adjusted quarterly average on-balance sheet assets. The Tier 1 leverage ratio differs from the SLR primarily in that the denominator of the Tier 1 leverage ratio is a quarterly average of on-balance sheet assets, while the SLR additionally includes off-balance sheet exposures. We must maintain a minimum Tier 1 leverage ratio of 4%.We are also subject to a minimum SLR of 3%, and as a U.S. G-SIB, we must maintain a 2% SLR buffer in order to avoid any limitations on distributions to shareholders and discretionary bonus payments to certain executives. If we do not maintain this buffer, limitations on these distributions and discretionary bonus payments would be increasingly stringent based upon the extent of the shortfall. TABLE 42: TIER 1 AND SUPPLEMENTARY LEVERAGE RATIOS(Dollars in millions)December 31, 2022December 31, 2021State Street:Tier 1 capital$16,523 $17,923 Average assets284,346 303,007 Less: adjustments for deductions from tier 1 capital and other(8,668)(9,440)Adjusted average assets for Tier 1 leverage ratio275,678 293,567 Additional SLR exposure40,126 32,985 Adjustments for deductions of qualifying central bank deposits(78,455)(84,113)Total assets for SLR$237,349 $242,439 Tier 1 leverage ratio(1)6.0 %6.1 %Supplementary leverage ratio7.0 7.4 State Street Bank(2):Tier 1 capital$18,273 $18,845 Average assets281,527 299,379 Less: adjustments for deductions from tier 1 capital and other(8,307)(8,976)Adjusted average assets for Tier 1 leverage ratio273,220 290,403 Additional SLR exposure42,043 32,985 Adjustments for deductions of qualifying central bank deposits(78,455)(84,113)Total assets for SLR$236,808 $239,275 Tier 1 leverage ratio (1)6.7 %6.5 %Supplementary leverage ratio7.7 7.9 (1) Tier 1 leverage ratios were calculated in conformity with the Basel III final rule.(2) The SLR rule requires that, as of January 1, 2018, (i) State Street Bank maintains an SLR of at least 6.0% to be well capitalized under the U.S. banking regulators’ Prompt Corrective Action Framework and (ii) we maintain an SLR of at least 5.0% to avoid limitations on capital distributions and discretionary bonus payments. In addition to the SLR, State Street Bank is subject to a well capitalized Tier 1 leverage ratio requirement of 5.0%.Total Loss-Absorbing Capacity (TLAC)The Federal Reserve's final rule on TLAC, LTD and clean holding company requirements for U.S. domiciled G-SIBs, such as us, is intended to improve the resiliency and resolvability of certain U.S. banking organizations through enhanced prudential standards, and requires us, among other things, to comply with minimum requirements for external TLAC (combined eligible tier 1 regulatory capital and LTD) and LTD. Specifically, we must hold: Amount equal to:External TLACGreater of:•21.5% of total RWA (18.0% minimum plus 2.5% plus a G-SIB surcharge calculated for these purposes under Method 1 of 1.0% plus any applicable counter- cyclical buffer, which is currently 0%); and •9.5% of total leverage exposure (7.5% minimum plus the SLR buffer of 2.0%), as defined by the SLR final rule.Qualifying external LTDGreater of:•7.0% of RWA (6.0% minimum plus a G-SIB surcharge calculated for these purposes under method 2 of 1.0%); and •4.5% of total leverage exposure, as defined by the SLR final rule.As of April 1, 2020, the TLAC and LTD requirements calibrated to the SLR denominator reflect the deduction of certain central bank balances as prescribed by the regulatory relief implemented under the EGRRCPA.The following table presents external LTD and external TLAC as of December 31, 2022.TABLE 43: TOTAL LOSS-ABSORBING CAPACITYAs of December 31, 2022(Dollars in millions)ActualRequirementTotal loss-absorbing capacity:Risk-weighted assets$29,676 27.7 %$23,054 21.5 %Total leverage exposure29,676 12.5 22,548 9.5 Long-term debt:Risk-weighted assets12,403 11.6 7,506 7.0 Total leverage exposure12,403 5.2 10,681 4.5 Additional information about TLAC is provided under "Total Loss-Absorbing Capacity" in "Supervision and Regulation" in Business in this Form 10-K. State Street Corporation | 116MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSRegulatory DevelopmentsIn April 2018, the Federal Reserve issued a proposed rule which would replace the current 2.0% SLR buffer for G-SIBs, with a buffer equal to 50% of their G-SIB surcharge. This proposal would also make conforming modifications to our TLAC and eligible LTD requirements applicable to G-SIBs. At this point in time, it is unclear whether this proposal will be implemented as proposed.In November 2019, the Federal Reserve and other U.S. federal banking agencies issued a final rule that, among other things, implemented the SA-CCR, a methodology for calculating the exposure amount for derivative contracts. Under the final rule, which became effective on January 1, 2022, we have the option to use the SA-CCR or the IMM to measure the exposure amount of our cleared and uncleared derivative transactions under our advanced approaches calculation. We have elected to use the SA-CCR for purposes of our advanced approach capital calculations. We are required to determine the amount of these exposures using the SA-CCR under our standardized approach capital calculation. Additionally, we have to apply a revised formula to determine the RWA amount of our central counterparty default fund contributions. On March 4, 2020, the U.S. federal banking agencies issued the SCB final rule that replaces, under the standardized approach, the capital conservation buffer (2.5%) with a SCB calculated as the difference between an institution’s starting and lowest projected CET1 ratio under the CCAR severely adverse scenario plus planned common stock dividend payments (as a percentage of RWA) from the fourth through seventh quarter of the CCAR planning horizon.The Federal Reserve and other U.S. federal banking agencies issued an interim final rule effective in March 2020 and later finalized on a permanent basis on August 26, 2020, which revised the definition of eligible retained income for all U.S. banking organizations. The revised definition of eligible retained income makes any automatic limitations on capital distributions, where a banking organization's regulatory ratios were to decline below the respective minimum requirements, take effect on a more gradual basis.Effective April 1, 2020, the Federal Reserve and other U.S. federal banking agencies adopted a final rule under EGRRCPA that establishes a deduction for qualifying central bank deposits from a custodial banking organization’s total leverage exposure equal to the lesser of (i) the total amount of funds the custodial banking organization and its consolidated subsidiaries have on deposit at qualifying central banks and (ii) the total amount of client funds on deposit at the custodial banking organization that are linked to fiduciary or custodial and safekeeping accounts. For the quarter ended December 31, 2022, we deducted $78.5 billion of average balances held on deposit at central banks from the denominator used in the calculation of our SLR, based on this custodial banking deduction.On October 20, 2020, the Federal Reserve and other U.S. federal banking agencies issued a final rule that requires us and State Street Bank to make certain deductions from regulatory capital for investments in certain unsecured debt instruments, including eligible LTD under the TLAC rule, issued by the Parent Company and other U.S. and foreign G-SIBs. The final rule became effective on April 1, 2021.On June 23, 2022, we were notified by the Federal Reserve of the results from the 2022 supervisory stress test. Our SCB calculated under this supervisory stress test was well below the 2.5% minimum, resulting in an SCB at that floor, which was effective starting October 1, 2022 and will run through September 30, 2023. On September 7, 2022, the Federal Reserve's Vice Chair For Supervision stated that the Federal Reserve was undertaking a holistic review of U.S. capital requirements that will help the regulator consider adjustments to the current framework. In addition, on September 9, 2022, the U.S. Banking Agencies reaffirmed their commitment to implementing revised regulatory capital requirements that align with the final set of Basel III standards (Basel IV package) issued by the Basel Committee on Banking Supervision in December 2017. They intend to seek public comments on a joint proposed rule in the coming months.For additional information about regulatory developments, refer to the "Regulatory Capital Adequacy and Liquidity Standards" section of "Supervision and Regulation" in Business in this Form 10-K. State Street Corporation | 117MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSCapital ActionsPreferred StockThe following table summarizes selected terms of each of the series of the preferred stock issued and outstanding as of December 31, 2022:TABLE 44: PREFERRED STOCK ISSUED AND OUTSTANDINGPreferred Stock(1):Issuance DateDepositary Shares IssuedAmount outstanding (in millions)Ownership Interest Per Depositary ShareLiquidation Preference Per ShareLiquidation Preference Per Depositary SharePer Annum Dividend RateDividend Payment FrequencyCarrying Value as of December 31, 2022 (In millions)Redemption Date(2)Series D(3)February 201430,000,000 $750 1/4,000th$100,000 $25 5.90% to but excluding March 15, 2024, then a floating rate equal to the three-month LIBOR plus 3.108%Quarterly: March, June, September and December$742 March 15, 2024Series F(4)(5)May 2015250,000 2501/100th100,000 1,000 5.25% to but excluding September 15, 2020, then a floating rate equal to the three-month LIBOR plus 3.597%, or 8.366% effective December 15, 2022Quarterly: March, June, September and December247 September 15, 2020Series G(6)April 201620,000,000 5001/4,000th100,000 25 5.35% to but excluding March 15, 2026, then a floating rate equal to the three-month LIBOR plus 3.709%Quarterly: March, June, September and December493 March 15, 2026Series H(7)September 2018500,000 5001/100th100,000 1,000 5.625% to but excluding December 15, 2023, then a floating rate equal to the three-month LIBOR plus 2.539%Semi-annually: June and December494 December 15, 2023(1) The preferred stock and corresponding depositary shares may be redeemed at our option in whole, but not in part, prior to the redemption date upon the occurrence of a regulatory capital treatment event, as defined in the certificate of designation, at a redemption price equal to the liquidation price per share and liquidation price per depositary share plus any declared and unpaid dividends, without accumulation of any undeclared dividends.(2) On the redemption date, or any dividend payment date thereafter, the preferred stock and corresponding depositary shares may be redeemed by us, in whole or in part, at the liquidation price per share and liquidation price per depositary share plus any declared and unpaid dividends, without accumulation of any undeclared dividends.(3) The dividend rate for the floating rate period of the Series D preferred stock that begins on March 15, 2024 and all subsequent floating rate periods will transition to a new, fixed rate in accordance with the LIBOR Act and the contractual terms of the Series D preferred stock. (4) Series F preferred stock is redeemable on September 15, 2020 and on each succeeding dividend payment date.(5) In accordance with the LIBOR Act, the benchmark interest rate used to calculate the dividend rate of the Series F preferred stock issued and outstanding will transition from LIBOR to CME Term SOFR, plus 0.26161%, beginning with the September 15, 2023 dividend period.(6) The dividend rate for the floating rate period of the Series G preferred stock that begins on March 15, 2026 and all subsequent floating rate periods will remain at the current fixed rate in accordance with the LIBOR Act and the contractual terms of the Series G preferred stock. (7) In accordance with the LIBOR Act, the benchmark interest rate to be used to calculate the dividend rate during the floating rate period of the Series H preferred stock that begins on December 15, 2023 will transition from LIBOR to CME Term SOFR, plus 0.26161%.On March 15, 2021, we redeemed an aggregate of $500 million, or 5,000 of the 7,500 outstanding shares of our non-cumulative perpetual preferred stock, Series F, for cash at a redemption price of $100,000 per share (equivalent to $1,000 per depositary share) plus all declared and unpaid dividends. The following table presents the dividends declared for each of the series of preferred stock issued and outstanding for the periods indicated:TABLE 45: PREFERRED STOCK DIVIDENDSYears Ended December 31, 20222021(Dollars in millions, except per share amounts)Dividends Declared per ShareDividends Declared per Depositary ShareTotalDividends Declared per ShareDividends Declared per Depositary ShareTotalPreferred Stock:Series D$5,900 $1.48 $44 $5,900 $1.48 $44 Series F5,208 52.08 13 3,808 38.08 15 Series G5,352 1.32 27 5,352 1.32 27 Series H5,625 56.25 28 5,625 56.25 28 Total$112 $114 State Street Corporation | 118MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSCommon StockIn July 2021, our Board approved a share repurchase program authorizing the purchase of up to $3.0 billion of our common stock through the end of 2022. We did not repurchase any common stock during the first three quarters of 2022. In October 2022, we resumed our share repurchases and purchased $1.5 billion of our common stock in the fourth quarter of 2022 under the 2021 Program. In January 2023, our Board approved a share repurchase program authorizing the purchase of up to $4.5 billion of our common stock through December 31, 2023. The table below presents the activity under our common share repurchase program for the period indicated:TABLE 46: SHARES REPURCHASEDYear Ended December 31,2022Shares Acquired (In millions)Average Cost per ShareTotal Acquired (In millions)2021 Program19.5 $76.81 $1,500 The table below presents the dividends declared on common stock for the periods indicated:TABLE 47: COMMON STOCK DIVIDENDSYears Ended December 31, 20222021Dividends Declared per ShareTotal(In millions)Dividends Declared per ShareTotal(In millions)Common Stock$2.40 $871 $2.18 $779 Federal and state banking regulations place certain restrictions on dividends paid by subsidiary banks to the parent holding company. In addition, banking regulators have the authority to prohibit bank holding companies from paying dividends. For information concerning limitations on dividends from our subsidiary banks, refer to "Related Stockholder Matters" included under Item 5, Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, and to Note 15 to the consolidated financial statements in this Form 10-K. Our common stock and preferred stock dividends, including the declaration, timing and amount thereof, are subject to consideration and approval by the Board at the relevant times.Stock purchases under our common share repurchase program may be made using various types of transactions, including open market purchases, accelerated share repurchases or other transactions off the market, and may be made under Rule 10b5-1 trading programs. The timing and amount of any stock purchases and the type of transaction may not be ratable over the duration of the program, may vary from reporting period to reporting period and will depend on several factors, including our capital position and our financial performance, investment opportunities, market conditions, the nature and timing of implementation of revisions to the Basel III framework and the amount of common stock issued as part of employee compensation programs. The common share repurchase program does not have specific price targets and may be suspended at any time. State Street Corporation | 119MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSOFF-BALANCE SHEET ARRANGEMENTSOn behalf of clients enrolled in our securities lending program, we lend securities to banks, broker/dealers and other institutions. In most circumstances, we indemnify our clients for the fair market value of those securities against a failure of the borrower to return such securities. Though these transactions are collateralized, the substantial volume of these activities necessitates detailed credit-based underwriting and monitoring processes. The aggregate amount of indemnified securities on loan totaled $348.92 billion and $385.74 billion as of December 31, 2022 and 2021, respectively. We require the borrower to provide collateral in an amount in excess of 100% of the fair market value of the securities borrowed. We hold the collateral received in connection with these securities lending services as agent, and the collateral is not recorded in our consolidated statement of condition. We revalue the securities on loan and the collateral daily to determine if additional collateral is necessary or if excess collateral is required to be returned to the borrower. We held, as agent, cash and securities totaling $366.90 billion and $404.12 billion as collateral for indemnified securities on loan as of December 31, 2022 and 2021, respectively.The cash collateral held by us as agent is invested on behalf of our clients. In certain cases, the cash collateral is invested in third-party repurchase agreements, for which we indemnify the client against loss of the principal invested. We require the counterparty to the indemnified repurchase agreement to provide collateral in an amount in excess of 100% of the amount of the repurchase agreement. In our role as agent, the indemnified repurchase agreements and the related collateral held by us are not recorded in our consolidated statement of condition. Of the collateral of $366.90 billion and $404.12 billion, referenced above, $54.11 billion and $61.56 billion was invested in indemnified repurchase agreements as of December 31, 2022 and 2021, respectively. We or our agents held $57.90 billion and $67.01 billion as collateral for indemnified investments in repurchase agreements as of December 31, 2022 and 2021, respectively.Additional information about our securities finance activities and other off-balance sheet arrangements is provided in Notes 10, 12 and 14 to the consolidated financial statements in this Form 10-K.SIGNIFICANT ACCOUNTING ESTIMATESOur consolidated financial statements are prepared in conformity with U.S. GAAP, and we apply accounting policies that affect the determination of amounts reported in the consolidated financial statements. Certain of our accounting policies, by their nature, require management to make judgments, involving significant estimates and assumptions, about the effects of matters that are inherently uncertain. These estimates and assumptions are based on information available as of the date of the consolidated financial statements, and changes in this information over time could materially affect the amounts of assets, liabilities, equity, revenue and expenses reported in subsequent consolidated financial statements. Based on the sensitivity of reported financial statement amounts to the underlying estimates and assumptions, the more significant accounting policies identified by management are:•Recurring fair value measurements;•Allowance for credit losses;•Impairment of goodwill and other intangible assets; and•Contingencies. These policies require the most subjective or complex judgments, and underlying estimates and assumptions could be most subject to revision as new information becomes available. An understanding of the judgments, estimates and assumptions underlying these accounting policies is essential to the understanding of our reported results of operations and financial condition. The following is a discussion of the above-mentioned significant accounting estimates. Additional information on our significant accounting policies, including references to applicable footnotes, is provided in Note 1 to the consolidated financial statements in this Form 10-K. Fair Value Measurements We carry certain of our financial assets and liabilities at fair value in our consolidated financial statements on a recurring basis, including trading account assets and liabilities, AFS debt securities, certain equity securities and various types of derivative financial instruments. Changes in the fair value of these financial assets and liabilities are recorded either as components of our consolidated statement of income or as components of other comprehensive income within shareholders' equity in our consolidated statement of condition. In addition to those financial assets and liabilities that we carry at fair value in our consolidated financial statements on a recurring basis, we estimate the fair values of other financial assets and liabilities that we carry at amortized cost in our consolidated statement of condition, and we disclose these fair value estimates in the notes to our consolidated financial statements. We estimate the State Street Corporation | 120MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSfair values of these financial assets and liabilities using the definition of fair value described below. U.S. GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants on the measurement date. When we measure fair value for our financial assets and liabilities, we consider the principal or the most advantageous market in which we would transact; we also consider assumptions that market participants would use when pricing the asset or liability. When possible, we look to active and observable markets to measure the fair value of identical, or similar, financial assets and liabilities. When identical financial assets and liabilities are not traded in active markets, we look to market-observable data for similar assets and liabilities. In some instances, certain assets and liabilities are not actively traded in observable markets; as a result, we use alternate valuation techniques to measure their fair value. We categorize the financial assets and liabilities that we carry at fair value in our consolidated statement of condition on a recurring basis based on U.S. GAAP's prescribed three-level valuation hierarchy. The hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (level 1) and the lowest priority to valuation methods using significant unobservable inputs (level 3). With respect to derivative instruments, we evaluate the fair value impact of the credit risk of our counterparties. We consider such factors as the market-based probability of default by our counterparties, and our current and expected potential future net exposures by remaining maturities, in determining the appropriate measurements of fair value. Additional information with respect to the assets and liabilities carried by us at fair value on a recurring basis is provided in Note 2 to the consolidated financial statements in this Form 10-K. Allowance for Credit LossesWe record an allowance for credit losses related to certain on-balance sheet credit exposures, including our financial assets held at amortized cost, as well as certain off-balance sheet credit exposures, including unfunded commitments and letters of credit. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods, factors and forecasts then prevailing may result in significant changes in the allowance for credit losses in those future periods. We estimate credit losses over the contractual life of the financial asset while factoring in prepayment activity where supported by data over a three year reasonable and supportable forecast period. We utilize baseline, upside and downside scenarios that are applied based on a probability weighting, in order to better reflect management’s expectation of expected credit losses given existing market conditions and the changes in the economic environment. The multiple scenarios are based on a three year horizon (or less depending on contractual maturity) and then revert linearly over a two year period to a ten-year historical average thereafter. The contractual term excludes expected extensions, renewals and modifications, but includes prepayment assumptions where applicable. Our allowance for credit losses is sensitive to a number of inputs, including macroeconomic forecast assumptions and credit rating migrations during the period. Our macroeconomic forecasts used in determining the December 31, 2022 allowance for credit losses consisted of three scenarios reflecting contractions in GDP and rising unemployment of varying severity, with the baseline scenario generally in line with market consensus of economic forecasts for GDP and unemployment. We placed the most weight on our baseline scenario, with the remaining weighting split equally between the upside and downside scenarios. Keeping all other factors constant, we estimate that if we had applied 100% weighting to the downside scenario, the allowance for credit losses as of December 31, 2022 would have been approximately $67 million higher. This estimate is intended to reflect the sensitivity of the allowance for credit losses to changes in our scenario weights and is not intended to be indicative of future changes in the allowance for credit losses. Additional information about our allowance for credit losses is provided in Notes 3 and 4 to the consolidated financial statements in this Form 10-K. State Street Corporation | 121MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSGoodwill and Other Intangible Assets Goodwill represents the excess of the cost of an acquisition over the fair value of the net tangible and other intangible assets acquired at the acquisition date. Other intangible assets represent purchased long-lived intangible assets, primarily client relationships, core deposit intangible assets and technology that can be distinguished from goodwill because of contractual rights or because the asset can be exchanged on its own or in combination with a related contract, asset or liability. Other intangible assets are initially measured at their acquisition date fair value, the determination of which requires management judgment. Goodwill is not amortized, while other intangible assets are amortized over their estimated useful lives.Management reviews goodwill for impairment annually or more frequently if circumstances arise or events occur that indicate an impairment of the carrying amount may exist. We begin our review by first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Events that may indicate impairment include: significant or adverse changes in the business, economic or political climate; an adverse action or assessment by a regulator; unanticipated competition; and a more-likely-than-not expectation that we will sell or otherwise dispose of a business to which the goodwill or other intangible assets relate. If we conclude from the qualitative assessment of goodwill impairment that it is more likely than not that a reporting unit’s fair value is greater than its carrying amount, quantitative tests are not required. However, if we determine it is more likely than not that a reporting unit’s fair value is less than its carrying amount, then we complete a quantitative assessment to determine if there is goodwill impairment. We may elect to bypass the qualitative assessment and complete a quantitative assessment in any given year.In 2022, we assessed goodwill for impairment using a qualitative assessment. Based on our evaluation of the qualitative factors noted above, we determined that it was more likely than not that the fair value of each of the reporting units exceeded its respective carrying amount. We determined there was no goodwill impairment in 2022.Other intangible assets are supported by the future cash flows that are directly associated with and expected to arise as a direct result of the use of the intangible asset, less any costs associated with the intangible asset’s eventual disposition. We evaluate other intangible assets for impairment at the lowest level for which there are identifiable cash flows that are largely independent of the cash flows from other groups of assets using the following process. First, we routinely assess whether impairment indicators are present. When impairment indicators are identified as being present, we compare the estimated future net undiscounted cash flows of the intangible asset with its carrying value. If the future net undiscounted cash flows are greater than the carrying value, then there is no impairment, but if the intangible asset's net undiscounted cash flows are less than its carrying value, we are required to calculate impairment. An impairment is recognized by writing the intangible asset down to its fair value. We evaluate intangible assets for indicators of impairment on a quarterly basis. There were no impairments taken on other intangible assets in 2022.Additional information about goodwill and other intangible assets, including information by line of business, is provided in Note 5 to the consolidated financial statements in this Form 10-K. ContingenciesInformation on significant estimates and judgments related with establishing litigation reserves is discussed in Note 13 of the consolidated financial statements in this Form 10-K.RECENT ACCOUNTING DEVELOPMENTSInformation with respect to recent accounting developments is provided in Note 1 to the consolidated financial statements in this Form 10-K. OTHER MATTERSReplacement of Interbank Offered Rates including LIBOROn March 5, 2021, the Intercontinental Exchange Benchmark Administration (IBA) announced, in conjunction with the United Kingdom Financial Conduct Authority (FCA), that it would cease the publication of all EUR and Swiss Franc LIBOR settings, the overnight, one week, two week, two month and twelve month GBP LIBOR and Japanese yen (JPY) LIBOR settings, and the one week and two month USD LIBOR settings, as of December 31, 2021. Furthermore, the IBA announced that as of June 30, 2023, it would cease the publication of the overnight and twelve month USD LIBOR settings and that as of June 30, 2023 the one month, three month and six month USD LIBOR settings would become non-representative. On September 29, 2021, the FCA announced that it would compel the IBA to continue the publication of the one month, three month and six month GBP and JPY LIBOR settings, on a synthetic, non-representative basis from year-end 2021 for a period of at least one year. On June 30, 2022, the FCA issued a consultation on winding down synthetic tenors of GBP LIBOR and on the potential introduction of a synthetic version of certain USD LIBOR settings as of June 30, 2023. On September State Street Corporation | 122MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS29, 2022, the FCA confirmed the cessation of all synthetic JPY LIBOR settings as of December 31, 2022, and the cessation of the one month and six month synthetic GBP LIBOR settings as of March 30, 2023. On November 23, 2022, the FCA issued a proposal to compel publication of a synthetic version of the one month, three month and six month USD LIBOR settings until September 30, 2024, while also confirming that the publication of a synthetic version of the three month GBP LIBOR setting would end as of March 30, 2024. A final decision from the FCA on the status of a synthetic version of the one month, three month and six month USD LIBOR settings beyond June 30, 2023 is expected in early 2023.On March 15, 2022, the U.S. Congress adopted, as part of the Consolidated Appropriation Act of 2022, the Adjustable Interest Rate (LIBOR) Act which provides certain statutory requirements and guidance for the selection and use of alternative reference rates in legacy financial contracts governed by U.S. law that do not provide for the use of a clearly defined or practicable alternative reference rate. On July 19, 2022, the Federal Reserve issued a notice of proposed rulemaking on a proposal to implement the LIBOR Act, as required by its terms. On December 16, 2022, the Federal Reserve adopted a final rule implementing the LIBOR Act. The final rule is effective February 27, 2023.We have established a process to identify, assess, plan for and remediate the use of LIBOR and other reference rates affected by reference rate reform that addresses both direct exposures on our balance sheet, and, more importantly, the use of LIBOR in our various service provider roles to our customers. This process is led by a multidisciplinary LIBOR program management office (LIBOR PMO), established in September 2018. The LIBOR PMO will continue to drive firm-wide results throughout 2023. The LIBOR PMO reports regularly to executive management of the firm, and our key regulators, on progress with respect to the adoption of alternative reference rates for various financial products and services, client communications, updating of our quantitative models and information technology systems, managing third-party vendors, contracts remediation, evaluation of fallback provisions contained in LIBOR-priced loans, investment securities, derivatives and long-term debt and general operational readiness for each stage of the transition. Most of the LIBOR PMO's work for implementation of the transition to alternate reference rates is substantially complete, and contingency plans have been developed with respect to identified uncertainties. No incremental material investments are expected to be needed for systems and processes related to the transition. Potential risks that could impact our remediation efforts include overall transition readiness across the industry, third-party vendor dependencies and resource constraints from the concentration of remediation activities at key points in the transition process.Our direct on-balance sheet exposures to LIBOR are limited and primarily include assets held in the investment portfolio, certain loans made through Global Credit Finance and issuances of long-term debt and preferred stock. We have planned for, and are prepared to transition, our remaining balance sheet exposures in a manner consistent with regulatory guidance and the availability of interim solutions for various legacy LIBOR contracts. We will not originate or issue new LIBOR-based loans or long-term debt, and any purchases of LIBOR-based investment securities will be screened for adequate fallback language. Our remaining exposure outstanding at the end of June 2023 is largely governed by existing fallback language or the LIBOR Act which provides for appropriate fallback provisions. Substantial risks and uncertainties are associated with the market transition away from the use of LIBOR as an interest rate benchmark in financial instruments and contracts. Our financial performance depends, in part, on our ability to adapt to market changes promptly, while avoiding increased related expenses or operational errors. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKThe information provided under “Market Risk Management” in "Financial Condition" in our Management's Discussion and Analysis in this Form 10-K, is incorporated by reference herein.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended July 1, 2022, as filed with the SEC on August 5, 2022, for a discussion of our critical accounting policies and estimates.Recent Accounting PronouncementsSee “Part I, Item 1. Financial Statements—Note 1. Basis of Presentation and Summary of Significant Accounting Policies” for information regarding the effect of new accounting pronouncements on our financial statements.ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe have exposure to market risks due to the volatility of interest rates, foreign currency exchange rates, credit rating changes and equity and bond markets. A portion of these risks may be hedged, but fluctuations could impact our results of operations, financial position and cash flows.Interest Rate Risk. Our exposure to market risk for changes in interest rates relates primarily to our cash investment portfolio. As of December 30, 2022, we had no available-for-sale debt securities that had been in a continuous unrealized loss position for a period greater than 12 months. We determined no impairment related to credit losses for available-for-sale debt securities as of December 30, 2022. We have fixed rate and variable rate debt obligations. We enter into debt obligations for general corporate purposes including capital expenditures and working capital needs. Our Term Loans bear interest at a variable rate equal to SOFR plus a variable margin.We have entered into certain interest rate swap agreements to convert the variable interest rate on the Term Loans to fixed interest rates. The objective of the interest rate swap agreements is to eliminate the variability of interest payment cash flows associated with the variable interest rate under the Term Loans. We designated the interest rate swaps as cash flow hedges. As of December 30, 2022, the aggregate notional amount of the Company’s interest-rate swap contracts was $1.6 billion, of which $600 million will mature in September 2025 and $1.0 billion will mature in July 2027.The table below presents principal amounts and related fixed or weighted-average interest rates by year of maturity for our investment portfolio and debt obligations as of December 30, 2022. Fiscal Years EndedTotalFair Value at December 30, 2022(Dollars in millions, except percentages)20232024202520262027ThereafterAssets Money market funds, time deposits and certificates of depositFloating rate$174 $— $— $— $— $— $174 $174 Average interest rate4.36 %4.36 %Other debt securities Fixed rate$— $— $— $15 $— $1 $16 $16 Debt Fixed rate$540 $500 $479 $— $505 $2,276 $4,300 $4,057 Average interest rate4.75 %4.88 %4.75 %— %4.88 %6.18 %5.54 %Variable rate$68 $86 $137 $667 $144 $698 $1,800 $1,712 Average interest rate5.53 %5.48 %5.48 %5.63 %5.42 %5.47 %5.53 %38Table of ContentsForeign Currency Exchange Risk. From time to time, we may enter into foreign currency forward exchange contracts to manage exposure related to certain foreign currency commitments and anticipated foreign currency denominated expenditures. Our policy prohibits us from entering into derivative financial instruments for speculative or trading purposes. We hedge portions of our foreign currency denominated balance sheet positions with foreign currency forward exchange contracts to reduce the risk that our earnings will be adversely affected by changes in currency exchange rates. The change in fair value of these contracts is recognized in earnings in the same period as the gains and losses from the remeasurement of the assets and liabilities. All foreign currency forward exchange contracts mature within 12 months.We recognized a net loss of $12 million and a net gain of $6 million in Cost of revenue and Interest expense, respectively, related to the loss of hedge designation on discontinued cash flow hedges during the three months ended December 30, 2022. We recognized a net loss of $19 million and a net gain of $8 million in Cost of revenue and Interest expense, respectively, related to the loss of hedge designation on discontinued cash flow hedges during the six months ended December 30, 2022.The table below provides information as of December 30, 2022 about our foreign currency forward exchange contracts. The table is provided in dollar equivalent amounts and presents the notional amounts (at the contract exchange rates) and the weighted-average contractual foreign currency exchange rates. (Dollars in millions, except weighted-average contract rate)Notional AmountWeighted-Average Contract RateEstimated Fair Value(1)Foreign currency forward exchange contracts: Singapore Dollar$218 $1.37 $4 Thai Baht150 $34.51 2 Chinese Renminbi93 $6.79 (2)British Pound Sterling81 $0.81 (1)Total$542 $3 ___________________________________(1) Equivalent to the unrealized net gain (loss) on existing contracts. Other Market Risks. We have exposure to counterparty credit downgrades in the form of credit risk related to our foreign currency forward exchange contracts and our fixed income portfolio. We monitor and limit our credit exposure for our foreign currency forward exchange contracts by performing ongoing credit evaluations. We also manage the notional amount of contracts entered into with any one counterparty and we maintain limits on maximum tenor of contracts based on the credit rating of the financial institution. Additionally, the investment portfolio is diversified and structured to minimize credit risk.Changes in our corporate issuer credit ratings have minimal impact on our near-term financial results, but downgrades may negatively impact our future ability to raise capital, our ability to execute transactions with various counterparties, and may increase the cost of such capital.We are subject to equity market risks due to changes in the fair value of the notional investments selected by our employees as part of our non-qualified deferred compensation plan—the SDCP. In fiscal year 2014, we entered into a TRS agreement in order to manage the equity market risks associated with the SDCP liabilities. We pay a floating rate, based on LIBOR plus an interest rate spread, on the notional amount of the TRS. The TRS is designed to substantially offset changes in the SDCP liabilities due to changes in the value of the investment options made by employees. See “Part I, Item 1. Financial Statements—Note 6. Derivative Financial Instruments” of this Quarterly Report on Form 10-Q.ITEM 4.CONTROLS AND PROCEDURESEvaluation of Disclosure Controls and ProceduresAs required by the Exchange Act Rule 13a-15, we carried out an evaluation under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based on the evaluation, our management, including our chief executive officer and chief financial officer, concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are effective as of December 30, 2022. 39Table of ContentsChanges in Internal Control over Financial ReportingDuring the quarter ended December 30, 2022, there were no changes in our internal control over financial reporting that have materially affected, or were reasonably likely to materially affect, our internal control over financial reporting. PART IIOTHER INFORMATIONITEM 1.LEGAL PROCEEDINGSFor a discussion of legal proceedings, see “Part I, Item 1. Financial Statements—Note 12. Legal, Environmental and Other Contingencies” of this Quarterly Report on Form 10-Q.ITEM 1A.RISK FACTORS Summary of Risk FactorsThe following is a summary of the principal risks and uncertainties that could materially adversely affect our business, results of operations, financial condition, cash flows, brand or the price of our outstanding ordinary shares and make an investment in our ordinary shares speculative or risky. Risks Related to our Business, Operations and Industry•Our ability to increase our revenue and maintain our market share depends on our ability to successfully introduce and achieve market acceptance of new products on a timely basis. If our products do not keep pace with customer requirements, our results of operations will be adversely affected.•We operate in highly competitive markets and our failure to anticipate and respond to technological changes and other market developments, including price, could harm our ability to compete.•We may be adversely affected by the loss of, or reduced, delayed or canceled purchases by, one or more of our key customers.•We are dependent on sales to distributors and retailers, which may increase price erosion and the volatility of our sales.•We must plan our investments in our products and incur costs before we have customer orders or know about the market conditions at the time the products are produced. If we fail to predict demand accurately for our products or if the markets for our products change, we may have insufficient demand or we may be unable to meet demand, which may materially adversely affect our financial condition and results of operations.•Changes in demand for computer systems, data storage subsystems and consumer electronic devices may in the future cause a decline in demand for our products.•We have a long and unpredictable sales cycle for nearline storage solutions, which impairs our ability to accurately predict our financial and operating results in any period and may adversely affect our ability to forecast the need for investments and expenditures.•We experience seasonal declines in the sales of our consumer products during the second half of our fiscal year which may adversely affect our results of operations.•We may not be successful in our efforts to grow our systems, SSD and Lyve revenues.•Our worldwide sales and manufacturing operations subject us to risks that may adversely affect our business related to disruptions in international markets, currency exchange fluctuations, increased costs and global health outbreaks.•The ongoing COVID-19 pandemic has impacted our business, operating results and financial condition, as well as the operations and financial performance of many of the customers and suppliers in industries that we serve. We are unable to predict the extent to which the pandemic and related effects will adversely impact our business operations, financial performance, results of operations, financial position and the achievement of our strategic objectives.•If we do not control our costs, we will not be able to compete effectively and may suffer an adverse impact on our financial condition.Risks Associated with Supply and Manufacturing40Table of Contents•Shortages or delays in the receipt of, or cost increases in, critical components, equipment or raw materials necessary to manufacture our products, may cause us to suffer lower operating margins, production delays and other material adverse effects.•Shortages or delays in critical components, as well as reliance on single-source suppliers, can affect our production and development of products and may harm our operating results.•We have cancelled purchased commitments with suppliers and incurred cost associated with such cancellations, and if revenues fall or customer demand decreases significantly, we may not meet all of our purchase commitments to certain suppliers in the future, which could result in penalties, increased manufacturing costs or excess inventory.•Due to the complexity of our products, some defects may only become detectable after deployment.Risks Related to Human Capital•The loss of or inability to attract, retain and motivate key executive officers and employees could negatively impact our business prospects.•We are subject to risks related to corporate and social responsibility and reputation.Risks Related to Financial Performance or General Economic Conditions•Changes in the macroeconomic environment have impacted and may in the future negatively impact our results of operations.•We may not be able to generate sufficient cash flows from operations and our investments to meet our liquidity requirements, including servicing our indebtedness.•We are subject to counterparty default risks.•Our quarterly results of operations fluctuate, sometimes significantly, from period to period, and may cause our share price to decline.•Any cost reduction initiatives that we undertake may not deliver the results we expect, and these actions may adversely affect our business.•The effect of geopolitical uncertainties, war, terrorism, natural disasters, public health issues and other circumstances, on national and/ or international commerce and on the global economy, could materially adversely affect our results of operations and financial condition.Legal, Regulatory and Compliance Risks•Our business is subject to various laws, regulations, governmental policies, litigation, governmental investigations or governmental proceedings that may cause us to incur significant expense or adversely impact our results or operations and financial condition.•Some of our products and services are subject to export control laws and other laws affecting the countries in which our products and services may be sold, distributed, or delivered and any changes to or violation of these laws could have a material adverse effect on our business, results of operations, financial condition and cash flows.•Changes in U.S. trade policy, including the imposition of sanctions or tariffs and the resulting consequences, may have a material adverse impact on our business and results of operations.•We may be unable to protect our intellectual property rights, which could adversely affect our business, financial condition and results of operations.•We are at times subject to intellectual property proceedings and claims which could cause us to incur significant additional costs or prevent us from selling our products, and which could adversely affect our results of operations and financial condition.•Our business and certain products and services depend in part on IP and technology licensed from third parties, as well as data centers and infrastructure operated by third parties.Risks Related to Information Technology, Data and Information Security•We could suffer a loss of revenue and increased costs, exposure to significant liability including legal and regulatory consequences, reputational harm and other serious negative consequences in the event of cyber-attacks, ransomware or other cyber security breaches or incidents that disrupt our operations or result in unauthorized access to, or the loss, corruption, unavailability or dissemination of proprietary or confidential information of our customers or about us or our customers or other third parties.41Table of Contents•We must successfully implement our new global enterprise resource planning system and maintain and upgrade our IT systems, and our failure to do so could have a material adverse effect on our business, financial condition and results of operations.Risks Related to Owning our Ordinary Shares•The price of our ordinary shares may be volatile and could decline significantly.•Any decision to reduce or discontinue the payment of cash dividends to our shareholders or the repurchase of our ordinary shares pursuant to our previously announced share repurchase program could cause the market price of our ordinary shares to decline significantly.RISKS RELATED TO OUR BUSINESS, OPERATIONS AND INDUSTRYOur ability to increase our revenue and maintain our market share depends on our ability to successfully introduce and achieve market acceptance of new products on a timely basis. If our products do not keep pace with customer requirements, our results of operations will be adversely affected.The markets for our products are characterized by rapid technological change, frequent new product introductions and technology enhancements, uncertain product life cycles and changes in customer demand. The success of our products and services also often depends on whether our offerings are compatible with our customers’ or third-parties’ products or services and their changing technologies. Our customers demand new generations of storage products as advances in computer hardware and software have created the need for improved storage, with features such as increased storage capacity, enhanced security, energy efficiency, improved performance and reliability and lower cost. We, and our competitors, have developed improved products, and we will need to continue to do so in the future.Historically, our results of operations have substantially depended upon our ability to be among the first-to-market with new data storage product offerings. We may face technological, operational and financial challenges in developing new products. In addition, our investments in new product development may not yield the anticipated benefits. Our market share, revenue and results of operations in the future may be adversely affected if we fail to: •develop new products, identify business strategies and timely introduce competitive product offerings to meet technological shifts, or we are unable to execute successfully;•consistently maintain our time-to-market performance with our new products; •produce these products in adequate volume; •meet specifications or satisfy compatibility requirements;•qualify these products with key customers on a timely basis by meeting our customers’ performance and quality specifications; or •achieve acceptable manufacturing yields, quality and costs with these products.Accordingly, we cannot accurately determine the ultimate effect that our new products will have on our results of operations. Our failure to accurately anticipate customers’ needs and accurately identify the shift in technological changes could materially adversely affect our long-term financial results. In addition, the concentration of customers in our largest end markets magnifies the potential effect of missing a product qualification opportunity. If the delivery of our products is delayed, our customers may use our competitors’ products to meet their requirements. When we develop new products with higher capacity and more advanced technology, our results of operations may decline because the increased difficulty and complexity associated with producing these products increases the likelihood of reliability, quality or operability problems. If our products experience increases in failure rates, are of low quality or are not reliable, customers may reduce their purchases of our products, our factory utilization may decrease and our manufacturing rework and scrap costs and our service and warranty costs may increase. In addition, a decline in the reliability of our products may make it more difficult for us to effectively compete with our competitors.Additionally, we may be unable to produce new products that have higher capacities and more advanced technologies in the volumes and timeframes that are required to meet customer demand. We are transitioning to key areal density recording technologies that use HAMR technology to increase HDD capacities. If our transitions to more advanced technologies, including the transition to HDDs utilizing HAMR technology, require development and production cycles that are longer than anticipated or if we otherwise fail to implement new HDD technologies successfully, we may lose sales and market share, which could significantly harm our financial results.We cannot assure you that we will be among the leaders in time-to-market with new products or that we will be able to successfully qualify new products with our customers in the future. If our new products are not successful, our future results of operations may be adversely affected.42Table of ContentsWe operate in highly competitive markets and our failure to anticipate and respond to technological changes and other market developments, including price, could harm our ability to compete. We face intense competition in the data storage industry. Our principal sources of competition include HDD and SSD manufacturers, and companies that provide storage subsystems, including electronic manufacturing services and contract electronic manufacturing. The markets for our data storage products are characterized by technological change, which is driven in part by the adoption of new industry standards. These standards provide mechanisms to ensure technology component interoperability but they also hinder our ability to innovate or differentiate our products. When this occurs, our products may be deemed commodities, which could result in downward pressure on prices.We also experience competition from other companies that produce alternative storage technologies such as flash memory, where increasing capacity, decreasing cost, energy efficiency and improvements in performance have resulted in SSDs that offer increased competition with our lower capacity, smaller form factor HDDs and a declining trend in demand for HDDs in our legacy markets. Some customers for both mass capacity storage and legacy markets have adopted SSDs as an alternative to hard drives in certain applications. Further adoption of SSDs or other alternative storage technologies may limit our total addressable HDD market, impact the competitiveness of our product portfolio and reduce our market share. Any resulting increase in competition could have a material adverse effect on our business, financial condition and results of operations.We may be adversely affected by the loss of, or reduced, delayed or canceled purchases by, one or more of our key customers.Some of our key customers such as OEM customers including large hyperscale data center companies and CSPs account for a large portion of our revenue in our mass capacity markets. While we have long-standing relationships with many of our customers, if any key customers were to significantly reduce, defer or cancel their purchases from us or delay product acceptances, or we were prohibited from selling to those key customers, our results of operations would be adversely affected. Although sales to key customers may vary from period to period, a key customer that permanently discontinues or significantly reduces its relationship with us, or that we are prohibited from selling to, could be difficult to replace. In line with industry practice, new key customers usually require that we pass a lengthy and rigorous qualification process. Accordingly, it may be difficult or costly for us to attract new key customers. Conversely, if one of our key customers unexpectedly increases its orders, and if we are unable to produce the additional product volumes in a timely manner, this could also damage our customer relationships and reputation, which may adversely affect our results of operations. Additionally, some of our key customers are subject to cyclical demand which resulted in December 2022 quarter and may result in the future in variability of their orders and timing of their purchase with us and if one of our key customers unexpectedly reduces, delays or cancels orders, our revenues and results of operations may be adversely affected.Furthermore, if there is consolidation among our customer base, our customers may be able to command increased leverage in negotiating prices and other terms of sale, which could adversely affect our profitability. Furthermore, if such customer pressures require us to reduce our pricing such that our gross margins are diminished, it might not be feasible to sell to a particular customer, which could result in a decrease in our revenue. Consolidation among our customer base may also lead to reduced demand for our products, replacement of our products by the combined entity with those of our competitors and cancellations of orders, each of which could adversely affect our results of operations. If a significant transaction or regulatory impact involving any of our key customers results in the loss of or reduction in purchases by these key customers, it could have a materially adverse effect on our business, results of operations and financial condition.We are dependent on sales to distributors and retailers, which may increase price erosion and the volatility of our sales.A substantial portion of our sales has been to distributors and retailers of disk drive products. Certain of our distributors and retailers may also market competing products. We face significant competition in this distribution channel as a result of limited product qualification programs and a focus on price, terms and product availability. Sales volumes through this channel are also less predictable and subject to greater volatility. In addition, deterioration in business and economic conditions could exacerbate price erosion and volatility as distributors or retailers lower prices to compensate for lower demand and higher inventory levels. Our distributors’ and retailers’ ability to access credit to fund their operations may also affect their purchases of our products. If prices decline significantly in this distribution channel or our distributors or retailers reduce purchases of our products or if distributors or retailers experience financial difficulties or terminate their relationships with us, our revenues and results of operations would be adversely affected.We must plan our investments in our products and incur costs before we have customer orders or know about the market conditions at the time the products are produced. If we fail to predict demand accurately for our products or if the markets for our products change, we may have insufficient demand or we may be unable to meet demand, which may materially adversely affect our financial condition and results of operations.43Table of ContentsOur results of operation are highly dependent on strong cloud and enterprise and/or consumer spending and the resulting demand for our products. Reduced or weak demand, particularly from our key cloud and enterprise customers as a result of a significant change in macroeconomic conditions may result in a significant reduction or cancellation of their purchases from us which can and have materially adversely impacted our business and financial condition.Our manufacturing process requires us to make significant product-specific investments in inventory for production at least three to six months in advance. As a result, we incur inventory and manufacturing costs in advance of anticipated sales that may never materialize or that may be substantially lower than expected. If actual demand for our products is lower than the forecast, we may also experience excess and obsolescence of inventory, higher inventory carrying costs, factory underutilization charges and manufacturing rework costs, which have resulted in and could result in adverse material effects on our financial condition and results of operations.Other factors that have affected and may continue to affect our ability to anticipate or meet the demand for our products and adversely affect our results of operations include:•competitive product announcements or technological advances that result in excess supply when customers cancel purchases in anticipation of newer products; •variable demand resulting from unanticipated upward or downward pricing pressures; •our ability to successfully qualify, manufacture and sell our data storage products; •changes in our product mix, which may adversely affect our gross margins; •key customers deferring or canceling purchases or delaying product acceptances, or unexpected increases in their orders;•manufacturing delays or interruptions, particularly at our manufacturing facilities in China, Malaysia, Northern Ireland, Singapore, Thailand or the United States;•limited access to components that we obtain from a single or a limited number of suppliers; and •the impact of changes in foreign currency exchange rates on the cost of producing our products and the effective price of our products to non-U.S. customers.Changes in demand for computer systems, data storage subsystems and consumer electronic devices may in the future cause a decline in demand for our products.Our products are components in computers, data storage systems and consumer electronic devices. Historically, the demand for these products has been volatile. Unexpected slowdowns in demand for computers, data storage subsystems or consumer electronic devices generally result in sharp declines in demand for our products. Declines in customer spending on the systems and devices that incorporate our products could have a material adverse effect on demand for our products and on our financial condition and results of operations. Uncertain global economic and business conditions can exacerbate these risks. We are dependent on our long-term investments to manufacture adequate products. Our investment decisions in adding new assembly and test capacity require significant planning and lead-time, and a failure to accurately forecast demand for our products could cause us to over-invest or under-invest, which would lead to excess capacity, underutilization charges, or impairments. Sales to the legacy markets remain an important part of our business. These markets, however, have been, and we expect them to continue to be, adversely affected by: •announcements or introductions of major new operating systems or semiconductor improvements or shifts in customer preferences, performance requirements and behavior, such as the shift to tablet computers, smart phones, NAND flash memory or similar devices that meet customers’ cost and capacity metrics; •longer product life cycles; and•changes in macroeconomic conditions that cause customers to spend less, such as the imposition of new tariffs, increased laws and regulations and increased unemployment levels. 44Table of ContentsWe believe that the deterioration of demand for disk drives in certain of the legacy markets has accelerated, and this deterioration may continue or further accelerate, which could cause our operating results to suffer.In addition, we believe announcements regarding competitive product introductions from time to time have caused customers to defer or cancel their purchases, making certain inventory obsolete. Whenever an oversupply of products in the market causes our industry to have higher than anticipated inventory levels, we experience even more intense price competition from other manufacturers than usual, which may materially adversely affect our financial results.We have a long and unpredictable sales cycle for nearline storage solutions, which impairs our ability to accurately predict our financial and operating results in any period and may adversely affect our ability to forecast the need for investments and expenditures.Our nearline storage solutions are technically complex and we typically supply them in high quantities to a small number of customers. Many of our products are also tailored to meet the specific requirements of individual customers and are often integrated by our customers into the systems and products that they sell. Factors that affect the length of our sales cycle include:•the time required for developing, testing and evaluating our products before they are deployed; •the size of the deployment; and •the complexity of system configuration necessary to deploy our products.As a result, our sales cycle for nearline storage solutions could exceed one year and frequently are unpredictable. Additionally, our nearline storage solutions is subject to variability of sales primarily due to the timing of IT spending or a reflection of cyclical demand from CSPs based on the timing of their procurement and deployment requirements and their ability to procure other components needed to build out data center infrastructure. Given the length of development and qualification programs and unpredictability of the sales cycle, we may be unable to accurately forecast product demand, which may result in excess inventory and associated inventory reserves or write-downs, which could harm our business, financial condition and results of operations.We experience seasonal declines in the sales of our consumer products during the second half of our fiscal year which may adversely affect our results of operations.In certain end markets, sales of computers, storage subsystems and consumer electronic devices tend to be seasonal, and therefore, we expect to continue to experience seasonality in our business as we respond to variations in our customers’ demand for our products. In particular, we anticipate that sales of our consumer products will continue to be lower during the second half of our fiscal year. Retail sales of certain of our legacy markets solutions traditionally experience higher demand in the first half of our fiscal year driven by consumer spending in the back-to-school season from late summer to fall and the traditional holiday shopping season from fall to winter. We experience seasonal reductions in the second half of our fiscal year in the business activities of our customers during international holidays like Lunar New Year, as well as in the summer months (particularly in Europe), which typically result in lower sales during those periods. Since our working capital needs peak during periods in which we are increasing production in anticipation of orders that have not yet been received, our results of operations will fluctuate even if the forecasted demand for our products proves accurate. Failure to anticipate consumer demand for our branded solutions as well as an inability to maintain effective working relationships with retail and online distributors may also adversely impact our future results of operations. Furthermore, it is difficult for us to evaluate the degree to which this seasonality may affect our business in future periods because of the rate and unpredictability of product transitions and new product introductions, as well as macroeconomic conditions. In particular, during periods where there are rapidly changing macroeconomic conditions, historical seasonality trends may not be a good indicator to predict our future performance and results of operations.We may not be successful in our efforts to grow our systems, SSD and Lyve revenues.We have made and continue to make investments to grow our systems, SSD and Lyve platform revenues. Our ability to grow systems, SSD and Lyve revenues is subject to the following risks:•we may be unable to accurately estimate and predict data center capacity and requirements; •we may not be able to offer compelling solutions or services to enterprises, subscribers, or consumers; •we may be unable to obtain cost effective supply of NAND flash memory in order to offer competitive SSD solutions; and •our cloud systems revenues generally have a longer sales cycle, and growth is likely to depend on relatively large customer orders, which may increase the variability of our results of operations and the difficulty of matching revenues with expenses. Our results of operations and share price may be adversely affected if we are not successful in our efforts to grow our revenues as anticipated. In addition, our growth in these markets may bring us into closer competition with some of our customers or potential customers, which may decrease their willingness to do business with us.45Table of ContentsOur worldwide sales and manufacturing operations subject us to risks that may adversely affect our business related to disruptions in international markets, currency exchange fluctuations, increased costs and global health outbreaks.We are a global company and have significant sales operations outside of the United States, including sales personnel and customer support operations. We also generate a significant portion of our revenue from sales outside the U.S. Disruptions in the economic, environmental, political, legal or regulatory landscape in the countries where we operate may have a material adverse impact on our manufacturing and sales operations. Disruptions in financial markets, the deterioration of global economic conditions and geopolitical uncertainty and instability or war, such as the military action against Ukraine launched by Russia, have had and may continue to have an impact on our sales to customers and end-users located in the EMEA region.Prices for our products are denominated predominantly in dollars, even when sold to customers that are located outside the U.S. An increase in the value of the dollar could increase the real cost to our customers of our products in those markets outside of the U.S. where we sell in dollars. This could adversely impact our sales and market share in such areas or increase pressure on us to lower our price, and adversely impact our profit margins. In addition, we have revenue and expenses denominated in currencies other than the dollar, primarily the Thai Baht, Singaporean dollar, Chinese Renminbi and British Pound Sterling, which further exposes us to adverse movements in foreign currency exchange rates. A weakened dollar could increase the effective cost of our expenses such as payroll, utilities, tax and marketing expenses, as well as overseas capital expenditures. Any of these events could have a material adverse effect on our results of operations. We have attempted to manage the impact of foreign currency exchange rate changes by, among other things, entering into foreign currency forward exchange contracts from time to time, which could be designated as cash flow hedges or not designated as hedging instruments. Our hedging strategy may be ineffective, and specific hedges may expire and not be renewed or may not offset any or more than a portion of the adverse financial impact resulting from currency variations. The hedging activities may not cover our full exposure, subject us to certain counterparty credit risks and may impact our results of operations. See “Item 3. Quantitative and Qualitative Disclosures About Market Risk— Foreign Currency Exchange Risk” of this report for additional information about our foreign currency exchange risk.The shipping and transportation costs associated with our international operations are typically higher than those associated with our U.S. operations, resulting in decreased operating margins in some countries. Volatility in fuel costs, political instability or constraints in or increases in the costs of air transportation may lead us to develop alternative shipment methods, which could disrupt our ability to receive raw materials, or ship finished product, and as a result our business and results of operations may be harmed.The occurrence of a pandemic disease, such as the recent COVID-19 pandemic, has impacted and may adversely impact our operations (including, without limitation, logistical and other operational costs) and the operations of some of our customers.The ongoing COVID-19 pandemic has impacted our business, operating results and financial condition, as well as the operations and financial performance of many of the customers and suppliers in industries that we serve. We are unable to predict the extent to which the pandemic and related effects will adversely impact our business operations, financial performance, results of operations, financial position and the achievement of our strategic objectives.The COVID-19 pandemic has resulted in a widespread health crisis and numerous disease control measures being taken to limit its spread. The impact of the pandemic on our business has included or could in the future include:•disruptions to or restrictions on our ability to ensure the continuous manufacture and supply of our products and services, including insufficiency of our existing inventory levels and temporary or permanent closures or reductions in operational capacity of our facilities or the facilities of our direct or indirect suppliers or customers, and any supply chain disruptions; •temporary shortages of skilled employees available to staff manufacturing facilities due to stay at home orders and travel restrictions within as well as into and out of countries;•increases in operational expenses and other costs related to requirements implemented to mitigate the impact of the COVID-19 pandemic;•delays or limitations on the ability of our customers to perform or make timely payments;•reductions in short- and long-term demand for our products, or other disruptions in technology buying patterns;•adverse effects on economies and financial markets globally or in various markets throughout the world, potentially leading to a prolonged economic downturn or reductions in business and consumer spending, which may result in decreased net revenue, gross margins, or earnings and/or in increased expenses and difficulty in managing inventory levels;•delays to and/or lengthening of our sales or development cycles or qualification activity;•challenges for us, our direct and indirect suppliers and our customers in obtaining financing due to turmoil in financial markets;46Table of Contents•workforce disruptions due to illness, quarantines, governmental actions, other restrictions and/or the social distancing measures we have taken to mitigate the impact of the COVID-19 pandemic in an effort to protect the health and well-being of our employees, customers, suppliers and of the communities in which we operate; •increased vulnerability to cyberattacks due to the significant number of employees working remotely; and•our management team continuing to commit significant time, attention and resources to monitoring the COVID-19 pandemic and seeking to mitigate its effects on our business and workforce.The COVID-19 pandemic has increased economic and demand uncertainty. It continues to negatively affect our business and there is uncertainty around its duration and impact. The extent to which the COVID-19 pandemic will continue to impact our business, financial condition and results of operations is uncertain.There are many factors outside of our control, such as new strains of COVID-19 virus, the distribution and efficacy of the existing or new vaccines, the response and measures taken by government authorities around the world, and the response of the financial and consumer markets to the prolonged pandemic and governmental measures. These impacts, individually or in the aggregate, could have a material and adverse effect on our business, results of operations and financial condition. Such effect may be exacerbated in the event the pandemic and the measures taken in response to it, and their effects, persist for an extended period of time, or if there is a resurgence of the outbreak or variants thereof. Under any of these circumstances, the resumption of normal business operations may be delayed or hampered by lingering effects of the COVID-19 pandemic on our operations, direct and indirect suppliers, partners and customers. The COVID-19 pandemic may also heighten other risks described in this Risk Factors section.If we do not control our costs, we will not be able to compete effectively and may suffer an adverse impact on our financial condition.We continually seek to make our cost structure and business processes more efficient. We are focused on increasing workforce flexibility and scalability, and improving overall competitiveness by leveraging our global capabilities, as well as external talent and skills, worldwide. Our strategy involves, to a substantial degree, increasing revenue and exabytes volume while at the same time controlling expenses. Because our vertical design and manufacturing strategy, our operations have higher costs that are fixed or difficult to reduce in the short-term, including our costs related to utilization of existing facilities and equipment. If we fail to forecast demand accurately or if there is a partial or complete reduction in long-term demand for our products, we could be required to write off inventory, record excess capacity charges which could negatively impact our gross margin and our financial results. If we do not control our manufacturing and operating expenses, our ability to compete in the marketplace may be impaired. In the past, activities to reduce costs have included closures and transfers of facilities, significant personnel reductions, restructuring efforts, asset write-offs and efforts to increase automation. Our restructuring efforts may not yield the intended benefits and may be unsuccessful or disruptive to our business operations which may materially adversely affect our financial results.RISKS ASSOCIATED WITH SUPPLY AND MANUFACTURINGShortages or delays in the receipt of, or cost increases in, critical components, equipment or raw materials necessary to manufacture our products, may cause us to suffer lower operating margins, production delays and other material adverse effects.The cost, quality, availability and supply of components, subassemblies, certain equipment and raw materials used to manufacture our products and key components like recording media and heads are critical to our success. Particularly important for our products are components such as read/write heads, substrates for recording media, ASICs, spindle motors, printed circuit boards, suspension assemblies and NAND flash memory. In addition, the equipment we use to manufacture our products and components is frequently custom made and comes from a few suppliers and the lead times required to obtain manufacturing equipment can be significant. Our efforts to control our costs, including capital expenditures, may also affect our ability to obtain or maintain such inputs and equipment, which could affect our ability to meet future demand for our products. 47Table of ContentsWe rely on sole or a limited number of direct and indirect suppliers for some or all of these components that we do not manufacture, including substrates for recording media, read/write heads, ASICs, spindle motors, printed circuit boards, suspension assemblies and NAND flash memory. In light of this small, consolidated supplier base, if our suppliers increased their prices as a result of inflationary pressures from the current macroeconomic conditions or other changes in economic conditions, our results of operations would be negatively affected. Also, many of such direct and indirect component suppliers are geographically concentrated, making our supply chain more vulnerable to regional disruptions such as severe weather, the occurrence of local or global health issues or pandemics, acts of terrorism, war and an unpredictable geopolitical climate, which may have a material impact on the production, availability and transportation of many components. We have experienced and continue to experience disruptions in our supply chain due to the impact of the COVID-19 pandemic, which has also impacted and may adversely impact our operations (including, without limitation, logistical and other operational costs) and the operations of some of our key direct and indirect suppliers. If our direct and indirect vendors for these components are unable to meet our cost, quality, supply and transportation requirements, continue to remain financially viable or fulfill their contractual commitments and obligations, we could experience disruption in our supply chain, including shortages in supply or increases in production costs, which would materially adversely affect our results of operations. The current worldwide shortage of semiconductors exacerbates these risks.Certain rare earth elements are critical in the manufacture of our products. We purchase components that contain rare earth elements from a number of countries, including China. We cannot predict whether any nation will impose regulations or trade barriers including tariffs, duties, quotas or embargoes upon the rare earth elements incorporated into our products that would restrict the worldwide supply of such metals or increase their cost. We have experienced and continuing to experience increased costs and production delays when we were unable to obtain the necessary equipment or sufficient quantities of some components, and/or have been forced to pay higher prices or make volume purchase commitments or advance deposits for some components, equipment or raw materials that were in short supply in the industry in general. Further, if our customers experience shortages of components or materials used in their products it could result in a decrease in demand for our products and have an adverse effect on our results of operations. If any major supplier were to restrict the supply available to us or increase the cost of the rare earth elements used in our products, we could experience a shortage in supply or an increase in production costs, which would adversely affect our results of operations.Shortages or delays in critical components, as well as reliance on single-source suppliers, can affect our production and development of products and may harm our operating results. We are dependent on a limited number of qualified suppliers who provide critical materials or components. If there is a shortage of, or delay in supplying us with, critical components, equipment or raw materials, then:•it is likely that our suppliers would raise their prices and, if we could not pass these price increases to our customers, our operating margin would decline;•we may have to reengineer some products, which would likely cause production and shipment delays, make the reengineered products more costly and provide us with a lower rate of return on these products; •we would likely have to allocate the components we receive to certain of our products and ship less of others, which could reduce our revenues and could cause us to lose sales to customers who could purchase more of their required products from manufacturers that either did not experience these shortages or delays or that made different allocations; and •we may be late in shipping products, causing potential customers to make purchases from our competitors, thus causing our revenue and operating margin to decline.We cannot assure you that we will be able to obtain critical components in a timely and economic manner. The industry is currently experiencing a global shortage of semiconductors and other electronic components. In addition, many of our suppliers’ manufacturing facilities are fully utilized. If they fail to invest in additional capacity or deliver components in the required timeframe, such failure would have an impact on our ability to ramp new products, and may result in a loss of revenue or market share if our competitors did not utilize the same components and were not affected.We often aim to lead the market in new technology deployments and leverage unique and customized technology from single source suppliers who are early adopters in the emerging market. Our options in supplier selection in these cases are limited and the supplier-based technology has been and may continue to be single sourced until wider adoption of the technology occurs and any necessary licenses become available. In such cases, any technical issues in the supplier’s technology may cause us to delay shipments of our new technology deployments and harm our financial position.48Table of ContentsWe have cancelled purchase commitments with suppliers and incurred cost associated with such cancellations, and if revenues fall or customer demand decreases significantly, we may not meet our purchase commitments to certain suppliers in the future, which could result in penalties, increased manufacturing costs or excess inventory.From time to time, we enter into long-term, non-cancelable purchase commitments or make large up-front investments with certain suppliers in order to secure certain components or technologies for the production of our products or to supplement our internal manufacturing capacity for certain components. In the December 2022 quarter, we have cancelled purchase commitments with certain suppliers due to a change in forecasted demand and incurred fees associated with such cancellation. If our actual revenues in the future are lower than our projections or if customer demand decreases significantly below our projections, we may not meet our purchase commitments with suppliers. As a result, it is possible that our revenues will not be sufficient to recoup our up-front investments, in which case we will have to shift output from our internal manufacturing facilities to these suppliers, resulting in higher internal manufacturing costs, or make penalty-type payments under the terms of these contracts. Additionally, because our markets are volatile, competitive and subject to rapid technology and price changes, we face inventory and other asset risks in the event we do not fully utilize purchase commitments. If we cancel purchase commitments, are unable to fully utilize our purchase commitments or if we shift output from our internal manufacturing facilities in order to meet the commitments, our gross margin and operating margin could be materially adversely impacted.Due to the complexity of our products, some defects may only become detectable after deployment.Our products are highly complex and are designed to operate in and form part of larger complex networks and storage systems. Our products may contain a defect or be perceived as containing a defect by our customers as a result of improper use or maintenance. Lead times required to manufacture certain components are significant, and a quality excursion may take significant time and resources to remediate. Defects in our products, third-party components or in the networks and systems of which they form a part, directly or indirectly, have resulted in and may in the future result in: •increased costs and product delays until complex solution level interoperability issues are resolved;•costs associated with the remediation of any problems attributable to our products;•loss of or delays in revenues;•loss of customers;•failure to achieve market acceptance and loss of market share;•increased service and warranty costs; and•increased insurance costs.Defects in our products could also result in legal actions by our customers for breach of warranty, property damage, injury or death. Such legal actions, including but not limited to product liability claims could exceed the level of insurance coverage that we have obtained. Any significant uninsured claims could significantly harm our financial condition.RISKS RELATED TO HUMAN CAPITALThe loss of or inability to attract, retain and motivate key executive officers and employees could negatively impact our business prospects.Our future performance depends to a significant degree upon the continued service of key members of management as well as marketing, sales and product development personnel. We believe our future success will also depend in large part upon our ability to attract, retain and further motivate highly skilled management, marketing, sales and product development personnel. We have experienced intense competition for qualified and capable personnel, including in the U.S., Thailand, China, Singapore and Northern Ireland, and we cannot assure you that we will be able to retain our key employees or that we will be successful in attracting, assimilating and retaining personnel in the future. Additionally, because a portion of our key personnel’s compensation is contingent upon the performance of our business, including through cash bonuses and equity compensation, when the market price of our ordinary shares fluctuates or our results of operations or financial condition are negatively impacted, we may be at a competitive disadvantage for retaining and hiring employees. The reductions in workforce that result from our historical restructurings have also made and may continue to make it difficult for us to recruit and retain personnel. Increased difficulty in accessing, recruiting or retaining personnel may lead to increased manufacturing and employment compensation costs, which could adversely affect our results of operations. The loss of one or more of our key personnel or the inability to hire and retain key personnel could have a material adverse effect on our business, results of operations and financial condition.49Table of ContentsWe are subject to risks related to corporate and social responsibility and reputation.Many factors influence our reputation including the perception held by our customers, suppliers, partners, shareholders, other key stakeholders and the communities in which we operate. We face increasing scrutiny related to environmental, social and governance activities. We risk damage to our reputation if we fail to act responsibly in a number of areas, such as diversity and inclusion, environmental stewardship, sustainability, supply chain management, climate change, workplace conduct and human rights. Any harm to our reputation could impact employee engagement and retention, our corporate culture and the willingness of customers, suppliers and partners to do business with us, which could have a material adverse effect on our business, results of operations and cash flows. Further, despite our policies to the contrary, we may not be able to control the conduct of every individual actor, and our employees and personnel may violate environmental, social or governance standards or engage in other unethical conduct. These acts, or any accusation of such conduct, even if proven to be false, could adversely impact the reputation of our business.RISKS RELATED TO FINANCIAL PERFORMANCE OR GENERAL ECONOMIC CONDITIONSChanges in the macroeconomic environment have impacted and may in the future negatively impact our results of operations.Changes, especially when there are rapid changes, in macroeconomic conditions may affect consumer and enterprise spending, and as a result, our customers may postpone or cancel spending in response to volatility in credit and equity markets, negative financial news and/or declines in income or asset values, all of which may have a material adverse effect on the demand for our products and/or result in significant decreases in our product prices. Other factors that could have a material adverse effect on demand for our products and on our financial condition and results of operations include inflation, slower growth or recession, conditions in the labor market, healthcare costs, access to credit, consumer confidence and other macroeconomic factors affecting consumer and business spending behavior. These changes could happen rapidly and we may not be able to react quickly to prevent or limit our losses or exposures.Macroeconomic developments such as slowing global economies, trade disputes, sanctions, increased tariffs between the U.S. and China, Mexico and other countries, the withdrawal of the United Kingdom (“U.K.”) from the EU, or adverse economic conditions worldwide resulting from the COVID-19 pandemic and efforts of governments and private industry to slow the pandemic or efforts of governments to stimulate or stabilize the economy may adversely impact our business. Significant inflation and related increases in interest rates, have negatively affected our business in recent quarters and could continue in the near future to negatively affect our business, operating results or financial condition or the markets in which we operate, which, in turn, could adversely affect the price of our ordinary shares. A general weakening of, and related declining corporate confidence in, the global economy or the curtailment in government or corporate spending could cause current or potential customers to reduce their information technology (“IT”) budgets or be unable to fund data storage products, which could cause customers to delay, decrease or cancel purchases of our products or cause customers to not pay us or to delay paying us for previously purchased products and services.We may not be able to generate sufficient cash flows from operations and our investments to meet our liquidity requirements, including servicing our indebtedness.Our business may not generate sufficient cash flows to enable us to meet our liquidity requirements, including working capital, capital expenditures, product development efforts, investments, servicing our indebtedness and other general corporate requirements. If we cannot fund our liquidity requirements, we may have to reduce or delay capital expenditures, product development efforts, investments and other general corporate expenditures. We cannot assure you that any of these remedies would, if necessary, be effected on commercially reasonable terms, or at all, or that they would permit us to meet our obligations, which would affect our results of operations. In addition, our ability to service our debt obligations and comply with debt covenants depends on our financial performance. If we fail to meet our debt service obligations or fail to comply with debt covenants, or are unable to modify, obtain a waiver, or cure a debt covenant on terms acceptable to us or at all, we could be in default of our debt agreements and instruments. Such a default could result in an acceleration of other debt and may require us to engage in distressed debt transactions on terms unfavorable to us, which could have a material negative impact on our financial performance, stock market price and operations.We are leveraged and require significant amounts of cash to service our debt. Our debt and debt service requirements could adversely affect our ability to operate our business and may reduce our options for capital allocation. Our high level of debt presents the following risks:•we are required to use a substantial portion of our cash flow from operations to pay principal and interest on our debt, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, product development efforts, strategic acquisitions, investments and alliances and other general corporate requirements;50Table of Contents•our substantial leverage increases our vulnerability to economic downturns, decreased availability of capital and adverse competitive and industry conditions and could place us at a competitive disadvantage compared to those of our competitors that are less leveraged;•our debt service obligations could limit our flexibility in planning for, or reacting to, changes in our business and our industry, and could limit our ability to borrow more money for operations or capital in the future and implement our business strategies;•our level of debt may restrict us from raising, or make it more costly to raise, additional financing on satisfactory terms to fund working capital, capital expenditures, product development efforts, strategic acquisitions, investments and alliances and other general corporate requirements; and•covenants in our debt instruments limit our ability to pay future dividends or make other restricted payments and investments.In addition, in the event that we need to refinance all or a portion of our outstanding debt as it matures or incur additional debt to fund our operations, we may not be able to obtain terms as favorable as the terms of our existing debt or refinance our existing debt or incur additional debt to fund our operations at all. If prevailing interest rates or other factors result in higher interest rates upon refinancing, then the interest expense relating to the refinanced debt would increase. Furthermore, if any rating agency changes our credit rating or outlook, our debt and equity securities could be negatively affected, which could adversely affect our ability to refinance existing debt or raise additional capital.We are subject to counterparty default risks.We have numerous arrangements with financial institutions that subject us to counterparty default risks, including cash and investment deposits, and foreign currency forward exchange contracts and other derivative instruments. As a result, we are subject to the risk that the counterparty to one or more of these arrangements will, voluntarily or involuntarily, default on its performance obligations. In times of market distress in particular, a counterparty may not comply with its contractual commitments that could then lead to it defaulting on its obligations with little or no notice to us, thereby limiting our ability to take action to lessen or cover our exposure. Additionally, our ability to mitigate our counterparty exposures could be limited by the terms of the relevant agreements or because market conditions prevent us from taking effective action. If one of our counterparties becomes insolvent or files for bankruptcy, our ability to recover any losses suffered as a result of that counterparty's default may be limited by the liquidity of the counterparty or the applicable laws governing the bankruptcy proceedings. In the event of any such counterparty default, we could incur significant losses, which could have a material adverse effect on our business, results of operations, or financial condition.Further, our customers could have reduced access to working capital due to global economic conditions, higher interest rates, reduced bank lending resulting from contractions in the money supply or the deterioration in the customer’s, or their bank’s financial condition or the inability to access other financing, which would increase our credit and non-payment risk, and could result in an increase in our operating costs or a reduction in our revenue. Also, our customers outside of the United States are sometimes allowed longer time periods for payment than our U.S. customers. This increases the risk of nonpayment due to the possibility that the financial condition of particular customers may worsen during the course of the payment period. In addition, some of our OEM customers have adopted a subcontractor model that requires us to contract directly with companies, such as original design manufacturers, that provide manufacturing and fulfillment services to our OEM customers. Because these subcontractors are generally not as well capitalized as our direct OEM customers, this subcontractor model exposes us to increased credit risks. Our agreements with our OEM customers may not permit us to increase our product prices to alleviate this increased credit risk.Our quarterly results of operations fluctuate, sometimes significantly, from period to period, and may cause our share price to decline.Our quarterly revenue and results of operations fluctuate, sometimes significantly, from period to period. These fluctuations, which we expect to continue, have been and may continue to be precipitated by a variety of factors, including:•uncertainty in global economic and political conditions, and instability or war (such as the military action against Ukraine launched by Russia) or adverse changes in the level of economic activity in the major regions in which we do business; •pandemics, such as COVID-19, or other global health issues that impact our operations as well as those of our customers and suppliers;•competitive pressures resulting in lower prices by our competitors which may shift demand away from our products; •announcements of new products, services or technological innovations by us or our competitors, and delays or problems in our introduction of new, more cost-effective products, the inability to achieve high production yields or delays in customer qualification or initial product quality issues; •changes in customer demand or the purchasing patterns or behavior of our customers; •application of new or revised industry standards; 51Table of Contents•disruptions in our supply chain, including increased costs or adverse changes in availability of supplies of raw materials or components;•increased costs of electricity and/or other energy sources, freight and logistics costs or other materials or services necessary for the operation of our business;•the impact of corporate restructuring activities that we have and may continue to engage in; •changes in the demand for the computer systems and data storage products that contain our products; •unfavorable supply and demand imbalances; •our high proportion of fixed costs, including manufacturing and research and development expenses; •any impairments in goodwill or other long-lived assets; •changes in tax laws, such as global tax developments applicable to multinational businesses; the impact of trade barriers, such as import/export duties and restrictions, sanctions, tariffs and quotas, imposed by the U.S. or other countries in which the Company conducts business; •the evolving legal and regulatory, economic, environmental and administrative climate in the international markets where the Company operates; and •adverse changes in the performance of our products. As a result, we believe that quarter-to-quarter and year-over-year comparisons of our revenue and results of operations may not be meaningful, and that these comparisons may not be an accurate indicator of our future performance. Our results of operations in one or more future quarters may fail to meet the expectations of investment research analysts or investors, which could cause an immediate and significant decline in our market value.Any cost reduction initiatives that we undertake may not deliver the results we expect, and these actions may adversely affect our business. From time to time, we engage in restructuring plans that have resulted and may continue to result in workforce reduction and consolidation of our real estate facilities and our manufacturing footprint. In addition, management will continue to evaluate our global footprint and cost structure, and additional restructuring plans are expected to be formalized. As a result of our restructurings, we have experienced and may in the future experience a loss of continuity, loss of accumulated knowledge, disruptions to our operations and inefficiency during transitional periods. Any cost-cutting measures could impact employee retention. In addition, we cannot be sure that any future cost reductions or global footprint consolidations will deliver the results we expect, be successful in reducing our overall expenses as we expect or that additional costs will not offset any such reductions or global footprint consolidation. If our operating costs are higher than we expect or if we do not maintain adequate control of our costs and expenses, our results of operations may be adversely affected.The effect of geopolitical uncertainties, war, terrorism, natural disasters, public health issues and other circumstances, on national and/or international commerce and on the global economy, could materially adversely affect our results of operations and financial condition.Geopolitical uncertainty, terrorism, instability or war, such as the military action against Ukraine launched by Russia, natural disasters, public health issues and other business interruptions have caused and could cause damage or disruption to international commerce and the global economy, and thus could have a strong negative effect on our business, our direct and indirect suppliers, logistics providers, manufacturing vendors and customers. Our business operations are subject to interruption by natural disasters such as floods and earthquakes, fires, power or water shortages, terrorist attacks, other hostile acts, labor disputes, public health issues (such as the COVID-19 pandemic) and related mitigation actions, and other events beyond our control. Such events may decrease demand for our products, make it difficult or impossible for us to make and deliver products to our customers or to receive components from our direct and indirect suppliers, and create delays and inefficiencies in our supply chain. A significant natural disaster, such as an earthquake, fire, flood, or significant power outage could have an adverse impact on our business, results of operations, and financial condition. The impact of climate change may increase these risks due to changes in weather patterns, such as increases in storm intensity, sea-level rise and temperature extremes in areas where we or our suppliers and customers conduct business. We have a number of our employees and executive officers located in the San Francisco Bay Area, a region known for seismic activity, wildfires and drought conditions, and in Asia, near major earthquake faults known for seismic activity. To mitigate wildfire risk, electric utilities are deploying public safety power shutoffs, which affects electricity reliability to our facilities and our communities. Many of our suppliers and customers are also located in areas with risks of natural disasters. In the event of a natural disaster, losses and significant recovery time could be required to resume operations and our financial condition and results of operations could be materially adversely affected. 52Table of ContentsShould major public health issues, including pandemics, arise, we could be negatively affected by stringent employee travel restrictions, additional limitations or cost increases in freight and other logistical services, governmental actions limiting the movement of products or employees between regions, increases in or changes to data collection and reporting obligations, delays in production ramps of new products, and disruptions in our operations and those of some of our key direct and indirect suppliers and customers. For example, the COVID-19 pandemic resulted in government-imposed travel restrictions, border closures, stay-at-home orders, facility closures or operating constraints in a number of our global locations, disruptions in our operations and those of our suppliers, partners, and customers, increases in air freight rates, limited numbers of employees available to staff manufacturing operations, and shortages of supplies of personal protective equipment required for our manufacturing operations. If any of these circumstances continue for an additional extended period of time, our manufacturing ability and capacity, or those of our key direct and indirect suppliers or customers, could be impacted, and our results of operations and financial condition could be adversely affected.LEGAL, REGULATORY AND COMPLIANCE RISKSOur business is subject to various laws, regulations, governmental policies, litigation, governmental investigations or governmental proceedings that may cause us to incur significant expense or adversely impact our results or operations and financial condition. Our business is subject to regulation under a wide variety of U.S. federal and state and non-U.S. laws, regulations and policies. Laws, regulations and policies may change in ways that will require us to modify our business model and objectives or affect our returns on investments by restricting existing activities and products, subjecting them to escalating costs or prohibiting them outright. In particular, potential uncertainty of changes to global tax laws, including global initiatives put forth by the Organization for Economic Co-operation and Development, and tax laws in any jurisdiction in which we operate have had and may continue to have an effect on our business, corporate structure, operations, sales, liquidity, capital requirements, effective tax rate, results of operations, and financial performance. Jurisdictions such as China, Malaysia, Northern Ireland, Singapore, Thailand and the U.S., in which we have significant operating assets, and the European Union each have exercised and continue to exercise significant influence over many aspects of their domestic economies including, but not limited to, fair competition, tax practices, anti-corruption, anti-trust, data privacy, protection, security and sovereignty, price controls and international trade, which have had and may continue to have an adverse effect on our business operations and financial condition.Our business, particularly our Lyve products and related services, is subject to state, federal, and international laws and regulations relating to data privacy, data protection and data security. Changes to our products or services or the manner in which our customers utilize our products or services may result in new or enhanced costly compliance requirements and governmental or regulatory scrutiny. Additionally, our business is subject to state, federal, and international laws and regulations that subject us to requirements to notify vendors, customers, or employees of a data security breach.Further, the sale and manufacturing of products in certain states and countries has and may continue to subject us and our suppliers to state, federal and international laws and regulations governing protection of the environment, including those governing climate change, discharges of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites, restrictions on the presence of certain substances in electronic products and the responsibility for environmentally safe disposal or recycling. If additional or more stringent requirements are imposed on us and our suppliers in the future, we could incur additional operating costs and capital expenditures. If we fail to comply with applicable environmental laws, regulations, initiatives, or standards of conduct, our customers may refuse to purchase our products and we could be subject to fines, penalties and possible prohibition of sales of our products into one or more states or countries, liability to our customers and damage to our reputation, which could result in a material adverse effect on our financial condition or results of operations.As the laws and regulations to which we are subject to continue to change and vary greatly from jurisdiction to jurisdiction, compliance with such laws and regulations may be onerous, may create uncertainty as to how they will be applied and interpreted, and may continue to increase our cost of doing business globally.From time to time, we have been and may continue to be involved in various legal, regulatory or administrative investigations, inquiries, negotiations or proceedings arising in the normal course of business. Litigation, government investigations or governmental proceedings are subject to inherent risks and uncertainties that may cause an outcome to differ materially from our expectations and may result in us being required to pay substantial damages, fines or penalties and cease certain practices or activities, which could materially harm our business. The costs associated with litigation and government investigations can also be unpredictable depending on the complexity and length of time devoted to such litigation or investigation. Litigation, investigations or government proceedings may also divert the efforts and attention of our key personnel, which could also harm our business.53Table of ContentsIn addition, regulation or government scrutiny may impact the requirements for marketing our products and slow our ability to introduce new products, resulting in an adverse impact on our business. Although we have implemented policies and procedures designed to ensure compliance, there can be no assurance that our employees, contractors or agents will not violate these or other applicable laws, rules and regulations to which we are and may be subject. Violations of these laws and regulations could lead to significant penalties, restraints on our export or import privileges, monetary fines, government investigations, disruption of our operating activities, damage to our reputation and corporate brand, criminal proceedings and regulatory or other actions that could materially adversely affect our results of operations. The political and media scrutiny surrounding a governmental investigation for the violation of such laws, even if an investigation does not result in a finding of violation, could cause us significant expense and collateral consequences, including reputational harm, that could have an adverse impact on our business, results of operations and financial condition.Some of our products and services are subject to export control laws and other laws affecting the countries in which our products and services may be sold, distributed, or delivered, and any changes to or violation of these laws could have a material adverse effect on our business, results of operations, financial condition and cash flows.Due to the global nature of our business, we are subject to import and export restrictions and regulations, including the Export Administration Regulations administered by the BIS and the trade and economic sanctions regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”). We incorporate encryption technology into certain of our products and solutions. These encryption products and the underlying technology may be exported outside of the United States only with export authorizations, including by license, a license exception or other appropriate government authorizations, including the filing of an encryption registration. The U.S., through the BIS and OFAC, places restrictions on the sale or export of certain products and services to certain countries, persons and entities, as well as for certain end-uses, such as military, military-intelligence and weapons of mass destruction end-uses. The U.S. government also imposes sanctions through executive orders restricting U.S. companies from conducting business activities with specified individuals and companies. Although we have controls and procedures to ensure compliance with all applicable regulations and orders, we cannot predict whether changes in laws or regulations by the U.S., China or another jurisdiction will affect our ability to sell our products and services to existing or new customers. Additionally, we cannot ensure that our interpretation of relevant restrictions and regulations will be accepted in all cases by relevant regulatory and enforcement authorities. For example, on August 29, 2022, we received a PCL from the BIS, alleging violations of the EAR. The PCL alleges we acted in violation of the EAR by providing our HDDs to a customer and its affiliates listed on the BIS Entity List between August 2020 and September 2021. We have responded to the PCL, setting forth our position that we did not engage in prohibited conduct as alleged by BIS, because, among other reasons, our HDDs are not subject to the EAR. We are engaged in discussions with BIS to see if a resolution can be reached. The matters raised by the PCL remain unresolved at this time, and there can be no assurance as to the timing or terms of any final outcome. Also, if a resolution is not reached, we believe that this matter will result in litigation between the Company and BIS. We are unable at this time to estimate the range of loss and/or penalty, although it is possible that the outcome could have a material impact on our business, results of operations, financial condition, and cash flows.Violators of any U.S. export control and sanctions laws may be subject to significant penalties, which may include monetary fines, criminal proceedings against them and their officers and employees, a denial of export privileges, and suspension or debarment from selling products to the U.S. government. Moreover, the sanctions imposed by the U.S. government could be expanded in the future. Our products could be shipped to those targets or for restricted end-uses by third parties, including potentially our channel partners, despite our precautions. In addition, if our partners fail to obtain appropriate import, export or re-export licenses or permits, we may also be adversely affected, through reputational harm as well as other negative consequences including government investigations and penalties. A significant portion of our sales are to customers in Asia Pacific and in other geographies that have been the recent focus of changes in U.S. policies. Any further limitation that impedes our ability to export or sell our products and services could materially adversely affect our business, results of operations, financial condition and cash flows.54Table of ContentsOther countries also regulate the import and export of certain encryption and other technology, including import and export licensing requirements, and have enacted laws that could limit our ability to sell or distribute our products and services or could limit our partners’ or customers’ ability to sell or use our products and services in those countries, which could materially adversely affect our business, results of operations, financial condition and cash flows. Violations of these regulations may result in significant penalties and fines. Changes in our products and services or future changes in export and import regulations may create delays in the introduction of our products and services in those countries, prevent our customers from deploying our products and services globally or, in some cases, prevent the export or import or sale of our products and services to certain countries, governments or persons altogether. From time to time, various governmental agencies have proposed additional regulation of encryption technology, including the escrow and government recovery of private encryption keys. Any change in export or import regulations, economic sanctions or related legislation, increased export and import controls, or change in the countries, governments, persons or technologies targeted by such regulations, in the countries where we operate could result in decreased use of our products and services by, or in our decreased ability to export or sell our products and services to, new or existing customers, which could materially adversely affect our business, results of operations, financial condition and cash flows.If we were ever found to have violated applicable export control laws, we may be subject to penalties which could have a material and adverse impact on our business, results of operations, financial condition and cash flows. Even if we were not found to have violated such laws, the political and media scrutiny surrounding any governmental investigation of us could cause us significant expense and reputational harm. Such collateral consequences could have a material adverse impact on our business, results of operations, financial condition and cash flows.Changes in U.S. trade policy, including the imposition of sanctions or tariffs and the resulting consequences, may have a material adverse impact on our business and results of operations.We face uncertainty with regard to U.S. government trade policy. Current U.S. government trade policy includes tariffs on certain non-U.S. goods, including information and communication technology products. These measures may materially increase costs for goods imported into the United States. This in turn could require us to materially increase prices to our customers which may reduce demand, or, if we are unable to increase prices to adequately address any tariffs, quotas or duties, could lower our margin on products sold and negatively impact our financial performance. Changes in U.S. trade policy have resulted in, and could result in more, U.S. trading partners adopting responsive trade policies, including imposition of increased tariffs, quotas or duties. Such policies could make it more difficult or costly for us to export our products to those countries, therefore negatively impacting our financial performance.We may be unable to protect our intellectual property rights, which could adversely affect our business, financial condition and results of operations.We rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements, security measures and licensing arrangements to protect our intellectual property rights. In the past, we have been involved in significant and expensive disputes regarding our intellectual property rights and those of others, including claims that we may be infringing patents, trademarks and other intellectual property rights of third parties. We expect that we will be involved in similar disputes in the future. There can be no assurance that: •any of our existing patents will continue to be held valid, if challenged; •patents will be issued for any of our pending applications; •any claims allowed from existing or pending patents will have sufficient scope or strength to protect us; •our patents will be issued in the primary countries where our products are sold in order to protect our rights and potential commercial advantage; •we will be able to protect our trade secrets and other proprietary information through confidentiality agreements with our customers, suppliers and employees and through other security measures; and •others will not gain access to our trade secrets. In addition, our competitors may be able to design their products around our patents and other proprietary rights. Enforcement of our rights often requires litigation. If we bring a patent infringement action and are not successful, our competitors would be able to use similar technology to compete with us. Moreover, the defendant in such an action may successfully countersue us for infringement of their patents or assert a counterclaim that our patents are invalid or unenforceable.Furthermore, we have significant operations and sales in countries where intellectual property laws and enforcement policies are often less developed, less stringent or more difficult to enforce than in the United States. Therefore, we cannot be certain that we will be able to protect our intellectual property rights in jurisdictions outside the United States.55Table of ContentsWe are at times subject to intellectual property proceedings and claims which could cause us to incur significant additional costs or prevent us from selling our products, and which could adversely affect our results of operations and financial condition. We are subject from time-to-time to legal proceedings and claims, including claims of alleged infringement of the patents, trademarks and other intellectual property rights of third parties by us, or our customers, in connection with the use of our products. Intellectual property litigation can be expensive and time-consuming, regardless of the merits of any claim, and could divert our management’s attention from operating our business. In addition, intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, which may cause actual results to differ materially from our expectations. Some of the actions that we face from time-to-time seek injunctions against the sale of our products and/or substantial monetary damages, which, if granted or awarded, could materially harm our business, financial condition and operating results. We cannot be certain that our products do not and will not infringe issued patents or other intellectual property rights of others. We may not be aware of currently filed patent applications that relate to our products or technology. If patents are later issued on these applications, we may be liable for infringement. If our products were found to infringe the intellectual property rights of others, we could be required to pay substantial damages, cease the manufacture, use and sale of infringing products in one or more geographic locations, expend significant resources to develop non-infringing technology, discontinue the use of specific processes or obtain licenses to the technology infringed. We might not be able to obtain the necessary licenses on acceptable terms, or at all, or be able to reengineer our products successfully to avoid infringement. Any of the foregoing could cause us to incur significant costs and prevent us from selling our products, which could adversely affect our results of operations and financial condition. See “Item 1. Financial Statements—Note 12. Legal, Environmental and Other Contingencies” contained in this report for a description of pending intellectual property proceedings.Our business and certain products and services depend in part on IP and technology licensed from third parties, as well as data centers and infrastructure operated by third parties.Some of our business and some of our products rely on or include software licensed from third parties, including open source licenses. We may not be able to obtain or continue to obtain licenses from these third parties at all or on reasonable terms, or such third parties may demand cross-licenses to our intellectual property. Third-party components and technology may become obsolete, defective or incompatible with future versions of our products or services, or our relationship with the third party may deteriorate, or our agreements may expire or be terminated. We may face legal or business disputes with licensors that may threaten or lead to the disruption of inbound licensing relationships. In order to remain in compliance with the terms of our licenses, we monitor and manage our use of third-party software, including both proprietary and open source license terms to avoid subjecting our products and services to conditions we do not intend, such as the licensing or public disclosure of our intellectual property without compensation or on undesirable terms. The terms of many open source licenses have not been interpreted by U.S. courts, and these licenses could be construed in a way that could impose unanticipated conditions or restrictions on our ability to commercialize our products or services. Additionally, some of these licenses may not be available to us in the future on terms that are acceptable or that allow our product offerings to remain competitive. Our inability to obtain licenses or rights on favorable terms could have a material effect on our business, financial condition, results of operations and cash flow, including if we are required to take remedial action that may divert resources away from our development efforts.In addition, we also rely upon third-party hosted infrastructure partners globally to serve customers and operate certain aspects of our business or services. Any disruption of or interference at our hosted infrastructure partners would impact our operations and our business could be adversely impacted.RISKS RELATED TO INFORMATION TECHNOLOGY, DATA AND INFORMATION SECURITYWe could suffer a loss of revenue and increased costs, exposure to significant liability including legal and regulatory consequences, reputational harm and other serious negative consequences in the event of cyber-attacks, ransomware or other cyber security breaches or incidents that disrupt our operations or result in unauthorized access to, or the loss, corruption, unavailability or dissemination of proprietary or confidential information of our customers or about us or other third parties.56Table of ContentsOur operations are dependent upon our ability to protect our digital infrastructure and data. We manage and store various proprietary information and sensitive or confidential data relating to our operations, as well as to our customers, suppliers, employees and other third parties, and we store subscribers’ data on our edge-to-cloud mass storage platform. As our operations become more automated, increasingly interdependent and our edge-to-cloud mass storage platform service grows, our exposure to the risks posed by storage, transfer, and maintenance of data, such as corruption, loss or unavailability of, or damage to, and other security risks to, data, will continue to increase. Despite the measures we and our vendors put in place to secure our computer equipment and data belonging to us, our customers, suppliers, employees or other third parties, the computer equipment and data have been and may continue to be vulnerable to phishing, employee error, hacking, ransomware and other cyberattacks, malfeasance, system error or other irregularities or incidents, including from breaches and incidents or attacks at third party vendors we utilize. In addition, the measures we take may not be sufficient for all eventualities. We anticipate that these threats will continue to grow in scope and complexity over time due to the development and deployment of increasingly advanced tools and techniques to attack or to exploit any security vulnerabilities of our products and services.The costs to eliminate or address the foregoing security problems and security vulnerabilities before or after a security breach or incident may be significant. Certain legacy IT systems may not be easily remediated, and our disaster recovery planning may not be sufficient for all eventualities. Our remediation efforts may not be successful and could result in interruptions, delays or cessation of service, and loss of existing or potential customers that may impede our sales, manufacturing, distribution or other critical functions and may result in litigation or governmental investigations, fines, penalties, indemnity obligations and other potential liability and costs for us, materially damage our brand or otherwise materially harm our business.We must successfully implement our new global enterprise resource planning system and maintain and upgrade our IT systems, and our failure to do so could have a material adverse effect on our business, financial condition and results of operations.From time to time, we expand and improve our IT systems to support our business going forward. Consequently, we are in the process of implementing, and will continue to invest in and implement, modifications and upgrades to our IT systems and procedures, including making changes to legacy systems or acquiring new systems with new functionality, and building new policies, procedures, training programs and monitoring tools.We are engaged in a multi-year implementation of a new global enterprise resource planning system (“ERP”) which requires significant investment of human and financial resources. The ERP is designed to efficiently maintain our financial records and provide information important to the operation of our business to our management team. In implementing the ERP, we may experience significant increases to inherent costs and risks associated with changing and acquiring these systems, policies, procedures and monitoring tools, including capital expenditures, additional operating expenses, demands on management time and other risks and costs of delays or difficulties in transitioning to or integrating new systems policies, procedures or monitoring tools into our current systems. Any significant disruption or deficiency in the design and implementation of the ERP may adversely affect our ability to process orders, ship product, send invoices and track payments, fulfill contractual obligations, maintain effective disclosure controls and internal control over financial reporting or otherwise operate our business. These implementations, modifications and upgrades may not result in productivity improvements at a level that outweighs the costs of implementation, or at all. In addition, difficulties with implementing new technology systems, such as ERP, delays in our timeline for planned improvements, significant system failures or our inability to successfully modify our IT systems, policies, procedures or monitoring tools to respond to changes in our business needs in the past have caused and in the future may cause disruptions in our business operations, increase data security risks, and may have a material adverse effect on our business, financial condition and results of operations.RISKS RELATED TO OWNING OUR ORDINARY SHARESThe price of our ordinary shares may be volatile and could decline significantly. The market price of our ordinary shares has fluctuated and may continue to fluctuate or decline significantly in response to various factors some of which are beyond our control, including: •general stock market conditions, or general uncertainty in stock market conditions due to global economic conditions and negative financial news unrelated to our business or industry, including the impact of the COVID-19 pandemic; •the timing and amount of or the discontinuance of our share repurchases; •actual or anticipated variations in our results of operations; •announcements of innovations, new products, significant contracts, acquisitions, or significant price reductions by us or our competitors, including those competitors who offer alternative storage technology solutions; •our failure to meet our guidance or the performance estimates of investment research analysts, or changes in financial estimates by investment research analysts; •significant announcements by or changes in financial condition of a large customer; 57Table of Contents•the ability of our customers to procure necessary components which may impact their demand or timing of their demand for our products, especially during a period of persistent supply chain shortages;•reduction in demand from our key customers due to macroeconomic conditions that reduce cloud, enterprise or consumer spending;•actual or perceived security breaches or security vulnerabilities;•actual or anticipated changes in the credit ratings of our indebtedness by rating agencies; and •the sale of our ordinary shares held by certain equity investors or members of management. In addition, in the past, following periods of decline in the market price of a company’s securities, class action lawsuits have often been pursued against that company. If similar litigation were pursued against us, it could result in substantial costs and a diversion of management’s attention and resources, which could materially adversely affect our results of operations, financial condition and liquidity.Any decision to reduce or discontinue the payment of cash dividends to our shareholders or the repurchase of our ordinary shares pursuant to our previously announced share repurchase program could cause the market price of our ordinary shares to decline significantly.Although historically we have announced regular cash dividend payments and a share repurchase program, we are under no obligation to pay cash dividends to our shareholders in the future at historical levels or at all or to repurchase our ordinary shares at any particular price or at all. The declaration and payment of any future dividends is at the discretion of our Board of Directors. Our previously announced share repurchase program was paused in the December 2022 quarter and may be discontinued at any time. Our payment of quarterly cash dividends and the repurchase of our ordinary shares pursuant to our share repurchase program are subject to, among other things, our financial position and results of operations, distributable reserves, available cash and cash flow, capital and regulatory requirements, market and economic conditions, our ordinary share price and other factors. Any reduction or discontinuance by us of the payment of quarterly cash dividends or the repurchase of our ordinary shares pursuant to our share repurchase program could cause the market price of our ordinary shares to decline significantly. Moreover, in the event our payment of quarterly cash dividends or repurchases of our ordinary shares are reduced or discontinued, our failure to resume such activities at historical levels could result in a persistent lower market valuation of our ordinary shares.ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS Repurchase of Equity SecuritiesAll repurchases of our outstanding ordinary shares are effected as redemptions in accordance with our Constitution. As of December 30, 2022, $1.9 billion remained available for repurchases under the existing repurchase authorization. There is no expiration date on this authorization. The timing of purchases will depend upon prevailing market conditions, alternative uses of capital and other factors. We may limit or terminate the repurchase program at any time. The following table sets forth information with respect to all repurchases of our ordinary shares made during the fiscal quarter ended December 30, 2022, including statutory tax withholdings related to vesting of employee equity awards (in millions, except average price paid per share):PeriodTotal Number of Shares Repurchased(1)Average Price Paid Per Share(1)Total Number of Shares Repurchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs(1)October 1, 2022 through October 28, 2022— — — $1,926 October 29, 2022 through November 25, 2022— — — 1,926 November 26, 2022 through December 30, 2022— — — 1,926 Total— — __________________________________________(1) Repurchase of shares pursuant to the repurchase program described above, as well as tax withholdings. ITEM 3.DEFAULTS UPON SENIOR SECURITIESNone.58Table of ContentsITEM 4.MINE SAFETY DISCLOSURESNot applicable.ITEM 5.OTHER INFORMATION Not applicable.59Table of ContentsITEM 6.EXHIBITSIncorporated by ReferenceExhibit No. Description of ExhibitForm File No.ExhibitFiling DateFiled Herewith3.1Certificate of Incorporation of Seagate Technology Holdings plc10-K001-315603.18/6/20213.2Constitution of Seagate Technology Holdings public limited company as of May 18, 2021 (as amended by special resolution dated May 14, 2021)S-8001-315604.110/20/202110.1Indenture for the New Notes, dated as of November 30, 2022, among Seagate HDD Cayman, as Issuer, Seagate Technology Unlimited Company and Seagate Technology Holdings plc, as Guarantors, and Computershare Trust Company, National Association, as Trustee8-K001-315604.111/30/202210.2Form of 9.625% Senior Note due 20328-K001-315604.211/30/202210.3Registration Rights Agreement for the New Notes, dated as of November 30, 2022, among Seagate HDD Cayman, Seagate Technology Unlimited Company, Seagate Technology Holdings plc, Morgan Stanley & Co. LLC, MUFG Securities Americas Inc., BofA Securities, Inc., Scotia Capital (USA) Inc., Wells Fargo Securities, LLC and BNP Paribas Securities Corp8-K001-315604.311/30/202210.4Seventh Amendment, dated as of November 8, 2022 to the Credit Agreement as of February 2019X31.1Certification of the Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14 (a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002X31.2Certification of the Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14 (a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002X32.1†Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002X101.INSInline XBRL Instance Document.101.SCHInline XBRL Taxonomy Extension Schema.101.CALInline XBRL Taxonomy Extension Calculation Linkbase Document.101.LABInline XBRL Taxonomy Extension Label Linkbase Document.101.PREInline XBRL Taxonomy Extension Presentation Linkbase Document.101.DEFInline XBRL Taxonomy Extension Definition Linkbase.104Inline XBRL Cover page and contained in Exhibit 101.+ Management contract or compensatory plan or arrangement.60Table of Contents† The certifications attached as Exhibit 32.1 that accompany this Quarterly Report on Form 10-Q are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of Seagate Technology Holdings plc under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing. 61Table of ContentsSIGNATURESPursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SEAGATE TECHNOLOGY HOLDINGS PUBLIC LIMITED COMPANY DATE:January 25, 2023 BY:/s/ Gianluca Romano Gianluca Romano Executive Vice President and Chief Financial Officer(Principal Financial and Accounting Officer)62 EX-10.4 2 stx-ex104_20221230.htm EX-10.4 Document EXHIBIT 10.4SEVENTH AMENDMENT THIS SEVENTH AMENDMENT, dated as of November 8, 2022 (this “Amendment”), to the Existing Credit Agreement referred to below, is among SEAGATE TECHNOLOGY HOLDINGS PUBLIC LIMITED COMPANY, a public limited company incorporated under the laws of Ireland (“STX”), SEAGATE HDD CAYMAN, an exempted company incorporated with limited liability under the laws of the Cayman Islands (the “Borrower”), THE BANK OF NOVA SCOTIA, as administrative agent (in such capacity, the “Administrative Agent”) and the Lenders (as defined below) constituting the Required Lenders (as defined in the Credit Agreement referred to below).W I T N E S S E T H:WHEREAS, pursuant to the Credit Agreement, dated as of February 20, 2019 (as amended, supplemented, amended and restated or otherwise modified prior to the date hereof, the “Existing Credit Agreement,” and as further amended, supplemented, amended and restated or otherwise modified, the “Credit Agreement”), among STX (as successor to Seagate Technology Unlimited Company, an unlimited company incorporated under the laws of Ireland), the Borrower, the lenders from time to time party thereto (the “Lenders”) and the Administrative Agent, such Lenders have agreed to make Loans and have made Loans, and the Issuing Banks have agreed to issue (and have issued) Letters of Credit to the Borrower; WHEREAS, STX and the Borrower have requested, subject to the terms and conditions hereinafter set forth, that the Existing Credit Agreement be amended to, among other things, modify certain covenants during the Covenant Relief Period (as defined in the Credit Agreement).WHEREAS, the Administrative Agent and the Lenders that are signatories hereto, constituting the Required Lenders, have agreed to such and other amendments on the terms and conditions set forth in this Amendment.NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto hereby agree as follows:ARTICLE I DEFINITIONSSECTION 1.1. Certain Definitions. The following terms (whether or not underscored) when used in this Amendment shall have the following meanings:“Amendment” is defined in the preamble.“Credit Agreement” is defined in the first recital“Existing Credit Agreement” is defined in the first recital.“Lenders” is defined in the first recital.“Seventh Amendment Effective Date” is defined in Section 3.1.4125-8394-2461.5SECTION 1.1. Credit Agreement Defined Terms. Unless otherwise defined herein or the context otherwise requires, terms defined in the Credit Agreement and used in this Amendment shall have the meanings given to them in the Credit Agreement.ARTICLE IIAMENDMENTS OF THE EXISTING CREDIT AGREEMENT, ETC.SECTION 2.1. Amendments to Existing Credit Agreement. The Existing Credit Agreement is hereby amended to delete the struck text (indicated textually in the same manner as the following example: stricken text) and to add the underlined text (indicated textually in the same manner as the following example: underlined text) as set forth in the Credit Agreement attached hereto as Exhibit A.SECTION 2.1. Effect on Commitments and Outstanding Loans and Letters of Credit. Unless otherwise provided herein, (i) all Commitments in effect under the Existing Credit Agreement immediately prior to the Seventh Amendment Effective Date shall continue in effect under the Credit Agreement and (ii) all Loans and Letters of Credit (if any) outstanding and issued under the Existing Credit Agreement immediately prior to the Seventh Amendment Effective Date shall continue to be outstanding and issued under the Credit Agreement, and on and after the Seventh Amendment Effective Date the terms of the Credit Agreement shall govern the rights and obligations of the Borrower, the other Loan Parties, the Lenders, the Issuing Banks and the Administrative Agent with respect thereto.ARTICLE IIICONDITIONS TO EFFECTIVENESSSECTION 3.1. This Amendment shall become effective upon the date (the “Seventh Amendment Effective Date”) when each of the conditions set forth in this Article shall have been satisfied. For purposes of determining compliance with the conditions specified in this Article, the Administrative Agent and each Lender that has signed this Amendment shall be deemed to have waived, consented to, approved, accepted and be satisfied with each document or other matter that must be “in form and substance satisfactory” to the Administrative Agent or a Lender or otherwise required thereunder to be consented to or approved by or acceptable or satisfactory to the Administrative Agent or a Lender.SECTION 3.1.1. Execution of Counterparts. The Administrative Agent shall have received copies of this Amendment, duly executed and delivered by an authorized officer or representative of STX and of the Borrower, each Lender named on a signature page hereto, and the Administrative Agent.SECTION 3.1.2. Affirmation. The Administrative Agent shall have received counterparts of an affirmation, dated as of the Seventh Amendment Effective Date, in form and substance reasonably satisfactory to the Administrative Agent, duly executed and delivered by an authorized officer of each Guarantor.SECTION 3.1.3. Resolutions, etc. The Administrative Agent shall have received such documents and certificates as the Administrative Agent or its counsel may reasonably request relating to the organization or incorporation, existence and good standing of each Loan Party, the authorization of the execution, delivery and performance of the Loan Documents by each Loan Party and any other legal matters relating to each Loan Party or the Loan Documents, all in form and substance reasonably satisfactory to the Administrative Agent and its counsel.24125-8394-2461.5SECTION 3.1.4. No Material Adverse Change. The Lenders shall be satisfied that there shall have been no material adverse effect on the business, assets, financial condition or operations of STX and its subsidiaries, taken as a whole, since July 1, 2022.SECTION 3.1.5. PATRIOT Act. Upon the request of any Lender, made at least ten days prior to the Seventh Amendment Effective Date, the Borrower shall provide such information so requested in connection with applicable “know your customer” and “anti-money laundering” rules and regulations, including the USA PATRIOT Act, in each case at least five days prior to the Seventh Amendment Effective Date.SECTION 3.1.6. Fees and Expenses. The Administrative Agent shall have received all fees and other amounts due and payable on or prior to the Seventh Amendment Effective Date, including in each case, to the extent invoiced, reimbursement or payment of all reasonable out-of-pocket expenses (including reasonable fees, charges and disbursements of counsel) required to be reimbursed or paid by the Borrower under any Loan Document.ARTICLE IVMISCELLANEOUS PROVISIONSSECTION 4.1. Representations and Warranties. To induce the Lenders and the Administrative Agent to enter into this Amendment, STX and the Borrower represent and warrant to the Lenders and the Administrative Agent that as of the Seventh Amendment Effective Date: (a) both before and after giving effect to this Amendment, all of the statements set forth in clause (a) of Section 4.02 of the Existing Credit Agreement are true and correct; (b) both before and after giving effect to this Amendment, no Default has occurred and is continuing, or will result therefrom; (c) this Amendment constitutes the legal, valid and binding obligation of STX and the Borrower, enforceable in accordance with its terms, subject to applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium or other laws affecting creditors’ rights generally and to general principles of equity and an implied covenant of good faith and fair dealing, regardless of whether considered in a proceeding in equity or at law in accordance with its terms; and(d) no authorizations, consents, or approvals by any Person are required for the execution and delivery by, or for the effectiveness or enforceability against, any Loan Party of this Amendment except such as have been made or obtained and are in full force and effect.SECTION 4.2. Effect of Amendment. The parties hereto agree as follows:(a) This Amendment shall not constitute an amendment or waiver of or consent to any provision of the Existing Credit Agreement or any other Loan Document not expressly referred to herein and shall not be construed as an amendment, waiver or consent to any action on the part of the Borrower that would require an amendment, waiver or consent of the Administrative Agent or any Lender under any of the Loan Documents except as expressly stated herein. Except as expressly amended hereby, the provisions of the Existing Credit Agreement and the Loan Documents shall remain unchanged and shall continue to be, and shall remain, in full force and effect in accordance with their respective terms. It is the intent of the parties hereto, and the parties 34125-8394-2461.5hereto agree, that this Amendment shall not constitute a novation of the Existing Credit Agreement, any other Loan Document or any of the rights, obligations or liabilities thereunder.(b) On and after the Seventh Amendment Effective Date, each reference in the Existing Credit Agreement to “this Agreement,” “hereunder,” “hereof,” “herein,” or words of like import, and each reference to the Existing Credit Agreement in any other Loan Document shall be deemed a reference to the Existing Credit Agreement as amended hereby. This Amendment, executed pursuant to the Existing Credit Agreement, shall constitute a “Loan Document” for all purposes of the Existing Credit Agreement and the other Loan Documents and shall be construed, administered and applied in accordance with all of the terms and provisions of the Credit Agreement. SECTION 4.3. Fees and Expenses. The Borrower agrees to reimburse the Administrative Agent for its reasonable and documented out-of-pocket expenses arising in connection with this Amendment, including the reasonable fees, charges and disbursements of counsel for the Administrative Agent.SECTION 4.4. Successors and Assigns. This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns.SECTION 4.5. Headings. The headings of this Amendment are for purposes of reference only and shall not limit or otherwise affect the meaning hereof.SECTION 4.6. Counterparts. This Amendment may be executed by one or more of the parties to this Amendment on any number of separate counterparts, each of which when executed and delivered shall be deemed an original, and all such counterparts taken together shall be deemed to constitute one and the same document. Delivery of an executed counterpart of a signature page to this Amendment by electronic signature, pdf, facsimile or other electronic transmission shall be effective as delivery of an original executed counterpart of this Amendment.SECTION 4.7. GOVERNING LAW. THIS AMENDMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK. STX AND THE BORROWER HEREBY IRREVOCABLY AND UNCONDITIONALLY SUBMITS, FOR ITSELF AND ITS PROPERTY, TO THE EXCLUSIVE JURISDICTION OF THE SUPREME COURT OF THE STATE OF NEW YORK SITTING IN NEW YORK COUNTY AND OF THE UNITED STATES DISTRICT COURT OF THE SOUTHERN DISTRICT OF NEW YORK, AND ANY APPELLATE COURT FROM ANY THEREOF, TO THE SAME EXTENT SET FORTH IN SECTION 9.09(b) OF THE CREDIT AGREEMENT. SECTION 4.8. WAIVER OF JURY TRIAL. EACH PARTY HERETO HEREBY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY RIGHT IT MAY HAVE TO A TRIAL BY JURY IN ANY LEGAL PROCEEDING DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATING TO THIS AMENDMENT OR ANY OTHER LOAN DOCUMENT OR THE TRANSACTIONS CONTEMPLATED THEREBY (WHETHER BASED ON CONTRACT, TORT OR ANY OTHER THEORY). EACH PARTY HERETO (A) CERTIFIES THAT NO REPRESENTATIVE, AGENT OR ATTORNEY OF ANY OTHER PARTY HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PARTY WOULD NOT, IN THE EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVER AND (B) ACKNOWLEDGES THAT IT AND THE OTHER PARTIES HERETO HAVE BEEN INDUCED TO ENTER INTO THIS AMENDMENT BY, 44125-8394-2461.5AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS IN THIS SECTION.IN WITNESS WHEREOF, the parties hereto have caused this Amendment to the Existing Credit Agreement to be duly executed and delivered as of the day and year first above written.SEAGATE TECHNOLOGY HOLDINGS PUBLIC LIMITED COMPANYBy: /s/ Walter Chang Name: Walter Chang Title: Treasurer, Authorized Signatory [Signature Page to Seventh Amendment to Credit Agreement]SEAGATE HDD CAYMANBy: /s/ Walter Chang Name: Walter Chang Title: Treasurer, Authorized Signatory [Signature Page to Seventh Amendment to Credit Agreement]THE BANK OF NOVA SCOTIA, in its capacity as the Administrative Agent and a LenderBy: /s/ Khrystyna Manko Name: Khrystyna Manko Title: Director[Signature Page to Seventh Amendment to Credit Agreement]BANK OF AMERICA N.A., as a LenderBy: /s/ Herman Chang Name: Herman Chang Title: Vice President[Signature Page to Seventh Amendment to Credit Agreement]BNP PARIBAS, as a LenderBy: /s/ George Ko Name: George Ko Title: DirectorBy: /s/Theodore Olson Name: Theodore Olson Title: Managing Director[Signature Page to Seventh Amendment to Credit Agreement]MORGAN STANLEY BANK, N.A., as a LenderBy: /s/ Philip Magdaleno Name: Philip Magdaleno Title: Authorized Signatory[Signature Page to Seventh Amendment to Credit Agreement]MUFG BANK, LTD., as a LenderBy: /s/ Colin Donnarumma Name: Colin Donnarumma Title: Vice President[Signature Page to Seventh Amendment to Credit Agreement]WELLS FARGO BANK, NATIONAL ASSOCIATION, as a LenderBy: /s/ Gambo Audu Name: GAMBO AUDU Title: VICE PRESIDENT[Signature Page to Seventh Amendment to Credit Agreement]DBS BANK LTD., as a LenderBy: /s/ Kate Khoo Name: Kate Khoo Title: Vice President[Signature Page to Seventh Amendment to Credit Agreement]CITIBANK, N.A., as a LenderBy: /s/ Carmen-Christina Kelleher Name: Carmen-Christina Kelleher Title: Vice President[Signature Page to Seventh Amendment to Credit Agreement]INDUSTRIAL AND COMMERCIAL BANK OF CHINA LIMITED, NEW YORK BRANCH, as a LenderBy: /s/ Tony Huang Name: Tony Huang Title: DirectorBy: /s/ Yuanyuan Peng Name: Yuanyuan Peng Title: Executive Director[Signature Page to Seventh Amendment to Credit Agreement]SUMITOMO MITSUI BANKING CORPORATION, as a LenderBy: /s/ Irlen Mak Name: Irlen Mak Title: Director[Signature Page to Seventh Amendment to Credit Agreement]U.S. BANK NATIONAL ASSOCIATION, as a LenderBy: /s/ Alexander Wilson Name: Alexander Wilson Title: Assistant Vice President[Signature Page to Seventh Amendment to Credit Agreement]OVERSEA-CHINESE BANKING CORPORATION, LIMITED, LOS ANGELES AGENCY, as a LenderBy: /s/ Grace Sun Name: Grace Sun Title: Deputy General Manager[Signature Page to Seventh Amendment to Credit Agreement]BANK OF TAIWAN, as a LenderBy: /s/ Dixon Wang Name: Dixon Wang Title: SVP & GM[Signature Page to Seventh Amendment to Credit Agreement]MEGA INTERNATIONAL COMMERCIAL BANK CO., LTD., NEW YORK BRANCH, as a LenderBy: /s/ Tung Wei Wu Name: Tung Wei Wu Title: AVP[Signature Page to Seventh Amendment to Credit Agreement]BARCLAYS BANK PLD, as a LenderBy: /s/ Sean Duggan Name: Sean Duggan Title: Director[Signature Page to Seventh Amendment to Credit Agreement]CAPITAL ONE, NATIONAL ASSOCIATION, as a LenderBy: /s/ Denis Cronin Name: Denis Cronin Title: Duly Authorized Signatory[Signature Page to Seventh Amendment to Credit Agreement]CHINA CITIC BANK INTERNATIONAL LIMITED, as a LenderBy: /s/ Qing Hong Name: Qing Hong Title: General Manager & Branch Manager, New York Branch[Signature Page to Seventh Amendment to Credit Agreement]KEYBANK NATIONAL ASSOCIATION, as a LenderBy: /s/ Allyn A. Coskun Name: Allyn A. Coskun Title: Vice President[Signature Page to Seventh Amendment to Credit Agreement]EXHIBIT A(to Seventh Amendment)[Attached]4125-8394-2461.5EXECUTION COPYCREDIT AGREEMENT dated as of February 20, 2019,amongSEAGATE TECHNOLOGY HOLDINGS PUBLIC LIMITED COMPANY,SEAGATE HDD CAYMAN,as the Borrower,The Lenders Party Hereto,THE BANK OF NOVA SCOTIA, as Administrative AgentREVOLVING CREDIT FACILITY BOOKRUNNERS:The Bank of Nova Scotia, BofA Securities, Inc., BNP Paribas Securities Corp., Morgan Stanley Senior Funding, Inc., MUFG Bank, Ltd. and Wells Fargo Bank, National AssociationTERM LOAN A1 / TERM LOAN A2 BOOKRUNNERS:The Bank of Nova Scotia, BofA Securities, Inc., MUFG Bank, Ltd., Wells Fargo Bank, National Association, DBS Bank LTD., Oversea-Chinese Banking Corporation Limited and Sumitomo Mitsui Banking CorporationTERM LOAN A3 BOOKRUNNERS:The Bank of Nova Scotia, Industrial and Commercial Bank of China, New York Branch, DBS Bank LTD., KeyBank National Association, MUFG Bank, Ltd., Oversea-Chinese Banking Corporation Limited and Bank of America, N.A.4159-0944-0061.4TABLE OF CONTENTSPage ARTICLE IDefinitions1SECTION 1.01 Defined Terms1SECTION 1.02 Classification of Loans and Borrowings41SECTION 1.03 Terms Generally42SECTION 1.04 Accounting Terms; GAAP42SECTION 1.05 Exchange Rates43SECTION 1.06 Divisions43ARTICLE IIThe Credits43SECTION 2.01 Commitments43SECTION 2.02 Loans and Borrowings44SECTION 2.03 Requests for Borrowings45SECTION 2.04 Swingline Loans45SECTION 2.05 Letters of Credit47SECTION 2.06 Funding of Borrowings53SECTION 2.07 Interest Elections54SECTION 2.08 Termination and Reduction of Commitments55SECTION 2.09 Repayment of Loans; Evidence of Debt56SECTION 2.10 Prepayment and Repayment of Loans57SECTION 2.11 Fees59SECTION 2.12 Interest60SECTION 2.13 Inability to Determine Rates61SECTION 2.14 Increased Costs61SECTION 2.15 Break Funding Payments63SECTION 2.16 Taxes63SECTION 2.17 Payments Generally; Pro Rata Treatment; Sharing of Set-offs65SECTION 2.18 Mitigation Obligations; Replacement of Lenders67SECTION 2.19 Change in Law68SECTION 2.20 [RESERVED]69SECTION 2.21 Incremental Loans69SECTION 2.22 Defaulting Lenders69-i-4159-0944-0061.4TABLE OF CONTENTS(continued)PageSECTION 2.23 Maturity Date Extension72SECTION 2.24 Benchmark Replacement Setting72ARTICLE IIIRepresentations and Warranties74SECTION 3.01 Organization; Powers74SECTION 3.02 Authorization; Enforceability74SECTION 3.03 Governmental Approvals; No Conflicts75SECTION 3.04 Financial Condition; No Material Adverse Change75SECTION 3.05 Properties75SECTION 3.06 Litigation and Environmental Matters76SECTION 3.07 Compliance with Laws and Agreements76SECTION 3.08 Investment Company Status76SECTION 3.09 Taxes77SECTION 3.10 ERISA77SECTION 3.11 Disclosure77SECTION 3.12 Subsidiaries77SECTION 3.13 Insurance77SECTION 3.14 Labor Matters77SECTION 3.15 Sanctioned Persons, etc78SECTION 3.16 USA PATRIOT Act, Etc79ARTICLE IVConditions79SECTION 4.01 Conditions to Initial Borrowing79SECTION 4.02 Each Credit Event81ARTICLE VAffirmative Covenants81SECTION 5.01 Financial Statements and Other Information82SECTION 5.02 Notices of Material Events83SECTION 5.03 [RESERVED].84SECTION 5.04 Existence; Conduct of Business84SECTION 5.05 Payment of Obligations84SECTION 5.06 Maintenance of Properties84SECTION 5.07 Insurance84-ii-4159-0944-0061.4TABLE OF CONTENTS(continued)PageSECTION 5.08 Further Assurances85SECTION 5.09 Books and Records; Inspection Rights85SECTION 5.10 Compliance with Laws85SECTION 5.11 Use of Proceeds of Loans and Letters of Credit85SECTION 5.12 Senior Obligations86SECTION 5.13 Additional Subsidiaries86ARTICLE VINegative Covenants86SECTION 6.01 Indebtedness87SECTION 6.02 Liens89SECTION 6.03 Fundamental Changes90SECTION 6.04 Investments, Loans, Advances, Guarantees and Acquisitions91SECTION 6.05 Asset Sales93SECTION 6.06 Swap Agreements94SECTION 6.07 Restricted Payments94SECTION 6.08 Transactions with Affiliates95SECTION 6.09 Restrictive Agreements95SECTION 6.10 Amendment of Material Documents96SECTION 6.11 Interest Coverage Ratio97SECTION 6.12 Total Leverage Ratio97SECTION 6.13 Minimum Liquidity97SECTION 6.14 OFAC Compliance97SECTION 6.15 Successor Transaction97SECTION 6.16 Maximum Aggregate Debt.97ARTICLE VIIEvents of Default98SECTION 7.01 Events of Default98SECTION 7.02 Exclusion of Immaterial Subsidiaries100ARTICLE VIIIThe Administrative Agent100SECTION 8.01 The Administrative Agent as Agent100SECTION 8.02 The Administrative Agent as Lender100SECTION 8.03 No Duties101-iii-4159-0944-0061.4TABLE OF CONTENTS(continued)PageSECTION 8.04 Reliance by the Agent and Exculpation101SECTION 8.05 Delegation of Agent’s Obligations101SECTION 8.06 Successor102SECTION 8.07 Credit Decisions102SECTION 8.08 Limitations on Obligations of Certain Transaction Parties102SECTION 8.09 Guarantee Matters103SECTION 8.10 Certain ERISA Matters103SECTION 8.11 Erroneous Payments104ARTICLE IXMiscellaneous108SECTION 9.01 Notices108SECTION 9.02 Waivers; Amendments109SECTION 9.03 Expenses; Indemnity; Damage Waiver112SECTION 9.04 Successors and Assigns113SECTION 9.05 Survival119SECTION 9.06 Counterparts; Integration; Effectiveness119SECTION 9.07 Severability119SECTION 9.08 Right of Setoff119SECTION 9.09 Governing Law; Jurisdiction; Consent to Service of Process120SECTION 9.10 WAIVER OF JURY TRIAL121SECTION 9.11 Headings121SECTION 9.12 Confidentiality121SECTION 9.13 Interest Rate Limitation122SECTION 9.14 Judgment Currency122SECTION 9.15 USA PATRIOT Act123SECTION 9.16 Acknowledgement and Consent to Bail-In of Affected Financial Institutions123SECTION 9.17 Acknowledgement Regarding Any Supported QFCs123-iv-4159-0944-0061.4TABLE OF CONTENTS(continued)PageSchedule 2.01 Lenders and CommitmentsSchedule 3.06Disclosed MattersSchedule 3.12SubsidiariesSchedule 6.01Existing IndebtednessSchedule 6.02Existing LiensSchedule 6.04Existing InvestmentsSchedule 6.09Existing Restrictive AgreementsExhibit AForm of Assignment and Acceptance AgreementExhibit BForm of U.S. Guarantee AgreementExhibit CForm of Indemnity, Subrogation and Contribution AgreementExhibit DForm of Borrowing RequestExhibit EForm of Issuance RequestExhibit FForm of Interest Election RequestExhibit GForm of Certificate of Financial OfficerExhibit HForm of Revolving Note Exhibit I-1Form of Term Note A1Exhibit I-2Form of Term Note A2Exhibit I-3Form of Term Note A3-v-4159-0944-0061.4CREDIT AGREEMENTThis CREDIT AGREEMENT, dated as of February 20, 2019 (this “Agreement”), is among SEAGATE TECHNOLOGY HOLDINGS PUBLIC LIMITED COMPANY, a public limited company incorporated under the laws of Ireland (“STX”), SEAGATE HDD CAYMAN, an exempted company incorporated with limited liability under the laws of the Cayman Islands (the “Borrower”), the various financial institutions and other Persons from time to time parties hereto (the “Lenders”) and THE BANK OF NOVA SCOTIA (“Scotiabank”), as administrative agent (in such capacity, “Administrative Agent”).W I T N E S S E T H:WHEREAS, the Borrower has requested that the Lenders make, and the Lenders have made, Loans (such capitalized term, and other terms used in the preamble and these recitals to have the meanings set forth in Article I) to the Borrower in an aggregate principal amount not to exceed the applicable Commitment;WHEREAS, the Loan Parties have requested that this Agreement be amended pursuant to the Seventh Amendment to, among other things, modify certain covenants during the Covenant Relief Period; andWHEREAS, the Required Lenders are willing, on the terms and subject to the conditions set forth in the Seventh Amendment, to amend the Loan Documents in certain respects, including to modify certain covenants during the Covenant Relief Period;NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows:ARTICLE IDefinitionsSECTION 1.01 Defined Terms. As used in this Agreement, the following terms have the meanings specified below:“ABR,” when used in reference to any Loan or Borrowing, refers to whether such Loan, or the Loans comprising such Borrowing, are bearing interest at a rate determined by reference to the Alternate Base Rate. “ABR Term SOFR Determination Day” has the meaning specified in the definition of “Term SOFR”.“Adjusted Term SOFR” means, for purposes of any calculation, the rate per annum equal to (a) Term SOFR for such calculation plus (b) the Term SOFR Adjustment; provided that if Adjusted Term SOFR as so determined shall ever be less than the Floor, then Adjusted Term SOFR shall be deemed to be the Floor.“Administrative Agent” means Scotiabank, in its capacity as administrative agent for the Lenders hereunder, and its successors in such capacity as provided in Article VIII.“Administrative Questionnaire” means an administrative questionnaire in a form supplied by the Administrative Agent.4159-0944-0061.4“Affected Financial Institution” means (i) any EEA Financial Institution or (ii) any UK Financial Institution.“Affiliate” means, with respect to a specified Person, another Person that directly, or indirectly through one or more intermediaries, Controls or is Controlled by or is under common Control with the Person specified. Notwithstanding the foregoing, (i) no individual shall be deemed to be an Affiliate of a Person solely by reason of his or her being an officer or director of such Person and (ii) Thanachart Bank shall be deemed to be an Affiliate of The Bank of Nova Scotia.“Agreement” has the meaning assigned to such term in the preamble to this Agreement.“Alternate Base Rate” means, for any day, a rate per annum equal to the greatest of (a) the Base Rate in effect on such day, (b) the Federal Funds Effective Rate in effect on such day plus ½ of 1% and (c) the Adjusted Term SOFR for a one-month Interest Period (to the extent such rate is available) on such day (or if such day is not a Business Day, the immediately preceding Business Day) plus 1%. Any change in the Alternate Base Rate due to a change in the Base Rate, the Federal Funds Effective Rate or the Adjusted Term SOFR shall be effective from and including the effective date of such change in the Base Rate, the Federal Funds Effective Rate or the Adjusted Term SOFR, respectively. Notwithstanding the foregoing, if the Alternate Base Rate shall be less than zero, then such rate shall be deemed zero for purposes hereof. “Alternative Currency” means any currency that is freely available, freely transferable and freely convertible into dollars and in which dealings in deposits are carried on in the New York, London or Tokyo interbank markets, provided that such currency is reasonably acceptable to the Administrative Agent and the applicable Issuing Bank.“Alternative Currency LC Exposure” means, at any time, the sum of (a) the Dollar Equivalent of the aggregate undrawn and unexpired amount of all outstanding Alternative Currency Letters of Credit at such time plus (b) the Dollar Equivalent of the aggregate principal amount of all LC Disbursements in respect of Alternative Currency Letters of Credit that have not yet been reimbursed at such time.“Alternative Currency Letter of Credit” means a Letter of Credit denominated in an Alternative Currency.“Anti-Terrorism Order” means United States Executive Order No. 13224.“Applicable Margin” means, prior to the Sixth Amendment Effective Date, the rate set forth in this Agreement prior to the effectiveness of the Sixth Amendment, and thereafter as follows, for any day, with respect to any SOFR Loan or ABR Loan or with respect to the commitment fees payable hereunder, as the case may be, the applicable rate per annum set forth below under the applicable caption, as the case may be, based upon the corporate issuer rating (or the equivalent thereof) (referred to as the “Issuer Ratings”) of the Borrower or one of its parent entities issued by Moody’s and S&P, respectively, applicable on such date to the Borrower or one of its parent entities, as applicable:24159-0944-0061.4REVOLVING LOANSIssuer RatingRevolving LoanSOFR SpreadRevolving LoanABR SpreadRevolving LoanCommitment Fee Rate Category 1Equal to or higher than:BBB by S&PBaa2 by Moody’s 1.125%0.125%0.150%Category 2BBB- by S&PBaa3 by Moody’s1.375%0.375%0.200%Category 3BB+ by S&PBa1 by Moody’s1.625%0.625%0.250%Category 4BB by S&PBa2 by Moody’s1.875%0.875%0.325%Category 5Equal to or lower than:BB- by S&PBa3 by Moody’s2.375%1.375%0.400%TERM LOANSIssuer RatingTerm Loan A1 SOFR SpreadTerm Loan A1ABR SpreadTerm Loan A2 SOFR SpreadTerm Loan A2ABR SpreadTerm Loan A3SOFR SpreadTerm Loan A3ABR SpreadCategory 1Equal to or higher than:BBB by S&PBaa2 by Moody’s 1.125%0.125%1.250%0.250%1.250%0.250%Category 2BBB- by S&PBaa3 by Moody’s1.375%0.375%1.500%0.500%1.500%0.500%Category 3BB+ by S&PBa1 by Moody’s1.625%0.625%1.750%0.750%1.750%0.750%Category 4BB by S&PBa2 by Moody’s1.875%0.875%2.000%1.000%2.000%1.000%Category 5Equal to or lower than:BB- by S&PBa3 by Moody’s2.375%1.375%2.500%1.500%2.500%1.500%34159-0944-0061.4Subject to the next sentence, on and following the Sixth Amendment Effective Date the Applicable Margin for Term Loan A3 maintained as (a) ABR Loans will be no less than 0.750% per annum and (b) SOFR Loans will be no less than 1.750% per annum. Upon delivery of the compliance certificate pursuant to clause (c) of Section 5.01 for the first full fiscal quarter occurring after the Sixth Amendment Effective Date, the Applicable Margin for Term Loan A3 will be as specified in accordance with the grid above. For purposes of the foregoing, if on any date Moody’s and S&P shall have in effect Issuer Ratings within different Categories, the Applicable Margin and Commitment Fee Rate shall be based on the higher of the two ratings unless one of the two ratings is two or more Categories lower than the other, in which case the Applicable Margin and Commitment Fee Rate shall be determined by reference to the Category next lower than that of the higher of the two ratings. If either Moody’s or S&P shall not have an Issuer Rating in effect (other than by reason of the last sentence of this clause), then such rating agency shall be deemed to have established a rating in Category 5. If the Issuer Rating established or deemed to have been established by a rating agency shall be changed (other than as a result of a change in the rating system of such rating agency), such change shall be effective as of the date on which it is first announced by the applicable rating agency, irrespective of when notice of such change shall have been furnished by the Borrower to the Administrative Agent and the Lenders pursuant to delivery of financial information or otherwise. Each change in the Applicable Margin and Commitment Fee Rate shall apply during the period commencing on the effective date of such change and ending on the date immediately preceding the effective date of the next such change. If the rating system of a rating agency shall change, or if such rating agency shall cease to be in the business of rating borrowers, then the Borrower and the Lenders shall negotiate in good faith to amend this definition to reflect such changed rating system or the unavailability of ratings from such rating agency and, pending the effectiveness of any such amendment, the Applicable Margin and commitment fee shall be determined by reference to the rating most recently in effect prior to such change or cessation.“Applicable Percentage” means, as to any Lender on any date of determination (and without duplication), the percentage that (a) (i) the outstanding principal amount of all Loans, (ii) the LC Exposure, and (iii) if Commitments have not theretofore been terminated or expired, the unfunded amount of such Commitments, of or owing to such Lender bears to (b) (i) the outstanding principal amount of all Loans, (ii) the aggregate LC Exposure, and (iii) if Commitments have not theretofore been terminated or expired, the unfunded amount of such Commitments, of or owing to all Lenders.“Approved Electronic Platform” is defined in Section 8.11(d).“Assignment and Acceptance Agreement” means the Assignment and Acceptance Agreement in substantially the form of Exhibit A hereto.“Availability Period” means (a) in the case of Revolving Loans, the period from and including the Fifth Amendment Effective Date to but excluding the earlier of the Maturity Date and the date of termination or expiration of the corresponding Revolving Commitment for Revolving Loans; (b) in the case of Term Loan A1 and Term Loan A2, the Fifth Amendment Effective Date; and (c) in the case of Term Loan A3, the Sixth Amendment Effective Date.“Available Tenor” means, as of any date of determination and with respect to the then-current Benchmark, as applicable, (a) if such Benchmark is a term rate, any tenor for such Benchmark (or component thereof) that is or may be used for determining the length of an interest period pursuant to this Agreement or (b) otherwise, any payment period for interest calculated with reference to such Benchmark (or component thereof) that is or may be used for 44159-0944-0061.4determining any frequency of making payments of interest calculated with reference to such Benchmark pursuant to this Agreement, in each case, as of such date and not including, for the avoidance of doubt, any tenor for such Benchmark that is then-removed from the definition of “Interest Period” pursuant to Section 2.24(d).“Bail-In Action” means the exercise of any Write-Down and Conversion Powers by the applicable Resolution Authority in respect of any liability of an Affected Financial Institution.“Bail-In Legislation” means, (a) with respect to any EEA Member Country implementing Article 55 of Directive 2014/59/EU of the European Parliament and of the Council of the European Union, the implementing law, rule, regulation or requirement for such EEA Member Country from time to time which is described in the EU Bail-In Legislation Schedule and (b) with respect to the United Kingdom, Part I of the United Kingdom Banking Act 2009 (as amended from time to time) and any other law, regulation or rule applicable in the United Kingdom relating to the resolution of unsound or failing banks, investment firms or other financial institutions or their affiliates (other than through liquidation, administration or other insolvency proceedings).“Base Rate” means, at any time, the rate of interest then most recently established by the Administrative Agent in New York as its base rate for dollars loaned in the United States. The Base Rate is not necessarily intended to be the lowest rate of interest determined by the Administrative Agent in connection with extensions of credit. “Benchmark” means, initially, the Term SOFR Reference Rate; provided that if a Benchmark Transition Event has occurred with respect to the Term SOFR Reference Rate or the then-current Benchmark, then “Benchmark” means the applicable Benchmark Replacement to the extent that such Benchmark Replacement has replaced such prior benchmark rate pursuant to Section 2.24(a). “Benchmark Replacement” means, with respect to any Benchmark Transition Event, the sum of: (a) the alternate benchmark rate that has been selected by the Administrative Agent and the Borrower, giving due consideration to (i) any selection or recommendation of a replacement benchmark rate or the mechanism for determining such a rate by the Relevant Governmental Body or (ii) any evolving or then-prevailing market convention for determining a benchmark rate as a replacement to the then-current Benchmark for Dollar-denominated syndicated credit facilities at such time and (b) the related Benchmark Replacement Adjustment; provided that, if such Benchmark Replacement as so determined would be less than the Floor, such Benchmark Replacement will be deemed to be the Floor for the purposes of this Agreement and the other Loan Documents.“Benchmark Replacement Adjustment” means, with respect to any replacement of the then-current Benchmark with an Unadjusted Benchmark Replacement for each applicable Interest Period, the spread adjustment, or method for calculating or determining such spread adjustment (which may be a positive or a negative value or zero), that has been selected by the Administrative Agent and the Borrower, giving due consideration to (a) any selection or recommendation of a spread adjustment, or method for calculating or determining such spread adjustment, for the replacement of such Benchmark with the applicable Unadjusted Benchmark Replacement by the Relevant Governmental Body or (b) any evolving or then-prevailing market convention for determining a spread adjustment, or method for calculating or determining such spread adjustment, for the replacement of such Benchmark with the applicable Unadjusted Benchmark Replacement for dollar-denominated syndicated credit facilities at such time.“Benchmark Replacement Conforming Changes” means, with respect to any Benchmark Replacement, any technical, administrative or operational changes (including changes to the 54159-0944-0061.4definition of “Alternate Base Rate”, the definition of “Business Day”, the definition of “Interest Period”, the definition of “U.S. Government Securities Business Day”, timing and frequency of determining rates and making payments of interest, timing of borrowing requests or prepayment, conversion or continuation notices, length of lookback periods, the applicability of breakage provisions, and other technical, administrative or operational matters) that the Administrative Agent decides may be appropriate to reflect the adoption and implementation of such Benchmark Replacement and to permit the use and administration thereof by the Administrative Agent in a manner substantially consistent with market practice (or, if the Administrative Agent decides that adoption of any portion of such market practice is not administratively feasible or if the Administrative Agent determines that no market practice for the administration of such Benchmark Replacement exists, in such other manner of administration as the Administrative Agent decides is reasonably necessary in connection with the administration of this Agreement and the other Loan Documents).“Benchmark Replacement Date” means the earlier to occur of the following events with respect to the then-current Benchmark: (a) in the case of clause (a) or (b) of the definition of “Benchmark Transition Event,” the later of (i) the date of the public statement or publication of information referenced therein and (ii) the date on which the administrator of such Benchmark (or the published component used in the calculation thereof) permanently or indefinitely ceases to provide all Available Tenors of such Benchmark (or such component thereof); or (b) in the case of clause (c) of the definition of “Benchmark Transition Event,” the first date on which all Available Tenors of such Benchmark (or the published component used in the calculation thereof) have been determined and announced by the regulatory supervisor for the administrator of such Benchmark (or such component thereof) to be non-representative; provided that such non-representativeness will be determined by reference to the most recent statement or publication referenced in such clause (c) and even if any Available Tenor of such Benchmark (or such component thereof) continues to be provided on such date.For the avoidance of doubt, the “Benchmark Replacement Date” will be deemed to have occurred in the case of clause (a) or (b) with respect to any Benchmark upon the occurrence of the applicable event or events set forth therein with respect to all then-current Available Tenors of such Benchmark (or the published component used in the calculation thereof).“Benchmark Transition Event” means the occurrence of one or more of the following events with respect to the then-current Benchmark:(a) a public statement or publication of information by or on behalf of the administrator of such Benchmark (or the published component used in the calculation thereof) announcing that such administrator has ceased or will cease to provide all Available Tenors of such Benchmark (or such component thereof), permanently or indefinitely, provided that, at the time of such statement or publication, there is no successor administrator that will continue to provide any Available Tenor of such Benchmark (or such component thereof); (b) a public statement or publication of information by the regulatory supervisor for the administrator of such Benchmark (or the published component used in the calculation thereof), the Federal Reserve Board, the Federal Reserve Bank of New York, an insolvency official with jurisdiction over the administrator for such Benchmark (or such component), a resolution authority with jurisdiction over the administrator for such Benchmark (or such component) or a court or an entity with similar insolvency or resolution authority over the administrator for such Benchmark (or such component), which states that the administrator for such Benchmark (or such component) has ceased or will cease to provide all Available Tenors of such Benchmark (or such component thereof) permanently or indefinitely; provided that, at the time of such statement or publication, there is no successor administrator that will continue to provide any Available Tenor of such Benchmark (or such component thereof); or 64159-0944-0061.4(c) a public statement or publication of information by the regulatory supervisor for the administrator of such Benchmark (or the published component used in the calculation thereof) announcing that all Available Tenors of such Benchmark (or such component thereof) are not, or as of a specified future date will not be, representative.For the avoidance of doubt, a “Benchmark Transition Event” will be deemed to have occurred with respect to any Benchmark if a public statement or publication of information set forth above has occurred with respect to each then-current Available Tenor of such Benchmark (or the published component used in the calculation thereof).“Benchmark Transition Start Date” means, in the case of a Benchmark Transition Event, the earlier of (a) the applicable Benchmark Replacement Date and (b) if such Benchmark Transition Event is a public statement or publication of information of a prospective event, the 90th day prior to the expected date of such event as of such public statement or publication of information (or if the expected date of such prospective event is fewer than ninety (90) days after such statement or publication, the date of such statement or publication).“Benchmark Unavailability Period means the period (if any) (a) beginning at the time that a Benchmark Replacement Date has occurred if, at such time, no Benchmark Replacement has replaced the then-current Benchmark for all purposes hereunder and under any Loan Document in accordance with Section 2.24 and (b) ending at the time that a Benchmark Replacement has replaced the then-current Benchmark for all purposes hereunder and under any Loan Document in accordance with Section 2.24.“Beneficial Ownership Certification” means a certification regarding beneficial ownership to the extent required by the Beneficial Ownership Regulation, which certification shall be substantially similar in substance to the form of Certification Regarding Beneficial Owners of Legal Entity Customers included as Appendix A to the Beneficial Ownership Regulation.“Beneficial Ownership Regulation” means 31 C.F.R. § 1010.230.“Benefit Plan” means any of (a) an “employee benefit plan” (as defined in ERISA) that is subject to Title I of ERISA; (b) a “plan” as defined in and subject to Section 4975 of the Code; or (c) any Person whose assets include (for purposes of ERISA Section 3(42) or otherwise for purposes of Title I of ERISA or Section 4975 of the Code) the assets of any such “employee benefit plan” or “plan.”“BHC Act Affiliate” of a party means an “affiliate” (as such term is defined under, and interpreted in accordance with, 12 U.S.C. 1841(k)) of such party. “Board” means the Board of Governors of the Federal Reserve System of the United States of America.“Bookrunner” means each of Scotiabank and the Lenders listed on Schedule 2.01 hereto, in their capacities as the Bookrunners for the Revolving Loan facility or the Term Loan facility, as applicable.“Borrower” has the meaning assigned to such term in the preamble to this Agreement.“Borrowing” means (a) as applicable, Revolving Loans or Term Loans of the same Class and Type, made, converted or continued on the same date and, in the case of SOFR Loans, as to which a single Interest Period is in effect, or (b) a Swingline Loan.74159-0944-0061.4“Borrowing Request” means a request by the Borrower for a Borrowing in accordance with Section 2.03 substantially the form of Exhibit D hereto.“Business Day” means any day that is not a Saturday, Sunday or other day that is a legal holiday under the laws of the State of New York or is a day on which banking institutions in such state are authorized or required by Law to close.“Calculation Date” means (a) the last Business Day of each calendar month and (b) if on the last Business Day of any calendar week the total Revolving Exposures exceed 75% of the total Revolving Commitments (giving effect to any reductions in the Revolving Commitments scheduled to occur on such day), such Business Day.“Capital Expenditures” means, for any period, without duplication, (a) the additions to property, plant and equipment and other capital expenditures of STX, the Borrower and the Subsidiaries that are (or would be) set forth in a consolidated statement of cash flows of STX for such period prepared in accordance with GAAP and (b) Capital Lease Obligations incurred by STX, the Borrower and the Subsidiaries during such period, provided that the term “Capital Expenditures” (i) shall be net of landlord construction allowances, (ii) shall not include expenditures to the extent they are made with the proceeds of the issuance of Equity Interests of STX, the Borrower or any Subsidiary after the Effective Date, (iii) shall not include expenditures of proceeds of insurance settlements, condemnation awards and other settlements in respect of lost, destroyed, damaged or condemned assets, equipment or other property to the extent such expenditures are made to replace or repair such lost, destroyed, damaged or condemned assets, equipment or other property or otherwise to acquire assets useful in the business of STX, the Borrower or any Subsidiary within 365 days of receipt of such proceeds, (iv) shall not include the purchase price of equipment to the extent the consideration therefor consists of used or surplus equipment being traded in at such time or the proceeds of a concurrent sale of such used or surplus equipment, in each case in the ordinary course of business, and (v) shall not include expenditures to the extent they are made with the proceeds of sales of assets outside the ordinary course of business that are permitted by Section 6.05.“Capital Lease Obligations” of any Person means the obligations of such Person to pay rent or other amounts under any lease of (or other arrangement conveying the right to use) real or personal property, or a combination thereof, which obligations are required to be classified and accounted for as capital leases on a balance sheet of such Person under GAAP, and the amount of such obligations shall be the capitalized amount thereof determined in accordance with GAAP; provided that all leases that would have been treated as operating leases under GAAP on the date hereof shall continue to be so treated notwithstanding any change in GAAP that would re-classify such leases as capital leases.“Cash Collateralize” shall mean, in respect of any obligations, to provide and pledge (as a first priority perfected security interest) cash collateral for such obligations in dollars, with the Administrative Agent pursuant to documentation in form and substance reasonably satisfactory to the Administrative Agent (and “Cash Collateralization” has a corresponding meaning).“Cash Management Obligations” has the meaning assigned to such term in clause (c) of the definition of the term “Obligations”.“Cash-Pay Preferred Equity” means any preferred shares or other preferred Equity Interests that are issued by STX or ST and that require the payment of mandatory cash dividends.“CERCLA” means the Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. § 9601 et seq.84159-0944-0061.4“Certificate of Financial Officer” means a Certificate of Financial Officer in substantially the form of Exhibit G hereto, or such other form as the Borrower and Administrative Agent shall agree to.“CFC Subsidiary” means, with respect to any U.S. Subsidiary, a direct or indirect subsidiary of such U.S. Subsidiary that is a controlled foreign corporation within the meaning of Section 957 of the Code.“Change in Control” means:(a) the failure of STX to own, directly or indirectly, 100% of the Equity Interests in the Borrower;(b) the acquisition of ownership, directly or indirectly, beneficially or of record, by any Person or group (within the meaning of the Securities Exchange Act of 1934 and the rules of the SEC thereunder as in effect on the date hereof), of Equity Interests in STX representing greater than 35% of the aggregate ordinary voting power and aggregate equity value represented by the issued and outstanding Equity Interests in STX; provided, however that subject to compliance with Section 6.15 a transaction (referred to as a “Successor Transaction”) will not be deemed to involve a Change in Control under this clause if (i) STX becomes a direct or indirect wholly owned subsidiary of a holding company, and (ii)(x) the direct or indirect holders of the Voting Stock of such holding company immediately following that transaction are substantially the same as the holders of STX’s Voting Stock immediately prior to that transaction or (y) immediately following that transaction no “person” or “group” (other than a holding company satisfying the requirements of this sentence) is the beneficial owner, directly or indirectly, of more than 35% of the Voting Stock of such holding company;(c) occupation of a majority of the seats (other than vacant seats) on the board of directors of STX or the Borrower by Persons who were neither (i) nominated by at least a majority of the board of directors of STX, SDST or the Borrower, as applicable, nor (ii) appointed by a vote of a majority of directors so nominated; or(d) the occurrence of a “Change of Control” or “Change of Control Trigger Event” (or similar terms) in each case as defined in any applicable Senior Note Document or any document governing or evidencing any extension, renewal, refinancing or replacement of any Senior Notes permitted pursuant to Section 6.01(a)(ii), in each case solely to the extent such “Change of Control” or “Change of Control Trigger Event” (or similar term) gives the holders of such Indebtedness the right to accelerate such Indebtedness or to have such Indebtedness repurchased or otherwise retired or repaid by the issuer thereof or a third-party on such issuer’s behalf.“Change in Law” means (a) the adoption of any law, rule or regulation after the date of this Agreement, (b) any change in any law, rule or regulation or in the interpretation or application thereof by any Governmental Authority after the date of this Agreement or (c) compliance by any Lender or any Issuing Bank (or, for purposes of Section 2.14(b), by any lending office of such Lender or by such Lender’s or such Issuing Bank’s holding company, if any) with any request, guideline or directive (whether or not having the force of law) of any Governmental Authority made or issued after the date of this Agreement. Whenever there is a reference in this Agreement to the adoption of any applicable law, rule, or regulation, or any change in any applicable law, rule, or regulation, or any change in the interpretation or administration thereof by any Governmental Authority, central bank, or comparable agency charged with the interpretation or administration thereof, or compliance by any Lender (or its LIBO lending office) or any Issuing Bank with any request or directive (whether or not having the force of law) made after the Effective Date, notwithstanding anything contained herein to the 94159-0944-0061.4contrary, (i) the Dodd-Frank Wall Street Reform and Consumer Protection Act and all requests, guidelines, or directives in connection therewith shall be deemed to have gone into effect and adopted after the Effective Date, and (ii) all requests, rules, guidelines, or directives promulgated by the Bank for International Settlements, the Basel Committee on Banking Supervision (or any successor or similar authority), or the United States (or foreign) regulatory authorities, in each case pursuant to Basel III, shall in each case be deemed to be a “Change in Law,” regardless of the date enacted, adopted or issued.“Class”, when used in reference to any Loan or Borrowing, refers to whether such Loan, or the Loans comprising such Borrowing, are Term Loan A1, Term Loan A2, Term Loan A3, Revolving Loans or Swingline Loans, as applicable, and, when used in reference to any Commitment, refers to whether such Commitment is a Term Loan Commitment, Revolving Commitment or Swingline Commitment.“Code” means the Internal Revenue Code of 1986, as amended from time to time.“Commitment” means (a) with respect to any Lender, such Lender’s Revolving Commitment or Term Loan Commitment, and (b) with respect to any Swingline Lender, its Swingline Commitment.“Commitment Fee Rate” means the rate applicable to the payment of commitment fees as set forth in the definition of Applicable Margin.“Commodity Exchange Act” means the Commodity Exchange Act (7 U.S.C. § 1 et seq.), as amended from time to time, and any successor statute.“Connection Income Taxes” means Other Connection Taxes that are imposed on or measured by net income (however denominated) or that are franchise Taxes or branch profits Taxes.“Consolidated Cash Interest Expense” means, for any period, the excess of (a) the sum of (i) the interest expense (including imputed interest expense in respect of Capital Lease Obligations and the implied interest in respect of Permitted Receivables Factoring) of STX, the Borrower and the Subsidiaries for such period, determined on a consolidated basis in accordance with GAAP, plus (ii) any interest accrued during such period in respect of Indebtedness of STX, the Borrower or any Subsidiary that is required to be capitalized rather than included in such consolidated interest expense for such period in accordance with GAAP, plus (iii) any cash payments made during such period in respect of obligations referred to in clause (b)(ii) below that were amortized or accrued in a previous period, plus (iv) to the extent not otherwise included, commissions, discounts, yields and other fees, charges and amounts incurred in connection with any Permitted Receivables Factoring during such period that are payable to any Person other than STX, the Borrower or any Subsidiary and any other amounts for such period that are comparable to or in the nature of interest under any Permitted Receivables Factoring (including losses on the sale of assets relating to any Permitted Receivables Factoring accounted for as a “true sale”), minus (b) the sum of (i) to the extent included in such consolidated interest expense for such period, non-cash amounts attributable to amortization of financing costs paid in a previous period, plus (ii) to the extent included in such consolidated interest expense for such period, non-cash amounts attributable to amortization of debt discounts or accrued interest or dividends payable in kind for such period. “Consolidated EBITDA” means, for any period, Consolidated Net Income for such period plus 104159-0944-0061.4(a) without duplication and to the extent deducted in determining such Consolidated Net Income, the sum of (i) consolidated interest expense for such period (including, to the extent not otherwise included in consolidated interest expense for such period, commissions, discounts, yields and other fees, charges and amounts incurred during such period in connection with any Permitted Receivables Factoring that are payable to any Person other than STX, the Borrower or any Subsidiary and any other amounts for such period comparable to or in the nature of interest under any Permitted Receivables Factoring (including losses on the sale of assets relating to any Permitted Receivables Factoring accounted for as a “true sale”) and any non-cash accruals, capitalizations, amortizations or similar adjustments made under the definition of “Consolidated Cash Interest Expense”),(ii) consolidated income tax expense for such period, (iii) all amounts attributable to depreciation and amortization for such period, (iv) all extraordinary charges during such period, (v) non-cash expenses during such period resulting from (A) the grant of stock or stock options to management and employees of STX, the Borrower or any Subsidiary or (B) the treatment of such options under variable plan accounting, (vi) the aggregate amount of deferred financing expenses for such period, (vii) all other non-cash charges, non-cash expenses or non-cash losses of STX, the Borrower or any Subsidiary for such period (excluding any such charge, expense or loss incurred in the ordinary course of business that constitutes an accrual of or a reserve for cash charges for any future period), provided, however, that cash payments made in such period or in any future period (other than payments made under the terms of the Deferred Compensation Plans to, or for the benefit of, participants in such Deferred Compensation Plans) in respect of such non-cash charges, expenses or losses (excluding any such charge, expense or loss incurred in the ordinary course of business that constitutes an accrual of or a reserve for cash charges for any future period) shall be subtracted from Consolidated Net Income in calculating Consolidated EBITDA in the period when such payments are made, and (viii) any non-recurring fees, expenses or charges realized by STX, the Borrower or any Subsidiary for such period related to any offering of Equity Interests or incurrence of Indebtedness permitted to be issued or incurred under Section 6.01 (whether or not successful) or any acquisitions or dispositions by STX, the Borrower or any Subsidiary permitted hereunder and fees, expenses and charges related to the execution, delivery and performance of the Loan Documents by STX and the Borrower, and minus (b) without duplication and to the extent included in determining such Consolidated Net Income, (i) any extraordinary gains for such period, (ii) interest income for such period and (iii) all non-cash items increasing Consolidated Net Income for such period (excluding any items that represent the reversal of any accrual of, or cash reserve for, 114159-0944-0061.4anticipated cash charges in any prior period that are described in the parenthetical to clause (a)(vii) above), all determined on a consolidated basis in accordance with GAAP. For purposes of calculating the Total Leverage Ratio or the Interest Coverage Ratio as of any date, if STX, the Borrower or any Subsidiary has made any Material Acquisition permitted by Section 6.04 or any Material Sale outside of the ordinary course of business permitted by Section 6.05 during the period of four consecutive fiscal quarters ending on the date on which the most recent fiscal quarter ended, Consolidated EBITDA for the relevant period for testing compliance shall be calculated after giving pro forma effect thereto, as if such Material Acquisition or Material Sale outside of the ordinary course of business (and any related incurrence, repayment or assumption of Indebtedness with any new Indebtedness being deemed to be amortized over the applicable testing period in accordance with its terms) had occurred on the first day of the relevant period for testing compliance. Any pro forma calculations pursuant to the immediately preceding sentence shall be determined in good faith by a Financial Officer of the Borrower and may include adjustments (A) for all purposes under this Agreement, for operating expense reductions that would be permitted pursuant to Article XI of Regulation S-X under the Securities Act of 1933, as amended, or (B) for all purposes under this Agreement other than for purposes of determining whether any acquisition complies with clause (p)(ii)(A) of Section 6.04, to eliminate the actual, historical operating expenses attributable to any lease or other contract, any personnel or any facility as a direct result of the termination of such lease or other contract, the termination of such personnel or the closing of such facility, in each case only if such termination or closing has been effected within three months after an acquisition in connection with such acquisition, provided that the Borrower’s calculation of such adjustments is set forth in a certificate signed by a Financial Officer of the Borrower.“Consolidated Net Income” means, for any period, the net income or loss of STX, the Borrower and the Subsidiaries for such period determined on a consolidated basis in accordance with GAAP, provided that, except as otherwise provided in the definition of Consolidated EBITDA with respect to the calculation of the Total Leverage Ratio or the Interest Coverage Ratio, there shall be excluded from such net income or loss (a) the income of any Person (that is not a Subsidiary) in which any other Person (other than STX, the Borrower or any Subsidiary or any director holding qualifying shares in compliance with applicable law) owns an Equity Interest, except to the extent of the amount of dividends or other distributions actually paid to STX, the Borrower or any Subsidiary by such Person during such period, and (b) the income or loss of any Person accrued prior to the date on which it becomes a Subsidiary or is merged into or consolidated with STX, the Borrower or any Subsidiary or the date on which such Person’s assets are acquired by STX, the Borrower or any Subsidiary.“Consolidated Total Assets” means, as of any date, the total assets of the Borrower and its subsidiaries on such date determined on a consolidated basis in accordance with GAAP.“Control” means the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of a Person, whether through the ability to exercise voting power, by contract or otherwise. “Controlling” and “Controlled” have meanings correlative thereto.“Covenant Relief Period” means the period beginning on the Seventh Amendment Effective Date and ending on the Covenant Relief Termination Date. “Covenant Relief Termination Date” means the earlier of (a) June 28, 2024 and (b) the occurrence of a Covenant Relief Termination Event.124159-0944-0061.4“Covenant Relief Termination Event” means the occurrence of the following: (a) during the period beginning on the Seventh Amendment Effective Date and ending on June 28, 2024, the Certificate of Financial Officer delivered by STX for the most recently ended fiscal quarter shows a Total Leverage Ratio of less than or equal to 3:00 to 1:00 and (b) within 30 days after delivery of such Certificate of Financial Officer, the Borrower notifies the Administrative Agent in writing that it has terminated the Covenant Relief Period.“Covered Entity” means any of the following: (i) a “covered entity” as that term is defined in, and interpreted in accordance with, 12 C.F.R. § 252.82(b); (ii) a “covered bank” as that term is defined in, and interpreted in accordance with, 12 C.F.R. § 47.3(b); or (iii) a “covered FSI” as that term is defined in, and interpreted in accordance with, 12 C.F.R. § 382.2(b). “Covered Party” is defined in Section 9.17.“Default” means any event or condition that constitutes an Event of Default or that upon notice, lapse of time or both would, unless cured or waived, become an Event of Default.“Defaulting Lender” shall mean, at any time, a Lender (a) that has failed for three or more Business Days to comply with its obligations under this Agreement to make a Loan and/or to make a payment to an Issuing Bank in respect of a Letter of Credit or to a Swingline Lender in respect of a Swingline Loan (each a “funding obligation”), unless such Lender notifies the Administrative Agent and the Borrower in writing that such failure is the result of such Lender’s determination that one or more conditions precedent to funding (each of which conditions precedent, together with any applicable default, shall be specifically identified in such writing) has not been satisfied, (b) that has notified the Administrative Agent or the Borrower, or has stated publicly, that it will not comply with any such funding obligation hereunder, or has defaulted on, its obligation to fund generally under any other loan agreement, credit agreement or other financing agreement, (c) that has, for three or more Business Days, failed to confirm in writing to the Administrative Agent, in response to a written request of the Administrative Agent, that it will comply with its funding obligations hereunder, (d) with respect to which a Lender Insolvency Event has occurred and is continuing, or (e) that has become the subject of a Bail-in Action.“Default Right” has the meaning assigned to that term in, and shall be interpreted in accordance with, 12 C.F.R. §§ 252.81, 47.2 or 382.1, as applicable.“Deferred Compensation Plans” means (a) the deferred compensation plan dated as of January 1, 2002, of Seagate US LLC (as amended, waived, supplemented or otherwise modified from time to time), (b) any other plan established in lieu of, or to renew or replace, in whole or in part, any plan referred to in clause (a) above or this clause (b) and (c) any Guarantee by STX or any Subsidiary of any obligation under any Deferred Compensation Plan referred to in clause (a) or (b) above.“Disclosed Matters” means the actions, suits and proceedings and the environmental matters disclosed in Schedule 3.06.“Documentation Agent” means each Lender listed on Schedule 2.01 hereto, in its capacity as the Documentation Agent.“Dollar Equivalent” means, on any date of determination, (a) for the purposes of determining compliance with Article VI or the existence of an Event of Default under Article VII, with respect to any amount denominated in a currency other than dollars, the equivalent in dollars of such amount, determined in good faith by the Borrower in a manner consistent with the 134159-0944-0061.4way such amount is or would be reflected on the audited consolidated financial statements delivered pursuant to Section 5.01(a) for the fiscal year in which such determination is made, and (b) for the purposes of Article II, with respect to any amount denominated in an Alternative Currency, the equivalent in dollars of such amount, determined by the Administrative Agent pursuant to Section 1.05(a) using the applicable Exchange Rate with respect to such Alternative Currency.“dollars” or “$” refers to lawful money of the United States of America.“EEA Financial Institution” means (a) any credit institution or investment firm established in any EEA Member Country that is subject to the supervision of an EEA Resolution Authority, (b) any entity established in an EEA Member Country that is a parent of an institution described in clause (a) of this definition, or (c) any financial institution established in an EEA Member Country that is a subsidiary of an institution described in clauses (a) or (b) of this definition and is subject to consolidated supervision with its parent.“EEA Member Country” means any of the member states of the European Union, Iceland, Liechtenstein, and Norway.“EEA Resolution Authority” means any public administrative authority or any person entrusted with public administrative authority of any EEA Member Country (including any delegee) having responsibility for the resolution of any EEA Financial Institution.“Effective Date” means February 20, 2019.“Environmental Laws” means all laws, rules, regulations, codes, ordinances, orders, decrees, judgments, injunctions or other legally enforceable requirements issued, promulgated or entered into by or with any Governmental Authority, relating to the protection of the environment, preservation or reclamation of natural resources or the presence, management, Release or threatened Release of any Hazardous Material.“Environmental Liability” means any liabilities, obligations, damages, claims, actions, suits, judgments or orders, contingent or otherwise (including any costs of environmental remediation, administrative oversight costs, fines, penalties or indemnities), of STX, the Borrower or any Subsidiary resulting from or relating to (a) the non-compliance with any Environmental Law, (b) the generation, use, handling, transportation, storage, treatment or disposal of any Hazardous Materials, (c) exposure to any Hazardous Materials, (d) the Release or threatened Release of any Hazardous Materials or (e) any contract, agreement or other consensual arrangement pursuant to which liability is assumed or imposed with respect to any of the foregoing.“Equity Interests” means shares of capital stock, partnership interests, membership interests in a limited liability company, beneficial interests in a trust or other equity ownership interests in a Person.“ERISA” means the Employee Retirement Income Security Act of 1974, as amended, and the rules and regulations promulgated thereunder.“ERISA Affiliate” means any trade or business (whether or not incorporated) that, together with the Borrower, is treated as a single employer under Section 414(b) or (c) of the Code or, solely for purposes of Section 302 of ERISA and Section 412 of the Code, is treated as a single employer under Section 414 of the Code.144159-0944-0061.4“ERISA Event” means (a) any “reportable event”, as defined in Section 4043 of ERISA or the regulations issued thereunder with respect to a Plan that is subject to Title IV of ERISA (other than an event for which the 30-day notice period is waived), (b) any failure by any Plan to satisfy the minimum funding standards (within the meaning of Section 412 of the Code or Section 302 of ERISA) applicable to such Plan whether or not waived, (c) the filing pursuant to Section 412 of the Code or Section 302 of ERISA of an application for a waiver of the minimum funding standard with respect to any Plan, (d) the incurrence by the Borrower or any ERISA Affiliate of any liability under Title IV of ERISA with respect to the termination of any Plan, (e) a determination that any Plan is, or is expected to be, in “at-risk” status (within the meaning of Section 430 of the Code or Section 303 of ERISA); (f) the receipt by the Borrower or any ERISA Affiliate from the PBGC or a plan administrator of any notice relating to an intention to terminate any Plan or to appoint a trustee to administer any Plan under Section 4042 of ERISA, (g) the incurrence by the Borrower or any ERISA Affiliate of any liability with respect to the withdrawal or partial withdrawal from any Plan or Multiemployer Plan or (h) the receipt by the Borrower or any ERISA Affiliate of any notice, or the receipt by any Multiemployer Plan from the Borrower or any ERISA Affiliate of any notice, concerning the imposition of Withdrawal Liability or a determination that a Multiemployer Plan is insolvent (within the meaning of Section 4245 of ERISA), or in endangered or critical status (within the meaning of Section 305 of ERISA).“Erroneous Payment” has the meaning assigned to it in Section 8.11(a).“Erroneous Payment Deficiency Assignment” has the meaning assigned to it in Section 8.11(d)(i).“Erroneous Payment Impacted Class” has the meaning assigned to it in Section 8.11(d)(i).“Erroneous Payment Return Deficiency” has the meaning assigned to it in Section 8.11(d)(i).“Erroneous Payment Subrogation Rights” has the meaning assigned to it in Section 8.11(e). “EU Bail-In Legislation Schedule” means the EU Bail-In Legislation Schedule published by the Loan Market Association (or any successor person), as in effect from time to time.“Event of Default” has the meaning assigned to such term in Section 7.01.“Exchange Rate” means, on any day, with respect to any Alternative Currency, the rate at which such Alternative Currency may be exchanged into dollars, as set forth at approximately 11:00 a.m., New York City time, on such day on the applicable Reuters World Spot Page. In the event that any such rate does not appear on any Reuters World Spot Page, the Exchange Rate shall be determined by reference to such other publicly available service for displaying exchange rates reasonably selected by the Administrative Agent in consultation with the Borrower for such purpose or, at the discretion of the Administrative Agent in consultation with the Borrower, such Exchange Rate shall instead be the arithmetic average of the spot rates of exchange of the Administrative Agent in the market where its foreign currency exchange operations in respect of such Alternative Currency are then being conducted, at or about 10:00 a.m., local time, on such day for the purchase of the applicable Alternative Currency for delivery two Business Days later, provided that, if at the time of any such determination, for any reason, no such spot rate is being quoted, the Administrative Agent may use any other reasonable method it deems appropriate to determine such rate, and such determination shall be presumed correct absent manifest error.154159-0944-0061.4“Excluded Swap Obligation” means, with respect to any Guarantor, any Swap Obligation if, and to the extent that, all or a portion of the guaranty of such Guarantor of, or the grant by such Guarantor of a security interest to secure, as applicable, such Swap Obligation (or any guaranty thereof) is or becomes illegal under the Commodity Exchange Act or any rule, regulation or order of the Commodity Futures Trading Commission (or the application or official interpretation of any thereof) by virtue of such Guarantor’s failure for any reason to constitute an “eligible contract participant” as defined in the Commodity Exchange Act and the regulations thereunder at the time the guaranty from, or the grant of a security interest by (as applicable) such Guarantor becomes effective with respect to such Swap Obligation. If a Swap Obligation arises under a master agreement governing more than one Swap, such exclusion shall apply only to the portion of such Swap Obligation that is attributable to Swaps for which such guaranty or security interest is or becomes illegal.“Excluded Taxes” means any of the following taxes imposed on or with respect to a Recipient or required to be withheld or deducted from a payment to a Recipient: (a)Taxes imposed on (or measured by) net income (however denominated), franchise Taxes, and branch profit Taxes, in each case (i) imposed as a result of such Recipient being organized under the laws of, or having its principal office or, in the case of any Lender, its applicable lending office located in, the jurisdiction imposing such Tax (or any political subdivision thereof) or (ii) that are Other Connection Taxes, (b) in the case of a Lender, Cayman Islands withholding Taxes imposed on amounts payable to or for the account of such Lender with respect to an applicable interest in a Loan or Commitment pursuant to a law in effect on the date on which (i) such Lender acquires such interest in the Loan or Commitment (other than pursuant to an assignment request by the Borrower under Section 2.18(b)) or (ii) such Lender changes its lending office, except in each case to the extent that, pursuant to Section 2.16 amounts with respect to such Taxes were payable either to such Lender’s assignor immediately before such Lender became a party hereto or to such Lender immediately before it changed its lending office. (c) Taxes attributable to such Recipient’s failure to comply with Section 2.16(f) and (d) any withholding Taxes imposed under FATCA.“Extending Lender” has the meaning assigned to such term in Section 2.23. “FATCA” means (i) Sections 1471 through 1474 of the Code, as in effect on the Effective Date (or any amended or successor version that is substantively comparable and not materially more onerous to comply with), and any current or future regulations or official interpretations thereof, any agreements entered into pursuant to Section 1471(b)(1) of the Code, and the Common Reporting Standard issued by the Organisation of Economic Co-operation and Development (“CRS”), and (ii) any fiscal or regulatory legislation, rules, guidance notes or practices adopted pursuant to any intergovernmental agreement entered into in connection with the implementation of such sections of the Code or CRS.“Federal Funds Effective Rate” means, for any day, the weighted average (rounded upwards, if necessary, to the next 1/100 of 1%) of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published on the next succeeding Business Day by the Federal Reserve Bank of New York, or, if such rate is not so published for any day that is a Business Day, the average (rounded upwards, if necessary, to the next 1/100 of 1%) of the quotations for such day for such transactions received by the Administrative Agent from three Federal funds brokers of recognized standing selected by it.“Fee Letter” means the (a) Administrative Agent’s Fee Letter, dated September 13, 2021 between the Borrower and the Administrative Agent and (b) the Fee Letter, dated the Seventh Amendment Effective Date, between the Borrower and the Administrative Agent.164159-0944-0061.4“Fifth Amendment” means the Fifth Amendment, dated as of October 14, 2021, to this Agreement, among the Borrower, STX, the Lenders party thereto, and the Administrative Agent. “Fifth Amendment Effective Date” is defined in the Fifth Amendment. “Finance Parties” means (a) each Lender (and any Affiliate of such Lender to which any Cash Management Obligation is owed), (b) each Issuing Bank, (c) the Administrative Agent, (d) each counterparty to any Swap Agreement with a Loan Party the obligations under which constitute Obligations, (e) the beneficiaries of each indemnification obligation undertaken by any Loan Party under any Loan Document, (f) each counterparty to any Platinum Lease with a Loan Party the obligations under which constitute Obligations and (g) the successors and assigns of each of the foregoing.“Financial Officer” means the chief financial officer, principal accounting officer, treasurer, assistant treasurer or controller of STX or the Borrower, as the case may be.“First Amendment” means the First Amendment, dated as of May 28, 2019, to this Agreement, among the Borrower, STX, the Additional Lenders party thereto, and the Administrative Agent. “First Amendment Effective Date” is defined in the First Amendment. “Fitch” means Fitch Ratings, Inc.“Floor” means 0.00%.“Foreign Lender” means any Lender that is organized under the laws of a jurisdiction other than the jurisdiction in which the Borrower is located.“Foreign Subsidiary” means any Subsidiary that is organized under the laws of a jurisdiction other than (a) the United States of America (including any State thereof and the District of Columbia) or (b) the Cayman Islands.“Foreign Subsidiary Guarantee Agreement” means an agreement between any Foreign Subsidiary and the Administrative Agent that (a) provides a Guarantee of the Obligations by such Foreign Subsidiary in favor of, and other rights and benefits to, the Administrative Agent and the other Finance Parties substantially the same as the Guarantee of the Obligations and the other rights and benefits provided by the U.S. Guarantee Agreement (except as prohibited by applicable law) and (b) is otherwise in form and substance reasonably satisfactory to the Administrative Agent.“Fourth Amendment” means the Fourth Amendment, dated as of May 18, 2021, to this Agreement, among the Borrower, STX, and the Administrative Agent on behalf of the Lenders.“Fourth Amendment Effective Date” is defined in the Fourth Amendment.“Funded Indebtedness” means, as of any date, the sum of (a) the aggregate principal amount of Indebtedness of STX, the Borrower and the Subsidiaries outstanding as of such date, in the amount that would be reflected on a balance sheet prepared as of such date on a consolidated basis in accordance with GAAP, (b) without duplication, the aggregate amount of any Guarantee by STX, the Borrower or any Subsidiary of any such Indebtedness of any other Person, and (c) without duplication, the aggregate liquidation value (or equivalent thereof) of Cash-Pay Preferred Equity (including any deferred dividend payments with respect thereto) as of such date. 174159-0944-0061.4“GAAP” means generally accepted accounting principles in the United States of America.“Governmental Authority” means the government of the United States of America, any other nation or any political subdivision thereof, whether state or local, and any agency, authority, instrumentality, regulatory body, court, central bank or other entity exercising executive, legislative, judicial, taxing, regulatory or administrative powers or functions of or pertaining to government.“Guarantee” of or by any Person (the “guarantor”) means any obligation, contingent or otherwise, of the guarantor guaranteeing or having the economic effect of guaranteeing any Indebtedness or other obligation of any other Person (the “primary obligor”) in any manner, whether directly or indirectly, and including any obligation of the guarantor, direct or indirect, (a) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or other obligation or to purchase (or to advance or supply funds for the purchase of) any security for the payment thereof, (b) to purchase or lease property, securities or services for the purpose of assuring the owner of such Indebtedness or other obligation of the payment thereof, (c) to maintain working capital, equity capital or any other financial statement condition or liquidity of the primary obligor so as to enable the primary obligor to pay such Indebtedness or other obligation or (d) as an account party in respect of any letter of credit or letter of guaranty issued to support such Indebtedness or obligation, provided that the term “Guarantee” shall not include endorsements for collection or deposit in the ordinary course of business.“Guarantee Agreements” means (a) with respect to each U.S. Loan Party, each Loan Party organized under the laws of the Cayman Islands and each other Loan Party reasonably designated by the Administrative Agent, the U.S. Guarantee Agreement; (b) the Parent Guarantee; and (c) with respect to each other Loan Party, a Foreign Subsidiary Guarantee Agreement.“Guarantee Requirement” means, at any time, the requirement that:(a) the Administrative Agent shall have received from each Loan Party a counterpart of each of (i) the applicable Guarantee Agreement, and (ii) in the case of any Loan Party that executes the U.S. Guarantee Agreement, the Indemnity, Subrogation and Contribution Agreement.(b) within 30 days after the request therefor by the Administrative Agent (or such longer period as the Administrative Agent may agree in its discretion), the Borrower shall have delivered to the Administrative Agent a signed copy of an opinion, addressed to the Administrative Agent and the other Finance Parties, of counsel for the Loan Parties reasonably acceptable to the Administrative Agent as to such matters set forth in this definition as the Administrative Agent may reasonably request.Notwithstanding anything in this definition to the contrary, (i) no Guarantee by any Person shall be required pursuant to this definition if the Administrative Agent determines, after consultation with the Borrower, that (a) providing such Guarantee would (x) violate the law of the jurisdiction in which the Person providing such Guarantee, (y) violate the terms of any material contract binding on STX, the Borrower or any Subsidiary, or (z) result in a material adverse tax consequence to the Person providing such Guarantee, or (b) the cost to STX, the Borrower or any Subsidiary of providing such Guarantee would be excessive in view of the related benefits to be received by the Lenders therefrom, and (iii) no Obligation of any U.S. Loan Party shall be required to be Guaranteed by any CFC Subsidiary or any Qualified CFC Holding Company, in each case of any U.S. Subsidiary.184159-0944-0061.4“Guarantors” means, collectively, as of the Effective Date, Seagate UC, ST, SDST, Seagate Technology (US), STI, Seagate Technology (Ireland), an exempted company incorporated with limited liability in the Cayman Islands, Seagate Technology LLC, a Delaware limited liability company, Seagate International (Johor) Sdn. Bhd., a limited company incorporated in Malaysia, Seagate Technology (Thailand) Limited, a limited company incorporated in Thailand, Seagate Singapore International Headquarters Pte. Ltd., a private limited company incorporated in Singapore and, following the Effective Date, STX and all other direct and indirect Subsidiaries of STX required to deliver a guaranty of the Obligations pursuant to Section 5.13 of this Agreement.“Hazardous Materials” means all explosive, radioactive, hazardous or toxic substances, wastes or other pollutants, including petroleum or petroleum distillates, asbestos or asbestos containing materials, polychlorinated biphenyls, radon gas, infectious or medical wastes, and all substances or wastes regulated due to their harmful or deleterious nature or characteristics pursuant to any applicable Environmental Law, including any material listed as a hazardous substance under Section 101(14) of CERCLA. “Immaterial Subsidiary” means, on any day, a Subsidiary that holds less than 2.50% of the Consolidated Total Assets as of the last day of the fiscal quarter of STX most recently ended prior to such day, provided that the term “Immaterial Subsidiary” shall not include any wholly-owned Subsidiary that has executed and delivered to the Administrative Agent a Guarantee Agreement (or, if applicable, a supplement thereto) and satisfied the Guarantee Requirement (to the extent applicable to such Subsidiary). “Incremental Amendment” is defined in Section 2.21(b).“Incremental Closing Date” is defined in Section 2.21(c).“Incremental Lender” is defined in Section 2.21(b).“Incremental Loan” is defined in Section 2.21(a).“Incremental Loan Commitment” is defined in Section 2.21(a).“Incremental Revolving Loan Commitment” is defined in Section 2.21(a).“Incremental Revolving Loan Increase” is defined in Section 2.21(a).“Incremental Term Loan” is defined in Section 2.21(a).“Incremental Term Loan Commitment” is defined in Section 2.21(a).“Indebtedness” of any Person means, without duplication, (a) all obligations of such Person for borrowed money, (b) all obligations of such Person evidenced by bonds, debentures, notes or similar instruments, (c) all obligations of such Person upon which interest charges are customarily paid, (d) all obligations of such Person under conditional sale or other title retention agreements relating to property acquired by such Person, (e) all obligations of such Person in respect of the deferred purchase price of property or services (excluding current accounts payable incurred in the ordinary course of business and any earn-out obligation until such obligation becomes a liability on the balance sheet of such Person in accordance with GAAP), (f) all Indebtedness of others secured by (or for which the holder of such Indebtedness has an existing right, contingent or otherwise, to be secured by) any Lien on property owned or acquired by such Person, whether or not the Indebtedness secured thereby has been assumed, (g) all Guarantees by such Person of Indebtedness of others, (h) all Capital Lease Obligations of such Person, (i) all 194159-0944-0061.4obligations, contingent or otherwise, of such Person as an account party in respect of letters of credit and letters of guaranty, (j) all obligations, contingent or otherwise, of such Person in respect of bankers’ acceptances, (k) the amount of all Permitted Receivables Factoring of such Person and (l) all Cash-Pay Preferred Equity. The Indebtedness of any Person shall include the Indebtedness of any other entity (including any partnership in which such Person is a general partner) to the extent such Person is liable therefor as a result of such Person’s ownership interest in or other relationship with such entity, except to the extent the terms of such Indebtedness provide that such Person is not liable therefor. Notwithstanding anything to the contrary in this paragraph, the term “Indebtedness” shall not include (i) obligations under Swap Agreements, (ii) agreements providing for indemnification, purchase price adjustments or similar obligations incurred or assumed in connection with the acquisition or disposition of assets or stock, (iii) liabilities incurred under the Deferred Compensation Plans or (iv) liabilities customarily incurred under the Platinum Leases.“Indemnified Taxes” means (a) Taxes, other than Excluded Taxes, imposed on or with respect to any payment made by or on account of any obligation of the Borrower or any Loan Party under any Loan Document and (b) to the extent not otherwise described in (a), Other Taxes.“Indemnity, Subrogation and Contribution Agreement” means the Indemnity, Subrogation and Contribution Agreement in substantially the form of Exhibit C hereto.“Interest Coverage Ratio” means, on any date, the ratio of (a) Consolidated EBITDA for the period of four consecutive fiscal quarters of STX ended on such date for which financial statements have been delivered pursuant to Section 5.01 to (b) Consolidated Cash Interest Expense for such period.“Interest Election Request” means a request by the Borrower to convert or continue a Borrowing in accordance with Section 2.07 in substantially the form of Exhibit F hereto.“Interest Payment Date” means (a) with respect to any ABR Loan (other than a Swingline Loan), the last day of each March, June, September and December, (b) with respect to any SOFR Loan, the last day of the Interest Period applicable to the Borrowing of which such Loan is a part and, in the case of a SOFR Borrowing with an Interest Period of more than three months’ duration, each day prior to the last day of such Interest Period that occurs at intervals of three months’ duration after the first day of such Interest Period, and (c) with respect to any Swingline Loan, the day that such Loan is required to be repaid.“Interest Period” means, with respect to any SOFR Borrowing, the period commencing on the date of such Borrowing and ending on the numerically corresponding day in the calendar month that is one, three or six months (or, with the consent of each Lender, twelve months) thereafter, as the Borrower may elect, provided that (a) if any Interest Period would end on a day other than a Business Day, such Interest Period shall be extended to the next succeeding Business Day unless such next succeeding Business Day would fall in the next calendar month, in which case such Interest Period shall end on the next preceding Business Day and (b) any Interest Period that commences on the last Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the last calendar month of such Interest Period) shall end on the last Business Day of the last calendar month of such Interest Period. For purposes hereof, the date of a Borrowing initially shall be the date on which such Borrowing is made and, in the case of a Borrowing, thereafter shall be the effective date of the most recent conversion or continuation of such Borrowing.“Investment” has the meaning assigned to such term in Section 6.04.204159-0944-0061.4“Investment Grade Period” means any period (a) commencing on the first day on which (x) two or more of the Issuer Ratings are Investment Grade Ratings and (y) no Default or Event of Default has occurred and is continuing and (b) ending on the date on which two or more of the Issuer Ratings are no longer Investment Grade Ratings.“Investment Grade Ratings” means that two or more of the following Issuer Ratings have been concurrently established by the applicable rating agencies: BBB- (or, for purposes of Section 6.05, BBB) or higher from S&P, Baa3 (or, for purposes of Section 6.05, Baa2) or higher from Moody’s and/or BBB- (or, for purposes of Section 6.05, BBB) or higher from Fitch.“ISDA Definitions” means the 2006 ISDA Definitions published by the International Swaps and Derivatives Association, Inc. or any successor thereto, as amended or supplemented from time to time, or any successor definitional booklet for interest rate derivatives published from time to time by the International Swaps and Derivatives Association, Inc. or such successor thereto.“Issuance Request” means an Issuance Request in substantially the form of Exhibit E hereto.“Issuer Ratings” is defined in the definition of Applicable Margin.“Issuing Bank” means, as the context may require, (a) Scotiabank, with respect to Letters of Credit issued by it, and (b) any other Lender that becomes an Issuing Bank pursuant to Section 2.05(l), with respect to Letters of Credit issued by it, and, in each case, its successors in such capacity as provided in Section 2.05(i). Each Issuing Bank may, in its discretion, arrange for one or more Letters of Credit to be issued by Affiliates of such Issuing Bank, in which case the term “Issuing Bank” shall include any such Affiliate with respect to Letters of Credit issued by such Affiliate.“LC Disbursement” means a payment made by an Issuing Bank pursuant to a Letter of Credit.“LC Exposure” means, at any time, the sum of (a) the aggregate undrawn and unexpired amount of all outstanding Letters of Credit denominated in dollars at such time plus (b) the aggregate amount of all LC Disbursements that were made in dollars and that have not yet been reimbursed by or on behalf of the Borrower at such time plus (c) the Alternative Currency LC Exposure at such time. The LC Exposure of any Lender at any time shall be its Applicable Percentage of the total LC Exposure at such time.“Lender Affiliate” means, (a) with respect to any Lender, (i) an Affiliate of such Lender or (ii) an entity (whether a corporation, partnership, trust or otherwise) that is engaged in making, purchasing, holding or otherwise investing in bank loans and similar extensions of credit in the ordinary course of its business and is administered or managed by such Lender or an Affiliate of such Lender and (b) with respect to any Lender that is a fund that invests in bank loans and similar extensions of credit, any other fund that invests in bank loans and similar extensions of credit and is managed by the same investment advisor as such Lender or by an Affiliate of such investment advisor.“Lender Insolvency Event” shall mean that (a) a Lender or its Parent Company is insolvent, or is generally unable to pay its debts as they become due, or admits in writing its inability to pay its debts as they become due, or makes a general assignment for the benefit of its creditors, or (b) a Lender or its Parent Company is the subject of a bankruptcy, insolvency, reorganization, liquidation or similar proceeding, or a receiver, trustee, conservator, custodian or the like has been appointed for such Lender or its Parent Company, or such Lender or its Parent 214159-0944-0061.4Company has taken any action in furtherance of or indicating its consent to or acquiescence in any such proceeding or appointment, or (c) a Lender or its Parent Company has been adjudicated as, or determined by any Governmental Authority having regulatory authority over such Person or its assets to be, insolvent, provided that, for the avoidance of doubt, a Lender Insolvency Event shall not be deemed to have occurred solely by virtue of the ownership or acquisition of any equity interest in or control of a Lender or a Parent Company thereof by a Governmental Authority or an instrumentality thereof.“Lenders” means the Persons listed on Schedule 2.01 and any other Person that shall have become a party hereto pursuant to Section 9.04, other than any such Person that ceases to be a party hereto pursuant to Section 9.04. Unless the context otherwise requires, the term “Lenders” includes the Swingline Lenders.“Letter of Credit” means any letter of credit issued pursuant to this Agreement.“Lien” means, with respect to any asset, (a) any mortgage, deed of trust, lien, pledge, hypothecation, encumbrance, charge or security interest in, on or of such asset and (b) the interest of a vendor or a lessor under any conditional sale agreement, capital lease or title retention agreement (or any financing lease having substantially the same economic effect as any of the foregoing) relating to such asset.“Liquidity Amount” means, as of any date, (a) during any Investment Grade Period, an amount equal to the aggregate amount of cash, cash equivalents and short-term investments not subject to a Lien or security interest in favor of any Person that would be reflected as cash, cash equivalents or short-term investments on a consolidated balance sheet of STX prepared in accordance with GAAP, owned by the Borrower and its subsidiaries on such date; and (b) during any Non-Investment Grade Period, an amount equal to (i) the sum of (A) the aggregate amount of cash, cash equivalents and short-term investments not subject to a Lien or security interest in favor of any Person that would be reflected as cash, cash equivalents or short-term investments on a consolidated balance sheet of STX prepared in accordance with GAAP, owned by the Borrower and its subsidiaries on such date and (B) the available borrowing capacity on the Revolving Commitment and any Permitted Receivables Factoring, provided that the Revolving Commitment and Permitted Receivables Factoring’s remaining term to maturity is greater than one year, minus (ii) the aggregate principal amount of Funded Indebtedness outstanding on such date the remaining term to maturity of which equals one year or less.“Loan Document Obligations” has the meaning assigned to such term in the definition of “Obligations”.“Loan Documents” means this Agreement, the Guarantee Agreements, any Promissory Notes and any other document or instrument executed and delivered by any Loan Party that by its terms states that it is a Loan Document, and in each case any amendments, restatements, supplements or modifications to any of the foregoing.“Loan Parties” means, collectively, the Borrower and each Guarantor.“Loans” means the loans made by the Lenders to the Borrower pursuant to this Agreement, including Revolving Loans, Swingline Loans and Term Loans.“Material Acquisition” means, at any time, any acquisition (whether by purchase, merger, consolidation or otherwise) by STX, the Borrower or any Subsidiary that is permitted hereunder 224159-0944-0061.4and for which the sum (without duplication) of all consideration paid or otherwise delivered by STX, the Borrower and the Subsidiaries in connection with such acquisition (including the principal amount of any Indebtedness issued as deferred purchase price and the fair market value, determined reasonably and in good faith by the Borrower, of any other non-cash consideration, including Equity Interests in STX or any Subsidiary) plus the aggregate principal amount of all Indebtedness otherwise incurred or assumed by STX, the Borrower or any Subsidiary in connection with such acquisition (including Indebtedness of any acquired Person outstanding at the time of such acquisition) exceeds the amount that is equal to 5% of Consolidated Total Assets as of the end of the fiscal year of STX most recently ended at or prior to such time. “Material Adverse Effect” means a material adverse effect on (a) the business, assets, operations, properties or financial condition of STX, the Borrower and the Subsidiaries, taken as a whole, (b) the ability of the Loan Parties to perform their obligations under the Loan Documents or (c) any material rights of or benefits available to the Lenders under the Loan Documents.“Material Indebtedness” means Indebtedness (other than the Loans and Letters of Credit), or obligations in respect of one or more Swap Agreements, of any one or more of STX, the Borrower or any Subsidiary in an aggregate principal amount exceeding $100,000,000. For purposes of determining Material Indebtedness, the “principal amount” of the obligations of any Person in respect of any Swap Agreement at any time shall be the maximum aggregate amount (giving effect to any netting agreements) that such Person would be required to pay if such Swap Agreement were terminated at such time.“Material Sale” means, at any time, any sale, transfer or other disposition of any property or asset of STX, the Borrower or any Subsidiary that is permitted hereunder and for which all consideration paid or otherwise delivered to STX, the Borrower and the Subsidiaries in connection with such sale, transfer or other disposition (including the principal amount of any Indebtedness issued as deferred purchase price and the fair market value, determined reasonably and in good faith by the Borrower, of any other non-cash consideration, including Equity Interests) plus the aggregate principal amount of all Indebtedness of STX, the Borrower and the Subsidiaries assumed by the purchaser of such property or asset in connection with such sale (including Indebtedness of any Person sold, transferred or disposed of by STX, the Borrower or any Subsidiary that is assumed by the purchaser of such Person in connection with such sale) exceeds the amount that is equal to 5% of Consolidated Total Assets as of the end of the fiscal year of STX most recently ended at or prior to such time. “Maturity Date” means with respect to (a) Term Loan A1, September 16, 2025; (b) Term Loan A2, July 30, 2027; (c) Term Loan A3, July 30, 2027; and (d) Revolving Loans and related Swingline Loans, October 14, 2026. If the applicable scheduled Maturity Date is not a Business Day, then the actual Maturity Date shall be the Business Day immediately preceding such scheduled date.“Moody’s” means Moody’s Investors Service, Inc. and its successors.“Multiemployer Plan” means a multiemployer plan as defined in Section 4001(a)(3) of ERISA to which the Borrower or any ERISA Affiliate is making or is obligated to make any contributions.“New Obligor” is defined in Section 6.15.“Non-Consenting Lender” shall mean any Lender which has not consented to any proposed amendment, modification, waiver or termination of the Loan Documents pursuant to 234159-0944-0061.4Section 9.02 requiring the consent of all Lenders or all affected Lenders in respect of which the consent of the Required Lenders is obtained.“Non-Extending Lender” has the meaning assigned to such term in Section 2.23.“Non-Investment Grade Period” means any period of time other than an Investment Grade Period.“Obligations” means (a) the due and punctual payment of (i) the principal of and premium, if any, and interest (including interest accruing during the pendency of any bankruptcy, insolvency, receivership or other similar proceeding, regardless of whether allowed or allowable in such proceeding) on the Loans, when and as due, whether at maturity, by acceleration, upon one or more dates set for prepayment or otherwise, (ii) each payment required to be made by the Borrower in respect of any Letter of Credit, when and as due, including payments in respect of reimbursement of disbursements made by any Issuing Bank with respect thereto, interest thereon and obligations to provide, under certain circumstances, cash collateral in connection therewith and (iii) all other monetary obligations, including fees, costs, expenses and indemnities, whether primary, secondary, direct, contingent, fixed or otherwise (including monetary obligations incurred during the pendency of any bankruptcy, insolvency, receivership or other similar proceeding, regardless of whether allowed or allowable in such proceeding), of the Loan Parties to the Finance Parties under this Agreement and the other Loan Documents (all the foregoing obligations being collectively called the “Loan Document Obligations”), (b) unless otherwise agreed to in writing by the applicable Lender or Affiliate of a Lender party thereto, the due and punctual payment of all obligations of the Borrower or any other Loan Party under each Swap Agreement (it being understood that, for purposes of this clause (b), the term “Swap Agreement” shall not include Platinum Leases or Swap Agreements permitted under clause (c)(i)(B) or clause (c)(ii) of Section 6.06) that (i) is in effect on the Effective Date with a counterparty that is a Lender (or an Affiliate of a Lender) as of the Effective Date or (ii) is entered into after the Effective Date with any counterparty that is a Lender (or an Affiliate of a Lender) at the time such Swap Agreement is entered into (the obligations referred to in this clause (b) being collectively referred to as the “Swap Obligations”), (c) the due and punctual payment of all obligations in respect of overdrafts and related liabilities owed to any Lender or any of its Affiliates and arising from treasury, depositary and cash management services or in connection with any automated clearing house transfers of funds (the obligations referred to in this clause (c) being collectively referred to as the “Cash Management Obligations”),(d) unless otherwise agreed to in writing by the applicable Lender or Affiliate of a Lender party thereto, the due and punctual payment of all obligations of the Borrower or any other Loan Party under each Platinum Lease that (i) is in effect on the Effective Date with a lessor that is a Lender (or an Affiliate of a Lender) as of the Effective Date or (ii) is entered into after the Effective Date with any lessor that is a Lender (or an Affiliate of a Lender) at the time such Platinum Lease is entered into (the obligations referred to in this clause (d) being collectively referred to as the “Platinum Lease Obligations”). Notwithstanding the foregoing, Obligations shall not include any Excluded Swap Obligations, and (e) without duplication of any of the foregoing, the Loan Parties obligations to pay, discharge and satisfy the Erroneous Payment Subrogation Rights.244159-0944-0061.4“OFAC” means the U.S. Department of the Treasury’s Office of Foreign Assets Control, and any successor thereto.“Other Connection Taxes” means, with respect to any Recipient, Taxes imposed as a result of a present or former connection between such Recipient and the jurisdiction imposing such Tax (other than connections arising from such Recipient having executed, delivered, become a party to, performed its obligations under, received payments under, received or perfected a security interest under, engaged in any other transaction pursuant to or enforced any Loan Document, or sold or assigned an interest in any Loan or Loan Document).“Other Taxes” means all present or future stamp, court or documentary, intangible, recording, filing or similar Taxes that arise from any payment made under, from the execution, delivery, performance, enforcement or registration of, from the receipt or perfection of a security interest under, or otherwise with respect to, any Loan Document, except any such Taxes that are Other Connection Taxes imposed with respect to an assignment (other than an assignment made pursuant to Section 2.18(b)).“Overdraft Facility” means any same-day overdraft facility extended by a bank or other lending institution to STX, the Borrower or any Subsidiary.“Parent Company” shall mean, with respect to a Lender, the bank holding company (as defined in Federal Reserve Board Regulation Y), if any, of such Lender, and/or any Person owning, beneficially or of record, directly or indirectly, a majority of the shares of such Lender.“Parent Guarantee” means a guarantee by STX, Seagate UC or other parent entity of the Borrower, as applicable.“Participant” has the meaning assigned to such term in Section 9.04(e).“Participant Register” has the meaning assigned to such term in Section 9.04(h).“Payment Recipient” has the meaning assigned to it in Section 8.11(a).“PBGC” means the Pension Benefit Guaranty Corporation referred to and defined in ERISA and any successor entity performing similar functions.“Periodic Term SOFR Determination Day” has the meaning specified in the definition of “Term SOFR”.“Permitted Encumbrances” means:(a) Liens imposed by law for taxes or other governmental charges that are not yet due or are being contested in compliance with Section 5.05;(b) landlords’, carriers’, warehousemen’s, mechanics’, materialmen’s, repairmen’s and other like Liens imposed by law, arising in the ordinary course of business and securing obligations that are not overdue by more than 30 days or are being contested in compliance with Section 5.05;(c) pledges and deposits made in the ordinary course of business in compliance with workers’ compensation, unemployment insurance and other social security laws or regulations;254159-0944-0061.4(d) Liens to secure the performance of bids, trade contracts, leases, statutory obligations, surety and appeal bonds, performance bonds and other obligations of a like nature, in each case in the ordinary course of business;(e) judgment liens in respect of judgments that do not constitute an Event of Default under clause (k) of Section 7.01;(f) easements, zoning restrictions, licenses, reservations, covenants, utility easements, building restrictions, rights-of-way and similar encumbrances on real property imposed by law or arising in the ordinary course of business and minor defects or irregularities in title that do not secure any monetary obligations and do not materially detract from the value of the affected property or interfere with the ordinary conduct of business of STX, the Borrower or any Subsidiary;(g) any interest or title of a lessor under any lease permitted by this Agreement;(h) Liens in favor of customs and revenue authorities arising as a matter of law to secure payment of customs duties in connection with the importation of goods;(i) leases or subleases granted to other Persons and not interfering in any material respect with the business of STX, the Borrower and the Subsidiaries, taken as a whole; (j) licenses of intellectual property granted in the ordinary course of business; and(k) Liens substantially similar to the Liens described in clauses (a) through (j) of this definition and arising by operation of law in any jurisdiction outside of the United States of America.provided that the term “Permitted Encumbrances” shall not include any Lien securing Indebtedness. “Permitted Investments” means:(a) direct obligations of the United States of America or any agency thereof or obligations guaranteed by the United States of America or any agency thereof;(b) investments in commercial paper maturing not more than one year after the date of acquisition issued by a corporation (other than an Affiliate of the Borrower) organized and in existence under the laws of the United States of America or any foreign country recognized by the United States of America and having, at such date of acquisition, a rating of “P-1” (or better) from Moody’s or “A-1” (or better) from S&P(c) investments in (i) certificates of deposit, bankers’ acceptances, time deposits and money market deposit accounts maturing not more than one year after the date of acquisition thereof issued or guaranteed by or placed with any commercial bank or trust company organized under the laws of the United States of America or any State thereof or any foreign country recognized by the United States of America or (ii) obligations of United States Federal agencies sponsored by the Federal government (including, without limitation, the Federal Home Loan Bank, Federal Farm Credit Bank, Federal Home Loan Mortgage Corporation and Federal National Mortgage Association) that are not direct obligations of the United States of America or any State thereof and are not obligations guaranteed by the United States of America or any State thereof, in each case which bank, trust company or Federally sponsored agency has a combined capital and surplus and undivided profits in excess of $250,000,000 (or the foreign currency equivalent thereof) and has outstanding debt which is rated “A” (or such similar equivalent 264159-0944-0061.4rating) or higher by at least one nationally recognized statistical rating organization (as defined in Rule 436 under the Securities Act of 1933, as amended);(d) fully collateralized repurchase obligations with a term of not more than 45 days for securities described in clause (a) above or clause (e), (f) or (g) below and entered into with a financial institution satisfying the criteria described in clause (c) above;(e) investments in securities issued or fully guaranteed by any state, commonwealth or territory of the United States of America or any political subdivision or taxing authority thereof having maturities of not more than three years from the date of acquisition thereof and, having a rating of at least “AA” from S&P or “Aa” from Moody’s;(f) investments in securities with maturities of one year or less from the date of acquisition issued or fully guaranteed by any state, commonwealth or territory of the United States of America, or by any political subdivision or taxing authority thereof, and having a rating of at least “A” from S&P or from Moody’s;(g) investments in securities issued by any foreign government or any political subdivision of any foreign government or any public instrumentality thereof having maturities of not more than six months from the date of acquisition thereof and, at the time of acquisition, having one of the two highest credit ratings obtainable from S&P or from Moody’s;(h) investments in corporate bonds or notes having maturities of not more than five years from the date of acquisition thereof and having a rating of at least “A” from S&P or from Moody’s;(i) auction rate preferred stock having maturities of not more than 90 days from the date of acquisition thereof, provided that the long-term senior unsecured debt of the issuer of such preferred stock shall have a rating of at least “A” from S&P or from Moody’s;(j) investments in funds that invest substantially all their assets in one or more types of securities described in clauses (a) through (i) above; and(k) money market funds that (i) comply with the criteria set forth in SEC Rule 2a-7 under the Investment Company Act of 1940 and (ii) have portfolio assets of at least $1,000,000,000.“Permitted Obligation” means an obligation of STX, the Borrower or any Subsidiary (for purposes of this definition, a “Primary Obligor”) not constituting Indebtedness, including obligations under the Swap Agreements permitted under Section 6.06, provided (a) such obligation is entered into in the ordinary course of such Primary Obligor’s business, (b) any Guarantee of such obligation by STX, any Subsidiary or the Borrower, is given in the ordinary course of business, and (c) any Guarantee of such obligation is reasonably consistent with the practices of STX, any such Subsidiary or the Borrower and reasonably necessary to permit the Primary Obligor to incur such obligation. “Permitted Priority Debt Amount” means an amount not to exceed $50,000,000 at any time outstanding.“Permitted Receivables Factoring” means any transaction or series of transactions that may be entered into by the Borrower or any Subsidiary in the nature of a non-recourse, “true sale” factoring arrangement and not a securitization of assets or involving the incurrence of indebtedness for borrowed money, pursuant to which it may sell, convey, or otherwise transfer (which sale, conveyance, or transfer may include or be supported by the grant of a security 274159-0944-0061.4interest in) Receivables or interests therein and all collateral securing such Receivables, all contracts and contract rights, purchase orders, security interests, financing statements or other documentation in respect of such Receivables, any guarantees, indemnities, warranties or other obligations in respect of such Receivables, and any collections or proceeds of any of the foregoing (collectively, the “Related Assets”), directly to one or more purchasers (other than the Borrower or any Subsidiary); it being understood that a Permitted Receivables Factoring may involve periodic sales, conveyances, and transfers of Receivables and Related Assets and/or transactions in which new Receivables and Related Assets, or interests therein, are sold, conveyed, or transferred, provided that any such transactions shall provide for recourse to such Subsidiary or the Borrower (as applicable) only in respect of the cash flows in respect of such Receivables and Related Assets and to the extent of breaches of representations and warranties or covenants relating to the Receivables, dilution of the Receivables, customary disputes and deductions, and customary indemnities and other customary undertakings in the jurisdiction relevant to such factoring transactions; and provided further that the aggregate principal amount of Permitted Receivables Factoring shall not exceed $750,000,000 at any time outstanding.The “amount” or “principal amount” of any Permitted Receivables Factoring shall be deemed at any time to be the cash purchase price paid by the buyer in connection with its purchase of Receivables less the amount of collections received by the Borrower or any Subsidiary in respect of such Receivables and paid to such buyer, excluding any amounts applied to purchase fees or discount.“Permitted Secured Debt Amount” has the meaning assigned to such term in Section 6.02(g).“Permitted Subsidiary Debt Amount” has the meaning assigned to such term in Section 6.01(a)(ix).“Person” means any natural person, corporation, limited liability company, trust, joint venture, association, company, partnership, Governmental Authority or other entity.“Plan” means any “employee pension benefit plan” as defined in Section 3(2) of ERISA (other than a Multiemployer Plan), which is subject to the provisions of Title IV of ERISA or Section 412 of the Code or Section 302 of ERISA, and in respect of which the Borrower or any ERISA Affiliate is (or, if such plan were terminated, would under Section 4069 of ERISA be deemed to be) an “employer” as defined in Section 3(5) of ERISA.“Platinum Lease Obligations” has the meaning assigned to such term in the definition of “Obligations”.“Platinum Leases” means, collectively, leasing arrangements with respect to platinum and other precious metals that are entered into from time to time by the Borrower or any Subsidiary in the ordinary course of their business, including that certain Master Lease and Hedging Contracts Agreement for Precious Metals, dated as of April 25, 2008, between The Bank of Nova Scotia and STI, and any associated Guarantee of STI’s obligations thereunder. For the avoidance of doubt, “Platinum Leases” shall include any Swap Agreement that is (x) entered into with the lessor (or any Affiliate thereof) under any leasing arrangement described in the immediately preceding sentence and (y) involves, or is settled by reference to, platinum or any other precious metal that is the subject of such leasing arrangement.“Promissory Notes” means any promissory notes delivered pursuant to the terms of this Agreement, including each Revolving Note and each Term Note.“Proposed Change” has the meaning assigned to such term in Section 9.02(b).284159-0944-0061.4“PTE” means a prohibited transaction class exemption issued by the U.S. Department of Labor, as any such exemption may be amended from time to time.“QFC” has the meaning assigned to the term “qualified financial contract” in, and shall be interpreted in accordance with, 12 U.S.C. 5390(c)(8)(D).“QFC Credit Support” is defined in Section 9.17. “Qualified CFC Holding Company” means, any Subsidiary substantially all of whose assets consists of Equity Interests of either (i) a CFC Subsidiary or (ii) another Qualified CFC Holding Company.“Qualified ECP Guarantor” means, in respect of any Swap Obligation, each Guarantor that at the time of the relevant guaranty (or grant of the relevant security interest, as applicable) becomes effective with respect to such Swap Obligation, has total assets exceeding $10,000,000 or otherwise constitutes an “eligible contract participant” under the Commodity Exchange Act or any regulations promulgated thereunder and can cause another Person to qualify as an “eligible contract participant” at such time by entering into a cross-guaranty pursuant to Section 1a(18)(A)(v)(II) of the Commodity Exchange Act.“Quarterly Payment Date” means the last day of March, June, September and December, or, if any such day is not a Business Day, the next succeeding Business Day.“Recipient” means (a) the Administrative Agent, (b) any Lender or (c) any Issuing Bank, or any other recipient of any payment to be made by or on account of the Borrower or any Loan Party under any Loan Document.“Receivables” means accounts receivable (including all rights to payment created by or arising from the sale of goods, leases of goods or the rendition of services, no matter how evidenced (including in the form of a chattel paper) and whether or not earned by performance.“Register” has the meaning assigned to such term in Section 9.04(b)(iv).“Related Assets” has the meaning assigned to such term in the definition of the term “Permitted Receivables Factoring”.“Related Parties” means, with respect to any specified Person, such Person’s Affiliates and the respective directors, officers, employees, agents, trustees and advisors of such Person and such Person’s Affiliates.“Release” means any release, spill, emission, leaking, dumping, injection, pouring, deposit, disposal, discharge, dispersal, leaching or migration into the environment (including ambient air, surface water, groundwater, land surface or subsurface strata), or within any building, structure, facility or fixture subject to human occupation.“Relevant Governmental Body” means the Federal Reserve Board or the Federal Reserve Bank of New York, or a committee officially endorsed or convened by the Federal Reserve Board or the Federal Reserve Bank of New York, or any successor thereto.“Required Lenders” means, at any time, Lenders holding more than 50% of the aggregate unused Commitments and outstanding Loans at such time.“Reset Date” has the meaning assigned to such term in Section 1.05(a).294159-0944-0061.4“Resolution Authority” means an EEA Resolution Authority or, with respect to any UK Financial Institution, a UK Resolution Authority.“Restricted Payment” means (a) any dividend or other distribution (whether in cash, securities or other property) with respect to any Equity Interests (other than any Cash Pay Preferred Equity) in STX, the Borrower or any Subsidiary, or any payment (whether in cash, securities or other property), including any sinking fund or similar deposit, on account of the purchase, redemption, retirement, acquisition, cancelation or termination of any Equity Interests in STX, the Borrower or any Subsidiary or any option, warrant or other right to acquire any such Equity Interests in STX, the Borrower or any Subsidiary and (b) any distribution or other payment (whether in cash, securities or other property or any combination thereof) under or in respect of any Deferred Compensation Plan. “Revolving Commitment” means, with respect to any Lender, the commitment of such Lender to make the Revolving Loans hereunder in a maximum principal amount as set forth opposite such Lender’s name under the “Revolving Commitment” column on Schedule 2.01, and as thereafter modified in accordance with the terms of this Agreement. The Revolving Commitments as of the Sixth Amendment Effective Date are set forth on Schedule 2.01 to this Agreement (as amended on such date), as such amount may be reduced or increased from time to time pursuant to the terms hereof (including pursuant to assignments by or to such Lender pursuant to Section 9.04). A Lender shall not have any Revolving Commitment for Revolving Loans if the amount set forth for such Lender under the Revolving Commitment column is zero. As of the Sixth Amendment Effective Date the aggregate Revolving Commitment equaled $1,750,000,000.“Revolving Exposure” means, with respect to any Lender at any time, the sum of (a) the outstanding principal amount of such Lender’s Revolving Loans at such time and (b) such Lender’s LC Exposure and Swingline Exposure at such time.“Revolving Loan Lender” means any Lender that has a Revolving Commitment, and if the obligation to make Revolving Loans has terminated or been cancelled, then any Lender that is owed any Revolving Loan.“Revolving Loans” is defined in clause (a) of Section 2.01.“Revolving Loan Percentage” means, relative to any Lender on any date, the percentage that such Lender’s Revolving Commitment bears to the Revolving Commitments of all Lenders on such date. If the obligation of Lenders to make Revolving Loans has expired or been terminated, then the Revolving Loan Percentage of a Lender on any date shall be the percentage that such Lender’s Revolving Exposure bears to the Revolving Exposure owing to all Lenders on such date.“Revolving Note” means a promissory note of the Borrower payable to any Lender in the form of Exhibit H (as such promissory note may be amended, endorsed or otherwise modified from time to time), evidencing the aggregate Indebtedness of the Borrower to such Revolving Loan Lender resulting from outstanding Revolving Loans, and also means all other promissory notes accepted from time to time in substitution therefor or renewal thereof.“S&P” means Standard & Poor’s Ratings Group, Inc. and its successors.“Sanctioned Country” means, at any time, a country or territory which is the subject or target of broad, territorial Sanctions (at the time of this Agreement, Crimea, Cuba, Iran, North Korea, Syria, the Crimea Region of Ukraine, the so-called Donetsk People’s Republic and the so-called Luhansk People’s Republic).304159-0944-0061.4“Sanctioned Person” means, at any time, (a) any Person listed in any Sanctions-related list of designated Persons maintained by OFAC, the U.S. Department of State, Global Affairs Canada, the United Nations Security Council, the European Union, Her Majesty’s Treasury, or other relevant sanctions authority; (b) any Person controlled by any such Person; or (c)(i) an agency of the government of a Sanctioned Country, (ii) an organization controlled by a Sanctioned Country, or (iii) a Person resident in a Sanctioned Country, to the extent subject to Sanctions.“Sanctions” is defined in Section 3.15(a).“Scotiabank” has the meaning assigned to such term in the preamble to this Agreement.“SDST” means Seagate Data Storage Technology, an exempted company incorporated with limited liability in the Cayman Islands.“Seagate Technology (US)” means Seagate Technology (US) Holdings, Inc., a Delaware corporation.“Seagate UC” means Seagate Technology Unlimited Company, an unlimited company incorporated under the laws of Ireland (f/k/a Seagate Technology public limited company).“SEC” means the Securities and Exchange Commission or any Governmental Authority succeeding to any of its principal functions.“Second Amendment” means the Second Amendment and Joinder Agreement, dated as of September 16, 2019, among STX, the Borrower, the Lenders party thereto and the Administrative Agent.“Second Amendment Effective Date” is defined in the Second Amendment.“Senior Notes” means, collectively, (i) the 4.75% Senior Notes due 2023, (ii) the 4.875% Senior Notes due 2024, (iii) the 4.75% Senior Notes due 2025, (iv) the 4.875% Senior Notes due 2027, (v) the 5.75% Senior Notes due 2034, (vi) 3.125% Senior Notes due 2029, (vii) 4.091% Senior Notes due 2029, (viii) 3.375% Senior Notes due 2031, (ix) 4.125% Senior Notes due 2031 and (x) unsecured notes issued by the Borrower or STX following the Effective Date, and in the case of clauses (i) through (x), the Indebtedness represented thereby (including any respective Parent Guarantees and the Exchange Notes (each as defined in the Senior Note Documents), the respective guarantees of the Exchange Notes, and any replacement notes, or other similar or replacement guarantees), provided, that in the case of clause (x), both before and after giving effect to the incurrence of Indebtedness thereunder, no Default or Event of Default shall have occurred and be continuing or would result therefrom (including under Sections 6.11, 6.12, or 6.13, on a pro forma basis).“Senior Note Documents” means the indentures under which the Senior Notes are issued and all other instruments, agreements and other documents evidencing or governing the Senior Notes or providing for any Guarantees in respect thereof from STX, Seagate UC, the Borrower or any Subsidiary, as applicable.“Seventh Amendment” means the Seventh Amendment, dated as of November 8, 2022, among STX, the Borrower, the Lenders party thereto and the Administrative Agent.“Seventh Amendment Effective Date” is defined in the Seventh Amendment.314159-0944-0061.4“Sixth Amendment” means the Sixth Amendment, dated as of August 18, 2022, to this Agreement, among the Borrower, STX, the Lenders party thereto, and the Administrative Agent. “Sixth Amendment Effective Date” is defined in the Sixth Amendment. “SOFR” means, with respect to any day, the secured overnight financing rate as administered by the SOFR Administrator.“SOFR Administrator” means the Federal Reserve Bank of New York (or a successor administrator of the secured overnight financing rate).“SOFR Borrowing” means, as to any Borrowing, the SOFR Loans comprising such Borrowing.“SOFR Loan” means a Loan that bears interest at a rate based on the Adjusted Term SOFR, other than pursuant to clause (c) of the definition of “Alternate Base Rate”.“SPV” has the meaning assigned to such term in Section 9.04(h).“ST” means Seagate Technology, an exempted company incorporated with limited liability under the laws of the Cayman Islands.“STI” means Seagate Technology International, an exempted company incorporated with limited liability under the laws of the Cayman Islands.“STX” means, except as otherwise expressly provided in any Loan Document, (i) at all times, and with respect to all events, actions or circumstances, prior to the Fourth Amendment Effective Date, Seagate UC, and (ii) on and following the Fourth Amendment Effective Date, Seagate Technology Holdings plc, a public limited company incorporated under the laws of Ireland.“subsidiary” means, with respect to any Person (the “parent”) at any date, any corporation, limited liability company, partnership, association or other entity the accounts of which would be consolidated with those of the parent in the parent’s consolidated financial statements if such financial statements were prepared in accordance with GAAP as of such date, as well as any other corporation, limited liability company, partnership, association or other entity of which securities or other ownership interests representing more than 50% of the ordinary voting power or, in the case of a partnership, more than 50% of the general partnership interests are, as of such date, owned, controlled or held by the parent or one or more subsidiaries of the parent or by the parent and one or more subsidiaries of the parent.“Subsidiary” means any subsidiary of STX or Seagate UC, as applicable, other than the Borrower.“Subsidiary Loan Party” means any wholly-owned Subsidiary, except (a) any Immaterial Subsidiary, (b) [RESERVED], and (c) any Subsidiary that is not required to execute and deliver a Guarantee Agreement pursuant to the Guarantee Requirement or Section 5.13. Notwithstanding the foregoing, no Subsidiary will be required to become a Subsidiary Loan Party if the Administrative Agent determines, taking into account all legal and practical considerations, that the Administrative Agent, on behalf of the Finance Parties, will not be able to realize the benefits intended to be created by such Subsidiary’s Guarantee of the Obligations.“Successor Transaction” is defined in clause (b) of the definition of “Change in Control.”324159-0944-0061.4“Supported QFC” is defined in Section 9.17.“Swap” means any agreement, contract or transaction that constitutes a “swap” within the meaning of section 1a(47) of the Commodity Exchange Act.“Swap Agreement” means any agreement with respect to any swap, forward, future or derivative transaction or option or similar agreement involving, or settled by reference to, one or more rates, currencies, commodities, equity or debt instruments or securities, or economic, financial or pricing indices or measures of economic, financial or pricing risk or value or any similar transaction or any combination of these transactions, provided that no phantom stock or similar plan providing for payments only on account of services provided by current or former directors, officers, employees or consultants of the Borrower or any Subsidiary shall be a Swap Agreement.“Swap Obligations” has the meaning assigned to such term in clause (b) of the definition of the term “Obligations.”“Swingline Commitment” means the commitment of the Swingline Lenders to make Swingline Loans.“Swingline Exposure” means, at any time, the aggregate principal amount of all Swingline Loans outstanding at such time. The Swingline Exposure of any Lender at any time shall be its Applicable Percentage of the total Swingline Exposure at such time.“Swingline Lenders” means, as the context may require, (a) Scotiabank, with respect to Swingline Loans made by it, and (b) any other Lender that becomes a Swingline Lender pursuant to Section 2.04(d), with respect to Swingline Loans made by it, and, in each case, its successors in such capacity.“Swingline Loan” means a Loan made pursuant to Section 2.04.“Syndication Agent” means the Lender listed on Schedule 2.01 hereto, in its capacity as the Syndication Agent.“Taxes” means any and all current or future taxes, levies, imposts, duties, deductions, charges or withholdings (including backup withholding), assessments, fees, or other charges imposed by any Governmental Authority, including any interest, additions to tax or penalties applicable thereto.“Term Loan A1” is defined in clause (b) of Section 2.01.“Term Loan A2” is defined in clause (b) of Section 2.01.“Term Loan A3” is defined in clause (c) of Section 2.01.“Term Loan A1 Lender” means any Lender that has a Commitment to make Term Loan A1, or if the obligation to make Term Loan A1 has terminated or been cancelled, then any Lender that is owed any Term Loan A1.“Term Loan A2 Lender” means any Lender that has a Commitment to make Term Loan A2, or if the obligation to make Term Loan A2 has terminated or been cancelled, then any Lender that is owed any Term Loan A2.334159-0944-0061.4“Term Loan A3 Lender” means any Lender that has a Commitment to make Term Loan A3, or if the obligation to make Term Loan A3 has terminated or been cancelled, then any Lender that is owed any Term Loan A3.“Term Loan Commitment” means, with respect to any Lender, the commitment of such Lender to make the applicable Class of Term Loans hereunder in a maximum principal amount as set forth opposite such Lender’s name under the “Term Loan Commitment” column on Schedule 2.01, and as thereafter modified in accordance with the terms of this Agreement. The Term Loan Commitments as of the Sixth Amendment Effective Date are set forth on Schedule 2.01 to this Agreement (as amended on such date). A Lender shall not have any Term Loan Commitment for a Class of Term Loans if the amount set forth for such Lender under the applicable Class of “Term Loan Commitment” column is zero.“Term Loan Lender” means, as the context may require, a Term Loan A1 Lender, a Term Loan A2 Lender or a Term Loan A3 Lender.“Term Loan Percentage” means, relative to any Lender on any date, a percentage expressed as the sum of such Lender’s Term Loan Commitment of a particular Class of Term Loans and principal amount of outstanding Term Loans of such Class owing to such Lender to the sum of the Term Loan Commitments of all Lenders in that Class of Term Loans and principal amount of outstanding Term Loans of such Class of all Lenders on such date. If the obligation of Lenders to make Term Loans has expired or been terminated, then the Term Loan Percentage of a Lender on any date shall be the percentage that the outstanding principal amount of Term Loans of a particular Class owing to such Lender bears to the outstanding principal amount of Term Loans of such Class owing to all Lenders on such date.“Term Loans” is defined in clause (c) of Section 2.01 and a “Term Loan” is a loan made pursuant to clauses (b) and (c) of Section 2.01.“Term Note A1” means a promissory note of the Borrower payable to any Lender in the form of Exhibit I-1 (as such promissory note may be amended, endorsed or otherwise modified from time to time), evidencing the aggregate Indebtedness of the Borrower to such Lender resulting from outstanding Term Loan A1, and also means all other promissory notes accepted from time to time in substitution therefor or renewal thereof.“Term Note A2” means a promissory note of the Borrower payable to any Lender in the form of Exhibit I-2 (as such promissory note may be amended, endorsed or otherwise modified from time to time), evidencing the aggregate Indebtedness of the Borrower to such Lender resulting from outstanding Term Loan A2, and also means all other promissory notes accepted from time to time in substitution therefor or renewal thereof.“Term Note A3” means a promissory note of the Borrower payable to any Lender in the form of Exhibit I-3 (as such promissory note may be amended, endorsed or otherwise modified from time to time), evidencing the aggregate Indebtedness of the Borrower to such Lender resulting from outstanding Term Loan A3, and also means all other promissory notes accepted from time to time in substitution therefor or renewal thereof.“Term Note” means, as the context may require, a Term Note A1, a Term Note A2 or a Term Note A3.“Term SOFR” means:(a) for any calculation with respect to a SOFR Loan, the Term SOFR Reference Rate for a tenor comparable to the applicable Interest Period on the day (such day, the 344159-0944-0061.4“Periodic Term SOFR Determination Day”) that is two (2) U.S. Government Securities Business Days prior to the first day of such Interest Period, as such rate is published by the Term SOFR Administrator; provided that if as of 5:00 p.m., New York City time, on any Periodic Term SOFR Determination Day the Term SOFR Reference Rate for the applicable tenor has not been published by the Term SOFR Administrator and a Benchmark Replacement Date with respect to the Term SOFR Reference Rate has not occurred, then Term SOFR will be the Term SOFR Reference Rate for such tenor as published by the Term SOFR Administrator on the first preceding U.S. Government Securities Business Day for which such Term SOFR Reference Rate for such tenor was published by the Term SOFR Administrator so long as such first preceding U.S. Government Securities Business Day is not more than three (3) U.S. Government Securities Business Days prior to such Periodic Term SOFR Determination Day; and(b) for any calculation with respect to an ABR Loan on any day, the Term SOFR Reference Rate for a tenor of one month on the day (such day, the “ABR Term SOFR Determination Day”) that is two (2) U.S. Government Securities Business Days prior to such day, as such rate is published by the Term SOFR Administrator; provided that if as of 5:00 p.m., New York City time, on any ABR Term SOFR Determination Day, the Term SOFR Reference Rate for the applicable tenor has not been published by the Term SOFR Administrator and a Benchmark Replacement Date with respect to the Term SOFR Reference Rate has not occurred, then Term SOFR will be the Term SOFR Reference Rate for such tenor as published by the Term SOFR Administrator on the first preceding U.S. Government Securities Business Day for which such Term SOFR Reference Rate for such tenor was published by the Term SOFR Administrator so long as such first preceding U.S. Government Securities Business Day is not more than three (3) U.S. Government Securities Business Days prior to such ABR SOFR Determination Day.“Term SOFR Adjustment” means for any calculation with respect to an ABR Loan or a SOFR Loan, 0.10% per annum.“Term SOFR Administrator” means CME Group Benchmark Administration Limited (or a successor administrator of the Term SOFR Reference Rate selected by the Administrative Agent in its reasonable discretion).“Term SOFR Reference Rate” means the forward-looking term rate based on SOFR.“Third Amendment” means the Third Amendment, dated as of January 13, 2021, to this Agreement, among the Borrower, STX, the Lenders party thereto, and the Administrative Agent.“Third Amendment Effective Date” is defined in the Third Amendment.“Total Leverage Ratio” means, on any date, the ratio of (a) Funded Indebtedness as of such date to (b) Consolidated EBITDA for the period of four consecutive fiscal quarters of STX ended on such date for which financial statements have been delivered pursuant to Section 5.01.“Type”, when used in reference to any Loan or Borrowing, refers to whether the rate of interest on such Loan, or on the Loans comprising such Borrowing, is determined by reference to the Adjusted Term SOFR or the Alternate Base Rate.“UK Financial Institution” means any BRRD Undertaking (as such term is defined under the PRA Rulebook (as amended from time to time) promulgated by the United Kingdom Prudential Regulation Authority) or any person falling within IFPRU 11.6 of the FCA Handbook (as amended from time to time) promulgated by the United Kingdom Financial Conduct Authority, which includes certain credit institutions and investment firms, and certain affiliates of such credit institutions or investment firms.354159-0944-0061.4“UK Resolution Authority” means the Bank of England or any public administrative authority having responsibility for the resolution of any UK Financial Institution.“Unadjusted Benchmark Replacement” means the applicable Benchmark Replacement excluding the related Benchmark Replacement Adjustment.“USA PATRIOT Act” shall have the meaning assigned to such term in Section 9.15.“U.S. Government Securities Business Day” means any day except for (a) a Saturday, (b) a Sunday or (c) a day on which the Securities Industry and Financial Markets Association recommends that the fixed income departments of its members be closed for the entire day for purposes of trading in United States government securities.“U.S. Guarantee Agreement” means the U.S. Guarantee Agreement in substantially the form of Exhibit B hereto.“U.S. Loan Parties” means any Loan Parties that are organized under the laws of the United States of America or any State thereof or the District of Columbia.“U.S. Special Resolution Regimes” is defined in Section 9.17.“U.S. Subsidiary” means any Subsidiary that is organized under the laws of the United States of America or any State thereof or the District of Columbia.“Voting Stock” of a Person means all classes of Equity Interests of such Person then outstanding and normally entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof.“wholly-owned Subsidiary” means, with respect to any Person at any date, a subsidiary of such Person of which securities or other ownership interests representing 100% of the Equity Interests (other than directors’ qualifying shares) are, as of such date, owned, controlled or held by such Person or one or more wholly-owned subsidiaries of such Person or by such Person and one or more wholly-owned subsidiaries of such Person.“Withdrawal Liability” means liability to a Multiemployer Plan as a result of a complete or partial withdrawal from such Multiemployer Plan, as such terms are defined in Part I of Subtitle E of Title IV of ERISA.“Write-Down and Conversion Powers” means, (i) with respect to any EEA Resolution Authority, the write-down and conversion powers of such EEA Resolution Authority from time to time under the Bail-In Legislation for the applicable EEA Member Country, which write-down and conversion powers are described in the EU Bail-In Legislation Schedule, and (ii) with respect to the United Kingdom, any powers of the applicable Resolution Authority under the Bail-In Legislation to cancel, reduce, modify or change the form of a liability of any UK Financial Institution or any contract or instrument under which that liability arises, to convert all or part of that liability into shares, securities or obligations of that person or any other person, to provide that any such contract or instrument is to have effect as if a right had been exercised under it or to suspend any obligation in respect of that liability or any of the powers under that Bail-In Legislation that are related to or ancillary to any of those powers.SECTION 1.02 Classification of Loans and Borrowings. For purposes of this Agreement, Loans may be classified and referred to by Class (e.g., a “Revolving Loan” or “Term Loan A1”) or by Type (e.g., a “SOFR Loan”) or by Class and Type (e.g., a “SOFR Revolving Loan” or “SOFR Term Loan A1”). Borrowings also may be classified and referred to by Class 364159-0944-0061.4(e.g., a “Revolving Borrowing”) or by Type (e.g., a “SOFR Borrowing”) or by Class and Type (e.g., a “SOFR Revolving Borrowing”).SECTION 1.03 Terms Generally. The definitions of terms herein shall apply equally to the singular and plural forms of the terms defined. Whenever the context may require, any pronoun shall include the corresponding masculine, feminine and neuter forms. The words “include”, “includes” and “including” shall be deemed to be followed by the phrase “without limitation”. The word “will” shall be construed to have the same meaning and effect as the word “shall”. Unless the context requires otherwise (a) any definition of or reference to any agreement, instrument or other document herein shall be construed as referring to such agreement, instrument or other document as from time to time amended, amended and restated, supplemented or otherwise modified (subject to any restrictions on such amendments, amendments and restatements, supplements or modifications set forth herein), (b) any reference herein to any Person shall be construed to include such Person’s successors and assigns, (c) the words “herein”, “hereof” and “hereunder”, and words of similar import, shall be construed to refer to this Agreement in its entirety and not to any particular provision hereof, (d) all references herein to Articles, Sections, Exhibits and Schedules shall be construed to refer to Articles and Sections of, and Exhibits and Schedules to, this Agreement and (e) the words “asset” and “property” shall be construed to have the same meaning and effect and to refer to any and all tangible and intangible assets and properties, including cash, securities, accounts and contract rights.SECTION 1.04 Accounting Terms; GAAP. Except as otherwise expressly provided herein, all terms of an accounting or financial nature shall be construed in accordance with GAAP, as in effect from time to time, provided that, if the Borrower notifies the Administrative Agent that the Borrower requests an amendment to any provision (including any definition) hereof to eliminate the effect of any change occurring after the date hereof in GAAP or in the application thereof on the operation of such provision (or if the Administrative Agent notifies the Borrower that the Required Lenders request an amendment to any provision hereof for such purpose), regardless of whether any such notice is given before or after such change in GAAP or in the application thereof, then such provision shall be interpreted on the basis of GAAP as in effect and applied immediately before such change shall have become effective until such notice shall have been withdrawn or such provision amended in accordance herewith. For the purposes of determining compliance under Section 6.01, Section 6.02, Section 6.04, Section 6.05, Section 6.07, Section 6.08, Section 6.11, Section 6.12 and Section 6.13 with respect to any amount in a currency other than dollars, such amount shall be deemed to equal the Dollar Equivalent thereof (determined in good faith by the Borrower) at the time such amount was incurred or expended, as the case may be. Notwithstanding any changes in GAAP, any lease of STX and its subsidiaries that would be characterized as an operating lease under GAAP applied on a basis consistent with those used in preparing the financial statements for the fiscal year ended June 29, 2018 (whether that lease is entered into before or after the Effective Date) will not constitute a Capital Lease Obligation under this Agreement or any other Loan Document as a result of those changes in GAAP unless otherwise agreed to in writing by STX and the Required Lenders. Consolidated Cash Interest Expense, Consolidated EBITDA and Consolidated Net Income for any period shall be determined by aggregating (without duplication) the results of Seagate UC and its Subsidiaries for all relevant periods ending prior to the Fourth Amendment Effective Date (determined in accordance with such definitions and as if the references to “STX” therein are to Seagate UC) with those of Seagate Technology Holdings PLC and its Subsidiaries for all periods ending on or after the Fourth Amendment Effective Date.SECTION 1.05 Exchange Rates.(a) Not later than 1:00 p.m., New York City time, on each Calculation Date, the Administrative Agent shall (i) determine the Exchange Rate as of such Calculation Date to be 374159-0944-0061.4used for calculating the Dollar Equivalent amounts of each Alternative Currency in which an outstanding Alternative Currency Letter of Credit or unreimbursed LC Disbursement is denominated and (ii) give notice thereof to the Borrower. The Exchange Rates so determined shall become effective on the first Business Day immediately following the relevant Calculation Date (a “Reset Date”), shall remain effective until the next succeeding Reset Date and shall for all purposes of this Agreement (other than as set forth in Section 2.05(b) and other than converting into dollars under Sections 2.05(d), (e), (h), (j) and (k) and 2.12(b) the obligations of the Borrower and the Lenders in respect of LC Disbursements that have not been reimbursed when due) be the Exchange Rates employed in converting any amounts between the applicable currencies.(b) Not later than 5:00 p.m., New York City time, on each Reset Date, the Administrative Agent shall (i) determine the Alternative Currency LC Exposure on such date (after giving effect to any Alternative Currency Letters of Credit issued, renewed or terminated or requested to be issued, renewed or terminated on such date) and (ii) notify the Borrower and each Issuing Bank of the results of such determination.SECTION 1.06 Divisions. For all purposes under the Loan Documents, in connection with any division or plan of division under Delaware law (or any comparable event under a different jurisdiction’s laws): (a) if any asset, right, obligation or liability of any Person becomes the asset, right, obligation or liability of a different Person, then it shall be deemed to have been transferred from the original Person to the subsequent Person, and (b) if any new Person comes into existence, such new Person shall be deemed to have been organized on the first date of its existence by the holders of its Equity Interest at such time.ARTICLE IIIThe CreditsSECTION 2.01 Commitments. The following terms shall govern a Lender’s obligation to make Loans to the Borrower.(a) Subject to the terms and conditions set forth herein, each Revolving Loan Lender agrees to make loans (referred to as its “Revolving Loan”) in dollars to the Borrower from time to time during the applicable Availability Period in accordance with its Revolving Loan Percentage, so long as the aggregate principal amount of the Revolving Loans made by such Lender will not result in such Lender’s applicable Revolving Exposure exceeding such Lender’s Revolving Commitment. (b) Subject to the terms and conditions set forth herein, each Term Loan A1 Lender agreed to make a loan (referred to as its “Term Loan A1”) and each Term Loan A2 Lender agreed to make a loan (referred to as its “Term Loan A2”) in dollars to the Borrower, in one Borrowing for each Tranche on the Fifth Amendment Effective Date, in accordance with its Term Loan Percentage, so long as the aggregate principal amount of the applicable Class of Term Loans made by such Lender did not exceed such Lender’s Term Loan Commitment for such Class of Term Loans. Once repaid or prepaid, Term Loan A1 and Term Loan A2 may not be reborrowed.(c) Subject to the terms and conditions set forth herein, each Term Loan A3 Lender agrees to make a loan (referred to as its “Term Loan A3,” and together with the Term Loan A1 and Term Loan A2, collectively referred to as the “Term Loans”) in dollars to the Borrower, in one Borrowing on the Sixth Amendment Effective Date, in accordance with its Term Loan Percentage, so long as the aggregate principal amount of the applicable Class of Term Loans 384159-0944-0061.4made by such Lender will not exceed such Lender’s Term Loan Commitment for such Class of Term Loans. Once repaid or prepaid, Term Loan A3 may not be reborrowed.SECTION 2.02 Loans and Borrowings. (a) Each Revolving Loan or Term Loan shall be made as part of a Borrowing for such Loans, consisting of Loans of the same Type and Class made by the applicable Lenders ratably in accordance with their respective Commitments for the requested Class of Loans to be borrowed, and the Borrower may request, in its discretion, (i) Revolving Loans to be made, (ii) Term Loans to be made as Term Loan A1 or Term Loan A2 or a combination thereof or (iii) Term Loans to be made as Term Loan A3. The failure of any Lender to make any Loan required to be made by it shall not relieve any other Lender of its obligations hereunder, provided that the Commitments of the Lenders are several and no Lender shall be responsible for any other Lender’s failure to make Loans as required.(b) Subject to Section 2.13, each Borrowing shall be comprised entirely of ABR Loans or SOFR Loans as the Borrower may request in accordance herewith. Each Swingline Loan shall be an ABR Loan. Each Lender at its option may make any SOFR Loan by causing any domestic or foreign branch or Affiliate of such Lender to make such Loan, provided that (i) any exercise of such option shall not affect the obligation of the Borrower to repay such Loan in accordance with the terms of this Agreement and (ii) the Borrower shall not be required to make any greater payment under Section 2.14 or Section 2.16 to the applicable Lender than such Lender would have been entitled to receive if such Lender had not exercised such option.(c) At the commencement of each Interest Period for any SOFR Borrowing, such Borrowing shall be in an aggregate amount that is an integral multiple of $1,000,000 and not less than $5,000,000. At the time that each ABR Borrowing is made, such Borrowing shall be in an aggregate amount that is an integral multiple of $500,000 and not less than $1,000,000, provided that an ABR Borrowing may be in an aggregate amount that is equal to the entire unused balance of the aggregate Revolving Commitments or that is required to finance the reimbursement of an LC Disbursement as contemplated by Section 2.05(e). Each Swingline Loan shall be in an amount that is an integral multiple of $100,000 and not less than $500,000. Borrowings of more than one Type and Class may be outstanding at the same time, provided that there shall not at any time be more than a total of 15 SOFR Borrowings outstanding.(d) Notwithstanding any other provision of this Agreement, the Borrower shall not be entitled to request, or to elect to convert or continue, any Borrowing if the Interest Period requested with respect thereto would end after the Maturity Date applicable for such Loan.SECTION 2.03 Requests for Borrowings. To request a Borrowing of Revolving Loans or of Term Loans the Borrower shall notify the Administrative Agent of such request by telephone (a) in the case of a SOFR Borrowing, not later than 1:00 p.m., New York City time, three Business Days before the date of the proposed Borrowing or (b) in the case of an ABR Borrowing, not later than 2:00 p.m., New York City time, one Business Day before the date of the proposed Borrowing, provided that any such notice of an ABR Borrowing to finance the reimbursement of an LC Disbursement as contemplated by Section 2.05(e) may be given not later than 1:00 p.m., New York City time, on the date of the proposed Borrowing. Each such telephonic Borrowing Request shall be irrevocable and shall be confirmed promptly by hand delivery or telecopy to the Administrative Agent of a written Borrowing Request in a form approved by the Administrative Agent and signed by the Borrower. Each such telephonic and written Borrowing Request shall specify the following information in compliance with Section 2.02:(i) the aggregate amount, and the applicable Class, of the requested Borrowing;394159-0944-0061.4(ii) the date of such Borrowing, which shall be a Business Day;(iii) whether such Borrowing is to be an ABR Borrowing or a SOFR Borrowing;(iv) in the case of a SOFR Borrowing, the initial Interest Period to be applicable thereto, which shall be a period contemplated by the definition of the term “Interest Period”; and(v) the location and number of the Borrower’s account to which funds are to be disbursed, which shall comply with the requirements of Section 2.06.If no election as to the Type of Borrowing is specified, then the requested Borrowing shall be an ABR Borrowing. If no Interest Period is specified with respect to any requested SOFR Borrowing, then the Borrower shall be deemed to have selected an Interest Period of one month’s duration. Promptly following receipt of a Borrowing Request in accordance with this Section 2.03, the Administrative Agent shall advise each Lender of the details thereof and of the amount of such Lender’s Loan to be made as part of the requested Borrowing.SECTION 2.04 Swingline Loans. (a) Subject to the terms and conditions set forth herein, each Swingline Lender agrees to make Swingline Loans to the Borrower from time to time during the Availability Period, in an aggregate principal amount at any time outstanding that will not result in (i) the aggregate principal amount of outstanding Swingline Loans of all Swingline Lenders exceeding $50,000,000 or (ii) the aggregate Revolving Exposures exceeding the aggregate Revolving Commitments, provided that no Swingline Lender shall be required to make a Swingline Loan to refinance an outstanding Swingline Loan, and by requesting a Swingline Loan the Borrower shall be deemed to be representing to each Swingline Lender that the terms set forth in clauses (a)(i) and (a)(ii) above are true and correct on the date of the requested Swingline Loan. Within the foregoing limits and subject to the terms and conditions set forth herein, the Borrower may borrow, prepay and reborrow Swingline Loans.(b) To request a Swingline Loan, the Borrower shall notify the Administrative Agent of such request by telephone (confirmed by telecopy), not later than 2:00 p.m., New York City time, on the day of such proposed Swingline Loan and which Swingline Lender is to make the requested Swingline Loan. Each such notice shall be irrevocable and shall specify the requested date (which shall be a Business Day) and amount of the requested Swingline Loan. The Administrative Agent will promptly advise the Swingline Lender of any such notice received from the Borrower. The Swingline Lender shall make each Swingline Loan available to the Borrower by means of a credit to the general deposit account of the Borrower maintained with such Swingline Lender (or, in the case of a Swingline Loan made to finance the reimbursement of an LC Disbursement as provided in Section 2.05(e), by remittance to the Issuing Bank or, to the extent that the Lenders have made payments pursuant to Section 2.05(e) to reimburse the Issuing Bank, to such Lenders and the Issuing Bank as their interests may appear) by 4:00 p.m., New York City time, on the requested date of such Swingline Loan.(c) Each Swingline Lender may by written notice given to the Administrative Agent not later than 12:30 p.m., New York City time, on any Business Day require the Lenders to acquire participations on such Business Day in all or a portion of the Swingline Loans made by it and then outstanding. Such notice shall specify the aggregate amount of Swingline Loans in which Lenders will participate. Promptly upon receipt of such notice, the Administrative Agent will give notice thereof to each Lender, specifying in such notice such Lender’s Applicable Percentage of such Swingline Loan or Swingline Loans. Each Lender hereby absolutely and unconditionally agrees, upon receipt of notice as provided above, to pay to the Administrative Agent, for the account of the applicable Swingline Lender, such Lender’s Applicable Percentage 404159-0944-0061.4of such Swingline Loan or Swingline Loans. Each Lender acknowledges and agrees that its obligation to acquire participations in Swingline Loans pursuant to this clause is absolute and unconditional and shall not be affected by any circumstance whatsoever, including the occurrence and continuance of a Default or reduction or termination of the Commitments, and that each such payment shall be made without any offset, abatement, withholding or reduction whatsoever. Each Lender shall comply with its obligation under this clause by wire transfer of immediately available funds, in the same manner as provided in Section 2.06 with respect to Loans made by such Lender (and Section 2.06 shall apply, mutatis mutandis, to the payment obligations of the Lenders), and the Administrative Agent shall promptly pay to the Swingline Lender that has made the applicable demand the amounts so received by it from the Lenders. The Administrative Agent shall notify the Borrower of any participations in any Swingline Loan acquired pursuant to this clause, and thereafter payments in respect of such Swingline Loan shall be made to the Administrative Agent and not to the applicable Swingline Lender. Any amounts received by such Swingline Lender from the Borrower (or other party on behalf of the Borrower) in respect of a Swingline Loan after receipt by such Swingline Lender of the proceeds of a sale of participations therein shall be promptly remitted to the Administrative Agent; any such amounts received by the Administrative Agent shall be promptly remitted by the Administrative Agent to the Lenders that shall have made their payments pursuant to this clause and to such Swingline Lender, as their interests may appear, provided that any such payment so remitted shall be repaid to such Swingline Lender or to the Administrative Agent, as applicable, if and to the extent such payment is required to be refunded to the Borrower for any reason. The purchase of participations in a Swingline Loan pursuant to this clause shall not relieve the Borrower of any default in the payment thereof.(d) Additional Swingline Lenders. The Borrower may, at any time and from time to time with the consent of the Administrative Agent (which consent shall not be unreasonably withheld) and such Lender, designate one or more additional Lenders to act as a Swingline Lender under the terms of this Agreement, provided that the total number of Lenders so designated at any time shall not exceed five. Any Lender designated as a Swingline Lender pursuant to this clause (d) shall be deemed to be a “Swingline Lender” for the purposes of this Agreement (in addition to being a Lender) with respect to Swingline Loans made by such Lender.SECTION 2.05 Letters of Credit. (a) General. Subject to the terms and conditions set forth herein, the Borrower may request the issuance of Letters of Credit for its own account, pursuant to an Issuance Request or such other form reasonably acceptable to the Administrative Agent and the Issuing Bank that has been requested to issue a Letter of Credit, at any time and from time to time during the Availability Period and prior to the date that is five Business Days prior to the Maturity Date. In the event of any inconsistency between the terms and conditions of this Agreement and the terms and conditions of any form of letter of credit application or other agreement submitted by the Borrower to, or entered into by the Borrower with, an Issuing Bank relating to such Issuing Bank’s Letter of Credit, the terms and conditions of this Agreement shall control.(b) Notice of Issuance, Amendment, Renewal, Extension; Certain Conditions. To request the issuance of a Letter of Credit (or the amendment, renewal or extension of an outstanding Letter of Credit), the Borrower shall hand deliver or telecopy (or transmit by electronic communication, if arrangements for doing so have been approved by the Issuing Bank that has been requested to issue a Letter of Credit) to such Issuing Bank and the Administrative Agent (reasonably in advance of the requested date of issuance, amendment, renewal or extension) an Issuance Request or other notice requesting the issuance of a Letter of Credit, or identifying the Letter of Credit to be amended, renewed or extended, and specifying the date of issuance, amendment, renewal or extension (which shall be a Business Day), the date on which 414159-0944-0061.4such Letter of Credit is to expire (which shall comply with clause (c) of this Section 2.05), the amount of such Letter of Credit, the currency in which such Letter of Credit is to be denominated (which shall be dollars or, subject to Section 2.19, an Alternative Currency), the name and address of the beneficiary thereof and such other information as shall be necessary to prepare, amend, renew or extend such Letter of Credit. If requested by an Issuing Bank, the Borrower also shall submit a letter of credit application on such Issuing Bank’s standard form in connection with any request for a Letter of Credit. A Letter of Credit shall be issued, amended, renewed or extended only if (and upon issuance, amendment, renewal or extension of each Letter of Credit the Borrower shall be deemed to represent and warrant that), after giving effect to such issuance, amendment, renewal or extension (i) the LC Exposure shall not exceed $75,000,000 and (ii) the aggregate Revolving Exposures shall not exceed the aggregate Revolving Commitments.(c) Expiration Date. Each Letter of Credit shall expire at or prior to the close of business on the earlier of (i)(A) the date that is one year after the date of the issuance of such Letter of Credit (or, in the case of any renewal or extension thereof, one year after the date of such renewal or extension) or (B) such other date mutually agreed upon by the Issuing Bank that issued such Letter of Credit and the Borrower (but in no event shall such date be later than as provided in clause (ii) of this clause (c)) and (ii) the date that is five Business Days prior to the Maturity Date.(d) Participations. By the issuance of a Letter of Credit (or an amendment to a Letter of Credit increasing the amount thereof) and without any further action on the part of any Issuing Bank or the Lenders, each Issuing Bank hereby grants to each Revolving Loan Lender, and each Revolving Loan Lender hereby acquires from each Issuing Bank, a participation in such Letter of Credit equal to such Revolving Loan Lender’s Applicable Percentage of the aggregate amount available to be drawn under such Letter of Credit. In consideration and in furtherance of the foregoing, each Revolving Loan Lender hereby absolutely and unconditionally agrees to pay to the Administrative Agent in dollars, for the account of each Issuing Bank, such Revolving Loan Lender’s Applicable Percentage of (i) each LC Disbursement made by such Issuing Bank in dollars and (ii) the Dollar Equivalent, using the Exchange Rates on the date such payment is required, of each LC Disbursement made by such Issuing Bank in an Alternative Currency and, in each case, not reimbursed by the Borrower on the date due as provided in clause (e) of this Section 2.05, or of any reimbursement payment required to be refunded to the Borrower for any reason (or, if such reimbursement payment was refunded in an Alternative Currency, the Dollar Equivalent thereof using the Exchange Rates on the date of such refund). Each Revolving Loan Lender acknowledges and agrees that its obligation to acquire participations pursuant to this clause in respect of Letters of Credit is absolute and unconditional and shall not be affected by any circumstance whatsoever, including any amendment, renewal or extension of any Letter of Credit or the occurrence and continuance of a Default or reduction or termination of the Commitments, and that each such payment shall be made without any offset, abatement, withholding or reduction whatsoever.(e) Reimbursement. If any Issuing Bank shall make any LC Disbursement in respect of a Letter of Credit, the Borrower shall reimburse such LC Disbursement by paying to the Administrative Agent an amount equal to such LC Disbursement, in dollars or (subject to the two immediately succeeding sentences) the applicable Alternative Currency, not later than 2:00 p.m., New York City time, on the Business Day immediately following the date on which the Borrower receives notice of such LC Disbursement, provided that, in the case of any LC Disbursement made in dollars, the Borrower may, subject to the conditions to borrowing set forth herein, request in accordance with Section 2.03 or Section 2.04 that such payment be financed with an ABR Revolving Borrowing or Swingline Loan in an equivalent amount and, to the extent so financed, the Borrower’s obligation to make such payment shall be discharged and replaced by the resulting ABR Revolving Borrowing or Swingline Loan. If the Borrower’s 424159-0944-0061.4reimbursement of, or obligation to reimburse, any amounts in any Alternative Currency would subject the Administrative Agent, any Issuing Bank or any Lender to any stamp duty, ad valorem charge or similar tax that would not be payable if such reimbursement were made or required to be made in dollars, the Borrower shall reimburse each LC Disbursement made in such Alternative Currency in dollars, in an amount equal to the Dollar Equivalent, calculated using the applicable Exchange Rate on the date such LC Disbursement is made, of such LC Disbursement. If the Borrower fails to make such payment when due, then (i) if such payment relates to an Alternative Currency Letter of Credit, automatically and with no further action required, the Borrower’s obligation to reimburse the applicable LC Disbursement shall be permanently converted into an obligation to reimburse the Dollar Equivalent, calculated using the Exchange Rates on the date when such payment was due, of such LC Disbursement and (ii) the Administrative Agent shall promptly notify the applicable Issuing Bank and each Lender of the applicable LC Disbursement, the Dollar Equivalent thereof (if such LC Disbursement relates to an Alternative Currency Letter of Credit), the payment then due from the Borrower in respect thereof and such Lender’s Applicable Percentage thereof. Promptly following receipt of such notice, each Lender shall pay to the Administrative Agent in dollars its Applicable Percentage of the payment then due from the Borrower (determined as provided in clause (i) above, if such payment relates to an Alternative Currency Letter of Credit), in the same manner as provided in Section 2.06 with respect to Loans made by such Lender (and Section 2.06 shall apply, mutatis mutandis, to the payment obligations of the Lenders), and the Administrative Agent shall promptly pay to the applicable Issuing Bank in dollars the amounts so received by it from the Lenders. Promptly following receipt by the Administrative Agent of any payment from the Borrower pursuant to this clause, the Administrative Agent shall distribute such payment to such Issuing Bank or, to the extent that Lenders have made payments pursuant to this clause to reimburse such Issuing Bank, then to such Lenders and the Issuing Bank as their interests may appear. Any payment made by a Lender pursuant to this clause to reimburse the applicable Issuing Bank for any LC Disbursement (other than the funding of ABR Revolving Loans or a Swingline Loan as contemplated above) shall not constitute a Loan and shall not relieve the Borrower of its obligation to reimburse such LC Disbursement.(f) Obligations Absolute. The Borrower’s obligation to reimburse LC Disbursements as provided in clause (e) of this Section 2.05 shall be absolute, unconditional and irrevocable, and shall be performed strictly in accordance with the terms of this Agreement under any and all circumstances whatsoever and irrespective of (i) any lack of validity or enforceability of any Letter of Credit, any application for the issuance of a Letter of Credit or this Agreement, or any term or provision therein, (ii) any draft or other document presented under a Letter of Credit proving to be forged, fraudulent or invalid in any respect or any statement therein being untrue or inaccurate in any respect, (iii) payment by any Issuing Bank under a Letter of Credit against presentation of a draft or other document that does not comply with the terms of such Letter of Credit or (iv) any other event or circumstance whatsoever, whether or not similar to any of the foregoing, that might, but for the provisions of this Section 2.05, constitute a legal or equitable discharge of, or provide a right of setoff against, the Borrower’s obligations hereunder. None of the Administrative Agent, the Lenders, any Issuing Bank or any of their respective Related Parties shall have any liability or responsibility by reason of or in connection with the issuance or transfer of any Letter of Credit or any payment or failure to make any payment thereunder (irrespective of any of the circumstances referred to in the preceding sentence), or any error, omission, interruption, loss or delay in transmission or delivery of any draft, notice or other communication under or relating to any Letter of Credit (including any document required to make a drawing thereunder), any error in interpretation of technical terms or any consequence arising from causes beyond the control of any Issuing Bank, provided that the foregoing provisions of this clause (f) shall not be construed to excuse any Issuing Bank from liability to the Borrower to the extent of any direct damages (as opposed to consequential damages, claims in respect of which are hereby waived by the Borrower to the extent permitted by applicable law) suffered by the Borrower that are caused by (A) such Issuing Bank’s failure to exercise care 434159-0944-0061.4when determining whether drafts and other documents presented under a Letter of Credit comply with the terms thereof or (B) such Issuing Bank’s failure to issue a Letter of Credit in accordance with the terms of this Agreement when requested by the Borrower pursuant to Section 2.05(b). The parties hereto expressly agree that, in the absence of gross negligence or willful misconduct on the part of an Issuing Bank, such Issuing Bank shall be deemed to have exercised care in each such determination and each issuance of (or failure to issue) a Letter of Credit. In furtherance of the foregoing and without limiting the generality thereof, the parties agree that, with respect to documents presented that appear on their face to be in substantial compliance with the terms of a Letter of Credit, each the Issuing Bank may, in its sole discretion, either accept and make payment upon such documents without responsibility for further investigation or refuse to accept and make payment upon such documents if such documents are not in strict compliance with the terms of such Letter of Credit.(g) Disbursement Procedures. Each Issuing Bank shall, promptly following its receipt thereof, examine all documents purporting to represent a demand for payment under a Letter of Credit issued by it. Each Issuing Bank shall promptly notify the Administrative Agent and the Borrower by telephone (confirmed by telecopy) of such demand for payment and whether such Issuing Bank has made or will make an LC Disbursement thereunder, provided that any failure to give or delay in giving such notice shall not relieve the Borrower of its obligation to reimburse such Issuing Bank and the Lenders with respect to any such LC Disbursement in accordance with clause (e) of this Section 2.05.(h) Interim Interest. If any Issuing Bank shall make any LC Disbursement, then, unless the Borrower shall reimburse such LC Disbursement in full on the date such LC Disbursement is made, the unpaid amount thereof shall bear interest, for each day from and including the date such LC Disbursement is made to but excluding the date that the Borrower reimburses such LC Disbursement, at the rate per annum then applicable to ABR Revolving Loans, provided that if the Borrower fails to reimburse such LC Disbursement when due pursuant to clause (e) of this Section 2.05, then Section 2.12(c) shall apply, provided further that, in the case of any LC Disbursement made under an Alternative Currency Letter of Credit, the amount of interest due with respect thereto shall (i) in the case of any LC Disbursement that is reimbursed on or before the Business Day immediately succeeding such LC Disbursement, (A) be payable in the applicable Alternative Currency and (B) bear interest at a rate equal to the rate reasonably determined by the applicable Issuing Bank to be the cost to such Issuing Bank of funding such LC Disbursement plus the Applicable Margin applicable to SOFR Loans at such time and (ii) in the case of any LC Disbursement that is reimbursed after the Business Day immediately succeeding such LC Disbursement, (A) be payable in dollars, (B) accrue on the Dollar Equivalent, calculated using the Exchange Rates on the date such LC Disbursement was made, of such LC Disbursement and (C) bear interest at the rate per annum then applicable to ABR Revolving Loans, subject to Section 2.12(c). Interest accrued pursuant to this clause shall be for the account of the Issuing Bank, except that interest accrued on and after the date of payment by any Lender pursuant to clause (e) of this Section 2.05 to reimburse the Issuing Bank shall be for the account of such Lender to the extent of such payment.(i) Replacement of an Issuing Bank. Any Issuing Bank may be replaced at any time by written agreement among the Borrower, the replaced Issuing Bank and the successor Issuing Bank and by notifying the Administrative Agent of such replacement. The Administrative Agent shall notify the Lenders of any such replacement of any Issuing Bank. At the time any such replacement shall become effective, the Borrower shall pay all unpaid fees accrued for the account of the replaced Issuing Bank pursuant to Section 2.11(b). From and after the effective date of any such replacement, (i) the successor Issuing Bank shall have all the rights and obligations of an Issuing Bank under this Agreement with respect to Letters of Credit to be issued thereafter and (ii) references herein to the term “Issuing Bank” shall be deemed to refer to such successor or to any previous Issuing Bank, or to such successor and all previous Issuing 444159-0944-0061.4Banks, as the context shall require. After the replacement of an Issuing Bank hereunder, the replaced Issuing Bank shall remain a party hereto and shall continue to have all the rights and obligations of an Issuing Bank under this Agreement with respect to Letters of Credit issued by it prior to such replacement but shall not be required to issue additional Letters of Credit.(j) Cash Collateralization. If any Event of Default shall occur and be continuing, on the Business Day that the Borrower receives notice from the Administrative Agent or the Required Lenders demanding the deposit of cash collateral pursuant to this clause, the Borrower shall deposit in an account with the Administrative Agent, in the name of the Administrative Agent and for the benefit of the Lenders, an amount in dollars and in cash equal to the LC Exposure as of such date plus any accrued and unpaid interest thereon, provided that (i) the portions of such amount attributable to undrawn Alternative Currency Letters of Credit or LC Disbursements in an Alternative Currency that the Borrower is not late in reimbursing shall be deposited in the applicable Alternative Currencies in the actual amounts of such undrawn Letters of Credit and LC Disbursements and (ii) upon the occurrence of any Event of Default with respect to the Borrower described in clause (h) or (i) of Section 7.01 the obligation to deposit such cash collateral shall become effective immediately, and such deposit shall become immediately due and payable in dollars, without demand or other notice of any kind. For the purposes of this clause, the Alternative Currency LC Exposure shall be calculated using the Exchange Rates on the date that notice demanding cash collateralization is delivered to the Borrower. The Borrower also shall deposit cash collateral pursuant to this clause as and to the extent required by Section 2.10(b). Each such deposit pursuant to this clause or pursuant to Section 2.10(b) shall be held by the Administrative Agent as collateral for the payment and performance of the obligations of the Borrower under this Agreement. The Administrative Agent shall have exclusive dominion and control, including the exclusive right of withdrawal, over such account. Other than any interest earned on the investment of such deposits, which investments shall be made at the option and sole discretion of the Administrative Agent and at the Borrower’s risk and expense, such deposits shall not bear interest. Interest or profits, if any, on such investments shall accumulate in such account. Moneys in such account shall be applied by the Administrative Agent to reimburse the applicable Issuing Bank for LC Disbursements for which it has not been reimbursed and, to the extent not so applied, shall be held for the satisfaction of the reimbursement obligations of the Borrower for the LC Exposure at such time or, if the maturity of the Loans has been accelerated, be applied to satisfy other obligations of the Borrower under this Agreement. If the Borrower is required to provide an amount of cash collateral hereunder as a result of the occurrence of an Event of Default, such amount (to the extent not applied as aforesaid) shall be returned to the Borrower within three Business Days after all Events of Default have been cured or waived. If the Borrower is required to provide an amount of cash collateral hereunder pursuant to Section 2.10(b), such amount (to the extent not applied as aforesaid) shall be returned to the Borrower as and to the extent that, after giving effect to such return, the Borrower would remain in compliance with Section 2.10(b) and no Event of Default shall have occurred and be continuing.(k) Conversion. In the event that the Loans become immediately due and payable on any date pursuant to Section 7.01, all amounts (i) that the Borrower is at the time or thereafter becomes required to reimburse or otherwise pay to the Administrative Agent in respect of LC Disbursements made under any Alternative Currency Letter of Credit (other than amounts in respect of which the Borrower has deposited cash collateral pursuant to Section 2.05(j), if such cash collateral was deposited in the applicable Alternative Currency to the extent so deposited or applied), (ii) that the Lenders are at the time or thereafter become required to pay to the Administrative Agent and the Administrative Agent is at the time or thereafter becomes required to distribute to the applicable Issuing Bank pursuant to clause (e) of this Section 2.05 in respect of unreimbursed LC Disbursements made under any Alternative Currency Letter of Credit and (iii) of each Lender’s participation in any Alternative Currency Letter of Credit under which an LC Disbursement has been made shall, automatically and with no further action required, be 454159-0944-0061.4converted into the Dollar Equivalent, calculated using the Exchange Rates on such date (or in the case of any LC Disbursement made after such date, on the date such LC Disbursement is made), of such amounts. On and after such conversion, all amounts accruing and owed to the Administrative Agent, any Issuing Bank or any Lender in respect of the obligations described in this clause shall accrue and be payable in dollars at the rates otherwise applicable hereunder.(l) Additional Issuing Banks. The Borrower may, at any time and from time to time with the consent of the Administrative Agent (which consent shall not be unreasonably withheld) and such Lender, designate one or more additional Lenders to act as an Issuing Bank under the terms of this Agreement, provided that the total number of Lenders so designated at any time shall not exceed five. Any Lender designated as an Issuing Bank pursuant to this clause (l) shall be deemed to be an “Issuing Bank” for the purposes of this Agreement (in addition to being a Lender) with respect to Letters of Credit issued by such Lender.(m) Reporting. Each Issuing Bank will report in writing to the Administrative Agent (i) on the first Business Day of each week, the aggregate face amount of Letters of Credit issued by it and outstanding as of the last Business Day of the preceding week, (ii) on or prior to each Business Day on which an Issuing Bank expects to issue, amend, renew or extend any Letter of Credit, the date of such issuance or amendment and the aggregate face amount of Letters of Credit to be issued, amended, renewed or extended by it and outstanding after giving effect to such issuance, amendment, renewal or extension (and such Issuing Bank shall advise the Administrative Agent on such Business Day whether such issuance, amendment, renewal or extension occurred and whether the amount thereof changed), (iii) on each Business Day on which an Issuing Bank makes any LC Disbursement, the date of such LC Disbursement and the amount of such LC Disbursement and (iv) on any Business Day on which the Borrower fails to reimburse an LC Disbursement required to be reimbursed to such Issuing Bank on such day, the date of such failure and amount of such LC Disbursement.SECTION 2.06 Funding of Borrowings. (a) Each Lender shall make each Loan to be made by it hereunder on the proposed date thereof by wire transfer of immediately available funds by 12:00 noon, New York City time, to the account of the Administrative Agent most recently designated by it for such purpose by notice to the Lenders, provided that Swingline Loans shall be made as provided in Section 2.04. The Administrative Agent will make such Loans available to the Borrower by promptly crediting the amounts so received, in like funds, to an account of the Borrower maintained with the Administrative Agent in New York City and designated by the Borrower in the applicable Borrowing Request, provided that ABR Revolving Loans and Swingline Loans made to finance the reimbursement of an LC Disbursement as provided in Section 2.05(e) shall be remitted by the Administrative Agent to the Issuing Bank or, to the extent that Lenders have made payments pursuant to Section 2.05(e) to reimburse such Issuing Bank, then to such Lenders and such Issuing Bank as their interests may appear.(b) Unless the Administrative Agent shall have received notice from a Lender prior to the proposed date of any Borrowing that such Lender will not make available to the Administrative Agent such Lender’s share of such Borrowing, the Administrative Agent may assume that such Lender has made such share available on such date in accordance with clause (a) of this Section 2.06 and may, in reliance upon such assumption, make available to the Borrower a corresponding amount. In such event, if a Lender has not in fact made its share of the applicable Borrowing available to the Administrative Agent, then the applicable Lender and the Borrower severally agree to pay to the Administrative Agent forthwith on demand such corresponding amount with interest thereon, for each day from and including the date such amount is made available to the Borrower to but excluding the date of payment to the Administrative Agent, at (i) in the case of such Lender, the greater of the Federal Funds Effective 464159-0944-0061.4Rate and a rate determined by the Administrative Agent in accordance with banking industry rules on interbank compensation or (ii) in the case of the Borrower, the interest rate applicable to ABR Loans. If such Lender pays such amount to the Administrative Agent, then such amount shall constitute such Lender’s Loan included in such Borrowing.(c) Nothing in this Section 2.06 shall be deemed to relieve any Lender from its obligation to fulfill its Commitments hereunder or to prejudice any rights that the Borrower may have against any Lender as a result of any default by any such Lender hereunder (it being understood, however, that no Lender shall be responsible for the failure of any other Lender to fulfill its Commitments hereunder).SECTION 2.07 Interest Elections. (a) Each Borrowing initially shall be of the Type specified in the applicable Borrowing Request or designated by Section 2.03 and, in the case of a SOFR Borrowing, shall have an initial Interest Period as specified in such Borrowing Request or designated by Section 2.03. Thereafter, the Borrower may elect to convert such Borrowing to a different Type or to continue such Borrowing and, in the case of a SOFR Borrowing, may elect Interest Periods therefor, all as provided in this Section 2.07. The Borrower may elect different options with respect to different portions of the affected Borrowing, in which case each such portion shall be allocated ratably among the Lenders holding the Loans comprising such Borrowing, and the Loans comprising each such portion shall be considered a separate Borrowing. This Section 2.07 shall not apply to Swingline Borrowings, which may not be converted or continued.(b) To make an election pursuant to this Section 2.07, the Borrower shall notify the Administrative Agent of such election by telephone by the time that a Borrowing Request would be required under Section 2.03 if the Borrower were requesting a Borrowing of the Type resulting from such election to be made on the effective date of such election. Each such telephonic Interest Election Request shall be irrevocable and shall be confirmed promptly by hand delivery or telecopy to the Administrative Agent of a written Interest Election Request.(c) Each telephonic and written Interest Election Request shall specify the following information in compliance with Section 2.02:(i) the Borrowing to which such Interest Election Request applies and, if different options are being elected with respect to different portions thereof, the portions thereof to be allocated to each resulting Borrowing (in which case the information to be specified pursuant to clauses (iii) and (iv) below shall be specified for each resulting Borrowing);(ii) the effective date of the election made pursuant to such Interest Election Request, which shall be a Business Day;(iii) whether the resulting Borrowing is to be an ABR Borrowing or a SOFR Borrowing; and(iv) if the resulting Borrowing is a SOFR Borrowing, the Interest Period to be applicable thereto after giving effect to such election, which shall be a period contemplated by the definition of the term “Interest Period”.If any such Interest Election Request requests a SOFR Borrowing but does not specify an Interest Period, then the Borrower shall be deemed to have selected an Interest Period of one month’s duration.474159-0944-0061.4(d) Promptly following receipt of an Interest Election Request, the Administrative Agent shall advise each Lender of the details thereof and of such Lender’s portion of each resulting Borrowing.(e) If the Borrower fails to deliver a timely Interest Election Request with respect to a SOFR Borrowing prior to the end of the Interest Period applicable thereto, then, unless such Borrowing is repaid as provided herein, at the end of such Interest Period such Borrowing shall be converted to an ABR Borrowing. Notwithstanding any contrary provision hereof, if an Event of Default has occurred and is continuing and the Administrative Agent, at the request of the Required Lenders, so notifies the Borrower, then, so long as an Event of Default is continuing (i) no outstanding Borrowing may be converted to or continued as a SOFR Borrowing and (ii) unless repaid, each SOFR Borrowing shall be converted to an ABR Borrowing at the end of the Interest Period applicable thereto.SECTION 2.08 Termination and Reduction of Commitments.(a) Unless previously terminated, the Commitments of Revolving Loans shall terminate on the Maturity Date for Revolving Loans.(b) The Borrower may, without premium or penalty, at any time terminate, or from time to time reduce, in its sole discretion the Commitments of any Class, provided that (i) each reduction of the Commitments of any Class shall be in an amount that is an integral multiple of $1,000,000 and not less than $5,000,000 (or if less, the remaining Commitments of such Class) and (ii) the Borrower shall not terminate or reduce the Revolving Commitments if, after giving effect to any concurrent prepayment of the Loans in accordance with Section 2.10, the aggregate Revolving Exposures would exceed the aggregate Revolving Commitments.(c) The Borrower shall notify the Administrative Agent of any election to terminate or reduce the Commitments under clause (b) of this Section 2.08 at least three Business Days prior to the effective date of such termination or reduction, specifying such election and the effective date thereof. Promptly following receipt of any notice, the Administrative Agent shall advise the Lenders of the contents thereof. Each notice delivered by the Borrower pursuant to this Section 2.08 shall be irrevocable, provided that a notice of termination of the Commitments delivered by the Borrower may state that such notice is conditioned upon the effectiveness of other credit facilities, in which case such notice may be revoked by the Borrower (by notice to the Administrative Agent on or prior to the specified effective date) if such condition is not satisfied. Any termination or reduction of the Commitments of any Class shall be permanent. Each reduction of the Revolving Commitments shall be made ratably among the Lenders in accordance with their respective Revolving Commitments. Each reduction of the Term Loan Commitments of any Class shall be made ratably among the Lenders in accordance with their respective Term Loan Commitments of that Class.SECTION 2.09 Repayment of Loans; Evidence of Debt. (a) The Borrower hereby unconditionally promises to pay (i) to the Administrative Agent for the account of each Lender the then unpaid principal amount of each Revolving Loan of such Lender on the Maturity Date applicable to Revolving Loans and (ii) to the Swingline Lender the then unpaid principal amount of each Swingline Loan on the earlier of the Maturity Date corresponding to Revolving Loans and the first date after such Swingline Loan is made that is the 15th or last day of a calendar month and is at least five Business Days after such Swingline Loan is made, provided that on each date that a Revolving Borrowing is made, the Borrower shall repay all Swingline Loans that were outstanding on the date such Borrowing was requested.484159-0944-0061.4(b) Each Lender shall maintain in accordance with its usual practice an account or accounts evidencing the indebtedness of the Borrower to such Lender resulting from each Loan made by such Lender, including the amounts of principal and interest payable and paid to such Lender from time to time hereunder.(c) The Administrative Agent shall maintain accounts in which it shall record (i) the amount of each Loan made hereunder, the Class and Type thereof and the Interest Period applicable thereto, (ii) the amount of any principal or interest due and payable or to become due and payable from the Borrower to each Lender hereunder and (iii) the amount of any sum received by the Administrative Agent hereunder for the account of the Lenders and each Lender’s share thereof, which accounts the Administrative Agent will make available to the Borrower upon its reasonable request.(d) The entries made in the accounts maintained pursuant to clause (b) or (c) of this Section 2.09 shall be prima facie evidence of the existence and amounts of the obligations recorded therein, provided that the failure of any Lender or the Administrative Agent to maintain such accounts or any error therein shall not in any manner affect the obligation of the Borrower to repay the Loans and pay interest thereon in accordance with the terms of this Agreement.(e) Any Lender may request that Loans of any Class made by it be evidenced by a promissory note. In such event, the Borrower shall prepare, execute and deliver to such Lender a Promissory Note payable to the order of such Lender (or, if requested by such Lender, to such Lender and its registered assigns). Thereafter, the Loans evidenced by such promissory note and interest thereon shall at all times (including after assignment pursuant to Section 9.04) be represented by one or more Promissory Notes payable to the order of the payee named therein (or, if such Promissory Note is a registered note, to such payee and its registered assigns).SECTION 2.10 Prepayment and Repayment of Loans(a) The Borrower shall have the right at any time and from time to time to prepay any Borrowing in whole or in part, without premium or penalty (but subject to Section 2.15), subject to the requirements of this Section 2.10.(b) In the event and on each occasion that the aggregate Revolving Exposures exceed the aggregate Revolving Commitments, the Borrower shall prepay Revolving Borrowings or Swingline Borrowings, or, if no such Borrowings are outstanding, deposit cash collateral in an account with the Administrative Agent pursuant to Section 2.05(j), in an aggregate amount equal to such excess.(c) Prior to any optional or mandatory prepayment of Borrowings hereunder, the Borrower shall select the Borrowing or Borrowings of the particular Class to be prepaid and shall specify such selection in the notice of such prepayment pursuant to clause (d) of this Section 2.10.(d) The Borrower shall notify the Administrative Agent (and, in the case of prepayment of a Swingline Loan, the Swingline Lenders) by telephone (confirmed by telecopy) of any prepayment hereunder (i) in the case of prepayment of a SOFR Borrowing, not later than 1:00 p.m., New York City time, three Business Days before the date of prepayment, (ii) in the case of prepayment of an ABR Borrowing, not later than 2:00 p.m., New York City time, one Business Day before the date of prepayment or (iii) in the case of prepayment of a Swingline Loan, not later than 2:00 p.m., New York City time, on the date of prepayment. Each such notice shall be irrevocable and shall specify the prepayment date and the principal amount of each Borrowing or portion thereof to be prepaid, provided that, if a notice of optional prepayment of any Loans is given in connection with a conditional notice of termination of the 494159-0944-0061.4Commitments as contemplated by Section 2.08 or in contemplation of the effectiveness of other credit facilities or other refinancing transaction, then such notice of prepayment may be revoked if such notice of termination is revoked in accordance with Section 2.08 or if the contemplated credit facilities or other refinancing transaction are not funded. Promptly following receipt of any such notice (other than a notice relating solely to Swingline Loans), the Administrative Agent shall advise the Lenders of the contents thereof. Each partial prepayment of any Borrowing shall be in an amount that would be permitted in the case of an advance of a Borrowing of the same Type as provided in Section 2.02, except as necessary to apply fully the required amount of a mandatory prepayment. Each prepayment of a portion of any Borrowing shall be applied ratably to the Loans included in the prepaid Borrowing. Prepayments shall be accompanied by accrued interest to the extent required by Section 2.12. (e) On each Quarterly Payment Date occurring during any period set forth below and on the Maturity Date, the Borrower shall make a scheduled repayment of the aggregate outstanding principal amount of Term Loan A1 in an amount equal to that set forth below opposite such Quarterly Payment Date or the Maturity Date in respect of Term Loan A1, as applicable:PeriodAmount of Required Principal RepaymentFifth Amendment Effective Date through (and including) 09/30/22$0.0012/31/22 through (and including) 09/30/24$7,500,000.0012/31/24 through (and including)06/30/25$11,250,000.00Maturity Date for Term Loan A1The then outstanding principal amount of Term Loan A1(f) On each Quarterly Payment Date occurring during any period set forth below and on the Maturity Date, the Borrower shall make a scheduled repayment of the aggregate outstanding principal amount of Term Loan A2 in an amount equal to that set forth below opposite such Quarterly Payment Date or the Maturity Date in respect of Term Loan A2, as applicable:504159-0944-0061.4PeriodAmount of Required Principal RepaymentFifth Amendment Effective Date through (and including) 09/30/22$0.0012/31/22 through (and including) 09/30/24$7,500,000.0012/31/24 through (and including)09/30/25$11,250,000.0012/31/25 through (and including)06/30/27$15,000,000.00Maturity Date for Term Loan A2The then outstanding principal amount of Term Loan A2(g) On each Quarterly Payment Date occurring during any period set forth below and on the Maturity Date, the Borrower shall make a scheduled repayment of the aggregate outstanding principal amount of Term Loan A3 in an amount equal to that set forth below opposite such Quarterly Payment Date or the Maturity Date in respect of Term Loan A3, as applicable:PeriodAmount of Required Principal Repayment12/31/22 through (and including) 06/30/23$7,500,000.0009/30/23 through (and including) 06/30/24$13,500,000.0009/30/24 through (and including)06/30/26$16,500,000.0009/30/26 through (and including)06/30/27$21,000,000.00Maturity Date for Term Loan A3The then outstanding principal amount of Term Loan A3514159-0944-0061.4SECTION 2.11 Fees. (a) The Borrower agrees to pay to the Administrative Agent for the account of each Revolving Loan Lender a commitment fee, which shall accrue at the applicable Commitment Fee Rate set forth in the definition of Applicable Margin on the average daily unused amount of the applicable Revolving Commitment of such Lender during the period from and including the Effective Date to but excluding the date on which such Revolving Commitment terminates or expires. Accrued commitment fees shall be payable in arrears on the third Business Day following the last day of March, June, September and December of each year and on the date on which the applicable Revolving Commitments terminate, commencing on the first such date to occur after the date hereof. All commitment fees shall be computed on the basis of a year of 360 days and shall be payable for the actual number of days elapsed (including the first day but excluding the last day). For purposes of computing commitment fees, a Revolving Commitment of a Lender shall be deemed to be used to the extent of the outstanding Revolving Loans and LC Exposure of such Lender (and the Swingline Exposure of such Lender shall be disregarded for such purpose).(b) The Borrower agrees to pay (i) to the Administrative Agent for the account of each Revolving Loan Lender a participation fee with respect to its participations in Letters of Credit, which shall accrue at the same Applicable Margin used to determine the interest rate applicable to SOFR Loans of Revolving Loans to which such Lender has a Revolving Commitment on the average daily amount of such Lender’s LC Exposure (excluding any portion thereof attributable to unreimbursed LC Disbursements) during the period from and including the Effective Date to but excluding the later of the date on which such Lender’s Revolving Commitment terminates and the date on which such Lender ceases to have any LC Exposure, and (ii) to each Issuing Bank a fronting fee, which shall accrue at the rate or rates per annum separately agreed upon between the Borrower and such Issuing Bank on the average daily amount of the LC Exposure (excluding any portion thereof attributable to unreimbursed LC Disbursements) attributable to Letters of Credit issued by such Issuing Bank during the period from and including the Effective Date to but excluding the later of the date of termination of the Revolving Commitments and the date on which there ceases to be any LC Exposure, as well as such Issuing Bank’s standard fees with respect to the issuance, amendment, renewal or extension of any Letter of Credit or processing of drawings thereunder. Participation fees and fronting fees accrued through and including the last day of March, June, September and December of each year shall be payable on the third Business Day following such last day, commencing on the first such date to occur after the Effective Date, provided that all such fees shall be payable on the date on which any Revolving Commitments terminate and any such fees accruing after such date on which Revolving Commitments terminate shall be payable on demand. Any other fees payable to any Issuing Bank pursuant to this clause shall be payable within 10 days after demand. All participation fees and fronting fees shall be computed on the basis of a year of 360 days and shall be payable for the actual number of days elapsed (including the first day but excluding the last day). For purposes of computing the average daily amount of the Revolving Exposure for Revolving Commitments for any period under this Section 2.11(b), the average daily amount of the Alternative Currency LC Exposure for such period shall be calculated by multiplying (x) the average daily balance of each Alternative Currency Letter of Credit (expressed in the currency in which such Alternative Currency Letter of Credit or Loans are denominated) by (y) the Exchange Rate for each such Alternative Currency in effect on the last Business Day of such period or by such other reasonable method that the Administrative Agent deems appropriate.524159-0944-0061.4(c) The Borrower agrees to pay to the Administrative Agent, for its own account, fees payable in the amounts and at the times separately agreed upon in the Fee Letter between the Borrower and the Administrative Agent.(d) All fees payable hereunder shall be paid on the dates due, in immediately available funds in dollars, to the Administrative Agent (or to the Issuing Bank, in the case of fees payable to it) for distribution, in the case of commitment fees and participation fees, to the Lenders entitled thereto. Fees paid shall not be refundable under any circumstances.SECTION 2.12 Interest. (a) The Loans comprising each ABR Borrowing (including each Swingline Loan) shall bear interest at the Alternate Base Rate plus the Applicable Margin.(b) The Loans comprising each SOFR Borrowing shall bear interest at the Adjusted Term SOFR for the Interest Period in effect for such Borrowing plus the Applicable Margin. (c) Notwithstanding the foregoing, if any principal of or interest on any Loan or any fee or other amount payable by the Borrower hereunder is not paid when due, whether at stated maturity, upon acceleration or otherwise, such overdue amount shall bear interest, after as well as before judgment, to the fullest extent permitted by applicable law, at a rate per annum equal to (i) in the case of overdue principal of any Loan, 2.00% plus the rate otherwise applicable to such Loan as provided in the preceding clauses of this Section 2.12 or (ii) in the case of any other amount, 2.00% plus the rate applicable to ABR Loans as provided in clause (a) of this Section 2.12.(d) Accrued interest on each Loan shall be payable in arrears (i) on each Interest Payment Date for such Loan and (ii) in the case of Revolving Loans, upon termination of the Revolving Commitments, provided that (A) interest accrued pursuant to clause (d) of this Section 2.12 shall be payable on demand, (B) in the event of any repayment or prepayment of any Loan (other than a prepayment of an ABR Revolving Loan prior to the end of the applicable Availability Period), accrued interest on the principal amount repaid or prepaid shall be payable on the date of such repayment or prepayment and (C) in the event of any conversion of any SOFR Loan prior to the end of the current Interest Period therefor, accrued interest on such Loan shall be payable on the effective date of such conversion.(e) All interest hereunder shall be computed on the basis of a year of 360 days, except that interest computed by reference to the Alternate Base Rate at times when the Alternate Base Rate is based on the Base Rate shall be computed on the basis of a year of 365 days (or 366 days in a leap year), and in each case shall be payable for the actual number of days elapsed (including the first day but excluding the last day). The applicable Alternate Base Rate or Adjusted Term SOFR shall be determined by the Administrative Agent in accordance with the terms hereof, and such determination shall be prima facie evidence thereof.SECTION 2.13 Inability to Determine Rates. Subject to Section 2.24, if, on or prior to the first day of any Interest Period for any SOFR Loan:(a) the Administrative Agent determines (which determination shall be conclusive and binding absent manifest error) that “Adjusted Term SOFR” cannot be determined pursuant to the definition thereof, or534159-0944-0061.4(b) the Required Lenders determine that for any reason in connection with any request for a SOFR Loan or a conversion thereto or a continuation thereof that Adjusted Term SOFR for any requested Interest Period with respect to a proposed SOFR Loan does not adequately and fairly reflect the cost to such Lenders of making and maintaining such Loan, and the Required Lenders have provided notice of such determination to the Administrative Agent,then, in each case, the Administrative Agent will promptly so notify the Borrower and each Lender.Upon notice thereof by the Administrative Agent to the Borrower, any obligation of the Lenders to make SOFR Loans, and any right of the Borrower to continue SOFR Loans or to convert ABR Loans to SOFR Loans, shall be suspended (to the extent of the affected SOFR Loans or affected Interest Periods) until the Administrative Agent (with respect to clause (b), at the instruction of the Required Lenders) revokes such notice. Upon receipt of such notice, (i) the Borrower may revoke any pending request for a borrowing of, conversion to or continuation of SOFR Loans (to the extent of the affected SOFR Loans or affected Interest Periods) or, failing that, the Borrower will be deemed to have converted any such request into a request for a Borrowing of or conversion to ABR Loans in the amount specified therein and (ii) any outstanding affected SOFR Loans will be deemed to have been converted into ABR Loans at the end of the applicable Interest Period. Upon any such conversion, the Borrower shall also pay accrued interest on the amount so converted, together with any additional amounts required pursuant to Section 2.16. Subject to Section 2.24, if the Administrative Agent determines (which determination shall be conclusive and binding absent manifest error) that “Adjusted Term SOFR” cannot be determined pursuant to the definition thereof on any given day, the interest rate on ABR Loans shall be determined by the Administrative Agent without reference to clause (c) of the definition of “Alternate Base Rate” until the Administrative Agent revokes such determination.SECTION 2.14 Increased Costs. (a) If any Change in Law shall:(i) impose, modify or deem applicable any reserve, special deposit, compulsory loan, insurance charge or similar requirement against assets of, deposits with or for the account of, or credit extended by, any Lender or the Issuing Bank; (ii) subject any Recipient to any Taxes (other than (A) Indemnified Taxes, (B) Taxes described in clauses (b) through (d) of the definition of Excluded Taxes and (C) Connection Income Taxes) on its loans, loan principal, letters of credit, commitments, or other obligations, or its deposits, reserves, other liabilities or capital attributable thereto; or(iii) impose on any Lender or any Issuing Bank any other condition, cost or expense affecting this Agreement or Loans made by such Lender or any Letter of Credit or participation therein; and the result of any of the foregoing shall be to increase the cost to such Lender of making or maintaining any Loan (or of maintaining its obligation to make any such Loan) or to increase the cost to such Lender or such Issuing Bank of participating in, issuing or maintaining any Letter of Credit or to reduce the amount of any sum received or receivable by such Lender or such Issuing Bank hereunder (whether of principal, interest or otherwise), then the Borrower will pay to such Lender or such Issuing Bank, as the case may be, such additional amount or amounts as will compensate such Lender or such Issuing Bank, as the case may be, for such additional costs incurred or reduction suffered.(b) If any Change in Law regarding capital requirements or liquidity requirements has or would have the effect of reducing the rate of return on any Lender’s or any Issuing Bank’s capital or on the capital of such Lender’s or such Issuing Bank’s holding company, if any, as a 544159-0944-0061.4consequence of this Agreement or the Loans made by, or participations in Letters of Credit held by, such Lender, or the Letters of Credit issued by such Issuing Bank, to a level below that which such Lender or such Issuing Bank or such Lender’s or such Issuing Bank’s holding company could have achieved but for such Change in Law (taking into consideration such Lender’s or such Issuing Bank’s policies and the policies of such Lender’s or such Issuing Bank’s holding company with respect to capital adequacy), then from time to time the Borrower will pay to such Lender or such Issuing Bank, as the case may be, such additional amount or amounts as will compensate such Lender or such Issuing Bank or such Lender’s or such Issuing Bank’s holding company for any such reduction suffered; provided that to the extent any increased costs or reductions are incurred by any Lender as a result of any requests, rules, guidelines, or directives promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act or pursuant to Basel III after the Effective Date, then such Lender shall be compensated pursuant to clauses (a) and (b) only if such Lender imposes such charges under other syndicated credit facilities involving similarly situated borrowers.(c) A certificate of a Lender or an Issuing Bank setting forth the amount or amounts necessary to compensate such Lender or such Issuing Bank or its holding company, as the case may be, as specified in clause (a) or (b) of this Section 2.14, and setting forth in reasonable detail the basis on which such amount or amounts were calculated and stating that such calculation has been made in a manner consistent with the treatment given by such Lender or Issuing Bank to similar businesses in similar circumstances, shall be delivered to the Borrower and shall be prima facie evidence thereof. The Borrower shall pay such Lender or such Issuing Bank, as the case may be, the amount shown as due on any such certificate within 15 days after receipt thereof.(d) Failure or delay on the part of any Lender or any Issuing Bank to demand compensation pursuant to this Section 2.14 shall not constitute a waiver of such Lender’s or such Issuing Bank’s right to demand such compensation, provided that the Borrower shall not be required to compensate a Lender or an Issuing Bank pursuant to this Section 2.14 for any increased costs or reductions incurred more than 180 days prior to the date that such Lender or such Issuing Bank, as the case may be, notifies the Borrower of the Change in Law giving rise to such increased costs or reductions and of such Lender’s or such Issuing Bank’s intention to claim compensation therefor; and provided further that, if the Change in Law giving rise to such increased costs or reductions is retroactive, then the 180-day period referred to above shall be extended to include the period of retroactive effect thereof.SECTION 2.15 Break Funding Payments. In the event of (a) the payment of any principal of any SOFR Loan other than on the last day of an Interest Period applicable thereto (including as a result of an Event of Default), (b) the conversion of any SOFR Loan other than on the last day of the Interest Period applicable thereto, (c) the failure to borrow, convert, continue or prepay any SOFR Loan on the date specified in any notice delivered pursuant hereto (regardless of whether such notice may be revoked under Section 2.10(d) and is revoked in accordance therewith) or (d) the assignment of any SOFR Loan other than on the last day of the Interest Period applicable thereto as a result of a request by the Borrower pursuant to Section 2.18, then, in any such event, the Borrower shall compensate each applicable Lender for the loss (other than lost profits), cost and expense attributable to such event. In the case of a SOFR Loan, such loss, cost or expense to any Lender shall be deemed to include an amount reasonably determined by such Lender to be the excess, if any, of (i) the amount of interest that would have accrued on the principal amount of such Loan had such event not occurred, at the Adjusted Term SOFR that would have been applicable to such Loan, for the period from the date of such event to the last day of the then current Interest Period therefor (or, in the case of a failure to borrow, convert or continue, for the period that would have been the Interest Period for such Loan), over (ii) the amount of interest that would accrue on such principal amount for such period at the interest rate that such Lender would bid were it to bid, at the commencement of such period, for dollar deposits of a comparable amount and period from other banks in the market. A certificate 554159-0944-0061.4of any Lender setting forth any amount or amounts that such Lender is entitled to receive pursuant to this Section 2.15, and setting forth in reasonable detail the basis on which such amount or amounts were calculated, shall be delivered to the Borrower and shall be prima facie evidence thereof. The Borrower shall pay such Lender the amount shown as due on any such certificate within 15 days after receipt thereof.SECTION 2.16 Taxes. (a) Any and all payments by or on account of any obligation of the Borrower under any Loan Document shall be made free and clear of and without deduction or withholding for any Taxes, except as required by applicable law; provided that if the Borrower shall be required to deduct any Taxes from such payments, then the Borrower shall make such deductions and pay the full amount deducted to the relevant Governmental Authority in accordance with applicable law and, if any such Tax is an Indemnified Tax, then the sum payable shall be increased as necessary so that after making all required deductions or withholdings (including deductions or withholdings applicable to additional sums payable under this Section 2.16) the Administrative Agent, Lender or Issuing Bank (as the case may be) receives an amount equal to the sum it would have received had no such deductions or withholdings been made.(b) In addition, the Borrower shall pay, or at the option of the Administrative Agent timely reimburse it for the payment of, any Other Taxes to the relevant Governmental Authority in accordance with applicable law.(c) The Borrower shall indemnify the Administrative Agent, each Lender and each Issuing Bank, within 10 days after written demand therefor, for the full amount of any Indemnified Taxes payable or paid or required to be withheld or deducted from a payment by the Administrative Agent, such Lender or such Issuing Bank, as the case may be, on or with respect to any payment by or on account of any obligation of the Borrower under any Loan Document (including Indemnified Taxes imposed or asserted on or attributable to amounts payable under this Section 2.16) and any reasonable expenses arising therefrom or with respect thereto, whether or not such Indemnified Taxes were correctly or legally imposed or asserted by the relevant Governmental Authority. A certificate as to the amount of such payment or liability delivered to the Borrower by a Lender or an Issuing Bank, or by the Administrative Agent on its own behalf or on behalf of a Lender or an Issuing Bank, containing a reasonably detailed description of such payment or liability shall be conclusive absent manifest error.(d) As soon as practicable after any payment of Taxes by the Borrower to a Governmental Authority, the Borrower shall deliver to the Administrative Agent the original or a certified copy of a receipt issued by such Governmental Authority evidencing such payment, a copy of the return reporting such payment or other evidence of such payment reasonably satisfactory to the Administrative Agent.(e) Each Lender shall severally indemnify the Administrative Agent, within 10 days after written demand therefor, for (i) any Indemnified Taxes attributable to such Lender (but only to the extent that the Borrower has not already indemnified the Administrative Agent for such Indemnified Taxes and without limiting the obligation of the Borrower to do so), (ii) any Taxes attributable to such Lender’s failure to comply with the provisions of Section 9.04(h) relating to the maintenance of a Participant Register and (iii) the full amount of any Excluded Taxes (and any related penalties, interest or expense) paid by the Administrative Agent or any Issuing Bank, as the case may be, on or with respect to any payment to or for the account of such Lender by or on account of any obligation of any Loan Party under any Loan Document, whether or not such Excluded Taxes were correctly or legally imposed or asserted by the relevant Governmental Authority. A certificate as to the amount of such payment or liability delivered to any Lender by 564159-0944-0061.4any Issuing Bank or by the Administrative Agent on its own behalf or on behalf of any Issuing Bank shall be conclusive absent manifest error.(f) Any Lender (or Participant) that is entitled to an exemption from or reduction of withholding tax under the law of the jurisdiction in which the Borrower is located, or under any treaty to which such jurisdiction is a party, with respect to payments under this Agreement shall deliver to the Borrower (with a copy to the Administrative Agent) (or, in the case of a Participant, to the Lender from which the related participation was purchased), at the time or times requested by the Borrower, such properly completed and executed documentation prescribed by applicable law or reasonably requested by the Borrower as will permit such payments to be made without withholding or at a reduced rate. In addition, each Lender (or Participant) shall deliver substitute forms promptly upon the obsolescence or invalidity of any form previously delivered by such Lender (or Participant). In addition, any Lender, if reasonably requested by the Borrower or the Administrative Agent, shall deliver such other documentation prescribed by applicable law or reasonably requested by the Borrower or the Administrative Agent as will enable the Borrower or the Administrative Agent to determine whether or not such Lender is subject to backup withholding or information reporting requirements. Notwithstanding anything to the contrary in the preceding three sentences, the completion, execution and submission of such documentation shall not be required if in the Lender’s (or Participant’s) reasonable judgment such completion, execution or submission would subject such Lender (or Participant) to any material unreimbursed cost or expense or would materially prejudice the legal or commercial position of such Lender (or Participant).(g) If the Administrative Agent, a Lender or an Issuing Bank determines, in its sole discretion, that it has received a refund of any Taxes as to which it has been indemnified by the Borrower or with respect to which the Borrower has paid additional amounts pursuant to this Section 2.16, which the Administrative Agent, such Lender or such Issuing Bank is able to identify as such, it shall pay over such refund to the Borrower (but only to the extent of indemnity payments made, or additional amounts paid, by the Borrower under this Section 2.16 with respect to the Taxes giving rise to such refund), net of all reasonable out-of-pocket expenses of the Administrative Agent, such Lender or such Issuing Bank and without interest (other than any interest paid by the relevant Governmental Authority with respect to such refund), provided, however, that the Borrower, upon the request of the Administrative Agent, such Lender or such Issuing Bank, agrees to repay the amount paid over to the Borrower (plus any penalties, interest or other charges imposed by the relevant Governmental Authority) to the Administrative Agent, such Lender or such Issuing Bank in the event the Administrative Agent, such Lender or such Issuing Bank is required to repay such refund to such Governmental Authority. Notwithstanding anything to the contrary in this paragraph (g), in no event will the Administrative Agent, Lender, or Issuing Bank be required to pay any amount to a Borrower pursuant to this paragraph (g) the payment of which would place the Administrative Agent, Lender, or Issuing Bank in a less favorable net after-Tax position than the Administrative Agent, Lender, or Issuing Bank would have been in if the Tax subject to indemnification and giving rise to such refund had not been deducted, withheld or otherwise imposed and the indemnification payments or additional amounts with respect to such Tax had never been paid. Nothing contained in this clause shall require the Administrative Agent, any Lender or any Issuing Bank to make available its tax returns (or any other information relating to its Taxes that it deems confidential) to the Borrower or any other Person.(h) If a payment made to a Lender under any Loan Document would be subject to U.S. federal withholding Tax imposed by FATCA if such Lender were to fail to comply with the applicable reporting requirements of FATCA (including those contained in Section 1471(b) or 1472(b) of the Code, as applicable), such Lender shall deliver to the Borrower and the Administrative Agent at the time or times prescribed by law and at such time or times reasonably requested by the Borrower or the Administrative Agent such documentation prescribed by 574159-0944-0061.4applicable law (including as prescribed by Section 1471(b)(3)(C)(i) of the Code), and such additional documentation reasonably requested by the Borrower or the Administrative Agent, as may be necessary for the Borrower and the Administrative Agent to comply with their obligations under FATCA, to determine that such Lender has complied with such Lender’s obligations under FATCA and to determine the amount to deduct and withhold from such payment. Solely for purposes of this clause, “FATCA” shall include any amendments made to FATCA after the date of this Credit Agreement. Each Lender agrees that if any form or certification it previously delivered expires or becomes obsolete or inaccurate in any respect, it shall update such form or certification or promptly notify the Borrower and the Administrative Agent in writing of its legal inability to do so. (i) Each party’s obligations under this Section 2.16 shall survive the resignation or replacement of the Administrative Agent or any assignment of rights by, or the replacement of, a Lender, the termination of the Commitments and the repayment, satisfaction or discharge of all obligations under any Loan Document.SECTION 2.17 Payments Generally; Pro Rata Treatment; Sharing of Set-offs. (a) The Borrower shall make each payment required to be made by it hereunder or under any other Loan Document (whether of principal, interest, fees or reimbursement of LC Disbursements, or of amounts payable under Section 2.14, Section 2.15 or Section 2.16, or otherwise) prior to the time expressly required hereunder or under such other Loan Document for such payment (or, if no such time is expressly required, prior to 2:00 p.m., New York City time), on the date when due, in immediately available funds, without set-off or counterclaim. Any amounts received after such time on any date may, in the discretion of the Administrative Agent, be deemed to have been received on the next succeeding Business Day for purposes of calculating interest thereon. All such payments shall be made to the Administrative Agent at its offices at The Bank of Nova Scotia, GWS Loan Operations, 720 King Street West, 2nd Floor, Toronto, Ontario, M5V 2T3, Attn: U.S. Agency Loan Operations, except payments to be made directly to any Issuing Bank or any Swingline Lender as expressly provided herein and except that payments pursuant to Section 2.14, Section 2.15, Section 2.16 and Section 9.03 shall be made directly to the Persons entitled thereto and payments pursuant to any other Loan Documents shall be made to the Persons specified therein. The Administrative Agent shall distribute any such payments received by it for the account of any other Person to the appropriate recipient promptly following receipt thereof. If any payment under any Loan Document shall be due on a day that is not a Business Day, the date for payment shall be extended to the next succeeding Business Day, and, in the case of any payment accruing interest, interest thereon shall be payable for the period of such extension. Except as provided in Section 2.05(e), all payments under each Loan Document shall be made in dollars.(b) If at any time insufficient funds are received by and available to the Administrative Agent to pay fully all amounts of principal, unreimbursed LC Disbursements, interest and fees then due hereunder (including if any amounts are received as a result of the exercise of remedies under the Loan Documents) such funds shall be applied (i) first to the payment of all Obligations owing to the Administrative Agent, in its capacity as the Administrative Agent (including the fees and expenses of counsel to the Administrative Agent), (ii) second, towards payment of interest (including interest accruing after the commencement of a proceeding in bankruptcy, insolvency or similar law, whether or not permitted as a claim under such law), fees and expenses then due hereunder or another Loan Document, ratably among the parties entitled thereto in accordance with the amounts of interest, fees and expenses then due to such parties, (iii) third, towards payment of principal of Loans and unreimbursed LC Disbursements then due hereunder, to the cash collateralization for contingent liabilities under Letters of Credit outstanding and to amounts owing under Cash Management Obligations, Swap Obligations and Platinum Lease Obligations, ratably among the parties entitled thereto in 584159-0944-0061.4accordance with the amounts of principal of Loans, unreimbursed LC Disbursements and contingent liabilities under Letters of Credit, and amounts owing under Cash Management Obligations, Swap Obligations and Platinum Lease Obligations then due to such parties, and (iv) fourth, towards the payment of all other Obligations then due and owing to the Finance Parties, ratably among the Persons entitled thereto in accordance with the amount of other Obligations then due to such Persons. (c) If any Lender shall, by exercising any right of set-off or counterclaim or otherwise, obtain payment in respect of any principal of or interest on any of its Loans or participations in LC Disbursements or Swingline Loans resulting in such Lender receiving payment of a greater proportion of the aggregate amount of its Loans and participations in LC Disbursements and Swingline Loans and accrued interest thereon than the proportion received by any other Lender, then the Lender receiving such greater proportion shall purchase (for cash at face value) participations in the Loans and participations in LC Disbursements and Swingline Loans of other Lenders to the extent necessary so that the benefit of all such payments shall be shared by the Lenders ratably in accordance with the aggregate amount of principal of and accrued interest on their respective Loans and participations in LC Disbursements and Swingline Loans, provided that (i) if any such participations are purchased and all or any portion of the payment giving rise thereto is recovered, such participations shall be rescinded and the purchase price restored to the extent of such recovery, without interest, and (ii) the provisions of this clause shall not be construed to apply to any payment made by the Borrower pursuant to and in accordance with the express terms of this Agreement or any payment obtained by a Lender as consideration for the assignment of or sale of a participation in any of its Loans or participations in LC Disbursements to any assignee or participant, other than to the Borrower or any Subsidiary or Affiliate thereof (as to which the provisions of this clause shall apply). The Borrower consents to the foregoing and agrees, to the extent it may effectively do so under applicable law, that any Lender acquiring a participation pursuant to the foregoing arrangements may exercise against the Borrower rights of set-off and counterclaim with respect to such participation as fully as if such Lender were a direct creditor of the Borrower in the amount of such participation. Notwithstanding the foregoing, no amounts set off with respect to any Guarantor shall be applied to any Excluded Swap Obligations of such Guarantor. (d) Unless the Administrative Agent shall have received notice from the Borrower prior to the date on which any payment is due to the Administrative Agent for the account of the Lenders or an Issuing Bank hereunder that the Borrower will not make such payment, the Administrative Agent may assume that the Borrower has made such payment on such date in accordance herewith and may, in reliance upon such assumption, distribute to the Lenders or the Issuing Banks, as the case may be, the amount due. In such event, if the Borrower has not in fact made such payment, then each of the Lenders or the Issuing Banks, as the case may be, severally agrees to repay to the Administrative Agent forthwith on demand the amount so distributed to such Lender or Issuing Bank with interest thereon, for each day from and including the date such amount is distributed to it to but excluding the date of payment to the Administrative Agent, at the greater of the Federal Funds Effective Rate and a rate determined by the Administrative Agent in accordance with banking industry rules on interbank compensation.(e) If any Lender shall fail to make any payment required to be made by it pursuant to Section 2.04(c), Section 2.05(d), Section 2.05(e), Section 2.06(b), Section 2.17(d) or Section 9.03(c), then the Administrative Agent may, in its discretion (notwithstanding any contrary provision hereof), apply any amounts thereafter received by the Administrative Agent for the account of such Lender to satisfy such Lender’s obligations under such Sections until all such unsatisfied obligations are fully paid.SECTION 2.18 Mitigation Obligations; Replacement of Lenders. 594159-0944-0061.4(a) If any Lender requests compensation under Section 2.14, or if the Borrower is required to pay any additional amount to any Lender or any Governmental Authority for the account of any Lender pursuant to Section 2.16, then such Lender shall use reasonable efforts to designate a different lending office for funding or booking its Loans hereunder or to assign its rights and obligations hereunder to another of its offices, branches or affiliates, if, in the reasonable judgment of such Lender, such designation or assignment (i) would eliminate or reduce amounts payable pursuant to Section 2.14 or 2.16, as the case may be, in the future and (ii) would not subject such Lender to any unreimbursed cost or expense and would not otherwise be disadvantageous to such Lender. The Borrower hereby agrees to pay all reasonable costs and expenses incurred by any Lender in connection with any such designation or assignment.(b) If any Lender requests compensation under Section 2.14, or if the Borrower is required to pay any additional amount to any Lender or any Governmental Authority for the account of any Lender pursuant to Section 2.16, or if any Lender becomes a Defaulting Lender, then the Borrower may, at its sole expense and effort, upon notice to such Lender and the Administrative Agent, require such Lender to assign and delegate, without recourse (in accordance with and subject to the restrictions contained in Section 9.04), all its interests, rights and obligations under this Agreement to an assignee that shall assume such obligations (which assignee may be another Lender, if a Lender accepts such assignment), provided that (i) the Borrower shall have received the prior written consent of the Administrative Agent, each Swingline Lender and each Issuing Bank (which consent (x) shall not be unreasonably withheld or delayed and (y) in the case of any consent required by any Issuing Bank, shall be deemed to have been given in the event that such Issuing Bank fails to respond in writing to a request for written consent within two Business Days of receipt thereof), (ii) such Lender shall have received payment of an amount equal to the outstanding principal of its Loans and participations in LC Disbursements and Swingline Loans, accrued interest thereon, accrued fees and all other amounts payable to it hereunder, from the assignee (to the extent of such outstanding principal and accrued interest and fees) or the Borrower (in the case of all other amounts) and (iii) in the case of any such assignment resulting from a claim for compensation under Section 2.14 or payments required to be made pursuant to Section 2.16, such assignment will result in a material reduction in such compensation or payments. A Lender shall not be required to make any such assignment and delegation if, prior thereto, as a result of a waiver by such Lender or otherwise, the circumstances entitling the Borrower to require such assignment and delegation cease to apply. Nothing in this Section 2.18 shall be deemed to prejudice any rights that the Borrower may have against any Lender as a result of any default by any such Lender in its obligations to fund Loans hereunder.SECTION 2.19 Change in Law. Notwithstanding any other provision of this Agreement, if, after the date hereof, (i) any Change in Law shall make it unlawful for any Issuing Bank to issue Letters of Credit denominated in an Alternative Currency, or (ii) there shall have occurred any change in national or international financial, political or economic conditions (including the imposition of or any change in exchange controls) or currency exchange rates that would make it impracticable for any Issuing Bank to issue Letters of Credit denominated in such Alternative Currency for the account of the Borrower, then by prompt written notice thereof to the Borrower and to the Administrative Agent (which notice shall be withdrawn whenever such circumstances no longer exist), such Issuing Bank may declare that Letters of Credit will not thereafter be issued by it in the affected Alternative Currency or Alternative Currencies, whereupon the affected Alternative Currency or Alternative Currencies shall be deemed (for the duration of such declaration) not to constitute an Alternative Currency for purposes of the issuance of Letters of Credit by such Issuing Bank.SECTION 2.20 [RESERVED].SECTION 2.21 Incremental Loans.604159-0944-0061.4(a) Other than during the Covenant Relief Period, from time to time during the Availability Period, subject to the terms and conditions set forth herein, the Borrower may, by notice to the Administrative Agent (whereupon the Administrative Agent shall promptly deliver a copy to each of the Lenders), elect to request the establishment of:(i) one or more incremental term loan commitments (any such incremental term loan commitment, an “Incremental Term Loan Commitment”) to make one or more additional term loans (any such additional term loan, an “Incremental Term Loan”); or(ii) one or more increases in the Revolving Loan Commitments (any such increase, an “Incremental Revolving Loan Commitment” and, together with the Incremental Term Loan Commitments, the “Incremental Loan Commitments”) to make revolving loans under the Revolving Loan Facility (any such increase, an “Incremental Revolving Loan Increase” and, together with the Incremental Term Loans, the “Incremental Loans”);provided that (i) the Borrower may not request any Incremental Loan Commitments or Incremental Loans during the Covenant Relief Period and (ii) at the time of each such request and upon the effectiveness of each Incremental Amendment, (A) no Default has occurred and is continuing or shall result therefrom and (B) the Borrower shall have delivered a certificate of a Financial Officer to the effect set forth in clause (A) above. Notwithstanding anything to the contrary herein, (1) the total aggregate principal amount for all such Incremental Loan Commitments shall not (as of any date of incurrence thereof) exceed $100,000,000 and (2) the total aggregate amount for each Incremental Loan Commitment (and the Incremental Loans made thereunder) shall not be less than a minimum principal amount of $10,000,000 or, if less, the remaining amount permitted pursuant to the foregoing clause (1). (b) Each notice from the Borrower pursuant to this Section 2.21 shall set forth the requested amount of the relevant Incremental Loan Commitment. Any additional bank, financial institution, existing Lender or other Person that elects to provide a portion of any Incremental Loan Commitment shall be reasonably satisfactory to the Borrower, the Administrative Agent, and with respect to Incremental Revolving Loan Commitments, each Swingline Lender and each Issuing Bank (any such bank, financial institution, existing Lender or other Person being called an “Incremental Lender”) and, if not already a Lender, shall become a Lender under this Agreement pursuant to an Incremental Amendment. Each Incremental Loan Commitment shall be effected by an amendment (an “Incremental Amendment”) to this Agreement and, as appropriate, the other Loan Documents, executed by STX, the Borrower, such Incremental Lender and the Administrative Agent. No Lender shall be obligated to provide any Incremental Loan Commitment, unless it so agrees. (c) Commitments in respect of any (i) Incremental Revolving Loan Commitment shall become Revolving Commitments (or in the case of any Incremental Revolving Loan Commitment to be provided by an existing Lender, an increase in such Lender’s Revolving Commitment) under this Agreement and (ii) Incremental Term Loan Commitment shall be a Term Loan Commitment (and a separate facility under this Agreement). An Incremental Amendment may, without the consent of any other Lenders, effect such amendments to any Loan Documents as may be necessary or appropriate, in the opinion of the Administrative Agent, to effect the provisions of this Section 2.21. The effectiveness of any Incremental Amendment shall, unless otherwise agreed to by the Administrative Agent and the Incremental Lenders, be subject to the satisfaction on the date thereof (each, an “Incremental Closing Date”) of each of the conditions set forth in Section 4.02 (it being understood that all references to “the date of such Borrowing” in Section 4.02 shall be deemed to refer to the Incremental Closing Date). The proceeds of any Incremental Loans made pursuant to Incremental Loan Commitments will be 614159-0944-0061.4used only for working capital and other general corporate purposes of the Borrower and its subsidiaries.(d) Upon each Incremental Revolving Loan Increase pursuant to this Section 2.21, (i) each Lender immediately prior to such increase will automatically and without further act be deemed to have assigned to each Incremental Lender, and each Incremental Lender will automatically and without further act be deemed to have assumed, a portion of such Lender’s participations hereunder in outstanding Letters of Credit and Swingline Loans such that, after giving effect to such Incremental Revolving Loan Increase and each such deemed assignment and assumption of participations, the percentage of the aggregate outstanding (A) participations hereunder in Letters of Credit and (B) participations hereunder in Swingline Loans held by each Lender (including each Incremental Lender) will equal such Lender’s Applicable Percentage and (ii) if, on the date of such Incremental Revolving Loan Increase, there are any Revolving Loans outstanding, such Revolving Loans shall be prepaid from the proceeds of additional Revolving Loans made hereunder (reflecting such Incremental Revolving Loan Increase), which prepayment shall be accompanied by accrued interest on the Revolving Loans being prepaid and any costs incurred by any Lender in accordance with Section 2.15. The Administrative Agent and the Lenders hereby agree that the minimum borrowing, pro rata borrowing and pro rata payment requirements contained elsewhere in this Agreement shall not apply to the transactions effected pursuant to the immediately preceding sentence.SECTION 2.2 Defaulting Lenders(a) If a Lender becomes, and during the period it remains, a Defaulting Lender, the following provisions shall apply, notwithstanding anything to the contrary in this Agreement:(i) the applicable LC Exposure(s) and applicable Swingline Exposure(s) of such Defaulting Lender will, subject to the limitation in the first proviso below, automatically be reallocated (effective on the day such Lender becomes a Defaulting Lender) among the Non-Defaulting Lenders pro rata in accordance with their respective Applicable Percentages, provided that (a) no Default or Event of Default has occurred and is continuing, (b) the sum of each Non-Defaulting Lender’s total Revolving Exposure may not in any event exceed the Revolving Commitment of such Non-Defaulting Lender as in effect at the time of such reallocation and (c) neither such reallocation nor any payment by a Non-Defaulting Lender pursuant thereto will constitute a waiver or release of any claim the Borrower, the Administrative Agent, any Issuing Bank, any Swingline Lender or any other Lender may have against such Defaulting Lender or cause such Defaulting Lender to be a Non-Defaulting Lender;(ii) to the extent that any portion (the “unreallocated portion”) of the LC Exposure and Swingline Exposure of any Defaulting Lender cannot be so reallocated for any reason, the Borrower will, not later than two Business Days after demand by the Administrative Agent (at the direction of any Issuing Bank or any Swingline Lender), (a) Cash Collateralize the obligations of the Borrower to such Issuing Bank or Swingline Lender in respect of such LC Exposure or Swingline Exposure, as the case may be, in an amount equal to the aggregate amount of the unreallocated portion of the LC Exposure and Swingline Exposure of such Defaulting Lender, or (b) in the case of such Swingline Loan exposure, prepay (subject to clause (v) below) and/or Cash Collateralize in full the unreallocated portion thereof, or (c) make other arrangements satisfactory to the Administrative Agent, the applicable Issuing Bank or the applicable Swingline Lender in their sole discretion to protect them against the risk of non-payment by such Defaulting Lender; (iii) in addition to the other conditions precedent set forth in this Section, no Issuing Bank will be required to issue, amend or increase any Letter of Credit, and no Swingline Lender will be required to make any Swingline Loans, unless they are satisfied that 100% of the 624159-0944-0061.4related LC Exposure and Swingline Exposure is fully covered or eliminated by any combination satisfactory to the Issuing Banks and the Swingline Lenders, as the case may be, of the following:(A) the LC Exposure and Swingline Exposure of such Defaulting Lender is reallocated, as to outstanding and future Letters of Credit and Swingline Loans, to the Non-Defaulting Lenders as provided in clause (a)(i) above; and(B) without limiting the provisions of clause (a)(ii) above, the Borrower Cash Collateralizes the obligations of the Borrower in respect of such Letters of Credit or Swingline Loans in an amount at least equal to the aggregate amount of the unreallocated obligations (contingent or otherwise) of such Defaulting Lender in respect of such Letters of Credit or Swingline Loans, or the Borrower makes other arrangements satisfactory to the Administrative Agent and the applicable Issuing Bank or the applicable Swingline Lender, as the case may be, in their sole discretion, to protect them against the risk of non-payment by such Defaulting Lender;provided that (a) the sum of each Non-Defaulting Lender’s total Revolving Exposure may not in any event exceed the Revolving Commitment of such Non-Defaulting Lender, and (b) neither any such reallocation nor any payment by a Non-Defaulting Lender pursuant thereto nor any such Cash Collateralization or reduction will constitute a waiver or release of any claim the Borrower, the Administrative Agent, the Issuing Bank, the Swingline Lender or any other Lender may have against such Defaulting Lender, or cause such Defaulting Lender to be a Non-Defaulting Lender;(iv) with the written approval of the Required Lenders, the Borrower may terminate (on a non-ratable basis) the unused amount of the Revolving Commitment or Term Loan Commitment of a Defaulting Lender, and in such event the provisions of clause (v) below will apply to all amounts thereafter paid by the Borrower for the account of any such Defaulting Lender under this Agreement (whether on account of principal, interest, fees, indemnity or other amounts), provided that such termination will not be deemed to be a waiver or release of any claim the Borrower, the Administrative Agent, any Issuing Bank or any Lender may have against such Defaulting Lender;(v) any amount paid by the Borrower for the account of a Defaulting Lender under this Agreement (whether on account of principal, interest, fees, indemnity payments or other amounts) will be retained by the Administrative Agent in a segregated non-interest bearing account until the termination of the Revolving Commitments at which time the funds in such account will be applied by the Administrative Agent, to the fullest extent permitted by law, in the following order of priority: first to the payment of any amounts owing by such Defaulting Lender to the Administrative Agent under this Agreement, second to the payment of any amounts owing by such Defaulting Lender to the Issuing Banks or Swingline Lenders under this Agreement, third to the payment of post-default interest and then current interest due and payable to the Lenders hereunder other than Defaulting Lenders, ratably among them in accordance with the amounts of such interest then due and payable to them, fourth to the payment of fees then due and payable to the Non-Defaulting Lenders hereunder, ratably among them in accordance with the amounts of such fees then due and payable to them, fifth to pay principal and unreimbursed LC Disbursements then due and payable to the Non-Defaulting Lenders hereunder ratably in accordance with the amounts thereof then due and payable to them, sixth to the ratable payment of other amounts then due and payable to the Non-Defaulting Lenders, seventh to pay any amounts owing to the Loan Parties by such Defaulting Lender and eighth to pay amounts owing under this Agreement to such Defaulting Lender or as a court of competent jurisdiction may otherwise direct; 634159-0944-0061.4(vi) except for the matters listed in Section 9.02(b)(i) through (b)(ix) directly applicable to such Defaulting Lender, such Defaulting Lender will not (i) have the right to vote regarding any issue on which voting is required or advisable under this Agreement or any other Loan Document and, with respect to any such Lender, the amount of the Revolving Commitment, Term Loan Commitment or Loans, as applicable, held by such Lender shall not be counted as outstanding for purposes of determining “Required Lenders” (in either the numerator or the denominator) hereunder, (ii) except as set forth in clause (v) immediately above, be entitled to receive any payments of principal, interest or fees from the Borrower or the Administrative Agent (or the other Lenders) in respect of Letters of Credit or its Loans (without prejudice to the rights of the Lenders other than Defaulting Lenders in respect of such fees), provided that (1) to the extent that a portion of the LC Exposure of such Defaulting Lender is reallocated to the Non-Defaulting Lenders pursuant to clause (a)(ii), such fees that would have accrued for the benefit of such Defaulting Lender will instead accrue for the benefit of and be payable to such Non-Defaulting Lenders, pro rata in accordance with their respective Revolving Commitments and (2) to the extent any portion of such LC Exposure cannot be so reallocated, unless such portion of such LC Exposure is Cash Collateralized, such fees will instead accrue for the benefit of and be payable to the Issuing Bank; and(vii) the Borrower may, at its sole expense and effort, upon notice to such Defaulting Lender and the Administrative Agent, in accordance with Section 2.18(b) and 9.04, require such Defaulting Lender to assign and delegate, without recourse all its interests, rights and obligations under this Agreement. (b) If the Borrower, the Administrative Agent, the Issuing Banks and the Swingline Lenders agree in writing in their discretion that a Lender that is a Defaulting Lender should no longer be deemed to be a Defaulting Lender, as the case may be, the Administrative Agent will so notify the parties hereto, whereupon as of the effective date specified in such notice and subject to any conditions set forth therein, the LC Exposure and the Swingline Exposure of the other Lenders shall be readjusted to reflect the inclusion of such Lender’s Commitment, and such Lender will purchase at par such portion of outstanding Revolving Loans of the other Lenders and/or make such other adjustments as the Administrative Agent may determine to be necessary to cause the Revolving Exposure of the Lenders to be on a pro rata basis in accordance with their respective Applicable Percentages, whereupon such Lender will cease to be a Defaulting Lender and will be a Non-Defaulting Lender (and such Revolving Exposure of each Lender will automatically be adjusted on a prospective basis to reflect the foregoing) and if any cash collateral has been posted with respect to such Defaulting Lender, the Administrative Agent will promptly return such cash collateral to the Borrower, provided that no adjustments will be made retroactively with respect to fees accrued or payments made by or on behalf of the Borrower while such Lender was a Defaulting Lender, and provided, further, that except to the extent otherwise expressly agreed by the affected parties, no change hereunder from Defaulting Lender to Non-Defaulting Lender will constitute a waiver or release of any claim of any party hereunder arising from such Lender’s having been a Defaulting Lender.SECTION 2.23 Maturity Date Extension The Borrower may at any time and from time to time, by notice to the Administrative Agent, propose an extension of the Maturity Date, which proposal may include a proposal to change the Applicable Margin (including any provisions in the definition thereof) as may be specified in such proposal. Upon receipt of any such proposal the Administrative Agent shall promptly notify each applicable Lender thereof. Each applicable Lender shall respond to such proposal in writing within 30 calendar days after the date of such proposal and any failure of a Lender to respond within such period shall be deemed to be a rejection of such proposal. If any Lender consents to such proposal (each such consenting Lender, an “Extending Lender”), the Maturity Date applicable to each Extending Lender shall be extended to the date specified in the Borrower’s extension proposal and the Applicable Margin 644159-0944-0061.4with respect to each such Extending Lender shall be adjusted in the manner specified in such proposal, if any, and each Non-Extending Lender will be treated as provided in Section 2.23(b).(b) If any Lender does not consent to any extension request that becomes effective pursuant to Section 2.23(a) (each such Lender, a “Non-Extending Lender”), then the applicable Maturity Date for such Non-Extending Lender shall remain unchanged from that applicable prior to the extension and the Commitments of each Non-Extending Lender and the existing Applicable Margin shall continue in full force and effect.(c) Notwithstanding the provisions of Section 9.02(b), the Borrower and the Administrative Agent (and the Extending Lenders) shall be entitled to enter into any amendments to this Agreement that the Administrative Agent believes are necessary or appropriate to reflect, or to provide for the integration of, any extension of the Maturity Date or change in Applicable Margins pursuant to this Section 2.23 without the consent of any Non-Extending Lender.SECTION 2.24 Benchmark Replacement Setting. (a) Benchmark Replacement. Notwithstanding anything to the contrary herein or in any other Loan Document, upon the occurrence of a Benchmark Transition Event, the Administrative Agent and the Borrower may amend this Agreement to replace the then-current Benchmark with a Benchmark Replacement. Any such amendment with respect to a Benchmark Transition Event will become effective at 5:00 p.m. (New York City time) on the fifth (5th) Business Day after the Administrative Agent has posted such proposed amendment to all affected Lenders and the Borrower so long as the Administrative Agent has not received, by such time, written notice of objection to such amendment from Lenders comprising the Required Lenders. No replacement of a Benchmark with a Benchmark Replacement pursuant to this Section 2.24(a) will occur prior to the applicable Benchmark Transition Start Date.(b) Benchmark Replacement Conforming Changes. In connection with the use, administration, adoption or implementation of a Benchmark Replacement, the Administrative Agent will have the right to make Conforming Changes from time to time and, notwithstanding anything to the contrary herein or in any other Loan Document, any amendments implementing such Conforming Changes will become effective without any further action or consent of any other party to this Agreement or any other Loan Document.(c) Notices; Standards for Decisions and Determinations. The Administrative Agent shall promptly notify the Borrower and the Lenders of (i) the implementation of any Benchmark Replacement, (ii) the effectiveness of any Benchmark Replacement Conforming Changes and (iii) (x) the removal or reinstatement of any tenor of a Benchmark pursuant to Section 2.24(d) and (y) the commencement or conclusion of any Benchmark Unavailability Period. Any determination, decision or election that may be made by the Administrative Agent or, if applicable, any Lender (or group of Lenders) pursuant to this Section 2.24, including any determination with respect to a tenor, rate or adjustment or of the occurrence or non-occurrence of an event, circumstance or date and any decision to take or refrain from taking any action or selection, will be conclusive and binding absent manifest error and may be made in its or their sole discretion and without consent from any other party to this Agreement or any other Loan Document, except, in each case, as expressly required pursuant to this Section 2.24.(d) Unavailability of Tenor of Benchmark. Notwithstanding anything to the contrary herein or in any other Loan Document, at any time (including in connection with the implementation of a Benchmark Replacement), (x) if the then-current Benchmark is a term rate (including the Term SOFR Reference Rate) and either (i) any tenor for such Benchmark is not 654159-0944-0061.4displayed on a screen or other information service that publishes such rate from time to time as selected by the Administrative Agent in its reasonable discretion or (ii) the regulatory supervisor for the administrator of such Benchmark has provided a public statement or publication of information announcing that any tenor for such Benchmark is not or will not be representative, then the Administrative Agent may modify the definition of “Interest Period” (or any similar or analogous definition) for any Benchmark settings at or after such time to remove such unavailable or non-representative tenor and (y) if a tenor that was removed pursuant to clause (x) above either (i) is subsequently displayed on a screen or information service for a Benchmark (including a Benchmark Replacement) or (ii) is not, or is no longer, subject to an announcement that it is not or will not be representative for a Benchmark (including a Benchmark Replacement), then the Administrative Agent may modify the definition of “Interest Period” (or any similar or analogous definition) for all Benchmark settings at or after such time to reinstate such previously removed tenor.(e) Benchmark Unavailability Period. Upon the Borrower’s receipt of notice of the commencement of a Benchmark Unavailability Period, (i) the Borrower may revoke any pending request for a Borrowing of, conversion to or continuation of SOFR Loans to be made, converted or continued during any Benchmark Unavailability Period and, failing that, the Borrower will be deemed to have converted any such request into a request for a Borrowing of or conversion to ABR Loans and (ii) any outstanding affected SOFR Loans will be deemed to have been converted to ABR Loans at the end of the applicable Interest Period. During a Benchmark Unavailability Period or at any time that a tenor for the then-current Benchmark is not an Available Tenor, the component of the Alternate Base Rate based upon the then-current Benchmark or such tenor for such Benchmark, as applicable, will not be used in any determination of the Alternate Base Rate.ARTICLE IIIRepresentations and Warranties Each of STX and the Borrower represents and warrants to the Lenders with respect to itself and its Subsidiaries that:SECTION 3.01 Organization; Powers. Each of STX, the Borrower and the Subsidiaries is duly incorporated or organized, validly existing and (where such concept exists in any relevant jurisdiction) in good standing under the laws of the jurisdiction of its incorporation or organization, has all requisite power and authority to carry on its business as now conducted and, except where the failure to do so, individually or in the aggregate, could not reasonably be expected to result in a Material Adverse Effect, is qualified to do business in, and is in good standing in, every jurisdiction where such qualification is required.SECTION 3.02 Authorization; Enforceability. The execution, delivery and performance by each Loan Party of the Loan Documents to which it is a party are within its powers and have been duly authorized by all necessary action. This Agreement has been duly executed and delivered by each of STX and the Borrower and (solely for purposes of Section 9.09(d)) Seagate Technology (US) and constitutes, and each other Loan Document to which each Loan Party is to be a party, when executed and delivered by such Loan Party will constitute, a legal, valid and binding obligation of such Loan Party (as the case may be), enforceable in accordance with its terms, subject to applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium or other laws affecting creditors’ rights generally and to general principles of equity and an implied covenant of good faith and fair dealing, regardless of whether considered in a proceeding in equity or at law.664159-0944-0061.4SECTION 3.03 Governmental Approvals; No Conflicts. The execution, delivery and performance by each Loan Party of the Loan Documents to which it is a party (a) do not require any consent or approval of, registration or filing with, or any other action by or before, any Governmental Authority, except such as have been obtained or made and are in full force and effect and filings and other actions necessary to perfect Liens created under the Loan Documents, and except where the failure to obtain such consent or approval or to make such registration or filing, individually or in the aggregate, could not reasonably be expected to have a Material Adverse Effect, (b) will not violate any applicable law, regulation or any order of any Governmental Authority in any material respect or the memorandum and articles of association, constitution, charter, by-laws or other organizational documents of STX, the Borrower or any other Loan Party, (c) will not violate or result in a default under any indenture, material agreement or other material instrument binding upon STX, the Borrower or any Subsidiary or any of their respective assets, or give rise to a right thereunder to require any payment to be made by STX, the Borrower or any Subsidiary, except for violations or payments that, individually and in the aggregate, could not reasonably be expected to have a Material Adverse Effect, and (d) will not result in the creation or imposition of any Lien on any asset of STX, the Borrower or any Subsidiary, except for Liens created under the Loan Documents.SECTION 3.04 Financial Condition; No Material Adverse Change. (a) Seagate UC has heretofore furnished to the Lenders the audited consolidated balance sheet and related statements of operations, stockholders’ equity and cash flows of Seagate UC as of and for the fiscal year ended June 29, 2018 setting forth in comparative form the figures for the previous fiscal year and reported on by Ernst & Young LLP, independent auditors, to the effect that such financial statements present fairly, in all material respects, the consolidated financial condition and results of operations and cash flows of Seagate UC, the Borrower and the Subsidiaries on a consolidated basis as of such dates and for such periods in accordance with GAAP consistently applied.(b) Except as disclosed in the financial statements referred to in clause (a) above or the notes thereto and except for the Disclosed Matters, none of Seagate UC, the Borrower or the Subsidiaries has, as of the Effective Date after giving effect to any Revolving Loans made on such date, any material contingent liabilities, unusual long-term commitments or unrealized losses.(c) Since June 29, 2018 there has been no material adverse change in the business, financial condition or results of operations of STX, the Borrower and the Subsidiaries, taken as a whole.SECTION 3.05 Properties. (a) Each of STX, the Borrower and the Subsidiaries has good title to, or valid leasehold interests in, all its real and personal property material to its business, except for defects in title that do not interfere with its ability to conduct its business as currently conducted or to utilize such properties for their intended purposes and subject to the Liens permitted by Section 6.02.(b) Each of STX, the Borrower and the Subsidiaries owns, or is licensed to use, all trademarks, tradenames, copyrights, patents and other intellectual property material to its business, and the use thereof by STX, the Borrower and the Subsidiaries does not infringe upon the rights of any other Person, except for any such infringements that, individually and in the aggregate, could not reasonably be expected to result in a Material Adverse Effect.SECTION 3.06 Litigation and Environmental Matters. 674159-0944-0061.4(a) Except for the Disclosed Matters, there are no actions, suits or proceedings by or before any arbitrator or Governmental Authority pending against or, to the knowledge of STX or the Borrower, threatened against or affecting STX, the Borrower or any Subsidiary (i) that could reasonably be expected, individually or in the aggregate, to result in a Material Adverse Effect or (ii)(A) that involve any of the Loan Documents or the execution, delivery and performance by STX, the Borrower or any other Loan Party thereof, (B) that are not frivolous and (C) if adversely determined, would reasonably be expected to be adverse to the interests of the Lenders.(b) Except for the Disclosed Matters and except with respect to any other matters that, individually and in the aggregate, would not reasonably be expected to result in a Material Adverse Effect, none of STX, the Borrower or any Subsidiary (i) is in violation of any applicable Environmental Law or any obligation to obtain, maintain or comply with any permit, license or other approval required under any applicable Environmental Law, (ii) has become subject to any Environmental Liability, (iii) has received written notice of any claim with respect to any Environmental Liability or (iv) knows of any basis to reasonably expect the imposition of any Environmental Liability.(c) Since the date of this Agreement, there has been no change in the status of the Disclosed Matters that, individually or in the aggregate, has resulted in, or materially increased the likelihood of, a Material Adverse Effect.SECTION 3.07 Compliance with Laws and Agreements. Each of STX, the Borrower and the Subsidiaries is in compliance with all laws, regulations and orders of any Governmental Authority applicable to it or its property and all indentures, agreements and other instruments binding upon it or its property, except where the failure to do so, individually and in the aggregate, could not reasonably be expected to result in a Material Adverse Effect. No Default has occurred and is continuing.SECTION 3.08 Investment Company Status. None of STX, the Borrower or any Subsidiary is an “investment company” as defined in, or subject to regulation under, the Investment Company Act of 1940.SECTION 3.09 Taxes. Each of STX, the Borrower and the Subsidiaries has timely filed or caused to be filed all federal, state, and other tax returns and reports required to have been filed and has paid or caused to be paid all federal state or other taxes, assessments, fees and other governmental charges levied or imposed upon them or their properties, income or assets otherwise due and payable and required to have been paid by it, except (a) any Taxes that are being contested in good faith by appropriate proceedings and for which STX, the Borrower or such Subsidiary, as applicable, has set aside on its books adequate reserves that are being maintained in accordance with GAAP or (b) to the extent that the failure to do so could not reasonably be expected to result in a Material Adverse Effect.SECTION 3.10 ERISA. No ERISA Event has occurred or is reasonably expected to occur that, when taken together with all other such ERISA Events for which liability is reasonably expected to occur, would reasonably be expected to result in a Material Adverse Effect. The present value of all accumulated benefit obligations under all underfunded Plans (based on the assumptions used for purposes of Accounting Standards Codification No. 715: Compensation-Retirement Benefits) did not, as of the date of the most recent financial statements reflecting such amounts, exceed the fair market value of the assets of all such underfunded Plans by an amount that would reasonably be expected to result in a Material Adverse Effect.SECTION 3.11 Disclosure. The reports, financial statements, certificates or other written information furnished by or on behalf of STX, Seagate UC or the Borrower, as 684159-0944-0061.4applicable, to the Administrative Agent or any Lender in connection with the negotiation of this Agreement or any other Loan Document or delivered hereunder or thereunder (as modified or supplemented by other information so furnished), taken as a whole, do not contain any material misstatement of fact or omit to state any material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not materially misleading, provided that, (a) with respect to projected financial information, STX and the Borrower represent only that such information was prepared in good faith based upon assumptions believed to be reasonable at the time and (b) with respect to information regarding the hard disc drive market and other industry data, STX and the Borrower represent only that such information was prepared by third-party industry research firms, and although STX and the Borrower believe such information is reliable, STX and the Borrower cannot guarantee the accuracy and completeness of such information and have not independently verified such information. As of the Effective Date, the information included in the Beneficial Ownership Certification, to the knowledge of STX and the Borrower (if such certification was required to be delivered by the Administrative Agent) is true and correct in all respects.SECTION 3.12 Subsidiaries. Schedule 3.12 sets forth the name of, and the ownership interest of Seagate UC, the Borrower and each subsidiary in, each other subsidiary, in each case as of the Effective Date.SECTION 3.13 Insurance. As of the Effective Date, all premiums in respect of all material insurance maintained by or on behalf of Seagate UC, the Borrower and the Subsidiaries that are required to have been paid have been paid. STX and the Borrower believe that the insurance maintained by or on behalf of STX, the Borrower and the Subsidiaries is adequate in all material respects.SECTION 3.14 Labor Matters. As of the Effective Date, there are no strikes, lockouts or slowdowns against Seagate UC, the Borrower or any Subsidiary pending or, to the knowledge of Seagate UC or the Borrower, threatened that would reasonably be expected to have a Material Adverse Effect. Except as could not be reasonably expected to result in a Material Adverse Effect, (a) the hours worked by and payments made to employees of STX, the Borrower and the Subsidiaries have not been in violation of the Fair Labor Standards Act or any other applicable Federal, state, local or foreign law dealing with such matters, (b) all payments due from STX, the Borrower or any Subsidiary, or for which any claim may be made against STX, the Borrower or any Subsidiary, on account of wages and employee health and welfare insurance and other benefits, have been paid or accrued as a liability on the books of STX, the Borrower or such Subsidiary and (c) the execution, delivery and performance of the Loan Documents by STX and the Borrower will not give rise to any right of termination or right of renegotiation on the part of any union under any collective bargaining agreement to which STX, the Borrower or any Subsidiary is bound.SECTION 3.15 Sanctioned Persons, etc.(a) No Loan Party or any of its Affiliates or its Subsidiaries, or to the knowledge of any Loan Party, any director, officer, employee, agent, or Affiliate of any Loan Party or any of its Subsidiaries is a Person that is, or is owned 50.0% or more, individually or in the aggregate, directly or indirectly or controlled by Persons that are (i) the subject of any sanctions administered or enforced by OFAC, the U.S. Department of State, the laws of Canada, the United Nations Security Council, the European Union, Her Majesty’s Treasury, or other relevant sanctions authority (collectively, “Sanctions”), or (ii) located, organized or resident in a country or territory that is a Sanctioned Country or otherwise the subject of Sanctions, including (as of the Effective Date), Crimea, Cuba, Iran, North Korea, Syria, the Crimea Region of Ukraine, the so-called Donetsk People’s Republic and the so-called Luhansk People’s Republic. Each Loan Party and its Affiliates, and their respective directors and officers and, to the knowledge of the 694159-0944-0061.4Borrower, the employees and agents of such Loan Parties and Affiliates, are in compliance with all applicable Sanctions and with the Foreign Corrupt Practices Act of 1977, as amended, and the rules and regulations thereunder (the “FCPA”) and any other applicable anti-corruption law and any applicable anti-money laundering law, in each case in all material respects. Each Loan Party and its Subsidiaries have instituted and maintain policies and procedures reasonably designed to ensure compliance with applicable Sanctions, applicable anti-corruption law and any applicable anti-money laundering law.(b) No part of the proceeds of any extension of credit hereunder will be used directly or indirectly for the purpose of funding any operations in, finance any investments or activities in, or make any payments to, a Sanctioned Person or a Sanctioned Country, in each case to the extent prohibited by Sanctions. Neither the making of the extensions of credit hereunder nor the use of the proceeds thereof will violate the USA PATRIOT Act.(c) None of the proceeds of the extensions of credit made under this Agreement will violate the Trading with the Enemy Act, as amended, or any of the foreign assets control regulations of the United States Treasury Department (31 CFR, Subtitle B, Chapter V, as amended), or any enabling legislation or executive order relating thereto.(d) No Loan Party (i) is, or will become, a Person described or designated in the Specially Designated Nationals and Blocked Persons List of the OFAC or in Section 1 of the Anti-Terrorism Order, or (ii) directly or, knowingly, indirectly (A) engages, or will engage, in any dealings or transactions, or (B) is, or will be otherwise associated with, any such Person, in each case to the extent prohibited by Sanctions or the Anti-Terrorism Order.(e) None of the proceeds of the extensions of credit made under this Agreement will be used, directly or indirectly, for any payments to any governmental official or employee, political party, official of a political party, candidate for political office, or anyone else acting in an official capacity, for the purpose of obtaining, retaining or directing business or obtaining any improper advantage, in violation of the FCPA or applicable anti-corruption law.SECTION 3.16 USA PATRIOT Act, Etc. To the extent applicable, each Loan Party is in compliance, in all material respects, with (i) the Trading with the Enemy Act, as amended, and each of the foreign assets control regulations of the United States Treasury Department (31 CFR, Subtitle B, Chapter V, as amended) and any other enabling legislation or executive order relating thereto, and (ii) the USA PATRIOT Act.ARTICLE IVConditionsSECTION 4.01 Conditions to Initial Borrowing. The obligations of the Lenders to make Loans and of the Issuing Banks to issue Letters of Credit hereunder shall not become effective until the date on which each of the following conditions is satisfied (or waived in accordance with Section 9.02):(a) The Administrative Agent (or its counsel) shall have received from each party hereto either (i) a counterpart of this Agreement (a “Lender Addendum”) signed on behalf of such party or (ii) written evidence satisfactory to the Administrative Agent (which may include telecopy transmission of a signed Lender Addendum) that such party has signed a counterpart of this Agreement.704159-0944-0061.4(b) The U.S. Guarantee Agreement shall have been duly executed by STX and each other Guarantor as of the Effective Date and delivered to the Administrative Agent.(c) The Administrative Agent shall have received a favorable written opinion (addressed to the Administrative Agent and the Lenders and dated the Effective Date) of (i) Simpson Thacher & Bartlett LLP, New York counsel for STX and certain other Loan Parties, (ii) Arthur Cox, Irish counsel to STX, (iii) General Counsel of STX, and (iv) Maples and Calder (Cayman) LLP, Cayman Islands counsel for the Borrower and certain other Loan Parties, in each case in form and substance satisfactory to the Administrative Agent. Each Loan Party hereby requests such counsel to deliver such opinions. (d) The Administrative Agent shall have received such documents and certificates as the Administrative Agent or its counsel may reasonably request relating to the organization or incorporation, existence and good standing of each Loan Party, the authorization of the execution, delivery and performance of the Loan Documents by each Loan Party and any other legal matters relating to each Loan Party or the Loan Documents, all in form and substance reasonably satisfactory to the Administrative Agent and its counsel.(e) The Administrative Agent shall have received a certificate, dated the Effective Date and signed by the President, a Vice President or a Financial Officer of the Borrower, confirming compliance with the conditions set forth in clauses (a) and (b) of Section 4.02.(f) The Administrative Agent shall have received evidence reasonably satisfactory to it that (i) the Borrower has paid or, concurrently with the making of the initial Loans under this Agreement will pay, in full all debt and accrued and unpaid fees, interest, and other amounts owing under the Credit Agreement, dated as of January 18, 2011 (as amended, supplemented or otherwise modified from time to time), among STX, the Borrower, the lenders party thereto and the Administrative Agent, and (ii) such credit agreement (including the commitment to make any further extensions of credit thereunder) has been terminated and no longer in effect.(g) The Administrative Agent shall have received, for the account of each Lender that has requested a Promissory Note, such Lender’s Promissory Note duly executed and delivered by an authorized officer of the Borrower.(h) The Administrative Agent shall have received insurance certificates evidencing insurance coverage required to be maintained pursuant to each Loan Document and naming the Administrative Agent on behalf of the Finance Parties as additional insured (in the case of liability insurance), and providing that no cancellation of the policies will be made without at least thirty days’ prior written notice to the Administrative Agent.(i) The Lenders shall be satisfied that there shall have been no material adverse effect on the business, assets, financial condition or operations of STX and its subsidiaries, taken as a whole, since June 29, 2018.(j) Upon the reasonable request of any Lender, made at least ten days prior to the Effective Date, the Borrower shall provide such information so requested in connection with applicable “know your customer” and “anti-money laundering” rules and regulations, including the USA PATRIOT Act, in each case at least five days prior to the Effective Date. (k) Prior to the Effective Date, if the Borrower qualifies as a “legal entity customer” under the Beneficial Ownership Regulation, the Borrower shall deliver a Beneficial Ownership Certification in relation to the Borrower. 714159-0944-0061.4(l) The Administrative Agent shall have received all fees and other amounts due and payable on or prior to the Effective Date, including in each case, to the extent invoiced, reimbursement or payment of all reasonable out-of-pocket expenses (including reasonable fees, charges and disbursements of counsel) required to be reimbursed or paid by the Borrower under any Loan Document.The Administrative Agent shall notify the Borrower and the Lenders as to the satisfaction of the documentary delivery requirements set forth above, and such notice shall be conclusive and binding. SECTION 4.02 Each Credit Event. The obligation of each Lender to make a Loan on the occasion of any Borrowing, and of each Issuing Bank to issue, amend, renew or extend any Letter of Credit, is subject to receipt of the request therefor in accordance herewith and to the satisfaction of the following conditions:(a) The representations and warranties of each Loan Party set forth in the Loan Documents to which it is a party shall be true and correct in all material respects (other than representations and warranties that are subject to a Material Adverse Effect or a materiality qualifier, in which case such representations and warranties shall be true and correct) on and as of the date of such Borrowing or the date of issuance, amendment, renewal or extension of such Letter of Credit, as applicable, except to the extent such representations and warranties expressly relate to an earlier date, in which case such representations and warranties shall be true and correct in all material respects (other than representations and warranties that were subject to a Material Adverse Effect or a materiality qualifier, in which case such representations and warranties shall have been true and correct) in each case as of such earlier date. (b) At the time of and immediately after giving effect to such Borrowing or the issuance, amendment, renewal or extension of such Letter of Credit, as applicable, no Default shall have occurred and be continuing.(c) With respect to the issuance of any Letter of Credit or the making of any Swingline Loan, there is no Defaulting Lender at the time such Swingline Loan is to be made or Letter of Credit is to be issued, unless the L/C Exposure or Swingline Exposure of such Defaulting Lender is re-allocated to non-Defaulting Lenders and/or the Borrower has Cash Collateralized or made other arrangements with respect to any such non-reallocated Exposure of such Defaulting Lender all in accordance with Section 2.22.Each Borrowing and each issuance, amendment, renewal or extension of a Letter of Credit shall be deemed to constitute a representation and warranty by STX and the Borrower on the date thereof as to the matters specified in clauses (a) and (b) of this Section 4.02. For purposes of the foregoing, the term “Borrowing” shall not include the continuation or conversion of Loans in which the aggregate amount of such Loans is not being increased.ARTICLE VAffirmative Covenants Until the Commitments have expired or been terminated and the principal of and interest on each Loan and all fees payable hereunder shall have been paid in full and all Letters of Credit shall have expired or terminated and all LC Disbursements shall have been reimbursed, each of STX and the Borrower covenants and agrees with the Lenders that:SECTION 5.01 Financial Statements and Other Information. STX will furnish to the Administrative Agent:724159-0944-0061.4(a) within 90 days after the end of each fiscal year of STX, its audited consolidated balance sheet and related statements of operations, stockholders’ equity and cash flows as of the end of and for such year, setting forth in each case in comparative form the figures for the previous fiscal year, all reported on by Ernst & Young LLP or other independent public accountants of recognized national standing (without a “going concern” or like qualification or exception and without any qualification or exception as to the scope of such audit or any other material qualification or exception) to the effect that such consolidated financial statements present fairly in all material respects the consolidated financial condition and results of operations of STX, the Borrower and the Subsidiaries on a consolidated basis in accordance with GAAP consistently applied;(b) within 45 days after the end of each of the first three fiscal quarters of each fiscal year of STX, its unaudited consolidated balance sheet and related statements of operations, stockholders’ equity and cash flows as of the end of and for such fiscal quarter and the then-elapsed portion of the fiscal year, setting forth in each case in comparative form the figures for the corresponding period or periods of (or, in the case of the balance sheet, as of the end of) the previous fiscal year, all certified by one of its Financial Officers as presenting fairly in all material respects the consolidated financial condition and results of operations of STX, the Borrower and the Subsidiaries on a consolidated basis in accordance with GAAP consistently applied, subject to normal year-end audit adjustments and the absence of footnotes;(c) concurrently with any delivery of financial statements under clause (a) or (b) above, a Certificate of Financial Officer of the Person delivering such financial statements (i) certifying as to whether a Default has occurred and, if a Default has occurred, specifying the details thereof and any action taken or proposed to be taken with respect thereto, (ii) setting forth reasonably detailed calculations demonstrating compliance with Sections 6.11, 6.12 and 6.13 (iii) stating whether any material change in GAAP or in the application thereof has occurred since the date of STX’s audited financial statements referred to in Section 3.04 and, if any such change has occurred, specifying the effect of such change on the financial statements accompanying such certificate and (iv) identifying any Material Acquisitions that have been consummated by the Borrower or any Subsidiary since the end of the previous fiscal quarter, including the date on which each such Material Acquisition was consummated and the consideration therefor;(d) promptly after the same become publicly available, copies of all periodic and other reports, proxy statements and other materials filed by STX, the Borrower or any Subsidiary with the SEC or with any national securities exchange not otherwise required to be delivered to the Administrative Agent pursuant hereto;(e) promptly following any reasonable request of the Administrative Agent therefor, copies of (i) any documents described in Section 101(k)(1) of ERISA that the Borrower or any of its ERISA Affiliates have requested with respect to any Multiemployer Plan and (ii) any notices described in Section 101(l)(1) of ERISA that the Borrower or any of its ERISA Affiliates have requested with respect to any Multiemployer Plan, provided that if the Borrower or any of its ERISA Affiliates have not requested such documents or notices from the administrator or sponsor of the applicable Plan or Multiemployer Plan, the Borrower or its ERISA Affiliate(s), as applicable, shall promptly make a request for such documents or notices from such administrator or sponsor and shall provide copies of such documents and notices promptly after receipt thereof; and(f) promptly following any request therefor, such other information regarding the operations, business affairs and financial condition of STX, the Borrower or any Subsidiary, or compliance with the terms of any Loan Document, as the Administrative Agent or any Lender, through the Administrative Agent, may reasonably request (including information required by the USA PATRIOT Act).734159-0944-0061.4Documents required to be delivered pursuant to Section 5.01(a) or (b) (to the extent any such documents are included in materials otherwise filed with the SEC) may be delivered electronically and, if so delivered, shall be deemed to have been delivered on the date (i) on which the Borrower posts such documents or provides a link thereto on the Borrower’s website on the internet at http://www.seagate.com or (ii) on which such documents are posted on the Borrower’s behalf on SyndTrak or another relevant website, if any, to which each Lender and the Administrative Agent have access (whether a commercial, third-party website or whether sponsored by the Administrative Agent), provided that (A) upon written request by the Administrative Agent, the Borrower shall deliver paper copies of such documents to the Administrative Agent for further distribution to each Lender until a written request to cease delivering paper copies is given by the Administrative Agent and (B) the Borrower shall notify (which may be by facsimile or electronic mail) the Administrative Agent of the posting of any such documents and provide to the Administrative Agent by electronic mail electronic versions (i.e., soft copies) of such documents. Each Lender shall be solely responsible for timely accessing posted documents or requesting delivery of paper copies of such documents from the Administrative Agent and maintaining its copies of such documents.SECTION 5.02 Notices of Material Events. STX and the Borrower will furnish, promptly upon STX’s or the Borrower’s obtaining knowledge thereof, to the Administrative Agent written notice of the following:(a) the occurrence of any Default;(b) the filing or commencement of any action, suit or proceeding by or before any arbitrator or Governmental Authority against or affecting STX, the Borrower or any Affiliate thereof that, if adversely determined, could reasonably be expected to result in a Material Adverse Effect;(c) the occurrence of any ERISA Event that, alone or together with any other ERISA Events that have occurred, could reasonably be expected to result in material liability of STX, the Borrower and the Subsidiaries, taken as a whole;(d) the occurrence of any change to the Issuer Ratings by S&P, Moody’s or Fitch; (e) any change in the information provided in the Beneficial Ownership Certification (if previously provided at the Administrative Agent’s request) that would result in a change to the list of beneficial owners identified in parts (c) or (d) of such Beneficial Ownership Certification; and(f) any other development that results in, or could reasonably be expected to result in, a Material Adverse Effect.Each notice delivered under this Section 5.02 shall be accompanied by a statement of a Financial Officer or other executive officer of STX or the Borrower, as applicable, setting forth the details of the event or development requiring such notice and any action taken or proposed to be taken with respect thereto.SECTION 5.03 [RESERVED].SECTION 5.04 Existence; Conduct of Business. Each of STX and the Borrower will, and will cause each of its subsidiaries to, do or cause to be done all things necessary to preserve, renew and keep in full force and effect (a) its legal existence and (b) the rights, contracts, licenses, permits, privileges, franchises, patents, copyrights, trademarks and trade names used in the conduct of the business of STX, the Borrower and the Subsidiaries, except, in the case of 744159-0944-0061.4clause (b) of this Section, to the extent that the failure to take any such action could not reasonably be expected to have a Material Adverse Effect, provided that the foregoing shall not prohibit any merger, consolidation, liquidation or dissolution permitted under Section 6.03 or any sale of assets permitted under Section 6.05.SECTION 5.05 Payment of Obligations. Each of STX and the Borrower will, and will cause each of its subsidiaries to, pay its Material Indebtedness and material Tax liabilities, before the same shall become delinquent or in default, except where (a) the validity or amount thereof is being contested in good faith by appropriate proceedings, (b) STX, the Borrower or the applicable Subsidiary has set aside on its books adequate reserves with respect thereto in accordance with GAAP, (c) such contest effectively suspends collection of the contested obligation and the enforcement of any Lien securing such obligation and (d) the failure to make payment pending such contest could not reasonably be expected to result in a Material Adverse Effect.SECTION 5.06 Maintenance of Properties. Each of STX and the Borrower will, and will cause each of its subsidiaries to, keep and maintain all material property necessary to the conduct of the business of STX, the Borrower and the Subsidiaries, taken as a whole, in good working order and condition, ordinary wear and tear excepted.SECTION 5.07 Insurance. Each of STX and the Borrower will, and will cause each of its subsidiaries to, maintain, with financially sound and reputable insurance companies insurance in such amounts (with no greater risk retention) and against such risks as are customarily maintained by companies of established repute engaged in the same or similar businesses operating in the same or similar locations. The Borrower will furnish to the Administrative Agent, upon request, information in reasonable detail as to the insurance so maintained.SECTION 5.08 Further Assurances. Each of STX and the Borrower will, and will cause each Subsidiary Loan Party to, execute any and all further documents, agreements and instruments, and take all such further actions that may be required under any applicable law, or that the Administrative Agent may reasonably request, to cause the Guarantee Requirement to be and remain satisfied, all at the expense of the Borrower.SECTION 5.09 Books and Records; Inspection Rights. Each of STX and the Borrower will, and will cause each of its subsidiaries to, keep proper books of record and account in which full, true and correct entries are made of all material dealings and transactions in relation to its business and activities. Each of STX and the Borrower will, and will cause each of its subsidiaries to, permit any representatives designated by the Administrative Agent or any Lender, upon reasonable prior notice, to visit and inspect its properties, to examine and make extracts from its books and records, and to discuss its affairs, finances and condition with its officers and independent accountants, all at such reasonable times and at such reasonable intervals as may be reasonably requested, provided that any such visit or inspection by a Lender other than the Administrative Agent shall be coordinated by (and any request for such a visit or inspection shall be presented through) the Administrative Agent.SECTION 5.10 Compliance with Laws. (a) Each of STX and the Borrower will, and will cause each of their Subsidiaries to, comply with all laws, rules, regulations and orders of any Governmental Authority applicable to it or its property, except where the failure to do so, individually or in the aggregate, could not reasonably be expected to result in a Material Adverse Effect.(b) Each of STX and the Borrower will, and will cause each of their Subsidiaries to, maintain in effect policies and procedures reasonably designed to ensure compliance by each 754159-0944-0061.4Loan Party, their respective Subsidiaries, and their respective directors, officers, employees, and agents with applicable Sanctions, applicable anti-corruption law and any applicable anti-money laundering law.SECTION 5.11 Use of Proceeds of Loans and Letters of Credit. The proceeds of (a) Term Loan A1 and Term Loan A2 will be utilized (i) to refinance existing Indebtedness, including the Term Loans due September 16, 2025 outstanding under (and as defined in) this Agreement prior to giving effect to the Fifth Amendment and the 4.25% Senior Notes due March 2022 and to pay accrued interest and premium thereon (and in the case of such 4.25% Senior Notes, to be repaid or prepaid at any time on or following the Fifth Amendment Effective Date, at the Borrower’s sole discretion), and (ii) for general corporate purposes; (b) Term Loan A3 will be utilized for general corporate purposes; and (c) the Revolving Loans and Swingline Loans will be used only for working capital and other general corporate purposes of the Borrower and its Subsidiaries, and Letters of Credit will be issued only to support obligations of the Borrower or any Subsidiary incurred in the ordinary course of business; provided, that notwithstanding the foregoing, (a) no part of the proceeds of any Loan or issuance of, or proceeds from, any Letter of Credit will be used, whether directly or indirectly, (i) for any purpose that entails a violation of any of the Regulations of the Board, including Regulations T, U and X or (ii) in contravention of the representations made in Section 3.15(b), (c) or (e), and (b) the Borrower will not, directly, or knowingly, indirectly, lend, contribute or otherwise make available such proceeds to any Subsidiary, joint venture partner or other Person, (i) for the purpose of funding any activities or business of or with any Person, or in any country or territory, that, at the time of such funding, is the subject of Sanctions, in each case to the extent prohibited by Sanctions or (ii) in any other manner that would result in a violation of Sanctions by any Person (including any Person participating in the Loans or Letters of Credit, whether as Administrative Agent, Issuing Bank, Lender, underwriter, advisor, investor, or otherwise).SECTION 5.12 Senior Obligations. STX and the Borrower will, and will cause each Subsidiary Loan Party to, ensure that its obligations under this Agreement and the other Loan Documents to which it is a party shall at all times rank at least pari passu in right of payment with all its other present and future senior Indebtedness, except for obligations accorded preference by mandatory provisions of law. SECTION 5.13 Additional Subsidiaries. If any Subsidiary is formed or acquired after the Effective Date, STX and the Borrower will (a) within ten Business Days after such Subsidiary is formed or acquired (or such longer period as the Administrative Agent may agree in its discretion), notify the Administrative Agent and the Lenders thereof and (b) within 30 Business Days after such Subsidiary is formed or acquired (or, if such Subsidiary is a Foreign Subsidiary, within 60 Business Days after such Foreign Subsidiary is formed or acquired (or such longer period as the Administrative Agent may agree in its discretion)), cause the Guarantee Requirement to be satisfied with respect to such Subsidiary (if it is a Subsidiary Loan Party), provided that if the Administrative Agent determines, after consultation with the Borrower, that (i) such additional Subsidiary providing a Guarantee would violate the law of the jurisdiction where such Subsidiary is organized or would result in a material adverse tax consequence to such additional Subsidiary or (ii) the cost to STX, the Borrower and the Subsidiaries of such additional Subsidiary providing a Guarantee would be excessive in view of the related benefits to be received by the Lenders, then STX and the Borrower shall not be required to cause the Guarantee Requirement to be satisfied with respect to such additional Subsidiary (and such additional Subsidiary shall not be a Subsidiary Loan Party for purposes of this Agreement and the other Loan Documents).764159-0944-0061.4ARTICLE VINegative Covenants Until the Commitments have expired or been terminated, the principal of and interest on each Loan and all fees payable hereunder have been paid in full, all Letters of Credit have expired or been terminated, and all LC Disbursements shall have been reimbursed, each of STX and the Borrower covenants and agrees with the Lenders that:SECTION 6.01 Indebtedness.(a) Each of STX and the Borrower will not, and will not permit any of its subsidiaries to, create, incur, assume or permit to exist any Indebtedness, except:(i) Indebtedness created under the Loan Documents;(ii) the Senior Notes and extensions, renewals, refinancings and replacements of the Senior Notes that do not increase the outstanding principal amount thereof or result in an earlier maturity date or decreased weighted average life thereof, and that do not contain covenants that are more restrictive from the Borrower’s perspective than the covenants contained in this Agreement, provided that the applicable refinancing or replacement Indebtedness need not be incurred substantially concurrently with the consummation of such refinancing or replacement so long as such refinancing or replacement Indebtedness is incurred no earlier than six months prior to the date on which the applicable Senior Notes are refinanced or replaced, as the case may be;(iii) Indebtedness (other than in respect of the Senior Notes) existing on the Effective Date and set forth in Schedule 6.01 and extensions, renewals, refinancings and replacements of any such Indebtedness that do not increase the outstanding principal amount thereof or result in an earlier maturity date or decreased weighted average life thereof;(iv) Indebtedness (x) of STX to the Borrower or any Subsidiary, (y) of the Borrower to STX or any Subsidiary and (z) of any Subsidiary to STX, the Borrower or any other Subsidiary, provided that (A) Indebtedness of any Subsidiary that is not a Loan Party to STX, the Borrower or any Subsidiary Loan Party shall be subject to Section 6.04 and (B) Indebtedness of the Borrower to STX or any Subsidiary and Indebtedness of STX or any Subsidiary Loan Party to any Subsidiary that is not a Subsidiary Loan Party shall be subordinated to the Obligations on terms reasonably satisfactory to the Administrative Agent;(v) Guarantees (x) by STX or the Borrower of Indebtedness or Permitted Obligations of any Subsidiary, (y) by the Borrower of Indebtedness or Permitted Obligations of STX and (z) by any Subsidiary of Indebtedness or Permitted Obligations of STX or the Borrower or any other Subsidiary, provided that (A) such Indebtedness or Permitted Obligations is otherwise permitted hereunder, (B) Guarantees by STX, the Borrower or any Subsidiary Loan Party of Indebtedness of any Subsidiary that is not a Loan Party shall be subject to Section 6.04, (C) Guarantees by any Loan Party permitted under this clause (v) shall be subordinated to the Obligations of the applicable Subsidiary to the same extent, if any, and on the same terms as the Indebtedness so Guaranteed is subordinated to the Obligations and (D) none of the Indebtedness for borrowed money incurred pursuant to clause (ii), (iii) or (ix) of this Section 6.01(a) shall be Guaranteed by any Subsidiary, unless such Subsidiary is a Loan Party that has Guaranteed the Obligations pursuant to a Guarantee Agreement;774159-0944-0061.4(vi) Indebtedness of STX, the Borrower or any Subsidiary in respect of workers’ compensation claims, self-insurance obligations, performance bonds, surety, appeal or similar bonds and completion guarantees provided by the Borrower and the Subsidiaries in the ordinary course of their business, provided that upon the incurrence of Indebtedness with respect to reimbursement type obligations regarding workers’ compensation claims, such obligations are reimbursed within 30 days following such incurrence;(vii) Indebtedness of STX, the Borrower or any Subsidiary representing deferred compensation to employees of STX, the Borrower or any Subsidiary incurred in the ordinary course of business of STX, the Borrower or the applicable Subsidiary, consistent with the historical practices of STX, the Borrower or such Subsidiary;(viii) drawings under Overdraft Facilities, provided that any drawing that is not repaid in full on the Business Day following the day that such drawing was made shall not be permitted by this clause;(ix) other Indebtedness, provided that (A) at the time of any incurrence of Indebtedness pursuant to this clause (ix), after giving effect to such incurrence, the aggregate principal amount of all Indebtedness outstanding pursuant to this clause (ix) shall not exceed $150,000,000 and (B) the sum of (i) the aggregate principal amount of Indebtedness incurred by the non-Loan Party Subsidiaries pursuant to this clause (ix) (including any such Indebtedness of this type incurred pursuant to Section 6.01(a)(iii), and in the aggregate referred to as the “Permitted Subsidiary Debt Amount”) and (ii) the Permitted Secured Debt Amount, in each case at any time outstanding, shall not exceed the Permitted Priority Debt Amount;(x) any Permitted Receivables Factoring;(xi) purchase money obligations or other similar obligations (including obligations in respect of mortgage, industrial revenue bond, industrial development bond, and similar financings) (i) in respect of capital leases, or (ii) incurred to finance the acquisition, construction, or improvement of any fixed or capital assets, in each case, together with any modifications, extensions, renewals, refundings, replacements, and extensions of any such Indebtedness that do not increase the outstanding principal amount thereof (provided, in each case, that such Indebtedness is incurred within 270 days of the acquisition of such property); (xii) Guarantees by the Borrower delivered in the ordinary course of its business of the obligations of suppliers, customers, franchisees and licensees of the Borrower, its Subsidiaries and, subject to Section 6.08, other Affiliates; and(xiii) Guarantees by STX, the Borrower and its Subsidiaries in respect of lease agreements of STX, the Borrower or any Subsidiary not exceeding $100,000,000 in the aggregate at any time.(b) Each of STX and the Borrower will not, and will not permit any of its subsidiaries to, issue any preferred Equity Interests, except that STX may issue preferred shares or other preferred Equity Interests that do not require mandatory cash dividends (other than Cash-Pay Preferred Equity that is issued in accordance with Section 6.01(a)) or redemptions and do not provide for any right on the part of the holder to require redemption, repurchase or repayment thereof, in each case prior to the date that is 91 days after the latest Maturity Date then applicable to the Loans.SECTION 6.02 Liens. Each of STX and the Borrower will not, and will not permit any of its subsidiaries to, create, incur, assume or permit to exist any Lien on any property or asset 784159-0944-0061.4now owned or hereafter acquired by it, or assign or sell any income or revenues (including accounts receivable) or rights in respect thereof, except:(a) Permitted Encumbrances and Liens created under the Loan Documents;(b) any Lien on any property or asset of Seagate UC, the Borrower or any Subsidiary existing on the Effective Date and set forth in Schedule 6.02, provided that (i) such Lien shall not apply to any other property or asset of the Borrower or any Subsidiary, and (ii) such Lien shall secure only those obligations that it secures on the Effective Date and extensions, renewals and replacements thereof that do not increase the outstanding principal amount thereof;(c) Liens arising solely by virtue of any statutory or common law provision relating to banker’s liens, rights of setoff or similar rights;(d) Liens in favor of a landlord on leasehold improvements in leased premises;(e) Liens arising from Permitted Investments described in clause (d) of the definition of the term Permitted Investments;(f) Uniform Commercial Code financing statements filed in respect of Permitted Receivables Factoring;(g) other Liens securing Indebtedness, provided that the sum of (i) the aggregate principal amount of Indebtedness secured pursuant to this clause (g) (together with any secured Indebtedness described in Section 6.02(b), and in the aggregate referred to as the “Permitted Secured Debt Amount”) and (ii) the Permitted Subsidiary Debt Amount, in each case at any time outstanding, shall not exceed the Permitted Priority Debt Amount;(h) Liens (including cash collateral) securing obligations arising under any Swap Agreement with a counterparty that is not a Finance Party (or an Affiliate thereof) so long as the aggregate outstanding principal amount of the obligations secured thereby does not exceed $100,000,000 at any time, provided that no more than $50,000,000 of such obligations may be secured by Liens that rank equally with, or are senior to, the Liens securing the Obligations; (i) during any Non-Investment Grade Period, Liens incurred during any prior Investment Grade Period pursuant to clause (g) of this Section 6.02 and outstanding at the end of the immediately preceding Investment Grade Period, provided that such Liens could not be classified as Liens created, incurred, assumed or permitted pursuant to clauses (a) through (h) of this Section 6.02;(j) Liens arising in the ordinary course of business of STX, the Borrower and the Subsidiaries on metals leased to STX, the Borrower or any Subsidiary under any Platinum Lease; and(k) Liens securing Indebtedness pursuant to Section 6.01(a)(xi); provided that (i) such Liens attach at all times only to the assets so financed except for accession to the property that is affixed or incorporated into the property covered by such Lien or financed with the proceeds of such Indebtedness and the proceeds and the products thereof, and (ii) individual financings or leases of equipment provided by one lender or lessor may be cross collateralized to other financings of equipment provided by such lender or lessor.SECTION 6.03 Fundamental Changes. 794159-0944-0061.4(a) Neither STX nor the Borrower will, and will not permit any of their respective Subsidiaries to, merge into or consolidate with any other Person, or permit any other Person to merge into or consolidate with STX or the Borrower or any of their respective Subsidiaries, or liquidate or dissolve, nor will STX or the Borrower sell, transfer, lease or otherwise dispose of (in one transaction or in a series of transactions) all or substantially all the assets of the Borrower and the Subsidiaries, taken as a whole (whether directly or through the sale, transfer, lease or other disposition of the assets of one or more Subsidiaries), except that, if at the time thereof and immediately after giving effect thereto no Default shall have occurred and be continuing, (i) any Person may merge with STX or the Borrower in a transaction in which the surviving entity is a Person organized or existing under the laws of the United States of America, any State thereof, the District of Columbia or Ireland or the Cayman Islands and, if such surviving entity is not STX or the Borrower, as the case may be, such Person expressly assumes, in writing, all the obligations of STX or the Borrower, as the case may be, under the Loan Documents and provides the Lenders with requisite “know-your-customer” information as reasonably requested by a Lender, and (ii) any Person may merge into any Subsidiary in a transaction in which the surviving entity is a Subsidiary and (if any party to such merger is a Subsidiary Loan Party) is a Subsidiary Loan Party and any Subsidiary may liquidate or dissolve if the Borrower determines in good faith that such liquidation or dissolution is in the best interests of the Borrower and is not materially disadvantageous to the Lenders, provided that any such merger involving a Person that is not a wholly-owned Subsidiary of the Borrower immediately prior to such merger shall not be permitted unless also permitted by Sections 6.04 and 6.08. Notwithstanding anything to the contrary herein, this clause (a) shall not prohibit a Successor Transaction in compliance with Section 6.15.(b) Each of STX and the Borrower will not, and will not permit any of its subsidiaries to, engage to any material extent in any business other than businesses of the type conducted by STX, the Borrower and the Subsidiaries on the date of execution of this Agreement and businesses reasonably related, ancillary or complementary thereto, including Permitted Receivables Factoring.SECTION 6.04 Investments, Loans, Advances, Guarantees and Acquisitions. Each of STX and the Borrower will not, and will not permit any of its subsidiaries to, purchase, hold or acquire (including pursuant to any merger with any Person that was not a wholly-owned Subsidiary of the Borrower prior to such merger) any Equity Interests in or evidences of Indebtedness or other securities (including any option, warrant or other right to acquire any of the foregoing) of, make or permit to exist any loans or advances to, Guarantee any obligations of, or make or permit to exist any investment or any other interest in, any other Person, or purchase or otherwise acquire (in one transaction or a series of transactions) any assets of any other Person constituting a business unit (any of the foregoing, an “Investment”), except:(a) Permitted Investments;(b) investments existing on the Effective Date and set forth on Schedule 6.04;(c) investments by STX, the Borrower and the Subsidiaries in Equity Interests in each other, provided that no investment may be made pursuant to this clause (c) by a Loan Party in the Equity Interests of a Subsidiary that is not a Loan Party unless such investment is being made in the ordinary course of business of STX, the Borrower and the Subsidiaries;(d) loans or advances (x) made by STX to the Borrower or any Subsidiary, (y) made by the Borrower to any Subsidiary and (z) made by any Subsidiary to STX, the Borrower or any other Subsidiary, provided that no loan or advance in excess of $15,000,000 in the aggregate for all such loans or advances may be made pursuant to this clause (d) by a Loan Party to a 804159-0944-0061.4Subsidiary that is not a Loan Party unless such loan or advance is being made in the ordinary course of business of STX, the Borrower and the Subsidiaries;(e) Guarantees constituting Indebtedness permitted by Section 6.01 and Guarantees of Permitted Obligations permitted by Section 6.01, provided that no Guarantee (of other than the Obligations) in excess of $15,000,000 in the aggregate for all Guarantees constituting Indebtedness may be made pursuant to this clause (e) by any Loan Party of the Indebtedness of any Subsidiary that is not a Loan Party unless such Guarantee is being made in the ordinary course of business of STX, the Borrower and the Subsidiaries;(f) investments received in connection with the bankruptcy or reorganization of, or settlement of delinquent accounts and disputes with, customers and suppliers, in each case in the ordinary course of business;(g) any investments in or loans to any other Person received as non-cash consideration for sales, transfers, leases and other dispositions permitted by Section 6.05;(h) Guarantees by STX, the Borrower and the Subsidiaries of leases other than Capital Lease Obligations entered into by any Subsidiary as lessee;(i) extensions of credit in the nature of accounts receivable or notes receivable in the ordinary course of business;(j) investments in payroll, travel and similar advances to cover matters that are expected at the time of such advances ultimately to be treated as expenses for accounting purposes and that are made in the ordinary course of business;(k) investments in or acquisitions of stock, obligations or securities received in settlement of debts created in the ordinary course of business and owing to STX, the Borrower or any Subsidiary or in satisfaction of judgments;(l) investments in the form of Swap Agreements permitted under Section 6.06;(m) investments, loans, advances, guarantees and acquisitions resulting from a foreclosure by STX, the Borrower or any Subsidiary with respect to any secured investment or other transfer of title with respect to any secured investment in default;(n) investments, loans, advances, guarantees and acquisitions the consideration for which consists solely of shares of common stock of STX;(o) investments arising as a result of any Permitted Receivables Factoring;(p) other Investments, provided that (i) no Default has occurred and is continuing or would result from any such Investment, (ii) in the case of any such Investment in an amount that exceeds $100,000,000, (A) STX is in compliance, on a pro forma basis after giving effect to any such Investment (after giving effect to any reduction in operating expenses permitted to be included for this purpose in the calculation set forth in the definition of the term Consolidated EBITDA), with the covenants contained in Section 6.11 and Section 6.12 recomputed as of the last day of the most recently ended fiscal quarter of STX for which financial information is available, as if such Investment (and any related incurrence or repayment of Indebtedness, with any new Indebtedness being deemed to be amortized over the applicable testing period in accordance with its terms) had occurred on the first day of each relevant period for testing such compliance; and (B) the Administrative Agent shall have received a certificate from a Financial Officer of STX that certifies compliance with clauses (p)(ii)(A) and (p)(iii), together with all 814159-0944-0061.4relevant financial information for the Person or assets to be acquired and reasonably detailed calculations demonstrating compliance with the requirement set forth in clause (ii)(A) and (iii) both before and after giving effect to such Investment and any related Borrowing, the Liquidity Amount shall not be less than $800,000,000; and (q) prepayments or advances to vendors or suppliers of semiconductors in connection with any guarantee of supply by, or to fund the expansion of supply capacity by, such vendor or supplier, in an aggregate amount not to exceed $50,000,000 at any one time outstanding.SECTION 6.05 Asset Sales. During a Non-Investment Grade Period, each of STX and the Borrower will not, and will not permit any of its Subsidiaries to, sell, transfer, lease or otherwise dispose of any asset, including any Equity Interest owned by it, nor will STX or the Borrower permit any of its subsidiaries to issue any additional Equity Interests in such Subsidiary (other than any Subsidiary issuing directors’ qualifying shares or issuing Equity Interests to STX, the Borrower or any Subsidiary in compliance with Section 6.04(c)), except:(a) sales of inventory, used or surplus equipment and Permitted Investments in the ordinary course of business and periodic clearance of aged inventory;(b) sales, transfers and other dispositions of Equity Interests to STX, the Borrower or any Subsidiary, provided that any such sale, transfer or other disposition involving a Subsidiary that is not a Subsidiary Loan Party (to the extent that such sale, transfer or other disposition is not made in the ordinary course of business of STX, the Borrower and the Subsidiaries) shall be made in compliance with Section 6.08;(c) sales of assets received by STX, the Borrower or any Subsidiary upon the exercise of a power of sale or foreclosure by STX, the Borrower or any Subsidiary with respect to any secured investment or other transfer of title with respect to any secured investment in default;(d) licensing and cross-licensing arrangements entered into in the ordinary course of business of STX, the Borrower or any Subsidiary involving any technology or other intellectual property of STX, the Borrower or such Subsidiary;(e) sales, transfers and other dispositions to STX, the Borrower or any Subsidiary, provided that any such sale, transfer or other disposition involving a Subsidiary that is not a Subsidiary Loan Party (to the extent that such sale, transfer or other disposition is not made in the ordinary course of business of STX, the Borrower and the Subsidiaries) shall be made in compliance with Section 6.08;(f) sales, transfers and other dispositions of Receivables and Related Assets pursuant to any Permitted Receivables Factoring;(g) sales, transfers and other dispositions that are not permitted by any other clause of this Section 6.05, provided that the aggregate fair market value of all assets sold, transferred or otherwise disposed of in reliance upon this clause (g) shall not exceed during any fiscal year of STX the amount that is equal to 15% of Consolidated Total Assets as of the end of the immediately preceding fiscal year of STX;(h) licensing of assets that constitute technology or other intellectual property to joint ventures in connection with investments permitted by Section 6.04; (i) sales of assets pursuant to a transaction permitted by Section 6.03(a); and824159-0944-0061.4(j) sale and leaseback transactions entered into in the ordinary course of business of STX, the Borrower and the Subsidiaries involving the sale and subsequent leaseback pursuant to a Platinum Lease of platinum or other precious metals, so long as such sale is consummated substantially simultaneously with the acquisition of the platinum or other precious metals so sold;provided that all sales, transfers, leases and other dispositions permitted hereby (other than those permitted by clause (b) or (e) above) shall be made for fair market value.SECTION 6.06 Swap Agreements. Each of STX and the Borrower will not, and will not permit any of its subsidiaries to, enter into any Swap Agreement, except (a) Swap Agreements entered into to hedge or mitigate risks to which STX, the Borrower or any Subsidiary has actual exposure, (other than those in respect of Equity Interests of STX, the Borrower or any Subsidiary, which shall be governed by clause (c) of this Section), (b) Swap Agreements entered into in order to effectively cap, collar or exchange interest rates (from fixed to floating rates, from one floating rate to another floating rate or otherwise) with respect to any interest-bearing liability or investment of STX, the Borrower or any Subsidiary, or (c)(i) Swap Agreements entered into by STX, the Borrower or any Subsidiary, and payments (in either cash or Equity Interests as applicable) required thereunder, (A) in respect of Equity Interests in STX providing for payments to current or former directors, officers or employees of STX, the Borrower and any Subsidiary or their heirs or estates and (B) in respect of Equity Interests in STX, the Borrower or any Subsidiary in connection with any redemption or repurchase by STX of its Equity Interests, and (ii) to the extent not permitted under clause (c)(i), any other Swap Agreements entered into by STX, the Borrower or any Subsidiary, and payments (in either cash or Equity Interests as applicable) required thereunder in respect of Equity Interests in STX; provided, that Restricted Payments required by the Swap Agreements entered into in reliance on this clause (c) shall only be made in the same circumstances under which, and in the amounts that, STX, the Borrower and the Subsidiaries are then permitted to make Restricted Payments pursuant to Section 6.07, and such Restricted Payments made during any fiscal year shall be deemed to reduce the amount of Restricted Payments available during such fiscal year under Section 6.07. SECTION 6.07 Restricted Payments. During any Non-Investment Grade Period, the Borrower will not, and STX and the Borrower will not permit any of their respective subsidiaries to, declare or make, or agree to pay or make, directly or indirectly, any Restricted Payment, except:(a) the Borrower and the Subsidiaries may declare and pay dividends ratably with respect to their Equity Interests payable solely in additional shares of their Equity Interests;(b) the Borrower and the Subsidiaries may declare and pay dividends or distributions ratably with respect to their Equity Interests, provided if the Borrower merges with or consolidates with or into STX (or if different the ultimate parent of the Borrower which is a publicly traded Person), then the Borrower shall no longer be able to declare and pay ratable dividends or distributions pursuant to this clause (b);(c) Restricted Payments consisting of cash dividends paid quarterly in respect of STX’s Equity Interests, provided that (i) no such Restricted Payments pursuant to this clause (c) shall be declared, permitted or made in an aggregate amount that is greater than $700,000,000 in any four consecutive fiscal quarter period, and (ii) after giving effect to each such Restricted Payment referred to in this clause (c) and any related Borrowing, the Liquidity Amount shall not be less than $800,000,000; and(d) other Restricted Payments, provided that (i) during the Covenant Relief Period, no such Restricted Payments shall be declared, permitted or made if before or after giving effect 834159-0944-0061.4thereto, the Total Leverage Ratio is, or on a pro forma basis would be, greater than 3.25:1.00, calculated based upon the financial information most recently delivered to the Administrative Agent pursuant to clause (c) of Section 5.01, (ii) at any time other than the Covenant Relief Period, no such Restricted Payments shall be declared, permitted or made if before or after giving effect thereto, the Total Leverage Ratio is, or on a pro forma basis would be, greater than 3.75:1.00, calculated based upon the financial information most recently delivered to the Administrative Agent pursuant to clause (c) of Section 5.01, and (iii) after giving effect to each such Restricted Payment referred to in this clause (d) and any related Borrowing, the Liquidity Amount shall not be less than $800,000,000.If any Restricted Payment described in any clause of this Section 6.07 made at the time an Investment Grade Period ends exceeds the amount of Restricted Payments that would be permitted at the time the succeeding Non-Investment Grade Period commences, then the amount of such excess shall be deemed to have been permitted under this Section.SECTION 6.08 Transactions with Affiliates. Each of STX and the Borrower will not, and will not permit any of its subsidiaries to, sell, lease or otherwise transfer any property or assets to, or purchase, lease or otherwise acquire any property or assets from, or otherwise engage in any other transactions with, any of its Affiliates, in excess of $15,000,000 except (a) transactions that are at prices and on terms and conditions not less favorable to STX, the Borrower or such Subsidiary than could be obtained on an arm’s-length basis from unrelated third parties, (b) transactions between or among STX, the Borrower and the Subsidiary Loan Parties (and, if the applicable transaction is a transaction in the ordinary course of business of STX, the Borrower and the applicable Subsidiary, any other Subsidiary) not involving any other Affiliate, (c) any issuance of securities, or other payments, awards or grants in cash, securities or otherwise pursuant to, or the funding of, employment arrangements, stock options and stock ownership plans approved by the board of directors of STX, the Borrower or any Subsidiary, (d) the grant of stock options or similar rights to officers, employees, consultants and directors of STX, the Borrower or any Subsidiary pursuant to plans approved by the board of directors of STX, the Borrower or, in the case of any such grant to an officer, employee, consultant or director of any Subsidiary, such Subsidiary and the payment of amounts or the issuance of securities pursuant thereto and (e) transactions otherwise permitted under this Agreement.SECTION 6.09 Restrictive Agreements. Each of STX and the Borrower will not, and will not permit any of its subsidiaries to, directly or indirectly, enter into, incur or permit to exist any agreement or other arrangement that prohibits, restricts or imposes any condition upon (a) the ability of STX, the Borrower or any Subsidiary to create, incur or permit to exist any Lien upon any of its property or assets to secure the obligations of STX and the Borrower under the Loan Documents or(b) the ability of any Subsidiary to pay dividends or other distributions with respect to any shares of its capital stock or to make or repay loans or advances to STX, the Borrower or any other Subsidiary or to Guarantee Indebtedness of STX, the Borrower or any other Subsidiary, provided that (i) the foregoing shall not apply to restrictions and conditions imposed by law or any Loan Document, (ii) the foregoing shall not apply to restrictions and conditions existing on the Effective Date imposed by any Senior Note Document or identified on Schedule 6.09 (but shall apply to any refinancing, replacement, extension or renewal of, or any amendment or modification expanding the scope of, any such restriction or condition), 844159-0944-0061.4(iii) the foregoing shall not apply to customary restrictions and conditions contained in agreements relating to the sale of any Subsidiary pending such sale, provided such restrictions and conditions apply only to such Subsidiary and such sale is permitted hereunder, (iv) the foregoing shall not apply to customary restrictions on or customary conditions to the payment of dividends or other distributions on, or the creation of Liens over, Equity Interests owned by STX, the Borrower or any Subsidiary in any joint venture or like enterprise that is not a Subsidiary contained in the constitutive documents of such joint venture or enterprise, (v) the foregoing shall not apply to restrictions or conditions imposed by any agreement relating to Indebtedness permitted by subclause (B) of Section 6.01(a)(ix) of this Agreement if such restrictions or conditions apply only to the property or assets securing such Indebtedness (in the case of clause (a) of the foregoing) and/or only to the Subsidiary incurring such Indebtedness or its subsidiaries (in the case of clause (b) of the foregoing), (vi) clause (a) of the foregoing shall not apply to customary provisions in leases or licenses (or sublicenses) of intellectual or similar property restricting the assignment, subletting or transfer thereof, (vii) clause (a) of the foregoing shall not apply to restrictions or conditions imposed by any agreement relating to any Permitted Receivables Factoring, provided that such restrictions or conditions apply only to the Receivables and the Related Assets that are the subject of such Permitted Receivables Factoring, and (viii) [RESERVED].SECTION 6.10 Amendment of Material Documents. Neither STX nor the Borrower will, nor will STX and the Borrower permit any of their respective subsidiaries to, amend, modify or waive any of its rights under (a) its certificate of incorporation, by-laws, memorandum or articles of association or other organizational documents or (b) any Senior Note Document, except to the extent that such amendments, modifications or waivers, individually or in the aggregate, would not reasonably be expected to have a Material Adverse Effect or be materially adverse to the Lenders.SECTION 6.11 Interest Coverage Ratio. STX will not permit the Interest Coverage Ratio as of the end of any fiscal quarter to be less than 3.25 to 1.00.SECTION 6.12 Total Leverage Ratio.(a) For any fiscal quarter ending during the Covenant Relief Period, STX will not permit the Total Leverage Ratio (i) as of the fiscal quarters ending December 30, 2022, March 31, 2023 and June 30, 2023, to exceed 5.00 to 1.00, (ii) as of the fiscal quarter ending September 29, 2023, to exceed 4.75 to 1.00 and (iii) as of the fiscal quarters ending December 29, 2023, March 29, 2024 and June 28, 2024, to exceed 4.50 to 1.00; and(b) for any fiscal quarter ending at any time other than during the Covenant Relief Period, STX will not permit the Total Leverage Ratio as of the end of such fiscal quarter to exceed 4.00 to 1.00. SECTION 6.13 Minimum Liquidity. STX will not permit the Liquidity Amount to be less than $700,000,000 at any time. 854159-0944-0061.4SECTION 6.14 OFAC Compliance. The Borrower will not, and will not permit any of its Subsidiaries to, do business in a Sanctioned Country or with a Sanctioned Person in violation of the economic sanctions of the United States administered by OFAC.SECTION 6.15 Successor Transaction. STX will not consummate a Successor Transaction unless prior to or contemporaneous with the consummation thereof (i) unless otherwise agreed to by the Required Lenders, the Administrative Agent shall have received a guarantee of all Obligations in form and substance satisfactory to it or a joinder to the U.S. Guarantee Agreement, from any Persons (including any holding companies) created or otherwise involved (referred to as a “New Obligor”) in the Successor Transaction, (ii) if STX is no longer the ultimate parent owner of the Borrower, unless otherwise agreed to by the Required Lenders, then each New Obligor shall have executed and delivered a joinder to this Agreement satisfactory to the Administrative Agent pursuant to which it becomes obligated for the same obligations binding on STX prior to the Successor Transaction, and (iii) the Administrative Agent (on behalf of the Lenders and itself), STX, the Borrower and, if applicable in the reasonable determination of the Administrative Agent, the New Obligor shall have executed and delivered an amendment to this Agreement and any other Loan Documents as specified by, and in form and substance reasonably satisfactory to, the Administrative Agent to reflect the New Obligor as the ultimate parent of STX and to preserve the rights and remedies of the Finance Parties and to ensure that such right and remedies are not adversely affected by the Successor Transaction. Notwithstanding the terms of Section 9.02(b), the Lenders hereby consent to, and authorize and direct the Administrative Agent to execute and deliver, (i) such amendments described in the preceding sentence on their behalf without any further consent of the Lenders (provided that, except as described in clause (ii) of this sentence, any such amendments shall not involve any modifications of the type set forth in Section 9.02 (b)(i) through (b)(vii)) and (ii) releases of STX as an obligor under the Loan Documents and as a Guarantor upon the approval of the Required Lenders. In connection with the foregoing, the Lenders and Administrative Agent agree that if approved by the Required Lenders, the removal of STX as a Guarantor in the event of a Successor Transaction does not adversely affect their rights and remedies.SECTION 6.16 Maximum Aggregate Debt. Notwithstanding any of the terms of this Agreement to the contrary, other than in connection with the Loan Documents, the Borrower will not, and will not permit any of its subsidiaries to, create, assume, incur, Guarantee (as defined in any Senior Note Document) or otherwise become liable for or suffer to exist Aggregate Debt (as defined in any Senior Note Document) in excess of $150,000,000 in the aggregate at any time outstanding during the Cap Period (as defined in the U.S. Guarantee Agreement).ARTICLE VIIEvents of DefaultSECTION 7.01 Events of Default. If any of the following events (“Events of Default”) shall occur:(a) the Borrower shall fail to pay any principal of any Loan or any reimbursement obligation in respect of any LC Disbursement when and as the same shall become due and payable, whether at the due date thereof or at a date fixed for prepayment thereof or otherwise;(b) the Borrower shall fail to pay any interest on any Loan or any fee or any other amount (other than an amount referred to in clause (a) of this Section 7.01) payable under this Agreement or any other Loan Document, when and as the same shall become due and payable, and such failure shall continue unremedied for a period of five days;864159-0944-0061.4(c) any representation or warranty made or deemed made by or on behalf of STX, the Borrower or any Subsidiary in or in connection with any Loan Document or any amendment or modification thereof or waiver thereunder, or in any report, certificate, financial statement or other document furnished pursuant to or in connection with any Loan Document or any amendment or modification thereof or waiver thereunder, shall prove to have been incorrect in any material respect when made or deemed made;(d) STX or the Borrower shall fail to observe or perform any covenant, condition or agreement contained in Section 5.02(a), Section 5.04 (with respect to the existence of STX or the Borrower), Section 5.09 or in Article VI;(e) STX or the Borrower shall fail to observe or perform any covenant, condition or agreement contained in any Loan Document (other than those specified in clause (a), (b) or (d) of this Section 7.01), and such failure shall continue unremedied for a period of 30 days after notice thereof from the Administrative Agent to the Borrower (which notice will be given at the request of any Lender);(f) STX, the Borrower or any Subsidiary shall fail to make any payment (whether of principal or interest and regardless of amount) in respect of any Material Indebtedness, when and as the same shall become due and payable after giving effect to any applicable grace period with respect thereto;(g) any event or condition occurs that results in any Material Indebtedness becoming due or any Permitted Receivables Factoring terminating (except voluntary terminations) prior to its scheduled maturity or that enables or permits the holder or holders of any Material Indebtedness or any trustee or agent on its or their behalf to cause any Material Indebtedness to become due or any Permitted Receivables Factoring to be terminated, or to require the prepayment, repurchase, redemption or defeasance thereof, prior to its scheduled maturity, provided that this clause (g) shall not apply to secured Indebtedness that becomes due as a result of the voluntary sale or transfer of the property or assets securing such Indebtedness;(h) an involuntary proceeding shall be commenced or an involuntary petition shall be filed seeking (i) liquidation, reorganization, examinership or other relief in respect of STX, the Borrower or, subject to Section 7.02, any Subsidiary or its debts, or of a substantial part of its assets, under any Federal, state or foreign bankruptcy, insolvency, receivership, examinership or similar law now or hereafter in effect or (ii) the appointment of a receiver, trustee, custodian, sequestrator, conservator, liquidator, examiner or similar official for STX, the Borrower or, subject to Section 7.02, any Subsidiary or for a substantial part of its assets, and, in any such case, such proceeding or petition shall continue undismissed for 60 days or an order or decree approving or ordering any of the foregoing shall be entered;(i) STX, the Borrower or, subject to Section 7.02, any Subsidiary shall (i) voluntarily commence any proceeding or file any petition seeking dissolution, winding-up, liquidation, reorganization, court protection or other relief under any Federal, state or foreign bankruptcy, insolvency, receivership, examinership or similar law now or hereafter in effect, (ii) consent to the institution of, or fail to contest in a timely and appropriate manner, any proceeding or petition described in clause (h) of this Section 7.01, (iii) apply for or consent to the appointment of a receiver, trustee, custodian, sequestrator, conservator, liquidator, examiner or similar official for STX, the Borrower or, subject to Section 7.02, any Subsidiary or for a substantial part of its assets, (iv) file an answer admitting the material allegations of a petition filed against it in any such proceeding, (v) make a general assignment for the benefit of creditors or (vi) take any action for the purpose of effecting any of the foregoing;874159-0944-0061.4(j) STX, the Borrower or, subject to Section 7.02, any Subsidiary shall become unable, admit in writing its inability or fail generally to pay its debts as they become due;(k) one or more judgments for the payment of money in an aggregate amount in excess of $100,000,000 (net of amounts covered by insurance as to which the insurer has admitted liability in writing) shall be rendered against STX, the Borrower, any Subsidiary or any combination thereof and the same shall remain undischarged for a period of 30 consecutive days during which execution shall not be effectively stayed, or any action shall be legally taken by a judgment creditor to attach or levy upon any assets of STX, the Borrower or any Subsidiary to enforce any such judgment;(l) an ERISA Event shall have occurred that, when taken together with all other ERISA Events that have occurred, could reasonably be expected to result in a Material Adverse Effect;(m) a Change in Control shall occur; or(n) the Guarantee under the Guarantee Agreement for any reason shall cease to be in full force and effect (other than in accordance with its terms), or any Loan Party (other than the Borrower) shall deny in writing that it has any further liability under the Guarantee Agreement (other than as a result of the discharge of such Loan Party) in accordance with the terms of the Loan Documents);then, and in every such event (other than an event with respect to the Borrower described in clause (h) or (i) of this Section 7.01), and at any time thereafter during the continuance of such event, the Administrative Agent may, and at the request of the Required Lenders shall, by notice to the Borrower, take either or both of the following actions, at the same or different times: (i) terminate the Commitments, and thereupon the Commitments shall terminate immediately, and (ii) declare the Loans then outstanding to be due and payable in whole (or in part, in which case any principal not so declared to be due and payable may thereafter be declared to be due and payable), and thereupon the principal of the Loans so declared to be due and payable, together with accrued interest thereon and all fees and other obligations of the Borrower accrued hereunder, shall become due and payable immediately, without presentment, demand, protest or other notice of any kind, all of which are hereby waived by the Borrower; and in case of any event with respect to the Borrower described in clause (h) or (i) of this Section 7.01, the Commitments shall automatically terminate and the principal of the Loans then outstanding, together with accrued interest thereon and all fees and other obligations of the Borrower accrued hereunder, shall automatically become due and payable, without presentment, demand, protest or other notice of any kind, all of which are hereby waived by the Borrower.SECTION 7.02 Exclusion of Immaterial Subsidiaries. Solely for the purposes of determining whether a Default has occurred under clause (h), (i) or (j) of Section 7.01, any reference in any such clause to any Subsidiary shall be deemed not to include any Subsidiary affected by any event or circumstance referred to in any such clause that did not, as of the last day of the fiscal quarter of STX most recently ended, have assets with a value in excess of 5.0% of the Consolidated Total Assets as of such date, provided that if it is necessary to exclude more than one Subsidiary from clause (h), (i) or (j) of Section 7.01 pursuant to this Section 7.02 in order to avoid a Default thereunder, all excluded Subsidiaries shall be considered to be a single consolidated Subsidiary for purposes of determining whether the condition specified above is satisfied. 884159-0944-0061.4ARTICLE VIIIThe Administrative AgentSECTION 8.01 The Administrative Agent as Agent. Each Lender and each Issuing Bank hereby irrevocably appoints the Administrative Agent as its agent and authorizes the Administrative Agent to take such actions on its behalf and to exercise such powers as are delegated to the Administrative Agent by the terms of the Loan Documents, together with such actions and powers as are reasonably incidental thereto. Except to the extent expressly provided in this Article VIII, the provisions of this Article VIII are solely for the benefit of the Administrative Agent, the Lenders and the Issuing Banks, and no Loan Party shall have rights as a third party beneficiary of any of such provisions.SECTION 8.02 The Administrative Agent as Lender. The bank serving as the Administrative Agent hereunder shall have the same rights and powers in its capacity as a Lender as any other Lender and may exercise the same as though it were not the Administrative Agent, and such bank and its Affiliates may accept deposits from, lend money to and generally engage in any kind of business with STX, the Borrower or any Subsidiary or other Affiliate thereof as if it were not the Administrative Agent hereunder.SECTION 8.03 No Duties. The Administrative Agent shall not have any duties or obligations except those expressly set forth in the Loan Documents. Without limiting the generality of the foregoing, (a) the Administrative Agent shall not be subject to any fiduciary or other implied duties, regardless of whether a Default has occurred and is continuing, (b) the Administrative Agent shall not have any duty to take any discretionary action or exercise any discretionary powers, except discretionary rights and powers expressly contemplated by the Loan Documents that the Administrative Agent is required to exercise in writing by the Required Lenders (or such other number or percentage of the Lenders as shall be necessary or believed by the Administrative Agent in good faith to be necessary under the circumstances as provided in Section 9.02), and (c) except as expressly set forth in the Loan Documents, the Administrative Agent shall not have any duty to disclose, and shall not be liable for the failure to disclose, any information relating to STX, Borrower or any Subsidiary that is communicated to or obtained by the bank serving as the Administrative Agent or any of its Affiliates in any capacity. The Administrative Agent shall not be liable for any action taken or not taken by it with the consent or at the request of the Required Lenders (or such other number or percentage of the Lenders as shall be necessary under the circumstances as provided in Section 9.02) or in the absence of its own gross negligence or willful misconduct. The Administrative Agent shall be deemed not to have knowledge of any Default unless and until written notice thereof is given to the Administrative Agent by STX, the Borrower or a Lender, and the Administrative Agent shall not be responsible for or have any duty to ascertain or inquire into (i) any statement, warranty or representation made in or in connection with any Loan Document, (ii) the contents of any certificate, report or other document delivered thereunder or in connection therewith, (iii) the performance or observance of any of the covenants, agreements or other terms or conditions set forth in any Loan Document or the occurrence of any Default, (iv) the validity, enforceability, effectiveness or genuineness of any Loan Document or any other agreement, instrument or document or (v) the satisfaction of any condition set forth in Article IV or elsewhere in any Loan Document, other than to confirm receipt of items expressly required to be delivered to the Administrative Agent.SECTION 8.04 Reliance by the Agent and Exculpation. The Administrative Agent shall be entitled to rely upon, and shall not incur any liability for relying upon, any notice, request, certificate, consent, statement, instrument, document or other writing (including any electronic message, Internet or intranet website posting or other distribution) believed by it to be 894159-0944-0061.4genuine and to have been signed or sent or otherwise authenticated by the proper Person. The Administrative Agent also may rely upon any statement made to it orally or by telephone and believed by it to be made by the proper Person, and shall not incur any liability for relying thereon. The Administrative Agent may consult with legal counsel (who may be counsel for the Borrower), independent accountants and other experts selected by it, and shall not be liable for any action taken or not taken by it in accordance with the advice of any such counsel, accountants or experts.SECTION 8.05 Delegation of Agent’s Obligations. The Administrative Agent may perform any of and all its duties and exercise its rights and powers by or through any one or more sub-agents appointed by the Administrative Agent. The Administrative Agent and any such sub-agent may perform any of and all its duties and exercise its rights and powers by or through their respective Related Parties. The exculpatory provisions of this Article VIII shall apply to any such sub-agent and to the Related Parties of the Administrative Agent and any such sub-agent, and shall apply to their respective activities in connection with the syndication of the credit facilities provided for herein as well as activities as the Administrative Agent.In determining (i) whether conditions precedent to the effectiveness of this Agreement have been satisfied, or (ii) compliance with any condition hereunder to the making of a Loan, or the issuance, amendment, renewal or extension of a Letter of Credit, in each case, that by its terms must be fulfilled to the satisfaction of a Lender or an Issuing Bank, the Administrative Agent may presume that such condition precedent or condition to extension of credit is satisfactory to such Lender or such Issuing Bank, unless the Administrative Agent shall have received notice to the contrary from such Lender or such Issuing Bank prior to the Administrative Agent’s declaration that the conditions precedent for the documentary deliverables as required under Section 4.01 have been satisfied, or the making of such Loan or the issuance, amendment, renewal or extension of such Letter of Credit.SECTION 8.06 Successor. Subject to the appointment and acceptance of a successor Administrative Agent as provided in this Section, the Administrative Agent may resign at any time upon notice to the Lenders, the Issuing Bank and the Borrower. Upon any such resignation, the Required Lenders shall have the right, subject to the approval of the Borrower (which approval shall not be unreasonably withheld), to appoint a successor. If no successor shall have been so appointed by the Required Lenders and shall have accepted such appointment within 30 days after the retiring Administrative Agent gives notice of its resignation, then the retiring Administrative Agent may, on behalf of the Lenders and the Issuing Bank, appoint a successor Administrative Agent that shall be a bank with an office in New York, New York, or an Affiliate of any such bank. Upon the acceptance of its appointment as the Administrative Agent hereunder by a successor, such successor shall succeed to and become vested with all the rights, powers, privileges and duties of the retiring Administrative Agent, and the retiring Administrative Agent shall be discharged from all its duties and obligations under the Loan Documents in its capacity as the Administrative Agent. The fees payable by the Borrower to a successor Administrative Agent shall be the same as those payable to its predecessor unless otherwise agreed between the Borrower and such successor. After the Administrative Agent’s resignation hereunder, the provisions of this Article VIII and Section 9.03 shall continue in effect for the benefit of such retiring Administrative Agent, its sub-agents and their respective Related Parties in respect of any actions taken or omitted to be taken by any of them while the retiring Administrative Agent was acting as the Administrative Agent.SECTION 8.07 Credit Decisions. Each Lender acknowledges that it has, independently and without reliance upon the Administrative Agent or any other Lender or any of their Related Parties and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon the Administrative Agent or any other Lender or 904159-0944-0061.4any of their Related Parties and based on such documents and information as it shall from time to time deem appropriate, continue to make its own decisions in taking or not taking action under or based upon any Loan Document or any related agreement or any document furnished thereunder.SECTION 8.08 Limitations on Obligations of Certain Transaction Parties. Notwithstanding anything herein to the contrary, none of the Arrangers, Bookrunners, Syndication Agent or Documentation Agents shall have any powers, duties or responsibilities under any Loan Document, except in its capacity, as applicable, as the Administrative Agent, a Lender or an Issuing Bank hereunder. It is agreed that the Bookrunners, Syndication Agents and Documentation Agents shall have no duties or responsibilities under this Agreement or any other Loan Document in their capacities as such. No Bookrunner, Syndication Agent or Documentation Agent shall have or be deemed to have any fiduciary relationship with any Lender. Each Lender acknowledges that it has not relied, and will not rely, on the Bookrunners, Syndication Agents or Documentation Agents in deciding to enter into this Agreement or any other Loan Document or in taking or not taking any action hereunder or thereunder.SECTION 8.09 Guarantee Matters. The Lenders and the Issuing Banks irrevocably authorize the Administrative Agent, at its option and in its discretion: (a) to release any Lien on collateral (if any) granted to or held by the Administrative Agent under any Loan Document (i) upon the Maturity Date, (ii) that is disposed of or to be disposed of as part of or in connection with any transfer or sale permitted hereunder or under any other Loan Document, or (iii) subject to Section 9.02, if approved, authorized or ratified in writing by the Required Lenders or all Lenders, if so required; and(b) if any Person that is a Guarantor ceases to be required to be a Guarantor as a result of a transaction permitted hereunder, to release such Guarantor from its obligations under the applicable Guarantee Agreement. Upon request by the Administrative Agent at any time, the Required Lenders will confirm in writing the authority of the Administrative Agent to release any Lien on collateral held by such Agent or any Guarantor from its obligations under the Loan Documents pursuant to this Section.SECTION 8.10 Certain ERISA Matters. (a) Each Lender (x) represents and warrants, as of the date such Person became a Lender party hereto, to, and (y) covenants, from the date such Person became a Lender party hereto to the date such Person ceases being a Lender party hereto, that at least one of the following is and will be true: (i) such Lender is not using “plan assets” (within the meaning of Section 3(42) of ERISA or otherwise) of one or more Benefit Plans with respect to such Lender’s entrance into, participation in, administration of and performance of the Loans, the Letters of Credit, the Commitments, this Agreement or the other Loan Documents, (ii) the transaction exemption set forth in one or more PTEs, such as PTE 84-14 (a class exemption for certain transactions determined by independent qualified professional asset managers), PTE 95-60 (a class exemption for certain transactions involving insurance company general accounts), PTE 90-1 (a class exemption for certain transactions involving insurance company pooled separate accounts), PTE 91-38 (a class exemption for certain transactions involving bank collective investment funds) or PTE 96-23 (a class exemption for certain transactions determined by in-house asset managers), is applicable with respect to such Lender’s entrance into, participation in, administration of and performance of the Loans, the Letters of Credit, the Commitments, this Agreement and the other Loan Documents, or914159-0944-0061.4(iii) (A) such Lender is an investment fund managed by a “Qualified Professional Asset Manager” (within the meaning of Part VI of PTE 84-14), (B) such Qualified Professional Asset Manager made the investment decision on behalf of such Lender to enter into, participate in, administer and perform the Loans, the Letters of Credit, the Commitments, this Agreement and the other Loan Documents, (C) the entrance into, participation in, administration of and performance of the Loans, the Letters of Credit, the Commitments and this Agreement and the other Loan Documents satisfies the requirements of sub-sections (b) through (g) of Part I of PTE 84- 14 and (D) to the best knowledge of such Lender, the requirements of subsection (a) of Part I of PTE 84-14 are satisfied with respect to such Lender’s entrance into, participation in, administration of and performance of the Loans, the Letters of Credit, the Commitments and this Agreement and the other Loan Documents. (b) In addition, unless either (x) clause (a)(i) is true with respect to a Lender or (y) a Lender has provided another representation, warranty and covenant in accordance with clause (a)(iii), such Lender further (i) represents and warrants, as of the date such Person became a Lender party hereto, to, and (ii) covenants, from the date such Person became a Lender party hereto to the date such Person ceases being a Lender party hereto, for the benefit of, the Administrative Agent (and not to or for the benefit of the Borrower or any other Loan Party), that the Administrative Agent is not a fiduciary with respect to the assets of such Lender involved in such Lender’s entrance into, participation in, administration of and performance of the Loans, the Letters of Credit, the Commitments, this Agreement and the other Loan Documents (including in connection with the reservation or exercise of any rights by the Administrative Agent under this Agreement or any other Loan Document).SECTION 8.11 Erroneous Payments. (a) If the Administrative Agent (x) notifies a Lender, Issuing Bank or any Person who has received funds on behalf of a Lender or Issuing Bank (any such Lender, Issuing Bank or other recipient, a “Payment Recipient”) that the Administrative Agent has determined in its reasonable discretion (whether or not after receipt of any notice under immediately succeeding clause (b)) that any funds (as set forth in such notice from the Administrative Agent) received by such Payment Recipient from the Administrative Agent or any of its Affiliates were erroneously or mistakenly transmitted to, or otherwise erroneously or mistakenly received by, such Payment Recipient (whether or not known to such Lender, Issuing Bank or other Payment Recipient on its behalf) (any such funds, whether transmitted or received as a payment, prepayment or repayment of principal, interest, fees, distribution or otherwise, individually and collectively, an “Erroneous Payment”) and (y) demands in writing the return of such Erroneous Payment (or a portion thereof) (provided, that, without limiting any other rights or remedies (whether at law or in equity), the Administrative Agent may not make any such demand under this clause (a) with respect to an Erroneous Payment unless such demand is made within five Business Days of the date of receipt of such Erroneous Payment by the applicable Payment Recipient), such Erroneous Payment shall at all times remain the property of the Administrative Agent pending its return or repayment as contemplated below in this Section 8.11 and held in trust for the benefit of the Administrative Agent, and such Lender and Issuing Bank shall (or, with respect to any Payment Recipient who received such funds on such Lender’s or Issuing Bank’s behalf, shall cause such Payment Recipient to) promptly, but in no event later than two Business Days thereafter (or such later date as the Administrative Agent may, in its sole discretion, specify in writing), return to the Administrative Agent the amount of any such Erroneous Payment (or portion thereof) as to which such a demand was made, in same day funds (in the currency so received), together with interest thereon (except to the extent waived in writing by the Administrative Agent) in respect of each day from and including the date such Erroneous Payment (or portion thereof) was received by such Payment Recipient to the date such amount is repaid to the Administrative Agent in same day funds at the greater of the Federal Funds Effective Rate and a rate determined by the Administrative Agent in accordance with banking industry rules on interbank 924159-0944-0061.4compensation from time to time in effect. A notice of the Administrative Agent to any Payment Recipient under this clause (a) shall be conclusive, absent manifest error.(b) Without limiting immediately preceding clause (a), each Payment Recipient who has received funds on behalf of a Lender or Issuing Bank agrees that if it receives a payment, prepayment or repayment (whether received as a payment, prepayment or repayment of principal, interest, fees, distribution or otherwise) from the Administrative Agent (or any of its Affiliates) (x) that is in a different amount than, or on a different date from, that specified in this Agreement, any Loan Document or in a notice of payment, prepayment or repayment sent by the Administrative Agent (or any of its Affiliates) with respect to such payment, prepayment or repayment, (y) that was not preceded or accompanied by a notice of payment, prepayment or repayment sent by the Administrative Agent (or any of its Affiliates), or (z) that such Payment Recipient, otherwise becomes aware was transmitted, or received, in error or by mistake (in whole or in part), then in each such case: (i) it acknowledges and agrees that (A) in the case of immediately preceding clauses (x) or (y), an error and mistake shall be presumed to have been made (absent written confirmation from the Administrative Agent to the contrary) or (B) an error and mistake has been made (in the case of immediately preceding clause (z)), in each case, with respect to such payment, prepayment or repayment; and(ii) such Lender or Issuing Bank shall use commercially reasonable efforts to (and shall use commercially reasonable efforts to cause any Payment Recipient that receives funds on its respective behalf to) promptly (and, in all events, within one Business Day of its knowledge of the occurrence of any of the circumstances described in immediately preceding clauses (x), (y) and (z)) notify the Administrative Agent of its receipt of such payment, prepayment or repayment, the details thereof (in reasonable detail) and that it is so notifying the Administrative Agent pursuant to this clause (b).For the avoidance of doubt, the failure to deliver a notice to the Administrative Agent pursuant to this clause (b) shall not have any effect on a Payment Recipient’s obligations pursuant to clause (a) of this Section 8.11 or on whether or not an Erroneous Payment has been made.(c) Each Lender and Issuing Bank hereby authorizes the Administrative Agent to set off, net and apply any and all amounts at any time owing to such Lender or Issuing Bank under any Loan Document, or otherwise payable or distributable by the Administrative Agent to such Lender or Issuing Bank under any Loan Document with respect to any payment of principal, interest, fees or other amounts, against any amount that the Administrative Agent has demanded to be returned under clause (a) of this Section 8.11.(d) (i) In the event that an Erroneous Payment (or portion thereof) is not recovered by the Administrative Agent for any reason, after demand therefor in accordance with immediately preceding clause (a), from any Lender that has received such Erroneous Payment (or portion thereof) (and/or from any Payment Recipient who received such Erroneous Payment (or portion thereof) on its respective behalf) (such unrecovered amount, an “Erroneous Payment Return Deficiency”), upon the Administrative Agent’s notice to such Lender at any time, then effective immediately (with the consideration therefor being acknowledged by the parties hereto), (A) such Lender shall be deemed to have assigned its Loans (but not its Commitments) of the relevant Class with respect to which such Erroneous Payment was made (the “Erroneous Payment Impacted Class”) in an amount equal to the Erroneous Payment Return Deficiency (or such lesser amount as the Administrative Agent may specify) (such assignment of the Loans (but not Commitments) of the Erroneous Payment Impacted Class, the “Erroneous Payment Deficiency Assignment”) (on a cashless basis and such amount calculated at par plus any accrued and unpaid interest (with the assignment fee to be waived by the Administrative Agent 934159-0944-0061.4in such instance)), and is hereby (together with the Borrower) deemed to execute and deliver an Assignment and Acceptance Agreement (or, to the extent applicable, an agreement incorporating an Assignment and Acceptance Agreement by reference pursuant to an electronic platform approved by the Administrative Agent (an “Approved Electronic Platform”) as to which the Administrative Agent and such parties are participants) with respect to such Erroneous Payment Deficiency Assignment, and such Lender shall deliver any Notes evidencing such Loans to the Borrower or the Administrative Agent (but the failure of such Person to deliver any such Notes shall not affect the effectiveness of the foregoing assignment), (B) the Administrative Agent as the assignee Lender shall be deemed to have acquired the Erroneous Payment Deficiency Assignment, (C) upon such deemed acquisition, the Administrative Agent as the assignee Lender shall become a Lender, as applicable, hereunder with respect to such Erroneous Payment Deficiency Assignment and the assigning Lender shall cease to be a Lender, as applicable, hereunder with respect to such Erroneous Payment Deficiency Assignment, excluding, for the avoidance of doubt, its obligations under the indemnification provisions of this Agreement and its applicable Commitments which shall survive as to such assigning Lender, (D) the Administrative Agent and the Borrower shall each be deemed to have waived any consents required under this Agreement to any such Erroneous Payment Deficiency Assignment, and (E) the Administrative Agent will reflect in the Register its ownership interest in the Loans subject to the Erroneous Payment Deficiency Assignment. For the avoidance of doubt, no Erroneous Payment Deficiency Assignment will reduce the Commitments of any Lender and such Commitments shall remain available in accordance with the terms of this Agreement. (ii) Subject to Section 9.04 (but excluding, in all events, any assignment consent or approval requirements (whether from the Borrower or otherwise)), the Administrative Agent may, in its discretion, sell any Loans acquired pursuant to an Erroneous Payment Deficiency Assignment and upon receipt of the proceeds of such sale, the Erroneous Payment Return Deficiency owing by the applicable Lender shall be reduced by the net proceeds of the sale of such Loan (or portion thereof), and the Administrative Agent shall retain all other rights, remedies and claims against such Lender (and/or against any Payment Recipient that receives funds on its respective behalf). In addition, an Erroneous Payment Return Deficiency owing by the applicable Lender (x) shall be reduced by the proceeds of prepayments or repayments of principal and interest, or other distribution in respect of principal and interest, received by the Administrative Agent on or with respect to any such Loans acquired from such Lender pursuant to an Erroneous Payment Deficiency Assignment (to the extent that any such Loans are then owned by the Administrative Agent) and (y) may, in the sole discretion of the Administrative Agent, be reduced by any amount specified by the Administrative Agent in writing to the applicable Lender from time to time.(e) The parties hereto agree that (x) irrespective of whether the Administrative Agent may be equitably subrogated, in the event that an Erroneous Payment (or portion thereof) is not recovered from any Payment Recipient that has received such Erroneous Payment (or portion thereof) for any reason, the Administrative Agent shall be subrogated to all the rights and interests of such Payment Recipient (and, in the case of any Payment Recipient who has received funds on behalf of a Lender, Issuing Bank or Secured Party, to the rights and interests of such Lender, Issuing Bank or Secured Party, as the case may be) under the Loan Documents with respect to such amount (the “Erroneous Payment Subrogation Rights”) (provided that the Loan Parties’ Obligations under the Loan Documents in respect of the Erroneous Payment Subrogation Rights shall not be duplicative of such Obligations in respect of Loans that have been assigned to the Administrative Agent under an Erroneous Payment Deficiency Assignment) and (y) an Erroneous Payment shall not pay, prepay, repay, discharge or otherwise satisfy any Obligations owed by the Borrower or any other Loan Party; provided that this Section shall not be interpreted to increase (or accelerate the due date for), or have the effect of increasing (or accelerating the due date for), the Obligations of the Borrower relative to the amount (and/or timing for payment) of the Obligations that would have been payable had such Erroneous Payment not been made by 944159-0944-0061.4the Administrative Agent; provided, further, that for the avoidance of doubt, immediately preceding clauses (x) and (y) shall not apply to the extent any such Erroneous Payment is, and solely with respect to the amount of such Erroneous Payment that is, comprised of funds received by the Administrative Agent from the Borrower for the purpose of making such Erroneous Payment.(f) To the extent permitted by applicable law, no Payment Recipient shall assert any right or claim to an Erroneous Payment, and hereby waives, and is deemed to waive, any claim, counterclaim, defense or right of set-off or recoupment with respect to any demand, claim or counterclaim by the Administrative Agent for the return of any Erroneous Payment received, including, without limitation, any defense based on “discharge for value” or any similar doctrine.Each party’s obligations, agreements and waivers under this Section shall survive the resignation or replacement of the Administrative Agent, any transfer of rights or obligations by, or the replacement of, a Lender or Issuing Bank, the termination of the Commitments and/or the repayment, satisfaction or discharge of all Obligations (or any portion thereof) under any Loan Document.ARTICLE IXMiscellaneousSECTION 9.01 Notices. Except in the case of notices and other communications expressly permitted to be given by telephone, all notices and other communications provided for herein shall be in writing and shall be delivered by hand or overnight courier service, mailed by certified or registered mail or sent by telecopy, as follows:(a) if to STX or the Borrower, to it at:47488 Kato RoadFremont, California 94538Attention: Walter ChangEmail: walter.chang@seagate.com(b) if to the Administrative Agent:The Bank of Nova Scotia GWS Loan Operations 720 King Street West, 2nd Floor Toronto, Ontario M5V 2T3Attn: U.S. Loan Agency Operations Phone: (212) 225-5706Fax: (212) 225-5708E-mail: corporatelending.dealops@scotiabank.com(c) if to an Issuing Bank other than the Administrative Agent (if applicable), to it at the address or telecopy number set forth separately in writing;(d) if to a Swingline Lender other than the Administrative Agent (if applicable), to it at the address or telecopy number set forth separately in writing; and954159-0944-0061.4(e) if to any other Lender, to it at its address (or telecopy number) set forth in its Administrative Questionnaire.Any party hereto may change its address or telecopy number for notices and other communications hereunder by notice to the other parties hereto. Notices and other communications to the Lenders and any Issuing Bank hereunder may also be delivered or furnished by electronic communication (including e-mail and Internet or intranet websites) pursuant to procedures approved by the Administrative Agent, provided that the foregoing shall not apply to notices to any Lender or any Issuing Bank pursuant to Article II if such Lender or the applicable Issuing Bank, as applicable, has notified the Administrative Agent that it is incapable of receiving notices under such Article by electronic communication. The Administrative Agent or the Borrower may, in its discretion, agree to accept notices and other communications to it hereunder by electronic communications pursuant to procedures approved by it, provided that approval of such procedures may be limited to particular notices or communications. All notices and other communications given to any party hereto in accordance with the provisions of this Agreement shall be deemed to have been given on the date of receipt.SECTION 9.02 Waivers; Amendments. (a) No failure or delay by the Administrative Agent, any Issuing Bank or any Lender in exercising any right or power under any Loan Document shall operate as a waiver thereof, nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such a right or power, preclude any other or further exercise thereof or the exercise of any other right or power. The rights and remedies of the Administrative Agent, each Issuing Bank and the Lenders under the Loan Documents are cumulative and are not exclusive of any rights or remedies that they would otherwise have. No waiver of any provision of any Loan Document or consent to any departure by STX or the Borrower therefrom shall in any event be effective unless the same shall be permitted by clause (b) of this Section 9.02, and then such waiver or consent shall be effective only in the specific instance and for the purpose for which given. Without limiting the generality of the foregoing, the making of a Loan or the issuance, amendment, renewal or extension of a Letter of Credit shall not be construed as a waiver of any Default, regardless of whether the Administrative Agent, any Lender or any Issuing Bank may have had notice or knowledge of such Default at the time. No notice or demand on STX or the Borrower in any case shall entitle STX or the Borrower to any other or further notice or demand in similar or other circumstances.(b) Except as provided in Section 2.21, Section 2.23 with respect to any Maturity Date extension and Section 2.24(a), neither this Agreement nor any other Loan Document nor any provision hereof or thereof may be waived, amended or modified except, in the case of this Agreement, pursuant to an agreement or agreements in writing entered into by STX, the Borrower and the Required Lenders or, in the case of any other Loan Document, pursuant to an agreement or agreements in writing entered into by each of STX and the Borrower, if they are parties thereto, and the Administrative Agent, in each case with the consent of the Required Lenders, provided that no such agreement shall (i) extend or increase the Commitment of any Lender without the written consent of such Lender, (ii) reduce the principal amount of any Loan or LC Disbursement or reduce the rate of interest thereon, or reduce any fees payable hereunder, without the written consent of each Lender directly affected thereby, (iii) postpone the final maturity of any Loan or the required date of reimbursement of any LC Disbursement, or any required date for the payment of any interest or 964159-0944-0061.4fees payable hereunder, or reduce the amount of, waive or excuse any such required payment, or postpone the scheduled date of expiration of any Commitment, without the written consent of each Lender affected thereby, (iv) change Section 2.17(b) or (c) in a manner that would alter the pro rata sharing of payments required thereby, without the written consent of each Lender, (v) change any of the provisions of this Section 9.02 or the percentage set forth in the definition of the term “Required Lenders” or any other provision of any Loan Document specifying the number or percentage of Lenders required to waive, amend or modify any rights thereunder or make any determination or grant any consent thereunder, without the written consent of each Lender, (vi) release any Guarantor from its Guarantee under the applicable Guarantee Agreement (except as expressly provided herein or in such Guarantee Agreement), or limit its liability in respect of such Guarantee, without the written consent of each Lender,(vii) change the definition of the term “Interest Period” to permit the Borrower to select interest periods of 9 or 12 months for SOFR Borrowings without the written consent of each Lender affected thereby, or(viii) if a Revolving Loan, Swingline Loan or Letter of Credit is being requested, modify conditions precedent set forth in Section 4.02 without the consent of Revolving Loan Lenders holding, in the aggregate, no less than 50.0% of the Revolving Loan Percentages, provided further that no such agreement shall amend, modify or otherwise affect the rights or duties of the Administrative Agent, any Issuing Bank or any Swingline Lender under this Agreement or the Guarantee Agreement without the prior written consent of the Administrative Agent, such Issuing Bank or such Swingline Lender, as the case may be. (c) In connection with any proposed amendment, modification, waiver or termination (a “Proposed Change”) to any Loan Document requiring the consent of all affected Lenders, if the consent of the Required Lenders to such Proposed Change is obtained, but the consent to such Proposed Change of other Lenders whose consent is required is not obtained (any such Lender whose consent is not obtained as described in this Section 9.02(b) being referred to as a “Non-Consenting Lender”), then, so long as the Lender that is acting as the Administrative Agent is not a Non-Consenting Lender, at the Borrower’s request, any assignee that is reasonably acceptable to the Administrative Agent (and that is not a Non-Consenting Lender) shall have the right, with the prior consent of the Administrative Agent, each Swingline Lender and each Issuing Bank (which consent (x) shall not be unreasonably withheld or delayed and (y) in the case of any consent required by any Issuing Bank, shall be deemed to have been given in the event that such Issuing Bank fails to respond in writing to a request for consent within two Business Days of receipt thereof), to purchase from such Non-Consenting Lender, and such Non-Consenting Lender agrees that it shall, upon the Borrower’s request, sell and assign to such assignee, at no expense to such Non-Consenting Lender (including with respect to any processing and recordation fees that may be applicable pursuant to Section 9.04(b)(ii)(c), which shall be paid by the assignee or the Borrower), all the Revolving Commitments and Revolving Loans (in the case of a Revolving Loan Lender) and the Term Loan Commitments and Term Loans (in the case of a Term Loan Lender) of such Non-Consenting Lender for an amount equal to the principal balance of all applicable Loans (and in the case of a Revolving Loan Lender, funded participations in Swingline Loans and unreimbursed LC Disbursements) 974159-0944-0061.4held by such Non-Consenting Lender and all accrued interest, fees and other amounts with respect thereto through the date of sale (including amounts under Sections 2.14, 2.15 and 2.16), such purchase and sale to be consummated pursuant to an executed Assignment and Acceptance in accordance with Section 9.04(b) (which Assignment and Acceptance need not be signed by such Non-Consenting Lender). (d) Notwithstanding anything to the contrary herein, (i) no Defaulting Lender shall have any right to approve or disapprove any amendment, waiver or consent hereunder, except that the Commitment of such Lender may not be increased or extended without the consent of such Lender and (ii) no Defaulting Lender shall be included as a Lender for purposes of the calculation of “Required Lenders” (in either the numerator or the denominator). (e) Notwithstanding anything contained herein to the contrary, this Agreement may be amended and restated without the consent of any Lender (but with the consent of the Borrower and the Administrative Agent) if, upon giving effect to such amendment and restatement, such Lender shall no longer be a party to this Agreement (as so amended and restated), the Commitments of such Lender shall have terminated (but such Lender shall continue to be entitled to the benefits of Sections 2.14 through 2.16 (inclusive) and 9.03, and in each other term of a Loan Document that expressly survives termination of such Loan Document), such Lender shall have no other Commitment or other Obligation hereunder and shall have been paid in full all principal, interest and other amounts owing to it or accrued for its account under this Agreement (and in the case of an Issuing Bank, all of its LC Exposure has been Cash Collateralized). For the avoidance of doubt it is understood that any transaction permitted by Section 2.23 shall not be subject to this Section 9.02.SECTION 9.06 Expenses; Indemnity; Damage Waiver. (a) The Borrower shall pay (i) all reasonable out-of-pocket expenses incurred by the Administrative Agent and its Affiliates, including the reasonable fees, charges and disbursements of one counsel for the Administrative Agent in connection with the syndication of the credit facilities provided for herein, the preparation and administration of the Loan Documents or any amendments, modifications or waivers of the provisions thereof (whether or not the transactions contemplated thereby shall be consummated), (ii) all reasonable out-of-pocket expenses incurred by any Issuing Bank in connection with the issuance, amendment, renewal or extension of any Letter of Credit or any demand for payment thereunder and (iii) all reasonable out-of-pocket expenses incurred by the Administrative Agent, any Issuing Bank or any Lender, including the reasonable fees, charges and disbursements of one counsel each, in each applicable jurisdiction, for the Administrative Agent, any Issuing Bank or any Lender, in connection with the enforcement or protection of its rights in connection with the Loan Documents, including its rights under this Section 9.03, or in connection with the Loans made or Letters of Credit issued hereunder, including all such reasonable out-of-pocket expenses incurred during any workout, restructuring or negotiations in respect of such Loans or Letters of Credit.(b) The Borrower shall indemnify the Administrative Agent, each Issuing Bank and each Lender, and each Related Party of any of the foregoing Persons (each such Person being called an “Indemnitee”) against, and hold each Indemnitee harmless from, any and all losses, claims, damages, liabilities (including any Environmental Liability) and related expenses, including the reasonable fees, charges and disbursements of any counsel for any Indemnitee, incurred by or asserted against any Indemnitee by any third party or by STX, the Borrower or any Subsidiary arising out of, in connection with, or as a result of (i) any Loan or Letter of Credit or the use of the proceeds therefrom (including any refusal by any Issuing Bank to honor a demand for payment under a Letter of Credit if the documents presented in connection with such demand do not strictly comply with the terms of such Letter of Credit), (ii) any actual or alleged presence, Release or threatened Release of Hazardous Materials at, onto or from any property 984159-0944-0061.4currently or formerly owned or operated by STX, the Borrower or any Subsidiary, or any other Environmental Liability related in any way to STX, the Borrower or any Subsidiary, or (iii) any actual or prospective claim, litigation, investigation or proceeding relating to any of the foregoing, whether based on contract, tort or any other theory, whether brought by a third party or by STX, the Borrower or any Subsidiary and regardless of whether any Indemnitee is a party thereto, provided that such indemnity shall not, as to any Indemnitee, be available to the extent that such losses, claims, damages, liabilities or related expenses resulted from the gross negligence or willful misconduct, as determined in a finally determined nonappealable judgment by a court of competent jurisdiction, of such Indemnitee.(c) To the extent that the Borrower fails to pay any amount required to be paid by it to the Administrative Agent, any Issuing Bank or any Swingline Lender under clause (a) or (b) of this Section 9.03, each Lender severally agrees to pay to the Administrative Agent, such Issuing Bank or such Swingline Lender, as the case may be, such Lender’s Applicable Percentage (determined as of the time that the applicable unreimbursed expense or indemnity payment is sought) of such unpaid amount, provided that the unreimbursed expense or indemnified loss, claim, damage, liability or related expense, as the case may be, was incurred by or asserted against the Administrative Agent, such Issuing Bank or such Swingline Lender in its capacity as such.(d) To the fullest extent permitted by applicable law, neither STX nor the Borrower shall assert, and each hereby waives, any claim against any Indemnitee, on any theory of liability, for special, indirect, consequential or punitive damages (as opposed to direct or actual damages) arising out of, in connection with, or as a result of, any Loan Document or any agreement or instrument contemplated thereby (including the execution, delivery and performance by STX and the Borrower of such Loan Document, agreement or instrument), any Loan or Letter of Credit or the use of the proceeds thereof. In addition, no Indemnitee shall be liable for any damages arising from the use by others of information or other materials obtained through electronic, telecommunications or other information transmission systems, except to the extent such damages resulted from the gross negligence or willful misconduct, as determined in a finally determined nonappealable judgment by a court of competent jurisdiction, of such Indemnitee.(e) All amounts due under this Section 9.03 shall be payable promptly after written demand therefor.(f) No director, officer, employee, stockholder or member, as such, of any Loan Party shall have any liability for the obligations of such Loan Party under the Loan Documents or for any claim based on, in respect of or by reason of such obligations or their creation, provided that the foregoing shall not be construed to relieve any Loan Party of its obligations under any Loan Document.SECTION 9.04 Successors and Assigns. (a) The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns permitted hereby (including any Affiliate of any Issuing Bank that issues any Letter of Credit), except that (i) the Borrower may not assign or otherwise transfer any of its rights or obligations hereunder without the prior written consent of each Lender (and any attempted assignment or transfer by the Borrower without such consent shall be null and void) and (ii) no Lender may assign or otherwise transfer its rights or obligations hereunder except in accordance with this Section 9.04. Nothing in this Agreement, expressed or implied, shall be construed to confer upon any Person (other than the parties hereto, their respective successors and assigns permitted hereby (including any Affiliate of any Issuing Bank that issues any Letter of Credit), Participants (to the extent provided in 994159-0944-0061.4clause (e) of this Section 9.04) and, to the extent expressly contemplated hereby, the Related Parties of each of the Administrative Agent, the Issuing Banks and the Lenders) any legal or equitable right, remedy or claim under or by reason of this Agreement.(b) (i) Subject to the conditions set forth in clause (b)(ii) below, any Lender may assign to one or more assignees (other than any natural person or holding company, investment vehicle or trust for, or owned and operated for the primary benefit of, a natural person, or any Defaulting Lender) all or a portion of its rights and obligations under this Agreement (including all or a portion of its Commitment and the Loans at the time owing to it), provided that except in the case of an assignment of Loans or Commitments to a Lender or Lender Affiliate, the Borrower, the Administrative Agent and, if the assignment is of Revolving Commitments or Revolving Loans, then also each Swingline Lender and each Issuing Bank, must give their prior written consent to such assignment (which consent (x) shall not be unreasonably withheld or delayed, (y) in the case of any consent required by any Issuing Bank, shall be deemed to have been given in the event that such Issuing Bank fails to respond in writing to a request for consent within two Business Days of receipt thereof, and (z) in the case of the Borrower, shall be deemed to have consented to any such assignment unless it shall object thereto by written notice to the Administrative Agent within five Business Days after having received notice thereof); and provided further that no such consent of the Borrower shall be required if an Event of Default under clause (a), (b), (h) or (i) of Section 7.01 has occurred and is continuing.(ii) Assignments shall be subject to the following additional conditions: (A) except in the case of an assignment to a Lender or a Lender Affiliate or an assignment of the entire remaining amount of the assigning Lender’s Loans and Commitment (or, after the Revolving Commitments have been terminated, the Revolving Exposure of a Revolving Loan Lender), the amount of the applicable Loans and Commitment of the assigning Lender subject to each such assignment (determined as of the date the Assignment and Acceptance with respect to such assignment is delivered to the Administrative Agent) shall be an amount not less than $5,000,000, unless each of the Borrower and the Administrative Agent (and, in the case of an assignment of all or a portion of a Revolving Commitment or any Lender’s obligations in respect of its Swingline Exposure, each Swingline Lender) otherwise consent, which consent shall not be unreasonably withheld or delayed, provided that the Borrower shall be deemed to have consented to any such assignment unless it shall object thereto by written notice to the Administrative Agent within five Business Days after having received notice thereof, and provided that no such consent of the Borrower shall be required if an Event of Default under clause (a), (b), (h) or (i) of Section 7.01 has occurred and is continuing, (B) each partial assignment of one Class of an assigning Lender’s Commitments or Loans shall be made as an assignment of a proportionate part of all the assigning Lender’s rights and obligations under such Class of Commitments or Loans, (C) the parties to each assignment shall execute and deliver to the Administrative Agent an Assignment and Acceptance, together with a processing and recordation fee of $3,500, provided that assignments made pursuant to Section 2.18(b) shall not require the signature of the assigning Lender to become effective, and (D) the assignee, if it shall not be a Lender, shall deliver to the Administrative Agent an Administrative Questionnaire and any tax forms required by Section 2.16(f).(iii) Subject to acceptance and recording thereof pursuant to clause (b)(v) of this Section 9.04, from and after the effective date specified in each Assignment and Acceptance, the assignee thereunder shall be a party hereto and, to the extent of the interest assigned by such Assignment and Acceptance, have the rights and obligations of a Lender under this Agreement (provided that any liability of the Borrower to such assignee under Section 2.14, Section 2.15 or Section 2.16 shall be limited to the amount, if any, that would have been payable thereunder by the Borrower in the absence of such assignment; and provided further that an assignee that is a Foreign Lender shall not be entitled to the benefits of Section 2.16 unless such assignee agrees to comply with the requirements of Section 2.16(f)), and the assigning Lender thereunder shall, to 1004159-0944-0061.4the extent of the interest assigned by such Assignment and Acceptance, be released from its obligations under this Agreement (and, in the case of an Assignment and Acceptance covering all of the assigning Lender’s rights and obligations under this Agreement, such Lender shall cease to be a party hereto but shall continue to be entitled to the benefits of Section 2.14, Section 2.15, Section 2.16 and Section 9.03 and to any fees payable hereunder that have accrued for such Lender’s account but have not yet been paid). Any assignment or transfer by a Lender of rights or obligations under this Agreement that does not comply with this clause (b) shall be treated for purposes of this Agreement as a sale by such Lender of a participation in such rights and obligations in accordance with clause (c)(i) of this Section 9.04.(iv) The Administrative Agent, acting for this purpose as a non-fiduciary agent of the Borrower, shall maintain at one of its offices in The City of New York a copy of each Assignment and Acceptance delivered to it and a register for the recordation of the names and addresses of the Lenders, and the Commitment of, and principal amount of the Loans and LC Disbursements owing to, each Lender pursuant to the terms hereof from time to time (the “Register”). The entries in the Register shall be conclusive, and STX, the Borrower, the Administrative Agent, the Issuing Banks and the Lenders shall treat each Person whose name is recorded in the Register pursuant to the terms hereof as a Lender hereunder for all purposes of this Agreement, notwithstanding notice to the contrary. The Register shall be available for inspection by the Borrower, the Issuing Bank and any Lender, at any reasonable time and from time to time upon reasonable prior notice.(c) Upon its receipt of a duly completed Assignment and Acceptance executed by an assigning Lender and an assignee, the assignee’s completed Administrative Questionnaire and any tax forms required by Section 2.16(f) (unless the assignee shall already be a Lender hereunder), the processing and recordation fee referred to in clause (b) of this Section 9.04 and any written consent to such assignment required by clause (b) of this Section 9.04, the Administrative Agent shall accept such Assignment and Acceptance and record the information contained therein in the Register. No assignment shall be effective for purposes of this Agreement unless it has been recorded in the Register as provided in this clause.(d) The words “execution”, “signed”, “signature” and words of like import in any Assignment and Acceptance shall be deemed to include electronic signatures or the keeping of records in electronic form, each of which shall be of the same legal effect, validity or enforceability as a manually executed signature or the use of a paper-based recordkeeping system, as the case may be, to the extent and as provided for in any applicable law, including the Federal Electronic Signatures in Global and National Commerce Act, the New York State Electronic Signatures and Records Act or any other similar state laws based on the Uniform Electronic Transactions Act.(e) (i) Any Lender may, without the consent of the Borrower, the Administrative Agent, the Issuing Banks or the Swingline Lenders, sell participations to one or more banks or other entities (other than any natural person or holding company, investment vehicle or trust for, or owned and operated for the primary benefit of, a natural person, or any Defaulting Lender) (a “Participant”) in all or a portion of such Lender’s rights and obligations under this Agreement (including all or a portion of its Commitment and the Loans owing to it), provided that (A) such Lender’s obligations under this Agreement shall remain unchanged, (B) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations and (C) STX, the Borrower, the Administrative Agent, the Issuing Banks and the other Lenders shall continue to deal solely and directly with such Lender in connection with such Lender’s rights and obligations under this Agreement. Any agreement or instrument pursuant to which a Lender sells such a participation shall provide that such Lender shall retain the sole right to enforce the Loan Documents and to approve any amendment, modification or waiver of any provision of the Loan Documents, provided that such agreement or instrument may provide that such Lender will 1014159-0944-0061.4not, without the consent of the Participant, agree to any amendment, modification or waiver described in the first proviso to Section 9.02(b) that affects such Participant. Subject to clause (f) of this Section 9.04, the Borrower agrees that each Participant shall be entitled to the benefits of Section 2.14, Section 2.15 and Section 2.16 to the same extent as if it were a Lender and had acquired its interest by assignment pursuant to clause (b) of this Section 9.04. To the extent permitted by law, each Participant also shall be entitled to the benefits of Section 9.08 as though it were a Lender, provided that such Participant agrees to be subject to Section 2.17(c) as though it were a Lender.(ii) A Participant shall not be entitled to receive any greater payment under Section 2.14 or 2.16 than the applicable Lender would have been entitled to receive with respect to the participation sold to such Participant, unless the sale of the participation to such Participant is made with the Borrower’s prior written consent or except to the extent such entitlement to receive a greater payment results from a Change in Law that occurs after the Participant acquired the applicable participation.(f) Any Lender may at any time pledge or assign a security interest in all or any portion of its rights under this Agreement to secure obligations of such Lender, including any pledge or assignment to secure obligations to a Federal Reserve Bank, and this Section 9.04 shall not apply to any such pledge or assignment of a security interest, provided that no such pledge or assignment of a security interest shall release a Lender from any of its obligations hereunder or substitute any such pledgee or assignee for such Lender as a party hereto. In the case of any Lender that is a fund that invests in bank loans, such Lender may, without the consent of the Borrower or the Administrative Agent, assign or pledge all or any portion of any instrument evidencing its rights as a Lender under this Agreement to any trustee for, or any other representative of holders of obligations owed or securities issued by, such fund, as security for such obligations or securities, provided that any foreclosure or similar action by such trustee or representative shall be subject to the provisions of this Section 9.04 concerning assignments.(g) In the event that S&P or Moody’s shall, after the date that any Lender becomes a Revolving Loan Lender, downgrade the long-term certificate deposit ratings or long-term senior unsecured debt ratings of such Revolving Loan Lender (or the parent company thereof), and the resulting ratings shall be BBB+ or lower by S&P or Baa1 or lower by Moody’s, then each Swingline Lender and each Issuing Bank shall have the right, but not the obligation, at its own expense, upon notice to such Revolving Loan Lender, the Administrative Agent and the Borrower and the consent of the Borrower if such ratings of such proposed replacement are not at least one rating higher, to replace such Revolving Loan Lender with respect to such Revolving Loan Lender’s Revolving Commitment with an assignee (in accordance with and subject to the restrictions contained in clause (b) above, including the right of the Borrower and the Administrative Agent to consent to the identity of such assignee (which consent shall not be unreasonably withheld or delayed)), and such Revolving Loan Lender hereby agrees to transfer and assign without recourse (in accordance with and subject to the restrictions contained in clause (b) above) all its interests, rights and obligations in respect of its Revolving Commitment to such assignee, provided, however, that (i) no such assignment shall conflict with any law, rule and regulation or order of any Governmental Authority, (ii) such Revolving Loan Lender shall have received payment of an amount equal to the outstanding principal of its Revolving Loans and participations in LC Disbursements and Swingline Loans, accrued interest thereon, accrued fees and all other amounts payable to it (in its capacity as a Revolving Loan Lender) hereunder from the assignee (to the extent of such outstanding principal and accrued interest and fees) or the Borrower (in the case of all other amounts and (iii) the Borrower or such assignee shall have paid to the Administrative Agent the processing and recordation fee specified in Section 9.04(b).(h) Notwithstanding anything to the contrary contained herein, any Lender (a “Granting Lender”) may grant to a special purpose funding vehicle (an “SPV”), identified as 1024159-0944-0061.4such in writing from time to time by the Granting Lender to the Administrative Agent and the Borrower, the option to provide to the Borrower all or any part of any Loan that such Granting Lender would otherwise be obligated to make to the Borrower pursuant to this Agreement, provided that (i) nothing herein shall constitute a commitment by any SPV to make any Loan or, except as provided in the immediately succeeding sentence, affect in any way the Commitment of the Granting Lender and (ii) if an SPV elects not to exercise such option or otherwise fails to provide all or any part of such Loan, the Granting Lender shall be obligated to make such Loan pursuant to the terms hereof. The making of a Loan by an SPV hereunder shall utilize the Commitment of the Granting Lender to the same extent, and as if, such Loan were made by such Granting Lender. In the event that an SPV provides all or any part of any Loan, STX, the Borrower and the Administrative Agent shall continue to deal solely and directly with the Granting Lender with respect to such Loan, including with respect to the giving of notices and the delivery of financial statements, certificates and other documents (including pursuant to Article V) and information. Each party hereto hereby agrees that no SPV shall (A) be liable for any indemnity or similar payment obligation under this Agreement (all liability for which shall remain with the Granting Lender), (B) have any voting rights under Section 9.02 or Article VII or with respect to any other matter under this Agreement to which the Lenders are entitled to give their consent (all of which voting rights shall remain with the Granting Lender) or (C) be entitled to receive any greater amount pursuant to Section 2.14, Section 2.15, Section 2.16 or Section 9.03 than the Granting Lender would have been entitled to receive in respect of the amount of any Loan provided by the SPV if the Granting Lender had in fact made such Loan. In furtherance of the foregoing, each party hereto hereby agrees (which agreement shall survive the termination of this Agreement) that, prior to the date that is one year and one day after the payment in full of all outstanding commercial paper or other senior indebtedness of any SPV, such party will not institute against, or join any other person in instituting against, such SPV any bankruptcy, reorganization, arrangement, insolvency or liquidation proceedings under the laws of the United States or any State thereof. In addition, notwithstanding anything to the contrary contained in this Section 9.04, any SPV may (i) with notice to, but without the prior written consent of, the Borrower and the Administrative Agent and without paying any processing fee therefor, assign all or a portion of its interests in any Loans to the Granting Lender or to any financial institutions (consented to by the Borrower and the Administrative Agent) providing liquidity and/or credit support to or for the account of such SPV to support the funding or maintenance of Loans and (ii) disclose on a confidential basis any non-public information relating to its Loans to any rating agency, commercial paper dealer or provider of any surety, guarantee or credit or liquidity enhancement to such SPV. As this Section 9.04(h) applies to any particular SPV, this Section may not be amended without the written consent of such SPV.Each Lender that sells a participation shall, acting solely for this purpose as a non-fiduciary agent of the Borrower (solely for tax purposes), maintain a register on which it enters the name and address of each Participant and the principal amounts (and stated interest) of each Participant’s interest in the Loans or other Loan Document Obligations (the “Participant Register”); provided that no Lender shall have any obligation to disclose all or any portion of the Participant Register (including the identity of any Participant or any information relating to a Participant's interest in any Commitments, Loans, Letters of Credit or its other Loan Document Obligations) to any Person except to the extent that such disclosure is necessary to establish that such Commitment, Loan, Letter of Credit or other Obligation is in registered form under Section 5f.103-1(c) and Proposed Section 1.163-5(b) of the United States Treasury Regulations. The entries in the Participant Register shall be conclusive absent manifest error, and such Lender shall treat each Person whose name is recorded in the Participant Register as the owner of such participation for all purposes of this Agreement notwithstanding any notice to the contrary. For the avoidance of doubt, the Administrative Agent (in its capacity as Administrative Agent) shall have no responsibility for maintaining a Participant Register.1034159-0944-0061.4SECTION 9.05 Survival. All covenants, agreements, representations and warranties made by the Loan Parties in the Loan Documents and in the certificates or other instruments delivered in connection with or pursuant to any Loan Document shall be considered to have been relied upon by the other parties hereto and shall survive the execution and delivery of the Loan Documents and the making of any Loans and issuance of any Letters of Credit, regardless of any investigation made by any such other party or on its behalf and notwithstanding that the Administrative Agent, any Issuing Bank or any Lender may have had notice or knowledge of any Default or incorrect representation or warranty at the time any credit is extended hereunder, and shall continue in full force and effect as long as the principal of or any accrued interest on any Loan or any fee or any other amount payable under this Agreement is outstanding and unpaid or any Letter of Credit is outstanding and so long as the Commitments have not expired or terminated. The provisions of Section 2.14, Section 2.15, Section 2.16 and Section 9.03 and Article VIII shall survive and remain in full force and effect regardless of the consummation of the transactions contemplated hereby, the repayment of the Loans, the expiration or termination of the Letters of Credit and the Commitments or the termination of this Agreement or any provision hereof.SECTION 9.06 Counterparts; Integration; Effectiveness. This Agreement may be executed in counterparts (and by different parties hereto on different counterparts), each of which shall constitute an original, but all of which when taken together shall constitute a single contract. This Agreement, the other Loan Documents and any separate letter agreements with respect to fees payable to the Administrative Agent or the syndication of the Loans and Commitments constitute the entire contract among the parties relating to the subject matter hereof and supersede any and all previous agreements and understandings, oral or written, relating to the subject matter hereof. Except as provided in Section 4.01, this Agreement shall become effective when it shall have been executed by the Administrative Agent and when the Administrative Agent shall have received counterparts hereof that, when taken together, bear the signatures of each of the other parties hereto, and thereafter shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. Delivery of an executed counterpart of a signature page of this Agreement by electronic signature, telecopy or Adobe .pdf transmission shall be effective as delivery of a manually executed counterpart of this Agreement.SECTION 9.07 Severability. Any provision of this Agreement held to be invalid, illegal or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such invalidity, illegality or unenforceability without affecting the validity, legality and enforceability of the remaining provisions hereof; and the invalidity of a particular provision in a particular jurisdiction shall not invalidate such provision in any other jurisdiction.SECTION 9.08 Right of Setoff. If an Event of Default shall have occurred and be continuing, each Lender and each of its Affiliates is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final, in whatever currency) at any time held and other obligations (in whatever currency) at any time owing by such Lender or any such Affiliate to or for the credit or the account of the Borrower against any of and all the obligations of the Borrower then existing under this Agreement (to the extent such obligations of the Borrower are then due and payable (by acceleration or otherwise)) held by such Lender, irrespective of whether or not such Lender shall have made any demand under this Agreement and although such obligations may be unmatured or are owed to a branch or office of such Lender different from the branch or office holding such deposit or obligated on such Indebtedness. The applicable Lender shall notify the Borrower and the Administrative Agent of such setoff and application, provided that any failure to give or any delay in giving such notice shall not affect the validity of any such setoff and application under this Section 9.08. The rights of each Lender 1044159-0944-0061.4and its Affiliates under this Section 9.08 are in addition to other rights and remedies (including other rights of setoff) that such Lender and its Affiliates may have.SECTION 9.09 Governing Law; Jurisdiction; Consent to Service of Process.(a) THIS AGREEMENT SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAW OF THE STATE OF NEW YORK.(b) Each of STX and the Borrower hereby irrevocably and unconditionally submits, for itself and its property, to the exclusive jurisdiction of the Supreme Court of the State of New York sitting in New York County and of the United States District Court of the Southern District of New York, and any appellate court from any thereof, in any action or proceeding arising out of or relating to any Loan Document, or for recognition or enforcement of any judgment, and each of the parties hereto hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in such New York State court or, to the extent permitted by law, in such Federal court. Each of the parties hereto agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing in any Loan Document shall affect any right that the Administrative Agent, any Issuing Bank or any Lender may otherwise have to bring any action or proceeding relating to any Loan Document against STX, the Borrower or their respective properties in the courts of any jurisdiction.(c) Each of STX and the Borrower hereby irrevocably and unconditionally waives, to the fullest extent it may legally and effectively do so, any objection that it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to any Loan Document in any court referred to in clause (b) of this Section 9.09. Each of the parties hereto hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court.(d) Each party to this Agreement irrevocably consents to service of process in the manner provided for notices in Section 9.01. Nothing in any Loan Document will affect the right of any party to this Agreement to serve process in any other manner permitted by law. Each of STX and the Borrower hereby irrevocably appoint Seagate Technology (US) as agent for service of process in the United States and Seagate Technology (US) hereby accepts such appointment and agrees that its address for purposes of this clause and similar clauses in the U.S. Guarantee Agreement is that set forth in Section 9.01(a). Seagate Technology (US) agrees that its appointment is irrevocable so long as any Obligations remain outstanding under this Agreement, and that it shall give the Administrative Agent at least 10 Business Days’ notice of any change to its address upon which service of process can be made on it pursuant to this Section. In any event, the address at which service of process can be made shall be an address located in New York or California.SECTION 9.10 WAIVER OF JURY TRIAL. EACH PARTY HERETO HEREBY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY RIGHT IT MAY HAVE TO A TRIAL BY JURY IN ANY LEGAL PROCEEDING DIRECTLY OR INDIRECTLY ARISING OUT OF OR RELATING TO ANY LOAN DOCUMENT OR THE TRANSACTIONS CONTEMPLATED THEREBY (WHETHER BASED ON CONTRACT, TORT OR ANY OTHER THEORY). EACH PARTY HERETO (A) CERTIFIES THAT NO REPRESENTATIVE, AGENT OR ATTORNEY OF ANY OTHER PARTY HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT SUCH OTHER PARTY WOULD NOT, IN THE EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVER AND (B) ACKNOWLEDGES THAT IT AND THE OTHER PARTIES HERETO HAVE BEEN INDUCED TO ENTER INTO THIS AGREEMENT BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS IN THIS SECTION 9.10.1054159-0944-0061.4SECTION 9.11 Headings. Article and Section headings and the Table of Contents used herein are for convenience of reference only, are not part of this Agreement and shall not affect the construction of, or be taken into consideration in interpreting, this Agreement.SECTION 9.12 Confidentiality. Each of the Administrative Agent, the Issuing Banks and the Lenders agrees to maintain the confidentiality of the Information (as defined below), except that Information may be disclosed (a) to its and its Affiliates’ directors, officers, employees and agents, including accountants, legal counsel and other advisors (it being understood that the Persons to whom such disclosure is made will be informed of the confidential nature of such Information and instructed to keep such Information confidential), (b) to the extent requested by any regulatory authority or self-regulatory authority, (c) to the extent required by applicable laws or regulations or by any subpoena or similar legal process, (d) to any other party to this Agreement, (e) in connection with the exercise of any remedies hereunder or any suit, action or proceeding relating to any Loan Document or the enforcement of rights thereunder, (f) subject to an agreement containing provisions substantially the same as those of this Section 9.12 (or an agreement to be bound by the provisions of this Section 9.12), to (i) any assignee of, Participant in, or credit insurance provider for, or any prospective assignee, Participant or credit insurance provider, in any of its rights or obligations under this Agreement or (ii) any actual or prospective direct or indirect contractual counterparties in swap or other derivative agreements or such contractual counterparties’ professional advisors, (g) with the consent of the Borrower, (h) to the extent such Information (i) becomes publicly available other than as a result of a breach of this Section 9.12 or (ii) becomes available to the Administrative Agent, any Issuing Bank or any Lender on a nonconfidential basis from a source other than STX, Seagate UC or the Borrower or (i) to any nationally recognized rating agency that requires access to information about a Lender’s investment portfolio in connection with ratings issued with respect to such Lender. In the case of any disclosure of Information pursuant to clause (c) or clause (e) of the preceding sentence, the Administrative Agent will inform the Borrower of such disclosure of which it has knowledge and to the extent it is not prohibited under applicable law from notifying the Borrower. For the purposes of this Section 9.12, the term “Information” means all information received from STX, Seagate UC or the Borrower relating to STX, Seagate UC or the Borrower or their business, other than any such information that is available to the Administrative Agent, any Issuing Bank or any Lender on a nonconfidential basis prior to disclosure by STX, Seagate UC or the Borrower. Any Person required to maintain the confidentiality of Information as provided in this Section 9.12 shall be considered to have complied with its obligation to do so if such Person has exercised the same degree of care to maintain the confidentiality of such Information as such Person would accord to its own confidential information.SECTION 9.13 Interest Rate Limitation. Notwithstanding anything herein to the contrary, if at any time the interest rate applicable to any Loan or participation in any LC Disbursement, together with all fees, charges and other amounts that are treated as interest on such Loan or LC Disbursement or participation therein under applicable law (collectively the “Charges”), shall exceed the maximum lawful rate (the “Maximum Rate”) that may be contracted for, charged, taken, received or reserved by the Lender holding such Loan or LC Disbursement or participation therein in accordance with applicable law, the rate of interest payable in respect of such Loan hereunder, together with all Charges payable in respect thereof, shall be limited to the Maximum Rate and, to the extent lawful, the interest and Charges that would have been payable in respect of such Loan or LC Disbursement or participation therein but were not payable as a result of the operation of this Section 9.13 shall be cumulated and the interest and Charges payable to such Lender in respect of other Loans or LC Disbursements or participations therein or periods shall be increased (but not above the Maximum Rate therefor) until such cumulated amount, together with interest thereon at the Federal Funds Effective Rate to the date of repayment, shall have been received by such Lender.1064159-0944-0061.4SECTION 9.14 Judgment Currency. (a) The Borrower’s obligations hereunder and the Borrower’s and STX’s obligations under the other Loan Documents to make payments in dollars (the “Obligation Currency”) shall not be discharged or satisfied by any tender or recovery pursuant to any judgment expressed in or converted into any currency other than the Obligation Currency, except to the extent that such tender or recovery results in the effective receipt by the Administrative Agent, an Issuing Bank’s or a Lender of the full amount of the Obligation Currency expressed to be payable to the Administrative Agent, such Issuing Bank or such Lender under the Loan Documents. If, for the purpose of obtaining or enforcing judgment against the Borrower in any court or in any jurisdiction, it becomes necessary to convert into or from any currency other than the Obligation Currency (such other currency being hereinafter referred to as the “Judgment Currency”) an amount due in the Obligation Currency, the conversion shall be made, at the rate of exchange (as quoted by the Administrative Agent or, if the Administrative Agent does not quote a rate of exchange on such currency, by a known dealer in such currency designated by the Administrative Agent) determined, in each case, as of the date immediately preceding the day on which the judgment is given (such Business Day being hereinafter referred to as the “Judgment Currency Conversion Date”).(b) If there is a change in the rate of exchange prevailing between the Judgment Currency Conversion Date and the date of actual payment of the amount due, the Borrower and STX covenants and agrees to pay, or cause to be paid, such additional amounts, if any (but in any event not a lesser amount), as may be necessary to ensure that the amount paid in the Judgment Currency, when converted at the rate of exchange prevailing on the date of payment, will produce the amount of the Obligation Currency that could have been purchased with the amount of Judgment Currency stipulated in the judgment or judicial award at the rate of exchange prevailing on the Judgment Currency Conversion Date.(c) For purposes of determining the rate of exchange for this Section 9.14, such amounts shall include any premium and costs payable in connection with the purchase of the Obligation Currency.SECTION 9.15 USA PATRIOT Act. Each Lender hereby notifies STX and the Borrower that pursuant to the requirements of the USA PATRIOT Act (Title III of Pub. L. 107-56 (signed into law October 26, 2001)) (the “USA PATRIOT Act”), it is required to obtain, verify and record information that identifies STX and the Borrower, which information includes the name and address of STX and the Borrower and other information that will allow such Lender to identify STX and the Borrower in accordance with the USA PATRIOT Act.SECTION 9.16 Acknowledgement and Consent to Bail-In of Affected Financial Institutions. Notwithstanding anything to the contrary in this Agreement or in any other agreement, arrangement or understanding among any such parties, each party hereto acknowledges that any liability of any Affected Financial Institution arising hereunder, to the extent such liability is unsecured, may be subject to the write-down and conversion powers of an applicable Resolution Authority and agrees and consents to, and acknowledges and agrees to be bound by:(a) the application of any Write-Down and Conversion Powers by an applicable Resolution Authority to any such liabilities arising hereunder which may be payable to it by any party hereto that is an Affected Financial Institution; and(b) the effects of any Bail-In Action on any such liability, including, if applicable (i) a reduction in full or in part or cancellation of any such liability; (ii) a conversion of all, or a portion of, such liability into shares or other instruments of ownership in such Affected Financial 1074159-0944-0061.4Institution, its parent undertaking, or a bridge institution that may be issued to it or otherwise conferred on it, and that such shares or other instruments of ownership will be accepted by it in lieu of any rights with respect to any such liability under this Agreement; or (iii) the variation of the terms of such liability in connection with the exercise of the Write-Down and Conversion Powers of any Resolution Authority.SECTION 9.17 Acknowledgement Regarding Any Supported QFCs. To the extent that the Loan Documents provide support, through a guarantee or otherwise, for Swap Agreements or any other agreement or instrument that is a QFC (such support, “QFC Credit Support” and each such QFC a “Supported QFC”), the parties acknowledge and agree with respect to the resolution power of the Federal Deposit Insurance Corporation under the Federal Deposit Insurance Act and Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (together with the regulations promulgated thereunder, the “U.S. Special Resolution Regimes”) in respect of such Supported QFC and QFC Credit Support (with the provisions below applicable notwithstanding that the Loan Documents and any Supported QFC may in fact be stated to be governed by the laws of the State of New York and/or of the United States or any other state of the United States) that in the event a Covered Entity that is party to a Supported QFC (each, a “Covered Party”) becomes subject to a proceeding under a U.S. Special Resolution Regime, the transfer of such Supported QFC and the benefit of such QFC Credit Support (and any interest and obligation in or under such Supported QFC and such QFC Credit Support, and any rights in property securing such Supported QFC or such QFC Credit Support) from such Covered Party will be effective to the same extent as the transfer would be effective under the U.S. Special Resolution Regime if the Supported QFC and such QFC Credit Support (and any such interest, obligation and rights in property) were governed by the laws of the United States or a state of the United States. In the event a Covered Party or a BHC Act Affiliate of a Covered Party becomes subject to a proceeding under a U.S. Special Resolution Regime, Default Rights under the Loan Documents that might otherwise apply to such Supported QFC or any QFC Credit Support that may be exercised against such Covered Party are permitted to be exercised to no greater extent than such Default Rights could be exercised under the U.S. Special Resolution Regime if the Supported QFC and the Loan Documents were governed by the laws of the United States or a state of the United States. Without limitation of the foregoing, it is understood and agreed that rights and remedies of the parties with respect to a Defaulting Lender shall in no event affect the rights of any Covered Party with respect to a Supported QFC or any QFC Credit Support.1084159-0944-0061.4 EX-31.1 3 stx-ex311_20221230.htm EX-31.1 DocumentEXHIBIT 31.1 CERTIFICATION I, Dr. William D. Mosley, certify that: 1.I have reviewed this quarterly report on Form 10-Q of Seagate Technology Holdings plc;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd)disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; andb)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date:January 25, 2023/s/ Dr. William D. Mosley Name:Dr. William D. Mosley Title:Chief Executive Officer and Director (Principal Executive Officer) EX-31.2 4 stx-ex312_20221230.htm EX-31.2 DocumentEXHIBIT 31.2 CERTIFICATION I, Gianluca Romano, certify that: 1.I have reviewed this quarterly report on Form 10-Q of Seagate Technology Holdings plc;2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;b)designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;c)evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd)disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):a)all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; andb)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date:January 25, 2023/s/ Gianluca Romano Name:Gianluca Romano Title:Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) EX-32.1 5 stx-ex321_20221230.htm EX-32.1 DocumentEXHIBIT 32.1 CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 This certification is not to be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and does not constitute a part of the Quarterly Report of Seagate Technology Holdings plc (the “Company”) on Form 10-Q for the fiscal quarter ended December 30, 2022, as filed with the Securities and Exchange Commission on the date hereof (the “Report”). In connection with the Report, we, Dr. William D. Mosley, Chief Executive Officer of the Company, and Gianluca Romano, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that: (1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: January 25, 2023/s/ Dr. William D. Mosley Name:Dr. William D. 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DefinitionThe exact name of the entity filing the report as specified in its charter, which is required by forms filed with the SEC. + ReferencesReference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher SEC -Name Exchange Act -Number 240 -Section 12 -Subsection b-2 + Details Name: dei_EntityRegistrantName Namespace Prefix: dei_ Data Type: xbrli:normalizedStringItemType Balance Type: na Period Type: duration X - DefinitionBoolean flag that is true when the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. + ReferencesReference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher SEC -Name Exchange Act -Number 240 -Section 12 -Subsection b-2 + Details Name: dei_EntityShellCompany Namespace Prefix: dei_ Data Type: xbrli:booleanItemType Balance Type: na Period Type: duration X - DefinitionIndicates that the company is a Smaller Reporting Company (SRC). + ReferencesReference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher SEC -Name Exchange Act -Number 240 -Section 12 -Subsection b-2 + Details Name: dei_EntitySmallBusiness Namespace Prefix: dei_ Data Type: xbrli:booleanItemType Balance Type: na Period Type: duration X - DefinitionThe Tax Identification Number (TIN), also known as an Employer Identification Number (EIN), is a unique 9-digit value assigned by the IRS. + ReferencesReference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher SEC -Name Exchange Act -Number 240 -Section 12 -Subsection b-2 + Details Name: dei_EntityTaxIdentificationNumber Namespace Prefix: dei_ Data Type: dei:employerIdItemType Balance Type: na Period Type: duration X - DefinitionLocal phone number for entity. + ReferencesNo definition available. + Details Name: dei_LocalPhoneNumber Namespace Prefix: dei_ Data Type: xbrli:normalizedStringItemType Balance Type: na Period Type: duration X - DefinitionTitle of a 12(b) registered security. + ReferencesReference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher SEC -Name Exchange Act -Number 240 -Section 12 -Subsection b + Details Name: dei_Security12bTitle Namespace Prefix: dei_ Data Type: dei:securityTitleItemType Balance Type: na Period Type: duration X - DefinitionName of the Exchange on which a security is registered. + ReferencesReference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher SEC -Name Exchange Act -Number 240 -Section 12 -Subsection d1-1 + Details Name: dei_SecurityExchangeName Namespace Prefix: dei_ Data Type: dei:edgarExchangeCodeItemType Balance Type: na Period Type: duration X - DefinitionTrading symbol of an instrument as listed on an exchange. + ReferencesNo definition available. + Details Name: dei_TradingSymbol Namespace Prefix: dei_ Data Type: dei:tradingSymbolItemType Balance Type: na Period Type: duration XML 12 R2.htm IDEA: XBRL DOCUMENT v3.22.4 CONDENSED CONSOLIDATED BALANCE SHEETS - USD ($) Dec. 30, 2022 Jul. 01, 2022 Current assets: Cash and cash equivalents $ 770,000,000 $ 615,000,000 Accounts receivable, net 840,000,000 1,532,000,000 Inventories 1,194,000,000 1,565,000,000 Other current assets 277,000,000 321,000,000 Total current assets 3,081,000,000 4,033,000,000 Property, equipment and leasehold improvements, net 2,122,000,000 2,239,000,000 Goodwill 1,237,000,000 1,237,000,000 Other intangible assets, net 3,000,000 9,000,000 Deferred Income Tax Assets, Net 1,135,000,000 1,132,000,000 Other assets, net 289,000,000 294,000,000 Total Assets 7,867,000,000 8,944,000,000 Current liabilities: Accounts payable 1,085,000,000 2,058,000,000 Accrued employee compensation 107,000,000 252,000,000 Accrued warranty 68,000,000 65,000,000 Accrued expenses 829,000,000 596,000,000 Total current liabilities 2,725,000,000 3,555,000,000 Long-term accrued warranty 85,000,000 83,000,000 Other non-current liabilities 134,000,000 135,000,000 Long-term Debt, Excluding Current Maturities 5,393,000,000 5,062,000,000 Total Liabilities 8,337,000,000 8,835,000,000 Shareholders’ (Deficit) Equity: Ordinary shares and additional paid-in capital 7,281,000,000 7,190,000,000 Accumulated other comprehensive income 99,000,000 36,000,000 Accumulated deficit (7,850,000,000) (7,117,000,000) Total Shareholders’ (Deficit) Equity (470,000,000) 109,000,000 Total Liabilities and Shareholders’ (Deficit) Equity 7,867,000,000 8,944,000,000 Less: current portion of debt, net of debt issuance costs $ 636,000,000 $ 584,000,000 X - 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Its principal products are hard disk drives, commonly referred to as disk drives, hard drives or HDDs. In addition to HDDs, the Company produces a broad range of data storage products including solid state drives (“SSDs”), solid state hybrid drives (“SSHDs”), storage subsystems, as well as a scalable edge-to-cloud mass data platform that includes data transfer shuttles and a storage-as-a-service cloud.HDDs are devices that store digitally encoded data on rapidly rotating disks with magnetic surfaces. HDDs continue to be the primary medium of mass data storage due to their performance attributes, reliability, high capacities, superior quality and cost effectiveness. Complementing existing storage architectures, SSDs use integrated circuit assemblies as memory to store data, and most SSDs use NAND flash memory. In contrast to HDDs and SSDs, SSHDs combine the features of SSDs and HDDs in the same unit, containing a high-capacity HDD and a smaller SSD acting as a cache to improve performance.The Company’s HDD products are designed for mass capacity storage and legacy markets. Mass capacity storage involves well-established use cases—such as hyperscale data centers and public clouds as well as emerging use cases. Legacy markets include markets the Company continues to sell to but that it does not plan to invest in significantly. The Company’s HDD and SSD product portfolio includes Serial Advanced Technology Attachment, Serial Attached SCSI and Non-Volatile Memory Express based designs to support a wide variety of mass capacity and legacy applications.The Company’s systems portfolio includes storage subsystems for enterprises, cloud service providers, scale-out storage servers and original equipment manufacturers (“OEMs”). Engineered for modularity, mobility, capacity and performance, these solutions include the Company’s enterprise HDDs and SSDs, enabling customers to integrate powerful, scalable storage within existing environments or create new ecosystems from the ground up in a secure, cost-effective manner. The Company’s Lyve portfolio provides a simple, cost-efficient and secure way to manage massive volumes of data across the distributed enterprise. The Lyve platform includes a shuttle solution that enables enterprises to transfer massive amounts of data from endpoints to the core cloud, a storage-as-a-service cloud offering that provides frictionless mass capacity storage at the metro edge. Basis of Presentation and ConsolidationThe unaudited Condensed Consolidated Financial Statements of the Company and the accompanying notes were prepared in accordance with United States (“U.S.”) Generally Accepted Accounting Principles (“GAAP”). The Company’s unaudited condensed consolidated financial statements include the accounts of the Company and all its wholly-owned and majority-owned subsidiaries, after elimination of intercompany transactions and balances.The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company’s condensed consolidated financial statements and accompanying notes. These estimates and assumptions include the impact of the COVID-19 pandemic. Actual results could differ materially from those estimates. The methods, estimates and judgments the Company uses in applying its most critical accounting policies have a significant impact on the results the Company reports in its condensed consolidated financial statements. The Company’s consolidated financial statements for the fiscal year ended July 1, 2022 are included in its Annual Report on Form 10-K, as filed with the U.S. Securities and Exchange Commission (“SEC”) on August 5, 2022. The Company believes that the disclosures included in these unaudited condensed consolidated financial statements, when read in conjunction with its consolidated financial statements as of July 1, 2022, and the notes thereto, are adequate to make the information presented not misleading. The results of operations for the three and six months ended December 30, 2022 are not necessarily indicative of the results to be expected for any subsequent interim period or for the Company’s fiscal year ending June 30, 2023.Fiscal YearThe Company operates and reports financial results on a fiscal year of 52 or 53 weeks ending on the Friday closest to June 30. In fiscal years with 53 weeks, the first quarter consists of 14 weeks and the remaining quarters consist of 13 weeks each. Both the three and six months ended December 30, 2022 and the three and six months ended December 31, 2021 consisted of 13 and 26 weeks, respectively. Fiscal years 2023 and 2022 both comprise of 52 weeks and end on June 30, 2023 and July 1, 2022, respectively. The fiscal quarters ended December 30, 2022, September 30, 2022 and December 31, 2021, are also referred to herein as the “December 2022 quarter”, the “September 2022 quarter” and the “December 2021 quarter”, respectively.Summary of Significant Accounting PoliciesThere have been no material changes to the Company’s significant accounting policies disclosed in Note 1. Basis of Presentation and Summary of Significant Accounting Policies of “Financial Statements and Supplementary Data” contained in Part II,
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+ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThis section of our Annual Report on Form 10-K discusses our financial condition and results of operations for the fiscal years ended December 31, 2022 and 2021, and year-to-year comparisons between fiscal 2022 and fiscal 2021 in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). A discussion of our financial condition and results of operations for the fiscal year ended December 31, 2020 and year-to-year comparisons between fiscal 2021 and fiscal 2020 that is not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed on February 3, 2022.Our free cash flow measure included in the section entitled “—Key Business Metrics—Free Cash Flow,” is not in accordance with GAAP. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from non-GAAP financial measures used by other companies, limiting its usefulness for comparison purposes. We encourage investors to carefully consider our results under GAAP, as well as our supplemental non-GAAP results, to more fully understand our business.OverviewServiceNow was founded on a simple premise: a better technology platform will help work flow better. Our purpose is to make the world work better for everyone. We help global enterprises across industries, universities and governments to digitize their workflows. The Now Platform, seamlessly connects workflows across siloed organizations and systems in a way that unlocks productivity, improves experiences for both employees and customers and delivers real business outcomes. We organize our workflow applications along four primary areas: Technology, Customer and Industry, Employee and Creator. The Now Platform enables our customers’ digital transformation from non-integrated enterprise technology solutions with manual and disconnected processes and activities, to integrated enterprise technology solutions with automation and connected processes and activities. The transformation to digital operations, enabled by the Now Platform, increases our customers’ resiliency and security and delivers great experiences and additional value to their employees and consumers.We are closely monitoring the unfolding events of the Russian invasion of Ukraine. While the Russia-Ukraine conflict is still evolving and the outcome remains highly uncertain, we do not believe the Russia-Ukraine conflict will have a material impact on our business and results of operations. However, if the Russia-Ukraine conflict continues or worsens, leading to greater global economic disruptions and uncertainty, our business and results of operations could be materially impacted. Our customers in Russia represented an immaterial portion of our net assets and total consolidated revenues both as of and for the year ended December 31, 2022 and December 31, 2021.See the “Risk Factors” section in Part I, Item 1A of this Annual Report for further discussion of the possible impact of the Russia-Ukraine conflict on our business.Key Business MetricsRemaining performance obligations. Transaction price allocated to remaining performance obligations (“RPO”) represents contracted revenue that has not yet been recognized, which includes deferred revenue and non-cancelable amounts that will be invoiced and recognized as revenue in future periods. RPO excludes contracts that are billed in arrears, such as certain time and materials contracts, as we apply the “right to invoice” practical expedient under relevant accounting guidance. Current remaining performance obligations (“cRPO”) represents RPO that will be recognized as revenue in the next 12 months.30Table of ContentsAs of December 31, 2022, our RPO was $14 billion, of which 49% represented cRPO. RPO and cRPO increased by 22%, respectively, compared to December 31, 2021. Factors that may cause our RPO to vary from period to period include the following:•Foreign currency exchange rates. While a majority of our contracts have historically been in U.S. Dollars, an increasing percentage of our contracts in recent periods has been in foreign currencies, particularly the Euro and British Pound Sterling. Fluctuations in foreign currency exchange rates as of the balance sheet date will cause variability in our RPO.•Mix of offerings. In a minority of cases, we allow our customers to host our software by themselves or through a third-party service provider. In self-hosted offerings, we recognize a portion of the revenue upfront upon the delivery of the software and as a result, such revenue is excluded from RPO. •Subscription start date. From time to time, we enter into contracts with a subscription start date in the future and these amounts are included in RPO if such contracts are signed by the balance sheet date. •Timing of contract renewals. While customers typically renew their contracts at the end of the contract term, from time to time, customers may do so either before or after the scheduled expiration date. For example, in cases where we are successful in selling additional products or services to an existing customer, a customer may decide to renew its existing contract early to ensure that all its contracts expire on the same date. In other cases, prolonged negotiations or other factors may result in a contract not being renewed until after it has expired. •Contract duration. While we typically enter into multi-year subscription services, the duration of our contracts varies. Further, we continue to see an increase in the number of 12-month agreements entered into with the U.S. federal government throughout the year, with the highest number of agreements entered into in the quarter ended September 30, driven primarily by timing of their annual budget expenditures. We sometimes also enter into contracts with durations that have a 12-month or shorter term to enable the contracts to co-terminate with the existing contract. The contract duration will cause variability in our RPO. Number of customers with ACV greater than $1 million. We count the total number of customers with annual contract value (“ACV”) greater than $1 million as of the end of the period. We had 1,637, 1,346, and 1,082 customers with ACV greater than $1 million as of December 31, 2022, 2021 and 2020, respectively. For purposes of customer count, a customer is defined as an entity that has a unique Dunn & Bradstreet Global Ultimate (“GULT”) Data Universal Numbering System (“DUNS”) number and an active subscription contract as of the measurement date. The DUNS number is a global standard for business identification and tracking. We make exceptions for holding companies, government entities and other organizations for which the GULT, in our judgment, does not accurately represent the ServiceNow customer. For example, while all U.S. government agencies roll up to “Government of the United States” under the GULT, we count each government agency that we contract with as a separate customer. Our customer count is subject to adjustments for acquisitions, spin-offs and other market activity; accordingly, we restate previously disclosed number of customers with ACV greater than $1 million calculations to allow for comparability. ACV is calculated based on the foreign exchange rate in effect at the time the contract was signed. Foreign exchange rate fluctuations could cause some variability in the number of customers with ACV greater than $1 million. We believe information regarding the total number of customers with ACV greater than $1 million provides useful information to investors because it is an indicator of our growing customer base and demonstrates the value customers are receiving from the Now Platform. Free cash flow. We define free cash flow, a non-GAAP financial measure, as GAAP net cash provided by operating activities reduced by purchases of property and equipment. Purchases of property and equipment are otherwise included in cash used in investing activities under GAAP. We believe information regarding free cash flow provides useful information to investors because it is an indicator of the strength and performance of our business operations. However, our calculation of free cash flow may not be comparable to similar measures used by other companies. A calculation of free cash flow is provided below:31Table of Contents Year Ended December 31, 202220212020(in millions)Free cash flow:Net cash provided by operating activities$2,723 $2,191 $1,786 Purchases of property and equipment(550)(392)(419)Free cash flow (1)$2,173 $1,799 $1,367 (1)Free cash flow for the years ended December 31, 2021 and 2020 include the effect of $15 million and $82 million, respectively, relating to the repayments of convertible senior notes attributable to debt discount. Refer to Note 11 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details.We have historically seen higher collections in the quarter ended March 31 due to seasonality in timing of entering into customer contracts, which is significantly higher in the quarter ended December 31. Additionally, we have historically seen higher disbursements in the quarters ended March 31 and September 30 due to payouts under our annual commission plans, purchases under our employee stock purchase plan, payouts under our bonus plans and coupon payments related to our 2030 Notes beginning in 2021.Renewal rate. We calculate our renewal rate by subtracting our attrition rate from 100%. Our attrition rate for a period is equal to the ACV from customers lost during the period, divided by the sum of (i) the total ACV from all customers that renewed during the period, excluding changes in price or users, and (ii) the total ACV from all customers lost during the period. Accordingly, our renewal rate is calculated based on ACV and is not based on the number of customers that have renewed. Further, our renewal rate does not reflect increased or decreased purchases from our customers to the extent such customers are not lost customers or lapsed renewals. A lost customer is a customer that did not renew an expiring contract and that, in our judgment, will not be renewed. Typically, a customer that reduces its subscription upon renewal is not considered a lost customer. However, in instances where the subscription decrease represents the majority of the customer’s ACV, we may deem the renewal as a lost customer. For our renewal rate calculation, we define a customer as an entity with a separate production instance of our service and an active subscription contract as of the measurement date, instead of an entity with a unique GULT or DUNS number. We adjust our renewal rate for acquisitions, consolidations and other customer events that cause the merging of two or more accounts occurring at the time of renewal. Our renewal rate was 98% for each of the years ended December 31, 2022, 2021 and 2020. As our renewal rate is impacted by the timing of renewals, which could occur in advance of, or subsequent to the original contract end date, period-to-period comparison of renewal rates may not be meaningful.Critical Accounting Policies and Significant Judgments and EstimatesOur management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported revenues and expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ from these estimates under different assumptions or conditions and such differences could be material.While our significant accounting policies are more fully described in Note 2 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our audited consolidated financial statements.32Table of ContentsRevenue RecognitionWe derive our revenues predominately from subscription revenues, which are primarily comprised of subscription fees that give customers access to the ordered subscription service, related support and updates, if any, to the subscribed service during the subscription term. For our cloud services, we recognize subscription revenues ratably over the contract term beginning on the commencement date of each contract, the date we make our services available to our customers. Our contracts with customers typically include a fixed amount of consideration and are generally non-cancelable and without any refund-type provisions. Subscription revenues also include revenues from self-hosted offerings in which customers deploy, or we grant customers the option to deploy without significant penalty, our subscription service internally or contract with a third party to host the software. For these contracts, we account for the software element separately from the related support and updates as they are distinct performance obligations. The transaction price is allocated to separate performance obligations on a relative standalone selling price (“SSP”) basis. The transaction price allocated to the software element is recognized when transfer of control of the software to the customer is complete. The transaction price allocated to the related support and updates are recognized ratably over the contract term. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. For these contracts, the transaction price is allocated to the separate performance obligations on a relative SSP basis. Evaluating the terms and conditions included within our customer contracts for appropriate revenue recognition and determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.Deferred Commissions Deferred commissions are the incremental selling costs that are associated with acquiring customer contracts and consist primarily of sales commissions paid to our sales organization and referral fees paid to independent third parties. Commissions and referral fees earned upon the execution of initial and expansion contracts are primarily deferred and amortized over a period of benefit that we have determined to be five years consistent with prior year. Commissions earned upon the renewal of customer contracts are deferred and amortized over the average renewal term. Additionally, for self-hosted offerings, consistent with the recognition of subscription revenues for self-hosted offerings, a portion of the commission cost is expensed upfront when the self-hosted offering is made available. Determining the period of benefit, including average renewal term, requires judgment for which we take into consideration our customer contracts, our technology life cycle and other factors. Business CombinationsThe allocation of the purchase price in a business combination requires management to make significant estimates in determining the fair value of acquired assets and assumed liabilities, especially with respect to intangible assets. The excess of the purchase price in a business combination over the fair value of these tangible and intangible assets acquired and liabilities assumed is recorded as goodwill. Critical estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows, discount rates, the time and expense to recreate the assets and profit margin a market participant would receive. These estimates are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. The Company evaluates these estimates and assumptions as new information is obtained and may record adjustments to the fair value of the tangible and intangible assets acquired and liabilities assumed but not later than one year from the acquisition date. Income Taxes Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective government taxing authorities. Significant judgment is required in determining our tax expense (benefit) and in evaluating our tax positions, including evaluating uncertainties and the complexity of taxes on foreign earnings. We review our tax positions quarterly and adjust the balances as new information becomes available. 33Table of ContentsDeferred tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carryforwards. We evaluate the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including future growth, forecasted earnings, future taxable income, the mix of earnings in the jurisdictions in which we operate, historical earnings, taxable income in prior years, if carryback is permitted under the law, carryforward periods and prudent and feasible tax planning strategies. A valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. To the extent sufficient positive evidence becomes available, we may release all or a portion of our valuation allowance in one or more future periods. A release of the valuation allowance, if any, would result in the recognition of certain deferred tax assets and a material income tax benefit for the period in which such release is recorded.Due to cumulative losses, including tax deductible stock compensation, and based on all available positive and negative evidence, we have determined that it is more likely than not that our U.S. deferred tax assets will not be realizable as of December 31, 2022. Management applied significant judgment in assessing the positive and negative evidence available in the determination of the amount of deferred tax assets that were more likely than not to be realized in the future. In determining the need, or continued need, for a valuation allowance, we considered the weighting of the positive and negative evidence which includes, among other things, cumulative losses including tax deductible stock compensation expense, future growth, forecasted earnings and future taxable income. However, given our current earnings, anticipated future earnings and future taxable income, we believe there is a reasonable possibility that within the next 12 months, sufficient positive evidence may become available to allow us to reach a conclusion that the U.S. valuation allowance will no longer be needed. The exact timing and amount of the valuation allowance release are subject to change on the basis of the level of sustained U.S. profitability that the Company is able to actually achieve, as well as the amount of tax deductible stock compensation dependent upon our publicly traded share price, foreign currency movements and macroeconomic conditions, among other factors. See Note 16 – Income Taxes, in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information on discussion on valuation allowance. Our tax positions are subject to income tax audits by multiple tax jurisdictions throughout the world. We recognize the tax benefit of an uncertain tax position only if it is more likely than not the position is sustainable upon examination by the taxing authority based on the technical merits. We measure the tax benefit recognized as the largest amount of benefit which is more likely than not to be realized upon settlement with the taxing authority. We recognize interest accrued and penalties related to unrecognized tax benefits in our tax provision. Significant judgment is required to evaluate uncertain tax positions. Our evaluations are based upon a number of factors, including changes in facts or circumstances, changes in tax law or guidance, correspondence with tax authorities during the course of audits and effective settlement of audit issues. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in our income tax expense in the period in which we make the change, which could have a material impact on our effective tax rate and operating results.We calculate the current and deferred income tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed in subsequent years and record adjustments based on filed income tax returns when identified. The amount of income taxes paid is subject to examination by U.S. federal, state and foreign tax authorities. The estimate of the potential outcome of any uncertain tax issue is subject to management’s assessment of relevant risks, facts and circumstances existing at that time. To the extent the assessment of such tax position changes, we record the change in estimate in the period in which we make the determination.Change in Accounting EstimateSee Note 2 —Summary of Significant Accounting Policies — Use of Estimates, of the notes to our consolidated financial statements included in this Annual Report on Form 10-K for additional information on our change in estimated useful life of our data center equipment during 2022.34Table of ContentsComponents of Results of Operations RevenuesSubscription revenues. Subscription revenues are primarily comprised of fees that give customers access to the ordered subscription service for both self-hosted offerings and cloud-based subscription offerings, and related standard and enhanced support and updates, if any, to the subscription service during the subscription term. For our cloud-based offerings, we recognize revenue ratably over the subscription term. For self-hosted offerings, a substantial portion of the sales price is recognized upon delivery of the software, which may cause greater variability in our subscription revenues and subscription gross margin. Pricing includes multiple instances, hosting and support services, data backup and disaster recovery services, as well as future updates, when and if available, offered during the subscription term. We typically invoice our customers for subscription fees in annual increments upon execution of the initial contract or subsequent renewal. Our contracts are generally non-cancelable during the subscription term, though a customer can terminate for breach if we materially fail to perform. Professional services and other revenues. Our arrangements for professional services are primarily on a time-and-materials basis, and we generally invoice our customers monthly in arrears for the professional services based on actual hours and expenses incurred. Some of our professional services arrangements are on a fixed fee. Professional services revenues are recognized as services are delivered. Other revenues primarily consist of fees from customer training delivered on-site or through publicly available classes. Typical payment terms require our customers to pay us within 30 days of invoice. We sell our subscription services primarily through our direct sales organization. We also sell services through managed service providers and resale partners. We also generate revenues from certain professional services and from training of customers and partner personnel, through both our direct team and indirect channel sales. Revenues from our direct sales organization represented 79%, 79% and 81% of our total revenues for the years ended December 31, 2022, 2021 and 2020, respectively. For purposes of calculating revenues from our direct sales organization, revenues from systems integrators and managed services providers are included as part of the direct sales organization. Seasonality. We have historically experienced seasonality in terms of when we enter into customer agreements. We sign a significantly higher percentage of agreements with new customers, as well as expansion with existing customers, in the fourth quarter of each year. The increase in customer agreements for the fourth quarter is primarily a result of both large enterprise account buying patterns typical in the software industry, which are driven primarily by the expiration of annual authorized budgeted expenditures, and the terms of our commission plans, which incentivize our direct sales organization to meet their annual quotas by December 31. Furthermore, we usually sign a significant portion of these agreements during the last month, and often the last two weeks, of each quarter. This seasonality of entering into customer agreements is sometimes not immediately apparent in our revenues, due to the fact that we recognize subscription revenues from our cloud offering contracts over the term of the subscription agreement, which is generally 12 to 36 months, leading to a higher RPO in the fourth quarter. Although these seasonal factors are common in the technology industry, historical patterns should not be considered a reliable indicator of our future sales activity or performance.Cost of RevenuesCost of subscription revenues. Cost of subscription revenues consists primarily of expenses related to hosting our services and providing support to our customers. These expenses are comprised of data center capacity costs, which include colocation costs associated with our data centers as well as interconnectivity between data centers, depreciation related to our infrastructure hardware equipment dedicated for customer use, amortization of intangible assets, expenses associated with software, public cloud service costs, IT services and dedicated customer support, personnel-related costs directly associated with data center operations and customer support, including salaries, benefits, bonuses and stock-based compensation and allocated overhead.Cost of professional services and other revenues. Cost of professional services and other revenues consists primarily of personnel-related costs directly associated with our professional services and training departments, including salaries, benefits, bonuses and stock-based compensation, the costs of contracted third-party partners, travel expenses and allocated overhead.Professional services are performed directly by our services team, as well as by contracted third-party partners. Fees paid by us to third-party partners are primarily recognized as cost of revenues as the professional services are delivered. Cost of revenues associated with our professional services engagements contracted with third-party partners as a percentage of professional services and other revenues was 12%, 14% and 10% for the years ended December 31, 2022, 2021 and 2020, respectively.35Table of ContentsSales and MarketingSales and marketing expenses consist primarily of personnel-related expenses directly associated with our sales and marketing staff, including salaries, benefits, bonuses and stock-based compensation. Sales and marketing expenses also include the amortization of commissions paid to our sales employees, including related payroll taxes and fringe benefits. In addition, sales and marketing expenses include branding expenses, marketing program expenses, which include events such as Knowledge, and costs associated with purchasing advertising and marketing data, software and subscription services dedicated for sales and marketing use and allocated overhead.Research and DevelopmentResearch and development expenses consist primarily of personnel-related expenses directly associated with our research and development staff, including salaries, benefits, bonuses and stock-based compensation and allocated overhead. Research and development expenses also include data center capacity costs, costs associated with outside services contracted for research and development purposes and depreciation of infrastructure hardware equipment that is used solely for research and development purposes. General and AdministrativeGeneral and administrative expenses consist primarily of personnel-related expenses for our executive, finance, legal, human resources, facilities and administrative personnel, including salaries, benefits, bonuses and stock-based compensation, external legal, accounting and other professional services fees, other corporate expenses, amortization of intangible assets and allocated overhead.Provision for Income TaxesProvision for income taxes consist of federal, state and foreign income taxes. Due to cumulative losses, we maintain a valuation allowance against our U.S. deferred tax assets as of December 31, 2022 and 2021. We consider all available evidence, both positive and negative, including but not limited to earnings history, projected future outcomes, industry and market trends and the nature of each of the deferred tax assets in assessing the extent to which a valuation allowance should be applied against our U.S. and foreign deferred tax assets. Comparison of the years ended December 31, 2022 and 2021 Revenues Year Ended December 31,% Change 20222021(dollars in millions)Revenues:Subscription$6,891 $5,573 24 %Professional services and other354 323 10 %Total revenues$7,245 $5,896 23 %Percentage of revenues:Subscription95 %95 %Professional services and other5 %5 %Total100 %100 %Subscription revenues increased by $1.3 billion for the year ended December 31, 2022, compared to the prior year, primarily driven by increased purchases by new and existing customers. Included in subscription revenues is $253 million and $241 million of revenues recognized upfront from the delivery of software associated with self-hosted offerings during the years ended December 31, 2022 and 2021, respectively. 36Table of ContentsWe expect subscription revenues for the year ending December 31, 2023 to increase in absolute dollars and increase slightly as a percentage of revenue as we continue to add new customers and existing customers increase their usage of our products compared to the year ended December 31, 2022.Our expectations for revenues, cost of revenues and operating expenses for the year ending December 31, 2023 are based on the 31-day average of foreign exchange rates for December 31, 2022.Subscription revenues consist of the following:Year Ended December 31,% Change20222021(dollars in millions)Digital workflow products$6,077 $4,882 24 %ITOM products814 691 18 %Total subscription revenues$6,891 $5,573 24 %Our digital workflow products include the Now Platform, IT Service Management, Strategic Portfolio Management (formerly known as IT Business Management), IT Asset Management and Enterprise Management, Security Operations, Integrated Risk Management (formerly, Governance, Risk and Compliance), ESG Management, HR Service Delivery, Workplace Service Delivery, Legal Service Delivery, Customer Service Management, Field Service Management, Industry Solutions, App Engine, Automation Engine, Platform Privacy and Security, Procurement Operation Management and Impact are generally priced on a per user basis. Our IT Operations Management (“ITOM”) products are generally priced on a subscription unit basis, which allows us to measure customers’ management of various IT resources, and decreasingly on a per node (physical or virtual server) basis. Professional services and other revenues increased by $31 million for the year ended December 31, 2022, compared to the prior year, due to an increase in services and trainings provided to new and existing customers. We expect professional services and other revenues for the year ending December 31, 2023 to decrease in absolute dollars and to decrease slightly as a percentage of revenue compared to the year ended December 31, 2022. We continue to be focused on deploying our internal professional services organization as a strategic resource and working with our partner ecosystem to contract directly with customers for implementation services delivery.Cost of Revenues and Gross Profit Percentage Year Ended December 31,% Change 20222021 (dollars in millions) Cost of revenues:Subscription$1,187 $1,022 16 %Professional services and other386 331 17 %Total cost of revenues$1,573 $1,353 16 %Gross profit percentage:Subscription83 %82 %Professional services and other(9)%(2)%Total gross profit percentage78 %77 %Gross profit:$5,672 $4,543 25 %37Table of ContentsCost of subscription revenues increased by $165 million for the year ended December 31, 2022, compared to the prior year, primarily due to increased headcount and increased costs to support the growth of our subscription offerings including costs to support customers in regulated markets. Personnel-related costs including stock-based compensation and overhead expenses increased by $142 million as compared to prior year. Maintenance costs to support the expansion of our data center capacity, including public cloud service costs, increased by $46 million and amortization of intangible assets increased by $8 million as a result of recent acquisitions as compared to the prior year. Depreciation expense related to data center hardware and software decreased by $45 million, primarily due to the change in estimated useful life of data center equipment from three years to four years, for the year ended December 31, 2022, as compared to prior year.We expect our cost of subscription revenues for the year ending December 31, 2023 to increase in absolute dollars as we provide subscription services to more customers and increase usage within our customer instances and to increase slightly as a percentage of revenue compared to the year ended December 31, 2022. We will continue to incur incremental costs to attract customers in regulated markets by adopting public cloud offerings as well as increased support for customers impacted by new and evolving data residency requirements. To the extent future acquisitions are consummated, our cost of subscription revenues may increase due to additional non-cash charges associated with the amortization of intangible assets acquired. Our subscription gross profit percentage was 83% and 82% for the years ended December 31, 2022 and 2021, respectively. We expect our subscription gross profit percentage to decrease slightly for the year ending December 31, 2023 compared to the year ended December 31, 2022.Cost of professional services and other revenues increased by $55 million for the year ended December 31, 2022 as compared to the prior year. The increase was primarily due to increased headcount to support growth resulting in an increase in personnel-related costs including stock-based compensation, travel and overhead expenses.Our professional services and other gross loss percentage increased to 9% for the year ended December 31, 2022, compared to 2% in the prior year, primarily driven by planned increase in headcount costs to support the business growth, increase in travel expense for customer implementations and investment in strategic initiatives. We expect our professional services and other gross loss percentage to increase for the year ending December 31, 2023 compared to the year ended December 31, 2022.Sales and Marketing Year Ended December 31,% Change 20222021 (dollars in millions) Sales and marketing$2,814 $2,292 23 %Percentage of revenues39 %39 %Sales and marketing expenses increased by $522 million for the year ended December 31, 2022, compared to the prior year, primarily due to increased headcount resulting in an increase in personnel-related costs including stock-based compensation and overhead expenses of $411 million, compared to the prior year. Amortization expenses associated with deferred commissions increased by $68 million, compared to the prior year, due to an increase in contracts with new customers, expansion and renewal contracts. Other sales and marketing program expenses, which include branding, costs associated with purchasing advertising, marketing events and market data, increased by $33 million compared to the prior year, primarily due to increased program costs and travel for our annual Knowledge user conference. We expect sales and marketing expenses for the year ending December 31, 2023 to increase in absolute dollars and to decrease slightly as a percentage of revenue compared to the year ended December 31, 2022, as we continue to see leverage from increased sales productivity and marketing efficiencies offset by growth in our international operations in 2023.Research and Development Year Ended December 31,% Change 20222021 (dollars in millions) Research and development$1,768 $1,397 27 %Percentage of revenues24 %24 %38Table of ContentsResearch and development expenses (“R&D”) increased by $371 million during the year ended December 31, 2022, compared to the prior year, primarily due to increased headcount resulting in an increase in personnel-related costs including stock-based compensation and overhead expenses of $363 million compared to prior year. We expect R&D expenses for the year ending December 31, 2023 to increase in absolute dollars, but remain relatively flat as a percentage of revenue compared to the year ended December 31, 2022, as we continue to improve the existing functionality of our services, develop new applications to fill market needs and enhance our core platform.General and Administrative Year Ended December 31,% Change 20222021 (dollars in millions) General and administrative$735 $597 23 %Percentage of revenues10 %10 %General and administrative expenses (“G&A”) increased by $138 million during the year ended December 31, 2022, compared to the prior year, primarily due to increased headcount resulting in an increase in personnel-related costs including stock-based compensation and overhead expenses of $142 million. We expect G&A expenses for the year ending December 31, 2023 to increase in absolute dollars but remain relatively flat as a percentage of revenue compared to the year ended December 31, 2022, as we continue to see leverage from continued G&A productivity. Stock-based Compensation Year Ended December 31,% Change 20222021 (dollars in millions) Cost of revenues:Subscription$157 $128 23 %Professional services and other67 59 14 %Sales and marketing459 389 18 %Research and development495 395 25 %General and administrative223 160 39 %Total stock-based compensation$1,401 $1,131 24 %Percentage of revenues19 %19 %Stock-based compensation increased by $270 million during the year ended December 31, 2022, compared to the prior year, primarily due to additional grants to current and new employees. Stock-based compensation is inherently difficult to forecast due to fluctuations in our stock price. Based upon our stock price as of December 31, 2022, we expect stock-based compensation to continue to increase in absolute dollars for the year ending December 31, 2023 as we continue to issue stock-based awards to our employees, but decrease slightly as a percentage of revenue compared to the year ended December 31, 2022. We expect stock-based compensation as a percentage of revenue to decline over time as we continue to grow.39Table of ContentsForeign Currency ExchangeOur international operations have provided and will continue to provide a significant portion of our total revenues. Revenues outside North America represented 35% and 36% of total revenues for the years ended December 31, 2022 and 2021, respectively. Because we primarily transact in foreign currencies for sales outside of the United States, the general strengthening of the U.S. Dollar relative to other major foreign currencies (primarily the Euro and British Pound Sterling) during the year ended December 31, 2022 had an unfavorable impact on our revenues. For entities reporting in currencies other than the U.S. Dollar, if we had translated our results for the year ended December 31, 2022 at the exchange rates in effect for the year ended December 31, 2021 rather than the actual exchange rates in effect during the period, our reported subscription revenues and professional services and other revenues would have been $274 million and $19 million higher for the year ended December 31, 2022, respectively.In addition, because we primarily transact in foreign currencies for cost of revenues and operating expenses outside of the United States, the general strengthening of the U.S. Dollar relative to other major foreign currencies had a favorable impact on our cost of revenue, sales and marketing expense and R&D expenses during the year ended December 31, 2022. For entities reporting in currencies other than the U.S. Dollar, if we had translated our results for the year ended December 31, 2022 at the exchange rates in effect for the year ended December 31, 2021 rather than the actual exchange rates in effect during the period, our reported cost of revenues, sales and marketing and R&D expenses would have been $48 million, $78 million and $19 million higher for the year ended December 31, 2022, respectively. The impact from the foreign currency movements from the year ended December 31, 2021 to the year ended December 31, 2022 was not material to G&A expenses.Interest ExpenseYear Ended December 31,% Change20222021(dollars in millions)Interest expense$(27)$(28)(4 %)Percentage of revenues— %— %Interest expense decreased during the year ended December 31, 2022, compared to the prior year. For the year ending December 31, 2023, we expect to incur approximately $23 million of interest expense related to the 2030 Notes.Other Income (Expense), net Year Ended December 31,% Change 20222021 (dollars in millions) Interest income$82 $20 310 %Other(11)— NMOther income (expense), net$71 $20 255 %NM - Not meaningfulOther income (expense), net increased by $51 million during the year ended December 31, 2022, compared to the prior year, primarily driven by an increase in investment income from our managed portfolio resulting from the increase in interest rates.To mitigate our risks associated with fluctuations in foreign currency exchange rates, we enter into foreign currency derivative contracts with maturities of 12 months or less to hedge a portion of our net outstanding monetary assets and liabilities. These hedging contracts may reduce, but cannot entirely eliminate, the impact of adverse currency exchange rate movements. The gains (losses) recognized for these foreign currency forward contracts in other income (expense), net were immaterial for the years ended December 31, 2022 and 2021. 40Table of ContentsProvision for Income Taxes Year Ended December 31,% Change 20222021 (dollars in millions) Income before income taxes$399 $249 60 %Provision for income taxes74 19 289 %Effective tax rate19 %8 %138 % Our effective tax rate was 19% and 8% for the year ended December 31, 2022 and December 31, 2021. The difference in rates was primarily attributable to revaluation of our deferred taxes to account for a change in United Kingdom tax rate and a partial valuation allowance related to acquired Lightstep, Inc. deferred tax liabilities in the year ended December 31, 2021. The income tax provision for the year ended December 31, 2022 was primarily attributable to the mix of earnings and losses in foreign jurisdictions with differing tax rates, state tax expense and the valuation allowance in the United States.We continue to maintain a full valuation allowance on our U.S. federal and state deferred tax assets and the significant components of the tax expense recorded are current cash taxes payable in various jurisdictions. The cash tax expenses are impacted by each jurisdiction’s individual tax rates, laws on timing of recognition of income and deductions, and availability of net operating losses and tax credits. Given the full valuation allowance on our U.S. federal and state deferred tax assets, sensitivity of current cash taxes to local rules and our foreign structuring, we expect that our effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates. To the extent sufficient positive evidence becomes available, we may release all or a portion of our valuation allowance in one or more future periods. A release of the valuation allowance, if any, would result in the recognition of certain deferred tax assets and a material income tax benefit for the period in which such release is recorded.See Note 16– Income Taxes, in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for our reconciliation of income taxes at the statutory federal rate to the provision for income taxes.Liquidity and Capital Resources We generate cash inflows from operations primarily from selling subscription services which are generally paid in advance of provisioning services, and cash outflows to develop new services and core technologies that further enhance the Now Platform, engage our customer and enhance their experience, and enable and transform our business operations. Subscription services arrangements typically have a three-year duration, and we have experienced a renewal rate of 98% for the years ended December 31, 2022, 2021 and 2020. Cash outflows from operations are principally comprised of the salaries, bonuses, commissions, and benefits for our workforce; licenses and services arrangements that are integral to our business operations and data centers; and operating lease arrangements that underlie our facilities. We have generated positive operating cash flows for more than ten years as we continue to grow our business in pursuit of our business strategy, and we expect to grow our business and generate positive cash flows from operations during 2023. When assessing sources of liquidity, we also include cash and cash equivalents, short-term investments and long-term investments totaling $6.4 billion as of December 31, 2022.Our working capital requirements are principally comprised of non-contract workforce salaries, bonuses, commissions, and benefits and, to a lesser extent, cancellable and non-cancelable licenses and services arrangements that are integral to our business operations, and operating lease obligations. In addition, we made the payment for the investment in Celonis SE of $100 million during the year ended December 31, 2022. Non-cancelable purchase commitments for business operations total $1,271 million as of December 31, 2022, due primarily over the next five years. Operating lease obligations totaling $895 million are principally associated with leased facilities and have varying maturities with $467 million due over the next five years.41Table of ContentsTo grow our business, we also invest in capital and other resources to expand our data centers and enable our workforce, and we acquire technology and businesses to supplement our technology portfolio. Our capital expenditures are typically under cancelable arrangements primarily used to support the installed base and growth of our hosted business. We have also issued long-term debt to finance our business. In August 2020, we issued 1.40% fixed rate ten-year notes with an aggregate principal amount of $1.5 billion due on September 1, 2030 (the “2030 Notes”). In May and June 2017, we issued the 2022 Notes with an aggregate principal amount of $782.5 million. During the year ended December 31, 2022, we paid cash to settle $94 million in principal of the 2022 Notes, which was comprised of early conversions of $6 million and remaining principal of $88 million for final settlement on June 1, 2022, the maturity date of our 2022 Notes.Our free cash flows, together with our other sources of liquidity, are available to service our liabilities as well as our cancellable and non-cancellable arrangements. We anticipate cash flows generated from operations, cash, cash equivalents and investments will be sufficient to meet our liquidity needs for at least the next 12 months. As we look beyond the next 12 months, we seek to continue to grow free cash flows necessary to fund our operations and grow our business. If we require additional capital resources, we may seek to finance our operations from the current funds available or additional equity or debt financing. Year Ended December 31, 20222021 (in millions)Net cash provided by operating activities$2,723 $2,191 Net cash used in investing activities(2,583)(1,607)Net cash used in financing activities(344)(506)Net (decrease)/increase in cash, cash equivalents and restricted cash(257)53 Operating ActivitiesNet cash provided by operating activities was $2.7 billion for the year ended December 31, 2022 compared to $2.2 billion for the prior year. The net increase in operating cash flow was primarily due to higher collections driven by revenue growth. Investing ActivitiesNet cash used in investing activities for the year ended December 31, 2022 was $2.6 billion compared to $1.6 billion for the prior year. The net increase in cash used in investing activities was primarily due to a $1,427 million increase in net purchases of investments, a $96 million increase in non-marketable investments mainly in Celonis SE and a $158 million increase in purchases of property and equipment, offset by a $694 million decrease in business combinations.Financing Activities Net cash used in financing activities for the year ended December 31, 2022 was $344 million compared to $506 million for the prior year. The net decrease in cash used in financing activities is primarily due to a $185 million decrease in taxes paid related to net share settlement of equity awards, a $10 million increase in proceeds from employee stock plans, offset by a $33 million increase in repayments of convertible senior notes attributable to principal.Contractual Obligations and CommitmentsOur estimated future obligations consist of leases, a non-cancelable $500 million agreement with Microsoft to purchase cloud services over five years for accelerating the Azure adoption for mutual customers, purchase obligations, debt and unrecognized tax benefits as of December 31, 2022. Refer to Note 17 “Commitments and Contingencies” to our consolidated financial statements included in this Annual Report on Form 10-K for more information.42Table of ContentsITEM 7A.QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKForeign Currency Exchange RiskWe have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. Dollar, primarily the Euro and British Pound Sterling. We are a net receiver of Euro and British Pound Sterling, and therefore benefit from a weakening of the U.S. Dollar relative to these currencies and, conversely, are adversely affected by a strengthening of the U.S. Dollar relative to these currencies. Revenues denominated in U.S. Dollar as a percentage of total revenues was 72%, 70% and 71% for the years ended December 31, 2022, 2021 and 2020, respectively. A hypothetical 10% increase in the U.S. Dollar against other currencies would have resulted in a decrease in operating income of $75 million, $62 million and $47 million for the years ended December 31, 2022, 2021 and 2020, respectively. This analysis disregards the possibilities that rates can move in opposite directions and that losses from one geographic area may be offset by gains from another geographic area.To mitigate our risks associated with fluctuations in foreign currency exchange rates, we enter into foreign currency derivative contracts to hedge a portion of our net outstanding monetary assets and liabilities. These derivative contracts are intended to offset gains or losses related to remeasuring monetary assets and liabilities that are denominated in currencies other than the functional currency of the entities in which they are recorded.These derivative contracts expose us to credit risk to the extent that the counterparties may be unable to meet the terms of the arrangement. We mitigate this credit risk by transacting with major financial institutions with high credit ratings and entering into master netting arrangements, which permit net settlement of transactions with the same counterparty. While the contract or notional amount is often used to express the volume of foreign currency derivative contracts, the amounts potentially subject to credit risk are generally limited to the amounts, if any, by which the counterparties’ obligations under the agreements exceed our obligations to the counterparties. We are not required to pledge, and are not entitled to receive, cash collateral related to these derivative instruments. We do not enter into derivative contracts for trading or speculative purposes. Refer to Note 8 in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information. Interest Rate Sensitivity We had an aggregate of $6.4 billion in cash, cash equivalents, short-term investments and long-term investments as of December 31, 2022. This amount was invested primarily in money market funds, certificates of deposit, corporate notes and bonds, government and agency securities and other debt securities with a minimum rating of BBB by Standard & Poor’s, Baa2 by Moody’s or BBB by Fitch. The primary objectives of our investment activities are the preservation of capital and support of our liquidity requirements. Our investments are exposed to market risk due to fluctuations in interest rates, which may affect our interest income and the fair market value of our investments. As of December 31, 2022, a hypothetical 100 basis point increase in interest rates would have resulted in an approximate $39 million decline of the fair value of our available-for-sale securities. This estimate is based on a sensitivity model that measures market value changes when changes in interest rates occur.As of December 31, 2021, we had an aggregate of $4.9 billion in cash, cash equivalents, short-term investments and long-term investments, and a hypothetical 100 basis point increase in interest rates would have resulted in an approximate $30 million decline of the fair value of our available-for-sale securities. 43Table of ContentsMarket RiskIn August 2020, we issued 1.40% fixed rate ten-year notes with an aggregate principal amount of $1.5 billion due on September 1, 2030. The 2030 Notes were issued at 99.63% of principal and we incurred approximately $13 million of debt issuance costs. Interest is payable semi-annually in arrears on March 1 and September 1 of each year, beginning on March 1, 2021, and the entire outstanding principal amount is due at maturity on September 1, 2030. The 2030 Notes are unsecured obligations and the indentures governing the 2030 Notes contain customary events of default and covenants that, among others and subject to exceptions, restrict the Company’s ability to incur or guarantee debt secured by liens on specified assets or enter into sale and lease-back transactions with respect to specified properties. In May and June 2017, we issued the 2022 Notes with an aggregate principal amount of $782.5 million. These 2022 Notes were recorded at face value less unamortized discount on our consolidated balance sheet. Because these instruments do not bear interest, we had no economic interest rate exposure associated with changes in interest rates. However, the fair value of our 2022 Notes was exposed to interest rate risks. In addition, the fair value of the 2022 Notes was affected by our stock price due to the conversion feature and would generally increase as the stock price increases. The remaining principal of 2022 Notes was settled on June 1, 2022. We hold cash balances with multiple financial institutions in various countries and these balances routinely exceed deposit insurance limits.As of December 31, 2022 and 2021, we had $252 million and $99 million, respectively, of non-marketable equity investments in privately held companies. Recording upward and downward adjustments to the carrying value of our non-marketable equity investments requires quantitative assessments of the fair value of our non-marketable equity investments using various valuation methodologies and involves the use of estimates. The timing and amount of observable price changes are influenced by market dynamics that can impact the valuation of our non-marketable equity investments. These changes could be material based on market conditions and events.44Table of Contents
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report, particularly under the heading "Risk Factors." OverviewWe are a Silicon Valley-based provider of accelerated compute platforms that are application-optimized high performance and high-efficiency server and storage systems for a variety of markets, including enterprise data centers, cloud computing, AI, 5G and edge computing. Our Total IT Solutions include complete servers, storage systems, modular blade servers, blades, workstations, full rack-scale solutions, networking devices, server sub-systems, server management and security software. We also provide global support and services to help our customers install, upgrade and maintain their computing infrastructure. We commenced operations in 1993 and have been profitable every year since inception. For fiscal years 2023, 2022 and 2021, our net income was $640.0 million, $285.2 million and $111.9 million, respectively. In order to increase our sales and profits, we believe that we must continue to develop flexible and application optimized server and storage solutions and be among the first to market with new features and products. We must also continue to expand our software and customer service and support offerings, particularly as we increasingly focus on larger enterprise customers. Additionally, we must focus on development of our sales partners and distribution channels to further expand our market share. We measure our financial success based on various indicators, including growth in net sales, gross profit margin and operating margin. Among the key non-financial indicators of our success is our ability to rapidly introduce new products and deliver the latest application-optimized server and storage solutions. In this regard, we work closely with microprocessor and other key component vendors to take advantage of new technologies as they are introduced. Historically, our ability to introduce new products rapidly has allowed us to benefit from technology transitions such as the introduction of new microprocessors and storage technologies, and as a result, we monitor the product introduction cycles of Intel Corporation, NVIDIA Corporation, Advanced Micro Devices, Inc., Samsung Electronics Company Limited, Micron Technology, Inc. and others closely and carefully. This also impacts our research and development expenditures as we continue to invest more in our current and future product development efforts.COVID-19 Pandemic Impact Our business and financial outlook have experienced, and may continue to face, challenges due to adverse macroeconomic conditions and uncertainties. These factors encompass labor shortages, disruptions in the supply chain, inflation, higher interest rates, and fluctuations in capital markets. The global business landscape encountered widespread disruption as a consequence of the COVID-19 pandemic, which commenced in early 2020. The extent of its direct or indirect impact on general market conditions, as well as our business, results of operations, cash flows, and financial condition, is contingent upon uncertain future developments, including the emergence of new variants.We remain committed to continuously assessing the nature and extent of the impact of general macroeconomic conditions and the ongoing COVID-19 pandemic on our business. For a more comprehensive discussion, please refer to the "Risk Factors" included in Part I, Item 1A of this Annual Report on Form 10-K.Financial HighlightsThe following is a summary of financial highlights of fiscal years 2023 and 2022:•Net sales increased by 37.1% in fiscal year 2023 as compared to fiscal year 2022.•Gross margin increased to 18.0% in fiscal year 2023 from 15.4% in fiscal year 2022, primarily due to product and customer mix and decreased logistic costs.•Operating expenses increased by 12.3% in fiscal year 2023 as compared to fiscal year 2022, primarily due to the increase in personnel expenses as a result of salary increases, equity grants and a higher headcount.SMCI | 2023 Form 10-K | 37•Net income increased to $640.0 million in fiscal year 2023 as compared to $285.2 million in fiscal year 2022, which was primarily due to the higher net sales and lower operating expenses as a percentage of revenues in fiscal year 2023 as compared to fiscal year 2022.•Our cash and cash equivalents were $440.5 million and $267.4 million at the end of fiscal years 2023 and 2022, respectively. In fiscal year 2023, we generated net cash of $172.4 million, comprised of $663.6 million provided by operating activities primarily due to increased net income, $448.3 million used in financing activities primarily due to repayment of debt and stock repurchase, and $39.5 million cash used in investing activities primarily due to $36.8 million in purchases of property and equipment.Critical Accounting Policies and EstimatesGeneralOur discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, net sales and expenses. We evaluate our estimates on an on-going basis based on a) historical experience, b) assumptions we believe to be reasonable under the circumstances and are not readily apparent from other sources, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Because these estimates can vary depending on the situation, actual results may differ from the estimates. Making estimates and judgments about future events is inherently unpredictable and is subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to have been incorrect, it could have a material impact on our results of operations, financial position and statement of cash flows. These estimates and judgements have not fluctuated significantly for the fiscal year ended June 30, 2023 compared to prior fiscal years.A summary of significant accounting policies is included in Part II, Item 8, Note 1, “Organization and Summary of Significant Accounting Policies” in our notes to the consolidated financial statements in this Annual Report. Management believes the following are the most critical accounting policies and reflect the significant estimates and assumptions used in the preparation of the consolidated financial statements.Revenue RecognitionThe most critical accounting policy estimate and judgments required in applying ASC 606, Revenue Recognition of Contracts from Customers, and our revenue recognition policy relate to the determination of the transaction price, distinct performance obligations and the evaluation of the standalone selling price (the “SSP”) for each performance obligation.We generate revenues from the sale of server and storage systems, subsystems, accessories, services, server software management solutions, and support services. Many of our customer contracts include multiple performance obligations. Judgment is required in determining whether each performance obligation within a customer contract is distinct. This assessment involves subjective determinations and requires management to make judgments about the individual promised goods or services and whether such goods or services are separable from the other aspects of the contractual relationship.As part of determining the transaction price in contracts with customers, we may be required to estimate variable consideration when determining the amount of revenue to recognize. We estimate reserves for future sales returns based on a review of our history of actual returns. Based upon historical experience, a refund liability is recorded at the time of sale for estimated product returns and an asset is recognized for the amount expected to be recorded in inventory upon product return, less the expected recovery costs. We also estimate the costs of customer and distributor programs and incentive offerings such as price protection, customer rebates, as well as the estimated costs of cooperative marketing arrangements where the fair value of the benefit derived from the costs cannot be reasonably estimated. Any provision is recorded as a reduction of revenue at the time of sale based on an evaluation of the contract terms and historical experience.SMCI | 2023 Form 10-K | 38We allocate the transaction price for each customer contract to each performance obligation based on the relative SSP for each performance obligation within each contract. We recognize the amount of transaction price allocated to each performance obligation within a customer contract as revenue at the time the respective performance obligation is satisfied by transferring control of the promised good or service to a customer. Determining the relative SSP for contracts that contain multiple performance obligations requires significant judgement. We determine standalone selling prices based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, we apply judgment to estimate the SSP. For substantially all performance obligations, we are able to establish the SSP based on the observable prices of products or services sold separately in comparable circumstances to similar customers. We typically establish an SSP range for our products and services, which is reassessed on a periodic basis or when facts and circumstances change. SSP for our products and services can evolve over time due to changes in our pricing practices, internally approved pricing guidelines with respect to geographies, customer type, internal costs, and gross margin objectives for the related performance obligations which can also be influenced by intense competition, changes in demand for our products and services, economic and other factors.InventoriesInventories are stated at lower of cost, using weighted average cost method, or net realizable value. Net realizable value is the estimated selling price of our products in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Inventories consist of purchased parts and raw materials (principally electronic components), work in process (principally products being assembled) and finished goods. We evaluate inventory on a quarterly basis for lower of cost or net realizable value and excess and obsolescence and, as necessary, write down the valuation of inventories based upon our inventory aging, forecasted usage and sales, anticipated selling price, product obsolescence and other factors. Once inventory is written down, its new value is maintained until it is sold or scrapped.We receive various rebate incentives from certain suppliers based on our contractual arrangements, including volume-based rebates. The rebates earned are recognized as a reduction of cost of inventories and reduce the cost of sales in the period when the related inventory is sold. We determine the volume-based rebates to be recognized in the cost of sales on a first-in, first-out basis.Income TaxesAs part of the process of preparing our consolidated financial statements, we are required to estimate our taxes in each of the jurisdictions in which we operate. We estimate actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as accruals and allowances not currently deductible for tax purposes. These differences result in deferred tax assets, which are included in our consolidated balance sheets. In general, deferred tax assets represent future tax benefits to be received when certain expenses previously recognized in our consolidated statements of income become deductible expenses under applicable income tax laws, or when loss or credit carryforwards are utilized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We continue to assess the need for a valuation allowance on the deferred tax assets by evaluating both positive and negative evidence that may exist. Any adjustment to the valuation allowance on deferred tax assets would be recorded in the consolidated statements of income for the period that the adjustment is determined to be required.We recognize tax liabilities for uncertain income tax positions on the income tax return based on the two-step process. The first step is to determine whether it is more likely than not that each income tax position would be sustained upon audit. The second step is to estimate and measure the tax benefit as the amount that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority. Estimating these amounts requires us to determine the probability of various possible outcomes. We evaluate these uncertain tax positions on a quarterly basis. This evaluation is based on the consideration of several factors, including changes in facts or circumstances, changes in applicable tax law, settlement of issues under audit and new exposures. If we later determine that our exposure is lower or that the liability is not sufficient to cover our revised expectations, we adjust the liability and reflect a related charge in our tax provision during the period in which we make such a determination.SMCI | 2023 Form 10-K | 39Stock-Based CompensationWe measure and recognize compensation expense for all share-based awards made to employees and non-employees, including stock options, restricted stock units ("RSUs") and performance-based restricted stock units (“PRSUs”). We recognize the grant date fair value of all share-based awards over the requisite service period and account for forfeitures as they occur. Stock option and RSU awards are recognized to expense on a straight-line basis over the requisite service period. PRSU awards are recognized to expense using an accelerated method only when it is probable that a performance condition is met during the vesting period. If it is not probable, no expense is recognized and the previously recognized expense is reversed. We base initial accrual of compensation expense on the estimated number of PRSUs that are expected to vest over the requisite service period. That estimate is revised if subsequent information indicates that the actual number of PRSUs is likely to differ from previous estimates. The cumulative effect on current and prior periods of a change in the estimated number of PRSUs expected to vest is recognized in stock-based compensation expense in the period of the change. Previously recognized compensation expense is not reversed if vested stock options, RSUs or PRSUs for which the requisite service has been rendered and the performance condition has been met expire unexercised or are not settled.The fair value of RSUs and PRSUs is based on the closing market price of our common stock on the date of grant. We estimate the fair value of stock options granted using a Black-Scholes option pricing model. This model requires us to make estimates and assumptions with respect to the expected term of the option and the expected volatility of the price of our common stock. The expected term represents the period that our stock-based awards are expected to be outstanding and was determined based on our historical experience. The expected volatility is based on the historical volatility of our common stock. The assumptions used to determine the fair value of the option awards represent management’s best estimates. These estimates involve inherent uncertainties and the application of management’s judgment. Our use of the Black-Scholes option-pricing model requires the input of highly subjective assumptions. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future.Results of Operations The following table presents certain items of our consolidated statements of operations expressed as a percentage of revenue.Years Ended June 30,202320222021Net sales100.0 %100.0 %100.0 %Cost of sales82.0 %84.6 %85.0 %Gross profit18.0 %15.4 %15.0 %Operating expenses:Research and development4.3 %5.2 %6.3 %Sales and marketing1.6 %1.7 %2.4 %General and administrative1.4 %2.0 %2.8 %Total operating expenses7.3 %8.9 %11.5 %Income from operations10.7 %6.5 %3.5 %Other income (expense), net0.1 %0.2 %(0.1)%Interest expense(0.1)%(0.1)%(0.1)%Income before income tax provision10.7 %6.6 %3.3 %Income tax provision(1.6)%(1.0)%(0.2)%Share of (loss) income from equity investee, net of taxes(0.1)%— %— %Net income9.0 %5.6 %3.1 %SMCI | 2023 Form 10-K | 40Net SalesNet sales consist of sales of our server and storage solutions, including systems and related services and subsystems and accessories. The main factors that impact net sales of our server and storage systems are the number of compute nodes sold and the average selling prices per node. The main factors that impact net sales of our subsystems and accessories are units shipped and the average selling price per unit. The prices for our server and storage systems range widely depending upon the configuration, including the number of compute nodes in a server system as well as the level of integration of key components such as SSDs and memory. The prices for our subsystems and accessories can also vary widely based on whether a customer is purchasing power supplies, server boards, chassis or other accessories.A compute node is an independent hardware configuration within a server system capable of having its own CPU, memory and storage and that is capable of running its own instance of a non-virtualized operating system. The number of compute nodes sold, which can vary by product, is an important metric we use to track our business. Measuring volume using compute nodes enables more consistent measurement across different server form factors and across different vendors. As with most electronics-based product life cycles, average selling prices typically are highest at the time of introduction of new products that utilize the latest technology and tend to decrease over time as such products mature in the market and are replaced by next generation products. Additionally, in order to remain competitive throughout all industry cycles, we actively change our selling price per unit in response to changes in costs for key components such as CPU/GPU, memory and storage.The following table presents net sales by product type for fiscal years 2023, 2022 and 2021 (dollars in millions):Years Ended June 30,2023 over 2022 Change2022 over 2021 Change202320222021$%$%Server and storage systems$6,569.8 $4,463.8 $2,790.3 $2,106.0 47.2 %$1,673.5 60.0 %Percentage of total net sales92.2 %85.9 %78.4 %Subsystems and accessories553.7 732.3 767.1 (178.6)(24.4)%(34.8)(4.5)%Percentage of total net sales7.8 %14.1 %21.6 %Total net sales$7,123.5 $5,196.1 $3,557.4 $1,927.4 37.1 %$1,638.7 46.1 %Fiscal Year 2023 Compared with Fiscal Year 2022During fiscal year 2023 we experienced increased revenue from server and storage systems, particularly from our large enterprise and datacenter customers. The year-over-year increase in net sales of server and storage systems was primarily due to the strong demands from such customers for GPU, high performance computing (“HPC”), and rack-scale solutions which are generally more complex and of higher value, resulting in an increase of average selling prices. The year-over-year decrease in net sales of subsystems and accessories was primarily due to our emphasis on selling full systems and servers. Our services and software revenue, included in server and storage systems revenue, increased by $28.0 million year-over-year. Fiscal Year 2022 Compared with Fiscal Year 2021 During fiscal year 2022 we experienced increased revenue from server and storage systems, particularly from our large enterprise and datacenter customers. The year-over-year increase in net sales of server and storage systems was primarily due to an increase of average selling prices per compute node by approximately 32% as well as an increase of approximately 23% in the number of units of compute nodes sold. The year-over-year decrease in net sales of subsystems and accessories was primarily due to our emphasis on selling full systems and servers. Our services and software revenue, included in server and storage systems revenue, increased by $2.5 million year-over-year. SMCI | 2023 Form 10-K | 41The following table presents percentages of net sales by geographic region for fiscal years 2023, 2022 and 2021 (dollars in millions): Years Ended June 30,2023 over 2022 Change2022 over 2021 Change202320222021$%$%United States$4,834.1 $3,035.5 $2,107.9 $1,798.6 59.3 %$927.6 44.0 %Percentage of total net sales67.9 %58.4 %59.3 %Asia1,050.8 1,139.9 699.7 (89.1)(7.8)%440.2 62.9 %Percentage of total net sales14.7 %21.9 %19.7 %Europe1,003.1 825.2 614.8 177.9 21.6 %210.4 34.2 %Percentage of total net sales14.1 %15.9 %17.3 %Others235.5 195.5 135.0 40.0 20.5 %60.5 44.8 %Percentage of total net sales3.3 %3.7 %3.7 %Total net sales$7,123.5 $5,196.1 $3,557.4 $1,927.4 37.1 %$1,638.7 46.1 %Fiscal Year 2023 Compared with Fiscal Year 2022The year-over-year increase in overall net sales is the result of increased selling prices and units shipped of product sold especially to large enterprise and datacenter customers. The United States experienced the highest percentage growth among all regions. This is due to increased demand from datacenter customers in the United States for GPU, high performance computing (“HPC”), and rack-scale solutions. The year-over-year decrease in Asia is mainly due to economic slowdown in China and Japan during fiscal year 2023 which heavily reduced the sales activities in that region.Fiscal Year 2022 Compared with Fiscal Year 2021The year-over-year increase in overall net sales is the result of increased selling prices and quantities of product shipments. Asia experienced the highest percentage growth among all regions. China, Japan and Korea exceeded the overall regional average of growth, which was the primary driver of the increases in net sales in Asia. Russia experienced a year over year decrease due to the conflict in that region, which decrease had an immaterial impact on our overall performance.Cost of Sales and Gross MarginCost of sales primarily consists of the costs to manufacture our products, including the costs of materials, contract manufacturing, shipping, personnel expenses, including salaries, benefits, stock-based compensation and incentive bonuses, equipment and facility expenses, warranty costs and inventory excess and obsolescence provisions. The primary factors that impact our cost of sales are the mix of products sold and cost of materials, which include purchased parts and material costs, shipping costs, salary and benefits and overhead costs related to production as well as economies of scale gained from higher production volume in our facilities. Cost of sales as a percentage of net sales may increase or decrease over time if the changes in average selling prices are not matched by corresponding changes in our costs. Our cost of sales as a percentage of net sales is also impacted by the extent to which we are able to efficiently utilize our expanding manufacturing capacity. Because we generally do not have long-term fixed supply agreements, our cost of sales is subject to frequent change based on the availability of materials and other market conditions.We use several suppliers and contract manufacturers to design and manufacture subsystems in accordance with our specifications, with most final assembly and testing performed at our manufacturing facilities in the same region where our products are sold. We work with Ablecom, one of our key contract manufacturers and also a related party, to optimize modular designs for our chassis and certain other components. We also outsource to Compuware, also a related party, a portion of our design activities and a significant part of the manufacturing of components, particularly power supplies. Our purchases of products from Ablecom and Compuware combined represented 6.6%, 8.3% and 7.8% of our cost of sales for fiscal years 2023, 2022 and 2021, respectively. For further details on our dealings with related parties, see Part II, Item 8, Note 9, “Related Party Transactions.” SMCI | 2023 Form 10-K | 42Cost of sales and gross margin for fiscal years 2023, 2022 and 2021, are as follows (dollars in millions):Years Ended June 30,2023 over 2022 Change2022 over 2021 Change202320222021$%$%Cost of sales$5,840.5 $4,396.1 $3,022.9 $1,444.4 32.9 %$1,373.2 45.4 %Gross profit1,283.0 800.0 534.5 483.0 60.4 %265.5 49.7 %Gross margin18.0 %15.4 %15.0 %2.6 %0.4 %Fiscal Year 2023 Compared with Fiscal Year 2022The year-over-year increase in cost of sales was primarily attributed to an increase of $1,379.6 million in costs of materials and contract manufacturing expenses primarily related to the increased shipments of our products and solutions, a $59.2 million increase in overhead costs which includes labor costs attributed to increase of operation activities, a $36.6 million increase in inventory reserves, and a $13.6 million increase in other cost of sales partially offset by a $44.6 million decrease in freight charges due to a reduced need to expedite shipments due to disruptions in the supply chain caused by the COVID-19 pandemic. The year-over-year increase in the gross margin percentage was primarily due to favorable product and customer mix and lower other cost of goods sold as a percentage of sales, based on higher volumes.Fiscal Year 2022 Compared with Fiscal Year 2021The year-over-year increase in cost of sales was primarily attributed to an increase of $1,262.6 million in costs of materials and contract manufacturing expenses primarily related to the increase in net sales volume, a $54.9 million increase in freight charges, a $23.6 million increase in overhead costs, a $18.9 million increase due to lower cost recovery of cost paid in prior periods, a $8.3 million increase in excess and obsolete inventory charges and a $4.9 million increase in other cost of sales. The year-over-year increase in the gross margin percentage was primarily due to sales prices increases, product and customer mix and higher capitalization of manufacturing overhead due to higher inventory levels, offset by higher costs from freight, overhead, other cost of sales, excess and obsolete inventory charges, and lower recovery of costs from prior periods. Since the start of the COVID-19 pandemic, we have experienced an increase in costs of sales, logistics costs as well as direct labor costs as we incentivized our employees. This increase in costs negatively impacts our gross margin, and we expect these higher costs to continue for the duration of the COVID-19 pandemic.Operating Expenses Research and development expenses consist of personnel expenses, including salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our research and development personnel, as well as product development costs such as materials and supplies, consulting services, third-party testing services and equipment and facility expenses related to our research and development activities. All research and development costs are expensed as incurred. We occasionally receive non-recurring engineering ("NRE") funding from certain suppliers and customers for joint development. Under these arrangements, we are reimbursed for certain research and development costs that we incur as part of the joint development efforts with our suppliers and customers. These amounts offset a portion of the related research and development expenses and have the effect of reducing our reported research and development expenses.Sales and marketing expenses consist primarily of personnel expenses, including salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our sales and marketing personnel, cost for tradeshows, independent sales representative fees and marketing programs. From time to time, we receive marketing development funding from certain suppliers. Under these arrangements, we are reimbursed for certain marketing costs that we incur as part of the joint promotion of our products and those of our suppliers. These amounts offset a portion of the related expenses and have the effect of reducing our reported sales and marketing expenses. The timing, magnitude and estimated usage of these programs can result in significant variations in reported sales and marketing expenses from period to period. Spending on cooperative marketing, reimbursed by our suppliers, typically increases in connection with new product releases by our suppliers.SMCI | 2023 Form 10-K | 43General and administrative expenses consist primarily of general corporate costs, including personnel expenses such as salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our general and administrative personnel, financial reporting, information technology, corporate governance and compliance, outside legal, audit, tax fees, insurance and bad debt reserves on accounts receivable.Operating expenses for fiscal years 2023, 2022 and 2021 are as follows (dollars in millions):Years Ended June 30,2023 over 2022 Change2022 over 2021 Change202320222021$%$%Research and development$307.3 $272.3 $224.4 $35.0 12.9 %$47.9 21.3 %Percentage of total net sales4.3 %5.2 %6.3 %Sales and marketing115.0 90.1 85.7 24.9 27.6 %4.4 5.1 %Percentage of total net sales1.6 %1.7 %2.4 %General and administrative99.6 102.4 100.5 (2.8)(2.7)%1.9 1.9 %Percentage of total net sales1.4 %2.0 %2.8 %Total operating expenses$521.9 $464.8 $410.6 57.1 12.3 %54.2 13.2 % Fiscal Year 2023 Compared with Fiscal Year 2022 The year-over-year increase in research and development expenses was primarily driven by a $43.5 million increase in compensation expenses due to salary increases, higher headcount and the cost of equity awards as we expanded our workforce and invested in key talent, and a $2.6 million increase in product development costs to support the development of next generation products and technologies, offset by a $11.1 million increase in research and development credits received from certain suppliers and customers.The year-over-year increase in sales and marketing expenses was primarily driven by a $23.8 million increase in compensation expenses due to salary increases, higher headcount and the cost of equity awards and a $4.6 million increase in travel and trade show expenses to drive new sales opportunities for our products and customer support, offset by a $3.5 million increase in marketing development funds received.The year-over-year decrease in general and administrative expenses was primarily due to a $5.2 million decrease in professional fees and other, a $2.0 million decrease in litigation settlement expenses relating to a derivative lawsuit, partially offset by an increase of $4.4 million in compensation expenses associated with the cost of equity awards.Fiscal Year 2022 Compared with Fiscal Year 2021 The year-over-year increase in research and development expenses was primarily due to a $40.8 million increase in personnel expenses due to salary increases and a higher headcount, $3.7 million lower research and development credits from certain suppliers and customers towards our development efforts and a $3.4 million increase in product development costs.The year-over-year increase in sales and marketing expenses was primarily due to a $9.6 million increase in personnel expenses due to salary increases and a higher headcount, offset by a $5.7 million increase in marketing development funds received and a $0.5 million increase in advertising and other expenses.The year-over-year increase in general and administrative expenses was primarily due to a $4.1 million increase in legal and litigation settlement expenses and $6.6 million increase in personnel and other expenses due to salary increases and a higher headcount offset by decrease of $1.5 million in professional fees driven by lower expenses incurred to remediate the causes that led to the delay in filing our periodic reports with the SEC and the associated restatement of our previously issued financial statements and a $7.3 million decrease in expense from special performance awards.Interest and Other Income (Expense), NetOther income (expense), net consists primarily of interest earned on our investment and cash balances and foreign exchange gains and losses. Interest expense represents interest expense on our term loans and lines of credit.SMCI | 2023 Form 10-K | 44Interest and other income (expense), net for fiscal years 2023, 2022 and 2021 are as follows (dollars in millions):Years Ended June 30,2023 over 2022 Change2022 over 2021 Change202320222021$%$%Other income (expense), net$3.6 $8.1 $(2.8)$(4.5)(55.6)%$10.9 (389.3)%Interest expense(10.5)(6.4)(2.5)(4.1)64.1 %(3.9)156.0 %Interest and other income (expense), net$(6.9)$1.7 $(5.3)$(8.6)(505.9)%$7.0 (132.1)%Fiscal Year 2023 Compared with Fiscal Year 2022The change of $8.6 million in interest and other income (expense), net was primarily attributable to a $4.5 million decrease in foreign exchange gain due to unfavorable currency fluctuations primarily related to our borrowing facilities in Taiwan and a $4.1 million increase in interest expense due to increase in interest rates on our outstanding loan balances.Fiscal Year 2022 Compared with Fiscal Year 2021The change of $7.0 million in interest and other income (expense), net was primarily attributable to a $10.9 million increase in foreign exchange gain due to favorable currency fluctuations primarily related to our borrowing facilities in Taiwan offset by a $3.9 million increase in interest expense due to increase in loan balances and interest rates.Provision for Income TaxesOur income tax provision is based on our taxable income generated in the jurisdictions in which we operate, which primarily include the United States, Taiwan, and the Netherlands. Our effective tax rate differs from the statutory rate primarily due to research and development tax credits, certain non-deductible expenses, tax benefits from foreign derived intangible income and stock-based compensation. A reconciliation of the federal statutory income tax rate to our effective tax rate is set forth in Part II, Item 8, Note 11, “Income Taxes” to the consolidated financial statements in this Annual Report.Provision for income taxes and effective tax rates for fiscal years 2023, 2022 and 2021 are as follows (dollars in millions):Years Ended June 30,2023 over 2022 Change2022 over 2021 Change202320222021$%$%Income tax provision$110.7 $52.9 $6.9 $57.8 109.3 %$46.0 666.7 %Percentage of total net sales1.6 %1.0 %0.2 %Effective tax rate14.7 %15.7 %5.8 %Fiscal Year 2023 Compared with Fiscal Year 2022The year-over-year decrease in the effective tax rate is attributable to higher tax deductions from disqualified disposition of stock-based compensation, an increase in the R&D tax credit, and an increase in foreign-derived income. As a result of these favorable elements which were partially offset by certain unfavorable items including an increase in state taxes, the total effective tax rate decreased by 1%, declining from 15.7% in the fiscal year ended June 30, 2022, to 14.7% in the fiscal year ended June 30, 2023.Fiscal Year 2022 Compared with Fiscal Year 2021The year-over-year increase in the effective tax rate was primarily due to a significant increase in revenue and income before tax. Total effective tax rate increased by 9.5% from 5.8% for the fiscal year ended June 30, 2021 to 15.7% for the fiscal year ended June 30, 2022. This increase was driven by a 15.4% increase in the overall effective tax rate. R&D credit reduced the effective tax rate by 3.5% and foreign derived income reduced the effective tax rate by 1.4%.Share of Income (Loss) from Equity Investee, Net of TaxesShare of income from equity investee, net of taxes represents our share of income (loss) from the Corporate Venture in which we have a 30% ownership. SMCI | 2023 Form 10-K | 45Share of income (loss) from equity investee, net of taxes for fiscal years 2023, 2022 and 2021 are as follows (dollars in millions):Years Ended June 30,2023 over 2022 Change2022 over 2021 Change202320222021$%$%Share of income (loss) from equity investee, net of taxes$(3.6)$1.2 $0.2 $(4.8)(400.0)%$1.0 (500.0)%Percentage of total net sales— %— %— %Fiscal Year 2023 Compared with Fiscal Year 2022The period-over-period decrease of $4.8 million in share of income from equity investee, net of taxes was primarily due to lower net income recognized by the Corporate Venture.Fiscal Year 2022 Compared with Fiscal Year 2021The period-over-period increase of $1.0 million in share of income from equity investee, net of taxes was primarily due to more net income recognized by the Corporate Venture.Liquidity and Capital ResourcesWe have financed our growth primarily with funds generated from operations, in addition to utilizing borrowing facilities, particularly in relation to an increase in the need for working capital due to longer supply chain manufacturing and delivery times as well as the financing of real property acquisitions and funds received from the exercise of employee stock options. Our cash and cash equivalents were $440.5 million and $267.4 million as of June 30, 2023 and 2022, respectively. Our cash in foreign locations was $192.3 million and $169.5 million as of June 30, 2023 and 2022, respectively. Amounts held outside of the U.S. are generally utilized to support non-U.S. liquidity needs. Repatriations generally will not be taxable from a U.S. federal tax perspective but may be subject to state income or foreign withholding tax. Where local restrictions prevent an efficient intercompany transfer of funds, our intent is to keep cash balances outside of the U.S. and to meet liquidity needs through operating cash flows, external borrowings, or both. We do not expect restrictions or potential taxes incurred on repatriation of amounts held outside of the U.S. to have a material effect on our overall liquidity, financial condition or results of operations.We believe that our current cash, cash equivalents, borrowing capacity available from our credit facilities and internally generated cash flows will be sufficient to support our operating businesses and maturing debt and interest payments for the 12 months following the issuance of these consolidated financial statements. On June 17, 2023, the Company through the Taiwan subsidiary, entered into a Notification and Confirmation pursuant to which the Taiwan subsidiary and E.SUN Bank agreed to drawdowns of up to US$30 million for an import o/a financing loan with a tenor of 120 days (the “2023 Import O/A Loan”). We continue to evaluate financing options that may be required to support the growth of our business, if it occurs more rapidly than anticipated.On January 29, 2021, a duly authorized subcommittee of the Board of Directors approved the Prior Repurchase Program, which permitted us to repurchase up to an aggregate of $200.0 million of our common stock at market prices. The program was effective until the earlier of July 31, 2022 or the date when the maximum amount of common stock is repurchased. We had $150.0 million of remaining availability under the Prior Repurchase Program as of June 30, 2022, and such program subsequently expired on July 31, 2022. On August 3, 2022, after the expiration of the Prior Share Repurchase Program on July 31, 2022, a duly authorized subcommittee of our Board approved a new share repurchase program to repurchase shares of our common stock for up to $200 million at prevailing prices in the open market. The share repurchase program is effective until January 31, 2024 or until the maximum amount of common stock is repurchased, whichever occurs first. We repurchased 1,553,350 shares of common stock for $150 million during the fiscal year ended June 30, 2023 under this program and had $50.0 million of remaining availability as of June 30, 2023. SMCI | 2023 Form 10-K | 46Our key cash flow metrics were as follows (dollars in millions):Years Ended June 30,2023 over 20222022 over 2021202320222021Net cash provided by (used in) operating activities$663.6 $(440.8)$123.0 $1,104.4 $(563.8)Net cash used in investing activities$(39.5)$(46.3)$(58.0)$6.8 $11.7 Net cash (used in) provided by financing activities$(448.3)$522.9 $(44.4)$(971.2)$567.3 Net increase in cash, cash equivalents and restricted cash$172.4 $35.1 $21.1 $137.3 $14.0 Operating ActivitiesNet cash provided by operating activities increased by $1,104.4 million for fiscal year 2023 as compared to fiscal year 2022. The increase was primarily due to an increase in net cash provided from net working capital of $796.7 million, a $354.8 million increase in net income due to the increase in sales of our products and solutions, a $21.6 million increase in stock-based compensation expense as a result of an increase in the cost of equity awards, a $11.1 million decrease in unrealized gain due to currency fluctuation, and a $6.4 million increase in other non-cash items. These changes are offset by an increase of $86.2 million in deferred income taxes primarily due to increase in capitalized research and development costs.Net cash provided by operating activities decreased by $563.8 million for fiscal year 2022 as compared to fiscal year 2021. The decrease was primarily due to an increase in net cash required for net working capital of $739.6 million to meet customer demand, support expected business growth and mitigate supply chain risk as a result of the COVID-19 pandemic environment and a $16.2 million decrease in unrealized gain and loss. These decreases are partially offset by increases in provision for excess and obsolete inventories of $8.3 million, depreciation and amortization expense of $4.3 million, stock-based compensation expense of $4.3 million and net income of $173.3 million. Since the beginning of the COVID-19 pandemic and the accompanying supply chain disruptions our management decided to increase our holdings of all components of our inventory (finished goods, work in process and purchased parts and raw materials). This decision reflected our belief that we had opportunities to increase our net sales if we could mitigate the risk of being unable to satisfy customer demand because of these supply chain disruptions, including longer lead times. We expect disruption of the supply chain and longer lead times to continue for the foreseeable future and therefore expect to continue to carry larger amounts of inventory than we would if the supply chain were functioning more normally and predictably.Investing ActivitiesNet cash used in investing activities was $39.5 million, $46.3 million and $58.0 million for fiscal years 2023, 2022 and 2021, respectively, as we invested in our Green Computing Park in San Jose to expand our manufacturing capacity and office, expanded our Bade Facility in Taiwan and made purchases of property, plant and equipment.Financing ActivitiesNet cash used in financing activities increased by $971.2 million for fiscal year 2023 as compared to fiscal year 2022 primarily due to repurchases of our common stock for $150.0 million reflecting our commitment to return value to our shareholders and repayment of net borrowings of $813.2 million. Net cash used in financing activities increased by $567.3 million for fiscal year 2022 as compared to fiscal year 2021 primarily due to an increase of $446.2 million in proceeds from borrowings net of repayment, offset by a $130.0 million decrease in stock repurchases.Other Factors Affecting Liquidity and Capital Resources Refer to Part II, Item 8, Note 7, “Short-term and Long-term Debt” in our notes to consolidated financial statements in this Annual Report on Form 10-K for further information on our outstanding debt.SMCI | 2023 Form 10-K | 47Capital Expenditure RequirementsWe anticipate our capital expenditures in fiscal year 2024 will be in range of $105.0 million to $115.0 million, relating primarily to costs associated with our manufacturing capabilities, including tooling for new products, new information technology investments, and facilities upgrades. During the second quarter of fiscal year 2023, we entered into a letter of understanding to acquire land in Malaysia to expand our manufacturing operations. A definitive agreement to acquire such land, subject to various conditions, was subsequently executed in January 2023. We are obtaining early access to such land prior to the acquisition, and we anticipate additional capital expenditures in fiscal year 2024 of $75.0 million (included in the above range) for such initiative. In addition, we will continue to evaluate new business opportunities and new markets. As a result, our future growth within the existing business or new opportunities and markets may dictate the need for additional facilities and capital expenditures to support that growth. We evaluate capital expenditure projects based on a variety of factors, including expected strategic impacts (such as forecasted impact on revenue growth, productivity, expenses, service levels and customer retention) and our expected return on investment.We intend to continue to focus our capital expenditures in fiscal year 2024 to support the growth of our operations. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced software and services offerings and investments in our office facilities and our IT system infrastructure.Contractual ObligationsOur estimated future obligations as of June 30, 2023, include both current and long term obligations. For our long-term debt as noted in Part II, Item 8, Note 7, “Short-term and Long-term Debt”, we have a current obligation of $170.1 million and a long-term obligation of $120.2 million. Under our operating leases as noted in Part II, Item 8, Note 8, "Leases", we have a current obligation of $7.8 million and a long-term obligation of $12.2 million. As noted in Part II, Item 8, Note 12, "Commitments and Contingencies", we have current obligations related to noncancelable purchase commitments of $2.3 billion. We have not provided a detailed estimate of the payment timing of unrecognized tax benefits due to the uncertainty of when the related tax settlements will become due. See Part II, Item 8, Note 11, “Income Taxes” to the consolidated financial statements in this Annual Report for a discussion of income taxes.Recent Accounting PronouncementsFor a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements, see Part II, Item 8, Note 1, “Organization and Summary of Significant Accounting Policies” to the consolidated financial statements in this Annual Report.SMCI | 2023 Form 10-K | 48Item 7A. Quantitative and Qualitative Disclosure About Market RiskInterest Rate RiskThe primary objectives of our investment activities are to preserve principal, provide liquidity and maximize income without significantly increasing the risk. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the fair value of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in money market funds and certificates of deposit. Our investment in an auction rate security has been classified as non-current due to the lack of a liquid market for these securities. Since our results of operations are not dependent on investments, the risk associated with fluctuating interest rates is limited to our investment portfolio, and we believe that a 10% change in interest rates would not have a significant impact on our results of operations. As of June 30, 2023, our investments were in money market funds, certificates of deposits and auction rate securities. We are exposed to changes in interest rates as a result of our borrowings under our term loan and revolving lines of credit. The interest rates for the term loans and the revolving lines of credit ranged from 1.20% to 7.08% at June 30, 2023. Based on the outstanding principal indebtedness of $290.3 million under our credit facilities as of June 30, 2023, we believe that a 10% change in interest rates would not have a significant impact on our results of operations. Foreign Currency RiskTo date, our international customer and supplier agreements have been denominated primarily in U.S. dollars and accordingly, we have limited exposure to foreign currency exchange rate fluctuations from customer agreements, and do not currently engage in foreign currency hedging transactions. The functional currency of our subsidiaries in the Netherlands and Taiwan is the U.S. dollar. However, certain loans and transactions in these entities are denominated in a currency other than the U.S. dollar, and thus we are subject to foreign currency exchange rate fluctuations associated with re-measurement to U.S. dollars. Such fluctuations have not been significant historically. Realized and unrealized foreign exchange gain (loss) for fiscal years 2023, 2022 and 2021 was $0.2 million, $7.7 million and $(3.2) million, respectively.SMCI | 2023 Form 10-K | 49
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional information.Services and ProductsWe provide mobile wireless communications services through a variety of service plan options. We also offer for sale to customers a wide selection of wireless devices, including smartphones, wearables, tablets, home broadband routers and other mobile communication devices that are manufactured by various suppliers. Our most popular service plan offering is Magenta Max, which allows customers to subscribe for wireless communications services separately from the purchase of a device. This plan includes unlimited talk, text and data on our network, 5G access at no extra cost, scam protection features and more. We also offer an Essentials rate plan for customers who want the basics at a lower price point, as well as specific rate plans to qualifying customers, including Business, Military and Veterans, First Responder, and Unlimited 55+. At the time of device purchase, qualified customers can finance all or a portion of the individual device or accessory purchase price over an installment period, generally of 24 months, using an equipment installment plan (“EIP”). For certain existing customers, devices are leased over an initial period of up to 18 months and may be upgraded when eligibility requirements are met.5Table of ContentsIn addition to our mobile wireless communications services, we offer High Speed Internet, which is a fixed wireless product that utilizes the excess capacity of our nationwide 5G network. Our fixed wireless product is available to millions of domestic households, providing an alternative to traditional landline internet service providers and expanding access to many people who have historically had only one choice or no access to traditional home broadband. With our High Speed Internet plan, customers can access the internet without worrying about annual service contracts, data overages or hidden fees. We also provide products and services that are complementary to our wireless communications services, including device protection, financial services, advertising and wireline communication services to domestic and international customers. In September 2022, we entered into an agreement for the sale of the Wireline Business. See Note 16 – Wireline for additional information.CustomersWe provide wireless communications services to a variety of customers needing connectivity, but focus primarily on two categories of customers: •Postpaid customers generally are qualified to pay after receiving wireless communications services utilizing phones, High Speed Internet, tablets, wearables, DIGITS and other connected devices; and•Prepaid customers generally pay for wireless communications services, including High Speed Internet, in advance. Our prepaid customers include customers of T-Mobile and Metro by T-Mobile.Our customer base includes consumers as well as business customers, who are provided services under the T-Mobile for Business brand.We provide Machine-to-Machine (“M2M”) and Mobile Virtual Network Operator (“MVNO”) customers access to our network. This access and the customer relationship are managed by wholesale partners, with whom we have commercial agreements permitting them to sell services utilizing our network. We generate the majority of our service revenues by providing wireless communications services to postpaid and prepaid customers. Our ability to attract and retain postpaid and prepaid customers is important to our business in the generation of service revenues, equipment revenues and other revenues. In 2022, our service revenues generated by providing wireless communications services by customer category were:•75% Postpaid customers;•16% Prepaid customers; and •9% Wholesale and other services.Substantially all of our revenues for the years ended December 31, 2022, 2021 and 2020, were earned in the United States, including Puerto Rico and the U.S. Virgin Islands. Network StrategyUtilizing our multi-layer spectrum portfolio, our mission is to become “Famous for Network.” We have deployed low-band, mid-band and mmWave spectrum dedicated for 5G across our dense and broad network to create what we believe is America’s largest, fastest, most reliable and most awarded 5G network. The Merger greatly enhanced our spectrum position. Integration of the spectrum and network assets acquired in the Merger is expected to continue through 2023. Our integration strategy includes deploying the acquired spectrum on the combined network assets to supplement capacity, migrating Sprint customers to our network and optimizing the combined assets by decommissioning redundant sites. As of December 31, 2022, we have decommissioned substantially all targeted Sprint macro sites. As a result of the Merger, we have achieved, and expect to continue to achieve, significant synergies and cost reductions by eliminating redundancies within our network, as well as through other business processes and operations.6Table of ContentsSpectrum PositionWe provide wireless communications services utilizing low-band spectrum licenses covering our 600 MHz and 700 MHz spectrum, mid-band spectrum licenses, such as Advanced Wireless Services (“AWS”), Personal Communications Services (“PCS”) and 2.5 GHz spectrum, and mmWave spectrum.•We controlled, or expected to control based on previously announced auction results, an average of 388 MHz of combined low- and mid-band spectrum nationwide as of December 31, 2022. This spectrum is comprised of:•An average of 38 MHz in the 600 MHz band;•An average of 10 MHz in the 700 MHz band;•An average of 14 MHz in the 800 MHz band;•An average of 40 MHz in the 1700 MHz AWS band;•An average of 66 MHz in the 1900 MHz PCS band;•An average of 181 MHz in the 2.5 GHz band;•An average of 12 MHz in the 3.45 GHz band; and•An average of 27 MHz in the C-band.•We controlled an average of 1,157 GHz of combined mmWave spectrum licenses.•In January 2022, the FCC announced that we were the winning bidder of 199 licenses in Auction 110 (mid-band spectrum) for an aggregate purchase price of $2.9 billion. On May 4, 2022, the FCC issued to us the licenses won in Auction 110.•In August 2022, we entered into license purchase agreements pursuant to which we will acquire spectrum in the 600 MHz band in exchange for total cash consideration of $3.5 billion. See Note 6 – Goodwill, Spectrum License Transactions and Other Intangible Assets for additional details.•In September 2022, the FCC announced that we were the winning bidder of 7,156 licenses in Auction 108 (2.5 GHz spectrum) for an aggregate price of $304 million. The timing of when the licenses will be issued will be determined by the FCC after all post-auction procedures have been completed. •We plan to evaluate future spectrum purchases in future auctions and in the secondary market to further augment our current spectrum position.•As of December 31, 2022, we had equipment deployed on approximately 79,000 macro cell sites and 41,000 small cell/distributed antenna system sites across our network. 5G LeadershipOur 5G network is America’s largest, fastest, most reliable and most awarded:•As of December 31, 2022, our Ultra Capacity 5G utilizing mid-band and mmWave spectrum covers 263 million people.•As of December 31, 2022, our total 5G coverage, including low-band spectrum, covers 325 million people, reaching 98% of Americans.CompetitionThe wireless communications services industry is highly competitive. We are the second largest provider of wireless communications services in the U.S. as measured by our total postpaid and prepaid customers. Our competitors include other national carriers, such as AT&T Inc. (“AT&T”) and Verizon Communications, Inc. (“Verizon”). In addition, our competitors include numerous smaller and regional carriers, MVNOs, including Comcast Corporation, Charter Communications, Inc., Altice USA, Inc. and DISH, many of which offer no-contract, postpaid and prepaid service plans. Competitors also include providers who offer similar communication services, such as voice, messaging and data services, using alternative technologies. Competitive factors within the wireless communications services industry include pricing, market saturation, service and product offerings, customer experience, network investment and quality, development and deployment of technologies and regulatory changes. Some of our competitors have shown a willingness to use aggressive pricing or offer bundled services as a potential source of differentiation. 7Table of ContentsHuman CapitalEmployeesAs of December 31, 2022, we employed approximately 71,000 full-time and part-time employees, including network, retail, administrative and customer support functions.Attraction and RetentionWe employ a highly skilled workforce within a broad range of functions. Substantially all of our employees are located throughout the United States, including Puerto Rico, to serve our nationwide network and retail operations. Our headquarters are located in Bellevue, Washington, and Overland Park, Kansas.We attract and retain our workforce through a dynamic and inclusive culture and by providing a comprehensive set of benefits, including:•Competitive medical, dental and vision benefits;•Family-building benefits designed to meet the diverse needs of our employees, including IVF and IUI, adoption and surrogacy benefits;•Annual stock grants to all full-time and part-time employees and a discounted Employee Stock Purchase Program;•A 401(k) Savings Plan;•Nationwide minimum pay of at least $20 per hour to all full-time and part-time employees;•LiveMagenta: a custom-branded program for employee engagement and well-being, including free access to life coaches, financial coaches and tools for healthy living;•Access to personal health advocates offering independent guidance;•A generous paid time off program, including paid family leave;•Tuition assistance for all full-time and part-time employees, including full tuition partnerships with multiple schools; and•A matching program for employee donations and volunteering.Training and DevelopmentCareer growth and development is foundational to T-Mobile’s culture and success. We want to deliver the best experiences from the best teams, and one way we do that is by offering an array of development programs and resources to build diverse talent and empower our people to succeed through every step of their career. It is all easily accessible on our Magenta University site, which is our one-stop shop for all things career development and learning. The online learning portal is designed to put employees in the driver’s seat and give them access to mentoring, training, videos, books, job search and interview tips, and much more. By strategically investing in the following three key areas of career development and learning, we are developing our talent now and for the future.•Evolve skills and careers – Learn every day, champion relentless improvement, develop critical skills, explore career possibilities, and build the desired career; •Advance leadership expertise – Build critical leadership capabilities, enable leadership growth at all levels, and develop skills to lead in the future; and•Champion diversity, equity and inclusion (“DE&I”) - Promote inclusive habits and behaviors, enhance belonging and connectedness, and advocate for equitable opportunities.Diversity, Equity and InclusionDE&I have always been a part of the Un-carrier culture, and we are committed to having DE&I touch every aspect of our future. Our Equity in Action Plan is a five-year plan that spans the values we live by, how we invest in and provide opportunities for our employees, how we select the suppliers we do business with and how we advocate for our communities.8Table of ContentsFor our employees, we have established six DE&I Employee Resource Groups and four sub-affinity groups that have helped us establish and maintain a culture of inclusion. Currently, we have over 45 DE&I chapters across the nation that help spearhead volunteer opportunities, events and meaningful conversation with employees at a local level. Our DE&I Employee Resource Groups include the following:•Accessibility Community at T-Mobile;•Multicultural Alliance;•Asia Pacific & Allies Network;•Black Empowerment Network;•Indigenous Peoples Network;•Magenta Latinx Network;•Multigenerational Network;•Pride;•Veterans & Allies Network; and•Women & Allies Network. As part of T-Mobile’s Equity In Action Plan and Promises, we have established an External Diversity and Inclusion Council in connection with our civil rights memorandum of understanding. The council includes civil rights leaders representing a wide range of underrepresented communities. Together with T-Mobile, the council will help identify ways to improve our efforts in focus areas such as corporate governance, workforce recruitment and retention, procurement, entrepreneurship, philanthropy and community investment. Since April 2020, we have achieved a significant portion of the Equity In Action Promises.As DE&I are instrumental to our culture and values, we are also on a mission to create fair and equitable opportunities for all suppliers, including veteran-owned, disability-owned, woman-owned, minority-owned, LGBT-owned and small and disadvantaged businesses. We have implemented a Supplier Diversity Category Management Strategy for our network technology procurement organization to help identify opportunities and develop actionable targets for progress on this topic.Environmental SustainabilityReducing Carbon FootprintWe are working to reduce the impact of our operations on the climate by setting carbon reduction goals that are aligned with science and investing in renewable energy. We are reducing our carbon footprint through several initiatives, including:•Setting a science-based net-zero target for 2040 that includes Scope 1, 2 and 3 emissions;•Investing in renewable energy, as evidenced by our RE100 pledge, a global initiative that unites businesses committed to 100% renewable electricity. We first met this goal in 2021 and then again in 2022 by matching our electricity usage with renewable energy credits acquired through a variety of sources, including through our engagement in Virtual Power Purchasing Agreements and a Green Direct tariff agreement with nine clean energy providers for expected annual provision of approximately 3.5 million megawatt hours of renewable electricity; •Continuously testing and evaluating new, efficient equipment for our facilities, including switch stations, cell sites, retail stores and customer experience centers to reduce energy consumption; and•Promoting the circular economy through our device reuse and recycle program, which collects millions of devices for reuse, resale, and recycling annually.Responsible SourcingWe believe our suppliers are a valuable extension of our business and corporate values. Our Supplier Code of Conduct outlines expectations around ethical business practices for our suppliers. We require our suppliers to operate in full compliance with the laws, rules, regulations and ethical standards of the countries in which they operate or provide products or services. We expect our suppliers to share our commitment to ethical conduct and environmentally responsible business practices while they conduct business with or on behalf of us.We employ a third-party risk management (“TPRM”) process to screen for anti-corruption, global sanctions, human rights and environmental risks before engaging with a supplier. Our TPRM process also continuously monitors current suppliers for policy violations and risks.9Table of ContentsRegulationThe FCC regulates many key aspects of our business, including licensing, construction, the operation and use of our network, modifications of our network, control and ownership of our licenses and authorizations, the sale, transfer and acquisition of certain licenses, domestic roaming arrangements and interconnection agreements, pursuant to its authority under the Communications Act of 1934, as amended (“Communications Act”). The FCC has a number of complex requirements that affect our operations and pending proceedings regarding additional or modified requirements that could increase our costs or diminish our revenues. For example, the FCC has rules regarding provision of 911, 988 and E-911 services, porting telephone numbers, interconnection, roaming, internet openness or net neutrality, disabilities access, privacy and cybersecurity, consumer protection and the universal service and Lifeline programs. Many of these and other issues are being considered in ongoing proceedings, and we cannot predict whether or how such actions will affect our business, financial condition or operating results. Our ability to provide services and generate revenues could be harmed by adverse regulatory action or changes to existing laws and regulations. In addition, regulation of companies that offer competing services can impact our business indirectly. Except for operations in certain unlicensed frequency bands, wireless communications services providers generally must be licensed by the FCC to provide communications services at specified spectrum frequencies within specified geographic areas, and must comply with the rules and policies governing the use of the spectrum as adopted by the FCC. The FCC issues each license for a fixed period of time, typically 10-15 years depending on the particular licenses. While the FCC has generally renewed licenses given to operating companies like us, the FCC has authority both to revoke a license for cause and to deny a license renewal if a renewal is not in the public interest. Furthermore, we could be subject to fines, forfeitures and other penalties for failure to comply with FCC regulations, even if any such noncompliance was unintentional. In extreme cases, penalties can include revocation of our licenses. The loss of any licenses, or any related fines or forfeitures, could adversely affect our business, results of operations and financial condition. In addition, the FCC retains the right to modify rules related to use of licensed spectrum, which could impact T-Mobile’s ability to provide services.Additionally, Congress’s and the FCC’s allocation of additional spectrum for broadband commercial mobile radio service (“CMRS”), which includes cellular, PCS and other wireless services, could significantly increase and intensify competition. We cannot assess the impact that any developments that may occur in the U.S. economy or any future spectrum allocations by the FCC may have on license values. FCC spectrum auctions and other market developments may adversely affect the market value of our licenses or our competitive position in the future. A significant decline in the value of our licenses could adversely affect our financial condition and results of operations. In addition, the FCC periodically reviews its policies on how to evaluate carriers’ spectrum holdings. A change in these policies could affect spectrum resources and competition among us and other carriers. Congress and the FCC have imposed limitations on foreign ownership of CMRS licensees that exceed 20% direct ownership or 25% indirect ownership through an entity controlling the licensee. The FCC has ruled that higher levels of indirect foreign ownership, even up to 100%, are presumptively consistent with the public interest, but must be reviewed and approved. Consistent with that established policy, the FCC has issued a declaratory ruling authorizing up to 100% ownership of our Company by DT.For our Educational Broadband Service (“EBS”) licenses in the 2.5 GHz band, FCC rules previously limited eligibility to hold EBS licenses to accredited educational institutions and certain governmental, religious and nonprofit entities, while permitting those license holders to lease up to 95% of their capacity for non-educational purposes. Therefore, we have historically accessed EBS spectrum primarily through long-term leasing arrangements with EBS license holders. Our EBS spectrum leases typically have an initial term equal to the remaining term of the EBS license, with an option to renew the lease for additional terms, for a total lease term of up to 30 years. On April 27, 2020, the FCC lifted the restriction on who can hold EBS licenses and the 30-year limitation on lease duration, among other changes. The elimination of these restrictions allows current license holders to sell their licenses, including to T-Mobile. While a majority of our leases have contractual provisions enabling us to match offers, we may be forced to compete with others to purchase 2.5 GHz licenses on the secondary market and expend additional capital earlier than we may have anticipated. T-Mobile has started to acquire some of these EBS licenses, but we continue to lease spectrum in this band and expect that to be the case for some time.While the Communications Act generally preempts state and local governments from regulating the entry of, or the rates charged by, wireless communications services providers, certain state and local governments regulate other terms and conditions of wireless service, including billing, termination of service arrangements and the imposition of early termination fees, advertising, network outages, the use of devices while driving, service mapping, protection of consumer information, zoning and land use. Notwithstanding this federal preemption, several states are considering or have passed laws or regulations 10Table of Contentsthat could potentially set prices, minimum performance standards and/or restrictions on service discontinuation that could impact our business in those states.In addition, following the FCC’s adoption of the 2017 Restoring Internet Freedom (“RIF”) Order reclassifying broadband internet access services as non-common carrier “information services”, a number of states have sought to impose state-specific net neutrality, rate-setting, and privacy requirements on providers’ broadband services. The FCC’s RIF Order expressly preempted such state efforts, which are inconsistent with the FCC’s federal deregulatory approach. In 2019, however, the DC Circuit issued a ruling largely upholding the RIF Order, but also vacating the portion of the ruling broadly preempting state/local measures regulating broadband services. The court left open the prospect that particular state laws could still unlawfully conflict with the FCC RIF Order and be preempted; court challenges to some state enactments are pending.While most states pursuing net neutrality legislation are largely seeking to codify the repealed federal rules, there are differences in some states, notably California, which has passed separate privacy and net neutrality legislation, Colorado, Connecticut, Utah and Virginia, which have passed privacy laws; and New York, which has passed a broadband rate-setting law. There are also efforts within Congress to pass federal legislation to codify uniform federal privacy and net neutrality requirements. Ensuring the preemption of separate state requirements, including the California laws, is critical to this effort. If not preempted or rescinded, separate state requirements will impose significant business costs and could also result in increased litigation costs and enforcement risks. State authority over wireless broadband services will remain unsettled until final action by the courts or Congress.In addition, the Federal Trade Commission (“FTC”) and other federal agencies have jurisdiction over some consumer protection matters and the elimination and prevention of anticompetitive business practices with respect to the provision of non-common carrier services. Further, the FCC and the Federal Aviation Administration regulate the siting, lighting and construction of transmitter towers and antennae. Tower siting and construction are also subject to state and local zoning, as well as federal statutes regarding environmental and historic preservation. The future costs to comply with all relevant regulations are, to some extent, unknown, and changes to regulations, or the applicability of regulations, could result in higher operating and capital expenses, or reduced revenues in the future. Available InformationThe SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically at www.sec.gov. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are also publicly available free of charge on the investor relations section of our website at investor.t-mobile.com as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Our corporate governance guidelines, director selection guidelines, code of ethics for senior financial officers, code of business conduct, speak up policy, supplier code of conduct, and charters for the audit, compensation, nominating and corporate governance, executive and CEO selection committees of our Board of Directors are also posted on the investor relations section of our website at investor.t-mobile.com. The information on our website is not part of this or any other report we file with, or furnish to, the SEC.Item 1A. Risk FactorsIn addition to the other information contained in this Form 10-K, the following risk factors should be considered carefully in evaluating T-Mobile. Our business, financial condition, liquidity, or operating results, as well as the price of our common stock and other securities, could be materially adversely affected by any of these risks.Risks Related to Our Business and the Wireless Industry Competition, industry consolidation, and changes in the market for wireless communications services and other forms of connectivity could negatively affect our ability to attract and retain customers and adversely affect our business, financial condition and operating results.We have multiple competitors that possess either more or different access to wireless assets, and yet we compete for customers based principally on service/device offerings, price, network coverage, speed and quality, and customer service. We expect the wireless industry’s customer growth rate to moderate over time in comparison with historical growth rates, leading to ongoing competition for customers. We also expect that our customers’ appetite for data services will place increasing demands on wireless service providers. This competition and increasing demands for data services will continue to put pressure on pricing and margins as companies, including us, compete for a relatively fixed pool of customers with an ever-expanding variety of 11Table of Contentsproducts and services. Our ability to compete will depend upon, among other things, continued absolute and relative improvement in network quality, capacity and customer service, effective marketing and selling of products and services, innovation, and attractive pricing, all of which will involve significant expenses.We face increased competition from other service providers in the connectivity sector from within and outside of the wireless industry, including from cable, fiber and satellite providers, as industry sectors converge. Cable companies such as Comcast, Charter, and Altice are diversifying outside cable, voice and broadband services to also offer wireless services. Fiber companies such as Lumen Technologies and Windstream have announced plans for fiber buildouts, often supported by government funding. We expect DISH, which has already acquired several MVNOs, to build a wireless network and offer competitive postpaid and prepaid wireless service plans. Verizon and AT&T have refocused on connectivity services, including fiber builds and deployment of next generation wireless technology, and we expect both companies to increase competitive pressure, including by expanding partnerships and offerings. These factors could make it more difficult for us to continue to attract and retain customers, by adversely affecting our competitive position and ability to grow, including affecting our fixed wireless High Speed Internet growth plans, which could have a material adverse effect on our business, financial condition, and operating results.We have seen, and continue to expect, additional joint ventures, mergers, acquisitions, and strategic alliances in the converged connectivity sector, which could result in larger competitors competing for a limited number of customers. Further consolidation could negatively impact our businesses, including wholesale. For example, we have experienced and will continue to experience declining revenues from our wholesale business as Verizon migrates legacy TracFone customers off the T-Mobile network and DISH services more of its Boost Mobile customers with their standalone network. Our competitors may also enter into exclusive handset, device, or content arrangements, execute pervasive advertising and marketing campaigns, or otherwise improve their cost position relative to ours, making it more difficult for us to compete and negatively impacting our business. In addition, refusal of our competitors and partners to provide critical access to resources and inputs, such as roaming and/or backhaul services to us, on reasonable terms could negatively impact our business.We have experienced criminal cyberattacks and could in the future be further harmed by disruption, data loss or other security breaches, whether directly or indirectly through third parties.Our business involves the receipt, storage, and transmission of confidential information about our customers, such as sensitive personal, account and payment card information, confidential information about our employees and suppliers, and other sensitive information about our Company, such as our business plans, transactions, financial information, and intellectual property (collectively, “Confidential Information”). We are subject to persistent cyberattacks and threats to our networks, systems, and supply chain from a variety of bad actors, many of whom attempt to gain access to and compromise Confidential Information by exploiting bugs, errors, misconfigurations or other vulnerabilities in our networks and other systems (including purchased and third-party systems) or by engaging in credential harvesting or social engineering. In some cases, these bad actors may obtain unauthorized access to Confidential Information utilizing credentials taken from our customers, employees, or third parties. Other bad actors aim to cause serious operational disruptions to our business or networks through other means, such as through ransomware or distributed denial of services attacks. Cyberattacks against companies like ours have increased in frequency and potential harm over time, and the methods used to gain unauthorized access constantly evolve, making it increasingly difficult to anticipate, prevent, and/or detect incidents successfully in every instance. They are perpetrated by a variety of groups and persons, including state-sponsored parties, malicious actors, employees, contractors, or other unrelated third parties. Some of these persons reside in jurisdictions where law enforcement measures to address such attacks are ineffective or unavailable, and such attacks may even be perpetrated by or at the behest of foreign governments.In addition, we routinely provide certain Confidential Information to third-party providers whose products and services are used in our business operations, including as part of our IT systems, such as cloud services. These third-party providers have experienced in the past, and will continue to experience in the future, cyberattacks that involve attempts to obtain unauthorized access to our Confidential Information and/or to create operational disruptions that could adversely affect our business, and these providers also face other security challenges common to all parties that collect and process information.In August 2021, we disclosed that our systems were subject to a criminal cyberattack that compromised certain data of millions of our current customers, former customers, and prospective customers, including, in some instances, social security numbers, names, addresses, dates of birth and driver’s license/identification numbers. With the assistance of outside cybersecurity experts, we located and closed the unauthorized access to our systems and identified current, former, and prospective customers whose information was impacted and notified them, consistent with state and federal requirements. We have incurred certain cyberattack-related expenses, including costs to remediate the attack, provide additional customer support and enhance 12Table of Contentscustomer protection, and expect to incur additional expense in future periods resulting from the attack. For more information, see “Recent Cyberattacks” in the Overview section of our Management’s Discussion and Analysis of Financial Condition and Results of Operations. As a result of the August 2021 cyberattack, we are subject to numerous claims, lawsuits and regulatory inquiries, the ongoing costs of which may be material, and we may be subject to further regulatory inquiries and private litigation. For more information, see “– Contingencies and Litigation – Litigation and Regulatory Matters” in Note 19 – Commitments and Contingencies of the Notes to the Consolidated Financial Statements.In January 2023, we disclosed that a bad actor was obtaining data through a single Application Programming Interface (“API”) without authorization. Based on our investigation to date, the impacted API is only able to provide a limited set of customer account data, including name, billing address, email, phone number, date of birth, T-Mobile account number and information such as the number of lines on the account and plan features. The result from our investigation to date indicates that the bad actor(s) obtained data from this API for approximately 37 million current postpaid and prepaid customer accounts, though many of these accounts did not include the full data set. We believe that the bad actor first retrieved data through the impacted API starting on or around November 25, 2022. We continue to investigate the incident and have notified individuals whose information was impacted consistent with state and federal requirements.As a result of the August 2021 cyberattack and the January 2023 cyberattack, we may incur significant costs or experience other material financial impacts, which may not be covered by, or may exceed the coverage limits of, our cyber liability insurance, and such costs and impacts may have a material adverse effect on our business, reputation, financial condition, cash flows and operating results.In addition to the recent cyberattacks, we have experienced other unrelated immaterial incidents involving unauthorized access to certain Confidential Information. Typically, these incidents have involved attempts to commit fraud by taking control of a customer’s phone line, often by using compromised credentials. In other cases, the incidents have involved unauthorized access to certain of our customers’ private information, including credit card information, financial data, social security numbers or passwords, and to certain of our intellectual property. Our procedures and safeguards to prevent unauthorized access to Confidential Information and to defend against cyberattacks seeking to disrupt our operations must be continually evaluated and enhanced to address the ever-evolving threat landscape and changing cybersecurity regulations. These preventative actions require the investment of significant resources and management time and attention. Additionally, we do not have control of the cybersecurity systems, breach prevention, and response protocols of our third-party providers. While T-Mobile may have contractual rights to assess the effectiveness of many of our providers’ systems and protocols, we do not have the means to know or assess the effectiveness of all of our providers’ systems and controls at all times. We cannot provide any assurances that actions taken by us, or our third-party providers, will adequately repel a significant cyberattack or prevent or substantially mitigate the impacts of cybersecurity breaches or misuses of Confidential Information, unauthorized access to our networks or systems or exploits against third-party environments, or that we, or our third-party providers, will be able to effectively identify, investigate, and remediate such incidents in a timely manner or at all. We expect to continue to be the target of cyberattacks, given the nature of our business, and we expect the same with respect to our third-party providers. If we fail to protect Confidential Information or to prevent operational disruptions from future cyberattacks, there may be a material adverse effect on our business, reputation, financial condition, cash flows, and operating results.If we are unable to take advantage of technological developments on a timely basis, we may experience a decline in demand for our services or face challenges in implementing or evolving our business strategy.Significant technological changes continue to impact our industry. In order to grow and remain competitive, we will need to adapt to changes in available technology, continually invest in our network, increase network capacity, enhance our existing offerings, and introduce new offerings to meet our current and potential customers’ changing service demands. Enhancing our network, including the ongoing deployment of our 5G network, is subject to risks related to equipment changes and the migration of customers from older technologies. Negative public perception of, and regulations regarding, the perceived health risks relating to 5G networks could undermine market acceptance of our 5G services. Adopting new and sophisticated technologies may result in implementation issues, such as scheduling and supplier delays, unexpected or increased costs, technological constraints, regulatory permitting issues, customer dissatisfaction, and other issues that could cause delays in launching new technological capabilities, which in turn could result in significant costs or reduce the anticipated benefits of the upgrades. If our new services fail to retain or gain acceptance in the marketplace or if costs associated with these services are higher than anticipated, this could have a material adverse effect on our business, brand, financial condition, and operating results.13Table of ContentsWe rely on highly skilled personnel throughout all levels of our business. Our business could be harmed if we are unable to retain or motivate key personnel, hire qualified personnel, or maintain our corporate culture.The market for highly skilled workers and leaders is extremely competitive. We believe our future success depends in substantial part on our ability to recruit, hire, motivate, develop, and retain talented personnel for all areas of our organization, including our CEO and the other members of our senior leadership team. Doing so may be difficult due to many factors, including fluctuations in economic and industry conditions, changes to U.S. immigration policy, competitors’ hiring and remote working policies and practices, employee intolerance for the significant changes within, and demands on, our Company and our industry, and the effectiveness of our compensation programs. If key employees depart or we are unable to recruit successfully, our business could be negatively impacted. Further, inflationary cost pressures may increase our costs, including employee compensation, and lead to increased employee attrition to the extent our compensation does not keep up with inflation, particularly if our competitors’ compensation does. In addition, certain members of our senior leadership team, including our CEO have term employment agreements with us. Our inability to extend the terms of these employment agreements or to replace these members of our senior leadership team at the end of their terms with qualified and capable successors could hinder our strategic planning and execution.In addition, the new hybrid work model introduced during the global COVID-19 pandemic (the “Pandemic”) required T-Mobile to change and evolve our company culture. As our culture continues to evolve, we may experience adverse impacts on our ability to attract, retain and motivate key personnel, as existing and prospective employees may experience uncertainty about their future roles with us. If key employees depart, our business could be negatively impacted. We may incur significant costs in identifying, hiring and replacing employees, and we may lose significant expertise and talent. As a result, we may not be able to meet our business plan, and our business, financial condition and operating results may be materially adversely affected.System failures and business disruptions may prevent us from providing reliable service, which could materially adversely affect our reputation and financial condition.We rely upon systems and networks - those of third-party suppliers and other providers, in addition to our own - to provide and support our service offerings. System, network, or infrastructure failures resulting from a number of causes may prevent us from providing reliable service. Examples of these risks include:•physical damage, power surges or outages, equipment failure, or other service disruptions with respect to both our wireless and wireline networks, including those resulting from severe weather, storms and natural disasters, which may occur more frequently or with greater intensity as a result of global climate change, public health crises, terrorist attacks, political instability and volatility and acts of war;•chronic changes in physical conditions, such as sea-level rise or changes in temperature or precipitation patterns, which may impact the operating conditions of our infrastructure or other infrastructure we rely on;•human error, such as responding to deceptive communications or unintentionally executing malicious code;•unauthorized access to our IT and business systems or to our network and critical infrastructure and those of our suppliers and other providers;•supplier failures or delays; and•system failures or outages of our business systems or communications network.Such events could cause us to lose customers and revenue, incur expenses, suffer reputational damage, and subject us to fines, penalties, adverse actions or judgments, litigation, or governmental investigations. Remediation costs could include liability for information loss, costs of repairing infrastructure and systems, and/or costs of incentives offered to customers. Our insurance may not cover or may not be adequate to fully reimburse us for costs and losses associated with such events, and such events may also impact the availability of insurance at costs and other terms we find acceptable for future events.The scarcity and cost of additional wireless spectrum, and regulations relating to spectrum use, may adversely affect our business, financial condition, and operating results.We continue to deploy spectrum to expand and deepen our 5G coverage, maintain our quality of service, meet increasing customer demands, and deploy new technologies. In order to expand and differentiate from our competitors, we will continue to actively seek to make additional investment in spectrum, which could be significant.14Table of ContentsThe continued interest in, and acquisition of, spectrum by existing carriers and others, including speculators, may reduce our ability to acquire and/or increase the cost of acquiring spectrum in the secondary market, including leasing, or purchasing additional spectrum in the 2.5 GHz band, or negatively impact our ability to gain access to spectrum through other means, including government auctions. Additionally, increased interest from third parties in acquiring spectrum may make it difficult to renew leases of some of our existing 2.5 GHz spectrum holdings in the future. Additionally, the FCC may not be able to provide sufficient additional spectrum to auction or we may be unable to secure the spectrum necessary to maintain or enhance our competitive position in any auction we may elect to participate in or in the secondary market, on favorable terms or at all. Any return on our investment in spectrum depends on our ability to attract additional customers and to provide additional services and usage to existing customers.The FCC, or other government entities, may impose conditions on the acquisition and use of new wireless broadband mobile spectrum that may negatively impact our ability to obtain spectrum economically or in appropriate configurations or coverage areas.If we cannot acquire needed spectrum from the government or otherwise, if competitors acquire spectrum that will allow them to provide services competitive with our services, or if we cannot deploy services over acquired spectrum on a timely basis without burdensome conditions, at reasonable cost, and while maintaining network quality levels, our ability to attract and retain customers and our business, financial condition and operating results could be materially adversely affected.We are modernizing our billing system architecture for our customers. As part of this strategy, we are converting Sprint’s legacy customers onto T-Mobile’s billing platforms. As a result, we will operate and maintain multiple billing systems until such conversion is completed. Any unanticipated difficulties, disruption, or significant delays in either of these efforts could have adverse operational, financial, and reputational effects on our business.We are currently operating and maintaining multiple billing systems and supporting platforms. We expect to continue to do so until successful conversion of Sprint’s legacy customers to T-Mobile’s existing billing platforms. We may encounter unanticipated difficulties or experience delays in the ongoing integration efforts with respect to billing, causing major system or business disruptions. In addition, we or our supporting vendors may experience errors, cyber-attacks or other operational disruptions that could negatively impact us and over which we may have limited control. Interruptions and/or failure of these billing systems could disrupt our operations and impact our ability to provide or bill for our services, retain customers, attract new customers, or negatively impact overall customer experience. Any occurrence of the foregoing could cause material adverse effects on our operations and financial condition, and/or material weaknesses in our internal control over financial reporting and reputational damage.The challenges in satisfying the large number of Government Commitments in the required time frames and the significant cumulative cost incurred in tracking, monitoring, and complying with them over multiple years could continue to adversely impact our business, financial condition, and operating results.In connection with the regulatory proceedings and approvals required to close the Transactions, we agreed to fulfill various Government Commitments. These Government Commitments include, among other things, extensive 5G network build-out commitments, obligations to deliver high-speed wireless services to the vast majority of Americans and marketing our in-home fixed wireless product to households where spectrum capacity is sufficient. Other Government Commitments relate to national security, pricing and availability of rate plans, employment, substantial monetary contributions to support several different organizations, and implementation of diversity, equity and inclusion initiatives. Most Government Commitments have specified time frames for compliance and reporting, and we continue to focus on taking the actions required to fulfill them. Any failure to fulfill our obligations under these Government Commitments in a timely manner could result in substantial fines, penalties, or other legal and administrative actions and/or reputational harm.We expect to continue incurring significant costs, expenses, and fees to track, monitor, comply with and fulfill our obligations under these Government Commitments over a number of years. In addition, abiding by the Government Commitments may divert our management’s time and energy away from other business operations and could force us to make business decisions we would not otherwise make and forego taking actions that might be beneficial to the Company. The challenges in continuing to satisfy the large number of Government Commitments in the required time frames and the cost incurred in tracking, monitoring, and complying with them could also adversely impact our business, financial condition and operating results and hinder our ability to effectively compete.15Table of ContentsEconomic, political and market conditions may adversely affect our business, financial condition, and operating results.Our business, financial condition and operating results are sensitive to changes in general economic conditions, including interest rates, consumer credit conditions, consumer debt levels, consumer confidence, unemployment rates, economic growth, energy costs, rates of inflation (or concerns about deflation), supply chain disruptions, impacts of current geopolitical instability caused by the war in Ukraine, and other macro-economic factors.The wireless industry, broadly, is dependent on population growth, as a result, we expect the wireless industry’s customer growth rate to be moderate in comparison with historical growth rates, leading to ongoing competition for customers. In addition, the Government Commitments place certain limitations on our ability to increase prices, which limits our ability to pass along growing costs to customers. Rising prices for goods, services, and labor due to inflation could adversely impact our margins and/or growth.Our services and device financing plans are available to a broad customer base, a significant segment of which may be vulnerable to weak economic conditions, particularly our subprime customers. We may have greater difficulty in gaining new customers within this segment, and existing customers may be more likely to terminate service and default on device financing plans due to an inability to pay.Weak economic and credit conditions may also adversely impact our suppliers, dealers, and wholesale partners or MVNOs, some of which may file for bankruptcy, or may experience cash flow or liquidity problems, or may be unable to obtain or refinance credit such that they may no longer be able to operate. Any of these could adversely impact our ability to distribute, market, or sell our products and services.Our business may be adversely impacted if we are not able to successfully manage the ongoing commercial and transition services arrangements entered into in connection with the Prepaid Transaction and known or unknown liabilities arising in connection therewith.In connection with the closing of the Prepaid Transaction, we and DISH entered into certain commercial and transition services arrangements, including a Master Network Services Agreement (the “MNSA”) and a license purchase agreement (the “DISH License Purchase Agreement”). Pursuant to the MNSA, DISH will receive network services from the Company for a period of seven years. As set forth in the MNSA, the Company will provide DISH, among other things, (a) legacy network services for certain Boost Mobile prepaid end users on the Sprint network, (b) T-Mobile network services for certain end users that have been migrated to the T-Mobile network or provisioned on the T-Mobile network by or on behalf of DISH and (c) infrastructure mobile network operator services to assist in the access and integration of the DISH network. Pursuant to the DISH License Purchase Agreement, DISH has agreed to purchase all of Sprint’s 800 MHz spectrum (approximately 13.5 MHz of nationwide spectrum) for a total of approximately $3.6 billion in a transaction to be completed, subject to certain additional closing conditions, following an application for FCC approval to be filed three years following the closing of the Merger; provided, however, that if DISH breaches the DISH License Purchase agreement prior to the closing or fails to deliver the purchase price following the satisfaction or waiver of all closing conditions, DISH’s sole liability will be to pay us a fee of approximately $72 million. In such instance, T-Mobile is required, unless otherwise approved under the Consent Decree, to conduct an auction of all of Sprint’s 800 MHz spectrum under the terms set forth in the Consent Decree, but would not be required to divest such spectrum for an amount less than $3.6 billion. The parties are required to file an application for the transfer by April 1, 2023. The covered spectrum sale must occur within the later of three years after the closing of the Prepaid Transaction and five days after receipt of the approval from the FCC of the application.Failure to successfully manage these ongoing commercial and transition services arrangements entered into in connection with the Prepaid Transaction and liabilities arising in connection therewith may result in material unanticipated problems, including diversion of management time and energy, significant expenses and liabilities. There may also be other potential adverse consequences and unforeseen increased expenses, or liabilities associated with the Prepaid Transaction, the occurrence of which could materially impact our business, financial condition, liquidity, and operating results. In addition, there may be an increase in competition from DISH and other third parties that DISH may enter into commercial agreements with, who are significantly larger and with greater resources and scale advantages as compared to us. Such increased competition may result in our loss of customers and other business relationships.Any acquisition, divestiture, investment, or merger may subject us to significant risks, any of which may harm our business.We may pursue acquisitions of, investments in or mergers with other companies, or the acquisition of technologies, services, products or other assets, that we believe would complement or expand our business. We may also elect to divest some of our 16Table of Contentsassets to third parties. Some of these potential transactions could be significant relative to the size of our business and operations. Any such transaction would involve a number of risks and could present financial, managerial and operational challenges, including:•diversion of management attention from running our existing business;•increased costs to integrate the networks, spectrum, technology, personnel, customer base and business practices of the company involved in any such transaction with our business;•difficulties in effectively integrating the financial and operational systems of the business involved in any such transaction into (or supplanting such systems with) our financial and operational reporting infrastructure and internal control framework in an effective and timely manner;•potential exposure to material liabilities not discovered in the due diligence process or as a result of any litigation arising in connection with any such transaction;•significant transaction-related expenses in connection with any such transaction, whether consummated or not;•risks related to our ability to obtain any required regulatory approvals necessary to consummate any such transaction; and•any business, technology, service, or product involved in any such transaction may significantly under-perform relative to our expectations, and we may not achieve the benefits we expect from the transaction, which could, among other things, also result in a write-down of goodwill and other intangible assets associated with such transaction.For any or all of these reasons, as well as unknown risks, acquisitions, divestitures, investments, or mergers may have a material adverse effect on our business, financial condition and operating results.We rely on third parties to provide products and services for the operation of our business, and the failure or inability of such parties to provide these products or services could adversely affect our business, financial condition, and operating results.We have a diverse set of suppliers to help us develop, maintain, and troubleshoot products and services such as wireless and wireline network components, software development services, and billing and customer service support. However, in certain areas such as, billing services, voice, and data communications transport services, wireless or wireline network infrastructure equipment, handsets, other devices, back-office processes and payment processing, there are a limited number of suppliers who can provide adequate support for us, which decreases our flexibility to switch to alternative third parties. Unexpected termination of our arrangement with any of these suppliers or difficulties in renewing our commercial arrangements with them could have a material and adverse effect on our business operations.Our suppliers are also subject to their own risks, including, but not limited to, economic, financial and credit conditions, labor force disruptions, geopolitical tensions, disruptions in global supply chain and the risks of natural catastrophic events such as earthquakes, floods, hurricanes, and public health crises such as the Pandemic which may result in performance below the levels required by their contracts. Our business could be severely disrupted if critical suppliers or service providers fail to comply with their contracts or if we experience delays or service degradation during any transition to a new outsourcing provider or other supplier or if we are required to replace the supplied products or services with those from another source, especially if the replacement becomes necessary on short notice. Any such disruptions could have a material adverse effect on our business, financial condition, and operating results.Further, some of our suppliers may provide services from outside of the United States, which carries additional regulatory and legal obligations. We rely on suppliers to provide us with contractual assurances and to disclose accurate information regarding risks associated with their provision of products or services in accordance with our policies and standards, including our Supplier Code of Conduct and our third-party risk management practices. The failure of our suppliers to comply with our expectations and policies could expose us to additional legal and litigation risks and lead to unexpected contract terminations. We may not fully realize the synergy benefits from the Transactions in the expected time frame. Our ability to realize the expected benefits from the Merger will depend on our ability to integrate the two businesses in a manner that facilitates growth opportunities and achieves the projected cost savings. Although we have completed a number of integration activities, we continue the process and may incur additional expenses as a result of challenges in combining operations such as: 17Table of Contents•difficulties in integrating operations and systems, including intellectual property and communications systems, administrative and information technology infrastructure, and supplier and vendor arrangements;•difficulties in operating and maintaining multiple billing and related support systems until conversion is completed;•difficulties in managing the expanded operations of a significantly larger and more complex company;•compliance with Government Commitments relating to national security; and•other potential adverse consequences and unforeseen increased expenses or liabilities associated with the Transactions.Risks Related to Our IndebtednessOur substantial level of indebtedness could adversely affect our business flexibility, ability to service our debt, and increase our borrowing costs.We have, and we expect that we will continue to have, a substantial amount of debt. Our substantial level of indebtedness could have the effect of, among other things, reducing our flexibility in responding to changing business, economic, market and industry conditions and increasing the amount of cash required to service our debt. In addition, this level of indebtedness may also reduce funds available for capital expenditures, any board-approved share repurchases and other activities. Those impacts may put us at a competitive disadvantage relative to other companies with lower debt levels. Further, we may need to incur substantial additional indebtedness in the future, subject to the restrictions contained in our debt instruments, if any, which could increase the risks associated with our capital structure.Our ability to service our substantial debt obligations will depend on future performance, which will be affected by business, economic, market and industry conditions and other factors, including our ability to achieve the expected benefits of the Transactions. There is no guarantee that we will be able to generate sufficient cash flow to service our debt obligations when due. If we are unable to meet such obligations or fail to comply with the financial and other restrictive covenants contained in the agreements governing such debt obligations, we may be required to refinance all or part of our debt, sell important strategic assets at unfavorable prices or make additional borrowings. We may not be able to, at any given time, refinance our debt, sell assets, or make additional borrowings on commercially reasonable terms or at all, which could have a material adverse effect on our business, financial condition, and operating results.Changes in credit market conditions could adversely affect our ability to raise debt favorably.Instability in the global financial markets, inflation, policies of various governmental and regulatory agencies, including changes in monetary policy and interest rates, and other general economic conditions could lead to volatility in the credit and equity markets. This volatility could limit our access to the capital markets, leading to higher borrowing costs or, in some cases, the inability to obtain financing on terms that are acceptable to us or at all.In addition, any hedging agreements we may enter into to limit our exposure to interest rate increases or foreign currency fluctuations may not offer complete protection from these risks or may be unsuccessful, and consequently may effectively increase the interest rate we pay on our debt or the exchange rate with respect to any debt we may incur in a foreign currency, and any portion not subject to such hedging agreements would have full exposure to interest rate increases or foreign currency fluctuations, as applicable. If any financial institutions that are parties to our hedging agreements were to default on their payment obligations to us, declare bankruptcy or become insolvent, we would be unhedged against the underlying exposures. Any posting of collateral by us under our hedging agreements and the modification or termination of any of our hedging agreements could negatively impact our liquidity or other financial metrics. Any of these risks could have a material adverse effect on our business, financial condition, and operating results.The agreements governing our indebtedness and other financings include restrictive covenants that limit our operatingflexibility.The agreements governing our indebtedness and other financings impose operating and financial restrictions. These restrictions, subject in certain cases to customary baskets, exceptions and maintenance and incurrence-based financial tests, together with our debt service obligations, may limit our ability to engage in transactions and pursue strategic business opportunities. These restrictions could limit our ability to obtain debt financing, refinance or pay principal on our outstanding indebtedness, complete acquisitions for cash or indebtedness or react to business, economic, market and industry conditions and other changes in our operating environment or the economy. Any future indebtedness that we incur may contain similar or more restrictive covenants. Any failure to comply with the restrictions of our debt agreements may result in an event of default under these agreements, which in turn may result in defaults or acceleration of obligations under these and other agreements, giving our lenders the right to terminate the commitments they had made or the right to require us to repay all amounts then 18Table of Contentsoutstanding plus any interest, fees, penalties, or premiums. An event of default may also compel us to sell certain assets securing indebtedness under certain of these agreements.Credit rating downgrades and/or inability to access debt markets could adversely affect our business, cash flows, financial condition, and operating results.Credit ratings impact the cost and availability of future borrowings and, as a result, cost of capital. Our current ratings reflect each rating agency’s opinion of our financial strength, operating performance, and ability to meet our debt obligations. Our capital structure and business model are reliant on continued access to debt markets. Each rating agency reviews our ratings periodically, and there can be no assurance that such ratings will be maintained in the future. A downgrade in our corporate rating and/or our issued debt ratings could impact our ability to access debt markets and adversely affect our business, cash flows, financial condition, and operating results.Risks Related to Legal and Regulatory MattersFailure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could result in a loss of investor confidence regarding our financial statements and reputational damage.Under Section 404 of the Sarbanes-Oxley Act, we, along with our independent registered public accounting firm, are required to report on the effectiveness of our internal control over financial reporting. There can be no assurance that remediation of any material weaknesses that may be identified would be completed in a timely manner or that the remedial measures will prevent other control deficiencies or material weaknesses. If we are unable to remediate material weaknesses in internal control over financial reporting, then our ability to analyze, record and report financial information free of material misstatements, to prepare financial statements within the time periods specified by the rules and forms of the SEC and otherwise to comply with the requirements of Section 404 of the Sarbanes-Oxley Act would be negatively impacted. As a result, we may experience negative impacts to our business financial condition or operating results, which would restrict our ability to access the capital markets, require the expenditure of significant resources to correct the weaknesses or deficiencies, subject us to fines, penalties, investigations, or judgments, harm our reputation, or otherwise cause a decline in trading price of our stock and investor confidence.Changes in regulations or in the regulatory framework under which we operate could adversely affect our business, financial condition, and operating results.We are subject to regulatory oversight by various federal, state, and local agencies, as well as judicial review and actions, on issues related to the wireless industry that include, but are not limited to, roaming, interconnection, spectrum allocation and licensing, facilities siting, pole attachments, intercarrier compensation, Universal Service Fund, 911 services, consumer protection, consumer privacy, and cybersecurity. We are also subject to regulations in connection with other aspects of our business, including device financing and insurance activities.The FCC regulates the licensing, construction, modification, operation, ownership, sale, and interconnection of wireless communications systems, as do some state and local regulatory agencies. In particular, the FCC imposes significant regulation on licensees of wireless spectrum with respect to how radio spectrum is used by licensees, the nature of the services that licensees may offer and how the services may be offered, and the resolution of issues of interference between operators in the same or adjacent spectrum bands. Changes necessary to resolve interference issues or concerns may have a significant impact on our ability to fully utilize our spectrum. As an example, we recently won spectrum licenses in the so-called “C band” to support our continued rollout of 5G technology and services. There have been concerns raised that use of this spectrum by wireless carriers for 5G deployment could interfere with the altimeters in certain aircraft, and there is an ongoing discussion between the industry, the FCC, and the FAA as to whether and how 5G operations should be limited around airports. Additionally, the FTC and other federal and state agencies have asserted that they have jurisdiction over some consumer protection matters, and the elimination and prevention of anticompetitive business practices with respect to the provision of wireless products and services.We cannot assure that the FCC or any other federal, state, or local agencies will not adopt regulations, implement new programs, or take enforcement or other actions that would adversely affect our business, impose new costs, or require changes in current or planned operations, including timing of the shutdown of legacy technologies. For example, in response to the Pandemic, the California Public Utilities Commission adopted a resolution providing a moratorium on customer disconnects and late fees for certain California customers facing financial hardship. Additionally, in 2015 and 2016, the FCC established net neutrality and privacy regimes that applied to our operations. Both sets of rules potentially subjected some of our initiatives and practices to more burdensome requirements and heightened scrutiny by federal and state regulators, the public, edge providers, 19Table of Contentsand private litigants regarding whether such initiatives or practices are compliant. While the FCC rules were largely rolled back in December 2017, the current FCC updated transparency obligations to require nutrition-style broadband label disclosures effective potentially in 2023 that could prompt regulatory inquiries, and the FCC could decide to establish new net neutrality requirements. In addition, some states and other jurisdictions have enacted laws in these areas (including, for example, California and other states’ net neutrality laws, the CCPA and CPRA as discussed below) and others are considering enacting similar laws. It also is uncertain what rules may be promulgated under the current administration (e.g., the FTC has discussed promulgating privacy rules), perpetuating the risk and uncertainty regarding the regulatory environment and compliance around these issues.In addition, states are increasingly focused on the quality of service and support that wireless communications service providers provide to their customers and several states have proposed or enacted new and potentially burdensome regulations in this area. We also face potential investigations by, and inquiries from or actions by state public utility commissions. We also cannot assure that Congress will not amend the Communications Act, from which the FCC obtains its authority, and which serves to limit state authority, or enact other legislation in a manner that could be adverse to our business.Failure to comply with applicable regulations could have a material adverse effect on our business, financial condition, and operating results. We could be subject to fines, forfeitures, and other penalties (including, in extreme cases, revocation of our spectrum licenses) for failure to comply with the FCC or other governmental regulations, even if any such noncompliance was unintentional. The loss of any licenses, or any related fines or forfeitures, could adversely affect our business, financial condition, and operating results.Laws and regulations relating to the handling of privacy and data protection may result in increased costs, legal claims, fines against us, or reputational damage.In January 2020, the California Consumer Privacy Act (the “CCPA”) became effective, creating new data privacy rights for California residents and new compliance obligations for us and industry in general, in addition to private rights of action for certain types of data breaches. Moreover, new privacy laws are being developed and/or enacted in many jurisdictions, for example, in Colorado, Utah, Connecticut, Virginia, and in California, where the California Privacy Rights Act (“CPRA”) (which modifies the CCPA) recently became effective. All of these new privacy laws and others that we expect to be developed and enacted going forward will impose additional data protection obligations and potential liability on companies such as ours doing business in those states.We have incurred and will continue to incur significant implementation costs to ensure compliance with the CCPA, the CPRA, new privacy laws in other states, and their related regulations, including managing the complexity of laws that vary from state to state. Both federal and state governments are considering additional privacy laws and regulations which, if passed, could further impact our business, strategies, offerings, and initiatives and cause us to incur further costs. Any actual or perceived failure to comply with the CCPA, CPRA, other data privacy laws or regulations, or related contractual or other obligations, or any perceived privacy rights violation, could lead to investigations, claims, and proceedings by governmental entities and private parties, damages for contract breaches, and other significant costs, penalties, and other liabilities, as well as harm to our reputation and market position.Unfavorable outcomes of legal proceedings may adversely affect our business, reputation, financial condition, cash flows and operating results. We and our affiliates are involved in various disputes, governmental and/or regulatory inspections, investigations and proceedings, mass arbitrations and litigation matters. Such legal proceedings can be complex, costly, and highly disruptive to our business operations by diverting the attention and energy of management and other key personnel.In connection with the Transactions, we became subject to a number of legal proceedings, including a putative shareholder class action and derivative lawsuit and a putative antitrust class action. For more information, see “– Contingencies and Litigation – Litigation and Regulatory Matters” in Note 19 – Commitments and Contingencies of the Notes to the Consolidated Financial Statements. It is possible that stockholders of T-Mobile and/or Sprint may file additional putative class action lawsuits or shareholder derivative actions against the Company and the legacy T-Mobile board of directors and/or the legacy Sprint board of directors. Among other remedies, these stockholders could seek damages. The outcome of any litigation is uncertain and any such potential lawsuits could result in substantial costs and may be costly and distracting to management.Additionally, on April 1, 2020, in connection with the closing of the Merger, we assumed the contingencies and litigation matters of Sprint. Those matters include a wide variety of disputes, claims, government agency investigations and enforcement 20Table of Contentsactions and other proceedings. Unfavorable resolution of these matters could require making additional reimbursements and paying additional fines and penalties.On February 28, 2020, we received a Notice of Apparent Liability for Forfeiture and Admonishment from the FCC, which proposed a penalty against us for allegedly violating Section 222 of the Communications Act and the FCC’s regulations governing the privacy of customer information. We recorded an accrual for an estimated payment amount as of March 31, 2020, which is included in Accounts payable and accrued liabilities on our Consolidated Balance Sheets.As a result of the August 2021 cyberattack, we are subject to numerous lawsuits, including consolidated class action lawsuits seeking unspecified monetary damages, mass consumer arbitrations, a shareholder derivative lawsuit and inquiries by various government agencies, law enforcement and other governmental authorities, and we may be subject to further regulatory inquiries and private litigation. We are cooperating fully with regulators and vigorously defending against the class actions and other lawsuits. On July 22, 2022, we entered into an agreement to settle the consolidated class action lawsuit. On July 26, 2022, we received preliminary approval of the proposed settlement, which remains subject to final court approval. The court conducted a final approval hearing on January 20, 2023, and we await a ruling from the court. If approved by the court, under the terms of the proposed settlement, we would pay an aggregate of $350 million to fund claims submitted by class members, the legal fees of plaintiffs’ counsel and the costs of administering the settlement. We would also commit to an aggregate incremental spend of $150 million for data security and related technology in 2022 and 2023. In connection with the proposed class action settlement and other settlements of separate consumer claims that have been previously completed or are currently pending, we recorded a total pre-tax charge of approximately $400 million during the three months ended June 30, 2022. In light of the inherent uncertainties involved in such matters and based on the information currently available to us, we believe it is reasonably possible that we could incur additional losses associated with these proceedings and inquiries, and we will continue to evaluate information as it becomes known and will record an estimate for losses at the time or times when it is both probable that a loss has been incurred and the amount of the loss is reasonably estimable. In addition, in connection with the January 2023 cyberattack, we have received notices of consumer class actions and regulatory inquires, to which we will respond to in due course. Ongoing legal and other costs related to these proceedings and inquiries, as well as any potential future proceedings and inquiries related to the August 2021 cyberattack and the January 2023 cyberattack, may be substantial, and losses associated with any adverse judgments, settlements, penalties or other resolutions of such proceedings and inquiries could be significant and have a material adverse impact on our business, reputation, financial condition, cash flows and operating results.We, along with equipment manufacturers and other carriers, are subject to current and potential future lawsuits alleging adverse health effects arising from the use of wireless handsets or from wireless transmission equipment such as cell towers. In addition, the FCC has from time to time gathered data regarding wireless device emissions, and its assessment of the risks associated with using wireless devices may evolve based on its findings. Any of these allegations or changes in risk assessments could result in customers purchasing fewer devices and wireless services, could result in significant legal and regulatory liability, and could have a material adverse effect on our business, reputation, financial condition, cash flows and operating results.The assessment of the outcome of legal proceedings, including our potential liability, if any, is a highly subjective process that requires judgments about future events that are not within our control. The amounts ultimately received or paid upon settlement or pursuant to final judgment, order or decree may differ materially from amounts accrued in our financial statements. In addition, litigation or similar proceedings could impose restraints on our current or future manner of doing business. Such potential outcomes including judgments, awards, settlements or orders could have a material adverse effect on our business, reputation, financial condition, cash flows and operating results.We offer regulated financial services products. These products expose us to a wide variety of state and federal regulations.The financing of devices, such as through our EIP, JUMP! On Demand or other leasing programs, such as those acquired in the Merger, has expanded our regulatory compliance obligations. Failure to remain compliant with applicable regulations may increase our risk exposure in the following areas:•consumer complaints and potential examinations or enforcement actions by federal and state regulatory agencies, including, but not limited to, the Consumer Financial Protection Bureau, state attorneys general, the FCC and the FTC; and•regulatory fines, penalties, enforcement actions, civil litigation, and/or class action lawsuits.21Table of ContentsFailure to comply with applicable regulations and the realization of any of these risks could have a material adverse effect on our business, financial condition, and operating results.Our business may be impacted by new or amended tax laws or regulations or administrative interpretations and judicial decisions affecting the scope or application of tax laws or regulations.In connection with the products and services we sell, we calculate, collect, and remit various federal, state, and local taxes, fees and regulatory charges (“tax” or “taxes”) to numerous federal, state and local governmental authorities, including federal and state USF contributions and common carrier regulatory charges and public safety fees. As many of our service plans offer taxes and fees inclusive, our business results could be adversely impacted by increases in taxes and fees. In addition, we incur and pay state and local transaction taxes and fees on purchases of goods and services used in our business.Tax laws are dynamic and subject to change as new laws are passed and new interpretations of the laws are issued or applied. In many cases, the application of existing, newly enacted or amended tax laws may be uncertain and subject to different interpretations, especially when evaluated against new technologies and telecommunications services, such as broadband internet access and cloud-related services and in the context of our merger with Sprint. Legislative changes, administrative interpretations and judicial decisions affecting the scope or application of tax laws could also impact revenue reported and taxes due on tax inclusive plans. Additionally, failure to comply with any of the tax laws could subject us to additional taxes, fines, penalties, or other adverse actions.In the event that federal, state, and/or local municipalities were to significantly increase taxes and regulatory or public safety charges on our network, operations, or services, or seek to impose new taxes or charges, it could have a material adverse effect on our business, financial condition, and operating results.Our wireless licenses are subject to renewal and may be revoked in the event that we violate applicable laws.Our existing wireless licenses are subject to renewal upon the expiration of the period for which they are granted. Our licenses have been granted with an expectation of renewal and the FCC has approved our license renewal applications. However, the Communications Act provides that licenses may be revoked for cause and license renewal applications denied if the FCC determines that a renewal would not serve the public interest. If we fail to timely file to renew any wireless license or fail to meet any regulatory requirements for renewal, including construction and substantial service requirements, we could be denied a license renewal. Many of our wireless licenses are subject to interim or final construction requirements and there is no guarantee that the FCC will find our construction, or the construction of prior licensees, sufficient to meet the build-out or renewal requirements. Accordingly, we cannot assure that the FCC will renew our wireless licenses upon their expiration. If any of our wireless licenses were to be revoked or not renewed upon expiration, we would not be permitted to provide services under that license, which could have a material adverse effect on our business, financial condition, and operating results.Risks Related to Ownership of Our Common StockOur Certificate of Incorporation designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain actions and proceedings, which could limit the ability of our stockholders to obtain a judicial forum of their choice for disputes with the Company or its directors, officers or employees.Our Certificate of Incorporation provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the Company, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer or employee of the Company to the Company or its stockholders, (iii) any action asserting a claim arising pursuant to any provision of the General Corporation Law of the State of Delaware, the Certificate of Incorporation or the Company's bylaws or (iv) any other action asserting a claim arising under, in connection with, and governed by the internal affairs doctrine. This choice of forum provision does not waive our compliance with our obligations under the federal securities laws and the rules and regulations thereunder. Moreover, the provision does not apply to suits brought to enforce a duty or liability created by the Exchange Act or by the Securities Act of 1933, as amended.This choice of forum provision may increase costs to bring a claim, discourage claims or limit a stockholder's ability to bring a claim in a judicial forum that the stockholder finds favorable for disputes with the Company or its directors, officers or employees, which may discourage such lawsuits against the Company and its directors, officers and employees, even though an action, if successful, might benefit our stockholders. Alternatively, if a court were to find the choice of forum provision to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such matters in other jurisdictions, which could increase our costs of litigation and adversely affect our business and financial condition.22Table of ContentsDT controls a majority of the voting power of our common stock and the T-Mobile trademarks we utilize in our business, and may have interests that differ from the interests of our other stockholders.DT is a party to the SoftBank Proxy Agreement (as defined in Note 14 – SoftBank Equity Transaction to the Consolidated Financial Statements). In addition, on June 22, 2020, DT, Claure Mobile LLC (“CM LLC”), and Marcelo Claure entered into a Proxy, Lock-up and ROFR Agreement (the “Claure Proxy Agreement” and together with the SoftBank Proxy Agreement, the “Proxy Agreements”). Pursuant to the Proxy Agreements, at any meeting of our stockholders, the shares of our common stock beneficially owned by SoftBank or CM LLC will be voted in the manner as directed by DT. In addition, DT holds direct and indirect call options that give DT the right to acquire up to approximately 35 million shares of our common stock held by SoftBank.Accordingly, DT controls a majority of the voting power of our common stock and therefore we are a “controlled company,” as defined in the NASDAQ Stock Market LLC (“NASDAQ”) listing rules, and we are not subject to NASDAQ requirements that would otherwise require us to have a majority of independent directors, a nominating committee composed solely of independent directors or a compensation committee composed solely of independent directors. Accordingly, our stockholders will not be afforded the same protections as stockholders of other NASDAQ-listed companies generally receive with respect to corporate governance for so long as we rely on these exemptions from the corporate governance requirements.In addition, pursuant to our Certificate of Incorporation and the Second Amended and Restated Stockholders’ Agreement, as long as DT beneficially owns 30% or more of our outstanding common stock, we are restricted from taking certain actions without DT’s prior written consent, including (i) incurring indebtedness above certain levels based on a specified debt to cash flow ratio, (ii) taking any action that would cause a default under any instrument evidencing indebtedness involving DT or its affiliates, (iii) acquiring or disposing of assets or entering into mergers or similar acquisitions in excess of $1.0 billion, (iv) changing the size of our board of directors, (v) subject to certain exceptions, issuing equity of 10% or more of the then-outstanding shares of our common stock, or issuing equity to redeem debt held by DT, (vi) repurchasing or redeeming equity securities or making any extraordinary or in-kind dividend other than on a pro rata basis, or (vii) making certain changes involving our CEO. We are also restricted from amending our Certificate of Incorporation and bylaws in any manner that could adversely affect DT’s rights under the Second Amended and Restated Stockholders’ Agreement for as long as DT beneficially owns 5% or more of our outstanding common stock. These restrictions could prevent us from taking actions that our board of directors might otherwise determine are in the best interests of the Company and our stockholders, or that may be in the best interests of our other stockholders.DT effectively has control over all matters submitted to our stockholders for approval, including the election or removal of directors, changes to our Certificate of Incorporation, a sale or merger of our Company and other transactions requiring stockholder approval under Delaware law. DT’s controlling interest may have the effect of making it more difficult for a third party to acquire, or discouraging a third party from seeking to acquire, the Company and DT, as the controlling stockholder, may have strategic, financial, or other interests different from our other stockholders, including as the holder of a portion of our debt and as the counterparty in a number of commercial arrangements, and may make decisions adverse to the interests of our other stockholders.In addition, we license certain trademarks from DT, including the right to use the trademark “T-Mobile” as a name for the Company and our flagship brand under a trademark license agreement, as amended, with DT. As described in more detail in our Proxy Statement on Schedule 14A filed with the SEC on April 27, 2022 under the heading “Transactions with Related Persons and Approval,” we are obligated to pay DT a royalty in an amount equal to 0.25% (the “royalty rate”) of the net revenue (as defined in the trademark license) generated by products and services sold by the Company under the licensed trademarks subject to a cap of $80 million per calendar year through December 31, 2028. We and DT are obligated to negotiate a new trademark license when (i) DT has 50% or less of the voting power of the outstanding shares of capital stock of the Company or (ii) any third party owns or controls, directly or indirectly, 50% or more of the voting power of the outstanding shares of capital stock of the Company, or otherwise has the power to direct or cause the direction of the management and policies of the Company. If we and DT fail to agree on a new trademark license, either we or DT may terminate the trademark license and such termination shall be effective, in the case of clause (i) above, on the third anniversary after a notice of termination and, in the case of clause (ii) above, on the second anniversary after a notice of termination. A further increase in the royalty rate or termination of the trademark license could have a material adverse effect on our business, financial condition, and operating results.23Table of ContentsFuture sales of our common stock by DT and SoftBank and foreign ownership limitations by the FCC could have a negative impact on our stock price and decrease the value of our stock.We cannot predict the effect, if any, that market sales of shares of our common stock by DT or SoftBank will have on the prevailing trading price of our common stock. Sales of a substantial number of shares of our common stock could cause our stock price to decline.We, DT and SoftBank are parties to the Second Amended and Restated Stockholders’ Agreement pursuant to which DT is free to transfer its shares in public sales without notice, as long as such transactions would not result in a third party owning more than 30% of the outstanding shares of our common stock. If a transfer were to exceed the 30% threshold, it would be prohibited unless the transfer were approved by our board of directors, or the transferee were to make a binding offer to purchase all of the other outstanding shares on the same price and terms. The Second Amended and Restated Stockholders’ Agreement does not otherwise impose any other restrictions on the sales of common stock by DT or SoftBank. Moreover, the Second Amended and Restated Stockholders’ Agreement generally requires us to cooperate with DT to facilitate the resale of our common stock or debt securities held by DT under shelf registration statements we have filed. The sale of shares of our common stock by DT or SoftBank (other than in transactions involving the purchase of all of our outstanding shares) could significantly increase the number of shares available in the market, which could cause a decrease in our stock price. In addition, even if DT or SoftBank does not sell a large number of their shares into the market, their rights to transfer a large number of shares into the market could depress our stock price.Furthermore, under existing law, no more than 20% of an FCC licensee’s capital stock may be directly owned, or no more than 25% indirectly owned, or voted by non-U.S. citizens or their representatives, by a foreign government or its representatives or by a foreign corporation. If an FCC licensee is controlled by another entity, up to 25% of that entity’s capital stock may be owned or voted by non-U.S. citizens or their representatives, by a foreign government or its representatives or by a foreign corporation. Foreign ownership above the 25% holding company level may be allowed if the FCC finds such higher levels consistent with the public interest. The FCC has ruled that higher levels of foreign ownership, even up to 100%, are presumptively consistent with the public interest with respect to investors from certain nations. If our foreign ownership by previously unapproved foreign parties were to exceed the permitted level without further FCC authorization, the FCC could subject us to a range of penalties, including an order for us to divest the foreign ownership in part, fines, license revocation or denials of license renewals. If ownership of our common stock by an unapproved foreign entity were to become subject to such limitations, or if any ownership of our common stock violates any other rule or regulation of the FCC applicable to us, our Certificate of Incorporation provides for certain redemption provisions at a pre-determined price which may be less than fair market value. These limitations and our Certificate of Incorporation may limit our ability to attract additional equity financing outside the United States and decrease the value of our common stock.We cannot guarantee that our 2022 Stock Repurchase Program will be fully consummated or that our 2022 Stock Repurchase Program will enhance long-term stockholder value.Our Board of Directors has authorized our 2022 Stock Repurchase Program for up to $14.0 billion of the Company’s common stock through September 30, 2023, with $3.0 billion spent by the Company on share repurchases as of December 31, 2022, and an additional $2.1 billion spent by the Company from January 1, 2023 through February 10, 2023. Any additional share repurchases will depend upon, among other factors, our cash balances and potential future capital requirements, our results of operations and financial condition, our ability to access capital markets, our priorities for the use of cash for other purposes, the price of our common stock, and other factors that we may deem relevant. The existence of the 2022 Stock Repurchase Program could cause our stock price, in certain cases, to be higher or lower than it otherwise would be and could potentially reduce the market liquidity or have other unintended consequences for our stock. We can provide no assurance that we will repurchase shares of our common stock at favorable prices, if at all. Although the program is intended to enhance long-term stockholder value, there is no assurance it will do so.In addition, the 2022 Stock Repurchase Program does not obligate the Company to acquire any particular amount of common stock. The 2022 Stock Repurchase Program may be suspended or discontinued, or the amount to be spent by the Company to repurchase shares could be reduced, at any time at the Company’s discretion. Any decision to reduce or discontinue repurchasing shares of our common stock pursuant to our 2022 Stock Repurchase Program could cause the market price for our common stock to decline and may negatively impact our reputation and investor confidence in us. 24Table of ContentsItem 1B. Unresolved Staff CommentsNone.Item 2. Properties Our properties are best described on a collective basis, as no individual property is material. Our property and equipment consists of the following:(percent of gross property and equipment)December 31, 2022December 31, 2021Wireless communication systems68 %66 %Land, buildings and building equipment5 %5 %Data processing equipment and other27 %29 %Total100 %100 %Wireless communication systems primarily consist of assets used to operate our wireless network and information technology data centers, including switching equipment, radio frequency equipment, tower assets, High Speed Internet routers, construction in progress and leasehold improvements related to the wireless network and asset retirement costs.Land, buildings and building equipment primarily consist of land and land improvements, central office buildings or any other buildings that house network equipment, buildings used for administrative and other purposes, related construction in progress and certain network service equipment.Data processing equipment and other primarily consists of data processing equipment, office equipment, capitalized software, leased wireless devices, construction in progress and leasehold improvements.We also lease distributed antenna systems and small cell sites, as well as properties throughout the United States that contain data and switching centers, customer call centers, retail locations, warehouses and administrative spaces.Item 3. Legal ProceedingsFor more information regarding the legal proceedings in which we are involved, see Note 19 – Commitments and Contingencies of the Notes to the Consolidated Financial Statements.Item 4. Mine Safety Disclosures Not applicable.25Table of ContentsPART II.Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesMarket InformationOur common stock is traded on the NASDAQ Global Select Market under the symbol “TMUS.” We are included within the S&P 500 in the Wireless Telecommunication Services GICS (Global Industry Classification Standard) Sub-Industry index. As of January 31, 2023, there were 15,719 registered stockholders of record of our common stock, but we estimate the total number of stockholders to be much higher as a number of our shares are held by brokers or dealers for their customers in street name.We have never paid or declared any cash dividends on our common stock, and we do not intend to declare or pay any cash dividends on our common stock in the foreseeable future. We currently intend to use future earnings, if any, to invest in our business and for general corporate purposes, including the continued build-out of our 5G network, expansion of our business, the integration of T-Mobile’s and Sprint’s businesses, and share repurchases as appropriate. Therefore, we do not anticipate paying any cash dividends on our common stock in the foreseeable future; capital appreciation, if any, of our common stock will be the sole source of potential gain.Issuer Purchases of Equity SecuritiesThe table below provides information regarding our share repurchases during the three months ended December 31, 2022:(in millions, except share and per share amounts)Total Number of Shares PurchasedAverage Price Paid per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value of Shares that may yet be Purchased Under the Plans or Programs (1)October 1, 2022 - October 31, 20228,357,758 $138.04 8,357,758 $12,178 November 1, 2022 - November 30, 20223,307,350 148.26 3,307,350 11,687 December 1, 2022 - December 31, 20224,803,986 143.09 4,803,986 11,000 Total16,469,094 16,469,094 (1) On September 8, 2022, our Board of Directors authorized our 2022 Stock Repurchase Program for up to $14.0 billion of our common stock through September 30, 2023, with up to $3.0 billion by December 31, 2022. The amounts presented represent the remaining shares authorized for purchase under the 2022 Stock Repurchase Program as of the end of the period.See Note 15 - Repurchases of Common Stock of the Notes to the Consolidated Financial Statements for more information about our 2022 Stock Repurchase Program.26Table of ContentsPerformance GraphThe graph below compares the five-year cumulative total returns of T-Mobile, the S&P 500 index, the NASDAQ Composite index and the Dow Jones US Mobile Telecommunications TSM index. The graph tracks the performance of a $100 investment, with the reinvestment of all dividends, from December 31, 2017 to December 31, 2022. The five-year cumulative total returns of T-Mobile, the S&P 500 index, the NASDAQ Composite index and the Dow Jones US Mobile Telecommunications TSM index, as illustrated in the graph above, are as follows:At December 31,(in dollars)201720182019202020212022T-Mobile US, Inc.$100.00 $100.16 $123.48 $212.33 $182.62 $220.44 S&P 500100.00 95.62 125.72 148.85 191.58 156.89 NASDAQ Composite100.00 97.16 132.81 192.47 235.15 158.65 Dow Jones US Mobile Telecommunications TSM100.00 119.01 134.96 147.15 134.45 121.36 The stock price performance included in this graph is not necessarily indicative of future stock price performance.Item 6. [Reserved]27Table of ContentsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsOverviewThe objectives of our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are to provide users of our consolidated financial statements with the following:•A narrative explanation from the perspective of management of our financial condition, results of operations, cash flows, liquidity and certain other factors that may affect future results;•Context to the consolidated financial statements; and•Information that allows assessment of the likelihood that past performance is indicative of future performance.Our MD&A is provided as a supplement to, and should be read together with, our audited consolidated financial statements as of December 31, 2022 and 2021, and for each of the three years in the period ended December 31, 2022, included in Part II, Item 8 of this Form 10-K. Except as expressly stated, the financial condition and results of operations discussed throughout our MD&A are those of T-Mobile US, Inc. and its consolidated subsidiaries.Sprint Merger, Network Integration and Decommissioning ActivitiesTransaction OverviewOn April 1, 2020, we completed the Merger with Sprint, a communications company offering a comprehensive range of wireless and wireline communications products and services. As a result, Sprint and its subsidiaries became wholly owned consolidated subsidiaries of T-Mobile.The Merger has altered the size and scope of our operations, impacting our assets, liabilities, obligations, capital requirements and performance measures. As a combined company, we have been able to enhance the breadth and depth of our nationwide 5G network, accelerate innovation, increase competition in the U.S. wireless and broadband industries and achieve significant synergies and cost reductions by eliminating redundancies within the combined network as well as other business processes and operations.For more information regarding our Business Combination Agreement, see Note 2 – Business Combinations of the Notes to the Consolidated Financial Statements.Merger-Related CostsMerger-related costs associated with the Merger and acquisitions of affiliates generally include:•Integration costs to achieve efficiencies in network, retail, information technology and back office operations, migrate customers to the T-Mobile network and billing systems and the impact of legal matters assumed as part of the Merger;•Restructuring costs, including severance, store rationalization and network decommissioning; and•Transaction costs, including legal and professional services related to the completion of the transactions.Restructuring costs are disclosed in Note 20 – Restructuring Costs of the Notes to the Consolidated Financial Statements. Merger-related costs have been excluded from our calculations of Adjusted EBITDA and Core Adjusted EBITDA, which are non-GAAP financial measures, as we do not consider these costs to be reflective of our ongoing operating performance. See “Adjusted EBITDA and Core Adjusted EBITDA” in the “Performance Measures” section of this MD&A. Net cash payments for Merger-related costs, including payments related to our restructuring plan, are included in Net cash provided by operating activities on our Consolidated Statements of Cash Flows.28Table of ContentsMerger-related costs are presented below:(in millions)Year Ended December 31,2022 Versus 20212021 Versus 2020202220212020$ Change% Change$ Change% ChangeMerger-related costsCost of services, exclusive of depreciation and amortization$2,670 $1,015 $646 $1,655 163 %$369 57 %Cost of equipment sales, exclusive of depreciation and amortization1,524 1,018 6 506 50 %1,012 NMSelling, general and administrative775 1,074 1,263 (299)(28)%(189)(15)%Total Merger-related costs$4,969 $3,107 $1,915 $1,862 60 %$1,192 62 %Net cash payments for Merger-related costs$3,364 $2,170 $1,493 $1,194 55 %$677 45 %NM - Not MeaningfulWe expect to incur substantially all of the remaining projected Merger-related costs of approximately $1.0 billion, excluding capital expenditures, by the end of 2023, with the cash expenditure for the Merger-related costs extending beyond 2023.We are evaluating additional restructuring initiatives which are dependent on consultations and negotiation with certain counterparties and the expected impact on our business operations, which could affect the amount or timing of the restructuring costs and related payments. We expect our principal sources of funding to be sufficient to meet our liquidity requirements and anticipated payments associated with the restructuring initiatives.Network IntegrationAs of December 31, 2022, we have decommissioned substantially all Sprint macro sites targeted for shut down. Our integration and decommissioning initiatives also included the acceleration or termination of certain of our operating and financing leases for cell sites, switch sites and network equipment. To achieve Merger synergies in network costs, we continue to perform rationalization activities to identify duplicative networks, backhaul services and other agreements, in addition to decommissioning certain small cell sites and distributed antenna systems.To allow for the realization of these synergies associated with network integration, we retired certain legacy networks, including the legacy Sprint CDMA network in the second quarter and the legacy Sprint LTE network in the third quarter of 2022. Customers impacted by the decommissioning of these networks have been excluded from our customer base and postpaid account base. See the “Performance Measures” section of this MD&A for more details.RestructuringUpon the close of the Merger, we began implementing restructuring initiatives to realize cost efficiencies from the Merger. The major activities associated with the restructuring initiatives to date include:•Contract termination costs associated with rationalization of retail stores, distribution channels, duplicative network and backhaul services and other agreements;•Severance costs associated with the reduction of redundant processes and functions; and•The decommissioning of certain small cell sites and distributed antenna systems to achieve Merger synergies in network costs. For more information regarding our restructuring activities, see Note 20 – Restructuring Costs of the Notes to the Consolidated Financial Statements.29Table of ContentsAnticipated Merger SynergiesAs a result of our ongoing restructuring and integration activities, we expect to realize Merger synergies by eliminating redundancies within our combined network (see “Network Integration” above) as well as other business processes and operations (see “Restructuring” above). For full-year 2023, we expect Merger synergies from Selling, general and administrative expense reductions of $2.5 billion to $2.7 billion, Cost of service expense reductions of $3.1 billion to $3.2 billion and avoided network expenses of $1.6 billion.WirelinePreviously, the operation of the legacy Sprint CDMA and LTE wireless networks was supported by the legacy Sprint Wireline network. During the second quarter of 2022, we retired the legacy Sprint CDMA network and began the orderly shut-down of the LTE network, which was completed during the third quarter. As a result of these actions during the second quarter of 2022, we determined that the retirement of the legacy Sprint CDMA and LTE wireless networks triggered the need to assess the Wireline long-lived assets for impairment, as these assets no longer support our wireless network and the associated customers and cash flows in a significant manner. The results of this assessment indicated that certain Wireline long-lived assets were impaired, and as a result, we recorded non-cash impairment expense of $477 million related to Wireline Property and equipment, Operating lease right-of-use assets and Other intangible assets for the year ended December 31, 2022, all of which relates to the impairment recognized during the three months ended June 30, 2022. We continue to provide Wireline services to existing Wireline customers as of December 31, 2022.For more information regarding this non-cash impairment, see Note 16 – Wireline of the Notes to the Consolidated Financial Statements.On September 6, 2022, we entered into the Wireline Sale Agreement to sell the Wireline Business for a total purchase price of $1. In addition, at the consummation of the Wireline Transaction, we will enter into an agreement for IP transit services for $700 million. Subject to the satisfaction or waiver of certain conditions and the other terms and conditions of the Wireline Sale Agreement, the Wireline Transaction is expected to close mid-year 2023. As a result of the Wireline Sale Agreement and related anticipated Wireline Transaction, we concluded that the Wireline Business met the held for sale criteria upon entering into the Wireline Sale Agreement. As such, the assets and liabilities of the Wireline Business disposal group are classified as held for sale and presented within Other current assets and Other current liabilities on our Consolidated Balance Sheets as of December 31, 2022. In connection with the expected sale of the Wireline Business and classification of related assets and liabilities as held for sale, we recognized a pre-tax loss of $1.1 billion during the year ended December 31, 2022, which is included within Loss on disposal group held for sale on our Consolidated Statements of Comprehensive Income. The fair value of the Wireline Business disposal group, less costs to sell, will be reassessed during each subsequent reporting period it remains classified as held for sale, and any remeasurement to the lower of carrying amount or fair value less costs to sell will be reported as an adjustment to the Loss on disposal group held for sale.For more information regarding the Wireline Sale Agreement, see Note 16 – Wireline of the Notes to the Consolidated Financial Statements.Recent CyberattacksIn August 2021, we were subject to a criminal cyberattack involving unauthorized access to T-Mobile’s systems. As a result of the attack, we are subject to numerous arbitration demands and lawsuits, including class action lawsuits, and regulatory inquiries as described in Note 19 – Commitments and Contingencies of the Notes to the Consolidated Financial Statements.In connection with the proposed class action settlement and the separate settlements reached with a number of consumers, we recorded a total pre-tax charge of approximately $400 million during the three months ended June 30, 2022. We expect to continue to incur additional expenses in future periods, including costs to remediate the attack, resolve inquiries by various government authorities, provide additional customer support and enhance customer protection, only some of which may be covered and reimbursable by insurance. In addition to the committed aggregate incremental spend of $150 million for data security and related technology in 2022 and 2023 under the proposed settlement agreement, we intend to allocate substantial additional resources towards cybersecurity initiatives over the next several years.During the year ended December 31, 2022, we recognized $100 million in reimbursements from insurance carriers for costs incurred related to the August 2021 cyberattack. We are pursuing additional reimbursements from insurance carriers for costs incurred related to the August 2021 cyberattack.30Table of ContentsIn January 2023, we disclosed that a bad actor was obtaining data through a single Application Programming Interface (“API”) without authorization. Based on our investigation to date, the impacted API is only able to provide a limited set of customer account data, including name, billing address, email, phone number, date of birth, T-Mobile account number and information such as the number of lines on the account and plan features. The result from our investigation to date indicates that the bad actor(s) obtained data from this API for approximately 37 million current postpaid and prepaid customer accounts, though many of these accounts did not include the full data set. We believe that the bad actor first retrieved data through the impacted API starting on or around November 25, 2022. We continue to investigate the incident and have notified individuals whose information was impacted consistent with state and federal requirements.We will respond to litigation and regulatory inquiries in connection with this incident and may incur significant expenses. However, we cannot predict the timing or outcome of any of these potential matters, or whether we may be subject to regulatory inquiries, investigations, or enforcement actions. In addition, we are unable to predict the full impact of this incident on customer behavior in the future, including whether a change in our customers’ behavior could negatively impact our results of operations on an ongoing basis, although we presently do not expect that it will have a material effect on our operations.Additionally, following the August 2021 cyberattack, we commenced a substantial multi-year investment working with leading external cybersecurity experts to enhance our cybersecurity capabilities and transform our approach to cybersecurity. While we have made progress to date, we plan to continue to make substantial investments to strengthen our cybersecurity program in future periods.Revenue TrendsIn 2023, we expect Service revenues to continue to grow, primarily due to continued postpaid account and customer growth as well as Postpaid Average Revenue per Account (“postpaid ARPA”) growth driven by the execution of our strategy to continuously deepen our account relationships, including growth in High Speed Internet. We expect the increase in postpaid service revenues to be partially offset by a decrease in Wholesale and other service revenues, primarily driven by the sale of the Wireline business, which is expected to close mid-2023, the migration by Verizon of legacy TracFone customers off of the T-Mobile network and as DISH services more of its Boost customers with their standalone network. We also expect lower lease revenues as a result of the continued strategic shift in device financing from leasing to EIP.Operating Expense TrendsIn 2023, we expect Total operating expenses to decrease, primarily due to continued synergy realization benefiting Cost of services and Selling, general and administrative expense as well as a significant decrease in Merger-related costs from $5.0 billion in 2022 to approximately $1.0 billion expected in 2023 as the majority of our integration activities have been completed. We further expect a decrease in operating expenses, primarily Cost of services, associated with serving Wireline customers driven by the sale of the Wireline business which is expected to close mid-2023. The trend of decreasing depreciation on leased devices is expected to continue as a result of the continued strategic shift in device financing from leasing to EIP.Macroeconomic TrendsMacroeconomic trends may result in adverse impacts on our business, and we continue to monitor these potential impacts, including potential economic recession, changes in the Federal Reserve’s monetary policy, as well as geopolitical risks, including the war in Ukraine. Such scenarios and uncertainties may affect, among others, expected credit loss activity as well as certain fair value estimates. To date, price inflation has not had a significant impact on our operations as we have fixed rates established through long-term contracts for many of our most significant costs, including tower agreements and backhaul contracts. Similarly, our exposure to the impact of rising interest rates is limited, primarily to any new debt issuances or draws on our revolving credit facility, as interest is paid on our Senior Notes at a fixed rate. We continue to monitor the impact of these trends on the payment performance of our customers.Inflation Reduction ActOn August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (“IRA”) into law. The IRA includes several changes to existing tax law, including a minimum tax on adjusted financial statement income of applicable corporations and an excise tax on certain corporate stock buybacks. The tax provisions included in the IRA are generally effective beginning January 1, 2023, and had no significant impact to the 2022 consolidated financial statements. Management does not expect the IRA to have a significant impact on our operating results or cash flows in 2023, and we continue to review the IRA tax provisions to assess impacts to our future consolidated financial statements.31Table of ContentsResults of OperationsSet forth below is a summary of our consolidated financial results:Year Ended December 31,2022 Versus 20212021 Versus 2020(in millions)202220212020$ Change% Change$ Change% ChangeRevenuesPostpaid revenues$45,919 $42,562 $36,306 $3,357 8 %$6,256 17 %Prepaid revenues9,857 9,733 9,421 124 1 %312 3 %Wholesale and other service revenues5,547 6,074 4,668 (527)(9)%1,406 30 %Total service revenues61,323 58,369 50,395 2,954 5 %7,974 16 %Equipment revenues17,130 20,727 17,312 (3,597)(17)%3,415 20 %Other revenues1,118 1,022 690 96 9 %332 48 %Total revenues79,571 80,118 68,397 (547)(1)%11,721 17 %Operating expensesCost of services, exclusive of depreciation and amortization shown separately below14,666 13,934 11,878 732 5 %2,056 17 %Cost of equipment sales, exclusive of depreciation and amortization shown separately below21,540 22,671 16,388 (1,131)(5)%6,283 38 %Selling, general and administrative21,607 20,238 18,926 1,369 7 %1,312 7 %Impairment expense477 — 418 477 NM(418)(100)%Loss on disposal group held for sale1,087 — — 1,087 NM— NMDepreciation and amortization13,651 16,383 14,151 (2,732)(17)%2,232 16 %Total operating expenses73,028 73,226 61,761 (198)— %11,465 19 %Operating income6,543 6,892 6,636 (349)(5)%256 4 %Other expense, netInterest expense, net(3,364)(3,342)(2,701)(22)1 %(641)24 %Other expense, net(33)(199)(405)166 (83)%206 (51)%Total other expense, net(3,397)(3,541)(3,106)144 (4)%(435)14 %Income before income taxes3,146 3,351 3,530 (205)(6)%(179)(5)%Income tax expense(556)(327)(786)(229)70 %459 (58)%Income from continuing operations2,590 3,024 2,744 (434)(14)%280 10 %Income from discontinued operations, net of tax— — 320 — NM(320)(100)%Net income$2,590 $3,024 $3,064 $(434)(14)%$(40)(1)%Statement of Cash Flows DataNet cash provided by operating activities$16,781 $13,917 $8,640 $2,864 21 %$5,277 61 %Net cash used in investing activities(12,359)(19,386)(12,715)7,027 (36)%(6,671)52 %Net cash (used in) provided by financing activities(6,451)1,709 13,010 (8,160)(477)%(11,301)(87)%Non-GAAP Financial MeasuresAdjusted EBITDA$27,821 $26,924 $24,557 $897 3 %$2,367 10 %Core Adjusted EBITDA26,391 23,576 20,376 2,815 12 %3,200 16 %Free Cash Flow7,656 5,6463,0012,01036 %2,64588 %NM - Not Meaningful32Table of ContentsThe following discussion and analysis is for the year ended December 31, 2022, compared to the same period in 2021 unless otherwise stated. For a discussion and analysis of the year ended December 31, 2021, compared to the same period in 2020, please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 11, 2022.Total revenues decreased $547 million, or 1%. The components of these changes are discussed below.Postpaid revenues increased $3.4 billion, or 8%, primarily from:•Higher average postpaid accounts; and•Higher postpaid ARPA. See “Postpaid ARPA” in the “Performance Measures” section of this MD&A. Prepaid revenues increased $124 million, or 1%, primarily from higher average prepaid customers.Wholesale and other service revenues decreased $527 million, or 9%, primarily from: •Lower advertising, MVNO and Wireline revenues; partially offset by•Higher Lifeline revenues.Equipment revenues decreased $3.6 billion, or 17%, primarily from:•A decrease of $1.9 billion in lease revenues and a decrease of $599 million in customer purchases of leased devices primarily due to a lower number of customer devices under lease as a result of the continued strategic shift in device financing from leasing to EIP; and•A decrease of $787 million in device sales revenue, excluding purchased leased devices, primarily from:•A decrease in the number of devices sold primarily driven by lower prepaid sales, partially offset by higher upgrade volume for Sprint customers to facilitate their migration to the T-Mobile network;•Slightly lower average revenue per device sold, primarily driven by higher promotions, which included promotions for Sprint customers to facilitate their migration to the T-Mobile network; and•An increase in contra-revenue primarily driven by higher imputed interest rates on EIPs, which is recognized in Other revenues over the device financing term.Other revenues increased $96 million, or 9%, primarily from:•Higher interest income driven by higher imputed interest rates on EIPs which is recognized over the device financing term.Total operating expenses decreased $198 million. The components of this change are discussed below.Cost of services, exclusive of depreciation and amortization, increased $732 million, or 5%, primarily from:•An increase of $1.7 billion in Merger-related costs related to network decommissioning and integration costs; and•Higher site costs related to the continued build-out of our nationwide 5G network; partially offset by•Higher realized Merger synergies.Cost of equipment sales, exclusive of depreciation and amortization, decreased $1.1 billion, or 5%, primarily from:•A decrease of $964 million in customer purchases of leased devices, primarily due to a lower number of customer devices under lease as a result of the continued strategic shift in device financing from leasing to EIP; and•A decrease of $503 million in device cost of equipment sales, excluding purchased leased devices, primarily from:•A decrease in the number of devices sold primarily driven by lower prepaid sales, partially offset by higher upgrade volume for Sprint customers to facilitate their migration to the T-Mobile network; partially offset by•Slightly higher average cost per device sold due to an increase in the high-end device mix; partially offset by •Higher device insurance claims and warranty fulfillment expense.33Table of Contents•Cost of equipment sales for the year ended December 31, 2022, included $1.5 billion of Merger-related costs, primarily to facilitate the migration of Sprint customers to the T-Mobile network, compared to $1.0 billion for the year ended December 31, 2021.Selling, general and administrative expenses increased $1.4 billion, or 7%, primarily from:•An increase of $773 million in bad debt expense and losses from sales of receivables, driven by higher receivable balances, as well as normalization relative to muted Pandemic levels in 2021 and estimated potential future macroeconomic impacts;•Higher legal-related expenses, net of recoveries, including $400 million recognized in June 2022 for the settlement of certain litigation associated with the August 2021 cyberattack, partially offset by $100 million in reimbursements from insurance carriers received in 2022 associated with the August 2021 cyberattack; and•Higher costs related to outsourced functions; partially offset by•Higher realized Merger synergies and lower Merger-related costs; and•Gains from the sale of certain IP addresses held by the Wireline Business.•Selling, general and administrative expenses for the year ended December 31, 2022, included $775 million of Merger-related costs, primarily related to integration, restructuring and legal-related expenses, partially offset by $333 million received in gross settlements for certain patent litigation assumed in the Merger, compared to $1.1 billion of Merger-related costs for the year ended December 31, 2021.Impairment expense was $477 million for the year ended December 31, 2022, due to the non-cash impairment of certain Wireline Property and equipment, Operating lease right-of-use assets and Other intangible assets. See Note 16 - Wireline of the Notes to the Consolidated Financial Statements for additional information. There was no impairment expense for the year ended December 31, 2021.Loss on disposal group held for sale was $1.1 billion for the year ended December 31, 2022, due to the agreement for the sale of the Wireline Business. See Note 16 - Wireline of the Notes to the Consolidated Financial Statements for additional information. There was no loss on disposal group held for sale for the year ended December 31, 2021.Depreciation and amortization decreased $2.7 billion, or 17%, primarily from: •Lower depreciation expense on leased devices, resulting from a lower number of total customer devices under lease; •Certain 4G-related network assets becoming fully depreciated, including assets impacted by the decommissioning of the legacy Sprint CDMA and LTE networks; and•Lower amortization expense on certain intangible assets acquired in the Merger; partially offset by•Higher depreciation expense, excluding leased devices, from the continued build-out of our nationwide 5G network.Operating income, the components of which are discussed above, decreased $349 million, or 5%. Interest expense, net was essentially flat and was impacted by the following:•Lower average debt outstanding and a lower average effective interest rate due to the retirement of higher interest rate debt and the issuance of a lower gross principal amount of lower interest rate debt; offset by •Lower capitalized interest related to the deployment of our 600 MHz spectrum.Other expense, net decreased $166 million, or 83%, primarily from losses on the extinguishment of debt in 2021.Income before income taxes, the components of which are discussed above, was $3.1 billion and $3.4 billion for the years ended December 31, 2022 and 2021, respectively. Income tax expense increased $229 million, or 70%, primarily from:•Tax benefits recognized in the year ended December 31, 2021, associated with legal entity reorganization related to historical Sprint entities, including a reduction in the valuation allowance against deferred tax assets in certain state jurisdictions, that did not impact 2022; partially offset by•Tax benefits recognized in 2022 associated with internal restructuring.34Table of ContentsOur effective tax rate was 17.7% and 9.8% for the years ended December 31, 2022 and 2021, respectively.Net income, the components of which are discussed above, was $2.6 billion and $3.0 billion for the years ended December 31, 2022 and 2021, respectively.Net income for the year ended December 31, 2022, included the following:•Merger-related costs, net of tax, of $3.7 billion for the year ended December 31, 2022, compared to $2.3 billion for the year ended December 31, 2021.•Loss on disposal group held for sale of $815 million, net of tax, for the year ended December 31, 2022, compared to no loss on disposal group held for sale for the year ended December 31, 2021.•Impairment expense of $358 million, net of tax, for the year ended December 31, 2022, compared to no impairment expense for the year ended December 31, 2021.•Certain legal-related expenses, net of recoveries, including from the impact of the settlement of certain litigation associated with the August 2021 cyberattack, of $293 million, net of tax, for the year ended December 31, 2022.Guarantor Financial InformationIn connection with our Merger with Sprint, we assumed certain registered debt to third parties issued by Sprint, Sprint Communications LLC, formerly known as Sprint Communications, Inc. (“Sprint Communications”) and Sprint Capital Corporation (collectively, the “Sprint Issuers”). As of December 31, 2022, all the registered debt to third parties issued by Sprint Communications had matured and Sprint Communications no longer has any such debt outstanding.Pursuant to the applicable indentures and supplemental indentures, the Senior Notes to affiliates and third parties issued by T-Mobile USA, Inc. and the Sprint Issuers (collectively, the “Issuers”) are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by T-Mobile (“Parent”) and certain of Parent’s 100% owned subsidiaries (“Guarantor Subsidiaries”). The guarantees of the Guarantor Subsidiaries are subject to release in limited circumstances only upon the occurrence of certain customary conditions. Generally, the guarantees of the Guarantor Subsidiaries with respect to the Senior Notes issued by T-Mobile USA, Inc. (other than $3.5 billion in principal amount of Senior Notes issued in 2017 and 2018) and the credit agreement entered into by T-Mobile USA, Inc. will be automatically and unconditionally released if, immediately following such release and any concurrent releases of other guarantees, the aggregate principal amount of indebtedness of non-guarantor subsidiaries (other than certain specified subsidiaries) would not exceed $2.0 billion. The indentures, supplemental indentures and credit agreements governing the long-term debt contain covenants that, among other things, limit the ability of the Issuers or borrowers and the Guarantor Subsidiaries to incur more debt, create liens or other encumbrances, and merge, consolidate or sell, or otherwise dispose of, substantially all of their assets. Basis of PresentationThe following tables include summarized financial information of the obligor groups of debt issued by T-Mobile USA, Inc., Sprint and Sprint Capital Corporation. The summarized financial information of each obligor group is presented on a combined basis with balances and transactions within the obligor group eliminated. Investments in and the equity in earnings of non-guarantor subsidiaries, which would otherwise be consolidated in accordance with GAAP, are excluded from the below summarized financial information pursuant to SEC Regulation S-X Rule 13-01.The summarized balance sheet information for the consolidated obligor group of debt issued by T-Mobile USA, Inc. is presented in the table below:(in millions)December 31, 2022December 31, 2021Current assets$17,661 $19,522 Noncurrent assets181,673 174,980 Current liabilities23,146 22,195 Noncurrent liabilities120,385 115,126 Due to non-guarantors9,325 8,208 Due to related parties1,571 3,842 35Table of ContentsThe summarized results of operations information for the consolidated obligor group of debt issued by T-Mobile USA, Inc. is presented in the table below: Year EndedDecember 31, 2022Year EndedDecember 31, 2021(in millions)Total revenues$77,054 $78,538 Operating income2,985 3,835 Net (loss) income(572)402 Revenue from non-guarantors2,427 1,769 Operating expenses to non-guarantors2,659 2,655 Other expense to non-guarantors(327)(148)The summarized balance sheet information for the consolidated obligor group of debt issued by Sprint is presented in the table below: (in millions)December 31, 2022December 31, 2021Current assets$9,319 $11,969 Noncurrent assets11,271 10,347 Current liabilities15,854 15,136 Noncurrent liabilities65,118 70,262 Due to non-guarantors3,930 — Due from non-guarantors— 1,787 Due to related parties1,571 3,842 The summarized results of operations information for the consolidated obligor group of debt issued by Sprint is presented in the table below:Year EndedDecember 31, 2022Year EndedDecember 31, 2021(in millions)Total revenues$7 $7 Operating loss(3,479)(751)Net income (loss) (1)2,471 (2,161)Other income, net, from non-guarantors525 1,706 (1) Net income for the year ended December 31, 2022, includes tax benefits recognized associated with internal restructuring.The summarized balance sheet information for the consolidated obligor group of debt issued by Sprint Capital Corporation is presented in the table below: (in millions)December 31, 2022December 31, 2021Current assets$9,320 $11,969 Noncurrent assets16,337 19,375 Current liabilities15,926 15,208 Noncurrent liabilities66,516 75,753 Due from non-guarantors5,066 10,814 Due to related parties1,571 3,842 The summarized results of operations information for the consolidated obligor group of debt issued by Sprint Capital Corporation is presented in the table below: Year EndedDecember 31, 2022Year EndedDecember 31, 2021(in millions)Total revenues$7 $7 Operating loss(3,479)(751)Net income (loss) (1)2,604 (2,590)Other income, net, from non-guarantors941 2,076 (1) Net income for the year ended December 31, 2022, includes tax benefits recognized associated with internal restructuring.Performance MeasuresIn managing our business and assessing financial performance, we supplement the information provided by our consolidated financial statements with other operating or statistical data and non-GAAP financial measures. These operating and financial measures are utilized by our management to evaluate our operating performance and, in certain cases, our ability to meet 36Table of Contentsliquidity requirements. Although companies in the wireless industry may not define each of these measures in precisely the same way, we believe that these measures facilitate comparisons with other companies in the wireless industry on key operating and financial measures.Total Postpaid AccountsA postpaid account is generally defined as a billing account number that generates revenue. Postpaid accounts generally consist of customers that are qualified for postpaid service utilizing phones, High Speed Internet, tablets, wearables, DIGITS or other connected devices, where they generally pay after receiving service.As of December 31,2022 Versus 20212021 Versus 2020(in thousands)202220212020# Change% Change# Change% ChangeTotal postpaid customer accounts (1) (2) (3)28,526 27,216 25,754 1,310 5 %1,462 6 %(1) Customers impacted by the decommissioning of the legacy Sprint CDMA and LTE and T-Mobile UMTS networks have been excluded from our postpaid account base resulting in the removal of 57,000 postpaid accounts in the first quarter of 2022 and 69,000 postpaid accounts in the second quarter of 2022.(2) In the first quarter of 2021, we acquired 4,000 postpaid accounts through our acquisition of an affiliate. In the third quarter of 2021, we acquired 270,000 postpaid accounts through our acquisition of the Wireless Assets of Shentel.(3) Includes accounts acquired in connection with the Merger and certain account base adjustments. See Sprint Merger Account Base Adjustments table below.Total postpaid customer accounts increased 1,310,000, or 5%, primarily due to the Company’s differentiated growth strategy in new and under-penetrated markets, including continued growth in High Speed Internet.Sprint Merger Account Base AdjustmentsCertain adjustments were made to align the account reporting policies of T-Mobile and Sprint. The adjustments made to the reported T-Mobile and Sprint ending account base as of March 31, 2020 are presented below: (in thousands)Postpaid AccountsReconciliation to beginning accountsT-Mobile accounts as reported, end of period March 31, 202015,244 Sprint accounts, end of period March 31, 202011,246 Total combined accounts, end of period March 31, 202026,490 AdjustmentsReseller reclassification to wholesale accounts (1)(1)EIP reclassification from postpaid to prepaid (2)(963)Rate plan threshold (3)(18)Collection policy alignment (4)(76)Miscellaneous adjustments (5)(47)Total Adjustments(1,105)Adjusted beginning accounts as of April 1, 202025,385 (1) In connection with the closing of the Merger, we refined our definition of wholesale accounts resulting in the reclassification of certain postpaid and prepaid reseller accounts to wholesale accounts.(2) Prepaid accounts with a customer with a device installment billing plan historically included as Sprint postpaid accounts have been reclassified to prepaid accounts to align with T-Mobile policy.(3) Accounts with customers who have rate plans with monthly recurring charges that are considered insignificant have been excluded from our reported accounts.(4) Certain Sprint accounts subject to collection activity for an extended period of time have been excluded from our reported accounts to align with T-Mobile policy.(5) Miscellaneous insignificant adjustments to align with T-Mobile policy.Postpaid Net Account AdditionsThe following table sets forth the number of postpaid net account additions:Year Ended December 31,2022 Versus 20212021 Versus 2020(in thousands)202220212020# Change% Change# Change% ChangePostpaid net account additions1,436 1,188 566 248 21 %622 110 %37Table of ContentsPostpaid net account additions increased 248,000, or 21%, primarily due to continued growth resulting from the Company’s differentiated growth strategy in new and under-penetrated markets, including continued growth in High Speed Internet.CustomersA customer is generally defined as a SIM number with a unique T-Mobile identifier which is associated with an account that generates revenue. Customers are qualified either for postpaid service utilizing phones, High Speed Internet, tablets, wearables, DIGITS or other connected devices, where they generally pay after receiving service, or prepaid service, where they generally pay in advance of receiving service.The following table sets forth the number of ending customers:As of December 31,2022 Versus 20212021 Versus 2020(in thousands)202220212020# Change% Change# Change% ChangeCustomers, end of periodPostpaid phone customers (1) (2) (3)72,834 70,262 66,618 2,572 4 %3,644 5 %Postpaid other customers (1) (2) (3)19,398 17,401 14,732 1,997 11 %2,669 18 %Total postpaid customers92,232 87,663 81,350 4,569 5 %6,313 8 %Prepaid customers (1) (3)21,366 21,056 20,714 310 1 %342 2 %Total customers113,598 108,719 102,064 4,879 4 %6,655 7 %Acquired customers, net of base adjustments (1) (2) (3)(1,878)818 29,228 (2,696)(330)%(28,410)(97)%(1) Customers impacted by the decommissioning of the legacy Sprint CDMA and LTE and T-Mobile UMTS networks have been excluded from our customer base resulting in the removal of 212,000 postpaid phone customers and 349,000 postpaid other customers in the first quarter of 2022 and 284,000 postpaid phone customers, 946,000 postpaid other customers and 28,000 prepaid customers in the second quarter of 2022. In connection with our acquisition of companies, we included a base adjustment in the first quarter of 2022 to increase postpaid phone customers by 17,000 and reduce postpaid other customers by 14,000. Certain customers now serviced through reseller contracts were removed from our reported postpaid customer base resulting in the removal of 42,000 postpaid phone customers and 20,000 postpaid other customers in the second quarter of 2022.(2) In the first quarter of 2021, we acquired 11,000 postpaid phone customers and 1,000 postpaid other customers through our acquisition of an affiliate. In the third quarter of 2021, we acquired 716,000 postpaid phone customers and 90,000 postpaid other customers through our acquisition of the Wireless Assets from Shentel.(3) Includes customers acquired in connection with the Merger and certain customer base adjustments. See Sprint Merger Customer Base Adjustments and Net Customer Additions tables below.Total customers increased 4,879,000, or 4%, primarily from:•Higher postpaid phone customers, primarily due to growth in new customer account relationships;•Higher postpaid other customers, primarily due to growth in other connected devices, including growth in High Speed Internet and wearable products; and•Higher prepaid customers, primarily due to the continued success of our prepaid business due to promotional activity and rate plan offers, including the introduction of our prepaid High Speed Internet offering, partially offset by lower prepaid industry demand associated with continued industry shift to postpaid plans.Total customers included High Speed Internet customers of 2,646,000 and 646,000 as of December 31, 2022 and 2021, respectively.38Table of ContentsSprint Merger Customer Base AdjustmentsCertain adjustments were made to align the customer reporting policies of T-Mobile and Sprint. The adjustments made to the reported T-Mobile and Sprint ending customer base as of March 31, 2020, are presented below: (in thousands)Postpaid phone customersPostpaid other customersTotal postpaid customersPrepaid customersTotal customersReconciliation to beginning customersT-Mobile customers as reported, end of period March 31, 202040,797 7,014 47,811 20,732 68,543 Sprint customers as reported, end of period March 31, 202025,916 8,428 34,344 8,256 42,600 Total combined customers, end of period March 31, 202066,713 15,442 82,155 28,988 111,143 AdjustmentsReseller reclassification to wholesale customers (1)(199)(2,872)(3,071)— (3,071)EIP reclassification from postpaid to prepaid (2)(963)— (963)963 — Divested prepaid customers (3)— — — (9,207)(9,207)Rate plan threshold (4)(182)(918)(1,100)— (1,100)Customers with non-phone devices (5)(226)226 — — — Collection policy alignment (6)(150)(46)(196)— (196)Miscellaneous adjustments (7)(141)(43)(184)(302)(486)Total Adjustments(1,861)(3,653)(5,514)(8,546)(14,060)Adjusted beginning customers as of April 1, 202064,852 11,789 76,641 20,442 97,083 (1) In connection with the closing of the Merger, we refined our definition of wholesale customers, resulting in the reclassification of certain postpaid and prepaid reseller customers to wholesale customers. Starting with the three months ended March 31, 2020, we discontinued reporting wholesale customers to focus on postpaid and prepaid customers and wholesale revenues, which we consider more relevant than the number of wholesale customers given the expansion of M2M and IoT products.(2) Prepaid customers with a device installment billing plan historically included as Sprint postpaid customers have been reclassified to prepaid customers to align with T-Mobile policy.(3) Customers associated with the Sprint wireless prepaid and Boost Mobile brands that were divested on July 1, 2020, have been excluded from our reported customers.(4) Customers who have rate plans with monthly recurring charges which are considered insignificant have been excluded from our reported customers.(5) Customers with postpaid phone rate plans without a phone (e.g., non-phone devices) have been reclassified from postpaid phone to postpaid other customers to align with T-Mobile policy.(6) Certain Sprint customers subject to collection activity for an extended period of time have been excluded from our reported customers to align with T-Mobile policy.(7) Miscellaneous insignificant adjustments to align with T-Mobile policy.Net Customer AdditionsThe following table sets forth the number of net customer additions:Year Ended December 31,2022 Versus 20212021 Versus 2020(in thousands)202220212020# Change% Change# Change% ChangeNet customer additionsPostpaid phone customers 3,093 2,917 2,218 176 6 %699 32 %Postpaid other customers3,326 2,578 3,268 748 29 %(690)(21)%Total postpaid customers6,419 5,495 5,486 924 17 %9 — %Prepaid customers338 342 145 (4)(1)%197 136 %Total customers6,757 5,837 5,631 920 16 %206 4 %Adjustments to customers(1,878)818 29,228 (2,696)(330)%(28,410)(97)%Total net customer additions increased 920,000, or 16%, primarily from: •Higher postpaid other net customer additions, primarily due to an increase in postpaid High Speed Internet net customer additions and other connected devices, partially offset by lower net additions from mobile internet devices; and•Higher postpaid phone net customer additions, primarily due to lower churn, partially offset by lower gross additions driven by industry switching activity normalizing closer to pre-Pandemic levels; partially offset by•Lower prepaid net customer additions associated with the continued industry shift to postpaid plans, partially offset by the introduction of our prepaid High Speed Internet offering and lower churn.39Table of Contents•High Speed Internet net customer additions included in postpaid other net customer additions were 1,764,000 and 546,000 for the years ended December 31, 2022 and 2021, respectively. High Speed Internet net customer additions included in prepaid net customer additions were 236,000 for the year ended December 31, 2022. Our prepaid High Speed Internet launch was in the first quarter of 2022. Therefore, there were no prepaid High Speed Internet net customer additions for the year ended December 31, 2021.ChurnChurn represents the number of customers whose service was disconnected as a percentage of the average number of customers during the specified period further divided by the number of months in the period. The number of customers whose service was disconnected is presented net of customers that subsequently had their service restored within a certain period of time and excludes customers who received service for less than a certain minimum period of time. We believe that churn provides management, investors and analysts with useful information to evaluate customer retention and loyalty. The following table sets forth the churn:Year Ended December 31,Bps Change 2022 Versus 2021Bps Change 2021 Versus 2020202220212020Postpaid phone churn0.88 %0.98 %0.90 %-10 bps8 bpsPrepaid churn2.77 %2.83 %3.03 %-6 bps-20 bpsPostpaid phone churn decreased 10 basis points, primarily from:•Reduced Sprint churn as we progress through the integration process; partially offset by•More normalized payment performance relative to muted Pandemic levels in 2021. Prepaid churn decreased 6 basis points, primarily from:•Promotional activity; partially offset by•More normalized payment performance relative to muted Pandemic levels in 2021. Postpaid Average Revenue Per AccountPostpaid ARPA represents the average monthly postpaid service revenue earned per account. Postpaid ARPA is calculated as Postpaid revenues for the specified period divided by the average number of postpaid accounts during the period, further divided by the number of months in the period. We believe postpaid ARPA provides management, investors and analysts with useful information to assess and evaluate our postpaid service revenue realization and assist in forecasting our future postpaid service revenues on a per account basis. We consider postpaid ARPA to be indicative of our revenue growth potential given the increase in the average number of postpaid phone customers per account and increases in postpaid other customers, including High Speed Internet, tablets, wearables, DIGITS or other connected devices.The following table sets forth our operating measure ARPA:(in dollars)Year Ended December 31,2022 Versus 20212021 Versus 2020202220212020$ Change% Change$ Change% ChangePostpaid ARPA$137.43 $134.03 $131.78 $3.40 3 %$2.25 2 %40Table of ContentsPostpaid ARPA increased $3.40, or 3%, primarily from:•Higher premium services, including Magenta Max;•Higher non-recurring charges relative to muted Pandemic levels in 2021; and•An increase in customers per account, including continued adoption of High Speed Internet from existing accounts; partially offset by•An increase in High Speed Internet only accounts and increased promotional activity, including growth in rate plans for specific customer cohorts such as Business, Military, and First Responder.Average Revenue Per UserAverage Revenue per User (“ARPU”) represents the average monthly service revenue earned per customer. ARPU is calculated as service revenues for the specified period divided by the average number of customers during the period, further divided by the number of months in the period. We believe ARPU provides management, investors and analysts with useful information to assess and evaluate our service revenue per customer and assist in forecasting our future service revenues generated from our customer base. Postpaid phone ARPU excludes postpaid other customers and related revenues, which include High Speed Internet, tablets, wearables, DIGITS and other connected devices.The following table sets forth our operating measure ARPU:(in dollars)Year Ended December 31,2022 Versus 20212021 Versus 2020202220212020$ Change% Change$ Change% ChangePostpaid phone ARPU$48.78 $47.75 $47.74 $1.03 2 %$0.01 — %Prepaid ARPU38.76 38.79 38.12 (0.03)— %0.67 2 %Postpaid Phone ARPUPostpaid phone ARPU increased $1.03, or 2%, primarily due to:•Higher premium services, including Magenta Max; and•Higher non-recurring charges relative to muted Pandemic levels in 2021; partially offset by •Increased promotional activity, including growth in rate plans for specific customer cohorts such as Business, Military, and First Responder.Prepaid ARPUPrepaid ARPU was essentially flat, primarily from:•Increased promotional activity; offset by •Higher premium services; and•Higher non-recurring charges.Adjusted EBITDA and Core Adjusted EBITDAAdjusted EBITDA represents earnings before Interest expense, net of Interest income, Income tax expense, Depreciation and amortization, stock-based compensation and certain income and expenses not reflective of our ongoing operating performance. Core Adjusted EBITDA represents Adjusted EBITDA less device lease revenues. Adjusted EBITDA margin represents Adjusted EBITDA divided by Service revenues. Core Adjusted EBITDA margin represents Core Adjusted EBITDA divided by Service revenues.Adjusted EBITDA, Adjusted EBITDA margin, Core Adjusted EBITDA and Core Adjusted EBITDA margin are non-GAAP financial measures utilized by our management to monitor the financial performance of our operations. We historically used Adjusted EBITDA and we currently use Core Adjusted EBITDA internally as a measure to evaluate and compensate our personnel and management for their performance. We use Adjusted EBITDA and Core Adjusted EBITDA as benchmarks to evaluate our operating performance in comparison to our competitors. Management believes analysts and investors use Adjusted EBITDA and Core Adjusted EBITDA as supplemental measures to evaluate overall operating performance and to facilitate comparisons with other wireless communications services companies because they are indicative of our ongoing 41Table of Contentsoperating performance and trends by excluding the impact of interest expense from financing, non-cash depreciation and amortization from capital investments, stock-based compensation, Merger-related costs, including network decommissioning costs, impairment expense, losses on disposal groups held for sale and certain legal-related recoveries and expenses, as well as other special income and expenses which are not reflective of our core business activities. Management believes analysts and investors use Core Adjusted EBITDA because it normalizes for the transition in the Company’s device financing strategy, by excluding the impact of device lease revenues from Adjusted EBITDA, to align with the exclusion of the related depreciation expense on leased devices from Adjusted EBITDA. Adjusted EBITDA, Adjusted EBITDA margin, Core Adjusted EBITDA and Core Adjusted EBITDA margin have limitations as analytical tools and should not be considered in isolation or as substitutes for income from operations, net income or any other measure of financial performance reported in accordance with GAAP.The following table illustrates the calculation of Adjusted EBITDA and Core Adjusted EBITDA and reconciles Adjusted EBITDA and Core Adjusted EBITDA to Net income, which we consider to be the most directly comparable GAAP financial measure:Year Ended December 31,2022 Versus 20212021 Versus 2020(in millions)202220212020$ Change% Change$ Change% ChangeNet income$2,590 $3,024 $3,064 $(434)(14)%$(40)(1)%Adjustments:Income from discontinued operations, net of tax— — (320)— NM320 (100)%Income from continuing operations2,590 3,024 2,744 (434)(14)%280 10 %Interest expense, net3,364 3,342 2,701 22 1 %641 24 %Other expense, net33 199 405 (166)(83)%(206)(51)%Income tax expense556 327 786 229 70 %(459)(58)%Operating income6,543 6,892 6,636 (349)(5)%256 4 %Depreciation and amortization13,651 16,383 14,151 (2,732)(17)%2,232 16 %Operating income from discontinued operations (1)— — 432 — NM(432)(100)%Stock-based compensation (2)576 521 516 55 11 %5 1 %Merger-related costs4,969 3,107 1,915 1,862 60 %1,192 62 %COVID-19-related costs— — 458 — NM(458)(100)%Impairment expense477 — 418 477 NM(418)(100)%Legal-related expenses, net (3)391 — — 391 NM— NMLoss on disposal group held for sale1,087 — — 1,087 NM— NMOther, net (4)127 21 31 106 505 %(10)(32)%Adjusted EBITDA27,821 26,924 24,557 897 3 %2,367 10 %Lease revenues(1,430)(3,348)(4,181)1,918 (57)%833 (20)%Core Adjusted EBITDA$26,391 $23,576 $20,376 $2,815 12 %$3,200 16 %Net income margin (Net income divided by Service revenues)4 %5 %6 %-100 bps-100 bpsAdjusted EBITDA margin (Adjusted EBITDA divided by Service revenues)45 %46 %49 %-100 bps-300 bpsCore Adjusted EBITDA margin (Core Adjusted EBITDA divided by Service revenues)43 %40 %40 %300 bps— bps(1)Following the Prepaid Transaction starting on July 1, 2020, we provide MVNO services to DISH. We have included the operating income from April 1, 2020 through June 30, 2020, in our determination of Adjusted EBITDA to reflect contributions of the Prepaid Business that were replaced by the MVNO Agreement beginning on July 1, 2020 in order to enable management, analysts and investors to better assess ongoing operating performance and trends.(2)Stock-based compensation includes payroll tax impacts and may not agree with stock-based compensation expense on the consolidated financial statements. Additionally, certain stock-based compensation expenses associated with the Transactions have been included in Merger-related costs. (3)Legal-related expenses, net, consists of the settlement of certain litigation associated with the August 2021 cyberattack and is presented net of insurance recoveries.(4)Other, net, primarily consists of certain severance, restructuring and other expenses and income, including gains from the sale of IP addresses, not directly attributable to the Merger which are not reflective of T-Mobile’s core business activities (“special items”), and are, therefore, excluded from Adjusted EBITDA and Core Adjusted EBITDA. NM - Not meaningfulCore Adjusted EBITDA increased $2.8 billion, or 12%, for the year ended December 31, 2022. The components comprising Core Adjusted EBITDA are discussed further above. 42Table of ContentsThe increase was primarily due to:•Higher Total service revenues;•Lower Cost of equipment sales, excluding Merger-related costs; and •Lower Cost of services, excluding Merger-related costs; partially offset by•Lower Equipment revenues, excluding lease revenues; and•Higher Selling, general and administrative expenses, excluding Merger-related costs, certain legal-related expenses, net of recoveries, and other special items, such as gains from the sale of IP addresses.Adjusted EBITDA increased $897 million, or 3%, for the year ended December 31, 2022, primarily due to the fluctuations in Core Adjusted EBITDA, discussed above, partially offset by lower lease revenues, which decreased $1.9 billion for the year ended December 31, 2022.Liquidity and Capital ResourcesOur principal sources of liquidity are our cash and cash equivalents and cash generated from operations, proceeds from issuance of debt, financing leases, the sale of certain receivables and the Revolving Credit Facility (as defined below). Further, the incurrence of additional indebtedness may inhibit our ability to incur new debt in the future to finance our business strategy under the terms governing our existing and future indebtedness.Cash FlowsThe following is a condensed schedule of our cash flows:Year Ended December 31,2022 Versus 20212021 Versus 2020(in millions)202220212020$ Change% Change$ Change% ChangeNet cash provided by operating activities$16,781 $13,917 $8,640 $2,864 21 %$5,277 61 %Net cash used in investing activities(12,359)(19,386)(12,715)7,027 (36)%(6,671)52 %Net cash (used in) provided by financing activities(6,451)1,709 13,010 (8,160)(477)%(11,301)(87)%Operating ActivitiesNet cash provided by operating activities increased $2.9 billion, or 21%, primarily from:•A $4.1 billion decrease in net cash outflows from changes in working capital, primarily due to lower use of cash from Short- and long-term operating lease liabilities, including the impact of a $1.0 billion advance rent payment related to the modification of one of our master lease agreements during the year ended December 31, 2021, EIP receivables, Other current and long-term liabilities and Inventories, partially offset by higher use of cash from Accounts receivable; partially offset by•A $1.2 billion decrease in Net income, adjusted for non-cash income and expense.•Net cash provided by operating activities includes the impact of $3.4 billion and $2.2 billion in net payments for Merger-related costs for the years ended December 31, 2022 and 2021, respectively.Investing ActivitiesNet cash used in investing activities decreased $7.0 billion or 36%. The use of cash was primarily from:•$14.0 billion in Purchases of property and equipment, including capitalized interest, from the accelerated build-out of our nationwide 5G network, including from network integration related to the Merger; and•$3.3 billion in Purchases of spectrum licenses and other intangible assets, including deposits, primarily due to $2.8 billion paid for spectrum licenses won at the conclusion of Auction 110 in February 2022 and $304 million paid in total for spectrum licenses won at the conclusion of Auction 108 in September 2022; partially offset by •$4.8 billion in Proceeds related to beneficial interests in securitization transactions.43Table of ContentsFinancing ActivitiesNet cash used in financing activities was $6.5 billion for the year ended December 31, 2022, compared to net cash provided by financing activities of $1.7 billion for the year ended December 31, 2021. The use of cash was primarily from:•$5.6 billion in Repayments of long-term debt;•$3.0 billion in Repurchases of common stock;•$1.2 billion in Repayments of financing lease obligations; and•$243 million in Tax withholdings on share-based awards; partially offset by•$3.7 billion in Proceeds from issuance of long-term debt.Cash and Cash EquivalentsAs of December 31, 2022, our Cash and cash equivalents were $4.5 billion compared to $6.6 billion at December 31, 2021.Free Cash FlowFree Cash Flow represents Net cash provided by operating activities less cash payments for Purchases of property and equipment, including Proceeds from sales of tower sites and Proceeds related to beneficial interests in securitization transactions and less Cash payments for debt prepayment or debt extinguishment costs. Free Cash Flow is a non-GAAP financial measure utilized by management, investors and analysts of our financial information to evaluate cash available to pay debt, repurchase shares and provide further investment in the business.In 2022 and 2021, we received proceeds from the sale of tower sites of $9 million and $40 million, respectively, which are included in Proceeds from sales of tower sites within Net cash used in investing activities on our Consolidated Statements of Cash Flows. As these proceeds were from the sale of fixed assets and are used by management to assess cash available for capital expenditures during the year, we determined the proceeds are relevant for the calculation of Free Cash Flow and included them in the table below. Other proceeds from the sale of fixed assets for the periods presented are not significant. We have presented the impact of the sales in the table below, which reconciles Free Cash Flow and Free Cash Flow, excluding gross payments for the settlement of interest rate swaps, to Net cash provided by operating activities, which we consider to be the most directly comparable GAAP financial measure.Year Ended December 31,2022 Versus 20212021 Versus 2020(in millions)202220212020$ Change% Change$ Change% ChangeNet cash provided by operating activities$16,781 $13,917 $8,640 $2,864 21 %$5,277 61 %Cash purchases of property and equipment, including capitalized interest(13,970)(12,326)(11,034)(1,644)13 %(1,292)12 %Proceeds from sales of tower sites9 40 — (31)(78)%40 NMProceeds related to beneficial interests in securitization transactions4,836 4,131 3,134 705 17 %997 32 %Cash payments for debt prepayment or debt extinguishment costs— (116)(82)116 (100)%(34)41 %Free Cash Flow$7,656 $5,646 $658 $2,010 36 %$4,988 758 %Gross cash paid for the settlement of interest rate swaps— — 2,343 — NM(2,343)(100)%Free Cash Flow, excluding gross payments for the settlement of interest rate swaps$7,656 $5,646 $3,001 $2,010 36 %$2,645 88 %NM - Not MeaningfulFree Cash Flow increased $2.0 billion, or 36%. The increase was primarily impacted by the following:•Higher Net cash provided by operating activities, as described above; and•Higher Proceeds related to beneficial interests in securitization transactions, which were offset in Net cash provided by operating activities; partially offset by•Higher Cash purchases of property and equipment, including capitalized interest.•Free Cash Flow includes $3.4 billion and $2.2 billion in net payments for Merger-related costs for the years ended December 31, 2022 and 2021, respectively.During the years ended December 31, 2022 and 2021, there were no significant net cash proceeds from securitization.44Table of ContentsBorrowing CapacityWe maintain a revolving credit facility (the “Revolving Credit Facility”) with an aggregate commitment amount of $7.5 billion. As of December 31, 2022, there was no outstanding balance under the Revolving Credit Facility. See Note 8 - Debt of the Notes to the Consolidated Financial Statements for more information regarding the Revolving Credit Facility. Debt FinancingAs of December 31, 2022, our total debt and financing lease liabilities were $74.5 billion, excluding our tower obligations, of which $66.8 billion was classified as long-term debt and $1.4 billion was classified as long-term financing lease liabilities.During the year ended December 31, 2022, we issued long-term debt for net proceeds of $3.7 billion and repaid short- and long-term debt with an aggregate principal amount of $5.6 billion.Subsequent to December 31, 2022, on February 9, 2023, we issued $1.0 billion of 4.950% Senior Notes due 2028, $1.3 billion of 5.050% Senior Notes due 2033 and $750 million of 5.650% Senior Notes due 2053.For more information regarding our debt financing transactions, see Note 8 – Debt of the Notes to the Consolidated Financial Statements.Spectrum AuctionsIn March 2021, the FCC announced that we were the winning bidder of 142 licenses in Auction 107 (C-band spectrum) for an aggregate purchase price of $9.3 billion, excluding relocation costs. We expect to incur an additional $767 million in fixed relocation costs, which will be paid through 2024.In January 2022, the FCC announced that we were the winning bidder of 199 licenses in Auction 110 (3.45 GHz spectrum) for an aggregate purchase price of $2.9 billion. At the inception of Auction 110 in September 2021, we deposited $100 million. We paid the FCC the remaining $2.8 billion for the licenses won in the auction in February 2022.In September 2022, the FCC announced that we were the winning bidder of 7,156 licenses in Auction 108 (2.5 GHz spectrum) for an aggregate price of $304 million. At the inception of Auction 108 in June 2022, we deposited $65 million. We paid the FCC the remaining $239 million for the licenses won in the auction in September 2022. Our receipt of these licenses was still awaiting FCC final approval of the auction results as of December 31, 2022.For more information regarding our spectrum licenses, see Note 6 – Goodwill, Spectrum License Transactions and Other Intangible Assets of the Notes to the Consolidated Financial Statements.License Purchase AgreementsOn August 8, 2022, we entered into License Purchase Agreements to acquire spectrum in the 600 MHz band from Channel 51 License Co LLC and LB License Co, LLC in exchange for total cash consideration of $3.5 billion. The closing of this purchase was still awaiting FCC final approval as of December 31, 2022. For more information regarding our License Purchase Agreements, see Note 6 – Goodwill, Spectrum License Transactions and Other Intangible Assets of the Notes to the Consolidated Financial Statements.Off-Balance Sheet Arrangements We have arrangements, as amended from time to time, to sell certain EIP accounts receivable and service accounts receivable on a revolving basis as a source of liquidity. As of December 31, 2022, we derecognized net receivables of $2.4 billion upon sale through these arrangements. For more information regarding these off-balance sheet arrangements, see Note 4 – Sales of Certain Receivables of the Notes to the Consolidated Financial Statements.45Table of ContentsFuture Sources and Uses of LiquidityWe may seek additional sources of liquidity, including through the issuance of additional debt, to continue to opportunistically acquire spectrum licenses or other long-lived assets in private party transactions, repurchase shares, or for the refinancing of existing long-term debt on an opportunistic basis. Excluding liquidity that could be needed for spectrum acquisitions, other long-lived assets or for any potential stockholder returns, we expect our principal sources of funding to be sufficient to meet our anticipated liquidity needs for business operations for the next 12 months as well as our longer-term liquidity needs. Our intended use of any such funds is for general corporate purposes, including for capital expenditures, spectrum purchases, opportunistic investments and acquisitions, redemption of debt, tower obligations, share repurchases and the execution of our integration plan. We determine future liquidity requirements for operations, capital expenditures and share repurchases based in large part upon projected financial and operating performance, and opportunities to acquire additional spectrum or repurchase shares. We regularly review and update these projections for changes in current and projected financial and operating results, general economic conditions, the competitive landscape and other factors. We have incurred, and will incur, substantial expenses to comply with the Government Commitments, and we are also expected to incur substantial restructuring expenses in connection with integrating and coordinating T-Mobile’s and Sprint’s businesses, operations, policies and procedures. See “Restructuring” in this MD&A. While we have assumed that a certain level of Merger-related expenses will be incurred, factors beyond our control, including required consultation and negotiation with certain counterparties, could affect the total amount or the timing of these expenses. These expenses could exceed the costs historically borne by us and adversely affect our financial condition and results of operations. There are a number of additional risks and uncertainties, including those due to the impact of the Pandemic, that could cause our financial and operating results and capital requirements to differ materially from our projections, which could cause future liquidity to differ materially from our assessment. The indentures, supplemental indentures and credit agreements governing our long-term debt to affiliates and third parties, excluding financing leases, contain covenants that, among other things, limit the ability of the Issuers or borrowers and the Guarantor Subsidiaries to incur more debt, create liens or other encumbrances, and merge, consolidate or sell, or otherwise dispose of, substantially all of their assets. We were in compliance with all restrictive debt covenants as of December 31, 2022.Financing Lease FacilitiesWe have entered into uncommitted financing lease facilities with certain third parties that provide us with the ability to enter into financing leases for network equipment and services. As of December 31, 2022, we have committed to $7.5 billion of financing leases under these financing lease facilities, of which $1.2 billion was executed during the year ended December 31, 2022. We expect to enter into up to an additional $1.2 billion in financing lease commitments during the year ending December 31, 2023. Capital ExpendituresOur liquidity requirements have been driven primarily by capital expenditures for spectrum licenses, the construction, expansion and upgrading of our network infrastructure and the integration of the networks, spectrum, technology, personnel and customer base of T-Mobile and Sprint. Property and equipment capital expenditures primarily relate to the integration of our network and spectrum licenses, including acquired Sprint PCS and 2.5 GHz spectrum licenses, as we build out our nationwide 5G network. We expect a reduction in capital expenditures related to these efforts following 2022. Future capital expenditure requirements will include the deployment of our recently acquired C-band and 3.45 GHz spectrum licenses. For more information regarding our spectrum licenses, see Note 6 – Goodwill, Spectrum License Transactions and Other Intangible Assets of the Notes to the Consolidated Financial Statements.Stockholder ReturnsWe have never declared or paid any cash dividends on our common stock, and we do not intend to declare or pay any cash dividends on our common stock in the foreseeable future.On September 8, 2022, our Board of Directors authorized our 2022 Stock Repurchase Program for up to $14.0 billion of our common stock through September 30, 2023. During the year ended December 31, 2022, we repurchased shares of our common stock for a total purchase price of $3.0 billion, all of which were purchased under the 2022 Stock Repurchase Program and occurred during the period from September 8, 2022, through December 31, 2022. As of December 31, 2022, we had up to $11.0 billion remaining under the 2022 Stock Repurchase Program.46Table of ContentsSubsequent to December 31, 2022, from January 1, 2023, through February 10, 2023, we repurchased additional shares of our common stock for a total purchase price of $2.1 billion. As of February 10, 2023, we had up to $8.9 billion remaining under the 2022 Stock Repurchase Program.For additional information regarding the 2022 Stock Repurchase Program, see Note 15 – Repurchases of Common Stock of the Notes to the Consolidated Financial Statements.Contractual ObligationsIn connection with the regulatory approvals of the Transactions, we made commitments to various state and federal agencies, including the U.S. Department of Justice and FCC. For more information regarding these commitments, see Note 19 – Commitments and Contingencies of the Notes to the Consolidated Financial Statements.The following table summarizes our material contractual obligations and borrowings as of December 31, 2022, and the timing and effect that such commitments are expected to have on our liquidity and capital requirements in future periods:(in millions)Less Than 1 Year1 - 3 Years3 - 5 YearsMore Than 5 YearsTotalLong-term debt (1)$5,070 $9,142 $10,735 $46,117 $71,064 Interest on long-term debt3,122 5,089 4,134 17,929 30,274 Financing lease liabilities, including imputed interest1,216 1,334 67 11 2,628 Tower obligations (2)424 816 788 4,512 6,540 Operating lease liabilities, including imputed interest4,847 8,419 7,061 21,453 41,780 Purchase obligations (3) (4)4,542 4,876 2,809 2,816 15,043 Spectrum leases and service credits (5)315 587 634 4,615 6,151 Total contractual obligations$19,536 $30,263 $26,228 $97,453 $173,480 (1)Represents principal amounts of long-term debt to affiliates and third parties at maturity, excluding unamortized premiums, discounts, debt issuance costs, consent fees, and financing lease obligations. See Note 8 – Debt of the Notes to the Consolidated Financial Statements for further information.(2)Future minimum payments, including principal and interest payments, related to the tower obligations. See Note 9 – Tower Obligations of the Notes to the Consolidated Financial Statements for further information.(3)The minimum commitment for certain obligations is based on termination penalties that could be paid to exit the contracts. Termination penalties are included in the above table as payments due as of the earliest we could exit the contract, typically in less than one year. For certain contracts that include fixed volume purchase commitments and fixed prices for various products, the purchase obligations are calculated using fixed volumes and contractually fixed prices for the products that are expected to be purchased. This table does not include open purchase orders as of December 31, 2022 under normal business purposes. See Note 19 – Commitments and Contingencies of the Notes to the Consolidated Financial Statements for further information. (4)On August 8, 2022, we entered into License Purchase Agreements to acquire spectrum in the 600 MHz band from Channel 51 License Co LLC and LB License Co, LLC in exchange for total cash consideration of $3.5 billion. The agreements remain subject to regulatory approval and the purchase price of $3.5 billion is excluded from our reported purchase obligations above.(5)Spectrum lease agreements are typically for five to 10 years with automatic renewal provisions, bringing the total term of the agreements up to 30 years.Certain commitments and obligations are included in the table based on the year of required payment or an estimate of the year of payment. Other long-term liabilities have been omitted from the table above due to the uncertainty of the timing of payments, combined with the lack of historical trends to predict future payments.The purchase obligations reflected in the table above are primarily commitments to purchase spectrum licenses, wireless devices, network services, equipment, software, marketing sponsorship agreements and other items in the ordinary course of business. These amounts do not represent our entire anticipated purchases in the future, but represent only those items for which we are contractually committed. Where we are committed to make a minimum payment to the supplier regardless of whether we take delivery, we have included only that minimum payment as a purchase obligation. The acquisition of spectrum licenses is subject to regulatory approval and other customary closing conditions.47Table of ContentsRelated Party TransactionsWe have related party transactions associated with DT or its affiliates in the ordinary course of business, including intercompany servicing and licensing.As of February 10, 2023, DT and SoftBank held, directly or indirectly, approximately 49.6% and 3.3%, respectively, of the outstanding T-Mobile common stock, with the remaining approximately 47.1% of the outstanding T-Mobile common stock held by other stockholders. As a result of the Proxy, Lock-Up and ROFR Agreement, dated April 1, 2020, by and between DT and SoftBank and the Proxy, Lock-Up and ROFR Agreement, dated June 22, 2020, by and among DT, Claure Mobile LLC, and Marcelo Claure, DT has voting control, as of February 10, 2023, over approximately 53.3% of the outstanding T-Mobile common stock.Disclosure of Iranian Activities under Section 13(r) of the Exchange ActSection 219 of the Iran Threat Reduction and the Syria Human Rights Act of 2012 added Section 13(r) to the Exchange Act. Section 13(r) requires an issuer to disclose in its annual or quarterly reports, as applicable, whether it or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or with designated natural persons or entities involved in terrorism or the proliferation of weapons of mass destruction. Disclosure is required even where the activities, transactions or dealings are conducted outside the U.S. by non-U.S. affiliates in compliance with applicable law, and whether or not the activities are sanctionable under U.S. law.As of the date of this report, we are not aware of any activity, transaction or dealing by us or any of our affiliates for the year ended December 31, 2022, that requires disclosure in this report under Section 13(r) of the Exchange Act, except as set forth below with respect to affiliates that we do not control and that are our affiliates solely due to their common control with either DT or SoftBank. We have relied upon DT and SoftBank for information regarding their respective activities, transactions and dealings.DT, through certain of its non-U.S. subsidiaries, is party to roaming and interconnect agreements with the following mobile and fixed line telecommunication providers in Iran, some of which are or may be government-controlled entities: Telecommunication Kish Company, Mobile Telecommunication Company of Iran, and Telecommunication Infrastructure Company of Iran. In addition, during the year ended December 31, 2022, DT, through certain of its non-U.S. subsidiaries, provided basic telecommunications services to four customers in Germany identified on the Specially Designated Nationals and Blocked Persons List maintained by the U.S. Department of Treasury’s Office of Foreign Assets Control: Bank Melli, Europäisch-Iranische Handelsbank, CPG Engineering & Commercial Services GmbH and Golgohar Trade and Technology GmbH. These services have been terminated or are in the process of being terminated. For the year ended December 31, 2022, gross revenues of all DT affiliates generated by roaming and interconnection traffic and telecommunications services with the Iranian parties identified herein were less than $0.1 million, and the estimated net profits were less than $0.1 million.In addition, DT, through certain of its non-U.S. subsidiaries that operate a fixed-line network in their respective European home countries (in particular Germany), provides telecommunications services in the ordinary course of business to the Embassy of Iran in those European countries. Gross revenues and net profits recorded from these activities for the year ended, were less than $0.1 million. We understand that DT intends to continue these activities.Separately, SoftBank, through one of its non-U.S. subsidiaries, provides roaming services in Iran through Irancell Telecommunications Services Company. During the year ended December 31, 2022, SoftBank had no gross revenues from such services and no net profit was generated. We understand that the SoftBank subsidiary intends to continue such services. This subsidiary also provides telecommunications services in the ordinary course of business to accounts affiliated with the Embassy of Iran in Japan. During the year ended December 31, 2022, SoftBank estimates that gross revenues and net profit generated by such services were both under $0.1 million. We understand that the SoftBank subsidiary is obligated under contract and intends to continue such services.In addition, SoftBank, through one of its non-U.S. indirect subsidiaries, provides office supplies to the Embassy of Iran in Japan. SoftBank estimates that gross revenue and net profit generated by such services during the year ended December 31, 2022, were both under $0.1 million. We understand that the SoftBank subsidiary intends to continue such activities.48Table of ContentsCritical Accounting EstimatesOur significant accounting policies are fundamental to understanding our results of operations and financial condition as they require that we use estimates and assumptions that may affect the value of our assets or liabilities and financial results. See Note 1 – Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements for further information.Two of these policies, discussed below, relate to critical estimates because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. Actual results could differ from those estimates.Management and the Audit Committee of the Board of Directors have reviewed and approved the accounting policies associated with these critical estimates.DepreciationOur property and equipment balance represents a significant component of our consolidated assets. We record property and equipment at cost, and we generally depreciate property and equipment on a straight-line basis over the estimated useful life of the assets. If all other factors were to remain unchanged, we expect that a one-year increase in the useful lives of our in-service property and equipment, exclusive of leased devices, would have resulted in a decrease of approximately $3.1 billion in our 2022 depreciation expense and that a one-year decrease in the useful life would have resulted in an increase of approximately $4.0 billion in our 2022 depreciation expense.See Note 1 – Summary of Significant Accounting Policies and Note 5 – Property and Equipment of the Notes to the Consolidated Financial Statements for information regarding depreciation of assets, including management’s underlying estimates of useful lives.Income TaxesDeferred tax assets and liabilities are recognized based on temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates expected to be in effect when these differences are realized. A valuation allowance is recorded when it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of a deferred tax asset depends on the ability to generate sufficient taxable income of the appropriate character and in the appropriate taxing jurisdictions within the carryforward periods available.We account for uncertainty in income taxes recognized in the financial statements in accordance with the accounting guidance for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We assess whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position and adjust the unrecognized tax benefits in light of changes in facts and circumstances, such as changes in tax law, interactions with taxing authorities and developments in case law.The income tax laws of the jurisdictions in which we operate are complex and subject to different interpretations by management and the relevant government taxing authorities. In establishing a provision for income tax expense, we must make judgments about the application of these inherently complex tax laws. We must also make estimates about when in the future certain items will affect taxable income in the various tax jurisdictions. Our interpretations may be subjected to review during examination by taxing authorities and disputes may arise over the respective tax positions. We attempt to resolve these disputes during the tax examination and audit process and ultimately through the court system when applicable. We monitor relevant tax authorities and revise our estimate of accrued income taxes due to changes in income tax laws and their interpretation by the courts and regulatory authorities on a quarterly basis. Revisions of our estimate of accrued income taxes also may result from our own income tax planning and from the resolution of income tax controversies. Such revisions in our estimates may be material to our Income tax expense for any given quarter. Accounting Pronouncements Not Yet AdoptedFor information regarding recently issued accounting standards, see Note 1 – Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements.49Table of ContentsItem 7A. Quantitative and Qualitative Disclosures About Market RiskWe are exposed to economic risks in the normal course of business, primarily from changes in interest rates, including changes in investment yields and changes in spreads due to credit risk and other factors. These risks, along with other business risks, impact our cost of capital. Our policy is to manage exposure related to fluctuations in interest rates in order to manage capital costs, control financial risks and maintain financial flexibility over the long term. We have established interest rate risk limits that are closely monitored by measuring interest rate sensitivities of our debt portfolio. We do not foresee significant changes in the strategies used to manage market risk in the near future.Certain potential sources of financing available to us, including our Revolving Credit Facility, bear interest that is indexed to a benchmark rate plus a fixed margin. As of December 31, 2022, we did not have outstanding balances under these facilities. See Note 8 – Debt of the Notes to the Consolidated Financial Statements for additional information.50Index for Notes to the Consolidated Financial Statements
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion of the Company's financial condition and results of operations should be read together with the Company’s consolidated financial statements and notes to those financial statements included elsewhere in this document. When used herein, the terms “the Company,” "Tapestry," “we,” “us” and “our” refer to Tapestry, Inc., including consolidated subsidiaries. References to "Coach," "Stuart Weitzman," "Kate Spade" or "kate spade new york" refer only to the referenced brand.INTRODUCTIONManagement’s discussion and analysis of financial condition and results of operations (“MD&A”) is provided as a supplement to the accompanying consolidated financial statements and notes thereto to help provide an understanding of our results of operations, financial condition, and liquidity. MD&A is organized as follows:•Overview. This section provides a general description of the business and brands as well as the Company’s growth strategy.•Global Economic Conditions and Industry Trends. This section includes a discussion on global economic conditions and industry trends that affect comparability that are important in understanding results of operations and financial conditions, and in anticipating future trends.•Results of operations. An analysis of our results of operations in fiscal 2023 compared to fiscal 2022.•Non-GAAP measures. This section includes non-GAAP measures that are useful to investors and others in evaluating the Company’s ongoing operating and financial results in a manner that is consistent with management's evaluation of business performance and understanding how such results compare with the Company’s historical performance.•Financial Condition. This section includes a discussion on liquidity and capital resources including an analysis of changes in cash flow as well as working capital and capital expenditures.•Critical Accounting policies and estimates. This section includes any critical accounting policies or estimates that impact the Company. OVERVIEWThe fiscal year ended July 1, 2023 was a 52-week period, July 2, 2022 was a 52-week period, and July 3, 2021 was a 53-week period.Tapestry, Inc. (the "Company") is a leading New York-based house of iconic accessories and lifestyle brands. Our global house of brands unites the magic of Coach, kate spade new york and Stuart Weitzman. Each of our brands are unique and independent, while sharing a commitment to innovation and authenticity defined by distinctive products and differentiated customer experiences across channels and geographies. We use our collective strengths to move our customers and empower our communities, to make the fashion industry more sustainable, and to build a company that’s equitable, inclusive, and diverse. Individually, our brands are iconic. Together, we can stretch what’s possible.The Company has three reportable segments:•Coach - Includes global sales of primarily Coach brand products to customers through Coach operated stores, including e-commerce sites and concession shop-in-shops, sales to wholesale customers and through independent third-party distributors.•Kate Spade - Includes global sales primarily of kate spade new york brand products to customers through Kate Spade operated stores, including e-commerce sites and concession shop-in-shops, sales to wholesale customers and through independent third-party distributors.•Stuart Weitzman - Includes global sales of Stuart Weitzman brand products primarily through Stuart Weitzman operated stores, sales to wholesale customers, through e-commerce sites and through independent third-party distributors. Each of our brands is unique and independent, while sharing a commitment to innovation and authenticity defined by distinctive products and differentiated customer experiences across channels and geographies. Our success does not depend solely on the performance of a single channel, geographic area or brand. 332025 Growth StrategyBuilding on the success of the strategic growth plan from fiscal 2020 through fiscal 2022 (the “Acceleration Program”), in the first quarter of fiscal 2023, the Company introduced the 2025 growth strategy (“futurespeed”), designed to amplify and extend the competitive advantages of its brands, with a focus on four strategic priorities:•Building Lasting Customer Relationships: The Company’s brands aim to leverage Tapestry’s transformed business model to drive customer lifetime value through a combination of increased customer acquisition, retention and reactivation.•Fueling Fashion Innovation & Product Excellence: The Company aims to drive sustained growth in core handbags and small leathergoods, while accelerating gains in footwear and lifestyle products.•Delivering Compelling Omni-Channel Experiences: The Company aims to extend its omni-channel leadership to meet the customer wherever they shop, delivering growth online and in stores.•Powering Global Growth: The Company aims to support balanced growth across regions, prioritizing North America and China, its largest markets, while capitalizing on opportunities in under-penetrated geographies such as Southeast Asia and Europe.GLOBAL ECONOMIC CONDITIONS AND INDUSTRY TRENDSThe environment in which we operate is subject to a number of different factors driving global consumer spending. Consumer preferences, macroeconomic conditions, foreign currency fluctuations and geopolitical events continue to impact overall levels of consumer travel and spending on discretionary items, with inconsistent patterns across channels and geographies.We will continue to monitor the below trends and evaluate and adjust our operating strategies and cost management opportunities to mitigate the related impact on our results of operations, while remaining focused on the long-term growth of our business and protecting the value of our brands.Furthermore, refer to Part I, Item 1 - "Business" for additional discussion on our expected store openings and closures within each of our segments. For a detailed discussion of significant risk factors that have the potential to cause our actual results to differ materially from our expectations, see Part I, Item 1A. "Risk Factors".Current Macroeconomic Conditions and OutlookDuring fiscal 2023, the macroeconomic environment remained challenging and volatile. Several organizations that monitor the world’s economy, including the International Monetary Fund, continue to forecast growth in the global economy. Some of these organizations have recently revised the forecast slightly upwards since the third quarter of fiscal 2023. Nevertheless, the updated forecast is still below the historical average, which is reflective of the current volatile environment, including higher than anticipated inflation, tighter monetary and fiscal policies aiming to lower inflation, financial market volatility, and the negative economic impacts due to the crisis in Ukraine. The World Health Organization (“WHO”) announced in May 2023 that it no longer considered Covid-19 to be a global health emergency. Supply chains have largely recovered, and shipping costs and delivery times are back to pre-pandemic levels. In fiscal 2023, the U.S. Dollar has appreciated as compared to foreign currencies in regions where we conduct our business. During fiscal 2023, this trend has resulted in adverse impacts to our business as compared to prior year, including, but not limited to, decreased Net sales of $217.5 million, negative impact to gross margin of approximately 90 basis points, and negative impact to operating margin of approximately 120 basis point.Currency volatility, political instability and potential changes to trade agreements or duty rates may also contribute to a worsening of the macroeconomic environment or adversely impact our business. Since fiscal 2019, the U.S. and China have both imposed tariffs on the importation of certain product categories into the respective country, with limited progress in negotiations to reduce or remove the tariffs.In response to the current environment, the Company continues to take strategic actions considering near-term exigencies and remains committed to maintaining the health of the brands and business. 34Covid-19 PandemicThe Covid-19 pandemic has resulted in varying degrees of business disruption for the Company since it began in fiscal 2020 and has impacted all regions around the world, resulting in restrictions and shutdowns implemented by national, state, and local authorities. Such disruptions continued during the first half of fiscal 2023, and the Company's results in Greater China were adversely impacted as a result of the Covid-19 pandemic. Starting in December 2022, certain government restrictions were lifted in the region and business trends have improved. Although the impact of the Covid-19 pandemic during fiscal 2023 has generally been less significant than those experienced in fiscal years 2021 and 2022, we cannot predict for how long and to what extent the Covid-19 pandemic may continue to impact our business, financial condition, and results of operations. We continue to monitor the latest developments regarding the Covid-19 pandemic and potential impacts on our business, operating results and outlook. Refer to Part I, Item 1A. "Risk Factors" for additional discussion regarding risks to our business associated with the Covid-19 pandemic. Supply Chain and Logistics Challenges Covid-19 has and may cause disruptions in the Company’s supply chain within our third-party manufacturers and logistics providers. During fiscal 2022, certain of the Company’s third-party manufacturers, primarily located in Vietnam, experienced ongoing and longer-than-expected government mandated restrictions, which resulted in a significant decrease in production capacity for these third-party manufacturers. In response, the Company took deliberate actions such as shifting production to other countries, adjusting its merchandising strategies, where possible, and increasing the use of air freight to expedite delivery. Based on these actions and improved production levels, the Company has and expects that it will continue to be able to meet anticipated levels of demand. The Company has experienced other global logistical challenges, such as delays as a result of port congestion, vessel availability, container shortages for imported products and rising freight costs.During fiscal 2023, freight costs on inbound shipments have started to moderate and the Company has significantly reduced the use of air freight when compared to fiscal 2022. As a result, during fiscal 2023, the Company incurred lower freight expense of $84.8 million when compared to the prior year, positively impacting gross margin by approximately 140 basis points.Generalized System of Preferences (“GSP”) programThe Company has historically benefited from duty-free imports on certain products from certain countries pursuant to the U.S. Generalized System of Preferences (“GSP”) program. The GSP program expired in the third quarter of fiscal 2021, resulting in additional duties and negatively impacting gross profit.Crisis in UkraineIn the third quarter of fiscal 2022, a humanitarian crisis unfolded in Ukraine, which has created significant economic uncertainty in the region. The Company does not have directly operated stores in Russia or Ukraine and has a minimal distributor and wholesale business which was less than 0.1% of the Company’s total Net sales for fiscal 2023 and fiscal 2022. Starting in the third quarter of fiscal 2022 the Company paused all wholesale shipments to Russia. The Company's total business in Europe represented less than 5% of fiscal 2023 and fiscal 2022 total Net sales.Tax LegislationOver the past year, there has been significant discussion with regards to tax legislation by both the Biden Administration and the Organization for Economic Cooperation and Development (“OECD”). On August 16, 2022, the Inflation Reduction Act of 2022 was signed into law by the Biden Administration, with tax provisions primarily focused on implementing a 15% corporate alternative minimum tax on global adjusted financial statement income ("CAMT") and a 1% excise tax on share repurchases. On December 12, 2022, the European Union member states also reached agreement to implement the OECD’s reform of international taxation known as Pillar Two Global Anti-Base Erosion ("GloBE") Rules, which broadly mirror the Inflation Reduction Act by imposing a 15% global minimum tax on multinational companies. The CAMT and GloBE are anticipated to be effective beginning in fiscal 2024 and fiscal 2025, respectively. The US Treasury and the OECD continue to seek input and release guidance on the CAMT and GloBE legislation and how the two will interact, so it is unclear at this time what, if any, impact either will have on the Company’s tax rate and financial results. We will continue to evaluate their impact as further information becomes available. With respect to the 1% excise tax on net share repurchases, this provision of the Inflation Reduction Act was effective on January 1, 2023 and did not have a material impact on our financial statements. This excise tax is recorded in Retained earnings as part of Stockholders' Equity.35 RESULTS OF OPERATIONSFISCAL 2023 COMPARED TO FISCAL 2022 The following table summarizes results of operations for fiscal 2023 compared to fiscal 2022. All percentages shown in the tables below and the related discussion that follows have been calculated using unrounded numbers. Fiscal Year EndedJuly 1, 2023July 2, 2022Variance (millions, except per share data) Amount% ofnet salesAmount% ofnet salesAmount%Net sales$6,660.9 100.0 %$6,684.5 100.0 %$(23.6)(0.4)%Gross profit4,714.9 70.8 4,650.4 69.6 64.5 1.4 SG&A expenses3,542.5 53.1 3,474.6 52.0 67.9 2.0 Operating income (loss)1,172.4 17.6 1,175.8 17.6 (3.4)(0.3)Loss on extinguishment of debt— — 53.7 0.8 (53.7)NMInterest expense, net27.6 0.4 58.7 0.9 (31.1)(53.0)Other expense (income)1.7 — 16.4 0.2 (14.7)(89.5)Income (Loss) before provision for income taxes1,143.1 17.2 1,047.0 15.7 96.1 9.2 Provision for income taxes207.1 3.1 190.7 2.9 16.4 8.6Net income (loss)936.0 14.1 856.3 12.8 79.7 9.3 Net income (loss) per share: Basic$3.96 $3.24 $0.72 22.2 Diluted$3.88 $3.17 $0.71 22.3 NM - Not meaningfulGAAP to Non-GAAP ReconciliationThe Company’s reported results are presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”). There were no charges affecting comparability during fiscal 2023. The reported results during fiscal 2022 reflect certain items which affect the comparability of our results, as noted in the following tables. Refer to "Non-GAAP Measures" herein for further discussion on the Non-GAAP measures.36Fiscal 2022 ItemsFiscal Year Ended July 2, 2022Items affecting comparability GAAP Basis(As Reported)Acceleration ProgramDebt ExtinguishmentNon-GAAP Basis(Excluding Items)(millions, except per share data) Coach3,553.8 — — 3,553.8 Kate Spade912.0 — — 912.0 Stuart Weitzman184.6 — — 184.6 Gross profit$4,650.4 $— $— $4,650.4 Coach2,079.9 6.7 — 2,073.2 Kate Spade754.6 5.9 — 748.7 Stuart Weitzman182.8 3.6 — 179.2 Corporate457.3 26.6 — 430.7 SG&A expenses$3,474.6 $42.8 $— $3,431.8 Coach1,473.9 (6.7)— 1,480.6 Kate Spade157.4 (5.9)— 163.3 Stuart Weitzman1.8 (3.6)— 5.4 Corporate(457.3)(26.6)— (430.7)Operating income (loss)$1,175.8 $(42.8)$— $1,218.6 Loss on extinguishment of debt53.7 — 53.7 — Provision for income taxes190.7 (3.4)(12.9)207.0 Net income (loss)$856.3 $(39.4)$(40.8)$936.5 Net income (loss) per diluted common share$3.17 $(0.15)$(0.15)$3.47 In fiscal 2022 the Company incurred adjustments as follows:•Debt Extinguishment - Debt extinguishment charges relate to the premiums, amortization and fees associated with the $500 million cash tender of the Company's 2027 Senior Notes and 2025 Senior Notes in the second quarter of fiscal 2022. Refer to Note 12, "Debt," for further information.•Acceleration Program - Total charges incurred under the Acceleration Program are primarily share-based compensation and professional fees incurred as a result of the development and execution of the Company's comprehensive strategic initiative. Refer to the "Executive Overview" herein and Note 5, "Restructuring Activities," for further information.These actions taken together increased the Company's SG&A expenses by $42.8 million, increased Loss on extinguishment of debt by $53.7 million and decreased Provision for income taxes by 16.3 million, negatively impacting net income by 80.2 million, or 0.30 per diluted share. 37Tapestry, Inc. Summary - Fiscal 2023Currency Fluctuation EffectsThe change in net sales and gross margin in fiscal 2023 compared to fiscal 2022 has been presented both including and excluding currency fluctuation effects. All percentages shown in the tables below and the discussion that follows have been calculated using unrounded numbers.Net SalesFiscal Year EndedVarianceJuly 1, 2023July 2, 2022Amount%Constant Currency Change(millions)Coach$4,960.4 $4,921.3 $39.1 0.8 %4.5 %Kate Spade1,418.9 1,445.5 (26.6)(1.8)0.2 Stuart Weitzman 281.6 317.7 (36.1)(11.4)(9.1)Total Tapestry$6,660.9 $6,684.5 $(23.6)(0.4)2.9 Net sales in fiscal 2023 decreased 0.4% or $23.6 million to $6.66 billion. Excluding the impact of foreign currency, net sales increased by 2.9% or $193.9 million.•Coach Net Sales increased 0.8% or $39.1 million to $4.96 billion in fiscal 2023. Excluding the impact of foreign currency, net sales increased 4.5% or $219.9 million. This increase in net sales was primarily due to an increase of $161.3 million in net retail sales driven by an increase of store sales globally, partially offset by a decrease in e-commerce sales. The increase in net sales was also attributed to a $30.5 million increase in wholesale sales.•Kate Spade Net Sales decreased 1.8% or $26.6 million to $1.42 billion in fiscal 2023. Excluding the impact of foreign currency, net sales increased 0.2% or $3.0 million. This increase in net sales was primarily due to an increase of $2.4 million in net retail sales driven by higher store sales globally, partially offset by a decrease in e-commerce sales. •Stuart Weitzman Net Sales decreased by 11.4% or $36.1 million to $281.6 million in fiscal 2023. Excluding the impact of foreign currency, net sales decreased 9.1% or $29.0 million. This decrease in net sales was primarily due to a decrease of $15.3 million in net retail sales driven by a decrease in stores globally, partially offset by a increase in e-commerce sales. This decrease in net sales was also attributed to a $13.7 million decrease in wholesale sales.Gross ProfitFiscal Year EndedJuly 1, 2023July 2, 2022Variance(millions)Amount% of Net SalesAmount% of Net SalesAmount%Coach$3,647.1 73.5 %$3,553.8 72.2 %$93.3 2.6 %Kate Spade900.1 63.4 912.0 63.1 (11.9)(1.3)Stuart Weitzman 167.7 59.6 184.6 58.1 (16.9)(9.1)Tapestry$4,714.9 70.8 $4,650.4 69.6 $64.5 1.4 Gross profit increased 1.4% or $64.5 million to $4.71 billion in fiscal 2023 from $4.65 billion in fiscal 2022. Gross margin increased 120 basis points to 70.8% in fiscal 2023 from 69.6% in fiscal 2022. This increase in Gross margin was primarily attributed to lower freight costs, net pricing improvements and favorable geography mix, partially offset by unfavorable currency translation. Refer to "Current Macroeconomic Conditions and Outlook" and "Supply Chain and Logistics Challenges" herein, for further information.The Company includes inbound product-related transportation costs from our service providers within Cost of sales. The Company, similar to some companies, includes certain transportation-related costs due to our distribution network in SG&A expenses rather than in Cost of sales; for this reason, our gross margins may not be comparable to that of entities that include all costs related to their distribution network in Cost of sales.38Selling, General and Administrative ExpensesFiscal Year EndedJuly 1, 2023July 2, 2022Variance(millions)Amount% of Net SalesAmount% of Net SalesAmount%Coach(1)$2,117.2 42.7 %$2,079.9 42.3 %$37.3 1.8 %Kate Spade(1)785.1 55.3 754.6 52.2 30.5 4.0 Stuart Weitzman(1)174.4 62.0 182.8 57.5 (8.4)(4.6)Corporate(1)(2)465.8 NA457.3 NA8.5 1.9 Tapestry$3,542.5 53.1 $3,474.6 52.0 $67.9 2.0 SG&A expenses increased 2.0% or $67.9 million to $3.54 billion in fiscal 2023 as compared to $3.47 billion in fiscal 2022. As a percentage of net sales, SG&A expenses increased to 53.1% during fiscal 2023 as compared to 52.0% during fiscal 2022. Excluding items affecting comparability of $42.8 million in fiscal 2022, SG&A expenses increased 3.2% or $110.7 million to $3.54 billion from $3.43 billion in fiscal 2022. SG&A as a percentage of net sales increased 180 basis points to 53.1% compared to 51.3% in fiscal 2022. This increase in SG&A as a percentage of net sales was primarily due to higher information technology costs, increased occupancy costs, and higher marketing spend. (1)In fiscal 2022, Coach, Kate Spade, Stuart Weitzman and Corporate incurred charges affecting comparability of $6.7 million, $5.9 million, $3.6 million and $26.6 million respectively. Excluding those items affecting comparability:•Coach: SG&A expenses increased 2.1% or $44.0 million to $2.12 billion from $2.07 billion in fiscal 2022; and SG&A expenses as a percentage of net sales increased to 42.7% in fiscal 2023 from 42.1% in fiscal 2022. •Kate Spade: SG&A expenses increased 4.9% or $36.4 million to $785.1 million from $748.7 million in fiscal 2022; and SG&A expenses as a percentage of net sales increased to 55.3% in fiscal 2023 from 51.8% in fiscal 2022.•Stuart Weitzman: SG&A expenses decreased 2.7% or $4.8 million to $174.4 million from $179.2 million in fiscal 2022; and SG&A expenses as a percentage of net sales increased to 62.0% in fiscal 2023 from 56.4% in fiscal 2022.•Corporate: SG&A expenses increased 8.2% or $35.1 million to $465.8 in fiscal 2023 as compared to $430.7 million in fiscal 2022.(2)Corporate expenses, which are included within SG&A expenses discussed above but are not directly attributable to a reportable segment.Operating Income (Loss)Fiscal Year EndedJuly 1, 2023July 2, 2022Variance(millions)Amount% of Net SalesAmount% of Net SalesAmount%Coach$1,529.9 30.8 %$1,473.9 29.9 %$56.0 3.8 %Kate Spade115.0 8.1 157.4 10.9 (42.4)(27.0)Stuart Weitzman (6.7)(2.4)1.8 0.6 (8.5)NMCorporate(465.8)—(457.3) NA (8.5)(1.9)Tapestry$1,172.4 17.6 $1,175.8 17.6 $(3.4)(0.3)Operating income decreased $3.4 million to $1.17 billion during fiscal 2023 as compared to $1.18 billion in fiscal 2022. Operating margin remained even at 17.6% in fiscal 2023 as compared to 17.6% in fiscal 2022. Excluding items affecting comparability of $42.8 million in fiscal 2022, operating income decreased $46.2 million to $1.17 billion from $1.22 billion in fiscal 2022; and operating margin decreased 60 basis points to 17.6% in fiscal 2023 as compared to 18.2% in fiscal 2022. This decrease in operating margin was primarily attributed to a increase of 180 basis points in SG&A as a percentage of sales partially offset by a 120 basis points increase in gross margin.39•Coach Operating Income increased $56.0 million to $1.53 billion in fiscal 2023, resulting in an operating margin increase of 90 basis points to 30.8%, as compared to $1.47 billion and 29.9%, respectively in fiscal 2022. Excluding items affecting comparability, Coach operating income increased $49.3 million to $1.53 billion from $1.48 billion in fiscal 2022; and operating margin increased 70 basis points to 30.8% in fiscal 2023 as compared to 30.1% in fiscal 2022. This increase in operating margin was primarily attributed to a 130 basis points increase in gross margin, mainly due to lower freight costs and net pricing improvements, partially offset by unfavorable currency translation, and a 60 basis point increase in SG&A expenses as a percentage of net sales, mainly due to higher information technology costs and higher marketing spend, partially offset by a decrease in selling costs. •Kate Spade Operating Income decreased $42.4 million to $115.0 million in fiscal 2023, resulting in an operating margin decrease of 280 basis points to 8.1%, as compared to 157.4 million and 10.9%, respectively in fiscal 2022. Excluding items affecting comparability, Kate Spade operating income decreased $48.3 million to $115.0 million from $163.3 million in fiscal 2022; and operating margin decreased 320 basis points to 8.1% in fiscal 2023 as compared to 11.3% in fiscal 2022. This decrease in operating margin was primarily attributed to a 350 basis points increase in SG&A expenses as a percentage of net sales, partially due to deleverage of expenses on lower net sales. This increase in SG&A expenses as a percentage of net sales was mainly due to an increase in selling and distribution costs, higher information technology costs and increased occupancy costs, partially offset by a 30 basis points increase in gross margin, mainly due to lower freight costs and favorable geography mix, partially offset by unfavorable currency translation, increased promotional activity and unfavorable channel mix.•Stuart Weitzman Operating Loss increased $8.5 million to a loss of $6.7 million in fiscal 2023, resulting in an operating margin decrease of 300 basis points to (2.4)%, as compared to operating income of $1.8 million in fiscal 2022 and operating margin of 0.6%. Excluding items affecting comparability, Stuart Weitzman operating loss increased $12.1 million to an operating loss of $6.7 million from operating income of $5.4 million in fiscal 2022; and operating margin decreased 410 basis points to (2.4)% in fiscal 2023 as compared to 1.7% in fiscal 2022. This decrease in operating margin was primarily attributable to a 560 basis point increase in SG&A expenses as a percentage of net sales, partially due to deleverage of expenses on lower net sales. This increase in SG&A expenses as a percentage of net sales was mainly due to higher marketing spend, increased compensation costs, higher information technology costs and higher depreciation, partially offset by a 150 basis points increase in gross margin, primarily attributed to net pricing improvements and lower freight costs, partially offset by unfavorable currency translation.•Corporate Operating Loss increased (1.9)% or $8.5 million to $465.8 million in fiscal 2023. Excluding items affecting comparability, Corporate operating loss increased $35.1 million to $465.8 million from $430.7 million in fiscal 2022. This increase in operating loss was attributed to an increase in SG&A expenses primarily due to higher information technology costs, higher professional fees, increased compensation costs and increased occupancy costs. Loss on Extinguishment of DebtThere was no loss on extinguishment of debt in fiscal 2023 as compared to $53.7 million in fiscal 2022. This was primarily related to the premiums, amortization and fees associated with the partial tender of the company's 2027 senior notes and 2025 senior notes.Interest Expense, netNet interest expense decreased 53.0% or $31.1 million to $27.6 million in fiscal 2023 as compared to $58.7 million in fiscal 2022. This decrease in Interest expense, net was mainly due to the favorable impact of the net investment hedges, lower bond interest expense on senior notes, as well as higher interest income offset by higher interest on the term loan.Other Expense (Income)Other expense decreased $14.7 million to $1.7 million in fiscal 2023 as compared to an expense of $16.4 million in fiscal 2022. This decrease in other expense was related to a decrease in foreign exchange losses. Provision for Income TaxesThe effective tax rate was 18.1% in fiscal 2023 as compared to 18.2% in fiscal 2022. Excluding items affecting comparability, the effective tax rate was 18.1% in fiscal 2022. Net Income (Loss)Net income increased $79.7 million to a net income of $936.0 million in fiscal 2023 as compared to a net income of $856.3 million in fiscal 2022. Excluding items affecting comparability, net income decreased $0.5 million to $936.0 million in fiscal 2023 from $936.5 million in fiscal 2022. 40Net Income (Loss) per ShareNet income per diluted share was $3.88 in fiscal 2023 as compared to net income per diluted share of $3.17 in fiscal 2022. Excluding items affecting comparability, net income per diluted share increased $0.41 to $3.88 in fiscal 2023 from $3.47 in fiscal 2022, primarily due to higher net income and a decrease in shares outstanding.FISCAL 2022 COMPARED TO FISCAL 2021 The comparison of fiscal 2022 to 2021 has been omitted from this Form 10-K, but can be referenced in our Form 10-K for the fiscal year ended July 2, 2022, filed on August 18, 2022 within Part II. Item 7. "Management's Discussion and Analysis of Financial Conditions and Results of Operations".NON-GAAP MEASURES The Company’s reported results are presented in accordance with GAAP. There were no items affecting comparability during fiscal 2023. The reported SG&A expenses, operating income, loss on extinguishment of debt, provision for income taxes, net income and earnings per diluted share in fiscal 2022 reflect certain items, including Acceleration Program costs and debt extinguishment costs. As a supplement to the Company's reported results, these metrics are also reported on a non-GAAP basis to exclude the impact of these items along with a reconciliation to the most directly comparable GAAP measures.The Company has historically reported comparable store sales, which reflects sales performance at stores that have been open for at least 12 months, and includes sales from e-commerce sites. The Company excludes new stores, including newly acquired locations, from the comparable store base for the first twelve months of operation. The Company excludes closed stores from the calculation. Comparable store sales are not adjusted for store expansions. Due to extensive temporary store closures resulting from the impact of the Covid-19 pandemic, comparable store sales are not reported for the fiscal year ended July 1, 2023 as the Company does not believe this metric is currently meaningful to the readers of its financial statements for this period.These non-GAAP performance measures were used by management to conduct and evaluate its business during its regular review of operating results for the periods affected. Management and the Company’s Board utilized these non-GAAP measures to make decisions about the uses of Company resources, analyze performance between periods, develop internal projections and measure management performance. The Company’s internal management reporting excluded these items. In addition, the human resources committee of the Company’s Board uses these non-GAAP measures when setting and assessing achievement of incentive compensation goals.The Company operates on a global basis and reports financial results in U.S. dollars in accordance with GAAP. Fluctuations in foreign currency exchange rates can affect the amounts reported by the Company in U.S. dollars with respect to its foreign revenues and profit. Accordingly, certain material increases and decreases in operating results for the Company and its segments have been presented both including and excluding currency fluctuation effects. These effects occur from translating foreign-denominated amounts into U.S. dollars and comparing to the same period in the prior fiscal year. Constant currency information compares results between periods as if exchange rates had remained constant period-over-period. The Company calculates constant currency revenue results by translating current period revenue in local currency using the prior year period's currency conversion rate.We believe these non-GAAP measures are useful to investors and others in evaluating the Company’s ongoing operating and financial results in a manner that is consistent with management's evaluation of business performance and understanding how such results compare with the Company’s historical performance. Additionally, we believe presenting certain increases and decreases in constant currency provides a framework for assessing the performance of the Company's business outside the United States and helps investors and analysts understand the effect of significant year-over-year currency fluctuations. We believe excluding these items assists investors and others in developing expectations of future performance.By providing the non-GAAP measures, as a supplement to GAAP information, we believe we are enhancing investors’ understanding of our business and our results of operations. The non-GAAP financial measures are limited in their usefulness and should be considered in addition to, and not in lieu of, GAAP financial measures. Further, these non-GAAP measures may be unique to the Company, as they may be different from non-GAAP measures used by other companies.For a detailed discussion on these non-GAAP measures, see Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations."41FINANCIAL CONDITIONCash Flows - Fiscal 2023 Compared to Fiscal 2022 Fiscal Year EndedJuly 1,2023July 2,2022Change(millions)Net cash provided by (used in) operating activities$975.2 $853.2 $122.0 Net cash provided by (used in) investing activities5.7 (253.6)259.3 Net cash provided by (used in) financing activities(1,035.9)(1,778.1)742.2 Effect of exchange rate changes on cash and cash equivalents(8.7)(39.4)30.7 Net increase (decrease) in cash and cash equivalents$(63.7)$(1,217.9)$1,154.2 The Company’s cash and cash equivalents decreased by $63.7 million in fiscal 2023 compared to a decrease of $1.22 billion in fiscal 2022, as discussed below.Net cash provided by (used in) operating activitiesNet cash provided by operating activities increased $122.0 million primarily due to changes in operating assets and liabilities of $149.9 million and higher net income of $79.7 million, partially offset by lower impact of non-cash adjustments of $107.6 million.The $149.9 million change in our operating asset and liability balances was primarily driven by: •Inventories were a source of cash of $49.9 million in fiscal 2023 as compared to a use of cash of $311.7 million in fiscal 2022, primarily driven by lower in-transits and receipts due to the strategic decision to pull back on receipts as well as normalization of lead times.•Trade accounts receivable were a source of cash of $44.1 million in fiscal 2023 as compared to a use of cash of $96.0 million in fiscal 2022, primarily driven by higher wholesale sales in fiscal 2022 compared to fiscal 2021.•Accounts payable were a use of cash of $98.1 million in fiscal 2023 as compared to a source of cash of $86.4 million in fiscal 2022, primarily driven by lower in-transit inventory and receipts compared to prior year due to the strategic decision to pull back on receipts.•Accrued liabilities were a use of cash of $93.0 million in fiscal 2023 as compared to a use of cash of $16.1 million in fiscal 2022, primarily driven by a decrease in accruals for the Annual Incentive Plan, a decrease in accrued freight and duty, partially offset by an increase in accrued interest due to the net investment hedge and the timing of income tax payments.•Other liabilities were a use of cash of $61.1 million in fiscal 2023 as compared to a use of cash of $9.2 million in fiscal 2022, primarily driven by lower long-term transition tax due to timing of payment schedule. Net cash provided by (used in) investing activitiesNet cash provided by investing activities was $5.7 million in fiscal 2023 compared to a use of cash of $253.6 million in fiscal 2022, resulting in a $259.3 million increase in net cash provided by investing activities. The $5.7 million source of cash in fiscal 2023 is primarily due to proceeds from maturities and sales of investments of $148.0 million, settlement of net investment hedge of $41.9 million, partially offset by capital expenditures of $184.2 million.The $253.6 million use of cash in fiscal 2022 is primarily due to purchases of investments of $540.4 million and capital expenditures of $93.9 million, partially offset by proceeds from maturities and sales of investments of $380.7 million.Net cash provided by (used in) financing activitiesNet cash used in financing activities was $1.04 billion in fiscal 2023 as compared to a use of cash of $1.78 billion in fiscal 2022, resulting in a $742.2 million decrease in net cash used in financing activities.The $1.04 billion use of cash in fiscal 2023 was primarily due to repurchase of common stock of $703.5 million, dividend payments of $283.3 million as well as taxes paid to net settle share-based awards of $55.6 million.The $1.78 billion use of cash in fiscal 2022 was primarily due to repurchase of common stock of $1.60 billion, repayment of debt of $900.0 million, payment of dividends of $264.4 million and the payment of debt extinguishment costs of $50.7 million, partially offset by proceeds from debt, net of discount of $998.5 million.42Cash Flows - Fiscal 2022 Compared to Fiscal 2021 The comparison of fiscal 2022 to 2021 has been omitted from this Form 10-K, but can be referenced in our Form 10-K for the fiscal year ended July 2, 2022, filed on August 18, 2022 within Part II. Item 7. "Management's Discussion and Analysis of Financial Conditions and Results of Operations".Working Capital and Capital ExpendituresAs of July 1, 2023, in addition to our cash flows from operations, our sources of liquidity and capital resources were comprised of the following:Sources of LiquidityOutstanding IndebtednessTotal Available Liquidity(1)(millions)Cash and cash equivalents(1)$726.1 $— $726.1 Short-term investments(1)15.4 — 15.4 Revolving Credit Facility(2)1,250.0 — 1,250.0 Term Loan(2)468.8 468.8 — 3.050% Senior Notes due 2032(3)500.0 500.0 — 4.125% Senior Notes due 2027(3)396.6 396.6 — 4.250% Senior Notes due 2025(3)303.4 303.4 — Total$3,660.3 $1,668.8 $1,991.5 (1) As of July 1, 2023, approximately 47.0% of our Cash and cash equivalents and Short-term investments were held outside the United States. (2) On May 11, 2022, the Company entered into a definitive agreement whereby Bank of America, N.A., as administrative agent, other agents party thereto, and a syndicate of banks and financial institutions have made available to the Company a $1.25 billion revolving credit facility (the "$1.25 Billion Revolving Credit Facility") and an unsecured $500.0 Million Term Loan (the “Term Loan”). Both the $1.25 Billion Revolving Credit Facility and Term Loan (collectively, the “Credit Facilities”) will mature on May 11, 2027. The Company and its subsidiaries must comply on a quarterly basis with a maximum 4.0 to 1.0 ratio of (a) consolidated debt minus unrestricted cash and cash equivalents in excess of $300 million to (b) consolidated EBITDAR.Borrowings under the $1.25 Billion Revolving Credit Facility bear interest at a rate per annum equal to, at the Company’s option, (i) for borrowings in U.S. Dollars, either (a) an alternate base rate or (b) a term secured overnight financing rate, (ii) for borrowings in Euros, the Euro Interbank Offered Rate, (iii) for borrowings in Pounds Sterling, the Sterling Overnight Index Average Reference Rate and (iv) for borrowings in Japanese Yen, the Tokyo Interbank Offer Rate, plus, in each case, an applicable margin. The applicable margin will be adjusted by reference to a grid (the “Pricing Grid”) based on the ratio of (a) consolidated debt to (b) consolidated EBITDAR (the “Gross Leverage Ratio”). Additionally, the Company will pay facility fees, calculated at a rate per annum determined in accordance with the Pricing Grid, on the full amount of the $1.25 Billion Revolving Credit Facility, payable quarterly in arrears, and certain fees with respect to letters of credit that are issued. The $1.25 Billion Revolving Credit Facility may be used to finance the working capital needs, capital expenditures, permitted investments, share purchases, dividends and other general corporate purposes of the Company and its subsidiaries (which may include commercial paper backup). There were no outstanding borrowings on the $1.25 Billion Revolving Credit Facility as of July 1, 2023.The Term Loan includes a two-month delayed draw period from the closing date. On June 14, 2022 the Company drew down on the Term Loan to satisfy the Company’s remaining obligations under the 3.000% senior unsecured notes due 2022 and for general corporate purposes. The Term Loan amortizes in an amount equal to 5.00% per annum, with payments made quarterly. As of July 1, 2023, $25.0 million of the Term Loan is included in Current debt on the Consolidated Balance Sheets. Borrowings under the Term Loan bear interest at a rate per annum equal to, at the Company’s option, either (i) an alternate base rate or (ii) a term secured overnight financing rate plus, in each case, an applicable margin. The applicable margin will be adjusted by reference to a pricing grid based on the Gross Leverage Ratio. Additionally, the Company will pay a ticking fee on the undrawn amount of the Term Loan. Refer to Note 12, "Debt," for further information on our existing debt instruments. 43(3) In December 2021, the Company issued $500.0 million aggregate principal amount of 3.050% senior unsecured notes due March 15, 2032 at 99.705% of par (the "2032 Senior Notes") and completed cash tender offers for $203.4 million and $296.6 million of the outstanding aggregate principal amount under its 2027 Senior Notes and 2025 Senior Notes, respectively. In June 2017, the Company issued $600.0 million aggregate principal amount of 2027 Senior Notes. In March 2015, the Company issued $600.0 million aggregate principal amount of 2025 Senior Notes. Furthermore, the indentures for the 2032 Senior Notes, 2027 Senior Notes, and 2025 Senior Notes contain certain covenants limiting the Company’s ability to: (i) create certain liens, (ii) enter into certain sale and leaseback transactions and (iii) merge, or consolidate or transfer, sell or lease all or substantially all of the Company’s assets. As of July 1, 2023, no known events of default have occurred. Refer to Note 12, "Debt," for further information on our existing debt instruments.We believe that our Revolving Credit Facility is adequately diversified with no undue concentrations in any one financial institution. As of July 1, 2023, there were 14 financial institutions participating in the Revolving Credit Facility and Term Loans, with no one participant maintaining a combined maximum commitment percentage in excess of 14%. We have no reason to believe at this time that the participating institutions will be unable to fulfill their obligations to provide financing in accordance with the terms of the facility in the event we elect to draw funds in the foreseeable future. We have the ability to draw on our credit facilities or access other sources of financing options available to us in the credit and capital markets for, among other things, acquisition or integration-related costs, our restructuring initiatives, settlement of a material contingency, or a material adverse business or macroeconomic development, as well as for other general corporate business purposes. Management believes that cash flows from operations, access to the credit and capital markets and our credit lines, on-hand cash and cash equivalents and our investments will provide adequate funds to support our operating, capital, and debt service requirements for fiscal 2023 and beyond. There can be no assurance that any such capital will be available to the Company on acceptable terms or at all. Our ability to fund working capital needs, planned capital expenditures, and scheduled debt payments, as well as to comply with all of the financial covenants under our debt agreements, depends on future operating performance and cash flow. This future operating performance and cash flow are subject to prevailing economic conditions, and to financial, business and other factors, some of which are beyond the Company's control.To improve our working capital efficiency, we make available to certain suppliers a voluntary supply chain finance (“SCF”) program that enables our suppliers to sell their receivables from the Company to a global financial institution on a non-recourse basis at a rate that leverages our credit rating. We do not have the ability to refinance or modify payment terms to the global financial institution through the SCF program. No guarantees are provided by the Company or any of our subsidiaries under the SCF program.Total capital expenditures and cloud computing implementation costs were $260.8 million in fiscal 2023 as the Company continues to prioritize investing in digital capabilities. Certain cloud computing implementation costs are recognized within Prepaid expenses and Other assets on the Consolidated Balance Sheets. SeasonalityThe Company's results are typically affected by seasonal trends. During the first fiscal quarter, we typically build inventory for the winter and holiday season. In the second fiscal quarter, working capital requirements are reduced substantially as we generate higher net sales and operating income, especially during the holiday season. Fluctuations in net sales, operating income and operating cash flows of the Company in any fiscal quarter may be affected by the timing of wholesale shipments and other events affecting retail sales, including weather and macroeconomic events, and pandemics such as Covid-19.Stock Repurchase PlanOn May 12, 2022, the Company announced the Board of Directors authorized the additional repurchase of up to $1.50 billion of its common stock (the "2022 Share Repurchase Program"). Pursuant to this program, purchases of the Company's common stock will be made subject to market conditions and at prevailing market prices, through open market purchases. Repurchased shares of common stock will become authorized but unissued shares. These shares may be issued in the future for general corporate and other purposes. In addition, the Company may terminate or limit the stock repurchase program at any time. As of July 1, 2023 the Company had $800 million of additional shares available to be repurchased as authorized under the 2022 Share Repurchase Program. Refer to Part II, Item 5. "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities," for further information. During fiscal 2023, the Company repurchased $700 million worth of shares.44Contractual and Other ObligationsFirm CommitmentsAs of July 1, 2023, the Company's contractual obligations are as follows:TotalFiscal2024Fiscal2025 – 2026Fiscal2027 – 2028Fiscal 2029and Beyond(millions)Capital expenditure & cloud computing implementation commitments$20.4 $16.9 $3.5 $— $— Inventory purchase obligations352.6 352.6 — — — Operating lease obligations1,947.6 376.7 536.1 348.3 686.5 Finance lease obligations2.7 1.4 1.3 — — Debt repayment1,668.8 25.0 353.4 790.4 500.0 Interest on outstanding debt(1)345.8 74.0 130.8 80.0 61.0 Mandatory transition tax payments(2)68.3 24.8 43.5 — — Other187.5 102.9 81.7 2.9 — Total$4,593.7 $974.3 $1,150.3 $1,221.6 $1,247.5 (1) Interest on outstanding debt includes fixed interest expenses for unsecured notes and variable interest expenses for the term loan. The estimated interest expenses associated with our term loan is based on the current interest rate as of July 1, 2023. Refer to Note 12, "Debt," for further information. (2) Mandatory transition tax payments represent our tax obligation incurred in connection with the deemed repatriation of previously deferred foreign earnings pursuant to the Tax Legislation. Refer to Note 15, "Income Taxes," for further information.We expect to fund these firm commitments with operating cash flows generated in the normal course of business and, if necessary, through availability under our credit facilities or other accessible sources of financing. Excluded from the above contractual obligations table is the non-current liability for unrecognized tax benefits of $100.6 million as of July 1, 2023, as we cannot make a reliable estimate of the period in which the liability will be settled, if ever. Besides the firm commitments noted above, the above table excludes other amounts included in current liabilities in the Consolidated Balance Sheets at July 1, 2023 as these items will be paid within one year and certain long-term liabilities not requiring cash payments. Capri Holdings Limited AcquisitionOn August 10, 2023, the Company entered into an Agreement and Plan of Merger by and among the Company, Sunrise Merger Sub, Inc., a direct wholly owned subsidiary of Tapestry, and Capri Holdings Limited. Refer to Note 21, "Subsequent Event," herein for further information.The Company intends to fund the acquisition through a combination of senior notes, term loans and excess Tapestry cash. Furthermore, on August 10, 2023, the Company entered into a bridge facility commitment letter pursuant to which Bank of America, N.A., BofA Securities, Inc. and Morgan Stanley Senior Funding, Inc. committed to provide up to $8.0 billion under a 364-day senior unsecured bridge loan facility to finance the acquisition.Off-Balance Sheet ArrangementsIn addition to the commitments included in the table above, we have outstanding letters of credit, surety bonds and bank guarantees of $37.1 million as of July 1, 2023, primarily serving to collateralize our obligation to third parties for duty, leases, insurance claims and materials used in product manufacturing. These letters of credit expire at various dates through calendar 2028. We do not maintain any other off-balance sheet arrangements, transactions, obligations, or other relationships with unconsolidated entities that would be expected to have a material current or future effect on our consolidated financial statements. Refer to Note 13, "Commitments and Contingencies," for further information.45CRITICAL ACCOUNTING POLICIES AND ESTIMATESThe preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect our results of operations, financial condition and cash flows as well as the disclosure of contingent assets and liabilities as of the date of the Company's financial statements. Actual results could differ from estimates in amounts that may be material to the financial statements. Predicting future events is inherently an imprecise activity and, as such, requires the use of judgment. Actual results could differ from estimates in amounts that may be material to the financial statements. The development and selection of the Company’s critical accounting policies and estimates are periodically reviewed with the Audit Committee of the Board.The accounting policies discussed below are considered critical because changes to certain judgments and assumptions inherent in these policies could affect the financial statements. For more information on the Company's accounting policies, please refer to the Notes to Consolidated Financial Statements.Revenue RecognitionRevenue is recognized when the Company satisfies its performance obligations by transferring control of promised products or services to its customers, which may be at a point of time or over time. Control is transferred when the customer obtains the ability to direct the use of and obtain substantially all of the remaining benefits from the products or services. The amount of revenue recognized is the amount of consideration to which the Company expects to be entitled, including estimation of sale terms that may create variability in the consideration. Revenue subject to variability is constrained to an amount which will not result in a significant reversal in future periods when the contingency that creates variability is resolved.Retail store and concession shop-in-shop revenues are recognized at the point-of-sale, when the customer obtains physical possession of the products. Digital revenue from sales of products ordered through the Company’s e-commerce sites is recognized upon delivery and receipt of the shipment by its customers and includes shipping and handling charges paid by customers. Retail and digital revenues are recorded net of estimated returns, which are estimated by developing an expected value based on historical experience. Payment is due at the point of sale.The Company recognizes revenue within the wholesale channel at the time title passes and risk of loss is transferred to customers, which is generally at the point of shipment of products but may occur upon receipt of the shipment by the customer in certain cases. Wholesale revenue is recorded net of estimates for returns, discounts, end-of-season markdowns, cooperative advertising allowances and other consideration provided to the customer. The Company's historical estimates of these variable amounts have not differed materially from actual results. The Company recognizes licensing revenue over time during the contract period in which licensees are granted access to the Company's trademarks. These arrangements require licensees to pay a sales-based royalty and may include a contractually guaranteed minimum royalty amount. Revenue for contractually guaranteed minimum royalty amounts is recognized ratably over the license year and any excess sales-based royalties are recognized as earned once the minimum royalty threshold is achieved.At July 1, 2023, a 10% change in the allowances for estimated uncollectible accounts, markdowns and returns would not have resulted in a material change in the Company's reserves and net sales.InventoriesThe Company holds inventory that is sold through retail and wholesale distribution channels, including e-commerce sites. Substantially all of the Company's inventories are comprised of finished goods, and are reported at the lower of cost or net realizable value. Inventory costs include material, conversion costs, freight and duties and are primarily determined on a weighted-average cost basis. The Company reserves for inventory, including slow-moving and aged inventory, based on current product demand, expected future demand and historical experience. A decrease in product demand due to changing customer tastes, buying patterns or increased competition could impact the Company's evaluation of its inventory and additional reserves might be required. Estimates may differ from actual results due to the quantity, quality and mix of products in inventory, consumer and retailer preferences and market conditions. At July 1, 2023, a 10% change in the inventory reserve, would not have resulted in material change in inventory and cost of sales.46Goodwill and Other Intangible AssetsUpon acquisition, the Company estimates and records the fair value of purchased intangible assets, which primarily consists of brands, customer relationships, right-of-use assets and order backlog. Goodwill and certain other intangible assets deemed to have indefinite useful lives, including brand intangible assets, are not amortized, but are assessed for impairment at least annually. Finite-lived intangible assets are amortized over their respective estimated useful lives and, along with other long-lived assets as noted above, are evaluated for impairment periodically whenever events or changes in circumstances indicate that their related carrying values may not be fully recoverable. Estimates of fair value for finite-lived and indefinite-lived intangible assets are primarily determined using discounted cash flows and the multi-period excess earnings method, respectively, with consideration of market comparisons as appropriate. This approach uses significant estimates and assumptions, including projected future cash flows, discount rates and growth rates.The Company generally performs its annual goodwill and indefinite-lived intangible assets impairment analysis using a quantitative approach. The quantitative goodwill impairment test identifies the existence of potential impairment by comparing the fair value of each reporting unit with its carrying value, including goodwill. If the fair value of a reporting unit exceeds its carrying value, the reporting unit's goodwill is considered not to be impaired. If the carrying value of a reporting unit exceeds its fair value, an impairment charge is recognized in an amount equal to that excess. The impairment charge recognized is limited to the amount of goodwill allocated to that reporting unit.Determination of the fair value of a reporting unit and intangible asset is based on management's assessment, considering independent third-party appraisals when necessary. Furthermore, this determination is judgmental in nature and often involves the use of significant estimates and assumptions, which may include projected future cash flows, discount rates, growth rates, and determination of appropriate market comparables and recent transactions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and the amount of any such charge. The Company performs its annual impairment assessment of goodwill as well as brand intangibles at the beginning of the fourth quarter of each fiscal year. The Company determined that there was no impairment in fiscal 2023, fiscal 2022 and fiscal 2021. Based on the annual assessment in fiscal 2023, the fair values of our Coach brand reporting units significantly exceeded their respective carrying values. The fair values of the Kate Spade brand reporting unit and indefinite-lived brand as of the fiscal 2023 testing date exceeded their carrying values by approximately 20% and 40%, respectively. Several factors could impact the Kate Spade brand's ability to achieve expected future cash flows, including the optimization of the store fleet productivity, the success of international expansion strategies, the impact of promotional activity, continued economic volatility and potential operational challenges related to the macroeconomic factors, the reception of new collections in all channels, and other initiatives aimed at increasing profitability of the business. Given the relatively small excess of fair value over carrying value as noted above, if profitability trends decline during fiscal 2024 from those that are expected, it is possible that an interim test, or our annual impairment test, could result in an impairment of these assets. Valuation of Long-Lived AssetsLong-lived assets, such as property and equipment, are evaluated for impairment whenever events or circumstances indicate that the carrying value of the assets may not be recoverable. In evaluating long-lived assets for recoverability, the Company uses its best estimate of future cash flows expected to result from the use of the related asset group and its eventual disposition. To the extent that estimated future undiscounted net cash flows attributable to the asset are less than its carrying value, an impairment loss is recognized equal to the difference between the carrying value of such asset and its fair value, considering external market participant assumptions.In determining future cash flows, the Company takes various factors into account, including the effects of macroeconomic trends such as consumer spending, in-store capital investments, promotional cadence, the level of advertising and changes in merchandising strategy. Since the determination of future cash flows is an estimate of future performance, there may be future impairments in the event that future cash flows do not meet expectations.47Share-Based CompensationThe Company recognizes the cost of equity awards to employees and the non-employee Directors based on the grant-date fair value of those awards. The grant-date fair values of share unit awards are based on the fair value of the Company's common stock on the date of grant. The grant-date fair value of stock option awards is determined using the Black-Scholes option pricing model and involves several assumptions, including the expected term of the option, expected volatility and dividend yield. The expected term of options represents the period of time that the options granted are expected to be outstanding and is based on historical experience. Expected volatility is based on historical volatility of the Company’s stock as well as the implied volatility from publicly traded options on the Company's stock. Dividend yield is based on the current expected annual dividend per share and the Company’s stock price. Changes in the assumptions used to determine the Black-Scholes value could result in significant changes in the Black-Scholes value. For stock options and share unit awards, the Company recognizes share-based compensation net of estimated forfeitures and revises the estimates in subsequent periods if actual forfeitures differ from the estimates. The Company estimates the forfeiture rate based on historical experience as well as expected future behavior.The Company grants performance-based share awards to key executives, the vesting of which is subject to the executive’s continuing employment and the Company's or individual's achievement of certain performance goals. On a quarterly basis, the Company assesses actual performance versus the predetermined performance goals, and adjusts the share-based compensation expense to reflect the relative performance achievement. Actual distributed shares are calculated upon conclusion of the service and performance periods, and include dividend equivalent shares. If the performance-based award incorporates a market condition, the grant-date fair value of such award is determined using a pricing model, such as a Monte Carlo Simulation.A hypothetical 10% change in our stock-based compensation expense would not have a material impact to our fiscal 2023 net income. Income TaxesThe Company’s effective tax rate is based on pre-tax income, statutory tax rates, tax laws and regulations, and tax planning strategies available in the various jurisdictions in which the Company operates. The Company classifies interest and penalties on uncertain tax positions in the Provision for income taxes. The Company records net deferred tax assets to the extent it believes that it is more likely than not that these assets will be realized. In making such determination, the Company considers all available evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent and expected future results of operation. The Company reduces deferred tax assets by a valuation allowance if, based upon the weight of available evidence, it is more likely than not that some amount of deferred tax assets is not expected to be realized. The Company is not permanently reinvested with respect to earnings of a limited number of foreign entities and has recorded the tax consequences of remitting earnings from these entities. The Company is permanently reinvested with respect to all other earnings. The Company recognizes the impact of tax positions in the financial statements if those positions will more likely than not be sustained on audit, based on the technical merits of the position. Although the Company believes that the estimates and assumptions used are reasonable and legally supportable, the final determination of tax audits could be different than that which is reflected in historical tax provisions and recorded assets and liabilities. Tax authorities periodically audit the Company’s income tax returns and the tax authorities may take a contrary position that could result in a significant impact on the Company's results of operations. Significant management judgment is required in determining the effective tax rate, in evaluating tax positions and in determining the net realizable value of deferred tax assets.Refer to Note 15, “Income Taxes,” for further information.Recent Accounting PronouncementsRefer to Note 3, "Significant Accounting Policies," to the accompanying audited consolidated financial statements for a description of certain recently adopted, issued or proposed accounting standards which may impact our consolidated financial statements in future reporting periods.48ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKMarket RiskThe market risk inherent in our financial instruments represents the potential loss in fair value, earnings or cash flows, arising from adverse changes in foreign currency exchange rates or interest rates. The Company manages these exposures through operating and financing activities and, when appropriate, through the use of derivative financial instruments. The use of derivative financial instruments is in accordance with the Company's risk management policies, and we do not enter into derivative transactions for speculative or trading purposes.The quantitative disclosures in the following discussion are based on quoted market prices obtained through independent pricing sources for the same or similar types of financial instruments, taking into consideration the underlying terms and maturities and theoretical pricing models. These quantitative disclosures do not represent the maximum possible loss or any expected loss that may occur, since actual results may differ from those estimates.Foreign Currency Exchange Rate RiskForeign currency exposures arise from transactions, including firm commitments and anticipated contracts, denominated in a currency other than the entity’s functional currency, and from foreign-denominated revenues and expenses translated into U.S. dollars. The majority of the Company's purchases and sales involving international parties, excluding international consumer sales, are denominated in U.S. dollars and, therefore, our foreign currency exchange risk is limited. The Company is exposed to risk from foreign currency exchange rate fluctuations resulting from its operating subsidiaries’ transactions denominated in foreign currencies. To mitigate such risk, certain subsidiaries enter into forward currency contracts. As of July 1, 2023 and July 2, 2022, forward currency contracts designated as cash flow hedges with a notional amount of $842.3 million and $41.5 million, respectively, were outstanding. As a result of the use of derivative instruments, we are exposed to the risk that counterparties to the derivative instruments will fail to meet their contractual obligations. To mitigate the counterparty credit risk, we only enter into derivative contracts with carefully selected financial institutions. The Company also reviews the creditworthiness of our counterparties on a regular basis. As a result of the above considerations, we do not believe that we are exposed to any undue concentration of counterparty credit risk associated with our derivative contracts as of July 1, 2023.The Company is also exposed to transaction risk from foreign currency exchange rate fluctuations with respect to various cross-currency intercompany loans, payables and receivables. This primarily includes exposure to exchange rate fluctuations in the Chinese Renminbi, the British Pound Sterling and the Japanese Yen. To manage the exchange rate risk related to these balances, the Company enters into forward currency contracts. As of July 1, 2023 and July 2, 2022, the total notional values of outstanding forward foreign currency contracts related to these loans, payables and receivables were $272.3 million and $274.1 million, respectively.We perform a sensitivity analysis to determine the effects that market risk exposures may have on the fair values of our forward foreign currency exchange and cross-currency swap contracts. Under the terms of our cross-currency swaps, we will exchange the semi-annual fixed rate payments on United States denominated debt for fixed rate payments of 2.4% to 2.7% in Euros and 0.1% to (0.3)% in Japanese Yen. We assess the risk of loss in the fair values of these contracts that would result from hypothetical changes in foreign currency exchange rates. This analysis assumes a like movement by the foreign currencies in our hedge portfolio against the U.S. Dollar. As of July 1, 2023, a 10% appreciation or depreciation of the U.S. Dollar against the foreign currencies under contract would result in a net increase or decrease, respectively, in the fair value of our derivative portfolio of approximately $185 million. This hypothetical net change in fair value should ultimately be largely offset by the net change in the related underlying hedged items. Refer to Note 10, "Derivative Investments and Hedging Activities," for additional information.Interest Rate RiskThe Company is exposed to interest rate risk in relation to its $1.25 Billion Revolving Credit Facility and $500.0 Million Term Loan entered into under the credit agreement dated May 11, 2022, the Term Loan, the 2032 Senior Notes, 2027 Senior Notes, and 2025 Senior Notes (collectively the "Senior Notes") and investments.49Our exposure to changes in interest rates is primarily attributable to debt outstanding under the $1.25 Billion Revolving Credit Facility and $500.0 Million Term Loan (collectively, the "Credit Facilities"). Borrowings under the $1.25 Billion Revolving Credit Facility bear interest at a rate per annum equal to, at the Company’s option, (i) for borrowings in U.S. Dollars, either (a) an alternate base rate or (b) a term secured overnight financing rate, (ii) for borrowings in Euros, the Euro Interbank Offered Rate, (iii) for borrowings in Pounds Sterling, the Sterling Overnight Index Average Reference Rate and (iv) for borrowings in Japanese Yen, the Tokyo Interbank Offer Rate, plus, in each case, an applicable margin. The applicable margin will be adjusted by reference to a grid (the “Pricing Grid”) based on the ratio of (a) consolidated debt to (b) consolidated EBITDAR (the “Gross Leverage Ratio”). Borrowings under the Term Loan bear interest at a rate per annum equal to, at the Company’s option, either (i) an alternate base rate or (ii) a term secured overnight financing rate plus, in each case, an applicable margin. The applicable margin will be adjusted by reference to a pricing grid based on the Gross Leverage Ratio. Borrowings under the Credit Facilities are subject to interest rate risk due to changes in SOFR. A hypothetical 10% change in the Credit Facilities' interest rates would have resulted in an immaterial change in interest expense in fiscal 2023.The Company is exposed to changes in interest rates related to the fair value of the Senior Notes. At July 1, 2023, the fair value of the 2032 Senior Notes, 2027 Senior Notes and 2025 Senior Notes was approximately $399 million, $372 million and $295 million, respectively. At July 2, 2022, the fair value of the 2032 Senior Notes, 2027 Senior Notes and 2025 Senior Notes was approximately $409 million, $383 million and $304 million, respectively. These fair values are based on external pricing data, including available quoted market prices of these instruments, and consideration of comparable debt instruments with similar interest rates and trading frequency, among other factors, and are classified as Level 2 measurements within the fair value hierarchy. The interest rate payable on the 2027 Senior Notes will be subject to adjustments from time to time if either Moody’s or S&P or a substitute rating agency (as defined in the Prospectus Supplement furnished with the SEC on June 7, 2017) downgrades (or downgrades and subsequently upgrades) the credit rating assigned to the respective Senior Notes of such series.The Company’s investment portfolio is maintained in accordance with the Company’s investment policy, which defines our investment principles including credit quality standards and limits the credit exposure of any single issuer. The primary objective of our investment activities is the preservation of principal while maximizing interest income and minimizing risk. We do not hold any investments for trading purposes.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation 28 Item 7A. Quantitative and Qualitative Disclosures about Market Risk 43
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+ITEM 7. Management’s discussion and analysis of financial condition and results of operationsOverviewWe design and manufacture semiconductors that we sell to electronics designers and manufacturers all over the world. Technology is the foundation of our company, but ultimately, our objective and the best metric for owners to measure our progress is through the growth of free cash flow per share over the long term.Our strategy to maximize long-term free cash flow per share growth has three elements:1.A great business model that is focused on analog and embedded processing products and built around four sustainable competitive advantages. The four sustainable competitive advantages are powerful in combination and provide tangible benefits:(a) A strong foundation of manufacturing and technology that provides lower costs and greater control of our supply chain.(b) A broad portfolio of analog and embedded processing products that offers more opportunity per customer and more value for our investments.(c) The reach of our market channels that gives access to more customers and more of their design projects, leading to the opportunity to sell more of our products into each design and gives us better insight and knowledge of customer needs.(d) Diversity and longevity of our products, markets and customer positions that provide less single point dependency and longer returns on our investments. Together, these competitive advantages help position TI in a unique class of companies capable of generating and returning significant amounts of cash for our owners. We make our investments with an eye towards long-term strengthening and leveraging of these advantages.2.Discipline in allocating capital to the best opportunities. This spans how we select R&D projects, develop new capabilities like TI.com, invest in new manufacturing capacity or how we think about acquisitions and returning cash to our owners.3.Efficiency, which means constantly striving for more output for every dollar spent.We believe that our business model with the combined effect of our four competitive advantages sets TI apart from our peers and will for a long time to come. We will invest to strengthen our competitive advantages, be disciplined in capital allocation and stay diligent in our pursuit of efficiencies. Finally, we will remain focused on the belief that long-term growth of free cash flow per share is the ultimate measure to generate value. Management’s discussion and analysis of financial condition and results of operations (MD&A) should be read in conjunction with the financial statements and the related notes that appear elsewhere in this document. In the following discussion of our results of operations:•Our segments represent groups of similar products that are combined on the basis of similar design and development requirements, product characteristics, manufacturing processes and distribution channels, and how management allocates resources and measures results. See Note 1 to the financial statements for more information regarding our segments.•When we discuss our results:◦Unless otherwise noted, changes in our revenue are attributable to changes in customer demand, which are evidenced by fluctuations in shipment volumes.◦New products do not tend to have a significant impact on our revenue in any given period because we sell such a large number of products.◦From time to time, our revenue and gross profit are affected by changes in demand for higher-priced or lower-priced products, which we refer to as changes in the “mix” of products shipped.17◦Because we own much of our manufacturing capacity, a significant portion of our operating cost is fixed. When factory loadings decrease, our fixed costs are spread over reduced output and, absent other circumstances, our profit margins decrease. Conversely, as factory loadings increase, our fixed costs are spread over increased output and, absent other circumstances, our profit margins increase.•For an explanation of free cash flow, see the Non-GAAP financial information section.•All dollar amounts in the tables are stated in millions of U.S. dollars.Our results of operations provides details of our financial results for 2022 and 2021 and year-to-year comparisons between 2022 and 2021. Discussion of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in “Management’s discussion and analysis of financial condition and results of operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.The coronavirus (COVID-19) pandemic and its effects are impacting and will likely continue to impact market conditions and business operations across industries worldwide, including at TI. Therefore, we remain cautious about how the economy might behave for the next few years and continue to monitor potential impact on our operations.After a sustained period of growth, a market correction began in 2022. As a result, demand for our products weakened, and we expect this to continue into 2023. During this time, we will continue to manage our operating plan and expenses with a steady hand as we focus on long-term investments to strengthen our competitive advantages.Results of operationsOur strategic focus is on analog and embedded processing products. We sell our products into six end markets: industrial, automotive, personal electronics, communications equipment, enterprise systems and other. While all of these end markets represent good opportunities, we place additional strategic emphasis on designing and selling our products into the industrial and automotive markets, which we believe represent the best long-term growth opportunities. Gross margin of 68.8% reflected the quality of our product portfolio, as well as the efficiency of our manufacturing strategy, including the benefit of 300-mm production.Our focus on analog and embedded processing allows us to generate strong cash flow from operations. Our cash flow from operations of $8.72 billion underscored the strength of our business model. Free cash flow was $5.92 billion and represented 29.6% of revenue. During 2022, we invested $3.37 billion in R&D and SG&A, invested $2.80 billion in capital expenditures and returned $7.91 billion to shareholders through dividends and stock repurchases.Details of financial results – 2022 compared with 2021Revenue of $20.03 billion increased $1.68 billion, or 9.2%, due to higher revenue from Analog and, to a lesser extent, Embedded Processing. This increase benefited from higher prices and the mix of products shipped.Gross profit of $13.77 billion was up $1.40 billion, or 11.3%, primarily due to higher revenue. As a percentage of revenue, gross profit increased to 68.8% from 67.5%.Operating expenses (R&D and SG&A) were $3.37 billion compared with $3.22 billion, as a result of increased investments in R&D and inflation.Restructuring charges/other was $257 million compared with $54 million due to integration charges at our Lehi, Utah, manufacturing facility in both periods, which were partially offset by gains on sales of assets in 2021. The charges associated with our Lehi facility transitioned to cost of revenue once production began in December 2022. See Note 11 to the financial statements.Operating profit was $10.14 billion, or 50.6% of revenue, compared with $8.96 billion, or 48.8% of revenue.Other income and expense (OI&E) was $106 million of income compared with $143 million of income. See Note 11 to the financial statements.18Interest and debt expense of $214 million increased $30 million due to the issuance of additional long-term debt. See Note 8 to the financial statements.Our provision for income taxes was $1.28 billion compared with $1.15 billion. This increase was primarily due to higher income before income taxes and lower discrete tax benefits compared to 2021. Our effective tax rate, which includes discrete tax items, was 12.8% in 2022 compared with 12.9% in 2021. See Note 4 to the financial statements for a reconciliation of the U.S. statutory corporate tax rate to our effective tax rate.Net income was $8.75 billion compared with $7.77 billion. EPS was $9.41 compared with $8.26.Segment results – 2022 compared with 2021Analog (includes Power and Signal Chain product lines)20222021ChangeRevenue$15,359 $14,050 9 %Operating profit8,359 7,393 13 %Operating profit % of revenue54.4 %52.6 %Analog revenue increased in both product lines, led by Signal Chain. Operating profit increased primarily due to higher revenue and associated gross profit.Embedded Processing (includes microcontrollers and processors)20222021ChangeRevenue$3,261 $3,049 7 %Operating profit1,253 1,174 7 %Operating profit % of revenue38.4 %38.5 %Embedded Processing revenue increased. Operating profit increased primarily due to higher revenue and associated gross profit.Other (includes DLP® products, calculators and custom ASIC products)20222021ChangeRevenue$1,408 $1,245 13 %Operating profit *528 393 34 %Operating profit % of revenue37.5 %31.6 %*Includes acquisition charges and restructuring charges/otherOther revenue increased $163 million, and operating profit increased $135 million.Financial conditionAt the end of 2022, total cash (cash and cash equivalents plus short-term investments) was $9.07 billion, a decrease of $672 million from the end of 2021.Accounts receivable were $1.90 billion, an increase of $194 million compared with the end of 2021. Days sales outstanding at the end of 2022 were 37 compared with 32 at the end of 2021.Inventory was $2.76 billion, an increase of $847 million from the end of 2021. Days of inventory at the end of 2022 were 157 compared with 116 at the end of 2021.19Liquidity and capital resourcesOur primary source of liquidity is cash flow from operations. Additional sources of liquidity are cash and cash equivalents, short-term investments and access to debt markets. We also have a variable-rate, revolving credit facility. As of December 31, 2022, our credit facility was undrawn, and we had no commercial paper outstanding. Cash flows from operating activities for 2022 were $8.72 billion, a decrease of $36 million due to higher cash used for working capital as we continued to strategically build our inventory, offset by higher net income.Investing activities for 2022 used $3.58 billion compared with $4.10 billion in 2021. Capital expenditures were $2.80 billion compared with $2.46 billion in 2021 and were primarily for semiconductor manufacturing equipment and facilities in both periods, including the purchase of our 300-mm semiconductor factory in Lehi, Utah, during 2021. Short-term investments used cash of $826 million in 2022 compared with $1.65 billion in 2021.As we continue to invest to strengthen our competitive advantage in manufacturing and technology as part of our long-term capacity planning, our capital expenditures are expected to be higher than historical levels. In August 2022, the U.S. government enacted the U.S. CHIPS and Science Act, which provides funding for manufacturing grants and research investments and establishes a 25% investment tax credit for certain investments in U.S. semiconductor manufacturing. We expect to receive the cash benefit associated with the investment tax credit for qualifying capital expenditures in future periods and to apply for other incentives provided by the legislation.Financing activities for 2022 used $6.72 billion compared with $3.14 billion in 2021. In 2022, we received net proceeds of $1.49 billion from the issuance of fixed-rate, long-term debt and retired maturing debt of $500 million. In 2021, we received net proceeds of $1.50 billion from the issuance of fixed-rate, long-term debt and retired maturing debt of $550 million. Dividends paid in 2022 were $4.30 billion compared with $3.89 billion in 2021, reflecting an increased dividend rate, partially offset by fewer shares outstanding. We used $3.62 billion to repurchase 22.2 million shares of our common stock compared with $527 million used in 2021 to repurchase 2.9 million shares. Employee exercises of stock options provided cash proceeds of $241 million compared with $377 million in 2021.We had $3.05 billion of cash and cash equivalents and $6.02 billion of short-term investments as of December 31, 2022. We believe we have the necessary financial resources and operating plans to fund our working capital needs, capital expenditures, dividend and debt-related payments and other business requirements for at least the next 12 months.Non-GAAP financial informationThis MD&A includes references to free cash flow and ratios based on that measure. These are financial measures that were not prepared in accordance with generally accepted accounting principles in the United States (GAAP). Free cash flow was calculated by subtracting capital expenditures from the most directly comparable GAAP measure, cash flows from operating activities (also referred to as cash flow from operations).We believe that free cash flow and the associated ratios provide insight into our liquidity, our cash-generating capability and the amount of cash potentially available to return to shareholders, as well as insight into our financial performance. These non-GAAP measures are supplemental to the comparable GAAP measures.Reconciliation to the most directly comparable GAAP measures is provided in the table below.For Years Ended December 31,20222021Cash flow from operations (GAAP)$8,720 $8,756 Capital expenditures(2,797)(2,462)Free cash flow (non-GAAP)$5,923 $6,294 Revenue$20,028 $18,344 Cash flow from operations as a percentage of revenue (GAAP)43.5 %47.7 %Free cash flow as a percentage of revenue (non-GAAP)29.6 %34.3 %20Critical accounting estimatesOur accounting policies are more fully described in Note 2 of the consolidated financial statements. As disclosed in Note 2, the preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Management believes it is unlikely that applying other estimates and assumptions would have a material impact on the financial statements. We consider the following accounting policies to be those that are most important to the portrayal of our financial condition and that require a higher degree of judgment.Income taxesIn determining net income for financial statement purposes, we must make certain estimates and judgments in the calculation of tax provisions and the resultant tax liabilities and in the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of revenue and expense. In the ordinary course of global business, there may be many transactions and calculations where the ultimate tax outcome is uncertain. The calculation of tax liabilities involves dealing with uncertainties in the interpretation and application of complex tax laws, and significant judgment is necessary to (i) determine whether, based on the technical merits, a tax position is more likely than not to be sustained and (ii) measure the amount of tax benefit that qualifies for recognition. We recognize potential liabilities for anticipated tax audit issues in the United States and other tax jurisdictions based on an estimate of the ultimate resolution of whether, and the extent to which, additional taxes will be due. Although we believe the estimates are reasonable, no assurance can be given that the final outcome of these matters will not be different from what is reflected in the historical income tax provisions and accruals.As part of our financial process, we must assess the likelihood that our deferred tax assets can be recovered. If recovery is not likely, the provision for taxes must be increased by recording a reserve in the form of a valuation allowance for the deferred tax assets that are estimated not to be ultimately recoverable. Our judgment regarding future recoverability of our deferred tax assets may change due to various factors, including changes in U.S. or international tax laws and changes in market conditions and their impact on our assessment of taxable income in future periods. These changes, if any, may require adjustments to the valuation allowances and an accompanying reduction or increase in net income in the period when such determinations are made.Inventory valuation allowancesInventory is valued net of allowances for unsalable or obsolete raw materials, work in process and finished goods. Statistical allowances are determined quarterly for raw materials and work in process based on historical disposals of inventory for salability and obsolescence reasons. For finished goods, quarterly statistical allowances are determined by comparing inventory levels of individual parts to historical shipments, current backlog and estimated future sales in order to identify inventory considered unlikely to be sold. A specific allowance for each material type will be carried if there is a significant event not captured by the statistical allowance, such as an end-of-life part or demand with imminent risk of cancellation. Allowances are also calculated quarterly for instances where inventoried costs for individual products are in excess of the net realizable value for those products. Actual future write-offs of inventory for salability and obsolescence reasons may differ from estimates and calculations used to determine valuation allowances due to changes in customer demand, customer negotiations, technology shifts and other factors.Commitments and contingenciesSee Note 10 to the financial statements for a discussion of our commitments and contingencies.21ITEM 7A. Quantitative and qualitative disclosures about market riskForeign exchange riskThe U.S. dollar is our functional currency for financial reporting. Our non-U.S. entities own assets or liabilities denominated in U.S. dollars or other currencies, and exchange rate fluctuations in those jurisdictions may impact our effective tax rate.Our balance sheet also reflects amounts remeasured from non-U.S. dollar currencies. Because most of the aggregate non-U.S. dollar balance sheet exposure is hedged by forward currency exchange contracts, which are based on year-end 2022 balances and currency exchange rates, a hypothetical 10% plus or minus fluctuation in non-U.S. currency exchange rates relative to the U.S. dollar would result in a pretax currency exchange gain or loss of approximately $3 million.We use these forward currency exchange contracts to reduce the earnings impact that exchange rate fluctuations may have on our non-U.S. dollar net balance sheet exposures. As of December 31, 2022, we had forward currency exchange contracts outstanding with a notional value of $387 million to hedge net balance sheet exposures (including $118 million to sell Japanese yen, $78 million to sell British pounds and $49 million to buy Chinese yuan). Similar hedging activities existed at year-end 2021.Interest rate riskWe have the following potential exposure to changes in interest rates: (i) the effect of changes in interest rates on the fair value of our investments in cash equivalents and short-term investments, which could produce a gain or a loss; and (ii) the effect of changes in interest rates on the fair value of our debt.As of December 31, 2022, a hypothetical 100 basis point increase in interest rates would decrease the fair value of our investments in cash equivalents and short-term investments by about $15 million and decrease the fair value of our long-term debt by $566 million. Because interest rates on our long-term debt are fixed, changes in interest rates would not affect the cash flows associated with long-term debt.Equity riskLong-term investments at year-end 2022 include the following:•Investments in mutual funds – includes mutual funds that were selected to generate returns that offset changes in certain liabilities related to deferred compensation arrangements. The mutual funds hold a variety of debt and equity investments.•Investments in venture capital funds – includes investments in limited partnerships (accounted for under either the equity method or at cost with adjustments to observable market changes or impairments).•Equity investments – includes non-marketable (non-publicly traded) equity securities.Investments in mutual funds are stated at fair value. Changes in prices of the mutual fund investments are expected to offset related changes in certain deferred compensation liabilities. Non-marketable equity securities and certain venture capital funds are stated at cost minus impairment, if any, plus or minus changes resulting from qualifying observable price changes. Investments in the remaining venture capital funds are stated using the equity method. See Note 6 to the financial statements for details of equity and other long-term investments.We also utilize total return swaps to economically hedge exposure to changes in liabilities related to the market risks of certain deferred compensation arrangements with employees. Gains or losses from changes in the fair value of these total return swaps generally offset the related losses or gains on the deferred compensation liabilities.22
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsReference is made throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations to Notes to the Consolidated Financial Statements, which begin on page F-1 of this report. Management’s Discussion and Analysis of Financial Condition and Results of Operations for 2020 is included in Item 7 of the company’s 2021 Annual Report on Form 10-K filed with the Securities and Exchange Commission. The company refers to various amounts or measures not prepared in accordance with generally accepted accounting principles (non-GAAP measures). These non-GAAP measures are further described and reconciled to their most directly comparable amount or measure under the section “Non-GAAP Measures” later in this Management’s Discussion and Analysis of Financial Condition and Results of Operations.OverviewThermo Fisher Scientific Inc. enables customers to make the world healthier, cleaner and safer by helping them accelerate life sciences research, solve complex analytical challenges, increase laboratory productivity, and improve patient health through 18THERMO FISHER SCIENTIFIC INC.diagnostics and the development and manufacture of life-changing therapies. Markets served include pharmaceutical and biotech, academic and government, industrial and applied, as well as healthcare and diagnostics. The company’s operations fall into four segments (Note 4): Life Sciences Solutions, Analytical Instruments, Specialty Diagnostics and Laboratory Products and Biopharma Services. Consolidated Results(Dollars in millions except per share amounts)20222021ChangeRevenues$44,915 $39,211 15 %GAAP operating income$8,393 $10,028 (16)%GAAP operating income margin18.7 %25.6 %(6.9) ptAdjusted operating income (non-GAAP measure)$10,985 $12,138 (9)%Adjusted operating income margin (non-GAAP measure)24.5 %31.0 %(6.5) ptGAAP diluted earnings per share attributable to Thermo Fisher Scientific Inc.$17.63 $19.46 (9)%Adjusted earnings per share (non-GAAP measure)$23.24 $25.13 (8)%Organic Revenue GrowthRevenue growth15 %Impact of acquisitions18 %Impact of currency translation(3)%Organic revenue growth* (non-GAAP measure)0 %* Results may not sum due to rounding. Since 2020, the Life Sciences Solutions and Specialty Diagnostics segments as well as the laboratory products business have supported COVID-19 diagnostic testing, scaling and evolving their molecular diagnostics solutions and plastic consumables businesses to respond to the ongoing COVID-19 pandemic. The biosciences and bioproduction businesses have expanded their capacity to meet the needs of pharma and biotech customers as they have expanded their own production volumes to meet global vaccine manufacturing requirements. Additionally, our pharma services business has provided our pharma and biotech customers with the services they needed to develop and produce vaccines and therapies globally. While these positive impacts are expected to continue through 2023, the duration and extent of future revenues from such sales are uncertain and dependent primarily on customer testing as well as therapy and vaccine demand. Sales of products related to COVID-19 testing were $3.11 billion and $7.26 billion in 2022 and 2021, respectively. During 2022 demand from pharma and biotech customers was very strong, driven by our differentiated customer value proposition and trusted partner status. We saw good growth in the academic and government market as we remain well positioned to meet customer needs. The industrial and applied market was strong, driven by robust demand for our analytical instruments serving our semi-conductor and materials science customers. The diagnostics and healthcare market declined due to decreased demand for COVID-19 testing products. During 2022, robust sales growth in North America and the Asia Pacific region, including China, was partially offset by a decline in COVID-19 testing demand. In Europe, strong sales were more than offset during 2022 due to lower COVID-19 testing demand. Contributions to organic revenue during 2022 were driven by the Laboratory Products and Biopharma Services and Analytical Instruments segments, as offset by the Life Sciences Solutions and Specialty Diagnostics segments.The company continues to execute its proven growth strategy which consists of three pillars:•Developing high-impact, innovative new products,•Leveraging our scale in high-growth and emerging markets, and•Delivering a unique value proposition to our customers.GAAP operating income margin and adjusted operating income margin decreased in 2022 due primarily to lower COVID-19 testing volumes, continued strategic growth investments, and the expected impact of incorporating recent acquisitions. This was partially offset by strong pricing realization across all segments to address higher inflation while also driving strong productivity. GAAP operating income margin in 2022 was also impacted by higher amortization expense as a result of 2021 acquisitions. The company’s references to strategic growth investments generally refer to targeted spending for enhancing commercial capabilities, including expansion of geographic sales reach and e-commerce platforms, marketing initiatives, expanded service and operational infrastructure, research and development projects and other expenditures to enhance the customer experience, as well as incentive compensation and recognition for employees. The company’s references throughout this discussion to 19THERMO FISHER SCIENTIFIC INC.productivity improvements generally refer to improved cost efficiencies from its Practical Process Improvement (PPI) business system including reduced costs resulting from implementing continuous improvement methodologies, global sourcing initiatives, a lower cost structure following restructuring actions, including headcount reductions and consolidation of facilities, and low cost region manufacturing.Notable Recent AcquisitionsOn January 15, 2021, the company acquired, within the Laboratory Products and Biopharma Services segment, the Belgium-based European viral vector manufacturing business of Groupe Novasep SAS. The European viral vector manufacturing business provides manufacturing services for vaccines and therapies to biotechnology companies and large biopharma customers. The acquisition expands the segment’s capabilities for cell and gene vaccines and therapies. On February 25, 2021, the company acquired, within the Life Sciences Solutions segment, Mesa Biotech, Inc., a U.S.-based molecular diagnostic company. Mesa Biotech has developed and commercialized a PCR based rapid point-of-care testing platform available for detecting infectious diseases including COVID-19. The acquisition enables the company to accelerate the availability of reliable and accurate advanced molecular diagnostics at the point of care. On September 30, 2021, the company assumed operating responsibility, within the Laboratory Products and Biopharma Services segment, of a new state-of-the-art biologics manufacturing facility in Lengnau, Switzerland from CSL Limited to perform pharma services for CSL with capacity to serve other customers as well. On December 8, 2021, the company acquired, within the Laboratory Products and Biopharma Services segment, PPD, Inc., a U.S.-based global provider of clinical research services to the pharma and biotech industry. The addition of PPD’s clinical research services enhances our offering to biotech and pharma customers by enabling them to accelerate innovation and increase their productivity within the drug development process. On December 30, 2021, the company acquired, within the Life Sciences Solutions segment, PeproTech, Inc., a U.S.-based developer and manufacturer of recombinant proteins. PeproTech provides bioscience reagents known as recombinant proteins, including cytokines and growth factors. The acquisition expands the segment’s bioscience offerings.On January 3, 2023, the company acquired, within the Specialty Diagnostics segment, The Binding Site Group, a U.K.-based provider of specialty diagnostic assays and instruments to improve the diagnosis and management of blood cancers and immune system disorders. The acquisition expands the segment’s portfolio with the addition of pioneering innovation in diagnostics and monitoring for multiple myeloma. Segment ResultsThe company’s management evaluates segment operating performance using operating income before certain charges/credits as defined in Note 4. Accordingly, the following segment data are reported on this basis.(Dollars in millions)20222021RevenuesLife Sciences Solutions$13,532 $15,631 Analytical Instruments6,624 6,069 Specialty Diagnostics4,763 5,659 Laboratory Products and Biopharma Services22,511 14,862 Eliminations(2,515)(3,010)Consolidated revenues$44,915 $39,211 Life Sciences SolutionsOrganic* (non-GAAP measure)(Dollars in millions)20222021TotalChangeCurrencyTranslationAcquisitions/ DivestituresRevenues$13,532 $15,631 (13)%(3)%1 %(12)%Segment income$5,582 $7,817 (29)%Segment income margin41.2 %50.0 %(8.8) ptThe decrease in organic revenues in 2022 was primarily due to lower revenue in the genetic sciences business, driven by moderation in testing demand to diagnose COVID-19, partially offset by growth in the bioproduction business. The decrease in segment income margin resulted primarily from business mix and strategic growth investments, partially offset by productivity improvements.20THERMO FISHER SCIENTIFIC INC.Analytical InstrumentsOrganic* (non-GAAP measure)(Dollars in millions)20222021TotalChangeCurrencyTranslationAcquisitions/ DivestituresRevenues$6,624 $6,069 9 %(5)%0 %14 %Segment income1,507 1,197 26 %Segment income margin22.8 %19.7 %3.1 ptThe increase in organic revenues in 2022 was due to increased demand across all the segment’s businesses, with particular strength in the electron microscopy and chromatography and mass spectrometry businesses. The increase in segment income margin resulted primarily from profit on higher sales, productivity improvements and business mix, offset in part by strategic growth investments. Specialty DiagnosticsOrganic* (non-GAAP measure)(Dollars in millions)20222021TotalChangeCurrencyTranslationAcquisitions/ DivestituresRevenues$4,763 $5,659 (16)%(3)%0 %(13)%Segment income1,024 1,280 (20)%Segment income margin21.5 %22.6 %(1.1) ptThe decrease in organic revenues in 2022 was primarily driven by products addressing diagnosis of COVID-19, partially offset by growth in the immunodiagnostics and transplant diagnostics businesses. The decrease in segment income margin was primarily due to lower COVID-19 testing volume, largely offset by productivity improvements and positive business mix. Segment income margin in 2021 was also impacted by a $13 million credit to cost of product revenue as a result of changing the method of accounting for inventories.Laboratory Products and Biopharma ServicesOrganic* (non-GAAP measure)(Dollars in millions)20222021TotalChangeCurrencyTranslationAcquisitions/ DivestituresRevenues$22,511 $14,862 51 %(3)%45 %10 %Segment income2,872 1,844 56 %Segment income margin12.8 %12.4 %0.4 ptThe increase in organic revenues in 2022 was primarily due to higher sales across each of the segment’s businesses, with particular strength in the pharma services business and research and safety market channel. PPD, the company’s clinical research business, contributed $7.11 billion of revenue during 2022. The increase in segment income margin was primarily due to the benefit of recent acquisitions, profit on higher sales, and productivity improvements, offset in part by strategic growth investments. Segment income margin in 2021 was also impacted by a $20 million credit to cost of product revenue as a result of changing the method of accounting for inventories.* Results may not sum due to roundingNon-operating Items(Dollars in millions)20222021Net interest expense$454 $493 GAAP other income/(expense)(104)(694)Adjusted other income/(expense) (non-GAAP measure)13 38 GAAP tax rate9.0 %12.5 %Adjusted tax rate (non-GAAP measure)13.0 %14.6 %Net interest expense (interest expense less interest income) decreased due primarily to lower average interest rates on debt and higher average interest rates on cash balances, partially offset by the increase in debt to finance the acquisition of PPD and for general corporate purposes. See additional discussion under the caption “Liquidity and Capital Resources” below. GAAP other income/(expense) and adjusted other income/(expense) includes currency transaction gains, losses on non-operating monetary assets and liabilities, and net periodic pension benefit cost/income, excluding the service cost component. GAAP other income/(expense) in 2022 also includes $160 million of net losses on investments, $26 million of losses on the 21THERMO FISHER SCIENTIFIC INC.early extinguishment of debt (Note 10), partially offset by $67 million of net gains on derivative instruments to address certain foreign currency risks and $2 million of net settlement gains on pension plans. GAAP other income/(expense) in 2021 also includes $767 million of losses on the early extinguishment of debt and $36 million of financing costs associated with obtaining bridge financing commitments in connection with the agreement to acquire PPD (Note 2), offset in part by $66 million of net gains on investments. The company’s GAAP and adjusted tax rates decreased in 2022 compared to 2021 primarily due to releases of valuation allowances of $87 million in 2022 in jurisdictions where the deferred tax assets are now expected to be realized. The company’s 2022 GAAP tax rate was also impacted by changes in tax rates and higher amortization expense as a result of 2021 acquisitions, as well as a net benefit of $208 million resulting from tax audit settlements (see Note 8). The company’s 2021 GAAP and adjusted tax rates were also impacted by income tax benefits on intra-entity transactions totaling $284 million.The effective tax rate in both 2022 and 2021 was also affected by relatively significant earnings in lower tax jurisdictions. Due primarily to the non-deductibility of intangible asset amortization for tax purposes, the company’s cash payments for income taxes were higher than its income tax expense for financial reporting purposes and totaled $1.23 billion and $2.18 billion in 2022 and 2021, respectively. The company expects its GAAP effective tax rate in 2023 will be between 7% and 9% based on currently forecasted rates of profitability in the countries in which the company conducts business and expected generation of foreign tax credits. The effective tax rate can vary significantly from period to period as a result of discrete income tax factors and events. The company expects its adjusted tax rate will be approximately 11% in 2023. The company has operations and a taxable presence in approximately 70 countries outside the U.S. Some of these countries have lower tax rates than the U.S. The company’s ability to obtain a benefit from lower tax rates outside the U.S. is dependent on its relative levels of income in countries outside the U.S. and on the statutory tax rates in those countries. Based on the dispersion of the company’s non-U.S. income tax provision among many countries, the company believes that a change in the statutory tax rate in any individual country is not likely to materially affect the company’s income tax provision or net income, aside from any resulting one-time adjustment to the company’s deferred tax balances to reflect a new rate.Liquidity and Capital ResourcesThe company’s proven growth strategy has enabled it to generate free cash flow as well as access the capital markets. The company deploys its capital primarily via mergers and acquisitions and secondarily via share buybacks and dividends.December 31,December 31,(In millions)20222021Cash and cash equivalents$8,524 $4,477 Total debt34,488 34,870 Approximately half of the company’s cash balances and cash flows from operations are from outside the U.S. The company uses its non-U.S. cash for needs outside of the U.S. including acquisitions, capacity expansion, and repayment of third-party foreign debt by foreign subsidiaries. In addition, the company also transfers cash to the U.S. using non-taxable returns of capital as well as dividends where the related U.S. dividend received deduction or foreign tax credit equals any tax cost arising from the dividends. As a result of using such means of transferring cash to the U.S., the company does not expect any material adverse liquidity effects from its significant non-U.S. cash balances for the foreseeable future. The company believes that its existing cash and cash equivalents and its future cash flow from operations together with available borrowing capacity under its revolving credit agreement will be sufficient to meet the cash requirements of its existing businesses for the foreseeable future, including at least the next 24 months. As of December 31, 2022, the company’s short-term debt totaled $5.58 billion. The company has a revolving credit facility with a bank group that provides up to $5.00 billion of unsecured multi-currency revolving credit (Note 10). If the company borrows under this facility, it intends to leave undrawn an amount equivalent to outstanding commercial paper to provide a source of funds in the event that commercial paper markets are not available. As of December 31, 2022, no borrowings were outstanding under the company’s revolving credit facility, although available capacity was reduced by immaterial outstanding letters of credit.22THERMO FISHER SCIENTIFIC INC.(In millions)20222021Net cash provided by operating activities$9,154 $9,312 Net cash used in investing activities(2,159)(21,932)Net cash (used in) provided by financing activities(2,810)6,581 Free cash flow (non-GAAP measure)6,935 6,809 Operating ActivitiesDuring 2022, cash provided by income was offset in part by investments in working capital. Increases in accounts receivable and inventories used cash of $0.43 billion and $0.83 billion, respectively, primarily to support growth in sales. An increase in accounts payable provided cash of $0.65 billion. Cash payments for income taxes were $1.23 billion during 2022. During 2021, cash provided by income was offset in part by investments in working capital. Increases in accounts receivable and inventories used cash of $0.20 billion and $1.07 billion, respectively, primarily to support growth in sales. An increase in accounts payable provided cash of $0.48 billion. Changes in other assets and other liabilities used cash of $0.72 billion primarily due to the timing of tax and incentive compensation payments. Cash payments for income taxes were $2.18 billion during 2021. The company is contingently liable with respect to certain legal proceedings and related matters. An unfavorable outcome that differs materially from current accrual estimates, if any, for one or more of the matters described under the heading “Product Liability, Workers Compensation and Other Personal Injury Matters,” in Note 12 could have a material adverse effect on the company’s financial position as well as its results of operations and cash flows.Investing ActivitiesDuring 2022, acquisitions used cash of $0.04 billion. The company’s investing activities were principally for the purchase of property, plant and equipment for capacity and capability investments.During 2021, acquisitions used cash of $19.40 billion. The company’s investing activities also included the purchase of $2.52 billion of property, plant and equipment. The company expects that for all of 2023, expenditures for property, plant and equipment, net of disposals, will be approximately $2.0 billion.Financing ActivitiesDuring 2022, issuance of senior notes provided $3.19 billion in cash. Repayment of senior notes and net commercial paper activity used cash of $0.38 billion and $2.16 billion, respectively. The company’s financing activities also included the repurchase of $3.00 billion of the company’s common stock (5.3 million shares) and the payment of $0.46 billion in cash dividends. On September 23, 2021, the Board of Directors authorized the repurchase of up to $3.00 billion of the company’s common stock. All of the shares of common stock repurchased by the company during the fourth quarter of 2022 were purchased under this program, depleting the 2021 authorization. On November 10, 2022, the Board of Directors authorized the repurchase of up to $4.00 billion of the company’s common stock. Early in the first quarter of 2023, the company repurchased $3.00 billion of the company's common stock (5.2 million shares). At February 23, 2023, authorization remained for $1.00 billion of future repurchases of the company’s common stock. During 2021, issuance of senior notes provided $18.14 billion of cash. A net increase in commercial paper obligations provided cash of $2.51 billion. Repayment of debt used cash of $11.74 billion, including $4.30 billion to repay the debt assumed in the acquisition of PPD. The company’s financing activities also included the repurchase of $2.00 billion of the company's common stock (4.1 million shares) and the payment of $0.40 billion in cash dividends.In addition to the obligations on the balance sheet at December 31, 2022, which include, but are not limited to, debt (Note 10), unrecognized tax benefits (Note 8), operating leases (Note 11), pension obligations (Note 7) and contingent consideration (Note 14), the company has entered into unconditional purchase obligations, in the ordinary course of business, that include agreements to purchase goods, services or fixed assets and to pay royalties (Note 12). Non-GAAP MeasuresIn addition to the financial measures prepared in accordance with generally accepted accounting principles (GAAP), we use certain non-GAAP financial measures such as organic revenue growth, which is reported revenue growth, excluding the impacts of revenues from acquired/divested businesses and the effects of currency translation. We report organic revenue growth because Thermo Fisher management believes that in order to understand the company’s short-term and long-term financial trends, investors may wish to consider the impact of acquisitions/divestitures and foreign currency translation on 23THERMO FISHER SCIENTIFIC INC.revenues. Thermo Fisher management uses organic revenue growth to forecast and evaluate the operational performance of the company as well as to compare revenues of current periods to prior periods.We report adjusted operating income, adjusted operating income margin, adjusted other income/(expense), adjusted tax rate, and adjusted EPS. We believe that the use of these non-GAAP financial measures, in addition to GAAP financial measures, helps investors to gain a better understanding of our core operating results and future prospects, consistent with how management measures and forecasts the company’s core operating performance, especially when comparing such results to previous periods, forecasts, and to the performance of our competitors. Such measures are also used by management in their financial and operating decision-making and for compensation purposes. To calculate these measures we exclude, as applicable:•Certain acquisition-related costs, including charges for the sale of inventories revalued at the date of acquisition, significant transaction/acquisition-related costs, including changes in estimates of contingent acquisition-related consideration, and other costs associated with obtaining short-term financing commitments for pending/recent acquisitions. We exclude these costs because we do not believe they are indicative of our normal operating costs.•Costs/income associated with restructuring activities and large-scale abandonments of product lines, such as reducing overhead and consolidating facilities. We exclude these costs because we believe that the costs related to restructuring activities and large-scale abandonment of product lines are not indicative of our normal operating costs.•Equity in earnings/losses of unconsolidated entities; impairments of long-lived assets; and certain other gains and losses that are either isolated or cannot be expected to occur again with any predictability, including gains/losses on investments, the sale of businesses, product lines, and real estate, significant litigation-related matters, curtailments/settlements of pension plans, and the early retirement of debt. We exclude these items because they are outside of our normal operations and/or, in certain cases, are difficult to forecast accurately for future periods. •The expense associated with the amortization of acquisition-related intangible assets because a significant portion of the purchase price for acquisitions may be allocated to intangible assets that have lives of up to 20 years. Exclusion of the amortization expense allows comparisons of operating results that are consistent over time for both our newly acquired and long-held businesses and with both acquisitive and non-acquisitive peer companies.•The tax impacts of the above items and the impact of significant tax audits or events (such as changes in deferred taxes from enacted tax rate/law changes), the latter of which we exclude because they are outside of our normal operations and difficult to forecast accurately for future periods.We report free cash flow, which is operating cash flow excluding net capital expenditures, to provide a view of the continuing operations’ ability to generate cash for use in acquisitions and other investing and financing activities. The company also uses this measure as an indication of the strength of the company. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure.The non-GAAP financial measures of the company’s results of operations and cash flows included in this Form 10-K are not meant to be considered superior to or a substitute for the company’s results of operations prepared in accordance with GAAP. Reconciliations of such non-GAAP financial measures to the most directly comparable GAAP financial measures are set forth within the “Overview” and “Results of Operations” sections and below. (Dollars in millions except per share amounts)20222021Reconciliation of adjusted operating income and adjusted operating income marginGAAP operating income$8,393 18.7 %$10,028 25.6 %Cost of revenues adjustments (a)46 0.1 %8 0.0 %Selling, general and administrative expenses adjustments (b)37 0.1 %144 0.4 %Restructuring and other costs (c)114 0.3 %197 0.5 %Amortization of acquisition-related intangible assets2,395 5.3 %1,761 4.5 %Adjusted operating income (non-GAAP measure)$10,985 24.5 %$12,138 31.0 %Reconciliation of adjusted other income/(expense)GAAP other income/(expense)$(104)$(694)Adjustments (d)117 732 Adjusted other income/(expense) (non-GAAP measure)$13 $38 24THERMO FISHER SCIENTIFIC INC.(Dollars in millions except per share amounts)20222021Reconciliation of adjusted tax rateGAAP tax rate9.0 %12.5 %Adjustments (e)4.0 %2.1 %Adjusted tax rate (non-GAAP measure)13.0 %14.6 %Reconciliation of adjusted earnings per shareGAAP diluted earnings per share (EPS) attributable to Thermo Fisher Scientific Inc.$17.63 $19.46 Cost of revenues adjustments (a)0.12 0.02 Selling, general and administrative expenses adjustments (b)0.09 0.36 Restructuring and other costs (c)0.29 0.50 Amortization of acquisition-related intangible assets6.07 4.43 Other income/expense adjustments (d)0.30 1.84 Provision for income taxes adjustments (e)(1.70)(1.49)Equity in earnings/losses of unconsolidated entities0.44 0.01 Adjusted EPS (non-GAAP measure)$23.24 $25.13 Reconciliation of free cash flowGAAP net cash provided by operating activities$9,154 $9,312 Purchases of property, plant and equipment(2,243)(2,523)Proceeds from sale of property, plant and equipment24 20 Free cash flow (non-GAAP measure)$6,935 $6,809 (a) Adjusted results exclude charges for the sale of inventories revalued at the date of acquisition. Adjusted results in 2022 also exclude $27 million of inventory write-downs associated with large-scale abandonment of product lines.(b) Adjusted results exclude certain third-party expenses, principally transaction/integration costs related to recent acquisitions, charges/credits for changes in estimates of contingent acquisition consideration, and charges associated with product liability litigation.(c) Adjusted results exclude restructuring and other costs consisting principally of severance, impairments of long-lived assets, charges/credits for environmental-related matters, abandoned facility and other expenses of headcount reductions within several businesses and real estate consolidations. Adjusted results in 2022 also exclude $14 million of gain on the sale of intellectual property. Adjusted results in 2021 also exclude $122 million of charges for impairments of acquired intangible assets and $35 million of charges for compensation due to employees at recently acquired businesses at the date of acquisition.(d) Adjusted results exclude net gains/losses on investments and losses on the early extinguishment of debt. Adjusted results in 2022 also exclude $67 million of net gains on derivative instruments to address certain foreign currency risks and $2 million of net settlement gains for pension plans. Adjusted results in 2021 also exclude $36 million of charges for amortization of bridge loan commitment fees related to a pending acquisition.(e) Adjusted provision for income taxes excludes incremental tax impacts for the reconciling items between GAAP and adjusted net income, incremental tax impacts as a result of tax rate/law changes and the tax impacts from audit settlements (including a $658 million benefit from an audit settlement in 2022). Adjusted results in 2022 also exclude a $423 million charge for the impact of deferred tax realizability assessments as a result of audit settlements.Critical Accounting Policies and EstimatesThe company’s discussion and analysis of its financial condition and results of operations is based upon its financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent liabilities. On an on-going basis, management evaluates its estimates, including those related to acquisition-related measurements and income taxes. Management believes the most complex and sensitive judgments, because of their significance to the consolidated financial statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Management bases its estimates on historical experience, current market and economic conditions and other assumptions that management believes are reasonable. The results of these estimates form the basis for judgments about the carrying value of assets and liabilities where the values are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. 25THERMO FISHER SCIENTIFIC INC.The company believes the following represent its critical accounting policies and estimates used in the preparation of its financial statements:Acquisition-related Measurements Business CombinationsThe company uses assumptions and estimates in determining the fair value of assets acquired and liabilities assumed in a business combination. The determination of the fair value of intangible assets, which represent a significant portion of the purchase price in many of the company’s acquisitions, requires the use of significant judgment with regard to (i) the fair value and (ii) whether such intangibles are amortizable or non-amortizable and, if the former, the period and the method by which the intangible asset will be amortized. The company estimates the fair value of acquisition-related intangible assets principally based on projections of cash flows that will arise from identifiable intangible assets of acquired businesses, which include estimates of customer attrition and technology obsolescence rates. The projected cash flows are discounted to determine the present value of the assets at the dates of acquisition. See Note 2 for additional information about our recent business combinations.Goodwill and Indefinite-lived Intangible AssetsThe company evaluates goodwill and indefinite-lived intangible assets for impairment annually and when events occur or circumstances change that would more likely than not reduce the fair value of an asset below its carrying amount. Events or circumstances that might require an interim evaluation include unexpected adverse business conditions, economic factors, unanticipated technological changes or competitive activities, loss of key personnel and acts by governments and courts, among others. Goodwill and indefinite-lived intangible assets totaled $41.20 billion and $1.24 billion, respectively, at December 31, 2022 (see Note 1 for additional information). Estimates of discounted future cash flows require assumptions related to revenue and operating income growth rates, discount rates and other factors. For the goodwill impairment tests, the company also considers (i) peer revenues and earnings trading multiples from companies that have operational and financial characteristics that are similar to the respective reporting units and (ii) estimated weighted average costs of capital. Different assumptions from those made in the company’s analysis could materially affect projected cash flows and the company’s evaluation of goodwill and indefinite-lived intangible assets for impairment.Except as described below, the company performed the quantitative goodwill impairment test for all of its reporting units and indefinite-lived intangible assets. Determinations of fair value based on projections of discounted cash flows, which decreased from the prior year projections primarily due to higher discount rates, and based on peer revenues and earnings trading multiples, which also decreased from the prior year, were sufficient to conclude that no impairments of goodwill or indefinite-lived intangible assets existed at the end of the tenth fiscal month of 2022, the date of the company’s annual impairment testing. There were no interim impairments of goodwill or indefinite-lived intangible assets in 2022. There can be no assurance, however, that adverse events or conditions will not cause the fair values of these assets to decline. Should the fair values of the company’s reporting units or indefinite-lived intangible assets decline because of reduced operating performance, market declines, or other indicators of impairment, or as a result of changes in the discount rates, charges for impairment may be necessary.With the completion of the PPD acquisition in December 2021, the company established two new reporting units that solely consist of the legacy PPD businesses, the book carrying values of which equaled their fair values as of the acquisition date. During its annual 2022 goodwill impairment assessments, the company performed qualitative assessments of these reporting units and determined that no events had occurred and no circumstances had changed that would more-likely-than-not reduce the fair values of the reporting units below their carrying amounts. As a result, the company did not perform the quantitative goodwill impairment tests for these reporting units. Given that the fair values of the reporting units were unlikely to be substantially in excess of their carrying values as of the annual 2022 assessment date, relatively small decreases in future cash flows versus anticipated results, decreases in peer trading multiples and/or increases in weighted average costs of capital could result in impairment of goodwill. The reporting units consisting of the legacy PPD businesses had $13.41 billion of goodwill, and an overall carrying value of $19.30 billion as of December 31, 2022.Definite-lived Intangible AssetsDefinite-lived intangible assets totaled $16.21 billion at December 31, 2022 (see Note 1 for additional information). Certain definite-lived intangible assets have largely independent cash flows. The company reviews these definite-lived intangible assets for impairment individually when indication of potential impairment exists, such as a significant reduction in cash flows associated with the assets. Actual cash flows arising from a particular intangible asset could vary from projected cash flows, which could imply different carrying values from those established at the dates of acquisition and which could result in impairment of such asset. Most of the company’s definite-lived intangible assets are used in conjunction with other assets, such as property, plant and equipment and operating lease right-of-use assets. In these situations, the company considers 26THERMO FISHER SCIENTIFIC INC.the asset groups to be the units of account for impairment testing. The company recorded impairments of $0.12 billion in 2021 (see Note 16).Income TaxesUnrecognized Tax BenefitsIn the ordinary course of business there is inherent uncertainty in quantifying the company’s income tax positions. The company assesses income tax positions and records tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, the company has recorded the largest amount of tax benefit with a greater than 50 percent likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. Should tax return positions that the company expects are sustainable not be sustained upon audit, the company could be required to record an incremental tax provision for such taxes. The company’s liability for these unrecognized tax benefits totaled $0.57 billion at December 31, 2022, compared to $1.12 billion at December 31, 2021, primarily as a result of an audit settlement (see Note 8).The company operates in numerous countries under many legal forms and, as a result, is subject to the jurisdiction of numerous domestic and non-U.S. tax authorities, as well as to tax agreements and treaties among these governments. Determination of taxable income in any jurisdiction requires the company to interpret the related tax laws and regulations and the use of estimates and assumptions regarding significant future events, such as the amount, timing and character of deductions, permissible revenue recognition methods under the tax law and the sources and character of income and tax credits. Changes in tax laws, regulations, agreements and treaties, currency exchange restrictions or the company’s level of operations or profitability in each taxing jurisdiction could have an impact upon the amount of current and deferred tax balances and hence the company’s net income.Valuation AllowancesThe company estimates the degree to which tax assets will result in a benefit, after consideration of all positive and negative evidence, and provides a valuation allowance for tax assets that it believes will more likely than not go unused. In situations in which the company has been able to determine that its deferred tax assets will be realized, that determination generally relies on future reversals of taxable temporary differences and expected future taxable income. If it becomes more likely than not that a tax asset will be used, the company reverses the related valuation allowance. Any such reversals are recorded as a reduction of the company’s tax provision. The company’s tax valuation allowance totaled $1.32 billion at December 31, 2022, compared to $0.97 billion at December 31, 2021, primarily driven by the assessment of additional tax assets resulting from an audit settlement during the year (see Note 8). Should the company’s actual future taxable income by tax jurisdiction vary from estimates, additional allowances or reversals thereof may be necessary.Recent Accounting PronouncementsA description of recently issued accounting standards is included under the heading “Recent Accounting Pronouncements” in Note 1.Item 7A. Quantitative and Qualitative Disclosures About Market RiskThe company is exposed to market risk from changes in interest rates and currency exchange rates, which could affect its future results of operations and financial condition. The company manages its exposure to these risks through its regular operating and financing activities. The company has periodically hedged interest rate risks of fixed-rate instruments with offsetting interest rate swaps. Additionally, the company uses short-term forward and option contracts primarily to hedge certain balance sheet and operational exposures resulting from changes in currency exchange rates. Such exposures result from purchases, sales, cash and intercompany loans that are denominated in currencies other than the functional currencies of the respective operations. The currency-exchange contracts principally hedge transactions denominated in euro, British pounds sterling, Singapore dollars, Japanese yen, Hong Kong dollars, Czech koruna and Swedish krona. Income and losses arising from these derivative contracts are recognized as offsets to losses and income resulting from the underlying exposure being hedged. The company does not enter into speculative derivative agreements.Interest RatesThe company is exposed to changes in interest rates while conducting normal business operations as a result of ongoing investing and financing activities, which affect the company’s debt as well as cash and cash equivalents. As of December 31, 2022, the company’s debt portfolio was comprised primarily of fixed rate borrowings. The fair market value of the company’s fixed interest rate debt is subject to interest rate risk. Generally, the fair market value of fixed interest rate debt will increase as 27THERMO FISHER SCIENTIFIC INC.interest rates fall and decrease as interest rates rise. The total estimated fair value of the company’s debt at December 31, 2022 was $30.29 billion (Note 14). Fair values were determined from available market prices using current interest rates and terms to maturity. If interest rates were to decrease by 100 basis points, the fair value of the company’s debt at December 31, 2022 would increase by approximately $2.00 billion. If interest rates were to increase by 100 basis points, the fair value of the company’s debt at December 31, 2022 would decrease by approximately $1.75 billion.In addition, interest rate changes would result in a change in the company’s interest expense due to variable-rate debt instruments including swap arrangements. In 2022, a 100 basis point increase in interest rates on the swap arrangements and variable-rate debt would have increased the company’s annual pre-tax interest expense by approximately $35 million.Currency Exchange RatesThe company views its investment in international subsidiaries with a functional currency other than the U.S. dollar as permanent. The company’s investment in international subsidiaries is sensitive to fluctuations in currency exchange rates. The functional currencies of the company’s international subsidiaries are principally denominated in euro, British pounds sterling, Swedish krona, Canadian dollars, Norwegian kroner and Danish kroner. The effect of a change in the period ending currency exchange rates on the company’s net investment in international subsidiaries is reflected in the “accumulated other comprehensive items” component of shareholders’ equity. The company also uses foreign currency-denominated debt to partially hedge its net investments in foreign operations against adverse movements in exchange rates. A 10% depreciation in year-end 2022 functional currencies, relative to the U.S. dollar, would result in a reduction of shareholders’ equity of approximately $1.45 billion.The fair value of forward currency-exchange contracts is sensitive to changes in currency exchange rates. The fair value of forward currency-exchange contracts is the estimated amount that the company would pay or receive upon termination of the contract, taking into account the change in currency exchange rates. A 10% depreciation in year-end 2022 non-functional currency exchange rates related to the company’s contracts would result in an additional unrealized loss on forward currency-exchange contracts of $9 million. A 10% appreciation in year-end 2022 non-functional currency exchange rates related to the company’s contracts would result in an unrealized gain on forward currency-exchange contracts of $9 million. The unrealized gains or losses on forward currency-exchange contracts resulting from changes in currency exchange rates are expected to approximately offset losses or gains on the exposures being hedged.Certain of the company’s cash and cash equivalents are denominated in currencies other than the functional currency of the depositor and are sensitive to changes in currency exchange rates. A 10% depreciation in the related year-end 2022 non-functional currency exchange rates applied to such cash balances would result in a negative impact of $21 million on the company’s net income.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis is intended to provide the reader with information that will assist in understanding the significant factors affecting our consolidated operating results, financial condition, liquidity, and capital resources during the two-year period ended December 31, 2022 (our fiscal years 2022 and 2021). For a comparison of our results of operations for fiscal year December 25, 2021 and December 26, 2020, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 25, 2021, filed with the SEC on February 17, 2022. This discussion should be read in conjunction with our Consolidated Financial Statements and Notes to the Consolidated Financial Statements included elsewhere in this report. This discussion contains forward-looking statements and information. See “Forward-Looking Statements and Information” and “Risk Factors” included elsewhere in this report.Tractor Supply reports its financial results in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Tractor Supply also uses certain non-GAAP measures that fall within the meaning of Securities and Exchange Commission Regulation G and Regulation S-K Item 10(e), which may provide users of the financial information with additional meaningful comparison to prior reported results. Non-GAAP measures do not have standardized definitions and are not defined by U.S. GAAP. Therefore, Tractor Supply’s non-GAAP measures are unlikely to be comparable to similar measures presented by other companies. The presentation of these non-GAAP measures should not be considered in isolation from, as a substitute for, or as superior to the financial information presented in accordance with U.S. GAAP. We believe this information is useful in providing period-to-period comparisons of the results of our continuing operations. OverviewFounded in 1938, Tractor Supply Company (the “Company” or “Tractor Supply” or “we” or “our” or “us”) is the largest rural lifestyle retailer in the United States (“U.S.”). The Company is focused on supplying the needs of recreational farmers, ranchers, and all those who enjoy living the rural lifestyle (which we refer to as the “Out Here” lifestyle). As of December 31, 2022, we operated 2,333 retail stores in 49 states under the names Tractor Supply Company, Petsense by Tractor Supply, and Orscheln Farm and Home. Our stores are located primarily in towns outlying major metropolitan markets and in rural communities. We also operate websites under the names TractorSupply.com and Petsense.com, as well as a Tractor Supply Company mobile application. Through our stores and e-commerce channels, we offer the following comprehensive selection of merchandise:•Equine, livestock, pet, and small animal products, including items necessary for their health, care, growth, and containment (i.e., fencing);•Hardware, truck, towing, and tool products;•Seasonal products, including heating, lawn and garden items, power equipment, gifts, and toys;•Work/recreational clothing and footwear; and•Maintenance products for agricultural and rural use.Tractor Supply Company believes we can grow our business by being a more integral part of our customers’ lives as the dependable supplier of “Out Here” lifestyle solutions, creating customer loyalty through personalized experiences, and providing convenience that our customers expect at anytime, anywhere, and in any way they choose. Our long-term growth strategy is to: (1) expand and deepen our customer base by providing personal, localized, and memorable customer engagements by leveraging content, social media, and digital shopping experiences, attracting new customers and driving loyalty, (2) evolve customer experiences by digitizing our business processes and furthering our omni-channel capabilities, (3) offer relevant assortments and services across all channels through exclusive and national brands and continue to grow our total addressable market by introducing new products and services through our test and learn strategy, (4) drive operational excellence and productivity through continuous improvement, increasing space utilization, and implementing advanced supply chain capabilities to support growth, scale and agility, and (5) expand through selective acquisitions, as such opportunities arise, to add complementary businesses and to enhance penetration into new and existing markets to supplement organic growth.Achieving this strategy will require a foundational focus on: (1) connecting, empowering and growing our team to enhance their lives and the communities they live in, enabling them to provide legendary service to our customers, and (2) allocating resources in a disciplined and efficient manner to drive profitable growth and build stockholder value, including leveraging technology and automation, to align our cost structure to support new business capabilities for margin improvement and cost reductions.Over the past five years, we have experienced considerable growth in stores, growing from 1,853 stores at the end of fiscal 2017 to 2,333 stores (2,066 Tractor Supply retail stores, 186 Petsense by Tractor Supply retail stores, and 81 Orscheln Farm and Home retail stores) at the end of fiscal 2022, and in net sales, with a compounded annual growth rate of approximately 14.4%. Given the size of the communities that we target, we believe that there is ample opportunity for new store growth in many existing and new markets. We have developed a proven method for selecting store sites, and we believe we have significant 30Indexadditional opportunities for new Tractor Supply stores. We also believe that there is opportunity for continued growth for Petsense by Tractor Supply stores. In October 2022, we acquired 81 stores from Orscheln Farm and Home that will be rebranded to Tractor Supply by the end of 2023.Executive SummaryIn fiscal 2022, we opened 63 new Tractor Supply stores in 25 states and nine new Petsense by Tractor Supply stores in seven states. We also acquired 81 Orscheln Farm and Home stores in eight states. In fiscal 2021, we opened 80 new Tractor Supply stores in 27 states and seven new Petsense by Tractor Supply stores in four states. This resulted in a selling square footage increase of approximately 11% in fiscal 2022 and 4% in fiscal 2021.Net sales increased 11.6% to $14.20 billion in fiscal 2022 from $12.73 billion in fiscal 2021. The fiscal year included an extra sales week as part of the Company's 53-week calendar in 2022, which represented 1.8 percentage points of the 11.6% sales growth. Comparable store sales increased 6.3% in fiscal 2022 versus a 16.9% increase in fiscal 2021. Gross profit increased 11.1% to $4.97 billion in fiscal 2022 from $4.48 billion in fiscal 2021, and gross margin decreased 17 basis points to 35.0% of net sales in fiscal 2022 from 35.2% of net sales in fiscal 2021. Operating income decreased 16 basis points to 10.1% of net sales in fiscal 2022 from 10.3% of net sales in fiscal 2021. For fiscal 2022, net income was $1.09 billion, or $9.71 per diluted share, compared to $997.1 million, or $8.61 per diluted share, in fiscal 2021. We ended fiscal 2022 with $202.5 million in cash and cash equivalents and outstanding debt of $1.16 billion, after returning $1.11 billion to our stockholders through stock repurchases and quarterly cash dividends.Performance MetricsComparable Store MetricsComparable store metrics are a key performance indicator used in the retail industry and by the Company to measure the performance of the underlying business. Our comparable store metrics are calculated on an annual basis using sales generated from all stores open at least one year and all online sales and exclude certain adjustments to net sales. Stores closed during either of the years being compared are removed from our comparable store metrics calculations. Stores relocated during either of the years being compared are not removed from our comparable store metrics calculations. If the effect of relocated stores on our comparable store metrics calculations became material, we would remove relocated stores from the calculations.Transaction Count and Transaction ValueTransaction count and transaction value metrics are used by the Company to measure sales performance. Transaction count represents the number of customer transactions during a given period. Transaction value represents the average amount paid per transaction and is calculated as net sales divided by the total number of customer transactions during a given period.Significant Accounting Policies and EstimatesManagement’s discussion and analysis of our financial position and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires management to make informed estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Our financial position and/or results of operations may be materially different when reported under different conditions or when using different assumptions in the application of such policies. In the event estimates or assumptions prove to be different from actual amounts, adjustments are made in subsequent periods to reflect more current information. Our significant accounting policies are disclosed in Note 1 to the Consolidated Financial Statements. The following discussion addresses our most critical accounting policies and estimates, which are those that are both important to the portrayal of our financial condition and results of operations and that require significant judgment or use of complex estimates.31IndexMerchandise Inventory:We identify potentially excess and slow-moving inventory by evaluating turn rates, historical and expected future sales trends, age of merchandise, overall inventory levels, current cost of inventory, and other benchmarks. We have established an inventory valuation reserve to recognize the estimated impairment in value (i.e., an inability to realize the full carrying value) based on our aggregate assessment of these valuation indicators under prevailing market conditions and current merchandising strategies.We also have established a reserve for estimating inventory shrinkage between physical inventory counts. The reserve is established by assessing the chain-wide average shrinkage experience rate, applied to the related periods’ sales volumes. Such assessments are updated on a regular basis for the most recent individual store experiences. Our general policy is to perform physical inventories at least once a year for each store that has been open more than twelve months.We do not believe our merchandise inventories are subject to significant risk of obsolescence in the near term. However, changes in market conditions or consumer purchasing patterns could result in the need for additional reserves. Our impairment reserves contain uncertainties because the calculations require management to make assumptions and to apply judgment regarding forecasted customer demand and the promotional environment. The estimated store inventory shrink rate is based on historical experience. We believe historical rates are a reasonably accurate reflection of future trends. Our shrinkage reserve contains uncertainties because the calculation requires management to make assumptions and to apply judgment regarding future shrinkage trends, the effect of loss prevention measures and merchandising strategies.We have not made any material changes in the accounting methodology used to recognize inventory impairment reserves or shrinkage in the financial periods presented. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate impairment or shrinkage. However, if assumptions regarding consumer demand, clearance potential or inventory loss for certain products are inaccurate, we may be exposed to losses or gains that could be material. A 10% change in our inventory impairment reserve as of December 31, 2022, would have affected net income by approximately $1.8 million in fiscal 2022. A 10% change in our shrinkage reserve as of December 31, 2022, would have affected net income by approximately $4.8 million in fiscal 2022.In addition, we receive funding from substantially all of our significant merchandise vendors, in support of our business initiatives, through a variety of programs and arrangements, including guaranteed vendor support funds (“vendor support”) and volume-based rebate funds (“volume rebates”). The amounts received are subject to terms of vendor agreements, most of which are “evergreen”, reflecting the on-going relationship with our significant merchandise vendors. Certain of our agreements, primarily volume rebates, are renegotiated annually, based on expected annual purchases of the vendor’s product. Vendor funding is initially deferred as a reduction of the purchase price of inventory, and then recognized as a reduction of cost of merchandise as the related inventory is sold. During interim periods, the amount of vendor support and volume rebates are estimated based upon initial commitments and anticipated purchase levels with applicable vendors.We have not made any material changes in the accounting methodology used to establish our vendor funding reserves in the financial periods presented. At the end of each fiscal year, a significant portion of the actual purchase activity is known. Thus, we do not believe there is a reasonable likelihood that there will be a material change in the amounts recorded as vendor funding. We do not believe there is a significant collectability risk related to vendor funding amounts due to us at the end of fiscal 2022. If a 10% reserve had been applied against our outstanding vendor funding due as of December 31, 2022, net income would have been affected by approximately $2.6 million in fiscal 2022. Although it is unlikely that there will be any significant reduction in historical levels of vendor funding, if such a reduction were to occur in future periods, the Company could experience a higher inventory balance and higher cost of sales.For vendor funding, we estimate the purchase volume (and related vendor funding) based on our current knowledge of inventory levels, sales trends and expected customer demand, as well as planned new store openings and relocations. Although we believe we can reasonably estimate purchase volume and related volume rebates at interim periods, it is possible that actual year-end results could be different from previously estimated amounts. Our allocation methodology contains uncertainties because the calculation requires management to make assumptions and to apply judgment regarding customer demand, purchasing activity, target thresholds, vendor attrition and collectability.32IndexSelf-Insurance Reserves:We self-insure a significant portion of our workers’ compensation insurance and general liability (including product liability) insurance plans. We have stop-loss insurance policies to protect from individual losses over specified dollar values. Provisions for losses related to our self-insured liabilities are based upon periodic independent actuarially determined estimates that consider a number of factors including historical claims experience, loss development factors, and severity factors.The full extent of certain workers’ compensation and general liability claims may not become fully determined for several years. Our self-insured liabilities contain uncertainties because management is required to make assumptions and to apply judgment to estimate the ultimate cost to settle reported claims and claims incurred but not reported as of the balance sheet date based upon historical data and experience, including actuarial calculations.We have not made any material changes in the accounting methodology used to establish our self-insurance reserves in the financial periods presented. We do not believe there is a reasonable likelihood that there will be a material change in the assumptions we use to calculate insurance reserves. However, if we experience a significant increase in the number of claims or the cost associated with these claims, we may be exposed to losses that could be material. A 10% change in our self-insurance reserves as of December 31, 2022, would have affected net income by approximately $9.8 million in fiscal 2022.Impairment of Long-Lived Assets:Long-lived assets, including lease right-of-use assets, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. When evaluating long-lived assets for potential impairment, we first compare the carrying value of the asset or asset group to its estimated undiscounted future cash flows. The evaluation for long-lived assets is performed at the lowest level of identifiable cash flows, which is generally the individual store level. The significant assumptions used to determine estimated undiscounted cash flows include cash inflows and outflows directly resulting from the use of those assets in operations, including margin on net sales, payroll and related items, occupancy costs, insurance allocations, and other costs to operate a store. If the estimated future cash flows are less than the carrying value of the related asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the related asset or asset group to its estimated fair value, which may be based on an estimated future cash flow model, market valuation, or other valuation technique, as appropriate. We recognize an impairment loss if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If we recognize an impairment loss, the adjusted carrying amount of the asset becomes its new cost basis. For a depreciable long-lived asset, the new cost basis will be depreciated (amortized) over the remaining estimated useful life of that asset.Our impairment loss calculations contain uncertainties because they require management to make assumptions and to apply judgment to estimate future cash flows and asset fair values.We have not made any material changes in our impairment loss assessment methodology in the financial periods presented.We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate long-lived asset impairment losses. None of these estimates and assumptions are significantly sensitive, and a 10% change in any of these estimates would not have a material impact on our analysis. However, if actual results are not consistent with our estimates and assumptions used in estimating future cash flows and asset fair values, we may be exposed to losses that could be material. There were no significant long-lived assets impairment charges recognized in fiscal 2022.Impairment of Goodwill and Other Indefinite-Lived Intangible Assets:Goodwill and other indefinite-lived intangible assets are evaluated for impairment annually, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In accordance with the accounting standards, an entity has the option first to assess qualitative factors to determine whether events and circumstances indicate that it is more likely than not that goodwill or an indefinite-lived intangible asset is impaired. If after such assessment an entity concludes that the asset is not impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the asset using a quantitative impairment test, and if impaired, the associated assets must be written down to fair value. 33IndexThe quantitative impairment test for goodwill compares the fair value of a reporting unit with the carrying value of its net assets, including goodwill. If the fair value of the reporting unit is less than the carrying value of the reporting unit, an impairment charge would be recorded to the Company’s operations, for the amount in which the carrying amount exceeds the reporting unit’s fair value. We determine fair values for each reporting unit using the market approach, when available and appropriate, the income approach, or a combination of both. The income approach involves forecasting projected financial information (such as revenue growth rates, profit margins, tax rates, and capital expenditures) and selecting a discount rate that reflects the risk inherent in estimated future cash flows. Under the market approach, the fair value is based on observed market data. If multiple valuation methodologies are used, the results are weighted appropriately. The quantitative impairment test for other indefinite-lived intangible assets involves comparing the carrying amount of the asset to the sum of the discounted cash flows expected to be generated by the asset. If the implied fair value of the indefinite-lived intangible asset is less than the carrying value, an impairment charge would be recorded to the Company’s operations. Our impairment loss calculation contains uncertainties because they require management to make assumptions and to apply judgment to qualitative factors as well as estimate future cash flows and asset fair values, including forecasting projected financial information and selecting the discount rate that reflects the risk inherent in future cash flows.The valuation approaches utilized to estimate fair value for the purposes of the impairment tests of goodwill and other indefinite-lived intangible assets require the use of assumptions and estimates, which involve a degree of uncertainty. If actual results are not consistent with our estimates and assumptions used in estimating future cash flows and asset fair values, we may be exposed to non-cash impairment losses that could be material.There were no goodwill or other indefinite-lived intangible assets impairment charges recognized in fiscal 2022.Results of OperationsThe following table sets forth, for the periods indicated, certain items in the Consolidated Statements of Income expressed as a percentage of net sales.Fiscal Year 20222021Net sales100.00 %100.00 %Cost of merchandise sold (a)65.00 64.83 Gross margin (a)35.00 35.17 Selling, general and administrative expenses (a)22.48 22.78 Depreciation and amortization2.42 2.12 Operating income10.10 10.26 Interest expense, net0.22 0.21 Income before income taxes9.88 10.05 Income tax expense2.22 2.22 Net income7.66 %7.83 %(a) Our gross margin amounts may not be comparable to those of other retailers since some retailers include all of the costs related to their distribution facility network in cost of merchandise sold and others (like our Company) exclude a portion of these distribution facility network costs from gross margin and instead include them in selling, general, and administrative expenses; refer to Note 1 – Significant Accounting Policies of the Notes to the Consolidated Financial Statements, included in Item 8 Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.Fiscal 2022 Compared to Fiscal 2021 Net sales increased 11.6% to $14.20 billion in fiscal 2022 from $12.73 billion in fiscal 2021. The fiscal year included an extra sales week as part of the Company's 53-week fiscal calendar in 2022, which represented 1.8 percentage points of the 11.6% sales growth. Comparable store sales increased 6.3% to $13.80 billion versus a 16.9% increase in fiscal 2021. The comparable store average transaction value increased 6.9% and comparable store average transaction count decreased 0.6% for fiscal 2022, as compared to an increase of 9.8% and 7.1% in fiscal 2021, respectively. Comparable store sales growth reflects continued strength in every day, needs-based merchandise, including consumable, usable, and edible (“C.U.E.”) products, winter seasonal goods and year-round product categories, partially offset by a colder start to the spring selling season of fiscal 2022 along with 34Indexsevere drought during the summer months in many of our markets. The Company’s store sales in the prior year benefited from favorable weather conditions as well as government stimulus throughout fiscal 2021.In addition to comparable store sales growth in fiscal 2022, sales from stores opened less than one year were $396.2 million in fiscal 2022, which represented 3.1 percentage points of the 11.6% increase over fiscal 2021 net sales. Sales from stores opened less than one year were $324.6 million in fiscal 2021, which represented 3.1 percentage points of the 19.9% increase over fiscal 2020 net sales. The acquisition of Orscheln Farm and Home in October 2022 added approximately $80.0 million to net sales in the fourth quarter, which were included in the sales from stores opened less than one year in fiscal 2022. The following table summarizes our store growth during fiscal 2022 and 2021:Fiscal YearStore Count Information:20222021Tractor SupplyBeginning of period2,003 1,923 New stores opened63 80 Stores closed— — End of period2,066 2,003 Petsense by Tractor SupplyBeginning of period 178 182 New stores opened9 7 Stores closed(1)(11)End of period186 178 Orscheln Farm and HomeStores acquired81 — End of period81 — Consolidated end of period2,333 2,181 Stores relocated 7 3 The following table indicates the percentage of net sales represented by each of our major product categories during fiscal 2022 and 2021: Percent of Net SalesFiscal YearProduct Category:20222021Livestock and Pet50 %47 %Seasonal, Gift and Toy Products21 21 Hardware, Tools and Truck19 21 Clothing and Footwear7 8 Agriculture3 3 Total100 %100 %Gross profit increased 11.1% to $4.97 billion in fiscal 2022 compared to $4.48 billion in fiscal 2021. As a percent of net sales, gross margin decreased 17 basis points to 35.0% for fiscal 2022 compared to 35.2% for fiscal 2021. The decrease in gross margin as a percent of net sales was primarily driven by higher product cost inflation, higher transportation costs, and, to a lesser extent, product mix shift towards C.U.E. products, which run at a slightly lower margin rate. Heightened transportation costs were experienced in domestic and import freight, along with rising fuel prices. The Company's price management program and other key gross margin enhancing initiatives effectively offset a significant portion of these gross margin pressures.Total selling, general and administrative (“SG&A”) expenses, including depreciation and amortization, increased 11.6% to $3.54 billion in fiscal 2022 from $3.17 billion in fiscal 2021. The Company's strategic growth initiatives, including related depreciation and amortization, investments in team member compensation and benefits, and, to a lesser extent, the impact of transaction expenses and early integration costs associated with the Orscheln Farm and Home acquisition contributed to an increase in SG&A as a percent of net sales. The increase was partially offset by a reduction of COVID-19 response costs, more 35Indexnormalized incentive compensation, and leverage in occupancy and other costs from the increase in comparable stores sales. This culminated in SG&A expenses, as a percent of net sales, being flat at 24.9% compared to fiscal 2021.Our effective income tax rate increased to 22.5% for fiscal 2022 compared to 22.1% in fiscal 2021. The primary drivers for the increase in the Company's effective income tax rate were decreased share-based compensation activity and federal tax credits, partially offset by increased state income tax credits.Net income in fiscal 2022 was $1.09 billion, or $9.71 per diluted share, compared to $997.1 million, or $8.61 per diluted share, in fiscal 2021. The benefit of the 53rd week contributed approximately $0.16 to diluted EPS in fiscal 2022.During fiscal 2022, we repurchased approximately 3.4 million shares of the Company’s common stock at a total cost of $700.1 million as part of our share repurchase program. In fiscal 2021, we repurchased approximately 4.4 million shares at a total cost of $798.9 million.Fiscal 2021 Compared to Fiscal 2020 For a comparison of our performance and financial metrics for the fiscal years ended December 25, 2021 and December 26, 2020, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 25, 2021, filed with the SEC on February 17, 2022.Liquidity and Capital Resources In addition to normal operating expenses, our primary ongoing cash requirements are for new store expansion, existing store remodeling and improvements, store relocations, distribution facility capacity and improvements, information technology, inventory purchases, repayment of existing borrowings under our debt facilities, share repurchases, cash dividends, and selective acquisitions as opportunities arise. Our primary ongoing sources of liquidity are existing cash balances, cash provided from operations, remaining funds available under our debt facilities, operating and finance leases, and normal trade credit. Our inventory and accounts payable levels typically build in the first and third fiscal quarters to support the higher sales volume of the spring and cold-weather selling seasons, respectively.We believe that our existing cash balances, expected cash flow from future operations, funds available under our debt facilities, operating and finance leases, normal trade credit, and access to the long-term debt capital markets will be sufficient to fund our operations and capital allocation needs through the end of fiscal 2023.36IndexWorking CapitalAt December 31, 2022, the Company had working capital of $781.6 million, which decreased $404.0 million from fiscal 2021. The shifts in working capital were attributable to changes in the following components of current assets and current liabilities (in millions): December 31, 2022December 25, 2021VarianceCurrent assets: Cash and cash equivalents$202.5 $878.0 $(675.5)Inventories2,709.6 2,191.2 518.4 Prepaid expenses and other current assets245.7 164.1 81.6 Income taxes receivable— 17.1 (17.1)Total current assets3,157.8 3,250.4 (92.6)Current liabilities: Accounts payable1,398.3 1,155.6 242.7 Accrued employee compensation120.3 109.6 10.7 Other accrued expenses498.6 474.4 24.2 Current portion of finance lease obligations3.2 3.9 (0.7)Current portion of operating lease obligations346.4 321.3 25.1 Income taxes payable9.5 — 9.5 Total current liabilities2,376.2 2,064.8 311.4 Working capital$781.6 $1,185.6 $(404.0)Note: amounts may not sum to totals due to roundingIn comparison to December 25, 2021, working capital as of December 31, 2022 was impacted most significantly by changes in cash and cash equivalents, inventories, and accounts payable.•The decrease in cash and cash equivalents was primarily driven by capital expenditures to support strategic growth, share repurchases, cash dividends to stockholders, and the acquisition of Orscheln Farm and Home, partially offset by positive cash flows generated from operations and net borrowings under the Company’s debt facilities.•The increase in inventories and accounts payable resulted from an increase in average inventory per store driven by our commitment to support our strong sales trends, combined with the impact inflation had on retail prices. Additionally, overall inventory and accounts payable levels increased from the acquisition of Orscheln and the purchase of additional inventory to support new store growth. 37IndexDebtThe following table summarizes the Company’s outstanding debt as of the dates indicated (in millions):December 31,2022December 25,20211.75% Senior Notes$650.0 $650.0 3.70% Senior Notes150.0 150.0 Senior Credit Facility:November 2020 Term Loan— 200.0 Revolving Credit Facility378.00 — Total outstanding borrowings1,178.0 1,000.0 Less: unamortized debt discounts and issuance costs(13.9)(13.6)Total debt1,164.1 986.4 Less: current portion of long-term debt— — Long-term debt$1,164.1 $986.4 Outstanding letters of credit$52.6 $52.9 We manage our business and financial ratios to target an investment-grade bond rating, which has historically allowed flexible access to financing at reasonable market costs. As of December 31, 2022, and the date of this filing, February 23, 2023, the Company's senior unsecured debt is rated “Baa1,” by Moody’s Investor Services with a stable outlook and “BBB” by Standard & Poor’s with a stable outlook. These ratings have been obtained with the understanding that Moody’s Investors Services and Standard & Poor’s will continue to monitor our credit and make future adjustments to these ratings to the extent warranted. The ratings are not a recommendation to buy, sell or hold our securities, may be changed, superseded or withdrawn at any time and should be evaluated independently of any other rating.Our current ratings, as well as future rating agency actions, could impact our ability to finance our operations on satisfactory terms and affect our financing costs. There can be no assurance that we will maintain or improve our current credit ratings. On September 30, 2022, we entered into a new credit agreement, providing for a credit facility (the “2022 Senior Credit Facility”), consisting of a revolving credit facility (the “Revolving Credit Facility”) in the maximum principal amount of $1.20 billion (with a sublimit of $50.0 million for swingline loans and a sublimit of $150.0 million for letters of credit). In addition, we have an option to increase the Revolving Credit Facility or establish term loans in an amount not to exceed $500.0 million in the aggregate, subject to, among other things, the receipt of commitments for the increase amount. The 2022 Senior Credit Facility is unsecured and has a five year term with two options to request that the lenders extend the maturity date of the obligations owed to each lender for one year (and the right to replace any lenders electing not to extend).For additional information about the Company’s debt and credit facilities, refer to Note 5 to the Consolidated Financial Statements. Sources and Uses of CashOur primary source of liquidity is cash provided by operations and funds available under our debt facilities. Principal uses of cash for investing activities are capital expenditures and acquisitions while principal uses of cash for financing activities are repurchase of the Company’s common stock and cash dividends paid to stockholders. 38IndexThe following table presents a summary of cash flows provided by or used in operating, investing, and financing activities for fiscal years 2022 and 2021 (in millions):Fiscal Year 20222021(53 weeks)(52 weeks)Net cash provided by operating activities$1,357.0 $1,138.7 Net cash used in investing activities(1,093.7)(627.3)Net cash used in financing activities(938.8)(975.1)Net decrease in cash and cash equivalents$(675.5)$(463.7)Operating ActivitiesOperating activities provided cash of $1.36 billion and $1.14 billion in fiscal 2022 and 2021, respectively. The $218.3 million increase in net cash provided by operating activities in fiscal 2022, compared to fiscal 2021, was due to changes in the following (in millions): Fiscal YearVariance 20222021(53 weeks)(52 weeks)Net income$1,088.7 $997.1 $91.6 Depreciation and amortization343.1 270.2 72.9 Share-based compensation expense53.8 47.6 6.2 Deferred income taxes51.7 29.1 22.6 Inventories and accounts payable(187.4)(228.4)41.0 Prepaid expenses and other current assets(64.1)(30.5)(33.6)Accrued expenses(6.7)127.8 (134.5)Income taxes26.6 (37.0)63.6 Other, net51.3 (37.2)88.5 Net cash provided by operating activities$1,357.0 $1,138.7 $218.3 The $218.3 million increase in net cash provided by operating activities in fiscal 2022, compared to fiscal 2021, is primarily driven by a year-over-year increase in our net income as well as the net impact of changes in our operating assets and liabilities, primarily due to the Company's strategic initiatives as well as the timing of accruals and related payments.Investing ActivitiesInvesting activities used cash of $1.09 billion and $627.3 million in fiscal 2022 and 2021, respectively. The $466.4 million increase in net cash used in investing activities primarily reflects the acquisition of Orscheln Farm and Home as well as an increase in capital expenditures in fiscal 2022 compared to fiscal 2021, partially offset by cash received from Orscheln stores divestitures.39IndexInvesting activities, including capital expenditures, for fiscal 2022 and 2021 were as follows (in millions):Fiscal YearVariance 20222021(53 weeks)(52 weeks)Existing stores$367.7 $326.9 $40.8 Distribution center capacity and improvements156.1 93.3 62.8 New and relocated stores and stores not yet opened126.7 73.0 53.7 Information technology119.5 124.8 (5.3)Corporate and other3.4 10.4 (7.0)Total capital expenditures$773.4 $628.4 $145.0 Proceeds from sale of property and equipment(1.0)(1.1)0.1 Acquisition of Orscheln, net of cash acquired390.8 — 390.8 Proceeds from sale of business assets(69.4)— $(69.4)Net cash used in investing activities$1,093.7 $627.3 $466.4 The increase in spending for existing stores in fiscal 2022 as compared to fiscal 2021 primarily reflects our strategic initiatives related to store remodels, including internal space productivity and the outside garden center transformations. Spending in both fiscal 2022 and fiscal 2021 also includes routine refresh activity, as well as security enhancements.The increase in spending for distribution center capacity and improvements in fiscal 2022 as compared to fiscal 2021 is primarily related to the construction of new distribution centers in Navarre, Ohio and Maumelle, Arkansas. On January 18, 2023, the Company opened its ninth distribution center located in Navarre, Ohio, which expanded the distribution center capacity by approximately 900,000 square feet. The Maumelle, Arkansas distribution center is currently expected to begin operations in the first quarter of fiscal 2024 and will expand our distribution capacity by approximately 1,200,000 square feet. The above table reflects an investment in 63 new Tractor Supply stores, nine new Petsense by Tractor Supply stores, and seven store relocations during fiscal 2022. In fiscal 2021, we opened 80 new Tractor Supply stores and seven new Petsense by Tractor Supply stores and had three store relocations. The increase in spending for new and relocated stores and stores not yet opened in fiscal 2022 as compared to fiscal 2021 is primarily due to the timing of stores openings, as well as acceleration of spend in 2022 for stores expected to open in 2023.The spending on information technology represents continued support of our store growth and our omni-channel initiatives, as well as improvements in security and compliance and other strategic initiatives. Overall cash flow used in investing activities was also impacted by the acquisition of Orscheln Farm and Home and the subsequent store divestitures to Bomgaars Supply, Inc. and Buchheit Enterprises, Inc.Our projected capital expenditures for fiscal 2023 are currently estimated to be in a range of approximately $700.0 million to $775.0 million. The capital expenditures include a plan to open approximately 70 new Tractor Supply stores, complete the Orscheln conversions to Tractor Supply, continue the remodeling of our stores (“Project Fusion”) and garden center transformations, and open 10 to 15 new Petsense by Tractor Supply stores. Additionally, we anticipate the continued build out of our tenth distribution center in Maumelle, Arkansas during 2023 with operations beginning in the first quarter of fiscal 2024. We also plan to support our continued improvements in technology and infrastructure at our existing stores, along with ongoing investments to enhance our digital and omni-channel capabilities to better serve our customers.Financing ActivitiesFinancing activities used cash of $938.8 million and $975.1 million in fiscal 2022 and 2021, respectively. The $36.3 million decrease in net cash used in financing activities in fiscal 2022, compared to fiscal 2021, was due to changes in the following (in millions): 40IndexFiscal Year 20222021Variance(53 weeks)(52 weeks)Net borrowings and repayments under debt facilities$(178.0)$— $(178.0)Repurchase of common stock700.1 798.9 (98.8)Net proceeds from issuance of common stock(25.5)(82.2)56.7 Cash dividends paid to stockholders409.6 239.0 170.6 Other, net32.6 19.4 13.2 Net cash used in financing activities$938.8 $975.1 $(36.3)The decrease in net cash used in financing activities in fiscal 2022, compared to fiscal 2021, is primarily due to borrowings under our new 2022 Senior Credit Facility and increased returns of capital to our stockholders in the form of cash dividends and repurchases of common stock. Repurchase of Common StockThe Company’s Board of Directors has authorized common stock repurchases under a share repurchase program which was announced in February 2007. The authorization amount of the program, which has been increased from time to time, is currently authorized for up to $6.50 billion, exclusive of any fees, commissions or other expenses related to such repurchases. The authorized amount reflects a $2.00 billion increase to the share repurchase program which was approved by our Board of Directors on January 26, 2022. The share repurchase program does not have an expiration date. The repurchases may be made from time to time on the open market or in privately negotiated transactions. The timing and amount of any shares repurchased under the program will depend on a variety of factors, including price, corporate and regulatory requirements, capital availability, and other market conditions. Repurchased shares are accounted for at cost and will be held in treasury for future issuance. The program may be limited, temporarily paused, or terminated at any time without prior notice. We repurchased approximately 3.4 million and 4.4 million shares of common stock under the share repurchase program at a total cost of $700.1 million and $798.9 million in fiscal 2022 and 2021, respectively. Our projected share repurchases for fiscal 2023 are currently estimated to be in a range of approximately $575 million to $675 million. Cash Dividends Paid to StockholdersWe paid cash dividends totaling $409.6 million and $239.0 million in fiscal 2022 and 2021, respectively. In fiscal 2022, we declared and paid cash dividends to stockholders of $3.68 per common share outstanding as compared to $2.08 per common share outstanding in fiscal 2021. These payments reflect an increase in the quarterly dividend in all four quarters of fiscal 2022 to $0.92 per share from $0.52 per share in all four quarters of fiscal 2021. On February 8, 2023, the Company’s Board of Directors declared a quarterly cash dividend of $1.03 per share of the Company’s outstanding common stock. The dividend will be paid on March 14, 2023, to stockholders of record as of the close of business on February 27, 2023.It is the present intention of the Company’s Board of Directors to continue to pay a quarterly cash dividend; however, the declaration and payment amount of future dividends will be determined by the Company’s Board of Directors in its sole discretion and will depend upon the earnings, financial condition, and capital needs of the Company, along with any other factors which the Company’s Board of Directors deem relevant.New Accounting PronouncementsRefer to Note 1 to the Consolidated Financial Statements for recently adopted accounting pronouncements and recently issued pronouncements not yet adopted as of December 31, 2022.41IndexItem 7A. Quantitative and Qualitative Disclosures About Market RiskInterest Rate RiskWe are exposed to interest rate changes, primarily as a result of borrowings under our 2022 Senior Credit Facility (as discussed in Note 5 to the Consolidated Financial Statements), which bear interest based on variable rates. We use an interest rate swap to manage our exposure to the impact of interest rate changes. Prior to the issuance of our 2022 Senior Credit Facility on September 30, 2022, our variable-rate debt was fully hedged. At December 31, 2022, we had $378.0 million outstanding under the 2022 Senior Credit Facility, of which $200.0 million was hedged by the interest rate swap. Fixed-rate debt and variable-rate debt covered by the interest rate swap represented 85% of total outstanding debt as of December 31, 2022. Therefore, fluctuations in interest rates did not have a material impact on our financial condition and results of operations. Purchase Price VolatilityAlthough we cannot determine the full effect of inflation and deflation on our operations, we believe our sales and results of operations are affected by both. We are subject to market risk with respect to the pricing of certain products and services, which include, among other items, grain, corn, steel, petroleum, cotton, and other commodities, as well as duties, tariffs, diesel fuel, and transportation services. Therefore, we may experience both inflationary and deflationary pressure on product cost, which may impact consumer demand and, as a result, sales and gross margin. Our strategy is to reduce or mitigate the effects of purchase price volatility, principally by taking advantage of vendor incentive programs, economies of scale from increased volume of purchases, adjusting retail prices, and selectively buying from the most competitive vendors without sacrificing quality.42Index
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+Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following is a discussion and analysis of the Company’s financial condition and results of operations for the years ended December 31, 2022 and 2021, including year-to-year comparisons between 2022 and 2021. Year-to-year comparisons between 2021 and 2020 have been omitted from this Form 10-K, but may be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2021. FINANCIAL HIGHLIGHTS2022 Consolidated Results of Operations•Net income of $2.84 billion, or $11.91 per share basic and $11.77 per share diluted•Net earned premiums of $33.76 billion •Catastrophe losses of $1.88 billion ($1.48 billion after-tax)•Net favorable prior year reserve development of $649 million ($512 million after-tax)•Combined ratio of 95.6% •Net investment income of $2.56 billion ($2.17 billion after-tax)•Operating cash flows of $6.47 billion 2022 Consolidated Financial Condition•Total investments of $80.45 billion; fixed maturities and short-term securities comprise 93% of total investments•Total assets of $115.72 billion •Total debt of $7.29 billion, resulting in a debt-to-total capital ratio of 25.3% (21.6% excluding net unrealized investment losses, net of tax, included in shareholders' equity)•Total capital returned to shareholders of $2.94 billion, comprising $2.06 billion of share repurchases and $880 million of dividends•Shareholders’ equity of $21.56 billion •Net unrealized investment losses of $6.22 billion ($4.90 billion after-tax)•Book value per common share of $92.90•Holding company liquidity of $1.45 billion 59CONSOLIDATED OVERVIEWConsolidated Results of Operations(for the year ended December 31, in millions except per share amounts)202220212020Revenues Premiums$33,763 $30,855 $29,044 Net investment income2,562 3,033 2,227 Fee income412 402 429 Net realized investment gains (losses)(204)171 2 Other revenues351 355 279 Total revenues36,884 34,816 31,981 Claims and expenses Claims and claim adjustment expenses22,854 20,298 19,123 Amortization of deferred acquisition costs5,515 5,043 4,773 General and administrative expenses4,810 4,677 4,509 Interest expense351 340 339 Total claims and expenses33,530 30,358 28,744 Income before income taxes3,354 4,458 3,237 Income tax expense512 796 540 Net income$2,842 $3,662 $2,697 Net income per share Basic$11.91 $14.63 $10.56 Diluted$11.77 $14.49 $10.52 Combined ratio Loss and loss adjustment expense ratio67.1 %65.1 %65.1 %Underwriting expense ratio28.5 29.4 29.9 Combined ratio95.6 %94.5 %95.0 %The following discussions of the Company’s net income and segment income (loss) are presented on an after-tax basis. Discussions of the components of net income and segment income (loss) are presented on a pre-tax basis, unless otherwise noted. Discussions of earnings per common share are presented on a diluted basis.OverviewDiluted net income per share of $11.77 in 2022 decreased by 19% from diluted net income per share of $14.49 in 2021. Net income of $2.84 billion in 2022 decreased by 22% from net income of $3.66 billion in 2021. The lower rate of decrease in diluted net income per share reflected the impact of share repurchases in recent periods. The decrease in income before income taxes primarily reflected the pre-tax impacts of (i) lower net investment income, (ii) net realized investment losses compared to net realized investment gains in 2021 and (iii) lower underwriting margins excluding catastrophe losses and prior year reserve development ("underlying underwriting margins"), partially offset by (iv) higher net favorable prior year reserve development. Net favorable prior year reserve development in 2022 and 2021 was $649 million and $538 million, respectively. Catastrophe losses in 2022 and 2021 were $1.88 billion and $1.85 billion, respectively. The lower underlying underwriting margins in 2022 were driven by Personal Insurance, partially offset by Business Insurance and Bond & Specialty Insurance. Underlying underwriting margins in 2021 reflected a net favorable impact associated with the pandemic. Income tax expense in 2022 was lower than in 2021, primarily reflecting the impact of the decrease in income before income taxes and a $47 million reduction in income tax expense in the first quarter of 2022 as a result of the resolution of prior year tax matters. The Company has insurance operations in Canada, the United Kingdom, the Republic of Ireland and throughout other parts of the world as a corporate member of Lloyd’s, as well as in Brazil and Colombia, primarily through joint ventures. Because these operations are conducted in local currencies other than the U.S. dollar, the Company is subject to changes in foreign currency exchange rates. For the years ended December 31, 2022 and 2021, changes in foreign currency exchange rates had the impact of lowering the reported line items in the statement of income by insignificant amounts. The impact of these changes was not material to the Company’s net income or segment income for the periods reported. 60RevenuesEarned PremiumsEarned premiums in 2022 were $33.76 billion, $2.91 billion or 9% higher than in 2021. In Business Insurance, earned premiums in 2022 increased by 9% over 2021. Earned premiums in Business Insurance in 2021 were negatively impacted by lower net written premiums primarily in the latter half of 2020 due to a modest reduction in exposures and a decrease in new business volume, in each case impacted by COVID-19 and related economic conditions. In Bond & Specialty Insurance, earned premiums in 2022 increased by 9% over 2021. In Personal Insurance, earned premiums in 2022 increased by 11% over 2021. Earned premiums in Bond & Specialty Insurance and Personal Insurance in 2021 were not materially impacted by COVID-19 and related economic conditions. Factors contributing to the change in earned premiums in each segment in 2022 as compared with 2021 are discussed in more detail in the segment discussions that follow. Net Investment IncomeThe following table sets forth information regarding the Company’s investments.(for the year ended December 31, in millions)202220212020Average investments(1)$87,191 $83,574 $78,070 Pre-tax net investment income2,562 3,033 2,227 After-tax net investment income2,170 $2,541 1,908 Average pre-tax yield(2)2.9 %3.6 %2.9 %Average after-tax yield(2)2.5 %3.0 %2.4 %___________________________________________(1)Excludes net unrealized investment gains and losses and reflects cash, receivables for investment sales, payables on investment purchases and accrued investment income.(2)Excludes net realized and net unrealized investment gains and losses.Net investment income in 2022 was $2.56 billion, $471 million or 16% lower than in 2021. Net investment income from fixed maturity investments in 2022 was $2.11 billion, $124 million higher than in 2021. The increase primarily resulted from a higher average level of fixed maturity investments and higher average yields. Net investment income from short-term securities in 2022 was $73 million, $66 million higher than in 2021. The increase primarily resulted from higher short-term average yields, partially offset by a lower level of short-term investments. The Company's remaining investment portfolios had net investment income of $419 million in 2022, $658 million lower than in 2021, primarily reflecting the impact of lower returns from private equity partnerships as compared to very strong returns in 2021. Included in other investments are private equity, hedge fund and real estate partnerships that are accounted for under the equity method of accounting and typically report their financial statement information to the Company one month to three months following the end of the reporting period. Accordingly, net investment income from these other investments is generally reflected in the Company's financial statements on a quarter lag basis. Fee IncomeFee income in 2022 was $412 million, $10 million higher than in 2021. The National Accounts market in Business Insurance is the primary source of the Company’s fee-based business and is discussed in the Business Insurance segment discussion that follows. 61Net Realized Investment Gains (Losses)The following table sets forth information regarding the Company’s net pre-tax realized investment gains (losses).(for the year ended December 31, in millions)202220212020Impairment gains (losses): Fixed maturities$(26)$(2)$(15)Real estate investments(12)— — Other investments— — (40)Net realized investment gains (losses) on equity securities still held(61)78 27 Other net realized investment gains (losses), including from sales(105)95 30 Total$(204)$171 $2 Net realized investment losses on equity securities still held of $61 million in 2022 were driven by the impact of changes in fair value attributable to unfavorable equity markets. Net realized investment gains on equity securities still held of $78 million in 2021 were driven by the impact of changes in fair value attributable to favorable equity markets.Other net realized investment losses in 2022 included $72 million of net realized investment losses related to fixed maturity investments, $8 million of net realized investment losses related to equity securities sold and $25 million of net realized investment losses related to other investments. Other net realized investment gains in 2021 included $69 million of net realized investment gains related to fixed maturity investments, $17 million of net realized investment gains related to equity securities sold and $9 million of net realized investment gains related to other investments. Other RevenuesOther revenues in 2022 were $351 million, $4 million lower than 2021. Other revenues include revenues from Simply Business, installment premium charges and other policyholder service charges. Other revenues from Simply Business were negatively impacted by changes in foreign currency exchange rates. Claims and ExpensesClaims and Claim Adjustment ExpensesClaims and claim adjustment expenses in 2022 were $22.85 billion, $2.56 billion or 13% higher than 2021, primarily reflecting the impacts of (i) higher business volumes, (ii) loss cost trends, including elevated losses in both the automobile and homeowners and other product lines in Personal Insurance and (iii) favorable loss activity associated with the pandemic in 2021 in Business Insurance, partially offset by (iv) higher net favorable prior year reserve development. Catastrophes in 2022 primarily resulted from a significant winter storm that impacted most of the U.S. and parts of Canada and Hurricanes Ian and Fiona, as well as severe wind and hail storms in several regions of the United States. Catastrophes in 2021 primarily resulted from winter storms, Hurricane Ida, tornado activity in Kentucky and severe wind and hail storms in several regions of the United States, as well as a wildfire in Colorado. Catastrophe and non-catastrophe weather-related losses in 2021 were reduced by the full $350 million of recoveries available under the Company's 2021 Underlying Property Aggregate Catastrophe Excess-of-Loss Reinsurance Treaty.Factors contributing to net favorable prior year reserve development during the years ended December 31, 2022, 2021 and 2020 are discussed in more detail in note 8 of the notes to the consolidated financial statements.Significant Catastrophe LossesThe Company defines a “catastrophe” as an event:•that is designated a catastrophe by internationally recognized organizations that track and report on insured losses resulting from catastrophic events, such as Property Claim Services (PCS) for events in the United States and Canada; and•for which the Company’s estimates of its ultimate losses before reinsurance and taxes exceed a pre-established dollar threshold.62The Company’s threshold for disclosing catastrophes is primarily determined at the reportable segment level. If a threshold for one segment or a combination thereof is exceeded and the other segments have losses from the same event, losses from the event are identified as catastrophe losses in the segment results and for the consolidated results of the Company. Additionally, an aggregate threshold is applied for International business across all reportable segments. The threshold for 2022 ranged from approximately $20 million to $30 million of losses before reinsurance and taxes.The following table presents the amount of losses recorded by the Company for significant catastrophes that occurred in 2022, 2021 and 2020, the amount of net unfavorable (favorable) prior year reserve development recognized in 2022 and 2021 for catastrophes that occurred in 2021 and 2020, and the estimate of ultimate losses for those catastrophes at December 31, 2022, 2021 and 2020. For purposes of the table, a significant catastrophe is an event for which the Company estimates its ultimate losses will be $100 million or more after reinsurance and before taxes. Losses Incurred / Unfavorable (Favorable)Prior Year Reserve Development for the Year Ended December 31,Estimated Ultimate Losses atDecember 31,(in millions, pre-tax and net of reinsurance)(1)2022202120202022202120202020PCS Serial Number:16 — Tennessee tornado activity3 (9)151145 142 15119 — Severe storms(2)(9)134123 125 13420 — Severe storms6 (25)165146 140 16533 — Civil unrest(7)(7)10086 93 10044 — Tropical Storm Isaias3 (22)140121 118 14046 — Midwest derecho3 (10)212205 202 21268 — California wildfire - Glass fire (2)(19)(9)145117 136 1452021PCS Serial Number:15 — Winter storm(13)228 n/a215 228 n/a17 — Winter storm(25)508 n/a483 508 n/a29 — Severe wind storms(12)105 n/a93 105 n/a60 — Hurricane Ida(81)417 n/a336 417 n/a76 — Tornado outbreak(18)131 n/a113 131 n/a2022PCS Serial Number:33 — Severe wind and hail storms137 n/an/a137 n/an/a35 — Severe wind and hail storms184 n/an/a184 n/an/a43 — Severe wind and hail storms122 n/an/a122 n/an/a61 — Hurricane Ian227 n/an/a227 n/an/a73 — Winter storm512 n/an/a512 n/an/a___________________________________________(1) Amounts are reported pre-tax and net of recoveries under all applicable reinsurance treaties, except for the Company's 2022, 2021 and 2020 Underlying Property Aggregate Catastrophe Excess-of-Loss Treaties. Those treaties covered the accumulation of certain property losses arising from one or multiple occurrences (both catastrophe and non-catastrophe events) for the period January 1, 2022 through and including December 31, 2022, the period January 1, 2021 through and including December 31, 2021 and the period January 1, 2020 through and including December 31, 2020, respectively. As a result, the benefit from the 2021 and 2020 treaties are not included in the table as the allocation of the treaties' benefit to each identified catastrophe changes each time there are additional events or changes in estimated losses from any covered event. (2) In addition to the Glass fire, there were 16 other PCS-designated wildfires in 2020. While none of the 16 wildfires were individually large enough to meet the Company's threshold for disclosure as a significant catastrophe in this table, total losses in 2020 from those wildfires were $169 million, of which two wildfires totaling $73 million met the Company's threshold for disclosure as catastrophes.n/a: not applicable.63Amortization of Deferred Acquisition CostsAmortization of deferred acquisition costs in 2022 was $5.52 billion, $472 million or 9% higher than in 2021. The increase in 2022 was generally consistent with the increase in earned premiums. Amortization of deferred acquisition costs is discussed in more detail in the segment discussions that follow. General and Administrative ExpensesGeneral and administrative expenses in 2022 were $4.81 billion, $133 million or 3% higher than in 2021, primarily reflecting the impact of costs associated with higher business volumes. General and administrative expenses in 2021 included the benefit of lower net expenses related to COVID-19 and related economic conditions. General and administrative expenses are discussed in more detail in the segment discussions that follow.Interest ExpenseInterest expense in 2022 and 2021 was $351 million and $340 million, respectively.Income Tax ExpenseIncome tax expense in 2022 was $512 million, $284 million or 36% lower than in 2021, primarily reflecting the impact of the $1.10 billion decrease in income before income taxes in 2022 and the $47 million reduction in income tax expense in the first quarter of 2022 as a result of the resolution of prior year tax matters.The Company’s effective tax rate was 15% and 18% in 2022 and 2021, respectively. The effective tax rates in both years were lower than the statutory rate of 21%, primarily due to the impact of tax-exempt investment income on the calculation of the Company’s income tax provision. In addition, the effective tax rate for 2022 was reduced by the impact of the resolution of prior year tax matters discussed above. Combined RatioThe combined ratio of 95.6% in 2022 was 1.1 points higher than the combined ratio of 94.5% in 2021. The loss and loss adjustment expense ratio of 67.1% in 2022 was 2.0 points higher than the loss and loss adjustment expense ratio of 65.1% in 2021. The underwriting expense ratio of 28.5% in 2022 was 0.9 points lower than the underwriting expense ratio of 29.4% in 2021. Catastrophe losses in 2022 and 2021 accounted for 5.5 points and 6.0 points, respectively, of the combined ratio. Net favorable prior year reserve development in 2022 and 2021 provided 1.9 points and 1.8 points of benefit, respectively, to the combined ratio. The combined ratio excluding prior year reserve development and catastrophe losses ("underlying combined ratio") in 2022 was 1.7 points higher than the 2021 ratio on the same basis, primarily reflecting the impacts of (i) elevated losses in both the automobile and homeowners and other product lines in Personal Insurance and (ii) a favorable impact associated with the pandemic in 2021 in Business Insurance, partially offset by (iii) the benefit of earned pricing in Business Insurance and Bond & Specialty Insurance and (iv) a lower expense ratio.The combined ratio continues to be impacted by the tort environment, including more aggressive attorney involvement in insurance claims.64Written PremiumsConsolidated gross and net written premiums were as follows: Gross Written Premiums(for the year ended December 31, in millions)202220212020Business Insurance$19,521 $17,829 $17,060 Bond & Specialty Insurance4,082 3,725 3,184 Personal Insurance14,273 12,690 11,519 Total$37,876 $34,244 $31,763 Net Written Premiums(for the year ended December 31, in millions)202220212020Business Insurance$17,635 $16,092 $15,431 Bond & Specialty Insurance3,732 3,376 2,951 Personal Insurance14,047 12,491 11,350 Total$35,414 $31,959 $29,732 Gross and net written premiums in 2022 both increased by 11% over 2021. Factors contributing to the changes in gross and net written premiums in each segment are discussed in more detail in the segment discussions that follow.RESULTS OF OPERATIONS BY SEGMENTBusiness InsuranceResults of Business Insurance were as follows:(for the year ended December 31, in millions)202220212020Revenues Earned premiums$17,095 $15,734 $15,294 Net investment income1,864 2,265 1,633 Fee income382 375 405 Other revenues248 235 176 Total revenues19,589 18,609 17,508 Total claims and expenses16,522 15,725 15,986 Segment income before income taxes3,067 2,884 1,522 Income tax expense536 499 213 Segment income$2,531 $2,385 $1,309 Loss and loss adjustment expense ratio62.8 %65.0 %69.4 %Underwriting expense ratio29.7 30.7 30.9 Combined ratio92.5 %95.7 %100.3 %65OverviewSegment income in 2022 was $2.53 billion, $146 million or 6% higher than segment income of $2.39 billion in 2021. The increase in segment income before income taxes primarily reflected the pre-tax impacts of (i) higher underlying underwriting margins, (ii) higher net favorable prior year reserve development and (iii) lower catastrophe losses, partially offset by (iv) lower net investment income. Net favorable prior year reserve development in 2022 and 2021 was $381 million and $173 million, respectively. Catastrophe losses in 2022 and 2021 were $654 million and $793 million, respectively. The higher underlying underwriting margins primarily reflected the impacts of (i) higher business volumes and (ii) the benefit of earned pricing, partially offset by (iii) a favorable impact associated with the pandemic in 2021. Income tax expense in 2022 was higher than in 2021, primarily reflecting the impact of the increase in segment income before income taxes. RevenuesEarned PremiumsEarned premiums in 2022 were $17.10 billion, $1.36 billion or 9% higher than in 2021, primarily reflecting the increase in net written premiums over the preceding twelve months. Earned premiums in 2021 were negatively impacted by lower net written premiums primarily in the latter half of 2020 due to a modest reduction in exposures and a decrease in new business volume, in each case impacted by COVID-19 and related economic conditions. Net Investment IncomeNet investment income in 2022 was $1.86 billion, $401 million or 18% lower than in 2021. Refer to the “Net Investment Income” section of the “Consolidated Results of Operations” discussion for a description of the factors contributing to the decrease in the Company’s consolidated net investment income in 2022 compared with 2021. In addition, refer to note 2 of the notes to the consolidated financial statements for a discussion of the Company’s net investment income allocation methodology. Fee IncomeNational Accounts is the primary source of fee income due to revenue from its large deductible policies and service businesses, which include risk management, claims administration, loss control and risk management information services provided to third parties, as well as policy issuance and claims management services to workers’ compensation residual market pools. Fee income in 2022 was $382 million, $7 million or 2% higher than in 2021, primarily reflecting higher serviced premium volume from the workers' compensation residual market pool, partially offset by lower claim volume under administration associated with large deductible policies. Other RevenuesOther revenues in 2022 were $248 million, $13 million or 6% higher than in 2021, and include the receipt of a surplus distribution from a state workers' compensation fund. Other revenues also included revenues from Simply Business, installment premium charges and other policyholder service charges. Other revenues from Simply Business were negatively impacted by changes in foreign currency exchange rates. Claims and ExpensesClaims and Claim Adjustment ExpensesClaims and claim adjustment expenses in 2022 were $10.91 billion, $509 million or 5% higher than in 2021, primarily reflecting the impacts of (i) loss cost trends, (ii) higher business volumes and (iii) favorable loss activity associated with the pandemic in 2021, partially offset by (iv) higher net favorable prior year reserve development and (v) lower catastrophe losses. Catastrophe losses and non-catastrophe weather-related losses in 2021 were reduced by recoveries under the Company's 2021 Underlying Property Aggregate Catastrophe Excess-of-Loss Reinsurance Treaty. Factors contributing to net prior year reserve development during the years ended December 31, 2022, 2021 and 2020 are discussed in more detail in note 8 of the notes to the consolidated financial statements. 66Amortization of Deferred Acquisition CostsAmortization of deferred acquisition costs in 2022 was $2.79 billion, $207 million or 8% higher than in 2021, generally consistent with the increase in earned premiums. General and Administrative ExpensesGeneral and administrative expenses in 2022 were $2.83 billion, $81 million or 3% higher than in 2021, primarily reflecting the impact of higher business volumes. General and administrative expenses in 2021 included the benefit of lower travel-related expenses attributable to COVID-19 and related economic conditions.Income Tax ExpenseIncome tax expense in 2022 was $536 million, $37 million or 7% higher than in 2021, primarily reflecting the impact of the $183 million increase in segment income before income taxes in 2022. Income tax expense in 2022 was reduced by $3 million as a result of the resolution of prior year tax matters.Combined RatioThe combined ratio of 92.5% in 2022 was 3.2 points lower than the combined ratio of 95.7% in 2021. The loss and loss adjustment expense ratio of 62.8% in 2022 was 2.2 points lower than the loss and loss adjustment expense ratio of 65.0% in 2021. The underwriting expense ratio of 29.7% in 2022 was 1.0 points lower than the underwriting expense ratio of 30.7% in 2021. Catastrophe losses in 2022 and 2021 accounted for 3.8 points and 5.1 points, respectively, of the combined ratio. Net favorable prior year reserve development in 2022 and 2021 provided 2.2 points and 1.1 points of benefit, respectively, to the combined ratio. The underlying combined ratio in 2022 was 0.8 points lower than the 2021 ratio on the same basis, primarily reflecting the impacts of (i) a lower expense ratio and (ii) the benefit of earned pricing, partially offset by (iii) a favorable impact associated with the pandemic in 2021.Written PremiumsBusiness Insurance’s gross and net written premiums by market were as follows: Gross Written Premiums(for the year ended December 31, in millions)202220212020Domestic: Select Accounts$3,126 $2,860 $2,848 Middle Market10,532 9,487 9,017 National Accounts1,642 1,517 1,540 National Property and Other2,942 2,701 2,460 Total Domestic18,242 16,565 15,865 International1,279 1,264 1,195 Total Business Insurance$19,521 $17,829 $17,060 67 Net Written Premiums(for the year ended December 31, in millions)202220212020Domestic: Select Accounts$3,099 $2,833 $2,821 Middle Market9,923 8,933 8,511 National Accounts1,085 987 996 National Property and Other2,467 2,265 2,086 Total Domestic16,574 15,018 14,414 International1,061 1,074 1,017 Total Business Insurance$17,635 $16,092 $15,431 Gross and net written premiums in 2022 increased by 9% and 10%, respectively, over 2021. Select Accounts. Net written premiums of $3.10 billion in 2022 increased by 9% over 2021. Retention rates remained strong in 2022 and increased over 2021. Renewal premium changes in 2022 remained positive and were lower than in 2021. New business premiums in 2022 increased over 2021. Middle Market. Net written premiums of $9.92 billion in 2022 increased by 11% over 2021. Retention rates remained strong in 2022 and increased over 2021. Renewal premium changes in 2022 remained positive and were lower than in 2021. New business premiums in 2022 increased over 2021. National Accounts. Net written premiums of $1.09 billion in 2022 increased by 10% over 2021. Retention rates remained strong in 2022 and increased over 2021. Renewal premium changes in 2022 remained positive and were higher than in 2021. New business premiums in 2022 decreased from 2021. National Property and Other. Net written premiums of $2.47 billion in 2022 increased by 9% over 2021. Retention rates remained strong in 2022 and increased over 2021. Renewal premium changes in 2022 remained positive and were higher than in 2021. New business premiums in 2022 increased over 2021. International. Net written premiums of $1.06 billion in 2022 decreased by 1% from 2021, primarily driven by the impact of changes in foreign currency exchange rates.Bond & Specialty InsuranceResults of Bond & Specialty Insurance were as follows:(for the year ended December 31, in millions)202220212020Revenues Earned premiums$3,418 $3,138 $2,823 Net investment income258 247 213 Other revenues20 23 27 Total revenues3,696 3,408 3,063 Total claims and expenses2,593 2,575 2,483 Segment income before income taxes1,103 833 580 Income tax expense195 165 107 Segment income$908 $668 $473 Loss and loss adjustment expense ratio39.9 %46.6 %51.5 %Underwriting expense ratio35.4 34.9 35.9 Combined ratio75.3 %81.5 %87.4 %68OverviewSegment income in 2022 was $908 million, $240 million or 36% higher than segment income of $668 million in 2021. The increase in segment income before income taxes primarily reflected the pre-tax impacts of (i) higher underlying underwriting margins and (ii) higher net favorable prior year reserve development. Net favorable prior year reserve development in 2022 and 2021 was $222 million and $105 million, respectively. Catastrophe losses in 2022 and 2021 were $25 million and $40 million, respectively. The higher underlying underwriting margins primarily reflected the impacts of (i) higher business volumes and (ii) the benefit of earned pricing, partially offset by (iii) higher general and administrative expenses. Income tax expense in 2022 was higher than in 2021, primarily reflecting the impact of the increase in segment income before income taxes, partially offset by a $24 million reduction in income tax expense in the first quarter of 2022 as a result of the resolution of prior year tax matters. RevenuesEarned PremiumsEarned premiums in 2022 were $3.42 billion, $280 million or 9% higher than in 2021, primarily reflecting an increase in net written premiums over the preceding twelve months. Net Investment IncomeNet investment income in 2022 was $258 million, $11 million or 4% higher than in 2021. Included in Bond & Specialty Insurance are certain legal entities whose invested assets and related net investment income are reported exclusively in this segment and not allocated among all business segments. Refer to the “Net Investment Income” section of the “Consolidated Results of Operations” discussion for a description of the factors contributing to the decrease in the Company’s consolidated net investment income in 2022 as compared with 2021. In addition, refer to note 2 of the notes to the consolidated financial statements for a discussion of the Company’s net investment income allocation methodology. Claims and ExpensesClaims and Claim Adjustment ExpensesClaims and claim adjustment expenses in 2022 were $1.38 billion, $95 million or 6% lower than in 2021, primarily reflecting the impacts of (i) higher net favorable prior year reserve development and (ii) lower catastrophe losses, partially offset by (iii) higher business volumes.Factors contributing to net prior year reserve development during the years ended December 31, 2022, 2021 and 2020 are discussed in more detail in note 8 of the notes to the consolidated financial statements. Amortization of Deferred Acquisition CostsAmortization of deferred acquisition costs in 2022 was $625 million, $55 million or 10% higher than in 2021, generally consistent with the increase in earned premiums.General and Administrative ExpensesGeneral and administrative expenses in 2022 were $590 million, $58 million or 11% higher than in 2021, primarily reflecting the impact of higher business volumes.Income Tax ExpenseIncome tax expense in 2022 was $195 million, $30 million or 18% higher than in 2021, primarily reflecting the impact of the $270 million increase in segment income before income taxes in 2022, partially offset by the $24 million reduction in income tax expense in the first quarter of 2022 as a result of the resolution of prior year tax matters. Combined RatioThe combined ratio of 75.3% in 2022 was 6.2 points lower than the combined ratio of 81.5% in 2021. The loss and loss adjustment expense ratio of 39.9% in 2022 was 6.7 points lower than the loss and loss adjustment expense ratio of 46.6% in 692021. The underwriting expense ratio of 35.4% in 2022 was 0.5 points higher than the underwriting expense ratio of 34.9% in 2021. Net favorable prior year reserve development in 2022 and 2021 provided 6.5 points and 3.3 points of benefit, respectively, to the combined ratio. Catastrophe losses in 2022 and 2021 accounted for 0.7 points and 1.3 points, respectively, of the combined ratio. The underlying combined ratio in 2022 was 2.4 points lower than the 2021 ratio on the same basis, primarily reflecting the benefit of earned pricing.Written PremiumsBond & Specialty Insurance’s gross and net written premiums were as follows: Gross Written Premiums(for the year ended December 31, in millions)202220212020Domestic: Management Liability$2,361 $2,243 $1,920 Surety1,153 952 910 Total Domestic3,514 3,195 2,830 International568 530 354 Total Bond & Specialty Insurance$4,082 $3,725 $3,184 Net Written Premiums(for the year ended December 31, in millions)202220212020Domestic: Management Liability$2,112 $1,983 $1,769 Surety1,081 888 845 Total Domestic3,193 2,871 2,614 International539 505 337 Total Bond & Specialty Insurance$3,732 $3,376 $2,951 Gross written premiums and net written premiums in 2022 increased by 10% and 11%, respectively, over 2021.Domestic. Net written premiums in 2022 were $3.19 billion, $322 million or 11% higher than in 2021. Excluding the surety line of business, for which the following are not relevant measures, retention rates remained strong in 2022 and increased over 2021. Renewal premium changes in 2022 remained positive and were lower than in 2021. New business premiums in 2022 increased over 2021. International. Net written premiums in 2022 were $539 million, $34 million or 7% higher than in 2021, primarily driven by increases in the United Kingdom and broader Europe, as well as Canada, partially offset by the impact of changes in foreign currency exchange rates. 70Personal InsuranceResults of Personal Insurance were as follows:(for the year ended December 31, in millions)202220212020Revenues Earned premiums$13,250 $11,983 $10,927 Net investment income440 521 381 Fee income30 27 24 Other revenues83 97 76 Total revenues13,803 12,628 11,408 Total claims and expenses14,033 11,689 9,905 Segment income (loss) before income taxes(230)939 1,503 Income tax expense (benefit)(90)179 308 Segment income (loss)$(140)$760 $1,195 Loss and loss adjustment expense ratio79.8 %70.3 %62.8 %Underwriting expense ratio25.1 26.2 26.9 Combined ratio104.9 %96.5 %89.7 %OverviewSegment loss in 2022 was $140 million, compared with segment income of $760 million in 2021. Segment loss before income taxes primarily reflected the pre-tax impacts of (i) lower underlying underwriting margins, (ii) lower net favorable prior year reserve development, (iii) higher catastrophe losses and (iv) lower net investment income. Catastrophe losses in 2022 and 2021 were $1.20 billion and $1.01 billion, respectively. Net favorable prior year reserve development in 2022 and 2021 was $46 million and $260 million, respectively. The lower underlying underwriting margins primarily reflected the impacts of (i) elevated losses in both the automobile and homeowners and other product lines, partially offset by (ii) higher business volumes. The segment recorded an income tax benefit in 2022 compared to income tax expense in 2021, primarily reflecting the impact of the segment loss before income taxes compared with segment income before income taxes in 2021 and a $20 million reduction in income tax expense in the first quarter of 2022 as a result of the resolution of prior year tax matters. RevenuesEarned PremiumsEarned premiums in 2022 were $13.25 billion, $1.27 billion or 11% higher than in 2021, primarily reflecting the increase in net written premiums over the preceding twelve months. Net Investment IncomeNet investment income in 2022 was $440 million, $81 million or 16% lower than in 2021. Refer to the “Net Investment Income” section of the “Consolidated Results of Operations” discussion for a description of the factors contributing to the decrease in the Company’s consolidated net investment income in 2022 as compared with 2021. In addition, refer to note 2 of the notes to the consolidated financial statements for a discussion of the Company’s net investment income allocation methodology. Other RevenuesOther revenues in all years presented primarily consisted of installment premium charges. 71Claims and Expenses Claims and Claim Adjustment ExpensesClaims and claim adjustment expenses in 2022 were $10.57 billion, $2.14 billion or 25% higher than in 2021, primarily reflecting the impacts of (i) loss cost trends, including elevated losses in both the automobile and homeowners and other product lines, (ii) higher business volumes, (iii) lower net favorable prior year reserve development and (iv) higher catastrophe losses. Catastrophe losses and non-catastrophe weather-related losses in 2021 were reduced by recoveries under the Company's 2021 Underlying Property Aggregate Catastrophe Excess-of-Loss Reinsurance Treaty. Net favorable prior year reserve development was not significant for the year ended December 31, 2022. Factors contributing to net favorable prior year reserve development during the years ended December 31, 2021 and 2020 are discussed in more detail in note 8 of the notes to the consolidated financial statements. Amortization of Deferred Acquisition CostsAmortization of deferred acquisition costs in 2022 was $2.10 billion, $210 million or 11% higher than in 2021, generally consistent with the increase in earned premiums. General and Administrative ExpensesGeneral and administrative expenses in 2022 were $1.36 billion, $8 million or 1% lower than in 2021, primarily reflecting lower contingent commissions, partially offset by the impact of higher business volumes. Income Tax Expense (Benefit)The income tax benefit in 2022 was $90 million, compared with income tax expense of $179 million in 2021, primarily reflecting the impact of the segment loss before income taxes of $230 million in 2022 compared with segment income before income taxes of $939 million in 2021 and the $20 million reduction in income tax expense in the first quarter of 2022 as a result of the resolution of prior year tax matters.Combined RatioThe combined ratio of 104.9% in 2022 was 8.4 points higher than the combined ratio of 96.5% in 2021. The loss and loss adjustment expense ratio of 79.8% in 2022 was 9.5 points higher than the loss and loss adjustment expense ratio of 70.3% in 2021. The underwriting expense ratio of 25.1% in 2022 was 1.1 points lower than the underwriting expense ratio of 26.2% in 2021. Catastrophe losses accounted for 9.0 points and 8.5 points of the combined ratio in 2022 and 2021, respectively. Net favorable prior year reserve development in 2022 and 2021 provided 0.3 points and 2.2 points of benefit, respectively, to the combined ratio. The underlying combined ratio in 2022 was 6.0 points higher than the 2021 ratio on the same basis, primarily reflecting the impacts of (i) elevated losses in both the automobile and homeowners and other product lines, partially offset by (ii) a lower expense ratio. 72Written PremiumsPersonal Insurance’s gross and net written premiums were as follows: Gross Written Premiums(for the year ended December 31, in millions)202220212020Domestic: Automobile$6,507 $5,852 $5,395 Homeowners and Other7,099 6,137 5,457 Total Domestic13,606 11,989 10,852 International667 701 667 Total Personal Insurance$14,273 $12,690 $11,519 Net Written Premiums(for the year ended December 31, in millions)202220212020Domestic: Automobile$6,482 $5,827 $5,369 Homeowners and Other6,916 5,980 5,329 Total Domestic13,398 11,807 10,698 International649 684 652 Total Personal Insurance$14,047 $12,491 $11,350 Gross and net written premiums in 2022 both increased by 12% over 2021.DomesticAutomobile net written premiums of $6.48 billion in 2022 increased by 11% over 2021. Retention rates remained strong in 2022 but were lower than in 2021. Renewal premium changes in 2022 remained positive and were higher than in 2021. New business premiums in 2022 increased over 2021. Homeowners and Other net written premiums of $6.92 billion in 2022 increased by 16% over 2021. Retention rates remained strong in 2022 but were lower than in 2021. Renewal premium changes in 2022 remained positive and were higher than in 2021. New business premiums in 2022 were comparable with 2021. For its Domestic business, Personal Insurance had approximately 9.2 million and 8.9 million active policies at December 31, 2022 and 2021, respectively.International International net written premiums of $649 million in 2022 decreased by 5% from 2021, driven by the impact of changes in foreign currency exchange rates and declines in the automobile product line. For its International business, Personal Insurance had approximately 449,000 and 477,000 active policies at December 31, 2022 and 2021, respectively. Interest Expense and Other(for the year ended December 31, in millions)202220212020Income (loss)$(301)$(291)$(291)The income (loss) for Interest Expense and Other in 2022 and 2021 was $(301) million and $(291) million, respectively. Pre-tax interest expense in 2022 and 2021 was $351 million and $340 million, respectively. After-tax interest expense in 2022 and 2021 was $277 million and $269 million, respectively. 73ASBESTOS CLAIMS AND LITIGATIONThe Company believes that the property and casualty insurance industry has suffered from court decisions and other trends that have expanded insurance coverage for asbestos claims far beyond the original intent of insurers and policyholders. The Company has received and continues to receive a significant number of asbestos claims. Factors underlying these claim filings include continued intensive advertising by lawyers seeking asbestos claimants and the focus by plaintiffs on defendants, such as manufacturers of talcum powder, who were not traditionally primary targets of asbestos litigation. The focus on these defendants is primarily the result of the number of traditional asbestos defendants who have sought bankruptcy protection in previous years. The bankruptcy of many traditional defendants has also caused increased settlement demands against those policyholders who are not in bankruptcy but remain in the tort system. Currently, in many jurisdictions, those who allege very serious injury and who can present credible medical evidence of their injuries are receiving priority trial settings in the courts, while those who have not shown any credible disease manifestation are having their hearing dates delayed or placed on an inactive docket. Prioritizing claims involving credible evidence of injuries, along with the focus on defendants who were not traditionally primary targets of asbestos litigation, contributes to the claims and claim adjustment expense payment patterns experienced by the Company. The Company’s asbestos-related claims and claim adjustment expense experience also has been impacted by the unavailability of other insurance sources potentially available to policyholders, whether through exhaustion of policy limits or through the insolvency of other participating insurers. The Company continues to be involved in disputes, including litigation, with a number of policyholders, some of whom are in bankruptcy, over coverage for asbestos-related claims. Many coverage disputes with policyholders are only resolved through settlement agreements. Because many policyholders make exaggerated demands, it is difficult to predict the outcome of settlement negotiations. Settlements involving bankrupt policyholders may include extensive releases which are favorable to the Company, but which could result in settlements for larger amounts than originally anticipated. Although the Company has seen a reduction in the overall risk associated with these disputes, it remains difficult to predict the ultimate cost of these claims. As in the past, the Company will continue to pursue settlement opportunities. In addition to claims against policyholders, proceedings have been launched directly against insurers, including the Company, by individuals challenging insurers’ conduct with respect to the handling of past asbestos claims and by individuals seeking damages arising from alleged asbestos-related bodily injuries. It is possible that other direct actions against insurers, including the Company, could be filed in the future. It is difficult to predict the outcome of these proceedings, including whether the plaintiffs would be able to sustain these actions against insurers based on novel legal theories of liability. The Company believes it has meritorious defenses to any such claims and has received favorable rulings in certain jurisdictions.Because each policyholder presents different liability and coverage issues, the Company generally reviews the exposure presented by each policyholder with open claims at least annually. Among the factors the Company may consider in the course of this review are: available insurance coverage, including the role of any umbrella or excess insurance the Company has issued to the policyholder; limits and deductibles; an analysis of the policyholder’s potential liability; the jurisdictions involved; past and anticipated future claim activity and loss development on pending claims; past settlement values of similar claims; allocated claim adjustment expense; the potential role of other insurance; the role, if any, of non-asbestos claims or potential non-asbestos claims in any resolution process; and applicable coverage defenses or determinations, if any, including the determination as to whether or not an asbestos claim is a products/completed operation claim subject to an aggregate limit and the available coverage, if any, for that claim. The Company's net asbestos reserves at December 31, 2022 and 2021 were $1.31 billion and $1.34 billion, respectively, and include case reserves, IBNR reserves and reserves for the costs of defending asbestos-related coverage litigation. IBNR reserves include amounts for new claims and adverse development on existing policyholders, as well as reserves for claims from policyholders reporting asbestos claims for the first time and for policyholders for which there is, or may be, litigation. Asbestos reserves also include amounts related to certain policyholders with whom the Company has entered into permanent settlement agreements, which are based on the expected payout for each policyholder under the applicable agreement. Additionally, a portion of the asbestos reserves relates to assumed reinsurance contracts primarily consisting of reinsurance of excess coverage, including various pool participations. The Company conducts an annual review of domestic policyholders with open asbestos claims. Policyholders are identified for this review based upon, among other factors: a combination of past payments and current case reserves in excess of a specified threshold (currently $100,000), perceived level of exposure, number of reported claims, products/completed operations and potential “non-product” exposures, size of policyholder and geographic distribution of products or services sold by the policyholder. 74In the third quarter of 2022, the Company completed its annual in-depth asbestos claim review, including a review of policyholders with open claims and litigation cases for potential product and "non-product" liability. The number of policyholders with open asbestos claims and net asbestos payments were relatively flat compared to 2021. Payments on behalf of these policyholders continue to be influenced by an increase in severity for certain policyholders and a high level of litigation activity in a limited number of jurisdictions where individuals alleging serious asbestos-related injury, primarily mesothelioma, continue to target defendants who were not traditionally primary targets of asbestos litigation. The Company’s quarterly asbestos reserve reviews include an analysis of exposure and claim payment patterns by policyholder, as well as recent settlements, policyholder bankruptcies, judicial rulings and legislative actions. The Company also analyzes developing payment patterns among policyholders and the assumed reinsurance component of reserves, as well as projected reinsurance billings and recoveries. In addition, the Company reviews its historical gross and net loss and expense paid experience, year-by-year, to assess any emerging trends, fluctuations, or characteristics suggested by the aggregate paid activity. Conventional actuarial methods are not utilized to establish asbestos reserves, and the Company’s evaluations have not resulted in a reliable method to determine a meaningful average asbestos defense or indemnity payment. The completion of these reviews and analyses in 2022, 2021 and 2020 resulted in $212 million, $225 million and $295 million increases, respectively, to the Company’s net asbestos reserves. In each year, the reserve increases were primarily driven by increases in the Company’s estimate of projected settlement and defense costs related to a broad number of policyholders. The increase in the estimate of projected settlement and defense costs primarily resulted from payment trends that continue to be higher than previously anticipated due to the continued high level of mesothelioma claim filings and the impact of the current litigation environment surrounding those claims discussed above. Over the past decade, the property and casualty insurance industry, including the Company, has experienced net unfavorable prior year reserve development with regard to asbestos reserves, but the Company believes that over that period there has been a reduction in the volatility associated with the Company’s overall asbestos exposure as the overall asbestos environment has evolved from one dominated by exposure to significant litigation risks, particularly coverage disputes relating to policyholders in bankruptcy who were asserting that their claims were not subject to the aggregate limits contained in their policies, to an environment primarily driven by a frequency of litigation related to individuals with mesothelioma. The Company’s overall view of the current underlying asbestos environment is essentially unchanged from recent periods, and there remains a high degree of uncertainty with respect to future exposure to asbestos claims.Net asbestos paid loss and loss expenses in 2022, 2021 and 2020 were $245 million, $221 million and $237 million, respectively. Approximately 2%, 9% and 1% of total net paid losses in 2022, 2021 and 2020, respectively, related to policyholders with whom the Company entered into settlement agreements that limit those policyholders' ability to present future claims to the Company.75The following table displays activity for asbestos losses and loss expenses and reserves:(at and for the year ended December 31, in millions)202220212020Beginning reserves: Gross$1,687 $1,668 $1,601 Ceded(346)(330)(322)Net1,341 1,338 1,279 Incurred losses and loss expenses: Gross287 287 362 Ceded(75)(62)(67)Net212 225 295 Paid loss and loss expenses: Gross298 267 295 Ceded(53)(46)(58)Net245 221 237 Foreign exchange and other: Gross(2)(1)— Ceded(1)— 1 Net(3)(1)1 Ending reserves: Gross1,674 1,687 1,668 Ceded(369)(346)(330)Net$1,305 $1,341 $1,338 ENVIRONMENTAL CLAIMS AND LITIGATIONThe Company has received and continues to receive claims from policyholders who allege that they are liable for injury or damage arising out of the alleged storage, emissions or disposal of toxic substances, frequently under policies issued prior to the mid-1980s. These claims are mainly brought pursuant to various state or federal statutes that require a liable party to undertake or pay for environmental remediation. For example, the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) enables private parties as well as federal and state governments to take action with respect to releases and threatened releases of hazardous substances. This federal statute permits the recovery of response costs from some liable parties and may require liable parties to undertake their own remedial action. Liability under these statutes may be joint and several with other responsible parties. The Company has also been, and continues to be, involved in litigation involving insurance coverage issues pertaining to environmental claims. The Company believes that some court decisions pertaining to environmental claims have interpreted the insurance coverage to be broader than the original intent of the insurers and policyholders. For more information regarding environmental claims and litigation, see note 8 of the notes to the consolidated financial statements.In 2022, 2021 and 2020, the Company increased its net environmental reserves by $132 million, $89 million and $54 million, respectively. Net environmental paid loss and loss expenses in 2022, 2021 and 2020 were $82 million, $75 million and $69 million, respectively. Net environmental reserves were $371 million, $321 million and $307 million at December 31, 2022, 2021 and 2020, respectively. UNCERTAINTY REGARDING ADEQUACY OF ASBESTOS AND ENVIRONMENTAL RESERVESAs a result of the processes and procedures discussed above, management believes that the reserves carried for asbestos and environmental claims are appropriately established based upon known facts, current law and management’s judgment. However, the uncertainties surrounding the final resolution of these claims continue, and it is difficult to determine the ultimate exposure for asbestos and environmental claims and related litigation. As a result, these reserves are subject to revision as new information becomes available and as claims develop. The continuing uncertainties include, without limitation:•the risks and lack of predictability inherent in complex litigation;76•a further increase in the cost to resolve, and/or the number of, asbestos and environmental claims beyond that which is anticipated;•the emergence of a greater number of asbestos claims than anticipated as a result of extended life expectancies resulting from medical advances and lifestyle improvements;•the role of any umbrella or excess policies we have issued;•the resolution or adjudication of disputes concerning coverage for asbestos and environmental claims in a manner inconsistent with our previous assessment of these disputes;•the number and outcome of direct actions against us;•future developments pertaining to our ability to recover reinsurance for asbestos and environmental claims;•any impact on asbestos defendants we insure due to the bankruptcy of other asbestos defendants;•the unavailability of other insurance sources potentially available to policyholders, whether through exhaustion of policy limits or through the insolvency of other participating insurers; and•uncertainties arising from the insolvency or bankruptcy of policyholders.Changes in the legal, regulatory and legislative environment may impact the future resolution of asbestos and environmental claims and result in adverse loss reserve development. The emergence of a greater number of asbestos or environmental claims beyond that which is anticipated may result in adverse loss reserve development. Changes in applicable legislation and future court and regulatory decisions and interpretations, including the outcome of legal challenges to legislative and/or judicial reforms establishing medical criteria for the pursuit of asbestos claims, could affect the settlement of asbestos and environmental claims. It is also difficult to predict the ultimate outcome of complex coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations often involve a large number of claimants and other parties and require court approval to be effective. As part of its continuing analysis of asbestos and environmental reserves, the Company continues to study the implications of these and other developments.Because of the uncertainties set forth above, additional liabilities may arise for amounts in excess of the Company’s current reserves. In addition, the Company’s estimate of claims and claim adjustment expenses may change. These additional liabilities or increases in estimates, or a range of either, cannot now be reasonably estimated and could result in income statement charges that could be material to the Company’s operating results in future periods.INVESTMENT PORTFOLIOThe Company’s invested assets at December 31, 2022 were $80.45 billion, of which 93% was invested in fixed maturity and short-term investments, 1% in equity securities, 1% in real estate investments and 5% in other investments. Because the primary purpose of the investment portfolio is to fund future claims payments, the Company employs a thoughtful investment philosophy that focuses on appropriate risk-adjusted returns. A significant majority of funds available for investment are deployed in a widely diversified portfolio of high quality, liquid, taxable U.S. government, tax-exempt and taxable U.S. municipal and taxable corporate and U.S. agency mortgage-backed bonds. The carrying value of the Company’s fixed maturity portfolio at December 31, 2022 was $71.16 billion. The Company closely monitors the duration of its fixed maturity investments, and investment purchases and sales are executed with the objective of having adequate funds available to satisfy the Company’s insurance and debt obligations. The weighted average credit quality of the Company’s fixed maturity portfolio, both including and excluding U.S. Treasury securities, was “Aa2” at both December 31, 2022 and 2021. Below investment grade securities represented 1.3% and 1.4% of the total fixed maturity investment portfolio at December 31, 2022 and 2021, respectively. The weighted average effective duration of fixed maturities and short-term securities was 4.6 (4.8 excluding short-term securities) at December 31, 2022 and 4.2 (4.4 excluding short-term securities) at December 31, 2021. 77The carrying values of investments in fixed maturities classified as available for sale at December 31, 2022 and 2021 were as follows: 20222021(at December 31, in millions)Carrying ValueWeighted Average CreditQuality (1)Carrying ValueWeighted Average CreditQuality (1)U.S. Treasury securities and obligations of U.S. government and government agencies and authorities$5,438 Aaa/Aa1$3,562 Aaa/Aa1Obligations of U.S. states, municipalities and political subdivisions: Local general obligation17,823 Aaa/Aa119,667 Aaa/Aa1Revenue10,198 Aaa/Aa111,940 Aaa/Aa1State general obligation1,019 Aaa/Aa11,223 Aaa/Aa1Pre-refunded2,339 Aaa/Aa14,032 Aaa/Aa1Total obligations of U.S. states, municipalities and political subdivisions31,379 36,862 Debt securities issued by foreign governments994 Aaa/Aa11,041 Aaa/Aa1Mortgage-backed securities, collateralized mortgage obligations and pass-through securities1,991 Aaa/Aa11,817 Aaa/Aa1Corporate and all other bonds: Financial: Bank4,505 A14,473 A1Insurance1,628 Aa31,626 Aa3Finance/leasing47 Ba234 Ba3Brokerage and asset management136 A1101 Aa3Total financial6,316 6,234 Industrial17,237 A319,459 A3Public utility4,064 A24,706 A2Canadian municipal securities1,523 Aa11,687 Aa2Sovereign corporate securities (2)559 Aaa607 AaaCommercial mortgage-backed securities and project loans (3)1,136 Aaa1,304 AaaAsset-backed and other523 Aa1531 Aa1Total corporate and all other bonds31,358 34,528 Total fixed maturities$71,160 Aa2$77,810 Aa2___________________________________________(1)Rated using external rating agencies or by the Company when a public rating does not exist.(2)Sovereign corporate securities include corporate securities that are backed by a government and include sovereign banks and securities issued under the Federal Ship Financing Programs.(3)Included in commercial mortgage-backed securities and project loans at December 31, 2022 and 2021 were $131 million and $207 million of securities guaranteed by the U.S. government, respectively.78The following table sets forth the Company’s fixed maturity investment portfolio rated using external ratings agencies or by the Company when a public rating does not exist:(at December 31, 2022, in millions)CarryingValuePercent of TotalCarrying ValueQuality Rating: Aaa$31,688 44.6 %Aa16,217 22.8 A13,333 18.7 Baa8,992 12.6 Total investment grade70,230 98.7 Below investment grade930 1.3 Total fixed maturities$71,160 100.0 %Obligations of U.S. States, Municipalities and Political SubdivisionsThe Company’s fixed maturity investment portfolio at December 31, 2022 and 2021 included $31.38 billion and $36.86 billion, respectively, of securities which are obligations of U.S. states, municipalities and political subdivisions (collectively referred to as the municipal bond portfolio). The municipal bond portfolio is diversified across the United States, the District of Columbia and Puerto Rico and includes general obligation and revenue bonds issued by states, cities, counties, school districts and similar issuers. Included in the municipal bond portfolio at December 31, 2022 and 2021 were $2.34 billion and $4.03 billion, respectively, of pre-refunded bonds, which are bonds for which U.S. states or municipalities have established irrevocable trusts, almost exclusively comprised of U.S. Treasury securities and obligations of U.S. government and government agencies and authorities. These trusts were created to fund the payment of principal and interest due under the bonds. The irrevocable trusts are verified as to their sufficiency by an independent verification agent of the underwriter, issuer or trustee. All of the Company’s holdings of securities issued by Puerto Rico and related entities have either been pre-refunded and therefore are defeased by U.S. Treasury securities or have FHA guarantees subject to federal appropriation. 79The following table shows the geographic distribution of the $29.04 billion of municipal bonds at December 31, 2022 that were not pre-refunded:(at December 31, 2022, in millions)State GeneralObligationLocal GeneralObligationRevenueTotal CarryingValueWeighted AverageCreditQuality(1)State: Texas$38 $2,928 $1,457 $4,423 AaaCalifornia— 1,905 453 2,358 Aaa/Aa1Virginia41 967 780 1,788 Aaa/Aa1Washington114 1,140 305 1,559 Aaa/Aa1North Carolina167 756 462 1,385 AaaMinnesota142 954 175 1,271 Aaa/Aa1Colorado— 775 364 1,139 Aa1Massachusetts— 202 843 1,045 Aaa/Aa1Maryland31 866 126 1,023 Aaa/Aa1Wisconsin68 769 97 934 Aa1Tennessee7 807 88 902 Aa1Florida50 148 603 801 Aa1Georgia141 541 51 733 Aaa/Aa1All others (2)220 5,065 4,394 9,679 Aaa/Aa1Total$1,019 $17,823 $10,198 $29,040 Aaa/Aa1___________________________________________(1)Rated using external rating agencies or by the Company when a public rating does not exist. Ratings shown are the higher of the rating of the underlying issuer or the insurer in the case of securities enhanced by third-party insurance for the payment of principal and interest in the event of issuer default.(2)No other single state accounted for 2.5% or more of the total non-pre-refunded municipal bonds.80The following table displays the funding sources for the $10.20 billion of municipal bonds identified as revenue bonds in the foregoing table at December 31, 2022:(at December 31, 2022, in millions)CarryingValueWeighted AverageCreditQuality(1)Source: Water$2,830 Aaa/Aa1Higher education2,563 Aaa/Aa1Sewer1,005 Aaa/Aa1Power utilities703 Aa1Special tax486 Aaa/Aa1Transit355 Aaa/Aa1Highway tolls227 Aa2Industrial183 Aa3Fuel sales181 Aa1Health care177 Aa2Housing30 Aaa/Aa1Lease30 Aaa/Aa1Natural gas10 Aa2Lottery7 Aa1Other revenue sources1,411 Aaa/Aa1Total$10,198 Aaa/Aa1___________________________________________(1)Rated using external rating agencies or by the Company when a public rating does not exist. Ratings shown are the higher of the rating of the underlying issuer or the insurer in the case of securities enhanced by third-party insurance for the payment of principal and interest in the event of issuer default.The Company bases its investment decision on the underlying credit characteristics of the municipal security. The weighted average credit rating of the municipal bond portfolio was “Aaa/Aa1” at December 31, 2022.Debt Securities Issued by Foreign GovernmentsThe following table shows the geographic distribution of the Company’s long-term fixed maturity investments in debt securities issued by foreign governments at December 31, 2022:(at December 31, 2022, in millions)CarryingValueWeighted Average CreditQuality (1)Foreign Government: Canada$800 Aaa/Aa1United Kingdom177 Aa3All others (2,3)17 Aa1Total$994 Aaa/Aa1___________________________________________(1)Rated using external rating agencies or by the Company when a public rating does not exist.(2)The Company does not have direct exposure to sovereign debt issued by the Republic of Ireland, Italy, Greece, Portugal or Spain.(3) No other country accounted for 2.5% or more of total debt securities issued by foreign governments.The following table shows the Company’s Eurozone exposure at December 31, 2022 to all debt securities issued by foreign governments, financial companies, sovereign corporations (including sovereign banks) whose securities are backed by the respective country’s government and all other corporate securities (comprised of industrial corporations and utility companies) which could be affected if economic conditions deteriorated due to a prolonged recession:81 Corporate Securities Debt Securities Issuedby Foreign GovernmentsFinancialSovereign CorporatesAll Other(at December 31, 2022, in millions)CarryingValueWeighted AverageCreditQuality (1)CarryingValueWeighted AverageCreditQuality (1)CarryingValueWeighted AverageCreditQuality (1)CarryingValueWeighted AverageCreditQuality (1)Eurozone Periphery Spain$— — $57 Aa3$— — $6 Baa3Ireland— — — — — — 151 Baa2Italy— — — — — — — — Greece— — — — — — — — Portugal— — — — — — — — Subtotal— 57 — 157 Eurozone Non-Periphery Germany10 Aaa— — 275 Aaa/Aa1435 A3France75 Aa2— — — — 537 A1Netherlands— — 92 A1104 Aaa184 A2Finland— — 44 Aa3— — — — Belgium— — — — — — 113 Baa1Austria— — — — 137 Aa2— — Subtotal85 136 516 1,269 Total$85 $193 $516 $1,426 ___________________________________________(1)Rated using external rating agencies or by the Company when a public rating does not exist. The table includes $487 million of short-term securities which have the highest ratings issued by external rating agencies for short-term issuances. For purposes of this table, the short-term securities, which are rated “A-1+” and/or “P-1,” are included as “Aaa” rated securities.In addition to fixed maturities noted in the foregoing table, the Company has exposure totaling $289 million to private equity limited partnerships and real estate partnerships (both of which are included in other investments in the Company’s consolidated balance sheet) whose primary investing focus is across Europe. The Company has unfunded commitments totaling $169 million to these partnerships. Mortgage-Backed Securities, Collateralized Mortgage Obligations and Pass-Through SecuritiesThe Company’s fixed maturity investment portfolio at December 31, 2022 and 2021 included $1.99 billion and $1.82 billion, respectively, of residential mortgage-backed securities, including pass-through-securities and collateralized mortgage obligations (CMOs), all of which are subject to prepayment risk (either shortening or lengthening of duration). While prepayment risk for securities and its effect on income cannot be fully controlled, particularly when interest rates move dramatically, the Company’s investment strategy generally favors securities that reduce this risk within expected interest rate ranges. The Company makes investments in residential CMOs that are either guaranteed by GNMA, FNMA or FHLMC, or if not guaranteed, are senior or super-senior positions within their respective securitizations. Both guaranteed and non-guaranteed residential CMOs allocate the distribution of payments from the underlying mortgages among different classes of bondholders. In addition, non-guaranteed residential CMOs provide structures that allocate the impact of credit losses to different classes of bondholders. Senior and super-senior CMOs are protected, to varying degrees, from credit losses as those losses are initially allocated to subordinated bondholders. The Company’s investment strategy is to purchase CMO tranches that are expected to offer the most favorable return given the Company’s assessment of associated risks. The Company does not purchase residual interests in CMOs. For more information regarding the Company’s investments in residential mortgage-backed securities, see note 3 of the notes to the consolidated financial statements. Commercial Mortgage-Backed Securities and Project LoansAt December 31, 2022 and 2021, the Company held commercial mortgage-backed securities (including FHA project loans) of $1.14 billion and $1.30 billion, respectively. For more information regarding the Company’s investments in commercial mortgage-backed securities, see note 3 of the notes to the consolidated financial statements.82Equity Securities, Real Estate and Short-Term InvestmentsSee note 1 of the notes to the consolidated financial statements for further information about these invested asset classes.Other InvestmentsThe Company also invests in private equity, hedge fund and real estate partnerships, and joint ventures. These asset classes have historically provided a higher return than investments in fixed maturities but are subject to more volatility. The Company also enters into certain derivative financial instruments from time to time that are reported as part of other investments. At December 31, 2022 and 2021, the carrying value of the Company's other investments was $4.07 billion and $3.86 billion, respectively. The Company has unfunded commitments to private equity limited partnerships, real estate partnerships and others in which it invests. These commitments totaled $1.80 billion and $1.70 billion at December 31, 2022 and 2021, respectively. It is the opinion of the Company’s management that the Company has adequate liquidity to meet these commitments. Securities LendingThe Company has, from time to time, engaged in securities lending activities from which it generates net investment income by lending certain of its investments to other institutions for short periods of time. At December 31, 2022 and 2021, the Company had $445 million and $253 million, respectively, of securities on loan, respectively, as part of a tri-party lending agreement. The average monthly balance of securities on loan during 2022 and 2021 was $347 million and $329 million, respectively. Borrowers of these securities provide collateral equal to at least 102% of the market value of the loaned securities plus accrued interest. The Company did not incur any investment losses in its securities lending program for the years ended December 31, 2022 and 2021.Lloyd’s Trust DepositsThe Company meets its capital requirements to support its underwriting at Lloyd’s using a combination of the share capital and retained earnings of the Company's subsidiaries participating in Lloyd's, trust deposits and uncollateralized letters of credit. Securities with a fair value of approximately $28 million and $33 million held by a wholly-owned subsidiary at December 31, 2022 and 2021, respectively, and $58 million and $34 million held by TRV at December 31, 2022 and 2021, respectively, were pledged into Lloyd’s trust accounts to provide a portion of the Lloyd’s capital requirements. For more information regarding the Company’s utilization of uncollateralized letters of credit, see “Liquidity and Capital Resources” herein. Net Unrealized Investment Gains (Losses)The net unrealized investment gains (losses) that were included in shareholders' equity were as follows:(at December 31, in millions)202220212020Fixed maturities$(6,217)$3,062 $5,175 Other(3)(2)— Unrealized investment gains (losses) before tax(6,220)3,060 5,175 Tax expense (benefit)(1,322)645 1,101 Net unrealized investment gains (losses) included in shareholders' equity at end of year$(4,898)$2,415 $4,074 Net unrealized investment losses included in shareholders’ equity were $4.90 billion at December 31, 2022 compared with net unrealized investment gains of $2.42 billion at December 31, 2021. At December 31, 2022, the Company had $2.18 billion fixed maturity investments reported at fair value for which fair value was less than 80% of amortized cost. At December 31, 2021, the Company had no fixed maturity investments reported at fair value for which fair value was less than 80% of amortized cost. These year-over-year changes were driven by rising interest rates. Since the Company generally holds its high-quality fixed maturity investments to maturity, these net unrealized losses are considered temporary in nature and are not expected to result in significant realized losses. In addition, given the temporary nature of net unrealized losses combined with the Company’s strong operating cash flows, which include income received on investments and the proceeds received upon maturity of the investments, the net unrealized investment loss is not expected to meaningfully impact the Company’s assessment of capital adequacy or liquidity. Equity securities, which include common and non-redeemable preferred stocks, are reported at fair value with changes in fair value recognized in net income.83For fixed maturity investments where fair value is less than the carrying value and the Company did not reach a decision to impair, the Company continues to have the intent and ability to hold such investments to a projected recovery in value, which may not be until maturity.At December 31, 2022 and 2021, below investment grade securities comprised 1.3% and 1.4%, respectively, of the fair value of the Company’s fixed maturity investment portfolio. Included in below investment grade securities at December 31, 2022 were securities in an unrealized loss position that, in the aggregate, had an amortized cost of $937 million and a fair value of $844 million, resulting in a net pre-tax unrealized investment loss of $93 million. These securities in an unrealized loss position represented 1% of both the amortized cost and fair value of the fixed maturity portfolio at December 31, 2022 and accounted for 1.5% of the total gross pre-tax unrealized investment loss in the fixed maturity portfolio at December 31, 2022.Impairment ChargesImpairment charges included in net realized investment gains (losses) in the consolidated statement of income were $38 million, $2 million and $55 million for the years ended December 31, 2022, 2021 and 2020, respectively. See note 3 of the notes to the consolidated financial statements for further information.Purchases and Sales of Investment SecuritiesPurchases and sales of investments are based on cash requirements, the characteristics of the insurance liabilities and current market conditions. The Company identifies investments to be sold to achieve its primary investment goals of assuring the Company’s ability to meet policyholder obligations as well as to optimize investment returns, given these obligations.During the year ended December 31, 2022, the Company incurred pre-tax realized losses of $99 million on the sale of fixed maturity investments having a fair value of $2.07 billion. CATASTROPHE MODELINGThe Company uses various analyses and methods, including proprietary and third-party modeling processes, to make underwriting and reinsurance decisions designed to manage its exposure to catastrophic events. There are no industry-standard methodologies or assumptions for projecting catastrophe exposure. Accordingly, catastrophe estimates provided by different insurers may not be comparable. The Company actively monitors and evaluates changes in third-party models and, when necessary, calibrates the catastrophe risk model estimates delivered via its own proprietary modeling processes. The Company considers historical loss experience, recent events, underwriting practices, market share analyses, external scientific analysis and various other factors, including non-modeled losses, to refine its proprietary view of catastrophe risk. These proprietary models are updated regularly as new information and techniques emerge.Based on the proprietary and third-party models utilized by the Company, the tables below set forth, as of December 31, 2022, the probabilities that estimated losses, comprising claims and allocated claim adjustment expenses (but excluding unallocated claim adjustment expenses), from a single event occurring in a one-year timeframe will equal or exceed the indicated loss amounts (expressed in dollars, net of tax, and as a percentage of the Company’s common equity). For example, on the basis described below the tables, the Company estimates that there is a one percent chance that the Company’s loss from a single U.S. and Canadian hurricane in a one-year timeframe would equal or exceed $2.1 billion, or 8% of the Company’s common equity at December 31, 2022. Dollars (in billions)Likelihood of Exceedance (1)Single U.S. andCanadianHurricaneSingle U.S. andCanadianEarthquake2.0% (1-in-50)$1.7 $0.6 1.0% (1-in-100)$2.1 $1.1 0.4% (1-in-250)$3.4 $1.9 0.1% (1-in-1,000)$7.4 $3.1 84 Percentage of Common Equity (2)Likelihood of ExceedanceSingle U.S. andCanadianHurricaneSingle U.S. andCanadianEarthquake2.0% (1-in-50)6 %2 %1.0% (1-in-100)8 %4 %0.4% (1-in-250)13 %7 %0.1% (1-in-1,000)28 %12 %___________________________________________(1) An event that has, for example, a 2% likelihood of exceedance is sometimes described as a “1-in-50 year event.” As noted above, however, the probabilities in the table represent the likelihood of losses from a single event equaling or exceeding the indicated threshold loss amount in a one-year timeframe, not over a multi-year timeframe. Also, because the probabilities relate to a single event, the probabilities do not address the likelihood of more than one event occurring in a particular period, and, therefore, the amounts do not address potential aggregate catastrophe losses occurring in a one-year timeframe. (2) The percentage of common equity is calculated by dividing (a) indicated loss amounts in dollars by (b) total common equity excluding net unrealized investment gains and losses, net of taxes, included in shareholders’ equity. Net unrealized investment gains and losses can be significantly impacted by both discretionary and other economic factors and are not necessarily indicative of operating trends. Accordingly, the Company’s management uses the percentage of common equity calculated on this basis as a metric to evaluate the potential impact of a single hurricane or single earthquake on the Company’s financial position for purposes of making underwriting and reinsurance decisions. The threshold loss amounts in the tables above, which are based on the Company’s in-force portfolio at December 31, 2022 and catastrophe reinsurance program at January 1, 2023, are net of reinsurance, after-tax and exclude unallocated claim adjustment expenses, which historically have been less than 10% of loss estimates. For further information regarding the Company’s reinsurance, see “Item 1-Business-Reinsurance.” The amounts for hurricanes reflect U.S. and Canadian exposures and include property exposures, property residual market exposures and an adjustment for certain non-property exposures. The hurricane loss amounts are based on the Company’s catastrophe risk model estimates and include losses from the hurricane hazards of wind and storm surge. The amounts for earthquakes reflect U.S. and Canadian property and workers’ compensation exposures. These loss amounts include the effects of exposure growth, inflation and modeling updates based on recent trends and scientific analysis. The Company does not believe that the inclusion of hurricane or earthquake losses arising from other geographical areas or other exposures would materially change the estimated threshold loss amounts. Catastrophe modeling relies upon inputs based on experience, science, engineering and history. These inputs reflect a significant amount of judgment and are subject to changes which may result in volatility in the modeled output. Catastrophe modeling output may also fail to account for risks that are outside the range of normal probability or are otherwise unforeseeable. Catastrophe modeling assumptions include, among others, the portion of purchased reinsurance that is collectible after a catastrophic event, which may prove to be materially incorrect. Consequently, catastrophe modeling estimates are subject to significant uncertainty. In the tables above, the uncertainty associated with the estimated threshold loss amounts increases significantly as the likelihood of exceedance decreases. In other words, in the case of a relatively more remote event (e.g., 1-in-1,000), the estimated threshold loss amount is relatively less reliable. Actual losses from an event could materially exceed the indicated threshold loss amount. In addition, more than one such event could occur in any period. Moreover, the Company is exposed to the risk of material losses from other than property and workers’ compensation coverages arising out of hurricanes and earthquakes, and it is exposed to catastrophe losses from perils other than hurricanes and earthquakes, such as tornadoes and other windstorms, hail, wildfires, severe winter weather, floods, tsunamis, volcanic eruptions, solar flares and other naturally-occurring events, as well as acts of terrorism and cyber events. In addition, compared to models for hurricanes, models for earthquakes are less reliable due to there being a more limited number of significant historical events to analyze, while models for tornadoes, hail storms, wildfires and winter storms are newer and may be less reliable due to the highly random geographic nature and size of these events. Accordingly, these models may be less accurate in predicting risks and estimating losses. Further, changes in climate conditions could cause our underlying modeling data to be less predictive, thus limiting our ability to effectively evaluate and manage catastrophe risk. As compared to natural catastrophes, modeling for man-made catastrophes, such as terrorism and cyber events, is even more difficult and less reliable, and for some events (both natural and man-made), models are either in early stages of development and, therefore, not widely adopted, or are not available.85For more information about the Company’s exposure to catastrophe losses, see “Item 1A-Risk Factors-High levels of catastrophe losses, including as a result of factors such as increased concentrations of insured exposures in catastrophe-prone areas, could materially and adversely affect our results of operations, our financial position and/or liquidity, and could adversely impact our ratings, our ability to raise capital and the availability and cost of reinsurance” and “Item 1A-Risk Factors- We may be adversely affected if our pricing and capital models provide materially different indications than actual results.” CHANGING CLIMATE CONDITIONSSevere weather events over the last two decades underscore the unpredictability of climate trends. For example, the frequency and/or severity of hurricane, tornado, hail and wildfire events in the United States have been more volatile during this time period. The insurance industry has experienced increased catastrophe losses due to a number of potential causal factors, including, in addition to weather/climate variability, aging infrastructure, more people living in, and moving to, high-risk areas, population growth in areas with weaker enforcement of building codes, urban expansion, an increase in the number of amenities included in, and average size of, a home and increased inflation, including as a result of post-event demand surge. We believe that changing climate conditions have also likely added to the frequency and severity of natural disasters and created additional uncertainty as to future trends and exposures. Climate studies by government agencies, academic institutions, catastrophe modeling organizations and other groups indicate that an increase in frequency and/or intensity of hurricanes, heavy precipitation events, flash flooding, sea level rise, droughts, heat waves and wildfires has occurred, and can be expected into the future. Understanding the potential impacts of changing climate conditions is important to the Company's business. Changing climate conditions are expected to evolve over decades. Importantly, because most of its policies renew annually, the Company is able to respond to these changes over time through adjustments to its underwriting strategy, product pricing and related policy terms and conditions, as appropriate. As an example, in recent years the Company has focused on enhancing the strategic management of its catastrophe exposure, adding experts in data science, meteorology, including climate and flood science, wind and structural engineering and geophysics, among others, to its catastrophe management organization. The Company has also established dedicated teams for each catastrophe peril, with the goal of developing industry-leading scientific and underwriting expertise. This expertise has been incorporated into the Company’s product development, risk selection, pricing, capital allocation and claim response. The Company discusses how changing climate conditions may present other issues for its business under “Item 1A - Risk Factors.” and “Outlook.” For example, among other things: •Increasingly unpredictable and severe weather conditions could result in increased frequency and severity of claims under policies issued by the Company. See “Item 1A—Risk Factors—High levels of catastrophe losses, including as a result of factors such as increased concentrations of insured exposures in catastrophe-prone areas and changing climate conditions, could materially and adversely affect our results of operations, our financial position and/or liquidity, and could adversely impact our ratings, our ability to raise capital and the availability and cost of reinsurance” and “-Outlook-Underwriting Gain/Loss.” Moreover, the Company's catastrophe models may be less reliable due to the increased unpredictability in frequency and severity of severe weather events, emerging trends in climate conditions and regulatory responses to catastrophe events not being appropriately reflected in the models, in addition to the other factors mentioned above. Accordingly, the Company may be subject to increased losses from catastrophes and other weather-related events. •Changing climate conditions could also impact the creditworthiness of issuers of securities in which the Company invests. For example, water supply adequacy could impact the creditworthiness of bond issuers with significant assets or business activities in the Southwestern United States; more frequent and/or severe hurricanes could impact the creditworthiness of issuers with significant assets or business activities in the Southeastern United States, among other areas; and increased regulation adopted in response to potential changes in climate conditions could impact the creditworthiness of issuers affected by such regulations. In addition, as issuers of securities in which the Company invests become increasingly focused on mitigating the potential environmental impact of their operations, the costs associated with such initiatives could affect the business models and realized returns of such issuers. See “Item 1A—Risk Factors—Our investment portfolio is subject to credit and interest rate risk, and may suffer reduced or low returns or material realized or unrealized losses.”•Increased regulation adopted in response to potential changes in climate conditions may impact the Company and its customers, including state insurance regulations that could impact the Company’s ability to manage property exposures in areas vulnerable to significant climate driven losses. For example, state laws have been passed that restrict a carrier's ability to cancel or non-renew certain policies within or adjacent to declared state of emergency zip codes and mandate discounts for risk mitigation practices that may not be effective. If the Company is unable to implement risk-based pricing, modify policy terms or reduce exposures to the extent necessary to address rising losses 86related to catastrophes and smaller scale weather events (should those increased losses occur), its business may be adversely affected. See “Item 1—Business—U.S. State and Federal Regulation—Regulatory and Legislative Responses to Catastrophes.” In addition, climate change regulation could increase the Company’s customers’ costs of doing business. For example, insureds faced with carbon management regulatory requirements may have less available capital for investment in loss prevention and safety features which may, over time, increase loss exposures. Increased regulation may also result in reduced economic activity, which would decrease the amount of insurable assets and businesses, and increased claim costs, to the extent such regulations require that damaged homes or businesses be rebuilt according to more expensive specifications. •The full range of potential liability exposures related to changing climate conditions continues to evolve. For example, from time to time third parties sue our policyholders alleging that they caused or contributed to changing climate conditions. Through the Company’s Enterprise Casualty Emerging Risk Committee and its Committee on Climate, Energy and the Environment, the Company works with its business units and corporate groups, as appropriate, to identify and try to assess climate change-related liability issues, which are continually evolving and often hard to fully evaluate. The Company regularly reviews emerging issues, including changing climate conditions, to consider potential changes to its modeling and the use of such modeling, as well as to help determine the need for new underwriting strategies, coverage modifications or new products. See “Item 1A—Risk Factors—The effects of emerging claim and coverage issues on our business are uncertain, and court decisions or legislative changes that take place after we issue our policies can result in an unexpected increase in the number of claims and have a material adverse impact on our results of operations.”REINSURANCE RECOVERABLESThe Company reinsures a portion of the risks it underwrites in order to control its exposure to losses. For additional discussion regarding the Company’s reinsurance coverage, see “Part I—Item 1—Business—Reinsurance.”The following table summarizes the composition of the Company’s reinsurance recoverables:(at December 31, in millions)20222021Gross reinsurance recoverables on paid and unpaid claims and claim adjustment expenses$3,792 $3,931 Gross structured settlements2,802 2,900 Mandatory pools and associations1,601 1,762 Gross reinsurance recoverables8,195 8,593 Allowance for estimated uncollectible reinsurance(132)(141)Net reinsurance recoverables$8,063 $8,452 Net reinsurance recoverables at December 31, 2022 decreased by $389 million from December 31, 2021, primarily reflecting cash collections and decreases in mandatory pools and associations and structured settlements in 2022. The following table presents the Company’s top five reinsurer groups by reinsurance recoverable at December 31, 2022 (in millions). Also included is the A.M. Best rating of the Company's predominant reinsurer from each such reinsurer group at February 16, 2023:Reinsurer GroupReinsuranceRecoverableA.M. Best Rating of Group’s PredominantReinsurerSwiss Re Group$561 A+second highest of 16 ratingsBerkshire Hathaway515 A++highest of 16 ratingsMunich Re Group318 A+second highest of 16 ratingsAxa Group152 A+second highest of 16 ratingsPartnerRe Group140 A+second highest of 16 ratingsAt December 31, 2022, the Company held $1.00 billion of collateral in the form of letters of credit, funds and trust agreements held to fully or partially collateralize certain reinsurance recoverables.87Included in net reinsurance recoverables are amounts related to structured settlements, which are annuities purchased from various life insurance companies to settle certain personal physical injury claims, of which workers’ compensation claims comprise a significant portion. In cases where the Company did not receive a release from the claimant, the amount due from the life insurance company related to the structured settlement is included in the Company’s consolidated balance sheet as a reinsurance recoverable and the related claim cost is included in the liability for claims and claim adjustment expense reserves, as the Company retains the contingent liability to the claimant. If it is expected that the life insurance company is not able to pay, the Company would recognize an impairment of the related reinsurance recoverable if, and to the extent, the purchased annuities are not covered by state guaranty associations. In the event that the life insurance company fails to make the required annuity payments, the Company would be required to make such payments. The following table presents the Company’s top five groups by structured settlements at December 31, 2022 (in millions). Also included is the A.M. Best rating of the Company’s predominant insurer from each such insurer group at February 16, 2023: GroupStructuredSettlementsA.M. Best Rating of Group’s PredominantInsurerFidelity & Guaranty Life Group$699 A-fourth highest of 16 ratingsGenworth Financial Group310 B-eighth highest of 16 ratingsJohn Hancock Group249 A+second highest of 16 ratingsSymetra Financial Corporation215 Athird highest of 16 ratingsBrighthouse Financial, Inc. 207 Athird highest of 16 ratingsThe Company considers the ratings and related outlook assigned to reinsurance companies and life insurance companies by various independent ratings agencies in assessing the adequacy of its allowance for uncollectible amounts.OUTLOOK The following discussion provides outlook information for certain key drivers of the Company’s results of operations and capital position.Premiums. The Company’s earned premiums are a function of net written premium volume. Net written premiums comprise both renewal business and new business and are recognized as earned premium over the term of the underlying policies. When business renews, the amount of net written premiums associated with that business may increase or decrease (renewal premium change) as a result of increases or decreases in rate and/or insured exposures, which the Company considers as a measure of units of exposure (such as the number and value of vehicles or properties insured). Net written premiums from both renewal and new business, and therefore earned premiums, are impacted by competitive market conditions as well as general economic conditions, which, particularly in the case of Business Insurance, affect audit premium adjustments, policy endorsements and mid-term cancellations. Net written premiums may also be impacted by the structure of reinsurance programs and related costs, as well as changes in foreign currency exchange rates.Overall, the Company expects that retention levels (the amount of expiring premium that renews, before the impact of renewal premium changes) will remain strong by historical standards during 2023. Property and casualty insurance market conditions are expected to remain competitive during 2023 for new business. In each of the Company’s business segments, new business generally has less of an impact on underwriting profitability than renewal business, given the volume of new business relative to renewal business. However, in periods of meaningful increases in new business, despite its positive impact on underwriting gains over time, the impact of higher new business levels may negatively impact the combined ratio for a period of time. In periods of meaningful decreases in new business, despite its negative impact on underwriting gains over time, the impact of lower new business levels may positively impact the combined ratio for a period of time.Effective January 1, 2023, the Company entered into a quota share reinsurance agreement with subsidiaries of Fidelis Insurance Holdings Limited (Fidelis) pursuant to which the Company will assume 20% of the business written by Fidelis during 2023, subject to a loss ratio cap. The Company’s portion of net written premiums from Fidelis is expected to be approximately $550 million to $600 million for the full year and will be reported as part of the International results of Business Insurance. The Company also has a minority investment in Fidelis. Underwriting Gain/Loss. The Company’s underwriting gain/loss can be significantly impacted by catastrophe losses and net favorable or unfavorable prior year reserve development, as well as underlying underwriting margins. Underlying underwriting margins can be impacted by a number of factors, including variability in non-catastrophe weather, large loss and other loss 88activity; changes in current period loss estimates resulting from prior period loss development; changes in loss cost trends; changes in business mix; changes in reinsurance coverages and/or costs; premium adjustments; and variability in expenses and assessments. Catastrophe losses and non-catastrophe weather-related losses are inherently unpredictable from period to period. The Company’s results of operations could be adversely impacted if significant catastrophe and non-catastrophe weather-related losses were to occur.On average for the ten-year period ended December 31, 2022, the Company experienced approximately 41% of its annual catastrophe losses during the second quarter, primarily arising out of severe wind and hail storms, including tornadoes. Hurricanes, wildfires and winter storms tend to happen at other times of the year and can also have a material impact on the Company's results of operations. Catastrophe losses incurred in a particular quarter in any given year may differ materially from historical experience. In addition, most of the Company's reinsurance programs renew on January 1 or July 1 of each year, and, therefore, any changes to the availability, cost or coverage terms of such programs will be effective after such dates.Over much of the past decade, the Company’s results have included significant amounts of net favorable prior year reserve development driven by better than expected loss experience. However, given the inherent uncertainty in estimating claims and claim adjustment expense reserves, loss experience could develop such that the Company recognizes in future periods higher or lower levels of favorable prior year reserve development, no favorable prior year reserve development or unfavorable prior year reserve development. In addition, the ongoing review of prior year claims and claim adjustment expense reserves, or other changes in current period circumstances, may result in the Company revising current year loss estimates upward or downward in future periods of the current year.It is possible that changes in economic conditions, the supply chain, the labor market and geopolitical tensions, as well as steps taken by federal, state and/or local governments and the Federal Reserve, could lead to higher or lower inflation than the Company anticipated, which could in turn lead to an increase or decrease in the Company’s loss costs and the need to strengthen or reduce claims and claim adjustment expense reserves. These impacts of inflation on loss costs and claims and claim adjustment expense reserves could be more pronounced for those lines of business that require a relatively longer period of time to finalize and settle claims for a given accident year and, accordingly, are relatively more inflation sensitive. Labor shortages, higher costs of used vehicles and parts, and increased demand and decreased supply for raw materials are adversely impacting severity in our auto and property businesses and may continue to do so in future quarters. For a further discussion, see “Part I—Item 1A—Risk Factors—If actual claims exceed our claims and claim adjustment expense reserves, or if changes in the estimated level of claims and claim adjustment expense reserves are necessary, including as a result of, among other things, changes in the legal/tort, regulatory and economic environments in which the Company operates, our financial results could be materially and adversely affected.” The Company’s results of operations may be impacted by a number of other factors, including an economic slowdown, a recession, financial market volatility, supply chain disruptions, monetary and fiscal policy measures (including future actions or inactions of the United States government related to the “debt-ceiling”), heightened geopolitical tensions, fluctuations in interest rates and foreign currency exchange rates, the political and regulatory environment, changes to the U.S. Federal budget and potential changes in tax laws. Investment Portfolio. The Company expects to continue to focus its investment strategy on maintaining a high-quality investment portfolio and a relatively short average effective duration. The weighted average effective duration of fixed maturities and short-term securities was 4.6 (4.8 excluding short-term securities) at December 31, 2022. From time to time, the Company enters into short positions in U.S. Treasury futures contracts to manage the duration of its fixed maturity portfolio. At December 31, 2022, the Company had no open U.S. Treasury futures contracts. The Company regularly evaluates its investment alternatives and mix. Currently, the majority of the Company’s investments are comprised of a widely diversified portfolio of high-quality, liquid, taxable U.S. government, tax-exempt and taxable U.S. municipal and taxable corporate and U.S. agency mortgage-backed bonds. The Company also invests much smaller amounts in equity securities, real estate, and private equity, hedge fund and real estate partnerships, and joint ventures. These investment classes have the potential for higher returns but also the potential for greater volatility and higher degrees of risk, including less stable rates of return and less liquidity.Approximately 26% of the fixed maturity portfolio is expected to mature over the next three years (including the early redemption of bonds, assuming interest rates (including credit spreads) do not rise significantly by applicable call dates). As a result, the overall yield on and composition of its portfolio could be meaningfully impacted by the types of investments available for reinvestment with the proceeds of maturing bonds. 89Net investment income is a material contributor to the Company’s results of operations. Based on our current expectations for slightly higher levels of fixed income investments and the impact of expected higher reinvestment yields on fixed income investments, the Company expects that after-tax net investment income from that portfolio will be approximately $515 million in the first quarter of 2023, increasing to an estimated $560 million by the fourth quarter of 2023. This expectation could be impacted by the direction of interest rates and disruptions in global financial markets. Included in other investments are private equity, hedge fund and real estate partnerships that are accounted for under the equity method of accounting and typically report their financial statement information to the Company one month to three months following the end of the reporting period. Accordingly, net investment income or loss from these other investments is generally reflected in the Company's financial statements on a quarter lag basis. The Company’s net investment income in future periods from its non-fixed income investment portfolio will be impacted, positively or negatively, by the performance of global financial markets. The Company had net pre-tax realized investment losses of $204 million in 2022. Changes in global financial markets could result in net realized investment gains or losses in the Company’s investment portfolio. The Company had a net pre-tax unrealized investment loss of $6.22 billion ($4.90 billion after-tax) in its fixed maturity investment portfolio at December 31, 2022, compared to a net pre-tax unrealized investment gain of $3.06 billion ($2.42 billion after-tax) at December 31, 2021, primarily due to the increases in interest rates during 2022. While the Company does not attempt to predict future interest rate movements, a rising interest rate environment reduces the market value of fixed maturity investments and, therefore, reduces shareholders’ equity, and a declining interest rate environment has the opposite effects. Since the Company generally holds its high-quality fixed maturity investments to maturity, the net unrealized loss discussed above is considered temporary in nature and is not expected to result in significant realized losses. In addition, given the temporary nature of net unrealized losses combined with the Company’s strong operating cash flows, which include income received on investments and the proceeds received upon maturity of the investments, the net unrealized investment loss is not expected to meaningfully impact the Company’s assessment of capital adequacy or liquidity. Additionally, disruptions in global financial markets could also impact the market value of the Company’s investment portfolio. The Company's investment portfolio has benefited from certain tax exemptions (primarily those related to interest from municipal bonds) and certain other tax laws, including, but not limited to, those governing dividends-received deductions and tax credits (such as foreign tax credits). Changes in these laws could adversely impact the value of the Company's investment portfolio. See “Our businesses are heavily regulated by the states and countries in which we conduct business, including licensing, market conduct and financial supervision, and changes in regulation, including higher tax rates, may reduce our profitability and limit our growth” included in “Part I—Item 1A—Risk Factors.” For further discussion of the Company’s investment portfolio, see “Investment Portfolio.” For a discussion of the risks to the Company’s business during or following a financial market disruption and risks to the Company’s investment portfolio, see the risk factors entitled “During or following a period of financial market disruption or an economic downturn, our business could be materially and adversely affected” and “Our investment portfolio is subject to credit and interest rate risk, and may suffer reduced or low returns or material realized or unrealized losses” included in “Part I—Item 1A—Risk Factors.” For a discussion of the risks to the Company’s investments from foreign currency exchange rate fluctuations, see the risk factor entitled “We are subject to additional risks associated with our business outside the United States” included in “Part I—Item 1A—Risk Factors” and see “Part II—Item 7A—Quantitative and Qualitative Disclosures About Market Risk—Foreign Currency Exchange Rate Risk.” Capital Position. The Company believes it has a strong capital position and, as part of its ongoing efforts to create shareholder value, expects to continue to return capital not needed to support its business operations to its shareholders, subject to the considerations described below. The Company expects that, generally over time, the combination of dividends to common shareholders and common share repurchases will likely not exceed net income. The Company also expects that to the extent that it continues to grow premium volumes, the level of capital to support the Company's financial strength ratings will also increase, and accordingly, the amount of capital returned to shareholders relative to earnings would be somewhat less than it otherwise would have been absent the growth in premium volumes. The timing and actual number of shares to be repurchased in the future will depend on a variety of additional factors, including the Company’s financial position, earnings, share price, catastrophe losses, maintaining capital levels appropriate for the Company’s business operations, changes in levels of written premiums, funding of the Company’s qualified pension plan, capital requirements of the Company’s operating subsidiaries, legal requirements, regulatory constraints, other investment opportunities (including mergers and acquisitions and related financings), market conditions, changes in tax laws (including the Inflation Reduction Act) and other factors. For information regarding the Company’s common share repurchases in 2022, see “Liquidity and Capital Resources” herein. S&P has announced that it intends to change its capital adequacy model. While the proposed model has not been finalized, it could increase the level of capital S&P requires for a particular financial strength rating. As part of its capital management strategy, the Company will continue to make its own assessment of the appropriate level of capital to support the Company’s business 90operations. For a discussion of the risks to the Company's claims-paying and financial strength ratings, see the risk factor entitled “A downgrade in our claims-paying and financial strength ratings could adversely impact our business volumes, adversely impact our ability to access the capital markets and increase our borrowing costs” included in “Part I—Item 1A—Risk Factors.”As a result of the Company’s business outside of the United States, primarily in Canada, the United Kingdom (including Lloyd’s), the Republic of Ireland and in Brazil through a joint venture, the Company’s capital is also subject to the effects of changes in foreign currency exchange rates. Strengthening of the U.S. dollar in comparison to other currencies could result in a reduction in shareholders’ equity, while a weakening of the U.S. dollar in comparison to other currencies could result in an increase in shareholders' equity. For additional discussion of the Company’s foreign exchange market risk exposure, see “Part II—Item 7A—Quantitative and Qualitative Disclosures About Market Risk.”Many of the statements in this “Outlook” section and in “Liquidity and Capital Resources” are forward-looking statements, which are subject to risks and uncertainties that are often difficult to predict and beyond the Company’s control. Actual results could differ materially from those expressed or implied by such forward-looking statements. Further, such forward-looking statements speak only as of the date of this report and the Company undertakes no obligation to update them. See “—Forward Looking Statements.” For a discussion of potential risks and uncertainties that could impact the Company’s results of operations or financial position, see “Part I—Item 1A—Risk Factors” and “Critical Accounting Estimates.” LIQUIDITY AND CAPITAL RESOURCESConsistent with 2021, the Company's liquidity and capital resources were not materially impacted by COVID-19 and related economic conditions during 2022.Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the cash requirements of its business operations and to satisfy general corporate purposes when needed.Operating Company Liquidity. The liquidity requirements of the Company’s insurance subsidiaries are met primarily by funds generated from premiums, fees, income received on investments and investment maturities. Cash provided from these sources is used primarily for claims and claim adjustment expense payments and operating expenses. The insurance subsidiaries’ liquidity requirements can be impacted by, among other factors, the timing and amount of catastrophe claims, which are inherently unpredictable, as well as the timing and amount of reinsurance recoveries, which may be affected by reinsurer solvency and reinsurance coverage disputes. Additionally, the variability of asbestos-related claim payments, as well as the volatility of potential judgments and settlements arising out of litigation, may also result in increased liquidity requirements. Increases in interest rates in 2022 resulted in net unrealized investment losses; however, since the Company generally holds its high-quality fixed maturity investments to maturity, the net unrealized loss is considered temporary in nature and is not expected to result in significant realized losses. In addition, given the temporary nature of net unrealized losses combined with the Company’s strong operating cash flows, which include income received on investments and the proceeds received upon maturity of the investments, the net unrealized investment loss is not expected to meaningfully impact the Company’s assessment of capital adequacy or liquidity. It is the opinion of the Company’s management that the insurance subsidiaries’ future liquidity needs will be adequately met from all of the sources described above. Subject to restrictions imposed by states in which the Company’s insurance subsidiaries are domiciled, the Company’s principal insurance subsidiaries pay dividends to their respective parent companies, which, in turn, pay dividends to the corporate holding (parent) company (TRV). For further information regarding restrictions on dividends paid by the Company’s insurance subsidiaries, see “Part I—Item 1—Business—Regulation.” Holding Company Liquidity. TRV’s liquidity requirements primarily include shareholder dividends, debt servicing, common share repurchases and, from time to time, contributions to its qualified domestic pension plan. At December 31, 2022, TRV held total cash and short-term invested assets in the United States aggregating $1.45 billion and having a weighted average maturity of 39 days. TRV has established a holding company liquidity target equal to its estimated annual pre-tax interest expense and common shareholder dividends (currently approximately $1.20 billion). TRV’s holding company liquidity of $1.45 billion at December 31, 2022 exceeded this target, and it is the opinion of the Company’s management that these assets are sufficient to meet TRV’s current liquidity requirements.TRV is not dependent on dividends or other forms of repatriation from its foreign operations to support its liquidity needs. The undistributed earnings of the Company’s foreign operations are intended to be permanently reinvested in those operations, and such earnings were not material to the Company’s financial position or liquidity at December 31, 2022. 91TRV has a shelf registration statement filed with the Securities and Exchange Commission that expires on June 8, 2025 which permits it to issue securities from time to time. TRV also has a $1.0 billion line of credit facility with a syndicate of financial institutions that expires on June 15, 2027. At December 31, 2022, the Company had $100 million of commercial paper outstanding. TRV is not reliant on its commercial paper program to meet its operating cash flow needs. The Company has no senior notes or junior subordinated debentures maturing until April 2026, at which time $200 million of senior notes will mature. The Company utilized uncollateralized letters of credit issued by major banks with an aggregate limit of $260 million to provide a portion of the capital needed to support its obligations at Lloyd’s at December 31, 2022. If uncollateralized letters of credit are not available at a reasonable price or at all in the future, the Company can collateralize these letters of credit or may have to seek alternative means of supporting its obligations at Lloyd’s, which could include utilizing holding company funds on hand. Operating ActivitiesNet cash provided by operating activities were $6.47 billion and $7.27 billion in 2022 and 2021, respectively. The decrease in cash flows in 2022 primarily reflected the impacts of higher levels of payments for claims and claim adjustment expenses and commissions, partially offset by higher levels of cash received for premiums. The increase in cash paid for claims and claim adjustment expenses in 2022 was impacted by business growth and higher loss costs. Cash paid for claims and claim adjustment expenses continue to be impacted by reduced judicial system and claims settlement activity related to COVID-19 and related economic conditions. The increase in cash received for premiums in 2022 compared to the prior year was impacted by business growth including the impact of positive renewal premium changes. Investing ActivitiesNet cash used in investing activities was $3.73 billion and $5.20 billion in 2022 and 2021, respectively. The Company’s consolidated total investments at December 31, 2022 decreased by $6.92 billion, or 8% from December 31, 2021, primarily reflecting the impacts of (i) net unrealized losses on investments at December 31, 2022 as compared with net unrealized investment gains at December 31, 2021, due to the impact of higher interest rates during 2022 and (ii) net cash used in financing activities, partially offset by (iii) net cash flows provided by operating activities.The Company’s investment portfolio is managed to support its insurance operations; accordingly, the portfolio is positioned to meet obligations to policyholders. As such, the primary goals of the Company’s asset-liability management process are to satisfy the insurance liabilities and maintain sufficient liquidity to cover fluctuations in projected liability cash flows. Generally, the expected principal and interest payments produced by the Company’s fixed maturity portfolio adequately fund the estimated runoff of the Company’s insurance reserves. Although this is not an exact cash flow match in each period, the substantial amount by which the market value of the fixed maturity portfolio exceeds the value of the net insurance liabilities, as well as the positive cash flow from newly sold policies and the large amount of high quality liquid bonds, contributes to the Company’s ability to fund claim payments without having to sell illiquid assets or access credit facilities. Financing ActivitiesNet cash used in financing activities were $2.67 billion and $2.04 billion in 2022 and 2021, respectively. The totals in both 2022 and 2021 reflected common share repurchases and dividends paid to shareholders, partially offset by the net proceeds from employee stock option exercises. The total in 2021 also included net proceeds from the issuance of debt. Common share repurchases in 2022 and 2021 were $2.06 billion and $2.20 billion, respectively.92Debt Transactions.2021. On June 8, 2021, the Company issued $750 million aggregate principal amount of 3.05% senior notes that will mature on June 8, 2051. The net proceeds of the issuance, after the deduction of the underwriting discount and expenses payable by the Company, totaled approximately $739 million. Interest on the senior notes is payable semi-annually in arrears on June 8 and December 8. Prior to December 8, 2050, the senior notes may be redeemed, in whole or in part, at the Company’s option, at any time or from time to time, at a redemption price equal to the greater of (a) 100% of the principal amount of any senior notes to be redeemed or (b) the sum of the present values of the remaining scheduled payments of principal and interest to but excluding December 8, 2050 on any senior notes to be redeemed (exclusive of interest accrued to the date of redemption) discounted to the date of redemption on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months) at the then current Treasury rate (as defined in the senior notes), plus 15 basis points. On or after December 8, 2050, the senior notes may be redeemed, in whole or in part, at the Company’s option, at any time or from time to time, at a redemption price equal to 100% of the principal amount of any senior notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.Dividends. Dividends paid to shareholders were $875 million and $869 million in 2022 and 2021, respectively. The declaration and payment of future dividends to holders of the Company’s common stock will be at the discretion of the Company’s Board of Directors and will depend upon many factors, including the Company’s financial position, earnings, capital requirements of the Company’s operating subsidiaries, legal requirements, regulatory constraints and other factors as the Board of Directors deems relevant. Dividends will be paid by the Company only if declared by its Board of Directors out of funds legally available, subject to any other restrictions that may be applicable to the Company. On January 24, 2023, the Company announced that its Board of Directors declared a regular quarterly dividend of $0.93 per share, payable March 31, 2023 to shareholders of record on March 10, 2023. Share Repurchases. The Company’s Board of Directors has approved common share repurchase authorizations under which repurchases may be made from time to time in the open market, pursuant to pre-set trading plans meeting the requirements of Rule 10b5-1 under the Securities Exchange Act of 1934, in private transactions or otherwise. The authorizations do not have a stated expiration date. The most recent authorization was approved by the Board of Directors on April 20, 2021 and added $5.0 billion of repurchase capacity to the $805 million capacity remaining at that date. The Company expects that, generally over time, the combination of dividends to common shareholders and common share repurchases will likely not exceed net income. The Company also expects that to the extent that it continues to grow premium volumes, the amount of capital returned to shareholders relative to earnings would be somewhat less than it otherwise would have been. The timing and actual number of shares to be repurchased in the future will depend on a variety of factors, including the Company’s financial position, earnings, share price, catastrophe losses, maintaining capital levels appropriate for the Company’s business operations, changes in levels of written premiums, funding of the Company’s qualified pension plan, capital requirements of the Company’s operating subsidiaries, legal requirements, regulatory constraints, other investment opportunities (including mergers and acquisitions and related financings), market conditions, changes in tax laws (including the Inflation Reduction Act) and other factors. During 2022, the Company repurchased 11.6 million shares under its share repurchase authorization, for a total of $2.00 billion. The average cost per share repurchased was $172.82. Common share repurchases in 2022 were slightly lower than the total of $2.16 billion in 2021. At December 31, 2022, the Company had $2.00 billion of capacity remaining under its share repurchase authorization. From the inception of the first authorization on May 2, 2006 through December 31, 2022, the Company has repurchased a cumulative total of 538.5 million shares for a total of $39.00 billion, or an average of $72.42 per share. In 2022 and 2021, the Company acquired 0.4 million and 0.3 million shares of common stock, respectively, from employees as treasury stock primarily to cover payroll withholding taxes in connection with the vesting of restricted stock unit awards and performance share awards, and shares used by employees to cover the price of certain stock options that were exercised.Capital ResourcesCapital resources reflect the overall financial strength of the Company and its ability to borrow funds at competitive rates and raise new capital to meet its needs. The following table summarizes the components of the Company’s capital structure at December 31, 2022 and 2021:93(at December 31, in millions)20222021Debt: Short-term$100 $100 Long-term7,254 7,254 Net unamortized fair value adjustments and debt issuance costs(62)(64)Total debt7,292 7,290 Shareholders’ equity: Common stock and retained earnings, less treasury stock28,005 27,694 Accumulated other comprehensive income(6,445)1,193 Total shareholders’ equity21,560 28,887 Total capitalization$28,852 $36,177 Total capitalization at December 31, 2022 was $28.85 billion, $7.33 billion lower than at December 31, 2021, primarily reflecting the impacts of (i) other comprehensive loss of $7.64 billion, primarily reflecting the decrease in net unrealized appreciation on investments due to an increase in interest rates during 2022, (ii) common share repurchases totaling $2.00 billion under the Company’s share repurchase authorization and (iii) shareholder dividends of $880 million, partially offset by (iv) net income of $2.84 billion and (v) proceeds from the exercise of employee share options of $267 million. The following table provides a reconciliation of total capitalization presented in the foregoing table to total capitalization excluding net unrealized gains (losses) on investments, net of taxes, included in shareholders' equity:(at December 31, dollars in millions)20222021Total capitalization$28,852 $36,177 Less: net unrealized gains (losses) on investments, net of taxes, included in shareholders' equity(4,898)2,415 Total capitalization excluding net unrealized gains (losses) on investments, net of taxes, included in shareholders' equity$33,750 $33,762 Debt-to-total capital ratio25.3 %20.2 %Debt-to-total capital ratio excluding net unrealized gains (losses) on investments, net of taxes, included in shareholders' equity21.6 %21.6 %The increase in the debt-to-total capital ratio was primarily due to net unrealized investment losses at December 31, 2022 compared to net unrealized investment gains at December 31, 2021 as a result of rising interest rates. The debt-to-total capital ratio excluding net unrealized gains (losses) on investments, net of taxes, included in shareholders’ equity, is calculated by dividing (a) debt by (b) total capitalization excluding net unrealized gains and losses on investments, net of taxes, included in shareholders’ equity. Net unrealized gains and losses on investments can be significantly impacted by both interest rate movements and other economic factors. Accordingly, in the opinion of the Company’s management, the debt-to-total capital ratio calculated on this basis provides another useful metric for investors to understand the Company’s financial leverage position. The Company’s ratio of debt-to-total capital excluding after-tax net unrealized investment gains (losses) included in shareholders’ equity of 21.6% at December 31, 2022 was within the Company’s target range of 15% to 25%.Credit Agreement. The Company is a party to a five-year, $1.0 billion revolving credit agreement with a syndicate of financial institutions that expires on June 15, 2027. Terms of the credit agreement are discussed in more detail in note 9 of the notes to the consolidated financial statements.Shelf Registration. The Company has filed a universal shelf registration statement with the Securities and Exchange Commission that expires on June 8, 2025 for the potential offering and sale of securities. The Company may offer these securities from time to time at prices and on other terms to be determined at the time of offering.Share Repurchase Authorization. At December 31, 2022, the Company had $2.00 billion of capacity remaining under its share repurchase authorization approved by the Board of Directors.94Cash Requirements from Contractual and Other ObligationsThe following table summarizes, as of December 31, 2022, the Company’s future payments under material contractual obligations and estimated claims and claim-related payments. The table includes only liabilities at December 31, 2022 that are expected to be settled in cash.The table below includes the amount and estimated future timing of claims and claim-related payments. The amounts do not represent the exact liability, but instead represent estimates, generally utilizing actuarial projection techniques, at a given accounting date. These estimates include expectations of what the ultimate settlement and administration of claims will cost based on the Company’s assessment of facts and circumstances known, review of historical settlement patterns, estimates of trends in claims severity, frequency, legal theories of liability and other factors. Variables in the reserve estimation process can be affected by both internal and external events, such as changes in claims handling procedures, economic inflation or deflation, legal trends and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Additionally, there may be significant reporting lags between the occurrence of the policyholder event and the time it is actually reported to the insurer. The future cash flows related to the items contained in the table below required estimation of both amount (including severity considerations) and timing. Amount and timing are frequently estimated separately. An estimation of both amount and timing of future cash flows related to claims and claim-related payments has unavoidable estimation uncertainty. The material cash requirements from contractual and other obligations at December 31, 2022 were as follows:Payments Due by Period (in millions)TotalLess than1 Year1-3Years3-5YearsAfter 5YearsDebt Senior notes$7,000 $— $— $200 $6,800 Junior subordinated debentures254 — — 125 129 Total debt principal7,254 — — 325 6,929 Interest6,571 348 696 673 4,854 Total long-term debt obligations (1)13,825 348 696 998 11,783 Real estate and other operating leases (2)308 93 121 70 24 Information systems-related commitments (3)563 272 222 69 — Long-term unfunded investment commitments (4)1,802 399 544 601 258 Estimated claims and claim-related payments Claims and claim adjustment expenses (5)57,014 12,897 14,599 7,223 22,295 Claims from large deductible policies (6)— — — — — Total estimated claims and claim-related payments57,014 12,897 14,599 7,223 22,295 Total$73,512 $14,009 $16,182 $8,961 $34,360 ________________________________________(1)See note 9 of the notes to the consolidated financial statements for a further discussion of outstanding indebtedness. Because the amounts reported in the foregoing table include principal and interest, the total long-term debt obligations will not agree with the amounts reported in note 9.(2)Represents agreements entered into in the ordinary course of business to lease office space, equipment and furniture. (3)Includes agreements with vendors to purchase system software (including software as a service), software maintenance services and technology-related costs.(4)Represents estimated timing for fulfilling unfunded commitments for private equity limited partnerships, real estate partnerships and other, as well as a put/call option entered into by the Company in connection with a business acquisition.(5)The amounts in “Claims and claim adjustment expenses” in the table above represent the estimated timing of future payments for both reported and unreported claims incurred and related claim adjustment expenses, gross of reinsurance recoverables, excluding structured settlements expected to be paid by annuity companies. The Company has entered into reinsurance agreements to manage its exposure to losses and protect its capital as described in note 6 of the notes to the consolidated financial statements.95In order to qualify for reinsurance accounting, a reinsurance agreement must indemnify the insurer from insurance risk, i.e., the agreement must transfer amount and timing risk. Since the timing and amount of cash inflows from such reinsurance agreements are directly related to the underlying payment of claims and claim adjustment expenses by the insurer, reinsurance recoverables are recognized in a manner consistent with the liabilities (the estimated liability for claims and claim adjustment expenses) relating to the underlying reinsured contracts. The presence of any feature that can delay timely reimbursement of claims by a reinsurer results in the reinsurance contract being accounted for as a deposit rather than reinsurance. The assumptions used in estimating the amount and timing of the reinsurance recoverables are consistent with those used in estimating the amount and timing of the related liabilities.The estimated future cash inflows from the Company’s reinsurance contracts that qualify for reinsurance accounting are as follows:(in millions)TotalLess than 1Year1-3Years3-5YearsAfter 5YearsReinsurance recoverables$5,088 $926 $1,055 $604 $2,503 The Company manages its business and evaluates its liabilities for claims and claim adjustment expenses on a net of reinsurance basis. The estimated cash flows on a net of reinsurance basis are as follows:(in millions)TotalLess than 1Year1-3Years3-5YearsAfter 5YearsClaims and claim adjustment expenses, net$51,926 $11,971 $13,544 $6,619 $19,792 For business underwritten by non-U.S. operations, future cash flows related to reported and unreported claims incurred and related claim adjustment expenses were translated at the spot rate on December 31, 2022.The amounts reported in the table above and in the table of reinsurance recoverables above are presented on a nominal basis and have not been adjusted to reflect the time value of money. Accordingly, the amounts above will differ from the Company’s balance sheet to the extent that the liability for claims and claim adjustment expenses and the related reinsurance recoverables have been discounted in the balance sheet. See note 1 of the notes to the consolidated financial statements.(6) Workers’ compensation large deductible policies provide third-party coverage in which the Company typically is responsible for paying the entire loss under such policies and then seeks reimbursement from the insured for the deductible amount. “Claims from large deductible policies” represent the estimated future payment for claims and claim related expenses below the deductible amount, net of the estimated recovery of the deductible. The liability and the related deductible receivable for unpaid claims are presented in the consolidated balance sheet as “contractholder payables” and “contractholder receivables,” respectively. Most deductibles for such policies are paid directly from the policyholder’s escrow, which is periodically replenished by the policyholder. The payment of the loss amounts above the deductible are reported within “Claims and claim adjustment expenses” in the above table. Because the timing of the collection of the deductible (contractholder receivables) occurs shortly after the payment of the deductible to a claimant (contractholder payables), these cash flows offset each other in the table.The estimated timing of the payment of the contractholder payables and the collection of contractholder receivables (net of allowance for expected credit losses) for workers’ compensation policies is presented below:(in millions)TotalLess than 1Year1-3Years3-5YearsAfter 5YearsContractholder payables/receivables$3,579 $1,087 $1,040 $463 $989 The above table does not include an analysis of liabilities reported for structured settlements for which the Company has purchased annuities and remains contingently liable in the event of default by the company issuing the annuity. The Company is not reasonably likely to incur material future payment obligations under such agreements. In addition, the Company is not currently subject to any minimum funding requirements for its qualified pension plan. Accordingly, future contributions are not included in the foregoing table. The Company believes that the combination of operating company liquidity, holding company liquidity, its investment portfolio and its capital resources are sufficient to meet its contractual obligations. 96Dividend AvailabilityThe Company’s principal insurance subsidiaries are domiciled in the State of Connecticut. The insurance holding company laws of Connecticut applicable to the Company’s subsidiaries requires notice to, and approval by, the state insurance commissioner for the declaration or payment of any dividend that, together with other distributions made within the preceding twelve months, exceeds the greater of 10% of the insurer’s statutory capital and surplus as of the preceding December 31, or the insurer’s net income for the twelve-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices and by state regulation. This declaration or payment is further limited by adjusted unassigned surplus, as determined in accordance with statutory accounting practices. The insurance holding company laws of other states in which the Company’s subsidiaries are domiciled generally contain similar, although in some instances somewhat more restrictive, limitations on the payment of dividends. A maximum of $2.55 billion is available by the end of 2023 for such dividends to the holding company, TRV, without prior approval of the Connecticut Insurance Department. The Company may choose to accelerate the timing within 2023 and/or increase the amount of dividends from its insurance subsidiaries in 2023, which could result in certain dividends being subject to approval by the Connecticut Insurance Department. In addition to the regulatory restrictions on the availability of dividends that can be paid by the Company’s U.S. insurance subsidiaries, the maximum amount of dividends that may be paid to the Company’s shareholders is limited, to a lesser degree, by certain covenants contained in its line of credit agreement with a syndicate of financial institutions that require the Company to maintain a minimum consolidated net worth as described in note 9 of the notes to the consolidated financial statements.TRV is not dependent on dividends or other forms of repatriation from its foreign operations to support its liquidity needs. The undistributed earnings of the Company’s foreign operations are intended to be permanently reinvested in those operations, and such earnings were not material to the Company’s financial position or liquidity at December 31, 2022. TRV and its two non-insurance holding company subsidiaries received dividends of $2.90 billion and $2.18 billion from their U.S. insurance subsidiaries in 2022 and 2021, respectively.Pension and Other Postretirement Benefit PlansThe Company sponsors a qualified non-contributory defined benefit pension plan (the qualified domestic pension plan), which covers substantially all U.S. domestic employees and provides benefits primarily under a cash balance formula. In addition, the Company sponsors a nonqualified defined benefit pension plan which covers certain highly-compensated employees, pension plans for employees of its foreign subsidiaries, and a postretirement health and life insurance benefit plan for employees satisfying certain age and service requirements and for certain retirees. The qualified domestic pension plan is subject to regulations under the Employee Retirement Income Security Act of 1974 as amended (ERISA), which requires plans to meet minimum standards of funding and requires such plans to subscribe to plan termination insurance through the Pension Benefit Guaranty Corporation (PBGC). The Company does not have a minimum funding requirement for the qualified domestic pension plan for 2023 and does not anticipate having a minimum funding requirement in 2024. The Company has significant discretion in making contributions above those necessary to satisfy the minimum funding requirements. In 2022, 2021 and 2020, there was no minimum funding requirement for the qualified domestic pension plan. In 2022, 2021 and 2020, the Company made no voluntary contributions to the qualified domestic pension plan. The qualified domestic pension plan had a funded status of 116% at both December 31, 2022 and 2021. Based on its funded status at December 31, 2022, the Company does not currently anticipate making a voluntary contribution to the qualified domestic pension plan in 2023. In determining future contributions, the Company will consider the performance of the plan’s investment portfolio, the effects of interest rates on the projected benefit obligation of the plan and the Company’s other capital requirements. The qualified domestic pension plan assets are managed to maximize long-term total return while maintaining an appropriate level of risk. The Company’s overall investment strategy is to achieve a mix of approximately 85% to 90% of investments for long-term growth and 10% to 15% for near-term benefit payments with a diversification of asset types, fund strategies and fund managers. The current target allocations for plan assets are 55% to 65% equity securities and 20% to 40% fixed income securities, with the remainder allocated to short-term securities. For 2023, the Company plans to apply an expected long-term rate of return on plan assets of 7.00%, compared with 6.50% in 2022. The expected rate of return reflects the Company’s current expectations with regard to long-term returns in the capital markets, taking into account the pension plan’s asset allocation targets, the historical performance and current valuation of U.S. and international equities, and the level of long term interest rate and inflation expectations. 97For further discussion of the pension and other postretirement benefit plans, see note 15 of the notes to the consolidated financial statements.Risk-Based CapitalThe NAIC has an RBC requirement for most property and casualty insurance companies, which determines minimum capital requirements and is intended to raise the level of protection for policyholder obligations. The Company’s U.S. insurance subsidiaries are subject to these NAIC RBC requirements based on laws that have been adopted by individual states. These requirements subject insurers having policyholders’ surplus less than that required by the RBC calculation to varying degrees of regulatory action, depending on the level of capital inadequacy. Each of the Company’s U.S. insurance subsidiaries had policyholders’ surplus at December 31, 2022 significantly above the level at which any RBC regulatory action would occur. Regulators in the jurisdictions in which the Company’s foreign insurance subsidiaries are located require insurance companies to maintain certain levels of capital depending on, among other things, the type and amount of insurance policies written. Each of the Company’s foreign insurance subsidiaries had capital significantly above their respective regulatory requirements at December 31, 2022.Off-Balance Sheet ArrangementsThe Company has entered into certain contingent obligations for guarantees related to selling businesses to third parties, certain investments, certain insurance policy obligations of former insurance subsidiaries and various other indemnifications. See note 17 of the notes to the consolidated financial statements. The Company does not believe it is reasonably likely that these arrangements will have a material current or future effect on the Company’s financial position, changes in financial position, revenues and expenses, results of operations, liquidity, capital expenditures or capital resources. CRITICAL ACCOUNTING ESTIMATESThe Company considers its most significant accounting estimates to be those applied to claims and claim adjustment expense reserves and related reinsurance recoverables, and impairments of investments, goodwill and other intangible assets.Claims and Claim Adjustment Expense ReservesGross claims and claim adjustment expense reserves by product line were as follows: December 31, 2022December 31, 2021(in millions)CaseIBNRTotalCaseIBNRTotalGeneral liability$5,465 $9,220 $14,685 $5,351 $8,863 $14,214 Commercial property1,200 439 1,639 1,220 392 1,612 Commercial multi-peril2,624 2,759 5,383 2,404 2,573 4,977 Commercial automobile2,625 2,388 5,013 2,594 2,335 4,929 Workers’ compensation10,034 9,458 19,492 10,152 9,551 19,703 Fidelity and surety166 496 662 188 436 624 Personal automobile2,139 2,133 4,272 2,062 1,765 3,827 Personal homeowners and other1,095 1,913 3,008 1,021 1,395 2,416 International and other2,420 2,069 4,489 2,525 2,070 4,595 Property-casualty27,768 30,875 58,643 27,517 29,380 56,897 Accident and health6 — 6 10 — 10 Claims and claim adjustment expense reserves$27,774 $30,875 $58,649 $27,527 $29,380 $56,907 The $1.74 billion increase in gross claims and claim adjustment expense reserves since December 31, 2021 primarily reflected the impacts of (i) higher volumes of insured exposures, (ii) loss cost trends for the current accident year and (iii) catastrophe losses in 2022, partially offset by (iv) claim payments made during 2022 and (v) net favorable prior year reserve development.Asbestos and environmental reserves are included in the General liability, Commercial multi-peril and International and other lines in the foregoing summary table. Asbestos and environmental reserves are discussed separately; see “Asbestos Claims and 98Litigation,” “Environmental Claims and Litigation” and “Uncertainty Regarding Adequacy of Asbestos and Environmental Reserves” herein.Claims and claim adjustment expense reserves represent management’s estimate of the ultimate liability for unpaid losses and loss adjustment expenses for claims that have been reported and claims that have been incurred but not yet reported (IBNR) as of the balance sheet date. Claims and claim adjustment expense reserves do not represent an exact calculation of liability, but instead represent management estimates, primarily utilizing actuarial expertise and projection methods. These estimates are expectations of what the ultimate settlement and administration of claims will cost upon final resolution in the future, based on the Company’s assessment of facts and circumstances then known, review of historical settlement patterns, estimates of trends in claims severity and frequency, expected interpretations of legal theories of liability and other factors. In establishing gross claims and claim adjustment expense reserves, the Company also considers salvage and subrogation. Estimated recoveries from reinsurance are included in “Reinsurance Recoverables” as an asset on the Company’s consolidated balance sheet. The claims and claim adjustment expense reserves are reviewed regularly by qualified actuaries employed by the Company. The process of estimating claims and claim adjustment expense reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, changes in individuals involved in the reserve estimation process, economic inflation, changes in the tort environment, legal trends and legislative changes, among others. The impact of many of these items on ultimate costs for claims and claim adjustment expenses is difficult to estimate. Estimation difficulties also differ significantly by product line due to differences in claim complexity, the volume of claims, the potential severity of individual claims, the determination of occurrence date for a claim and reporting lags (the time between the occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout the process, including the application of various individual experiences and expertise to multiple sets of data and analyses. The Company refines its estimates in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. The Company rigorously attempts to consider all significant facts and circumstances known at the time claims and claim adjustment expense reserves are established. Due to the inherent uncertainty underlying these estimates including, but not limited to, the future settlement environment, final resolution of the estimated liability for claims and claim adjustment expenses may be higher or lower than the related claims and claim adjustment expense reserves at the reporting date. Therefore, actual paid losses, as claims are settled in the future, may be materially different than the amount currently recorded-favorable or unfavorable. Because establishment of claims and claim adjustment expense reserves is an inherently uncertain process involving estimates and the application of judgment, currently established claims and claim adjustment expense reserves may change. The Company reflects adjustments to the reserves in the results of operations in the period the estimates are changed. There are also additional risks which impact the estimation of ultimate costs for catastrophes. For example, the estimation of reserves related to hurricanes, tornadoes, wildfires and other catastrophic events can be affected by the inability of the Company and its insureds to access portions of the impacted areas, the complexity of factors contributing to the losses, the legal and regulatory uncertainties, including the interpretation of policy terms and conditions, and the nature of the information available to establish the reserves. Complex factors include, but are not limited to: determining whether damage was caused by flooding versus wind; evaluating general liability and pollution exposures; estimating additional living expenses; estimating the impact of demand surge, infrastructure disruption, fraud, the effect of mold damage and business interruption costs; and reinsurance collectibility. The timing of a catastrophe, such as at or near the end of a reporting period, can also affect the information available to the Company in estimating reserves for that reporting period. The estimates related to catastrophes are adjusted as actual claims emerge. A portion of the Company’s gross claims and claim adjustment expense reserves (totaling $2.07 billion at December 31, 2022) are for asbestos and environmental claims and related litigation. While the ongoing review of asbestos and environmental claims and associated liabilities considers the inconsistencies of court decisions as to coverage, plaintiffs’ expanded theories of liability and the risks inherent in complex litigation and other uncertainties, in the opinion of the Company’s management, it is possible that the outcome of the continued uncertainties regarding these claims could result in liability in future periods that differs from current insurance reserves by an amount that could be material to the Company’s future operating results. See the preceding discussion of “Asbestos Claims and Litigation” and “Environmental Claims and Litigation.”99General DiscussionThe process for estimating the liabilities for claims and claim adjustment expenses begins with the collection and analysis of claim data. Data on individual reported claims, both current and historical, including paid amounts and individual claim adjuster estimates, are grouped by common characteristics (components) and evaluated by actuaries in their analyses of ultimate claim liabilities. Such data is occasionally supplemented with external data as available and when appropriate. The process of analyzing reserves for a component is undertaken on a regular basis, generally quarterly, in light of continually updated information. Multiple estimation methods are available for the analysis of ultimate claim liabilities. Each estimation method has its own set of assumption variables and its own advantages and disadvantages, with no single estimation method being better than the others in all situations and no one set of assumption variables being meaningful for all product line components. The relative strengths and weaknesses of the particular estimation methods when applied to a particular group of claims can also change over time. Therefore, the actual choice of estimation method(s) can change with each evaluation. The estimation method(s) chosen are those that are believed to produce the most reliable indication at that particular evaluation date for the claim liabilities being evaluated. In most cases, multiple estimation methods will be valid for the particular facts and circumstances of the claim liabilities being evaluated. This will result in a range of reasonable estimates for any particular claim liability. The Company uses such range analyses to back test whether previously established estimates for reserves by reporting segments are reasonable, given available information. Reported values found to be closer to the endpoints of a range of reasonable estimates are subject to further detailed reviews. These reviews may substantiate the validity of management’s recorded estimate or lead to a change in the reported estimate. The exact boundary points of these ranges are more qualitative than quantitative in nature, as no clear line of demarcation exists to determine when the set of underlying assumptions for an estimation method switches from being reasonable to unreasonable. As a result, the Company does not believe that the endpoints of these ranges are or would be comparable across companies. In addition, potential interactions among the different estimation assumptions for different product lines make the aggregation of individual ranges a highly judgmental and inexact process. Property-casualty insurance policies are either written on a “claims-made” or on an “occurrence” basis. Claims-made policies generally cover, subject to requirements in individual policies, claims reported during the policy period. Policies that are written on an occurrence basis require that the insured demonstrate that a loss occurred in the policy period, even if the insured reports the loss many years later. Most general liability policies are written on an occurrence basis. These policies are subject to substantial loss development over time as facts and circumstances change in the years following the policy issuance. The occurrence form, which accounts for much of the reserve development in asbestos and environmental exposures, is also used to provide coverage for construction general liability, including construction defect. Occurrence-based forms of insurance for general liability exposures require substantial projection of loss trends, which can be influenced by a number of factors, including future inflation, judicial interpretations and societal litigation trends (e.g., size of jury awards and propensity of individuals to pursue litigation), among others. A basic premise in most actuarial analyses is that past patterns demonstrated in the data will repeat themselves in the future, absent a material change in the associated risk factors discussed below. To the extent a material change affecting the ultimate claim liability is known, such change is estimated to the extent possible through an analysis of internal company data and, if available and when appropriate, external data. Such a measurement is specific to the facts and circumstances of the particular claim portfolio and the known change being evaluated. Significant structural changes to the available data, product mix or organization can materially impact the reserve estimation process. In addition, the introduction of new products creates a unique risk as historical company data would typically not be available. Informed judgment is applied throughout the reserving process. This includes the application of various individual experiences and expertise to multiple sets of data and analyses. In addition to actuaries, experts involved with the reserving process also include underwriting and claims personnel and lawyers, as well as other company management. Therefore, management may have to consider varying individual viewpoints as part of its estimation of claims and claim adjustment expense reserves. It is also likely that during periods of significant change, such as a merger, consistent application of informed judgment becomes even more complicated and difficult.100The variables discussed above in this general discussion have different impacts on reserve estimation uncertainty for a given product line, depending on the length of the claim tail, the reporting lag, the impact of individual claims and the complexity of the claim process for a given product line. Product lines are generally classifiable as either long tail or short tail, based on the average length of time between the event triggering claims under a policy and the final resolution of those claims. Short tail claims are reported and settled quickly, resulting in less estimation variability. The longer the time to final claim resolution, the greater the exposure to estimation risks and hence the greater the estimation uncertainty. A major component of the claim tail is the reporting lag. The reporting lag, which is the time between the event triggering a claim and the reporting of the claim to the insurer, makes estimating IBNR inherently more uncertain. In addition, the greater the reporting lag, the greater the proportion of IBNR to the total claim liability for the product line. Writing new products with material reporting lags can result in adding several years’ worth of IBNR claim exposure before the reporting lag exposure becomes clearly observable, thereby increasing the risk associated with estimating the liabilities for claims and claim adjustment expenses for such products. The most extreme example of claim liabilities with long reporting lags are asbestos claims. For some lines, the impact of large individual claims can be material to the analysis. These lines are generally referred to as being “low frequency/high severity,” while lines without this “large claim” sensitivity are referred to as “high frequency/low severity.” Estimates of claim liabilities for low frequency/high severity lines can be sensitive to the impact of a small number of potentially large claims. As a result, the role of judgment is much greater for these reserve estimates. In contrast, for high frequency/low severity lines the impact of individual claims is relatively minor and the range of reasonable reserve estimates is likely narrower and more stable. Claim complexity can also greatly affect the estimation process by impacting the number of assumptions needed to produce the estimate, the potential stability of the underlying data and claim process, and the ability to gain an understanding of the data. Product lines with greater claim complexity, such as for certain surety and construction exposures, have inherently greater estimation uncertainty. Actuaries have to exercise a considerable degree of judgment in the evaluation of all these factors in their analysis of reserves. The human element in the application of actuarial judgment is unavoidable when faced with material uncertainty. Different actuaries may choose different assumptions when faced with such uncertainty, based on their individual backgrounds, professional experiences and areas of focus. Hence, the estimates selected by the various actuaries may differ materially from each other. Lastly, significant structural changes to the available data, product mix or organization can also materially impact the reserve estimation process. Events such as mergers increase the inherent uncertainty of reserve estimates for a period of time, until stable trends re-establish themselves within the new organization. Risk FactorsThe major causes of material uncertainty (“risk factors”) generally will vary for each product line, as well as for each separately analyzed component of the product line. In a few cases, such risk factors are explicit assumptions of the estimation method, but in most cases, they are implicit. For example, a method may explicitly assume that a certain percentage of claims will close each year, but will implicitly assume that the legal interpretation of existing contract language will remain unchanged. Actual results will likely vary from expectations for each of these assumptions, causing actual paid losses, as claims are settled in the future, to be different in amount than the reserves being estimated currently. Some risk factors will affect more than one product line. Examples, some of which have been exacerbated by COVID-19, include changes in claim department practices, changes in the tort environment, changes in settlement patterns, regulatory and legislative actions, court actions, timeliness of claim reporting, state mix of claimants, medical utilization and degree of claimant fraud. The extent of the impact of a risk factor will also vary by components within a product line. Individual risk factors are also subject to interactions with other risk factors within product line components. The effect of a particular risk factor on estimates of claim liabilities cannot be isolated in most cases. For example, estimates of potential claim settlements may be impacted by the risk associated with potential court rulings, but the final settlement agreement typically does not delineate how much of the settled amount is due to this and other factors. 101The evaluation of data is also subject to distortion from extreme events or structural shifts, sometimes in unanticipated ways. For example, the timing of claims payments in one geographic region may be impacted if claim adjusters are temporarily reassigned from that region to help settle catastrophe claims in another region. While some changes in the claim environment are sudden in nature (such as a new court ruling affecting the interpretation of all contracts in that jurisdiction), others are more evolutionary. Evolutionary changes can occur when multiple factors affect final claim values, with the uncertainty surrounding each factor being resolved separately, in stepwise fashion. The final impact is not known until all steps have occurred. Sudden changes generally cause a one-time shift in claim liability estimates, although there may be some lag in reliable quantification of their impact. Evolutionary changes generally cause a series of shifts in claim liability estimates, as each component of the evolutionary change becomes evident and estimable. Actuarial Methods for Analyzing and Estimating Claims and Claim Adjustment Expense ReservesThe principal estimation and analysis methods utilized by the Company’s actuaries to evaluate management’s existing estimates for prior accident periods are the paid loss development method, the case incurred development method, the Bornhuetter-Ferguson (BF) method, and average value analysis combined with the reported claim development method. The BF method is usually utilized for more recent accident periods, with a transition to other methods as the underlying claim data becomes more voluminous and therefore more credible. These estimation and analysis methods are typically referred to as conventional actuarial methods. (See note 8 of the notes to the consolidated financial statements for an explanation of these methods). While the Company utilizes these conventional actuarial methods to estimate the claims liability for its various businesses, Company actuaries evaluating a particular component for a product line may select from the full range of methods developed within the casualty actuarial profession. The Company’s actuaries are also regularly monitoring developments within the profession for advances in existing techniques or the creation of new techniques that might improve current and future estimates.Some components of a product line may be susceptible to infrequent large claims or not be subject to conventional methods. In such cases, the Company’s actuarial analysis will isolate such components for review. The reserves excluding such large claims are generally analyzed using the conventional methods described above. The reserves associated with large claims are then analyzed utilizing various methods, such as:•Estimating the number of large claims and their average values based on historical trends from prior accident periods, adjusted for the current environment and supplemented with actual data for the accident year analyzed to the extent available.•Utilizing individual claim adjuster estimates of the large claims, combined with continual monitoring of the aggregate accuracy of such claim adjuster estimates. (This monitoring may lead to supplemental adjustments to the aggregate of such claim estimates).•Utilizing historic longer-term average ratios of large claims to small claims, and applying such ratios to the estimated ultimate small claims from conventional analysis.•Ground-up analysis of the underlying exposure (typically used for asbestos and environmental). The results of such methodologies are subjected to various reasonability and diagnostic tests, including implied incurred-loss-to-earned-premium ratios, non-zero claim severity trends and paid-to-incurred loss ratios. An actual versus expected analysis is also performed comparing actual loss development to expected development embedded within management’s estimate. Additional analyses may be performed based on the results of these diagnostics, including the investigation of other actuarial methods. The methods described above are generally utilized to evaluate management’s estimate for prior accident periods. For the initial estimate of the current accident year, however, the available claim data is typically insufficient to produce a reliable indication. As a result, the initial estimate for an accident year is generally based on an exposure-based method using either the loss ratio projection method or the expected loss method. The loss ratio projection method, which is typically used for guaranteed-cost business, develops an initial estimate for an accident year by multiplying earned premiums for the accident year by a projected loss ratio. The projected loss ratio is determined by analyzing prior period experience, and adjusting for loss cost trends, rate level differences, mix of business changes and other known or observed factors influencing the current accident year relative to prior accident years. The exact number of prior accident years utilized varies by product line component, based on the stability and consistency of the individual accident year estimates. The expected loss method, which is typically used for 102loss sensitive business, develops an initial estimate of ultimate claims and claim adjustment expenses for an accident year by analyzing exposures by account.Management’s EstimatesAt least once per quarter, members of Company management meet with the Company’s actuaries to review the latest claims and claim adjustment expense reserve analyses. Based on these analyses, management determines whether its ultimate claim liability estimates should be changed from the prior period. In doing so, it must evaluate whether the new data provided represents credible actionable information or an anomaly that will have no effect on estimated ultimate claim liability. For example, as described above, payments may have decreased in one geographic region due to fewer claim adjusters being available to process claims. The resulting claim payment patterns would be analyzed to determine whether or not the change in payment pattern represents a change in ultimate claim liability. This type of assessment requires considerable judgment. It is frequently not possible to determine whether a change in the data is an anomaly until sometime after the event. Even if a change is determined to be permanent, it is not always possible to reliably determine the extent of the change until sometime later. The overall detailed analyses supporting such an effort can take several months to perform as the underlying causes of the trends observed need to be evaluated, which may require the gathering or assembling of data not previously available. It may also include interviews with experts involved with the underlying processes. As a result, there can be a time lag between the emergence of a change and a determination that the change should be reflected in the Company’s estimated claim liabilities. The final estimate selected by management in a reporting period is based on these various detailed analyses of past data, adjusted to reflect any new actionable information. The Audit Committee of the Board of Directors reviews the process by which the Company establishes reserves for the purpose of the Company’s financial statements. Discussion of Product LinesThe following section details reserving considerations and common risk factors by product line. There are many additional risk factors that may impact ultimate claim costs. Each risk factor presented will have a different impact on required reserves. Also, risk factors can have offsetting or compounding effects on required reserves. For example, in workers’ compensation, the use of expensive medical procedures that result in medical cost inflation may enable workers to return to work faster, thereby lowering indemnity costs. Thus, in almost all cases, it is impossible to discretely measure the effect of a single risk factor and construct a meaningful sensitivity expectation. In order to provide information on reasonably possible reserving changes by product line, the historical changes in year-end claims and claim adjustment expense reserves over a one-year period are provided for the U.S. product lines. This information is provided for both the Company and the industry for the nine most recent years, and is based on the most recent publicly available data for the reported line(s) that most closely match the individual product line being discussed. These changes were calculated, net of reinsurance, from statutory annual statement data found in Schedule P of those statements, and represent the reported reserve development on the beginning-of-the-year claim liabilities divided by the beginning claim liabilities, all accident years combined, excluding non-defense related claim adjustment expense. Data presented for the Company includes history for the entire Travelers group (U.S. companies only), as required by the statutory reporting instructions promulgated by state regulatory authorities for Schedule P. Comparable data for non-U.S. companies is not available. General LiabilityGeneral liability is generally considered a long tail line, as it takes a relatively long period of time to finalize and settle claims from a given accident year. The speed of claim reporting and claim settlement is a function of the characteristics of claims, including specific coverage provided, the jurisdiction and specific policy provisions such as self-insured retentions, among others. There are numerous components underlying the general liability product line. Some of these have relatively moderate payment patterns (with most of the claims for a given accident year closed within five to seven years), while others can have extreme lags in both reporting and payment of claims (e.g., a reporting lag of a decade or more for “construction defect” claims). While the majority of general liability coverages are written on an “occurrence” basis, certain general liability coverages (such as those covering management and professional liability, including cyber coverages) are typically insured on a “claims-made” basis. 103General liability reserves are generally analyzed as two components: primary and excess/umbrella, with the primary component generally analyzed separately for bodily injury and property damage. Bodily injury liability payments reimburse the claimant for damages pertaining to physical injury as a result of the policyholder’s legal obligation arising from non-intentional acts such as negligence, subject to the insurance policy provisions. In some cases the damages can include future wage loss (which is a function of future earnings power and wage inflation) and future medical treatment costs. Property damage liability payments result from damages to the claimant’s private property arising from the policyholder’s legal obligation for non-intentional acts. In most cases, property damage losses are a function of costs as of the loss date, or soon thereafter. In addition, sizable or unique exposures are reviewed separately. These exposures include asbestos, environmental, other mass torts, construction defect and large unique accounts that would otherwise distort the analysis. These unique categories often require a very high degree of judgment and require reserve analyses that do not rely on conventional actuarial methods. Defense costs are also a part of the insured costs covered by liability policies and can be significant, sometimes greater than the cost of the actual paid claims. For some products this risk is mitigated by policy language such that the insured portion of defense costs is included in the policy limit available to pay the claim. Such “defense within the limits” policies are most common for “claims-made” products. When defense costs are outside of the policy limits, the full amount of the policy limit is available to pay claims and the amounts paid for defense costs have no contractual limit. This line is typically the largest source of reserve estimate uncertainty in the United States (excluding assumed reinsurance contracts covering the same risk). Major contributors to this reserve estimate uncertainty include the reporting lag (i.e., the length of time between the event triggering coverage and the actual reporting of the claim), the number of parties involved in the underlying tort action, whether the “event” triggering coverage is confined to only one time period or is spread over multiple time periods, the potential dollars involved (in the individual claim actions), whether such claims were reasonably foreseeable and intended to be covered at the time the contracts were written (i.e., coverage dispute potential), and the potential for mass claim actions. Claims with longer reporting lags result in greater estimation uncertainty. This is especially true for alleged claims with a latency feature, particularly where courts have ruled that coverage is spread over multiple policy years, hence involving multiple defendants (and their insurers and reinsurers) and multiple policies (thereby increasing the potential dollars involved and the underlying settlement complexity). Claims with long latencies also increase the potential recognition lag (i.e., the lag between writing a type of policy in a certain market and the recognition that such policies have potential mass tort and/or latent claim exposure). The amount of reserve estimate uncertainty also varies significantly by component for the general liability product line. The components in this product line with the longest latency, longest reporting lags, largest potential dollars involved and greatest claim settlement complexity are asbestos and environmental. Components that include latency, reporting lag and/or complexity issues, but to a materially lesser extent than asbestos and environmental, include construction defect and other mass tort actions. Many components of general liability are not subject to material latency or claim complexity risks and hence have materially less uncertainty than the previously mentioned components. In general, components with shorter reporting lags, fewer parties involved in settlement negotiations, only one policy potentially triggered per claim, fewer potential settlement dollars, reasonably foreseeable (and stable) potential hazards/claims and no mass tort potential result in much less reserve estimate uncertainty than components without those characteristics. In addition to the conventional actuarial methods mentioned in the general discussion section, the company utilizes various report year development methods for the construction defect components of this product line. The Construction Defect report year development analysis is supplemented with projected claim counts and average values for IBNR claim counts. For components with greater lags in claim reporting, such as excess and umbrella components of this product line, the Company relies more heavily on the BF method than on the paid and case incurred development methods. Examples of common risk factors, or perceptions thereof, that could change and, thus, affect the required general liability reserves (beyond those included in the general discussion section) include: General liability risk factors •Changes in claim handling philosophies •Changes in policy provisions or court interpretation of such provisions •New or expanded theories of liability •Trends in jury awards •Changes in the propensity to sue, in general with specificity to particular issues •Changes in the propensity to litigate rather than settle a claim•Increases in attorney involvement in, or impact on, claims104•Changes in statutes of limitations •Changes in the underlying court system •Distortions from losses resulting from large single accounts or single issues •Changes in tort law •Shifts in lawsuit mix between federal and state courts •Changes in claim adjuster processes or reporting which may cause distortions in the data being analyzed •The impact of inflation on loss costs•Changes in settlement patterns General liability book of business risk factors •Changes in policy provisions (e.g., deductibles, policy limits, endorsements) •Changes in underwriting standards •Product mix (e.g., size of account, industries insured, jurisdiction mix) Unanticipated changes in risk factors can affect reserves. As an indicator of the causal effect that a change in one or more risk factors could have on reserves for general liability (excluding asbestos and environmental), a 1% increase (decrease) in incremental paid loss development for each future calendar year could result in a 1.6% increase (decrease) in claims and claim adjustment expense reserves.Historically, the one-year change in the reserve estimate for this product line, excluding estimated asbestos and environmental amounts, over the last nine years has varied from -5% to 6% (averaging -1%) for the Company, and from -3% to 3% (averaging 0%) for the industry overall. The Company’s year-to-year changes are driven by, and are based on, observed events during the year. The Company believes that its range of historical outcomes is illustrative of reasonably possible one-year changes in reserve estimates for this product line. General liability reserves (excluding asbestos and environmental) represent approximately 22% of the Company’s total claims and claim adjustment expense reserves. The Company’s change in reserve estimate for this product line related to the last nine accident years, which excludes the impacts of increases in asbestos and environmental reserves, the extension of the statute of limitations for childhood sexual molestation claims and increases in reserves in the Company's runoff operations, was 2% for 2022, 1% for 2021 and 3% for 2020. The 2022 change primarily reflected higher than expected loss experience in Business Insurance for accident years 2017 through 2019. The 2021 change primarily reflected higher than expected loss experience in Bond & Specialty Insurance for accident years 2012 and 2017 through 2019 and in Business Insurance for accident years 2018 through 2020. The 2020 change primarily reflected higher than expected loss experience in Business Insurance for both primary and excess coverages for accident years 2015 through 2019 and in Bond & Specialty Insurance for accident years 2015, 2018 and 2019.Commercial PropertyCommercial property is generally considered a short tail line with a simpler and faster claim reporting and adjustment process than liability coverages, and less uncertainty in the reserve setting process (except for more complex business interruption claims). It is generally viewed as a moderate frequency, low to moderate severity line, except for catastrophes and coverage related to large properties. The claim reporting and settlement process for property coverage claim reserves is generally restricted to the insured and the insurer. Overall, the claim liabilities for this line create a low estimation risk, except possibly for catastrophes and business interruption claims. Commercial property reserves are typically analyzed in two components, one for catastrophic or other large single events, and another for all other events. Examples of common risk factors, or perceptions thereof, that could change and, thus, affect the required property reserves (beyond those included in the general discussion section) include: Commercial property risk factors •Physical concentration of policyholders •Availability and cost of local contractors •Inflation and materials shortages•For the more severe catastrophic events, “demand surge” inflation, which refers to significant short-term increases in building material and labor costs due to a sharp increase in demand for those materials and services •Local building codes •Amount of time to return property to full usage (for business interruption claims) •Frequency of claim re-openings on claims previously closed•Court interpretation of policy provisions (such as occurrence definition, wind versus flooding or communicable disease exclusions) 105•Lags in reporting claims (e.g., winter damage to summer homes, hidden damage after an earthquake, hail damage to roofs and/or equipment on roofs) •Court or legislative changes to the statute of limitations •Weather/climate variabilityCommercial property book of business risk factors •Policy provisions mix (e.g., deductibles, policy limits, endorsements) •Changes in underwriting standards Unanticipated changes in risk factors can affect reserves. As an indicator of the causal effect that a change in one or more risk factors could have on reserves for property, a 1% increase (decrease) in incremental paid loss development for each future calendar year could result in a 1.1% increase (decrease) in claims and claim adjustment expense reserves.Historically, the one-year change in the reserve estimate for this product line over the last nine years has varied from -21% to -6% (averaging -11%) for the Company, and from -10% to -2% (averaging -6%) for the industry overall. The Company’s year-to-year changes are driven by, and are based on, observed events during the year. The Company believes that its range of historical outcomes is illustrative of reasonably possible one-year changes in reserve estimates for this product line. Commercial property reserves represent approximately 3% of the Company’s total claims and claim adjustment expense reserves.Since commercial property is considered a short tail coverage, the one year change for commercial property can be more volatile than that for the longer tail product lines. This is due to the fact that the majority of the reserve for commercial property relates to the most recent accident year, which is subject to the most uncertainty for all product lines. This recent accident year uncertainty is relevant to commercial property because weather-related events that occur in the second half of the year may not be completely resolved until the following year. Reserve estimates associated with catastrophes may take even longer to resolve. The reserve estimates for this product line are also potentially subject to material changes due to uncertainty in measuring ultimate losses for significant catastrophes such as hurricanes, tornadoes, hail storms and wildfires. The Company’s change in reserve estimate for this product line was -8% for 2022, -10% for 2021 and -11% for 2020. The 2022 change primarily reflected better than expected loss experience related to both catastrophe and non-catastrophe losses for accident years 2020 and 2021. The 2021 change primarily reflected better than expected loss experience related to both catastrophe and non-catastrophe losses for accident year 2020. The 2020 change primarily reflected better than expected loss experience related to both catastrophe and non-catastrophe losses for accident year 2019 and the PG&E subrogation recovery for accident years 2017 and 2018. Commercial Multi-PerilCommercial multi-peril provides a combination of property and liability coverage typically for small businesses and, therefore, includes both short and long tail coverages. For property coverage, it generally takes a relatively short period of time to close claims, while for the other coverages, generally for the liability coverages, it takes a longer period of time to close claims. The reserving risk for this line is dominated by the liability coverage portion of this product, except occasionally in the event of catastrophic or other large single loss events. The reserving risk for this line differs from that of the general liability product line and the property product line due to the nature of the customer. Commercial multi-peril is generally sold to small- to mid-sized accounts, while the customer profile for general liability and commercial property includes larger customers. See “Commercial property risk factors” and “General liability risk factors,” discussed above, with regard to reserving risk for commercial multi-peril. Unanticipated changes in risk factors can affect reserves. As an indicator of the causal effect that a change in one or more risk factors could have on reserves for commercial multi-peril (excluding asbestos and environmental), a 1% increase (decrease) in incremental paid loss development for each future calendar year could result in a 1.3% increase (decrease) in claims and claim adjustment expense reserves.Historically, the one-year change in the reserve estimate for this product line, excluding estimated asbestos and environmental amounts, over the last nine years has varied from -5% to 4% (averaging 0%) for the Company, and from -3% to 1% (averaging -1%) for the industry overall. The Company’s year-to-year changes are driven by, and are based on, observed events during the year. The Company believes that its range of historical outcomes is illustrative of reasonably possible one-year changes in 106reserve estimates for this product line. Commercial multi-peril reserves (excluding asbestos and environmental reserves) represent approximately 9% of the Company’s total claims and claim adjustment expense reserves.As discussed above, this line combines general liability and commercial property coverages and it has been impacted in the past by many of the same events as those two lines.The Company’s change in reserve estimate for this product line related to the last nine accident years, which excludes the impacts of increases in asbestos and environmental reserves and increases in reserves in the Company's runoff operations, was -2% for 2022, 0% for 2021 and 0% for 2020. The 2022 change primarily reflected better than expected loss experience for property coverages for accident year 2021. In 2021, higher than expected loss experience for liability coverages for accident years 2017 and 2018 was largely offset by better than expected loss experience for liability coverages for accident years 2012 through 2016. In 2020, higher than expected loss experience for liability coverages for accident year 2019 was largely offset by the PG&E subrogation recovery for accident years 2017 and 2018.Commercial AutomobileThe commercial automobile product line is a mix of property and liability coverages and, therefore, includes both short and long tail coverages. The payments that are made quickly typically pertain to auto physical damage (property) claims and property damage (liability) claims. The payments that take longer to finalize and are more difficult to estimate relate to bodily injury claims. In general, claim reporting lags are generally short, claim complexity is not a major issue, and the line is viewed as high frequency, low to moderate severity. Overall, the claim liabilities for this line create a moderate estimation risk. Recently, the Company has seen more of an increase in the rate of attorney involvement than it had anticipated and a lengthening of the claim development pattern. As a consequence, the Company has experienced a higher level of bodily injury severity than it had anticipated. Commercial automobile reserves are typically analyzed in four components: bodily injury liability; property damage liability; collision claims; and comprehensive claims. These last two components have minimum reserve risk and fast payouts and, accordingly, separate risk factors are not presented. The Company utilizes the conventional actuarial methods mentioned in the general discussion above in estimating claim liabilities for this line. This is supplemented with detailed custom analyses where needed.Examples of common risk factors, or perceptions thereof, that could change and, thus, affect the required commercial automobile reserves (beyond those included in the general discussion section) include: Bodily injury and property damage liability risk factors •Trends in jury awards •Changes in the underlying court system •Changes in case law •Litigation trends•Increases in attorney involvement in, or impact on, claims•Frequency of claims with payment capped by policy limits •Change in average severity of accidents, or proportion of severe accidents, including the impact of inflation •Changes in auto safety technology•Subrogation opportunities •Changes in claim handling philosophies •Frequency of visits to health providers •Number of medical procedures given during visits to health providers •Types of health providers used •Types of medical treatments received •Changes in cost of medical treatments •Degree of patient responsiveness to treatment Commercial automobile book of business risk factors •Changes in policy provisions (e.g., deductibles, policy limits, endorsements, etc.) •Changes in mix of insured vehicles (e.g., long haul trucks versus local and smaller vehicles, fleet risks versus non-fleets) •Changes in underwriting standards 107Unanticipated changes in risk factors can affect reserves. As an indicator of the causal effect that a change in one or more risk factors could have on reserves for commercial automobile, a 1% increase (decrease) in incremental paid loss development for each future calendar year could result in a 1.3% increase (decrease) in claims and claim adjustment expense reserves. Historically, the one-year change in the reserve estimate for this product line over the last nine years has varied from -2% to 11% (averaging 2%) for the Company, and from 2% to 7% (averaging 5%) for the industry overall. The Company’s year-to-year changes are driven by, and are based on, observed events during the year. The Company believes that its range of historical outcomes is illustrative of reasonably possible one-year changes in reserve estimates for this product line. Commercial automobile reserves represent approximately 9% of the Company’s total claims and claim adjustment expense reserves.The Company’s change in reserve estimate for this product line was 0% for 2022, -2% for 2021 and 4% for 2020. In 2022, higher than expected loss experience for liability coverages for accident years 2017 through 2019 and 2021 was largely offset by better than expected loss experience for physical damage coverages for accident year 2021 and for liability coverages for accident year 2020. The 2021 change primarily reflected better than expected loss experience for liability and physical damage coverages for accident year 2020. The 2020 change primarily reflected higher than expected loss experience for liability coverages for accident year 2019.Workers’ CompensationWorkers’ compensation is generally considered a long tail coverage, as it takes a relatively long period of time to finalize claims from a given accident year. While certain payments such as initial medical treatment or temporary wage replacement for the injured worker are made quickly, some other payments are made over the course of several years, such as awards for permanent partial injuries. In addition, some payments can run as long as the injured worker’s life, such as permanent disability benefits and on-going medical care. Despite the possibility of long payment tails, the reporting lags are generally short, payment obligations are generally not complex, and most of the liability can be considered high frequency with moderate severity. The largest reserve risk generally comes from the low frequency, high severity claims providing lifetime coverage for medical expense arising from a worker’s injury, as such claims are subject to greater inflation risk. Overall, the claim liabilities for this line create a somewhat greater than moderate estimation risk. Workers’ compensation reserves are typically analyzed in three components: indemnity losses, medical losses and claim adjustment expenses. Examples of common risk factors, or perceptions thereof, that could change and, thus, affect the required workers’ compensation reserves (beyond those included in the general discussion section) include: Indemnity risk factors •Time required to recover from the injury •Degree of available transitional jobs •Degree of legal involvement •Changes in the interpretations and processes of the administrative bodies that oversee workers’ compensation claims •Future wage inflation for states that index benefits •Changes in the administrative policies of second injury funds Medical risk factors •Changes in the cost of medical treatments (including prescription drugs) and underlying fee schedules (“inflation”)•Availability of medical providers and medical wage impacts •Frequency of visits to health providers •Number of medical procedures given during visits to health providers •Types of health providers used •Type of medical treatments received •Use of preferred provider networks and other medical cost containment practices •Availability of new medical processes and equipment •Changes in the use of pharmaceutical drugs, including drugs for pain management •Degree of patient responsiveness to treatment General workers’ compensation risk factors •Frequency of reopening claims previously closed •Mortality trends of injured workers with lifetime benefits and medical treatment 108•Changes in statutory benefits, including due to presumption laws•The impact, if any, of potential future changes to government health insurance legislationWorkers’ compensation book of business risk factors •Product mix •Injury type mix •Changes in underwriting standards Unanticipated changes in risk factors can affect reserves. As an indicator of the causal effect that a change in one or more risk factors could have on reserves for workers’ compensation, a 1% increase (decrease) in incremental paid loss development for each future calendar year could result in a 1.2% increase (decrease) in claims and claim adjustment expense reserves.Historically, the one-year change in the reserve estimate for this product line over the last nine years has varied from -4% to 0% (averaging -3%) for the Company, and from -5% to -1% (averaging -3%) for the industry overall. The Company’s year-to-year changes are driven by, and are based on, observed events during the year. The Company believes that its range of historical outcomes is illustrative of reasonably possible one-year changes in reserve estimates for this product line. Workers’ compensation reserves represent approximately 33% of the Company’s total claims and claim adjustment expense reserves.The Company’s change in reserve estimate for this product line was -4% for 2022, -3% for 2021 and -3% for 2020. The 2022 change primarily reflected better than expected loss experience for accident years 2021 and prior. The 2021 change primarily reflected better than expected loss experience for accident years 2020 and prior. The 2020 change primarily reflected better than expected loss experience for accident years 2018 and prior. Fidelity and SuretyFidelity is generally considered a short tail coverage. It takes a relatively short period of time to finalize and settle most fidelity claims. The volatility of fidelity reserves is generally related to the type of business of the insured, the size and complexity of the insured’s business operations, amount of policy limit and attachment point of coverage. The uncertainty surrounding reserves for small, commercial insureds is typically less than the uncertainty for large commercial or financial institutions. The high frequency, low severity nature of small commercial fidelity losses provides for stability in loss estimates, whereas the low frequency, high severity nature of losses for large insureds results in a wider range of ultimate loss outcomes. Actuarial techniques that rely on a stable pattern of loss development are generally not applicable to low frequency, high severity claims. Surety has certain components that are generally considered short tail coverages with short reporting lags, although large individual construction and commercial surety contracts can result in a long settlement tail, based on the length and complexity of the construction project(s) or commercial transaction being bonded. The frequency of losses in surety generally has a lagging correlation with economic cycles as the primary cause of surety loss is the inability of an insured to fulfill its contractual obligations. The Company actively seeks to mitigate this exposure to loss through disciplined risk selection, adherence to underwriting standards and ongoing monitoring of contractor progress in significant construction projects. The volatility of surety losses is generally related to the type of business performed by the bonded party, the type of bonded obligation, the amount of limit exposed to loss and the amount of assets available to the surety company to mitigate losses, such as unbilled contract funds, collateral, first and third party indemnity, and other security positions of a bonded party's assets. Certain classes of surety claims are very high severity, low frequency in nature. These can include large construction contractors involved with one or multiple large, complex projects as well as certain large commercial surety exposures. Other claim factors affecting reserve variability of surety include litigation related to amounts owed by the bonded party and due to the surety company (e.g., salvage and subrogation efforts), the results of financial restructuring of a bonded party and the availability and cost of replacement contractors, labor and materials.Examples of common risk factors, or perceptions thereof, that could change and, thus, affect the required fidelity and surety reserves (beyond those included in the general discussion section) include: Fidelity risk factors •Type of business of insured •Policy limit and attachment points •Third-party claims •Coverage litigation •Complexity of claims •Growth in insureds’ operations 109 Surety risk factors •Economic trends, including the general level of construction activity •Concentration of reserves in a relatively few large claims •Type of business bonded •Type of obligation bonded •Cumulative limits of liability for the bonded party•Assets available to mitigate loss •Defective workmanship/latent defects •Financial strategy of the bonded party •Changes in statutory obligations •Geographic spread of business Fidelity and Surety book of business risk factors•Changes in policy provisions (e.g., deductibles, limits, endorsements) •Changes in underwriting standards Unanticipated changes in risk factors can affect reserves. As an indicator of the causal effect that a change in one or more risk factors could have on reserves for fidelity and surety, a 1% increase (decrease) in incremental paid loss development for each future calendar year could result in a 1.5% increase (decrease) in claims and claim adjustment expense reserves.Historically, the one-year change in the reserve estimate for this product line over the last nine years has varied from -36% to -10% (averaging -22%) for the Company, and from -18% to 0% (averaging -12%) for the industry overall. The Company’s year-to-year changes are driven by, and are based on, observed events during the year. The Company believes that its range of historical outcomes is illustrative of reasonably possible one-year changes in reserve estimates for this product line. Fidelity and surety reserves represent approximately 1% of the Company’s total claims and claim adjustment expense reserves.In general, developments on single large claims (both adverse and favorable) are a primary source of changes in reserve estimates for this product line.The Company’s change in reserve estimate for this product line was -30% for 2022, -27% for 2021 and -12% for 2020. The 2022 change primarily reflected better than expected loss experience in the fidelity and surety product line for accident years 2015 through 2019 and 2021. The 2021 change primarily reflected better than expected loss experience in the fidelity and surety product line for accident years 2015 through 2017 and 2020. The 2020 change primarily reflected better than expected loss experience in the fidelity and surety product line for accident years 2015, 2018 and 2019. Personal AutomobilePersonal automobile includes both short and long tail coverages. The payments that are made quickly typically pertain to auto physical damage (property) claims and property damage (liability) claims. The payments that take longer to finalize and are more difficult to estimate relate to bodily injury claims. Reporting lags are relatively short and the claim settlement process for personal automobile liability generally is the least complex of the liability products. It is generally viewed as a high frequency, low to moderate severity product line. Overall, the claim liabilities for this line create a moderate estimation risk. Personal automobile reserves are typically analyzed in five components: bodily injury liability, property damage liability, no-fault losses, collision claims and comprehensive claims. These last two components have minimum reserve risk and fast payouts and, accordingly, separate factors are not presented. Examples of common risk factors, or perceptions thereof, that could change and, thus, affect the required personal automobile reserves (beyond those included in the general reserve discussion section) include: Bodily injury, property damage liability and no-fault risk factors •Trends in jury awards •Changes in the underlying court system and its philosophy •Changes in case law •Litigation trends•Increases in attorney involvement in, or impact on, claims•Frequency of claims with payment capped by policy limits •Change in frequency trends, including the impact of changes in driving behavior110•Change in average severity of accidents, or proportion of severe accidents, including the impact of inflation, changes in driving behavior and the involvement of pedestrians •Changes in auto technology, including safety features •Subrogation opportunities •Frequency of visits to health providers•Number of medical procedures given during visits to health providers •Types of health providers used •Types of medical treatments received •Changes in cost of medical treatments •Effectiveness of no-fault laws •Degree of patient responsiveness to treatment •Changes in claim handling philosophies Personal automobile book of business risk factors •Changes in policy provisions (e.g., deductibles, policy limits, endorsements, etc.) •Changes in underwriting standards •Changes in the use of permissible data for rating and underwritingUnanticipated changes in risk factors can affect reserves. As an indicator of the causal effect that a change in one or more risk factors could have on reserves for personal automobile, a 1% increase (decrease) in incremental paid loss development for each future calendar year could result in a 1.1% increase (decrease) in claims and claim adjustment expense reserves.Historically, the one-year change in the reserve estimate for this product line over the last nine years has varied from -4% to 3% (averaging -1%) for the Company, and from -2% to 2% (averaging 0%) for the industry overall. The Company’s year-to-year changes are driven by, and are based on, observed events during the year. The Company believes that its range of historical outcomes is illustrative of reasonably possible one-year changes in reserve estimates for this product line. Personal automobile reserves represent approximately 7% of the Company’s total claims and claim adjustment expense reserves.The Company’s change in reserve estimate for this product line was 0% for 2022, -4% for 2021 and -2% for 2020. In 2022, higher than expected loss experience for liability coverages for accident year 2021 was largely offset by better than expected loss experience for physical damage coverages for accident year 2021 and for liability coverages for accident years 2018 through 2020. The 2021 change primarily reflected better than expected loss experience for liability and physical damage coverages for accident years 2017 through 2020. The 2020 change primarily reflected better than expected loss experience for liability and physical damage coverages for accident years 2016 through 2018.Personal Homeowners and OtherHomeowners is generally considered a short tail coverage. Most payments are related to the property portion of the policy, where the claim reporting and settlement process is generally restricted to the insured and the insurer. Claims on property coverage are typically reported soon after the actual damage occurs, although delays of several months are not unusual. The resulting settlement process is typically fairly short term, although exceptions do exist. The liability portion of the homeowners policy generates claims which take longer to pay due to the involvement of litigation and negotiation, but with generally small reporting lags. Personal Insurance Other products include personal umbrella policies, among others. See “general liability reserving risk factors,” discussed above, for reserving risk factors related to umbrella coverages. Overall, the line is generally high frequency, low to moderate severity (except for catastrophes), with simple to moderate claim complexity. Homeowners reserves are typically analyzed in two components: non-catastrophe related losses and catastrophe losses. Examples of common risk factors, or perceptions thereof, that could change and, thus, affect the required homeowners reserves (beyond those included in the general discussion section) include: Homeowners and Other risk factors •Weather/climate variability•Inflation and materials costs and shortages111•For the more severe catastrophic events, “demand surge” inflation, which refers to significant short-term increases in building material and labor costs due to a sharp increase in demand for those materials and services •Amount of time to return property to residential use •Lags in reporting claims (e.g., winter damage to summer homes, hidden damage after an earthquake, hail damage to roofs and/or equipment on roofs) •Availability and cost of local contractors •Quality of construction of insured homes•Local building codes •Litigation trends •Trends in jury awards •Court interpretation of policy provisions (such as occurrence definition, or wind versus flooding) •Court or legislative changes to the statute of limitations •Salvage and subrogation opportunities Homeowners and Other book of business risk factors •Policy provisions mix (e.g., deductibles, policy limits, endorsements, etc.) •Degree of concentration of policyholders •Changes in underwriting standards•Changes in the use of permissible data for rating and underwriting Unanticipated changes in risk factors can affect reserves. As an indicator of the causal effect that a change in one or more risk factors could have on reserves for personal homeowners and other, a 1% increase (decrease) in incremental paid loss development for each future calendar year could result in a 1.1% increase (decrease) in claims and claim adjustment expense reserves.Historically, the one-year change in the reserve estimate for this product line (excluding Personal Insurance Other, which for statutory reporting purposes is included with other lines of business) over the last nine years has varied from -28% to 3% (averaging -8%) for the Company, and from -7% to 1% (averaging -2%) for the industry overall. The Company’s year-to-year changes are driven by, and are based on, observed events during the year. The Company believes that its range of historical outcomes is illustrative of reasonably possible one-year changes in reserve estimates for this product line. Personal homeowners and other reserves represent approximately 5% of the Company’s total claims and claim adjustment expense reserves.This line combines both liability and property coverages; however, the majority of the reserves relate to property. While property is considered a short tail coverage, the one year change for property can be more volatile than that for the longer tail product lines. This is due to the fact that the majority of the reserve for property relates to the most recent accident year, which is subject to the most uncertainty for all product lines. This recent accident year uncertainty is relevant to property because weather-related events in the second half of the year may not be completely resolved until the following year. Reserve estimates associated with catastrophes, including wildfires in recent years, may take even longer to resolve. The Company’s change in reserve estimate for this product line (excluding Personal Insurance Other) was -2% for 2022, -9% for 2021 and -28% for 2020. The 2022 change primarily reflected better than expected loss experience for catastrophe and non-catastrophe losses for accident years 2018 through 2020. The 2021 change primarily reflected better than expected loss experience for catastrophe and non-catastrophe losses for accident years 2016 through 2018 and 2020. The 2020 change primarily reflected the PG&E subrogation recovery for accident years 2017 and 2018, partially offset by higher than expected loss experience for catastrophe and non-catastrophe losses for accident year 2019. International and OtherInternational and other includes products written by the Company’s international operations, as well as all other products not explicitly discussed above. The principal component of “other” claim reserves is assumed reinsurance written on an excess-of-loss basis, which may include reinsurance of non-U.S. exposures, and is runoff business. International and other claim liabilities result from a mix of coverages, currencies and jurisdictions/countries. The common characteristic is the need to customize the analysis to the individual component, and the inability to rely on data characterizations and reporting requirements in the U.S. statutory reporting framework. Due to changes in the business mix for this product line over time, incurred claim liabilities for more recent years are generally shorter-tailed (due to both the products and the jurisdictions involved, e.g., Canada, the Republic of Ireland and the United 112Kingdom), compared to the older liabilities from runoff operations that are extremely long tail (e.g., U.S. excess liabilities reinsured through the London market, and several underwriting pools in runoff). The speed of claim reporting and claim settlement is a function of the specific coverage provided, the jurisdiction, the distribution system (e.g., underwriting pool versus direct) and the proximity of the insurance sale to the insured hazard (e.g., insured and insurer located in different countries). In particular, liabilities arising from the underwriting pools in runoff may result in significant reporting lags, settlement lags and claim complexity, due to the need to coordinate with other pool members or co-insurers through a broker or lead-insurer for claim settlement purposes.International reserves are generally analyzed by country and general coverage category (e.g., General Liability in Canada, Commercial Property in the United Kingdom, etc.). The business is also generally split by direct versus assumed reinsurance for a given coverage. Where the underlying insured hazard is outside the United States, the underlying coverages are generally similar to those described under the Homeowners, Personal Automobile, Commercial Automobile, General Liability, Commercial Property and Surety discussions above, taking into account differences in the legal environment and differences in terms and conditions. However, statutory coverage differences exist amongst various jurisdictions. For example, in some jurisdictions there are no aggregate policy limits on certain liability coverages.Other reserves, primarily assumed reinsurance in runoff, are generally analyzed by program/pool, treaty type, and general coverage category (e.g., General Liability — excess of loss reinsurance). Excess exposure requires the insured to “prove” not only claims under the policy, but also the prior payment of claims reaching up to the excess policy’s attachment point. Examples of common risk factors, or perceptions thereof, that could change and, thus, affect the required International and other reserves (beyond those included in the general discussion section, and in the Personal Automobile, Homeowners, General Liability, Commercial Property, Commercial Automobile and Surety discussions above) include: International and other risk factors •Changes in claim handling procedures, including those of the primary carriers •Changes in policy provisions or court interpretation of such provision •Economic trends•New theories of liability •Trends in jury awards •Changes in the propensity to sue •Changes in statutes of limitations •Changes in the underlying court system •Distortions from losses resulting from large single accounts or single issues •Changes in tort law •Changes in claim adjuster office structure (causing distortions in the data) •Changes in foreign currency exchange ratesInternational and other book of business risk factors •Changes in policy provisions (e.g., deductibles, policy limits, endorsements, “claims-made” language) •Changes in underwriting standards •Product mix (e.g., size of account, industries insured, jurisdiction mix) Unanticipated changes in risk factors can affect reserves. As an indicator of the causal effect that a change in one or more risk factors could have on reserves for International and other (excluding asbestos and environmental), a 1% increase (decrease) in incremental paid loss development for each future calendar year could result in a 1.3% increase (decrease) in claims and claim adjustment expense reserves. International and other reserves (excluding asbestos and environmental) represent approximately 7% of the Company’s total claims and claim adjustment expense reserves. International and other represents a combination of different product lines, some of which are in runoff. Comparative historical information is not available for international product lines as insurers domiciled outside of the United States do not file U.S. statutory reports. Comparative historical information on runoff business is not indicative of reasonably possible one-year changes in the reserve estimate for this mix of runoff business. Accordingly, the Company has not included comparative analyses for International and other. 113Reinsurance RecoverablesAmounts recoverable from reinsurers are estimated in a manner consistent with the associated claim liability. The Company evaluates and monitors the financial condition of its reinsurers under voluntary reinsurance arrangements to minimize its exposure to significant losses from reinsurer insolvencies. In addition, in the ordinary course of business, the Company becomes involved in coverage disputes with its reinsurers. Some of these disputes could result in lawsuits and arbitrations brought by or against the reinsurers to determine the Company’s rights and obligations under the various reinsurance agreements. The Company employs dedicated specialists and comprehensive strategies to manage reinsurance collections and disputes. The Company has entered into a reinsurance contract in connection with catastrophe bonds issued by Long Point Re IV. This contract meets the requirements to be accounted for as reinsurance in accordance with guidance for accounting for reinsurance contracts. The catastrophe bonds are described in more detail in “Item 1-Business-Catastrophe Reinsurance.” Recoverables attributable to structured settlements relate primarily to personal injury claims, of which workers’ compensation claims comprise a significant portion, for which the Company has purchased annuities and remains contingently liable in the event of a default by the companies issuing the annuities. Recoverables attributable to mandatory pools and associations relate primarily to workers’ compensation service business. These recoverables are supported by the participating insurance companies’ obligation to pay a pro rata share based on each company’s voluntary market share of written premium in each state in which it is a pool participant. In the event a member of a mandatory pool or association defaults on its share of the pool’s or association’s obligations, the other members’ share of such obligation increases proportionally. The Company reports its reinsurance recoverables net of an allowance for estimated uncollectible reinsurance. The allowance is based upon the Company’s ongoing review of amounts outstanding, length of collection periods, changes in reinsurer credit standing, disputes, applicable coverage defenses and other relevant factors. For structured settlements, the allowance is also based upon the Company’s ongoing review of life insurers’ creditworthiness and estimated amounts of coverage that would be available from state guaranty funds if a life insurer defaults. A probability-of-default methodology which reflects current and forecasted economic conditions is used to estimate the amount of uncollectible reinsurance due to credit-related factors and the estimate is reported in an allowance for estimated uncollectible reinsurance. The allowance also includes estimated uncollectible amounts related to dispute risk with reinsurers. Amounts deemed to be uncollectible, including amounts due from known insolvent reinsurers, are written off against the allowance. Changes in the allowance, as well as any subsequent collections of amounts previously written off, are reported as part of claims and claim adjustment expenses. The Company evaluates and monitors the financial condition of its reinsurers under voluntary reinsurance arrangements to minimize its exposure to significant losses from reinsurer insolvencies.ImpairmentsInvestment ImpairmentsSee note 1 of the notes to the consolidated financial statements for a discussion of investment impairments. Due to the subjective nature of the Company’s analysis and estimates of future cash flows, along with the judgment that must be applied in the analysis, it is possible that the Company could reach a different conclusion whether or not to impair a security if it had access to additional information about the issuer. Additionally, it is possible that the issuer's actual ability to meet contractual obligations may be different than what the Company determined during its analysis, which may lead to a different impairment conclusion in future periods. Goodwill and Other Intangible Assets ImpairmentsThe Company performs a review, on at least an annual basis, of goodwill held by the reporting units which are the Company’s three operating and reportable segments: Business Insurance; Bond & Specialty Insurance; and Personal Insurance. The Company uses a discounted cash flow model to estimate the fair value of its reporting units that incorporates multiple inputs into discounted cash flow calculations, including assumptions that market participants may make in valuing the reporting unit. The discounted cash flow model is an income approach to valuation that is based on a detailed cash flow analysis for deriving a current fair value of reporting units and is representative of the Company’s reporting units’ current and expected future financial performance. The assumptions used include earnings projections, including projected growth, projected levels of economic capital needed to support the business, and the weighted average cost of capital used for purposes of discounting the projected cash flows. Changes in the estimates of projected earnings, business growth, economic capital, and the weighted average cost of capital will directly impact the estimated fair value of the reporting units and, depending on the directional 114change of inputs, may increase the risk of impairment of goodwill. Once the Company estimates the fair value of its reporting units, those estimates are compared to their carrying values. If the carrying values of the reporting units were to exceed their fair value, the amount of the impairment would be calculated, and goodwill adjusted accordingly.Other indefinite-lived intangible assets held by the Company are also reviewed for impairment on at least an annual basis. The Company uses various methods for estimating the fair value of the intangible assets and relies on inputs such as replacement cost, projected earnings, including projected growth of earnings, and market royalty rates applied to the projected earnings.See note 1 of the notes to the consolidated financial statements for a discussion of impairments of goodwill and other intangible assets.OTHER UNCERTAINTIESFor a discussion of other risks and uncertainties that could impact the Company’s results of operations or financial position, see note 17 of the notes to the consolidated financial statements and “Item 1A—Risk Factors.” FORWARD-LOOKING STATEMENTSThis report contains, and management may make, certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, may be forward-looking statements. Words such as “may,” “will,” “should,” “likely,” “probably,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “believes,” “views,” “estimates” and similar expressions are used to identify these forward-looking statements. These statements include, among other things, the Company’s statements about:•the Company’s outlook, the impact of trends on its business, such as the impact of elevated industrywide loss costs in Personal Insurance, and its future results of operations and financial condition (including, among other things, anticipated premium volume, premium rates, renewal premium changes, underwriting margins and underlying underwriting margins, net and core income, investment income and performance, loss costs, return on equity, core return on equity and expected current returns, and combined ratios and underlying combined ratios); •the impact of legislative or regulatory actions or court decisions; •share repurchase plans;•future pension plan contributions;•the sufficiency of the Company’s reserves, including asbestos; •the impact of emerging claims issues as well as other insurance and non-insurance litigation;•the cost and availability of reinsurance coverage;•catastrophe losses and modeling, including statements about probabilities or likelihood of exceedance; •the impact of investment (including changes in interest rates), economic (including inflation, changes in tax laws, changes in commodity prices and fluctuations in foreign currency exchange rates) and underwriting market conditions; •the impact of changing climate conditions;•the impact of COVID-19 and related economic conditions;•strategic and operational initiatives to improve profitability and competitiveness; •the Company's competitive advantages and innovation agenda;•new product offerings;•the impact of developments in the tort environment, such as increased attorney involvement in insurance claims; and•the impact of developments in the geopolitical environment. The Company cautions investors that such statements are subject to risks and uncertainties, many of which are difficult to predict and generally beyond the Company’s control, that could cause actual results to differ materially from those expressed in, or implied or projected by, the forward-looking information and statements.For a discussion of some of the factors that could cause actual results to differ, see “Item 1A-Risk Factors” and “Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations.”The Company’s forward-looking statements speak only as of the date of this report or as of the date they are made, and the Company undertakes no obligation to update its forward-looking statements.115Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISKMarket risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates (inclusive of credit spreads), foreign currency exchange rates and other relevant market rate or price changes. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying assets are traded. The following is a discussion of the Company's primary market risk exposures and how those exposures are managed as of December 31, 2022. The Company's market risk sensitive instruments, including derivatives, are primarily entered into for purposes other than trading.The carrying value of the Company's investment portfolio at December 31, 2022 and 2021 was $80.45 billion and $87.38 billion, respectively, of which 89% was invested in fixed maturity securities at both periods. At December 31, 2022 and 2021, approximately 7.0% and 6.8%, respectively, of the Company's invested assets were denominated in foreign currencies. The Company's exposure to equity price risk is not significant. The Company has no direct commodity risk and is not a party to any credit default swaps.The primary market risks to the investment portfolio are interest rate risk and credit risk associated with investments in fixed maturity securities. The portfolio duration is primarily managed through cash market transactions and treasury futures transactions. For additional information regarding the Company’s investments, see notes 3 and 4 of the notes to the consolidated financial statements as well as the “Investment Portfolio” and “Outlook” sections of “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The primary market risk for all of the Company’s debt is interest rate risk at the time of refinancing. The Company monitors the interest rate environment and evaluates refinancing opportunities as maturity dates approach. For additional information regarding the Company’s debt, see note 9 of the notes to the consolidated financial statements as well as the “Liquidity and Capital Resources” section of “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The Company’s foreign exchange market risk exposure is concentrated in the Company’s invested assets, insurance reserves and shareholders’ equity denominated in foreign currencies. Cash flows from the Company’s foreign operations are the primary source of funds for the purchase of investments denominated in foreign currencies. The Company purchases these investments primarily to fund insurance reserves and other liabilities denominated in the same currency, effectively reducing its foreign currency exchange rate exposure. Invested assets denominated in the Canadian dollar comprised approximately 4.2% of the total invested assets at both December 31, 2022 and 2021. Invested assets denominated in the British Pound Sterling comprised approximately 2.2% and 2.1% of total invested assets at December 31, 2022 and 2021, respectively. Invested assets denominated in other currencies at December 31, 2022 and 2021 were not material.There were no other significant changes in the Company's primary market risk exposures or in how those exposures were managed for the year ended December 31, 2022 compared to the year ended December 31, 2021. The Company does not currently anticipate significant changes in its primary market risk exposures or in how those exposures are managed in future reporting periods based upon what is known or expected to be in effect in future reporting periods.SENSITIVITY ANALYSISSensitivity analysis is defined as the measurement of potential loss in future earnings, fair values or cash flows of market sensitive instruments resulting from one or more selected hypothetical changes in interest rates and other market rates or prices over a selected period of time. In the Company’s sensitivity analysis model, a hypothetical change in market rates is selected that is expected to reflect reasonably possible near-term changes in those rates. “Near-term” means a period of time going forward up to one year from the date of the consolidated financial statements. Actual results may differ from the hypothetical change in market rates assumed in this disclosure, especially since this sensitivity analysis does not reflect the results of any actions that would be taken by the Company to mitigate such hypothetical losses in fair value. Interest Rate RiskIn this sensitivity analysis model, the Company uses fair values to measure its potential loss. The sensitivity analysis model includes the following financial instruments entered into for purposes other than trading: fixed maturities, non-redeemable preferred stocks, mortgage loans, short-term securities and debt and derivative financial instruments. The primary market risk to the Company's market sensitive instruments is interest rate risk (inclusive of credit spreads). The sensitivity analysis model uses 116various basis point changes in interest rates to measure the hypothetical change in fair value of financial instruments included in the model.For invested assets with primary exposure to interest rate risk, estimates of portfolio duration and convexity are used to model the loss of fair value that would be expected to result from a parallel increase in interest rates. Durations on invested assets are adjusted for call, put and interest rate reset features. Durations on tax-exempt securities are adjusted for the fact that the yields on such securities do not normally move in lockstep with changes in the U.S. Treasury curve. Fixed maturity portfolio durations are calculated on a market value-weighted basis, including accrued interest, using holdings as of December 31, 2022 and 2021.For debt, the change in fair value is determined by calculating hypothetical December 31, 2022 and 2021 ending prices based on yields adjusted to reflect a 100 basis point change, comparing such hypothetical ending prices to actual ending prices, and multiplying the difference by the par or securities outstanding.The sensitivity analysis model used by the Company produces a loss in fair value of market sensitive instruments of approximately $2.68 billion and $2.33 billion based on a 100 basis point increase in interest rates at December 31, 2022 and 2021, respectively.The loss estimates do not take into account the impact of possible interventions that the Company might reasonably undertake in order to mitigate or avoid losses that would result from emerging interest rate trends. In addition, the loss value only reflects the impact of an interest rate increase on the fair value of the Company's financial instruments.Foreign Currency Exchange Rate RiskThe Company uses fair values of investment securities to measure its potential loss from foreign denominated investments. A hypothetical 10% reduction in value of foreign denominated investments is used to estimate the impact on the market value of the foreign denominated holdings. The Company's analysis indicates that a hypothetical 10% reduction in the value of foreign denominated investments would be expected to produce a loss in fair value of approximately $563 million and $596 million at December 31, 2022 and 2021, respectively.117
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+Item 7.Impact of Recent Events on Our BusinessMacroeconomic conditions, including geopolitical tensions, such as the ongoing military conflict between Russia and Ukraine and related sanctions, exchange rate and interest rate volatility, and inflationary pressures, will continue to evolve globally. In the second half of 2022, our organic hardware sales growth and bookings moderated from slowing demand in some of our end markets served by our dealer channels and also from dealer inventories moving towards lower levels due to improved product lead times and macroeconomic concerns. The greatest impact was a decline in Europe where the impacts of foreign currency exchange rates, the ongoing military conflict in Ukraine, and energy inflation were the greatest. Supply Chain Over the past year, we experienced inflationary cost increases for certain components of our hardware products due to supply chain disruptions resulting from parts and labor shortages and an increase in worldwide demand for components. In response, we increased customer pricing to offset inflationary pressures. In the second half of 2022, these cost pressures lessened as component supply became more readily available. We expect these cost pressures will continue to diminish over time as supply chain conditions continue to normalize. Additionally, over the past year, due to extended component lead times, we made binding commitments over a longer horizon for certain components. This has impacted our working capital in the short term; however, we expect supply dynamics and customer demand to normalize over time.34Table of Contents Foreign Currency FluctuationsWe generate over half of our revenue from sales to customers outside of the U.S. In 2022, due to the strengthening of the U.S. dollar, year-over-year unfavorable foreign currency impacts on revenue and operating income were $114.1 million or 4% and $26.0 million or 5%. Interest Rates FluctuationsThe global inflation rate has risen sharply, and interest rates are rising in an effort to curb inflation. In addition to the negative impact macroeconomic conditions have had on our sales, we may experience higher borrowing costs on existing variable rate debt and future debt issuances, including financing related to the pending acquisition of Transporeon.Ongoing Military Conflict in UkraineWe are monitoring and responding to effects of the ongoing military conflict in Ukraine. In the first quarter of 2022, we stopped selling to Russia and Belarus customers and wrote off uncollected customer receivables and inventory located in these countries, which was not material to our consolidated financial statements. Total revenue associated with Russia and Belarus customers, either sold directly or indirectly through resellers or OEMs, was less than 2% of our total Company revenue for 2021. We are focused on providing products and support to non-sanctioned Ukrainian customers and contributing to relief efforts. Acquisitions and DivestituresWe acquire businesses that align with our long-term growth strategies including our strategic product roadmap and, conversely, we divest certain business that no longer fit those strategies.In December 2022, we signed a definitive agreement to acquire Transporeon in an all-cash transaction valued at approximately €1.88 billion or $2.0 billion. Transporeon, a Germany-based company, is a leading cloud-based transportation management software platform that connects key stakeholders across the industry lifecycle to positively impact the optimization of global supply chains, in alignment with our Connect and Scale strategy. We believe the acquisition will advance our sustainability strategy by reducing under-utilized carrier capacity and “empty miles” and increase our international footprint and long-term Transportation opportunities. The acquisition will be funded through a combination of cash on hand and debt. We expect this acquisition to close in the first half of 2023, subject to customary closing conditions including the receipt of merger control clearances in Austria, Germany, and Poland. Transporeon will be reported in our Transportation segment. In 2022, we acquired two businesses, with total purchase consideration of $379.5 million. In the aggregate, the acquired businesses contributed less than 1% of our total revenue during 2022. In 2022, we divested six businesses with total proceeds of $226.3 million. For 2021, the revenue and operating income for these divested businesses were approximately $201.7 million and $33.0 million. For additional discussion of acquisitions and divestitures, refer to Note 3 “Acquisitions and Divestitures” of this report.CRITICAL ACCOUNTING POLICIES AND ESTIMATESThe preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles (“GAAP”) requires us to make judgments, assumptions, and estimates that affect the reported amounts of assets, liabilities, revenue, costs of sales, operating expenses, and related disclosures. We consider the accounting polices described below to be our critical accounting policies. These critical accounting policies are impacted significantly by judgments, assumptions, and estimates used in the preparation of the consolidated financial statements, and actual results could differ materially from the amounts reported based on these policies. Our accounting policies are more fully described in Note 1 “Description of Business and Accounting Policies” of this report. Revenue RecognitionRevenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration that we expect to receive in exchange for those products or services. Revenue is recognized net of allowance for returns and any taxes collected from customers. We enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations; however, determining whether products or services are considered distinct performance obligations that should be accounted for separately versus together may sometimes require significant judgment.Judgment is required to determine stand-alone selling price (“SSP”) for each performance obligation. We use a range of amounts to estimate SSP when products and services are sold separately and determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, we determine SSP using information that may include market conditions and other observable inputs.35Table of Contents Income TaxesWe are a U.S. based multinational company operating in multiple U.S. and foreign jurisdictions. Judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and may not accurately forecast actual tax audit outcomes. Determining whether an uncertain tax position is effectively settled requires judgment. Changes in recognition or measurement of our uncertain tax positions would result in the recognition of a tax benefit or an additional charge to the tax provision.Income taxes are accounted for under the liability method, whereby deferred tax assets or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect for the year in which the differences are expected to affect taxable income. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if we believe it is more likely than not such assets will not be realized.We are subject to the periodic examination of our domestic and foreign tax returns by the IRS, state, local, and foreign tax authorities who may challenge our tax positions. We regularly assess the likelihood of adverse outcomes from these examinations in determining the adequacy of our provision for income taxes.Business Combinations and Valuation of Goodwill and Purchased Intangible AssetsFor business combinations, we allocate the purchase consideration to the assets acquired, liabilities assumed, and any noncontrolling interest based on their fair values at the acquisition date. When determining the fair values, we make significant estimates and assumptions, especially concerning intangible assets. Critical estimates when valuing intangible assets include expected future cash flows based on consideration of future growth rates and margins, customer attrition rates, future changes in technology and brand awareness, loyalty and position, and discount rates. Any purchase consideration in excess of the fair values of the net assets acquired is recorded as goodwill. We evaluate goodwill on an annual basis in our fourth quarter or more frequently if indicators of potential impairment exist. To determine whether goodwill is impaired, we first assess qualitative factors. Qualitative factors include but are not limited to macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, or other relevant company-specific events. If it is determined more likely than not that the fair value of a goodwill reporting unit is less than its carrying amount, we perform a quantitative analysis. Alternatively, we may bypass the qualitative assessment and perform a quantitative impairment test.When performing a quantitative approach, we compare the reporting unit’s carrying amount, including goodwill, to the reporting unit's fair value. The estimation of a reporting unit's fair value involves using estimates and assumptions, including expected future operating performance using risk-adjusted discount rates. If the reporting unit's carrying amount exceeds its fair value, an impairment loss is recognized. We review intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable based on their future cash flows. The estimated future cash flows are primarily based on assumptions about expected future operating performance. 36Table of Contents RESULTS OF OPERATIONSOverviewThe following table shows revenue by category, gross margin and gross margin as a percentage of revenue, operating income and operating income as a percentage of revenue, diluted earnings per share, and annualized recurring revenue compared for the periods indicated:20222021Dollar Change % Change(In millions) Revenue: Product$2,152.0 $2,247.5 $(95.5)(4)% Service641.3 649.4 (8.1)(1)% Subscription883.0 762.2 120.8 16 %Total revenue$3,676.3 $3,659.1 $17.2 — %Gross margin2,105.6 2,034.7 70.9 3 %Gross margin as a % of revenue57.3 %55.6 %Operating income510.9 561.0 (50.1)(9)%Operating income as a % of revenue13.9 %15.3 %Diluted earnings per share$1.80 $1.94 $(0.14)(7)%Non-GAAP revenue (1)$3,676.3 $3,659.4 $16.9 — %Non-GAAP operating income (1)841.5 857.0 (15.5)(2)%Non-GAAP operating income as a % of Non-GAAP revenue (1)22.9 %23.4 %Non-GAAP diluted earnings per share (1)$2.64 $2.66 $(0.02)(1)%Annualized Recurring Revenue (“ARR”) (1)$1,603.7 $1,409.1 $194.6 14 %(1) Refer to “Supplemental Disclosure of Non-GAAP Financial Measures and Annualized Recurring Revenue” of this report for definitions. Basis of PresentationWe use a 52–53 week fiscal year ending on the Friday nearest to December 31, which for 2022 was December 30, 2022. Both 2022 and 2021 were 52–week years. Year 2022 Compared with Year 2021Revenue 2022Change versus 2021% ChangeChange in total revenue— %Acquisitions1 %Divestitures(4)%Foreign currency exchange(4)%Organic revenue growth - total revenue7 %Although organic revenue increased for fiscal 2022, it decelerated in the second half of the year due to slowing demand in some of our end markets and reductions in dealer inventory levels as a result of improved product lead times and macroeconomic concerns. Additionally, Geospatial had unusually strong hardware sales in the previous year. Throughout the year, software and subscription sales were strong in buildings businesses in Buildings and Infrastructure, and to a lesser extent, positioning services in Resources and Utilities and Transportation enterprise business, as evidenced by organic ARR growth of 16%.37Table of Contents 2022Change versus 2021% ChangeChange in product revenue(4)%Acquisitions— %Divestitures(5)%Foreign currency exchange(3)%Organic revenue growth - product revenue4 %Change in service revenue(1)%Acquisitions4 %Divestitures(1)%Foreign currency exchange(4)%Organic revenue growth - service revenue— %Change in subscription revenue16 %Acquisitions1 %Divestitures(2)%Foreign currency exchange(2)%Organic revenue growth - subscription revenue19 %Organic product revenue increased due to term license software growth throughout the year, as well as stronger hardware and related software sales in the first half of the year. In the second half of the year, slowing demand for our hardware and related software products impacted sales in Buildings and Infrastructure, Geospatial, and Resources and Utilities. Organic service revenue was relatively flat. Organic subscription revenue increased primarily due to strong growth in Buildings and Infrastructure and, to a lesser extent, in Resources and Utilities, Transportation, and Geospatial.During 2022, sales to customers in North America represented 53%; Europe represented 28%; Asia Pacific represented 11%; and the rest of world represented 8% of our total revenue.No single customer accounted for 10% or more of our total revenue or accounts receivable in 2022 and 2021. Gross MarginGross margins varied due to several factors including product mix, customer pricing, distribution channel, and product costs.Gross margin increased primarily due to organic revenue growth in Buildings and Infrastructure and Resources and Utilities, partially offset by divestitures and unfavorable foreign currency. Gross margin as a percentage of total revenue increased due to an increased mix of software and subscription sales, price increases, and to a lesser extent, divestitures of lower margin hardware centric businesses. Operating IncomeOperating income decreased primarily due to divestitures and unfavorable foreign currency, partially offset by organic revenue and gross margin expansion. Additionally, operating expense increased due to investments related to our Connect and Scale strategy and increased sales and marketing costs primarily related to trade shows and increased travel. Other contributors to increased operating expense included restructuring costs, charitable donations, and higher acquisition and divestiture transaction costs partially offset by a reduction in incentive compensation. Operating income as a percentage of revenue decreased primarily due to increased operating expense, partially offset by increased gross margin as a percentage of revenue.38Table of Contents Research and Development, Sales and Marketing, and General and Administrative ExpensesThe following table shows research and development (“R&D”), sales and marketing (“S&M”), and general and administrative (“G&A”) expense along with these expenses as a percentage of revenue for the periods indicated: 20222021Dollar Change % Change (In millions) Research and development$542.1 $536.6 $5.5 1 %Percentage of revenue14.7 %14.7 %Sales and marketing553.6 506.8 46.8 9 %Percentage of revenue15.1 %13.9 %General and administrative422.2 369.1 53.1 14 %Percentage of revenue11.5 %10.1 %Total$1,517.9 $1,412.5 $105.4 7 %R&D expense increased primarily due to slightly higher compensation expense and the impact of acquisitions, partially offset by favorable foreign currency and divestitures. We believe that the development and introduction of new solutions are critical to our future success, and we expect to continue the active development of new products.S&M expense increased primarily due to higher compensation expense, including commissions, higher marketing costs including trade shows, higher travel expenses, and the impact of acquisitions. These increases were partially offset by favorable foreign currency and divestitures.G&A expense increased primarily due to investments related to our Connect and Scale strategy, charitable donations to the Trimble Foundation, and acquisition and divestiture transaction costs. These increases were partially offset by a reduction in incentive compensation, favorable foreign currency, and divestitures. Amortization of Purchased Intangible AssetsThe following table shows amortization of purchased intangible assets for the periods indicated:20222021Dollar Change% Change (In millions) Cost of sales$85.0 $87.7 $(2.7)(3)%Operating expenses46.6 50.9 (4.3)(8)%Total amortization expense of purchased intangibles$131.6 $138.6 $(7.0)(5)%Total amortization expense of purchased intangibles as a percentage of revenue4 %4 %In 2022, total amortization of purchased intangibles decreased primarily due to the expiration of prior years’ acquisition amortization. Non-Operating Income, NetThe following table shows non-operating income, net for the periods indicated:20222021Dollar Change% Change(In millions) Divestitures gain, net$99.0 $41.4 $57.6 139 %Interest expense, net(71.1)(65.4)(5.7)9 %Income from equity method investments, net31.1 37.7 (6.6)(18)%Other expense, net(0.8)(0.1)(0.7)700 %Total non-operating income, net$58.2 $13.6 $44.6 328 %In 2022, non-operating income increased primarily due to higher gains from divestitures, partially offset by lower joint-venture profitability, higher interest expense due to Bridge Facility fees, and fluctuations in deferred compensation plan assets included in Other expense, net.39Table of Contents Income Tax ProvisionOur effective income tax rates for 2022 and 2021 were 21.0% and 14.2%. The effective income tax rate in 2022 increased compared to 2021 primarily due to a one-time tax benefit recorded in 2021 related to the revaluation of the Netherlands deferred tax assets mentioned below and lower stock-based compensation deductions during 2022.In December 2021, due to a change in the Netherlands tax law, the statutory tax rate was increased from 25.0% to 25.8% effective January 1, 2022. As a result, we recorded a one-time tax benefit of $14.4 million in 2021 due to the revaluation of the Netherlands deferred tax assets.On August 16, 2022, the U.S. federal government enacted the Inflation Reduction Act (“IRA”) of 2022. The IRA includes a 15% corporate alternative minimum tax effective in 2024 for certain large corporations, a 1% excise tax on net share repurchases after December 31, 2022, and several tax incentives to promote clean energy. We do not expect the provisions of the IRA to have a material impact on our financial results.Results by SegmentWe report our financial performance, including revenue and operating income, based on four reportable segments: Buildings and Infrastructure, Geospatial, Resources and Utilities, and Transportation. Our Chief Executive Officer and Chief Operating Decision Maker views and evaluates operations based on the results of our reportable operating segments under our management reporting system. These results are not necessarily in conformance with U.S. GAAP. For additional discussion of our segments, refer to Note 6 “Reporting Segment and Geographic Information” of this report.The following table shows a breakdown of revenue and operating income by segment for the periods indicated:20222021Dollar Change% Change (In millions) Buildings and InfrastructureSegment revenue$1,494.0 $1,422.7 $71.3 5 %Segment revenue as a percent of total revenue40.6 %38.9 %Segment operating income $406.3 $411.7 $(5.4)(1)%Segment operating income as a percent of segment revenue27.2 %28.9 %GeospatialSegment revenue$756.5 $828.9 $(72.4)(9)%Segment revenue as a percent of total revenue20.6 %22.6 %Segment operating income $221.4 $244.1 $(22.7)(9)%Segment operating income as a percent of segment revenue29.3 %29.4 %Resources and UtilitiesSegment revenue$821.6 $771.3 $50.3 7 %Segment revenue as a percent of total revenue22.4 %21.1 %Segment operating income $278.3 $264.0 $14.3 5 %Segment operating income as a percent of segment revenue33.9 %34.2 %TransportationSegment revenue$604.2 $636.5 $(32.3)(5)%Segment revenue as a percent of total revenue16.4 %17.4 %Segment operating income $58.8 $43.4 $15.4 35 %Segment operating income as a percent of segment revenue9.7 %6.8 %40Table of Contents The following table shows a reconciliation of our consolidated segment operating income to our consolidated income before income taxes for the periods indicated:20222021(In millions) Consolidated segment operating income$964.8 $963.2 Unallocated general corporate expenses(123.3)(106.2)Purchase accounting adjustments(131.6)(134.5)Acquisition / divestiture items(32.8)(21.8)Stock-based compensation / deferred compensation(112.0)(128.6)Restructuring and other costs(54.2)(11.1)Consolidated operating income510.9 561.0 Total non-operating income, net58.2 13.6 Consolidated income before taxes$569.1 $574.6 Buildings and Infrastructure2022Change versus 2021% ChangeChange in revenue - Buildings and Infrastructure5 %Acquisitions2 %Divestitures(5)%Foreign currency exchange(3)%Organic revenue growth11 %Organic revenue increased due to demand for our subscription and term license software recurring offerings. The increases resulted from higher sales to new and existing customers, as well as conversions from perpetual software to recurring offerings. Civil construction hardware and related software license revenue increased due to relative strength in the North American construction market in the first half of 2022, partially offset by weaker hardware sales, particularly in Europe, in the second half of the year.Despite revenue and gross margin expansion, operating income decreased primarily due to higher operating expense, unfavorable foreign currency, and divestitures. Operating expense increased due to investments in our Connect and Scale strategy as well as higher marketing and travel costs. Operating income as a percentage of revenue decreased primarily due to higher operating expense, partially offset by gross margin expansion due to product mix. Geospatial2022Change versus 2021% ChangeChange in revenue - Geospatial(9)%Acquisitions— %Divestitures(5)%Foreign currency exchange(3)%Organic revenue growth(1)%Organic revenue decreased slightly due to unusually strong hardware sales in the prior year and the softening of hardware sales in the second half of 2022, partially offset by higher software and subscription sales.Operating income decreased primarily due to divestitures and reduced revenue, partially offset by better gross margin due to product mix. Operating income as a percentage of revenue was relatively flat.41Table of Contents Resources and Utilities2022Change versus 2021% ChangeChange in revenue - Resources and Utilities7 %Acquisitions— %Divestitures(1)%Foreign currency exchange(4)%Organic revenue growth12 %Organic revenue increased due to relative strength in agriculture, particularly in the OEM channel, as well as price increases, partially offset by weaker agriculture sales in the reseller channel, particularly Europe, in the second half of the year. To a lesser extent, revenue was favorably impacted by higher subscription revenue in positioning services.Operating income increased primarily due to organic revenue expansion, partially offset by unfavorable foreign currency, and higher operating expenses due to investments in our Connect and Scale strategy. Operating income as a percentage of revenue was relatively flat.Transportation2022Change versus 2021% ChangeChange in revenue - Transportation(5)%Acquisitions— %Divestitures(3)%Foreign currency exchange(1)%Organic revenue growth(1)%Organic revenue decreased primarily driven by lower mobility hardware sales to North American customers. Enterprise subscription revenue continued to experience growth as the business transitions from a perpetual software license model.Operating income and operating income as a percentage of revenue increased primarily due to targeted cost reductions and gross margin expansion due to product mix, partially offset by divestitures and reduced revenue. We continue to maintain focus on new product introductions and transitions to recurring revenue.LIQUIDITY AND CAPITAL RESOURCESAt the End of Year20222021Dollar Change% Change (In millions) Cash and cash equivalents$271.0 $325.7 $(54.7)(17)%As a percentage of total assets3.7 %4.6 %Principal balance of outstanding debt$1,525.0 $1,300.0 $225.0 17 %Years20222021Dollar Change% Change (In millions) Cash provided by operating activities$391.2 $750.5 $(359.3)(48)%Cash used in investing activities(226.3)(203.5)(22.8)11 %Cash used in financing activities(199.0)(447.7)248.7 (56)%Effect of exchange rate changes on cash and cash equivalents(20.6)(11.3)(9.3)82 %Net increase in cash and cash equivalents$(54.7)$88.0 Operating ActivitiesThe decrease in cash provided by operating activities was primarily driven by lower net income after adjusting for non-cash items and divestiture gains, higher bonus and cash tax payments, higher accounts receivable, higher inventory purchases, and lower accounts payable associated with the timing of inventory payments. The decreases were partially offset by an increase in deferred revenue.42Table of Contents Investing ActivitiesThe increase in cash used in investing activities was primarily due to higher payments related to businesses acquired in 2022, partially offset by higher proceeds from divestitures. Financing ActivitiesThe decrease in cash used in financing activities was primarily driven by higher proceeds of revolving credit facilities, which was used in part to fund the B2W acquisition, partially offset by an increase in common stock repurchases.Cash and Cash EquivalentsWe believe that our cash and cash equivalents and borrowings, along with cash provided by operations will be sufficient in the foreseeable future to meet our anticipated operating cash needs, expenditures related to our Connect and Scale strategy, and debt service. In March 2022, we entered into a five-year, unsecured revolving loan facility for borrowings up to $1.25 billion, which replaced the 2018 Credit Facility. The 2022 Credit Facility contains an option to increase the borrowings up to $1.75 billion with lender approval. At the end of 2022, $225.0 million was outstanding under the 2022 Credit Facility.In December 2022, in connection with our pending acquisition of Transporeon, we arranged to incur substantial new debt obligations, which will be drawn prior to the acquisition closing date. These arrangements include: •a term loan credit agreement providing for an unsecured delayed draw term loan facility in the aggregate principal amount of $1.0 billion, comprised of commitments for a 3-year tranche in the amount of $500.0 million and a 5-year tranche in the amount of $500.0 million, and •an amendment to our 2022 Credit Facility that made $600.0 million of the existing commitments under the Credit Facility available for the pending acquisition of Transporeon and increased our maximum permitted leverage ratio following the closing of the acquisition. Prior to arranging the above two transactions, we had entered into a 364-day bridge facility commitment letter (the “Bridge Facility”) that provided for up to €1.88 billion of commitments for term loans to fund our acquisition of Transporeon. The Bridge Facility was reduced to €500 million by the term loan credit agreement and the amended 2022 Credit Facility. We anticipate refinancing some or all of our outstanding indebtedness and debt commitments at or prior to their maturities, which could involve us accessing the capital markets. A provision enacted in the Tax Cuts and Jobs Act of 2017 related to the capitalization of research and development costs for tax purposes became effective on January 1, 2022. In 2022, we paid $88.0 million with respect to this tax provision. Additionally, if this provision is not deferred or repealed in 2023, we expect that cash tax payments in 2023 will be slightly lower than 2022.Our material cash requirements include the following contractual and other obligations and cash needs:LeasesWe have operating leases primarily for certain of our major facilities including corporate offices, research and development facilities, and manufacturing facilities. Operating leases represent undiscounted lease payments and include short-term leases. At the end of 2022, we had fixed lease payment obligations of $171.6 million, with $48.7 million payable within the next 12 months. Refer to Note 8 “Leases” of this report for additional information regarding our leases.Tax PayableAt the end of 2022, we had income taxes payable of $64.6 million, with $23.7 million payable within the next 12 months. The amount payable within the next 12 months includes $13.6 million representing a one-time transition tax liability as a result of the 2017 Tax Cuts and Jobs Act (the “Tax Act”). In addition, we have unrecognized tax benefits of $75.5 million included in Other non-current liabilities, including interest and penalties. At this time, we cannot make a reasonably reliable estimate of the period of cash settlement with tax authorities regarding this liability. Refer to Note 12 “Income Taxes” of this report for additional information regarding our taxes.Other Purchase Obligations and CommitmentsPurchase obligations and commitments primarily relate to investments in our platform associated with our Connect and Scale strategy and non-cancellable inventory commitments. At the end of 2022, we had operating purchase obligations and commitments of $858.8 million, with $326.2 million payable within the next 12 months. Refer to Note 9 “Commitments and Contingencies” of this report for additional information regarding our purchase obligations and commitments. Other than the items discussed above, we do not have any off-balance sheet financing arrangements or liabilities.43Table of Contents DebtAt the end of 2022, we had outstanding floating and fixed-rate senior notes with varying maturities for an aggregate principal amount of approximately $1.5 billion. Future interest payments total $260.5 million, with $67.3 million payable within the next 12 months.During 2022, we had $224.6 million of proceeds from debt, net of the payments. Refer to Note 7 “Debt” of this report for additional information regarding our debt.Stock Repurchase ProgramWe have a 2021 Stock Repurchase Program authorized by our Board of Directors, that allows us to repurchase shares from time to time, subject to business and market conditions and other investment opportunities, through open market transactions, privately-negotiated transactions, accelerated stock repurchase plans, or by other means for up to $750 million. The 2021 Stock Repurchase Program does not obligate us to acquire any specific number of shares. Because of the additional outstanding indebtedness we have and expect to incur in connection with the pending Transporeon acquisition, we have temporarily discontinued share repurchases. Refer to Note 14 “Common Stock Repurchase” of this report for additional information regarding our 2021 Stock Repurchase Program.EFFECT OF NEW ACCOUNTING PRONOUNCEMENTSThe impact of recent accounting pronouncements is disclosed in Note 1 “Description of Business and Accounting Policies” of this report.44Table of Contents SUPPLEMENTAL DISCLOSURE OF NON-GAAP FINANCIAL MEASURES AND ANNUALIZED RECURRING REVENUETo supplement our consolidated financial information, we include non-GAAP financial measures, which are not meant to be considered in isolation or as a substitute for comparable GAAP. We believe non-GAAP financial measures provide useful information to investors and others in understanding our “core operating performance”, which excludes the (i) effect of non-cash items and certain variable charges not expected to recur; and (ii) transactions that are not meaningful in comparison to our past operating performance or not reflective of ongoing financial results. Lastly, we believe that our core operating performance offers a supplemental measure for period-to-period comparisons and can be used to evaluate our historical and prospective financial performance, as well as our performance relative to competitors. Organic revenue growth is a non-GAAP measure that refers to revenue excluding the impacts of (i) foreign currency translation, and (ii) acquisitions and divestitures. We believe organic revenue growth provides useful information in evaluating the results of our business because it excludes items that are not indicative of ongoing performance or impact comparability with the prior year. We provide a reconciliation tables showing the change in revenue growth to organic revenue growth in the “Results of Operations” section found earlier in this Item 7.In addition to providing non-GAAP financial measures, we disclose Annualized Recurring Revenue (“ARR”) to give the investors supplementary indicators of the value of our current recurring revenue contracts. ARR represents the estimated annualized value of recurring revenue, including subscription, maintenance and support revenue, and term license contracts for the quarter. ARR is calculated by taking our non-GAAP recurring revenue for the current quarter and adding the portion of the contract value of all of our term licenses attributable to the current quarter, and dividing that sum by the number of days in the quarter and then multiplying that quotient by 365. Organic ARR refers to annualized recurring revenue excluding the impacts of (i) foreign currency translation, and (ii) acquisitions and divestitures. ARR and organic ARR should be viewed independently of revenue and deferred revenue as they are performance measures and are not intended to be combined with or to replace either of those items. The non-GAAP financial measures, definitions, and explanations to the adjustments to comparable GAAP measures are included below: Years 202220212020(In millions, except per share data) DollarAmount% ofRevenueDollarAmount% ofRevenueDollarAmount% ofRevenueREVENUE:GAAP revenue:$3,676.3 $3,659.1 $3,147.7 Purchase accounting adjustments(A)— 0.3 4.3 Non-GAAP revenue:$3,676.3 $3,659.4 $3,152.0 GROSS MARGIN:GAAP gross margin:$2,105.6 57.3 %$2,034.7 55.6 %$1,754.9 55.8 %Purchase accounting adjustments(A)85.0 88.0 96.6 Acquisition / divestiture items(B)0.2 — 1.7 Stock-based compensation / deferred compensation(C)12.1 9.8 7.2 Restructuring and other costs(D)1.7 0.2 1.2 Non-GAAP gross margin:$2,204.6 60.0 %$2,132.7 58.3 %$1,861.6 59.1 %OPERATING EXPENSES:GAAP operating expenses:$1,594.7 43.4 %$1,473.7 40.3 %$1,335.1 42.4 %Purchase accounting adjustments(A)(46.6)(46.5)(60.0)Acquisition / divestiture items(B)(32.6)(21.8)(19.7)Stock-based compensation / deferred compensation(C)(99.9)(118.8)(83.2)Restructuring and other costs(D)(52.5)(10.9)(30.2)Non-GAAP operating expenses:$1,363.1 37.1 %$1,275.7 34.9 %$1,142.0 36.2 %OPERATING INCOME:GAAP operating income:$510.9 13.9 %$561.0 15.3 %$419.8 13.3 %Purchase accounting adjustments(A)131.6 134.5 156.6 Acquisition / divestiture items(B)32.8 21.8 21.4 Stock-based compensation / deferred compensation(C)112.0 128.6 90.4 Restructuring and other costs(D)54.2 11.1 31.4 Non-GAAP operating income:$841.5 22.9 %$857.0 23.4 %$719.6 22.8 %45Table of Contents NON-OPERATING INCOME (EXPENSE), NET:GAAP non-operating income (expense), net:$58.2 $13.6 $(24.8)Acquisition / divestiture items(B)(107.5)(42.1)(12.2)Deferred compensation(C)8.5 (6.1)(7.5)Restructuring and other costs(D)6.0 — — Non-GAAP non-operating expense, net:$(34.8)$(34.6)$(44.5) GAAP andNon-GAAPTax Rate % (H) GAAP andNon-GAAPTax Rate % (H) GAAP andNon-GAAPTax Rate % (H)INCOME TAX PROVISION (BENEFIT):GAAP income tax provision:$119.4 21.0 %$81.8 14.2 %$4.4 1.1 %Non-GAAP items tax effected(E)49.9 41.4 48.5 Difference in GAAP and Non-GAAP tax rate(F)(22.9)7.5 (4.9)IP restructuring and tax law change impacts(G)— 14.4 64.0 Non-GAAP income tax provision:$146.4 18.2 %$145.1 17.6 %$112.0 16.6 %NET INCOME:GAAP net income attributable to Trimble Inc.:$449.7 $492.7 $389.9 Purchase accounting adjustments(A)131.6 134.5 156.6 Acquisition / divestiture items(B)(74.7)(20.3)9.2 Stock-based compensation / deferred compensation(C)120.5 122.5 82.9 Restructuring and other costs(D)60.2 11.1 31.4 Non-GAAP tax adjustments(E) - (G)(27.0)(63.3)(107.6)Non-GAAP net income attributable to Trimble Inc.:$660.3 $677.2 $562.4 DILUTED NET INCOME PER SHARE:GAAP diluted net income per share attributable to Trimble Inc.:$1.80 $1.94 $1.55 Purchase accounting adjustments(A)0.53 0.53 0.62 Acquisition / divestiture items(B)(0.30)(0.08)0.04 Stock-based compensation / deferred compensation(C)0.48 0.48 0.33 Restructuring and other costs(D)0.24 0.04 0.12 Non-GAAP tax adjustments(E) - (G)(0.11)(0.25)(0.43)Non-GAAP diluted net income per share attributable to Trimble Inc.:$2.64 $2.66 $2.23 ADJUSTED EBITDA:OPERATING INCOME:GAAP net income attributable to Trimble Inc.:$449.7 $492.7 $389.9 Non-operating income (expense), net, income tax provision, and net gain attributable to noncontrolling interests 61.2 68.3 29.9 GAAP operating income:510.9 561.0 419.8 Purchase accounting adjustments(A)131.6 134.5 156.6 Acquisition / divestiture items(B)32.8 21.8 21.4 Stock-based compensation / deferred compensation(C)112.0 128.6 90.4 Restructuring and other costs(D)54.2 11.1 31.4 Non-GAAP operating income:$841.5 $857.0 $719.6 Depreciation expense and cloud computing amortization44.7 42.2 39.7 Income from equity method investments, net31.1 37.7 39.4 Adjusted EBITDA:$917.3 25.0 %$936.9 25.6 %$798.7 25.3 %46Table of Contents Non-GAAP DefinitionsNon-GAAP revenueWe define Non-GAAP revenue as GAAP revenue, excluding the effects of purchase accounting adjustments for acquisitions occurring prior to 2021. We believe this measure helps investors understand the performance of our business including acquisitions, as non-GAAP revenue excludes the effects of certain acquired deferred revenue that was written down to fair value in purchase accounting. Management believes that excluding fair value purchase accounting adjustments more closely correlates with the ordinary and ongoing course of the acquired company’s operations and facilitates analysis of revenue growth and trends.Non-GAAP gross margin We define Non-GAAP gross margin as GAAP gross margin, excluding the effects of purchase accounting adjustments, acquisition/divestiture items, stock-based compensation, deferred compensation, and restructuring and other costs. We believe our investors benefit by understanding our non-GAAP gross margin as a way of understanding how product mix, pricing decisions, and manufacturing costs influence our business.Non-GAAP operating expenses We define Non-GAAP operating expenses as GAAP operating expenses, excluding the effects of purchase accounting adjustments, acquisition/divestiture items, stock-based compensation, deferred compensation, and restructuring and other costs. We believe this measure is important to investors evaluating our non-GAAP spending in relation to revenue.Non-GAAP operating incomeWe define Non-GAAP operating income as GAAP operating income, excluding the effects of purchase accounting adjustments, acquisition/divestiture items, stock-based compensation, deferred compensation, and restructuring, and other costs. We believe our investors benefit by understanding our non-GAAP operating income trends, which are driven by revenue, gross margin, and spending. Non-GAAP non-operating expense, netWe define Non-GAAP non-operating expenses, net as GAAP non-operating expenses, net, excluding acquisition/divestiture items, deferred compensation, and restructuring and other costs. We believe this measure helps investors evaluate our non-operating expense trends. Non-GAAP income tax provisionWe define Non-GAAP income tax provision as GAAP income tax provision, excluding charges and benefits such as net deferred tax impacts resulting from the non-U.S. intercompany transfer of intellectual property, tax law changes, and significant one-time reserve releases upon the statute of limitations expirations. We believe this measure helps investors because it provides for consistent treatment of excluded items in our non-GAAP presentation and a difference in the GAAP and non-GAAP tax rates.Non-GAAP net incomeWe define Non-GAAP net income as GAAP net income, excluding the effects of purchase accounting adjustments, acquisition/divestiture items, stock-based compensation, restructuring and other costs, and non-GAAP tax adjustments. This measure provides a supplemental view of net income trends, which are driven by non-GAAP income before taxes and our non-GAAP tax rate. Non-GAAP diluted net income per shareWe define Non-GAAP diluted net income per share as GAAP diluted net income per share, excluding the effects of purchase accounting adjustments, acquisition/divestiture items, stock-based compensation, restructuring and other costs, and non-GAAP tax adjustments. We believe our investors benefit by understanding our non-GAAP operating performance as reflected in a per share calculation as a way of measuring non-GAAP operating performance by ownership in the company.Adjusted EBITDAWe define Adjusted EBITDA as non-GAAP operating income plus depreciation expense, cloud computing amortization, and income from equity method investments, net. Other companies may define Adjusted EBITDA differently. Adjusted EBITDA is not intended to purport to be an alternative to net income or operating income as a measure of operating performance or cash flow from operating activities as a measure of liquidity. Adjusted EBITDA is a performance measure that we believe offers a useful view of the overall operations of our business because it facilitates operating performance comparisons by removing 47Table of Contents potential differences caused by variations unrelated to operating performance, such as capital structures (interest expense), income taxes, depreciation, and amortization of purchased intangibles and cloud computing costs. Explanations of Non-GAAP adjustments(A)Purchase accounting adjustments. Purchase accounting adjustments consist of the following:(i)Acquired deferred revenue adjustment. We adopted ASU 2021-08 in the fourth quarter of 2021 for all acquisitions occurring in 2021 and going forward, which requires the application of ASC 606, Revenue from Contracts with Customers, to recognize and measure contract assets and contract liabilities on the acquisition date. For acquisitions occurring prior to 2021, non-GAAP revenue excludes the adjustment to our revenue as a result of measuring the contract liability at fair value on the acquisition date. (ii)Amortization of acquired capitalized commissions. Purchase accounting generally requires entities to eliminate capitalized sales commissions balances as of the acquisition date. Non-GAAP operating expenses exclude the adjustments that eliminate the capitalized sales commissions. For acquisitions occurring prior to 2021, non-GAAP operating expenses exclude the adjustment of acquired capitalized commissions amortization.(iii)Amortization of purchased intangible assets. Non-GAAP gross margin and operating expenses exclude the amortization of purchased intangible assets, which primarily represents technology and/or customer relationships already developed.(B)Acquisition / divestiture items. Non-GAAP gross margin and operating expenses exclude acquisition costs consisting of external and incremental costs resulting directly from merger and acquisition and strategic investment activities such as legal, due diligence, integration, and other closing costs, including the acceleration of acquisition stock options and adjustments to the fair value of earn-out liabilities. Non-GAAP non-operating expense, net, excludes unusual one-time acquisition/divestiture charges, including foreign currency exchange rate gains/losses related to an acquisition, divestiture gains/losses, and strategic investment impairments. These are one-time costs that vary significantly in amount and timing and are not indicative of our core operating performance. (C)Stock-based compensation / deferred compensation. Non-GAAP gross margin and operating expenses exclude stock-based compensation and income or expense associated with movement in our non-qualified deferred compensation plan liabilities. Changes in non-qualified deferred compensation plan assets, included in non-operating expense, net, offset the income or expense in the plan liabilities. (D)Restructuring and other costs. Non- GAAP gross margin and operating expenses exclude restructuring and other costs comprised of termination benefits related to reductions in employee headcount and closure or exit of facilities, executive severance agreements, costs incurred in exiting business activities in Russia and Belarus, other business exit costs, Bridge Facility fees, as well as a $20 million commitment to donate to the Trimble Foundation to be paid over four quarters. (E)Non-GAAP items tax effected. This amount adjusts the provision for income taxes to reflect the effect of the non-GAAP items (A) - (D) on non-GAAP net income. This amount excludes the GAAP tax rate impact resulting from the non-U.S. intercompany transfer of intellectual property, which is separately disclosed in item (G). (F)Difference in GAAP and Non-GAAP tax rate. This amount represents the difference between the GAAP and non-GAAP tax rates applied to the non-GAAP operating income plus the non-GAAP non-operating expense, net. The GAAP tax rate used for this calculation excludes the net deferred tax impacts resulting from the non-U.S. intercompany transfer of intellectual property, which is separately disclosed in item (G). The non-GAAP tax rate excludes charges and benefits such as net deferred tax impacts resulting from a non-U.S. intercompany transfer of intellectual property and significant one-time reserve releases upon statute of limitations expirations. (G)IP restructuring and tax law change impacts. These amounts represent net deferred tax impacts resulting from a non-U.S. intercompany transfer of intellectual property, consistent with tax law changes, including tax rates changes, and our international business operations. (H)GAAP and non-GAAP tax rate percentages. These percentages are defined as GAAP income tax provision as a percentage of GAAP income before taxes and non-GAAP income tax provision as a percentage of non-GAAP income before taxes.48Table of Contents Item 7A. Quantitative and Qualitative Disclosures about Market RiskWe are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We use certain derivative financial instruments to manage these risks. We do not use derivative financial instruments for speculative purposes. All financial instruments are used in accordance with policies approved by our board of directors.Market Interest Rate RiskOur cash equivalents consisted primarily of interest and non-interest bearing bank deposits as well as bank time deposits. The main objective of these instruments is safety of principal and liquidity while maximizing return, without significantly increasing risk.Due to the nature of our cash equivalents that they are readily convertible to cash, we do not anticipate any material effect on our portfolio due to fluctuations in interest rates.We are exposed to market risk due to the possibility of changing interest rates under our credit facilities, including the 2022 Credit Facility, 2022 Term Loan Credit Agreement, and the Bridge Facility. We also have four unsecured, uncommitted, revolving credit facilities that are callable by the bank at any time. We may borrow funds under the 2022 Credit Facility and uncommitted facilities in U.S. Dollars, Euros, or in certain other agreed currencies as described in Note 7 “Debt” of this report.At the end of 2022, we had two $75.0 million, one €100.0 million, and one £55.0 million revolving credit facilities, which are uncommitted. At the end of 2022, $225.0 million was outstanding under the 2022 Credit Facility. We expect to issue fixed-rate debt in the first half of 2023 as part of the pending acquisition of Transporeon and to refinance existing debt. To minimize interest rate fluctuations, in December 2022, we entered into a contract to offset the changes in the price of U.S. Treasury Notes with an original maturity of 10 years for the period commencing on the contract date and ending May 31, 2023 (“Treasury Rate Lock”). The Treasury Rate Lock is marked-to-market each period through other comprehensive income until the debt is issued, and the effective interest rate method is applied. The nominal amount is $400 million, and the fair value at the end of 2022 is $7.2 million.While not predictive, a hypothetical 50 basis point increase or decrease in the 10-year U.S. Treasury rate as of December 30, 2022 would change the fair value of the Treasury Rate Lock by $16.5 million.Foreign Currency Exchange Rate RiskWe operate in international markets, which expose us to market risk associated with foreign currency exchange rate fluctuations between the U.S. Dollar and various foreign currencies, the most significant of which is the Euro. In addition, volatile market conditions arising from the COVID-19 pandemic could result in changes in exchange rates.Historically, the majority of our revenue contracts are denominated in U.S. Dollars, with the most significant exception being Europe, where we invoice primarily in Euro. Additionally, a portion of our expenses, primarily the cost to manufacture, cost of personnel to deliver technical support on our products and professional services, sales and sales support, and research and development, are denominated in foreign currencies, primarily the Euro.Revenue resulting from selling in local currencies and costs incurred in local currencies are exposed to foreign currency exchange rate fluctuations, which can affect our operating income. As exchange rates vary, operating income may differ from expectations. In 2022, revenue and operating income were unfavorably impacted by foreign currency exchange rates by $114.1 million and $26.0 million. We enter into foreign currency forward contracts to minimize the short-term impact of foreign currency exchange rate fluctuations on cash, debt, and certain trade and intercompany receivables and payables, primarily denominated in Euro, New Zealand Dollars, Brazilian Real, and Canadian Dollars. These contracts reduce the exposure to fluctuations in foreign currency exchange rate movements, as the gains and losses associated with foreign currency balances are generally offset with the gains and losses on the forward contracts. Additionally, in December 2022, we entered into a foreign currency exchange rate contract to minimize foreign currency fluctuations on the €1.88 billion or $2.0 billion pending acquisition of Transporeon. 49Table of Contents Our foreign currency contracts are marked-to-market through earnings every period and generally range in maturity from one to two months, or from four to six months for acquisitions. We do not enter into foreign currency contracts for trading purposes. Foreign currency contracts outstanding at the end of 2022 and 2021 are summarized as follows: At the End of 2022At the End of 2021 NominalAmountFairValueNominalAmountFairValue(In millions)Forward contracts:Purchased$(77.9)$— $(107.5)$0.1 Sold$130.6 $0.2 $183.6 $(0.2)Foreign currency exchange contract related to acquisition$1,999.4 $10.4 $— $— While not predictive, a hypothetical 5% decrease in the Euro as of December 30, 2022 would change the fair value of the foreign currency exchange contract related to the pending acquisition of Transporeon by $68 million.50Table of Contents TRIMBLE INC.INDEX TO FINANCIAL STATEMENTS Consolidated Balance Sheets52Consolidated Statements of Income53Consolidated Statements of Comprehensive Income54Consolidated Statements of Stockholders’ Equity55Consolidated Statements of Cash Flows56Notes to Consolidated Financial Statements57Reports of Independent Registered Public Accounting Firm (PCAOB ID: 42)7751Table of Contents
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report on Form 10-K for the year ended December 31, 2021.A description of certain factors that may affect our future results and risk factors is set forth in Part I, Item 1A-Risk Factors of this report.Executive OverviewThis year was a strategic turning point for Truist as we began to shift our focus to executional excellence and purposeful growth. Results for 2022 were solid, reflecting post-integration momentum and progress in many areas. Robust loan growth, significant margin expansion, and good cost discipline contributed to our strong performance. Credit quality remains strong reflecting our conservative credit culture and diverse business mix. We also delivered on our commitment to achieve positive operating leverage for the full-year 2022.We fulfilled our purpose to inspire and build better lives and communities in many ways throughout the year. We showed care for our teammates with a bold increase in our minimum wage; created new ways to meet clients’ needs through initiatives like Truist One Banking and enhanced digital offerings like Truist Assist, Truist Invest Pro, and Truist Trade; and supported our communities, including introducing a $120 million commitment to small businesses. In addition, we exceeded our $60 billion Community Benefits Plan commitment that we established at the time of the Merger.We continued to have strong momentum during the year with regards to other environmental, social and governance initiatives that we have undertaken. We announced our goal to achieve net zero greenhouse gas emissions by 2050, which will help support our clients’ transition to a low-carbon economy. In support of this goal, we joined the Partnership for Carbon Accounting Financials, and set 2030 goals to reduce Scope 1 and Scope 2 emissions by 35% each, and to reduce water consumption by 25%, relative to 2019. With 17.2% of senior leadership roles being held by ethnically diverse teammates, we have exceeded our original goal and we aspire for continued growth in this area, and surpassed our goal of 10% spend with diverse suppliers in 2022. Truist was ranked 5th overall within the JUST 100 list and recognized as one of Fortune Magazine’s Most Admired Companies.Truist maintained strong capital and liquidity in 2022 and made a number of strategic investments to deploy capital and expand on its businesses. During 2022, Truist made the following acquisitions:•BankDirect Capital Finance, the insurance premium finance unit of Texas Capital Bancshares, which resulted in the addition of approximately $3.1 billion of loans;•BenefitMall, one of the nation’s leading benefit wholesale general insurance agencies, to broaden the selection of products and services offered by IH’s wholesale insurance broker;•Kensington Vanguard National Land Services, one of the largest independent full-service national title insurance agencies, to expand IH’s presence in the title insurance market; and•A noncontrolling equity interest in SunTrust Merchant Services, LLC, in exchange for the rights to certain merchant banking relationships, including relationships previously referred by Truist to SunTrust Merchant Services, LLC.Truist increased the quarterly common dividend 8% during the year and declared total common dividends of $2.00 per share during 2022. The dividend payout ratio for 2022 was 45% compared to 41% for the prior year. The total payout ratio for 2022 was 49% compared to 68% for the prior year.40 Truist Financial CorporationFinancial ResultsNet income available to common shareholders totaled $5.9 billion for 2022, a 1.8% decrease from the prior year. On a diluted per common share basis, earnings for 2022 were $4.43, compared to $4.47 for 2021. Truist’s results of operations for 2022 produced a return on average assets of 1.15% and a return on average common shareholders’ equity of 10.4% compared to prior year ratios of 1.23% and 9.7%, respectively. Results include merger-related and restructuring charges of $513 million ($393 million after-tax) for 2022 compared to $822 million ($631 million after-tax) for 2021, and incremental operating expenses related to the Merger of $465 million ($356 million after-tax) for 2022 compared to $771 million ($592 million after-tax) for 2021. Additionally, the 2022 results include a gain on the redemption of noncontrolling equity interest of $74 million ($57 million after-tax) related to the acquisition of certain merchant services relationships, a gain on the early extinguishment of long-term debt of $39 million ($30 million after-tax), partially offset by net losses on the sales of securities of $71 million ($54 million after-tax). The 2021 results include charitable contributions of $200 million ($153 million after-tax), an acceleration of loss recognition related to certain terminated cash flow hedges of $36 million ($28 million after tax), and a one-time professional fee expense of $30 million ($23 million after tax), partially offset by a small gain on extinguishment of debt.Table 8: Earnings HighlightsYear Ended December 31,(Dollars in millions)Change2022202120202022 vs. 20212021 vs. 2020Net income available to common shareholders$5,927 $6,033 $4,184 $(106)$1,849 Diluted earnings per common share4.43 4.47 3.08 (0.04)1.39 Net interest income - taxable equivalent$14,458 $13,114 $13,951 $1,344 $(837)Noninterest income8,719 9,290 8,879 (571)411 Total taxable-equivalent revenue$23,177 $22,404 $22,830 $773 $(426)Less taxable-equivalent adjustment142 108 125 Total revenue$23,035 $22,296 $22,705 Return on average assets1.15 %1.23 %0.90 %(0.08)%0.33 %Return on average common shareholders’ equity10.4 9.7 6.8 0.7 2.9 Net interest margin - taxable equivalent3.01 2.86 3.22 0.15 (0.36)Truist’s revenue for 2022 was $23.0 billion. On a TE basis, revenue was $23.2 billion, which represents an increase of $773 million compared to 2021. Net interest income on a TE basis was $14.5 billion, an increase of $1.3 billion primarily due to higher market interest rates coupled with strong loan growth and well controlled deposit costs. These increases were partially offset by lower purchase accounting accretion and lower PPP revenue. Average earning assets increased $22.3 billion, or 4.9%, compared to the earlier year. The increase in average earning assets reflects a $13.4 billion, or 4.6%, increase in average outstanding loans and a $7.8 billion, or 5.6%, increase in average securities. Average deposits increased $19.7 billion, or 4.9%, and average short-term borrowings increased $8.8 billion, or 142%, partially offset by a decrease in average long-term debt of $3.2 billion, or 8.7%, compared to the earlier year. Noninterest income for 2022 decreased $571 million compared to 2021 primarily due to lower investment banking and mortgage banking income, partially offset by growth in insurance revenues.NIM was 3.01% for 2022, up 15 basis points compared to the prior year primarily due to higher market interest rates and well controlled deposit costs. The growth in NIM was negatively impacted by lower purchase accounting accretion, which benefited NIM by 13 basis points in 2022 compared to 26 basis points in 2021. The TE yield on the total loan portfolio for 2022 was 4.36%, up 41 basis points. The TE yield on the average securities portfolio was 1.88%, up 38 basis points. The average cost of interest-bearing deposits was 0.42%, up 36 basis points. The average cost of total deposits was 0.27%, up 23 basis points. The average cost of long-term debt was 2.31%, up 78 basis points. The increases in rates on assets and liabilities reflects the rising rate environment during 2022.The provision for credit losses was $777 million, compared to a benefit of $813 million for the prior year. The current year reflects strong loan growth and a moderate decline in the ALLL ratio, whereas the prior year included reserve releases due to the improving economic environment during that period. Net charge-offs were $823 million, compared to $697 million for the prior year. The net charge-off ratio for the current year of 0.27% was up three basis points compared to the earlier year primarily driven by normalizing trends across certain consumer portfolios, partially offset by lower charge offs in the commercial and industrial portfolio.Noninterest expense decreased $527 million, or 3.5%, compared to the prior year. Excluding the aforementioned items and the impact of amortization expense for intangibles, noninterest expense increased $380 million, or 3.0%, driven by higher professional fees, operational losses, expenses related to acquired companies and marketing expenses, partially offset by lower occupancy and equipment expenses.The provision for income taxes was $1.4 billion for 2022, compared to $1.6 billion to 2021. The effective tax rate for 2022 was 18.3%, compared to 19.5% for the prior year. The decrease in the effective tax rate was primarily driven by higher favorable permanent tax items and an increase in discrete tax benefits.Truist Financial Corporation 41Truist’s total assets at December 31, 2022 were $555.3 billion, an increase of $14.0 billion, or 2.6%, compared to December 31, 2021. Total loans and leases at December 31, 2022, were $327.4 billion, an increase of $33.1 billion, or 11% compared with December 31, 2021. The increase in loans reflects strong production during the year across most industry verticals and product groups in the commercial and industrial portfolio, as well as growth in the majority of the consumer portfolios. Truist’s total investment securities portfolio declined $25.1 billion, or 16%, as paydowns and maturities were reinvested in the loan portfolio and the fair value of the AFS portfolio declined due to the rising rate environment. In the first quarter of 2022, Truist transferred $59.4 billion of AFS securities to HTM as the Company continues to execute upon its asset-liability management strategies.Total liabilities at December 31, 2022 were $494.7 billion, an increase of $22.7 billion, or 4.8%, from the prior year, reflecting an increase of $18.1 billion in short-term borrowings and an increase of $7.3 billion, or 20%, in long-term debt, partially offset by a decrease of $3.0 billion, or 0.7%, in deposits.Total shareholders’ equity was $60.5 billion at December 31, 2022, a decrease of $8.7 billion from December 31, 2021. This decline includes a decrease of $12.0 billion in AOCI and $3.0 billion in dividends, partially offset by $6.3 billion in net income. Truist’s book value per common share at December 31, 2022 was $40.58, compared to $47.14 at December 31, 2021.Asset quality ratios were relatively stable at December 31, 2022 compared to the prior year, reflecting Truist’s prudent risk culture and portfolio diversification. Nonperforming loans and leases held for investment were 0.36% of loans and leases held for investment at December 31, 2022, down two basis points compared to December 31, 2021. The ALLL ratio was 1.34% compared to 1.53% for prior year. The ratio of the ALLL to net charge-offs was 5.32X for 2022, compared to 6.36X in 2021.As of December 31, 2022, the CET1 ratio was 9.0% and the average LCR was 112%. The 60 basis point decline in the CET1 ratio compared to December 31, 2021 primarily reflects strong loan growth, acquisitions, and the impact from the phase-in of the CECL transition relief.On February 16, 2023, the Company entered into an agreement to sell a 20% stake of the common equity in Truist Insurance Holdings, a subsidiary of Truist and the sixth-largest insurance brokerage in the U.S., for $1.95 billion to an investor group led by Stone Point Capital, LLC. The closing of the investment is expected to occur in the second quarter of 2023, subject to customary closing conditions and regulatory approvals. The transaction allows Truist to maintain strategic flexibility and future upside in Truist Insurance Holdings, which will continue to benefit from Truist’s operations, access to capital, and client relationships. Truist will also preserve and enhance its client service approach to offering leading insurance products to its banking clients. Moreover, Truist Insurance Holdings gains an experienced partner in Stone Point, which brings deep industry expertise and access to capital to help accelerate Truist Insurance Holdings’ growth. Upon closing of the transaction, a five-person Board will be formed to oversee Truist Insurance Holdings, comprising four members appointed by Truist and one member appointed by Stone Point.Key Areas of FocusTruist’s business is dynamic and complex. Consequently, management annually evaluates and, as necessary, adjusts the Company’s business strategy in the context of the current operating environment. During this process, management considers the current financial condition and performance of the Company and its expectations for future economic activity from both a national and local market perspective. Achieving key strategic objectives and long-term financial goals is subject to many uncertainties and challenges. In the opinion of management, the following are the key areas of focus most likely to impact Truist’s near to medium term performance:•Actualizing our purpose to inspire and build better lives and communities and driving executional excellence to realize our potential;•More focus on integrated relationship management to deepen relationships, improve client experiences, and/or deliver the bank as One Team;•Digitizing the enterprise through our “T3 strategy” to create a world-class client experience and streamline, simplify, and automate processes and operations; and•Making Truist a great place to work through our purpose-driven and inclusive culture, competitive compensation and benefits, and compelling career development and growth opportunities.In addition, certain other challenges and unforeseen events could have a near term impact on Truist’s financial condition and results of operations. See the sections titled “Forward-Looking Statements” and “Risk Factors” for additional examples of such challenges.42 Truist Financial CorporationAnalysis of Results of OperationsNet Interest Income and NIM2022 compared to 2021TE net interest income for the year ended December 31, 2022 was up $1.3 billion, or 10%, compared to the prior year primarily due to higher market interest rates coupled with strong loan growth and well controlled deposit costs, partially offset by lower purchase accounting accretion and lower PPP revenue. Average earning assets increased $22.3 billion, or 4.9%, compared to the prior period. The increase in average earning assets reflects a $13.4 billion, or 4.6%, increase in average total loans and leases and a $7.8 billion, or 5.6%, increase in average securities. Average deposits increased $19.7 billion, or 4.9%, and average short-term borrowings increased $8.8 billion, or 142%, compared to the prior year, while average long-term debt decreased $3.2 billion, or 8.7%.Net interest margin was 3.01% for the year ended December 31, 2022, up 15 basis points compared to the prior year. The growth in NIM was negatively impacted by lower purchase accounting accretion, which benefited NIM by 13 basis points in 2022 compared to 26 basis points in 2021. The yield on the total loan portfolio for the year ended December 31, 2022 was 4.36%, up 41 basis points compared to the prior year, reflecting higher market interest rates, partially offset by lower purchase accounting accretion and lower PPP revenue. The yield on the average securities portfolio was 1.88% for the year ended December 31, 2022, up 38 basis points compared to the prior year primarily due to the higher rate environment.The average cost of total deposits was 0.27% for the year ended December 31, 2022, up 23 basis points compared to the prior year. The average cost on short-term borrowings was 2.58% for the year ended December 31, 2022, up 182 basis points compared to the prior year. The average cost on long-term debt was 2.31% for the year ended December 31, 2022, up 78 basis points compared to the prior year. The increase in rates on deposits and other funding sources was largely attributable to the higher rate environment.As of December 31, 2022, the remaining unamortized fair value marks on the loan and lease portfolio and long-term debt were $741 million and $81 million, respectively, with no remaining mark for deposits. As of December 31, 2021, the remaining unamortized fair value marks on the loan and lease portfolio, deposits and long-term debt were $1.3 billion, $7 million, and $139 million, respectively.The remaining unamortized purchase accounting fair value mark on loans and leases consists of $474 million for consumer loans and leases, and $267 million for commercial loans and leases. These amounts will be recognized over the remaining contractual lives of the underlying instruments or as paydowns occur.The major components of net interest income and the related annualized yields as well as the variances between the periods caused by changes in interest rates versus changes in volumes are summarized below.Truist Financial Corporation 43Table 9: Taxable-Equivalent Net Interest Income and Rate / Volume Analysis (1)2022 vs. 20212021 vs. 2020Year Ended December 31,(Dollars in millions)Average Balances (5)Yield/RateIncome/ExpenseIncr.(Decr.)Change due toIncr.(Decr.)Change due to202220212020202220212020202220212020RateVolumeRateVolumeAssets Total securities, at amortized cost: (2) U.S. Treasury$10,591 $7,633 $2,194 0.88 %0.73 %1.81 %$93 $56 $40 $37 $13 $24 $16 $(35)$51 GSE498 1,799 1,846 2.24 2.29 2.33 11 41 43 (30)(1)(29)(2)(1)(1)Agency MBS131,669 128,306 78,564 1.94 1.52 2.07 2,552 1,953 1,625 599 547 52 328 (511)839 States and political subdivisions392 429 501 3.88 3.55 3.92 15 15 19 — 1 (1)(4)(2)(2)Non-agency MBS4,072 1,299 86 2.30 2.20 16.81 94 28 15 66 1 65 13 (23)36 Other44 31 36 3.60 1.90 2.33 2 1 1 1 1 — — — — Total securities147,266 139,497 83,227 1.88 1.50 2.09 2,767 2,094 1,743 673 562 111 351 (572)923 Interest earning trading assets5,767 5,602 4,655 4.15 2.78 3.62 239 156 168 83 78 5 (12)(43)31 Other earning assets (3)20,429 19,498 31,240 1.88 0.24 0.50 384 48 156 336 334 2 (108)(63)(45)Loans and leases, net of unearned income: (4) Commercial and industrial149,030 137,304 147,603 3.91 3.04 3.42 5,823 4,174 5,053 1,649 1,270 379 (879)(540)(339)CRE22,697 25,269 27,410 4.01 2.85 3.32 920 728 914 192 271 (79)(186)(119)(67)Commercial Construction5,326 6,053 6,659 4.46 2.98 3.72 228 173 243 55 79 (24)(70)(48)(22)Residential mortgage51,721 45,500 51,423 3.60 4.14 4.51 1,860 1,884 2,320 (24)(263)239 (436)(181)(255)Residential home equity and direct25,232 25,319 26,951 5.64 5.69 6.03 1,422 1,441 1,625 (19)(14)(5)(184)(89)(95)Indirect auto27,197 26,621 25,055 5.50 6.12 6.61 1,497 1,629 1,656 (132)(167)35 (27)(127)100 Indirect other11,876 10,935 11,264 6.39 6.70 7.11 758 731 801 27 (35)62 (70)(46)(24)Student6,114 7,251 7,596 4.97 3.99 4.62 304 289 351 15 65 (50)(62)(47)(15)Credit card4,753 4,650 5,027 9.57 8.92 9.34 455 415 470 40 31 9 (55)(21)(34)Total loans and leases HFI303,946 288,902 308,988 4.36 3.97 4.35 13,267 11,464 13,433 1,803 1,237 566 (1,969)(1,218)(751)LHFS2,889 4,546 5,513 4.23 2.63 3.13 122 120 173 2 56 (54)(53)(25)(28)Total loans and leases306,835 293,448 314,501 4.36 3.95 4.33 13,389 11,584 13,606 1,805 1,293 512 (2,022)(1,243)(779)Total earning assets480,297 458,045 433,623 3.49 3.03 3.61 16,779 13,882 15,673 2,897 2,267 630 (1,791)(1,921)130 Nonearning assets63,533 64,340 65,462 Total assets$543,830 $522,385 $499,085 Liabilities and Shareholders’ Equity Interest-bearing deposits: Interest-checking$111,539 $107,311 $94,879 0.47 0.05 0.23 519 59 216 460 458 2 (157)(183)26 Money market and savings145,645 134,303 123,826 0.37 0.03 0.21 536 35 264 501 497 4 (229)(248)19 Time deposits15,514 18,025 30,008 0.58 0.30 1.02 90 54 305 36 44 (8)(251)(160)(91)Total interest-bearing deposits (6)272,698 259,639 248,713 0.42 0.06 0.32 1,145 148 785 997 999 (2)(637)(591)(46)Short-term borrowings14,957 6,170 10,129 2.58 0.76 1.35 385 47 137 338 212 126 (90)(48)(42)Long-term debt34,172 37,410 45,793 2.31 1.53 1.75 791 573 800 218 271 (53)(227)(92)(135)Total interest-bearing liabilities321,827 303,219 304,635 0.72 0.25 0.57 2,321 768 1,722 1,553 1,482 71 (954)(731)(223)Noninterest-bearing deposits (6)145,392 138,733 114,580 Other liabilities12,794 11,300 11,846 Shareholders’ equity63,817 69,133 68,024 Total liabilities and shareholders’ equity$543,830 $522,385 $499,085 Average interest-rate spread 2.77 %2.78 %3.04 % NIM/net interest income - taxable equivalent 3.01 %2.86 %3.22 %$14,458 $13,114 $13,951 $1,344 $785 $559 $(837)$(1,190)$353 Taxable-equivalent adjustment $142 $108 $125 (1)Yields are stated on a TE basis utilizing federal tax rate. The change in interest not solely due to changes in rate or volume has been allocated based on the pro-rata absolute dollar amount of each. Interest income includes certain fees, deferred costs, and dividends.(2)Total securities include AFS and HTM securities.(3)Includes cash equivalents, interest-bearing deposits with banks, FHLB stock and other earning assets.(4)Fees, which are not material for any of the periods shown, are included for rate calculation purposes. NPLs are included in the average balances.(5)Represents daily average balances. Excludes basis adjustments for fair value hedges.(6)Total deposit costs were 0.27%, 0.04%, and 0.22% for the years ended December 31, 2022, 2021, and 2020, respectively.44 Truist Financial CorporationProvision for Credit Losses2022 compared to 2021The provision for credit losses was $777 million for the year ended December 31, 2022, compared to a benefit of $813 million for the prior year. The current year reflects strong loan growth and a moderate decline in the ALLL ratio, whereas the prior year included reserve releases due to the improving economic environment during that period. Net charge-offs for the year ended December 31, 2022 totaled $823 million compared to $697 million in the prior year. The net charge-off ratio for the current year of 0.27% was up three basis points compared to the prior year.Refer to “Note 5. Loans and ACL” for additional discussion of the ACL.Noninterest IncomeNoninterest income is a significant contributor to Truist’s financial results. Management focuses on diversifying its sources of revenue to reduce Truist’s reliance on traditional spread-based interest income, as certain fee-based activities are a relatively stable revenue source during periods of changing interest rates. During 2022, the Company reclassified certain line items within noninterest income. See “Note 1. Basis of Presentation” for additional details. The following table provides a breakdown of Truist’s noninterest income:Table 10: Noninterest IncomeYear Ended December 31,% Change(Dollars in millions)2022202120202022 vs. 20212021 vs. 2020Insurance income$3,043 $2,627 $2,193 15.8 %19.8 %Wealth management income1,338 1,392 1,277 (3.9)9.0 Investment banking and trading income995 1,441 1,010 (31.0)42.7 Service charges on deposits1,026 1,060 1,020 (3.2)3.9 Card and payment related fees944 874 761 8.0 14.8 Mortgage banking income460 734 1,185 (37.3)(38.1)Lending related fees375 349 315 7.4 10.8 Operating lease income258 262 309 (1.5)(15.2)Securities gains (losses)(71)— 402 NM(100.0)Other income351 551 407 (36.3)35.4 Total noninterest income$8,719 $9,290 $8,879 (6.1)4.6 2022 compared to 2021Noninterest income for the year ended December 31, 2022 decreased $571 million, or 6.1%, compared to the prior year. The current year includes net securities losses of $71 million and the gain on the redemption of noncontrolling equity interest (other income) of $74 million. The earlier year included a gain of $37 million from the divestiture of certain businesses (other income). Excluding the aforementioned items, noninterest income was down $537 million, or 5.8%, compared to the prior year. Investment banking and trading income decreased $446 million, or 31%, due to lower capital markets activity and lower merger and acquisition fees. Mortgage banking income decreased $274 million, or 37%, as lower production income (due to lower margins and refinance volumes resulting from the higher rate environment) was partially offset by higher residential servicing income (due to lower prepayments and servicing portfolio purchases). Excluding the aforementioned gains, other income decreased $237 million, or 46%, primarily due to valuation changes from assets held for certain post-retirement benefits, which is primarily offset by lower personnel expense, lower investment income and valuation marks from the Company’s SBIC and other strategic investments and lower derivative trading income. Wealth management income decreased $54 million, or 3.9%, primarily due to lower market valuations. Insurance income increased $416 million, or 16%, due to acquisitions and continued organic growth. Card and payment related fees increased $70 million, or 8.0%, due to the first quarter 2022 acquisition of certain merchant services relationships and increased activity.Truist Financial Corporation 45Noninterest ExpenseDuring 2022, the Company reclassified certain line items within noninterest expense. See “Note 1. Basis of Presentation” for additional details. The following table provides a breakdown of Truist’s noninterest expense:Table 11: Noninterest ExpenseYear Ended December 31,% Change(Dollars in millions)2022202120202022 vs. 20212021 vs. 2020Personnel expense$8,467 $8,632 $8,146 (1.9)%6.0 %Professional fees and outside processing1,411 1,442 1,252 (2.1)15.2 Software expense932 945 862 (1.4)9.6 Net occupancy expense744 764 904 (2.6)(15.5)Amortization of intangibles583 574 685 1.6 (16.2)Equipment expense478 513 484 (6.8)6.0 Marketing and customer development352 294 273 19.7 7.7 Operating lease depreciation184 190 258 (3.2)(26.4)Regulatory costs183 137 125 33.6 9.6 Merger-related and restructuring charges513 822 860 (37.6)(4.4)Other expense742 803 1,048 (7.6)(23.4)Total noninterest expense$14,589 $15,116 $14,897 (3.5)1.5 2022 compared to 2021Noninterest expense for the year ended December 31, 2022 was down $527 million, or 3.5%, compared to the earlier year. Merger-related and restructuring charges decreased $309 million due to diminishing integration-related activities and lower costs in connection with the voluntary separation and retirement program, partially offset by higher costs for client day one conversions. Incremental operating expenses related to the Merger decreased $306 million, primarily reflecting lower personnel and professional fees and outside processing expenses. The current year includes a $39 million gain on the redemption of FHLB advances (other expense). The prior year includes $200 million for charitable contributions to the Truist Foundation and the Truist Charitable Fund (other expense), $36 million of expense associated with an acceleration of loss recognition related to certain terminated cash flow hedges (other expense), a $30 million professional fee to develop an ongoing program to identify, prioritize, and roadmap teammate generated revenue growth and expense savings opportunities beyond the Merger, and a small gain on the extinguishment of debt (other expense).Excluding the aforementioned items and the amortization of intangibles, adjusted noninterest expense increased $380 million, or 3.0%, compared to the earlier year. Other expense was down $61 million, but was up $217 million, or 39%, on an adjusted basis primarily due to increased operational losses and teammate travel expenses. Professional fees and outside processing expenses were down $31 million, but up $173 million, or 20%, on an adjusted basis due to increased project spend for enterprise technology investments and increased call center staffing. Marketing and customer development expense increased $58 million ($66 million, or 23% on an adjusted basis) due to increased spend to continue to build and strengthen Truist’s brand. Net occupancy expense decreased $20 million ($47 million, or 6.2% on an adjusted basis) primarily due to consolidations of branches and other facilities. Equipment expense decreased $35 million ($41 million, or 8.2% on an adjusted basis) primarily due to laptop purchases in the prior year. Personnel expense decreased $165 million, or 1.9% ($18 million, or 0.2% on an adjusted basis) due to lower other post-retirement benefit expense, which is almost entirely offset by lower other income, lower incentives expenses, and lower defined benefit costs, partially offset by higher salaries due to additional personnel costs for acquisitions, annual merit increases, and investments in revenue producing businesses and enterprise technology, and higher medical claims.Merger-Related and Restructuring ChargesTruist has incurred certain merger-related and restructuring charges, which include:•severance and personnel-related costs or credits;•occupancy and equipment charges or credits, which relate to costs or gains associated with lease terminations, obsolete equipment write-offs and the sale of duplicate facilities and equipment;•professional services, which relate to legal and investment banking advisory fees and other consulting services pertaining to restructuring initiatives or transactions;•systems conversion and related charges, which represent costs to integrate the entity’s information technology systems;•other merger-related and restructuring charges or credits, which include expenses necessary to convert and combine the acquired branches and operations of merged companies, direct media advertising related to the mergers and acquisitions, asset and supply inventory write-offs, and other similar charges; and•write-offs related to exiting certain businesses.46 Truist Financial CorporationMerger-related and restructuring accruals are established when the costs are incurred or once all requirements for a plan to dispose of or outsource certain business functions have been approved by management. Merger and restructuring accruals are re-evaluated periodically and adjusted as necessary. The remaining accruals at December 31, 2022 are generally expected to be utilized within one year, unless they relate to specific contracts that expire later.The following table presents a summary of merger-related and restructuring charges and the related accruals. The 2022 and 2021 merger-related and restructuring costs primarily reflect charges as a result of the Merger, including costs for severance and other benefits, costs related to exiting facilities, and other restructuring initiatives.Table 12: Merger-Related and Restructuring Accrual Activity(Dollars in millions)Accrual at Jan 1, 2021ExpenseUtilizedAccrual at Dec 31, 2021ExpenseUtilizedAccrual at Dec 31, 2022Severance and personnel-related$36 $336 $(295)$77 $92 $(160)$9 Occupancy and equipment— 139 (139)— 175 (175)— Professional services16 256 (235)37 142 (167)12 Systems conversion and related costs— 59 (59)— 60 (60)— Other11 32 (31)12 44 (51)5 Total (1)$63 $822 $(759)$126 $513 $(613)$26 (1)Related to the Merger, the Company recognized $368 million of expense for the year ended December 31, 2022. At December 31, 2022, the Company had an accrual of $19 million related to the Merger. The remaining expense and accrual relate to other restructuring activities.Segment ResultsTruist operates and measures business activity across three segments: Consumer Banking and Wealth, Corporate and Commercial Banking, and Insurance Holdings, with functional activities included in Other, Treasury, and Corporate. The Company’s business segment structure is based on the manner in which financial information is evaluated by management as well as the products and services provided or the type of client served.The segment results are presented based on internal management methodologies that were designed to support these strategic objectives. Unlike financial accounting, there is no comprehensive authoritative body of guidance for management accounting equivalent to GAAP. The application and development of management reporting methodologies is an active process and undergoes periodic enhancements. The implementation of these enhancements to the internal management reporting methodology may materially affect the results disclosed for each segment, with no impact on consolidated results. When significant changes to management reporting methodologies take place, the impact of these changes is quantified and prior period information is revised.Prior period results have been revised to reflect management reporting methodology changes resulting from the integration of heritage BB&T and heritage SunTrust measurement processes and systems. Changes primarily relate to funds transfer pricing and internal equity allocations. The changes impacted 2021 and 2020 segment net interest income reported in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report on Form 10-K for the year ended December 31, 2021. CB&W, C&CB, and IH increased $868 million, $566 million, and $15 million, respectively, for 2021 and increased $117 million, $375 million, and $15 million, respectively, for 2020. These increases were offset with decreases in OT&C of $1.4 billion for 2021 and $507 million for 2020.See “Note 21. Operating Segments” for additional disclosures related to Truist’s operating segments, including the internal accounting and reporting practices used to manage these segments.Table 13: Net Income by Reportable Segment Year Ended December 31,% Change(Dollars in millions)2022202120202022 vs. 20212021 vs. 2020Consumer Banking and Wealth$3,785 $3,770 $3,019 0.4 %24.9 %Corporate and Commercial Banking4,395 4,830 2,690 (9.0)79.6 Insurance Holdings546 530 418 3.0 26.8 Other, Treasury & Corporate(2,459)(2,693)(1,635)(8.7)64.7 Truist Financial Corporation$6,267 $6,437 $4,492 (2.6)43.3 Truist Financial Corporation 472022 compared to 2021Consumer Banking and WealthCB&W net income was $3.8 billion for the year ended December 31, 2022, an increase of $15 million, or 0.4%, compared to the prior year. Segment net interest income increased $975 million primarily due to favorable funding credit on deposits attributable to the higher rate environment and higher average loan and deposit balances, partially offset by decreased loan spreads and lower purchase accounting accretion. The allocated provision for credit losses increased $717 million primarily due to a reserve release in the prior year as well as loan growth and a moderately slower economic outlook in the current year. Noninterest income decreased $274 million primarily due to a decrease in residential mortgage income. Noninterest expense decreased $94 million primarily due to lower net occupancy and incentive expenses as well as lower merger-related and restructuring charges, partially offset by increased operational losses.CB&W average loans and leases held for investment increased $4.9 billion, or 3.7%, for the year ended December 31, 2022 compared to the prior year driven primarily by an increase in residential mortgage loans as well as increases in the Service Finance, prime auto, and recreational lending portfolios. These increases were partially offset by lower mortgage warehouse lending as well as runoff in other partnership lending programs and student loans.CB&W average total deposits increased $8.9 billion, or 3.7%, for the year ended December 31, 2022 compared to the prior year primarily due to increases in average noninterest bearing deposits, money market and savings, and interest bearing checking, partially offset by a decline in time deposits.CB&W had 2,123 banking offices at December 31, 2022, a decrease of 394 offices compared to December 31, 2021. The decrease in offices was driven primarily by the consolidation of branches as a result of the Merger.Truist Wealth had assets under management of $180.4 billion as of December 31, 2022, a decrease of $29.2 billion, or 14%, compared to the prior year primarily due to market declines, partially offset by positive organic growth in assets under management.Corporate and Commercial BankingC&CB net income was $4.4 billion for the year ended December 31, 2022, a decrease of $435 million, or 9.0%, compared to the prior year. Segment net interest income increased $740 million primarily due to higher funding credit on deposits and increases to noninterest bearing deposit balances, partially offset by lower purchase accounting accretion and lower fee income associated with PPP loan forgiveness. The allocated provision for credit losses increased $786 million which reflects lower allowance releases in the current year compared to the prior year, partially offset by lower net charge-offs in the current year. Noninterest income decreased $513 million primarily due lower investment banking revenue. Noninterest expense decreased $31 million primarily due to lower incentive expense tied to lower revenues and lower professional fees as well as lower merger-related and restructuring charges, partially offset by investments in revenue producers.C&CB average loans and leases held for investment increased $11.0 billion, or 7.2%, for the year ended December 31, 2022 compared to the prior year. Excluding a $5.7 billion decrease in average PPP loans, average loans held for investment were up $16.6 billion, or 11%, primarily driven by an increase in the commercial and industrial portfolio loans, partially offset by a decrease in average commercial real estate and commercial construction loans.C&CB average total deposits decreased $1.9 billion, or 1.3%, for the year ended December 31, 2022 compared to the prior year primarily due to a decrease in average interest bearing deposits, partially offset by an increase in noninterest bearing deposits.Insurance HoldingsIH net income was $546 million for the year ended December 31, 2022, an increase of $16 million, or 3.0%, compared to the prior year. Noninterest income increased $441 million, or 17%, primarily due to acquisitions and organic growth. Noninterest expense increased $425 million, or 20%, primarily due to investments in new hires and teammates, performance-driven incentive expense, higher merger-related charges related to acquisitions, and an increase in travel and entertainment expense.48 Truist Financial CorporationOther, Treasury, and CorporateOT&C generated a net loss of $2.5 billion for the year ended December 31, 2022, compared to a net loss of $2.7 billion in the prior year. Segment net interest income decreased $435 million due to higher funding credit on deposits to other segments, partially offset by higher funds transfer charges to other segments for loans and higher earnings in the securities portfolio from the higher rate environment. The allocated provision for credit losses increased $80 million, which reflects a build in the reserve for unfunded commitments in the current year compared to a release in the prior year. Noninterest income decreased $225 million primarily due to valuation changes from assets held for certain post-retirement benefits, which is primarily offset by lower personnel expense, and losses on the sale of securities in the current year. Noninterest expense decreased $827 million primarily due to lower personnel expense, charitable contributions to the Truist Foundation and the Truist Charitable Fund in the prior year, and lower merger-related and restructuring charges and incremental operating expenses related to the Merger.Analysis of Financial Condition Investment ActivitiesTruist’s Board-approved investment policy is carried out by the MRLCC, which meets regularly to review the economic environment and establish investment strategies. The MRLCC also has much broader responsibilities, which are discussed in the “Market Risk” section in MD&A.Investment strategies are reviewed by the MRLCC based on the interest rate environment, balance sheet mix, actual and anticipated loan demand, funding opportunities and the overall interest rate sensitivity of the Company. In general, the goals of the investment portfolio are: (i) to provide sufficient liquid assets to meet unanticipated deposit and loan fluctuations and overall funds management objectives; (ii) to provide eligible securities to secure public funds, trust deposits and other borrowings; and (iii) to earn an optimal return on funds invested commensurate with meeting the requirements of (i) and (ii) and consistent with the Company’s risk appetite.Truist Bank invests in securities allowable under bank regulations. These securities may include obligations of the U.S. Treasury, U.S. government agencies, GSEs (including MBS), bank eligible obligations of any state or political subdivision, non-agency MBS, structured notes, bank eligible corporate obligations (including corporate debentures), commercial paper, negotiable CDs, bankers’ acceptances, mutual funds, and limited types of equity securities.Table 14: Composition of Securities Portfolio(Dollars in millions)Dec 31, 2022Dec 31, 2021AFS securities (at fair value):U.S. Treasury$10,295 $9,795 GSE303 1,698 Agency MBS - residential55,225 134,042 Agency MBS - commercial2,424 2,882 States and political subdivisions416 420 Non-agency MBS3,117 4,258 Other21 28 Total AFS securities71,801 153,123 HTM securities (at amortized cost): Agency MBS - residential57,713 1,494 Total securities$129,514 $154,617 The securities portfolio totaled $129.5 billion at December 31, 2022, compared to $154.6 billion at December 31, 2021. The decrease includes paydowns and maturities of $20.8 billion, as well as market declines of $14.0 billion, partially offset by purchases of $10.1 billion. In the first quarter of 2022, Truist transferred $59.4 billion of AFS securities to HTM as the Company continues to execute upon its asset-liability management strategies. As of December 31, 2022, 41% of the investment securities portfolio was classified as held-to-maturity based on amortized cost.As of December 31, 2022, approximately 5.6% of the securities portfolio was variable rate, excluding the impact of swaps, compared to 4.6% as of December 31, 2021. The effective duration of the securities portfolio was 6.7 years at December 31, 2022, compared to 5.8 years at December 31, 2021, excluding the impact of unsettled security purchases at period end. The increase in duration was driven by higher rates, resulting in slower prepayments and longer average lives for the MBS portfolio.U.S. Treasury, GSE, and Agency MBS represents 97% of the total securities portfolio as of December 31, 2022 and December 31, 2021. While the overwhelming majority of the portfolio remains in agency MBS securities, the Company also holds AAA rated non-agency MBS as the risk adjusted returns for these securities are more attractive than agency MBS.Truist Financial Corporation 49The following table presents the securities portfolio by major category of security holdings with ranges of maturities and average yields:Table 15: Securities Yields by Major Category and MaturityDecember 31, 2022(Dollars in millions)AFSHTMFair ValueEffective Yield (1)Amortized CostEffective Yield (1)U.S. Treasury: Within one year$1,619 1.30 %$— — %One to five years8,196 0.98 — — Five to ten years455 1.35 — — After ten years25 3.02 — — Total10,295 1.05 — — GSE: One to five years7 2.91 — — Five to ten years10 3.06 — — After ten years286 2.93 — — Total303 2.94 — — Agency MBS - residential: (2) One to five years15 2.49 — — Five to ten years534 2.49 — — After ten years54,676 2.54 57,713 1.79 Total55,225 2.54 57,713 1.79 Agency MBS - commercial: (2)Within one year1 2.80 — — One to five years7 2.87 — — Five to ten years66 3.51 — — After ten years2,350 1.78 — — Total2,424 1.83 — — States and political subdivisions: Within one year3 6.37 — — One to five years72 3.44 — — Five to ten years165 4.75 — — After ten years176 3.78 — — Total416 4.12 — — Non-agency MBS: (2) After ten years3,117 2.38 — — Total3,117 2.38 — — Other: Within one year6 3.79 — — Five to ten years15 6.21 — — Total21 5.50 — — Total securities$71,801 2.31 $57,713 1.79 (1)Yields represent interest computed under the effective interest method on a TE basis using the federal income tax rate and the amortized cost of the securities.(2)For purposes of the maturity table, MBS, which are not due at a single maturity date, have been included in maturity groupings based on the contractual maturity. The expected life of MBS will differ from contractual maturities because borrowers may have the right to call or prepay the underlying mortgage loans.50 Truist Financial CorporationLending ActivitiesTruist strives to meet the credit needs of its clients while pursuing a balanced strategy of loan profitability, loan growth, and loan quality. Management believes that this purpose can best be accomplished by building strong client relationships over time and developing in-depth local market knowledge. The Company employs strict underwriting criteria governing the degree of risk assumed and the diversity of the loan portfolio in terms of type, industry, and geographical concentration.Truist lends to a diverse client base that is geographically dispersed to mitigate concentration risk arising from local and regional economic downturns. The following discussion provides additional information on the Company’s loan and lease portfolios. Refer to the “Risk Management” section for a discussion of the credit risk management policies used to manage the portfolios.Commercial Loan and Lease PortfolioCommercial loans and leases represent the largest category of the Company’s loan and lease portfolio. Commercial Community Banking generally targets small-to-middle market businesses with annual sales between $2 million and $500 million, while CIB provides lending solutions to large corporate clients. The commercial loan and lease portfolio consists of lending to public and private business clients and is composed of commercial and industrial, owner occupied, equipment leasing and financing, commercial real estate, government and institutional financing, and premium financingIn accordance with the Company’s lending policy, each commercial loan undergoes a detailed underwriting process. Commercial loans are typically priced with an interest rate tied to market indices, such as the prime rate or SOFR and are individually monitored and reviewed for deterioration in the ability of the client to repay the loan. The majority of Truist’s commercial loans are secured by real estate, business equipment, inventories, and other types of collateral.Residential Mortgage Loan PortfolioTruist primarily originates conforming mortgage loans, loans under FHA, U.S. Department of Veterans Affairs, or U.S. Department of Agriculture programs, and higher quality jumbo and construction-to-permanent loans for 1-4 family residential properties. Conforming loans are loans that are underwritten in accordance with the underwriting standards set forth by FNMA and FHLMC. They are generally collateralized by one-to-four-family residential real estate, typically have loan-to-collateral value ratios of 80% or less at origination, or have mortgage insurance as required by investors and are made to borrowers in good credit standing.Risks associated with mortgage lending include interest rate risk, which is mitigated through the sale of a substantial portion of conforming fixed-rate loans in the secondary mortgage market and an effective MSR hedging process. Credit risk is managed through rigorous underwriting procedures and mortgage insurance. The right to service the loans and receive servicing income is generally retained when conforming loans are sold. Management believes that the retention of mortgage servicing diversifies income while enabling Truist to build long-term client relationships and offer high quality client service. Truist also purchases residential mortgage loans from correspondent originators. The loans purchased from third-party originators are subject to substantially the same underwriting and risk-management criteria as loans originated internally.Residential Home Equity and Direct Loan PortfolioThe residential home equity and direct loan portfolio is composed of a wide variety of secured and unsecured loans offered through Truist’s branch network, as well as loans originated by LightStream, Truist’s national online consumer lending division. Loans originated through the Truist branch network include revolving home equity lines of credit secured by first or second liens on residential real estate and certain other secured and unsecured lending marketed to qualifying clients and other creditworthy candidates in Truist’s market areas. LightStream provides fixed-rate, unsecured lending to consumers with strong credit through its proprietary online loan origination system.Indirect Auto Loan PortfolioThe indirect auto portfolio primarily includes secured indirect installment loans to consumers for the purchase of new and used automobiles. The indirect auto portfolio also includes nonprime and near prime automobile finance. Such loans are originated through approved franchised and independent dealers throughout the Truist market area and nationally through Regional Acceptance Corporation. These loans are relatively homogeneous, and no single loan is individually significant in terms of its size and potential risk of loss. Indirect auto loans are subject to rigorous lending policies and procedures and are underwritten with note amounts and credit limits that are consistent with the Company’s risk philosophy. In addition to its normal underwriting due diligence, Truist uses application systems and scoring systems to help underwrite and manage the credit risk in its indirect auto portfolio.Truist Financial Corporation 51Indirect Other Loan PortfolioThe indirect other portfolio includes secured indirect installment loans to consumers for the purchase of new and used boats and recreational vehicles. The indirect other portfolio also includes small ticket consumer lending related to the purchase of power sports and outdoor power equipment, and trailers. These loans are relatively homogeneous, and no single loan is individually significant in terms of its size and potential risk of loss. These loans are subject to similar rigorous lending policies and procedures as the indirect auto loan portfolio. The indirect other loan portfolio also includes other indirect and point-of-sale lending to consumers to finance home improvements, furniture purchases, certain elective health-care services, and other consumer products segments. These loans are originated in accordance with strict underwriting criteria as determined by Truist.Student Loan PortfolioThe student loan portfolio is primarily composed of government guaranteed student loans and additionally includes certain private student loans originated by third parties. The government guarantee mitigates substantially all of the risk related to principal and interest repayment for this component of the portfolio. Private student loans were purchased from third-party originators with credit enhancements that partially mitigate the Company’s credit exposure.Credit Card Loan PortfolioThe credit card portfolio consists of the outstanding balances on credit cards. Truist markets credit cards to its existing client base and does not solicit cardholders through nationwide programs or other forms of mass marketing. Such balances are generally unsecured and actively managed.Refer to “Note 5. Loans and ACL” for additional information.The following table summarizes the loan portfolio:Table 16: Loans and Leases as of Period End(Dollars in millions)Dec 31, 2022Dec 31, 2021Commercial:Commercial and industrial$164,307 $138,762 CRE22,676 23,951 Commercial construction5,849 4,971 Consumer:Residential mortgage56,645 47,852 Residential home equity and direct25,432 25,066 Indirect auto27,951 26,441 Indirect other12,977 10,883 Student5,287 6,780 Credit card4,867 4,807 Total loans and leases HFI325,991 289,513 LHFS1,444 4,812 Total loans and leases$327,435 $294,325 Loans and leases HFI were $326.0 billion at December 31, 2022, up $36.5 billion compared to 2021.Commercial loans increased $25.1 billion during 2022 primarily due to broad-based growth within the commercial and industrial portfolio and the BankDirect acquisition, which added $3.1 billion of loans on November 1, 2022. These increases were partially offset by a $1.9 billion decline in PPP loans.Consumer loans, including credit cards, increased $11.3 billion during 2022 primarily due to an $8.8 billion increase in residential mortgages due to correspondent channel production and lower prepayments, a $2.1 billion increase in indirect other primarily due to growth from Service Finance, recreational lending, and Sheffield portfolios, partially offset by runoff in other partnership lending programs, and a $1.5 billion increase in indirect auto primarily in the prime auto segment. These increases were partially offset by $1.5 billion runoff in student loans.LHFS decreased $3.4 billion during 2022 primarily due to certain residential mortgage correspondent channel production being retained and lower overall mortgage volumes due to rising rate environment, as well as a decline in commercial loans.52 Truist Financial CorporationThe following table presents a summary of the loans and leases by scheduled repayment period and interest rate terms. Determinations of maturities are based on scheduled repayments, except when rollovers or extensions are included for purposes of measuring the ACL. Truist’s credit policy typically does not permit automatic renewal of loans. At the scheduled maturity date (including balloon payment date), the client generally must request a new loan to replace the matured loan and execute either a new note or note modification with rate, terms and conditions negotiated at that time.Table 17: Loan MaturitiesDecember 31, 2022(Dollars in millions)1 Year or Less1 to 5 Years5 to 15 YearsAfter 15 YearsTotalFixed rate: Commercial:Commercial and industrial$11,761 $15,801 $12,459 $2,278 $42,299 CRE556 2,185 1,209 3 3,953 Commercial construction16 91 45 2 154 Total commercial12,333 18,077 13,713 2,283 46,406 Consumer:Residential mortgage1,627 6,616 17,051 25,692 50,986 Residential home equity and direct3,238 7,767 3,585 495 15,085 Indirect auto6,136 19,748 2,067 — 27,951 Indirect other2,423 6,034 3,774 717 12,948 Student23 99 76 1 199 Total consumer13,447 40,264 26,553 26,905 107,169 Credit card79 — — — 79 Total fixed rate25,859 58,341 40,266 29,188 153,654 Variable rate: Commercial:Commercial and industrial24,184 84,302 12,098 1,424 122,008 CRE3,419 12,765 2,535 4 18,723 Commercial construction1,340 4,161 175 19 5,695 Total commercial28,943 101,228 14,808 1,447 146,426 Consumer:Residential mortgage177 750 2,087 2,645 5,659 Residential home equity and direct814 4,924 4,578 31 10,347 Indirect other1 5 22 1 29 Student318 1,539 2,555 676 5,088 Total consumer1,310 7,218 9,242 3,353 21,123 Credit card4,788 — — — 4,788 Total variable rate35,041 108,446 24,050 4,800 172,337 Total loans and leases HFI$60,900 $166,787 $64,316 $33,988 $325,991 Certain residential mortgage loans have an initial period where the borrower is only required to pay the periodic interest. After the interest-only period, the loan will require the payment of both interest and principal over the remaining term. The outstanding balances of variable rate residential mortgage loans in the interest-only phase were approximately $342 million and $288 million at December 31, 2022 and December 31, 2021, respectively.The following table presents the composition of average loans and leases:Table 18: Average Loans and LeasesFor the Three Months Ended(Dollars in millions)Dec 31, 2022Sep 30, 2022Jun 30, 2022Mar 31, 2022Dec 31, 2021Commercial:Commercial and industrial$159,308 $152,123 $145,558 $138,872 $134,804 CRE22,497 22,245 22,508 23,555 24,396 Commercial construction5,711 5,284 5,256 5,046 5,341 Consumer:Residential mortgage56,292 53,271 49,237 47,976 47,185 Residential home equity and direct25,518 25,394 25,124 24,883 25,146 Indirect auto28,117 28,057 26,496 26,088 26,841 Indirect other12,848 12,300 11,471 10,860 10,978 Student5,533 5,958 6,331 6,648 6,884 Credit card4,842 4,755 4,728 4,682 4,769 Total average loans and leases HFI$320,666 $309,387 $296,709 $288,610 $286,344 Truist Financial Corporation 53Average loans and leases held for investment for the fourth quarter of 2022 were $320.7 billion, up $11.3 billion, or 3.6%, compared to the third quarter of 2022. The company added $3.1 billion of loans in conjunction with the acquisition of BankDirect on November 1, 2022, which contributed $2.1 billion of average loan growth for the fourth quarter of 2022. Excluding the acquisition, average loans and leases held for investment increased $9.2 billion, or 3.0% compared to the third quarter of 2022.Average commercial loans increased $7.9 billion, or 4.4%, due to broad-based growth within the commercial and industrial portfolio and the BankDirect acquisition.Average consumer loans increased $3.3 billion, or 2.7%, due to a $3.0 billion increase in residential mortgages due to correspondent channel production and lower prepayments. In addition, indirect other increased $548 million primarily due to growth from the Service Finance, recreational lending, and Sheffield portfolios, partially offset by runoff in other partnership lending programs. These increases were partially offset by $425 million runoff in student loans.54 Truist Financial CorporationAsset QualityThe following tables summarize asset quality information:Table 19: Asset Quality(Dollars in millions)Dec 31, 2022Dec 31, 2021NPAs:NPLs:Commercial and industrial$398 $394 CRE82 29 Commercial construction— 7 Residential mortgage240 296 Residential home equity and direct173 141 Indirect auto289 218 Indirect other6 5 Total NPLs HFI1,188 1,090 Loans held for sale— 22 Total nonaccrual loans and leases1,188 1,112 Foreclosed real estate4 8 Other foreclosed property58 43 Total nonperforming assets$1,250 $1,163 TDRs:Performing TDRs:Commercial and industrial$136 $147 CRE5 5 Commercial construction1 — Residential mortgage - government guaranteed917 480 Residential mortgage - nonguaranteed335 212 Residential home equity and direct76 98 Indirect auto462 389 Indirect other6 7 Student - nonguaranteed30 25 Credit card18 27 Total performing TDRs1,986 1,390 Nonperforming TDRs214 152 Total TDRs$2,200 $1,542 Loans 90 days or more past due and still accruing:Commercial and industrial$49 $13 CRE1 — Commercial construction— — Residential mortgage - government guaranteed759 978 Residential mortgage - nonguaranteed27 31 Residential home equity and direct15 9 Indirect auto1 1 Indirect other10 3 Student - government guaranteed702 864 Student - nonguaranteed4 4 Credit card37 27 Total loans 90 days or more past due and still accruing$1,605 $1,930 Loans 30-89 days past due and still accruing:Commercial and industrial$256 $130 CRE25 20 Commercial construction5 2 Residential mortgage - government guaranteed268 256 Residential mortgage - nonguaranteed346 258 Residential home equity and direct127 107 Indirect auto646 607 Indirect other128 64 Student - government guaranteed396 549 Student - nonguaranteed6 6 Credit card64 45 Total loans 30-89 days past due and still accruing$2,267 $2,044 Truist Financial Corporation 55Nonperforming assets totaled $1.3 billion at December 31, 2022, up $87 million compared to December 31, 2021 due to increases in the indirect auto and CRE portfolios, partially offset by a decrease in the residential mortgage portfolio. Nonperforming loans and leases represented 0.36% of total loans and leases, down two basis points compared to December 31, 2021.Performing TDRs were up $596 million compared to the prior year primarily due to increases in residential mortgages and indirect auto.Loans 90 days or more past due and still accruing totaled $1.6 billion at December 31, 2022, down $325 million compared to the prior yearprimarily due to a decline in government guaranteed residential mortgages and government guaranteed student loans. Excluding government guaranteed loans, the ratio of loans 90 days or more past due and still accruing as a percentage of loans and leases was 0.04% at December 31, 2022, up one basis point from December 31, 2021.Loans 30-89 days past due and still accruing totaled $2.3 billion at December 31, 2022, up $223 million compared to the prior year due to increases in the commercial and industrial, nonguaranteed residential mortgage, and indirect other portfolios, partially offset by a decline in the student portfolio. The ratio of loans 30-89 days or more past due and still accruing as a percentage of loans and leases was 0.70% at December 31, 2022, down one basis point compared to the prior year.Problem loans include NPLs and loans that are 90 days or more past due and still accruing as disclosed in Table 19. In addition, for the commercial portfolio segment, loans that are rated special mention or substandard performing are closely monitored by management as potential problem loans. Refer to “Note 5. Loans and ACL” for the amortized cost basis of loans by origination year and credit quality indicator as well as additional disclosures related to NPLs.Table 20: Asset Quality RatiosDec 31, 2022Dec 31, 2021Loans 30-89 days past due and still accruing as a percentage of loans and leases HFI0.70 %0.71 %Loans 90 days or more past due and still accruing as a percentage of loans and leases HFI0.49 0.67 NPLs as a percentage of loans and leases HFI0.36 0.38 NPLs as a percentage of total loans and leases (1)0.36 0.38 NPAs as a percentage of:Total assets (1)0.23 0.21 Loans and leases HFI plus foreclosed property0.38 0.39 ALLL as a percentage of loans and leases HFI1.34 1.53 Ratio of ALLL to NPLs3.68x4.07xLoans 90 days or more past due and still accruing as a percentage of loans and leases HFI, excluding PPP and other government guaranteed (2)0.04 %0.03 %(1)Includes LHFS.(2)This asset quality ratio has been adjusted to remove the impact of government guaranteed loans. Management believes the inclusion of such assets in this asset quality ratio results in distortion of this ratio because collection of principal and interest is reasonably assured, or the ratio might not be comparable to other periods presented or to other portfolios that do not have government guarantees.Table 21: Asset Quality Ratios (Continued)Year Ended December 31,202220212020Net charge-offs as a percentage of average loans and leases HFI:Commercial:Commercial and industrial0.04 %0.10 %0.21 %CRE0.02 0.01 0.27 Commercial construction(0.07)(0.03)0.28 Consumer:Residential mortgage(0.01)0.02 0.09 Residential home equity and direct0.84 0.54 0.61 Indirect auto1.17 0.92 1.16 Indirect other0.64 0.30 0.32 Student0.34 0.31 0.29 Credit card2.98 2.42 2.99 Total0.27 0.24 0.36 Ratio of ALLL to net charge-offs5.32x6.36x5.21x 56 Truist Financial CorporationThe following table presents activity related to NPAs:Table 22: Rollforward of NPAs(Dollars in millions)20222021Balance, January 1$1,163 $1,387 New NPAs1,983 2,008 Advances and principal increases662 364 Disposals of foreclosed assets (1)(471)(356)Disposals of NPLs (2)(129)(274)Charge-offs and losses(494)(401)Payments(917)(970)Transfers to performing status(560)(546)Other, net13 (49)Ending balance, December 31$1,250 $1,163 (1)Includes charge-offs and losses recorded upon sale of $130 million and $115 million for the year ended December 31, 2022 and 2021, respectively.(2)Includes gains, net of charge-offs recorded upon sale of $2 million and $3 million for the year ended December 31, 2022 and 2021, respectively.TDRs occur when a borrower is experiencing, or is expected to experience, financial difficulties in the near term and a concession has been granted to the borrower. As a result, Truist works with borrowers to prevent further difficulties and to improve the likelihood of recovery on a loan. To facilitate this process, a concessionary modification that would not otherwise be considered may be granted, resulting in classification of the loan as a TDR.The following table provides a summary of performing TDR activity:Table 23: Rollforward of Performing TDRs(Dollars in millions)20222021Balance, January 1$1,390 $1,361 Inflows1,055 651 Payments and payoffs (1)(283)(407)Charge-offs(36)(44)Transfers to nonperforming TDRs (2)(48)(46)Removal due to the passage of time(72)(12)Non-concessionary re-modifications(1)(15)Transferred to LHFS, sold and other(19)(98)Balance, December 31$1,986 $1,390 (1)Includes scheduled principal payments, prepayments, and payoffs of amounts outstanding.(2)Represent loans that no longer meet the requirements necessary to reflect the loan in accruing status.The following table provides further details regarding the payment status of TDRs outstanding:Table 24: Payment Status of TDRs (1)December 31, 2022(Dollars in millions)CurrentPast Due 30-89 DaysPast Due 90 Days Or MoreTotalPerforming TDRs: Commercial:Commercial and industrial$135 99.3 %$1 0.7 %$— — %$136 CRE5 100.0 — — — — 5 Commercial construction1 100.0 — — — — 1 Consumer:Residential mortgage - government guaranteed496 54.1 111 12.1 310 33.8 917 Residential mortgage - nonguaranteed294 87.7 31 9.3 10 3.0 335 Residential home equity and direct71 93.4 5 6.6 — — 76 Indirect auto389 84.2 73 15.8 — — 462 Indirect other5 83.3 1 16.7 — — 6 Student - nonguaranteed27 90.0 2 6.7 1 3.3 30 Credit card15 83.3 2 11.1 1 5.6 18 Total performing TDRs1,438 72.4 226 11.4 322 16.2 1,986 Nonperforming TDRs90 42.0 32 15.0 92 43.0 214 Total TDRs$1,528 69.5 $258 11.7 $414 18.8 $2,200 (1)Past due performing TDRs are included in past due disclosures and nonperforming TDRs are included in NPL disclosures.Truist Financial Corporation 57ACLActivity related to the ACL is presented in the following tables:Table 25: Activity in ACLYear Ended December 31,(Dollars in millions)202220212020Balance, beginning of period$4,695 $6,199 $1,889 CECL adoption - impact to retained earnings before tax— — 2,762 CECL adoption - reserves on PCD assets— — 378 Provision for credit losses777 (813)2,335 Charge-offs: Commercial and industrial(143)(243)(412)CRE(13)(10)(78)Commercial construction(1)(2)(30)Residential mortgage(9)(23)(56)Residential home equity and direct(294)(214)(231)Indirect auto(411)(336)(378)Indirect other(100)(57)(60)Student(22)(24)(23)Credit card(176)(150)(182)Total charge-offs(1,169)(1,059)(1,450)Recoveries: Commercial and industrial87 107 96 CRE8 6 5 Commercial construction5 4 11 Residential mortgage16 12 10 Residential home equity and direct81 79 66 Indirect auto91 92 87 Indirect other23 24 23 Student1 1 1 Credit card34 37 32 Total recoveries346 362 331 Net charge-offs(823)(697)(1,119)Other— 6 (46)Balance, end of period$4,649 $4,695 $6,199 ACL:ALLL$4,377 $4,435 5,835 RUFC272 260 364 Total ACL$4,649 $4,695 $6,199 Net charge-offs during 2022 totaled $823 million, or 0.27% as a percentage of average loans, and were up three basis points compared to the prior year, primarily driven by normalizing trends across certain consumer loan portfolios, partially offset by lower charge offs in the commercial and industrial portfolio.The allowance for credit losses was $4.6 billion and includes $4.4 billion for the allowance for loan and lease losses and $272 million for the reserve for unfunded commitments. The ALLL ratio was 1.34%, compared to 1.53% at December 31, 2021. The decline in the ALLL ratio was due to strong portfolio performance and growth in higher quality loans, partially offset by a moderately slower economic outlook. The ALLL covered nonperforming loans and leases held for investment 3.68 times compared to 4.07 times at December 31, 2021. At December 31, 2022, the ALLL was 5.32 times annualized net charge-offs, compared to 6.36x times at December 31, 2021.58 Truist Financial CorporationThe following table presents an allocation of the ALLL. The entire amount of the allowance is available to absorb losses occurring in any category of loans and leases.Table 26: Allocation of ALLL by CategoryDecember 31, 2022December 31, 2021(Dollars in millions)Amount% ALLL in Each Category% Loans in Each CategoryAmount% ALLL in Each Category% Loans in Each CategoryCommercial and industrial$1,409 32.3 %50.3 %$1,426 32.2 %47.9 %CRE224 5.1 7.0 350 7.9 8.3 Commercial construction46 1.1 1.8 52 1.2 1.7 Residential mortgage399 9.1 17.4 308 6.9 16.5 Residential home equity and direct549 12.5 7.8 615 13.9 8.7 Indirect auto981 22.4 8.6 1,022 23.0 9.1 Indirect other311 7.1 4.0 195 4.4 3.8 Student98 2.2 1.6 117 2.6 2.3 Credit card360 8.2 1.5 350 7.9 1.7 Total ALLL4,377 100.0 %100.0 %4,435 100.0 %100.0 %RUFC272 260 Total ACL$4,649 $4,695 Truist monitors the performance of its home equity loans and lines secured by second liens similarly to other consumer loans and utilizes assumptions specific to these loans in determining the necessary ALLL. Truist also receives notification when the first lien holder, whether Truist or another financial institution, has initiated foreclosure proceedings against the borrower. When notified that the first lien is in the process of foreclosure, Truist obtains valuations to determine if any additional charge-offs or reserves are warranted. These valuations are updated at least annually thereafter.Truist has limited ability to monitor the delinquency status of the first lien, unless the first lien is held or serviced by Truist. Truist estimates credit losses on second lien loans where the first lien is delinquent based on historical experience; the increased risk of loss on these credits is reflected in the ALLL. As of December 31, 2022, Truist held or serviced the first lien on 32% of its second lien positions.Other AssetsThe components of other assets are presented in the following table:Table 27: Other Assets as of Period End(Dollars in millions)Dec 31, 2022Dec 31, 2021Bank-owned life insurance$7,618 $7,281 Tax credit and other private equity investments6,825 6,309 Prepaid pension assets4,539 5,938 DTAs3,027 — Accounts receivable2,682 2,244 Accrued income2,265 1,791 Leased assets and related assets2,082 2,092 FHLB stock1,279 48 ROU assets1,193 1,168 Prepaid expenses1,162 1,152 Equity securities at fair value898 1,066 Derivative assets684 2,370 Other874 690 Total other assets$35,128 $32,149 Funding ActivitiesDeposits are the primary source of funds for the Company’s lending and investing activities. Scheduled payments and maturities from portfolios of loans and investment securities also provide a stable source of funds. FHLB advances, other secured borrowings, Federal funds purchased and other short-term borrowed funds, as well as long-term debt issued through the capital markets, all provide supplemental liquidity sources. Funding activities are monitored and governed through Truist’s overall ALM process under the governance and oversight of the MRLCC, which is further discussed in the “Market Risk” section in MD&A. The following section provides a brief description of the various sources of funds.Truist Financial Corporation 59DepositsDeposits are obtained principally from individuals and businesses within Truist’s geographic area and include noninterest-bearing checking accounts, interest-bearing checking accounts, savings accounts, money market deposit accounts, CDs, and IRAs. Deposit account terms vary with respect to the minimum balance required, the time period the funds must remain on deposit and service charge schedules. Interest rates paid on specific deposit types are determined based on (i) competitor deposit rates, (ii) the anticipated amount and timing of funding needs, (iii) the availability and cost of alternative sources of funding, and (iv) anticipated future economic conditions and interest rates. Deposits are attractive sources of funding because of their stability and relative cost.The following table presents a summary of deposits:Table 28: Deposits as of Period End(Dollars in millions)Dec 31, 2022Dec 31, 2021Noninterest-bearing deposits$135,742 $145,892 Interest checking110,464 115,754 Money market and savings143,815 138,956 Time deposits23,474 15,886 Total deposits$413,495 $416,488 Deposits totaled $413.5 billion at December 31, 2022, a decrease of $3.0 billion from December 31, 2021. The decline in deposits reflects the impacts of monetary tightening, inflation, and higher interest rate alternatives, partially offset by growth in time deposits, which reflects increases in various wholesale deposit products to support funding.The amount of deposits above the FDIC’s limit of $250,000 was $189.6 billion and $202.5 billion as of December 31, 2022 and 2021, respectively, calculated using the same methodology as the Call Report for Truist Bank. The following table summarizes the maturities of time deposit accounts above $250,000:Table 29: Scheduled Maturities of Time Deposits $250,000 and GreaterDecember 31, 2022(Dollars in millions)Three months or less$6,995 Over three through six months285 Over six through twelve months747 Over twelve months178 Total$8,205 The following table presents average deposits:Table 30: Average DepositsThree Months Ended(Dollars in millions)Dec 31, 2022Sep 30, 2022Jun 30, 2022Mar 31, 2022Dec 31, 2021Noninterest-bearing deposits$141,032 $146,041 $148,610 $145,933 $146,492 Interest checking110,001 111,645 112,375 112,159 110,506 Money market and savings144,730 147,659 148,632 141,500 137,676 Time deposits17,513 14,751 14,133 15,646 16,292 Total average deposits$413,276 $420,096 $423,750 $415,238 $410,966 Average deposits for the fourth quarter of 2022 were $413.3 billion, a decrease of $6.8 billion, or 1.6%, compared to the prior quarter. The decrease in deposits was primarily driven by the impacts of monetary tightening, inflation, and higher interest rate alternatives. Average noninterest-bearing deposits decreased 3.4% compared to the prior quarter and represented 34.1% of total deposits for the fourth quarter of 2022. Average money market and savings and interest checking declined 2.0% and 1.5%, respectively, compared to the prior quarter. Average time deposits increased 19% primarily due to an increase in wholesale time deposit products.60 Truist Financial CorporationBorrowingsThe types of short-term borrowings that have been, or may be, used by the Company include Federal funds purchased, securities sold under repurchase agreements, master notes, commercial paper, short-term bank notes, and short-term FHLB advances. Short-term borrowings fluctuate based on the Company’s funding needs. While deposits remain the primary source for funding loan originations, management uses short-term borrowings as a supplementary funding source for loan growth and other balance sheet management purposes. The following table summarizes certain information for the past three years with respect to short-term borrowings excluding trading liabilities, hedges, and collateral in excess of derivative exposure:Table 31: Short-Term BorrowingsAs Of / For The Year Ended December 31,(Dollars in millions)202220212020Securities sold under agreements to repurchase:Maximum outstanding at any month-end during the year$6,033 $3,279 $2,348 Balance outstanding at end of year2,128 2,435 1,221 Average outstanding during the year2,670 2,382 1,504 Average interest rate during the year1.33 %0.07 %0.64 %Average interest rate at end of year4.36 0.01 0.13 Federal funds purchased and short-term borrowed funds:Maximum outstanding at any month-end during the year$22,324 $6,244 $19,392 Balance outstanding at end of year19,340 808 3,372 Average outstanding during the year10,135 1,936 6,951 Average interest rate during the year2.79 %0.12 %1.17 %Average interest rate at end of year4.38 0.08 0.20 At December 31, 2022, short-term borrowings totaled $23.4 billion, an increase of $18.1 billion compared to December 31, 2021. Average short-term borrowings were $15.0 billion, or 3.2% of total funding, for the year ended December 31, 2022, as compared to $6.2 billion, or 1.4%, for the prior year.Long-term debt provides funding and, to a lesser extent, regulatory capital, and primarily consists of senior and subordinated notes issued by Truist and Truist Bank. Long-term debt totaled $43.2 billion at December 31, 2022, an increase of $7.3 billion compared to December 31, 2021. During the year ended December 31, 2022, the Company had maturities and redemptions of $5.9 billion of senior and $300 million of subordinated long-term debt and redeemed $800 million of FHLB advances, which resulted in a gain on early extinguishment of long-term debt of $39 million. The Company issued $3.9 billion fixed-to-floating rate senior notes with an interest rate between 4.12% and 6.12% due July 28, 2026 to October 28, 2033 and $1.0 billion fixed-to-floating rate subordinated notes with an interest rate of 4.92% due July 28, 2033. Additionally, Truist issued $10.8 billion notional of FHLB floating rate advances. The average cost of long-term debt was 2.31% for the year ended December 31, 2022, up 78 basis points compared to the same period in 2021.The increases in short-term borrowings and long-term debt were primarily to fund $33.1 billion of strong loan growth during 2022.In January 2023, Truist issued $1.5 billion fixed-to-floating rate senior notes with an interest rate of 4.87% due January 26, 2029 and $1.5 billion fixed-to-floating rate senior notes with an interest rate of 5.12% due January 26, 2034.Shareholders’ EquityTotal shareholders’ equity was $60.5 billion at December 31, 2022, a decrease of $8.7 billion from December 31, 2021. This decline includes a decrease of $12.0 billion in AOCI and $3.0 billion in dividends, partially offset by $6.3 billion in net income. Truist’s book value per common share at December 31, 2022 was $40.58, compared to $47.14 at December 31, 2021.Truist Financial Corporation 61Risk ManagementTruist maintains a comprehensive risk management framework supported by people, processes, and systems to identify, measure, monitor, manage, and report significant risks arising from its exposures and business activities. Effective risk management involves optimizing risk and return while operating in a safe and sound manner, and promoting compliance with applicable laws and regulations. The Company’s risk management framework promotes the execution of business strategies and objectives in alignment with its risk appetite.Truist has developed and employs a risk framework that further guides business functions in identifying, measuring, responding to, monitoring, and reporting on possible exposures to the organization. The risk taxonomy drives internal risk measurement and monitoring and enables Truist to clearly and transparently communicate to stakeholders the level of potential risk the Company faces and the Company’s position on managing risk to acceptable levels.Truist is committed to fostering a culture that supports identification and escalation of risks across the organization. All teammates are responsible for upholding the Company’s purpose, mission, and values, and are encouraged to speak up if there is any activity or behavior that is inconsistent with the Company’s culture. The Truist code of ethics guides the Company’s decision making and informs teammates on how to act in the absence of specific guidance.Truist seeks an appropriate return for the risk taken in its business operations. Risk-taking activities are evaluated and prioritized to identify those that present attractive risk-adjusted returns, while preserving asset value and capital.Truist’s compensation plans are designed to consider teammate’s adherence to and successful implementation of Truist’s risk values and associated policies and procedures. The Company’s compensation structure supports its core values and sound risk management practices in an effort to promote judicious risk-taking behavior.Truist’s purpose, mission, and values are the foundation for the risk management framework utilized at Truist and therefore serve as the basis on which the risk appetite and risk strategy are built. Truist’s RMO provides independent oversight and guidance for risk-taking across the enterprise. In keeping with the belief that consistent values drive long-term behaviors, Truist’s RMO has established the following risk values which guide teammates’ day-to-day activities:•Managing risk is the responsibility of every teammate.•Proactively identifying risk and managing the inherent risks of their businesses is the responsibility of the business units.•Managing risk with a balanced approach which includes quality, profitability, and growth.•Utilizing sound and consistent risk management practices.•Thoroughly analyzing risk quantitatively and qualitatively.•Realizing lower cost of capital from high quality risk management.Truist places significant emphasis on risk management oversight and maintains a separate Board-level Risk Committee, which assists the Board in its oversight of the Company’s risk management function. The Committee is responsible for approving and periodically reviewing the Company’s risk management framework and risk management policies as well as monitoring the Company’s risk profile, approving risk appetite statements, and providing input to management regarding Truist’s risk appetite and risk profile.The RMO is led by the CRO and is responsible for overseeing the identification, measurement, monitoring, management, and reporting of risk. The CRO has direct access to the Board to communicate any risk issues (current or emerging) as well as the performance of the risk management activities throughout the enterprise.As illustrated below, the risk management framework is supported by three lines of defense. The following figure describes the roles of the three lines of defense:62 Truist Financial CorporationTruist’s Risk Governance framework is designed to provide comprehensive Board and Executive Leadership risk oversight, maintaining a committee governance structure that is designed to ensure alignment and execution of the risk management framework. The committee structure provides a mechanism to allow for efficient aggregation and escalation of risk information from the business units up to the risk programs, Executive Leadership and ultimately the Board.The executive level committees include the ERC, ECRC, MRLCC, EBPCC, TMC, and DC, each of which is chaired by a member of Executive Leadership. These committees provide oversight of each of the primary risk types.The ERC establishes a fully integrated view of risks across the company, provides broad strategic oversight of all risk types, and oversees corporate-wide strategies for identifying, assessing, controlling, measuring, monitoring, and reporting risk at the enterprise level. The ERC is responsible for maintaining an effective risk management framework and monitoring its adoption and execution across the enterprise. The ERC is chaired by the CRO, and its membership includes all members of Executive Leadership and the Chief Audit Officer.Truist Financial Corporation 63Principal types of inherent risk include market, credit, liquidity, technology, compliance, strategic, reputational, and operational risks. The following is a discussion of these risks.Market RiskMarket risk is the risk to current or anticipated earnings, capital, or economic value arising from changes in the market value of portfolios, securities, or other financial instruments. Market risk results from changes in the level, volatility, or correlations among financial market risk factors or prices, including interest rates, credit spreads, foreign exchange rates, equity, and commodity prices.Effective management of market risk is essential to achieving Truist’s strategic financial objectives. Truist’s most significant market risk exposure is to interest rate risk in its balance sheet; however, market risk also results from underlying product liquidity risk, price risk, and volatility risk in Truist’s business units. Interest rate risk results from differences between the timing of rate changes and the timing of cash flows associated with assets and liabilities (re-pricing risk); from changing rate relationships among different yield curves affecting bank activities (basis risk); from changing rate relationships across the spectrum of maturities (yield curve risk); and from interest-related options inherently embedded in bank products (options risk).The primary objectives of effective market risk management are to minimize adverse effects from changes in market risk factors on net interest income, net income, and capital, and to offset the risk of price changes for certain assets and liabilities recorded at fair value. At Truist, market risk management also includes the enterprise-wide IPV function.Interest Rate Market RiskAs a financial institution, Truist is exposed to interest rate risk from assets, liabilities, and off-balance sheet positions. To keep net interest margin as stable as possible, Truist actively manages its interest rate risk exposure through the strategic repricing of its assets and liabilities, taking into account the volumes, maturities, and mix. Truist primarily uses three methods to measure and monitor its interest rate risk: (i) simulations of possible changes to net interest income over the next two years based on gradual changes in interest rates; (ii) analysis of interest rate shock scenarios; and (iii) analysis of economic value of equity based on changes in interest rates.The Company’s simulation model takes into account assumptions related to prepayment trends, using a combination of market data and internal historical experiences for deposits and loans, as well as scheduled maturities and payments, and the expected outlook for the economy and interest rates. These assumptions are reviewed and adjusted monthly to reflect changes in current interest rates compared to the rates applicable to Truist’s assets and liabilities. The model also considers Truist’s current and prospective liquidity position, current balance sheet volumes, projected growth and/or contractions, accessibility of funds for short-term needs and capital maintenance.Deposit betas (the sensitivity of deposit rate changes relative to market rate changes) are an important assumption in the interest rate risk modeling process. Truist applies deposit beta assumptions to non-maturity interest-bearing deposit accounts when determining its interest rate sensitivity. Non-maturity, interest-bearing deposit accounts include interest checking accounts, savings accounts, and money market accounts that do not have a contractual maturity. Truist applies an average deposit beta of approximately 50% to its non-maturity interest-bearing accounts when determining its interest rate sensitivity. Truist also regularly conducts sensitivity analyses on other key variables, including noninterest-bearing deposits, to determine the impact these variables could have on the Company’s interest rate risk position. The predictive value of the simulation model depends upon the accuracy of the assumptions, but management believes that it provides helpful information for the management of interest rate risk.The following table shows the effect that the indicated changes in interest rates would have on net interest income as projected for the next 12 months assuming a gradual change in interest rates as described below.Table 32: Interest Sensitivity Simulation AnalysisInterest Rate ScenarioAnnualized Hypothetical Percentage Change in Net Interest IncomeGradual Change in Prime Rate (bps)Prime RateDec 31, 2022Dec 31, 2021Dec 31, 2022Dec 31, 2021Up 1008.50 %4.25 %(0.11)%5.18 %Up 508.00 3.75 0.03 3.94 No Change7.50 3.25 — — Down 50 (1)7.00 2.75 (0.96)(1.78)Down 100 (1)6.50 2.25 (1.29)(2.06)(1)The Down 50 and 100 rate scenarios incorporate a floor of one basis point.64 Truist Financial CorporationTruist has established parameters related to interest rate sensitivity measures that prescribe a maximum negative impact on net interest income under different interest rate scenarios that would result in an escalation to the Board. The following parameters and interest rate scenarios are considered Truist’s primary measures of interest rate risk:•Maximum decrease in net interest income of 7.5% for the next 12 months assuming a 100 basis point gradual change in interest rates over four quarters; and a•Maximum decrease in net interest income of 10% for the next 12 months assuming an immediate 100 basis point parallel shock change in interest rates. This interest rate shock analysis is designed to create an outer bound of acceptable interest rate risk.Management considers how the interest rate risk position could be impacted by changes in balance sheet mix. Liquidity in the banking industry was very strong post-COVID-19, which resulted in growth in noninterest-bearing demand deposits. However, with the significant increase in rates in 2022, noninterest-bearing deposits have begun to disintermediate to interest-bearing accounts. Additional balance movement above what is currently projected would reduce the asset sensitivity of Truist’s balance sheet because the Company may increase interest-bearing funds to offset the loss of this advantageous funding source. Alternatively, the Company may reduce the size of its investment portfolio to offset the loss of noninterest-bearing demand deposits to limit the impact on the balance sheet’s asset sensitivity. The behavior of these deposits is one of the most important assumptions used in determining the interest rate risk position of Truist. A decrease in the amount of these deposits in the future would reduce the asset sensitivity of Truist’s balance sheet because the Company may increase interest-bearing funds to offset the loss of this advantageous funding source.The following table shows the results of Truist’s interest-rate sensitivity position assuming the loss of additional demand deposits and an associated increase in managed rate deposits versus current projections under various interest rate scenarios. For purposes of this analysis, Truist modeled the incremental beta of managed rate deposits for the replacement of the demand deposits at 100%.Table 33: Deposit Mix Sensitivity AnalysisGradual Change in Rates (bps)Base Scenario at December 31, 2022 (1)Results Assuming a Decrease in Noninterest-Bearing Demand Deposits$20 Billion$40 BillionUp 100(0.11)%(0.77)%(1.44)%Up 500.03 (0.45)(0.94)(1)The base scenario is equal to the annualized hypothetical percentage change in net interest income at December 31, 2022 as presented in the preceding table.Truist uses financial instruments including derivatives to manage interest rate risk related to securities, commercial loans, MSRs, and mortgage banking operations, long-term debt, and other funding sources. Truist has utilized derivatives to facilitate transactions on behalf of its clients and as part of associated hedging activities. As of December 31, 2022, Truist had derivative financial instruments outstanding with notional amounts totaling $333.0 billion, with an associated net negative fair value of $2.3 billion. See “Note 19. Derivative Financial Instruments” for additional disclosures.LIBOR TransitionFor most tenors of U.S. dollar LIBOR, the administrator of LIBOR extended publication until June 30, 2023. To prepare for the transition to an alternative reference rate, management formed a cross-functional project team to address the LIBOR transition. The project team performed an assessment to identify the potential risks related to the transition from LIBOR to a new index or multiple indices and provides updates to Executive Leadership and the Board. As of December 31, 2022, Truist had outstanding LIBOR-based instruments that mature after June 30, 2023, including loan and lease exposures totaling approximately $135 billion, notional derivative exposure totaling approximately $131 billion, long-term debt of $1.1 billion, and preferred stock of $1.5 billion. These amounts are inclusive of remediated contracts, which contain adequate fallback language for the transition.Contract fallback language for existing loans and leases has largely been reviewed and certain contracts will require amendments to support the transition away from LIBOR. Impacted lines of business have started remediating these contracts to include standardized fallback language or amending contracts to new reference rates at maturities or based on client request. Current fallback language used to remediate contracts that mature after June 30, 2023 is generally consistent with ARRC recommendations and includes use of “hardwired fallback” language, which will transition loans to a SOFR based rate after June 30, 2023.Truist Financial Corporation 65The progress and approach to remediation will vary based on the type of contract and existing language used in the agreement. For commercial lending, a significant number of remaining LIBOR contracts will require client outreach and remediation. Through mid-2022, the Company’s primary focus was supporting new loan production using SOFR and other alternative reference rates as well as transitioning any renewing LIBOR based contracts to alternative reference rates. Efforts have shifted to amend and remediate contracts, excluding mortgage and student loans, that mature post June 30, 2023 ($127 billion), which will continue to be the focus during 2023. Of the contracts remaining on LIBOR that have not yet been remediated or modified to a new reference rate, Truist’s intends to add / update fallback language or move these contracts to new references rates prior to cessation. A significant portion of these contracts contain existing fallback language that will transition the contract to a Prime based rate if not remediated, while a smaller population contains no historical fallback language. Should the institution be unable to remediate all contracts, those based on Prime will be prioritized to provide a more consistent client experience with the “hardwired fallback” transition to SOFR. If there are remaining contracts without fallback language, Truist may leverage recent legislation and corresponding safe harbor provision to transition these loans to SOFR.Truist’s adjustable-rate mortgage products ($3.5 billion) have consistent and adequate fallback language to transition away from LIBOR in line with industry expectations; therefore, these contracts will not require remediation. Remediation of student loans ($4.7 billion) will follow pending guidance from the Department of Education on the replacement rate for payment allowances on certain student loans and recent guidance from the CFPB to allow transition to “comparable rates,” in the private student loan portfolio, where LIBOR is used directly.Upon the discontinuation of LIBOR, derivatives that reference LIBOR will transition to a SOFR-based replacement rate as set forth in the ISDA protocol addressing LIBOR fallbacks or as established under the recently passed Adjustable Interest Rate (LIBOR) Act and rules promulgated thereunder by the FRB. Certain derivatives without a clearly defined or practicable replacement benchmark rate will use the recent Federal legislation to replace LIBOR with a SOFR-based rate established by FRB rulemaking and follow the ISDA Protocol for transition. This legislation will also provide additional administrative benefit for a small portion of the commercial and consumer lending portfolios where contracts do not contain fallback language and have not yet been remediated, providing a remediation path to a SOFR based rate.In addition, the transition from LIBOR to an alternative reference rate, such as SOFR, for the Company’s preferred stock and the Company’s and Truist Bank’s floating rate notes is dependent on a number of factors, including the fallback language for the applicable series of preferred stock or notes, the application of the LIBOR Act and the rules promulgated thereunder by the FRB, determinations to be made by third-party calculation or paying agents rather than the Company or Truist Bank as to the replacement rates, and the impact of any publication of a synthetic U.S. dollar LIBOR as currently proposed by the Financial Conduct Authority. See “Note 12. Shareholders’ Equity” for information about preferred stock using LIBOR.Training has been provided for impacted teammates and will continue during 2023. Truist will continue to provide timely notices and information to impacted clients about the transition during the first half of 2023. Truist continues to manage the impact of these contracts and other financial instruments, systems implications, hedging strategies, and related operational and market risks on established project plans for business and operational readiness to support the transition.As of December 31, 2021, Truist ceased entering into new contracts with a LIBOR reference rate for all product offerings, except on a limited basis, as permissible. The Company is actively using SOFR as a reference rate and has originated approximately $119 billion of loans, issued $9.9 billion of long-term debt, and has $108 billion in notional derivative exposure using this alternative reference rate as of December 31, 2022. Alternatives, such as SOFR, may react differently from LIBOR in times of economic stress. Truist expects SOFR to be the primary pricing benchmark used across the industry and will continue to offer additional SOFR based products. Market risks associated with the transition to alternative reference rates are dependent on market conditions as loans are transitioned to alternative reference rates during 2022 and early 2023. Additional alternative reference rates, such as Bloomberg Short Term Bank Yield, will be supported based on market demand. Other emerging credit sensitive rates will be evaluated as additional alternatives for LIBOR based on market developments. For a further discussion of the various risks associated with the potential cessation of LIBOR and the transition to alternative reference rates, refer to the section titled “Item1A. Risk Factors.”Market Risk from Trading ActivitiesAs a financial intermediary, Truist provides its clients access to derivatives, foreign exchange and securities markets, which generate market risks. Trading market risk is managed using a comprehensive risk management approach, which includes measuring risk using VaR, stress testing, and sensitivity analysis. Risk metrics are monitored against a suite of limits on a daily basis at both the trading desk level and at the aggregate portfolio level, which is intended to ensure that exposures are in line with Truist’s risk appetite.Truist is also subject to risk-based capital guidelines for market risk under the Market Risk Rule.66 Truist Financial CorporationCovered Trading PositionsCovered positions subject to the Market Risk Rule include trading assets and liabilities, specifically those held for the purpose of short-term resale or with the intent of benefiting from actual or expected short-term price movements or to lock in arbitrage profits. Truist’s trading portfolio of covered positions results primarily from market making and underwriting services for the Company’s clients, as well as associated risk mitigating hedging activity. The trading portfolio, measured in terms of VaR, consists primarily of four sub-portfolios of covered positions: (i) credit trading, (ii) fixed income securities, (iii) interest rate derivatives, and (iv) equity derivatives. As a market maker across different asset classes, Truist’s trading portfolio also contains other sub-portfolios, including foreign exchange, loan trading, and commodity derivatives; however, these portfolios do not generate material trading risk exposures.Valuation policies and methodologies exist for all trading positions. Additionally, these positions are subject to independent price verification. See “Note 19. Derivative Financial Instruments,” “Note 18. Fair Value Disclosures,” and “Critical Accounting Policies” herein for discussion of valuation policies and methodologies.SecuritizationsAs of December 31, 2022, the aggregate market value of on-balance sheet securitization positions subject to the Market Risk Rule was $12 million, all of which were non-agency asset backed securities positions. Consistent with the Market Risk Rule requirements, the Company performs pre-purchase due diligence on each securitization position to identify the characteristics including, but not limited to, deal structure and the asset quality of the underlying assets, that materially affect valuation and performance. Securitization positions are subject to Truist’s comprehensive risk management framework, which includes daily monitoring against a suite of limits. There were no off-balance sheet securitization positions during the reporting period.Correlation Trading PositionsThe trading portfolio of covered positions did not contain any correlation trading positions as of December 31, 2022.VaR-Based MeasuresVaR measures the potential loss of a given position or portfolio of positions at a specified confidence level and time horizon. Truist utilizes a historical VaR methodology to measure and aggregate risks across its covered trading positions. For risk management purposes, the VaR calculation is based on a historical simulation approach and measures the potential trading losses using a one-day holding period at a one-tail, 99% confidence level. For Market Risk Rule purposes, the Company calculates VaR using a 10-day holding period and a 99% confidence level. Due to inherent limitations of the VaR methodology, such as the assumption that past market behavior is indicative of future market performance, VaR is only one of several tools used to measure and manage market risk. Other tools used to actively manage market risk include stress testing, scenario analysis, and stop loss limits.The trading portfolio’s VaR profile is influenced by a variety of factors, including the size and composition of the portfolio, market volatility, and the correlation between different positions. A portfolio of trading positions is typically less risky than the sum of the risk from each of the individual sub-portfolios, because, under normal market conditions, risk within each category partially offsets the exposure to other risk categories. The following table summarizes certain VaR-based measures for the 12 months ended December 31, 2022 and 2021. Average one and ten-day VaR measures for the year ended December 31, 2022 increased from the same period of last year, primarily driven by higher market volatility in 2022. Maximum one and ten-day VaR measures for the year ended December 31, 2022 were lower than 2021 as heightened market volatility experienced during March 2020 was used for measuring VaR until March 2021.Truist Financial Corporation 67Table 34: VaR-based MeasuresYear Ended December 31,20222021(Dollars in millions)10-Day Holding Period1-Day Holding Period10-Day Holding Period1-Day Holding PeriodVaR-based Measures:Maximum$38 $14 $68 $16 Average17 5 14 4 Minimum6 3 3 1 Period-end20 6 13 5 VaR by Risk Class:Interest Rate Risk6 3 Credit Spread Risk8 5 Equity Price Risk1 1 Foreign Exchange Risk— — Portfolio Diversification(9)(5)Period-end6 5 Stressed VaR-based measuresStressed VaR, another component of market risk capital, is calculated using the same internal models as used for the VaR-based measure. Stressed VaR is calculated over a ten-day holding period at a one-tail, 99% confidence level and employs a historical simulation approach based on a continuous twelve-month historical window selected to reflect a period of significant financial stress for the Company’s trading portfolio. The following table summarizes Stressed VaR-based measures:Table 35: Stressed VaR-based Measures - 10 Day Holding PeriodYear Ended December 31,(Dollars in millions)20222021Maximum$109 $118 Average70 59 Minimum40 26 Period-end77 65 Compared to the prior year, the average Stressed VaR measures increased primarily due to higher market making inventory levels in 2022.Specific Risk MeasuresSpecific risk is a measure of idiosyncratic risk that could result from risk factors other than broad market movements (e.g., default or event risks). The Market Risk Rule provides fixed risk weights under a standardized measurement method while also allowing a model-based approach, subject to regulatory approval. Truist utilizes the standardized measurement method to calculate the specific risk component of market risk regulatory capital. As such, incremental risk capital requirements do not apply.VaR Model BacktestingIn accordance with the Market Risk Rule, the Company evaluates the accuracy of its VaR model through daily backtesting by comparing aggregate daily trading gains and losses (excluding fees, commissions, reserves, net interest income, and intraday trading) from covered positions with the corresponding daily VaR-based measures generated by the model. As illustrated in the following graph, there were no Company-wide VaR backtesting exceptions during the twelve months ended December 31, 2022. The total number of Company-wide VaR backtesting exceptions over the preceding twelve months is used to determine the multiplication factor for the VaR-based capital requirement under the Market Risk Rule. The capital multiplication factor increases from a minimum of three to a maximum of four, depending on the number of exceptions. All Company-wide VaR backtesting exceptions are thoroughly reviewed in the context of VaR model use and performance. There was no change in the capital multiplication factor over the preceding twelve months.68 Truist Financial CorporationModel Risk OversightMRO is responsible for the independent model validation of all decision tools and models including trading market risk models. The validation activities are conducted in accordance with MRO policy, which incorporates regulatory guidance related to the evaluation of model conceptual soundness, ongoing monitoring, and outcomes analysis. As part of ongoing monitoring efforts, the performance of all trading risk models are reviewed regularly to preemptively address emerging developments in financial markets, assess evolving modeling approaches, and identify potential model enhancement.Stress TestingThe Company uses a comprehensive range of stress testing techniques to help monitor risks across trading desks and to augment standard daily VaR and other risk limits reporting. The stress testing framework is designed to quantify the impact of extreme, but plausible, stress scenarios that could lead to large, unexpected losses. Stress tests include simulations for historical repeats and hypothetical risk factor shocks. All trading positions within each applicable market risk category (interest rate risk, equity risk, foreign exchange rate risk, credit spread risk, and commodity price risk) are included in the Company’s comprehensive stress testing framework. Management reviews stress testing scenarios on an ongoing basis and makes updates, as necessary, which is intended to ensure that both current and emerging risks are captured appropriately. Management also utilizes stress analyses to support the Company’s capital adequacy assessment standards. See the “Capital” section of MD&A for additional discussion of capital adequacy.Credit RiskCredit risk is the risk to current or anticipated earnings or capital arising from the default, inability or unwillingness of a borrower, obligor, or counterparty to meet the terms of any financial obligation to Truist or otherwise perform as agreed. Credit risk exists in all activities where success depends on the performance of a borrower, obligor, or counterparty. Credit risk arises when Truist funds are extended, committed, invested, or otherwise exposed through actual or implied contractual agreements, whether on or off-balance sheet. Credit risk increases when the credit quality of an issuer whose securities or other instruments the bank holds has deteriorated.Truist has established the following general practices to manage credit risk:•limiting the amount of credit that individual lenders may extend to a borrower;•establishing a process for credit approval accountability;•careful initial underwriting and analysis of borrower, transaction, market and collateral risks;•ongoing servicing and monitoring of individual loans and lending relationships;•continuous monitoring of the portfolio, market dynamics and the economy; and•periodically reevaluating the Company’s strategy and overall exposure as economic, market and other relevant conditions change.Truist Financial Corporation 69The following discussion describes the underwriting procedures and overall risk management of Truist’s lending function.Underwriting ApproachThe loan portfolio is a primary source of profitability and risk; therefore, proper loan underwriting is critical to Truist’s long-term financial success. Truist’s underwriting approach is designed to define acceptable combinations of specific risk-mitigating features that promote credit relationships that conform to Truist’s risk philosophy. Provided below is a summary of the most significant underwriting criteria used to evaluate new loans and loan renewals:•Cash flow and debt service coverage - cash flow adequacy is a necessary condition of creditworthiness, meaning that loans must either be clearly supported by a borrower’s cash flow or, if not, must be justified by secondary repayment sources.•Secondary sources of repayment - alternative repayment funds are a significant risk-mitigating factor as long as they are liquid, can be easily accessed, and provide adequate resources to supplement the primary cash flow source.•Value of any underlying collateral - loans are generally secured by the asset being financed. Because an analysis of the primary and secondary sources of repayment is the most important factor, collateral, unless it is liquid, does not justify loans that cannot be serviced by the borrower’s normal cash flows.•Overall creditworthiness of the client, taking into account the client’s relationships, both past and current, with Truist and other lenders - Truist’s success depends on building lasting and mutually beneficial relationships with clients, which involves assessing their financial position and background.•Level of equity invested in the transaction - in general, borrowers are required to contribute or invest a portion of their own funds prior to any loan advances.Refer to the “Lending Activities” section in MD&A for a discussion of each loan and lease portfolio.Liquidity RiskLiquidity risk is the risk that (i) Truist will be unable to meet its obligations as they come due because of an inability to obtain adequate funding (funding liquidity risk), or (ii) Truist cannot easily unwind or offset specific exposures without significantly lowering market prices because of inadequate market depth or market disruptions (market liquidity risk). Refer to the “Liquidity” section in MD&A for additional discussion.Technology RiskTechnology risk is the business risk associated with the use, ownership, operation, involvement, influence, and adoption of information technology across the Company. Truist has defined and adopted a technology risk framework that provides the foundation for technology risk strategy, program, and oversight and defines key objectives, operating model components, risk domains, and capabilities to manage this risk.Cybersecurity RiskThe technology landscape is constantly evolving, and new and unforeseen threats and actions by others may disrupt operations or result in losses beyond Truist’s risk control thresholds. Truist maintains a comprehensive risk-based information security / cybersecurity framework implemented through people, processes, and technology whereby Truist actively monitors and evaluates threats, events, and the performance of its business operations and continually adapts its risk mitigation activities accordingly.Truist’s framework aligns with those of the National Institute of Standards and Technology, Cyber Risk Institute, the International Standards Organization 27000 series, the IT Governance Institute, and the Control Objectives for Information and Related Technology, as well as conforms with the requirements and guidance from applicable regulatory authorities, including the Federal Financial Institutions Examination Council. In addition, Truist’s framework, which includes internally and externally focused capabilities, drives the development and implementation of Truist’s data security strategy that is designed to reduce risk while enabling Truist’s corporate business objectives.Truist has built an organization with dedicated, skilled talent to operationalize Truist’s cybersecurity strategy. The cybersecurity strategy is enabled by continuous enhancement of Truist’s multilayered defenses including advanced capabilities for early and rapid cyber threat identification, detection, protection, response, and recovery. Truist participates in the federally recognized Financial Services Information Sharing and Analysis Center as a key part of the Company’s cyber threat intelligence and response programs, as well as other industry organizations and initiatives that promote industry best practices such as harmonized cybersecurity standards, cyber readiness, and secure consumer financial data sharing.70 Truist Financial CorporationTo further mitigate the risks presented by an evolving cyber threat landscape, Truist provides data protection guidance to clients and promotes data protection awareness and accountability through mandatory teammate training. Truist conducts scenario-driven test exercises simulating impacts and consequences developed through analysis of real-world technology incidents as well as known and anticipated cyber threats. These exercises are designed to assess the viability of Truist’s crisis response and management programs and provide the basis for continuous improvement.Truist’s cybersecurity risk program is overseen by Executive Leadership and the Board. Regular updates on the status of the cybersecurity risk program, including information security risks and incidents, emerging threats, and control environment, are aggregated and escalated to Executive Leadership and the Board. Additionally, Truist has a Cyber Incident Response Team that manages significant cyber-specific events with escalation up to Executive Leadership and the Board. Truist’s framework requires annual exercises at a minimum to test Truist’s preparedness. The Board devotes significant time and attention to its oversight of cyber security risk and approves related information security policies. Although Truist has invested substantial resources to manage and reduce cybersecurity risk, it is not possible to completely eliminate this risk. Truist obtains insurance that protects against certain losses, expenses, and damages associated with cybersecurity risk. See Item 1A, “Risk Factors,” for additional information regarding cybersecurity risk.Compliance RiskCompliance risk is the risk to current or anticipated earnings or capital arising from violations of laws, rules, or regulations, or from non-conformance with prescribed practices, internal policies, and procedures or ethical standards. This risk exposes Truist to fines, civil monetary penalties, payment of damages, and the voiding of contracts. Compliance risk can result in diminished reputation, reduced franchise or enterprise value, limited business opportunities, and lessened expansion potential.Strategic RiskStrategic risk is the risk of financial loss, diminished stakeholder confidence, or negative impact to human capital resulting from ineffective strategy setting and execution, adverse business decisions, or lack of responsiveness to changes in the banking industry and operating environment. Truist is committed to fulfilling its overall strategic objectives by selecting business strategies and operating businesses in a manner consistent with its established risk appetite, achieving profitability/earnings growth and maintaining strong confidence and trust with its key stakeholder constituencies.Reputational RiskReputational risk is the risk to current or anticipated earnings, capital, enterprise value, the Truist brand, and public confidence arising from negative publicity or public opinion, whether real or perceived, regarding Truist’s business practices, products, services, transactions, or other activities undertaken by Truist, its representatives, or its partners. A negative reputation may impair Truist’s relationship with clients, teammates, communities, or shareholders, and it is often a residual risk that arises when other risks are not managed properly.Operational RiskOperational risk is the risk to current or anticipated earnings or capital arising from inadequate or failed internal processes, people, and systems or from external events. It includes legal risk, which is the risk of loss arising from defective transactions, litigation or claims made, or the failure to adequately protect company-owned assets. An operational loss occurs when an event results in a loss or reserve originating from operational risk.Model RiskModel risk is the risk to current or anticipated earnings or capital from decisions based on incorrect or misused model outputs. Truist uses models for many purposes, including the valuation of financial positions, estimation of credit losses, and the measurement of risk. Valuation models are used to value certain financial instruments for which quoted prices may not be readily available. Valuation models are also used as inputs for VaR, the estimation of VaR itself, regulatory capital, stress testing, and the ACL. Models are owned by the applicable BUs, who are responsible for the development, implementation, and use of their models. Oversight of these functions is performed by the MRO, which is a component of the RMO. Once models have been approved, model owners are responsible for the maintenance of an appropriate operating environment and must monitor and evaluate the performance of the models on a recurring basis. Models are updated in response to changes in portfolio composition, industry and economic conditions, technological capabilities, and other developments.Truist Financial Corporation 71MRO manages model risk in a holistic manner through a suite of model governance and model validation activities. The risk of each model is assessed and classified into various risk tiers. Additionally, MRO maintains an enterprise-wide model inventory containing relevant model information. Regarding model validation, MRO utilizes internal validation analysts and managers with skill sets in predictive modeling to perform detailed reviews of model development, implementation, and conceptual soundness. On certain occasions, the MRO will also engage external parties to assist with validation efforts. Once in a production environment, MRO assesses a model’s performance on a periodic basis through ongoing monitoring reviews. MRO tracks issues that have been identified during model validation or through ongoing monitoring and engages with model owners to ensure their timely remediation. MRO gauges model risk utilizing a collection of key risk indicators, which are periodically reported to relevant committees, including but not limited to, the Model Risk Oversight Committee as well as the Board Risk Committee. MRO will also present model risk topics to the Board Risk Committee as necessary.LiquidityLiquidity represents the continuing ability to meet funding needs, including deposit withdrawals, repayment of borrowings and other liabilities, and funding of loan commitments. In addition to the level of liquid assets, such as cash, cash equivalents, and AFS securities, other factors affect the ability to meet liquidity needs, including access to a variety of funding sources, maintaining borrowing capacity, growing core deposits, loan repayment, and the ability to securitize or package loans for sale.Truist monitors the ability to meet client demand for funds under both normal and stressed market conditions. In considering its liquidity position, management evaluates Truist’s funding mix based on client core funding, client rate-sensitive funding, and national markets funding. In addition, management evaluates exposure to rate-sensitive funding sources that mature in one year or less. Management also measures liquidity needs against 30 days of stressed cash outflows for Truist and Truist Bank. To ensure a strong liquidity position and compliance with regulatory requirements, management maintains a liquid asset buffer of cash on hand and highly liquid unencumbered securities.Internal Liquidity Stress TestingLiquidity stress testing is designed to ensure that Truist and Truist Bank have sufficient liquidity for a variety of institution-specific and market-wide adverse scenarios. Each liquidity stress test scenario applies defined assumptions to execute sources and uses of liquidity over varying planning horizons. The types of expected liquidity uses during a stressed event may include deposit attrition, contractual maturities, reductions in unsecured and secured funding, and increased draws on unfunded commitments. To mitigate liquidity outflows, Truist has identified sources of liquidity; however, access to these sources of liquidity could be affected within a stressed environment.Truist maintains a liquidity buffer of cash on hand and highly liquid unencumbered securities that is sufficient to meet the projected net stressed cash-flow needs and maintain compliance with regulatory requirements. The liquidity buffer consists of unencumbered highly liquid assets and Truist’s liquidity buffer is substantially the same in composition to what qualifies as HQLA under the LCR Rule.Contingency Funding PlanTruist has a contingency funding plan designed to ensure that liquidity sources are sufficient to meet ongoing obligations and commitments, particularly in the event of a liquidity contraction. This plan is designed to examine and quantify the organization’s liquidity under the various internal liquidity stress scenarios and is periodically tested to assess the plan’s reliability. Additionally, the plan provides a framework for management and other teammates to follow in the event of a liquidity contraction or in anticipation of such an event. The plan addresses authority for activation and decision making, liquidity options, and the responsibilities of key departments in the event of a liquidity contraction.LCR and HQLAThe LCR rule requires that Truist and Truist Bank maintain an amount of eligible HQLA that is sufficient to meet its estimated total net cash outflows over a prospective 30 calendar-day period of stress. Eligible HQLA, for purposes of calculating the LCR, is the amount of unencumbered HQLA that satisfy operational requirements of the LCR rule. Truist and Truist Bank are subject to the Category III reduced LCR requirements. Truist held average weighted eligible HQLA of $89.4 billion and Truist’s average LCR was 112% for the three months ended December 31, 2022.Effective July 2021, Truist became subject to final rules implementing the NSFR, which are designed to ensure that banking organizations maintain a stable, long-term funding profile in relation to their asset composition and off-balance sheet activities. At December 31, 2022, the Company was compliant with this requirement.72 Truist Financial CorporationSources of FundsManagement believes current sources of liquidity are sufficient to meet Truist’s on- and off-balance sheet obligations. Truist funds its balance sheet through diverse sources of funding including client deposits, secured and unsecured capital markets funding, and shareholders’ equity. Truist Bank’s primary source of funding is client deposits. Continued access to client deposits is highly dependent on public confidence in the stability of Truist Bank and its ability to return funds to clients when requested.Truist Bank maintains a number of diverse funding sources to meet its liquidity requirements. These sources include unsecured borrowings from the capital markets through the issuance of senior or subordinated bank notes, institutional CDs, overnight and term Federal funds markets, and retail brokered CDs. Truist Bank also maintains access to secured borrowing sources including FHLB advances, repurchase agreements, and the FRB discount window. Available investment securities could be pledged to create additional secured borrowing capacity. The following table presents a summary of Truist Bank’s available secured borrowing capacity and eligible cash at the FRB:Table 36: Selected Liquidity Sources(Dollars in millions)Dec 31, 2022Dec 31, 2021Unused borrowing capacity:FRB$49,250 $52,170 FHLB20,770 49,244 Available investment securities (after haircuts)85,401 116,600 Available secured borrowing capacity155,421 218,014 Eligible cash at the FRB15,556 14,714 Total$170,977 $232,728 At December 31, 2022, Truist Bank’s available secured borrowing capacity represented approximately 4.7 times the amount of wholesale funding maturities in one-year or less. FHLB unused borrowing capacity was $20.8 billion at December 31, 2022, down from $49.2 billion at December 31, 2021 primarily due to increases in short-term borrowings.Parent CompanyThe Parent Company serves as the primary source of capital for the operating subsidiaries. The Parent Company’s assets consist primarily of cash on deposit with Truist Bank, equity investments in subsidiaries, advances to subsidiaries, and notes receivable from subsidiaries. The principal obligations of the Parent Company are payments on long-term debt. The main sources of funds for the Parent Company are dividends and management fees from subsidiaries, repayments of advances to subsidiaries, and proceeds from the issuance of equity and long-term debt. The primary uses of funds by the Parent Company are investments in subsidiaries, advances to subsidiaries, dividend payments to common and preferred shareholders, repurchases of common stock, and payments on long-term debt. See “Note 22. Parent Company Financial Information” for additional information regarding dividends from subsidiaries and debt transactions.Access to funding at the Parent Company is more sensitive to market disruptions. Therefore, Truist prudently manages cash levels at the Parent Company to cover a minimum of one year of projected cash outflows which includes unfunded external commitments, debt service, common and preferred dividends and scheduled debt maturities, without the benefit of any new cash inflows. Truist maintains a significant buffer above the projected one year of cash outflows. In determining the buffer, Truist considers cash requirements for common and preferred dividends, unfunded commitments to affiliates, serving as a source of strength to Truist Bank, and being able to withstand sustained market disruptions that could limit access to the capital markets. At December 31, 2022 and December 31, 2021, the Parent Company had 37 months and 35 months, respectively, of cash on hand to satisfy projected cash outflows, and 22 months and 19 months, respectively, when including the payment of common stock dividends.Credit RatingsCredit ratings are forward-looking opinions of rating agencies as to the Company’s ability to meet its financial commitments and repay its securities and obligations in accordance with their terms of issuance. Credit ratings influence both borrowing costs and access to the capital markets. The Company’s credit ratings are continuously monitored by the rating agencies and are subject to change at any time. As Truist seeks to maintain high-quality credit ratings, management meets with the major rating agencies on a regular basis to provide financial and business updates and to discuss current outlooks and trends. See Item 1A, “Risk Factors” for additional information regarding factors that influence credit ratings and potential risks that could materialize in the event of downgrade in the Company’s credit ratings.Truist Financial Corporation 73The following table presents the credit ratings and outlooks of Truist and Truist Bank as of December 31, 2022:Table 37: Credit Ratings of Truist Financial Corporation and Truist Bank Moody’sS&PFitchDBRS MorningstarTruist Financial Corporation:IssuerA3A- / A-2A+ / F1AAL / R-1MSenior unsecuredA3A-AAALSubordinatedA3BBB+A-AHPreferred stockBaa2(hyb)BBB-BBBALTruist Bank:IssuerA2A / A-1A+ / F1AA / R-1HSenior unsecuredA2AA+AADepositsAa3 / P-1NAAA- / F1+AASubordinated(P) A2A-AAALRatings outlook:Credit trendStablePositiveStableStableRecent changes in the Company’s credit ratings and outlooks include:•On January 19, 2022, S&P Global Ratings published Truist’s assigned ESG Credit Indicators of E-2, S-2, and G-2, which were consistent with the scores assigned to most other banks and which indicated that environmental, social and governance factors have “no material influence” on the rating agency’s analysis of the Company.•On August 15, 2022, DBRS Morningstar upgraded the ratings of Truist, including the Long-Term Issuer Rating to “AA (low)” from “A (high).” DBRS Morningstar also upgraded the ratings of Truist Bank, including the Long-Term Issuer Rating to “AA” from “AA (low).” The trend for all ratings was revised to “Stable” from “Positive.” The rating actions reflected the scale, quality, and diversity of Truist’s franchise; the completion of the Merger integration; Truist’s diversified products and geography; and the Company’s sound balance sheet fundamentals and conservative risk profile.•On October 21, 2022, Fitch Ratings affirmed the ratings of Truist and Truist Bank, including the long-term and short-term issuer default ratings at “A+” and “F1,” respectively, for both entities. Fitch Ratings also maintained a “stable” ratings outlook for all ratings. In affirming the ratings, Fitch cited Truist’s diverse business model, conservative credit culture, and the completion of the Merger integration.•On November 3, 2022, Moody’s Investors Service affirmed all of the ratings of Truist and its subsidiaries, including Truist Bank. Moody’s also maintained a “stable” rating outlook for Truist. Moody’s stated that the affirmation of Truist’s ratings reflects the effective completion of its multi-year integration and Truist’s strong, diverse, and resilient platform for organic growth, among, among other factors.Management believes current sources of liquidity are adequate to meet Truist’s current requirements and plans for continued growth. As of December 31, 2022, the Company had $2.1 billion in obligations to purchase goods or services that are enforceable and legally binding. Many of the purchase obligations have terms that are not fixed and determinable and are included in the total amount of obligations based upon the estimated timing and amount of payment. In addition, certain of the purchase agreements contain clauses that would allow Truist to cancel the agreement with specified notice; however, that impact is not included in determining the total amount of obligations. See “Note 9. Other Assets and Liabilities,” “Note 11. Borrowings,” and “Note 16. Commitments and Contingencies” for additional information regarding outstanding balances of sources of liquidity and contractual commitments and obligations.CapitalThe maintenance of appropriate levels of capital is a management priority and is monitored on a regular basis. Truist’s principal goals related to the maintenance of capital are to provide adequate capital to support Truist’s risk profile consistent with the Board-approved risk appetite, provide financial flexibility to support future growth and client needs, comply with relevant laws, regulations, and supervisory guidance, achieve optimal credit ratings for Truist and its subsidiaries, remain a source of strength for its subsidiaries, and provide a competitive return to shareholders. Risk-based capital ratios, which include CET1 capital, Tier 1 capital, and Total capital are calculated based on regulatory guidance related to the measurement of capital and risk-weighted assets.74 Truist Financial CorporationTruist regularly performs stress testing on its capital levels and is required to periodically submit the Company’s capital plans and stress testing results to the banking regulators. Management regularly monitors the capital position of Truist on both a consolidated and bank-level basis. In this regard, management’s objective is to maintain capital at levels that are in excess of internal capital limits, which are above the regulatory “well capitalized” minimums. Management has implemented internal stress capital ratio minimums to evaluate whether capital ratios calculated after the effect of alternative capital actions are likely to remain above internal minimums. Breaches of internal stressed minimums prompt a review of the planned capital actions included in Truist’s capital plan.Table 38: Capital Requirements Minimum CapitalWell CapitalizedMinimum Capital Plus Stress Capital Buffer (1) TruistTruist BankCET14.5 %NA6.5 %7.0 %Tier 1 capital6.0 6.0 %8.0 8.5 Total capital8.0 10.0 10.0 10.5 Leverage ratio4.0 NA5.0 NASupplementary leverage ratio3.0 NANANA(1)Reflects a SCB requirement of 2.5% applicable to Truist as of December 31, 2022. Truist’s SCB requirement, received in the 2022 CCAR process, is effective from October 1, 2022 to September 30, 2023.Payments of cash dividends and repurchases of common shares are the methods used to manage any excess capital generated. In addition, management closely monitors the Parent Company’s double leverage ratio (investments in subsidiaries as a percentage of shareholders’ equity). The active management of the subsidiaries’ equity capital is the process used to manage this important driver of Parent Company liquidity and is a key element in the management of Truist’s capital position.Management intends to maintain capital at Truist Bank at levels that exceed the minimum capital plus CCB. This will also result in Truist Bank being “well-capitalized” for regulatory purposes. Secondarily, it is management’s intent to maintain Truist Bank’s capital at levels that result in regulatory risk-based capital ratios that are generally comparable with peers of similar size, complexity, and risk profile. If the capital levels of Truist Bank increase above these guidelines, excess capital may be transferred to the Parent Company in the form of special dividend payments, subject to regulatory and other operating considerations.Management’s capital deployment plan in order of preference is to focus on (i) organic growth, (ii) dividends, (iii) strategic opportunities and acquisitions, and (iv) share repurchases if excess capital is available.Truist Bank’s capital ratios are presented in the following table:Table 39: Capital Ratios - Truist BankDec 31, 2022Dec 31, 2021CET110.6 %10.5 %Tier 1 capital10.6 10.5 Total capital12.1 12.0 Leverage ratio8.5 8.0 Supplementary leverage ratio7.3 6.9Truist Financial Corporation 75Truist’s capital ratios are presented in the following table:Table 40: Capital Ratios - Truist Financial Corporation(Dollars in millions, except per share data, shares in thousands)Dec 31, 2022Dec 31, 2021Risk-based: CET19.0 %9.6 %Tier 1 capital10.5 11.3 Total capital12.4 13.2 Leverage ratio8.5 8.7 Supplementary leverage ratio7.3 7.4 Non-GAAP capital measure (1): Tangible common equity per common share$18.04 $25.47 Calculation of tangible common equity (1): Total shareholders’ equity$60,537 $69,271 Less: Preferred stock6,673 6,673 Noncontrolling interests23 — Goodwill and intangible assets, net of deferred taxes29,908 28,772 Tangible common equity$23,933 $33,826 Risk-weighted assets$434,413 $390,886 Common shares outstanding at end of period1,326,829 1,327,818 (1)Tangible common equity and related measures are non-GAAP measures that exclude the impact of intangible assets, net of deferred taxes, and their related amortization. These measures are useful for evaluating the performance of a business consistently, whether acquired or developed internally. Truist’s management uses these measures to assess profitability, returns relative to balance sheet risk, and shareholder value. These capital measures are not necessarily comparable to similar capital measures that may be presented by other companies.Truist’s capital level at December 31, 2022 remains strong compared to the regulatory levels for well capitalized banks. Truist’s CET1 ratio was 9.0% as of December 31, 2022. The decline compared to the 2021 CET1 ratio primarily reflects strong loan growth, acquisitions, and the impact from the phase-in of the CECL transition relief.Truist increased the quarterly common dividend 8% during the year, paid $2.7 billion in common stock dividends or $2.00 per share, and repurchased $250 million of common stock. The dividend payout ratio for 2022 was 45% compared to 41% for the prior year. The total payout ratio for 2022 was 49% compared to 68% for the prior year, reflecting a greater focus on deploying capital to fund organic growth and acquisitions in 2022. In early 2023, Truist declared common dividends of $0.52 per share for the first quarter of 2023.ReclassificationsIn certain circumstances, reclassifications have been made to prior period information to conform to the current presentation. Such reclassifications had no effect on previously reported shareholders’ equity or net income. Refer to “Note 1. Basis of Presentation” for additional discussion regarding reclassifications.Critical Accounting PoliciesThe accounting and reporting policies of Truist are in accordance with GAAP and conform to the accounting and reporting guidelines prescribed by bank regulatory authorities. The financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues and expenses. Different assumptions in the application of these policies could result in material changes in the consolidated financial position and/or consolidated results of operations and related disclosures. Understanding Truist’s accounting policies is fundamental to understanding the consolidated financial position and consolidated results of operations. Accordingly, Truist’s significant accounting policies and effects of new accounting pronouncements are discussed in detail in “Note 1. Basis of Presentation.”The following is a summary of Truist’s critical accounting policies that are highly dependent on estimates, assumptions, and judgments. These critical accounting policies are reviewed with the Audit Committee of the Board of Directors on a periodic basis.76 Truist Financial CorporationACLTruist’s ACL represents management’s best estimate of expected future credit losses related to the loan and lease portfolios and off-balance sheet lending commitments at the balance sheet date. Estimates of expected future loan and lease losses are determined by using statistical models and management’s judgement. The models are designed to forecast probability of default, exposure at default and loss given default by correlating certain macroeconomic forecast data to historical experience. The models are generally applied at the portfolio level to pools of loans with similar risk characteristics. The macroeconomic data used in the models is based on forecasted variables for the reasonable and supportable period of two years. Beyond this forecast period the models gradually revert to long-term historical loss conditions over a one-year period. As a means of addressing uncertainty related to future economic conditions, the quantitative allowance includes an adjustment that reflects model output calculated using a range of potential future economic conditions. Expected losses are estimated through contractual maturity, giving appropriate consideration to expected prepayments unless the borrower has a right to renew that is not cancellable or it is reasonably expected that the loan will be modified as a TDR.A qualitative allowance which incorporates management’s judgement is also included in the estimation of expected future loan and lease losses, including qualitative adjustments in circumstances where the model output is inconsistent with management’s expectations with respect to expected credit losses. This allowance is used to adjust for limitations in modeled results related to the current economic conditions, and considerations with respect to the impact of current and expected events or risks, the outcomes of which are uncertain and may not be completely considered by quantitative models.Management considers a range of macroeconomic forecast data in connection with the allowance estimation process. Under the range of scenarios considered as of December 31, 2022, use of the Company’s pessimistic scenario would have resulted in an increase to the modeled allowance results of approximately $2.2 billion. This estimate reflects the sensitivity of the modeled allowance estimate to macroeconomic forecast data but does not consider other qualitative adjustments that could increase or decrease modeled loss estimates calculated using this alternative economic scenario.The Company individually evaluates expected credits losses related to loans and leases that do not share similar risk characteristics and loans that have been classified as a TDR. For individually evaluated loans, the ALLL is determined through review of data specific to the borrower and related collateral, if any, while for TDRs, default expectations and estimated prepayment speeds that are specific to each of the restructured loan populations are incorporated in the determination of the ALLL.The methodology used to determine an estimate for the RUFC is similar to that used to determine the funded component of the ALLL and is measured over the period there is a contractual obligation to extend credit that is not unconditionally cancellable. The RUFC is adjusted for factors specific to binding commitments, including the probability of funding and exposure at default. A detailed discussion of the methodology used in determining the ACL is included in “Note 1. Basis of Presentation.”Fair Value of Financial InstrumentsThe vast majority of assets and liabilities measured at fair value on a recurring basis are based on either quoted market prices or market prices for similar instruments. Refer to “Note 18. Fair Value Disclosures” for additional disclosures regarding the fair value of financial instruments and “Note 2. Business Combinations” for additional disclosures regarding business combinations.SecuritiesTruist generally utilizes a third-party pricing service in determining the fair value of its AFS investment securities, whereas trading securities are priced internally. Fair value measurements for investment securities are derived from market-based pricing matrices that were developed using observable inputs that include benchmark yields, benchmark securities, reported trades, offers, bids, issuer spreads, and broker quotes. Management performs procedures to evaluate the fair values provided by the third-party service provider. These procedures, which are performed independent of the responsible business unit, include comparison of pricing information received from the third-party pricing service to other third-party pricing sources, review of additional information provided by the third-party pricing service and other third-party sources for selected securities and back-testing to compare the price realized on security sales to the daily pricing information received from the third-party pricing service. The Enterprise Valuation Committee, which provides oversight to Truist’s enterprise-wide IPV function, is responsible for the comparison of pricing information received from the third-party pricing service or internally to other third-party pricing sources, approving tolerance limits determined by IPV for price comparison exceptions, reviewing significant changes to pricing and valuation policies and reviewing and approving the pricing decisions made on any illiquid and hard-to-price securities. When market observable data is not available, which generally occurs due to the lack of liquidity or inactive markets for certain securities, the valuation of the security is subjective and may involve substantial judgment by management to reflect unobservable input assumptions.Truist Financial Corporation 77MSRsTruist’s primary class of MSRs for which it separately manages the economic risks relates to residential mortgages. Residential MSRs do not trade in an active, open market with readily observable prices. While sales of MSRs do occur, the precise terms and conditions typically are not readily available. Accordingly, Truist estimates the fair value of residential MSRs using a stochastic OAS valuation model to project residential MSR cash flows over multiple interest rate scenarios, which are then discounted at risk-adjusted rates. The OAS model considers portfolio characteristics, contractually specified servicing fees, prepayment assumptions, delinquency rates, late charges, other ancillary revenue, costs to service and other economic factors. Truist reassesses and periodically adjusts the underlying inputs and assumptions in the OAS model to reflect market conditions and assumptions that a market participant would consider in valuing the residential MSR asset.Fair value estimates and assumptions are compared to industry surveys, recent market activity, actual portfolio experience and, when available, observable market data. Due to the nature of the valuation inputs, residential MSRs are classified within Level 3 of the valuation hierarchy. The value of residential MSRs is significantly affected by mortgage interest rates available in the marketplace, which influence mortgage loan prepayment speeds. In general, during periods of declining interest rates, the value of MSRs declines due to increasing prepayments attributable to increased mortgage-refinance activity. Conversely, during periods of rising interest rates, the value of residential MSRs generally increases due to reduced refinance activity. Truist typically hedges against market value changes in the residential MSRs. Refer to “Note 8. Loan Servicing” for quantitative disclosures reflecting the effect that changes in management’s assumptions would have on the fair value of residential MSRs.LHFSTruist originates certain residential and commercial mortgage loans for sale to investors that are measured at fair value. The fair value is primarily based on quoted market prices for securities backed by similar types of loans. Changes in the fair value are recorded as components of Mortgage banking income, while the related origination costs are generally recognized in Personnel expense when incurred. The changes in fair value are largely driven by changes in interest rates subsequent to loan funding and changes in the fair value of servicing associated with the LHFS. Truist uses various derivative instruments to mitigate the economic effect of changes in fair value of the underlying loans. LHFS also includes certain loans, generally carried at LOCOM, where management has committed to a formal plan of sale and the loans are available for immediate sale. Adjustments to reflect unrealized gains and losses resulting from changes in fair value, up to the original carrying amount, and realized gains and losses upon ultimate sale are classified as noninterest income. The fair value of these loans is estimated using observable market prices when available. When observable market prices are not available, the Company uses judgment and estimates fair value using internal models that reflect assumptions consistent with those that would be used by a market participant in estimating fair value. Refer to “Note 1. Basis of Presentation” for further description of the Company’s accounting for LHFS.Trading LoansTruist elects to measure certain loans at fair value for financial reporting where fair value aligns with the underlying business purpose. Specifically, loans included within this classification include trading loans that are (i) purchased in connection with the Company’s TRS business, (ii) part of the loan sales and trading business within the C&CB segment, or (iii) backed by the SBA. Refer to “Note 16. Commitments and Contingencies,” and “Note 19. Derivative Financial Instruments,” for further discussion of the Company’s TRS business. The loans purchased in connection with the Company’s TRS and sales and trading businesses are primarily commercial and corporate leveraged loans valued based on quoted prices for identical or similar instruments in markets that are not active by a third-party pricing service. SBA loans are fully guaranteed by the U.S. government as to contractual principal and interest and there is sufficient observable trading activity upon which to base the estimate of fair value.Derivative Assets and LiabilitiesTruist uses derivatives to manage various financial risks and in a dealer capacity to facilitate client transactions. Truist mitigates credit risk by subjecting counterparties to credit reviews and approvals similar to those used in making loans and other extensions of credit. In addition, certain counterparties are required to provide collateral to Truist when their unsecured loss positions exceed certain negotiated limits. The fair values of derivative financial instruments are determined based on quoted market prices and internal pricing models that use market observable data for interest rates, foreign exchange, equity, and credit. The fair value of interest rate lock commitments, which are related to mortgage loan commitments, is based on quoted market prices adjusted for commitments that Truist does not expect to fund and includes the value attributable to the net servicing fee. Refer to “Note 19. Derivative Financial Instruments” for further information on the Company’s derivatives.78 Truist Financial CorporationGoodwill and Other Intangible AssetsThe acquisition method of accounting requires that assets acquired and liabilities assumed in business combinations are recorded at their fair values. This often involves estimates based on third-party valuations or internal valuations based on discounted cash flow analyses or other valuation techniques, which are inherently subjective. The amortization of definite-lived intangible assets is based upon the estimated economic benefits to be received, which is also subjective. Business combinations also typically result in goodwill, which is subject to ongoing periodic impairment tests based on the fair values of the reporting units to which the acquired goodwill relates. Refer to “Note 1. Basis of Presentation” for a description of the impairment testing process.At December 31, 2022, Truist’s reporting units with goodwill balances were CB&W, C&CB, and IH. Management reviews the goodwill of each reporting unit for impairment on an annual basis as of October 1 or more often if events or circumstances indicate that it is more-likely-than-not that the fair value of a reporting unit is below its carrying value. For its annual impairment review, Truist elected to perform a qualitative test of each of its reporting units.In performing the qualitative assessment as of October 1, 2022, the Company evaluated events and circumstances since the last quantitative goodwill assessment, macroeconomic conditions, Truist’s own operations, key financial metrics, as well as reporting unit and Company financial performance, and the industry in which it operates. After assessing all relevant events or circumstances, Truist concluded that it is not more-likely-than-not that the fair value of a reporting unit is below its carrying value.The Company also performs sensitivity analyses around the assumptions used in the most recent quantitative test as well as relevant events or circumstances in order to assess the reasonableness of the assumptions, and the resulting estimated fair values. While the Company’s sensitivity analyses did not indicate risk of impairment as of October 1, 2022, future potential changes in these assumptions may impact the estimated fair value of a reporting unit and cause the fair value of the reporting unit to be below its carrying value. Additionally, a reporting unit’s carrying value could change based on market conditions, asset growth, or the risk profile of those reporting units, which could impact whether the fair value of a reporting unit is less than carrying value.The Company monitored events and circumstances during the fourth quarter of 2022, concluding that it was not more-likely-than-not that the fair value of one or more of its reporting units is below its respective carrying amount as of December 31, 2022.Income TaxesTruist is subject to income tax laws of the U.S., its states, and the municipalities in which the Company conducts business. In estimating the net amount due to or to be received from tax jurisdictions either currently or in the future, the Company assesses the appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent, and other pertinent information. The income tax laws are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities. Significant judgment is required in determining the tax accruals and in evaluating the Company’s tax positions, including evaluating uncertain tax positions. Changes in the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws and new judicial guidance, the status of examinations by the tax authorities, and newly enacted statutory and regulatory guidance that could impact the relative merits and risks of tax positions. These changes, when they occur, impact tax expense and can materially affect operating results. Truist reviews tax positions quarterly and adjusts accrued taxes as new information becomes available.Deferred income tax assets represent amounts available to reduce income taxes payable in future years. Such assets arise due to temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from NOL and tax credit carryforwards. The Company regularly evaluates the ability to realize DTAs, recognizing a valuation allowance if, based on the weight of available evidence, it is more-likely-than-not that some portion or all of the DTA will not be realized. In determining whether a valuation allowance is necessary, the Company considers the level of taxable income in prior years to the extent that carrybacks are permitted under current tax laws, as well as estimates of future pre-tax and taxable income and tax planning strategies that would, if necessary, be implemented. Truist currently maintains a valuation allowance for certain state carryforwards. For additional income tax information, refer to “Note 1. Basis of Presentation” and “Note 14. Income Taxes.”Pension and Postretirement Benefit ObligationsTruist offers various pension plans and postretirement benefit plans to teammates. Calculation of the obligations and related expenses under these plans requires the use of actuarial valuation methods and assumptions, which are subject to management judgment and may differ significantly if different assumptions are used. The discount rate assumption used to measure the postretirement benefit obligations is set by reference to an AA Above Median corporate bond yield curve and the individual characteristics of the plans such as projected cash flow patterns and payment durations.Truist Financial Corporation 79Management also considered the sensitivity that changes in the expected return on plan assets and the discount rate would have on pension expense. For the Company’s qualified plans, a decrease of 25 basis points in the discount rate would result in additional pension expense of approximately $46 million for 2023, while a decrease of 100 basis points in the expected return on plan assets would result in an increase of approximately $136 million in pension expense for 2023. This estimate reflects the sensitivity of certain factors considered in calculation of pension expense but does not consider all factors that could increase or decrease estimates calculated.The calculation of pension assets and liabilities is also impacted by the year-end valuation, which takes into account the difference between the actual return on plan assets and the estimated return on plan assets that was recognized during the year, as well as an updated discount rate based on current market rates. The year-end valuation resulted in a pre-tax loss in other comprehensive income of $1.9 billion for all pension plans. As expected return on plan assets is determined with the prior year-end’s plan asset valuation, the lower year-end plan asset valuation and related amortization of accumulated other comprehensive income will reduce the expected return on plan assets component of net periodic pension cost recognized in other expense in 2023.Refer to “Note 15. Benefit Plans” for disclosures related to the benefit plans.80 Truist Financial Corporation
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K. For a comparison of our Results of Operations for the years ended December 31, 2021, and 2020, and our Cash Flow discussion for the year ended December 2021, see “Part II, Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on February 23, 2022. CAUTIONARY NOTE CONCERNING FORWARD-LOOKING STATEMENTSThis document contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are not historical in nature and typically address future or anticipated events, trends, expectations or beliefs with respect to our financial condition, results of operations or business. Forward-looking statements often contain words such as “believes,” “expects,” “anticipates,” “foresees,” “forecasts,” “estimates,” “plans,” “intends,” “continues,” “may,” “will,” “should,” “projects,” “might,” “could” or other similar words or phrases. Similarly, statements that describe our business strategy, outlook, objectives, plans, intentions or goals also are forward-looking statements. We believe there is a reasonable basis for our forward-looking statements, but they are inherently subject to risks and uncertainties and actual results could differ materially from the expectations and beliefs reflected in the forward-looking statements. We presently consider the following to be among the important factors that could cause actual results to differ materially from our expectations and beliefs: (1) the continuing effects of the COVID-19 pandemic, including its potential effects on the economic environment, our customers and our operations, as well as any changes to federal, state or local government laws, regulations or orders in connection with the pandemic; (2) changes in the budgets or regulatory environments of our clients, primarily local and state governments, that could negatively impact information technology spending; (3) disruption to our business and harm to our competitive position resulting from cyber-attacks and security vulnerabilities; (4) our ability to protect client information from security breaches and provide uninterrupted operations of data centers; (5) our ability to achieve growth or operational synergies through the integration of acquired businesses, while avoiding unanticipated costs and disruptions to existing operations; (6) material portions of our business require the internet infrastructure to be adequately maintained; (7) our ability to achieve our financial forecasts due to various factors, including project delays by our clients, reductions in transaction size, fewer transactions, delays in delivery of new products or releases or a decline in our renewal rates for service agreements; (8) general economic, political and market conditions, including inflation and changes in interest rates; (9) technological and market risks associated with the development of new products or services or of new versions of existing or acquired products or services; (10) competition in the industry in which we conduct business and the impact of competition on pricing, client retention and pressure for new products or services; (11) the ability to attract and retain qualified personnel and dealing with the loss or retirement of key members of management or other key personnel; and (12) costs of compliance and any failure to comply with government and stock exchange regulations. A detailed discussion of these factors and other risks that affect our business are described in Item 1A, “Risk Factors”. We expressly disclaim any obligation to publicly update or revise our forward-looking statements.OVERVIEWGeneralWe provide integrated information management solutions and services for the public sector. We develop and market a broad line of software products and services to address the IT needs of public sector entities. We provide subscription-based services such as software as a service (“SaaS”), transaction-based fees primarily related to digital government services and online payment processing, and electronic document filing solutions (“e-filing”), which simplify the filing and management of court related documents. In addition, we provide professional IT services to our clients, including software and hardware installation, data conversion, training, and for certain clients, product modifications, along with continuing maintenance and support for clients using our systems. Additionally, we provide property appraisal outsourcing services for taxing jurisdictions.We provide our software systems and related professional services and appraisal services through seven business units, which focus on the following products:•financial management, education and planning, regulatory, and maintenance software solutions;•financial management, municipal courts, planning, regulatory, and maintenance software solutions;•courts and justice and public safety software solutions; •data and insights solutions;•appraisal and tax software solutions, land and vital records management software solutions, and property appraisal services;•development platform solutions including case management and business process management; and•digital government and payments solutions.25In accordance with ASC 280-10, Segment Reporting, we report our results in two reportable segments. The Enterprise Software (“ES”) reportable segment provides public sector entities with software systems and services to meet their information technology and automation needs for mission-critical “back-office” functions such as: financial management and education; planning, regulatory and maintenance; courts and justice; public safety; data and insights; appraisal and tax software solutions; land and vital records management software solutions; and property appraisal services. The Platform Technologies (“PT”) reportable segment provides public sector entities with software solutions to perform transaction processing, streamline data processing, and improve operations and workflows such as digital government and payments solutions and development platform solutions.We evaluate performance based on several factors, of which the primary financial measure is business segment operating income. We define segment operating income for our business units as income before non-cash amortization of intangible assets associated with their acquisitions, interest expense, and income taxes. Segment operating income includes intercompany transactions. The majority of intercompany transactions relate to contracts involving more than one unit and are valued based on the contractual arrangement. Corporate segment operating loss primarily consists of compensation costs for the executive management team, certain shared services staff, and share-based compensation expense for the entire company. Corporate segment operating income also includes revenues and expenses related to a company-wide user conference. As of January 1, 2022, the appraisal and tax software solutions, land and vital records management software solutions, and property appraisal service business unit, which was previously reported in the Appraisal & Tax ("A&T") reportable segment, was moved to the ES reportable segment. The digital government and payments solutions, which was previously reported in the NIC reportable segment, and development platform solutions moved to the PT reportable segment to reflect changes in the way in which management makes operating decisions, allocates resources, and manages the growth and profitability of the Company. As a result of the changes in our reportable segments, the former A&T and NIC reportable segments are no longer considered separate segments. Prior period amounts for the ES and PT reportable segments have been adjusted to reflect the segment change. See Note 17, "Segment and Related Information," in the notes to the consolidated financial statements for additional information. Certain amounts for previous years have been reclassified to conform to the current year presentation. We have elected to present amortization of software development, previously included in the cost of revenues software licenses and royalties line item, in a separate category line item on the consolidated statements of income for all reporting periods presented. Previously disclosed as selling, general and administrative expense is now disclosed in separate line items: sales and marketing expense and general and administrative expense on the consolidated statements of income for all reporting periods presented.Recent Acquisitions 2022On October 31, 2022, we acquired Rapid Financial Solutions, LLC, a principal provider of reliable, scalable, and secure payments with best-in-class card issuance and digital disbursement capabilities. The total purchase price, net of cash acquired of $2.2 million, was approximately $67.7 million, consisting of $51.2 million paid in cash, $18.2 million of common stock, and $500,000 related to working capital holdbacks, subject to certain post-closing adjustments.On February 8, 2022, we acquired US eDirect Inc. (US eDirect), a leading provider of technology solutions for campground and outdoor recreation management. The total purchase price, net of cash acquired of $6.4 million, was approximately $116.5 million, consisting of $118.8 million paid in cash and approximately $4.1 million related to indemnity holdbacks.2021On September 9, 2021, we acquired all the equity interest of Ultimate Information Systems, Inc. (dba Arx). Arx is a cloud-based platform which creates accessible technology to enable a modern-day police force that is fully transparent, accountable, and a trusted resource to the community it serves. The total purchase price, net of cash acquired, was approximately $12.8 million.On September 1, 2021, we acquired VendEngine, Inc (VendEngine), a cloud-based software provider focused on financial technology for the corrections market. The total purchase price, net of cash acquired of $1.7 million, was approximately $83.6 million, consisting of $81.6 million paid in cash, and approximately $3.8 million related to indemnity holdbacks.On April 21, 2021, we acquired NIC, a leading digital government solutions and payment company that primarily serves federal and state government agencies. The total purchase price, net of cash acquired of $331.8 million, was approximately $2.0 billion, consisting of cash paid of $2.3 billion and $1.9 million of purchase consideration related to the conversion of unvested restricted stock awards.On March 31, 2021, we completed two acquisitions, Glass Arc, Inc. (dba ReadySub) and DataSpec, Inc. (DataSpec), for the combined purchase price of $12.1 million. 262022 Operating ResultsFor the twelve months ended December 31, 2022, total revenues increased 16% compared to the prior period. Excluding the 2022 impact of recent acquisitions1, total revenues increased 4% compared to prior period. Revenues from acquisitions contributed 12.4% of growth for the twelve months ended December 31, 2022. Subscriptions revenue grew 29.0% for the twelve months ended December 31, 2022, due to an ongoing shift toward a cloud-based, software as a service business model, as well as the inclusion of transaction-based revenue from NIC’s digital government and payments processing businesses. Excluding the 2022 impact of recent acquisitions1, subscriptions revenue increased 6.3% for the twelve months ended December 31, 2022. The majority of our revenues are comprised of revenues from subscriptions and maintenance, which we consider to be recurring revenues. Annualized recurring revenues ("ARR") is calculated based on quarter-to-date end total recurring revenues multiplied by four. ARR was $1.50 billion and $1.39 billion as of December 31, 2022, and 2021, respectively. ARR increased 8% compared to the prior period, due to an increase in subscriptions revenue due to an ongoing shift toward SaaS arrangements.For the twelve months ended December 31, 2022, total revenues include COVID-related subscriptions revenue of $10.8 million from NIC’s Tour Health offering and professional services revenue of $40.2 million from pandemic unemployment and Virginia rent relief offerings. These programs all ended in 2022 and we do not expect to generate COVID-related subscriptions revenue and professional services revenue in future periods. We monitor and analyze several key performance indicators in order to manage our business and evaluate our financial and operating performance. These indicators include the following:Revenues – We derive our revenues from five primary sources: subscription-based arrangements; maintenance; professional services; sale of software licenses and royalties; and appraisal services. Subscriptions and maintenance are considered recurring revenue sources and comprised approximately 80% of our revenues in 2022. The number of new SaaS clients and the number of existing clients who convert from our traditional software arrangements to our SaaS model are a significant driver of our revenue growth, together with new software license sales and maintenance rate increases. We monitor ARR which is calculated based on quarter-to-date end total recurring revenues multiplied by four. As of December 31, 2022, ARR was $1.50 billion. In addition, we also monitor our customer base and turnover, which historically is very low. During 2022, based on our number of customers, turnover was approximately 2%.Cost of Revenues and Gross Margins – Our primary cost component is personnel expenses in connection with providing software implementation, subscription-based services, maintenance and support, and appraisal services to our clients. We can improve gross margins by controlling headcount and related costs and by expanding our revenue base, especially from those products and services that produce incremental revenue with minimal incremental cost, such as software licenses and royalties, subscription-based services, and maintenance and support. Our appraisal projects are cyclical in nature, and we often employ appraisal personnel on a short-term basis to coincide with the life of a project. As of December 31, 2022, our total employee count included in cost of revenues increased to 5,021 from 4,746 at December 31, 2021, including 56 employees who joined us through acquisitions completed since December 31, 2021.Sales and Marketing (“S&M”) Expense – The primary components of S&M expense include sales personnel salaries and share-based compensation expense, sales commissions, travel-related expenses, advertising and marketing materials, and allocated depreciation, facilities, and IT support. Sales commissions typically fluctuate with revenues and share-based compensation expense generally increases based increased level of awards issues during the period and as the market price of our stock increases. Other administrative expenses tend to grow at a slower rate than revenues.General and Administrative (“G&A”) Expense – The primary components of G&A expense include personnel salaries and share-based compensation expense for general corporate functions, including senior management, finance, accounting, legal, human resources and corporate development, third party professional fees, travel-related expenses, insurance, allocation of depreciation, facilities and IT support costs, acquisition-related expenses and other administrative expenses. Share-based compensation expense generally increases as the market price of our stock increases. Other administrative expenses tend to grow at a slower rate than revenues.Liquidity and Cash Flows – The primary driver of our cash flows is net income. Uses of cash include acquisitions, capital investments in property and equipment and discretionary purchases of treasury stock. Our working capital needs are fairly stable throughout the year with the significant components of cash outflows being payment of personnel expenses offset by cash inflows representing collection of accounts receivable and cash receipts from clients in advance of revenue being earned. In recent years, 1 Excludes the 2022 incremental impact as a result of not having the recent acquisition for a full fiscal year.27we have also received significant amounts of cash from employees exercising stock options and contributing to our Employee Stock Purchase Plan.Balance Sheet – Cash, accounts receivable and days sales outstanding and deferred revenue balances are important indicators of our business.OutlookThe local government software market continues to be active with sales activity trending at or near pre-pandemic levels in most sectors of our business, and our backlog at December 31, 2022 reached $1.89 billion, a 5% increase from the prior period. We expect to continue to achieve solid growth in revenues and earnings. With our strong financial position and cash flow, we plan to continue to make significant investments in product development and accelerating our move to the cloud to better position us to continue to expand our addressable market and strengthen our competitive position over the long term. The expenses associated with the cloud transition are expected to pressure operating margins in 2023 and 2024.CRITICAL ACCOUNTING ESTIMATESOur discussion and analysis of financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements, the reported amounts of revenues, cost of revenues and expenses during the reporting period, and related disclosure of contingencies. The Notes to the Financial Statements included as part of this Annual Report describe our significant accounting policies used in the preparation of the financial statements. Significant items subject to such estimates and assumptions include the application of the progress toward completion methods of revenue recognition, estimated standalone selling price ("SSP") for distinct performance obligations, the fair value amount and estimated useful lives of intangible assets, determination of share-based compensation expense and allowance for losses and sales adjustments. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.We believe the following critical accounting policies require significant judgments and estimates used in the preparation of our financial statements.Revenue Recognition. We earn revenues from software licenses, royalties, subscription-based services, professional services, post-contract customer support (“PCS” or “maintenance”), hardware, and appraisal services. Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We determine revenue recognition through the following steps:•Identification of the contract, or contracts, with a customer•Identification of the performance obligations in the contract•Determination of the transaction price•Allocation of the transaction price to the performance obligations in the contract•Recognition of revenue when, or as, we satisfy a performance obligationOur software arrangements with customers contain multiple performance obligations that range from software licenses and SaaS arrangements, installation, training, and consulting to software modification and customization to meet specific customer needs (services), hosting, and PCS. For these contracts, we account for individual performance obligations separately when they are distinct. We evaluate whether separate performance obligations can be distinct or should be accounted for as one performance obligation. Arrangements that include professional services, such as training or installation, are evaluated to determine whether the customer can benefit from the services either on their own or together with other resources readily available to the customer and whether the services are separately identifiable from other promises in the contract. Many of our software arrangements involve “off-the-shelf” software. We recognize the revenue allocable to "off-the-shelf" software licenses and specified upgrades at a point in time when control of the software license transfers to the customer, unless the software is not considered distinct. We consider off-the-shelf software to be distinct when it can be added to an arrangement with minor changes in the underlying code, it can be used by the customer for the customer’s purpose upon installation, and remaining services such as training are not considered highly interdependent or highly interrelated to the product's functionality. 28For arrangements that involve significant production, modification or customization of the software, or where professional services are otherwise not considered distinct, we recognize revenue over time by measuring progress-to-completion. We measure progress-to-completion primarily using labor hours incurred as it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. These arrangements are often implemented over an extended period and occasionally require us to revise total cost estimates. Amounts recognized in revenue are calculated using the progress-to-completion measurement after giving effect to any changes in our cost estimates. Changes to total estimated contract costs, if any, are recorded in the period they are determined. Estimated losses on uncompleted contracts are recorded in the period in which we first determine that a loss is apparent. When professional services are distinct, the fee allocable to the service element is recognized over the time we perform the services and is billed on a time and material or milestones basis.Subscription-based services consist of revenues derived from SaaS arrangements, transaction and payment processing, electronic filing transactions, and digital government services. Revenue from subscription-based services is generally recognized over time on a ratable basis over the contract term, beginning on the date that our service is made available to the customer. For SaaS arrangements, we evaluate whether the customer has the contractual right to take possession of our software at any time during the hosting period without significant penalty and whether the customer can feasibly maintain the software on the customer’s hardware or enter into another arrangement with a third-party to host the software. We allocate contract value to each performance obligation of the arrangement that qualifies for treatment as a distinct element based on estimated SSP. We recognize SaaS arrangements ratably over the terms of the arrangements, which range from one to ten years, but are typically for periods of three to five years. For professional services associated with certain SaaS arrangements, we have concluded that the services are not distinct, and we recognize the revenue ratably over the remaining contractual period once we have provided the customer access to the software. We record amounts that have been invoiced in accounts receivable and in deferred revenue or revenues, depending on whether the revenue recognition criteria have been met.For transaction and payments revenue and e-filing transaction fees, we have the right to charge the customer an amount that directly corresponds with the value to the customer of our performance to date. Therefore, we recognize revenue for these services over time based on the amount billable to the customer in accordance with the 'as invoiced' practical expedient in ASC 606-10-55-18. In some cases, we are paid on a fixed fee basis and recognize the revenue ratably over the contractual period. Typically, the structure of our arrangements does not give rise to variable consideration. However, in those instances whereby variable consideration exists, we include in our estimates, additional revenue for variable consideration when we believe we have an enforceable right, the amount can be estimated reliably and its realization is probable. The transaction price is allocated to the separate performance obligations on a relative SSP basis. We determine the SSP based on our overall pricing objectives, taking into consideration market conditions and other factors, including the value of our contracts, the applications sold, customer demographics, and the number and types of users within our contracts. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine SSP using the expected cost-plus margin approach. Revenue is recognized net of allowances for sales adjustments and any taxes collected from customers, which are subsequently remitted to governmental authorities.We maintain allowances for losses and sales adjustments, which losses are recorded against revenues at the time the loss is incurred. Since most of our clients are domestic governmental entities, we rarely incur a credit loss resulting from the inability of a client to make required payments. Events or changes in circumstances that indicate the carrying amount for the allowances for losses and sales adjustments may require revision, include, but are not limited to, managing our client’s expectations regarding the scope of the services to be delivered and defects or errors in new versions or enhancements of our software products. Our allowance for losses and sales adjustments of $14.8 million and $12.1 million at December 31, 2022, and December 31, 2021, respectively, does not include provisions for credit losses. As of January 1, 2020, we adopted ASU 2016-13, Financial Instruments - Credit Losses, and primarily evaluated our historical experience with credit losses related to trade and other receivables. Because we rarely experience credit losses with our clients, we have not recorded a material reserve for credit losses.In connection with certain of our contracts, we have recorded retentions receivable or unbilled receivables consisting of costs and estimated profit in excess of billings as of the balance sheet date. Many of the contracts which give rise to unbilled receivables at a given balance sheet date are subject to billings in the subsequent accounting period. We review unbilled receivables and related contract provisions to ensure we are justified in recognizing revenue prior to billing the customer and that we have objective evidence which allows us to recognize such revenue. In addition, we have a sizable amount of deferred revenue, which represents billings in excess of revenue earned. The majority of this liability consists of subscriptions and maintenance billings for which payments are made in advance and the revenue is ratably earned over the subscription or maintenance billing period, generally one year. We also have deferred revenue for those contracts in which we receive a deposit and the conditions in which to record revenue for the service or product have not been met. On a periodic basis, we review by customer the detail components of our deferred revenue to ensure our accounting remains appropriate.29Business Combinations. Accounting for the acquisition of a business requires the allocation of the purchase price to the various assets acquired and liabilities assumed at their respective fair values. The determination of fair value requires the use of significant estimates and assumptions, and in making these determinations, management uses all available information. For tangible and identifiable intangible assets acquired in a business combination, management estimates the fair value of assets acquired and liabilities assumed based on quoted market prices, the carrying value of the acquired assets and widely accepted valuation techniques, including discounted cash flows and market multiple analyses. The assumptions made in performing these valuations include, but are not limited to, discount rates, future revenues and operating costs, projections of capital costs, and other assumptions believed to be consistent with those used by principal market participants. Due to the specialized nature of these calculations, we engage third-party specialists to assist management in evaluating our assumptions as well as appropriately measuring the fair value of assets acquired and liabilities assumed. We adjust the preliminary purchase price allocation, as necessary, up to one year after the acquisition closing date as we obtain new information about facts and circumstances that existed as of the closing date. If actual results are materially different than the assumptions we used to determine fair value of the assets acquired and liabilities assumed through a business combination as well as the estimated useful lives of the acquired intangible assets, it is possible that adjustments to the carrying values of such assets and liabilities will have a material impact on our financial position and results of operations.Intangible Assets and Goodwill. Our business acquisitions typically result in the creation of goodwill and other intangible asset balances, and these balances affect the amount and timing of future period amortization expense, as well as expense we could possibly incur as a result of an impairment charge. The cost of acquired companies is allocated to identifiable tangible and intangible assets based on estimated fair value, with the excess allocated to goodwill. Accordingly, we have a significant balance of acquisition date intangible assets, including software, customer related intangibles, trade name, leases and goodwill. These intangible assets (other than goodwill) are amortized over their estimated useful lives. We currently have no intangible assets with indefinite lives other than goodwill.We assess goodwill for impairment annually, or more frequently whenever events or changes in circumstances indicate its carrying value may not be recoverable. We begin with the qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying value before applying the quantitative assessment described below. When testing goodwill for impairment quantitatively, we first compare the fair value of each reporting unit with its carrying amount. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized. The fair values calculated in our impairment tests are determined using discounted cash flow models involving several assumptions (Level 3 inputs). The assumptions that are used are based upon what we believe a hypothetical marketplace participant would use in estimating fair value. We base our fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. We evaluate the reasonableness of the fair value calculations of our reporting units by comparing the total of the fair value of all of our reporting units to our total market capitalization. During the fourth quarter, as part of our annual impairment test as of October 1, we performed qualitative assessments for the reporting units containing the recently acquired data and insights, digital government and payments solutions, and development platform solutions, and concluded no impairment existed as of our annual assessment date. Approximately $1.7 billion, or 70%, of total goodwill as of December 31, 2022, relates to these reporting units, which as a result of these recent acquisitions, do not have significant excess fair values over carrying values. We performed qualitative assessments for the remaining reporting units in which we determined that it not more likely than not that the fair value exceeded the carrying value; therefore, we did not perform a Step 1 quantitative impairment test. Our annual goodwill impairment analysis did not result in an impairment charge. During 2022, we have recorded no impairment to goodwill as no triggering events or change in circumstances indicating a potential impairment has occurred as of period-end.Determining the fair value of our reporting units involves the use of significant estimates and assumptions and considerable management judgment. We base our fair value estimates on assumptions we believe to be reasonable at the time, but such assumptions are subject to inherent uncertainty. Changes in market conditions or other factors outside of our control, such as the COVID-19 pandemic, could cause us to change key assumptions and our judgment about a reporting unit’s prospects. Similarly, in a specific period, a reporting unit could significantly underperform relative to its historical or projected future operating results. Either situation could result in a meaningfully different estimate of the fair value of our reporting units, and a consequent future impairment charge. 30All intangible assets (other than goodwill) are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of other intangible assets is measured by comparison of the carrying amount to estimated undiscounted future cash flows. The assessment of recoverability or of the estimated useful life for amortization purposes will be affected if the timing or the amount of estimated future operating cash flows is not achieved. Such indicators may include, among others: a significant decline in expected future cash flows; a sustained, significant decline in stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; and reductions in growth rates. In addition, products, capabilities, or technologies developed by others may render our software products obsolete or non-competitive. Any adverse change in these factors could have a significant impact on the recoverability of goodwill or other intangible assets. During 2022, we did not identify any triggering events that would indicate that the carrying amount of our intangible assets may not be recoverable.Recent adoption of new accounting pronouncementsIn October 2021, the FASB issued ASU 2021-08 - Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (ASC 805) (“ASU 2021-08”). ASU 2021-08 requires an acquirer in a business combination to recognize and measure contract assets and contract liabilities (deferred revenue) from acquired contracts using the revenue recognition guidance in Topic 606. Under this "Topic 606 approach," the acquirer applies the revenue model as if it had originated the contracts. This is a departure from the current requirement to measure contract assets and contract liabilities at fair value. ASU 2021-08 is effective for all public business entities in annual and interim periods starting after December 15, 2022, and early adoption is permitted. An entity that early adopts should apply the amendments (1) retrospectively to all business combinations for which the acquisition date occurs on or after the beginning of the fiscal year that includes the interim period of early application and (2) prospectively to all business combinations that occur on or after the date of initial application. We early adopted as of January 1, 2022. The adoption of ASU 2021-08 resulted in no adjustments to the fair value of the deferred revenue balances assumed in our 2022 acquisitions. See Note 2, “Acquisitions,” to the consolidated financial statements for further discussion. Recent Accounting Guidance not yet AdoptedThere were no new not yet adopted accounting pronouncements currently issued that would affect the Company or have a material impact on its consolidated financial position or results of operations in future periods. 31ANALYSIS OF RESULTS OF OPERATIONS AND OTHERThe following discussion compares the historical results of operations on a basis consistent with GAAP for the years ended December 31, 2022, 2021 and 2020.Percentage of Total RevenuesYears Ended December 31,202220212020Revenues: Subscriptions54.7 %49.3 %31.4 %Maintenance25.3 29.8 41.9 Professional services13.1 13.2 16.7 Software licenses and royalties3.2 4.6 6.5 Appraisal services1.9 1.7 1.9 Hardware and other1.8 1.4 1.6 Total revenues100.0 100.0 100.0 Cost of revenues: Subscriptions, maintenance, and professional services51.6 50.3 45.8 Software licenses, royalties, and amortization of acquired software3.1 3.1 3.2 Amortization of software development0.4 0.1 — Appraisal services1.3 1.2 1.4 Hardware and other1.3 0.8 1.1 Sales and marketing expense7.3 7.4 8.8 General and administrative expense14.4 17.1 14.4 Research and development expense5.7 5.9 7.9 Amortization of customer and trade name intangibles3.3 2.8 1.9 Operating income11.6 11.3 15.5 Interest expense(1.5)(1.5)(0.1)Other income, net0.1 0.1 0.3 Income before income taxes10.2 9.9 15.7 Income tax provision (benefit)1.3 (0.2)(1.8)Net income8.9 %10.1 %17.5 %2022 Compared to 2021 RevenuesRecent AcquisitionsOn October 31, 2022, we acquired Rapid Financial Solutions, LLC (Rapid), a provider of reliable, scalable, and secure payments with best-in-class card issuance and digital disbursement capabilities. On February 8, 2022, we acquired US eDirect Inc. (US eDirect), a leading provider of technology solutions for campground and outdoor recreation management. On April 21, 2021, we acquired NIC, Inc., a leading digital government solutions and payment company that serves federal, state and local government agencies. US eDirect and Rapid are operated as a part of the digital government and payment solutions business unit (also known as the NIC division) and the results of NIC, US eDirect, and Rapid from their respective dates of acquisition, are included with the operating results of the PT segment.32The following table details revenues for the NIC division for the period from acquisition through December 31, 2022 and 2021, which are presented in our consolidated statements of income from the date of acquisition and included in the operating results of the PT reportable segment (in thousands).20222021Revenues:Subscriptions$470,904 $344,692 Maintenance810 560 Professional services50,006 23,665 Software licenses and royalties— — Appraisal services— — Hardware and other— — Total revenues$521,720 $368,917 Subscriptions.The following table sets forth a comparison of our subscriptions revenue for the years ended December 31 ($ in thousands): Change20222021$%ES$526,323 $425,078 $101,245 24 %PT485,981 359,357 126,624 35 Total subscriptions revenue$1,012,304 $784,435 $227,869 29 %Less: Revenue from recent acquisitions 2(178,363)— (178,363)Total subscriptions revenue excluding acquisitions$833,941 $784,435 $49,506 6 %Subscriptions revenue consists of revenue derived from our SaaS arrangements and transaction-based fees primarily related to digital government services and payment processing. We also provide electronic document filing solutions (“e-filing”) that simplify the filing and management of court related documents for courts and law offices. E-filing revenue is derived from transaction fees and fixed fee arrangements.Subscriptions revenue grew 29% compared to 2021, primarily due to the inclusion of transaction-based revenues from NIC including Rapid and US eDirect from the respective dates of acquisition. Excluding the incremental impact of recent acquisitions, subscriptions revenue increased 6%. New SaaS clients as well as existing clients who converted to our SaaS model provided the majority of the subscriptions revenue increase. In 2022, we added 609 new SaaS clients and 336 existing clients elected to convert to our SaaS model. Our mix of new software contracts in 2022 was approximately 23% perpetual software license arrangements and approximately 77% subscription-based arrangements compared to total new client mix in 2021 of approximately 33% perpetual software license arrangements and approximately 67% subscription-based arrangements. Total subscriptions revenue derived from transaction-based fees was $600.8 million and $454.8 million for the twelve months ended December 31, 2022 and 2021, respectively. The increase of $146.0 million or 32% is attributable to inclusion of the NIC division, including Rapid and US eDirect transaction-based revenues from the respective dates of acquisition. Transaction-based revenue from the NIC division was $470.9 million and $344.7 million for the twelve months ended December 31, 2022, and 2021, respectively. Excluding NIC, transaction-based fees contributed $19.8 million to the increase in subscriptions revenue due to the increased volumes of online payments and e-filing services in 2022.2 Excludes the 2022 incremental impact as a result of not having the recent acquisition for a full fiscal year.33Maintenance.The following table sets forth a comparison of our maintenance revenue for the years ended December 31 ($ in thousands): Change20222021$%ES$444,143 $439,589 $4,554 1 %PT24,312 34,698 (10,386)(30)Total maintenance revenue$468,455 $474,287 $(5,832)(1)%Less: Revenue from recent acquisitions 2(689)— (689)Total maintenance revenue excluding acquisitions$467,766 $474,287 $(6,521)(1)%We provide maintenance and support services for our software products and certain third-party software. Maintenance revenue decreased 1% compared to the prior period. Maintenance revenue declined mainly due to attrition related to a legacy case management solution and clients converting from on-premises license arrangements to SaaS, partially offset by annual maintenance rate increases and maintenance associated with new software license sales.Annualized Recurring RevenuesSubscriptions and maintenance are considered recurring revenue sources. Annualized recurring revenues ("ARR") is calculated based on quarter-end total recurring revenues multiplied by four. ARR was $1.50 billion and $1.39 billion as of December 31, 2022, and 2021, respectively. ARR increased 8% compared to the prior period due to an increase in subscriptions revenue resulting from an ongoing shift toward SaaS arrangements.Professional services.The following table sets forth a comparison of our professional services revenue for the years ended December 31 ($ in thousands): Change20222021$%ES$170,462 $165,396 $5,066 3 %PT72,655 43,995 28,660 65 Total professional services revenue$243,117 $209,391 $33,726 16 %Less: Revenue from recent acquisitions 2(17,073)— (17,073)Total professional services revenue excluding acquisitions$226,044 $209,391 $16,653 8 %Professional services revenue primarily consists of professional services billed in connection with implementing our software, converting client data, training client personnel, custom development activities and consulting. New clients who purchase our proprietary software licenses or subscriptions generally also contract with us to provide the related professional services. Existing clients also periodically purchase additional training, consulting and minor programming services. Professional services revenue increased 16% compared to the prior year, primarily due to the inclusion of revenues from recent acquisitions from the date of acquisition. Excluding the incremental impact of recent acquisitions, professional services revenue increased 8%. The increase in professional services revenue is primarily attributed to higher revenues generated by the continued COVID pandemic-related rent relief services and the return of billable travel revenue as onsite services have increased since 2021. The increases are partially offset by more clients selecting our cloud solutions instead of our on-premises license arrangements which typically require more professional services.34Software licenses and royalties.The following table sets forth a comparison of our software licenses and royalties revenue for the years ended December 31 ($ in thousands): Change20222021$%ES$55,158 $66,816 $(11,658)(17)%PT4,248 7,636 (3,388)(44)Total software licenses and royalties revenue$59,406 $74,452 $(15,046)(20)%Less: Revenue from recent acquisitions 2— — — Total software licenses and royalties revenue excluding acquisitions$59,406 $74,452 $(15,046)(20)%Software licenses and royalties revenue decreased 20% compared to the prior period. The decline is primarily attributed to the shift in the mix of new software contracts toward more subscription-based agreements compared to the prior period. Although the mix of new contracts between subscription-based and perpetual license arrangements may vary from quarter to quarter and year to year, we expect the decline in software license revenues will accelerate as we continue to shift our model away from perpetual licenses to SaaS. Subscription-based arrangements result in lower software license revenue in the initial year as compared to perpetual software license arrangements but generate higher overall revenue over the term of the contract. Appraisal services.The following table sets forth a comparison of our appraisal services revenue for the years ended December 31 ($ in thousands): Change20222021$%ES$34,508 $27,788 $6,720 24 %PT— — — — Total appraisal services revenue$34,508 $27,788 $6,720 24 %Less: Revenue from recent acquisitions 2— — — Total appraisal services revenue excluding acquisitions$34,508 $27,788 $6,720 24 %In 2022, appraisal services revenue grew 24% compared to the prior period primarily due to relaxed travel restrictions allowing for the ramp-up of appraisal services for several new revaluation contracts which started in recent quarters. The appraisal services business is somewhat cyclical and driven in part by statutory revaluation cycles in various states.Cost of revenues and gross marginsThe following table sets forth a comparison of the key components of our cost of revenues for the years ended December 31 ($ in thousands): Change20222021$%Subscriptions, maintenance, and professional services$953,897 $799,158 $154,739 19 %Software licenses and royalties6,083 3,552 2,531 71 Amortization of software development6,507 2,325 4,182 180 Amortization of acquired software52,192 45,601 6,591 14 Appraisal services23,988 19,061 4,927 26 Hardware and other23,674 12,946 10,728 83 Total cost of revenues$1,066,341 $882,643 $183,698 21 %35The following table sets forth a comparison of gross margin percentage by revenue type for the years ended December 31:20222021ChangeSubscriptions, maintenance, and professional services44.7 %45.6 %(0.9)%Software licenses, royalties, software development, and acquired software(9.0)30.9 (39.9)Appraisal services30.5 31.4 (0.9)Hardware and other27.0 41.0 (14.0)Overall gross margin42.4 %44.6 %(2.2)%Gross margin percentage by revenue type, excluding the incremental impact of recent acquisitions 2, for the years ended December 31:20222021ChangeSubscriptions, maintenance, and professional services45.8 %45.6 %0.2 %Software licenses, royalties, software development, and acquired software7.1 30.9 (23.8)Appraisal services30.5 31.4 (0.9)Hardware and other27.9 41.0 (13.1)Overall gross margin43.8 %44.6 %(0.8)%Subscriptions, maintenance, and professional services. Cost of subscriptions, maintenance and professional services primarily consists of personnel costs related to installation of our software, conversion of client data, training client personnel and support activities and various other services such as custom client development, on-going operation of SaaS, digital government, and other transaction-based services such as e-filing. Other costs included are interchange fees required to process credit/debit card transactions and bank fees to process automated clearinghouse transactions related to our payments business. In 2022, the subscriptions, maintenance and professional services gross margin declined 0.9% compared to the prior period primarily due to several factors, including lower maintenance revenue resulting from attrition related to a legacy case management solution; a post-COVID return of low-margin revenues such as billable travel; higher personnel costs related to inflation, as well as costs related to onboarding new professional services employees who are not yet billable; and higher hosting costs related to our accelerated shift to the cloud. Our implementation and support staff grew by 225 employees since December 31, 2021, as we increased hiring to ensure that we are well-positioned to deliver our current backlog and anticipated new business. Excluding the incremental impact from recent acquisitions of $70 million, gross margin was 45.8% in 2022, a slight increase of 0.2% which is attributable to an increase in SaaS arrangements and the decline in low margin COVID-related transaction-based revenues compared to the prior period.Software licenses, royalties, software development, and acquired software. Amortization expense for acquired software comprises the majority of costs of software licenses, royalties, software development, and acquired software. We do not have any direct costs associated with royalties. The gross margin for software licenses, royalties, software development, and acquired software was negative 9.0% in 2022 and 30.9% in 2021. Excluding the impact of amortization expense of acquired software, the margin was 78.8% in 2022 and 92.1% in 2021. The decline in software licenses, royalties, software development, and acquired software gross margin compared to the prior period is due to lower revenue from software licenses.Appraisal services. Appraisal services revenue comprised approximately 1.9% of total revenues. The appraisal services gross margin decrease of 0.9% compared to 2021 is primarily due to higher personnel costs related to inflation, as well as increased low margin billable travel revenue. The appraisal services business is somewhat cyclical and driven in part by statutory revaluation cycles in various states.Overall gross margin. Our 2022 blended gross margin decreased 2.2% compared to 2021, principally due to the inclusion of NIC’s revenues (including lower margin COVID related revenues), which historically have lower margins than Tyler’s software-related revenues. Excluding the incremental impact from recent acquisitions of $60 million, overall gross margin was 43.8% in 2022. The decrease of 0.8% in overall gross margin compared to the prior period is due to lower revenue from software licenses and maintenance, higher hosting costs related to our accelerated shift to the cloud, and higher personnel costs. Excluding employees from recent acquisitions, our implementation and support, and appraisal staff grew by 219 employees since December 31, 2021, as we increased hiring to ensure that we are well-positioned to deliver our current backlog and anticipated new business. 36Sales and marketing expenseSales and Marketing expense (“S&M”) consists primarily of salaries, employee benefits, travel, share-based compensation expense, commissions and related overhead costs for sales and marketing employees, as well as professional fees, trade show activities, advertising costs and other marketing costs. The following table sets forth a comparison of our S&M expenses for the years ended December 31 ($ in thousands): Change20222021$%Sales and marketing expense$135,743 $118,624 $17,119 14 %S&M as a percentage of revenue was 7.3% in 2022 compared to 7.4% in 2021. S&M expense increased approximately 14% compared to the prior period, primarily due to the inclusion of recent acquisitions’ S&M expense. Excluding the incremental impact of S&M expense from recent acquisitions of $5.6 million, S&M increased 10% compared to the prior period. Higher S&M expense is due to higher bonus and commission expense relating to improved operating results, increase in road show and user conference expenses, increase in travel-related expenses, and higher sales and marketing personnel costs from increased employee headcount.General and administrative expenseGeneral and administrative (“G&A”) expense consists primarily of personnel salaries and share-based compensation expense for general corporate functions, including senior management, finance, accounting, legal, human resources and corporate development, third party professional fees, travel-related expenses, insurance, allocation of depreciation, facilities and IT support costs, acquisition-related expenses and other administrative expenses. The following table sets forth a comparison of our G&A expense for the years ended December 31 ($ in thousands): Change20222021$%General and administrative expense$267,324 $271,955 $(4,631)(2)%G&A as a percentage of revenue was 14.4% in 2022 compared to 17.1% in 2021. G&A expense decreased approximately 2% compared to the prior period. The decrease in G&A is primarily attributed to lower transaction costs related to recent acquisitions and lower share-based compensation expense. G&A includes $2.0 million of transaction expenses related to acquisitions completed in 2022 compared to $23.5 million of transaction expense related to acquisitions completed in 2021. During 2022, stock compensation expense declined $5.5 million compared to 2021, generally due to a lower fair value of each share-based award resulting from the decline in our stock price. The decreases are offset by inclusion of G&A expense from acquisitions of $21.5 million, higher bonus expense due to improved operating results, increases in amortization of software development for internal use, increases in travel-related expenses and other administrative costs, and higher personnel costs from increased employee headcount. In 2022, G&A expense also included $2.8 million related to lease restructuring and other asset write-offs.Research and development expenseResearch and development expense consists primarily of salaries, employee benefits and related overhead costs associated with new product development. The following table sets forth a comparison of our research and development expense for the years ended December 31 ($ in thousands): Change20222021$%Research and development expense$105,184 $93,481 $11,703 13 %Research and development expense consists mainly of costs associated with development of new products and technologies from which we do not currently generate significant revenue.Research and development expense as a percent of total revenue was 5.7% in 2022 compared to 5.9% in 2021. Research and development expense increased 13% in 2022 compared to the prior period, mainly due to a number of new Tyler product development initiatives across our product suites, including increased investments in research and development at recently acquired businesses. 37Amortization of other intangiblesOther intangibles are comprised of the excess of the purchase price over the fair value of net tangible assets acquired that are allocated to acquired software and customer related, trade name, and leases acquired intangibles. The remaining excess purchase price is allocated to goodwill that is not subject to amortization. Amortization expense related to acquired software is included with cost of revenues while amortization expense of customer and trade name intangibles is recorded as operating expense. The estimated useful lives of other intangibles range from one to 25 years. The following table sets forth a comparison of our amortization of other intangibles for the years ended December 31 ($ in thousands): Change20222021$%Amortization of other intangibles$61,363 $44,849 $16,514 37 %Amortization of other intangibles increased due to the impact of intangibles added with several acquisitions completed in 2022 and 2021.Estimated annual amortization expense relating to customer related, trade name, and acquired lease intangibles, excluding acquired software for which the amortization expense is recorded as cost of revenues, for the next five years and thereafter is as follows (in thousands):2023$70,233 202454,141 202553,404 202652,586 202752,143 Thereafter524,162 Interest expenseThe following table sets forth a comparison of our interest expense for the years ended December 31 ($ in thousands): Change20222021$%Interest expense$(28,379)$(23,298)$(5,081)22%Interest expense is comprised of interest expense and non-usage and other fees associated with our borrowings. The change in interest expense compared to the prior period is attributable to an increase in amortization expense related to debt issuance costs, resulting from our accelerated repayment of the term loans, coupled with an increase in interest rates compared to the prior period.Other income, netThe following table sets forth a comparison of our other income, net for the years ended December 31 ($ in thousands): Change20222021$%Other income, net$1,723 $1,544 $179 12%Other income, net, is primarily comprised of interest income from invested cash. The change in other income, net, compared to the prior period is due to increased interest income generated from invested cash as a result of higher interest rates in 2022 compared to 2021.38Income tax provisionThe following table sets forth a comparison of our income tax provision for the years ended December 31 ($ in thousands): Change20222021$%Income tax provision (benefit)$23,353 $(2,477)$25,830 (1,043)%Effective income tax rate12.4 %(1.6)% The increase in the income tax provision and the effective income tax rate in 2022 compared to the prior period is principally driven by a decrease in excess tax benefits from share-based compensation and an increase in liabilities for uncertain tax positions, offset by an increase in research tax credit benefits. The share-based exercise and vesting activity in 2022 generated $7.8 million of excess tax benefits, while exercise and vesting activity in 2021 generated $47.7 million of excess tax benefits. The tax benefits related to research tax credits totaled $31.3 million in 2022 compared to $5.0 million in 2021, as a result of completing a multiyear research and development tax credit study during 2022. The effective income tax rates for the periods presented were different from the statutory United States federal income tax rate of 21% primarily due to excess tax benefits from share-based compensation and the tax benefits of research tax credits, offset by an increase in liabilities for uncertain tax positions, state income taxes, and non-deductible business expenses. Excluding the impact of the excess tax benefits, uncertain tax positions and research credits, our income tax provision and effective tax rate in 2022 would have been $54.1 million and 28.8%, respectively, and in 2021, would have been $50.6 million and 31.8%, respectively.FINANCIAL CONDITION AND LIQUIDITYAs of December 31, 2022, we had cash and cash equivalents of $173.9 million compared to $309.2 million at December 31, 2021. We also had $55.5 million invested in investment grade corporate bonds, municipal bonds and asset-backed securities as of December 31, 2022, compared to $98.7 million at December 31, 2021. These investments have varying maturity dates through 2027 and are held as available-for-sale. As of December 31, 2022, we had $395.0 million outstanding borrowings under our 2021 Credit Agreement and one outstanding letter of credit totaling $1.5 million in favor of a client contract. We believe our cash on hand, cash from operating activities, availability under our revolving line of credit, and access to the credit markets provide us with sufficient flexibility to meet our long-term financial needs.The following table sets forth a summary of cash flows for the years ended December 31 (in thousands):202220212020Cash flows provided (used) by: Operating activities$381,455 $371,753 $355,089 Investing activities(172,530)(2,090,935)(98,320)Financing activities(344,239)1,424,730 114,172 Net (decrease) increase in cash and cash equivalents$(135,314)$(294,452)$370,941 Net cash provided by operating activities continues to be our primary source of funds to finance operating needs and capital expenditures. Other potential capital resources include cash on hand, public and private issuances of debt or equity securities, and bank borrowings. It is possible that our ability to access the capital and credit markets in the future may be limited by economic conditions or other factors. We currently believe that our cash on hand, cash provided by operating activities, and available credit are sufficient to fund our working capital requirements, capital expenditures, income tax obligations, and share repurchases for at least the next twelve months.In 2022, operating activities provided cash of $381.5 million compared to $371.8 million in 2021. Operating activities that provided cash were primarily comprised of net income of $164.2 million, non-cash depreciation and amortization charges of $159.1 million, non-cash share-based compensation expense of $103.0 million and non-cash amortization of operating lease right-of-use assets of $13.0 million. Working capital, excluding cash, decreased approximately $60.6 million mainly due to timing of payments to and receipts from our government partners, timing of payments of payroll related taxes and vendor invoices, and deferred taxes associated with tax research credits and stock option activity during the period. These decreases were offset by the timing of tax payments, prepaid expenses, and increase in deferred revenue during the period. In general, changes in deferred revenue are cyclical and primarily driven by the timing of our maintenance renewal billings. Our renewal dates occur throughout the year, but our largest renewal billing cycles occur in the second and fourth quarters. Subscription renewals are billed throughout the year.39Days sales outstanding (DSO) in accounts receivable were 115 days at December 31, 2022, compared to 108 days at December 31, 2021. DSO is calculated based on quarter-end accounts receivable divided by the quotient of annualized quarterly revenues divided by 360 days. The increase in DSO compared to December 31, 2021, is attributed to slower payments from certain large clients and timing of receipts from our government partners. Investing activities used cash of $172.5 million in 2022 compared to $2.1 billion in 2021. On October 31, 2022, we acquired Rapid Financial Solutions, LLC, for the total purchase price, net of cash acquired of $2.2 million, of approximately $67.7 million, consisting of $51.2 million paid in cash, $18.2 million of common stock, and $500,000 related to working capital holdbacks, subject to certain post-closing adjustments. On May 31, 2022, we completed the acquisition of Quatred, LLC for the total cash price of approximately $637,000. On February 8, 2022, we acquired US eDirect Inc, for the total purchase price, net of cash acquired of $6.4 million, of approximately $116.5 million, consisting of $118.8 million paid in cash and approximately $4.1 million related to indemnity holdbacks. During 2022, we also paid approximately $1.9 million in indemnity and working capital holdbacks related to acquisitions completed in late 2021. In addition, approximately $27.6 million of software development costs were capitalized. Approximately $22.5 million was invested in property and equipment, including $4.5 million related to real estate. The remaining additions were for computer equipment and furniture and fixtures in support of growth, particularly with respect to data centers supporting growth in our cloud-based offerings. Investing activities used cash of $2.1 billion in 2021. We invested $77.5 million and received $131.4 million in proceeds from investment grade corporate bonds, municipal bonds and asset-backed securities with maturity dates ranging from 2022 through 2027. On March 31, 2021, we completed two acquisitions with the total purchase price, net of cash acquired, of $12.1 million paid in cash. On April 21, 2021, we completed the acquisition of NIC for the total purchase price of $2.0 billion, net of cash acquired of $331.8 million, including cash paid of $2.3 billion and $1.9 million of purchase consideration related to the conversion of unvested restricted stock awards. On September 1, 2021, we acquired VendEngine for the total purchase price, net of cash acquired of $1.7 million, of approximately $83.8 million consisting of $80.2 million paid in cash and approximately $5.4 million related to indemnity holdbacks, subject to certain post-closing adjustments. On September 9, 2021, we acquired all of the equity interest of Arx for the total purchase price, net of cash acquired, of approximately $12.8 million, of which $12.3 million was paid in cash and approximately $500,000 was accrued for indemnity holdbacks. Approximately $33.9 million was invested in property and equipment, including $12.8 million related to real estate. In addition, approximately $21.7 million of software development was capitalized in 2021. The remaining additions were for computer equipment and furniture and fixtures in support of internal growth, with the majority associated with our data centers supporting growth in our cloud-based offerings. These expenditures were funded from cash generated from operations.Financing activities used cash of $344.2 million in 2022 compared to cash provided of $1.4 billion in 2021, primarily attributable to repayment of $360.0 million of term debt, partially offset by payments received from stock option exercises, net of withheld shares for taxes upon equity award and employee stock purchase plan activity. Financing activities provided cash of $1.4 billion in 2021. Financing activities in 2021 were primarily comprised of proceeds from the issuance of the Convertible Senior Notes and the 2021 Credit Agreement. On March 9, 2021, we issued $600.0 million aggregate principal amount of Convertible Senior Notes. The net proceeds from the issuance of the Convertible Senior Notes were $591.4 million, net of initial purchasers’ discounts of $6.0 million and debt issuance costs of $2.6 million. On April 21, 2021, in connection with the completion of the NIC acquisition, the Company, as borrower, entered into a new 2021 Credit Agreement with various lenders consisting of an unsecured revolving credit facility of up to $500.0 million and unsecured term loans totaling $900.0 million. The net proceeds from the borrowings under the 2021 Credit Agreement were $1.1 billion, net of debt discounts of $7.2 million and debt issuance costs of $4.9 million and $6.4 million of commitment fees paid related to the terminated $1.6 billion unsecured bridge loan facility. During the twelve months ended December 31, 2021, we repaid $250.0 million of the unsecured revolving credit facility and $145.0 million of the term debt. The remainder of the financing activities was comprised of receipts of $109.9 million from stock option exercises and employee stock purchase plan activity. We also purchased approximately 33,000 shares of our common stock for an aggregate purchase price of $13.0 million.In February 2019, our board of directors authorized the repurchase of an additional 1.5 million shares of our common stock. The repurchase program, which was approved by our board of directors, was originally announced in October 2002 and was amended at various times from 2003 through 2019. As of February 22, 2023, we have authorization from our board of directors to repurchase up to 2.3 million additional shares of our common stock. Our share repurchase program allows us to repurchase shares at our discretion. Market conditions influence the timing of the buybacks and the number of shares repurchased, as well as the volume of employee stock option exercises. Share repurchases are generally funded using our existing cash balances and borrowings under our credit facility and may occur through open market purchases and transactions structured through investment banking institutions, privately negotiated transactions and/or other mechanisms. There is no expiration date specified for the authorization and we intend to repurchase stock under the plan from time to time.40As of December 31, 2022, we had $600 million in outstanding principal for the Convertible Senior Notes due 2026. Under our 2021 Credit Agreement, we had $395 million in outstanding principal for the Term Loans, no outstanding borrowings under the 2021 Revolving Credit Facility, and an available borrowing capacity of $500 million as of December 31, 2022. As of December 31, 2022, we had one outstanding letter of credit totaling $1.5 million. The letter of credit, which guarantees our performance under a client contract, renews automatically annually unless canceled in writing and expires in the third quarter of 2026. For the twelve months ended December 31, 2022, we repaid $360 million of the Term Loans under 2021 Credit Agreement. We paid interest of $21.3 million in 2022, $17.7 million in 2021, including $6.4 million related to the senior unsecured bridge loan facility commitment fee in 2021, and $610,000 in 2020. See Note 6, “Debt,” to the consolidated financial statements for discussions of the Convertible Senior Notes and the 2021 Credit Agreement. We paid income taxes, net of refunds received, of $38.5 million in 2022, $2.2 million in 2021, and $3.3 million in 2020. In 2022, stock option exercise activity generated net tax benefits of $7.8 million and reduced tax payments accordingly, as compared to $47.7 million and $60.2 million in 2021 and 2020, respectively.For tax years beginning on or after January 1, 2022, the Tax Cuts and Jobs Act of 2017 (“TCJA”) eliminates the option to currently deduct research and development expenses and requires taxpayers to capitalize and amortize them over five years for research activities performed in the United States and 15 years for research activities performed outside the United States pursuant to IRC Section 174. Although Congress is considering legislation that would repeal or defer this capitalization and amortization requirement, it is not certain that this provision will be repealed or otherwise modified. If the requirement is not repealed or replaced, it will increase our U.S. federal and state cash tax payments and reduce cash flows in fiscal year 2023 and future years.We anticipate that 2023 capital spending will be between $68 million and $70 million, including approximately $16 million related to real estate and approximately $37 million of software development. We expect the majority of the other capital spending will consist of computer equipment and software for infrastructure replacements and expansion. We also expect cash tax payments to be higher as a result of IRC Section 174. Capital spending and cash tax payments are expected to be funded from existing cash balances and cash flows from operations.From time to time we engage in discussions with potential acquisition candidates. In order to pursue such opportunities, which could require significant commitments of capital, we may be required to incur debt or to issue additional potentially dilutive securities in the future. No assurance can be given as to our future acquisition opportunities and how such opportunities will be financed. We lease office facilities for use in our operations, as well as transportation and other equipment. Most of our leases are non-cancelable operating lease agreements and they expire from one to 12 years. Some of these leases include options to extend for up to six years. Our estimated future obligations consist of debt, uncertain tax positions, leases, and purchase commitments as of December 31, 2022. Refer to Note 6, “Debt,” Note 10, “Income Tax,” Note 14, “Leases,” and Note 16, “Commitment and Contingencies,” to the consolidated financial statements for related discussions.CAPITALIZATIONAt December 31, 2022, our capitalization consisted of $987.4 million of outstanding debt and $2.6 billion of shareholders’ equity.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.Market risk represents the risk of loss that may affect us due to adverse changes in financial market prices and interest rates. As of December 31, 2022, we had $395.0 million of outstanding borrowings under our 2021 Credit Agreement and available borrowing capacity under the 2021 Credit Agreement was $500.0 million.Borrowings under the Revolving Credit Facility and the Term Loan A-1 bear interest, at the Company’s option, at a per annum rate of either (1) the Administrative Agent’s prime commercial lending rate (subject to certain higher rate determinations) (the “Base Rate”) plus a margin of 0.125% to 0.75% or (2) the one-, three-, six-, or, subject to approval by all lenders, twelve-month LIBOR rate plus a margin of 1.125% to 1.75%. The Term Loan A-2 bears interest, at the Company’s option, at a per annum rate of either (1) the Base Rate plus a margin of 0% to 0.5% or (2) the one-, three-, six-, or, subject to approval by all lenders, twelve-month LIBOR rate plus a margin of 0.875% to 1.5%. During the twelve months ended December 31, 2022, the effective interest rate for our borrowings was 3.79%. Based on the aggregate outstanding principal balance under the 2021 Credit Agreement as of December 31, 2022, of $395.0 million, each quarter point change in interest rates would result in a $1.0 million change in annual interest expense.41In January 2023, we amended our 2021 Credit Agreement to replace the LIBOR reference rate with the SOFR reference rate. Assuming that SOFR replaces LIBOR and is appropriately adjusted to equate to one-month LIBOR, we expect that there should be minimal impact on our operations.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations– By Reportable Segment” for a discussion of our financial results by segment. Available Information We make certain filings with the SEC, including our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments and exhibits to those reports. We make such filings available free of charge through our website, http://www.targaresources.com, as soon as reasonably practicable after they are filed with the SEC. Our press releases and recent analyst presentations are also available on our website. The SEC also maintains an internet website at http://www.sec.gov that contains reports, proxy and information statements and other information regarding issuers, including us, that file electronically with the SEC. The information contained on the websites referenced in this Annual Report on Form 10-K is not incorporated herein by reference. 26 Item 1A. Risk Factors. The nature of our business activities subjects us to certain hazards and risks. You should consider carefully the following risk factors together with all the other information contained in this report. If any of the following risks were to occur, then our business, financial condition, cash flows and results of operations could be materially adversely affected. Summary Risk Factors Risks Related to our Results of Operations •Our cash flow is affected by supply and demand for natural gas, NGL products and crude oil and by natural gas, NGL, crude oil and condensate prices, and decreases in commodity prices and/or activity levels could adversely affect our results of operations and financial condition. •A reduction in demand for NGL products by the petrochemical, refinery or other industries or by the fuel or export markets, or a significant increase in NGL product supply relative to this demand, could materially adversely affect our business, results of operations and financial condition. •The natural decline in production in our operating regions and in other regions from which we source NGL supplies means our long-term success depends on our ability to obtain new sources of supplies of natural gas, NGLs and crude oil, which depends on certain factors beyond our control. Any decrease in supplies of natural gas, NGLs or crude oil could adversely affect our business and operating results. •Our industry is highly competitive and increased competitive pressure could adversely affect our business and operating results. •We operate in areas of high industry activity, which may affect our ability to hire, train or retain qualified personnel needed to manage and operate our business. •If third-party pipelines and other facilities interconnected to our natural gas and crude oil gathering systems, terminals and processing facilities become partially or fully unavailable to transport natural gas, NGLs and crude oil, our revenues could be adversely affected. •We typically do not obtain independent evaluations of natural gas or crude oil reserves dedicated to our gathering pipeline systems; therefore, volumes on our systems in the future could be less than we anticipate. •We do not own most of the land on which our pipelines, terminals and compression facilities are located, which could disrupt our operations. •If we lose any of our named executive officers, our business may be adversely affected. •Climatic events may damage our pipelines and other facilities, limit our ability or increase the costs to operate our business and adversely impact our customers on whom we rely on for throughput as well as third party vendors from whom we receive goods, which developments could cause us to incur significant costs and adversely affect our business, results of operations and financial condition. •Our business involves many hazards and operational risks, some of which may not be insured or fully covered by insurance. If a significant accident or event occurs for which we are not fully insured, if we fail to recover all anticipated insurance proceeds for significant accidents or events for which we are insured, or if we fail to rebuild facilities damaged by such accidents or events, our operations and financial results could be adversely affected. •Unexpected volume changes due to production variability or to gathering, plant or pipeline system disruptions may increase our exposure to commodity price movements. •Portions of our pipeline systems may require increased expenditures for maintenance and repair owing to the age of some of our systems, which expenditures or resulting loss of revenue due to pipeline age or condition could have a material adverse effect on our business and results of operations. •Terrorist attacks and the threat of terrorist attacks have resulted in increased costs to our business. Continued global and domestic hostilities may adversely impact our results of operations. •We face opposition to operation and expansion of our pipelines and facilities from various individuals and groups. •We may incur significant costs and liabilities resulting from performance of pipeline integrity testing programs and related repairs. •We are subject to cybersecurity risks. A cyber incident could occur and result in information theft, data corruption, operational disruption and/or financial loss. •The widespread outbreak of pandemics (like COVID-19) or any other public health crisis that impacts the global demand for energy commodities may have material adverse effects on our business, financial position, results of operations and/or cash flows. Risks Related to our Capital Projects and Future Growth •Our expansion or modification of existing assets or the construction of new assets may not result in revenue increases and are subject to regulatory, environmental, political, legal and economic risks, which could adversely affect our results of operations and financial condition. •If we do not develop growth projects and/or make acquisitions for expanding existing assets or constructing new assets on economically acceptable terms, or fail to efficiently and effectively integrate developed or acquired assets with our asset base, our future growth will be limited. In addition, any acquisitions we complete are subject to substantial risks that could adversely affect our financial condition and results of operations and reduce our ability to pay dividends to stockholders. In addition, we may not achieve the expected results of any acquisitions and any adverse conditions or developments related to such acquisitions may have a negative impact on our operations and financial condition. •We may be unable to cause our joint ventures to take or not to take certain actions unless some or all of our joint venture participants agree and certain of our joint venture partners may fail or refuse to fund their respective portions of capital projects that we believe are necessary to expand or maintain such joint venture’s business. 27 Risks Related to our Financial Condition •If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. In addition, potential changes in accounting standards might cause us to revise our financial results and disclosure in the future. •We are exposed to credit risks of our customers, and any material nonpayment or nonperformance by our key customers could adversely affect our cash flow and results of operations. •Continuing or worsening inflationary issues and associated changes in monetary policy have resulted in and may result in additional increases to the cost of our goods, services and personnel, which in turn cause our capital expenditures and operating costs to rise. •Changes in future business conditions could have a negative impact on the demand for our services and could cause recorded long-lived assets to become further impaired, and our financial condition and results of operations could suffer if there is a negative impact on the demand for our services and an additional impairment of long-lived assets. •Our hedging activities may not be effective in reducing the variability of our cash flows and may, in certain circumstances, increase the variability of our cash flows. Moreover, our hedges may not fully protect us against volatility in basis differentials. Finally, the percentage of our expected equity commodity volumes that are hedged decreases substantially over time. •If we fail to balance our purchases and sales of the commodities we handle, our exposure to commodity price risk will increase. •The amounts we pay in dividends may vary from anticipated amounts and circumstances may arise that lead to conflicts between using funds to pay anticipated dividends or to invest in our business. •If dividends on our shares of common stock are not paid with respect to any fiscal quarter, our stockholders will not be entitled to receive that quarter’s payments in the future. •Our future tax liability may be greater than expected if our NOL carryforwards are limited, we do not generate expected deductions, or tax authorities successfully challenge certain of our tax positions. •Changes in tax laws or the interpretation thereof or the imposition of new or increased taxes may adversely affect our financial condition, results of operations and cash flows. •Derivatives legislation and its implementing regulations could have a material adverse effect on our ability to use derivative instruments to reduce the effect of commodity price, interest rate and other risks associated with our business. Risks Related to the Ownership of our Common Stock •Future sales of our common stock in the public market could lower our stock price, and any additional capital raised by us through the sale of equity or convertible securities may dilute your ownership in us. •Our amended and restated certificate of incorporation and amended and restated bylaws, as well as Delaware law, contain provisions that could discourage acquisition bids or merger proposals, which may adversely affect the market price of our common stock. •We may issue preferred stock whose terms could adversely affect the voting power or value of our common stock. Risks Related to our Indebtedness •Continued increases in interest rates, due to associated Federal Reserve policies or otherwise, could adversely affect our cost of capital, which could increase our funding costs and reduce the overall profitability of our business. •We have a substantial amount of indebtedness which may adversely affect our financial position and we may still be able to incur substantially more debt, which could collectively increase the risks associated with compliance with our financial covenants. •The terms of our debt agreements may restrict our current and future operations, particularly our ability to respond to changes in business or to take certain actions, including to pay dividends to our stockholders. Risks Related to Regulatory Matters •Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change that could result in increased operating costs, limit the areas in which oil and natural gas production may occur, and reduce demand for the products and services we provide. •Increasing stakeholder and market attention to ESG matters may impact our business. •We could incur significant costs in complying with more stringent occupational safety and health requirements. •Laws, regulations and executive orders limiting hydraulic fracturing activities could result in restrictions, delays or cancellations in drilling and completing new oil and natural gas wells by our customers, which could adversely impact our revenues by decreasing the volumes of natural gas, NGLs or crude oil through our facilities and reducing the utilization of our assets. •Our operations are subject to environmental laws and regulations and a failure to comply or an accidental release into the environment may cause us to incur significant costs and liabilities. •A change in the jurisdictional characterization of some of our assets by federal, state, tribal or local regulatory agencies or a change in policy by those agencies may result in increased regulation of our assets, which may (i) cause our revenues to decline and operating expenses to increase or (ii) delay or increase the cost of expansion projects. •Federal and state legislative and regulatory initiatives relating to pipeline safety that require the use of new or more stringent safety controls or result in more rigorous enforcement of applicable legal requirements could subject us to increased capital costs, operational delays and costs of operation. •Should we fail to comply with all applicable FERC-administered statutes, rules, regulations and orders, we could be subject to substantial penalties and fines. •We are or may become subject to cybersecurity and data privacy laws, regulations, litigation and directives relating to our processing of personal information. 28 Risks Related to our Results of Operations Our cash flow is affected by supply and demand for natural gas, NGL products and crude oil and by natural gas, NGL, crude oil and condensate prices, and decreases in commodity prices and/or activity levels could adversely affect our results of operations and financial condition. Our operations can be affected by the level of natural gas, NGL and crude oil prices and the relationship between these prices. The prices of natural gas, NGLs and crude oil have been volatile, and we expect this volatility to continue. Our future cash flows may be materially adversely affected if we experience significant, prolonged price deterioration. The markets and prices for natural gas, NGLs and crude oil depend upon factors beyond our control. These factors include supply and demand for these commodities, which fluctuates with changes in market and economic conditions, and other factors, including: •the impact of seasonality and weather, including severe weather conditions and other natural disasters, such as flooding, droughts and winter storms, the frequency, severity and impact of which could be increased by the effects of climate change; •general economic conditions and economic conditions impacting our primary markets, including the impact of continued inflation and rising interest rates and associated changes in monetary policy; •the economic conditions of our customers; •the level of domestic crude oil and natural gas production and consumption; •the availability of imported natural gas, liquefied natural gas, NGLs and crude oil; •actions taken by major foreign oil and gas producing nations; •the availability of local, intrastate and interstate transportation systems and storage for residue natural gas and NGLs; •the availability of domestic storage for crude oil; •the availability and marketing of competitive fuels and/or feedstocks; •the impact of energy conservation efforts and the related transition to a low carbon economy, as a result of the IRA or otherwise; •stockholder activism and activities by non-governmental organizations to limit certain sources of funding for the energy sector or restrict the exploration, development and production of crude oil and natural gas; and •the extent and nature of governmental regulation and taxation, including those related to the prorationing of oil and gas production. Our primary natural gas gathering and processing arrangements that expose us to commodity price risk are our percent-of-proceeds arrangements. Under these arrangements, we generally process natural gas from producers and remit to the producers an agreed percentage of the proceeds from the sale of residue gas and NGL products at market prices or a percentage of residue gas and NGL products at the tailgate of our processing facilities. In some percent-of-proceeds arrangements, we remit to the producer a percentage of an index-based price for residue gas and NGL products, less agreed adjustments, rather than remitting a portion of the actual sales proceeds. Under these types of arrangements, our revenues and cash flows increase or decrease, whichever is applicable, as the prices of natural gas, NGLs and crude oil fluctuate, to the extent our exposure to these prices is unhedged. See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.” A reduction in demand for NGL products by the petrochemical, refinery or other industries or by the fuel or export markets, or a significant increase in NGL product supply relative to this demand, could materially adversely affect our business, results of operations and financial condition. The NGL products we produce have a variety of applications, including heating fuels, petrochemical feedstocks and refining blend stocks. A reduction in demand for NGL products, whether because of general or industry-specific economic conditions, new government regulations, including the IRA, global competition, reduced demand by consumers for products made with NGL products (for example, reduced petrochemical demand observed due to lower activity in the automobile and construction industries), reduced demand for propane or butane exports whether for price or other reasons, increased competition from petroleum-based feedstocks due to pricing 29 differences, mild winter weather for some NGL applications or other reasons, could result in a decline in the volume of NGL products we handle or reduce the fees we charge for our services. Also, increased supply of NGL products could reduce the value of NGLs handled by us and reduce the margins realized. Our NGL products and their demand are affected as follows: Ethane. Ethane is typically supplied as purity ethane and as part of an ethane-propane mix. Ethane is primarily used in the petrochemical industry as feedstock for ethylene, one of the basic building blocks for a wide range of plastics and other chemical products. Although ethane is typically extracted as part of the mixed NGL stream at gas processing plants, if natural gas prices increase significantly in relation to NGL product prices or if the demand for ethylene falls, it may be more profitable for natural gas processors to leave the ethane in the natural gas stream, thereby reducing the volume of NGLs delivered for fractionation and marketing. Propane. Propane is used as a petrochemical feedstock in the production of ethylene and propylene, as a heating, engine and industrial fuel, and in agricultural applications such as crop drying. Changes in demand for ethylene and propylene could adversely affect demand for propane. The demand for propane as a heating fuel is significantly affected by weather conditions. The volume of propane sold is increasingly driven by international exports supplying a growing global demand for the product. Domestically in the U.S., propane is at its highest during the six-month peak heating season of October through March. Demand for our propane may be reduced during periods of slow global economic growth and warmer-than-normal weather. Normal Butane. Normal butane is used in the production of isobutane, as a refined petroleum product blending component, as a fuel gas (either alone or in a mixture with propane) and in the production of ethylene and propylene. Changes in the composition of refined petroleum products resulting from governmental regulation, changes in feedstocks, products and economics, and demand for heating fuel, ethylene and propylene could adversely affect demand for normal butane. The volume of butane sold is increasingly driven by international exports supplying a growing demand for the product. Isobutane. Isobutane is predominantly used in refineries to produce alkylates to enhance octane levels. Accordingly, any action that reduces demand for motor gasoline or demand for isobutane to produce alkylates for octane enhancement might reduce demand for isobutane. Natural Gasoline. Natural gasoline is used as a blending component for certain refined petroleum products and as a feedstock used in the production of ethylene and propylene. Changes in the mandated composition of motor gasoline resulting from governmental regulation, and in demand for ethylene and propylene, could adversely affect demand for natural gasoline. NGLs and products produced from NGLs also compete with products from global markets. Any reduced demand or increased supply for ethane, propane, normal butane, isobutane or natural gasoline in the markets we access for any of the reasons stated above could adversely affect both demand for the services we provide and NGL prices, which could negatively impact our results of operations and financial condition. The natural decline in production in our operating regions and in other regions from which we source NGL supplies means our long-term success depends on our ability to obtain new sources of supplies of natural gas, NGLs and crude oil, which depends on certain factors beyond our control. Any decrease in supplies of natural gas, NGLs or crude oil could adversely affect our business and operating results. Our gathering systems are connected to crude oil and natural gas wells from which production will naturally decline over time, which means that the cash flows associated with these sources of natural gas and crude oil will likely also decline over time. Our logistics assets are similarly impacted by declines in NGL supplies in the regions in which we operate as well as other regions from which we source NGLs. To maintain or increase throughput levels on our gathering systems and the utilization rate at our processing plants and our treating and fractionation facilities, we must continually obtain new natural gas, NGL and crude oil supplies. A material decrease in natural gas or crude oil production from producing areas on which we rely, as a result of depressed commodity prices or otherwise, could result in a decline in the volume of natural gas or crude oil that we gather and process, NGLs that we transport or NGL products delivered to our fractionation facilities. Our ability to obtain additional sources of natural gas, NGLs and crude oil depends, in part, on the level of successful drilling and production activity near our gathering systems and, in part, on the level of successful drilling and production in other areas from which we source NGL and crude oil supplies. We have no control over the level of such activity in the areas of our operations, the amount of reserves associated with the wells or the rate at which production from a well will decline. In addition, we have no control over producers or their drilling, completion or production decisions, which are affected by, among other things, prevailing and projected energy prices, demand for hydrocarbons, the level of reserves, geological considerations, governmental regulations, the availability of drilling rigs, other production and development costs and the availability and cost of capital. Fluctuations in energy prices can greatly affect production rates and investments by third parties in the development of new oil and natural gas reserves. Drilling and production activity generally decreases as crude oil and natural gas prices decrease. Prices of crude oil and natural gas have been historically volatile, and we expect this volatility to continue. Consequently, even if new natural gas or crude 30 oil reserves are discovered in areas served by our assets, producers may choose not to develop those reserves. For example, low prices for natural gas combined with high levels of natural gas in storage could result in curtailment or shut-in of natural gas production similar to the production shut-ins we experienced in 2020 due to the impacts of the COVID-19 pandemic. Furthermore, in response to depressed commodity prices, during 2020 and early 2021 many operators announced substantial reductions in their estimated capital expenditures, rig count and completion crews. Reductions in exploration and production activity, competitor actions or shut-ins by producers in the areas in which we operate may prevent us from obtaining supplies of natural gas or crude oil to replace the natural decline in volumes from existing wells, which could result in reduced volumes through our facilities and reduced utilization of our gathering, treating, processing, transportation and fractionation assets. Our industry is highly competitive and increased competitive pressure could adversely affect our business and operating results. We compete with similar enterprises in our respective areas of operation. Some of our competitors are large crude oil, natural gas and NGL companies that have greater financial resources and access to supplies of natural gas, NGLs and crude oil than we do. Some of these competitors may expand or construct gathering, processing, storage, terminaling and transportation systems that would create additional competition for the services we provide to our customers. In addition, customers who are significant producers of natural gas may develop their own gathering, processing, storage, terminaling and transportation systems in lieu of using those operated by us. Our ability to renew or replace existing contracts with our customers at rates sufficient to maintain current revenues and cash flows could be adversely affected by the activities of our competitors and our customers. All of these competitive pressures could have a material adverse effect on our business, results of operations and financial condition. We operate in areas of high industry activity, which may affect our ability to hire, train or retain qualified personnel needed to manage and operate our business. We operate in areas in which industry activity has increased rapidly. As a result, demand for qualified personnel in these areas, particularly those related to our Permian and Badlands assets, and the cost to attract and retain such personnel, has increased over the past few years due to competition, and may increase substantially in the future. Moreover, our competitors may be able to offer better compensation packages to attract and retain qualified personnel than we are able to offer. Any delay or inability to secure the personnel necessary for us to continue or complete our current and planned development projects, or any significant increases in costs with respect to the hiring, training or retention of qualified personnel, could have a material adverse effect on our business, financial condition and results of operations. If third-party pipelines and other facilities interconnected to our natural gas and crude oil gathering systems, terminals and processing facilities become partially or fully unavailable to transport natural gas, NGLs and crude oil, our revenues could be adversely affected. We depend upon third-party pipelines, storage and other facilities that provide delivery options to and from our gathering and processing facilities. Since we do not own or operate these pipelines or other facilities, their continuing operation in their current manner is not within our control. If any of these third-party facilities become partially or fully unavailable, or if the quality specifications for their facilities change so as to restrict our ability to utilize them, our revenues could be adversely affected. We typically do not obtain independent evaluations of natural gas or crude oil reserves dedicated to our gathering pipeline systems; therefore, volumes on our systems in the future could be less than we anticipate. We typically do not obtain independent evaluations of natural gas or crude oil reserves connected to our gathering systems due to the unwillingness of producers to provide reserve information as well as the cost of such evaluations. Accordingly, we do not have independent estimates of total reserves dedicated to our gathering systems or the anticipated life of such reserves. If the total reserves or estimated life of the reserves connected to our gathering systems is less than we anticipate and we are unable to secure additional sources of supply, then the volumes of natural gas or crude oil transported on our gathering systems in the future could be less than we anticipate. A decline in the volumes on our systems could have a material adverse effect on our business, results of operations and financial condition. 31 We do not own most of the land on which our pipelines, terminals and compression facilities are located, which could disrupt our operations. We do not own most of the land on which our pipelines, terminals and compression facilities are located, and we are therefore subject to the possibility of more onerous terms and/or increased costs to retain necessary land use if we do not have valid rights of way or leases or if such rights of way or leases lapse or terminate. We sometimes obtain the rights to land owned by third parties and governmental agencies for a specific period of time. Additionally, the federal Tenth Circuit Court of Appeals has held that tribal ownership of even a very small fractional interest in an allotted land, that is, tribal land owned or at one time owned by an individual Indian landowner, bars condemnation of any interest in the allotment. Consequently, the inability to condemn such allotted lands under circumstances where an existing pipeline rights of way may soon lapse or terminate serves as an additional impediment for pipeline operators. We cannot guarantee that we will always be able to renew existing rights of way or obtain new rights of way without experiencing significant costs. Any loss of rights with respect to our real property, through our inability to renew rights of way contracts or leases, or otherwise, could cause us to cease operations on the affected land, increase costs related to continuing operations elsewhere and reduce our revenue. If we lose any of our named executive officers, our business may be adversely affected. Our success is dependent upon the efforts of our named executive officers. Our named executive officers are responsible for executing our business strategies. There is substantial competition for qualified personnel in the midstream oil and gas industry. We may not be able to retain our existing named executive officers or fill new positions or vacancies created by expansion or turnover. We have not entered into employment agreements with any of our named executive officers. In addition, we do not maintain “key man” life insurance on the lives of any of our named executive officers. A loss of one or more of our named executive officers could harm our business and prevent us from implementing our business strategies. Climatic events may damage our pipelines and other facilities, limit our ability or increase the costs to operate our business and adversely impact our customers on whom we rely on for throughput as well as third party vendors from whom we receive goods, which developments could cause us to incur significant costs and adversely affect our business, results of operations and financial condition. Climatic events in the areas in which we or our customers operate can cause disruptions and in some cases suspension of our operations and development activities. For example, unseasonably wet weather, extended periods of below freezing weather, or hurricanes, among other disruptive weather patterns, may cause a loss of throughput from temporary cessation of activities or lost, damaged or ineffective equipment. Our planning for normal climatic variation, insurance programs and emergency recovery plans may inadequately mitigate the effects of such weather conditions, and not all such effects can be predicted, eliminated or insured against. Potential climatic changes may have significant physical effects, such as increased frequency and severity of storms, floods and wintry conditions and could have an adverse effect on our continued operations as well as the operations of our oil and gas exploration and production customers that deliver natural gas to us for processing and throughput, our third party vendors that supply us with goods, and third party insurance providers that make insuring products available to defray our costs or offset any damages and losses we incur. Any unusual or prolonged severe climatic events or increased frequency thereof, such as freezing weather or rain, earthquakes, hurricanes, droughts, or floods in our oil and gas exploration and production customers’ or our third party vendors’ areas of operations or markets, whether due to climatic change or otherwise, could have a material adverse effect on our business, results of operations and financial condition. Our operations along the Gulf Coast, in offshore waters and at major river crossings in particular could be adversely impacted by changing climatic conditions, as rising sea levels, subsidence and erosion are potential causes for serious damage to our pipelines and other facilities, which could affect our ability to provide services. These damages could result in leakage, migration, releases or spills from our operations to surface or subsurface soils, surface water, groundwater or to the Gulf of Mexico and could result in liability, remedial obligations or otherwise have a negative impact on continued operations. Additionally, rising sea levels, subsidence and erosion processes could impact our oil and gas exploration and production customers who operate along the Gulf Coast, and they may be unable to utilize our services. Adverse climatic impacts, whether inland or along the coast or offshore, could also affect our third-party suppliers, which could limit their ability to provide us with the necessary products and services enabling us to maintain operation of our pipelines and other facilities. As a result, we may incur significant costs to repair, preserve or make more efficient our pipeline infrastructure and other facilities. Such costs could adversely affect our business, financial condition, results of operations and cash flows. Moreover, we could incur significant costs to weatherize or upgrade weatherization of our facility equipment in anticipation of future climatic events. For example, following Texas Governor Greg Abbott's direction to adopt rules related to weather resiliency, in August 2022, the Texas Railroad Commission adopted the Weather Emergency Preparedness Standards rule, which requires critical gas facilities on the state’s Electricity Supply Chain Map (including gas pipelines that directly serve electricity generation) to (i) weatherize to help ensure sustained operations during a weather emergency, (ii) correct known issues that caused weather-related forced stoppages and (iii) contact the Texas Railroad Commission if a facility sustains a weather-related forced stoppage during a weather emergency. Inspectors from the Critical Infrastructure Division of the Texas Railroad Commission began inspections on December 1, 2022. If, upon inspection, 32 we are required to further weatherize or update weatherization of certain facilities, we may incur significant costs to complete any additional weatherization. Additionally, issues beyond our control, such as grid reliability or the severity of any such weather event, might undermine any winterization or emergency weather preparedness efforts we make. Furthermore, our operations in western Texas and New Mexico may be sensitive to drought and restrictions on water use. Our business involves many hazards and operational risks, some of which may not be insured or fully covered by insurance. If a significant accident or event occurs for which we are not fully insured, if we fail to recover all anticipated insurance proceeds for significant accidents or events for which we are insured, or if we fail to rebuild facilities damaged by such accidents or events, our operations and financial results could be adversely affected. Our operations are subject to many hazards inherent in purchasing, gathering, compressing, treating, processing and/or selling natural gas; storing, fractionating, treating, transporting and selling NGLs and NGL products; and purchasing, gathering, storing and/or terminaling crude oil, including: •damage to pipelines and plants, related equipment and surrounding properties caused by hurricanes, tornadoes, floods, fires and other natural disasters, explosions and acts of terrorism; •inadvertent damage from third parties, including from motor vehicles and construction, farm or utility equipment; •damage that is the result of our negligence or any of our employees’ negligence; •leaks of natural gas, NGLs, crude oil and other hydrocarbons or losses of natural gas or NGLs as a result of the malfunction of equipment or facilities; •spills or other unauthorized releases of natural gas, NGLs, crude oil, other hydrocarbons or waste materials that contaminate the environment, including soils, surface water and groundwater, and otherwise adversely impact natural resources; and •other hazards that could also result in personal injury, loss of life, pollution and/or suspension of operations. These risks could result in substantial losses due to personal injury, loss of life, severe damage to and destruction of property and equipment, and pollution or other environmental or natural resource damage, and may result in delay, curtailment or suspension of our related operations. A natural disaster or other hazard affecting the areas in which we operate could have a material adverse effect on our operations. We are not fully insured against all risks inherent to our business. Additionally, while we are insured against pollution resulting from environmental accidents that occur on a sudden and accidental basis, we may not be insured against all environmental accidents that might occur, some of which may result in toxic tort claims. If a significant accident or event occurs that is not fully insured, if we fail to recover all anticipated insurance proceeds for significant accidents or events for which we are insured, or if we fail to rebuild facilities damaged by such accidents or events, our operations and financial condition could be adversely affected. In addition, we may not be able to maintain or obtain insurance of the type and amount we desire at reasonable rates. As a result of market conditions, premiums and deductibles for certain of our insurance policies have increased substantially, and could escalate further. For example, following the occurrence of severe hurricanes along the U.S. Gulf Coast in recent years, insurance premiums, deductibles and co-insurance requirements increased substantially, and terms were generally less favorable than terms that could be obtained prior to such hurricanes, with some coverage unavailable at any cost. Unexpected volume changes due to production variability or to gathering, plant or pipeline system disruptions may increase our exposure to commodity price movements. We sell processed natural gas at plant tailgates or at pipeline pooling points. Sales made to natural gas marketers and end-users may be interrupted by disruptions to volumes anywhere along the system. We attempt to balance sales with volumes supplied from processing operations, but unexpected volume variations due to production variability or to gathering, plant or pipeline system disruptions may expose us to volume imbalances which, in conjunction with movements in commodity prices, could materially impact our income from operations and cash flow. 33 Portions of our pipeline systems may require increased expenditures for maintenance and repair owing to the age of some of our systems, which expenditures or resulting loss of revenue due to pipeline age or condition could have a material adverse effect on our business and results of operations. Some portions of the pipeline systems that we operate have been in service for several decades prior to our purchase of them. Consequently, there may be historical occurrences or latent issues regarding our pipeline systems that our executive management may be unaware of and that may have a material adverse effect on our business and results of operations. The age and condition of some of our pipeline systems could also result in increased maintenance or repair expenditures, and any downtime associated with increased maintenance and repair activities could materially reduce our revenue. Any significant increase in maintenance and repair expenditures or loss of revenue due to the age or condition of some portions of our pipeline systems could adversely affect our business and results of operations. Terrorist attacks and the threat of terrorist attacks have resulted in increased costs to our business. Continued global and domestic hostilities may adversely impact our results of operations. The long-term impact of terrorist attacks, such as the attacks that occurred on September 11, 2001, and the threat of future terrorist attacks on our industry in general and on us in particular is not known at this time. However, resulting regulatory requirements and/or related business decisions associated with security are likely to increase our costs. Increased security measures taken by us as a precaution against possible terrorist attacks have resulted in increased costs to our business. Uncertainty surrounding continued global and domestic hostilities may affect our operations in unpredictable ways, including disruptions of crude oil supplies and markets for our products, and the possibility that infrastructure facilities could be direct targets, or indirect casualties, of an act of terror. Changes in the insurance markets attributable to terrorist attacks may make certain types of insurance more difficult for us to obtain. Moreover, the insurance that may be available to us may be significantly more expensive than our existing insurance coverage or coverage may be reduced or unavailable. Instability in the financial markets as a result of terrorism or war could also affect our ability to raise capital. We face opposition to operation and expansion of our pipelines and facilities from various individuals and groups. We have experienced, and may encounter from time to time, opposition to the operation and expansion of our pipelines and facilities from governmental officials, non-governmental environmental organizations and groups, landowners, tribal groups, local groups and other advocates. In some instances, we encounter opposition which disfavors hydrocarbon-based energy supplies regardless of practical implementation or financial considerations. Opposition to our operation and expansion can take many forms, including the delay, denial or termination of required governmental permits or approvals, organized protests, attempts to block or sabotage our operations, intervention in regulatory or administrative proceedings involving our assets or lawsuits or other actions designed to prevent, disrupt, delay or terminate the operation or expansion of our assets and business. Similar actions pursued against our oil and gas customers could result in interruptions or limitations to their businesses, which could reduce demand for our services. Any such event that restricts, delays or prevents the expansion of our or our customers’ businesses, interrupts the revenues generated by our or our customers’ operations or causes us or our customers to make significant expenditures not covered by insurance could adversely affect our business, results of operations, and financial condition, as well as reduce the demand for our services. Increased regulatory attention to environmental justice matters at the federal and state level may also provide communities opposed to our operations with greater opportunities to challenge or delay the permitting approval process. We may incur significant costs and liabilities resulting from performance of pipeline integrity testing programs and related repairs. Pursuant to the authority under the NGPSA and HLPSA, PHMSA has established rules requiring pipeline operators to develop and implement integrity management programs for certain natural gas and hazardous liquids pipelines located where a pipeline leak or rupture could affect higher and moderate consequence risk areas, known as HCAs and MCAs, which are areas where a release could have the most significant adverse consequences. Among other things, these regulations require operators of covered pipelines to: •perform ongoing assessments of pipeline integrity; •identify and characterize applicable threats to pipeline segments that could impact an HCA, MCA or Class 3 or 4 area; •maintain processes for data collection, integration and analysis; •repair and remediate pipelines as necessary; and •implement preventive and mitigating actions. 34 With adoption of the Pipeline Safety, Regulatory Certainty, and Job Creation Act of 2011 (“2011 Pipeline Safety Act”), the Protecting our Infrastructure of Pipelines and Enhancing Safety Act of 2016 (“2016 Pipeline Safety Act”) and the Protecting Our Infrastructure of Pipelines and Enhancing Safety (“PIPES”) Act of 2020 over the past decade, existing mandates require PHMSA to impose more stringent pipeline safety standards. As a result of those legislative enactments, PHMSA has issued several significant rulemakings. For example, more recently, in November 2021, PHMSA issued a final rule establishing two new classes of onshore gas gathering pipelines—Type R and Type C—and imposed safety regulations on approximately 400,000 miles of previously unregulated onshore gas gathering lines that, among other things, established criteria for inspection and repair of fugitive emissions, extended reporting requirements to all gas gathering operators and applied a set of minimum safety requirements to certain gas gathering pipelines with large diameters and high operating pressures. Separately, in June 2021, PHMSA issued an Advisory Bulletin advising pipeline and pipeline facility operators of applicable requirements to update their inspection and maintenance plans for the elimination of hazardous leaks and minimization of natural gas released from pipeline facilities. PHMSA, together with state regulators, were expected to commence inspection of operator plans in 2022. In August 2022, PHMSA finalized additional pipeline safety rules, which adjusted the repair criteria for pipelines in HCAs, created new criteria for pipelines in non-HCAs, and strengthened integrity management assessment requirements, among other items. The integrity-related requirements and other provisions of the 2011 Pipeline Safety Act, the 2016 Pipeline Safety Act, and the PIPES Act of 2020, as well as any implementation of PHMSA rules thereunder, could require us to pursue additional capital projects or conduct integrity or maintenance programs on an accelerated basis and incur increased operating costs that could have a material adverse effect on our costs of transportation services as well as our business, results of operations and financial condition. In addition, certain states, including Texas, Louisiana, Oklahoma, New Mexico, and North Dakota, where we conduct operations, have adopted regulations similar to existing PHMSA regulations for certain intrastate natural gas and hazardous liquids pipelines. We plan to continue our pipeline integrity inspection programs to assess and maintain the integrity of our pipelines. The results of these inspections may cause us to incur material and unanticipated capital and operating expenditures for repairs or upgrades deemed necessary to ensure the continued safe and reliable operation of our pipelines. We are subject to cybersecurity risks. A cyber incident could occur and result in information theft, data corruption, operational disruption and/or financial loss. The oil and natural gas industry has become increasingly dependent on digital technologies to conduct business. For example, we depend on digital technologies to operate our facilities, serve our customers and record financial data. At the same time, cyber incidents, including deliberate attacks, have increased. In May 2021, a ransomware attack on a major U.S. refined products pipeline forced the operator to temporarily shut down the pipeline, resulting in disruption of fuel supplies along the East Coast. The U.S. government has issued public warnings that indicate that energy assets might be specific targets of cybersecurity threats. Our technologies, systems and networks, and those of our vendors, suppliers, customers and other business partners, may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of proprietary and other information, or could adversely disrupt our business operations. In addition, certain cyber incidents, such as surveillance, may remain undetected for an extended period. Our systems for protecting against cybersecurity risks may not be sufficient. As cyber incidents continue to evolve, we will likely be required to expend additional resources to enhance our security posture and cybersecurity defenses or to investigate and remediate any vulnerability to or consequences of cyber incidents. Our insurance coverages for cyber-attacks may not be sufficient to cover all the losses we may experience as a result of a cyber incident. The widespread outbreak pandemics (like COVID-19) or any other public health crisis that impacts the global demand for energy commodities may have material adverse effects on our business, financial position, results of operations and/or cash flows. We face risks related to the outbreak of illnesses, pandemics and other public health crises that are outside of our control and could significantly disrupt our operations and adversely affect our financial condition. The effects of the COVID-19 pandemic, including travel bans, prohibitions on group events and gatherings, shutdowns of certain businesses, curfews, shelter-in-place orders and recommendations to practice social distancing in addition to other actions taken by both businesses and governments, resulted in a significant and swift reduction in international and U.S. economic activity. 35 Since the beginning of 2021, the distribution of COVID-19 vaccines progressed and many government-imposed restrictions were relaxed or rescinded. However, we continue to monitor the effects of the pandemic on our operations. Our results of operations and financial condition have been and may continue to be adversely affected by the COVID-19 pandemic. The extent to which our operating and financial results are affected by COVID-19 will depend on various factors and consequences beyond our control, such as the emergence of more contagious and harmful variants of the COVID-19 virus, the duration and scope of the pandemic, additional actions by businesses and governments in response to the pandemic, and the speed and effectiveness of responses to combat the virus. COVID-19, and the volatile regional and global economic conditions stemming from the pandemic, could also aggravate the other risk factors that we identify herein. While the effects of the COVID-19 pandemic have lessened recently in the United States, we cannot predict the duration or future effects of the pandemic, or more contagious and harmful variants of the COVID-19 virus, and such effects may materially adversely affect our results of operations and financial condition in a manner that is not currently known to us or that we do not currently consider to present significant risks to our operations. Risks Related to our Capital Projects and Future Growth Our expansion or modification of existing assets or the construction of new assets may not result in revenue increases and are subject to regulatory, environmental, political, legal and economic risks, which could adversely affect our results of operations and financial condition. The construction of additions or modifications to our existing systems and the construction of new midstream assets involve numerous regulatory, environmental, political and legal uncertainties beyond our control and may require the expenditure of significant amounts of capital. If we undertake these projects, they may not be completed on schedule, at the budgeted cost or at all. For example, the construction of additional systems may be delayed or require greater capital investment if the commodity prices of certain supplies, such as steel pipe, increase due to imposed tariffs. Moreover, our revenues may not increase immediately upon the expenditure of funds on a particular project. For instance, if we build a new pipeline, fractionation facility or gas processing plant, the construction may occur over an extended period of time and we will not receive any material increases in revenues until the project is completed. Moreover, we may construct pipelines or facilities to capture anticipated future growth in production in a region in which such growth does not materialize. Since we are not engaged in the exploration for and development of natural gas and oil reserves, we do not possess reserve expertise and we often do not have access to third-party estimates of potential reserves in an area prior to constructing pipelines or facilities in such area. To the extent we rely on estimates of future production in any decision to construct additions to our systems, such estimates may prove to be inaccurate because there are numerous uncertainties inherent in estimating quantities of future production. As a result, new pipelines or facilities may not be able to attract enough throughput to achieve our expected investment return, which could adversely affect our results of operations and financial condition. In addition, the construction of additions to our existing gathering and transportation assets may require us to obtain new rights of way prior to constructing new pipelines. We may be unable to obtain or renew such rights of way to connect new natural gas and crude oil supplies to our existing gathering lines or capitalize on other attractive expansion opportunities. Additionally, it may become more expensive for us to obtain new rights of way or to renew existing rights of way. If the cost of renewing or obtaining new rights of way increases, our cash flows could be adversely affected. If we do not develop growth projects and/or make acquisitions for expanding existing assets or constructing new assets on economically acceptable terms, or fail to efficiently and effectively integrate developed or acquired assets with our asset base, our future growth will be limited. In addition, any acquisitions we complete are subject to substantial risks that could adversely affect our financial condition and results of operations and reduce our ability to pay dividends to stockholders. In addition, we may not achieve the expected results of any acquisitions and any adverse conditions or developments related to such acquisitions may have a negative impact on our operations and financial condition. Our ability to grow depends, in part, on our ability to develop growth projects and/or make acquisitions that result in an increase in cash generated from operations. If we are unable to develop accretive growth projects or make accretive acquisitions because we are unable to (1) develop growth projects economically or identify attractive acquisition candidates and negotiate acceptable acquisition agreements or, (2) obtain financing for these projects or acquisitions on economically acceptable terms, or (3) compete successfully for growth projects or acquisitions, then our future growth and ability to return increasing capital to our shareholders may be limited. Any growth project or acquisition involves potential risks, including, among other things: •operating a significantly larger combined organization and adding new or expanded operations; •difficulties in the assimilation of the assets and operations of the growth projects or acquired businesses, especially if the assets developed or acquired are in a new business segment and/or geographic area; •the risk that crude oil and natural gas reserves expected to support the acquired assets may not be of the anticipated magnitude or may not be developed as anticipated; 36 •the failure to realize expected volumes, revenues, profitability or growth; •the failure to realize any expected synergies and cost savings; •coordinating geographically disparate organizations, systems and facilities; •the assumption of environmental and other unknown liabilities; •limitations on rights to indemnity from the seller in an acquisition or the contractors and suppliers in growth projects; •the failure to attain or maintain compliance with environmental and other governmental regulations; •inaccurate assumptions about the overall costs of equity or debt or the tightening of capital markets and access to new capital; •the diversion of management’s and employees’ attention from other business concerns; •challenges associated with joint venture relationships and minority investments, including dependence on joint venture partners, controlling shareholders or management who may have business interests, strategies or goals that are inconsistent with ours; and •customer or key employee losses at the acquired businesses or to a competitor. If these risks materialize, any growth project or acquired assets may inhibit our growth, fail to deliver expected benefits and/or add further unexpected costs. Challenges may arise whenever businesses with different operations or management are combined, and we may experience unanticipated delays in realizing the benefits of a growth project or acquisition if we fail to successfully integrate such businesses, including the Delaware Basin Acquisition and South Texas Acquisition, with our operations. If we consummate any future growth project or acquisition, our capitalization and results of operations may change significantly and you may not have the opportunity to evaluate the economic, financial and other relevant information that we will consider in evaluating future growth projects or acquisitions. Our growth and acquisition strategy is based, in part, on our expectation of ongoing divestitures of energy assets by industry participants and new opportunities created by industry expansion. A material decrease in such divestitures or in opportunities for economic commercial expansion would limit our opportunities for future growth projects or acquisitions and could adversely affect our operations and cash flows available to pay cash dividends to our stockholders. Growth projects may increase our concentration in a line of business or geographic region and acquisitions may significantly increase our size and diversify the geographic areas in which we operate. In addition, we may not achieve the desired effect from any future growth projects or acquisitions. We may be unable to cause our joint ventures to take or not to take certain actions unless some or all of our joint venture participants agree. We participate in several joint ventures whose corporate governance structures require at least a majority in interest vote to authorize many basic activities and require a greater voting interest (sometimes up to 100%) to authorize more significant activities. Examples of these more significant activities include, among others, large expenditures or contractual commitments, the construction or acquisition of assets, borrowing money or otherwise raising capital, making distributions, transactions with affiliates of a joint venture participant, litigation and transactions not in the ordinary course of business. Without the concurrence of joint venture participants with enough voting interests, we may be unable to cause any of our joint ventures to take or not take certain actions, even though taking or preventing those actions may be in our best interests or the particular joint venture. In addition, subject to certain conditions, any joint venture owner may sell, transfer or otherwise modify its ownership interest in a joint venture, whether in a transaction involving third parties or the other joint owners. Any such transaction could result in our partnering with different or additional parties. 37 We may operate a portion of our business with one or more joint venture partners where we own a minority interest and/or are not the operator, which may restrict our operational and corporate flexibility. Actions taken by the other partner or third-party operator may materially impact our financial position and results of operations, and we may not realize the benefits we expect to realize from a joint venture. As is common in the midstream industry, we may operate one or more of our properties with one or more joint venture partners where we own a minority interest and/or contract with a third party to control operations. These relationships could require us to share operational and other control, such that we may no longer have the flexibility to control completely the development of these properties. If we do not timely meet our financial commitments in such circumstances, our rights to participate may be adversely affected. If a joint venture partner is unable or fails to pay its portion of development costs or if a third-party operator does not operate in accordance with our expectations, our costs of operations could be increased. We could also incur liability as a result of actions taken by a joint venture partner or third-party operator. Disputes between us and the other party may result in litigation or arbitration that would increase our expenses, delay or terminate projects and distract our officers and directors from focusing their time and effort on our business. Risks Related to our Financial Condition If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. In addition, potential changes in accounting standards might cause us to revise our financial results and disclosure in the future. Effective internal controls are necessary for us to provide timely and reliable financial reports and effectively prevent fraud. If we cannot provide timely and reliable financial reports or prevent fraud, our reputation and operating results would be harmed. We continue to enhance our internal controls and financial reporting capabilities. These enhancements require a significant commitment of resources, personnel and the development and maintenance of formalized internal reporting procedures to ensure the reliability of our financial reporting. Our efforts to update and maintain our internal controls may not be successful, and we may be unable to maintain adequate controls over our financial processes and reporting now or in the future, including future compliance with the obligations under Section 404 of the Sarbanes-Oxley Act of 2002. Any failure to maintain effective controls or difficulties encountered in the effective improvement of our internal controls could prevent us from timely and reliably reporting our financial results and may harm our operating results. Ineffective internal controls could also cause investors to lose confidence in our reported financial information. In addition, the Financial Accounting Standards Board or the SEC could enact new accounting standards that might impact how we are required to record revenues, expenses, assets and liabilities. Any significant change in accounting standards or disclosure requirements could have a material effect on our results of operations, financial condition and ability to comply with our debt obligations. We are exposed to credit risks of our customers, and any material nonpayment or nonperformance by our key customers could adversely affect our cash flow and results of operations. Many of our customers may experience financial problems that could have a significant effect on their creditworthiness, especially in a depressed commodity price environment. A decline in natural gas, NGL and crude oil prices may adversely affect the business, financial condition, results of operations, creditworthiness, cash flows and prospects of some of our customers. Severe financial problems encountered by our customers could limit our ability to collect amounts owed to us, or to enforce performance of obligations under contractual arrangements. In addition, many of our customers finance their activities through cash flow from operations, the incurrence of debt or the issuance of equity. The combination of reduction of cash flow resulting from a decline in commodity prices, a reduction in borrowing bases under reserve-based credit facilities and the lack of availability of debt or equity financing may result in a significant reduction of our customers’ liquidity and limit their ability to make payment or perform on their obligations to us. Additionally, a decline in the share price of some of our public customers may place them in danger of becoming delisted from a public securities exchange, limiting their access to the public capital markets and further restricting their liquidity. Furthermore, some of our customers may be highly leveraged and subject to their own operating and regulatory risks, which increases the risk that they may default on their obligations to us. To the extent one or more of our key customers is in financial distress or commences bankruptcy proceedings, contracts with these customers may be subject to renegotiation or rejection under applicable provisions of the United States Bankruptcy Code. Furthermore, some bankruptcy courts have found that, in certain cases oil, gas and water gathering agreements do not create covenants running with the land under governing law and are thus subject to rejection in Chapter 11 proceedings. Whether a particular contract is subject to rejection depends on the wording of the contract, the governing law and the forum where a particular bankruptcy case is filed. Financial problems experienced by our customers could result in the impairment of our long-lived assets, reduction of our operating cash flows and may also reduce or curtail their future use of our products and services, which could reduce our revenues. Any material nonpayment or nonperformance by our key customers or our derivative counterparties could reduce our ability to pay cash dividends to our stockholders. 38 Continuing or worsening inflationary issues and associated changes in monetary policy have resulted in and may result in additional increases to the cost of our goods, services and personnel, which in turn cause our capital expenditures and operating costs to rise. The U.S. inflation rate increased in 2021, 2022 and into 2023. These inflationary pressures have resulted in and may result in additional increases to the costs of our goods, services and personnel, which in turn cause our capital expenditures and operating costs to rise. Sustained levels of high inflation have likewise caused the U.S. Federal Reserve and other central banks to increase interest rates multiple times in 2022. The U.S. Federal Reserve has raised and may continue to raise benchmark interest rates in 2023 in an effort to curb inflationary pressure on the costs of goods and services across the U.S., which could have the effects of raising the cost of capital and depressing economic growth, either of which—or the combination thereof—could negatively impact the financial and operating results of our business. To the extent elevated inflation remains, we may experience further cost increases for our operations, including services, labor costs and equipment if our operating activity increases. Higher oil and natural gas prices may cause the costs of materials and services to continue to rise. We cannot predict any future trends in the rate of inflation and a significant increase in inflation, to the extent we are unable to recover higher costs through higher prices and revenues, would negatively impact our business, financial condition and results of operations. Changes in future business conditions could have a negative impact on the demand for our services and could cause recorded long-lived assets to become further impaired, and our financial condition and results of operations could suffer if there is a negative impact on the demand for our services and an additional impairment of long-lived assets. We evaluate long-lived assets, including related intangibles, for impairment when events or changes in circumstances indicate, in management's judgment, that the carrying value of such assets may not be recoverable. Asset recoverability is measured by comparing the carrying value of the asset or asset group with its expected future pre-tax undiscounted cash flows. These cash flow estimates require us to make projections and assumptions for many years into the future for pricing, demand, competition, operating cost and other factors. Global oil and natural gas commodity prices, particularly crude oil, remain volatile. Decreases in commodity prices have previously had, and could continue to have, a negative impact on the demand for our services and our market capitalization. Should energy industry conditions deteriorate, there is a possibility that long-lived assets may be impaired in a future period. For example, in the fourth quarter of 2021, we recorded a non-cash pre-tax impairment of $452.3 million primarily associated with the partial impairment of gas processing facilities and gathering systems associated with our Central operations in our Gathering and Processing segment. Any additional impairment charges that we may take in the future could be material to our financial statements. We cannot accurately predict the amount and timing of any impairment of long-lived assets. For further discussion of our impairments of long-lived assets, see Note 5 — Property, Plant and Equipment and Intangible Assets of the “Consolidated Financial Statements” included in this Annual Report. Our hedging activities may not be effective in reducing the variability of our cash flows and may, in certain circumstances, increase the variability of our cash flows. Moreover, our hedges may not fully protect us against volatility in basis differentials. Finally, the percentage of our expected equity commodity volumes that are hedged decreases substantially over time. We have entered into derivative transactions related to only a portion of our equity volumes, future commodity purchases and sales, and transportation basis risk. As a result, we will continue to have direct commodity price risk to the unhedged portion. Our actual future volumes may be significantly higher or lower than we estimated at the time we entered into the derivative transactions for that period. If the actual amount is higher than we estimated, we will have greater commodity price risk than we intended. If the actual amount is lower than the amount that is subject to our derivative financial instruments, we might be forced to satisfy all or a portion of our derivative transactions without the benefit of the cash flow from our sale of the underlying physical commodity. The percentages of our expected equity volumes that are covered by our hedges decrease over time. To the extent we hedge our commodity price risk, we may forego the benefits we would otherwise experience if commodity prices were to change in our favor. The derivative instruments we utilize for these hedges are based on posted market prices, which may be higher or lower than the actual natural gas, NGL and condensate prices that we realize in our operations. These pricing differentials may be substantial and could materially impact the prices we ultimately realize. Market and economic conditions may adversely affect our hedge counterparties’ ability to meet their obligations. Given volatility in the financial and commodity markets, we may experience defaults by our hedge counterparties. In addition, our exchange traded futures are subject to margin requirements, which creates variability in our cash flows as commodity prices fluctuate. As a result of these and other factors, our hedging activities may not be as effective as we intend in reducing the variability of our cash flows, and in certain circumstances may actually increase the variability of our cash flows. See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.” 39 If we fail to balance our purchases and sales of the commodities we handle, our exposure to commodity price risk will increase. We may not be successful in balancing our purchases and sales of the commodities we handle. In addition, a producer could fail to deliver promised volumes to us or deliver in excess of contracted volumes, or a purchaser could purchase less than contracted volumes. Any of these actions could cause an imbalance between our purchases and sales. If our purchases and sales are not balanced, we will face increased exposure to commodity price risks and could have increased volatility in our operating income. The amounts we pay in dividends may vary from anticipated amounts and circumstances may arise that lead to conflicts between using funds to pay anticipated dividends or to invest in our business. The determination of the amounts of cash dividends, if any, to be declared and paid will depend upon our financial condition, results of operations, cash flow, the level of our capital expenditures, future business prospects and any other matters that our board of directors, in consultation with management, deems relevant. Many of these matters are affected by factors beyond our control and therefore, the actual amount of cash that is available for dividends to our stockholders may vary from anticipated amounts. Additionally, as events present themselves or become reasonably foreseeable, our board of directors, which determines our business strategy and our dividends, may decide to address those matters by utilizing capital that may otherwise be used for our dividend. For example, in March 2020, our board of directors approved a reduction in our quarterly cash dividend to $0.10 per share for the quarter ended March 31, 2020 and maintained such dividend amount through the quarter ended September 30, 2021. Our board of directors may also determine that an increase in our dividend is appropriate. If we issue additional shares of common or preferred stock or we incur debt, the payment of dividends on those additional shares or interest on that debt could increase the risk that we will be unable to maintain or increase our cash dividend levels. If dividends on our shares of common stock are not paid with respect to any fiscal quarter, our stockholders will not be entitled to receive that quarter’s payments in the future. Dividends to our common stockholders are not cumulative. Consequently, if dividends on our shares of common stock are not paid with respect to any fiscal quarter, our stockholders will not be entitled to receive that quarter’s payments in the future. Our future tax liability may be greater than expected if our NOL carryforwards are limited, we do not generate expected deductions, or tax authorities successfully challenge certain of our tax positions. As of December 31, 2022, we have U.S. federal NOL carryforwards of $6.8 billion, some of which expire between 2036 to 2037 while others have no expiration date. Subject to the CAMT discussed below, we expect to be able to utilize these NOL carryforwards and generate deductions to offset all or a portion of our future taxable income. This expectation is based upon assumptions we have made regarding, among other things, our income, capital expenditures and net working capital, and the current expectation that our NOL carryforwards will not become subject to future limitations under Section 382 of the Internal Revenue Code of 1986, as amended (“Section 382”). Section 382 generally imposes an annual limitation on the amount of NOLs that may be used to offset taxable income when a corporation has undergone an “ownership change” (as determined under Section 382). An ownership change generally occurs if one or more stockholders (or groups of stockholders) who are each deemed to own at least 5% of our stock change their ownership by more than 50 percentage points over their lowest ownership percentage within a rolling three-year period. In the event that an ownership change were to occur, utilization of our NOLs carryforwards would be subject to an annual limitation under Section 382, determined by multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in Section 382, subject to certain adjustments. While we expect to be able to utilize our NOL carryforwards and generate deductions to offset all or a portion of our future taxable income (subject to the CAMT discussed below), in the event that deductions are not generated as expected, one or more of our tax positions are successfully challenged by the IRS (in a tax audit or otherwise) or our NOL carryforwards are subject to future limitations under Section 382, our future tax liability may be greater than expected. 40 Changes in tax laws or the interpretation thereof or the imposition of new or increased taxes may adversely affect our financial condition, results of operations and cash flows. U.S. federal and state legislation is periodically proposed that would, if enacted into law, make significant changes to tax laws and could materially increase our tax obligations, adversely affecting our financial condition, results of operations and cash flows. For example, on August 16, 2022, President Biden signed into law the IRA which includes, among other things, the CAMT. Under the CAMT, a 15% minimum tax will be imposed on certain financial statement income of “applicable corporations.” The IRA treats a corporation as an applicable corporation in any taxable year in which the “average annual adjusted financial statement income” of such corporation for the three taxable year period ending prior to such taxable year exceeds $1 billion. Based on our current interpretation of the IRA, the CAMT and related guidance and a number of operational, economic, accounting and regulatory assumptions, we do not anticipate being an applicable corporation in the near term, but we are likely to become an applicable corporation in a subsequent tax year. If we become an applicable corporation and our CAMT liability is greater than our regular U.S. federal income tax liability for any particular tax year, the CAMT liability would effectively accelerate our future U.S. federal income tax obligations, reducing our cash available for distribution in that year, but provide an offsetting credit against our regular U.S. federal income tax liability for a future year. As a result, our current expectation is that the impact of the CAMT is limited to timing differences in future tax years. The foregoing analysis is based upon our current interpretation of the provisions contained in the IRA, the CAMT and related guidance. In the future the U.S. Department of the Treasury and the Internal Revenue Service are expected to release regulations and additional interpretive guidance relating to such legislation, and any significant variance from our current interpretation could result in a change in our analysis of the application of the CAMT to us. Derivatives legislation and its implementing regulations could have a material adverse effect on our ability to use derivative instruments to reduce the effect of commodity price, interest rate and other risks associated with our business. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), enacted in July 2010, established federal oversight and regulation of the over-the-counter derivatives market and entities, such as us, that participate in that market. The Dodd-Frank Act required the CFTC and the SEC to promulgate rules and regulations implementing the Dodd-Frank Act, and most of these regulations have been finalized. In October 2020, the CFTC adopted new rules that will place limits on positions in certain core futures and equivalent swaps contracts for or linked to certain physical commodities, subject to exceptions for certain bona fide hedging transactions. The new rules became effective in December 2020 but have a general compliance date of January 1, 2022 for covered future positions and January 1, 2023 for covered swaps positions. We have not experienced a material impediment to, and do not expect these regulations to materially impede, our hedging activity at this time. The CFTC has designated certain interest rate swaps and credit default swaps for mandatory clearing and the associated rules also will require us, in connection with covered derivative activities, to comply with clearing and trade-execution requirements or take steps to qualify for an exemption to such requirements. Although we qualify for the end-user exception from the mandatory clearing requirements for swaps entered to hedge our commercial risks, the application of the mandatory clearing and trade execution requirements to other market participants, such as swap dealers, may change the cost and availability of the swaps that we use for hedging. The CFTC and the federal banking regulators have adopted regulations requiring certain counterparties to swaps to post initial and variation margin. However, our current hedging activities would qualify for the non-financial end user exemption from the margin requirements. The Dodd-Frank Act and any new regulations could increase the cost of derivative contracts or potentially reduce the availability of derivatives to protect against risks we encounter. If we reduce our use of derivatives as a result of the Dodd-Frank Act and regulations implementing the Dodd-Frank Act, our results of operations may become more volatile and our cash flows may be less predictable, which could adversely affect our ability to plan for and fund capital expenditures. Any of these consequences could have a material adverse effect on us, our financial condition and our results of operations. The European Union (the “EU”) and other non-U.S. jurisdictions are also implementing regulations with respect to the derivatives market. To the extent we enter into swaps with counterparties in foreign jurisdictions or counterparties with other businesses that subject them to regulation in foreign jurisdictions, we may be impacted by such regulations. The implementing regulations adopted by the EU and by other non-U.S. jurisdictions could have a material adverse effect on us, our financial condition and our results of operations. 41 Risks Related to the Ownership of our Common Stock Future sales of our common stock in the public market could lower our stock price, and any additional capital raised by us through the sale of equity or convertible securities may dilute your ownership in us. We or our stockholders may sell shares of common stock in subsequent public offerings. We may also issue additional shares of common stock or convertible securities. As of December 31, 2022, we had 226,042,229 outstanding shares of common stock. We cannot predict the size of future issuances of our common stock or the effect, if any, that future issuances and sales of shares of our common stock will have on the market price of our common stock. Sales of substantial amounts of our common stock (including shares issued in connection with an acquisition), or the perception that such sales could occur, may adversely affect prevailing market prices of our common stock. Our amended and restated certificate of incorporation and amended and restated bylaws, as well as Delaware law, contain provisions that could discourage acquisition bids or merger proposals, which may adversely affect the market price of our common stock. Our amended and restated certificate of incorporation authorizes our board of directors to issue preferred stock without stockholder approval. If our board of directors elects to issue preferred stock, it could be more difficult for a third party to acquire us. In addition, some provisions of our amended and restated certificate of incorporation and amended and restated bylaws could make it more difficult for a third party to acquire control of us, even if the change of control would be beneficial to our stockholders, including provisions which require: •a classified board of directors, so that only approximately one-third of our directors are elected each year; •limitations on the removal of directors; and •limitations on the ability of our stockholders to call special meetings and establish advance notice provisions for stockholder proposals and nominations for elections to the board of directors to be acted upon at meetings of stockholders. Delaware law prohibits us from engaging in any business combination with any “interested stockholder,” meaning generally that a stockholder who beneficially owns more than 15% of our stock cannot acquire us for a period of three years from the date this person became an interested stockholder, unless various conditions are met, such as approval of the transaction by our board of directors. We may issue preferred stock whose terms could adversely affect the voting power or value of our common stock. Our amended and restated certificate of incorporation authorizes us to issue, without the approval of our stockholders, one or more classes or series of preferred stock having such designations and powers, preferences, including preferences over our common stock respecting dividends and distributions, rights, qualifications, limitations and restrictions as our board of directors may determine. The terms of one or more classes or series of preferred stock could adversely impact the voting power or value of our common stock. For example, we might grant holders of preferred stock the right to elect some number of our directors in all events or on the happening of specified events or the right to veto specified transactions. Similarly, the repurchase or redemption rights or liquidation preferences we might assign to holders of preferred stock could affect the residual value of our common stock. Risks Related to Our Indebtedness Continued increases in interest rates, due to associated Federal Reserve policies or otherwise, could adversely affect our cost of capital, which could increase our funding costs and reduce the overall profitability of our business. We have significant exposure to increases in interest rates. As of December 31, 2022, our total indebtedness was $11,610.4 million, excluding $8.4 million of unamortized discounts and $65.6 million of debt issuance costs, of which $7,784.4 million was at fixed interest rates, $3,598.7 million was at variable interest rates and $227.3 million consisted of finance lease liabilities. A hypothetical change of 100 basis points in the rate of our variable interest rate debt would impact our consolidated annual interest expense by $36.0 million based on our December 31, 2022 debt balances. We additionally had $1.4 billion of additional borrowing capacity available under the TRGP Revolver after accounting for $33.2 million of letters of credit, under which borrowing is exposed to such increases in variable interest rates. As a result of our variable interest debt, our results of operations could be adversely affected by increases in interest rates, due to associated Federal Reserve policies or otherwise. Additionally, like all equity investments, an investment in our equity securities is subject to certain risks. In exchange for accepting these risks, investors may expect to receive a higher rate of return than would otherwise be obtainable from lower-risk investments. Accordingly, as interest rates rise, the ability of investors to obtain higher risk-adjusted rates of return by purchasing government-backed debt securities may cause a corresponding decline in demand for riskier investments generally, including yield-based equity investments. 42 Reduced demand for our common stock resulting from investors seeking other more favorable investment opportunities may cause the trading price of our common stock to decline. We have a substantial amount of indebtedness which may adversely affect our financial position and we may still be able to incur substantially more debt, which could collectively increase the risks associated with compliance with our financial covenants. We have a substantial amount of indebtedness. As of December 31, 2022, we had $2.8 billion outstanding TRGP senior unsecured notes, excluding $8.4 million of unamortized discounts and $5.0 billion outstanding of the Partnership’s senior unsecured notes. We also had $800.0 million outstanding under the Securitization Facility. In addition, we had (i) $1.5 billion of borrowing outstanding under the Term Loan Facility, and (ii) $290.0 million of borrowings outstanding under the TRGP Revolver, $33.2 million of letters of credit outstanding, $1,008.7 million of borrowings outstanding under the Commercial Paper Program and $1.4 billion of additional borrowing capacity available under the TRGP Revolver. For the years ended December 31, 2022, 2021 and 2020, our consolidated interest expense, net was $446.1 million, $387.9 million and $391.3 million. Our substantial level of indebtedness increases the possibility that we may be unable to generate cash sufficient to pay, when due, the principal of, interest on or other amounts due in respect of indebtedness. This substantial indebtedness, combined with lease and other financial obligations and contractual commitments, could have other important consequences to us, including the following: •our ability to obtain additional financing, if necessary, for working capital, capital expenditures, acquisitions or other purposes may be impaired or such financing may not be available on favorable terms; •satisfying our obligations with respect to indebtedness may be more difficult and any failure to comply with the obligations of any debt instruments could result in an event of default under the agreements governing such indebtedness; •we will need a portion of cash flow to make interest payments on debt, reducing the funds that would otherwise be available for operations and future business opportunities; •our debt level may influence how counterparties view our creditworthiness, which could limit our ability to enter into commercial transactions at favorable rates or require us to post additional collateral in commercial transactions; •our debt level will make us more vulnerable to competitive pressures or a downturn in our business or the economy generally; and •our debt level may limit flexibility in planning for, or responding to, changing business and economic conditions. Our long-term unsecured debt is currently rated by Fitch, Moody’s and S&P. As of December 31, 2022, Targa’s senior unsecured debt was rated “BBB-” by Fitch, “Baa3” by Moody’s and “BBB-” by S&P. Any future downgrades in our credit ratings could negatively impact our cost of raising capital, and a downgrade could also adversely affect our ability to effectively execute aspects of our strategy and to access capital in the public markets. Our International Swaps and Derivatives Association (“ISDA”) agreements contain credit-risk related contingent features. Following the release of the collateral securing our TRGP Revolver as a result of our credit rating, our derivative positions are no longer secured. As of December 31, 2022, we have outstanding net derivative positions that contain credit-risk related contingent features that are in a net liability position of $266.7 million. If our credit rating is downgraded below investment grade by both Moody’s and S&P, as defined in our ISDAs, we estimate that as of December 31, 2022, we would be required to post $31.4 million of collateral to certain counterparties per the terms of our ISDAs. Our ability to service our debt will depend upon, among other things, our future financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, some of which are beyond our control. If our operating results are not sufficient to service our current or future indebtedness, we will be forced to take actions such as reducing or delaying business activities, investments or capital expenditures, acquisitions, selling assets, restructuring or refinancing debt, or seeking additional equity capital, and such results may adversely affect our ability to make cash dividends. We may not be able to affect any of these actions on satisfactory terms, or at all. We may be able to incur substantial additional indebtedness in the future. The TRGP Revolver provides an available commitment of $2.75 billion and allows us to request increases in commitments up to an additional $500.0 million. Although our debt agreements contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of significant qualifications and exceptions, and any indebtedness incurred in compliance with these restrictions could be substantial. If we incur additional debt, this could increase the risks associated with compliance with our financial covenants. 43 The terms of our debt agreements may restrict our current and future operations, particularly our ability to respond to changes in business or to take certain actions, including to pay dividends to our stockholders. The agreements governing our outstanding indebtedness contain, and any future indebtedness we incur will likely contain, a number of restrictive covenants that impose significant operating and financial restrictions, including restrictions on our ability to engage in acts that may be in our best long-term interests. These agreements include covenants that, among other things, restrict our ability to: •incur or guarantee additional indebtedness or issue additional preferred stock; •pay dividends on our equity securities or to our equity holders or redeem, repurchase or retire our equity securities or subordinated indebtedness; •make investments and certain acquisitions; •sell or transfer assets, including equity securities of our subsidiaries; •engage in affiliate transactions; •consolidate or merge; •incur liens; •prepay, redeem and repurchase certain debt, subject to certain exceptions; •enter into sale and lease-back transactions or take-or-pay contracts; and •change business activities conducted by us. In addition, certain of our debt agreements require us to satisfy and maintain specified financial ratios and other financial condition tests. Our ability to meet those financial ratios and tests can be affected by events beyond our control, and we cannot assure you that we will meet those ratios and tests. A breach of any of these covenants could result in an event of default under our debt agreements. Upon the occurrence of such an event of default, all amounts outstanding under the applicable debt agreements could be declared to be immediately due and payable and all applicable commitments to extend further credit could be terminated. If we are unable to repay the accelerated debt under the Securitization Facility, the lenders under the Securitization Facility could proceed against the collateral granted to them to secure the indebtedness. We have pledged the accounts receivables of Targa Receivables LLC under the Securitization Facility. If the indebtedness under our debt agreements is accelerated, we cannot assure you that we will have sufficient assets to repay the indebtedness. The operating and financial restrictions and covenants in these debt agreements and any future financing agreements may adversely affect our ability to finance future operations or capital needs or to engage in other business activities. Risks Related to Regulatory Matters Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change that could result in increased operating costs, limit the areas in which oil and natural gas production may occur, and reduce demand for the products and services we provide. The threat of climate change continues to attract considerable attention in the United States and in foreign countries. As a result, numerous proposals have been made and could continue to be made at the international, national, regional and state levels of government to monitor and limit emissions of GHGs. As a result, our operations as well as the operations of our oil and natural gas exploration and production customers, are subject to a series of regulatory, political, litigation, and financial risks associated with the production and processing of fossil fuels and emission of GHGs. In the United States, no comprehensive climate change legislation has been implemented at the federal level, though recent laws such as the IRA advance numerous climate-related objectives. However, because the U.S. Supreme Court has held that GHG emissions constitute a pollutant under the CAA, the EPA has adopted rules that, among other things, establish construction and operating permit reviews for GHG emissions from certain large stationary sources, require the monitoring and annual reporting of GHG emissions from 44 certain petroleum and natural gas system sources, implement New Source Performance Standards directing the reduction of methane from certain new, modified, or reconstructed facilities in the oil and natural gas sector, and together with the DOT, implement GHG emissions limits on vehicles manufactured for operation in the United States. Additionally, in August 2022, the IRA was signed into law, which appropriates significant federal funding for renewable energy initiatives and amends the federal Clean Air Act to impose a first-time fee on the emission of methane from sources required to report their GHG emissions to the EPA, including those sources in the onshore petroleum and natural gas production and gathering and boosting source categories. The methane emissions charge would start in calendar year 2024 at $900 per ton of methane, increase to $1,200 in 2025, and be set at $1,500 for 2026 and each year after. Calculation of the fee is based on certain thresholds established in the IRA. The methane emissions fee and renewable and low carbon energy funding provisions of the law could increase our and our customers’ operating costs and accelerate the transition away from fossil fuels, which could in turn reduce demand for our products and services and adversely affect our business and results of operations. In recent years, there has been considerable uncertainty surrounding regulation of methane emissions. In response to President Biden's executive order calling on the EPA to revisit federal regulations regarding methane in November 2021, the EPA issued a proposed rule that, if finalized, would make the existing regulations in Subpart OOOOa more stringent and establish Subpart OOOOb to expand emissions reduction requirements for new, modified and reconstructed oil and gas sources, including certain source types not previously regulated under Subpart OOOOa. In addition, the proposed rule would create a new Subpart OOOOc which would require states to develop plans to reduce methane and volatile organic compound emissions from existing sources that must be at least as effective as presumptive standards set by the EPA. This proposed rule would apply to upstream and midstream facilities at oil and natural gas well sites, natural gas gathering and boosting compressor stations, natural gas processing plants, and transmission and storage facilities. Owners or operators of affected emission units or processes would have to comply with specific standards of performance that may include leak detection using optical gas imaging and subsequent repair requirements, reduction of emissions by 95% through capture and control systems, zero-emission requirements, operations and maintenance requirements, and so-called green well completion requirements. In November 2022, the EPA published a supplemental methane proposal, which, among other items, sets forth specific revisions strengthening the first nationwide emission guidelines for states to limit methane emissions from existing crude oil and natural gas facilities. The proposal also revises requirements for fugitive emissions monitoring and repair as well as equipment leaks and the frequency of monitoring surveys, establishes a “super-emitter” response program to timely mitigate emissions events, and provides additional options for the use of advanced monitoring to encourage the deployment of innovative technologies to detect and reduce methane emissions. The proposal is currently subject to public comment and is expected to be finalized in 2023; however, it is likely that these requirements will be subject to legal challenges. While we cannot predict the final scope or compliance costs of these proposed regulatory requirements, any such requirements have the potential to increase our operating costs and thus may adversely affect our financial results and cash flows. Various states and groups of states have also adopted or are considering adopting legislation, regulations or other regulatory initiatives that are focused on areas of coverage similar to what the federal government has or may consider, including GHG cap and trade programs, carbon taxes, reporting and tracking programs, and restriction of emissions. At the international level, there exists the United Nations-sponsored “Paris Agreement,” which is a non-binding agreement for nations to limit their GHG emissions through individually-determined reduction goals every five years after 2020. President Biden announced in April 2021 a new, more rigorous nationally determined emissions reduction level of 50-52% reduction from 2005 levels in economy-wide net GHG emissions by 2030. Moreover, the international community gathered again in Glasgow in November 2021 at the 26th Conference of the Parties (“COP26”), during which the multiple announcements were made, including a call for parties to eliminate certain fossil fuel subsidies and pursue further action on non-CO2 GHGs. Relatedly, at COP26, the United States and European Union jointly announced the launch of a Global Methane Pledge, an initiative which over 100 countries joined, committing to a collective goal of reducing global methane emissions by at least 30 percent from 2020 levels by 2030, including “all feasible reductions” in the energy sector. At COP27 in Sharm El-Sheik in November 2022, countries reiterated the agreements from COP26 and were called upon to accelerate efforts toward the phase out of inefficient fossil fuel subsidies. The US also announced, in conjunction with the European Union and other partner countries, that it would develop standards for monitoring and reporting methane emissions to help create a market for low methane-intensity natural gas. Although no firm commitment or timeline to phase out or phase down all fossil fuels was made at COP27, there can be no guarantees that countries will not seek to implement such a phase out in the future. The impacts of these actions, orders, pledges, agreements and any legislation or regulation promulgated to fulfill the United States’ commitments under the Paris Agreement, COP26, COP27, or other international conventions cannot be predicted at this time and it is unclear what additional initiatives may be adopted or implemented that may have adverse effects on our operations. Governmental, scientific, and public concern over the threat of climate change arising from GHG emissions has resulted in increasing political risks in the United States, that may limit hydraulic fracturing of oil and natural gas wells, restrict flaring and venting during natural gas production on federal properties, and ban or restrict new or existing leases for production of minerals on federal properties. President Biden has issued several executive orders and strategies focused on addressing climate change, including items that may impact costs to produce, or demand for, oil and gas. Other actions relating to oil and natural gas production activities that could be pursued by the Biden Administration may include more restrictive requirements for the establishment of oil and natural gas pipeline infrastructure or the permitting of liquefied natural gas export facilities. For example, in November 2022 the BLM proposed a rule that 45 would limit flaring from well sites on federal lands, as well as allow the delay or denial of permits if BLM finds that an operator’s methane waste minimization plan is insufficient. The Biden Administration has also called for revisions and restrictions to the leasing and permitting programs for oil and gas development on federal lands and, for a time, suspended federal oil and gas leasing activities. The U.S. Department of the Interior’s comprehensive review of the federal leasing program resulted in a reduction in the volume of onshore land held for lease and an increased royalty rate. Any regulatory changes that restrict or require modifications to our or our suppliers’ existing operations or future expansions plans could reduce the demand for the products and services we provide, increase our operating costs and may have a negative impact on our financial condition. Litigation risks are also increasing, as a number of cities, local governments, and other plaintiffs have sought to bring suit against the largest oil and natural gas exploration and production companies in state or federal court, alleging, among other things, that such companies created public nuisances by producing fuels that contributed to global warming effects, such as rising sea levels, and therefore are responsible for roadway and infrastructure damages as a result, or alleging that the companies have been aware of the adverse effects of climate change for some time but defrauded their investors by failing to adequately disclose those impacts. Should we be targeted by any similar litigation, involvement in such a case could have adverse financial and reputational impacts and an unfavorable ruling could significantly impact our operations and adversely impact our financial condition. Additionally, our access to capital may be impacted by climate change policies. Stockholders and bondholders currently invested in fossil fuel energy companies but concerned about the potential effects of climate change may elect in the future to shift some or all of their investments into non-fossil fuel energy related sectors. Institutional investors who provide financing to fossil fuel energy companies have also become more attentive to sustainability lending practices that favor “clean” power sources such as wind and solar photovoltaic, making those sources more attractive, and some of them may elect not to provide funding for fossil fuel energy companies. Many of the largest U.S. banks have made “net zero” carbon emission commitments and have announced that they will be assessing financed emissions across their portfolios and taking steps to quantify and reduce those emissions. These and other developments in the financial sector could lead to some lenders restricting access to capital for or divesting from certain industries or companies, including the oil and natural gas sector, or requiring that borrowers take additional steps to reduce their GHG emissions. Additionally, there is the possibility that financial institutions will be required to adopt policies that limit funding to the fossil fuel sector. In late 2020, the Federal Reserve announced that it had joined the Network for Greening the Financial System (NGFS), a consortium of financial regulators focused on addressing climate-related risks in the financial sector and, in September 2022, the Federal Reserve announced that six of the U.S.’ largest banks will participate in a pilot climate scenario analysis exercise to enhance the ability of firms and supervisors to measure and mange climate-related financial risk. The Federal Reserve released its pilot exercise in January 2023 which is designed to analyze the impact of both physical and transition risks related to climate change on specific assets of the banks’ portfolios. While we cannot predict what policies may result from these developments, a material reduction in the capital available to the fossil fuel industry could make it more difficult to secure funding for exploration, development, production, transportation, and processing activities, which could impact our and our suppliers’ and customers’ businesses and operations. In addition, in March 2022, the SEC released a proposed rule that would establish a framework for the reporting of climate risks, targets, and metrics. A final rule is anticipated to be released by Q2 2023. Although the final form and substance of this rule and its requirements are not yet known and its ultimate impact on our business is uncertain, the proposed rule, if finalized, may result in increased legal, accounting and financial compliance costs for us and our suppliers and customers related to the assessment and disclosure of climate-related risks. We may also face increased litigation risks related to disclosures made pursuant to the rule if finalized as proposed. In addition, enhanced climate disclosure requirements could accelerate the trend of certain stakeholders and lenders in restricting or seeking more stringent conditions with respect to their investments in our customers in the energy industry and companies like ours that support the energy industry. Separately, the SEC has also announced that it is scrutinizing existing climate-change related disclosures in public filings, increasing the potential for enforcement if the SEC were to allege an issuer’s existing climate disclosures misleading or deficient. The adoption and implementation of any international, federal or state legislation, regulations or other regulatory initiatives that impose more stringent standards for GHG emissions from the oil and natural gas sector or otherwise restrict the areas in which this sector may produce oil and natural gas or generate GHG emissions could result in increased costs of compliance or costs of consuming, and thereby reduce demand for oil and natural gas, which could reduce demand for our services and products. Additionally, political, litigation, and financial risks may result in our oil and natural gas customers restricting or cancelling production activities, incurring liability for infrastructure damages as a result of climatic changes, or impairing their ability to continue to operate in an economic manner, which also could reduce demand for our services and products. One or more of these developments could have a material adverse effect on our business, financial condition and results of operation. Finally, increasing concentrations of GHGs in the Earth’s atmosphere may produce climate changes that have significant physical effects, such as increased frequency and severity of storms, droughts, floods, rising sea levels and other extreme climatic events, as well as chronic shifts in temperature and precipitation patterns. These climatic developments have the potential to cause physical damage to our assets and those of our suppliers and customers and thus could have an adverse effect on our operations and supply chain, including resulting in changes to costs associated with maintaining or insuring our assets. Additionally, changing meteorological conditions, particularly temperature, may result in changes to the amount, timing, or location of demand for energy or the products our customers 46 produce. While our consideration of changing weather conditions and inclusion of safety factors in design is intended to reduce the uncertainties that climate change and other events may potentially introduce, our ability to mitigate the adverse impacts of these events depends in part on the effectiveness of our facilities and our disaster preparedness and response and business continuity planning, which may not have considered or be prepared for every eventuality. If any such effects of climate changes were to occur, they could have an adverse effect on our financial condition and results of operations and the financial condition and operations of our customers. Increasing stakeholder and market attention to ESG matters may impact our business. Increasing attention to climate change, increasing societal expectations on companies to address climate change, and potential consumer use of substitutes to energy commodities may result in increased costs, reduced demand for our customers’ products and our services, reduced profits, increased investigations and litigation, and negative impacts on our stock price and access to capital markets. Increasing attention to climate change, for example, may result in demand shifts for our or our customers’ hydrocarbon products and additional governmental investigations and private litigation against us or those customers. As part of our ongoing effort to enhance our ESG practices, our Board of Directors has established a Sustainability Committee. Committee members oversee management’s implementation of ESG policies and provide insight to the Board on the effectiveness of integrating sustainability into our various business activities. We have also appointed a senior vice president of sustainability, who reports directly to our CEO and also regularly provides reports on relevant ESG matters to our Board of Directors. We also published our 2021 Sustainability Report, which provides updates on our performance related to certain ESG topics and sets certain ESG goals, such as reductions in methane intensity in line with the ONE Future goals. While we may elect to seek out various additional voluntary ESG targets now or in the future, such targets are aspirational. Moreover, despite our governance oversight in place, we may not be able to adequately identify ESG-related risks and opportunities and, further, may not be able to meet ESG targets in the manner or on such a timeline as initially contemplated, or at all, including as a result of unforeseen costs or technical difficulties associated with achieving such results. Moreover, ESG-related actions or statements that we may make or take are sometimes based on expectations, assumptions, or third-party information that we currently believe to be reasonable, but which may subsequently be determined to be erroneous or be subject to misinterpretation. Moreover, to the extent we elected to pursue such targets and were able to achieve the desired target levels, such achievement may have been accomplished as a result of entering into various contractual arrangements, including the purchase of various credits or offsets that may be deemed to mitigate our ESG impact instead of actual changes in our ESG performance. However, we cannot guarantee that there will be sufficient offsets for purchase or that, notwithstanding our reliance on any reputable third party registries, that the offsets we do purchase will successfully achieve the emissions reductions they represent. Notwithstanding our election to pursue aspirational targets now or in the future, we may receive pressure from investors, lenders or other groups to adopt more aggressive climate or other ESG-related goals, but we cannot guarantee that we will be able to implement such goals because of potential costs or technical or operational obstacles. In addition, organizations that provide information to investors on corporate governance and related matters have developed ratings processes for evaluating companies on their approach to ESG matters. Additionally, we and other companies in our industry publish sustainability reports that are made available to investors. Such ratings and reports are used by some investors to inform their investment and voting decisions. Unfavorable ESG ratings may lead to increased negative investor sentiment toward us or our customers and to the diversion of investment to other industries which could have a negative impact on our stock price and/or our access to and costs of capital. Also, certain institutional lenders may decide not to provide funding to us or our customers’ companies based on ESG concerns, which could adversely affect our financial condition and access to capital for potential growth projects. Increasingly, investors, lenders, and other stakeholders are focusing on issues related to environmental justice, which may result in increased scrutiny of our applicable regulatory processes and additional costs of compliance. Furthermore, public statements with respect to ESG matters, such as emissions reduction goals, other environmental targets, or other commitments addressing certain social issues, are becoming increasingly subject to heightened scrutiny from public and governmental authorities related to the risk of potential “greenwashing,” i.e., misleading information or false claims overstating potential ESG benefits. Certain non-governmental organizations and other private actors have also filed lawsuits under various securities and consumer protection laws alleging that certain ESG-statements, goals, or standards were misleading, false, or otherwise deceptive. As a result, we may face increased litigation risks from private parties and governmental authorities related to our ESG efforts. In addition, any alleged claims of greenwashing against us or others in our industry may lead to further negative sentiment and diversion of investments. Additionally, we expect there will likely be increasing levels of regulation, disclosure-related and otherwise, with respect to ESG matters, and we could face increasing costs as we attempt to comply with and navigate further regulatory ESG-related focus and scrutiny. We could incur significant costs in complying with more stringent occupational safety and health requirements. We are subject to stringent federal and state laws and regulations, including the federal Occupational Safety and Health Act and comparable state statutes, whose purpose is to protect the health and safety of workers, both generally and within the pipeline industry. In addition, the federal Occupational Safety and Health Administration’s (“OSHA”) hazard communication standard, the EPA 47 community right-to-know regulations under Title III of the Federal Superfund Amendment and Reauthorization Act and comparable state statutes require that information be maintained concerning hazardous materials used or produced in our operations and that this information be provided to employees, state and local government authorities and citizens. We and the entities in which we own an interest are subject to OSHA Process Safety Management regulations, which are designed to prevent or minimize the consequences of catastrophic releases of toxic, reactive, flammable or explosive chemicals. Failure to comply with these laws and regulations or any newly adopted laws or regulations may result in assessment of sanctions including administrative, civil and criminal penalties, the imposition of investigatory, remedial and corrective action obligations or the incurrence of capital expenditures, any of which could have a material adverse effect on our business, financial condition and results of operations. Laws, regulations and executive orders limiting hydraulic fracturing activities could result in restrictions, delays or cancellations in drilling and completing new oil and natural gas wells by our customers, which could adversely impact our revenues by decreasing the volumes of natural gas, NGLs or crude oil through our facilities and reducing the utilization of our assets. While we do not conduct hydraulic fracturing, many of our oil and gas exploration and production customers do perform such activities. Hydraulic fracturing is typically regulated by state oil and gas commissions, but several federal agencies have asserted regulatory authority over, proposed or promulgated regulations governing, and conducted investigations relating to certain aspects of the process, including the EPA. In addition, Congress has from time to time considered the adoption of legislation to provide for federal regulation of hydraulic fracturing. Moreover, President Biden issued an executive order in January 2021 suspending the issuance of new leases on federal lands and waters pending completion of a study of current oil and gas practices but, in August 2022, a U.S. District Court issued a permanent injunction that blocked President Biden’s order suspending new leases. Litigation concerning this issue remains pending. Notwithstanding these recent legal developments, further restrictions may be adopted by the Biden Administration that could restrict hydraulic fracturing activities on federal lands and waters. Many states have adopted legal requirements that have imposed new or more stringent permitting, public disclosure or well construction requirements on hydraulic fracturing activities, including in states where we or our customers conduct operations. States could further elect to suspend or prohibit hydraulic fracturing activities in the future. While governments may also seek to adopt ordinances within their jurisdictions regulating the time, place and manner of drilling activities in general or hydraulic fracturing activities in particular, non-governmental organizations may also seek to restrict hydraulic fracturing through ballot initiatives, such as those that have been pursued in Colorado. New or more stringent laws, regulations, executive orders or regulatory or ballot initiatives relating to the hydraulic fracturing process could lead to our customers reducing crude oil and natural gas drilling activities using hydraulic fracturing techniques, while increased public opposition to activities using such techniques may result in operational delays, restrictions, cessations, or increased litigation. Any one or more of such developments could reduce demand for our gathering, processing and fractionation services and have a material adverse effect on our business, financial condition and results of operations. Our operations are subject to environmental laws and regulations and a failure to comply or an accidental release into the environment may cause us to incur significant costs and liabilities. Our operations are subject to numerous federal, tribal, state and local environmental laws and regulations governing occupational health and safety, the discharge of pollutants into the environment or otherwise relating to environmental protection. These laws and regulations may impose numerous obligations that are applicable to our operations including acquisition of a permit or other approval before conducting regulated activities, restrictions on the types, quantities and concentration of materials that can be released into the environment; limitation or prohibition of construction and operating activities in environmentally sensitive areas such as wetlands, urban areas, wilderness regions and other protected areas; requiring capital expenditures to comply with pollution control requirements, and imposition of substantial liabilities for pollution resulting from our operations. Numerous governmental authorities, such as the EPA and BLM, and analogous state agencies, have the power to enforce compliance with these laws and regulations and the permits and approvals issued under them, which can often require difficult and costly actions. Failure to comply with these laws and regulations or any newly adopted laws or regulations may result in assessment of sanctions including administrative, civil and criminal penalties, the imposition of investigatory, remedial and corrective action obligations or the incurrence of capital expenditures; the occurrence of restrictions, delays or cancellations in the permitting or performance of projects, and the issuance of orders enjoining or conditioning performance of some or all of our operations in a particular area. Certain environmental laws impose strict, joint and several liability for costs required to clean up and restore sites where hazardous substances, hydrocarbons or waste products have been released, even under circumstances where the substances, hydrocarbons or wastes have been released by a predecessor operator or the activities conducted and from which a release emanated complied with applicable law. Moreover, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by noise, odor, or the release of hazardous substances, hydrocarbons or wastes into the environment. The risk of incurring environmental costs and liabilities in connection with our operations is significant due to our handling of natural gas, NGLs, crude oil and other petroleum products, because of air emissions and product-related discharges arising out of our operations, 48 and as a result of historical industry operations and waste disposal practices. For example, an accidental release from one of our facilities could subject us to substantial liabilities arising from environmental cleanup and restoration costs, claims made by neighboring landowners and other third parties for personal injury, natural resource and property damages and fines or penalties for related violations of environmental laws or regulations. Moreover, stricter laws, regulations or enforcement policies could significantly increase our operational or compliance costs and the cost of any remediation that may become necessary. For example, in October 2021 the EPA announced plans to reconsider the Trump Administration’s December 2020 decision to retain the 2015 ground ozone standard, rather than making it more stringent, a decision on which is not expected until 2023. Also, there continues to be uncertainty on the federal government’s applicable jurisdictional reach under the Clean Water Act over waters of the United States, including wetlands, as the EPA and the U.S. Army Corps of Engineers (“Corps”) under the Obama, Trump and Biden Administrations have pursued multiple rulemakings since 2015 in an attempt to determine the scope of such reach. Most recently, in December 2022, the EPA and Corps released a final revised definition of “waters of the United States” founded upon the pre-2015 regulations and including updates to incorporate existing Supreme Court decisions and recognizing regional and geographic differences. However, the new rule has already been challenged, with the State of Texas and industry groups filing separate suits in federal court in Texas on January 18, 2023. Moreover, the EPA and the Corps have announced an intent to develop a subsequent rule further revising the definition. Judicial developments further add to this uncertainty. In October 2022, the U.S. Supreme Court heard arguments in Sackett v. EPA which involves issues relating to the legal tests used to determine whether wetlands are “waters of the United States.” The Supreme Court is expected to release an opinion in this case in 2023, which could impact the regulatory definition and its implementation. The implementation of the final rule and the resultant expansion of the scope of the Clean Water Act’s jurisdiction in areas where we or our customers conduct operations, could lead to delays, restrictions or cessation of the development of projects, result in longer permitting timelines, or increased compliance expenditures or mitigation costs for our and our oil and natural gas customers’ operations, which may reduce the rate of production of natural gas or crude oil from operators with whom we have a business relationship and, in turn, have a material adverse effect on our business, results of operations and cash flows. Separately, Nationwide Permit (“NWP”) 12, which is available under the Clean Water Act for certain oil and gas activities, has been subject to legal challenges and regulatory revision in recent years. Following legal challenges to NWP 12 in the federal district court for the District of Montana, the Corps reissued NWP 12 for oil and natural gas pipeline activities, including certain revisions to the conditions for the use of NWP 12; however, an October 2021 decision by the District Court for the Northern District of California resulted in a vacatur of a 2020 rule revising the Clean Water Act Section 401 certification process. The U.S. Supreme Court has since stayed this vacatur and the EPA has proposed a rule to update and replace the relevant regulations, public comment on which closed in August 2022. While the Corps has resumed permitting decisions for such NWPs, the Corps has advised that, as part of the permitting decision process, the Corps will coordinate with certifying authorities on Section 401 certifications as needed, which may result in permit delays or otherwise impact our operations or those of our customers. Additionally, in March 2022, the Corps announced that it was seeking stakeholder input on a formal review of NWP 12. While the full extent and impact of these actions is unclear at this time, any disruption in our ability to obtain coverage under NWP 12 or other general permits may result in increased costs and project delays if we are forced to seek individual permits from the Corps. This in turn could have an adverse effect on our business, financial condition and results of operation. A change in the jurisdictional characterization of some of our assets by federal, state, tribal or local regulatory agencies or a change in policy by those agencies may result in increased regulation of our assets, which may (i) cause our revenues to decline and operating expenses to increase or (ii) delay or increase the cost of expansion projects. With the exception of the Driver Residue Pipeline, TPL SouthTex Transmission Company LP, Targa Midland Gas Pipeline LLC, Midland-Permian Pipeline LLC, Targa SouthTex Mustang Transmission Ltd., and Targa SouthTex Transmission LP, which are each subject to FERC regulation under the NGPA or limited FERC regulation under the NGA, our natural gas pipeline operations are generally exempt from FERC regulation, but FERC regulation still affects our non-FERC jurisdictional businesses and the markets for products derived from these businesses, including certain FERC reporting and posting requirements in a given year. We believe that the natural gas pipelines in our gathering systems meet the traditional tests FERC has used to establish a pipeline’s status as a gatherer not subject to regulation as a natural gas company. However, the distinction between FERC-regulated transmission services and federally unregulated gathering services is the subject of substantial, ongoing litigation, so the classification and regulation of our gathering facilities are subject to change based on future determinations by FERC, the courts or Congress. We also operate natural gas pipelines that extend from some of our processing plants to interconnections with both intrastate and interstate natural gas pipelines. Those facilities, known in the industry as “plant tailgate” pipelines, typically operate at transmission pressure levels and may transport “pipeline quality” natural gas. Because our plant tailgate pipelines are relatively short, we treat them as “stub” lines, which are exempt from FERC’s jurisdiction under the Natural Gas Act. 49 Targa NGL, Targa Gulf Coast, and Grand Prix Joint Venture have pipelines that are considered common carrier pipelines subject to regulation by FERC under the ICA. The ICA requires that we maintain tariffs on file with FERC for each of the Targa NGL, Targa Gulf Coast and Grand Prix Joint Venture common carrier pipelines that have not been granted a waiver. Those tariffs set forth the rates we charge for providing transportation services as well as the rules and regulations governing these services. The ICA requires, among other things, that rates on interstate common carrier pipelines be “just and reasonable” and non-discriminatory. With respect to pipelines that have been granted a waiver of the ICA and related regulations by FERC, should a particular pipeline’s circumstances change, FERC could, either at the request of other entities or on its own initiative, assert that such pipeline no longer qualifies for a waiver. In the event that FERC were to determine that one or more of these pipelines no longer qualified for a waiver, we would likely be required to file a tariff with FERC for the applicable pipeline(s), provide a cost justification for the transportation charge, and provide regulated services to all potential shippers without undue discrimination. Such a change in the jurisdictional status of transportation on these pipelines could adversely affect our results of operations. The classification of some of our gathering facilities, transportation pipelines, and purchase and sale transactions as FERC-jurisdictional or non-jurisdictional may be subject to change based on future determinations by FERC, the courts or Congress, in which case, our operating costs could increase and we could be subject to enforcement actions under the EP Act of 2005. Various federal agencies within the U.S. Department of the Interior, particularly the BLM, Office of Natural Resources Revenue (formerly the Minerals Management Service) and the Bureau of Indian Affairs, along with the Three Affiliated Tribes, promulgate and enforce regulations pertaining to operations on the Fort Berthold Indian Reservation, on which we operate a significant portion of our Badlands gathering and processing assets. The Three Affiliated Tribes is a sovereign nation having the right to enforce certain laws and regulations independent from federal, state and local statutes and regulations. These tribal laws and regulations include various taxes, fees and other conditions that apply to lessees, operators and contractors conducting operations on Native American tribal lands. Lessees and operators conducting operations on tribal lands can generally be subject to the Native American tribal court system. One or more of these factors may increase our costs of doing business on the Fort Berthold Indian Reservation and may have an adverse impact on our ability to effectively transport products within the Fort Berthold Indian Reservation or to conduct our operations on such lands. Other FERC regulations may indirectly impact our businesses and the markets for products derived from these businesses. FERC’s policies and practices across the range of its natural gas and liquids regulatory activities, including, for example, its policies on open access transportation, gas quality, ratemaking, capacity release and market center promotion, may indirectly affect the natural gas and liquids markets. In recent years, FERC has pursued pro-competitive policies in its regulation of interstate natural gas and liquids pipelines. However, we cannot assure you that FERC will continue this approach as it considers matters such as pipeline rates and rules and policies that may affect rights of access to transportation capacity. For more information regarding the regulation of our operations, see “Item 1. Business—Regulation of Operations.” Federal and state legislative and regulatory initiatives relating to pipeline safety that require the use of new or more stringent safety controls or result in more rigorous enforcement of applicable legal requirements could subject us to increased capital costs, operational delays and costs of operation. Legislation in the past decade has resulted in more stringent mandates for pipeline safety and has charged PHMSA with developing and adopting regulations that impose increased pipeline safety requirements on pipeline operators. In particular, the NGPSA and HLPSA were amended in recent years by the 2011 Pipeline Safety Act, the 2016 Pipeline Safety Act and, most recently, the PIPES Act of 2020. Each of these laws imposed increased pipeline safety obligations on pipeline operators. The 2011 Pipeline Safety Act directed the promulgation of expanded integrity management requirements, automatic or remote-controlled valve, and excess flow valve use, leak detection system installation, material strength pipeline testing and verification of records confirming the maximum allowable pressure of certain intrastate gas transmission pipelines, whereas the 2016 Pipeline Safety Act also empowered PHMSA to address unsafe conditions or practices constituting imminent hazards by imposing emergency measures on pipeline facility owners and operators without prior notice or an opportunity for a hearing. The PIPES Act of 2020 reauthorized PHMSA through fiscal year 2023 and directed the agency to move forward with several regulatory initiatives, including obligating operators of non-rural gas gathering lines and new and existing transmission and distribution pipeline facilities to conduct certain leak detection and repair programs and to require facility inspection and maintenance plans to align with those regulations. In furtherance of the PIPES Act of 2020, PHMSA issued final rules in November 2021 and August 2022, respectively, imposing a number of additional requirements. For further details, please see the risk factor entitled “We may incur significant costs and liabilities resulting from performance of pipeline integrity testing programs and related repairs.” The imposition of new or enhanced safety requirements, or any issuance or reinterpretation of guidance by PHMSA or any state agencies with respect thereto, may require us to install new or modified safety controls, pursue additional capital projects or conduct maintenance programs on an accelerated basis, any or all of which tasks could result in increased operating costs that could have an adverse effect on our results of operations or financial position. 50 Should we fail to comply with all applicable FERC-administered statutes, rules, regulations and orders, we could be subject to substantial penalties and fines. Under the EP Act of 2005, FERC has civil penalty authority under the NGA and NGPA to impose penalties for violations of the NGA or NGPA up to a maximum amount that is adjusted annually for inflation, which for 2023 equals approximately $1.5 million per violation per day, as well as authority to order disgorgement of profits associated with any violation. While our systems other than the Driver Residue Pipeline, TPL SouthTex Transmission Company LP, TPL SouthTex Pipeline Company LLC, Targa Midland Gas Pipeline LLC, Midland-Permian Pipeline LLC, Targa SouthTex Mustang Transmission Ltd., and Targa SouthTex Transmission LP, have not been regulated by FERC under the NGA or NGPA, FERC has adopted regulations that may subject certain of our otherwise non-FERC jurisdictional facilities to FERC annual reporting and daily scheduled flow and capacity posting requirements. In addition, FERC has civil penalty authority under the ICA to impose penalties for violations under the ICA up to a maximum amount that is adjusted annually for inflation, which for 2023 was up to approximately $15,662 per violation per day, and failure to comply with the ICA and regulations implementing the ICA could subject us to civil penalty liability. For more information regarding regulation of our operations, see “Item 1. Business—Regulation of Operations.” Additional rules and legislation pertaining to those and other matters may be considered or adopted by FERC from time to time. We are or may become subject to cybersecurity and data privacy laws, regulations, litigation and directives relating to our processing of personal information. The jurisdictions in which we operate (including the United States) may have laws governing how we must respond to a cyber incident that results in the unauthorized access, disclosure, or loss of personal information. Additionally, new laws and regulations governing data privacy and unauthorized disclosure of confidential information, including recent California legislation (which, among other things, provides for a private right of action), pose increasingly complex compliance challenges and could potentially elevate our costs over time. Although our business does not involve large-scale processing of personal information, our business does involve collection, use, and other processing of personal information of our employees, investors, contractors, suppliers, and customer contacts. As legislation continues to develop and cyber incidents continue to evolve, we will likely be required to expend significant resources to continue to modify or enhance our protective measures to comply with such legislation and to detect, investigate and remediate vulnerabilities to cyber incidents. Any failure by us, or a company we acquire, to comply with such laws and regulations could result in reputational harm, loss of goodwill, penalties, liabilities, and/or mandated changes in our business practices. 51 Item 1B. Unresolved Staff Comments. None. Item 2. Properties. A description of our properties is contained in “Item 1. Business” in this Annual Report. Our principal executive offices are located at 811 Louisiana Street, Suite 2100, Houston, Texas 77002 and our telephone number is 713-584-1000. Item 3. Legal Proceedings. On December 26, 2018, Vitol Americas Corp. (“Vitol”) filed a lawsuit in the 80th District Court of Harris County (the “District Court”), Texas against Targa Channelview LLC, then a subsidiary of the Company (“Targa Channelview”), seeking recovery of $129.0 million in payments made to Targa Channelview, additional monetary damages, attorneys’ fees and costs. Vitol alleges that Targa Channelview breached an agreement, dated December 27, 2015, for crude oil and condensate between Targa Channelview and Noble Americas Corp. (the “Splitter Agreement”), which provided for Targa Channelview to construct a crude oil and condensate splitter (the “Splitter”) adjacent to a barge dock owned by Targa Channelview to provide services contemplated by the Splitter Agreement. In January 2018, Vitol acquired Noble Americas Corp. and on December 23, 2018, Vitol voluntarily elected to terminate the Splitter Agreement claiming that Targa Channelview failed to timely achieve start-up of the Splitter. Vitol’s lawsuit also alleges Targa Channelview made a series of misrepresentations about the capability of the barge dock that would service crude oil and condensate volumes to be processed by the Splitter and Splitter products. Vitol seeks return of $129.0 million in payments made to Targa Channelview prior to the start-up of the Splitter, as well as additional damages. On the same date that Vitol filed its lawsuit, Targa Channelview filed a lawsuit against Vitol seeking a judicial determination that Vitol’s sole and exclusive remedy was Vitol’s voluntarily termination of the Splitter Agreement and, as a result, Vitol was not entitled to the return of any prior payments under the Splitter Agreement or other damages as alleged. Targa also seeks recovery of its attorneys’ fees and costs in the lawsuit. On October 15, 2020, the District Court awarded Vitol $129.0 million (plus interest) following a bench trial. In addition, the District Court awarded Vitol $10.5 million in damages for losses and demurrage on crude oil that Vitol purchased for start-up efforts. The Company appealed the award in the Fourteenth Court of Appeals in Houston, Texas. In October 2020, we sold Targa Channelview, but under the agreements governing the sale, we retained the liabilities associated with the Vitol proceedings. On September 13, 2022, the Fourteenth Court of Appeals upheld the trial court’s judgment in part with regard to the return of Vitol’s prior payments, but modified the judgment to delete Vitol’s ability to recover any damages related to losses or demurrage on crude oil. We have filed a petition for review with the Supreme Court of Texas, and the appeal remains pending. The cumulative amount of interest on the award through December 31, 2022, if accrued, would have been approximately $42.6 million. Additional information required for this item is provided in Note 18 – Contingencies, under the heading “Legal Proceedings” included in the Notes to Consolidated Financial Statements included under Part II, Item 8 of this Annual Report, which is incorporated by reference into this item. Item 4. Mine Safety Disclosures. Not applicable. 52 PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Market Information Our common stock is listed on the NYSE under the symbol “TRGP.” As of December 31, 2022, there were 182 stockholders of record of our common stock. This number does not include stockholders whose shares are held in trust by other entities. The actual number of stockholders is greater than the number of holders of record. As of February 17, 2023, there were 226,639,398 shares of common stock outstanding. Stock Performance Graph On October 12, 2022, we were added to the Standard & Poor's 500 Stock Index (the "S&P 500 Index"). We replaced the NYSE Composite Index (the “NYSE Index”) with the S&P 500 Index, as we believe this index is a more relevant benchmark to measure the Company's performance. We have continued to present the NYSE Index in this Annual Report for 2022 as a transitional measure. The graph below compares the cumulative total return to holders of Targa Resources Corp.’s common stock, the NYSE Index, the S&P 500 Index and the Alerian US Midstream Energy Index (the “AMUS Index”) during the period beginning on December 31, 2017 and ending on December 31, 2022. The performance graph was prepared based on the following assumptions: (i) $100 was invested in our common stock and in each of the indices at the beginning of the period, and (ii) dividends were reinvested on the relevant payment dates. The stock price performance included in this graph is historical and not necessarily indicative of future stock price performance. 53 Year Ended December 31, 2017 2018 2019 2020 2021 2022 Targa Resources Corp. $ 100.00 $ 80.09 $ 99.46 $ 66.93 $ 133.87 $ 192.20 NYSE Index $ 100.00 $ 91.05 $ 114.28 $ 122.26 $ 147.54 $ 133.75 S&P 500 Index $ 100.00 $ 95.62 $ 125.72 $ 148.85 $ 191.58 $ 156.88 AMUS Index $ 100.00 $ 89.09 $ 102.95 $ 77.26 $ 112.04 $ 145.15 Pursuant to Instruction 7 to Item 201(e) of Regulation S-K, the above stock performance graph and related information is being furnished and is not being filed with the SEC, and as such shall not be deemed to be incorporated by reference into any filing that incorporates this Annual Report by reference. Our Dividend Policy We intend to continue to pay a quarterly dividend to our common stockholders; however, any payment of future dividends is dependent upon our financial condition, results of operations, cash flows, the level of our capital expenditures, future business prospects and any other matters that our board of directors, in consultation with management, deems relevant. Covenants contained in our debt agreements could limit the payment of dividends. For a discussion of restrictions on our and our subsidiaries’ ability to pay dividends or make distributions, please see Note 8 – Debt Obligations in our Consolidated Financial Statements beginning on page F-1 in this Form 10-K. Recent Sales of Unregistered Equity Securities There were no sales of unregistered equity securities for the year ended December 31, 2022. Repurchase of Equity by Targa Resources Corp, or Affiliated Purchasers Period Total number of shares purchased (1) Average price per share Total number of shares purchased as part of publicly announced plans (2) Maximum approximate dollar value of shares that may yet be purchased under the plan (in thousands) (2) October 1, 2022 - October 31, 2022 135,863 $ 62.51 61,845 $ 167,765 November 1, 2022 - November 30, 2022 165,697 $ 72.53 165,442 $ 155,763 December 1, 2022 - December 31, 2022 168,511 $ 71.22 168,511 $ 173,762 _________________________________ (1)Includes 395,798 shares purchased under our $500 million common share repurchase program, as well as 74,273 shares that were withheld by us to satisfy tax withholding obligations of certain of our officers, directors and key employees that arose upon the lapse of restrictions on restricted stock. (2)In the fourth quarter 2020, our board of directors approved a share repurchase program for the repurchase of up to $500 million of our outstanding common stock. We may discontinue this share repurchase program at any time and are not obligated to repurchase any specific dollar amount or number of shares. Item 6. Reserved. 54 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes included in Part IV of this Annual Report. Additional sections in this Annual Report should be helpful to the reading of our discussion and analysis, including the following: (i) a description of our business strategy found in “Item 1. Business–Overview”; (ii) a description of recent developments, found in “Item 1. Business–Recent Developments”; and (iii) a description of risk factors affecting us and our business, found in “Item 1A. Risk Factors.” Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Annual Report can be found in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2021. General Trends and Outlook We expect our results of operations to continue to be affected by the following key trends: commodity prices, volume throughput and demand for our products and services, contract terms and mix, the impact of our hedging activities, the cost to operate and support assets, volatile capital markets, competition and increased regulation. These expectations are based on assumptions made by us and information currently available to us. To the extent our underlying assumptions about or interpretations of available information prove to be incorrect, our actual results may vary materially from our expected results. Commodity Prices There has been, and we believe there will continue to be, volatility in commodity prices and in the relationships among natural gas, NGL and crude oil prices. The volatility and uncertainty of natural gas, NGL and crude oil prices impact drilling, completion and other investment decisions by producers and ultimately supply to our systems. See “Item 1A. Risk Factors – Our cash flow is affected by supply and demand for natural gas, NGL products, and crude oil, and by natural gas, NGL, crude oil and condensate prices, and decreases in supply, demand or these prices could adversely affect our results of operations and financial condition.” Our operating income generally improves in an environment of higher natural gas, NGL and condensate prices. Our processing profitability is largely dependent upon pricing and the supply of and market demand for natural gas, NGLs and condensate, both of which are beyond our control. In a declining commodity price environment, without taking into account our hedges, we will realize a reduction in cash flows under our percent-of-proceeds contracts proportionate to average price declines. The significant level of margin we derive from fee-based arrangements across our operations and particularly in our Downstream Business combined with our hedging arrangements helps to mitigate our exposure to commodity price movements. For additional information regarding our hedging activities, see “Item 7A. Quantitative and Qualitative Disclosures about Market Risk — Commodity Price Risk.” The following table presents selected average annual and quarterly industry index prices for natural gas, selected NGL products and crude oil for the periods presented: Natural Gas $/MMBtu (1) Illustrative Targa NGL $/gal (2) Crude Oil $/Bbl (3) 2022 4th Quarter $ 6.27 $ 0.72 $ 82.63 3rd Quarter 8.19 0.94 91.64 2nd Quarter 7.17 1.09 108.42 1st Quarter 4.92 1.04 94.38 2022 Average 6.64 0.95 94.27 2021 4th Quarter $ 5.84 $ 0.94 $ 77.17 3rd Quarter 4.01 0.86 70.55 2nd Quarter 2.83 0.66 66.06 1st Quarter 2.70 0.65 57.80 2021 Average 3.85 0.78 67.90 (1)Natural gas prices are based on average first of month prices from Henry Hub Inside FERC commercial index prices. (2)“Illustrative Targa NGL” pricing is weighted using average quarterly prices from Mont Belvieu Non-TET monthly commercial index and represents the following composition for the periods noted: 2022: 43% ethane, 32% propane, 12% normal butane, 4% isobutane and 9% natural gasoline 2021: 45% ethane, 31% propane, 11% normal butane, 4% isobutane and 9% natural gasoline (3)Crude oil prices are based on average quarterly prices of West Texas Intermediate crude oil as measured on the NYMEX. 55 Volumes and Demand for our Services Fluctuations in energy prices can greatly affect production rates and investments by third parties in the development and production of new oil and natural gas reserves. Our operations are affected by the level of crude, natural gas and NGL prices, the relationship among these prices and related activity levels from our customers. In our gathering and processing operations, plant inlet volumes, crude oil volumes and capacity utilization rates generally are driven by wellhead production and our competitive and contractual position on a regional basis and more broadly by the impact of prices for crude oil, natural gas and NGLs on exploration and production activity in the areas of our operations. Drilling and production activity generally decreases as crude oil and natural gas prices decrease below commercially acceptable levels. Producers generally focus their drilling activity on certain basins depending on commodity price fundamentals. Our asset systems are predominantly located in some of the most economic basins in the United States. The factors that impact the gathering and processing volumes also impact the total volumes that flow to our Downstream Business. Accordingly, increased producer activity will drive demand for our midstream services and may result in incremental growth capital expenditures. Demand for our transportation, fractionation and other fee-based services is largely correlated with producer activity levels. Demand for our international export, storage and terminaling services has remained relatively constant, as demand for these services is based on a number of domestic and international factors. Contract Terms, Contract Mix and the Impact of Commodity Prices Across our operations and particularly in our Downstream Business, we benefit from long-term fee-based arrangements for our services. Our Gathering and Processing segment contract mix also has components of fee-based margin, such as fee floors and other fee-based services which mitigate against low commodity prices. The significant level of margin we derive from fee-based arrangements combined with our hedging arrangements helps to mitigate our exposure to commodity price movements. Volatility in commodity prices can have a significant impact on our profitability, especially those percent-of-proceeds contracts that create direct exposure to changes in energy prices by paying us for gathering and processing services with a portion of proceeds from the commodities handled (“equity volumes”). Contract terms in the Gathering and Processing segment are based upon a variety of factors, including natural gas and crude quality, geographic location, competitive dynamics and the pricing environment at the time the contract is executed, and customer requirements. Our gathering and processing contract mix and, accordingly, our exposure to crude, natural gas and NGL prices may change as a result of producer preferences, competition and changes in production as wells decline at different rates or are added, our expansion into regions where different types of contracts are more common and other market factors. The contract terms and contract mix of our Downstream Business can also have a significant impact on our results of operations. Transportation and fractionation services are supported by fee-based contracts whose rates and terms are driven by NGL supply and transportation and fractionation capacity. Export services are supported by fee-based contracts whose rates and terms are driven by global LPG supply and demand fundamentals. The Logistics and Transportation segment includes predominantly fee-based contracts. Impact of Our Commodity Price Hedging Activities We have hedged the commodity price risk associated with a portion of our expected natural gas, NGL and condensate equity volumes, future commodity purchases and sales, and transportation basis risk by entering into financially settled derivative transactions. These transactions include swaps, futures, and purchased puts (or floors) and calls (or caps) to hedge additional expected equity commodity volumes without creating volumetric risk. We intend to continue managing our exposure to commodity prices in the future by entering into derivative transactions. We actively manage the Downstream Business product inventory and other working capital levels to reduce exposure to changing prices. For additional information regarding our hedging activities, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk–Commodity Price Risk.” Operating Expenses Variable costs such as service and repairs can impact our results. Continued expansion of existing assets will also give rise to additional operating expenses, which will affect our results. The employees supporting our operations are employees of Targa Resources LLC, a Delaware limited liability company, and an indirect wholly-owned subsidiary of ours. 56 Volatile Capital Markets and Competition We continuously consider and enter into discussions regarding potential growth projects and acquisitions and may contemplate external funding for potential growth projects and acquisitions. Any limitations on our access to capital may impair our ability to execute this strategy. If the cost of such capital becomes too expensive, our ability to develop or acquire strategic and accretive assets may be limited. We may not be able to raise the necessary funds on satisfactory terms, if at all. The primary factors influencing our cost of borrowing include interest rates, credit spreads, covenants, underwriting or loan origination fees and similar charges we pay to lenders. These factors may impair our ability to execute our growth and acquisition strategy. Current economic conditions and competition for asset purchases and development opportunities could limit our ability to fully execute our growth strategy. Due to increased volatility in commodity prices and the broader market, the ability of companies in the oil and gas industry to seek financing and access the capital markets on favorable terms or at all has been negatively impacted. We believe we have sufficient access to financial resources and liquidity necessary to meet our requirements for working capital, debt service payments and capital expenditures in 2023 and beyond. For additional information regarding our financing activities, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Our Liquidity and Capital Resources.” Increased Regulation Additional regulation in various areas has the potential to materially impact our operations and financial condition. For example, increased regulation of hydraulic fracturing used by producers and increased GHG emission regulations may cause reductions in supplies of natural gas, NGLs and crude oil from producers. Please read “Laws and regulations regarding hydraulic fracturing could result in restrictions, delays or cancellations in drilling and completing new oil and natural gas wells by our customers, which could adversely impact our revenues by decreasing the volumes of natural gas, NGLs or crude oil through our facilities and reducing the utilization of our assets”, “Our and our customers’ operations are subject to a number of risks arising out of the threat of climate change (including legislation or regulation to address climate change) that could result in increased operating costs, limit the areas in which oil and natural gas production may occur, and reduce demand for the products and services we provide,” and “Increasing stakeholder and market attention to ESG matters may impact our business” under Item 1A. of this Annual Report. Similarly, the forthcoming rules and regulations of the CFTC may limit our ability or increase the cost to use derivatives, which could create more volatility and less predictability in our results of operations. How We Evaluate Our Operations The profitability of our business is a function of the difference between: (i) the revenues we receive from our operations, including fee-based revenues from services and revenues from the natural gas, NGLs, crude oil and condensate we sell, and (ii) the costs associated with conducting our operations, including the costs of wellhead natural gas, crude oil and mixed NGLs that we purchase as well as operating, general and administrative costs and the impact of our commodity hedging activities. Because commodity price movements tend to impact both revenues and costs, increases or decreases in our revenues alone are not necessarily indicative of increases or decreases in our profitability. Our contract portfolio, the prevailing pricing environment for crude oil, natural gas and NGLs, the impact of our commodity hedging program and its ability to mitigate exposure to commodity price movements and the volumes of crude oil, natural gas and NGL throughput on our systems are important factors in determining our profitability. Our profitability is also affected by the NGL content in gathered wellhead natural gas, supply and demand for our products and services, utilization of our assets and changes in our customer mix. Our profitability is also impacted by fee-based contracts. Our growing capital expenditures for pipelines and gathering and processing assets underpinned by fee-based margin, expansion of our Downstream facilities, continued focus on adding fee-based margin to our existing and future gathering and processing contracts, as well as third-party acquisitions of businesses and assets, will continue to increase the number of our contracts that are fee-based. Fixed fees for services such as gathering and processing, transportation, fractionation, storage, terminaling and crude oil gathering are not directly tied to changes in market prices for commodities. Nevertheless, a change in market dynamics such as available commodity throughput does affect profitability. Management uses a variety of financial measures and operational measurements to analyze our performance. These include: (1) throughput volumes, facility efficiencies and fuel consumption, (2) operating expenses, (3) capital expenditures and (4) the following non-GAAP measures: adjusted EBITDA, distributable cash flow, adjusted free cash flow and adjusted operating margin (segment). 57 Throughput Volumes, Facility Efficiencies and Fuel Consumption Our profitability is impacted by our ability to add new sources of natural gas supply and crude oil supply to offset the natural decline of existing volumes from oil and natural gas wells that are connected to our gathering and processing systems. This is achieved by connecting new wells and adding new volumes in existing areas of production, as well as by capturing crude oil and natural gas supplies currently gathered by third parties. Similarly, our profitability is impacted by our ability to add new sources of mixed NGL supply, connected by third-party transportation and Grand Prix, to our Downstream Business fractionation facilities and at times to our export facilities. We fractionate NGLs generated by our gathering and processing plants, as well as by contracting for mixed NGL supply from third-party facilities. In addition, we seek to increase adjusted operating margin by limiting volume losses, reducing fuel consumption and by increasing efficiency. With our gathering systems’ extensive use of remote monitoring capabilities, we monitor the volumes received at the wellhead or central delivery points along our gathering systems, the volume of natural gas received at our processing plant inlets and the volumes of NGLs and residue natural gas recovered by our processing plants. We also monitor the volumes of NGLs received, stored, fractionated and delivered across our logistics assets. This information is tracked through our processing plants and Downstream Business facilities to determine customer settlements for sales and volume related fees for service and helps us increase efficiency and reduce fuel consumption. As part of monitoring the efficiency of our operations, we measure the difference between the volume of natural gas received at the wellhead or central delivery points on our gathering systems and the volume received at the inlet of our processing plants as an indicator of fuel consumption and line loss. We also track the difference between the volume of natural gas received at the inlet of the processing plant and the NGLs and residue gas produced at the outlet of such plant to monitor the fuel consumption and recoveries of our facilities. Similar tracking is performed for our crude oil gathering and logistics assets and our NGL pipelines. These volume, recovery and fuel consumption measurements are an important part of our operational efficiency analysis and safety programs. Operating Expenses Operating expenses are costs associated with the operation of specific assets. Labor, contract services, repair and maintenance and ad valorem taxes comprise the most significant portion of our operating expenses. These expenses remain relatively stable and independent of the volumes through our systems, but may increase with system expansions and will fluctuate depending on the scope of the activities performed during a specific period. Capital Expenditures Our capital expenditures are classified as growth capital expenditures and maintenance capital expenditures. Growth capital expenditures improve the service capability of the existing assets, extend asset useful lives, increase capacities from existing levels, add capabilities, and reduce costs or enhance revenues. Maintenance capital expenditures are those expenditures that are necessary to maintain the service capability of our existing assets, including the replacement of system components and equipment, which are worn, obsolete or completing their useful life and expenditures to remain in compliance with environmental laws and regulations. Capital spending associated with growth and maintenance projects is closely monitored. Return on investment is analyzed before a capital project is approved, spending is closely monitored throughout the development of the project, and the subsequent operational performance is compared to the assumptions used in the economic analysis performed for the capital investment approval. Non-GAAP Measures We utilize non-GAAP measures to analyze our performance. Adjusted EBITDA, distributable cash flow, adjusted free cash flow and adjusted operating margin (segment) are non-GAAP measures. The GAAP measures most directly comparable to these non-GAAP measures are income (loss) from operations, Net income (loss) attributable to Targa Resources Corp. and segment operating margin. These non-GAAP measures should not be considered as an alternative to GAAP measures and have important limitations as analytical tools. Investors should not consider these measures in isolation or as a substitute for analysis of our results as reported under GAAP. Additionally, because our non-GAAP measures exclude some, but not all, items that affect income and segment operating margin, and are defined differently by different companies within our industry, our definitions may not be comparable with similarly titled measures of other companies, thereby diminishing their utility. Management compensates for the limitations of our non-GAAP measures as analytical tools by reviewing the comparable GAAP measures, understanding the differences between the measures and incorporating these insights into our decision-making processes. 58 Adjusted Operating Margin We define adjusted operating margin for our segments as revenues less product purchases and fuel. It is impacted by volumes and commodity prices as well as by our contract mix and commodity hedging program. Gathering and Processing adjusted operating margin consists primarily of: •service fees related to natural gas and crude oil gathering, treating and processing; and •revenues from the sale of natural gas, condensate, crude oil and NGLs less producer settlements, fuel and transport and our equity volume hedge settlements. Logistics and Transportation adjusted operating margin consists primarily of: •service fees (including the pass-through of energy costs included in certain fee rates); •system product gains and losses; and •NGL and natural gas sales, less NGL and natural gas purchases, fuel, third-party transportation costs and the net inventory change. The adjusted operating margin impacts of mark-to-market hedge unrealized changes in fair value are reported in Other. Adjusted operating margin for our segments provides useful information to investors because it is used as a supplemental financial measure by management and by external users of our financial statements, including investors and commercial banks, to assess: •the financial performance of our assets without regard to financing methods, capital structure or historical cost basis; •our operating performance and return on capital as compared to other companies in the midstream energy sector, without regard to financing or capital structure; and •the viability of capital expenditure projects and acquisitions and the overall rates of return on alternative investment opportunities. Management reviews adjusted operating margin and operating margin for our segments monthly as a core internal management process. We believe that investors benefit from having access to the same financial measures that management uses in evaluating our operating results. The reconciliation of our adjusted operating margin to the most directly comparable GAAP measure is presented under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – By Reportable Segment.” Adjusted EBITDA We define adjusted EBITDA as Net income (loss) attributable to Targa Resources Corp. before interest, income taxes, depreciation and amortization, and other items that we believe should be adjusted consistent with our core operating performance. The adjusting items are detailed in the adjusted EBITDA reconciliation table and its footnotes. Adjusted EBITDA is used as a supplemental financial measure by us and by external users of our financial statements such as investors, commercial banks and others to measure the ability of our assets to generate cash sufficient to pay interest costs, support our indebtedness and pay dividends to our investors. Distributable Cash Flow and Adjusted Free Cash Flow We define distributable cash flow as adjusted EBITDA less cash interest expense on debt obligations, cash tax (expense) benefit and maintenance capital expenditures (net of any reimbursements of project costs). We define adjusted free cash flow as distributable cash flow less growth capital expenditures, net of contributions from noncontrolling interest and net contributions to investments in unconsolidated affiliates. Distributable cash flow and adjusted free cash flow are performance measures used by us and by external users of our financial statements, such as investors, commercial banks and research analysts, to assess our ability to generate cash earnings (after servicing our debt and funding capital expenditures) to be used for corporate purposes, such as payment of dividends, retirement of debt or redemption of other financing arrangements. 59 Our Non-GAAP Financial Measures The following tables reconcile the non-GAAP financial measures used by management to the most directly comparable GAAP measures for the periods indicated. Year Ended December 31, 2022 2021 (In millions) Reconciliation of Net income (loss) attributable to Targa Resources Corp. to Adjusted EBITDA, Distributable Cash Flow and Adjusted Free Cash Flow Net income (loss) attributable to Targa Resources Corp. $ 1,195.5 $ 71.2 Interest (income) expense, net 446.1 387.9 Income tax expense (benefit) 131.8 14.8 Depreciation and amortization expense 1,096.0 870.6 Impairment of long-lived assets — 452.3 (Gain) loss on sale or disposition of assets (9.6 ) 2.0 Write-down of assets 9.8 10.3 (Gain) loss from financing activities (1) 49.6 16.6 (Gain) loss from sale of equity method investment (435.9 ) — Transaction costs related to business acquisition (2) 23.9 — Equity (earnings) loss (9.1 ) 23.9 Distributions from unconsolidated affiliates and preferred partner interests, net 27.2 116.5 Change in contingent considerations — 0.1 Compensation on equity grants 57.5 59.2 Risk management activities 302.5 116.0 Noncontrolling interests adjustments (3) 15.8 (89.4 ) Adjusted EBITDA $ 2,901.1 $ 2,052.0 Interest expense on debt obligations (4) (447.6 ) (376.2 ) Maintenance capital expenditures, net (5) (168.1 ) (131.7 ) Cash taxes (6.7 ) (2.7 ) Distributable Cash Flow $ 2,278.7 $ 1,541.4 Growth capital expenditures, net (5) (1,177.2 ) (407.7 ) Adjusted Free Cash Flow $ 1,101.5 $ 1,133.7 (1)Gains or losses on debt repurchases or early debt extinguishments. (2)Includes financial advisory, legal and other professional fees, and other one-time transaction costs. (3)Noncontrolling interest portion of depreciation and amortization expense (including the effects of the impairment of long-lived assets on non-controlling interests). (4)Excludes amortization of interest expense. (5)Represents capital expenditures, net of contributions from noncontrolling interests and includes net contributions to investments in unconsolidated affiliates. 60 Consolidated Results of Operations The following table and discussion is a summary of our consolidated results of operations: Year Ended December 31, 2022 2021 2022 vs. 2021 (In millions) Revenues: Sales of commodities $ 19,066.0 $ 15,602.5 $ 3,463.5 22 % Fees from midstream services 1,863.8 1,347.3 516.5 38 % Total revenues 20,929.8 16,949.8 3,980.0 23 % Product purchases and fuel 16,882.1 13,729.5 3,152.6 23 % Operating expenses 912.8 747.0 165.8 22 % Depreciation and amortization expense 1,096.0 870.6 225.4 26 % General and administrative expense 309.7 273.2 36.5 13 % Impairment of long-lived assets — 452.3 (452.3 ) (100 %) Other operating (income) expense 0.2 12.4 (12.2 ) (98 %) Income (loss) from operations 1,729.0 864.8 864.2 100 % Interest expense, net (446.1 ) (387.9 ) (58.2 ) 15 % Equity earnings (loss) 9.1 (23.9 ) 33.0 138 % Gain (loss) from financing activities (49.6 ) (16.6 ) (33.0 ) 199 % Gain (loss) from sale of equity method investment 435.9 — 435.9 100 % Other, net (15.1 ) 0.5 (15.6 ) NM Income tax (expense) benefit (131.8 ) (14.8 ) (117.0 ) NM Net income (loss) 1,531.4 422.1 1,109.3 263 % Less: Net income (loss) attributable to noncontrolling interests 335.9 350.9 (15.0 ) (4 %) Net income (loss) attributable to Targa Resources Corp. 1,195.5 71.2 1,124.3 NM Premium on repurchase of noncontrolling interests, net of tax 53.2 — 53.2 100 % Dividends on Series A Preferred Stock 30.0 87.3 (57.3 ) (66 %) Deemed dividends on Series A Preferred Stock 215.5 — 215.5 100 % Net income (loss) attributable to common shareholders $ 896.8 $ (16.1 ) $ 912.9 NM Financial data: Adjusted EBITDA (1) $ 2,901.1 $ 2,052.0 $ 849.1 41 % Distributable cash flow (1) 2,278.7 1,541.4 737.3 48 % Adjusted free cash flow (1) 1,101.5 1,133.7 (32.2 ) (3 %) (1)Adjusted EBITDA, distributable cash flow and adjusted free cash flow are non-GAAP financial measures and are discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations–How We Evaluate Our Operations.” NM Due to a low denominator, the noted percentage change is disproportionately high and, as a result, is not considered meaningful. 2022 Compared to 2021 The increase in commodity sales reflects higher natural gas, NGL and condensate prices ($3,116.3 million) and higher NGL, natural gas and condensate volumes ($615.9 million), partially offset by the unfavorable impact of hedges ($264.1 million). The increase in fees from midstream services is primarily due to higher gas gathering and processing fees including the impact of the acquisition of certain assets in the Delaware Basin, and transportation and fractionation volumes, partially offset by lower export fees. The increase in product purchases and fuel reflects higher natural gas, NGL and condensate prices and higher NGL, natural gas and condensate volumes. The increase in operating expenses is primarily due to increased activity and system expansions, the acquisition of certain assets in South Texas and the Delaware Basin, and inflation, partially offset by the impact of a major winter storm that affected regions across Texas, New Mexico, Oklahoma and Louisiana during the first quarter of 2021. See “—Results of Operations—By Reportable Segment” for additional information on a segment basis. The increase in depreciation and amortization expense is primarily due to the acquisition of certain assets in the Delaware Basin and South Texas, the shortening of depreciable lives of certain assets that have been, or will be, idled and the impact of system expansions on our asset base, partially offset by a lower depreciable base associated with assets that were impaired during the fourth quarter of 2021. The increase in general and administrative expense is primarily due to higher compensation and benefits, insurance costs and professional fees. 61 In 2021, we recognized a non-cash pre-tax impairment loss of $452.3 million on assets in the South Texas region associated with our Central operations. See Note 5 - Property, Plant and Equipment and Intangible Assets for further discussion. Other operating (income) expense in 2021 consisted primarily of the write-down of certain assets to their recoverable amounts. The increase in interest expense, net is primarily due to higher net borrowings, partially offset by the change in fair value of the mandatorily redeemable preferred interests, higher capitalized interest resulting from higher growth capital investments, and lower commitment fees. The increase in equity earnings is primarily due to lower losses resulting from the purchase of our remaining interests in the two joint ventures in South Texas that we previously held as investments in unconsolidated affiliates and lower losses from GCF, partially offset by lower earnings resulting from the impact of the GCX Sale and lower earnings from our investment in Little Missouri 4 LLC. See Note 7 – Investments in Unconsolidated Affiliates for further discussion. During 2022, the Partnership redeemed the 5.375% Senior Notes due 2027 and the 5.875% Senior Notes due 2026. In addition, we terminated the Previous TRGP Revolver and the Partnership Revolver. These transactions resulted in a net loss from financing activities. During 2021, the Partnership redeemed the 5.125% Senior Notes due 2025 and the 4.250% Senior Notes due 2023 and Targa Pipeline Partners LP redeemed its TPL 4.750% Senior Notes due 2021 and TPL 5.875% Senior Notes due 2023, resulting in a net loss from financing activities. During 2022, we completed the GCX Sale resulting in a gain from sale of an equity method investment. See Note 4 - Acquisitions and Divestitures for further discussion. The increase in income tax expense is primarily due to an increase in pre-tax book income, partially offset by a larger release of the valuation allowance in 2022 compared to 2021, the impact of statutory rate changes in Oklahoma and Louisiana in 2021 and the correction of a state tax error in 2021. The decrease in net income (loss) attributable to noncontrolling interests is primarily due to the DevCo JV Repurchase, partially offset by impairment losses in 2021 allocated to noncontrolling interest holders in the Carnero Joint Venture, higher income allocation to noncontrolling interests holders in the Grand Prix Joint Venture and Centrahoma Processing, LLC., and an increase in noncontrolling interest for a joint venture partner in WestTX. The decrease in dividends on Series A Preferred is due to the full redemption of all of our issued and outstanding shares of Series A Preferred during 2022. See Note 11 – Preferred Stock for further discussion. Results of Operations—By Reportable Segment Our operating margins by reportable segment are: Gathering andProcessing Logistics and Transportation Other (In millions) Year Ended: December 31, 2022 $ 1,981.0 $ 1,456.3 $ (302.4 ) December 31, 2021 1,325.3 1,264.3 (115.9 ) 62 Gathering and Processing Segment Year Ended December 31, 2022 2021 2022 vs. 2021 (In millions, except operating statistics and price amounts) Operating margin $ 1,981.0 $ 1,325.3 $ 655.7 49 % Operating expenses 611.8 476.2 135.6 28 % Adjusted operating margin $ 2,592.8 $ 1,801.5 $ 791.3 44 % Operating statistics (1): Plant natural gas inlet, MMcf/d (2) (3) Permian Midland (4) 2,223.6 1,928.4 295.2 15 % Permian Delaware (5) 1,536.1 839.8 696.3 83 % Total Permian 3,759.7 2,768.2 991.5 SouthTX (6) 276.5 177.7 98.8 56 % North Texas 187.0 178.9 8.1 5 % SouthOK (6) 406.8 405.9 0.9 — WestOK 208.7 212.6 (3.9 ) (2 %) Total Central 1,079.0 975.1 103.9 Badlands (6) (7) 134.9 139.8 (4.9 ) (4 %) Total Field 4,973.6 3,883.1 1,090.5 Coastal 537.6 587.2 (49.6 ) (8 %) Total 5,511.2 4,470.3 1,040.9 23 % NGL production, MBbl/d (3) Permian Midland (4) 321.7 277.9 43.8 16 % Permian Delaware (5) 193.9 114.1 79.8 70 % Total Permian 515.6 392.0 123.6 SouthTX (6) 31.2 22.2 9.0 41 % North Texas 21.2 20.1 1.1 5 % SouthOK (6) 47.6 49.5 (1.9 ) (4 %) WestOK 14.6 16.5 (1.9 ) (12 %) Total Central 114.6 108.3 6.3 Badlands (6) 16.1 16.2 (0.1 ) (1 %) Total Field 646.3 516.5 129.8 Coastal 32.0 33.9 (1.9 ) (6 %) Total 678.3 550.4 127.9 23 % Crude oil, Badlands, MBbl/d 117.6 140.9 (23.3 ) (17 %) Crude oil, Permian, MBbl/d 29.5 35.0 (5.5 ) (16 %) Natural gas sales, BBtu/d (3) 2,320.6 2,207.7 112.9 5 % NGL sales, MBbl/d (3) 438.7 394.6 44.1 11 % Condensate sales, MBbl/d 15.5 14.9 0.6 4 % Average realized prices - inclusive of hedges (8): Natural gas, $/MMBtu 5.35 3.27 2.08 64 % NGL, $/gal 0.75 0.61 0.14 23 % Condensate, $/Bbl 88.26 60.02 28.24 47 % (1)Segment operating statistics include the effect of intersegment amounts, which have been eliminated from the consolidated presentation. For all volume statistics presented, the numerator is the total volume sold during the period and the denominator is the number of calendar days during the period. (2)Plant natural gas inlet represents our undivided interest in the volume of natural gas passing through the meter located at the inlet of a natural gas processing plant, other than Badlands. (3)Plant natural gas inlet volumes and gross NGL production volumes include producer take-in-kind volumes, while natural gas sales and NGL sales exclude producer take-in-kind volumes. (4)Permian Midland includes operations in WestTX, of which we own 72.8% undivided interest, and other plants that are owned 100% by us. Operating results for the WestTX undivided interest assets are presented on a pro-rata net basis in our reported financials. (5)Includes operations from the acquisition of certain assets in the Delaware Basin for the period effective August 1, 2022. (6)Operations include facilities that are not wholly owned by us. SouthTX operating statistics include the impact of the South Texas Acquisition for the period effective April 21, 2022. For more information regarding our joint ventures and jointly owned facilities, see “Item 1. Business—Our Business Operations.” (7)Badlands natural gas inlet represents the total wellhead volume and includes the Targa volumes processed at the Little Missouri 4 plant. (8)Average realized prices include the effect of realized commodity hedge gain/loss attributable to our equity volumes. The price is calculated using total commodity sales plus the hedge gain/loss as the numerator and total sales volume as the denominator. 63 The following table presents the realized commodity hedge gain (loss) attributable to our equity volumes that are included in the adjusted operating margin of the Gathering and Processing segment: Year Ended December 31, 2022 Year Ended December 31, 2021 (In millions, except volumetric data and price amounts) Volume Settled Price Spread (1) Gain (Loss) Volume Settled Price Spread (1) Gain (Loss) Natural gas (BBtu) 74.8 $ (2.13 ) $ (159.2 ) 76.8 $ (1.41 ) $ (108.0 ) NGL (MMgal) 717.6 (0.30 ) (213.0 ) 581.5 (0.26 ) (153.1 ) Crude oil (MBbl) 2.2 (31.73 ) (69.8 ) 2.1 (14.33 ) (30.1 ) $ (442.0 ) $ (291.2 ) (1)The price spread is the differential between the contracted derivative instrument pricing and the price of the corresponding settled commodity transaction. 2022 Compared to 2021 The increase in adjusted operating margin was due to higher realized commodity prices, higher natural gas inlet volumes, and higher fees resulting in increased margin predominantly in the Permian. The increase in natural gas inlet volumes in the Permian was attributable to the acquisition of certain assets in the Delaware Basin during the third quarter of 2022, higher producer activity and the addition of the Legacy and Red Hills VI plants during the third quarter of 2022. The decrease in volumes in the Coastal region was due to lower producer activity. The increase in operating expenses was predominantly due to the acquisition of certain assets in South Texas and the Delaware Basin in the second and third quarters of 2022, which included one-time acquisition costs. Additionally, higher volumes in the Permian, the addition of the Legacy and Red Hills VI plants during the third quarter of 2022 and the Heim plant in the third quarter of 2021, and inflation impacts, resulted in increased costs. Logistics and Transportation Segment Year Ended December 31, 2022 2021 2022 vs. 2021 (In millions, except operating statistics) Operating margin $ 1,456.3 $ 1,264.3 $ 192.0 15% Operating expenses 300.2 273.0 27.2 10% Adjusted operating margin $ 1,756.5 $ 1,537.3 $ 219.2 14% Operating statistics MBbl/d (1): NGL pipeline transportation volumes (2) 488.6 396.2 92.4 23% Fractionation volumes 731.7 616.0 115.7 19% Export volumes (3) 314.5 316.9 (2.4 ) (1%) NGL sales 866.3 834.9 31.4 4% (1)Segment operating statistics include intersegment amounts, which have been eliminated from the consolidated presentation. For all volume statistics presented, the numerator is the total volume sold during the period and the denominator is the number of calendar days during the period. (2)Represents the total quantity of mixed NGLs that earn a transportation margin. (3)Export volumes represent the quantity of NGL products delivered to third-party customers at our Galena Park Marine Terminal that are destined for international markets. 2022 Compared to 2021 The increase in adjusted operating margin was due to higher pipeline transportation and fractionation margin and higher marketing margin, partially offset by lower LPG export margin. Pipeline transportation and fractionation volumes benefited from higher supply volumes primarily from our Permian Gathering and Processing systems and higher fees. Marketing margin increased due to greater optimization opportunities. LPG export margin decreased primarily due to higher fuel and power costs. The increase in operating expenses was primarily due to higher repairs and maintenance. Other Year Ended December 31, 2022 2021 2022 vs. 2021 (In millions) Operating margin $ (302.4 ) $ (115.9 ) $ (186.5 ) Adjusted operating margin $ (302.4 ) $ (115.9 ) $ (186.5 ) Other contains the results of commodity derivative activity mark-to-market gains/losses related to derivative contracts that were not designated as cash flow hedges. We have entered into derivative instruments to hedge the commodity price associated with a portion of 64 our future commodity purchases and sales and natural gas transportation basis risk within our Logistics and Transportation segment. See further details of our risk management program in “Item 7A. – Quantitative and Qualitative Disclosures About Market Risk.” Our Liquidity and Capital Resources As of December 31, 2022, inclusive of our consolidated joint venture accounts, we had $219.0 million of Cash and cash equivalents on our Consolidated Balance Sheets. On a consolidated basis, our main sources of liquidity and capital resources are internally generated cash flows from operations, borrowings under the TRGP Revolver, Commercial Paper Program, Securitization Facility, and access to debt and equity capital markets. We supplement these sources of liquidity with joint venture arrangements and proceeds from asset sales. Our exposure to adverse credit conditions includes our credit facilities, cash investments, hedging abilities, customer performance risks and counterparty performance risks. We believe our sources of liquidity and capital resources are sufficient to meet our anticipated cash requirements for at least the next twelve months to satisfy our obligations. Our ability to generate cash is subject to a number of factors, some of which are beyond our control. These include commodity prices and ongoing efforts to manage operating costs and maintenance capital expenditures, as well as general economic, financial, competitive, legislative, regulatory and other factors. For additional discussion on recent factors impacting our liquidity and capital resources, see “Recent Developments.” Our liquidity and capital resources are managed on a consolidated basis. We have the ability to access the Partnership's liquidity as well as the ability to contribute capital to the Partnership. The actual amount we declare as dividends depends on our consolidated financial condition, results of operations, cash flow, the level of our capital expenditures, future business prospects, compliance with our debt covenants and any other matters that our board of directors deems relevant. Short-term Liquidity Our principal sources of short-term liquidity consist of internally generated cash flow, borrowings available under the TRGP Revolver, as well as our right to request additional commitment increases under the TRGP Revolver, the Securitization Facility, proceeds from debt and equity offerings, and joint ventures and/or asset sales. Based on anticipated levels of operations and absent any disruptive events, we believe our liquidity is sufficient to finance our operations, capital expenditures, quarterly cash dividends and obligations, as discussed further below, for at least the next twelve months. Our short-term liquidity on a consolidated basis as of February 17, 2023, was: Consolidated Total (In millions) Cash on hand (1) $ 209.5 Total availability under the Securitization Facility 800.0 Total availability under the TRGP Revolver and Commercial Paper Program 2,750.0 3,759.5 Less: Outstanding borrowings under the Securitization Facility (800.0 ) Outstanding borrowings under the TRGP Revolver and Commercial Paper Program (432.5 ) Outstanding letters of credit under the TRGP Revolver (35.2 ) Total liquidity $ 2,491.8 (1)Includes cash held in our consolidated joint venture accounts. Other potential capital resources associated with our existing arrangements include our right to request an additional $500.0 million in commitment increases under the TRGP Revolver, subject to the terms therein. The TRGP Revolver matures on February 17, 2027. A portion of our capital resources are allocated to letters of credit to satisfy certain counterparty credit requirements. As of December 31, 2022, we had $33.2 million in letters of credit outstanding under the TRGP Revolver. The letters of credit also reflect certain counterparties’ views of our financial condition and ability to satisfy our performance obligations, as well as commodity prices and other factors. Working Capital Working capital is the amount by which current assets exceed current liabilities. On a consolidated basis, at the end of any given month, accounts receivable and payable tied to commodity sales and purchases are relatively balanced, with receivables from customers being offset by plant settlements payable to producers. The factors that typically cause overall variability in our reported total working capital are: (i) our cash position; (ii) liquids inventory levels, which we closely manage, and valuation; (iii) changes in payables and accruals related to major growth capital projects; (iv) changes in the fair value of the current portion of derivative contracts; (v) monthly swings 65 in borrowings under the Securitization Facility; and (vi) major structural changes in our asset base or business operations, such as certain organic growth capital projects and acquisitions or divestitures. Working capital as of December 31, 2022 decreased $181.4 million compared to December 31, 2021. The decrease was primarily due to higher net borrowing on the Securitization Facility, and higher accounts payable and accruals related to growth projects in the Permian, partially offset by an increase to NGL inventory, higher net assets from hedging activities, and an increase in receivables resulting from higher commodity prices. Long-term Financing Our long-term financing consists of potentially raising funds through long-term debt obligations, the issuance of common stock, preferred stock, or joint venture arrangements. The majority of our debt is fixed rate borrowings; however, we have some exposure to the risk of changes in interest rates, primarily as a result of the variable rate borrowings under the TRGP Revolver, Term Loan Facility, the Securitization Facility, and the potential for variable rate borrowing under the Commercial Paper Program. We may enter into interest rate hedges with the intent to mitigate the impact of changes in interest rates on cash flows. As of December 31, 2022, we did not have any interest rate hedges. To date, our debt balances and our subsidiaries’ debt balances have not adversely affected our operations, ability to grow or ability to repay or refinance indebtedness. For additional information about our debt-related transactions, see Note 8 - Debt Obligations to our consolidated financial statements. For information about our interest rate risk, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk—Interest Rate Risk.” In February 2022, we entered into the TRGP Revolver. The TRGP Revolver provides for a revolving credit facility in an initial aggregate principal amount up to $2.75 billion, with an option to increase such maximum aggregate principal amount by up to $500.0 million in the future, subject to the terms of the TRGP Revolver, including a swing line sub-facility of up to $100.0 million. The TRGP Revolver matures in February 2027. In connection with our entry into the TRGP Revolver, we terminated the Previous TRGP Revolver and the Partnership Revolver. In February 2022, TRGP and the Partnership received a corporate investment grade credit rating from S&P and Fitch, and in March 2022, the Partnership received a corporate investment grade credit rating from Moody’s. As a result, in accordance with the TRGP Revolver, the collateral under the TRGP Revolver was released from the liens securing our obligations thereunder. As a result of the termination of the Previous TRGP Revolver and the Partnership Revolver, we recorded a loss of $0.8 million due to a write-off of debt issuance costs. In February 2022, we and certain of our subsidiaries entered into a parent guarantee whereby each party to the agreement unconditionally guarantees, jointly and severally, the payment of all of the obligations of the Partnership and Targa Resources Partners Finance Corporation (together with the Partnership, the “Partnership Issuers”) under the respective indentures governing the Partnership Issuers’ senior unsecured notes. As of December 31, 2022, $5.0 billion of the Partnership Issuers’ senior unsecured notes was outstanding. In March 2022, the Partnership redeemed all of the 5.375% Notes with available liquidity under the TRGP Revolver. As a result of the redemption of the 5.375% Notes, we recorded a loss due to debt extinguishment of $15.0 million comprised of $12.6 million of premiums paid and a write-off of $2.4 million of debt issuance costs. In April 2022, we completed an underwritten public offering of the 4.200% Notes and the 4.950% Notes, resulting in net proceeds of approximately $1.5 billion. A portion of the net proceeds from the issuance was used to fund the concurrent March Tender Offer and the subsequent redemption of the Partnership’s 5.875% Notes, with the remainder of the net proceeds used for repayment of the outstanding borrowings under the TRGP Revolver. As a result of the March Tender Offer and the subsequent redemption of the 5.875% Notes, we recorded a loss due to debt extinguishment of $33.8 million comprised of $29.3 million of premiums paid and a write-off of $4.5 million of debt issuance costs. In April 2022, the Partnership amended the Securitization Facility to, among other things, extend the facility termination date to April 19, 2023 and replace the LIBOR-based interest rate option with SOFR-based interest rate options, including term SOFR and daily simple SOFR. In September 2022, the Partnership amended the Securitization Facility to, among other things, increase the facility size from $400.0 million to $800.0 million and extend the facility termination date to September 1, 2023. In May 2022, we redeemed all of our issued and outstanding shares of Series A Preferred at a redemption price of $1,050.00 per share, plus $8.87 per share, which is the amount of accrued and unpaid dividends from April 1, 2022 up to, but not including, the redemption date of May 3, 2022. Following the redemption, we have no Series A Preferred outstanding and all rights of the holders of shares of Series A Preferred were terminated. See Note 11 - Preferred Stock in our Consolidated Financial Statements beginning on page F-1 in this Form 10-K. 66 In July 2022, we completed an underwritten public offering of the 5.200% Notes and the 6.250% Notes, resulting in net proceeds of approximately $1.2 billion. We used the net proceeds from the issuance to fund a portion of the Delaware Basin Acquisition. In July 2022, we entered into the Term Loan Facility. The Term Loan Facility provides for a three-year, $1.5 billion unsecured term loan facility and matures in July 2025. We used the proceeds to fund a portion of the Delaware Basin Acquisition. In July 2022, we established the Commercial Paper Program. Under the terms of the Commercial Paper Program, we may issue, from time to time, unsecured commercial paper notes with varying maturities of less than one year. Amounts available under the Commercial Paper Program may be issued, repaid and re-issued from time to time, with the maximum aggregate face or principal amount outstanding at any one time not to exceed $2.75 billion. We maintain a minimum available borrowing capacity under the TRGP Revolver equal to the aggregate amount outstanding under the Commercial Paper Program as support. The Commercial Paper Program is guaranteed by each subsidiary that guarantees the TRGP Revolver. As of December 31, 2022, we had $1.0 billion outstanding under the Commercial Paper Program. In January 2023, we completed the underwritten public offering of the 6.125% Notes and the 6.500% Notes, resulting in net proceeds of approximately $1.7 billion. We used a portion of the net proceeds from the issuance to fund the Grand Prix Transaction and the remaining net proceeds for general corporate purposes, including to reduce borrowings under the TRGP Revolver and the Commercial Paper Program. In the future, we or the Partnership may redeem, purchase or exchange certain of our and/or the Partnership’s outstanding debt through redemption calls, cash purchases and/or exchanges for other debt, in open market purchases, privately negotiated transactions or otherwise. Such calls, repurchases, exchanges or redemptions, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. To date, our debt balances and our subsidiaries’ debt balances have not adversely affected our operations, ability to grow or ability to repay or refinance indebtedness. Compliance with Debt Covenants As of December 31, 2022, both we and the Partnership were in compliance with the covenants contained in our various debt agreements. Cash Flow Analysis Cash Flows from Operating Activities Year Ended December 31, 2022 2021 2022 vs. 2021 (In millions) $ 2,380.8 $ 2,302.9 $ 77.9 The primary drivers of cash flows from operating activities are (i) the collection of cash from customers from the sale of NGLs and natural gas, as well as fees for processing, gathering, export, fractionation, terminaling, storage and transportation, (ii) the payment of amounts related to the purchase of NGLs, natural gas and crude oil (iii) changes in payables and accruals related to major growth capital projects; and (iv) the payment of other expenses, primarily field operating costs, general and administrative expense and interest expense. In addition, we use derivative instruments to manage our exposure to commodity price risk. Changes in the prices of the commodities we hedge impact our derivative settlements as well as our margin deposit requirements on unsettled futures contracts. The increase in net cash provided by operations was primarily due to higher commodity prices, resulting in higher collections from customers, partially offset by an increase in payments for product purchases and fuel and hedge transactions. Cash Flows from Investing Activities Year Ended December 31, 2022 2021 2022 vs. 2021 (In millions) $ (4,149.7 ) $ (473.2 ) $ (3,676.5 ) The increase in net cash used in investing activities was primarily due to the outlays for the Delaware Basin Acquisition and the South Texas Acquisition. Additionally, there were higher outlays for property, plant and equipment resulting from construction activities in the Permian, partially offset by proceeds from the GCX Sale. See “Recent Developments” for further details on our 2022 expansions. 67 Cash Flows from Financing Activities Year Ended December 31, 2022 2021 (In millions) Source of Financing Activities, net Debt, including financing costs $ 4,651.5 $ (1,189.1 ) Redemption of Series A Preferred Stock (965.2 ) — Repurchase of noncontrolling interests (926.3 ) — Dividends (379.7 ) (187.5 ) Contributions from (distributions to) noncontrolling interests (290.3 ) (484.2 ) Repurchase of shares (260.6 ) (53.2 ) Net cash provided by (used in) financing activities $ 1,829.4 $ (1,914.0 ) The change in net cash provided by (used in) financing activities was primarily due to net borrowings of debt in 2022, as compared to net repayments of debt in 2021, partially offset by the redemption of the Series A Preferred and repurchases of non-controlling interests in the DevCo JVs and common stock during 2022. Additionally, higher dividends were paid in 2022 due to the increase in our common stock dividends from $0.10 to $0.35 per common share in January 2022. Summarized Combined Financial Information for Guarantee of Securities of Subsidiaries Our subsidiaries that guarantee our obligations under the TRGP Revolver (the “Obligated Group”) also fully and unconditionally guarantee, jointly and severally, the payment of TRGP’s and the Partnership Issuers’ senior notes, the payment of the notes under the Commercial Paper Program and our obligations under the Term Loan Facility, subject to certain limited exceptions. In lieu of providing separate financial statements for the Obligated Group, we have presented the following supplemental summarized Combined Balance Sheet and Statement of Operations information for the Obligated Group based on Rule 13-01 of the SEC’s Regulation S-X. All significant intercompany items among the Obligated Group have been eliminated in the supplemental summarized combined financial information. The Obligated Group’s investment balances in our non-guarantor subsidiaries have been excluded from the supplemental summarized combined financial information. Significant intercompany balances and activity for the Obligated Group with other related parties, including our non-guarantor subsidiaries (referred to as “affiliates”), are presented separately in the following supplemental summarized combined financial information. Summarized Combined Balance Sheet and Statement of Operations information for the Obligated Group follows: Summarized Combined Balance Sheet Information December 31, 2022 (In millions) ASSETS Current assets $ 1,386.9 Current assets - affiliates 6.0 Long-term assets 10,163.5 Long-term assets - affiliates 10.5 Total assets $ 11,566.9 LIABILITIES AND OWNERS' EQUITY Current liabilities $ 1,779.3 Current liabilities - affiliates 64.2 Long-term liabilities 11,315.6 Targa Resources Corp. stockholders' equity (1,592.2 ) Total liabilities and owners' equity $ 11,566.9 Summarized Combined Statement of Operations Information Year Ended December 31, 2022 (In millions) Revenues $ 21,264.0 Operating income (loss) 205.3 Net income (loss) 101.6 Dividends on Series A Preferred 30.0 68 Common Stock Dividends The following table details the dividends declared and/or paid by us to common shareholders for 2022: Three Months Ended Date Paid orTo Be Paid Total CommonDividends Declared Amount of CommonDividends Paid orTo Be Paid AccruedDividends (1) Dividends Declared per Share of Common Stock (In millions, except per share amounts) December 31, 2022 February 15, 2023 $ 80.5 $ 79.3 $ 1.2 $ 0.35000 September 30, 2022 November 15, 2022 80.5 79.2 1.3 0.35000 June 30, 2022 August 15, 2022 80.7 79.3 1.4 0.35000 March 31, 2022 May 16, 2022 81.2 79.8 1.4 0.35000 (1)Represents accrued dividends on restricted stock and restricted stock units that are payable upon vesting. Preferred Dividends Series A Preferred Redemption In May 2022, we redeemed in full all of our issued and outstanding shares of Series A Preferred at a redemption price of $1,050.00 per share, plus $8.87 per share, which is the amount of accrued and unpaid dividends from April 1, 2022 up to, but not including, the redemption date of May 3, 2022. The difference between the consideration paid of $973.4 million (including unpaid dividends of $8.2 million) and the net carrying value of the shares redeemed was $223.7 million, of which $215.5 million was recorded as deemed dividends in our Consolidated Statements of Operations in the second quarter of 2022. Following the redemption, we have no Series A Preferred outstanding and all rights of the holders of shares of Series A Preferred were terminated. See Note 11 - Preferred Stock to our Consolidated Financial Statements. Prior to the redemption of our Series A Preferred in May 2022, our Series A Preferred bore a cumulative 9.5% fixed dividend payable at the end of each fiscal quarter. During the year ended December 31, 2022, we paid $51.8 million of dividends to preferred shareholders. Capital Expenditures The following table details cash outlays for capital projects for the years ended December 31, 2022 and 2021: Year Ended December 31, 2022 2021 (In millions) Capital expenditures: Growth (1) $ 1,219.0 $ 421.9 Maintenance (2) 175.4 138.6 Gross capital expenditures 1,394.4 560.5 Transfers from materials and supplies inventory to property, plant and equipment — (2.4 ) Change in capital project payables and accruals, net (60.1 ) (53.0 ) Cash outlays for capital projects $ 1,334.3 $ 505.1 (1)Growth capital expenditures, net of contributions from noncontrolling interests and including net contributions to investments in unconsolidated affiliates, were $1,177.2 million and $407.7 million for the years ended December 31, 2022 and 2021. (2)Maintenance capital expenditures, net of contributions from noncontrolling interests, were $168.1 million and $131.7 million for the years ended December 31, 2022 and 2021. The increase in total growth capital expenditures was primarily due to system expansions in the Permian in response to forecasted production growth and higher activity levels, and expansions in our downstream business. The increase in total maintenance capital expenditures was primarily due to our growing infrastructure footprint. With our announced natural gas processing additions currently under construction in the Permian region, coupled with the construction of our Daytona NGL Pipeline and Train 9 fractionator in Mont Belvieu, we currently estimate that in 2023 we will invest between $1.8 to $1.9 billion in net growth capital expenditures for announced projects. Future growth capital expenditures may vary based on 69 investment opportunities. We expect that 2023 maintenance capital expenditures, net of noncontrolling interests, will be approximately $175 million. Off-Balance Sheet Arrangements As of December 31, 2022, there were $243.2 million in surety bonds outstanding related to various performance obligations. These are in place to support various performance obligations as required by (i) statutes within the regulatory jurisdictions where we operate and (ii) counterparty support. Obligations under these surety bonds are not normally called, as we typically comply with the underlying performance requirement. We have invested in entities that are not consolidated in our financial statements. For information on our obligations with respect to these investments, as well as our obligations with respect to related letters of credit, see Note 7 – Investments in Unconsolidated Affiliates and Note 8 – Debt Obligations. Contractual Obligations We believe we have sufficient liquidity to fund our operations and meet our short-term and long-term obligations. The following is a summary of our material future contractual obligations: Contractual Obligations: Total Within 12 Months (in millions) Long-term debt obligations (1) $ 10,583.1 $ — Interest on debt obligations (2) 4,869.6 570.9 Operating leases (3) 47.1 15.7 Finance leases (4) 265.3 42.5 Land site lease and rights of way (5) 247.6 6.9 Purchase obligations (6) 2,437.8 1,341.4 Other long-term liabilities (7) 133.4 41.7 Total $ 18,583.9 $ 2,019.1 (1)Represents scheduled future maturities of long-term debt obligation. See Note 8 - Debt Obligations for more information. (2)Represents interest expense on long-term debt obligations based on both fixed debt interest rates and prevailing December 31, 2022 rates for floating debt. See Note 8 - Debt Obligations for more information. (3)Includes minimum payments on operating lease obligations for office space and railcars. See Note 10 - Leases for more information. (4)Includes minimum payments on finance lease obligations for compressors, substations, vehicles and tractors. See Note 10 - Leases for more information. (5)Land site lease and rights of way provide for surface and underground access for gathering, processing and distribution assets that are located on property not owned by us. These agreements expire at various dates with varying terms, some of which are perpetual. See Note 17 - Commitments for more information. (6)Includes commitments for pipeline capacity payments for firm transportation and throughput and deficiency agreements, purchase of natural gas and NGLs, capital expenditures, operating expenses and service contracts. Contracts that will be settled at future spot prices are valued using prices as of December 31, 2022. (7)Includes long-term liabilities of which we are certain of the amount and timing, including certain arrangements that resulted in deferred revenue and other liabilities pertaining to accrued dividends. See Note 9 - Other Long-term Liabilities for more information. Critical Accounting Policies and Estimates The accounting policies and estimates discussed below are considered by management to be critical to an understanding of our financial statements because their application requires the most significant judgments from management in estimating matters for financial reporting that are inherently uncertain. See the description of our accounting policies in the notes to the financial statements for additional information about our critical accounting policies and estimates. Business Acquisitions For business acquisitions, we generally recognize the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their estimated fair values on the acquisition date. Goodwill results when the cost of a business acquisition exceeds the fair value of the net identifiable assets of the acquired business. Determining fair value requires management’s judgment and involves the use of significant estimates and assumptions with respect to projections of future production volumes, pricing and cash flows, benchmark analysis of comparable public companies, discount rates, expectations regarding customer contracts and relationships, and other management estimates. The judgments made in the determination of the estimated fair value assigned to the assets acquired, liabilities assumed and any noncontrolling interest in the investee, the duration of each liability, and any resulting goodwill can materially impact the financial statements in periods after acquisition. See Note 4 – Acquisitions and Divestitures in our Consolidated Financial Statements. 70 Depreciation of Property, Plant and Equipment and Amortization of Intangible Assets Depreciation of our property, plant and equipment is computed using the straight-line method over the estimated useful lives of the assets. Our estimate of depreciation incorporates assumptions regarding the useful economic lives and residual values of our assets. The determination of useful lives of property, plant and equipment requires us to make various assumptions, including our expected use of the asset and the supply of and demand for hydrocarbons in the markets served, normal wear and tear of facilities, and the extent and frequency of maintenance programs. We amortize the costs of our intangible assets in a manner that closely resembles the expected benefit pattern of the intangible assets or on a straight-line basis, where such pattern is not readily determinable, over the periods in which we benefit from services provided to customers. At the time assets are placed in service or acquired, we believe such assumptions are reasonable; however, circumstances may develop that would cause us to change these assumptions, which would change our depreciation/amortization amounts prospectively. Impairment of Long-Lived Assets, including Intangible Assets We evaluate long-lived assets, including intangible assets, for impairment when events or changes in circumstances indicate our carrying amount of an asset may not be recoverable, including changes to our estimates that could have an impact on our assessment of asset recoverability. Asset recoverability is measured by comparing the carrying value of the asset or asset group with its expected future pre-tax undiscounted cash flows. Individual assets are grouped at the lowest level for which the related identifiable cash flows are largely independent of the cash flows of other assets and liabilities. These cash flow estimates require us to make judgments and assumptions related to operating and cash flow results, economic obsolescence, the business climate, contractual, legal and other factors. If the carrying amount exceeds the expected future undiscounted cash flows, we recognize a non-cash pre-tax impairment charge equal to the excess of net book value over fair value as determined by quoted market prices in active markets or present value techniques if quotes are unavailable. The estimated cash flows used to assess recoverability of our long-lived assets and measure fair value of our asset groups are derived from current business plans, which are developed using near-term price and volume projections reflective of the current environment and management's projections for long-term average prices and volumes. In addition to near and long-term price assumptions, other key assumptions include volume projections, operating costs, timing of incurring such costs and the use of an appropriate terminal value and discount rate. Any changes we make to these projections and assumptions could result in significant revisions to our evaluation of recoverability of our long-lived assets and the recognition of additional impairments. Price Risk Management (Hedging) Our net income and cash flows are subject to volatility stemming from changes in commodity prices and interest rates. In an effort to reduce the volatility of our cash flows, we have entered into derivative financial instruments to hedge the commodity price associated with a portion of our expected natural gas, NGL, and condensate equity volumes, future commodity purchases and sales, and transportation basis risk. One of the factors that can affect our operating results each period is the price assumptions used to value our derivative financial instruments, which are reflected at their fair values on the balance sheet. We determine the fair value of our derivative instruments using present value methods or standard option valuation models with assumptions about commodity prices based on those observed in underlying markets. Changes in the methods or assumptions we use to calculate the fair value of our derivative instruments could have a material effect on our consolidated financial statements. Recent Accounting Pronouncements For a discussion of recent accounting pronouncements that will affect us, see Note 3 – Significant Accounting Policies in our Consolidated Financial Statements. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. Our principal market risks are our exposure to changes in commodity prices, particularly to the prices of natural gas, NGLs and crude oil, changes in interest rates, as well as nonperformance by our risk management counterparties and customers. 71 Risk Management We evaluate counterparty risks related to our commodity derivative contracts and trade credit. All of our commodity derivatives are with major financial institutions or major energy companies. Should any of these financial counterparties not perform, we may not realize the benefit of some of our hedges under lower commodity prices, which could have a material adverse effect on our results of operations. We sell our natural gas, NGLs and condensate to a variety of purchasers. Non-performance by a trade creditor could result in losses. Crude oil, NGL and natural gas prices are volatile. In an effort to reduce the variability of our cash flows, we have entered into derivative instruments to hedge the commodity price associated with a portion of our expected natural gas, NGL and condensate equity volumes, future commodity purchases and sales, and transportation basis risk through 2027. Market conditions may also impact our ability to enter into future commodity derivative contracts. Commodity Price Risk A portion of our revenues are derived from percent-of-proceeds contracts under which we receive a portion of the proceeds from the sale of commodities as payment for services. The prices of natural gas, NGLs and crude oil are subject to fluctuations in response to changes in supply, demand, market uncertainty and a variety of additional factors beyond our control. We monitor these risks and enter into hedging transactions designed to mitigate the impact of commodity price fluctuations on our business. Cash flows from a derivative instrument designated as a hedge are classified in the same category as the cash flows from the item being hedged. The primary purpose of our commodity risk management activities is to hedge some of the exposure to commodity price risk and reduce fluctuations in our operating cash flow due to fluctuations in commodity prices. In an effort to reduce the variability of our cash flows, as of December 31, 2022, we have hedged the commodity price associated with a portion of our expected (i) natural gas, NGL, and condensate equity volumes in our Gathering and Processing operations that result from our percent-of-proceeds processing arrangements, (ii) future commodity purchases and sales in our Logistics and Transportation segment and (iii) natural gas transportation basis risk in our Logistics and Transportation segment. We hedge a higher percentage of our expected equity volumes in the current year compared to future years, for which we hedge incrementally lower percentages of expected equity volumes. We also enter into commodity financial instruments to help manage other short term commodity related business risks of our ongoing operations and in conjunction with marketing opportunities available to us in the operations of our logistics and transportation assets. With swaps, we typically receive an agreed fixed price for a specified notional quantity of commodities and we pay the hedge counterparty a floating price for that same quantity based upon published index prices. Since we receive from our customers substantially the same floating index price from the sale of the underlying physical commodity, these transactions are designed to effectively lock in the agreed fixed price in advance for the volumes hedged. In order to avoid having a greater volume hedged than our actual equity volumes, we typically limit our use of swaps to hedge the prices of less than our expected equity volumes. We utilize purchased puts (or floors) and calls (or caps) to hedge additional expected equity commodity volumes without creating volumetric risk. We may buy calls in connection with swap positions to create a price floor with upside. We intend to continue to manage our exposure to commodity prices in the future by entering into derivative transactions using swaps, collars, purchased puts (or floors), futures or other derivative instruments as market conditions permit. When entering into new hedges, we intend to generally match the NGL product composition and the NGL and natural gas delivery points to those of our physical equity volumes. The NGL hedges cover specific NGL products based upon the expected equity NGL composition. We believe this strategy avoids uncorrelated risks resulting from employing hedges on crude oil or other petroleum products as “proxy” hedges of NGL prices. The fair values of our natural gas and NGL hedges are based on published index prices for delivery at various locations, which closely approximate the actual natural gas and NGL delivery points. A portion of our condensate sales are hedged using crude oil hedges that are based on the NYMEX futures contracts for West Texas Intermediate light, sweet crude. A majority of these commodity price hedges are documented pursuant to a standard International Swap Dealers Association form with customized credit and legal terms. The principal counterparties (or, if applicable, their guarantors) have investment grade credit ratings. While we have no current obligation to post cash, letters of credit or other additional collateral to secure these hedges so long as we maintain our current credit rating, we could be obligated to post collateral to secure the hedges in the event of an adverse change in our creditworthiness where a counterparty’s exposure to our credit increases over the term of the hedge as a result of higher commodity prices. A purchased put (or floor) transaction does not expose our counterparties to credit risk, as we have no obligation to make future payments beyond the premium paid to enter into the transaction; however, we are exposed to the risk of default by the counterparty, which is the risk that the counterparty will not honor its obligation under the put transaction. We also enter into commodity price hedging transactions using futures contracts on futures exchanges. Exchange traded futures are subject to exchange margin requirements, so we may have to increase our cash deposit due to a rise in natural gas, NGL or crude oil prices. Unlike bilateral hedges, we are not subject to counterparty credit risks when using futures on futures exchanges. 72 These contracts may expose us to the risk of financial loss in certain circumstances. Generally, our hedging arrangements provide us protection on the hedged volumes if prices decline below the prices at which these hedges are set. If prices rise above the prices at which they have been hedged, we will receive less revenue on the hedged volumes than we would receive in the absence of hedges (other than with respect to purchased calls). To analyze the risk associated with our derivative instruments, we utilize a sensitivity analysis. The sensitivity analysis measures the change in fair value of our derivative instruments based on a hypothetical 10% change in the underlying commodity prices, but does not reflect the impact that the same hypothetical price movement would have on the related hedged items. The financial statement impact on the fair value of a derivative instrument resulting from a change in commodity price would normally be offset by a corresponding gain or loss on the hedged item under hedge accounting. The fair values of our derivative instruments are also influenced by changes in market volatility for option contracts and the discount rates used to determine the present values. The following table shows the effect of hypothetical price movements on the estimated fair value of our derivative instruments as of December 31, 2022: Fair Value Result of 10% Price Decrease Result of 10% Price Increase (In millions) Natural gas $ (267.6 ) $ (185.1 ) $ (350.1 ) NGLs 34.2 123.1 (54.7 ) Crude oil (22.4 ) 5.7 (50.5 ) Total $ (255.8 ) $ (56.3 ) $ (455.3 ) The table above contains all derivative instruments outstanding as of the stated date for the purpose of hedging commodity price risk, which we are exposed to due to our equity volumes and future commodity purchases and sales, as well as basis differentials related to our gas transportation arrangements. During the years ended December 31, 2022 and 2021, our operating revenues decreased by $(754.7) million and $(490.6) million as a result of transactions accounted for as derivatives. The estimated fair value of our risk management position has moved from a net liability position of $316.7 million at December 31, 2021 to $255.8 million at December 31, 2022. Forward commodity prices have increased relative to the fixed prices on our derivative contracts, creating the net liability position. Interest Rate Risk We are exposed to the risk of changes in interest rates, primarily as a result of variable rate borrowings under the TRGP Revolver, the Commercial Paper Program, the Securitization Facility, and the Term Loan Facility. As of December 31, 2022, we do not have any interest rate hedges. However, we may enter into interest rate hedges in the future with the intent to mitigate the impact of changes in interest rates on cash flows. To the extent that interest rates increase, interest expense for the TRGP Revolver, the Commercial Paper Program, the Securitization Facility and the Term Loan Facility will also increase. As of December 31, 2022, we had $3.6 billion in outstanding variable rate borrowings. A hypothetical change of 100 basis points in the rate of our variable interest rate debt would impact our consolidated annual interest expense by $36.0 million based on our December 31, 2022 debt balances. Counterparty Credit Risk We are subject to risk of losses resulting from nonpayment or nonperformance by our counterparties. The credit exposure related to commodity derivative instruments is represented by the fair value of the asset position (i.e. the fair value of expected future receipts) at the reporting date. Our futures contracts have limited credit risk since they are cleared through an exchange and are margined daily. Should the creditworthiness of one or more of the counterparties decline, our ability to mitigate nonperformance risk is limited to a counterparty agreeing to either a voluntary termination and subsequent cash settlement or a novation of the derivative contract to a third party. In the event of a counterparty default, we may sustain a loss and our cash receipts could be negatively impacted. We have master netting provisions in the International Swap Dealers Association agreements with our derivative counterparties. These netting provisions allow us to net settle asset and liability positions with the same counterparties within the same Targa entity, and would reduce our maximum loss due to counterparty credit risk by $19.1 million as of December 31, 2022. The range of losses attributable to our individual counterparties as of December 31, 2022 would be between $1.9 million and $16.4 million, depending on the counterparty in default. 73 Customer Credit Risk We extend credit to customers and other parties in the normal course of business. We have established various procedures to manage our credit exposure, including performing initial and subsequent credit risk analyses, setting maximum credit limits and terms and requiring credit enhancements when necessary. We use credit enhancements including (but not limited to) letters of credit, prepayments, parental guarantees and rights of offset to limit credit risk to ensure that our established credit criteria are followed and financial loss is mitigated or minimized. We have an active credit management process, which is focused on controlling loss exposure due to bankruptcies or other liquidity issues of counterparties. Our allowance for doubtful accounts was $2.2 million and $0.1 million as of December 31, 2022 and December 31, 2021, respectively. The change in the allowance for doubtful accounts was primarily due to the Delaware Basin Acquisition. No customer comprised 10% or greater of our consolidated revenues during the years ended December 31, 2022 and 2021, respectively.
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. For further discussion of our products and services, technology and competitive strengths, refer to Item 1- Business. For discussion related to changes in financial condition and the results of operations for fiscal year 2021-related items, refer to Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for fiscal year 2021, which was filed with the Securities and Exchange Commission on February 7, 2022. Overview and 2022 Highlights Our mission is to accelerate the world’s transition to sustainable energy. We design, develop, manufacture, lease and sell high-performance fully electric vehicles, solar energy generation systems and energy storage products. We also offer maintenance, installation, operation, financial and other services related to our products. Additionally, we are increasingly focused on products and services based on artificial intelligence, robotics and automation. In 2022, we produced 1,369,611 consumer vehicles and delivered 1,313,851 consumer vehicles, despite ongoing supply chain and logistics challenges and factory shutdowns. We are currently focused on increasing vehicle production, capacity and delivery capabilities, improving and developing battery technologies, improving our FSD capabilities, increasing the affordability and efficiency of our vehicles, bringing new products to market and expanding our global infrastructure. In 2022, we deployed 6.5 GWh of energy storage products and 348 megawatts of solar energy systems. We are currently focused on ramping production of energy storage products, improving our Solar Roof installation capability and efficiency, and increasing market share of retrofit and new build solar energy systems. In 2022, we recognized total revenues of $81.46 billion, respectively, representing an increase of $27.64 billion, compared to the prior year. We continue to ramp production, build new manufacturing capacity and expand our operations to enable increased deliveries and deployments of our products and further revenue growth. In 2022, our net income attributable to common stockholders was $12.56 billion, representing a favorable change of $7.04 billion, compared to the prior year. We continue to focus on improving our profitability through production and operational efficiencies. We ended 2022 with $22.19 billion in cash and cash equivalents and investments, representing an increase of $4.48 billion from the end of 2021. Our cash flows provided by operating activities during 2022 and 2021 were $14.72 billion and $11.50 billion, respectively, representing an increase of $3.23 billion. Capital expenditures amounted to $7.16 billion during 2022, compared to $6.48 billion during 2021. Sustained growth has allowed our business to generally fund itself, and we will continue investing in a number of capital-intensive projects in upcoming periods. Management Opportunities, Challenges and Uncertainties and 2023 Outlook Automotive—Production The following is a summary of the status of production of each of our announced vehicle models in production and under development, as of the date of this Annual Report on Form 10-K: Production Location Vehicle Model(s) Production Status Fremont Factory Model S / Model X Active Model 3 / Model Y Active Gigafactory Shanghai Model 3 / Model Y Active Gigafactory Berlin-Brandenburg Model Y Active Gigafactory Texas Model Y Active Cybertruck Tooling Gigafactory Nevada Tesla Semi Pilot production TBD Tesla Roadster In development TBD Robotaxi & Others In development 32 We are focused on growing our manufacturing capacity, which includes ramping all of our production vehicles to their installed production capacities as well as increasing production rate, efficiency and capacity at our current factories. The next phase of production growth will depend on the ramp at Gigafactory Berlin-Brandenburg and Gigafactory Texas, as well as our ability to add to our available sources of battery cell supply by manufacturing our own cells that we are developing to have high-volume output, lower capital and production costs and longer range. Our goals are to improve vehicle performance, decrease production costs and increase affordability. However, these plans are subject to uncertainties inherent in establishing and ramping manufacturing operations, which may be exacerbated by the new product and manufacturing technologies we are introducing, the number of concurrent international projects, any industry-wide component constraints, labor shortages and any future impact from events outside of our control such as the COVID-19 pandemic. Moreover, we have set ambitious technological targets with our plans for battery cells as well as for iterative manufacturing and design improvements for our vehicles with each new factory. Automotive—Demand and Sales Our cost reduction efforts, cost innovation strategies, and additional localized procurement and manufacturing are key to our vehicles’ affordability, and for example, have allowed us to competitively price our vehicles in China. We will also continue to generate demand and brand awareness by improving our vehicles’ performance and functionality, including through products based on artificial intelligence such as Autopilot and FSD, and other software features, and delivering new vehicles, such as the Tesla Semi in December 2022. Moreover, we expect to continue to benefit from ongoing electrification of the automotive sector and increasing environmental awareness. However, we operate in a cyclical industry that is sensitive to political and regulatory uncertainty, including with respect to trade and the environment, all of which can be compounded by inflationary pressures, rising energy prices, increases in interest rates and any future global impact from the COVID-19 pandemic. For example, in the earlier part of 2022, the automotive industry in general experienced part shortages and supplier disruptions which impacted production leading to a general increase in vehicle pricing. As the year progressed, inflationary pressures increased across the markets in which we operate. In an effort to curb this trend, central banks in developed countries raised interest rates rapidly and substantially, impacting the affordability of vehicle lease and finance arrangements. Further, sales of vehicles in the automotive industry also tend to be cyclical in many markets, which may expose us to increased volatility as we expand and adjust our operations. Moreover, as additional competitors enter the marketplace and help bring the world closer to sustainable transportation, we will have to adjust and continue to execute well to maintain our momentum. These macroeconomic and industry trends have had, and will likely continue to have, an impact on the pricing of, and order rate for our vehicles, and we will continue to adjust accordingly to such developments. Automotive—Deliveries and Customer Infrastructure As our production increases, we must work constantly to similarly increase vehicle delivery capability so that it does not become a bottleneck on our total deliveries. Beginning the second half of 2022, due to continuing challenges caused by vehicle transportation capacity during peak delivery periods, we began transitioning to a more even regional mix of vehicle builds each week, which led to an increase in cars in transit at the end of the year. Increasing the exports of vehicles manufactured at Gigafactory Shanghai has also been effective in mitigating the strain on our deliveries in markets outside of the United States, and we expect to benefit further from situating additional factories closer to local markets, including the production launch at Gigafactory Berlin-Brandenburg and Gigafactory Austin. As we expand our manufacturing operations globally, we will also have to continue to increase and staff our delivery, servicing and charging infrastructure accordingly, maintain our vehicle reliability and optimize our Supercharger locations to ensure cost effectiveness and customer satisfaction. In particular, we remain focused on increasing the capability and efficiency of our servicing operations. Energy Generation and Storage Demand, Production and Deployment The long-term success of this business is dependent upon increasing margins through greater volumes. We continue to increase the production of our energy storage products to meet high levels of demand. For Megapack, energy storage deployments can vary meaningfully quarter to quarter depending on the timing of specific project milestones. For Powerwall, better availability and growing grid stability concerns drive higher customer interest. We remain committed to growing our retrofit solar energy business by offering a low-cost and simplified online ordering experience. In addition, we continue to seek to improve our installation capabilities and price efficiencies for Solar Roof. As these product lines grow, we will have to maintain adequate battery cell supply for our energy storage products and hire additional personnel, particularly skilled electricians, to support the ramp of Solar Roof. 33 Cash Flow and Capital Expenditure Trends Our capital expenditures are typically difficult to project beyond the short-term given the number and breadth of our core projects at any given time, and may further be impacted by uncertainties in future global market conditions. We are simultaneously ramping new products, ramping manufacturing facilities on three continents and piloting the development and manufacture of new battery cell technologies, and the pace of our capital spend may vary depending on overall priority among projects, the pace at which we meet milestones, production adjustments to and among our various products, increased capital efficiencies and the addition of new projects. Owing and subject to the foregoing as well as the pipeline of announced projects under development, all other continuing infrastructure growth and varying levels of inflation, we currently expect our capital expenditures to be between $6.00 to $8.00 billion in 2023 and between $7.00 to $9.00 billion in each of the following two fiscal years. Our business has recently been consistently generating cash flow from operations in excess of our level of capital spend, and with better working capital management resulting in shorter days sales outstanding than days payable outstanding, our sales growth is also facilitating positive cash generation. We have and will continue to utilize such cash flows, among other things, to do more vertical integration, expand our product roadmap and provide financing options to our customers. On the other hand, we are likely to see heightened levels of capital expenditures during certain periods depending on the specific pace of our capital-intensive projects and rising material prices and increasing supply chain and labor expenses resulting from changes in global trade conditions and labor availability associated with the COVID-19 pandemic. Overall, we expect our ability to be self-funding to continue as long as macroeconomic factors support current trends in our sales. Operating Expense Trends As long as we see expanding sales, and excluding the potential impact of macroeconomic conditions including increased labor costs and impairment charges on certain assets as explained below, we generally expect operating expenses relative to revenues to decrease as we continue to increase operational efficiency and process automation. We expect operating expenses to continue to grow in 2023 as we are expanding our operations globally. In the first quarter of 2021, we invested an aggregate $1.50 billion in bitcoin. As with any investment and consistent with how we manage fiat-based cash and cash-equivalent accounts, we may increase or decrease our holdings of digital assets at any time based on the needs of the business and our view of market and environmental conditions. Digital assets are considered indefinite-lived intangible assets under applicable accounting rules. Accordingly, any decrease in their fair values below our carrying values for such assets at any time subsequent to their acquisition will require us to recognize impairment charges, whereas we may make no upward revisions for any market price increases until a sale. For any digital assets held now or in the future, these charges may negatively impact our profitability in the periods in which such impairments occur even if the overall market values of these assets increase. For example, in the year ended December 31, 2022, we recorded $204 million of impairment losses resulting from changes to the carrying value of our bitcoin and gains of $64 million on certain conversions of bitcoin into fiat currency by us. Critical Accounting Policies and Estimates The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”). The preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience, as appropriate, and on various other assumptions that we believe to be reasonable under the circumstances. Changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. We evaluate our estimates and assumptions on an ongoing basis. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows may be affected. The estimates used for, but not limited to, determining significant economic incentive for resale value guarantee arrangements, sales return reserves, the collectability of accounts and financing receivables, inventory valuation, warranties, fair value of long-lived assets, goodwill, fair value of financial instruments, fair value and residual value of operating lease vehicles and solar energy systems subject to leases could be impacted. We have assessed the impact and are not aware of any specific events or circumstances that required an update to our estimates and assumptions or materially affected the carrying value of our assets or liabilities as of the date of issuance of this Annual Report on Form 10-K. These estimates may change as new events occur and additional information is obtained. Actual results could differ materially from these estimates under different assumptions or conditions. 34 Revenue Recognition Automotive Sales Automotive sales revenue includes revenues related to cash and financing deliveries of new vehicles, and specific other features and services that meet the definition of a performance obligation under Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”), including access to our FSD features, internet connectivity, Supercharger network and over-the-air software updates. We recognize revenue on automotive sales upon delivery to the customer, which is when the control of a vehicle transfers. Payments are typically received at the point control transfers or in accordance with payment terms customary to the business, except sales we finance for which payments are collected over the contractual loan term. We also recognize a sales return reserve based on historical experience plus consideration for expected future market values, when we offer resale value guarantees or similar buyback terms. Other features and services such as access to our internet connectivity, legacy programs offering unlimited free Supercharging and over-the-air software updates are provisioned upon control transfer of a vehicle and recognized over time on a straight-line basis as we have a stand-ready obligation to deliver such services to the customer. Other limited free Supercharging incentives are recognized based on actual usage or expiration, whichever is earlier. We recognize revenue related to these other features and services over the performance period, which is generally the expected ownership life of the vehicle. Revenue related to FSD is recognized when functionality is delivered to the customer and the portion related to software updates is recognized over time. For our obligations related to automotive sales, we estimate standalone selling price by considering costs used to develop and deliver the service, third-party pricing of similar options and other information that may be available. Any fees that are paid or payable by us to a customer’s lender when we arrange the financing are recognized as an offset against automotive sales revenue. Costs to obtain a contract mainly relate to commissions paid to our sales personnel for the sale of vehicles. As our contract costs related to automotive sales are typically fulfilled within one year, the costs to obtain a contract are expensed as incurred. Amounts billed to customers related to shipping and handling are classified as automotive sales revenue, and we have elected to recognize the cost for freight and shipping when control over vehicles, parts or accessories have transferred to the customer as an expense in cost of automotive sales revenue. Our policy is to exclude taxes collected from a customer from the transaction price of automotive contracts. We offer resale value guarantees or similar buy-back terms to certain international customers who purchase vehicles and who finance their vehicles through one of our specified commercial banking partners. Under these programs, we receive full payment for the vehicle sales price at the time of delivery and our counterparty has the option of selling their vehicle back to us during the guarantee period, which currently is generally at the end of the term of the applicable loan or financing program, for a pre-determined resale value. We account for such automotive sales as a sale with a right of return when we do not believe the customer has a significant economic incentive to exercise the resale value guarantee provided to them at contract inception. The process to determine whether there is a significant economic incentive includes a comparison of a vehicle’s estimated market value at the time the option is exercisable with the guaranteed resale value to determine the customer’s economic incentive to exercise. On a quarterly basis, we assess the estimated market values of vehicles sold with resale value guarantees to determine whether there have been changes to the likelihood of future product returns. As we accumulate more data related to the resale values of our vehicles or as market conditions change, there may be material changes to their estimated values. Inventory Valuation Inventories are stated at the lower of cost or net realizable value. Cost is computed using standard cost for vehicles and energy products, which approximates actual cost on a first-in, first-out basis. We record inventory write-downs for excess or obsolete inventories based upon assumptions about current and future demand forecasts. If our inventory on-hand is in excess of our future demand forecast, the excess amounts are written-off. We also review our inventory to determine whether its carrying value exceeds the net amount realizable upon the ultimate sale of the inventory. This requires us to determine the estimated selling price of our vehicles less the estimated cost to convert the inventory on-hand into a finished product. Once inventory is written-down, a new, lower cost basis for that inventory is established and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Should our estimates of future selling prices or production costs change, additional and potentially material write-downs may be required. A small change in our estimates may result in a material charge to our reported financial results. 35 Warranties We provide a manufacturer’s warranty on all new and used vehicles and a warranty on the installation and components of the energy generation and storage systems we sell for periods typically between 10 to 25 years. We accrue a warranty reserve for the products sold by us, which includes our best estimate of the projected costs to repair or replace items under warranties and recalls if identified. These estimates are based on actual claims incurred to date and an estimate of the nature, frequency and costs of future claims. These estimates are inherently uncertain given our relatively short history of sales, and changes to our historical or projected warranty experience may cause material changes to the warranty reserve in the future. The warranty reserve does not include projected warranty costs associated with our vehicles subject to operating lease accounting and our solar energy systems under lease contracts or PPAs, as the costs to repair these warranty claims are expensed as incurred. The portion of the warranty reserve expected to be incurred within the next 12 months is included within Accrued liabilities and other, while the remaining balance is included within Other long-term liabilities on the consolidated balance sheets. Warranty expense is recorded as a component of Cost of revenues in the consolidated statements of operations. Due to the magnitude of our automotive business, accrued warranty balance is primarily related to our automotive segment. Stock-Based Compensation We use the fair value method of accounting for our stock options and restricted stock units (“RSUs”) granted to employees and for our employee stock purchase plan (the “ESPP”) to measure the cost of employee services received in exchange for the stock-based awards. The fair value of stock option awards with only service and/or performance conditions is estimated on the grant or offering date using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model requires inputs such as the risk-free interest rate, expected term and expected volatility. These inputs are subjective and generally require significant judgment. The fair value of RSUs is measured on the grant date based on the closing fair market value of our common stock. The resulting cost is recognized over the period during which an employee is required to provide service in exchange for the awards, usually the vesting period, which is generally four years for stock options and RSUs and six months for the ESPP. Stock-based compensation expense is recognized on a straight-line basis, net of actual forfeitures in the period. For performance-based awards, stock-based compensation expense is recognized over the expected performance achievement period of individual performance milestones when the achievement of each individual performance milestone becomes probable. As we accumulate additional employee stock-based awards data over time and as we incorporate market data related to our common stock, we may calculate significantly different volatilities and expected lives, which could materially impact the valuation of our stock-based awards and the stock-based compensation expense that we will recognize in future periods. Stock-based compensation expense is recorded in Cost of revenues, Research and development expense and Selling, general and administrative expense in the consolidated statements of operations. Income Taxes We are subject to taxes in the U.S. and in many foreign jurisdictions. Significant judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We make these estimates and judgments about our future taxable income that are based on assumptions that are consistent with our future plans. Tax laws, regulations and administrative practices may be subject to change due to economic or political conditions including fundamental changes to the tax laws applicable to corporate multinationals. The U.S., many countries in the European Union and a number of other countries are actively considering changes in this regard. As of December 31, 2022, we had recorded a full valuation allowance on our net U.S. deferred tax assets because we expect that it is more likely than not that our U.S. deferred tax assets will not be realized. Should the actual amounts differ from our estimates, the amount of our valuation allowance could be materially impacted. Furthermore, significant judgment is required in evaluating our tax positions. In the ordinary course of business, there are many transactions and calculations for which the ultimate tax settlement is uncertain. As a result, we recognize the effect of this uncertainty on our tax attributes or taxes payable based on our estimates of the eventual outcome. These effects are recognized when, despite our belief that our tax return positions are supportable, we believe that it is more likely than not that some of those positions may not be fully sustained upon review by tax authorities. We are required to file income tax returns in the U.S. and various foreign jurisdictions, which requires us to interpret the applicable tax laws and regulations in effect in such jurisdictions. Such returns are subject to audit by the various federal, state and foreign taxing authorities, who may disagree with respect to our tax positions. We believe that our consideration is adequate for all open audit years based on our assessment of many factors, including past experience and interpretations of tax law. We review and update our estimates in light of changing facts and circumstances, such as the closing of a tax audit, the lapse of a statute of limitations or a change in estimate. To the extent that the final tax outcome of these matters differs from our expectations, such differences may impact income tax expense in the period in which such determination is made. The eventual impact on our income tax expense depends in part if we still have a valuation allowance recorded against our deferred tax assets in the period that such determination is made. 36 Results of Operations Revenues Year Ended December 31, 2022 vs. 2021 Change 2021 vs. 2020 Change (Dollars in millions) 2022 2021 2020 $ % $ % Automotive sales $ 67,210 $ 44,125 $ 24,604 $ 23,085 52 % $ 19,521 79 % Automotive regulatory credits 1,776 1,465 1,580 311 21 % (115 ) (7 )% Automotive leasing 2,476 1,642 1,052 834 51 % 590 56 % Total automotive revenues 71,462 47,232 27,236 24,230 51 % 19,996 73 % Services and other 6,091 3,802 2,306 2,289 60 % 1,496 65 % Total automotive & services and other segment revenue 77,553 51,034 29,542 26,519 52 % 21,492 73 % Energy generation and storage segment revenue 3,909 2,789 1,994 1,120 40 % 795 40 % Total revenues $ 81,462 $ 53,823 $ 31,536 $ 27,639 51 % $ 22,287 71 % Automotive & Services and Other Segment Automotive sales revenue includes revenues related to cash and financing deliveries of new Model S, Model X, Semi, Model 3, and Model Y vehicles, including access to our FSD features, internet connectivity, free Supercharging programs and over-the-air software updates. These deliveries are vehicles that are not subject to lease accounting. Automotive regulatory credits includes sales of regulatory credits to other automotive manufacturers. Our revenue from automotive regulatory credits is directly related to our new vehicle production, sales and pricing negotiated with our customers. We monetize them proactively as new vehicles are sold based on standing arrangements with buyers of such credits, typically as close as possible to the production and delivery of the vehicle or changes in regulation impacting the credits. Automotive leasing revenue includes the amortization of revenue for vehicles under direct operating lease agreements. Additionally, automotive leasing revenue includes direct sales-type leasing programs where we recognize all revenue associated with the sales-type lease upon delivery to the customer. Services and other revenue consists of non-warranty after-sales vehicle services and parts, paid Supercharging, sales of used vehicles, retail merchandise and vehicle insurance revenue. 2022 compared to 2021 Automotive sales revenue increased $23.09 billion, or 52%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily due to an increase of 347,024 Model 3 and Model Y deliveries, and an increase of 38,183 Model S and Model X deliveries year over year. This was achieved from production ramping of Model Y at Gigafactory Shanghai and the Fremont Factory as well as the start of production at Gigafactory Berlin-Brandenburg and Gigafactory Texas in 2022, at a higher combined average selling price from a higher proportion of Model Y sales despite a negative impact from the United States dollar strengthening against other foreign currencies in 2022 compared to the prior period. There was also an increase in production of Model S and Model X and an increase in the combined average selling price of Model S and Model X with a higher proportion of Model X sales, compared to the prior period as deliveries of the new versions of Model S and Model X began ramping in the second and fourth quarters of 2021, respectively. Further, during the fourth quarter of 2022, we recognized $324 million in revenue related to the general FSD feature release in North America. Automotive regulatory credits revenue increased $311 million, or 21%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily due to changes in regulation which entitled us to additional consideration of $288 million in revenue in the first quarter of 2022 for credits sold previously, in the absence of which we had only an immaterial increase in automotive regulatory credits revenue. Automotive leasing revenue increased $834 million, or 51%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021. The change is primarily due to an increase in activities under our direct operating lease program as well as an increase in direct sales-type leasing revenue. Services and other revenue increased $2.29 billion, or 60%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021. The change is primarily due to increase in used vehicle revenue driven by increases in volume and average selling prices of used Tesla and non-Tesla vehicles, non-warranty maintenance services revenue as our fleet continues to grow, paid Supercharging revenue, insurance services revenue and retail merchandise revenue. 37 Energy Generation and Storage Segment Energy generation and storage revenue includes sales and leasing of solar energy generation and energy storage products, financing of solar energy generation products, services related to such products and sales of solar energy systems incentives. 2022 compared to 2021 Energy generation and storage revenue increased $1.12 billion, or 40%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily due to an increase in energy storage deployments of Megapack, Powerwall and higher average selling price of Megapack, as well as on solar cash and loan deployments driven by price increases in 2022. Cost of Revenues and Gross Margin Year Ended December 31, 2022 vs. 2021 Change 2021 vs. 2020 Change (Dollars in millions) 2022 2021 2020 $ % $ % Cost of revenues Automotive sales $ 49,599 $ 32,415 $ 19,696 $ 17,184 53 % $ 12,719 65 % Automotive leasing 1,509 978 563 531 54 % 415 74 % Total automotive cost of revenues 51,108 33,393 20,259 17,715 53 % 13,134 65 % Services and other 5,880 3,906 2,671 1,974 51 % 1,235 46 % Total automotive & services and other segment cost of revenues 56,988 37,299 22,930 19,689 53 % 14,369 63 % Energy generation and storage segment 3,621 2,918 1,976 703 24 % 942 48 % Total cost of revenues $ 60,609 $ 40,217 $ 24,906 $ 20,392 51 % $ 15,311 61 % Gross profit total automotive $ 20,354 $ 13,839 $ 6,977 Gross margin total automotive 28.5 % 29.3 % 25.6 % Gross profit total automotive & services and other segment $ 20,565 $ 13,735 $ 6,612 Gross margin total automotive & services and other segment 26.5 % 26.9 % 22.4 % Gross profit energy generation and storage segment $ 288 $ (129 ) $ 18 Gross margin energy generation and storage segment 7.4 % (4.6 )% 0.9 % Total gross profit $ 20,853 $ 13,606 $ 6,630 Total gross margin 25.6 % 25.3 % 21.0 % Automotive & Services and Other Segment Cost of automotive sales revenue includes direct and indirect materials, labor costs, manufacturing overhead, including depreciation costs of tooling and machinery, shipping and logistic costs, vehicle connectivity costs, allocations of electricity and infrastructure costs related to our free Supercharging programs and reserves for estimated warranty expenses. Cost of automotive sales revenues also includes adjustments to warranty expense and charges to write down the carrying value of our inventory when it exceeds its estimated net realizable value and to provide for obsolete and on-hand inventory in excess of forecasted demand. Cost of automotive leasing revenue includes the depreciation of operating lease vehicles, cost of goods sold associated with direct sales-type leases and warranty expense related to leased vehicles. Cost of automotive leasing revenue also includes vehicle connectivity costs and allocations of electricity and infrastructure costs related to our Supercharger network for vehicles under our leasing programs. Cost of services and other revenue includes costs associated with providing non-warranty after-sales services and parts, costs of paid Supercharging, cost of used vehicles including refurbishment costs, costs for retail merchandise, and costs to provide vehicle insurance. 38 2022 compared to 2021 Cost of automotive sales revenue increased $17.18 billion, or 53%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021, in line with the growth in revenue year over year, as discussed above. The average combined cost per unit of Model 3 and Model Y increased year over year due to rising raw material, logistics and warranty costs. There were also idle capacity charges of $306 million primarily related to the temporary suspension of production at Gigafactory Shanghai as well as the ramping up of production in Gigafactory Texas and our proprietary battery cells manufacturing during the year ended December 31, 2022. We had also incurred costs related to the ramp up of production in Gigafactory Berlin-Brandenburg during the year ended December 31, 2022. These increases were partially offset by a decrease in combined average Model S and Model X costs per unit driven by lower average cost for the new versions from ramping up production. Further, these increases in costs of revenue were positively impacted by the United States dollar strengthening against other foreign currencies in 2022 compared to the prior period. Cost of automotive leasing revenue increased $531 million, or 54%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily due to an increase in cumulative vehicles under our direct operating lease program and an increase in direct sales-type leasing cost of revenues from more activities in the current year. Cost of services and other revenue increased $1.97 billion, or 51%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021. The change is primarily due to an increase in used vehicle cost of revenue driven by increases in volume and costs of used Tesla and non-Tesla vehicle sales, an increase in non-warranty maintenance service revenue, and an increase in costs of paid Supercharging, insurance services and retail merchandise. Gross margin for total automotive decreased from 29.3% to 28.5% in the year ended December 31, 2022 as compared to the year ended December 31, 2021. This was driven by the changes in automotive sales revenue and cost of automotive sales revenue, partially offset by an increase in regulatory credits revenue, as discussed earlier. Gross margin for total automotive & services and other segment decreased from 26.9% to 26.5% in the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily due to the automotive gross margin decrease discussed above, partially offset by an improvement in our services and other gross margin. Additionally, services and other was a higher percentage of the segment gross margin during the year ended 2022 as compared to the prior year. Energy Generation and Storage Segment Cost of energy generation and storage revenue includes direct and indirect material and labor costs, warehouse rent, freight, warranty expense, other overhead costs and amortization of certain acquired intangible assets. Cost of energy generation and storage revenue also includes charges to write down the carrying value of our inventory when it exceeds its estimated net realizable value and to provide for obsolete and on-hand inventory in excess of forecasted demand. In agreements for solar energy system and PPAs where we are the lessor, the cost of revenue is primarily comprised of depreciation of the cost of leased solar energy systems, maintenance costs associated with those systems and amortization of any initial direct costs. 2022 compared to 2021 Cost of energy generation and storage revenue increased $703 million, or 24%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily due to increases in energy storage deployments of Megapack and Powerwall, as well as higher average cost of solar cash and loan deployments due to increased component costs. Gross margin for energy generation and storage increased from -4.6% to 7.4% in the year ended December 31, 2022 as compared to the year ended December 31, 2021. This was driven by the growth in energy generation and storage revenue and cost of energy generation and storage revenue as discussed above. Additionally, there was a higher proportion of energy storage sales, which operated at a higher gross margin, within the segment. 39 Research and Development Expense Year Ended December 31, 2022 vs. 2021 Change 2021 vs. 2020 Change (Dollars in millions) 2022 2021 2020 $ % $ % Research and development $ 3,075 $ 2,593 $ 1,491 $ 482 19 % $ 1,102 74 % As a percentage of revenues 4 % 5 % 5 % Research and development (“R&D”) expenses consist primarily of personnel costs for our teams in engineering and research, manufacturing engineering and manufacturing test organizations, prototyping expense, contract and professional services and amortized equipment expense. R&D expenses increased $482 million, or 19%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021. The increase was primarily due to a $175 million increase in employee and labor related expenses, a $132 million increase in facilities, outside services, freight and depreciation expense, a $101 million increase in R&D expensed materials and an $87 million increase in stock-based compensation expense. These increases were to support our expanding product roadmap and technologies including our proprietary battery cells. Further, there were additional R&D expenses in the first quarter of 2022 as we were in the pre-production phase at Gigafactory Texas and started production at Gigafactory Berlin-Brandenburg only closer to the end of the first quarter of 2022. R&D expenses as a percentage of revenue decreased from 5% to 4% in the year ended December 31, 2022 as compared to the year ended December 31, 2021. Our R&D expenses have decreased as a proportion of total revenues despite expanding product roadmap and technologies. Selling, General and Administrative Expense Year Ended December 31, 2022 vs. 2021 Change 2021 vs. 2020 Change (Dollars in millions) 2022 2021 2020 $ % $ % Selling, general and administrative $ 3,946 $ 4,517 $ 3,145 $ (571 ) (13 )% $ 1,372 44 % As a percentage of revenues 5 % 8 % 10 % Selling, general and administrative (“SG&A”) expenses generally consist of personnel and facilities costs related to our stores, marketing, sales, executive, finance, human resources, information technology and legal organizations, as well as fees for professional and contract services and litigation settlements. SG&A expenses decreased $571 million, or 13%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021. This is primarily due to a decrease of $822 million in stock-based compensation expense, most of which is attributable to the lower stock-based compensation expense of $844 million on the 2018 CEO Performance Award. This was partially offset by the overall growth in stock-based compensation due to increased headcount. See Note 13, Equity Incentive Plans, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. There was also a decrease of $87 million in overall employee and labor related expenses driven by a decrease of $340 million of additional payroll tax due to our CEO's option exercises from the 2012 CEO Performance Award in 2021, partially offset by an increase in other employee and labor costs from increased headcount. These decreases were partially offset by an increase of $222 million in facilities-related expenses, and an increase of $117 million in professional services, sales and marketing activities and other costs. SG&A expenses as a percentage of revenue decreased from 8% to 5% in the year ended December 31, 2022 as compared to the year ended December 31, 2021. Our SG&A expenses have decreased as a proportion of total revenues due to the decrease in expenses as discussed above, in addition to operational efficiencies. Restructuring and Other Expense Year Ended December 31, 2022 vs. 2021 Change 2021 vs. 2020 Change (Dollars in millions) 2022 2021 2020 $ % $ % Restructuring and other $ 176 $ (27 ) $ — $ 203 Not meaningful $ (27 ) Not meaningful During the years ended December 31, 2022 and 2021, we recorded $204 million and $101 million, respectively, of impairment losses on digital assets, respectively. During the years ended December 31, 2022 and 2021, we also realized gains of $64 million and $128 million, respectively, in connection with converting our holdings of digital assets into fiat currency. See Note 3, Digital Assets, Net, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details. Additionally, we recorded other expenses of $36 million during the second quarter of the year ended December 31, 2022, related to employee terminations. 40 Interest Income Year Ended December 31, 2022 vs. 2021 Change 2021 vs. 2020 Change (Dollars in millions) 2022 2021 2020 $ % $ % Interest income $ 297 $ 56 $ 30 $ 241 430 % $ 26 87 % Interest income increased $241 million, or 430%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021. This increase was primarily due to higher interest earned on our cash and cash equivalents and short-term investments during the year ended 2022 compared to the prior period. This was driven by an increase in our average cash and cash equivalents and short-term investments balance and rising interest rates. Interest Expense Year Ended December 31, 2022 vs. 2021 Change 2021 vs. 2020 Change (Dollars in millions) 2022 2021 2020 $ % $ % Interest expense $ (191 ) $ (371 ) $ (748 ) $ 180 (49 )% $ 377 (50 )% Interest expense decreased $180 million, or 49%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021. This decrease was primarily due to the continued reduction in our overall debt balance offset by lower capitalized interest. See Note 11, Debt, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details. Other (Expense) Income, Net Year Ended December 31, 2022 vs. 2021 Change 2021 vs. 2020 Change (Dollars in millions) 2022 2021 2020 $ % $ % Other (expense) income, net $ (43 ) $ 135 $ (122 ) $ (178 ) Not meaningful $ 257 Not meaningful Other (expense) income, net, consists primarily of foreign exchange gains and losses related to our foreign currency-denominated monetary assets and liabilities. We expect our foreign exchange gains and losses will vary depending upon movements in the underlying exchange rates. Other (expense) income, net, changed unfavorably by $178 million in the year ended December 31, 2022 as compared to the year ended December 31, 2021. The change is primarily due to fluctuations in foreign currency exchange rates. Provision for Income Taxes Year Ended December 31, 2022 vs. 2021 Change 2021 vs. 2020 Change (Dollars in millions) 2022 2021 2020 $ % $ % Provision for income taxes $ 1,132 $ 699 $ 292 $ 433 62 % $ 407 139 % Effective tax rate 8 % 11 % 25 % Our provision for income taxes increased by $433 million, or 62%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily due to the increase in our pre-tax income year over year. Our effective tax rate decreased from 11% to 8% in the year ended December 31, 2022 as compared to the year ended December 31, 2021, primarily due to changes in mix of jurisdictional earnings. See Note 14, Income Taxes, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details. Net Income Attributable to Noncontrolling Interests and Redeemable Noncontrolling Interests Year Ended December 31, 2022 vs. 2021 Change 2021 vs. 2020 Change (Dollars in millions) 2022 2021 2020 $ % $ % Net income attributable to noncontrolling interests and redeemable noncontrolling interests in subsidiaries $ 31 $ 125 $ 141 $ (94 ) (75 )% $ (16 ) (11 )% 41 Net income attributable to noncontrolling interests and redeemable noncontrolling interests decreased by $94 million, or 75%, in the year ended December 31, 2022 as compared to the year ended December 31, 2021. These changes were due to a decrease in allocations to financing fund investors. Liquidity and Capital Resources We expect to continue to generate net positive operating cash flow as we have done in the last four fiscal years. The cash we generate from our core operations enables us to fund ongoing operations and production, our research and development projects for new products and technologies including our proprietary battery cells, additional manufacturing ramps at existing manufacturing facilities such as the Fremont Factory, Gigafactory Nevada, Gigafactory Shanghai and Gigafactory New York, the ramp of Gigafactory Berlin-Brandenburg and Gigafactory Texas and the continued expansion of our retail and service locations, body shops, Mobile Service fleet, Supercharger network and energy product installation capabilities. In addition, because a large portion of our future expenditures will be to fund our growth, we expect that if needed we will be able to adjust our capital and operating expenditures by operating segment. For example, if our near-term manufacturing operations decrease in scale or ramp more slowly than expected, including due to global economic or business conditions, we may choose to correspondingly slow the pace of our capital expenditures. Finally, we continually evaluate our cash needs and may decide it is best to raise additional capital or seek alternative financing sources to fund the rapid growth of our business, including through drawdowns on existing or new debt facilities or financing funds. Conversely, we may also from time to time determine that it is in our best interests to voluntarily repay certain indebtedness early. Accordingly, we believe that our current sources of funds will provide us with adequate liquidity during the 12-month period following December 31, 2022, as well as in the long-term. See the sections below for more details regarding the material requirements for cash in our business and our sources of liquidity to meet such needs. Material Cash Requirements From time to time in the ordinary course of business, we enter into agreements with vendors for the purchase of components and raw materials to be used in the manufacture of our products. However, due to contractual terms, variability in the precise growth curves of our development and production ramps, and opportunities to renegotiate pricing, we generally do not have binding and enforceable purchase orders under such contracts beyond the short-term, and the timing and magnitude of purchase orders beyond such period is difficult to accurately project. As discussed in and subject to the considerations referenced in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations—Management Opportunities, Challenges and Risks and 2023 Outlook—Cash Flow and Capital Expenditure Trends in this Annual Report on Form 10-K, we currently expect our capital expenditures to support our projects globally to be between $6.00 to $8.00 billion in 2023 and between $7.00 to $9.00 billion in each of the following two fiscal years. In connection with our operations at Gigafactory New York, we have an agreement to spend or incur $5.00 billion in combined capital, operational expenses, costs of goods sold and other costs in the State of New York through December 31, 2029 (pursuant to a deferral of our required timelines to meet such obligations that was granted in April 2021, and which was memorialized in an amendment to our agreement with the SUNY Foundation in August 2021). We also have an operating lease arrangement with the local government of Shanghai pursuant to which we are required to spend RMB 14.08 billion in capital expenditures at Gigafactory Shanghai by the end of 2023. For details regarding these obligations, refer to Note 15, Commitments and Contingencies, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. As of December 31, 2022, we and our subsidiaries had outstanding $2.06 billion in aggregate principal amount of indebtedness, of which $1.02 billion is scheduled to become due in the succeeding 12 months. As of December 31, 2022, our total minimum lease payments was $4.28 billion, of which $1.14 billion is due in the succeeding 12 months. For details regarding our indebtedness and lease obligations, refer to Note 11, Debt, and Note 12, Leases, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Sources and Conditions of Liquidity Our sources to fund our material cash requirements are predominantly from our deliveries and servicing of new and used vehicles, sales and installations of our energy storage products and solar energy systems, proceeds from debt facilities and proceeds from equity offerings, when applicable. 42 As of December 31, 2022, we had $16.25 billion and $5.93 billion of cash and cash equivalents and short-term investments, respectively. Balances held in foreign currencies had a U.S. dollar equivalent of $3.42 billion and consisted primarily of Chinese yuan, euros and British pounds. In addition, we had $2.42 billion of unused committed amounts under our credit facilities as of December 31, 2022, which included $2.27 billion under our Credit Agreement which was terminated in January 2023. Certain of such unused committed amounts are subject to satisfying specified conditions prior to draw-down (such as pledging to our lenders sufficient amounts of qualified receivables, inventories, leased vehicles and our interests in those leases, solar energy systems and the associated customer contracts or various other assets). In January 2023, we entered into an unsecured revolving credit facility providing for a commitment of up to $5.0 billion. For details regarding our indebtedness, refer to Note 11, Debt, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. We continue adapting our strategy to meet our liquidity and risk objectives, such as investing in U.S. government and other investments, to do more vertical integration, expand our product roadmap and provide financing options to our customers. Summary of Cash Flows Year Ended December 31, (Dollars in millions) 2022 2021 2020 Net cash provided by operating activities $ 14,724 $ 11,497 $ 5,943 Net cash used in investing activities $ (11,973 ) $ (7,868 ) $ (3,132 ) Net cash (used in) provided by financing activities $ (3,527 ) $ (5,203 ) $ 9,973 Cash Flows from Operating Activities Our cash flows from operating activities are significantly affected by our cash investments to support the growth of our business in areas such as research and development and selling, general and administrative and working capital. Our operating cash inflows include cash from vehicle sales and related servicing, customer lease and financing payments, customer deposits, cash from sales of regulatory credits and energy generation and storage products. These cash inflows are offset by our payments to suppliers for production materials and parts used in our manufacturing process, operating expenses, operating lease payments and interest payments on our financings. Net cash provided by operating activities increased by $3.23 billion to $14.72 billion during the year ended December 31, 2022 from $11.50 billion during the year ended December 31, 2021. This increase was primarily due to the increase in net income excluding non-cash expenses, gains and losses of $7.65 billion, offset by the overall increase in net operating assets and liabilities of $4.43 billion. The increase in our net operating assets and liabilities was mainly driven by a larger increase of inventory in the year ended December 31, 2022 as compared to the year ended December 31, 2021, partially offset by a larger increase of accounts payable and accrued liabilities, to support the ramp up in production at our factories and larger increases in other non-current assets and prepaid expenses and other current assets. Additionally, the increase in our net operating assets and other liabilities was partially offset by a larger increase in other long-term liabilities as compared to the prior year. Cash Flows from Investing Activities Cash flows from investing activities and their variability across each period related primarily to capital expenditures, which were $7.16 billion for the year ended December 31, 2022 and $6.48 billion for the year ended December 31, 2021, mainly for the expansions of Gigafactory Texas, the Fremont Factory, Gigafactory Berlin-Brandenburg, and Gigafactory Shanghai. We also purchased $5.84 billion of investments in the year ended December 31, 2022. Additionally, cash inflows related to sales of digital assets were $936 million in the year ended December 31, 2022, and net cash outflows related to digital assets were $1.23 billion in the year ended December 31, 2021 from purchases of digital assets for $1.50 billion offset by proceeds from sales of digital assets of $272 million. Cash Flows from Financing Activities Net cash used in financing activities decreased by $1.68 billion to $3.53 billion during the year ended December 31, 2022 from $5.20 billion during the year ended December 31, 2021. The decrease was primarily due to a $1.92 billion decrease in repayments of convertible and other debt, net of proceeds from issuances of debt. See Note 11, Debt, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details regarding our debt obligations. Recent Accounting Pronouncements See Note 2, Summary of Significant Accounting Policies, to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. 43 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Foreign Currency Risk We transact business globally in multiple currencies and hence have foreign currency risks related to our revenue, costs of revenue, operating expenses and localized subsidiary debt denominated in currencies other than the U.S. dollar (primarily the Chinese yuan, euro, pound sterling and Norwegian krone in relation to our current year operations). In general, we are a net receiver of currencies other than the U.S. dollar for our foreign subsidiaries. Accordingly, changes in exchange rates affect our revenue and other operating results as expressed in U.S. dollars as we do not typically hedge foreign currency risk. We have also experienced, and will continue to experience, fluctuations in our net income as a result of gains (losses) on the settlement and the re-measurement of monetary assets and liabilities denominated in currencies that are not the local currency (primarily consisting of our intercompany and cash and cash equivalents balances). We considered the historical trends in foreign currency exchange rates and determined that it is reasonably possible that adverse changes in foreign currency exchange rates of 10% for all currencies could be experienced in the near-term. These changes were applied to our total monetary assets and liabilities denominated in currencies other than our local currencies at the balance sheet date to compute the impact these changes would have had on our net income before income taxes. These changes would have resulted in a gain or loss of $473 million at December 31, 2022 and $277 million at December 31, 2021, assuming no foreign currency hedging. 44
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+Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed under Item 1A. Risk Factors in this Annual Report on Form 10-K. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Annual Report.This section discusses 2022 and 2021 significant items affecting our consolidated operating results, financial condition and liquidity and provides a year-to-year comparison between 2022 and 2021. Discussions of 2020 significant items and year-to-year comparisons between 2021 and 2020 have been excluded in this Form 10-K and can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for year ended December 31, 2021.OverviewOrganizationalTrane Technologies plc is a global climate innovator. We bring sustainable and efficient solutions to buildings, homes and transportation through our strategic brands, Trane® and Thermo King®, and our environmentally responsible portfolio of products, services and connected intelligent controls. 2030 Sustainability CommitmentsOur commitment to sustainability extends to the environmental and social impacts of our people, operations, products and services. We have announced ambitious 2030 Sustainability Commitments, including our Gigaton Challenge to reduce customers' carbon emissions by a billion metric tons. We are one of a handful of companies whose emissions reductions targets have been validated three times by the SBTi, and one of the very few companies worldwide whose net-zero targets have also been validated. We are Leading by Example as we make progress toward carbon-neutral operations and zero waste-to-landfill across our global footprint and net positive water use in water-stressed locations. Our Opportunity for All commitment focuses on gender parity in leadership, workforce diversity reflective of our communities, and a citizenship strategy that helps underserved communities through enhanced learning environments and pathways to green and Science, Technology, Engineering and Math (STEM) careers.Recent AcquisitionsOn October 31, 2022, we completed the acquisition of AL-KO Air Technology (AL-KO). AL-KO brings complementary, high-performing solutions to the comprehensive Trane Commercial HVAC product and services portfolios in Europe and Asia. The results of the acquisition are reported within the EMEA and Asia Pacific segments. On April 1, 2022, we completed a channel acquisition of a Commercial HVAC independent dealer to support our ongoing strategy to expand our distribution network and service area. The results of the channel acquisition are reported within the Americas segment. Significant EventsReorganization of Aldrich and MurrayOn June 18, 2020 (Petition Date), our indirect wholly-owned subsidiaries, Aldrich and Murray each filed a voluntary petition for reorganization under the Bankruptcy Code. As a result of the Chapter 11 filings, all asbestos-related lawsuits against Aldrich and Murray have been stayed due to the imposition of a statutory automatic stay applicable in Chapter 11 bankruptcy cases. Only Aldrich and Murray have filed for Chapter 11 relief. Neither Aldrich's wholly-owned subsidiary, 200 Park, Murray's wholly-owned subsidiary, ClimateLabs, nor the Trane Companies are part of the Chapter 11 filings. The goal of these Chapter 11 filings is to resolve equitably and permanently all current and future asbestos-related claims in a manner beneficial to claimants, Aldrich and Murray through court approval of a plan of reorganization that would create a trust pursuant to section 524(g) of the Bankruptcy Code, establish claims resolution procedures for all current and future asbestos-related claims against Aldrich and Murray and channel such claims to the trust for resolution in accordance with those procedures.Aldrich and its wholly-owned subsidiary 200 Park and Murray and its wholly-owned subsidiary ClimateLabs were deconsolidated as of the Petition Date and their respective assets and liabilities were derecognized from our Consolidated Financial Statements. 27Table of ContentsDuring the year ended December 31, 2021, in connection with the agreement in principle reached by Aldrich and Murray with the FCR and the motion filed on September 24, 2021 to create a $270.0 million "qualified settlement fund" within the meaning of the Treasury Regulations under Section 468B of the Internal Revenue Code (QSF), we recorded a charge of $21.2 million to increase our Funding Agreement liability to $270.0 million. The corresponding charge was bifurcated between Other income/ (expense), net of $7.2 million relating to Murray and discontinued operations of $14.0 million relating to Aldrich.On January 27, 2022, the Bankruptcy Court granted the request to fund the QSF, which was funded on March 2, 2022, resulting in an operating cash outflow of $270.0 million in our Consolidated Statement of Cash Flows, of which $91.8 million was allocated to continuing operations and $178.2 million was allocated to discontinued operations for the year ended December 31, 2022. At this point in the Chapter 11 cases of Aldrich and Murray, it is not possible to predict whether the Bankruptcy Court will approve the terms of the Plan, what the extent of the asbestos liability will be or how long the Chapter 11 cases will last. The Chapter 11 cases remain pending as of February 10, 2023.For detailed information on the bankruptcy cases of Aldrich and Murray, see Part I, Item 1, "Business - Asbestos-Related Matters," Part I, Item 1A, "Risk Factors - Risks Related to Litigation," Part I, Item 3, "Legal Proceedings," and Part II, Item 8, Consolidated Financial Statements, Note 1, "Description of Company," and Note 20, "Commitments and Contingencies."Trends and Economic EventsWe are a global corporation with worldwide operations. As a global business, our operations are affected by worldwide, regional and industry-specific economic factors as well as political and social factors wherever we operate or do business. Our geographic diversity and the breadth of our product and services portfolios have helped mitigate the impact of any one industry or the economy of any single country on our consolidated operating results. Given our broad range of products manufactured and geographic markets served, management uses a variety of factors to predict the outlook for the Company. We monitor key competitors and customers in order to gauge relative performance and the outlook for the future. We regularly perform detailed evaluations of the different market segments we are serving to proactively detect trends and to adapt our strategies accordingly, including potential triggers and actions to be taken under recessionary scenarios. In addition, we believe our backlog and order levels are indicative of future revenue and thus are a key measure of anticipated performance.Current economic conditions remain mixed across our end markets. The COVID-19 global pandemic continues to impact both the global Heating, Ventilation and Air Conditioning (HVAC) and Transport end markets as disruptions and delays in the global supply chain and resource constraints continue to be experienced. However, despite these challenges, overall end market demand remained healthy as we continued to proactively manage global supply chain and resource constraints by working closely with our suppliers, customers and logistics providers to mitigate the impacts on our business as we continue to sell, install and service our products.We expect market conditions to remain mixed across the geographies where we serve our customers as the impact from COVID-19 eases; however, macroeconomic events including the material cost, wage and energy inflation and tightening financial conditions, as a result of higher interest rates, could increase the likelihood of deteriorating economic conditions which could have a negative impact on our business. The extent to which the COVID-19 pandemic and other macro economic conditions continue to impact the Company's results of operations and financial condition will depend on future developments that are highly uncertain and cannot be predicted. See Part I, Item 1A, "Risk Factors - Risks Related to Economic Conditions," for more information. Furthermore, when Russia invaded Ukraine in February 2022, we immediately halted new orders and shipments into and out of Russia and Belarus. As of December 31, 2022, we have exited all business activity within these markets. To date, the Russia-Ukraine war has not had a material adverse effect on our business or financial performance. See Part I, Item 1A Risk Factors for more information.We believe we have a solid foundation of global brands that are highly differentiated in all of our major product lines. Our geographic and product diversity coupled with our large installed product base provides growth opportunities within our service and corresponding parts and replacement revenue streams. In addition, we are investing substantial resources to innovate and develop new products and services which we expect will drive our future growth.28Table of ContentsResults of OperationsYear Ended December 31, 2022 Compared to the Year Ended December 31, 2021 - Consolidated ResultsDollar amounts in millions20222021Period Change2022 % of revenues2021 % of revenuesNet revenues$15,991.7 $14,136.4 $1,855.3 Cost of goods sold(11,026.9)(9,666.8)(1,360.1)69.0%68.4%Gross profit4,964.8 4,469.6 495.2 31.0%31.6%Selling and administrative expenses(2,545.9)(2,446.3)(99.6)15.9%17.3%Operating income2,418.9 2,023.3 395.6 15.1%14.3%Interest expense(223.5)(233.7)10.2 Other income/(expense), net(23.3)1.1 (24.4) Earnings before income taxes2,172.1 1,790.7 381.4 Provision for income taxes(375.9)(333.5)(42.4) Earnings from continuing operations1,796.2 1,457.2 339.0 Discontinued operations, net of tax(21.5)(20.6)(0.9) Net earnings$1,774.7 $1,436.6 $338.1 Net RevenuesNet revenues for the year ended December 31, 2022 increased by 13.1%, or $1,855.3 million, compared with the same period of 2021. The components of the period change were as follows:Pricing9.6 %Volume4.9 %Acquisitions0.8 %Currency translation(2.2)%Total13.1 %The increase in Net revenues was primarily driven by inflation-based price increases, end customer demand within all our reportable segments and incremental revenues from acquisitions, partially offset by an unfavorable impact from foreign currency translation. Pricing and volume increases were experienced in all segments. Refer to “Results by Segment” below for a discussion of Net revenues by segment.Gross Profit MarginGross profit margin for the year ended December 31, 2022 decreased 60 basis points to 31.0% compared to 31.6% for the same period of 2021 primarily due to significant direct material, freight and other inflation, and unfavorable impacts to productivity arising from supply chain, freight and logistics challenges, partially offset by inflation-based price increases. Selling and Administrative ExpensesSelling and administrative expenses for the year ended December 31, 2022 increased by 4.1%, or $99.6 million, compared with the same period of 2021. The increase in Selling and administrative expenses was primarily driven by an increase in human capital related costs as a result of investing in our people, travel costs and amortization due to acquisitions, partially offset by favorable non-cash adjustments to contingent consideration of $46.9 million.Selling and administrative expenses as a percentage of Net revenues for the year ended December 31, 2022 decreased 140 basis points from 17.3% to 15.9% primarily due to higher revenues year-over-year. Interest ExpenseInterest expense for the year ended December 31, 2022 decreased by 4.4% or $10.2 million compared with the same period of 2021 primarily due to the repayments of $125.0 million of 9.000% Debentures in August 2021 and $300.0 million of 2.900% Senior notes in February 2021.29Table of ContentsOther Income/(Expense), NetThe components of Other income/(expense), net, for the years ended December 31 were as follows:In millions20222021Interest income$9.2 $4.0 Foreign currency exchange loss(17.9)(10.7)Other components of net periodic benefit credit/(cost)(10.6)(1.6)Other activity, net(4.0)9.4 Other income/(expense), net$(23.3)$1.1 Other income /(expense), net includes the results from activities other than normal business operations such as interest income and foreign currency gains and losses on transactions that are denominated in a currency other than an entity’s functional currency. In addition, we include the components of net periodic benefit credit/(cost) for pension and post retirement obligations other than the service cost component. During the year ended December 31, 2022, we recorded a $15.0 million settlement charge for a compensation related payment to a retired executive within other components of net periodic benefit credit/(cost). Other activity, net primarily includes items associated with certain legal matters, as well as asbestos-related activities of Murray. During the year ended December 31, 2021, we recorded a gain of $12.8 million related to the release of a pension indemnification liability, partially offset by a charge of $7.2 million to increase our Funding Agreement liability from asbestos-related activities of Murray.Provision for Income TaxesThe 2022 effective tax rate was 17.3% which was lower than the U.S. Statutory rate of 21% due to a $48.2 million reduction in valuation allowances primarily related to certain net state deferred tax assets resulting from U.S. legal entity restructurings and deferred tax assets associated with foreign tax credits as a result of an increase in the current year amount of creditable foreign source income. Additional tax benefits included in this year's effective rate are $12.4 million, net related to the current year's effects of a prepayment of an intercompany obligation in 2021, excess tax benefits from employee share-based payments and earnings in non-U.S. jurisdictions, which in aggregate have a lower effective tax rate. These amounts were partially offset by U.S. state and local taxes and certain non-deductible employee expenses. Revenues from non-U.S. jurisdictions accounted for approximately 28% of our total 2022 revenues, such that a material portion of our pretax income was earned and taxed outside the U.S. at rates ranging from 0% to 38%. When comparing the results of multiple reporting periods, among other factors, the mix of earnings between U.S. and foreign jurisdictions can cause variability in our overall effective tax rate.The 2021 effective tax rate was 18.6% which was lower than the U.S. Statutory rate of 21% due to a $21.4 million reduction in valuation allowances on deferred tax assets primarily related to foreign tax credits as a result of an increase in current year foreign source income, excess tax benefits from employee share-based payments, and earnings in non-U.S. jurisdictions, which in aggregate have a lower effective tax rate. These amounts were partially offset by the recognition of a net $11.6 million tax expense related to a prepayment of an intercompany obligation, U.S. state and local taxes and certain non-deductible employee expenses. Revenues from non-U.S. jurisdictions accounted for approximately 29.0% of our total 2021 revenues, such that a material portion of our pretax income was earned and taxed outside the U.S. at rates ranging from 0% to 38%. When comparing the results of multiple reporting periods, among other factors, the mix of earnings between U.S. and foreign jurisdictions can cause variability in our overall effective tax rate.Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021 - Segment ResultsWe operate under four regional operating segments designed to create deep customer focus and relevance in markets around the world. The Company determined that its two Europe, Middle East and Africa (EMEA) operating segments meet the aggregation criteria based on similar operating and economic characteristics, resulting in one reportable segment. Therefore, the Company has three regional reportable segments, Americas, EMEA and Asia Pacific.•Our Americas segment innovates for customers in North America and Latin America. The Americas segment encompasses commercial heating, cooling and ventilation systems, building controls, and energy services and solutions; residential heating and cooling; and transport refrigeration systems and solutions.•Our EMEA segment innovates for customers in the Europe, Middle East and Africa region. The EMEA segment encompasses heating, cooling and ventilation systems, services and solutions for commercial buildings, and transport refrigeration systems and solutions. •Our Asia Pacific segment innovates for customers throughout the Asia Pacific region. The Asia Pacific segment encompasses heating, cooling and ventilation systems, services and solutions for commercial buildings and transport refrigeration systems and solutions.30Table of ContentsManagement measures segment operating performance based on net earnings excluding interest expense, income taxes, depreciation and amortization, restructuring, non-cash adjustments for contingent consideration, insurance settlement on property claim in Q3 2022, merger and acquisition-related costs, unallocated corporate expenses and discontinued operations (Segment Adjusted EBITDA). Segment Adjusted EBITDA is not defined under accounting principles generally accepted in the United States of America (GAAP) and may not be comparable to similarly-titled measures used by other companies and should not be considered a substitute for net earnings or other results reported in accordance with GAAP. We believe Segment Adjusted EBITDA provides the most relevant measure of profitability as well as earnings power and the ability to generate cash. This measure is a useful financial metric to assess our operating performance from period to period by excluding certain items that we believe are not representative of our core business and we use this measure for business planning purposes. Segment Adjusted EBITDA also provides a useful tool for assessing the comparability between periods and our ability to generate cash from operations sufficient to pay taxes, to service debt and to undertake capital expenditures because it eliminates non-cash charges such as depreciation and amortization expense. The following discussion compares our results for each of our three reportable segments for the year ended December 31, 2022 compared to the year ended December 31, 2021.Dollar amounts in millions20222021% ChangeAmericasNet revenues$12,640.8 $10,957.1 15.4 %Segment Adjusted EBITDA2,326.3 2,008.8 15.8 %Segment Adjusted EBITDA as a percentage of net revenues18.4 %18.3 %EMEANet revenues$2,034.5 $1,944.9 4.6 %Segment Adjusted EBITDA338.1 359.2 (5.9)%Segment Adjusted EBITDA as a percentage of net revenues16.6 %18.5 %Asia PacificNet revenues$1,316.4 $1,234.4 6.6 %Segment Adjusted EBITDA248.3 228.5 8.7 %Segment Adjusted EBITDA as a percentage of net revenues18.9 %18.5 %Total Net revenues$15,991.7 $14,136.4 13.1 %Total Segment Adjusted EBITDA2,912.7 2,596.5 12.2 %Total Segment Adjusted EBITDA as a percentage of net revenues18.2 %18.4 %31Table of ContentsAmericasNet revenues for the year ended December 31, 2022 increased by 15.4% or $1,683.7 million, compared with the same period of 2021. The components of the period change were as follows:Pricing10.7 %Volume4.2 %Acquisitions0.7 %Currency translation(0.2)%Total15.4 %The increase in Net revenues was primarily driven by inflation-based price increases, higher volumes driven by increased end-customer demand and incremental revenues from acquisitions.Segment Adjusted EBITDA margin for the year ended December 31, 2022 increased by 10 basis points to 18.4% compared to 18.3% for the same period of 2021 primarily due to favorable pricing, volume and productivity largely offset by higher material costs, other inflation and higher costs to serve customers arising from supply chain, freight and logistics challenges. EMEANet revenues for the year ended December 31, 2022 increased by 4.6% or $89.6 million, compared with the same period of 2021. The components of the period change were as follows:Pricing7.1 %Volume7.4 %Acquisitions1.2 %Currency translation(11.1)%Total4.6 %The increase in Net revenues was primarily driven by higher volumes driven by increased end-customer demand, inflation-based price increases and incremental revenues from acquisitions, partially offset by the unfavorable currency translation. Excluding the impact of foreign currency translation and acquisitions, Net revenues increased by 14.5% Segment Adjusted EBITDA margin for the year ended December 31, 2022 decreased by 190 basis points to 16.6% compared to 18.5% for the same period of 2021 primarily due to favorable pricing, volume and productivity, more than offset by higher material costs, other inflation and higher costs to serve customers arising from supply chain, freight and logistics challenges. Asia PacificNet revenues for the year ended December 31, 2022 increased by 6.6% or $82.0 million, compared with the same period of 2021. The components of the period change were as follows:Pricing3.4 %Volume8.4 %Acquisitions0.7 %Currency translation(5.9)%Total6.6 %The increase in Net revenues was primarily driven by higher volumes related to increased end-customer demand. Inflation-based price increases and incremental revenues from acquisitions were partially offset by an unfavorable impact from foreign currency translation. Excluding the impact of foreign currency translation and acquisitions, Net revenues increased by 11.8%. Segment Adjusted EBITDA margin for the year ended December 31, 2022 increased by 40 basis points to 18.9% compared to 18.5% for the same period of 2021 primarily due to favorable pricing, volume and productivity, partially offset by higher material costs, other inflation and higher costs to serve customers arising from supply chain, freight and logistics challenges. 32Table of ContentsLiquidity and Capital ResourcesWe assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. In doing so, we review and analyze our current cash on hand, the number of days our sales are outstanding, inventory turns, capital expenditure commitments and income tax payments. Our cash requirements primarily consist of the following:•Funding of working capital•Debt service requirements•Funding of capital expenditures•Dividend payments•Funding of acquisitions, joint ventures and equity investments•Share repurchasesOur primary sources of liquidity include cash balances on hand, cash flows from operations, proceeds from debt offerings, commercial paper, and borrowing availability under our existing credit facilities. We earn a significant amount of our operating income in jurisdictions where it is deemed to be permanently reinvested. Our most prominent jurisdiction of operation is the U.S. We expect existing cash and cash equivalents available to the U.S. operations, the cash generated by our U.S. operations, our committed credit lines as well as our expected ability to access the capital and debt markets will be sufficient to fund our U.S. operating and capital needs for at least the next twelve months and thereafter for the foreseeable future. In addition, we expect existing non-U.S. cash and cash equivalents and the cash generated by our non-U.S. operations will be sufficient to fund our non-U.S. operating and capital needs for at least the next twelve months and thereafter for the foreseeable future. The maximum aggregate amount of unsecured commercial paper notes available to be issued, on a private placement basis, under the commercial paper program is $2.0 billion, of which we had no outstanding balance as of December 31, 2022.As of December 31, 2022, we had $1,220.5 million of cash and cash equivalents on hand, of which $814.5 million was held by non-U.S. subsidiaries. Cash and cash equivalents held by our non-U.S. subsidiaries are generally available for use in our U.S. operations via intercompany loans, equity infusions or via distributions from direct or indirectly owned non-U.S. subsidiaries for which we do not assert permanent reinvestment. As a result of the Tax Cuts and Jobs Act in 2017, additional repatriation opportunities to access cash and cash equivalents held by non-U.S. subsidiaries have been created. In general, repatriation of cash to the U.S. can be completed with no significant incremental U.S. tax. However, to the extent that we repatriate funds from non-U.S. subsidiaries for which we assert permanent reinvestment to fund our U.S. operations, we would be required to accrue and pay applicable non-U.S. taxes. As of December 31, 2022, we currently have no plans to repatriate funds from subsidiaries for which we assert permanent reinvestment.Share repurchases are made from time to time in accordance with management's balanced capital allocation strategy, subject to market conditions and regulatory requirements. In February 2022, the Company's Board of Directors authorized the repurchase of up to $3.0 billion of its ordinary shares (2022 Authorization) upon the completion of its current share repurchase program of up to $2.0 billion of its ordinary shares which was authorized in 2021 (2021 Authorization). During the year ended December 31, 2022, we repurchased and canceled $1,200.0 million of ordinary shares leaving approximately $200 million remaining under the 2021 Authorization as of December 31, 2022.We expect to pay a competitive and growing dividend. Since the launch of Trane Technologies in March 2020, we have increased our quarterly share dividend by 26%, from $0.53 to $0.67 per ordinary share, or $2.12 to $2.68 per share annualized. All four 2022 quarterly dividends were paid during the year ended December 31, 2022. In February 2023, our Board of Directors declared an increase in our quarterly share dividend by 12%, from $0.67 to $0.75 per ordinary share, or $2.68 to $3.00 per share annualized starting in the first quarter of 2023. We continue to actively manage and strengthen our business portfolio to meet the current and future needs of our customers. We achieve this partly through engaging in research and development and sustaining activities and partly through acquisitions. Sustaining activities include costs incurred to reduce production costs, improve existing products, create custom solutions for customers and provide support to our manufacturing facilities. Our research and development and sustaining costs account for approximately two percent of annual Net revenues. Each year, we make investments in new product development and new technology innovation as they are key factors in achieving our strategic objectives as a leader in the climate sector. In addition, we make investments in technology and business for our operational sustainability programs. For example, during the year ended December 31, 2022, we invested in onsite solar energy generation systems at our Pueblo, Colorado and Monterrey, Mexico facilities to generate electricity to offset fossil based electricity purchased from the grid. We ramped up operations of the onsite solar system at our Zhongshan, China facility. Two key factories in China (Taicang and Zhongshan) recently entered into supply agreements to receive a significant quantity of electricity generated from 100 percent renewable sources. We also transitioned to a next generation refrigerant with low global warming potential (GWP) for transport equipment manufactured at our Arecibo, Puerto Rico facility and are actively working to transition to low GWP refrigerant on our first commercial product at our Pueblo, Colorado factory. We also completed a major step to decarbonize our Charmes, France facility by shifting from a natural gas fueled hot water heating system to Trane Technologies’ latest heat pump system. This project is a dual benefit of 33Table of Contentsreducing Scope 1 carbon and serving as a heat pump system showcase for our customer engagement. These actions represent important steps to reduce our Scope 1 and Scope 2 carbon emissions and improve our customer’s carbon performance over the operating life of Trane Technologies’ cooling equipment. Furthermore, during the year ended December 31, 2022, we also completed implementation of processing equipment for our Tyler, Texas facility to fully achieve zero waste to landfill. These Leading by Example successes did not result in material expenditures for the year ended December 31, 2022. In pursuing our business strategy, we routinely conduct discussions, evaluate targets and enter into agreements regarding possible acquisitions, divestitures, joint ventures and equity investments. Since 2020, we acquired several businesses, entered into joint ventures and invested in companies that complement existing products and services further enhancing our product portfolio. During the years ended December 31, 2022 and December 31, 2021, we deployed capital of approximately $256 million and $340 million, respectively attributable to acquisitions and equity investments. We incur costs associated with restructuring initiatives intended to result in improved operating performance, profitability and working capital levels. Actions associated with these initiatives may include workforce reductions, improving manufacturing productivity, realignment of management structures and rationalizing certain assets. Post separation, we have reduced costs by approximately $240 million through December 31, 2022 and expect to reduce costs by an additional $60 million by 2023 for a total of $300 million in total annual savings under our transformation initiatives. In order to achieve these cost savings, we anticipate to incur costs up to $150 million through 2023. We have incurred approximately $130 million of costs cumulatively through December 31, 2022. We believe that our existing cash flow, committed credit lines and access to the capital markets will be sufficient to fund share repurchases, dividends, research and development, sustaining activities, business portfolio changes and ongoing restructuring actions.Certain of our subsidiaries entered into Funding Agreements with Aldrich and Murray pursuant to which those subsidiaries are obligated, among other things, to pay the costs and expenses of Aldrich and Murray during the pendency of the Chapter 11 cases to the extent distributions from their respective subsidiaries are insufficient to do so and to provide an amount for the funding for a trust established pursuant to section 524(g) of the Bankruptcy Code, to the extent that the other assets of Aldrich and Murray are insufficient to provide the requisite trust funding. During the third quarter of 2021, Aldrich and Murray filed a motion with the Bankruptcy Court to create a $270.0 million QSF. The funds held in the QSF would be available to provide funding for the Section 524(g) Trust upon effectiveness of the Plan. On January 27, 2022, the Bankruptcy Court granted the request to fund the QSF, which was funded on March 2, 2022. As the COVID-19 global pandemic impacts both the broader economy and our operations, we will continue to assess our liquidity needs and our ability to access capital markets. A continued worldwide disruption could materially affect economies and financial markets worldwide, resulting in an economic downturn that could affect demand for our products, our ability to obtain financing on favorable terms and otherwise adversely impact our business, financial condition and results of operations. See Part I, Item 1A, "Risk Factors - Risks Related to Economic Conditions" for more information.LiquidityThe following table contains several key measures of our financial condition and liquidity at the periods ended December 31:In millions20222021Cash and cash equivalents$1,220.5 $2,159.2 Short-term borrowings and current maturities of long-term debt1,048.0 350.4 Long-term debt3,788.3 4,491.7 Total debt4,836.3 4,842.1 Total Trane Technologies plc shareholders’ equity6,088.6 6,255.9 Total equity6,105.2 6,273.1 Debt-to-total capital ratio44.2 %43.6 %Debt and Credit FacilitiesAs of December 31, 2022, our short-term obligations primarily consist of current maturities of $699.7 million of long-term debt that matures in June 2023 and $340.8 million of fixed rate debentures that contain a put feature that the holders may exercise on each anniversary of the issuance date. If exercised, we are obligated to repay in whole or in part, at the holder’s option, the outstanding principal amount (plus accrued and unpaid interest) of the debentures held by the holder. We also maintain a commercial paper program which is used for general corporate purposes. Under the program, the maximum aggregate amount of unsecured commercial paper notes available to be issued, on a private placement basis, is $2.0 billion as of December 31, 2022. We had no commercial paper outstanding at December 31, 2022 and December 31, 2021. See Note 7, "Debt and Credit Facilities", to the Consolidated Financial Statements for additional information regarding the terms of our short-term obligations.34Table of ContentsOur long-term obligations primarily consist of long-term debt with final maturity dates ranging between 2024 and 2049. In addition, we maintain two $1.0 billion senior unsecured revolving credit facilities, one of which matures in June 2026 and the other which matures in April 2027. The facilities provide support for our commercial paper program and can be used for working capital and other general corporate purposes. Total commitments of $2.0 billion were unused at December 31, 2022 and December 31, 2021. See Note 7, "Debt and Credit Facilities", to the Consolidated Financial Statements and further below in Supplemental Guarantor Financial Information for additional information regarding the terms of our long-term obligations and their related guarantees.Cash FlowsThe following table reflects the major categories of cash flows for the years ended December 31, respectively. For additional details, please see the Consolidated Statements of Cash Flows in the Consolidated Financial Statements.In millions20222021Net cash provided by continuing operating activities$1,698.7 $1,594.4 Net cash used in continuing investing activities(539.8)(545.7)Net cash used in continuing financing activities(1,852.2)(2,127.6)Operating ActivitiesNet cash provided by continuing operating activities for the year ended December 31, 2022 was $1,698.7 million, of which net income provided $2,248.8 million after adjusting for non-cash transactions. Net cash provided by continuing operating activities for the year ended December 31, 2021 was $1,594.4 million, of which net income provided $1,837.5 million after adjusting for non-cash transactions. The year-over-year increase in net cash provided by continuing operating activities was primarily due to higher net earnings, partially offset by higher working capital balances in the current year, the funding of the continuing operations component of the QSF for $91.8 million and a compensation related payment to a retired executive.Investing ActivitiesCash flows from investing activities represents inflows and outflows regarding the purchase and sale of assets. Primary activities associated with these items include capital expenditures, proceeds from the sale of property, plant and equipment, acquisitions, investments in joint ventures and divestitures. During the year ended December 31, 2022, net cash used in investing activities from continuing operations was $539.8 million. The primary drivers of the usage was attributable to capital expenditures of $291.8 million and acquisition of businesses, which totaled $234.7 million, net of cash acquired. During the year ended December 31, 2021, net cash used in investing activities from continuing operations was $545.7 million. The primary drivers of the usage was attributable to the acquisition of businesses, which totaled $269.2 million, net of cash acquired, $223.0 million of capital expenditures and other investing activities of $68.6 million, primarily related to investment in several companies that complement existing products and services further enhancing our product portfolio.Financing ActivitiesCash flows from financing activities represent inflows and outflows that account for external activities affecting equity and debt. Primary activities associated with these actions include paying dividends to shareholders, repurchasing our own shares, issuing our stock and debt transactions. During the year ended December 31, 2022, net cash used in financing activities from continuing operations was $1,852.2 million. The primary drivers of the outflow related to the repurchase of $1,200.2 million in ordinary shares and dividends paid to ordinary shareholders of $620.2 million. During the year ended December 31, 2021, net cash used in financing activities from continuing operations was $2,127.6 million. The primary driver of the outflow related to the repurchase of $1,100.3 million in ordinary shares, dividends paid to ordinary shareholders of $561.1 million and the repayment of long-term debt of $432.5 million.35Table of ContentsFree Cash FlowFree cash flow is a non-GAAP measure and defined as Net cash provided by (used in) continuing operating activities adjusted for capital expenditures, cash payments for restructuring, transformation costs, the continuing operations component of the QSF funding and payout of executive compensation less an insurance settlement on a property claim in Q3 2022. This measure is useful to management and investors because it is consistent with management's assessment of our operating cash flow performance. The most comparable GAAP measure to free cash flow is Net cash provided by (used in) continuing operating activities. Free cash flow may not be comparable to similarly-titled measures used by other companies and should not be considered a substitute for Net cash provided by (used in) continuing operating activities in accordance with GAAP.A reconciliation of Net cash provided by (used in) continuing operating activities to free cash flow the years ended December 31 is as follows:In millions20222021Net cash provided by (used in) continuing operating activities$1,698.7 $1,594.4 Capital expenditures(291.8)(223.0)Cash payments for restructuring17.9 38.1 Transformation costs paid9.6 21.4 QSF funding (continuing operations component)91.8 — Compensation related payment to a retired executive64.3 — Insurance settlement on property claim in Q3 2022(25.0)— Free cash flow (1)$1,565.5 $1,430.9 (1) Represents a non-GAAP measure.Pension PlansOur investment objective in managing defined benefit plan assets is to ensure that all present and future benefit obligations are met as they come due. We seek to achieve this goal while trying to mitigate volatility in plan funded status, contribution and expense by better matching the characteristics of the plan assets to that of the plan liabilities. Our approach to asset allocation is to increase fixed income assets as the plan's funded status improves. We monitor plan funded status and asset allocation regularly in addition to investment manager performance. In addition, we monitor the impact of market conditions on our defined benefit plans on a regular basis. None of our defined benefit pension plans have experienced a significant impact on their liquidity due to market volatility. See Note 11, "Pension and Postretirement Benefits Other Than Pensions", to the Consolidated Financial Statements for additional information regarding pensions.Capital ResourcesBased on historical performance and current expectations, we believe our cash and cash equivalents balance, the cash generated from our operations, our committed credit lines and our expected ability to access capital markets will satisfy our working capital needs, capital expenditures, dividends, share repurchases, upcoming debt maturities, and other liquidity requirements associated with our operations for the foreseeable future.Capital expenditures were $291.8 million, $223.0 million and $146.2 million for the years ended December 31, 2022, 2021 and 2020, respectively. Our investments continue to improve manufacturing productivity, reduce costs, provide environmental enhancements, upgrade information technology infrastructure and security and advanced technologies for existing facilities. The capital expenditure program for 2023 is estimated to be approximately 1.5% to 2.0% of revenues, including amounts approved in prior periods. Many of these projects are subject to review and cancellation at our option without incurring substantial charges.For financial market risk impacting the Company, see Part II, Item 7A, "Quantitative and Qualitative Disclosure About Market Risk."36Table of ContentsCapitalizationIn addition to cash on hand and operating cash flow, we maintain significant credit availability under our Commercial Paper Program. Our ability to borrow at a cost-effective rate under the Commercial Paper Program is contingent upon maintaining an investment-grade credit rating. As of December 31, 2022, our credit ratings were as follows, remaining unchanged from 2021: Short-termLong-termMoody’sP-2Baa2Standard and Poor’sA-2BBBThe credit ratings set forth above are not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal by the assigning rating organization. Each rating should be evaluated independently of any other rating.Our public debt does not contain financial covenants and our revolving credit lines have a debt-to-total capital covenant of 65%. As of December 31, 2022, our debt-to-total capital ratio was significantly beneath this limit.Contractual ObligationsOur contractual cash obligations include required payments of long-term debt principal and interest, purchase obligations and expected obligations under our pension and postretirement benefit plans. In addition, we have required payments of operating leases, income taxes and expected obligations under the Funding agreement, environmental and product liability matters. For additional information regarding leases, income taxes, including unrecognized tax benefits, and contingent liabilities, see Note 10 "Leases", Note 16 "Income Taxes" and Note 20 "Commitments and Contingencies", respectively, to the Consolidated Financial Statements. Our material cash requirements include the following contractual and other obligations.DebtAt December 31, 2022, we had outstanding aggregate long-term debt principal payments of $4,863.0 million, with $1,048.3 million payable within 12 months. The amount payable within 12 months includes $340.8 million of debt redeemable at the option of the holder. The scheduled maturities of these bonds range between 2027 and 2028. Future interest payments on long-term debt total $2,186.5 million, with $199.7 million payable within 12 months. See Note 7, "Debt and Credit Facilities", to the Consolidated Financial Statements for additional information regarding debt.Purchase ObligationsPurchase obligations include commitments under legally enforceable contracts or purchase orders. At December 31, 2022, we had purchase obligations of $1,239.2 million, which are primarily payable within 12 months.PensionsIt is our objective to contribute to the pension plans to ensure adequate funds are available in the plans to make benefit payments to plan participants and beneficiaries when required. We currently expect that we will contribute approximately $69 million to our enterprise plans worldwide in 2023. The timing and amounts of future contributions are dependent upon the funding status of the plan, which is expected to vary as a result of changes in interest rates, returns on underlying assets, and other factors. See Note 11, "Pensions and Postretirement Benefits Other Than Pensions", to the Consolidated Financial Statements for additional information regarding pensions.Postretirement Benefits Other than PensionsWe fund postretirement benefit costs principally on a pay-as-you-go basis as medical costs are incurred by covered retiree populations. Benefit payments, which are net of expected plan participant contributions and Medicare Part D subsidy, are expected to be approximately $35 million in 2023. See Note 11, "Pensions and Postretirement Benefits Other Than Pensions", to the Consolidated Financial Statements for additional information regarding postretirement benefits other than pensions.37Table of ContentsSupplemental Guarantor Financial InformationTrane Technologies plc (Plc or Parent Company) and certain of its 100% directly or indirectly owned subsidiaries provide guarantees of public debt issued by other 100% directly or indirectly owned subsidiaries of Plc. The following table shows our guarantor relationships as of December 31, 2022:Parent, issuer or guarantorsNotes issuedNotes guaranteedTrane Technologies plc (Plc)NoneAll registered notes and debenturesTrane Technologies Irish Holdings Unlimited Company (TT Holdings)NoneAll notes issued by TTFL and TTC HoldCoTrane Technologies Lux International Holding Company S.à.r.l. (TT International)NoneAll notes issued by TTFL and TTC HoldCoTrane Technologies Global Holding Company Limited (TT Global)NoneAll notes issued by TTFL and TTC HoldCoTrane Technologies Financing Limited(TTFL)3.550% Senior notes due 20243.500% Senior notes due 20263.800% Senior notes due 20294.650% Senior notes due 20444.500% Senior notes due 2049All notes and debentures issued by TTC HoldCo and TTCTrane Technologies HoldCo Inc. (TTC HoldCo)4.250% Senior notes due 20233.750% Senior notes due 20285.750% Senior notes due 20434.300% Senior notes due 2048All notes issued by TTFLTrane Technologies Company LLC (TTC)7.200% Debentures due 2023-20256.480% Debentures due 2025Puttable debentures due 2027-2028All notes issued by TTFL and TTC HoldCoEach subsidiary debt issuer and guarantor is owned 100% directly or indirectly by the Parent Company. Each guarantee is full and unconditional, and provided on a joint and several basis. There are no significant restrictions of the Parent Company, or any guarantor, to obtain funds from its subsidiaries, such as provisions in debt agreements that prohibit dividend payments, loans or advances to the parent by a subsidiary. The following tables present summarized financial information for the Parent Company and subsidiary debt issuers and guarantors on a combined basis (together, "obligor group") after elimination of intercompany transactions and balances based on the Company’s legal entity ownerships and guarantees outstanding at December 31, 2022. Our obligor groups as of December 31, 2022 were as follows: Obligor group 1 consists of Plc, TT Holdings, TT International, TT Global, TTFL, TTC HoldCo and TTC; Obligor group 2 consists of Plc, TTFL and TTC.Summarized Statements of EarningsYear ended December 31, 2022In millionsObligor group 1Obligor group 2Net revenues$— $— Gross profit (loss)— — Intercompany interest and fees(44.2)224.5 Earnings (loss) from continuing operations(644.3)(28.9)Discontinued operations, net of tax(14.4)(19.5)Net earnings (loss)(658.7)(48.4)Less: Net earnings attributable to noncontrolling interests— — Net earnings (loss) attributable to Trane Technologies plc$(658.7)$(48.4)38Table of ContentsSummarized Balance SheetDecember 31, 2022In millionsObligor group 1Obligor group 2ASSETSIntercompany receivables$860.0 $1,092.1 Current assets1,011.6 1,231.7 Intercompany notes receivable1,831.9 4,781.6 Noncurrent assets2,582.3 5,383.1 LIABILITIESIntercompany payables3,303.5 1,792.1 Current liabilities4,851.8 2,611.9 Intercompany notes payable2,400.0 2,400.0 Noncurrent liabilities6,789.8 5,433.4 Critical Accounting EstimatesManagement’s Discussion and Analysis of Financial Condition and Results of Operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). The preparation of financial statements in conformity with those accounting principles requires management to use judgment in making estimates and assumptions based on the relevant information available at the end of each period. These estimates and assumptions have a significant effect on reported amounts of assets and liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities because they result primarily from the need to make estimates and assumptions on matters that are inherently uncertain. Actual results may differ from these estimates. If updated information or actual amounts are different from previous estimates, the revisions are included in our results for the period in which they become known.The following is a summary of certain accounting estimates and assumptions made by management that we consider critical.•Goodwill and indefinite-lived intangible assets – We have significant goodwill and indefinite-lived intangible assets on our balance sheet related to acquisitions. These assets are tested and reviewed annually during the fourth quarter for impairment or when there is a significant change in events or circumstances that indicate that the fair value of an asset is more likely than not less than the carrying amount of the asset. In addition, an interim impairment test is completed upon a triggering event or when there is a reorganization of reporting structure or disposal of all or a portion of a reporting unit. The determination of estimated fair value requires us to make assumptions about estimated cash flows, including profit margins, long-term forecasts, discount rates and terminal growth rates. We developed these assumptions based on the market and geographic risks unique to each reporting unit. The estimates of fair value are based on the best information available as of the date of the assessment, which primarily incorporates management assumptions about expected future cash flows.Annual Goodwill Impairment TestImpairment of goodwill is tested at the reporting unit level. The test compares the carrying amount of the reporting unit to its estimated fair value. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. To the extent that the carrying value of the reporting unit exceeds its estimated fair value, an impairment loss would be recognized for the amount by which the reporting unit's carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill in that reporting unit.As quoted market prices are not available for our reporting units, the calculation of their estimated fair value is determined using three valuation techniques: a discounted cash flow model (an income approach), a market-adjusted multiple of earnings and revenues (a market approach), and a similar transactions method (also a market approach). The discounted cash flow approach relies on our estimates of future cash flows and explicitly addresses factors such as timing, growth and margins, with due consideration given to forecasting risk. The multiple of earnings and revenues approach reflects the market's expectations for future growth and risk, with adjustments to account for differences between the guideline publicly traded companies and the subject reporting units. The similar transactions method considers prices paid in transactions that have recently occurred in our industry or in related industries. These valuation techniques are weighted 50%, 40% and 10%, respectively.39Table of ContentsUnder the income approach, we assumed a forecasted cash flow period of five years with discount rates ranging from 10.0% to 12.0% and a terminal growth rate of 3.0% Under the guideline public company method, we used an adjusted multiple ranging from 9.0 to 17.5 of projected earnings before interest, taxes, depreciation and amortization (EBITDA) based on the market information of comparable companies. Additionally, we compared the estimated aggregate fair value of our reporting units to our overall market capitalization. For all reporting units, the excess of the estimated fair value over carrying value (expressed as a percentage of carrying value) exceeded 200%. A significant increase in the discount rate, decrease in the long-term growth rate, or substantial reductions in our end markets and volume assumptions could have a negative impact on the estimated fair value of these reporting unitsOther Indefinite-lived intangible assetsOther intangible assets with indefinite useful lives are tested for impairment on an annual basis. The fair value of intangible assets with indefinite useful lives is determined on a relief from royalty methodology (income approach) which is based on the implied royalty paid, at an appropriate discount rate, to license the use of an asset rather than owning the asset. The present value of the after-tax cost savings (i.e., royalty relief) indicates the estimated fair value of the asset. Any excess of the carrying value over the estimated fair value would be recognized as an impairment loss equal to that excess. In testing our other indefinite-lived intangible assets for impairment, we assumed forecasted revenues for a period of five years with discount rates ranging from 10.0% to 14.0%, terminal growth rates of 3.0%, and royalty rates ranging from 0.5% to 4.5%. For all indefinite-lived intangible assets, the excess of the estimated fair value over carrying value (expressed as a percentage of carrying value) exceeded 25%. A significant increase in the discount rate, decrease in the long-term growth rate, decrease in the royalty rate or substantial reductions in our end markets and volume assumptions could have a negative impact on the estimated fair values of any of our tradenames.•Business combinations - Acquisitions that meet the definition of a business combination are recorded using the acquisition method of accounting. We include the operating results of acquired entities from their respective dates of acquisition. We recognize and measure the identifiable assets acquired, liabilities assumed, including contingent consideration relating to potential earnout provisions. and any non-controlling interest as of the acquisition date fair value. The valuation of intangible assets is determined using an income approach methodology. We use assumptions to value the intangible assets including projected future revenues, customer attrition rates, royalty rates, tax rates and discount rates. The excess, if any, of total consideration transferred in a business combination over the fair value of identifiable assets acquired, liabilities assumed, and any non-controlling interest is recognized as goodwill. Costs incurred as a result of a business combination other than costs related to the issuance of debt or equity securities are recorded in the period the costs are incurred.Contingent considerationWe assess any contingent consideration included in the consideration paid of a business combination. The value recorded is based on estimates of future financial projections on revenue under various potential scenarios, in which a Monte Carlo simulation model runs many iterations based on comparable companies' revenue growth rates and their implied revenue volatilities. These cash flow projections are discounted with a risk adjusted rate. Each quarter until such contingent amounts are earned, the fair value of the liability is remeasured at each reporting period and adjusted as a component of operating expenses based on changes to the underlying assumptions. The estimates used to determine the fair value of the contingent consideration liability are subject to significant judgment, specifically revenue growth rates, implied revenue volatilities and discount rates. •Asbestos matters – Prior to the Petition Date, certain of our wholly-owned subsidiaries and former companies were named as defendants in asbestos-related lawsuits in state and federal courts. We recorded a liability for our actual and anticipated future claims as well as an asset for anticipated insurance settlements. We performed a detailed analysis and projected an estimated range of the total liability for pending and unasserted future asbestos-related claims. We recorded the liability at the low end of the range as we believed that no amount within the range is a better estimate than any other amount. Our key assumptions underlying the estimated asbestos-related liabilities included the number of people occupationally exposed and likely to develop asbestos-related diseases such as mesothelioma and lung cancer, the number of people likely to file an asbestos-related personal injury claim against us, the average settlement and resolution of each claim and the percentage of claims resolved with no payment. Asbestos-related defense costs were excluded from the asbestos claims liability and were recorded separately as services were incurred. None of our existing or previously-owned businesses were a producer or manufacturer of asbestos. We recorded certain income and expenses associated with our asbestos liabilities and corresponding insurance recoveries within Discontinued operations, net of tax, as they related to previously divested businesses, except for amounts associated with asbestos liabilities and corresponding insurance recoveries of Murray and its predecessors, which were recorded within continuing operations. 40Table of Contents•Revenue recognition – Revenue is recognized when control of a good or service promised in a contract (i.e., performance obligation) is transferred to a customer. Control is obtained when a customer has the ability to direct the use of and obtain substantially all of the remaining benefits from that good or service. A majority of our revenues are recognized at a point-in-time as control is transferred at a distinct point in time per the terms of a contract. However, a portion of our revenues are recognized over time as the customer simultaneously receives control as we perform work under a contract. For these arrangements, the cost-to-cost input method is used as it best depicts the transfer of control to the customer that occurs as we incur costs.The transaction price allocated to performance obligations reflects our expectations about the consideration we will be entitled to receive from a customer. To determine the transaction price, variable and non-cash consideration are assessed as well as whether a significant financing component exists. We include variable consideration in the estimated transaction price when it is probable that significant reversal of revenue recognized would not occur when the uncertainty associated with variable consideration is subsequently resolved. We consider historical data in determining our best estimates of variable consideration, and the related accruals are recorded using the expected value method.We enter into sales arrangements that contain multiple goods and services. For these arrangements, each good or service is evaluated to determine whether it represents a distinct performance obligation and whether the sales price for each obligation is representative of standalone selling price. If available, we utilize observable prices for goods or services sold separately to similar customers in similar circumstances to evaluate relative standalone selling price. List prices are used if they are determined to be representative of standalone selling prices. Where necessary, we ensure that the total transaction price is then allocated to the distinct performance obligations based on the determination of their relative standalone selling price at the inception of the arrangement.We recognize revenue for delivered goods or services when the delivered good or service is distinct, control of the good or service has transferred to the customer, and only customary refund or return rights related to the goods or services exist. For extended warranties and long-term service agreements, revenue for these distinct performance obligations are recognized over time on a straight-line basis over the respective contract term. •Income taxes – Deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax bases of assets and liabilities, applying enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. We recognize future tax benefits, such as net operating losses and tax credits, to the extent that realizing these benefits is considered in our judgment to be more likely than not. We regularly review the recoverability of our deferred tax assets considering our historic profitability, projected future taxable income, timing of the reversals of existing temporary differences and the feasibility of our tax planning strategies. Where appropriate, we record a valuation allowance with respect to a future tax benefit.The provision for income taxes involves a significant amount of management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which we operate. Future changes in applicable laws, projected levels of taxable income, and tax planning could change the effective tax rate and tax balances recorded by us. In addition, tax authorities periodically review income tax returns filed by us and can raise issues regarding our filing positions, timing and amount of income or deductions, and the allocation of income among the jurisdictions in which we operate. A significant period of time may elapse between the filing of an income tax return and the ultimate resolution of an issue raised by a revenue authority with respect to that return. We believe that we have adequately provided for any reasonably foreseeable resolution of these matters. We will adjust our estimate if significant events so dictate. To the extent that the ultimate results differ from our original or adjusted estimates, the effect will be recorded in the provision for income taxes in the period that the matter is finally resolved.•Employee benefit plans – We provide a range of benefits to eligible employees and retirees, including pensions, postretirement and postemployment benefits. Determining the cost associated with such benefits is dependent on various actuarial assumptions including discount rates, expected return on plan assets, compensation increases, mortality, turnover rates and healthcare cost trend rates. Actuarial valuations are performed to determine expense in accordance with GAAP. Actual results may differ from the actuarial assumptions and are generally accumulated and amortized into earnings over future periods. We review our actuarial assumptions at each measurement date and make modifications to the assumptions based on current rates and trends, if appropriate. The discount rate, the rate of compensation increase and the expected long-term rates of return on plan assets are determined as of each measurement date. We believe that the assumptions utilized in recording our obligations under our plans are reasonable based on input from our actuaries, outside investment advisors and information as to assumptions used by plan sponsors.41Table of ContentsChanges in any of the assumptions can have an impact on the net periodic pension cost or postretirement benefit cost. Estimated sensitivities to the expected 2023 net periodic pension cost of a 0.25% rate decline in the two basic assumptions are as follows: the decline in the discount rate would increase expense by $0.4 million and the decline in the estimated return on assets would increase expense by $4.9 million. A 0.25% rate decrease in the discount rate for postretirement benefits would increase expected 2023 net periodic postretirement benefit cost by $0.3 million.Recent Accounting PronouncementsSee Note 2, "Summary of Significant Accounting Policies" to the Consolidated Financial Statements for a discussion of recent accounting pronouncements.Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKWe are exposed to fluctuations in currency exchange rates, interest rates and commodity prices which could impact our results of operations and financial condition. Foreign Currency ExposuresWe have operations throughout the world that manufacture and sell products in various international markets. As a result, we are exposed to movements in exchange rates of various currencies against the U.S. dollar as well as against other currencies throughout the world. Many of our non-U.S. operations have a functional currency other than the U.S. dollar, and their results are translated into U.S. dollars for reporting purposes. Therefore, our reported results will be higher or lower depending on the weakening or strengthening of the U.S. dollar against the respective foreign currency. Our largest concentration of revenues from non-U.S. operations as of December 31, 2022 are in Euros and Chinese Yuan. A hypothetical 10% unfavorable change in the average exchange rate used to translate Net revenues for the year ended December 31, 2022 from either Euros or Chinese Yuan-based operations into U.S. dollars would result in a decline of approximately $140 million and $60 million, respectively. We use derivative instruments to hedge those material exposures that cannot be naturally offset. The instruments utilized are viewed as risk management tools, primarily involve little complexity and are not used for trading or speculative purposes. To minimize the risk of counterparty non-performance, derivative instrument agreements are made only through major financial institutions with significant experience in such derivative instruments.We evaluate our exposure to changes in currency exchange rates on our foreign currency derivatives using a sensitivity analysis. The sensitivity analysis is a measurement of the potential loss in fair value based on a percentage change in exchange rates. Based on the currency derivative instruments in place at December 31, 2022, a hypothetical change in fair value of those derivative instruments assuming a 10% adverse change in exchange rates would result in an unrealized loss of approximately $7.5 million, as compared with $18.1 million at December 31, 2021. These amounts, when realized, would be offset by changes in the fair value of the underlying transactions.Commodity Price ExposuresWe are exposed to volatility in the prices of commodities used in some of our products and we use commodity hedge contracts in the financial derivatives market and fixed price purchase contracts to manage this exposure. Commodity risks are systematically managed pursuant to policy guidelines. As a cash flow hedge, gains and losses resulting from the hedging instruments mitigate a portion of our exposures to changes in commodity prices. The maturities of the commodity hedge contracts coincide with the expected purchase of the commodities. Based on the commodity derivative instruments in place at December 31, 2022, a hypothetical change in fair value of those derivative instruments assuming a 10% decrease in commodity prices would result in an unrealized loss of approximately $9.0 million, as compared with $7.5 million at December 31, 2021. These amounts, when realized, would be offset by changes in the fair value of the underlying commodity purchases.Interest Rate ExposureOur debt portfolio mainly consists of fixed-rate instruments, and therefore any fluctuation in market interest rates is not expected to have a material effect on our results of operations.42Table of Contents
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K. We have elected to omit discussion on the earliest of the three years covered by the consolidated financial statements presented. Refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations located in our Annual Report on Form 10-K for the year ended December 31, 2021, filed on February 24, 2022, for reference to discussion of the fiscal year ended December 31, 2020, the earliest of the three fiscal years presented.In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. You should review the sections titled “Special Note Regarding Forward-Looking Statements” for a discussion of forward-looking statements and in Part I, Item 1A, “Risk Factors”, for a discussion of factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis and elsewhere in this Annual Report on Form 10-K.OverviewWe are a technology platform that uses a massive network, leading technology, operational excellence, and product expertise to power movement from point A to point B. We develop and operate proprietary technology applications supporting a variety of offerings on our platform. We connect consumers with providers of ride services, merchants as well as delivery service providers for meal preparation, grocery and other delivery services. Uber also connects consumers with public transportation networks. We use this same network, technology, operational excellence, and product expertise to connect Shippers with Carriers in the freight industry by providing Carriers with the ability to book a shipment, transportation management and other logistics services. We are also developing technologies designed to provide new solutions to everyday problems.Driver Classification DevelopmentsThe classification of Drivers is currently being challenged in courts, by legislators and by government agencies in the United States and abroad. We are involved in numerous legal proceedings globally, including putative class and collective class action lawsuits, demands for arbitration, charges and claims before administrative agencies, and investigations or audits by labor, social security, and tax authorities that claim that Drivers should be treated as our employees (or as workers or quasi-employees where those statuses exist), rather than as independent contractors. Of particular note are proceedings in California, where on May 5, 2020, the California Attorney General, in conjunction with the city attorneys for San Francisco, Los Angeles and San Diego, filed a complaint in San Francisco Superior Court (the “Court”) against Uber and Lyft, Inc., alleging that drivers are misclassified, and sought an injunction and monetary damages related to the alleged competitive advantage caused by the alleged misclassification of drivers.47On August 10, 2020, the Court issued a preliminary injunction order prohibiting us from classifying Drivers as independent contractors and from violating various wage and hour laws. Following a stay of the injunction and our unsuccessful appeal of the injunction to a Court of Appeal, we were ordered to comply with the preliminary injunction. In November 2020, California voters approved Proposition 22, a state ballot initiative that provides a framework for drivers that use platforms like ours for independent work. Proposition 22 went into effect in December 2020. Although our stipulation to dissolve the California Attorney General’s preliminary injunction was granted in April 2021, that litigation remains pending, and we also may face liability relating to periods before the effective date of Proposition 22.In January 2021, a petition was filed with the California Supreme Court by several drivers and a labor union alleging that Proposition 22 is unconstitutional, which was denied. The same drivers and labor union have since filed a similar challenge in California Superior Court, and in August 2021, the Alameda County Superior Court ruled that Proposition 22 is unconstitutional. On September 21, 2021, the State of California filed an appeal of that decision with the California Court of Appeal, and the Protect App-Based Drivers and Services organization, who intervened in the matter, has also filed an appeal. Oral argument was heard and we await a decision.To comply with Proposition 22, we have incurred and expect to incur additional expenses, including expenses associated with a guaranteed minimum earnings floor for Drivers, insurance for injury protection and subsidies for health care. We do not expect these changes will have a material impact on our business, results of operations, financial position, or cash flows.Also of note, on October 28, 2015, a claim by 25 Drivers, including Mr. Y. Aslam and Mr. J. Farrar, was brought in the United Kingdom (“UK”) Employment Tribunal against us asserting that they should be classified as “workers” (a separate category between independent contractors and employees) in the UK rather than independent contractors. The tribunal ruled on October 28, 2016 that the Drivers were workers whenever our App is switched on and they are ready and able to take trips, based on an assessment of the App in July 2016. The Court of Appeal rejected our appeal in a majority decision on December 19, 2018. We appealed to the Supreme Court and a hearing at the Supreme Court took place in July 2020.On February 19, 2021, the Supreme Court of the UK upheld the tribunal ruling. Subsequently, we initiated a historical claims settlement process for UK drivers. Damages may include back pay including holiday pay and minimum wage. Additional claimants have also filed and each claimant will be required to bring their own separate action to an employment tribunal to determine whether they met the “worker” classification and if so, how much each claimant will be awarded.On March 16, 2021, we announced that more than 70,000 drivers in the UK will be treated as workers, earning at least the National Living Wage when driving with Uber. They will also be paid for holiday time and all those eligible will be automatically enrolled into a pension plan. We have also completed a settlement process with drivers in the UK to proactively resolve historical claims relating to their classification under UK law. Our portal for drivers to register for a settlement of historical holiday pay and national minimum wage liabilities closed on July 22, 2021 and we have extended offers to all drivers eligible for settlement who are not already represented by an attorney and have made payments to the drivers who accepted our offers. Compensation hearings will take place for claimants who have not settled their historic claims, where the tribunal will assess our position on the correct approach to working time, expenses, and holiday pay.On June 23, 2021, we received a compliance notice from the UK pension regulator to facilitate our auto-enrollment implementation. We have completed the enrollment of eligible drivers in the UK into a pension plan.If, as a result of legislation or judicial decisions, we are required to classify Drivers as employees, workers or quasi-employees where those statuses exist, we would incur significant additional expenses for compensating Drivers, including expenses associated with the application of wage and hour laws (including minimum wage, overtime, and meal and rest period requirements), employee benefits, social security contributions, taxes (direct and indirect), and potential penalties. Additionally, we may not have adequate Driver supply as Drivers may opt out of our platform given the loss of flexibility under an employment model, and we may not be able to hire a majority of the Drivers currently using our platform. Any of these events could negatively impact our business, result of operations, financial position, and cash flows.For a discussion of risk factors related to how misclassification challenges may impact our business, result of operations, financial position and operating condition and cash flows, see the risk factor titled “-Our business would be adversely affected if Drivers were classified as employees, workers or quasi-employees” included in Part I, Item 1A, “Risk Factors”, and Note 14 – Commitments and Contingencies to our consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.In addition, if we are required to classify Drivers as employees, this may impact our current financial statement presentation including revenue, cost of revenue, incentives and promotions as further described in Note 1 – Description of Business and Summary of Significant Accounting Policies in the notes to the consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” and the section titled “Critical Accounting Estimates” in Part II, Item 7, of this Annual Report on Form 10-K.48Financial and Operational HighlightsYear Ended December 31,Constant Currency (1)(In millions, except percentages)202120222021 to 2022 % Change2021 to 2022 % ChangeMonthly Active Platform Consumers (“MAPCs”) (2), (3)11813111 %Trips (2)6,3687,64220 %Gross Bookings (2)$90,415 $115,395 28 %33 %Revenue$17,455 $31,877 83 %90 %Net loss attributable to Uber Technologies, Inc. (4)$(496)$(9,141)**Mobility Adjusted EBITDA$1,596 $3,299 107 %Delivery Adjusted EBITDA$(348)$551 **Adjusted EBITDA (1), (2)$(774)$1,713 **Net cash provided by (used in) operating activities (5)$(445)$642 **Free cash flow (1), (5)$(743)$390 **(1) See the section titled “Reconciliations of Non-GAAP Financial Measures” for more information and reconciliations to the most directly comparable GAAP financial measure.(2) See the section titled “Certain Key Metrics and Non-GAAP Financial Measures” below for more information.(3) MAPCs presented for annual periods are MAPCs for the fourth quarter of the year.(4) Net loss attributable to Uber Technologies, Inc. included stock-based compensation expense of $1.2 billion and $1.8 billion during the years ended December 31, 2021 and 2022, respectively.(5) Net cash used in operating activities and free cash flow during the year ended December 31, 2021 reflected a $1.0 billion cash inflow related to a legacy auto insurance transfer. For additional information on the legacy auto insurance transfer, refer to Note 1 – Description of Business and Summary of Significant Accounting Policies to our consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K as well as the section titled “Liquidity and Capital Resources” for more information.Net cash provided by operating activities and free cash flow during the year ended December 31, 2022 reflected an approximately $733 million (GBP 613 million) cash outflow related to the resolution of all outstanding HMRC VAT claims that were paid during the fourth quarter of 2022. For additional information on this matter, refer to Note 14 – Commitments and Contingencies to our consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K as well as the section titled “Liquidity and Capital Resources”.** Percentage not meaningful.Highlights for 2022In the fourth quarter of 2022, our MAPCs were 131 million, growing 7 million, or 6%, quarter-over-quarter, and growing 11% compared to the same period in 2021.Overall Gross Bookings increased by $25.0 billion in 2022, up 28%, or 33% on a constant currency basis, compared to 2021. Mobility Gross Bookings grew 48% year-over-year, on a constant currency basis, primarily due to increases in Trip volumes as the business recovers from the impacts of the coronavirus pandemic (“COVID-19”). Delivery Gross Bookings grew 14% year-over-year, on a constant currency basis, primarily driven by growth in the US & Canada. Freight Gross Bookings grew 226% year-over-year, on a constant currency basis, primarily attributable to the acquisition of Tupelo Parent, Inc. (“Transplace”) in the fourth quarter of 2021.Revenue was $31.9 billion, or up 83% year-over-year. Revenue growth outpaced Gross Bookings growth primarily due to a $4.8 billion increase in our Freight business primarily due to the acquisition of Transplace during the fourth quarter of 2021, the net favorable impact to Mobility revenue of $3.9 billion as a result of business model changes in the UK and accruals made for the resolution of historical claims in the UK relating to the classification of drivers, and an $892 million increase in Delivery revenue resulting from an increase in certain Courier payments and incentives that are recorded in cost of revenue, exclusive of depreciation and amortization, for certain markets where we are primarily responsible for Delivery services and pay Couriers for services provided.Net loss attributable to Uber Technologies, Inc. was $9.1 billion, which includes the unfavorable impact of a pre-tax unrealized loss on debt and equity securities, net, of $7.0 billion primarily related to changes in the fair value of our marketable equity securities, including: a $3.0 billion net unrealized loss on our Aurora investments, a $2.1 billion net unrealized loss on our Grab investment, a $1.0 billion net unrealized loss on our Didi investment, a $747 million change of fair value on our Zomato investment, as well as a 49$142 million net unrealized loss on other investments. Net loss attributable to Uber Technologies, Inc. also included $1.8 billion of stock-based compensation expense.Adjusted EBITDA was $1.7 billion, growing $2.5 billion compared to 2021. Mobility Adjusted EBITDA profit was $3.3 billion, up $1.7 billion compared to 2021. Delivery Adjusted EBITDA profit was $551 million, up $899 million from Delivery Adjusted EBITDA loss of $348 million in 2021.We ended the year with $4.3 billion in unrestricted cash, cash equivalents and short-term investments.Other DevelopmentsCOVID-19COVID-19 rapidly changed market and economic conditions globally, impacting Drivers, Merchants, consumers and business partners, as well as our business, results of operations, financial position, and cash flows. Various governmental restrictions, including the declaration of a federal National Emergency, multiple cities’ and states’ declarations of states of emergency, school and business closings, quarantines, restrictions on travel, limitations on social or public gatherings, and other measures have, and may continue to have, an adverse impact on our business and operations. For example, we temporarily suspended our shared rides offering globally, and continue to offer “leave at door” delivery options for Delivery offerings. We also responded to COVID-19 by launching new, or expanding existing, services or features on an expedited basis, particularly those related to delivery of food and other goods.Furthermore, we have experienced, and may continue to experience, Driver supply constraints. For a discussion of the potential impacts of COVID-19 on our business, results of operations, financial position, and cash flows refer to Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K.Components of Results of OperationsRevenueWe generate substantially all of our revenue from fees paid by Drivers and Merchants for use of our platform. We have concluded that we are an agent in these arrangements as we arrange for other parties to provide the service to the end-user. Under this model, revenue is net of Driver and Merchant earnings and Driver incentives. We act as an agent in these transactions by connecting consumers to Drivers and Merchants to facilitate a Trip, meal or grocery delivery service.In 2022, we modified our arrangements in certain markets and, as a result, concluded we are responsible for the provision of Mobility services to end-users in those markets. We have determined that in these transactions, end-users are our customers and our sole performance obligation in the transaction is to provide transportation services to the end-user. We recognize revenue when a trip is complete. In these markets where we are responsible for Mobility services, we present revenue from end-users on a gross basis, as we control the service provided by Drivers to end-users, while payments to Drivers in exchange for Mobility services are recognized in cost of revenue, exclusive of depreciation and amortization.For additional discussion related to our revenue, see the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates - Revenue Recognition,” “Note 1 – Description of Business and Summary of Significant Accounting Policies - Revenue Recognition,” and “Note 2 – Revenue” to our consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Cost of Revenue, Exclusive of Depreciation and AmortizationCost of revenue, exclusive of depreciation and amortization, primarily consists of certain insurance costs related to our Mobility and Delivery offerings, credit card processing fees, bank fees, data center and networking expenses, mobile device and service costs, costs incurred with Carriers for Uber Freight transportation services, amounts related to fare chargebacks and other credit card losses as well as costs incurred for certain Mobility and Delivery transactions where we are primarily responsible for Mobility or Delivery services and pay Drivers and Couriers for services.We expect that cost of revenue, exclusive of depreciation and amortization, will fluctuate on an absolute dollar basis for the foreseeable future in line with Trip volume changes on the platform. As Trips increase or decrease, we expect related changes for insurance costs, credit card processing fees, hosting and co-located data center expenses, maps license fees, and other cost of revenue, exclusive of depreciation and amortization.Operations and SupportOperations and support expenses primarily consist of compensation expenses, including stock-based compensation, for employees that support operations in cities, including the general managers, Driver operations, platform user support representatives and community managers. Also included is the cost of customer support, Driver background checks and the allocation of certain corporate costs.As our business recovers from the impacts of COVID-19 and Trip volume increases, we would expect operations and support expenses to increase on an absolute dollar basis for the foreseeable future, but decrease as a percentage of revenue as we become more efficient in supporting platform users.50Sales and MarketingSales and marketing expenses primarily consist of compensation costs, including stock-based compensation to sales and marketing employees, advertising costs, product marketing costs and discounts, loyalty programs, promotions, refunds, and credits provided to end-users who are not customers, and the allocation of certain corporate costs. We expense advertising and other promotional expenditures as incurred.As our business recovers from the impacts of COVID-19, we would anticipate sales and marketing expenses to increase on an absolute dollar basis for the foreseeable future but vary from period to period as a percentage of revenue due to timing of marketing campaigns.Research and DevelopmentResearch and development expenses primarily consist of compensation costs, including stock-based compensation, for employees in engineering, design and product development. Expenses includes ATG and Other Technology Programs development expenses prior to the divestiture of our ATG business in January 2021, as well as expenses associated with ongoing improvements to, and maintenance of, existing products and services, and allocation of certain corporate costs. We expense substantially all research and development expenses as incurred.We expect research and development expenses to increase and vary from period to period as a percentage of revenue as we continue to invest in research and development activities relating to ongoing improvements to and maintenance of our platform offerings and other research and development programs, offset by a decrease in investments in our ATG and Other Technology Programs subsequent to the sale of our ATG Business in 2021.General and AdministrativeGeneral and administrative expenses primarily consist of compensation costs, including stock-based compensation, for executive management and administrative employees, including finance and accounting, human resources, policy and communications, legal, and certain impairment charges, as well as allocation of certain corporate costs, occupancy, and general corporate insurance costs. General and administrative expenses also include certain legal settlements.As our business recovers from the impacts of COVID-19 and Trip volume increases, we expect that general and administrative expenses will increase on an absolute dollar basis for the foreseeable future, but decrease as a percentage of revenue as we achieve improved fixed cost leverage and efficiencies in our internal support functions.Depreciation and AmortizationDepreciation and amortization expenses primarily consist of depreciation on buildings, site improvements, computer and network equipment, software, leasehold improvements, furniture and fixtures, and amortization of intangible assets. Depreciation includes expenses associated with buildings, site improvements, computer and network equipment, leased vehicles, and furniture, fixtures, as well as leasehold improvements. Amortization includes expenses associated with our capitalized internal-use software and acquired intangible assets.Interest ExpenseInterest expense consists primarily of interest expense associated with our outstanding debt, including accretion of debt discount. For additional detail related to our debt obligations, see “Note 8 – Long-Term Debt and Revolving Credit Arrangements” to our consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Other Income (Expense), NetOther income (expense), net primarily includes the following items:•Interest income, which consists primarily of interest earned on our cash and cash equivalents and restricted cash and cash equivalents.•Foreign currency exchange gains (losses), net, which consist primarily of remeasurement of transactions and monetary assets and liabilities denominated in currencies other than the functional currency at the end of the period.•Gain on business divestitures, net.•Gain from sale of investments, which consists primarily of gain from the sale of our entire equity interest in the Yandex Self Driving Group B.V. (“SDG”), and the derecognition of our entire equity interest in the Demerged Businesses in 2021. For additional information, see “Note 4 - Equity Method Investments” to our consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.•Unrealized gain (loss) on debt and equity securities, net, which consists primarily of gains (losses) from fair value adjustments relating to our marketable and non-marketable securities.51•Impairment of equity method investment.•Revaluation of MLU B.V. call option, which represents changes in fair value recorded on the call option granted to Yandex (“MLU B.V. Call Option”).•Other, net.Provision for (Benefit from) Income TaxesWe are subject to income taxes in the United States and foreign jurisdictions in which we do business. These foreign jurisdictions have different statutory tax rates than those in the United States. Additionally, certain of our foreign earnings may also be taxable in the United States. Accordingly, our effective tax rate will vary depending on the relative proportion of foreign to domestic income, changes in the valuation allowance on our U.S. and Netherlands' deferred tax assets, and changes in tax laws.Equity Method InvestmentsEquity method investments primarily includes the results of our share of income or loss from our Yandex.Taxi joint venture.Results of OperationsThe following table summarizes our consolidated statements of operations for each of the periods presented (in millions):Year Ended December 31,20212022Revenue$17,455 $31,877 Costs and expensesCost of revenue, exclusive of depreciation and amortization shown separately below9,351 19,659 Operations and support1,877 2,413 Sales and marketing4,789 4,756 Research and development2,054 2,798 General and administrative2,316 3,136 Depreciation and amortization902 947 Total costs and expenses21,289 33,709 Loss from operations(3,834)(1,832)Interest expense(483)(565)Other income (expense), net3,292 (7,029)Loss before income taxes and income (loss) from equity method investments(1,025)(9,426)Provision for (benefit from) income taxes(492)(181)Income (loss) from equity method investments(37)107 Net loss including non-controlling interests(570)(9,138)Less: net income (loss) attributable to non-controlling interests, net of tax(74)3 Net loss attributable to Uber Technologies, Inc.$(496)$(9,141)52The following table sets forth the components of our consolidated statements of operations for each of the periods presented as a percentage of revenue (1):Year Ended December 31,20212022Revenue100 %100 %Costs and expensesCost of revenue, exclusive of depreciation and amortization shown separately below54 %62 %Operations and support11 %8 %Sales and marketing27 %15 %Research and development12 %9 %General and administrative13 %10 %Depreciation and amortization5 %3 %Total costs and expenses122 %106 %Loss from operations(22)%(6)%Interest expense(3)%(2)%Other income (expense), net19 %(22)%Loss before income taxes and income (loss) from equity method investments(6)%(30)%Provision for (benefit from) income taxes(3)%(1)%Income (loss) from equity method investments— %— %Net loss including non-controlling interests(3)%(29)%Less: net income (loss) attributable to non-controlling interests, net of tax— %— %Net loss attributable to Uber Technologies, Inc.(3)%(29)%(1) Totals of percentage of revenues may not foot due to rounding.Comparison of the Years Ended December 31, 2021 and 2022RevenueYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Revenue$17,455 $31,877 83 %2022 Compared to 2021Revenue increased $14.4 billion, or 83%, primarily attributable to an increase in Gross Bookings of 28%, or 33% on a constant currency basis. The increase in Gross Bookings was primarily driven by increases in Mobility Trip volumes as the business recovers from the impacts of COVID-19 and a $4.8 billion increase in Freight Gross Bookings resulting primarily from the acquisition of Transplace in the fourth quarter of 2021. Additionally, we saw a $3.9 billion net increase in Mobility revenue as a result of business model changes in the UK and accruals made for the resolution of historical claims in the UK relating to the classification of drivers. We also saw an $892 million increase in Delivery revenue resulting from an increase in certain Courier payments and incentives that are recorded in cost of revenue, exclusive of depreciation and amortization, for certain markets where we are primarily responsible for Delivery services and pay Couriers for services provided. Cost of Revenue, Exclusive of Depreciation and AmortizationYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Cost of revenue, exclusive of depreciation and amortization$9,351 $19,659 110 %Percentage of revenue54 %62 %2022 Compared to 2021Cost of revenue, exclusive of depreciation and amortization, increased $10.3 billion, or 110%, mainly due to a $3.3 billion increase in Freight Carrier payments resulting from the acquisition of Transplace in the fourth quarter of 2021, a $2.7 billion increase in Mobility Driver payments and incentives that are recorded in cost of revenue, exclusive of depreciation and amortization, as a result of business model changes in the UK, a $1.4 billion increase in insurance expense primarily due to an increase in miles driven in our 53Mobility business, and a $1.4 billion increase in Courier payments and incentives that are recorded in cost of revenue for certain markets where we are primarily responsible for Delivery services and pay Couriers for services provided.Operations and SupportYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Operations and support$1,877 $2,413 29 %Percentage of revenue11 %8 %2022 Compared to 2021Operations and support expenses increased $536 million, or 29%, primarily attributable to a $336 million increase in employee headcount costs, a $114 million increase in external contractor expenses, and a $15 million increase in stock-based compensation.Sales and MarketingYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Sales and marketing$4,789 $4,756 (1)%Percentage of revenue27 %15 %2022 Compared to 2021Sales and marketing expenses decreased $33 million, or 1%, primarily attributable to a $227 million decrease in consumer discounts, rider facing loyalty expense, promotions, credits and refunds to $2.2 billion compared to $2.4 billion in 2021, partially offset by a $152 million increase in employee headcount costs, a $25 million increase in indirect advertising and marketing, and an $19 million increase in stock-based compensation.Research and DevelopmentYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Research and development$2,054 $2,798 36 %Percentage of revenue12 %9 %2022 Compared to 2021Research and development expenses increased $744 million, or 36%, primarily attributable to a $446 million increase in stock-based compensation and a $360 million increase in employee headcount costs.General and AdministrativeYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022General and administrative$2,316 $3,136 35 %Percentage of revenue13 %10 %2022 Compared to 2021General and administrative expenses increased $820 million, or 35%, primarily attributable to a $661 million increase in legal, tax, and regulatory reserve changes and settlements and a $145 million increase to stock-based compensation. Depreciation and AmortizationYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Depreciation and amortization$902 $947 5 %Percentage of revenue5 %3 %2022 Compared to 2021Depreciation and amortization expenses increased $45 million, or 5%, primarily attributable to $93 million in additional amortization expenses primarily related to Transplace and Drizly intangible assets, partially offset by a $48 million decrease in 54depreciation primarily due to fixed assets that fully depreciated in 2021.Interest ExpenseYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Interest expense$(483)$(565)17 %Percentage of revenue(3)%(2)%2022 Compared to 2021Interest expense increased by $82 million, or 17%, primarily attributable to a $43 million increase in interest expense resulting from the issuance of our $1.5 billion 2029 Senior Notes in August 2021 and $41 million increase in interest expense on our term loans due to higher LIBOR rate.Other Income (Expense), NetYear Ended December 31,2021 to 2022% Change(In millions, except percentages)20212022Interest income$37 $139 276 %Foreign currency exchange gains (losses), net(67)(147)(119)%Gain on business divestitures, net1,684 14 (99)%Gain from sale of investments413 — (100)%Unrealized gain (loss) on debt and equity securities, net1,142 (7,045)**Impairment of equity method investment— (182)(100)%Revaluation of MLU B.V. call option— 191 100 %Other, net83 1 (99)%Other income (expense), net$3,292 $(7,029)**Percentage of revenue19 %(22)%** Percentage not meaningful.2022 Compared to 2021Interest income increased by $102 million or 276% primarily attributable to Federal interest rate increases and increasing investment allocation fixed income instruments.Gain on business divestitures, net decreased by $1.7 billion due to primarily due to a $1.6 billion gain on the sale of our ATG Business to Aurora recognized in the first quarter of 2021. For additional information, see Note 18 – Divestitures included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Gain from sale of investments decreased by $413 million primarily due to the sale to Yandex of our (i) 4.5% equity interest in MLU B.V., (ii) our entire equity interest in Yandex Self Driving Group B.V. and (iii) all of our equity interest in the Demerged Businesses. For additional information, see Note 4 - Equity Method Investments included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Unrealized gain (loss) on debt and equity securities, net decreased by $8.2 billion primarily due to a $3.0 billion net unrealized loss on our Aurora investment, a $2.1 billion net unrealized loss on our Grab Investment, a $1.0 billion net unrealized loss on our Didi investment, a $747 million change of fair value on our Zomato investment, as well as a $142 million net unrealized loss on other investments. For additional information, see Note 3 – Investments and Fair Value Measurement included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Impairment of equity method investment represents a $182 million impairment loss recorded on our MLU B.V. equity method investment. For additional information, see Note 4 - Equity Method Investments included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Revaluation of MLU B.V. call option represents a $191 million net gain for the change in fair value of the call option granted to Yandex (“MLU B.V. Call Option”). For additional information, see Note 4 - Equity Method Investments included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.55Provision for (Benefit from) Income TaxesYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Provision for (benefit from) income taxes$(492)$(181)63 %Effective tax rate48.0 %1.9 %2022 Compared to 2021Provision for (benefit from) income taxes decreased by $311 million primarily due to the deferred China and U.S. tax impact related to our investment in Didi, the deferred U.S. tax impact related to the acquisitions recognized in 2021, offset by the deferred U.S. tax impact related to our investments in Aurora, Grab, and Zomato.Income (Loss) from Equity Method InvestmentsYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Income (loss) from equity method investments$(37)$107 **Percentage of revenue— %— %** Percentage not meaningful.2022 Compared to 2021Income (loss) from equity method investments increased by $144 million due to an increase in our portion of the net income from our Yandex.Taxi joint venture.Segment Results of OperationsWe operate our business as three operating and reportable segments: Mobility, Delivery, and Freight. For additional information about our segments, see Note 13 – Segment Information and Geographic Information in the notes to the consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.RevenueYear Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Mobility$6,953 $14,029 102 %Delivery8,362 10,901 30 %Freight2,132 6,947 226 %All Other (1)8 — (100)%Total revenue$17,455 $31,877 83 %(1) Includes historical results of ATG and Other Technology Programs and New Mobility. Refer to Note 13 – Segment Information and Geographic Information and Note 18 – Divestitures for further information.Segment Adjusted EBITDASegment Adjusted EBITDA is defined as revenue less the following expenses: cost of revenue, exclusive of depreciation and amortization, operations and support, sales and marketing, and general and administrative and research and development expenses associated with our segments. Segment adjusted EBITDA also excludes non-cash items, certain transactions that are not indicative of ongoing segment operating performance and/or items that management does not believe are reflective of our ongoing core operations. For additional information, see Note 13 – Segment Information and Geographic Information to our consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.56Year Ended December 31,2021 to 2022 % Change(In millions, except percentages)20212022Mobility$1,596 $3,299 107 %Delivery(348)551 **Freight(130)— 100 %All Other (1)(11)— 100 %Corporate G&A and Platform R&D (2), (3)(1,881)(2,137)(14)%Adjusted EBITDA (4)$(774)$1,713 **(1) Includes historical results of ATG and Other Technology Programs and New Mobility. Refer to Note 13 – Segment Information and Geographic Information and Note 18 – Divestitures for further information regarding the sale of our ATG Business.(2) Excluding stock-based compensation expense.(3) Includes costs that are not directly attributable to our reportable segments. Corporate G&A also includes certain shared costs such as finance, accounting, tax, human resources, information technology and legal costs. Platform R&D also includes mapping and payment technologies and support and development of the internal technology infrastructure. Our allocation methodology is periodically evaluated and may change.(4) See the section titled “Reconciliations of Non-GAAP Financial Measures” for more information and reconciliations to the most directly comparable GAAP financial measure.** Percentage not meaningful.Mobility SegmentFor the year ended December 31, 2022 compared to the same period in 2021, Mobility revenue increased $7.1 billion, or 102% and Mobility adjusted EBITDA profit increased $1.7 billion, or 107%.Mobility revenue increased primarily attributable to an increase in Mobility Gross Bookings due to increases in Trip volumes as the business recovers from the impacts of COVID-19. Mobility revenue also had a net increase of $3.9 billion from business model changes in the UK and accruals made for the resolution of historical claims in the UK relating to the classification of drivers.Mobility adjusted EBITDA profit increased primarily attributable to an increase in Mobility revenue, partially offset by a $1.4 billion increase in insurance expense as a result of an increase in miles driven and a $298 million increase in credit card processing costs.Delivery SegmentFor the year ended December 31, 2022 compared to the same period in 2021, Delivery revenue increased $2.5 billion, or 30% and Delivery adjusted EBITDA grew $899 million, or 258%.Delivery revenue increased primarily attributable to an increase in Delivery Gross Bookings of 14%, on a constant currency basis, driven by an increase in food delivery orders and higher basket sizes. Delivery Take Rate improved to 19.5% from 16.2% compared to the same period in 2021 driven by an overall improvement in basket sizes and increase in orders. Additionally, we saw an $892 million increase in Delivery revenue and Take Rate resulting from an increase in certain Courier payments and incentives that are recorded in cost of revenue, exclusive of depreciation and amortization, for certain markets where we are primarily responsible for Delivery services and pay Couriers for services provided.Delivery Adjusted EBITDA improvement is primarily attributable to an increase in Delivery revenue, partially offset by (i) a $1.6 billion increase in cost of revenue, exclusive of depreciation and amortization, driven by a $1.4 billion increase in Courier payments and incentives that are recorded in cost of revenue for certain markets where we are primarily responsible for Delivery services and pay Couriers for services provided, and (ii) a $231 million increase in employee headcount costs.Freight SegmentFor the year ended December 31, 2022 compared to the same period in 2021, Freight revenue increased $4.8 billion, or 226% and Freight adjusted EBITDA grew $130 million, or 100%.Freight revenue increased primarily attributable to the acquisition of Transplace in the fourth quarter of 2021. Additionally, the increase in Freight revenue is also driven by the growth in the number of shippers and carriers on the network combined with an increase in volumes with our top Shippers.Freight adjusted EBITDA improvement is attributable to a $4.8 billion improvement in Freight revenue, partially offset by (i) $4.3 billion of certain Shipper payments recorded in cost of revenue, exclusive of depreciation and amortization, mainly due to a $3.3 57billion increase in Freight Carrier payments resulting from the acquisition of Transplace in the fourth quarter of 2021, and (ii) a $329 million increase in employee headcount costs.All Other For the year ended December 31, 2022 compared to the same period in 2021, All Other revenue decreased $8 million, or 100% and All Other adjusted EBITDA grew $11 million, or 100%.All Other revenue decreased and All Other adjusted EBITDA grew primarily due to the favorable impact of the sale of our ATG Business in the first quarter of 2021.Certain Key Metrics and Non-GAAP Financial MeasuresAdjusted EBITDA and revenue growth rates in constant currency are non-GAAP financial measures. For more information about how we use these non-GAAP financial measures in our business, the limitations of these measures, and reconciliations of these measures to the most directly comparable GAAP financial measures, see the section titled “Reconciliations of Non-GAAP Financial Measures.”Monthly Active Platform Consumers. MAPCs is the number of unique consumers who completed a Mobility or New Mobility ride or received a Delivery order on our platform at least once in a given month, averaged over each month in the quarter. While a unique consumer can use multiple product offerings on our platform in a given month, that unique consumer is counted as only one MAPC. We use MAPCs to assess the adoption of our platform and frequency of transactions, which are key factors in our penetration of the countries in which we operate.Trips. We define Trips as the number of completed consumer Mobility or New Mobility rides and Delivery orders in a given period. For example, an UberX Share ride with three paying consumers represents three unique Trips, whereas an UberX ride with three passengers represents one Trip. We believe that Trips are a useful metric to measure the scale and usage of our platform.58Gross Bookings. We define Gross Bookings as the total dollar value, including any applicable taxes, tolls, and fees, of: Mobility rides; Delivery orders (in each case without any adjustment for consumer discounts and refunds); Driver and Merchant earnings; Driver incentives and Freight revenue. Gross Bookings do not include tips earned by Drivers. Gross Bookings are an indication of the scale of our current platform, which ultimately impacts revenue. (In millions)Q1 2021Q2 2021Q3 2021Q4 2021Q1 2022Q2 2022Q3 2022Q4 2022Mobility$6,773 $8,640 $9,883 $11,340 $10,723 $13,364 $13,684 $14,894 Delivery12,461 12,912 12,828 13,444 13,903 13,876 13,684 14,315 Freight302 348 402 1,082 1,823 1,838 1,751 1,540 Take Rate is defined as revenue as a percentage of Gross Bookings.Adjusted EBITDA. See the section titled “Reconciliations of Non-GAAP Financial Measures” for our definition and a reconciliation of net loss attributable to Uber Technologies, Inc. to Adjusted EBITDA.Year Ended December 31,(In millions, except percentages)202120222021 to 2022 % ChangeAdjusted EBITDA$(774)$1,713 **** Percentage not meaningful.2022 Compared to 2021Adjusted EBITDA improved $2.5 billion, to $1.7 billion, primarily attributable to a $1.7 billion increase in Mobility Adjusted EBITDA, a $899 million improvement in Delivery Adjusted EBITDA, as well as a $130 million increase in Freight Adjusted EBITDA, partially offset by a $256 million increase in Corporate G&A and Platform R&D costs.Reconciliations of Non-GAAP Financial MeasuresWe collect and analyze operating and financial data to evaluate the health of our business and assess our performance. In addition to revenue, net income (loss), income (loss) from operations, and other results under GAAP, we use Adjusted EBITDA, revenue growth rates in constant currency and free cash flow, which are described below, to evaluate our business. We use these non-GAAP financial measures for financial and operational decision-making and as a means to evaluate period-to-period comparisons. We believe that these non-GAAP financial measures provide meaningful supplemental information regarding our performance by excluding certain items that may not be indicative of our recurring core business operating results.We believe that both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting, and analyzing future periods. These non-GAAP financial measures also facilitate management’s internal comparisons to our historical performance. We believe these non-GAAP financial measures are useful to investors both because (1) they allow for greater transparency with respect to key metrics used by management in its financial and operational decision-making and (2) they are used by our institutional investors and the analyst community to help them analyze the health of our business. Accordingly, we believe that these non-GAAP financial measures provide useful information to investors and others in understanding and evaluating our operating results in the same manner as our management team and board of directors. Our calculation of these non-GAAP financial measures may differ from similarly-titled non-GAAP measures, if any, reported by our peer 59companies. These non-GAAP financial measures should not be considered in isolation from, or as substitutes for, financial information prepared in accordance with GAAP.Adjusted EBITDAWe define Adjusted EBITDA as net income (loss), excluding (i) income (loss) from discontinued operations, net of income taxes, (ii) net income (loss) attributable to non-controlling interests, net of tax, (iii) provision for (benefit from) income taxes, (iv) income (loss) from equity method investments, (v) interest expense, (vi) other income (expense), net, (vii) depreciation and amortization, (viii) stock-based compensation expense, (ix) certain legal, tax, and regulatory reserve changes and settlements, (x) goodwill and asset impairments/loss on sale of assets, (xi) acquisition, financing and divestitures related expenses, (xii) restructuring and related charges and (xiii) other items not indicative of our ongoing operating performance, including COVID-19 response initiatives related payments for financial assistance to Drivers personally impacted by COVID-19, the cost of personal protective equipment distributed to Drivers, Driver reimbursement for their cost of purchasing personal protective equipment, the costs related to free rides and food deliveries to healthcare workers, seniors, and others in need as well as charitable donations.We have included Adjusted EBITDA in this Annual Report on Form 10-K because it is a key measure used by our management team to evaluate our operating performance, generate future operating plans, and make strategic decisions, including those relating to operating expenses. Accordingly, we believe that Adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management team and board of directors. In addition, it provides a useful measure for period-to-period comparisons of our business, as it removes the effect of certain non-cash expenses and certain variable charges. To help our board, management and investors assess the impact of COVID-19 on our results of operations, we are excluding the impacts of COVID-19 response initiatives related payments for financial assistance to Drivers personally impacted by COVID-19, the cost of personal protective equipment distributed to Drivers, Driver reimbursement for their cost of purchasing personal protective equipment, the costs related to free rides and food deliveries to healthcare workers, seniors, and others in need as well as charitable donations from Adjusted EBITDA. Our board and management find the exclusion of the impact of these COVID-19 response initiatives from Adjusted EBITDA to be useful because it allows us and our investors to assess the impact of these response initiatives on our results of operations.COVID-19 Response InitiativesTo support those whose earning opportunities have been depressed as a result of COVID-19, as well as communities hit hard by the pandemic, we have announced and implemented several initiatives, including, in particular, payments for financial assistance to Drivers personally impacted by COVID-19, the cost of personal protective equipment distributed to Drivers, Driver reimbursement for their cost of purchasing personal protective equipment, the costs related to free rides and food deliveries to healthcare workers, seniors, and others in need as well as charitable donations. The payments for financial assistance to Drivers personally impacted by COVID-19 and Driver reimbursement for their cost of purchasing personal protective equipment are recorded as a reduction to revenue. The cost of personal protective equipment distributed to Drivers, the costs related to free rides and food deliveries to healthcare workers, seniors, and others in need as well as charitable donations are recorded as an expense in our costs and expenses.Limitations of Non-GAAP Financial Measures and Adjusted EBITDA ReconciliationAdjusted EBITDA has limitations as a financial measure, should be considered as supplemental in nature, and is not meant as a substitute for the related financial information prepared in accordance with GAAP. These limitations include the following:•Adjusted EBITDA excludes certain recurring, non-cash charges, such as depreciation of property and equipment and amortization of intangible assets, and although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect all cash capital expenditure requirements for such replacements or for new capital expenditure requirements;•Adjusted EBITDA excludes stock-based compensation expense, which has been, and will continue to be for the foreseeable future, a significant recurring expense in our business and an important part of our compensation strategy;•Adjusted EBITDA excludes certain restructuring and related charges, part of which may be settled in cash;•Adjusted EBITDA excludes other items not indicative of our ongoing operating performance, including COVID-19 response initiatives related payments for financial assistance to Drivers personally impacted by COVID-19, the cost of personal protective equipment distributed to Drivers, Driver reimbursement for their cost of purchasing personal protective equipment, the costs related to free rides and food deliveries to healthcare workers, seniors, and others in need as well as charitable donations;•Adjusted EBITDA does not reflect period to period changes in taxes, income tax expense or the cash necessary to pay income taxes;•Adjusted EBITDA does not reflect the components of other income (expense), net, which primarily includes: interest income; foreign currency exchange gains (losses), net; gain (loss) on business divestitures, net; and unrealized gain (loss) on debt and equity securities, net; and impairment of debt and equity securities; and60•Adjusted EBITDA excludes certain legal, tax, and regulatory reserve changes and settlements that may reduce cash available to us. The following table presents a reconciliation of net loss attributable to Uber Technologies, Inc., the most directly comparable GAAP financial measure, to Adjusted EBITDA for each of the periods indicated:Year Ended December 31,(In millions)20212022Adjusted EBITDA reconciliation:Net loss attributable to Uber Technologies, Inc.$(496)$(9,141)Add (deduct):Net income (loss) attributable to non-controlling interests, net of tax(74)3 Provision for (benefit from) income taxes(492)(181)(Income) loss from equity method investments37 (107)Interest expense483 565 Other (income) expense, net(3,292)7,029 Depreciation and amortization902 947 Stock-based compensation expense1,168 1,793 Legal, tax, and regulatory reserve changes and settlements526 732 Goodwill and asset impairments/loss on sale of assets157 25 Acquisition, financing and divestitures related expenses102 46 Accelerated lease costs related to cease-use of ROU assets5 6 COVID-19 response initiatives54 1 Loss on lease arrangement, net— 7 Restructuring and related charges, net— 2 Legacy auto insurance transfer (1)103 — Mass arbitration fees, net43 (14)Adjusted EBITDA$(774)$1,713 (1) For further information, refer to Note 1 – Description of Business and Summary of Significant Accounting Policies in the notes to the consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Constant CurrencyWe compare the percent change in our current period results from the corresponding prior period using constant currency disclosure. We present constant currency growth rate information to provide a framework for assessing how our underlying revenue performed excluding the effect of foreign currency rate fluctuations. We calculate constant currency by translating our current period financial results using the corresponding prior period’s monthly exchange rates for our transacted currencies other than the U.S. dollar. Free Cash FlowWe define free cash flow as net cash flows from operating activities less capital expenditures. The following table presents a reconciliation of free cash flow to the most directly comparable GAAP financial measure for each of the periods indicated:Year Ended December 31,(In millions)20212022Free cash flow reconciliation:Net cash provided by (used in) operating activities (1)$(445)$642 Purchases of property and equipment(298)(252)Free cash flow (1)$(743)$390 (1) Net cash used in operating activities and free cash flow during the year ended December 31, 2021 reflected a $1.0 billion cash inflow related to a legacy auto insurance transfer. For additional information on the legacy auto insurance transfer, refer to the section titled “Liquidity and Capital Resources” for more information.61Net cash provided by operating activities and free cash flow during the year ended December 31, 2022 reflected a cash outflow of approximately $733 million (GBP 613 million) related to the resolution of outstanding HMRC VAT claims that were paid during the fourth quarter of 2022. For additional information on this matter, refer to Note 14 – Commitments and Contingencies to our consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K as well as the section titled “Liquidity and Capital Resources.”Liquidity and Capital ResourcesYear Ended December 31,(In millions)20212022Net cash provided by (used in) operating activities$(445)$642 Net cash used in investing activities(1,201)(1,637)Net cash provided by financing activities1,780 15 Operating ActivitiesNet cash provided by operating activities was $642 million for the year ended December 31, 2022, primarily consisting of $9.1 billion of net loss, adjusted for certain non-cash items, which primarily included $7.0 billion in unrealized losses from equity securities, $1.8 billion of stock-based compensation expense, and $947 million depreciation and amortization expense as well as a $335 million decrease in cash consumed by working capital. The decrease in cash consumed by working capital was primarily driven by an increase in our insurance reserves and accrued expenses and other current liabilities, partially offset by higher accounts receivable. Net cash provided by operating activities reflects a cash outflow of approximately $733 million (GBP 613 million) related to the resolution of outstanding HMRC VAT claims that were paid during the fourth quarter of 2022. For additional information on this matter, refer to Note 14 – Commitments and Contingencies to our consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Net cash used in operating activities was $445 million for the year ended December 31, 2021, primarily consisting of $570 million of net loss, adjusted for certain non-cash items, which primarily included $1.7 billion in gain on business divestitures, $1.2 billion of stock-based compensation expense, $1.1 billion of unrealized gain on debt and equity securities, $413 million of gain from sale of investments, depreciation and amortization expense of $902 million, as well as a $477 million decrease in cash consumed by working capital. The decrease in cash consumed by working capital and other operating activities was primarily driven by an increase in accrued expenses and other liabilities, an increase in our insurance reserves, partially offset by higher accounts receivable and prepaid expenses and lower operating lease liabilities. Net cash used in operating activities also reflects a $1.0 billion cash inflow related to legacy auto insurance transfer. For additional information on the legacy auto insurance transfer, see Note 1 – Description of Business and Summary of Significant Accounting Policies included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Investing ActivitiesNet cash used in investing activities was $1.6 billion for the year ended December 31, 2022, primarily consisting of $1.7 billion in purchases of marketable securities, $252 million in purchases of property and equipment, and $59 million in acquisition of business, net of cash acquired, partially offset by proceeds from maturities and sales of marketable securities of $376 million.Net cash used in investing activities was $1.2 billion for the year ended December 31, 2021, primarily consisting of $2.3 billion in acquisition of businesses, net of cash acquired, $1.1 billion in purchases of marketable securities, $982 million in purchases of non-marketable equity securities, $297 million in purchases of notes receivable, and $298 million in purchases of property and equipment, partially offset by proceeds from maturities and sales of marketable securities of $2.3 billion, proceeds from the sale of equity method investments of $1.0 billion and proceeds from sale of non-marketable equity securities of $500 million.Financing ActivitiesNet cash provided by financing activities was $15 million for the year ended December 31, 2022, primarily consisting of proceeds from sale of subsidiary stock units of $255 million, and proceeds from the issuance of common stock under the Employee Stock Purchase Plan of $92 million, partially offset by $184 million of principal payments on finance leases, and $80 million of principal repayment on the non-interest bearing unsecured convertible notes related to the acquisition of Careem (“Careem Notes”).Net cash provided by financing activities was $1.8 billion for the year ended December 31, 2021, primarily consisting of $1.5 billion of proceeds from issuance of notes, net of issuance costs, $675 million of proceeds from issuance of subsidiary preferred stock units, partially offset by $307 million of principal repayment on Careem Notes and $226 million principal payments on finance leases.Other InformationAs of December 31, 2022, $2.4 billion of our $4.2 billion in cash and cash equivalents was held by our foreign subsidiaries. Cash held outside the United States may be repatriated, subject to certain limitations, and would be available to be used to fund our domestic operations. Repatriation of funds may result in immaterial tax liabilities. We believe that our existing cash balance in the 62United States is sufficient to fund our working capital needs in the United States. We are in compliance with our debt and line of credit covenants as of December 31, 2022, including by meeting our reporting obligations. We also believe that our sources of funding and our available line of credit will be sufficient to satisfy our currently anticipated cash requirements including capital expenditures, working capital requirements, collateral requirements, potential acquisitions, potential prepayments of contested indirect tax assessments (“pay-to-play”), and other liquidity requirements through at least the next 12 months. We intend to continue to evaluate and may, in certain circumstances, take preemptive action to preserve liquidity. Non-Income Tax MattersOn October 31, 2022, we resolved all outstanding HMRC (the tax regulator in the UK) VAT claims related to periods prior to our model change on March 14, 2022. There was not a material impact to our statement of operations as we had adequate reserves recorded related to this resolution. During the fourth quarter of 2022, we made a payment of approximately $733 million (GBP 613 million) for this resolution. For additional information, see Note 14 – Commitments and Contingencies in the section titled “Notes to Consolidated Financial Statements” included in Part II, Item 8 of this Annual Report on Form 10-K.CommitmentsLeasesOur operating lease portfolio primarily consists of corporate offices. For additional information, see Note 6 - Leases in the notes to the consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Long-Term DebtWe have long-term debt with varying maturities dates through 2029. For additional information, see Note 8 – Long-Term Debt and Revolving Credit Arrangements in the notes to the consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Purchase CommitmentsWe have non-cancelable commitments which primarily relate to network and cloud services and other items in the ordinary course of business. These amounts are determined based on the non-cancelable quantities to which we are contractually obligated. In November 2022, we entered into commercial technology agreements with vendors for cloud computing services (“2022 Cloud Computing Service Agreements”). We are committed to spend an aggregate of at least $2.9 billion through November 2029, of which $160 million is short-term. We may pay more than the minimum purchase commitment to our cloud-computing web services providers based on usage. As of December 31, 2022, the amounts utilized for these agreements are immaterial.As of December 31, 2022, we had $3.2 billion in non-cancelable commitments, this includes the $2.9 billion in 2022 Cloud Computing Service Agreements discussed above. The non-cancellable commitments have varying expiration terms through November 2029.Critical Accounting EstimatesWe believe that the following accounting policies involve a high degree of judgment and complexity and are critical to understanding and evaluating our consolidated financial condition and results of our operations. An accounting policy is considered to be critical if it requires judgment on a significant accounting estimate to be made based on assumptions about matters that are uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the reported amounts of assets, liabilities, revenue and expenses, and related disclosures in our audited consolidated financial statements. We have based our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Although we believe that the estimates we use are reasonable, due to the inherent uncertainty involved in making those estimates, actual results reported in future periods could differ from those estimates.We believe that the following critical accounting policies reflect the more significant judgments, estimates and assumptions used in the preparation of our consolidated financial statements. For additional information, see the disclosure included in Note 1 – Description of Business and Summary of Significant Accounting Policies in the notes to the consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.Revenue RecognitionWe derive our revenue principally from service fees paid by Drivers and Merchants for the use of our platform in connection with our Mobility products and Delivery offering provided by Drivers and Merchants to end-users. Our sole performance obligation in the transaction is to connect Drivers and Merchants with end-users to facilitate the completion of a successful ridesharing trip or delivery. In certain markets, we also generate revenue from end-users and charge a direct fee for use of the platform and in exchange for 63Mobility and Delivery services. With exception of these markets, end-users are not our customers because end-users access our platform for free and we have no performance obligation to end-users.Judgment is required in evaluating the presentation of revenue on a gross versus net basis based on whether we control the service provided to the end-user and are the principal in the transaction (gross), or we arrange for other parties to provide the service to the end-user and are the agent in the transaction (net). We have concluded that we are the agent in most markets as we arrange for Drivers and Merchants to provide the service to the end user in Mobility and Delivery transactions. The assessment of whether we are considered the principal or the agent in a transaction could impact the accounting for certain payments and incentives provided to Drivers and end-users and change the timing and amount of revenue recognized.In certain markets, consumers have the option to pay Drivers cash for trips, and we generally collect our service fee from Drivers for these trips by offsetting against any other amounts due to Drivers, including Driver incentives. We have concluded collectability of such amounts is not probable until collected. As such, uncollected service fees for cash trips are not recognized as revenue in our consolidated financial statements until collected.Driver IncentivesWe offer various incentive programs to Drivers. Judgment is required to determine the appropriate classification of these incentives. Incentives provided to customers are recorded as a reduction of revenue if we do not receive a distinct service in exchange or cannot reasonably estimate the fair value of the service received. Incentives offered in exchange for specific services, such as referral services are recorded as sales and marketing expenses.End-User Discounts and PromotionsWe offer discounts and promotions to end-users (that are not customers) to encourage use of our platform. Judgment is required to determine the appropriate classification of these incentives. End-user discounts and promotions are recorded to sales and marketing expenses with the exception of market-wide promotions which are recorded as a reduction of revenue.Business CombinationsWe allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired advertiser, fleet, merchant, and end-user contracts, acquired technology, and trade names, based on expected future growth rates and margins, attrition rates, future changes in technology and royalty for similar brand licenses, useful lives, and discount rates.Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Allocation of purchase consideration to identifiable assets and liabilities affects our amortization expense, as acquired finite-lived intangible assets are amortized over the useful life, whereas any indefinite lived intangible assets, including goodwill, are not amortized. During the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.Investments—Non-Marketable Equity and Debt SecuritiesWe hold investments in privately held companies in the form of equity securities and debt securities without readily determinable fair values and in which we do not have a controlling interest or significant influence. Investments in equity securities without readily determinable fair values are initially recorded at cost and are subsequently adjusted to fair value for impairments and price changes from observable transactions in the same or a similar security from the same issuer. Investments in material available-for-sale debt securities are recorded initially at fair value and subsequently remeasured to fair value at each reporting date with the changes in fair value recognized in other comprehensive income (loss), net of tax. We may elect the fair value option for financial instruments and account for investments in debt and equity securities at fair value with changes reported in net income (loss) from continuing operations.Investments in privately held equity and debt securities are valued using significant unobservable inputs or data in inactive markets. This valuation requires judgment due to the absence of market prices and inherent lack of liquidity and are classified as Level 3 in the fair value hierarchy. In determining the estimated fair value of our investments in privately held companies, we utilize the most recent data available including observed transactions such as equity financing transactions of the investees and sales of the existing shares of the investees’ securities. In addition, the determination of whether an observed transaction is similar to the equity and debt securities held by us requires significant management judgment based on the rights and preferences of the securities.We assess our investment portfolio of privately held equity and debt securities quarterly for impairment. The impairment analysis for investments in equity securities includes a qualitative analysis of factors including the investee’s financial performance, industry and market conditions, and other relevant factors. If an equity investment is considered to be impaired we will establish a new carrying 64value for the investment and recognize an impairment loss through our consolidated statement of operations. Investments in debt securities are evaluated for impairment quarterly based on whether its fair value has declined below its amortized cost. In circumstances where we intend to sell, or are more likely than not required to sell the security before it recovers its amortized cost basis, the difference between the fair value and amortized cost is recognized as a loss in the consolidated financial statement of operations, with a corresponding write-down of the security’s amortized cost. In circumstances where neither condition exists, we then evaluate whether a decline is due to credit-related factors. The factors considered in determining whether a credit loss exists can include the extent to which fair value is less than the amortized cost basis, changes in the credit quality of the underlying loan obligors, credit ratings actions, as well as other factors. To determine the portion of a decline in fair value that is credit-related, we compare the present value of the expected cash flows of the security discounted at the security’s effective interest rate to the amortized cost basis of the security. A credit-related impairment is limited to the difference between fair value and amortized cost, and recognized as an allowance for credit loss on the consolidated balance sheet with a corresponding adjustment to net income (loss). Any remaining decline in fair value that is non-credit related is recognized in other comprehensive income (loss), net of tax. Improvements in expected cash flows due to improvements in credit are recognized through reversal of the credit loss and corresponding reduction in the allowance for credit loss.Equity Method InvestmentsWe account for investments in the common stock or in-substance common stock of entities that provide us with the ability to exercise significant influence, but not a controlling financial interest, using the equity method. Investments accounted for under the equity method are initially recorded at cost. Subsequently, we recognize through the consolidated statements of operations, and as an adjustment to the investment balance, our proportionate share of the investee entities’ net income or loss, and the amortization of basis differences. In accounting for these investments, we record our share of the entities’ net income or loss one quarter in arrears. Equity method investments for which the fair value option is elected are measured at fair value on a recurring basis with changes in fair value reflected in earnings.We review our equity method investments for impairment whenever events or changes in business circumstances indicate that the carrying value of the investment may not be fully recoverable. Qualitative and quantitative factors considered as indicators of a potential impairment include financial results and operating trends of the investees, implied values in transactions of the investee’s securities, severity and length of decline in value, and our intention for holding the investment, among other factors. If an impairment is determined to be other-than-temporary, the fair value of the impaired investment would have to be determined and an impairment charge recorded for the difference between the fair value and the carrying value of the investment. The fair value determination, particularly for investments in privately held companies, requires significant judgment to determine appropriate estimates and assumptions. Changes in these estimates and assumptions could affect the calculation of the fair value of the investments and the determination of the impairment charges.Goodwill Impairment AssessmentWe review goodwill for impairment annually (in the fourth quarter) and whenever events or changes in circumstances indicate that goodwill might be impaired. We make certain judgments and assumptions to determine our reporting units and in allocating shared assets and liabilities to determine the carrying values for each of our reporting units. Determination of reporting units is based on a judgmental evaluation of the level at which our segment managers review financial results, evaluate performance, and allocate resources.Judgment in the assessment of qualitative factors of impairment include, among other factors: financial performance; legal, regulatory, contractual, political, business, and other factors; entity specific factors; industry and market considerations, macroeconomic conditions, and other relevant events and factors affecting the reporting unit. To the extent we determine that it is more likely than not that the fair value of the reporting unit is less than its carrying value, a quantitative test is then performed.Performing a quantitative goodwill impairment test includes the determination of the fair value of a reporting unit and involves significant estimates and assumptions. These estimates and assumptions include, among others, revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions, and the determination of appropriate market comparables.Loss ContingenciesWe are involved in legal proceedings, claims, and regulatory, indirect tax examinations, or government inquiries and investigations that may arise in the ordinary course of business. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred and the amount can be reasonably estimated. If we determine that a loss is reasonably possible and the loss or range of loss can be reasonably estimated, we disclose the possible loss in the accompanying notes to the consolidated financial statements.We review the developments in our contingencies that could affect the amount of the provisions that have been previously recorded, and the matters and related reasonably possible losses disclosed. We make adjustments to our provisions and changes to our disclosures accordingly to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Significant judgment is required to determine both the probability and the estimated amount of loss. These estimates have been based 65on our assessment of the facts and circumstances at each balance sheet date and are subject to change based on new information and future events.The outcomes of litigation, regulatory, indirect tax examinations and investigations are inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management’s expectations, our results of operations, financial condition, or cash flows, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected.Income TaxesWe are subject to income taxes in the United States and foreign jurisdictions. We account for income taxes using the asset and liability method. The establishment of deferred tax assets from intra-entity transfers of intangible assets requires management to make significant estimates and assumptions to determine the fair value of such intangible assets. Significant estimates in valuing intangible assets may include, but are not necessarily limited to, internal revenue and expense forecasts, the estimated life of the intangible assets, comparable transaction values, and/or discount rates. The discount rates used to discount expected future cash flows to present value are derived from a weighted-average cost of capital analysis and are adjusted to reflect the inherent risks related to the cash flow. Although we believe the assumptions and estimates we have made are reasonable and appropriate, they are based, in part, on historical experience, internal and external comparable data and are inherently uncertain. Unanticipated events and circumstances may occur that could affect either the accuracy or validity of such assumptions, estimates or actual results.We account for uncertainty in tax positions by recognizing a tax benefit from uncertain tax positions when it is more-likely-than-not that the position will be sustained upon examination. Evaluating our uncertain tax positions and determining our provision for income taxes are inherently uncertain and require making judgments, assumptions, and estimates. While we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences may impact the provision for income taxes and the effective tax rate in the period in which such determination is made.The provision for income taxes includes the impact of reserve provisions and changes to reserves as well as the related net interest and penalties. In addition, we are subject to the continuous examination of our income tax returns by the IRS and other tax authorities which may assert assessments against us. We regularly assess the likelihood of adverse outcomes resulting from these examinations and assessments to determine the adequacy of our provision for income taxes.Insurance ReservesWe use a combination of third-party insurance and self-insurance mechanisms, including a wholly-owned captive insurance subsidiary, to provide for the potential liabilities for certain risks, including auto liability, uninsured and underinsured motorist, auto physical damage, general liability, and workers’ compensation. The insurance reserves is an estimate of our potential liability for unpaid losses and loss adjustment expenses, which represents the estimate of the ultimate unpaid obligation for risks retained by us and includes an amount for case reserves related to reported claims and an amount for losses incurred but not reported as of the balance sheet date. The estimate of the ultimate unpaid obligation utilizes generally accepted actuarial methods applied to historical claim and loss experience. In addition, we use assumptions based on actuarial judgment related to claim and loss development patterns and expected loss costs, which consider frequency trends, severity trends, and relevant industry data. These reserves are continually reviewed and adjusted as experience develops and new information becomes known. Adjustments, if any, relating to accidents that occurred in prior years are reflected in the current year results of operations.All estimates of ultimate losses and allocated loss adjustment expenses, and of resulting reserves, are subject to inherent variability caused by the nature of the insurance claim settlement process. Such variability is increased for us due to limited historical experience and the nature of the coverage provided. Actual results depend upon the outcome of future contingent events and can be affected by many factors, such as claim settlement processes and changes in the economic, legal, and social environments. As a result, the net amounts that will ultimately be paid to settle the liability, and when these amounts will be paid, may vary in the near term from the estimated amounts.While management believes that the insurance reserve amount is adequate, the ultimate liability may be in excess of, or less than, the amount provided.Stock-Based CompensationWe have granted stock-based awards consisting primarily of stock options, restricted common stock, RSUs, warrants, and SARs to employees, members of our board of directors and non-employees. The substantial majority of our stock-based awards have been made to employees. The majority of our outstanding RSUs, as well as certain options, SARs, and shares of restricted common stock, contain a service-based vesting condition. A small portion of the awards contains service-based vesting condition as well as performance-based vesting condition and/or market-based vesting condition. The service-based vesting condition for the majority of these awards is satisfied over four years. The performance-based vesting condition is satisfied upon meeting predetermined targets of 66certain financial and operation metrics. The market-based vesting condition is satisfied upon reaching predetermined targets of fully diluted equity values. We account for stock-based employee compensation under the fair value recognition and measurement provisions, in accordance with applicable accounting standards, which requires compensation expense for the grant-date fair value of stock-based awards to be recognized over the requisite service period. We account for forfeitures when they occur.We have elected to use the Black-Scholes option-pricing model to determine the fair value of stock options, warrants, and SARs on the grant date. The Black-Scholes option-pricing model requires certain subjective inputs and assumptions, including the fair value of our common stock, the expected term, risk-free interest rates, expected stock price volatility, and expected dividend yield of our common stock.These assumptions used in the Black-Scholes option-pricing model, other than the fair value of our common stock, are estimated as follows:•Expected term. We estimate the expected term based on the simplified method for employees and on the contractual term for non-employees.•Risk-free interest rate. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant.•Expected volatility. We estimate the volatility of our common stock on the date of grant based on the weighted-average historical stock price volatility of our own common shares within the same length of period as the expected term. Where, in some cases, our common share trading history is shorter than the expected term, we consider comparable publicly-traded companies in our industry group.•Expected dividend yield. Expected dividend yield is zero percent, as we have not paid and do not anticipate paying dividends on our common stock.We continue to use judgment in evaluating the expected volatility and expected term utilized in our stock-based compensation expense calculation on a prospective basis. As we continue to accumulate additional data related to our common stock, we may refine our estimates of expected volatility and expected term, which could materially impact our future stock-based compensation expense.Recent Accounting Pronouncements See Note 1 – Description of Business and Summary of Significant Accounting Policies, to the consolidated financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data,” of this Annual Report on Form 10-K.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are exposed to market risks in the ordinary course of our business. These risks primarily include interest rate risk, investment risk, and foreign currency risk as follows:Interest Rate RiskOur exposures to market risk for changes in interest rates relate primarily to our 2025 Refinanced Term Loan and 2027 Refinanced Term Loan Facilities. The 2025 and 2027 Refinanced Term Loan Facilities represent floating rate notes and are carried at amortized cost. Therefore, fluctuations in interest rates will impact our consolidated financial statements. A rising interest rate environment will increase the amount of interest paid on these loans. A hypothetical 100 basis point increase or decrease in interest rates would not have a material effect on our financial results.The fair value of our fixed rate notes will generally fluctuate with movements of interest rates, increasing in periods of declining rates of interest and declining in periods of increasing rates of interest. A hypothetical 100 basis point increase in interest rates would have decreased the fair value of our notes by $232 million as of December 31, 2022.Investment Risk Our investment policy objective aims to preserve capital and meet liquidity requirements without significantly increasing risk. We had cash and cash equivalents including restricted cash and cash equivalents totaling $7.8 billion and $6.7 billion as of December 31, 2021 and December 31, 2022, respectively. Marketable debt securities classified as restricted investments and short-term investments totaled $1.7 billion as of December 31, 2022. As of December 31, 2022, our cash, cash equivalents, and marketable debt securities primarily consist of money market funds, cash deposits, U.S. government securities, U.S. government agency securities, and investment-grade corporate debt securities. We do not enter into investments for trading or speculative purposes. Investments in fixed rate securities carry a degree of interest rate risk. Changes in rates would primarily impact interest income due to the relatively short-term nature of our investments. A hypothetical 100 basis point change in interest rates would not have a material effect on our financial results.We are exposed to certain risk related to the carrying amounts of investments in other companies, including our minority-owned, privately-held affiliates and recently public companies, compared to their fair value. We hold privately held investments in illiquid private company stock which are inherently difficult to value given the lack of publicly available information. We also hold equity securities with readily determinable fair values which are subject to equity price risk. These investments in privately-held affiliates and 67recently public companies may increase the volatility in our net income/(loss) in future periods due to changes in the fair value of these investments. In certain cases, our ability to sell these investments may be impacted by contractual obligations to hold the securities for a set period of time after a public offering. As of December 31, 2022, the carrying value of our investments was $6.9 billion, including equity method investments and restricted investments.Foreign Currency RiskWe transact business globally in multiple currencies. Our international revenue, as well as costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. We are exposed to foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar. Accordingly, changes in exchange rates may negatively affect our future revenue and other operating results as expressed in U.S. dollars. Our foreign currency risk is partially mitigated as our revenue recognized in currencies other than the U.S. dollar is diversified across geographic regions and we incur expenses in the same currencies in such regions.We have experienced and will continue to experience fluctuations in our net income/(loss) as a result of transaction gains or (losses) related to remeasurement of our asset and liability balances that are denominated in currencies other than the functional currency of the entities in which they are recorded. Foreign currency rates may also impact the value of our equity method investment in our Yandex.Taxi joint venture. At this time, we do not, but we may in the future, enter into derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk.68
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this Annual Report on Form 10-K.Overview We were founded in 1990 as a beauty retailer at a time when prestige, mass, and salon products were sold through distinct channels – department stores for prestige products; drug stores and mass merchandisers for mass products; and salons and authorized retail outlets for professional hair care products. We developed a unique specialty retail concept that offers a broad range of brands and price points, select beauty services, and a convenient and welcoming shopping environment. We define our target consumer as a beauty enthusiast, a consumer who is passionate about the beauty category, uses beauty for self-expression, experimentation, and self-investment, and has high expectations for the shopping experience. We estimate beauty enthusiasts represent approximately 65% of shoppers and 80% of beauty products and services spend in the U.S. We believe our strategy provides us with the competitive advantages that have contributed to our financial performance.Today, we are the largest specialty beauty retailer in the United States and the premier beauty destination for cosmetics, fragrance, skin care products, hair care products, and salon services. Key aspects of our business include: a differentiated assortment of more than 25,000 beauty products across a variety of categories and price points as well as a variety of beauty services, including salon services, in more than 1,350 stores predominantly located in convenient, high-traffic locations; engaging digital experiences delivered through our website, Ulta.com, and our mobile applications; our best-in-class loyalty program that enables members to earn points for every dollar spent on products and beauty services and provides us with deep, proprietary customer insights; and our ability to cultivate human connection with warm and welcoming guest experiences across all of our channels. The continued growth of our business and any future increases in net sales, net income, and cash flows is dependent on our ability to execute our strategic priorities: 1) drive breakthrough and disruptive growth through an expanded definition of All Things Beauty; 2) evolve the omnichannel experience through connected physical and digital ecosystems, All In Your World; 3) expand and deepen our presence across the beauty journey, solidifying Ulta Beauty at the Heart of the Beauty Community; 4) drive operational excellence and optimization; 5) protect and cultivate our world-class culture and talent; and 6) expand our environmental and social impact. We believe the attractive and growing U.S. beauty products and salon services industry, the expanding definition of beauty and the role that omnichannel capabilities play in consumers’ lives, coupled with Ulta Beauty’s competitive strengths, position us to capture additional market share in the industry.Comparable sales is a key metric that is monitored closely within the retail industry. Our comparable sales have fluctuated in the past, and we expect them to continue to fluctuate in the future. A variety of factors affect our comparable sales, including general U.S. economic conditions, changes in merchandise strategy or mix, and timing and effectiveness of our marketing activities, among others.Over the long term, our growth strategy is to increase total net sales through growing our comparable sales, expanding omnichannel capabilities, and opening new stores. Long-term operating profit is expected to increase as a result of our efforts to optimize our real estate portfolio, expand merchandise margin, and leverage our fixed store costs with comparable sales increases and operating efficiencies, partially offset by incremental investments in people, guest experiences, systems, and supply chain required to support a 1,500 to 1,700 store chain in the U.S. with successful e-commerce and competitive omnichannel capabilities.31 Table of ContentsCurrent TrendsImpact of COVID-19We closely monitor the continuing impact of COVID-19 on all facets of our business. While operations during fiscal 2022 did not appear to be negatively impacted, the COVID-19 pandemic and the conditions and trends that originated during the pandemic could have negative impacts in the future. The extent of the impact of the pandemic and the conditions and trends that originated during the pandemic on our future business and financial results will depend on, among other things, the potential of temporary restrictions on operating hours, in-store services or reclosing of certain stores or other facilities of ours or our brand partners and other suppliers, supply chain disruptions, increased transportation and shipping costs, higher wholesale costs, increased labor costs, and the duration, timing and severity of the impact of the foregoing on consumer spending. Industry trends​Our research indicates that Ulta Beauty has captured meaningful market share across all categories over the last several years. However, the COVID-19 pandemic and its various impacts changed consumer behavior and consumption of beauty products, at least temporarily, due to the closures of offices, retail stores, and other businesses and the significant decline in travel, entertainment and social gatherings. The overall beauty market declined in 2020, stabilized in 2021, and expanded in 2022, as consumers resumed in-person shopping while maintaining some of their online shopping behaviors. We remain confident that our differentiated and diverse business model, our commitment to strategic investments, and our highly engaged associates will continue to drive market share gains over the long term.​Impact of inflation and other macroeconomic trends Although we do not believe inflation had a material impact on our sales during fiscal 2022, continued pressure from inflation or other evolving macroeconomic conditions could have an adverse impact on consumer spending and could lead to a recession. Furthermore, inflationary pressures, as well as other macroeconomic trends, could negatively impact our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net sales if the selling prices of our products do not increase with higher costs. In addition, inflation could materially increase the interest rates on any future debt.Basis of presentation​The Company has one reportable segment, which includes retail stores, salon services, and e-commerce. We recognize merchandise revenue at the point of sale in our retail stores. E-commerce sales are recognized upon shipment or guest pickup of the merchandise based on meeting the transfer of control criteria. Retail store and e-commerce sales are recorded net of estimated returns. Shipping and handling are treated as costs to fulfill the contract and not a separate performance obligation. Accordingly, we recognize revenue for our single performance obligation related to online sales at the time control of the merchandise passes to the customer, which is at the time of shipment or guest pickup. We provide refunds for merchandise returns within 60 days from the original purchase date. State sales taxes are presented on a net basis as we consider our self a pass-through conduit for collecting and remitting state sales tax. Salon service revenue is recognized at the time the service is provided to the guest. Gift card sales revenue is deferred until the guest redeems the gift card. Company coupons and other incentives are recorded as a reduction of net sales. Other revenue includes the private label and co-branded credit card programs, royalties derived from the partnership with Target Corporation, and deferred revenue related to the loyalty program and gift card breakage.​Comparable sales reflect sales for stores beginning on the first day of the 14th month of operation. Therefore, a store is included in our comparable store base on the first day of the period after one year of operations plus the initial one-month grand opening period. Non-comparable store sales include sales from new stores that have not yet completed their 13th month of operation and stores that were closed for part or all of the period in either year. Remodeled stores are included in comparable sales unless the store was closed for a portion of the current or prior period. Comparable sales 32 Table of Contentsinclude retail sales, salon services, and e-commerce. There may be variations in the way in which some of our competitors and other retailers calculate comparable or same store sales.Measuring comparable sales allows us to evaluate the performance of our store base as well as several other aspects of our overall strategy. Several factors could positively or negatively impact our comparable sales results:●the general national, regional, and local economic conditions and corresponding impact on customer spending levels;●the introduction of new products or brands;●the location of new stores in existing store markets;●competition;●our ability to respond on a timely basis to changes in consumer preferences;●the effectiveness of our various merchandising and marketing activities; and●the number of new stores opened and the impact on the average age of all of our comparable stores.Cost of sales includes:●the cost of merchandise sold, offset by vendor income that is not a reimbursement of specific, incremental, and identifiable costs;●distribution costs including labor and related benefits, freight, rent, depreciation and amortization, real estate taxes, utilities, and insurance;●shipping and handling costs;●retail store occupancy costs including rent, depreciation and amortization, real estate taxes, utilities, repairs and maintenance, insurance, and licenses;●salon services payroll and benefits; and●shrink and inventory valuation reserves.Our cost of sales may be negatively impacted as we open new stores. Changes in our merchandise or channel mix may also have an impact on cost of sales. This presentation of items included in cost of sales may not be comparable to the way in which our competitors or other retailers compute their cost of sales.Selling, general and administrative expenses include:●payroll, bonus, and benefit costs for retail store and corporate employees;●advertising and marketing costs, offset by vendor income that is a reimbursement of specific, incremental, and identifiable costs;●occupancy costs related to our corporate office facilities;●stock-based compensation expense;●depreciation and amortization for all assets, except those related to our retail stores and distribution operations, which are included in cost of sales; and●legal, finance, information systems, and other corporate overhead costs.This presentation of items in selling, general and administrative expenses may not be comparable to the way in which our competitors or other retailers compute their selling, general and administrative expenses.Impairment, restructuring and other costs include long-lived asset impairment charges, restructuring costs associated with store closings, costs associated with the suspension of our Canadian expansion, and employee related severance costs. Pre-opening expenses include non-capital expenditures during the period prior to store opening for new, remodeled, and relocated stores including rent during the construction period for new and relocated stores, store set-up labor, management and employee training, and grand opening advertising.33 Table of ContentsInterest (income) expense, net includes both interest income and expense. Interest income represents interest from cash equivalents and short-term investments with maturities of twelve months or less from the date of purchase. Interest expense includes interest costs and facility fees associated with our credit facility, which is structured as an asset-based lending instrument. Our credit facility interest is based on a variable interest rate structure which can result in increased cost in periods of rising interest rates. Income tax expense reflects the federal statutory tax rate and the weighted average state statutory tax rate for the states in which we operate stores.Results of operationsOur fiscal years are the 52- or 53-week periods ending on the Saturday closest to January 31. The Company’s fiscal years ended January 28, 2023 (fiscal 2022), January 29, 2022 (fiscal 2021), and January 30, 2021 (fiscal 2020) were all 52-week years.As of January 28, 2023, we operated 1,355 stores across 50 states. The following tables present the components of our consolidated results of operations for the periods indicated:​​​​​​​​​​​​Fiscal year ended​​January 28,​January 29,​January 30,(Dollars in thousands)​2023 2022 2021Net sales ​$ 10,208,580​$ 8,630,889​$ 6,151,953Cost of sales​​ 6,164,070​​ 5,262,335​​ 4,202,794Gross profit​​ 4,044,510​​ 3,368,554​​ 1,949,159​​​​​​​​​​Selling, general and administrative expenses​​ 2,395,299​​ 2,061,545​​ 1,583,017Impairment, restructuring and other costs​​ —​​ —​​ 114,322Pre-opening expenses​​ 10,601​​ 9,517​​ 15,000Operating income​​ 1,638,610​​ 1,297,492​​ 236,820Interest (income) expense, net​​ (4,934)​​ 1,663​​ 5,735Income before income taxes​​ 1,643,544​​ 1,295,829​​ 231,085Income tax expense​​ 401,136​​ 309,992​​ 55,250Net income​$ 1,242,408​$ 985,837​$ 175,835​​​​​​​​​​Other operating data:​​​​​​​​​Number of stores end of year​​1,355​​1,308​​1,264Comparable sales​​15.6%​​37.9%​​(17.9%)​​​​​​​​​​​​​​Fiscal year ended​​January 28,​January 29,​January 30,(Percentage of net sales)​2023 2022 2021Net sales ​​100.0%​​100.0%​​100.0%Cost of sales​​60.4%​​61.0%​​68.3%Gross profit​​39.6%​​39.0%​​31.7%​​​​​​​​​​Selling, general and administrative expenses​​23.5%​​23.9%​​25.7%Impairment, restructuring and other costs​​0.0%​​0.0%​​1.9%Pre-opening expenses​​0.1%​​0.1%​​0.2%Operating income​​16.1%​​15.0%​​3.9%Interest (income) expense, net​​0.0%​​0.0%​​0.1%Income before income taxes​​16.1%​​15.0%​​3.8%Income tax expense​​3.9%​​3.6%​​0.9%Net income​​12.2%​​11.4%​​2.9%34 Table of ContentsFiscal year 2022 versus fiscal year 2021Net salesNet sales increased $1.6 billion, or 18.3%, to $10.2 billion in fiscal 2022 compared to $8.6 billion in fiscal 2021. The net sales increase was primarily due to the favorable impact from the continued resilience of the beauty category, retail price increases, the impact of new brands and product innovation, increased social occasions and fewer COVID-19 limitations compared to fiscal 2021, and an increase of $77.3 million in other revenue. The total comparable sales increase of 15.6% in fiscal 2022, compared to an increase of 37.9% in fiscal 2021, was driven by a 10.8% increase in transactions and a 4.3% increase in average ticket. ​Gross profitGross profit increased $676.0 million, or 20.1%, to $4.0 billion in fiscal 2022, compared to $3.4 billion in fiscal 2021. Gross profit as a percentage of net sales increased 60 basis points to 39.6% in fiscal 2022 compared to 39.0% in fiscal 2021. The increase in gross profit margin was primarily due to:●100 basis points of leverage of fixed costs attributed to the impact of higher sales and ongoing occupancy cost optimization efforts;●60 basis points of leverage in other revenue primarily due to credit card income growth, an increase in royalty income from our partnership with Target, and higher loyalty point redemptions; and●20 basis points of leverage due to favorable channel mix shifts; partially offset by●70 basis points of deleverage in inventory shrink; and●50 basis points of deleverage in merchandise margins driven by brand mix and lapping benefits from favorable inventory reserve adjustments in fiscal 2021, partially offset by the timing of retail price changes.​Selling, general and administrative expensesSelling, general and administrative (SG&A) expenses increased $333.8 million, or 16.2%, to $2.4 billion in fiscal 2022 compared to $2.1 billion in fiscal 2021. As a percentage of net sales, SG&A expenses decreased 40 basis points to 23.5% in fiscal 2022 compared to 23.9% in fiscal 2021. The leverage of SG&A expenses was primarily due to:●80 basis points of leverage due to lower marketing expenses; and●20 basis points of leverage of incentive compensation due to higher sales; partially offset by●40 basis points of deleverage of corporate overhead primarily due to strategic investments; and●20 basis points of deleverage of store payroll and benefits due to wage investments. ​Pre-opening expensesPre-opening expenses increased $1.1 million, or 11.4%, to $10.6 million in fiscal 2022 compared to $9.5 million in fiscal 2021.Interest (income) expense, netInterest income, net was $4.9 million in fiscal 2022 compared to $1.7 million of interest expense, net in fiscal 2021. Interest income represents interest from cash equivalents and short-term investments with maturities of twelve months or less from the date of purchase. Interest expense represents interest on borrowings and fees related to the credit facility. We did not have any outstanding borrowings on our credit facility as of January 28, 2023 and January 29, 2022. Income tax expenseIncome tax expense of $401.1 million in fiscal 2022 represents an effective tax rate of 24.4%, compared to fiscal 2021 income tax expense of $310.0 million and an effective tax rate of 23.9%. The higher income tax expense is primarily due 35 Table of Contentsto less tax benefit from the income tax accounting for share-based compensation and an increase in state tax expense compared to fiscal 2021.​Net incomeNet income increased $256.6 million to $1.2 billion in fiscal 2022 compared to $985.8 million in fiscal 2021. The increase in net income was primarily due to a $676.0 million increase in gross profit, partially offset by a $333.8 million increase in SG&A expenses and $91.1 million increase in income taxes. Fiscal year 2021 versus fiscal year 2020Net salesNet sales increased $2.5 billion, or 40.3%, to $8.6 billion in fiscal 2021 compared to $6.2 billion in fiscal 2020. The net sales increase was primarily due to the favorable impact from stronger consumer confidence, government stimulus payments, and the easing of COVID-19 restrictions, and an increase of $15.1 million in other revenue. The total comparable sales increase of 37.9% in fiscal 2021, compared to a decrease of 17.9% in fiscal 2020, was driven by a 30.0% increase in transactions and a 6.0% increase in average ticket. ​Gross profitGross profit increased $1.4 billion, or 72.8%, to $3.4 billion in fiscal 2021, compared to $1.9 billion in fiscal 2020. Gross profit as a percentage of net sales increased 730 basis points to 39.0% in fiscal 2021 compared to 31.7% in fiscal 2020. The increase in gross profit margin was primarily due to:●300 basis points leverage of fixed costs attributed to the impact of higher sales; ●190 basis points of improvements in merchandise margins driven by lower promotional activity and cost optimization efforts; ●140 basis points of leverage due to favorable channel mix shifts; and●100 basis points of leverage in salon expenses attributed to the impact of higher sales.​Selling, general and administrative expensesSG&A expenses increased $0.5 billion, or 30.2%, to $2.1 billion in fiscal 2021 compared to $1.6 billion in fiscal 2020. As a percentage of net sales, SG&A expenses decreased 180 basis points to 23.9% in fiscal 2021 compared to 25.7% in fiscal 2020. The leverage in SG&A expenses was primarily due to:●180 basis points of leverage of corporate overhead due to higher sales; ●90 basis points of leverage of store payroll and benefits due to higher sales; and●50 basis points of leverage of store expenses due to higher sales; partially offset by●80 basis points of deleverage due to less employee retention credits received under the Coronavirus Aid, Relief and Economic Security Act (CARES Act); and●60 basis points of deleverage due to higher incentive compensation.​Impairment, restructuring and other costs There were no impairment, restructuring and other costs recognized in fiscal 2021 compared to $114.3 million for fiscal 2020, which consisted of $41.9 million due to the impairment of tangible long-lived assets and operating lease assets associated with certain retail stores, $29.1 million related to the suspension of the planned expansion to Canada, $27.5 million related to the permanent closure of 19 stores, and $15.8 million of severance charges. ​36 Table of ContentsPre-opening expensesPre-opening expenses decreased $5.5 million, or 36.6%, to $9.5 million in fiscal 2021 compared to $15.0 million in fiscal 2020 due to current year real estate activity and stores expected to open in the first quarter of fiscal 2022 compared to the first quarter of fiscal 2021. Interest expense, netInterest expense, net was $1.7 million in fiscal 2021 compared to $5.7 million of interest expense, net in fiscal 2020. Interest expense represents interest on borrowings and fees related to the credit facility. Interest income results from short-term investments. We did not have any outstanding borrowings on our credit facility as of January 29, 2022 and January 30, 2021. Income tax expenseIncome tax expense of $310.0 million in fiscal 2021 represents an effective tax rate of 23.9%, compared to fiscal 2020 income tax expense of $55.3 million and an effective tax rate of 23.9%. The higher income tax expense is primarily due to higher operating income compared to fiscal 2020.​Net incomeNet income increased $810.0 million to $985.8 million in fiscal 2021 compared to $175.8 million in fiscal 2020. The increase in net income was primarily due to a $1.4 billion increase in gross profit and a $114.3 million decrease in impairment, restructuring and other costs, partially offset by a $0.5 billion increase in SG&A expenses and $254.7 million increase in income taxes. Liquidity and capital resourcesOur primary sources of liquidity are cash and cash equivalents, cash flows from operations, and borrowings under our credit facility. The most significant components of our working capital are merchandise inventories and cash and cash equivalents reduced by accounts payable, accrued liabilities, and deferred revenue. As of January 28, 2023 and January 29, 2022, we had cash and cash equivalents of $737.9 million and $431.6 million, respectively.Our primary cash needs are for rent, capital expenditures for new, remodeled, and relocated stores, increased merchandise inventories related to store expansion and new brand additions, supply chain improvements, share repurchases, and continued investment in our information technology systems.Our most significant ongoing short-term cash requirements relate primarily to funding operations (including expenditures for lease expenses, inventory, labor, distribution, advertising and marketing, and tax liabilities) as well as periodic spend for capital expenditures, investments, and share repurchases. Our working capital needs are greatest from August through November each year as a result of our inventory build-up during this period for the approaching holiday season. Long-term cash requirements primarily relate to funding lease expenses and other purchase commitments.We generally fund short-term and long-term cash requirements with cash from operating activities. We believe our primary sources of liquidity will satisfy our cash requirements over both the short term (the next twelve months) and long term.37 Table of ContentsThe following table summarizes contractual cash requirements as of January 28, 2023:​​​​​​​​​​​​​​​​​​​​​​Less Than ​1 to 3​3 to 5​More than 5(In thousands) Total 1 Year Years Years YearsOperating lease obligations (1)​$ 2,211,981​$ 342,680​$ 719,329​$ 564,184​$ 585,788Purchase obligations ​​ 111,233​​ 63,419​​ 46,225​​ 1,589​​ —Total (2)​$ 2,323,214​$ 406,099​$ 765,554​$ 565,773​$ 585,788(1)These amounts are for our undiscounted lease obligations recorded in our consolidated balance sheets as operating lease liabilities. Also included are legally binding minimum lease payments for leases signed but not yet commenced of $91.5 million, which are excluded from operating lease liabilities shown on our consolidated balance sheets. (2)The unrecognized tax benefit of $4.2 million as of January 28, 2023 is excluded due to uncertainty regarding the realization and timing of the related future cash flows, if any.Purchase obligations reflect legally binding agreements entered into by the Company to purchase goods or services. The amount of purchase obligations relates to commitments for products and services and other goods and service contracts entered into as of January 28, 2023. Excluded from purchase obligations are normal purchases and contracts entered into in the ordinary course of business. Cash flowsWe believe our ability to generate substantial cash from operating activities and readily secure financing at competitive rates are key strengths that give us significant flexibility to meet our short and long-term financial commitments. The following table presents a summary of our cash flows during the last three years:​​​​​​​​​​​​Fiscal year ended​​January 28,​January 29,​January 30,(In thousands) 2023 2022 2021Net cash provided by operating activities​$ 1,481,915​$ 1,059,265​$ 810,355Net cash used in investing activities​​ (314,584)​​ (176,484)​​ (48,751)Net cash used in financing activities​​ (861,014)​​ (1,497,216)​​ (107,934)Operating activitiesOperating activities consist of net income adjusted for certain non-cash items, including depreciation and amortization, non-cash lease expense, long-lived asset impairment charges, deferred income taxes, stock-based compensation expense, realized gains or losses on disposal of property and equipment, and the effect of working capital changes. The increase in net cash provided by operating activities in fiscal 2022 is mainly due to the increase in net income, a smaller increase in merchandise inventories in fiscal 2022, and the timing of receivable collections, partially offset by the timing of payables and a smaller increase in deferred revenue compared to fiscal 2021. The increase in net income was primarily due to an increase in gross profit resulting from higher sales, partially offset by an increase in SG&A expenses and income taxes. Merchandise inventories, net were $1.6 billion at January 28, 2023, compared to $1.5 billion at January 29, 2022, representing an increase of $104.2 million or 7.0%. The increase in total inventory is primarily due to the following:●$54 million increase due to the addition of 47 new stores opened since January 29, 2022; ●$25 million increase due to new key brand launches; and●$25 million increase primarily due to inventory cost increases.38 Table of ContentsThe increase in net cash provided by operating activities in fiscal 2021 relative to fiscal 2020 was primarily due to the increase in net income and deferred revenue, partially offset by higher merchandise inventories, higher cash outflow from higher income taxes, and lower long-lived asset impairment charges compared to fiscal 2020. ​Investing activitiesWe have historically used cash primarily for new, remodeled, relocated, and refreshed stores, supply chain investments, short-term investments, and investments in information technology systems. Investment activities for capital expenditures were $312.1 million during fiscal 2022, compared to $172.2 million during fiscal 2021.The increase in net cash used in investing activities in fiscal 2022 relative to fiscal 2021 was primarily due to more capital expenditures compared to fiscal 2021. The increase in net cash used in investing activities in fiscal 2021 relative to fiscal 2020 was primarily due to less proceeds of short-term investments and more capital expenditures compared to fiscal 2020. Capital expenditures​The following table presents a summary of our store activities during the last three years: ​​​​​​​​ Fiscal year ended​​January 28, January 29, January 30,​​2023​2022​2021Stores opened​ 47​ 48​ 30Stores remodeled​ 20​ 9​ –Stores relocated​ 12​ 7​ 5​During fiscal 2022, the average investment required to open a new Ulta Beauty store was approximately $1.7 million, which includes capital investment net of landlord contributions, pre-opening expenses, and initial inventory net of payables. Capital expenditures during the last three years by major category are as follows:​​​​​​​​​​​​​​​Budget​​​​​​​​​​​Fiscal ​Fiscal​Fiscal​Fiscal(In millions) 2023 2022 2021 2020New, Remodeled, and Relocated Stores​$ 156​$ 102​$ 73​$ 56Merchandising and Refreshed Stores​​ 48​​ 34​​ 16​​ 14Information Technology Systems​​ 108​​ 74​​ 37​​ 36Supply Chain​​ 113​​ 70​​ 23​​ 13Store Maintenance and Other​​ 50​​ 32​​ 23​​ 33Total​$475​$312​$ 172​$152​Our future investments will depend primarily on the number of new, remodeled, and relocated stores, information technology systems investments, and supply chain investments that we undertake and the timing of these expenditures. Based on past performance and current expectations, we believe our sources of liquidity will be sufficient to fund future capital expenditures. We expect fiscal 2023 capital expenditures will be up to $475 million and will be used primarily to fund our new, remodeled, and relocated stores and strategic priorities, including investments in information technology systems and supply chain optimization.​​39 Table of ContentsFinancing activitiesFinancing activities include share repurchases, borrowing and repayment of our revolving credit facility, and capital stock transactions. Purchases of treasury shares represent the fair value of common shares repurchased from plan participants in connection with shares withheld to satisfy minimum statutory tax obligations upon the vesting of restricted stock.The decrease in net cash used in financing activities in fiscal 2022 relative to fiscal 2021 was primarily due to a decrease in share repurchases. The increase in net cash used in financing activities in fiscal 2021 relative to fiscal 2020 was primarily due to an increase in share repurchases offset by an increase in stock option exercises, and no activity under our revolving credit facility. We had no borrowings outstanding under the credit facility at the end of fiscal 2022, 2021 and 2020. The zero outstanding borrowings position is due to a combination of factors including sales demand, overall performance of management initiatives including expense control, and inventory and other working capital reductions. We may require borrowings under the facility from time to time in future periods for unexpected business disruptions, to support our new store program, seasonal inventory needs, or share repurchases. Share repurchase programIn March 2020, the Board of Directors authorized a share repurchase program (the 2020 Share Repurchase Program) pursuant to which the Company could repurchase up to $1.6 billion of the Company’s common stock. The 2020 Share Repurchase Program authorization revoked the previously authorized but unused amounts from the earlier share repurchase program. The 2020 Share Repurchase Program did not have an expiration date but provided for suspension or discontinuation at any time. In March 2022, the Board of Directors authorized a new share repurchase program (the 2022 Share Repurchase Program) pursuant to which the Company may repurchase up to $2.0 billion of the Company’s common stock. The 2022 Share Repurchase Program authorization revokes the previously authorized but unused amounts from the 2020 Share Repurchase Program. The 2022 Share Repurchase Program does not have an expiration date and may be suspended or discontinued at any time.​A summary of common stock repurchase activity is presented in the following table:​​​​​​​​​​​​Fiscal year ended​​January 28,​January 29,​January 30,(Dollars in millions) 2023​2022​2021Shares repurchased​​ 2,192,556​​ 4,249,632​​ 474,794Total cost of shares repurchased​$ 900.0​$ 1,521.9​$ 114.9​​Credit facilityOn March 11, 2020, we entered into Amendment No. 1 to the Second Amended and Restated Loan Agreement (as so amended, the Loan Agreement) with Wells Fargo Bank, National Association, as Administrative Agent, Collateral Agent and a Lender thereunder; Wells Fargo Bank, National Association and JPMorgan Chase Bank, N.A., as Lead Arrangers and Bookrunners; JPMorgan Chase Bank, N.A., as Syndication Agent and a Lender; PNC Bank, National Association, as Documentation Agent and a Lender; and the other lenders party thereto. The Loan Agreement matures on March 11, 2025, provides maximum revolving loans equal to the lesser of $1.0 billion or a percentage of eligible owned inventory and eligible owned receivables (which borrowing base may, at the election of the Company and satisfaction of certain conditions, include a percentage of qualified cash), contains a $50.0 million subfacility for letters of credit and allows the Company to increase the revolving facility by an additional $100.0 million, subject to the consent by each lender and other conditions. The Loan Agreement contains a requirement to maintain a fixed charge coverage ratio of not less than 1.0 to 1.0 during such periods when availability under the Loan Agreement falls below a specified threshold. 40 Table of ContentsSubstantially all of the Company’s assets are pledged as collateral for outstanding borrowings under the Loan Agreement. Outstanding borrowings bear interest, at the Company’s election, at either a base rate plus a margin of 0% to 0.125% or the London Interbank Offered Rate plus a margin of 1.125% to 1.250%, with such margins based on the Company’s borrowing availability, and the unused line fee is 0.20% per annum.As of January 28, 2023 and January 29, 2022, we had no borrowings outstanding under the credit facility and we were in compliance with all terms and covenants of the Loan Agreement.SeasonalityOur business is subject to seasonal fluctuation. Significant portions of our net sales and profits are realized during the fourth quarter of the fiscal year due to the holiday selling season. To a lesser extent, our business is also affected by Mother’s Day and Valentine’s Day. Any decrease in sales during these higher sales volume periods could have an adverse effect on our business, financial condition, or operating results for the entire fiscal year. Our quarterly results of operations have varied in the past and are likely to do so again in the future. As such, we believe that period-to-period comparisons of our results of operations should not be relied upon as an indication of our future performance.Critical accounting policies and estimatesManagement’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements required the use of estimates and judgments that affect the reported amounts of our assets, liabilities, revenues, and expenses. Management bases estimates on historical experience and other assumptions it believes to be reasonable under the circumstances and evaluates these estimates on an on-going basis. Actual results may differ from these estimates. A discussion of our more significant estimates follows. Management has discussed the development, selection, and disclosure of these estimates and assumptions with the Audit Committee of the Board of Directors.Inventory valuationMerchandise inventories are carried at the lower of cost or net realizable value. Cost is determined using the moving average cost method and includes costs incurred to purchase and distribute goods as well as related vendor allowances including co-op advertising, markdowns, and volume discounts. We record valuation adjustments to our inventories if the cost of a specific product on hand exceeds the amount we expect to realize from the ultimate sale or disposal of the inventory. These estimates are based on management’s judgment regarding future demand, age of inventory, and analysis of historical experience. If actual demand or market conditions are different than those projected by management, future merchandise margin rates may be affected by adjustments to these estimates.Inventories are adjusted for the results of periodic physical inventory counts at each of our locations. We record a shrink reserve representing management’s estimate of inventory losses by location that have occurred since the date of the last physical count. This estimate is based on management’s analysis of historical results and operating trends.We do not believe that there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our inventory reserves. Adjustments to earnings resulting from revisions to management’s estimates of the inventory reserves have been insignificant during fiscal 2022, 2021 and 2020. An increase or decrease in the lower of cost or net realizable value reserve of 10% would not have a material impact on our operating income for fiscal 2022. An increase or decrease in the shrink rate included in the shrink reserve calculation of 10% would not have a material impact on our operating income for fiscal 2022.​​41 Table of ContentsVendor allowancesThe majority of cash consideration received from a vendor is considered to be a reduction of the cost of the related products and is reflected in cost of sales in our consolidated statements of income as the related products are sold unless it is in exchange for an asset or service or a reimbursement of a specific, incremental, identifiable cost incurred by the Company in selling the vendors’ products. We estimate the amount recorded as a reduction of inventory at the end of each period based on a detailed analysis of inventory turns and management’s analysis of the facts and circumstances of the various contractual agreements with vendors. We record cash consideration expected to be received from vendors in receivables. We do not believe there is a reasonable likelihood there will be a material change in the future estimates or assumptions we use to calculate our reduction of inventory. An increase or decrease in inventory turns of five basis points would not have a material impact on our operating income for fiscal 2022.Impairment of long-lived tangible assetsWe review long-lived tangible assets whenever events or circumstances indicate these assets might not be recoverable. Assets are primarily reviewed at the store level, which is the lowest level for which cash flows can be identified. Significant estimates are used in determining future operating results of each store over its remaining lease term. An impairment loss would be recorded if the carrying amount of the long-lived asset exceeds its fair value. We do not believe there is a reasonable likelihood there will be a material change in the future estimates or assumptions we use to calculate our impairment charges. During fiscal 2020, we recognized $72.5 million of impairment of long-lived tangible and right-of-use assets which consisted of $41.9 million due to the carrying values of certain long-lived assets exceeding their respective fair values, $19.6 million related to the suspension of the planned expansion to Canada, and $11.0 million related to the permanent closure of 19 stores. No impairment charges were recognized in fiscal 2022 or fiscal 2021.Loyalty programWe maintain a customer loyalty program, Ultamate Rewards, which allows members to earn points based on purchases of merchandise or services. Points earned are valid for at least one year. The loyalty program represents a material right to the customer and points may be redeemed on future products and services. Revenue from the loyalty program is recognized when the members redeem points or points expire. We defer revenue related to points earned that have not yet been redeemed. The amount of deferred revenue includes estimates for the standalone selling price of points earned by members and the percentage of points expected to be redeemed. The expected redemption percentage is based on historical redemption patterns and considers current information or trends. The standalone selling price of points earned and the estimated redemption rate is evaluated each reporting period. We do not believe there is a reasonable likelihood there will be a material change in the future estimates or assumptions used to calculate the estimated redemption rate. Adjustments to earnings resulting from revisions to management’s estimates of the redemption rates have been insignificant during fiscal 2022, 2021 and 2020. An increase or decrease in the estimated redemption rate of 5% would not have a material impact on our operating income in fiscal 2022. ​Income taxes​We are subject to income taxes in the United States. Judgment is required in determining our provision for income taxes and income tax assets and liabilities, including evaluating uncertainties in the application of accounting principles and complex tax laws.​We recognize deferred income taxes for the estimated future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are anticipated to be recovered or settled. The effect on deferred taxes of a change in income tax rates is recognized in the consolidated statements of income in the period of enactment. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets to the amount expected to be realized unless it is more-likely-than-not that such assets will be realized in full. The estimated tax benefit of an uncertain tax position is 42 Table of Contentsrecorded in our consolidated financial statements only after determining a more-likely-than-not probability that the uncertain tax position will withstand challenge, if any, from applicable taxing authorities. ​Judgment is required in assessing the future tax consequences of events that have been recognized on our consolidated financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements.Item 7A. Quantitative and Qualitative Disclosures about Market RiskMarket risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily the result of fluctuations in interest rates. We do not hold or issue financial instruments for trading purposes.Interest rate riskWe are exposed to interest rate risks primarily through borrowings under our credit facility. Interest on our borrowings is based upon variable rates. We did not have any outstanding borrowings on our credit facility as of January 28, 2023, January 29, 2022 or January 30, 2021.
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+ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSOur discussion and analysis of our financial condition and results of operations for 2022 as compared to 2021 are discussed below. For a discussion of our financial condition and results of operations for 2021 as compared to 2020, please refer to Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2021 Annual Report on Form 10-K, except as set forth below.OVERVIEWWe are a global biotechnology company that invests in scientific innovation to create transformative medicines for people with serious diseases, with a focus on specialty markets. We have four approved medicines that treat the underlying cause of cystic fibrosis (“CF”), a life-threatening genetic disease, and we continue to focus on developing additional treatments for CF. Beyond CF, we have a pipeline that includes mid- and late-stage clinical programs in sickle cell disease, beta thalassemia, acute and neuropathic pain, APOL1-mediated kidney disease, type 1 diabetes, and alpha-1 antitrypsin deficiency, and earlier-stage programs in diseases such as muscular dystrophies. Our triple combination regimen, TRIKAFTA/KAFTRIO (elexacaftor/tezacaftor/ivacaftor and ivacaftor), was approved in 2019 in the United States (the “U.S.”) and in 2020 in the European Union (the “E.U.”). Collectively, our four medicines are being used by the majority of the approximately 88,000 people with CF in North America, Europe, and Australia. We are evaluating our medicines in additional patient populations, including younger children, with the goal of having small molecule treatments for all people who have at least one mutation in their cystic fibrosis transmembrane conductance regulator (“CFTR”) gene that is response to our CFTR modulators. We also are pursuing genetic therapies for people with CF who do not make CFTR protein and, as a result, cannot benefit from our current CF medicines.Financial HighlightsRevenuesIn 2022, our net product revenues increased to $8.9 billion as compared to $7.6 billion in 2021, primarily due to the strong uptake of TRIKAFTA/KAFTRIO in multiple countries internationally and continued steady performance of TRIKAFTA in the U.S., following the June 2021 launch of TRIKAFTA for children with CF 6 through 11 years of age.ExpensesOur total research and development (“R&D”), acquired in-process research and development (“AIPR&D”), and selling, general and administrative (“SG&A”) expenses decreased to $3.6 billion as compared to $3.9 billion in 2021. The decrease was primarily due to decreased AIPR&D following a $900.0 million upfront payment we made in 2021 to CRISPR in connection with an amendment to our exa-cel collaboration, partially offset by increased spend to advance the progression of several product candidates into mid- to late-stage clinical development. Cost of sales was 12% of our net product revenues in 2022 and 2021.CashOur cash, cash equivalents and marketable securities increased to $10.8 billion as of December 31, 2022 as compared to $7.5 billion as of December 31, 2021 primarily due to our net product revenues and operating cash flows, partially offset by income tax payments and our $315.0 million acquisition of ViaCyte.64Business Updates Marketed ProductsWe expect to continue to grow our CF business by increasing the number of people with CF who are eligible and able to receive our medicines, including younger people, and providing improved treatment options for people who are already eligible for one of our medicines. Recent and anticipated progress in activities supporting these efforts is included below:•The European Commission and the United Kingdom’s Medicines and Healthcare products Regulatory Agency (“MHRA”) granted marketing authorization for KAFTRIO for the treatment of children with CF 6 through 11 years of age who have at least one F508del mutation in the CFTR gene.•The U.S. Food and Drug Administration (the “FDA”) approved the use of ORKAMBI in children with CF 12 months to less than 24 months of age who are homozygous for the F508del mutation in the CFTR gene.•In the fourth quarter of 2022, we submitted global regulatory filings for TRIKAFTA/KAFTRIO in children with CF 2 to 5 years of age and for KALYDECO in children with CF from 1 month to less than 4 months of age.•TRIKAFTA/KAFTRIO is now approved and reimbursed or accessible in more than 30 countries outside the U.S. PipelineWe continue to advance a pipeline of potentially transformative small molecule and cell and genetic therapies aimed at treating serious diseases. Recent and anticipated progress in activities supporting these efforts is included below. Cystic Fibrosis•We are conducting two Phase 3 global, randomized, double-blind, active-controlled clinical trials, SKYLINE 102 and SKYLINE 103, evaluating our new once-daily investigational triple combination of vanzacaftor/tezacaftor/deutivacaftor, formerly known as VX-121/tezacaftor/VX-561, in people with CF 12 years of age and older, and have completed enrollment in these trials. We expect to complete these clinical trials by the end of 2023. We also have initiated a clinical trial of vanzacaftor/tezacaftor/deutivacaftor in children with CF 6 to 11 years of age, known as the RIDGELINE study. •In collaboration with Moderna, we are developing VX-522, an mRNA therapeutic for the treatment of people with CF who do not produce any CFTR protein. In December 2022, the FDA cleared our Investigational New Drug Application (“IND”) for VX-522. We have initiated a single-ascending dose clinical trial for VX-522 in people with CF, which is active and enrolling patients. We expect to complete this single ascending dose clinical trial and initiate the multiple ascending dose clinical trial in 2023. The FDA has granted Fast Track designation for VX-522.Sickle Cell Disease and Beta Thalassemia•We are evaluating the use of a non-viral ex vivo CRISPR gene-editing therapy, exagamglogene autotemcel (“exa-cel”), formerly known as CTX001, for the treatment of sickle cell disease (“SCD”) and transfusion-dependent beta thalassemia (“TDT”). •In the fourth quarter of 2022, we completed regulatory submissions to the European Medicines Agency (“EMA”) and the MHRA for exa-cel for SCD and TDT, and both the EMA and the MHRA have validated the marketing authorization application. Exa-cel has been granted EMA Priority Medicines (“PRIME”) designation in the E.U. and Orphan Drug designation in the E.U. and the United Kingdom (the “U.K.”).•In November 2022, we initiated the submission of a biologics licensing application (“BLA”) for exa-cel for SCD and TDT for rolling review by the FDA, and expect to complete the submission by the end of the first quarter of 2023. In the U.S., exa-cel has been granted Fast Track, Regenerative Medicine Advanced Therapy, Rare Pediatric Disease, and Orphan Drug designations.•Two additional Phase 3 clinical trials evaluating exa-cel in pediatric patients with SCD and TDT are ongoing.65Pain•We have discovered multiple selective small molecule inhibitors of NaV1.8, with the objective of creating a new class of pain medicines that provide effective non-opioid pain relief, without abuse potential. In March 2022, we announced positive Phase 2 data for VX-548, a NaV1.8 inhibitor, for treatment of acute pain. We have initiated two randomized, double-blind, placebo-controlled Phase 3 trials with a total of 2,000 patients with moderate to severe acute pain following bunionectomy or abdominoplasty surgery. The Phase 3 program for VX-548 also includes a single-arm study evaluating the safety and effectiveness of VX-548 in multiple other types of moderate to severe pain. We expect to complete these Phase 3 trials in late 2023 or early 2024. •The FDA granted VX-548 Breakthrough Therapy and Fast Track designations for the treatment of moderate to severe acute pain.•At the end of 2022, we initiated a Phase 2 clinical trial evaluating VX-548 in diabetic peripheral neuropathy, a common form of peripheral neuropathic pain.APOL1-Mediated Kidney Disease•Inaxaplin, formerly known as VX-147, is our small molecule for the treatment of APOL1-mediated kidney disease (“AMKD”), including APOL1-mediated focal segmental glomerulosclerosis (“FSGS”). Based on positive Phase 2 data in FSGS, we initiated pivotal development of inaxaplin in a single Phase 2/3 adaptive clinical trial in patients with AMKD. We continue to enroll patients in this Phase 2/3 clinical trial and we expect to complete the Phase 2 dose-ranging portion of the trial in 2023.•The FDA granted inaxaplin Breakthrough Therapy designation for APOL1-mediated FSGS and the EMA granted inaxaplin Orphan Drug and PRIME designations for AMKD. Type 1 Diabetes•VX-880 is a stem cell-derived, allogeneic, fully differentiated, insulin-producing islet cell replacement therapy, using standard immunosuppression to protect the implanted cells. A clinical trial is ongoing to evaluate VX-880 as a potential treatment for type 1 diabetes (“T1D”), and proof-of-concept has been achieved. We have completed enrollment in Part B of the Phase 1/2 clinical trial and, after completion of Part B, we expect to begin Part C of the trial, with concurrent dosing, in 2023.•We continue to advance additional programs in T1D, in which these same stem cell-derived, fully differentiated, insulin-producing islet cells are encapsulated and implanted in an immunoprotective device or are modified to produce hypoimmune cells with the goal of eliminating the need for immunosuppression. In December 2022, our Clinical Trial Application (“CTA”) in Canada for VX-264, the cells and device program, was authorized and we plan to begin screening, enrollment and dosing in Canada in the coming months. In the U.S., the IND is on hold.Alpha-1 Antitrypsin Deficiency•We are working to address the underlying genetic cause of alpha-1 antitrypsin (“AAT”) deficiency (“AATD”). We are developing novel small molecule correctors of Z-AAT protein folding, with the goal of enabling the secretion of functional AAT into the blood and addressing both the lung and the liver aspects of AATD. We have initiated a Phase 1 clinical trial for VX-634, which is the first in a series of next-wave investigational molecules with significantly improved potency and drug-like properties as compared to our previous AAT correctors, allowing potential exploration of the full dose response.•We initiated a second Phase 2 clinical trial of VX-864, a first-generation AAT corrector, to assess the impact of longer-term treatment on the liver, as well as the levels of functional AAT in the plasma.Duchenne Muscular Dystrophy•We are investigating a novel approach to treating Duchenne muscular dystrophy (“DMD”), which delivers CRISPR/Cas9 gene-editing technology to muscle cells, with the goal of restoring near-full length dystrophin protein expression by targeting specific mutations in the dystrophin gene that cause the disease. We are conducting enabling studies for our first in vivo gene-editing therapy for DMD and we expect to submit an IND for this program in 2023.66Investment in External InnovationRecent investments in external innovation are included below.•We acquired from Catalyst Biosciences, Inc. (“Catalyst”) a portfolio of protease medicines that target the complement system and related intellectual property.•We acquired ViaCyte, Inc. (“ViaCyte”), a biotechnology company focused on delivering novel stem cell-derived cell replacement therapies as a potential functional cure for T1D. A Phase 1/2 clinical trial of VCTX-211, a hypoimmune cell program that we are developing in partnership with CRISPR Therapeutics AG (“CRISPR”), is active and enrolling patients.•We established a strategic collaboration and licensing agreement with Entrada Therapeutics, Inc. (“Entrada”), focused on discovering and developing intracellular Endosomal Escape Vehicle (“EEV”) therapeutics for DM1 (the “Entrada Agreement”).Our Business EnvironmentOur net product revenues come from the sale of our medicines for the treatment of CF. Our CF strategy involves continuing to develop and obtain approval and reimbursement for treatment regimens that will provide benefits to all people with CF and increasing the number of people with CF eligible and able to receive our medicines, including through label expansions, expanded reimbursement, and the development of new medicines. We are advancing our pipeline of product candidates for the treatment of serious diseases outside of CF. Our strategy is to combine transformative advances in the understanding of causal human biology and the science of therapeutics to discover and develop innovative medicines. This approach includes advancing multiple compounds from each program, spanning multiple modalities, into early clinical trials to obtain patient data that can inform selection of the most promising compounds for later-stage development, and to inform discovery and development of additional compounds. We aim to rapidly follow our first-in-class therapies that achieve proof-of-concept with potential best-in-class candidates to provide durable clinical and commercial success.In pursuit of new product candidates and therapies in specialty markets, we invest in research and development. We believe that pursuing research in diverse areas allows us to balance the risks inherent in product development and may provide product candidates that will form our pipeline in future years. To supplement our internal research programs, we acquire technologies and programs and collaborate with biopharmaceutical and technology companies, leading academic research institutions, government laboratories, foundations and other organizations, as needed, to advance research in our areas of therapeutic interest and to access technologies needed to execute on our strategy.Discovery and development of a new pharmaceutical or biological product is a difficult and lengthy process that requires significant financial resources along with extensive technical and regulatory expertise. Across the industry, most potential drug or biological products never progress into development, and most products that do advance into development never receive marketing approval. Our investments in product candidates are subject to considerable risks. We closely monitor the results of our discovery, research, clinical trials and nonclinical studies and frequently evaluate our product development programs in light of new data and scientific, business and commercial insights, with the objective of balancing risk and potential. This process can result in rapid changes in focus and priorities as new information becomes available and as we gain additional understanding of our ongoing programs and potential new programs, as well as those of our competitors.Our business also requires ensuring appropriate manufacturing and reimbursement of our products. As we advance our product candidates through clinical development toward commercialization and market and sell our approved products, we build and maintain our supply chain and quality assurance resources. We rely on a global network of third parties and our internal capabilities to manufacture and distribute our products for commercial sale and post-approval clinical trials and to manufacture and distribute our product candidates for clinical trials. In addition to establishing supply chains for each new approved product, we adapt our supply chain for existing products to include additional formulations or to increase scale of production for existing products as needed. The processes for cell and genetic therapies can be more complex than those required for small molecule drugs and require additional investments in different systems, equipment, facilities and expertise. We are focused on ensuring the stability of the supply chains for our current products, as well as for our pipeline programs. Sales of our products depend, to a large degree, on the extent to which our products are reimbursed by third-party payors, such as government health programs, commercial insurance and managed health care organizations. Reimbursement for our products, including our potential pipeline therapies, cannot be assured and may take significant periods of time to obtain. We 67dedicate substantial management and other resources to obtain and maintain appropriate levels of reimbursement for our products from third-party payors, including governmental organizations in the U.S. and ex-U.S. markets.In the U.S., we have worked successfully with third-party payors to promptly obtain appropriate levels of reimbursement for our CF medicines. We plan to continue to engage in discussions with numerous commercial insurers and managed health care organizations, along with government health programs that are typically managed by authorities in the individual states, to ensure that payors recognize the significant benefits that our medicines provide and provide patients with appropriate levels of access to our medicines now and in the future. We cannot, however, predict how recent changes in the law, including through the Inflation Reduction Act of 2022, will affect our ability to negotiate successfully with third-party payors in the future. In ex-U.S. markets, we seek government reimbursement for our medicines on a country-by-country or region-by-region basis, as required. This is necessary for each new medicine, as well as for label expansions for our current medicines. We expect to continue to focus significant resources to obtain expanded reimbursement for our CF medicines and, ultimately, pipeline therapies, in U.S. and ex-U.S. markets.Strategic TransactionsAcquisitionsAs part of our business strategy, we seek to acquire products, product candidates and other technologies and businesses that are aligned with our corporate and research and development strategies and complement and advance our ongoing research and development efforts.In 2022, we acquired ViaCyte, a privately held biotechnology company with intellectual property, tools, technologies and assets with potential to accelerate development of our T1D programs, for $315.0 million; and acquired from Catalyst a portfolio of protease medicines that target the complement system and related intellectual property (the “Catalyst complement portfolio”) for $60.0 million. We expect to continue to identify and evaluate potential acquisitions and may include larger transactions or later-stage assets.Our acquisition of ViaCyte was accounted for as a business combination. As of the acquisition date, the cash payment was allocated primarily to goodwill and the fair value of an in-process research and development asset. Operating expenses incurred by ViaCyte after the acquisition date and specific expenses associated with the acquisition are reflected in our consolidated statement of operations.Our acquisition of the Catalyst complement portfolio was accounted for as an asset acquisition because substantially all the fair value acquired was concentrated in in-process research and development assets, which did not constitute a business, and for which we determined there was no alternative future use. As a result, we recorded our $60.0 million upfront payment to AIPR&D.Please refer to our critical accounting policies, “Acquisitions,” for further information regarding the significant judgments and estimates related to our acquisitions.Collaboration and In-Licensing ArrangementsWe enter into arrangements with third parties, including collaboration and licensing arrangements, for the development, manufacture and commercialization of products, product candidates, and other technologies that have the potential to complement our ongoing research and development efforts.Over the last several years, we entered into collaboration agreements with a number of companies, including Arbor Biotechnologies, Inc., CRISPR, Kymera Therapeutics, Inc., Mammoth Biosciences, Inc., Moderna, Inc., Obsidian Therapeutics, Inc., and Verve Therapeutics, Inc. Generally, when we in-license a technology or product candidate, we make upfront payments to the collaborator, assume the costs of the program and/or agree to make contingent payments, which could consist of milestone, royalty and option payments. Most of these collaboration payments are expensed as AIPR&D however, depending on many factors, including the structure of the collaboration, the stage of development of the acquired technology, the significance of the in-licensed product candidate to the collaborator’s operations and the other activities in which our collaborators are engaged, the accounting for these transactions can vary significantly. We expect to continue to identify and evaluate collaboration and licensing opportunities that may be similar to or different from the collaborations and licenses that we have engaged in previously.68In addition, in the fourth quarter of 2022, we announced a strategic collaboration and licensing agreement (the “Entrada Agreement”) with Entrada focused on discovering and developing intracellular EEV therapeutics for DM1. In February 2023, the Entrada Agreement closed upon, among other things, the satisfaction of customary closing conditions and the expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act. Upon closing, we made an upfront payment of approximately $224.0 million to Entrada, and purchased approximately $26.0 million of Entrada’s common stock in connection with the Entrada Agreement. We will account for the Entrada Agreement in the first quarter of 2023.Joint Development and Commercialization Agreement with CRISPRIn 2017, we entered into a joint development and commercialization agreement (the “Original JDCA”) with CRISPR, pursuant to which we are developing and preparing to commercialize exa-cel for SCD and TDT. The Original JDCA was entered into following our exercise of an option to co-develop and co-commercialize the hemoglobinopathies program that was contained in a collaboration agreement that we entered into with CRISPR in 2015. In April 2021, we and CRISPR entered into an amendment and restatement of the Original JDCA (the “A&R JDCA”). In June 2021, we made a $900.0 million upfront payment to CRISPR in connection with the closing of the transactions contemplated by the A&R JDCA. We concluded that we did not have any alternative future use for the acquired in-process research and development and recorded this upfront payment to AIPR&D. Under the terms of the A&R JDCA, we are leading worldwide development, manufacturing, and commercialization of exa-cel. As of July 1, 2021, 60% of the net profits and net losses for exa-cel are allocated to us and 40% of the net profits and net losses for exa-cel are allocated to CRISPR, subject to certain adjustments. CRISPR may earn an additional one-time $200.0 million milestone payment upon regulatory approval of exa-cel. We concluded that the Original JDCA and the A&R JDCA are cost-sharing arrangements, which result in the net impact of the arrangements, excluding amounts recorded to AIPR&D, being recorded in “Research and development expenses” in our consolidated statements of operations.Acquired In-Process Research and DevelopmentIn 2022 and 2021, our AIPR&D included $115.5 million and $1.1 billion, respectively, related to upfront, contingent milestone, or other payments pursuant to our business development transactions, including the collaborations, licenses of third-party technologies, and asset acquisitions described above.Out-License AgreementsWe also have out-licensed internally developed programs to collaborators who are leading the development of these programs. Pursuant to these out-licensing arrangements, our collaborators are responsible for the research, development, and commercialization costs associated with these programs, and we are entitled to receive contingent milestone and/or royalty payments. As a result, we do not expect to incur significant expenses in connection with these programs and have the potential for future collaborative and royalty revenues resulting from these programs. None of our out-license agreements had a significant impact on our consolidated statements of operations during 2022 and 2021.Please refer to Note B, “Acquired In-Process Research and Development and Other Arrangements,” for further information regarding our in-license agreements and out-license agreements. Strategic InvestmentsIn connection with our business development activities, we have periodically made equity investments in our collaborators. As of December 31, 2022, we held strategic equity investments in certain public and private companies, and we expect to make additional strategic equity investments in the future. While we invest the majority of our cash, cash equivalents, and marketable securities in instruments that meet specific credit quality standards and limit our exposure to any one issue or type of instrument, our strategic investments are maintained and managed separately from our other cash, cash equivalents, and marketable securities. As discussed below in “Other Income (Expense), Net” in our Results of Operations, any changes in the fair value of equity investments with readily determinable fair values (including publicly traded securities) are recorded to other income (expense), net in our consolidated statements of operations.69RESULTS OF OPERATIONS2022% Change2021% Change2020(in millions, except percentages and per share amounts)Revenues$8,930.7 18%$7,574.4 22%$6,205.7 Operating costs and expenses4,623.3 (4)%4,792.3 43%3,349.4 Income from operations4,307.4 55%2,782.1 (3)%2,856.3 Other non-operating (expense) income, net(75.0)45%(51.7)**260.6 Provision for income taxes910.4 134%388.3 (4)%405.2 Net income$3,322.0 42%$2,342.1 (14)%$2,711.7 Net income per diluted common share$12.82 $9.01 $10.29 Diluted shares used in per share calculations259.1 259.9 263.4 ** Not meaningfulRevenues2022% Change2021% Change2020(in millions, except percentages)TRIKAFTA/KAFTRIO$7,686.8 35%$5,697.2 47%$3,863.8 SYMDEKO/SYMKEVI180.0 (57)%420.4 (33)%628.6 ORKAMBI510.7 (34)%771.6 (15)%907.5 KALYDECO553.2 (19)%684.2 (15)%802.9 Product revenues, net8,930.7 18%7,573.4 22%6,202.8 Other revenues— **1.0 **2.9 Total revenues$8,930.7 18%$7,574.4 22%$6,205.7 ** Not meaningfulProduct Revenues, NetIn 2022, our net product revenues increased by $1.4 billion, or 18%, as compared to 2021 primarily due to the launches of TRIKAFTA/ KAFTRIO in multiple countries internationally and the continued performance of TRIKAFTA in the U.S., following the June 2021 launch of TRIKAFTA for children with CF 6 through 11 years of age. Decreases in revenues for our products other than TRIKAFTA/KAFTRIO were primarily the result of patients switching from these medicines to TRIKAFTA/KAFTRIO. Our net product revenues from the U.S. and from ex-U.S. markets were as follows: 2022% Change2021% Change2020(in millions, except percentages)United States$5,699.3 8%$5,287.3 10%$4,826.4 ex-U.S.3,231.4 41%2,286.1 66%1,376.4 Product revenues, net$8,930.7 18%$7,573.4 22%$6,202.8 We expect that our net product revenues will increase in 2023 as a result of the continued performance of TRIKAFTA/KAFTRIO, label expansions into younger age groups for our previously approved products, and expanded access to our medicines.70Operating Costs and Expenses2022% Change2021% Change2020(in millions, except percentages)Cost of sales$1,080.3 19%$904.2 23%$736.3 Research and development expenses2,540.3 31%1,937.8 18%1,644.9 Acquired in-process research and development expenses115.5 (90)%1,113.3 503%184.6 Selling, general and administrative expenses944.7 12%840.1 9%770.5 Change in fair value of contingent consideration(57.5)**(3.1)**13.1 Total costs and expenses$4,623.3 (4)%$4,792.3 43%$3,349.4 ** Not meaningfulBeginning in 2022, we separately classify upfront, contingent milestone, or other payments pursuant to our business development transactions, including collaborations, licenses of third-party technologies, and asset acquisitions as “Acquired in-process research and development expenses,” in our consolidated statements of operations in cases where such acquired assets do not have an alternative future use. To conform prior periods to our current presentation, we have reclassified $1.1 billion and $184.6 million from “Research and development expenses” to AIPR&D for 2021 and 2020, respectively.Cost of SalesOur cost of sales primarily consists of third-party royalties payable on net sales of our products as well as the cost of producing inventories. Pursuant to our agreement with the Cystic Fibrosis Foundation, our tiered third-party royalties on sales of TRIKAFTA/KAFTRIO, SYMDEKO/SYMKEVI, KALYDECO, and ORKAMBI, calculated as a percentage of net sales, range from the single digits to the sub-teens, with royalties on sales of TRIKAFTA/KAFTRIO lower than for our other products. Over the last several years, our cost of sales has been increasing due to increased net product revenues. Our cost of sales as a percentage of our net product revenues was 12% in each of 2022 and 2021. In 2023, we expect our total cost of sales will increase due to expected increases in our net product revenues and our cost of sales as a percentage of our net product revenues will be similar to our cost of sales as a percentage of net product revenues in 2022 and 2021. Research and Development Expenses2022% Change2021% Change2020(in millions, except percentages)Research expenses$626.7 22%$512.3 13%$452.1 Development expenses1,913.6 34%1,425.5 20%1,192.8 Total research and development expenses$2,540.3 31%$1,937.8 18%$1,644.9 Our research and development expenses include internal and external costs incurred for research and development of our products and product candidates. We do not assign our internal costs, such as salary and benefits, stock-based compensation expense, laboratory supplies and other direct expenses and infrastructure costs, to individual products or product candidates, because the employees within our research and development groups typically are deployed across multiple research and development programs. We assign external costs of services provided to us by clinical research organizations and other outsourced research by individual program. Our internal costs are significantly greater than our external costs. All research and development costs for our products and product candidates are expensed as incurred.71Over the past three years, we have incurred $7.5 billion in total research and development and AIPR&D expenses associated with product discovery and development. The successful development of our product candidates is highly uncertain and subject to a number of risks. In addition, the duration of clinical trials may vary substantially according to the type, complexity and novelty of the product candidate and the disease indication being targeted. The FDA and comparable agencies in foreign countries impose substantial requirements on the introduction of therapeutic pharmaceutical products, typically requiring lengthy and detailed laboratory and clinical testing procedures, sampling activities and other costly and time-consuming procedures. Data obtained from nonclinical and clinical activities at any step in the testing process may be adverse and lead to discontinuation or redirection of development activities. Data obtained from these activities also are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. The duration and cost of discovery, nonclinical studies and clinical trials may vary significantly over the life of a project and are difficult to predict. Therefore, accurate and meaningful estimates of the ultimate costs to bring our product candidates to market are not available. Any estimates regarding development and regulatory timelines for our product candidates are highly subjective and subject to change. Until we have data from Phase 3 clinical trials, we cannot make a meaningful estimate regarding when, or if, a clinical development program will generate revenues and cash flows. Research Expenses2022Change %2021Change %2020(in millions, except percentages)Research Expenses:Salary and benefits$159.5 17%$136.7 5%$129.8 Stock-based compensation expense84.0 9%77.3 (10)%85.6 Outsourced services and other direct expenses189.6 19%160.0 38%116.2 Intangible asset impairment charge13.0 **— **— Infrastructure costs180.6 31%138.3 15%120.5 Total research expenses$626.7 22%$512.3 13%$452.1 ** Not meaningfulOur research expenses have been increasing over the last several years as we have invested in our pipeline and expanded our cell and genetic therapy capabilities, resulting in increased headcount and infrastructure costs associated with our research facilities. We expect to continue to invest in our research programs with a focus on creating transformative medicines for serious diseases.Development Expenses2022Change %2021Change %2020(in millions, except percentages)Development Expenses:Salary and benefits$475.1 37%$347.6 18%$295.7 Stock-based compensation expense213.9 12%191.0 8%177.1 Outsourced services and other direct expenses912.9 45%629.4 23%512.2 Infrastructure costs311.7 21%257.5 24%207.8 Total development expenses$1,913.6 34%$1,425.5 20%$1,192.8 Our development expenses increased by $488.1 million, or 34%, in 2022 as compared to 2021, primarily due to increased costs to support clinical trials associated with our advancing pipeline programs, including our CF triple combination of vanzacaftor/tezacaftor/deutivacaftor, pain and T1D. We are investing in both our internal headcount, leveraging outsourced services, and investing in infrastructure to support these programs. We expect our development expenses to continue to increase in 2023 as a result of our advancing pipeline programs, including our pain and T1D programs. In 2022 and 2021, costs related to our CF programs represented the largest portion of our development costs. 72Acquired In-process Research and Development Expenses2022% Change2021% Change2020(in millions, except percentages)Acquired in-process research and development expenses$115.5 (90)%$1,113.3 503%$184.6 AIPR&D in 2022 was primarily related to a $60.0 million payment to acquire the Catalyst complement portfolio, a $25.0 million upfront payment pursuant to our license agreement with Verve, and various other payments. AIPR&D in 2021 included the $900.0 million upfront payment to CRISPR, a $60.0 million option payment to ApoLo1 Bio, LLC to buy-out all future milestone and royalty payments, and upfront payments of $31.0 million and $25.0 million to Mammoth Biosciences, Inc. and Arbor Biotechnologies, Inc., respectively. Our AIPR&D has historically fluctuated, and is expected to continue to fluctuate, from one period to another due to upfront, contingent milestone, and other payments pursuant to our existing and future business development transactions, including collaborations, licenses of third-party technologies, and asset acquisitions.Selling, General and Administrative Expenses2022% Change2021% Change2020(in millions, except percentages)Selling, general and administrative expenses$944.7 12%$840.1 9%$770.5 Selling, general and administrative expenses increased by 12% in 2022 as compared to 2021, primarily due to the continued investment to support the commercialization of our medicines and increased support for our pipeline product candidates. We expect our selling, general and administrative expenses to continue to increase in 2023 as we progress our efforts in preparation for the commercialization of exa-cel. Contingent Consideration The fair value of our contingent consideration decreased by $57.5 million in 2022, primarily as a result of a revision to the scope of certain gene-editing programs in the second quarter of 2022. The fair value of contingent consideration decreased by $3.1 million in 2021. In future periods, we expect the fair value of contingent consideration to increase or decrease based on, among other things, our estimates of the probability of achieving and the timing of these contingent development and regulatory milestone payments, as well as the time value of money and changes in market interest rates.Other Non-Operating Income (Expense), NetInterest IncomeInterest income increased to $144.6 million in 2022, as compared to $4.9 million in 2021, primarily due to increased market interest rates and increased cash equivalents and available-for-sale debt securities. Our future interest income is dependent on the amount of, and prevailing market interest rates on, our outstanding cash equivalents and available-for-sale debt securities.Interest Expense Interest expense was $54.8 million in 2022 as compared to $61.5 million in 2021. The majority of our interest expense in these periods was related to imputed interest expense associated with our leased corporate headquarters in Boston.73Other Income (Expense), NetOther income (expense), net was expense of $164.8 million in 2022 and income of $4.9 million in 2021. The vast majority of these amounts relate to net unrealized gains or losses resulting from changes in the fair value and sales of certain of our strategic investments. As of December 31, 2022, the fair value of our investments in publicly traded companies was $116.8 million. To the extent that we continue to hold strategic investments in publicly traded companies, we will record other income (expense) related to these investments on a quarterly basis. We expect that due to the volatility of the stock price of biotechnology companies, our other income (expense), net will fluctuate in future periods based on increases or decreases in the fair value of our strategic investments.Income TaxesOur effective tax rate fluctuates from year to year due to the global nature of our operations. The factors that most significantly impact our effective tax rate include changes in tax laws, variability in the allocation of our taxable earnings among multiple jurisdictions, the amount and characterization of our research and development expenses, the levels of certain deductions and credits, adjustments to the value of our uncertain tax positions, acquisitions and third-party collaboration and licensing transactions.Our provision for income taxes was $910.4 million for 2022 and $388.3 million for 2021. Our effective tax rate of 21.5% for 2022 was higher than the U.S. statutory rate primarily due to an increase in our unrecognized tax benefit liabilities associated with intercompany transfer pricing matters partially offset by excess tax benefits related to stock-based compensation, tax credits, and changes in our estimated prior-year tax liabilities.Our effective tax rate of 14.2% for 2021 was lower than the U.S. statutory rate primarily due to discrete tax benefits of (i) $94.8 million associated with an increase in the U.K.’s corporate tax rate from 19% to 25%, which was enacted in June 2021 and will become effective in April 2023, and (ii) $44.1 million resulting from an R&D tax credit study that we completed in 2021.LIQUIDITY AND CAPITAL RESOURCESThe following table summarizes the components of our financial condition as of December 31, 2022 and 2021:20222021% Change(in millions)Cash, cash equivalents and marketable securities$10,778.5 $7,524.9 43%Working Capital:Total current assets$13,234.8 $9,560.6 38%Total current liabilities(2,742.1)(2,142.0)28%Total working capital$10,492.7 $7,418.6 41%Working CapitalAs of December 31, 2022, total working capital was $10.5 billion, which represented an increase of $3.1 billion from $7.4 billion as of December 31, 2021. The increase in total working capital in 2022 was primarily related to $4.1 billion of cash provided by operations driven by increased product revenues, partially offset by our $295.9 million net payment to acquire ViaCyte and purchases of property and equipment. 74Cash Flows202220212020(in millions)Net cash provided by (used in):Operating activities$4,129.9 $2,643.5 $3,253.5 Investing activities$(321.1)$(340.9)$99.4 Financing activities$(67.7)$(1,478.0)$(505.3)Operating Activities Cash provided by operating activities was $4.1 billion in 2022 as compared to $2.6 billion in 2021 primarily due to a $979.9 million increase in net income resulting from increased product revenues, the $900.0 million upfront payment to CRISPR paid in 2021, and an increase in product revenue accruals, partially offset by higher income tax payments.Investing ActivitiesCash used in investing activities was $321.1 million and $340.9 million in 2022 and 2021, respectively. In 2022, our investing activities included a net payment of $295.9 million to acquire ViaCyte and $204.7 million in purchases of property and equipment, partially offset by net sales and maturities of available-for-sale debt securities of $227.3 million. Our investing activities in 2021 primarily related to purchases of property and equipment, and, to a lesser extent, purchases of notes receivable and strategic investments.Financing ActivitiesCash used in financing activities was $67.7 million and $1.5 billion in 2022 and 2021, respectively. In 2022, the largest portion of our financing activities were payments related to our employee stock benefit plans and payments on finance leases. In 2021, the largest portion of our financing activities was $1.4 billion of share repurchases pursuant to our share repurchase programs. Sources and Uses of LiquidityAs of December 31, 2022, we had cash, cash equivalents, and marketable securities of $10.8 billion, which represented an increase of $3.3 billion from $7.5 billion as of December 31, 2021. We intend to rely on our existing cash, cash equivalents and marketable securities together with cash flows from product sales as our primary source of liquidity.We expect that cash flows from our products together with our current cash, cash equivalents and marketable securities will be sufficient to fund our operations for at least the next twelve months. The adequacy of our available funds to meet our future operating and capital requirements will depend on many factors, including the amounts of future revenues generated by our products, and the potential introduction of one or more of our other product candidates to the market, the level of our business development activities and the number, breadth, cost and prospects of our research and development programs.Credit Facilities & Financing Strategy We may borrow up to a total of $500.0 million pursuant to a revolving credit facility that we entered into in July 2022 and could repay and reborrow amounts under this revolving credit agreement without penalty. Subject to certain conditions, we could request that the borrowing capacity be increased by an additional $500.0 million, for a total of $1.0 billion. Negative covenants in our credit agreement could prohibit or limit our ability to access this source of liquidity. As of December 31, 2022, the facility was undrawn, and we were in compliance with these covenants.In July 2022, in conjunction with entering into our new credit agreement, we terminated the $500.0 million credit agreement we entered into in 2019. In September 2022, a $2.0 billion credit agreement we entered into in 2020 expired in accordance with its terms.We may also raise additional capital by borrowing under credit agreements, through public offerings or private placements of our securities, or securing new collaborative agreements or other methods of financing. We will continue to manage our capital structure and will consider all financing opportunities, whenever they may occur, that could strengthen 75our long-term liquidity profile. There can be no assurance that any such financing opportunities will be available on acceptable terms, if at all.Future Capital RequirementsWe have significant future capital requirements, including:•Expected operating expenses to conduct research and development activities, manufacture and commercialize our existing and future products, and to operate our organization.•Facility and finance lease obligations as described below.•Royalties we pay to the Cystic Fibrosis Foundation on sales of our CF products.•Cash paid for income taxes.In addition, we have significant potential future capital requirements including:•We have entered into certain business development-related agreements with third parties that include the funding of certain research, development, and commercialization efforts. Certain of our transactions, including collaborations, licensing arrangements, and asset acquisitions, include the potential for future milestone and royalty payments by us upon the achievement of pre-established developmental and regulatory targets and/or commercial targets. Our obligation to fund these research and development and commercialization efforts and to pay these potential milestone and royalties is contingent upon continued involvement in the programs and/or the lack of any adverse events that could cause the discontinuance of the programs associated with our collaborations, licensing arrangements and acquisitions. We may enter into additional business development transactions, including acquisitions, collaborations, licensing arrangements and equity investments, that require additional capital.•To the extent we borrow amounts under our existing credit agreement, we would be required to repay any outstanding principal amounts in 2027.•In February 2023, our Board of Directors approved a share repurchase program, pursuant to which we are authorized to repurchase up to $3.0 billion of our common stock. The share repurchase program does not have an expiration date and can be discontinued at any time.Additional information on several of our future capital requirements is provided below.Research and Development CostsAt any point in time, we have several ongoing clinical trials at various stages of clinical development. Our clinical trial costs are dependent on, among other things, our research activities advancing to later-stage clinical development as well as the size, number, and length of our clinical trials.LeasesFinance LeasesOur corporate headquarters is in two buildings that we lease at Fan Pier in Boston, Massachusetts. We commenced lease payments on these buildings in 2013 and the initial lease periods end in December 2028. We also lease office and laboratory space in San Diego, California. We commenced lease payments for this building in 2019 pursuant to an initial 16-year lease term. We account for each of these buildings as finance leases.Operating LeasesWe account for our remaining real estate leases as operating leases, including office and laboratory space at the Jeffrey Leiden Center for Cell and Genetic Therapies near our corporate headquarters. Base rent payments commenced in 2021 pursuant to an initial 15-year lease term for this building.76Our total future minimum lease payments for our finance and operating leases for each of the next five years and in total are included in Note M, “Leases.” The total future undiscounted minimum lease payments were $666.3 million and $491.3 million related to our finance and operating leases, respectively, as of December 31, 2022.CRITICAL ACCOUNTING POLICIES AND ESTIMATESOur discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements prepared in accordance with generally accepted accounting principles in the U.S. The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported periods. These items are monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are reflected in reported results for the period in which the change occurs. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.We believe that our application of the following accounting policies, each of which requires significant judgments and estimates on the part of management, are the most critical to aid in fully understanding and evaluating our reported financial results:•revenue recognition;•acquisitions, including intangible assets, goodwill and contingent consideration; and•income taxes.Our accounting policies, including the ones discussed below, are more fully described in Note A, “Nature of Business and Accounting Policies.”Revenue RecognitionProduct Revenues, NetWe generate product revenues from sales in the U.S. and in international markets. We sell our products principally to a limited number of specialty pharmacy and specialty distributors in the U.S., which account for the largest portion of our total revenues. We make international sales primarily through distributor arrangements and to retail pharmacies or pharmacy chains, as well as to hospitals and clinics, many of which are government-owned or supported customers. Our customers in the U.S. subsequently resell our products to patients and health care providers. We contract with government agencies so that our products will be eligible for purchase by, or partial or full reimbursement from, such third-party payors. We recognize net product revenues from sales of our products when our customers obtain control of our products, which typically occurs upon delivery to our customers. Revenues from our product sales are recorded at the net sales price, or transaction price, which requires us to make several significant estimates regarding the net sales price. The most significant estimate we are required to make is related to government and private payor rebates, chargebacks, discounts and fees, collectively rebates. The values of the rebates provided to third-party payors per course of treatment vary significantly and are based on government-mandated discounts and our arrangements with other third-party payors. To estimate our total rebates, we estimate the percentage of prescriptions that will be covered by each third-party payor, which is referred to as the payor mix. We track available information regarding changes, if any, to the payor mix for our products, to our contractual terms with third-party payors and to applicable governmental programs and regulations and levels of our products in the distribution channel. We adjust our estimated rebates based upon new information as it becomes available, including information regarding actual rebates for our products. Claims by third-party payors for rebates are submitted to us significantly after the related sales, potentially resulting in adjustments in the period in which the new information becomes known. Our credits to revenue related to prior period sales have not been significant (typically less than 1% of gross product revenues) and primarily related to U.S. rebates. 77The following table summarizes activity related to our accruals for rebates for 2022, 2021 and 2020:(in millions)Balance as of December 31, 2019$635.7 Provision related to 2020 sales1,284.1 Adjustments related to prior year(s) sales0.6 Credits/payments made(1,144.8)Balance as of December 31, 2020$775.6 Provision related to 2021 sales2,126.1 Adjustments related to prior year(s) sales(27.6)Credits/payments made(2,035.5)Balance as of December 31, 2021$838.6 Provision related to 2022 sales2,977.2 Adjustments related to prior year(s) sales(10.4)Credits/payments made(2,514.0)Balance as of December 31, 2022$1,291.4 We have also entered into annual contracts with government-owned and supported customers in international markets that limit the amount of annual reimbursement we can receive. Upon exceeding the annual reimbursement amount, products are provided free of charge, which is a material right. We defer a portion of the consideration received, which includes upfront payments and fees, for shipments made up to the annual reimbursement limit as “Other current liabilities.” The deferred amount is recognized as revenue when the free products are shipped. To estimate the portion of the consideration received to be recognized as revenue and the portion of the amount to be deferred, we rely on our forecast of the number of units we will distribute during the applicable annual period in each international market in which our contracts with government-owned and supported customers limit the amount of annual reimbursement we can receive. Our forecasts are based on, among other things, our historical experience.The preceding estimates and judgments materially affect our recognition of net product revenues. Changes in our estimates of net product revenues could have a material effect on net product revenues recorded in the period in which we determine that change occurs.Acquisitions As part of our business strategy, we seek to acquire products, product candidates and other technologies and businesses that are aligned with our corporate and research and development strategies and complement and advance our ongoing research and development efforts. If we determine that substantially all the fair value that we acquire in an acquisition is concentrated in a single asset, and the acquisition does not constitute a business, we account for it as an asset acquisition. For an asset acquisition of intellectual property that has not yet achieved regulatory approval, we record our upfront payment to AIPR&D, as long as we determine there is no alternative future use for the asset that was acquired.If the fair value that we acquired in an acquisition is distributed among more than one asset, and the acquisition constitutes a business, we account for it as a business combination.We are required to make several significant judgments and estimates to calculate the purchase price for our business combinations and then allocate it to the assets that we have acquired and the liabilities that we have assumed on our consolidated balance sheet. The most significant judgments and estimates relate to the fair value of the in-process research and development assets and contingent consideration liabilities related to these business combinations. Based on these judgments and estimates, the fair value of the goodwill that we record as a result of these business combinations may be material. Once recorded, these assets are subject to quarterly impairment analysis and our contingent consideration liabilities are adjusted quarterly, which requires similar judgments and estimates.78Intangible AssetsIn 2022, we recorded a $216.6 million in-process research and development intangible asset related to our acquisition of ViaCyte on our consolidated balance sheet. We also recorded a $13.0 million impairment of an in-process research and development intangible asset to “Research and development expenses,” due to a decision to revise the scope of certain acquired gene-editing programs. As of December 31, 2022, we had $603.6 million of in-process research and development assets on our consolidated balance sheet. Each of these assets is accounted for as an indefinite-lived intangible asset and reflected on our consolidated balance sheets until either the project underlying it is completed or the asset becomes impaired. Our in-process research and development intangible assets are tested for impairment on an annual basis, and more frequently if indicators are present or changes in circumstances suggest that impairment may exist. When we determine that an asset has become impaired or we abandon a project, we write down the carrying value of the related intangible asset to its fair value and record an impairment charge in the period in which the impairment occurs.To determine the fair value of our in-process research and development assets, we have utilized either the multi-period excess earnings or the relief from royalty methods of the income approach. Each method requires us to estimate the probability of technical and regulatory success, revenue projections and growth rates, and appropriate discount and tax rates. The multi-period excess earnings method also requires us to estimate development and commercial costs. The relief from royalty method also requires us to estimate the after-tax royalty savings expected from ownership of the asset that we acquired.Contingent ConsiderationAs of December 31, 2022 and 2021, we had $129.0 million and $186.5 million, respectively, of liabilities on our consolidated balance sheets attributable to the fair value of the contingent development and regulatory payments that we may owe to Exonics’ former equity holders upon the achievement of certain events. The decrease in fair value of contingent consideration during 2022 was primarily due to a revision to the scope of certain acquired gene-editing programs.We record an increase or a decrease in the fair value of the contingent consideration liabilities on our consolidated balance sheet and in our consolidated statement of operations on a quarterly basis. We determine the fair value of our contingent consideration liabilities using a probability weighted discounted cash flow method of the income approach, which requires us to make estimates of the timing of regulatory and commercial milestone achievement and the corresponding estimated probability of technical and regulatory success rates. Significant judgment is used in determining the appropriateness of these assumptions during each reporting period. Reasonable changes in these assumptions can cause material changes to the fair value of our contingent consideration liabilities. Due to the early stage of Exonics’ programs, these significant assumptions could be affected by future economic and market conditions.GoodwillAs of December 31, 2022 and 2021, we had goodwill of $1.1 billion and $1.0 billion, respectively, on our consolidated balance sheets. In 2022, we recorded $85.8 million of goodwill on our consolidated balance sheet related to our acquisition of ViaCyte. In 2021, we did not have any business combinations; therefore, we did not record any additional goodwill. Goodwill reflects the difference between the fair value of the consideration transferred and the fair value of the net assets acquired. Thus, the goodwill that we record is dependent on the significant judgments and estimates inherent in the fair value of our in-process research and development assets and contingent consideration liabilities. We have one reporting unit for goodwill reporting purposes. We evaluate our goodwill for impairment on an annual basis, and more frequently if indicators are present or changes in circumstances suggest that impairment may exist. We have not identified any goodwill impairment to date.Income Taxes We utilize the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and tax basis of assets and liabilities using enacted tax rates in effect for years in which the temporary differences are expected to reverse. If our estimate of the tax effect of reversing temporary differences is (i) not reflective of actual outcomes, (ii) modified to reflect new developments or interpretations of the tax law, or (iii) revised to incorporate new accounting principles, or changes in the expected timing or manner of the reversal, our results of operations could be materially impacted. We provide a valuation allowance when it is more likely than not that deferred tax assets will not be realized. On a 79periodic basis, we reassess our valuation allowances on our deferred tax assets, weighing positive and negative evidence to assess the recoverability of the deferred tax assets. Significant judgment is required in making these assessments to maintain or reverse our valuation allowances and, to the extent our future expectations change we would have to assess the recoverability of these deferred tax assets at that time. As of December 31, 2022, we maintained a valuation allowance of $237.8 million related primarily to U.S. state tax attributes.We record liabilities related to uncertain tax positions by prescribing a minimum recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We adjust our liability to reflect any subsequent changes in the relevant facts and circumstances surrounding the uncertain positions. We are subject to tax laws and audits in multiple jurisdictions and significant judgment is required in making this assessment. Consequently, we regularly re-evaluate uncertain tax positions and consider various factors, including, but not limited to, changes in tax law, the measurement of tax positions taken or expected to be taken in tax returns, and changes in facts or circumstances related to a tax position. As of December 31, 2022, our liability for uncertain tax positions was $459.6 million. RECENT ACCOUNTING PRONOUNCEMENTSRefer to Note A, “Nature of Business and Accounting Policies,” in the accompanying notes to the consolidated financial statements for a discussion of recent accounting pronouncements and new accounting pronouncements adopted during 2022. 80ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKInterest Rate RiskFinancial InstrumentsAs part of our investment portfolio, we own financial instruments that are sensitive to market risks. The investment portfolio is used to preserve our capital, provide adequate liquidity and earn returns commensurate with our risk appetite. We invest in instruments that meet the credit quality standards outlined in our investment policy, which also limits the amount of credit exposure to any one issue or type of instrument. These instruments principally include securities issued by the U.S. government and its agencies, investment-grade corporate bonds and commercial paper, and money market funds. These investments are denominated in U.S. Dollars and none are held for trading purposes.All of our interest-bearing securities are subject to interest rate risk and could change in value if interest rates fluctuate. Substantially all of our investment portfolio consists of marketable securities with active secondary or resale markets to help ensure portfolio liquidity, and we have implemented guidelines limiting the term-to-maturity of our investment instruments. Since we account for these securities as available-for-sale, no gains or losses are realized due to changes in the fair value of our investments unless we sell our investments prior to maturity or incur a credit loss. Due to the conservative nature of these instruments, we do not believe that the fair value of our investments has a material exposure to interest rate risk.While we are exposed to global interest rate fluctuations, our investment portfolio is most affected by fluctuations in U.S. interest rates, which affect the interest earned on our cash, cash equivalents and marketable securities. Credit AgreementIn 2022, we entered into a $500.0 million unsecured revolving credit facility (“credit agreement”). Loans under this credit agreement bear interest, at our option, at a base rate or a Secured Overnight Financing Rate (“SOFR”), plus an applicable margin based on our consolidated leverage ratio (the ratio of our total consolidated funded indebtedness to our consolidated EBITDA for the most recently completed four fiscal quarter period). Pursuant to our credit agreement, the applicable margin on base rate loans ranges from 0.000% to 0.500% and the applicable margin on SOFR loans ranges from 1.000% to 1.500%. We do not believe that changes in interest rates related to our credit agreement would have a material effect on our consolidated financial statements. As of December 31, 2022, we had no principal or interest outstanding under our credit facility. A portion of our “Interest expense” in 2023 will be dependent on whether, and to what extent, we borrow amounts under this facility. Foreign Exchange Market RiskAs a result of our foreign operations, we face significant exposure to movements in foreign currency exchange rates, primarily the Euro and British Pound against the U.S. dollar. Fluctuations in the amounts of our foreign revenues and fluctuations in foreign currency exchange rates, may have a positive or negative effect on our foreign exchange rate exposure. The current exposures arise primarily from cash, accounts receivable, intercompany receivables and payables, payables and accruals and inventories.We have a foreign currency management program, which is separate from our investment policy and portfolio, with the objective of reducing the effect of exchange rate fluctuations on our operating results and forecasted revenues denominated in foreign currencies. We currently have cash flow hedges for the Euro, British Pound, Canadian Dollar, Swiss Franc and Australian Dollar related to a portion of our forecasted product revenues that qualify for hedge accounting treatment under U.S. GAAP. We do not seek hedge accounting treatment for our foreign currency forward contracts related to monetary assets and liabilities that impact our operating results. As of December 31, 2022, we held foreign exchange forward contracts that were designated as cash flow hedges with notional amounts totaling $2.2 billion representing a net fair value of $33.1 million on our consolidated balance sheet.Although not predictive in nature, we believe a hypothetical 10% threshold reflects a reasonably possible near-term change in exchange rates. If the December 31, 2022 exchange rates were to change by a hypothetical 10%, the fair value recorded on our consolidated balance sheet related to our foreign exchange forward contracts that were designated as cash flow hedges as of December 31, 2022 would change by approximately $220.2 million. However, since these contracts hedge a specific portion of our forecasted product revenues denominated in certain foreign currencies, any change in the fair value of these contracts is recorded in “Accumulated other comprehensive income” on our consolidated balance sheets and is 81reclassified to earnings in the same periods during which the underlying product revenues affect earnings. Therefore, any change in the fair value of these contracts that would result from a hypothetical 10% change in exchange rates would be entirely offset by the change in value associated with the underlying hedged product revenues resulting in no impact on our future anticipated earnings and cash flows with respect to the hedged portion of our forecasted product revenues. Equity Price RiskInformation required by this section is incorporated by reference from the discussion in the “Strategic Investments” section of this Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with our historical financial statements and the related notes included elsewhere in this annual report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in or implied by any of the forward-looking statements as a result of various factors, including but not limited to those listed under “Risk Factors” and “Special Note Regarding Forward-Looking Statements.” New risks and uncertainties come up from time to time, and it is impossible to predict these events or how they may affect us. We have no obligation to update any forward-looking statements after the date hereof, except as required by applicable federal securities law. This discussion includes a comparison of our results of operations, liquidity and capital resources, financing and financing capacity and cash flow for the years ended December 31, 2022 and 2021. We are a leading data analytics provider serving customers in the insurance markets. Using advanced technologies to collect and analyze billions of records, we draw on unique data assets and deep domain expertise to provide innovations that may be integrated into customer workflows. We offer predictive analytics and decision support solutions to customers in rating, underwriting, claims, catastrophe and weather risk, global risk analytics, and many other fields. In the U.S., and around the world, we help customers protect people, property, and financial assets. Refer to Item 1. Business for further discussion. Our customers use our solutions to make better decisions about risk and opportunities with greater efficiency and discipline. We refer to these products and services as “solutions” due to the integration among our services and the flexibility that enables our customers to purchase components or the comprehensive package. These solutions take various forms, including data, statistical models, or tailored analytics, all designed to allow our customers to make more logical decisions. We believe our solutions for analyzing risk positively impact our customers’ revenues and help them better manage their costs. 30 Table of Contents Recent Developments On October 28, 2022, we entered into an equity purchase agreement to sell our Energy business to Planet Jersey Buyer Ltd, an entity that was formed on behalf of, and is controlled by, The Veritas Capital Fund VIII, L.P. and its affiliated funds and entities (“Veritas Capital”), for a purchase price of $3,100.0 million (subject to customary purchase price adjustments for, among other things, the cash, working capital and indebtedness of the Energy business as of the closing) and up to $200 million of additional contingent cash consideration based on Veritas Capital’s future return on its investment paid through a Class C Partnership interest. This transaction closed on February 1, 2023. The Energy business qualified as held for sale in the fourth quarter of 2022 and was classified as a discontinued operation per the guidance in ASC 205-20, Discontinued Operations, as we determined, qualitatively and quantitatively, that this transaction represents a strategic shift that has or will have a major effect on our operations and financial results. Accordingly, all results of the Energy business have been removed from continuing operations and presented as discontinued operations in our consolidated statements of operations and as held for sale assets and liabilities on our balance sheet for all periods presented. On February 1, 2023, we entered into an agreement to acquire Mavera for a net cash purchase price of $29.3 million, of which $4.2 million represents indemnity escrows. Mavera is a Sweden-based InsurTech firm with a strong regional presence and established customer base for its personal injury claims management platform. Mavera will support our expansion in continental Europe and its continued growth as a technology and analytics partner to the global insurance industry. On January 17, 2023 and February 1, 2023, we made repayments of $20 million and $970 million, respectively, under the Syndicated Credit Facility. As a result of this activity, we now have the ability to draw up to $995.6 million from our Syndicated Credit Facility. Subsequent to December 31, 2022, the outstanding borrowings under the Bilateral Term Loan Facility of $125.0 million and the Bilateral Revolving Credit Facility of $275.0 million were repaid. Executive Summary Key Performance Metrics Revenue growth. We use year-over-year revenue growth as a key performance metric. We assess revenue growth based on our ability to generate increased revenue through increased sales to existing customers, sales to new customers, sales of new or expanded solutions to existing and new customers, and strategic acquisitions of new businesses. We believe our business’s ability to grow recurring revenue and generate positive cash flow is the key indicator of the successful execution of our business strategy. We use year-over-year revenue and EBITDA growth as metrics to measure our performance. EBITDA and EBITDA margin are non-GAAP financial measures. EBITDA is defined as net income before interest expense, provision for income taxes, and depreciation and amortization of fixed and intangible assets. We calculate EBITDA margin as EBITDA divided by revenues. The respective nearest applicable GAAP financial measures are net income and net income margin. Although EBITDA is a non-GAAP financial measure, EBITDA is frequently used by securities analysts, lenders, and others in their evaluation of companies; EBITDA has limitations as an analytical tool, and should not be considered in isolation, or as a substitute for an analysis of our operating income, net income, or cash flow from operating activities reported under GAAP. Management uses EBITDA and EBITDA margin in conjunction with traditional GAAP operating performance measures as part of its overall assessment company performance. We believe these measures are useful and meaningful because they help us allocate resources, make business decisions, allow for greater transparency regarding our operating performance, and facilitate period-to-period comparisons. Some of these limitations involved in the use of EBITDA are: • EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments. • EBITDA does not reflect changes in, or cash requirements for, our working capital needs. • Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized often will have to be replaced in the future and EBITDA does not reflect any cash requirements for such replacements. • Other companies in our industry may calculate EBITDA differently than we do, limiting its usefulness as a comparative measure. EBITDA growth. We use EBITDA growth as a measure of our ability to balance the size of revenue growth with cost management and investing for future growth. EBITDA growth allows for greater transparency regarding our operating performance and facilitate period-to-period comparison. EBITDA margin. We use EBITDA margin as a performance measure to assess segment performance and scalability of our business. We assess EBITDA margin based on our ability to increase revenues while controlling expense growth. 31 Table of Contents Revenues Our Insurance segment provides underwriting and ratings, and claims insurance data for the U.S. P&C insurance industry. This segment's revenues represented approximately 98% and 90% of our revenues for the years ended December 31, 2022 and 2021, respectively. Our customers in this segment include most of the P&C insurance providers in the U.S. Our former Energy and Specialized Markets segment no longer includes the Energy business as it was classified as a discontinued operation in the fourth quarter of 2022. The Energy and Specialized Markets segment consists of our environmental health and safety business, which was sold on March 11, 2022. Our former Energy and Specialized Markets segment's revenues represented approximately 1% and 5% of our revenues for the years ended December 31, 2022 and 2021. Our former Financial Services segment provided competitive benchmarking, decisioning algorithms, business intelligence, and customized analytic services to financial institutions, payment networks and processors, alternative lenders, regulators and merchants. Our former Financial Services segment's revenues represented approximately 1% and 5% of our revenues for the years ended December 31, 2022 and 2021, respectively. We earn revenues through agreements for hosted subscriptions, advisory/consulting services, and for transactional solutions, recurring and non-recurring. Subscriptions for our solutions are generally paid in advance of rendering services either quarterly or in full upon commencement of the subscription period, which is usually for one year and automatically renewed each year. As a result, the timing of our cash flows generally precedes our recognition of revenues and income and our cash flow from operations tends to be higher in the first quarter as we receive subscription payments. Examples of these arrangements include subscriptions that allow our customers to access our standardized coverage language, our claims fraud database, or our actuarial services throughout the subscription period. In general, we experience minimal revenue seasonality within the business. Approximately 81% of the revenues in our Insurance segment for the years ended December 31, 2022 and 2021 were derived from hosted subscriptions through agreements (generally one to five years) for our solutions. We also provide advisory/consulting services, which help our customers get more value out of our analytics and their subscriptions. In addition, certain of our solutions are paid for by our customers on a transactional basis, recurring and non-recurring. For example, we have solutions that allow our customers to access property-specific rating and underwriting information to price a policy on a commercial building, or compare a P&C insurance or a workers' compensation claim with information in our databases, or use our repair cost estimation solutions on a case-by-case basis. For the years ended December 31, 2022 and 2021, approximately 19% of our consolidated revenues were derived from providing transactional and advisory/consulting solutions. Principal Operating Costs and Expenses Personnel expenses are a major component of both our cost of revenues and selling, general and administrative expenses. Personnel expenses, which represented approximately 59.2% and 56.3% of ourtotal operating expenses (excluding gains/losses related to dispositions) for each of the years ended December 31, 2022 and 2021, respectively, include salaries, benefits, incentive compensation, equity compensation costs, sales commissions, employment taxes, recruiting costs, and outsourced temporary agency costs. We assign personnel expenses between two categories, cost of revenues and selling, general and administrative costs, based on the actual costs associated with each employee. We categorize employees who maintain our solutions as cost of revenues, and all other personnel, including executive managers, salespeople, marketing, business development, finance, legal, human resources, and administrative services, as selling, general and administrative expenses. A significant portion of our other operating costs, such as facilities and communications, are either captured within cost of revenues or selling, general and administrative expense based on the nature of the work being performed. While we expect to grow our headcount over time to take advantage of our market opportunities, we believe that the economies of scale in our operating model will allow us to grow our personnel expenses at a lower rate than revenues. Historically, our EBITDA margin has improved because we have been able to increase revenues without a proportionate corresponding increase in expenses. However, part of our corporate strategy is to invest in new solutions and new businesses, which may offset margin expansion. Cost of Revenues. Our cost of revenues consists primarily of personnel expenses. Cost of revenues also includes the expenses associated with the acquisition and verification of data, the maintenance of our existing solutions, and the development and enhancement of our next-generation solutions. Our cost of revenues excludes depreciation and amortization. Selling, General and Administrative Expense. Our selling, general and administrative expense also consists primarily of personnel costs. A portion of the other operating costs such as facilities, insurance, and communications are allocated to selling, general and administrative costs based on the nature of the work being performed by the employee. Our selling, general and administrative expenses excludes depreciation and amortization. 32 Table of Contents Trends Affecting Our Business A significant change in P&C insurers’ profitability could affect the demand for our solutions. For insurers, the keys to profitability include increasing investment income, premium growth and disciplined and accurate underwriting of risks. Growth in P&C insurers’ direct written premiums is cyclical, with total industry premium growth receding from a peak of 14.8% in 2002 to a trough of negative 3.1% in 2009 and subsequently recovering to 5.1% in 2019. In 2020, industry premium growth declined to 2.3% due to the COVID-19 pandemic. Direct premium growth accelerated to 9.5% in 2021 indicating a recovery from the COVID-19 pandemic. Based on the most recent results available, direct written premiums continued to grow in 2022. As the pandemic related issues continue winding down, new economic concerns such as inflation and rising interest rates have risen to the fore. Despite increasing interest rates in 2022, the annualized yield on investments (not attributable to cash transfers from outside the P/C industry) is 2.5% as of nine-months 2022, down from the 2.6% yield for year-end 2021. Both recent results are lower than the historical 15-year average of 3.4%, showing that yields have yet to follow the trend in interest rates. From 2020 to 2022, insurers were also challenged by heightened catastrophic losses associated with a record number of events that ISO's Property Claims Service had classified as catastrophes. The catastrophes of 2020 included hurricane Laura and the Midwest derecho, as well as multiple wildfires in the Western states, while the most notable events of 2021 included the winter storm in February that left much of Texas without power and Hurricane Ida in August. Calendar year 2022 was marked by Hurricane Ian in September, the deadliest hurricane to strike Florida since 1935. All three of these hurricanes - Laura, Ida, and Ian - are among the strongest hurricanes to ever make landfall in the United States. In Florida specifically, the high overall claim risk, as evidenced by Ian, combined with the litigious environment poses an even greater risk to insurers who have faced two consecutive years with significant net underwriting losses. In California, the Department of Insurance enacted regulations for wildfire mitigation discounts in rating plans and wildfire risk models in response to an insurance affordability crisis in wildfire prone areas. We continue to provide the necessary coverages and data and analytics to meet the changing needs of communities, regulators and insurers as illustrated by these events. In response to rising inflation, carriers are working to reset pricing to fix loss ratios and improve profitability. This has slowed their marketing spend for customer acquisition. Until premium pricing adjustments take effect and profitability improves, carriers are refraining from spending to drive new policy volume, creating short term impacts on demand and volume for our Marketing Solutions offerings and auto underwriting solutions. Trends in catastrophe and non-catastrophe losses (such as from weather, climate, casualty, terrorism, pandemics, and tsunamis) can have an effect on our customers’ profitability, and therefore on their appetite for buying analytics to help them manage their risks. Any increase or decrease in frequency or severity of these events over time could lead to an increased or decreased demand for our catastrophe modeling, catastrophe loss information, and repair cost solutions. Likewise, any structural changes in the reinsurance and related brokerage industry from alternative capital or newer technologies could affect demand for our products. We also have a portion of our revenue related to the number of claims processed due to losses, which can be impacted by seasonal storm activity. The need by our customers to fight insurance fraud - both in claims and at policy inception - could lead to increased demand for our underwriting and claims solutions. In the life insurance market, carriers are looking to modernize and digitize their core platforms, as well as offer streamlined underwriting decision-making process to expand the number of policies, which can be offered more rapidly, and without cumbersome medical tests. Our no-code modular technology stack and advanced analytics (such as using electronic health records to model mortality and detecting of tobacco use through voice analysis) enable the digital transformation of our customers' core infrastructure and automate their decision-making processes across the policy lifecycle. 33 Table of Contents Description of Acquisitions We acquired thirteen businesses since January 1, 2020. These acquisitions affect the comparability of our consolidated results of operations between periods. See a description of our 2022 acquisitions below and Note 10. Acquisitions to our consolidated financial statements included in this annual report on Form 10-K for further discussions. On March 1, 2022, we acquired 100 percent of the stock of Opta Information Intelligence Corp. ("Opta") for a net cash purchase price of $217.5 million excluding working capital adjustments, of which $0.8 million represents indemnity escrows. Opta, a leading provider of property intelligence and innovative technology solutions in Canada, has become a part of the underwriting & rating category within our Insurance segment. We believe this acquisition further expands our footprint in the Canadian market and supports Verisk in reshaping risk management with valuable business intelligence. On February 11, 2022, we acquired 100 percent of the membership interest of Infutor Data Solutions ("Infutor") for a net cash purchase price of $220.7 million excluding working capital adjustments, of which $1.5 million represents a working capital escrow, plus a contingent earn-out payment of up to $25.0 million subject to the achievement of certain revenue and other performance targets. Infutor, a leading provider of identity resolution and consumer intelligence data, has become part of the underwriting & rating category within our Insurance segment. We believe this acquisition further enhances Verisk's marketing solutions offerings to companies across several industries, including the insurance industry. Description of Dispositions and Discontinued Operations See a description of our 2022 dispositions and businesses held for sale below and Note 11. Dispositions and Discontinued Operations to our consolidated financial statements included in this annual report on Form 10-K for further discussions. As described above, we completed the sale of our Energy business on February 1, 2023. The Energy business qualified as held for sale in the fourth quarter of 2022 and was classified as a discontinued operation. Accordingly, all results of the Energy business have been removed from continuing operations and presented as discontinued operations in our consolidated statements of operations and as held for sale on the balance sheet for all periods presented. On April 8, 2022, the sale of Verisk Financial Services, our Financial Services segment, to TransUnion, a global information and insights company, was completed for net cash proceeds of $498.3 million. An impairment loss of $73.7 million and a loss on the sale of $15.6 million were included in "Other operating (income) loss" within our accompanying consolidated statements of operations for the year ended 2022, respectively. We had a $134.0 million impairment to the long-lived assets for our Financial Services reporting unit including $88.2 million to intangible assets and $45.8 million to fixed assets for the year ended 2021. We assessed the sale of our Financial Services segment per the guidance in ASC 205-20, Discontinued Operations, and determined that this transaction did not qualify as a discontinued operation as its total revenues and assets did not meet the thresholds exemplified in the guidance, quantitatively or qualitatively, to represent a strategic shift that has or will have a major effect on our operations and financial results. Verisk Financial Services generated revenue of $37.6 million in 2022. On March 11, 2022, the sale of our environmental health and safety business ("3E Company Environmental, Ecological and Engineering") within the Energy and Specialized Markets segment, was completed for proceeds of $575.0 million, net of cash and excluding contingent consideration. In the first quarter of 2022, we recognized a gain of $450.8 million. The major classes of assets and liabilities disposed of, reflected in our consolidated balance sheets as of March 11, 2022. We assessed the sale of our environmental health and safety business per the guidance in ASC 205-20, Discontinued Operations, and determined that this transaction did not qualify as a discontinued operation as its total revenues and assets did not meet the thresholds exemplified in the guidance, quantitatively or qualitatively, to represent a strategic shift that has or will have a major effect on our operations and financial results. 34 Table of Contents Year Ended December 31, 2022 Compared to Year Ended December 31, 2021 Consolidated Results of Continuing Operations Revenues Revenues were $2,497.0 million for the year ended December 31, 2022 compared to $2,462.5 million for the year ended December 31, 2021, an increase of $34.5 million or 1.4%. Our recent acquisitions (Data Driven Safety, LLC, Infutor Data Solutions, LLC, and Opta Information Intelligence Corp. within the underwriting & rating category of the Insurance segment, ACTINEO GmbH, Automated Insurance Solutions Ltd. and Pruvan Inc., within the claims category of the Insurance segment) and dispositions (the Specialized Markets segment and the Financial Services segment) reduced net revenues by $93.8 million. The remaining growth in consolidated revenues of $128.3 million or 5.8% is related to increased revenues within our Insurance segment. Refer to the Results of Operations by Segment within this section for more information regarding our revenues. 2022 2021 Percentage change Percentage change excluding recent acquisitions, businesses held for sale and disposition (in millions) Insurance $ 2,437.0 $ 2,206.9 10.4 % 5.8 % Energy and Specialized Markets 22.4 112.8 (80.1 )% — % Financial Services 37.6 142.8 (73.7 )% — % Total revenues $ 2,497.0 $ 2,462.5 1.4 % 5.8 % Cost of Revenues Cost of revenues was $824.6 million for the year ended December 31, 2022 compared to $853.7 million for the year ended December 31, 2021, an decrease of $29.1 million or 3.4%. Our recent acquisitions and dispositions accounted for a net decrease of $54.9 million in cost of revenues, which was primarily related to salaries and employee benefits. The remaining cost of revenues of $25.8 million or 3.6% was primarily due to increases in salaries and employee benefits of $15.0 million, information technology expenses of $13.6 million and travel expenses of $3.5 million. These increases were partially offset by decreases in data costs of $4.7 million, professional consulting fees of $0.9 million and other operating cost of $0.7 million. Selling, General and Administrative Expenses Selling, general and administrative expenses ("SGA") were $381.5 million for the year ended December 31, 2022 compared to $313.2 million for the year ended December 31, 2021, an increase of $68.3 million or 21.8%. Our recent acquisitions and dispositions accounted for an increase of $13.7 million in SGA primarily related to salaries and employee benefits. Our acquisition-related costs (earn-outs) accounted for a decrease of $3.6 million (See Note 10. Acquisitions to our consolidated financial statements included in this annual report on Form 10-K). The remaining SGA increase of $58.2 million or 21.3% was primarily due to increases in professional consulting costs of $49.2 million, travel expenses of $4.6 million, salaries and employee benefits of $4.2 million and information technology expenses of $0.4 million. The increase in professional consulting costs is primarily due to the release of the previously established Xactware Solutions Patent Litigation's ("EVT Litigation Reserve") reserve once the final payment was made in the fourth quarter of 2021 (the original accrual for this matter was recorded as part of SGA). These increases were partially offset by decreases of other operating costs of $0.2 million. 35 Table of Contents Depreciation and Amortization of Fixed Assets Depreciation and amortization of fixed assets was $164.2 million for the year ended December 31, 2022 compared to $170.3 million for the year ended December 31, 2021, a decrease of $6.1 million or 3.6%. The decrease was primarily driven by recent dispositions of $20.5 million, partially offset by $13.1 million attributed to assets placed into service to support data capacity expansion and revenue growth and $1.3 million related to recent acquisitions. Amortization of Intangible Assets Amortization of intangible assets was $74.4 million for the year ended December 31, 2022 compared to $79.9 million for the year ended December 31, 2021, a decrease of $5.5 million or 6.9%. The decrease was primarily driven by recent dispositions of $20.1 million, and intangible assets that were fully amortized of $8.6 million, partially offset by additional amortization of intangible assets incurred in connection with our recent acquisitions of $23.2 million. Other Operating (Income)Loss Other operating income was a gain of $354.2 million for the year ended December 31, 2022 compared to a loss of $134.0 million for the year ended December 31, 2021. This increase of $488.2 million was primarily related to the net gain from our dispositions within our former Energy and Specialized Markets and Verisk Financial Services segments. Investment (Loss)Income and Others, Net Investment (loss)income and others, net was a loss of $5.3 million for the year ended December 31, 2022 compared to a gain of $2.1 million for the year ended December 31, 2021. The decrease was primarily due to impact of foreign currencies. Interest Expense Interest expense was $138.8 million for the year ended December 31, 2022 compared to $127.0 million for the year ended December 31, 2021, an increase of $11.8 million or 9.3%. The increase in interest expense was primarily due to increased borrowings and higher interest rates on our Syndicated Credit Facility, and the addition of a Bilateral Term Loan Credit Facility during the first quarter of 2022, partially offset by the maturity of our 4.125% senior notes. Provision for Income Taxes The provision for income taxes was $220.3 million for the year ended December 31, 2022 compared to $179.4 million for the year ended December 31, 2021, an increase of $40.9 million or 22.8%. The effective tax rate was 17.5% for the year ended December 31, 2022 compared to 22.8% for the year ended December 31, 2021. The decrease in the effective tax rate in 2022 compared to 2021 was primarily due to a tax rate benefit in connection with the sale of our environmental health and safety business for which a benefit was recognized for the difference between book and tax basis of our investment. The 2022 rate was also lower than 2021 due to a $30.3 million release of a United Kingdom valuation allowance related to interest expense utilization and a reduced Global Intangible Low Taxed Income ("GILTI") inclusion in the current period versus the prior period, partially offset by reduced stock option exercises resulting in lower tax benefits from equity compensation in the current period versus the prior period. Net Income Margin The net income margin for our consolidated results was 41.7% for the year ended December 31, 2022 compared to 24.7% for each of the year ended December 31, 2021. The increase in net income margin was primarily related to the net gain from the sale of our environmental health and safety business and the Financial Services segment in addition to an impairment of our Financial Services segment in 2021. EBITDA Margin [1] The EBITDA margin for our consolidated results was 65.7% for the year ended December 31, 2022 compared to 47.3% for the year ended December 31, 2021. The increase in EBITDA margin was primarily related to the net gain from our dispositions within our former Energy and Specialized Markets and Verisk Financial Services segments. The increase in EBITDA margin was primarily driven by the net gain from the sale of our environmental health and safety business and the Financial Services segment, which positively impacted our margin by 14.2%. [1] Note: Consolidated EBITDA margin, a non-GAAP measure, is calculated as a percentage of consolidated revenue. A reconciliation from net income to EBITDA is in the table below: Year Ended December 31, 2022 2021 Net Income $ 954.3 $ 666.3 Less: (Loss) income from discontinued operations, net of tax (benefit) expense of $(131.5) and $29.7, respectively (87.8 ) 59.2 Income from continuing operations 1,042.1 607.1 Depreciation and amortization of fixed assets 164.2 170.3 Amortization of intangible assets 74.4 79.9 Interest expense 138.8 127.0 Provision for income taxes 220.3 179.4 EBITDA $ 1,639.8 $ 1,163.7 Revenue $ 2,497.0 $ 2,462.5 EBITDA Margin 65.7 % 47.3 % 36 Table of Contents Results of Continuing Operations by Segment Our Energy and Specialized Market segment was comprised of two businesses, our Energy business and Specialized Market business. On March 11, 2022, we completed the sale of 3E Company Environmental, Ecological and Engineering, which made up the Specialized Markets within this segment. This transaction did not qualify as a discontinued operation. The Energy business qualified as held for sale in the fourth quarter of 2022 and was classified as a discontinued operation. Accordingly, all results of the Energy business have been removed from continuing operations and presented as discontinued operations in our consolidated statements of operations for all periods presented. On February 1, 2023, we completed the sale of our Energy business. On April 8, 2022, we completed the sale of Verisk Financial Services, our Financial Services segment, to TransUnion. This transaction did not qualify as a discontinued operation. As a result of these sale transactions, we have excluded the Energy and Specialized Markets and Financial Services segments from our management's discussion and analysis of the results of operations by segment. See a description of our 2022 dispositions and businesses held for sale below and Note 11. Dispositions and Discontinued Operations to our consolidated financial statements included in this annual report on Form 10-K for further discussions. Insurance Revenues Revenues were $2,437.0 million for the year ended December 31, 2022 compared to $2,206.9 million for the year ended December 31, 2021, an increase of $230.1 million or 10.4%. Our underwriting & rating revenues increased $179.4 million or 11.5%. Our claims revenues increased $50.7 million or 7.8%. 2022 2021 Percentage change Percentage change excluding recent acquisitions, businesses held for sale and disposition (in millions) Underwriting & rating $ 1,734.5 $ 1,555.1 11.5 % 5.9 % Claims 702.5 651.8 7.8 % 5.6 % Total Insurance $ 2,437.0 $ 2,206.9 10.4 % 5.8 % Our recent acquisitions (Data Driven Safety, LLC, Infutor Data Solutions, LLC, and Opta Information Intelligence Corp. within the underwriting & rating category of the Insurance segment, ACTINEO GmbH, Automated Insurance Solutions Ltd. and Pruvan Inc., within the claims category of the Insurance segment) contributed net revenues of $101.8 million, while the remaining Insurance revenues increased $128.3 million or 5.8%. Our underwriting & rating revenues increased $91.8 million or 5.9% primarily due to an annual increase in prices derived from continued enhancements to the content of the solutions within our industry-standard insurance programs as well as selling expanded solutions to existing customers within commercial and personal lines. In addition, catastrophe modeling services contributed to the growth. Our claims revenues increased $36.5 million or 5.6%, primarily due to growth in our repair cost estimating solutions revenue and claims analytics revenue related to annual price as well as volume increases. Cost of Revenues Cost of revenues for our Insurance segment was $781.9 million for the year ended December 31, 2022 compared to $704.4 million for the year ended December 31, 2021, an increase of $77.5 million or 11.0%. Our recent acquisitions and dispositions represented a net increase of $51.7 million in cost of revenues, which was primarily related to salaries and employee benefits. The remaining increase in cost of revenues of $25.8 million or 3.6% was primarily due to increases in salaries and employee benefits of $15.0 million, information technology expenses of $13.6 million and travel expenses of $3.5 million. These increases were partially offset by decreases in data costs of $4.7 million, professional consulting fees of $0.9 million and other operating cost of $0.7 million. Selling, General and Administrative Expenses SGA expenses for our Insurance segment were $347.4 million for the year ended December 31, 2022 compared to $239.1 million for the year ended December 31, 2021, an increase of $108.3 million or 45.3%. Our recent acquisitions and dispositions accounted for an increase of $53.7 million primarily related to salaries and employee benefits. Our acquisition-related costs (earn-outs) accounted for a decrease of $3.6 million. The remaining increase in SGA of $58.2 million or 21.3% was primarily due to increases in professional consulting costs of $49.2 million, travel expenses of $4.6 million, salaries and employee benefits of $4.2 million and information technology expenses of $0.4 million. The increase in professional consulting costs is primarily due to the release of the previously established EVT Litigation Reserve once the final payment was made in the fourth quarter of 2021 (the original accrual for this matter was recorded as part of SGA). These increases were partially offset by decreases of other operating costs of $0.2 million. Investment (Loss) Income and Others, Net Investment (loss) income and others, net was a loss of $4.7 million for the year ended December 31, 2022 compared to a gain of $1.8 million for the year ended December 31, 2021. The decrease was primarily due to impact of foreign currencies. EBITDA EBITDA for our Insurance segment was $1,303.0 million for the year ended December 31, 2022 compared to $1,265.2 million for the year ended December 31, 2021. The EBITDA margin for our Insurance segment was 53.5% for the year ended December 31, 2022 compared to 57.3% for the year ended December 31, 2021. The decrease in EBITDA was primarily due to the release of the previously established EVT Litigation Reserve during the fourth quarter of 2021. 37 Table of Contents Year Ended December 31, 2021 Compared to Year Ended December 31, 2020 Consolidated Results of Continuing Operations Revenues Revenues were $2,462.5 million for the year ended December 31, 2021 compared to $2,269.4 million for the year ended December 31, 2020, an increase of $193.1 million or 8.5%. Our recent acquisitions (Franco Signor, Jornaya, Whitespace, Ignite Software Systems, Data Driven Safety within the underwriting & rating category of the Insurance segment, and ACTINEO within the claims category of the Insurance segment) and dispositions (the aerial imagery sourcing group and the compliance background screening business within the claims category of the Insurance segment and the data warehouse business within the Financial Services segment) increased net revenues by $50.9 million. The remaining growth in consolidated revenues of $142.2 million or 6.3% is primarily related to increased revenues within our Insurance segment. Refer to the Results of Operations by Segment within this section for more information regarding our revenues. 2021 2020 Percentage change Percentage change excluding recent acquisitions, businesses held for sale and disposition (in millions) Insurance $ 2,206.9 $ 2,008.7 9.9 % 7.3 % Energy and Specialized Markets 112.8 104.0 8.5 % 8.5 % Financial Services 142.8 156.7 (8.9 )% (8.1 )% Total revenues $ 2,462.5 $ 2,269.4 8.5 % 6.3 % Cost of Revenue Cost of revenues was $853.7 million for the year ended December 31, 2021 compared to $791.7 million for the year ended December 31, 2020, an increase of $62.0 million or 7.8%. Our recent acquisitions and dispositions accounted for a net increase of $12.3 million in cost of revenues, which was primarily related to salaries and employee benefits. The remaining cost of revenues of $49.7 million or 6.3% was primarily due to increases in salaries and employee benefits of $26.7 million, information technology expenses of $17.6 million, professional consulting fees of $2.4 million, data cost of $0.7 million and other operating cost of $3.6 million. These increases were partially offset by a decrease in travel expense of $1.3 million. Selling, General and Administrative Expenses Selling, general and administrative expenses ("SGA") were $313.2 million for the year ended December 31, 2021 compared to $308.2 million for the year ended December 31, 2020, an increase of $5.0 million or 1.6%. Our recent acquisitions and dispositions accounted for an increase of $14.6 million in SGA primarily related to salaries and employee benefits. Our acquisition-related costs (earn-outs) accounted for a decrease of $2.0 million (See Note 10. Acquisitions to our consolidated financial statements included in this annual report on Form 10-K). The remaining SGA decrease of $7.6 million or 2.5% was primarily due to decreases in professional consulting costs of $37.9 million, travel expenses of $1.4 million and other operating cost of $0.2 million. The decrease in professional consulting costs is primarily due to the release of the previously established Xactware Solutions Patent Litigation's ("EVT Litigation Reserve") reserve once the final payment was made in the fourth quarter of 2021 (the original accrual for this matter was recorded as part of SGA). These decreases were partially offset by increases of salaries and employee benefits of $28.2 million and information technology expenses of $3.8 million. Depreciation and Amortization of Fixed Assets Depreciation and amortization of fixed assets was $170.3 million for the year ended December 31, 2021 compared to $159.2 million for the year ended December 31, 2020, an increase of $11.0 million or 6.9%. The increase was primarily attributed to $11.8 million assets placed into service to support data capacity expansion and revenue growth and $0.4 million related to recent acquisitions, partially offset by recent dispositions of $1.2 million. Amortization of Intangible Assets Amortization of intangible assets was $79.9 million for the year ended December 31, 2021 compared to $73.4 million for the year ended December 31, 2020, an increase of $6.5 million or 9.0%. This increase was primarily driven by the additional amortization of intangible assets incurred in connection with our recent acquisitions of $11.2 million, partially offset by intangible assets that were fully amortized of $4.5 million and our recent dispositions of $0.2 million. 38 Table of Contents Other Operating Income(Loss) Other operating income was a loss of $134.0 million for the year ended December 31, 2021 compared to a gain of $19.4 million for the year ended December 31, 2020. This decrease of $153.6 million was primarily related to the long-lived impairment loss associated with our Financial Services segment recorded in the current period and gains associated with the dispositions of our compliance background screening business and data warehouse business that were recorded in 2020. Investment (Loss)Income and Others, Net Investment (loss) income and others, net was a gain of $2.1 million for the year ended December 31, 2021 compared to a gain of $0.4 million for the year ended December 31, 2020. The increase was primarily due to impact of foreign currencies. Interest Expense Interest expense was $127.0 million for the year ended December 31, 2021 compared to $138.3 million for the year ended December 31, 2020, a decrease of $11.3 million or 8.2%. We repaid our 5.800% senior notes in May 2021, which contributed to a lower interest expense. Provision for Income Taxes The provision for income taxes was $179.4 million for the year ended December 31, 2021 compared to $164.6 million for the year ended December 31, 2020, an increase of $14.8 million or 9.0%. The effective tax rate was 22.8% for the year ended December 31, 2021 compared to 20.1% for the year ended December 31, 2020. The increase in the effective tax rate in 2021 compared to 2020 was primarily due to the deferred tax impact of the tax rate increase in the United Kingdom that was enacted and recorded in 2021 and the impact of higher tax benefits from equity compensation in the prior period versus the current period. Net Income Margin The net income margin for our consolidated results was 24.7% for the year ended December 31, 2021 compared to 28.8% for each of the year ended December 31, 2020. The decrease in net income margin was primarily related to the long-lived asset impairment loss associated with our Financial Services segment. EBITDA Margin [1] The EBITDA margin for our consolidated results was 47.3% for the year ended December 31, 2021 compared to 52.4% for the year ended December 31, 2020. The decrease in EBITDA margin was primarily related to the long-lived asset impairment loss associated with our Financial Services segment, partially offset by the release of the previously established EVT Litigation Reserve once the final payment was made in December 2021. [1] Note: Consolidated EBITDA margin, a non-GAAP measure, is calculated as a percentage of consolidated revenue. A reconciliation from net income to EBITDA is in the table below: Year Ended December 31, 2021 2020 Net Income $ 666.3 $ 712.7 Less: Income from discontinued operations, net of tax expense of $29.7 and $20.1, respectively 59.2 58.9 Income from continuing operations 607.1 653.8 Depreciation and amortization of fixed assets 170.3 159.2 Amortization of intangible assets 79.9 73.4 Interest expense 127.0 138.3 Provision for income taxes 179.4 164.6 EBITDA $ 1,163.7 $ 1,189.3 Revenue $ 2,462.5 $ 2,269.4 EBITDA Margin 47.3 % 52.4 % 39 Table of Contents Results of Continuing Operations by Segment As previously described in our “Results of Continuing Operations by Segment for year ended December 31, 2022 compared to year ended December 31, 2021, we have excluded Energy and Specialized Markets segment and Financial Services segment from the results of operations by segment due to the sale of these two segments. See a description of our 2022 dispositions and businesses held for sale below and Note 11. Dispositions and Discontinued Operations to our consolidated financial statements included in this annual report on Form 10-K for further discussions. Insurance Revenues Revenues were $2,206.9 million for the year ended December 31, 2021 compared to $2,008.7 million for the year ended December 31, 2020, an increase of $198.2 million or 9.9%. Our underwriting & rating revenues increased $142.1 million or 10.1%. Our claims revenues increased $56.1 million or 9.4%. 2021 2020 Percentage change Percentage change excluding recent acquisitions, businesses held for sale and disposition (in millions) Underwriting & rating $ 1,555.1 $ 1,413.0 10.1 % 7.2 % Claims 651.8 595.7 9.4 % 7.5 % Total Insurance $ 2,206.9 $ 2,008.7 9.9 % 7.3 % Our recent acquisitions (Franco Signor, Jornaya, Whitespace, Ignite Software Systems, and Data Driven Safety within the underwriting & rating category and ACTINEO within the claims category) and dispositions (the aerial imagery sourcing group and the compliance background screening business within the claims category) contributed net revenues of $52.2 million, while the remaining Insurance revenues increased $146.0 million or 7.3%. Our underwriting & rating revenues increased $101.7 million or 7.2% primarily due to an annual increase in prices derived from continued enhancements to the content of the solutions within our industry-standard insurance programs as well as selling expanded solutions to existing customers within commercial and personal lines. In addition, catastrophe modeling services contributed to the growth. Our claims revenues increased $44.3 million or 7.5%, primarily due to growth in our repair cost estimating solutions revenue and claims analytics revenue related to annual price as well as volume increases. Cost of Revenues Cost of revenues for our Insurance segment was $704.4 million for the year ended December 31, 2021 compared to $644.4 million for the year ended December 31, 2020, an increase of $60.0 million or 9.3%. Our recent acquisitions and dispositions represented a net increase of $13.0 million in cost of revenues, which was primarily related to salaries and employee benefits. The remaining increase in cost of revenues of $47.0 million or 7.4% was primarily due to increases in salaries and employee benefits of $25.4 million, information technology expenses of $16.5 million, professional consulting fees of $2.9 million, data cost of $2.0 million and other operating cost of $0.8 million. These increases were partially offset by a decrease in travel expense of $0.6 million. Selling, General and Administrative Expenses SG&A expenses for our Insurance segment were $239.1 million for the year ended December 31, 2021 compared to $248.1 million for the year ended December 31, 2020, a decrease of $9.0 million or 3.6%. Our recent acquisitions and dispositions accounted for an increase of $15.1 million primarily related to salaries and employee benefits. Our acquisition-related costs (earn-outs) accounted for a decrease of $2.0 million. The remaining decrease in SGA of $22.1 million or 9.1% was primarily due to decreases in professional consulting costs of $42.2 million, travel expenses of $1.2 million and other operating cost of $0.7 million. The decrease in professional consulting fees was primarily due to the release of the previously established EVT Litigation Reserve once the final payment was made in the fourth quarter of 2021 (the original accrual for this matter was recorded as part of SGA). These decreases were partially offset by increases of salaries and employee benefits of $19.5 million and information technology expenses of $2.6 million. Investment (Loss) Income and Others, Net Investment (loss) income and others, net was a gain of $1.8 million for the year ended December 31, 2021 compared to a gain of $0.3 million for the year ended December 31, 2020. The gain was primarily due to impact of foreign currencies. EBITDA EBITDA for our Insurance segment was $1,265.2 million for the year ended December 31, 2021 compared to $1,132.4 million for the year ended December 31, 2020. The EBITDA margin for our Insurance segment was 57.3% for the year ended December 31, 2021 compared to 56.4% for the year ended December 31, 2020. The increase in EBITDA was primarily due to the release of the previously established EVT Litigation Reserve once the final payment was made in the fourth quarter of 2021, a reduction in travel expenses as a result of COVID-19, and cost discipline. 40 Table of Contents Quarterly Results of Operations The following table set forth our quarterly unaudited consolidated statement of operations data for each of the eight quarters in the period ended December 31, 2022. In management's opinion, the quarterly data has been prepared on the same basis as the audited consolidated financial statements and includes all adjustments necessary to state fairly the information for the periods presented. Our Energy business is classified as discontinued operations. March 31, June 30, September 30, December 31, 2022 (in millions, except for per share data) Statement of operations data: Revenues $ 643.6 $ 612.9 $ 610.1 $ 630.4 Cost of revenue 228.7 195.5 195.2 205.2 Operating income 622.8 247.6 253.6 282.5 Income from continuing operations 487.0 173.5 165.8 215.8 Net Income attributable to Verisk 505.7 197.6 189.4 61.2 Basic earnings per share: Income from continuing operations $ 3.03 $ 1.10 $ 1.06 $ 1.38 Net income attributable to Verisk $ 3.15 $ 1.25 $ 1.21 $ 0.39 Diluted earnings per share: Income from continuing operations $ 3.01 $ 1.09 $ 1.05 $ 1.37 Net income attributable to Verisk $ 3.13 $ 1.24 $ 1.20 $ 0.39 March 31, June 30, September 30, December 31, 2021 (in millions, except for per share data) Statement of operations data: Revenues $ 597.2 $ 613.1 $ 621.9 $ 630.3 Cost of revenue 212.5 212.6 212.4 216.2 Operating income 227.2 246.9 266.2 171.1 Income from continuing operations 147.0 159.2 182.6 118.3 Net income attributable to Verisk 168.6 153.9 201.8 141.9 Basic earnings per share: Income from continuing operations $ 0.90 $ 0.98 $ 1.13 $ 0.73 Net income attributable to Verisk $ 1.04 $ 0.95 $ 1.25 $ 0.88 Diluted earnings per share: Income from continuing operations $ 0.89 $ 0.98 $ 1.12 $ 0.73 Net income attributable to Verisk $ 1.03 $ 0.94 $ 1.24 $ 0.87 41 Table of Contents Liquidity and Capital Resources As of December 31, 2022 and 2021, we had cash and cash equivalents and available-for-sale securities of $296.7 million and $285.3 million, respectively, inclusive of cash included within assets held for sale. Subscriptions for our solutions are billed and generally paid in advance of rendering services either quarterly or in full upon commencement of the subscription period, which is usually for one year. Subscriptions are automatically renewed at the beginning of each calendar year. We have historically generated significant cash flows from operations. As a result of this factor, as well as the availability of funds under our Syndicated Credit Facility (as defined below) and the Bilateral Revolving Credit Facility (as defined below), we believe we will have sufficient cash to meet our working capital, human capital and capital expenditure needs, and to fuel our future growth plans. We have historically managed the business with a working capital deficit due to the fact that, as described above, we offer our solutions and services primarily through annual subscriptions or long-term contracts, which are generally prepaid quarterly or annually in advance of the services being rendered. When cash is received for prepayment of invoices, we record an asset (cash and cash equivalents) on our balance sheet with the offset recorded as a current liability (deferred revenues). This current liability is deferred revenue that does not require a direct cash outflow since our customers have prepaid and are obligated to purchase the services. In most businesses, growth in revenue typically leads to an increase in the accounts receivable balance causing a use of cash as a company grows. Unlike these businesses, our cash position is favorably affected by revenue growth, which results in a source of cash due to our customers prepaying for most of our services. Our capital expenditures as a percentage of revenues for the years ended December 31, 2022 and 2021, were 8.1% and 8.5%, respectively. Expenditures related to developing and enhancing our solutions are predominately related to internal-use software and are capitalized in accordance with ASC 350-40, “Accounting for Costs of Computer Software Developed or Obtained for Internal Use.” We also capitalize amounts in accordance with ASC 985-20, “Software to be Sold, Leased or Otherwise Marketed.” We have historically used a portion of our cash for repurchases of our common stock from our stockholders. For the years ended December 31, 2022, 2021, and 2020, we repurchased $1,662.5 million, $475.0 million and $348.8 million, respectively, of our common stock. For the years ended December 31, 2022, 2021, and 2020, we also paid dividends of $195.2 million, $188.2 million, and $175.8 million, respectively. Financing and Financing Capacity We had total debt, excluding finance lease obligations, unamortized discounts and premium, and debt issuance costs of $3,740.0 million and $3,310.0 million at December 31, 2022 and 2021, respectively. The debt at December 31, 2022 primarily consists of senior notes issued in 2020, 2019 and 2015 and borrowings outstanding under our committed senior unsecured syndicated revolving credit facility ("Syndicated Credit Facility"), described below, our bilateral revolving credit facility (“Bilateral Revolving Credit Facility”) and our bilateral term loan credit facility (“Bilateral Term Loan Credit Facility”). Together, the Syndicated Credit Facility, the Bilateral Revolving Credit Facility, the Bilateral Term Loan Credit Facility are referred to as our “Credit Facilities”. Interest on the senior notes is payable semi-annually each year. The unamortized discount and debt issuance costs were recorded as "Long-term debt" in the accompanying consolidated balance sheets, and will be amortized to "Interest expense" in the accompanying consolidated statements of operations within this Form 10-K over the life of the respective senior note. The indenture governing the senior notes restricts our ability to, among other things, create certain liens, enter into sale/leaseback transactions and consolidate with, sell, lease, convey, or otherwise transfer all or substantially all of our assets, or merge with or into, any other person or entity. As of December 31, 2022, we had senior notes with an aggregate principal amount of $2,350.0 million outstanding, and we were in compliance with our financial and non-financial debt covenants. We have a $1,000.0 million Syndicated Credit Facility with Bank of America N.A., HSBC Bank USA, N.A., JP Morgan Chase Bank, N.A., Wells Fargo Bank, National Association, Citibank, N.A., Credit Suisse AG, Cayman Islands Branch, Morgan Stanley Bank, N.A., First Commercial Bank, Ltd., Los Angeles Branch, TD Bank, N.A., and the Northern Trust Company. The financial covenants thereunder require that, at the end of any fiscal quarter, we have a consolidated funded debt leverage ratio of less than 3.5 to 1.0. At our election, the maximum consolidated funded debt leverage ratio could be permitted to increase one time each to 4.0 to 1.0 and 4.25 to 1.0. The Syndicated Credit Facility may be used for general corporate purposes, including working capital needs and capital expenditures, acquisitions, dividends and the share repurchase program (the "Repurchase Program"). As of December 31, 2022, we were in compliance with all financial and other debt covenants under the Syndicated Credit Facility. As of December 31, 2022 and 2021, the available capacity under the Syndicated Credit Facility was $5.6 million and $384.9 million, net of the letters of credit of $4.4 million and $5.1 million, respectively. Subsequent to December 31, 2022 we have made repayments of $990.0 million under the Syndicated Credit Facility. As a result of this activity, we now have the ability to draw up to $995.6 million from our Syndicated Credit Facility. On March 11, 2022, we entered into a $125.0 million Bilateral Term Loan Credit Facility with Bank of America, N.A with an agreed maturity date of September 12, 2022. On September 9, 2022, we amended the Bilateral Term Loan Credit Facility to provide a one-year extension with an agreed maturity date of September 9, 2023. Subsequent to December 31, 2022, we repaid the full $125.0 million outstanding principal amount under our Bilateral Term Loan Credit Facility agreement. On September 9, 2022 we also added a 364-day $275.0 million Bilateral Revolving Credit Facility to be available starting October 3, 2022. The Bilateral Revolving Credit Facility carry an interest rate of 135 basis points plus the one-month BSBY margin at the time. The Bilateral Revolving Credit Facility may be used for general corporate purposes, including working capital needs and capital expenditures, acquisitions, dividend payments, and the Repurchase Program. In December 2022, we borrowed $275.0 million on the Bilateral Revolving Credit Facility, of which $250.0 million was utilized for share repurchases in the fourth quarter of 2022. Subsequent to December 31, 2022, we repaid the full $275.0 million outstanding principal amount under our Bilateral Revolving Credit Facility. 42 Table of Contents Cash Flow The following table summarizes our cash flow data for the years ended December 31: 2022 2021 2020 (in millions) Net cash provided by operating activities $ 1,059.0 $ 1,155.7 $ 1,068.2 Net cash provided by (used in) investing activities $ 301.4 $ (592.0 ) $ (595.8 ) Net cash used in financing activities $ (1,330.2 ) $ (498.9 ) $ (445.2 ) Operating Activities Net cash provided by operating activities was $1,059.0 million for the year ended December 31, 2022 compared to $1,155.7 million for the year ended December 31, 2021, a decrease of $96.7 million, or 8.4%. The decrease is primarily related to the sale of our environmental health and safety business ("3E") and Financial Services segment, as well as an increase in tax payments of $310.8 million primarily due to the gain on the sale of 3E, partially offset by an impairment related to the Financial Services segment and the Energy business of $243.4 million and the prior year settlement of our EVT litigation reserve of $75.0 million. Net cash provided by operating activities was $1,155.7 million for the year ended December 31, 2021 compared to $1,068.2 million for the year ended December 31, 2020, an increase of $87.5 million, or 8.2%. The increase was primarily due to an increase in operating profit, exclusive of the non-cash impairment of long-lived assets, and customer collections, partially offset by the settlement of our EVT litigation reserve of $75.0 million. Investing Activities Net cash provided by investing activities of $301.4 million for the year ended December 31, 2022 was primarily related to the $1,073.3 million in proceeds from the sale of 3E and our Financial Services segment, partially offset by acquisitions and purchase of non-controlling interest, including escrow funding associated with these acquisitions, of $451.2 million, capital expenditures of $274.7 million and investments in nonpublic companies of $46.0 million. Net cash used in investing activities of $592.0 million for the year ended December 31, 2021 was primarily related to acquisitions, including escrow funding associated with these acquisitions, of $299.0 million, capital expenditures of $268.4 million, and investments in nonpublic companies of $23.6 million. Net cash used in investing activities of $595.8 million for the year ended December 31, 2020 was primarily related to acquisitions, including escrow funding associated with these acquisitions, of $285.1 million, investing in nonpublic companies of $94.8 million, and capital expenditures of $246.8 million, partially offset by the sale of our background screening business within out Insurance segment of $23.1 million. Financing Activities Net cash used in financing activities of $1,330.2 million for the year ended December 31, 2022 was primarily related to repurchases of common stock of $1,662.5 million, repayment of our $350.0 million 4.125% senior notes on September 12, 2022, and dividend payments of $195.2 million, partially offset by proceeds under our Bilateral Term Loan Credit Facility of $125.0 million, proceeds from our Bilateral Revolving Credit Facility of $275.0 million, proceeds, net of repayments of debt under our Syndicated Credit Facility of $380.0 million and proceeds from stock options exercised of $132.5 million. Net cash used in financing activities of $498.9 million for the year ended December 31, 2021was primarily related to repurchases of common stock of $475.0 million, repayment of our $450.0 million 5.800% senior notes on May 3, 2021, and dividend payments of $188.2 million, partially offset by proceeds, net of repayments, from our Syndicated Credit Facility of $560.0 million and proceeds from stock options exercised of $84.3 million. Net cash used in financing activities of $445.2 million for the year ended December 31, 2020 was primarily related to proceeds, net of repayments of debt from our Syndicated Credit Facility of $445.0 million, repurchases of common stock of $348.8 million, and dividend payments of $175.8 million, partially offset by proceeds from the issuance of long-term debt and net of original discount, of $494.8 million, and proceeds from stock options exercised of $88.0 million. 43 Table of Contents Contractual Obligations The following table summarizes our contractual obligations at December 31, 2022 and the future periods in which such obligations are expected to be settled in cash: Payments Due by Period Total Less than 1 year 2-3 years 4-5 years More than 5 years (in millions) Contractual obligations Long-term debt, current portion of long-term debt and interest $ 4,915.1 $ 1,492.5 $ 1,076.8 $ 124.3 $ 2,221.5 Operating leases 263.4 34.6 57.0 52.8 119.0 Pension and postretirement plans (1) 12.8 1.6 3.0 2.5 5.7 Finance lease obligations 4.3 3.1 1.1 0.1 — Total (2) $ 5,195.6 $ 1,531.8 $ 1,137.9 $ 179.7 $ 2,346.2 (1) Our funding policy is to contribute at least equal to the minimum legal funding requirement. (2) Unrecognized tax benefits of approximately $3.2 million have been recorded as liabilities in accordance with Accounting for Uncertainty in Income Taxes — an interpretation of ASC 740, which have been omitted from the table above, and we are uncertain as to if or when such amounts may be settled, with the exception of those amounts subject to a statute of limitation. Related to the unrecognized tax benefits, we also have recorded a liability for potential penalties and interest of $0.4 million. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements. Critical Accounting Policies and Estimates Our management’s discussion and analysis of financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements require management to make estimates and judgments that affect reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the dates of the financial statements and revenue and expenses during the reporting periods. These estimates are based on historical experience and on other assumptions that are believed to be reasonable under the circumstances. On an ongoing basis, management evaluates its estimates, including those related to revenue recognition, goodwill and intangible assets, pension and other postretirement benefits, stock-based compensation, and income taxes. Actual results may differ from these assumptions or conditions. Revenue Recognition We recognize revenue based on the transfer of promised goods or services to customers for the amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. Revenue is recognized in a five-step model: 1) identify the contract with a customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations in the contract; and 5) recognize revenue when or as we satisfy a performance obligation. Revenues for hosted subscription services are recognized ratably over the subscription term. Revenues from certain discrete project based advisory/consulting services are recognized over time by measuring the progress toward complete satisfaction of the performance obligation, based on the input method of consulting hours worked; this aligns with the results achieved and value transferred to the customer. Revenues from transactional solutions are recognized as the solutions are delivered or services performed at point in time. We invoice our customers in annual, quarterly, or monthly installments. Amounts billed and collected in advance are recorded as deferred revenues on the balance sheet and are recognized as the services are performed and revenue recognition criteria are met. 44 Table of Contents Stock-Based Compensation Stock-based compensation cost, including stock options, restricted stock, and performance share units ("PSUs"), is measured at the grant date, based on the fair value of the awards granted, and is recognized as expense over the requisite service period. The fair value of stock options is measured using a Black-Scholes option-pricing model, which requires the use of several estimates, including expected term, expected risk-free interest rate, expected volatility, and expected dividend yield. The fair value of the restricted stock is determined using the closing price of our common stock on the grant date. The fair value of PSUs is determined on the grant date using the Monte Carlo Simulation model. Option grants and restricted stock awards are generally expensed ratably over the four-year vesting period. PSUs are generally expensed ratably over the three-year vesting period. We follow the substantive vesting period approach for awards granted after January 1, 2005, which requires that stock-based compensation expense be recognized over the period from the date of grant to the date when the award is no longer contingent on the employee providing additional service. We estimate expected forfeitures of equity awards at the date of grant and recognize compensation expense only for those awards expected to vest. The forfeiture assumption is ultimately adjusted to the actual forfeiture rate. Goodwill and Intangibles Goodwill represents the excess of acquisition costs over the fair value of tangible net assets and identifiable intangible assets of the businesses acquired. Goodwill and intangible assets deemed to have indefinite lives are not amortized. Intangible assets determined to have definite lives are amortized over their useful lives. Goodwill and intangible assets with indefinite lives are subject to impairment testing annually as of June 30, or whenever events or changes in circumstances indicate that the carrying amount may not be fully recoverable, using the guidance and criteria described in the accounting standard for Goodwill and Other Intangible Assets. This testing compares carrying values to fair values and, when appropriate, the carrying value of these assets is reduced to fair value. As of December 31, 2022, we had goodwill from continuing operations of $1,676.0 million, which represents 24.1% of our total assets. During 2022, we performed an impairment test as of June 30, 2022 and confirmed that no impairment charge was necessary as the fair value of each reporting unit exceeded its carrying value. Subsequent to performing our annual impairment test, we continued to monitor these reporting units for events that would trigger an interim impairment test; other than the impairment of the Energy business that was triggered once the entity was classified as held for sale, we did not identify any other triggering events. There are many assumptions and estimates used that directly impact the results of impairment testing, including an estimate of future expected revenues, EBITDA, EBITDA margins and cash flows, useful lives and discount rates, and an estimate of value using multiples derived from the stock prices of publicly traded guideline companies applied to such expected cash flows and market approaches in order to estimate fair value. We have the ability to influence the outcome and ultimate results based on the assumptions and estimates we choose for determining the fair value of our reporting units. To mitigate undue influence, we set criteria and benchmarks that are reviewed and approved by various levels of management and reviewed by other independent parties. The determination of whether or not goodwill or indefinite-lived acquired intangible assets have become impaired involves a significant level of judgment in the assumptions and estimates underlying the approach used to determine the value of our reporting units. Changes in our strategy or market conditions could significantly impact these judgments and require an impairment to be recorded to intangible assets and goodwill. In connection with the held for sale classification of the Energy business, we recognized an impairment of $303.7 million, partially offset by a deferred tax benefit of $75.9 million on the remeasurement of the disposal group held for sale, which has been included in discontinued operations in our consolidated statement of operations for the year ended December 31, 2022. Upon classification of the Energy business as held for sale, its cumulative foreign currency translation adjustment within shareholders' equity was included with its carrying value, which primarily resulted in the impairment. Due to the deterioration in the performance of our former Financial Services reporting unit and the finalization of the sale price, we reassessed the recoverability of these long-lived assets during the first quarter of 2022, resulting in a $73.7 million impairment. In the fourth quarter of 2021, we recognized a $134.0 million impairment to the long-lived assets for our Financial Services reporting unit including $88.2 million to intangible assets and $45.8 million to fixed assets. These impairments are included within "Other operating income, net" in our consolidated statements of operations. We allocate the fair value of the purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of the purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. The estimates used in valuing the intangible assets are determined with the assistance of third-party specialists, a discounted cash flow analysis and estimates made by management. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings. Pension and Postretirement Certain assumptions are used in the determination of our annual net period benefit (credit) cost and the disclosure of the funded status of these plans. The principal assumptions concern the discount rate used to measure the projected benefit obligation and the expected return on plan assets. We revise these assumptions based on an annual evaluation of long-term trends and market conditions that may have an impact on the cost of providing retirement benefits. In determining the discount rate, we utilize quoted rates from long-term bond indices, and changes in long-term bond rates over the past year, cash flow models and other data sources we consider reasonable based upon the life expectancy and mortality rate of eligible employees. As part of our evaluation, we calculate the approximate average yields on securities that were selected to match our separate projected cash flows for both the pension and postretirement plans. Our separate benefit plan cash flows are input into actuarial models that include data for corporate bonds rated AA or better at the measurement date. The outputs from the actuarial models are assessed against the prior year’s discount rate and quoted rates for long-term bond indices. For our pension plans at December 31, 2022, we determined this rate to be 5.49%, an increase of 2.74% from the 2.75% rate used at December 31, 2021. Our postretirement rate was 5.25% at December 31, 2022 an increase of 3.00% from the 2.25% rate used at December 31, 2021. The expected return on plan assets is determined by taking into consideration our analysis of our actual historical investment returns to a broader long-term forecast adjusted based on our target investment allocation, and the current economic environment. Our pension asset investment guidelines target an investment portfolio allocation of 55% debt securities and 45% equity securities. As of December 31, 2022, the pension plan assets were allocated 52.9% debt securities, 41.4% equity securities, 5.0% real estate and 0.7% other. The VEBA Plan target allocation is 100% debt securities. We have used our target investment allocation to derive the expected return as we believe this allocation will be retained on an ongoing basis that will be commensurate with the projected cash flows of the plan. The expected return for each investment category within our target investment allocation is developed using average historical rates of return for each targeted investment category, considering the projected cash flow of the qualified pension plan and postretirement plan. The difference between this expected return and the actual return on plan assets is generally deferred and recognized over subsequent periods through future net periodic benefit (credits) costs. We believe these considerations provide the basis for reasonable assumptions with respect to the expected long-term rate of return on plan assets. When actual plan experience differs from the assumptions used, actuarial gains or losses arise. We amortize, as a component of annual pension expense, total outstanding actuarial gains or losses over the estimated average expected remaining lifetime of plan participants to the extent that the gain/loss exceeds 10% of the greater of the beginning-of-year projected benefit obligation or the market-related value of plan assets. For our pension and postretirement plans, the total actuarial losses as of December 31, 2022 that have not been recognized in annual expense are $147.8 million and $3.2 million, respectively, and we expect to recognize a net periodic pension and postretirement expenses of $5.3 million and $0.1 million, respectively, in 2023 related to the amortization of actuarial losses. A one percent change in discount rate and future rate of return on plan assets would have the following effects: Pension Postretirement 1% Decrease 1% Increase 1% Decrease 1% Increase Benefit (Credit) Cost Projected Benefit Obligation Benefit (Credit) Cost Projected Benefit Obligation Benefit (Credit) Cost Projected Benefit Obligation Benefit (Credit) Cost Projected Benefit Obligation Discount Rate $ (0.8 ) $ 28.2 $ 0.6 $ (24.4 ) $ - $ 0.3 $ - $ (0.3 ) Expected Rate of Return on Assets $ 4.4 $ - $ (4.4 ) $ - $ 0.1 $ - $ (0.1 ) $ - Income Taxes In projecting future taxable income, we develop assumptions including the amount of future state, federal and foreign pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we use to manage the underlying businesses. The calculation of our tax liabilities also involves dealing with uncertainties in the application and evolution of complex tax laws and regulations in other jurisdictions. We account for uncertain tax positions in accordance with Accounting for Uncertainty in Income Taxes — an interpretation of ASC 740, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under this interpretation, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, based on the technical merits of the position. We recognize and adjust our liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined. 45 Table of Contents We estimate unrecognized tax positions of $0.9 million that may be recognized by December 31, 2023, due to expiration of statutes of limitations and resolution of audits with taxing authorities, net of additional uncertain tax positions. As of December 31, 2022, we have gross federal, state, and foreign income tax net operating loss carryforwards of $85.3 million, which will expire at various dates from 2023 through 2042. Such net operating loss carryforwards expire as follows: Years Ending (In millions) 2023 - 2030 $ 20.8 2031 - 2035 11.7 2036 - 2042 52.8 Total $ 85.3 The net deferred income tax liability of $114.0 million consists primarily of timing differences involving amortization. Recent Accounting Pronouncements For a discussion of recent accounting pronouncements, refer to Note 2(s) to the audited consolidated financial statements included elsewhere in this annual report on Form 10-K. 46 Table of Contents Item 7A. Quantitative and Qualitative Disclosures about Market Risk Interest Rate Risk We are exposed to market risk from fluctuations in interest rates. As of December 31, 2022, we had borrowings outstanding under our Credit Facilities of $1,390.0 million. The borrowings under the Syndicated Credit Facility bear interest at variable rates based on LIBOR plus 1.0% to 1.625% depending on the public debt rating defined in the credit agreement. The current margin is 1.25% for $990.0 million under the Syndicated Credit Facility as a result of the current public debt rating. A change in interest rates on variable rate debt impacts our pre-tax income and cash flows but does not impact the fair value of the instruments. Subsequent to December 31, 2022, we have made repayments of $1,390.0 million on our Credit Facilities. As a result of this activity, we now have the ability to draw up to $1,395.6 million from our Credit Facilities. On September 9, 2022, we amended the $125.0 million Bilateral Term Loan Facility and established the $275.0 million Bilateral Revolving Credit Facility with maturity dates of September 9, 2023 and October 2, 2023, respectively. The Bilateral Credit Facilities carry an interest rate of 135 basis points plus the one-month BSBY and may be used for general corporate purposes, including working capital needs and capital expenditures, acquisitions, dividend payments and the Repurchase Program. The Bilateral Credit Facilities are now subject to the replacement of LIBOR. Interest on the Bilateral Credit Facilities is based on BSBY and we have the choice of the Secured Overnight Financing Rate ("SOFR") or the BSBY as part of the Bilateral Credit Facilities agreement. As our only current contract that is subject to the LIBOR rate is the existing Syndicated Credit Facility, the impact will be dependent on what the outstanding borrowing amount is on the Syndicated Credit Facility and the relevant interest rate that will be contractually applicable. Should we amend or extend our Syndicated Credit Facility to reflect SOFR or BSBY, based on recent borrowings and applicable SOFR, we do not anticipate such an amendment to have a material impact on the business. Based on our overall interest rate exposure as of December 31, 2022, a one percent change in interest rate would result in a change in annual pre-tax interest expense of approximately $13.9 million based on our current borrowing levels outstanding on December 31, 2022. Foreign Currency Risk Our foreign-based businesses and results of operations are exposed to movements in the U.S. dollar to British pounds and other foreign currency exchange rates. A portion of our revenue is denominated in British pounds and other foreign currencies. If the U.S. dollar strengthens against British pounds and other foreign currencies, our revenues reported in U.S. dollars would decline. With regard to operating expense, our primary exposure to foreign currency exchange risk relates to operating expense incurred in British pounds and other foreign currencies. If British pounds and other foreign currencies strengthen, costs reported in U.S. dollars will increase. Movements in the U.S. dollar to British pounds and other foreign currency exchange rates did not have a material effect on our revenue for the year ended December 31, 2022. A hypothetical ten percent change in average exchange rates versus the U.S. dollar would not have resulted in a material change to our earnings.
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+Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations included within this report.The following table summarizes our various operations as of December 31:​​​​​​ 2022 2021Landfills owned or operated 259 260Transfer stations 337 340Material recovery facilities 97 96​​Item 3. Legal Proceedings.Information regarding our legal proceedings can be found under the Environmental Matters and Litigation sections of Note 10 to the Consolidated Financial Statements included within this report.​Item 4. Mine Safety Disclosures.Information concerning mine safety and other regulatory matters required by Section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act and Item 104 of Regulation S-K is included in Exhibit 95 to this annual report.PART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.Our common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “WM.” The number of holders of record of our common stock on January 31, 2023 was 7,847.33 Table of ContentsThe graph below shows the relative investment performance of Waste Management, Inc. common stock, the S&P 500 Index and the Dow Jones Waste & Disposal Services Index for the last five years, assuming reinvestment of dividends at date of payment into the common stock. The graph is presented pursuant to SEC rules and is not meant to be an indication of our future performance.​​​​​​​​​​​​​​​​​​​​​ ​ 12/31/17 12/31/18 12/31/19 12/31/20 12/31/21 12/31/22Waste Management, Inc.​$ 100​$ 105​$ 137​$ 145​$ 208​$ 199S&P 500 Index​$ 100​$ 96​$ 126​$ 149​$ 192​$ 157Dow Jones Waste & Disposal Services Index​$ 100​$ 100​$ 135​$ 144​$ 201​$ 191​​34 Table of ContentsThe Company repurchases shares of its common stock as part of capital allocation programs authorized by our Board of Directors. During 2022, we repurchased an aggregate of $1.5 billion of our common stock under accelerated share repurchase (“ASR”) agreements and open market transactions, which equated to 9.4 million shares with a weighted average price per share of $160.32, inclusive of per-share commissions. In addition, in December 2021, we executed an ASR agreement that completed in January 2022, at which time we received 0.4 million shares. See Note 13 to the Consolidated Financial Statements for additional information. We announced in December 2022 that the Board of Directors has authorized up to $1.5 billion in future share repurchases. This new authorization replaces our prior $1.5 billion authorization that was fully utilized in 2022.The following table summarizes common stock repurchases made during the fourth quarter of 2022 (shares in millions):Issuer Purchases of Equity Securities​​​​​​​​​​​​​​​​​​​Total Number of​​​ ​​Total​​​​Shares Purchased as​Approximate Maximum ​​Number of​Average​Part of Publicly​Dollar Value of Shares that ​​Shares​Price Paid​Announced Plans or​May Yet be Purchased Under Period Purchased per Share Programs the Plans or Programs October 1 — 31 0.1​$ 159.79(a) 0.1​$417 million​November 1 — 30 2.1​$ 161.19(b) 2.1​$84 million​December 1 — 31 0.5​$ 161.19(b) 0.5​$1.5 billion​Total 2.7​$ 161.13​ 2.7​​​​(a)In October 2022, we repurchased 125,167 shares of our common stock in open market transactions in compliance with Rule 10b5-1 and Rule 10b-18 of the Exchange Act for $20 million, inclusive of per-share commissions, at a weighted average price of $159.79.(b)In November 2022, we delivered $417 million cash and received 2.1 million shares pursuant to an Accelerated Share Repurchase (“ASR”) agreement executed in late October 2022. In December 2022, we completed the ASR agreement and received 0.5 million additional shares based on a final weighted average price of $161.19. The “Average Price Paid per Share” in the table represents the final weighted average price per share paid for the ASR agreement.​Any future share repurchases will be made at the discretion of management and will depend on various factors including our net earnings, financial condition and cash required for future business plans, growth and acquisitions. ​Item 6. [Reserved]None.Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.This section includes a discussion of our results of operations for the three years ended December 31, 2022. This discussion may contain forward-looking statements that anticipate results based on management’s plans that are subject to uncertainty. We discuss in more detail various factors that could cause actual results to differ materially from expectations in Item 1A. Risk Factors. The following discussion should be read considering those disclosures and together with the Consolidated Financial Statements and the notes thereto.OverviewWe are North America’s leading provider of comprehensive environmental solutions, providing services throughout the United States (“U.S.”) and Canada. We partner with our residential, commercial, industrial and municipal customers and the communities we serve to manage and reduce waste at each stage from collection to disposal, while recovering valuable resources and creating clean, renewable energy. We own or operate the largest network of landfills throughout the U.S. and Canada. In order to make disposal more practical for larger urban markets, where the distance to landfills is typically farther, we manage transfer stations that consolidate, compact and transport waste efficiently and economically. 35 Table of ContentsThrough our subsidiaries, including our Waste Management Renewable Energy (“WM Renewable Energy”) business, we are also a leading developer, operator and owner of landfill gas-to-energy facilities in the U.S. and Canada that produce renewable electricity and renewable natural gas, which is a significant source of fuel for our natural gas fleet. Additionally, we are a leading recycler in the U.S. and Canada, handling materials that include paper, cardboard, glass, plastic and metal. Our “Solid Waste” business is operated and managed locally by our subsidiaries that focus on distinct geographic areas and provide collection, transfer, disposal, and recycling and resource recovery services. Our senior management evaluates, oversees and manages the financial performance of our Solid Waste operations through two operating segments. Our East Tier primarily consists of geographic areas located in the Eastern U.S., the Great Lakes region and substantially all of Canada. Our West Tier primarily includes geographic areas located in the Western U.S., including the upper Midwest region, and British Columbia, Canada. Each of our Solid Waste operating segments provides integrated environmental services, including collection, transfer, recycling, and disposal. Our Solid Waste operating revenues are primarily generated from fees charged for our collection, transfer, disposal, and recycling and resource recovery services, and from sales of commodities by our recycling and landfill gas-to-energy operations. Revenues from our collection operations are influenced by factors such as collection frequency, type of collection equipment furnished, type and volume or weight of the waste collected, distance to the disposal facility or material recovery facility and our disposal costs. Revenues from our landfill operations consist of tipping fees, which are generally based on the type and weight or volume of waste being disposed of at our disposal facilities. Fees charged at transfer stations are generally based on the weight or volume of waste deposited, considering our cost of loading, transporting and disposing of the solid waste at a disposal site. Recycling revenues generally consist of tipping fees and the sale of recycling commodities to third parties. The fees we charge for our services generally include our environmental, fuel surcharge and regulatory recovery fees which are intended to pass through to customers direct and indirect costs incurred. We also provide additional services that are not managed through our Solid Waste business, described under Results of Operations below.Business EnvironmentThe waste industry is a comparatively mature and stable industry. However, customers increasingly expect more of their waste materials to be recovered and those waste streams are becoming more complex. In addition, many state and local governments mandate diversion, recycling and waste reduction at the source and prohibit the disposal of certain types of waste at landfills. We monitor these developments to adapt our service offerings. As companies, individuals and communities look for ways to be more sustainable, we promote our comprehensive services that go beyond our core business of collecting and disposing of waste in order to meet their needs. This includes expanding traditional recycling services, increasing organics collection and processing, and expanding our renewable energy projects to meet the evolving needs of our diverse customer base. As North America’s leading provider of comprehensive environmental solutions, we are taking big, bold steps to catalyze positive change – change that will impact our Company as well as the communities we serve. Consistent with our Company’s long-standing commitment to sustainability and environmental stewardship, we published our 2022 Sustainability Report providing details on our Environmental, Social and Governance (“ESG”) performance and outlining new 2030 goals. The Sustainability Report conveys the strong linkage between the Company’s ESG goals and our growth strategy, inclusive of the planned expansion of the Company’s recycling and renewable energy businesses. The information in this report can be found at https://sustainability.wm.com but it does not constitute a part of, and is not incorporated by reference into, this Annual Report on Form 10 K. For further discussion see Item1. Business – Regulation – Recent Developments and Focus Areas in Policy and Regulation.We encounter intense competition from governmental, quasi-governmental and private service providers based on pricing, and to a much lesser extent, the nature of service offerings, particularly in the residential line of business. Our industry is directly affected by changes in general economic factors, including increases and decreases in consumer spending, business expansions and construction activity. These factors generally correlate to volumes of waste generated and impact our revenue. Negative economic conditions and other macroeconomic trends can and have caused customers to reduce their service needs. Such negative economic conditions, in addition to competitor actions, can impact our strategy to negotiate, renew, or expand service contracts and grow our business. We also encounter competition for acquisitions and growth opportunities. General economic factors and the market for consumer goods, in addition to regulatory developments, can also significantly impact commodity prices for the recyclable materials we sell. Significant components of our operating expenses vary directly as we experience changes in revenue due to volume and a heightened pace of 36 Table of Contentsinflation. Volume changes can fluctuate significantly by line of business and volume changes in higher margin businesses, such as what we saw with COVID-19, can impact key financial metrics. We must dynamically manage our cost structure in response to volume changes and cost inflation.We believe the Company’s industry-leading asset network and strategic focus on investing in our people and our digital platform will give the Company the necessary tools to address the evolving challenges impacting the Company and our industry. In line with our commitment to continuous improvement and a differentiated customer experience, we remain focused on our automation and optimization investments to enhance our operational efficiency and change the way we interact with our customers. Enhancements made through these initiatives are intended to seamlessly and digitally connect all the Company’s functions required to service our customers in order to provide the best experience and service. In late 2021, we began to execute on the next phase of this technology enablement strategy to automate and optimize certain elements of our service delivery model. This next phase will prioritize reduced labor dependency on certain high-turnover jobs, particularly in customer experience, recycling and residential collection. We continue to make these investments to further digitalize our customer self-service and implement technologies to further enhance the safety, reliability and efficiency of our collection operations. Additionally, in 2022, we implemented a new general ledger accounting system, complementary finance enterprise resource planning system and a human capital management system, which will drive operational and service excellence by empowering our people through a modern, simplified and connected employee experience.Macroeconomic pressures, including inflation and rising interest rates, and market disruption, resulting in labor market, supply chain and transportation constraints are continuing. Significant global supply chain disruption and the heightened pace of inflation have reduced availability and increased costs for the goods and services we purchase, with a particular impact on our repair and maintenance costs. Supply chain constraints have also caused delayed delivery of fleet, steel containers and other purchases. Aspects of our business rely on third-party transportation providers, and such services have become more limited and expensive. While demand for recyclables generally continues to trend upwards, during the second half of 2022, we saw significant declines in commodity prices for recycled materials, and we expect continued significant headwinds from commodity prices for recycled material into 2023, resulting from the slowdown in the global economy, which reduced retail demand and the corresponding need for cardboard packaging to ship retail goods. We are also currently experiencing margin pressures from other commodity-driven business impacts, particularly from higher fuel prices. The constrained labor market has resulted in increased costs for wage adjustments, overtime hours and training new hires. Geopolitical conflict and the resulting international response, including Russia’s invasion of Ukraine, have also exacerbated market disruption, leading to volatility in commodity prices, impacts on the availability and cost of energy, and vendor and supplier disruptions across the global supply chain. The extent and duration of the impact of these labor market, supply chain, transportation and recycling challenges are subject to numerous external factors beyond our control, including broader macroeconomic conditions; recessionary fears and/or an economic recession; size, location, and qualifications of the labor pool; wage and price structures; adoption of new or revised regulations; future resurgence of COVID-19 or other pandemic conditions and restrictions; geopolitical conflicts and responses and supply and demand for recycled materials. As we experience inflationary cost pressures, we focus on our strategic pricing efforts, as well as operating efficiencies and cost controls, to maintain and grow our earnings and cash flow. With these macroeconomic pressures, we remain focused on putting our people first to ensure that they are well positioned to execute our daily operations diligently and safely. We are encouraged by our results in 2022 and remain focused on delivering outstanding customer service, managing our variable costs with changing volumes and investing in technology that will enhance our customers’ experience and reduce our cost to serve.Acquisition of Advanced Disposal Services, Inc. (“Advanced Disposal”)On October 30, 2020, we completed our acquisition of all outstanding shares of Advanced Disposal for $30.30 per share in cash, pursuant to an Agreement and Plan of Merger dated April 14, 2019, as amended on June 24, 2020. Total enterprise value of the acquisition was $4.6 billion when including approximately $1.8 billion of Advanced Disposal’s net debt. This acquisition grew our footprint and allows us to provide differentiated, sustainable waste management and recycling services to approximately three million new commercial, industrial and residential customers primarily located in the Eastern half of the U.S. In connection with our acquisition of Advanced Disposal, we and Advanced Disposal entered into an agreement that provided for GFL Environmental to acquire a combination of assets from us and Advanced Disposal 37 Table of Contentsto address divestitures required by the U.S. Department of Justice. Immediately following the acquisition, the divestiture transactions were consummated and the Company subsequently received cash proceeds from the sale of $856 million.For the year ended December 31, 2022 and 2021, we incurred integration related costs of $10 million and $51 million, respectively, and for the year ended December 31, 2020, we incurred acquisition and integration related costs of $156 million, which were primarily classified as “Selling, general and administrative expenses”. The post-closing operating results of Advanced Disposal have been included in our consolidated financial statements, within our existing reportable segments. Post-closing through December 31, 2020, Advanced Disposal recognized $205 million, $142 million and $60 million of revenue, operating expenses and selling, general and administrative expenses, respectively, which are included in our Consolidated Statement of Operations. For more information related to our acquisitions, see Notes 11 and 17 to the Consolidated Financial Statements and the Summary of Cash Flow Activity section below.COVID-19 ImpactThe impacts of COVID-19 on the global economy increased rapidly during the second quarter of 2020, affecting our business in most geographies and across a variety of our customer types. Over the past two years, our volumes have recovered, largely exceeding volumes from the pre-pandemic levels in 2019. While we continue to be optimistic about North America’s overall economic recovery from the impacts of the COVID-19 pandemic. A significant future resurgence in transmission of COVID-19, a significant new virus variant, or other pandemic conditions that result in business closures and social restrictions could adversely impact our volumes and costs in the future. Current Year Financial ResultsDuring 2022, we continued to advance our strategic priorities—enhancing employee engagement, improving our operations through the use of technology and automation, and investing in growth through our recycling and renewable energy businesses. This strategic focus, combined with strong operational execution resulted in increased revenue, income from operations and income from operations margin driven primarily by both yield and volume growth in our collection and disposal business. We were able to achieve these results despite high inflationary cost pressures. We remain diligent in offering a competitively profitable service that meets the needs of our customers and are focused on driving operating efficiencies and reducing discretionary spend. We continue to invest in our people through market wage adjustments, investments in our digital platform and training for our team members. Despite the significant downturn in commodity prices for recyclable materials in the second half of the year, we remain committed to our investment in recycling automation, which reduces costs and increases throughput, positioning us to overcome commodity price headwinds and deliver a differentiated service. We also continue to make investments in automation and optimization to enhance our operational efficiency and improve labor productivity for all lines of business. During 2022, the Company allocated $2,587 million of available cash to capital expenditures. We also allocated $2,577 million of available cash to our shareholders during 2022 through dividends and common stock repurchases.Key elements of our 2022 financial results include:●Revenues of $19,698 million for 2022 compared with $17,931 million in 2021, an increase of $1,767 million, or 9.9%. The increase is primarily attributable to (i) higher yield in our collection and disposal lines of business; (ii) increases from our fuel surcharge program and (iii) higher volume in our collection and disposal lines of business;●Operating expenses of $12,294 million in 2022, or 62.4% of revenues, compared with $11,111 million, or 62.0% of revenues, in 2021. The $1,183 million increase is primarily attributable to (i) inflationary cost pressures, particularly for maintenance and repairs and subcontractor costs; (ii) commodity-driven business impacts from higher fuel prices and recycling and (iii) labor cost increases from frontline employee wage adjustments;●Selling, general and administrative expenses of $1,938 million in 2022, or 9.8% of revenues, compared with $1,864 million, or 10.4% of revenues, in 2021. The $74 million increase is primarily attributable to (i) higher costs associated with our strategic investments in our digital platform and sustainability initiatives; (ii) increased labor costs primarily from higher annual incentive compensation costs and merit increases; (iii) increased 38 Table of Contentsbusiness travel and entertainment expense and (iv) an increase in provision for bad debts; partially offset by (i) lower long-term incentive compensation costs; (ii) market adjustments for deferred compensation plans related to investment performance and (iii) lower litigation costs;●Income from operations of $3,365 million, or 17.1% of revenues, in 2022 compared with $2,965 million, or 16.5% of revenues, in 2021. The increase in the current year was primarily driven by revenue growth in our collection and disposal lines of business driven by both yield and volume, partially offset by (i) inflationary cost pressures; (ii) labor cost increases from frontline employee wage adjustments; (iii) non-cash asset impairments; and (iv) reduced profitability in our recycling business;●Net income attributable to Waste Management, Inc. was $2,238 million, or $5.39 per diluted share, compared with $1,816 million, or $4.29 per diluted share, in 2021. The increase in income from operations, as discussed above, in addition to a net loss on early extinguishment of debt of $220 million in 2021 that did not repeat in 2022, drove an increase in net income;●Net cash provided by operating activities was $4,536 million in 2022, compared with $4,338 million in 2021. The increase in net cash provided by operating activities was driven by (i) an increase in earnings and (ii) lower interest payments during 2022. These results were partially offset by higher income tax payments in 2022 primarily as a result of higher pre-tax earnings and a deposit of approximately $103 million that was made to the Internal Revenue Service (“IRS”) related to a disputed tax matter. The Company expects to seek a refund of the entire amount deposited with the IRS and litigate any denial of the claim for refund. See Note 8 to the Consolidated Financial Statements for further discussion; and●Free cash flow was $1,976 million in 2022, compared with $2,530 million in 2021. The decrease in free cash flow is primarily attributable to (i) an increase in capital spending, primarily driven by our intentional investment in sustainability growth projects as well as timing differences in our fixed asset purchases to support our ongoing operations and (ii) higher income tax payments in 2022. This decrease was partially offset by increased earnings in 2022. Free cash flow is a non-GAAP measure of liquidity. Refer to Free Cash Flow below for our definition of free cash flow, additional information about our use of this measure, and a reconciliation to net cash provided by operating activities, which is the most comparable GAAP measure.Results of OperationsOperating RevenuesOur Solid Waste operating revenues are primarily generated from fees charged for our collection, transfer, disposal, and recycling and resource recovery services, and from sales of commodities by our recycling and landfill gas-to-energy operations. We also provide additional services that are not managed through our Solid Waste business, including both our Strategic Business Solutions (“WMSBS”) and Sustainability and Environmental Services (“SES”) businesses, which include landfill gas-to-energy services, environmental solutions services and recycling brokerage services. We also offer 39 Table of Contentscertain other expanded service offerings and solutions. The mix of operating revenues from our major lines of business for the year ended December 31 are as follows (in millions):​​​​​​​​​​​​ 2022 2021 2020Commercial​​$ 5,450​$ 4,760​$ 4,102Industrial​​ 3,681​ 3,210​ 2,770Residential​​ 3,339​ 3,172​ 2,716Other collection​​ 699​ 533​ 465Total collection​​ 13,169​ 11,675​ 10,053Landfill​​ 4,600​ 4,153​ 3,667Transfer​​ 2,143​ 2,072​ 1,855Recycling​​ 1,701​ 1,681​ 1,127Other (a)​​ 2,405​ 2,112​ 1,776Intercompany (b)​​ (4,320)​ (3,762)​ (3,260)Total​​$ 19,698​$ 17,931​$ 15,218(a)The “Other” line of business includes (i) certain services provided by our WMSBS business; (ii) certain services within our sustainability business including our landfill gas to energy operations managed by our WM Renewable Energy business and (iii) certain other expanded service offerings and solutions and reflects the results of non-operating entities that provide financial assurance and self-insurance support for our Solid Waste business, net of intercompany activity. Revenue attributable to collection, landfill, transfer and recycling services provided by our “Other” businesses has been reflected as a component of the relevant line of business for purposes of presentation in this table.(b)Intercompany revenues between lines of business are eliminated in the Consolidated Financial Statements included within this report.The following table provides details associated with the period-to-period change in revenues and average yield for the year ended December 31 (dollars in millions):​​​​​​​​​​​​​​​​​​​​​​​​​​​2022 vs. 2021 ​​2021 vs. 2020 ​​​​​As a % of​ ​​​​As a % of ​​​​As a % of ​​​​As a % of ​​​​​Related​​​​​Total ​​​​Related ​​​​Total ​ Amount Business(a) Amount Company(b)​ Amount Business(a) Amount Company(b)​Collection and disposal​$ 1,025​6.7 %​​​​​​​$ 468​3.5 %​​​​​​Recycling (c)​ 19​1.2 ​​ ​​​​​ 537​51.5 ​​ ​​​​Fuel surcharges and other ​ 474​51.7 ​​ ​​​​​ 240​36.9 ​​ ​​​​Total average yield (d)​ ​​​​​$ 1,518​8.5 %​ ​​​​​$ 1,245​8.2 %Volume ​ ​​​​​ 233​1.3 ​​ ​​​​​ 435​2.8 ​Internal revenue growth​​​​​​​​ 1,751​9.8 ​​​​​​​​​ 1,680​11.0 ​Acquisitions​​​​​​​​ 62​0.4 ​​​​​​​​​ 1,032​6.8 ​Divestitures​​​​​​​​ (15)​(0.1)​​​​​​​​​ (49)​(0.3)​Foreign currency translation ​​​​​​​​ (31)​(0.2)​​​​​​​​​ 50​0.3 ​Total​​​​​​​$ 1,767​9.9 %​​​​​​​$ 2,713​17.8 %(a)Calculated by dividing the increase or decrease for the current year by the prior year’s related business revenue adjusted to exclude the impacts of divestitures for the current year.(b)Calculated by dividing the increase or decrease for the current year by the prior year’s total Company revenue adjusted to exclude the impacts of divestitures for the current year.(c)Includes combined impact of commodity price variability and changes in fees.(d)The amounts reported herein represent the changes in our revenue attributable to average yield for the total Company. 40 Table of ContentsThe following provides further details about our period-to-period change in revenues:Average YieldCollection and Disposal Average Yield — This measure reflects the effect on our revenue from the pricing activities of our collection, transfer and landfill operations, exclusive of volume changes. Revenue growth from collection and disposal average yield includes not only base rate changes and environmental and service fee fluctuations, but also (i) certain average price changes related to the overall mix of services, which are due to the types of services provided; (ii) changes in average price from new and lost business and (iii) price decreases to retain customers.The details of our revenue growth from collection and disposal average yield for the year ended December 31 are as follows (dollars in millions):​​​​​​​​​​​​​​​ 2022 vs. 2021 2021 vs. 2020​​​​​​​As a % of ​​​As a % of​​​​​​​Related ​​​Related​​ ​Amount Business Amount Business Commercial​​$ 406​9.2 % $ 152​3.9 %Industrial​​ 307​10.2 ​ 126​4.8 ​Residential​​ 185​6.1 ​ 119​4.5 ​Total collection​​ 898​8.2 ​ 397​4.2 ​Landfill​​ 79​3.1 ​ 42​1.8 ​Transfer​​ 48​4.5 ​ 29​2.9 ​Total collection and disposal​​$ 1,025​6.7 % $ 468​3.5 %​Our overall strategic pricing efforts are focused on recovering our higher cost to service our customers that we experience in our business by increasing our average unit rate. We experienced strong average yield growth in our collection line of business of 8.2% in 2022, up from 4.2% in 2021, illustrating our focus on our pricing efforts in this inflationary environment. We are driving improvements in our residential line of business, aligning the price charged for services we provide to our customers with the costs to provide the services, resulting in increased average yield in 2022 of 6.1%, up from 4.5% in 2021. We are also continuing to see growth in our disposal business with our municipal solid waste business experiencing average yield of 6.2% in 2022, up from 3.2% in 2021. Recycling — Recycling revenues attributable to yield increased $19 million and $537 million in 2022 and 2021, respectively, as compared with the prior year periods, primarily from higher market prices for recycling commodities in 2021 and the first half of 2022, before the significant downturn in the second half of 2022. Demand for recycled materials strengthened through 2021 and into early 2022, primarily driven by the growth in e-commerce, businesses re-opening, and manufacturers committing to use more recycled content in their packaging. In 2022, we experienced all-time high recycling commodity pricing in the first half of the year to be followed by historically low pricing through the second half of the year, resulting from the slowdown in the global economy, which reduced retail demand and the corresponding need for cardboard packaging to ship retail goods. We expect significant commodity price headwinds to continue into 2023. Average market prices for recycling commodities at the Company’s facilities were approximately 10% lower and 115% higher in 2022 and 2021, respectively, when compared with the prior year periods. Revenue decline from lower commodity pricing was offset by higher pricing in our recycling brokerage business as well as our continued focus on a fee-based pricing model that ensures fees paid by customers cover the cost of processing materials and the impact on our cost structure of managing contamination in the recycling stream. Fuel Surcharges and Other — These fees, which include (i) our fuel surcharge program, (ii) yield from our WM Renewable Energy business and (iii) other mandated fees, increased $474 million and $240 million in 2022 and 2021, respectively, as compared to the prior year periods. Fuel surcharge revenues are based on and fluctuate in response to changes in the national average prices for diesel fuel, and also vary with changes in our volume-based revenue activity. Market prices for diesel fuel were over 50% and 30% higher in 2022 and 2021, as compared to the prior year periods. Revenue from yield growth in our WM Renewable Energy business increased $48 million and $85 million in 2022 and 2021, respectively, as compared to the prior year period, primarily driven by increases in the value for electricity and 41 Table of Contentsrenewable natural gas credits. The mandated fees are primarily related to fees and taxes assessed by various state, county and municipal government agencies at our landfills and transfer stations. These amounts have not significantly impacted the change in revenue for the periods presented. VolumeOur revenues from volume (excluding volumes from acquisitions and divestitures) increased $233 million, or 1.3%, and $435 million, or 2.8%, in 2022 and 2021, respectively, as compared with the prior year periods. Our collection and disposal business volumes grew 1.8% and 3.0% in 2022 and 2021, respectively.Our 2022 volume growth has moderated when compared to the accelerated volume recovery from COVID-related impacts experienced in 2021. Special waste volumes at our landfills have been the most significant driver of volume growth, primarily due to an increase in event-driven projects. In addition, our WMSBS business volumes grew as a result of our continued focus on a differentiated service model for national accounts customers. Our volumes have been impacted by our intentional efforts to reduce unprofitable residential and industrial collection volumes.We experienced higher volume growth in 2021 relative to the sharp decline experienced in April 2020 as a result of COVID-related impacts. The pace of recovery in our volumes accelerated in the second quarter of 2021 and continued in the second half of 2021 with minimal impact from periodic resurgences in transmission of COVID-19 virus variants as communities and businesses have remained open. The portions of our business that had the most pronounced decreases in volume due to the pandemic were our industrial and commercial collection businesses and our landfill volumes. Acquisitions and DivestituresAcquisitions and divestitures resulted in a net increase in revenues of $47 million, or 0.3%, and $983 million, or 6.5%, in 2022 and 2021, respectively, as compared with the prior year periods, with the increase in 2021 primarily due to our acquisition of Advanced Disposal. Operating ExpensesOur operating expenses are comprised of (i) labor and related benefits costs (excluding labor costs associated with maintenance and repairs discussed below), which include salaries and wages, bonuses, related payroll taxes, insurance and benefits costs and the costs associated with contract labor; (ii) transfer and disposal costs, which include tipping fees paid to third-party disposal facilities and transfer stations; (iii) maintenance and repairs costs relating to equipment, vehicles and facilities and related labor costs; (iv) subcontractor costs, which include the costs of independent haulers who transport waste collected by us to disposal facilities and are affected by variables such as volumes, distance and fuel prices; (v) costs of goods sold, which includes the cost to purchase recycling materials for our recycling line of business, including certain rebates paid to suppliers; (vi) fuel costs, net of tax credits for alternative fuel, which represent the costs of fuel to operate our truck fleet and landfill operating equipment; (vii) disposal and franchise fees and taxes, which include landfill taxes, municipal franchise fees, host community fees, contingent landfill lease payments and royalties; (viii) landfill operating costs, which include interest accretion on landfill liabilities, interest accretion on and discount rate adjustments to environmental remediation liabilities and recovery assets, leachate and methane collection and treatment, landfill remediation costs and other landfill site costs; (ix) risk management costs, which include general liability, automobile liability and workers’ compensation claims programs costs and (x) other operating costs, which include gains and losses on sale of assets, telecommunications, equipment and facility lease expenses, property taxes, utilities and supplies. Variations in volumes year-over-year, as discussed above in Operating Revenues, in addition to cost inflation, affect the comparability of the components of our operating expenses.42 Table of ContentsThe following table summarizes the major components of our operating expenses for the year ended December 31 (dollars in millions and as a percentage of revenues):​​​​​​​​​​​​​​​​​​​​ 2022​ 2021​ 2020​Labor and related benefits​$ 3,452 17.5 % ​$ 3,223 18.0 %​$ 2,746 18.1 %Transfer and disposal costs​ 1,215​6.2 ​​ 1,161​6.5 ​​ 1,135​7.5 ​Maintenance and repairs​ 1,835​9.3 ​​ 1,596​8.9 ​​ 1,331​8.7 ​Subcontractor costs​ 2,006​10.2 ​​ 1,766​9.9 ​​ 1,523​10.0 ​Cost of goods sold​ 973​4.9 ​​ 936​5.2 ​​ 553​3.6 ​Fuel​ 592​3.0 ​​ 393​2.2 ​​ 265​1.7 ​Disposal and franchise fees and taxes​ 720​3.7 ​​ 698​3.9 ​​ 606​4.0 ​Landfill operating costs​ 421​2.1 ​​ 412​2.3 ​​ 394​2.6 ​Risk management​ 348​1.8 ​​ 344​1.9 ​​ 269​1.8 ​Other​ 732​3.7 ​​ 582​3.2 ​​ 519​3.4 ​​​$ 12,294​ 62.4% ​$ 11,111​62.0 % ​$ 9,341​61.4 %​Our operating expenses in 2022 increased, as compared with 2021, primarily due to (i) inflationary cost pressures, particularly for maintenance and repairs and subcontractor costs; (ii) commodity-driven business impacts from higher fuel prices and recycling and (iii) labor cost pressure from frontline employee wage adjustments. We also continue to focus on operating efficiency and efforts to control costs.Our operating expenses in 2021 increased, as compared with 2020, primarily due to (i) increased volumes from the acquisition of Advanced Disposal; (ii) commodity-driven business impacts, particularly from recycling brokerage rebates and higher fuel prices; (iii) volume recovery from earlier pandemic-driven lows; (iv) labor cost pressure from frontline employee wage adjustments, increased turnover driving up training costs and higher overtime due to driver shortages and volume growth and (v) inflationary cost pressures, primarily in the second half of 2021. These impacts were partially offset by our continued focus on operating efficiency and efforts to control costs as volumes grow.Significant items affecting the comparison of operating expenses between reported periods include: Labor and Related Benefits — The increase in labor and related benefits costs in 2022, as compared with 2021,was largely driven by (i) proactive market wage adjustments to hire and retain talent; (ii) annual merit and annual incentive compensation cost increases and (iii) increases in health and welfare costs attributable to our intentional investment in delivering a leading benefits program for our employees and increases in medical care activity. The increase in labor and related benefits costs in 2021, as compared with 2020, was largely driven by (i) increased labor and related benefits costs related to our acquisition of Advanced Disposal; (ii) merit and proactive market wage adjustments to hire and retain talent; (iii) volume increases, particularly in our commercial and industrial collection businesses, which when combined with driver shortages and turnover in certain markets, increased overtime and training hours; (iv) higher annual incentive compensation and (v) increases in health and welfare costs attributable to medical care activity generally returning to pre-pandemic levels.Transfer and Disposal Costs — The increase in transfer and disposal costs in 2022, as compared with 2021, was largely driven by inflationary cost increases, which includes increased disposal fees at third-party sites and higher fuel from our third-party haulers offset, in part, by decreases in residential collection and transfer volume. The increase in transfer and disposal costs in 2021, as compared with 2020, was largely driven by increased volume, which includes the volumes from our acquisition of Advanced Disposal and inflationary cost increases from our third-party haulers. Maintenance and Repairs — The increase in maintenance and repairs costs in 2022, as compared with 2021,was largely driven by (i) inflationary cost increases for parts, supplies and third-party services; (ii) additional fleet maintenance driven by supply chain constraints, which have delayed deliveries of new trucks; (iii) labor cost increases for our technicians, including higher overtime; (iv) increased building maintenance costs including improvements to facilities and (v) an increase in container repairs driven by delays in delivery of steel containers due to supply chain constraints. The increase in maintenance and repairs costs in 2021, as compared with 2020, was largely driven by (i) our acquisition of Advanced Disposal, including intentional investments to bring the acquired fleet to our standards; (ii) inflationary cost 43 Table of Contentsincreases for parts, supplies and third-party services; (iii) additional fleet maintenance driven by commercial and industrial collection volume increases; (iv) labor cost increases for our technicians, including higher overtime from labor shortages; (v) an increase in container repairs driven by volume increases and delays in normal course capital expenditures for steel containers due to both steel costs and supply chain constraints and (vi) increased building maintenance costs including improvements to facilities.Subcontractor Costs — The increase in subcontractor costs in 2022, as compared with 2021,was largely driven by (i) inflationary cost increases, particularly for fuel and labor costs from third-party haulers and (ii) an increase in volumes in our WMSBS business, which relies more extensively on subcontracted hauling than our collection and disposal business. The increase in subcontractor costs in 2021, as compared with 2020, was largely driven by (i) inflationary cost increases from third-party haulers and higher volumes; (ii) an increase in volumes in our WMSBS business and (iii) the acquisition of Advanced Disposal.Cost of Goods Sold — The increase in cost of goods sold in 2022, as compared with 2021, was primarily driven by all-time high recycling commodity pricing in the first half of the year offset, in part, by the historically low pricing through the second half of the year. The increase in cost of goods sold in 2021, as compared with 2020, was primarily driven by increases in market prices for recycling commodities of approximately 115% and to a lesser extent, higher recycling volumes.Fuel — The increase in fuel costs in 2022, as compared with 2021, was primarily due to increases in market diesel and natural gas fuel prices as compared to the prior year. The increase in fuel costs in 2021, as compared with 2020, was primarily due to (i) increases in market diesel and natural gas fuel prices; (ii) the acquisition of Advanced Disposal and (iii) volume increases in our commercial and industrial collection businesses.Disposal and Franchise Fees and Taxes — The increase in disposal and franchise fees and taxes in 2022, as compared with 2021, was primarily driven by higher franchise fees, driven by an increase in landfill volumes, paid to certain municipalities where we operate and overall rate increases in our fees and taxes paid on our disposal volumes. The increase in disposal and franchise fees and taxes in 2021, as compared with 2020, was primarily driven by (i) landfill volume increases; (ii) disposal rate increases at certain landfills and (iii) additional costs attributable to our acquisition of Advanced Disposal.Landfill Operating Costs — Our landfill operating costs increased in 2022, as compared with 2021, primarily due to increases in methane and leachate management costs and other site maintenance costs, in part due to inflation. The increase in landfill operating costs in 2021, as compared with 2020, was primarily due to volume increases, including from our acquisition of Advanced Disposal and increased testing and monitoring costs. These increases were partially offset by (i) lower leachate management costs, primarily due to the cessation of certain transportation costs in our East Tier segment and (ii) changes in the measurement of our environmental remediation obligations and recovery assets. The increases in both 2022 and 2021 were offset, in part, by changes in the measurement of our environmental remediation obligations and recovery assets in each year. Our measurement of these balances includes application of a risk-free discount rate, which is based on the rate for U.S. Treasury bonds. The discount rate increased, which resulted in a reduction in the net liability balance and a credit to expense, in both 2021 and 2022 with more significant impact in 2022. Conversely, in 2020, there was a decrease in the discount rate, which resulted in an increase in the net liability balance and a charge to expense.Risk Management — Risk management costs increased slightly in 2022, as compared with 2021, primarily due to inflation in premiums. The increase in risk management costs in 2021, as compared with 2020, was primarily due to our acquisition of Advanced Disposal and overall economic recovery from COVID-driven impacts, increasing business activity and claim volumes and related costs.Other — Other operating cost increases in 2022, as compared with 2021, were primarily due to (i) inflationary cost pressures; (ii) higher equipment rental costs attributable, in part, to supply chain constraints slowing normal course fleet and equipment orders; (iii) higher utility costs at our facilities and (iv) an increase in business travel in 2022. Additionally, a favorable litigation settlement in 2021 impacted the comparison. Other operating cost increases in 2021, as compared with 2020, were due to our acquisition of Advanced Disposal and increased equipment rental costs attributable, in part, to increased volumes and supply chain constraints slowing normal course fleet and equipment orders. Additionally, during the second half of 2021, additional volumes and inflationary cost pressures drove an increase in various costs. Partially 44 Table of Contentsoffsetting these was a favorable litigation settlement in 2021. Additionally, net gains on sales of certain assets during each year impacted the comparability of the reported periods Selling, General and Administrative Expenses Our selling, general and administrative expenses consist of (i) labor and related benefits costs, which include salaries, bonuses, related insurance and benefits, contract labor, payroll taxes and equity-based compensation; (ii) professional fees, which include fees for consulting, legal, audit and tax services; (iii) provision for bad debts, which includes allowances for uncollectible customer accounts and collection fees and (iv) other selling, general and administrative expenses, which include, among other costs, facility-related expenses, voice and data telecommunication, advertising, bank charges, computer costs, travel and entertainment, rentals, postage and printing. In addition, the financial impacts of litigation reserves generally are included in our “Other” selling, general and administrative expenses.The following table summarizes the major components of our selling, general and administrative expenses for the year ended December 31 (dollars in millions and as a percentage of revenues):​​​​​​​​​​​​​​​​​​​​ 2022​ 2021​ 2020​Labor and related benefits​$ 1,195 6.1%​$ 1,215 6.8%​$ 1,057 6.9%Professional fees​ 268​ 1.4​​ 228​ 1.3​​ 256​ 1.7​Provision for bad debts​ 50​ 0.2​​ 37​ 0.2​​ 54​ 0.4​Other​ 425​ 2.1​​ 384​ 2.1​​ 361​ 2.4​​​$ 1,938​ 9.8%​$ 1,864​ 10.4%​$ 1,728​ 11.4%​Selling, general and administrative expenses in 2022, as compared with 2021, increased primarily due to (i) strategic investments in our digital platform, including those that support our ongoing sustainability initiatives; (ii) higher annual incentive compensation costs and merit increases for our employees; (iii) increased business travel and entertainment expense and (iv) an increase in provision for bad debts, partially offset by (i) lower long-term incentive compensation costs; (ii) market adjustments for deferred compensation plans related to investment performance and (iii) lower litigation costs.​Selling, general and administrative expenses in 2021, as compared with 2020, increased primarily due to (i) higher incentive compensation costs; (ii) strategic investments in our digital platform and (iii) increased labor, support and integration costs following our acquisition of Advanced Disposal. Partially offsetting these increases are lower consulting, advisory and legal fees following the completion of our acquisition of Advanced Disposal in 2020 and improvements in our provision for bad debts as collections returned to pre-pandemic levels.​Although our costs increased in 2022 and 2021, the significant revenue increases positioned us to reduce our overall selling, general and administrative expenses as a percentage of revenues when compared with each of the prior year periods.​Significant items affecting the comparison of our selling, general and administrative expenses between reported periods include: Labor and Related Benefits — The decrease in labor and related benefits costs in 2022, as compared with 2021, was primarily due to (i) lower long-term incentive compensation costs; (ii) reductions in contract labor and (iii) market adjustments for deferred compensation plans related to investment performance, partially offset by higher annual incentive compensation and annual merit increases for our employees. The increase in labor and related benefits costs in 2021, as compared with 2020, was primarily due to (i) higher incentive compensation costs; (ii) additional headcount, including from our acquisition of Advanced Disposal; (iii) annual merit increases for our employees; (iv) costs associated with our strategic investments in our digital platform and (v) increases in health and welfare costs attributable to medical care activities generally returning to pre-pandemic levels from the lower level experienced during 2020. Professional Fees — The increase in professional fees in 2022, as compared with 2021, was primarily driven by strategic investments in our digital platform, including those that support our ongoing sustainability initiatives, partially 45 Table of Contentsoffset by lower acquisition and integration costs. Professional fees decreased in 2021, as compared with 2020, primarily due to lower consulting, advisory and legal fees following the completion of our acquisition of Advanced Disposal in 2020, partially offset by increased strategic investments in our digital platform and integration costs related to our acquisition of Advanced Disposal. Provision for Bad Debts — The increase in provision for bad debts in 2022, as compared with 2021, is primarily related to (i) increased revenue; (ii) increased collection risk with certain customers and (iii) favorable adjustments to our reserves taken in 2021 as a result of improvement in customer account collections. The decrease in provision for bad debts in 2021, as compared with 2020, was primarily due to an overall improvement in customer account collections and decreased collection risk with certain customers. Other — The increase in other expenses in 2022, as compared with 2021, was primarily driven by costs associated with technology infrastructure to support our strategic investments in our digital platform and an increase in business travel and entertainment expense, partially offset by lower litigation costs. The increase in other expenses in 2021, as compared with 2020, was primarily driven by costs associated with our acquisition of Advanced Disposal and increased technology infrastructure costs to support our strategic investments in our digital platform. Depreciation, Depletion and Amortization ExpensesThe following table summarizes the components of our depreciation, depletion and amortization expenses for the year ended December 31 (dollars in millions and as a percentage of revenues):​​​​​​​​​​​​​​​​​​​​ 2022​ 2021​ 2020 Depreciation of tangible property and equipment​$ 1,155 5.9%​$ 1,125 6.2%​$ 996 6.6%Depletion of landfill airspace​ 754​ 3.8​​ 731​ 4.1​​ 568​ 3.7​Amortization of intangible assets​ 129​ 0.6​​ 143​ 0.8​​ 107​ 0.7​​​$ 2,038​10.3 %​$ 1,999​11.1 %​$ 1,671​11.0 %​The increase in depreciation of tangible property and equipment in 2022, as compared with 2021, was primarily driven by investments in capital assets, including containers to service our customers and strategic investments in our digital platform. The increase in depletion of landfill airspace in 2022, as compared with 2021, was primarily driven by changes in depletion rates from revisions in landfill cost estimates and increased volumes at our landfills, partially offset by a prior year charge due to management’s decision to close a landfill in our West Tier segment earlier than expected, resulting in the acceleration of the timing of capping, closure, and post-closure activities. The decrease in amortization of intangible assets in 2022, as compared with 2021, was primarily driven by the amortization of acquired intangible assets from the acquisition of Advanced Disposal.The increase in depreciation of tangible property and equipment in 2021, as compared with 2020, was related to our acquisition of Advanced Disposal and investments in capital assets, including our fleet, heavy equipment at our landfills and containers to service our customers. The increase in depletion of landfill airspace in 2021, as compared with 2020, was driven by (i) changes in depletion rates driven by revisions in landfill estimates, including a $15 million charge due to management’s decision to close a landfill in our West Tier segment earlier than expected; (ii) our acquisition of Advanced Disposal and (iii) landfill volume increases associated with the economic recovery from COVID-driven impacts. Additionally, 2020 benefited from a decrease in the inflation rate used to estimate capping, closure, and post-closure asset retirement obligations. The increase in amortization of intangible assets in 2021, as compared with 2020, was primarily driven by the amortization of acquired intangible assets related to the acquisition of Advanced Disposal.RestructuringDuring the year ended December 31, 2021, we recognized $8 million of restructuring charges primarily related to our acquisition of Advanced Disposal. During the year ended December 31, 2020, we recognized $9 million of restructuring 46 Table of Contentscharges primarily related to modifying our field sales and customer services structures to better support our strategic investments in our digital platform.(Gain) Loss from Divestitures, Asset Impairments and Unusual Items, NetThe following table summarizes the major components of (gain) loss from divestitures, asset impairments and unusual items, net for the year ended December 31 (in millions):​​​​​​​​​​ ​ 2022 2021 2020Gain from divestitures, net​$ (5)​$ (44)​$ (33)Asset impairments​ 50​ 8​ 68Other​ 17​ 20​ —​​$ 62​$ (16)​$ 35​For the year ended December 31, 2022, we recognized $62 million of net charges consisting of (i) $50 million of asset impairment charges primarily related to management’s decision to close two landfills within our East Tier segment and (ii) a $17 million charge pertaining to reserves for loss contingencies in our Corporate and Other segment to adjust an indirect wholly-owned subsidiary’s estimated potential share of the liability for a proposed environmental remediation plan at a closed site, as discussed in Note 10 to the Consolidated Financial Statements. These losses were partially offset by a $5 million gain from the divestiture of a solid waste business in our West Tier segment.For the year ended December 31, 2021, we recognized net gains of $16 million primarily consisting of (i) a $35 million pre-tax gain from the recognition of cumulative translation adjustments on the divestiture of certain non-strategic Canadian operations in our East Tier segment and (ii) an $8 million gain from divestitures of certain ancillary operations in our Other segment. These gains were partially offset by (i) a $20 million charge pertaining to reserves for loss contingencies in our Corporate and Other segment and (ii) $8 million of asset impairment charges primarily related to our WM Renewable Energy business within our Other segment.For the year ended December 31, 2020, we recognized $35 million of net charges primarily related to (i) a $33 million net gain associated with net asset divestitures executed to address requirements of the U.S. Department of Justice in connection with our acquisition of Advanced Disposal, primarily within our West Tier segment; (ii) $41 million of non-cash impairment charges primarily related to two landfills and an oil field waste injection facility in our West Tier segment; (iii) a $20 million non-cash impairment charge in our East Tier segment due to management’s decision to close a landfill once its constructed airspace is filled and abandon any remaining permitted airspace and (iv) $7 million of net charges primarily related to non-cash impairments of certain assets within our WM Renewable Energy business in our Other segment. See Note 2 to the Consolidated Financial Statements for additional information related to the accounting policy and analysis involved in identifying and calculating impairments. 47 Table of ContentsIncome from OperationsThe following table summarizes income from operations for the year ended December 31 (dollars in millions):​​​​​​​​​​​​​​​​​​​​​​​​​​Period-to- ​​​Period-to-​​​​​​​​​Period ​​​Period​​​​​ 2022 Change 2021 Change 2020​Solid Waste: ​ ​ ​​ ​ ​​​ East Tier ​$ 2,249​$ 212 10.4 % $ 2,037​$ 365 21.8 % $ 1,672​West Tier​ 2,346​ 243 11.6 ​ 2,103​ 303 16.8 ​ 1,800​Solid Waste​ 4,595​ 455 11.0 ​ 4,140​ 668 19.2 ​ 3,472​Other (a)​ 26​ (8) *​ 34​ 76 *​ (42)​Corporate and Other (b)​​ (1,256)​​ (47)​3.9 ​​ (1,209)​​ (213)​21.4 ​​ (996)​Total​$ 3,365​$ 400 13.5 % $ 2,965​$ 531 21.8 % $ 2,434​Percentage of revenues​​ 17.1%​​ ​​​ 16.5%​​ ​​​ 16.0%* Percentage change does not provide a meaningful comparison.(a)“Other” includes (i) elements of our WMSBS business that are not included in the operations of our reportable segments; (ii) elements of our sustainability business that includes landfill gas-to-energy operations managed by our WM Renewable Energy business, our SES business and recycling brokerage services and not included in the operations of our reportable segments; (iii) certain other expanded service offerings and solutions and (iv) the results of non-operating entities that provide financial assurance and self-insurance support for our Solid Waste business, net of intercompany activity.(b)“Corporate and Other” operating results reflect certain costs incurred for various support services that are not allocated to our reportable segments. These support services include, among other things, treasury, legal, digital, tax, insurance, centralized service center processes, other administrative functions and the maintenance of our closed landfills. Income from operations for “Corporate and Other” also includes costs associated with our long-term incentive program.Solid Waste — The most significant items affecting the results of operations of our Solid Waste business during the three years ended December 31, 2022 are summarized below:●Income from operations in our Solid Waste business increased in 2022, as compared with 2021, primarily due to revenue growth in our collection and disposal businesses driven by both yield and volume. This increase was partially offset by (i) inflationary cost pressures; (ii) labor cost increases from frontline employee wage adjustments; (iii) divestitures, asset impairments and unusual items discussed above in (Gain) Loss from Divestitures, Asset Impairments and Unusual Items, Net; that impacted our East Tier results and (iv) reduced profitability in our recycling business from the decline in recycling commodity prices and lower volumes.●Income from operations in our Solid Waste business increased in 2021, as compared with 2020, primarily due to (i) revenue growth in our collection and disposal businesses driven by both yield and volume, as well as the acquisition of Advanced Disposal; (ii) improved profitability in our recycling business from higher market prices for recycling commodities and improved costs at facilities where we have made investments in enhanced technology and equipment and (iii) changes from divestitures, asset impairments and unusual items discussed above in (Gain) Loss from Divestitures, Asset Impairments and Unusual Items, Net that impacted both Tiers’ results. These increases were partially offset by (i) labor cost pressure from frontline employee wage adjustments, increased turnover driving up training costs and higher overtime due to driver shortages and volume growth; (ii) increased landfill depletion from higher volumes and revisions in landfill estimates, including the anticipated timing of capping, closure and post-closure activities at certain landfills and adjustments in 2020 to the inflation rate used to estimate capping, closure, and post-closure asset retirement obligations that benefitted costs in 2020 and (iii) inflationary cost pressures. During 2021, the positive earnings contributions from Advanced Disposal were offset by elevated depreciation, depletion and amortization of acquired assets.48 Table of ContentsOther — The decrease in income from operations in 2022, as compared with 2021, was due to the recognition of acquisition and integration-related costs, as well as, a prior year gain from divestitures of certain ancillary operations in our Other segment, discussed above in (Gain) Loss from Divestitures, Asset Impairments and Unusual Items, Net, partially offset by improved profitability in our SES and WMSBS businesses. The increase in income from operations for 2021, as compared to 2020, was primarily driven by increased market values for renewable energy credits generated by our WM Renewable Energy business.​Corporate and Other — The most significant items affecting the results of operations for Corporate and Other during the three years ended December 31, 2022 are summarized below:●These costs increased in 2022, as compared with 2021, primarily due to strategic investments in our digital platform and sustainability initiatives, partially offset by lower acquisition and integration related costs.●These costs increased in 2021, as compared with 2020, due to (i) higher incentive compensation costs; (ii) increased labor, support and integration costs following our acquisition of Advanced Disposal; (iii) strategic investments in our digital platform; (iv) increased health and welfare costs attributable to medical care activity generally returning to pre-pandemic levels from the lower levels experienced during 2020 and (v) charges pertaining to reserves for certain loss contingencies during 2021. These increases were partially offset by lower consulting, advisory and legal fees following the completion of our acquisition of Advanced Disposal in the fourth quarter of 2020 and changes in the measurement of our environmental remediation obligations and recovery assets in both 2020 and 2021. Interest Expense, NetOur interest expense, net was $378 million, $365 million and $425 million in 2022, 2021 and 2020, respectively. The increase in interest expense, net for 2022 was primarily related to borrowings incurred under our $1.0 billion two-year, U.S. term credit agreement (“Term Loan”) and increases in interest rates on our floating-rate debt, including commercial paper and variable-rate tax-exempt bonds. Partially offsetting these increases were benefits from higher capitalized interest and increases in interest income as a result of higher cash and cash equivalent balances.The decrease in interest expense, net for 2021 was primarily due to certain refinancing activities, as discussed further below, including (i) the redemption of $3.0 billion of senior notes in July 2020 and the issuance of $2.5 billion of senior notes in November 2020 at lower rates and (ii) the retirement of $1.3 billion of certain high-coupon senior notes and concurrent issuance of $950 million of lower coupon senior notes in May 2021. The decreases were partially offset by decreases in interest income as a result of lower cash and cash equivalents balances in 2021. See Note 6 to the Consolidated Financial Statements for more information related to our debt balances.Loss on Early Extinguishment of Debt, Net In May 2021, WMI issued $950 million of senior notes. Concurrently, we used the net proceeds from the newly issued senior notes of $942 million and available cash on hand to retire $1.3 billion of certain high-coupon senior notes. The loss on early extinguishment of debt for 2021 includes $220 million of charges related to this tender offer, including cash paid of $211 million related to premiums and other third-party costs, and $9 million primarily related to unamortized discounts and debt issuance costs. See Note 6 to the Consolidated Financial Statements for more information related to these transactions.In July 2020, we recognized a $52 million loss on early extinguishment of debt in our Consolidated Statement of Operations related to the mandatory redemption of $3.0 billion of senior notes with a special mandatory redemption feature (the “SMR Notes”). The loss includes $30 million of premiums paid and $22 million of unamortized discounts and debt issuance costs. Pursuant to the terms of the SMR Notes, we were required to redeem all of such outstanding notes paying debt holders 101% of the aggregate principal amounts of such notes, plus accrued but unpaid interest, as a result of the Advanced Disposal acquisition not being completed by July 14, 2020. Accordingly, the redemption was completed on 49 Table of ContentsJuly 20, 2020 using available cash on hand and, to a lesser extent, commercial paper borrowings. The cash paid included the $3.0 billion principal amount of debt redeemed, $30 million of related premiums and $8 million of accrued interest. During the fourth quarter of 2020, we repaid the outstanding borrowings under a 364-day revolving credit facility and contemporaneously terminated the facility, at which time we recognized a $2 million loss on early extinguishment of debt in our Consolidated Statement of Operations related to unamortized debt issuance costs. Additionally, at the time of acquisition, Advanced Disposal had outstanding $425 million of 5.625% senior notes due November 2024. In November 2020, we redeemed the notes pursuant to an optional redemption feature upon which we recognized a $1 million gain on early extinguishment of debt in our Consolidated Statement of Operations due to the difference in carrying value and redemption price.Equity in Net Losses of Unconsolidated EntitiesWe recognized equity in net losses of unconsolidated entities of $67 million, $36 million and $68 million in 2022, 2021 and 2020, respectively. The losses for each period were primarily related to our noncontrolling interests in entities established to invest in and manage low-income housing properties. We generate tax benefits, including tax credits, from the losses incurred from these investments, which are discussed further in Notes 8 and 18 to the Consolidated Financial Statements. We also held a residual financial interest in an entity that owned a refined coal facility that qualified for federal tax credits. In 2020, the entity sold the majority of its assets resulting in a $7 million non-cash impairment charge at that time. Income Tax ExpenseWe recorded income tax expense of $678 million, $532 million and $397 million in 2022, 2021 and 2020, respectively, resulting in effective income tax rates of 23.2%, 22.6% and 20.9% for the years ended December 31, 2022, 2021 and 2020, respectively. The comparability of our income tax expense for the reported periods has been primarily affected by the following:●Investments Qualifying for Federal Tax Credits — Our low-income housing properties investments reduced our income tax expense by $99 million, $74 million and $87 million, primarily due to tax credits realized from these investments for the years ended December 31, 2022, 2021 and 2020, respectively. See Note 18 to the Consolidated Financial Statements for additional information related to these unconsolidated variable interest entities;●Equity-Based Compensation — During 2022, 2021 and 2020, we recognized a reduction in our income tax expense of $17 million, $18 million and $27 million, respectively, for excess tax benefits related to the vesting or exercise of equity-based compensation awards;●State Net Operating Losses and Credits — During 2022, 2021 and 2020, we recognized state net operating losses and credits resulting in a reduction in our income tax expense of $8 million, $15 million and $12 million, respectively; ●Tax Audit Settlements — We file income tax returns in the U.S. and Canada, as well as other state and local jurisdictions. We are currently under audit by various taxing authorities and our audits are in various stages of completion. During the reported periods, we settled various tax audits, which resulted in a reduction in our income tax expense of $6 million, $13 million and $10 million for the years ended December 31, 2022, 2021 and 2020, respectively;●Adjustments to Accruals and Related Deferred Taxes — Adjustments to our accruals and related deferred taxes primarily due to the filing of our income tax returns, analysis of our deferred tax balances and uncertain tax positions, and changes in state and foreign laws resulted in an increase in our income tax expense of $1 million and $17 million for the years ended December 31, 2022 and 2021, respectively, and a reduction in our income tax expense of $3 million for the year ended December 31, 2020;●Tax Implications of Divestitures – During 2021, we recognized a pre-tax gain from the recognition of cumulative translation adjustments on the divestiture of certain non-strategic Canadian operations. This gain was not taxable, which benefited our effective income tax rate for the year ended December 31, 2021;50 Table of Contents●Non-Deductible Transaction Costs — During 2020, we recognized the detrimental tax impact of $27 million of non-deductible transaction costs related to our acquisition of Advanced Disposal. The tax rules require the capitalization of certain facilitative costs on the acquisition of stock of a company resulting in the applicable costs not being deductible for tax purposes; and●Tax Legislation — The Inflation Reduction Act of 2022 (“IRA”) was signed into law by President Biden on August 16, 2022 and contains a number of tax-related provisions. The provisions of the IRA related to alternative fuel tax credits secure approximately $55 million of annual pre-tax benefit (to be recorded as a reduction in our operating expense) from tax credits through 2024, which is in line with the benefit we have realized from our alternative fuel tax credits in prior years. Additionally, we will incur an excise tax of 1% for future common stock repurchases, which will be reflected in the cost of purchasing the underlying shares as a component of treasury stock. The IRA contains a number of additional provisions related to tax incentives for investments in renewable energy production, carbon capture, and other climate actions, as well as the overall measurement of corporate income taxes. Given the complexity and uncertainty around the applicability of the legislation to our specific facts and circumstances, we continue to analyze the IRA provisions to identify and quantify potential opportunities and applicable benefits included in the legislation. The current expectation is the minimum corporate tax will not have an impact on the Company. With respect to only the investment tax credit aspect of the IRA, we expect the cumulative benefit to be between $250 million and $350 million, a large portion of which is anticipated to be realized in 2025. Additionally, the production tax credit incentives for investments in renewable energy and the carbon capture provisions of the IRA will likely result in incremental benefit, although at this time the amount of those benefits have not been quantified. See Note 8 to the Consolidated Financial Statements for more information related to income taxes. Landfill and Environmental Remediation Discussion and AnalysisWe owned or operated 254 solid waste landfills and five secure hazardous waste landfills as of December 31, 2022 and 255 solid waste landfills and five secure hazardous waste landfills as of December 31, 2021. For these landfills, the following table reflects changes in capacity, as measured in tons of waste, for the year ended December 31 and remaining airspace, measured in cubic yards of waste, as of December 31 (in millions):​​​​​​​​​​​​​​​2022​2021​​Remaining​​​​​Remaining​​​​​​Permitted​ Expansion​Total​Permitted​Expansion​Total​​Capacity​Capacity​Capacity​Capacity​Capacity​CapacityBalance as of beginning of year (in tons)​ 4,889​ 174​ 5,063​ 4,891​ 191​ 5,082Acquisitions, divestitures, newly permitted landfills and closures 163 — 163 (4) — (4)Changes in expansions pursued (a) — 62 62 — 105 105Expansion permits granted (b) 57 (57) — 126 (126) —Depletable tons received (125) — (125) (124) — (124)Changes in engineering estimates and other (c) (d) 181 11 192 — 4 4Balance as of end of year (in tons) (e) 5,165 190 5,355 4,889 174 5,063Balance as of end of year (in cubic yards) (e) 5,079 180 5,259 4,808 163 4,971(a)Amounts reflected here relate to the combined impacts of (i) new expansions pursued; (ii) increases or decreases in the airspace being pursued for ongoing expansion efforts; (iii) adjustments for differences between the airspace being pursued and airspace granted and (iv) decreases due to decisions to no longer pursue expansion permits, if any.(b)We received expansion permits at 12 of our landfills during 2022 and seven of our landfills during 2021, demonstrating our continued success in working with municipalities and regulatory agencies to expand the disposal airspace of our existing landfills.(c)Changes in engineering estimates can result in changes to the estimated available remaining airspace of a landfill or changes in the utilization of such landfill airspace, affecting the number of tons that can be placed in the future. Estimates of the amount of waste that can be placed in the future are reviewed annually by our engineers and are based on a number of factors, including standard engineering techniques and site-specific factors such as current and 51 Table of Contentsprojected mix of waste type; initial and projected waste density; estimated number of years of life remaining; depth of underlying waste; anticipated access to moisture through precipitation or recirculation of landfill leachate and operating practices. We continually focus on improving the utilization of airspace through efforts that may include recirculating landfill leachate where allowed by permit; optimizing the placement of daily cover materials and increasing initial compaction through improved landfill equipment, operations and training.(d)In 2022, a change in accounting estimate resulted in an increase of 190 million tons across certain landfills. (e)See Note 2 to the Consolidated Financial Statements for discussion of converting remaining cubic yards of airspace to tons of capacity.The depletable tons received at our landfills for the year ended December 31 are shown below (tons in thousands):​​​​​​​​​​​​​​​2022​2021​ # of Depletable Tons per # of Depletable Tons per​ Sites Tons Day Sites Tons DaySolid waste landfills (a) 254(b) 123,462 452 255 123,163 451Hazardous waste landfills 5 652 2 5 586 2​ 259 124,114 454 260 123,749 453Solid waste landfills closed, divested or lease or other contractual agreement expired during related year 4 633 9 114 ​ 124,747​ 123,863(c) (a)As of December 31, 2022 and 2021, we had 15 landfills and 14 landfills, respectively, which were not accepting waste.(b)In 2022, we (i) executed one new contractual agreement; (ii) reopened one previously closed landfill; (iii) developed one new landfill; (iv) closed three landfills and (v) closed one landfill operated under contractual agreement.(c)December 31, 2021 tons have been restated for comparability purposes by removing 1.6 million tons received at the landfill that were not depleted as they were used for beneficial purposes and generally were redirected from the permitted airspace to other areas of the landfill.As of December 31, 2022, we owned or controlled the management of 231 sites with remedial activities, are in closure or have received a certification of closure or post-closure from the applicable regulatory agency.Based on remaining permitted airspace as of December 31, 2022 and projected annual disposal volume, the weighted average remaining landfill life for all of our owned or operated landfills is approximately 39 years. Many of our landfills have the potential for expanded airspace beyond what is currently permitted. We monitor the availability of permitted airspace at each of our landfills and evaluate whether to pursue an expansion at a given landfill based on estimated future disposal volume, disposal prices, construction and operating costs, remaining airspace and likelihood of obtaining an expansion permit. We are seeking expansion permits at 16 of our landfills that meet the expansion criteria outlined in the Critical Accounting Estimates and Assumptions — Landfills section below. Although no assurances can be made that all future expansions will be permitted or permitted as designed, the weighted average remaining landfill life for all owned or operated landfills is approximately 40 years when considering remaining permitted airspace, expansion airspace and projected annual disposal volume.52 Table of ContentsThe number of landfills owned or operated as of December 31, 2022, segregated by their estimated operating lives based on remaining permitted and expansion airspace and projected annual disposal volume, was as follows:​​​​​ # of Landfills​0 to 5 years 28​6 to 10 years 23​11 to 20 years 53​21 to 40 years 62​41+ years 93​Total 259(a)(a)Of the 259 landfills, 218 are owned, 29 are operated under lease agreements and 12 are operated under other contractual agreements. For the landfills not owned, we are usually responsible for final capping, closure and post-closure obligations.Landfill Assets — We capitalize various costs that we incur to prepare a landfill to accept waste. These costs generally include expenditures for land (including the landfill footprint and required landfill buffer property), permitting, excavation, liner material and installation, landfill leachate collection systems, landfill gas collection systems, environmental monitoring equipment for groundwater and landfill gas, directly related engineering, capitalized interest, and on-site road construction and other capital infrastructure costs. The cost basis of our landfill assets also includes estimates of future costs associated with landfill final capping, closure and post-closure activities, which are discussed further below.The changes to the cost basis of our landfill assets and accumulated landfill airspace depletion for the year ended December 31, 2022 are reflected in the table below (in millions):​​​​​​​​​​​ ​​ Accumulated ​Net Book​​Cost Basis of​Landfill Airspace​​Value of​ Landfill Assets Depletion Landfill AssetsDecember 31, 2021​$ 17,734​$ (10,390)​$ 7,344Capital additions​ 791​ —​ 791Asset retirement obligations incurred and capitalized​ 114​ —​ 114Depletion of landfill airspace​ —​ (754)​ (754)Foreign currency translation​ (81)​ 36​ (45)Asset retirements and other adjustments​ (32)​ 212​ 180December 31, 2022​$ 18,526​$ (10,896)​$ 7,630​As of December 31, 2022, we estimate that we will spend approximately $731 million in 2023, and approximately $1.6 billion in 2024 and 2025 combined, for the construction and development of our landfill assets. The specific timing of landfill capital spending is dependent on future events and spending estimates are subject to change due to fluctuations in landfill waste volumes, changes in environmental requirements and other factors impacting landfill operations.Landfill and Environmental Remediation Liabilities — As we accept waste at our landfills, we incur significant asset retirement obligations, which include liabilities associated with landfill final capping, closure and post-closure activities. These liabilities are accounted for in accordance with authoritative guidance on accounting for asset retirement obligations and are discussed in Note 2 to the Consolidated Financial Statements. We also have liabilities for the remediation of properties that have incurred environmental damage, which generally was caused by operations or for damage caused by conditions that existed before we acquired operations or a site. We recognize environmental remediation liabilities when we determine that the liability is probable and the estimated cost for the likely remedy can be reasonably estimated.53 Table of ContentsThe changes to landfill and environmental remediation liabilities for the year ended December 31, 2022 are reflected in the table below (in millions):​​​​​​​​​​​​Environmental​ Landfill RemediationDecember 31, 2021​$ 2,326​$ 213Obligations incurred and capitalized​ 114 —Obligations settled​ (121) (28)Interest accretion​ 108 4Revisions in estimates and interest rate assumptions (a)​ 243 15Acquisitions, divestitures and other adjustments ​ (6) —December 31, 2022​$ 2,664​$ 204(a)In 2021, the increase in our landfill liabilities for revisions in estimates and interest rate assumptions was $33 million. The increase in our landfill liabilities in 2022 is primarily due to inflationary cost pressures that are expected to impact costs over the remaining landfill lives.Landfill Operating Costs — The following table summarizes our landfill operating costs for the year ended December 31 (in millions):​​​​​​​​​​ ​ 2022 2021 2020Interest accretion on landfill liabilities​$ 108​$ 108​$ 103Interest accretion on and discount rate adjustments to environmental remediation liabilities and recovery assets​ (10)​ (2)​ 9Leachate and methane collection and treatment​ 193​ 183​ 189Landfill remediation costs​ 12​ 6​ 1Other landfill site costs​ 118​ 117​ 92Total landfill operating costs​$ 421​$ 412​$ 394​Depletion of Landfill Airspace — Depletion of landfill airspace, which is included as a component of depreciation, depletion and amortization expenses, includes the following:●the depletion of landfill capital costs, including (i) costs that have been incurred and capitalized and (ii) estimated future costs for landfill development and construction required to develop our landfills to their remaining permitted and expansion airspace; and●the depletion of asset retirement costs arising from landfill final capping, closure and post-closure obligations, including (i) costs that have been incurred and capitalized and (ii) projected asset retirement costs.Depletion expense is recorded on a units-of-consumption basis, applying cost as a rate per ton. The rate per ton is calculated by dividing each component of the depletable basis of a landfill (net of accumulated depletion) by the number of tons needed to fill the corresponding asset’s remaining permitted and expansion airspace. Landfill capital costs and closure and post-closure asset retirement costs are generally incurred to support the operation of the landfill over its entire operating life and are, therefore, depleted on a per-ton basis using a landfill’s total permitted and expansion airspace. Final capping asset retirement costs are related to a specific final capping event and are, therefore, depleted on a per-ton basis using each discrete final capping event’s estimated permitted and expansion airspace. Accordingly, each landfill has multiple per-ton depletion rates.54 Table of ContentsThe following table presents our landfill airspace depletion expense on a per-ton basis for the year ended December 31:​​​​​​​​​​​ 2022 2021 2020Depletion of landfill airspace (in millions)​$ 754​$ 731​$ 568Tons received, net of redirected waste (in millions)​ 125​ 124​ 112Average landfill airspace depletion expense per ton​$ 6.05​$ 5.90​$ 5.07​Different per-ton depletion rates are applied at each of our 259 landfills, and per-ton depletion rates vary significantly from one landfill to another due to (i) inconsistencies that often exist in construction costs and provincial, state and local regulatory requirements for landfill development and landfill final capping, closure and post-closure activities and (ii) differences in the cost basis of landfills that we develop versus those that we acquire. Accordingly, our landfill airspace depletion expense measured on a per-ton basis can fluctuate due to changes in the mix of volumes we receive across the Company each year. Liquidity and Capital Resources The Company consistently generates annual cash flow from operations that meets and exceeds our working capital needs, allows for payment of our dividends, investment in the business through capital expenditures and tuck-in acquisitions, and funding of strategic sustainability growth investments. We continually monitor our actual and forecasted cash flows, our liquidity and our capital resources, enabling us to plan for our present needs and fund unbudgeted business requirements that may arise during the year. The Company believes that its investment grade credit ratings, large value of unencumbered assets and modest leverage enable it to obtain adequate financing to meet its ongoing capital, operating, strategic and other liquidity requirements. Summary of Contractual Obligations The following table summarizes our significant contractual obligations as of December 31, 2022 (other than recorded obligations related to liabilities associated with environmental remediation costs and non-cancelable operating lease obligations, which are discussed further in Notes 3 and 7 to the Consolidated Financial Statements, respectively) and the anticipated effect of these obligations on our liquidity in future years (in millions):​​​​​​​​​​​​​​​​​​​​​​ ​ 2023 2024 2025 2026 2027 Thereafter TotalRecorded Obligations: ​ ​ ​ ​ ​ ​ ​ Final capping, closure and post-closure liabilities (a)​$ 137​$ 219​$ 212​$ 181​$ 147​$ 3,162​$ 4,058Debt payments (b)​ 2,423​ 1,290​ 1,324​ 673​ 1,163​ 8,275​ 15,148Unrecorded Obligations:​ ​ ​ ​ ​ ​ ​ ​Interest on debt (c)​ 451​ 384​ 349​ 326​ 297​ 2,691​ 4,498Estimated unconditional purchase obligations (d)​ 192​ 158​ 114​ 101​ 34​ 369​ 968Anticipated liquidity impact as of December 31, 2022​$ 3,203​$ 2,051​$ 1,999​$ 1,281​$ 1,641​$ 14,497​$ 24,672(a)Includes liabilities for final capping, closure and post-closure costs recorded in our Consolidated Balance Sheet as of December 31, 2022, without the impact of discounting and inflation. Our recorded liabilities for final capping, closure and post-closure costs will increase as we continue to place additional tons within the permitted airspace at our landfills.(b)These amounts represent the scheduled principal payments based on their contractual maturities related to our long-term debt and financing leases, excluding interest. Refer to Note 6 to the Consolidated Financial Statements for additional information regarding our debt obligations.(c)Interest on our fixed-rate debt was calculated based on contractual rates and interest on our variable-rate debt was calculated based on interest rates as of December 31, 2022. As of December 31, 2022, we had $89 million of accrued interest related to our debt obligations.(d)Our unrecorded obligations represent purchase commitments from which we expect to realize an economic benefit in future periods. We have also made certain guarantees that we do not expect to materially affect our current or future 55 Table of Contentsfinancial position, results of operations or liquidity. See Note 10 to the Consolidated Financial Statements for discussion of the nature and terms of our unconditional purchase obligations and guarantees. Summary of Cash and Cash Equivalents, Restricted Funds and Debt ObligationsThe following is a summary of our cash and cash equivalents, restricted funds and debt balances as of December 31 (in millions):​​​​​​​​ 2022 2021Cash and cash equivalents​$ 351​$ 118Restricted funds:​ ​ ​Insurance reserves​$ 313​$ 305Final capping, closure, post-closure and environmental remediation funds​​ 113​​ 118Other​ 5​ 5Total restricted funds (a)​$ 431​$ 428Debt:​ ​ Current portion​$ 414​$ 708Long-term portion​ 14,570​ 12,697Total debt​$ 14,984​$ 13,405(a)As of December 31, 2022 and 2021, $83 million and $80 million, respectively, of these account balances was included in other current assets in our Consolidated Balance Sheets.Debt — We use long-term borrowings in addition to the cash we generate from operations as part of our overall financial strategy to support and grow our business. We primarily use senior notes and tax-exempt bonds to borrow on a long-term basis, but we also use other instruments and facilities, when appropriate. The components of our borrowings as of December 31, 2022 are described in Note 6 to the Consolidated Financial Statements.As of December 31, 2022, we had approximately $3.1 billion of debt maturing within the next 12 months, including (i) $1.7 billion of short-term borrowings under our commercial paper program (net of related discount on issuance); (ii) $725 million of tax-exempt bonds with term interest rate periods that expire within the next 12 months, which is prior to their scheduled maturities; (iii) $500 million of 2.4% senior notes that mature in May 2023 and (iv) $192 million of other debt with scheduled maturities within the next 12 months, including $65 million of tax-exempt bonds. As of December 31, 2022, we have classified $2.7 billion of debt maturing in the next 12 months as long term because we have the intent and ability to refinance these borrowings on a long-term basis as supported by the forecasted available capacity under our $3.5 billion long-term U.S. and Canadian revolving credit facility (“$3.5 billion revolving credit facility”). The remaining $414 million of debt maturing in the next 12 months is classified as current obligations.In May 2022, WMI issued $1.0 billion of 4.15% senior notes due April 15, 2032, the net proceeds of which were $992 million. We used the net proceeds to redeem our $500 million of 2.9% senior notes due September 2022 in advance of their scheduled maturity, to repay a portion of outstanding borrowings under our commercial paper program and for general corporate purposes.​In May 2022, we entered into a Term Loan to be used for general corporate purposes and as of December 31, 2022, we had $1.0 billion of outstanding borrowings. WM Holdings guarantees all of the obligations under the Term Loan. ​See Note 6 to the Consolidated Financial Statements for more information related to the debt transactions.​56 Table of ContentsWe have credit lines in place to support our liquidity and financial assurance needs. The following table summarizes our outstanding letters of credit, categorized by type of facility as of December 31 (in millions):​​​​​​​​ 2022 2021Revolving credit facility (a)​$ 166​$ 167Other letter of credit lines (b)​ 800​ 764​​$ 966​$ 931(a)As of December 31, 2022, we had an unused and available credit capacity of $1.6 billion.(b)As of December 31, 2022, these other letter of credit lines are uncommitted with terms extending through April 2024. Amendment and Extension of Revolving Credit FacilityIn May 2022, we amended and restated our $3.5 billion U.S. and Canadian revolving credit facility extending the term through May 2027. The agreement includes a $1.0 billion accordion feature that may be used to increase total capacity in future periods, and we have the option to request up to two one-year extensions. Waste Management of Canada Corporation and WM Quebec Inc., each an indirect wholly-owned subsidiary of WMI, are borrowers under the $3.5 billion revolving credit facility, and the agreement permits borrowing in Canadian dollars up to the U.S. dollar equivalent of $375 million, with such borrowings to be repaid in Canadian dollars. WM Holdings, a wholly-owned subsidiary of WMI, guarantees all the obligations under the $3.5 billion revolving credit facility. Refer to Note 6 to the Consolidated Financial Statements for additional information.Guarantor Financial InformationWM Holdings has fully and unconditionally guaranteed all of WMI’s senior indebtedness. WMI has fully and unconditionally guaranteed all of WM Holdings’ senior indebtedness. None of WMI’s other subsidiaries have guaranteed any of WMI’s or WM Holdings’ debt. In lieu of providing separate financial statements for the subsidiary issuer and guarantor (WMI and WM Holdings), we have presented the accompanying supplemental summarized combined balance sheet and income statement information for WMI and WM Holdings on a combined basis after elimination of intercompany transactions between WMI and WM Holdings and amounts related to investments in any subsidiary that is a non-guarantor (in millions):​​​​​​ December 31,2022Balance Sheet Information:​​​Current assets $ 193Noncurrent assets​​ 14Current liabilities​ 325Noncurrent liabilities:​​​Advances due to affiliates​​ 19,740Other noncurrent liabilities​ 12,618​​​​​​ Year Ended​​December 31, 2022Income Statement Information:​​​Revenue $ —Operating income​​ —Net loss​​ 184​​57 Table of ContentsSummary of Cash Flow ActivityThe following is a summary of our cash flows for the year ended December 31 (in millions):​​​​​​​​​​​ 2022 2021 2020Net cash provided by operating activities​$ 4,536​$ 4,338​$ 3,403Net cash used in investing activities​$ (3,063)​$ (1,894)​$ (4,847)Net cash used in financing activities​$ (1,216)​$ (2,900)​$ (1,559)​Net Cash Provided by Operating Activities — Our operating cash flows for 2022, as compared with 2021, increased by $198 million. The increase was largely driven by increased earnings in our collection and disposal and WM Renewable Energy businesses. We also experienced lower interest payments due to timing and refinancing activities in 2021 that reduced our overall interest rate. Partially offsetting our increase in cash from operating activities were higher income tax payments as a result of higher earnings in 2022 and a deposit of approximately $103 million that was made to the IRS related to a disputed tax matter. The Company expects to seek a refund of the entire amount deposited with the IRS and litigate any denial of the claim for refund. See Note 8 to the Consolidated Financial Statements for further details. Our operating cash flows for 2021, as compared with 2020, increased by $935 million largely as a result of (i) an increase in earnings primarily attributable to our collection, disposal and recycling lines of business; (ii) our acquisition of Advanced Disposal; (iii) lower interest payments in 2021 primarily due to certain refinancing activities and the retirement of high-coupon debt during 2020 reducing our overall interest rates; (iv) lower income taxes paid in 2021 and (v) favorable changes in our working capital, net of effects of acquisitions and divestitures. Our working capital was favorably impacted by process improvements that contributed to a significant improvement in our days-to-collect metrics. These favorable impacts were partially offset by the timing of cash tax benefits received in 2020 associated with federal alternative fuel tax credits.Net Cash Used in Investing Activities — The most significant items affecting the comparison of our investing cash flows for the periods presented are summarized below:●Acquisitions — Our spending on acquisitions was $377 million, $76 million and $4,088 million in 2022, 2021 and 2020, respectively, of which $377 million, $75 million and $4,085 million, respectively, are considered cash used in investing activities. The remaining spend is financing or operating activities related to the timing of contingent consideration paid. Substantially all of these acquisitions are related to our Solid Waste business. Our acquisition spending in 2022 was primarily attributable to the purchase of a controlling interest in a business intended to accelerate our film and plastic wrap recycling capabilities. Our acquisition spending in 2020 was primarily attributable to Advanced Disposal. See Note 17 to the Consolidated Financial Statements for additional information. We continue to focus on accretive acquisitions and growth opportunities that will enhance and expand our existing service offerings.●Capital Expenditures — We used $2,587 million, $1,904 million and $1,632 million for capital expenditures in 2022, 2021 and 2020, respectively. The increase in 2022 is primarily driven by our intentional investment in growth capital spending on recycling and renewable energy projects, as well as timing differences in our fixed asset purchases to support our ongoing operations. The increase in 2021 is due in part to intentional steps the Company took to accelerate growth capital spending on recycling and renewable energy projects. Additionally, in 2020 we took proactive steps to reduce the amount of capital spending required due to the decrease in volumes as a result of COVID-19. The Company continues to maintain a disciplined focus on capital management to prioritize investments for expansion, the replacement of aging assets and assets that support our strategy of continuous improvement through efficiency and innovation. In addition, we continue to make progress on our planned investments to expand our renewable energy and recycling businesses. We expect to spend between $2.0 billion and $2.1 billion on capital expenditures to support our normal course business in 2023. Additionally, we expect to spend approximately $1.1 billion on capital expenditures for recycling and renewable energy growth projects in 2023.●Proceeds from Divestitures — Proceeds from divestitures of businesses and other assets, net of cash divested, were $27 million, $96 million and $885 million in 2022, 2021 and 2020, respectively. In 2021, our proceeds are primarily the result of the sale of certain non-strategic Canadian operations. In 2020, our proceeds included 58 Table of Contents$856 million related to the sale of assets required to be sold by the U.S. Department of Justice in connection with our acquisition of Advanced Disposal. The remaining amounts in 2022, 2021 and 2020 generally related to the sale of fixed assets. ●Other, Net — Our spending within other, net was $126 million, $11 million, and $15 million in 2022, 2021 and 2020, respectively. During 2022, 2021 and 2020, we used $23 million, $32 million and $14 million, respectively, of cash from restricted cash and cash equivalents to invest in available-for-sale securities. In 2022, we used $67 million to fund secured convertible promissory notes associated with an acquisition and $28 million to make an initial cash payment associated with a low-income housing investment. Our 2021 cash spend was partially offset by proceeds received from the sale of an equity method investment. Net Cash Used in Financing Activities — The most significant items affecting the comparison of our financing cash flows for the periods presented are summarized below:●Debt Borrowings (Repayments) — The following summarizes our cash borrowings and repayments of debt for the year ended December 31 (in millions):​​​​​​​​​​​ 2022 2021 2020Borrowings: ​ ​​ ​​ Revolving credit facility $ —​$ —​$ 50Commercial paper program (a) ​ 6,596​​ 6,831​​ 3,630364-day revolving credit facility (b) ​ —​​ —​​ 3,000Term loan​​ 1,000​​ —​​ —Senior notes​​ 992​​ 942​​ 2,479Tax-exempt bonds​​ 100​​ 175​​ 261​ $ 8,688​$ 7,948​$ 9,420Repayments: ​ ​ Revolving credit facility $ —​$ —​$ (50)Commercial paper program (a) ​ (6,664)​​ (6,872)​​ (1,822)364-day revolving credit facility (b) ​ —​​ —​​ (3,000)Senior notes​​ (500)​​ (1,289)​​ (4,000)Advanced Disposal senior notes (c)​​ —​​ —​​ (437)Tax-exempt bonds (71)​ (127)​ (212)Other debt (93)​ (116)​ (108)​ $ (7,328)​$ (8,404)​$ (9,629)Net cash borrowings (repayments)​$ 1,360​$ (456)​$ (209)(a)Commercial paper borrowings incurred in 2022 and 2021 were primarily to support acquisitions and general corporate purposes. Commercial paper borrowings incurred in 2020 were used for the redemption of the SMR Notes and to partially fund our acquisition of Advanced Disposal. (b)In November 2020, we terminated our 364-day revolving facility contemporaneously with repayment of all outstanding borrowings with proceeds from our November 2020 senior notes issuance.(c)Advanced Disposal had certain outstanding senior notes which were redeemed in 2020 pursuant to an optional redemption feature as further discussed in Note 17 to the Consolidated Financial Statements. Refer to Note 6 to the Consolidated Financial Statements for additional information related to our debt borrowings and repayments.●Premiums and Other Paid on Early Extinguishment of Debt — During 2021, we paid premiums and other third-party costs of $211 million to retire certain high-coupon notes as discussed further in Note 6 to the Consolidated Financial Statements. During 2020, we paid premiums of $30 million to redeem $3.0 billion of senior notes that contained a special mandatory redemption feature tied to the timing of the Advanced Disposal acquisition closing. See Loss on Early Extinguishment of Debt, Net for further discussion.59 Table of Contents●Common Stock Repurchase Program — For the periods presented, all share repurchases have been made in accordance with financial plans approved by our Board of Directors. We allocated $1,500 million, $1,350 million and $402 million of available cash to common stock repurchases during 2022, 2021, and 2020, respectively. See Note 13 to the Consolidated Financial Statements for additional information.We announced in December 2022 that the Board of Directors has authorized up to $1.5 billion in future share repurchases. Any future share repurchases will be made at the discretion of management and will depend on factors similar to those considered by the Board of Directors in making dividend declarations and listed below, as well as market conditions.●Cash Dividends — For the periods presented, all dividends have been declared by our Board of Directors. Cash dividends declared and paid were $1,077 million in 2022, or $2.60 per common share, $970 million in 2021, or $2.30 per common share, and $927 million in 2020, or $2.18 per common share.In December 2022, we announced that our Board of Directors expects to increase the quarterly dividend from $0.65 to $0.70 per share for dividends declared in 2023. However, all future dividend declarations are at the discretion of the Board of Directors and depend on various factors, including our net earnings, financial condition, cash required for future business plans, growth and acquisitions and other factors the Board of Directors may deem relevant.●Exercise of Common Stock Options — The exercise of common stock options generated financing cash inflows of $44 million, $66 million and $63 million from the exercise of 675,000, 962,000 and 1,039,000 of employee stock options during 2022, 2021 and 2020, respectively. Free Cash FlowWe are presenting free cash flow, which is a non-GAAP measure of liquidity, in our disclosures because we use this measure in the evaluation and management of our business. We define free cash flow as net cash provided by operating activities, less capital expenditures, plus proceeds from divestitures of businesses and other assets, net of cash divested. We believe it is indicative of our ability to pay our quarterly dividends, repurchase common stock, fund acquisitions and other investments and, in the absence of refinancings, to repay our debt obligations. Free cash flow is not intended to replace net cash provided by operating activities, which is the most comparable GAAP measure. We believe free cash flow gives investors useful insight into how we view our liquidity, but the use of free cash flow as a liquidity measure has material limitations because it excludes certain expenditures that are required or that we have committed to, such as declared dividend payments and debt service requirements.Our calculation of free cash flow and reconciliation to net cash provided by operating activities is shown in the table below for the year ended December 31 (in millions), and may not be calculated the same as similarly-titled measures presented by other companies:​​​​​​​​​​​ 2022 2021 2020Net cash provided by operating activities ​$ 4,536​$ 4,338​$ 3,403Capital expenditures to support the business​​ (2,026)​​ (1,665)​​ (1,606)Capital expenditures - sustainability growth investments (a)​​ (561)​​ (239)​​ (26)Total Capital expenditures​ (2,587)​ (1,904)​ (1,632)Proceeds from divestitures of businesses and other assets, net of cash divested​ 27​ 96​ 885Free cash flow​$ 1,976​$ 2,530​$ 2,656(a)These growth investments are intended to further our sustainability leadership position by increasing recycling volumes and growing renewable natural gas generation. We expect they will deliver circular solutions for our customers and drive environmental value to the communities we serve. Critical Accounting Estimates and Assumptions In preparing our financial statements, we make numerous estimates and assumptions that affect the accounting for and recognition and disclosure of assets, liabilities, equity, revenues and expenses. We must make these estimates and 60 Table of Contentsassumptions because certain information that we use is dependent on future events, cannot be calculated with precision from available data or simply cannot be calculated. In some cases, these estimates are difficult to determine, and we must exercise significant judgment. In preparing our financial statements, the most difficult, subjective and complex estimates and the assumptions that present the greatest amount of uncertainty relate to our accounting for landfills, environmental remediation liabilities, long-lived asset impairments, intangible asset impairments and the fair value of assets and liabilities acquired in business combinations. Each of these items is discussed in additional detail below and in Note 2 to the Consolidated Financial Statements. Actual results could differ materially from the estimates and assumptions that we use in the preparation of our financial statements.Landfills Accounting for landfills requires that significant estimates and assumptions be made regarding (i) the cost to construct and develop each landfill asset; (ii) the estimated fair value of final capping, closure and post-closure asset retirement obligations, which must consider both the expected cost and timing of these activities and (iii) the determination of each landfill’s remaining permitted and expansion airspace.Landfill Costs — We estimate the total cost to develop each of our landfill sites to its remaining permitted and expansion airspace. This estimate includes such costs as landfill liner material and installation, excavation for airspace, landfill leachate collection systems, landfill gas collection systems, environmental monitoring equipment for groundwater and landfill gas, directly related engineering, capitalized interest, on-site road construction and other capital infrastructure costs. Additionally, landfill development includes all land purchases for the landfill footprint and landfill buffer property. The projection of these landfill costs is dependent, in part, on future events. The remaining depletable basis of each landfill includes costs to develop a site to its remaining permitted and expansion airspace and includes amounts previously expended and capitalized, net of accumulated airspace depletion, and projections of future purchase and development costs.Final Capping Costs — We estimate the cost for each final capping event based on the area to be capped and the capping materials and activities required. The estimates also consider when these costs are anticipated to be paid and factor in inflation and discount rates. Our engineering personnel allocate landfill final capping costs to specific final capping events and the capping costs are depleted as waste is disposed of at the landfill. We review these costs annually, or more often if significant facts change. Changes in estimates, such as timing or cost of construction, for final capping events immediately impact the required liability and the corresponding asset. When the change in estimate relates to a fully consumed landfill, the adjustment to the asset must be depleted immediately through expense. When the change in estimate relates to a final capping event at a landfill with remaining airspace, the adjustment to the asset is recognized in income prospectively as a component of landfill airspace depletion.Closure and Post-Closure Costs — We base our estimates for closure and post-closure costs on our interpretations of permit and regulatory requirements for closure and post-closure monitoring and maintenance. The estimates for landfill closure and post-closure costs also consider when the costs are anticipated to be paid and factor in inflation and discount rates. The possibility of changing legal and regulatory requirements and the forward-looking nature of these types of costs make any estimation or assumption less certain. Changes in estimates for closure and post-closure events immediately impact the required liability and the corresponding asset. When the change in estimate relates to a fully consumed landfill, the adjustment to the asset must be depleted immediately through expense. When the change in estimate relates to a landfill with remaining airspace, the adjustment to the asset is recognized in income prospectively as a component of landfill airspace depletion.Remaining Permitted Airspace — Our engineers, in consultation with third-party engineering consultants and surveyors, are responsible for determining remaining permitted airspace at our landfills. The remaining permitted airspace is determined by an annual survey, which is used to compare the existing landfill topography to the expected final landfill topography.Expansion Airspace — We also include currently unpermitted expansion airspace in our estimate of remaining permitted and expansion airspace in certain circumstances. First, for unpermitted airspace to be initially included in our estimate of remaining permitted and expansion airspace, we must believe that obtaining the expansion permit is likely. 61 Table of ContentsSecond, we must generally expect the initial expansion permit application to be submitted within one year and the final expansion permit to be received within five years, in addition to meeting the following criteria:●Personnel are actively working on the expansion of an existing landfill, including efforts to obtain land use and local, state or provincial approvals;●We have a legal right to use or obtain land to be included in the expansion plan;●There are no significant known technical, legal, community, business, or political restrictions or similar issues that could negatively affect the success of such expansion; and●Financial analysis has been completed based on conceptual design, and the results demonstrate that the expansion meets Company criteria for investment.These criteria are evaluated by our field-based engineers, accountants, managers and others to identify potential obstacles to obtaining the permits. Once the unpermitted airspace is included, our policy provides that airspace may continue to be included in remaining permitted and expansion airspace even if certain of these criteria are no longer met as long as we continue to believe we will ultimately obtain the permit, based on the facts and circumstances of a specific landfill. In these circumstances, continued inclusion must be approved through a landfill-specific review process that includes approval by our Chief Financial Officer on a quarterly basis. When we include the expansion airspace in our calculations of remaining permitted and expansion airspace, we also include the projected costs for development, as well as the projected asset retirement costs related to final capping, closure and post-closure of the expansion in the depletable basis of the landfill.Once the remaining permitted and expansion airspace is determined in cubic yards, an airspace utilization factor (“AUF”) is established to calculate the remaining permitted and expansion capacity in tons. The AUF is established using the measured density obtained from previous annual surveys and is then adjusted to account for future settlement. The amount of settlement that is forecasted will consider several site-specific factors including current and projected mix of waste type, initial and projected waste density, estimated number of years of life remaining, depth of underlying waste, anticipated access to moisture through precipitation or recirculation of landfill leachate and operating practices. In addition, the initial selection of the AUF is subject to a subsequent multi-level review by our engineering group and the AUF used is reviewed on a periodic basis and revised as necessary. Our historical experience generally indicates that the impact of settlement at a landfill is greater later in the life of the landfill when the waste placed at the landfill approaches its highest point under the permit requirements.After determining the costs and remaining permitted and expansion capacity at each of our landfills, we determine the per ton rates that will be expensed as waste is received and deposited at the landfill by dividing the costs by the corresponding number of tons. We calculate per ton depletion rates for each landfill for assets associated with each final capping event, for assets related to closure and post-closure activities and for all other costs capitalized or to be capitalized in the future. These rates per ton are updated annually, or more often, as significant facts change.It is possible that actual results, including the amount of costs incurred, the timing of final capping, closure and post-closure activities, our airspace utilization or the success of our expansion efforts could ultimately turn out to be significantly different from our estimates and assumptions. To the extent that such estimates, or related assumptions, prove to be significantly different than actual results, lower earnings may be experienced due to higher depletion rates or higher expenses; or higher earnings may result if the opposite occurs. Most significantly, if it is determined that expansion capacity should no longer be considered in calculating the recoverability of a landfill asset, we may be required to recognize an asset impairment or incur significantly higher depletion expense. If at any time management makes the decision to abandon the expansion effort, the capitalized costs related to the expansion effort are expensed immediately.Environmental Remediation LiabilitiesA significant portion of our operating costs and capital expenditures could be characterized as costs of environmental protection. The nature of our operations, particularly with respect to the construction, operation and maintenance of our landfills subjects us to an array of laws and regulations relating to the protection of the environment. Under current laws 62 Table of Contentsand regulations, we may have liabilities for environmental damage caused by our operations, or for damage caused by conditions that existed before we acquired a site. In addition to remediation activity required by state or local authorities, such liabilities include potentially responsible party (“PRP”) investigations. The costs associated with these liabilities can include settlements, certain legal and consultant fees, as well as incremental internal and external costs directly associated with site investigation and clean up. Where it is probable that a liability has been incurred, we estimate costs required to remediate sites based on site-specific facts and circumstances. We routinely review and evaluate sites that require remediation and determine our estimated cost for the likely remedy based on a number of estimates and assumptions. Next, we review the same type of information with respect to other named and unnamed PRPs. Estimates of the costs for the likely remedy are then either developed using our internal resources or by third-party environmental engineers or other service providers. Internally developed estimates are based on:●Management’s judgment and experience in remediating our own and unrelated parties’ sites;●Information available from regulatory agencies as to costs of remediation;●The number, financial resources and relative degree of responsibility of other PRPs who may be liable for remediation of a specific site; and●The typical allocation of costs among PRPs, unless the actual allocation has been determined.Fair Value of Nonfinancial Assets and LiabilitiesSignificant estimates are made in determining the fair value of long-lived tangible and intangible assets (i.e., property and equipment, intangible assets and goodwill) during the impairment evaluation process. In addition, the majority of assets acquired and liabilities assumed in a business combination are required to be recognized at fair value under the relevant accounting guidance.Fair value is computed using several factors, including projected future operating results, economic projections, anticipated future cash flows, comparable marketplace data and the cost of capital. There are inherent uncertainties related to these factors and to our judgment in applying them in our analysis. However, we believe our methodology for estimating the fair value of our reporting units is reasonable.Property and Equipment, Including Landfills and Definite-Lived Intangible Assets — We monitor the carrying value of our long-lived assets for potential impairment on an ongoing basis and test the recoverability of such assets generally using significant unobservable (“Level 3”) inputs whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. These events or changes in circumstances, including management decisions pertaining to such assets, are referred to as impairment indicators. If an impairment indicator occurs, we perform a test of recoverability by comparing the carrying value of the asset or asset group to its undiscounted expected future cash flows. If cash flows cannot be separately and independently identified for a single asset, we will determine whether an impairment has occurred for the group of assets for which we can identify the projected cash flows. If the carrying values are in excess of undiscounted expected future cash flows, we measure any impairment by comparing the fair value of the asset or asset group to its carrying value and the difference is recorded in the period that the impairment indicator occurs. Fair value is generally determined by considering (i) internally developed discounted projected cash flow analysis of the asset or asset group; (ii) actual third-party valuations and/or (iii) information available regarding the current market for similar assets. Estimating future cash flows requires significant judgment and projections may vary from the cash flows eventually realized, which could impact our ability to accurately assess whether an asset has been impaired.The assessment of impairment indicators and the recoverability of our capitalized costs associated with landfills and related expansion projects require significant judgment due to the unique nature of the waste industry, the highly regulated permitting process and the sensitive estimates involved. During the review of a landfill expansion application, a regulator may initially deny the expansion application although the expansion permit is ultimately granted. In addition, management may periodically divert waste from one landfill to another to conserve remaining permitted landfill airspace, or a landfill may be required to cease accepting waste, prior to receipt of the expansion permit. However, such events occur in the ordinary course of business in the waste industry and do not necessarily result in impairment of our landfill assets because, 63 Table of Contentsafter consideration of all facts, such events may not affect our belief that we will ultimately obtain the expansion permit. As a result, our tests of recoverability, which generally make use of a probability-weighted cash flow estimation approach, may indicate that no impairment loss should be recorded.Indefinite-Lived Intangible Assets, Including Goodwill — At least annually using a measurement date of October 1, and more frequently if warranted, we assess the indefinite-lived intangible assets including the goodwill of our reporting units for impairment using Level 3 inputs.We first perform a qualitative assessment to determine if it was more likely than not that the fair value of a reporting unit is less than its carrying value. If the assessment indicates a possible impairment, we complete a quantitative review, comparing the estimated fair value of a reporting unit to its carrying amount, including goodwill. An impairment charge is recognized if the asset’s estimated fair value was less than its carrying amount. Fair value is typically estimated using an income approach using Level 3 inputs. However, when appropriate, we may also use a market approach. The income approach is based on the long-term projected future cash flows of the reporting units. We discount the estimated cash flows to present value using a weighted average cost of capital that considers factors such as market assumptions, the timing of the cash flows and the risks inherent in those cash flows. We believe that this approach is appropriate because it provides a fair value estimate based upon the reporting units’ expected long-term performance considering the economic and market conditions that generally affect our business. The market approach estimates fair value by measuring the aggregate market value of publicly-traded companies with similar characteristics to our business as a multiple of their reported earnings. We then apply that multiple to the reporting units’ earnings to estimate their fair values. We believe that this approach may also be appropriate in certain circumstances because it provides a fair value estimate using valuation inputs from entities with operations and economic characteristics comparable to our reporting units.Acquisitions — In accordance with the purchase method of accounting, the purchase price paid for an acquisition is allocated to the assets and liabilities acquired based upon their estimated fair values as of the acquisition date, with the excess of the purchase price over the net assets acquired recorded as goodwill. When we are in the process of valuing all of the assets and liabilities acquired in an acquisition, there can be subsequent adjustments to our estimates of fair value and resulting preliminary purchase price allocation. Generally, the valuation of our acquired asset and liabilities rely on complex estimates and assumptions.Acquisition-date fair value estimates are revised as necessary if, and when, additional information regarding these contingencies becomes available to further define and quantify assets acquired and liabilities assumed. Subsequent to finalization of purchase accounting, these revisions are accounted for as adjustments to income from operations. All acquisition-related transaction costs are expensed as incurred. See Note 17 to the Consolidated Financial Statements for additional information related to our acquisitions, including our 2020 acquisition of Advanced Disposal.See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — (Gain) Loss from Divestitures, Asset Impairments and Unusual Items, Net. InflationMacroeconomic pressures, including inflation and market disruption resulting in labor, supply chain and transportation constraints are continuing. Significant global supply chain disruption and the heightened pace of inflation has reduced availability and increased costs for the goods and services we purchase, with a particular impact on our repair and maintenance costs. Supply chain constraints have also caused delayed delivery of fleet, steel containers and other purchases. Aspects of our business rely on third-party transportation providers, and such services have become more limited and expensive. Our overall strategic pricing efforts are focused on recovering as much of the inflationary cost increases we experience in our business as possible by increasing our average unit rate, but such efforts may not be successful for various reasons including the pace of inflation, operating cost inefficiencies, contractual limitations, and market responses. Throughout 2022, many of these contract lookback provisions began to capture the inflationary cost increases experienced since the second half of 2021 in the price escalation calculation; however, such timing lag persists and will continue to restrict our ability to address proactively future rapid cost increases for those contracts. Refer to Item 1A. Risk Factors for further discussion. 64 Table of ContentsItem 7A. Quantitative and Qualitative Disclosures about Market Risk. In the normal course of business, we are exposed to market risks, including changes in interest rates, certain commodity prices and Canadian currency rates. From time to time, we use derivatives to manage some portion of these risks. The Company had no derivatives outstanding as of December 31, 2022.Interest Rate Exposure — Our exposure to market risk for changes in interest rates relates primarily to our financing activities. As of December 31, 2022, we had $15.1 billion of long-term debt, excluding the impacts of accounting for debt issuance costs, discounts and fair value adjustments attributable to terminated interest rate derivatives. We have $3.5 billion of debt that is exposed to changes in market interest rates within the next 12 months comprised primarily of (i) $1.7 billion of short-term borrowings under our commercial paper program; (ii) $1.0 billion of long-term borrowings under our $1.0 billion, two-year, U.S. term credit agreement and (iii) $725 million of tax-exempt bonds with term interest rate periods that expire within the next 12 months. We currently estimate that a 100-basis point increase in the interest rates of our outstanding variable-rate debt obligations would increase our 2023 interest expense by $28 million.Our remaining outstanding debt obligations have fixed interest rates through either the scheduled maturity of the debt or, for certain of our fixed-rate tax-exempt bonds, through the end of a term interest rate period that exceeds 12 months. The fair value of our fixed-rate debt obligations can increase or decrease significantly if market interest rates change.We performed a sensitivity analysis to determine how market rate changes might affect the fair value of our market risk-sensitive debt instruments. This analysis is inherently limited because it reflects a singular, hypothetical set of assumptions. Actual market movements may vary significantly from our assumptions. An instantaneous, 100-basis point increase in interest rates across all maturities attributable to these instruments would have decreased the fair value of our debt by approximately $700 million as of December 31, 2022.We are also exposed to interest rate market risk from our cash and cash equivalent balances, as well as assets held in restricted trust fund accounts. These assets are generally invested in high-quality, liquid instruments including money market funds that invest in U.S. government obligations with original maturities of three months or less. We believe that our exposure to changes in fair value of these assets due to interest rate fluctuations is insignificant as the fair value generally approximates our cost basis. We also invest a portion of our restricted trust fund account balances in available-for-sale securities, including U.S. Treasury securities, U.S. agency securities, municipal securities, mortgage- and asset-backed securities, which generally mature over the next nine years, as well as equity securities.Commodity Price Exposure — In the normal course of our business, we are subject to operating agreements that expose us to market risks arising from changes in the prices for commodities such as diesel fuel, electricity (and related renewable energy credits) and recycled materials, including old corrugated cardboard and plastics. We work to manage these risks through operational strategies that focus on capturing our costs in the prices we charge our customers for the services provided. Accordingly, as the market prices for these commodities increase or decrease, our revenues, operating costs and margins may also increase or decrease. Recycling revenues attributable to yield increased $19 million and $537 million in 2022 and 2021, respectively, as compared with the prior year periods, primarily from higher market prices for recycling commodities in 2021 and the first half of 2022, before the significant downturn in the second half of 2022. Demand for recycled materials strengthened through 2021 and into early 2022, primarily driven by the growth in e-commerce, businesses re-opening, and manufacturers committing to use more recycled content in their packaging. In 2022, we experienced all-time high recycling commodity pricing in the first half of the year to be followed by historically low pricing through the second half of the year, resulting from the slowdown in the global economy, which reduced retail demand and the corresponding need for cardboard packaging to ship retail goods. We expect significant commodity price headwinds to continue into 2023. Average market prices for recycling commodities at the Company’s facilities were approximately 10% lower and 115% higher in 2022 and 2021, respectively, when compared with the prior year periods. Revenue decline from lower commodity pricing was offset by higher pricing in our recycling brokerage business as well as our continued focus on a fee-based pricing model that ensures fees paid by customers cover the cost of processing materials and the impact on our cost structure of managing contamination in the recycling stream. Variability in commodity prices can also impact the margins of our business as certain components of our revenue are structured as a pass through of costs, including recycling brokerage and fuel surcharges.65 Table of ContentsThe primary drivers of renewable fuel development at our landfills are tax policies, such as the recently expanded federal tax credits for renewable natural gas (“RNG”) production and renewable electricity generation, and federal and state incentive programs, such as the federal Renewable Fuel Standard (“RFS”) program and the California Low Carbon Fuel Standard. At the federal level, oil refiners and importers are required through the RFS program to blend specified volumes of renewable transportation fuels with gasoline or buy credits, referred to as renewable identification numbers (“RINs”), from renewable fuel producers. The Company has invested, and continues to invest, in facilities that capture and convert landfill gas into RNG, and also works with facilities that capture and convert dairy digester gas into RNG, so that we can participate in the program, and the Company has stated its intention to grow its asset base to notably increase its RNG production by 2026. RINs prices generally respond to regulations enacted by the EPA, as well as fluctuations in supply and demand. The value of the RINs associated with RNG is set through a market established by the program.Prior to 2022, the EPA has promulgated rules on an annual basis establishing refiners’ obligations to purchase RNG and other cellulosic biofuels under the RFS program; however, the EPA issued a highly anticipated proposed rule in late 2022 setting forth the direction of the RFS program for compliance years 2023 through 2025. Although this proposal delivers on many reforms that benefit the solid waste sector, the EPA’s programmatic shift towards multi-year standards could lead to market uncertainty and volatility in the price of RINs. We continue to advocate for the current administration to implement policies that ensure long term stability for renewable transportation fuels and expand opportunities for the biogas sector to participate in the RFS program. Changes in the RFS market, the structure of the RFS program or RINs prices and demand can and has impacted the financial performance of the facilities constructed to capture and treat the gas. Such changes could impact or alter our projected future investments, and such investments may not yield the results anticipated.Currency Rate Exposure — We have operations in Canada as well as certain support functions in India. Where significant, we have quantified and described the impact of foreign currency translation on components of income, including operating revenue and operating expenses. However, the impact of foreign currency has not materially affected our results of operations. ​66 Table of Contents
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+Item 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSOVERVIEWWabtec is one of the world’s largest providers of value-added, technology-based locomotives, equipment, systems and services for the global freight rail and passenger transit industries, and also serves customers in the mining, marine, and industrial markets. Our highly engineered products, which are intended to enhance safety, improve productivity and reduce maintenance costs for customers, can be found on most locomotives, freight cars, passenger transit cars and buses around the world. Our core products and services are essential in the safe and efficient operation of freight rail and passenger transit vehicles. Wabtec is a global company with operations in over 50 countries and our products can be found in more than 100 countries throughout the world. In 2022, approximately 55% of the Company’s net sales came from customers outside the U.S.Wabtec’s long-term financial goals are to drive strong cash flow conversion, maintain a strong credit profile while minimizing our overall cost of capital, increase margins through strict attention to cost controls, drive improved efficiencies across the business, and increase revenues through a focused growth strategy, including product innovation and new technologies, global and market expansion, aftermarket products and services, and strategic acquisitions. In addition, Management evaluates the Company’s current operational performance through measures such as safety, quality and on-time delivery.The Company primarily serves the worldwide freight and transit rail industries. Our operating results are largely dependent on the level of activity, financial condition and capital spending plans of railroads and passenger transit agencies around the world, and transportation equipment manufacturers who serve those markets. Many factors influence these industries, including general economic conditions; traffic volumes, as measured by freight carloads and passenger ridership; number of locomotives and railcars in operation; government spending on public transportation; and investment in new technologies. In general, trends such as urbanization and growth in developing markets, sustainability and environmental awareness, investment in technology solutions, an aging equipment fleet, and growth in global trade are expected to drive continued investment in freight rail and passenger transit.The Company monitors a variety of factors and statistics to gauge market activity. Freight rail markets around the world are driven primarily by overall economic conditions and activity, while Transit markets are driven primarily by government funding and passenger ridership. Changes in these market drivers can cause fluctuations in demand for Wabtec's products and services.Business UpdateDuring 2022, Wabtec achieved a multitude of accomplishments while successfully navigating volatile market conditions. Through leveraging our installed customer base and our innovative scalable technologies, Wabtec was able to secure several key contracts globally that position the Company for long-term revenue generation. These contracts include the largest locomotive modernization deal in rail industry history, orders for our FLXdrive battery-electric powered locomotives, international locomotive orders, as well as a North American locomotive order with a Class I railroad. Wabtec executed on calculated market expansions through several strategic acquisitions that will allow us to leverage current and future product and service offerings for greater market share. Wabtec continued significant progress on our sustainability initiatives as exhibited in our completed green bond allocation and with our battery electric locomotive being recognized for sustainable innovation by the Business Intelligence Group and awarded “Commercial Technology of the Year” at the Platts Global Energy Awards. Management also launched Integration 2.0 to further poise the company for operational efficiencies into the future. During the first quarter of 2022, Wabtec announced Integration 2.0, a three-year strategic initiative to target incremental run rate synergies estimated to be between $75 million and $90 million by 2025. The scope of the review includes consolidating our operating footprint, reducing headcount, streamlining the end-to-end manufacturing process, restructuring the North America distribution channels, expanding operations in low-cost countries and simplifying the business through systems enablement, including the source-to-pay process. Management will also consider additional capital investments to further simplify and streamline the business. The Company anticipates that it will incur one-time charges of approximately $135 million to $165 million related to this initiative. The estimate could change based on the specific programs approved or changes to the scope of the review. During 2022, the Company incurred one-time charges related to the initiative of approximately $46 million, primarily for employee-related costs associated with site consolidations in Europe and costs related to the restructuring of the North America distribution channels. See Note 21 of "Notes to Consolidated Financial Statements" included in Part II, Item 8 of this report for additional information. The unfavorable global economic conditions driven by the impacts of the pandemic and supply chain disruptions, and further intensified by the Russian invasion of Ukraine, continue to have an adverse impact on our operations and business results. Impacts for the years ended December 31, 2022, and 2021 are discussed in more detail in the Results of Operations section below. Supply chain disruptions and labor availability have caused component, raw material and chip shortages 28resulting in an adverse effect on the timing of the Company’s revenue generation. Additionally, broad-based inflation, escalation of diesel, metals, energy and other commodity costs, transportation and logistics costs, labor costs, and foreign currency exchange rate fluctuations all continue to impact our results. The Russian invasion of Ukraine and the resultant sanctions related to Russia and Belarus have further impacted our supply and distribution channels and caused significant price inflation which had, and are expected to continue to have, adverse effects on Wabtec’s business results. For the year ended December 31, 2021, prior to the Russian invasion of Ukraine and the resulting imposition of various sanctions against Russia and Belarus, Wabtec had earnings of approximately $40 million attributable to customers in Russia, while earnings from customers in Ukraine and Belarus were not significant. As of December 31, 2022 and 2021, Wabtec had approximately $14 million and $20 million of assets, respectively, related to Russian operations, which were primarily cash and inventory. Management has determined, based on information currently available, that these assets are expected to be recoverable and therefore no impairment was recorded during 2022. This will continue to be monitored and may result in a future impairment charge based on changes in the situation. Management determined that inventory related to operations in Ukraine were not expected to be recoverable and were written off resulting in an insignificant charge during the first quarter of 2022. Remaining assets related to Ukraine and those in Belarus were not significant.The Company has implemented various mitigating actions intended to lessen the impact of these unfavorable economic conditions. These actions include implementing price escalations and surcharges, driving operational efficiencies through various cost mitigation efforts and discretionary spend management, strategically sourcing materials, reviewing and modifying distribution logistics, and accelerating integration synergies where possible, including Integration 2.0. Additionally, the Company has proactively built-up inventory ahead of expected growth and in response to supply chain challenges to minimize further interruption on customer orders. The Company expects to continue to incur increased costs in future quarters. We also face the possibility that additional actions may be taken by governmental authorities and private industry, or government policies may become more restrictive in response to the pandemic, especially if COVID-19 transmission rates increase in certain areas, which could result in curtailing operations of our plants. Uncertainty around the economic conditions driven by the pandemic and the Russian invasion of Ukraine could result in significant adverse impacts to the Company. Changes in trade regulations, retaliatory measures, advancements, or changes in the conflict in Ukraine could cause significant adverse impacts to our customers, suppliers, distribution channels and operating locations, and in turn could result in material adverse impacts to the business, including impairment charges from changes in estimates.Management will continue to monitor the evolving situations but, as a result of the numerous uncertainties surrounding the pandemic, continued supply chain disruptions, labor shortages, inflation, and the Russian invasion of Ukraine, we are unable to specifically predict the extent and length of time that our business may be negatively impacted. Uncertainty around general global economic and market conditions, including fluctuations in currency exchange rates, could have an impact on our sales and operations in 2023 and beyond. To the extent that these factors cause further instability of capital markets, supply chain disruptions including shortages of raw materials or component parts, labor availability, longer sales cycles, deferral or delay of customer orders, or an inability to market or distribute our products effectively, our business and results of operations could be materially adversely affected. Cyber Incident As previously announced, on June 26, 2022, we detected a cyber security incident which impacted the Company’s network. The Company promptly activated incident response protocols, which included shutting down certain systems, and commenced an investigation of the incident. The Company also notified law enforcement and engaged legal counsel and other third-party incident response and cybersecurity professionals. Based on the Company's assessment, the incident has not had a material financial impact and the Company does not believe the incident will have a material impact on its business, operations or financial results. The Company maintains cyber insurance, subject to certain deductibles and policy limitations typical for its size and industry. ACQUISITIONSDuring 2022, the Freight Segment made three strategic acquisitions for a combined purchase price of $89 million. Two of the acquisitions are reported in the Digital Electronics product line and one is reported in the Services product line. Each of the acquisitions in 2022 are individually and collectively immaterial. On March 31, 2021, the Services product line of the Freight Segment acquired Nordco, a leading North American supplier of new, rebuilt and used maintenance of way equipment. The Company also made acquisitions in prior periods not listed above which are individually and collectively immaterial. For additional information related to these acquisitions refer to Note 3 of "Notes to Consolidated Financial Statements" included in Part II, Item 8 of this report. 29RESULTS OF OPERATIONSConsolidated Results2022 COMPARED TO 2021 The following table shows our Consolidated Statements of Operations for the years indicated. For the year ended December 31,In millions20222021Net sales:Sales of goods$6,459 $6,205 Sales of services1,903 1,617 Total net sales8,362 7,822 Cost of sales:Cost of goods(4,791)(4,545)Cost of services(1,031)(908)Total cost of sales(5,822)(5,453)Gross profit2,540 2,369 Operating expenses:Selling, general and administrative expenses(1,029)(1,030)Engineering expenses(209)(176)Amortization expense(291)(287)Total operating expenses(1,529)(1,493)Income from operations1,011 876 Other income and expenses:Interest expense, net(186)(177)Other income, net29 38 Income before income taxes 854 737 Income tax expense(213)(172)Net income641 565 Less: Net income attributable to noncontrolling interest(8)(7)Net income attributable to Wabtec shareholders$633 $558 The following table shows the major components of the change in net sales in 2022 from 2021:In millionsFreight SegmentTransit SegmentTotal2021 Net Sales$5,239 $2,583 $7,822 Acquisitions83 4 87 Foreign Exchange(62)(242)(304)Organic752 5 757 2022 Net Sales$6,012 $2,350 $8,362 The following discussion compares our results for the year ended December 31, 2022 to the year ended December 31, 2021. The discussion comparing our results for the year ended December 31, 2021 to the year ended December 31, 2020 is included within Management's Discussion and Analysis of Financial Condition and Results of Operation in our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 17, 2022.Net sales Net sales for the year ended December 31, 2022 increased by $540 million, or 6.9%, to $8.36 billion compared to the same period in 2021. Organic sales increased $757 million which is primarily attributable to the Freight Segment driven by an increase in Services sales from higher locomotive modernizations and a larger active locomotive fleet, and an increase in Equipment sales due to higher international locomotive sales and higher mining equipment sales. In addition, Components sales increased due to a higher railcar build, increased railcars in operation, and growth in industrial end-markets and Digital Electronics sales increased due to higher demand for on-board locomotive products and technology upgrades. Sales from 30acquisitions contributed $87 million, primarily in the Freight Segment and unfavorable changes in foreign exchange rates decreased sales by $304 million, primarily in the Transit segment. Cost of salesCost of sales for the year ended December 31, 2022 increased by $369 million, or 6.8%, to $5.82 billion compared to the same period in 2021. The increase is primarily due to the increase in sales and increased materials, labor and transportation costs. Cost of sales as a percentage of sales was 69.6% and 69.7% for the years ended December 31, 2022 and 2021, respectively. The decrease as a percentage of sales is primarily due to improved productivity and lower restructuring costs, partially offset by unfavorable product mix and the increase in the costs described above. Cost of sales for the years ended December 31, 2022 and 2021 included $43 million and $53 million, respectively, of restructuring costs primarily for footprint rationalization and headcount actions, with the amount in 2022 primarily related to Integration 2.0.Operating expenses Total operating expenses increased $36 million, or 2.4%, for the year ended December 31, 2022 compared to the same period in 2021. Operating expenses as a percentage of sales was 18.3% and 19.1% for the years ended December 31, 2022 and 2021, respectively. Selling, general and administrative expenses ("SG&A") decreased $1 million for the year ended December 31, 2022 compared to the same period in 2021. The decrease is primarily due to a decrease in restructuring costs, the effects of foreign exchange rates and lower employee compensation and benefit costs, partially offset by costs incurred to support the higher sales volume and incremental expense from acquisitions. Restructuring costs included in SG&A were $9 million and $25 million for the years ended December 31, 2022 and 2021, respectively, and were primarily for headcount actions and footprint rationalization programs, with the amount in 2022 primarily related to Integration 2.0. Engineering expense increased $33 million primarily due to investments in new technology and incremental costs from acquisitions. Amortization expense increased $4 million, due to acquisitions. Interest expense, net Interest expense, net, increased $9 million to $186 million for the year ended December 31, 2022 over the same period in 2021 primarily attributable to higher average interest rates.Other income, netOther income, net, decreased $9 million to $29 million for the year ended December 31, 2022 compared to the same period of 2021. The decrease is primarily attributable to lower foreign exchange gains and lower equity income in the current year compared to the prior year.Income taxes The effective income tax rate was 25.0% and 23.2% for the years ended December 31, 2022 and 2021, respectively, representing a 1.8 percentage point increase. The rate for the year ended December 31, 2021 was favorably impacted by filing amended federal and state income tax returns for a prior year to incorporate changes in tax regulations. The absence of this benefit in the current year was partially offset by a more favorable earnings mix across jurisdictions. See Note 11 of "Notes to Consolidated Financial Statements" included in Part II, Item 8 of this report for additional information.31Freight SegmentThe following table shows our Consolidated Statements of Operations for our Freight Segment:For the year ended December 31,In millions20222021Net sales:Sales of goods$4,125 $3,646 Sales of services1,887 1,593 Total net sales6,012 5,239 Cost of sales:Cost of goods(3,098)(2,682)Cost of services(1,018)(890)Total cost of sales(4,116)(3,572)Gross profit1,896 1,667 Operating expenses(1,032)(950)Income from operations ($)$864 $717 Income from operations (% of net sales)14.4 %13.7 %The following table shows the major components of the change in net sales for the Freight Segment in 2022 from 2021:In millions2021 Net Sales$5,239 Acquisitions83 Foreign Exchange(62)Changes in Sales by Product Line:Services347 Equipment251 Components96 Digital Electronics58 2022 Net Sales$6,012 Net salesFreight Segment sales increased by $773 million, or 14.8%, to $6.01 billion, compared to the same period in 2021 which was primarily attributable to an increase in Services sales from higher locomotive modernizations and a larger active locomotive fleet, and an increase in Equipment sales due to higher international locomotive sales and higher mining equipment sales. In addition, Components sales increased due to a higher railcar build, increased railcars in operation, and growth in industrial end-markets and Digital Electronics sales increased due to higher demand for on-board locomotive products and technology upgrades. Sales from acquisitions contributed $83 million and the effects of unfavorable foreign exchange rates decreased sales by $62 million. Cost of salesFreight Segment cost of sales increased by $544 million, or 15.2%, to $4.12 billion, compared to the same period in 2021. The increase is primarily due to the increase in sales and increased materials, transportation and labor costs. Cost of sales as a percentage of sales was 68.5% and 68.2% for the years ended December 31, 2022 and 2021, respectively, representing a 0.3 percentage point increase primarily from the higher costs described above, higher restructuring costs and unfavorable product mix, partially offset by improved productivity. Cost of sales for the years ended December 31, 2022 and 2021 includes $15 million and $8 million, respectively, of restructuring costs, primarily for headcount actions and footprint rationalization, with the amount in 2022 primarily related to Integration 2.0. Operating expensesFreight Segment operating expenses increased $82 million, or 8.6%, for the year ended December 31, 2022 compared to the same period in 2021. SG&A increased $41 million for the year ended December 31, 2022 compared to the same period in 2021. The increase is primarily due to higher costs to support the increase in sales volumes, incremental expense from 32acquisitions and higher technology costs. Engineering expense increased $36 million primarily due to investments in new technology and incremental expense from acquisitions. Amortization expense increased $5 million due to acquisitions. 33Transit SegmentThe following table shows our Consolidated Statements of Operations for our Transit Segment:For the year ended December 31,In millions20222021Net sales$2,350 $2,583 Cost of sales(1,706)(1,881)Gross profit644 702 Operating expenses(413)(464)Income from operations ($)$231 $238 Income from operations (% of net sales)9.8 %9.2 %The following table shows the major components of the change in net sales for the Transit Segment in 2022 from 2021:In millions2021 Net Sales$2,583 Foreign Exchange(242)Acquisitions4Changes in Sales by Product Line:Original Equipment Manufacturing(3)Aftermarket8 2022 Net Sales$2,350 Net salesTransit Segment sales for the year ended December 31, 2022 decreased by $233 million, or 9.0%, to $2.35 billion compared to the same period in 2021, with foreign exchange rates being the primary driver of the decrease. Transit segment organic sales increased $5 million with the primary driver being increased demand and an increase in government transportation spending, particularly for Aftermarket products. Additionally, both Original Equipment Manufacturing and Aftermarket sales were impacted by supply chain issues and manufacturing disruptions caused by the second quarter cyber incident.Cost of salesTransit Segment cost of sales for the year ended December 31, 2022 decreased by $175 million, or 9.3%, to $1.71 billion compared to the same period in 2021. The decrease is primarily due to the decreased sales discussed above, decreased restructuring costs and the effect of foreign exchange rates. Cost of sales as a percentage of sales was 72.6% and 72.8% for the years ended December 31, 2022 and 2021, respectively, representing a 0.2 percentage point decrease. This can be attributed to improved productivity and savings from prior year cost actions taken through restructuring programs, partially offset by increased materials, transportation and labor costs and inefficiencies associated with the cyber incident. Cost of sales for the years ended December 31, 2022 and 2021 included $28 million and $45 million of restructuring costs, respectively, primarily for headcount actions and footprint rationalization in Europe, with the amount in 2022 primarily related to Integration 2.0. Operating expensesTransit Segment operating expenses decreased $51 million, or 11.0%, in 2022 compared to the same period in 2021 driven primarily by a decrease in SG&A of $47 million. The decrease is due to the decrease in sales, the effects of foreign exchange rates, lower employee compensation and benefit costs, the cost actions taken in the prior year and decreased restructuring costs. Restructuring costs included within SG&A were $9 million and $14 million for the years ended December 31, 2022 and 2021, respectively, and were primarily for headcount actions for footprint rationalization in Europe, with the amount in 2022 primarily related to Integration 2.0. Engineering expense decreased $3 million and amortization expense decreased $1 million both due to the effects of foreign exchange rates.34Liquidity and Capital ResourcesLiquidity is provided by operating cash flows and borrowings under the Company’s Senior Notes and unsecured credit facility with a consortium of commercial banks. Additionally, the Company utilizes the revolving receivables program and supply chain financing program described below for added flexibility as part of our liquidity management strategy. The following is a summary of selected cash flow information and other relevant data:For the year endedDecember 31,In millions20222021Cash provided by (used for): Operating activities$1,038 $1,073 Investing activities$(235)$(540)Financing activities$(708)$(653) Operating activities. Cash provided by operations decreased $35 million in 2022 to $1,038 million compared with $1,073 million in 2021. Significant changes to the sources and (uses) of cash for the twelve month periods include the following:•$11 million attributable to higher Net income and other changes in the related statements of income amounts;•$(106) million from net changes in working capital driven by: $(327) million unfavorable change in inventory from proactive inventory build-ups ahead of expected growth, in response to supply chain challenges, and in preparation for certain large contracts secured during 2022, as well as higher costs of inventory due to inflation; $197 million in accounts payable, primarily due to the timing of payments to suppliers; and, $24 million from changes in receivables due to timing and volume of sales and the net change in the Revolving Receivables Program;•$143 million from changes in the timing of customer deposits; and,•$(100) million from higher employee related benefits and the timing of payments related to severance accruals.Investing activities. In 2022 and 2021, cash used for investing activities was $(235) million and $(540) million, respectively. The major components of the cash outflow in 2022 was planned additions to property, plant, and equipment of $(149) million for continued investments in our facilities and manufacturing processes, and $(89) million in net cash paid for acquisitions. The major components of the cash outflow in 2021 were $(435) million in net cash paid for acquisitions, primarily for Nordco, and $(130) million for additions to property, plant, and equipment.Financing activities. In 2022, cash used for financing activities was $(708) million, which included $(473) million for share repurchases, $(111) million of dividend payments, $(101) million of contingent consideration payments related to the GE Transportation acquisition, and net debt payments of $(30) million, which includes the partial redemption of the 2024 Notes mentioned below. In 2021, cash used for financing activities was $(653) million which included, $(300) million for share repurchases, net debt payments of $(161) million, primarily resulting from the repayment of the 364 Day Facility and issuance of the Euro Notes mentioned below, $(99) million of contingent consideration payments related to the GE Transportation acquisition and $(92) million of dividend payments. During the second quarter of 2022, the Company redeemed $25 million of principal from the 2024 Notes plus a premium and the related accrued interest. On August 15, 2022, the Company amended, restated and replaced the then-existing credit agreement. The Restated Credit Agreement updated the multi-currency revolving credit facility from $1.2 billion to $1.5 billion and added a new Delayed Draw Term Loan of up to $250 million. The Company borrows and repays against the revolving credit facility for added flexibility in liquidity to manage cash during the operating cycle. The proceeds from borrowing and the repayments are shown within the "Proceeds from debt, net of issuance costs" and "Payments of debt" lines, respectively, presented in the Consolidated Statements of Cash Flows. On June 3, 2021, Wabtec Transportation Netherlands B.V. ("Wabtec Netherlands") issued €500 million of 1.25% Senior Notes due in 2027, which are fully and unconditionally guaranteed by the Company, for approximately $599 million in proceeds after consideration of the discount. Also on June 3, 2021, the Company repaid all outstanding borrowings and interest related to the 364 Day Facility, effectively retiring the facility. Additional information with respect to credit facilities and long-term debt is included in Note 9 of "Notes to Consolidated Financial Statements” included in Part II, Item 8 of this report. As of December 31, 2022, the Company held approximately $541 million of cash, cash equivalents, and restricted cash. Of this amount, approximately $88 million was held within the United States and approximately $453 million was held outside 35of the United States, primarily in India, China, Europe, and Brazil. While repatriation of some cash held outside the United States may be restricted by local laws, most of the Company’s foreign cash could be repatriated to the United States net of any tax impacts. As of December 31, 2022, $7 million of the Company's $541 million cash balance was classified as restricted cash. Revolving Receivables Program The Company utilizes a revolving receivables facility to sell up to $350 million of certain receivables through our bankruptcy-remote subsidiary to a financial institution on a recurring basis in exchange for cash equal to the gross receivables sold. As customers pay their balances, we transfer additional receivables into the program, which could result in our gross receivables sold being higher or lower than collections reinvested for any applicable periods. Net cash received/(remitted) from the revolving receivables program was $60 million and $(53) million for the years ended December 31, 2022 and 2021, respectively. Additional information with respect to the Revolving Receivables Program is included in Note 2 of "Notes to Consolidated Financial Statements" included in Part II, Item 8 of this report and incorporated by reference herein.Supply Chain Financing ProgramThe Company has entered into supply chain financing arrangements with third-party financial institutions to provide our vendors with enhanced payment options while providing the Company with added working capital flexibility. The Company does not provide any guarantees under these arrangements, does not have an economic interest in our supplier's voluntary participation and does not receive an economic benefit from the financial institutions. The arrangements do not change the payable terms negotiated by the Company and our vendors and does not result in a change in the classification of amounts due as accounts payable in the Consolidated Balance Sheets.Guarantor Summarized Financial Information—US Notes The obligations under the Company's US Notes have been fully and unconditionally guaranteed by certain of the parent company's U.S. subsidiaries. Each guarantor is 100% owned by the parent company, with the exception of GE Transportation, a Wabtec Company, which has 15,000 shares outstanding of Class A Non-Voting Preferred Stock held by General Electric Company. The Euro Notes are issued by Wabtec Netherlands and are fully and unconditionally guaranteed by the Company.On January 1, 2022, the Company completed an internal legal entity reorganization that resulted in changes to the subsidiaries and operating divisions serving as guarantors under the Company's US Notes. As such, certain prior year amounts have been reclassified, where necessary, to conform to the current year presentation in line with the legal reorganization. Refer to Exhibit 22 for the updated list of guarantor subsidiaries. The following tables present summarized financial information of the parent and the guarantor subsidiaries on a combined basis. The combined summarized financial information eliminates intercompany balances and transactions among the parent and guarantor subsidiaries and equity in earnings and investments in any guarantor subsidiaries or non-guarantor subsidiaries. The summarized financial information is provided in accordance with the reporting requirements of Rule 13-01 under SEC Regulation S-X for the issuer and guarantor subsidiaries.36Summarized Statement of IncomeUnauditedWestinghouse Air Brake Technologies Corp. and Guarantor SubsidiariesIn millionsYear Ended December 31, 2022Net sales$4,761 Gross profit1,111 Net income attributable to Wabtec shareholders282 Summarized Balance SheetsUnauditedWestinghouse Air Brake Technologies Corp. and Guarantor SubsidiariesIn millionsDecember 31, 2022December 31, 2021Current assets$1,328 $1,057 Noncurrent assets$2,384 $2,344 Current liabilities$1,881 $1,414 Long-term debt$3,209 $3,483 Other non-current liabilities$551 $592 The following is a description of the transactions between the combined Westinghouse Air Brake Technologies Corp. and guarantor subsidiaries with non-guarantor subsidiaries.UnauditedWestinghouse Air Brake Technologies Corp. and Guarantor SubsidiariesIn millionsYear Ended December 31, 2022Net sales to Non-Guarantor Subsidiaries$763 Purchases from Non-Guarantor Subsidiaries1,143 UnauditedWestinghouse Air Brake Technologies Corp. and Guarantor SubsidiariesIn millionsDecember 31, 2022Amount due (to)/from Non-Guarantor Subsidiaries$(6,821)Summarized Financial Information—Euro NotesThe obligations under Wabtec Netherlands’ Euro Notes are fully and unconditionally guaranteed by the Company. Wabtec Netherlands is a wholly-owned, indirect subsidiary of the parent company. Wabtec Netherlands is a holding company and does not have any independent operations. Its assets consist of its investments in subsidiaries, which are separate and distinct legal entities that are not guarantors of the Euro Notes and have no obligations to pay amounts due under Wabtec Netherlands’ obligations. On January 1, 2022, the Company completed an internal legal entity reorganization that resulted in changes to the operating divisions serving as the parent guarantor under the Company's Euro Notes. As such, certain prior year amounts have been reclassified, where necessary, to conform to the current year presentation in line with the legal reorganization.The following tables present summarized financial information of Wabtec Netherlands, as the issuer of the Euro Notes, and Westinghouse Air Brake Technologies Corporation, as the parent guarantor, on a combined basis. The combined summarized financial information eliminates all intercompany balances and transactions among Wabtec Netherlands and Westinghouse Air Brake Technologies Corporation as well as all equity in earnings from and investments in any subsidiary of Westinghouse Air Brake Technologies Corporation, other than Wabtec Netherlands, which we refer to below as the Non-Issuer and Non-Guarantor Subsidiaries. The summarized financial information is provided in accordance with the reporting requirements of Rule 13-01 under SEC Regulation S-X for the issuer and parent guarantor.37Summarized Statement of IncomeUnauditedIssuer and GuarantorIn millionsTwelve Months Ended December 31, 2022Net sales$437 Gross profit68 Net loss attributable to Wabtec shareholders(318)Summarized Balance SheetsUnauditedIssuer and GuarantorIn millionsDecember 31, 2022December 31, 2021Current assets$264 $217 Noncurrent assets$770 $770 Current liabilities$733 $479 Long-term debt$3,740 $4,044 Other non-current liabilities$128 $207 The following is a description of the transactions between the combined Westinghouse Air Brake Technologies Corp. and Wabtec Netherlands, with the subsidiaries of Westinghouse Air Brake Technologies Corp., other than Wabtec Netherlands, none of which are guarantors of the Euro Notes.UnauditedIssuer and GuarantorIn millionsTwelve Months Ended December 31, 2021Net sales to non-issuer and non-guarantor subsidiaries$33 Purchases from non-issuer and non-guarantor subsidiaries82 UnauditedIssuer and GuarantorIn millionsDecember 31, 2021Amount due from/(to) non-issuer and non-guarantor subsidiaries$(7,703)38Contractual Obligations and Off-Balance Sheet ArrangementsThe Company is obligated to make future payments under various contracts such as purchase, debt and lease agreements and has certain contingent commitments. The Company has grouped these contractual obligations and off-balance sheet arrangements into operating activities, financing activities, and investing activities in the same manner as they are classified in the Statement of Consolidated Cash Flows to provide a better understanding of the nature of the obligations and arrangements and to provide a basis for comparison to historical information. The table below provides a summary of contractual obligations and off-balance sheet arrangements as of December 31, 2022:In millionsTotal20232024-252026-272028+Operating activities: Purchase obligations (1)$168 $157 $10 $1 $— Operating leases (2)357619968129Pension and postretirement benefit payments (3)189 17 35 38 99 Interest payments (4)607 153 229 163 62 Financing activities: Long-term debt4,023 251 1,237 1,285 1,250 Dividends to shareholders (5)123 123 — — — Contingent consideration (6)154 105 49 — — Total$5,621 $867 $1,659 $1,555 $1,540 (1)Purchase obligations represent non-cancelable contractual obligations at December 31, 2022. In addition, the Company had approximately $1.7 billion of open purchase orders for which the related goods or services had not been received. Although open purchase orders are considered enforceable and legally binding, their terms generally allow us the option to cancel, reschedule and adjust our requirements based on our business needs prior to the delivery of goods or performance of services.(2)Operating leases represent multi-year obligations for rental of facilities and equipment. (3)Pension and postretirement benefit payments includes expected payments to participants out of plan assets and corporate assets. The benefit payments are based on actuarial estimates using current assumptions for discount rates, expected return on long-term assets and rate of compensation increases. The Company expects to contribute $2 million to pension plan investments in 2023. (4)Interest payments on the Senior Notes are based on interest rates in effect as of December 31, 2022 and are calculated on debt with maturities that extend to 2028. (5)Shareholder dividends are subject to approval by the Company’s Board of Directors, currently at an annual rate of approximately $123 million.(6)Contingent consideration represents the total remaining payable to General Electric (GE) resulting from the 2019 acquisition of GE Transportation. The timing of the cash payments to GE is directly related to the future timing of tax benefits received by the Company and could change. The above table does not reflect uncertain tax positions of $33 million, the timing of which are uncertain. Refer to Note 11 of the “Notes to Consolidated Financial Statements” included in Part II, Item 8 of this report for additional information on uncertain tax positions. Additionally, the Company arranges for certain types of bank guarantees and letters of credit, such as performance bonds, bid bonds and financial guarantees, that are issued by certain banks and insurance companies to support customer contracts. At December 31, 2022, the total value of these bank guarantees and letters of credit were $865 million and expire on various dates through 2039. Amounts include interest payments based on contractual terms and the Company’s current interest rate.Forward Looking StatementsWe believe that all statements other than statements of historical facts included in this report, including certain statements under “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may constitute forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. Although we believe that our assumptions made in connection with the forward-looking statements are reasonable, we cannot assure that our assumptions and expectations are correct.39These forward-looking statements are subject to various risks, uncertainties and assumptions about us, including, among other things:Economic and industry conditions•changes in general economic and/or industry specific conditions, including the impacts of tax and tariff programs, inflation, supply chain disruptions, foreign currency exchange, and industry consolidation;•prolonged unfavorable economic and industry conditions in the markets served by us, including North America, South America, Europe, Australia, Asia and Africa;•decline in demand for freight cars, locomotives, passenger transit cars, buses and related products and services;•reliance on major original equipment manufacturer customers;•original equipment manufacturers’ program delays;•demand for services in the freight and passenger rail industry;•demand for our products and services;•orders either being delayed, canceled, not returning to historical levels, or reduced or any combination of the foregoing;•consolidations in the rail industry;•continued outsourcing by our customers; •industry demand for faster and more efficient braking equipment;•fluctuations in interest rates and foreign currency exchange rates; •availability of credit; or•changes in market consensus as to what attributes are required for projects to be considered "green" or "sustainable" or negative perceptions regarding determinations in such regard with respect to our Green Finance Framework;Operating factors•supply disruptions;•technical difficulties;•changes in operating conditions and costs;•increases in raw material costs;•successful introduction of new products;•performance under material long-term contracts;•labor availability and relations;•the outcome of our existing or any future legal proceedings, including litigation involving our principal customers and any litigation with respect to environmental matters, asbestos-related matters, pension liabilities, warranties, product liabilities, competition and anti-trust matters or intellectual property claims;•completion and integration of acquisitions; •the development and use of new technology; or•cybersecurity and data protection risks;Competitive factors•the actions of competitors; or•the outcome of negotiations with partners, suppliers, customers or others;Political/governmental factors•political stability in relevant areas of the world, including the impacts of war and conflicts;•future regulation/deregulation of our customers and/or the rail industry;•levels of governmental funding on transit projects, including for some of our customers;40•political developments and laws and regulations, including those related to Positive Train Control; •federal and state income tax legislation; •sanctions imposed on countries and persons; or•the outcome of negotiations with governments;COVID-19 factors•the severity and duration of the pandemic;•deterioration of general economic conditions;•shutdown of one or more of our operating facilities;•supply chain and sourcing disruptions; •ability of our customers to pay timely for goods and services delivered;•health of our employees; •ability to retain and recruit talented employees; or •difficulty in obtaining debt or equity financing.Statements in this Form 10-K apply only as of the date on which such statements are made, and except as required by law, we undertake no obligation to update any statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.Critical Accounting EstimatesThe preparation of the financial statements in accordance with generally accepted accounting principles requires management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Areas of uncertainty that require judgments, estimates and assumptions include the accounting for allowance for doubtful accounts, inventories, business combinations, goodwill and other intangible assets, warranty reserves, income taxes, and revenue recognition. Management uses historical experience and all available information to make these judgments and estimates, and actual results may differ from those estimates and assumptions that are used to prepare the Company’s financial statements at any given time. Despite these inherent limitations, management believes that Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and the financial statements and related footnotes provide a meaningful and fair perspective of the Company. A summary of the Company’s significant accounting policies is included in Note 2 in the “Notes to Consolidated Financial Statements” included in Part II, Item 8 of this report. Management believes that the application of these policies on a consistent basis enables the Company to provide the users of the financial statements with useful and reliable information about the Company’s operating results and financial condition.Accounts Receivable and Allowance for Doubtful Accounts:Description The Company provides an allowance for doubtful accounts to cover anticipated losses on uncollectible accounts receivable.Judgments and Uncertainties The allowance for doubtful accounts receivable reflects our best estimate of expected losses inherent in our receivable portfolio determined on the basis of historical experience, relevant credit forecast information, changes to customer's solvency and other currently available evidence.Effect if Actual Results Differ From Assumptions If our estimates regarding the collectability of troubled accounts, and/or our actual losses within our receivable portfolio exceed our estimated losses, we may be exposed to the expense of increasing our allowance for doubtful accounts and loss of cash flows.Inventories:Description Inventories are stated at the lower of cost or net realizable value and are reviewed to ensure that an adequate provision is recognized for excess, slow moving and obsolete inventories, and net realizable value reserves.Judgments and Uncertainties Cost is determined primarily using the first-in, first-out (FIFO) method. Inventory costs include material, labor and overhead. The Company compares inventory components to prior year sales history, current backlog and anticipated future requirements. To the extent that inventory parts exceed estimated usage and demand, a reserve is recognized 41to reduce the carrying value of inventory. Also, specific reserves are established for known inventory obsolescence, a decline in market value, or loss of a customer with specific inventory.Effect if Actual Results Differ From Assumptions If the market value or demand for our products were to decrease due to changing market conditions, the Company could be at risk of incurring write-downs to adjust inventory value to a net realizable value lower than stated cost. If our estimates regarding sales and backlog requirements are inaccurate, we may be exposed to the expense of increasing our reserves for slow moving and obsolete inventory.Business Combinations:Description The Company accounts for business acquisitions in accordance with ASC 805, Business Combinations, which requires the purchase price of the acquired business to be allocated to tangible and intangible assets acquired and liabilities assumed based on the respective fair values. The amount of purchase price which is in excess of the fair values of assets acquired and liabilities assumed is recognized as goodwill. Judgments and Uncertainties Discounted cash flow models are used to estimate the fair values of acquired contract backlog, customer relationships, intellectual property intangibles and trade names, and below-market customer contract liabilities. The significant assumptions used to estimate the value of the intangible assets and below-market customer contract liabilities include revenue growth rates, projected profit margins, discount rates, royalty rates, customer attrition rates, revenue obsolescence rates and market participant profit margins. These significant assumptions are forward-looking and could be affected by future economic and market conditions.Effect if Actual Results Differ From Assumptions Different assumptions may result in materially different values for assets acquired and liabilities assumed, which may impact the Company's financial position and future results of operations, including potential future impairment charges.Goodwill and Indefinite-Lived Intangible Assets:Description Goodwill and indefinite-lived intangibles are required to be tested for impairment at least annually. The Company performs its annual impairment test during the fourth quarter and more frequently when indicators of impairment are present. The Company reviews goodwill for impairment at the reporting unit level. The Company has identified three reporting units for purposes of testing goodwill for impairment. Two reporting units exist within the Freight segment and the Transit segment is also a reporting unit. The evaluation of impairment involves comparing the current fair value of the business to the recorded value (including goodwill).Judgments and Uncertainties A number of significant assumptions and estimates are involved in the application of the impairment test, including the identification of macroeconomic conditions, industry and market considerations, cost factors, and overall financial performance. We also consider Wabtec-specific events and share price trends and making the assessment on whether each relevant factor will impact the impairment test positively or negatively and the magnitude of any such amount.Effect if Actual Results Differ From Assumptions Management considers historical experience and all available information at the time the fair values of its reporting units are estimated. However, actual amounts realized may differ from those used to evaluate the impairment of goodwill and indefinite lived intangible assets. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed to impairment losses that could be material to our results of operations.Warranty Reserves:Description The Company provides warranty reserves to cover expected costs from repairing or replacing products with durability, quality or workmanship issues occurring during established warranty periods.Judgments and Uncertainties In general, reserves are provided for as a percentage of sales, based on historical experience. In addition, specific reserves are established for known warranty issues and their estimable losses.Effect if Actual Results Differ From Assumptions If actual results are not consistent with the assumptions and judgments used to calculate our warranty liability, the Company may be exposed to the expense of increasing our reserves for warranty expense.Income Taxes:Description Wabtec records an estimated liability for income and other taxes based on what it determines will likely be paid in various tax jurisdictions in which it operates in accordance with ASC 740-10 Accounting for Income Taxes and Accounting for Uncertainty in Income Taxes.Judgments and Uncertainties The estimate of our tax obligations are uncertain because management must use judgment to estimate the exposures associated with our various filing positions, as well as realization of our deferred tax assets. ASC 740-10 establishes a recognition and measurement threshold to determine the amount of tax benefit that should be recognized related to uncertain tax positions.42Effect if Actual Results Differ From Assumptions Management uses its best judgment in the determination of these amounts. However, the liabilities ultimately realized and paid are dependent on various matters including the resolution of the tax audits in the various affected tax jurisdictions and may differ from the amounts recorded. An adjustment to the estimated liability would be recorded through income in the period in which new information changes the expected outcome of an uncertain tax position. A deferred tax valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized.Revenue Recognition:Description Revenue is recognized in accordance with ASC 606 Revenue from Contracts with Customers. The Company recognizes a portion of its revenues on long-term customer agreements involving the design and production of highly engineered products that require revenue to be recognized over time because these products have no alternative use without significant economic loss and the agreements contain an enforceable right to payment including a reasonable profit margin from the customer in the event of contract termination. Generally, the Company uses an input method for determining the amount of revenue, cost and gross margin to recognize over time for these customer agreements. The input method used for these agreements recognizes revenue based on our efforts to satisfy the performance obligation and includes costs of material and labor, both of which give an accurate representation of the progress made toward complete satisfaction of a particular performance obligation. The Company may also use the output method which recognizes revenue based on direct measurements of the value transferred to the customer.Judgments and Uncertainties Accounting for long-term customer agreements involves a judgmental process of estimating the total sales and costs for each contract, which results in the development of estimated profit margin percentages. Contract estimates related to long-term projects are based on various assumptions to project the outcome of future events that could span several years. These assumptions include cost of materials, labor availability and productivity, complexity of the work to be performed, and the performance of suppliers, customers and subcontractors that may be associated with the contract. Factors that influence these estimates include inflationary trends, foreign exchange rates, technical and schedule risk, internal and subcontractor performance trends, business volume assumptions, asset utilization, and anticipated labor agreements. Generally, pricing is defined in our contracts but may include an estimate of variable consideration when required by the terms of the individual customer contract. Types of variable consideration that the Company typically has include volume discounts, prompt payment discounts, price escalation clauses, liquidating damages, and performance bonuses. Effect if Actual Results Differ From Assumptions Should market conditions and customer demands dictate changes to our standard shipping terms, the Company may be impacted by longer than typical revenue recognition cycles. The development of expected contract costs and contract profit margin percentages involves procedures and personnel in all areas that provide financial or production information on the status of contracts. Due to the significance of judgments in the estimation process, it is likely that materially different revenue and cost amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. Changes in underlying assumptions/estimates, inflation or deflation, foreign currency exchange rates, supplier performance, or other circumstances may adversely or positively affect financial performance in future periods. Some of our contracts are expected to be completed in a loss position. Provisions are made currently for estimated losses on uncompleted contracts and are updated as necessary. Item 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKAll market risk sensitive instruments were entered into for non-trading purposes.Interest Rate RiskIn the ordinary course of business, Wabtec is exposed to risks that increases in interest rates may adversely affect funding costs associated with its available variable-rate debt facilities. At December 31, 2022, the Company's interest risk related to variable-rate debt is limited to the amounts borrowed under the multi-currency Revolving Credit Facility. At December 31, 2022 and 2021, the Company had no outstanding variable rate debt. Foreign Currency Exchange Rate RiskThe Company is exposed to certain risks associated with changes in foreign currency exchange rates to the extent our operations are conducted in currencies other than the U.S. dollar. To reduce the impact of changes in currency exchange rates, the Company has periodically entered into foreign currency forward contracts. Refer to “Financial Derivatives and Hedging Activities” in Notes 2, 17 and 20 of “Notes to Consolidated Financial Statements” included in Part II, Item 8 of this report for more information regarding foreign currency exchange risk and sales by geographic area.43
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion includes forward-looking statements. See ‘Disclaimer Regarding Forward-looking Statements’ for certain cautionary information regarding forward-looking statements and Part I, Item 1A Risk Factors for a list of factors that could cause actual results to differ materially from those predicted in those statements. This discussion includes references to non-GAAP financial measures as defined in the rules of the SEC. We present such non-GAAP financial measures, specifically, adjusted, constant currency and organic non-GAAP financial measures, as we believe such information is of interest to the investment community because it provides additional meaningful methods of evaluating certain aspects of the Company’s operating performance from period to period on a basis that may not be otherwise apparent under U.S. GAAP, and these provide a measure against which our businesses may be assessed in the future. Our methods of calculating these measures may differ from those used by other companies and therefore comparability may be limited. These financial measures should be viewed in addition to, not in lieu of, the consolidated financial statements for the year ended December 31, 2022. See ‘Non-GAAP Financial Measures’ below for further discussion of our adjusted, constant currency and organic non-GAAP financial measures. Executive Overview Market Conditions Typically, our business benefits from regulatory change, political risk or economic uncertainty. Insurance broking generally tracks the economy, but demand for both insurance broking and consulting services usually remains steady during times of uncertainty. We have some businesses, such as our health and benefits and administration businesses, which can be counter cyclical during the early period of a significant economic change. Within our insurance and brokerage business, due to the cyclical nature of the insurance market and the impact of other market conditions on insurance premiums, commission revenue may vary widely between accounting periods. A period of low or declining premium rates, generally known as a ‘soft’ or ‘softening’ market, generally leads to downward pressure on commission revenue and can have a material adverse impact on our revenue and operating margin. A ‘hard’ or ‘firming’ market, during which premium rates rise, generally has a favorable impact on our revenue and operating margin. Rates, however, vary by geography, industry and client segment. As a result, and due to the global and diverse nature of our business, we view rates in the aggregate. Overall, we are currently seeing a modest but definite increase in pricing in the market. Market conditions in the broking industry in which we operate are generally defined by factors such as the strength of the economies in the various geographic regions in which we serve around the world, insurance rate movements, and insurance and reinsurance buying patterns of our clients. The markets for our consulting, technology and solutions, and marketplace services are affected by economic, regulatory and legislative changes, technological developments, and increased competition from established and new competitors. We believe that the primary factors in selecting a human resources or risk management consulting firm include reputation, the ability to provide measurable increases to shareholder value and return on investment, global scale, quality of service and the ability to tailor services to clients’ unique needs. In that regard, we are focused on developing and implementing technology, data and analytic solutions for both internal operations and for maintaining industry standards and meeting client preferences. We have made such investments from time to time and may decide, based on perceived business needs, to make investments in the future that may be different from past practice or what we currently anticipate. With regard to the market for exchanges, we believe that clients base their decisions on a variety of factors that include the ability of the provider to deliver measurable cost savings for clients, a strong reputation for efficient execution and an innovative service delivery model and platform. Part of the employer-sponsored insurance market has matured and become more fragmented while other segments remain in the entry phase. As these market segments continue to evolve, we may experience growth in intervals, with periods of accelerated expansion balanced by periods of modest growth. In recent years, growth in the market for exchanges has slowed, and this trend may continue. From time to time, including but not limited to the period after the announcement of the proposed Aon plc (‘Aon’) combination through the period that has followed the termination of the proposed combination, we have lost (and may in the future continue to lose) colleagues who manage substantial client relationships or possess substantial experience or expertise; when we lose colleagues such as those, it often results in such colleagues competing against us. Further, the full impact of this competition may be delayed due to the timing of restrictive covenants or client renewals. We believe that this dynamic, which was most pronounced in our Risk & 44 Broking segment during 2021, has caused the segment’s growth rate for 2022 to be meaningfully slower than other competitors. This dynamic may be difficult to predict, given that the adverse impact in future periods is more significant than in the periods in which employees departed. It is possible that growth could be different than expected and our results of operations could be significantly and adversely impacted by this factor going into 2023. See Part I, Item 1A Risk Factors in this Annual Report on Form 10-K for discussions of risks that may affect our ability to compete. Outlook Following Russia Divestiture In the third quarter of 2022, we completed the transfer of ownership of our Russian subsidiaries to local management and, given current conditions, do not anticipate resuming operations in Russia within the foreseeable future. The Russian entities were primarily within our Risk & Broking segment. We have estimated that the annualized run-rate impact from the divestiture of our Russian operations is approximately $120 million of revenue. Additionally, the Russian business was highly profitable, with operating margins in excess of double the enterprise-level margins. Because we did not receive significant proceeds in connection with the divestiture with which to reinvest in the business, the lost profits will adversely impact earnings, margins and cash flow. For additional information about the risks relating to lost profits following the divestiture of our Russian subsidiaries see Part I, Item 1A Risk Factors – ‘Our business, financial condition, results of operations, and long-term goals may continue to be adversely affected, possibly materially, by negative impacts on the global economy and capital markets resulting from the war between Russia and Ukraine or any other geopolitical tensions’. Transformation Program In the fourth quarter of 2021, we initiated a three-year ‘Transformation program’ designed to enhance operations, optimize technology and align our real estate footprint to our new ways of working. During the third quarter of 2022, we revised the expected costs and savings under the program and we now expect the program to generate annual cost savings in excess of $360 million by the end of 2024. The program is expected to incur cumulative costs of $630 million and capital expenditures of approximately $270 million, for a total investment of $900 million. The main categories of charges will be in the following four areas: •Real estate rationalization — includes costs to align the real estate footprint to our new ways of working (hybrid work) and includes breakage fees and the impairment of right-of-use assets and other related leasehold assets. •Technology modernization — these charges are incurred in moving to common platforms and technologies, including migrating certain platforms and applications to the cloud. This category will include the impairment of technology assets that are duplicative or no longer revenue-producing, as well as costs for technology investments that do not qualify for capitalization. •Process optimization — these costs will be incurred in the right-shoring strategy and automation of our operations, which will include optimizing resource deployment and appropriate colleague alignment. These costs will include process and organizational design costs, severance and separation-related costs and temporary retention costs. •Other — other costs not included above including fees for professional services, other contract terminations not related to the above categories and supplier migration costs. Certain costs under the Transformation program are accounted for under ASC 420, Exit or Disposal Cost Obligation, and are included as restructuring costs in the consolidated statements of comprehensive income. For the years ended December 31, 2022 and 2021, restructuring charges under our Transformation program totaled $99 million and $26 million, respectively. Other costs incurred under the Transformation program are included in transaction and transformation, net and were $136 million for the year ended December 31, 2022. From the actions taken during 2022, we have identified an additional $129 million of annualized run-rate savings during the year due to newly-realized opportunities and incremental sources of value, and $149 million of cumulative annualized run-rate savings identified to date since the inception of the program, which savings overall are primarily attributable to the reduction of real estate and technology costs, as well as process optimization. The benefits from the program began to be recognized during 2022. For a discussion of some of the risks associated with the Transformation program, please see Part I, Item 1A Risk Factors - ‘We may not be able to fully realize the anticipated benefits of our growth strategy’ and other Risk Factors in this Annual Report on Form 10-K. 45 Financial Statement Overview For management’s discussion of our results of operations for the year ended December 31, 2021 in comparison with the year ended December 31, 2020, please see our Annual Report on Form 10-K filed with the SEC on February 24, 2022. The tables below set forth our summarized consolidated statements of comprehensive income and data as a percentage of revenue for the periods indicated. Consolidated Statements of Comprehensive Income ($ in millions, except per share data) Years ended December 31, 2022 2021 Revenue $ 8,866 100 % $ 8,998 100 % Costs of providing services Salaries and benefits 5,065 57 % 5,253 58 % Other operating expenses 1,776 20 % 1,673 19 % Depreciation 255 3 % 281 3 % Amortization 312 4 % 369 4 % Restructuring costs 99 1 % 26 — % Transaction and transformation, net 181 2 % (806 ) (9 )% Total costs of providing services 7,688 6,796 Income from operations 1,178 13 % 2,202 24 % Interest expense (208 ) (2 )% (211 ) (2 )% Other income, net 288 3 % 701 8 % INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 1,258 14 % 2,692 30 % Provision for income taxes (194 ) (2 )% (536 ) (6 )% INCOME FROM CONTINUING OPERATIONS 1,064 12 % 2,156 24 % (LOSS)/INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX (40 ) — % 2,080 23 % Income attributable to non-controlling interests (15 ) — % (14 ) — % NET INCOME ATTRIBUTABLE TO WTW $ 1,009 11 % $ 4,222 47 % Diluted earnings per share from continuing operations $ 9.34 $ 16.63 Consolidated Revenue (Continuing Operations) We derive the majority of our revenue from commissions from our brokerage services and fees for consulting and administration services. No single client represented a significant concentration of our consolidated revenue for any of our three most recent fiscal years. The following table details our top five markets based on percentage of consolidated revenue (in U.S. dollars) from the countries where work was performed for the year ended December 31, 2022. These figures do not represent the currency of the related revenue, which is presented in the next table. Geographic Region % of Revenue United States 54 % United Kingdom 18 % France 4 % Canada 3 % Germany 3 % 46 The table below details the approximate percentage of our revenue and expenses from continuing operations by transactional currency for the year ended December 31, 2022. Transactional Currency Revenue Expenses (i) U.S. dollars 60 % 55 % Pounds sterling 11 % 17 % Euro 14 % 12 % Other currencies 15 % 16 % (i)These percentages exclude certain expenses for significant items which will not be settled in cash, or which we believe to be items that are not core to our current or future operations. These items include amortization of intangible assets and transaction and transformation, net. The following table sets forth the total revenue for the years ended December 31, 2022 and 2021 and the components of the change in total revenue for the year ended December 31, 2022, as compared to the prior year. The components of the revenue change may not add due to rounding. Components of Revenue Change As Less: Constant Less: Years Ended December 31, Reported Currency Currency Acquisitions/ Organic 2022 2021 Change Impact Change Divestitures Change ($ in millions) Revenue $ 8,866 $ 8,998 (1)% (4)% 2% (1)% 4% Revenue for the year ended December 31, 2022 was $8.9 billion, compared to $9.0 billion for the year ended December 31, 2021, a decrease of $132 million, or 1%, on an as-reported basis. This decrease was primarily driven by unfavorable foreign currency exchange movement. Adjusting for the impact of foreign currency and acquisitions and disposals, our organic revenue growth was 4% for the year ended December 31, 2022. The increase in organic revenue was driven by both segments. Our revenue can be materially impacted by changes in currency conversions, which can fluctuate significantly over the course of a calendar year. For the year ended December 31, 2022, currency translation decreased our consolidated revenue by $335 million. The primary currencies driving these changes were the Euro and Pound sterling. Definitions of Constant Currency Change and Organic Change are included in the section entitled ‘Non-GAAP Financial Measures’ elsewhere within this Form 10-K. Segment Revenue For further information on our segment reorganization and a full description of our businesses, please see Part I, Item 1, ‘Business – Segment Reorganization’ elsewhere within this Annual Report on Form 10-K. Due to the reorganization of our segments in 2022, prior-year segment information has been retrospectively adjusted to conform to the current-year presentation. Segment revenue excludes amounts that were directly incurred on behalf of our clients and reimbursed by them (reimbursed expenses); however, these amounts are included in consolidated revenue, as permitted by applicable accounting standards and SEC rules. See Note 5 – Segment Information within Item 8 of this Annual Report on Form 10-K for more information about how our segment revenue is calculated and a reconciliation to our GAAP results. The Company experiences seasonal fluctuations in its revenue. Revenue is typically higher during the Company’s first and fourth quarters due primarily to the timing of broking-related activities. For all tables presented below, the components of the revenue change may not add due to rounding. Health, Wealth & Career (‘HWC’) The HWC segment provides an array of advice, broking, solutions and technology for employee benefit plans, institutional investors, compensation and career programs, and the employee experience overall. HWC is the larger of the two segments of the Company, generating approximately 60% of our segment revenue for the year ended December 31, 2022. Addressing four key areas, Health, Wealth, Career and Benefits Delivery & Outsourcing, the segment is focused on addressing our clients’ people and risk needs to help them succeed in a global marketplace. 47 The following table sets forth HWC segment revenue for the years ended December 31, 2022 and 2021, and the components of the change in revenue for the year ended December 31, 2022 from the year ended December 31, 2021. Components of Revenue Change As Less: Constant Less: Years Ended December 31, Reported Currency Currency Acquisitions/ Organic 2022 2021 Change Impact Change Divestitures Change ($ in millions) Segment revenue $ 5,287 $ 5,268 —% (3)% 4% —% 3% HWC segment revenue for both the years ended December 31, 2022 and 2021 was $5.3 billion. Organic growth was led by the Benefits Delivery & Outsourcing business driven by Medicare Advantage sales and its expanded client base. The Health business’ revenue grew from improved retention and expansion of our client portfolio. Career also contributed strong growth, driven by demand for our advisory services, survey offerings, compensation benchmarking products and project activity. Year-over-year organic growth in our Wealth businesses was flat, with increases from higher project activity across all regions, primarily related to financial market volatility and higher levels of regulatory work in Great Britain, offset by declines in our Investments business due to headwinds from the negative impact of capital market performance and performance fees received in the prior year. The following table sets forth HWC segment revenue for the years ended December 31, 2021 and 2020, and the components of the change in revenue for the year ended December 31, 2021 from the year ended December 31, 2020. Components of Revenue Change As Less: Constant Less: Years Ended December 31, Reported Currency Currency Acquisitions/ Organic 2021 2020 Change Impact Change Divestitures Change ($ in millions) Segment revenue $ 5,268 $ 4,895 8% 2% 6% —% 6% HWC segment revenue for the years ended December 31, 2021 and 2020 was $5.3 billion and $4.9 billion, respectively. On both an as-reported and organic basis, Benefits Delivery & Administration was led by Individual Marketplace, primarily by TRANZACT, which had strong growth in Medicare Advantage sales. Career revenue growth was driven by strong market demand for rewards advisory work and talent and compensation products. Wealth revenue increased with notable growth in Europe, driven by funding advice and Guaranteed Minimum Pension equalization work, along with advisory-related fees in our Investments business. Health revenue grew from increased consulting work and a gain recorded in connection with a book-of-business settlement in North America, alongside continued expansion of our local portfolios and global benefits management appointments outside of North America. Benefits Delivery & Outsourcing revenue increased primarily due to new project and client activity in Europe and in North America, driven by an expanded client base and project work stemming from temporary federal policy changes affecting group healthcare plans. Risk & Broking (‘R&B’) The R&B segment provides a broad range of risk advice, insurance brokerage and consulting services to clients worldwide ranging from small businesses to multinational corporations. R&B generated approximately 40% of our segment revenue for the year ended December 31, 2022. The segment comprises two primary businesses - Corporate Risk & Broking and Insurance Consulting and Technology. The following table sets forth R&B segment revenue for the years ended December 31, 2022 and 2021, and the components of the change in revenue for the year ended December 31, 2022 from the year ended December 31, 2021. Components of Revenue Change As Less: Constant Less: Years Ended December 31, Reported Currency Currency Acquisitions/ Organic 2022 2021 Change Impact Change Divestitures Change ($ in millions) Segment revenue $ 3,460 $ 3,564 (3)% (5)% 2% (2)% 3% R&B segment revenue for the years ended December 31, 2022 and 2021 was $3.5 billion and $3.6 billion, respectively. This decrease on an as-reported basis was primarily driven by unfavorable foreign currency exchange movement. On an organic basis, CRB’s revenue grew across all regions, driven by our global lines of business, primarily Aerospace and Construction. ICT’s organic revenue grew from increased software sales and advisory work. 48 The following table sets forth R&B segment revenue for the years ended December 31, 2021 and 2020, and the components of the change in revenue for the year ended December 31, 2021 from the year ended December 31, 2020. Components of Revenue Change As Less: Constant Less: Years Ended December 31, Reported Currency Currency Acquisitions/ Organic 2021 2020 Change Impact Change Divestitures Change ($ in millions) Segment revenue $ 3,564 $ 3,316 7% 2% 5% —% 5% R&B segment revenue for the years ended December 31, 2021 and 2020 was $3.6 billion and $3.3 billion, respectively. On both an as-reported and organic basis, CRB North America led the segment with gains recorded in connection with book-of-business sales and settlements alongside strong renewals, primarily in FINEX, Marine, Aerospace and Construction. CRB International revenue increased with new business generation, primarily in the FINEX and Construction insurance lines. Advisory-related fees led the revenue growth in Insurance Consulting and Technology. CRB Revenue in Europe was down due to challenges related to senior staff departures. Costs of Providing Services (Continuing Operations) Total costs of providing services for the year ended December 31, 2022 were $7.7 billion, compared to $6.8 billion for the year ended December 31, 2021, an increase of $892 million, or 13%. This increase was primarily due to the $1 billion income receipt related to the termination of our then-proposed Aon transaction, which was received during the third quarter of 2021 and partially offset total costs in that year. See the following discussion for further details. Salaries and Benefits Salaries and benefits for the year ended December 31, 2022 were $5.1 billion, compared to $5.3 billion for the year ended December 31, 2021, a decrease of $188 million, or 4%. The decrease in the current year is primarily due to lower salary expense related to our non-U.S. workforce resulting from favorable foreign currency exchange movements and lower discretionary and incentive costs. Overall, currency translation decreased our salaries and benefits expense by $234 million during 2022. Salaries and benefits, as a percentage of revenue, represented 57% and 58% for the years ended December 31, 2022 and 2021, respectively. Other Operating Expenses Other operating expenses include occupancy, legal, marketing, licenses, royalties, supplies, technology, printing and telephone costs, as well as insurance, including premiums on excess insurance and losses on professional liability claims, travel by colleagues, publications, professional subscriptions and development, recruitment, other professional fees and irrecoverable value-added and sales taxes. Additionally, other operating expenses included costs historically allocated to our Willis Re business which are partially offset by fees under a cost reimbursement Transition Services Agreement (‘TSA’; see Note 3 — Acquisitions and Divestitures within Item 8 of this Annual Report on Form 10-K) with Gallagher. Other operating expenses for the year ended December 31, 2022 were $1.8 billion, compared to $1.7 billion for the year ended December 31 2021, an increase of $103 million, or 6%. This increase was primarily due to asset impairments associated with our Russian divestiture. These impairments were mostly accounts receivables derived from Russian insurance contracts placed by U.K. brokers in the London market (see Note 3 — Acquisitions and Divestitures within Item 8 of this Annual Report on Form 10-K). Additionally, costs increased due to higher travel and entertainment costs as post-pandemic activity increased, local office expenses, professional services and business insurance costs. These costs were partially offset by lower non-income-related tax expense and occupancy costs which are the result of actions taken in our restructuring program. Depreciation Depreciation represents the expense incurred over the useful lives of our tangible fixed assets and internally-developed software. Depreciation for the year ended December 31, 2022 was $255 million, compared to $281 million for the year ended December 31, 2021, a decrease of $26 million, or 9%. The year-over-year decrease was primarily due to a lower depreciable base of assets resulting from business disposals over the last two years, a lower dollar value of assets placed in service during 2021 and favorable foreign currency exchange movements. 49 Amortization Amortization represents the amortization of acquired intangible assets, including acquired internally-developed software. Amortization for the year ended December 31, 2022 was $312 million, compared to $369 million for the year ended December 31, 2021, a decrease of $57 million, or 15%. Our intangible amortization is generally more heavily weighted to the initial years of the useful lives of the related intangibles, and therefore amortization related to intangible assets will continue to decrease over time. Restructuring Costs Restructuring costs for the years ended December 31, 2022 and 2021 were $99 million and $26 million, respectively. Restructuring costs in the current year primarily related to the real estate rationalization and technology modernization components of the Transformation program (see Transformation Program within this section and Note 6 — Restructuring Costs within Item 8 of this Annual Report on Form 10-K). Restructuring costs in the prior year primarily related to the real estate rationalization component of the Transformation program. Transaction and Transformation, Net Transaction and transformation, net for the year ended December 31, 2022 was $181 million of expenses, compared to income of $806 million for the year ended December 31, 2021. Transaction and transformation expenses for the current year were comprised of costs related to our Transformation program, primarily compensation costs and consulting fees, as well as legal fees and other transaction-related costs. The income for the prior year consisted mostly of the $1 billion income receipt related to the termination of our then-proposed combination with Aon, and was partially offset by legal and other professional fees related to this terminated transaction. Income from Operations Income from operations for the year ended December 31, 2022 was $1.2 billion, compared to $2.2 billion for the year ended December 31, 2021, a decrease of $1.0 billion. The decrease was primarily due to the prior-year $1 billion income receipt from the termination of the then-proposed Aon transaction, which resulted in lower total costs. Interest Expense Interest expense for the years ended December 31, 2022 and 2021 was $208 million and $211 million, respectively. Interest expense, which arose primarily from our senior notes, decreased by $3 million for the year ended December 31, 2022, which was primarily the result of lower average levels of indebtedness in the current year. Other Income, Net Other income, net includes gains and losses on disposals of operations, pension credits or expenses that are not attributable to service expense, interest in earnings of associates, foreign exchange gains and losses and other miscellaneous non-operating income and costs. Other income, net for the year ended December 31, 2022 was $288 million, compared to $701 million for the year ended December 31, 2021, a decrease of $413 million. Other income, net decreased primarily due to the prior year including the net gain on disposal of our Miller business (see Note 3 — Acquisitions and Divestitures within Item 8 of this Annual Report on Form 10-K). Provision for Income Taxes Provision for income taxes on continuing operations for the year ended December 31, 2022 was $194 million, compared to $536 million for the year ended December 31, 2021. The effective tax rates for the years ended December 31, 2022 and 2021 were 15.4% and 19.9%, respectively. These effective tax rates are calculated using extended values from our consolidated statements of comprehensive income and are therefore more precise tax rates than can be calculated from rounded values. The current-year effective tax rate includes a $34 million tax benefit associated with amending the Company’s U.S. federal income tax returns for tax years 2019 and 2020, primarily related to the reduction of Base Erosion and Anti Abuse Tax (‘BEAT’). The prior-year effective tax rate includes a $250 million estimated tax expense related to the income receipt associated with the termination of our then-proposed combination with Aon, as well as a $40 million tax expense related to the remeasurement of deferred tax assets and liabilities associated with an increase in the U.K. tax rate from 19% to 25%. 50 (Loss)/Income from Discontinued Operations, Net of Tax The following table presents selected financial information as it relates to income from discontinued operations, net of tax: Years ended December 31, 2022 2021 Revenue from discontinued operations $ 48 $ 721 Costs of providing services Salaries and benefits 14 350 Other operating expenses 10 59 Amortization — 2 Transaction and transformation, net — 33 Total costs of providing services 24 444 Other income, net 5 2 Income from discontinued operations before income taxes 29 279 (Loss)/gain on disposal of Willis Re (65 ) 2,300 Benefit from/(provision for) income tax expense 1 (500 ) Net income (payable to)/receivable from Gallagher on Deferred Closing (5 ) 1 (Loss)/income from discontinued operations, net of tax $ (40 ) $ 2,080 (Loss)/income from discontinued operations, net of tax for the years ended December 31, 2022 and 2021 was a loss of $40 million and income of $2.1 billion, respectively. The operations of our Willis Re business were reclassified to discontinued operations upon our entering into an agreement to sell the business during the third quarter of 2021 (see Note 3 - Acquisitions and Divestitures within Item 8 of this Annual Report on Form 10-K). Gains and losses from discontinued operations in the current year are primarily attributable to the adjustments to the gain on disposal resulting from finalizing the value of the net assets transferred and the operations of the deferred closing entities and run-off activity associated with the divestiture. Net Income Attributable to WTW Net income attributable to WTW for the year ended December 31, 2022 was $1.0 billion, compared to $4.2 billion for the year ended December 31, 2021, a decrease of $3.2 billion, or 76%. This decrease was primarily due to lower net income from the discontinued operations of our Willis Re business and the prior-year $1 billion income receipt related to the termination of our then-proposed combination with Aon. Liquidity and Capital Resources Executive Summary Our principal sources of liquidity are funds generated by operating activities, available cash and cash equivalents and amounts available under our revolving credit facilities and any new debt offerings. These sources of liquidity will fund our short-term and long-term obligations at December 31, 2022. Our most significant long-term obligations include mandatory debt and related interest, operating leases and pension obligations and contributions to our qualified pension plans. There has been significant volatility in financial markets, including occasional declines in equity markets, inflation and changes in interest rates and reduced liquidity on a global basis. Specific to WTW, over the past few years, the COVID-19 pandemic had an initial negative impact on discretionary work we perform for our clients, but we subsequently saw increased demand for these services begin to return in the second quarter of 2021 and continue during 2022. Although reduced in 2020 and 2021, spending on travel and associated expenses has increased in 2022 following the return to office for many companies which has increased in-person interactions. Based on our current balance sheet and cash flows, current market conditions and information available to us at this time, we believe that WTW has access to sufficient liquidity, which includes all of the borrowing capacity available to draw against our $1.5 billion revolving credit facility, to meet our cash needs for the next twelve months, including investments in the business for growth, scheduled debt repayments, share repurchases and dividend payments. During the year ended December 31, 2022, we completed an offering of $750 million aggregate principal amount of 4.650% senior notes due 2027, using the proceeds in part to repay in full our €540 million ($582 million on the date of repayment) aggregate principal amount of 2.125% Senior Notes due 2022 ($594 million including accrued interest), which were to mature during the second quarter of 2022. Additionally, during 2022, our board of directors approved a $1.0 billion increase to the existing share repurchase program, and during the year ended December 31, 2022 we repurchased $3.5 billion of shares, with remaining authorization to repurchase an additional $1.3 billion. 51 From time to time, we will consider whether to repurchase shares based on many factors, including market and economic conditions, applicable legal requirements and other business considerations. The share repurchase program has no termination date and may be suspended or discontinued at any time. Before its disposal last year, Willis Re’s operating cash flows approximated its pre-tax income and any adjustments for working capital movements (see Note 3 — Acquisitions and Divestitures in Item 8 within this Annual Report on Form 10-K). Certain costs historically allocated to the Willis Re business are included in continuing operations and were retained following the disposal, but are being partially offset by reimbursements through the TSA. Costs incurred to service the TSA are expected to be reduced as part of the Company’s Transformation program as quickly as possible when the services are no longer required by Gallagher. Events that could change the historical cash flow dynamics discussed above include significant changes in operating results, potential future acquisitions or divestitures, material changes in geographic sources of cash, unexpected adverse impacts from litigation or regulatory matters, or future pension funding during periods of severe downturn in the capital markets. Distributable Profits - We are required under Irish law to have available ‘distributable profits’ to make share repurchases or pay dividends to shareholders. Distributable profits are created through the earnings of the Irish parent company and, among other methods, through intercompany dividends or a reduction in share capital approved by the High Court of Ireland. Distributable profits are not linked to a U.S. GAAP reported amount (e.g. retained earnings). At WTW's Annual General Meeting on June 8, 2022, its shareholders voted in favor of a proposed capital reduction. In accordance with Part 3 of the Irish Companies Act 2014 the Parent Company submitted an application to the High Court of Ireland to reduce its share premium account. On July 19, 2022, the High Court of Ireland approved a reduction of the share premium account of the Parent Company of approximately $9.5 billion, with the resulting balance being treated as realized profits of the Parent Company. The High Court of Ireland's order was registered with the Irish Companies Registration Office and became effective on July 21, 2022. Tax considerations - The Company recognizes deferred tax balances related to the undistributed earnings of subsidiaries when it expects that it will recover those undistributed earnings in a taxable manner, such as through receipt of dividends or sale of the investments. We continue to have certain subsidiaries whose earnings have not been deemed permanently reinvested, for which we have been accruing estimates of the tax effects of such repatriation. Excluding these certain subsidiaries, we continue to assert that the historical cumulative earnings for the remainder of our subsidiaries have been reinvested indefinitely and therefore do not provide deferred taxes on these amounts. If future events, including material changes in estimates of cash, working capital, long-term investment requirements or additional legislation, necessitate that these earnings be distributed, an additional provision for income and foreign withholding taxes, net of credits, may be necessary. Other potential sources of cash may be through the settlement of intercompany loans or return of capital distributions in a tax-efficient manner. Cash and Cash Equivalents Our cash and cash equivalents at December 31, 2022 and 2021 totaled $1.3 billion and $4.5 billion, respectively. The decrease in cash from December 31, 2021 to December 31, 2022 was due primarily to $3.5 billion of share repurchases. Additionally, we had all of the borrowing capacity available to draw against our $1.5 billion revolving credit facility at December 31, 2022. Included within cash and cash equivalents at December 31, 2022 and 2021 are amounts held for regulatory capital adequacy requirements, including $99 million and $120 million, respectively, held within our regulated U.K. entities. 52 Summarized Consolidated Cash Flows The following table presents the summarized consolidated cash flow information for the years ended: Years ended December 31, 2022 2021 (in millions) Net cash from/(used in): Operating activities $ 812 $ 2,061 Investing activities (173 ) 2,570 Financing activities (3,445 ) (3,114 ) (DECREASE)/INCREASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH (2,806 ) 1,517 Effect of exchange rate changes on cash, cash equivalents and restricted cash (164 ) (127 ) CASH, CASH EQUIVALENTS AND RESTRICTED CASH, BEGINNING OF YEAR (i) 7,691 6,301 CASH, CASH EQUIVALENTS AND RESTRICTED CASH, END OF YEAR (i) $ 4,721 $ 7,691 (i)The amounts of the cash, cash equivalents and restricted cash, their respective classification on the consolidated balance sheets, as well as their respective portions of the increase or decrease in cash, cash equivalents and restricted cash for each of the periods presented, have been included in Note 21 — Supplemental Disclosures of Cash Flow Information within Item 8 of this Annual Report on Form 10-K. Cash Flows From Operating Activities Cash flows from operating activities were $812 million for 2022, compared to $2.1 billion for 2021. The $812 million net cash from operating activities for 2022 included net income of $1.0 billion, and $676 million of favorable non-cash adjustments, partially offset by unfavorable changes in operating assets and liabilities of $888 million. The $676 million of favorable non-cash adjustments primarily includes depreciation, amortization and non-cash lease expense. The decrease in cash flows from operating activities as compared to the prior year was due primarily to the prior-year income receipt of $1 billion related to the termination of the then-proposed Aon transaction, 2022 tax payments related to this income receipt, and the elimination of Willis Re cash generation following the divestiture. Cash flows from operating activities of $2.1 billion for 2021 included net income of $4.2 billion, partially offset by $1.7 billion of unfavorable non-cash adjustments and by unfavorable changes in operating assets and liabilities of $449 million. The $1.7 billion of unfavorable non-cash adjustments primarily includes the net gains on sales of operations, depreciation, amortization and non-cash lease expense. The cash flows from operating activities for 2021 mostly included the $1 billion of income receipt related to the termination of the proposed Aon transaction, partially offset by $383 million in tax payments primarily related to the disposal of Willis Re and the income receipt of the termination payment, net legal settlement payments of $185 million and $250 million of increased bonus and benefit-related payments made during the year ended December 31, 2021. Cash Flows (Used In)/From Investing Activities Cash flows used in investing activities for the year ended December 31, 2022 were $173 million compared to cash flows from investing activities of $2.6 billion for the year ended December 31, 2021. The cash flows used in investing activities for the year ended December 31, 2022 consisted of capital expenditures and capitalized software additions of $204 million and net cash outflows for acquisitions and divestitures of $169 million, partially offset by sales of investments of $200 million. Cash flows from investing activities for the year ended December 31, 2021 were $2.6 billion, which primarily included the proceeds from the sale of Willis Re of $3.3 billion and Miller of $696 million and other smaller disposals, partially offset by cash and fiduciary funds transferred on disposal of $1.0 billion, purchases of investments of $200 million, capital expenditures and capitalized software additions of $201 million and net cash paid for acquisitions of $47 million. Cash Flows Used In Financing Activities Cash flows used in financing activities for the year ended December 31, 2022 were $3.4 billion. The significant financing activities included share repurchases of $3.5 billion, debt repayments of $585 million and dividend payments of $369 million, partially offset by $750 million of net proceeds from issuance of debt and $354 million of net proceeds from fiduciary funds held for clients. Cash flows used in financing activities for the year ended December 31, 2021 were $3.1 billion. The significant financing activities included share repurchases of $1.6 billion, debt repayments of $1.0 billion and dividend payments of $374 million. 53 Indebtedness Total debt, total equity, and the capitalization ratio at December 31, 2022 and December 31, 2021 were as follows: December 31, 2022 2021 (in millions) Long-term debt $ 4,471 $ 3,974 Current debt 250 613 Total debt $ 4,721 $ 4,587 Total WTW shareholders’ equity $ 10,016 $ 13,260 Capitalization ratio 32.0 % 25.7 % The capitalization ratio increased from December 31, 2021 primarily due to $3.5 billion of share repurchases during the year ended December 31, 2022. At December 31, 2022, our mandatory debt repayments over the next twelve months include $250 million outstanding on our 4.625% senior notes due 2023. For more information regarding our current and long-term debt, please see ‘Supplemental Guarantor Financial Information’ elsewhere within this Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations. At December 31, 2022 and 2021, we were in compliance with all financial covenants. Fiduciary Funds As an intermediary, we hold funds, generally in a fiduciary capacity, for the account of third parties, typically as the result of premiums received from clients that are in transit to insurers and claims due to clients that are in transit from insurers. We also hold funds for clients of our benefits account businesses. These fiduciary funds are included in fiduciary assets on our consolidated balance sheets. We present the equal and corresponding fiduciary liabilities related to these fiduciary funds representing amounts or claims due to our clients or premiums due on their behalf to insurers on our consolidated balance sheets. Fiduciary funds are generally required to be kept in regulated bank accounts subject to guidelines which emphasize capital preservation and liquidity; such funds are not available to service the Company’s debt or for other corporate purposes. Notwithstanding the legal relationships with clients and insurers, the Company is entitled to retain investment income earned on certain of these fiduciary funds in accordance with industry custom and practice and, in some cases, as supported by agreements with insureds. At December 31, 2022 and 2021, we had fiduciary funds of $3.6 billion and $3.4 billion, respectively, of which $945 million and $719 million, respectively, are attributable to our Willis Re business. Share Repurchase Program The Company is authorized to repurchase shares, by way of redemption or otherwise, and will consider whether to do so from time to time, based on many factors, including market conditions. There are no expiration dates for our repurchase plans or programs. On July 26, 2021, the board of directors approved a $1.0 billion increase to the existing share repurchase program, which was previously at $500 million. Additionally, on September 16, 2021, the board of directors approved a $4.0 billion increase to the existing share repurchase program, and on May 25, 2022, approved a $1.0 billion increase to the existing share repurchase program. These increases brought the total approved authorization to $6.5 billion. See Part II, Item 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities in this Annual Report on Form 10-K for further information regarding the Company’s share repurchase program. At December 31, 2022, approximately $1.3 billion remained on the current repurchase authority. The maximum number of shares that could be repurchased based on the closing price of our ordinary shares on December 31, 2022 of $244.58 was 5,489,619. 54 The following table presents specified information about the Company’s repurchases of ordinary shares for the year ended December 31, 2022: Year endedDecember 31, 2022 Shares repurchased 15,729,085 Average price per share $224.42 Aggregate repurchase cost (excluding broker costs) $3.5 billion Dividends Total cash dividends of $369 million were paid during the year ended December 31, 2022. In February 2023, the board of directors approved a quarterly cash dividend of $0.84 per share ($3.36 per share annualized rate), which will be paid on or around April 17, 2023 to shareholders of record as of March 31, 2023. Capital Commitments The Company’s capital expenditures for fixed assets and software for internal use were $138 million for the year ended December 31, 2022. Capital expenditures for fixed assets and software for internal use, which include expenditures under our Transformation program, are expected to be in the range of $225 million to $250 million for the year ended December 31, 2023. We expect cash from operations to adequately provide for these cash needs. Supplemental Guarantor Financial Information As of December 31, 2022, WTW has issued the following debt securities (the ‘notes’): a)Willis North America Inc. (‘Willis North America’) has approximately $3.7 billion senior notes outstanding, of which $650 million were issued on May 16, 2017, $1.0 billion were issued on September 10, 2018, $1.0 billion were issued on September 10, 2019, $275 million were issued on May 29, 2020, and $750 million were issued on May 19, 2022; and b)Trinity Acquisition plc has approximately $1.1 billion senior notes outstanding, of which $525 million were issued on August 15, 2013 and $550 million were issued on March 22, 2016, and a $1.5 billion revolving credit facility, on which no balance was outstanding at December 31, 2022. The following table presents a summary of the entities that issue each note and those wholly-owned subsidiaries of the Company that guarantee each respective note on a joint and several basis as of December 31, 2022. These subsidiaries are all consolidated by Willis Towers Watson plc (the ‘parent company’) and together with the parent company comprise the ‘Obligor group’. Entity Trinity Acquisition plc Notes Willis North America Inc. Notes Willis Towers Watson plc Guarantor Guarantor Trinity Acquisition plc Issuer Guarantor Willis North America Inc. Guarantor Issuer Willis Netherlands Holdings B.V. Guarantor Guarantor Willis Investment UK Holdings Limited Guarantor Guarantor TA I Limited Guarantor Guarantor Willis Group Limited Guarantor Guarantor Willis Towers Watson Sub Holdings Unlimited Company Guarantor Guarantor Willis Towers Watson UK Holdings Limited Guarantor Guarantor The notes issued by Willis North America and Trinity Acquisition plc: •rank equally with all of the issuer’s existing and future unsubordinated and unsecured debt; •rank equally with the issuer’s guarantee of all of the existing senior debt of the Company and the other guarantors, including any debt under the Revolving Credit Facility; •are senior in right of payment to all of the issuer’s future subordinated debt; and •are effectively subordinated to all of the issuer’s secured debt to the extent of the value of the assets securing such debt. All other subsidiaries of the parent company are non-guarantor subsidiaries (‘the non-guarantor subsidiaries’). 55 Each member of the Obligor group has only a stockholder’s claim on the assets of the non-guarantor subsidiaries. This stockholder’s claim is junior to the claims that creditors have against those non-guarantor subsidiaries. Holders of the notes will only be creditors of the Obligor group and not creditors of the non-guarantor subsidiaries. As a result, all of the existing and future liabilities of the non-guarantor subsidiaries, including any claims of trade creditors and preferred stockholders, will be structurally senior to the notes. As of and for the periods ended December 31, 2022 and 2021, the non-guarantor subsidiaries represented substantially all of the total assets and accounted for substantially all of the total revenue of the Company prior to consolidating adjustments. The non-guarantor subsidiaries have other liabilities, including contingent liabilities that may be significant. Each indenture does not contain any limitations on the amount of additional debt that the Obligor group and the non-guarantor subsidiaries may incur. The amounts of this debt could be substantial, and this debt may be debt of the non-guarantor subsidiaries, in which case this debt would be effectively senior in right of payment to the notes. The notes are obligations exclusively of the Obligor group. Substantially all of the Obligor group’s operations are conducted through its non-guarantor subsidiaries. Therefore, the Obligor group’s ability to service its debt, including the notes, is dependent upon the net cash flows of its non-guarantor subsidiaries and their ability to distribute those net cash flows as dividends, loans or other payments to the Obligor group. Certain laws restrict the ability of these non-guarantor subsidiaries to pay dividends and make loans and advances to the Obligor group. In addition, such non-guarantor subsidiaries may enter into contractual arrangements that limit their ability to pay dividends and make loans and advances to the Obligor group. Intercompany balances and transactions between members of the Obligor group have been eliminated. All intercompany balances and transactions between the Obligor group and the non-guarantor subsidiaries have been presented in the disclosures below on a net presentation basis, rather than a gross basis, as this better reflects the nature of the intercompany positions and presents the funding or funded position that is to be received or owed. The intercompany balances and transactions between the Obligor group and non-guarantor subsidiaries, presented below, relate to a number of items including loan funding for acquisitions and other purposes, transfers of surplus cash between subsidiary companies, funding provided for working capital purposes, settlement of expense accounts, transactions related to share-based payment arrangements and share issuances, intercompany royalty arrangements, intercompany dividends and intercompany interest. At December 31, 2022 and 2021, the intercompany balances of the Obligor group with non-guarantor subsidiaries were net receivables of $600 million and $700 million, respectively, and net payables of $10.2 billion and $8.1 billion, respectively. No balances or transactions of non-guarantor subsidiaries are presented in the disclosures other than the intercompany items noted above. Presented below is certain summarized financial information for the Obligor group. As of December 31, 2022 As of December 31, 2021 (in millions) Total current assets $ 216 $ 243 Total non-current assets 685 862 Total current liabilities 6,916 7,747 Total non-current liabilities 8,212 5,298 Year endedDecember 31, 2022 (in millions) Revenue $ 2,139 Income from operations 1,650 Income from operations before income taxes (i) 1,102 Net income 1,287 Net income attributable to Willis Towers Watson 1,287 (i)Includes intercompany expense, net of the Obligor group from non-guarantor subsidiaries of $132 million for the year ended December 31, 2022. 56 Non-GAAP Financial Measures In order to assist readers of our consolidated financial statements in understanding the core operating results that WTW’s management uses to evaluate the business and for financial planning purposes, we present the following non-GAAP measures and their most directly comparable U.S. GAAP measure: Most Directly Comparable U.S. GAAP Measure Non-GAAP Measure As reported change Constant currency change As reported change Organic change Income from operations/margin Adjusted operating income/margin Net income/margin Adjusted EBITDA/margin Net income attributable to WTW Adjusted net income Diluted earnings per share Adjusted diluted earnings per share Income from continuing operations before income taxes Adjusted income before taxes Provision for income taxes/U.S. GAAP tax rate Adjusted income taxes/tax rate Net cash from operating activities Free cash flow The Company believes that these measures are relevant and provide pertinent information widely used by analysts, investors and other interested parties in our industry to provide a baseline for evaluating and comparing our operating performance, and in the case of free cash flow, our liquidity results. Within the measures referred to as ‘adjusted’, we adjust for significant items which will not be settled in cash, or which we believe to be items that are not core to our current or future operations. These items include the following: •Income and loss from discontinued operations, net of tax – Adjustment to remove the after-tax income or loss from discontinued operations and the after-tax gain attributable to the divestiture of our Willis Re business. •Restructuring costs and transaction and transformation, net – Management believes it is appropriate to adjust for restructuring costs and transaction and transformation, net when they relate to a specific significant program with a defined set of activities and costs that are not expected to continue beyond a defined period of time, or significant acquisition-related transaction expenses. We believe the adjustment is necessary to present how the Company is performing, both now and in the future when the incurrence of these costs will have concluded. Transaction and transformation, net in 2021 includes the income receipt related to the termination of the then-proposed Aon transaction. •Impairment – Adjustment to remove the impairment related to the net assets of our Russian business that are held outside of our Russian entities. •Gains and losses on disposals of operations – Adjustment to remove the gains or losses resulting from disposed operations that have not been classified as discontinued operations. •Pension settlement and curtailment gains and losses – Adjustment to remove significant pension settlement and curtailment gains and losses to better present how the Company is performing. •Provisions for significant litigation – We will include provisions for litigation matters which we believe are not representative of our core business operations. These amounts are presented net of insurance and other recovery receivables. •Tax effect of statutory rate changes – Relates to the incremental tax expense or benefit from significant statutory income tax rate changes enacted in material jurisdictions in which we operate. •Tax effect of the Coronavirus Aid, Relief, and Economic Security (‘CARES’) Act – Relates to the incremental tax expense or benefit, primarily from the BEAT, generated from electing or changing elections of certain income tax provisions available under the CARES Act. •Tax effect of internal reorganizations – Relates to the U.S. income tax expense resulting from the completion of internal reorganizations of the ownership of certain businesses that reduced the investments held by our U.S.-controlled subsidiaries. These non-GAAP measures are not defined in the same manner by all companies and may not be comparable to other similarly titled measures of other companies. Non-GAAP measures should be considered in addition to, and not as a substitute for, the information contained within our consolidated financial statements. 57 Constant Currency Change and Organic Change We evaluate our revenue on an as reported (U.S. GAAP), constant currency and organic basis. We believe presenting constant currency and organic information provides valuable supplemental information regarding our comparable results, consistent with how we evaluate our performance internally. •Constant Currency Change - Represents the year-over-year change in revenue excluding the impact of foreign currency fluctuations. To calculate this impact, the prior year local currency results are first translated using the current year monthly average exchange rates. The change is calculated by comparing the prior year revenue, translated at the current year monthly average exchange rates, to the current year as reported revenue, for the same period. We believe constant currency measures provide useful information to investors because they provide transparency to performance by excluding the effects that foreign currency exchange rate fluctuations have on period-over-period comparability given volatility in foreign currency exchange markets. •Organic Change - Excludes the impact of fluctuations in foreign currency exchange rates as described above and the period-over-period impact of acquisitions and divestitures on current-year revenue. We believe that excluding transaction-related items from our U.S. GAAP financial measures provides useful supplemental information to our investors, and it is important in illustrating what our core operating results would have been had we not included these transaction-related items, since the nature, size and number of these transaction-related items can vary from period to period. The constant currency and organic change results, and a reconciliation from the reported results for consolidated revenue, are included in the ‘Consolidated Revenue (Continuing Operations)’ section within this Form 10-K. These measures are also reported by segment in the ‘Segment Revenue’ section within this Form 10-K. A reconciliation of the reported change to the constant currency and organic change for the year ended December 31, 2022 from the year ended December 31, 2021 is as follows. The components of revenue change may not add due to rounding. Components of Revenue Change As Less: Constant Less: Years ended December 31, Reported Currency Currency Acquisitions/ Organic 2022 2021 Change Impact Change Divestitures Change ($ in millions) Revenue $ 8,866 $ 8,998 (1)% (4)% 2% (1)% 4% For the year ended December 31, 2022, our as-reported revenue declined by 1%, primarily as a result of unfavorable foreign currency exchange movement. Adjusting for the impacts of foreign currency and acquisitions and disposals in the calculation of our organic activity, our revenue grew by 4% for the year ended December 31, 2022. The increase to our organic revenue was driven by both segments. Adjusted Operating Income/Margin We consider adjusted operating income/margin to be important financial measures, which are used internally to evaluate and assess our core operations and to benchmark our operating results against our competitors. Adjusted operating income is defined as income from operations adjusted for impairment, amortization, restructuring costs, transaction and transformation, net and non-recurring items that, in management’s judgment, significantly affect the period-over-period assessment of operating results. Adjusted operating income margin is calculated by dividing adjusted operating income by revenue. 58 Reconciliations of income from operations to adjusted operating income for the years ended December 31, 2022 and 2021 are as follows: Years Ended December 31, 2022 2021 ($ in millions) Income from operations $ 1,178 $ 2,202 Adjusted for certain items: Impairment 81 — Amortization 312 369 Restructuring costs 99 26 Transaction and transformation, net 181 (806 ) Adjusted operating income $ 1,851 $ 1,791 Income from operations margin 13.3 % 24.5 % Adjusted operating income margin 20.9 % 19.9 % Adjusted operating income increased for the year ended December 31, 2022 to $1.9 billion, from $1.8 billion for the year ended December 31, 2021. This increase resulted from salaries and benefits, as a percentage of revenue, reducing from 58% to 57% on an as- reported basis, primarily related to the reduction in discretionary and incentive costs. Adjusted EBITDA/Margin We consider adjusted EBITDA/margin to be important financial measures, which are used internally to evaluate and assess our core operations, to benchmark our operating results against our competitors and to evaluate and measure our performance-based compensation plans. Adjusted EBITDA is defined as net income adjusted for income from discontinued operations, net of tax, provision for income taxes, interest expense, impairment, depreciation and amortization, restructuring costs, transaction and transformation, net, gains and losses on disposals of operations and non-recurring items that, in management’s judgment, significantly affect the period-over-period assessment of operating results. Adjusted EBITDA margin is calculated by dividing adjusted EBITDA by revenue. Reconciliations of net income to adjusted EBITDA for the years ended December 31, 2022 and 2021 are as follows: Years Ended December 31, 2022 2021 ($ in millions) NET INCOME $ 1,024 $ 4,236 Loss/(income) from discontinued operations, net of tax 40 (2,080 ) Provision for income taxes 194 536 Interest expense 208 211 Impairment 81 — Depreciation 255 281 Amortization 312 369 Restructuring costs 99 26 Transaction and transformation, net 181 (806 ) Gain on disposal of operations (7 ) (379 ) Adjusted EBITDA $ 2,387 $ 2,394 Net income margin 11.5 % 47.1 % Adjusted EBITDA margin 26.9 % 26.6 % Adjusted EBITDA for both the years ended December 31, 2022 and 2021 was $2.4 billion, a decrease of $7 million. This decrease was due to lower pension income, partially offset by salaries and benefits, as a percentage of revenue, reducing from 58% to 57% on an as-reported basis, primarily related to the reduction in discretionary and incentive costs in the current year. Adjusted Net Income and Adjusted Diluted Earnings Per Share Adjusted net income is defined as net income attributable to WTW adjusted for income from discontinued operations, net of tax, impairment, amortization, restructuring costs, transaction and transformation, net, gains and losses on disposals of operations and non-recurring items that, in management’s judgment, significantly affect the period-over-period assessment of operating results and the related tax effect of those adjustments and the tax effects of internal reorganizations. This measure is used solely for the purpose of calculating adjusted diluted earnings per share. 59 Adjusted diluted earnings per share is defined as adjusted net income divided by the weighted-average number of ordinary shares, diluted. Adjusted diluted earnings per share is used to internally evaluate and assess our core operations and to benchmark our operating results against our competitors. Reconciliations of net income attributable to WTW to adjusted diluted earnings per share for the years ended December 31, 2022 and 2021 are as follows: Years Ended December 31, 2022 2021 ($ and weighted-average shares in millions) NET INCOME ATTRIBUTABLE TO WTW $ 1,009 $ 4,222 Adjusted for certain items: Loss/(income) from discontinued operations, net of tax 40 (2,080 ) Impairment 81 — Amortization 312 369 Restructuring costs 99 26 Transaction and transformation, net 181 (806 ) Gain on disposal of operations (7 ) (379 ) Tax effect on certain items listed above (i) (188 ) 103 Tax effect of statutory rate change — 40 Tax effect of the CARES Act (24 ) — Tax effect of internal reorganizations 4 — $ 1,507 $ 1,495 Weighted-average ordinary shares — diluted 112 129 Diluted earnings per share $ 8.98 $ 32.78 Adjusted for certain items (ii): Loss/(income) from discontinued operations, net of tax 0.36 (16.15 ) Impairment 0.72 — Amortization 2.78 2.86 Restructuring costs 0.88 0.20 Transaction and transformation, net 1.61 (6.26 ) Gain on disposal of operations (0.06 ) (2.94 ) Tax effect on certain items listed above (i) (1.67 ) 0.79 Tax effect of statutory rate change — 0.31 Tax effect of the CARES Act (0.21 ) — Tax effect of internal reorganizations 0.04 — Adjusted diluted earnings per share $ 13.41 $ 11.60 (i)The tax effect was calculated using an effective tax rate for each item. (ii)Per share values and totals may differ due to rounding. Our adjusted diluted earnings per share increased for the year ended December 31, 2022 as compared to the year ended December 31, 2021 primarily due to a lower weighted-average outstanding share count attributable to our share repurchase activity in the current year. Adjusted Income Before Taxes and Adjusted Income Taxes/Tax Rate Adjusted income before taxes is defined as income from operations before income taxes adjusted for impairment, amortization, restructuring costs, transaction and transformation, net, gains and losses on disposals of operations and non-recurring items that, in management’s judgment, significantly affect the period-over-period assessment of operating results. Adjusted income before taxes is used solely for the purpose of calculating the adjusted income tax rate. Adjusted income taxes/tax rate is defined as the provision for income taxes adjusted for taxes on certain items of impairment, amortization, restructuring costs, transaction and transformation, net, gains and losses on disposals of operations, the tax effects of internal reorganizations and non-recurring items that, in management’s judgment, significantly affect the period-over-period assessment of operating results, divided by adjusted income before taxes. Adjusted income taxes is used solely for the purpose of calculating the adjusted income tax rate. 60 Management believes that the adjusted income tax rate presents a rate that is more closely aligned to the rate that we would incur if not for the reduction of pre-tax income for the adjusted items and the tax effects of internal reorganizations, which are not core to our current and future operations. Reconciliations of income from continuing operations before income taxes to adjusted income before taxes and provision for income taxes to adjusted income taxes for the years ended December 31, 2022 and 2021 are as follows: Years Ended December 31, 2022 2021 ($ in millions) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES $ 1,258 $ 2,692 Adjusted for certain items: Impairment 81 — Amortization 312 369 Restructuring costs 99 26 Transaction and transformation, net 181 (806 ) Gain on disposal of operations (7 ) (379 ) Adjusted income before taxes $ 1,924 $ 1,902 Provision for income taxes $ 194 $ 536 Tax effect on certain items listed above (i) 188 (103 ) Tax effect of statutory rate change — (40 ) Tax effect of the CARES Act 24 — Tax effect of internal reorganizations (4 ) — Adjusted income taxes $ 402 $ 393 U.S. GAAP tax rate 15.4 % 19.9 % Adjusted income tax rate 20.9 % 20.7 % (i)The tax effect was calculated using an effective tax rate for each item. Our U.S. GAAP tax rates were 15.4% and 19.9% for the years ended December 31, 2022 and 2021, respectively. The current-year effective tax rate includes a $34 million tax benefit associated with amending the Company’s U.S. federal income tax returns for tax years 2019 and 2020, primarily related to a reduction in the BEAT. The effective tax rate for the year ended December 31, 2021 includes a $250 million estimated tax expense related to the income receipt associated with the termination of our then-proposed combination with Aon, as well as a $40 million tax expense related to the remeasurement of deferred tax assets and liabilities associated with an increase in the U.K. tax rate from 19% to 25%. Our adjusted income tax rates were 20.9% and 20.7% for the years ended December 31, 2022 and 2021, respectively. Free Cash Flow Free cash flow is defined as cash flows from operating activities less cash used to purchase fixed assets and software for internal use. Free cash flow is a liquidity measure and is not meant to represent residual cash flow available for discretionary expenditures. Management believes that free cash flow presents the core operating performance and cash generating capabilities of our business operations. Reconciliations of cash flows from operating activities to free cash flow for the years ended December 31, 2022 and 2021 are as follows: Years ended December 31, 2022 2021 (in millions) Cash flows from operating activities $ 812 $ 2,061 Less: Additions to fixed assets and software for internal use (138 ) (148 ) Free cash flow $ 674 $ 1,913 61 The unfavorable movement in free cash flows in the current year was due primarily to the prior-year income receipt of $1 billion related to the termination of the then-proposed Aon transaction, tax payments in 2022 related to this income receipt, and the elimination of Willis Re cash generation following the divestiture. Additionally, the free cash flow for the prior year presented includes the operating cash flows of Willis Re through December 1, 2021. Willis Re’s operating cash flows approximate its pre-tax income and any adjustments for working capital movements (see Note 3 — Acquisitions and Divestitures within Item 8 of this Annual Report on Form 10-K for further information), the absence of which is expected to be partially made up by reimbursements through the TSA. Critical Accounting Estimates These consolidated financial statements conform to U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. The areas that we believe include critical accounting estimates are revenue recognition, costs to fulfill under our broking contracts, valuation of billed and unbilled receivables from clients, income taxes, commitments, contingencies and accrued liabilities, pension assumptions, and goodwill and intangible assets. The critical accounting estimates discussed below involve making difficult, subjective or complex accounting estimates that could have a material effect on our financial condition and results of operations. These critical accounting estimates require us to make assumptions about matters that are highly uncertain at the time of the estimate or assumption. Different estimates that we could have used, or changes in estimates that are reasonably likely to occur, may have a material effect on our results of operations and financial condition. Revenue Recognition We use significant estimates related to revenue recognition most commonly during our estimation of the transaction prices or where we recognize revenue over time on a proportional performance basis. A brief description of these policies and estimates is included below: Estimation of transaction prices — This process occurs most frequently in certain broking transactions. In situations in which our fees are not fixed but are variable, we must estimate the likely commission per policy, taking into account the likelihood of cancellation before the end of the policy. For Medicare broking and Affinity arrangements, the commissions to which we will be entitled can vary based on the underlying individual insurance policies that are placed. For Medicare broking in particular, we base the estimates of transaction prices on supportable evidence from an analysis of past transactions, and only include amounts that are probable of being received or not refunded (referred to as applying ‘constraint’ under ASC 606, Revenue From Contracts With Customers). In our direct-to-consumer Medicare broking arrangements, the estimate of the total renewal commissions that will be received over the lifetime of the policy requires significant judgment, and will vary based on product type, estimated commission rates, the expected lives of the respective policies and other factors. The Company has applied an actuarial model to account for these uncertainties, which is updated periodically based on actual experience. Each of these processes result in us estimating a transaction price that may be significantly lower than the ultimate amount of commissions we may collect. The transaction price is then adjusted over time as we receive confirmation of our remuneration through receipt of commissions, or as other information becomes available. Proportional performance basis over time recognition — Where we recognize revenue on a proportional performance basis, primarily in our consulting and outsourced administration arrangements, the amount we recognize is affected by a number of factors that can change the estimated amount of work required to complete the project, such as the staffing on the engagement and/or the level of client participation. Our periodic engagement evaluations require us to make judgments and estimates regarding the overall profitability and stages of project completion that, in turn, affect how we recognize revenue. We recognize a loss on an engagement when estimated revenue to be received for that engagement is less than the total estimated costs associated with the engagement. Losses are recognized in the period in which the loss becomes probable and the amount of the loss is reasonably estimable. Costs to Fulfill —Broking Contracts For our broking business, the Company must estimate the fulfillment costs incurred during the pre-placement of the broking contracts. These judgments include the following: •which activities in the pre-placement process should be eligible for capitalization; •the amount of time and effort expended on those pre-placement activities; •the amount of payroll and related costs eligible for capitalization; and, •the monthly or quarterly timing of underlying insurance and reinsurance policy inception dates. 62 Valuation of Billed and Unbilled Receivables from Clients We maintain allowances for doubtful accounts to reflect estimated losses resulting from a client’s failure to pay for the services after the services have been rendered, which are recorded in other operating expenses. We also maintain allowances related to our unbilled receivables for such items as expected realization or client disputes, the related provision for which is recorded as a reduction to revenue. Our allowance policy is based in part on the aging of the billed and unbilled client receivables and has been developed based on our write-off history. However, facts and circumstances, such as the average length of time the receivables are past due, general market conditions at the time we perform the work, current economic trends and our clients’ ability to pay, may cause fluctuations in our valuation of billed and unbilled receivables. Income Taxes The Company recognizes deferred tax assets and liabilities for the estimated future tax consequences of events attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating and capital loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized for continuing operations in the consolidated statement of comprehensive income in the period in which the change is enacted. Deferred tax assets are reduced through the establishment of a valuation allowance at such time as, based on available evidence, it is more likely than not that the deferred tax assets will not be realized. The Company adjusts valuation allowances to measure deferred tax assets at the amounts considered realizable in future periods, which is assessed at each balance sheet date. In making such determinations, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operating results. We place more reliance on evidence that is objectively verifiable. Commitments, Contingencies and Accrued Liabilities We have established provisions against various actual and potential claims, lawsuits and other proceedings relating principally to alleged errors and omissions in connection with the placement of insurance and reinsurance and the provision of consulting services in the ordinary course of business. Such provisions cover claims that have been reported but not paid and also claims that have been incurred but not reported. These provisions are established based on actuarial estimates together with individual case reviews and are believed to be adequate in the light of current information and legal advice. In certain cases, where a range of loss exists, we accrue the minimum amount in the range if no amount within the range is a better estimate than any other amount. See Note 15 — Commitments and Contingencies in Item 8 within this Annual Report on Form 10-K. Pension Assumptions We maintain defined benefit pension plans for employees in several countries, with the most significant defined benefit plans offered in the U.S. and U.K. Our disclosures in Note 13 — Retirement Benefits contain additional information about our other less significant but material retirement plans. Within our critical accounting policy discussion, we have excluded analysis for plans outside of those noted in the description below, as any variance of recorded information based on management’s estimates would be immaterial. Descriptions of our U.S. and U.K. plans, which comprise 89% of our projected benefit obligations and 92% of our plan assets, are below: United States Legacy Willis – This plan was frozen in 2009. Approximately 600 WTW employees in the United States have a frozen accrued benefit under this plan. WTW Plan – Substantially all U.S. employees are eligible to participate in this plan. Benefits are provided under a stable value pension plan design. The original stable value design came into effect on January 1, 2012. Plan participants prior to July 1, 2017 earn benefits without having to make employee contributions, and all newly-eligible employees after that date are required to contribute 2% of pay on an after-tax basis to participate in the plan. United Kingdom Legacy Willis – This plan covers approximately one-fifth of the Legacy Willis employees in the United Kingdom. The plan is now closed to new entrants. New employees in the United Kingdom are offered the opportunity to join a defined contribution plan. 63 Legacy Towers Watson – Benefit accruals earned under the Legacy Watson Wyatt defined benefit plan (predominantly pension benefits) ceased on February 28, 2015, although benefits earned prior to January 1, 2008 retain a link to salary until the employee leaves the Company. Benefit accruals earned under the legacy Towers Perrin defined benefit plan (predominantly lump sum benefits) were frozen on March 31, 2008. All participants now accrue defined contribution benefits. The determination of the Company’s obligations and annual expense under the plans is based on a number of assumptions that, given the longevity of the plans, are long-term in focus. A change in one or a combination of these assumptions could have a material impact on our projected benefit obligation. However, certain of these changes, such as changes in the discount rates and other actuarial assumptions, are not recognized immediately in net income, but are instead recorded in other comprehensive income. The accumulated gains and losses not yet recognized in net income are amortized into net income as a component of the net periodic benefit cost/(income) over the average remaining service period or average remaining life expectancy, as appropriate, of the plan’s participants to the extent that the net gains or losses as of the beginning of the year exceed 10% of the greater of the market-related value of plan assets or the projected benefit obligation. WTW considers several factors prior to the start of each fiscal year when determining the appropriate annual assumptions, including economic forecasts, relevant benchmarks, historical trends, portfolio composition and peer company comparisons. These assumptions, used to determine our pension liabilities and pension expense, are reviewed annually by senior management and changed when appropriate. A discount rate will be changed annually if underlying rates have moved, whereas an expected long-term return on assets will be changed less frequently as longer-term trends in asset returns emerge or long-term target asset allocations are revised. To calculate the discount rate, we use the granular approach to determining service cost and interest cost. The expected rate of return assumptions for all plans are supported by an analysis of the weighted-average yield expected to be achieved with the anticipated makeup of investments. We have allowed for actual and known inflation in preparing our estimates. Other material assumptions include rates of participant mortality, and the expected long-term rates of compensation and pension increases. Funding is based on actuarially determined contributions and is limited to amounts that are currently deductible for tax purposes, or as agreed to with the plan trustees for the U.K. plans. Since funding calculations are based on different measurements than those used for accounting purposes, pension contributions are not equal to net periodic benefit cost. We recorded a combined $161 million net periodic benefit income for our U.S. and U.K. plans for the year ended December 31, 2022. For the U.S. and U.K. plans, the following table presents our estimated net periodic benefit income for 2023 and the impact to both plans of a 0.25% increase and decrease to both the expected return on assets (‘EROA’) and the discount rate assumptions; and the projected benefit obligations as of December 31, 2022 and the impact of a 0.25% increase and decrease to the discount rates: Totals - current estimates Impact of 0.25% change to EROA Impact of 0.25% change to discount rate Increase Decrease Increase Decrease Estimated 2023 (income): U.S. Plans $ (41 ) $ (9 ) $ 9 $ 1 $ (1 ) U.K. Plans nil $ (7 ) $ 7 $ (1 ) $ 1 Projected benefit obligation at December 31, 2022: U.S. Plans $ 3,871 N/A N/A $ (96 ) $ 100 U.K. Plans $ 2,435 N/A N/A $ (78 ) $ 84 Economic factors and conditions often affect multiple assumptions simultaneously, and the effects of changes in key assumptions are not necessarily linear. Goodwill and Intangible Assets — Impairment Review In applying the acquisition method of accounting for business combinations, amounts assigned to identifiable assets and liabilities acquired were based on estimated fair values as of the date of acquisition, with the remainder recorded as goodwill. Intangible assets are initially valued at fair value using generally accepted valuation methods appropriate for the type of intangible asset. Intangible assets with definite lives are amortized over their estimated useful lives and are reviewed for impairment if indicators of impairment arise. Intangible assets with indefinite lives are tested for impairment annually as of October 1, and whenever indicators of impairment arise. The fair value of the intangible assets is compared with their carrying value and an impairment loss would be recognized for the amount by which the carrying amount exceeds the fair value. Goodwill is tested for impairment annually as of October 1, and whenever indicators of impairment arise. Goodwill is tested at the reporting unit level, and the Company had seven reporting units as of October 1, 2022. During fiscal year 2022, the Company performed the impairment test for all reporting units. Each of the reporting unit’s estimated fair values were in excess of their carrying values, and we did not record any impairment losses of goodwill. 64 To perform the test, we used valuation techniques to estimate the fair value of a reporting unit that are under the income and/or market approaches of valuation methods: •Discounted cash flow method — Under the discounted cash flow method, an income approach, the business enterprise value is determined by discounting to present value the terminal value which is calculated using debt-free after-tax cash flows for a finite period of years. Key estimates in this approach were internal financial projection estimates prepared by management, assessment of business risk, and expected rates of return on capital. •Guideline public company method — The guideline public company method, a market approach, develops valuation multiples by comparing our reporting units to similar publicly traded companies. Key estimates and determination of valuation multiples rely on the selection of similar companies, obtaining forecast revenue and EBITDA estimates for the similar companies and selection of valuation multiples as they apply to the reporting unit characteristics. •Guideline transaction method — Under the guideline transactions method, a market approach, actual transaction prices and operating data from companies deemed reasonably similar to the reporting units are used to develop valuation multiples as an indication of how much a knowledgeable investor in the marketplace would be willing to pay for the business units. 65 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Financial Risk Management We are exposed to market risk from changes in foreign currency exchange rates. In order to manage the risk arising from these exposures, we enter into a variety of foreign currency derivatives. We do not hold financial or derivative instruments for trading purposes. A discussion of our accounting policies for financial and derivative instruments is included in Note 2 — Basis of Presentation, Significant Accounting Policies and Recent Accounting Pronouncements and Note 10 — Derivative Financial Instruments within Item 8 of this Annual Report on Form 10-K. Foreign Exchange Risk Because of the large number of countries and currencies we operate in, movements in currency exchange rates may affect our results. We report our operating results and financial condition in U.S. dollars. Our U.S. operations earn revenue and incur expenses primarily in U.S. dollars. Outside the U.S., we predominantly generate revenue and expenses in the local currency with the exception of our London market operations which earn revenue in several currencies but incur expenses predominantly in Pounds sterling. The table below gives an approximate analysis of revenue and expenses from continuing operations by currency in 2022. U.S.dollars Poundssterling Euro Othercurrencies Revenue 60% 11% 14% 15% Expenses (i) 55% 17% 12% 16% (i)These percentages exclude certain expenses for significant items which will not be settled in cash, or which we believe to be items that are not core to our current or future operations. These items include amortization of intangible assets and transaction and transformation, net. Our principal exposures to foreign exchange risk arise from: •our London market operations; •intercompany lending between subsidiaries; and •translation. London market operations The Company’s primary foreign exchange risks in its London market operations arise from changes in the exchange rate between the U.S. dollar and Pound sterling as its London market operations earn the majority of its revenue in U.S. dollars but incur expenses predominantly in Pounds sterling and may also hold significant foreign currency asset or liability positions on its consolidated balance sheet. In addition, the London market operations earn significant revenue in Euro and Japanese yen. The foreign exchange risks in our London market operations are hedged to the extent that: •forecasted Pounds sterling expenses exceed Pounds sterling revenue, in which case the Company limits its exposure to this exchange rate risk by the use of forward contracts matched to a portion of the forecasted Pounds sterling outflows arising in the ordinary course of business. In addition, we are also exposed to foreign exchange risk on any net Pounds sterling asset or liability position in our London market operations; and •the U.K. operations also earn significant revenue in Euro and Japanese yen. The Company limits its exposure to changes in the exchange rates between the U.S. dollar and these currencies by the use of foreign exchange contracts matched to a proportion of forecast cash inflows in these specific currencies and periods. Intercompany lending between subsidiaries The Company engages in intercompany borrowing and lending between subsidiaries, primarily through its in-house banking operations which give rise to foreign exchange exposures. The Company mitigates these risks through the use of short-term foreign currency forward and swap transactions that offset the underlying exposure created when the borrower and lender have different functional currencies. These derivatives are not generally designated as hedging instruments and at December 31, 2022, we had 66 notional amounts of $1.7 billion (denominated primarily in U.S. dollars, Pound sterling, Euro and Australian dollars), with a net asset fair value of $24 million. Such derivatives typically mature within three months. Translation risk Outside our U.S. and London market operations, we predominantly earn revenue and incur expenses in the local currency. When we translate the results and net assets of these operations into U.S. dollars for reporting purposes, movements in exchange rates will affect reported results and net assets. For example, if the U.S. dollar strengthens against the Euro, the reported results of our Eurozone operations in U.S. dollar terms will be lower. The table below provides information about our foreign currency forward exchange contracts which are designated as hedging instruments and are sensitive to exchange rate risk. The table summarizes the U.S. dollar equivalent amounts of each currency bought and sold forward and the weighted-average contractual exchange rates. All forward exchange contracts mature within two years. Settlement date before December 31, 2023 2024 December 31, 2022 Contractamount Averagecontractualexchangerate Contractamount Averagecontractualexchangerate (millions) (millions) Foreign currency sold U.S. dollars sold for Pounds sterling $ 74 $1.26 = £1 $ 30 $1.21 = £1 Euros sold for U.S. dollars 23 €1 = $1.11 5 €1 = $1.03 Japanese yen sold for U.S. dollars 2 ¥122.34= $1 — ¥127.18= $1 Total $ 99 $ 35 Fair value (i) $ (2 ) $ (1 ) (i)Represents the difference between the contract amount and the cash flow in U.S. dollars which would have been receivable had the foreign currency forward exchange contracts been entered into on December 31, 2022 at the forward exchange rates prevailing at that date. Income earned within foreign subsidiaries outside of the U.K. is generally offset by expenses in the same local currency, however the Company does have exposure to foreign exchange movements on the net income of these entities. Interest Rate Risk The Company has access to $1.5 billion under a revolving credit facility (see Note 11 — Debt within Item 8 of this Annual Report on Form 10-K for further information). As of December 31, 2022, no amount was drawn on this facility. We are also subject to market risk from exposure to changes in interest rates based on our investing activities where our primary interest rate risk arises from changes in short-term interest rates in U.S. dollars, Pounds sterling and Euros. The table below provides information about our financial instruments that are sensitive to changes in interest rates. The Company had no outstanding floating rate-based debt at December 31, 2022. Expected to mature before December 31, 2023 2024 2025 2026 2027 Thereafter Total Fair Value (i) ($ in millions) Fixed rate debt Principal $ 250 $ 650 $ — $ 550 $ 750 $ 2,550 $ 4,750 $ 4,317 Fixed rate payable 4.625 % 3.600 % — 4.400 % 4.650 % 4.186 % 4.227 % (i)Represents the net present value of the expected cash flows discounted at current market rates of interest or quoted market rates as appropriate. Interest Income on Fiduciary Funds We are exposed to interest rate risk. Specifically, as a result of our operating activities, we receive cash for premiums and claims which we deposit in high-quality bank term deposit and money market funds where permitted. We earn interest on these funds, which is included in our consolidated financial statements as interest income. These funds are regulated in terms of access and the instruments in which they may be invested, most of which are short-term in maturity. As a result of measures taken by central banks around the world, rates offered on these investments have increased, in some cases significantly over the course of the year. As a result, interest income has improved substantially this year, with the greatest impact having been recognized in the second half of 67 2022. Interest income in the future will be a function of the short-term rates we are able to obtain by currency and the cash balances available to invest in these instruments. Interest income was $55 million, $12 million and $18 million for the years ended December 31, 2022, 2021 and 2020, respectively. At December 31, 2022, we held $2.2 billion of fiduciary funds invested in interest-bearing accounts. If short-term interest rates increased or decreased by 25 basis points, interest earned on these invested fiduciary funds, and therefore our interest income recognized, would increase or decrease by approximately $5 million on an annualized basis. Credit Risk and Concentrations of Credit Risk Credit risk represents the loss that would be recognized at the reporting date if counterparties failed to perform as contracted. The Company currently does not anticipate non-performance by its counterparties. The Company generally does not require collateral or other security to support financial instruments with credit risk. Concentrations of credit risk that arise from financial instruments exist for groups of customers or counterparties when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. Financial instruments on the balance sheet that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, fiduciary funds, accounts receivable and derivatives which are recorded at fair value. The Company maintains a policy of providing for the diversification of cash and cash equivalent investments and places such investments in an extensive number of financial institutions to limit the amount of credit risk exposure. These financial institutions are monitored on an ongoing basis for credit quality predominantly using information provided by credit agencies. Concentrations of credit risk with respect to receivables are limited due to the large number of clients and markets in which the Company does business, as well as the dispersion across many geographic areas. Management does not believe that significant risk exists in connection with the Company’s concentrations of credit as of December 31, 2022. 68
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+Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with, and is qualified in its entirety by, the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. Discussion of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2021. OverviewWe are a designer, developer, and operator of integrated resorts featuring luxury hotel rooms, high-end retail space, an array of dining and entertainment options, meeting and convention facilities, and gaming, all supported by an unparalleled focus on our guests, our people, and our community. Through our approximately 72% ownership of Wynn Macau, Limited ("WML"), our concessionaire Wynn Resorts (Macau) S.A. ("Wynn Macau SA") operates two integrated resorts in the Macau Special Administrative Region ("Macau") of the People's Republic of China ("PRC"), Wynn Palace and Wynn Macau (collectively, our "Macau Operations"). In Las Vegas, Nevada, we operate and, with the exception of certain retail space, own 100% of Wynn Las Vegas. Additionally, we are a 50.1% owner and managing member of a joint venture that owns and leases certain retail space at Wynn Las Vegas (the "Retail Joint Venture"). We refer to Wynn Las Vegas, Encore, an expansion at Wynn Las Vegas, and the Retail Joint Venture as our Las Vegas Operations. In Everett, Massachusetts, we operate Encore Boston Harbor, an integrated resort. We also hold an approximately 97% interest in, and consolidate, Wynn Interactive Ltd. ("Wynn Interactive"), through which we operate WynnBet, our digital sports betting and casino gaming business.On December 1, 2022, we closed on our sale-leaseback arrangement with respect to certain real estate assets related to Encore Boston Harbor (the "EBH Transaction"). Upon closing of the related transactions, we received cash proceeds of approximately $1.70 billion in exchange for the sale of such real estate assets, and concurrently entered into a lease agreement for the purpose of continuing to operate the Encore Boston Harbor integrated resort. The lease agreement provides for an initial annual minimum base rent of $100.0 million for an initial term of 30 years, subject to certain annual rent escalations and renewal provisions, and obligates the Company to continue paying certain payments in lieu of property taxes. We expect to use the proceeds from the EBH Transaction in accordance with the reinvestment and asset sale provisions of our senior secured credit facilities.Recent DevelopmentsCOVID-19 UpdateSince the outbreak of COVID-19, visitation to Macau has fallen significantly, driven by the strong deterrent effect of the COVID-19 pandemic on travel and social activities, quarantine measures put in place in Macau and elsewhere, travel and entry restrictions and conditions in Macau, the PRC, Hong Kong and Taiwan involving COVID-19 testing and mandatory quarantine, among other things, periods of mandatory closure of certain businesses and facilities, including gaming operations, and the suspension or reduced accessibility of transportation to and from Macau. Over the course of December 2022 and January 2023, Macau authorities relaxed or eliminated most COVID-19 related protective measures, and as of February 27, 2023, there are no remaining entry restrictions or mandatory quarantine requirements in place for travelers to Macau, and testing requirements for inbound travelers from the PRC, Hong Kong, and Taiwan have been discontinued. Nevertheless, given the inherent uncertainty around the likelihood, extent, and timing of a potential reimposition of restrictions on the general public, travel, or certain activities, management is unable to reasonably predict whether such restrictions would impact our properties in the future, or the extent such restrictions, if reimposed, would impact our results of operations, cash flows, or financial condition.35 Table of ContentsKey Operating MeasuresCertain key operating measures specific to the gaming industry are included in our discussion of our operational performance for the periods for which the Consolidated Statements of Operations are presented. These key operating measures are presented as supplemental disclosures because management and/or certain investors use these measures to better understand period-over-period fluctuations in our casino and hotel operating revenues. These key operating measures are defined below:•Table drop in mass market for our Macau Operations is the amount of cash that is deposited in a gaming table's drop box plus cash chips purchased at the casino cage. •Table drop for our Las Vegas Operations is the amount of cash and net markers issued that are deposited in a gaming table's drop box.•Table drop for Encore Boston Harbor is the amount of cash and gross markers issued that are deposited in a gaming table's drop box.•Rolling chips are non-negotiable identifiable chips that are used to track turnover for purposes of calculating incentives within our Macau Operations' VIP program.•Turnover is the sum of all losing rolling chip wagers within our Macau Operations' VIP program. •Table games win is the amount of table drop or turnover that is retained and recorded as casino revenues. Table games win is before discounts, commissions and the allocation of casino revenues to rooms, food and beverage and other revenues for services provided to casino customers on a complimentary basis. Table games win does not include poker rake.•Slot machine win is the amount of handle (representing the total amount wagered) that is retained by us and is recorded as casino revenues. Slot machine win is after adjustment for progressive accruals and free play, but before discounts and the allocation of casino revenues to rooms, food and beverage and other revenues for services provided to casino customers on a complimentary basis.•Poker rake is the portion of cash wagered by patrons in our poker rooms that is retained by the casino as a service fee, after adjustment for progressive accruals, but before the allocation of casino revenues to rooms, food and beverage and other revenues for services provided to casino customers on a complimentary basis. Poker tables are not included in our measure of average number of table games.•Average daily rate ("ADR") is calculated by dividing total room revenues, including complimentaries (less service charges, if any), by total rooms occupied. •Revenue per available room ("REVPAR") is calculated by dividing total room revenues, including complimentaries (less service charges, if any), by total rooms available. •Occupancy is calculated by dividing total occupied rooms, including complimentary rooms, by the total rooms available. Below is a discussion of the methodologies used to calculate win percentages at our resorts.In our VIP operations in Macau, customers primarily purchase rolling chips from the casino cage and can only use them to make wagers. Winning wagers are paid in cash chips. The loss of the rolling chips in the VIP operations is recorded as turnover and provides a base for calculating VIP win percentage. It is customary in Macau to measure VIP play using this rolling chip method. We typically expect our win as a percentage of turnover from these operations to be within the range of 3.1% to 3.4%; however, reduced gaming volumes as a result of COVID-19 containment measures implemented in Macau may cause volatility in our Macau Operations’ VIP win percentages.In our mass market operations in Macau, customers may purchase cash chips at either the gaming tables or at the casino cage. The measurements from our VIP and mass market operations are not comparable as the measurement method used in our mass market operations tracks the initial purchase of chips at the table and at the casino cage, while the measurement method from our VIP operations tracks the sum of all losing wagers. Accordingly, the base measurement from the VIP operations is much larger than the base measurement from the mass market operations. As a result, the expected win percentage with the same amount of gaming win is lower in the VIP operations when compared to the mass market operations.In Las Vegas, customers purchase chips at the gaming tables in exchange for cash and markers. Customers may then redeem markers at the gaming tables or at the casino cage. The cash and markers, net of redemptions, used to purchase chips are deposited in the gaming table's drop box. This is the base of measurement that we use for calculating win percentage. Each type of table game has its own theoretical win percentage. Our expected table games win percentage is 22% to 26%.36 Table of ContentsAt Encore Boston Harbor, customers purchase chips at the gaming tables in exchange for cash and markers. Customers may then redeem markers only at the casino cage. The cash and gross markers used to purchase chips are deposited in the gaming table's drop box. This is the base of measurement that we use for calculating win percentage. Each type of table game has its own theoretical win percentage. Our expected table games win percentage is 18% to 22%.Results of OperationsSummary annual resultsThe following table summarizes our financial results for the periods presented (dollars in thousands, except per share data):Year Ended December 31,20222021Increase/ (Decrease)Percent ChangeOperating revenues$3,756,825 $3,763,664 $(6,839)(0.2)Net loss attributable to Wynn Resorts, Limited(423,856)(755,786)(331,930)(43.9)Diluted net loss per share(3.73)(6.64)(2.91)(43.8)The decrease in operating revenues for the year ended December 31, 2022 was primarily driven by decreases of $472.7 million and $314.8 million at Wynn Palace and Wynn Macau, respectively, resulting from decreased gaming volumes due to certain travel-related restrictions and conditions, including COVID-19 testing and other procedures related to the COVID-19 pandemic. The decrease in operating revenues was partially offset by increases in operating revenues of $628.5 million and $139.6 million from our Las Vegas Operations and Encore Boston Harbor, respectively, as a result of increased gaming volumes as well as increases in hotel occupancy and covers at restaurants. The decrease in net loss attributable to Wynn Resorts, Limited for the year ended December 31, 2022 was primarily related to a gain recognized upon closing of the EBH Transaction and decreased marketing costs at Wynn Interactive.Financial results for the year ended December 31, 2022 compared to the year ended December 31, 2021.Operating revenuesThe following table presents our operating revenues (dollars in thousands): Year Ended December 31, 20222021Increase/ (Decrease)Percent ChangeOperating revenuesMacau Operations:Wynn Palace$410,289 $883,007 $(472,718)(53.5)Wynn Macau311,249 626,015 (314,766)(50.3)Total Macau Operations721,538 1,509,022 (787,484)(52.2)Las Vegas Operations2,132,136 1,503,681 628,455 41.8 Encore Boston Harbor 831,073 691,523 139,550 20.2 Wynn Interactive72,078 59,438 12,640 21.3 $3,756,825 $3,763,664 $(6,839)(0.2)37 Table of ContentsThe following table presents our casino and non-casino operating revenues (dollars in thousands): Year Ended December 31, 20222021Increase/ (Decrease)Percent ChangeOperating revenuesCasino revenues$1,632,541 $2,133,420 $(500,879)(23.5)Non-casino revenues:Rooms802,138 592,571 209,567 35.4 Food and beverage846,214 633,911 212,303 33.5 Entertainment, retail and other475,932 403,762 72,170 17.9 Total non-casino revenues2,124,284 1,630,244 494,040 30.3 $3,756,825 $3,763,664 $(6,839)(0.2)Casino revenues for the year ended December 31, 2022 were 43.5% of operating revenues, compared to 56.7% for the same period of 2021. Non-casino revenues for the year ended December 31, 2022 were 56.5% of operating revenues, compared to 43.3% for the year ended December 31, 2021. 38 Table of ContentsCasino revenuesCasino revenues decreased as a result of lower gaming volumes at our Macau Operations due to pandemic-related travel restrictions, offset by higher gaming volumes at our Las Vegas Operations and Encore Boston Harbor. The table below sets forth our casino revenues and associated key operating measures (dollars in thousands, except for win per unit per day): Year Ended December 31, 20222021Increase/ (Decrease)Percent ChangeMacau Operations (1): Wynn Palace:Total casino revenues$255,886 $677,917 $(422,031)(62.3)VIP: Average number of table games53 93 (40)(43.0)VIP turnover$2,641,321 $6,435,947 $(3,794,626)(59.0)VIP table games win$23,471 $253,767 $(230,296)(90.8)VIP win as a % of turnover0.89 %3.94 %(3.05)Table games win per unit per day$1,259 $7,443 $(6,184)(83.1)Mass market: Average number of table games229 229 — — Table drop $1,312,786 $2,415,841 $(1,103,055)(45.7)Table games win$282,138 $540,234 $(258,096)(47.8)Table games win % 21.5 %22.4 %(0.9)Table games win per unit per day$3,489 $6,463 $(2,974)(46.0)Average number of slot machines623 710 (87)(12.3)Slot machine handle$732,197 $1,454,577 $(722,380)(49.7)Slot machine win$31,295 $58,152 $(26,857)(46.2)Slot machine win per unit per day$142 $224 $(82)(36.6) Wynn Macau:Total casino revenues$216,639 $476,999 $(260,360)(54.6)VIP: Average number of table games41 81 (40)(49.4)VIP turnover$1,771,143 $5,488,118 $(3,716,975)(67.7)VIP table games win$55,999 $155,064 $(99,065)(63.9)VIP win as a % of turnover3.16 %2.83 %0.33 Table games win per unit per day$3,828 $5,250 $(1,422)(27.1)Mass market: Average number of table games235 240 (5)(2.1)Table drop $1,170,633 $2,230,348 $(1,059,715)(47.5)Table games win$189,769 $412,753 $(222,984)(54.0)Table games win % 16.2 %18.5 %(2.3)Table games win per unit per day$2,284 $4,720 $(2,436)(51.6)Average number of slot machines646 587 59 10.1 Slot machine handle$895,466 $1,057,303 $(161,837)(15.3)Slot machine win$31,768 $35,483 $(3,715)(10.5)Slot machine win per unit per day$139 $166 $(27)(16.3)39 Table of Contents Year Ended December 31, 20222021Increase/ (Decrease)Percent ChangeLas Vegas Operations:Total casino revenues$535,279 $426,440 $108,839 25.5 Average number of table games234 210 24 11.4 Table drop$2,274,010 $1,842,792 $431,218 23.4 Table games win$511,746 $407,195 $104,551 25.7 Table games win %22.5 %22.1 %0.4 Table games win per unit per day$5,990 $5,323 $667 12.5 Average number of slot machines1,703 1,688 15 0.9 Slot machine handle$5,617,775 $4,379,421 $1,238,354 28.3 Slot machine win$394,052 $297,548 $96,504 32.4 Slot machine win per unit per day$634 $483 $151 31.3 Poker rake$19,680 $14,552 $5,128 35.2 Encore Boston Harbor (2):Total casino revenues$624,738 $552,064 $72,674 13.2 Average number of table games187 189 (2)(1.1)Table drop$1,447,851 $1,267,908 $179,943 14.2 Table games win$315,057 $273,174 $41,883 15.3 Table games win %21.8 %21.5 %0.3 Table games win per unit per day$4,604 $3,959 $645 16.3 Average number of slot machines2,716 2,387 329 13.8 Slot machine handle$5,007,772 $4,377,181 $630,591 14.4 Slot machine win$402,688 $358,827 $43,861 12.2 Slot machine win per unit per day$406 $412 $(6)(1.5)Poker rake$9,476 $— $9,476 NMNM - Not meaningful.(1) The results of our Macau Operations for the years ended December 31, 2022 and 2021 were negatively impacted by the closure of our casino operations in Macau for a 12-day period in July 2022 and certain travel-related restrictions and conditions, including COVID-19 testing and other mitigation procedures, related to the COVID-19 pandemic.(2) On January 25, 2021, Encore Boston Harbor restored 24-hour casino operations and reopened its hotel tower on a Thursday through Sunday weekly schedule. The property reopened its hotel tower to seven days per week as of September 1, 2021.40 Table of ContentsNon-casino revenuesThe table below sets forth our room revenues and associated key operating measures:Year Ended December 31,20222021Increase/ (Decrease)Percent ChangeMacau Operations: Wynn Palace:Total room revenues (dollars in thousands)$40,079 $69,022 $(28,943)(41.9)Occupancy38.4 %58.5 %(20.1)ADR$156 $182 $(26)(14.3)REVPAR$60 $107 $(47)(43.9) Wynn Macau:Total room revenues (dollars in thousands)$25,691 $50,492 $(24,801)(49.1)Occupancy41.1 %58.8 %(17.7)ADR$154 $213 $(59)(27.7)REVPAR$63 $125 $(62)(49.6)Las Vegas Operations:Total room revenues (dollars in thousands)$651,291 $425,777 $225,514 53.0 Occupancy86.7 %69.5 %17.2 ADR$454 $386 $68 17.6 REVPAR$393 $268 $125 46.6 Encore Boston Harbor (1):Total room revenues (dollars in thousands)$85,078 $47,280 $37,798 79.9 Occupancy91.4 %85.2 %6.2 ADR$382 $328 $54 16.5 REVPAR$349 $279 $70 25.1 (1) Encore Boston Harbor room statistics have been computed based on 250 days of operation in the year ended December 31, 2021, representing the number of nights hotel rooms were offered for sale to the public. The property reopened its hotel tower to seven days per week as of September 1, 2021.Room revenues increased $209.6 million, primarily due to higher occupancy and ADR at our Las Vegas Operations and Encore Boston Harbor. Food and beverage revenues increased $212.3 million, primarily due to increased restaurant covers and nightlife revenues at our Las Vegas Operations. Entertainment, retail and other revenues increased $72.2 million, primarily due to increased convention sales, retail revenues from our owned and leased outlets, and entertainment venue sales, including tickets sales for the exclusive production Awakening which premiered in November 2022, all at our Las Vegas Operations.41 Table of ContentsOperating expensesThe table below presents operating expenses (dollars in thousands): Year Ended December 31, 20222021Increase/ (Decrease)Percent ChangeOperating expenses:Casino$1,099,801 $1,394,098 $(294,297)(21.1)Rooms261,343 197,734 63,609 32.2 Food and beverage700,549 516,391 184,158 35.7 Entertainment, retail and other328,529 450,358 (121,829)(27.1)General and administrative830,450 796,592 33,858 4.3 Provision for credit losses(7,295)29,487 (36,782)(124.7)Pre-opening20,643 6,821 13,822 202.6 Depreciation and amortization692,318 715,962 (23,644)(3.3)Gain on EBH Transaction, net (181,989)— (181,989)NMProperty charges and other113,152 50,762 62,390 122.9 Total operating expenses$3,857,501 $4,158,205 $(300,704)(7.2)NM - Not meaningful.Total operating expenses decreased $300.7 million compared to the year ended December 31, 2021, due to decreased casino expenses and the gain recorded in connection with the EBH Transaction. Casino expenses decreased $231.9 million and $150.8 million at Wynn Palace and Wynn Macau, respectively. These decreases were primarily due to reductions in gaming tax expense driven by the declines in casino revenues at each of Wynn Palace and Wynn Macau, resulting from pandemic-related travel restrictions, partially offset by increased casino expenses of $45.5 million and $42.9 million at our Las Vegas Operations and Encore Boston Harbor, respectively, primarily due to increased operating costs, including gaming tax expense, driven by the increase in casino revenues. Room expenses increased $49.4 million and $19.2 million at our Las Vegas Operations and Encore Boston Harbor, respectively. These increases were primarily a result of higher operating costs related to the increase in occupancy. Food and beverage expenses increased $173.9 million and $19.8 million at our Las Vegas Operations and Encore Boston Harbor, respectively. These increases were primarily a result of higher operating costs related to the increase in food and beverage revenues as well as higher nightlife entertainment costs associated with increased business volumes at our Las Vegas Operations' nightlife venues. Entertainment, retail and other expenses decreased $165.6 million at Wynn Interactive, primarily due to decreased marketing costs, partially offset by an increase of $48.3 million at our Las Vegas operations, primarily due to higher operating costs associated with increased levels of business. General and administrative expenses increased primarily due to increases of $44.5 million and $30.4 million at our Las Vegas Operations and Encore Boston Harbor, respectively. These increases were attributable to increased payroll and operating costs resulting from higher business volumes, partially offset by decreased general and administrative expenses of $19.1 million and $17.3 million at Wynn Palace and Wynn Macau, respectively, due to decreased payroll and operating costs attributable to lower business volumes. The provision for credit losses decreased $17.3 million, $14.0 million, and $5.9 million at Wynn Palace, Wynn Macau, and our Las Vegas Operations, respectively. The decreases were primarily due to the impact of historical collection patterns and expectations of current and future collection trends, as well as the specific review of customer accounts, on our estimated credit loss for the respective periods.For the year ended December 31, 2022, pre-opening expenses totaled $20.6 million, which primarily related to reconfiguring the theater space at Wynn Las Vegas to host an all-new, exclusive theatrical production, Awakening, which 42 Table of Contentspremiered in November 2022. For the year ended December 31, 2021, pre-opening expenses totaled $6.8 million, which primarily related to restaurant remodels at our Las Vegas Operations. Depreciation and amortization decreased $37.8 million at Wynn Palace, primarily due to certain furniture, fixture and equipment assets reaching the end of their useful lives in the first quarter of 2022.We recorded a gain of $182.0 million related to the closing of the EBH Transaction in December 2022. Property charges and other expenses for the year ended December 31, 2022 consisted primarily of restructuring costs incurred by Wynn Interactive, including contract termination costs of $32.8 million and impairment of goodwill and other finite-lived intangible assets of $37.8 million and $10.3 million, respectively. In addition, we incurred asset abandonments of $3.3 million, $22.6 million, and $1.3 million at our Las Vegas Operations, Wynn Palace, and Wynn Macau, respectively. Our property charges and other expenses for the year ended December 31, 2021 consisted primarily of advocacy-related expenses of $12.5 million and impairment of goodwill of $10.3 million at Wynn Interactive, asset abandonments of $9.7 million, $4.2 million, $2.3 million, and $1.8 million at our Las Vegas Operations, Wynn Palace, Encore Boston Harbor, and Wynn Macau, respectively, and other contingency expenses of $8.7 million at Wynn Macau.Interest expense, net of capitalized interestThe following table summarizes information related to interest expense (dollars in thousands): Year Ended December 31, 20222021Increase/ (Decrease)Percent ChangeInterest expenseInterest cost, including amortization of debt issuance costs and original issue discount and premium$650,885 $605,562 $45,323 7.5 Weighted average total debt balance$12,135,627 $12,195,881 Weighted average interest rate5.36 %4.96 %Interest costs increased primarily due to an increase in the weighted average interest rate. Other non-operating income and expensesWe incurred a foreign currency remeasurement gain of $5.8 million and a loss of $23.9 million for the years ended December 31, 2022 and 2021, respectively. The impact of the exchange rate fluctuation of the Macau pataca, in relation to the U.S. dollar, on the remeasurements of U.S. dollar denominated debt and other obligations from our Macau-related entities drove the variability between periods. We recorded a gain of $16.0 million and $11.4 million for the years ended December 31, 2022 and 2021, respectively, from change in derivatives fair value.We recorded a $2.1 million loss on extinguishment of debt for the year ended December 31, 2021 related to full prepayments of the Wynn Macau Credit Facilities.Income TaxesFor the years ended December 31, 2022 and 2021, we recorded an income tax expense of $9.3 million and $0.5 million, respectively. The 2022 income tax expense primarily relates to U.S. profitability and changes in U.S. deferred taxes. The 2021 income tax expense primarily relates to the Macau dividend tax agreement that provides for an annual payment of MOP 12.8 million (approximately $1.6 million) as complementary tax otherwise due by stockholders of Wynn Macau SA partially offset by a decrease in foreign deferred tax liabilities related to intangibles.43 Table of ContentsIn March 2021, the Company received an extension of its Macau dividend tax agreement, providing for a payment of MOP 12.8 million (approximately $1.6 million) for 2021 and MOP 6.3 million (approximately $0.8 million) for the period ending June 26, 2022. In December 2022, the Company applied for an extension of this agreement from June 27, 2022 through December 31, 2022 , the date Concession Extension Agreement expired. The extension is subject to approval.In April 2020, Wynn Macau SA received an extension of the exemption from Macau's 12% Complementary Tax on casino gaming profits earned from January 1, 2021 to June 26, 2022. In September 2022, Wynn Macau SA received an extension of the exemption from the Complementary Tax on casino gaming profits through December 31, 2022. For the years ended December 31, 2022 and 2021, we did not have any casino gaming profits exempt from the Macau Complementary Tax. Our non-gaming profits remain subject to the Macau Complementary Tax and casino winnings remain subject to the Macau special gaming tax and other levies together totaling 39% in accordance with our concession agreement. In December 2022, the Company applied for an exemption from Complementary Tax on casino gaming profits commencing January 1, 2023. The application is subject to approval.Net loss attributable to noncontrolling interestsNet loss attributable to noncontrolling interests was $285.5 million for the year ended December 31, 2022, compared to net loss of $256.2 million for the year ended December 31, 2021. These amounts are primarily related to the noncontrolling interests' share of net loss from WML. Segment InformationAs further described in Item 8—"Financial Statements and Supplementary Data," Note 19, "Segment Information," we use Adjusted Property EBITDAR to manage the operating results of our segments. Adjusted Property EBITDAR is net income (loss) before interest, income taxes, depreciation and amortization, pre-opening expenses, gain on EBH Transaction, net, property charges and other, triple-net operating lease rent expense related to Encore Boston Harbor, management and license fees, corporate expenses and other (including intercompany golf course, meeting and convention, and water rights leases), stock-based compensation, change in derivatives fair value, loss on extinguishment of debt, and other non-operating income and expenses. Adjusted Property EBITDAR is presented exclusively as a supplemental disclosure because management believes that it is widely used to measure the performance, and as a basis for valuation, of gaming companies. Management uses Adjusted Property EBITDAR as a measure of the operating performance of its segments and to compare the operating performance of its properties with those of its competitors, as well as a basis for determining certain incentive compensation. We also present Adjusted Property EBITDAR because it is used by some investors to measure a company's ability to incur and service debt, make capital expenditures and meet working capital requirements. Gaming companies have historically reported EBITDAR as a supplement to GAAP. In order to view the operations of their casinos on a more stand-alone basis, gaming companies, including us, have historically excluded from their EBITDAR calculations preopening expenses, property charges, corporate expenses and stock-based compensation, that do not relate to the management of specific casino properties. However, Adjusted Property EBITDAR should not be considered as an alternative to operating income (loss) as an indicator of our performance, as an alternative to cash flows from operating activities as a measure of liquidity, or as an alternative to any other measure determined in accordance with GAAP. Unlike net income (loss), Adjusted Property EBITDAR does not include depreciation or interest expense and therefore does not reflect current or future capital expenditures or the cost of capital. We have significant uses of cash flows, including capital expenditures, triple-net operating lease rent expense related to Encore Boston Harbor, interest payments, debt principal repayments, income taxes and other non-recurring charges, which are not reflected in Adjusted Property EBITDAR. Also, our calculation of Adjusted Property EBITDAR may be different from the calculation methods used by other companies and, therefore, comparability may be limited.44 Table of ContentsThe following table summarizes Adjusted Property EBITDAR (in thousands) for Wynn Palace, Wynn Macau, Las Vegas Operations, and Encore Boston Harbor as reviewed by management and summarized in Item 8—"Financial Statements and Supplementary Data," Note 19, "Segment Information." That footnote also presents a reconciliation of Adjusted Property EBITDAR to net loss attributable to Wynn Resorts, Limited.Year Ended December 31,20222021Increase/ (Decrease)Wynn Palace$(96,557)$91,646 $(188,203)Wynn Macau(124,047)4,209 (128,256)Las Vegas Operations801,095 530,878 270,217 Encore Boston Harbor243,386 210,068 33,318 Wynn Interactive(98,490)(267,360)168,870 Adjusted Property EBITDAR at Wynn Palace and Wynn Macau decreased $188.2 million and $128.3 million for the year ended December 31, 2022, respectively, primarily due to a decrease in operating revenues, partially offset by a decrease in operating expenses. Our Macau Operations for the year ended December 31, 2022 continued to be negatively impacted by certain travel-related restrictions and conditions, including COVID-19 testing and other procedures related to the COVID-19 pandemic. Adjusted Property EBITDAR at our Las Vegas Operations increased $270.2 million for the year ended December 31, 2022, primarily due to an increase in revenues from hotel and food and beverage operations.Adjusted Property EBITDAR at Encore Boston Harbor increased $33.3 million for the year ended December 31, 2022, primarily due to an increase in revenues from casino and hotel operations, partially offset by increased operating expenses.Adjusted Property EBITDAR at Wynn Interactive increased $168.9 million for the year ended December 31, 2022, primarily due to decreased marketing and promotional expenses. Refer to the discussions above regarding the specific details of our results of operations. 45 Table of ContentsLiquidity and Capital Resources Our cash flows were as follows (in thousands):Year Ended December 31,Cash Flows - Summary 20222021Net cash used in operating activities$(71,272)$(222,591)Net cash provided by (used in) investing activities: Capital expenditures, net of construction payables and retention(300,127)(290,657)Purchase of intangible and other assets(52,377)(56,034)Proceeds from EBH Transaction1,700,000 — Proceeds from sale of assets and other1,471 4,268 Net cash provided by (used in) investing activities1,348,967 (342,423)Net cash used in financing activities: Proceeds from issuance of long-term debt211,435 1,340,281 Repayments of long-term debt(50,000)(2,488,401)Proceeds from issuance of Wynn Resorts, Limited common stock— 841,896 Repurchase of common stock(187,499)(13,842)Proceeds from issuance of subsidiary common stock2,895 4,662 Proceeds from sale of noncontrolling interest in subsidiary50,033 — Payments to acquire ownership interest in subsidiary— (5,433)Distribution to noncontrolling interest(27,744)(18,761)Dividends paid(1,445)(1,553)Finance lease payments(18,188)(15,658)Payments for financing costs(3,165)(31,193)Net cash used in financing activities(23,678)(388,002)Effect of exchange rate on cash, cash equivalents and restricted cash (2,094)(2,301)Increase (decrease) in cash, cash equivalents and restricted cash $1,251,923 $(955,317)Operating ActivitiesOur operating cash flows primarily consist of operating income (excluding depreciation and amortization and other non-cash charges), interest paid and earned, and changes in working capital accounts such as receivables, inventories, prepaid expenses, and payables. Our table games play is a mix of cash play and credit play, while our slot machine play is conducted primarily on a cash basis. A significant portion of our table games revenue is attributable to the play of a limited number of premium customers who gamble on credit. The ability to collect these gaming receivables may impact our operating cash flow for the period. Our rooms, food and beverage, and entertainment, retail and other revenue is conducted on a cash and credit basis. Accordingly, operating cash flows will be impacted by changes in operating income and accounts receivable, net.During the year ended December 31, 2022, the decrease in net cash used in operating activities was primarily due to a decrease in marketing expenses related to Wynn Interactive and an increase in customer deposits. During the year ended December 31, 2021, the decrease in net cash used in operating activities was primarily due to increased operating revenues, partially offset by an increase in operating expenses and changes in working capital accounts, including a decrease in customer deposits primarily due to withdrawals by gaming promoters. 46 Table of ContentsInvesting ActivitiesOur investing activities primarily consist of project capital expenditures and maintenance capital expenditures associated with maintaining and continually refining our world-class integrated resort properties.During the year ended December 31, 2022, we incurred capital expenditures of $226.4 million at our Las Vegas Operations primarily related to the Wynn Las Vegas room remodel and theater reconfiguration, and $20.2 million at Encore Boston Harbor, $31.9 million at Wynn Palace, and $13.0 million at Wynn Macau primarily related to maintenance capital expenditures. We also received $1.70 billion in cash proceeds upon closing of the EBH Transaction. In addition, we made a $40.2 million investment in an unconsolidated affiliate.During the year ended December 31, 2021, we incurred capital expenditures of $168.8 million at our Las Vegas Operations primarily related to the Wynn Las Vegas room remodel, and $38.7 million at Encore Boston Harbor, $37.2 million at Wynn Palace, and $25.2 million at Wynn Macau primarily related to maintenance capital expenditures.Financing ActivitiesDuring the year ended December 31, 2022, we repurchased 2,956,331 shares of our common stock for approximately $171.3 million under our equity repurchase program. We also borrowed $211.4 million under the WM Cayman II Revolver and made quarterly amortization payments under the WRF Term Loan totaling $50.0 million. In addition, we received a $50.0 million contribution from a noncontrolling interest holder in exchange for a 49.9% interest in certain retail space contributed by the Company to the Retail Joint Venture and used cash of $27.7 million for distributions to noncontrolling interest holders of the Retail Joint Venture. During the year ended December 31, 2021, we received proceeds of $841.9 million from our February 2021 equity offering and used $716.0 million of the proceeds from the equity offering to repay the outstanding borrowings under the WRF Revolver. We also paid $464.7 million of outstanding principal owed under the Wynn Macau Term Loan and prepaid the outstanding $1.26 billion of borrowings under the Wynn Macau Credit Facilities along with related financing costs, using proceeds from the borrowing of $1.09 billion under the WM Cayman II Revolver along with $200.0 million of cash. In addition, we borrowed $200.4 million under the WM Cayman II Revolver, and made quarterly amortization payments under the WRF Term Loan totaling $50.0 million.Capital ResourcesThe COVID-19 pandemic has materially impacted and may continue to materially impact our Macau Operations' business, financial condition, and results of operations. While as of February 27, 2023, there are no remaining entry restrictions or mandatory quarantine requirements in place for travelers to Macau or elsewhere that directly impact visitation to our other properties, and we believe our unrestricted cash, cash flows from operations and revolver borrowing capacity will enable us to fund our current obligations for the next twelve months and beyond. Nevertheless, given the inherent uncertainty around the likelihood, extent, and timing of a potential reimposition of restrictions on the general public, travel, or certain activities, management is unable to reasonably predict whether such restrictions would impact our properties in the future, or the extent such restrictions, if reimposed, would impact our results of operations, cash flows, or financial condition and our ability to access capital. Refer to Item 8—"Financial Statements and Supplementary Data," Note 7, "Long-Term Debt" in the accompanying consolidated financial statements for more information regarding each of the Company's debt agreements. The following table summarizes our unrestricted cash and cash equivalents and available revolver borrowing capacity, excluding capacity under intercompany loan agreements, presented by significant financing entity as of December 31, 2022 (in thousands):Total Cash and Cash EquivalentsRevolver Borrowing CapacityWynn Macau, Limited and subsidiaries$951,901 $— Wynn Resorts Finance, LLC (1)2,303,420 836,985 Wynn Resorts, Limited and other395,119 — Total$3,650,440 $836,985 (1) Excluding Wynn Macau, Limited and subsidiaries. 47 Table of ContentsWynn Macau, Limited and subsidiaries. WML generates cash from our Macau Operations and may utilize proceeds from the WM Cayman II Revolver and its intercompany revolving loan facility with Wynn Resorts, Limited to fund working capital requirements as needed. We expect to use this cash to fund working capital and capital expenditure requirements at WML and our Macau Operations, and to service our WML Senior Notes and WM Cayman II Revolver. WML paid no dividends during 2022 or 2021.The borrowings under the WM Cayman II Revolver bear interest at LIBOR or HIBOR plus a margin of 2.625% per annum until June 30, 2022, the date from which the margin will be 1.875% to 2.875% per annum based on WM Cayman II’s leverage ratio on a consolidated basis, subject to a floor on the interest rate margin of 2.625% per annum through June 30, 2023. The final maturity of all outstanding loans under the Revolving Facility is September 16, 2025.On May 5, 2022, WM Cayman II and its lenders agreed to waive certain financial covenants in the facility agreement under the WM Cayman II Revolver in respect of the relevant periods ending on the following applicable test dates: (a) June 30, 2022; (b) September 30, 2022; (c) December 31, 2022; and (d) March 31, 2023; and to provide for a floor on the interest rate margin of 2.625% per annum through June 30, 2023. WML, as guarantor, may be subject to certain restrictions on payments of dividends or distributions to its shareholders, unless certain financial criteria have been satisfied through the facility agreement.If our portion of our cash and cash equivalents were repatriated to the U.S. on December 31, 2022, it would be subject to minimal U.S. taxes in the year of repatriation.Wynn Resorts Finance, LLC and subsidiaries. Wynn Resorts Finance, LLC ("WRF" or "Wynn Resorts Finance") generates cash from distributions from its subsidiaries, which include our Macau Operations, Wynn Las Vegas, and Encore Boston Harbor, and capital contributions from Wynn Resorts, as required. In addition, WRF may utilize its available revolving borrowing capacity as needed. We expect to use this cash to service our WRF Credit Facilities, the WRF Senior Notes and the Wynn Las Vegas Senior Notes, and to fund working capital and capital expenditure requirements as needed. WRF is a holding company and, as a result, its ability to pay dividends to Wynn Resorts is dependent on WRF receiving distributions from its subsidiaries, which include WML, Wynn Las Vegas, LLC, and Wynn MA. The WRF Credit Agreement contains customary negative and financial covenants, including, but not limited to, covenants that restrict WRF's ability to pay dividends or distributions and incur additional indebtedness. In June 2022, Wynn Las Vegas completed its hotel room remodel for total project costs of approximately $215 million. In October 2022, Wynn Las Vegas completed its theater reconfiguration for total project costs of approximately $110 million. The specially redesigned theater was custom designed to host an all-new, exclusive theatrical production, Awakening, which premiered in November 2022.Upon closing of the EBH Transaction in December 2022, we received cash proceeds of approximately $1.70 billion in exchange for the sale of certain real estate assets related to Encore Boston Harbor, and concurrently entered into a lease agreement for the purpose of continuing to operate the Encore Boston Harbor integrated resort. The triple-net lease agreement provides for an initial annual minimum base rent of $100.0 million for an initial term of 30 years, subject to certain annual rent escalations and renewal provisions, and obligates the Company to continue paying certain payments in lieu of property taxes. We expect to use the proceeds from the EBH Transaction in accordance with the reinvestment and asset sale provisions of our senior secured credit facilities. On February 16, 2023, WRF issued $600.0 million aggregate principal amount of 7 1/8% Senior Notes due 2031 (the "2031 WRF Senior Notes") in a private offering. The 2031 WRF Senior Notes were issued at par, for proceeds of $596.2 million, net of $3.8 million of related fees and expenses. Also on February 16, 2023, WRF completed a cash tender offer for any and all of the outstanding principal amount of the 2025 WRF Senior Notes, and accepted for purchase valid tenders with respect to $506.4 million and paid a tender premium of $12.4 million. We used a portion of the net proceeds from the offering of the 2031 WRF Senior Notes to purchase such tendered 2025 WRF Senior Notes and to pay related fees and expenses, and intend to use the remaining net proceeds for general corporate purposes. We intend to redeem the remaining outstanding 2025 WRF Senior Notes using cash held by WRF on or after April 15, 2023, when such senior notes are redeemable at a price equal to 101.938% of the principal amount plus accrued interest under the terms of their indenture.48 Table of ContentsWe intend to repurchase or redeem all of the outstanding Wynn Las Vegas 4.25% Senior Notes due 2023 using cash held by WRF during or after March 2023, when such senior notes are redeemable at a price equal to 100% of the principal amount plus accrued interest under the terms of their indenture.Wynn Resorts, Limited and other subsidiaries. Wynn Resorts, Limited is a holding company and, as a result, our ability to pay dividends is dependent on our ability to obtain funds and our subsidiaries' ability to provide funds to us. Wynn Resorts, Limited and other primarily generates cash from royalty (including intellectual property license) and management agreements with our resorts, dividends and distributions from our subsidiaries, and the operations of the Retail Joint Venture of which we own 50.1%. Fees payable by Wynn Macau SA to Wynn Resorts, Limited under its intellectual property license agreement are capped at $75.2 million for the year ended December 31, 2023. We expect to use cash held by Wynn Resorts, Limited and other to service our Retail Term Loan, to fund working capital needs of our subsidiaries, and for general corporate purposes.Other Factors Affecting LiquidityWe may refinance all or a portion of our indebtedness on or before maturity. We cannot assure you that we will be able to refinance any of the indebtedness on acceptable terms or at all.Legal proceedings in which we are involved also may impact our liquidity. No assurance can be provided as to the outcome of such proceedings. In addition, litigation inherently involves significant costs. For information regarding legal proceedings, see Item 8—"Financial Statements and Supplementary Data," Note 17, "Commitments and Contingencies."In April 2016, our Board of Directors has authorized an equity repurchase program of up to $1.00 billion. Under the equity repurchase program, we may repurchase the Company's outstanding shares from time to time through open market purchases, in privately negotiated transactions, and under plans complying with Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). We repurchased 2,956,331 shares of our common stock at an average price of $57.95 per share, for an aggregate cost of $171.3 million under this equity repurchase program during the year ended December 31, 2022. As of December 31, 2022, we had $628.8 million in repurchase authority remaining under the program.We have in the past repurchased, and in the future, we may periodically consider repurchasing our outstanding notes for cash. The amount of any shares and/or notes to be repurchased, as well as the timing of any repurchases, will be based on business, market and other conditions and factors, including price, contractual requirements or consents, and capital availability.New business developments or other unforeseen events may occur, resulting in the need to raise additional funds. We continue to explore opportunities to develop additional gaming or related businesses in domestic and international markets. There can be no assurances regarding the business prospects with respect to any other opportunity. Any new development may require us to obtain additional financing. We may decide to conduct any such development through Wynn Resorts, Limited or through subsidiaries separate from the Las Vegas, Boston or Macau-related entities.49 Table of ContentsContractual CommitmentsThe following table summarizes our scheduled contractual commitments as of December 31, 2022 (in thousands): Payments Due By PeriodLess Than1 Year1 to 3Years4 to 5YearsAfter5 YearsTotalLong-term debt obligations$550,000 $5,882,973 $2,630,000 $3,100,000 $12,162,973 Fixed interest payments490,579 812,367 469,254 217,411 1,989,611 Estimated variable interest payments (1)195,657 277,175 — — 472,832 Macau gaming premium (2)13,199 26,398 26,398 65,997 131,992 Macau Property Transfer Agreement payments (3)6,612 13,225 44,082 110,206 174,125 Construction contracts and commitments126,289 19,547 — — 145,836 Operating leases136,924 272,700 275,637 3,946,778 4,632,039 Finance leases19,913 14,293 2,589 62,784 99,579 Employment agreements (4)77,595 71,538 3,827 3,903 156,863 Massachusetts surrounding community payments (5)14,695 30,312 31,612 93,600 170,219 Other (6)203,299 96,620 40,435 68,246 408,600 Total contractual commitments$1,834,762 $7,517,148 $3,523,834 $7,668,925 $20,544,669 (1) Amounts for all periods represent our estimated future interest payments on our debt facilities based upon amounts outstanding and LIBOR or HIBOR rates as of December 31, 2022. Actual rates will vary.(2) Represents the fixed and minimum variable gaming premium amounts payable under the Gaming Concession Contract, based on the number and type of gaming tables and machines we operate. (3) Represents amounts payable under the Property Transfer Agreements (as defined in Item 8—"Financial Statements and Supplementary Data," Note 5, "Property and Equipment, net").(4) Represents payments to executive officers, other members of management and certain key employees. Employment agreements generally have three to five year terms and typically indicate a base salary and often contain provisions for discretionary bonuses. Certain of the executives are also entitled to a separation payment if terminated without "cause" or upon voluntary termination of employment for "good reason" following a "change of control" (as these terms are defined in the employment contracts). (5) Represents payments to certain communities surrounding Encore Boston Harbor, required as a condition of the gaming license awarded to Wynn MA, LLC.(6) Other includes open purchase orders, future charitable contributions, performance contracts and other contracts. As further discussed in Item 8—"Financial Statements and Supplementary Data," Note 13, "Income Taxes," we had $136.0 million of unrecognized tax benefits as of December 31, 2022. Due to the inherent uncertainty of the underlying tax positions, it is not practicable to assign this liability to any particular year and therefore it is not included in the table above as of December 31, 2022. On December 16, 2022, Wynn Macau SA entered into a definitive gaming concession contract (the "Gaming Concession Contract") with the government of Macau, pursuant to which Wynn Macau SA was granted a 10-year gaming concession commencing on January 1, 2023 and expiring on December 31, 2032, to operate games of chance at Wynn Palace and Wynn Macau.In addition to the Macau gaming premium and Property Transfer Agreements payment commitments included in the table above, Wynn Macau SA committed to pay a gaming tax assessed at the rate of 35% of gross gaming revenues, plus additional special levies equal to 5% of gross gaming revenues, throughout the term of the Gaming Concession Contract. Wynn Macau SA also committed to make certain non-gaming and gaming investments in the amount of MOP17.73 billion (approximately $2.21 billion) over the course of the ten-year term of the Gaming Concession Contract. MOP16.50 billion (approximately $2.05 billion) of the committed investment will be used for non-gaming capital projects and event programming in connection with, among others, attraction of foreign tourists, conventions and exhibitions, entertainment performances, sports events, culture and art, health and wellness, themed amusement, gastronomy, community tourism and maritime tourism. Wynn Macau SA will be required to increase its investment in non-gaming projects by 20% in the following year if market-wide gross gaming revenues increase to MOP180.00 billion (approximately $22.41 billion) in any one year (the "Trigger Event"). The required increase will be reduced to 16%, 12%, 8%, 4% or 0%, respectively, if the Trigger Event occurs during the sixth, seventh, eighth, ninth or tenth year of the concession period, respectively.See Item 8—"Financial Statements and Supplementary Data," Note 17, "Commitments and Contingencies," for additional information regarding the amounts owed under the Gaming Concession Contract and Macau gaming law.50 Table of ContentsCritical Accounting Policies and EstimatesThe preparation of our consolidated financial statements in conformity with GAAP involves the use of estimates and assumptions that affect the amounts reported in the consolidated financial statements. Certain of our accounting policies require management to apply significant judgment in defining the appropriate assumptions integral to financial estimates and on an ongoing basis, management evaluates those estimates. Judgments are based on historical experience, terms of existing contracts, industry trends and information available from outside sources, as appropriate. However, by their nature, judgments are subject to an inherent degree of uncertainty, and therefore actual results could differ from our estimates.Sale-leaseback TransactionOn December 1, 2022, the Company closed on a sale-leaseback arrangement with respect to certain real estate assets related to Encore Boston Harbor (the "EBH Transaction"). Upon closing of the EBH Transaction, the Company received cash proceeds of approximately $1.70 billion in exchange for the sale of such real estate assets, recognizing a gain on sale of $182.0 million, and concurrently entered into a lease agreement with respect to the sold assets for the purpose of continuing to operate the Encore Boston Harbor integrated resort. Upon entering into the lease agreement, the Company recognized an operating lease asset and a corresponding operating lease liability of $1.51 billion.Accounting for sale-leaseback transactions requires significant management judgement and estimates, including with respect to the determination of whether the transaction qualifies as a sale as defined within GAAP, operating versus finance lease classification, and inputs into the measurement of lease assets and liabilities. In determining whether the transaction qualifies as a sale, we are required to assess whether a contract exists and if so, whether control has passed to the counterparty in the contract. Control indicators include, but are not limited to, whether the entity has a present right to payment for the asset, whether the customer has legal title to the asset, whether the entity has transferred physical possession of the asset, whether the customer has significant risks and rewards of ownership of the asset, and whether the customer has accepted the asset. Concluding whether a sale has occurred requires significant judgement in determining whether the rights and obligations created by the sale agreement convey control to the counterparty in the transaction.In a sale-leaseback arrangement, we are required to determine whether the lease is classified as an operating lease or a finance lease. A finance lease would preclude sale accounting. A lessee is required to classify a lease as a finance lease if, among other factors, (1) the term is for the major part of the remaining economic life of the underlying asset or 2) the present value of the sum of the lease payments equals or exceeds substantially all of the fair value of the underlying asset. Lease terms include options to extend the lease when it is reasonably certain that such option will be exercised. The Company’s operating lease related to Encore Boston Harbor contains an initial term of 30 years from December 2022 to November 2052 with one thirty-year renewal period at the Company’s option, which, in management judgement, is not considered to be reasonably certain of being exercised. The determination of whether the present value of the sum of the lease payments equals or exceeds substantially all of the fair value of the underlying asset requires the use of estimates, in both determining the discount rate to measure the present value of the sum of the lease payments and in determining the fair value of the underlying assets. As the interest rate implicit in our leases is not readily determinable, we use our incremental borrowing rate, which is defined by GAAP as the "rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment," to determine the present value of lease payments. Inputs into our selected incremental borrowing rate which require management's judgement include quantifying our entity-specific credit risk and risks associated with the economic environment specific to the leased assets. In determining the fair value of the underlying assets, we use a combination of the income, market, and cost approaches, which include inputs such as estimated future cash flows, the selection of recently sold comparable properties, and estimated cost to construct a comparable asset. 51 Table of ContentsAllowance for Credit LossesA substantial portion of our outstanding receivables relates to casino credit play. Credit play, through the issuance of markers, represents a significant portion of the table games volume. Our goal is to maintain strict controls over the issuance of credit and aggressively pursue collection from those customers who fail to pay their balances in a timely fashion. These collection efforts may include the mailing of statements and delinquency notices, personal contacts, the use of outside collection agencies, and litigation. Markers issued at our Las Vegas Operations and Encore Boston Harbor are generally legally enforceable instruments in the United States, and United States assets of foreign customers may be used to satisfy judgments entered in the United States.The enforceability of markers and other forms of credit related to gaming debt outside of the United States varies from country to country. Some foreign countries do not recognize the enforceability of gaming related debt, or make enforcement burdensome. We closely consider the likelihood and difficulty of enforceability, among other factors, when issuing credit to customers who are not residents of the United States. In addition to our internal credit and collection departments, we have a network of legal, accounting and collection professionals to assist us in our determinations regarding enforceability and our overall collection efforts.We regularly evaluate our reserve for credit losses based on a specific review of customer accounts and outstanding gaming promoter accounts, taking into consideration the amount owed, the age of the account, the customer's financial condition, management's experience with historical and current collection trends, current economic and business conditions, and management's expectations of future economic and business conditions and forecasts. Accounts are written off when management deems them to be uncollectible. Recoveries of accounts previously written off are recorded when received. The following table presents key statistics related to our casino accounts receivable (dollars in thousands):December 31,20222021Casino accounts receivable$171,893 $199,030 Allowance for casino credit losses $74,207 $106,958 Allowance as a percentage of casino accounts receivable43.2 %53.7 %The decrease in allowance for casino credit losses as shown in the table above is primarily due to the impact of historical collection patterns and expectations of current and future collection trends, as well as the specific review of customer accounts. Although the Company believes that its allowance is adequate, it is possible the estimated amounts of cash collections with respect to receivables could change. Our allowance for credit losses is based on our estimates of amounts collectible and depends on the risk assessments and judgments by management regarding realizability, the current and expected future state of the economy and our credit policy. Our reserve methodology is applied similarly to credit extended at each of our resorts. As of December 31, 2022 and 2021, 34.3% and 42.9%, respectively, of our outstanding casino accounts receivable balance originated at our Macau Operations. As of December 31, 2022, a 100 basis point change in the allowance for credit losses as a percentage of casino accounts receivable would change the provision for credit losses by approximately $1.7 million.As our customer payment experience evolves, we will continue to refine our estimated allowance for credit losses. Accordingly, the associated provision for credit losses may fluctuate. Because individual customer account balances can be significant, the reserve and the provision can change significantly between periods as we become aware of additional information about a customer or changes occur in a region's economy or legal system.Impairment of Long-lived Assets, Intangible assets, and GoodwillWe evaluate our property and equipment and other long-lived assets for impairment in accordance with applicable accounting standards. For assets to be disposed of we recognize the asset at the lower of carrying value or fair market value less costs of disposal, as estimated based on comparable asset sales, solicited offers, or a discounted cash flow model. For assets to be held and used, we review for impairment whenever indicators of impairment exist. In reviewing for impairment, we compare the estimated future cash flows of the asset, on an undiscounted basis, to the carrying value of the asset. If the undiscounted cash flows exceed the carrying value, no impairment is indicated. If the undiscounted cash flows do not exceed the carrying value, an impairment is recorded based on the fair value of the asset, typically measured using a discounted cash flow model. If 52 Table of Contentsan asset is still under development, future cash flows include remaining construction costs. All recognized impairment losses, whether for assets to be disposed of or assets to be held and used, are recorded as operating expenses.During the year ended December 31, 2022, Wynn Palace and Wynn Macau continued to experience disruptions to their respective businesses as a result of the COVID-19 pandemic as noted in Note 1, "Organization and Business." As a result, we concluded that a triggering event occurred at each of these asset groups. We tested our asset groups for recoverability as of December 31, 2022, and concluded no impairment existed at that date as the estimated undiscounted future cash flows exceeded the net carrying amount for each of the asset groups. The tests for recoverability include estimates of future cash flows and the useful lives of our primary assets. These estimates are subjective and may change should the COVID-19 pandemic, including travel restrictions and operating capacity limitations, persist longer than expected. Unfavorable changes in the Company's estimates could require an impairment charge in the future.The Company tests goodwill for impairment annually, or more frequently if events or changes in circumstances indicate that this asset may be impaired. The Company’s test of goodwill impairment starts with a qualitative assessment to determine whether it is necessary to perform a quantitative goodwill impairment test. If qualitative factors indicate that the fair value of the reporting unit is more likely than not less than its carrying amount, then a quantitative goodwill impairment test is performed. For the quantitative analysis, the Company compares the fair value of its reporting unit to its carrying value. If the estimated fair value exceeds its carrying value, goodwill is considered not to be impaired and no additional steps are necessary. However, if the fair value of the reporting unit is less than its carrying amount, goodwill impairment is recorded equal to the difference between the carrying amount of the reporting unit and its fair value, not to exceed the carrying amount of goodwill. Most of the Company’s goodwill balance as of December 31, 2022 and 2021 was the result of an acquisition during the fourth quarter of 2020.During the year ended December 31, 2022, as a result of changes in forecasts and other industry-specific factors and management's decision to cease the operations of Betbull Limited ("BetBull"), a subsidiary of Wynn Interactive, the Company recognized impairment of goodwill and other finite-lived intangible assets of $37.8 million and $10.3 million, respectively. On November 12, 2021, Wynn Resorts announced the termination of a previously announced agreement and plan of merger which contemplated the combination of Wynn Interactive and a special purpose acquisition company. The Company concluded that the termination of the agreement constituted a potential indicator of impairment, and as a result of revisiting its estimated fair value of the reporting units comprising Wynn Interactive based on a combination of the income and market approaches, recognized goodwill impairment of $10.3 million during the year ended December 31, 2021.Litigation and Contingency EstimatesWe are subject to various claims, legal actions and other contingencies, and we accrue for these matters when they are both probable and estimable. For matters that arose on or prior to the balance sheet date, we estimate any accruals based on the relevant facts and circumstances available through the date of issuance of the financial statements. We include the accruals associated with any contingent matters in other accrued liabilities on the consolidated balance sheets.Item 7A. Quantitative and Qualitative Disclosures About Market Risk Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates and commodity prices.Interest Rate RisksOne of our primary exposures to market risk is interest rate risk associated with our debt facilities that bear interest based on floating rates. We attempt to manage interest rate risk by managing the mix of long-term fixed rate borrowings and variable rate borrowings, supplemented by hedging activities as believed by us to be appropriate. We cannot assure you that these risk management strategies will have the desired effect, and interest rate fluctuations could have a negative impact on our results of operations and cash flows. The following table provides estimated future cash flow information derived from our best estimates of repayments as of December 31, 2022, of our expected long-term indebtedness and related weighted average interest rates by expected maturity dates. However, we cannot predict the LIBOR or HIBOR rates that will be in effect in the future. Actual rates will vary. Additionally, the potential effect that the proposed LIBOR phaseout could have on our business and financial condition cannot yet be determined (see Item 1A—"Risk Factors," Risks Related to our Indebtedness for further discussion). The one-month 53 Table of ContentsLIBOR and HIBOR rates as of December 31, 2022 of 4.39% and 4.35%, respectively, were used for all variable rate calculations in the table below.The information is presented in U.S. dollar equivalents as applicable. Year Ending December 31,Expected Maturity Date20232024202520262027ThereafterTotal(dollars in millions)Long-term debt:Fixed rate$500.0 $600.0 $2,380.0 $1,000.0 $1,630.0 $3,100.0 $9,210.0 Average interest rate4.3 %4.9 %6.1 %5.5 %5.3 %5.4 %5.5 %Variable rate$50.0 $787.5 $2,115.5 $— $— $— $2,953.0 Average interest rate6.1 %6.1 %6.8 %— %— %— %6.6 %Interest Rate SensitivityAs of December 31, 2022, approximately 76.0% of our long-term debt was based on fixed rates. Based on our borrowings as of December 31, 2022 and an interest rate collar on the Retail Term Loan, an assumed 100 basis point increase or decrease in the variable rates would cause our annual interest expense to change by $23.4 million or $27.2 million, respectively.In order to mitigate exposure to interest rate fluctuations on the Retail Term Loan, the Company entered into a five year interest rate collar with a notional value of $615.0 million. The interest rate collar establishes a range whereby the Company will pay the counterparty if one-month LIBOR falls below the established floor rate of 1.00%, and the counterparty will pay the Company if one-month LIBOR exceeds the ceiling rate of 3.75%.Foreign Currency RisksThe currency delineated in Wynn Macau SA's Gaming Concession Contract with the government of Macau is the Macau pataca (see Item 1 - "Business - Regulation and Licensing - Macau" for further discussion). The Macau pataca, which is not a freely convertible currency, is linked to the Hong Kong dollar, and in many cases the two are used interchangeably in Macau. The Hong Kong dollar is linked to the U.S. dollar and the exchange rate between these two currencies has remained relatively stable over the past several years. However, the exchange linkages of the Hong Kong dollar and the Macau pataca, and the Hong Kong dollar and the U.S. dollar, are subject to potential changes due to, among other things, changes in Chinese governmental policies and international economic and political developments.If the Hong Kong dollar and the Macau pataca are not linked to the U.S. dollar in the future, severe fluctuations in the exchange rate for these currencies may result. We also cannot assure you that the current rate of exchange fixed by the applicable monetary authorities for these currencies will remain at the same level.We expect most of the revenues and expenses for any casino that we operate in Macau will be denominated in Hong Kong dollars or Macau patacas; however, a significant portion of our Wynn Macau, Limited and Wynn Macau SA debt is denominated in U.S. dollars. Fluctuations in the exchange rates resulting in weakening of the Macau pataca or the Hong Kong dollar in relation to the U.S. dollar could have materially adverse effects on our results, financial condition, and ability to service debt. Based on our balances as of December 31, 2022, an assumed 1% change in the U.S. dollar/Hong Kong dollar exchange rate would cause a foreign currency transaction gain/loss of $50.1 million.54 Table of Contents
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+ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.Management’s discussion and analysis of financial condition and results of operations is a supplement to and should be read in conjunction with the accompanying consolidated financial statements and related notes. This section provides additional information regarding our businesses, current developments, results of operations, cash flows, financial condition, contractual commitments, critical accounting policies, and estimates that require significant judgment and thus have the most significant potential impact on our consolidated financial statements. This discussion and analysis is intended to better allow investors to view the company from management's perspective.This section provides an analysis of our financial results for the fiscal year ended December 31, 2022 compared to the fiscal year ended December 31, 2021. A discussion of our results of operations and liquidity for the fiscal year ended December 31, 2021 compared to the fiscal year ended December 31, 2020 can be found under Item 7 in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed on February 24, 2022, which is available free of charge on the SEC’s website at www.sec.gov and our Investor Relations website at ir.wbd.com. The information contained on our website is not part of this Annual Report on Form 10-K and is not incorporated by reference herein.BUSINESS OVERVIEWOn April 8, 2022, Discovery, a global media company that provides content across multiple distribution platforms, including linear, free-to-air, and broadcast television, authenticated GO applications, digital distribution arrangements, content licensing arrangements, and DTC subscription products, completed its Merger with the WM Business of AT&T and changed its name from “Discovery, Inc.” to “Warner Bros. Discovery, Inc.” On April 11, 2022, our shares started trading on Nasdaq under the trading symbol WBD. (See Note 3 and Note 4 to the accompanying consolidated financial statements.)Warner Bros. Discovery is a premier global media and entertainment company that combines the WarnerMedia Business’s premium entertainment, sports and news assets with Discovery’s leading non-fiction and international entertainment and sports businesses, thus offering audiences a differentiated portfolio of content, brands and franchises across television, film, streaming and gaming. Some of our iconic brands and franchises include Warner Bros. Pictures Group, Warner Bros. Television Group, DC, HBO, HBO Max, Discovery Channel, discovery+, CNN, HGTV, Food Network, TNT, TBS, TLC, OWN, Warner Bros. Games, Batman, Superman, Wonder Woman, Harry Potter, Looney Tunes, Hanna-Barbera, Game of Thrones, and The Lord of the Rings. For a discussion of our global portfolio see our business overview set forth in Item 1, “Business” in this Annual Report on Form 10-K.In connection with the Merger, we have announced and taken actions to implement projects to achieve cost synergies for the Company. We finalized the framework supporting our ongoing restructuring and transformation initiatives during 2022, which include, among other things, strategic content programming assessments, organization restructuring, facility consolidation activities, and other contract termination costs. We expect that we will incur approximately $4.1 - $5.3 billion in pre-tax restructuring charges. Of the total expected pre-tax restructuring charges, we expect total cash expenditures to be $1.0 - $ 1.5 billion. We incurred $3.8 billion of pre-tax restructuring charges during the year ended December 31, 2022. While our restructuring efforts are ongoing, the restructuring program is expected to be substantially completed by the end of 2024.In connection with the Merger, we reevaluated and changed our segment presentation and reportable segments during 2022. As of December 31, 2022, we classified our operations in three reportable segments:•Studios, consisting primarily of the production and release of feature films for initial exhibition in theaters, production and initial licensing of television programs to third parties and our networks/DTC services, distribution of our films and television programs to various third party and internal television and streaming services, distribution through the home entertainment market (physical and digital), related consumer products and themed experience licensing, and interactive gaming;•Networks, consisting principally of our domestic and international television networks; and •DTC, consisting primarily of our premium pay-TV and streaming services. Our segment presentation was aligned with our management structure and the financial information management uses to make decisions about operating matters, such as the allocation of resources and business performance assessments. Prior periods have been recast to conform to the current period presentation.During 2022, we exited our operations in Russia and removed all of our channels and services from the market. We do not expect these actions to have a material effect on our consolidated financial statements. 33For further discussion of financial information for our segments and the geographical areas in which we do business, our content development activities, and revenues, see our business overview set forth in Item 1, “Business” and Note 23 to the consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. Impact of COVID-19We continue to closely monitor the ongoing impact of COVID-19 on all aspects of our business and geographies; however, the nature and full extent of COVID-19’s effects on our operations and results are not yet known and will depend on future developments, which are highly uncertain and cannot be predicted. Certain key sources of revenue for the Studios segment, including theatrical revenues, original television productions, studio operations, and themed entertainment, have been adversely impacted by governmentally imposed shutdowns and related labor interruptions and constraints on consumer activity, particularly in the context of public entertainment venues, such as cinemas and theme parks.34RESULTS OF OPERATIONSThe discussion below compares our actual and pro forma combined results, as if the Merger occurred on January 1, 2021, for the year ended December 31, 2022 to the year ended December 31, 2021. Management believes reviewing our combined operating results in addition to actual operating results is useful in identifying trends in, or reaching conclusions regarding, the overall operating performance of our businesses. Our Studios, Networks, DTC, Corporate, and inter-segment eliminations information is based on the historical operating results of the respective segments and include, where applicable, adjustments for (i) additional costs of revenues from the fair value step-up of film and television library, (ii) additional amortization expense related to acquired intangible assets, (iii) additional depreciation expense from the fair value of property and equipment, (iv) transaction costs and other one-time non-recurring costs, (v) additional interest expense for borrowings related to the Merger and amortization associated with fair value adjustments of debt assumed, (vi) changes to align accounting policies, (vii) elimination of intercompany activity, and (viii) associated tax-related impacts of adjustments.Adjustments do not include costs related to integration activities, cost savings or synergies that have been or may be achieved by the combined businesses. Pro forma amounts are not necessarily indicative of what our results would have been had we operated the combined businesses since January 1, 2021 and should not be taken as indicative of the Company’s future consolidated results of operations.Actual amounts for the year ended December 31, 2022 include results of operations for Discovery for the entire period and WM for the period subsequent to the completion of the Merger on April 8, 2022.Foreign Exchange Impacting ComparabilityIn addition to the Merger, the impact of exchange rates on our business is an important factor in understanding period-to-period comparisons of our results. For example, our international revenues are favorably impacted as the U.S. dollar weakens relative to other foreign currencies, and unfavorably impacted as the U.S. dollar strengthens relative to other foreign currencies. We believe the presentation of results on a constant currency basis (“ex-FX”), in addition to results reported in accordance with U.S. GAAP provides useful information about our operating performance because the presentation ex-FX excludes the effects of foreign currency volatility and highlights our core operating results. The presentation of results on a constant currency basis should be considered in addition to, but not a substitute for, measures of financial performance reported in accordance with U.S. GAAP.The ex-FX change represents the percentage change on a period-over-period basis adjusted for foreign currency impacts. The ex-FX change is calculated as the difference between the current year amounts translated at a baseline rate, which is a spot rate for each of our currencies determined early in the fiscal year as part of our forecasting process (the “2022 Baseline Rate”), and the prior year amounts translated at the same 2022 Baseline Rate. In addition, consistent with the assumption of a constant currency environment, our ex-FX results exclude the impact of our foreign currency hedging activities, as well as realized and unrealized foreign currency transaction gains and losses. Results on a constant currency basis, as we present them, may not be comparable to similarly titled measures used by other companies.35Consolidated Results of Operations – 2022 vs. 2021Our consolidated results of operations for 2022 and 2021 were as follows (in millions). Year Ended December 31,20222021% ChangeActualPro FormaAdjustmentsPro Forma CombinedActual (a)Pro FormaAdjustmentsPro Forma CombinedActualPro Forma Combined(Actual)Combined(ex-FX)Revenues:Advertising$8,524 $1,412 $9,936 $6,194 $4,395 $10,589 38 %(6)%(4)%Distribution16,142 4,339 20,481 5,202 15,579 20,781 NM(1)%— %Content8,360 3,297 11,657 737 12,455 13,192 NM(12)%(9)%Other791 230 1,021 58 706 764 NM34 %36 %Total revenues33,817 9,278 43,095 12,191 33,135 45,326 NM(5)%(3)%Costs of revenues, excluding depreciation and amortization20,442 5,125 25,567 4,620 21,353 25,973 NM(2)%1 %Selling, general and administrative9,678 1,745 11,423 4,016 8,987 13,003 NM(12)%(10)%Depreciation and amortization7,193 34 7,227 1,582 6,774 8,356 NM(14)%(13)%Restructuring3,757 (90)3,667 32 90 122 NMNMNMImpairment and loss (gain) on disposition and disposal groups117 — 117 (71)223 152 NM(23)%(23)%Total costs and expenses41,187 6,814 48,001 10,179 37,427 47,606 NM1 %3 %Operating (loss) income(7,370)2,464 (4,906)2,012 (4,292)(2,280)NMNMNMInterest expense, net(1,777)(515)(2,292)(633)(2,026)(2,659)Loss from equity investees, net(160)(20)(180)(18)14 (4)Other income, net347 139 486 72 100 172 (Loss) income before income taxes(8,960)2,068 (6,892)1,433 (6,204)(4,771)Income tax benefit (expense)1,663 (56)1,607 (236)1,448 1,212 Net (loss) income(7,297)2,012 (5,285)1,197 (4,756)(3,559)Net income attributable to noncontrolling interests(68)— (68)(138)— (138)Net income attributable to redeemable noncontrolling interests(6)— (6)(53)— (53)Net (loss) income available to Warner Bros. Discovery, Inc.$(7,371)$2,012 $(5,359)$1,006 $(4,756)$(3,750)(a) Prior year actual results have been recast to conform to the current period presentation as a result of the Merger and segment recast. NM - Not meaningfulUnless otherwise indicated, the discussion through operating (loss) income below is on a pro-forma combined basis, ex-FX, since the actual increases year over year for revenues, cost of revenues, and selling, general and administrative expenses are substantially attributable to the Merger. The percent changes of line items below operating (loss) income in the table above are not included as the activity is principally in U.S. dollars.RevenuesAdvertising revenues are principally generated from the sale of commercial time on linear (television networks and authenticated TVE applications) and digital platforms (DTC subscription services and websites), and sold primarily on a national basis in the U.S. and on a pan-regional or local-language feed basis outside the U.S. Advertising contracts generally have a term of one year or less. Advertising revenue is dependent upon a number of factors, including the number of subscribers to our channels, viewership demographics, the popularity of our content, our ability to sell commercial time over a group of channels, the stage of development of television markets, and the popularity of FTA television. Revenue from advertising is subject to seasonality, market-based variations, the mix in sales of commercial time between the upfront and scatter markets, and general economic conditions. Advertising revenue is typically highest in the second and fourth quarters. In some cases, advertising sales are subject to ratings guarantees that require us to provide additional advertising time if the guaranteed audience levels are not achieved. We also generate revenue from the sale of advertising through our digital platforms on a stand-alone basis and as part of advertising packages with our television networks.36Advertising revenue decreased 4% in 2022, primarily attributable to declines in domestic general entertainment and news networks, partially offset by subscriber growth on our DTC ad-supported tiers and higher sports advertising in the U.S. due to the NCAA Men's Final Four and Championship games airing on our networks and the addition of the NHL starting in the fourth quarter of 2021.Distribution revenues are generated from fees charged to network distributors, which include cable, DTH satellite, telecommunications and digital service providers, and DTC subscribers. The largest component of distribution revenue is comprised of linear distribution rights to our networks from cable, DTH satellite and telecommunication service providers. We have contracts with distributors representing most cable and satellite service providers around the world, including the largest operators in the U.S. and major international distributors. Distribution revenues are largely dependent on the rates negotiated in the agreements, the number of subscribers that receive our networks, the number of platforms covered in the distribution agreement, and the market demand for the content that we provide. From time to time, renewals of multi-year carriage agreements include significant year one market adjustments to re-set subscriber rates, which then increase at rates lower than the initial increase in the following years. In some cases, we have provided distributors launch incentives, in the form of cash payments or free periods, to carry our networks. Distribution revenue was flat in 2022, primarily attributable to a decline in linear subscribers in the U.S. and lower contractual affiliate rates in some European markets, as well as a decline in wholesale revenues primarily due to the expiration of HBO Max on Amazon Channels in September 2021, offset by global retail subscriber gains on DTC platforms. HBO Max re-launched on Amazon Channels in December 2022.Content revenues are generated from the release of feature films for initial exhibition in theaters, the licensing of feature films and television programs to various television, SVOD and other digital markets, distribution of feature films and television programs in the physical and digital home entertainment market, sales of console games and mobile in-game content, sublicensing of sports rights, and licensing of intellectual property such as characters and brands.Content revenue decreased 9% in 2022, primarily attributable to lower TV licensing and home entertainment revenue, partially offset by higher theatrical film rental revenue and higher third-party licensing of HBO content. Other revenue primarily consists of studio production services and tours. Other revenue increased 36% in 2022, primarily attributable to a full year of results for the Warner Bros. Studio Tour London and Hollywood, as well as the Harry Potter flagship store in New York, which opened in June 2021, and services provided to the unconsolidated BT Sport joint venture.Costs of RevenuesOur principal component of costs of revenues is content expense. Content expense includes television/digital series, specials, films, and sporting events. The costs of producing a content asset and bringing that asset to market consist of production costs, participation costs, and exploitation costs.Costs of revenues increased 1% in 2022, primarily attributable to increased programming expenses on DTC platforms, higher theatrical product content expense, higher sports-related expense globally, and increased expense at CNN, partially offset by lower television product content expense and distribution fees.Selling, General and AdministrativeSelling, general and administrative expenses consist principally of employee costs, marketing costs, research costs, occupancy, and back office support fees.Selling, general and administrative expenses decreased 10% in 2022, primarily attributable to lower marketing expenses.Depreciation and AmortizationDepreciation and amortization expense includes depreciation of fixed assets and amortization of finite-lived intangible assets. Depreciation and amortization decreased 13% in 2022, primarily attributable to a change in amortization method from the straight-line method to the sum of the months’ digits method for some of the WM assets acquired.Restructuring In connection with the Merger, the Company has announced and taken actions to implement projects to achieve cost synergies for the Company. Restructuring was $3,694 million and $121 million in 2022 and 2021, respectively. Restructuring in 2022 primarily related to strategic content programming assessments, organization restructuring, facility consolidation activities, and other contract termination costs. (See Note 6 to the accompanying consolidated financial statements.)37Impairment and Loss (Gain) on Dispositions and Disposals GroupsImpairment and loss (gain) on disposition and disposal groups was a $117 million and $152 million loss in 2022 and 2021, respectively. The loss in 2022 was primarily attributable to the write-down to the estimated fair value, less costs to sell, of the Ranch Lot and Knoxville office building and land in connection with the classification as assets held for sale. (See Note 18 to the accompanying consolidated financial statements.) The gain in 2021 was primarily attributable to the sale of our Great American Country network, partially offset by the WM sale of Hello Sunshine. (See Note 4 to the accompanying consolidated financial statements.)Interest Expense, netActual interest expense, net increased $1,144 million in 2022, primarily attributable to debt assumed as a result of the Merger. (See Note 11 and Note 13 to the accompanying consolidated financial statements.)Loss from Equity Investees, netActual losses from our equity method investees were $160 million and $18 million in 2022 and 2021, respectively. The changes are attributable to the Company's share of earnings and losses from its equity investees. (See Note 10 to the accompanying consolidated financial statements.)Other Income, netThe table below presents the details of other income, net (in millions).Year Ended December 31,20222021Foreign currency (losses) gains, net$(150)$93 Gains (losses) on derivative instruments, net475 (33)Gain on sale of investment with readily determinable fair value— 15 Change in the value of investments with readily determinable fair value(105)(6)Change in fair value of equity investments without readily determinable fair value(142)(13)Gain on sale of equity method investments 195 4 Loss on extinguishment of debt— (10)Other income, net74 22 Total other income, net$347 $72 Income Taxes The following table reconciles our effective income tax rate to the U.S. federal statutory income tax rate.Year Ended December 31,20222021Pre-tax income at U.S. federal statutory income tax rate$(1,881)21 %$301 21 %State and local income taxes, net of federal tax benefit(218)3 %108 7 %Effect of foreign operations246 (3)%25 2 %Preferred stock conversion premium charge166 (2)%— — %UK Finance Act legislative change— — %(155)(11)%Noncontrolling interest adjustment(17)— %(40)(3)%Other, net41 — %(3)— %Income tax (benefit) expense$(1,663)19 %$236 16 %Income tax (benefit) expense was $(1,663) million and $236 million, and the Company’s effective tax rate was 19% and 16% for 2022 and 2021, respectively. The decrease in the tax expense for the year ended December 31, 2022, was primarily attributable to a decrease in pre-tax book income, partially offset by an unfavorable tax adjustment related to the 2022 preferred stock conversion transaction expense that was not deductible for tax purposes (see Note 3), as well as the effect of foreign operations, including taxation and allocation of income and losses across multiple foreign jurisdictions. The decrease for the year ended December 31, 2022 was further offset by a deferred tax benefit of $155 million recorded in 2021 resulting from the UK Finance Act 2021 enacted in June 2021.38Segment Results of Operations – 2022 vs. 2021The Company evaluates the operating performance of its operating segments based on financial measures such as revenues and Adjusted EBITDA. Adjusted EBITDA is defined as operating income excluding:•employee share-based compensation;•depreciation and amortization;•restructuring and facility consolidation;•certain impairment charges;•gains and losses on business and asset dispositions;•certain inter-segment eliminations;•third-party transaction and integration costs;•amortization of purchase accounting fair value step-up for content;•amortization of capitalized interest for content; and •other items impacting comparability. The Company uses this measure to assess the operating results and performance of its segments, perform analytical comparisons, identify strategies to improve performance, and allocate resources to each segment. The Company believes Adjusted EBITDA is relevant to investors because it allows them to analyze the operating performance of each segment using the same metric management uses. The Company excludes employee share-based compensation, restructuring, certain impairment charges, gains and losses on business and asset dispositions, and transaction and integration costs from the calculation of Adjusted EBITDA due to their impact on comparability between periods. The Company also excludes the depreciation of fixed assets and amortization of intangible assets, amortization of purchase accounting fair value step-up for content, and amortization of capitalized interest for content, as these amounts do not represent cash payments in the current reporting period. Certain corporate expenses and inter-segment eliminations related to production studios are excluded from segment results to enable executive management to evaluate segment performance based upon the decisions of segment executives. Adjusted EBITDA should be considered in addition to, but not a substitute for, operating income, net income, and other measures of financial performance reported in accordance with U.S. GAAP. The table below presents our Adjusted EBITDA by segment (in millions). Year Ended December 31, 20222021% ChangeStudios$1,772 $14 NMNetworks8,725 5,533 58 %DTC(1,596)(1,345)(19)%Corporate(1,200)(385)NMInter-segment eliminations 17 — NM39 Studios Segment The following table presents, for our Studios segment, revenues by type, certain operating expenses, Adjusted EBITDA and a reconciliation of Adjusted EBITDA to operating (loss) income (in millions). Year Ended December 31, 20222021% ChangeActualPro FormaAdjustmentsPro FormaCombinedActual (a)Pro FormaAdjustmentsPro FormaCombinedActualPro Forma Combined(Actual)Pro FormaCombined(ex-FX)Revenues:Advertising$15 $9 $24 $— $123 $123 NM(80)%(80)%Distribution12 6 18 — 14 14 NM29 %29 %Content9,156 3,898 13,054 20 14,336 14,356 NM(9)%(7)%Other548 154 702 — 516 516 NM36 %36 %Total revenues9,731 4,067 13,798 20 14,989 15,009 NM(8)%(6)%Costs of revenues, excluding depreciation and amortization6,310 2,392 8,702 3 9,589 9,592 NM(9)%(7)%Selling, general and administrative1,649 698 2,347 3 2,769 2,772 NM(15)%(13)%Adjusted EBITDA1,772 977 2,749 14 2,631 2,645 NM4 %8 %Depreciation and amortization501 39 540 — 691 691 Employee share-based compensation1 26 27 — 85 85 Restructuring1,050 (38)1,012 — 38 38 Transaction and integration costs 9 — 9 — — — Inter-segment eliminations5 — 5 — — — Impairment and loss on disposition and disposal groups30 — 30 — — — Amortization of fair value step-up for content1,370 (785)585 — 1,588 1,588 Operating (loss) income$(1,194)$1,735 $541 $14 $229 $243 (a) Prior year actual results have been recast to conform to the current period presentation as a result of the Merger and segment recast. The discussion below is on a pro forma combined basis, ex-FX, since the actual increases year over year for revenues, cost of revenue, selling, general and administrative expenses and Adjusted EBITDA are substantially attributable to the Merger.RevenuesContent revenue decreased 7% in 2022, primarily attributable to lower TV licensing and home entertainment revenue, partially offset by higher theatrical film rental revenue. TV licensing revenue decreased mainly due to large television licensing deals in the prior year and the timing of initial telecast revenue, as the prior year benefited from the ramp up of TV production following COVID-related delays in 2020. Home entertainment revenue was lower due to strong COVID-induced demand in the prior year and fewer new releases of theatrical products. Theatrical film rental revenue was favorably impacted by improved performance of our theatrical slate and improved audience attendance at movie theaters.Other revenue increased 36% in 2022, primarily attributable to a full year of results for the Warner Bros. Studio Tour London and Hollywood, as well as the Harry Potter flagship store in New York, which opened in June 2021.Costs of RevenuesCosts of revenues decreased 7% in 2022, primarily attributable to lower television product content expense and distribution fees related to the aforementioned television licensing deals, partially offset by higher theatrical product content expense.Selling, General and AdministrativeSelling, general and administrative expenses decreased 13% in 2022, primarily attributable to lower marketing expense due to fewer theatrical releases in 2022.Adjusted EBITDAAdjusted EBITDA increased 8% in 2022.40 Networks Segment The table below presents, for our Networks segment, revenues by type, certain operating expenses, Adjusted EBITDA and a reconciliation of Adjusted EBITDA to operating income (in millions). Year Ended December 31, 20222021% ChangeActualPro FormaAdjustmentsPro FormaCombinedActual (a)Pro FormaAdjustmentsPro FormaCombinedActualPro Forma Combined(Actual)Pro FormaCombined(ex-FX)Revenues:Advertising$8,224 $1,380 $9,604 $6,063 $4,330 $10,393 36 %(8)%(5)%Distribution9,759 2,183 11,942 4,486 7,843 12,329 NM(3)%(1)%Content1,120 220 1,340 706 568 1,274 59 %5 %7 %Other245 55 300 56 178 234 NM28 %35 %Total revenues19,348 3,838 23,186 11,311 12,919 24,230 71 %(4)%(2)%Costs of revenues, excluding depreciation and amortization8,006 2,148 10,154 3,926 6,098 10,024 NM1 %4 %Selling, general and administrative2,617 364 2,981 1,852 1,367 3,219 41 %(7)%(5)%Adjusted EBITDA8,725 1,326 10,051 5,533 5,454 10,987 58 %(9)%(7)%Depreciation and amortization4,687 4 4,691 1,212 4,151 5,363 Employee share-based compensation— 9 9 — 41 41 Restructuring1,003 (5)998 30 5 35 Transaction and integration costs2 — 2 4 — 4 Amortization of fair value step-up for content73 425 498 — 476 476 Inter-segment eliminations17 — 17 — — — Impairment and loss (gain) on disposition and disposal groups24 — 24 (72)(1)(73)Operating income$2,919 $893 $3,812 $4,359 $782 $5,141 (a) Prior year actual results have been recast to conform to the current period presentation as a result of the Merger and segment recast. The discussion below is on a pro forma combined basis, ex-FX, since the actual increases year over year for revenues, cost of revenue, selling, general and administrative expenses and Adjusted EBITDA are substantially attributable to the Merger.RevenuesAdvertising revenue decreased 5% in 2022, primarily attributable to declines in domestic general entertainment and news networks, partially offset by higher sports advertising in the U.S. due to the NCAA Men's Final Four and Championship games airing on our networks and the addition of the NHL starting in the fourth quarter of 2021.Distribution revenue decreased 1% in 2022, primarily attributable to a decline in linear subscribers in the U.S. and lower contractual affiliate rates in some European markets, partially offset by an increase in contractual affiliate rates in the U.S. and certain Latin American markets and premium sports packages in Latin America.Content revenue increased by 7% in 2022, primarily attributable to higher inter-segment licensing of content to DTC, partially offset by overall net lower sub-licensing revenue for the Winter Olympics in 2022 compared to the Summer Olympics in 2021. Other revenue increased 35% in 2022, primarily attributable to services provided to the unconsolidated BT Sport joint venture.Costs of RevenuesCosts of revenues increased 4% in 2022, primarily attributable to higher sports-related expense globally, increased expense at CNN, and costs associated with providing services to the unconsolidated BT Sport joint venture, partially offset by lower content expense due to the previously announced restructuring program and lower international sports rights driven by the Winter Olympics in 2022 (as compared to the Summer Olympics in 2021).Selling, General and AdministrativeSelling, general and administrative expenses decreased 5% in 2022, primarily attributable to lower personnel and marketing expenses.Adjusted EBITDAAdjusted EBITDA decreased 7% in 2022.41 DTC Segment The following table presents, for our DTC segment, revenues by type, certain operating expenses, Adjusted EBITDA and a reconciliation of Adjusted EBITDA to operating loss (in millions). Year Ended December 31, 20222021% ChangeActualPro FormaAdjustmentsPro FormaCombinedActual (a)Pro FormaAdjustmentsPro FormaCombinedActualPro Forma Combined(Actual)Pro FormaCombined(ex-FX)Revenues:Advertising$371 $36 $407 $131 $49 $180 NMNMNMDistribution6,371 2,150 8,521 716 7,722 8,438 NM1 %3 %Content522 230 752 11 622 633 NM19 %19 %Other10 3 13 2 12 14 NM(7)%— %Total revenues7,274 2,419 9,693 860 8,405 9,265 NM5 %6 %Costs of revenues, excluding depreciation and amortization6,211 1,977 8,188 691 6,166 6,857 NM19 %21 %Selling, general and administrative2,659 909 3,568 1,514 2,759 4,273 76 %(16)%(16)%Adjusted EBITDA(1,596)(467)(2,063)(1,345)(520)(1,865)(19)%(11)%(11)%Depreciation and amortization1,733 31 1,764 275 1,757 2,032 Employee share-based compensation(1)— (1)— 16 16 Restructuring1,551 (3)1,548 2 3 5 Transaction and integration costs 2 — 2 1 — 1 Amortization of fair value step-up for content390 (52)338 — 293 293 Inter-segment eliminations9 — 9 — — — Impairment and loss on disposition and disposal groups13 — 13 1 — 1 Operating loss$(5,293)$(443)$(5,736)$(1,624)$(2,589)$(4,213)(a) Prior year actual results have been recast to conform to the current period presentation as a result of the Merger and segment recast. The discussion below is on a pro forma combined basis, ex-FX, since the actual increases year over year for revenues, cost of revenue, selling, general and administrative expenses and Adjusted EBITDA are substantially attributable to the Merger.RevenuesAs of December 31, 2022, we had 96.1 million DTC subscribers.2 Advertising revenue increased $229 million in 2022, primarily attributable to subscriber growth on our DTC ad-supported tiers.Distribution revenue increased 3% in 2022, primarily attributable to global retail subscriber gains, partially offset by a decline in wholesale revenues primarily due to the expiration of HBO Max on Amazon Channels in September 2021. HBO Max re-launched on Amazon Channels in December 2022.Content revenue increased 19% in 2022, primarily attributable to higher third-party licensing of HBO content. 2 We define a “DTC Subscription” as: (i) a retail subscription to discovery+, HBO or HBO Max for which we have recognized subscription revenue, whether directly or through a third party, from a direct-to-consumer platform; (ii) a wholesale subscription to discovery+, HBO, or HBO Max for which we have recognized subscription revenue from a fixed-fee arrangement with a third party and where the individual user has activated their subscription; (iii) a wholesale subscription to discovery+, HBO or HBO Max for which we have recognized subscription revenue on a per subscriber basis; and (iv) users on free trials who convert to a subscription for which we have recognized subscription revenue within the first seven days of the calendar month immediately following the month in which their free trial expires.We may refer to the aggregate number of DTC Subscriptions as “subscribers.”The reported number of “subscribers” included herein and the definition of “DTC Subscription” as used herein excludes: (i) individuals who subscribe to DTC products, other than discovery+, HBO and HBO Max, that may be offered by us or by certain joint venture partners or affiliated parties from time to time; (ii) a limited number of international discovery+ subscribers that are part of non-strategic partnerships or short-term arrangements as may be identified by the Company from time to time; (iii) domestic and international Cinemax subscribers, and international basic HBO subscribers; and (iv) users on free trials except for those users on free trial that convert to a DTC Subscription within the first seven days of the next month as noted above. 42Costs of RevenuesCost of revenues increased 21% in 2022, primarily attributable to increased programming expenses, which were moderated by the previously announced restructuring program.Selling, General, and Administrative ExpensesSelling, general and administrative expenses decreased 16% in 2022, primarily attributable to more efficient marketing-related spend. Adjusted EBITDAAdjusted EBITDA decreased 11% in 2022. CorporateThe following table presents our Adjusted EBITDA and a reconciliation of Adjusted EBITDA to operating loss (in millions): Year Ended December 31, 20222021% ChangeActualPro FormaAdjustmentsPro FormaCombinedActualPro FormaAdjustmentsPro FormaCombinedActualPro Forma Combined(Actual)Pro FormaCombined(ex-FX)Adjusted EBITDA$(1,200)$(353)$(1,553)$(385)$(966)$(1,351)NM(15)%(17)%Employee share-based compensation410 (11)399 167 177 344 Depreciation and amortization272 (40)232 95 175 270 Restructuring195 (44)151 — 44 44 Transaction and integration costs1,182 (564)618 90 1,138 1,228 Impairment and loss on disposition and disposal groups50 — 50 — 224 224 Inter-segment eliminations(31)— (31)— — — Operating loss$(3,278)$306 $(2,972)$(737)$(2,724)$(3,461)Corporate operations primarily consist of executive management and administrative support services, which are recorded in selling, general and administrative expense, as well as substantially all of our share-based compensation and third-party transaction and integration costs. Adjusted EBITDA decreased 17% for 2022, primarily attributable to increased securitization costs from higher interest rates, partially offset by lower personnel costs.As reported transaction and integration costs for 2022 included the impact of the issuance of additional shares of WBD common stock to Advance/Newhouse Programming Partnership of $789 million upon the closing of the Merger. (See Note 3 to the accompanying consolidated financial statements.)43Inter-segment EliminationsThe following table presents our inter-segment eliminations by revenue and expense, Adjusted EBITDA and a reconciliation of Adjusted EBITDA to operating loss (in millions): Year Ended December 31, 20222021% ChangeActualPro FormaAdjustmentsPro FormaCombinedActualPro FormaAdjustmentsPro FormaCombinedActualPro Forma Combined(Actual)Pro FormaCombined(ex-FX)Inter-segment revenue eliminations$(2,566)$(1,065)$(3,631)$— $(3,219)$(3,219)NM(13)%(13)%Inter-segment expense eliminations(2,583)(1,038)(3,621)— (3,229)(3,229)NM(12)%(12)%Adjusted EBITDA17 (27)(10)— 10 10 NMNMNMRestructuring(42)— (42)— — — Amortization of fair value step-up for content583 — 583 — — — Operating (loss) income$(524)$(27)$(551)$— $10 $10 Inter-segment revenue and expense eliminations primarily represent inter-segment content transactions and marketing and promotion activity between reportable segments. In our current segment structure, in certain instances, production and distribution activities are in different segments. Inter-segment content transactions are presented “gross” (i.e. the segment producing and/or licensing the content reports revenue and profit from inter-segment transactions in a manner similar to the reporting of third-party transactions, and the required eliminations are reported on the separate “Eliminations” line when presenting our summary of segment results). Generally, timing of revenue recognition is similar to the reporting of third-party transactions. The segment distributing the content, e.g. via our DTC or linear services, capitalizes the cost of inter-segment content transactions, including “mark-ups” and amortizes the costs over the shorter of the license term, if applicable, or the expected period of use. The content amortization expense related to the inter-segment profit is also eliminated on the separate “Eliminations” line when presenting our summary of segment results.44LIQUIDITY AND CAPITAL RESOURCESLiquiditySources of CashHistorically, we have generated a significant amount of cash from operations. During 2022, we funded our working capital needs primarily through cash flows from operations. As of December 31, 2022, we had $3.7 billion of cash and cash equivalents on hand. We are a well-known seasoned issuer and have the ability to conduct registered offerings of securities, including debt securities, common stock and preferred stock, on short notice, subject to market conditions. Access to sufficient capital from the public market is not assured. We have a $6.0 billion revolving credit facility and commercial paper program described below. We also participate in a revolving receivables program and an accounts receivable factoring program described below.•Debt Revolving Credit Facility and Commercial PaperIn June 2021, Discovery Communication, LLC (“DCL”) entered into a multicurrency revolving credit agreement (the “Revolving Credit Agreement”), replacing the existing $2.5 billion credit agreement, dated February 4, 2016, as amended, among DCL, the Company, certain lenders from time to time party thereto, and Bank of America, N.A., as administrative agent. DCL has the capacity to borrow up to $6.0 billion under the Revolving Credit Agreement (the “Credit Facility”). The Revolving Credit Agreement includes a $150 million sublimit for the issuance of standby letters of credit. DCL may also request additional commitments up to $1.0 billion from the lenders upon the satisfaction of certain conditions. Obligations under the Revolving Credit Agreement are unsecured and are fully and unconditionally guaranteed by the Company, Scripps Networks, and WarnerMedia Holdings, Inc. The Credit Facility will be available on a revolving basis until June 2026, with an option for up to two additional 364-day renewal periods subject to the lenders' consent. The Revolving Credit Agreement contains customary representations and warranties as well as affirmative and negative covenants. As of December 31, 2022, DCL was in compliance with all covenants and there were no events of default under the Revolving Credit Agreement. Additionally, the Company’s commercial paper program is supported by the Credit Facility. Under the commercial paper program, the Company may issue up to $1.5 billion, including up to $500 million of euro-denominated borrowings. Borrowing capacity under the Credit Facility is reduced by any outstanding borrowings under the commercial paper program.As of December 31, 2022 and 2021, the Company had no outstanding borrowings under the Credit Facility or the commercial paper program. •Revolving Receivables ProgramThe Company has a revolving agreement to transfer up to $5.7 billion of certain receivables through its bankruptcy-remote subsidiary, Warner Bros. Discovery Receivables Funding, LLC, to various financial institutions on a recurring basis in exchange for cash equal to the gross receivables transferred. The Company services the sold receivables for the financial institution for a fee and pays fees to the financial institution in connection with this revolving agreement. As customers pay their balances, the Company’s available capacity under this revolving agreement increases and typically the Company transfers additional receivables into the program. In some cases, the Company may have collections that have not yet been remitted to the bank, resulting in a liability. The outstanding portfolio of receivables derecognized from our consolidated balance sheets was $5,366 million as of December 31, 2022.•Accounts Receivable FactoringThe Company has a factoring agreement to sell certain of its non-U.S. trade accounts receivable on a non-recourse basis to a third-party financial institution. Total trade accounts receivable sold under the Company’s factoring arrangements was $477 million as of December 31, 2022.•DerivativesWe received investing proceeds of $752 million during the year ended December 31, 2022 from the unwind and settlement of derivative instruments. (See Note 13 to the accompanying consolidated financial statements.)•Investments and Business CombinationsIn addition to other investments, we completed the sale of our minority interests in Discovery Education and Golden Maple Limited (known as Tencent Video VIP) and received cash of $306 million during the year ended December 31, 2022.45Additionally, we acquired $3.6 billion of cash in connection with the Merger and the post-closing working capital settlement process.Uses of CashOur primary uses of cash include the creation and acquisition of new content, business acquisitions, income taxes, personnel costs, costs to develop and market HBO Max and discovery+, principal and interest payments on our outstanding senior notes, funding for various equity method and other investments, and repurchases of our capital stock.•Content AcquisitionWe plan to continue to invest significantly in the creation and acquisition of new content, as well as certain sports rights. Subsequent to the Merger, our contractual commitments to acquire content have increased significantly. Additional information regarding contractual commitments to acquire content is set forth in “Material Cash Requirements from Known Contractual and Other Obligations” in Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations.” •DebtTerm LoanDuring the year ended December 31, 2022, we repaid $6.0 billion of aggregate principal amount outstanding of our term loans prior to the due dates of October 2023 and April 2025.Senior NotesDuring the year ended December 31, 2022, we repaid in full at maturity $327 million of aggregate principal amount outstanding of our 2.375% Euro Denominated Senior Notes due March 2022 and issued notices for the redemption in full of all $192 million of aggregate principal amount outstanding of our 3.250% senior notes due in 2023 and all $796 million of aggregate principal amount outstanding of our 2.950% senior notes due 2023 (collectively the “2023 Notes”). The 2023 Notes were redeemed in December 2022 for an aggregate redemption price of $988 million, plus accrued interest. During 2022, we also assumed $41.5 billion of senior notes (at par value) and term loans in connection with the Merger.In addition, we have $363 million of senior notes coming due in 2023.•Capital Expenditures and Investments in Next Generation InitiativesWe effected capital expenditures of $987 million in 2022, including amounts capitalized to support our next generation platforms, such as HBO Max and discovery+. In addition, we expect to continue to incur significant costs to develop and market our combined streaming service in the future.•Investments and Business CombinationsOur uses of cash have included investments in equity method investments and equity investments without readily determinable fair value. (See Note 10 to the accompanying consolidated financial statements.) We provide funding to our investees from time to time. We contributed $168 million and $184 million in 2022 and 2021, respectively, for investments in and advances to our investees. We have and expect to continue to incur significant, one-time transaction and integration costs during the first year following the Merger. (See Note 4 to the accompanying consolidated financial statements.)•Redeemable Noncontrolling Interest and Noncontrolling InterestDue to business combinations, we also had redeemable equity balances of $318 million at December 31, 2022 which may require the use of cash in the event holders of noncontrolling interests put their interests to us. In 2022, GoldenTree exercised its put right and we are required to purchase GoldenTree’s noncontrolling interest. (See Note 19 to the accompanying consolidated financial statements.) Distributions to noncontrolling interests and redeemable noncontrolling interests totaled $300 million and $251 million in 2022 and 2021, respectively.•Common Stock RepurchasesHistorically, we have funded our stock repurchases through a combination of cash on hand, cash generated by operations and the issuance of debt. In February 2020, our board of directors authorized additional stock repurchases of up to $2 billion upon completion of our existing $1 billion authorization announced in May 2019. Under the new stock repurchase authorization, management is authorized to purchase shares from time to time through open market purchases at prevailing prices or privately negotiated purchases subject to market conditions and other factors. (See Note 3 to the accompanying consolidated financial statements.) There were no common stock repurchases during 2022 or 2021.46•Income Taxes and InterestWe expect to continue to make payments for income taxes and interest on our outstanding senior notes. During 2022 and 2021, we made cash payments of $1,027 million and $643 million for income taxes and $1,539 million and $664 million for interest on our outstanding debt, respectively. Cash required for interest payments has increased significantly as a result of the Merger.Cash FlowsThe following table presents changes in cash and cash equivalents (in millions).Year Ended December 31,20222021Cash, cash equivalents, and restricted cash, beginning of period$3,905 $2,122 Cash provided by operating activities4,304 2,798 Cash provided by (used in) investing activities3,524 (56)Cash used in financing activities(7,742)(853)Effect of exchange rate changes on cash, cash equivalents, and restricted cash(61)(106)Net change in cash, cash equivalents, and restricted cash25 1,783 Cash, cash equivalents, and restricted cash, end of period$3,930 $3,905 Operating ActivitiesCash provided by operating activities was $4,304 million and $2,798 million in 2022 and 2021, respectively. The increase in cash provided by operating activities was primarily attributable to an increase in net income, excluding non-cash items, and working capital initiatives, partially offset by other negative fluctuations in working capital activity.Investing ActivitiesCash provided by (used in) investing activities was $3,524 million and $(56) million in 2022 and 2021, respectively. The increase in cash provided by investing activities was primarily attributable to proceeds received from cash acquired during the Merger and the post-closing working capital settlement process and cash received from the unwind and settlement of derivative instruments, partially offset by increased purchases of property and equipment and a reduction in cash received from the sales and maturities of investments during the year ended December 31, 2022.Financing ActivitiesCash used in financing activities was $7,742 million and $853 million in 2022 and 2021, respectively. The increase in cash used in financing activities was primarily attributable to principal repayments made on our term loans during the year ended December 31, 2022.Capital ResourcesAs of December 31, 2022, capital resources were comprised of the following (in millions). December 31, 2022 TotalCapacityOutstandingIndebtednessUnusedCapacityCash and cash equivalents$3,731 $— $3,731 Revolving credit facility and commercial paper program6,000 — 6,000 Term loans4,000 4,000 — Senior notes (a)45,276 45,276 — Total$59,007 $49,276 $9,731 (a) Interest on senior notes is paid annually or semi-annually. Our senior notes outstanding as of December 31, 2022 had interest rates that ranged from 1.900% to 9.150% and will mature between 2023 and 2062.We expect that our cash balance, cash generated from operations and availability under the Credit Agreement will be sufficient to fund our cash needs for both the short-term and the long-term. Our borrowing costs and access to capital markets can be affected by short and long-term debt ratings assigned by independent rating agencies which are based, in part, on our performance as measured by credit metrics such as interest coverage and leverage ratios.47As of December 31, 2022, we held $3.1 billion of our $3.7 billion of cash and cash equivalents in our foreign subsidiaries. The 2017 Tax Act features a participation exemption regime with current taxation of certain foreign income and imposes a mandatory repatriation toll tax on unremitted foreign earnings. Notwithstanding the U.S. taxation of these amounts, we intend to continue to reinvest these funds outside of the U.S. Our current plans do not demonstrate a need to repatriate them to the U.S. However, if these funds were to be needed in the U.S., we would be required to accrue and pay non-U.S. taxes to repatriate them. The determination of the amount of unrecognized deferred income tax liability with respect to these undistributed foreign earnings is not practicable.MATERIAL CASH REQUIREMENTS FROM KNOWN CONTRACTUAL AND OTHER OBLIGATIONSAs of December 31, 2022, our significant contractual and other obligations were as follows (in millions).TotalShort-termLong-termLong-term debt:Principal payments$49,276 $363 $48,913 Interest payments35,537 2,267 33,270 Purchase obligations:Content29,732 7,969 21,763 Other3,047 1,597 1,450 Finance lease obligations282 82 200 Operating lease obligations4,304 465 3,839 Pension and other employee obligations1,378 501 877 Total$123,556 $13,244 $110,312 Long-term DebtPrincipal payments on long-term debt reflect the repayment of our outstanding senior notes, at face value, assuming repayment will occur upon maturity. Interest payments on our outstanding senior notes are projected based on their contractual interest rates and maturity dates.Additionally, DCL's revolving credit facility allows DCL and certain designated foreign subsidiaries of DCL to borrow up to $6.0 billion, including a $150 million sublimit for the issuance of standby letters of credit. DCL may also request additional commitments up to $1.0 billion from the lenders upon the satisfaction of certain conditions. Additionally, the Company's commercial paper program is supported by the Credit Facility. Under the commercial paper program, the Company may issue up to $1.5 billion, including up to $500 million of euro-denominated borrowings. Borrowing capacity under the Credit Facility is effectively reduced by any outstanding borrowings under the commercial paper program. As of December 31, 2022, we had no outstanding borrowings under the Credit Facility or the commercial paper program. (See Note 11 to the accompanying consolidated financial statements.)Purchase ObligationsContent purchase obligations include commitments and liabilities associated with third-party producers and sports associations for content that airs on our television networks and DTC services. Production and licensing contracts generally require: purchase of a specified number of episodes; payments during production or over the term of a license; and include both programs that have been delivered and are available for airing and programs that have not yet been produced or sporting events that have not yet taken place. If the content is ultimately never produced, our commitments expire without obligation. The commitments exclude content liabilities recognized on the consolidated balance sheet. We expect to enter into additional production contracts and content licenses to meet our future content needs.Other purchase obligations include agreements with certain vendors and suppliers for the purchase of goods and services whereby the underlying agreements are enforceable, legally binding and specify all significant terms. Significant purchase obligations include transmission services, television rating services, marketing commitments and research, equipment purchases, and information technology and other services. Some of these contracts do not require the purchase of fixed or minimum quantities and generally may be terminated with a 30-day to 60-day advance notice without penalty, and are not included in the table above past the 30-day to 60-day advance notice period. 48Finance Lease ObligationsWe acquire satellite transponders and other equipment through multi-year finance lease arrangements. Principal payments on finance lease obligations reflect amounts due under our finance lease agreements. Interest payments on our outstanding finance lease obligations are based on the stated or implied rate in our finance lease agreements. (See Note 12 to the accompanying consolidated financial statements.)Operating Lease ObligationsWe obtain office space and equipment under multi-year lease arrangements. Most operating leases are not cancelable prior to their expiration. Payments for operating leases represent the amounts due under the agreements assuming the agreements are not canceled prior to their expiration. (See Note 12 to the accompanying consolidated financial statements.)Pension and Other Employee ObligationsWe sponsor a qualified defined benefit pension plan (“Pension Plan”) that covers certain U.S.-based employees. We also have a non-qualified Supplemental Executive Retirement Plan (“SERP”). In connection with the Merger, the Company assumed four U.S. nonqualified pension plans that are noncontributory and unfunded and several non-U.S. pension plans (See Note 17 to the accompanying consolidated financial statements.)Contractual commitments include payments to meet minimum funding requirements of our Pension Plan in 2023 and estimated benefit payments for our SERP that exceed plan assets. Payments for the SERP have been estimated over a ten-year period. While benefit payments under these plans are expected to continue beyond 2031, we believe it is not practicable to estimate payments beyond this period.We are unable to reasonably predict the ultimate amount of any payments due to cash-settled share-based compensation awards. As of December 31, 2022, the current portion of the liability for cash-settled share-based compensation awards was $4 million.Unrecognized Tax BenefitsWe are unable to reasonably predict the ultimate amount or timing of settlement of our unrecognized tax benefits because, until formal resolutions are reached, reasonable estimates of the amount and timing of cash settlements with the respective taxing authorities are not practicable. Our unrecognized tax benefits totaled $1,929 million as of December 31, 2022.Six Flags GuaranteeIn connection with WM’s former investment in the Six Flags (as defined below) theme parks located in Georgia and Texas (collectively, the “Parks”), in 1997, certain subsidiaries of the Company agreed to guarantee (the “Six Flags Guarantee”) certain obligations of the partnerships that hold the Parks (the “Partnerships”) for the benefit of the limited partners in such Partnerships, including, annual payments made to the Parks or to the limited partners and additional obligations at the end of the respective terms for the Partnerships in 2027 and 2028 (the “Guaranteed Obligations”). The aggregate gross undiscounted estimated future cash flow requirements covered by the Six Flags Guarantee over the remaining term (through 2028) are $544 million. To date, no payments have been made by us pursuant to the Six Flags Guarantee. Six Flags Entertainment Corporation (formerly known as Six Flags, Inc. and Premier Parks Inc.) (“Six Flags”), which has the controlling interest in the Parks, has agreed, pursuant to a subordinated indemnity agreement (the “Subordinated Indemnity Agreement”), to guarantee the performance of the Guaranteed Obligations when due and to indemnify the Company, among others, if the Six Flags Guarantee is called upon. If Six Flags defaults on its indemnification obligations, we have the right to acquire control of the managing partner of the Parks. Six Flags’ obligations to us are further secured by its interest in all limited partnership units held by Six Flags. Based on our evaluation of the current facts and circumstances surrounding the Guaranteed Obligations and the Subordinated Indemnity Agreement, we are unable to predict the loss, if any, that may be incurred under the Guaranteed Obligations, and no liability for the arrangements has been recognized as of December 31, 2022. Because of the specific circumstances surrounding the arrangements and the fact that no active or observable market exists for this type of financial guarantee, we are unable to determine a current fair value for the Guaranteed Obligations and related Subordinated Indemnity Agreement.Other Contingent CommitmentsOther contingent commitments primarily include contingent payments for post-production term advance obligations on certain co-financing arrangements, as well as operating lease commitment guarantees, letters of credit, bank guarantees, and surety bonds, which generally support performance and payments for a wide range of global contingent and firm obligations, including insurance, litigation appeals, real estate leases, and other operational needs.49The Company's other contingent commitments at December 31, 2022 were $283 million, with $279 million estimated to be due in 2026. For other contingent commitments where payment obligations are outside our control, the timing of amounts represents the earliest period in which the payment could be requested. For the remaining other contingent commitments, the timing of the amounts presented represents when the maximum contingent commitment will expire but does not mean that we expect to incur an obligation to make any payments within that time period. In addition, these amounts do not reflect the effects of any indemnification rights we might possess.Put RightsWe have granted put rights to certain consolidated subsidiaries, but we are unable to reasonably predict the ultimate amount or timing of any payment. We recorded the carrying value of the noncontrolling interest in the equity associated with the put rights as a component of redeemable noncontrolling interest in the amount of $318 million. (See Note 19 to the accompanying consolidated financial statements.)Noncontrolling InterestThe Food Network and Cooking Channel are operated and organized under the terms of the TV Food Network Partnership (the “Partnership”). We hold interests in the Partnership, along with another noncontrolling owner. The Partnership agreement specifies a dissolution date of December 31, 2023. If the term of the Partnership is not extended prior to that date, the Partnership agreement permits us, as holder of 80% of the applicable votes, to reconstitute the Partnership and continue its business. If for some reason the Partnership is not continued, it will be required to limit its activities to winding up, settling debts, liquidating assets and distributing proceeds to the partners in proportion to their partnership interests.Summarized Guarantor Financial Information Basis of PresentationAs of December 31, 2022 and December 31, 2021, all of the Company’s outstanding $13.8 billion registered senior notes have been issued by DCL, a wholly owned subsidiary of the Company, and guaranteed by the Company, Scripps Networks, and WarnerMedia Holdings, Inc. As of December 31, 2022, the Company also has outstanding $30.0 billion of senior notes issued by WarnerMedia Holdings, Inc. and guaranteed by the Company, Scripps and DCL; $1.5 billion of senior notes issued by the legacy WarnerMedia Business (not guaranteed); and approximately $23 million of un-exchanged senior notes issued by Scripps Networks (not guaranteed). (See Note 11 to the accompanying consolidated financial statements.) DCL primarily includes the Discovery Channel and TLC networks in the U.S. DCL is a wholly owned subsidiary of the Company. Scripps Networks is also wholly owned by the Company. The tables below present the summarized financial information as combined for Warner Bros. Discovery, Inc. (the “Parent”), Scripps Networks, DCL, and WarnerMedia Holdings, Inc. (collectively, the “Obligors”). All guarantees of DCL and WarnerMedia Holdings, Inc.'s senior notes (the “Note Guarantees”) are full and unconditional, joint and several and unsecured, and cover all payment obligations arising under the senior notes. Note Guarantees issued by Scripps Networks, DCL or WarnerMedia Holdings, Inc., or any subsidiary of the Parent that in the future issues a Note Guarantee (each, a “Subsidiary Guarantor”) may be released and discharged (i) concurrently with any direct or indirect sale or disposition of such Subsidiary Guarantor or any interest therein, (ii) at any time that such Subsidiary Guarantor is released from all of its obligations under its guarantee of payment, (iii) upon the merger or consolidation of any Subsidiary Guarantor with and into DCL, WarnerMedia Holdings, Inc. or the Parent or another Subsidiary Guarantor, as applicable, or upon the liquidation of such Subsidiary Guarantor and (iv) other customary events constituting a discharge of the Obligors’ obligations.50Summarized Financial Information The Company has included the accompanying summarized combined financial information of the Obligors after the elimination of intercompany transactions and balances among the Obligors and the elimination of equity in earnings from and investments in any subsidiary of the Parent that is a non-guarantor (in millions). The summarized balance sheet information as of December 31, 2022 does not include information with respect to WarnerMedia Holdings, Inc., as WarnerMedia Holdings, Inc. was a wholly-owned subsidiary of AT&T with de minimis assets and no operating activities for the year ended December 31, 2022. The summarized income statement information for the year ended December 31, 2022 includes information with respect to WarnerMedia Holdings, Inc. beginning subsequent to the close of the Merger.December 31, 2022Current assets$1,949 Non-guarantor intercompany trade receivables, net112 Noncurrent assets5,785 Current liabilities1,095 Noncurrent liabilities48,839 Year Ended December 31, 2022Revenues$2,066 Operating loss(574)Net loss(1,672)Net loss available to Discovery, Inc.(1,680)Additional information regarding the changes in our outstanding indebtedness and the significant terms and provisions of our revolving credit facility and outstanding indebtedness is discussed in Note 11 to the accompanying consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.RELATED PARTY TRANSACTIONSIn the ordinary course of business, we enter into transactions with related parties, primarily the Liberty Entities and our equity method investees. Information regarding transactions and amounts with related parties is discussed in Note 21 to the accompanying consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.NEW ACCOUNTING AND REPORTING PRONOUNCEMENTSWe adopted certain accounting and reporting standards during 2022. Information regarding our adoption of new accounting and reporting standards is discussed in Note 2 to the accompanying consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.CRITICAL ACCOUNTING ESTIMATESOur consolidated financial statements are prepared in accordance with U.S. GAAP, which requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and assumptions, including those related to uncertain tax positions, goodwill and intangible assets, content rights, consolidation and revenue recognition. We base our estimates on historical experience, current developments and on various other assumptions that we believe to be reasonable under these circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that cannot readily be determined from other sources. There can be no assurance that actual results will not differ from those estimates. Management considers an accounting estimate to be critical if it required assumptions to be made that were uncertain at the time the estimate was made and changes in the estimate or different estimates could have a material effect on our results of operations. 51The development and selection of these critical accounting estimates have been determined by management and the related disclosures have been reviewed with the Audit Committee of the board of directors of the Company. We believe the following accounting estimates are critical to our business operations and the understanding of our results of operations and involve the more significant judgments and estimates used in the preparation of our consolidated financial statements.Uncertain Tax PositionsWe are subject to income taxes in numerous U.S. and foreign jurisdictions. From time to time, we engage in transactions or take filing positions in which the tax consequences may be uncertain and may recognize tax liabilities based on estimates of whether additional taxes and interest will be due. We establish a reserve for uncertain tax positions unless we determine that such positions are more likely than not to be sustained upon examination based on their technical merits, including the resolution of any appeals or litigation processes. We include interest and where appropriate, potential penalties, as a component of income tax expense on the consolidated statement of operations. This assessment relies on estimates and assumptions and may involve a series of complex judgments about future events including the status and results of income tax audits with the relevant tax authorities. Significant judgment is exercised in evaluating all relevant information, the technical merits of the tax positions, and the accurate measurement of uncertain tax positions when determining the amount of reserve and whether positions taken on our tax returns are more likely than not to be sustained. This also involves the use of significant estimates and assumptions with respect to the potential outcome of positions taken on tax returns that may be reviewed by tax authorities. At December 31, 2022, the reserve for uncertain tax positions was $1,929 million, and it is reasonably possible that the total amount of unrecognized tax benefits related to certain of our uncertain tax positions could decrease by as much as $316 million within the next twelve months as a result of ongoing audits, foreign judicial proceedings, lapses of statutes of limitations or regulatory developments.Goodwill and Intangible AssetsGoodwill is allocated to our reporting units, which are our operating segments or one level below our operating segments (the component level). Reporting units are determined by the discrete financial information available for the component and whether it is regularly reviewed by segment management. Components are aggregated into a single reporting unit if they share similar economic characteristics. Our reporting units are Studios, Networks, and DTC.We evaluate our goodwill for impairment annually as of October 1 or earlier upon the occurrence of substantive unfavorable changes in economic conditions, industry trends, costs, cash flows, or ongoing declines in market capitalization. If we believe that as a result of our qualitative assessment it is not more likely than not that the fair value of a reporting unit is greater than its carrying amount, a quantitative impairment test is required. The quantitative impairment test requires significant judgment in determining the fair value of the reporting units. We determine the fair value of our reporting units by using a combination of the income approach, which incorporates the use of the discounted cash flow (“DCF”) method and the market multiple approach, which incorporates the use of EBITDA multiples based on market data. For the DCF method, we use projections specific to the reporting unit, as well as those based on general economic conditions, which require the use of significant estimates and assumptions. Determining fair value specific to each reporting unit requires us to exercise judgment when selecting the appropriate discount rates, control premiums, terminal growth rates, relevant comparable company earnings multiples and the amount and timing of expected future cash flows, including revenue growth rates and profit margins. The cash flows employed in the DCF analysis for each reporting unit are based on the reporting unit's budget, long range plan, and recent operating performance. Discount rate assumptions are based on an assessment of the risk inherent in the future cash flows of the respective reporting unit and market conditions.2022 Impairment AnalysisAs of October 1, 2022, we performed a quantitative goodwill impairment assessment for all reporting units consistent with our accounting policy. The estimated fair value of each reporting unit exceeded its carrying value by at least 20% and, therefore, no impairment was recorded. Due to declining levels of global GDP growth and execution risk associated with anticipated growth in the Company’s DTC reporting unit, which is the DTC segment, the Company will continue to monitor its reporting units for changes that could impact recoverability.Content RightsWe capitalize the costs to produce or acquire feature films and television programs, and we amortize costs and test for impairment based on whether the content is predominately monetized individually, or as a group.52For films and television programs predominantly monetized individually, the amount of capitalized film and television production costs amortized and the amount of participations and residuals to be recognized as expense in a particular period are determined using the individual film forecast method. Under this method, the amortization of capitalized costs and the accrual of participations and residuals are based on the proportion of the film’s or television program’s revenues recognized for such period to the film’s or television program’s estimated remaining ultimate revenues (i.e., the total revenue to be received throughout a film’s or television program’s remaining life cycle).For theatrical films, which are monetized on an individual basis, the process of estimating ultimate revenues requires us to make a series of judgments related to future revenue-generating activities associated with a particular film. Prior to the theatrical release of a film, our estimates are based on factors such as the historical performance of similar films, the star power of the lead actors, the rating and genre of the film, pre-release market research (including test market screenings), international distribution plans and the expected number of theaters in which the film will be released. Subsequent to release, ultimate revenues are updated to reflect initial performance, which is often predictive of future performance.For television programs that are monetized on an individual basis, ultimate revenues are estimated based on factors including the performance of similar programs in each applicable market, firm commitments in hand from customers that license the program in the future, and the popularity of the program in its initial markets.For a film or television program that is predominantly monetized on its own but also monetized with other films and/or programs (such as our DTC or linear services), we make a reasonable estimate of the value attributable to the film or program’s exploitation while monetized with other films/programs, based on relative market rates, and expense such costs as the film or television program is exhibited.Ultimates for content monetized on an individual basis are reviewed and updated (as applicable) on a quarterly basis; any adjustments are applied prospectively as of the beginning of the fiscal year of the change.For programs monetized as a group, including licensed programming, amortization expense for network programs is generally based on projected usage, generally resulting in an accelerated or straight-line amortization pattern. Adjustments to projected usage are applied prospectively in the period of the change. Streaming and premium pay-TV content amortization is based on estimated viewing patterns, as there are generally limited to no direct revenues to associate to the individual content assets for premium pay-TV. As such, number of views is most representative of the use of the title.Judgment is required to determine the useful lives and amortization patterns of our content assets that are predominately monetized as a group. Critical assumptions include: (i) the grouping of content with similar characteristics, (ii) the application of a quantitative revenue forecast model or historical viewership model based on the adequacy of historical data, (iii) determining the appropriate historical periods to utilize and the relative weighting of those historical periods in the forecast model, and (iv) incorporating secondary revenue streams. We then consider the appropriate application of the quantitative assessment given forecasted content use, expected content investment and market trends. Content use and future revenues may differ from estimates based on changes in expectations related to market acceptance, network affiliate fee rates, advertising demand, the number of cable and satellite television subscribers receiving our networks, the number of subscribers to our streaming services, and program usage. Accordingly, we review our estimates and planned usage at least quarterly and revise our assumptions if necessary.ConsolidationWe have ownership and other interests in and contractual arrangements with various entities, including corporations, partnerships, and limited liability companies. For each such entity, we evaluate our ownership, other interests and contractual arrangements to determine whether we should consolidate the entity or account for its interest as an investment at inception and upon reconsideration events. As part of its evaluation, we initially determine whether the entity is a variable interest entity (“VIE”). Management evaluates key considerations through a qualitative and quantitative analysis in determining whether an entity is a VIE including whether (i) the entity has sufficient equity to finance its activities without additional financial support from other parties, (ii) the ability or inability to make significant decisions about the entity’s operations, and (iii) the proportionality of voting rights of investors relative to their obligations to absorb the expected losses (or receive the expected returns) of the entity. If the entity is a VIE and if we have a variable interest in the entity, we use judgment in determining if we are the primary beneficiary and are thus required to consolidate the entity. In making this determination, we evaluate whether we or another party involved with the VIE (1) has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (2) has the obligation to absorb losses of or receive benefits from the VIE that could be significant to the VIE.53If it is concluded that an entity is not a VIE, we consider our proportional voting interests in the entity and consolidate majority-owned subsidiaries in which a controlling financial interest is maintained. A controlling financial interest is determined by majority ownership and the absence of substantive third-party participation rights. Key factors we consider in determining the presence of substantive third-party participation rights include, but are not limited to, control of the board of directors, budget approval or veto rights, or operational rights that significantly impact the economic performance of the business such as programming, creative development, marketing, and selection of key personnel. Ownership interests in unconsolidated entities for which we have significant influence are accounted for as equity method.We evaluated reconsideration events during the year ended December 31, 2022 and concluded there were no changes to our consolidation assessments.Revenue RecognitionAs described in Note 2, revenue is recognized upon transfer of control of promised services or goods to customers in an amount that reflects the consideration that we expect to receive in exchange for those services or goods. Significant estimates and judgements are applied in determining the timing of revenue recognition for certain types of transactions, such as bundled arrangements for advertising sales and content licensing arrangements.A substantial portion of the advertising contracts in the U.S. and certain international markets guarantee the advertiser a minimum audience level that either the program in which their advertisements are aired or the advertisement will reach. These advertising campaigns are considered to represent a single, distinct performance obligation. For such contracts, judgment is required in measuring progress across our single performance obligation. Various factors such as pricing specific to the channel, daypart and targeted demographic, as well as audience guarantees, are considered in determining how to appropriately measure progress across the campaigns. Revenues are ultimately recognized based on the guaranteed audience level delivered multiplied by the average price per impression.Our content licensing arrangements often include fixed license fees from the licensing of feature films and television programs in the off-network cable, premium pay, syndication, streaming, and international television and streaming markets. For arrangements that include multiple titles and/or staggered availabilities across geographical regions, the availability of each title and/or each region is considered a separate performance obligation, and the fixed fee is allocated to each title/region based on comparable market rates and recognized as revenue when the title is available for use by the licensee.Our games sometimes include digital offerings such as in-game purchases or other online features. In these cases, we determine the timing of satisfaction of our performance obligations based on the nature of the deliverable (e.g., whether the type of in-game purchase can be consumed by the player right away (“consumable good”, or used by the player over time “durable good”)), and if recognized over time, we estimate the duration of consumer game play based on available game play, historical, or market data.See Item 1A, “Risk Factors” for details on significant risks that could impact our ability to successfully grow our cash flows. For an in-depth discussion of each of our significant accounting policies, including our critical accounting policies and further information regarding estimates and assumptions involved in their application, see Note 2 to the accompanying consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk.Our financial position, earnings and cash flows are exposed to market risks and can be affected by, among other things, economic conditions, interest rate changes, foreign currency fluctuations, and changes in the market values of investments. We have established policies, procedures and internal processes governing our management of market risks and the use of financial instruments to manage our exposure to such risks.Interest RatesWe are exposed to the impact of interest rate changes primarily through our actual and potential borrowing activities. During the year ended December 31, 2022, we had access to a $6.0 billion multicurrency revolving credit facility. We had no outstanding borrowings as of December 31, 2022. We also have access to a commercial paper program, which had no outstanding borrowings as of December 31, 2022. The interest rate on borrowings under the revolving credit facility is based on a floating rate based on the applicable currency of the borrowing plus a margin. The revolving credit facility matures in June 2026, with the option for up to two additional 364-day renewal periods. As of December 31, 2022, we had $44.8 billion of fixed-rate senior notes, at par value.54Our current objectives in managing exposure to interest rate changes are to limit the impact of interest rates on earnings and cash flows. To achieve these objectives, we may enter into derivative instruments, effectively converting fixed rate borrowings to variable rate borrowings indexed to benchmark interest rates in order to reduce the amount of interest paid, or to limit the impact of volatility in interest rates on future issuances of fixed rate debt. (See Note 13 to the accompanying consolidated financial statements.)As of December 31, 2022, the fair value of our outstanding senior notes, including accrued interest, was $38.0 billion. The fair value of our long-term debt may vary as a result of market conditions and other factors. A change in market interest rates will impact the fair market value of our fixed rate debt. The potential change in fair value of these senior notes from a 100 basis-point increase in quoted interest rates across all maturities, often referred to as a parallel shift in the yield curve, would be a decrease in fair value of approximately $2.6 billion as of December 31, 2022.Foreign Currency Exchange RatesWe transact business globally and are subject to risks associated with changing foreign currency exchange rates. Market risk refers to the risk of loss arising from adverse changes in foreign currency exchange rates. The risk of loss can be assessed from the perspective of adverse changes in fair values, cash flows, and future earnings. We operate from hubs in EMEA, Latin America, and Asia, with net earnings reinvested locally and working capital requirements met from existing liquid funds. To the extent such funds are not sufficient to meet working capital requirements, drawdowns in the appropriate local currency are available from intercompany borrowings or from our revolving credit facility. The earnings of certain international operations are expected to be reinvested in those businesses indefinitely. The functional currency of most of our international subsidiaries is the local currency. We are exposed to foreign currency risk to the extent that we enter into transactions denominated in currencies other than our subsidiaries’ respective functional currencies (“non-functional currency risk”). Such transactions include affiliate and ad sales arrangements, content arrangements, equipment and other vendor purchases, and intercompany transactions. Changes in exchange rates with respect to amounts recorded in our consolidated balance sheets related to these items will result in unrealized foreign currency transaction gains and losses based upon period-end exchange rates. We also record realized foreign currency transaction gains and losses upon settlement of the transactions. Moreover, we will experience fluctuations in our revenues and expenses solely as a result of changes in foreign currency exchange rates. We also are exposed to unfavorable and potentially volatile fluctuations of the U.S. dollar, which is our reporting currency, against the currencies of our operating subsidiaries when their respective financial statements are translated into U.S. dollars for inclusion in our consolidated financial statements. Cumulative translation adjustments are recorded in accumulated other comprehensive loss as a separate component of equity. Any increase or decrease in the value of the U.S. dollar against any foreign functional currency of one of our operating subsidiaries will cause us to experience unrealized foreign currency translation gains or losses with respect to amounts already invested in such foreign currencies. Accordingly, we may experience a negative impact on our net income, other comprehensive (loss) income and equity with respect to our holdings solely as a result of changes in foreign currency. The majority of our foreign currency exposure is tied to Europe and Latin America. We may enter into derivative instruments that change in value as foreign currency exchange rates change to hedge certain exposures associated with affiliate revenue, the cost of producing or acquiring content, certain intercompany transactions, or in connection with forecasted business combinations. These contracts hedge forecasted foreign currency transactions in order to mitigate fluctuations in our earnings and cash flows associated with changes in foreign currency exchange rates. Our objective in managing exposure to foreign currency fluctuations is to reduce volatility of earnings and cash flows. Most of our non-functional currency risks related to our revenue, operating expenses and capital expenditures were not hedged as of December 31, 2022. We generally do not hedge against the risk that we may incur non-cash losses upon the translation of the financial statements of our subsidiaries and affiliates into U.S. dollars. (See Note 13 to the accompanying consolidated financial statements.)DerivativesWe may use derivative financial instruments to modify our exposure to exogenous events and market risks from changes in foreign currency exchange rates and interest rates. We do not use derivatives unless there is an underlying exposure. While derivatives are used to mitigate cash flow risk and the risk of declines in fair value, they also limit potential economic benefits to our business in the event of positive shifts in foreign currency exchange rates and interest rates. We do not hold or enter into financial instruments for speculative trading purposes. (See Note 13 to the accompanying consolidated financial statements.)55Market Values of Investments and Liabilities In addition to derivatives, we had investments in entities accounted for as equity method investments, equity investments, and other highly liquid instruments, such as money market funds and mutual funds, that are accounted for at fair value. We also have liabilities, such as deferred compensation, that are accounted for at fair value (See Note 10 and Note 14 to the accompanying consolidated financial statements). Investments in mutual funds include both fixed- and floating-rate interest earning securities that carry a degree of interest rate risk. Fixed-rate securities may have their fair market value adversely impacted by a rise in interest rates, while floating-rate securities may produce less income than predicted if interest rates fall. Due in part to these factors, our income from such investments may decrease in the future. Liabilities carried at fair value, such as deferred compensation, may experience capital gains that result in increased liabilities and expenses as the capital gains occur. We may enter into derivative financial instruments to hedge the risk of these market value changes. (See Note 13 to the accompanying consolidated financial statements.)56
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, particularly in “Risk Factors” included in Part I, Item 1A of this report.The following discussion of our financial condition and results of operations covers fiscal 2023 and 2022 items and year-over-year comparisons between fiscal 2023 and 2022. Discussions of fiscal 2021 items and year-over-year comparisons between fiscal 2022 and 2021 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 31, 2022, that was filed with the SEC on February 28, 2022.OverviewWorkday delivers applications for financial management, spend management, human capital management, planning, and analytics. With Workday, our customers have a unified system that can help them plan, execute, analyze, and extend to other applications and environments, thereby helping them continuously adapt how they manage their business and operations. Our diverse customer base includes medium-sized and large, global organizations within numerous industry categories, including professional and business services, financial services, healthcare, education, government, technology, media, retail, and hospitality.We have achieved significant growth since our inception in 2005, with a substantial amount of our growth coming from new customers. Our current financial focus is on growing our revenues and expanding both our customer base and our footprint within our existing customers. While we have a history of GAAP operating losses, we strive to invest in a disciplined manner across all of our functional areas to sustain continued near-term revenue growth and support our long-term initiatives. We expect our product development, sales and marketing, and general and administrative expenses as a percentage of total revenues will decrease over the longer term as we grow our revenues, and we anticipate that we will gain economies of scale by increasing our customer base without direct incremental development costs.We plan to reinvest a significant portion of our incremental revenues in future periods to grow our business. We have invested and expect to continue to invest heavily in our product development efforts to deliver additional compelling applications, enhance existing applications, and to address customers’ evolving needs. In addition, we plan to continue to expand our ability to sell our applications globally, particularly in Europe and Asia-Pacific, by investing in product development and customer support to address the business needs of targeted local markets, increasing our sales organization and marketing programs, acquiring and leasing additional office space, and expanding our ecosystem of service partners to support local deployments. We expect to make further significant investments in our data center capacity and equipment and third-party hosted infrastructure platforms as we plan for future growth. We are also investing in personnel to support our growing customer base.We regularly evaluate acquisition and investment opportunities in complementary businesses, employee teams, services, technologies, and intellectual property rights in an effort to expand our product and service offerings. For example, in fiscal 2022, we acquired Peakon, a continuous listening platform that captures real-time employee sentiment, Zimit, a configure, price, quote solution built for services industries, and VNDLY, a cloud-based external workforce and vendor management technology. We expect to continue making such acquisitions and investments in the future. While we remain focused on improving operating margin, these acquisitions and investments will increase our costs on an absolute basis in the near term. Many of these investments will occur in advance of experiencing any direct benefit from them and could make it difficult to determine if we are allocating our resources efficiently.Since inception, we have also invested heavily in our professional services organization to help ensure that customers successfully deploy and adopt our applications. Additionally, we continue to expand our professional services partner ecosystem to further support our customers. We believe our investment in professional services, as well as partners building consulting practices around Workday and helping to deliver additional innovation and solutions, will drive additional customer subscriptions and continued growth in revenues. Due to our ability to leverage the expanding partner ecosystem, we expect the rate of professional services revenue growth to decline over time and continue to be lower than subscription revenue growth.36Table of ContentsImpact of Current Economic ConditionsRecent macroeconomic events including higher inflation, the U.S. Federal Reserve raising interest rates, the COVID-19 pandemic, and the Russian invasion of Ukraine have negatively impacted the global economy, disrupted global supply chains, and created significant uncertainty, volatility, and disruption of financial markets. Despite the continuing uncertainty associated with these events, we are confident in the long-term overall health of our business, the strength of our product offerings, and our ability to continue to execute on our strategy and help our customers on their HR and finance digital transformation journeys. Demand for our products remains strong, and we continue to achieve solid new subscription bookings.Our near-term revenues are relatively predictable as a result of our subscription-based business model. We have experienced, and may continue to experience, the lengthening of certain sales cycles, particularly within net new opportunities. If the economic uncertainty continues, we may also experience a negative impact on customer renewals, sales and marketing efforts, revenue growth rates, customer deployments, customer collections, product development, or other financial metrics. Any of these factors could harm our business, financial condition, and operating results. For further discussion of the potential impacts of recent macroeconomic events on our business, financial condition, and operating results, see “Risk Factors” included in Part I, Item 1A of this report.Financial Results OverviewThe following table provides an overview of our key metrics (in thousands, except percentages, basis points, and headcount data): As of and for the Years Ended January 31, 20232022ChangeTotal revenues$6,215,818 $5,138,798 21 %Subscription services revenues$5,567,206 $4,546,313 22 %GAAP operating income (loss)$(222,200)$(116,450)91 %Non-GAAP operating income (1)$1,209,636 $1,149,704 5 %GAAP operating margin(3.6)%(2.3)%(130 bps)Non-GAAP operating margin (1)19.5 %22.4 %(290 bps)Operating cash flows$1,657,195 $1,650,704 0 %Total subscription revenue backlog$16,448,155 $12,806,855 28 %24-month subscription revenue backlog$9,677,373 $7,975,554 21 %Cash, cash equivalents, and marketable securities$6,121,394 $3,644,161 68 %Headcount17,744 15,204 17 %(1)See “Non-GAAP Financial Measures” below for further information.Components of Results of OperationsRevenuesWe derive our revenues from subscription services and professional services. Subscription services revenues primarily consist of fees that give our customers access to our cloud applications, which include related customer support. Professional services revenues include fees for deployment services, optimization services, and training.Subscription services revenues accounted for approximately 90% of our total revenues during fiscal 2023, and represented 96% of our total unearned revenue as of January 31, 2023. Subscription services revenues are driven primarily by the number of customers, the number of workers at each customer, the specific applications subscribed to by each customer, and the price of our applications.37Table of ContentsThe mix of applications to which each customer subscribes can affect our financial performance due to price differentials in our applications. Pricing for our applications varies based on many factors, including the complexity and maturity of the application and its acceptance in the marketplace. New products or services offerings by competitors in the future could also impact the mix and pricing of our offerings.Subscription services revenues are recognized over time as services are delivered and consumed concurrently over the contractual term, beginning on the date our service is made available to the customer. Our subscription contracts typically have a term of three years or longer and are generally noncancelable. We generally invoice our customers annually in advance. Amounts that have been invoiced are initially recorded as unearned revenue.Our consulting engagements are billed on a time and materials basis or a fixed price basis. For contracts billed on a time and materials basis, revenues are recognized over time as the professional services are performed. For contracts billed on a fixed price basis, revenues are recognized over time based on the proportion of the professional services performed. In some cases, we supplement our consulting teams by subcontracting resources from our service partners and deploying them on customer engagements. As the Workday-related consulting practices of our partner firms continues to develop, we expect these partners to increasingly contract directly with our subscription customers.Subscription Revenue BacklogOur subscription revenue backlog, which is also referred to as remaining performance obligations for subscription contracts, represents contracted subscription services revenues that have not yet been recognized and includes billed and unbilled amounts. Subscription revenue backlog may fluctuate from period to period due to a number of factors, including the timing of renewals and overall renewal rates, new business growth, average contract duration, and seasonality.Costs and ExpensesCosts of subscription services revenues. Costs of subscription services revenues consist primarily of employee-related expenses associated with hosting our applications and providing customer support, expenses related to data centers and computing infrastructure operated by third parties, and depreciation of computer equipment and software.Costs of professional services revenues. Costs of professional services revenues consist primarily of employee-related expenses associated with these services, subcontractor expenses, and travel expenses.Product development expenses. Product development expenses consist primarily of employee-related expenses associated with our efforts to add new features and applications, increase functionality, and enhance the ease of use of our cloud applications.Sales and marketing expenses. Sales and marketing expenses consist primarily of employee-related expenses, sales commissions, marketing programs, and travel expenses. Marketing programs consist of advertising, events, corporate communications, brand awareness, brand ambassador campaigns, and product marketing activities. Sales commissions are considered incremental costs of obtaining a contract with a customer. Sales commissions for new revenue contracts are capitalized and amortized on a straight-line basis over a period of benefit that we have determined to be five years.General and administrative expenses. General and administrative expenses consist of employee-related expenses for finance and accounting, legal, HR, information systems personnel, professional fees, and other corporate expenses.Results of OperationsRevenuesOur total revenues for fiscal 2023, 2022, and 2021, were as follows (in thousands): Year Ended January 31, 202320222021Subscription services$5,567,206 $4,546,313 $3,788,452 Professional services648,612 592,485 529,544 Total revenues$6,215,818 $5,138,798 $4,317,996 38Table of ContentsTotal revenues were $6.2 billion for fiscal 2023, compared to $5.1 billion for fiscal 2022, an increase of $1.1 billion, or 21%. Subscription services revenues were $5.6 billion for fiscal 2023, compared to $4.5 billion for fiscal 2022, an increase of $1.0 billion, or 22%. The increase in subscription services revenues was primarily due to an increased number of customer contracts and strong customer renewals, with gross and net retention rates over 95% and over 100%, respectively. Professional services revenues were $649 million for fiscal 2023, compared to $592 million for fiscal 2022, an increase of $56 million, or 9%. The increase in professional services revenues was primarily due to Workday performing deployment and integration services for higher valued contracts.Subscription Revenue BacklogAs of January 31, 2023, our total subscription revenue backlog was $16.4 billion, with $9.7 billion expected to be recognized in revenues over the next 24 months. As of January 31, 2022, our total subscription revenue backlog was $12.8 billion, with $8.0 billion expected to be recognized in revenues over the next 24 months. The increase in subscription revenue backlog during fiscal 2023 was primarily driven by the addition of new customers, expansion of our product offerings with existing customers, and the timing of renewals.Operating ExpensesGAAP operating expenses were $6.4 billion for fiscal 2023, compared to $5.3 billion for fiscal 2022, an increase of $1.2 billion, or 23%. The increase in GAAP operating expenses was primarily due to an increase of $845 million in employee-related expenses, including share-based compensation. The main driver for the increase in employee-related expenses was higher headcount. We also recognized $40 million of expense from the workforce realignment announced in the fourth quarter of fiscal 2023. Additionally, we incurred costs related to our performance-based cash bonus program that we introduced in the fourth quarter of fiscal 2022 for all employees not covered under an existing cash incentive plan (“performance-based cash bonus program”). This program replaced our performance based restricted stock unit (“PRSU”) bonus program, resulting in a net increase of $36 million. Further, we changed the vesting dates of all unvested restricted stock units (“RSU”) from the 15th to the 5th of each month which resulted in an acceleration of share-based compensation expense of $28 million in the fourth quarter of fiscal 2023.Additional increases within GAAP operating expenses included $94 million in facilities and IT-related expenses partly driven by our employees returning to our offices, $75 million in third-party expenses for hardware maintenance and data center capacity reflecting our continued investment in our technical operations infrastructure, and $54 million in travel expenses and $51 million related to marketing programs partly driven by a return to in-person events.Non-GAAP operating expenses were $5.0 billion for fiscal 2023, compared to $4.0 billion for fiscal 2022, an increase of $1.0 billion, or 25%. The increase in non-GAAP operating expenses included $686 million in employee-related expenses primarily due to higher headcount, of which $102 million was related to the new performance-based cash bonus program, and $34 million was related to the workforce realignment. Additionally, there were increases of $94 million in facilities and IT-related expenses partly driven by our employees returning to our offices, $75 million in third-party expenses for hardware maintenance and data center capacity reflecting our continued investment in our technical operations infrastructure, and $54 million in travel expenses and $51 million related to marketing programs partly driven by a return to in-person events. Non-GAAP operating expenses were calculated by excluding share-based compensation expenses and certain other expenses, which consist of employer payroll tax-related items on employee stock transactions and amortization of acquisition-related intangible assets. See “Non-GAAP Financial Measures” below for further information.Reconciliations of our GAAP to non-GAAP operating expenses were as follows (in thousands): Year Ended January 31, 2023 GAAP Operating ExpensesShare-Based Compensation ExpensesOther Operating Expenses (1)Non-GAAP Operating Expenses (2)Costs of subscription services$1,011,447 $(106,119)$(59,769)$845,559 Costs of professional services703,731 (110,216)(6,678)586,837 Product development2,270,660 (618,973)(23,162)1,628,525 Sales and marketing1,848,093 (249,248)(42,490)1,556,355 General and administrative604,087 (210,066)(5,115)388,906 Total costs and expenses$6,438,018 $(1,294,622)$(137,214)$5,006,182 39Table of Contents Year Ended January 31, 2022 GAAP Operating ExpensesShare-Based Compensation ExpensesOther Operating Expenses (1)Non-GAAP Operating Expenses (2)Costs of subscription services$795,854 $(85,713)$(54,551)$655,590 Costs of professional services632,241 (113,443)(11,181)507,617 Product development1,879,220 (543,135)(32,935)1,303,150 Sales and marketing1,461,921 (215,692)(47,457)1,198,772 General and administrative486,012 (154,422)(7,625)323,965 Total costs and expenses$5,255,248 $(1,112,405)$(153,749)$3,989,094 Year Ended January 31, 2021 GAAP Operating ExpensesShare-Based Compensation ExpensesOther Operating Expenses (1)Non-GAAP Operating Expenses (2)Costs of subscription services$611,912 $(63,253)$(34,799)$513,860 Costs of professional services586,220 (101,869)(6,486)477,865 Product development1,721,222 (505,376)(27,567)1,188,279 Sales and marketing1,233,173 (202,819)(35,797)994,557 General and administrative414,068 (131,537)(6,337)276,194 Total costs and expenses$4,566,595 $(1,004,854)$(110,986)$3,450,755 (1)Other operating expenses include amortization of acquisition-related intangible assets of $86 million, $78 million, and $60 million for fiscal 2023, 2022, and 2021, respectively. In addition, other operating expenses include employer payroll tax-related items on employee stock transactions of $52 million, $76 million, and $51 million for fiscal 2023, 2022, and 2021, respectively.(2)See “Non-GAAP Financial Measures” below for further information.Costs of Subscription ServicesGAAP operating expenses in costs of subscription services were $1.0 billion for fiscal 2023, compared to $796 million for fiscal 2022, an increase of $216 million, or 27%. The increase in costs of subscription services included increases of $100 million in employee-related expenses, including share-based compensation, primarily due to higher headcount, $60 million in third-party expenses for hardware maintenance and data center capacity, and $23 million in facilities and IT-related expenses.Non-GAAP operating expenses in costs of subscription services were $846 million for fiscal 2023, compared to $656 million for fiscal 2022, an increase of $190 million, or 29%. The increase in costs of subscription services included increases of $81 million in employee-related expenses primarily due to higher headcount, $60 million in third-party expenses for hardware maintenance and data center capacity, and $23 million in facilities and IT-related expenses. We expect GAAP and non-GAAP operating expenses in costs of subscription services will continue to increase in absolute dollars as we improve and expand our technical operations infrastructure, including our data centers and computing infrastructure operated by third parties.Costs of Professional ServicesGAAP operating expenses in costs of professional services were $704 million for fiscal 2023, compared to $632 million for fiscal 2022, an increase of $71 million, or 11%. The increase in costs of professional services included an increase of $48 million in employee-related expenses, including share-based compensation, primarily due to higher headcount.Non-GAAP operating expenses in costs of professional services were $587 million for fiscal 2023, compared to $508 million for fiscal 2022, an increase of $79 million, or 16%. The increase in costs of professional services included an increase of $56 million in employee-related expenses primarily due to higher headcount.We expect GAAP and non-GAAP costs of professional services as a percentage of total revenues to continue to decline as we continue to rely on our service partners to deploy our applications and as the number of our customers continues to grow.40Table of ContentsProduct DevelopmentGAAP operating expenses in product development were $2.3 billion for fiscal 2023, compared to $1.9 billion for fiscal 2022, an increase of $391 million, or 21%. The increase in product development expenses included increases of $346 million in employee-related expenses, including share-based compensation, primarily due to higher headcount and $32 million in facilities and IT-related expenses.Non-GAAP operating expenses in product development were $1.6 billion for fiscal 2023, compared to $1.3 billion for fiscal 2022, an increase of $325 million, or 25%. The increase in product development expenses included increases of $279 million in employee-related expenses primarily due to higher headcount, of which $62 million was related to the new performance-based cash bonus program, and $32 million in facilities and IT-related expenses.We expect GAAP and non-GAAP product development expenses will continue to increase in absolute dollars as we improve and extend our applications and develop new technologies.Sales and MarketingGAAP operating expenses in sales and marketing were $1.8 billion for fiscal 2023, compared to $1.5 billion for fiscal 2022, an increase of $386 million, or 26%. The increase in sales and marketing expenses included increases of $255 million in employee-related expenses, including share-based compensation, primarily due to higher headcount and $48 million related to marketing programs and $33 million in travel expenses partly driven by a return to in-person events.Non-GAAP operating expenses in sales and marketing were $1.6 billion for fiscal 2023, compared to $1.2 billion for fiscal 2022, an increase of $358 million, or 30%. The increase in sales and marketing expenses included increases of $227 million in employee-related expenses primarily due to higher headcount and $48 million related to marketing programs and $33 million in travel expenses partly driven by a return to in-person events.We expect GAAP and non-GAAP sales and marketing expenses to increase in absolute dollars as we continue to invest in our domestic and international selling and marketing activities to expand brand awareness and attract new customers.General and AdministrativeGAAP operating expenses in general and administrative were $604 million for fiscal 2023, compared to $486 million for fiscal 2022, an increase of $118 million, or 24%. The increase in general and administrative expenses included an increase of $96 million in employee-related expenses, including share-based compensation, primarily due to higher headcount.Non-GAAP operating expenses in general and administrative were $389 million for fiscal 2023, compared to $324 million for fiscal 2022, an increase of $65 million, or 20%. The increase in general and administrative expenses included an increase of $43 million in employee-related expenses primarily due to higher headcount.We expect GAAP and non-GAAP general and administrative expenses will continue to increase in absolute dollars as we further invest in our infrastructure and support our global expansion.Operating MarginGAAP operating margin declined from (2.3)% for fiscal 2022 to (3.6)% for fiscal 2023, primarily related to increases in expenses due to higher headcount, a return to travel and in-person events, the workforce realignment, the rollout of the performance-based cash bonus program, an acceleration of share-based compensation expense caused by modifying the vesting dates of all unvested RSUs from the 15th to the 5th of each month, and other growth investments made across the business. These increases were offset in part by higher revenues.Non-GAAP operating margin declined from 22.4% for fiscal 2022 to 19.5% for fiscal 2023, primarily related to increases in expenses due to higher headcount, the rollout of the performance-based cash bonus program, a return to travel and in-person events, the workforce realignment, and other growth investments made across the business, offset in part by higher revenues. Non-GAAP operating margin was calculated using GAAP revenues and non-GAAP operating expenses. See “Non-GAAP Financial Measures” below for further information.41Table of ContentsReconciliations of our GAAP to non-GAAP operating income (loss) and operating margin were as follows (in thousands, except percentages): Year Ended January 31, 2023 GAAPShare-Based Compensation ExpensesOther Operating ExpensesNon-GAAP (1)Operating income (loss)$(222,200)$1,294,622 $137,214 $1,209,636 Operating margin(3.6)%20.8 %2.3 %19.5 % Year Ended January 31, 2022 GAAPShare-Based Compensation ExpensesOther Operating ExpensesNon-GAAP (1)Operating income (loss)$(116,450)$1,112,405 $153,749 $1,149,704 Operating margin(2.3)%21.6 %3.1 %22.4 % Year Ended January 31, 2021 GAAPShare-Based Compensation ExpensesOther Operating ExpensesNon-GAAP (1)Operating income (loss)$(248,599)$1,004,854 $110,986 $867,241 Operating margin(5.8)%23.3 %2.6 %20.1 %(1)See “Non-GAAP Financial Measures” below for further information.Other Income (Expense), NetWe had other income (expense), net of $(38) million, $133 million, and $(27) million during fiscal 2023, 2022, and 2021, respectively. Other expense, net in fiscal 2023 was primarily due to interest expense of $102 million on our debt primarily related to the Senior Notes and losses of $27 million on our equity investments. Expenses were offset by interest income of $98 million on our marketable securities from higher investment balances and rising interest rates. Other income, net in fiscal 2022 was primarily due to gains of $144 million on our equity investments, the majority of which related to an equity investment that completed its IPO during the period, offset by interest expense of $17 million on our debt.Non-GAAP Financial MeasuresRegulation S-K Item 10(e), “Use of non-GAAP financial measures in Commission filings,” defines and prescribes the conditions for use of non-GAAP financial information. Our measures of non-GAAP operating expenses, non-GAAP operating income (loss), and non-GAAP operating margin meet the definition of non-GAAP financial measures.Non-GAAP Operating Expenses, Non-GAAP Operating Income (Loss), and Non-GAAP Operating MarginWe use the non-GAAP financial measures of non-GAAP operating expenses, non-GAAP operating income (loss), and non-GAAP operating margin to understand and compare operating results across accounting periods, for internal budgeting and forecasting purposes, for short- and long-term operating plans, and to evaluate our financial performance. We believe that these non-GAAP measures reflect our ongoing business in a manner that allows for meaningful period-to-period comparisons and analysis of trends in our business. 42Table of ContentsOur non-GAAP operating expenses, non-GAAP operating income (loss), and non-GAAP operating margin exclude the components listed below. For the reasons set forth below, we believe that excluding these components provides useful information to investors and others in understanding and evaluating our operating results and prospects in the same manner as management, in comparing financial results across accounting periods and to those of peer companies, and to better understand the long-term performance of our core business.•Share-Based Compensation Expenses. Although share-based compensation is an important aspect of the compensation of our employees and executives, we believe it is useful to exclude share-based compensation expenses to better understand the long-term performance of our core business and to facilitate comparison of our results to those of peer companies. Share-based compensation expenses are determined using a number of factors, including our stock price, volatility, and forfeiture rates that are beyond our control and generally unrelated to operational decisions and performance in any particular period. Further, share-based compensation expenses are not reflective of the value ultimately received by the grant recipients.•Other Operating Expenses. Other operating expenses includes employer payroll tax-related items on employee stock transactions and amortization of acquisition-related intangible assets. The amount of employer payroll tax-related items on employee stock transactions is dependent on our stock price and other factors that are beyond our control and do not correlate to the operation of the business. For business combinations, we generally allocate a portion of the purchase price to intangible assets. The amount of the allocation is based on estimates and assumptions made by management and is subject to amortization. The amount of purchase price allocated to intangible assets and the term of its related amortization can vary significantly and are unique to each acquisition and thus we do not believe it is reflective of ongoing operations. Although we exclude the amortization of acquisition-related intangible assets from these non-GAAP measures, we believe that it is important for investors to understand that such intangible assets were recorded as part of purchase accounting and contribute to revenue generation.Limitations on the Use of Non-GAAP Financial MeasuresA limitation of our non-GAAP financial measures of non-GAAP operating expenses, non-GAAP operating income (loss), and non-GAAP operating margin is that they do not have uniform definitions. Our definitions will likely differ from the definitions used by other companies, including peer companies, and therefore comparability may be limited. Further, the non-GAAP financial measure of non-GAAP operating expenses has certain limitations because it does not reflect all items of expense that affect our operations and are reflected in the GAAP financial measure of total operating expenses. In the case of share-based compensation, if we did not pay out a portion of compensation in the form of share-based compensation and related employer payroll tax-related items, the cash salary expense included in operating expenses would be higher, which would affect our cash position.We compensate for these limitations by reconciling the non-GAAP financial measures to the most comparable GAAP financial measures. These non-GAAP financial measures should be considered in addition to, not as a substitute for or in isolation from, measures prepared in accordance with GAAP. We encourage investors and others to review our financial information in its entirety, not to rely on any single financial measure, and to view our non-GAAP financial measures in conjunction with the most comparable GAAP financial measures.See “Results of Operations—Operating Expenses” and “Results of Operations—Operating Margin” for reconciliations from the most directly comparable GAAP financial measures of GAAP operating expenses, GAAP operating income (loss), and GAAP operating margin, to the non-GAAP financial measures of non-GAAP operating expenses, non-GAAP operating income (loss), and non-GAAP operating margin, for fiscal 2023, 2022, and 2021.Liquidity and Capital ResourcesAs of January 31, 2023, our principal sources of liquidity were cash, cash equivalents, and marketable securities totaling $6.1 billion, which were primarily held for working capital purposes. Our cash equivalents and marketable securities are composed of, in order from largest to smallest, U.S. treasury securities, commercial paper, corporate bonds, U.S. agency obligations, money market funds, and marketable equity investments. We have financed our operations primarily through customer payments, issuance of debt, and sales of our common stock.We believe our existing cash, cash equivalents, marketable securities, cash provided by operating activities, unbilled amounts related to the remaining term of contracted noncancelable subscription agreements, which are not reflected on the Consolidated Balance Sheets, and, if necessary, our borrowing capacity under our 2022 Credit Agreement that provides for $1.0 billion of unsecured financing, are sufficient to meet our working capital, capital expenditure, and debt repayment needs over the next 12 months.43Table of ContentsOur long-term future capital requirements depend on many factors, including the effects of macroeconomic trends, customer growth rates, subscription renewal activity, headcount growth, the timing and extent of development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced services offerings, the timing and costs associated with the construction or acquisition of additional facilities, and our investment and acquisition activities. As part of our strategy, we may choose to seek additional debt or equity financing.Our cash flows fiscal 2023, 2022, and 2021 were as follows (in thousands): Year Ended January 31, 202320222021Net cash provided by (used in):Operating activities$1,657,195 $1,650,704 $1,268,441 Investing activities(2,505,926)(1,607,426)(1,241,624)Financing activities1,203,821 110,251 625,049 Effect of exchange rate changes(595)(705)1,334 Net increase (decrease) in cash, cash equivalents, and restricted cash$354,495 $152,824 $653,200 Operating ActivitiesCash provided by operating activities was $1.7 billion for both fiscal 2023 and 2022. In fiscal 2023, increased sales and related cash collections were offset by cash outlays related to higher headcount, return to travel and in-person events, a one-time intellectual property transfer tax payment, an interest payment on our Senior Notes, and other growth investments across the business.We expect our business to continue to generate sufficient operating cash flows; however, if the economic uncertainty caused by recent macroeconomic events worsens or is prolonged, our customers may request payment timing concessions, which could materially impact the timing and predictability of our operating cash flows in any given period.Investing ActivitiesCash used in investing activities for fiscal 2023 was $2.5 billion, which primarily resulted from purchases of marketable securities, net of maturities, of $2.2 billion using the proceeds from the Senior Notes offering, capital expenditures for data center and office space projects of $360 million, and purchases of non-marketable equity and other investments of $23 million. These payments were partially offset by proceeds of $116 million from sales of marketable and non-marketable securities.Cash used in investing activities for fiscal 2022 was $1.6 billion, which was primarily related to cash consideration for the acquisitions of VNDLY, Zimit, and Peakon, net of cash acquired, of $1.2 billion. Cash used in investing activities also included capital expenditures of $264 million mainly for data center projects, the purchase of leased office space within our corporate headquarters from an affiliate of our Co-Founder and CEO Emeritus, David Duffield, of $171 million, purchases of non-marketable equity and other investments of $123 million, and a cash outflow from the timing of purchases and maturities of marketable securities of $55 million. These payments were partially offset by proceeds of $199 million from sales of marketable securities.We expect capital expenditures will be approximately $340 million in fiscal 2024. This includes investments in our office facilities, corporate IT infrastructure, and customer data centers to support our continued growth.Financing ActivitiesFor fiscal 2023, cash provided by financing activities was $1.2 billion, which was primarily due to proceeds of $3.0 billion from borrowings on the Senior Notes, net of debt discount of $22 million, and $152 million from the issuance of common stock from employee equity plans, offset by the principal payment of $1.15 billion in connection with the conversion of our 0.25% convertible senior notes (“2022 Notes”), repayment of the term loan under the credit agreement entered into in April 2020 (“2020 Credit Agreement”) of $694 million, and repurchases of common stock under the Share Repurchase Program of $75 million.For fiscal 2022, cash provided by financing activities was $110 million, which was primarily due to proceeds of $148 million from the issuance of common stock from employee equity plans, offset by payments of $38 million on the term loan under the 2020 Credit Agreement.44Table of ContentsShare Repurchase ProgramIn November 2022, our Board of Directors authorized the repurchase of up to $500 million of our outstanding shares of Class A common stock. The Share Repurchase Program will have a term of 18 months, may be suspended or discontinued at any time, and does not obligate us to acquire any amount of Class A common stock. During fiscal 2023, we repurchased approximately 0.5 million shares of Class A common stock for approximately $75 million at an average price per share of $165.75. All repurchases were made in open market transactions. As of January 31, 2023, we were authorized to purchase a remaining $425 million of our outstanding shares of Class A common stock under the Share Repurchase Program.Contractual ObligationsOur contractual obligations primarily consist of borrowings under our Senior Notes, leases for office space and co-location facilities for data center capacity, agreements for third-party hosted infrastructure platforms for business operations, and other purchase obligations entered into in the ordinary course of business. The table below includes our material contractual obligations, excluding imputed interest, as of January 31, 2023 (in thousands). For further information, see the associated Notes to Consolidated Financial Statements included in Part II, Item 8 of this report referenced in the table below.Payments Due by Period TotalShort-termLong-termReferenceSenior Notes (1)$3,752,375 $110,250 $3,642,125 Note 11Operating leases300,821 97,387 203,434 Note 12Third-party hosted infrastructure platform obligations547,626 40,000 507,626 Note 13Other purchase obligations372,273 115,386 256,887 Note 13$4,973,095 $363,023 $4,610,072 (1)Consists of principal and interest payments on the Senior Notes.Critical Accounting Policies and EstimatesOur consolidated financial statements are prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates, judgements, and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates, judgements, and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.We believe that of our significant accounting policies, which are described in Note 2, Accounting Standards and Significant Accounting Policies, of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report, the following accounting policies and specific estimates involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and operating results.Revenue RecognitionWe derive our revenues from subscription services and professional services. Revenues are recognized when control of these services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to receive in exchange for services rendered.We determine revenue recognition through the following steps:•Identification of the contract, or contracts, with a customer;•Identification of the performance obligations in the contract;•Determination of the transaction price;•Allocation of the transaction price to the performance obligations in the contract; and•Recognition of revenues when, or as, we satisfy a performance obligation.We believe the area we apply the most critical judgement when determining revenue recognition relates to the identification of distinct performance obligations. 45Table of ContentsIdentification of Performance ObligationsA performance obligation is a promise in a contract with a customer to transfer products or services that are distinct. Our contracts with customers may include multiple promises to transfer services to a customer. Determining whether products and services are distinct performance obligations that should be accounted for separately or combined as a single performance obligation may require significant judgment that requires us to assess the nature of the promise and the value delivered to the customer. Our primary performance obligations consist of subscription services and professional services. We satisfy these performance obligations over time as we transfer the promised services to our customers. Subscription services are made up of a daily requirement to deliver the service to the customer. Each day the delivery of the service provides value to the customer and each day represents a measure toward completion of the service. As such, subscription services meet the criteria to be a series of distinct services. In determining whether professional services are distinct, we consider the following factors for each professional services agreement: availability of the services from other vendors, the nature of the professional services, the timing of when the professional services contract was signed in comparison to the subscription start date, and the contractual dependence of the service on the customer’s satisfaction with the professional services work. To date, we have concluded that professional services included in contracts with multiple performance obligations are generally distinct as the professional services are not interrelated with subscription services nor do they result in significant customization of the subscription service. As such, we view professional services as a performance obligation to the customer. At contract inception, we evaluate whether two or more contracts should be combined and accounted for as a single contract and whether the combined or single contract includes more than one performance obligation. We combine contracts entered into at or near the same time with the same customer if we determine that the contracts are negotiated as a package with a single commercial objective; the amount of consideration to be paid in one contract depends on the price or performance of the other contract; or the services promised in the contracts are a single performance obligation. For contracts that contain multiple performance obligations, we assess each promise separately and allocate the transaction price on a relative standalone selling price (“SSP”) basis. We apply significant judgment in identifying and evaluating any terms and conditions in contracts which may impact revenue recognition.Deferred CommissionsSales commissions earned by our sales force are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions for new revenue contracts are capitalized and then amortized on a straight-line basis over a period of benefit that we have determined to be five years. We determined the period of benefit by taking into consideration our customer contracts, our technology, and other factors. Periodically, we review whether events or changes in circumstances have occurred that could impact the period of benefit. Any future changes in circumstances around the terms of our initial and renewal contracts, customer attrition, underlying technology life, and certain other factors may materially change the period of benefit and therefore the amortization amounts recognized on the Consolidated Statements of Operations. There was no change to the period of benefit during the periods presented.Business Combinations, Goodwill, and Acquisition-Related Intangible AssetsWe allocate the purchase consideration of acquired companies to tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date, with the excess recorded to goodwill. The purchase price allocation process requires us to make significant estimates and assumptions related to the fair value of identifiable intangible assets, deferred tax asset valuation allowances, liabilities related to uncertain tax positions, and contingencies. Critical estimates used in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired customer contracts, expected life cycle and innovation timelines for acquired technologies, forecasted customer attrition rates and revenue growth, the fair value of pre-existing relationships, royalty rates for comparable market technologies, and discount rates. The amounts and estimated useful lives assigned to acquisition-related intangible assets impact the amount and timing of future amortization expense.We test goodwill and acquisition-related intangible assets for impairment on an annual basis, or more frequently if a significant event or circumstance indicates impairment, by considering qualitative and quantitative factors. Significant qualitative inputs used in our impairment tests include, but are not limited to, consideration of general macroeconomic conditions, industry market conditions, overall Workday financial performance, and growth or declines in Workday’s share price. The primary quantitative input for our impairment test is Workday’s market capitalization as of the date of the analysis. We also evaluate the estimated remaining useful lives of acquisition-related intangible assets for changes in circumstances that warrant a revision to the remaining periods of amortization at least annually, or more frequently if significant events or circumstances indicate a change in expected use.46Table of ContentsNon-Marketable Equity InvestmentsNon-marketable equity investments include investments in privately held companies without readily determinable fair values in which we do not own a controlling interest or exercise significant influence. We adjust the carrying values of non-marketable equity investments based on both observable and unobservable inputs or data in an inactive market. Valuations of non-marketable equity investments are inherently complex due to the lack of readily available market data, and require our judgment due to the absence of market prices and an inherent lack of liquidity. In addition, the rights and preferences related to the particular non-marketable equity investments, as compared to the rights and preferences of other securities within the company’s capital structure, may impact the magnitude of change in the fair value of our investment as compared to the change in total enterprise value of the company. We assess our non-marketable equity investments quarterly for impairment. Our impairment analysis encompasses a qualitative and quantitative analysis of key factors including the investee’s financial metrics, such as growth or decline in revenues and operating expenses, market acceptance of the investee’s product or technology, other competitive products or technology in the market, general market conditions, and the rate at which the investee is using its cash. These factors require significant judgment. If impairment indicators are identified, we will assess the severity and duration of the impairment.Change in Accounting EstimateIn February 2023, we completed an assessment of the useful lives of our data center equipment, including servers, network equipment, and integrated complete server and network racks. Due to advances in technology, as well as investments in software that increased efficiencies in how we operate our data center equipment, we determined we should increase the estimated useful lives of data center equipment from 3 years to 5 years. This change in accounting estimate will be effective beginning fiscal 2024. Based on the carrying amount of data center equipment that were in-service as of January 31, 2023, it is estimated this change will decrease our fiscal 2024 depreciation expense by approximately $93 million. Inclusive of our forecasted capital expenditures in fiscal 2024, it is estimated the change will decrease fiscal 2024 depreciation expense by an additional $7 million, or approximately $100 million in total.Recent Accounting PronouncementsSee Note 2, Accounting Standards and Significant Accounting Policies, of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report for a full description of recent accounting pronouncements.47Table of ContentsITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKRecent macroeconomic events have resulted in negative impacts on global economies and financial markets, which may increase our foreign currency exchange risk and interest rate risk. For further discussion of the potential impacts of these events on our business, financial condition, and operating results, see “Risk Factors” included in Part I, Item 1A of this report.Foreign Currency Exchange RiskWe transact business globally in multiple currencies. As a result, our operating results and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. As of January 31, 2023, our most significant currency exposures were the euro, British pound, Canadian dollar, and Australian dollar.Due to our exposure to market risks that may result from changes in foreign currency exchange rates, we enter into foreign currency derivative hedging transactions to mitigate these risks. For further information, see Note 10, Derivative Instruments, of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report.Interest Rate Risk on our InvestmentsWe had cash, cash equivalents, and marketable securities totaling $6.1 billion and $3.6 billion as of January 31, 2023, and 2022, respectively. Cash equivalents and marketable securities were invested primarily in U.S. treasury securities, U.S. agency obligations, corporate bonds, commercial paper, money market funds, and marketable equity investments. The cash, cash equivalents, and marketable securities are held primarily for working capital purposes. Our investment portfolios are managed to preserve capital and meet liquidity needs. We do not enter into investments for trading or speculative purposes.Our cash equivalents and our portfolio of debt securities are subject to market risk due to changes in interest rates. Fixed rate securities may have their market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fluctuate due to changes in interest rates or we may suffer losses in principal if we sell securities that decline in market value due to changes in interest rates. Further, since our debt securities are classified as “available-for-sale,” if the fair value of the security declines below its amortized cost basis, then any portion of that decline attributable to credit losses, to the extent expected to be nonrecoverable before the sale of the impaired security, is recognized on the Consolidated Statements of Operations.An immediate increase of 100 basis points in interest rates would have resulted in a $29 million and $11 million market value reduction in our investment portfolio as of January 31, 2023, and 2022, respectively. This estimate is based on a sensitivity model that measures market value changes when changes in interest rates occur.Interest Rate Risk on our DebtThe Senior Notes have fixed annual interest rates, and therefore we do not have economic interest rate exposure on these debt obligations. However, the fair values of the Senior Notes are exposed to interest rate risk. Generally, the fair values of the Senior Notes will increase as interest rates fall and decrease as interest rates rise.Borrowings under our 2022 Credit Agreement will bear interest, at our option, at a base rate plus a margin of 0.000% to 0.500% or a secured overnight financing rate (“SOFR”) plus 10 basis points, plus a margin of 0.750% to 1.500%, with such margin being determined based on our consolidated leverage ratio or debt rating. Because the interest rates applicable to borrowings under the 2022 Credit Agreement are variable, we are exposed to market risk from changes in the underlying index rates, which affect our cost of borrowing.For further information, see Note 11, Debt, of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report.48Table of Contents
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+ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto. This discussion summarizes the significant factors affecting our results of operations and the financial condition of our business. Except as otherwise indicated or unless the context otherwise requires, “Xylem,” “we,” “us,” “our” and “the Company” refer to Xylem Inc. and its subsidiaries. This section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021.OverviewXylem is a leading global water technology company. We design, manufacture and service highly engineered products and solutions ranging across a wide variety of critical applications in utility, industrial, residential and commercial building services settings. Our broad portfolio of solutions addresses customer needs across the water cycle, from the delivery, measurement and use of drinking water to the collection, test, treatment and analysis of wastewater to the return of water to the environment. Our product and service offerings are organized into three reportable segments that are aligned around the critical market applications they provide: Water Infrastructure, Applied Water and Measurement & Control Solutions. •Water Infrastructure serves the water infrastructure sector with pump systems that transport water from aquifers, lakes, rivers and seas; with filtration, ultraviolet and ozone systems that provide treatment, making the water fit to use; and pumping solutions that move the wastewater and storm water to treatment facilities where our mixers, biological treatment, monitoring and control systems provide the primary functions in the treatment process. We also provide sales and rental of specialty dewatering pumps and related equipment and services. Additionally, our offerings use monitoring and control, smart and connected technologies to allow for remote monitoring of performance and enable products to self-optimize pump operations maximizing energy efficiency and minimizing unplanned downtime and maintenance for our customers. In the Water Infrastructure segment, we provide the majority of our sales directly to customers along with strong applications expertise, while the remaining amount is through distribution partners.•Applied Water serves the water usage applications sector with water pressure boosting systems for heating, ventilation and air conditioning, and for fire protection systems to the residential and commercial building services markets. In addition, our pumps, heat exchangers and controls provide cooling to power plants and manufacturing facilities, circulation for food and beverage processing, as well as boosting systems for agricultural irrigation. In the Applied Water segment, we provide the majority of our sales through long-standing relationships with many of the leading independent distributors in the markets we serve, with the remainder going directly to customers.•Measurement & Control Solutions primarily serves the utility infrastructure solutions and services sector by delivering communications, smart metering, measurement and control technologies and critical infrastructure technologies that allow customers to more effectively use their distribution networks for the delivery, monitoring and control of critical resources such as water, electricity and natural gas. We also provide analytical instrumentation used to measure and analyze water quality, flow and level in clean water, wastewater, and outdoor environments. Additionally, we offer software and services including cloud-based analytics, remote monitoring and data management, leak detection, condition assessment, asset management and pressure monitoring solutions. In the Measurement & Control Solutions segment, we generate our sales through a combination of long-standing relationships with leading distributors and dedicated channel partners as well as direct sales depending on the regional availability of distribution channels and the type of product.38COVID-19 Pandemic Update and Macroeconomic ConditionsThe global spread of COVID-19 has curtailed the movement of people, goods and services worldwide, including in many of the regions where we sell our products and services and conduct operations. This section summarizes the most significant impacts related to the ongoing COVID-19 pandemic that we have experienced to date, and we have included additional details as applicable throughout other sections of this Annual Report. Given the magnitude and duration of the COVID-19 pandemic and its economic consequences, it has become more difficult to distinguish specific aspects of our operational and financial performance that are most directly related to the pandemic from those more broadly influenced by ongoing macroeconomic, market and industry dynamics that may be, to varying degrees, related to the pandemic and its consequences. The COVID-19 pandemic, as well as broader global market supply and demand dynamics, have adversely affected, and are expected to continue to adversely affect, our supply chains. We have experienced, and expect to continue experiencing shortages in the supply of components, including electronics, particularly semiconductors ("chips"), parts and raw materials. To help mitigate the effects of these challenges and increase the resilience of our supply chain, we continue to enhance and augment our risk management activities, including supplier pulsing and redundancy. Additionally, we have and continue to take measures with respect to buffer stock, the use of alternative suppliers and redesign of certain products to mitigate the impacts of the ongoing supply chain, freight and logistics delays and bolster our access to electronics, parts and raw materials. We have also experienced, and continue to experience, increased inflation, freight, logistics, labor and overhead costs. The Company has taken specific actions to mitigate these inflationary headwinds, including pricing actions to pass cost increases through to customers and productivity efforts, including selective chip allocation, product redesigns, alternate sourcing options, and global procurement efforts. We have also initiated and plan to continue to initiate restructuring actions in 2023 to further optimize our cost structure.These supply chain issues have also impacted our delivery times to customers. To some extent, our mitigation strategies have alleviated these issues but our lead times continue to be impacted to varying degrees. If these issues continue, they could have a negative impact on our results of operations.Many of our offices globally remain in a substantially remote work from home or hybrid status, with no material disruption to operations, financial reporting systems, internal control over financial reporting or disclosure controls and procedures.The severity, magnitude and duration of the COVID-19 pandemic and its economic consequences are uncertain, and the pandemic’s ongoing and future impacts on our business, financial condition, results of operations, and stock price remain uncertain and difficult to predict. Risks related to the impacts of COVID-19 as well as our supply chain are described in further detail under "Item 1A. Risk Factors" in the Company's 2022 Annual Report. Evoqua Acquisition On January 23, 2023, Xylem entered into a definitive agreement under which Xylem will acquire Evoqua, a leader in mission-critical water treatment solutions and services, in an all-stock transaction that reflects an implied enterprise value of approximately $7.5 billion. The transaction, which is anticipated to close in mid-2023, is subject to approval by shareholders of Xylem and Evoqua, the receipt of required regulatory approvals and other customary closing conditions. Evoqua, a leader in North America water treatment, complements Xylem’s distinctive portfolio of solutions with advanced water and wastewater treatment capabilities, a powerful and extensive network of service professionals and access to a number of attractive industrial markets with resilient, recurring revenue streams.Key Performance Indicators and Non-GAAP MeasuresManagement reviews key performance indicators including revenue, gross margins, segment operating income and operating income margins, free cash flow, orders growth, working capital and backlog, among others. In addition, we consider certain non-GAAP (or "adjusted") measures to be useful to management and investors evaluating our operating performance for the periods presented, and to provide a tool for evaluating our ongoing operations, liquidity and management of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment among competing strategic alternatives and initiatives, including, but not limited to, dividends, acquisitions, share repurchases and debt repayment. Excluding revenue, 39Xylem provides guidance only on a non-GAAP basis due to the inherent difficulty in forecasting certain amounts that would be included in GAAP earnings, such as discrete tax items, without unreasonable effort. These adjusted metrics are consistent with how management views our business and are used to make financial, operating and planning decisions. These metrics, however, are not measures of financial performance under GAAP and should not be considered a substitute for revenue, operating income, net income, earnings per share (basic and diluted) or net cash from operating activities as determined in accordance with GAAP. We consider the following non-GAAP measures to be key performance indicators, as well as the related reconciling items to the most directly comparable measure calculated and presented in accordance with GAAP. The non-GAAP measures may not be comparable to similarly-titled measures reported by other companies.•"organic revenue" and "organic orders" defined as revenue and orders, respectively, excluding the impact of fluctuations in foreign currency translation and contributions from acquisitions and divestitures. Divestitures include sales or discontinuance of insignificant portions of our business that did not meet the criteria for classification as a discontinued operation. The period-over-period change resulting from foreign currency translation impacts is determined by translating current period and prior period activity using the same currency conversion rate.•"constant currency" defined as financial results adjusted for foreign currency translation impacts by translating current period and prior period activity using the same currency conversion rate. This approach is used for countries whose functional currency is not the U.S. Dollar.•"adjusted net income" and "adjusted earnings per share" defined as net income and earnings per share, respectively, adjusted to exclude restructuring and realignment costs, special charges, gain or loss from sale of businesses and tax-related special items, as applicable. A reconciliation of adjusted net income and adjusted earnings per share is provided below. (in millions, except per share data)20222021Net income & Earnings per share$355 $1.96 $427 $2.35 Restructuring and realignment34 0.19 22 0.12 Special charges160 (a)0.89 12 0.07 (Gain) loss from sale of business(1)(0.01)(2)(0.01)Tax effects of adjustments (b)(32)(c)$(0.18)$(7)$(0.04)Adjusted net income & Adjusted earnings per share$516 $2.85 $452 $2.49 (a) The special charges in the year primarily relate to the U.K. pension settlement expense of $140 million and asset impairment charges of $14 million recorded in the period.(b) The tax effects of adjustments are calculated using the statutory tax rate, taking into consideration the nature of the item and the relevant taxing jurisdiction.(c) The $32 million in tax effects of adjustments in the period primarily consists of $23 million related to the U.K. pension settlement expense and $3 million related to the asset impairment charge.▪"adjusted operating expenses" and "adjusted gross profit" defined as operating expenses and gross profit, respectively, adjusted to exclude restructuring and realignment costs and special charges.▪"adjusted operating income" defined as operating income, adjusted to exclude restructuring and realignment costs and special charges, and "adjusted operating margin" defined as adjusted operating income divided by total revenue.▪“EBITDA” defined as earnings before interest, taxes, depreciation and amortization expense, "EBITDA margin" defined as EBITDA divided by total revenue, "adjusted EBITDA" reflects the adjustment to EBITDA to exclude share-based compensation charges, restructuring and realignment costs, special charges and gain or loss from sale of businesses, and "adjusted EBITDA margin" defined as adjusted EBITDA divided by total revenue. 40▪“realignment costs” defined as costs not included in restructuring costs that are incurred as part of actions taken to reposition our business, including items such as professional fees, severance, relocation, travel, facility set-up and other costs.▪“special charges" defined as costs incurred by the Company, such as acquisition and integration related costs, non-cash impairment charges and both operating and non-operating adjustments for costs related to the U.K. pension plan buy-out.▪"tax-related special items" defined as tax items, such as tax return versus tax provision adjustments, tax exam impacts, tax law change impacts, excess tax benefits/losses and other discrete tax adjustments.▪"free cash flow" defined as net cash from operating activities, as reported in the Statement of Cash Flows, less capital expenditures. Our definition of "free cash flow" does not consider certain non-discretionary cash payments, such as debt. The following table provides a reconciliation of free cash flow. (in millions)20222021Net cash provided by operating activities$596 $538 Capital expenditures(208)(208)Free cash flow$388 $330 Net cash used in investing activities$(191)$(183)Net cash provided (used) by financing activities$(790)$(855)Executive SummaryXylem reported revenue of $5,522 million for 2022, an increase of $327 million, or 6.3%, from $5,195 million reported in 2021. On a constant currency basis, revenue increased by $586 million, or 11.3%, during the year. The increase at constant currency was driven by an increase in organic revenue of $595 million reflecting strong organic growth in all end markets as well as across all major geographic regions.Operating income for 2022 was $622 million, reflecting an increase of $37 million, or 6.3%, compared to $585 million in 2021. Operating margin was 11.3% for both 2022 and 2021. Operating income for 2022 included an increase in special charges of $12 million and an unfavorable impact from increased restructuring and realignment costs of $12 million as compared to 2021. Excluding the impact of these items, adjusted operating income was $672 million, with an adjusted operating margin of 12.2% in 2022 as compared to adjusted operating income of $611 million with an adjusted operating margin of 11.8% in 2021, an increase of 40 basis points. The increase in adjusted operating margin was primarily due to cost reductions from our productivity, restructuring and other cost saving initiatives, favorable volume and price realization. These impacts were partially offset by cost inflation and increased spending on strategic investments.Additional financial highlights for 2022 include the following:•Net income of $355 million, or $1.96 per diluted share, down 16.6% ($516 million or $2.85 per diluted share on an adjusted basis, up 14.5% from 2021)•Net cash provided by operating activities of $596 million and free cash flow of $388 million, up 18% from 2021•Orders of $6,257 million, down 0.7% from $6,300 million in 2021 (up 4.0% on an organic basis)•Dividends paid to shareholders increased 7% in 2022.2023 Business OutlookWe anticipate total revenue growth in the range of 3% to 5% in 2023, with organic revenue growth anticipated to be in the range of 4% to 6%. The following is a summary of our 2022 organic revenue performance and the 2023 organic revenue outlook by end market.•Utilities revenue increased by approximately 10% for 2022 on an organic basis driven by strength in the U.S. and western Europe, partially offset by weakness in the emerging markets. For 2023, we expect organic revenue growth in the high-single-digits. On the clean water side, we expect improvements in chip supply through 2023 allowing for large deal deployments already secured in our backlog. Additionally, we can expect continued momentum for water quality products and increased demand for pipeline assessment services due to aging infrastructure. We expect wastewater utilities to remain focused on mission-critical applications in wastewater. Long-term capital expenditure outlook is strong due to aging infrastructure and the emerging markets’ continued advancement. 41•Industrial revenue increased by approximately 13% for 2022 on an organic basis driven by strength across all major geographic regions. For 2023, we expect organic revenue growth in the low to mid-single-digit range. We expect to see continued robust growth in our dewatering business, driven by mining demand and strategic growth investments. We expect sustained demand in light industrial activity globally.•In the commercial market, organic revenue in 2022 increased by approximately 12%, led by growth in the U.S and western Europe. For 2023, we expect organic revenue growth in the low-single-digit range. We expect sustained demand for energy efficient related projects, particularly in Europe, and continued commercial development in the emerging markets, partially offset by moderation in new construction. •In the residential market, organic revenue increased by approximately 16% in 2022 driven primarily by strength in the U.S. as well as strength in the emerging markets. This market is primarily driven by replacement revenue serviced through our distribution network. For 2023, we expect a low-single-digit organic revenue decline due to normalizing demand in the U.S., partially offset by continued strength in emerging markets.We will continue to strategically execute restructuring and realignment actions in an effort to optimize our cost structure, improve our operational efficiency and effectiveness, strengthen our competitive positioning and better serve our customers. During 2022, we incurred $15 million and $19 million in restructuring and realignment costs, respectively. We realized approximately $3 million of net savings from our 2022 actions. As a result of our 2022 actions we expect to realize approximately $14 million of incremental net savings in 2023 and beyond. During 2023, we currently expect to incur between $25 million and $35 million in restructuring and realignment costs.We are strongly positioned to deliver on our 2023 commitments with commercial and operational momentum. We expect resilient demand due to our differentiated solutions addressing long-term secular trends in our largest end markets. Our 2023 commitments are supported by backlog execution, price realization, continued productivity actions to more than offset the impact of persistent inflation and potential headwinds from slowing demand in our most cyclical end markets. Beyond 2023, we remain on track to deliver our longer-term strategic and financial milestones. In addition to our organic 2023 commitments, we expect to successfully integrate the planned merger of Xylem and Evoqua with a closing estimated by mid-2023.42Results of Operations(in millions)202220212022 v. 2021Revenue$5,522 $5,195 6.3 %Gross profit2,084 1,975 5.5 %Gross margin37.7 %38.0 %(30)bpRealignment costs4 4 — %Adjusted gross profit2,088 1,979 5.5 %Adjusted gross margin37.8 %38.1 %(30)bpTotal operating expenses1,462 1,390 5.2 %Expense to revenue ratio26.5 %26.8 %(30)bpRestructuring and realignment costs(30)(18)66.7 %Special charges(16)(4)300.0 %Adjusted operating expenses1,416 1,368 3.5 %Adjusted operating expenses to revenue ratio25.6 %26.3 %(70)bpOperating income622 585 6.3 %Operating margin11.3 %11.3 %— bpU.K. pension settlement expense140 — NMInterest and other non-operating expense, net43 76 (43.4)%Gain from sale of business1 2 (50.0)%Income tax expense85 84 1.2 %Tax rate19.2 %16.3 %290 bpNet income$355 $427 (16.9)%NM Not Meaningful2022 versus 2021 Revenue Revenue generated for 2022 was $5,522 million, an increase of $327 million, or 6.3%, compared to $5,195 million in 2021. On a constant currency basis, revenue grew 11.3% during 2022. The increase at constant currency was driven by an increase in organic revenue of $595 million, reflecting strong organic growth in all end markets as well as across all major geographic regions.The following table illustrates the impact from organic growth, recent acquisitions and divestitures, and foreign currency translation in relation to revenue during 2022:Water InfrastructureApplied WaterMeasurement & Control SolutionsTotal Xylem(in millions)$ Change% Change$ Change% Change$ Change% Change$ Change% Change2021 Revenue$2,247 $1,613 $1,335 $5,195 Organic Impact266 11.8 %220 13.6 %109 8.2 %595 11.5 %Acquisitions/(Divestitures)— — %— — %(9)(0.7)%(9)(0.2)%Constant Currency266 11.8 %220 13.6 %100 7.5 %586 11.3 %Foreign currency translation (a)(149)(6.6)%(66)(4.1)%(44)(3.3)%(259)(5.0)%Total change in revenue117 5.2 %154 9.5 %56 4.2 %327 6.3 %2022 Revenue$2,364 $1,767 $1,391 $5,522 (a)Foreign currency translation impact for the year primarily due to the weakening in value of various currencies against the U.S. Dollar, the largest being the Euro, the British Pound, the Swedish Krona, the Canadian Dollar, the Australian Dollar and the Hungarian Forint.43Water Infrastructure Water Infrastructure revenue increased $117 million, or 5.2%, to $2,364 million in 2022 (11.8% increase on a constant currency basis) compared to 2021. Revenue was negatively impacted by $149 million of foreign currency translation, with the change at constant currency coming entirely from organic growth of $266 million. Organic growth for the year was driven by strength in both the utility and industrial end markets. The utilities end market experienced organic growth of $151 million led by strength in the U.S. driven by strong price realization, solid backlog execution, timing of projects as compared to prior year and continued strength in the construction sector. Western Europe also experienced strong organic growth due to good price realization, coupled with strong demand in utilities' capital spending. This increase was partially offset by weakness in the emerging markets, primarily due to the continued negative impacts from COVID lockdowns in China. The industrial end market had $115 million of organic growth across all major geographic regions, particularly in western Europe due to strong backlog execution and good price realization, and in the emerging markets, driven by mining projects and price realization in both Latin America and Africa.From an application perspective, organic revenue growth was driven by our transport applications. Transportexperienced $247 million of revenue growth, almost half of which came from the dewatering application. All three of our major geographic regions contributed to the organic revenue growth in transport, led by the U.S. where we continued to experience strong price realization and had strong backlog coming into the year, followed by western Europe, which also experienced strong price realization coupled with strong demand from utility capital projects. We also experienced strong growth in the emerging markets driven by good price realization as well as robust mining demand in our dewatering business, particularity in Latin America and Africa, which more than offset declines in China due to COVID impacts. Organic revenue for the treatment application was $19 million for the year, as revenue growth from strong backlog execution in western Europe and the U.S. was partially offset by declines in emerging markets led by the continued negative COVID impacts on China.Applied WaterApplied Water revenue increased $154 million, or 9.5%, in 2022 (13.6% increase on a constant currency basis) compared to 2021. Revenue was negatively impacted by $66 million of foreign currency translation, with the change at constant currency coming entirely from organic growth during the year of $220 million. Organic growth was driven by strength in all three end markets and across all major geographic regions. The organic revenue growth was led by strength in the industrial water application of $103 million, where in the U.S. we benefited from price realization and demand from OEM customers, in western Europe where we had healthy order intake across the sector, and in the emerging markets where we saw market recovery in China, despite continued COVID restrictions. Commercial building services grew $74 million organically during the year, particularly in the U.S. and western Europe, where we benefited from strong price realization and healthy market conditions. The residential building services application had $43 million of organic revenue growth during the period, primarily in the U.S. driven by price realization and healthy market conditions.Measurement & Control Solutions Measurement & Control Solutions revenue increased $56 million, or 4.2%, in 2022 (7.5% increase on a constant currency basis) compared to 2021. Revenue was negatively impacted by $44 million of foreign currency translation during the year, with the change at constant currency driven by an organic growth of $109 million, or 8.2%, and $9 million of reduced revenue related to divestiture impacts during the year. We experienced organic revenue growth across all three major geographic regions and in both of the segment's end markets for the year, driven by $91 million of organic growth in the utility end market, primarily in the U.S. as a result of the easing of electronic component shortage and strong price realization, followed by $18 million in the industrial end market driven by strong backlog execution in our test business.From an application perspective, organic revenue growth during the year consisted entirely of growth in the water application of $114 million, which was slightly offset by a decline in the energy applications of $5 million. Organic revenue growth in the water application was driven by strength in the U.S. as a result of easing of electronic component shortages and strong price realization. Backlog execution in the emerging markets and strength in our test and pipeline assessment services businesses in western Europe also contributed to the growth. Declines in the energy applications were driven by impacts from electronic component shortages in the U.S. during the first half of the year, more than offsetting modest growth in the second half of the year.44Orders/Backlog An order represents a legally enforceable, written document that includes the scope of work or services to be performed or equipment to be supplied to a customer, the corresponding price and the expected delivery date for the applicable products or services to be provided. An order often takes the form of a customer purchase order or a signed quote from a Xylem business. Orders received during 2022 decreased by $43 million, or 0.7%, to $6,257 million (3.7% increase on a constant currency basis). Order intake was negatively impacted by $279 million of foreign currency translation and $18 million of reduced orders related to divestiture impacts. The increase on a constant currency basis primarily consisted of organic order growth of $254 million, or 4.0%, over the prior year. The following table illustrates the impact from organic growth, recent acquisitions and divestitures, and foreign currency translation in relation to orders during 2022:Water InfrastructureApplied WaterMeasurement & Control SolutionsTotal Xylem(in millions)$ Change% Change$ Change% Change$ Change% Change$ Change% Change2021 Orders$2,471 $1,860 $1,969 $6,300 Organic Impact302 12.2 %2 0.1 %(50)(2.5)%254 4.0 %Acquisitions/(Divestitures)— — %— — %(18)(0.9)%(18)(0.3)%Constant Currency302 12.2 %2 0.1 %(68)(3.5)%236 3.7 %Foreign currency translation (a)(166)(6.7)%(68)(3.7)%(45)(2.3)%(279)(4.4)%Total change in orders136 5.5 %(66)(3.5)%(113)(5.7)%(43)(0.7)%2022 Orders$2,607 $1,794 $1,856 $6,257 (a)Foreign currency translation impact for the year primarily due to the weakening in value of various currencies against the U.S. Dollar, the largest being the Euro, the British Pound, the Swedish Krona, the Canadian Dollar, the Australian Dollar and the Hungarian Forint.Water InfrastructureWater Infrastructure segment orders increased $136 million, or 5.5%, to $2,607 million (12.2% increase on a constant currency basis). Order intake during the year was negatively impacted by $166 million of foreign currency translation. Organic orders increased during the year as strength in the transport applications came primarily from the U.S. where we benefited from strong market demand in water utilities, price realization and timing of large infrastructure projects. Western Europe also contributed to order growth from increased demand in utility capital projects and healthy market conditions. The treatment application saw a slight decrease in orders driven by the emerging markets due to declines in China related to COVID impacts, which more than offset modest growth in the U.S. and western Europe.Applied Water Applied Water segment orders decreased $66 million, or 3.5%, to $1,794 million (flat on a constant currency basis). Order intake during the year was negatively impacted by $68 million of foreign currency translation, making organic order growth relatively flat. Weakness in the U.S. from lapping strong demand in the prior year was partially offset by strength in the emerging markets and western Europe as a result of strong project orders and stocking by channel partners.Measurement & Control SolutionsMeasurement & Control Solutions segment orders decreased $113 million, or 5.7%, to $1,856 million (3.5% decrease on a constant currency basis). Order weakness during the year was negatively impacted by $45 million of foreign currency translation and reduced orders related to divestiture impacts of $18 million. The organic order decrease was $50 million, or (2.5)%. The order declines during the year are lapping strong organic order growth of 38% in the prior year. The order weakness for the year was driven by the water application due to the moderation of early orders to mitigate electronic component shortages and longer lead times that drove order growth in the prior year. This decrease was partially offset by strength in the energy applications, primarily driven by demand and advanced ordering to address electronic component shortages.45Backlog Backlog includes orders on hand as well as contractual customer agreements at the end of the period. Delivery schedules vary from customer to customer based on their requirements. Annual or multi-year contracts are subject to rescheduling and cancellation by customers due to the long-term nature of the contracts. As such, beginning total backlog, plus orders, minus revenues, will not equal ending total backlog due to contract adjustments, foreign currency fluctuations, and other factors. Typically, large projects require longer lead production cycles and deployment schedules and delays occur from time to time. Total backlog was $3,605 million at December 31, 2022 and $3,240 million at December 31, 2021, an increase of 11.3%. We anticipate that approximately 55% of our total backlog at December 31, 2022 will be recognized as revenue during 2023.Gross Margin Gross margin as a percentage of consolidated revenue decreased 30 basis points to 37.7% in 2022 as compared to 38.0% in 2021.The gross margin decline for the year included 730 basis points of negative impacts, driven by 580 basis points of cost inflation, as well as increased spending on strategic investments of 60 basis points and 40 basis points of inventory management costs. These negative impacts were partially offset by favorable impacts of 700 basis points, driven by 470 basis points of price realization and 230 basis points of productivity savings.Operating Expenses(in millions)20222021ChangeSelling, general and administrative expenses$1,227 $1,179 4.1 %SG&A as a % of revenue22.2 %22.7 %(50)bpResearch and development expenses206 204 1.0 %R&D as a % of revenue3.7 %3.9 %(20)bpRestructuring and asset impairment charges29 7 314.3 %Operating expenses$1,462 $1,390 5.2 %Expense to revenue ratio26.5 %26.8 %(30)bpSelling, General and Administrative ("SG&A") Expenses SG&A expenses increased by $48 million (increase of 4.1%) to 22.2% of revenue in 2022, as compared to 22.7% of revenue in 2021. Revenue growth was higher than SG&A increases resulting in a lower SG&A as a percentage of sales. Cost increases were driven by increased investments in strategic growth initiatives of $59 million and inflation of $38 million, partially offset by $48 million of favorable currency impacts.Research and Development ("R&D") Expenses R&D expense was $206 million, or 3.7% of revenue, in 2022 which was fairly consistent with the 2021 expense of $204 million, or 3.9% of revenue. Restructuring and Asset Impairment ChargesRestructuringFrom time to time, the Company will incur costs related to restructuring actions in order to optimize our cost base and more strategically position itself. Restructuring charges were $15 million in 2022 as compared to $6 million in 2021.During 2022 we incurred these charges primarily as a continuation of our efforts to reposition our business to optimize our cost structure and improve our operational efficiency and effectiveness. The charges primarily included the reduction of headcount across all segments.In response to the changes in business and economic conditions arising as a result of the COVID-19 pandemic, on June 2, 2020 management committed to a restructuring plan that includes actions across our businesses and functions globally. The plan was designed to support our long-term financial resilience and simplify our operations, strengthen our competitive positioning and better serve our customers.As a result of this action, during 2021, we recognized restructuring charges of $4 million and $2 million in our Water Infrastructure and Applied Water segments, respectively. These charges included reduction of headcount across both segments. Other less significant restructuring actions taken in 2021 resulted in $3 million of charges during 2021 and are included in the information presented below.46The following is a roll-forward of employee position eliminations associated with restructuring activities for the years ended December 31, 2022 and 2021:20222021Planned reductions - January 160 319 Additional planned reductions203 83 Actual reductions and reversals(161)(342)Planned reductions - December 31102 60 The following table presents the total costs expected to be incurred, the amount incurred in the period, and the cumulative costs incurred to date for our 2020, 2021 and 2022 restructuring actions: (in millions)Water InfrastructureApplied WaterMeasurement & Control SolutionsCorporateTotalActions Commenced in 2022:Total expected costs$6 $4 $4 $— $14 Costs incurred during 20226 4 4 — 14 Total expected costs remaining$— $— $— $— $— Actions Commenced in 2021:Total expected costs$3 $— $— $— $3 Costs incurred during 20213 — — — 3 Costs incurred during 2022— — — — — Total expected costs remaining$— $— $— $— $— Actions Commenced in 2020:Total expected costs$23 $6 $30 $— $59 Costs incurred during 202019 4 30 — 53 Costs incurred during 20214 2 — — 6 Costs incurred during 2022— — — — — Total expected costs remaining$— $— $— $— $— During 2022, we also incurred charges of $1 million within the Measurement & Control Solutions segment, related to actions commenced prior to 2020. During 2021, we recorded a reduction of $3 million within the Measurement & Control Solutions segment, related to actions commenced prior to 2020. The Water Infrastructure, Applied Water and Measurement & Control Solutions actions commenced in 2022 consist primarily of severance charges. The actions commenced in 2022 are complete.The Water Infrastructure actions commenced in 2021 consist primarily of severance charges. The actions commenced in 2021 are complete.As a result of the actions initiated in 2022, we achieved savings of approximately $2 million in 2022 and estimate annual future net savings beginning in 2023 of approximately $14 million, resulting in $12 million of incremental savings from 2022 actions.47Asset Impairment During 2022, we determined that certain assets, primarily software and customer relationships, within our Measurement & Control Solutions segment were impaired. Accordingly, we recognized an impairment charge of $14 million. Refer to Note 11, "Goodwill and Other Intangible Assets," for additional information.Operating Income and Adjusted EBITDA Operating income was $622 million (operating margin of 11.3%) during 2022, an increase of $37 million, or 6.3%, when compared to operating income of $585 million (operating margin of 11.3%) during the prior year. Operating margin included unfavorable impacts of 40 basis points from increases in special charges and restructuring and realignment costs as compared to the prior year. Additionally, operating margin included 1020 basis points of expansion from favorable operating impacts, driven by a 670 basis point increase from price realization, 280 basis points from productivity savings and 70 basis points from favorable volume. Margin expansion was offset by 980 basis points of unfavorable impacts driven by 660 basis points of inflation, 180 basis points of increased spending on strategic investments, 40 basis points of inventory management costs and 30 basis points of unfavorable mix. Excluding special charges and restructuring and realignment costs, adjusted operating income was $672 million (adjusted operating margin of 12.2%) for 2022 as compared to adjusted operating income of $611 million (adjusted operating margin of 11.8%) during the prior year.Adjusted EBITDA was $940 million (adjusted EBITDA margin of 17.0%) during 2022, an increase of $50 million, or 5.6%, when compared to adjusted EBITDA of $890 million (adjusted EBITDA margin of 17.1%) during the prior year. The slight decrease in adjusted EBITDA margin was primarily due to the same factors impacting adjusted operating margin noted above; however, adjusted EBITDA margin did not benefit from a year over year reduction in depreciation and amortization expense. 48The table below provides a reconciliation of total and each segment's operating income to adjusted operating income, and a calculation of the corresponding adjusted operating margin: (In millions)20222021ChangeWater InfrastructureOperating income$418 $387 8.0 %Operating margin17.7 %17.2 %50 bpRestructuring and realignment costs11 12 (8.3)%Adjusted operating income$429 $399 7.5 %Adjusted operating margin18.1 %17.8 %30 bpApplied WaterOperating income$258 $240 7.5 %Operating margin14.6 %14.9 %(30)bpRestructuring and realignment costs13 7 85.7 %Special charges— 1 (100.0)%Adjusted operating income$271 $248 9.3 %Adjusted operating margin15.3 %15.4 %(10)bpMeasurement & Control SolutionsOperating income$2 $12 (83.3)%Operating margin0.1 %0.9 %(80)bpRestructuring and realignment costs10 3 233.3 %Special charges14 — NM%Adjusted operating income$26 $15 73.3 %Adjusted operating margin1.9 %1.1 %80 bpCorporate and otherOperating loss$(56)$(54)3.7 %Special charges2 3 (33.3)Adjusted operating loss$(54)$(51)5.9 %Total XylemOperating income$622 $585 6.3 %Operating margin11.3 %11.3 %— bpRestructuring and realignment costs34 22 54.5 %Special charges16 4 300.0 %Adjusted operating income$672 $611 10.0 %Adjusted operating margin12.2 %11.8 %40 bpNM Not Meaningful 49The table below provides a reconciliation of net income to consolidated EBITDA and adjusted EBITDA: (in millions)Year Ended December 31,20222021ChangeNet Income$355 $427 (17)%Net Income margin6.4 %8.2 %(180)bpDepreciation111 118 (6)%Amortization125 127 (2)%Interest expense, net34 69 (51)%Income tax expense85 84 1 %EBITDA$710 $825 (14)%Share-based compensation37 33 12 %Restructuring & realignment34 22 55 %U.K. pension settlement expense140 — 100 %Special charges20 12 67 %Gain from sale of business(1)(2)(50)%Adjusted EBITDA$940 $890 6 %Adjusted EBITDA margin17.0 %17.1 %(10)bpThe tables below provide a reconciliation of each segment's operating income (loss) to EBITDA and adjusted EBITDA: Year Ended December 31, 2022(in millions)Water Infrastructure Applied Water Systems Measurement & Control SolutionsOperating Income$418 $258 $2 Gain from sale of business— — 1 Depreciation44 17 33 Amortization9 2 104 Other non-operating expense(4)(2)(2)EBITDA$467 $275 $138 Share-based compensation2 4 6 Restructuring & realignment11 13 10 Special charges— — 14 Gain from sale of business— — (1)Adjusted EBITDA$480 $292 $167 Adjusted EBITDA margin20.3 %16.5 %12.0 %50Year Ended December 31, 2021(in millions)Water Infrastructure Applied Water Systems Measurement & Control SolutionsOperating Income$387 $240 $12 Gain from sale of business— 2 — Depreciation43 20 38 Amortization8 2 107 Other non-operating expense(5)(3)(2)EBITDA$433 $261 $155 Share-based compensation2 4 6 Restructuring & realignment12 7 3 Special charges— 1 — Gain from sale of business— (2)— Adjusted EBITDA$447 $271 $164 Adjusted EBITDA margin19.9 %16.8 %12.3 %2022 versus 2021(in millions)Water Infrastructure Applied Water Systems Measurement & Control SolutionsOperating Income (Loss)$31 $18 $(10)Gain from sale of business— (2)1 Depreciation1 (3)(5)Amortization1 — (3)Other non-operating expense1 1 — EBITDA$34 $14 $(17)Share-based compensation— — — Restructuring & realignment(1)6 7 Special charges— (1)14 Gain from sale of business— 2 (1)Adjusted EBITDA$33 $21 $3 Adjusted EBITDA margin0.4 %(0.3)%(0.3)%Water InfrastructureOperating income was $418 million for our Water Infrastructure segment (operating margin of 17.7%) during 2022, an increase of $31 million, or 8.0%, when compared to operating income of $387 million (operating margin of 17.2%) during the prior year, or a total increase of 50 basis points. Operating margin expansion included favorable impacts of 20 basis points from a decrease in restructuring and realignment costs as compared to the prior year. Additionally, operating margin expansion included 940 basis points from favorable operating impacts, driven by 560 basis points of price realization, 270 basis points from productivity savings and 110 basis points of favorable volume. Margin expansion was offset by 910 basis points of unfavorable impacts driven by 560 basis points of inflation, 220 basis points due to increased spending on strategic investments and 70 basis points of unfavorable mix. Excluding special charges and restructuring and realignment costs, adjusted operating income was $429 million (adjusted operating margin of 18.1%) during 2022 as compared to adjusted operating income of $399 million (adjusted operating margin of 17.8%) during the prior year.Adjusted EBITDA was $480 million (adjusted EBITDA margin of 20.3%) during 2022, an increase of $33 million, or 7.4%, when compared to adjusted EBITDA of $447 million (adjusted EBITDA margin of 19.9%) during the prior year. The increase in adjusted EBITDA margin was primarily due to the same factors impacting the increase in adjusted operating margin. 51Applied WaterOperating income was $258 million for our Applied Water segment (operating margin of 14.6%) during 2022, an increase of $18 million, or 7.5%, when compared to operating income of $240 million (operating margin of 14.9%) during the prior year, or a total decrease of 30 basis points. Operating margin declines included unfavorable impacts of 20 basis points from an increase in restructuring and realignment costs and special charges as compared to the prior year. Additionally, operating margin decline included 1290 basis points of unfavorable operating impacts, driven by 880 basis points of inflation, 110 basis points of increased spending on strategic investments, 120 basis points of increased inventory management costs and 40 basis points of unfavorable mix. Margin declines were offset by 1280 basis points from favorable operating impacts, which were driven by 930 basis points of price realization, 340 basis points from productivity savings and 10 basis points from favorable volume. Excluding special charges and restructuring and realignment costs, adjusted operating income was $271 million (adjusted operating margin of 15.3%) during 2022 as compared to adjusted operating income of $248 million (adjusted operating margin of 15.4%) during the prior year.Adjusted EBITDA was $292 million (adjusted EBITDA margin of 16.5%) during 2022, an increase of $21 million, or 7.7%, when compared to adjusted EBITDA of $271 million (adjusted EBITDA margin of 16.8%) during the prior year. The decrease in adjusted EBITDA margin was primarily due to the same factors impacting the decrease in adjusted operating margin. Measurement & Control Solutions Operating income was $2 million for our Measurement & Control Solutions (operating margin of 0.1%) during 2022, a decrease of $10 million, or 83.3%, when compared to operating income of $12 million (operating margin of 0.9%) during the prior year, or a total decrease of 80 basis points. Operating margin declines included unfavorable impacts of 160 basis points from an increase in special charges (asset impairment) and restructuring and realignment costs as compared to the prior year. Operating margin impacts included 790 basis points from favorable operating impacts consisting of 450 basis points of price realization, 230 basis points from productivity savings and 70 basis points from favorable volume. Favorable impacts were offset by 710 basis points of unfavorable impacts driven by 520 basis points of inflation, 100 basis points of higher performance related incentive costs and 40 basis points of increased spending on strategic investments. Excluding special charges and restructuring and realignment costs, adjusted operating income was $26 million (adjusted operating margin of 1.9%) during 2022 as compared to adjusted operating income of $15 million (adjusted operating margin of 1.1%) during the prior year.Adjusted EBITDA was $167 million (adjusted EBITDA margin of 12.0%) during 2022, an increase of $3 million, or 1.8%, when compared to adjusted EBITDA of $164 million (adjusted EBITDA margin of 12.3%) during the prior year. The decrease in adjusted EBITDA margin was due to the same factors as those impacting the increase in adjusted operating margin; however, adjusted EBITDA margin did not benefit from a year over year reduction in depreciation and amortization expense.Corporate and other Operating loss for corporate and other increased $2 million, or 3.7%, compared to the prior year. The increase in operating loss for the year was primarily due to higher performance related incentive costs.Interest ExpenseInterest expense was $50 million and $76 million for 2022 and 2021, respectively. The decrease in interest expense was primarily driven by interest expense incurred during 2021 related to our 4.875% Senior Notes due 2021 that were paid off in October 2021 and interest income related to additional net investment hedges executed in during 2022. See Note 14, "Credit Facilities and Debt", of our consolidated financial statements for a description of our credit facilities and long-term debt and related interest. U.K. Pension Settlement ExpenseThe Company initiated the process for a full buy-out of its largest defined benefit plan in the U.K. in 2019. During the first quarter of 2020, the Company purchased a bulk annuity policy as a plan asset to facilitate the termination and buy-out of the plan. The buy-out was completed in September 2022, at which point the remaining benefit obligations were transferred to the insurer and we were relieved of any further obligation. As a result, we recorded a pension settlement charge of £123 million (approximately $140 million) in the third quarter of 2022, primarily consisting of unrecognized actuarial losses. Refer to Note 15, "Post-retirement Benefit Plans", of our consolidated financial statements for additional information.52Income Tax Expense The income tax provision for 2022 was $85 million at an effective tax rate of 19.2% as compared to $84 million at an effective tax rate of 16.3% in 2021. The 2022 effective tax rate differs from that of 2021 primarily due to the impact of higher U.S. domestic pre-tax income in the current period. Liquidity and Capital ResourcesThe following table summarizes our sources and uses of cash:Year Ended December 31,(in millions)20222021ChangeOperating activities$596 $538 $58 Investing activities(191)(183)(8)Financing activities(790)(855)65 Foreign exchange (a)(20)(26)6 Total$(405)$(526)$121 (a)The decrease in negative impact of foreign exchange as compared to 2021 is primarily due to strengthening of the Euro partially offset by weakening of the Chinese Yuan.Sources and Uses of LiquidityOperating ActivitiesDuring 2022, net cash provided by operating activities was $596 million, compared to $538 million in 2021. The $58 million year-over-year increase was primarily driven by higher customer prepayments, timing of employee benefit payments and lower interest payments. Higher working capital levels, reflecting increased sales, partially offset these items. Investing ActivitiesCash used in investing activities was $191 million in 2022, compared to $183 million in 2021. This increase in cash used of $8 million was mainly driven by cash paid for investments, the settlement of a currency forward agreement and reduced proceeds from sales of businesses. Cash received from cross-currency swaps and cash investments partially offset the increased outflow.Financing ActivitiesCash used in financing activities was $790 million in 2022, compared to $855 million in 2021. The year-over-year decrease in cash used was mainly driven by lower debt repayments and reduced repurchases of common stock. Higher dividend payments and lower proceeds from employee stock options partially offset these items.Funding and Liquidity Strategy Our ability to fund our capital needs depends on our ongoing ability to generate cash from operations and access to bank financing and the capital markets. We continually evaluate aspects of our spending, including capital expenditures, strategic investments and dividends.Historically, we have generated operating cash flow sufficient to fund our primary cash needs. We currently do not expect any significant impact to our capital and financial resources from the COVID-19 pandemic, including our overall liquidity position based on our available cash and cash equivalents and our access to credit facilities and the capital markets, however we continue to monitor the ongoing impacts of the pandemic.If our cash flows from operations are less than we expect, we may need to incur debt or issue equity. From time to time, we may need to access the long-term and short-term capital markets to obtain financing. Our access to, and the availability of, financing on acceptable terms and conditions in the future will be impacted by many factors, including: (i) our credit ratings or absence of a credit rating, (ii) the liquidity of the overall capital markets, and (iii) the current state of the economy. There can be no assurance that such financing will be available to us on acceptable terms or that such financing will be available at all. Our securities are rated investment grade. A significant change in credit rating could impact our ability to borrow at favorable rates. See Note 14, "Credit Facilities and Debt", of our consolidated financial statements for a description of our credit facilities and long-term debt and a description of limitations on obtaining additional funding.53We monitor our global funding requirements and seek to meet our liquidity needs on a cost-effective basis. In addition, our existing committed credit facilities and access to the public debt markets would provide further liquidity if required. Based on our current global cash positions, cash flows from operations and access to the capital markets, we believe there is sufficient liquidity to meet our funding requirements and service debt and other obligations in both the U.S. and outside of the U.S. over the next 12 months. Currently, we have available liquidity of approximately $1.7 billion, consisting of $944 million of cash and $800 million of available credit facilities as disclosed in Note 14, "Credit Facilities and Debt", of our consolidated financial statements. Risk related to these items are described in our risk factor disclosures referenced under “Item 1A. Risk Factors". In the fourth quarter of 2022, the Company entered into an agreement with Idrica, a leader in water data management and analytics, to distribute Idrica’s GoAigua technology globally and take a minority stake in Idrica. Subject to customary closing conditions and regulatory clearance, Xylem expects to fund the investment with cash on hand for approximately €100 million in the first half of 2023. Contractual Obligations Material contractual obligations arising in the normal course of business primarily consist of debt obligations and related interest payments, lease obligations and unconditional purchase obligations. Refer Note 14, “Credit Facilities and Debt” and Note 10, “Leases” of the consolidated financial statements for related to these matters.The Company has future unconditional purchase commitments which are legally binding and that specify all significant terms including price and/or quantity. Total future commitments within the next twelve months for these obligations is $421 million, excluding contracts that can be canceled without penalty.Credit Facilities & Long-Term Contractual Commitments See Note 14, "Credit Facilities and Debt" of our consolidated financial statements for a description of our credit facilities and long-term debt. Non-U.S. OperationsAs we continue to grow our operations in the emerging markets and elsewhere outside of the U.S., we expect to continue to generate significant revenue from non-U.S. operations and expect that a substantial portion of our cash will be predominately held by our foreign subsidiaries. We expect to manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct business and the cost effectiveness with which those funds can be accessed. We may transfer cash from certain international subsidiaries to the U.S. and other international subsidiaries when we believe it is cost effective to do so. We continually review our domestic and foreign cash profile, expected future cash generation and investment opportunities and reassess whether there is a need to repatriate funds held internationally to support our U.S. operations. As of December 31, 2022, we have provided a deferred tax liability of $5 million for net foreign withholding taxes and state income taxes on $467 million of earnings expected to be repatriated to the U.S. parent as deemed necessary in the future. Off-Balance Sheet ArrangementsWe are a party to certain off-balance sheet arrangements including certain guarantees. For discussion of these arrangements, see Note 19, “Commitments and Contingencies” of the consolidated financial statements.Critical Accounting EstimatesThe preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and the disclosure of contingent liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.54Significant accounting policies used in the preparation of the consolidated financial statements are discussed in Note 1, “Summary of Significant Accounting Policies,” of the consolidated financial statements. Accounting estimates and assumptions discussed in this section are those that we consider most critical to an understanding of our financial statements because they are inherently uncertain, involve significant judgments, include areas where different estimates reasonably could have been used, and changes in the estimates that are reasonably possible could materially impact the financial statements. Management believes that the accounting estimates employed and the resulting balances are reasonable; however, actual results in these areas could differ from management’s estimates under different assumptions or conditions.Revenue Recognition. Xylem recognizes revenue in a manner that depicts the transfer of promised goods and services to customers in an amount that reflects the consideration to which it expects to be entitled for providing those goods and services. For each arrangement with a customer, we identify the contract and the associated performance obligations within the contract, determine the transaction price of that contract, allocate the transaction price to each performance obligation and recognize revenue as each performance obligation is satisfied.The satisfaction of performance obligations in a contract is based upon when the customer obtains control over the asset. Depending on the nature of the performance obligation, control transfers either at a particular point in time, or over time, which determines the recognition pattern of revenue.For product sales, other than long-term construction-type contracts, we recognize revenue once control has passed at a point in time, which is generally when products are shipped. In instances where contractual terms include a provision for customer acceptance, revenue is recognized when either (i) we have previously demonstrated that the product meets the specified criteria based on either seller or customer-specified objective criteria or (ii) upon formal acceptance received from the customer where the product has not been previously demonstrated to meet customer-specified objective criteria. We recognize revenue on product sales to channel partners, including resellers, distributors or value-added solution providers, at the point in time when the risks and rewards, possession, and title have transferred to the customer, which usually occurs at the point of delivery.Revenue from performance obligations related to services is primarily recognized over time, as the performance obligations are satisfied. In these instances, the customer consumes the benefit of the service as Xylem performs.Certain businesses also enter into long-term construction-type sales contracts where revenue is recognized over time. In these instances, revenue is recognized using a measure of progress that applies an input method based on costs incurred in relation to total estimated costs. We also recognize revenue for certain of these arrangements using the output method and measure progress based on shipments of product where control has transferred to the customer.For all contracts with customers, we determine the transaction price in the arrangement and allocate the transaction price to each performance obligation identified in the contract. Judgment is required to determine the appropriate unit of account, and we separate out the performance obligations if they are capable of being distinct and are distinct within the context of the contract. The transaction price is adjusted for our estimate of variable consideration, which may include a right of return, discounts, rebates, penalties and retainage. To estimate variable consideration, we apply the expected value or the most likely amount method, based on whichever method most appropriately predicts the amount of consideration we expect to be entitled to. The method applied is typically based on historical experience and known trends. We constrain the amounts of variable consideration that are included in the transaction price, to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur or when uncertainties around the variable consideration are resolved.Income Taxes. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities, applying enacted tax rates in effect for the year in which we expect the differences will reverse. Based on the evaluation of available evidence, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that we believe it is more likely than not we will realize these benefits. We periodically assess the likelihood that we will be able to recover our deferred tax assets and reflect any changes to our estimate of the amount we are more likely than not to realize in the valuation allowance, with a corresponding adjustment to earnings or other comprehensive income, as appropriate.In assessing the need for a valuation allowance, we look to the future reversal of existing taxable temporary differences, taxable income in carryback years and the feasibility of tax planning strategies and estimated future taxable income. The valuation allowance can be affected by changes to tax laws, changes to statutory tax rates and changes to future taxable income estimates.55We have recorded net foreign withholding taxes and state income taxes on earnings that are expected to be repatriated to the U.S. parent. We have not recorded any deferred taxes on the amounts that the Company currently does not intend to repatriate. The determination of deferred taxes on this amount is not practicable. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws in a multitude of jurisdictions across our global operations. We recognize potential liabilities and record tax liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. Furthermore, we recognize the tax benefit from an uncertain tax position only if based on the technical merits of the position it is more likely than not that the tax position will be sustained on examination by the taxing authorities or upon completion of the litigation process. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution.We adjust our liability for uncertain tax positions in light of changing facts and circumstances; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. If our estimate of tax liabilities proves to be less than the ultimate assessment, an additional tax expense would result. If a payment of these amounts ultimately proves to be less than the recorded amounts, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary.Business Combinations. We record acquisitions using the purchase method of accounting. All of the assets acquired, liabilities assumed, contractual contingencies and contingent consideration is recorded at fair value as of the acquisition date. The excess of the purchase price over the estimated fair values of the net tangible and intangible assets acquired is recorded as goodwill. The application of the purchase method of accounting for business combinations requires management to make significant estimates and assumptions in the determination of the fair value of assets acquired and liabilities assumed, in order to properly allocate purchase price consideration between assets that are depreciated and amortized from goodwill. These assumptions and estimates include a market participant’s use of the asset and the appropriate discount rates for a market participant. Our estimates are based on historical experience, information obtained from the management of the acquired companies and, when appropriate, includes assistance from independent third-party appraisal firms. Significant assumptions and estimates include, but are not limited to, the cash flows that an asset is expected to generate in the future, the cost to build/recreate certain technology, the appropriate weighted-average cost of capital, and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable. In addition, unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates.Goodwill and Intangible Assets. We review goodwill and indefinite-lived intangible assets for impairment annually and whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. We also review the carrying value of our finite-lived intangible assets for potential impairment when impairment indicators arise. We conduct our annual impairment test as of the first day of the fourth quarter. For goodwill, the estimated fair value of each reporting unit is compared to the carrying value of the net assets assigned to that reporting unit. If the estimated fair value of the reporting unit exceeds its carrying value, goodwill is not impaired. If the carrying value of the reporting unit exceeds its estimated fair value, then an impairment charge is recognized for that excess up to the amount of recorded goodwill. We estimate the fair value of our reporting units using an income approach. We estimate the fair value of our intangible assets with indefinite lives using either the income approach or the market approach. Under the income approach, we calculate fair value based on the present value of estimated future cash flows. Under the market approach, we calculate fair value based on recent sales and selling prices of similar assets. Determining the fair value of a reporting unit or an indefinite-lived intangible asset is judgmental in nature and involves the use of significant estimates and assumptions, particularly related to future operating results and cash flows. These estimates and assumptions include, but are not limited to, revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, assumed royalty rates, future economic and market conditions and identification of appropriate market comparable data. In addition, the identification of reporting units and the allocation of assets and liabilities to the reporting units when determining the carrying value of each reporting unit also require judgment. Goodwill is tested for impairment at either the operating segment identified in Note 21, “Segment and Geographic Data,” of the consolidated financial statements, or one level below. The fair value of our reporting units and indefinite-lived intangible assets is based on estimates and assumptions that are believed to be reasonable. Significant changes to these estimates and assumptions could adversely impact our conclusions. Actual future results may differ from those estimates.56The risks around impairment of our assets are included in our risk factor disclosures referenced under “Item 1A. Risk Factors".During the fourth quarter of 2022, we performed our annual impairment assessment and determined that the estimated fair values of our goodwill reporting units were substantially in excess of each of their carrying values. However, future goodwill impairment tests could result in a charge to earnings. We will continue to evaluate goodwill on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstances require us to do so. We determined that no material impairment of the indefinite-lived intangibles existed as of the measurement date in 2022. However, future indefinite-lived intangible impairment tests could result in a charge to earnings. We will continue to evaluate indefinite-lived intangibles on an annual basis as of the beginning of our fourth quarter and whenever events and changes in circumstances indicate there may be a potential impairment. Post-retirement Benefit Plans. Company employees around the world participate in numerous defined benefit plans. The determination of projected benefit obligations and the recognition of expenses related to these plans are dependent on various assumptions. These major assumptions primarily relate to discount rates, expected long-term rates of return on plan assets, rate of future compensation increases, mortality, years of service and other factors (some of which are disclosed in Note 15, “Post-retirement Benefit Plans,” of the consolidated financial statements). Actual results that differ from our assumptions are accumulated and amortized on a straight-line basis only to the extent they exceed 10% of the higher of the market-related value or projected benefit obligation, over the average remaining service period of active plan participants, or for plans with all or substantially all inactive participants, over the average remaining life expectancy.Significant AssumptionsManagement develops each assumption using relevant Company experience, in conjunction with market-related data for each individual country in which such plans exist. All assumptions are reviewed annually with third-party consultants and are adjusted as necessary. The table below provides the weighted average assumptions used to estimate our defined benefit pension obligations and costs as of and for the years ended 2022 and 2021. 20222021 U.S.Int’lU.S.Int’lBenefit Obligation AssumptionsDiscount rate5.25 %4.13 %3.00 %1.55 %Rate of future compensation increaseNM2.79 %NM2.84 %Net Periodic Benefit Cost AssumptionsDiscount rate3.00 %1.55 %2.50 %1.06 %Expected long-term return on plan assets5.50 %2.79 %6.50 %2.60 %Rate of future compensation increaseNM2.84 %NM2.79 %NM Not meaningful. The pension benefits for future service for all the U.S. pension plans are based on years of service and not impacted by future compensation increases.We determine the expected long-term rate of return on plan assets by evaluating both historical returns and estimates of future returns. Specifically, the Company analyzes the estimated future returns based on independent estimates of asset class returns and evaluates historical broad market returns over long-term timeframes based on the strategic asset allocation, which is detailed in Note 15, “Post-retirement Benefit Plans,” of the consolidated financial statements.For the recognition of net periodic pension cost, the calculation of the expected return on plan assets is generally derived by applying the expected long-term rate of return to the market-related value of plan assets. The market-related value of plan assets is based on average asset values at the measurement date over the last five years. The use of fair value, rather than a calculated value, could materially affect net periodic pension cost. The weighted average expected long-term rate of return for all of our plan assets to be used in determining net periodic benefit costs for 2023 is estimated at 5.90%. We estimate that every 25 basis point change in the expected return on plan assets impacts the expense by less than $1 million.The discount rate reflects our expectation of the present value of expected future cash payments for benefits at the measurement date. A decrease in the discount rate increases the present value of benefit obligations and increases pension expense. We base the discount rate assumption on current investment yields of high-quality fixed income investments during the retirement benefits maturity period. The pension discount rate was determined by considering an interest rate yield curve comprising AAA/AA bonds, with maturities between zero and 30 years, developed by the plan’s actuaries. Annual benefit payments are then discounted to present value using this yield 57curve to develop a single-point discount rate matching the plan’s characteristics. Our weighted average discount rate for all pension plans effective January 1, 2023, is 4.35%. We estimate that every 25 basis point change in the discount rate impacts the expense by less than $1 million.The rate of future compensation increase assumption reflects our long-term actual experience and future and near-term outlook. Effective January 1, 2023, our expected rate of future compensation is 2.94% for all pension plans. The estimated impact of a 25 basis point change in the expected rate of future compensation is less than $1 million.The Company initiated the process for a full buy-out of its largest defined benefit plan in the U.K. in 2019. During the first quarter of 2020, the Company purchased a bulk annuity policy as a plan asset to facilitate the termination and buy-out of the plan. The buy-out was completed in September 2022, at which point the remaining benefit obligations were transferred to the insurer and we were relieved of any further obligation. As a result, we recorded a pension settlement charge of £123 million (approximately $140 million), primarily consisting of unrecognized actuarial losses. The settlement also resulted in the recognition of $23 million in net tax benefits. The settlement of the plan did not impact our cash position. We currently anticipate making contributions to our pension and post-retirement benefit plans in the range of $18 million to $26 million during 2023. Approximately $5 million of contributions are expected to be made in the first quarter.Funded StatusFunded status is derived by subtracting the respective year-end values of the projected benefit obligations from the fair value of plan assets. We estimate that every 25 basis point change in the discount rate impacts the funded status by approximately $10 million.Fair Value of Plan AssetsThe plan assets of our pension plans comprise a broad range of investments, including domestic and foreign equity securities, interests in hedge funds, fixed income investments, insurance contracts, and cash and cash equivalents.A portion of our pension benefit plan assets portfolio comprises investments in hedge funds which are generally measured at net asset value. However, in certain instances, the values reported by the asset managers were not current at the measurement date. Accordingly, we made estimate adjustments to the last reported value where necessary to measure the assets at fair value at the measurement date. These adjustments consider information received from the asset managers, as well as general market information. The adjustment recorded at December 31, 2022 and 2021 for these assets represented less than 1% of total plan assets in each respective year. Asset values for other positions were generally measured using market observable prices. We estimate that a 5% change in asset values will impact funded status by approximately $10 million.New Accounting PronouncementsSee Note 2, “Recently Issued Accounting Pronouncements,” of the consolidated financial statements for a complete discussion of recent accounting pronouncements.58ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKWe are exposed to market risk, primarily related to foreign currency exchange rates and interest rates. These exposures are actively monitored by management. Our exposure to foreign exchange rate risk is due to certain costs, revenue and borrowings being denominated in currencies other than one of our subsidiaries' functional currency. Similarly, we are exposed to market risk as a result of changes in interest rates which may affect the cost of our financing. It is our policy and practice to use derivative financial instruments only to the extent necessary to manage exposures.Foreign Currency Exchange Rate RiskApproximately 53% of our 2022 revenues were from customers in various locations outside the U.S.Our economic foreign currency risk primarily relates to receipts from customers, payments to suppliers and intercompany transactions denominated in foreign currencies. We may use derivative financial instruments to offset risk related to receipts from customers and payments to suppliers, when it is believed that the exposure will not be limited by our normal operating and financing activities. We enter into currency forward contracts periodically in order to manage the exchange rate fluctuation risk on certain intercompany transactions associated with third-party sales and purchases. These risks are also mitigated by natural hedges including the presence of manufacturing facilities outside the U.S., global sourcing and other spending which occurs in foreign countries. Our principal foreign currency transaction exposures primarily relate to the Euro, Swedish Krona, British Pound, Canadian Dollar, Australian Dollar, and Polish Zloty. We estimate that a hypothetical 10% movement in foreign currency exchange rates would not have a material economic impact to Xylem’s financial position and results of operations.Additionally, we are subject to foreign exchange translation risk due to changes in the value of foreign currencies in relation to our reporting currency, the U.S. Dollar. The translation risk is primarily concentrated in the exchange rate between the U.S. Dollar and the Euro, Chinese Yuan, British Pound, Canadian Dollar, Australian Dollar, Swedish Krona and Indian Rupee. As the U.S. Dollar strengthens against other currencies in which we transact business, revenue and income will generally be negatively impacted, and if the U.S. Dollar weakens, revenue and income will generally be positively impacted. We expect to continue to generate significant revenue from non-U.S. operations and we expect our cash will be predominately held by our foreign subsidiaries. We expect to manage our worldwide cash requirements considering available funds among the many subsidiaries through which we conduct business and the cost effectiveness with which those funds can be accessed. We may transfer cash from certain international subsidiaries to the U.S. and other international subsidiaries when it is cost effective to do so, though we continually review our domestic and foreign cash profile, expected future cash generation and investment opportunities and reassess whether there is a need to repatriate funds held internationally to support our U.S. operations. We also hedge our investment in certain foreign subsidiaries via the use of cross-currency swaps. Accordingly, we estimate that a 10% movement of the U.S. Dollar to various foreign currency exchange rates we translate from, in aggregate would not have a material economic impact on our financial position and results of operations.Interest Rate Risk As of December 31, 2022, our long-term debt portfolio is primarily comprised of four series of fixed-rate senior notes that total approximately $1.9 billion. The senior notes are not exposed to interest rate risk as the bonds are at a fixed rate until maturity. Based on the current interest rate market we do not anticipate material risk associated with our debt refinancing within the target time frame of maturity. Commodity Price ExposuresFor a discussion of risks relating to commodity prices, refer to “Item 1A. Risk Factors.”59
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+Item 7.Management’s Discussion and Analysis of Financial Condition and Results of OperationsThis section generally discusses fiscal 2022 and 2021 items and year-over-year comparisons between 2022 and 2021. Discussions of 2020 items and year-over-year comparisons between 2021 and 2020 are not included herein. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021 for that discussion.OverviewThe Company is a global leader providing Enterprise Asset Intelligence (“EAI”) solutions in the Automatic Identification and Data Capture (“AIDC”) industry. The AIDC market consists of mobile computing, data capture, radio frequency identification devices (“RFID”), barcode printing, and other workflow automation products and services. The Company’s operations consist of two reportable segments that provide complementary offerings to our customers: Asset Intelligence & Tracking (“AIT”) and Enterprise Visibility & Mobility (“EVM”). Refer to Part I, Item 1 of this document for additional information.•The AIT segment is an industry leader in barcode printing and asset tracking technologies. Its major product lines include barcode and card printers, supplies, including temperature-monitoring labels and services.•The EVM segment is an industry leader in automatic information and data capture solutions. Its major product lines include mobile computing, data capture, RFID, fixed industrial scanning and machine vision, services, workflow optimization solutions and location solutions. Our workflow optimization solutions include cloud-based software subscriptions, retail solutions, and robotic automation solutions. During the past year, we have maintained our position as a market leader in our core businesses, which are generally considered to be comprised of our mobile computing and data capture products, printing products and supplies, as well as support and repair services. Customers across the industries that we serve have benefited from our core offerings to keep pace with the increasingly on-demand economy and to invest in their long-term technology capabilities. The Company has continued to make strategic investments to accelerate progress in certain adjacent and expansion markets. In June 2022, the Company acquired Matrox Electronic Systems Ltd. (“Matrox) for $881 million in cash, net of Matrox’s cash on-hand. Matrox, part of our EVM segment, is a leading provider of advanced machine vision components and software serving many end-markets. Through its acquisition of Matrox, the Company significantly expanded its machine vision products and software offerings. The Company also continues to focus on scaling and integrating our other recent acquisitions (Antuit.ai, Fetch Robotics, Adaptive Vision Sp. z.o.o., and Reflexis) providing growth opportunities across our software and robotic solution offerings. These investments were funded partly through cash flow generation from our core businesses operations as well as through borrowings and other working capital facilities that enable us to maintain strong liquidity and manageable debt leverage. As part of our ongoing supply chain optimization and resiliency initiatives, we extended the transition timeline of our distribution center in North America. The transition negatively impacted product fulfillment and operating results in the third quarter and contributed to elevated inventory levels. To mitigate the impacts associated with that transition, we resumed servicing customer orders through our existing logistics service provider. Additionally, in January 2023, we terminated our contractual arrangement with the new service provider and have directly assumed the distribution center lease and have staffed the facility with Zebra employees, hence assuming all operational activities at the location. We are actively managing our inventory levels and have been addressing certain component part shortages through a combination of entering long-term supply commitments with key vendors, utilizing expedited modes of transportation, as well as executing select product re-designs. We anticipate inventory levels to remain elevated from historical levels as we continue to manage through supply chain challenges.Macroeconomic Environment The acceleration of broad global cost inflation, a rising interest rate environment, and a stronger U.S. dollar in the current year have negatively impacted our operating results. We have partially mitigated the financial impacts of these headwinds through a combination of targeted price increases, as well as our ongoing foreign currency exchange and interest rate risk management programs. We believe that this challenging operating environment, partially due to the COVID-19 pandemic and Russia/Ukraine war, has contributed to a deceleration of certain customer demand, particularly late in the current year. The Company expects these macro conditions to persist into 2023. 27Table of ContentsIn the first quarter of 2022, we announced the suspension of our business operations in Russia. Neither Russia nor Ukraine comprises a material portion of our business; therefore, the war thus far has not had a significant effect on our results of operations. Additionally, the war has not significantly affected our ability to source supplies or deliver our products and services to our customers in the surrounding EMEA region. We will continue to monitor this for potential future adverse impacts on our business.In 2020, the global COVID-19 pandemic resulted in significant declines in customer demand and supply chain disruptions, which negatively impacted the Company’s Net sales and overall profitability. In 2021, customer demand sharply rebounded as the underlying trend to digitize and automate workflows accelerated, which, along with pent-up demand from customers who we believe previously delayed purchases due to the pandemic, benefited the Company’s 2021 sales and profitability. The level of demand for certain product components resulted in lengthened lead times, component shortages, and higher input costs, including freight and component parts. Component shortages for certain products and elevated input costs continued in 2022 which negatively impacted our ability to meet customer demand and our operating results.2022 Financial Highlights and Other Recent Developments •Net sales were $5,781 million in the current year compared to $5,627 million in the prior year.•Operating income was $529 million in the current year compared to $979 million in the prior year.•Net income was $463 million, or $8.80 per diluted share in the current year, compared to Net income of $837 million, or $15.52 per diluted share in the prior year.•Operating cash flow was $488 million in the current year compared to $1,069 million in the prior year.•We repurchased $751 million of common shares in the current year compared to $57 million in the prior year.Restructuring Activity In the third quarter of 2022, the Company committed to certain organizational changes and leased site rationalization actions designed to generate structural cost efficiencies (collectively referred to as the “2022 Productivity Plan”). The total cost under the 2022 Productivity Plan, which is expected to be completed in 2023, is estimated to be approximately $25 million. Exit and restructuring charges associated with the 2022 Productivity Plan were $12 million for the year ended December 31, 2022. The Company incurred Exit and restructuring costs, under previously announced programs of $2 million, $7 million, and $11 million for the years ended December 31, 2022, 2021 and 2020, respectively.License and Settlement AgreementOn June 30, 2022, the Company announced it entered into a License and Settlement Agreement (“Settlement”) resulting in a $372 million pre-tax charge, inclusive of $12 million of external legal fees, within Operating expenses on the Consolidated Statement of Operations. Under the Settlement, Zebra agreed to pay $360 million to the counterparty in eight quarterly payments of $45 million which began in the second quarter. See Item 3, Legal Proceedings and Note 14, Accrued Liabilities, Commitments, and Contingencies for additional information.Change in SegmentsIn the first quarter of 2022, the location solutions offering, which provides a range of RTLS and services that generate on-demand information about the physical location and status of high-valued assets, equipment, and people, moved from our AIT segment into our EVM segment contemporaneous with a change in our organizational structure and management of the business. We have reported our results reflecting this change, including historical periods, on a comparable basis. This change did not have an impact to the Consolidated Financial Statements.28Table of ContentsResults of Operations: Year Ended 2022 versus 2021 and Year Ended 2021 versus 2020 Consolidated Results of Operations (amounts in millions, except percentages) Year Ended December 31,PercentChange 2022 vs 2021PercentChange 2021 vs 2020 202220212020Net sales:Tangible products$4,915 $4,845 $3,813 1.4 %27.1 %Services and software866 782 635 10.7 %23.1 %Total Net sales5,781 5,627 4,448 2.7 %26.5 %Gross profit2,624 2,628 2,003 (0.2)%31.2 %Gross margin45.4 %46.7 %45.0 %(130) bps170 bpsOperating expenses2,095 1,649 1,352 27.0 %22.0 %Operating income$529 $979 $651 (46.0)%50.4 %Net sales to customers by geographic region were as follows (amounts in millions, except percentages): Year Ended December 31,PercentChange 2022 vs 2021PercentChange 2021 vs 2020 202220212020North America$2,919 $2,819 $2,319 3.5 %21.6 %EMEA1,920 1,976 1,495 (2.8)%32.2 %Asia-Pacific609 543 439 12.2 %23.7 %Latin America333 289 195 15.2 %48.2 %Total Net sales$5,781 $5,627 $4,448 2.7 %26.5 %Operating expenses are summarized below (amounts in millions, except percentages): Year Ended December 31,As a Percentage of Net sales 202220212020202220212020Selling and marketing$607 $587 $483 10.5 %10.4 %10.9 %Research and development570 567 453 9.9 %10.1 %10.2 %General and administrative375 348 304 6.5 %6.2 %6.8 %Settlement and related costs372 — — 6.4 %— — Amortization of intangible assets136 115 78 NMNMNMAcquisition and integration costs21 25 23 NMNMNMExit and restructuring costs14 7 11 NMNMNMTotal Operating expenses$2,095 $1,649 $1,352 36.2 %29.3 %30.4 %Consolidated Organic Net sales growth:Year Ended December 31,20222021Reported GAAP Consolidated Net sales growth2.7 %26.5 %Adjustments:Impact of foreign currency translations (1)2.0 %(2.1)%Impact of acquisitions (2)(1.5)%(1.2)%Consolidated Organic Net sales growth (3)3.2 %23.2 %(1)Operating results reported in U.S. Dollars are affected by foreign currency exchange rate fluctuations. Foreign currency translation impact represents the difference in results that are attributable to fluctuations in the currency exchange rates used to convert the results for businesses where the functional currency is not the U.S. Dollar. This impact is calculated by translating the current period results at the currency exchange rates used in the comparable prior year period, inclusive of the Company’s foreign currency hedging program.29Table of Contents(2)For purposes of computing Organic Net sales growth, amounts directly attributable to business acquisitions are excluded for twelve months following their respective acquisitions.(3)Consolidated Organic Net sales growth is a non-GAAP financial measure. See the Non-GAAP Measures section at the end of this item.2022 compared to 2021 Total Net sales increased $154 million or 2.7% compared to the prior year as our customers continue to digitize and automate their workflows. Net sales grew across both of our segments and most of our regions. Current year Net sales of both segments were negatively impacted by supply chain bottlenecks, which were particularly pronounced in our EVM segment. Prior year Net sales of both segments benefited from pent-up demand from customers who we believe delayed purchases in fiscal 2020 due to the COVID-19 pandemic. Excluding the effects of currency changes and acquisitions, the increase in Consolidated Organic Net sales was 3.2%.Gross margin decreased to 45.4% for the current year compared to 46.7% in the prior year. Gross margins were lower in both of our segments. The decrease in gross margin was primarily due to higher premium freight and component part costs, the negative impact of foreign currency changes, unfavorable business mix, and lower support service margins, partially offset by targeted price increases. The prior year gross margin included the benefit of partial recovery of Chinese import tariffs.Operating expenses for the years ended December 31, 2022 and 2021 were $2,095 million and $1,649 million, or 36.2% and 29.3% of Net sales, respectively. Excluding the Settlement charge, Operating expenses were 29.8% of Net sales in the current year, with an increase over the prior year primarily due to the inclusion of operating expenses and amortization of intangible assets associated with recently acquired businesses, and increased employee travel, which were partially offset by lower employee incentive-based compensation.Operating income was $529 million for the current year compared to $979 million for the prior year. The decrease was primarily due to the negative impact of the Settlement charge.Net income decreased 44.7% compared to the prior year due to lower Operating income and a higher income tax rate, which were partially offset by favorability in Other income (expense), net as follows:•Other income (expense), net was income of $15 million for the current year, compared to an expense of $11 million in the prior year primarily due to the current year benefiting from an $83 million gain on interest rate swaps compared to a $13 million gain in the prior year, which was partially offset by higher interest expense due to higher average outstanding debt levels and interest rates in the current year.•The Company’s effective tax rates for the years ended December 31, 2022 and December 31, 2021 were 14.9% and 13.5%, respectively. The increase in the effective tax rate compared to the prior year was primarily due to settlements with tax authorities, unfavorable return to provision adjustments, and lower share-based compensation deductions.Diluted earnings per share decreased to $8.80 as compared to $15.52 in the prior year due to lower Net income, partially offset by lower average shares outstanding.Results of Operations by SegmentThe following commentary should be read in conjunction with the financial results of each operating business segment as detailed in Note 20, Segment Information & Geographic Data in the Notes to Consolidated Financial Statements. To the extent applicable, segment operating income excludes business acquisition purchase accounting adjustments, amortization of intangible assets, acquisition and integration costs, impairment of goodwill and other intangibles, exit and restructuring costs, as well as certain other non-recurring costs (such as the Settlement in the current year).30Table of ContentsAsset Intelligence & Tracking Segment (“AIT”)(amounts in millions, except percentages) Year Ended December 31,PercentChange 2022 vs 2021PercentChange 2021 vs 2020 202220212020Net sales:Tangible products$1,641 $1,563 $1,286 5.0 %21.5 %Services and software95 94 83 1.1 %13.3 %Total Net sales1,736 1,657 1,369 4.8 %21.0 %Gross profit746 759 653 (1.7)%16.2 %Gross margin43.0 %45.8 %47.7 %(280) bps(190) bpsOperating expenses386 377 322 2.4 %17.1 %Operating income$360 $382 $331 (5.8)%15.4 %AIT Organic Net sales growth:Year Ended December 31,20222021AIT Reported GAAP Net sales growth4.8 %21.0 %Adjustments:Impact of foreign currency translations (1)1.9 %(1.9)%AIT Organic Net sales growth (2)6.7 %19.1 %(1)Operating results reported in U.S. Dollars are affected by foreign currency exchange rate fluctuations. Foreign currency translation impact represents the difference in results that are attributable to fluctuations in the currency exchange rates used to convert the results for businesses where the functional currency is not the U.S. Dollar. This impact is calculated by translating the current period results at the currency exchange rates used in the comparable prior year period, inclusive of the Company’s foreign currency hedging program.(2) AIT Organic Net sales growth is a non-GAAP financial measure. See the Non-GAAP Measures section at the end of this item.2022 compared to 2021 Total Net sales for AIT increased $79 million or 4.8% compared to the prior year primarily due to higher sales of printing products (contributing the majority of the total increase), supplies, and support services. Current year Net sales included the benefit of targeted price increases as well as the negative effects of supply chain bottlenecks, while prior year Net sales benefited from pent-up demand from customers who we believe delayed purchases in fiscal 2020 due to the COVID-19 pandemic. Excluding the impact of foreign currency changes, AIT Organic Net sales growth was 6.7%.Gross margin decreased to 43.0% in the current year compared to 45.8% in the prior year primarily due to higher premium freight and component part costs, the negative impact of foreign currency changes, and unfavorable business mix, partially offset by targeted price increases. The prior year gross margin included the benefit of partial recovery of Chinese import tariffs.Operating income decreased 5.8% in the current year compared to the prior year due to lower Gross profit and higher Operating expenses.31Table of ContentsEnterprise Visibility & Mobility Segment (“EVM”)(amounts in millions, except percentages) Year Ended December 31,PercentChange 2022 vs 2021PercentChange 2021 vs 2020 202220212020Net sales:Tangible products$3,274 $3,282 $2,527 (0.2)%29.9 %Services and software771 694 559 11.1 %24.2 %Total Net sales4,045 3,976 3,086 1.7 %28.8 %Gross profit1,878 1,875 1,363 0.2 %37.6 %Gross margin46.4 %47.2 %44.2 %(80) bps300 bpsOperating expenses1,166 1,125 906 3.6 %24.2 %Operating income$712 $750 $457 (5.1)%64.1 %EVM Organic Net sales growth:Year Ended December 31,20222021EVM Reported GAAP Net sales growth1.7 %28.8 %Adjustments:Impact of foreign currency translations (1)2.2 %(1.9)%Impact of acquisitions (2)(2.2)%(1.9)%EVM Organic Net sales growth (3)1.7 %25.0 %(1)Operating results reported in U.S. Dollars are affected by foreign currency exchange rate fluctuations. Foreign currency translation impact represents the difference in results that are attributable to fluctuations in the currency exchange rates used to convert the results for businesses where the functional currency is not the U.S. Dollar. This impact is calculated by translating the current period results at the currency exchange rates used in the comparable prior year period, inclusive of the Company’s foreign currency hedging program.(2)For purposes of computing EVM Organic Net sales growth, amounts directly attributable to the acquisitions of Adaptive Vision, Fetch, Antuit, and Matrox are excluded for twelve months following their respective acquisitions.(3)EVM Organic Net sales growth is a non-GAAP financial measure. See the Non-GAAP Measures section at the end of this item.2022 compared to 2021 Total Net sales for EVM increased $69 million or 1.7% compared to the prior year primarily due to higher sales of data capture products, contributions from our recent acquisitions, and higher sales of support services, which were partially offset by lower sales of mobile computing products and unfavorable foreign currency changes. Current year Net sales included the benefit of targeted price increases as well as the negative impact of supply chain bottlenecks, while prior year Net sales benefited from pent-up demand from customers who we believe delayed purchases in fiscal 2020 due to the COVID-19 pandemic. Excluding the impacts of foreign currency changes and acquisitions, EVM Organic Net sales growth was 1.7%.Gross margin decreased to 46.4% in the current year compared to 47.2% in the prior year primarily due to higher premium freight and component part costs, unfavorable business mix, the negative impact of foreign currency changes, and lower support service margins, partially offset by targeted price increases. The prior year gross margin included the benefit of partial recovery of Chinese import tariffs.Operating income for the current year decreased 5.1% compared to the prior year period primarily due to higher Operating expenses.32Table of ContentsLiquidity and Capital ResourcesThe primary factors that influence our liquidity include the amount and timing of cash collections from our customers, cash payments to our suppliers, capital expenditures, acquisitions, and share repurchases. Management believes that our existing capital resources, inclusive of available borrowing capacity on debt and other financing facilities and funds generated from operations, are sufficient to meet anticipated capital requirements and service our indebtedness. The following table summarizes our cash flow activities for the years indicated (in millions): Year Ended December 31,$ Change 2022 vs 2021$ Change 2021 vs 2020 202220212020Cash flow provided by (used in):Operating activities$488 $1,069 $962 $(581)$107 Investing activities(968)(546)(641)(422)95 Financing activities253 (371)(157)624 (214)Effect of exchange rates on cash balances— — (2)— 2 Net (decrease) increase in cash and cash equivalents, including restricted cash$(227)$152 $162 $(379)$(10)2022 vs. 2021 The change in our cash and cash equivalents balance during the current year is reflective of the following: •The decrease in cash provided by operating activities compared to the prior year was primarily due to higher inventory levels, current year payments associated with the Settlement, and higher payments of 2021 incentive compensation. These items were partially offset by favorability in the timing of customer collections and accounts receivable factoring activity in the current year in comparison to the prior year.•Cash used in investing activities was higher than the prior year primarily due to the $881 million acquisition of Matrox, with the prior year including cash payments of $453 million for the acquisitions of Antuit, Fetch, and Adaptive Vision.•Cash provided by financing activities during the year included $1,037 million in net debt proceeds primarily related to the Company's debt refinancing activities in the second quarter, partially offset by $751 million of common stock repurchases. Cash used in financing activities in the prior year was primarily comprised of $257 million net debt repayments, $57 million of common stock repurchases, and $56 million of net payments related to share-based compensation.Company DebtThe following table shows the carrying value of the Company’s debt (in millions):December 31,20222021Term Loan A$1,728 $888 Revolving Credit Facility50 — Receivables Financing Facilities254 108 Total debt$2,032 $996 Less: Debt issuance costs(4)(3)Less: Unamortized discounts(5)(2)Less: Current portion of debt(214)(69)Total long-term debt$1,809 $922 In May 2022, the Company refinanced its long-term credit facilities by entering into its third amendment to the Amended and Restated Credit Agreement (“Amendment No. 3”). Amendment No. 3 increased the Company’s borrowing under Term Loan A from $875 million to $1.75 billion and increased the Company’s borrowing capacity under the Revolving Credit Facility from $1 billion to $1.5 billion. Amendment No. 3 also extended the maturities of Term Loan A and the Revolving Credit Facility to May 25, 2027 and replaced LIBOR with SOFR as the benchmark reference rate.33Table of ContentsTerm Loan AThe principal on Term Loan A is due in quarterly installments, with the next quarterly installment due in March 2023 and the majority due upon maturity in 2027. The Company may make prepayments, in whole or in part, without premium or penalty, and would be required to prepay certain outstanding amounts in the event of certain circumstances or transactions. As of December 31, 2022, the Term Loan A interest rate was 5.67%. Interest payments are made monthly and are subject to variable rates plus an applicable margin.Revolving Credit FacilityThe Company has a Revolving Credit Facility that is available for working capital and other general business purposes, including letters of credit. As of December 31, 2022, the Company had letters of credit totaling $7 million, which reduced funds available for borrowings under the Revolving Credit Facility from $1,500 million to $1,493 million. As of December 31, 2022, the Revolving Credit Facility had an average interest rate of 5.71%. Upon borrowing, interest payments are made monthly and are subject to variable rates plus an applicable margin. The Revolving Credit Facility matures on May 25, 2027.Receivables Financing FacilitiesThe Company has two Receivables Financing Facilities with financial institutions that have a combined total borrowing limit of up to $280 million. As collateral, the Company pledges perfected first-priority security interests in its U.S. domestically originated accounts receivable. The Company has accounted for transactions under its Receivables Financing Facilities as secured borrowings. The Company’s first Receivables Financing Facility allows for borrowings of up to $180 million and matures on March 19, 2024. The Company’s second Receivable Financing Facility allows for borrowings of up to $100 million and matures on May 15, 2023.As of December 31, 2022, the Company’s Consolidated Balance Sheets included $785 million of receivables that were pledged under the two Receivables Financing Facilities. As of December 31, 2022, $254 million had been borrowed, of which $171 million was classified as current. Borrowings under the Receivables Financing Facilities bear interest at a variable rate plus an applicable margin. As of December 31, 2022, the Receivables Financing Facilities had an average interest rate of 5.33%. Interest is paid on these borrowings on a monthly basis.See Note 12, Long-Term Debt in the Notes to Consolidated Financial Statements for further details related to the Company’s debt instruments.Receivables FactoringThe Company currently has two Receivables Factoring arrangements, pursuant to which certain receivables are sold to banks without recourse in exchange for cash. One arrangement allows for the factoring of up to $25 million of uncollected receivables originated from the EMEA region. The second arrangement allows for the factoring of up to €150 million of uncollected receivables originated from the EMEA and Asia-Pacific regions. Transactions under the Receivables Factoring arrangements are accounted for as sales under Accounting Standards Codification 860, Transfers and Servicing of Financial Assets, with the sold receivables removed from the Company’s balance sheet. Under these Receivables Factoring arrangements, the Company does not maintain any beneficial interest in the receivables sold. The banks’ purchase of eligible receivables is subject to a maximum amount of uncollected receivables. The Company services the receivables on behalf of the banks, but otherwise maintains no significant continuing involvement with respect to the receivables. Sale proceeds that are representative of the fair value of factored receivables, less a factoring fee, are reflected in Net cash provided by operating activities on the Consolidated Statements of Cash Flows, while sale proceeds in excess of the fair value of factored receivables are reflected in Net cash used in financing activities on the Consolidated Statements of Cash Flows.As of December 31, 2022 and 2021 there were a total of $61 million and $24 million, respectively, of uncollected receivables that had been sold and removed from the Company’s Consolidated Balance Sheets.As servicer of sold receivables, the Company had $130 million and $141 million of obligations that were not yet remitted to banks as of December 31, 2022 and 2021, respectively. These obligations are included within Accrued liabilities on the Consolidated Balance Sheets, with changes in such obligations reflected within Net cash used in financing activities on the Consolidated Statements of Cash Flows.See Note 19, Accounts Receivable Factoring in the Notes to Consolidated Financial Statements for further details.34Table of ContentsShare RepurchasesOn May 17, 2022, the Company announced that its Board of Directors authorized a share repurchase program for up to $1 billion of its outstanding shares of common stock. This authorization augments the previous $1 billion share repurchase authorization which was announced on July 30, 2019. The newly authorized share repurchase program does not have a stated expiration date. The level of the Company’s repurchases depends on a number of factors, including its financial condition, capital requirements, cash flows, results of operations, future business prospects and other factors its management may deem relevant. The timing, volume, and nature of repurchases are subject to market conditions, applicable securities laws and other factors and may be amended, suspended or discontinued at any time. Repurchases may be affected from time to time through open market purchases, including pursuant to a pre-set trading plan meeting the requirements of Rule 10b5-1(c) of the Securities Exchange Act of 1934. During the year ended December 31, 2022, the Company repurchased 2,027,542 shares of common stock for approximately $751 million. As of December 31, 2022, the Company has cumulatively repurchased 3,323,283 shares of common stock for approximately $1.1 billion, resulting in a remaining amount of share repurchases authorized under the plans of $945 million. Subsequent to the year ended December 31, 2022, the Company has repurchased 55,811 shares of common stock for approximately $15 million through February 9, 2023.Future Cash RequirementsWe believe that our Cash and cash equivalents, which totaled $105 million as of December 31, 2022, along with anticipated cash generation from operations and available borrowing capacity on debt and other financing facilities, will be sufficient to fund the Company’s cash requirements during the next 12 months and thereafter based on our current business plans. Included in the Company’s Cash and cash equivalents are amounts held by foreign subsidiaries, which was $36 million and $39 million as of December 31, 2022 and 2021, respectively. We do not expect that Cash and cash equivalents held by foreign subsidiaries will need to be repatriated in order to fund the Company’s U.S. operations based on current cash requirements. Our cash requirements during the next 12 months and thereafter include payments to satisfy the following obligations:•Purchase obligations — We have a limited number of multi-year purchase commitments, primarily related to semiconductors and cloud-services, which contain minimum purchase requirements and are non-cancellable. As of December 31, 2022, these commitments were approximately $557 million. This amount excludes routine purchase orders for good and services, as well as amounts already reflected within Accounts payable or Accrued expenses on the Consolidated Balance Sheet. See Note 14, Accrued Liabilities, Commitments and Contingencies in the Notes to Consolidated Financial Statements for additional details.•Debt obligations — We expect to make total payments of approximately $237 million associated with the Company’s debt facilities in 2023. This expected use of cash is based on the Company’s current borrowings and applicable interest rates and margins as of December 31, 2022, and includes principal and interest payments along with expected cash settlements associated with the Company’s interest rate swaps. In the ordinary course of business, the Company may decide to borrow additional amounts or repay principal earlier than contractually owed, which would affect future cash payments. See Note 12, Long-Term Debt in the Notes to Consolidated Financial Statements for further details related to the Company’s debt facilities. •Leases obligations — We lease certain manufacturing facilities, distribution centers, sales and administrative offices, equipment, and vehicles. As of December 31, 2022, the Company’s fixed lease commitments totaled $243 million, of which $46 million is payable in 2023. See Note 13, Leases in the Notes to Consolidated Financial Statements for further details related to the Company’s lease arrangements.In addition to the expected cash requirements described above, the Company may use cash to fund strategic acquisitions, investments, or repurchase common stock under its share repurchase program. We also expect to spend approximately $75 million to $85 million on capital expenditures in 2023.Critical Accounting EstimatesManagement prepared the consolidated financial statements of the Company under accounting principles generally accepted in the U.S. The application of these principles requires the use of estimates which affect the amounts reported in our consolidated financial statements. While we believe that our estimates are reasonable based upon available information, actual results could differ substantially from those estimates. Note 2, Significant Accounting Policies in the Notes to Consolidated Financial Statements provides additional discussion of these items along with other significant accounting policies of the Company. The accounting estimates described below have been identified by Management as those that are most critical to our financial statements, as they require management to make significant judgments and assumptions about inherently uncertain matters.35Table of ContentsIncome Taxes We estimate a provision or benefit for income taxes and amounts to be settled or recovered in several tax jurisdictions globally. Our estimates are complex and involve significant judgments and interpretations of regulations. Resolution of income tax treatments in individual jurisdictions may not be known for several years after completion of a given year. We are also required to evaluate the realizability of our deferred tax assets on an ongoing basis, which requires estimation of our ability to generate future taxable income. In particular, our income tax provision or benefit is dependent on our ability to forecast future taxable income in the U.S., U.K., Singapore, and other jurisdictions. Significant judgments included in our forecasts include projecting future sales volumes and pricing, costs to manufacture and procure products and to deliver services and solutions, among other factors. There were no significant changes in estimates to our income tax provision during the current year.AcquisitionsWe account for acquired businesses using the acquisition method of accounting. This method requires that the purchase price be allocated to the identifiable assets acquired and liabilities assumed at their estimated fair values. The excess of the purchase price over the identifiable assets acquired and liabilities assumed is recorded as goodwill. The estimates used to determine the fair values of long-lived intangible assets can be complex and require judgment. We generally value intangible assets using income-based valuation methodologies, such as the excess earnings method, which require critical estimates that include, but are not limited to, future expected cash flows from revenues and the determination of discount rates.Goodwill ImpairmentGoodwill impairment testing consists of comparing the estimated fair value of each of our reporting units to its carrying value. Fair value determinations require judgment and are sensitive to changes in underlying assumptions, estimates, as well as market factors. We estimate the fair value of reporting units using both income and market-based valuation approaches. Estimating the fair value of reporting units requires that we make assumptions and estimates including projections of revenue and income growth rates as well as cash flows; capital investments; competitive and customer trends; appropriate peer group selection; market-based discount rates and other market factors. Our annual quantitative impairment test, most recently completed in the fourth quarter of 2022, continues to indicate that the fair values of each of our reporting units significantly exceed their respective carrying values. Revenue RecognitionWe recognize revenues when we transfer control of promised goods, solutions or services to our customers in an amount that reflects the consideration we expect to receive. The consideration that we expect to receive is estimated by reflecting reductions to our transaction price for product returns, rebates, and other incentives. These estimates are developed using the expected value that the Company anticipates receiving and are based on recent trends observed in similar transactions. Additionally, some of our contracts with customers contain multiple performance obligations, including various hardware, software, and/or services. For such contracts that contain multiple performance obligations, we allocate the estimated total transaction price to each performance obligation based on relative standalone selling prices (“SSP”). The determination of SSP is established at a regional level. SSP is based on observable prices in recent standalone transactions for the same or similar offerings, to the extent available, which is often applicable to tangible products and software licenses. Alternatively, in the absence of recent observable prices, the Company generally applies the expected cost-plus margin approach to professional services, repair and maintenance services, and solution offerings. There were no changes to our estimation processes for consideration received or SSP that materially affected revenues during the year. New Accounting PronouncementsSee Note 2, Significant Accounting Policies in the Notes to Consolidated Financial Statements regarding recent accounting pronouncements.Non-GAAP MeasuresThe Company has provided reconciliations of the supplemental non-GAAP financial measures, as defined under the rules of the Securities and Exchange Commission, presented herein to the most directly comparable financial measures calculated and presented in accordance with GAAP. These supplemental non-GAAP financial measures – Consolidated Organic Net sales growth, AIT Organic Net sales growth, and EVM Organic Net sales growth – are presented because our management evaluates our financial results both including and excluding the effects of business acquisitions and foreign currency translation, as applicable. Management believes that the supplemental non-GAAP financial measures presented provide additional perspective and insights when analyzing the core operating performance of our business from period to period and trends in our historical operating results. These supplemental non-GAAP financial measures should not be considered superior to, as a substitute for, or as an alternative to, and should be considered in conjunction with the GAAP financial measures presented.36Table of ContentsItem 7A. Quantitative and Qualitative Disclosures About Market RiskMarket risk is the sensitivity of income to changes in interest rates, commodity prices, and foreign currency changes. Zebra is primarily exposed to the following types of market risk: interest rate and foreign currency.Interest Rate RiskWe are exposed to interest rate volatility with regard to existing debt issuances. Our exposures include the London Inter-bank Offered Rate (“LIBOR”) and the Secured Overnight Financing Rate (“SOFR”). We use interest rate derivative contracts, including interest rate swaps, to mitigate the majority of the Company’s exposure from interest rate changes on existing debt and future debt issuances, thereby reducing the volatility of our financing costs and, based on current and projected market conditions, achieve a desired proportion of fixed versus floating-rate debt. Generally, under these interest rate swaps, we agree with a counterparty to exchange floating-rate for fixed-rate interest amounts with an agreed upon notional amount.The United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced in 2017 the phase out of LIBOR. We continue to closely monitor the phase out of LIBOR to assess any impacts to our debt and interest rate swap contracts. We have already taken actions to amend certain contracts to incorporate a SOFR benchmark rate, and we expect other key contracts will be amended to incorporate a SOFR benchmark rate before the LIBOR phase out is completed. As of December 31, 2022, our remaining contracts containing exposure to LIBOR pertain only to LIBOR tenors that will be phased out by June 30, 2023. As of December 31, 2022, we had approximately $2.0 billion of debt outstanding under our debt facilities, which bears interest determined by reference to a variable rate index. A one percentage point increase or decrease in interest rates would increase or decrease annual interest expense by approximately $12 million. This exposure includes the impact of associated forward interest rate swaps outstanding as of December 31, 2022. Refer to Note 11, Derivative Instruments in the Notes to Consolidated Financial Statements for further discussion of these risk mitigation activities. Exposure to variable interest may increase or decrease, to the extent that the Company’s borrowings under its debt facilities increase or decrease, respectively. Foreign Exchange RiskWe provide products, solutions and services in approximately 190 countries throughout the world and, therefore, at times are exposed to risk based on movements in foreign exchange rates. In some instances, we invoice customers in their local currency and have a resulting foreign currency denominated revenue transaction and accounts receivable. We also purchase certain raw materials and other items in foreign currencies. We manage these risks using derivative financial instruments, including foreign currency exchange contracts. See Note 11, Derivative Instruments in the Notes to Consolidated Financial Statements for further discussions of hedging activities.The currencies that we are primarily exposed to fluctuations in foreign currency exchange rates are the Euro, British Pound Sterling, and Czech Koruna. A one percentage point increase or decrease in exchange rates relative to the U.S. Dollar would increase or decrease our pre-tax income by approximately $2 million. This amount is inclusive of the impact of associated derivative contracts. 37Table of Contents
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+ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSManagement's discussion and analysis of financial condition and results of operations is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. Components of management's discussion and analysis of financial condition and results of operations include:•Overview•Financial Highlights and Market Conditions and Trends•Results of Operations •Comparison of 2022 to 2021•Comparable Store Sales and Total Comparable Sales•Non-GAAP Financial Measures•Liquidity and Capital Resources•Liquidity Outlook•Contractual Obligations and Commitments•Critical Accounting Policies and EstimatesOur fiscal year ends on the Sunday closest to January 31 of the following year, typically resulting in a 52-week year, but occasionally giving rise to an additional week, resulting in a 53-week year. Fiscal 2022 and 2021 were each 52-week years. This discussion and analysis contains forward-looking statements based on current expectations that involve risks, uncertainties and assumptions, such as our plans, objectives, expectations, and intentions included in the "Special Note Regarding Forward-Looking Statements." Our actual results and the timing of events may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those described in the "Item 1A. Risk Factors" section and elsewhere in this Annual Report on Form 10-K.We disclose material non-public information through one or more of the following channels: our investor relations website (http://corporate.lululemon.com/investors), the social media channels identified on our investor relations website, press releases, SEC filings, public conference calls, and webcasts.Overview In 2019 we announced our Power of Three growth plan which established our goal to double our total net revenue by 2023 and outlined our plans to double men's revenue, double digital net revenue, and to quadruple international net revenue. We achieved our goal to double our total net revenue ahead of schedule, and in 2022 we launched our new 5-year growth plan, the Power of Three ×2. Our Power of Three ×2 plan leverages the success of our prior growth strategy, and is comprised of three key pillars – Product Innovation, Guest Experience, and Market Expansion. We continue to see opportunity to grow our men's, direct to consumer, and international net revenue, while continuing to grow our core businesses.2022 was the inaugural year of our new plan and we successfully executed against our goals by delivering 30% net revenue growth. Our strength was balanced across channel, region, and merchandise category; and was achieved in a challenging macroeconomic backdrop with ongoing supply chain disruptions. The underlying trends that have fueled our business continue to do so, and include a desire for guests to live an active and healthy lifestyle, the desire for apparel that offers versatility, the desire to be part of a diverse and inclusive community, and the desire to achieve wellness, both physically and mentally.Product InnovationWe continue to solve for the unmet needs of our guest by bringing new technical innovations into our merchandise assortment. In 2022, we expanded our core running category with the launch of Senseknit, a proprietary fabric technology offering zoned compression. We entered new activities with our capsule collections for golf, tennis, and hiking. And we launched footwear, enabling us to provide a head-to-toe solution to our guests. The footwear collection currently includes three technical styles – Blissfeel, Chargefeel, and Strongfeel – all designed specifically for women. In addition, we launched a dual gender slide for pre- and post-workouts. 24Table of ContentsGuest Experience and MembershipOur omni operating model allows us to efficiently and effectively serve our guests in the ways most convenient to them – either in store or online. We saw strength across both channels in 2022 as net revenue in our company-operated store channel increased 29% and our direct to consumer net revenue increased 33%.Community is at the core of our brand. In 2022, we continued to engage with guests via in-store events, 10K runs in Atlanta and Houston, ambassador-led activations, and our Summer Sweat Games in China Mainland, among other in-person events. In addition, we connect with our community of guests through our connected fitness content provided by lululemon Studio.In October 2022, we launched our new two-tier membership program. The Essential membership tier is free and provides access to select content, as well as certain benefits in-store and online. We rebranded MIRROR to become lululemon Studio, the premium paid tier of the program which offers members a connected fitness experience via in-home hardware. As part of our membership launch, we also enhanced the lululemon Studio offering to include access to exclusive content provided by outside studio partners, as well as a discount on lululemon product purchases.As concerns with the COVID-19 pandemic have subsided the connected fitness industry has experienced challenging market conditions, and as a result we have seen weakening demand for our in-home fitness hardware. Hardware unit sales did not meet our expectations during the peak holiday selling period and the reduction in customer acquisition costs was less than anticipated. As a result, in the fourth quarter, we reviewed our strategy and we plan to evolve lululemon Studio to focus on digital app-based services. Building on the two-tier membership program, we will be expanding the lululemon Studio premium tier by enabling guests to access digital fitness content via a new app, launching in summer 2023, for a lower monthly fee. We believe this strategy will enable more guests to experience our digital fitness content, while also building a larger community of guests with a deeper connection to lululemon. In 2022 we recognized post-tax charges totaling $442.7 million related to lululemon Studio, including the impairment of goodwill, intangible assets, and property and equipment, and provisions against hardware inventory. See the section "Critical Accounting Policies and Estimates", Goodwill Impairment Assessment below and Note 8. Impairment of Goodwill and Other Assets included in Item 8 of Part II of this report for further information.Market ExpansionWe continued to expand our presence both in North America and in our international markets. During 2022, we opened 81 net new company-operated stores, including 31 stores in the PRC, nine stores in the rest of Asia Pacific, 32 stores in North America, and nine stores in Europe, including our first locations in Spain. In 2022, our net revenue in North America increased 29%. In our international markets, despite certain COVID-19 closures in the PRC, we saw net revenue growth of 35%. Financial HighlightsThe summary below compares 2022 to 2021 and provides both GAAP and non-GAAP financial measures. The adjusted financial measures for 2022 exclude $442.7 million of post-tax impairment and other charges recognized in relation to our lululemon Studio business unit (formerly MIRROR) and the post-tax net gain on the sale of an administrative building of $8.5 million. The adjusted financial measures for 2021 exclude acquisition-related expenses, and their related tax effects.•Net revenue increased 30% to $8.1 billion. On a constant dollar basis, net revenue increased 32%.•Total comparable sales increased 25%, or 28% on a constant dollar basis.–Comparable store sales increased 16%, or 19% on a constant dollar basis.–Direct to consumer net revenue increased 33%, or 35% on a constant dollar basis. •Gross profit increased 24% to $4.5 billion. Adjusted gross profit increased 26% to $4.6 billion.•Gross margin decreased 230 basis points to 55.4%. Adjusted gross margin decreased 150 basis points to 56.2%.•Income from operations was consistent at $1.3 billion. Adjusted income from operations increased 30% to $1.8 billion.25Table of Contents•Operating margin decreased 490 basis points to 16.4%. Adjusted operating margin increased 10 basis points to 22.1%.•Income tax expense increased 33% to $477.8 million. Our effective tax rate for 2022 was 35.9% compared to 26.9% for 2021. The adjusted effective tax rate was 28.1% and 26.2% for 2022 and 2021, respectively.•Diluted earnings per share were $6.68 for 2022 compared to $7.49 in 2021. Adjusted diluted earnings per share were $10.07 for 2022 compared to $7.79 in 2021.Refer to the non-GAAP reconciliation tables contained in the Non-GAAP Financial Measures section of this Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations for reconciliations between the above adjusted non-GAAP financial measures and the most directly comparable measures calculated in accordance with GAAP.Market Conditions and TrendsMacroeconomic conditions, the recent COVID-19 pandemic, and supply chain disruption impacted our business and operating costs in 2022 and 2021. Certain trends are expected to continue into 2023, with the impact varying by market.Macroeconomic ConditionsMacroeconomic conditions, including foreign currency fluctuations, inflationary pressures, and labor shortages have impacted our financial results. This includes higher air freight costs during the first half of 2022 and increased wage rates during 2022 compared to 2021. We have not increased the retail prices on the significant proportion of our products. Inflation, an anticipated economic downturn, and other macroeconomic factors could also impact consumer purchasing behaviors and sustained increases in costs may have an adverse effect on our operating margins.COVID-19 PandemicMost of our retail locations were open throughout 2022 and 2021, with certain locations temporarily closed due to COVID-19 resurgences, including certain closures during 2022 in the PRC.Supply chain disruptionIn 2021 and 2022 we experienced supply chain disruption, including delays in inbound delivery of our products as well as in manufacturing. This supply chain disruption caused us to use higher cost modes of transport, including increasing our use of air freight. The supply chain disruption we have experienced has contributed to the 50% increase in our inventory balance as of January 29, 2023 compared to January 30, 2022. We expect that while the growth rate in our inventories will exceed net revenue growth in the first half of 2023, the growth rate will be relatively in line with net revenue growth in the second half of 2023.The use of air freight reduced our gross margin during the first half of 2022, however, we began seeing an improvement in the supply chain issues and experienced lower inbound freight costs in the second half of 2022, and this resulted in an overall improvement to our gross margin from air freight costs for 2022 compared to 2021. We expect that we will similarly see improvements in our gross margin from air freight costs in the first half of 2023 compared to the prior year when there was the supply chain disruption. 26Table of ContentsResults of OperationsThe following table summarizes key components of our results of operations for the periods indicated: 2022202120222021 (In thousands)(Percentage of revenue)Net revenue$8,110,518 $6,256,617 100.0 %100.0 %Cost of goods sold3,618,178 2,648,052 44.6 42.3 Gross profit4,492,340 3,608,565 55.4 57.7 Selling, general and administrative expenses2,757,447 2,225,034 34.0 35.6 Amortization of intangible assets8,752 8,782 0.1 0.1 Impairment of goodwill and other assets407,913 — 5.0 — Acquisition-related expenses— 41,394 — 0.7 Gain on disposal of assets(10,180)— (0.1)— Income from operations1,328,408 1,333,355 16.4 21.3 Other income (expense), net4,163 514 0.1 — Income before income tax expense1,332,571 1,333,869 16.4 21.3 Income tax expense477,771 358,547 5.9 5.7 Net income$854,800 $975,322 10.5 %15.6 %Comparison of 2022 to 2021 Net RevenueNet revenue increased $1.9 billion, or 30%, to $8.1 billion in 2022 from $6.3 billion in 2021. On a constant dollar basis, assuming the average foreign currency exchange rates in 2022 remained constant with the average foreign currency exchange rates in 2021, net revenue increased $2.0 billion, or 32%.The increase in net revenue was primarily due to increased direct to consumer net revenue, as well as due to company-operated store net revenue, including from new company-operated stores and increased comparable store sales. Other net revenue also increased.Total comparable sales, which includes comparable store sales and direct to consumer, increased 25% in fiscal 2022 compared to fiscal 2021. Total comparable sales increased 28% on a constant dollar basis.Net revenue for 2022 and 2021 is summarized below.2022202120222021Year over year change (In thousands)(Percentage of revenue)(In thousands)(Percentage)Company-operated stores$3,648,127 $2,821,497 45.0 %45.1 %$826,630 29.3 %Direct to consumer3,699,791 2,777,944 45.6 44.4 921,847 33.2 Other762,600 657,176 9.4 10.5 105,424 16.0 Net revenue$8,110,518 $6,256,617 100.0 %100.0 %$1,853,901 29.6 %Company-Operated Stores. The increase in net revenue from our company-operated stores was driven by net revenue from company-operated stores that were opened or significantly expanded since 2021 which contributed $435.9 million to the increase. During 2022, we opened 81 net new company-operated stores, including 40 stores in Asia Pacific, 32 stores in North America, and nine stores in Europe. The increase in net revenue from our company-operated stores was also driven by increased comparable store sales. Comparable store sales increased 16%, or 19% on a constant dollar basis. The increase in comparable store sales was primarily a result of increased store traffic, partially offset by a decrease in conversion rates. Dollar value per transaction was consistent year over year.Direct to Consumer. Direct to consumer net revenue increased 33%, or 35% on a constant dollar basis. The increase in net revenue from our direct to consumer segment was primarily a result of increased traffic, partially offset by a decrease in conversion rates and a lower dollar value per transaction.27Table of ContentsOther. The increase in other net revenue was primarily due to increased outlet sales, sales to wholesale accounts, license and supply arrangement revenue, recommerce revenue, and revenue from our pop up locations. The increase in net revenue was partially offset by a decrease in net revenue from lululemon Studio.Gross Profit20222021Year over year change(In thousands)(In thousands)(Percentage)Gross profit$4,492,340 $3,608,565 $883,775 24.5 %Gross margin55.4 %57.7 %(230) basis pointsOur updated lululemon Studio strategy will focus on digital app based services and means we no longer expect to be able to sell all of the in-home hardware inventory above cost. We recognized a provision of $62.9 million against hardware inventory during the fourth quarter of 2022. This reduced 2022 gross margin by 80 basis points. Please refer to Note 8. Impairment of Goodwill and Other Assets included in Item 8 of Part II of this report. The remaining 150 basis point decrease in gross margin was primarily the result of:•a decrease in product margin of 100 basis points primarily due to higher markdowns, sales mix, and increased damages and shrink, partially offset by lower air freight costs; •an increase in costs related to our product departments and distribution centers as a percentage of net revenue of 60 basis points; and •an unfavorable impact of foreign currency exchange rates of 40 basis points.The decrease in gross margin was partially offset by leverage on occupancy and depreciation costs of 50 basis points, driven primarily by the increase in net revenue.Selling, General and Administrative Expenses20222021Year over year change(In thousands)(In thousands)(Percentage)Selling, general and administrative expenses$2,757,447 $2,225,034 $532,413 23.9 %Selling, general and administrative expenses as a percentage of net revenue34.0 %35.6 %(160) basis pointsThe increase in selling, general and administrative expenses was primarily due to:•an increase in head office costs of $283.7 million, comprised of:–an increase in costs of $142.2 million primarily due to increased depreciation of $43.5 million and increased technology costs, including cloud computing amortization, of $35.7 million, as well as increased brand and community costs and professional fees; and–an increase in employee costs of $141.5 million primarily due to an increase in salaries and wages expense of $76.5 million and incentive compensation of $34.8 million, as well as increased stock-based compensation expense and travel costs, primarily as a result of headcount growth and increased wage rates.•an increase in costs related to our operating channels of $249.5 million, comprised of:–an increase in variable costs of $127.6 million primarily due to an increase in distribution costs and credit card fees, primarily as a result of increased net revenue; –an increase in employee costs of $104.2 million primarily due to an increase in salaries and wages expense and incentive compensation in our company-operated store and direct to consumer channels, primarily due to growth in our business and increased wage rates;–an increase in other costs of $15.3 million primarily due to an increase in repairs and maintenance costs, depreciation, and technology costs, partially offset by a decrease in professional fees; and28Table of Contents–an increase in brand and community costs of $2.4 million primarily due to an increase in digital marketing expenses related to our direct to consumer channel, partially offset by a decrease in marketing expenses related to lululemon Studio.The increase in selling, general and administrative expenses was partially offset by a decrease in net foreign exchange and derivative revaluation losses of $0.8 million.Amortization of Intangible Assets20222021Year over year change(In thousands)(In thousands)(Percentage)Amortization of intangible assets$8,752 $8,782 $(30)(0.3)%The amortization of intangible assets was primarily the result of the amortization of intangible assets recognized upon the acquisition of MIRROR. Impairment of Goodwill and Other Assets20222021Year over year change(In thousands)(In thousands)(Percentage)Impairment of goodwill and other assets$407,913 $— $407,913 n/aDuring the fourth quarter of 2022, we recognized an impairment of goodwill and other long-lived assets in relation to our lululemon Studio business unit (formerly MIRROR). Please refer to the Critical Accounting Policies and Estimates section of this Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as Note 8. Impairment of Goodwill and Other Assets included in Item 8 of Part II of this report for further information.Acquisition-Related Expenses20222021Year over year change(In thousands)(In thousands)(Percentage)Acquisition-related expenses$— $41,394 $(41,394)(100.0)%In connection with our acquisition of MIRROR, we recognized acquisition-related compensation expenses of $38.4 million and transaction and integration related costs of $3.0 million in 2021. There were no acquisition-related expenses in 2022. Please refer to Note 9. Acquisition-Related Expenses included in Item 8 of Part II of this report for further information.Gain on Disposal of Assets20222021Year over year change(In thousands)(In thousands)(Percentage)Gain on disposal of assets$(10,180)$— $(10,180)n/aDuring the second quarter of 2022, we completed the sale of an administrative office building, which resulted in a pre-tax gain of $10.2 million. 29Table of ContentsIncome from OperationsOn a segment basis, we determine income from operations without taking into account our general corporate expenses and certain other expenses. Segmented income from operations is summarized below. 2022202120222021Year over year change(In thousands)(Percentage of net revenue of respective operating segment)(In thousands)(Percentage)Segmented income from operations:Company-operated stores$991,067 $727,735 27.2 %25.8 %$263,332 36.2 %Direct to consumer1,562,538 1,216,496 42.2 43.8 346,042 28.4 Other107,083 77,283 14.0 11.8 29,800 38.6 $2,660,688 $2,021,514 $639,174 31.6 %General corporate expenses862,867 637,983 224,884 35.2 lululemon Studio obsolescence provision62,928 — 62,928 n/aAmortization of intangible assets8,752 8,782 (30)(0.3)Impairment of goodwill and other assets407,913 — 407,913 n/aAcquisition-related expenses— 41,394 (41,394)(100.0)Gain on disposal of assets(10,180)— (10,180)n/aIncome from operations$1,328,408 $1,333,355 $(4,947)(0.4)%Operating margin16.4 %21.3 %(490) basis pointsCompany-Operated Stores. The increase in income from operations from company-operated stores was primarily the result of increased gross profit of $413.7 million, driven by increased net revenue. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses, primarily due to higher salaries and wages expense and higher incentive compensation as a result of the growth in our business and increased wage rates. Store operating costs increased, primarily due to increases in credit card fees and distribution costs as a result of higher net revenue, as well as increased repairs and maintenance. Income from operations as a percentage of company-operated stores net revenue increased due to leverage on selling, general and administrative expenses.Direct to Consumer. The increase in income from operations from our direct to consumer segment was primarily the result of increased gross profit of $527.9 million, driven by increased net revenue, partially offset by lower gross margin. The decrease in gross margin was primarily due to higher markdowns, sales mix, deleverage on distribution center and product team costs, and unfavorable foreign exchange, partially offset by lower air freight costs. The increase in gross profit was partially offset by an increase in selling, general and administrative expenses primarily due to higher distribution costs and credit card fees as a result of higher net revenue, as well as higher digital marketing expenses, depreciation, employee costs, and technology costs. Income from operations as a percentage of direct to consumer net revenue decreased primarily due to a decrease in gross margin, partially offset by leverage on selling, general and administrative expenses.Other. The increase in income from operations was primarily the result of a reduction in lululemon Studio marketing expenses and increased operating profit from our other lululemon retail operations. Increased net revenue from outlets, sales to wholesale accounts, license and supply arrangements, recommerce, and pop up locations resulted in increased gross profit. This was partially offset by a decrease in net revenue from lululemon Studio. Selling, general, and administrative expenses decreased due to lower lululemon Studio marketing costs, partially offset by higher people costs as a result of growth in our other lululemon retail locations. Income from operations as a percentage of other net revenue increased primarily due to leverage on selling, general and administrative expenses, partially offset by lower gross margin.General Corporate Expenses. The increase in general corporate expenses was primarily due to increased employee costs, primarily from headcount growth and increased wage rates, as well as increased depreciation, technology costs including cloud computing amortization, brand and community costs, and professional fees. The increase in general corporate expenses was partially offset by a decrease in net foreign exchange and derivative losses of $0.8 million. We expect general corporate expenses to continue to increase in future years as we grow our overall business and require increased efforts at our head office to support our operations.30Table of ContentsOther Income (Expense), Net20222021Year over year change(In thousands)(In thousands)(Percentage)Other income (expense), net$4,163 $514 $3,649 709.9 %The increase in other income, net was primarily due to an increase in interest income from higher interest rates, partially offset by an increase in other expenses.Income Tax Expense20222021Year over year change(In thousands)(In thousands)(Percentage)Income tax expense$477,771 $358,547 $119,224 33.3 %Effective tax rate35.9 %26.9 %900 basis pointsThe increase in the effective tax rate was primarily due to certain non-deductible expenses related to the impairment of goodwill and other assets recognized in relation to our lululemon Studio business unit (formerly MIRROR) partially offset by the gain on sale of an administrative building in 2022 which increased the effective tax rate by 780 basis points. Certain non-deductible expenses related to the MIRROR acquisition increased the effective tax rate by 70 basis points in 2021. The increase in the effective tax rate was also due to the accrual of U.S. state tax and Canadian withholding taxes on unremitted earnings which are not considered to be permanently reinvested, adjustments upon filing of certain income tax returns, and a decrease in deductions for stock-based compensation, partially offset by a decrease in non-deductible expenses in international jurisdictions. Excluding the impairment of goodwill and other assets recognized in relation to our lululemon Studio business unit and the gain on sale of an administrative building in 2022, and the MIRROR acquisition-related expenses in 2021, and their tax effects, our adjusted effective tax rates were 28.1% and 26.2% for 2022 and 2021, respectively.Net Income20222021Year over year change(In thousands)(In thousands)(Percentage)Net income$854,800 $975,322 $(120,522)(12.4)%The decrease in net income in 2022 was primarily due to an increase in selling, general and administrative expenses of $532.4 million, an impairment charge recognized in 2022 of $407.9 million, an increase in income tax expense of $119.2 million, partially offset by an increase in gross profit of $883.8 million, a decrease in acquisition-related expenses of $41.4 million, a gain on disposal of assets of $10.2 million, and an increase in other income (expense), net of $3.6 million. Excluding the impairment of goodwill and other assets in relation to our lululemon Studio business unit (formerly MIRROR) and the gain on sale of an administrative building in 2022, and the MIRROR acquisition-related expenses in 2021, and their tax effects, adjusted net income increased $273.7 million or 27.0%.Comparable Store Sales and Total Comparable SalesWe use comparable store sales to assess the performance of our existing stores as it allows us to monitor the performance of our business without the impact of recently opened or expanded stores. We use total comparable sales to evaluate the performance of our business from an omni-channel perspective. We believe investors would similarly find these metrics useful in assessing the performance of our business. Comparable store sales reflect net revenue from company-operated stores that have been open, or open after being significantly expanded, for at least 12 full fiscal months. Net revenue from a store is included in comparable store sales beginning with the first fiscal month for which the store has a full fiscal month of sales in the prior year. Comparable store sales exclude sales from new stores that have not been open for at least 12 full fiscal months, from stores which have not been in their significantly expanded space for at least 12 full fiscal months, and from stores which have been temporarily relocated for renovations or temporarily closed. Comparable store sales also exclude sales from direct to consumer and our other operations, as well as sales from company-operated stores that have closed.Total comparable sales combines comparable store sales and direct to consumer net revenue. 31Table of ContentsIn fiscal years with 53 weeks, the 53rd week of net revenue is excluded from the calculation of comparable sales. In the year following a 53 week year, the prior year period is shifted by one week to compare similar calendar weeks. Opening new stores and expanding existing stores is an important part of our growth strategy. Accordingly, total comparable sales is just one way of assessing the success of our growth strategy insofar as comparable sales do not reflect the performance of stores opened, or significantly expanded, within the last 12 full fiscal months. The comparable sales measures we report may not be equivalent to similarly titled measures reported by other companies.Non-GAAP Financial MeasuresConstant dollar changes in net revenue, total comparable sales, comparable store sales, and direct to consumer net revenue are non-GAAP financial measures.A constant dollar basis assumes the average foreign currency exchange rates for the period remained constant with the average foreign currency exchange rates for the same period of the prior year. We provide constant dollar changes in our results to help investors understand the underlying growth rate of net revenue excluding the impact of changes in foreign currency exchange rates.Adjusted gross profit, gross margin, income from operations, operating margin, income tax expense, effective tax rates, net income, and diluted earnings per share exclude the impairment of goodwill and other assets recognized in relation to our lululemon Studio business unit (formerly MIRROR), the gain on disposal of assets for the sale of an administrative office building, the MIRROR acquisition-related expenses, and the related income tax effects of these items. We believe these adjusted financial measures are useful to investors as they provide supplemental information that enable evaluation of the underlying trend in our operating performance, and enable a comparison to our historical financial information. Further, due to the finite and discrete nature of these items, we do not consider them to be normal operating expenses that are necessary to operate the business, or impairments or disposal gains that are expected to arise in the normal course of our operations. Management uses these adjusted financial measures and constant currency metrics internally when reviewing and assessing financial performance.The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or with greater prominence to, the financial information prepared and presented in accordance with GAAP. A reconciliation of the non-GAAP financial measures follows, which includes more detail on the GAAP financial measure that is most directly comparable to each non-GAAP financial measure, and the related reconciliations between these financial measures.Constant Dollar Changes in Net RevenueThe below changes in net revenue show the change compared to the corresponding period in the prior year.2022Net RevenueDirect to Consumer Net Revenue(In thousands)(Percentages)(Percentages)Change$1,853,901 30 %33 %Adjustments due to foreign currency exchange rate changes147,728 2 2 Change in constant dollars$2,001,629 32 %35 %32Table of ContentsConstant Dollar Changes in Total Comparable Sales, Comparable Store Sales, and Direct to Consumer Net RevenueThe below changes in total comparable sales, comparable store sales, and direct to consumer net revenue show the change compared to the corresponding period in the prior year.2022Total Comparable Sales1,2Comparable Store Sales2Direct to Consumer Net RevenueChange25 %16 %33 %Adjustments due to foreign currency exchange rate changes3 %3 2 Change in constant dollars28 %19 %35 %__________(1)Total comparable sales includes comparable store sales and direct to consumer net revenue.(2)Comparable store sales reflects net revenue from company-operated stores that have been open for at least 12 full fiscal months, or open for at least 12 full fiscal months after being significantly expanded.33Table of ContentsAdjusted financial measuresThe following tables reconcile adjusted financial measures with the most directly comparable measures calculated in accordance with GAAP. The 2022 adjustments relate to the impairment of goodwill and other assets in relation to our lululemon Studio business unit (formerly MIRROR) and the gain on sale of an administrative office building, and their related tax effects. The 2021 adjustments relate to MIRROR acquisition-related expenses, and their related tax effects. Please refer to Note 5. Property and Equipment, Note 8. Impairment of Goodwill and Other Assets, and Note 9. Acquisition-Related Expenses included in Item 8 of Part II of this report for further information on the nature of these amounts.2022Gross ProfitGross MarginIncome from OperationsOperating MarginIncome Tax ExpenseEffective Tax RateNet IncomeDiluted Earnings Per Share(In thousands, except per share amounts)GAAP results$4,492,340 55.4 %$1,328,408 16.4 %$477,771 35.9 %$854,800 $6.68 lululemon Studio charges:Obsolescence provision62,928 0.8 62,928 0.8 62,928 0.49 Impairment of goodwill362,492 4.4 362,492 2.83 Impairment of intangible assets40,585 0.5 40,585 0.32 Impairment of property and equipment4,836 0.1 4,836 0.04 Gain on disposal of assets(10,180)(0.1)(10,180)(0.08)Tax effect of the above26,510 (7.8)(26,510)(0.21)Adjusted results (non-GAAP)$4,555,268 56.2 %$1,789,069 22.1 %$504,281 28.1 %$1,288,951 $10.07 Fourth Quarter 2022(In thousands)Income from operations$314,426 lululemon Studio related charges:Obsolescence provision62,928 Impairment of goodwill362,492 Impairment of intangible assets40,585 Impairment of property and equipment4,836 Adjusted income from operations (non-GAAP)$785,267 2021Income from OperationsOperating MarginIncome Tax ExpenseEffective Tax RateNet IncomeDiluted Earnings Per Share(In thousands, except per share amounts)GAAP results$1,333,355 21.3 %$358,547 26.9 %$975,322 $7.49 Transaction and integration costs2,989 — 2,989 0.02 Acquisition-related compensation38,405 0.7 38,405 0.29 Tax effect of the above1,417 (0.7)(1,417)(0.01)Adjusted results (non-GAAP)$1,374,749 22.0 %$359,964 26.2 %$1,015,299 $7.79 34Table of ContentsLiquidity and Capital ResourcesOur primary sources of liquidity are our current balances of cash and cash equivalents, cash flows from operations, and capacity under our committed revolving credit facility. Our primary cash needs are capital expenditures for opening new stores and remodeling or relocating existing stores, investing in technology and making system enhancements, funding working capital requirements, and making other strategic capital investments both in North America and internationally. We may also use cash to repurchase shares of our common stock. Cash and cash equivalents in excess of our needs are held in interest bearing accounts with financial institutions, as well as in money market funds and term deposits.The following table summarizes our net cash flows provided by and used in operating, investing, and financing activities for the periods indicated: 20222021Year over year change (In thousands)Total cash provided by (used in):Operating activities$966,463 $1,389,108 $(422,645)Investing activities(569,937)(427,891)(142,046)Financing activities(467,487)(844,987)377,500 Effect of foreign currency exchange rate changes on cash and cash equivalents(34,043)(6,876)(27,167)Increase (decrease) in cash and cash equivalents$(105,004)$109,354 $(214,358)Operating ActivitiesThe decrease in cash provided by operating activities was primarily as a result of a decrease in cash flows from changes in operating assets and liabilities of $726.1 million. This decrease was primarily driven by changes in accounts payable, inventories, and income taxes. The decrease in cash provided by operating activities was also due to lower cash inflows related to derivatives not designated in a hedging relationship.The decrease in cash provided by operating activities was partially offset by an increase in depreciation and stock-based compensation expense.Investing ActivitiesThe increase in cash used in investing activities was primarily due to increased capital expenditures, partially offset by the settlement of net investment hedges and other investing activities. The increase in capital expenditures was primarily due to corporate expenditures and from our company-operated stores segment.Capital expenditures for our company-operated stores segment were $303.7 million and $189.6 million in 2022 and 2021, respectively. The capital expenditures for our company-operated stores segment in each period were primarily for opening new company-operated stores, for the remodeling or relocation of certain stores, ongoing store refurbishment, and increased investment in our new and existing distribution facilities. The capital expenditures for our company-operated stores segment also included $78.9 million to open 87 company-operated stores and $47.1 million to open 56 company-operated stores, in 2022 and 2021 respectively. We expect to open 45 to 50 new company-operated stores in 2023.Capital expenditures for our direct to consumer segment were $57.1 million and $81.7 million in 2022 and 2021, respectively. Capital expenditures in 2022 were primarily related to our distribution centers as well as other technology infrastructure and system initiatives.Capital expenditures related to corporate activities and other were $277.9 million and $123.2 million in 2022 and 2021, respectively. The increase in capital expenditures in each fiscal year was primarily due to investments in technology and business systems, and for increased capital expenditures on corporate office renovations. The proceeds of the sale of an administrative office building during the second quarter of 2022 are included in other investing activities.Financing ActivitiesThe decrease in cash used in financing activities was primarily the result of a decrease in our stock repurchases. During 2022, 1.4 million shares were repurchased at a total cost including commissions and excise taxes of $444.0 million. During 2021, 2.2 million shares were repurchased at a total cost including commissions of $812.6 million. The common stock was repurchased in the open market at prevailing market prices, including under plans complying with the provisions of Rule 10b5-1 and Rule 10b-18 of the Securities Exchange Act of 1934, with the timing and actual number of shares repurchased depending upon market conditions, eligibility to trade, and other factors.35Table of ContentsLiquidity OutlookWe believe our cash and cash equivalent balances, cash generated from operations, and borrowings available to us under our committed revolving credit facility will be adequate to meet our liquidity needs and capital expenditure requirements for at least the next 12 months. Our cash from operations may be negatively impacted by a decrease in demand for our products as well as the other factors described in "Item 1A. Risk Factors". In addition, we may make discretionary capital improvements with respect to our stores, distribution facilities, headquarters, or systems, or we may repurchase shares under an approved stock repurchase program, which we would expect to fund through the use of cash, issuance of debt or equity securities or other external financing sources to the extent we were unable to fund such expenditures out of our cash and cash equivalents and cash generated from operations.The following table includes certain measures of our liquidity:January 29, 2023(In thousands)Cash and cash equivalents$1,154,867 Working capital excluding cash and cash equivalents(1)512,388 Capacity under committed revolving credit facility393,480 __________(1)Working capital is calculated as current assets of $3.2 billion less current liabilities of $1.5 billion.Capital expenditures are expected to range between $660.0 million and $680.0 million in 2023.Our current commitments with respect to inventory purchases are included within our purchase obligations outlined below. The timing and cost of our inventory purchases will vary depending on a variety of factors such as revenue growth, assortment and purchasing decisions, product costs including freight and duty, and the availability of production capacity and speed. Our inventory balance as of January 29, 2023 was $1.4 billion, an increase of 50% from January 30, 2022. Increased air freight usage and cost have contributed to the increase in inventory. On a number of units basis, our inventory increased 58% compared to January 30, 2022. We expect that while the growth rate in our inventories will exceed net revenue growth in the first half of 2023, the growth rate will be relatively in line with net revenue growth in the second half of 2023.Our existing North America credit facility provides for $400.0 million in commitments under an unsecured five-year revolving credit facility. The credit facility has a maturity date of December 14, 2026, subject to extension under certain circumstances. As of January 29, 2023, aside from letters of credit of $6.5 million, we had no other borrowings outstanding under this credit facility. Further information regarding our credit facilities and associated covenants is outlined in Note 12. Revolving Credit Facilities included in Item 8 of Part II of this report.Contractual Obligations and CommitmentsLeases. We lease certain store and other retail locations, distribution centers, offices, and equipment under non-cancellable operating leases. Our leases generally have initial terms of between two and 15 years, and generally can be extended in increments between two and five years, if at all. The following table details our future minimum lease payments. Minimum lease commitments exclude variable lease expenses including contingent rent payments, common area maintenance, property taxes, and landlord's insurance. Purchase obligations. The amounts listed for purchase obligations in the table below represent agreements (including open purchase orders) to purchase products and for other expenditures in the ordinary course of business that are enforceable and legally binding and that specify all significant terms. In some cases, values are subject to change, such as for product purchases throughout the production process. The reported amounts exclude liabilities included in our consolidated balance sheets as of January 29, 2023.One-time transition tax payable. The U.S. tax reforms enacted in December 2017 imposed a mandatory transition tax on accumulated foreign subsidiary earnings which have not previously been subject to U.S. income tax. The one-time transition tax is payable over eight years beginning in fiscal 2018. The one-time transition tax payable is net of foreign tax credits, and the table below outlines the expected payments due by fiscal year.36Table of ContentsThe following table summarizes our contractual arrangements due by fiscal year as of January 29, 2023, and the timing and effect that such commitments are expected to have on our liquidity and cash flows in future periods: Total20232024202520262027Thereafter (In thousands)Operating leases (minimum rent)$1,174,024 $238,343 $265,787 $197,934 $143,603 $117,639 $210,718 Purchase obligations884,382 841,341 15,843 3,430 5,184 2,930 15,654 One-time transition tax payable38,073 9,518 12,691 15,864 — — — As of January 29, 2023, our operating lease commitments for distribution center operating leases which have been committed to, but not yet commenced, was $632.0 million, which is not reflected in the table above.We enter into standby letters of credit to secure certain of our obligations, including leases, taxes, and duties. As of January 29, 2023, letters of credit and letters of guarantee totaling $8.6 million had been issued, including $6.5 million under our committed revolving credit facility. Critical Accounting Policies and EstimatesThe preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions. Predicting future events is inherently an imprecise activity and, as such, requires the use of significant judgment. Actual results may vary from our estimates in amounts that may be material to the financial statements. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact our consolidated financial statements. Our critical accounting policies, estimates, and judgements are as follows, and see Note 2. Summary of Significant Accounting Policies included in Item 8 of Part II for additional information:Goodwill impairment assessmentGoodwill is tested annually for impairment on the first day of the fourth quarter, or more frequently if events or circumstances indicate it is more likely than not that an impairment may have occurred.We acquired Curiouser Products Inc., dba "MIRROR" in 2020, subsequently re-branded "lululemon Studio," and $362.5 million of goodwill was allocated to the lululemon Studio reporting unit.We performed a quantitative impairment analysis on October 31, 2022 for the lululemon Studio reporting unit. The result of this annual test concluded that the fair value of the lululemon Studio reporting unit exceeded its carrying value. We used a discounted cash flow model to estimate the fair value, supplemented by market analysis, which indicated the fair value of lululemon Studio was approximately 4% higher than its carrying value. The key assumptions of the fair value of the lululemon Studio reporting unit as of October 31, 2022 were the revenue growth rates, operating profit margins, and the discount rate. The test indicated that failure to increase the growth rate of new subscribers in the near term, or failure to reduce customer acquisition costs, or other internal or external factors could cause a material impairment of goodwill.Sales of hardware units did not meet our fourth quarter expectations and the reduction in customer acquisition costs was less than anticipated, and therefore our short and long term forecasts for lululemon Studio were revised downwards with an adverse impact on future expected cash flows. As a result, we reviewed our strategy and we plan to evolve lululemon Studio to focus on digital app-based services.We determined the lower than forecasted subscriber growth, and the shift in strategy, were triggering events which indicated we should conduct an impairment test as of January 29, 2023. We used a discounted cash flow model to estimate the fair value of the lululemon Studio reporting unit based on our updated strategic plans, supplemented by market comparable analysis. This led to the recognition of an impairment of goodwill of $362.5 million. The key assumptions in estimating the fair value of the lululemon Studio reporting unit were the revenue growth rates, operating profit margins, and the discount rate. The fair value of the lululemon Studio reporting unit is a Level 3 fair value measurement.Finite-lived intangible asset impairment assessmentAs of January 29, 2023, the performance of lululemon Studio in the fourth quarter of 2022 and our change in strategy were also triggering events which indicated we should test the related intangible assets for impairment. The undiscounted cash flows of the asset group to which the intangible assets belong were less than their carrying value, and therefore we calculated the fair value of the asset group, which was also less than its carrying value. This resulted in an impairment of $40.6 37Table of Contentsmillion, relating to the MIRROR brand, which is associated with in-home hardware and to the customer relationship intangible assets that were recognized as part of the acquisition. The carrying value of individual long-lived assets was not reduced to lower than their fair value. The fair values of the brand and the customer relationships were based on a relief from royalty method and a discounted cash flow model respectively, and are Level 3 fair value measurements.The relief from royalty method is dependent on certain key estimates, including forecast hardware and hardware subscriber revenues, the royalty rate, and the discount rate. Inventory provisionsInventory is valued at the lower of cost and net realizable value. We periodically review our inventories and make a provision for obsolescence and goods that have quality issues or that are damaged. We record a provision at an amount that is equal to the difference between the inventory cost and its net realizable value. As of January 29, 2023 the net carrying value of our inventories was $1.4 billion, which included provisions for obsolete and damaged inventory of $123.2 million. The provision is determined based upon assumptions about product quality, damages, future demand, selling prices, and market conditions, and includes a provision of $62.9 million against lululemon Studio hardware inventory. Our change in strategy related to lululemon Studio means we no longer expect to be able to sell all of the hardware inventory above cost. The net realizable value of the lululemon Studio inventory was determined based on hardware sales forecasts and assumptions regarding liquidation value. If we do not achieve our sales forecasts, have to sell the hardware at prices lower than our forecasts, or are unable to liquidate excess inventory and the prices we anticipate, this could reduce the net realizable value of this inventory below our estimate and we would increase our provision in the period in which we made such a determination. Deferred taxes on undistributed net investment of foreign subsidiaries. We have not recognized U.S. state income taxes and foreign withholding taxes on the net investment in our subsidiaries which we have determined to be indefinitely reinvested. This determination is based on the cash flow projections and operational and fiscal objectives of each of our foreign subsidiaries. Such estimates are inherently imprecise since many assumptions utilized in the projections are subject to revision in the future. For the portion of our net investment in our Canadian subsidiaries that is not indefinitely reinvested, we have recorded a deferred tax liability for the taxes which would be due upon repatriation. For distributions made by our Canadian subsidiaries, the amount of tax payable is partially dependent on how the repatriation transactions are made. The deferred tax liability has been recorded on the basis that we would choose to make the repatriation transactions in the most tax efficient manner. Specifically, to the extent that the Canadian subsidiaries have sufficient paid-up-capital, any such distributions would be made as a return of capital, rather than as a dividend, and therefore would not be subject to Canadian withholding tax.As of January 29, 2023, the net investment in our Canadian subsidiaries was $2.4 billion, of which $1.3 billion was determined to be indefinitely reinvested. The paid-up-capital balance of the Canadian subsidiaries was $740.6 million.We have recognized a deferred tax liability of $20.2 million as of January 29, 2023 which represents the Canadian withholding taxes payable on the portion of our Canadian earnings that are not indefinitely reinvested and cannot be repatriated as a return of capital, and U.S. state income taxes payable upon repatriation of the amounts which are not indefinitely reinvested.In future periods, if the net investment in our Canadian subsidiaries continues to grow, whether due to the accumulation of profits by these subsidiaries or due to a change in the amount that is indefinitely reinvested, we will record additional deferred tax liabilities, including both Canadian withholding taxes for the amount in excess of the paid-up capital balance and U.S. state income taxes, and our effective tax rate will increase. Absent any changes to the permanently reinvested amounts, or the paid-up-capital of our Canadian subsidiaries, we expect the effective tax rate to increase in 2023, where we will accrue Canadian withholding taxes and U.S. state income taxes for profits generated in our Canadian subsidiaries.ContingenciesWe are involved in legal proceedings regarding contractual and employment relationships and a variety of other matters. We record contingent liabilities when a loss is assessed to be probable and its amount is reasonably estimable. If it is reasonably possible that a material loss could occur through ongoing litigation, we provide disclosure in the footnotes to our financial statements. Assessing probability of loss and estimating the amount of probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third-party claimants and courts. Should we 38Table of Contentsexperience adverse court judgments or should negotiated outcomes differ to our expectations with respect to such ongoing litigation it could have a material adverse effect on our results of operations, financial position, and cash flows.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKForeign Currency Exchange Risk. The functional currency of our international subsidiaries is generally the applicable local currency. Our consolidated financial statements are presented in U.S. dollars. Therefore, the net revenue, expenses, assets, and liabilities of our international subsidiaries are translated from their functional currencies into U.S. dollars. Fluctuations in the value of the U.S. dollar affect the reported amounts of net revenue, expenses, assets, and liabilities. Foreign currency exchange differences which arise on translation of our international subsidiaries' balance sheets into U.S. dollars are recorded as other comprehensive income (loss), net of tax in accumulated other comprehensive income or loss within stockholders' equity.We also have exposure to changes in foreign currency exchange rates associated with transactions which are undertaken by our subsidiaries in currencies other than their functional currency. Such transactions include intercompany transactions and inventory purchases denominated in currencies other than the functional currency of the purchasing entity. As a result, we have been impacted by changes in foreign currency exchange rates and may be impacted for the foreseeable future. The potential impact of currency fluctuation increases as our international expansion increases.As of January 29, 2023, we had certain forward currency contracts outstanding in order to hedge a portion of the foreign currency exposure that arises on translation of a Canadian subsidiary into U.S. dollars. We also had certain forward currency contracts outstanding in an effort to reduce our exposure to the foreign currency exchange revaluation gains and losses that are recognized by our Canadian and Chinese subsidiaries on U.S. dollar denominated monetary assets and liabilities. Please refer to Note 16. Derivative Financial Instruments included in Item 8 of Part II of this report for further information, including details of the notional amounts outstanding.In the future, in an effort to reduce foreign currency exchange risks, we may enter into further derivative financial instruments including hedging additional currency pairs. We do not, and do not intend to, engage in the practice of trading derivative securities for profit.We currently generate a significant portion of our net revenue and incur a significant portion of our expenses in Canada. We also hold a significant portion of our net assets in Canada. The reporting currency for our consolidated financial statements is the U.S. dollar. A strengthening of the U.S. dollar against the Canadian dollar results in:•the following impacts to the consolidated statements of operations:–a decrease in our net revenue upon translation of the sales made by our Canadian operations into U.S. dollars for the purposes of consolidation;–a decrease in our selling, general and administrative expenses incurred by our Canadian operations upon translation into U.S. dollars for the purposes of consolidation;–foreign currency exchange revaluation gains by our Canadian subsidiaries on U.S. dollar denominated monetary assets and liabilities; and–derivative valuation losses on forward currency contracts not designated in a hedging relationship;•the following impacts to the consolidated balance sheets:–a decrease in the foreign currency translation adjustment which arises on the translation of our Canadian subsidiaries' balance sheets into U.S. dollars; and–net investment hedge losses from derivative valuation losses on forward currency contracts, entered into as net investment hedges of a Canadian subsidiary.During 2022, the change in the relative value of the U.S. dollar against the Canadian dollar resulted in a $54.5 million increase in accumulated other comprehensive loss within stockholders' equity. During 2021, the change in the relative value of the U.S. dollar against the Canadian dollar resulted in a $3.4 million increase in accumulated other comprehensive loss within stockholders' equity.A 10% appreciation in the relative value of the U.S. dollar against the Canadian dollar compared to the foreign currency exchange rates in effect for 2022 would have resulted in lower income from operations of approximately $30.9 million in 2022. This assumes a consistent 10% appreciation in the U.S. dollar against the Canadian dollar over the fiscal year. The timing 39Table of Contentsof changes in the relative value of the U.S. dollar combined with the seasonal nature of our business, can affect the magnitude of the impact that fluctuations in foreign currency exchange rates have on our income from operations.Interest Rate Risk. Our committed revolving credit facility provides us with available borrowings in an amount up to $400.0 million. Because our revolving credit facilities bear interest at a variable rate, we will be exposed to market risks relating to changes in interest rates, if we have a meaningful outstanding balance. As of January 29, 2023, aside from letters of credit of $6.5 million, there were no borrowings outstanding under these credit facilities. We currently do not engage in any interest rate hedging activity and currently have no intention to do so. However, in the future, if we have a meaningful outstanding balance under our revolving facility, in an effort to mitigate losses associated with these risks, we may at times enter into derivative financial instruments, although we have not historically done so. These may take the form of forward contracts, option contracts, or interest rate swaps. We do not, and do not intend to, engage in the practice of trading derivative securities for profit.Our cash and cash equivalent balances are held in the form of cash on hand, bank balances, and short-term deposits with original maturities of three months or less, and in money market funds. We do not believe these balances are subject to material interest rate risk.Credit Risk. We have cash on deposit with various large, reputable financial institutions and have invested in AAA-rated money market funds. The amount of cash and cash equivalents held with certain financial institutions exceeds government-insured limits. We are also exposed to credit-related losses in the event of nonperformance by the financial institutions that are counterparties to our forward currency contracts. The credit risk amount is our unrealized gains on our derivative instruments, based on foreign currency rates at the time of nonperformance. We have not experienced any losses related to these items, and we believe credit risk to be minimal. We seek to minimize our credit risk by entering into transactions with investment grade credit worthy and reputable financial institutions and by monitoring the credit standing of the financial institutions with whom we transact. We seek to limit the amount of exposure with any one counterparty.InflationInflationary factors such as increases in the cost of our product, as well as overhead costs and capital expenditures may adversely affect our operating results. During 2021 and the first half of 2022, our operating margin was impacted by higher air freight costs compared to fiscal 2021 and 2020 as a result of global supply chain disruption, as well as increased wage rates. Sustained increases in transportation costs, wages, and raw material costs, or other inflationary pressures in the future may have an adverse effect on our ability to maintain current levels of operating margin if the selling prices of our products do not increase with these increased costs, or we cannot identify cost efficiencies.40Table of Contents
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